Moody’s: SunTrust legacy mortgages cast many shadows

Potential $300 million liability not the end of it

Last week, SunTrust Banks (STI) reported in its annual regulatory filing that it is currently under investigation for mortgage violations and could face substantial penalties.

The company disclosed information related to various government entities’ new and ongoing investigations into its residential mortgage business.

The ultimate resolution of these matters, related to legacy mortgages going back to 2009, and the resulting settlements and penalties could result in materially higher costs for SunTrust that would be credit negative for the bank, according to Moody’s Investor Services’ report.

Neither SunTrust nor the U.S. attorneys and the Office of the Special Inspector General for the Troubled Asset Relief Program investigating it have indicated the range of potential penalties associated with the various inquiries.

SunTrust admitted in its filings that the bank “harmed borrowers and violated civil or criminal laws by making misrepresentations and failing to properly process applications for modifications of certain mortgages owned by the GSEs pursuant to the HAMP guidelines.”

SunTrust estimates it could be liable for losses in excess of related reserves to $300 million from $250 million previously. SunTrust’s recent quarterly earnings, on a pre-tax basis, have exceeded $500 million.

Moody’s reports that four separate items highlighted in SunTrust’s 10-K are noteworthy:

  • The U.S. Attorney’s Office for the Western District of Virginia and the special inspector general for the Troubled Asset Relief Program are investigating whether SunTrust harmed borrowers and violated laws by improperly processing mortgage modifications in 2009 and 2010 under the government’s Home Affordable Modification Program. Although SunTrust initially disclosed the investigation in its 2013 second quarter 10-Q, last week’s10-K added that government investigators have indicated they may impose “substantial penalties” on SunTrust.
  • SunTrust revealed that it has certain substantive disagreements with the government that may prevent it from reaching a definitive settlement related to Federal Housing Administration-insured mortgage loans. This suggests that the agreements in principle that SunTrust announced in October 2013 with the U.S. Department of Justice and the Department of Housing and Urban Development to settle claims arising from FHA-insured loans could fall apart.
  • SunTrust disclosed a new DOJ investigation into the origination and underwriting of mortgage loans that SunTrust sold to Fannie Mae and Freddie Mac. The investigation is in its preliminary stage and no details were provided.
  • SunTrust noted that the Federal Housing Finance Agency’s Office of Inspector General is conducting an audit related to the mortgage repurchase settlements between Fannie Mae and Freddie Mac, both of which are regulated by the FHFA, and banks. Presumably, the audit includes the 2013 agreements between SunTrust and those entities. Among its banking peers, SunTrust is likely not alone in facing further legacy mortgage costs from government investigations that are an outgrowth of the bursting of the national housing bubble. However, SunTrust has been particularly affected because its relative concentration in residential mortgages has been higher than peers.

Chart: Moody's

“Indeed, based on the lengthy saga of SunTrust’s legacy mortgage issues over the past few years, we cannot dismiss the possibility that its near-term earnings will once again be weighed down by settlements and penalties,” Moody’s reports. “As such, the ongoing and protracted inquiries into SunTrust’s mortgage activities are a time consuming and unwelcome development for a bank that has been trying to move definitively beyond its legacy mortgage issues for some time.”

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