NEW YORK ( TheStreet) -- Investors with a strong stomach could be looking at a rewarding bank-stock pick in Flagstar Bancorp ( FBC). The Troy, Mich., lender's shares are down 4% in Wednesday trading to $15.41 as a result of an expensive court ruling against the company that could set a nasty precedent for other mortgage lenders facing similar lawsuits. But Flagstar appears ready to absorb another major courtroom loss, although investors may not yet believe it. Assured Guaranty ( AGO) late on Tuesday was awarded $90.1 million. It claimed Flagstar made fraudulent representations that caused the bond insurer $116 million in damages and expenses. The lawsuits involved two securitizations of home-equity loans that Assured Guaranty insured. Judge Jed Rakoff of the U.S. Southern District of New York agreed with Assured Guaranty's expert witness that 606 of 800 sampled loans were "materially defective," failing to meet Flagstar's own underwriting standards. That is a very high rate of negative findings for a loan sample, and the judge rejected numerous challenges by Flagstar to the sampling methodology and process. Rakoff ruled that Flagstar should pay Assured Guaranty in full to cover all the claims the insurers had paid to investors, plus additional expenses yet to be determined. Assured Guaranty's shares rose over 4% to $18.51. Meanwhile, bond insurer MBIA ( MBI) was up 7% to $9.41. MBIA has a pending case against Flagstar, seeking $165 million in claims relating to two loan securitizations. Rakoff's ruling could lead to other decisions against mortgage lenders. Bank of America ( BAC) in April 2011 settled Assured Guaranty's mortgage-putback lawsuit, agreeing to pay $1.1 billion in cash and also to pay up to $5.3 billion to reimburse the company on losses from 21 mortgage-securitization transactions. But Bank of America still faces two lawsuits from MBIA, and has in turn filed suit challenging MBIA's division into two entities, to protect its municipal-bond business from mortgage-related losses.
Several analysts believe that Bank of America could settle MBIA's claims for $2 billion to $3 billion. However, any settlement decision by the bank must also take into account the other mortgage-putback settlements it is negotiating. Getting back to Flagstar, the company's stock was already down 17% this year through Tuesday's close at $16.01, pulling back from a 280% return during 2011. Flagstar had $14.1 billion in total assets as of Dec. 31. The company reported 2012 net income available to common stockholders of $223.7 million, or $3.74 a share, compared with a net loss of $198.9 million, or $3.62 a share, in 2011. The EPS figures are adjusted for the stock's 1-for-10 reverse split in October. During 2012 the company booked $990.9 million in gains on loan sales, as its mortgage lending business came roaring back. In 2011 gains on loan sales totaled $300.8 million. But investors sent the shares down 12% on Jan. 24 after the company reported fourth-quarter results. Gains on loan sales declined to $239 million from $334.4 million in the third quarter, reflecting declines in lending volume and also in secondary market spreads. (See TheStreet's Short-Term Mortgage Pain Is Long-Term Gain for Banks for a discussion on the effect of rising long-term rates on banks' gains on the sale of mortgage loans.) FBR analyst Paul Miller rates Flagstar "outperform," with a $25 price target. Miller said in a report Jan. 25 that he remained "confident the company's core profitability and momentum in the mortgage business remains high and will outpace remaining legacy costs." Flagstar reported a tangible book value of $18.97 a share as of Dec. 31, and Miller estimated that tangible book value would rise to roughly $25 by the end of 2014. Following Rakoff's ruling on the Assured Guaranty suit, Miller on Wednesday reiterated his view that tangible book value could hit $25 by the end of 2014, "even assuming moderating gain-on-sale margins and elevated legacy costs over the next two years." If the MBIA suit against Flagstar ends up with a similar result to the Assured Guaranty ruling, "it broadly equates to a worst-case loss of $1.50 per share to $2 per share" for Flagstar, according to Miller. The analyst also expects Flagstar to pay $17 million in additional expense reimbursements to Assured Guaranty. Flagstar had $193 million in mortgage-putback reserves as of Dec. 31. Miller said that "backing out our estimated total loss exposure from both MBIA and Assured of about $182 million, we have already built into our model an additional $338 million in losses," which he called a "conservative" estimate. Even with a reduced level of profitability for the mortgage business, FBR estimates that Flagstar will report $819 million in loan-sale gains this year. Miller estimates that Flagstar will earn $3.92 a share this year, although he also estimates that EPS will decline to $3.40 in 2014, with a sharp decline in gains on mortgage-loan sales. For investors who think the housing recovery and mortgage-lending boom will continue, it may be a good time to jump into Flagstar's shares after such a big slide. -- Written by Philip van Doorn in Jupiter, Fla. >Contact by Email. Follow @PhilipvanDoorn