Bank Lawyer's Blog

Singing The Perp Walk Blues

While The New York Times droned on about the failure of federal prosecutors to make the Wall Street Fat Cats pay for their nefarious misdeeds (missing the obvious reason that they've sold their souls to The Great Horned One and will prosper in this life while burning for eternity in the next), Jones Day was cranking out an analysis of all the criminal prosecutions that have so far been pursued against former officers and directors of failed commercial banks and thrifts, and a few failed banks where criminal prosecutions may be forthcoming.

As Jones Day observes, only a handful of prosecutions have occurred thus far against failed bank executives, while there have been many more prosecutions of mortgage brokers and borrowers ("low hanging fruit" Jones Day calls them). Yet, that should be cold comfort to the executives of failed financial institutions. As is the case with civil actions, these cases usually involve a complex set of facts and take some time to build. We're likely just starting to see the commencement of the prosectutions. In addition, "prosecutors appear convinced that there were plenty of bad actors." Finally, prosecutors have a wide range of criminal statutes to use to pursue defendants and they haven't been shy of using them in the past to nail those they consider to be the bad guys.

Of the cases that are discussed by Jones Day, many of them involve classic cases of corruption that we saw in the 1980s, including using borrowers or other customers to funnel loan proceeds to bank executives, insider trading,creating fictitious borrowers and/or mortgage loans and/or bank accounts, filing deliberately falsified financial reports, outright lying to the regulators, embezzlement, and similar incidents of self-dealing criminality.

One of the practices that may receive some future "play" in connection with other failed banks is the use of various tactics to "mask the true financial condition of the bank." These can include bogus loan restructurings or refinancings, questionable "new" appraised valuations of real estate collateral, and other financial sleight of hand whose goal is to keep the pony trotting down the track until the economy improves. The regulators frown on such activities and, some former bank officials are discovering, so do criminal prosecutors. While I think that there is still legitimate room to argue about the valuation of collateral, the appropriate level of reserves, and the proper treatment of restructured loans, I think that "pretend and extend" in its most egregious forms will subject former officers, and perhaps directors, to criminal liability, in addition to civil; liability. This will certainly be true in those cases where the actions are not supported by the advice of independent, reputable, outside advisors.

It's too early to tell with any degree of certainty where this is headed, but it appears that for the executives and directors of failed banks, it's going to be a bumpy ride.

Troubled Bank Templates

A recent complaint filed by the FDIC against former officers and directors of a failed bank followed what's become a fairly standard template. Although the Jacksonville (IL) Journal Courier calls the lawsuit a "fairly untypical maneuver," those of us who represent troubled banks and thrifts find the "maneuver" anything but "untypical."

In the case of Corn Belt Bank, which failed in 2009, the FDIC found five loans that caused losses to the bank ("Loss Loans"), alleged that the former directors and officers were negligent or grossly negligent in making the loans because they were improperly underwritten, and that the officers and directors breached their fiduciary duties to the bank. The former officers and directors failed to adequately inform themselves of the relevant risks and acted recklessly in approving them. In addition, the FDIC alleges undue loan concentration, out-of-area lending, high loan-to-value ratios, and overall weak loan administration. Finally, the FDIC alleges that regulatory examiners "repeatedly warned" the bank of these risks and the bank chose to ignore these warnings.

In another complaint filed by the FDIC against former officers and directors of Heritage Community Bank, which also failed in 2009 (and which we discussed a few months ago), the FDIC also alleged negligence, gross negligence and breach of fiduciary duty. In the Heritage Bank complaint, the bank, as is the case with many community banks that have failed and are expected to fail, grew rapidly by concentrating on commercial real estate loans, which went south when the economy crashed in 2008. According to the FDIC, the underwriting and loan administration and monitoring policies and procedures of the bank were deficient, which resulted in "Loss Loans" being made by the bank. The FDIC also alleges that instead of dealing conservatively with losses when they should have become evident by accurately classifying loans, increasing reserves, and preserving capital, the officers and directors "masked" the losses, continued to make deficient CRE loans, and, as a result, compounded the ultimate losses from those poorly underwritten loans. Again, the FDIC alleges that examiners warned the bank of these risks and that the warnings were ignored. In addition to losses on CRE loans, the FDIC is claiming losses on unjustified dividends and incentive payments made by the bank and claims specifically that the bank's former CFO was grossly negligent in failing to ensure that adequate reserves and capital were maintained, in advising that dividends and incentive compensation payments were proper, and in inaccurately advising the board of directors that interest on non-accrual loans "has only been deferred." Finally, the FDIC makes much of the bank's "undue concentration" on commercial real estate lending (responses to which we featured in our previous post linked above and in an earlier post from 2010).

