[Flagstar Letterhead]
February 13, 2006
Mr. Kevin Vaughn
Accounting Branch Chief
Division of Corporation Finance
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Mail Stop 4561
Re: Flagstar Bancorp, Inc.
Form 10-K filed March 23, 2005
File No. 001-16577
Dear Mr. Vaughn:
We are writing in response to your letter, dated November 23, 2005 (the
"Comment Letter"), regarding the Annual Report on Form 10-K filed by Flagstar
Bancorp, Inc. (the "10-K") on March 23, 2005. This letter is being provided to
you today pursuant to our written request for an extension of time made to the
staff of the Securities and Exchange Commission (the "Staff") on December 7,
2005 and also reflects our discussions with the Staff through January 26, 2006.
Please note that our responses below reflect our understanding that we may defer
any amendments to the 10-K pending the Staff's review of this letter.
Our responses to the Comment Letter are set forth below, in each case
preceded by a reproduction of the corresponding comment.
COMMENT NO. 1: We continue to disagree with your assertion that all of your
loans are sold on a non-recourse basis. Section 4.16 of the
AICPA Audit and Accounting Guide for Depository and Lending
Institutions defines recourse risk as the risk that an
investor may either reject a loan or require the mortgage
lender to repurchase the loan if there is a defect in
underwriting or documentation, or if the loan becomes
delinquent within a specified amount of time after purchase.
We continue to believe that your obligation to repurchase the
loans or indemnify the purchaser for any related losses in the
event of a breach in representations and warranties meets the
definition of recourse risk. As previously requested, please
revise throughout the document to clarify and reflect that
loans are sold on a limited-recourse basis with respect to
certain representations and warranties. If you continue to
believe otherwise, please provide us with your complete legal
analysis of the risks you retained and copies of the contracts
for the major types of loan sales. In addition, revise to
clearly identify the triggers or motivation for repurchasing
these loans if you
Mr. Kevin Vaughn
Securities and Exchange Commission
February 13, 2006
Page 2
believe you were not legally obligated to repurchase them or
otherwise bear the risk of loss.
RESPONSE NO. 1: As discussed with the Staff by telephone on December 2, 2005
and further on January 26, 2006, we propose to amend our
disclosure in our future SEC filings to describe Flagstar's
obligations with respect to loans sold by us in the secondary
market without referring to these sales as nonrecourse, and to
clarify the reasons we maintain a secondary market reserve for
these loan sales. We propose to amend our disclosure in our
future SEC filings to read as follows:
We sell most of the residential mortgage loans that we
originate into the secondary mortgage market. When we sell
mortgage loans, we make customary representations and
warranties to the purchasers about various characteristics
of each loan, such as the manner of origination, the
nature and extent of underwriting standards applied and
the types of documentation being provided. If a defect in
the origination process is identified, we may be required
to either repurchase the loan or indemnify the purchaser
for losses it sustains on the loan. If there are no such
defects, we have no liability to the purchaser for losses
it may incur on such loan. We maintain a secondary market
reserve to account for the expected losses related to
loans we may be required to repurchase (or the indemnity
payments we may have to make to purchasers). The secondary
market reserve takes into account both our estimate of
expected losses on loans sold during the current
accounting period, as well as adjustments to our previous
estimates of expected losses on loans sold during the
preceding five years. In each case these estimates are
based on our most recent data regarding loan repurchases,
actual credit losses on repurchased loans and recovery
history, among other factors. Changes in the secondary
market reserve due to current loan sales and adjustments
in our previous estimates are recorded together as an
increase or decrease in our gain on loan sales during the
current accounting period. The amount of the secondary
market reserve equaled $17.6 million and $19.0 million at
December 31, 2005 and 2004, respectively.
Please also see our responses to Comment No. 5 and Comment No.
7, each of which refers to this proposed disclosure language.
COMMENT NO. 2: Please revise your disclosure regarding Flagstar Credit
Corporation to quantify the exposure to losses for reinsurance
assumed as of each balance sheet date. Separately disclose the
amount of such reinsurance assumed related to loans you have
sold from reinsurance assumed related to loans held in your
portfolio. If you believe the amount of such exposure is not
material to your results of operations or cash flows, please
tell us the amounts.
