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Are Institutional Investors the Next Threat to the Big Banks?

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On Friday morning, JPMorgan Chase  (NYSE: JPM  ) reported its first quarterly loss since 2004. The biggest culprit in the loss? Legal settlements and expenses. Now a group of institutional investors are potentially stepping in to the bank's settlement talks with the government, intent on blocking any resolution that might cause them financial hardship. Since banks are all under the watchful eye of regulators and other financial watchdogs, should they be worried that their path to a quieter legal docket may be blocked by the investors they once courted?

Under pressure
One of the biggest stories lately for JPMorgan has been its ongoing talks with the U.S. government over various charges of mortgage-disclosure frauds by either the New York-based bank itself or several companies it acquired during the financial crisis. Some of the details about a potential resolution include having the bank pay $7 billion in penalties and $4 billion in consumer relief.

But as talks began to reach a potential resolution, Attorney General Eric Holder received a letter on Monday from the Association of Mortgage Investors, warning that some of the settlement terms may hurt investors. Thought it didn't name the bank directly, the letter warned that any large settlement with big banks could leave investors shouldering some of the burden if the banks are allowed to receive credit in the settlement by writing down some of the loans in bonds held by third-party investors.

Stepping in early
The letter was the association's means of stepping in before a settlement was agreed upon between the regulator and the banks. In the past, not reacting in such a quick manner has hurt investors. In last year's huge settlement between banks and 49 state attorneys general, which totaled $25 billion from five major banks, the various banks could receive credit for their portion of consumer relief requirements by writing down the balances of loans that they no longer owned, but only managed or serviced. The third-party investors who actually owned the loans were the ones shouldering the cost of the writedowns.

Some if the investors, including MetLife's (NYSE: MET  )  Nancy Mueller Handal, have criticized the settlement since the banks were able to write down the loan balances without any kind of reimbursement to the investors.

Other interruptions
Bank of America (NYSE: BAC  ) is also in the middle of a tussle with investors over its $8.5 billion settlement over mortgage-backed securities. Institutional investors, led by American International Group (NYSE: AIG  ) , have petitioned that the settlement is much too small for the scope of the MBS portfolio in question. Though the hearing that will decide the settlement's fate is on hold until mid-November, the bank could face a $60 billion price tag if the investors win the argument.

Everyday investors
Those of us on Main Street need to be looking out for ourselves, just as much as the institutional investors going head-to-head with the big banks and regulators. But since you don't have the megaphones that these big groups do, it may be easier for you to protect yourself through a good analysis of the companies you invest in. For JPMorgan and B of A, knowing that they have some huge legal issues in the mix and are likely to have continued expenses tied to their legal dockets, choosing them as an investment should be based on your confidence in their operation's ability to carry such costs. And with most of the market viewing continued legal battles as a negative, you may find that the banks become greater value plays as others walk away.

Still big winners
Though the financial crisis had a huge impact on the banking sector, both through financial hardships and legal problems, there has been plenty of evidence that the big banks are making their way back to record earnings. Have you missed out on the massive gains in bank stocks over the past few years? There's good news: It's not too late. Bargains of a lifetime are still available, but you need to know where to look. The Motley Fool's new report "Finding the Next Bank Stock Home Run" will show you how and where to find these deals. It's completely free -- click here to get started.

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