If we force place flood insurance after 1/1/16 are we required to escrow for the force placed premium since we would be increasing the loan amount by the flood insurance premium or does the MIRE apply only if new money is given to the borrower ?

This is being debated right now. I recently spoke at a state banking association compliance conference. At the conference, there was a regulatory panel and a FDIC examiner brought up this topic and said that adding force placed insurance to an existing loan was a MIRE event and triggers all of the requirements (SFHDF, Notice and escrows beginning 1/1/16). I questioned her on this and she read from a "secret" memo. When several of us asked about the source, she said it was an interagency memo but couldn't be released. When I asked the other regulators on the panel if they agreed, the OCC examiner sitting next to the FDIC examiner said she was not aware of this and disagreed. The FRB representative said nothing. There was an ABA staff member there that said he had not heard of this either.

After the conference, I called a FDIC examiner friend. He confirmed that at the end of Oct, there was an interagency memo released but only internally - not for public disclosure - so none of us even know about it. He read it to me and it confirms what the FDIC examiner said. I brought up several issues with this new interpretation. My FDIC contact asked me to write these things and send it to him. Below is what I sent him.

So, it appears we do have a new interpretation; it's been kept a secret and not published in any regulatory guidance to the banking industry and it doesn't make sense on several levels (as I explain in the letter below). When I hear more, I'll post it.

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I respectfully submit the following questions concerning the Interagency Policy Group’s (Group) opinion that adding force-placed flood insurance to a loan balance is an increase (a “MIRE event”) for the Flood Insurance Act.

1. Lenders don’t always know the premium amount of the force-placed policy at the time the insurance is ordered. Are they to guess? How would the proper amount of flood insurance be determined?

Let’s assume:
• A loan balance of $100,000 where a standard policy costs $2,000.
• The loan balance is the “lesser of 3” (loan amount, insurable value, maximum available).
• The borrower has purchased flood insurance in the past, but lets the policy lapse.
• The lender notifies the borrower of the requirement to renew the insurance at a $100,000 minimum.
• The borrower doesn’t renew the insurance.
• The lender orders a force-placed policy under the Mortgage Portfolio Protection Program (MPPP) for $100,000 and plans to add it to the loan balance, if the borrower doesn’t pay for it before.

If the Group’s opinion is true, then the lender has ordered an inadequate amount of insurance (100,000 instead of $102,000). Once the premium of $2,000 is added to the loan balance, does the lender begin the force placement process again by notifying the borrower that $102,000 in flood insurance is necessary?

Now assume the lender orders a policy in the amount of $102,000, knowing the previous policy cost $2,000. But when the MPPP policy bill arrives, the creditor learns that an MPPP Policy is more expensive than a standard policy. If the MPPP premium is $2,500 and the lender adds the premium to the loan balance (now $102,500), the lender is now $500 short of having the proper amount of flood insurance.

Does the lender now notify the borrower they are $500 shy of adequate coverage and begin force placement procedures again? This puts the borrower and creditor in an endless circle.

This could be seen as an impossible requirement for creditors and potentially abusive to borrowers.


2. If adding anything to the loan balance is seen as an increase, then what about late charges or other contractual fees that occur after closing? These subsequent events are triggered by the original loan agreement, not by a new request for credit (a true “MIRE event”).

Assume the same scenario as illustrated in #1 above. If a borrower has a current balance of $100,000 and incurs a late fee of $25, is the $100,000 flood insurance policy now considered inadequate? Is the lender now required to begin the force placement process?

If you’re going to require more flood insurance in this example, couldn’t this be seen as a “fee” on a late charge? Regulation AA prohibits the pyramiding of late fees. At a minimum, I believe this could be seen as an abusive practice under UDAAP.

Late fees added to the loan balance is not a new request for credit. It’s a contractually triggered event – no different than force-placed flood insurance.


3. Lenders are to determine the proper amount of insurance PRIOR to closing a loan based on the “lesser of 3”. While subsequent requests from the borrower such as extensions, renewals and increases, where the borrower and creditor mutually agree and sign a new loan agreement, do trigger the Flood Insurance Act requirements contractual events (like late fees, force placed flood insurance, other fees) should not effect the determination of whether flood insurance is adequate or not. My interpretation of the Act does not support the Group’s opinion that this is a MIRE event.

