Flood Insurance- Biggert Waters May Bring Some Big Changes

The passage of the Biggert Waters Act ("BWA") will bring some changes to the overall administration of loans in a flood zone for all banks.  However, for Banks with a sound compliance program for flood insurance the changes should be absorbed easily.  While some of the changes will be implemented through regulations, other changes are effective immediately.  In our opinion, the best approach is to start to address all of the changes immediately.

Force Placed Insurance Changes Required  by the Act

The FDPA has always required that when lenders determine that insurance is either inadequate or about to expire, borrowers must be notified immediately.  The lender is also required to force place insurance on the borrowers property if the borrowers fails to purchase the required insurance with 45 days after receiving notice.   One of the new provisions in the regulation addresses one of the areas of confusion that was part of this process.  Under the new provisions of the Act, the lender can charge fees that cover the complete time period from when the insurance lapsed or was deemed insufficient.   In other words, the fees that Banks can charge can go all the way back to the date that the insurance expired or was found to be inadequate. 

A second provision of the Act deals with lenders responsibility upon receiving notice that the borrower has purchased their own insurance.  Banks are directed  that they have 30 days to terminate a forced placed policy and refund fees for insurance that overlaps with the borrowers insurance.   

The changes to the Act also help to clear up another area that had caused some confusion; the documentation that the lender can use to prove that  insurance is in force.  According to the Act a declarations  page that has the insurance policy number as well as contact information for the insurance agent will be sufficient.    In the past, many regulators were requiring an actual binder before Banks could satisfy the documentation requirements.  

It is worth noting that these changes take place without the need for further regulations.  

Civil Money Penalties

In the past, one of the least scary parts of the flood insurance compliance was the fact that the civil money penalties that could be assessed were, quite frankly, very small.   This slap-on-the-wrist benefit has significantly been changed.  Individual penalties for violations can now be as large as $2,000 and the penalty cap per year has been removed.  In the unfortunate situation where examiners find a pattern and practice of violations, then civil money penalties can now become quite high!    

This section of the law will become active without  further regulations. 

Private Flood Insurance

One area of significant change is that Banks are now directed to accept private flood insurance  to meet the requirements of the regulation.  This is not to say that the insurance has to be private, but if the basic requirements of the Act are met, then private insurance can and should be accepted.  As a part of this provision, Banks will be expected to provide a notice to borrowers that will include  at least the following information:

·         That flood insurance is available from both private insurers and from the NFIP directly;

·         Flood Insurance that provides the same level of coverage as the NFIP is available privately:

·         Borrowers should shop around for the best deal

The best news here is that these provisions will not be effective until final regulations have been implemented.  However, proposed regulations have been submitted for public comment and there is nothing in the proposed regulations that appears to change the notification requirements.  

Escrow Requirements

One of the areas of largest departure from the past is a requirement that Banks establish an escrow account for payment of flood insurance for improved reals estate loans when the improvements are in a flood area.   These requirements will apply to all Banks that are larger than $1 billion in assets as of July 6, 2014. 

Managing Change

For our clients that already have a sound system for administering the flood insurance portfolio, these changes should create very little consternation.  The notice requirements for force-placed insurance should already be in place be a part of the ongoing practice of administering these loans.  However, now would be an excellent time to review your current policies and procedures to make sure that they do in fact detail what should be done when staff discover that insurance is either insufficient, or will soon expire.   

Now is also a great time to review the process for following up when a customer notifies the Bank that they did in fact obtain satisfactory insurance.  It appears that the new provisions of the BWA will create some liability for banks that do not respond by canceling forced placed insurance and refunding any money for overlapping coverage.   The systems in place must help the Bank respond quickly and accurately.  

We note that while final regulations are now being proposed, both the civil money penalty and forced placed provisions of the Act are considered self- enacting.  

The importance of a Consumer Compliance program at a Non consumer Bank

We often hear the familiar refrain “we really don’t make any consumer loans except the occasional accommodation for a good customer – so we really don’t need a compliance officer or a compliance program.”  For many a bank this conclusion can seem straight forward and logical.  However, nothing could be further from the truth! 

