Articles
Divorce in Downturn Economy
12.11.2008The news is unavoidable regarding the economy. It has reached almost every facet of our daily lives. As a matrimonial associate, it has certainly touched my daily professional life on every single case I see. A recent discussion with a colleague regarding severance packages as marital property provided the impetus for this article as I am sure in these times many attorneys will face very unique fact patterns in divorce cases. These unique fact patterns will ultimately resolve the question of whether a divorce in a downturn economy is fantasy for the soon to be divorced or folly.
The High Net Worth Client
A client with high net worth will likely have more assets currently being affected by the downturn in the economy. Her stock portfolio is likely heavily depressed in value. Her employment benefits package is likely tattered as this years’ bonus won’t compare to prior years’ bonuses. Likewise, all of her stock options are under water and her retirement portfolio has a depressed value.
For the potentially divorcing spouse, this might be a prime opportunity to divorce and provide their spouse with one-half the value of these assets at their current price in liquid assets, if any, and take all of the upside benefit when they rebound. I say when because the stock market has increased over every twenty year period, including the Great Depression. This downturn should be no different.
A high net worth client has a problem with regards to their marital home, however. Marital homes of high net worth clients, assuming they are in desirous areas, tend to retain value, unlike homes of the more economically ordinary client. For example, median sales prices of homes in Westfield, NJ, have increased from approximately $350,000 in 2000 to approximately $745,000 in October, 2008, according to the website Trulia.com. The median sales price has increased by 1.1% from October 2007 to September 2008. Compare that to Old Bridge, NJ, whose median home sales prices have fallen over the same period by 0.7%. Thus, the high net worth client has a home that may actually be worth more today than it was a year ago. However, because their other assets are worth less today than they were a year ago, a spousal buy out of the marital home may come at a greater than expected costs as it will take a greater proportion of undervalued assets to obtain the perhaps overvalued marital home given the overall condition of the economy.
In a high net worth situation, supported spouses often trade equity in pension assets for equity in the marital home. In today’s economy, this is a difficult, and perhaps, losing proposition. Pension assets are vastly underperforming, to put it mildly. A waiver of an underperforming asset for a performing or mildly underperforming asset (the marital residence) is overpaying for the marital home. The folly of this move is immediately recognizable in the short term, however, over the long term it could theoretically even out. Passive assets, which includes most peoples’ retirement accounts, normally get valued for distribution at the date of divorce or as close thereto as possible. A marital home gets valued sometime during litigation, closer to an early settlement panel date, but its value is not as concrete as that of a pension account on a given date. The ordinary waiver of an underperforming pension has the effect of having the supported spouse subsidize the pension losses in equitable distribution and giving up all of the potential (and likely) gain once the pension rebounds to ordinary levels. If the pension gain outpaces the residential real estate gain, then the move is also folly in the long run. This seems to indicate that trading a home in a desirous location should not be traded against pension offsets, at least not by using a valuation of the pension using today’s market numbers. A supporting spouse, however, may be very inclined to trade today’s pension dollars for tomorrow’s pension gains.
It seems, then, that for a high net worth client, the proper mix of underperforming and overperforming assets need to be pooled properly into a settlement agreement to come out ahead in this difficult economic time.
The Average Net Worth Client
For purposes of this analysis, the average net worth analysis is a home, a pension, and some liquid savings. For these clients, there is often not enough liquid or pension assets to fund a marital home buyout, so their scenario is vastly different from the high net worth individual. For these clients, a marital home buyout has historically been accomplished by a spousal buy out refinance.
Performing a spousal buy out refinance in today’s market may be a difficult achievement if your client’s credit is questionable, however, the biggest hurdle you may face may well be your client’s low expectations. A lot of clients reading the same mortgage industry news you read think the refinance spousal buy out is an unavailable option. This, according to Len Rossine, a divorce lending specialist at Countrywide Bank, FSB, is a mistake as most clients with at minimum reasonable credit ratings and documentable income can still perform a spousal buy out refinance, provided the valuation of the marital home is accurate. Mr. Rossine implore’s attorneys to obtain bank appraisals of the marital home and not private market home appraisals. According to Mr. Rossine, a bank will only commit financing based on a bank appraisal which is valid for a maximum of 120 days, making the private home appraisal almost meaningless to the bank. Mr. Rossine stresses that divorcing parties may be negotiating blindly if they are using a home appraisal since neither party may actually be able to finance the spousal buy out if the home appraisal differs from the bank appraisal.
The marital home sale is not the easy way out of a marital home these days, either, unless the parties are willing to sell at fire sale prices. Home sale volume is down, as is home sale price. Homes are sitting on the market for months without receiving purchase offers. The parties, unless quick selling the home, are likely to not realize the asset distribution for many months and will need to address the continuing carrying costs until it sells, unless they have agreed to both remain in the marital home post-divorce until is sells. The average net worth client cannot maintain contribution towards two homes for very long, so it is imperative to address the financial issues which will occur for many average net worth clients in the four to twelve month time frame during which the home is awaiting sale. These problems include systematic review and reduction of listing price, systematic review and reduction of contribution to ensure continued good faith on the party remaining in the marital home, and perhaps systematic review and reduction of any ongoing alimony/child support obligation until the sale of the home.
The average net worth client does not generally have the same pension / stock problem of the high net worth client as there are generally not enough of these assets to use to offset the equity in the marital residence. These assets are typically split in kind or by way of QDRO and there is not much of a problem.
Debts of an average net worth client, however, do present a problem as in today’s market there tends to be increased debt load, in one or both parties’ names. The joint named debt needs to be satisfied from some asset or the potential of default on the debt could be costly for your client. The problem, then, stems from the fact that, although a spousal buy out refinance is available, the loan to value ratio on the refinance may not be high enough to cover the joint debt load and the parties need a viable option. Viable options, although not pretty, are credit balance transfers to solely named credit card accounts, or pension loans.
For the average net worth client, then, a divorce which would have otherwise created a little financial pain, is likely to cause additional financial pain and uncertainty than if the parties had divorced last year or could wait for this credit market to ease.
Conclusion
Clients face difficult decisions in a “normal” divorce case in normal economic times. These difficult decisions are only compounded by the external factors presenting themselves in today’s market. Any negotiated settlement in today’s market needs to take careful consideration into a myriad of economic factors and how they will potentially affect the client’s rights and obligations. Additional contingency plans, which may not have been necessary in a standard property settlement agreement last year, are absolutely necessary this year. The contingency plans make the agreements more difficult to craft, more difficult to understand, and lengthier as they are addressing a “parade of horribles” that we all hope our clients can avoid. However, based on the bad news coming out every day, your client will be comforted by the fact that if these horribles occur, you’ve protected them from the downside risk.
Authored by Brian McFadden-DiNicola. All rights reserved.