In February of 2008, about three months after Citigroup disclosed that the value of its subprime securities had fallen by $8 to 11 billion since September 30, the Office of the Comptroller of the Currency informed Citigroup CEO Vikram Pandit by letter that its bank examiners had found that Citigroup lacked a reliable method for valuing subprime mortgage bonds, according to Jonathan Weil’s recent Bloomberg.com article entitled, “What Vikram Pandit Knew, and When He Knew It.”
One big problem that OCC examiners reportedly found was that Citigroup used a deficient discounted cash flow (DCF) model to value its CDOs, rather than using the value of the collateral as a starting point. Additionally, “over-reliance was placed on credit rating agency ratings without considering the appropriateness of these ratings to specific products or the true risk of the underlying collateral,” OCC examiners were quoted as saying.
Citigroup blamed downgrades by credit-rating companies that “occurred after the end of the third quarter,” according to the article.
Eight days after the OCC’s February 2008 letter to Pandit, Citigroup’s annual report said, “management believes that, as of Dec. 31, 2007, the company’s internal control over financial reporting is effective.” The problems cited by the OCC were not mentioned. The annual report was certified by Pandit and CFO Gary Crittenden, and vouched for by outside auditor KPMG.
KPMG must have known about the OCC’s concerns because it was copied on the OCC’s February 2008 letter to Pandit, but KPMG was paid $88.1 million in fees by Citigroup in 2007, according to the article.
Weil does not believe it credible that Citigroup’s losses occurred after September 2007, when Merrill Lynch & Co. had already written down its own subprime securities by $8.4 billion during the third quarter.
Nine months later Citigroup took a $45 billion taxpayer bailout, “still sporting a balance sheet that made it seem healthy,” according to the article.
“As I look at the deficiencies cited in the letter, taken as a whole, it appears that Citigroup had a material weakness with respect to valuing these financial instruments,” Ed Ketz, an accounting professor at Pennsylvania State University, who reportedly reviewed the OCC’s letter to Pandit at Weil’s request, was quoted as saying, adding: “It just is overwhelming by the time you get to the end of it.”
Citigroup failed to disclose these material facts and its shareholders deserve to know why, according to Weil.