Mr. Kevin Vaughn
Securities and Exchange Commission
February 13, 2006
Page 3
RESPONSE NO. 2: As discussed with the Staff, Flagstar Credit Corporation
("FCC") provides credit enhancement with respect to certain
pools of mortgage loans underwritten and originated by us
during each calendar year. However, most of the risk
associated with these pools is ceded to unaffiliated private
mortgage insurance companies. The private mortgage insurance
companies provide loss coverage for foreclosure losses on up
to 5% of the "insured risk" with respect to each pool of loans
and for any loss greater than 10% of the insured risk with
respect to each pool. The insured risk for any pool of loans
is only 20% or less of the principal balance of the loans in
the pool. FCC's share of the total amount of this insured risk
is an intermediate tranche of credit enhancement risk, which
covers the 5.01% to 10% range.1 Therefore, until credit losses
on the entire pool of insured loans exceed 5% of the insured
risk, FCC will have no liability on its credit enhancement
obligation. At December 31, 2004, FCC's maximum exposure
amounted to $100.8 million. However, given that the credit
enhancement is provided on an aggregated pool basis (rather
than on an individual loan basis), that FCC's obligation is
subordinated to the primary insurers, and that the insured
mortgage loans are fully collateralized, we believe FCC's
actual risk exposure is immaterial. To date, no claim has been
made against FCC on the mortgage loan credit enhancement it
provides. Accordingly, we believe that disclosing FCC's loss
exposure would suggest a potential for loss that is actually
remote and therefore would not provide any meaningful guidance
to investors.
COMMENT NO. 3: Tell us whether Flagstar Credit Corporation assumed PMI risk
on any of the loans you repurchased and subsequently recorded
losses on through the Secondary Marketing Reserve. Tell us
whether the third-party PMI insurer has paid any claims on
loans where they ceded reinsurance to Flagstar Credit. If so,
tell us the amounts involved and why reinsurance claims were
not triggered.
RESPONSE NO. 3: We may repurchase loans as to which FCC had provided its
secondary tranche of credit enhancement. As set forth in our
response to Comment No. 2 above, FCC would be liable for
losses in excess of 5% of the original "insured risk" of the
pool of loans, which would continue to include any repurchased
loans. In some cases, third party mortgage insurance companies
that provided the primary level of mortgage insurance on these
repurchased loans have paid claims to us for credit losses on
loans we have repurchased. However, as noted in our response
to Comment No. 2, we have not yet had a circumstance in which
the credit losses suffered by a pool of loans for which FCC
provided credit enhancement have risen to a level that would
affect FCC's risk layer. Accordingly, FCC has never made a
payment with respect to any loan repurchased by us.
- --------
1 Accordingly, FCC's maximum exposure at any time equals 5% of the insured
risk of the insured pools, or approximately 1% (i.e., 5% times the 20%
insured risk) of the total principal balance of the loans in the pool.
Mr. Kevin Vaughn
Securities and Exchange Commission
February 13, 2006
Page 4
COMMENT NO. 4: We note your response to comment 2 of our letter dated July 7,
2005. We disagree with your assertions that you do not hold
any retained interests in the loans sold to the FHLBI and that
you do not maintain any recourse on these loans. It is our
position that you do hold a beneficial interest in the loans
sold to the FHLBI as you maintain a right to receive all or a
portion of specified cash inflows from the loans via the
Lender Risk Account (LRA). It is also our position that you
have a recourse obligation related to these loans as you are
exposed to credit losses up to the amount of the LRA.
- As a result, the cash basis accounting you have employed
to date would not be an acceptable method of accounting
for the LRA. Please revise your financial statements
accordingly.
- Please revise to disclose how you account for all assets
obtained and liabilities incurred in the sale of loans to
the FHLBI. Refer to Questions 67 and 68 of the Q&A on SFAS
140 for additional guidance.
- Please provide us with an analysis of your history of
collections on the LRA that supports your estimates of the
LRA used in your revised methodology for these amounts.
