The Office of the Comptroller of the Currency has advised a bank that participation certificates representing interests in Federal Housing Administration-insured Title I property improvement loans should be treated as loans or extensions of credit to the seller-servicer rather than either Type I or Type III securities.
There is no quantitative limit on the purchase by a national bank of Type I securities, but banks may not hold Type III securities with values in excess of 10% of capital.
The bank acted as a private placement agent for Class APCs that represented 90% fractional undivided interests in pools of Title I loans.
The seller of the Class A Certificates is the insured party under Department of Housing and Urban Development regulations and retains legal title to the whole loans. The seller continues to service the underlying loans and must, by contract, pay the holders of the certificates 100% of the proceeds of any insurance paid on defaulted loans. The seller retains the remaining 10% undivided loan interests--Class B certificates--which represent the uninsured portion of the Title I loans. If HUD rejects a claim of insurance, the seller is obligated to repurchase the loan.
"In my opinion, the Class A certificates would not qualify as Type I securities," wrote Peter Liebesman, assistant director of the Legal Advisory Services Division of the OCC. "Although the Class A certificates represent the 90% portion of the loan pool that is eligible for the HUD Title I insurance, the HUD obligation to cover loan losses is limited to the amount of the lender's ~insurance coverage reserve account. ~Because of this limitation, the HUD insurance coverage does not represent the full faith and credit commitment of the United States to the repayment of the 90% portion of the underlying loans." Such a commitment is the fundamental requirement to be classified as Type I securities.
Liebesman did not rule that the certificates could not be classified as Type III securities, but advised the bank to ask for reconsideration after the OCC completes an in-progress review of whether private placement unregistered securities, such as the Class A certificates, can meet the marketability for investment securities.
"From the description that you have provided, it appears that the purchasers of the Class A certificates will place considerable reliance on the seller/servicer," wrote Liebesman.
"Not only does the purchaser rely on the seller/servicer to perform all the normal functions of a loan servicer, but the purchaser must also accept the seller's representation that the pooled loans do, in fact, qualify for HUD Title I insurance. In addition, the purchasers have no right to receive insurance proceeds from HUD, but must rely on the servicer to pursue the claims in its own right and to forward amounts received as specified under the contract.
"Accordingly, whether one focuses on the seller/servicer's retention of the subordinated Class B certificates or simply applies the OCC's previous rulings on the application of the lending limit to participation interests in pooled loans, it is my conclusion that the Class A certificates should be treated as loans or extensions of credit to the seller servicer... ."