August 11th, 2011
Econintersect: AIG and subsidiaries have filed suit against Bank and America claiming “massive fraud.” The language is extremely blunt in the complaint filed August 8, 2011 in the Supreme Court of the State of New York, County of New York. Other charges contain the terms “fraudulently induced”, “fraudulently misrepresented”, use of “false credit metrics”, “materially misrepresented”, “dramatically understated” ratios, “falsely represented”, “grossly misrepresented”, “systematic misrepresentations” and “dizzying array of toxic loan products”. Follow up:
Follow up:Here is the complete statement of the Nature of Action from Scripd:
NATURE OF ACTION
1. This case arises from a massive fraud perpetrated by Defendants Bank of America, Merrill Lynch, and Countrywide that has resulted in more than $10 billion in damages to AIG, and ultimately American taxpayers. AIG brings this action as part of its overall efforts to recoup such damages from these defendants and other parties.
2. Between 2005 and 2007, Defendants fraudulently induced AIG to invest in nearly 350 residential mortgage-backed securities (“RMBS”) at a price of over $28 billion. Driven by a single-minded desire to increase their share of the lucrative RMBS market and the considerable fees generated by it, Defendants created and marketed RMBS backed by hundreds of thousands of defective mortgages.
3. The Offering Materials used to sell the RMBS fraudulently misrepresented and concealed the actual credit quality of the mortgages by providing false quantitative data about the loans, thus masking the true credit risk of AIG’’s investments. The Offering Materials also falsely claimed that the mortgages had been issued pursuant to objective underwriting guidelines. In fact, the loan originators, including Defendants, encouraged borrowers to falsify loan applications, pressured property appraisers to inflate home values, and ignored obvious red flags in the underwriting process.
4. The stated underwriting guidelines had been replaced by an undisclosed governing principle: Defendants would originate or acquire any loan that could be sold to third party investors like AIG through RMBS securitization, no matter how risky. To make matters worse, Defendants provided to the rating agencies the same false credit metrics that riddled the Offering Materials, thus allowing Defendants to engineer inflated credit ratings for the RMBS, which they also used to market the securities. AIG, which suffered more than $10 billion in losses as a result of Defendants’’ misconduct, would not have purchased the securities if it had known the truth.
5. As Defendants knew, the true quality and value of the RMBS it was offering for sale depended on the credit quality of the mortgage loans underlying the RMBS. Investors like AIG assessed the risk of investing in RMBS based on quantitative, risk-related metrics regarding the loans backing the RMBS such as loan-to-value (“LTV”) ratios, combined loan-to-value (“CLTV”) ratios, and owner-occupancy statistics. These metrics are used to assess a borrower’s ability to repay a loan, and the likelihood of repayment. For investors, they are important measures of anticipated default rates and possible foreclosure recoveries in the mortgage pools. In the Offering Materials for every one of the RMBS at issue, Defendants materially misrepresented this critical information and thus grossly understated the riskiness of the mortgage loans that backed these securities.
6. Before filing this suit, AIG conducted an exhaustive forensic investigation of the loan pools underlying the RMBS it purchased to determine the extent of Defendants’ misconduct. AIG sampled loans from each RMBS transaction for which data was available. In total, AIG analyzed over 262,000 loans. For each of these loans, AIG analyzed public records, and conducted a retroactive appraisal using an industry leading valuation model and historical data. The results of AIG’s forensic investigation are startling:
• Defendants dramatically understated LTV and CLTV ratios. On average, 34.27% of the sampled loans actually had LTV ratios more than 10 percentage points higher than what was represented to AIG. Similarly, on average, 44.4% of the sampled loans actually had CLTV ratios more than 10 percentage points higher than what was represented to AIG.
• In almost every RMBS, Defendants falsely represented that not a single mortgage had an LTV ratio above 100%. In fact, on average, 16.8% of the mortgage loans in the sampled mortgage pools had LTV ratios above 100%, meaning the loans exceeded the value of the mortgaged properties themselves and were “underwater” from the date of origination.
• Defendants grossly misrepresented the properties backing the mortgages as owner-occupied. It is a well known fact in the mortgage industry that loan default rates on owner-occupied homes are much lower than second or third homes or investment properties. On average, Defendants overstated owner-occupancy by 14.1 percentage points.
• Defendants’ misrepresentations in the Offering Materials were based on false metrics in a staggering 40.2% of the sampled loans. Of the 262,322 loans tested, 105,568 were inconsistent with one or more of Defendants’’ metrics by 10 percentage points or more.
