<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY +
+OFFERS TO BUY BE ACCEPTED WITHOUT THE DELIVERY OF A FINAL PROSPECTUS +
+SUPPLEMENT AND ACCOMPANYING PROSPECTUS. THIS PROSPECTUS SUPPLEMENT AND THE +
+ACCOMPANYING PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE +
+SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF +
+ANY SUCH STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION DATED SEPTEMBER 13, 1996
PRELIMINARY PROSPECTUS SUPPLEMENT TO PROSPECTUS DATED MAY 21, 1996
$120,460,000
Capitol Revolving Home Equity Loan Trust 1996-1
Capitol Revolving Home Equity Loan Asset Backed Certificates,
Series 1996-1
Chevy Chase Bank, F.S.B.,
as Transferor and Servicer
----------
The Capitol Revolving Home Equity Loan Asset Backed Certificates, Series
1996-1 (the "Certificates"), will represent undivided interests in a
trust fund (the "Trust Fund") consisting primarily of a pool of
certain revolving credit line home equity loans made or to be made
in the future (the "Mortgage Loans") secured primarily by second
deeds of trust on one- to four-family residential properties.
The Mortgage Loans were originated by Chevy Chase Bank,
F.S.B. ("Chevy Chase" or the "Transferor"), which will
serve as servicer of the Mortgage Loans.
The aggregate undivided interest in the Trust Fund represented by the
Certificates will initially be equal to $120,460,000 which as of
September 1, 1996 (the "Initial Cut-off Date") is approximately 98% of
the sum of the Cut-off Date Trust Balances (as defined herein) of the
Initial Mortgage Loans and the Pre-Funded Amount (each as defined
herein). The remaining undivided interest in the Trust Fund not
represented by the Certificates (the "Transferor Interest")
will initially be equal to $2,458,585.68, which as of the
Initial Cut-off Date is approximately 2% of the sum of
the Cut-off Date Trust Balances of the Initial
Mortgage Loans and the Pre-Funded Amount.
On the Closing Date, $24,000,000 (the "Pre-Funded Amount") will be deposited
in the Pre-Funding Account (as defined herein). The Pre-Funded Amount may be
used by the Trust to acquire additional Mortgage Loans consisting of the
91-1 Mortgage Loans (as defined herein) to the extent available, and
other Mortgage Loans on or before June 20, 1997 (the "Subsequent Mortgage
Loans").
Distributions of principal and interest on the Certificates will be
made on the 20th day of each month or, if such date is not
a Business Day then on the succeeding Business
Day (a "Distribution Date"), commencing October
20, 1996.
On each Distribution Date, holders of the Certificates (the
"Certificateholders") will be entitled to receive, from and to the limited
extent of funds available in the Certificate Account (as defined herein),
distributions with respect to interest and principal calculated as set
forth herein. The Certificates are not guaranteed by the Transferor or
any affiliate thereof. However, on or before the issuance of the
Certificates, the Transferor will obtain from AMBAC Indemnity
Corporation (the "Certificate Insurer") a financial guaranty
insurance policy relating to the Certificates (the "Certificate
Insurance Policy"), in favor of the Trustee (as defined
herein). The Certificate Insurance Policy will protect
holders of Certificates against certain shortfalls in
amounts to be distributed at the times and to the extent
described herein. See "DESCRIPTION OF THE CERTIFICATES--
Certificate Insurance Policy" herein.
THERE CURRENTLY IS NO SECONDARY MARKET FOR THE CERTIFICATES. THE UNDERWRITERS
INTEND TO MAKE A SECONDARY MARKET IN THE CERTIFICATES, BUT HAVE NO OBLIGATION
TO DO SO. THE INTERESTS OF THE OWNERS OF THE CERTIFICATES WILL BE REPRESENTED
BY BOOK ENTRIES ON THE RECORDS OF THE DEPOSITORY TRUST COMPANY AND
PARTICIPATING MEMBERS THEREOF. POTENTIAL INVESTORS SHOULD CONSIDER, IN
ADDITION TO THESE FACTORS, THE OTHER INFORMATION SET FORTH IN "RISK
FACTORS" COMMENCING ON PAGE S-18 HEREIN AND ON PAGE 16 IN THE PROSPECTUS.
----------
THE CERTIFICATES REPRESENT BENEFICIAL INTERESTS IN THE TRUST ONLY AND DO NOT
EVIDENCE A SAVINGS ACCOUNT OR DEPOSIT OR OTHER OBLIGATION OF, OR INTEREST IN,
AND ARE NOT GUARANTEED BY, CHEVY CHASE OR ANY AFFILIATE THEREOF. NEITHER
THE CERTIFICATES NOR THE MORTGAGE LOANS ARE INSURED OR GUARANTEED BY THE
SAVINGS ASSOCIATION INSURANCE FUND, THE FEDERAL DEPOSIT INSURANCE
CORPORATION OR ANY OTHER GOVERNMENTAL AGENCY OR INSTRUMENTALITY.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS SUPPLEMENT. ANY REPRESENTATION TO
THE CONTRARY IS A CRIMINAL OFFENSE.
THE ATTORNEY GENERAL OF THE STATE OF NEW YORK HAS NOT PASSED ON OR ENDORSED
THE MERITS OF THIS OFFERING. ANY REPRESENTATION TO THE CONTRARY IS UNLAWFUL.
<TABLE>
<CAPTION>
Underwriting
Price to Discounts and Proceeds to
Public(1) Commissions(2) Transferor(2)
--------- -------------- -------------
<S> <C> <C> <C>
Per Certificate..........................
Total.................................... $ $ $
</TABLE>
(1) Plus accrued interest, if any, at the applicable rate from , 1996.
(2) Before deducting expenses payable by the Transferor, estimated to be $ .
----------
The Certificates are offered by the Underwriters when, as and if issued by
the Transferor, deliverable to and accepted by the Underwriters, and subject to
their right to reject orders in whole or in part. It is expected that delivery
of the Certificates in book-entry form will be made through the facilities of
The Depository Trust Company, Cedel Bank, societe anonyme, and Euroclear on or
about September , 1996, against payment in immediately available funds.
CS First Boston Merrill Lynch & Co.
The date of this Prospectus Supplement is September , 1996
<PAGE>
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE CERTIFICATES
AT LEVELS ABOVE THOSE WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH
STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
REPORTS TO CERTIFICATEHOLDERS
Unless and until Replacement Certificates (as defined herein) are issued,
the Trustee will provide to CEDE & Co., as nominee of The Depository Trust
Company ("DTC") and registered holder of the Certificates, monthly and annual
reports concerning the Certificates pursuant to the Pooling and Servicing
Agreement. See "DESCRIPTION OF THE CERTIFICATES--Reports to
Certificateholders" and "--Evidence as to Compliance" herein and "THE
AGREEMENTS--Reports to Holders" and "--Book Entry Securities" in the
accompanying Prospectus (the "Prospectus"). Such reports may be made available
by DTC and its participants to owners of the Certificates upon request in
accordance with the rules, regulations and procedures creating and affecting
DTC. Such reports will not constitute financial statements prepared in
accordance with generally accepted accounting principles. The Trust does not
intend to provide to any holder of the Certificates any financial information
that has been examined and reported upon, with an opinion expressed by, an
independent public accountant. The Transferor has determined that its
financial statements are not material to the offering made hereby and does not
intend to send any of its financial reports to Certificateholders. The
Servicer will file with the Securities and Exchange Commission (the
"Commission") such periodic reports with respect to the Trust as are required
by the Securities Exchange Act of 1934, as amended, and the rules, regulations
or orders of the Commission thereunder.
AVAILABLE INFORMATION
The Transferor has filed with the Commission a Registration Statement under
the Securities Act of 1933, as amended, with respect to the Certificates. This
Prospectus Supplement, which forms a part of the Registration Statement,
contains summaries of the material terms of the documents referred to herein,
but does not contain all of the information set forth in the Registration
Statement pursuant to the Rules and Regulations of the Commission. For further
information, reference is made to such Registration Statement and the exhibits
thereto. Such Registration Statement and exhibits can be inspected and copied
at prescribed rates at the public reference facilities maintained by the
Commission at its Public Reference Section, 450 Fifth Street, N.W.,
Washington, D.C. 20549, and at its Regional Offices located as follows,
Midwest Regional Office, 500 West Madison Street, Chicago, Illinois 60661; and
Northeast Regional Office, Seven World Trade Center, New York, New York 10048.
In addition, the Commission maintains a Web site at "http://www.sec.gov" that
contains information regarding registrants that file electronically with the
Commission.
The Trust Fund will be required to file certain reports with the Commission
pursuant to the requirements of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). The Transferor intends to cause the Trust Fund
to suspend filing such reports if and when such reports are no longer required
under the Exchange Act.
No person has been authorized to give any information or to make any
representation other than those contained in this Prospectus Supplement and,
if given or made, such information or representations must not be relied upon.
This Prospectus Supplement does not constitute an offer to sell or a
solicitation of an offer to buy any securities other than the Certificates
offered hereby nor an offer of the Certificates to any person in any state or
other jurisdiction in which such offer would be unlawful. The delivery of this
Prospectus Supplement at any time does not imply that information herein is
correct as of any time subsequent to its date.
S-2
<PAGE>
PROSPECTUS SUPPLEMENT SUMMARY OF TERMS
The following summary is qualified in its entirety by reference to the
detailed information appearing elsewhere in this Prospectus Supplement and the
accompanying Prospectus. Reference is made to the "Index of Principal Terms"
herein and the "Glossary of Terms" in the Prospectus for the location of
definitions of certain capitalized terms.
Securities Offered.......... Capitol Revolving Home Equity Loan Trust 1996-1
(the "Trust") will issue the Capitol Revolving
Home Equity Loan Asset Backed Certificates, Se-
ries 1996-1 (the "Certificates"), pursuant to a
Pooling and Servicing Agreement to be dated as of
September 1, 1996 (the "Pooling and Servicing
Agreement") by and between Chevy Chase Bank,
F.S.B. ("Chevy Chase"), as transferor and
servicer (the "Transferor" and "Servicer," re-
spectively, as the case may be), and The Chase
Manhattan Bank, as trustee and custodial agent
(the "Trustee" and "Custodial Agent," respective-
ly, as the case may be). As of the Closing Date
(as defined herein), the aggregate undivided in-
terest in the Trust represented by the Certifi-
cates will equal $120,460,000 (the "Original Cer-
tificate Principal Balance" and the "Original In-
vested Amount"), which represents approximately
98% of the sum of the Cut-off Date Trust Balances
of the Initial Mortgage Loans and the Pre-Funded
Amount. Following the Closing Date, the "Invested
Amount" with respect to any day will be an amount
equal to the Original Invested Amount minus the
sum of (i) the amount of Principal Collections
(as defined herein) previously distributed to
Certificateholders including Principal Collec-
tions distributed in payment of any Basis Risk
Payment (as defined herein) (including interest
accrued thereon), (ii) any amounts distributed as
principal to Certificateholders at the end of the
Pre-Funding Period from funds on deposit in the
Pre-Funding Account, (iii) an amount equal to the
product of the Certificateholders' Floating Allo-
cation Percentage and the Liquidation Loss
Amounts (each as defined herein) and (iv) the
amount of any Principal Collections previously
distributed to the Transferor in reduction of the
Overcollateralization Amount (as defined herein).
The Transferor will own the remaining undivided
interest in the Trust, which is equal to the Pool
Balance (as defined herein) minus the Invested
Amount (the "Transferor Interest"). The principal
balance of the outstanding Certificates (the
"Certificate Principal Balance") on any day is
equal to the Original Certificate Principal Bal-
ance minus the aggregate of amounts actually dis-
tributed as principal to the Certificateholders.
See "DESCRIPTION OF THE CERTIFICATES--Distribu-
tions on the Certificates" herein and "DESCRIP-
TION OF THE SECURITIES" in the Prospectus.
Trust Fund.................. The assets of the Trust (the "Trust Fund") will
consist primarily of a pool (the "Pool") of cer-
tain revolving credit line home equity loans made
or to be made in the future and conveyed to the
Trust on the Closing Date (the "Initial Mortgage
Loans") and 91-1 Mortgage Loans (as defined here-
in), provided such loans are purchased by Chevy
Chase from Trust 1991 (as defined herein), or
such other
S-3
<PAGE>
revolving credit line home equity loans to be
transferred to the Trust on or before the June
20, 1997 Distribution Date (the "Subsequent Mort-
gage Loans") (the Subsequent Mortgage Loans and
the Initial Mortgage Loans and any substitutions
for any such loans, collectively the "Mortgage
Loans") originated by Chevy Chase in the ordinary
course of its lending business and secured pri-
marily by second deeds of trust on one- to four-
family residential properties (the "Mortgaged
Properties") located in Maryland, Virginia and
the District of Columbia; the Trust's interest in
property that secured a Mortgage Loan which has
been acquired by foreclosure or deed in lieu of
foreclosure; the Certificate Account; the funds
on deposit in the Pre-Funding Account and the
Capitalized Interest Account (each as defined
herein); the Certificate Insurance Policy; the
Trust's interest in rights under certain hazard
insurance policies covering the Mortgaged Proper-
ties; and certain other property, as described
more fully herein.
The property conveyed to the Custodial Agent for
the benefit of the Trust will include certain of
the unpaid principal balances of certain of the
Mortgage Loans as of the opening of business on
September 1, 1996 (the "Initial Cut-off Date") in
the case of the Initial Mortgage Loans, and on
the first day of the month in which each Subse-
quent Mortgage Loan and any Eligible Substitute
Mortgage Loan (as defined herein) is conveyed to
the Trust (in each case, the "Cut-off Date" and
the "Cut-off Date Trust Balances") and, with re-
spect to each Mortgage Loan (other than the 91-1
Mortgage Loans), any additions thereto as a re-
sult of advances made after the Cut-off Date pur-
suant to the applicable loan agreements (the
"Loan Agreements") which evidence the Mortgage
Loans during the life of the Trust (the "Addi-
tional Balances"). The Additional Balances will
be funded by Chevy Chase, pursuant to the Loan
Agreements. The obligation to fund any Additional
Balances pursuant to the Loan Agreements will not
be transferred to the Trust. Certain balances
outstanding on December 1, 1990, December 1,
1991, December 1, 1992, September 1, 1993 and
September 1, 1994 with respect to certain of the
Mortgage Loans (the "Common Mortgage Loans") were
sold by the Transferor to Capitol Home Equity
Loan Trust 1990-1 ("Trust 1990"), Capitol Home
Equity Loan Trust 1991-1 ("Trust 1991"), Capitol
Home Equity Loan Trust 1992-1 ("Trust 1992"),
Capitol Home Equity Loan Trust 1993-1 ("Trust
1993") and Capitol Home Equity Loan Trust 1994-1
("Trust 1994" and together with the Trust 1990,
Trust 1991, Trust 1992 and Trust 1993, the "Prior
Trusts"), respectively. The Trust Fund will not
include any interest in any Sold Balances (as de-
fined herein).
The "Trust Balance" of a Mortgage Loan (other
than a Liquidated Mortgage Loan, which shall have
a Trust Balance of zero) on any day is equal to
its Cut-off Date Trust Balance, plus (i) any Ad-
ditional Balances in respect of such Mortgage
Loan, minus (ii) all collections credited against
the principal balance of such Mortgage
S-4
<PAGE>
Loan (excluding in the case of any Common Mort-
gage Loan, any such principal collections applied
to reduce the Sold Balances) in accordance with
the related Loan Agreement prior to such day;
provided, however, that if such Mortgage Loan is
a Common Mortgage Loan, the Cut-off Date Trust
Balance of such Mortgage Loan shall exclude the
Sold Balance thereof. "Pool Balance" shall mean
on any day an amount equal to the sum of the ag-
gregate of all Trust Balances on such day plus
the amount on deposit in the Pre-Funding Account
as of such day (excluding any net investment
earnings thereon). On the Closing Date the Trust
will include 1,087 Common Mortgage Loans having
$8,038,020.08 in aggregate Cut-off Date Trust
Balances which represent approximately 8.13% of
all of the Cut-off Date Trust Balances trans-
ferred and assigned to the Trust.
Transferor and Servicer..... Chevy Chase, a federally chartered stock savings
bank, will transfer and assign the Trust Balances
of the Mortgage Loans to the Trust in exchange
for the Certificates and the Transferor Interest
and will serve as Servicer of the Mortgage Loans.
The principal executive offices of Chevy Chase
are located at 8401 Connecticut Avenue, Chevy
Chase, Maryland 20815, and the telephone number
of Chevy Chase is (301) 986-7000. See "THE TRANS-
FEROR" herein and in the Prospectus.
Trustee..................... The Trustee is The Chase Manhattan Bank. The
Trustee's principal corporate trust office is lo-
cated at 450 West 33rd Street, 15th Floor, New
York, New York 10001.
Certificate Insurer......... The Certificate Insurer is AMBAC Indemnity Corpo-
ration. See "DESCRIPTION OF CERTIFICATE INSURER"
herein.
Collections................. All collections on the Mortgage Loans will be al-
located as to principal and interest in accor-
dance with the Loan Agreements. The Trust's share
of an amount allocated to interest on any Mort-
gage Loan (the "Trust Interest") shall equal the
product of (a) the amount allocated to interest
multiplied by (b) (x) the amount of interest ac-
crued at the Loan Rate on the Trust Balance dur-
ing the related Interest Period (as defined here-
in) divided by (y) the amount of interest accrued
at the Loan Rate on the Loan Balance during such
Interest Period. "Interest Period" means the
monthly period during which interest accrues on
the Mortgage Loans. "Loan Balance" as to any
Mortgage Loan and day, means the unpaid principal
balance of such Mortgage Loan upon which interest
accrued for such day was calculated. Collections
of principal received from a borrower on any Com-
mon Mortgage Loans for any day during any Collec-
tion Period will be applied first to reduce the
balance thereof transferred to Trust 1990, if
any, to zero, second to reduce the balance
thereof transferred to Trust 1991, if any (in-
cluding any such balances subsequently trans-
ferred to the Trust during the Pre- Funding Peri-
od), to zero, third to reduce the balance thereof
transferred to Trust 1992, if any, to zero,
fourth to reduce the balance thereof transferred
to Trust 1993, if any, to zero and fifth to re-
duce the balance thereof transferred to Trust
1994, if any, to zero before
S-5
<PAGE>
any such collections are applied in reduction of
the Trust Balance of such Common Mortgage Loan
(other than 91-1 Mortgage Loans). "Principal Col-
lections" for any Distribution Date, shall equal
(i) the Trust's share of principal collections
received from borrowers under the Mortgage Loans
in the related Collection Period (as defined
herein) after the application of the allocations
described in the preceding sentence, (ii) the
principal portion of the Net Trust Liquidation
Proceeds and Trust Insurance Proceeds and (iii)
the principal portion of the Retransfer Deposit
Amount (as defined herein) and the Substitution
Adjustment Amount (as defined herein) of a re-
transferred Mortgage Loan. As of the Initial Cut-
off Date, the aggregate amount of the balances of
Common Mortgage Loans owned by Trust 1990 is
$6,736,536.97, the aggregate amount of the bal-
ances of Common Mortgage Loans owned by Trust
1991 is $5,032,976.84, the aggregate amount of
the balances of Common Mortgage Loans owned by
Trust 1992 is $4,197,491.14, the aggregate amount
of the balances of Common Mortgage Loans owned by
Trust 1993 is $4,594,823.30 and the aggregate
amount of the balances of Common Mortgage Loans
owned by Trust 1994 is $8,255,179.60. Chevy Chase
and The Chase Manhattan Bank, who will act as
Servicer and Trustee, respectively, of the Trust,
also act as servicer and trustee, respectively of
Trust 1990, Trust 1991, Trust 1992, Trust 1993
and Trust 1994.
A "Sold Balance", with respect to any Common
Mortgage Loan, shall be equal to the portion of
the outstanding balance of such Common Mortgage
Loan transferred to a Prior Trust and not subse-
quently transferred to the Trust.
"Liquidation Proceeds" are proceeds (including
Insurance Proceeds but excluding any amounts
drawn on the Certificate Insurance Policy) re-
ceived in connection with the liquidation of Liq-
uidated Mortgage Loans (as defined herein). "Net
Liquidation Proceeds" with respect to a Mortgage
Loan are Liquidation Proceeds reduced by related
expenses (including any amount advanced in re-
spect of the repayment of a senior mortgage or
other Servicer Advance (as defined herein)). "In-
surance Proceeds" are proceeds paid to the
Servicer pursuant to any insurance policy cover-
ing a Mortgage Loan, reduced by related expenses.
The Trust's share of Net Liquidation Proceeds
("Net Trust Liquidation Proceeds") with respect
to any Liquidated Mortgage Loan will be equal to
the sum of (i) the Trust's pro rata share of Net
Liquidation Proceeds not to exceed Trust Interest
with respect to the period from the last day on
which interest was paid in full on such Liqui-
dated Mortgage Loan to the day on which such Liq-
uidated Mortgage Loan became a Liquidated Mort-
gage Loan and (ii) the Trust's pro rata share of
the amount remaining after the payment of such
Trust Interest and the interest payable to the
owners of Sold Balances. "Trust Insurance Pro-
ceeds" means as to any Mortgage Loan and Collec-
tion Period, the Trust's share of Insurance Pro-
ceeds, which share is equal to the
S-6
<PAGE>
product of (i) the Trust Percentage (as defined
herein) and (ii) Insurance Proceeds received dur-
ing such Collection Period which (x) are not Liq-
uidation Proceeds, (y) are not applied or ex-
pected to be applied to the restoration or repair
of the related Mortgaged Property or released to
the related mortgagor in accordance with the nor-
mal servicing procedures of the Servicer and (z)
will be applied by the Servicer in reduction of
the Loan Balance of such Mortgage Loan.
With respect to any Distribution Date, the aggre-
gate amount of Trust Interest collected in the
related Collection Period allocable to the Cer-
tificates ("Certificate Interest Collections")
will equal the aggregate amount of Daily Certifi-
cate Interest Collections for the related Collec-
tion Period. With respect to any day, "Daily Cer-
tificate Interest Collections" shall equal the
product of (i) the aggregate amount of Trust In-
terest collected on such day and (ii) the
Certificateholders' Floating Allocation Percent-
age on such day.
With respect to any day, the "Certificateholders'
Floating Allocation Percentage" will be the per-
centage equivalent of a fraction determined by
dividing the Invested Amount by the Pool Balance
as of the end of such day. The
"Certificateholders' Fixed Allocation Percentage"
(calculated for any day) will equal the greater
of (x) 98% and (y) the percentage equivalent of a
fraction, the numerator of which is the Invested
Amount and the denominator of which is the Pool
Balance as of the end of such day (but not more
than 100%). The Certificateholders' Fixed Alloca-
tion Percentage initially will be 98%.