RESPONSE NO. 4: We sold FHLBI approximately $335 million in loans from 2002
through 2005. At December 31, 2004, of those loans still
outstanding, the unpaid principal balance was $231 million. As
of that date, FHLBI maintained a corresponding Loss Reserve
Account (LRA) balance of approximately $120,000 or 0.05% of
the unpaid principal balance of those loans. Under the terms
of the FHLB loan purchase agreement we would be entitled to
the excess of the LRA over an FHLB-established 30 bps estimate
of expected losses in the loans we sold to the FHLB. We would
not, however, be responsible for any losses over and above
those that were reimbursed by the LRA.
Consistent with FAS 140, paragraphs 68 through 70, we
understand that generally an amount equal to the fair value of
the LRA would be recorded as a deferred income item and
accreted into income net of any expected losses arising from
the related loan pool. However, in our case, the current
amount of the LRA at issue is below our estimate of expected
losses on these loans. That is, in our judgment, our right to
receive any cash from the LRA is completely offset by the
expected losses inherent in the loan portfolios that we sold
to the FHLBI. Thus, the LRA effectively has no value to us.
Thus, although the FHLB's loan purchase program provides that
Flagstar has a right to receive any portion of the LRA not
applied against credit losses on the loan portfolio at a
future date, in our judgment there is no possibility of
Mr. Kevin Vaughn
Securities and Exchange Commission
February 13, 2006
Page 5
Flagstar ever receiving any material amount of these funds in
light of the rather insignificant size of the LRA as compared
to the related loan portfolio.
In the absence of any value being assigned to the LRA, we do
not believe it would be meaningful to investors from the
standpoint of accounting clarity to record the LRA as an asset
and to create a corresponding valuation allowance in an equal
amount to represent our estimate of expected losses on the
loans sold to the FHLBI. This is especially true given the
immaterial dollar amount of the LRA itself. Furthermore,
describing these loans as recourse obligations will, in our
opinion, create unnecessary confusion as to the true nature of
these loan sales. The fact of the matter is that FHLBI cannot
require us to "write a check" to reimburse it for any credit
losses above the LRA amount. In light of these facts, we
believe that our approach is not only reasonable, but is a
clear and accurate accounting for these transactions.
COMMENT NO. 5: We note your response to comment 4 of our letter dated July 7,
2005. We are still unclear as to the purpose of and accounting
for your secondary market reserve. You disclose that the
secondary marketing reserve is "a reserve against probable
losses that will be incurred due to the repurchase of mortgage
loans sold in the secondary market." Please advise us as
follows with respect to this reserve:
- Please revise to disclose whether you are recording an
obligation for the actual repurchase of these loans or
whether you are recording an allowance for potential
credit losses that you may realize once these loans are
repurchased.
- If the purpose of this reserve is to record an obligation
for the repurchase of these loans due to breaches in
representations and warranties, please tell us how your
accounting complies with the guidance set forth in FIN 45
related to guarantees. In addition, please revise future
filings to provide the disclosures required by paragraph
13 of FIN 45.
- If the purpose of this reserve is to record an allowance
for potential credit losses expected to be realized once
these loans are repurchased, please tell us the
authoritative literature upon which you relied in
determining this accounting to be appropriate and how you
determined that it was appropriate to net the Provision
for such losses against your Gain on sale.
RESPONSE NO. 5: As discussed in our response to Comment No. 1, the secondary
market reserve reflects our estimate of expected losses on
loans once they have been repurchased by Flagstar. It is not
the purpose of the reserve to record an obligation to actually
repurchase these loans. As noted in our response to Comment
No. 1, we propose to clarify the purpose of our secondary
market reserve in our future SEC filings.
Mr. Kevin Vaughn
Securities and Exchange Commission
February 13, 2006
Page 6
We believe that recording the provision for such expected
losses on loan sales (whether as a result of loan sales during
the current accounting period or to take into consideration
adjustments to our estimate of expected losses from loans sold
in previous periods) as an adjustment against our gain on loan
sales in the current period is consistent with paragraph 11 of
SFAS No. 140 and with industry practice.
COMMENT NO. 6: Please revise to provide a rollforward of this account balance
for the last three years.
