SECURITIES DEFINITION
Securities are broadly categorized into:
Debtsecurities (such asbanknotes,bondsanddebentures),Equitysecurities, e.g.,common stocks; and,Derivativecontracts, such asforwards,futures,optionsandswaps
Types of securities include:
Notes, stocks, treasury stocks, bonds, debentures, certificates of interest or participation in profit-sharing agreements, collateral-trust certificates, etc
SECURITIZATION DEFINED
Process, by which loans and other receivables are packaged, underwritten, and sold in the form of securities (instruments commonly known, as Asset Backed Securities).Involves pooling and repackaging of loans into securities that are then sold to investors.Securitization provides an additional funding source and may eliminate assets from a loan originator’s balance sheet.Often used to market small loans that would be difficult to sell on a stand-alone basis.
REMICS DEFINITION
Real Estate Mortgage Investment Conduits
Are a type of SPV used for the pooling ofmortgage loansand issuance ofmortgage-backed securities.They were introduced in 1987and are defined under theUnited StatesInternal Revenue Code(Tax Reform Act of 1986), and are the typical vehicle of choice for thesecuritizationof residential mortgages in the US.REMICs are investment vehicles that hold commercial and residential mortgages in trust and issuesecuritiesrepresenting an undivided interest in these mortgages.
Also called Collateralized Mortgage Obligations.
Investment vehicles that hold commercial andresidential mortgages in trust and issuesecuritiesrepresenting an undivided interest inthese mortgages.
REMICs are:
A trust into which pools of promissory notes(debt instruments – like an IOU) and mortgagesor trust deeds (the security instruments whichpermit foreclosure if the notes are not paid).
In short, a REMIC is
Mortgages into pools and issues pass-throughcertificates, multiclass bonds similar to acollateralized mortgage obligation (CMO), orother securities to investors in the secondarymortgage market.
A REMIC assembles
Consists of a fixed pool of mortgages brokenapart and marketed to investors as individualsecurities.Entitles the owner to a claim on theprincipalandinterestpayments on the particular mortgages underpinning the security.Pay aninterest ratethat is usually related to the interest rates the homeowners are paying on their mortgages.The equivalent of thecouponon a mortgage-backed security is a percentage of the interest and principal paid on the mortgages backing the security
Synthetic investment vehicle
Between 2004 and 2007 the residential loan market experienced tremendous growth.Lenders accommodated millions of borrowers, because they quickly sold the loans they made into the secondary mortgage market, thus “recycling” their funds for further loans.The vehicle of choice for these mortgage-backed securities (“MBS”) was the REMIC.These loan pools range in risk from the highest quality down the credit chain to the lowest quality.
REMICS BACKGROUND
The loans are, figuratively speaking, sliced and diced into many “tranches” (French for “slice”), each one varying in degrees of risk of default.Loans lose their identity as individual notes and mortgages, and consist only of blended pieces of loans.The riskier the tranche, the better the yield.
REMICS BACKGROUND
Wall Street investment banks developed a “private label” market (secondary market for loans without the quality-of-loan constraints imposed by Fannie and Freddie)It was this “private label” market that fueled the credit boom for many of the more innovative and riskier loan products, such as no-doc loans, stated income loans, Alt-A and Alt- B loans.
REMICS BACKGROUND
The rules for the operation of a REMIC arecontained in a voluminous document called aPooling and Servicing Agreement, or “PSA.”
REMICS AND TRUSTEE
The Sponsor of the REMIC is usually a large lending bank. It may or may not have actually made the loans, but acquired them from the loan originator.The Servicer, who may be a subsidiary of the Sponsor. The Servicer’s role is to manage, collect and distribute the funds generated by the pool.The Trustee, who is frequently another bank, but not the same as the Servicer.
PLAYERS
PSA provides that the original promissory notes are to be endorsed in blank to the Trustee, or the Trust.The Mortgages/Trust Deeds, each is to be recorded before being delivered to the REMIC Trustee or Custodian.The Trustee’s main responsibility is to take possession of the loan documents (the promissory notes, mortgages and trust deeds.
TRUSTEE ROLE
The Trustee is also responsible for the distribution of payments to the investors.PSA regulations state that upon creation of the REMIC, all of the promissory notes and mortgages and trust deeds (depending on the state law where the secured property is located) are required to be physically deposited with the Trustee or an appointed “Custodian.”
TRUSTEE ROLE
REMICS AND IRS RULES
Sec. 860D. REMIC definedTITLE 26,Subtitle A,CHAPTER 1,Subchapter M,PART IV, Sec. 860D.
(a)General ruleFor purposes of this title, the terms "real estate mortgage investment conduit" and "REMIC" mean any entity -(1)to which an election to be treated as a REMIC applies for the taxable year and all prior taxable years,(2)all of the interests in which are regular interests or residual interests,
(3)which has 1 (and only 1) class of residual interests (and all distributions, if any, with respect to such interests are pro rata),(4)as of the close of the 3rd month beginning after the startup day and at all times thereafter, substantially all of the assets of which consist of qualified mortgages and permitted investments,(5)which has a taxable year which is a calendar year, and
(6)with respect to which there are reasonable arrangements designed to ensure that –(A)residual interests in such entity are not held by disqualified organizations (as defined in section860E(e)(5)), and
(B)information necessary for the application of section860E(e)will be made available by the entity. In the case of a qualified liquidation (as defined in section860F(a)(4)(A)), paragraph (4) shall not apply during the liquidation period (as defined in section860F(a)(4)(B)).
If properly formed and operated, the REMIC entity is not taxed on its earnings, since the investors, i.e. the bondholders, are “passive ” – that is, they have no control over the operations of the trust.Taxation occurs only at the investor level, upon distribution of the REMIC earnings.In order to comply with the strict IRS tax rules governing them, REMICs are limited in the type of investments they may hold.
Permitted investments are generally “qualified mortgages,” i.e. those that (a) are principallysecured by interests in real propertyand (b) transferred into the REMIC within three months of its startup (or closing) date.IRS regulations provide that an obligation is “principally secured” by an interest in real property only if either:(A) FMV of the real property securing the obligation was at least equal to 80% of the issue price of the obligation at the time is contributed to the REMIC.(B) Substantially all of the proceeds of the obligation were used to acquire or to improve or protect an interest in real property.
REMICS AND IRS RULES
An entity which complies with the REMICS rules is treated as a pass-through entity for tax purposes.(Income is taxed to the MBS holders)A REMIC is subject to a 100% tax on prohibited transactions.IRS Regulations treat any significant modification of a mortgage loan held by a REMIC as an exchange of the original loan for the modified loan.Thus, a significant modification may cause the REMIC to lose its favorable tax status.
REMICS AND IRS RULES
Only limited relief was available prior to IRS action.Rev. Proc. 2009-45 more relaxed interpretation of the phrase: “reasonable foreseeable default”No maximum time period after which default is per se not foreseeable.Default is reasonably foreseeable if holder or servicer reasonably believes that there is a significant risk of default.(upon maturity or at an earlier age)Determination of significant risk of default must be based on a diligent contemporaneous determination.
NEW REMIC RULES(September, 2009)
Amendment of several sections of Section 1.860G-2 of the Income Tax Regulations.Permit a REMIC to release, substitute, add or otherwise alter a substantial amount of collateral for a mortgage loan or make certain other modifications.
NEW REMIC RULES(September, 2009)
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