On December 6, 2007, the Internal Revenue Service (“IRS”) issued Revenue Procedure 2007-72,1 agreeing not to challenge a securitization’s federal tax status for making “fast track modifications” recommended by the American Securitization Forum (“ASF”) to a limited category of securitized subprime residential adjustable-rate mortgage loans. Although narrow in its scope, the revenue procedure does provide some guidance on the potential tax consequences associated with a servicer’s business decision to make such fast track modifications in the current economic environment.
On the same date as the issuance of the revenue procedure, the ASF released a document entitled “Statement of Principles, Recommendations and Guidelines for a Streamlined Foreclosure and Loss Avoidance Framework for Securitized Subprime Adjustable Rate Mortgage Loans” (“Framework”). The ASF believes the Framework is consistent with the current authority of servicers to modify subprime mortgage loans under typical pooling and servicing agreements, and should constitute the standard and customary servicing procedures for the designated subprime loans on a going-forward basis. The ASF’s Framework only applies to first-lien subprime residential adjustable-rate mortgage loans that: (1) have an initial fixed interest rate period of 36 months or less; (2) were originated between January 1, 2005, and July 31, 2007; (3) are included in securitized pools; and (4) have an initial interest rate reset between January 1, 2008, and July 31, 2010 (“Designated Subprime ARMs”).
The Framework further classifies these Designated Subprime ARMs into the following three sub-categories:
- Segment 1 loans include “current loans” where the servicer determines that a borrower is likely to be able to refinance into any available mortgage product. The Framework defines current loans, in part, as loans not more than 30 days delinquent and which have not been more than 60 days delinquent more than once in the preceding 12 month period.
- Segment 2 loans include current loans where the servicer determines the borrower is unlikely to be able to refinance into any readily available mortgage product. Under the Framework, all current loans with an LTV greater than 97% (based on the first lien only) are deemed not to be eligible for refinancing into any available mortgage product.
- Segment 3 loans include non-current loans.
The Framework recommends fast track modifications only for certain Segment 2 loans where: (1) the borrower currently occupies the underlying property as a primary residence; (2) the borrower meets the “FICO test”2; and (3) the servicer determines that, at the upcoming interest rate reset date, the loan’s payment amount would go up by more than five percent.
If a Segment 2 loan is eligible for the Framework’s fast track modification procedures, the servicer can offer to modify the loan to extend the loan’s existing interest rate for up to five years following the loan’s scheduled interest rate reset date.
Scope and Practical Impact of Revenue Procedure 2007-72
Revenue Procedure 2007-72 only addresses two limited transactions: (1) fast-track modifications made to a qualifying Segment 2 loan; and (2) subordination of a second lien to any new lien created in connection with such a fast-track modification. The revenue procedure states that in such limited situations and only for transactions occurring prior to July 31, 2010, the IRS will not:
- challenge a securitization vehicle’s qualification as a “real estate mortgage investment • conduit” (“REMIC”) on the grounds that such transactions constitute a “significant modification” of the loan, or result in a deemed reissuance of the REMIC’s “regular interests,” under the REMIC Rules,3
- contend that such transactions constitute “prohibited transactions” under the REMIC Rules, or
- challenge a securitization vehicle’s qualification as a trust on the grounds that such transactions manifest a “power to vary” the investments of the trust’s certificateholders.
In the current subprime loan market environment, Revenue Procedure 2007-72 provides useful and needed guidance to the securitization industry on the tax consequences of choosing to follow the ASF’s Framework in making fast track modifications to qualifying Segment 2 loans. However, servicers should take note that the revenue procedure only provides guidance to securitization vehicles or their certificateholders on the federal tax consequences of fast track modifications to subprime mortgage loans.