The enormity of these numbers demonstrates that Defendants were engaged in a massive scheme to manipulate and deceive investors, like AIG, who had no alternative but to rely on the lies and omissions made by Defendants.
7. The results of AIG’’s forensic analysis are just the tip of the iceberg. The systemic misrepresentations regarding LTV, CLTV, and owner-occupancy address only a subset, albeit an important subset, of the representations Defendants made concerning the quality of the loan pools. These are the representations that AIG was able to analyze using forensic tools outside of the information in the loan files themselves. A myriad of other key factors that further address the integrity (or lack thereof) of Defendants’’ loan underwriting process——such as borrowers’’ income, employment verification, and the supposed compensating factors that were considered in approving “exceptions” to stated guidelines——can only be scrutinized by reviewing the actual loan files. AIG is confident that a review of the complete loan files in discovery will demonstrate that the fraud perpetrated by Defendants was even more rampant than AIG’s forensic analysis reveals.
8. Despite multiple requests by AIG, AIG has been unable to gain access to the loan files for nearly all of the RMBS underwritten by Defendants. A sample of loan files in a deal underwritten by Bank of America and for which AIG has been able to obtain loan files shows that a staggering 82% of the loans did not comply with underwriting guidelines, including examples such as these:
• Misrepresentation of Employment. The borrower stated on the loan application that she was self-employed as a builder for 25 years, earning $35,000 per month, and the co-borrower stated that he was also self-employed as a builder earning $30,000 per month. The borrower also listed on the application that she had been the owner of her building/construction business for 25 years; however, her year of birth was 1971, which would have made the borrower 10 years old when she became the owner of the business. Additionally, the loan file contained letters of incorporation for both the borrower and co-borrower’s businesses with inception dates of 9/28/1993 and 2/26/2002, respectively. A reasonably prudent underwriter should have noticed that the age discrepancy was a red flag and questioned the validity of the information contained on the loan application. The loan defaulted.
• Misrepresentation of Income. The borrower stated on the application that she was self-employed as a personal chef with a monthly income of $10,166.67, or $122,000.00 annually. The borrower’s tax returns, contained in the loan file, showed a gross income for the entire year of 2007 of $3,126.00 for services as a personal chef, and $27,225 as a self-employed personal assistant. The borrower earned monthly income that was $675 less than the amount of the subject loan mortgage payment in the year following the mortgage closing. The borrower made only one payment on the mortgage, and defaulted.
• Misrepresentation of Debt Obligations. The application failed to disclose that the borrower simultaneously closed on a second mortgage, originated by the same lender, in the same condominium complex. Public records show that the Borrower acquired a mortgage on the same day as the subject loan for $414,000 with a monthly payment of $4,995 for a property located in Dallas, Texas. The origination underwriter failed to include the monthly payment in the borrower’s debt-to-income ratio (“DTI”) for the subject loan, resulting in an imprudent underwriting decision. A recalculation of DTI based on the borrower’s undisclosed debt, and recalculated income of $1,200 per month, yields a DTI of 1,129.08%, which exceeds the guideline maximum allowable DTI of 55%. The loan defaulted.
9. Not only did Defendants create RMBS with shoddy loans, but they also engineered unduly positive credit ratings for these securities. Defendants knew that investors like AIG required RMBS to meet stringent credit ratings criteria, and thus duped the rating agencies into rating the senior tranches of these securities AAA. Defendants gave the rating agencies the same misrepresented data about loan characteristics and underwriting guidelines provided to AIG. The rating agencies analyzed their performance based on the false assumptions Defendants supplied. Because these assumptions understated the risks of the collateral pools, the rating agencies assigned unduly high credit ratings for the securities. Defendants then marketed the RMBS with the inflated ratings and misrepresented in the Offering Materials that the artificially high ratings were an accurate measure of their credit quality based on the misstated collateral pool data.
10. Also misstated in every one of the RMBS at issue were the underwriting guidelines that the lending banks were supposedly following. Both in the Offering Materials and at in-person due diligence meetings with AIG credit research personnel, Defendants represented that the collateral loans were issued pursuant to rational, objective criteria that would assess each borrower’s ability to pay and the market value of the underlying properties. Defendants misled AIG into believing that the loans in the pools were issued pursuant to the disclosed underwriting guidelines, when in fact those guidelines had been long abandoned. In fact, the only measure of whether a loan would be approved was whether it could be sold into a securitization.
