We are providing the payment deferral outlined in the CARES Act to all our loan customers, including loans held in portfolio and loans serviced for Fannie Mae. Some of our customers will soon be entering the repayment phase of the forbearance agreement. Would adding the accrued interest to the principal balance and re-amortizing the loan over the remaining term trigger flood insurance requirements as a M.I.R.E. event? Does it matter whether capitalizing the accrued interest would cause the loan balance to exceed the original principal balance? Also, would any other disclosure requirements be triggered — assuming the modification does not constitute a “refinancing” under Regulation Z?

We believe that adding unpaid interest to the loan’s principal balance (i.e., capitalizing the interest) —regardless of whether this would cause the loan balance to exceed the original principal balance — would trigger the flood insurance requirements, unless your loan contract permits unpaid interest to be capitalized, or your forbearance agreement by its terms is incorporated into the loan contract.

Generally, the flood insurance regulations require a lender to deliver a written flood insurance notice to a borrower whenever a loan secured by a building or a mobile home in a special flood hazard area is made, increased, renewed, or extended (a “M.I.R.E event”). The FDIC has issued COVID-19 FAQs providing that a triggering event could occur “if a lender increases the loan amount, either through capitalizing interest or adding fees . . . if such an increase is not permitted in the loan contract.” Additionally, when the banking agencies revised their flood insurance Q&As in 2009, they noted that a triggering event occurs “if capitalization results in an increase in the outstanding principal balance of the loan.” (Your primary federal regulator, the Federal Reserve, also issued COVID-19 Q&As, but they do not address whether capitalizing interest would be an “increase” resulting in a M.I.R.E. event.)

In response to our request for guidance, attorneys from the FDIC referred us to one of the proposed updated flood insurance Q&As, which have not yet been finalized. The proposed Q&A provides that if the loan contract “includes a provision permitting the lender . . . to advance funds to pay for flood insurance premiums and fees as additional debt to be secured by the building or mobile home, such an advancement would be considered part of the loan” and would not be considered a triggering event. However, the proposed Q&A noted that a triggering event would occur if “there is no explicit provision permitting this type of advancement of funds in the loan contract.”

We also contacted the Federal Reserve and received informal guidance indicating that the Federal Reserve would take the same position as the FDIC. The Federal Reserve attorneys suggested that a forbearance agreement that includes language incorporating its terms into the loan contract would be considered part of the loan contract for purposes of a M.I.R.E. analysis. In such a case, a loan contract (as modified by the forbearance agreement) could expressly permit unpaid interest to be capitalized, which then would not be considered an “increase” of the loan balance constituting a M.I.R.E. event.

Applying this analysis to the addition of unpaid interest to the loan balance, whether M.I.R.E. event has occurred depends on the wording of your loan agreement and forbearance agreement. If your loan contract expressly permits unpaid interest to be added to the loan balance, we do not believe that a M.I.R.E. event would result. Similarly, if your forbearance agreement expressly permits unpaid interest to be added to the loan balance and incorporates its terms into the original loan contract, we do not believe that a M.I.R.E. event would result.

Additionally, we are not aware of any other disclosure requirements that would be triggered by modifying a loan — provided the modification does not constitute a refinancing under Regulation Z.

For resources related to our guidance, please see:

FRB Flood Insurance Regulations, 12 CFR 208.25(i) (“Notice of special flood hazards and availability of Federal disaster relief assistance. When a member bank makes, increases, extends, or renews a loan secured by a building or a mobile home located or to be located in a special flood hazard area, the bank shall mail or deliver a written notice to the borrower and to the servicer in all cases whether or not flood insurance is available under the Act for the collateral securing the loan.”)

Interagency Q&As Regarding Flood Insurance, 74 Fed. Reg. 35913, 35925 (“5. Does the Regulation apply to loans that are being restructured or modified? Answer: It depends. If the loan otherwise meets the definition of a designated loan and if the lender increases the amount of the loan, or extends or renews the terms of the original loan, then the Regulation applies.”)

