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PCBB Banc Investment Daily June 10, 2013
Banc Investment Daily
June 10, 2013

Top of the World

Roughly 60Ys ago on May 29, the first successful ascent and descent of Mt Everest was accomplished by mountaineers Sir Edmund Hillary and Tenseng Norgay. Mt. Everest is the point at which the earth's surface reaches the greatest distance above sea level at 29,029 feet. The first attempts to reach the top of Everest were in the 1920s, where George Mallory and Andrew Irvine certainly got very close and maybe even reached the top in 1924, but perished on the descent. Climbers who attempt Everest spend substantial time in the so-called "death zone" - altitudes above 26,246 feet - and though many mountaineers have reached the top since the first ascent, there are still many deaths on the mountain due to lack of oxygen, exhaustion, extreme cold and climbing hazards.
Speaking of exhaustion and the death zone, lenders may be feeling that way when it comes to the compliance requirements related to flood insurance. There have been regulations surrounding flood insurance for some time, but after Hurricane Katrina the regulatory agencies got very serious and really started cracking down to make sure banks were following all of the regulations. Banks have to make sure loans secured by a building, either residential or non-residential or even a mobile home if it's permanently placed, must have flood insurance. To determine whether flood insurance is needed, bankers begin by checking to see whether the structure is located in Special Flood Hazard Area (SFHA), for which flood insurance in available under the National Flood Insurance Program (NFIP). Banks must ascertain that sufficient flood insurance is in place for the duration of the loan and are required to force place flood insurance if the borrower does not obtain it within a time window.
However, given regulatory updates and most recently the Biggert-Waters Flood Insurance Reform Act of 2012, there are a lot of uncertainties as to exactly what the regulations require and even which policy documents should be followed.
Let's look at some of the most problematic issues. To begin, flood zones have expanded in an effort to cover all possible risk areas and consideration must be given to a 500Y flood. This effort has caused many areas perceived to be very low risk to require insurance. Any loan secured with a property in a flood zone is subject to the requirement, so that could include a home equity loan or a line of credit, an individual condominium unit in a multi-story building, or even a commercial loan to a car wash (although the level of water damage to such a structure could be debated). SBA loans could also require flood insurance for inventory or equipment. The rules are complex and civil penalties are at stake for even minor errors, so bankers are on edge.
There is also the larger question of banks being required to police one specific kind of insurance coverage for collateral property. Wouldn't it be more logical to have flood insurance as a part of overall hazard insurance? The insurance industry with its experience and expertise has better tools to determine where flood insurance is necessary and where it isn't. Banks could be required to ascertain borrowers have hazard insurance, but not to determine exactly which hazard perhaps. After all, whether it is the danger of forest fires or drought or floods, all could have the same impact on the building in question. As things stand now and as with Mt. Everest, the climb is leading many to exhaustion.