Class Sues Flagstar Bank on RICO Claims

SCRANTON, Pa. (CN) - Flagstar Bank and Flagstar Reinsurance Co. defrauded homeowners of tens of millions of dollars in reinsurance premiums, a RICO class action claims in Federal Court.

Lead plaintiff Martinique E. Gordon claims that Flagstar exploited its position as mortgage lender to take kickbacks "in the form of purported reinsurance premiums that were paid by private mortgage insurers."

Flagstar, based in Michigan, is the largest publicly held savings bank in the Midwest, with "retail home loan centers" in 13 states and loans out in all 50 states. It had $13.6 billion in assets in 2011, according to publicly available information. It shares, traded on the New York Stock Exchange, were selling at $18.21 in early morning trading Wednesday.

According to Gordon's July 2 lawsuit, borrowers paid insurance premiums to private mortgage insurers selected by Flagstar, who kicked money to Flagstar in the form of "reinsurance" premiums.

Gordon and her husband say their mortgage insurance payments were $197.72 per month. Co-plaintiffs Susan and Steven Wolf's monthly payments were $326.65.

The six named plaintiffs sued Flagstar Bank and its mortgage lending subsidiaries and affiliates on behalf of all those who took out residential loans since Jan. 1, 2004.

Borrowers who cannot afford a 20 percent down payment must buy private mortgage insurance to protect the lender from default.

Gordon claims that Flagstar defrauded the class of "what would ultimately amount to $6 billion out of insurance premiums in exchange for assuming little or no risk," which "had the effect of reducing competition in the mortgage insurance market."

According to the 67-page complaint: "This was accomplished through a secretive 'pay-to-play-scheme' that utilized carefully crafted excess-of-loss reinsurance contracts that identified 'bands of losses' for which there was a purported risk of exposure or purported 'quota-share' reinsurance with the intent that the reinsurer would not actually be exposed to any real reinsurance risk. Further, even with regard to the purported band of exposure, certain lenders, including Flagstar Bank and their mortgage lending subsidiaries and/or affiliates, insulated themselves from providing any real reinsurance by: (a) making their captive reinsurance arrangements 'self-capitalizing,' in that they were required to put only 'nominal initial capital' into the trusts supporting the reinsurance contracts; and (b) providing no recourse for the failure to adequately fund the trusts. ...

"In other words, these lenders - including Flagstar Bank and its mortgage lending subsidiaries and/or affiliates - were 'playing with the house's money' with no risk of meaningful losses."

Gordon says that American Banker "aptly explained" the alleged fraud: "If defaults remained low, banks would pocket large premiums without paying any claims; if defaults were high, banks' losses would be capped at the amount of their small initial investments, plus the premiums paid by homeowners and passed along to them by their mortgage insurance partners. In other words, it appeared to be a no-lose proposition for the banks."

Flagstar doled out its mortgage insurance business to private insurers on a rotating basis, under "captive reinsurance agreements," which gave homebuyers "no opportunity to comparison-shop or select the provider of the private mortgage insurance," Gordon claims. And she says Flagstar lied to borrowers about its system.

"From 2004 through the end of 2010, Flagstar RE collected from the private mortgage insurers at least $32.5 million as its 'share' of the borrowers' private mortgage insurance premiums. In contract, Flagstar RE's 'share' of paid claims during this time period was approximately $438,000," the complaint states.

"Under the terms of the virtually identical reinsurance contracts entered into between private mortgage insurance providers and each of the top lender captive reinsurers in the country, including Flagstar Bank and Flagstar RE, the lenders were protected from any liability beyond their initial capital infusion and bore no real risk," according to the complaint. "Most significantly, each of these reinsurance contracts contained 'termination clauses' and 'trust caps' which, without a counter-balancing 'recourse' provision vis-à-vis the parent lender to ensure that the private mortgage insurance reinsured through termination would indeed continue to be reinsured - effectively allowed the reinsure to opt out of the scheme at its choosing and without suffering adverse consequences."

Plaintiffs seek class certification, restitution, disgorgement of ill-gotten gains with interest, damages and statutory damages for unjust enrichment and RICO fraud.

Their lead counsel is Peter Muhic with Kessler Topaz Meltzer & Check, of King of Prussia, Pa.

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