None of these allegations is "untypical," based on what we've seen thus far. In fact, these types of allegations are standard stuff. As I've discussed in the past, many community banks focused on commercial real estate and today are bearing the bitter fruit of that concentration. The Monday morning quarterbacking will continue. The fun has only begun.

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For those community bankers (and their advisers) who might be interested, Venable LLP partner Joseph Lynyak will deliver a one-hour webinar on April 14, 2011 for Bankerstuff on "Troubled Banks and Thrifts - A Guide Through The Maze." Joe represents troubled community banks and their officers and directors who are facing regulatory scrutiny and potential claims by the FDIC. He'll tell bankers who are in such straights what they're facing and what actions they should take to prepare.

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UPDATE: 04/11/11: A reader e-mailed me to point out my heinous error in indicating that the state in which the Jacksonville Journal Courier is located is Missouri rather than Illinois. I've corrected that error and sincerely hope that its inclusion in the original version of this post didn't ruin any one else's enjoyment of this post, cause an epileptic fit, or otherwise prompt the management of the Journal Courier to start drafting a complaint for defamation. My brother-in-law, a died-in-the-wool University of Kansas fan, once wore a tee-shirt to the Kansas-Missouri football game that read "Missouri: Literacy Ain't Everything." Therefore, I understand that a mistaken reference like the one I made above can start a shooting war.

FDIC Loss-Sharing Experience: Were The Regulators Too Aggressive With Writedowns?

There's another angle to yesterday's post about CRE loss amortization that was not discussed, but that is worth discussing. The Wall Street Journal article that was linked in that post explored, in part, the fact that CRE loan losses that are covered by FDIC loss-sharing agreements have turned out not to be as bad as originally expected by either the acquirers or the FDIC. That leads to the question of the accuracy of the original writedowns to real estate values and increases to general and specific loss reserves, that were required by bank examiners, writedowns and reserve increases that in many cases led to the failure of many of the banks involved. Were bank examiners too aggressive in some of their writedowns and loss assumptions? Certainly, officers and directors of many of the failed banks will argue that they were. Of what value will be the loss and recovery experience on FDIC loss-sharing agreements?

I'll leave it to the folks who like to get down into the thicket of loss reserves, fair market values, and accounting principles to wrestle with these issues. You can rest assured that many interested representatives of now-defunct banks that failed during the last several years and will fail in the next several, are going to be parsing the nuances.

As a general policy issue, however, it's worth noting that establishing reserves and setting fair market values involves both "art" and "science." Obviously, the FDIC and other bank regulators opt for a conservative approach, out of a concern to protect the insurance fund from losses and themselves from criticism for having been too soft. On the other hand, since such matters are those that involve some predictions about future events and those upon which reasonable people can disagree, is it good public policy to take the most pessimistic approach, an approach that results in more community bank failures, than it is to opt for a more moderate approach that preserves more community banks? I'm biased in favor of the the moderate approach, of course, which should cause no hearts to freeze in shock. People I respect disagree with me.

It's also interesting to me that neither the "experts" at the FDIC nor some of the finest commercial banking, investment banking, and private equity "players" in this country accurately predicted the recovery on commercial real estate loans over the past three years. What does that say about the reasonableness of expecting boards of directors and senior management of community banks to have foreseen the popping of the subprime mortgage bubble, the crash of 2008, and the depth of the resulting fall of commercial real estate loans? I realize that hindsight makes the past crystal clear, but not everyone is as brilliant as Sheila Bair, apparently not John Kanas or Wilbur Ross, and certainly not the average community bank board member. In this scenario, what was the "reasonably prudent man" (or "woman") supposed to have foreseen and, therefore, planned for? Again, reasonable people can--and do--disagree.

