First RMBS putback decision clears path for litigants

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At first glance, a judge's decision [3] ordering Flagstar Bancorp to pay Assured Guaranty $90.1 million in damages and fees to cover representation and warranty issues stemming from insured residential mortgage-backed securities transactions seems somewhat minor.  

But Manal Mehta, an analyst with Sunesis Capital, says the "ruling cannot be overstated."

Assured Guaranty President and CEO Dominic Frederico also called it the "first trial related to RMBS R&W (reps and warranties) putbacks that has come to a final court ruling, and it sets a strong precedent in support of the rights of Assured Guaranty in these cases."

Frederico added, "The decision establishes clear liability as it relates to originators and securitizers of RMBS transactions and strengthens Assured Guaranty’s resolve to seek full recovery from R&W providers that refuse to recognize this liability."

The court's decision is a potential lightening rod for banks involved in putback litigation with bond insurers and other parties over alleged breaches of reps and warranties tied to RMBS contracts, especially cases filed in the same jurisdiction.

Mehta believes the legal posturing of Judge Radkoff with the U.S. District Court for the Southern District of New York could spell trouble for Bank of America ($13.22 -0.216%) [4], which has been setting up its own mortgage-related loss reserves on the theory that bond insurers and litigants have to prove a violation of reps and warranties actually caused the resulting losses raised in court.

"In a comprehensive 103-page ruling, not only was Assured Guaranty awarded full reimbursement of its claims, but Judge Rakoff confirmed the use of statistical sampling and confirmed the monolines view of loss causation — that they do not have to prove a causal link between the violation of the rep and warranty with the loss," said Mehta. "This is directly contradictory to how Bank of America sets up its reserves."

Judge Rakoff writes about this prevailing ruling in his final opinion, stating that "the causation that must here be shown is that the alleged breaches caused plaintiff to incur an increased risk of loss. Risk of loss can be realized or not; it is the fact that Assured faced a greater risk than was warranted that is at issue for the question of breach."

The good news for Flagstar is the ruling "does quantify a primary legacy overhang on FBC shares, which, in our view, is a positive development," said Paul Miller, managing director with FBR Capital Markets.

He added, "We estimate total losses in the case to be approximately $100 million relative to the company's existing $82.7 million litigation reserve."

Flagstar will appeal, said Miller. But the court's decision is already capturing headlines with another bond insurer, MBIA, currently going after Flagstar in court for $165 million that was paid out in claims to cover losses stemming from two mortgage securitizations that MBIA guaranteed.

"Given that this initial court ruling awarded Assured Guaranty the claims it was seeking in the lawsuit, it's possible FBC could be liable for up to this amount. If that assumption holds true, it broadly equates to a worst-case loss of $1.50 per share to $2.00 per share on 4Q12 tangible book value of $18.97, assuming another $165 million from the outstanding MBIA suit on top of the additional $17 million the company may incur to true up this Assured settlement," Miller said.

FBR Capital says Flagstar has $193 million in reps and warranties reserves and $305 million in allowance for future loan losses.

"Backing out our estimated total loss exposure from both MBIA and Assured of $182 million, we have already built into our model an additional $338 million in losses. As such, we continue to view our assumptions as conservative," FBR Capital said about Flagstar.

Still, FBR is relatively positive about the Michigan-based bank. Miller added that "FBC can achieve a tangible book value of $25 by year-end 2014" even if it has to deal with elevated legacy costs.

Click here [5] for the full opinion.

kpanchuk@housingwire.com [6]