Real Estate Mortgage Real Estate Mortgage Investment ConduitsInvestment Conduits

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Brief History of REMICsBrief History of REMICs

Created by Congress in 1986 (Tax Reform Act – “TRA”) and administered by the IRS, REMICs were designed to bring consistency to the secondary loan market

Secondary loan market consists of:– Whole loan sales (individual and bulk)– “Pool” sales, consisting of

Pay-through securities (obligations collateralized by pool of loans) issued by Grantor & Owner Trusts or Offshore entities

Pass-through securities (undivided fractional interest in pool of loans) issued by Grantor Trusts

Preferred securities (backed by pool of loans) Other variations (e.g., earnings based accounts, etc.)

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History of REMICs, Cont.History of REMICs, Cont.

The TRA provided that, after 1991, an entity could only issue multi-class MBSs if it was a REMIC

Concurrent with the creation of REMICs, Congress created TMPs as a stick to incent multi-class issuers to make REMIC elections (TMP rules impose an entity level tax that is avoided if a REMIC election is made)

As alluded to above, REMICs are not subject to the system of corporate taxation that generally subjects shareholders to “double” taxation:– REMIC incurs interest expense for payments to

interest holders– Any remaining income is allocated to “equity” owner

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What, exactly, is a REMIC?What, exactly, is a REMIC?

A REMIC is any entity allowed under state law (e.g., corporation, trust, or partnership) that meets the requirements and elects to be treated as such; a REMIC may also be formed as a segregated pool of assets, rather than a separate legal entity

A REMIC is treated as a non-taxable entity and its regular interests are treated as debt

REMICs must meet interest, asset and arrangement tests

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REMIC - Federal Tax QualificationREMIC - Federal Tax Qualification

Interest Test– All interests must be either regular or residual

interests One residual class allowed with pro rata distributions

– Defined as anything that is not a regular interest Unlimited regular classes (including none)

– Issued on the startup day (a 10 day period, any one of which can be designated as the “startup” day)

– Designated as “regular interest”– Has fixed terms (maturity date)– Interest payments consist of specified portion of

interest payments on qualified mortgages which does not vary over life of class

– Unconditionally entitles holder to receive specified principal amount

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REMIC - Federal Tax Qualification, Cont.REMIC - Federal Tax Qualification, Cont.

Asset Test– Substantially all of its assets are comprised of “qualified

mortgages” and “permitted investments” Qualified Mortgages include:

– Any obligation which is principally secured by an interest in real property and is either transferred to the REMIC on the startup day or is purchased within 3 months pursuant to a fixed-price contract in effect on the startup day

– Any regular interest in another REMIC– Any qualified replacement mortgage, which is any obligation

that would be a qualified mortgage if it were transferred to the REMIC on the startup day, and that is received for either another obligation within the 3 month period or a defective obligation within 2 years of the startup day

A defective obligation is one in default or reasonably expected to default, issued under fraud, that does not conform to customary representation or warranty given by sponsor or prior owner

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REMIC - Federal Tax Qualification, Cont.REMIC - Federal Tax Qualification, Cont.

Asset Test, Cont.– Substantially all of its assets are comprised of

“qualified mortgages” and “permitted investments” Permitted investments include:

– Cash flow investments representing investment of payments received from qualified mortgages for a temporary period between receipt and the regularly scheduled date for distribution to REMIC interest holders (cannot exceed 13 months)

– Qualified reserve assets representing investment in a qualified reserve fund (established to pay REMIC expenses and/or amounts due on interests in the event of defaults, lower expected returns or other contingencies that could be provided for under a credit enhancement contract)

– Foreclosure property

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REMIC - Federal Tax Qualification, Cont.REMIC - Federal Tax Qualification, Cont.

Asset Test, Cont.– Substantially all of its assets are comprised of

“qualified mortgages” and “permitted investments” “Substantially all” means that no more than a de

minimis amount of other assets can be held by REMIC Safe harbor rule for satisfying de minimis test is

considered to be met if the aggregate tax basis of those other assets is less than 1 percent of the aggregate tax basis of all REMIC assets

If REMIC fails the assets test, REMIC status is lost effective retroactive to the first day of that year

If REMIC holds a de minimis amount of nonqualified assets, any net income attributable to those assets is subject to a 100 percent tax; REMIC status is not failed

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REMIC - Federal Tax Qualification, Cont.REMIC - Federal Tax Qualification, Cont.

