Compliance Blog

Happy Monday, compliance friends! We’re only 10 days out from turkey day, so start stocking up on gravy and dinner rolls!

In the meantime, let’s talk about flood insurance and mergers. We have received a few calls from credit unions shortly after a merger. Imagine a scenario where one credit union met the small lender exception and therefore did not escrow for flood insurance, but was then acquired by a larger credit union that never qualified for the small lender exception. The newly merged credit unions have asked if they are required to begin escrowing flood insurance premiums for the loans that were made while the small lender exception applied. The answer to this question is a bit unclear, but this blog will try to gleam some guidance from NCUA’s flood insurance rules.

NCUA’s flood insurance rule requires credit unions, and their servicers, to escrow premiums and fees for flood insurance when making, increasing, extending, or renewing a designated loan unless the credit union or a loan meets one of the exceptions in the rule. See, 12 CFR § 760.5(a)(1). Although there are multiple exceptions to the rule, we’ll focus on the small lender exception. Section 760.5(c)(1) of NCUA’s rules creates the small lender exception to the escrow requirements and section 760.5(c)(2) creates the “change in status” rule that applies after a credit union is no longer considered a small lender.

As with plenty of rules, there is not much guidance on how a merger affects the requirements for loans made under the small lender exception as outlined in section 760.5(c)(1). This is probably because not many credit unions met the small lender exception, and therefore this has not been a common question.

However, it may be the case that a merger falls within the scope of a “change in status” as described in section 760.5(c)(2):

“Change in status. If a credit union previously qualified for the [small lender] exception in paragraph (c)(1) of this section, but no longer qualifies for the exception because it had assets of $1 billion or more for two consecutive calendar year ends, the credit union must escrow premiums and fees for flood insurance pursuant to paragraph (a) of this section for any designated loan made, increased, extended, or renewed on or after July 1 of the first calendar year of changed status.”

As explained in a previous NAFCU article, “the rule includes transition rules for a credit union that has a change in status and no longer qualifies for the small- lender exception. If a credit union previously qualified for the small lender exception but now has assets of $1 billion or more for two consecutive calendar years, it would need to start escrowing the premiums and fees for loans "made, increased, extended, or renewed" on or after July 1 of the following year.” For example, assume a credit union qualified for the small lender exception in 2018, but had assets of $1 billion or more as of December 31, 2018, and December 31, 2019. In that case, the credit union would be required to begin escrowing for any loans made, increased, extended, or renewed on or after July 1, 2020.

For new loans, section 760.5(c)(2) requires a credit union to begin following the escrow requirements on July 1 of the first calendar year of the change in status. Similarly, if the credit union acquired an existing loan that did not require a flood insurance escrow, but the borrower decided to extend or renew the loan on or after July 1 of the first year of the change in status, the credit union is required to begin escrowing. However, for existing loans that were not renewed or extended, but are still outstanding after a change in status, section 760.5(d)(1) requires the credit union to offer borrowers the option to escrow the premiums for flood insurance.

Keep in mind the language of section 760.5(c)(2) refers to a credit union that previously qualified for the small lender exception and then no longer qualifies. It does not explicitly refer to whether an acquiring credit union should be treated as though there has been a “change in status” if the credit union that met the small lender exception is merged into another credit union, and the surviving credit union did not previously qualify for the exception at all. These rules do not refer to the situation of a merger where the existing loans were acquired by the surviving credit union. However, a conservative approach may be to treat the acquired outstanding loans as if a change in status has occurred, which may lead to the credit union following the processes of sections 760.5(c)(2) and (d). These processes may include sending notice and offering borrowers of acquired loans the option to escrow all premiums for flood insurance, as described in paragraph (d).

After reading the rule’s preamble and summary in the Federal Register, it seems as if the purpose of the small lender exception is to provide relief for small credit unions, but also to ensure that the exception is not used for credit unions that exceed the threshold asset size. It appears that the purpose of the “change in status” section is that larger credit unions with the capacity to escrow do not skip out on the requirements just because there was a point in time during which loans did not require flood insurance escrows. Because the application of these rules to a merger situation is not entirely clear, credit unions dealing with this type of scenario may want to consult their attorney for advice on how to proceed.