On each Distribution Date, the Certificate Inter-
est Collections, together with withdrawals, if
any, from the Capitalized Interest Account, and
any earnings received on the amounts on deposit
in the Pre-Funding Account for such Distribution
Date will be applied to the extent available in
the following order of priority: (i) as payment
of the Servicing Fee; (ii) as payment for the ac-
crued interest due and any overdue accrued inter-
est (with interest thereon) on the Certificate
Principal Balance of the Certificates (other than
any Basis Risk Payment (as defined herein) or ac-
crued interest thereon); (iii) as payment for the
premium for the Certificate Insurance Policy;
(iv) to pay Certificateholders the product of the
Certificateholders' Floating Allocation Percent-
age and the Liquidation Loss Amount (as defined
herein) for such Distribution Date; (v) as pay-
ment for any Liquidation Loss Amount allocable to
the Certificateholders for a previous Distribu-
tion Date that was not previously (a) funded by
Certificate Interest Collections, (b) reflected
in a reduction in the Overcollateralization
Amount or (c) funded by draws on the Certificate
Insurance Policy; (vi) to reimburse prior draws
made on the Certificate Insurance Policy together
with accrued interest thereon; (vii) to pay prin-
cipal on the Certificates until the Invested
Amount exceeds the Certificate Principal Balance
by the Required Overcollateralization Amount
(each as defined herein) (the aggregate of
amounts, if any, paid pursuant to this clause
(vii) being referred to herein as the "Acceler-
ated Principal Distribution Amount"); (viii) to
pay any other amounts owed to the Certificate
S-7
<PAGE>
Insurer pursuant to the Insurance Agreement (as
defined herein); (ix) as payment to
Certificateholders of any Basis Risk Payment (and
any accrued interest thereon) from any prior Dis-
tribution Date that has not previously been paid
and (x) to the Transferor. Certificate Interest
Collections remaining after payment of the
amounts described in clauses (i), (ii) and (iii)
above, shall be referred to herein as the
"Certificateholders' Excess Interest."
Any interest accruing on the Basis Risk Payment
shall accrue at the related Certificate Rate for
such period.
Certificateholders' Excess Interest may be insuf-
ficient to cover the Certificateholders' Floating
Allocation Percentage of Liquidation Loss
Amounts. If as a result of such insufficiency the
Certificate Principal Balance exceeds the In-
vested Amount, a draw in an amount equal to such
difference will be made on the Certificate Insur-
ance Policy in accordance with the terms of the
Certificate Insurance Policy and the proceeds of
such draw paid to the Certificateholders. Payment
of such amounts will reduce the Certificate Prin-
cipal Balance but not the Invested Amount.
The "Overcollateralization Amount" on any date of
determination is the amount, if any, by which the
Invested Amount exceeds the Certificate Principal
Balance on such day.
Payments to Certificateholders pursuant to
clauses (ii) and (ix) above will be interest pay-
ments on the Certificates. Although payments of
the Accelerated Principal Distribution Amount to
Certificateholders pursuant to clause (vii) above
will reduce the Certificate Principal Balance,
such payments will not reduce the Invested
Amount. Payments to Certificateholders pursuant
to clauses (vii) and (ix) above are not guaran-
teed by the Certificate Insurance Policy.
The "Required Overcollateralization Amount" is
equal to an amount which is the greater of (a)
$2,409,200; provided, however that on any date on
which Certificateholders' Excess Interest equals
or exceeds 2% of the Certificate Principal Bal-
ance (based on a six month rolling average) and
equals or exceeds 1.5% of the Certificate Princi-
pal Balance (based on a three month rolling aver-
age), the amount in this clause (a) shall be the
lesser of (x) $2,409,200 and (y) 3% of the Cer-
tificate Principal Balance and (b) the Basic
Overcollateralization Amount.
"Liquidation Loss Amount" means with respect to
any Liquidated Mortgage Loan, the unrecovered
Trust Balance thereof at the end of the related
Collection Period in which such Mortgage Loan be-
came a Liquidated Mortgage Loan, after giving ef-
fect to the principal portion of Net Trust Liqui-
dation Proceeds in connection therewith.
Principal Collections (after giving effect to any
Basis Risk Payment to be paid therefrom) will be
allocated to the Certificateholders in accordance
with the Certificateholders' Fixed Allocation
Percentage,
S-8
<PAGE>
but a lesser amount of Principal Collections may
be distributed to Certificateholders during the
Managed Amortization Period, as described below.
Payments of principal to the Certificateholders
over the term of the Trust will not exceed the
Original Certificate Principal Balance.
To the extent described herein, the Servicer will
deposit collections of principal and interest on
the Mortgage Loans in an account established for
such purpose under the Pooling and Servicing
Agreement (the "Certificate Account"). See "DE-
SCRIPTION OF THE CERTIFICATES--Payments on the
Mortgage Loans; Deposits to Certificate Account"
herein.
Pre-Funding Account......... On the Closing Date, an aggregate cash amount of
approximately $24,000,000 (the "Pre-Funded
Amount") will be deposited into an account estab-
lished with the Trustee on behalf of the Trust
(the "Pre-Funding Account"). Such amount will be
funded from the sale of the Certificates. From
the Closing Date until the earliest to occur of
(i) the Distribution Date on which the aggregate
amount on deposit in the Pre-Funding Account is
equal to or less than $100,000, (ii) the com-
mencement of the Rapid Amortization Period or
(iii) June 20, 1997 (the "Pre-Funding Period"),
the Trustee shall purchase, on behalf of the
Trust, the Subsequent Mortgage Loans. As a re-
sult, the aggregate principal balance of the
Mortgage Loans will increase by an amount equal
to the Cut-off Date Trust Balances of the Subse-
quent Mortgage Loans acquired by the Trust, and
the amount on deposit in the Pre-Funding Account
will decrease by such amount. In the event there
are any funds remaining in the Pre-Funding Ac-
count at the end of the Pre-Funding Period, the
Certificateholders' Fixed Allocation Percentage
of such funds (excluding any net investment earn-
ings thereon) shall be distributed to the
Certificateholders in respect of principal on the
Certificates.
It is intended that the Subsequent Mortgage Loans
will consist primarily of balances of revolving
credit line home equity loans originated by Chevy
Chase and transferred to Trust 1991 (the "91-1
Mortgage Loans"), provided such loans are pur-
chased by Chevy Chase from Trust 1991. The 91-1
Mortgage Loans have terms that are, and were
originated in a manner that is, substantially
similar to the Initial Mortgage Loans. Only those
91-1 Mortgage Loans that meet the eligibility
criteria requirements set forth in the Pooling
and Servicing Agreement and are approved by the
Certificate Insurer will be transferred to the
Trust. In the event that the 91-1 Mortgage Loans
are not available for purchase during the Pre-
Funding Period, the Transferor will use its best
efforts to transfer to the Trust revolving credit
line home equity loans that meet the eligibility
requirements set forth in the Pooling and Servic-
ing Agreement and are approved by the Certificate
Insurer during the Pre-Funding Period. See "RISK
FACTORS" herein and in the Prospectus.
Capitalized Interest On the Closing Date, there will be deposited $
Account..................... in an account (the "Capitalized Interest Ac-
count") in the name of the Trustee on
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<PAGE>
behalf of the Trust which will be used by the
Trustee during the Pre-Funding Period to cover
certain shortfalls in interest as described here-
in. Amounts in excess of the amount necessary to
cover such shortfalls (the "Overfunded Interest
Amount") are required to be paid directly to the
Transferor on each Distribution Date during the
Pre-Funding Period.
The "Capitalized Interest Requirement" is an
amount that may be withdrawn by the Trustee from
the Capitalized Interest Account on any Distribu-
tion Date during the Pre-Funding Period to be de-
posited into the Certificate Account. This amount
shall be the excess, if any, of (a) the sum of
(i) the amount of interest accruing at the Cer-
tificate Rate during the related Accrual Period
(as defined herein) on 98% of the amount on de-
posit in the Pre-Funding Account (excluding any
net investment earnings thereon) and (ii) the
product of (x) the Premium Rate (as defined here-
in) divided by twelve and (y) 98% of the amount
on deposit in the Pre-Funding Account (excluding
any net investment earnings thereon) as of the
close of business on the prior Distribution Date
(or, in the case of the first Distribution Date,
as of the Closing Date) over (b) the amount of
any net investment income earned on such amounts
on deposit in the Pre-Funding Account.
The "Premium Rate" is the per annum rate on which
the premium payable to the Certificate Insurer is
calculated, as set forth in the Insurance Agree-
ment.
Interest.................... Interest on the Certificates will be distributed
monthly on the 20th day of each month or, if such
date is not a Business Day, then the next suc-
ceeding Business Day (each, a "Distribution
Date"), commencing on October 20, 1996, at the
Certificate Rate for the related Accrual Period.
The "Certificate Rate" for an Accrual Period will
generally equal the sum of (a) the London
Interbank Offered Rate for United States dollar
deposits for one month ("LIBOR") quoted on the
Telerate Page 3750 on the second LIBOR Business
Day prior to the first day of such Accrual Period
(or as of two LIBOR Business Days prior to the
Closing Date, in the case of the first Accrual
Period) and (b) %, subject to a rate cap equal
to the Weighted Average Loan Rate (as defined
herein). In addition, if the Certificate Rate
would have exceeded the rate cap described above,
then the Certificateholders will be entitled to
receive such difference (the "Basis Risk Pay-
ment") from the following sources and in the fol-
lowing order of priority: (i) from
Certificateholders' Excess Interest to the extent
available as described herein under "DESCRIPTION
OF THE CERTIFICATES--Distributions on the Certif-
icates" and (ii) from Principal Collections only
to the extent that the Overcollateralization
Amount exceeds the Basic Overcollateralization
Amount. The Basis Risk Payment will bear interest
if it is not paid on the Distribution Date on
which it is due, but neither the Basis Risk Pay-
ment nor interest accrued thereon will be covered
by
S-10
<PAGE>
the Certificate Insurance Policy. Interest on the
Certificates in respect of any Distribution Date
will accrue from the preceding Distribution Date
(or in the case of the first Distribution Date,
from the date of the initial issuance of the Cer-
tificates (the "Closing Date")) through the day
preceding such Distribution Date (each such peri-
od, an "Accrual Period") on the basis of the ac-
tual number of days in the Accrual Period and a
360-day year.
Interest payments on the Certificates will be
funded from Certificate Interest Collections, the
Capitalized Interest Requirement, earnings re-
ceived on amounts on deposit in the Pre-Funding
Account, draws on the Certificate Insurance Pol-
icy and Principal Collections to the extent of
any Basis Risk Payment as described herein. See
"DESCRIPTION OF THE CERTIFICATES" herein.
As to any Distribution Date, the "Collection Pe-
riod" is the calendar month preceding such Dis-
tribution Date.
Principal Payments from
Principal Collections.......
For the period beginning on the first Distribu-
tion Date and, unless a Rapid Amortization Event
shall have earlier occurred, ending on the Dis-
tribution Date in September 2002 (the "Managed
Amortization Period"), the amount of Principal
Collections payable to Certificateholders as of
each Distribution Date during the Managed Amorti-
zation Period will equal, to the extent funds are
available therefor from Principal Collections
(after payment of any Basis Risk Payment from
Principal Collections on such Distribution Date
to the extent that the Overcollateralization
Amount exceeds the Basic Overcollateralization
Amount (as defined herein)), the Scheduled Prin-
cipal Collections Distribution Amount for such
Distribution Date. On any Distribution Date with
respect to the Managed Amortization Period, the
"Scheduled Principal Collections Distribution
Amount" shall equal the lesser of (i) the Maximum
Principal Payment and (ii) the Alternative Prin-
cipal Payment. With respect to any Distribution
Date, the "Alternative Principal Payment" is
equal to the greater of (x) 1% of the Certificate
Principal Balance immediately prior to such Dis-
tribution Date and (y) the amount, but not less
than zero, of the aggregate amount of Principal
Collections for the related Collection Period
(after giving effect to any Basis Risk Payment on
such Distribution Date) less the aggregate of
principal amounts drawn down each day ("Draws")
under the Loan Agreements during the related Col-
lection Period for the Mortgage Loans. On any
Distribution Date on which the
Overcollateralization Amount exceeds the Required
Overcollateralization Amount (after giving effect
to all distributions to Certificateholders on
such date), Principal Collections remaining after
distribution to Certificateholders of any Basis
Risk Payment and the Scheduled Principal Collec-
tions Distribution Amount shall be paid to the
Transferor in reduction of the
Overcollateralization Amount up to the extent of
such excess. With respect to any Distribution
Date, the
S-11
<PAGE>
"Maximum Principal Payment" will equal the prod-
uct of the Certificateholders' Fixed Allocation
Percentage and the aggregate amount of Principal
Collections for such Distribution Date (after
giving effect to any Basis Risk Payment on such
Distribution Date).
In the event any funds remain in the Pre-Funding
Account at the end of the Pre-Funding Period (ex-
cluding any net investment earnings thereon) af-
ter giving effect to the purchase of any Subse-
quent Mortgage Loans on such day, the
Certificateholders' Fixed Allocation Percentage
of such funds shall be distributed to the
Certificateholders in respect of principal on the
Certificates.
Beginning with the first Distribution Date relat-
ing to the Rapid Amortization Period, the amount
of Principal Collections payable to
Certificateholders on each Distribution Date will
be equal to the Maximum Principal Payment. See
"DESCRIPTION OF THE CERTIFICATES--Rapid Amortiza-
tion Period; Rapid Amortization Events" herein.
On the Distribution Date in July 2017 (the
"Stated Maturity Date"), Certificateholders will
be entitled to receive as payment of principal an
amount equal to the outstanding Certificate Prin-
cipal Balance, which to the extent funds are not
otherwise available therefor, a draw for such
amount on the Certificate Insurance Policy will
be made on such Distribution Date. See "DESCRIP-
TION OF THE CERTIFICATES--Certificate Insurance
Policy" herein.
Distributions of Principal Collections (after
giving effect to any Basis Risk Payment) based
upon the Certificateholders' Fixed Allocation
Percentage may result in distributions of princi-
pal to Certificateholders in amounts that are
greater relative to the declining Pool Balance
than would be the case if the Certificateholders'
Floating Allocation Percentage were used to de-
termine the percentage of Principal Collections
distributed in respect of the Certificate Princi-
pal Balance. The aggregate distributions of prin-
cipal to Certificateholders will not exceed the
Original Certificate Principal Balance.
Certificate Insurance On or before the Closing Date, the Certificate
Policy...................... Insurance Policy will be issued by the Certifi-
cate Insurer pursuant to the provisions of the
Pooling and Servicing Agreement and the Insurance
and Indemnity Agreement (the "Insurance Agree-
ment"), among the Transferor, the Servicer and
the Certificate Insurer. The Certificate Insur-
ance Policy will unconditionally and irrevocably
guarantee principal and interest payments on the
Certificates at the times and in the amounts de-
scribed below. On each Distribution Date, a draw
will be made on the Certificate Insurance Policy
equal to (i) the amount by which interest accrued
at the Certificate Rate on the outstanding Cer-
tificate Principal Balance exceeds all amounts on
deposit in the Certificate Account available to
be distributed therefor plus (ii) the amount, if
any, by which the Certificate Principal Balance
(after giving effect to all
S-12
<PAGE>
other amounts distributable and allocable to
principal on the Certificates) exceeds the In-
vested Amount as of such Distribution Date (after
giving effect to all other amounts distributable
and allocable to principal on the Certificates)
for such Distribution Date. Neither payments of
Accelerated Principal Distribution Amounts nor
Basis Risk Payments (including interest accrued
thereon) will be covered by the Certificate In-
surance Policy.
In addition, the Certificate Insurance Policy
will guarantee the payment of the outstanding
Certificate Principal Balance on the Stated Matu-
rity Date (after giving effect to all other
amounts distributed and allocable to principal)
on such Distribution Date.
In the absence of payments under the Certificate
Insurance Policy, Certificateholders will di-
rectly bear the credit and other risks associated
with their undivided interest in the Trust. See
"DESCRIPTION OF THE CERTIFICATES--Certificate In-
surance Policy" herein.
In the event the Certificate Insurer's claims
paying ratings have been reduced by any of the
Rating Agencies (as defined herein), the Trans-
feror may, but is not obligated to, either (i)
replace the Certificate Insurance Policy with a
financial guaranty insurance policy issued by an-
other certificate insurer, provided that the rat-
ings on the claims paying ability of such re-
placement certificate insurer are higher than
those of the certificate insurer sought to be re-
placed (after giving effect to such reduction) or
(ii) eliminate or provide another form of credit
enhancement; provided that in the case of clause
(ii), the Rating Agencies consent thereto and
confirm that the ratings of the Certificates will
be increased from their current levels (after
giving effect to such reduction) as a result of
such action.
Overcollateralization The distribution of Accelerated Principal Distri-
Amount...................... bution Amounts, if any, to Certificateholders is
expected to result in the Invested Amount being
greater than the Certificate Principal Balance,
thereby creating the Overcollateralization
Amount. To the extent that Certificateholders'
Excess Interest for any Distribution Date is in-
sufficient to pay Certificateholders the product
of the Certificateholders' Floating Allocation
Percentage and the Liquidation Loss Amount, the
Overcollateralization Amount, if any, shall be
reduced, which will have the result of reducing
the Invested Amount. Any Liquidation Loss Amounts
allocable to the Certificateholders and not cov-
ered by such overcollateralization will be cov-
ered by draws on the Certificate Insurance Policy
to the extent provided therein. Payments of Ac-
celerated Principal Distribution Amounts and Ba-
sis Risk Payments (including interest accrued
thereon) are not covered by the Certificate In-
surance Policy.
The Overcollateralization Amount will also be re-
duced by the amount of Principal Collections dis-
tributed to Certificateholders in payment of any
Basis Risk Payment (including interest accrued
thereon) and by the amount of Principal Collec-
tions distributed to the Transferor in reduction
of the Overcollateralization Amount.
S-13
<PAGE>
Final Payment of Principal;
Optional Termination........
The Trust will terminate on the Distribution Date
following the later of (a) the earlier of (i)
payment in full of all amounts owing to the Cer-
tificate Insurer and (ii) the final payment or
other liquidation of the last Mortgage Loan in
the Trust and (b) the earliest of (i) the Distri-
bution Date on which the Certificate Principal
Balance has been reduced to zero, (ii) the final
payment or other liquidation of the last Mortgage
Loan in the Trust and (iii) the Stated Maturity
Date. The Certificates will be subject to op-
tional purchase by the Transferor on any Distri-
bution Date after the Certificate Principal Bal-
ance is reduced to an amount less than or equal
to $6,023,000 (5% of the Original Certificate
Principal Balance) and all amounts due and owing
to the Certificate Insurer and unreimbursed draws
on the Certificate Insurance Policy, together
with interest thereon, as provided under the In-
surance Agreement, have been paid. The purchase
price will be equal to the sum of the outstanding
Certificate Principal Balance and accrued and un-
paid interest thereon at the Certificate Rate
through the day preceding the final Distribution
Date plus any Basis Risk Payment then due and in-
terest accrued thereon. See "DESCRIPTION OF THE
CERTIFICATES--Optional Termination; Retirement of
the Certificates" herein.
In addition, the Trust may be liquidated as a re-
sult of certain events of insolvency, receiver-
ship or conservatorship relating to the Transfer-
or. See "DESCRIPTION OF THE CERTIFICATES--Rapid
Amortization Period; Rapid Amortization Events"
herein.
Servicing Fee............... The Servicer will receive a fee (the "Servicing
Fee") computed monthly at a specified annual rate
(the "Servicing Fee Rate") on the Invested Amount
less 98% of the amount on deposit in the Pre-
Funding Account (excluding any net investment
earnings thereon) as of the opening of business
on the first day of the related Collection Period
or, with respect to the first Distribution Date,
as of the Closing Date. The Servicing Fee Rate
will be 0.50% if Chevy Chase is the Servicer and
up to a maximum of 0.75% if another person is ap-
pointed as successor Servicer pursuant to the
Pooling and Servicing Agreement. See "DESCRIPTION
OF THE CERTIFICATES--Servicing and Other Compen-
sation and Payment of Expenses" herein.
Record Date................. Distributions will be made on each Distribution
Date to the holders of record as reflected in the
certificate register maintained by the Trustee on
the day prior to such Distribution Date if the
Certificates are book-entry certificates and the
last day of the month preceding the month of the
related Distribution Date if the Certificates are
issued in definitive form, except that the final
distribution in respect of any Certificate will
be made only upon presentation and surrender of
such Certificate at the office or agency ap-
pointed by the Trustee for that purpose.
The Mortgage Loans.......... The Mortgage Loans are revolving credit line home
equity loans originated by the Transferor in its
home equity credit line loan program and are se-
cured by deeds of trust, of which approximately
S-14
<PAGE>
19.32% by principal balance are first deeds of
trust and the remainder of which are second deeds
of trust. The combined loan-to-value ratio of a
Mortgage Loan (computed at its Maximum Credit
Limit as of the Cut-off Date) and any related
first deed of trust loan (the "Combined Loan-to-
Value Ratio") did not exceed 100% based upon an
appraisal of the related Mortgaged Property per-
formed or obtained by the Transferor at the time
of execution of the related Loan Agreement. The
term to stated maturity for the Mortgage Loans
was either ten years or ten years and three
months after the date of origination or 20 years
after the later of the date of origina-tion of
the Mortgage Loan or the date of increase of the
Maximum Credit Limit of such Mortgage Loan.
Interest on the Mortgage Loans is computed daily
and payable monthly on the daily outstanding
principal balance at a floating rate per annum
equal at any time to the sum of a specified mar-
gin and the Base Rate (as defined herein). See
"THE MORTGAGE LOAN POOL" herein. Principal
amounts may be drawn down (up to the maximum per-
mitted principal amount as set forth in the terms
of the related Loan Agreement, the "Maximum
Credit Limit") or repaid under each Mortgage Loan
from time to time. Billing statements are pro-
duced as of the date the related billing cycle
ends (the "Cycle Date") and reflect all payment
activity and any additional borrowings by the
borrower since the last Cycle Date. See "THE
CHEVY CHASE HOME EQUITY LENDING PROGRAM--Servic-
ing" herein.
Minimum monthly payments are required to be made
on each Mortgage Loan for any period in which in-
terest accrues. Except for Mortgage Loans origi-
nated under the Sub-Prime Lending Program (as de-
fined herein), which begin amortizing after the
first five years, the minimum monthly payment for
a Mortgage Loan is an amount equal to the amount
of interest accrued during the related billing
cycle plus any late charges, administrative
charges and credit insurance charges and the
amount, if any, by which the outstanding balance
of such Mortgage Loan exceeds its Maximum Credit
Limit. Except for any principal amortization that
may result from such minimum monthly payments,
there are no required payments of principal, ex-
cept that the entire outstanding principal amount
of each Mortgage Loan is due on the maturity date
of such Mortgage Loan.
The approximate Trust Balances of the Initial
Mortgage Loans at the Initial Cut-off Date ranged
from $0 to $364,092 and averaged $19,875. At the
Initial Cut-off Date, Maximum Credit Limits of
the Initial Mortgage Loans ranged from $7,500 to
$500,000 and averaged approximately $51,332, and
the weighted average remaining term to stated ma-
turity of the Initial Mortgage Loans was 219
months. The latest scheduled maturity of any Ini-
tial Mortgage Loan is August 30, 2016. See "THE
CHEVY CHASE HOME EQUITY LENDING PROGRAM" herein.
