(CN) – Wells Fargo Bank, N.A. will pay $2.09 billion under the Financial Institutions Reform, Recovery, and Enforcement Act to settle claims it knowingly originated and sold residential mortgages it knew contained misstated income information, the Justice Department said Wednesday.
According to the government, investors, including federally insured financial institutions, suffered billions of dollars in losses from investing in residential mortgage-backed securities containing loans originated by Wells Fargo.
Wells Fargo sold at least 73,539 stated income loans between 2005 to 2007, and nearly half of those loans have defaulted, the Justice Department said.
“This settlement holds Wells Fargo accountable for actions that contributed to the financial crisis,” Acting Associate Attorney General Jesse Panuccio said in a written statement.
“It sends a strong message that the Department is committed to protecting the nation’s economy and financial markets against fraud,” Panuccio said.
The Financial Institutions Reform, Recovery, and Enforcement Act authorizes the federal government to seek civil penalties against financial institutions that violate various predicate criminal offenses, including wire and mail fraud.
The Justice Department alleged that, in 2005, Wells Fargo began an initiative to double its production of subprime and Alt-A loans. As part of that initative, the government said, Wells Fargo loosened its requirements for originating stated income loans – loans where a borrower simply states his or her income without providing any supporting income documentation.
To evaluate the integrity of its increasing volume of stated income loans, Wells Fargo subjected a sample of these loans to so-called “4506-T testing.” A 4506-T form is a government document signed by the borrower during the loan approval process that allows the lender to obtain the borrower’s tax transcripts from the Internal Revenue Service.
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.
After receiving these results, Wells Fargo conducted further internal testing. 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.
The results of Wells Fargo’s 4506-T testing were disclosed in internal monthly reports, which were widely distributed among Wells Fargo employees. According to the Justice Department, one Wells Fargo employee in risk management observed that the “4506-T results are 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.”
The government alleged that, despite its knowledge that a substantial portion of its stated income loans contained misstated income, Wells Fargo failed to disclose this information, and instead reported to investors false debt-to-income ratios in connection with the loans it sold.
Wells Fargo also allegedly heralded its fraud controls while failing to disclose the income discrepancies its controls had identified, the Justice Department said.
The government further alleged that Wells Fargo took steps to insulate itself from the risks of its stated income loans, by screening out many of these loans 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 Justice Department emphasized the claims resolved by this settlement are allegations only, and there has been no admission of liability.