One arena in which the "too hot/too cold" and "prudent/prescient" conundra will likely receive more attention is in a courtroom, when the FDIC pursues former officers and directors of failed banks. While only a half-dozen such suits have been filed to date, many more are on the way. Don't expect this issue to simply blow away in the wind. It will linger, and former officers and directors of failed banks will be paying close attention.

CRE Loss Amortization: One More Time, With Feeling

For Alfred Lord Tennyson, "In the Spring a young man's fancy lightly turns to thoughts of love." Obviously, Lord Tennyson never roamed within The Beltway or he would have known that in that rarefied atmosphere, April causes a young man's fancy to turn to accounting amortization forbearance.

On April 4th, US representative Ed Pulmutter of Colorado, along with three co-sponsors (also Colorado congressmen) introduced the HR 1356, the latest version of legislation that would allow any FDIC-insured depository institution with assets of less than $10 billion to amortize losses on commercial real estate loans and real estate owned over an extended period of time (this time seven years) on a straight-line basis, for capital reporting purposes. In other words, community banks hit hard by commercial real estate loan losses would get an extended period of time to absorb the hit to capital, rather than having to absorb the hit at once.

We went through this drill last year, when Rep. Prelmutter, a Democrat, along with Rep, Mike Coffman, a Republican (and one of the co-sponsors of HR 1356) added similar legislation to the House version of the small business lending bill that passed Congress last year (and which has had an underwhelming response from the banks it was intended to benefit). The CRE loss amortization provision was stripped from the Senate version of last year's bill and never reinserted.

As reported in today's Housing Wire, the majority of losses at banks that have failed (the overwhelming number of which have been community banks) are caused by commercial real estate loans. Therefore, it's logical to assume that the amortization relief would save a number of community banks from failure.

Last year, the federal banking regulators worked behind the scenes to torpedo such relief. They claimed that it would allow "zombie banks" to stalk the Earth, devouring the flesh of humans and spreading the plague to towns from Portland to Provincetown. Expect the same arguments this time around.

My sources inform me that one of the factors that may have persuaded Rep. Perlmutter to give this effort one more try was a recent Wall Street Journal article (paid subscription required) that discussed the "surprising fact" that the losses sustained by the FDIC on its loss-sharing agreements with the acquirers of failed banks and thrifts have been much lower than originally expected. Why? Glad you asked. Let's see what the Wall Street Journal discovered.

Some executives at U.S. banks that bought failed institutions using the FDIC lifeline agreed that losses on the troubled loans aren't piling up as high or as fast as they previously anticipated.

"The process is working," said James Wigand, who oversaw FDIC sales of failed banks during the crisis and leads a new division of the agency responsible for the largest U.S. banks. Enticing new owners to work out troubled assets slowly "minimized the effects of a bank's failure on local communities," he added.

[...]

"We are getting better performance than we thought due to a combination of ways that these loans are getting settled," said John Kanas, BankUnited's chairman, president and chief executive. As a result, the company expects to seek total payments of roughly $4 billion from the FDIC, a decline of about $1 billion.

"When we did our very first [failed-bank] deal, we thought it was nuclear winter," said Dennis Zember, chief financial officer at Ameris Bancorp, the Moultrie, Ga., buyer of six banks seized by regulators. "We didn't think we'd collect anything" from some borrowers.

Ameris executives now expect to finish cleaning up 70% of the loan portfolios at the failed banks by year end. As of Jan. 31, the FDIC had paid Ameris a total of $26 million for losses at three failed banks.

BB&T Corp., of Winston-Salem, N.C., has received $1.09 billion in reimbursements for soured loans it got in the 2009 takeover of Colonial BancGroup Inc.'s failed banking operations. Colonial, of Montgomery, Ala., is the fifth-largest bank failure in U.S. history.

"We are very pleased that our efforts have resulted in the portfolio performing better than our original estimates," said a BB&T spokeswoman. Many of Colonial's loans were concentrated in Florida construction and land development.

