Over the last few years, our industry has struggled with many changes: a changing marketplace where our major lender and realtor customers are consolidating and nationalizing; evolutions in technology which are changing the way we develop and deliver our product; and regulatory changes which have opened our marketplace to new competitors- in this case banks.
With the legislative changes in the Gramm-Leach-Bliley Act, (formerly called, the Financial Services Modernization Act (Public Law 106-102)) we are faced with a reconfigured world where our customer may want to become our competitor or our partner.
Here is a summary of the bill and how it will impact the title industry.
How We Got Here
The Gramm-Leach-Bliley Act repeals the Federal barriers of the Glass-Steagall Act, and of the 1956 Bank Holding Company Act, and facilitates formation of mega-holding companies which will try to provide consumers with one-stop shopping for banking, securities and insurance products. While viewed as a sea change by some, it actually stems the tide of change begun by the Office of the Comptroller of the Currency (OCC), the regulator of national banks. Successive Comptrollers issued a series of permissive interpretive opinions to national banks which have been upheld by the Courts, and which facilitated entry into the insurance industry. A long line of court decisions beginning with Merchants National broadened the powers of national banks. However, the Supreme Court’s Barnett decision in 1996 increased the need for Federal legislative action. The Court held that Florida’s state statute prohibiting affiliation of banks with insurance agencies was preempted by the national bank act. Because the Supreme Court held that the national bank act preempted those state statutes which "significantly interfered" with a bank’s ability to sell insurance, it threatened to remove the state law and regulation which the insurance industry has worked with for so long. In fact, the Court noted that the OCC could become the sole regulator of national bank insurance sales if it chose to do so.
Consequently, ALTA® and its members battled long and hard in the trenches of Capitol Hill to try and maintain state law and a level playing field for our industry as it dealt with these encroachments by the courts and the Federal regulators. To a large extent, we were successful. In addition, the Real Estate Settlement Procedures Act remains in effect, and will regulate bank entry.
The New Law
Now that President Clinton has signed the Gramm-Leach-Bliley Act into law, Federal regulators will begin to develop rules and guidance implementing the statute. In addition, the state insurance Commissioners and the NAIC have jurisdiction over provisions in the bill and will also play a substantial role in future developments. While several provisions of the Act, including those applying to insurance sales, take effect immediately, it is likely that many banks will not enter the market until guidance is issued by the various regulators.
How Soon - How Fast?
The law establishes new financial holding companies, which, as can be seen in the organizational chart, have authority to provide a wide array of financial, investment and insurance products. These financial holding companies are well capitalized and well managed bank holding companies which demonstrate that they meet Community Reinvestment Act requirements. Virgil Mattingly, General Counsel of the Federal Reserve System, stated recently that the Federal Reserve will issue guidance interpreting these requirements by March 11, 2000. Consequently, the title industry may see substantial interest in the near future, and a few bank holding companies may begin acquisitions, subject to later satisfaction of regulatory requirements. However, it appears likely that many bankholding companies, and as noted below, banks, may postpone actions until the Federal Reserve’s guidance is issued in March.
New Financial Holding Companies
These new financial super entities have a complex regulatory structure. As the "umbrella regulator" of these new financial super entities, the Federal Reserve retains the overall responsibility for financial holding companies with bank subsidiaries. The law does require that the Board rely, to the fullest extent possible, on public information and reports from, as well as examinations conducted by, the "functional" regulator. Chairman Alan Greenspan has remarked that,
"In the course of carrying out our supervisory responsibilities, these [reports] are to be the first and sole sources of information about those bank affiliated entities that are already regulated by others."
In fact, "bank regulators" and the holding company supervisor are to give great deference to the functional regulators and to interject themselves only in critical circumstances. And under no circumstances can a functionally regulated entity be forced to assist a depository or any other affiliate over the objections of the functional regulator. Consequently, as ALTA® fought hard to achieve that goal, the state insurance commissioner remains the primary regulator of the title insurance underwriter and any title agency activities housed in bank holding company affiliates.
