Flood Insurance, Contents, and Cross-Collateralization

Issue/Inquiry

The Bank asks for confirmation that flood insurance is not required in the following scenario: Loan (A) is secured by a building in a SFHA, and a second loan (B) is secured by the contents stored in that building. The Bank also asks whether cross-collateralization language contained in the loan documents for Loan A would trigger a requirement for flood insurance for the contents securing Loan B in this example.

Response Summary

The contents of the building securing Loan B would have to be insured against flood hazard only if the building also secured Loan B. If there is a cross-collateralization clause in Loan A, the building securing Loan A would also secure Loan B. In that case, flood insurance coverage for the contents would have to be obtained. Other aspects of the Flood Rules would be brought into play by the cross-collateralization clause, including the proper amount of coverage, obtaining a flood hazard determination, and providing a Notice of Flood Hazard.

Response Detail

Under the Flood Rules, a bank may not make, increase, renew, or extend a designated loan unless the building and any personal property securing the loan are covered by flood insurance for the term of the loan. This means that a bank is required to insure personal property in which it has a security interest against flood hazard only if that personal property is located in a building which also secures the loan. 12 CFR §339.3; Interagency Flood Questions and Answers, Q. 40.

In the example, the contents securing Loan B are in a building located in a special flood hazard area, but since the building is not securing the loan, there is no requirement under the regulation to cover the contents with flood insurance. While there is no regulatory requirement to insure the contents, the Bank may still want to have such insurance as a matter of prudence. However, this is a business decision for the Bank to make.

It should be noted that the question would be answered differently if there was a cross-collateralization clause in the documentation for Loan A.

As noted above, a bank may not make a designated loan unless the building and any personal property securing the loan are covered by flood insurance for the term of the loan. A “designated loan” is “a loan secured by a building or mobile home that is located or to be located in a special flood hazard area in which flood insurance is available under the [National Flood Insurance] Act.” 12 CFR §339.2.

Assuming that the cross-collateralization clause for Loan A covers the building securing Loan A, it would mean that the building would also secure the other obligations of the borrower, including Loan B. Since Loan B would now be a designated loan through the operation of the cross-collateralization clause, as it is secured by a building in a special flood hazard area, the Bank would also be required insure the contents of the building in which it has a security interest.

The cross-collateralization clause may bring other aspects of the Flood Rules into play. The flood coverage will have to be sufficient to cover the aggregate balances of Loans A and B, the insurable value of the building, or the coverage limits of the building, whichever is less.

The attachment of Loan B to the building securing Loan A would be an event triggering the need for a flood hazard determination being obtained and a Notice of Special Flood Hazard being provided to the borrower. The flood hazard determination requirement in this case could be fulfilled by the flood hazard determination already on file for Loan A, provided that it was made using the Special Flood Hazard Determination Form, it is not more than seven years old, and there have been no changes in the flood hazard designation of the property since it was made.

If there is a cross-collateralization clause for Loan B, this would mean that the contents securing Loan B would also secure Loan A. In determining the proper amount of flood insurance coverage for the contents, the Bank would have to consider the aggregate balances of Loans A and B and the coverage limits for the contents. The correct amount of coverage in this instance would be the lesser of the loan amounts, the insurable value of the contents, or the amount of coverage available.

This entry was posted on Monday, July 6th, 2015 at 2:00 pm.