How Much Will RBS Pay FHFA To Settle Mortgage Lawsuit?

RBS: Royal Bank of Scotland Group logo
RBS
Royal Bank of Scotland Group

Earlier this week, Bloomberg Intelligence estimated that the Royal Bank of Scotland Group (NYSE:RBS) will likely shell out $4.5 billion to finally put to rest the lawsuit filed against it by the Federal Housing Finance Agency (FHFA) in 2011. [1] The lawsuit, which was one of 18 filed by the housing regulator on behalf of Fannie Mae and Freddie Mac, is now one of only two that are yet to be settled. ((FHFA Legal Filings, FHFA Website, Sep 2 2011)) Given the fact that a U.S. court recently found the other holdout firm (Nomura) guilty of mis-selling mortgage-backed securities to the government-sponsored enterprises (GSEs) prior to 2008, RBS will be keen on settling the matter at the earliest. [2] Incidentally, a subsidiary of RBS was a co-defendant in the Normura lawsuit, as RBS Securities had underwritten some of those deals.

In this article, we detail the FHFA lawsuits which were settled by the other financial institutions over the years, and how much each of them paid in the process. Using this as reference, we try to arrive at our own estimate for RBS’s settlement figure for the issue.

See our full analysis for RBS

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In 2011, the FHFA launched a legal battle against some of the world’s biggest financial institutions in a bid to make them pay for the billions in losses they inflicted on mortgage enterprises Fannie Mae and Freddie Mac by downplaying the underlying risks involved in scores of mortgage-backed securities they originated. The lawsuits – 18 in all – sought recourse for mis-sold securities worth a little over $200 billion. Over the years, the FHFA made separate deals with all but two of these financial institutions – beginning with GE in January 2013. ((FHFA says settlement reached with GE in mortgage case, Reuters, Jan 23 2013))

The chart below details the settlement figures for each of these financial institutions as well as the total value of poor mortgage-backed securities that each of them sold to Fannie Mae and Freddie Mac, and is based on FHFA press releases. [3] It must be mentioned here that the figure for Bank of America includes the lawsuits against Countrywide as well as Merrill Lynch, while the numbers for JPMorgan are inclusive of Bear Stearns.

Financial Institution Securities Mis-sold Settlement Figure Fine %
Bank of America $57.4 billion $5.83 billion 10.2%
JPMorgan Chase $33 billion $4 billion 12.1%
RBS Group $30.4 billion Pending N.A.
Deutsche Bank $14.2 billion $1.925 billion 13.6%
Credit Suisse $14.1 billion $885 million 6.3%
Goldman Sachs $11.1 billion $1.2 billion 10.8%
Morgan Stanley $10.6 billion $1.25 billion 11.8%
HSBC $6.2 billion $550 million 8.9%
Ally Financial $6.0 billion $475 million 7.9%
Barclays $4.9 billion $280 million 5.7%
UBS $4.5 billion $885 million 19.7%
Citigroup $3.5 billion $250 million 7.1%
Nomura $2.0 billion Pending N.A.
Société Générale $1.3 billion $122 million 9.4%
First Horizon National $883 million $110 million 12.5%
GE $549 million $6.25 million 1.1%

As can be clearly seen here, the final settlement figures for the financial institutions have ranged from just 1% of the value of securities (GE) to almost 20% of the value of these securities (UBS). The difference can be easily explained by the fact that the deals take into account the actual proportion of securities that have been rendered worthless after the downturn. As GE is clearly an outlier here, removing the corresponding data indicates a range of 6-20% for the fines in terms of security value. This points to a fine of between $1.8 billion and $6 billion for RBS on the $30.4 billion in mortgage-backed securities it sold in the run-up to the economic downturn.

Given the size of the portfolio RBS sold, and considering only the banks with at least $10 billion in mis-sold securities, the average fine works out to 10.8% of the total value. This figure yields a prudent estimate for RBS’s settlement expense to be $3.3 billion. Notably, this is roughly equal to the £2.1 billion ($3.2 billion) in legal provisions created by RBS to cover the costs of a settlement with the FHFA.

But there is another important aspect here that could result in RBS being forced to shell out significantly more than the $3.3 billion we currently estimate. In the lawsuit against Nomura, the judge fined the Japanese bank along with the underwriter RBS a total of $806 million. [3] This represents a fine which is a good 40% of the total size of securities mis-sold by Nomura to the GSEs. A closer look at this $806 million fine amount shows that the actual expense imposed on the issuer of the securities, Nomura, was $170 million, while that for the underwriter, RBS, was $528 million. [1] The remaining $108 million is towards legal costs, and will be shared among the two banks.

This implies that any potential settlement by RBS may include a significant penalty over and above costs to cover the losses to the GSEs. The $4.5 billion estimate by Bloomberg Intelligence, therefore, seems reasonable. If this is indeed what RBS is forced to shell out, then it will incur a one-time charge of $1.3 billion in the quarter the deal is reached – hurting margins for its investment banking operations for that period.

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Notes:
  1. RBS Seen Facing Up to $4.5 Billion to Close Mortgage Suit, Bloomberg, May 27 2015 [] []
  2. Nomura, RBS must pay $806 mln in mortgage bond case-U.S. judge, Reuters, May 15 2015 []
  3. FHFA’s Update on Private Label Securities Action, FHFA Website, Sep 12 2014 [] []