When a farmland commercial loan is partially secured by second mortgage on a residence out of an abundance of caution, are we required to obtain title insurance for the residence? We have a loan secured by hundreds of acres of farmland, crops, vehicles, farm equipment, and an assignment of leases and rents, as well as a second mortgage on a residence and additional land surrounding the residence. We obtained title insurance covering the farmland, but not the residence and surrounding land. Should we have obtained title insurance covering the residence and surrounding land?

We are not aware of a requirement to obtain title insurance covering real estate securing a loan when the lien is obtained out of an abundance of caution. Of course, title insurance is strongly recommended for real estate-secured loans, but we do not believe that title insurance is required for real estate that is taken as a security purely out of an abundance of caution.

The FDIC Risk Management Manual of Examination Policies states that examiners must ensure that your bank has “performed a title and lien search of the property prior to taking a mortgage or advancing funds” on a real estate mortgage loan. Similarly, it states that the absence of a legal opinion or title insurance in a loan file is a “potential problem indicator.” However, we would analogize to the appraisal rules and supervisory loan-to-value ratio requirements, both of which exempt liens on real property that are taken out of an abundance of caution from their requirements.

Similarly, we think your bank has a reasonable argument that title insurance is unnecessary in cases where the lien on the residence and surrounding land was taken out of an abundance of caution. We do recommend memorializing this approach in your bank’s policies and procedures, with the steps taken to document and verify that a lien truly was taken out of an abundance of caution. The Interagency Appraisal and Evaluation Guidelines and Interagency Guidelines for Real Estate Lending Policies, both linked to below, include definitions and analysis related to “abundance of caution,” which should provide helpful guidance.

For resources related to our guidance, please see:

FDIC Risk Management Manual of Examination Policies, Section 3.2 – Loans, page 63 (“The examiner should ensure the bank has performed a title and lien search of the property prior to taking a mortgage or advancing funds. Proper procedure calls for an abstractor bringing the abstract up to date, and review of the abstract by an attorney or title insurance company.”)

FDIC Risk Management Manual of Examination Policies, Section 3.2 – Loans, page 44 (“Potential Problem Indicators by Document . . . . Correspondence and Credit Files – Missing and/or inadequate collateral or loan documentation, such as financial statements, security agreements, guarantees, assignments, hypothecation agreements, mortgages, appraisals, legal opinions and title insurance, property insurance, loan applications; evidence of borrower credit checks; corporate or partnership borrowing authorizations; letters indicating that a borrower has suffered financial difficulties or has been unable to meet established repayment programs; and documents that reveal other unfavorable factors relative to a line of credit.”)

OCC Comptroller’s Handbook, Agricultural Lending (October 2018) (“When considering real estate as collateral, a bank should first determine whether there are any existing liens against the property. As with chattel liens, attorneys, title companies, or bank personnel may perform real estate lien searches, and all findings should be documented. The bank may also require title insurance and name itself as loss payee to protect against possible undisclosed title defects. Whether insured or not, the bank should review carefully any exceptions noted in the preliminary lien search or title insurance binder. . . . In some small Ag communities with relatively stable real estate ownership, banks rely on an ownership and encumbrance (O&E) report to determine outstanding liens.”)

FDIC Appraisal Regulations, 12 CFR 323.3(a) (“Appraisals required. An appraisal performed by a State certified or licensed appraiser is required for all real estate-related financial transactions except those in which: . . . (2) A lien on real estate has been taken as collateral in an abundance of caution; . . .”)

Interagency Appraisal and Evaluation Guidelines (December 10, 2010) (“An institution may take a lien on real estate and be exempt from obtaining an appraisal if the lien on real estate is taken by the lender in an abundance of caution. This exemption is intended to have limited application, especially for real estate loans secured by residential properties in which the real estate is the only form of collateral. In order for a business loan to qualify for the abundance of caution exemption, the Agencies expect the extension of credit to be well supported by the borrower’s cash flow or collateral other than real property. . . . In addition, prior to making a final commitment to the borrower, the institution should document and retain in the credit file the analysis performed to verify that the abundance of caution exemption has been appropriately applied. . . .”)

12 CFR Part 365, Subpart A, Appendix A, Interagency Guidelines for Real Estate Lending Policies, Loans in Excess of the Supervisory Loan-to-Value Limits (“Excluded Transactions. The agencies also recognize that there are a number of lending situations in which other factors significantly outweigh the need to apply the supervisory loan-to-value limits. These include: . . . Loans for which a lien on or interest in real property is taken as additional collateral through an abundance of caution by the lender (e.g., the institution takes a blanket lien on all or substantially all of the assets of the borrower, and the value of the real property is low relative to the aggregate value of all other collateral).”)