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Bank of America Corp. BAC +4.12% will pay $16.65 billion to settle the government's accusations it sold flawed mortgage securities in the run up to the financial crisis, the largest settlement ever reached between the U.S. and a single company.
The settlement is an attempt by the U.S. government to put an exclamation point on a string of crisis-era enforcement actions and lawsuits that's cost U.S. banks more than $125 billion. The Bank of America settlement requires the Charlotte, N.C. lender to pay $9.65 billion in cash to the Justice Department, six states, and other government agencies, including the Securities and Exchange Commission. The bank will also provide $7 billion worth of aid for struggling consumers, through actions such as modifying mortgages for borrowers who owe more than their homes are worth, or demolishing derelict properties.
Bank of America agreed to pay a settlement of $16.65 billion over its mortgage lending, the largest ever between the U.S. and a single company. WSJ's Aaron Lucchetti joins MoneyBeat with the details.
The Justice Department's case against Bank of America provides one of the clearest windows to date into the behavior that fueled the 2008 financial crisis: Lenders knowingly providing credit to borrowers who could not afford the loans, then selling those ticking-time-bomb mortgages to unwitting investors. Borrowers ultimately defaulted on the loans, sending them into foreclosure and saddling investors with hefty losses.
Many of the mortgage securities in question were made by Countrywide Financial Corp. and Merrill Lynch & Co., before Bank of America agreed to buy the two companies in 2008. But the government found problems with Bank of America's own mortgage securities as well, including efforts by the bank to get around internal underwriting standards by changing applicants' financial information.
In at least one instance, an underwriter at Bank of America made more than 40 attempts to win an "accept" rating from an internal Countrywide system— known as CLUES—that would allow Bank of America to make a loan, according to a statement of facts signed by the U.S. and Bank of America.
"One underwriter characterized what she was doing as trying to 'trick' the CLUES system into giving an 'accept' rating," according to the document.
The devastating outcome from making weak loans was predicted by at least one top Countrywide executive—former CEO Angelo Mozilo —who warned in an Aug. 1, 2005 email to other executives that real-estate developers were anticipating a condo market collapse in areas like South Florida and Las Vegas and said the firm should avoid putting certain loans on its own balance sheet. Mr. Mozilo was worried the large increase in monthly payments required by many of the Countrywide-issued mortgages would ultimately cause borrowers to default.
"The simple reason is that when the loan resets in five years there will be enormous payment shock and the borrower is not sufficiently sophisticated to truly understand the consequences, then the bank will be dealing with foreclosure in potentially a deflated real-estate market. This would be both a financial and reputational catastrophe," Mr. Mozilo wrote, according to Justice Department documents.
Prosecutors in Los Angeles are preparing to file civil charges against Mr. Mozilo and other former Countrywide executives, according to a person familiar with the situation. Mr. Mozilo's lawyer, David Siegel, told The Wall Street Journal: "There is no sound or fair basis, in law or in fact, to pursue any claims against Angelo Mozilo."
The settlement comes on the heels of similar, but smaller, deals over precrisis mortgage-related conduct with CitigroupInc. C +2.54% for $7 billion and J.P. Morgan Chase JPM +1.56% & Co. for $13 billion. The Justice Department is expected to turn its attention next to other banks accused of selling flawed mortgage securities, including Goldman Sachs Group Inc. GS +0.74% and Wells Fargo WFC +1.03% & Co., according to people familiar with the matter.
"Bank of America has acknowledged that, in the years leading up to the financial crisis that devastated our economy in 2008, it, Merrill Lynch and Countrywide sold billions of dollars of RMBS backed by toxic loans whose quality and level of risk they knowingly misrepresented to investors and the U.S. government," Attorney General Eric Holdersaid at a news conference, referring to residential mortgage-backed securities.
The bank's chief executive, Brian Moynihan, said in a statement that the settlement "is in the best interests of our shareholders, and allows us to continue to focus on the future." Giant legal charges have depressed the bank's earnings for years, frustrating some investors.
Mr. Moynihan said that the settlement "resolves significant remaining mortgage-related exposures." The settlement also resolves claims by the Federal Housing Administration and Ginnie Mae. The settlements release the bank from matters related to mortgage securities as well as collateralized debt obligations and mortgage origination.
The bank said the settlement will cut third-quarter pretax earnings by $5.3 billion, or 43 cents per share after tax.
The settlement doesn't release the bank from criminal charges and the Justice Department reserved the right to file both criminal and civil charges against individuals.
The statement of facts, more detailed than those released in the J.P. Morgan and Citigroup settlements, paint an unflattering picture of Countrywide and Merrill as well as Bank of America.
The findings against Countrywide are particularly damning. The lender, an advocate of homeownership but also a pioneer of subprime and other risky loans, was itching to expand its market share in the early 2000s. When potential customers with lousy credit scores dropped in to apply for mortgages, Countrywide employees would sometimes shuffle them to "shadow" underwriting guidelines. The firm didn't verify whether some borrowers were being truthful about their income, and offered loans allowing borrowers to pay less than just the interest owed, meaning the amount borrowers owed grew over time instead of shrinking.
When Countrywide's executives were told that some borrowers appeared to be overstating their income, the chief risk officer shrugged off the concerns, writing in an email, "Many (most?) borrowers seek to report as little income as possible on their tax return."
"We need to be careful painting all of this as a 'misrep,'" the chief risk officer wrote. "Although that is obviously the case in some (perhaps many) instances, it won't be the case in all cases."
The Justice Department also found that Merrill Lynch ignored warnings from an outside vendor who noted the high number of "EV3" loans in certain subprime mortgage securities. The EV3 label was given to particularly questionable mortgages, such as those made to borrowers who had recently declared bankruptcy. Merrill traders, though, often overruled those labels.
In an internal email about a particular pool of loans, a consultant in Merrill Lynch's due diligence department wrote: "[h]ow much time do you want me to spend looking at these [loans] if [the co-head of Merrill Lynch's RMBS business] is going to keep them regardless of issues? . . . Makes you wonder why we have due diligence performed other than making sure the loan closed."
Bank of America also misled federal agencies to keep the easy money flowing, including misrepresenting the quality of loans it submitted to the Federal Housing Administration for government insurance—where the government shouldered the cost when the loans went bad.
The bank refinanced what had been a Countrywide loan, for about $156,000 on a 24-year-old mobile home, into a government-backed loan. The borrower, who was behind on his initial loan, was allowed to roll more than $12,000 of credit card and auto debt into the new government loan. He made two payments on the new FHA loan before defaulting, the Justice Department said.
Many of the mortgages that Bank of America submitted for government insurance have since defaulted, the Justice Department said.
Write to Christina Rexrode at christina.rexrode@wsj.com and Andrew Grossman at andrew.grossman@wsj.com
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