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Ambac Says JPMorgan Refused Mortgage Repurchases It Also Sought

Jan. 25 (Bloomberg) -- JPMorgan Chase & Co. demanded that a lender repurchase bad mortgages even as it resisted calls to buy back the loans from bonds created by Bear Stearns Cos., an insurer said in court papers.

“That would be pretty bad” if true, said Joshua Rosner, an analyst at New York-based research firm Graham Fisher & Co. He said such allegations show why “investors and consumers have a right to be distrustful of the banks’ statements.”

Ambac Assurance Corp., the debt guarantor partly seized last year by Wisconsin’s insurance commissioner, made the claim in a proposed amended complaint in its lawsuit against Bear Stearns’s EMC Mortgage unit, now owned by JPMorgan. Ambac, seeking to add a fraud claim to the case, referenced depositions, e-mail and letters in the filing, which was unsealed Jan. 14 in Manhattan federal court.

Mortgage-bond investors and other insurers, including Allstate Corp., Pacific Investment Management Co. and MBIA Inc., have accused loan sellers or bond underwriters of sometimes misrepresenting the quality of the underlying debt enough to trigger contractual or legal provisions requiring repurchases. So-called mortgage putbacks may cost banks and lenders as much as $90 billion, JPMorgan bond analysts said in an October report.

Jennifer Zuccarelli, a spokeswoman for New York-based JPMorgan, declined to comment on the filing, which the company had fought to keep secret. A federal judge must still rule on whether to allow the amended complaint to go forward.

Insured Bonds

Bear Stearns sought on March 11, 2008 -- just weeks before the collapsing company agreed to be bought by JPMorgan -- to have a lender buy back mortgages in bonds insured by Syncora Guarantee Inc., according to the filing. Bear Stearns said the mortgages failed to meet promised standards of quality.

At the same time, Bear Stearns was denying demands from Syncora that it repurchase the loans, even though the insurer cited the same flaws, according to the filing. Bear Stearns had bought the loans and packaged them into bonds to sell to investors.

JPMorgan later maintained “that it is EMC’s position that these breaches materially and adversely affect the value” of the loans, according to the complaint, which cited a June 26, 2008, letter from Alison Malkin, an executive director in JPMorgan’s securities unit, to the lender, a now-closed unit of Capital One Financial Corp.

‘Diametrically Opposing’

“Remarkably, Malkin took diametrically opposing positions in repeatedly refusing to comply with all but 4 percent of Syncora’s repurchase demands,” Ambac said in the proposed amended complaint.

The lawsuit was filed in November 2008. New York-based Ambac Financial Group Inc., Ambac Assurance’s parent, filed for bankruptcy protection last year. Syncora, which was ordered to stop paying claims by New York regulators in 2008, is also suing EMC Mortgage.

On Dec. 16, U.S. Magistrate Judge Theodore Katz issued a report and recommendations to U.S. District Court Judge Richard Berman in New York, who is presiding over the Ambac case. Katz, who is handling pretrial matters, recommended that Ambac be allowed to add a fraudulent-inducement claim against EMC.

EMC’s lawyers on Jan. 14 argued against letting Ambac file the proposed amended complaint. EMC has also asked Katz to reconsider his ruling.

JPMorgan last quarter set aside $1.5 billion in litigation reserves to cover costs related to buying back faulty mortgages. Chief Executive Officer Jamie Dimon said it will take years to resolve the disputes and to determine the ultimate cost to his bank.

‘Ugly Mess’

“It’s going to be a long ugly mess, but it won’t be life-threatening to JPMorgan,” he told analysts on a Jan. 14 conference call.

The bank also ignored the findings of mortgage-review firm Clayton Holdings LLC in abandoning mortgage repurchases that Bear Stearns had been considering in early 2008 stemming from a pool of 596 of loans in bonds guaranteed by Ambac, according to the insurer’s amended complaint.

Clayton found that 56 percent of the loans involved “material” breaches of Bear Stearns’s contractual promises, according to the filing, which cited a copy of a November 2007 document from the review firm to the company.

As Malkin overruled Bear Stearns decisions on which mortgages to repurchase to limit JPMorgan reserve expenses, the portion of those loans that were approved for repurchase fell to 2.2 percent by September 2008, according to the complaint.