Financial Subsidiaries - A New Entity
Activities can also be undertaken by the bank itself. ALTA® maintained language in the bill requiring that national banks seeking to operate a title agency in a state in which state chartered banks are authorized to engage in title insurance sales activities, must comply with the "manner, extent, and restrictions applicable to state chartered banks." Thus, those national banks selling title insurance under this authority at the bank level, must comply with the sales laws applicable to those state chartered banks. Many national banks also have title agency operations through operating subsidiaries, and those national banks’ operations are "grand fathered" or maintained under the bill. In addition, the bill also creates a new entity, a national bank "financial subsidiary." While financial subsidiaries may not engage in title insurance underwriting or real estate development activities, financial subsidiaries may engage in title insurance sales.
Like a bank holding company which chooses to become a financial holding company, a national bank seeking to establish a financial subsidiary must satisfy similar capitalization, management, and CRA requirements. Further, a national bank establishing a financial subsidiary must file a formal application with the OCC each time it does so. In addition, national banks may own partial interests in "financial subsidiaries." Most importantly, the state insurance regulator is the primary regulator over "financial subsidiary" insurance sales. Still, the OCC, a regulator financed by examination and other fees on its member banks, will continue to compete with the Federal Reserve, the financial holding company regulator, by providing liberal rules in order to increase bank income. Julie Williams, General Counsel of the Comptroller of the Currency, has indicated that because the Federal Reserve Board will be issuing guidance by March 11, the OCC, which has a statutory deadline of September 10, 2000, will also be issuing guidance by March.
State Insurance Regulators Gain Ground
The new law specifically protects state licensing laws. It also improves state regulator authority over current law. State regulators are granted equal deference with Federal regulators with respect to prospective laws.
Consumer Protection Provisions
The Federal banking regulators are required to consult with state insurance regulators to establish consumer protection regulations by November 12, 2000. These consumer protection regulations will cover sales practices, mandated disclosure requirements, advertising, separation of banking and non-banking activities, and consumer grievance processes.
The new law also requires that financial institutions, which could include title insurance companies and agencies, develop privacy policies. This provision was enacted as a Congressional reaction to public outcry based on a state attorney general’s action against U.S. Bancorp’s sale of customer lists to telemarketers. The law now requires that companies disclose their policies for collecting and protecting confidential information. The law also requires that companies develop policies which prohibit financial institutions from sharing (selling) customer lists of nonpublic personal information, unless the financial institution clearly discloses to the customer in writing or electronically, that such information may be disclosed to a third-party. Companies must inform customers that they have the right to prohibit sharing of their information with third parties not affiliated with the company.
The respective Federal banking agencies, after consulting with State insurance authorities designated by the National Association of Insurance Commissioners, shall prescribe regulations to implement these provisions. The regulations must be final by six months after date of enactment of the Act, May 11, 2000. While entities in bank holding companies will be subject to these bank regulator rules, independent entities will be subject to the Federal Trade Commission.
Why Are Banks Interested?
Why have banks wanted insurance authority in the first place? And will they exercise it in the insurance industry? First, while nationalization is occurring, real estate remains, in many places at this point, a local market. Therefore, in realtor-dominated markets, where lenders control only refinances, bank agencies may well be economically infeasible. In addition, in rural markets where there are few lenders that do not control significant market share, bank agencies may be impractical. Further, state controlled business statutes and other state statutes may serve as barriers to entry.
But what if banks do form agencies? Many years ago, prior to enactment of the Glass-Steagall Act restrictions, the title insurance industry existed in a world where banks were in the title business. The industry will definitely remain in existence and there are a wide variety of views as to what extent bank entry will occur. Savings and loans have always had authority to enter the business, and many have, as full service title agents. However, according to Dr. Nelson Lipshutz of the Regulatory Research Corporation in Newton, Massachusetts, the savings and loan experience may not be a reliable guide. "Rather," he states, "it may be a matter of economics. If it’s sufficiently cheaper for banks to outsource closing activities to title agents than to bring the closing operation in-house, banks will forego the attempt to capture the modest closing operation profit stream. If the costs go the other way, so will the market entry decision. The other important point to make is that acquisition goes both ways. It may make a lot of sense for a big agent to acquire a small bank to hold its escrow deposits. "
And the banking law does provide that flexibility.
