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Citi SBNH Questions: Just How Bad Is Citi's Repurchase Exposure?

Forced repurchase of mortgage securities and mortgage loans is not just a theoretical litigation risk.

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Citigroup Center

I quote: "In the event of a breach of the representations and warranties, the Company may be required to either repurchase the mortgage loans (generally at unpaid principal balance plus accrued interest) with the identified defects or indemnify (“make-whole”) the investor or insurer."

The quotation cited above does not come from the talking points of a securities class action plaintiff's attorney: It comes from Citi's 2009 10K.

I first wrote about Citi's SBNH (Serviced But Not Held) loan portfolio ten days ago. I coined the acronym SBNH on October 19, 2010 — because I believed then that this block of Citi exposure would become a prominent enough entity on the financial journalism landscape to require a convenient shorthand. (Only time will tell if this proves prescient.)

What led me to this conclusion about the SBNH portfolio?

A day earlier, on October 18, 2010, Citi held their Third Quarter 2010 Earnings Review conference call. I copied down the following quotation from John Gerspach, Citi's Chief Financial Officer, quoted, in part, below:

"Loans serviced, but not held, which best represents our outstanding loan originations held by third parties. Our total portfolio was $504 Billion, at the end of the third quarter...only a third of the portfolio represents unindemnified loans originated in 2006-2008, which have generated the bulk of our claims and repurchase activity."

I was struck by two things: 1) The impression that Citi appeared to be bracketing out this particular portfolio of loans as being at risk—to some greater or lesser degree—for "claims and repurchase activity"; and 2) by the sheer dollar magnitude of the total potential exposure. (By way of comparison, Citi's market cap now sits at about $121 billion)

With this framework in mind, I submitted "Seven Questions about Citi's 'Serviced But Not Held' (SBNH) loan portfolio" to Citi late yesterday afternoon.

Citi declined comment overall.

(But a Citi representative did provide a link to a publicly released document, as well as a reference to data contained in another publicly released document, which addressed at least one of my questions. I cite this source inline below.)

Here are the Seven Questions I sent to Citi:

Seven Questions about Citi's 'Serviced But Not Held' (SBNH) loan portfolio:

1) What percentage of your SBNH loan portfolio, by dollar volume and by number count, were originated by Citi, and what percentage of the loans were purchased, either wholesale or retail, and then securitized by Citi?

2) What are the default rates, and thirty day plus delinquency rates, by loan vintage, on your SBNH loan portfolio on both an absolute dollar and number count basis?

3) What percentage of the securities in your SBNH loan portfolio (where securitized), by loan vintage, are registered under the 1933 Act?

4) What percentage of SBNH loans, by loan vintage, currently have missing or incomplete loan documentation? (If unknown, what is the current status of the documentation review for loans within the SBNH portfolio?)

5) What are the changes to repurchase reserves, by quarter, since the publication of your 2009 10-K?

[I was able to answer this question based on a reference given to me by Citi in their response to my email. The source material is a publicly released documents.]

Answer:

1Q'10 — $450 Million

2Q'10 — $727 Million

3Q'10 — $952 Million

6) What are the current counts, by loan vintage, of your "requests for loan documentation" from the holders of the securities contained in your SBNH portfolio?

7) Where and how do the numbers contained on pages 21 and 22 of your third quarter PowerPoint deck tie back to the 3Q2010 financial supplement?

Just a bit of explanation on question #7: I have not yet been able to tie back the numbers from Citi's PowerPoint presentation, where Citi provides data on their SBNH loan portfolio, with Citi's 3Q2010 financial supplement. (I imagine this is because these exposures are not on Citi's balance sheet.) I was curious to see if Citi could provide some information on the potential linkage between the documents.

It's also worth remarking that Gerspach has specified that Citi is basing its projection on the unindemnified portion of the SBNH portfolio. That would exclude 22 percent of Citi’s SBNH loan portfolio—an exposure totaling $110 billion—from being included in Citi’s repurchase risk calculation.

But without more information about who is providing that indemnification, it’s very difficult to draw a reasonable assessment of how much assurance to take from it. Is the source of the indemnity still extant—or have they gone bankrupt? Are they well capitalized enough to pay out that kind of money? And, perhaps most likely of all, will the indemnifier contest the claim?

It’s hard for us to know, because we don’t have access to the terms of the indemnification—but it’s entirely possible that if investors argue that Citi made misrepresentative claims about their securities, then the third party indemnifier will balk at paying.

Think about it: If Citi did, in fact, mislead investors on at leave some of their loans, isn’t it possible that the indemnifiers would then claim that it was not their problem but Citi’s? You can almost hear the argument taking shape: “It’s not our fault you made representations and warranties to your investors that turned out not to be true? Why should we pay?” ____________________________________________

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