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Citigroup Makes Work for Itself: The Perks of Being a Bank Holding Company

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In January, the Office of the Comptroller of the Currency inked a $9.3 billion settlement with 13 mortgage servicers regarding foreclosure abuses, $3.6 billion of which is to be sent directly to borrowers injured by the banking industry's shenanigans.

The first wave of checks were set to be mailed in April, but neither the government nor the banks themselves, which included Bank of America (NYSE: BAC  ) , Citigroup (NYSE: C  ) , JPMorgan Chase (NYSE: JPM  ) , and Wells Fargo (NYSE: WFC  ) , were sending out the payments. That job went to Rust Consulting, a contractor often used by principals in settlement agreements.

Not only has Rust made one error after another in its efforts to administer this particular settlement, but the company is a subsidiary of SourceHOV, a company formerly owned by Apollo Global Management (NYSE: APO  ) . According to The Wall Street Journal, however, ownership of SourceHOV changed hands in March -- when it was sold to Citi Venture Capital International, a section of Citigroup.

Rust comes under scrutiny
Rust sent out the first 1.4 million checks in April, and things immediately went awry. Many could not cash their checks because, as it turned out, Rust had not transferred the money to the appropriate account in a timely manner. Then, in May, more mayhem ensued when nearly 100,000 consumers were sent checks written for less than the amount owed.

The company fixed both problems, but that wasn't the end of it. In late July, another large batch of checks went out, 400,000 of which were never delivered -- at least to the correct address. Many were returned to Rust as undeliverable, as well.

Regulators had a meeting with representatives of Rust Consulting back in May, after the first two debacles. Not only were agency officials fed up with the company's ineptitude, but the problems reflected badly on them, too. U.S. Senator Sherrod Brown questioned why regulators couldn't choose a more reliable contractor.

Interestingly, the settlement occurred because the foreclosure review process that the banks were undergoing was achingly slow, and regulators wanted to present those harmed by foreclosure abuses with some relief. The snafus have had the effect of making borrowers wait, again, until each issue is resolved.

A conflict of interest for Citi?
Rust's procedures have been questioned before, and the company seems to make a mess of rather simple processes. As far as the bounced checks are concerned, some officials referred to by The New York Times suggested that cash transfers are made only at the last minute in order to collect interest on the vast sums.

As for the short checks, those concerned payments made by Goldman Sachs (NYSE: GS  ) and Morgan Stanley (NYSE: MS  ) , both of which made a later entry into the settlement. Surely Rust must have known that those two banks had agreed to pay homeowners more than the other 11 servicers, yet the company cut the checks in amounts that were in line with what the earlier signatories were paying out.

The fact that Rust Consulting makes money administering the very types of settlements that involve Citigroup can certainly be interpreted as a conflict of interest. Analyst Eleanor Bloxham recently noted that the bank's investment in SourceHOV is a sort of hedge against the types of regulatory judgments that seem to ensnare banks so often these days.

I think she has a point. While she acknowledges the hedge is not intentional, the fact remains that money generated by Rust adds to Citi's bottom line. It's a conflict, no matter how you look at it. The only thing keeping this issue from being blatant is the layers and offshoots of the leviathan that is Citigroup. Citi's private equity arm likely makes its own decisions, and the whole bank holding company model serves to insulate Citi from the day-to-day workings of its subsidiaries. Still, the conflict exists, and Citigroup should take it seriously.

With the latest settlement check flub, the problem may resolve itself. If government officials were miffed before, they are probably livid by now. For Citi, moving the parent company of Rust Consulting off of its books will be a judicious way to hedge against huge headaches in the future.

Not all bank holding companies are created equal. While many investors are terrified about investing in big banking stocks after the crash,the sector has one notable stand-out. In a sea of mismanaged and dangerous peers, it rises above as "The Only Big Bank Built to Last." You can uncover the top pick that Warren Buffett loves in The Motley Fool's new report. It's free, so click here to access it now.

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