SVB Failure Starts Aggressive Regulation Talk in Washington, IMBs Take NoteThe Insured Closing Letter is Obsolete!

February 21, 2018
It did not take long after the Silicon Valley Bank failure for politicians in Washington to rush to the next available microphone and lament the “loosening of bank regulations”. Instinctively the finger pointing began, and in many quarters ended up in the direction of the prior administration’s policy to generally roll back stringent business regulations and allow free market decisions to govern various industries. Chief among the complainants (no pun intended) was Sen Elizabeth Warren, who emerged out of the 2008 crisis as an architect and advocate for the Wall Street Reform Act and the creation of the vaunted Consumer Financial Protection Bureau ( CFPB), which she briefly directed. Just yesterday in DC’s The Hill publication, Sen Warren was reported as blaming the the collapse of Silicon Valley Bank on Republicans in Congress, which in 2018 helped pass a law to ease bank regulations put in place following the 2008 financial crisis. “No one should be mistaken about what unfolded over the past few days in the U.S. banking system: These recent bank failures are the direct result of leaders in Washington weakening the financial rules,” Warren is quoted as saying. According to The Hill piece, Warren, who voted against the 2018 bank deregulation bill, said that the crises would have been avoided if the banks were required to hold more liquid assets because the bill exempted banks with less than $250 billion in assets from rigorous Fed stress tests. Warren and other Democrats say the old rules could have caught the issues at SVB sooner. Given that politicians generally “never let a crisis go to waste,” many now suspect that the banking industry is about to be slammed with heightened regulatory scrutiny, tighter operational rules, more audits and exams, and larger and very public fines, penalties and consent orders. What does this mean for independent mortgage bankers (IMBs)? It means that they have to get back to the compliance mindset they were frightened into adopting between 2008 and 2018, and before the bottoming out of interest rates led everyone to believe that easy money was here to stay and that self-regulation meant hiring more loan officers. Keep those risk management officers and compliance directors close by folks, we are all in for a bumpy ride on the regulatory

A recent panel on fraud issues included a healthy debate about the extent to which a lender can rely on the insured closing letter as a means to offset risk at the closing table.

Advocates felt that ALTA’s best practice initiative backed by the letters should give lenders sufficient assurances that any bad act at the closing table would be deterred or insured.  Others felt differently.  One audience member asserted that the insured closing letters were woefully inadequate to offset the type of risks that lenders care about most.

A careful reading of these letters exposes their limited applicability to a lender’s critical compliance and risk concerns.  In an era of heightened consumer protections, data security and risk monitoring what exactly do these letters, which are not an insurance product, offer?  Not enough to rely on them unconditionally.

Here are some of the key features of the standard insured closing letter issued nationally by various underwriters.  The language is similar if not identical no matter who is issuing the letter.

  • “We agree to reimburse you for an actual loss incurred when the issuing attorney or closing agent…fails to follow your written closing instructions to the extent that (a) title is impaired or liens not properly recorded, or (b) the agent commits fraud with your funds or misapplies your funds, or (c) commits fraud in handling your documents. (emphasis added)

Exclusions to the letter include:

  • Where the closing instructions vary from the title protection ordered in the title report;
  • Failure of the agent to deposit the mortgage proceeds into the bank which you designated by name;

Some issues not covered by these letters include:

  • Agents who conspire with others to commit fraud;
  • Agents who steal or misuse a consumer’s personal and financial data obtained at closing;
  • Agents who fail to report the fraud of others at the closing table;
  • Agents who comply with closing instructions but are complicit in straw buyer, short sale, fraud, foreclosure rescue fraud, and undisclosed intervening flips;
  • Agents who steal a borrower’s deposit or cash to close;
  • Agents who permit cash outside closing.

In addition because these letters are not an insurance product, they are not uniform nationally (several states prohibit them, notably New York), not regulated like insurance, and are invoiced as a title charge not an insurance premium.

Finally, because the letters are not insurance, disputes regarding coverage are relegated to the courts, where litigation costs are expensive.  There is no insurance commissioner to complain to and no regulatory authority to help mediate disputes and investigate bad claims acts.

Quite simply reliance on the insured closing letter as risk management is misplaced confidence in a document that was never intended to protect lenders from all of the types of risks they face when closing loans, risks that can ultimately result in repurchases and fraud losses.  More importantly the insured closing letter, when collected in the mortgage process, does not excuse a lender from conducting the type of due diligence it must perform to meet CFPB, OCC, HUD and FNMA requirements for vendor management and consumer protection.

Until a suitable replacement can be implemented nationwide lenders should view these letters for what they are worth:  one small part of a larger enterprise risk management obligation to protect consumers and assure loan quality.


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