Risk management is not a new concept
Today, more than ever, mortgage lenders and their warehouse bank and investor partners are focused on compliance, quality control (QC) and risk management. The reasons are very plain, losses from defective loans, caused by poor underwriting, fraud or negligence in origination, and fraud and negligence at the closing table, have caused unacceptable losses. These losses not only impact their businesses, but the consumers they serve. As a result, federal and state regulators and GSEs, including the OCC, NCUA, FDIC, HUD-OIG, FHA, FNMA and the recently formed Consumer Financial Protection Bureau (CFPB) have begun implementing stringent consumer protection measures addressing not only loan quality, sales tactics and compensation issues, but risks connected to third party service providers. Closing professionals, including attorneys, escrow agents, title agents and notaries, handle mortgage proceeds and critical collateral security documents, giving them significant authority and power over the loan process. It also provides them with ample opportunities to exploit their position in the loan closing transaction to commit fraud and otherwise serve their self-interests.
In the past decade, significant progress has been made within the mortgage industry to address some, but not all, of the pressure points that can cause fraud and hurt consumers. Great strides in technology and risk management tools have, for example, given lenders the ability to verity borrower identities, confirm property values, and evaluate credit risk. Lenders have focused on quality control, and are now expanding the focus to “quality assurance.” These initiates are being touted by the GSEs and regulators as the industry seeks to create a loan process that is quality conscious before a product is sold in the secondary market. The one area of the loan process that has seen little or no progress in risk management, quality control and quality assurance has been the closing process.
Why closing table risk management has been overlooked
In the past, lenders have assumed the risk associated with the unregulated and unsupervised nature of the closing process because losses from fraud at the closing had historically been a small percentage of overall mortgage fraud damages. That is why most lenders focused whatever spending they could allocate to fraud deterrence on front end fraud detection software, such as social security number verification, automated appraisal reviews and similar products. According to the Mortgage Bankers Association (MBA), lenders spent approximately $1 billion on fraud deterrent software to use in the origination and underwriting process in 2011. The amount of money spent to address fraud and negligence at closing was not in the calculus.
The numbers can no longer be ignored.
The FBI has allocated more agents nationwide to investigating escrow fraud than any other white collar crime. In 2011 the FBI reported $11 billion in mortgage fraud losses from Suspicious Activity Reports (SARs) filings, and for 2012, the number is estimated to come in at $13 billion. The FBI estimates that 15 percent of those losses are directly attributable to escrow and closing fraud. These figures appear to be supported by the Financial Crimes Enforcement Network (FINCen) July 2012 study of SARS reports between 2003-2011 which indicated that there has been unacceptable growth in fraud losses in the escrow and closing area, with a 20 percent increase in the most recent period. This means that there will be at least $2 billion in reported fraud losses from escrow and closing agents this year.
While fraud can take place in any part of the loan process, lenders are most at risk at the closing. Closing agents, who are responsible to disburse the lender’s money, to supervise the execution and delivery of the deed, note and mortgage instruments, are traditionally subject to little or no scrutiny. Professional licensing, while important as a barrier to entry into the profession, is not risk management. There is not one license that covers all of the various actors who handle funds and documents during a closing which, depending upon the state or region, includes lawyers, escrow agents, title agents, lenders, closers and realtors. Furthermore the licensing process is not uniform, comprehensive and ongoing, nor is there a mechanism to combine and share data nationally for all mortgage industry participants.
The current vetting by title underwriters and some banks is primarily static. It is not ongoing, it is not uniform, it is generally focused on entities, and does not involve the sharing of data nor is that data maintained in a user accessible database.
That leaves the closing protection letter or insured closing letter as it is sometimes called, which is a warranty letter and not insurance, issued by title underwriters in some but not all states (New York being a glaring example). The letter is issued with very little risk management mainly because title underwriters have little or no relationship beyond the contract title producer who writes their policies (and may work for more than one issuer). These producers typically delegate closing functions to third parties, independent contractors or non-employee agents who are so far removed from the underwriter that it is impossible for them to evaluate the risk associated with that person’s grant of authority at the closing table. There is also the conflict of interest associated with underwriters who must consider all operational decisions in the context of a sales driven environment. Lastly, underwriters have built an unfortunate reputation among lenders and other claimants who have sought to recover under a letter, finding the well-funded insurers ready, willing and able to litigate rather than pay claims. Consequently lenders and warehouse banks universally deride the CPL as generally “worthless.”
This volatile environment, faced with regulatory pressures never seen before, have called out for a new solution to an age old problem: How to identify and manage the risk of closing agents in a manner that is independent from conflicts, comprehensive, uniform, ongoing and offering shared data?
Other models have already succeeded
The mortgage industry has been favorable to innovation addressing third-party service provider risk in the past, and have readily embraced risk management providers offering outsource solutions. These solutions demonstrate that when lenders are faced with regulatory and loss pressures they will seek out and adopt third party solutions as an alternative to the cost and expense of building internal processes on their own.
For example, pressures to create greater risk management surrounding appraisals resulted in the proliferation of appraisal management companies (AMCs). These entities manage appraisal relationships, being responsible to verify appraiser credentials and skills and oversee an independent property evaluation process helping lenders meet their regulatory obligations in this area.
