NEP GENERAL

EXAS

Honorable Preston Smith Lieutenant Governor State of Texas Austin, Texas OpinionNo. C-793

Re: Eligibility of FHA insured first lien mortgages as investments ,forthe Permanent University Fund of the University of Texas, and the authority of the Board of Regents of the University of Texas, the State Board of Education, the State Board of Trustees of the Employees Retirement System and the State Board of Trustees of the Teacher Retirement System to contract for the servlclng of FRA insured first lien Dear Governor Smith: mortgage Investments.

You have requested reconsiderationof Attorney General's Q$-&o~8o ww-484 (August 5, 1958), hereinafterreferred to

- . In that opinion, the Attorney General said the PermanentUniversity Fund could not enter into contracts for servicing mortgages insured by the Federal Housing Administration (FHA)because:

"The first lien real estate mortgage securities Inquired about are not guaranteed in whole as requiredby Section lla of Article VII of the Constitutionof Texas and are not eligible as an investment of the Permanent University Fund of the University of Texas."

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Honorable Preston Smith, page 2 (C-793 ) 2

Your requestpoints to changes in the statutes and regulationspertaining to FHA Insuredmortgages since WW-484
was rendered and closeswith two questions that will be answered in order.

"(1) ARE FHA INSURED FIRST LIEN REAL ESTATE MORTGAGESNOW ELIGIBLEAS AN INVESTMENT FOR THE PERMANENT TH D E UNIVERsTTY

Ww-484 was limited to thosemortgages insuredby the FHA under Section 203 of the National Housing Act (12U.S.C. Sec. 1709), as amended, hereinafter referred to as the Act; this opinion is also so limited. The basic question recited in WW-484 was whether or not suchmortgages were "guaranteed In whole" as required by Section lla of Article VII of'the'Constltutionof Texas, the pertinentpart of which provides that:

"/?? The PermanentUniversity Fund may -- be invested in first lien real estatemortgage securitiesguaranteed in any manner in whqle by:the United States Governmentor any agency thereof

. . . . In making each and all of such investments said Board of Regents shallexercise the judgment and care under the clrcumstances then prevlilingwhich men of ordinary prudence, discrct$on and intelligence exercise in themanagement of their own affairs not in regard to speculationbut in regard to the permanent disposttionof their funds, considering the probable income therefrom as well as the probable safety~ of their capital

. . . . This amendment shall be self-enacting

. . . .'

After considerationof the statutes and regulations in effect on August 5> 1958, the Attorney General concluded in W-484 that the FHA insurancewas not sufficient to render themortgages "guaranteed

. . . in whole" for the benefit of the Permanen,t University Fund.

The Attorney General has always recognized the general effect of Section lla,ArticleVII of the Constitutionof Texas. In Attorney General'sOpinion No. m-263 (December 31, 1956), it was stated:

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"A considerationof the provisionsof. Article 7, Sections 10, 11, 11(a),,12 and 15 of the Constitution of Texas, shows quite clearly that the only change in our Constitution affected by the adoption of Article 7, Section 11(a) was to increase the permissive investments of the PermanentUniversity Fund. The sole purpose of the endowment or non-expendable fund is to produce revenue to maintain the institution endowed, and the
new provision of the Constitutionis merely to aid in the procurement of that objective by the broadening of the investmentportfolio."

This statementwas reiterated in Attorney General'sOpinion No. W-69 (March 18, 1957).

After careful considerationof amendments to the Act and the regulationspromulgated thereunder, this office consents to reconsider 'che,conclusion in WW-484 that FJJA insured first lien mortgages are not eligible investments for the PermanentUniversity Fund. The Act has been changed many times; therefore, for convenienceall citationswill be to the provisions of theAct as found in Title 12, U.S.C., Sections 1701 et. seq.