4. If it is the Group’s opinion that adding force placed flood insurance to a loan balance is a MIRE event, then all of the requirements of the Flood Insurance Act would be triggered. This means the creditor:

a) May need a new SFHDF (if the conditions for relying on the previous SFHDF aren’t met);
b) Would need a new Flood Notice; and
c) May have to begin requiring an escrow account for the flood insurance (beginning 1/1/16).

5. If this is truly considered an increase in principal, then it would be reasonable to assume that new disclosures including a Right of Rescission would also be needed. When looking at Reg. Z under 1026.23(f)(2) “new advances” and its related commentary:

For purposes of the right of rescission, a new advance does not include amounts attributed solely to the costs of the refinancing. These amounts would include §1026.4(c)(7) charges (such as attorneys fees and title examination and insurance fees, if bona fide and reasonable in amount), as well as insurance premiums and other charges that are not finance charges.

Since an increase in principal to pay fees including insurance premiums is not considered a “new advance” under Reg. Z, wouldn’t it be reasonable to determine that this was also the case for flood insurance?


6. If the Group believes adding force placed flood insurance is a MIRE event, please make this known to the banking industry with a public announcement rather than an internal document that cannot be shared. Currently, field examiners have a different set of rules than those they regulate.

Thank you,

David A. Dickinson
President
Banker’s Compliance Consulting

Thank you, David, for the update.

Why is this internal memo/opinion a secret, if in fact, banks are expected to comply? Shouldn't the regulators be offering guidance on these type of things BEFORE banks actually "get it wrong"? If the published guidance is not as clear cut to the pouint where they need to issue an internal memo/opinion for their examiners, shouldn't this warrant disclosure/communication of the same to the banks that are supposed to comply? Aren't the protection of the borrowers and the safety and soundness of lenders the first priority?

...and thank you David for the information and for submitting questions about the opinion..

You're exactly right Happy. That's what I'm trying to say in #6 of my letter to the regulator.

The regulator I spoke with agreed that this didn't seem reasonable and he indicated he would run it up the pipeline. Stay tuned.

Thanks David...reminds me of when the FRB cited us from guidance that was not even released yet. It was funny (not really) when the guidance came out some time later it was word for word exactly the same as the exam result letter. Coincidence? I think not.

David, any chance you've gotten any feedback yet from your letter?

No I haven't. I will send an email to the regulator to see if there's any thoughts/activity on the letter. Thanks for the reminder.

Update: I got a call from the FDIC on this issue. The FDIC has issued an internal email dated 1/25/16 addressing this. The FDIC examiner read parts of it to me, but stressed it was internal document. He also said the FDIC did not plan on issuing a FIL on this. Here's a summary of what I was told:

If the loan balance increases due to force placed insurance, it's a MIRE event. Therefore, you trigger everything: SFHDF (if you can't rely upon a previous one), new Notice, escrow, etc.

If you add the insurance to the loan balance, it can require a higher amount of insurance (as the loan balance is increased). Re-read #1 from my 12/10/15 post above. The examiner basically said you need to guess a little high to ensure you have enough coverage. He also said he didn't think a small amount under coverage would be an issue, but I've seen examiners that did have an issue with this.

The examiner said you could force place and not add the premium to the loan balance (put it in a suspense account), but that would create a separate, unsecured item, not governed by the loan contract. I'm not in favor of that.

So I see 2 options: 1) Don't add the force placed premium to the loan balance or 2) add it (possibly aiming high) and consider it a MIRE event (triggering everything).

I think this is worthy of discussing with your examiners so they understand the significance of this issue and we can hopefully get some formal guidance (FAQs) or get them to back off on this. I'm only hearing this from the FDIC and it's a new interpretation yet they are unwilling to put it out formally.

So I asked this question to my local FDIC examiner (not as eloquently as David) but here is the answer I received. I also asked what we are to do if a customer doesn't want to set up the escrow account. I do plan to ask about the potential new SFHD and the notice requirement.

