when taking a note receivable further secured by real estate is it necessary to comply with FIRREA, FEMA, etc? I have heard the argument that since your "TRUE" collateral is the note receivable that it is not necessary to comply with these regs.

From the FAQs

38. If a borrower offers a note on a single-family dwelling as collateral for a loan but the lender does not take a security interest in the dwelling itself, is this a designated loan that requires flood insurance?

Answer: No. A designated loan is a loan secured by a building or mobile home. In this example, the lender did not take a security interest in the building; therefore, the loan is not a designated loan.

I think the FIRREA part of the question here is related to whether an appraisal is required for such a transaction. I came to the conclusion that an appraisal or evaluation would be required if the borrower doesn't obtain such collateral valuations when they do their loan with the buyer of the property. However, it is a bit vague in the Regulation itself as far as whether such transactions are "real estate related financial transactions," though the exemptions section seems to imply that such notes receivables are "real estate related financial transactions."

If you are taking an assignment of the note - no - neither would apply. If you are taking an assignment of both the note and the security instrument, then the appraisal and flood rules would apply.

How do you make sense of the following?

[8. Transactions Involving Real Estate Notes
This exemption applies to appraisal requirements for transactions involving the purchase, sale, investment in, exchange of, or extension of credit secured by a loan or interest in a loan, pooled loans, or interests in real property, including mortgage-backed securities. If each note or real estate interest meets the Agencies’ regulatory requirements for appraisals at the time the real estate note was originated, the institution need not obtain a new appraisal to support its interest in the transaction. The institution should employ audit procedures and review a representative sample of appraisals supporting pooled loans or real estate notes to determine that the conditions of the exemption have been satisfied.

Principles of safe and sound banking practices require an institution to determine the suitability of purchasing or investing in existing real estate-secured loans and real estate interests. These transactions should have been originated according to secondary market standards and have a history of performance. The information from these sources, together with original documentation, should be sufficient to allow an institution to make appropriate credit decisions regarding these transactions.

An institution may presume that the underlying loans in a marketable, mortgage-backed security satisfy the requirements of the Agencies’ appraisal regulations whenever an issuer makes a public statement, such as in a prospectus, that the appraisals comply with the Agencies’ appraisal regulations. A marketable security is one that may be sold with reasonable promptness at a price that corresponds to its fair value. If the mortgages that secure the mortgage warehouse loan are sold to Fannie Mae or
Freddie Mac, the sale itself may be used to demonstrate that the underlying loans complied with the Agencies’ appraisal regulations. In such cases, the Agencies expect an institution to monitor its borrower’s performance in selling loans to the secondary market and take appropriate steps, such as increasing sampling and auditing of the loans and the supporting
documentation, if the borrower experiences more than a minimal rate of loans being put back by an investor.]

This would seem to indicate that an exemption exists if the initial transaction that created the note is supported by an appraisal. So, if there is no existing collateral valuation, then the exemption would not be valid. Why list as an exemption if the initial understanding is that this type of transaction would not require it?

"If each note or real estate interest meets the Agencies’ regulatory requirements for appraisals at the time the real estate note was originated, the institution need not obtain a new appraisal to support its interest in the transaction. "

That is either true or it is false.

I guess I am having a hard time figuring out the point you are trying to make?

So, conclude that statement is false. Then what?

Then you need an evaluation or appraisal according to your Board Approved Evaluation and Appraisal Policiy

By Regulation?

If yes, then that was my initial point.

"I came to the conclusion that an appraisal or evaluation would be required if the borrower doesn't obtain such collateral valuations when they do their loan with the buyer of the property."

If the entity doing the notes isn't getting any type of collateral valuation for real estate related transactions, then it would seem the Bank that takes the Notes Receivable as collateral would need to do so.

My point was, if all you are doing is taking "Notes Receivable" then you are not required to obtain any appraisals. Your collateral consists of the notes and not the real property.

If you are taking an assignment of both the notes and the security instruments, then the appraisal rules kick in.

Okay, back to square one, lol. I disagree. My understanding is that the Regulation seems to require it for Notes only collateral.

