“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.

Donna Kardos in the WSJ:

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.

Main image source

Last week was a very busy and very difficult week at re: The Auditors HQ. However, those of you who lost your jobs at PwC and other firms, or those who were left behind with survivor’s guilt, faced much tougher challenges.

Yes.

Look to your left, look to your right. You’re still there, but it’s highly likely that one of your colleagues will not be there three months from now. Not by choice. And not because anyone at PwC or any other firm is a “loser.”

Well, maybe there are some “losers”, but you’ll have to go back to my posts for that discussion.

The events of last week, including those that occurred in the world around us, have prompted me to formalize my Comments Policy and Privacy Policy/Terms of Use. These policies, to be honest, were always my standard operating procedure, but given the heightened and constant nature of the threats all around us, it’s time to commit them to print. I want you to know what they are, so you can act accordingly both on and off the site.

I started to see increased traffic on Tuesday of last week, after the blog post describing PwC Advisory’s planned staff cuts was posted Monday night. There was a considerable traffic increase over the typical run rate on Tuesday and Wednesday and then that rate doubled on Thursday and stayed at that level on Friday as actual cuts started to be reported both offline and online. I heard from multiple sources that the cuts were accelerated because of the blog post, which clearly upset some.

I also started to see more negative comments – about my decision to post the information, about my choice of visuals (which I now deeply regret in light of the Ft. Hood and Orlando incidents) and about me personally. I am a pretty good sport, but I will tell you… I saw some very ugly, very vulgar, very obscene and, in some cases, physically threatening comments on Thursday and Friday.

That had never happened before.

The biggest shock was that some of the most offensive comments were posted from the PwC network. When you visit this site, the web servers at our hosting service automatically recognize your domain name and IP address. If you are accessing the site from your company or firm network, the domain name and IP address will reveal nothing personal about you to me other than the IP address that you accessed the site from. But that IP address may be identified to me with a host or corporate name and location. It may be possible to obtain more information about users. That information is typically not accessible other than through legal means, but that is always a potential.

Late last Friday night, I accidentally posted an anonymous comment that made threats to PwC employees. Once notified of my mistake via another comment on Saturday morning, I immediately deleted that comment, issued an apology, then later deleted the notification and my apology, since the notification comment repeated the threatening words that the original poster did.

Later Saturday, I received a call from the Chief Information Security Officer of PwC US. In the spirit of cooperation, I agreed to provide PwC with the details I had for the comment that he felt threatened PwC employees. I also solicited his assistance in addressing the offensive and threatening comments that came from the PwC network.

I did this because I reserve the right to disclose user information to appropriate parties if I feel it will help protect and defend the person, rights, or property of re: The Auditors employees, any visitors to the re: The Auditors website or a company or individual that may legitimately feel threatened by anything posted on the site.

I will also disclose information to appropriate parties when, in good-faith, I believe that such action is necessary to comply with the law or to comply with a legal process served on re: The Auditors, to enforce this Privacy Policy or to enforce the re: The Auditors website Terms of Use.

I will also help identify persons who may be violating the law or the Terms of Use of re: The Auditors website; and I will cooperate with the investigations of any alleged illegal activities.

You should keep in mind that when you access the internet through your company or firm network or a public network or a paid ISP, you may be subject to monitoring or disclosure of your activities to law enforcement or others if you engage in illegal or threatening activities or violate your employer’s policies, subject to local laws and regulations.

I do actively not solicit tips or ask or encourage you to disclose confidential information or to violate any legal agreements that you are party to. I may, from time to time ask friends, acquaintances, contacts, and subject matter experts for verification, validation or elaboration of information I have obtained from public sources or that is based on my own experience. You must, of course, take responsibility for any information you provide to me or anyone else and for any and all applicable laws, regulations or contracts that information may be subject to. If I receive un-solicited information, I am under no obligation to determine its source or its legality. I may or may not be able to determine its veracity before publication and make no claims of such.

Caveat emptor.

In spite of what some might think, my goal is not to increase traffic to the site for traffic’s sake. The monetary and other benefits of that strategy for me are minimal. Instead, my objective is to provide useful information to inform your decision-making and to encourage sharing and discussion of relevant information within the community that has developed. That’s why the tone and spirit of the community is so important. Threats of violence, irresponsible obscenity, personal attacks towards me and others, or outing of anyone other than public figures and senior leadership of the firms and their clients is not welcome. These community standards will be strictly, and personally, enforced.

You will find a formal Privacy Policy along with the re: The Auditors Terms of Use here.

And although my Disclaimer is written in a humorous fashion, I’m actually quite serious.

Now comes word that E&Y will also rebrand. Of course, the news leaked in the UK and the global firm denies it. But, it’s probably all a function of the advice they’re getting from their media advisors. Leave it to a bunch of boring accountants to trust the “cool guys” to tell them how to be sexy again. Or maybe they’re soliciting advice from their new lobbying organization. That might be a better choice. At least they know how to spend the firms’ money effectively, rather than on new names and publicity stunts.

Ernst & Young launches rebrand plan
Ernst & Young launches a rebranding project that may see a complete overhaul of the firm’s image. The rebranding is the first by a Big Four firm since Deloitte decided to drop the ‘Touche’ from its name and design a new logo in 2003.

The exercise will not see E &Y change its name, but the firm is considering changing its logo and may revise its current strap line ‘Quality In Everything We Do’. Two separate sources at the UK firm indicated that it would be a worldwide revamp. But the global firm denied any plans, creating confusion as to how advanced the plans are. Details of budgets, timelines and which consultancies have been engaged to advise on the rebranding are also unclear.

The news comes as the firm places renewed emphasis on tightening relationships within its seven area structure and pushing into emerging markets. E&Y reveals today that growth rates in the industry are beginning to cool, as IFRS and Sarbanes-Oxley advisory work ease off.

The firm has grown UK revenues by nearly 50% over the last three years, outperforming its three main rivals, chairman Mark Otty said, but figures for 2006/07 showed that revenues had only grown by 9% to £1.23bn, down on the double-digit growth enjoyed in 2005 and 2006. Profits increased 7% to £328m.

Otty said: ‘For the last 12 months we have given a clear indication that our revenue growth in the UK was going to be reduced from the Sarbanes-Oxley inspired spike of 2006.’ The firm is pinning its growth hopes on financial services, which will be boosted by work on MiFID, and opportunities in emerging markets.

E&Y brought more than 3,000 staff on board and boasts an average of 473 partners. Profits per partner stood at £688,000. The firm stuck to its guns on not paying partners bonuses policy as is favoured by some of the other Big Four firms.

The global firm’s spokesman said: ‘We [always] review the way we present ourselves in the market place – but there are no plans to change our name, logo or strapline.’

Ernst & Young would not be the only major firm or body to pursue a rebranding in recent years. Deloitte, PricewaterhouseCoopers and the ICAEW have all undertaken branding revamps.

PwC’s infamous attempt to rebrand its consultancy arm as ‘Monday’ saw the firm pump £75m into the project, but fail to secure the internet domain name. The Deloitte ‘green dot’ exercise, commissioned by John Connolly in 2003, was a less traumatic event. The same cannot be said for the ICAEW, which faced criticism for the £65,000 it spent on redesigning its logo.