By encouraging the banks to work out loans over time, instead of foreclosing immediately, the borrowers were allowed breathing space to recover. As the economy slowly recovers--lo and behold!--borrowers are starting to repay their loans. As one exasperated trade association senior executive complained to me, if the regulators had given more community banks time to hold and work out these loans, more community banks could have survived. The CEOs of more than one failed bank told me that the loss-amortization provision alone would have saved their banks. Instead, who has benefited from the recovery of such loans? That's correct: big bank acquirers like Bank United, OneWest, US Bancorp, and BB&T. It's enough to make a grown man either cry, reach for a bottle of Jim Beam, or load a banana clip into an AR-15 and go hunting bipeds who carry briefcases.

According to other sources, the amortization bill is unlikely to make it through Congress on a stand-alone basis. It will need to attach itself, leech-like, to another financial institutions bill. In a year when many members of our dysfunctional national legislature are too busy pulling out rulers and comparing cup sizes to bother to keep the federal government funded, and with the federal bank regulators, especially the FDIC, certain to oppose this latest effort to throw "moral hazard" anchors into our nation's financial services safety net, initial hope for enactment is not overly optimistic. Nevertheless, you never know unless you try. Bankers who are interested can always contact their congress-persons and senators to urge them to get with the program. After all, 2012 is just a year away.

Auditor Anxiety Spreads

Here's a tidbit I'd like to pass along in between shifts helping Darth Vader build the Death Star:

Francine McKenna wrote a column for Forbes yesterday that discussed a story published on Tuesday in The Legal Intelligencer and written by attorneys Dianne S. Wainwright and Jonathan S. Ziss, that's entitled "FDIC Professional Liability Group Set To Pursue Audit Firms." The story, and Francine's column, since she interviewed the authors for additional insights, contain a good discussion of potential liability claims by the FDIC against auditors and potential defenses to those claims. Toward the end of the Intelligencer story are these interesting facts about the carnage that might be in the offing for more than just auditors.

As of Dec. 14, 2010, the FDIC has authorized suits against 109 individuals for D&O liability with damage claims of approximately $2.5 billion. This includes two filed D&O lawsuits naming 15 individuals. The FDIC also has authorized four fidelity bond and attorney malpractice lawsuits. The FDIC has not, as of mid-December, authorized suit against any audit firms based on violations of the standard of care. But that is neither to suggest nor to predict that such cases are not coming.

According to sources in the professional liability insurance and professional liability defense communities, in a good number of bank failures the FDIC has established a fulsome dialogue with the former auditors. This is typically centered around the auditors' work papers, whether produced informally or in response to a subpoena. There is, therefore, reason to conclude that this particular litigation pot is first coming to a boil. Look for claims in districts most rife with failed banks, such as Florida (42 failed banks since 2008) and Georgia (51), as opposed to, say, Pennsylvania (three).

As receiver, the FDIC has three years for tort claims and six years for breach-of-contract claims to file suit from the time a bank is closed. If state law permits a longer time, the state statute of limitations is followed. Given this limitations period, this story is long from over.

As Ziss told Francine, the FDIC will likely sue first in cases where the facts are most favorable for reaching a judgment (or settlement) that is beneficial to the FDIC and where the losses allegedly caused by the auditors' acts or missions are substantial. In other words, it's always best to first pick the low-hanging fruit to send a message to people who might have more formidable defenses that the FDIC means business, so you might as well pony up and avoid as much pain as possible. That's a smart strategy.

Francine closes her column with a quote from some know-nothing shyster from the sticks that, surprisingly, makes sense to me, even two days later.

Kevin Funnell a lawyer with the Dallas office of Bieging Shapiro & Burrus LLP and the author the Bank Lawyer’s Blog also thinks auditor anxiety is warranted.

"The fact that the FDIC is gearing up to go after auditors should be a red flag to 

all professionals, including attorneys and appraisers, who represented or worked for banks that fail."

According to Ziss and Wainright, attorneys should already be afraid, since the FDIC has authorized some malpractice lawsuits against failed banks' legal counsel and has not yet authorized suits against auditors. Therefore, it's not just "auditor anxiety" that I think is justified, it's "bank professional service provider anxiety." This is only the opening quarter of a ball game that could become very nasty and paranoia may be warranted. In fact, as William Burroughs once observed, "Sometimes paranoia's just having all the facts."

