Submitted by SB MH Research The mortgage crash seems like a lifetime ago with house prices and homeowner equity at record highs by a long shot and banks that have paid billions upon billions as restitution, some willingly and deservedly, some not. Most all the events are well known and documented. But few if any know the sordid story of one of the largest whole loan origination “malpractice schemes” to occur in the Housing Bubble era. The “SunTrust Agency Shortcut” loan program – and what is essentially a “hack” of the Fannie Mae automated underwriting system (AUS) -- was a massive, egregious whole loan origination scheme estimated at over 175k individual transactions nationwide for over BILLION. In fact, the dollar volume of questionable conforming loans originated by SunTrust
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Submitted by SB MH Research
The mortgage crash seems like a lifetime ago with house prices and homeowner equity at record highs by a long shot and banks that have paid billions upon billions as restitution, some willingly and deservedly, some not.
Most all the events are well known and documented. But few if any know the sordid story of one of the largest whole loan origination “malpractice schemes” to occur in the Housing Bubble era.
The “SunTrust Agency Shortcut” loan program – and what is essentially a “hack” of the Fannie Mae automated underwriting system (AUS) -- was a massive, egregious whole loan origination scheme estimated at over 175k individual transactions nationwide for over $30 BILLION. In fact, the dollar volume of questionable conforming loans originated by SunTrust Mortgage and sold to Fannie Mae exclusively is larger than SunTrust Bank’s market cap today.
The following is my research, evidence and summary material on the “SunTrust Shortcut” mortgage scheme. The name “Shortcut” speaks volumes by itself. But this scheme was unlike others from Countrywide for example.
I am releasing this information widely for public good and posterity, so this specific negligence is documented in hopes it never happens again.
SunTrust “Agency Shortcut”: Backgrounder
I spent the entirety of the mortgage and housing bubble on the front lines of the mortgage industry. I saw all the excesses, outright fraud and cognitive dissonance first-hand. I knew where all the bodies were buried when it all came apart despite banks, mortgage companies, investors, Wall St banks, David Lereah (blast from the past!) Ace Greenberg and the Fed all day, wall-to-wall in the financial media, telling everybody there is ‘nothing to see here’.
During the crash and recovery period, I operated as a professional financial analyst, researcher and advisor to the financial services and public sectors. From early 2006, when I first became fully convinced that all hell would break loose in mortgage and housing, I made a list of 48 mortgage and related publicly traded names that I thought were the worst or hidden offenders and have the potential to zero-out. I maintain research files on these companies tracking everything they did, would do and their outcomes to this day.
Most of the worst mortgage offenders either failed, were absorbed (willingly or forcibly), or paid heavy penalties to the Obama DOJ, some several times over. Most of the legal matters and settlements were for common, cookie-cutter things like FHA origination/sale fraud, servicing misconduct, foreclosure & mortgage modification dereliction, and securitization fraud.
However, a few companies skated for some reason or another. SunTrust Mortgage, a subsidiary of SunTrust Bank at the time, is one. Its residential mortgage “misconduct” was among the worst of the housing Bubble. Few know about this history of SunTrust and their particular legacy mortgage origination ‘indiscretions”, so egregious, they would make Angelo Mozillo blush, and which residually live on to this day.
SunTrust’s $30+ Billion Unknown Legacy Mortgage Malpractice: Introduction
SunTrust Mortgage enacted one of the largest whole loan origination malpractice schemes in the ‘Bubble Years’. To date, this egregious misconduct has never been discovered, unpacked, prosecuted, or settled by regulators or a class.
[It’s important to note that the actual “SunTrust Shortcut” scheme was not covered when SunTrust essentially “bought-out” their Fannie and Freddie rep and warranty liability in Oct 2013 (however, the Shortcut loan significantly increased Fannie defaults and repurchases and if Fannie would have known the fine details the settlement may have been larger). Nor, was the SunTrust Shortcut scheme the basis for the July 2014 $320 Million HAMP or $968 Million (largely FHA related) settlements.]
In summary, SunTrust’s commissioned-based loan officer and underwriter employees essentially learned to ‘hack’ Fannie Mae’s AUS to achieve a “special feature code” on certain popular “fully documented, prime” loan programs they offered. This code was unique to the SunTrust “Agency Shortcut” loan. The name “Shortcut” speaks loudly. This code enabled them to originate, fund and sell these loans missing critical supporting documentation that made them “fully documented”, prime loans in the first place. The resulting loans sold to Fannie Mae exclusively were far worse in quality than program guidelines called for or Fannie knew it was buying.
