Mortgage review hangs heavy over Michigan bank's new CEO

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Loan concentrations can be acceptable when all is well, but they can cause heartburn when something goes sideways.

Sterling Bancorp in Southfield, Mich., is learning that lesson the hard way.

The $3.3 billion-asset company is scrambling to find new sources of revenue after abruptly hitting the brakes on its popular Advantage Loan mortgage program while an outside firm audits its documentation procedures. The decision, made on Dec. 9, came just weeks after Sterling fired two top-producing lenders following an internal compliance review.

It was a bold move for Tom Lopp, who succeeded the recently retired Gary Judd as chairman and CEO on Nov. 30.

The decision stunned industry observers, leaving them to wonder what led to the decision.

"I was very surprised by the initial headlines," said Robert Bolton, president of Iron Bay Capital and a Sterling shareholder who was concerned about a dearth of details in Sterling's announcement. "It looked like there was something really bad there."

Uncertainty over the ongoing audit and mounting pressure on Sterling to find new ways to make money are among the reasons why Lopp is one of American Banker's community bankers to watch in 2020.

Lopp was unavailable to discuss the issue, but a company spokesman said management believes its loans are good and credit quality should remain solid.

Bolton, who spoke with Lopp after the announcement was made, said he was told the lenders were fired because they "didn't collect enough information" from applicants, adding that he was assured that all of the mortgages involved qualified borrowers.

Still, firing the lenders and halting the Advantage Loan program is sure to cut into profit at Sterling. About 86% of Sterling's total loans at Sept. 30 were mortgages, and Advantage Loans made up 83% of all mortgage production during the first nine months of 2019. The fired lenders contributed to 15% of all mortgage originations over that time.

Sterling is looking to make more multifamily, tenant-in-common, construction and commercial-and-industrial loans to offset some of the hit from the suspended mortgage program.

Advantage Loans allow applicants to use nonstandard forms of documentation, such as a letter from an employer or a monthly bank statement, to qualify, Ryan O'Loughlin, director of RMBS at Fitch, wrote in a note to clients after Sterling made its disclosures.

"These forms of documentation are more vulnerable to manipulation and misrepresentation than traditional documentation programs," O'Loughlin added.

Sterling's actions suggest "potentially broader issues with internal controls, which could include faulty documentation, appraisal issues or other problems," Aaron James Deer, an analyst at Sandler O’Neill, wrote in a note to clients. He warned of a heightened risk of regulatory scrutiny, such as restrictions on product offerings or branch expansion, or putbacks on previously sold mortgages.

To be sure, Sterling has enjoyed stellar credit quality since the financial crisis.

Sterling has suffered no losses on the more than $5 billion in Advantage Loans is has originated in the last eight and a half years, the company spokesman said. Borrowers are required, on average, to make a 42% down payment on those loans.

The historically strong performance of Sterling's loans in Fitch-rated pools reduces the odds that an underwriting issue will meaningfully influence credit risk, O'Loughlin said.

Bolton said the external review has not yet turned up as material weaknesses, and he is confident Lopp can quickly address the issue and shareholders' concerns.

"My feeling coming out of it is they identified the problem, they have a plan to fix it and now it's a really good buying opportunity," Bolton said.

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