Secured Lender Article Risk Management


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Secured Lender Article Risk Management

  1. 1. risk A New TwisT oN TiTle iNsurANce BY TheodoRe h. SpRInk And JeffReY p. MoodY Before July 2007 the market was awash in liquidity with far too much money chasing too few deals. Perhaps we should say too few well-structured deals. Before July 2007 the market was awash in liquidity with far too the basics much money chasing too few deals. Perhaps we should say too Title insurance now few well-structured deals: Hedge funds and private-equity part- available when “reliance nerships in competition with or financed by banks, were seeking collateral” is personal property to deploy vast sums of money from the constant flow of contribu- Risk managers now able tions from pension plans, endowment funds and foreign inves- to shift risk of current loan quality meltdown tors. In the wake of this competition, relaxed covenant packages Title Industry had and historically low-risk pricing, there has been very little room developed competing for error. ALTA-type of real estate title policy forms to benefit lenders
  2. 2. Attorney Scott McPhee of the Los Supervision’s Consultative Document on property as defined by Article 8 and Ar- Angeles office of Morrison Foerster LLP, Operational Risk stated: “The primary ticle 9 of the Uniform Commercial Code. who represents Countrywide as well as mechanism currently used for mitigat- Morrison Foerster’s McPhee, stated other leading lenders, stated, “Loan mar- ing operational risk exposure is insur- “both lenders and investors benefit from kets have suffered in recent years with ance.” Title insurance has been used by strengthened collateral positions, and ‘excess capital’ which has led to greater risk managers to shift risk in the past, shifting risk, as it relates to lien perfec- competition for loan originations and re- in what has become an essential com- tion and priority, makes sense”. laxed underwriting standards”. McPhee ponent of real estate secured lending The title industry has essentially ad- referred to such relaxed underwriting business and mortgage-backed opted the standard American Land Title standards as having an impact on credit securitization market. Association (ALTA) real estate title insur- quality, loan pricing, potential legal fees, Traditionally, real estate lenders for ance policy form to provide the benefits reliance collateral, default rates and both commercial and residential trans- of title insurance to commercial lenders ultimately, recoveries. actions, as well as investors, have used securing loans with non-real estate col- It has been noted over the last two title insurance to minimize documenta- lateral. In a few short years the nation’s years of Quarterly Senior Loan Surveys tion errors and to manage problems as- leading title insurers have produced that underwriting standards continued sociated with challenges to lien priority. newly available “UCC Insurance Policies” to trend downward. Implicit in these Lenders have benefited from the related in amounts covering an estimated $350 findings, loss-given-default exposures improvement in credit quality, second- billion in secured lending. had risen. At a recent Standard & Poors ary market value and liquidity. Sidley & Austin’s Fraser stated, “His- (S&P) symposium on CLOs and com- As late as the mid-1950s, real estate torically title insurance has played an mercial loans, it was suggested that the title insurance had not yet become uni- important role in the business of loan recovery rates on the S&P migration versally accepted or utilized by lenders. origination by insuring perfection and tables would need to be recalibrated to Lawyers’ legal opinions and abstracts priority of collateral and by protecting reflect an increased level of risk. were widely utilized in the nation’s real lenders from fraud, forgery and docu- S&P further proffered that the next estate markets. Standardized mentation defects”. Fraser added that cyclical downturn could be more severe real property title policy forms of “UCC insurance is the natural evolution than recent experience. Bruce Fraser of coverage, endorsed by the American of this concept in light of the growing the Los Angeles office of Sidley & Austin, Land Title Association (ALTA), were still need to establish the strength and qual- who represents Wells Fargo Bank as a decade away. ity of commercial loan assets, particu- well as other major lenders, stated, “The Many believe it was the secondary current and expected unstable future market, with the advent of Fannie Mae economic conditions will likely result in and Freddie Mac, that led to not only increased loan defaults, which will cause the importance of title insurance for greater reliance on credit quality and individual loan originations, but the risk management tools”. investment community’s need for en- The exposure to operational risk has hanced, high-quality, real estate related The primary also escalated substantially and has “securities”. In short, the advent of made many institutions more vulner- mortgage-backed securities relied on the mechanism able to losses from failed or inadequate efficiency and efficacy of title insurance internal processes, people and systems. as a fundamental risk-management tool. currently used From the perspective of risk managers, supervisors and shareholders, the conse- While title insurance is a cornerstone of the real estate lending practice, for mitigating quences of such failures are severe. traditional real estate title insurance operational As we will discover, one of the risk man- has evolved over the last few years to agement tools that bridges credit and become an accepted risk-management risk exposure is operational risk for secured commercial tool for secured lenders primarily within & industrial (C&I) loans has been used by the private equity space. insurance. bankers for years within their real estate However, there is one significant portfolios. difference: it is now available to lenders The Basel Committee on Banking in which “reliance collateral” is personal
