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Wells Fargo Admits Misconduct as Part of the $1.2B Accord

Wells Fargo & Company WFC admitted to malpractices as the company formally reached the $1.2 billion settlement with the U.S. government regarding the bank’s Federal Housing Administration (‘FHA’) lending program. The settlement was disclosed in February this year.

According to the latest release by the U.S. Department of Justice, Wells Fargo “admitted, acknowledged and accepted responsibility” to several things including wrongful certification to certain residential home mortgage loans as qualifying for FHA insurance in the period from May 2001 through Dec 2008. As a result, when some of these loans defaulted, the government had to pay the FHA insurance claims. Also, the San Francisco-based banking giant accepted that it did not disclose thousands of faulty mortgage loans to the Department of Housing and Urban Development (HUD).

Kurt Lofrano, who was Vice President of Credit Risk – Quality Assurance at Wells Fargo from Jan 1, 2002 to Dec 31, 2010, was also part of the settlement. Lofrano admitted to several claims.

Preet Bharara, U.S. Attorney for the Southern District of New York mentioned, “Today, Wells Fargo, one of the biggest mortgage lenders in the world, has been held responsible for years of reckless underwriting, while relying on government insurance to deal with the damage.”

Bharara also added, “Driven to maximize profits, Wells Fargo employed shoddy underwriting practices to drive up loan volume, at the expense of loan quality. Even though Wells Fargo identified through internal quality assurance reviews thousands of problematic loans, the bank decided not to report them to HUD. As a result, while Wells Fargo enjoyed huge profits from its FHA loan business, the government was left holding the bag when the bad loans went bust.”

Franklin Codel, President of Wells Fargo Home Lending Wells Fargo mentioned, “Today’s court filing details a previously announced agreement in principle that resolves not only the pending lawsuit filed by the U.S. Attorney for the Southern District of New York, but also a number of other potential claims going back as far as 15 years in some cases.”

Matter in Brief

The concerned case dates back to Oct 9, 2012, filed in U.S. District Court for the Southern District of New York and was later amended twice.  The U.S. government alleged that in the period from May 2001 and Oct 2005, Wells Fargo was engaged in “reckless” origination and underwriting of its FHA mortgage loans.

The company certified that more than 100,000 such FHA loans were in compliance with the requirements of HUD and hence stood eligible for FHA insurance. However, the bank was aware of the fact that a significant amount of these loans were too risky, defective and did not qualify under HUD standards. In fact, the loans were ineligible for FHA insurance claims.

Per the complaint “the extremely poor quality of Wells Fargo’s loans was a function of management’s nearly singular focus on increasing the volume of FHA originations – and the bank’s profits – rather than on the quality of the loans being originated.”

Owing to the false certification of those mortgage loans, the bank unfairly realized proceeds while putting billions of FHA dollars at stake. Consequently, on account of those faulty loans, FHA incurred payment of “hundreds of millions of dollars” in FHA benefits.

Bottom Line

Giving effect to legal costs, Wells Fargo reduced net income for full year 2015, by $134 million, or 3 cents per share. Net income for 2015 was revised at $22.9 billion or $4.12 per share as against previously reported figure of $23 billion or $4.15 per share.

Though the settlement affected Wells Fargo’s earnings for 2015, it relieved the company of the legacy issues. We remain encouraged by the efforts of the Wall Street Banking giant in gradually resolving its legal overhangs.

Other companies that have faced similar charges include JPMorgan Chase & Co. JPM, Citigroup Inc. C and Bank of America Corporation BAC. All these banks have previously reached settlements with the Justice Department.

Currently, Wells Fargo carries a Zacks Rank #4 (Sell).

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