Flood Insurance – Dangerous Waters Ahead!

If you have spent any time at all in the compliance world, you know one constant; flood insurance will be an area of risk. Flood insurance violations are consistently one of the most common bank compliance violations cited by the regulatory agencies. A strong compliance program includes a significant level of resources dedicated to the administration of the flood loan portfolio. Now, just when you think that you might have a strong level of control over the portfolio, along comes change!

Biggert Waters Changes

The first of these changes comes from the Biggert Waters Flood Insurance Reform Act of 2012. Buildings that are classified as Other Residential are now insurable up to $500,000 rather than the $250,000 maximum that applied previously.

Other residential Buildings are defined as non-condominium residential buildings designed for use for five or more families. Because of this change as of June 1, 2014, apartment buildings and residential/commercial buildings should be insured up to the lessor of:

  • The outstanding principal balance of the loan(s); or
  • The maximum amount of insurance available under the NFIP, which is the lesser of:
  • The maximum limit available for the particular type of structure; or
  • The “insurable value” of the structure

The change is that the maximum amount is now $500,000. The interagency statement that announced this change also pointed out that the new level of insurance is required immediately. Therefore, if you have collateral that is a multifamily dwelling unit that is in a flood zone; the time is now to make sure that you have adequate insurance.   

FDIC Interpretation

We have recently been made aware of an interpretation of mortgages used to secured loans that can be a game changer! The following language is common in mortgage instruments that are being used around the country;

THIS MORTGAGE, INCLUDING THE ASSIGNMENT OF RENTS AND THE SECURITY INTERESTIN THE RENTS AND PERSONAL PROPERTY,  IS GIVEN TO SECURE (A) PAYMENT OF THE INDEBTEDNESS ANO (B) PERFORMANCE OF ANY AND ALL OBLIGATIONS UNDER THE NOTE, THE RELATED DOCUMENTS, AND THIS MORTGAGE. THIS MORTGAGE IS GIVEN AND ACCEPTED ON THE FOLLOWING TERMS:

This language has recently been interpreted to create on the contents of the structure that is being pledged as collateral. If the property is in a flood zone, this means that the borrower will be expected to obtain flood insurance on the contents of the borrower.  The FDIC has held that flood content insurance is required regardless of whether or not the bank filed a UCC-1 financing statement. [1]  In the 12th district, the FDIC examination staff has taken the position that they will not require contents insurance on residential properties.

There have been cases where an institution has been allowed to demonstrate that they had no intention to take the contents as collateral. In these cases,  the requirements were:

  • The appraisal on the property could not mention the contents
  • The loan write up did not mention the contents

The cases when this approach has been allowed are limited. We recommend that for commercial loans with collateral in a flood zone that you;

  • Review the mortgage document to determine whether the language could possible create an inadvertent lien on contents ;
  • Prepare documentation that specifically states your intentions with the contents.  In other words, if you truly do not want to  take the contents as collateral, prepare a document that specifically waives the contents and get the customer to execute it
  • Ensure that all flood insurance is up to date and in an amount that is sufficient,

Contents Insurance Valuation

In the event the bank has taken contents as collateral either intentionally or in the manner described above, we note that the regulators have required that the bank establish the value of the collateral through independent means.

While the direction from the regulators has been somewhat sparse, it is clear that the loan file should have some documentation of the efforts that lending staff made to determine a value of the contents being insured. Among the ways that might be employed to determine value:

  • On site visits
  • Valuation services such as Kelly Blue Book
  • Customers financial statement if CPA prepared
  • Valuation used for loan funding

Just when you thought you had a handle on your flood loan portfolio, change can bite you!

 

[1] At the time of this posting, I was unaware of this interpretation being used by the Federal Reserve , the CFPB or the OCC.