When lenders began to experience unacceptable losses from poor quality broker originations (TPOs), private companies emerged charging brokers a fee to conduct an independent risk assessment and then providing this data to lenders as a pre-contract screening tool.
Perhaps the most successful example of an industry developed response to a glaring risk management issue has been the establishment of the National Mortgage Licensing System (NMLS). Recognizing the deficiencies in a non-uniform approach to qualifying and licensing mortgage originators, and the failure to share data on bad MLOs, a non-profit created by an industry association established a national database for the registration, evaluation and credentialing of mortgage loan originators. Initially offered in a handful of states in 2008, today every state participates in the NMLS program.
Thousands of lenders pay for risk tools today
In order to assure the quality of their loans, for themselves and for investor representation and warranty agreements, lenders today universally utilize third-party fraud tools for which they pay-per-click fees during the loan manufacturing process for every single loan.
Some of these tools include borrower identity checks through Social Security Number verification, automated property valuation verifications, bank deposit verifications, credit checks, tax return verifications, flood zone verifications, automated underwriting for credit risk, and others. Each of these tools have become universally adopted and utilized as critical loan process resources, and each involves a separate fee (between $7-$25) charged to the lender.
To date, despite regulatory requirements that lenders have something in place to identify, manage and report closing agent risk, there is no nationally accepted service and source of data addressing closing agent risk available to lenders beyond what is offered by a few new closing agent risk management specialty firms. Each of these firms approach the problem from the same perspective but with different models. However what the industry needs is a uniform approach, which is comprehensive and independent so as to be respected by banks and consumers, and which can offer appropriate tools at an affordable cost.
The market is very large and ripe for innovation
The MBA’s data reflects that the target market is vast with nearly 8.5 million residential mortgage closings in 2012 on $1.4 trillion in mortgage funding (down from a height of 12 million in 2007), including those resulting from new and existing home purchases, second mortgages, refinances, home equity loans, foreclosure sales and reverse mortgages. This large market can be divided into four distinct groups of potential customers:
►Those who want closing agent verification for financial transaction security (i.e. warehouse banks, mortgage lenders, community banks, credit unions and possible GSEs like FHA, FHLMC, FNMA and HUD );
►Those who want the benefit of closing agent verification to enhance their credentials and attract business (i.e. real estate lawyers, notaries public, realtors and real estate settlement companies),
►Those who want access to closing agent information to assist them in making decisions about whom to hire when they need representation at a real estate closing transaction (i.e., consumers), and
►Those who want a better insurance product and relief from risk and losses (title insurers)
The U.S. Census Bureau reports that there are 74 million homeowners in the country, of whom 34 million have at least one mortgage, and 12 million have two or more mortgages. According to the MBA, homeowners typically refinance their existing mortgages at least once every five years.
Based on available data from the MBA, NCUA, ALTA, NNA, ABA, the U.S. Census Bureau and other industry sources, there are approximately 18,000 mortgage lending entities (banks and non-bank lenders); 7,700 credit unions, and 250,000 settlement agents (escrow and title agents, real estate attorneys and real estate notaries) in the United States, as well as a half dozen major underwriters that dominate the title insurance industry.
Warehouse banks and lenders represent the key segment of the industry to drive a new risk management program. They need a compliance tool to meet regulatory pressure, they are facing an aggressive audit environment from state regulators and also investors that now re-underwrite each loan before it is sold and they are expected to protect consumers from harm from third parties who may act as agents in the mortgage process. As the regulatory environment has solidified, and the agencies and supervisory bodies have begun pressing lenders to demonstrate their commitment to meet risk management expectations, we have seen a growth in communications from banks seeking the programs and services to assist them in this regard.
Policymakers want change and consumers want protection
The author has had numerous meetings in Washington, D.C. with the CFPB, FDIC, OCC, NCUA and other policy makers to introduce the author’s vetting program and insurance concept, answer questions about industry risk issues and consumer loss data, and establish personal relationships with key government figures. During those meetings, the overall response was very positive and supportive of industry-led initiatives to address regulatory concerns about quality assurance and consumer protections. Consequently it is very likely that in 2013 we will see broader acceptance of escrow and closing fraud deterrence tools in the marketplace.
Since the CFPB’s third-party service provider management announcement (which simply extended to non-bank entities rules in place for years applicable to supervised banks) was made rather recently in April 2012 and only began to be widely circulated in summer 2012, the full impact of this new compliance requirement among mortgage lenders has yet to be felt.
The next 12 months in the industry will see incredible growth in the area of closing agent risk management. It is likely to become an integral part of mortgage lender quality assurance programs as it move towards an industry utility, much like appraisal management, broker management, and other mortgage quality and compliance tools.
Andrew Liput is president and CEO of Secure Settlements Inc., a company he founded after nearly 10 years studying the problem of escrow and closing fraud and the uninsured risks associated with mortgage closing professionals. In July 2012 he was invited by the MBA to address the CFPB and Closing Agent Risk at the Fraud and Risk Management Forum in Dallas. In December 2012 he provided a formal opinion to the National Association of Insurance Commissioners Title Insurance Task Force for its White Paper on Escrow and Title Reform. He is the author of numerous articles on fraud and risk management issues. He may be reached by e-mail at [email protected]