Federal Register: July 21, 2009 (Volume 74, Number 138)
DOCID: fr21jy09-107 FR Doc E9-17129
DEPARTMENT OF THE TREASURY
Veterans Affairs Department
Docket ID: [Docket ID OCC 2009-0014]
NOTICE: Part II
DOCID: fr21jy09-107
DOCUMENT ACTION: Notice and request for comment.
SUBJECT CATEGORY:
FEDERAL RESERVE SYSTEM
DATES: Effective date: September 21, 2009. Comment due date: Comments on the proposed questions and answers must be submitted on or before September 21, 2009.
DOCUMENT SUMMARY:
The OCC, Board, FDIC, OTS, FCA, and NCUA (collectively, the Agencies) are issuing final revisions to the Interagency Questions and Answers Regarding Flood Insurance (Interagency Questions and Answers). The Agencies are also soliciting comments on proposed revisions to the Interagency Questions and Answers. To help financial institutions meet their responsibilities under Federal flood insurance legislation and to increase public understanding of the flood insurance regulation, the Agencies are finalizing new and revised guidance, as well as proposing new and revised guidance that address the most frequently asked questions about flood insurance. The revised Interagency Questions and Answers contain staff guidance for agency personnel, financial institutions, and the public.
SUMMARY:
Treasury Department, Thrift Supervision Office
DOCUMENT BODY 2:
[Docket No. R1311]
FEDERAL DEPOSIT INSURANCE CORPORATION
RIN 3064ZA00
DEPARTMENT OF THE TREASURY
Office of Thrift Supervision
[Docket ID OTS20090005]
FARM CREDIT ADMINISTRATION
RIN 3052AC46
NATIONAL CREDIT UNION ADMINISTRATION
RIN 3133AD41
Loans in Areas Having Special Flood Hazards; Interagency
Questions and Answers Regarding Flood Insurance
SUPPLEMENTAL INFORMATION
Background
The National Flood Insurance Reform Act of 1994 (the Reform Act) (Title V of the Riegle Community Development and Regulatory Improvement Act of 1994) comprehensively revised the two Federal flood insurance statutes, the National Flood Insurance Act of 1968 and the Flood Disaster Protection Act of 1973. The Reform Act required the OCC, Board, FDIC, OTS, and NCUA to revise their flood insurance regulations and required the FCA to promulgate a flood insurance regulation for the first time. The OCC, Board, FDIC, OTS, NCUA, and FCA (collectively, ``the Agencies'') fulfilled these requirements by issuing a joint final rule in the summer of 1996. See 61 FR 45684 (August 29, 1996).
In connection with the 1996 joint rulemaking process, the Agencies
received a number of requests to clarify specific issues covering a
wide spectrum of the proposed rule's provisions. The Agencies addressed
many of these requests in the preamble to the joint final rule. The Agencies concluded, however, that given the
[[Page 35916]]
number, level of detail, and diversity of the requests, guidance
addressing the technical compliance issues would be helpful and
appropriate. Consequently, the Agencies decided to issue guidance to
address these technical issues subsequent to the promulgation of the
final rule (61 FR at 4568586). The Federal Financial Institutions
Examination Council (FFIEC) fulfilled that objective through the
initial release of the Interagency Questions and Answers in 1997 (1997
Interagency Questions and Answers). 62 FR 39523 (July 23, 1997).
In response to issues that had been raised, the Agencies, in coordination with the Federal Emergency Management Agency (FEMA), released for public comment proposed revisions to the 1997 Interagency Questions and Answers. 73 FR 15259 (March 21, 2008) (March 2008 Proposed Interagency Questions and Answers). Among the changes the Agencies proposed were the introduction of new questions and answers in a number of areas, including second lien mortgages, the imposition of civil money penalties, and loan syndications/participations. The Agencies also proposed substantive modifications to questions and answers previously adopted in the 1997 Interagency Questions and Answers pertaining to construction loans and condominiums. Finally, the Agencies proposed to revise and reorganize certain of the existing questions and answers to clarify areas of potential misunderstanding and to provide clearer guidance to users.
The Agencies received and considered comments from 59 public commenters, and are now adopting the Interagency Questions and Answers, comprising 77 questions and answers, revised as appropriate based on comments received. The Agencies made nonsubstantive revisions to certain answers upon further consideration either to more directly respond to the question asked or to provide additional clarity. The Agencies are also proposing five new questions and answers for public comment. These Interagency Questions and Answers supersede the 1997 Interagency Questions and Answers and supplement other guidance or interpretations issued by the Agencies and FEMA.
For ease of reference, the following terms are used throughout this
document: ``Act'' refers to the National Flood Insurance Act of 1968
and the Flood Disaster Protection Act of 1973, as revised by the
National Flood Insurance Reform Act of 1994 (codified at 42 U.S.C. 4001
et seq.). ``Regulation'' refers to each agency's current final flood insurance rule.\1\
\1\ The Agencies' rules are codified at 12 CFR part 22 (OCC), 12
CFR part 208 (Board), 12 CFR part 339 (FDIC), 12 CFR part 572 (OTS), 12 CFR part 614 (FCA), and 12 CFR part 760 (NCUA).
SectionbySection Analysis
Section I. Determining When Certain Loans Are Designated Loans for
Which Flood Insurance Is Required Under the Act and Regulation
The Agencies proposed this new section to address specific circumstances a lender may encounter when deciding whether a loan should be a designated loan for purposes of flood insurance. The proposed new section was intended to replace the previous section I in the 1997 Interagency Questions and Answers entitled ``Definitions'' and to incorporate existing questions from other sections addressing this topic and two new questions.
Proposed question and answer 1 addressed the applicability of the Regulation to loans made in a nonparticipating community. One commenter suggested the Agencies mention that a lender may choose to require private flood insurance per its loan agreement with the borrower, for buildings or mobile homes located outside a community in the National Flood Insurance Program (NFIP). The Agencies agree that lenders have such discretion, but do not believe that the question and answer requires further elaboration. Another commenter suggested the Agencies mention that Government Sponsored Enterprises (GSEs), such as Fannie Mae and Freddie Mac, may not purchase loans made on properties in a Special Flood Hazard Area (SFHA) in communities that do not participate in the NFIP. The Act does require GSEs to have procedures in place to ensure that purchased loans are in compliance with the mandatory purchase requirements. The Agencies do not believe that further elaboration is necessary and adopt the question and answer as proposed.