S-15
<PAGE>
All of the properties securing the Mortgage Loans
are required to be covered by standard hazard in-
surance policies insuring against losses due to
fire and various other causes. See "DESCRIPTION
OF THE CERTIFICATES--Hazard Insurance" herein and
"SERVICING OF LOANS--Maintenance of Insurance
Policies and Other Servicing Procedures" in the
Prospectus.
Mandatory Retransfer or
Substitution of Mortgage
Loans.......................
The Transferor or the Servicer (in certain cir-
cumstances), as the case may be, has the option
either to accept a retransfer of the Trust Bal-
ance of a Mortgage Loan, in the case of the
Transferor, or transfer, in the case of the
Servicer on account of (A) a material breach of a
representation or warranty made by the Transferor
in the Pooling and Servicing Agreement, (B) a ma-
terial defect in the related loan documentation
or (C) a change in certain terms of the related
Loan Agreement unless permitted as described in
"DESCRIPTION OF THE CERTIFICATES--Amendments to
Loan Agreements" and "--Collection and other Ser-
vicing Procedures" herein (each Mortgage Loan de-
scribed in (A) through (C) above, a "Defective
Mortgage Loan") or substitute balances of new
Mortgage Loans for such Trust Balances. Any Mort-
gage Loan so substituted (an "Eligible Substitute
Mortgage Loan") must, among other things, have a
Trust Balance (or if the new Mortgage Loan is a
Common Mortgage Loan, a balance conveyed to the
Trust) not less than 95% of the Trust Balance of
the Mortgage Loan for which it is being substi-
tuted, and a Loan Rate of not less than the cur-
rent Loan Rate of the Defective Mortgage Loan it
replaces and not more than 100 basis points in
excess thereof. See "DESCRIPTION OF THE CERTIFI-
CATES--Assignment of Mortgage Loan Trust Bal-
ances" herein.
Rating...................... It is a condition to the issuance of the Certifi-
cates that the Certificates be rated in the high-
est rating category by at least one nationally
recognized statistical rating organization, which
has been requested by the Transferor to rate the
Certificates (the "Rating Agency" or "Rating
Agencies"). The rating of the Certificates will
depend primarily on an assessment by a Rating
Agency of the underlying Mortgage Loans and the
claims paying ability of the Certificate Insurer
and in part on the level of protection provided
by the Overcollateralization Amount and
Certificateholders' Excess Interest. There can be
no assurance that the rating assigned to the Cer-
tificates on the date the Certificates are ini-
tially issued will not be reduced, suspended or
withdrawn by a Rating Agency in the future. The
ratings of the Certificates do not address the
payment of the Basis Risk Payment or interest ac-
crued thereon.
Certain Federal Income Tax
Consequences................
In the opinion of federal tax counsel to the
Transferor, under existing law the Certifi-
cates are properly characterized as debt for
federal income tax purposes as of the Clos-
ing Date. Under the Pooling and Servicing
Agreement, the Transferor and the
Certificateholders will agree to treat the
Certificates as indebtedness for federal,
state
S-16
<PAGE>
and local income and franchise tax purposes.
See "CERTAIN FEDERAL INCOME TAX CONSE-
QUENCES" herein and "FEDERAL INCOME TAX CON-
SIDERATIONS" in the Prospectus.
ERISA Considerations........ The Certificates may not be acquired or held by
or on behalf of (i) an employee benefit plan (as
defined in Section 3(3) of ERISA) that is subject
to Title I of ERISA, (ii) a plan described in
Section 4975(e)(1) of the Code, (iii) a govern-
mental plan described in Section 3(32) of ERISA
subject to any federal, state or local law which
is, to a material extent, similar to the provi-
sions of Section 406 of ERISA or Section 4975 of
the Code or (iv) any entity whose underlying as-
sets include plan assets by reason of a plan's
investment in such entity. The foregoing restric-
tions do not apply to the acquisition or holding
of Certificates with assets of the general ac-
count of an insurance company to the extent the
acquisition or holding, respectively, of such
Certificates is permissible under Section 401(c)
of ERISA and final regulations thereunder and
does not result in the contemplated operations of
the Trust being treated as violations of the pro-
hibited transaction rules. By its acceptance of a
Certificate, each Certificate Owner (as defined
herein) will be deemed to have represented and
warranted that it is not subject to the foregoing
restrictions.
Persons contemplating acquiring the Certificates
should consult their counsel to determine whether
they are purchasing on behalf of or with the
"plan assets" of any plan. See "ERISA CONSIDERA-
TIONS" herein for special considerations for pur-
chasers using assets of an insurance company gen-
eral account. See also "ERISA CONSIDERATIONS"
herein and in the Prospectus.
Legal Investment Although, as a condition to their issuance, the
Considerations.............. Certificates will be rated in the highest rating
category by a Rating Agency, the Certificates
will not constitute "mortgage related securities"
for purposes of the Secondary Mortgage Market En-
hancement Act of 1984 ("SMMEA"), because not all
of the deeds of trust securing the Mortgage Loans
are first deeds of trust. Accordingly, many in-
stitutions with legal authority to invest in com-
parably rated securities based on first mortgage
loans (i.e., "mortgage related securities" under
SMMEA) may not be legally authorized to invest in
the Certificates. See "LEGAL INVESTMENT CONSIDER-
ATIONS" herein and "LEGAL INVESTMENT" in the Pro-
spectus.
Registration of The Certificates initially will be registered in
Certificates................ the name of CEDE & Co., as the nominee of DTC.
The interests of owners of the Certificates (the
"Certificate Owners") will be represented by book
entries on the records of DTC and participating
members thereof. Certificates representing the
Certificates will be available in definitive form
only under the limited circumstances described
herein. See "RISK FACTORS--Book-Entry Registra-
tion" and "DESCRIPTION OF THE CERTIFICATES--Reg-
istration of Certificates" herein.
S-17
<PAGE>
RISK FACTORS
Prospective investors should consider, in addition to the factors described
under "RISK FACTORS" in the accompanying Prospectus, the following additional
risk factors in connection with a purchase of the Certificates.
Limited Liquidity. Issuance of the Certificates in book-entry form may
reduce the liquidity of such Certificates in the secondary trading market,
since investors may be unwilling to purchase Certificates for which they
cannot obtain physical certificates. See "DESCRIPTION OF THE CERTIFICATES--
Registration of Certificates" herein.
Book-Entry Registration. The Certificates initially will be represented by
certificates registered in the name of CEDE & Co., as the nominee of DTC, and
will not be registered in the names of the Certificate Owners or their
nominees. As a result, unless and until Replacement Certificates are issued,
Certificate Owners will not be recognized by the Trustee as
Certificateholders, as such term is used in the Pooling and Servicing
Agreement. Until such time, Certificate Owners will only be able to exercise
the rights of Certificateholders indirectly through DTC, Cedel or Euroclear
and their respective participating organizations.
Since transactions in the Certificates can be effected only through DTC,
Cedel, Euroclear, participating organizations, indirect participants or
certain banks, the ability of a Certificate Owner to pledge a Certificate to
persons or entities that do not participate in the DTC system, or otherwise to
take actions in respect of such Certificates, may be limited due to lack of a
physical certificate representing the Certificates.
Nature of Security. With the exception of Mortgage Loans originated under
the Sub-Prime Lending Program which begin amortizing after the first five
years, other than the payment of the outstanding principal balance of a
Mortgage Loan due at maturity, the required minimum monthly payments on such
Mortgage Loan consist of interest only and will not amortize the outstanding
principal of the Mortgage Loan. As a result, a borrower generally will be
required to pay the entire principal amount of the Mortgage Loan at its
maturity. The ability of a borrower to make such a payment may depend on the
borrower's ability to obtain refinancing of the balance due on the Mortgage
Loan. An increase in interest rates over the Loan Rate applicable at the time
the Mortgage Loan was originated may have an adverse effect on the borrower's
ability to pay the required monthly payment. In addition, such an increase in
interest rates may reduce the borrower's ability to obtain refinancing and to
pay the balance of the Mortgage Loan at its maturity.
Because the Mortgage Loans are secured primarily by junior liens subordinate
to the rights of the beneficiary under the related senior deed of trust, the
proceeds from any liquidation, insurance or condemnation proceeding will be
available to satisfy the outstanding balance of a Mortgage Loan only to the
extent that the claims of such first beneficiary (including any related
foreclosure costs) have been satisfied in full. In addition, a beneficiary
under a junior deed of trust may not foreclose upon the property securing such
deed of trust unless it forecloses subject to the related senior deed of
trust, in which case it must either pay the entire amount of the senior deed
of trust to the applicable beneficiary at or prior to the foreclosure sale or
undertake the obligation to make payments on the senior deed of trust in the
event of default thereunder. In servicing home equity mortgage loans in its
portfolio, it is the Servicer's practice to satisfy each such senior deed of
trust at or prior to the foreclosure sale only to the extent that it
determines any amounts so paid will be recoverable from future payments and
collections on the loan or otherwise. The Trust will have no source of funds
to satisfy each such senior deed of trust or make payments due to each senior
beneficiary. See "CERTAIN LEGAL ASPECTS OF THE LOANS--Foreclosure on Mortgages
and Deeds of Trust" and "--Junior Mortgages; Rights of Senior Mortgages" in
the Prospectus.
Because all of the Mortgaged Properties are located in Maryland, Virginia
and the District of Columbia, and principally located in the Washington, D.C.
metropolitan area, an overall decline in the Washington, D.C. residential real
estate market could adversely affect the values of the Mortgaged Properties
such that the outstanding Loan Balances, together with the outstanding
balances of any senior loans, may equal or exceed the value of such Mortgaged
Properties. There can be no assurance that residential property values will
not decline in future periods. See the tables under "THE CHEVY CHASE HOME
EQUITY LENDING PROGRAM"
S-18
<PAGE>
herein for delinquency and loss experience data with respect to the
Transferor's home equity loan portfolio. Because most of the Mortgage Loans
are secured by junior deeds of trust subordinate to the rights of the
beneficiaries under the related senior deeds of trust, such a decline could
extinguish the interest of the beneficiary of a junior deed of trust on the
Mortgaged Property before having any effect on the interest of the beneficiary
of a related senior deed of trust. The general condition of the Mortgaged
Property and other factors may have the effect of reducing the value of the
Mortgaged Property from the appraised value at the time the Mortgage Loan was
originated. Because payments in reduction of the outstanding principal balance
of a Mortgage Loan generally are not required prior to maturity, if there is a
subsequent reduction in value of the Mortgaged Property, the ratio of the
amount of the Mortgage Loan to the value of the Mortgaged Property may
increase from the ratio existing at the time the Mortgage Loan was originated.
Such an increase may reduce the likelihood that liquidation or other proceeds
will be sufficient to satisfy the Mortgage Loan after satisfaction of any
senior liens.
Even assuming that the Mortgaged Properties provide adequate security for
the Mortgage Loans, delay could be encountered in connection with the
liquidation of defaulted Mortgage Loans, with corresponding delays in the
receipt of related proceeds by Certificateholders. Further, the Servicer will
be entitled to make a Servicer Advance for all liquidation expenses with
respect to a Liquidated Mortgage Loan, which will be reimbursed to the
Servicer out of Liquidation Proceeds prior to any such amounts being available
to make payments on the Certificates with respect to such Liquidated Mortgage
Loan. See "CERTAIN LEGAL ASPECTS OF THE LOANS--Foreclosure on Mortgages and
Deeds of Trust" and "--Rights of Redemption" in the Prospectus.
Under federal and state environmental legislation and applicable case law,
it is unclear whether liability for the costs of eliminating environmental
hazards in respect of real property may be imposed on a secured lender (such
as the Trust) acquiring title to such real property. Such costs could be
substantial. See "CERTAIN LEGAL ASPECTS OF THE LOANS--Environmental
Legislation" and "RISK FACTORS--Potential Liability For Environmental
Conditions" in the Prospectus.
Cash Flow Considerations. Under the Pooling and Servicing Agreement, the
Certificate Rate is subject to a rate cap equal to the Weighted Average Loan
Rate of the Mortgage Loans. In the event that the Certificate Rate would have
exceeded the Weighted Average Loan Rate if such cap were not in effect,
Certificateholders will be entitled to receive the Basis Risk Payment to the
extent available from certain sources as described under "DESCRIPTION OF THE
CERTIFICATES--Distributions on the Certificates" herein. The Loan Rates for
loans which have their interest rate adjusted quarterly are based on the rate
of interest publicly announced from time to time as the "prime" or "base" rate
of interest charged by the index bank specified in the related loan agreement
as in effect on the last day of the last full calendar month of the
immediately preceding quarter; the Loan Rates for loans which have their
interest rate adjusted monthly are based on an index which is the highest
prime rate published in the "Money Rates" section of The Wall Street Journal
on the first Business Day of the calendar month (in each case, the "Base
Rate"). An extreme change in one month LIBOR at a time when the Weighted
Average Loan Rate does not experience a corresponding change could result in
the Certificate Rate being limited as described above. In addition, because
certain of the Loan Rates are adjusted quarterly and the Certificate Rate is
adjusted monthly, if interest rates generally should rise significantly during
any three-month period, there is a greater likelihood that the Certificate
Rate will be limited than would be the case if all of the Loan Rates were
adjusted each month. As of the Initial Cut-off Date, certain of the Initial
Mortgage Loans in the Pool bear interest at reduced promotional or
introductory rates. Such rates are generally in effect for a period of
approximately six months. To the extent the Mortgage Loans have promotional or
introductory rates in effect, the Weighted Average Loan Rate will be affected,
thereby limiting the Certificate Rate as described above.
Collections on the Mortgage Loans may vary because, among other things,
borrowers generally may make payments during any month (other than the month
in which the Mortgage Loan matures, unless the credit limit is exceeded) as
low as the interest payment for such month or as high as the entire
outstanding balance (plus accrued interest and other charges). Collections on
Mortgage Loans also may vary due to seasonal purchasing and payment habits of
borrowers.
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General credit risk may be greater to Certificateholders than to holders of
instruments representing interests in level-payment first deed of trust loans
since generally no payment of principal is required until final maturity
unless the credit limit is exceeded. Generally, unless the credit limit is
exceeded, minimum monthly payments will not exceed accrued interest except in
the month of the Mortgage Loan's maturity date, in which the Mortgage Loan is
scheduled to amortize fully. Borrowers under home equity loans originated by
the Transferor (other than loans originated under the Sub-Prime Lending
Program) are under no obligation to pay down all or part of their outstanding
principal balances prior to maturity unless the credit limit is exceeded, and,
in the event such balances have not been substantially paid down prior to
maturity, some borrowers may find themselves unable to make the required final
payment.
Prepayment Considerations. All of the Mortgage Loans may be prepaid in whole
or in part at any time. Generally, home equity loans are not viewed by
mortgagors as permanent financing. Accordingly, the Mortgage Loans may
experience a higher rate of prepayment than traditional mortgage loans. On the
other hand, because the Mortgage Loans are not fully amortizing, in the
absence of voluntary borrower prepayments they could experience slower rates
of principal payment than traditional, fully amortizing mortgages. The Trust's
prepayment experience may be affected by a wide variety of factors, including
general economic conditions, interest rates, the availability of alternative
financing and homeowner mobility.
The rate and timing of amortization of the Certificate Principal Balance
will be affected by the inclusion of Trust Balances of Common Mortgage Loans
in the Trust Fund. Common Mortgage Loans, which as of the Initial Cut-off Date
account for approximately 8.13% by principal amount of the balances to be
transferred to the Trust, are those Mortgage Loans which generated balances
that were transferred to Trust 1990, Trust 1991, Trust 1992, Trust 1993 or
Trust 1994. See table captioned "Data on Common Mortgage Loans" under "THE
MORTGAGE LOAN POOL" herein. Payments of principal (including prepayments) by a
borrower on a Common Mortgage Loan will be applied first to reduce to zero the
principal balance, if any, of such Common Mortgage Loan transferred to Trust
1990, second to reduce to zero the principal balance, if any, of such Common
Mortgage Loan transferred to Trust 1991 (including any such balance
subsequently transferred to the Trust during the Pre-Funding Period), third to
reduce to zero the principal balance, if any, of such Common Mortgage Loan
transferred to Trust 1992, fourth to reduce to zero the principal balance, if
any, of such Common Mortgage Loan transferred to Trust 1993 and fifth to
reduce to zero the principal balance, if any, of such Common Mortgage Loan
transferred to Trust 1994 before any such payments are applied to reduce the
Trust Balance of such Common Mortgage Loan (other than 91-1 Mortgage Loans).
Partial prepayments of Common Mortgage Loans therefore would affect the rate
and timing of distributions on the Certificates at a slower rate than partial
prepayments of other Mortgage Loans.
In the event that 91-1 Mortgage Loans are conveyed to the Trust during the
Pre-Funding Period, principal collections on such Mortgage Loans will be
applied in the priority described above as if such balances were still held by
Trust 1991, and no additional balances will be generated with respect thereto,
thereby affecting the average life of the Certificates.
Substantially all of the Mortgage Loans contain due-on-sale provisions. The
Servicer is obligated under the Pooling and Servicing Agreement to enforce
such provisions unless such enforcement is not permitted by applicable law.
The enforcement of a due-on-sale provision will have the same effect as a
prepayment of the related Mortgage Loan. See "CERTAIN LEGAL ASPECTS OF THE
MORTGAGE LOANS--Due-on-Sale Clauses" herein and "CERTAIN LEGAL ASPECTS OF THE
LOANS--Due-on-Sale Clauses in Mortgage Loans" in the Prospectus. For a
description of certain provisions of the Pooling and Servicing Agreement that
may affect the prepayment experience on the Mortgage Loans, see "DESCRIPTION
OF THE CERTIFICATES--Collection and Other Servicing Procedures" herein.
Under the Pooling and Servicing Agreement, the Transferor or the Servicer,
as applicable, will be obligated to purchase Defective Mortgage Loans or (in
specified circumstances) permitted to substitute Eligible Substitute Mortgage
Loans for Defective Mortgage Loans. The Certificateholders' portion of the
Retransfer Deposit Amount paid in connection with such a purchase or, in the
case of a substitution, the related Certificateholders' portion of the
Substitution Adjustment Amount will be deposited into the Certificate Account.
Amounts so
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deposited will be distributed to Certificateholders as a prepayment of the
Trust Balance of the applicable Defective Mortgage Loan, accelerating
distributions on the Certificates. See "DESCRIPTION OF THE CERTIFICATES--
Assignment of Mortgage Loan Trust Balances" herein.
Removal of Mortgage Loans. Subject to the satisfaction of certain conditions
contained in the Pooling and Servicing Agreement, the Transferor may from time
to time, by exercising its rights under the provisions of the Pooling and
Servicing Agreement for removing such Mortgage Loans as described herein,
remove certain Mortgage Loans, and the Trust Balances thereof, from the Trust.
Because such removal will result in the Pool Balance being decreased, the
weighted average life of the Certificates may change. See "MATURITY AND
PREPAYMENT CONSIDERATIONS" herein. For a description of the removal provisions
contained in the Pooling and Servicing Agreement, see "DESCRIPTION OF THE
CERTIFICATES--Optional Retransfers of Mortgage Loans to the Transferor"
herein.
Certificate Rating. The rating of the Certificates will depend primarily on
an assessment by a Rating Agency of the underlying Mortgage Loans and the
claims paying ability of the Certificate Insurer and in part on the level of
protection provided by the Overcollateralization Amount and
Certificateholders' Excess Interest. Any reduction in the rating assigned to
the claims-paying ability of the Certificate Insurer below the rating
initially given to the Certificates may result in a reduction in the rating of
the Certificates. The rating by the Rating Agencies of the Certificates is not
a recommendation to purchase, hold or sell the Certificates, inasmuch as such
rating does not comment as to the market price or suitability for a particular
investor. There is no assurance that the ratings will remain in effect for any
given period of time or that the ratings will not be reduced, suspended or
withdrawn by the Rating Agencies. The ratings of the Certificates do not
address the payment of the Basis Risk Payment or interest accrued thereon.
Legal Considerations. The Mortgage Loans are primarily secured by second
deeds of trust. With respect to any Mortgage Loan secured by a first deed of
trust, the Servicer has the power under certain circumstances to consent to a
new mortgage lien on the Mortgaged Property having priority over the related
Mortgage Loan. With respect to each Mortgage Loan secured by a second deed of
trust, the Trust will be entitled, to the extent described herein, to proceeds
that remain from the sale of the related Mortgaged Property after any related
first deed of trust loan and any other prior liens have been satisfied. In the
event that such proceeds are insufficient to satisfy both loans and such other
liens in the aggregate, the Trust and, accordingly, the Certificateholders, as
the holders of the second deed of trust loan, bear the risk of delay in
distributions while a deficiency judgment against the borrower is pursued and
the risk of delay until the Stated Maturity Date if the deficiency judgment is
not obtained and realized upon. See "CERTAIN LEGAL ASPECTS OF THE LOANS--
Junior Mortgages; Rights of Senior Mortgages" and "--Anti-Deficiency
Legislation and Other Limitations on Lenders" in the Prospectus.
Insolvency-Related Matters. The Transferor intends that the transfer of all
of the Transferor's right, title and interest in the Mortgage Loans to the
Trust be treated as a sale by the Transferor to the Trust and, accordingly,
that such Trust Balances will not be part of the assets of the Transferor in
the event of the appointment of a receiver or conservator for the Transferor
and will not be available to the creditors of the Transferor. In the event of
an insolvency of the Transferor, however, it is possible that a receiver or a
conservator for, or a creditor of, the Transferor may argue that the
transaction between the Transferor and the Trust was a pledge of each such
Mortgage Loan, in connection with a borrowing by the Transferor, rather than a
sale. If the transfer by the Transferor to the Trust is deemed to be a grant
to the Trust of a security interest in the Mortgage Loans, the Trust should
have an enforceable first priority perfected security interest in the Mortgage
Loans. If a receiver or conservator were appointed for the Transferor, certain
administrative expenses of the receiver or conservator may have priority over
the Trust's right, title and interest in the Mortgage Loans. For so long as
the Transferor is the Servicer, cash collections on the Trust Balances may be
held by the Transferor and commingled with its funds for brief periods, and in
an insolvency proceeding or receivership or conservatorship of the Transferor,
the Trust may not have a perfected interest in such commingled collections.
In the event that the Transferor's transfer of the Mortgage Loans to the
Trust is deemed to constitute the creation of a security interest in the
Mortgage Loans in favor of the Trust, to the extent such security interest was
validly perfected before the Transferor's insolvency and was not taken in
contemplation of insolvency of
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the Transferor, or with the intent to hinder, delay or defraud the Transferor
or the creditors of the Transferor, the Federal Deposit Insurance Act
("FDIA"), as amended by the Financial Institutions Reform, Recovery, and
Enforcement Act of 1989, as amended ("FIRREA"), provides that such security
interest will not be subject to avoidance by the Federal Deposit Insurance
Corporation (the "FDIC"), as receiver for the Transferor. Subject to
clarification by regulations or interpretations, positions taken by the FDIC
staff prior to the passage of FIRREA do not suggest that the FDIC, as receiver
or conservator for the Transferor, would interfere with the timely transfer to
the Trust of payments collected on the related Mortgage Loans. If, however,
the FDIC were to assert a contrary position, such as requiring the Trustee to
establish its right to those payments by submitting to and completing the
administrative claims procedure under the FDIA, or the conservator or receiver
were to request a stay of proceedings with respect to the Transferor, as
provided under the FDIA, delays in payments on the Certificates and possible
reductions in the amount of those payments could occur. A receiver or
conservator also may disaffirm or repudiate the Transferor's obligations under
the Pooling and Servicing Agreement to accept reassignment of Defective
Mortgage Loans or to accept reassignment of the Mortgage Loans or other
provisions of the Pooling and Servicing Agreement. The FDIA provides that a
claim for damages arising from the repudiation of a contract is limited to
"actual direct compensatory damages." In the event the FDIC were to be
appointed as conservator or receiver of the Transferor and were to repudiate
the Pooling and Servicing Agreement, then the amount payable out of available
collections on the Mortgage Loans to the Certificateholders could be lower
than the outstanding principal and accrued interest on the Certificates. In
addition, in the case of an Event of Default (as defined herein) relating to
the conservatorship or receivership of the Servicer, the receiver or
conservator may have the power either to terminate the Servicer and replace it
with a successor Servicer or to prevent the termination of the Servicer and
its replacement with a successor Servicer if no Event of Default exists other
than the receivership, conservatorship or insolvency of the Servicer.
