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OPINION

The never-ending saga of Credit Suisse’s RMBS settlement

Credit Suisse is making heavy work of meeting its obligations under a 2017 RMBS settlement with the US Department of Justice. If it wants to make real progress, it will have to bite the bullet soon.

Mark Baker on investment banking 1920px

RMBS settlements: remember them? Some 15 years after the great financial crisis, many banks are still wading through litigation associated with mortgages they packaged into residential mortgage-backed securities and other such delicacies. But what happens after a settlement is reached?

Not much, if Credit Suisse is any guide. The bank is due to report its first-quarter earnings on Wednesday and will doubtless have other things on its mind than the snail-like progress it has been making in meeting its obligations under a settlement it reached with the US Department of Justice (DoJ) in January 2017.

But then again, perhaps not. After all, as the bank noted in its most recent annual report, published on March 10, 2022, the (extended) deadline for it to meet its RMBS obligations expired at the end of 2021, meaning that the commitments that are still outstanding under the settlement will now increase at the rate of 5% a year until they are satisfied.

That’s no sideshow. According to an October 2021 report by the independent monitor tasked with overseeing the RMBS settlement, Credit Suisse has so far met only $372 million of its $2.8 billion consumer relief obligations. That’s just 13% with the deadline already gone, making it a pretty big miss.

For something that was in theory wrapped up more than five years ago, its persistence will be a source of frustration

And the bank certainly doesn’t think this problem is going away any time soon. Its current estimate is for it to meet its obligations under the settlement by 2026 at the earliest, more than doubling the period initially envisaged.

All of which adds to a nasty recent bout of pressure for Credit Suisse. Last Wednesday, the bank warned that it would report a loss for the first quarter of 2022, mostly because of its decision to increase litigation provisions by SFr600 million ($626 million) in the first quarter, taking them to SFr700 million for the period.

The bank didn’t say what the provisions related to, other than that they were to do with “previously disclosed legal matters, all of which originated more than a decade ago”.

A report on Sunday, by Swiss newspaper NZZ am Sonntag, said that the bank might be seeking to replace some longstanding senior staff, including chief legal officer Romeo Cerutti, chief financial officer David Mathers and Asia-Pacific head Helman Sitohang.

On the same day, Norway’s state oil fund, which is among the bank’s biggest 15 shareholders, said it would vote against relieving Credit Suisse directors and senior management of legal liability for the 2020 fiscal year at the bank’s next annual general meeting, scheduled for Friday. It will also back a proposal for a special auditor to be appointed to look into the ‘Swiss Leaks’ scandal and the Greensill supply-chain finance debacle.

Of course, this being Credit Suisse, there are plenty of “previously disclosed legal matters, all of which originated more than a decade ago”. But the RMBS settlement is a particular curiosity and bears a quick lack-of-progress report.

Pitching relief

The RMBS settlement was struck with the DoJ on January 18, 2017, and saw Credit Suisse resolve claims relating to RMBS that it packaged and sold between 2005 and 2007. The settlement directed the bank to pay a civil penalty of $2.48 billion and provide $2.8 billion in consumer relief through a combination of loan modifications for borrowers struggling to make payments or who had outstanding mortgages that were worth more than their homes, and through helping to fund affordable housing projects.

The $2.8 billion of relief has a number of sub-categories, including a minimum requirement for $980 million of loan principal forgiveness and a minimum of $1.75 billion of total loan modifications, including principal forgiveness. The affordable housing minimum obligation is $240 million.

The loan modifications themselves are handled by Select Portfolio Servicing (SPS), a mortgage servicing subsidiary of Credit Suisse. Monitoring compliance with the terms of the settlement is Neil Barofsky, lawyer at Jenner & Block. Barofsky produces periodic reports on the settlement that detail the submissions the bank makes and his own work in testing submitted loan modifications.

A first sample of modifications was submitted to Barofsky in the first half of 2018, and subsequent tranches of modifications have been made since then. But progress is slow. As of October 2021, Barofsky had validated $317.6 million in loan modification relief, of which some $52.6 million was principal forgiveness.

That is a mere 5.36% of the bank’s obligation to provide $980 million in principal forgiveness and 18% of its obligation for $1.75 billion of loan modifications. Affordable housing project funding is going a little better, with some $54 million funded so far, accounting for 23% of the minimum in that category.

The bank has been looking for ways to accelerate the pace. One way is to expand the scope of eligible modifications.

After the monitor published its seventh report, in October 2020, the bank came up with the idea of asking for 'short sales' to be included. These have no connection with the more familiar concept of short-selling in financial markets, but instead refer to occasions where a mortgage lender accepts the proceeds of a property sale as full repayment of the mortgage even if the outstanding mortgage balance was for a higher amount.

The bank and SPS worked with Barofsky for a few months to thrash out how such a scheme might work, and in the first half of 2021 a test batch of 100 completed short sales was submitted for analysis.

That first slug passed all the relevant protocols and the bank will now be submitting larger batches of sales.

For Credit Suisse, this is… good news? Sort of, but Barofsky’s October 2021 report makes it clear that he doesn’t think the expansion will go very far towards helping with the bank’s obligations.

That’s because while the bank had initially hoped it would be able to use short sales to meet its $980 million principal forgiveness objective in full, the DoJ had other ideas, concluding that while such arrangements could count towards overall loan modifications, they would not count as forgiveness of principal, but only forgiveness of balances.

The bank is now thinking about alternatives, including buying loans and modifying them on a principal basis, so that they count as principal forgiveness. It is also planning to submit extinguished second-lien loans and ramp up the submissions of other modifications that it has successfully submitted in the past for credit.

Nonetheless, it also expects to take much longer than originally envisaged to meet its targets. Remember, in its last annual report, Credit Suisse said that to do so would take until 2026 at the earliest.

In the context of Credit Suisse’s extensive list of legacy litigation exposures, it’s easy for its RMBS settlement to fly under the radar. But for something that was in theory wrapped up more than five years ago, its persistence will be a source of frustration.

Shareholders will be hoping the bank can finally report meaningful progress sooner rather than later.

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