  3. 3. Risk management is, of course, larly for rating agencies in asset-backed everyone’s Risk management is, of course, securitizations”. business within everyone’s business within the bank. The original concept of applying the However, risk managers are specifically benefits of real estate title insurance to the bank. charged with the responsibility to an- the commercial finance market segment ticipate, identify, quantify and manage was simple: If every bank in the United risk across each of their increasingly States originating real estate- secured complicated portfolio of businesses. loans requires real estate title insurance, And, as stated by Sidley’s Fraser, “The would those lenders originating nonreal strong economy in recent years may estate secured-loans not also gain have led lenders to fail to price-to-risk, from the risk protection benefits of title the additional protection of their lien particularly the legal risks associated insurance? position”, according to Sidley & Austin’s with equity and other personal property As the concept evolved, UCC insur- Bruce Fraser. collateral. UCC insurance imposes a dis- ance, available from the nation’s leading Most commercial loan documenta- cipline and provides a product that can real estate title insurance companies, tion defects that lead to a lender’s secu- significantly reduce these legal risks. became a relatively new development in rity interest being set aside are clerical In a complex and threatening the financial markets. Similar in many in nature: incorrect name of borrower, environment, evidenced by the recent respects to traditional real estate title search of the wrong jurisdiction, wrong eruption of subprime related credit qual- insurance, UCC insurance was intro- state of filing, the lack of filing the ap- ity and liquidity issues, hazards to the duced specifically to insure the lender’s propriate documents, an error in the bank’s capital are elevated. With a high security interest in non-real estate col- collateral description and the like. More- level of both loan and M&A activity over lateral for validity, enforceability, attach- over, it is often junior staff at either the the last three years, the opportunity for ment, perfection and priority. bank or the law firm that was respon- human error poses an additional but Additionally, UCC insurance was de- sible for perhaps the greatest risk to the undiagnosed danger. veloped to address fraud, forgery, insure lender: the loss of reliance collateral. Risk managers are now able to shift the lending gap and provide cost-of- Loans with documentation prob- commercial loan risk one might associ- defense coverage in the event of a chal- lems are usually not an issue until they ate with the potential broadening of the lenge to the lender’s security interest. default. The strong loan market has current consumer and residential loan From a secondary market perspective probably masked a number of commer- quality meltdown by utilizing a basic, and portfolio management standpoint, cial loan defects, particularly since there traditional and newly available solution: the policies are designed for the life-of- have been limited defaults in recent Time-tested title insurance with a new loan and are assignable. years. Documentation defects that will twist. TSL Articles 8 and 9 of the Uniform directly affect value and recoverability Ted Sprink is senior vice president and Commercial Code, refer to “personal of collateral have been kept somewhat national marketing director for the UCC Risk property” which includes inventory, below the surface by the simple fact Management Division of the Fidelity National furniture, fixtures, equipment, accounts that many of the affected loans are Financial Family of Companies. receivables, deposit accounts, general not in default. Morrison Foerster’s intangibles, securities and pledges McPhee added, “The transaction itself often crucial to the mezzanine lending benefits from the efficiency and markets. attention to detail required in the pro- More significantly from a lender’s cess of obtaining UCC insurance perspective, UCC insurance overcomes as a closing requirement.” limited “UCC search vendor” indemni- Perceived equity cushions and ample fication in connection to search office alternative sources of capital may have errors and omissions, indexing inconsis- artificially hidden problems associ- tencies and financing statement inaccu- ated with loan concentration, market racies. “My firm has recommended UCC saturation and actual cash flow and insurance for certain loan originations management difficulties in core lending in order for our clients to benefit from segments. Reprinted with permission from The Secured Lender, January/February 2008. By The Reprint Dept., 800-259-0470 (10952-0308)
  4. 4. KNOW RISK IN TIMES OF ECONOMIC UNCERTAINTY. The UCCPlus Risk Management Program helps senior credit and risk management professionals improve asset quality by insuring the bank’s security interest in commercial loans. Greater transparency, lower operational risk, reduced loan loss reserves, minimized regulatory capital requirements, improved liquidity and better operating margins. And, because coverage includes defense costs in the event of a third party challenge, and life-of-loan protection, UCCPlus improves credit quality, thereby enhancing loan values as an asset to secondary market investors. Better protection also improves institutional and regulatory performance: a strategy for insuring the future in a time of economic uncertainty. RISK MANAGEMENT Fidelity National Financial Family of Companies