Proof that the bank ignored a third-party review is “major, that’s hugely newsworthy,” said Isaac Gradman, a San Francisco-based consultant and formerly a lawyer at Howard Rice Nemerovski Canady Falk & Rabkin.

Both Sides

With the Syncora loans, “if they’re making an argument out of one side of their mouth and a different argument out of the other, that is arguably a breach of an implied covenant of good faith and would be very strong evidence to prove repurchase demands,” he said in a telephone interview. Gradman represented mortgage insurer PMI Group Inc. in a now-settled lawsuit over similar issues against General Electric Co. and its defunct mortgage unit

Ambac also alleges in its proposed complaint that, as early as 2005, Bear Stearns was making a strategy out of earning “double” money on shoddy mortgages. First Bear Stearns sold securities backed by the debt, then forced the mortgage lender that sold it the loans to pay up when they turned delinquent in the first few months or were otherwise proved to have breached originators’ representations, Ambac said.

Bear Stearns generally wouldn’t refund investors with that second pool of money, Ambac said in the filing.

Early Payment

While such so-called early payment defaults may not require repurchases of mortgages out of securities by the issuers of the bonds, because of differences between securitization contracts and those entered into by lenders, Bear Stearns’s policy raised questions at the time, according to the complaint.

External auditor PricewaterhouseCoopers LLP advised Bear Stearns in August 2006 that it needed to review loans that were defaulting or defective to see if their quality breached its obligations and begin the “immediate processing of the buy-out if there is a clear breach in order to match common industry practices, the expectation of investors and to comply” with its mortgage bonds’ contracts, according to the amended complaint.

Its own lawyers by early 2007 were making similar suggestions, according to the complaint.

Securitized Loans

By the end of 2005, Bear Stearns had moved to making sure to securitize home loans before their early payment default periods ended, without informing investors and insurers of the switch, according to the complaint.

Then, if the loans went delinquent or were otherwise found defective, the company would seek settlements from lenders, rather than repurchases, which would have required the cash paid by originators to flow through to the securitization trusts so the debt could be passed back, according to the complaint.

“That is how we pay for the lights,” one employee told another in an Aug. 11, 2005, e-mail cited in Ambac’s filing.

In 2007 and the first quarter of 2008, Bear Stearns resolved repurchase claims to lenders on more than $1.3 billion of mortgages through settlements or for other consideration, according to the complaint, which cited the deposition of an employee. The securities firm received more than $367 million of “economic value,” according to the complaint.

Wells Fargo Suit

Also this month, EMC Mortgage was sued by Wells Fargo & Co., which is acting as the trustee for another set of mortgage bonds, for refusing to turn over documents detailing the quality of loans packaged into those securities.

An investor believes the files show some of the loans should be repurchased, according to the complaint filed Jan. 18 in Delaware Chancery Court in Wilmington. Wells Fargo “has repeatedly requested that EMC provide access to the subject documents,” the San Francisco-based bank said in the complaint.

“EMC has played proverbial ‘rope a dope’ and otherwise continued to drag its feet, and has produced nothing,” according to the complaint.

Washington Mutual Inc., the Seattle-based bank whose assets were mostly acquired by JPMorgan after it failed in 2008, has been another source of litigation. Last September, Deutsche Bank AG, acting as a trustee for bondholders, refiled a lawsuit over allegedly misrepresented loans in $34 billion of WaMu mortgage securities, with $165 billion in original balances.

The suit, filed in federal court in the District of Columbia, included JPMorgan as a defendant after the Federal Deposit Insurance Corp. said that JPMorgan was wrongly claiming its insurance fund had agreed to cover the liabilities, according to the amended complaint.

JPMorgan is balking at turning over loan files to the trustee, according to Deutsche Bank. Either JPMorgan or the FDIC owes investors $6 billion to $10 billion, according to the complaint.

The case is Ambac v. EMC Mortgage, 08-cv-9464, U.S. District Court, Southern District of New York (Manhattan).

To contact the reporter on this story: Jody Shenn in New York at; Patricia Hurtado in New York federal court at; Prashant Gopal in New York at

To contact the editors responsible for this story: David E. Rovella at; Alan Goldstein at

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