U.S. Said to Prepare Mortgage Lawsuit Against BofA, JPMorgan

Bank of America Corp. (BAC) and JPMorgan Chase & Co. (JPM) are among lenders that may face a lawsuit by the U.S. Federal Housing Finance Agency over faulty mortgage loans, according to six people with knowledge of the matter.

The agency representing Fannie Mae and Freddie Mac is likely to act before next week’s deadline for legal claims, according to the people, who weren’t authorized to speak publicly. The amount may dwarf the $20 billion sought from the biggest mortgage servicers in a separate probe of lending and foreclosures by 50 state attorneys general, one person said.

Bank of America led declines in shares of U.S. lenders after the suit was reported in the New York Times earlier today. The FHFA has been demanding refunds from banks for loans sold to Fannie Mae and Freddie Mac that were based on false or missing information about borrowers and properties. The two government- backed mortgage finance firms had to be rescued by taxpayers as defaults on home loans soared toward record levels.

A lawsuit “is an uncertainty that can go on for years -- that gets the market quite nervous,” said Nader Naeimi, a Sydney-based strategist for AMP Capital Investors Ltd., which manages almost $100 billion. “Bank of America, being at the epicenter of these problems, is going to get smashed.”

Bank of America, based in Charlotte, North Carolina and the largest U.S. lender by assets, fell 66 cents, or 8.3 percent, to $7.25 at 3:27 p.m. in New York Stock Exchange composite trading. JPMorgan and Citigroup Inc. (C), both based in New York, slipped more than 4.5 percent, while San Francisco-based Wells Fargo & Co. (WFC), the biggest U.S. home lender, declined 4.4 percent.

Pressure on Shares

“Any bad news such as new lawsuits is inevitably going to put the stock under pressure,” said Richard Staite, an analyst at Atlantic Equities in London, referring to Bank of America. “There is a question hanging over the company as to whether it needs to raise new equity. If the lawsuit was to result in significant new losses, then it becomes more likely that the company might need to raise equity, which would be a difficult thing to do in the current market.”

Bank of America, JPMorgan, Goldman Sachs Group Inc. (GS) and Deutsche Bank AG (DBK) are among firms that may be sued by the agency for misrepresenting the quality of mortgage securities sold at the height of the housing bubble, the Times said. Morgan Stanley is likely to be included in the lawsuit, according to one of the people.

Mortgage Overhang

A separate report in the Wall Street Journal said Bank of America was told by the Federal Reserve to explain what steps it would take if its financial condition worsens. Chief Executive Officer Brian T. Moynihan has committed more than $30 billion to quelling claims for faulty mortgages since he took the top job in 2010.

“It doesn’t surprise me when we wake up and there’s somebody else trying to sue them,” said Marty Mosby, a Nashville, Tennessee-based analyst with Guggenheim Securities LLC. “The overhang and the pressure related to this residential real estate isn’t going away any time soon.”

The lawsuit involves purchases by Fannie Mae and Freddie Mac before the financial crisis in 2008 of private-label mortgage securities, which were assembled by firms that lack government guarantees, said two people with knowledge of plans for the lawsuit.

The suit will claim that banks misrepresented the quality of the underlying mortgages in the securities and thus are bound by their contracts to reimburse any losses, the two people said. Banks typically offer “representations and warranties” about the quality and terms of the loans, which includes a promise to buy back the loans or make up the difference if they decline in value. The FHFA plans to demand the latter, the people said.

Legal Options

Analysts and former regulators have said the cumulative impact of lawsuits from different agencies could backfire by imperiling the health of some banks. This could trigger a new round of bailouts that will hurt the same taxpayers that the government is trying to protect, they have said.

Neil Barofsky, former special inspector general for the Troubled Asset Relief Program, said via e-mail he’s “strongly opposed” to regulatory forbearance for the lenders, and that any further aid to banks should come with transparency and accountability.

‘Off the Cliff’

“The government needs to be as aggressive as possible to vindicate the taxpayers’ rights to get as much money from the big banks as possible,” Barofsky said earlier on Bloomberg Television. “If this ends up pushing them off the cliff and putting them in a position where they need to be bailed out again, that bailout should be done through the front door.”

The FHFA’s lawsuit may be motivated mainly by a desire to keep its options open as the deadline for filing legal claims approaches, according to two people with ties to the banks. Negotiations were under way, and in other circumstances a lawsuit and resolution would be announced together, one person said. With the deadline looming, the FHFA may be planning to preserve its legal rights and then return to settlement talks, the person said.

“We are not discussing our litigation,” said Stefanie Johnson, a spokeswoman at the FHFA. Officials at the lenders said they couldn’t comment. In a memo to Bank of America employees, Chief Financial Officer Bruce Thompson said the lender had made “tremendous progress” in resolving claims.

UBS Lawsuit

The bank is being sued now because in many cases, the statutes of limitations have been running out, he wrote. “Now we have to simply let the judicial process work.”

The costs so far and the prospect of even more claims caused some investors to question whether the bank may need more capital. Thompson said Bank of America has “more than enough capital to run our business” and said the lender doesn’t intend to issue more common stock to meet new regulatory standards starting in 2013. “There are many non-dilutive ways for us to get there,” he wrote.

The FHFA sued UBS AG, Switzerland’s biggest bank, in July over $4.5 billion in residential mortgage-backed securities sold to Fannie and Freddie, claiming they misstated the risks of the investments. The suit seeks unspecified damages.

Fannie Mae and Freddie Mac have operated under U.S. conservatorship since 2008, when they were seized amid subprime mortgage losses that pushed them toward insolvency.

BofA’s Options

Responding to the Fed’s call for an explanation of how Bank of America would respond to a deterioration in its financial condition, the lender outlined options including the issuance of a separate class of shares linked to the performance of its Merrill Lynch brokerage unit, the Wall Street Journal reported, citing people familiar with the matter. Such a step isn’t imminent, the newspaper said.

“I can’t imagine that it could be structured in an attractive way,” Staite said. “It doesn’t make sense for them to try to separate Merrill and list it separately.”

To contact the reporters on this story: Dawn Kopecki in New York at dkopecki@bloomberg.net; Laura Marcinek in New York at lmarcinek3@bloomberg.net.

To contact the editor responsible for this story: Rick Green in New York at rgreen18@bloomberg.net

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