LOGIC BEHIND THE SMALL BANK FLOOD ESCROW EXEMPTION

We discussed the issue of the small bank exemption from the new flood insurance escrow requirements in previous articles entitled Flood Rule Conundrum and Flood Rule Conundrum – Part II. We almost called this one Flood Rule Conundrum – Part III, but we thought that would be too repetitious too repetitious.

The issue is whether a small bank, that had previously escrowed for Higher-Priced Mortgage Loans (HPML), could be eligible for the new exemption from flood insurance escrow requirements. Although it took longer that it should have, it appears that all the federal regulatory agencies agree that that a small lender can still take advantage of the exception despite escrowing for HPMLs. The logic behind their decision flows as follows:

  1. Section 100209 of the Biggert-Waters Act provides an exemption to the escrow requirement for a designated loan for a lender with less than $1 billion in assets (small lender).
  1. A small lender is not eligible for the exemption if, on or before the date the Biggert-Waters Act became law, July 6, 2012, the small lender was legally required to escrow with respect to a designated loan for the entire term of that loan.
  1. Under section 1026.35 of Regulation Z, an HPML is subject to escrow requirements.
  1. The current version of Section 1026.35, which became effective on June 1, 2013, provides that an HPML may only be terminated upon the earlier of:
  • Termination of the underlying debt obligation; or
  • Receipt no earlier than five years after consummation of a consumer’s request to cancel the escrow account.
  1. The original HPML escrow requirements, which were effective on April 1, 2010, provided that a creditor may allow a consumer to cancel the escrow account, but no sooner than 12 months after consummation.
  1. Under either the original or current HPML escrow rule, a borrower can cancel the escrow before the end of the loan term. Therefore, the escrow coverage is not required for the entire term of the loan.

We are pleased that all of the agencies appear to be in agreement on the handling of this issue. We will be more pleased when the regulation, or at least the interagency Questions and Answers, are updated to reflect this guidance.

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