Proposed question and answer 2 explained that, upon a FEMA map change that results in a building or mobile home securing a loan being removed from an SFHA, a lender is no longer obligated to require mandatory flood insurance. However, the lender may choose to continue to require flood insurance for risk management purposes. The Agencies received one comment from an industry group suggesting the guidance in proposed question and answer 2 be amended to add language encouraging lenders to promptly remove the flood insurance requirement from a loan when the building or mobile home securing the loan is removed from an SFHA by way of a map change. The decision to require flood insurance in these instances is typically made on a casebycase basis, depending on a lender's risk management practices. The Agencies do not believe that a blanket statement encouraging lenders to remove flood insurance in such instances is an appropriate position; therefore, the question and answer is adopted as proposed.
Proposed question and answer 3 addressed whether a lender's purchase of a loan, secured by a mobile home or building located in an SFHA in which flood insurance is available under the Act, from another lender triggers any requirements under the Regulation. The Agencies received several comments opposing the reference to safety and soundness necessitating a due diligence review prior to purchasing the loan. The Agencies note that although lenders are not required to review loans for flood insurance compliance prior to purchase, depending upon the circumstances, safety and soundness considerations may sometimes necessitate such due diligence. As such, the Agencies do not concur with the commenter's opposition and adopt question and answer 3 as proposed.
The Agencies are adopting a new question and answer 4 addressing syndicated and participation loans following question and answer 3, which deals with purchased loans, to emphasize the need for similar treatment of purchased loans and syndicated and participation loans. The new question and answer was initially proposed as question and answer 40 under section VIII. Proposed section VIII on loan syndications and participations and the accompanying question and answer are removed and the remaining sections are renumbered accordingly.
Proposed question and answer 40 explained that, with respect to loan syndications and participations, individual participating lenders are responsible for ensuring compliance with flood insurance requirements. The proposed answer further explained that participating lenders may fulfill this obligation by performing upfront due diligence to ensure that the lead lender or agent has undertaken the necessary activities to make sure that appropriate flood insurance is obtained and has adequate controls to monitor the loan(s) on an ongoing basis.
The Agencies received several comments from financial institutions and industry trade groups opposing the
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differences between the guidance in proposed question and answer 3
regarding the purchase of a loan and the guidance in proposed question
and answer 40. A majority of the commenters argued that loan
participations and syndications should be treated the same as other
loan purchases for purposes of flood insurance. Several of these
commenters suggested that the Agencies' proposed treatment of loan
syndications and participations appeared to be inconsistent with
proposed question and answer 3 pertaining to purchased loans.
In response to these comments, the Agencies are revising the relevant question and answer to reflect that, as with purchased loans, the acquisition by a lender of an interest in a loan either by participation or syndication, after that loan has been made, does not trigger the requirements of the Act and Regulation, such as making a new flood determination or requiring a borrower to purchase flood insurance. Nonetheless, as with purchased loans, depending upon the circumstances, safety and soundness considerations may sometimes necessitate that the lender undertake due diligence to protect itself against the risk of flood or other types of loss.
If a regulated lender is involved in the making of the underlying
loan, but does not purchase a loan participation or syndication after
the loan has been made, the flood requirements of the Act and
Regulation would apply to the lender. The Agencies believe that lenders
who pool or contribute funds that will be advanced simultaneously to a
borrower as a loan secured by improved real estate would all be
considered to have ``made'' the loan under the Act and Regulation. In
such circumstances, each participating lender in a loan participation
or syndication is responsible for compliance with the Act and
Regulation. This does not mean that each participating lender must
separately obtain a flood determination or monitor whether flood
insurance premiums are paid. Rather, it means that each participating
lender subject to Federal flood insurance requirements should perform
upfront due diligence to ensure both that the lead lender or agent has
undertaken the necessary activities to make sure that the borrower
obtains appropriate flood insurance and that the lead lender or agent
has adequate controls to monitor the loan(s) on an ongoing basis for
compliance with the flood insurance requirements. The participating
lender should require as a condition to the loansharing agreement that
the lead lender or agent will provide participating lenders with
sufficient information on an ongoing basis to monitor compliance with
flood insurance requirements. A written representation provided by the
lead lender or syndication agent certifying that the borrower has obtained appropriate flood insurance would be sufficient.
Alternatively, the lead lender or syndication agent could provide
participants and syndication lenders with a copy of the declaration
page or other proof of insurance. The Agencies have incorporated minor
revisions to the question and answer to clarify this guidance.
Proposed question and answer 4 (final question and answer 5) addressed the applicability of the Regulation to loans being restructured because of the borrower's default on the original loan. In light of the many loan modifications being made, the Agencies have revised the question to address loan modifications as well as loans being restructured because of the borrower's default on the original loan. The guidance provided in the answer is applicable to either situation. The Agencies received one comment asking whether capitalization of a loan in the event of a default would constitute an increase in the loan, triggering the requirements of the Regulation. If the capitalization results in an increase in the outstanding principal balance of the loan, then the requirements of the Regulation will apply. Conversely, a loan restructure that does not result in an increase in the amount to the loan (or an extension of the term of the loan) will not trigger the requirements of the Regulation. The Agencies do not believe further elaboration addressing this comment is necessary. The Agencies adopt the question and answer as proposed with the changes made to include loan modifications, as well as restructuring of loans.
Proposed question and answer 5 (final question and answer 6), addressed whether table funded loans are treated as new loan originations. The Agencies did not receive any substantive comments and adopt the question and answer as proposed.
Proposed question and answer 6 (final question and answer 7)
explained that a lender is not required to perform a review of its
existing loan portfolio for purposes of the Act or Regulation; however,
sound risk management practices may lead a lender to conduct periodic
reviews. The Agencies received several comments opposing the reference
to safety and soundness necessitating a due diligence review of a
lender's portfolio. Although lenders are not required to review
existing loan portfolios for flood insurance compliance under the Act
or Regulation, the Agencies believe safety and soundness considerations
may sometimes necessitate such due diligence and therefore adopt the question and answer as proposed.