In W-484, portions of Section 204 of the Act (12U.S.C. Set

. 1710) were quoted in order to outline the procedure required when a mortgage has been foreclosed. Those portions will again be quoted with the relevant changes thereto emphasized:
"(a) I:n any case in which the mortgagee under a mortgage insured under section 1709 of this title flection 203 of the Act 7shall have foreclosed and-takenpossession of ths mortgaged property in acecrdansewith regulationsof, and within a period to be determinedby, the Commissicnez~

or shall, with the consent of the Commissfo.ner,

have otherwise acquired such property from themortgagor after default, the mortgagee shaX. be entitled to receive the benefit cf the insurance as hereinafter provided,upon (1) the prompt conveyance to the Commissionerof title to the property which

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meets the requirementsof rules and regulations of the Commissionerin force at the time the mortgage was insured, and which is evidenced in the manner prescribedby such rules and regulations,and (2) the assignment to him of all claims of themortgagee against themortgagor or others, arising out of themortgage transactionor foreclosureproceedings, except such claims as may have been released with the consent of the Commissioner. Upon such conveyanceand assignment

. . . the Commissioner shall, subject to the cash adjustmentherelnafter provided, issue to the mortgagee debentures having a total face value equal to the value of the mortgage and (subjectto subsection (e) (2) of this section) a certificate of claim, as hereinafterprovided. For the purposes of this subsection,the value of the mortgage shall be determined, in accordance with rules and regulationsprescribed by the CommLssioner,by adding to the amount of the originalprincipal obligation of the mortgage which was unpaid on the date of the institutionof foreclosureproceedings,or on the date of the acquisitionof the property after default other than by foreclosure the amount of all paymentswhich have been made by the mortgagee for taxes, ground rents, and water rates, which are liens prior to themortgage, speciab assessmentswhich are noted on the application for insuranceor which become liens after the Wsurance of the mortgage,

- - insurancepremiums,and any tax imposed by the United States upon any deed or other instrumentby which saidproperty was acquired by the mortgagee and transferred or conveyed to the Commissioner and by deducting from such total amount any amount received on

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account of themortgage after either of such dates, and any amount received as rent or other Income from the property, less reasonable expenses incurred in handling the property, after ei,ther of such dates And provided further, That with respect ;o mortgages whi.ch

are accep,ted

for insurance under Section 203(b) (2) (D) or under the secondproviso of section 1713 (c) (2) of this title, or under section 1715e of this title,
or with respect to any mortgage accepted for insuranceunder section 1709 of this title on or after August 2, 1954, theremay be included in the debentures issued by the Commissioner
onaccount of the cost of foreclosure (or of acquiring the property by othermeans) actually paid by themortgagee and approvedby the Commissioneran amount,not in excess of twothirds of s.uchcost or $75 whichever is the greater: And provided further,That with respect to a mortgape accepted for insurancepursuant to a commitment issued on or after September 2, 1964, the Commissionermay include in debenturesor in the cash payment an amount not to exceed the foreclosure,acquisition,and conveyance costs actuallypaid by the mortgagee and approved by the Commissioner And provided further, That where the claim'ispaid in
zn there shall be included in the cashp -.-,. ment I_~ ayan amo,un,t

egui,valent

to the compensation for loss of debenture interest that would be included in computing debentures if suchim
were being paid in debentures

. . . .'I 12 zT.S.C., Section 1710(a) (Kmpk,asis added).

In 1958, a mortgagee who foreclosedand took possession of the mortgaged property upon the mortgagor's default had the right to receivepayment of FHA insurance in the combination of (1) .FHAdebantures, (2) cash up to $50 and (3)
a certificate of claim, As demonstratedby the changes in the Act and discussed in greater detail, infra, the form of payment of PHA insurancehas changed considerably.

In W-484, Section 294(e) of theAct (12U.S.C. Sec. 1710(e)!, which defines a certificateof claim,was used
as evidence that the tnta~l race value of the debentures

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plus the cash adjustment could possibly be insufficientto make a mortgagee (the PermanentUniversity Fund) whole when
a mortgage was foreclosed, That provision now reads:

