JPM May Face Legal Costs Again

JPMorgan Chase & Co. (JPM - Analyst Report) may find itself in trouble as a Manhattan Federal Judge ruled against it in a lawsuit related to losses on securities driven by risky equity home loans. Syncora Guarantee Inc., a wing of Syncora Holdings Ltd. (SYCRF), had filed the lawsuit against JPMorgan's EMC Mortgage Corp unit.

Syncora had alleged that the violations of warranties by EMC triggered the underlying loans to default. According to the U.S district judge, Syncora need not substantiate its allegations in order to claim liability of banks in bearing the losses.

Moreover, the court favored Syncora by stating that the defendant can establish a material breach of contract by presenting the infringement of representations and warranties by EMC, which lead to a significant appreciation in material risk.

Syncora had alleged EMC of providing misleading information prior to signing of the agreement relating to insuring interest and principal repayments pertaining to $666 million bond created in 2007 which were supported by 9,871 equity home loans. Consequently, Syncora has shelled out more than $168.6 million in settling claims and consistently facing incremental material risk. However, the judge has denied equitable relief to Syncora.

From the viewpoint of the bond insurers, the court ruling could help them breathe a sigh of relief, as now the banks would become liable for the losses associated with sub prime and other perilous loans. Several insurance companies like Assured Guaranty Ltd. (AGO - Snapshot Report) and MBIA Inc. (MBI) are set to gain from the favorable court decision, which grants bond investors special preference because of their distinct legal interests as against the general investors.

Earlier, this year, Supreme Court of New York had ruled out a similar decision in favor of MBIA, which had sued Countrywide Financial, a unit of Bank of America Corporation (BAC - Analyst Report). MBIA has accused Countrywide for fraudulently inducing it to insure precarious mortgage backed securities worth $20 billion by providing misleading statements.

Conclusion

If JPMorgan repurchases risky loans due to legal pressure, its credit quality might deteriorate to an extent in the near term. JPMorgan is facing a deluge of lawsuits, elevated legal expenses and compensations for quite sometime now. These will severely affect its financials as well as its reputation. Moreover, with regulatory authorities cracking down hard on unwarranted activities of the banks, they need to overcome their dubious practices for their own good.

Currently, JPMorgan retains a Zacks #4 Rank, which translates into a short-term Sell rating. Considering the fundamentals, we also maintain a long-term Neutral recommendation on the stock.