Section II. Determining the Appropriate Amount of Flood Insurance Required Under the Act and Regulation
The Agencies proposed this section to provide guidance on how lenders should determine the appropriate amount of flood insurance to require the borrower to purchase. The Agencies received numerous comments on this proposed section. As a result of these comments, the Agencies have made both significant revisions to proposed questions and answers as well as proposed new questions and answers submitted for comment to provide greater clarity on this important area. The proposed new questions and answers are addressed in the SUPPLEMENTARY INFORMATION immediately following the Redesignation Table.
Proposed question and answer 7 (final question and answer 8) addressed what is meant by the ``maximum limit of coverage available for the particular type of property under the Act.'' The first part of the question and answer discussed the maximum caps on insurance available under the Act. The Agencies did not receive any substantive comments on this part of the question and answer and adopt it as proposed in final question and answer 8. The second part of the question and answer discussed the maximum limits on the coverage in the context of the regulation that provides that ``flood insurance coverage under the Act is limited to the overall value of the property securing the designated loan minus the value of the land on which the property is located,'' commonly referred to as insurable value. In response to the numerous comments received on the insurable value part of the proposed question and answer, the Agencies are proposing new questions and answers 9 and 10 for public comment. The Agencies otherwise adopt question and answer 7 (final question and answer 8) as proposed.
Proposed questions and answers 8 and 9 (final questions and answers
11 and 12 respectively) more fully defined the terms ``residential
building'' and ``nonresidential building.'' One commenter suggested
that the Agencies define residential and nonresidential buildings based
on the percentage of the building used in a certain way to account for mixed use buildings.
[[Page 35918]]
Proposed question and answer 8 (final question and answer 11) provides
that a residential building may have incidental nonresidential use as
long as such incidental use is limited to less than 25 percent of the
square footage of the building. A mixed use residential building where
greater than 25 percent of the square footage of the building is
devoted to incidental nonresidential use will be considered a
nonresidential building. Proposed question and answer 9 (final question
and answer 12) provides that a mixed use nonresidential building with
less than 75 percent of the square footage of the building used for
residential purposes will still be considered nonresidential. The
commenter also asked whether a farm house is residential or
nonresidential. If the farmhouse is used as a dwelling, then it will be considered residential.
Another commenter asked whether a lender is obligated to determine the amount of nonresidential use in a residential building and whether there are any record maintenance requirements. Typically, whether a building is nonresidential or residential is of most importance in determining the maximum limits of a general property form NFIP policy. A residential building covered under a general property form will have a maximum coverage limit of $250,000, while a nonresidential building covered under the same type of policy will have a maximum coverage limit of $500,000. Therefore, the lender needs to know whether the building is considered residential or nonresidential when it determines the amount of flood insurance coverage to require. Finally, a commenter asked whether a designated loan, secured by a residential building and a detached nonresidential building, such as a garage, would require separate nonresidential coverage on the detached nonresidential building. If the residential building is a onetofour family dwelling that is covered by a dwelling form NFIP policy, that policy will cover a detached garage at the same location as the dwelling, up to 10 percent of the limit of liability on the dwelling, so long as the detached garage is not used or held for use as a residence, a business or for farming purposes. In other cases, the lender must require the borrower to obtain coverage for each building securing the loan. The Agencies believe no further clarification is necessary and adopt the questions and answers as proposed.
Proposed question and answer 10 (final question and answer 13) illustrated how to apply the ``maximum limit of coverage available for the particular type of building under the Act.'' The majority of the comments received are addressed in the discussion below pertaining to new proposed questions and answers 9 and 10. The Agencies adopt question and answer 10 (final question and answer 13) as proposed.
Proposed questions and answers 11 and 12 (final questions and answers 14 and 15 respectively) were originally adopted in the 1997 Interagency Questions and Answers. The changes proposed by the Agencies in March 2008 were designed to provide greater clarity with no intended change in substance and meaning.
Four commenters addressed proposed question and answer 11, which dealt with flood insurance requirements where a designated loan is secured by more than one building. One commenter supported the proposed question and answer, but suggested that where the collateral is worthless and would not be replaced, lenders should not have to require the borrower to obtain flood insurance. The Agencies are proposing questions 9 and 10 for public comment to address the issue of determining insurable value for certain nonresidential buildings that include certain lowvalue nonresidential buildings. Another commenter asked whether a lender would be liable if the lender allocates the overall required flood insurance over several buildings and one building suffers flood damage and is underinsured. In such a circumstance, the lender would have complied with the Act and the Regulation. Of course, the lender has the option to require the borrower to obtain more flood insurance coverage than the minimum amount required if the lender believes there is a high risk of flood loss (see final question and answer 16). Two commenters suggested that the Agencies should explain how the lender should allocate the required amount of coverage for multiple buildings of different values that secure a single loan. One of these commenters suggested that allocation could be made by a square footage method. The Agencies agree that this is one reasonable method that could be used. Other methods may include a valuebased method, splitting the total coverage pro rata based on replacement cost value, or a functionality method, requiring a higher proportional share of coverage to those buildings that are most important to the ongoing operation of the borrower. The apportionment of the required coverage in any particular situation should reflect consideration by both the lender and borrower of their needs and risks. The Agencies believe no further clarification is necessary but revised the answer to address the technical issue that singlefamily dwellings are considered residential if less than 50 percent of the square footage is used for an incidental nonresidential purpose.
Twenty commenters addressed proposed question and answer 12, which addressed the flood insurance requirements where the insurable value of a building securing a designated loan is less than the outstanding principal balance of the loan. The comments generally raised concerns about the lack of a definition of ``insurable value,'' discussed above in connection with proposed question and answer 7. As previously mentioned, the Agencies are proposing new questions and answers 9 and 10 for public comment to address the issue of insurable value. One commenter also asked whether the Agencies will require a lender to review flood insurance policies annually at renewal and increase coverage as the replacement cost value increases. The Agencies typically will not require such a review. However, if at any time during the term of the loan, the lender determines that flood insurance coverage is insufficient, the lender must comply with the force placement procedures in the Regulation. The Agencies believe no further clarification is necessary and adopt the question and answer as proposed.