If a conservator or receiver were appointed for the Transferor, then a Rapid
Amortization Event (as defined herein) would occur with respect to the
Certificates then outstanding and, pursuant to the Pooling and Servicing
Agreement, Additional Balances (and Subsequent Mortgage Loans, if such events
occurred during the Pre-Funding Period) would not be transferred to the Trust
and the Trustee would sell the Trust Balances of the Mortgage Loans (unless
otherwise instructed by holders of more than 50% of the Certificate Principal
Balance and any person designated by the Transferor to the Trustee prior to
the time such conservator or receiver was appointed), thereby causing early
termination of the Trust. Unless a Certificate Insurer Default (as defined
herein) has occurred and is continuing, the Certificate Insurer will have the
power to make such instruction to the Trustee on behalf of the
Certificateholders and such person designated by the Transferor to the
Trustee. Certificateholders will suffer a loss if a Certificate Insurer
Default has previously occurred and is continuing and the Certificateholders'
portion of the net proceeds of such sale are insufficient to pay the
Certificateholders in full. If a Rapid Amortization Event occurs involving
either the insolvency of the Transferor or the appointment of a conservator or
receiver for the Transferor, the conservator or receiver may have the power to
prevent the early sale, liquidation or disposition of the Trust Balances of
the Mortgage Loans and the commencement of the Rapid Amortization Period. A
conservator or receiver may also have the power to cause the early sale of the
Trust Balances of the Mortgage Loans and the early retirement of the
Certificates or to prohibit the continued transfer of Additional Balances and
Subsequent Mortgage Loans to the Trust.
On or prior to the date of closing, the Transferor will have received an
opinion of Shaw, Pittman, Potts & Trowbridge, counsel to the Transferor, to
the effect that, based on certain assumptions, to the extent that the transfer
of the Mortgage Loans is considered to be a transfer for security, the
Custodial Agent for the benefit of the Trust will have a first priority
perfected security interest in the Mortgage Loans and that, on such basis,
such conservator or receiver should not interfere with payments to be made to
Certificateholders. It should be recognized, however, that a court is not
bound by such a legal opinion.
THE TRANSFEROR
The Transferor is a federally chartered stock savings bank. The Transferor's
executive offices are located at 8401 Connecticut Avenue, Chevy Chase,
Maryland 20815, and the Transferor's telephone number is (301) 986-7000. The
Transferor is subject to comprehensive regulation, examination and supervision
by the Office of Thrift
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Supervision ("OTS") within the Department of the Treasury and the FDIC.
Deposits at the Transferor are fully insured up to $100,000 per insured
depositor by the Savings Association Insurance Fund ("SAIF"), which is
administered by the FDIC.
At June 30, 1996, the Transferor had consolidated assets of approximately
$5.0 billion, deposits of approximately $4.2 billion, and stockholders' equity
of approximately $357.0 million. As a savings bank chartered under the laws of
the United States, the Transferor is subject to certain minimum regulatory
capital requirements imposed under FIRREA. At June 30, 1996, the Transferor
was in compliance with all such regulatory capital requirements in effect at
that date. In addition, the Transferor's capital ratios at June 30, 1996 were
sufficient for the Transferor to meet the ratios established for "well
capitalized" institutions pursuant to "prompt corrective action" regulations
promulgated by the OTS pursuant to the Federal Deposit Insurance Corporation
Improvement Act of 1991. On the basis of its balance sheet at June 30, 1996,
the Transferor also met the fully phased-in capital requirements under FIRREA
that took effect on July 1, 1996 as the last of the phase-in periods for the
deductions for capital expired, and, after giving effect to those deductions,
met the ratios established for "well capitalized" institutions under the
prompt corrective action regulations.
In connection with the termination of the Transferor's written agreement
with the OTS in March 1996, the Board of Directors of the Transferor has
adopted a resolution that addresses certain issues previously addressed by the
written agreement. The resolution also provides that the Transferor will
present a plan annually to the OTS detailing anticipated consumer loan
securitization activity.
Institutions insured by the SAIF, including the Transferor, currently pay
substantially higher deposit insurance premiums than similarly-situated
institutions insured by the Bank Insurance Fund ("BIF"). Legislation designed
to reduce or eliminate the disparity between BIF and SAIF insurance premiums
by, among other things, imposing on thrift institutions, including the
Transferor, a one-time assessment estimated to be up to 85 basis points on
their SAIF-insured deposits to capitalize the SAIF is being considered by
Congress. Congress is also considering legislation that would, among other
things: (i) abolish the OTS and transfer its functions to other agencies, and
(ii) require federally chartered thrifts, including the Transferor, to convert
to national bank or state bank or thrift charters. It cannot be determined
whether, or in what form, such legislation will eventually be enacted.
On August 20, 1996, President Clinton signed legislation eliminating a
provision of the Internal Revenue Code that permits thrifts that meet certain
requirements, including the Transferor, to establish reserves for bad debts
and to deduct each year reasonable additions to those reserves in lieu of
taking a deduction for bad debts actually sustained during the taxable year.
The legislation also requires thrifts to recapture and pay tax on bad debt
reserves accumulated since 1987 over a six year period, beginning with a
thrift's first taxable year after December 31, 1995 (or, if the thrift meets a
loan origination test, beginning up to two years later). This legislation will
not have a material impact on the Transferor's financial statements.
FORMATION OF THE TRUST
The Trust will be formed, in accordance with the laws of the State of New
York, pursuant to the Pooling and Servicing Agreement, and will be the issuer
of the Certificates. Prior to its formation, the Trust will have no assets or
obligations. The Trust will not engage in any business activity other than
acquiring and holding the Trust Balances of the Mortgage Loans, issuing the
Certificates and the Transferor Interest and making payments thereon. The
Trust does not expect to have any additional capital resources.
USE OF PROCEEDS
The net proceeds to be received from the sale of the Certificates will be
used to fund the Pre-Funding Account and the Capitalized Interest Account and
the remainder will be paid to the Transferor. The Transferor will use such
proceeds for its general corporate purposes.
THE CHEVY CHASE HOME EQUITY LENDING PROGRAM
Chevy Chase has originated variable-rate home equity revolving lines of
credit since 1983. At June 30, 1996, Chevy Chase had approximately $447.3
million aggregate principal amount of outstanding revolving credit line home
equity loans, including $60,512,343.23 of outstanding loan balances
transferred to Trust 1990, $33,341,073.64 of outstanding loan balances
transferred to Trust 1991, $30,658,093.51 of outstanding loan
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balances transferred to Trust 1992, $28,954,889.28 of outstanding loan
balances transferred to Trust 1993 and $62,277,466.09 of outstanding loan
balances transferred to Trust 1994. All of such transferred loan balances are
serviced by Chevy Chase.
UNDERWRITING PROCEDURES
Prior to approving a revolving credit line home equity loan, the Home Equity
Department of Chevy Chase undertakes a direct credit investigation of the
applicant designed to assess the applicant's ability and willingness to repay
the loan. This investigation includes the following procedures: (i) reviewing
an independent credit bureau report; (ii) verifying the applicant's employment
and income through a review of the applicant's most recent W-2 form or pay
stub (or, in the case of self-employed individuals, a minimum of two years of
tax returns) or telephone verification (coupled with a request for written
confirmation) by the applicant's current employer; (iii) obtaining written
verification of the balance of the first mortgage loan, if any; (iv) obtaining
and reviewing a written title report to ensure that all liens (including
property taxes), except for the first mortgage lien, if any, are paid off
prior to or at the time of settlement of the loan; and (v) obtaining a current
written appraisal of the property, including appropriate comparable property
appraisal information. If an applicant has been employed by a current employer
for less than two years, Chevy Chase also obtains verification of employment
and income information from the applicant's other employers within the
preceding two years.
Beginning in January 1996, applicants meeting either of the following
criteria may be approved based on the stated income of the applicant, a no-
inspection property analysis and a minimum credit score: (i) a requested line
of credit of less than $20,000 or (ii) a combined loan-to-value ratio of 60%
or less and a requested line of credit of $100,000 or less. The no-inspection
property analysis is an appraisal product provided by the Chevy Chase
Appraisal Department. This method of valuation renders a value based solely on
information gathered through county records, the Multiple Listing Service
(MLS) or internal Chevy Chase appraisal data, without a physical inspection of
the property. The information obtained is provided in a report and includes
the address of the property, a tax identification number, the assessed value
of the property (per tax records), the date of the valuation and the estimated
value.
If, after completion of the credit investigation, Chevy Chase accepts the
application, it assigns a maximum credit limit for a loan (the "Maximum Credit
Limit") based on the prospective borrower's ability to pay and overall
creditworthiness, the value of the mortgaged property and an acceptable
combined loan-to-value ratio.
Prior to January 1991, prospective borrowers generally were required to have
an effective gross monthly income in excess of $1,000, with effective gross
monthly income calculated by subtracting total monthly obligations from total
verified gross income. Total monthly obligations generally included first
mortgage debt (including escrow payments), other real estate obligations,
automobile loans, alimony and child support obligations, and tuition and
personal loans (excluding balances to be retired within four months), as well
as other obligations that appeared on an independent credit bureau report. If
the first mortgage loan contained an adjustable-rate feature, the projected
monthly principal and interest payments on such loans were calculated at an
annual percentage rate ("APR") of 15%. In addition, applicants were required
to have a debt-service ratio not greater than 30%, with the debt-service ratio
calculated by dividing the proposed monthly credit line payment by effective
gross monthly income.
In January 1991, Chevy Chase replaced the gross monthly income and debt-
service ratio criteria with a debt-to-income ratio test. The debt-to-income
ratio is derived by dividing the applicant's monthly payments on all existing
obligations, including the proposed home equity loan payment, by the
applicant's gross monthly income. If the applicant's debt-to-income ratio
exceeds 40% but is less than 55%, the applicant must demonstrate a positive
cash flow. Cash flow is determined by using a computer model that estimates
future living expenses based on current personal and demographic information.
Expenses used in the computation include federal, state and social security
taxes as well as estimated living expenses and debt payments. Applicants with
a debt-to-income ratio of 46% to 55% may be approved for a loan at a maximum
combined loan-to-value ratio of 75%.
Prospective borrowers also must have a consistent record of timely debt
payment (defined generally as payment of debt obligations which have been
received within 30 days of their due dates). Applicants with a past
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history of untimely credit payments may be eligible for a credit line provided
they have no current past-due credit and have not had any delinquent payments
within the two years preceding the application. In most cases, an application
will be rejected if it shows more than one payment delinquent in excess of 30
days on the applicant's first mortgage account.
In April 1995, Chevy Chase expanded its lending program to incorporate a
credit matrix to evaluate the credit background of applicants. Under this
program (the "Sub-Prime Lending Program"), borrowers with credit histories
that do not meet standard underwriting criteria may be eligible for a
variable-rate line with a combined maximum loan-to-value ratio of 65% to 75%
which is determined based upon a detailed analysis of their credit history.
Borrowers under such program may draw on their line of credit for the first
five years during which no payment of principal is required. Thereafter, no
draws are permitted and the loan will begin to amortize.
The determination of an acceptable appraised value is a function of the
residential property's quality, condition and appreciation history and
prospective market conditions. Except as described in the following
paragraphs, the combined loan-to-value ratio for loans secured by owner-
occupied, single-family properties generally may not exceed 80%, although a
maximum combined loan-to-value of 85% was used for loans originated from June
1988 through May 1990. In December 1990, Chevy Chase adopted a tiered combined
loan-to-value system for properties with appraised values of greater than
$400,000. Under the system, Chevy Chase assigns the following maximum combined
loan-to-value ratios to the corresponding increments of a property's appraised
value: up to $400,000 (80%), $401,000 to $800,000 (60%), $801,000 to
$1,200,000 (40%), $1,200,000 to $2,000,000 (20%) and over $2,000,000
(ineligible). If the first mortgage loan provides for negative amortization,
the maximum combined loan-to-value ratio may not exceed 75%. Certain of the
Mortgage Loans will be junior to mortgage loans that provide for negative
amortization. The combined loan-to-value ratio for loans secured by
condominiums may not exceed 70% (100% for the CreditLine 100 Program (as
defined below)). Prior to April 1990, Chevy Chase extended loans secured by
single-family rental properties at a maximum combined loan-to-value ratio of
70%. This program was reinstated in January 1994, with a maximum combined
loan-to-value ratio of 80%. No Mortgage Loans are secured by investor
properties (other than such single-family rental properties) or by commercial
or vacation properties.
In February 1994, Chevy Chase began offering loans secured by owner-
occupied, single-family properties with a maximum combined loan-to-value ratio
of 90%. Loans approved by Chevy Chase under this program must be approved and
insured by United Guaranty Residential Insurance Company of North Carolina
("United Guaranty"). United Guaranty provides 100% coverage against losses
resulting from borrower default on each insured loan subject to a maximum
limit of liability of 10% of the total loans approved in each policy year.
(United Guaranty does not cover default which results from the failure of a
borrower to pay any balloon payment.)
United Guaranty insures lines of credit up to $100,000. To meet United
Guaranty's underwriting guidelines, an applicant must have a debt-to-income
ratio of less than 38% and must have owned the property for at least 90 days.
Condominiums or rental properties are not eligible properties under this
program. United Guaranty requires that insured loans contain an interest rate
cap of 18% and also requires that any existing first mortgage have a balance
less than $300,000 and not allow for negative amortization.
In April 1995, Chevy Chase began offering loans secured by single-family,
owner-occupied and rental properties with a maximum combined loan-to value
ratio of 100% (the "CreditLine 100 Program") with credit limits ranging from
$7,500 to $25,000. Under this program, Chevy Chase utilizes a credit scoring
model. Loans under the program may be insured by United Guaranty. Chevy Chase
offers the CreditLine 100 Program without mortgage insurance for purchase
money second trusts, for lines secured by condominiums, lines where applicants
have a first mortgage with an outstanding balance greater than $250,000 and
lines where the applicant's debt-to-income ratio is greater than 35% and less
than 40%.
The minimum home equity revolving credit limit that Chevy Chase will
establish is $7,500. Revolving home equity lines of $50,000 or less must be
approved by Chevy Chase's home equity underwriting staff. Lines of more than
$50,000, up to $200,000, must be approved by the Division Vice President or
the Vice President of
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Production of the Home Equity Department. Lines in excess of $200,000 must be
approved by an officer at the level of Senior Vice President or above.
Chevy Chase obtains a property and judgment report on the mortgaged property
from its title agent, which confirms the last deed of record and any liens
filed against that deed. The property and judgment report is insured under the
title agent's errors and omissions coverage for up to $50,000 for a period of
one year from the date of settlement. Chevy Chase also generally obtains title
insurance on the mortgaged property, if (i) the home equity revolving credit
line will be secured by a first lien on the customer's real estate (unless
Chevy Chase is paying off a first lien held by an institutional lender), (ii)
the credit line will be subordinate to a first deed of trust held other than
by an institutional lender, (iii) the credit line exceeds $200,000, (iv) the
title is held in trust, or (v) the mortgaged property is a rental property.
LOAN TERMS
A borrower may access a home equity revolving line of credit by (i) writing
a check, (ii) telephoning the Home Equity Department and requesting funds to
be wire-transferred to a pre-authorized account, (iii) requesting a cashier's
check at a Chevy Chase branch office or (iv) telephoning the Home Equity
Department and requesting a cashier's check.
Home equity loans bear interest at a variable rate and generally are subject
to a maximum per annum interest rate of between 18% and 24%. The interest rate
on all home equity loans originated before April 1995 adjusts quarterly and,
beginning in April 1995, the interest rate on all new home equity loans
adjusts monthly. The daily periodic rate is 1/365th (generally 1/366th in the
case of leap years) of the APR, which is the sum of the Base Rate plus a
margin (the "Margin") of from 1.0% to 5.0%. Interest is calculated at a rate
applied to the daily balance of the account for each day of the billing cycle
(the "Loan Rate"). A borrower is generally required to make a minimum payment
for a Mortgage Loan each month in an amount equal to the amount of interest
accrued during the related billing cycle plus any administrative charges and
credit insurance charges and the amount, if any, by which the outstanding
balance of such Mortgage Loan exceeds its Maximum Credit Limit. Except for
principal amortization that may result from such monthly payments, there are
generally no required payments of principal, except that the entire
outstanding principal amount of most Mortgage Loans is due ten years or ten
years and three months after the date of origination or 20 years after the
later of the date of origination of the Mortgage Loan or the date of increase
of the Maximum Credit Limit of such Mortgage Loan. Since 1991, the term to
stated maturity of Mortgage Loans originated by Chevy Chase has been twenty
years from the date of origination and Chevy Chase does not extend the
maturity upon an increase of the Maximum Credit Limit. All payments are due 15
days after the 15th day of the month. The billing cycle runs from the 16th day
of the month preceding the month in which the billing statement is mailed
until the 15th day of the month in which the statement is mailed.
The Base Rate for loans which have their interest rate adjusted quarterly is
the rate of interest publicly announced from time to time as the "prime" or
"base" rate of interest charged by the index bank specified in the related
loan agreement as in effect on the last day of the last full calendar month of
the immediately preceding quarter; the Base Rate for loans which have their
interest rate adjusted monthly is the highest prime rate published in the
"Money Rates" section of The Wall Street Journal on the first Business Day of
the calendar month. Some loan agreements provide that, if the index bank
ceases to announce the Base Rate, Chevy Chase will designate a replacement
method for calculating the interest rate on the loan that is comparable to the
above-described method, upon notification to the borrower in accordance with
such loan agreement. When a change in the Base Rate is published, a change in
the Loan Rate will take effect on a specified date in the first month of the
quarter following the date of the published change for loans which have their
interest rates adjusted quarterly, or in the month of the published change,
for loans which have their interest rates adjusted monthly, and the new Loan
Rate will apply to new loans and charges as well as to the existing Loan
Balance.
In order to promote its home equity lending program, Chevy Chase has offered
promotional or introductory offers to prospective borrowers. Since April 1995,
customers have been offered settlement without closing costs and a 4.9%
introductory rate for the first six months after settlement; however,
customers opening a loan with a combined loan-to-value ratio greater than 80%
but less than 90% are offered settlement without closing costs
S-26
<PAGE>
and a 5.9% introductory rate for the first six months after settlement.
Customers approved under the Sub-Prime Lending Program are offered an
introductory rate for the first six months after settlement equal to the prime
rate published in the "Money Rates" section of The Wall Street Journal. Since
November 1995, Chevy Chase has offered the option of an introductory rate or a
transfer bonus. Customers selecting the transfer bonus offer will receive $100
for every $5,000 transferred to a new Chevy Chase Home Equity Line from
another institution.
The borrower may draw principal amounts on the loan (up to the Maximum
Credit Limit of the loan) or repay such amounts from time to time. Except for
any amortization of principal that may occur during the amortization period of
loans in the Sub-Prime Lending Program and as a result of the required monthly
minimum payments, there are no required payments of principal until maturity.
For revolving credit line home equity loans originated prior to November 7,
1989, Chevy Chase has the right, under each such loan, on prior notice of the
amendment in accordance with federal and applicable state law, to change its
terms. This includes the right to increase the monthly periodic rate or to
change the Base Rate at any time. If Chevy Chase increases the minimum payment
or the maximum rate of finance charge applied to any such loan, such changes
may apply to both new and outstanding balances if the borrower consents to
such changes in writing or uses the loan after the effective amendment date.
Chevy Chase has the right to require the borrower to pay the entire balance
due, plus all other accrued but unpaid charges, immediately, and to cancel the
credit privileges under the related loan agreement under certain
circumstances, which generally include the following: if the borrower commits
fraud or makes a material misrepresentation in connection with the credit
line; if the borrower fails to meet the repayment terms set forth in the loan
agreement; if the borrower acts or fails to act in any way that adversely
affects the mortgaged property or the security interest or any other interest
that Chevy Chase has in the mortgaged property; if the borrower fails to
maintain insurance on the mortgaged property as required by the deed of trust;
if the borrower fails to maintain the mortgaged property and such failure
adversely affects the value of the property; if a judgment is filed against
the borrower which adversely affects the security interest of Chevy Chase in
the mortgaged property; if the borrower does not have good and marketable
title to the mortgaged property; or if the warranties and representations made
by the borrower in connection with the credit line constitute fraud or
misrepresentation under applicable state law. Chevy Chase also has the right
to refuse to advance additional credit or to reduce a borrower's credit limit
under certain circumstances, generally including the following: if the value
of the mortgaged property declines significantly below its appraised value at
the time the credit line was established; if there is a material change in the
borrower's financial circumstances; if the borrower is in default of any
material obligation under the loan agreement related to the credit line or the
related deed of trust; if Chevy Chase is precluded by governmental action from
imposing the APR provided for in the loan agreement; if the security interest
of Chevy Chase in the mortgaged property is adversely affected by certain
circumstances; if Chevy Chase is notified by a government agency that further
advances to the borrower would constitute an unsafe and unsound practice; or
if the interest rate charged on the credit line reaches the maximum interest
rate permitted by law. All home equity accounts are subject to a monthly
automated account review through Equifax Credit Information Systems. This
review assists Chevy Chase in determining if there has been a material change
in the borrower's financial circumstances. The Trust will not have the ability
to amend the provisions of, or terminate, the Mortgage Loans.
In the event of a default on a first mortgage that is senior to any Mortgage
Loan, Chevy Chase has the right to satisfy the defaulted senior mortgage in
full or to cure such default and bring the defaulted senior mortgage current.
Chevy Chase may either take the action described above or may refrain from
taking any action based upon reasonable commercial practice in the industry
generally and its customary servicing procedures. Chevy Chase has the right to
add amounts expended in connection with any satisfaction or cure of a default
to the outstanding Loan Balance for such Mortgage Loan. See "CERTAIN LEGAL
ASPECTS OF THE LOANS--Foreclosure on Mortgages and Deeds of Trust" and "--
Junior Mortgages; Rights of Senior Mortgages" in the Prospectus.
S-27
<PAGE>
SERVICING
In its capacity as Servicer, Chevy Chase will be responsible for servicing
the Mortgage Loans.
