Sterling Bank suspends non-QM lending

admin | December 20, 2019

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

The first potential blip in non-QM underwriting popped up last week when Sterling Bank & Trust suspended its Advantage Loan limited documentation program. While the stoppage raises concerns, the risk appears modest as Sterling loans make up less than 2% of all non-QM collateral. Some deals, however, have outsized exposure.

The news came in a December 9 SEC filing where the bank suspended the program to review documentation procedures.  “Management believes it is prudent to temporarily halt the program,” the filing noted, “as it continues to audit documentation on past loans and puts in place additional systems and controls to ensure the Bank’s policies and procedures are followed on loans originated under the program. It is the Company’s intention to resume the Advantage Loan program as soon as management is confident its stated policies and procedures are being followed.”

The Sterling program targets individuals, including foreign nationals, whose income or credit may be difficult to document using traditional means, according to Kroll. Sterling often underwrites the borrower’s income using only a single month of bank statements. To compensate for this, the borrowers generally have high credit scores and low loan-to-value ratios.

An analysis of Sterling loans in non-QM trusts does show that these loans have much higher average credit scores and much lower LTVs than the broader population of non-QM loans. As of November, loans originated by Sterling totaled $440 million or roughly 1.6% out of a universe of over $27 billion. Sterling loans had an average FICO of 749 and an average original combined LTV of 61 while the broader universe had an average FICO of 713 and an average combined LTV of 72. The broader population of loans contained roughly 30% full documentation loans while the Sterling loans were all limited documentation loans absent one trust, BRAVO 2019-NQM1, where 22% of the Sterling originated loans were full documentation (Exhibit 1). On trusts where the data was available, all Sterling loans were originated through retail channels. Given this, it appears any issues associated with documentation were not broker related.

 Exhibit 1: Comparing Sterling originations to the broader non-QM universe

Source: Amherst Insight Labs, Amherst Pierpont Securities

While the overall population of Sterling loans is small, there are meaningful concentrations in a few trusts. The $440 million of Sterling collateral is localized to seven non-QM trusts and only makes up the majority of the pool in one, Oaktree’s BHLD 2019-1 deal. By and large, Sterling collateral is performing better than the rest of the pool in most of these trusts but is showing marginally worse performance than other loans in BHLD 2019-1 and BHLD 2019-2. (Exhibit 2)

Exhibit 2: Comparing Sterling collateral to other loans across non-QM trusts

Source: Amherst Insight Labs, Amherst Pierpont Securities

While collateral performance appears benign, if defects in underwriting policies and procedures are discovered, it potentially opens the door to Ability-to-Repay challenges under the Qualified Mortgage rules on loans that default. Under the ATR rule, borrowers can either bring affirmative or defensive claims that the originator did not properly verify their ability to repay the loan. An affirmative claim can be brought within the first 36 months after the loan is originated. If the borrower is successful in bringing a claim, the borrower is entitled to finance charges, points and fees, attorney’s fees and $4,000 in statutory damages. Alternatively, a borrower can bring a defensive claim against foreclosure. A defensive claim can be made at any point during the life of the loan. While potential monetary exposure back to the originator is limited under the rule, a successful affirmative or defensive claim would preclude a foreclosure proceeding. In the event that the originator or servicer is unable to foreclose, it leaves modification as the only potential option to re-perform the borrower. To the extent that it is the only option available, it likely creates asymmetry where the borrower may be able to get more favorable modification terms than what otherwise may be warranted if the option to foreclose was available.

Given the small amount of exposure and clean performance, the potential impact of Sterling’s recent decision to suspend their program will in all likelihood be limited. That being said, it is the first potential sign of potential underwriting slippage in the burgeoning non-QM market.