11. Defendants’ abandonment of underwriting practices has been revealed through regulatory and public scrutiny of Defendants’ unscrupulous business practices. Investigations by the New York Attorney General, the Securities and Exchange Commission, the U.S. Senate Permanent Subcommittee on Investigations (“SPSI”), and Attorneys General for the states of California, Illinois, Florida, Washington, Indiana, and West Virginia, as well as interviews of Defendants’ senior officers and other key employees conducted by the Financial Crisis Inquiry Commission (“FCIC”), have brought to light Defendants’ shoddy practices. Just last week, the New York Attorney General filed papers in this Court asserting that Countrywide and Bank of America face both Martin Act liability and liability for ““persistent illegality in the conduct of business”” under Executive Law § 63(12) for, among other things, making ““repeated false representations in the Governing Agreements [of RMBS] that the quality of the mortgages sold into the Trusts would be ensured”” and ““repeatedly breaching representations and warranties concerning loan quality.”
12. Creating and selling RMBS was an extremely profitable business. Defendants’ internal documents, testimony from senior officers and other key employees under oath, as well as confidential interviews of former employees conducted by AIG prior to the filing of this complaint demonstrate that, during the subprime lending “gold rush” years of 2004 to 2007, each of the Defendants——Countrywide, Merrill, and Bank of America——competed fiercely to increase their market share and ratchet up profits from RMBS. In the process, Defendants brought to market hundreds of RMBS sold to AIG collateralized by loan pools that did not come close to satisfying the underwriting guidelines touted in the prospectus supplements.
13. Countrywide was one of the worst offenders. Its own senior officers and internal auditors have admitted that Countrywide compromised its underwriting integrity for the sake of fueling its profit machine:
• Countrywide Financial’s co-founder and CEO, Angelo Mozilo, stated to Wall Street analysts that his goal for Countrywide Financial was to “dominate” the mortgage market and “to get our overall market share to the ultimate 30% by 2006, 2007.”
• A former senior regional vice president of Countrywide was quoted in Business Week as saying that Countrywide “approached making loans like making widgets, focusing on cost to produce and not risk or compliance. Programs like ‘Fast and Easy’ where the income and assets were stated, not verified, were open to abuse and misuse. The fiduciary responsibility of making sure whether the loan should truly be done was not as important as getting the deal done.”
• In a November 2007 internal report, Countrywide admitted: “We were driven by market share, and wouldn’t say ‘no’ (to guideline expansion). …… Market share, size and dominance were driving themes . . . . Created huge upside in good times, but challenges in today’s environment. Net/net it was probably worth it.”
14. Countrywide implemented a matching strategy in which it adopted any lending practice of its competitors, no matter how liberal——a practice which resulted in Countrywide offering a dizzying array of toxic loan products. For example:
• In internal e-mails, Mozilo himself characterized Countrywide’s new subprime loan products as “toxic,” “poison,” and “the most dangerous product in existence.” Mozilo also observed that there was a “disregard for process [and] compliance with guidelines.”
• A former finance executive at Countrywide explained that: “To the extent more than 5 percent of the [mortgage] market was originating a particular product, any new alternative mortgage product, then Countrywide would originate it . . . . [I]t’s the proverbial race to the bottom.”
• John McMurray, Countrywide’s Chief Risk Officer, testified before the SEC that he agreed that whether Countrywide was “ceding our credit policy to the most aggressive players in the market” was a “pretty serious concern.”
• In an internal e-mail, Frank Aguilera, a Countrywide Managing Director responsible for risk management, reported that over 23% of the subprime loans at the time were generated as exceptions, even taking into account “all guidelines, published and not published, approved and not yet approved.” Aguilera wrote that ““[t]he results speak toward our inability to adequately impose and monitor controls on production operations.”
15. Though touting Countrywide’s adherence to underwriting guidelines publicly, Countrywide senior officers internally admitted that “saleability”——that is, whether Countrywide could sell the loan on the secondary market, rather than compliance with underwriting guidelines——became the sole factor governing whether a loan would be approved:
• In his testimony to the SEC, David Sambol, Countrywide Home Loans’’ President and Chief Operating Officer, identified a February 13, 2005 e-mail he wrote that said that ““our pricing philosophy”” should be expanded so that ““we should be willing to price virtually any loan that we reasonably believe we can sell/securitize without losing money, even if other lenders can’t or won’t do the deal.”
• In an internal e-mail, Countrywide’s Executive Vice President of Credit Risk Management, Christian Ingerslev, asked “should the line in the sand still be ‘unsaleable’? After looking at the performance, it ’s hard to recommend anything other than no. Heretofore that has been a challenging edict for Credit to implement (for obvious reasons) and the outcry is to just price the risk - regardless of performance.”
