Source: https://www.rskcompliance.com/2014/07/
Timestamp: 2019-04-24 14:18:20+00:00

Document:
The bank will be making a commercial mortgage refinance of a gas station which is located within a SFHA. There was a full appraisal completed which included a cost approach to the valuation and the replacement value. It asks which value should be used when calculating the value of the insurable structure. Are all components of the gas station insurable under the flood program?
Not all of the components of a gas station are eligible for coverage under the National Flood Insurance Program. The bank will have to identify those components which are eligible and have them insured for their actual cost value (“ACV”). The building will be insurable, but certain other items will be insurable only if they are part of the building or its contents. In the event the “depreciated cost” provided by the appraisal does not correspond to ACV, if may still be the basis of an alternative approach towards calculating the insurable value, which is permitted by the federal regulators.
Not all of the components of a gas station are eligible for coverage under the National Flood Insurance Program (“NFIP”). The bank will have to identify those components which are eligible and have them insured for their Actual Cost Value (“ACV”).
Loans eligible for coverage are those which are secured by improved real estate. “Improved real estate” refers to an insurable building on the property. A building is insurable if it has two load-bearing walls and a roof, and if more than 50 percent of its value is above ground.
If a security interest is taken in the contents of the building, the maximum amount of coverage available under the NFIP is $500,000.
ACV is the Replacement Cost Value (“RCV”) less depreciation. RCV is used for residential properties and ACV for all other properties.
In this case, the appraisal has an item for “Depreciated Cost of Site Improvements.” If this refers to the building itself, and if “depreciated cost” corresponds to ACV, it would be the starting point for calculating the insurable value of the property.
The appraisal also provides the depreciated cost of tanks, pumps, canopies, and signs, which make up the better part of the value of the property. From the standpoint of flood insurance coverage, however, these items may not be insurable, since they are not part of an insurable structure. Gas pumps and canopies may be roofed, but do not have load-bearing walls and would not be considered an insurable structure.
If “depreciated cost” and ACV are not the same, the federal regulators allow the lender and borrower, either by themselves or in consultation with the flood insurance provider or other appropriate professional, to choose from a variety of approaches or methods to establish the insurable value. They may use an appraisal based on a cost-value (i.e., not market value) approach, a construction-cost calculation, the insurable value used in a hazard insurance policy (but recognizing that the insurable value for flood insurance purposes may differ from the value for flood insurance purposes and that adjustments may be necessary), or any other reasonable approach, so long as it can be supported.
In this way, the “depreciated cost” provided by the appraisal may still provide the basis for an alternative approach towards calculating the insurable value.
The Bank’s management loan committee wants guidance on whether a loan to a limited liability company but for the purchase of the guarantor's personal residence, is a commercial loan or a consumer loan for the purpose of the consumer protection regulations.
A loan to a limited liability company to purchase a home for the guarantor is exempt from Regulation Z requirements, since the borrower is not a natural person, but would be covered by RESPA, since it is secured by residential real property and is not for a business purpose. Had the loan been for temporary financing, such as a construction loan, it would also have been exempt from RESPA. The Bank, however, should be comfortable with regards the credit underwriting aspects of the transaction, whether tax advantages are being sought through structuring the loan in this fashion, and how it will account for such an asset and liability.
A loan to a limited liability company to purchase the guarantor’s residence is exempt from Regulation Z requirements, since the borrower is not a natural person, but would be covered by RESPA, since it is secured by residential real property and is not for a business purpose.
The term “consumer credit” means an extension of credit to a consumer for a personal, family, or househould purpose. A “consumer” is a “natural person.” A loan to a limited liability company, therefore, would not be a loan to a natural person and thus would not be consumer credit, whatever the loan proceeds was used for. 12 CFR §§1026.2(a)(11), (12).
Business purpose loans are specifically exempted from Regulation Z coverage, including extensions of credit other than to a natural person. 12 CFR §1026.3(a)(2). In this regard, the Official Interpretations provide that “the exemption for transactions in which the borrower is not a natural person applies, for example, to loans to corporations, partnerships, associations, churches, unions, and fraternal organizations. This exemption applies regardless of the purpose of the credit extension and regardless of the fact that a natural person may guarantee or provide security for the credit.” Official Interpretations, ¶1026.3(a)-9.
Since the loan is for the guarantor’s personal residence, however, it would be subject to RESPA requirements. RESPA covers all federally-related mortgage loans, which are loans made by federally-insured institutions secured by first or subordinate liens on residential real property. “Residential real property” is property on which there is located or will be constructed, using the loan proceeds, a structure or structures designed principally for occupancy of from one to four families. 12 CFR §§1024.2, 5(a).
Business purpose loans are exempted from RESPA requirements. Regulation X, giving effect to RESPA, adopts the definition of “business purpose” in section 1026.3(a)(1) of Regulation Z, which is “an extension of credit primarily for business, commercial, or agricultural purposes.” In this case, while the loan is to a business entity, it does not have a business purpose. Thus, it is not exempted from RESPA requirements. 12 CFR §1024.5(b)(2). Pointedly, Regulation X does not adopt the larger definition of “business purpose” found in section 1026.3(a)(2) of Regulation Z, which is an extension of credit to other than a a natural person. For RESPA purposes, it is the use of the loan proceeds which controls, not the nature of the borrower.
If the loan was not being made for the purchase of the house but for its construction, it would have been exempt from RESPA as well as temporary financing. This exemption would not apply, however, if the construction loan is used as or may be converted to permanent financing by the same lender, or will finance the transfer of title to the first user. 12 CFR §1024.5(b)(3).
While the Bank’s question treats the matter as being fundamentally one of the applicability of the consumer protection regulations, it should also be comfortable with regards the credit underwriting aspects of the transaction, whether tax advantages are being sought through structuring the loan in this fashion, and how it will account for such an asset and liability.