Proposed question and answer 13 (final question and answer 16)
clarified that a lender can require more flood insurance than the
minimum required by the Regulation. The Regulation requires a minimum
amount of flood insurance; however, lenders may require more coverage,
if appropriate. Two commenters asked the Agencies to specify that
lenders may never require coverage that exceeds the insurable value of
a building. As stated in the question and answer, lenders should avoid
creating situations where a building is overinsured. Further, the
Agencies state in final question and answer 8 that ``an NFIP policy
will not cover an amount exceeding the insurable value of the
structure.'' Another commenter asked what penalties, if any, would be
imposed on a lender that requires over insurance. The Agencies note
that there are no penalties for over insurance under the Act and
Regulation. However, there may be penalties for overinsurance under
applicable State law. Finally, a commenter suggested that flood
insurance should not be required where the collateral building is
worthless and would not be replaced. The Agencies are proposing
questions 9 and 10 for public comment to address the issue of [[Page 35919]]
determining insurable value for certain nonresidential buildings that
include certain low value nonresidential buildings. Other than a
nonsubstantive revision to provide additional clarity, the Agencies adopt the question and answer as proposed.
Proposed question and answer 14 (final question and answer 17)
addressed lender considerations regarding the amount of the deductible
on a flood insurance policy purchased by a borrower. Generally, the
proposed guidance advised a lender to determine the reasonableness of
the deductible on a casebycase basis, taking into account the risk
that such a deductible would pose to the borrower and lender. The
Agencies received nine comments addressing proposed question and answer
14. Four commenters suggested that borrowers with lowvalue buildings
should be able to choose a deductible that exceeds the value of the
building with a result that flood insurance would not be required. The
Act and Regulation require flood insurance on all buildings at the
lesser of the outstanding principal balance of the loan or the maximum
amount available under the Act. A high deductible does not provide a de
facto waiver of this requirement. One commenter suggested that the
Agencies' position regarding not allowing a de facto waiver of the
flood insurance requirement on lowvalue buildings based on the
deductible amount contradicts the NFIP's policy of following the
standard practice in the financial industry of allowing lenders to
dictate the amount of the deductible according to the authority found
in the loan agreement. Other commenters stated that a lender should not
be required to determine deductibles on a casebycase basis but rather
through adoption of credit guidelines that apply acrosstheboard to
all loans. In general, the Agencies agree that lenders may adopt credit
guidelines that apply to most loans. However, such guidelines cannot
work to waive the flood insurance requirements of the Act and
Regulation. Finally, one commenter suggested that the Agencies should
mention that the GSEs may have maximum allowable deductibles. The
Agencies decline to revise the question and answer based on this
comment because information about GSE requirements is outside the scope
of this guidance. The Agencies adopt the question and answer as proposed.
Section III. Exemptions From the Mandatory Flood Insurance Requirements
This section contains only one question and answer, which describes
the statutory exemptions from the mandatory flood insurance
requirements. Proposed question and answer 15 (final question and
answer 18) was revised from the 1997 Interagency Questions and Answers
to provide greater clarity, with no intended change in substance or
meaning. The Agencies did not receive any substantive comments and adopt the question and answer as proposed.
Section IV. Flood Insurance Requirements for Construction Loans
The Agencies proposed this new section to clarify the requirements regarding the mandatory purchase of flood insurance for construction loans to erect buildings that will be located in an SFHA in light of concerns raised by some regulated lenders regarding borrowers' difficulties in obtaining flood insurance for construction loans at the time of loan origination. The Agencies received a number of comments on the proposed questions and answers concerning construction loans. Several commenters asked for guidance in determining the appropriate amount of flood insurance for a loan secured by a building during the course of construction. This guidance is provided in the discussion of the proposed new questions and answers 9 and 10 for public comment that addresses insurable value.
Proposed question and answer 16 (final question and answer 19) revises existing guidance to limit its scope and explained that a loan secured only by land located in an SFHA is not a designated loan that would require flood insurance coverage. The Agencies received one comment addressing this question and answer from a financial institution commenter that asked whether a loan secured by developed land without a structure on it, which, during the course of the loan, will not have any structure on it, necessitates a flood determination as it is considered residential real estate. The Agencies believe that the commenter has raised a valid point and have revised the proposed question and answer by removing the reference to ``raw'' land. The revised question and answer discusses loans secured only by ``land.'' Since a designated loan is a loan secured by a building or mobile home that is located or to be located in an SFHA, any loan secured only by land that is located in an SFHA is not a designated loan since it is not secured by a building or mobile home. In the case of this particular comment, the loan is not secured by either a building or mobile home; therefore, it is not a designated loan. The Agencies adopt the question and answer as proposed with the modification described above.
Proposed question and answer 17 (final question and answer 20) addressed whether a loan secured or to be secured by a building in the course of construction that is located or to be located in an SFHA in which flood insurance is available under the Act is a designated loan. The proposed answer provided that a lender must make a flood determination prior to loan origination for a construction loan. If the flood determination shows that the building securing the loan will be located in an SFHA, the lender must provide notice to the borrower, and must comply with the mandatory purchase requirements.
One financial institution commenter asked whether the lender/ servicer must provide continuing flood insurance coverage where a structure in an SFHA covered by flood insurance is considered a total loss/demolished and only the land remains and the structure is to be rebuilt. The Agencies believe that if there is remaining insurable value in the building, flood insurance should continue to be maintained. If the building has no remaining insurable value, then flood insurance is not required. Under these circumstances, the total loss situation is akin to a loan secured only by land located in an SFHA, which is addressed in final question and answer 19 discussed above, and is not a designated loan that would require flood insurance coverage. If the building is a total loss/demolished and has no remaining insurable value, but a new structure is going to be built in its place, it should be treated like a new construction loan as discussed below in proposed question and answer 19 (final question and answer 22). To the extent that any new structure that will be built is, or will be, located in an SFHA, then the lender must provide notice to the borrower, and must comply with the mandatory purchase requirements as outlined in proposed questions and answers 18 and 19 (final questions and answers 21 and 22). The lender can, of course, elect to maintain the flood insurance that had previously been in place on the prior demolished structure to avoid having to monitor the
reconstruction as discussed below.
