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**Office of the Comptroller of the Currency**

**Federal Deposit Insurance Corporation**

**Federal Reserve Board**

**Office of Thrift Supervision**

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March 17, 2003 **Interpretive Letter #987**

# April 2004

# 12 CFR 3

Dear **\[ \]**,

Thank you for your letters requesting clarification on the appropriate
capital treatment for second liens in structured mortgage transactions.
As you know, the Agencies issued a final rule on November 29, 2001
entitled the \"Capital Treatment of Recourse, Direct Credit Substitutes,
and Residual Interests in Asset Securitizations\" (Final Rule). The
Final Rule addresses a variety of exposures retained or assumed by a
banking organization. In the preamble to the Final Rule, the Agencies
stated that \"second liens will not, in most instances, constitute
recourse. Second mortgages or home equity loans generally will not be
considered recourse arrangements unless they actually function as credit
enhancements.\" \[66 FR 59621\]

In drafting the Final Rule, the Agencies\' determined that second
mortgages generally would not meet the definition of a recourse
arrangement, even when the first and second mortgage were made to the
same borrower at the same time. The Agencies view the second mortgage as
a separate transaction that does not \-- in and of itself \-- serve as a
credit enhancement. Generally, the holder of the first mortgage has a
senior claim on the collateral supporting the mortgages but would not
have any rights to payments made on the second mortgage. This is in
contrast to a typical recourse arrangement where any payments made by
the underlying borrowers are first used to satisfy the claims of the
senior investors in accordance with the terms and conditions of the
transaction. Further, the credit risk present in most structured second
liens is similar in most aspects to second liens originated on a
standalone basis, which are not considered to be recourse obligations
under our existing rules. For these reasons, the Agencies do not believe
that the second mortgage liens referenced in your letters meet the
definition of recourse as set forth in the Final Rule.

The Agencies are aware of elevated credit risk related to high
loan-to-value financing. Institutions with concentrations of second
liens in structured mortgage programs are often subject to higher
examiner scrutiny and, in some cases, higher capital requirements. For
example, the Agencies have issued subprime and high loan-to-value
residential real estate guidance that indicates when examiners should
assess higher capital charges for loans that pose a higher degree of
credit risk. We will also consider your concerns, particularly with
regard to the high loan-to-value structured mortgage programs, in future
revisions to our capital standards as part of our efforts to more
closely align regulatory capital requirements with risk.

Please contact Tom Boemio, Senior Supervisory Financial Analyst at the
Board on 202-452-2982, Amrit Sekhon, Risk Expert at the OCC on
202-874-5211, Jason Cave, Chief, Capital Markets Policy at the FDIC, or
Michael Solomon, Senior Program Manager for Capital Policy at the OTS on
202-906-6669, if you have any further questions with regard to this
clarification of the capital treatment of second liens in structured
mortgages.

Sincerely,

/s/ /s/

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Tommy Snow Norah Barger

Director, Capital Policy Deputy Associate Director

Comptroller of the Currency Federal Reserve Board

/s/ /s/

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John C. Price George French

Director, Supervision Policy Deputy Director

Office of Thrift Supervision Federal Deposit Insurance Corporation