FLOOD RULE CONUNDRUM: DOES YOUR FINANCIAL INSTITUTION QUALIFY FOR THE SMALL LENDER EXCEPTION?

On June 22nd, the agencies (FRB, OCC, FDIC, NCUA, and FCA) issued a joint final rule to modify existing flood regulations. On June 24th, we issued an article discussing these new interagency flood rules (to access that article click here) that examined the three main elements of the final rule: detached structures, escrow provisions, and force placement. Since then we have received numerous questions relating to the small lender exception to the escrow portion of the new flood rules.

The escrow portion of the final rule is not effective until January 1, 2016; however, this is the portion of the final rule that has us all scratching our heads a bit!

What is the Small Lender Escrow Exception?
The small lender exception states that except as provided by State law, regulated lending institutions that have total assets of less than $1 billion are excepted from the escrow requirement if, on or before July 6, 2012, the institution:
• In the case of a loan secured by residential improved real estate or a mobile home, was not required under Federal or State law to deposit taxes, insurance premiums, fees, or any other charges in an escrow account for the entire term of the loan; and
• Did not have a policy of consistently and uniformly requiring the deposit of taxes, insurance premiums, fees, or any other charges in an escrow account for loans secured by residential improved real estate or a mobile home.

Can Lenders Who Were Required to Escrow Under the HPML Rules Qualify for this Exception?
The concern for many small lenders is whether the requirement to escrow under the Higher Priced Mortgage Loan (HPML) rules, which was effective April 1, 2010, precludes them from utilizing the small lender escrow exception under the new flood rules because they were required to escrow prior to July 6, 2012 (enactment date of Biggert-Waters Act).

Does this small lender escrow exception test mean that only lenders who never made HPMLs and, therefore, never escrowed are eligible for the exemption? Or because HPMLs are permitted to be cancelled at the request of the borrower after year(s) one or five mean that an escrow isn’t “required to be maintained for the term of the loan” and, therefore, escrowing for HPMLs prior to July 6, 2012 doesn’t disqualify lenders from utilizing the small lender escrow exception under the new flood rules?

After much research and debate among our staff, we reached out to the agencies for clarification.

Agency Comments
We learned that the agencies have not come to a consensus on this issue either.

Of the agencies we contacted (OCC, FDIC, FRB, and NCUA) all but the FDIC confirmed that if a creditor escrowed prior to July 6, 2012 due to the HPML rules it would NOT PRECLUDE that creditor from utilizing the small lender escrow exception within the flood rules because there is the option to cancel the escrow account.

The FDIC, however, indicated that a creditor would not be eligible for the small lender escrow exception under the new flood rules if prior to the July 6, 2012 date the creditor had escrowed as required under the HPML rules.

Based on the unofficial responses we received during our conversations with the agencies, it is still unclear whether small lenders who escrowed for HMPLs prior to July 6, 2012 will qualify for the small lender escrow exception within the flood rules. This issue will likely take some time for all the issuing agencies to come to a consensus. Until then, if a financial institution qualifies for the small lender flood escrow exception, but did escrow for HPMLs prior to July 6, 2012, we recommend it prepare as if it will be required to escrow for flood insurance.

The agencies indicated that they tentatively plan to host an inter-agency webinar in the fall covering the new flood rules and addressing related questions. We hope to hear a definitive and unified opinion on this issue at that time. Watch our blog for the latest information and developments.

Written by Kelly Owsley and Robin Cooper

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