AIG's $10B Lawsuit Could Be a Knockout Punch to Bank of America

AIG's $10 billion lawsuit against Bank of America (BAC) would have been bad news even under good conditions. Under the current conditions it may be time to put out the fire and call in the FDIC.

AIG has sued BofA in order to recover more than $10 billion in losses on $28 billion of investments in mortgage backed securities. (Don't worry, Goldman Sachs (GS), JPMorgan Chase (JPM) and Deutsche Bank (DB), you haven't been forgotten. Expect suits of your own very soon.) The news caused the severely skittish market to further pound BofA's already beleaguered stock -- it's lost almost half of its value this year and near the end of trading Monday it was down 17 percent to 6.74.

And that was before BofA's late day non-response to Fannie Mae's demands for more settlement money. In a memo dated Monday, the bank tried to reassure staff and investors that it could withstand demands for compensation on soured loans:

We are considering a number of potential responses to this ... It is unknown whether Fannie Mae's continuing claims will result in increased representation and warranty liability.

BofA's poor stock performance before today reflected its status as an already reeling company. Last month it reported an $8.8 billion quarterly loss and was increasing its loss reserves to $20 billion for the second quarter. At the same time it was cutting deals with other investors who had lost money on mortgage backed securities.

BofA said these deals would allow it to put the mortgage mess behind them. Analyst reaction to this last point was far from unanimous: Some snickered, while others went to full on guffaws.

AIG's suit is a very direct objection to an $8.5 billion settlement agreement BofA had reached with a group of investors. That agreement would have had the bank pennies on every one of the $105 billion it owed to a group of investors including Pimco Investment Management (LTPZ), and Blackrock Financial Management (BLK), MetLife (MET) and the Federal Reserve Bank of New York. Although the settlement would exceed BofA's total profits since the onset of the financial crisis in 2008, AIG filed a request to intervene saying it believes the amount is too low.

The details of the suit won't surprise anyone who has been paying attention, but they still make for interesting reading. In one security 82 percent of the loans failed to comply with the underwriting guidelines as marketed to investors.

For instance, a borrower in that deal who said she was a builder with 25 years of experience was born in 1971. Another borrower inflated his income by about $90,000 on his application, though his tax return in the loan file showed the true figure.

Image: Wiki Commons
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