"(e) (1) Subject to paragraph (2), the certificateof claim issued by the Commissioner to any mortgagee shall be for an amount which the Commissionerdetermines to be sufficient, when added to the face value of the debentures issued and the cash adjustmentpaid to the mortgagee, to equal the amount which the mortgagee would have received if, at the time of the conveyance to the Commissionerof the property covered by the mortgage, themortgagor had redeemed the property and paid in full all obligationsunder the mortgage and a reasonable amount for necessary expenses incurred by the mortgagee in connection with the foreclosureproceedings,or the acquisition of the mortgaged property otherwise,and the conveyancethereof to the Commissioner. Each such certificateof claim shall provide that there shall accrue to the holder of such certificatewith respect to the face amount of such certificate,
an increment at the rate of 3 per centumper annum which shallnot be compounded. The amount to which the holder of any such certificate shall be en- ' titled shallbe determined as provided in subsection (f)of thls section.

(2) A certificateof claim shallnot be issued and the provisions of paragraph (1) of this subsection shallnot be applicable in the case of a mortgage accepted for insurancepursuant to a commitment issued on or after September 2, 1964." -(Emphasis

added).
Further, the FHA regulationsprovide: I

"If the mortgage was accepted for insurance pursuant to a commitment issued on or after September 2, 1964, no certificateof claim shall be issued.' 211C.F.R., Section 203.4:5(b). See also letter from FHA Commissionerto all approvedmortgagees dated September 2* 1964 (64-10).

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In wW-484 the protection afforded the Permanent University Pond by the FHA in the event of default by the mortgagor and foreclosureby themortgagee was examined. Today, the payment of insurance benefits is somewhatdifferent. First, the Act provides:

"Notwithstandingany other provisions of this chapterwith respect to the payment of insurancebenefits, the Commissioner Is authorized, in his discretion, to pay in cash or In debentures any insurance claim or part thereof which Is paid on or after August 10, 1965, on a mortgage or a loan which was insured under any section of this chapter eitherbefore or after such date. If payment is made in cash, it shall be in an amount equivalent to the face amount of the debentures that would otherwise be issuedplus an amount equivalent to the interestwhich the debentureswould have earned, computed to a date to be establishedpursu%nt to regulations issued by the Commissioner. 12 U.S.C., Section 1735d(a).
Further, the regulationsprovide:

The the 10, "If the application for insurancebenefits is acceptable to the Commissioner,payment of the insurance claimwill be made in cash, in debenturesor in a combinationof both, as determinedby t;e ;Ki,;siPonerat the time of the payment. 0

. a,Section 203.400.
present policy of the FHA is found in a letter from Commissioner to all approvedmortgagees datedAugust 1965 (65-g) that says on pages 5 - 6:

"FHA is now authorized to settle all mortgage insurance claims in cash or debentures at the option of FHA. All claims received on and after September 1, 1965, will be paid in cash,unless themortgagee specifically requests debentureswhen the claim is filed. A 90% partial settlementwill be made within 5 days after the claim is received. The

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final settlementwill be made after receipt of fiscal data and title requirements. The partial and final settlementwill include an interest allowance, comparable to the debenture rate, on the amount of the settlement. No cash remittances are to be made to FHA covering escrow deposits,undisbursedmortgage proceeds, etc. These amountswill be retainedby the mortgagee and offset in the claim settlement."

The formula for determining the amount of payment the FHA will make is found in 24 C.F,R., Sections 20x.401-203.404.

Should the,,mortgagee elect to accept debentures, the debentures are as to principal and &cerest by the United States fully and unconditionallyguarantee:

12U.S.C., Section 1710(d). (Emphasisadded). The'int&&t rate on'debentures is establishedby the method set out in 12U.S.C., Section 17150 and the regulationsprovide that:

"Debenturesshall bear interest from the date of issue, payable semiannuallyon the first day of January and the first day of July of each year at the rate in effect
as of the date the commitmentwas issued,
or as of the date the mortgage was endorsed for insurance,which ever rate is the higher .[on or after July 1, 1966, the effective rate is 4 5/8$-T." 24 C.F.R., Section 203.405.

Debenturesmature twent 24 C.F.R., ;: years from the date of issuance. Section 203. 06.

