RBS to pay $4.9 billion in DOJ settlement over mortgage bond misconduct

Settlement covers bank’s mortgage bond activities from 2005 to 2008

The Royal Bank of Scotland will pay nearly $5 billion in a settlement with the Department of Justice over the bank’s mortgage bond activities in the run-up to the housing crisis.

The DOJ announced Tuesday that it reached a $4.9 billion settlement with RBS that covers civil claims that RBS misled investors in the underwriting and issuing of residential mortgage-backed securities from 2005 through 2008.

According to the DOJ, the penalty is the largest one imposed by the DOJ over financial crisis misconduct by a single entity, but the penalty is much smaller than first thought.

Back in 2016, reports suggested that RBS may end up paying as much as $13 billion to settle the government’s inquiry into its mortgage bond activities.

And last year, RBS set aside an additional $3.8 billion to be used to settle with the DOJ. At the time, it was believed that RBS had at least $8 billion set aside for a settlement with the DOJ.

But the settlement comes in at just under $5 billion, just as RBS said that it would earlier this year when it announced that it reached a preliminary settlement with the DOJ.

The settlement terms are in line with what RBS said they would be, with the bank paying out a penalty of $4.9 billion, but the DOJ release on the matter delves into what exactly RBS is alleged to have done.

According to the DOJ, RBS made “hundreds of millions of dollars, while simultaneously ensuring that it received repayment of billions of dollars it had lent to originators to fund the faulty loans underlying the RMBS.”

The DOJ alleged that RBS used mortgage-backed securities to shift the risk of the faulty loans, and tens of billions of dollars in subsequent losses, onto “unsuspecting investors,” including nonprofits, retirement funds, and federally-insured financial institutions.

“As losses mounted, and after many mortgage lenders who originated those loans had gone out of business, RBS executives showed little regard for this misconduct and made light of it,” the DOJ claims.

According to the DOJ, RBS failed to reveal “systemic problems” with mortgage originators’ underwriting practices on the loans that were then securitized, despite allegedly knowing how many issues the loans had.

“RBS’ reviews of loans backing its RMBS confirmed that loan originators had failed to follow their own underwriting procedures, and that their procedures were ineffective at preventing risky loans from being made,” the DOJ said.

“As a result, RBS routinely found that borrowers for the loans in its RMBS did not have the ability to repay and that appraisals for the properties guaranteeing the loans had materially inflated the property values,” the DOJ continued. “RBS never disclosed that these material risks both existed and increased the likelihood that loans in its RMBS would default.”

In addition to faulty due diligence and a lack of willingness to communicate when problems were discovered, RBS was also accused of a litany of misconduct, including (emphasis added by HousingWire):

  • RBS changed due diligence findings without justification. RBS’ due diligence practices did not remove fraudulent and high-risk loans from its RMBS. For example, when RBS’s due diligence vendors graded loans materially defective, RBS frequently directed the vendors to “waive” the defects without justification. One due diligence vendor, which tracked waivers by most major participants in the RMBS industry, concluded that RBS waived material defects 30% more frequently than the industry average. RBS’ waiver of material defects routinely resulted in the securitization of loans with excessive risk. When it engaged in such waivers, RBS never included enhanced “scratch-and-dent” disclosures that would have alerted investors that loans with excessive risks were included in the RMBS.
  • RBS provided investors with inaccurate loan data. RBS’ due diligence frequently found that loan data – which RBS passed on to investors, who used the data to analyze the risks associated with its RMBS – were riddled with errors. Many inaccuracies made the loans look less risky than they actually were. RBS, however, did not require originators to correct the data errors. In one deal, where RBS identified over 600 data errors associated with 563 loans (including debt-to-income ratios understated by as much as 2,700%), RBS failed to disclose these errors even to the originator; instead, RBS reassured the originator that RBS had not required originators to correct data errors in the past and did not anticipate doing so for that deal.
  • RBS failed to disclose due diligence and kick-out caps. To develop and maintain business relations with originators, RBS agreed to limit the number of loans it could review (due diligence caps) and/or limit the number of materially defective loans it could remove from a RMBS (kick-out caps). RBS’ scheme reached its height in two deals issued in October 2007. In both of these RMBS, RBS identified hundreds of underlying loans that carried a particularly high risk of default and would cause losses to the RMBS investors. RBS kept these materially risky loans in the RMBS, without disclosing their inclusion to investors, because RBS had agreed to a kick-out cap limiting the number of defective loans that RBS could exclude from the securities in exchange for receiving a lower price for the loan pool. As a result, over the entirety of its scheme, RBS securitized tens of thousands of loans that it determined or suspected were fraudulent or had material problems without disclosing the nature of the loans to investors. 

“This resolution – the largest of its kind – holds RBS accountable for defrauding the people and institutions that form the backbone of our investing community,” said Andrew Lelling, U.S. Attorney for the District of Massachusetts.

“Despite assurances by RBS to its investors, RBS’ deals were backed by mortgage loans with a high risk of default,” Lelling continued. “Our settlement today makes clear that institutions like RBS cannot evade responsibility for the damage caused by their illicit conduct, and it serves as a reminder that the Justice Department, and this Office, will hold those who engage in fraudulent conduct accountable.”

The settlement is hardly RBS’ first for its crisis-era activities. Back in March, RBS reached a $500 million settlement with the state of New York over the bank’s pre-crisis mortgage bond activities.

And at other points over the last few years, the bank reached a $5.5 billion settlement with the Federal Housing Finance Agency; a $129.6 million settlement and a $1.1 billion settlement with the National Credit Union Administration; a $120 million settlement with the state of Connecticut, a separate $44 million settlement with the DOJ and the Special Inspector General for the Troubled Asset Relief Program; and a $125 million settlement with the state of California.

The notice from the DOJ notes that the allegations laid out against RBS are simply allegations, adding that the bank disputes the allegations and does not admit to any of the described conduct.

“We are pleased to have reached a final settlement with the DOJ and that we can focus our energy on serving our customers better and returning capital to our shareholders,” RBS CEO Ross McEwan said in a statement.“This settlement dates back to the period between 2005 and 2007. There is no place for the sort of unacceptable behaviour alleged by the DOJ at the bank we are building today.”

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