Chevy Chase generates statements on revolving credit line home equity loans
on the 15th day of each month (the "Cycle Date"). Payments are due 15 days
after the Cycle Date. On the 16th day after the Cycle Date, Chevy Chase deems
the borrower to be one day late. If payment has not been received within five
days after the due date, a system-generated reminder notice is sent to the
customer. If complete payment has not been received within 15 days after the
due date, Chevy Chase charges a late fee equal to 10% of the total amount due
(5% in the case of loans originated prior to July 1, 1986) or $25, whichever
is greater, and sends a system-generated late fee notice to the customer. A
second system-generated late notice, or a preprinted contact letter, is sent
to the customer if payment has not been received within 30 days after the
payment due date. If payment of the account becomes 45 days past due, and the
borrower has not made arrangements to bring the loan current, Chevy Chase
obtains an updated appraisal of the security property, verifies the status of
any first trust loan and sends a breach letter to the customer requiring that
the home equity loan and any such first trust loan be brought current to
prevent acceleration of the loan balance.
Chevy Chase follows practices customary in the savings industry in
attempting to cure delinquencies and in pursuing remedies upon default.
Generally, if the borrower does not cure the delinquency within 90 days, Chevy
Chase initiates foreclosure action. If the loan is not reinstated or paid in
full, an auction will be held to dispose of the property. If Chevy Chase
believes the offer is inadequate in view of the security property's appraised
value, Chevy Chase may decide to participate in the auction. If Chevy Chase is
the successful bidder, Chevy Chase will take steps to liquidate the property.
Servicing and collection policies may change over time in accordance with
Chevy Chase's business judgment, applicable laws and regulations, industry
practices and other items.
The following tables set forth the delinquency and loss experience for each
of the periods shown for Chevy Chase's portfolio of revolving credit line home
equity loans. (Loan balances transferred to Trust 1990, Trust 1991, Trust
1992, Trust 1993 or Trust 1994 are considered part of the Chevy Chase loan
portfolio for purposes of the following discussion.) Chevy Chase believes that
there have been no material trends or anomalies in the historical delinquency
and loss experience as represented in the following tables. The Mortgage Loans
have been selected from these home equity loans based upon the eligibility
criteria shown below in "THE MORTGAGE LOAN POOL." The data presented in the
following tables are for illustrative purposes only and there is no assurance
that the delinquency and loss experience of the Mortgage Loans will be similar
to that set forth below.
MORTGAGE LOAN DELINQUENCY EXPERIENCE(1)
CHEVY CHASE PORTFOLIO
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
AS OF DECEMBER 31, AS OF
-------------------------- JUNE 30,
1993 1994 1995 1996
-------- ------- ------- --------
<S> <C> <C> <C> <C>
Number of Mortgage Loans Serviced......... 19,736 19,532 18,931 18,541
Aggregate Loan Balances of Mortgage Loans
Serviced................................. $551,845 508,389 469,622 447,259
Loan Balance of Mortgage Loans 30-59 Days
Past Due(2).............................. 7,398 7,630 8,047 7,488
Loan Balance of Mortgage Loans 60-89 Days
Past Due(2).............................. 781 197 973 542
Loan Balance of Mortgage Loans 90 or More
Days Past Due(2)......................... 2,881 3,152 4,675 3,732
Total Delinquencies as a Percentage of
Aggregate Loan Balances of Mortgage Loans
Serviced................................. 2.00% 2.16% 2.92% 2.63%
</TABLE>
- --------
(1) All amounts are as of period end. Delinquency figures do not include past
due amounts of $50.00 or less.
(2) Contractually past due.
S-28
<PAGE>
MORTGAGE LOAN LOSS EXPERIENCE
CHEVY CHASE PORTFOLIO
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
TWELVE MONTHS ENDED SIX MONTHS
DECEMBER 31, ENDED
-------------------------- JUNE 30,
1993 1994 1995 1996
-------- ------- ------- ----------
<S> <C> <C> <C> <C>
Average Principal Balance of Mortgage
Loans Serviced....................... $601,702 522,373 491,250 455,658
Gross Charge Offs(1).................. 1,090 1,052 856 533
Recoveries on Loans Previously Charged
Off(1)............................... 49 77 22 13
Net Charge Offs(1).................... 1,041 975 834 520
Gross Charge Offs(1) as a Percentage
of Average Principal Balance......... 0.18% 0.20% 0.17% 0.23%(2)
Net Charge Offs(1) as a Percentage of
Average Principal Balance............ 0.17% 0.19% 0.17% 0.23%(2)
</TABLE>
- --------
(1) The term "charge off" refers to an actual liquidated loss incurred on a
mortgaged property. A charge off is recognized when a property is sold and
the loss actually is incurred.
(2) Annualized.
THE MORTGAGE LOAN POOL
The Initial Mortgage Loans are evidenced by loan agreements (each, a "Loan
Agreement") secured by deeds of trust (of which approximately 19.32% by
principal balance are first deeds of trust and the remainder are second deeds
of trust) on Mortgaged Properties located in Maryland, Virginia and the
District of Columbia. The term to stated maturity of most of the Initial
Mortgage Loans was either ten years or ten years and three months after the
date of origination or 20 years after the later of the date of origination of
the Initial Mortgage Loan or the date of increase of the Maximum Credit Limit
of such Initial Mortgage Loan. All of the Initial Mortgage Loans are
adjustable-rate mortgages.
Each Initial Mortgage Loan was selected by the Transferor for inclusion in
the Pool from those that met the following criteria, among others, as of the
Initial Cut-off Date: each Initial Mortgage Loan (i) had a current Trust
Balance of not more than $500,000; (ii) had a stated maturity date not later
than 240 months after the Initial Cut-off Date; (iii) was not 30 or more days
contractually delinquent; (iv) had a Combined Loan-to-Value Ratio at the
Initial Cut-off Date not in excess of 100%; (v) represented a first or second
lien position; (vi) was secured by a Mortgaged Property located in Maryland,
Virginia or the District of Columbia; and (vii) had a minimum variable
interest rate (excluding any introductory interest rate) equal to the Base
Rate plus 1.0%.
As of the Initial Cut-off Date, approximately 28.37% of the Trust Balances
of the Initial Mortgage Loans accrued interest at an introductory rate of 4.9%
for an initial period of approximately six months; approximately 0.13% of the
Trust Balances of the Initial Mortgage Loans accrued interest at an
introductory rate of 5.9% for an initial period of approximately six months
and approximately 0.87% of the Trust Balances of the Initial Mortgage Loans
accrued interest at an introductory rate of 8.25% for an initial period of
approximately six months. See "THE CHEVY CHASE HOME EQUITY LENDING PROGRAM--
Loan Terms" herein. All of the 1,259 Mortgage Loans with Trust Balances
accruing interest as of the Initial Cut-off Date at such introductory rates
will be fully indexed by May 10, 1997 and the Margin for such Initial Mortgage
Loans will be not less than 1.0%
As of the Initial Cut-off Date, approximately 1.99% of the Initial Mortgage
Loans were originated by Chevy Chase under the Sub-Prime Lending Program.
Each Initial Mortgage Loan was originated between August 1983 and the
Initial Cut-off Date in the ordinary course of Chevy Chase's revolving credit
line home equity loan program. The Initial Mortgage Loans had individual
Combined Loan-to-Value Ratios at the Initial Cut-off Date, based upon
appraisals of the related Mortgaged Properties obtained by or on behalf of the
Transferor at the time of execution of the related Loan Agreements, ranging
from approximately 2.70% to not more than 100%. As of the Initial Cut-off
Date, the average Trust Balance of the Initial Mortgage Loans was $19,875 and
the weighted average Combined Loan-to-Value Ratio of the Initial Mortgage
Loans was 66.02%. As of the Initial Cut-off Date, the weighted average loan
S-29
<PAGE>
utilization rate (computed by dividing the Loan Balance for each Initial
Mortgage Loan by the related Maximum Credit Limit) was 72.98% and the weighted
average second mortgage ratio (computed by dividing the Maximum Credit Limit
for each Initial Mortgage Loan by the sum of such Maximum Credit Limit and the
outstanding balances of all other mortgage loans affecting the related
Mortgaged Property) was 51.36%. The latest scheduled maturity of any Initial
Mortgage Loan in the Pool is August 30, 2016.
Set forth below is a description of certain additional characteristics of
the Initial Mortgage Loans as of the Initial Cut-off Date:
INITIAL CUT-OFF DATE TRUST BALANCES OF INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
NUMBER
OF % OF POOL
MORTGAGE BY TRUST
RANGE OF CUT-OFF DATE TRUST BALANCES LOANS TRUST BALANCES BALANCE
------------------------------------ -------- -------------- ---------
<S> <C> <C> <C>
$ 0.00 to $ 5,000.00.................... 1,607 $ 2,223,994.96 2.25%
$ 5,000.01 to $ 10,000.00.................... 649 4,950,108.72 5.00
$ 10,000.01 to $ 15,000.00.................... 566 7,072,685.00 7.15
$ 15,000.01 to $ 20,000.00.................... 471 8,286,347.83 8.38
$ 20,000.01 to $ 25,000.00.................... 404 9,221,799.41 9.32
$ 25,000.01 to $ 30,000.00.................... 252 6,982,377.26 7.06
$ 30,000.01 to $ 35,000.00.................... 165 5,381,027.96 5.44
$ 35,000.01 to $ 40,000.00.................... 156 5,900,991.96 5.97
$ 40,000.01 to $ 45,000.00.................... 119 5,077,910.67 5.13
$ 45,000.01 to $ 50,000.00.................... 124 5,930,935.54 6.00
$ 50,000.01 to $ 55,000.00.................... 67 3,519,731.84 3.56
$ 55,000.01 to $ 60,000.00.................... 64 3,708,951.68 3.75
$ 60,000.01 to $ 65,000.00.................... 51 3,175,474.05 3.21
$ 65,000.01 to $ 70,000.00.................... 53 3,590,139.22 3.63
$ 70,000.01 to $ 75,000.00.................... 35 2,542,982.65 2.57
$ 75,000.01 to $ 80,000.00.................... 24 1,868,752.34 1.89
$ 80,000.01 to $ 85,000.00.................... 17 1,397,572.42 1.41
$ 85,000.01 to $ 90,000.00.................... 27 2,365,550.09 2.39
$ 90,000.01 to $ 95,000.00.................... 10 930,359.10 0.94
$ 95,000.01 to $100,000.00.................... 33 3,247,603.83 3.28
$100,000.01 to $105,000.00.................... 19 1,941,542.02 1.96
$105,000.01 to $110,000.00.................... 9 963,437.51 0.97
$115,000.01 to $120,000.00.................... 8 938,370.11 0.95
$120,000.01 to $125,000.00.................... 5 614,221.09 0.62
$125,000.01 to $150,000.00.................... 17 2,341,769.17 2.37
$150,000.01 to $175,000.00.................... 14 2,231,777.69 2.26
$175,000.01 to $200,000.00.................... 5 919,681.49 0.93
$200,000.01 to $225,000.00.................... 1 204,848.43 0.21
$225,000.01 to $250,000.00.................... 2 484,545.77 0.49
$250,000.01 to $275,000.00.................... 1 253,173.22 0.25
$275,000.01 to $300,000.00.................... 1 285,831.00 0.29
$350,000.01 to $375,000.00.................... 1 364,091.65 0.37
----- -------------- ------
TOTAL....................................... 4,977 $98,918,585.68 100.00%
===== ============== ======
</TABLE>
S-30
<PAGE>
INITIAL CUT-OFF DATE LOAN RATES OF INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
WEIGHTED
NUMBER OF % OF POOL AVERAGE
MORTGAGE TRUST BY TRUST LOAN
RAGE OF LOAN RATESN LOANS BALANCE BALANCE RATE
- ------------------- --------- -------------- --------- --------
<S> <C> <C> <C> <C>
4.90% to 5.49%................... 1,237 $28,060,758.52 28.37% 4.90%
5.50% to 5.99%................... 3 133,126.91 0.13 5.90
8.00% to 8.49%................... 19 858,665.96 0.87 8.25
9.00% to 9.49%................... 791 31,724,956.38 32.07 9.25
9.50% to 9.99%................... 2,217 30,002,118.56 30.33 9.75
10.00% to 10.49%................... 305 1,993,594.17 2.01 10.25
10.50% to 10.99%................... 3 10,013.70 0.01 10.75
11.00% to 11.49%................... 108 1,865,494.19 1.89 11.25
11.50% to 11.99%................... 5 132,653.11 0.13 11.75
12.00% to 12.49%................... 281 3,932,675.81 3.98 12.25
12.50% to 12.99%................... 4 119,626.92 0.12 12.75
13.00% to 13.49%................... 4 84,901.45 0.09 13.25
----- -------------- ------ -----
TOTAL............................ 4,977 $98,918,585.68 100.00% 8.34%
===== ============== ====== =====
</TABLE>
COMBINED LOAN-TO-VALUE RATIOS OF INITIAL MORTGAGE LOANS(1)
<TABLE>
<CAPTION>
NUMBER OF % OF POOL
RANGE OF COMBINED MORTGAGE TRUST BY TRUST
LOAN-TO-VALUE RATIOS LOANS BALANCE BALANCE
- -------------------- --------- -------------- ---------
<S> <C> <C> <C>
Up to 50.00%................................. 1,114 $22,328,322.05 22.57%
50.01% to 55.00%............................. 188 4,550,003.15 4.60
55.01% to 60.00%............................. 240 6,213,470.27 6.28
60.01% to 65.00%............................. 233 5,699,492.82 5.76
65.01% to 70.00%............................. 327 7,561,328.41 7.64
70.01% to 75.00%............................. 440 9,215,788.58 9.32
75.01% to 80.00%............................. 995 20,398,543.96 20.62
80.01% to 85.00%............................. 515 7,271,005.33 7.35
85.01% to 90.00%............................. 535 9,928,015.21 10.04
90.01% to 95.00%............................. 186 3,083,237.40 3.12
95.01% AND ABOVE............................. 204 2,669,378.50 2.70
----- -------------- ------
TOTAL...................................... 4,977 $98,918,585.68 100.00%
===== ============== ======
</TABLE>
- --------
(1) Combined loan-to-value ratios of the Initial Mortgage Loans (computed at
their respective Maximum Credit Limits at the Initial Cut-off Date) and any
related first deeds of trust, based upon appraisals of the related
Mortgaged Properties performed or obtained by the Transferor at the time of
execution of the related Loan Agreements.
S-31
<PAGE>
USE OF MORTGAGED PROPERTIES OF INITIAL MORTGAGE LOANS(1)
<TABLE>
<CAPTION>
NUMBER OF % OF POOL
MORTGAGE BY TRUST
PROPERTY USE LOANS TRUST BALANCE BALANCE
- ------------ --------- -------------- ---------
<S> <C> <C> <C>
Rental property.............................. 43 $ 1,382,471.16 1.40%
Owner-occupied............................... 4,934 97,536,114.52 98.60
----- -------------- ------
TOTAL...................................... 4,977 $98,918,585.68 100.00%
===== ============== ======
</TABLE>
- --------
(1)Based on information supplied by the borrower in loan application.
GEOGRAPHICAL DISTRIBUTION OF MORTGAGED PROPERTIES OF INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
NUMBER OF % OF POOL
MORTGAGE BY TRUST
JURISDICTION LOANS TRUST BALANCE BALANCE
------------ --------- -------------- ---------
<S> <C> <C> <C>
Maryland..................................... 3,459 $66,745,737.83 67.48%
Virginia..................................... 1,212 24,159,333.42 24.42
District of Columbia......................... 306 8,013,514.43 8.10
----- -------------- ------
TOTAL...................................... 4,977 $98,918,585.68 100.00%
===== ============== ======
</TABLE>
INITIAL CUT-OFF DATE MARGIN RANGES OF INITIAL MORTGAGE LOANS(1)
<TABLE>
<CAPTION>
NUMBER OF % OF POOL
MORTGAGE BY TRUST
INITIAL CUT-OFF DATE MARGIN LOANS TRUST BALANCE BALANCE
--------------------------- --------- -------------- ---------
<S> <C> <C> <C>
1.0%......................................... 1,382 $49,956,823.81 50.50%
1.5%......................................... 2,860 39,778,933.33 40.21
2.0%......................................... 308 2,133,628.85 2.16
2.5%......................................... 4 29,013.70 0.03
3.0%......................................... 114 2,093,491.35 2.12
3.5%......................................... 11 245,807.50 0.25
4.0%......................................... 286 4,373,559.96 4.42
4.5% ........................................ 8 222,425.73 0.22
5.0%......................................... 4 84,901.45 0.09
----- -------------- ------
TOTAL...................................... 4,977 $98,918,585.68 100.00%
===== ============== ======
</TABLE>
- --------
(1) After expiration of any applicable introductory interest rate period. See
"THE CHEVY CHASE HOME EQUITY LENDING PROGRAM--LOAN TERMS."
S-32
<PAGE>
MONTHS REMAINING TO MATURITY OF INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
NUMBER % OF
OF POOL BY
MORTGAGE TRUST
NUMBER OF MONTHS REMAINING TO STATED MATURITY LOANS TRUST BALANCE BALANCE
--------------------------------------------- -------- -------------- -------
<S> <C> <C> <C>
1 - 6 Months................................ 16 $ 298,729.05 0.30%
7 - 12 Months................................ 51 709,354.13 0.72
13 - 18 Months................................ 25 542,663.87 0.55
19 - 24 Months................................ 17 103,346.18 0.10
25 - 30 Months................................ 1 97,778.41 0.10
31 - 36 Months................................ 1 507.86 0.00
115 - 126 Months................................ 2 39,165.80 0.04
127 - 138 Months................................ 2 40,972.50 0.04
139 - 150 Months ............................... 157 1,480,779.50 1.50
151 - 162 Months................................ 326 4,014,199.62 4.06
163 - 174 Months................................ 306 3,109,919.11 3.14
175 - 186 Months................................ 229 2,511,996.44 2.54
187 - 198 Months................................ 295 3,407,368.15 3.45
199 - 201 Months................................ 89 1,217,427.64 1.23
202 - 204 Months................................ 111 1,225,651.12 1.24
205 - 207 Months................................ 84 1,145,293.28 1.16
208 - 210 Months................................ 75 771,218.79 0.78
211 - 213 Months................................ 61 713,966.30 0.72
214 - 216 Months................................ 75 1,152,201.64 1.17
217 - 219 Months................................ 43 870,705.62 0.88
220 - 222 Months................................ 35 830,193.48 0.84
223 - 225 Months................................ 43 1,428,796.88 1.44
226 - 228 Months................................ 163 3,909,203.84 3.95
229 - 231 Months................................ 673 15,365,399.16 15.53
232 - 234 Months................................ 583 16,727,963.88 16.91
235 - 237 Months................................ 832 21,749,922.78 21.99
238 - 240 Months................................ 682 15,453,860.65 15.62
----- -------------- ------
TOTAL......................................... 4,977 $98,918,585.68 100.00%
===== ============== ======
</TABLE>
S-33
<PAGE>
MAXIMUM CREDIT LIMIT UTILIZATION RATES OF INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
RANGE OF MAXIMUM NUMBER OF % OF POOL
CREDIT LIMIT MORTGAGE TRUST BY TRUST CREDIT
UTILIZATION RATES LOANS BALANCE BALANCE LIMIT
----------------- --------- -------------- --------- ---------------
<S> <C> <C> <C> <C>
0.00% to 4.99%............ 682 $ 306,845.81 0.31% $ 39,854,000.00
5.00% to 9.99%............ 200 798,078.49 0.81 12,367,000.00
10.00% to 14.99%............ 175 1,216,687.69 1.23 10,626,500.00
15.00% to 19.99%............ 167 1,569,133.47 1.59 9,723,000.00
20.00% to 24.99%............ 170 2,066,806.69 2.09 10,022,500.00
25.00% to 29.99%............ 168 2,451,596.11 2.48 9,966,000.00
30.00% to 34.99%............ 177 2,768,569.61 2.80 9,759,500.00
35.00% to 39.99%............ 159 2,998,244.14 3.03 8,844,000.00
40.00% to 44.99%............ 158 3,086,618.41 3.12 8,168,000.00
45.00% to 49.99%............ 170 3,562,207.36 3.60 9,106,700.00
50.00% to 54.99%............ 185 4,395,285.50 4.44 10,018,500.00
55.00% to 59.99%............ 187 4,205,762.36 4.25 8,794,000.00
60.00% to 64.99%............ 175 4,760,033.37 4.81 9,115,500.00
65.00% to 69.99%............ 163 4,598,699.19 4.65 7,950,500.00
70.00% to 74.99%............ 145 4,294,137.16 4.34 7,139,000.00
75.00% to 79.99%............ 165 5,683,022.23 5.74 8,368,000.00
80.00% to 84.99%............ 183 5,987,842.48 6.05 8,795,000.00
85.00% to 89.99%............ 235 6,821,992.77 6.90 10,616,800.00
90.00% to 94.99%............ 312 8,711,966.20 8.81 12,469,400.00
95.00% to 100.00%............ 1,001 28,635,056.64 28.95 43,774,500.00
----- -------------- ------ ---------------
TOTAL...................... 4,977 $98,918,585.68 100.00% $255,478,400.00
===== ============== ====== ===============
</TABLE>
S-34
<PAGE>
DATA ON COMMON MORTGAGE LOANS INCLUDED AS INITIAL MORTGAGE LOANS(1)
<TABLE>
<CAPTION>
NUMBER % OF POOL
OF BY 1996-1 1990 1991 1992 1993 1994
OWNERSHIP OF MORTGAGE 1996-1 TRUST TRUST TRUST TRUST TRUST TRUST
MRTGAGE LOAN BALANCEO LOANS TRUST BALANCE BALANCE BALANCE BALANCE BALANCE BALANCE BALANCE
- --------------------- -------- -------------- --------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Trust 1996-1 only. 3,890 90,880,565.60 91.8741% 0.00 0.00 0.00 0.00 0.00
Trust 1996-1 and
1990.............. 37 296,676.62 0.2999 904,248.86 0.00 0.00 0.00 0.00
Trust 1996-1 and
1991.............. 21 220,923.59 0.2233 0.00 429,377.34 0.00 0.00 0.00
Trust 1996-1 and
1992.............. 33 233,389.81 0.2359 0.00 0.00 358,256.12 0.00 0.00
Trust 1996-1 and
1993.............. 52 342,934.71 0.3467 0.00 0.00 0.00 850,494.37 0.00
Trust 1996-1 and
1994.............. 315 3,189,500.49 3.2244 0.00 0.00 0.00 0.00 5,557,671.20
Trust 1996-1, 1990
and 1991.......... 33 94,589.14 0.0956 898,892.71 344,201.67 0.00 0.00 0.00
Trust 1996-1, 1990
and 1992.......... 10 23,198.11 0.0235 228,172.69 0.00 20,669.87 0.00 0.00
Trust 1996-1, 1990
and 1993.......... 8 59,225.48 0.0599 254,991.15 0.00 0.00 29,208.60 0.00
Trust 1996-1, 1990
and 1994.......... 10 27,494.45 0.0278 316,628.64 0.00 0.00 0.00 63,359.51
Trust 1996-1, 1991
and 1992.......... 18 41,742.05 0.0422 0.00 340,794.72 147,033.69 0.00 0.00
Trust 1996-1, 1991
and 1993.......... 7 86,480.86 0.0874 0.00 276,233.33 0.00 41,812.02 0.00
Trust 1996-1, 1991
and 1994.......... 15 42,617.16 0.0431 0.00 618,517.24 0.00 0.00 95,485.07
Trust 1996-1, 1992
and 1993.......... 28 215,802.66 0.2182 0.00 0.00 566,506.32 237,549.67 0.00
Trust 1996-1, 1992
and 1994.......... 21 125,071.65 0.1264 0.00 0.00 233,509.44 0.00 196,499.27
Trust 1996-1, 1993
and 1994.......... 113 1,027,318.93 1.0385 0.00 0.00 0.00 1,745,820.43 1,024,034.97
Trust 1996-1,
1990, 1991 and
1992.............. 35 239,685.14 0.2423 776,034.24 255,607.94 127,239.48 0.00 0.00
Trust 1996-1,
1990, 1991 and
1993.............. 11 42,831.25 0.0433 235,952.24 49,331.11 0.00 42,449.74 0.00
Trust 1996-1,
1990, 1991 and
1994.............. 9 88,934.39 0.0899 165,335.82 60,083.63 0.00 0.00 25,427.12
Trust 1996-1,
1990, 1992 and
1993.............. 4 3,738.06 0.0038 40,701.31 0.00 12,152.26 16,966.20 0.00
Trust 1996-1,
1990, 1992 and
1994.............. 8 12,518.94 0.0127 251,974.70 0.00 18,073.11 0.00 26,493.51
Trust 1996-1,
1990, 1993 and
1994.............. 2 32,806.56 0.0332 31,753.46 0.00 0.00 29,622.37 46,585.92
Trust 1996-1,
1991, 1992 and
1993.............. 26 116,469.37 0.1177 0.00 513,865.44 198,906.65 212,719.60 0.00
Trust 1996-1,
1991, 1992 and
1994.............. 15 89,605.94 0.0906 0.00 531,932.44 90,762.82 0.00 48,355.95
Trust 1996-1,
1991, 1993 and
1994.............. 5 8,136.00 0.0082 0.00 109,303.01 0.00 6,768.23 13,866.54
Trust 1996-1,
1992, 1993 and
1994.............. 86 665,009.87 0.6723 0.00 0.00 1,405,534.40 636,035.54 622,349.54
Trust 1996-1,
1990, 1991, 1992
and 1993.......... 25 138,249.22 0.1398 398,129.37 177,465.70 91,884.73 60,932.57 0.00
Trust 1996-1,
1990, 1991, 1992
and 1994.......... 28 83,520.56 0.0844 758,080.13 136,890.59 102,194.53 0.00 108,245.96
Trust 1996-1,
1990, 1991, 1993
and 1994.......... 7 12,428.29 0.0126 169,701.96 97,691.61 0.00 47,280.18 35,807.34
Trust 1996-1,
1990, 1992, 1993
and 1994.......... 8 25,906.54 0.0262 247,393.73 0.00 42,723.16 20,796.17 14,878.80
Trust 1996-1,
1991, 1992, 1993
and 1994.......... 45 232,795.24 0.2353 0.00 747,463.97 502,755.57 378,207.52 210,838.45
Trust 1996-1,
1990, 1991, 1992, 52 218,419.00 0.2208 1,058,545.96 344,217.10 279,288.99 238,160.09 165,280.45
1993 and 1994..... ----- -------------- -------- ------------- ------------- ------------- ------------- -------------
TOTAL........... 4,977 $98,918,585.68 100.0000% $6,736,536.97 $5,032,976.84 $4,197,491.14 $4,594,823.30 $8,255,179.60
===== ============== ======== ============= ============= ============= ============= =============
</TABLE>
- ----
(1) Common Mortgage Loans are those Initial Mortgage Loans which generated
balances that were transferred to Trust 1990, Trust 1991, Trust 1992,
Trust 1993 or Trust 1994. Principal collections on a Common Mortgage Loan
will be applied first to reduce the balance thereof transferred to Trust
1990, if any, to zero, second to reduce the balance thereof transferred to
Trust 1991, if any (including any such balances subsequently transferred
to the Trust during the Pre-Funding Period), to zero, third to reduce the
balance thereof transferred to Trust 1992, if any to zero, fourth to
reduce the balance thereof transferred to Trust 1993, if any, to zero and
fifth to reduce the balance thereof transferred to Trust 1994, if any, to
zero before any such collections are applied in reduction of the Trust
Balance of such Common Mortgage Loan (other than 91-1 Mortgage Loans). See
"RISK FACTORS--Prepayment Considerations."
