HSBC to pay $765 million in settlement over pre-crisis mortgage bonds

DOJ accused bank of selling mortgage-backed securities full of toxic loans

HSBC will pay $765 million to the federal government as part of a settlement that covers the bank’s mortgage bond activities in the run-up to the housing crisis.

The Department of Justice announced Tuesday that it reached a final settlement with HSBC that would resolve an investigation into the bank’s mortgage origination and securitization activities from 2005 to 2007.

The settlement agreement comes more than a year since rumors first began circulating that the bank was in settlement talks with the DOJ over its “legacy” residential mortgage-backed securities activities.

The final settlement figure doesn’t come as any shock either, considering that the bank itself said two months ago that it reached a preliminary settlement with the DOJ for the same amount as the final settlement.

But HSBC’s August announcement didn’t disclose exactly what conduct the bank was accused of engaging in. The DOJ’s announcement, on the other hand, goes into great detail about what HSBC allegedly did.

Put simply, the bank allegedly knew it was putting toxic loans into residential mortgage-backed securities and sold the bonds anyway.

“HSBC made choices that hurt people and abused their trust. HSBC chose to use a due diligence process it knew from the start didn’t work. It chose to put lots of defective mortgages into its deals,” Bob Troyer, United States Attorney for the District of Colorado, said in a statement.

“When HSBC saw problems, it chose to rush those deals out the door,” Troyer continued. “When deals went south, investors who trusted HSBC suffered.  And when the mortgages failed, communities across the country were blighted by foreclosure. If you make choices like this, beware. You will pay.”

The DOJ alleges that HSBC misrepresented the quality of its mortgage bonds to investors and claimed that its due diligence process would ensure that the bonds were as advertised.

The DOJ claims that as early as 2005, an HSBC credit risk manager said that they had concerns with HSBC’s due diligence process for the loans it was buying and securitizing.

But HSBC allegedly chose to “tout” its due diligence process to investors. The bank allegedly told investors that when it purchased subprime loans, it would randomly select loans to review for credit and compliance. But the bank’s process was allegedly not as random as it appeared to be.

Here’s how the DOJ describes some of HSBC’s alleged conduct:

To review the loans HSBC did select for review, HSBC used due diligence vendors, and HSBC saw the results of the vendors’ reviews of the loans before the deals were issued. Over a one-and-a-half year period, between January 2006 and June 2007, HSBC’s primary due diligence vendor flagged over 7,400 loans as having low grades—more than one out of every four loans the vendor reviewed for HSBC during that time. When HSBC employees saw loans with low grades, they sometimes “waived” those loans through or recategorized the grades to make the due diligence “percentages look better.” They also expressed views about the deals they were issuing. For example, in 2007, an HSBC trader said, in reference to an RMBS that HSBC was about to issue, “it will suck.”

On one loan pool bought in 2006, HSBC allegedly learned that the pool had an “abnormally large” and “alarmingly” high number of payment defaults. HSBC’s head of risk management for RMBS later wrote in an email that the pool’s high early payment default rate could be a signal that there were widespread problems with the pool.

Other employees in HSBC’s risk management group allegedly said that the pool “may be contaminated” and suggested waiting to securitize the loans until there was “further clarity” on the loans.

Just one day later, the head of HSBC’s whole loan trading risk management group said that he was “comfortable that we need not make any further disclosures to investors,” and the bank issued the securitization.

According to the DOJ, a post-close quality control review showed that loans in the securitization “appear to have fraud or misrep (misrepresentation).”

Despite knowing these things, HSBC would buy and securitize more loans from the same unnamed originator, despite the head of HSBC’s due diligence team concluding that the originator offered “bad collateral.”

HSBC, for its part, denies the allegations and does not admit to the conduct alleged by the DOJ, but chose to settle nonetheless.

“We are pleased to put this investigation related to activity that occurred more than a decade ago behind us,” Patrick Burke, president and chief executive officer, HSBC
 USA, said in a statement. “Since the financial crisis, HSBC has been strengthening our culture, processes and internal controls to ensure fair outcomes for our clients. The US management team is focused on putting historical matters into the rear view mirror and completing the turn-around of HSBC’s US operations.”

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