The Intersection of Consumer and Commercial Lending

Though it may not seem apparent a first glance, there are a number of ways that consumer regulations can creep into the overall operation of banks that consider themselves, non-consumer.    First, there are a number of consumer oriented regulations that apply to all lending, not just commercial lending.  In addition, certain types of commercial lending still have a consumer aspect to it.  For example, commercial loans to buy apartments may need to be reported under the Home Mortgage Disclosure Act (HMDA).  Finally it has become increasingly clear that regulators like the CFPB are willing to use broad interpretations of consumer regulations to increase the impact and influence of these regulations.  [1]

Among all of the consumer regulations with the biggest potential impact on commercial lending is Regulation B which is the implementing regulation for the law known as the Equal credit Opportunity Act.  The requirements of regulation B apply to ALL loans, not just consumer loans.   The requirement to make a credit decision within 30 days of receiving a completed application and giving proper notification of adverse action are well known portions of the regulation.  However, it is important to note that there are several other portions of this law that must be considered.  For example, Regulation B specifically prohibits discouragement of an applicant.  It also prohibits a bank form refusing to grant credit based upon marital status or from discounting government income.    Though this regulation has in the past generally only been applied to consumer lending, there is nothing in the regulation that could or would prevent regulators from applying it to commercial lending.  

In point of fact, Reg. B is actually the heart and soul of fair lending regulations.   When reviewing a Banks compliance with Fair Lending, one of the main considerations that regulator will make is whether or not fair and equal consideration is being given to all applicants.  The guidelines in Regulations B are used to determine whether or not a Bank’s credit process is being is designed to deliver outcomes that do not have disparate impact.  

 In addition to Reg. B and Fair lending considerations, all banks must meet the requirements of the Community Reinvestment Act.  Even for a small community bank the requirements of the act include identifying the credit needs of the assessment area and making a majority of loans within that area.  These requirements put, at a minimum, the onus on a Bank to be able to document why being a commercial loan only lender meets the credit needs of its community.  In other words, it is fair game for examiners to ask a bank to document how its decision to refrain from making consumer loans is a business decision and not one that has disparate impact.

Yet another area where the CFPB and by implication other regulatory agencies have shown a willingness to apply consumer based regulations across the board is the Unfair Deceptive, Abusive Acts or practices regulation commonly known as UDAAP.  The fact is that the practices or policies that may violate this rule are really in the eye of the beholder.  Therefore the possible ranges of practices that may violate this law are widespread.  Based upon current experiences of banks, it appears that products that have complicated or high fee schedules often come under close scrutiny here.  Even banks that are commercial loan only status can run afoul of UDAAP. 

HMDA is another consumer based regulation that has impact on all banks.  In cases, where a commercial loan includes the purchase of a dwelling unit, reporting may be required if your bank is a HMDA reporter.  So for example, where the borrower is purchasing a retail space that includes six condominiums, there may very like be the need to record the dwelling units on your HMDA LAR!  It is also clear that at some time in the very near future, Banks will be asked to compile information on loans to women and minority owned business in a manner that will mirror the information that is currently collected for the HMDA LAR. 

Consumer Regulations Apply 

Ultimately, there is no such thing as a Bank or financial institution that can completely avoid consumer regulations.   Therefore, as your bank begins to prepare its risk assessment consumer compliance must be part of the consideration.  Moreover, the decision to allocate little to no resources in this area can be one that a Bank will come to regret in the future.    One of the main reasons firms like ours exist is to assist community banks that have made the decision to de-emphasize consumer lending maintain a strong compliance program nevertheless.    

While the compliance management program at a commercial loan only bank does not need to be as extensive as a bank that has a great deal of activity, the basic components of the program are the same.  There have to be policies and procedures established by the Board of Directors that detail the standards for compliance, management information systems that monitor for compliance, internal controls and monitoring  and training for compliance.  Without these basic pillars, a compliance program will be inadequate and potential trouble for any bank. 

The compliance program at a Bank that is largely non consumer can quickly and easily be the first line of defense against significant enforcement actions.  Oftentimes, when consumer compliance is not a large part of the daily operation of a bank, the requirements of the regulations often go unnoticed.  Even the basic requirement of notice within 30 days can slip or flood Insurance that is required can be overlooked.  In an instant, the one area that in which the Bank thought there would never be a problem; consumer compliance,  becomes a colossal headache!  

Regardless of the size of your bank or the level of intensity of consumer lending, a need will always exist for a compliance management program.    

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[1] Recent actions against automobile lenders, credit card marketers and mortgage insurance brokers all serve as examples.  

