Flagstar to Stand Trial over Mortgage-Backed Securities

Flagstar Bancorp (FBC) in Troy, Mich. must stand trial over charges it breached contracts for financial guaranty insurance on roughly $1 billion in residential mortgage-backed securities it issued during the run-up to the financial crisis.

Bond insurer Assured Guaranty Municipal Corp., the plaintiff in the case, has put forward enough evidence to survive the $14.3 billion-asset company's motion to dismiss the case, U.S. District Judge Jed Rakoff in New York held Tuesday in an opinion that expanded on an order he issued in February.

"At trial, the trier of fact could conclude that these widespread failures to follow customary servicing practices constituted 'gross negligence, malfeasance or bad faith,'" Rakoff wrote. "Although the court is skeptical that plaintiff can meet this standard at trial, the court finds that the plaintiff has presented enough evidence to survive summary judgment on this claim."

Rakoff set a date of Oct. 9 for the trial.

Flagstar declined to comment. In heavy trading, its shares were down 4.6% late Wednesday, to $1.05.

The case stems from Assured's agreement to insure securities issued by Flagstar in 2005 and 2006 that were backed by home-equity loans Assured alleges were deficient. These alleged deficiencies ranged from fraud to a failure by Flagstar to adhere to its own underwriting guidelines, despite representations by the bank it originated the loans in good faith and expected them to be paid in full.

Assured also contends that Flagstar failed to service roughly one-third of the loans in the 2005 transaction and half the loans in the one a year later. Roughly $200 million of the loans turned out to be uncollectible, causing Assured to pay out more than $90 million in claims to bondholders.

Assured has similar suits pending against JPMorgan Chase (JPM), Credit Suisse and UBS AG. A New York judge ruled in August that the case against Credit Suisse could proceed, though he dismissed a portion of the case. Assured also reached large settlements with Bank of America (BAC) and Deutsche Bank without filing lawsuits.

Flagstar has lost nearly $1.4 billion since 2007 as it faced a series of defaults on mortgage loans. In February, the company agreed to pay up to $133 million to settle a dispute regarding underwriting practices associated with loans insured by the Federal Housing Administration.

In July, the company reported a profit of $86 million for the quarter that ended June 30. It was Flagstar's first quarterly profit in four years.