The Biggest Loser

When Ally Bank and Bank of America settled with Fannie Mae and Freddie Mac several weeks ago on repurchase request claims made by the GSEs, there was speculation in the trade press that these settlements might pave the way for other big banks subject to similar repurchase requests from Uncle Freddie and Auntie Fannie to pay up. There was also talk (including by this blog's bloviator) that the settlement terms looked a wee bit generous to the banks.

Well, Bank of America and Ally may have decided to "fold 'em," but Wells Fargo has decided to tell the GSEs that they can continue to "hold 'em." What's more, the creator of Stagecoach Island told the press that it doesn't think those settlements by its competitors were as generous as some of us might have thought.

Wells Fargo said Wednesday that it won’t follow Bank of America in reaching settlements with Fannie Mae or Freddie Mac on disputed mortgages sold to the mortgage financing giants.

Wells Chief Financial Officer Howard Atkins said the settlements reached by its competitors may not be as generous as some perceived them to be.

You can see the logic in Wells Fargo's "hang tough" attitude when you realize that the GSEs' demands for loan repurchases fell for the second consecutive quarter, and that all repurchase claims against Wells Fargo, including those from private investors and private mortgage insurers, are now down from an original face value of $3 billion to half that amount. Heck, if stiff-arming worked so well all the time for everyone, nobody would repurchase a dollar's worth of loans from the GSEs. If I were standing in Wells Fargo's shoes, I, too, might not think that the generous terms offered BofA were generous enough.

I guess the next step is up to the GSEs. Do they want to press forward aggressively with lawsuits against Wells Fargo, on the basis that if it continues to thumb its nose at its beloved Uncle and Aunt, no member of the family will ever again give them an ounce of respect when they make a repurchase demand? Or, perhaps, do they want to "rethink" their outstanding repurchase requests and make Wells an even better offer than they made Ally or BofA, an offer even a hard case like Wells wouldn't refuse? 20% of remaining  face? 10%? Throw in a snuggy with a picture of Franklin Raines on it?

After all, when your only business is buying and securitizing loans, you don't want to terminally alienate the nation's top mortgage loan originator any more than you can afford to terminally alienate any of the other top six originators (including Bank of America and Ally) who, combined, originate over two-thirds of the mortgage loans in this country (such has been the consolidation in the mortgage loan business since the subprime meltdown). There's no doubt that by making all these repurchase demands against the big banks, the GSEs have fundamentally changed the quality of loan originations by the major loan originators. I mean, look at Citigroup.

Three years after bad home loans helped trigger the recession and six weeks after the government cashed in the last of its $45 billion Citigroup investment, the New York-based bank is still selling mortgages that violate quality standards, according to an internal Freddie Mac review obtained by 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.

So, the GSEs have proved their point, and maybe it's time to put all this nastiness behind us, link arms, and mosey on down the highway, to a land where the taxpayer picks up Fannie's and Freddie's ultimate tab, which will include not only unrecovered losses on bum loans that weren't repurchased by big banks, but $160 million in legal fees for former officers of Fannie and Freddie who are accused by the government of making massive mistakes, if not engaging in outright wrongdoing. Unlike big banks, however, the taxpayer doesn't get a steep discount on his or her tax bill when it comes due each April merely by "hanging tough."

It's an interesting staring game going on, and, thus far, it appears to some of us that the GSEs are blinking. The ultimate loser of the game won't be Fannie or Freddie, however. To find that loser, all you have to do is to look in the mirror.

One Big Happy Family

Bailout beneficiary Citigroup got a boost from its largest shareholder--the US Treasury Department--when Treasury recently voted its 27% ownership interest (the largest single shareholder block) to affirm the reappointment of KPMG as Citi's auditor. That makes it 41 years in a row that KPMG has been Citi's auditor and, given how swimmingly Citi performed throughout the lead-up to the 2008 banking meltdown and the government's bailout of Citi, who could possibly have wished to replace such a crackerjack auditing outfit?

Well, Francine McKenna might be one such person.

