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Dick Bove Sees No Put-Back Apocalypse for Citi: Losses Could Be as Little as $5 Billion

How much is Citi likely to have to spend to buy back mortgages from investors?

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Citigroup Building

Well-known banking sector analyst Dick Bove thinks that Citi is at risk for $40 billion in put-back claims. Only $8 billion of those claims will ulimately be successful, in Bove's view. And, after recovering on the mortgages which it will have to repurchase, the total loss could be as low as $5 billion.

Bove begins his analysis of Citigroup's potential repurchase exposure with Citigroup's $504 billion portfolio of serviced but not held (SBNH) loans.

Bove nets out 22 percent of Citi's SBNH loan portfolio, to account for Citi's third party indemnifications. (Third party indemnifiers have agreed, according to Citigroup, to cover losses on the indemnified portion of the SBNH portfolio.) Once the indemnified portion of the portfolio is removed, we are left with the remaining 78 percent, or $393 billion. This number represents the total unhedged exposure of Citi's SBNH loan portfolio.

Bove next makes an estimate of what he thinks the potential default rate is likely to be on Citi's SBNH portfolio in the future.

Citigroup is reporting a current default rate on their SBNH portfolio of 8.1 percent. "That's consistent with FDIC data," Bove says, in reference to the nationally reported default rate of 7.47 percent.

In order to create what he believes to be a conservative estimate for the model, Bove uses a projected default rate of 20 percent for the SNBH portfolio. "That's two and a half times what the actual default rate on the portfolio is right now," he says. Bove believes that this increase in the model should account for the possibility of a substantial uptick in default rates.

Based on the 20 percent default rate, Citi would be looking at a pool of loans worth about $79 billion for potential claims to be submitted against.

Of course, the mortgage must actually be defective to be considered for repurchase. "If the mortgage is in default, but the paperwork is pristine, they can't be put back," says Bove.

In the next step of his model, Bove reduces the total dollar amount of the potential exposure to account for only those mortgages that have associated representations and warranties. Bove's analysis assumes that only one if four mortgages in Citi's service book have representations and warranties associated with their sale to investors.

(In his sworn testimony before the Financial Crisis Inquiry Commission, Richard Bowen indicates that all of the mortgages within one sizable channel of of Citi's loan acquisitions had representations and warranties associated with them. Unfortunately, Citi has not released the breakdown of the SBNH vintages by acquisition channel, so a more definitive analysis isn't possible at this time; therefore, Mr. Bove's 25 percent estimate for Citgroup's percentages of loans with representation and warranties may be more accurate overall. We really cannot tell without more information. Note: I have requested more detailed information about Citigroup's loan acquisition channels and the vintages related to the SBNH loan portfolio. That information has not yet been provided by Citigroup.)

Using Bove's 25 percent estimate to account for only those mortgages with associated representations and warranties would reduce Citigroup's total dollar amount at risk for put-backs down to about $20 billion.

After all the calculations to arrive at the dollar value at risk for attempted put-backs, Bove ultimately assumes that only 40 percent of the remaining $20 billion in exposure can be put-back successfully to

Citigroup, based on the terms of the representations and warranties of the loans involved.

That would bring us to a total of $8 billion: This number is the final estimate of money Citi might ultimately be required to pay out to investors.

Bove then accounts for a recovery value on the loans. The current average recovery on mortgage loans is 35 percent — using that figure would mean a 65 percent haircut for Citigroup.

Based on that calculation, Bove estimates Citi's total losses from their servicing book to be about $5 billion.

(Of course, the recovery process takes time, while the potential cash impact to Citi of paying investors would be immediate at the time of payment.)

However, there is an additional time factor to consider when evaluating any potential cash outlay from Citi. "It takes time to review all those loans," says Bove. "Once you've done that, all you've done is select out the mortgages you want to put-back. You haven't yet approached Citigroup. When you approach Citigroup, you now have to deal with the fact that they may object to every one of those loans" being put back to them.

After the loans have been submitted back to Citi, the legal process begins. Bove points out that courts have held that loans must be reviewed individually. And how long is that process going to take?

It's difficult to say, because the scenario of a legal review of that volume of loans has yet to unfold. This much seems likely: If the loans must be reviewed individually, there are going to be fairly significant time delays before the bank is forced to buyback the loans. To quote Bove: "It's going to be multiyear process." That means the costs of the putbacks to Citigroup would be booked against multiple calendar years.

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