Legal Trouble Brewing Over Mortgage Securities For Goldman

Goldman Sachs (NYSE:GS) may be staring at another major mortgage-related lawsuit against it from the Securities and Exchange Commission (SEC). ^[1] The global investment bank had earlier disclosed in its annual report that it received a “Wells notice” – a letter from the SEC of an impending enforcement action against it – in relation to a mortgage investment deal it completed in 2006. Data dug up by Fortune zeroes in on the Fremont Home Loan Trust (FHLT) 2006-E as the deal in question. The $1.3 billion deal which resulted in huge losses to investors may trigger another multi-million fine for Goldman if the investment bank is found guilty of misleading investors about the poor quality of loans underlying the deal. Other major banks including JPMorgan (NYSE:JPM) and Wells Fargo (NYSE:WFC) are also in the SEC’s cross-hairs over similar deals.

We maintain our $126 price estimate for Goldman’s stock, which is at a premium of about 5% to current market price.

See the full Trefis analysis for Goldman Sachs

SEC is Pulling Out Some Skeletons from the Closet

The underlying portfolio for the FHLT 2006-E deal consisted of more than 5,000 mortgages made by Fremont, more than half of which are currently non-performing. Over the years, the deal caused investors including Freddie Mac to bleed more than $565 million, and the number is only expected to pile up.

The SEC, based on the prospectus Goldman filed with it in 2006, alleges that the investment bank deliberately misled investors about the quality of the underlying portfolio despite having a clear idea of the poor loans it contained. Alleged misrepresentations include declaring significantly lower than actual non-performing loan figures (declared 0.01% compared to actual 23.5%) and reducing the share of loans made to real estate investors (declared 14% compared to actual 24%).

And If SEC Has its Way, It Will Hurt

The SEC’s stance against Goldman refreshes bad memories of the $550 million settlement by the bank in 2010. The settlement was the SEC’s largest ever and alleged that Goldman had similarly misled investors about the Abacus mortgage deal. Already reeling under the pressure of a multitude of mortgage-related lawsuits, this poses another real threat to Goldman’s value, as it could result in another hefty settlement for the bank – seriously hitting the bank’s margins.

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1. Exclusive: The $1.3 billion bond deal haunting Goldman, Fortune, Apr 3 2012 [↩]