Buried in the 1986 tax reform legislation was a rule change that will do much to make the nation's mortgage securities market more efficient and that could benefit homeowners.
The change created what's known as REMIC, for Real Estate Mortgage Investment Conduit. By themselves, REMICs aren't much. They aren't a new financial security or even a specific legal entity.
REMICs are vehicles for holding existing mortgage-backed securities in a way that bypasses several tax and accounting problems. REMICs can be structured as corporations, trusts, partnerships and in other legal forms.
Their securities can be issued as debt, stock, partnership units and the like. In short, think of REMICs as a financial chameleon that changes colors as the need arises.
Split for Economics
The adaptability and flexibility of REMICs are what make them so desirable. REMICs allow the principle and interest payments from pools of mortgage-backed bonds to be split into different securities "based purely on optimizing the economics rather than meeting artificial tax constraints," says Bernard J. Carl, a vice president with Salomon Brothers Inc. in New York City.
Pools of long-term mortgages can be divided into securities with short-, medium- and long-term maturities--for instance, those set for repayment in 5, 10, 15 or 20 years.
Since the investors want different maturities--and the various yields and risks that go with each--REMICs will appeal to a broader range of investors.
"REMICs allow you to create more value out of mortgage securities," says Joseph Hu, director of mortgage research for Shearson Lehman Brothers Inc. in New York City. "And that, ultimately, means lower mortgage rates for consumers."
More Mortgages Available
The effect on mortgage rates will be indirect, says Stan Ross, co-managing partner of Kenneth Leventhal & Co., a Los Angeles-based firm specializing in real estate planning. He predicts REMICs will add a slight downward pressure on mortgage rates, which are already near their lowest levels of the '80s.
Perhaps more significant than lowering interest rates, REMICs could make additional 30-year, fixed-rate mortgages available--the loans home buyers seem to prefer.
REMICs currently aren't conducive to channeling money into adjustable-rate mortgages (ARMS), although some Treasury Department regulations expected within a few months will likely rectify that.
Why would a floating-rate REMIC be desirable? Because it could attract a whole new range of foreign buyers to U.S. mortgage securities.
One of the key recent developments in the mortgage securities market, according to Eric Hemel, a vice president with First Boston Corp. in New York, is the advent of what's known as a floating-rate collateralized mortgage obligation, or CMO.
Since 1983, CMOs have allowed issuers to split up the cash flows from the underlying mortgages into short-, medium- and long-term classes. In fact, the tax and accounting problems of CMOs are what REMICs are largely designed to correct. That's why many CMOs are already being packaged as REMICs.
What's significant about a CMO with a floating-rate class is that foreign buyers are familiar with such securities, particularly those linked to LIBOR, a type of international prime rate.
"LIBOR floaters are the primary form in which corporate debt is issued worldwide," says Hemel. "So now you can sell mortgage cash flows to Japanese pension funds or Arabian sheiks or Indian insurance companies without their having to know very much about the mortgages underneath. "
That could substantially increase the number of potential buyers of U.S. mortgage securities. Mindful of this possible demand surge, Hemel thinks these LIBOR-floater CMOs will do more to lower mortgage interest rates than REMICs.