Another financial institution commenter asked whether a building in
the course of construction that will be a condominium building when
finished can be insured under a Residential Building Condominium
Association Policy (RCBAP) during the construction period. The RCBAP
can be sold to a condominium association only. Therefore, unless the building is under
[[Page 35920]]
the condominium form of ownership with a condominium association formed
at the time of construction, no RCBAP can be written. If there is no
condominium association, the lender should require the builder/
developer to obtain flood insurance under the NFIP General Property
form or private equivalent. If the building will be a residential
condominium, then the lender must require flood insurance to meet the
statutory requirements, up to the $250,000 flood insurance limit under the NFIP for an ``other residential'' building.
Finally, a loan servicer commenter asked the Agencies to clarify when flood insurance coverage takes effect when a lender opts to require flood insurance at origination of a construction loan. This comment is addressed in final question and answer 21. The Agencies adopt the final question and answer 20 as proposed.
Proposed question and answer 18 (final question and answer 21) explained that, generally, a building in the course of construction is eligible for coverage under an NFIP policy, and that coverage may be purchased prior to the start of construction. One financial institution commenter asked whether the definition of a ``building'' in the proposed question and answer has the same meaning as FEMA's definition in its Mandatory Purchase of Flood Insurance Guidelines.\2\ The Agencies believe that the definitions of ``building,'' as well as the definition of ``building in the course of construction,'' used by FEMA are fully consistent with the definition in the Regulation. The Agencies adopt the question and answer as proposed with only minor clarifications to the citation of FEMA's Flood Insurance Manual. \2\ FEMA, Mandatory Purchase of Flood Insurance Guidelines (September 2007) at GLS12. FEMA has made this booklet available electronically at http://www.fema.gov/library/viewRecord.do?id=2954. Hard copies are available by calling FEMA's Publication Warehouse at (800) 4802520.
Proposed question and answer 19 (final question and answer 22), addressed when flood insurance must be purchased for buildings under the course of construction. The answer provided lenders with flexibility regarding the timing of the mandatory purchase requirement for construction loans in response to concerns raised by lenders that borrowers have encountered difficulties in obtaining flood insurance for construction loans at the time of origination. Specifically, the Agencies proposed to permit lenders to allow borrowers to defer the purchase of flood insurance until a foundation slab has been poured and/or an elevation certificate has been issued. Lenders choosing this option, however, must require the borrower to have flood insurance in place before funds are disbursed to pay for building construction on the property securing the loan (except as necessary to pour the slab or perform preliminary site work). A lender who elects this approach and does not require flood insurance at loan origination must have adequate internal controls in place to ensure compliance. Moreover, lenders must still ensure that the required flood determination is completed at origination and that notice is given to borrowers if the property is located in an SFHA.
A financial institution and a financial institution membership organization commented that requiring lenders to have monitoring procedures in place to ensure that the borrower obtains flood insurance as soon as the foundation is complete or the elevation certificate issued is too burdensome. The Agencies note that if a lender determines that this option is too burdensome they may continue the practice of requiring flood insurance at origination. The monitoring procedures are only necessary in the event that lenders choose to require flood insurance at the time the foundation pad is completed and/or the elevation certificate is obtained. Therefore, the Agencies believe that no revision to the proposed question and answer is necessary.
Several commenters, including four financial institutions and a law firm that advises financial institutions, asked the Agencies for clarification regarding the ``timing'' options available for determining whether flood insurance is required for buildings in the course of construction, that is, the foundation alone and/or the issuance of an elevation certificate. Either the pouring of the foundation slab or the issuance of an elevation certificate provides sufficient information for a lender to determine whether the collateral building is located in an SFHA for which flood insurance is required. The Agencies believe that no further elaboration is necessary to address this issue in the question and answer.
Finally, one individual commenter indicated that it is unclear
whether an NFIP policy can be purchased before two walls and a roof
have been erected. FEMA guidance provides that buildings yet to be
walled and roofed are generally eligible for coverage after an
elevation certificate is obtained or a foundation slab is poured,
except where either construction is halted for more than 90 days or if
the lowest floor used for rating purposes is below Base Flood Elevation
(BFE). If the lowest floor is under BFE, then the building must be
walled and roofed before flood insurance coverage is available.\3\ The
Agencies believe that the commenter has raised a valid point and have
clarified the proposed question and answer accordingly. The Agencies otherwise adopt the question and answer as proposed.
\3\ FEMA, Mandatory Purchase of Flood Insurance Guidelines, at 3031.
The Agencies also proposed new question and answer 20 (final
question and answer 23) to clarify whether the 30day waiting period
for an NFIP policy applies when the purchase of flood insurance is
deferred in connection with a construction loan since there has been
confusion among lenders on this issue in the past. Per guidance from
FEMA, the answer provided that the 30day waiting period would not
apply in such cases.\4\ The NFIP would rely on the insurance agent's
representation that the exception applies unless a loss has occurred
during the first 30 days of the policy period. The Agencies did not
receive any substantive comments and adopt the question and answer as proposed.
\4\ FEMA, Mandatory Purchase of Flood Insurance Guidelines, at 30.
Section V. Flood Insurance Requirements for Nonresidential Buildings
The Agencies proposed this new section to address the flood insurance requirements for agricultural buildings that are taken as security for a loan, but that have limited utility to a farming operation, and loans secured by multiple buildings where some are located in an SFHA and others are not. Six commenters suggested that this section should be broadened to include all nonresidential buildings, including multiple nonresidential buildings over a large geographic area, not just those related to agriculture. The Agencies concur and have changed the title to section V to read ``Flood Insurance Requirements for Nonresidential Buildings'' and modified proposed questions and answers 21 and 22 (final question and answers 24 and 25) accordingly. Several commenters asked for guidance in determining the appropriate amount of flood insurance for loans secured by a nonresidential building, particularly for nonresidential buildings of low to no value. The Agencies are proposing questions 9 and 10 for public comment to address the issue of determining insurable value for certain nonresidential buildings that include certain low value nonresidential buildings.
[[Page 35921]]
Proposed question and answer 21 (final question and answer 24) explained that all buildings taken as security for a loan and located in an SFHA require flood insurance. The question and answer also explained that lenders may consider ``carving out'' a building from the security for a loan; however, it may be inappropriate for credit risk management reasons to do so. One commenter questioned whether lenders need to require flood insurance when the collateral is only a building (in the commenter's case, a grain bin) and not the real property where the building is located. Further, the commenter stated that they only use a UCC fixture filing to secure the building. Flood insurance is required for any building taken as collateral when that building is located in an SFHA in a participating community. This requirement is not predicated on whether the underlying real estate is also included in the loan collateral or the method used by the lender to secure its collateral. FEMA answered the question of whether a grain bin is a building by specifically including a grain bin in its definition of a nonresidential building, therefore flood insurance is required.\5\ \5\ FEMA, Flood Insurance Manual, GR 2.