Based upon current regulations and discussions revolving around the flood regulatory changes, as of this year, any time you make, increase, renew, or extend (MIRE) a loan with collateral located in a flood zone, escrow is required (unless you meet the small service provider exemption). In regards to force placement, if you force place flood insurance and add it to the loan, this is considered an increase. This increase will trigger the need for the establishment of escrow. This is a requirement and not an option for the bank or the customer, just as escrow for an HPML is a requirement and not an option. Once the insurance premium is added to the loan, escrow is expected to be established at that point.

In regards to your question about what to do if a customer refuses to escrow, it is not an option…just like it is not an option for the bank or customers to not get flood insurance if in a flood zone. This issue can probably be avoided with careful phrasing of the force placement notification. During the notification process, the customer can be told that flood insurance has lapsed and will result in force placement of the flood insurance premium that will be added to the loan and result in the requirement of flood insurance escrow going forward. At that point the customer has been given 2 options, buy his/her own policy or have it force placed that will increase their loan and result in flood escrow going forward.

Any further update? I am in the midst of performing an audit of compliance with the FDPA and have this exact scenario...

Home Equity LOC (no escrow established and as I recall, HELOCs are exempted from mandatory escrow) was force placed for remaining loan balance (let's use the example above and say $100,000)...after force placement a bill is sent to the borrower...after several attempts (letters) for payment, the premium (example $2,000) is added to the loan balance. New balance is now $102,000.

I am cringing at the thought of explaining that this is now a trigger (increase) and requires a new SFHD (if prior is older than 7 yrs, or map inquiry if less than 7 yrs), new notice to borrower, new force placement, etc. And once again, this would be a vicious circle if the same process is used. Not sure why we just did not create an escrow account and advance the funds from the escrow account.

We are regulated by the OCC...anyone hear of OCC examiners making an issue of this?

I have not worked for a bank that added forced placed insurance to the loan balance. I messes up everything if they pay it off. I think everyone needs to check and find out how their bank is actually handling this before assuming that this is some complicated issue that they have to deal with.

I would suggest that not adding it to the loan balance and re-amortizing the loan messes it all up. If you don't and a loan goes to term, the borrower could end up owing more than they paid for the house if you force placed insurance for 15-20 years. Nothing like setting yourself up for a UDAAP.

TryingToComply - I did not think we were adding to the loan balance either...but, now I see at least one where we have done it, hence my dilemma.

rlcarey, I'm not following you...can you rephrase? Thanks.

If you are not re-amortizing the loan whether or not you add the premiums to the loan balance or hold them in a separate bucket, if you are not re-amortizing the loan when you do it, the borrower could have a very large balance due at the end of the loan term.

Happy: You ask if there's been any further update. I think it is what it is - I've heard of nothing more from the regulators. They appear to be sticking with the "This is a MIRE event IF you add it to the loan balance." Interestingly, I've had 2 phone calls with 2 attorneys with the ABA. Both do not read the law the way the regulators do (either do I) and have commented that this is on their radar to take up with the regulators. However, I don't think that's a shot term solution.

TryingtoComply: I agree - you need to find out what your bank's procedure are. You say you haven't worked for a bank that adds insurance to the loan amount. Since this came to our attention, we've been polling our clients at seminars. Typically, we find the opposite. Most do add it to the loan balance. Informally, I've found about 5% of our clients put the insurance in a suspense account and 95% add it to the loan balance. That may be changing because of the new flood interpretation.

I wrote an article about this in our March newsletter. Here's how I closed out the article:
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Recommendations
Go back to the letter you sent the borrower on April 1st (in our previous example). You told them they needed $100,000 in insurance, but now they really need a higher amount. You never informed the borrower they needed this new higher amount and you didn’t tell them they would now be required to escrow. We recommend stating these potential consequences in the initial force placement letter. You may not be able to quote the exact amount of insurance (loan balance plus new/higher premium), but you can let them know it will be a higher amount. This clearly communicates the two options the borrower has: 1) purchase their own insurance, or 2) allow the bank to force place a higher amount of insurance, increase the borrower’s loan balance and begin to escrow for future flood insurance premiums.

You should also send the borrower a new Notice at this time. If you end up force placing insurance, you trigger a new notice prior to adding it to the loan balance. By sending the Notice with the force placement letter, you’ve met this requirement.

