Prudential building in Newark, NJ.
Prudential building in Newark, NJ. (Carmen Natale)

Prudential Financial claims in a suit filed in Newark federal court that Bank of America committed fraud by selling it $119 million in mortgage-backed securities that contained home loans issued under substandard underwriting practices.

Bank of America and its subsidiary, Merrill Lynch & Co., made misrepresentations about the quality of the certificates it sold to Prudential and about the residential mortgages underlying them, according to the suit. The suit says Prudential lost much of the market value in the securities it bought but does not quantify its losses.

The defendants misrepresented to Prudential the level of due diligence they performed on third-party issuers of mortgages, the suit claims. Prudential alleges the defendants also overstated the proportion of mortgages that were issued on owner-occupied homes, which are less likely to go into default than those issued for vacation homes or investment properties.

In one such offering, Bank of America indicated 89 percent of loans were for owner-occupied homes, while Prudential’s forensic analysis concluded the owner-occupied rate was 75 percent, according to the suit.

Prudential also claims that mortgages in the Bank of America securities were based on appraisals that were “designed merely to generate a value high enough to justify loan approval.”

The defendants also made misrepresentations about the proportion of homes in their loan portfolios that were “underwater,” or had a loan balance greater than its market value, the suit says. Bank of America represented that underwater loans represented less than 2 percent of its portfolio, but an investigation by Prudential found 60 percent of loans were underwater in some of the offerings.

As a result of the underwriting deficiencies, over 31 percent of the mortgage loans in the products sold by the defendants have had to be written off, the suit says. Most initially received high credit ratings but all have since been downgraded to “junk bond” status, the suit says.

“The economic downturn cannot explain the abnormally high percentage of defaults, foreclosures and delinquencies observed in the loan pools. Loan pools that were properly underwritten and contained loans with the represented characteristics would have experienced substantially fewer payment problems and substantially lower percentages of defaults, foreclosures and delinquencies,” Prudential said.

The investments were issued from 2004 to 2007 from a mix of mortgages issued by entities related to Bank of America and outside issuers.

Prudential’s complaint includes details from interviews with more than a dozen “confidential witnesses” who worked in mortgage underwriting for Bank of America and affiliated companies, which describe substandard underwriting practices that were applied to applicants for the mortgages it purchased.

In one interview, an unidentified former underwriter with a Merrill Lynch affiliate, First Franklin Financial, recalled an application from a waitress who claimed to earn $5,000 a month. The underwriter rejected the application, believing the claimed income was overstated, but her manager overrode her decision, reasoning that some cocktail waitresses at upscale establishments might have such an income. That was in spite of the fact that the applicant worked at a restaurant called Blueberry Hill, which the witness likened to the International House of Pancakes, the complaint states.

Prudential brings claims under the New Jersey Racketeer Influenced and Corrupt Organizations Act against both Bank of America and Merrill Lynch, and brings additional claims of common-law fraud, aiding and abetting, equitable fraud and negligent misrepresentation against Bank of America.

Prudential filed the suit in Essex County Superior Court on June 26 and the defendants removed it to federal court July 3.

Prudential is represented by lawyers from Quinn Emanuel Urquhart & Sullivan in New York and Lowenstein Sandler in Roseland. Bank of America’s lawyers are with Munger, Tolles & Olson in Los Angeles and Wolff & Samson in West Orange.

Bank of America spokesman Lawrence Grayson said the company would not comment on the litigation. Prudential spokesman Bob DeFillippo also declined to comment.

Contact the reporter at ctoutant@alm.com.