RBS Securities Inc., a subsidiary of the Royal Bank of Scotland, will pay Connecticut $120 million – the largest single state settlement ever – to resolve allegations the bank’s handling of mortgage-backed securities directly contributed to the 2008 financial crisis.
Connecticut Attorney General George Jepsen and Banking Commissioner Jorge Perez announced the historic settlement Monday. In it, the Department of Banking will get $250,000 to use for financial education, training and a financial literacy program. The other $119,750,000 will go to the state’s General Fund.
The settlement is the largest in Connecticut’s history, according to state officials. The second-largest came last year when the state got $36 million from a settlement with Standard & Poor’s that resolved allegations the company’s conduct contributed to the 2008 financial collapse.
State officials claimed that RBS contributed to the financial crises by failing to complete proper due diligence when it came to certain mortgage-backed investment tools.
“The collapse of financial instruments, especially residential mortgage-backed securities, was directly responsible for the financial crisis that led to the Great Recession that so badly impacted the economies of our state and our nation,” Jepsen said in a statement. “RBS failed to properly determine – and misstated – the quality of the mortgage loans comprising many mortgage-backed securities.”
A residential mortgage-backed security, or RMBS, is a type of investment product backed by the mortgage payments of thousands of homeowners. People who invest in RMBS are entitled to the cash flow from the underlying mortgage loans.
According to state officials, a major problem arose when, prior to 2008, the securities were backed by subprime mortgages that homeowners were unable to pay back when their home values sank during the recession. Subprime mortgages are loans given to borrowers with poor credit, who typically wouldn’t qualify for conventional loans.
“What we found through this investigation was that RBS, one of the largest RMBS (residential mortgage-backed securities) underwriters, failed on multiple fronts to ensure that the information it provided about RMBS deals was accurate,” Jepsen said.
Jepsen said his staff worked with the Department of Banking over the last four years to review thousands of documents, emails and records. They also analyzed data about RBS’s processes and procedures for conducting due diligence.
The attorney general said RBS was a key player in the RMBS business leading up to 2008, having underwritten $250 billion in securities that have endured more than $40 billion in losses.
“With today’s settlement, we are holding RBS accountable under Connecticut law for its behavior that contributed significantly to the 2008 financial crisis,” he said.
RBS, which no longer securitizes newly originated RMBS, said in a brief statement Monday it reached a settlement to resolve two outstanding civil lawsuits for $1.1 billion. The company will cover the settlement amount with “existing provisions,” the statement said.
As the lead underwriter for about 250 RMBS between 2005 and 2008, RBS was required to do due diligence on the mortgage loans it used as collateral. Connecticut alleged that the company’s due diligence process was “inadequate and resulted in omissions and misstatements in the representations made to the public and investors about the securities.”
In some cases, state official claim, third-party vendors hired by RBS gave the loans low grades in independent reviews but RBS regraded them at a higher level and included the loans in the RMBS pools.
Connecticut accused RBS of dishonest and unethical conduct, and of making false statements when representing its securities products.
“The ripple effect of the practices of financial institutions, coupled with the devaluing of residential mortgage backed securities, was felt by residents across Connecticut who were foreclosed out of their homes and lost their jobs as a result of the ensuing financial crisis,” Pérez said in a statement.
“One of the primary missions of our (Banking) department is to protect Connecticut residents and consumers of financial products. This settlement helps us do that by compelling a modification to RBS’s business practices that ensures this does not happen in the future,” Perez said.
Under the settlement, for 10 years, RBS must certify with the state Department of Banking that it complies with conditions of a plan approved by the National Adjudicatory Council of the Financial Industry Regulatory Authority.
RBS has agreed to comply with applicable Connecticut law, state officials said.
The Department of Banking’s share of the settlement money will be used to continue training staff to identify and investigate similar practices to RBS’ in the future, and for educational outreach to state residents, Perez said.