Nomura Holdings, Inc.NMR and The Royal Bank of Scotland Group plcRBS , two of the world's biggest banks, will be subjected to a trial today. Notably, the banks have been accused by the Federal Housing Finance Agency ('FHFA') of providing fraudulent details regarding mortgages sold to the government-backed mortgage financiers, Federal National Mortgage Association FNMA and Federal Home Loan Mortgage Corp. FMCC .
Reportedly, the lawyer of the U.S regulator will counter attorneys of both banks in a non-jury trial in Manhattan federal court. Additionally, the banks might be subjected to a compensatory fine of nearly $1 billion for damages related to the concerned securities sold prior to the 2008 economic crisis.
Many financial institutions resorted to inappropriate, misleading, aggressive and fraudulent methods to boost their mortgage operations during the pre-crisis period that fueled the sub-prime mortgage crisis. Consequently, Freddie Mac and Fannie Mae reached the brink of bankruptcy and the government intervened to rescue these lenders.
In order to avoid such dire situations in the future, the regulators started implementing stringent restrictions. Consequently in 2011, the Federal Housing Finance Agency ('FHFA') sued 18 financial organizations, including Wall Street biggies like The Goldman Sachs Group, Inc. and Bank of America Corp. BAC for selling faulty mortgage-backed securities to Freddie Mac and Fannie Mae that caused investors severe losses.
The RBS and NMR Part
The FHFA has accused the Japan-based Nomura, sponsor of the above mentioned securities, and Royal Bank of Scotland, the underwriter, of providing it with misleading details about securities worth $2 billion. Moreover, the regulator has alleged the underwriter of misconduct in the underwriting process, which artificially inflated the average value of securities by 11.1%.
If proven guilty, the banks will have to take over the distressed securities worth $480 million (valued a week ago), besides incurring the $1 billion fine.
In order to defend themselves, the banks have called for Daniel Mudd, an ex-Fannie Mae CEO, among other former employees of the government-backed financiers, to serve as evidence for the functionality of drop in housing prices and increasing unemployment in the resultant loss.
Further, the case which was formerly set to go to a jury will now be subjected to a bench trial before U.S. District Judge Denise Cote. Notably, most of Cote's rulings have been in favor of government agencies.
While FHA continues to successfully resolve issues as well as safeguard the interests of investors, such litigations and probes can adversely impact the banks' goodwill, besides jeopardizing their financial performance with fines and settlement charges. Moreover, in case the distressed securities are transferred to the accused banks, asset quality can face severe deterioration.
While Nomura carries a Zacks Rank #3 (Hold), Royal Bank of Scotland holds a Zacks Rank #4 (Sell).