S-35
<PAGE>
The Transferor has notified borrowers under certain of the Mortgage Loans of
an amendment to their Loan Agreements to the effect that all principal
payments by such borrowers will be applied to the outstanding principal
balances of the Mortgage Loans in the order in which such balances were
created. The Loan Agreements for the remaining Mortgage Loans contain a
comparable provision with respect to the application of principal payments.
No assurance can be given that values of the Mortgaged Properties as of the
dates of origination of the related Mortgage Loans have remained or will
remain constant. See "RISK FACTORS--Nature of Security" herein.
The Transferor has transferred and assigned to the Trustee for the benefit
of the holders of the Certificates all right, title and interest in the Trust
Balances of the Initial Mortgage Loans as of the Initial Cut-off Date. In
addition, Subsequent Mortgage Loans and Additional Balances will be
transferred by the Transferor to the Trust pursuant to the Pooling and
Servicing Agreement. See "ALLOCATIONS OF PAYMENTS ON THE COMMON MORTGAGE LOANS
BETWEEN THE TRUST AND TRUST 1990, TRUST 1991, TRUST 1992, TRUST 1993 AND TRUST
1994" herein.
Chevy Chase, as Servicer, will continue to service the Mortgage Loans
pursuant to the Pooling and Servicing Agreement, and will receive a monthly
servicing fee for such services. See "DESCRIPTION OF THE CERTIFICATES--
Assignment of Mortgage Loan Trust Balances" and "--Servicing and Other
Compensation and Payment of Expenses" herein.
DESCRIPTION OF CERTIFICATE INSURER
AMBAC Indemnity Corporation ("AMBAC") is a Wisconsin-domiciled stock
insurance corporation regulated by the Office of the Commissioner of Insurance
of the State of Wisconsin and licensed to do business in 50 states, the
District of Columbia, the Commonwealth of Puerto Rico and Guam. AMBAC
primarily insures newly issued municipal bonds. AMBAC is a wholly owned
subsidiary of AMBAC Inc., a 100% publicly held company. Moody's, Standard &
Poor's and Fitch have each assigned a triple-A claims-paying ability rating to
AMBAC.
AMBAC has entered into pro rata reinsurance agreements under which a
percentage of the insurance underwritten pursuant to certain of AMBAC's
municipal bond insurance programs has been and will be assumed by a number of
foreign and domestic unaffiliated reinsurers.
The following table sets forth AMBAC's capitalization as of December 31,
1993, December 31, 1994, December 31, 1995, and June 30, 1996, respectively,
on the basis of generally accepted accounting principles.
AMBAC INDEMNITY CORPORATION
CAPITALIZATION TABLE
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, DECEMBER 31, JUNE 30,
1993* 1994 1995 1996
------------ ------------ ------------ ---------
UNAUDITED
<S> <C> <C> <C> <C>
Unearned premiums............. 785 840 906 937
Other liabilities............. 192 136 295 286
Stockholder's equity:
Common Stock................ 82 82 82 82
Additional paid-in capital.. 444 444 481 514
Unrealized gain (loss) on
bonds; net of tax.......... 68 (46) 87 34
Retained earnings........... 668 782 907 912
----- ----- ----- -----
Total stockholder's equity.... 1,262 1,262 1,557 1,542
----- ----- ----- -----
Total liabilities and
stockholder's equity......... 2,239 2,238 2,758 2,765
===== ===== ===== =====
</TABLE>
- --------
* The financial information presented has been adjusted to reflect the effects
of Statement of Financial Accounting Standards No. 113 "Accounting and
Reporting for Reinsurance of Short Duration and Long Duration Contracts" which
AMBAC adopted during 1993.
S-36
<PAGE>
For additional financial information concerning AMBAC, see the audited
financial statements of AMBAC included in Appendix B to this Prospectus
Supplement.
Effective December 31, 1993, AMBAC adopted Statement of Financial Accounting
Standards No.115, "Accounting for Certain Debt and Equity Securities"
("Statement 115") with all investments designated as available-for-sale. As
required under Statement 115, prior years' financial statements have not been
restated. The cumulative effect of adopting Statement 115 as of December 31,
1993 was to increase AMBAC's stockholder's equity $63.6 million, net of tax.
The adoption of Statement 115 had no effect on earnings.
AMBAC makes no representation regarding the Certificates or the advisability
of investing in the Certificates and makes no representation regarding, nor
has it participated in the preparation of, this Prospectus Supplement other
than the information supplied by the Certificate Insurer and presented under
the heading "DESCRIPTION OF CERTIFICATE INSURER" and in the financial
statements hereto.
THE CERTIFICATE INSURANCE POLICY IS NOT COVERED BY THE PROPERTY/ CASUALTY
INSURANCE SECURITY FUND SPECIFIED IN ARTICLE 76 OF THE NEW YORK INSURANCE LAW.
ALLOCATIONS OF PAYMENTS ON THE COMMON MORTGAGE
LOANS BETWEEN THE TRUST AND TRUST 1990, TRUST 1991, TRUST 1992,
TRUST 1993 AND TRUST 1994
Balances outstanding on December 1, 1990, December 1, 1991, December 1,
1992, September 1, 1993 and September 1, 1994 with respect to certain of the
Mortgage Loans (the "Common Mortgage Loans") were transferred by the
Transferor to Trust 1990, Trust 1991, Trust 1992, Trust 1993 and Trust 1994,
respectively. The Cut-off Date Trust Balances of the Initial Mortgage Loans
and all Additional Balances with respect thereto have been transferred and
assigned to the Trust. Future payments on the Common Mortgage Loans will be
allocated between the Trust and the owners of the Sold Balances, in the
following manner:
(a) Each borrower's payment will be applied first to interest on the
Mortgage Loan at the then current Loan Rate. The Trust's share of an
interest payment on any Mortgage Loan (the "Trust Interest") shall equal
the product of (a) such interest payment and (b) (x) the amount of interest
accrued on the Trust Balance at the Loan Rate during the related Interest
Period divided by (y) the amount of interest accrued on the Loan Balance at
the Loan Rate during such Interest Period.
(b) Any remaining portion of a borrower's payment will be applied to
principal on the Mortgage Loan. Such collections of principal on the
Mortgage Loans during any Collection Period will be applied first to reduce
the balance thereof transferred to Trust 1990, if any, to zero, then to
reduce the balance thereof transferred to Trust 1991, if any (including any
such balances subsequently transferred to the Trust during the Pre-Funding
Period), to zero, then to reduce the balance thereof transferred to Trust
1992, if any, to zero, then to reduce the balance thereof transferred to
Trust 1993, if any, to zero, then to reduce the balance thereof transferred
to Trust 1994, if any, to zero before such payment is applied as a
principal payment in reduction of the Trust Balance of such Common Mortgage
Loan (other than 91-1 Mortgage Loans).
(c) The Trust's share of Net Liquidation Proceeds ("Net Trust Liquidation
Proceeds"), with respect to any Liquidated Mortgage Loan will be equal to
the sum of (i) the Trust's pro rata share of Net Liquidation Proceeds not
to exceed Trust Interest with respect to the period from the last day on
which interest was paid in full on such Liquidated Mortgage Loan to the day
on which such Liquidated Mortgage Loan became a Liquidated Mortgage Loan
and (ii) the Trust's pro rata share of the amount remaining after payment
of such Trust Interest and the interest payable to the owners of the Sold
Balances.
S-37
<PAGE>
(d) Insurance Proceeds (other than those included in Liquidation
Proceeds) received with respect to a Mortgage Loan will be allocated first
to unpaid interest in the manner described above. Any remaining proceeds
will be allocated on a pro rata basis between the Trust Balance and the
Sold Balances of such Mortgage Loan.
The "Trust Percentage" shall equal, with respect to any Mortgage Loan (other
than any Liquidated Mortgage Loan) for any day, the percentage (carried to
four decimal places) obtained by dividing the Trust Balance of such Mortgage
Loan for such day by the Loan Balance of such Mortgage Loan for such day. With
respect to any Liquidated Mortgage Loan on any day, the Trust Percentage will
equal the Trust Percentage on the day such Mortgage Loan became a Liquidated
Mortgage Loan.
MATURITY AND PREPAYMENT CONSIDERATIONS
The Pooling and Servicing Agreement, except as otherwise described herein,
provides that the Certificateholders will be entitled to receive on each
Distribution Date distributions of principal, in the amounts described herein,
until the Certificate Principal Balance is reduced to zero. In the event there
are any funds remaining in the Pre-Funding Account after the Pre-Funding
Period, the Certificateholders' Fixed Allocation Percentage of such funds
(excluding any net investment earnings thereon) shall be distributed to the
Certificateholders in respect of principal on the Certificates. During the
Managed Amortization Period, Certificateholders will receive amounts from
Principal Collections either generally based upon their Certificateholders'
Fixed Allocation Percentage of such collections received or a formula
described below, whichever is less. During the Rapid Amortization Period,
Certificateholders will receive amounts from Principal Collections generally
based upon their Certificateholders' Fixed Allocation Percentage. Because
prior principal distributions to Certificateholders serve to reduce the
Certificateholders' Floating Allocation Percentage but generally do not change
their Certificateholders' Fixed Allocation Percentage, allocations of
Principal Collections based on the Certificateholders' Fixed Allocation
Percentage may result in distributions of principal to the Certificateholders
in amounts that are, in most cases, greater relative to the declining balance
of the Pool than would be the case if the Certificateholders' Floating
Allocation Percentage were used to determine the percentage of Principal
Collections distributed to Certificateholders. This is especially true during
the Rapid Amortization Period when the Maximum Principal Payment and not a
lesser formula amount is used to determine the amount distributed to
Certificateholders. In addition, Certificate Interest Collections may be
distributed as principal to Certificateholders as part of the Accelerated
Principal Distribution Amount, if any. Moreover, to the extent of losses
allocable to the Certificateholders, Certificateholders may also receive as
payment of principal the amount of such losses either from Certificateholders'
Excess Interest or, in some instances, from draws under the Certificate
Insurance Policy. The level of losses may therefore affect the rate of payment
of principal on the Certificates.
To the extent borrowers make more draws than principal payments on the
Mortgage Loans, the Transferor Interest may grow. Because during the Rapid
Amortization Period the Certificateholders' share of Principal Collections is
based upon their Certificateholders' Fixed Allocation Percentage, an increase
in the Transferor Interest due to additional draws may also result in
Certificateholders receiving principal at a greater rate. The Pooling and
Servicing Agreement permits the Transferor, at its option, but subject to the
satisfaction of certain conditions specified in the Pooling and Servicing
Agreement, including the conditions described below, to remove certain
Mortgage Loans from the Trust at any time during the life of the Trust, so
long as the Transferor Interest (after giving effect to such removal) is not
less than the Overall Minimum Amount. Such removals may affect the rate at
which principal is distributed to Certificateholders by reducing the overall
Pool Balance and thus the amount of Principal Collections. See "DESCRIPTION OF
THE CERTIFICATES--Optional Retransfers of Mortgage Loans to the Transferor"
herein.
The rate and timing of amortization of the Certificate Principal Balance
will be affected by the inclusion of Trust Balances of Common Mortgage Loans
in the Trust Fund. Common Mortgage Loans, which account for approximately
8.13% by principal amount of the balances of Initial Mortgage Loans to be
transferred to the Trust, are those Mortgage Loans which generated balances
that were transferred to Trust 1990, Trust 1991, Trust
S-38
<PAGE>
1992, Trust 1993 or Trust 1994. See table captioned "Data on Common Mortgage
Loans" under "THE MORTGAGE LOAN POOL" herein. Payments of principal (including
prepayments) by a borrower on a Common Mortgage Loan will be applied first to
reduce to zero the principal balance, if any, of such Common Mortgage Loan
transferred to Trust 1990, second to reduce to zero the principal balance, if
any, of such Common Mortgage Loan transferred to Trust 1991 (including any
such balance subsequently transferred to the Trust during the Pre-Funding
Period), third to reduce to zero the principal balance, if any, of such Common
Mortgage Loan transferred to Trust 1992, fourth to reduce to zero the
principal balance, if any, of such Common Mortgage Loan transferred to Trust
1993 and fifth to reduce to zero the principal balance, if any, of such Common
Mortgage Loan transferred to Trust 1994 before any such payments are applied
to reduce the Trust Balance of such Common Mortgage Loan (other than the 91-1
Mortgage Loans). Partial prepayments of Common Mortgage Loans therefore would
affect the rate and timing of distributions on the Certificates at a slower
rate than partial prepayments of other Mortgage Loans.
The actual maturity of the Certificates will depend in part on the
availability of Subsequent Mortgage Loans. All of the Mortgage Loans may be
prepaid without penalty in full or in part at any time. The prepayment
experience with respect to the Mortgage Loans will affect the life of the
Certificates.
In the event that 91-1 Mortgage Loans are conveyed to the Trust during the
Pre-Funding Period, principal collections on such Mortgage Loans will be
applied in the priority described above as if such balances were still held by
Trust 1991. Accordingly, the Trust Balances of such Mortgage Loans will
decline at a rate faster than other Mortgage Loans held by the Trust. In
addition, no additional balances will be generated with respect to the 91-1
Mortgage Loans, thereby affecting the average life of the Certificates.
The rate of prepayment on the Mortgage Loans cannot be predicted. Home
equity revolving credit lines such as the Mortgage Loans have been originated
in significant volume only during the past eleven years and the Transferor is
not aware of any publicly available studies or statistics on the rate of
prepayment of such loans. Generally, home equity revolving credit lines are
not viewed by borrowers as permanent financing. Accordingly, the Mortgage
Loans may experience a higher rate of prepayment than traditional first
mortgage loans. On the other hand, because the Mortgage Loans amortize as
described herein, the absence of voluntary borrower prepayments could cause
rates of principal payment to be slower than those of traditional fully-
amortizing first mortgages. The prepayment experience of the Trust with
respect to the Mortgage Loans may be affected by a wide variety of factors,
including general economic conditions, economic conditions in Maryland,
Virginia and the District of Columbia, prevailing interest rate levels, the
availability of alternative financing and homeowner mobility, the frequency
and amount of any future draws on the Loan Agreements and changes affecting
the deductibility for Federal income tax purposes of interest payments on home
equity credit lines. Substantially all of the Mortgage Loans contain "due-on-
sale" provisions, and the Servicer is obligated to enforce such provisions,
unless such enforcement is not permitted by applicable law. The enforcement of
a "due-on-sale" provision will have the same effect as a prepayment of the
related Mortgage Loan. See "CERTAIN LEGAL ASPECTS OF MORTGAGE LOANS--Due-on-
Sale Clauses" herein and "CERTAIN LEGAL ASPECTS OF THE LOANS--Due-on-Sale
Clauses in Mortgage Loans" in the Prospectus.
The yield to an investor who purchases the Certificates in the secondary
market at a price other than par will vary from the anticipated yield if the
rate of prepayment on the Mortgage Loans is actually different than the rate
anticipated by such investor at the time such Certificates were purchased.
Collections on the Mortgage Loans may vary because, among other things,
borrowers may make payments during any month as low as the minimum monthly
payment for such month or as high as the entire outstanding principal balance
plus accrued interest and the fees and charges thereon. It is possible that
borrowers may fail to make scheduled payments. Collections on the Mortgage
Loans may vary due to seasonal purchasing and payment habits of borrowers. See
"RISK FACTORS--Prepayment Considerations" herein.
No assurance can be given as to the level of prepayments that will be
experienced by the Trust and it can be expected that a portion of borrowers
will not prepay their Mortgage Loans to any significant degree. See
"DESCRIPTION OF THE SECURITIES--Weighted Average Life of the Securities" in
the Prospectus.
S-39
<PAGE>
DESCRIPTION OF THE CERTIFICATES
The Certificates will be issued pursuant to the Pooling and Servicing
Agreement. The Pooling and Servicing Agreement is filed as an exhibit to the
Registration Statement of which this Prospectus Supplement is a part. The
following summary describes certain provisions of the Pooling and Servicing
Agreement, but does not purport to be complete and is subject to, and is
qualified in its entirety by reference to, all of the provisions of the
Pooling and Servicing Agreement.
GENERAL
The Certificates represent beneficial interests in the Trust only and do not
evidence a savings account or deposit or other obligation of, or interest in,
and are not guaranteed by, Chevy Chase or the Trustee or any of their
affiliates, or by the SAIF, the FDIC or any other government agency or
instrumentality.
The Certificates will be issued in denominations of $1,000 and integral
multiples thereof (except that one Certificate may be issued in a denomination
that is not an integral multiple of $1,000) and will evidence specified
undivided interests in the Trust. The Trust Fund, which represents the assets
of the Trust, will consist of, to the extent provided in the Pooling and
Servicing Agreement: (i) each of the Mortgage Loans, including any Subsequent
Mortgage Loans and any Eligible Substitute Mortgage Loans acquired by the
Trust, and Additional Balances that from time to time are subject to the
Pooling and Servicing Agreement, and principal and interest payments allocable
thereto; (ii) collections on the Mortgage Loans received after the Cut-off
Date that are allocable to the Trust Balances; (iii) the interest of the Trust
in Mortgaged Properties relating to the Mortgage Loans that are acquired by
foreclosure or deed in lieu of foreclosure; (iv) the Certificate Account; (v)
the Pre-Funding Account; (vi) the Capitalized Interest Account; (vii) the
Certificate Insurance Policy; (viii) the interest of the Trust in certain
hazard insurance policies maintained by the borrowers with respect to the
Mortgaged Properties; and (ix) the proceeds of the foregoing. The Trust Fund
will not include any interest in any Sold Balances.
Replacement Certificates, if issued, will be transferable and exchangeable
at the corporate trust office of the Trustee, which will initially act as
Certificate Registrar. No service charge will be made for any registration,
exchange or transfer of Certificates, but the Trustee may require payment of a
sum sufficient to cover any tax or other governmental charge.
The aggregate undivided interest in the Trust Fund represented by the
Certificates as of the Closing Date (as defined herein) will equal
$120,460,000 of principal (the "Original Certificate Principal Balance" and
the "Original Invested Amount"), which represents approximately 98% of the sum
of the Cut-off Date Trust Balances of the Initial Mortgage Loans and the Pre-
Funded Amount. Following the Closing Date, the "Invested Amount" with respect
to any day will be an amount equal to the Original Invested Amount minus the
sum of (i) the amount of Principal Collections previously distributed to
Certificateholders (including Principal Collections distributed in payment of
any Basis Risk Payment (including interest accrued thereon)), (ii) any amounts
distributed as principal to Certificateholders at the end of the Pre-Funding
Period from funds on deposit in the Pre-Funding Account, (iii) an amount equal
to the product of the Certificateholders' Floating Allocation Percentage and
the Liquidation Loss Amounts and (iv) the amount of any Principal Collections
previously distributed to the Transferor in reduction of the
Overcollateralization Amount. The principal balance of the outstanding
Certificates (the "Certificate Principal Balance") on any day is equal to the
Original Certificate Principal Balance minus the aggregate of amounts actually
distributed as principal to the Certificateholders. See "--Distributions on
the Certificates" below. Each Certificate represents the right to receive
payments of interest at the Certificate Rate and payments of principal as
described below.
