This week we learned SunTrust had to pay around a billion dollars to settle with the government over the mortgage fraud they committed against the GSEs. News of this investigation detailing how the bank committed the fraud was first reported by me at finance trade publication Growth Capitalist in November 2012. This means there is a high probability SunTrust knew for over a year they would have to pay a large fine for these actions but instead they kept telling shareholders their legacy mortgage problems with Fannie Mae and Freddie Mac were behind them.
Original news report Nov 2012 for Growth Capitalist:
November 5, 2012 by Teri Buhl
SunTrust under SEC Investigation
Atlanta-based SunTrust Banks (STI) is under investigation by regulators for alleged mortgage fraud against Fannie Mae. Whistleblowers who worked in SunTrust’s residential mortgage underwriting group filed a whistleblower suit with the Securities and Exchange Commission this spring. After the Washington, D.C. office of the SEC received the complaint a director of the SEC’s Atlanta office and a forensic accountant were assigned to begin an immediate investigation in the bank. Three people involved in the case told Growth Capital Investor interviews with SunTrust employees who worked in the bank’s mortgage unit started in May, along with an inspection of the methods SunTrust used to qualify prime loans sold to Fannie Mae.
SunTrust saw its stock price fall off a cliff in the financial crisis, and subsequently participated in the federal TARP program aimed at shoring up distressed banks. Investors who held the stock valued at $73 a share in October 2007 watched their investment wiped out when it fell to $7 by February 2009. Distressed investors who bought the stock in the high-teens at the end of 2011 have now witnessed a near 50% rise in the stock as the bank paid off its TARP funds and increased mortgage lending. Analysts started to boast buy ratings on the stock this year and Jefferies currently has a $32 price target on SunTrust.
But as bank executives have worked to clean up the troubled balance sheet created during its go-go lending years, 2005 to early 2008, the prior actions of its mortgage team could still place a dent in future profitability.
SunTrust financials show since 2005 they sold $233 billion of loans, with the bulk being bought by the GSEs (Fannie Mae and Freddie Mac). SunTrust built a special relationship with Fannie Mae who allowed them to have a custom underwriting system that connected to Fannie’s automated mortgage buying program. The Desktop Underwriter program, or DU, was designed to buy prime residential loans from banks like SunTrust who were heavy volume mortgage originators. The Federal Housing Finance Agency Office of Inspector General reported in an audit of Fannie’s lending standards that more 1,500 banks originated loans through the DU program in 2010, comprising 71% of all loans bought by the GSE. All SunTrust had to do was meet the right mix of income and personal asset qualifiers, enter them into Fannie’s DU system, and the loan was swiftly bought off the bank’s books, freeing up reserves for new loans. Fannie would then book these loans as ‘lender selected’ prime loans, even though there was little human inspection of the documents that qualified the borrower.
The SunTrust whistleblower complaint says bank executives then taught underwriters how to ‘trip the DU system’ to make it accept loans that were actually less than prime quality. All SunTrust had to do was make sure they were scored right and their custom DU Fannie Mae program even allowed them to re-enter borrower data multiple times until they got the right score. Internal documents from SunTrust management show how to avoid red flags or “beat the Fannie Mae DU system.” One whistleblower explains how they re-entered a borrower’s income ten times until they got the right acceptance score. Snapshots of these repeated DU data runs were turned over to the SEC in the whistleblower complaint along with internal memos that encourage underwriters to “get loans” into the DU systems.
“We knew we were making Alt-A loans but Fannie thought they we were selling them prime,” said one former SunTrust employee. “Then the bank would also book the loan as Prime because that’s what Fannie bought. This amounted to billions of Alt-A loans booked as Prime.”
Regulators are now looking at how SunTrust learned to beat Fannie’s underwriting system.
Bill Singer, a former regulatory attorney who reviewed the whistleblower claims, told Growth Capital Investor, “Given the allegations involving Fannie Mae’s auto-underwriting system, one truly has to wonder just what oversight and controls Fannie had in terms of the integrity of the data entered into its system, and, further, for the data entry interface itself. Beyond the necessary due diligence inherent in vetting the underwriting data, Fannie was also obligated, I would think, to make sure that its interface was not being gamed.”
The SEC is currently working with the mortgage task force, set up by the Obama administration, to investigate and prosecute individuals and financial institutions who contributed to criminal or civil violations that led to the financial crisis. The national watchdog includes prosecuting attorneys from the Department of Justice, state attorneys general, and securities enforcement attorneys.
“If it turns out that not only was fraudulent qualification data repeatedly submitted to Fannie but that the computerized interface was routinely over-ridden by laddering an applicant’s net worth, income, and assets in increasingly higher levels during a data-input session, the wrongdoing is no longer sourced solely from the originating bank but the finger must also be pointed at Fannie,” says Singer.
A third quarter earning presentation says the bank had $6.4 billion of mortgage repurchase requests – put-backs of under-performing or deficient mortgages by Fannie to the mortgage originator – with repurchase demand increasing 9% in Q2. Of that number only $1.4 billion have been recognized as a charge-off on SunTrust books.
In September SunTrust told investors the amount of money they reserve for repurchase requests was going to increase. The bank’s leadership claimed the increase was a direct result of conversations with Fannie Mae and Freddie Mac along with a review of full loan files, conversations that appear to have happened after the SEC began its investigation this May. When a bank adds to repurchase reserves it affects a bank’s capital levels, regulatory ratios and bottom line. SunTrust claims the 140% increase to repurchase reserves over the previous quarter should be the last significant increase to reserves.
Aleem Gillani, SunTrust CFO, told investors during its third quarter earnings call this month, “Our third quarter mortgage repurchase provision was $371 million. Consistent with last month’s announcement, we expect the resulting mortgage repurchase reserve to be sufficient to cover the estimated remaining losses from pre-2009 vintage loans sold to the GSEs.”
But analysts doubt the residential mortgage repurchases are over for SunTrust considering they also added another $400 million of repurchase requests in the third quarter. Repurchase requests are made on loans from 2005 to 2012. Ken Usdin, a Jefferies senior equity analyst, wrote on October 22 the downside scenario for SunTrust is, “mortgage repurchase losses are not done and litigation expense remains elevated.” SunTrust says of the third quarter repurchase demands, $78 million are from 2006, $213 million are 2007 vintage, and $68 million are 2008 vintage.
“If SunTrust was sued for not disclosing risk to its shareholders or civil mortgage fraud the SEC would ask for damages and three times those damages as a penalty,” says Singer.
SunTrust isn’t the only one regulators think gamed the GSE’s mortgage buying system. On October 25the Department of Justice filed a civil suit against Bank of America’s Countrywide unit for similar actions against the GSEs described in the SunTrust whistleblower suit. The DOJ claims the GSEs suffered at least $1 billion in losses from loans Countrywide sold that didn’t actually meet the standards they said they did.
In an email sent by one of the SunTrust whistleblowers after he read the Countrywide fraud suit, he said, “Two pages into reading this complaint it’s the same as ours just under a different name.”
A SunTrust spokesperson would not comment on the whistleblower claim or an SEC investigation. The SEC said it doesn’t comment on investigations. Former Fannie CEO, Daniel Mudd, is currently fighting a SEC securities suit that alleges the Fannie executive knew the bank was buying billions of less than prime loans in 2006 and 2007 but didn’t disclose this risk to shareholders.