In late December, the IRS issued guidance (Notice 2012-5 and Rev. Proc. 2012-14) that relaxed the real estate mortgage investment conduit (“REMIC”) and real estate investment trust (“REIT”) rules to accommodate refinanced “underwater” loans in Federal National Mortgage Association (“Fannie Mae”) and Federal Home Loan Mortgage Corporation (“Freddie Mac”) sponsored single family mortgagebacked securities.
The government recently expanded (on October 24, 2011; details announced on November 15, 2011) its Home Affordable Refinance Program (“HARP”). The government expects a wave of mortgage refinancings under the new program. The problem is that a lot of the new loans will be held by REMICs. The further problem is that REITs are expected to hold a lot of the residual and regular interests in those REMICs.
The new guidance applies to REMICs that are created after November 30, 2011 and is therefore designed to allow the new loans created in a HARP refinance to continue to be securitized in REMICs.
The issue under HARP is that a new loan may be “underwater” upon origination. Normally, mortgage loans that go into REMICs are secured by a house with a value equal to or greater than the loan amount (the test is only done once--when the loan is contributed to the REMIC). When a REMIC holds only these loans, a REIT that holds that REMIC’s regular or residual interests can treat the entire regular or residual interest as a “good” real estate asset that produces “good” real estate income (REITs have to have at least 75% good assets and 75% good income).
The problem with HARP loans is that the underlying real estate’s value may be less than the loan’s face amount. As long as the real estate is worth more than 80% of the loan amount, the loan can still go into a REMIC. However, absent the recent IRS pronouncement, the REMIC would have to report on a “look through” basis to its regular and residual interest holders, i.e., reporting precise percentages of “good” assets and “bad” assets. This, in turn, would require the REMIC to figure out, on a loan by loan basis, if the loan was underwater and by how much. Moreover, the REMIC would have to separately report income, if any, from the underlying real estate if the loan was foreclosed on and the REMIC acquired the property. All of this would obviously be a large headache.
What the new guidance does, in a nutshell, is allow a REIT that holds REMIC interests in a Fannie Mae or Freddie Mac guaranteed single family pool to automatically treat the interest as an 80% “good” asset and 20% “bad” asset that produces 80% “good” income and 20% “bad” income. This relieves the REMIC from cumbersome “look through” reporting. The guidance does not apply to “private label” REMICs.