Wells Fargo has agreed to pay a $2.09 billion civil money penalty for misrepresenting the value of mortgages it originated and sold to investors who suffered significant losses as a result.
The Department of Justice (DOJ) alleged that the bank knew income information included in the loans in question was inaccurate, and that the loans were of lower quality than the bank represented. Investors, including federally insured financial institutions, lost billions of dollars investing in residential mortgage-backed securities (RMBS) containing loans originated by Wells Fargo.
Wells Fargo sold at least 73,539 stated income loans included in RMBS from 2005 to 2007, according to the DOJ. Almost half of those loans have defaulted, leading to billions of dollars in losses to investors.
The DOJ ruled that the bank and several of its affiliates must pay the fine, incurring the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), which authorizes the federal government to seek civil penalties against financial institutions that violate various predicate criminal offenses, including wire and mail fraud.
“This settlement holds Wells Fargo accountable for actions that contributed to the financial crisis,” U.S. Acting Associate Attorney General Jesse Panuccio said in a press release. “It sends a strong message that the Department is committed to protecting the nation’s economy and financial markets against fraud.”
Under the terms of the agreement, the bank is able to pay the penalty to resolve all civil claims brought by the U.S. without admitting liability. Wells Fargo CEO Tim Sloan chalked up the RMBS losses related to inaccurate loan representations as “legacy issues” that the company now can leave in the rearview mirror.
“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,” Sloan said in a statement. “Wells Fargo remains focused on our important role as one of the nation’s leading providers of mortgage financing and on our commitment to expanding sustainable homeownership opportunities for our customers.”
Wells Fargo was charged with embarking on an initiative to double its production of subprime and Alt-A loans, characterized by borrowers with less than full documentation, lower credit scores and higher loan-to-values. As part of the initiative, Wells Fargo allegedly loosened its requirements for originating stated income loans – loans where a borrower simply states his or her income without providing any supporting income documentation.
“Abuses in the mortgage-backed securities industry led to a financial crisis that devastated millions of Americans,” Alex Tse, acting U.S. attorney for the Northern District of California, said in a statement. “Today’s agreement holds Wells Fargo responsible for originating and selling tens of thousands of loans that were packaged into securities and subsequently defaulted. Our office is steadfast in pursuing those who engage in wrongful conduct that hurts the public.”
To evaluate the integrity of its increasing volume of stated income loans, Wells Fargo tested a sample of loans using a 4506-T form, a government document signed by the borrower during the loan approval process to allow a lender to obtain the borrower’s tax transcripts from the Internal Revenue Service (IRS), the DOJ stated. 4506-T testing involves comparing the tax transcripts of the borrower with the income stated on the loan application.
“Wells Fargo implemented 4506-T testing on two of its programs. This testing revealed that more than 70 percent of the loans that Wells Fargo sampled had an ‘unacceptable’ variance (greater than 20 percent discrepancy between the borrower’s stated income and the income information reflected in the borrower’s most recent tax returns filed with the IRS), and the average variance was approximately 65 percent,” the DOJ said. “After receiving these results, Wells Fargo conducted further internal testing. This additional testing, performed by quality assurance analysts, was designed to determine if ‘plausible’ explanations existed for the ‘unacceptable’ variances over 20 percent. This additional step 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.”
Wells Fargo disclosed the 4506-T testing results in internal monthly reports, widely distributed among the bank’s employees. One Wells Fargo employee in risk management called the results “astounding” yet “instead of reacting in a way consistent with what is being reported WF [Wells Fargo] is expanding stated [income loan] programs in all business lines,” according to the DOJ.
Despite being aware that the stated income in a significant portion of the bank’s stated income loans was incorrect, Wells Fargo did not disclose that fact to investors, instead reporting false debt-to-income ratios in connection with the loans it sold, the DOJ alleged. The U.S. also alleged that Wells Fargo took attempted to insulate itself from the risks of its stated income loans by screening many of them out from its own loan portfolio held for investment and by limiting its liability to third parties for the accuracy of its stated income loans.
The settlement was the result of a coordinated effort between the Civil Division’s Commercial Litigation Branch and the U.S. Attorney’s Office for the Northern District of California, with investigative support from the Federal Housing Finance Agency, Office of Inspector General.