Taking only notes receivable as collateral on a loan where the notes receivable are secured by real estate would seem to be equivalent to Mortgage Backed Securities. If you have a loan secured by Mortgage Backed Securities, it is the Bond that secures the loan. There is no security instrument in the Real Estate given to the creditor.

I believe you are mixing apples and oranges here.

The Bond issuer holds mortgages which secures the MBS. So, when you take an MBS as collateral, you have a right to the underlying real property that secures the MSB.

If you take just a mortgage note for collateral and do not take assignment of the underlying security instrument, it is no different than loaning to a doctor and taking his accounts receivable as collateral. You have no direct right to the underlying collateral, and you are in no position to enforce anything in the security agreement.

It doesn't really fit the definition of "real estate-related financial transaction" because the loan is not secured by the real estate. The loan is secured by the note that is in turn secured by the real estate. A default on the loan entitles the lender to foreclose on the borrower's interest in the collateral note and collect payments on the collateral note. But it would not entitle the lender to foreclose on the real property that secures the collateral note. If the lender has foreclosed its interest in the collateral note, and the borrower under the collateral note defaults on that note, the lender could foreclose on the property and collect the proceeds up to the balance on the collateral note. But any excess proceeds would have to go back to the borrower on the collateral note because the property only secures the collateral note, not the lender's loan secured by the collateral note.

With that said, the regulation throws in "including mortgage-backed securities" at the end of this definition even though it doesn't really fit the rest of the definition. And the exception that NABW quoted makes it pretty clear that even though this situation does not actually involve a security interest in the property to secure the loan currently being made, the regulation requires appraisals of the properties unless the exception applies.

Randy's assessment is correct.

If you take an assignment only in the notes receivable secured by RE then the loan is secured by the notes receivable and not the RE. In the case of default how you get to the RE is a matter for your legal department.

If however you take an assignment in the note receivable and an assignment in the security instrument then the loan is now secured by both the notes receivable and the RE. Once the loan becomes secured by the RE the exemptions are lost.

Yeah, it's not really clear to me one way or another.

@Rainman: I would hazard to say they are understanding it through this part of the definition (assuming I am correct)

"The use of real property or interests in property as security for a loan or investment, including mortgage-backed securities."

Again, I agree the definition doesn't really match up, but the exemption 8 language seems to clearly imply that it does fit within the definition.

The key is "The use of real property or interests in property as security". With just an assignment of the note, you do not have that. The note could be secured by real estate, a car or anything else and without an assignment of the security instrument, the only thing you have is an interest in the note.

If you take a MBS as collateral, you have an interest in the real property as that is what the MBS represents - AKA Mortgage Backed - it does not say promissory note backed.

I agree with Randy's first paragraph and if the rule made sense, appraisals would not be required in such transactions. But the wording in the exception #8 seems (to me) to indicate that the FDIC sees it differently. If you are taking a security interest in a note secured by real estate, either the original lender must have done an appraisal or you must do it.

I disagree with Randy's second paragraph to an extent, because it depends on what is meant by "mortgage backed security." An MBS is often a bond that is secured by the notes (not secured by the real property). The bond issuer's default on the bond would not entitle the bondholders to foreclose on the real estate. It would allow them to foreclose on the notes that are secured by the real estate and collect the payments on those notes. In that case, the appraisal requirement should not apply (and maybe it doesn't). But if the mortgage backed security is instead a certificate representing an ownership interest in a pool of loans secured by real estate, then it is truly an obligation secured by real estate.

"if the mortgage backed security is instead a certificate representing an ownership interest in a pool of loans secured by real estate, then it is truly an obligation secured by real estate.:

If that is not the definition of a Mortgage Back Security, I truly have been asleep at the wheel for the last 45 years of banking.

As I said, there are two types. That's one of the two types.