The Transferor will own the remaining undivided interest in the Trust Fund
(the "Transferor Interest") which is equal to the Pool Balance less the
Invested Amount. In general, the Pool Balance will vary each day as principal
is paid on the Trust Balances of the Mortgage Loans, liquidation losses are
incurred, Additional Balances are drawn down by borrowers under the Loan
Agreements and Mortgage Loans are retransferred to the Transferor or the
Servicer, as applicable.
S-40
<PAGE>
The Transferor has the right to sell and pledge the Transferor Interest at
any time, provided (i) the Rating Agencies have notified the Transferor and the
Trustee in writing that such action will not result in the reduction or
withdrawal of the ratings assigned to the Certificates and have confirmed that
such action will not result in the reduction or withdrawal of the ratings of
the Certificates without regard to the Certificate Insurance Policy, and (ii)
certain other conditions in the Pooling and Servicing Agreement are satisfied.
ASSIGNMENT OF MORTGAGE LOAN TRUST BALANCES
At the time of issuance of the Certificates, the Transferor will assign to
The Chase Manhattan Bank, as custodial agent (the "Custodial Agent") for the
benefit of the Trustee all of its right, title and interest in and to the
Initial Mortgage Loans, including all payments of interest and principal, from
whatever source derived, which are received on or after the Initial Cut-off
Date and are allocable to the Trust Balances, together with the other assets
included in the Trust Fund. In addition, on or prior to the date the
Certificates are initially issued by the Trust, the Transferor will cause the
Certificate Insurance Policy to be delivered to the Trustee. Concurrently with
such assignment, the Trustee will deliver the Certificates and the Transferor
Interest to the Transferor. Subject to the following conditions, among others,
Subsequent Mortgage Loans, to the extent of the availability thereof and the
availability of sufficient funds on deposit in the Pre-Funding Account, will be
sold to the Trust on or before the last Distribution Date of the Pre-Funding
Period: (i) each Subsequent Mortgage Loan must meet the general criteria for
eligibility set forth in the Pooling and Servicing Agreement and (ii) the
selection of such Subsequent Mortgage Loans by the Transferor must be done in a
manner it believes will not materially adversely affect the Certificateholders
or the Certificate Insurer. In addition, any Additional Balances in respect of
such Mortgage Loans arising in the future will be transferred to the Trust.
Each Mortgage Loan will be identified in a schedule delivered to the Trustee.
Under the Pooling and Servicing Agreement, the documentation relating to each
Mortgage Loan (the "Mortgage Files") will be delivered to and maintained by the
Custodial Agent. The Transferor will be required to either (i) record
assignments of the Mortgage Loans and related Trust property in favor of the
Custodial Agent or (ii) deliver to the Custodial Agent assignments of each
Mortgage in recordable form, together with an opinion of counsel to the effect
that recording is not required to perfect a first priority security interest in
favor of the Custodial Agent. The Custodial Agent will review such Mortgage
Files, other than the Mortgage Files of Common Mortgage Loans previously
reviewed by the trustee of Trust 1990, the trustee of Trust 1991, the trustee
of Trust 1992, the trustee of Trust 1993 or the trustee of Trust 1994, within
the period specified in the Pooling and Servicing Agreement. If any document
required to be included in any Mortgage File does not bear manual signatures,
has not been received or is unrelated to the applicable Mortgage Loan, and such
defect is not cured as provided in the Pooling and Servicing Agreement
following receipt of notification thereof to the Transferor from the Trustee or
its agent, the Transferor will be required either to accept the retransfer of
or to replace the affected Trust Balance in the manner set forth below. In the
Pooling and Servicing Agreement, The Chase Manhattan Bank, formerly known as
Chemical Bank, as trustee of Trust 1990, Trust 1991, Trust 1992, Trust 1993 and
Trust 1994, will acknowledge the assignment of the Common Mortgage Loans to the
Trust and will agree that the Custodial Agent shall hold the Mortgage Files of
the Common Mortgage Loans for and on behalf of the Trust and each applicable
Prior Trust for so long as such Common Mortgage Loans are owned by the Trust or
by the applicable Prior Trust.
The Transferor will make certain representations and warranties as to the
accuracy in all material respects of certain information furnished to the
Trustee with respect to each Initial Mortgage Loan, including Combined Loan-to-
Value Ratio as of the Initial Cut-off Date, Cut-off Date Trust Balance and
minimum Loan Rate. In addition, the Transferor will represent and warrant that,
as of the Initial Cut-off Date, no Mortgage Loan was 30 or more days
contractually delinquent. Such representations and warranties will be repeated
for the Subsequent Mortgage Loans as of the date they are transferred to the
Trust. In the event there is a breach of any representation or warranty made by
the Transferor in the Pooling and Servicing Agreement as to a Mortgage Loan
that materially and adversely affects the interest of the Certificateholders in
such Mortgage Loan, the Transferor will, after the expiration of the applicable
cure period, be required either to (i) accept the retransfer of the related
Trust Balance from the Trust or (ii) substitute therefor an Eligible Substitute
Mortgage Loan, in each case in the manner described below.
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Any Mortgage Loan required to be accepted for retransfer from the Trust by
the Transferor as a result of a defect, omission or breach of representation
or warranty will be retransferred at a deposit amount equal to such Mortgage
Loan's Trust Balance as of the end of the Collection Period immediately
preceding the date of retransfer, plus accrued and unpaid interest on the
Trust Balance at the Loan Rate less the Servicing Fee Rate (the "Net Loan
Rate") through the Cycle Date occurring in such Collection Period (the
"Retransfer Deposit Amount"). The Certificateholders' portion of the
Retransfer Deposit Amount will be deposited into the Certificate Account on
the Business Day immediately preceding the Distribution Date in the month
following the Collection Period in which the related cure period expired.
As to any Eligible Substitute Mortgage Loan, the Transferor will deposit
into the Certificate Account the Certificateholders' portion of the amount, if
any, by which the conveyed balance of such Eligible Substitute Mortgage Loan
at the end of the Collection Period in which the events giving rise to the
related substitution occurred is less than the Trust Balance of the related
Mortgage Loan being removed from the Trust at the end of such Collection
Period (the "Substitution Adjustment Amount"). The Transferor will substitute
any Eligible Substitute Mortgage Loan, and deposit to the Certificate Account
the Certificateholders' portion of such Substitution Adjustment Amount into
the Certificate Account, on the Business Day immediately preceding the
Distribution Date in the month following such Collection Period. Upon
substitution, an Eligible Substitute Mortgage Loan will be subject to the
terms of the Pooling and Servicing Agreement and the Transferor will be deemed
to have made, with respect to such Eligible Substitute Mortgage Loan, as of
the date of substitution, the representations and warranties made by the
Transferor with respect to all other Mortgage Loans in the Trust. Upon receipt
by the Trustee of written notification of any such acceptance of retransfer or
substitution, subject to certain conditions set forth in the Pooling and
Servicing Agreement, the Trustee will execute and deliver an instrument of
transfer or assignment necessary to vest in the Transferor legal and
beneficial ownership of the Trust Balance of the retransferred Mortgage Loan
(including any property acquired in respect thereof or proceeds of any
insurance policy with respect thereto). The obligation of the Transferor to
accept a retransfer or replace any such Trust Balance will be the sole remedy
against the Transferor available to Certificateholders or the Trustee.
An Eligible Substitute Mortgage Loan is a Mortgage Loan that, as of the
substitution date, (i) has an outstanding Loan Balance (or if the new Mortgage
Loan is a Common Mortgage Loan, a balance conveyed to the Trust), not less
than 95% of the Trust Balance of the Defective Mortgage Loan it replaces as of
the substitution date; (ii) has a Loan Rate not less than the current Loan
Rate of such Defective Mortgage Loan and not more than 100 basis points in
excess thereof; (iii) has a Margin not less than the Margin of such Defective
Mortgage Loan and not more than 100 basis points in excess of the Margin of
such Defective Mortgage Loan; (iv) has a remaining term to maturity not
greater than nor more than six months less than the remaining term to maturity
of such Defective Mortgage Loan; (v) has a Combined Loan-to-Value Ratio not
greater than the Combined Loan-to-Value Ratio of such Defective Mortgage Loan
as of the related Cut-off Date or, in the case of an Eligible Substitute
Mortgage Loan that replaces a Mortgage Loan that has had an increase in its
Maximum Credit Limit, where such increase results in a Combined Loan-to-Value
Ratio (computed at the new Maximum Credit Limit and any related first mortgage
loan) in excess of 80%, has a Combined Loan-to-Value Ratio (computed at its
Maximum Credit Limit and any related first mortgage loan) not greater than
80%; (vi) has a maximum Loan Rate not lower than the maximum Loan Rate of such
Defective Mortgage Loan; (vii) has a Loan Rate that is based on the same index
as that of such Defective Mortgage Loan; (viii) is secured by a Mortgaged
Property that is subject to the same use and has the same structural
characteristic (attached or detached) as the Mortgaged Property securing such
Defective Mortgage Loan; and (ix) has a Mortgage in a lien position not junior
to the lien position of the Mortgage of such Defective Mortgage Loan. The
Maximum Credit Limit of an Eligible Substitute Mortgage Loan as of the
substitution date will be used in computing the Combined Loan-to-Value Ratio
of such Eligible Substitute Mortgage Loan on such date.
Pursuant to the Pooling and Servicing Agreement, the Servicer will service
and administer the Mortgage Loans, as more fully set forth below under "--
Collection and Other Servicing Procedures."
None of the Mortgage Loans are insured by the Federal Housing Administration
or guaranteed by the Veterans Administration or any other governmental agency
or instrumentality.
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AMENDMENTS TO LOAN AGREEMENTS
Subject to applicable law, the Servicer may change the terms of the Loan
Agreements at any time, provided that such changes (i) do not materially
adversely affect the interests of Certificateholders and (ii) are consistent
with prudent business practice.
The Servicer has agreed under the Pooling and Servicing Agreement that,
except as otherwise required by any requirement of law applicable to the
Servicer, it shall not reduce the Margin of any Mortgage Loan by more than
0.25% per annum unless the Servicer has received (a) an opinion of counsel
that such reduction in the Margin will not materially adversely affect the
characterization of the Certificates as debt for Federal income tax purposes,
(b) the consent of the Certificate Insurer and (c) confirmation from each
Rating Agency then rating the Certificates that such reduction will not cause
a reduction or withdrawal of the rating of the Certificates without regard to
the Certificate Insurance Policy.
The Servicer may extend the maturity date on (i) any Mortgage Loan which is
then currently in default under the terms of the related Loan Agreement, (ii)
any Mortgage Loan; provided that the Servicer may only grant the extensions
described in this clause (ii) on Mortgage Loans with aggregate Trust Balances
in any one calendar year of up to 2% of the Pool Balance (net of amounts on
deposit in the Pre-Funding Account) as of the beginning of such calendar year
and (iii) any Mortgage Loan in respect of which the Servicer has delivered a
certificate to the Trustee certifying that such extension will not materially
adversely affect the interests of the Certificateholders but, in no case,
beyond the last day of the Collection Period immediately preceding the Stated
Maturity Date.
CONSENT TO SENIOR LIENS
The Servicer may consent to the placement of a lien on any Mortgaged
Property senior to that of the related Mortgage Loan, provided that (i) such
action is consistent with reasonable commercial practice and (ii) such consent
is given in either of the following situations:
(a) immediately following the placement of such senior lien, such
Mortgage Loan is in a second lien position and either (A) the outstanding
principal amount of the mortgage loan secured by such senior lien is no
greater than the outstanding principal amount of the first mortgage loan
(if any) secured by the Mortgaged Property as of the date the related
Mortgage Loan was conveyed to the Trust or (B) an updated Combined Loan-to-
Value Ratio of such Mortgage Loan is not greater than the Combined Loan-to-
Value Ratio of such Mortgage Loan as of the date such Mortgage Loan was
conveyed to the Trust; or
(b) such senior lien secures a mortgage loan that refinances an existing
first mortgage loan and either (A) the outstanding principal amount of the
replacement first mortgage loan immediately following such refinancing is
not greater than the outstanding principal amount of such existing first
mortgage loan at the date of such refinancing or (B) an updated Combined
Loan-to-Value Ratio of the applicable Mortgage Loan is not greater than the
Combined Loan-to-Value Ratio of such Mortgage Loan as of the date such
Mortgage Loan was conveyed to the Trust.
OPTIONAL RETRANSFERS OF MORTGAGE LOANS TO THE TRANSFEROR
Subject to the conditions specified in the Pooling and Servicing Agreement,
if on the 27th day of any Collection Period or if that day is not a Business
Day the next preceding Business Day (the "Retransfer Notification Date") the
Removal Condition is satisfied, the Transferor may, but shall not be obligated
to, remove on the last Business Day of the Collection Period (the "Retransfer
Date") from the Trust, the entire Trust Balance of certain Mortgage Loans
without notice to the Certificateholders. Mortgage Loans so designated will
only be removed upon satisfaction of certain conditions specified in the
Pooling and Servicing Agreement, including: (i) the Removal Condition is
satisfied; (ii) the Transferor shall have delivered to the Trustee a "Mortgage
Loan Schedule" containing a list of all Mortgage Loans remaining in the Trust
after such removal; (iii) the Transferor shall represent and warrant that no
selection procedures reasonably believed by the Transferor to be adverse to
the interests of the Certificateholders or the Certificate Insurer were used
by the Transferor in
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selecting such Mortgage Loans; (iv) each Rating Agency shall have been
notified of the proposed retransfer and prior to the Retransfer Date shall not
have notified the Transferor that such retransfer would result in a reduction
or withdrawal of the ratings of the Certificates without regard to the
Certificate Insurance Policy, provided, however that with respect to the first
proposed retransfer, each Rating Agency shall have been notified of the
proposed retransfer and prior to the Retransfer Date shall have notified the
Transferor that such retransfer would not result in a reduction or withdrawal
of the ratings of the Certificates without regard to the Certificate Insurance
Policy; and (v) the Transferor shall have delivered to the Trustee and the
Certificate Insurer an officer's certificate confirming the conditions set
forth in clauses (i) through (iv) above.
The "Removal Condition" is satisfied if, on the Retransfer Date, after
giving effect to such removal the sum of the Transferor Interest and the
Overcollateralization Amount is not less than the greater of (a) 5% of the
Pool Balance on such date and (b) 2% of the Pool Balance on the Initial Cut-
off Date (the "Overall Minimum Amount"); provided, however, that (i) no
removal may occur if such removal would reduce the Overcollateralization
Amount below the Required Overcollateralization Amount and (ii) in addition to
the foregoing, during the Rapid Amortization Period, no removal shall occur
unless, (A) no Rapid Amortization Event has occurred, (B) immediately prior to
such removal, the Pool Balance is at least equal to the sum of (x) the
outstanding Certificate Principal Balance and (y) the Overall Minimum Amount
and (C) no other removal has occurred during the calendar year.
PAYMENTS ON THE MORTGAGE LOANS; DEPOSITS TO CERTIFICATE ACCOUNT
The Servicer has established and will maintain a single separate trust
account (the "Certificate Account") for the benefit of the Certificateholders
and the owner of the Transferor Interest, as their interests may appear. The
Certificate Account will be an Eligible Account (as defined herein). The
Servicer shall deposit into the Certificate Account amounts in respect of the
Trust Balances of the Mortgage Loans (excluding amounts representing
administrative charges, annual fees, taxes, assessments, credit insurance
charges, insurance proceeds to be applied to the restoration or repair of a
Mortgaged Property or similar items) on a daily basis within two Business Days
following receipt thereof in an amount equal to the sum of (i) Daily
Certificate Interest Collections and (ii) Daily Certificate Principal
Collections; provided, however, that during the Managed Amortization Period,
the Servicer shall only be required to deposit (a) Principal Collections for
any day less (b) Draws for such day on any day in which the aggregate amount
of Daily Certificate Principal Collections on deposit in the Certificate
Account is equal to or exceeds 1% of the Certificate Principal Balance as of
the immediately prior Distribution Date. To the extent that the aggregate
amount of Daily Certificate Principal Collections on deposit in the
Certificate Account at the end of the Collection Period is in excess of the
Scheduled Principal Collections Distribution Amount for the related
Distribution Date plus any Basis Risk Payment (including interest accrued
thereon) due on such Distribution Date and payable from Principal Collections,
on the second Business Day after the end of the Collection Period, the Trustee
shall withdraw the amount of such excess from the Certificate Account and
distribute such amount to the Transferor.
With respect to any Distribution Date, the aggregate amount of Trust
Interest collected in the related Collection Period allocable to the
Certificates ("Certificate Interest Collections") will equal the aggregate
amount of Daily Certificate Interest Collections for the related Collection
Period. With respect to any day, "Daily Certificate Interest Collections"
shall equal the product of (i) the aggregate amount of Trust Interest as of
such day and (ii) the Certificateholders' Floating Allocation Percentage for
such day. With respect to any day, the "Certificateholders' Floating
Allocation Percentage" is the percentage equivalent of a fraction determined
by dividing the Invested Amount by the Pool Balance as of such day. The
remaining amount of Trust Interest will be allocated to the Transferor
Interest.
With respect to any Distribution Date, "Principal Collections" shall equal
(i) the Trust's share of principal collections received from the borrowers
under the Mortgage Loans in the related Collection Period after the
application of such principal collections to the Sold Balances, (ii) the
principal portion of Net Trust Liquidation Proceeds and Trust Insurance
Proceeds and (iii) the principal portion of the Retransfer Deposit Amount and
the Substitution Adjustment Amount of a retransferred Mortgage Loan. "Daily
Certificate Principal Collections" shall mean for any day the product of the
Certificateholders' Fixed Allocation Percentage on such day and the aggregate
amount of Principal Collections received on such day.
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Amounts deposited in the Certificate Account will be invested in Permitted
Investments (as described in the Pooling and Servicing Agreement) maturing no
later than one Business Day prior to the Distribution Date or on such other
date as may be approved by the Rating Agencies and the Certificate Insurer. Not
later than the fifth Business Day prior to each Distribution Date (the
"Determination Date"), the Servicer will notify the Trustee of the amount of
such deposit to be included in funds available for the related Distribution
Date.
An "Eligible Account" is an account that is (i) maintained with a depository
institution which has a short-term certificate of deposit rating at the time of
any deposit therein in the highest short-term debt rating category by the
Rating Agencies, (ii) one or more accounts with a depository institution whose
accounts are fully insured by either the Savings Association Insurance Fund
("SAIF") or the Bank Insurance Fund ("BIF") of the Federal Deposit Insurance
Corporation with a minimum long-term unsecured debt rating of Baa3, (iii) a
trust account maintained with the Trustee in its corporate trust department or
(iv) otherwise acceptable to each Rating Agency as evidenced by a letter from
such Rating Agency to the Trustee, without reduction or withdrawal of their
then current ratings of the Certificates, and acceptable to the Certificate
Insurer.
"Permitted Investments" are specified in the Pooling and Servicing Agreement
and are limited to investments which meet the criteria of the Rating Agencies
from time to time as being consistent with their then current ratings of the
Certificates.
The Trustee will deposit any amounts drawn under the Certificate Insurance
Policy into the Certificate Account.
PRE-FUNDING ACCOUNT
On the Closing Date, an aggregate cash amount of approximately $24,000,000
(the "Pre-Funded Amount") will be deposited into an account established with
the Trustee on behalf of the Trust (the "Pre-Funding Account"). Such amount
will be funded from the sale of the Certificates. The Pre-Funded Amount will be
used to acquire Subsequent Mortgage Loans during the period from the Closing
Date to the earliest to occur of (i) the Distribution Date on which the
aggregate amount in the Pre-Funding Account is equal to or less than
(a) $100,000, (ii) the commencement of the Rapid Amortization Period or (iii)
the June 20, 1997 Distribution Date (the "Pre-Funding Period"). As a result,
the aggregate principal balance of the Mortgage Loans will increase by an
amount equal to the Cut-off Date Trust Balances of the Subsequent Mortgage
Loans acquired by the Trust, and the amount on deposit in the Pre-Funding
Account will decrease by such amount. In the event there are any funds
remaining in the Pre-Funding Account after the Pre-Funding Period, the
Certificateholders' Fixed Allocation Percentage of such funds (excluding any
net investment earnings thereon) shall be distributed to the Certificateholders
in respect of principal on the Certificates.
It is intended that the Subsequent Mortgage Loans will consist primarily of
balances of revolving credit line home equity loans originated by Chevy Chase
and transferred to Trust 1991 (the "91-1 Mortgage Loans"), provided such loans
are purchased by Chevy Chase from Trust 1991. The 91-1 Mortgage Loans have
terms that are, and were originated in a manner that is, substantially similar
to the Initial Mortgage Loans. Only those 91-1 Mortgage Loans that meet the
eligibility criteria requirements set forth in the Pooling and Servicing
Agreement and are approved by the Certificate Insurer will be transferred to
the Trust. Because some of the mortgage loans owned by Trust 1991 share
balances with Capitol Revolving Home Equity Loan Trust 1995-1 ("Trust 1995"),
such 91-1 Mortgage Loans, if transferred to the Trust, will constitute Common
Mortgage Loans and Trust 1995 will constitute a Prior Trust. As a result, the
balances of such Common Mortgage Loans transferred to Trust 1995 shall be
excluded from the Cut-off Date Trust Balance. In the event that 91-1 Mortgage
Loans are not available for purchase during the Pre-Funding Period, the
Transferor will use its best efforts to transfer to the Trust revolving credit
line home equity loans that meet the eligibility requirements set forth in the
Pooling and Servicing Agreement and are approved by the Certificate Insurer
during the Pre-Funding Period.
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CAPITALIZED INTEREST ACCOUNT
On the Closing Date, there will be deposited $ in an account (the
"Capitalized Interest Account") in the name of the Trustee on behalf of the
Trust which will be used by the Trustee during the Pre-Funding Period to cover
certain shortfalls in interest as described herein. Amounts in excess of the
amount necessary to cover such shortfalls (the "Overfunded Interest Amount")
are required to be paid directly to the Transferor on each Distribution Date
during the Pre-Funding Period.
The "Capitalized Interest Requirement" is an amount that may be withdrawn by
the Trustee from the Capitalized Interest Account on any Distribution Date
during the Pre-Funding Period to be deposited into the Certificate Account.
This amount shall be the excess, if any, of (a) the sum of (i) the amount of
interest accruing at the Certificate Rate during the related Accrual Period on
98% of the amount on deposit in the Pre-Funding Account (excluding any net
investment earnings thereon) and (ii) the product of (x) the Premium Rate
divided by twelve and (y) 98% of the amount on deposit in the Pre-Funding
Account (excluding any net investment earnings thereon) as of the close of
business on the prior Distribution Date (or, in the case of the first
Distribution Date, as of the Closing Date) over (b) the amount of any net
investment income earned on such amounts on deposit in the Pre-Funding
Account. The Trustee will deposit the Capitalized Interest Requirement into
the Certificate Account to be distributed as Certificate Interest Collections.
