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Investment Conduits
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rief History of REMICs
× Created by Congress in 1986 (Tax Reform Act ƛ ƠTRAơ) 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)
× Pay
Pay--through securities (obligations collateralized by pool of loans)
issued by Grantor & Owner Trusts or Offshore entities
× Pass
Pass--through securities (undivided fractional interest in pool of
loans) issued by Grantor Trusts
× Preferred securities (backed by pool of loans)
History of REMICs, Cont.
× The TRA provided that, after 1991, an entity could only issue multi-
multi-class
M
Ss if it was a REMIC
× Concurrent with the creation of REMICs, Congress created TMPs as a stick
to incent multi-
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 Ơdoubleơ taxation:
× REMIC incurs interest expense for payments to interest holders
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-
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
REMIC - Federal Tax Qualification,
Cont.
× Asset Test
× Substantially all of its assets are comprised of Ơqualified mortgagesơ and
Ơpermitted investmentsơ
× Qualified Mortgages include:
*
REMIC - Federal Tax Qualification,
Cont.
× Asset Test, Cont.
× Substantially all of its assets are comprised of Ơqualified mortgagesơ and
Ơpermitted investmentsơ
× ƠSubstantially allơ 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
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
REMIC - Federal Tax
Considerations, Cont.
× Prohibited Transactions, Cont.
× Certain loan modifications are deemed to be a
Ơdisposition of a qualified mortgageơ
× A change in the terms of a mortgage if the modified loan
differs Ơmaterially either in kind or in extentơ 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 Ơmaterialơ
× Changes in terms occasioned by default or reasonably
foreseeable default
× Assumption of mortgage
× The conversion of a convertible ARM
REMIC - Federal Tax
Considerations, Cont.
× Prohibited Transactions, Cont.
× Certain other modifications are deemed to be
a Ơdisposition of a qualified mortgageơ
× A change in obligor
× Addition or deletion of co-
co-obligor if it results in a
change in payment expectations
× Changes in security or credit enhancement
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-
clean-up call or qualified liquidation
× To a qualified reserve fund by a residual holder
REMIC ƛ 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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Usual Pay-Through Structure
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