On Tuesday,The Goldman Sachs Group Inc. (GS) was sued by National Credit Union Administration (NCUA), the U.S. regulator of credit unions. The complaint lodged claims that Goldman violated federal and state securities laws and misrepresented documents as an underwriter in the sale of $1.2 billion in mortgage-backed securities.
NCUA alleged that Goldman issued misleading statements and omissions related to the mortgage-backed securities, which led to the failure of U.S. Central Federal Credit Union in Lenexa, Kansas, and Western Corporate Federal Credit Union in San Dimas, California. Further, the agency claims $491 million in damages over losses incurred.
Regulators claim the documents used in offering the securities contained untrue statements or omissions, as to how risky the investments to be. These misrepresentations of the risks provoked investors to participate in investments, which have virtually no value at current levels.
NCUA has been operating the two failed credit unions since their failure in March 2009. Credit unions are owned by the members, who elect volunteer directors for governance. These credit unions operate as non-profit organizations with a lower expense base than banks. As a result, if they generate more than their required capital, the surplus is distributed among members.
There are two types of credit unions, namely retail and corporate. Retail credit unions lend money and take deposits from individuals. However, corporate credit unions do not deal directly with consumers. These institutions provide financing, check clearing and other services to retail credit unions.
Retail credit unions seem to be in good shape. But it’s also true that corporate credit unions are facing major trouble because of the high-risk mortgage-backed securities they bought from some major U.S. banks.
But the NCUA is not sitting idle. The Administration is pursuing banks that deceived credit unions for their own interests. NCUA inquires investment banks to recover losses in billions related to risky securities backed by mortgages, which led to failure of credit unions in the recent years. In June 2011, the NCUA sued JPMorgan Chase & Co. (JPM) and Royal Bank of Scotland plc (RBS), alleging that they deceived five large credit unions, by selling them more than $3 billion high-risk mortgage-backed securities that were expected to underperform.
Subsequently, shortly after buying these securities, many of the borrowers faced a default and the five credit unions failed. The NCUA seized two of the five credit unions in 2009 and the remaining three in 2010.
Of the total 7,000 U.S. credit unions, a significant number of institutions are victims of the mortgage crisis. Since 2009, more than 40 credit unions have failed and several others are struggling to survive.
However, the regulators are proactively trying to recover losses of credit unions through lawsuits against banks that were involved in malpractices related to selling mortgage-backed securities. The proceeds from these lawsuits would increase NCUA's insurance and emergency support funds to a considerable extent.
Earlier in July, Goldman was also sued by Liberty Mutual Insurance Co. and several other investors including Peerless Insurance Co., Employers Insurance Co., Safeco and Liberty Life Assurance Co. for misrepresenting the financial condition of Freddie Mac (FMCC) as an underwriter of Freddie's offering of Series Z preferred stock in late 2007. According to the lawsuit, Freddie Mac issued 240 million shares of Series Z preferred shares in November 2007, which raised approximately $5.9 billion. The shares were supported by billions of dollars in subprime residential mortgages. The investors alleged that Goldman misled them with statements and omissions related to the preferred stock offering based on which they invested $37.5 billion.
Last year also, Goldmansettled a charge by paying $550 million for not disclosing to the buyers the role of a hedge fund in formulating the CDOs and taking a short position and betting on them to perform poorly in the open market. The SEC has stepped up its investigation on Wall Street companies over the sale of CDOs that were responsible for significant losses suffered by the investors and financial crisis.
While such charges will dent Goldman’s reputation and its financials, we believe that investors, who have lost their hard-earned money in such investments, should feel relieved.
Shares of Goldman currently retain a Zacks #4 Rank, which translates into a short-term ‘Sell’ rating.Moreover, considering the fundamentals, we maintain a long-term “Underperform” recommendation on the stock.
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