Themortgagee now has ,the option of (1)obtaining
a cash payment of benefits, or (2) requesting debentures that are guaranteedby the United States. Even if the FHA Commissioner'spolicy should change the mortgagee would be paid in a combinationof cash and debentures;the certificates of claim have been abolished by Congress. FHA insured first lienmortgages, therefore,meet the constitutional standard and are now eligible investments for the Permanent University Fund, Themortgagee's option is to be exercised, of course,by the Board of Regents under the prudent investor standard set out in Section lla,ArticleVII of the Constitu-

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ticn cf Texas. The answer to your first questlon is, therefore, af?irmative.

We have held, supra, that the PermanentUniversity Fund is authorized to invest in FRA insured first lien mortgages. The followingFunds can also be invested in FHA insured first lienmortgages:

(1)Permanent School Fund. Article VII, Section 4 of the Constitutionof Texas and Article 2669(d), jV.C.S.

(2) State Retirement,Disability and Death CompensationFund. Article XVI, Section 62(a) of the Constitutionof Texas and Ar,ticle 62!28a,

Section 7A, V.C.S.

,,t;k! eat

ika::dn4t:her RetirementFund. Article III,

A&icle 2922-1, b of the Constitutionof Texas and

Section 13(l),V.C.S.

The authorityof the Board of Regents of the University of Texas, the S'ca,te Board of Education, the State Board of Trustees of the EmployeesRetirement System and the State Board of Trustees or the Teacher Retirement System of Texas (the agencies chargedwi,th administrationand control of each Fund) to c0ntrac.F: f'orservicingof mortgages is not expresslyprovided by sta.t%.:.te. There is, however,no statutory prohibition.

In Attornev GeneralvsGninion No. W-69, supra, it was said with refer+znce to a proposed procedure for the purchase and sale of corporate securities for the PermanentUniversity Fund:. . .

Honorable Preston Smith, page 10 (C-793)

"ArticleVII, Section 11(a), by its own terms, is self-enactingand the absolutely essentialpowers to carry the program into effect are necessarily conferredupon the Board of Regents by implication. The payment of such required commissions, fees and taxes, before the delivery of the securities to the PermanentUniversity Fund at the State Treasury, are costsof acquiring the securities and must be said from the PermanentUniversitv Fund. This is the ordinary and customarybusiness and accountingpractice and the constitutionalprovision infers that the customarybusiness procedureswill be followed." (Emphasis added). See First National Bank v. Port Arthur, 35 S.W.2d 258 (Tex. Civ. App. 1931,n.w.h.).
Since it is the customarybusiness and accountingpractice for institutionalmortgage investors to contractwith mortgage bankers for servicingof their investments,we find that the above named agenciesmay so contract.

Each Fund has been createdpursuant to separate constitutionaland statutoryprovisions. Each Fund has a separate set of statutes relating to its accounting aspects. Each controllingagency has a certain degree of discretion
as to the investment of each Fund. Opinion No. See Attorney General's

C-70LI(June7, 1966). Therefore, this office does not deem it appropriate to approve any single contract form for use by all agencies. We recommend that future servicing contractsbe submitted to this office for approval prior to execution.

In answer to your second question, it is our opinion that the Board of Regents of the University of Texas, the State Board of Edu.cation, the State Board of Trustees of the ,Employees

Retirement System and the State Board of Trustees of the Tea&m Retirement System have the authority to contraztw:ithcorrespondentsin various sections of Texas for the servicingof FHA insured first lienmortgage loans.

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SUMMARY--m--mFHA Insured first lienmortgages are eligible Investments for the Permanent UniversityFund of the University of Texas.

The Board of Regents of the University of Texas, the State Board of Education, the State Board of Trustees of the EmployeesRetirement System and the State Board of Trustees of the Teacher Retirement System have the authority to contract for the servicingof FHA lnsured first lien mortgages; however,we recommend that future servicing contractsbe submitted to this office for approvalprior to execution.
Respectfully submitted, '

WAGGONER CARR Attorney General of Texas

RCF:vg

APPROVEDr OPINION COMMITTEE
Ralph R. Rash, Chairman M. Paul Martin John W. Fainter, Jr. Mark W. White

APPROVED FOR THE ATTORNEY GENERAL By: T. B. Wright

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