Federal Reserve Board, Consumer Affairs Letter CA 20-7: Flood Insurance Compliance in Response to the Coronavirus (May 6, 2020) (“If a lender modifies a loan by extending the loan term, then this change is a triggering event, and flood insurance requirements would apply, provided no other existing exception to the requirements under the Federal Reserve’s regulation is applicable.”)

FDIC, FAQs for Financial Institutions Affected by COVID-19 (May 27, 2020) (“26. . . . Generally, a payment deferral program, such as a payment holiday or skip-a-payment program, is not a loan modification under the Federal flood insurance requirements and does not constitute a triggering event for purposes of flood insurance law because the term of the loan is not extended. However, if a lender extends the loan term, effectively modifying the loan, it is a triggering event and the flood insurance should cover the term of the loan plus any loan extension. Additionally, if a lender increases the loan amount, either through capitalizing interest or adding fees, then this would be a triggering event if such an increase is not permitted in the loan contract.”)

Interagency Q&As Regarding Flood Insurance, 74 Fed. Reg. 35913, 35917 (July 21, 2009) (“Proposed question and answer 4 (final question and answer 5) addressed the applicability of the Regulation to loans being restructured because of the borrower’s default on the original loan. . . . The Agencies received one comment asking whether capitalization of a loan in the event of a default would constitute an increase in the loan, triggering the requirements of the Regulation. If the capitalization results in an increase in the outstanding principal balance of the loan, then the requirements of the Regulation will apply. Conversely, a loan restructure that does not result in an increase in the amount to the loan (or an extension of the term of the loan) will not trigger the requirements of the Regulation. The Agencies do not believe further elaboration addressing this comment is necessary.”)

Proposed Rule, Interagency Q&As Regarding Flood Insurance, 85 Fed. Reg. 40442, 40474 (July 6, 2020) (“If the lender's loan contract with the borrower includes a provision permitting the lender . . . to advance funds to pay for flood insurance premiums and fees as additional debt to be secured by the building or mobile home, such an advancement would be considered part of the loan. As such, the addition of the flood insurance premiums and fees to the loan balance is not considered an ‘increase’ in the loan amount, and thus would not be considered a triggering event. If, however, there is no explicit provision permitting this type of advancement of funds in the loan contract, the addition of flood insurance premiums and fees to the borrower's loan balance would be considered an “increase” in the loan amount, and, therefore is considered a triggering event because no advancement of funds was contemplated as part of the loan.”)

Federal Reserve Board, Consumer Affairs Letter CA 20-7: Flood Insurance Compliance in Response to the Coronavirus (May 6, 2020) (“However, consistent with the ‘Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus (Revised)’ dated April 7, 2020, when exercising supervisory and enforcement responsibilities, the Federal Reserve will take into account the unique circumstances impacting borrowers and institutions resulting from the COVID-19 emergency. The Federal Reserve will take into account an institution’s good-faith efforts demonstrably designed to support consumers and comply with the flood insurance requirements. The Federal Reserve expects that supervisory feedback for institutions will be focused on identifying issues, correcting deficiencies, and ensuring appropriate remediation to consumers. The Federal Reserve does not expect to take a public enforcement action against an institution, provided that the circumstances were related to the COVID-19 emergency and that the institution made good faith efforts to support borrowers and comply with the flood insurance requirements, as well as responded to any needed corrective action.”)

FDIC, FAQs for Financial Institutions Affected by COVID-19 (May 27, 2020) (“25. . . . As lenders work with borrowers to address their financial service needs, Federal flood insurance requirements may be triggered upon the making, increasing, renewing or extending (i.e., a MIRE or triggering event) of any designated loan. For example, if a lender modifies a loan by extending the loan term, the loan modification would constitute a triggering event under flood insurance law, and the lender would be required to comply with certain flood insurance requirements, such as making a new flood hazard determination and providing notice to the borrower.”)

Regulation Z, 12 CFR 1026.20(a) (“A refinancing occurs when an existing obligation that was subject to this subpart is satisfied and replaced by a new obligation undertaken by the same consumer. A refinancing is a new transaction requiring new disclosures to the consumer. . . .”)