These low-quality (closer to “Alt-A” than Prime) loans were sold as high-quality, fully documented prime loans and ultimately peppered throughout Fannie MBS. Once the hack was used successfully and refined during the first year it led to a significant increase in loan volume for the Bank at a time when other lender’s and Fannie’s volume was flagging, which was a red flag itself.
From then, it spread like wildfire throughout the company and all lending channels and departments. Before too long, the SunTrust Wholesale division (TPO; Third-Party Originators; Mortgage Brokers) was training mortgage brokers nationwide how to hack the SunTrust Fannie Mae Automated Underwriting System.
Through power of “TPO”, SunTrust was able to act and take on risk like a bank several times its size. After a while, the misconduct was so pervasive and a part of every-day business that a cognitive dissonance set in companywide that what they were doing was not prudent, which perpetuated the mortgage misconduct.
All told, SunTrust originated up to 175,000 “Agency Shortcut” loans nationwide for over $30 Billion over about two years from thousands of SunTrust employee and Third-Party Originator (TPO) conspirator-partners nationally making it one of the largest, longest running and widest spread whole loan origination malpractice schemes of the credit/housing bubble.
This elegant, intentional, Fannie Mae Automated Underwriting System driven and enabled scheme was differentiated from any other of the period, as thousands of SunTrust commissioned production employees, production support personnel and TPO partners all had hands-on, specialized roles carrying out the misconduct and all benefitted from it.
SunTrust’s mortgage misconduct was highly differentiated and grand in scale. To an analyst, investor or regulator less acquainted with the fine nuances of the mortgage credit and capital markets their misconduct might appear to fit in the mold of the numerous, more ‘vanilla’ mortgage indiscretions that were discovered, investigated and prosecuted or settled over the past decade. But SunTrust’s mortgage misconduct was one-of-a-kind.
In the fullest interest of transparency in markets the general public need to know that these indiscretions did in fact occur and fully examine what occurred. Tens of thousands of homeowners, investors and municipalities were financially injured. While a high relative percentage of these bad loans resulted in default, foreclosure or modification thousands of them, largely 30-year fixed rate in nature, still exist in SunTrust’s and other lender’s servicing portfolios and are identifiable.
The following is a summary of the SunTrust “Agency Shortcut” scheme.
SunTrust “Agency Shortcut” Scheme Overview
During the credit bubble SunTrust Mortgage was an influential retail, wholesale and correspondent lender, the latter two channels pertaining to the riskiest origination funnel, TPO (Third-Party Originations). TPO – co-opting thousands of local mortgage brokers and bankers in the best lending markets in the nation -- allowed SunTrust, a relatively small bank and mortgage company, to lend at scale virtually nationwide despite not having a network of traditional brick and mortar bank branches in most states. Instead, it established about a dozen strategically located mortgage sales, processing, underwriting and funding operations centers in large, major metropolitan areas that were exclusive to mortgage and capable of extracting a high volume of business from states outside their bank footprint.
Through the power of TPO SunTrust was able to compete with massive financial institutions like BofA, Chase and Wells Fargo as equals in loan program variety, origination and secondary market activity but without all the fixed overhead. This was great when the credit markets were compliant as the credit bubble grew. But, when the tide turned it left smaller, TPO-heavy lenders -- that had been pretending to be mega-national banks for the purposes of mortgage lending -- without the balance sheet wherewithal to be able to manage through it. Furthermore, TPO loan volume was so large -- absolutely and as a percentage of their total volume -- and concentrated in the riskiest, high-flying regions it left banks such as SunTrust with massive representation and warranty exposure that dwarfed their loan and legal reserves for years afterward. This forced management into numerical and verbal gymnastics in quarterly financial statements and investor calls for years about such exposure either not existing or being mitigated years sooner than it ever could be.
During the years of 2006 to 2008 – interestingly, these years that encompass the beginning and official start of the credit and housing market collapse, a time other lenders were cutting off exotic loan programs and even shutting down the ability to draw on existing HELOCs -- SunTrust Mortgage originated for sale to Fannie Mae between $19 Billion and $38 Billion in “Shortcut” loans. The name “Shortcut” defines this misconduct well and is reminiscent of names given to other poor-quality exotic loans by lenders such as the Countrywide “Fast & Easy” and “Hustle”.
The “Shortcut” was SunTrust’s entrant into the high-volume, low-quality, originate-for-immediate-sale game. In fact, based on the timing, it’s obvious that SunTrust took advantage of other lenders leaving the exotic mortgage field or going out of business in order to capture loan volume and revenue through this misconduct.
