within a few months after we purchase the mortgage. Additional reviews, such as reviews of loans that become early payment defaults or foreclosures, take place when the default or foreclosure occurs.

The regional offices use several different methods to monitor compliance with our flood insurance requirements through the underwriting review process. Compliance checks include methods such as checking the HUD-1 settlement statement when the appraisal indicates that the property is in a floodplain to see if flood insurance coverage was paid for at closing and that a renewal premium is included as part of the escrow deposits. Another method involves appraisal field reviews that we have performed by appraisers that we select. The review appraiser checks the accuracy of the original appraisal report. The review appraisal includes a specific request for the reviewer to check the accuracy of the flood hazard area determination made by the original appraiser. If our spot-check appraisal indicates that the property is located in a flood zone, but the original appraisal did not so indicate, we will require the lender to ensure that appropriate insurance coverage is obtained.

Generally, we take the following actions based on the results of our underwriting reviews. If our review shows that the original appraisal determined that the property is located in a flood zone, the reviewer requires the lender to provide evidence of flood insurance. If the lender did not obtain the required flood insurance, the regional office will ask the lender to obtain the flood insurance. If the lender fails to supply the required coverage, the lender must repurchase the loan from Fannie Mae.

In addition to our mortgage underwriting reviews, lender compliance for flood insurance is also a component of our lender operational reviews. We do periodic onsite assessments of our lenders' mortgage servicing operation. The assessment includes a review of whether proper procedures are in place to ensure the maintenance of hazard insurance and, when required, flood insurance.

Servicing Requirements

Fannie Mae requires its lenders to monitor on an ongoing basis any changes in Special Flood Hazard Areas. If, during the normal course of business, a lender discovers that the redefinition of a floodplain has resulted in the property improvements being included in a flood zone, the lender must notify the mortgagor to obtain coverage against possible damage.

Fannie Mae also reminds servicers of the requirement for flood insurance as circumstances warrant. For example, in 1990 we notified servicers that FEMA maps of the Sacramento area had been redrawn and reminded them to notify borrowers of the need to obtain flood insurance. Periodically Fannie Mae revises its guidelines, including requirements concerning flood insurance where necessary. A recent revision clarified that floods are one of the hazards against which lenders could require borrowers to insure. Our requirements in this regard go beyond the Federal statute. Fannie Mae's Experience With Flood Losses

Over the past several years, our internal review procedures for acquired properties have revealed only three properties affected by flood damage, and in only one case was lack of flood insurance the cause of a loss. That case involved a mortgage that had been included in a servicing transfer that we initiated. Since the new servicer was not able to confirm whether flood insurance coverage was in effect, we absorbed the loss.

CURRENT STATUTORY REQUIREMENTS

Fannie Mae's flood insurance guidelines complement the statutory requirements of the National Flood Insurance Act of 1968 and the Flood Disaster Protection Act of 1973, and related regulations. These Federal laws require banking and thrift institutions to determine that a borrower has secured flood insurance prior to making, increasing, extending or renewing a loan secured by improved real estate in a flood hazard area, if a flood hazard map has been published for the community in which the property is located, and if the community in which the area is located participates in the National Flood Insurance Program. Congress initially enacted the flood insurance measures to reduce Federal expenses for disaster assistance, to promote prudent development of flood hazard areas, and to prevent banking institutions from making loans secured by real estate with a potential for flood loss.

If property securing the loan is in a flood hazard area, the bank or thrift must notify the borrower that the property is in that area and indicate whether related flood Federal disaster relief assistance is available. Banks and thrifts must maintain records that demonstrate compliance with the Acts and the implementing regulations. The statutes mandate enforcement by the primary supervisor of each banking or other covered lending institution.