A commenter stated that if the value of a building is worthless or nearly zero then flood insurance should not be required. The Act requires all buildings located in an SFHA and in a participating community to have flood insurance with only two exemptionswhen a building is Stateowned and covered by selfinsurance satisfactory to the Director of FEMA; and when the original loan balance is $5,000 or less and the original repayment term is one year or less. All other buildings are required to be covered by flood insurance. The Agencies are proposing questions 9 and 10 for public comment to address the issue of determining insurable value for certain nonresidential buildings that include certain low value nonresidential buildings.
Another commenter suggested that in determining ``insurable
value,'' institutions should be permitted to place good faith reliance on insurance agents who are better equipped to make these
determinations. Federally regulated lenders may solicit assistance when
evaluating insurable value and this assistance could include an
insurance professional. However, it is ultimately the lender's
responsibility to determine the insurable value of a building and, as
such, it must concur with the determination. The same commenter also
asked the Agencies to explain the rationale for treating hazard
insurance and flood insurance differently. The reason for treating
flood insurance and hazard insurance differently is that flood
insurance includes coverage for the repair or replacement cost of the
foundation and supporting structures whereas hazard insurance typically
does not include coverage of the foundation. Therefore, the calculation
of insurable value for flood insurance includes these repair or
replacement costs while the calculation of insurable value for hazard insurance does not.
Lastly, a commenter suggested that the Agencies include additional questions and answers about other problems that arise between lenders and insurance companies, such as insurance companies requiring higher amounts of coverage than the appraised value of a structure of minimal value. The amount of flood insurance required by the Act is the lesser of the outstanding principal balance of the loan, the maximum allowed under the Act, or the insurable value. The appraised market value of the structure is not a factor in determining the amount of required insurance. The Agencies adopt question and answer 21 with the changes made to include all nonresidential buildings and not just agricultural buildings.
Proposed question and answer 22 (final question and answer 25) addressed the flood insurance requirements for multiple agricultural buildings located throughout a large geographic area, some in an SFHA and some not. One commenter suggested that the Agencies modify the first sentence in the proposed answer to refer to ``improved property'' rather than ``property.'' The Agencies concur with this recommendation and have inserted ``improved real estate'' in the place of the term ``property'' throughout the answer. The term ``improved real estate,'' instead of the suggested ``improved property,'' was added because it is the term used in the Act.
A commenter asked the Agencies to address the situation where an
insurance company requires flood insurance on all buildings on the
property, not just those inside an SFHA and another commenter asked the
Agencies to mention that a lender can require flood insurance on
buildings not located in an SFHA. The Act does not prohibit a lender
from requiring more flood insurance than the minimum required by the
Act; a lender may have legitimate business reasons for requiring more
flood insurance than that required by the Act and neither the Act nor
the Regulation prohibits this additional flood insurance. Finally, a
commenter suggested that the Agencies modify the second to last
sentence in the answer to refer to ``improved property securing the
loan'' rather than ``designated loan.'' The Agencies have deleted this
sentence entirely as it is not needed to answer the question. The
Agencies adopt the question and answer with the modifications discussed above.
Section VI. Flood Insurance Requirements for Residential Condominiums
The Agencies proposed this new section to address flood insurance requirements for residential condominiums. The proposed section contained two previously existing questions and answers, which were modified and expanded, and five new questions and answers. The Agencies received numerous comments addressing this section.
A number of commenters addressed the 2007 FEMA requirement that insurance companies providing a Residential Building Association Policy (RCBAP) include the replacement cost value of the condominium building and the number of units in the building on the declaration page.\6\ Two commenters suggested that the Agencies should enforce this requirement over all insurance companies. The Agencies strongly support this FEMA requirement; however, the Agencies may only enforce the requirement against those entities over which the Agencies have jurisdiction. \6\ FEMA Memorandum for Write Your Own (WYO) Principal Coordinators and NFIP Servicing Agent (Apr. 18, 2004) (subject: Oct. 1, 2007 Program changes).
Proposed question and answer 23 (final question and answer 26) explained that residential condominiums were subject to the statutory and regulatory requirements for flood insurance. The Agencies received only one comment addressing this question and answer, which was in agreement with the guidance. The Agencies adopt the question and answer as proposed.
One commenter suggested that an RCBAP should be described in a separate question and answer in this section. Although the RCBAP was described within the proposed questions and answers, the Agencies have compiled the information from proposed questions and answers 24 and 25 into new question and answer 27 to specifically describe an RCBAP, and renumbered the remaining questions and answers accordingly.
Proposed question and answer 24 (final question and answer 28) [[Page 35922]]
discussed the amount of flood insurance that a lender must require with
respect to residential condominium units to comply with the mandatory
purchase requirements under the Act and the Regulation. The Agencies
received a number of comments addressing various aspects of this question and answer.
Several commenters suggested that lenders should be able to rely on the replacement cost value and number of units provided on the declaration page of the RCBAP in determining the insurable value of a condominium unit. The Agencies generally agree that a lender may rely on the replacement cost value and number of units provided on the declaration page unless it has reason to believe that such amounts conflict with other available information. If there is a conflict, the lender should notify the borrower of the facts that cause the lender to believe there is a conflict. If the lender believes that the borrower is underinsured, it should require the purchase of a Dwelling Policy for supplemental coverage. The Agencies have modified the question and answer accordingly.
Several commenters asked about other types of valuation information that may be appropriate to use in determining the insurable value of a condominium unit when the insurance provider does not include the replacement cost value and number of units on the RCBAP's declaration page. While the Agencies believe that the question and answer does not require further elaboration on this point, the Agencies note that consistent with safe and sound lending practices, lenders should maintain information about the value of their collateral. Even if the insurance provider does not include the replacement cost value of the condominium building and the total number of units on the declaration page, lenders typically have other sources of valuation information, including costapproach appraisals, automated valuation systems, and tax assessments. Further, many lenders' policies and procedures include obtaining specific documentation related to condominium collateral that may provide information about the condominium's insurable value, including copies of condominium master insurance policies or the declaration pages of such policies. The Agencies generally will not criticize a lender that, in good faith, has used a reasonable method to determine the insurable value.
