The Leading Indicator of Repurchase Risk Losses? Audited By KPMG
“It’s Like Déjà Vu All Over Again!”
January 30, 2010, Wall Street Journal:
Fannie, Freddie Chase Bad Mortgages
Lenders Like BofA, J.P. Morgan Repurchase Billions in Faulty Loans; Just a Drop in the Default Pool
Stuck with about $300 billion in loans to borrowers at least 90 days behind on payments, Fannie and Freddie have unleashed armies of auditors and other employees to sift through mortgage files for proof of underwriting flaws. The two mortgage-finance companies are flexing their muscles to force banks to repurchase loans found to contain improper documentation about a borrower’s income or outright lies.
April 14, 2010, FT Alphaville:
“…these repurchases are something to watch out for as JP Morgan reports Q1 earnings on Wednesday. The bank said in its last (2009) 10-k filing that:
In 2009, the costs of repurchasing mortgage loans that had been sold to government agencies such as Freddie Mac and Fannie Mae increased substantially for JPM, and could continue to increase substantially further. Accordingly, Equity Research 15 repurchase and/or indemnity obligations to government-sponsored enterprises or to private third-party purchasers could materially and adversely affect its results of operations and earnings in the future. It anticipates that its 2010 revenue could be negatively affected by elevated levels of repurchases of mortgages previously sold to GSEs.”
If you are a regular reader of this site, you may remember the first time I warned you about the poor disclosure practices surrounding repurchase risk. It was all the way back in March of 2007 and I was referring to the lack of disclosures surrounding New Century Financial.
In a filing with the Securities and Exchange Commission on Monday, New Century said lenders including Bank of America, Barclays, Citigroup, Credit Suisse, Goldman Sachs and Morgan Stanley had issued letters saying the company was in default. New Century also said its bankers had demanded that it accelerate its obligation to buy back outstanding mortgage loans financed under the lending arrangements. New Century said if its bankers demanded accelerated repurchase of all outstanding mortgages, it would cost the company $8.4bn, which it does not have…
I looked quickly at the 2005 Annual Report for New Century to find out who their auditors are and to see how “rapid” this decline really was. Interestingly, besides noticing that KPMG now has another worry at its doorstep, I didn’t see too much in the way of discussion in the “Risks” section of the risk that is now causing this worldwide financial crisis. There are 17 pages of discussion of general and REIT specific risk associated with this company, but no mention of the specific risk of the potential for their banks to accelerate the repurchase of mortgage loans financed under their significant number of lending arrangements. Although there is a detailed discussion of these lending arrangements later in the report, it does not seem that reserves or capital/liquidity requirements were sufficient to cover the possibility that one of or more lenders could for some reason decide to call the loans…Didn’t someone think that this would be a very big number (US 8.4 billion) if that happened?
New Century failed. There was a very detailed, well-done bankruptcy examiner’s report on that one, too. Mr. Missal pointed the finger at KPMG for not heeding the advice of their own experts, a la Andersen/Enron. Instead of the KPMG partner telling the client that their models for estimating potential losses were flawed, the partner told the staff to shut up and move on.
KPMG is now being sued for $1 billion for its sins at New Century.
The lawsuits filed Wednesday said that specialists at KPMG tried to point out errors in New Century’s financial statements but were silenced by the KPMG partner in charge of the audits “to protect KPMG’s business relationship with, and fees from, New Century.”
The claims are among the first to attempt to blame auditors for the subprime-mortgage crisis, which spread beyond lenders such as New Century and engulfed the global financial system.
If the New Century trustee is successful, ”it may embolden others to look more closely at the possibility of bringing [accounting] firms to some level of culpability for the things that happened,” that led to the credit crisis, Francine McKenna, president of McKenna Partners LLC, a corporate-governance consultancy, said in an interview.
I warned you again seven months ago that another KPMG client, Wachovia/Wells Fargo, has the same poor disclosure of repurchase risk.
Did Wells Fargo’s Auditors Miss Repurchase Risk?
How does the New Century situation and KPMG’s role in it remind me of Wells Fargo now? Well, in both cases, there’s no disclosure of the quantity and quality of the repurchase risk to the organization…The lack of disclosure of this issue here mirrors the lack of disclosure in New Century and perhaps in other KPMG clients such at Citigroup, Countrywide (now inside Bank of America) and others.
How do I know there could be a pattern? Because the inspections of KPMG by the PCAOB, their regulator, tell us they have been cited for auditing deficiencies just like this. Do we have to wait for another post-failure lawsuit to bring some sense, and some sunshine, to the system?
The latest announcements of potentially material losses due to forced repurchases of mortgages from Fannie Mae (Deloitte) and Freddie Mac (PwC) were made JP Morgan and Bank of America – both audited by PwC.
The biggest losers are likely to be Bank of America Corp., J.P. Morgan Chase & Co. and other mortgage lenders when the housing bubble burst…
Bank of America repurchased nearly $4.5 billion of loans during the first nine months of 2009, according to data compiled by Barclays. That was triple the $1.5 billion repurchased in all of 2008. Some of the bad mortgages were made by Countrywide Financial Corp., which was acquired by the Charlotte, N.C., bank in 2008. A bank spokeswoman declined to comment.
At J.P. Morgan, total buyback demands surged to $5.3 billion in 2009 from $4 billion in 2008, according to Barclays. The New York company, which bought the failed banking operations of Washington Mutual Inc.(Deloitte) in 2008, reported higher reserves for loan repurchases in the fourth quarter… J.P. Morgan and Bank of America don’t disclose how many loans they repurchased from Fannie and Freddie.
Countrywide, now owned by Bank of America, was a KPMG client.
Maybe y’all should kick the tires a little more on Citibank’s big comeback. Citi is the only big money center bank left that is audited by KPMG. Recent testimony before the Financial Crisis Inquiry Commission says their underwriting standards fell apart between 2005-2007.
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Good post, Francine. Once KPMG (and PWC cited above) attached the firms’ names to the financial statements, they became liable for damages caused by those misleading financials. I would have thought, with billions at stake, the audit firms would have been more careful. Unfortunately, they relied upon a history that passed by misbehaving audit firms. They’re going to catch it now. My primary fear is that the audit firms aren’t going to catch as much as they deserve.
Francine, you provide a valuable service with this blog. There is no one today who can do what you can. Keep up the good work.
Thank you for this.i remember talking to someone at Wachovia in early 2006 about this,and realized at that time that the real reason that lenders used mortgage brokers was to have the appearance of laying off the risk of repurchases.,,the chain of repurchase agreements ended with the small and midsize brokers who,for the most part went out of business leaving a corporate shell to hold the liabilities.There was and is individual responsibility for Mortgage Fraud but the prosecutions have been some what lacking
Regarding Comment #2- If his staff told the audit partner that New Century needed to reserve for repurcharse risk and the audit partner ignored that warning, the U.S. attorney should consider prosecuting that audit partner and anyone else who signed off on the audit.
Hi Francine,another great article…E&Y US named in the case against the Lehman Brothers Bank…The Auditors/Audit Partner/Report Sign Off Person is equally responsible as Lehman Brothers Execs…Same goes for PWC US Engagement Partners leading the engagement for Goldman Sachs,along with Goldman Sachs Execs…Stop wasting time on US Senate Inquiries…I saw the video of Head of Mortgage at Goldman Sachs US & he was clearly lying that he didn’t know what was going on…He was man running the show & having salary & perks no other employee dare to dream at Goldman Sachs US Branches…The Global Stock markets are in RED,taking each other leads…I predicted it’s going to “BE DOUBLE DIP RECESSION”,because the mess is coming out now…