Exclusive: The $1.3 billion bond deal haunting Goldman

FORTUNE -- The Securities and Exchange Commission is likely to bring charges soon against Goldman Sachs (GS) for a 2006 mortgage investment deal. The agency hasn't said which one yet, but Fortune has learned there's a good chance the SEC's case will focus on Fremont Home Loan Trust 2006-E, a bundle of more than 5,000 mortgages that has cost investors, including mortgage guarantor Freddie Mac and by extension U.S. taxpayers, an estimated $545 million.
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Even going by the prospectus Goldman distributed to investors at the time of the offering, the loans in FHLT 2006-E were risky bets. The deal was named after the now-defunct California mortgage brokerage by the same name that made all the loans in the trust. Fremont was known to be among the most lax lenders in the country. According to the original offering documents, 652 of the loans in FHLT 2006-E, or 13%, were made to borrowers with credit scores of 549 or worse - a score that would barely qualify you for a cell phone these days. Nearly 37% of the loans in the trust, or 1,857, were made to borrowers who were never asked to prove their income. More than a quarter of the loans were made to borrowers in California, one of the most overheated real estate markets at the time. Yet, the California loans in Fremont's portfolio had an average size of more than $330,000 to borrowers with credit scores that on average didn't break the mid-600s. So perhaps it's no surprise that, just 12 months after Goldman sold the deal, 32% of the mortgages in the trust had gone bad. Over 350 had entered foreclosure. Borrowers in another 785 mortgages hadn't made a payment in over a month.

But what makes FHLT 2006-E potentially fraudulent, and why the SEC is likely to sue Goldman, is that it appears the firm knew that even compared to the incredibly low standards it stated it was using to select loans for the deal, the mortgages Goldman actually sold to investors were a good deal worse. For instance, the deal's prospectus that Goldman assembled and distributed to investors, and filed with the SEC, said that there was only one home loan out of 5,012 in the Fremont trust, or 0.01%, in which a borrower had taken out more than their house was worth. But an audit conducted for the FHFA suit found that at least 1,179 loans in FHLT 2006-E, or 23.5%, were already underwater at the time Goldman was pitching the deal to investors. The suit alleges that Goldman also hid the number of loans in the Fremont trust that were made to real estate investors, which are generally considered riskier than a loan to someone who intends to live in a house themselves. Goldman's pitch claimed that just under 14% of the loans in FHLT 2006-E were made to investors. In fact, that number was over 24%.

"We found that major financial institutions had information of the defective nature of the loans they were packaging and selling that they never disclosed to investors," says Phil Angelides, who was the head of the Financial Crisis Inquiry Commission. "It was seminal to the cause of the financial crisis."

http://finance.fortune.cnn.com/2012/04/02/fremont-bond-goldman-sachs/