Jackson Jambalaya

"WASHINGTON (Thomson Financial) - The world's biggest bank, Citigroup, named former US Treasury chief Robert Rubin as its new chairman Sunday, replacing Charles Prince, who resigned after the bank's poor performance in the subprime mortgage crisis....

Like some of its rivals, Citigroup (nyse: C - news - people )'s balance sheet has been hit by losses from its exposure to mortgage-backed securities, which have been ravaged by the housing downturn...." http://www.forbes.com/afxnewslimited/feeds/afx/2007/11/04/afx4298181.html

Citigroup is one of the world's largest corporations, so large that it is considered by many in the financial community to be almost too big to govern. The above passage from Forbes is a perfect example of what is wrong at Citigroup. Citigroup's staggering losses are due in large part to subprime mortgage-backed securities. Since Citigroup has been hammered by them, it is reasonable to ask how Citigroup has changed its exposure to subprime mortgages.

Citigroup has a mortgage wholesale division, Citimortgage, which is one of the top five wholesale lenders in the mortgage industry (It wholesales mortgages to mortgage brokers. In 2006 it merged its subprime division, Citifinancial, with is prime mortgage division, Citimortgage.). At the end of 2006 it was the tenth largest subprime lender in with $5 billion of originations in the fourth quarter (http://www.marketwatch.com/news/story/top-10-subprime-originators-slanted/story.aspx?guid={100602BA-13D5-4B8C-BEB6-D5547594D449}&siteid=yhoo&dist=yhoo). However, as leading subprime lenders have gone out of business or have curtailed operations, Citimortgage is probably one of the top six or seven subprime mortgage lenders.

Citimortgage issues a daily rate sheet to mortgage companies and other clients such as banks that originate mortgage loans. These rate sheets are market driven and sometimes change several times in a day (the 10 year treasury bond is usually a reliable indicator of how mortgage interest rates will fare). According to Citimortgage's rate sheets, Citimortgage offers a variety of mortgage programs for borrowers: Fannie Mae, Freddie Mac, FHA, VA, and a program called "Expanded Lending." What exactly is "Expanded Lending"? Expanded Lending is the term Citimortgage uses for its subprime mortgage lending.

Some lenders still offer subprime mortgage lending programs but the programs are a shell of their former selves. There are very little, if any, "no down payment" programs for supbrime borrowers. ( In the past a borrower with a 580 or above credit score could get a mortgage without a down payment.) So-called Stated Income programs for subprime borrowers have gone the way of the dodo bird. One would expect Citimortgage to become more conservative in its subprime mortgage lending. However, a study of its rate sheets show it still offers programs currently considered to be very aggressive in the mortgage industry.

For starters, Citi offers a 100% loan-to-value mortgage for borrowers with a minimum 620 credit score. It also allows for cashout refinances (cashout refinances are generally considered to have a higher level of risk) at 100% LTV. There is no mortgage insurance for the program. If the borrower can not verify income based on pay stubs, tax returns, W-2's, and other similar verifications of income and employment, it allows the borrower to instead provide bank statements for an increase of .250 to the interest rate. Thus, the borrower is able to avoid long-established standards used for underwriting mortgages and protecting the lender from increased levels of risk.

Citi's aggressive subprime lending does not stop there, as it lends to borrowers with credit scores as low as 530, which is considered to be a poor credit score. A borrower with such a score can still get a mortgage from Citi if he only has 15% to put down on a house or if he has that much equity in the home. The bank statement option is still available to that borrower. Citi even offers an interest-only option to its borrowers, something that has been largely abandoned by many lenders in today's subprime climate. Citigroup has curtailed some of its lending practices recently (It quit approving 80/20 loans as well as dropping ARM programs for subprime borrowers. ). However, its subprime lending practices are probably the most aggressive in the industry.

The point of this bloviating is to ask what exactly is Citigroup's exposure to future subprime losses? If Citigroup is suffering from huge losses due to subprime mortgage-backed securities, then why is it the most aggressive subprime lender in the mortgage industry? One must wonder what Citi is thinking when it is offering subprime mortgages that require no down payment or mortgages to borrowers with low credit scores. Is Citi prepared to do what it takes to restore itself to profitability or is it merely rearranging the deck chairs as the ship sinks? What has probably happened is that Citigroup is so big that it is almost impossible for senior executives to know what is taking place at the lower levels as those at the boardroom level probably are not well-versed in the ways of mortgage lending. However, unless Mr. Rubin and other leaders of Citigroup pay more attention to its subprime mortgage lending, it can probably expect such losses to continue.

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More coverage: http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2007/11/05/bcnciti105.xml