Shortcut loans were labelled and sold as “fully documented prime” loans but in fact were all missing all of the exact income and asset documentation that makes a mortgage loan “fully documented” in the guidelines of Fannie Mae and investors in its mortgage backed securities. SunTrust quietly discontinued the loan program after two years in 2008 amidst a rush of failing lenders and significant scrutiny by Wall Street, the media and regulators.
Sure, some lenders and capital markets players originated and sold more than $30 billion in GSE residential loans or securities. But SunTrust was the only lender that had a national loan origination manufacturing production line built on malpractice and co-opted/taught thousands of their own bank-employee loan officers and underwriters and well as mortgage brokers and bankers to commit this highly specific mortgage misconduct from their own private PC’s on nearly 200,000 loans through a learned “hack” of Fannie Mae’s Automated Underwriting System.
SunTrust “Agency Shortcut” Scheme Details
Primarily: In their various earnings reports and filings, from 2006 on, SunTrust Bank (“STI”) and its wholly-owned subsidiary SunTrust Mortgage (“STM”) repeatedly misrepresented and omitted disclosing the risks associated with an “Alt-A” Stated Income/Stated Asset (“SISA”) loan program they co-developed for sale to FNMA, named “The Agency Shortcut Mortgage” (“Shortcut”), which was offered from mid-2006 to April 2008.
Also: STM originated and sold to Fannie Mae over $30 Billion of questionable loans that were much closer to “Alt-A” or “subprime” than prime. Shortcut’s atypically lax qualification guidelines (compared to industry standards) and its “same-as-full-doc” pricing meant STM would originate a large volume of these loans. As STM failed to institute meaningful internal controls that could have prevented commissioned sales personnel from submitting non-conforming, questionable and fraudulent loan applications, and as management turned a willful blind eye to problems (such as increasing Early Payment Default rates) when they came to light, the huge volume of Shortcut loans was even lower in quality than most Alt-As/SISAs.
Finally: As misconduct begets more misconduct, STM co-acted with the various Private Mortgage Insurance Companies (“MI Companies”) to cover-up the “reduced doc” nature of the Shortcut Loan Program by implementing special codes - or by ignoring the reduced doc feature altogether - on the MI applications, thereby falsely representing to the MI Companies’ regulators and investors that the Shortcut was a prime/full-doc loan.
Direct victims of the SunTrust Shortcut scheme include past and present STI equity and debt investors and FNMA Mortgage Backed Securities investors. Also, US taxpayers (as a result of the FHFA’s taking over FNMA and Freddie Mac), and unwitting Borrowers (who were unable to make timely payments on oversized loans they could not afford, ultimately resulting in foreclosure) suffered damages as well.
Individual States, municipalities and their citizens were also injured as SunTrust entered these markets far away from their traditional banking footprint, popped-up TPO mortgage origination and operation centers and originated billions of bad loans. Then, when the going got tough, they closed down their operations centers and retreated back to their footprint in the Southern United States leaving far away States and their residents to clean up the mess themselves.
Furthermore, as a result of the Shortcut scheme, substantial ill-gotten gains in the form of commissions, bonuses and other income flowed to STM’s salespersons, managers, directors, TPO originators, Realtors and anybody else involved in the origination and sale process of a Shortcut loan.
(Note: Institutions such as JPM Chase/WaMu, BofA/Countrywide, and others have been found liable (or have settled claims) for victimizing Fannie and Freddie by selling low-quality mortgages that failed to meet the representations and warranties promised. Among those damaged by their frauds were the investors in the GSE’s MBSs. Regardless of the extent Fannie knew or should have known that Shortcut loans were high-risk SISAs and not prime, STI itself knew these sub-standard loans would eventually end up in Fannie MBSs, and therefore that the undisclosed risk would -at the very least - be borne by those investors.)
Summary of Evidence:
A) When developing and Deploying the Agency Shortcut Program, SunTrust knew or should have known:
- It was a Stated Income/Stated Asset loan program (“SISA”) and - by virtue of its “reduced documentation” - therefore fit the bank’s own, in-house definition of “Alt-A.”
(Note: on SISA loans, the Borrower merely attests to his/her income and assets on the loan application and does not provide the pay stubs, tax returns, bank statements and like-documentation to support those figures.)
- SISAs - ubiquitously called “Liars’ Loans” - were known to be susceptible to fraudulently overstated income and asset figures and carried an outsized risk of serious delinquency and default.
- The Shortcut program served to implement the dual strategies STM disclosed at the 2006 Mortgage Bankers Association convention to: a) reduce loan processing times from 61-110 days down to 6 days; and b) “selectively transfer credit risk to other investors” (in this case, FNMA and, ultimately, Fannie’s MBS investors).