Arrangement Test– Entity must adopt reasonable arrangements

designed to ensure that residual interests are not held by disqualified organizations and that information sufficient to impose tax on transfers of residual interests to disqualified organizations is maintained Disqualified organization is any governmental entity

not subject to federal tax, or any international organization

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REMIC - Federal Tax Considerations, REMIC - Federal Tax Considerations, Cont.Cont.

Prohibited Transactions– Receipt of any fee or other compensation for

performance of services– Receipt of income attributable to any asset which is

neither a qualified mortgage nor a permitted investment– Any disposition of a qualified mortgage, other than:

Any substitution w/in first 3 months Any substitution of defective obligation w/in first 2 years Foreclosure, default or imminent default Other (qualified liquidation, clean-up call, bankruptcy)

– Any gain realized from sale of cash flow investment– All prohibited transaction income is subject to 100%

statutory rate

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REMIC - Federal Tax Considerations, REMIC - Federal Tax Considerations, Cont.Cont. Prohibited Transactions, Cont.

– Certain loan modifications are deemed to be a “disposition of a qualified mortgage”

A change in the terms of a mortgage if the modified loan differs “materially either in kind or in extent” from the original

– A modification changing the yield is material if the annual yield changes by more than 25 bps or 5% of the original annual yield

– A modification changing the timing of payments is material if the deferred payments are unconditionally payable later than the lesser of 5 years from the date of the deferral or 50% of the original term of the loan

Safe harbors where modification is never deemed “material”

– Changes in terms occasioned by default or reasonably foreseeable default

– Assumption of mortgage– The conversion of a convertible ARM

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REMIC - Federal Tax Considerations, REMIC - Federal Tax Considerations, Cont.Cont.

Prohibited Transactions, Cont.– Certain other modifications are deemed to be a

“disposition of a qualified mortgage” A change in obligor Addition or deletion of co-obligor if it results in a

change in payment expectations Changes in security or credit enhancement

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REMIC - Federal Tax Considerations, REMIC - Federal Tax Considerations, Cont.Cont.

Contributions Tax– 100% tax on any contributions made to the REMIC

after the startup day, with exception for cash contributions made: W/in 3 months after startup day To facilitate a clean-up call or qualified liquidation To a qualified reserve fund by a residual holder

Foreclosure Property Tax– 35% tax on any income from foreclosure property

comprised of: Rents from real property where contingent on profits Gain on sale where REMIC is dealer

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REMIC – Overview of Permissible REMIC – Overview of Permissible ActivitiesActivities Investment acquisitions may be made via contributions of

cash or other assets from sponsor only w/in first 10 days Investment dispositions

– May be made in exchange for other qualified assets for any reason during first 3 months

– May be made in exchange for other qualified assets during first 2 years only if original investments are or become defective

Financing operations are not allowed subsequent to initial issuance of regular and residual interests

Investment of cash flow are permissible, subject to fairly restrictive limitations

Loan modifications may be performed, subject to materiality or default test

Refinance solicitations of REMIC loan customers are generally not recommended, subject to industry administrative practices

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Sponsor

OwnerTrust

OwnerTrustee

BondTrustee

Collateral Cash & Ownership Interests

Physical Transfer of Collateral

Pledge of Collateral

• Collects payments on collateral• Reinvests collections over short-term• Makes payments on bonds• Pays expenses of trust

Manager(I-Bank)

Pay-ThruBonds

Cash

InvestorsPay-Thru

Bonds

Cash

Typical Pay-Through Structure

• Acts as trust administrator• Pays expenses of trust

Cash paymentson bonds

Cash payments onownership interests

Cash payments onownership interests

ServicerBorrowers

Principal & Interestpayments

Principal & Interestpayments lessServicer fees