Flood Escrow and Small Lender Exemption

Issue/Inquiry

The Bank has a question regarding the new flood escrow rule and its qualification for the small lender exemption. The Bank currently meets the exemption but has begun originating first mortgage residential loans for which it is escrowing for taxes and insurance. The loans will then be sold to a third party. Would the Bank still be exempt, since it is selling off the loans?

Response Summary

If the Bank satisfied all three elements of the small lender exemption when the flood escrow rule went into effect, it can make loans with flood escrows without losing the exemption. The question of whether it had a policy of requiring such escrows turns on its status on or before July 12, 2012. If it qualified as of that date with regards its policy and whether it was legally required to maintain escrows for the entire term of the loan, what it does after that date will not affect its status. Only if its asset size increases, so that it no longer qualifies as a small lender, will it be required to comply with the flood escrow rule.

Response Detail

Under the new flood escrow rule, financial institutions are generally required to escrow premiums and fees for flood insurance for consumer loans secured by residential real estate or mobile homes located in special flood hazard areas, when flood insurance is available under the National Flood Insurance Program. 12 CFR §339.5(a).

These requirements do not apply to an FDIC-supervised institution:

• That has total assets of less than $1 billion as of December 31 of either of the two prior calendar years
• On or before July 6, 2012:
  • That was not required under Federal or State law to deposit taxes, insurance premiums, fees, or any other charges in an escrow account for the entire term of any loan secured by residential improved real estate or mobile home
  • That did not have a policy of consistently and uniformly requiring the deposit of taxes, insurance premiums, fees, or any other charges in an escrow account for any loans secured by residential real estate or a mobile home.  12 CFR §339.5(c).

As per the section-by-section analysis by the regulatory agencies when the final rule was published, all three elements of the small lender exemption must be satisfied in order for an institution to be eligible for it. Federal Register, vol. 80, no. 139, page 43228.

Arguably, if a financial institution has a policy of “uniformly or consistently” establishing escrow accounts for any reason, including the satisfaction of requirements by third party investors that will be purchasing the loans, it would not qualify for the small lender exemption. However, the answer to this question depends on the status of the institution on or before July 6, 2012. If the institution did not have such a policy on or before that date, and it fulfills the other two elements, it qualifies for the exemption. Nothing the institution does after that date will affect its status, except for an increase in its asset size.

Therefore, if the Bank satisfied all three elements of the small lender exemption when the flood escrow rule went into effect, it can now establish flood escrow accounts for loans on a case-by-case basis, without being required to establish escrow accounts for all loans for which they would be appropriate. Only if the Bank’s asset size increases to $1 billion or more, as of December 31 of the prior two calendar years, would it become subject to the requirements of the flood escrow rule.

This entry was posted on Monday, May 23rd, 2016 at 3:30 pm.