Loan Participation & Flood Requirements
by Mary Beth Guard, BOL Guru
Question: A question came up about Flood Requirements. What if we are buying a participation from another financial institution? Is our bank still required to document compliance with the Flood regs or does that simply rest with the bank that actually filed the mortgage? If the agent did not comply with the reg, would we be held accountable in anyway from a regulatory standpoint (other than the risk of loss to collateral we may otherwise encounter if the property were actually flooded)?
Answer: From a strictly compliance standpoint, the four triggers for determining whether or not flood insurance must be procured are the times when a lender is:
making
extending
increasing or
renewing
a loan secured by improved real property or an affixed mobile home.
When you are purchasing a participation, you are not doing any of those four things, as the funds you are expending are going to the bank which made the loan -- not to the borrower.
From a risk management standpoint, however, your collateral may be at risk. For that reason, you will want to make sure the lead institution has a proper flood compliance program in place, that they made the flood determination within the proper time frame, recorded it on the Standard Flood Hazard Determination Form, and required the borrower to obtain insurance in the correct amount for the full term of the loan if the property did turn out to be in a flood hazard zone.
While the failure of the lead bank to take those steps would not necessarily be criticized in a compliance examination of your institution, it could certainly be the focus of examiner criticism in a safety and soundness exam because it impacts the soundness of the underlying loan.
It would be wise to have a provision in the participation agreement that would require the lead bank to buy back the participation in the event you subsequently determine the lead bank failed to properly discharge its flood compliance duties.
The original version appeared in the July/August 2003 edition of the Oklahoma Bankers Association Compliance Informer.
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