Mortgage Opportunity Funds

Transcription

1 Mortgage Opportunity Funds A Proposed REMIC Approach Tom Lyden April 9, 2009 A p r A

2 Typical Organizational Structure Taxable U.S. Investors Foreign Investors Tax Exempt Investors Domestic Feeder (Delaware L.P.) Offshore Feeder (Cayman Ltd.) Master Fund (Cayman L.P.) 2

3 Business Proposition Purchase pools of distressed mortgage loans at deep discounts to their aggregate unpaid principal balance Undertake a broad range of workout activities Reduce interest rates Forgive arrearages Reduce loan balances Accept short pay-offs Foreclose or deed in lieu of foreclosure Exert continuing effort to return loans to performing status 3

4 Threshold Tax Issues Foreign Investors ECI Foreign Investors are subject to tax on a net basis on income effectively connected with a U.S. trade or business FIRPTA Foreign Investors must treat gain from the sale or disposition of USRPI as though it were ECI Portfolio Interest Interest income that is not ECI is subject to income and withholding tax on a gross basis unless it qualifies a portfolio interest 4

5 Effectively Connected Income Investing and Trading This activity does not constitute a USTB and will not generate ECI Dealer Activity Acting as a merchant in stocks or securities is a USTB Lending or Finance Business Making mortgage loans to the public is a USTB 5

6 Would a Mortgage Opportunity Fund Be Engaged In A USTB? Lending or Finance Business No new funds will be advanced to mortgagors Loan modification activity, however, could be viewed as the equivalent of making loans to the public Dealer Activity Working out loans, followed by the sales of those loans could be viewed as dealer activity 6

7 A Suggested REMIC Approach Transform a pool of mortgage loans into MBS that are REMIC regular interests REMIC regular interests are treated as debt instruments issued by the REMIC Workout activity undertaken on behalf of the REMIC trust will not be attributed to the regular interest holder Interest and discount income on a REMIC regular interest is eligible for the portfolio interest exclusion REO is acquired and held through a domestic blocker corporation ( REO Corp ) 7

8 Purchase of Mortgage Pool Domestic Feeder Forms Purchaser LLC Purchaser LLC enters in to mortgage loan purchase agreement with third party seller Domestic Feeder Third Party Seller Mortgage Loans & REO Cash Purchase Price Purchaser LLC 8

9 Formation of REMIC Trust Purchaser sells REO and loans about to become REO to REO Corp Purchaser transfers mortgage loans to a newly formed common law trust pursuant to a trust agreement in exchange for two classes of pass-through certificates Regular Certificate Principal amount equal to aggregate UPB of mortgage pool Interest rate based on Net WAC of the pool Residual Certificate noneconomic Trust agreement requires REMIC election 9

10 Formation of REMIC Trust Offshore Feeder Domestic Feeder Master Fund REO REO Corp Cash Certificates Purchaser LLC Mortgage Loans REMIC Trust 10

11 Sale of Certificates Purchaser sells the Regular Certificates to Master Fund Cash price paid by Master Fund equals price paid by Purchaser to third party seller for mortgage loans held in REMIC Trust Price may also include an amount equal to the inducement payment needed to transfer the Residual Certificate Purchaser transfers the Residual Certificate to an unrelated party together with inducement payment 11

12 Post Transaction Master Fund Regular Certificate Residual Holder Residual Certificate REMIC Trust Mortgage Loans 12

13 REMIC Qualification REMIC Election Asset Test Qualified Mortgages Permitted Assets Interests Test All interests must be either regular or residual interests Only one class of residual interest Issued on a single startup day Arrangements Test 13

14 Qualified Mortgage Transferred to the REMIC On the startup day for regular or residual interests, or Purchase at a price fixed on the startup day during a limited three-month pre-funding period Principally secured by an interest in real property 125% LTV Test Use of Proceeds Test Reasonable belief Loan modifications 14

15 Regular Interests Designated as a regular interest Issued on the REMIC s startup day Issued with fixed terms Unconditionally entitles the holder to a specified principal amount Interest payments, if any, are based on a fixed rate, a permitted variable rate, or represent a specified portion of the interest payments on qualified mortgages. 15

16 Tax Treatment of REMIC Trust REMIC formation treated as an exchange of qualified mortgages for regular and residual interests No gain or loss recognized on formation REMIC s basis in assets equals FMV Gain or loss recognized on sale of interests A REMIC is not subject to federal income tax A REMIC computes taxable income or net loss each year Includes in income interest and discount income from mortgage loans Allowed a deduction for interest and OID expense on regular interests Mortgage Loan modification may accelerate income 16

17 REO Acquired by REMIC Trust Foreclosure property is a permitted asset for purposes of the REMIC asset test Foreclosure property is defined by cross reference to the REIT rules REO will not qualify as foreclosure property if the REMIC trust fails the improper knowledge standard REMIC Trust should not take title to REO if the related mortgage loan was significantly delinquent on the applicable cut-off date REO Corp should acquire REO Sale to REO Corp Distribution in respect of regular certificate 17

18 IRS Guidance Rev. Proc Fast-track modifications pursuant to ASF Framework Rev. Proc Foreclosure prevention plans developed by servicers Guidance is carefully circumscribed 18

19 Caveats Taxable Investors The transformation of mortgage loans into REMIC regular interests may not be optimal for taxable investors Converts market discount into OID Single Class REMIC concerns Gross-up income for REMIC investment expenses May be managed through issuance of a second class of regular interest REO Corp may not be optimal 19

20 Exit Strategy REMIC Trust sells all assets in a qualified liquidation and distributes proceeds in respect of regular interest REMIC does an in-kind liquidation by distributing assets in to the regular interest holder 20