Will the “Ability to Repay” Rules Create a Fair Lending Risk?  

Of the many regulations that will be implemented in 2014, one of the most talked about is the “ability to repay”   rule.  This rule requires banks to make a good faith effort to determine a borrower’s ability to repay a loan before the credit is extended. The rule specifies the type of documentation that is required to meet the standards set.  The rule also establishes a “safe harbor” that allows banks to be presumed to make loans that meet the standards of the regulation as long as the bank makes “qualifying loans”.  Essentially qualified mortgages are loans that are not deemed higher priced.[1] 

Generally, the decision has been made by banks that the best way to avoid the ability to repay rules is to simply make only qualifying mortgages.  For many banks, making the decision to originate only qualified mortgages also means reducing the type of products being offered and potentially the volume of consumer mortgages.  Some of our clients have asked then, whether or not the decision to offer only qualified mortgages will create a Fair Lending concern. 

The good news is that the regulatory agencies that comprised the FFIEC have issued a statement on this very topic.  [2]  At first glance it appears that the statement clearly tells banks that issuing only qualified mortgages should not be a Fair Lending concern. 

“…the Agencies do not anticipate that a creditor’s decision to offer only Qualified Mortgages would, absent other factors, elevate a supervised institution’s fair lending risk” [3]

However, we advise that the emphasis has to be placed on the words absent other factors.  And in fact, the statement goes on to describe what some of the other factors might be.   The statement makes clear that banks and financial institutions are always required to follow safe and sound practices when making loans.  And in point of fact, despite wide spread belief to the contrary, there is nothing in consumer regular that requires banks to make lower quality loans.   For example, the preamble to the Community Reinvestment Act specifically reminds banks that all loans should be made with safety and soundness as basic considerations.     

However, Fair Lending and its   regulations are a different “brand of cat” from other consumer regulations.   When reviewing a Bank’s compliance in the area of Fair Lending, regulators will consider not just compliance with the letter of the law, but also the impact that policies and practices have on members of the bank’s assessment area.   Therefore, the decision to make a certain type of loan or to cease offering a product can be totally in compliance with the requirements all consumer regulations.  However, the impact could be disproportionate to members of the banks customer base.  For example, suppose a bank decides to stop offering second mortgages, of longer than 5 years in length.   This decision is neutral on its face as it appears to impact all potential borrowers at the bank in the same manner.  However, if a study is completed that finds that this decision resulted in a reduction of all applicants that are in protected classes, there could be a Fair Lending concern.  The impact of the decision had a disparate impact on the borrowers from protect classes that reside in the bank’s assessment area. 

It is important to note that a practice can have a disparate impact and still not be a Fair Lending concern.  If the practice meets a legitimate business need that cannot reasonable be achieved in a manner that has less disparate impact, then the Fair Lending test is met.  [4]  The point here is that there must be some research done and documentation that there is a specific business purpose for the practice.  The decision discussed above can have the disparate impact that we described, but if the bank that made the decision can also show that there for example a direct relationship between the loan terms and its funding sources, there is likely a strong business reason for the decision. 

The interagency statement makes it clear that the same standard will be used to determine whether a bank’s decision to offer only qualified mortgages is a matter for Fair Lending concern.  As the statement notes, there are several ways that a financial institution can qualify for the safe harbor status including selling mortgages to federal agencies such as Fannie Mae and Freddie Mac.  Therefore, a decision to cease certain products without considering how they may still be qualified mortgages may not be received favorably by the regulators.   

In our opinions banks should not simply and arbitrarily decide to make only qualified mortgages in an attempt to meet the ability to repay rules.  A more thorough consideration is required.  Thought must be given to how this decision fits in with the strategic plan of the bank as well as the impact on the surrounding community.   Complete documentation of the business reasons why the decision is being made is critical to defending against claims of disparate impact or unfair practices.  

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[1] Higher-priced loans are generally defined as having an annual percentage rate (APR) that, as of the date the interest rate is set, exceeds the Average Prime Offer Rate (APOR) by 1.5 percentage points or more for first-lien loans and 3.5 percentage points or more for subordinate-lien loans

[2] CA 13-15 Interagency Statement on Fair Lending Compliance and the Ability-to-Repay and Qualified Mortgage Standards Rule

[3] Ibid

[4] Ibid