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JPMorgan Chase & Co. (JPM - Analyst Report) continues to be in troubled waters due to litigation issues arising from the sale of mortgage-backed securities (MBS) by the entities it acquired during the financial crisis. In less than a month’s time, the company has been again sued by the U.S. regulator for credit unions – National Credit Union Administration (NCUA) – for misrepresentation in the underwriting and sale of MBS worth over $2.2 billion.

The aforesaid MBS were sold to the U.S. Central, Western Corporate and Southwest Corporate federal credit unions (FCUs) by Washington Mutual – acquired by JPMorgan in 2008. Later, these three FCUs became insolvent and were placed under NCUA conservatorship and then liquidated due to the losses from these risky MBS.

Charges

Washington Mutual 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 these were sold.

The credit unions perceived these to be less risky; when in fact, the securities were substantially risky in nature. Moreover, it has been alleged that Washington Mutual ignored 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 three credit unions collapsed, triggering a crisis in the credit union industry.

Similar Charges Earlier

This is the third time that JPMorgan has been sued by NCUA. In December 2012, the company was charged for misrepresentation in the underwriting and sale of MBS worth over $3.6 billion. The aforesaid MBS were sold to the U.S. Central, Western Corporate, Southwest Corporate and Members United Corporate federal credit unions by Bear Stearns & Co.

Likewise, in June 2011, JPMorgan along with Royal Bank of Scotland PLC (RBS - Snapshot Report) 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 - Analyst Report) are facing similar lawsuits from NCUA. Moreover, to date, NCUA reached settlements with Deutsche Bank AG (DB - Analyst Report), HSBC Holdings plc 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 stemmed 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 these 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 the sale of 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. Moreover, we maintain a long-term ‘Neutral’ recommendation on the stock.

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