The flood insurance laws and regulations were designed to be enforced through primary mortgage lenders and their regulators, with complementary requirements for Fannie Mae and Freddie Mac. Fannie Mae has developed underwriting standards, discussed above, that address the Acts and also reinforce the overall framework applicable to primary lenders. Accurately identifying flood hazards and the need for flood insurance is essential to a lender's decision to make a loan. The reliability of the decision on these issues is also important to any subsequent purchase of the loan by an investor in the secondary market, such as Fannie Mae.

Although existing statutory language is clear in many respects, at least one significant question remains. The statute clearly applies wherever loans are made, increased, extended, or renewed. Thus the lender must require flood insurance whenever it originates a loan secured by property located in a Special Flood Hazard Area, or whenever it makes material changes in the terms of such a loan. What has been unclear in current law is whether the lender must require flood insurance with respect to an existing loan. This issue arises in three situations: when the lender erroneously failed to require flood insurance at origination; when insurance in place at origination was subsequently allowed to lapse; and when FEMA revises its floodplain maps, resulting in property that previously was not determined to be in a Special Flood Hazard Area at the time of the loan origination being so designated.

Some have argued that the current statutory language precludes lenders from requiring flood insurance for loans in remapped areas. When FEMA remapping in 1989 resulted in the reclassification of large areas in and around the city of Sacramento, lenders notified borrowers of the need to obtain flood insurance on the properties newly determined to be at risk. The California Insurance Commissioner and the County of Sacramento District Attorney's Office led a public campaign against these lenders, contending that they had no legal authority to require flood insurance with respect to existing loans. Lawsuits have been filed and are currently pending against five lenders, alleging violations of California law in the lenders' notices to borrowers asserting that flood insurance is required by Federal law. This lawsuit is in part the result of alleged lender errors in identifying properties as having been reclassified, but even with respect to the properties that FEMA unarguably determined to be flood prone, the complaint alleges that it was illegal for the lender to require flood insurance. Remapping of the Los Angeles area, expected to be completed in 1994, will exacerbate the situation.

VIEWS ON THE National FlooD INSURANCE Reform Act of 1993

The National Flood Insurance Reform Act of 1993 contains many initiatives that Fannie Mae believes would be beneficial. Additional insurance, more accessible and more accurate maps, and a standard form for information about flood areas are all positive developments. Because most provisions do not affect Fannie Mae directly, I will confine my comments on the specifics of the bill to the two areas where Fannie Mae has a significant interest.

Because of the difficulties due to the ambiguity of the current statute, Fannie Mae supports revisions to clarify the lender's authority to require the borrower to obtain flood insurance on existing loans, particularly loans reclassified as being located in a Special Flood Hazard Area after FEMA remapping. In order to maximize effectiveness of the Federal flood insurance program, it is important to include the largest possible number of properties located in Special Flood Hazard Areas. This increases the funds available to cover flood losses. To permit properties located in remapped areas to escape coverage requirements undercuts the effectiveness of the program, exposes homeowners and lenders to loss, and ultimately will increase costs to the Federal Government, which picks up the tab for uninsured properties damaged by floods. The large percentage of apparently uninsured properties damaged by the recent floods in the Mississippi valley and the resultant necessity to appropriate billions in flood relief have dramatized the need to increase the pool of covered prop

erties.

Fannie Mae supports the language of the bill that addresses this situation, but we feel that a technical correction would increase its effectiveness. Section 204 currently provides that lenders must notify borrowers of the need for flood insurance, and may force-place such insurance, if the lender discovers that the property is not covered "during the term of the loan secured by improved real estate or by a manufactured home located in an area that has been identified by the Director (of FEMA] as an area having special flood hazards." Because this provision does not address the timing of the Director's determination, it can be read as permitting the lender to require flood insurance only where that determination was made when the loan was secured by improved real property, i.e. at the time the loan was originated. This clearly would permit insurance to be required where the lender should have required it at the time of origination but failed to do so. It also permits the lender

to require insurance where insurance was obtained initially but subsequently was allowed to lapse. The bill language remains ambiguous, however, in the case of remapping. In order to clarify that the requirement for flood insurance also applies to properties that are not classified as flood-prone at origination but are picked up by subsequent remapping, we suggest that Section 204 be amended to begin "If, during the term of a loan secured by improved real estate or by a manufactured home located in an area that has been identified by the Director at the origination of the loan, or at any other time as an area having special flood hazards."