What Should be Considered in Expanding a Bank’s CRA Assessment Area?
A small New Jersey bank is considering expanding its assessment area to include a large city in an adjacent county, since it is making a large percentage of its loans there. Would such an expansion have any negative impacts or if there are any regulatory concerns?
The Community Reinvestment Act evaluates a bank’s record in meeting the financial needs of its community, which is to say, within its assessment area. If a small bank makes a majority of its loans outside its CRA assessment area, it will not meet the standards for “Satisfactory” under the lending criterion. In that case, the assessment area should be expanded to cover the areas where it makes a substantial proportion of its loans. If the bank makes most of its loans within its present assessment area, however, the desirability of expanding its assessment area will turn on the effect of the expansion on such factors as the distribution of loans within the assessment area to highly economically disadvantaged areas, low-income individuals, or businesses with gross annual revenues less than $1 million.
The bank’s loan-to-deposit ratio, adjusted for seasonal variation, and other lending-related activities, such as loan originations for sale to secondary markets, community development loans, or qualified investments.
The percentage of loans and lending-related activities in the bank’s assessment area.
The bank’s record of lending to and engaging in other lending-related activities for borrowers of different income levels and businesses of different sizes.
The geographic distribution of the bank’s loans.
The bank’s record of taking action, if warranted, in response to written complaints about its performance in helping to meet credit needs in its assessment area. 12 CFR §228.26(b).
The FDIC will take into consideration such factors as the bank’s record of serving the credit needs of highly economically disadvantaged areas in its assessment area, low-income individuals, or businesses with gross annual revenues of $1 million or less. Regulation BB, Appendix A to Part 228.
A “small bank” for CRA purposes is one with $250 million or less in assets as of December 31st the previous two calendar years.
The bank’s CRA assessment area is the area in which its performance in meeting the credit needs of its community will be evaluated. 12 CFR §228.41. It isn’t the same as the bank’s market or service areas, though it could be. The assessment area is the focus of the bank’s lending and service activities and should demonstrate those activities to best advantage.
The federal agencies have stated that a bank is not required to make a majority of its loans within its CRA assessment area and that it may still obtain a satisfactory rating in spite of its failure to do so. Lending would simply be one of the criteria considered in the evaluation. Interagency Questions and Answers, §__.26(b)(2)—1, A.1.
Under the small bank lending standards of section 228.26(b) of Regulation BB, however, the FDIC will look to see whether the majority of the bank’s loans are made within its assessment area. If the percentage of loans made in the assessment area is less than a majority, the bank will not meet the standards for “Satisfactory” under this performance criterion. In that case, the FDIC would consider such factors as the bank’s size and financial condition, its branching network, its business strategies, as well as economic conditions and loan demand. FDIC Compliance Manual, January 2014, XI-1.3.
While this analysis may come out in the bank’s favor, it is a very difficult hurdle to cross. If more than half of the bank’s loans are made outside its present assessment area, strong consideration must be given to expanding the assessment area.
Regulation BB does not prescribe a required threshold for community development loans, investments, or services. Instead, the bank may make an assessment of the needs of its assessment area and engage in various activities intended to address those needs. This means, however, that loans made outside the assessment area would not be considered in such a performance evaluation. 12 CFR §228.26(c); Interagency Questions and Answers, §__.26(c)—1, A.1.
In one respect, it doesn’t matter whether the bank makes most of its loans inside or outside of its assessment area. The lending test for small banks includes the loan-to-deposit ratio, and while no specific ratio has been established by regulation or law, federal regulators generally look for 60 percent loans-to-deposits. The loan-to-deposit ratio is calculated in the same manner as for the Uniform Bank Performance Report, by dividing the net loans by the net deposits. Loans will not be segregated as to whether they were made within or outside the bank’s assessment area. For that reason, additional loans will enhance the bank’s performance wherever they are made. 12 CFR 228.26(b); Interagency Questions and Answers, §__.26(b)(1)—3, A.3.
This brief discussion indicates that determining whether a course of action is desirable from a CRA standpoint requires the balancing of various factors. In doing so, it might be useful to think of CRA compliance as a story the bank must tell to its regulators of the way in which it is helping the people in its assessment area meet their financial needs. If the story is to be persuasive, there must be a compelling narrative with facts and figures to back it up.
In this case, the question the story must answer is whether expansion of the CRA assessment area will enhance the bank’s performance in those aspects valued by CRA.
If the bank makes more than half of its loans outside its present assessment area, the assessment area should be expanded to cover those areas in which it makes a substantial portion of its loans, regardless of any other factors involved. As noted, a bank may still obtain a satisfactory CRA rating even though most of its loans are made outside of its assessment area, but it is very difficult to do so.
The effect the proposed expansion will have on the distribution of its loans to low- to moderate-income geographies.
The effect the proposed expansion will have on the distribution of loans to individuals of different income levels and businesses of different sizes, given the products offered by the bank.
The effect of the proposed expansion on community development loans.
The effect of the proposed expansion on loans made to highly economically disadvantaged areas, low-income individuals, or businesses with gross annual revenues of $1 million or less.
Since the bank already makes a substantial proportion of its loans to the area proposed for the expansion, it should be able to develop the information necessary for this comparison.
For example, if the expansion will have the effect of increasing the distribution of loans to low- and moderate-income geographies or to low-income individuals or small businesses within the assessment area, it will be more desirable from a CRA assessment standpoint. It the expansion will have the opposite effect, it will be less desirable.
Any decision the bank makes, however, must be consistent with safe and sound banking practices.
The bank will also need to consider whether the proposed expansion will include contiguous geographies or political subdivisions.

References: §1026
 §1024
 §1024
 §228
 §228
 §228