Furthermore, if you charge a fee for force placement, you should inform the borrower of this in the initial notification letter. Last, you should inform the borrower that their failure to purchase adequate insurance would also result in a requirement to escrow for future flood insurance premiums (if applicable).


Alternative Approach
There is another way to get around all this. Instead of adding the premium for the force placed insurance to the loan balance, you could put it in a suspense account. This is not a MIRE event and the issues discussed in this article would be avoided. Seems like the easy answer, right? Not necessarily. There are operational issues as well as legal risks that could be triggered by using suspense accounts. For example, collection during foreclosure, quoting appropriate loan payoffs, etc. This is a management decision and should be discussed thoroughly.

In Closing
We have a new flood insurance interpretation and unfortunately it's not published in ANY regulatory guidance to the banking industry. You need to sit down and put your heads together to think through how you will comply with this requirement and adjust your procedures accordingly. Don’t hesitate to contact us if you need further clarification or training on these or other issues.

Rlcarey, thanks, understood.

David, thanks...I think this will help me explain to the business area what the concerns are and what other options can be used.

Update :

A client of ours attended a California Bankers Association seminar called "a day with the regulators" on 4/12/16. He said the FDIC, FRB, OCC and CFPB were there and they were having a big debate surrounding the newsletter article I wrote on the MIRE event when a bank force places for flood (see my post on 4/4/16). He tells me the CFPB had no opinion, the FRB & OCC said "no, this is not a MIRE event" and the FDIC said "yes it is". How interesting. This is supposed to be a Interagency opinion, so they shouldn't have different positions on it. However, it is consistent with what we are hearing from the field (only the FDIC is making an issue of this).

That's all he told me.

Sorry to keep bringing up this thread...but I have now learned that the same HELOC (non-escrow) in my scenario noted several posts above has also now had the principal balance increased significantly to advance payment for real estate taxes (let's assume this is allowed per the loan/note terms). So now the flood insurance amount is significantly less than the principal balance. FYI the loan is delinquent as well.

So, for an OCC regulated institution, would the advance (by the institution) of the real estate taxes (added to principal balance) on a delinquent loan be considered a triggering event? Any and all opinions would be appreciated.

In discussing this with someone else here, their thought is "no", since it is an advance by the bank, not a true principal balance draw on the line initiated by the borrower (FYI the line is shut so borrower can makes draws). He also likened it to a negative escrow on an escrowed loan saying flood insurance is not required to cover negative escrow balances that the borrower is obligated to pay.

Thanks.

Sorry to keep bringing up this thread...but I have now learned that the same HELOC (non-escrow) in my scenario (noted several posts above) has also now had the principal balance increased significantly to advance payment for real estate taxes (let's assume this is allowed per the loan/note terms). So now the flood insurance amount is significantly less than the principal balance. FYI the loan is delinquent as well.

So, for an OCC regulated institution, would the advance (by the institution) of the real estate taxes (added to principal balance) on a delinquent loan be considered a triggering event? Any and all opinions would be appreciated.

In discussing this with someone else here, their thought is "no", since it is an advance by the bank, not a true principal balance draw on the line initiated by the borrower (FYI the line is shut so borrower can not makes draws). He also likened it to a negative escrow on an escrowed loan saying flood insurance is not required to cover negative escrow balances that the borrower is obligated to pay.

Thanks.

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* My opinion is not necessarily that of my employer.

According to the Interagency Mystery Memo, what you described is an increase. Therefore, all flood requirements are triggered. The argument that the bank did the advancement didn't fly when I wrote a letter to the FDIC to challenge their position on this. If the principal balance has increased, it's an increase for Flood. Sorry.

Thanks David...that's what I was afraid of. I was secretly hoping someone would say the opposite and give some good backup/argument/support for it.

Interagency Mystery Memo...this will be a fight for me to really cite this as an issue in my audit <sigh>.

Actually, I think I am going to support not making this an issue for the audit (based on the ambiguity and David's 4/13/16 update which stated the OCC did not think this type of scenario is an increase), but to pass the info discussed here to the business unit and compliance officer. If it bites me in the you know what later, oh well I will have to take it.

Why would you not force place for the credit limit rather than the current balance on a HELOC??