Information Needed to Assess Flood Coverage for Multiple Buildings

INQUIRY/ISSUE

The Bank is making a $13,500,000 commercial loan secured by a complex of 17 multi-level industrial buildings located in a special flood hazard area. An appraisal shows “As Is” valuations using the sales and income approaches of $8,680,000 and $8,825,000, respectively. The tax assessment for the “building” is $1,775,000. Fire hazard insurance coverage has been obtained in the amount of $5,400,000 for the “existing structure.” The borrower has provided a declarations page showing flood insurance coverage in the amount of $1,000,000. The Bank asks whether this is sufficient.

RESPONSE SUMMARY

The amount of insurance required must be at least equal to lesser of the outstanding balance of the loan or the maximum amount of insurance available under the NFIP, which, in turn, is the lesser of the maximum amount available for the type of structures or the insurable value available for the structures. The insurable value of commercial property is the “Actual Cash Value” or “ACV,” which is the Replacement Cost Value less depreciation. This means that it will be necessary to determine the ACV of the properties securing the loan. There are a number of approaches available to establish insurable value, but the best one would be to have the buildings assessed by an appraiser on a cost-value or insurable basis. The information presently available, however, indicates that the flood insurance coverage presently on the buildings is insufficient.

RESPONSE DETAIL

Flood Insurance Required for Multiple Buildings

Under the flood rules, the amount of flood insurance required must be at least equal to the lesser of:

• The outstanding principal balance of the loan.
• The insurable value of the structure.
• The maximum amount of insurance available under the National Flood Insurance Program (“NFIP”). 12 CFR §339.3

If the real estate security contains more than one building located in a Special Flood Hazard Area (“SFHA”) in a participating community, the Bank must determine the amount of insurance required on each building and add these individual amounts together. The total amount of required flood insurance is the lesser of:

• The outstanding principal balance of the loan.
• The maximum amount of insurance available under the NFIP, which is the lesser of:
  • The maximum amount available for the type of structures.
  • The “insurable value” of the structures.

Loans in Areas Having Special Flood Hazards: Interagency Questions and Answers Regarding Flood Insurance (“Interagency Q&A”), Q.14; FDIC Compliance Manual, V-6.4

The interagency guidance on flood insurance provides the example of a lender making a loan in the principal amount of $150,000 secured by five nonresidential buildings, three of which are located in SFHAs within participating communities. It breaks the problem down as follows:

• Outstanding loan principal is $150,000
• Maximum amount of insurance under the NFIP:
  • Maximum limit available for the type of structure is $500,000 per building
  • Insurable value (for each nonresidential building for which insurance is required, which is $100,000 or $300,000 total)

The amount of insurance required for the three buildings is $150,000, which is the lesser of the outstanding loan balance or the maximum amount of insurance available under the NFIP. The amount of required flood insurance can be allocated between the buildings in varying amounts, so long as each is covered by flood insurance. Interagency Q&A, Q.14.

Insurable Value

The maximum amount of insurance available under the NFIP depends on the value of the insured collateral and the maximum caps on the amount of insurance available. For a nonresidential building located in a participating community, the maximum cap is $500,000. The “insurable value” is the overall value of the property, including the foundation and supporting structures, minus the value of the land. For nonresidential properties, such as the properties securing the proposed loan, the NFIP pays only Actual Cash Value, which is the cost to replace an item at the time of loss less depreciation. §12 CFR §339.3; Interagency Q&A, Qs.8 & 9.

Insurable Value of the Properties in Question

As noted, a factor in the flood rules is the insurable value of each building, since each building could be insured up to the $500,000 limit for commercial buildings, if there are no other limitations.

In this case, the appraisal for the properties was not based on a cost-value approach and only provides the aggregate market value of the 17 properties. There is a hazard insurance policy which provides a replacement cost value for the properties, but it is not broken down by the value assigned to each property. The appraisal also refers to the tax assessed value of the “building,” but again, there is no breakdown as to the value of the individual buildings.

Under the “Mandatory Purchase of Flood Insurance Guidelines” of the Federal Emergency Management Agency (“FEMA”), the insured value of nonresidential properties is normally based on the actual cash value, which is the replacement cost value less depreciation. In calculating the amount of insurance required, the Bank and the borrower, either by themselves or in consultation with the flood insurance provider or other appropriate professional, could choose from a number of approaches to establish the insurable value. They may use an appraisal based on a cost-value approach (not market-value), a construction-cost calculation, the insurable value used in a hazard insurance policy (with the understanding that insurable value for hazard insurance purposes may be different than that for flood insurance purposes, since most hazard insurance policies do not cover foundations), or any other reasonable approach, so long as it can be supported. Interagency Q&A, Q.9.

Given the size of the loan and the value of the collateral, the best approach will be to have the properties assessed by an appraiser on a cost-value or insurable basis.

The Bank or its borrower may also contact the issuer of the present flood insurance policy to find out the basis for the coverage provided.

Barring that, the replacement cost value given by the hazard insurance policy and the tax assessments for the improvements on each property may provide a useful starting point for understanding what the insurable value of each building could be.

Tax assessments are generally conservative in their valuation. If the tax assessment in this case is $1,775,000, it suggests that the buildings have a higher insurable value and that the present flood insurance coverage is insufficient.

As noted in the FEMA guidelines, the replacement cost value of the hazard insurance policy probably will not cover the foundation of the buildings, which would be considered part of the insurable value for flood purposes. If, as here, the hazard insurance policy provides coverage of $5,400,000 for the existing structure, it again suggests that the buildings have a higher insurable value and that the present flood insurance coverage is insufficient.

The Bank could contact the issuer of the hazard insurance to find out what values it assigned to each of the buildings to obtain its coverage amount, and whether the coverage included the foundations of the buildings.

Whatever approach the Bank takes, it will be important for it to document how it determined the insurable value of the property. This is what an examiner will be looking for.

This entry was posted on Friday, September 19th, 2014 at 3:53 pm.