JPMorgan Sued By NCUA Again: Mortgage Securities Worth $2.2 Billion Questioned

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In what is the third lawsuit by the National Credit Union Administration (NCUA) against JPMorgan (NYSE:JPM) since mid-2011, the credit union agency is seeking damages worth millions from one of the country’s biggest bank so that “the people who caused damage” to credit unions, “pick up (the) burden.” [1]

The latest lawsuit is directed against mortgage securities worth $2.2 billion issued by Washington Mutual (WaMu), well before it was acquired by JPMorgan in 2008, and comes within weeks of a similar lawsuit over $3.6 billion in mortgage securities issued by Bear Stearns, also acquired by JPMorgan in 2008. [2] JPMorgan was the first bank the NCUA filed charges against over the sale of faulty mortgage securities (worth $1.4 billion) in June 2011. [3] Since then, the agency has filed 10 lawsuits in all, against global investment banking giants including Barclays (NYSE:BCS), Credit Suisse (NYSE:CS), Goldman Sachs (NYSE:GS), RBS (NYSE:RBS), UBS (NYSE:UBS) and Wachovia (acquired by Wells Fargo (NYSE:WFC) in 2008). Deutsche Bank (NYSE:DB), Citigroup (NYSE:C) and HSBC (NYSE:HBC) avoided lawsuits by entering into multi-million dollar settlements with the NCUA.

We maintain a $46 price estimate for JPMorgan’s shares, which is around current market prices.

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The NCUA is charged with the responsibility of overseeing the sustainability of the nation’s credit unions – a mammoth task considering the fact that there are over 7,500 credit unions across the country, holding nearly a trillion in assets. [4] But since the economic downturn of 2008, the NCUA has really had its hands full, owing to the number of credit unions that have either gone belly up, or are threateningly close to doing so. And this is largely due to their billions in exposure to mortgage-backed securities originated by the global investment banks.

The NCUA has been going after the banking giants since then five of the nation’s biggest credit unions sank in the aftermath of the recession, alleging that the banks misled the credit unions about the true nature of underlying mortgages while selling them the securities. In fact, the NCUA maintains that in quite a few of the sales, the bank knew well that the mortgages will go bad within months, but never revealed this information. And as a result almost all the securities got the highest investment rating of AAA.

These allegations are quite similar to those expressed by retail and institutional investors around the globe in hundreds of lawsuits against the banks. And as we have mentioned on numerous occasions, each lawsuit adds to the burden on banks in terms of additional legal expenses coupled with a very real possibility of a multi-million dollar fine.

To put things into perspective, the three lawsuits by the NCUA against JPMorgan call to question the intention behind mortgage-backed securities worth $7.2 billion in total. And when the NCUA filed the first lawsuit (for $1.4 billion in securities), it expected to recover damages of around $300 million. Working out the math, damages in the vicinity of $1 billion from all lawsuits combined seem very plausible. Such a settlement would no doubt reflect in JPMorgan’s investment banking margin for the period it is incurred. To understand how a reduction in the bank’s margins affects its share price, you can make changes to the chart below.

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Notes:
  1. NCUA Sues J.P. Morgan, WaMu Capital and Others over $2.2 Billion in Faulty Securities, NCUA Press Releases, Jan 4 2013 []
  2. NCUA Sues J.P. Morgan and Bear, Stearns over $3.6 Billion in Faulty Securities, NCUA Press Releases, Dec 17 2012 []
  3. NCUA Suing Securities Firms to Recover Billions, NCUA Press Releases, Jun 20 2011 []
  4. Basic Information About Credit Unions, Credit Union National Association Website []
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