Q: I understand the rules to state that if a loan is secured by contents, but not by a building, the mandatory purchase of flood insurance rules do not apply even if the building in which those contents are housed is located in a Special Flood Hazard Area (SFHA). However, when both the building and the contents of that building secure the same loan, if the building is in the SFHA within a participating community then flood insurance would apply on both the building and the contents.
In the event that one loan (A) is secured by a building in a SFHA and a second loan (B) is secured by the contents stored in that building, flood insurance rules apply to the building secured loan. Do the flood insurance rules apply to the second content secured loan? We are questioning this because the building in which the contents are stored is in a SFHA and that building is held as collateral for a loan – just not the same loan.
Loan A is a $150,000 term loan secured by a building that is located in a SFHA, flood insurance rules apply and the borrower must obtain coverage on the building. Because contents are not part of the collateral for this loan, flood insurance is not required on the contents, but is required on the building.
Loan B is a $500,000 line of credit secured by inventory, equipment, and personal property. These items are housed in the building that secures Loan A, but the building is NOT part of the collateral for Loan B. Since the building is not part of the collateral for this loan, mandatory purchase does not apply to the contents.
Is that correct?
A: The interpretation is correct. Since Loan B is not secured by a building located in a SFHA, flood insurance is not required by law. However, a bank should consider risk management implications in this scenario. Using the example noted in the question, while Loan B does not trigger a regulatory requirement for flood insurance, it may be prudent from a risk management perspective to obtain such coverage in order to protect the bank’s collateral. A bank should consider the impact of cross-collateralization agreements, if applicable.
– This Q&A was included in the materials from the FDIC New York Region Regulatory Teleconference: “Flood Insurance – Flood Insurance Compliance and an Examiner’s Perspective” which took place on December 3, 2012. These materials may be found here: https://www.fdic.gov/news/conferences/NY/2012-12-03.html