Maybe KPMG knows this client best – a dubious honor. KPMG has been on the scene of Citi’s crimes and misdemeanors all over the world for 41 years.

Maybe Treasury feels like a mother who puts up with a gold digging daughter-in-law because daughter-in-law saw mom kissing the tennis pro and mom knows her son has slept with the baby-sitter…

Ouch!

Francine's just warming up, though. She notes that KPMG's fees to Citi have been relatively flat from 2007-2009.

This seems quite odd given the tumultuous times we’ve had the last two years. Auditors are supposed to assess the additional risk of fraud and material misstatement associated with events like a global economic crisis, taking on taxpayers as significant shareholders (November 2008) and the credit chaos in industry and sovereign capital markets.

Although she can't prove it, Francine thinks that it's more than merely a coincidence that Treasury acquired a huge chunk of Citi's common stock in 2008 and in 2009 KPMG's fees went down.

While the US Treasury, via the IRS, was scaring the living daylights out of KPMG over tax shelter abuses in 2005 and the Department of Justice was considering indicting the firm, KPMG was busily auditing the Department of Justice and the US Mint.  In 2007 and 2008 KPMG also audited the Department of Treasury’s Financial Management Service.

Re: The Auditors, November 28, 2006:

KPMG is negotiating with the Department of Justice about its troubles while Department of Justice is negotiating with KPMG, their auditors, regarding their audits of DOJ financial statements… in addition to the “too few to fail” doctrine at work here, there was also an attitude on the part of KPMG of, “Hey DOJ losers, who are you to call us a mismanaged, uncontrolled mess?”

At the last moment, the Department of Justice changed their mind about putting KPMG effectively “out of business” over the tax shelter sins.

[...]

This decision cemented the US government and general global regulatory posture of  “too few to fail” with regard to the largest audit firms.  What makes you think the US Treasury would ever force its close friend KPMG out of Citi?

When you read posts such as Francine's, which focus on the incestuous relationships among Capitol Hill, Wall Street, and the large "service providers" who "service" both, you'd swear that you could hear you grey-haired granny, sitting in her rocking chair on her front porch, puffing on her corncob pipe, and declaring knowingly,"This is what happens when cousins marry."

In banking, on Wall Street, and, apparently, in auditing, it's good to be "too big to fail."

Smoke and Mirrors

I'm not the only blogger bleating about loan repurchase risks.

Francine McKenna has been pounding the large audit firms for several years about their failure to catch the repurchase risk inherent in the business operations of large mortgage bankers like the defunct New Century and the merged-out-of-existence Countrywide Financial. She recently discussed the fact that although KPMG has settled litigation over the failures of New Century and Countrywide, it still faces litigation over Citigroup and Wells Fargo/Wachovia.She also mentions that Price Waterhouse Coopers faces similar risk with respect to its audits of Bank of America and JPMorgan Chase, both under heavy buyback pressure from Fannie and Freddie.

Francine's gone back and parsed previous public reports that estimate the potential buyback risk to banks like JPMorgan Chase and the quarterly reports that contain reserves for such losses, and thinks she smells the stench of a gross mismatch.

I went back and looked at the JPM Chase and Bank of America (BAC) 2009 Annual Reports for more clues.

From JPMorgan Chase:

Page 241: At December 31, 2009 and 2008, the Firm had recorded repurchase liabilities of $1.7 billion and $1.1 billion, respectively. The repurchase liabilities are intended to reflect the likelihood that JPMorgan Chase will have to perform under these representations and warranties and is based on information available at the reporting date. The estimate incorporates both presented demands and probable future demands and is the product of an estimated cure rate, an estimated loss severity and an estimated recovery rate from third parties, where applicable. The liabilities have been reported net of probable recoveries from third-parties and predominately as a reduction of mortgage fees and related income.

2009 compared to 2008, page 66: Noninterest revenue was $12.2 billion, up by $2.8 billion, or 30%, driven by the impact of the Washington Mutual transaction, wider margins on mortgage originations and higher net mortgage servicing revenue, partially offset by $1.6 billion in estimated losses related to the repurchase of previously sold loans.

