Jan. 1, 2005 marks the implementation of modifications in the American Jobs Creation Act 2004 relating to REMIC rules permitting the securitization of HELOC loans and reverse mortgages. Analysts speculated that the recent changes are expected to increase the flow of funds to HELOC borrowers.
Thacher Proffitt & Wood LLP said that prior to the modifications, existing rules made REMIC securitization of HELOCs economically disadvantageous, if not impossible. A crucial change in the new Act is the expansion of the definition of a qualified mortgage to accommodate HELOCs, reverse mortgage loans and any periodic advances.
Thacher said that starting next year, HELOC issuers would be able to issue time-tranched or credit tranched securities utilizing a REMIC structure. Additionally, a net interest margin bond may be issued to increase the amount of proceeds that are received by the sponsor.
Under the original provisions, any draw under a HELOC or reverse mortgage beyond the three months after the startup day would not be considered a REMIC qualified mortgage. Thacher Proffitt explained that this narrow definition' of a qualified reverse fund offered no mechanism to fund post-closing HELOC draws that are inside the REMIC. Aside from this, draws done three months after the startup date could not be funded outside the REMIC, because contributions from both the money to fund the draw, or the receivable created by the draw are subject to a 100% prohibited contributions tax.
Thacher said that the law now applies to any obligation representing a rise in the principal amount under the original terms of the obligation, provided three factors exist: the increase is attributable to the original terms of the obligation, it occurs after the startup day of the REMIC and is purchased by the REMIC pursuant to a fixed-price contract that is in effect on the startup day.
In other words, the new definition allows HELOCs - including periodic draws that occur more than three months past the startup day- to be considered qualified mortgages, provided that the HELOC or reverse mortgage loan account was purchased by the REMIC on the startup day, or within the limited three month pre-funding period.
Aside from redefining a qualified mortgage, the recent changes also include expanding the definition of a qualified reserve fund or a permitted investment - now encompassing intangible property held as part of a required reserve. Thacher added that a qualified reserve fund could now be used to finance future draws under a HELOC. However, the aggregate fair market value of such a reserve fund could not total over 50% of the aggregate fair market value of all the REMIC assets on startup.
In a report, Dominion Bond Rating Service noted that HELOCs are a growing part of consumer financing. Analysts note that in the first three quarters of 2004, $24 billion of HELOCs have been securitized, not counting the billions more of origination for portfolio retention. Analysts also said that further rate increases are expected to drive consumer spending needs towards the HELOC market.
Michael Nelson, senior vice president at DBRS, said that DBRS expects more second mortgage loan buying in the next couple of years. As rates go up, homeowners would rather apply for second mortgage rather than refinance their first one. A HELOC, being a second mortgage loan, would be a significant part of this especially in light of the recent changes. Not only would it become more economical for issuers to securitize HELOC loans, the product would also appeal to a broader range of investors, Nelson said. This was reiterated in the DBRS report when analysts wrote, "This recent change in the tax law will allow lenders to better access the capital markets, increasing the flow of funds to HELOC borrowers."
Bruce Fabrikant, a senior vice president from Moody's Investors Service, said that with the broadening of the REMIC rules, HELOC transactions - which in the past typically carried a financial guaranty and were issued through owner trusts versus REMICs - could now be issued as senior/sub structures. Although the changes offer another way to securitize HELOCs and reverse mortgages, Fabrikant feels that the new rules would probably not significantly impact origination volumes in the sectors.
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