Nomura, RBS Defective-Bond Suit Loss Seen Spurring Deals

Nomura Holdings Inc. and Royal Bank of Scotland Group Plc may face $500 million in damages for what a judge called an “enormous” deception in the sale of defective mortgage-backed securities, a ruling that may spur other banks to settle similar claims tied to the 2008 financial crisis.

Nomura and RBS were excoriated in a 361-page opinion by U.S. District Judge Denise Cote in Manhattan, whose ruling followed the first trial of claims that banks sold flawed securities to government-owned mortgage companies. After a three-week trial, Cote said they misled Fannie Mae and Freddie Mac and set a damages formula that may result in the government winning about half its original claim of $1 billion.

“The offering documents did not correctly describe the mortgage loans,” Cote, who heard the case without a jury, wrote Monday. “The magnitude of falsity, conservatively measured, is enormous.”

Before the trial, FHFA had reached $17.9 billion in settlements with other banks, including Bank of America Corp., JPMorgan Chase & Co. and Goldman Sachs Group Inc. The ruling against Nomura and RBS may encourage other banks to settle mortgage-related suits brought by regulators and private investors rather than face the bad publicity and cost of an adverse judgment, said Robert C. Hockett, a professor at Cornell Law School.

“They look pretty bad,” Hockett said in an interview. “They look like the strategy has blown up in their faces.”

Cote ordered the Federal Housing Finance Agency, which filed the case, to propose how much the banks should pay as a result of her ruling.

‘Consistently Candid’

“Nomura is confident that it was consistently candid, transparent and professional in all of its dealings with Fannie Mae and Freddie Mac,” Jonathan Hodgkinson, a U.S.-based spokesman for the bank, said in an e-mailed statement. Nomura will appeal, he said.

Linda Harper, a U.K.-based spokeswoman for RBS, declined to comment on the decision.

FHFA is pleased with the ruling and “looks forward to submitting proposed damages,” the agency’s general counsel, Alfred M. Pollard, said in an e-mailed statement.

Nomura Shares

Shares of Nomura fell 2 percent, the most among companies on the Topix index of securities firms, to 787.9 yen at the close of trading in Tokyo, paring this year’s gain to 14 percent.

“The drop may be due to profit-taking by short-term investors,” said Mitsushige Akino, executive officer at Ichiyoshi Asset Management Co. in Tokyo. “The lawsuit could be the catalyst, although the impact won’t last long because this has been expected.”

Legal costs are hampering Nomura’s efforts to return its overseas operations to profit. The Japanese firm had a fifth straight annual loss in its businesses abroad in the year ended March as it set aside an unspecified sum for lawsuits in the fourth quarter, financial results showed last month.

Cote rejected the banks’ claim that the housing crash, and not defects in the loans, was responsible for the collapse of the mortgage-backed securities.

David Reiss, a professor at Brooklyn Law School, called Cote’s ruling “incredibly thorough.” The judge included detailed factual rulings that may make it difficult for Nomura and RBS to win on appeal, he said.

‘Danger Batman!!’

The U.S. presented evidence from Nomura executives’ e-mails that suggested the bank might be aware it was selling troubled mortgage-backed securities. One e-mail described some of its mortgages as “crap.”

Another warned: “Danger Batman!!”

“The reason for Nomura’s lackluster due diligence program is not hard to find,” Cote said. The bank, competing to buy and securitize loans, sought to foster a “good relationship” with mortgage lenders and ignored “specific warnings about the risk of working with an originator,” she said.

The banks may use a series of rulings against them by Cote, before and during trial, as issues on appeal, lawyers said.

The judge barred Nomura from presenting some evidence, including limiting the bank’s ability to prove its claim that Fannie Mae and Freddie Mac didn’t suffer damages from buying the mortgage-backed bonds. The judge also ruled that FHFA didn’t have to prove Fannie Mae and Freddie Mac knew of Nomura’s alleged false statements.

‘Expressed Skepticism’

Elliott Stein, a Bloomberg Intelligence litigation analyst, wrote that Cote “expressed skepticism about some of Nomura’s contentions and little to none about the FHFA’s case” in closing arguments April 9.

The FHFA claimed Tokyo-based Nomura cheated Fannie Mae and Freddie Mac by selling them $2 billion of bonds backed by faulty mortgages. RBS underwrote four of the seven securitizations at issue in the trial.

Nomura and RBS argued that the documents issued in connection with bond sales adequately disclosed the risks and weren’t misleading. The banks also said that any alleged misstatements didn’t factor into decisions by Fannie Mae and Freddie Mac to buy the securities.

Most of the trial testimony came from experts reviewing Nomura’s diligence in packaging mortgages into securities and disclosures it made to Fannie Mae and Freddie Mac in sales from 2005 to 2007.

“This case is complex from almost any angle, but at its core there is a single simple question,” Cote wrote. “Did defendants accurately describe the home mortgages in the offering documents for the securities they sold that were backed by those mortgages?”

‘Disturbing Examples’

In concluding they didn’t, Cote cited what she called “disturbing examples” from Nomura’s files showing it was willing to securitize defective loans.

In at least 184 of 672 sample loans that were reviewed, home values were inflated and appraisers didn’t believe the figures they provided were correct, Cote said.

The FHFA also proved that from 45 percent to 59 percent of the loans backing the mortgage securities had underwriting defects that increased their credit risk.

“Guidelines were systematically disregarded,” she said.

Edinburgh-based RBS was sued separately by FHFA in federal court in Connecticut for selling $32 billion of its own mortgage-backed securities to Fannie Mae and Freddie Mac. That case is scheduled for trial next year.

The case is Federal Housing Finance Agency v. Nomura Holding America Inc., 11-cv-06201, U.S. District Court, Southern District of New York (Manhattan).

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