From 15 U.S.C. 78c:

(41) The term ‘‘mortgage related security’’ means a security that meets standards of credit-worthiness as established by the Commission, and either:

(A) represents ownership of one or more promissory notes or certificates of interest or participation in such notes . . . which notes: (i) are directly secured by a first lien on a single parcel of real estate . . . or

(B) is secured by one or more promissory notes or certificates of interest or participations in such notes (with or without recourse to the issuer thereof) and, by its terms, provides for payments of principal in relation to payments, or reasonable projections of payments, on notes meeting the requirements of subparagraphs (A)(i) and (ii) or certificates of interest or participations in promissory notes meeting such requirements. (Emphasis added.)

From investopedia:

A residential mortgage-backed security is constructed by one of two sources: a government agency such as the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), or by a non-agency investment-banking firm. First these entities sell or control a large number of residential loans. Next they package a large number of them together into a single pool of loans. Finally these entities essentially sell bonds backed by this pool of loans.

All you have said there is that a MBS is a ‘‘mortgage related security’’ and not all ‘‘mortgage related security’’s are MBSs.

And just so I am clear on my stance. All I am saying is that if you take an assignment of only a note and do not have an interest in the underlying property via the security interest, the appraisal guidelines and any appraisal regulations do not apply. They are just not a regulatory consideration. Just like the flood insurance regulations.

From a safety and soundness perspective, would I ever make a loan by just taking the note - the answer to that is heck no. We are just talking about the actual application of the regulatory guidelines and requirements.

That's not all I said. This is the condensed version of the investopedia explanation:

A residential mortgage-backed security is . . . bonds backed by this pool of loans.

Pools of loans consistent of both the notes and the security interests - I have never seen a MBS that was not. If you know of actual securities that are for sale that are only backed by mortgage notes, then I would like for you to send me a copy of the prospectus, as I have never seen one.

You are missing the distinction between:

a) ownership of a fractional share of a pool of notes secured by mortgages; and
b) ownership of a bond issued by the securitization party and secured by the pool of notes secured by mortgages

In the first case you bought a piece of the pool of loans. In the second case you made a loan secured by the pool of loans.

Yes, I am not arguing that point - but I have never seen an a) - have you?

I personally have not but FNMA says they issue them. And I thought you were saying that you had only seen a), which is the type that would require appraisals if they hadn't already been done.

Type a) would not require appraisals or flood insurance if they are only secured by the notes. It would be no different than making an accounts receivable loan.

OTHER SECURITY INTERESTS 11. If a borrower offers a note on a single-family dwelling as collateral for a loan but the lender does not take a security interest in the dwelling itself, is this a designated loan that requires flood insurance?

No. A designated loan is a loan secured by a building or mobile home that is located or to be located in an SFHA in which flood insurance is available under the Act. In this example, the lender did not take a security interest in the building; therefore, the loan is not a designated loan.

My [next to] last comment on this thread that has drug out beyond anyone's interest other than you and me: I fully agree with you on that point. My point was that that is a type of MBS, and by having the general reference to MBS in the regulation without specifying that they were referring to the other kind can lead to the impression that the regulation actually does require appraisals even though that doesn't make sense or fit with the rest of the definition.

I totally agree with your point. And issuance of bonds that are secured by notes (which in turn are secured by mortgages) is just doing that on a large scale instead of one at a time.

Whew - glad we beat that to death late on a Friday

Have a great weekend

You too. You're two hours closer to finishing than I am.

Is your opinion different if the Note Receivable transaction is between individual companies/corporations and not financial institutions? If you have an Assignment of Note and Mortgage recorded assigning the note rec between two companies and no financial institutions. Is the Lender/Company supposed to comply with appraisal and flood regulations? Is this Bank expected to make sure that the appraisal and flood regulations were followed on a transaction between two companies? Is that an EIC question?

FIs that I know of that do this place this responsibility on the borrower that is pledging the collateral. Many banks have warehouse lines, etc. that are secured by both the notes and the underlying real estate security instruments. If the original lender is subject to the flood regulations, it really does not matter at that point. But as an assignee, do you really want to mess with loans that do not comply? You are not purchasing the loans, as that would provide you an exemption until a triggering event. You are using them as collateral. Most FIs that I know will just not take an assignment of whole loans (note and security instrument) if the property is in the flood zone from borrowers that do not follow the flood insurance rules. Some might just take the note in those specific cases or just pass on that piece of collateral.