No End to Legal Woes at JPMorgan

JPMorgan Chase & Co. ( JPM - Analyst Report ) continues to be in sticky waters as litigation issues arising from the sale of mortgage backed securities (MBS) by Bear Stearns & Co. – acquired in 2008 – seem to be never ending. Now, the U.S. regulator for credit unions – National Credit Union Administration (NCUA) – has sued its unit, J.P. Morgan Securities, for misrepresentation in the underwriting and sale of MBS worth over $3.6 billion.

The aforesaid MBS were sold to U.S. Central, Western Corporate, Southwest Corporate and Members United Corporate federal credit unions. Later, these four became insolvent and were placed under NCUA conservatorship and then liquidated due to losses from these risky MBS.

Allegations

JPMorgan has been accused by NCUA of issuing misleading statements and omitting important details from the offering documents of the MBS in question. This led to obscurity regarding the risks associated with the MBS when they were sold.

The credit unions perceived them to be less risky, when in fact, the securities bore substantial risk. Moreover, it has been alleged that JPMorgan has been ignoring the underwriting guidelines specified in the offering documents.

As a result, when these MBS lost their value for defaults in the underlying assets, the value of investments of the credit unions in these MBS plummeted. Subsequently, the four credit unions collapsed, triggering a crisis in the credit union industry.

Similar Charges Earlier

This is the second time that JPMorgan has been sued by NCUA. In June 2011, the company along with Royal Bank of Scotland PLC ( RBS ) was accused of defrauding five large credit unions by selling more than $3 billion worth of high-risk MBS. NCUA seeks to recover about $840 million in losses at five wholesale credit unions through these lawsuits.

Further, many other global giants including Credit Suisse Group ( CS - Snapshot Report ) , Goldman Sachs Group Inc. ( GS - Analyst Report ) , Wells Fargo & Company ( WFC - Analyst Report ) and Barclays PLC ( BCS - Snapshot Report ) are facing similar lawsuits from NCUA. Moreover, to date, NCUA reached settlements with Deutsche Bank AG ( DB - Snapshot Report ) , HSBC Holdings plc ( HBC - Analyst Report ) and Citigroup Inc. ( C - Analyst Report ) worth about $171 million.

Our Viewpoint

Such cases are inevitably going to result in mounting litigation risks for JPMorgan, which pose a menace for both its image as well as financials. On the other hand, recoveries by NCUA would result in lowering of losses that arose from the failure of the credit unions.

Though the overall impact from such lawsuits is yet to be perceived, these measures are somewhat reassuring as they are aimed at resisting malpractices related to selling MBS. Most importantly, such measures would impart much needed transparency to banking procedures at the time of selling MBS.

Currently, JPMorgan retains a Zacks #3 Rank, which translates into a short-term Hold 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 rank. We also maintain a long-term ‘Neutral’ recommendation on the stock.