Big Banks with Big Legal Bills

The legal bills from the 2007-09 financial crisis keep rolling in, and they're starting to get ugly. JPMorgan Chase (JPM) and other big banks face billions of dollars in legal costs related to their role in the financial crisis, threatening their profits and the stock price gains they made in 2010, analysts say.

For the first nine months of 2010, JPMorgan, the second-biggest bank by assets, reported $5.2 billion of legal costs, which can include reserves for losses and payment of judgments. Bank of America (BAC), the largest U.S. bank, and Citigroup (C), ranked third, are also besieged by lawsuits stemming from the credit crisis, brought by plaintiffs ranging from homeowners who were foreclosed upon to institutional investors whose mortgage-backed bonds turned out to be money losers. "They're under legal attack," says Richard Bove, an analyst at Rochdale Securities in Lutz, Fla. "They're similar to the asbestos or the tobacco industry, and they're going to be repeatedly sued in the next few years."

JPMorgan's third-quarter net profit of $4.4 billion, up 23 percent from the previous year, would have been larger if it hadn't set aside $1.3 billion for lawsuits and $1 billion for mortgage repurchases. Legal costs will rise if the bank reserves money for multibillion-dollar lawsuits by Lehman Brothers and the trustee liquidating Bernard L. Madoff's firm. The bank used the word "litigation" about 50 times in its latest Securities and Exchange Commission quarterly filing. Litigation "ain't going away," Chief Executive Officer Jamie Dimon told analysts in an Oct. 13 conference call. "It's becoming a cost of doing business." Stephen Cutler, JPMorgan's in-house lawyer, declined to comment.

Bankrupt Lehman is suing JPMorgan for $8.6 billion in collateral it says was wrongly seized, plus tens of billions of dollars in damages, while Madoff trustee Irving Picard is demanding $6.4 billion on the grounds that the bank aided and abetted the biggest Ponzi scheme in history. JPMorgan is fighting both suits. Almost nine pages of JPMorgan's latest SEC quarterly filing deal with legal issues. They range from home foreclosure probes by state officials to shareholder lawsuits against Bear Stearns, which JPMorgan bought in 2008, and suits from nine Federal Home Loan Banks demanding compensation for mortgage-backed securities bought from JPMorgan, Bear Stearns, or Washington Mutual Bank, also purchased in 2008.

JPMorgan has been taking larger reserves than some rivals, according to company filings. Both JPMorgan and Bank of America disclose more information about their legal expenses than Citigroup or Wells Fargo (WFC), which don't give litigation cost totals in their regulatory filings. Shannon Bell, a spokeswoman for Citigroup, and Mary Eshet, a Wells Fargo spokeswoman, declined to comment.

Concerns that investors aren't getting enough information to assess litigation risks spurred the Financial Accounting Standards Board to issue proposals last year that would force banks to estimate litigation losses and say how much they're putting aside.

Because of claims over bad mortgages, this may be the banks' worst year for legal expenses since 2005, when Citigroup and JPMorgan each spent about $2 billion to resolve a lawsuit accusing them of helping energy trader Enron hide billions of dollars in debt from investors.

Bank of America reported $1.2 billion in litigation costs for the nine months through Sept. 30, excluding fees to outside law firms. Cases for which Bank of America already has reserved some money may wind up costing the bank $400 million to $1.9 billion more than it has set aside, according to its latest quarterly filing. The bank's nine-month litigation cost of $1.2 billion is up from $477 million the year before. "Our litigation-related expenses are cyclical and are not attributable to a single factor," says spokesman Lawrence Grayson.

Citigroup tries to settle lawsuits rather than contest them, it said in a filing. The bank still faces €14 billion ($18.4 billion) of claims for damages resulting from the bankruptcy of Parmalat, Italy's largest dairy company, in 2003.

Dimon articulated JPMorgan's approach to lawsuits in the October analyst call. "When we're wrong, we're going to settle," he said, "and when we're right, we're going to fight."

The bottom line: As claims mount, legal costs are taking billions of dollars out of profits at JPMorgan and other banks.

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