A reserve of $1.7 billion is much less than the $23.9 billion Compass Point Research and Trading estimated form the Wall Street Journal as JPM”s potential liability to the Federal Home Loan Banks alone, not including claims by Fannie Mae and Freddie Mac.

From Bank of America:

The Corporation records its liability for representations and warranties, and corporate guarantees in accrued expenses and other liabilities and records the related expense in mortgage banking income. During 2009 and 2008, the Corporation recorded representations and warranties expense of $1.9 billion and $246 million. During 2009 and 2008, the Corporation repurchased $1.5 billion and $448 million of loans from first lien securitization trusts under the Corporation’s representations and warranties and corporate guarantees and paid $730 million and $77 million to indemnify the investors or insurers. In addition, during 2009, the Corporation repurchased $13.1 billion of loans from first lien securitization trusts as a result of modifications, loan delinquencies or optional clean-up calls.

Bank of American admits “representations and warranties expense” as well as losses of $1.5 billion for repurchases of loans from first lien securitization trusts under their representations and warranties and corporate guarantees.  In addition, they’d already repurchased an additional $13.1 billion based on mods, delinquencies and other “clean-up”.

However, I can’t easily see anywhere in either bank what the actual reserves are for estimated future liabilities and how they come up with a number given the total loans sold by type and the current claims by various parties. I think it’s time for someone, perhaps the SEC, to demand more detailed disclosure about reserves for repurchase risk.

She also wonders how Deloitte can sign off on entities who are involved in both sides of the buy-back controversies.

Can PwC, in good faith, honestly sign off on financial statements on both sides of the disputes between the FHLBs and Freddie Mac and several PwC bank clients where completely different estimates of these liabilities are submitted?

I can understand judgment and leave some room for disagreement in a legal dispute as opposed to the valuation of an individual security. But, in the end, the quality of the documentation, the quality of the underwriting, the level of potential fraudulent documentation and the collectibility of the loan based on accuracy of the borrower ratings assigned at origination must all be relatively easy to ascertain on a comparable basis. These factors ultimately drive the value of the asset.

A loan doc is what it is. If it exists, that is.

The auditors have been helping the banks pull rabbits out of their hats for some time now.  But isn’t it about time we jump on the issue of audit firms behaving like Switzerland to protect their own self-interests? There are hundreds of millions of reasons in New York alone for PwC to stay neutral and to allow balance sheet “window dressing” via manipulation of reserves. But what does that say about the integrity of the financial information published by these banks?

Shareholders and other stakeholders will suffer greatly when the the banks eventually “surprise” us with the huge losses.

Strong stuff. Good stuff. Definitely worth a read.

Where a the federal banking regulators on these issues? Oh, that's right, we're talking about too-big-to-fail banks and audit firms. Similar facts involving a community bank and regional or local audit form would have had serious adverse supervisory consequences for them both long before this point.

It's Who You Know, Not What You Are

The Senate version of the small business lending bill that passed the Senate last week didn't contain even the watered-down version of the commercial real estate loss amortization provisions that the House version of the bill contained. As I noted in June, banks that would be able to take advantage of the amortization provisions of the House version would have to be banks that are not on the FDIC's troubled institutions list (not rated 4 or 5). In other words, if you were the type of bank that needed the assistance of loss amortization, you wouldn't have been able to receive it.

The Senate version of the legislation never contained the CRE loss amortization provision from the get-go and it was not added by amendment. Although House Democrats are apparently miffed that some of their pet provisions do not appear in the Senate bill, Nancy Pelosi has vowed to adopt the Senate version " because small business can’t wait another day for this legislation to be passed.” Imbuing that phrase with a bit more "truthiness," what Speaker Pelosi meant to say is that Democrats better get something passed that gives the appearance of helping small businesses because the mid-term elections are coming up in another six weeks and things look grim for her party. At least, they appear to be grim for anyone not running against Christine ("Hasn't Everyone Dabbled in Witchcraft?") O'Donnell.

