As published in Scotsman Guide's Residential Edition, March 2008.
The continued increase in lawsuits rooted in the nonprime crisis and the current regulatory proposals intended to address this crisis will significantly impact how and to whom residential mortgage brokers can make loans. Although compensation and licensing are issues in some of these suits and proposals, underwriting methods continue to be one of the most-significant areas of focus for brokers, the lawyers hired to represent them and the lawmakers charged with regulating them.
Underwriting is, in its fundamental sense, the establishment of criteria under which credit will be extended and borrowers' ability and likelihood to repay a loan will be analyzed. A sharpened focus on underwriting is not surprising, given many regulators and industry professionals blame relaxed underwriting standards and the "originate to distribute" model as causes for the nonprime crisis.
Comptroller of the Currency John C. Dugan summarized this viewpoint succinctly while addressing the American Bankers Association this past Oct. 8:
"When a bank makes a loan that it plans to hold, the fundamental standard it uses to underwrite the loan is that most basic of credit standards ... : The underwriting must be strong enough to create a reasonable expectation that the loan will be repaid ... [B]ut when a bank makes a loan that it plans to sell, then the credit evaluation shifts in an important way: The underwriting must be strong enough to create a reasonable expectation that the loan can be sold -- or put another way, the bank will underwrite to whatever standard the market will bear."
Most likely, brokers will feel the impacts of past underwriting tactics and new underwriting changes more than any sector of the residential mortgage market. In addition, underwriting standards accepted just a few months ago have resulted in lawsuits in which brokers are typically a prime target.
Going forward, brokers must be attuned to new legal requirements that may emphasize that there should be a reasonable likelihood of a borrower repaying a loan and that the loan should be suitable. Challenges and opportunities can arise from analyzing two types of current lawsuits, those related to loan buybacks and those related to race-based discrimination.
The past few years have seen a dramatic increase in the number of buyback suits, in which lenders demand that their brokers repurchase or indemnify them for bad loans. Frequently, these loans have featured an early payment default.
Although many of the loan products at issue in these suits have disappeared or exist in reduced capacity, they still can lead to litigation. Buyback suits are particularly unfortunate. They pit former business-partners against each other, forcing each to expend considerable time and money. Nonetheless, when certain high-risk loans become unmarketable or unattractive to hold on lenders' own books, the lenders frequently view litigation against their brokers as a means to recoup at least some of their losses.
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