16. Countrywide’s senior management knew that its loan origination guidelines were not being followed and that Countrywide was making loans that carried a high——and undisclosed——probability of default:
• In a May 22, 2005 internal e-mail, Chief Risk Officer McMurray warned President and COO Sambol that “exceptions are generally done at terms even more aggressive than our guidelines” and recommended that “[g]iven the expansion in guidelines and the growing likelihood that the real estate market will cool, this seems like an appropriate juncture to revisit our approach to exceptions.” He continued: “As a consequence of [Countrywide’s] strategy to have the widest product line in the industry, we are clearly out on the ‘frontier’ in many areas,” adding that that “frontier” had “high expected default rates and losses.”
• In the same e-mail thread, McMurray told Sambol that the company could face liability for its faulty underwriting practices and misrepresentations to investors: “We’ve sold much of the credit risk associated with high risk transactions away to third parties. Nevertheless, we will see higher rates of default on the riskier transactions and third parties coming back to us seeking a repurchase or indemnification based on an alleged R[epresentation] & W[arranty] breach as the rationale.” (Emphasis added).
• In a February 11, 2007 e-mail to Sambol, McMurray reiterated his concerns, stating: “I doubt this approach would play well with regulators, investors, rating agencies, etc. To some, this approach might seem like we’ve simply ceded our risk standards . . . to whoever has the most liberal guidelines.”
• McMurray also testified before the SEC that he was aware that there were instances where his credit risk department “reject[ed] proposals for new products and the people in sales nevertheless used the exceptions procedure to achieve the same result.”
• In an internal report forwarded to CEO Mozilo, Countrywide admitted that “borrower repayment capacity was not adequately assessed by the bank during the underwriting process for home equity loans” for mortgages originated by Countrywide in 2006 and 2007.
17. Moreover, Countrywide’s own diligence demonstrated that the loans it was pooling failed the criteria, but Countrywide ignored the results of its own analysis. Documents recently disclosed by the FCIC show that Countrywide retained the third-party due diligence firm Clayton Holdings, Inc. (“Clayton”) to analyze the loans it was considering placing in its securitizations. Clayton’s reports reveal that from the fourth quarter of 2006 to the first quarter of 2007, 26% of the mortgages Countrywide submitted to Clayton for review were rejected as outside underwriting guidelines. Of the mortgages that Clayton found defective, 12% were subsequently “waived in” by Countrywide and included in securitizations like the ones in which AIG invested. Clayton’s reports also include statistics on loans originated by Countrywide and submitted to Clayton for review, including Countrywide loans that were sold on the secondary market and included in non-Countrywide securitizations. During the same time period, Clayton found that between 13% and 24% of those loans were outside underwriting guidelines.
18. Merrill Lynch also systematically departed from its stated underwriting guidelines. Like Countrywide, starting in 2004, Merrill took aggressive action to climb to the top of the RMBS pile. In return for a guaranteed stream of mortgage loans for its securitizations, Merrill began offering “warehouse” financing to originating banks, which the lenders used to originate subprime mortgages, at little to no cost. At the same time, Merrill adopted liberal standards regarding the type of mortgage loans it was willing to acquire. In 2005, Merrill purchased a stake in subprime lender Ownit Mortgage Solutions, Inc. in order to control the stream of mortgage loans it could pool and then sell. In 2006, Merrill announced plans to buy another subprime lender, First Franklin. In his book on the financial crisis, David Faber summarized Merrill’s RMBS business strategy in no uncertain terms: “[Merrill] wanted to originate more mortgages, buy more mortgages, package more mortgages into securities, and package more of those securities into CDOs [collateralized debt obligations]. And of course, it wanted to sell those securities and CDOs as fast as it possibly could, because that’s where the money was.”
19. Intense industry competition led Merrill to loosen underwriting guidelines and to make as many loans as possible appear to pass muster under those guidelines. Merrill encouraged subprime lenders——including its own affiliates——to originate more low- and no documentation loans. These types of loans were frequently referred to as “liar loans” within the mortgage industry because of the frequency with which borrowers lied on their applications, often with the originators’ knowledge or active assistance. Merrill knew from its experience with loan securitization that “liar loans” were plagued by fraud, but it encouraged its affiliates and other subprime lenders to generate these loans anyway in order to increase loan volume and the price it could obtain for RMBS. Indeed, William Dallas, the chief executive of Ownit, stated that Merrill paid Ownit a greater amount for no-income verification loans than for full documentation loans.