- By offering Shortcuts at the same price as full doc - which was more than 2 points (or over .50% in rate) cheaper to the Borrower - they would capture a higher market share and originate substantially more volume than they otherwise would have, so not only would the Company’s short-term Gross/Net Income increase, but also commission, bonus and other income for certain personnel.
- The mortgages would eventually be placed into FNMA MBSs, but not properly identified as Alt-As/SISAs. Therefore, the MBSs investors would not be able to properly assess the riskiness of those pools…and the losses would be eventually be borne by those investors (via less-than-anticipated ROI/opportunity costs) and by Fannie (via their guarantees).
- As soon as STM actively marketed the availability of the program, it transformed the program from an ostensibly “Lender-Selected SISA” into a “Borrower-Selected SISA” and DQ/Default percentages would thereby skyrocket.
(Note: “Lender-Selected SISAs” are those wherein the Lender decides unilaterally not to review income or asset documentation because the overall risk of the loans(based on dubious criteria) are deemed sufficiently low and thereby presents an opportunity for the lender to reduce its own processing costs - and usually are offered to the borrower at the same rate and price as full-doc loans; “Borrower-Selected SISAs” are those wherein the Borrower specifically requests not to provide income and asset documentation to the lender and - usually - pays an increased rate and/or price for that feature. It’s been reported that “Lender-Selected SISAs” default at 1.4 times Full Doc loans; Per FNMA Filings, Borrower-Selected SISAs default at more than 5 times the rate of Full Doc loans - and that number actually is lower than the true rate due to FNMA’s definitions and methodologies.)
- By not requiring a Borrower-signed IRS form 4506 as part of the loan application - and by advertising such in their promotional materials - STM overtly invited Borrowers and Brokers to submit fraudulent loan applications.
(Note: A signed IRS Form 4506-T allows a lender to obtain a Borrower’s tax transcripts from the IRS to confirm income stated on the loan application is reasonably accurate, and - even when not exercised by the lender - serves as a deterrent to fraudulently overstated income on mortgage applications.)
- By failing to place adequate controls on brokers and commissioned salespersons in processing of the Shortcut loans - and by instructing them that the income stated on the application need merely be “reasonable” (as opposed to “accurate”) - STM subverted any meaningful risk assessment of the individual loans by their own underwriters.
(Note: examples of inadequate controls included allowing commissioned salespersons and their assistants to run the Automated Underwriting System (“Desktop Underwriter” or “DU”), allowing them to run DU an unlimited number of times, and instructing them they could evade underwriter scrutiny by inputting “reasonable”- not “accurate” - income and asset figures. These lax processes allowed the commissioned salespersons, etc. to modify the various inputs in DU until they reached an optimal configuration that resulted in a Shortcut approval.)
- The riskiness of SISA programs without 4506s - characteristics which carried at least a 2.125% (price) premium from their peers and competitors - far outweighed the benefits, if any, of requiring a (rather modest) 680-plus FICO score;
- By allowing monthly debt-to-income (“DTI”) ratios as high as 64.99% - far higher than the standard for prime loans, Shortcuts would devolve into something even closer to subprime.
(Note: industry standards for maximum DTI on SISA products were more commonly 45% - 50%, depending on the lender and/or other loan characteristics, such as LTV/CLTV and/or FICO score.)
- By advertising “No Payment Shock” publicly and to mortgage brokers as a feature in marketing materials STM obviated yet another risk assessment.
(Note: “Payment Shock” is a term that describes a significant increase in a borrower’s housing payment as a result of the new loan. If DTI ratios are fairly elevated, underwriters traditionally look to the borrower’s “ability to save” as indicated by their liquid assets as an offsetting factor to determine whether the borrower can handle the increased debt load.)
- Inconsistencies of Shortcut’s SISA characteristics versus its ersatz “Full doc” labeling had to be reconciled with the MI companies, such that “special negotiations” were required to resolve those inconsistencies.
(Note: Shortcut loans submitted to a majority of the MI companies required “special coding” and - to the extent that the MI companies may have failed to properly disclose to their own regulators and investors the full extent of reduced-document loans on their books - they may have been complicit in a related fraud.)
- The difficulties in placing a “Combo 2nd NIV” - (“NIV” = “No Income Verification”) - loan behind a Shortcut First mortgage created special difficulties, because including any income or asset documentation in a loan file - regardless whether it supported or contradicted other data in the file - disqualified it from Shortcut. Initially, STM required that underwriters use a cumbersome form (“The Agency Shortcut Mortgage Eligible Secondary Financing Checklist”) to reconcile the asset documentation requirements otherwise required on the Combo 2nd NIVs with the inability to include those same documents on the Shortcut.
