Uncategorized

MBS: Ability-to-repay survives its first legal test

| May 3, 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 effort by a borrower to challenge a lender’s mortgage underwriting under post-crisis federal rules has fallen short, potentially paving the way for more loans underwritten largely on the borrower’s ability to repay. The plaintiff claimed the lender did not properly ensure that ability after considering income, assets, employment, credit history and monthly expenses. It was the first legal test of federal ability-to-repay rules in effect since January 2014. The court rejected the claim.

The facts

The action, G. Ralph Elliott vs. First Federal Community Bank of Bucyrus, was brought in US District Court for the Southern District of Ohio Eastern Division before Judge Algenon L. Marbley with the decision filed on March 26. The plaintiff filed for both a Truth in Lending Act or TILA violation as well as common law negligence. The action was driven by a refinancing of a loan held by the defendant. In underwriting the loan, the plaintiff provided a draft copy of a separation agreement between himself and his wife that would pay him spousal support in the amount of $2,300 a month, representing 37% of his gross income. The loan application was initially denied by the bank, after which the plaintiff’s wife made representations that she would honor the separation agreement and the bank proceeded with the refinancing.  The bank also used jointly filed tax returns in their underwriting.

The coupled subsequently divorced with the plaintiff only receiving approximately 10% of the initially indicated spousal support. Additionally, he lost his salary working for his wife’s realty office. The plaintiff fell behind on payments as a result of his decreased income and brought the suit after he was served with a notice of duty-to-pay.

The analysis

The plaintiff argued that the lender argued that the bank failed to make a “reasonable good faith determination based on verified and documented information” that he had a “reasonable ability to repay the loan.” The court found that there was “no genuine dispute” that the bank had fulfilled their obligation under that standard. The plaintiff argued that the underwriting was done in violation of Appendix Q to TILA because it should not have counted spousal support or rental income in their calculation of the plaintiff’s debt-to-income ratio. The court granted summary judgement to the defendant based in part on language in Appendix Q which states “Alimony, child support or maintenance income may be considered effective if the consumer provides the required documentation, which includes the copy of the legal separation agreement.” As part of the summary judgement, the court entered a decree of foreclosure on the property.

The implications

The decision is a landmark given this the first action brought by a borrower that the lender violated the ability-to-repay standard. It would appear that the court chose to take a somewhat loose interpretation of the standard. Given the fact that the separation agreement was a draft it could be argued that it was, in point of fact, not a legal separation agreement as required under Appendix Q but that the bank was able to make a good faith determination of the borrower’s ability-to-repay as required by the broader standard. The court determined that the bank did its due diligence based on all information available to them at that time and could not reasonably foresee the events that led to the borrower’s decline in income. Given the fact that the separation agreement was not finalized coupled with the fact that the bank never qualified the plaintiff’s wife to see if she could provide the spousal support she represented she could, it appears that the summary judgement for the defendant bank would imply a fairly loose application of the standard.

Additionally, and somewhat curiously, in their decision the court refers to the plaintiff as a ‘consumer of above average sophistication.’ It is surprising that the court would put this in their decision as the ability-to-repay is the onus of the lender not the borrower and simply because a consumer may be better able to assess their own ability-to-repay, it should not relieve the lender of any of that burden.

The Qualified Mortgage rules went into effect in January of 2014 and with them came the Ability-to-Repay standard. Under the rule, a lender must make a ‘good faith’ determination that the borrower will be able to pay back the loan after considering the borrower’s income, assets, employment and credit history and monthly expenses. The standard was put in place with significant guidance around qualifying the borrower, specifically with regards to determining and documenting monthly debt and income under Appendix Q to Regulation Z, better known as the Truth in Lending Act or TILA.

Ultimately the decision in this case was almost unilaterally in favor of the lender based on what appears to be a fairly loose interpretation of ATR. It may pave the way for more lenders to gain comfort around the standard, causing non-QM originations to grow.

admin
jkillian@apsec.com
john.killian@santander.us 1 (646) 776-7714

This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.

Important Disclaimers

Copyright © 2023 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.

In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.

The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.

In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.

Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.

The Library

Search Articles