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Atlanta, GA-based major regional bank, SunTrust Banks, Inc. (STI - Analyst Report) recently finalized a settlement with the U.S. Department of Housing and Urban Development and the U.S. Department of Justice (:DOJ) worth $968 million. The settlement is related to the bank’s faulty mortgage servicing as well as lending and foreclosure practices in the pre-crisis period.

SunTrust will pay $500 million as compensation for the borrowers and homeowners, while the remaining $468 in cash will be paid as penalty for its wrongdoings. With this settlement, the company will resolve claims associated with origination of faulty mortgage loans insured by the Federal Housing Administration (:FHA) and a part of the National Mortgage Servicing Settlement.

SunTrust has acknowledged having served as an underwriter for faulty mortgage-backed securities sold between Jan 2006 and Mar 2012 that did not meet insurance criteria as laid down by the FHA. The company had concealed the relevant information, which resulted in huge losses for the U.S. insurer as well as the taxpayers.

It was further alleged that SunTrust, in an attempt to maximize its profit, had endorsed these mortgage securities. This enabled the bank to provide loans to homeowners without considering their credibility to return the same. Eventually, these risky mortgage securities defaulted, resulting in losses for homeowners as well as investors.

Further, SunTrust’s mortgage business continued to grow despite the downturn in the housing market following the financial crisis. However, the company failed to provide its underwriters with the necessary training required to meet the expansion in the business. Therefore, as a part of the latest settlement, the regulatory authorities have asked the company to review its mortgage underwriting processes and internal controls.

Earlier, in Oct 2013, the company had updated shareholders about its tentative agreement with the aforementioned regulatory authorities. It had also mentioned the penalty that it would be required to pay. Notably, the settlement will not impact earnings in the forthcoming quarters, thanks to the reserve that SunTrust has maintained for the same.

Though the latest settlement relieves SunTrust of a legal overhang, the company continues to face other litigations pertaining to its malpractices in the pre-crisis period. The DOJ is still investigating fraudulent activities related to the sale of risky mortgage loans to the Government-sponsored enterprises, Fannie Mae (FNMA) and Freddie Mac (FMCC). SunTrust’s role in the U.S. Treasury Department mortgage-modification program is under scrutiny as well.

Other Wall Street biggies embroiled in similar hassles include JPMorgan Chase & Co. (JPM - Analyst Report), Bank of America Corporation, Citigroup Inc. and Morgan Stanley.

Despite the legal issues related to SunTrust’s mortgage business, the company has witnessed a 42.1% increase in mortgage servicing related income in first-quarter 2014. However, given the still low interest rate scenario and uncertain market conditions, we remain skeptical about the sustainability of the same.

On the bright side, the company’s cost saving measures and consistent growth in the total loan portfolio will be growth drivers going forward.

Currently, SunTrust carries a Zacks Rank #3 (Hold).

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