The Federal National Mortgage Association (“Fannie Mae”) recently announced that, on a going-forward basis, it will be making structural changes to its credit risk transfer (“CRT”) program, including its Connecticut Avenue Securities (“CAS”) program, in order to expand the potential investor base for its CRT securities. This new structure, first proposed last year, should greatly enhance the ability of real estate investment trusts (“REITs”) to invest in CAS securities, as the newly structured CAS securities are expected to be qualifying real estate assets producing qualifying interest income under the REIT rules. It is also expected that the Federal Home Loan Mortgage Corporation (“Freddie Mac”) will be introducing similar changes with respect to its CRT securities, notably its Structured Agency Credit Risk (“STACR”) program.

CAS Securities Restructured as REMIC Regular Interests

Under the revised CAS program, CAS securities will be structured as notes (“CAS REMIC Notes”), issued by a trust, that represent “regular interests” in a real estate mortgage investment conduit (“REMIC”) for federal income tax purposes. Although the CAS REMIC Notes will now represent regular interests in a REMIC, it is not anticipated that the capital structure, cash flow waterfall, or loss provisions will vary significantly from the current structure. Specifically, at this time, Fannie Mae anticipates continuing to offer three classes (Class M1, Class M2, and Class B) of par-priced floating rate notes based on one-month LIBOR and with a final maturity of 12.5 years.

For REITs, the change is significant because, as REMIC regular interests, the CAS REMIC Notes are expected to represent “real estate assets” within the meaning of Section 856(c)(5)(B) of the Internal Revenue Code of 1986, as amended (the “Code”) (“Real Estate Assets”) and interest income from such CAS REMIC Notes is expected to constitute “interest on obligations secured by mortgages on real property” within the meaning of Code Section 856(c)(3)(B) (“Mortgage Interest”). In addition, although the REIT rules prescribe that if less than 95% of the assets of a REMIC are Real Estate Assets, then the REIT is treated as holding directly and receiving directly its proportionate share of the assets and income of the REMIC (both qualifying and non-qualifying), Fannie Mae has stated that it intends to ensure that at least 95% of each REMIC’s assets are Real Estate Assets. Moreover, in connection with each issuance of CAS REMIC Notes, Fannie Mae expects to receive an opinion of tax counsel concluding that, among other things, each CAS REMIC Note will (1) represent ownership of a REMIC regular interest and (2) be a qualifying Real Estate Asset that produces qualifying Mortgage Interest for REIT purposes, as described above. Consequently, a CAS REMIC Note is expected to be a qualifying asset for purposes of the 75% asset test applicable to REITs (the “75% Asset Test”) and produce qualifying income for both the 75% and 95% gross income tests applicable to REITs (together, the “Gross Income Tests”), thus greatly enhancing the ability of REITs to invest in CRT securities.

Very Limited Impact on Fannie Mae MBS Trust Investors

In order to facilitate the new CAS structure, Fannie Mae will also begin making REMIC elections with respect to the mortgage loans it conveys to its mortgage-backed securities trusts (“MBS Trusts”). Consequently, the mortgage-backed securities (“MBS”) related to an MBS Trust will also represent REMIC regular interests. However, the MBS issued by the MBS Trusts will continue to be single-class guaranteed mortgage pass-through certificates, and investors will continue to receive the same cash flows as before.

It is not anticipated that the REMIC elections will have a significant impact on investors in MBS Trusts, including REITs. Previously, most REITs investing in MBS relied on Revenue Ruling 84-10, in which the Internal Revenue Service ruled that, subject to certain limitations and qualifications, the MBS owned by a REIT are considered to represent Real Estate Assets and that interest income from such MBS is considered Mortgage Interest. While Revenue Ruling 84-10 will no longer be the basis for these conclusions with respect to MBS that represent REMIC regular interests, the ultimate conclusions themselves should remain the same; that is, the MBS should continue to be qualifying assets for the 75% Asset Test and interest thereon will be qualifying income for purposes of the Gross Income Tests.

Finally, in addition to the tax considerations discussed above, the Securities Industry and Financial Markets Association has analyzed the proposed changes to the MBS Trust program and has concluded that such changes will not disrupt to-be-announced market for MBS.