Several commenters agreed that RCBAP coverage written at replacement cost value, assuming that value is less than the outstanding principal amount of the loan or the maximum available under the Act, is the appropriate insurable value for a condominium building and that an RCBAP with that coverage would meet the mandatory purchase requirement for an individual unit borrower. The 1997 Interagency Questions and Answers stated that RCBAP coverage of 80 percent of replacement cost value was sufficient to meet the mandatory purchase requirement. Because of this change in policy, commenters urged the Agencies to ensure that the new guidance will apply only prospectively. Consistent with the stated intention in the March 2008 Proposed Interagency Questions and Answers, the Agencies intend that this guidance will apply to any loan that is made, increased, extended, or renewed on or after the effective date of these Interagency Questions and Answers.
The Agencies had previously indicated in the SUPPLEMENTARY INFORMATION to the March 2008 Proposed Interagency Questions and Answers that the new guidance would apply to a loan made prior to the effective date of this guidance, but only as of the first flood insurance policy renewal following the effective date of the guidance. Three commenters asked the Agencies to reconsider this position. The commenters asserted that lenders making loans secured by individual condominium units generally do not receive RCBAP renewal notifications from the insurance providers; therefore, the lender may not be in a position to make a determination at the first RCBAP renewal period following the effective date of this guidance.
Lenders are required to ensure that designated loans are covered by flood insurance for their term. However, the Agencies recognize that lenders made loans and required coverage amounts in reliance on the previous guidance. Therefore, the Agencies have agreed that the revised guidance will not apply to any loan made prior to the effective date of this guidance unless a trigger event occurs in connection with the loan (that is, the loan is refinanced, extended, increased, or renewed). Because the Agencies provided supervisory guidance that stated that an RCBAP with coverage at 80 percent of replacement cost value was sufficient, any loan for a condominium unit relying on an RCBAP with coverage that complied with that guidance was in compliance at the time it was made. Absent a new trigger event, the Agencies, therefore, will not require lenders to ensure that RCBAP coverage is increased to 100 percent on previously compliant loans made prior to the effective date of this new guidance. The Agencies have revised the proposed question and answer accordingly. The Agencies anticipate that the universe of loans affected by this policy will be relatively small and diminishing due to refinancing and other loan prepayments that typically occur in the first five years of a home mortgage.
Proposed question and answer 25 (final question and answer 29) addressed what a lender that makes a loan on an individual condominium unit must do if there is no RCBAP coverage. Three commenters addressed this question and answer. One commenter suggested that, in the example, the Agencies should clarify that the amount of insurance required is the ``minimum amount'' because that value ($175,000) is based on the principal amount of the loan, which is less than either the insurable value of the unit ($200,000) or the maximum amount available in a dwelling policy ($250,000). In response to this comment, the Agencies have added the qualifier ``at least'' before the amount of $175,000 to clarify that $175,000 is the minimum amount of insurance that must be required. As in other situations, a lender may require additional coverage.
Another commenter asked whether a unit owner's dwelling policy will
respond at all if there is no RCBAP on the condominium building.
Although this is a general insurance question that is outside the
Agencies' purview, FEMA guidance provides that, when there is no RCBAP
coverage on the condominium building, the unit owner's dwelling policy
will respond to losses to improvements owned by the insured and to
assessments charged by the condominium association, up to the building
coverage limits of the dwelling policy purchased.\7\ Finally, one other
commenter suggested that, when a condominium association refuses to
purchase an RCBAP, the lender should refuse to make a loan to a unit
owner because the unit owner's dwelling policy is not adequate to
protect the lender. The Agencies agree that there is risk to the lender
in accepting a dwelling policy as protection for the collateral.
However, this is a risk that the lender must weigh. Such policy,
however, does fulfill the mandatory purchase requirement. The Agencies
have amended the proposed question and answer to include additional
discussion on dwelling policies in response to these comments. The [[Page 35923]]
Agencies otherwise adopt the question and answer as proposed.
\7\ See FEMA, Mandatory Purchase of Flood Insurance Guidelines
at 4849; FEMA Flood Insurance Manual at p. POL 8 (FEMA's Flood Insurance Manual is updated every six months).
Proposed question and answer 26 (final question and answer 30) discussed what a lender must do if the condominium association's RCBAP coverage is insufficient to meet the mandatory purchase requirements for a loan secured by an individual residential condominium unit. Several commenters suggested changes to FEMA's flood insurance policies. It is beyond the Agencies' jurisdiction to address these suggestions, which are within the purview of FEMA. Interested parties should appropriately consult with FEMA concerning the actual operation of flood insurance policies.
Several other commenters noted that the purchase of a unit owner's dwelling policy may not provide adequate coverage to the unit owner or the lender as a supplement to an RCBAP providing insufficient coverage to meet the mandatory purchase requirement. As noted in the proposed question and answer, a dwelling policy may contain claim limitations; therefore, it is incumbent upon a lender to understand these limitations.
Several commenters also suggested that the Agencies should not put forth guidance encouraging lenders to apprise borrowers that there is risk involved when flood coverage is maintained under a unit owner dwelling policy along with an RCBAP that does not provide replacement cost coverage. The Agencies believe that although insurance professionals are in the best position to adequately explain the implications of such coverage, lenders should still be encouraged to alert their borrowers to the risk. FEMA's brochure, National Flood Insurance Program: Condominium Coverage, may provide some helpful information for borrowers. The Agencies adopt the question and answer as proposed.
Proposed question and answer 27 (final question and answer 31) discussed what a lender must do when it determines that a loan secured by a residential condominium unit is in a complex with a lapsed RCBAP. One commenter requested that the Agencies provide more guidance on the steps a lender should take to determine if there is a lapse in existing RCBAP coverage. As mentioned above, the Agencies are aware that, generally, a lender that is the mortgagee of a unit owner's loan would not receive notice that the condominium association's RCBAP has expired. However, if a trigger event occurs (that is, the lender makes, increases, extends, or renews a loan to the borrower secured by the unit) or if the lender otherwise makes a determination that the RCBAP has expired, then the lender will be required to follow the procedure outlined in final question and answer 28 and discussed above. The Agencies adopt the question and answer as proposed.
