Bank of America Corp was sued by American International Group Inc for more than $10 billion over an alleged massive fraud on mortgage debt, causing the bank's shares to tumble 22.8 percent amid worries it cannot manage a deepening litigation morass.

Shares of the largest U.S. bank fell to their lowest since March 2009, wiping out roughly one-third of the bank's market value, or in excess of $32 billion, over the last three trading days.

In afternoon trading, the shares were down $1.60, or 19.6 percent, to $6.57, after earlier falling to $6.31.

A lot of people think the bank will have to raise capital, and any major capital raise will be massively dilutive, said Paul Miller, an analyst at FBR Capital Markets. The bank just can't get its hands around the liabilities it's facing.

Monday's slide came amid the broad market decline that followed Standard & Poor's downgrade of United States credit ratings. AIG shares were down $2.78, or 11 percent, at $22.32.

The lawsuit may complicate Bank of America Chief Executive Brian Moynihan's efforts to contain losses from the bank's $2.5 billion purchase in July 2008 of Countrywide Financial Corp, the nation's biggest mortgage lender.

That purchase, engineered by Moynihan's predecessor Kenneth Lewis, is now considered a disaster for Charlotte, North Carolina-based Bank of America because of the costs of litigation and writing down bad loans.

Moynihan inherited a ton of excess baggage including Countrywide, which has become a sinking ship, said Michael Mullaney, who helps invest $9.5 billion at Fiduciary Trust Co in Boston, which has sold nearly all its shares in the bank. Bank of America's stock price will remain under duress.

Tony Plath, a finance professor at the University of North Carolina at Charlotte, said investors may be surmising that drastic action will be needed. If the stock trades at $6 or $7, there's just no way they can raise capital without just wiping out existing shareholders, he said.

BANK OF AMERICA SAYS AIG KNEW BETTER

The AIG case is among a growing number of lawsuits by investors seeking to hold banks responsible for losses on soured mortgages that contributed to the financial crisis.

AIG expects to pursue other litigation to recover losses from counterparties that sought to profit at our expense. Taxpayers still own 77 percent of the New York-based insurer, which received $182.3 billion of government bailouts.

In its complaint, AIG accused Bank of America and its Countrywide and Merrill Lynch units of misrepresenting the quality of its mortgage-backed securities, including more than $28 billion it bought, and lying to credit rating agencies about the underlying loans.

AIG said it examined 262,322 mortgages that backed 349 offerings it bought between 2005 and 2007, and found the quality of 40.2 percent of the mortgages was significantly inferior to what had been represented.

Defendants were engaged in a massive scheme to manipulate and deceive investors, like AIG, who had no alternative but to rely on the lies and omissions made, said the complaint, filed in the New York State Supreme Court in Manhattan.

Bank of America rejected AIG's allegations.

AIG recklessly chased high yields and profits throughout the mortgage and structured finance markets, spokesman Lawrence Di Rita said. It is the very definition of an informed, seasoned investor, with losses solely attributable to its own excesses and errors.

According to The New York Times, AIG is preparing similar lawsuits against other banks. Among these, it said, is Goldman Sachs Group Inc, which received $12.9 billion as one of the biggest beneficiaries of the government bailouts.

Goldman spokesman Stephen Cohen declined to comment.

The cost of protecting Bank of America debt against default for five years rose to $250,000 annually from $205,000 on Friday, according to Markit. It is nearly double the cost to protect debt from rival JPMorgan Chase & Co.

Bank of America is one of the sicker patients in the ward, said Jonathan Finger, a shareholder who runs Finger Interests Number One Ltd in Houston and was a leading critic of Lewis. Brian Moynihan and the management team have not gained the confidence and trust of investors.

Still, Miller said the job security of Moynihan, who replaced Lewis 1-1/2 years ago, may not be an immediate concern. I don't think Brian's gone, because who could replace him? he said.

Moynihan on Wednesday is scheduled to participate in a public conference call hosted by Fairholme Capital Management LLC, one of its largest shareholders.

Brian will have to give the performance of his life, Plath said.

AIG SAYS NO TO PENNIES-ON-THE-DOLLAR

Separately, AIG is protesting Bank of America's $8.5 billion agreement in late June to end most litigation by investors that bought securities backed by Countrywide loans.

Twenty-two investors, including BlackRock Inc and Allianz SE's Pacific Investment Management Co, signed on to that accord. But a growing number of other investors has called the payout too low, and say Bank of New York Mellon Corp as trustee did not negotiate fairly on their behalf.

According to an AIG court filing, Bank of New York Mellon decided to foist a pennies-on-the-dollar settlement on investors who lost roughly $108 billion, rather than focus on aggressively prosecuting Bank of America.

AIG said it owns certificates in 97 of the 530 trusts covered by the settlement.

New York Attorney General Eric Schneiderman is also moving to block the accord.

Bank of New York Mellon spokesman Kevin Heine declined to comment on AIG's filing, but repeated the bank's position that the settlement is reasonable.

The law firm Quinn Emanuel Urquhart & Sullivan filed the complaint and handles many other financial crisis cases. Michael Carlinsky, a lawyer who signed the AIG complaint, did not immediately respond to a request for comment.

The AIG lawsuit is American International Group Inc et al v. Bank of America Corp et al, New York State Supreme Court, New York County No. 652199/2011. The other case is In re: The Bank of New York Mellon in the same court, No. 651786/2011.

(Additional reporting by Ben Berkowitz, Lauren Tara LaCapra, Ciara Linnane, Andrew Longstreth and Sakthi Prasad; editing by John Wallace, Phil Berlowitz)

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