Is Citigroup Being Misled by Its Auditors on Put-Back Risk?

Citigroup is very confident that it has properly reserved for the potential impact of mortgage repurchase requests. But if Citi’s confidence is based on the work of KPMG, it may be misplaced.

Mark Lennihan

As NetNet has reported, Citi has an enormous portfolio of mortgages it services but does not hold—which it says is a good proxy of mortgages it sold to outside investors in mortgage-backed securities. All told, Citi has over a half-trillion dollars of these mortgages that could potentially create put-back exposure.

To date, Citi says it has only set-aside slightly less than $1 billionof reserves against repurchase risk. The bank has told us that they feel comfortable with this level of reserves because historically realized repurchase risk has been quite small. In short, they haven’t had to pay out much on these claims in the past, so they figure they won’t pay out much in the future.

As my colleague Ash Bennington and I have explained at length, we think that the historical size of claims and payouts may not be a good guide to future claims and payouts. A quick summary of our reasoning:

  • Investors holding mortgage-backed securities at far less than face value that are generating far less revenue than expected are more likely than investors holding paper valued at par to request put-backs;
  • The flaws in Citi’s mortgage pipeline became far more serious in 2006 and 2007 than they were in the past, according to sworn testimony by a former Citi executive;
  • Fannie Mae and Freddie Mac may come under political pressure to be more aggressive in pursuit of put-back opportunities;
  • Investors in mortgage-backed securities can point to the testimony of the former Citi executive in building their case, an advantage past investors didn’t have;
  • And, finally, investors are newly aware of their rights to repurchases and seem to be displaying a new appetite to make repurchase demands.

To put it differently, it’s as if we’ve made all sorts of new discoveries about the territory but Citi insists on pointing at an old map.

Where does the confidence in the map come from? It could be that Citi is taking assurance from the work of its auditors, KPMG. But this assurance could be misleading. As Francine McKenna of the blog Re:TheAuditors points out, KPMG has a long history of approving poor disclosures when it comes to repurchase risk.

McKenna first reported on poor disclosures at a KPMG audited company in 2007. That company was New Century. It hadn’t disclosed anything about repurchase risk in earlier filings with the Securities and Exchange Commission. But, suddenly, it was revealing that banks were demanding that it buy back mortgages it had sold. If all the mortgages were put back to the company, New Century said it would be on the hook for $8.4 billion.

Later, in an article for Business Insider, McKenna reported that Wells Fargo was not reporting the quantity and quality of its repurchase risk. At the time, Well Fargo was also a client of KPMG.

“Citi is the only big money center bank left that is audited by KPMG,” McKenna wrote. She notes that Countrywide, which is now a part of Bank of America, was audited by KPMG. Bank of America is widely assumed to have the largest repurchase risk, largely thanks to the acquisition of Countrywide.

So is the advice of KPMG part of the reason for Citi’s complacency when it comes to repurchase risk? Given the history of companies audited by KPMG missing repurchase risk, perhaps Citi should rethink that complacency.


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