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JPMorgan Chase & Co. (JPM - Analyst Report) became the latest financial institution to face legal charges from bond insurer, CIFG Assurance North America Inc. CIFG has dragged the company to court over losses suffered by the former on collateralized debt obligations(CDOs) created by Bear Stearns.

The lawsuit is based on CIFG’s financial-guaranty insurance, which was provided to credit default swaps, guaranteeing payment on notes issued by ACA ABS CDO 2006-2 Ltd. and Libertas Preferred Funding II Ltd. These were structured financial investments created by Bear Stearns.

CIFG alleges that Bear Stearns (acquired by JPMorgan in 2008) had stashed the CDOs with risky mortgage securities and convinced the former that independent firms have selected the collateral. As a result, CIFG agreed to provide the financial-guaranty insurance.

Consequently, huge losses – estimated to be around $100 million – were passed on to CIFG when those mortgage securities defaulted. CIFG filed the lawsuit in the New York State Supreme Court in Manhattan.

Apart from JPMorgan, CIFG has also pressed similar charges against a couple of other financial institutions. Last week, it sued Bank of America Corporation (BAC - Analyst Report) for fraudulent representations and breach of contract over insurance policies tied to residential mortgage backed securities (RMBS).

The bond insurer alleged that BofA issued misleading statements that concealed the associated risks and influenced it to provide insurance worth over $150 million to make these marketable to investors. As a result of these fraudulent representations by BofA, CIFG will have to shell out nearly $170 million in damages. CIFG filed the lawsuit relating to the issue in the New York State Supreme Court in Manhattan.

Other lawsuits include last month’s $277 million court case against GreenPoint Mortgage Funding Inc. and last year’s $275 million legal charge against The Goldman Sachs Group Inc. (GS - Analyst Report).

JPMorgan continues to face problems related to Bear Stearns’ acquisition, which it made at the height of the financial crisis. The company is passing through a rough patch with the litigation overhang.

Apart from the aforementioned lawsuit, JPMorgan is also facing money-laundering probe and many other legal hassles related to the sale of mortgage-backed securities. However, on the brighter side, the ill-effects of these are likely to be eliminated by the strong fundamentals of the company.

JPMorgan currently retains a Zacks #2 Rank, which translates into a short-term Buy rating. We believe that on account of such litigation overhangs, there is little possibility of any upward estimate revisions; hence, the stock is expected to hold its current Zacks Rank. However, considering the fundamentals, we maintain a long-term ‘Neutral’ recommendation on the stock.

 

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