(Note: “NIV” loans - which were offered by numerous lenders - are incrementally less risky than SISAs, as the Borrower’s Liquid Assets are reviewed and are generally required to be at least a given multiple of the Borrower’s stated monthly income. Also: Due to difficulties in requiring its employees to walk such a thin line re asset verifications - and following too many improperly completed “Checklist” forms - eventually STB reconfigured the Combo 2nd NIV program and abandoned the asset-verification requirement altogether, pricing the program slightly higher to include a “Shortcut Documentation Feature,” effectively turning the Combo 2nd into a SISA.)
B) During the SunTrust Agency Shortcut program’s lifespan, SunTrust knew or should have known:
- Early Payment Defaults (“EPDs” - deemed industry-wide to be a strong indicator of fraud) were rising significantly by summer 2007, yet - other than tepidly advising underwriters “to be on the lookout for fraud” - few significant steps were taken to reduce EPDs.
- The number of submissions to Fannie Mae DU on Shortcut loans was positively correlated to delinquencies and defaults, but it wasn’t until a couple of months prior to the termination of the Shortcut program - and then only at FNMA’s insistence - that a limit of 15 runs (still high) was imposed.
- SunTrust employee Account Executives (and their assistants and processors) “manufactured” Shortcut approvals in DU by “laddering” income and/or otherwise tweaking their inputs, not infrequently submitting loans to DU more than a dozen times.
- Wholesale area managers encouraged the AEs (and/or their support personnel) to run DU for their third-party client brokers - ostensibly as a “value-added” service, but actually because it increased the likelihood that STM employees (with more experience and understanding of the nuances of DU’s algorithms that generated Shortcut approvals) would input figures that would produce the desired outcome.
- Various “enhancements” to the program which were added periodically through most of 2007 served to make the Shortcut underwriting guidelines even “looser.” By December 20, 2007 - and only in the face of indisputably poor loan performance of the Shortcut - some of the program’s loosest guidelines were finally tightened, but even then, they still remained far looser than more traditional underwriting guidelines.
(Note: some of the “tightening” that occurred in December, 2007 (not “mid-2006” as stated in numerous SEC filings) included no longer allowing “outstanding mortgage delinquencies at time of application” or Property Inspection (Appraisal) Waivers - low-level qualification guidelines which really should have been implemented from Shortcut’s outset.)
- Area managers - taking their cues from an “anything goes (so long as its ‘sellable’)” mentality that characterized STM’s mortgage operations and from upper management’s mandate to reduce loan processing times - cut corners for risk assessment in not only the Agency Shortcut Program, but other loan programs as well.
(Note: For example, underwriters who questioned the validity of various file components were routinely told by managers to “just go with what you have” and approve the loan. At least one STM region’s policy included moving income, asset, and other critical verifications on Full-Doc loans from “prior to (loan) doc” conditions to “prior to funding” conditions - which served further to pressure underwriters from making adverse decisions. It was no surprise, then, when a complaint issued by the NY Atty. General in October 2012 against JPM Chase/Bear Stearns on shoddy mortgages singled out SunTrust for its eye-popping 86% defect rate on the originations they sold to Bear Stearns.)
- Despite guidelines ostensibly requiring “reasonable” income be stated on loan applications, a significant number of Shortcut loans did not meet even to that low standard. Management routinely gave “override” approvals on files the underwriters deemed to have suspect income and/or other shortcomings, and - to the WB’s knowledge - not once did management recommend a loan be declined when the underwriter thought it should be approved.
(Note: it was not until late-summer or fall of 2007 that underwriters were provided with even minimally adequate tools with which to assess reasonableness of salaried income borrowers. Regardless, managers still overrode the guidance offered by such tools, and routinely allowed “higher-than-reasonable” income to be used nonetheless.)
- HMDA data showed STM’s loan declinations overall - and specifically declines due to insufficient income - were substantially lower than their banking peers and competitors during the Agency Shortcut’s lifespan.
(Note: In 2007, SunTrust declined 4.4% of its applications and only 1.2% due to income; By way of example, Wells Fargo’s numbers were 18.6% (applications) and 3.6% (income) and BofA’s were 17.0% (applications) and 8.6% (income).)
- “Fallout ratios” (i.e. loan applications submitted but not funded) increased substantially after termination of the Shortcut Program, doubling or tripling for some commissioned salespersons.
(Note: This suggests, of course, that significantly fewer loan approvals could be manufactured without the “crutch” of allowing commissioned personnel to input falsified income and asset data into DU and generating Shortcut approvals.)