Banking and Finance Law Daily Wells Fargo will pay $2B for misrepresenting RMBS loan quality
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Wednesday, August 1, 2018

Wells Fargo will pay $2B for misrepresenting RMBS loan quality

By John M. Jascob, J.D., LL.M.

Wells Fargo Bank and several affiliates have agreed to pay $2.09 billion to settle charges that the bank misrepresented the quality of loans that were subsequently placed in residential mortgage-backed securities (RMBS). In an action brought under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA), the Justice Department had charged Wells Fargo with causing billions of dollars in investor losses because loans originated by the bank from 2005 to 2007 contained misstated income information and did not meet the quality that Wells Fargo represented.

"Abuses in the mortgage-backed securities industry led to a financial crisis that devastated millions of Americans," said Acting U.S. Attorney Alex G. Tse in a news release. "Today’s agreement holds Wells Fargo responsible for originating and selling tens of thousands of loans that were packaged into securities and subsequently defaulted." The news release observes that of the 73,539 stated income loans sold by Wells Fargo that were included in RMBS between 2005 to 2007, nearly half of those loans have defaulted.

"Courageous underwriting." Recitals in the settlement agreement state that as Well Fargo saw its retail market share of loan origination decrease, it sought to double its production of subprime and Alt-A loans from 2005 to 2006. Among other things, Wells Fargo instituted a campaign in 2005 called "Courageous Underwriting" that encouraged Wells Fargo’s underwriters to be more aggressive in approving loans that fell outside of the bank’s underwriting guidelines. The bank also added new categories of compensation for certain of its credit risk professionals, including "Market Risk Growth" and "Competitive Positioning to Drive Volume."

To evaluate the integrity of its increasing volume of stated income loans, Wells Fargo subjected a sample of these loans to "4506-T testing." The testing on two of the programs, however, revealed that more than 70 percent of the loans that Wells Fargo sampled had an "unacceptable" variance. Additional testing performed by quality assurance analysts revealed that nearly half of the stated income loans that Wells Fargo tested had both an unacceptable variance and the absence of a plausible explanation for that variance.

"Astounding" results. The government alleged that the results of Wells Fargo’s 4506-T testing were widely distributed among Wells Fargo employees, with one employee in risk management describing the testing results as "astounding." Despite the knowledge that a substantial portion of its stated income loans contained misstated income, however, Wells Fargo failed to disclose this information; instead, the bank reported to investors false debt-to-income ratios regarding the loans it sold. Wells Fargo also allegedly touted its fraud controls while failing to disclose the income discrepancies its controls had identified. Moreover, Wells Fargo took steps to insulate itself from risk by screening out many of the loan at issue from its own loan portfolio held for investment and by limiting its liability to third parties for the accuracy of its stated income loans.

"We are pleased to put behind us these legacy issues regarding claims related to residential mortgage-backed securities activities that occurred more than a decade ago," said CEO Tim Sloan in a Wells Fargo news release. Without admitting liability, Wells Fargo will pay the civil monetary penalty to resolve all civil claims under FIRREA. The government has also agreed to release the bank from any potential claims arising under the Program Fraud Civil Remedies Act, the Racketeer Influenced and Corrupt Organization Act, and the Injunctions against Fraud Act.

Attorneys: Douglas Chang, U.S. Attorney’S Office, for the United States.

Companies: Wells Fargo Bank, N.A.

MainStory: TopStory CaliforniaNews EnforcementActions FinancialIntermediaries Mortgages SecuritiesDerivatives

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