Another potential relief measure for a number of community banks hanging on by their fingernails flushed down the drain. Ah, well, if only you were a bank that got "special treatment." I'll bet any one of the six community banks that bit the dust last Friday wishes they had friends like Barney Frank and Maxine Waters In Congress and that the FDIC had been looking for loopholes to justify their counting prospective capital as capital before it was actually received. Remember when OTS officials were handed their heads for doing just that for IndyMac and some other thrifts that later failed?

It's nice that The Washington Post has brought into the clear this list of banks that might cause "unnecessary press or public relations" problems for the FDIC and how the FDIC acted in this case. Even the FDIC's inspector general wasn't aware of the list. It now "causes him some concern." Apparently, banks on this "double secret probation" list of banks whose failure might cause "adverse publicity" for the FDIC get a helping instead of a boot up the behind like the bad boys in Animal House, who were on a similar list. My response is, so what? Will anything change in our nation's capitol as a result of this "concern"? Will politicians be less corrupt or bank regulators less hypocritical in the future because the FDIC's IG is "concerned"?

[Sound of crickets chirping]

As one long-time banking attorney e-mailed me about this latest revelation, "This is about as ugly as it gets."

Blow Back For A Blowhard

I received some push back from a few readers on a couple of recent posts, and inasmuch as I long ago decided I didn't have time to both practice law and "police up" the blog's comments box from the leavings of tin foil hat wearers, university professors with a crackpot axe to grind, consultants trying to sell my readers their semi-worthless-to-totally-worthless services, Eastern European and Nigerian cybercrooks, spambots, people with way too much time on their hands trying to drag me into fights with other bloggers, and vitriolic wingnuts both pro and con the positions of yours falsely, I'll pass these comments along to readers via this post. My "opponents" are readers who respectfully disagree and since they voice reasonable opinions without using broad-brush labels with which to tar me or any four-letter Anglo-Saxon expletives or scatological references to describe the content of my posts, I've decided on a whim to give their views an airing.

In response to my recent post on the Wells Fargo class action litigation over the high-to-low posting of debit card and check expenditures, a former in-house counsel for one of the nation's largest financial institutions wrote that he thought that Judge Alsup's decision was founded solely upon the use of the word "may" rather than "will" in the portion of Wells Fargo's account agreement that discusses the use of "high-to-low" posting by the bank. Based on that interpretation, my correspondent thinks that Judge's Alsup's decision is certain to be overturned on appeal by the Ninth Circuit.

I think my correspondent is incorrect. While Judge Alsup does find that the use of the term "may" is misleading, he also gives much weight to the manner in which the disclosure of the posting process and its potential impact on consumers was "hidden" within an alleged mass of documentation saturated with mind-numbing legalese. He also determined (correctly or incorrectly) that Wells Fargo's advertising was misled  customers about this practice. As I said in my post, I'm not making a call on how this will turn out on appeal. The point I was trying to make in that post was that I, personally, find the use of such tactics to maximize fees at the expense of people trying to squeak by financially on a day-to-day basis to be distasteful, and a public relations black eye for bankers generally.

As to another recent post concerning Jeff Gerrish's contention that off-site monitoring by federal banking regulators results in examiners entering the bank with a predetermined rating that they then proceed to find evidence to support,  federal banking regulators, who did not wish to be identified or directly quoted (I assume they would be reprimanded for reading the heretical snark that is emoted by this blog), took issue with that contention. To paraphrase (but not quote) my correspondents, Jeff's theory is nice, but isn't more than an unproven theory. Offsite monitoring is often more generous than what "the boots on the ground" find when they venture into the bank and start getting into the weeds. While the majority of time the offsite and onsite determinations do mesh, there are many cases where examiners ultimately uncover less-than-strict supervision that has allowed banks to deviate substantially from their business plans in ways that are not reflected in the reported results upon which offsite ratings are based. Once examiners start plowing through loan files and overturning logs and rocks onsite, all kinds of grubs and worms start running about. Sometimes, the situation as revealed by the onsite examination is much worse than the offsite ratings would have indicated.

None of my correspondents cited a case where the offsite ratings were later determined to be heinously and unfairly negative, and that when examiners showed up, they determined that the bank was in much better shape than they would have expected coming in the door the first day of the examination. I'm sure that was merely an oversight.

"Eye of the beholder" stuff, for sure, eh?