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New York mortgage trial could have broad impact on Wall Street

By Nate Raymond

NEW YORK (Reuters) - A Michigan bank accused of misstating the quality of home loans it repackaged into mortgage-backed securities is set to go to trial on Wednesday, in a case that could affect pending lawsuits against some of Wall Street's biggest firms.

The lawsuit against Flagstar Bancorp Inc of Troy, Michigan, is one of the first to go to trial over claims that a lender misrepresented loans pooled into mortgage-backed offerings.

Flagstar was sued in 2011 by bond insurer Assured Guaranty Ltd , which had guaranteed $900 million of securities and was on the hook to pay investors when the investment plummeted in value in the housing market meltdown.

While Assured is seeking only $108 million in its breach-of-contract case -- a relatively small sum in financial industry litigation -- Wall Street will be watching the Manhattan federal court trial closely. Assured has also sued UBS AG , Credit Suisse Group AG , Deutsche Bank AG and JPMorgan Chase & Co over similar allegations.

Leading up to the lawsuit, Assured had demanded Flagstar repurchase some of the loans, and Flagstar refused, according to the insurer's complaint. Flagstar has countered that Assured is a sophisticated party that extensively reviewed the securities before agreeing to insure them.

During a September 5 insurance industry conference hosted by brokerage firm Keefe, Bruyette & Woods, Assured Chief Executive Dominic Frederico referred to the potential impact of a "big win" in the Flagstar case.

The other defendants "will all of a sudden get really interested in getting a settlement achieved," he said.

Ashweeta Durani, a spokeswoman for Assured, and Susan Bergesen, a spokeswoman for Flagstar, declined to comment for this story.

FIRST TO TRIAL

The Flagstar lawsuit is one of many cases over mortgage practices when the housing market was booming.

In February, Flagstar agreed to a $132.8 million settlement to resolve civil fraud claims by the U.S. Department of Justice that the bank had improperly approved thousands of home mortgages for government insurance.

The Justice Department on Tuesday sued Wells Fargo , also on allegations of falsely certifying mortgages that were federally insured.

In another case, the New York attorney general sued JPMorgan earlier this month over the quality of the loans in mortgage securities sold by Bear Stearns.

Other bond insurers, including MBIA Inc and Ambac Financial Group Inc , have also brought lawsuits similar to Assured's over repackaged mortgages. One of the biggest pending cases is MBIA's $3 billion lawsuit against Bank of America Corp's Countrywide Financial unit in New York State Supreme Court. A trial date in that case has not been set.

The Flagstar case has progressed swiftly to trial thanks in part to the presiding judge, Jed Rakoff, who is known for trying to get cases to move along quickly. A settlement is still possible ahead of the trial, but neither side would comment on whether any settlement discussions were underway.

Rakoff, who is hearing the case without a jury, is well known in the financial industry. He is the same judge who last year rejected Citigroup Inc's $285 million settlement with the U.S. Securities and Exchange Commission over the sale of toxic mortgage debt. He criticized the SEC for allowing the bank to settle without admitting or denying the allegations.

The Flagstar trial is expected to focus heavily on why certain loans were included in mortgage-backed securities, an issue at the heart of the lawsuits brought by the bond insurers.

The question is whether lenders misrepresented details of the loans, such as homeowners' credit scores and their debt-to-income ratios, painting a false picture of the default risks of mortgages underlying the securities. The insurers point to underwriting guidelines that required all the loans in the securities to meet standards.

Assured has accused Flagstar of falsely representing the quality and characteristics of loans packaged into two offerings issued in 2005 and 2006. An analysis of 800 loans found 610 instances of misrepresentations, according to Assured's lawsuit.

The trial could also test bond insurers' ability to recover damages using evidence from so-called "statistical sampling." Insurers say they should be able to rely on a sample of the multitude of loans underlying a mortgage pool, rather than have to go loan by loan to prove their case as the defendants have sought.

Flagstar has denied misrepresenting the loans, and has said Assured's case is based on "faulty statistical hypotheses."

The case is Assured Guaranty Municipal Corp v Flagstar Bank, FSB in U.S. District Court for the Southern District of New York, No. 11-2375

(Reporting By Nate Raymond in New York; Editing by Martha Graybow and Tim Dobbyn)

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