While banks must be prudent and follow applicable regulations, the latest guidelines from the Office of the Comptroller of the Currency may allow banks to justify a nuanced asset dissipation or depletion underwriting program, so long as it is backed by analysis.
On July 23, 2019, the OCC issued a bulletin reminding its regulated institutions to use safe and sound banking practices when underwriting a residential mortgage loan based on the applicant’s assets. While the bulletin does not provide much satisfaction for those seeking safe harbors or any specific guidance, it provides certain hints at what the OCC will look for in an examination.
Asset dissipation underwriting (or asset amortization or depletion underwriting) is a way for mortgage lenders to calculate a stream of funds derived from an applicant’s assets that could be available for loan payments, in addition to income (if any) received from employment or other sources. The bulletin notes that while the OCC’s regulated institutions have prudently administered asset depletion models for many years, examiners have seen an uptick that is unsupported by credit risk management practices and insufficiently compliant with existing regulations and guidelines.
One such existing regulation, which the bulletin mentions in a footnote, is the Consumer Financial Protection Bureau’s Ability to Repay/Qualified Mortgage (QM) Rule, applicable to most closed-end residential mortgage loans. That Rule allows a mortgage lender to consider an applicant’s current or reasonably expected assets in determining his/her ability to repay a mortgage loan, so long as the lender verifies the assets through financial institution statements or other reliable documents. Still, mortgage lenders must – when making QMs or non-QMs – calculate a debt-to-income ratio (DTI). (Non-QM lenders could also use a residual income figure.) Accordingly, if lenders are relying on an applicant’s assets, the lenders must come up with a monthly amount available for mortgage payments. However, unlike the Rule’s Appendix Q, which regulates how lenders may consider various types of income when making general QMs, neither the Rule nor Appendix Q specifies any requirements for unacceptable types of assets, discounts of asset values based on liquidity, amortization periods, or rate-of-return estimates.
While the OCC bulletin does not directly fill in any of those blanks, it does provide some clues. For instance, in connection with what constitutes an appropriate asset amortization/depletion period, the bulletin states that it would be “prudent” to use “a maximum term for the period of dissipation similar to other residential mortgages.” The bulletin continues by stating that “policies could be based on analysis that supports the mortgage loan’s actual term, or terms offered for other prudent residential real estate loans.” While those statements are somewhat vague, the OCC seems to indicate that a bank may not always have to use a 30-year asset depletion period (i.e., one that matches the loan’s full term), so long as the bank has “analysis” to justify a shorter period. Of course, even if a shorter period could be justified as prudent, the OCC is not commenting on whether a shorter period would comply with the CFPB’s Ability to Repay/QM Rule.
The OCC bulletin also indicates that prudent asset depletion underwriting would assume “either no rate of return on eligible assets or well-supported rates of return based on asset quality, liquidity, and price volatility.” While assuming no rate of return on an asset would be a conservative underwriting approach, the bulletin once again appears to indicate that a bank could take a less conservative approach (and assume a positive rate of return) if justified by analysis.
The bulletin provides that a bank’s asset depletion model should address several additional factors, including:
- Which transactions are eligible for such underwriting (perhaps based on an applicant’s credit score, loan-to-value ratio, or percentage of income derived from asset dissipation, in addition to considering the loan’s origination channel, purpose, and amortization period);
- Which assets are eligible for use in the model (based on asset quality, liquidity, and accessibility); and
- Discounts or adjustments for eligible asset values (considering liquidity and price volatility, and any liens or penalties for accessing the assets before maturity).
The bank also should adopt asset verification policies to document the assets’ ownership, value, location, and duration of existence, as well as processes to identify asset depletion loans so the bank can monitor performance, growth, and concentration.
The reluctance of the OCC (and the CFPB) to provide definitive rules for asset depletion underscores the fact that underwriting is an art, as well as a science. As we noted recently in this space, the CFPB will spend the next 18 months grappling with the future of the Ability to Repay/QM Rule and its effect on the availability of mortgage credit. That likely will (or should) include consideration of borrowers relying on assets (or on self-employment income or other nontraditional repayment resources) to show their ability to repay. While the OCC is reminding banks to be prudent, all lenders may want to participate in the CFPB’s determination of what is required.