Insurers, Still Struggling, Sue Biggest Banks

Bond insurers are suing financial-services firms with claims of fraud and misrepresentation.
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NEW YORK (

TheStreet

) -- For U.S. banks, the financial crisis is a thing of the past as

JPMorgan

(JPM) - Get Report

and

Goldman Sachs

(GS) - Get Report

record billions of dollars in quarterly earnings. For bond insurers, the nightmare continues, with companies such as

Ambac Financial Services

(ABK)

fighting for their survival.

Insurers are fighting back, laying the blame on banks and taking claims of misrepresentation and fraud to states' highest courts. The lowest claim is about half a billion dollars and the highest is $5.7 billion.

Ambac filed a claim in New York's Supreme Court against

Credit Suisse

(CS) - Get Report

a week ago. The insurer also has lawsuits in New York against

Citigroup

(C) - Get Report

and JPMorgan.

MBIA

(MBI) - Get Report

has filed claims against

Bank of America

(BAC) - Get Report

, including subsidiaries Countrywide and Merrill Lynch, and Credit Suisse.

Assured Guaranty

(AGO) - Get Report

has targeted JPMorgan.

Insurers, like many Americans, find bank bonuses galling, particularly since the government ensured their survival with unprecedented bailouts footed by taxpayer money. Major banks and securities firms are on pace to pay their employees a record $145 billion for 2009, an analysis by the

Wall Street Journal

showed. JPMorgan set aside $9.3 billion for compensation and benefits for investment-bank staff, or an average of $378,600 per employee.

The insurers, by contrast, saw their AAA ratings disappear as the housing crisis developed and are now struggling to survive. Ambac is widely seen as the weakest, having publicly discussed a potential 2011 bankruptcy. MBIA was forced to restructure, with the support of New York state's insurance regulator, and is now being sued for just that by, among others, Bank of America. Assured Guaranty is stronger than the others, but it's still under significant pressure.

The lawsuits vary, from claims that investment advisers failed to create conservative and prudent securities portfolios as required (JPMorgan), through offloading liabilities on mortgage-backed securities via fraudulent collateralized debt obligations (Citigroup, Bank of America and Credit Suisse), falsely claiming securitization pools had been appropriately underwritten (Bank of America and Credit Suisse) and creating a toxic pool of assets for reinsurance (JPMorgan). Two common themes: residential mortgage-backed securities and insurers' dependance on banks' scrupulousness.

Successful suits may not result in higher profits. Ambac, for one, has already accounted for $1.9 billion in remediations on its balance sheet as of Sept. 30. Peter Poillon, a spokesman for Ambac, said some of the amounts involved in the latest suit against Credit Suisse had been included in third-quarter results. The biggest benefit would be cash flow.

As insurers make payouts when a claim is made, there is an immediate cash loss. MBIA, for example, had paid out $1.4 billion by the time it filed its claim against Bank of America and was anticipating millions more. Cash outflow is the most likely way that Ambac would be forced into bankruptcy. That's why winning lawsuits is so important.

The biggest hurdle is time. Some of the cases are already a year old and could last as long as three years. As with Ambac's claim against JPMorgan, lawyers for defendants often file motions for dismissal. The wheels of justice grind slowly, and time isn't on Ambac's side. It's entirely possible that its cases won't be resolved until 2012.

If insurers win even some of the cases, their shares could skyrocket. The stock price of Ambac, once a thousand times higher than today, would look woefully low. It's likely that a victory by one insurer would cast a light on the others.

Insurers continue to investigate anomalies in transaction performances to try to determine whether there have been breaches in representations and warranties made by a counter party. If discovered, the insurers probably would try to reach a settlement with the banks. If agreements couldn't be reached, insurers might resort to legal action. We have probably not seen the last lawsuit filed.

Reported by Gavin Magor in Jupiter, Fla.

Gavin Magor is the senior analyst responsible for assigning financial-strength ratings to insurance companies. He conducts industry analysis and supports consumer products. Magor has more than 22 years of international experience in operations and credit-risk management, commercial lending and analysis. His experience includes international assignments in Sweden, Mexico, Brazil and the U.S. He holds a master's degree in business administration from The Open University in the U.K.