Loan Modifications May Be More Difficult Due to Securitization

As is well known, many home mortgages were sold and packaged into securitizied pass-through vehicles, usually trusts, known as REMICs (Real Estate Mortgage Investment Conduits) which in turn sold certificates to investors around the world. Although securitization presented borrowers with new financing opportunities, it brought with it a set of restrictions due to the Internal Revenue Code requirements that make it difficult for mortgage servicers and their trusts to modify mortgages if the homeowner falls into financial difficulties.

REMICs are tax-preferred entities that hold the securitized mortgages for the investor certificate-holders. The REMIC provisions are contained in Part IV of subchapter M of Chapter 1 of the Internal Revenue Code (sections 860A-860G). The REMIC provisions provide for a pass-through entity that issues multiple classes of interests representing undivided ownership interests in pools of residential and commercial mortgage loans. The certificates are of different levels of investment risk. The income from the mortgage loans in the REMIC is taxed to the holders of the interest in the REMIC.

In order to maintain its tax-preferred status, a REMIC must meet certain requirements of the Internal Revenue Code. REMICs, which are generally trusts, are typically not subject to federal income taxation. If REMICs engage in certain activities they may lose their status as a REMIC and may in some instances be subject to taxation, such as a 100% prohibited transaction tax.

After securitization, the REMIC's master servicer is responsible for collecting payments from the homeowners. The master servicer's responsbilities and authority are provided for a pooling and servicing agreement ("PSA") between the trustee of the REMIC and the master servicer. PSAs provide that the master servicer not take any action that will result in the loss of the REMIC's tax-preferred status. As a result, any request by a borrower for a modification of a mortgage held by a REMIC must be considered in view of the continued preferred tax status of the REMIC. A modification that may be otherwise desirable may be denied due to a necessity of maintaining REMIC tax-preferred status.

The IRS recently released proposed regulations that would expand the circumstances under which modifications of mortgage loans held by REMICs would be permitted.