1. JANUARY 2007
VOL. 5, NO. 1
F O R T H E C O M M E R C I A L F I N A N C E P R O F E S S I O N A L | W W W. A B F J O U R N A L . C O M
Time-Tested Title Insurance Emerges as
‘Best Practice’ Risk Management Tool for
Secured Lenders
By Theodore H. Sprink
Anticipating change has
become the foremost I t’s no easy task: anticipating the negative
shift in credit cycles; receiving regulatory
pressure to improve credit quality; protecting
reliance collateral; managing the staggering
Blocking & Tackling
Risk managers want their lending institutions
to have better credit quality, less risk, lower risk-
based capital requirements, reduced loan loss
challenge to the professional legal costs associated with charge-offs, modi- reserves, enhanced liquidity, greater margins
fications, foreclosure strategies and legal opin- and the opportunity for improved value of loans
risk manager, and perhaps no ions; managing loan loss reserves; maximizing sold into the secondary market. Risk managers
the demands of investors, secondary market want to avoid legal expenses associated with
place in society has change, offerings, recourse, puts, takes; determining challenges to reliance collateral, and the costs
operational risk; managing risk-adjusted capital; associated with the loss of collateral due to
uncertainty and risk become managing operating margins and liquidity. It can documentation defects and clerical errors. They
be just another day in the office — no simple seek to shift risk.
more problematic than the task, indeed. Fundamental “blocking & tackling” has been
According to regulatory authorities gathered used by lenders to shift risk in the past, in what
financial services industry. recently in Chicago for the professional Risk has become an essential component of the real
Management Association’s Annual Conference, estate-secured lending business and mortgage-
Challenges to risk managers risk managers were, in consideration of antici- backed securitization market. Traditionally real
pated yet undetermined changes to the financial estate lenders and investors have used title
are presented by economic, markets, urged to shift risk when possible, and to insurance to minimize documentation errors and
use all risk management tools at their disposal. to manage problems associated with challenges
credit cycle, asset quality, to lien priority. Lenders have benefited from the
A Regulatory Perspective related improvement in credit quality, secondary
regulatory and institutional Generally consistent in their remarks, repre- market value and liquidity
sentatives from the Office of the Controller of Title insurance is the real estate industry’s
changes. the Currency, the Federal Reserve System, The time-tested and preferred method of shifting
Federal Deposit Insurance Corporation and the risk. In recent years traditional real estate title
Office of Thrift Supervision discussed similar insurance has emerged as a best practice risk
general themes. Namely, that economic cycles management tool for secured lenders … with
cannot be effectively defined except to say, they one significant update; it is now available to
are unpredictable. lenders in which “reliance collateral” is personal
Further, the consistent theme in their property as defined by Article 8 and Article 9 of
comments seemed to reflect that we are likely the Uniform Commercial Code.
at the tipping point of the current credit cycle.
Liquidity in the market has resulted in too much Anticipating Change
money chasing too few deals. The result is an The title industry has essentially adapted
apparent erosion in underwriting standards and the time-tested American Land Title Association
the lender’s related exposure to loss-given- (ALTA) real estate title insurance policy form
default in the event of an economic downturn. to provide the benefits of title insurance to
Loan concentration is a concern, asset quality commercial lenders securing loans with non-real
is critical and there was the suggestion that the estate collateral. In a few short years the nation’s
future practice of examiners can be expected to leading title insurers have produced so-called
focus on risk management techniques as evidence “UCC Insurance Policies” in amounts covering an
of the bank’s capital and liquidity plans. estimated $150 billion in secured lending.

2. The industry has geared up to provide Articles 8 and 9 of the Uniform Commercial Shifting & Managing Risk
market-critical risk shifting for commercial Code, refer to “personal property,” which In recent years the stable economy has
lenders exposed to the dynamics of uncertainty, includes inventory, furniture, fixtures, equip- “masked” commercial loan defects, not linking
driven by anticipated yet undetermined factors ment, accounts receivables, deposit accounts, them particularly to defaults and loan recovery.
such as changes in employment, manufacturing, general intangibles, and securities and pledges Documentation defects that will directly impact
retail spending, interest rates, energy costs, real (often crucial to the mezzanine lending markets). value and recoverability of collateral have been
estate values, global stability, unfunded pension Now lenders can outsource UCC search, docu- kept somewhat below the surface by the simple
liabilities, and both regulatory and institutional ment preparation and filing functions, while fact that many of the affected loans are not in
changes in perception. In short, the cycle of wrapping the entire transaction in an insurance monetary default. This, notwithstanding the
loosening of credit common during economic policy offered by a handful of Fortune 500 potential for the borrower being headed toward
expansion and the tightening of credit anticipated insurance companies, effectively shifting risk for an insolvency proceeding, which is likely to result
during economic contraction will require a new the proper attachment, perfection and priority in a challenge to the lender’s security interest.