An additional correction to the scope of this provision also is needed to achieve maximum effectiveness in accomplishing the statutory objectives. The bill requires that borrowers be notified of the need for flood insurance by "regulated lending institutions" and Fannie Mae and Freddie Mac. We believe that this provision is both too broad and too narrow. It should include not only regulated lending institutions (i.e. banks and savings associations), but also other servicers such as mortgage bankers, in order to pick up all those who are in the best position to notify borrowers of the necessity for flood insurance. For the same reason, the secondary market agencies should not be included, because they have no direct contact with borrowers. We suggest that the bill be amended by substituting the phrase "lenders and servicers" for "regulated lending institution or Federal agency lender."

Finally, there is one section of the proposed legislation that Fannie Mae cannot support. Section 201(a)(3) would require the Director of the Office of Federal Housing Enterprise Oversight (OFHEO) to promulgate regulations mandating that Fannie Mae and Freddie Mac establish procedures to assure flood insurance coverage of all loans they purchase that are located in special flood hazard areas at the time of origination.

Fannie Mae appreciates that at first blush it seems like traditional practice for Congress to assign new regulatory requirements when it identifies a problem and assembles a package of directives to address the issue. But as the President and Vice President pointed out just last week in their initiatives to reinvent government, this standard operating procedure leads to so many new regulations that one needs forklifts to carry them around. We believe that in this case a close examination of the problems suggests that new regulatory authority is not necessary, would involve added costs for everyone, and moves away from the new regulatory approach Congress designed just last year in establishing our new regulator, OFHEO.

In this case, Fannie Mae and Freddie Mac have demonstrated through their own actions that we want the loans in Special Flood Hazard Areas to be covered by flood insurance. We support this policy not just because we agree with the public interest arguments, but because it is in our business interest to have this insurance.

In pursuing our business interest in having flood insurance coverage, we have encountered some resistance from some localities because no one expects floods or wants to pay for insurance-until the calamity arrives. So the problem to be fixed is for Congress to clarify the legal requirement-and our authority-so we can pursue a business interest that parallels the public policy interest. Indeed, our current procedures, conveyed through our contracts with lenders, are more extensive in specifying the need for insurance than is the bill. This is not a situation where a regulator needs new authority to compel us to take an action we may prefer not to take. In effect, one more regulation would mean more costs for regulatory recordkeeping, for internal control procedures designed to satisfy OFHEO, and ultimately for lenders and home buyers-without providing any additional protection.

Moreover, when Congress established our new regulator, just last year, it devised an integrated, cohesive approach that drew some lessons from experience with financial institutions regulations. Sometimes financial regulators have overlooked the safety and soundness "forest" when they have been ordered to check off a long list of detailed "trees" that is assembled piecemeal over the years. In establishing OFHEO, in contrast, the Congress charged its new Director with the duty to insure the adequate capitalization and safe operation of Fannie Mae and Freddie Mac. It would be unfortunate, less than a year after passage of the new Act, to begin an item-by-item "Balkanization" of our regulation-especially when the new regulation is not even directed at the real problem.

In sum, we urge Congress not to impose new regulations-not because we disagree with your goal-but because we share it, and we do not believe it is necessary to add to the regulatory costs of the housing finance system. Ensuring flood insurance coverage is something we want to do, are doing, and is in our interest to do; we believe the purpose of the bill is to ensure that we can do it.

