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Citigroup Settles Mortgage Inquiry for $7 billion

The $7 billion deal that Citigroup agreed to strike with the Justice Department involves one of the largest cash penalties ever paid to settle a federal inquiry into a bank suspected of mortgage misdeeds.

But another major component of the settlement has little to do with troubled mortgages. As part of the deal, Citigroup has also agreed to provide $180 million in financing to build affordable rental housing.

The unusual arrangement, which was outlined in the deal on Monday, underscores how difficult it remains for Citigroup to shed its rocky past and how federal prosecutors are getting creative in holding the nation’s big banks accountable for losses that crippled the global financial system in 2008.

Like other settlements the federal government has signed with Wall Street, Citigroup’s deal also requires the bank to modify mortgages of struggling homeowners. But Citigroup’s mortgage business has shrunk appreciably since the financial crisis, and the bank doesn’t service enough troubled mortgages to satisfy the monetary settlement terms for homeowner relief. So the bank agreed to finance affordable rental housing in unspecified “high cost of living areas.”

Wall Street watchdog groups and housing advocates said the terms of the $7 billion settlement highlight how the federal government has fallen short in its effort to hold banks accountable, noting that neither Citigroup nor any of its executives have been criminally charged for the bank’s mortgage problems.

In announcing the deal on Monday, Attorney General Eric H. Holder Jr. said the hard-fought settlement did not absolve the bank or its employees from facing criminal charges. “The bank’s misconduct was egregious,” he said. “As a result of their assurances that toxic financial products were sound, Citigroup was able to expand its market share and increase profits.”

The Justice Department said Citigroup routinely ignored warnings that a significant portion of the mortgages it was packaging and selling to investors in 2006 and 2007 had underwriting defects. In one internal email cited by prosecutors, a Citigroup trader wrote “went thru Diligence Reports and think that we should start praying … I would not be surprised if half of these loans went down.” But the bank securitized the loans anyway.

The Justice Department said it was this type of evidence that enabled prosecutors to extract a $4 billion cash penalty from Citigroup — the largest payment of its kind. That money will go into the United States Treasury’s general fund and is not earmarked for any particular use.
The deal also includes $2.5 billion in so-called soft dollars designated for the financing of rental housing, mortgage modifications, down payment assistance and donations to legal aid groups, among other measures intended to provide relief to consumers.

The Federal Deposit Insurance Corporation’s portion of the settlement — about $208 million — will reimburse creditors in three failed banks that owned large mortgage security portfolios — Citizens National Bank in Illinois, Strategic Capital Bank in Illinois and Colonial Bank in Alabama.

State attorneys general in California, Illinois, Massachusetts, New York and Delaware will receive a total of $291 million. California, for example, will reimburse its two largest public pension funds for mortgage-related losses they suffered during the financial crisis.
The payments to the states are tax-deductible, but the federal penalty is not.

In a boon for Citigroup, the deal with the Justice Department forgoes any potential cases against the bank related to collateralized debt obligations, or C.D.O.s, which were often tied to mortgages. While Citi was a relatively small player in the mortgage securities market, it was a leader on Wall Street in C.D.O.s.

As part of its rental housing commitment, Citigroup will provide financing to projects that may result in a loss to the bank. The Justice Department said the bank’s involvement would help fill a gap left by cities and states that cut funding for affordable housing because of the recession.

“We hope this measure will bring relief to families who were pushed into the rental market after losing their homes in the wake of the financial crisis,” said Tony West, the Justice Department’s lead negotiator with the bank. But for many borrowers who have already gone through foreclosures, the settlement comes too late, consumer advocates say.
“Seven billion sounds like a lot. But compared to the number of families that lost their homes, it is not very much at all,” said Isaac Simon Hodes, a community organizer with Lynn United for Change, a group that advocates on behalf of Boston-area residents facing foreclosure.
The bank must complete the consumer relief measures by the end of 2018.

In a call with reporters on Monday, Citigroup’s chief financial officer, John C. Gerspach, declined to say how much it would cost the bank to satisfy the consumer relief portions of the settlement. “These are hard-dollar costs,” Mr. Gerspach said.

Legal costs associated with the settlement dealt an immediate hit to Citigroup’s financial results. The bank took a $3.8 billion charge in the second quarter, leading profits to tumble 96 percent from a year ago.

Including the charge and one-time items, Citigroup earned $181 million, or 3 cents a share, compared with $4.18 billion, or $1.34 a share, in the second quarter of 2013.
Still, investors drove Citigroup’s shares up 3 percent on Monday, relieved that a settlement had been completed and heartened that the bank’s latest results were better than expected.
Excluding the mortgage settlement charge, Citigroup beat Wall Street’s analysts’ profit expectations, as its slumping trading revenue recovered slightly.

But much of that good news was overshadowed by the mortgage deal, which came after months of wrangling between prosecutors and the bank’s lawyers.

At the outset, the bank had expected to pay a fraction of that $7 billion. Citigroup’s first offer to settle the case was $363 million in April, revealing a wide disparity between what prosecutors and bank officials thought was an appropriate penalty.

That disparity stemmed largely from a disagreement over how to calculate the suspected harm that Citigroup’s mortgage securities caused investors. Citigroup linked its initial offer to the bank’s relatively small share of the market for mortgage securities, people briefed on the talks said. The Justice Department, however, rejected that argument, emphasizing instead what it saw as Citigroup’s level of culpability based on emails and other evidence it had uncovered.

The jockeying seemed to continue to the very end. In announcing the settlement, the Justice Department held a news conference in Washington at exactly the same time as bank executives discussed second-quarter results with Wall Street analysts.

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