level of risk management expertise. of their security interests. Perceived equity cushions and ample alterna-
The policy replaces the costly traditional tive sources of capital may have artificially hidden
Time Tested legal opinion rendered by borrower’s counsel problems associated with loan concentration,
The original concept of applying the benefits as a lender requirement, and provides cost- market saturation, actual cash flow and manage-
of real estate title insurance to the commercial of-defense in the event of a challenge to lien ment difficulties in core lending segments.
finance market segment was simply this: If virtu- attachment, perfection or priority. And, only What those of us who attended the Risk
ally every bank in the United States originating UCC insurance overcomes limited “UCC search Management Association Annual Conference
real estate-secured loans requires real estate vendor” indemnification in connection to search learned is that not even the top economic and
title insurance, would those lenders originating office errors and omissions, indexing inconsis- regulatory minds in the nation are willing to gamble
non-real estate secured loans not enjoy the same tencies and financing statement inaccuracies. on unlimited growth, economic expansion, avail-
benefits of title insurance? able credit or luck for underwriting commercial
As late as the mid-1950s real estate title Fire Insurance Before the House Burns loans — or in managing the risk inherent during
insurance had not yet become universally Down a time of economic change and instability.
accepted or utilized by lenders. Lawyers’ legal Market research has shown that most With change comes uncertainty. With uncer-
opinions and abstracts were widely utilized in the commercial loan documentation defects that tainty comes risk. A risk manager should use all
nation’s real estate markets. Standardized real lead to a lender’s security interest being set available tools in shifting risk. UCC insurance is
property title policy forms of coverage, endorsed aside are rather clerical in nature: incorrect a time-tested concept, now available to secured
by the ALTA, were still a decade away. name of borrower, searching of the wrong juris- lenders and commercial risk managers.
Many believe it is the secondary market, with diction, wrong state of filing, the lack of filing the
the advent of Fannie Mae and Freddie Mac and appropriate documents, an error in the collateral
their crucial roles in the American economy, that description, etc. The research indicated that it Theodore H. Sprink is senior
led to not only the importance of title insurance might be the lowest paid individual at either the vice president and national market-
for individual loan originations, but the invest- bank or the law firm that was responsible for ing director for the UCC Insurance
ment community’s need for enhanced, high perhaps the greatest risk to the lender: the loss Division of the Fidelity National
quality, real estate related “securities.” of reliance collateral. Financial Family of Companies.
The research also noted, that like the percep- The UCCPlus Risk Management Insurance Program
Enhancing Credit Quality tion of the value of insurance products, UCC is underwritten by Chicago Title, Fidelity National
This quality enhancement was provided by insurance may be viewed by many as similar Title and Ticor Title insurance companies, collectively
the nation’s title industry, based on the industry’s to the fire insurance we all purchase for our Fortune 500 #231. Sprink is one of the original
ability to deliver, insure and defend “clear personal homes — You don’t really need the architects of the UCC insurance value proposition,
title.” Although UCC insurance, available from fire insurance until the house catches on fire. introduced several years ago for the mezzanine and
the nation’s leading real estate title insurance In other words, there was unlikely to be a chal- securitization market segments. He can be reached at
companies, is a relative newcomer to the financial lenge to the lender’s security interest, unless 619-744-4410 or via e-mail at tsprink@fnf.com.
markets, lenders and investors are poised to gain there was a default. However, unlike the fire at Additional details about UCCPlus can be found at
many of the same benefits currently and promi- your home (that may not result in a total loss of www.uccplus.com
nently enjoyed in the real estate markets. contents), when a perfection or priority defect
Similar in many respects to traditional real occurs — even though a technical or monetary
estate title insurance, UCC insurance was devel- default may not yet have surfaced — it is often
oped specifically to insure the lender’s security catastrophic to the lender in that it consumes
interest in non-real estate collateral. all collateral.
So even loans known by the lender to be
UCC Insurance… A Risk Management Tool defective in documentation have, in some Theodore H. Sprink
UCC insurance is a title insurance product, institutions, not been an issue until such time Senior Vice President
which insures the lender’s security interest in as they were in (monetary) default. By then, it National Director of Sales & Marketing
loans secured by non-real estate assets for validity, is often too late — for our homes — as well Fidelity National Title Group, Inc.
enforceability, attachment, perfection and priority. as for the lender’s collateral position. The $35 UCC Insurance Division
701 “B” Street, Suite 1700
UCC insurance covers fraud, forgery, insures the indemnity furnished by the bank’s UCC search
San Diego, CA 92101
gap and provides cost-of-defense coverage in vendor, or the right to sue outside counsel, do Office: (619) 744-4410
the event of a challenge to the lender’s security not represent attractive alternatives to proper Mobile: (760) 604-0277
interest. Policies include UCC search and filing perfection and priority to the lender’s risk Fax: (619) 544-6289
services, are life-of-loan and are assignable. management team. www.uccplus.com
Reprinted with permission from the ABFJournal (Vol. 5, No. 1). Copyright © 2007. All rights Reserved.
#1-19302527 Reprinted by Reprint Management Services, 717.399.1900. To request a quote online, visit www.reprintbuyer.com.