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UPDATE 1-US official warns of lawsuit as BofA mortgage talks stall

(Adds details of speech, background, no comment from Bank of America)

WASHINGTON, July 16 (Reuters) - A U.S. Department of Justice official on Wednesday issued a thinly veiled threat to Bank of America Corp, saying that banks under investigation for shoddy mortgage securities they sold before the financial crisis must admit to misconduct and pay substantial penalties or face lawsuits from the agency.

The warning from No. 3 Justice official Tony West comes after a $7 billion settlement with Citigroup Inc earlier this week and as talks with Bank of America Corp have stalled over similar claims.

"Let me be clear: We do not investigate these matters intending to settle them," West said, without naming specific institutions.

"I would not be surprised if we were to see additional RMBS lawsuits in the future," he said during a speech to the Exchequer Club, a financial policy group in Washington.

The Justice Department-led residential mortgage-backed securities (RMBS) working group is conducting multiple investigations and has held talks with Bank of America to resolve a range of cases including one into securities sold by its Merrill Lynch unit.

A Bank of America spokesman declined to comment.

Talks have stalled in recent weeks, as the Justice Department has sought roughly $17 billion in cash penalties and help to struggling homeowners. The parties have stood as much as $5 billion apart, sources have said.

While the Justice Department has levied record penalties against financial institutions over mortgage misconduct, sanctions violations and other offenses, some lawmakers and other critics have questioned whether such penalties are enough and urged the government to take more cases to trial.

Republican Senator John McCain on Wednesday told the Justice Department in a letter that its settlement with Citigroup appeared to be "inadequate."

He said the deal did not appear to wholly compensate investors harmed by the shoddy securities and that it would not sufficiently deter banks from similar behavior in the future. He asked for the agency to clarify how it arrived at the deal's terms.

The U.S. Attorney's office in Charlotte sued Bank of America last year, accusing it of misleading investors on $850 million worth of mortgage securities, but that office is currently amending its lawsuit after a judge recommended the dismissal of its first complaint.

Bank of America has already reached nearly $50 billion in settlements with housing regulators, government-sponsored mortgage companies, bond insurers and private investors over legacy mortgage issues.

FACTS IN DISPUTE

West's speech comes one day after he and other Justice Department officials met with Bank of America representatives about a potential settlement, according to a person familiar with the talks. Negotiators made little progress towards a deal at the meeting, said the person, who declined to be named.

In his speech, West alluded to such meetings and said by the time negotiations reach his desk, investigators and Justice Department lawyers have already discussed facts and theories with banks under investigation for months.

"By the time I am sitting across the table from a financial institution to discuss whether we will settle or sue, there aren't generally many facts that remain in dispute," he said.

West said the agency would litigate such cases if it did not receive an admission of wrongful conduct, a substantial penalty and some redress to those harmed.

In another apparent nod to Bank of America, West said banks must do more to resolve the cases than seek a meeting with Attorney General Eric Holder. Reuters reported last week that the Charlotte-based bank was denied a meeting it had sought between Holder and Bank of America Chief Executive Officer Brian Moynihan.

(Reporting by Aruna Viswanatha in Washington, with additional reporting by Peter Rudegeair in New York; Editing by Karey Van Hall and Cynthia Osterman)