SUMMARY

Although the flood insurance statutes are designed to operate through banks, thrifts and other lenders with enforcement by the various financial institution regu

lators, Fannie Mae has drafted complementary underwriting guidelines that apply to our approved lenders. Our post-purchase reviews and other compliance checks also reinforce the supervision mandated by law by lenders' primary supervisors.

Through these measures, we have been able to minimize risk to Fannie Mae and thus enhance the integrity of our operations, and contribute to the investor confidence in our products that is vital to our public mission.

The National Flood Insurance Reform Act of 1993 would support the efforts of Fannie Mae in clarifying the authority of lenders to require flood insurance where FEMA remapping has changed the flood status of the security property. With some minor amendments in the legislative language, Fannie Mae would encourage the Congress to adopt these changes. Fannie Mae at the same time urges the Congress to omit redundant requirements for regulations in this area.

We welcome the opportunity to discuss this matter today, and will look forward to continuing to help the subcommittee in every possible way to improve administration of the flood insurance laws. I will be pleased to answer any questions you or Members of the subcommittee might have.

TESTIMONY OF MICHAEL K. STAMPER

EXECUTIVE VICE PRESIDENT, RISK MANAGEMENT

FEDERAL HOME LOAN MORTGAGE CORPORATION

Mr. Chairman and Members of the subcommittee, my name is Mike Stamper, and I am Executive Vice President, Risk Management of the Federal Home Loan Mortgage Corporation, better known as Freddie Mac. My division is responsible for the development and enforcement of quality standards for Freddie Mac's acquisition and administration of residential mortgages. I appreciate the opportunity to appear before you today to discuss flood insurance in general, and S. 1405, the National Flood Insurance Reform Act of 1993, in particular. Freddie Mac applauds your efforts, Senator Kerry, to clarify and strengthen the flood insurance policies and requirements in the National Flood Insurance Act of 1968 (“1968 Act") and the Flood Disaster Protection Act of 1973 ("1973 Act"). We have, however, two areas of concern with the legislation in its current form, which I will address in detail later in my testimony. Freddie Mac looks forward to working with the subcommittee and Congress as a whole on the issue of flood insurance.

Freddie Mac realizes the devastating impact that flooding can have on communities and individual homeowners, and we appreciate the important role that flood insurance plays in mitigating this impact in the unfortunate circumstances where it is needed. Pursuant to the 1973 Act, Freddie Mac is prohibited by law from purchasing mortgages secured by properties in Special Flood Hazard Areas ("SFHA8") as classified by the Federal Emergency Management Agency ("FEMA") if these properties are not covered by flood insurance. Freddie Mac believes that the procedures we have in place ensure that properties securing mortgage loans purchased by Freddie Mac are covered by flood insurance when they are determined to be exposed to flood risks. In fact, Freddie Mac's own requirements are more stringent than the statutory requirement in a number of areas.

Freddie Mac is a secondary market entity that purchases mortgage loans from lenders. In other words, we do not make mortgage loans ourselves. Instead, we purchase loans from entities that originate and service mortgages, to which we refer collectively as "seller/servicers." Freddie Mac purchases a large volume of mortgage loans; in 1992, we purchased 1.7 million of such loans, more than 6500 each business day. In order to process this high volume of transactions in a highly automated environment while ensuring the efficiency of the secondary market, we cannot review each loan in detail. Instead, we rely on contractual provisions in the form of representations and warranties made by our seller/servicers that the loans we purchase meet all legal requirements and our own guidelines. One such representation made to Freddie Mac by our seller/servicers is that a property required to have flood insurance is in fact covered by flood insurance for the life of the mortgage loan, unless the requirement no longer applies (such as when FEMA removes the area's SFHA designation).

In order to ensure that the representations made by the seller/servicers are true, Freddie Mac has a compliance monitoring system, which is summarized later in my testimony. This system works well. Freddie Mac has suffered no losses from flooding disasters such as Hurricane Hugo in 1989 and the Southwest flooding in 1990. To ensure that we are in fact in compliance with flood insurance requirements, last week we examined a sample of 9000 loans in our portfolio on properties in des

ignated disaster counties in nine States subject to the recent flooding in the Midwest. Of these 9000 loans, only 106 mortgaged properties were determined to be in SFHAS. Of the 106 loans secured by those properties, we found only two incidences of noncompliance.