20. Confidential witnesses interviewed by AIG prior to the filing of this complaint revealed that Merrill’s origination arms, Ownit and First Franklin, abandoned their underwriting guidelines to fuel Merrill’s securitization machine. For example, a former senior underwriter at Ownit told AIG that Ownit loan officers themselves were falsely inflating incomes and “fudging the numbers” to get stated income loans approved. This same former employee said that, at Ownit, the appraisal process was “owned by the loan officers” who enjoyed “a cozy relationship” with the appraisers. She stated that “excessive adjustments” were made to inflate appraisals and these adjustments were never challenged. A former underwriter at First Franklin stated that some of the lending practices at First Franklin were “basically criminal” and that First Franklin required its underwriters to depart from stated underwriting guidelines in a way “that we did not agree with, but had to do” in order to keep their jobs. When she and another former underwriter “spoke out” about the problematic lending practices taking place at First Franklin, they were both fired for attempting to “blow the whistle” on First Franklin’s problematic lending practices. Another former First Franklin underwriter disclosed to AIG that if an underwriter rejected a loan because did not meet underwriting criteria, her manager would re-direct the loan application to a certain loan processor who would “sign behind your back.”
21. Merrill issued RMBS with loans that it knew failed to meet stated guidelines. Like Countrywide, it conducted its own due diligence that revealed that loans it purchased from originators failed to meet disclosed underwriting standards. Merrill also retained Clayton to perform due diligence. Clayton found that 23% of the loans it reviewed for Merrill “failed to meet guidelines.” The loans had been granted despite the lack of any purported compensating factors justifying an exception. Yet Merrill “waived in” to its pools 32% of the toxic loans that Clayton identified as being outside the guidelines and sold them to investors like AIG.
22. Merrill’s former CEO John Thain summed up Merrill’s problem when he commented in a September 2010 interview: “[W]hen you have a system where you pay someone for originating mortgages simply on volume and nothing happens to them if the credit quality is bad, and nothing happens to them if the borrower is fraudulent on his loan application, and nothing happens to him if the appraisal’s fraudulent, then that’s probably not a very smart system.” This was precisely the system Merrill used to originate or acquire loans, securitize them into RMBS, and sell the securities to AIG and other unsuspecting investors.
23. Bank of America also departed from its own underwriting standards in order to keep pace with the market and to guarantee mortgage loans for its own securitizations. Bank of America was an aggressive competitor on the mortgage market, offering products that other lenders could not beat. Indeed, in an internal Countrywide e-mail, Mozilo himself noted Bank of America’s “aggressive move into mortgages” and complained that even Countrywide could not match some of Bank of America’s riskier products.
24. Confidential witnesses interviewed by AIG confirmed Bank of America’s improper origination and securitization practices. For example, one former employee revealed that Bank of America loan officers themselves inflated borrower income and “doctored the numbers” to get stated income loans approved. Another former Bank of America loan processor divulged that when borrowers accidentally submitted documentation for stated income loans that directly contradicted the income claimed by the borrowers, management told the loan processors to simply ignore the documentation: “we didn’t have to consider evidence” that directly contradicted borrowers’’ claims about their income. And according to yet another former employee, loan officers would often call appraisers and tell them “I need you to come in at this amount.” The appraisers would then return with the requested valuation. A confidential witness also revealed to AIG that Bank of America diverted severely credit-blemished loan applicants to its so-called “Plan C” group, which employed alternative underwriting criteria to approve and fund loans. The “Plan C” group had wide latitude to grant exceptions to Bank of America’s stated underwriting guidelines, and the group’s mandate was to find ways to fund loans that otherwise would be rejected——loans that one former Bank of America employee believed “should not have been funded under any circumstances.”
25. Clayton, which Bank of America also retained to perform due diligence, informed Bank of America that 30% of the loans it reviewed were defective. But Bank of America nevertheless “waived in” 27% of these toxic loans and included them in securitizations. Another confidential witness——a former Clayton employee——told AIG that Bank of America was not actually interested in the fundamental credit quality of the loans reviewed during Bank of America’s due diligence process. Instead, this former Clayton employee revealed that a Vice President of Structured Products at Bank of America specifically told him that he “didn’t give a flying f*** about DTI [debt-to-income ratios]” and other credit characteristics of the loans being reviewed. The Bank of America VP told this former Clayton employee that, “we [Bank of America] can sell [the loans] to whoever” and “we [Bank of America] can sell [the loans] down the line.”
26. These facts are only illustrative of Defendants’’ pattern of misconduct, which is discussed in further detail below. Defendants’’ misconduct can be explained quite simply. Countrywide, Merrill, and Bank of America did not tell AIG the truth about the loans that collateralized the securities. AIG reviewed and relied on the misleading misrepresentations about loan characteristics, favorable ratings, and embellished underwriting practices. It would not have purchased these securities had it known the truth. As a result, AIG lost over $10 billion.