Short for real estate mortgage investment conduit, this security is a multiple-class mortgage cash flow security backed by residential mortgage loans which have been grouped together. The REMIC securities group interest and principal payments into separately traded securities. By redirecting the cash flow from the mortgage-backed security, a security can be created that has different classes (also called tranches) that may have different interest-rate payments, maturities, and stipulations for prepayment. The variety of investment options enables these securities to meet the needs of different investors.
The REMIC is a type of collateralized mortgage obligation (CMO) and went into effect as part of the Tax Reform Act of 1986. The REMIC has replaced the CMO; however, the terms are used interchangeably. Freddie Mac and Fannie Mae are the largest issuers of REMIC securities. REMICs guaranteed by Ginnie Mae are backed by the full faith and credit of the U.S. government.
Within REMICs, there are several different types of securities. A Z-class REMIC pays no cash to the investor until other classes are paid off or another specified event occurs. The interest earned but not paid increases the principal balance of the class. Once the previous classes have paid off or the specified event occurs, the Z class becomes an interest-paying amortizing class. A sequential class is a security that receives principal payments in a prescribed sequence. A PO (principal-only) class does not bear interest and is entitled to receive only payments of principal. Rising interest rates have an adverse effect on POs because the payments remain steady while interest rates rise, resulting in a financial loss. A PAC (planned-amortization-class) REMIC is designed to give investors scheduled payments over a range of constant prepayment times. A fixed-rate class is a REMIC with an interest rate that does not change over the life of the class. A floating-rate class (floater) is a REMIC class that pays interest at a rate that is subject to periodic adjustments at a predetermined amount above a specific index. A current-pay class is a REMIC class that is currently paying principal and/or interest.