The recent floods in the Midwest have brought the country's flood insurance program under scrutiny. Some perceive a problem with the level of compliance with flood insurance requirements throughout the country, because many properties suffering flood damage are not covered by flood insurance. The requirements established by Federal law result, however, in cases where properties that are located in SFHAS are not covered by flood insurance. This is not necessarily a matter of noncompliance, but instead can be a matter of non-applicability of the laws. There are a number of reasons why owners of properties located in areas that experience flooding may not have flood insurance and yet not be in violation of statutory requirements.

• A homeowner may not have a mortgage, or the mortgage may have been originated prior to 1973, and therefore would never have been required by a lender to obtain flood insurance. Surveys show that 42 percent of owner-occupied singlefamily homes do not have mortgages.

• If a property does have a mortgage, that mortgage might have been originated by a non-Federally regulated institution who did not sell the mortgage to Freddie Mac or Fannie Mae. Properties securing mortgages originated under such circumstances are not required by Federal law to carry flood insurance.

• As a result of FEMA's active remapping of SFHAs over the past decade, it is possible that many of the areas that are now designated SFHAs were not so identified until after the mortgages were originated.

It is possible that only a portion of a property is in an SFHA. When the house on the property is in the portion which is not in the SFHA, under the 1973 Act flood insurance is not required.

• A homeowner may have received a FEMA Letter of Map Amendment, which essentially allows the lender to waive the flood insurance requirement. The property remains in an SFHA but FEMA recognizes that the property is above the 100year flood level. This waiver is, however, known only to FEMA, the homeowner, and the lender to whom the homeowner supplied the letter to document the request for flood insurance waiver. The community is not aware of the waiver and the flood map does not reflect this waiver.

• Although an area is designated an SFHA, a community may choose not to participate in the National Flood Insurance Program ("NFIP"). Though Federal flood insurance is not available in a non-participating community and Freddie Mac (and Fannie Mae) are not allowed to purchase mortgages secured by properties in SFHAS of a non-participating community, lenders are allowed to make conventional mortgages in such a community.

• If a portion of an NFIP-participating community has been designated by the Department of the Interior as an undeveloped coastal barrier, Federal flood insurance is not available for structures built after October 1, 1983. The 1968 Act, however, allows Federally-regulated lenders to make conventional mortgages secured by properties on an undeveloped coastal barrier even where such properties are not eligible for flood insurance.

• SFHA maps are difficult to read, and determinations about whether or not a property is in an SFHA can be inconclusive. We have seen different conclusions between an appraiser or a surveyor and a specialized flood hazard determination service. We have also seen different conclusions between two specialized flood hazard determination services. In fact, there seems to be increasing support for the notion that FEMA should be the only entity providing flood zone status determinations, and that SFHA maps should be revised to be easier to read. FEMA itself has struggled with the causes of noncompliance. In citing its figures for noncompliance FEMA has been historically unable to identify the specific causes for this noncompliance.

It is indicative of the difficulty of the flood insurance issue that even FEMA has not been able to provide information to Freddie Mac specifying which properties were required to have flood insurance but did not, or which lenders had allowed flood insurance coverage to lapse.

FLOOD INSURANCE REQUIREMENTS FOR FREDDIE MAC SELLER/SERVICERS

As noted above, existing Federal law prohibits Freddie Mac from purchasing mortgages secured by SFHA properties that are not covered by flood insurance. Specifically, Section 102 of the 1973 Act prohibits a Federal agency, defined in that Act to include Freddie Mac and Fannie Mae, from purchasing mortgages on SFHA properties that are not covered by flood insurance.