A security is generally a fundable,
negotiable financial instrument
representing financial value.
Debt
securities (such as banknotes, bonds and
debentures),
Equity
securities, e.g., common stocks; and,
Derivative
contracts, such as forwards, futures,
options and swaps
Notes,
stocks,
treasury
debentures,
certificates
participation
in
stocks,
of
profit-sharing
collateral-trust certificates, etc
bonds,
interest
or
agreements,
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.
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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.
Real Estate Mortgage Investment Conduits
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Are a type of SPV used for the pooling of mortgage
loans and issuance of mortgage-backed securities.
They were introduced in 1987 and are defined under
the United States Internal Revenue Code (Tax Reform
Act of 1986), and are the typical vehicle of choice for
the securitization of residential mortgages in the US.
REMICs are investment vehicles that hold commercial
and residential mortgages in trust and issue
securities representing an undivided interest in these
mortgages.
Investment vehicles that hold commercial and
residential mortgages in trust and issue
securities representing an undivided interest in
these mortgages.
A trust into which pools of promissory notes
(debt instruments – like an IOU) and mortgages
or trust deeds (the security instruments which
permit foreclosure if the notes are not paid).
Mortgages into pools and issues pass-through
certificates, multiclass bonds similar to a
collateralized mortgage obligation (CMO), or
other securities to investors in the secondary
mortgage market.
Consists of a fixed pool of mortgages broken
apart and marketed to investors as individual
securities.
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Entitles the owner to a claim on the principal and
interest payments on the particular mortgages
underpinning the security.
Pay an interest rate that is usually related to the
interest rates the homeowners are paying on their
mortgages.
The equivalent of the coupon on a mortgage-backed
security is a percentage of the interest and principal
paid on the mortgages backing the security
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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.
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The vehicle of choice for these mortgage-backed
securities (“MBS”) was the REMIC.
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These loan pools range in risk from the highest
quality down the credit chain to the lowest quality.
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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.
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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.
The rules for the operation of a REMIC are
contained in a voluminous document called a
Pooling and Servicing Agreement, or “PSA.”
◦ 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.
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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.
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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.”
Sec. 860D. REMIC defined
TITLE 26, Subtitle A, CHAPTER 1, Subchapter
M, PART IV, Sec. 860D.
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(a) General rule
For 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
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(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 section 860E(e)(5)), and
(B) information necessary for the application
of section 860E(e) will be made available by
the entity. In the case of a qualified
liquidation (as defined in section
860F(a)(4)(A)), paragraph (4) shall not apply
during the liquidation period (as defined in
section 860F(a)(4)(B)).
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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.
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Permitted investments are generally “qualified mortgages,”
i.e. those that (a) are principally secured by interests in
real property and (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.
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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.
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Only limited relief was available prior to IRS action.
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Rev. Proc. 2009-45 more relaxed interpretation of
the phrase: “reasonable foreseeable default”
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No maximum time period after which default is per
se not foreseeable.
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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.
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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.