RESPONSE NO. 6: The rollforward of the secondary market reserve for the
previous three years, as well as 2005, together with the
allocation of the provision between the amount provided for
the current year and the amount of the provision that relates
to changes in prior year estimates is as follows:
2005 2004 2003 2002
-------- -------- -------- --------
Beginning balance $ 19,002 $ 10,254 $ 9,084 $ 12,972
Provision charged to
Gain on sale --
Current 5,328 5,932 10,696 7,626
Prior 7,156 18,105 3,464 (2,785)
-------- -------- -------- --------
Total 12,484 24,037 14,160 4,841
-------- -------- -------- --------
Charge offs, net (13,936) (15,289) (12,990) (8,729)
-------- -------- -------- --------
Ending balance $ 17,550 $ 19,002 $ 10,254 $ 9,084
-------- -------- -------- --------
COMMENT NO. 7: Please revise to clearly identify the timing of the provision
for the secondary market reserve. Separately quantify the
amounts that were recorded at the time of the sale versus the
amounts that were recorded subsequent to the sale.
RESPONSE NO. 7: As noted in our response to Comment No. 1, the adjustment to
gain on loan sales in any accounting period for our provision
to the secondary market reserve results from (i) our estimate
of expected losses that we might incur on loans sold during
the accounting period and (ii) adjustments to our earlier
estimates of expected losses on loans sold during the
preceding five years. The entries for each are made based on
our internal methodology that we established effective in 2002
and continue to refine based on our ongoing analysis of credit
losses we incur on loans we repurchased.
Because of the inherent imprecision of our estimation process,
we believe that disclosure of these components of the
provision on the face of the statement of consolidated
earnings or elsewhere would improperly suggest a higher degree
Mr. Kevin Vaughn
Securities and Exchange Commission
February 13, 2006
Page 7
of certainty than is actually present. Indeed, this type of
disclosure could prove to be more confusing to financial
statement readers than helpful.
Accordingly, we propose to utilize the disclosure of our
secondary market reserve, as set forth in our response to
Comment 1, in future filings. Additionally, we will provide a
rollforward of our secondary market reserve for the periods
presented, but without the level of detail regarding the
provision as presented in Response No. 6.
COMMENT NO. 8: As requested in comment 6 of our previous letter, please
revise to provide the disclosures required by Item 307 of
Regulation S-K with respect to your disclosure controls and
procedures.
RESPONSE NO. 8: The disclosure required by Item 307 of Regulations S-K
regarding our disclosure controls and procedures was
inadvertently not included in our Annual Report on Form 10-K
for the year ended December 31, 2004. However, this disclosure
has been included in subsequent filings on Form 10-Q and,
accordingly, the current assessment of management of our
disclosure controls and procedures has been disclosed. As a
result, it does not seem worthwhile to amend our 10-K at this
time to include disclosure that has been superseded by
subsequent filings.
However, if the staff continues to be of the view that we
should amend our Annual Report on Form 10-K for the year ended
December 31, 2004, we will make the following disclosure:
Evaluation of Disclosure Controls and Procedures. A review
and evaluation was performed by our principal executive
and financial officers regarding the effectiveness of our
disclosure controls and procedures as of December 31,
2004, pursuant to Rule 13a-15(b) of the Securities Act of
1934. Based on that review and evaluation, the principal
executive and financial officers have concluded that our
current disclosure controls and procedures, as designed
and implemented, were not operating effectively as a
result of the material weaknesses reported in
"Management's annual report on internal control over
financial reporting" below."
Flagstar Bancorp hereby acknowledges that:
- it is responsible for the adequacy and accuracy of the
disclosure in the filings;
- Staff comments or changes to disclosure in response to staff
comments in the filings reviewed by the staff do not foreclose
the Commission from taking any action with respect to the
filing; and
Mr. Kevin Vaughn
Securities and Exchange Commission
February 13, 2006
Page 8
- it may not assert staff comments as a defense in any
proceeding initiated by the Commission or any person under the
federal securities laws of the United States.
We trust that the forgoing is responsive to your comments. If you have
any questions regarding the foregoing or require further information, please
contact the undersigned at (248) 312-5580 or our outside counsel Jeremy Johnson
of the Kutak Rock LLP law firm at (202) 828-2463.
Sincerely,
FLAGSTAR BANCORP, INC.
/s/ Paul D. Borja
----------------------------------------
By: Paul D. Borja
Its: Executive Vice President and Chief
Financial Officer