Other commentators believe that the cyclical nature of the real estate industry may make title insurance an unattractive acquisition. John Hawke, Comptroller of the Currency noted recently that, "The ability of a single financial organization to offer a full range of products and services strengthens banks by diversifying income streams and reducing their dependence on potentially volatile net interest income."
Yet bank’s experience with the sale of another form of insurance-annuities- has been mixed. Some institutions found that their attempts to market annuities simply depleted their sale of certificates of deposit, which depleted their asset base. Further, banks historically sell their mortgage banking subsidiaries when interest rates increase and their mortgage affiliate becomes less profitable. Thus, acquisition of title agencies may not be a profitable endeavor.
For example, in Wisconsin, banks have had the ability to enter the title business for many years. Several institutions have done so, but many have left the business. Over time, they have found that the rate of return generated was not worth the effort and capital expended. One commentator contends that banks have typically overestimated the number of orders they were able to control, and underestimated the difficulty in serving multiple branch locations.
Others feel that banks are not interested in engaging in title insurance underwriting. Frank Willey, President of Fidelity National Title Insurance Company, noted several obstacles banks would have to overcome in purchasing a title insurer. For instance, lender customers of the title insurance companies would be in competition with a potential bank acquirer on the mortgage origination side of the business. This would put a significant amount of the title insurer’s business at risk, which in turn would result in reduced profitability. Further, a title insurer’s revenues and profits are not countercyclical to those of a bank’s, and it would be very burdensome for banks to internally develop title insurance operations because the business is locally fragmented, meaning that a bank would need to have personnel in place with underwriting expertise specific to a particular geographic region. Additionally, a complex and costly infrastructure consisting of title plants, and sales and underwriting offices is required. It would appear that the ROE dynamics do not make a start-up title operation an attractive investment for a bank to consider.
How Will They Get In?
Based on the above summaries, it seems most likely that banks would enter through joint ventures rather than through creation or purchase of title agencies. To the extent that banks may act like the securities industry, they may follow current practices. That model could well be the joint ventures articulated over the last few years in a series of OCC opinions issued under the "small towns" authority. Limited liability partnerships requiring some capital investment, and compliance with state licensing laws and RESPA, were structured as joint ventures between national banks and title agencies. Compliance with state licensing laws and RESPA were required for those entities, and that model would still be workable under the new law. We may, in fact, see more interest in RESPA, and, with heavily regulated entities, see more interest in compliance. On November 17, 1999 , the Federal Deposit Insurance Corporation (FDIC), which insures both Federal and state banks, pointed out that examiners had noted incidents in which the fee collected by a financial institution for a third-party service exceeded the amount the institution actually paid to that third party, and that these arrangements violated Section 8 of RESPA. The FDIC further notes that contracts with third party settlement service providers, referral fees from mortgage companies to affiliated bank’s employees, and builder loans, are also listed as potential areas of concern. Consequently, RESPA and the Federal government will still be part of the picture.
In soliciting comments on the effect of the new law from industry practitioners, there was only one area where everyone agreed. While financial services laws may affect the way we do business, changes in technology will have a greater effect on the industry. As technology enables us to more efficiently interact with our customers and for our customers to interact with us we will continue to see changes. But the ability to search and insure, close loans quickly, improve our processes, and to continue to provide better customer service, will continue to ensure that our industry plays an integral role in the real estate settlement process.
Look for updates on this subject in future issues of ALTA® Advocate and Title News.
Ann vom Eigen can be reached at 202-296-3671 ext. 214 or firstname.lastname@example.org .