Proposed question and answer 28 (final question and answer 32) provided examples of how the coinsurance penalty applies when an RCBAP is purchased at less than 80 percent of replacement cost value, unless the amount of coverage meets the maximum coverage of $250,000 per unit. Two commenters asked about the purpose of this question and answer. The Agencies intended this question and answer to provide information on the topic to lenders. The Agencies adopt the question and answer as proposed.
Proposed question and answer 29 (final question and answer 33)
addressed the major factors that are involved with coverage limitations
of the individual unit owner's dwelling policy with respect to the
condominium association's RCBAP coverage. One commenter asked the
purpose of this question and answer and further asserted that lenders
should not be required to explain to borrowers about the limitations in
coverage. The Agencies intended this question and answer to be
informative in nature and agree that insurance professionals are in a
better position to explain policy limitations to their policyholders. The Agencies adopt the question and answer as proposed.
Section VII. Flood Insurance Requirements for Home Equity Loans, Lines
of Credit, Subordinate Liens, and Other Security Interests in Collateral Located in an SFHA
Proposed Section VII addressed flood insurance requirements for home equity loans, lines of credit, subordinate liens, and other security interests in collateral located in an SFHA. The proposed questions and answers primarily proposed only minor wording changes or clarifications to questions and answers in the 1997 Interagency Questions and Answers without any change in the substance or meaning. Several commenters addressed questions and answers in this section.
Proposed question and answer 30 (final question and answer 34), addressed when a home equity loan is considered a designated loan that requires flood insurance. The Agencies did not receive any substantive comments and adopt the question and answer as proposed.
Proposed question and answer 31 (final question and answer 35), addressed when a draw against an approved line of credit secured by property located in an SFHA requires flood insurance. Nine commenters questioned the statement that a designated loan requires a flood determination when application is made for that loan. The commenters noted that under the Act and Regulation, a lender or its servicer is responsible for performing a flood determination upon the making, increase, extension, or renewal of a loan, and not when a loan application is submitted. They further noted that applications are often withdrawn and that lenders usually have a flood determination performed when they are reasonably certain that one of the previously listed ``trigger'' events (e.g., the making or increasing) will occur. The commenters requested that this point be clarified. The Agencies agree with the commenters and are deleting the statement that a designated loan requires a flood determination when application is made for that loan. The Agencies otherwise adopt the question and answer as proposed.
Proposed question and answer 32 (final question and answer 36) addressed how much flood insurance is required when a lender makes a second mortgage secured by property located in an SFHA. Six commenters argued that a junior lienholder should not have to take senior liens into account when determining the required amount of flood insurance coverage. They asserted that the current requirement causes substantial cost and delay, resulting in an undue burden due to the need for either the junior lienholder or its servicer to engage in an expensive, time consuming search for prior liens. One commenter contended that the question and answer should state that the amount of coverage for a junior lien would be 100 percent of the insurable value of the property. Alternatively, the same commenter suggested multiple flood insurance policies on buildings with multiple liens as a means to address the problem. On the other hand, one commenter believed that the question and answer should remind lenders to add secondary loans to any existing flood insurance policy's mortgagee clause. Three commenters requested more guidance on how and when a lienholder should determine the value of any other liens on improved collateral property. One of these mentioned closing or upon renewal of a loan as two possible dates for such activity.
The Agencies believe that, given the provisions of an NFIP policy,
a lender cannot comply with Federal flood insurance requirements when it makes,
[[Page 35924]]
increases, extends, or renews a loan by requiring the borrower to
obtain NFIP flood insurance solely in the amount of the outstanding
principal balance of the lender's junior lien without regard to the
flood insurance coverage on any liens senior to that of the lender. As
illustrated in the examples in the question and answer, a junior
lienholder's failure to take such a step can leave that lienholder
partially or even fully unprotected by the borrower's NFIP policy in the event of a flood loss.
The final question and answer provides that a junior lienholder should work with the borrower, senior lienholder, or both these parties, to determine how much flood insurance is needed to adequately cover the improved real estate collateral to the lesser of the total of the outstanding principal balances on the junior loan and any senior loans, the maximum available under the Act, or the insurable value of the structure. The junior lienholder should also ensure that the borrower adds the junior lienholder's name as mortgagee/loss payee to an existing flood insurance policy.
The final question and answer also provides that a junior lienholder should obtain the borrower's consent in the loan agreement or otherwise for the junior lienholder to obtain information on balance and existing flood insurance coverage on senior lien loans from the senior lienholder. Commenters also contended that privacy concerns make it difficult for junior lienholders to obtain information from servicers or lenders about loan balances and existing flood insurance coverage. However, the Agencies have determined that the privacy provisions of the GrammLeachBliley Act, as implemented in the Agencies' regulations, do not prohibit sharing of the loan and flood insurance information between two lenders with liens on the same property, even without the borrower's consent.
One commenter noted that it is sometimes difficult to obtain information about the outstanding principal balance of other liens once a loan has been closed, such as at loan renewal, and asked what steps might be taken in that regard. The final question and answer states that junior lienholders have the option of obtaining a borrower's credit report to establish the outstanding balances of senior liens on property to aid in determining how much flood insurance is necessary upon increasing, extending or renewing a junior lien.
In the limited situation where a junior lienholder or its servicer is unable to obtain the necessary information about the amount of flood insurance in place on the outstanding balance of a senior lien (for example, in the context of a loan renewal), the final question and answer provides that the junior lienholder may presume that the amount of insurance coverage relating to the senior lien in place at the time the junior lien was first established (provided that the amount of flood insurance coverage relating to the senior lien was adequate at the time) continues to be sufficient.
The Agencies have revised the proposed question and answer to respond to these comments. The question and answer also provides examples illustrating the application of these methods of dealing with adequate flood insurance coverage for junior and senior liens. Specifically, the examples illustrate how a junior lienholder should handle situations such as: when a senior lienholder has obtained an inadequate amount of flood insurance coverage, when a senior lienholder is not subject to the Act's and Regulation's requirements; and when insurance coverage in the amount of the improved real estate's insurable value must be obtained by the junior lienholder.
Commenters also raised other issues related to ongoing flood insurance coverage on existing second lien loans in the context of force place