Just when you thought you had flood compliance under control at your institution,
new flood “hot buttons” pop up during compliance exams!
The most recent flood compliance “hot button” is related to flood contents insurance requirements.
Common mortgage language has been interpreted by the FDIC to create a requirement for flood insurance on the contents of the structure being pledged as collateral if the structure is in a hazardous flood zone.
Common language in mortgage instruments 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:
Regulators have held that contents coverage is required whether or not the lender filed a UCC-1 financial statement. It does not appear that they will hold the requirement on residential properties.
There have been a few cases where the lender was allowed to demonstrate they had no intention of taking the contents as collateral. In these cases, the requirements were:
1)The appraisal on the property could not mention the contents
2)The loan write up did not mention the contents
The cases when this approach has been allowed are limited, since the language in most mortgage and security agreements states that personal property is included. For commercial loans with collateral in a flood zone, we recommend that lenders should:
- Review the mortgage document to determine whether the language could possibly 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 for both the structure and the contents.
AND, the fun just continues…!
Contents Insurance Valuation is the next issue to consider.
In the event the lender has taken contents as collateral, either intentionally or in the manner described above, the regulators have required that they insure both, and they must 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
The flood rules require lenders to insure the contents, and structure in which they are located, in an amount equal to the lesser of:
- The combined maximum amount of insurance available under the NFIP for the structure and contents;
- The combined insurable value of the contents and structure; (Under the NFIP, the maximum amount of content coverage available for a non-residential structure under the regular program is $500,000.); or
- The total loan amount secured by the insurable collateral in a special flood hazard area.
Here is an example provided in the Interagency FAQ regarding insurable values when the lender takes both the contents and the structure as collateral:
Example: Lender A makes a loan for $200,000 that is secured by a warehouse with an insurable value of $150,000 and inventory in the warehouse worth $100,000. The Act and Regulation require that flood insurance coverage be obtained for the lesser of the outstanding principal balance of the loan or the maximum amount of flood insurance that is available under the NFIP. The maximum amount of insurance that is available for both building and contents is $500,000 for each category. In this situation, Federal flood insurance requirements could be satisfied by placing $150,000 worth of flood insurance coverage on the warehouse, thus insuring it to its insurable value, and $50,000 worth of contents flood insurance coverage on the inventory, thus providing total coverage in the amount of the outstanding principal balance of the loan. Note that this holds true even though the inventory is worth $100,000.