At a recent seminar, we were told that we were required to escrow for flood insurance starting January 1, 2016. As a “small lender” under the FDIC flood insurance rules, aren’t we exempt from that requirement? Before 2012, we never had a policy of regularly requiring escrow for any charges. However, now we require escrow for taxes and insurance for higher-priced mortgage loans (HPMLs). Do we lose our “small lender” exemption if we escrow for taxes and insurance for HPMLs, even if we are well under the asset threshold? Also, is an investment purpose loan secured by a 1-4 family residence exempt from escrow requirements?

No, if your bank began escrowing for taxes and insurance after 2012, your bank will not lose its “small lender” exemption from the general requirement to escrow flood insurance premiums for residential mortgage loans that are made, increased, extended or renewed on or after January 1, 2016.

A small lender is exempt from the flood insurance requirements in the FDIC’s flood insurance rules if it meets two requirements: (1) it has total assets of less than $1 billion as of December 31 of either of the two prior calendar years, and (2) it was not required to escrow any charges and did not have a policy of consistently and uniformly requiring escrow on or before July 6, 2012.

Your institution meets both elements of the small lender test: your assets are under $1 billion, and your bank was not subject to any escrow requirements and did not consistently and uniformly require escrow accounts on or before July 6, 2012. Your escrow activities subsequent to July 6, 2012, does not disqualify your institution from small lender status. Consequently, your bank is exempt from the flood insurance escrow requirements as a small lender.

We confirmed this interpretation with an FDIC attorney. The attorney initially provided us with the opposite conclusion, which he later recanted. The FDIC attorney’s email is copied below:

“I did some further research and found that the issue has arisen in the past, specifically in the form of a comment upon the proposed rule to implement the escrow requirement. The language below is excerpted from the preamble to the final rule that implemented the escrow requirements along with others, published July 21, 2015:

‘A financial institution trade group commenter asked whether a lender who began a policy of consistently and uniformly requiring the deposit of taxes, insurance premiums, fees, or any other charges in an escrow account after July 6, 2012, could still qualify for the small lender exception. Based on the FDPA and the Agencies’ regulations, which reference a lender’s policy on or before July 6, 2012, an institution could qualify for the exception if the policy of requiring escrow began after July 6, 2012, provided the lender meets the size threshold.’ See 80 Federal Register at 43228.

“In light of this statement, I recant my original opinion on this question and restate my answer as follows: if a depository institution should require escrow subsequent to July 6, 2012, to give an example, say for property taxes in 2017, it is our opinion that the depository institution would not then be obligated to escrow for flood insurance premiums as well, as long as it met the asset size qualification for a small lender. In other words, it would continue to be eligible for the small lender exception.”

And yes, an investment purpose loan, such as the one you described, would be exempt from the flood insurance escrow requirements and Regulation Z’s HPML escrow requirements.

For resources related to our guidance, please see:

FDIC Flood Insurance Rules, 12 CFR 339.5(c)(1) (“Small lender exception — (1) Qualification. Except as may be required under applicable State law, paragraphs (a), (b) and (d) of this section do not apply to an FDIC-supervised institution: (i) That has total assets of less than $1 billion as of December 31 of either of the two prior calendar years; and (ii) On or before July 6, 2012: (A) 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 a mobile home; and (B) 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 improved real estate or a mobile home.”)
Final Rule, Loans in Areas Having Special Flood Hazards, 80 Fed. Reg. 43215, 43228 (July 21, 2015) (“The Agencies also received several questions about the conditions, which the Agencies believe can be resolved by looking to the plain language of the FDPA, as adopted and implemented by the Agencies' regulations. A financial institution trade group commenter asked whether a lender who began a policy of consistently and uniformly requiring the deposit of taxes, insurance premiums, fees, or any other charges in an escrow account after July 6, 2012 could still qualify for the small lender exception. Based on the FDPA and the Agencies’ regulations, which reference a lender's policy on or before July 6, 2012, an institution could qualify for the exception if the policy of requiring escrow began after July 6, 2012, provided the lender meets the size threshold.”)
FDIC Flood Insurance Rules, 12 CFR 339.5(a)(2)(i) (The requirement to escrow flood insurance premiums “does not apply if: (i) The loan is an extension of credit primarily for business, commercial, or agricultural purposes

Regulation Z,12 CFR 1026.3(a)(1) (“The following transactions are not subject to this part or, if the exemption is limited to specified provisions of this part, are not subject to those provisions: 1. An extension of credit primarily for a business, commercial or agricultural purpose. . . .”)