Real Estate Mortgage Investment Conduits

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Real Estate Mortgage Investment Conduits
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Brief 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.

• 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?

• 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 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.

• 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.

• 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.

• 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.

• 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, 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, 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, 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, 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 Activities

• 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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Typical Pay-Through Structure
Sponsor
Cash payments on ownership interests
Collateral
Cash Ownership Interests
Owner Trust
Manager (I-Bank)
Investors
Pay-Thru Bonds
Pay-Thru Bonds
Cash
Cash
Physical Transfer of Collateral
Owner Trustee

• Acts as trust administrator
• Pays expenses of trust

Cash payments on bonds
Cash payments on ownership interests
Pledge of Collateral

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

Bond Trustee
Servicer
Borrowers
Principal Interest payments
Principal Interest payments less Servicer fees