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Citi Still Churned Out Flawed Mortgages Into 2010

Citigroup Building
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Citigroup Building

The assumption that big banks stopped selling defective mortgages to Fannie Mae and Freddie Mac after the housing bubble burst is wrong.

That's the clear message from a study by Freddie Mac of hundreds of mortgages sold to the government-owned mortgage giant in 2009 and 2010.

From 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.”

When Ash Bennington and I tried to calculate Citi's put-back exposure, we looked only at the mortgages from 2005-2007. Our assumption, which now seems wrong, was that Citi would have cleaned up its act following the bursting of the housing bubble.

Another frightening detail from Bloomberg:

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.

Got that? Thirty-two percent defective in late 2009.

Also, note that these are the performing loans. It seems fairly sensible to assume that if Freddie had examined non-perfoming loans, it would have found an even greater level of flawed documentation.

So the problem of flawed mortgages, and the risks that Citi could find itself having to repurchase huge numbers of the mortgages sold to Fannie and Freddie, is not a historical problem. It's a problem that flows right on up to the day before yesterday. And, probably, keeps on today. That could mean that the problem of put-back liability will be much bigger than many analysts and investors expect.

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