A Torrent Of Flood Guidance

The bank regulatory agencies have issued the long-awaited questions & answers on flood insurance. The Q&As, published on July 21, 1997, bring some clarity to many troublesome areas in the new regulation.

Designated Loan
The Q&As deal extensively with the definition of designated loan and the impact of that definition on coverage. For example, the document explains that designated loans include interim construction loans to construct a building that does or will secure the loan while loans to acquire raw land are not included. However, loans to construct improvements on the raw land would be covered when the construction phase is begun.

Home equity loans, including lines of credit, are designated loans subject to the requirement for flood hazard insurance if the property is located in a flood hazard area. For lines of credit, the covered loan would be the line limit. Draws made against the line would not trigger new coverage or certification requirements, but a request to increase the line of credit would trigger the requirements to the extent of the increase.

On commercial properties, loans secured only by contents of a building - such as inventory - are not covered loans. However, if the loan is secured by both the building and the contents, both are subject to the flood insurance coverage requirements.

Worth special note for commercial lenders is the conclusion that property taken as security in an abundance of caution is a covered transaction.

Thus, even abundance of caution transactions are subject to flood certification requirements. Also included as designated loans are restructured loans or workouts that are secured by improved real property, and loans secured by a third party guarantee secured by the third party's improved real property.

The simple rule of thumb to follow is that any improved real property securing a loan is covered. It doesn't matter how or why the property came into the picture, and it doesn't matter whether it is owned by the borrower or a third party.

Purchase Triggers
Lenders should give special attention to several situations that are outside of flood insurance purchase requirements. These include properties located in a non-participating community and loan purchases. While it is not necessary to purchase insurance in a non-participating community, the Q&A raises safety and soundness concerns about institution; making such loans.

Similar concerns relate to purchasing loans. Purchasing a loan is not a transaction that triggers the regulation's requirements. However, purchasing the loan is purchasing liability. Thus, in this situation also, the Q&A questions the wisdom of ignoring whether the loan originator has complied with flood insurance regulations. However, whenever the lender becomes aware of coverage concerns, or flood hazards, the lender must comply with the regulation.

Insurance Coverage
Loans that predate the increases in available coverage should be adjusted on their renewal date or the first anniversary date following March 1, 1995. Loans made after that date were subject to the new coverage limits.

Insurance can only be obtained on the value of the improvement. If the loan amount exceeds the value of the improvement, insurance cannot be obtained for the full loan amount but is limited to the value of the improvements.

Loan Servicing
When selling the servicing for a loan on which flood insurance is required, the lender should provide for flood insurance compliance in the contract with the new servicer. The servicer may not be subject to the flood insurance regulations. Therefore, these agreements are the only tool to pass on the requirements. Even with such a contractual agreement, the bank originating the loan remains ultimately liable. Choose your servicing purchasers with care.

Escrow Requirements
When the lender establishes an escrow account as a condition of a loan secured by residential real property, the flood insurance premium must be escrowed. The Q&As provide several clarifications to this rule. First, if the escrow account is voluntary - established by request of the borrower and not as a condition of the loan the flood insurance need not be paid into escrow. Moreover, the requirement applies only to loans originated after October 1, 1996.

However, any residential loan is covered by the escrow requirement. Thus, a loan on a mufti-family residence would be subject to the requirement. For mixed use properties, such as buildings that have both commercial and residential units, the predominant use would determine whether the property should be considered residential.

Certain types of escrow accounts, such as those for credit life insurance, would not trigger the flood insurance escrow requirement. Essentially, only required escrowing of costs or fees related to the real estate, such as taxes and hazard insurance, would trigger the requirement.

Forms and Notices
The new Q&As drive home the point that the certification form is required but notification to the customer can be given in any form chosen by the lender. It is not necessary to give a copy of the Standard Flood Hazard Determination Form ("SFHDF") to the customer. The lender can notify the customer by letter. Also, the lender only needs to notify customers whose security property is actually located in a flood hazard area.

There is no need to notify customers that their property is not located in a flood hazard zone. When improved real property securing a loan is located in a flood hazard area, the lender must notify the customer. In the case of multiple borrowers, the lender can send one notice to any one of the borrowers. To make internal procedures as consistent as possible, Compliance Action recommends using the same approach as for Regulation B adverse action notices: sending the notice to the principle borrower, if one is readily identifiable.

Refinancings
There have been numerous questions about how to treat refinancings and whether new flood certifications need to be performed. The Q&As give some clear guidance. First, only refinancings with the same lender can use a previous flood certification. A refinancing with a different lender is a new loan for purposes of flood insurance.

If the loan is with the same lender and the flood insurance requirements were fully complied with when the first loan was originated, the lender may re-use the flood certification if the determination is no more than seven years old and there have been no map revisions or updates that affect the property securing the loan.

The Q&As carry this concept into home equity lending. Essentially, the making of a home equity loan by a lender who has the first mortgage on the property can be treated as a refinancing. The lender can rely on the original determination but must determine whether the coverage is adequate. If you choose this option, make sure compliance was correct the first time and that nothing has changed! However, a new lender would need to make an independent determination.

Mobile Homes
Compliance with flood regulations for mobile home loans presents special problems because the property location - and the related flood hazard area - has not usually been selected or finalized when the loan application is submitted. In this situation, the flood hazard certification must be performed as soon as the property location is known. The Q&As advise lenders to use their best efforts to provide notice of flood hazard to applicants "at the earliest possible time." To accomplish this, Compliance Action recommends that the loan contract include a requirement that the borrower notify you as soon as a location is selected.

Mobile homes that are not located on a permanent foundation are "home only" loans and not subject to the regulation's requirements. However, the agencies en courage lenders to remind these borrowers of flood hazard issues. In addition, if the property is later located on a permanent foundation, the placement would trigger flood hazard insurance requirements.

ACTION STEPS

Review the commercial portfolio for "abundance of caution" loans. Determine whether flood insurance requirements have been complied with.
Review lines of credit, including home equity lines of credit, to determine whether flood insurance was properly certified.
Review any purchased loans to determine whether the loan originator complied with flood insurance regulations. If not, consider whether to certify the portfolio and force place insurance if necessary.
Review your loan servicing contracts - sales and purchases - for treatment of flood insurance compliance.
While you are reviewing contracts, review your real estate loan contracts. Even though you have legal authority to force place flood insurance, it's a good idea to also provide for that in the contract. Such a clause could prevent a lawsuit from a frustrated borrower.
If you make mobile home loans, include a provision in your loan agreements that requires the borrower to notify you as soon as a location has been selected.