DISTRIBUTIONS ON THE CERTIFICATES
Beginning with the first Distribution Date (which will occur on October 20,
1996), distributions on the Certificates will be made by the Trustee or the
Paying Agent on each Distribution Date to the persons in whose names such
Certificates are registered at the close of business on the day prior to each
Distribution Date or, if the Certificates are no longer book-entry
certificates, at the close of business on the last day of the month preceding
such Distribution Date (the "Record Date"). The term "Distribution Date" means
the 20th day of each month or, if such date is not a Business Day, then the
next succeeding Business Day. Distributions will be made by check or money
order mailed (or upon the request of a Certificateholder owning Certificates
having denominations aggregating at least $5,000,000, by wire transfer or as
otherwise agreed by the Trustee) to the address of the person entitled thereto
(which, in the case of book-entry certificates, will be DTC or its nominee) as
it appears on the Certificate Register in amounts calculated as described
herein on the Determination Date. However, the final distribution in respect
of the Certificates will be made only upon presentation and surrender thereof
at the office or the agency of the Trustee specified in the notice to
Certificateholders of such final distribution. For purposes of the Pooling and
Servicing Agreement, a "Business Day" is any day other than (i) a Saturday or
Sunday or (ii) a day on which banking institutions in the States of New York
or Maryland (or such other state in which the corporate trust office of the
Trustee or the main business office of the Paying Agent under the Pooling and
Servicing Agreement is located) are required or authorized by law to be
closed.
Application of Certificate Interest Collections. On each Distribution Date,
the Trustee or the Paying Agent will apply the Certificate Interest
Collections, together with withdrawals, if any, from the Capitalized Interest
Account, and any earnings received on the amounts on deposit in the Pre-
Funding Account in the following manner and order of priority:
(i) as payment of the Servicing Fee;
(ii) as payment for the accrued interest due and any overdue accrued
interest (with interest thereon) on the Certificate Principal Balance of
the Certificates (other than any Basis Risk Payment or interest accrued
thereon);
(iii) as payment for the premium for the Certificate Insurance Policy;
(iv) to pay Certificateholders the product of the Certificateholders'
Floating Allocation Percentage and the Liquidation Loss Amount for such
Distribution Date;
(v) as payment for any Liquidation Loss Amount allocable to the
Certificateholders for a previous Distribution Date that was not previously
(a) funded by Certificate Interest Collections allocable to the
Certificateholders, (b) reflected in a reduction of the
Overcollateralization Amount or (c) funded by draws on the Certificate
Insurance Policy;
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(vi) to reimburse prior draws made from the Certificate Insurance Policy
(with interest thereon at a rate specified in the Insurance Agreement);
(vii) to pay principal on the Certificates until the Invested Amount
exceeds the Certificate Principal Balance by the Required
Overcollateralization Amount (the aggregate amount so paid, the
"Accelerated Principal Distribution Amount");
(viii) to pay any other amounts owed to the Certificate Insurer pursuant
to the Insurance Agreement;
(ix) as payment to Certificateholders of any Basis Risk Payment (and any
accrued interest thereon) from any prior Distribution Date that has not
previously been paid; and
(x) to the Transferor.
Certificate Interest Collections remaining after payment of the amounts
described in clauses (i), (ii) and (iii) above, shall be referred to herein as
the "Certificateholders' Excess Interest."
Any interest accruing on the Basis Risk Payment shall accrue at the related
Certificate Rate for such period.
Payments to Certificateholders pursuant to clauses (ii) and (ix) above will
be interest payments on the Certificates. Although payments of the Accelerated
Principal Distribution Amount to Certificateholders pursuant to clause (vii)
will reduce the Certificate Principal Balance, such payments will not reduce
the Invested Amount. Payments to Certificateholders pursuant to clauses (vii)
and (ix) above are not guaranteed by the Certificate Insurance Policy.
The Certificateholders' Excess Interest may be insufficient to cover the
Certificateholders' Floating Allocation Percentage of Liquidation Loss
Amounts. If as a result of such insufficiency the Certificate Principal
Balance exceeds the Invested Amount as of such Distribution Date (after giving
effect to all other amounts distributable and allocable to principal on the
Certificates on such Distribution Date), a draw in an amount equal to such
difference will be made on the Certificate Insurance Policy in accordance with
the terms of the Certificate Insurance Policy and the amount of such draw will
be deposited in the Certificate Account for distribution to
Certificateholders. Payment of such amounts will reduce the Certificate
Principal Balance but not the Invested Amount. Any such insufficiency
resulting from the sale of the Trust Balances of the Mortgage Loans as the
result of an Insolvency Event shall result in a draw on the Certificate
Insurance Policy.
With respect to any date, the "Pool Balance" will be equal to the aggregate
of all Trust Balances on such date plus amounts on deposit in the Pre-Funding
Account on such date (excluding any net investment earnings thereon). The
Trust Balance of a Mortgage Loan (other than a Liquidated Mortgage Loan) on
any day is equal to the Cut-off Date Trust Balance thereof, plus (i) any
Additional Balances in respect of such Mortgage Loan minus (ii) all
collections credited against the principal balance of such Mortgage Loan
(excluding in the case of any Common Mortgage Loan, any such principal
collections applied to reduce the Sold Balances) in accordance with the
related Loan Agreement prior to such day, provided, however, that if such
Mortgage Loan is a Common Mortgage Loan, the Cut-off Date Trust Balance of
such Mortgage Loan shall exclude any Sold Balances. The Trust Balance of a
Liquidated Mortgage Loan after final recovery of related Liquidation Proceeds
shall be zero.
The "Required Overcollateralization Amount" is equal to an amount which is
the greater of (a)$2,409,200 provided, however that on any date on which
Certificateholders' Excess Interest equals or exceeds 2% of the Certificate
Principal Balance (based on a six month rolling average) and equals or exceeds
1.5% of the Certificate Principal Balance (based on a three month rolling
average), the amount in this clause (a) shall be the lesser of (x) $2,409,200
and (y) 3% of the Certificate Principal Balance and (b) the Basic
Overcollateralization Amount.
"Liquidation Loss Amount" means with respect to any Liquidated Mortgage
Loan, the unrecovered Trust Balance thereof at the end of the related
Collection Period in which such Mortgage Loan became a Liquidated Mortgage
Loan, after giving effect to the principal portion of the Net Trust
Liquidation Proceeds in connection therewith.
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A "Liquidated Mortgage Loan" means, as to any Distribution Date, any
Mortgage Loan in respect of which the Servicer has determined, based on the
servicing procedures specified in the Pooling and Servicing Agreement, as of
the end of the preceding Collection Period that all Liquidation Proceeds which
it expects to recover with respect to the disposition of the related Mortgaged
Property have been recovered. "Liquidation Proceeds" are the proceeds
(including Insurance Proceeds but excluding any amounts drawn on the
Certificate Insurance Policy) received in connection with the liquidation of
any Mortgage Loan, whether through trustee's sale, foreclosure sale or
otherwise. The Certificateholders' Floating Allocation Percentage of the
Liquidation Loss Amount will be allocated to the Certificateholders. Although
payment of Liquidation Loss Amounts will be paid from Certificateholders'
Excess Interest, such payments are payments of principal for purposes of
calculating the Invested Amount and the Certificate Principal Balance.
As to any Distribution Date, the "Collection Period" is the calendar month
preceding such Distribution Date.
Interest will be distributed on each Distribution Date at the Certificate
Rate for the related Accrual Period (as defined below). The "Certificate Rate"
for an Accrual Period will generally equal the sum of (a) LIBOR, determined as
specified herein, as of the second LIBOR Business Day prior to the immediately
preceding Distribution Date (or as of two LIBOR Business Days prior to the
Closing Date, in the case of the first Distribution Date) plus (b) % per
annum. Notwithstanding the foregoing, in no event will the Certificate Rate
exceed a rate equal to the average of the Loan Rates (net of the Servicing Fee
Rate and the Premium Rate) weighted on the basis of the average daily balance
of each Mortgage Loan during the preceding Collection Period (the "Weighted
Average Loan Rate"). If the Certificate Rate would have exceeded the rate cap
described above, then the Certificateholders will be entitled to receive such
difference (the "Basis Risk Payment") from the following sources and in the
following order of priority: (i) from Certificateholders' Excess Interest to
the extent available as described herein under "DESCRIPTION OF THE
CERTIFICATES--Distributions on the Certificates" and (ii) from Principal
Collections only to the extent that the Overcollateralization Amount exceeds
the Basic Overcollateralization Amount. The Basis Risk Payment will bear
interest if it is not paid on the Distribution Date on which it is due, but
neither the Basis Risk Payment nor interest accrued thereon will be covered by
the Certificate Insurance Policy. The "Basic Overcollateralization Amount"
shall mean on any date of determination the lesser of (i)$4,517,250 and (ii)
the sum of (A) the lesser of (x) 1% of the Original Certificate Principal
Balance and (y) 2% of the Certificate Principal Balance as of such date of
determination, (B) 25% of the Certificateholders' Floating Allocation
Percentage of the Trust Balances which are 60-89 days delinquent and (C) 75%
of the Certificateholders' Floating Allocation Percentage of the Trust
Balances which are 90 days or more delinquent; provided however that if Chevy
Chase has been replaced as Servicer and the Servicing Fee Rate increases up to
a maximum rate of .75%, then the amount in subclause (A)(x) and subclause
(A)(y) shall increase by an equal amount of up to a maximum of 0.25%.
Interest on the Certificates in respect of any Distribution Date will accrue
on the Certificate Principal Balance from the preceding Distribution Date (or
in the case of the first Distribution Date, from the date of the initial
issuance of the Certificates (the "Closing Date")) through the day preceding
such Distribution Date (each such period, an "Accrual Period") on the basis of
the actual number of days in the Accrual Period and a 360-day year. Interest
payments on the Certificates will be funded from Certificate Interest
Collections, the Capitalized Interest Requirement, earnings received on
amounts on deposit in the Pre-Funding Account, from draws on the Certificate
Insurance Policy and from Principal Collections to the extent of any Basis
Risk Payment as described herein.
Calculation of the LIBOR Rate. LIBOR with respect to any Accrual Period will
be established by the Trustee and will equal the rate for one month U.S.
dollar deposits quoted on Telerate Page 3750 as of 11:00 A.M., London time, on
the second LIBOR Business Day prior to the first day of such Accrual Period.
"Telerate Page 3750" means the display designated as page 3750 on the Telerate
Service (or such other page as may replace page 3750 on that service for the
purpose of displaying London interbank offered rates of major banks). If such
rate does not appear on such page (or such other page as may replace that page
on that service, or if such
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service is no longer offered, such other service for displaying LIBOR or
comparable rates as may be selected by the Servicer), the rate will be the
Reference Bank Rate. The "Reference Bank Rate" will be determined on the basis
of the rates at which deposits in U.S. dollars are offered by the reference
banks (which shall be three major banks that are engaged in transactions in
the London interbank market, selected by the Servicer) as of 11:00 A.M.,
London time, on the day that is two LIBOR Business Days prior to the
immediately proceeding Distribution Date to prime banks in the London
interbank market for a period one month in amounts approximately equal to the
Certificate Principal Balance then outstanding. The Trustee will request the
principal London office of each of the reference banks to provide a quotation
of its rate. If at least two such quotations are provided, the rate will be
the arithmetic mean of the quotations. If on such date fewer than two
quotations are provided as requested, the rate will be the arithmetic mean of
the rates quoted by one or more major banks in New York City, selected by the
Trustee after consultation with the Servicer, as of 11:00 A.M., New York City
time, on such date for loans in U.S. dollars to leading European banks for a
period of one month in amounts approximately equal to the Certificate
Principal Balance then outstanding. If no such quotations can be obtained, the
rate will be LIBOR for the prior Distribution Date. "LIBOR Business Day" means
any date other than (i) a Saturday or a Sunday or (ii) a day on which banking
institutions in the State of New York or in the city of London, England are
required or authorized by law to be closed.
Transferor Collections. Principal Collections allocable to the Transferor
Interest will be distributed to the Transferor only to the extent that such
distribution will not reduce the Transferor Interest below zero.
Overcollateralization. The distribution of the aggregate Accelerated
Principal Distribution Amount, if any, to Certificateholders may result in the
Invested Amount being greater than the Certificate Principal Balance, thereby
creating overcollateralization. The Overcollateralization Amount, if any, will
be available to absorb any Liquidation Loss Amount that is allocated to
Certificateholders and is not covered by the Certificateholders' Excess
Interest.
Distributions of Principal Collections. For the period beginning on the
first Distribution Date and, unless a Rapid Amortization Event shall have
earlier occurred, ending on the 72nd Distribution Date in September 2002 (the
"Managed Amortization Period"), the amount of Principal Collections payable to
Certificateholders as of each Distribution Date during the Managed
Amortization Period will equal, to the extent funds are available therefor
from Principal Collections (after payment of any Basis Risk Payment on such
Distribution Date), the Scheduled Principal Collections Distribution Amount
for such Distribution Date. See "--Managed Amortization Period" below. Upon
the earlier to occur of a Rapid Amortization Event or the Distribution Date in
October 2002, the Rapid Amortization Period will commence and the Maximum
Principal Payment will be distributed to the extent funds are available
therefore. See "--Rapid Amortization Period; Rapid Amortization Events" below.
In the event there are any funds remaining in the Pre-Funding Account after
the Pre-Funding Period, the Certificateholders' Fixed Allocation Percentage of
such funds (excluding any net investment earnings thereon) shall be
distributed to the Certificateholders in respect of principal on the
Certificates.
The Paying Agent. The Paying Agent shall initially be the Trustee together
with any successor thereto in such capacity (the "Paying Agent"). The Paying
Agent shall have the revocable power to withdraw funds from the Certificate
Account for the purpose of making distributions to the Certificateholders.
MANAGED AMORTIZATION PERIOD
For the period beginning on the first Distribution Date and, unless a Rapid
Amortization Event shall have earlier occurred, ending on the Distribution
Date in September 2002 (the "Managed Amortization Period"), the amount of
Principal Collections payable to Certificateholders as of each Distribution
Date during the Managed Amortization Period will equal, to the extent funds
are available therefor from Principal Collections (after payment of any Basis
Risk Payment from Principal Collections on such Distribution Date to the
extent that the Overcollateralization Amount exceeds the Basic
Overcollateralization Amount), the Scheduled Principal Collections
Distribution Amount for such Distribution Date. On any Distribution Date with
respect to the Managed Amortization Period, the "Scheduled Principal
Collections Distribution Amount" shall equal the lesser
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of (i) the Maximum Principal Payment and (ii) the Alternative Principal
Payment. With respect to any Distribution Date, the "Alternative Principal
Payment" is equal to the greater of (x) 1% of the Certificate Principal
Balance immediately prior to such Distribution Date and (y) the amount, but
not less than zero, of the aggregate amount of Principal Collections for the
related Collection Period (after giving effect to any Basis Risk Payment on
such Distribution Date) less the aggregate of principal amounts drawn down
each day ("Draws") under the Loan Agreements during the related Collection
Period for the Mortgage Loans. On any Distribution Date on which the
Overcollateralization Amount exceeds the Required Overcollateralization Amount
(after giving effect to all distributions to Certificateholders on such date),
Principal Collections remaining after distribution to Certificateholders of
any Basis Risk Payment and the Scheduled Principal Collections Distribution
Amount shall be paid to the Transferor to reduce the Overcollateralization
Amount up to the extent of such excess. With respect to any Distribution Date,
the "Maximum Principal Payment" will equal the product of the
Certificateholders' Fixed Allocation Percentage and the aggregate amount of
Principal Collections (after giving effect to any Basis Risk Payment on such
Distribution Date) for such Distribution Date.
Beginning with the first Distribution Date relating to the Rapid
Amortization Period, the amount of Principal Collections payable to
Certificateholders on each Distribution Date will be equal to the Maximum
Principal Payment.
Distributions of Principal Collections based upon the Certificateholders'
Fixed Allocation Percentage may result in distributions of principal to
Certificateholders in amounts that are greater relative to the declining Pool
Balance than would be the case if the Certificateholders' Floating Allocation
Percentage were used to determine the percentage of Principal Collections
distributable to Certificateholders. Principal Collections not allocated to
the Certificateholders will be allocated to the Transferor Interest. The
aggregate distributions of principal to the Certificateholders will not exceed
the Original Certificate Principal Balance.
RAPID AMORTIZATION PERIOD; RAPID AMORTIZATION EVENTS
The Managed Amortization Period will continue through the Distribution Date
in September 2002, unless a Rapid Amortization Event occurs prior to such date
in which case the Rapid Amortization Period will commence prior to such date.
Upon the occurrence of the earlier of a Rapid Amortization Event or the
Distribution Date in October 2002, (the "Rapid Amortization Period") the
Maximum Principal Payment will be distributed to Certificateholders to the
extent funds are available therefor. "Rapid Amortization Event" refers to any
of the following events:
(a) failure on the part of the Transferor (i) to make a payment or
deposit required under the Pooling and Servicing Agreement within five
Business Days after the date such payment or deposit is required to be
made, (ii) to record assignments when required or (iii) to observe or
perform in any material respect any other covenants or agreements of the
Transferor set forth in the Pooling and Servicing Agreement, which failure
materially adversely affects the interests of the Certificateholders or the
Certificate Insurer and continues unremedied and continues to materially
adversely affect the interests of the Certificateholders or the Certificate
Insurer for a period of 60 days after written notice;
(b) any representation or warranty made by the Transferor in the Pooling
and Servicing Agreement proves to have been incorrect in any material
respect when made and continues to be incorrect in any material respect for
a period of 60 days after written notice and as a result of which the
interests of the Certificateholders or the Certificate Insurer are
materially and adversely affected; provided, however, that a Rapid
Amortization Event shall not be deemed to occur if the Transferor has
accepted the retransfer of the related Mortgage Loans or all Mortgage Loans
if applicable during such period (or within an additional 60 days with the
consent of the Trustee) in accordance with the provisions of the Pooling
and Servicing Agreement;
(c) the occurrence of certain events of insolvency, receivership or
conservatorship relating to the Transferor;
(d) the Trust becomes subject to regulation by the Securities and
Exchange Commission as an investment company within the meaning of the
Investment Company Act of 1940, as amended;
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(e) a Trigger Event occurs under the Pooling and Servicing Agreement
(other than the event described in clause (iv) of the definition thereof);
(f) if the aggregate principal draws under the Certificate Insurance
Policy exceed 1% of the Pool Balance as of the Initial Cut-off Date; or
(g) if at any time, Liquidation Loss Amounts incurred by the Trust exceed
$1,204,600 and any of (i) Certificateholders' Excess Interest is less than
2% of the Certificate Principal Balance (based on a six month rolling
average), (ii) Certificateholders' Excess Interest is less than 1.5% of the
Certificate Principal Balance (based on a three month rolling average) or
(iii) there exists any unreimbursed draw under the Certificate Insurance
Policy.
In the case of any event described in clause (a), (b) or (e), a Rapid
Amortization Event will be deemed to have occurred only if, after the
applicable grace period described in such clauses, either the Certificate
Insurer, the Trustee or Certificateholders holding Certificates evidencing
more than 51% of the Certificate Principal Balance, by written notice to the
Servicer (and to the Trustee, if given by the Certificate Insurer or the
Certificateholders) declare that a Rapid Amortization Event has occurred as of
the date of such notice. In the case of any event described in clause (c),
(d), (f) or (g), a Rapid Amortization Event will be deemed to have occurred
without any notice or other action on the part of the Trustee, the Certificate
Insurer or the Certificateholders immediately upon the occurrence of such
event.
In addition to the consequences of a Rapid Amortization Event discussed
above, if an Insolvency Event occurs with respect to the Transferor, on the
day of any such filing or appointment the Transferor will immediately cease to
transfer Additional Balances and Subsequent Mortgage Loans to the Trust and
the Transferor will promptly give notice to the Trustee of any such Insolvency
Event. Unless otherwise instructed within a specified period by the holders of
more than 50% of the Certificate Principal Balance and any person designated
by the Transferor to the Trustee prior to the time such conservator or
receiver was appointed, the Trustee will sell, dispose of or otherwise
liquidate the Trust Balances of the Mortgage Loans in a commercially
reasonable manner and on commercially reasonable terms. Unless a Certificate
Insurer Default has occurred and is continuing, the Certificate Insurer will
have the power to make such instruction to the Trustee on behalf of the
Certificateholders and such person designated by the Transferor to the
Trustee. The proceeds from the sale, disposition or liquidation of the Trust
Balances of the Mortgage Loans will be treated as, and be allocated in the
same manner as collections, and the portion thereof allocated to
Certificateholders will be distributed to the Certificateholders on the
Distribution Date following the date such proceeds are received (the
"Dissolution Distribution Date"). If the Certificate Insurer elects to cause a
termination of the Trust under such circumstances, the Certificate Insurance
Policy will be available to cover the payment of the then-accrued and unpaid
interest on the outstanding Certificate Principal Balance at the Certificate
Rate, as well as the outstanding Certificate Principal Balance, in each case
on the Dissolution Distribution Date after giving effect to the allocation of
all other amounts distributed on or prior to such Dissolution Distribution
Date.
A "Certificate Insurer Default" occurs upon (i) the Certificate Insurer's
failure to make a payment required under the Certificate Insurance Policy in
accordance with its terms, or (ii) an Insolvency Event shall occur with
respect to the Certificate Insurer.
Notwithstanding the foregoing, if a conservator or receiver is appointed for
the Transferor and no Rapid Amortization Event exists other than such
conservatorship, receivership or insolvency of the Transferor, the conservator
or receiver may have the power to prevent the commencement of the Rapid
Amortization Period or the sale of the Trust Balances of the Mortgage Loans
described above.
An "Insolvency Event" shall occur, if the Transferor or the Certificate
Insurer, as applicable, shall consent to the appointment of a conservator or
receiver or liquidator or trustee in any insolvency, receivership,
conservatorship, readjustment of debt, marshaling of assets and liabilities or
similar proceedings of or relating to such person or relating to all or
substantially all of its property, or a court or agency or supervisory
authority having jurisdiction in the premises shall issue, or enter against
such person, a decree or order for the appointment
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of a conservator or receiver or liquidator or trustee in any insolvency,
receivership, conservatorship, readjustment of debt, marshaling of assets and
liabilities or similar proceedings or for the winding-up or liquidation of its
affairs; or such person shall admit in writing its inability to pay its debts
generally as they become due, file a petition to take advantage of any
applicable insolvency, reorganization, liquidation, receivership, or
conservatorship statute, make any assignment for the benefit of its creditors
or voluntarily suspend payment of its obligations; or a proceeding shall have
been instituted by a court having jurisdiction in the premises seeking a
decree or order for relief in respect of such person in an involuntary case
under any debtor relief law, or for the appointment of a receiver, liquidator,
assignee, trustee, custodian, sequestrator, conservator or other similar
official, of such person for any substantial part of its property, or for the
liquidation and winding-up of its affairs and, if instituted against such
person, any such proceeding shall continue undismissed or unstayed and in
effect for a period of 60 consecutive days, or any of the actions sought in
such proceeding shall occur.
CERTIFICATE INSURANCE POLICY
On or before the Closing Date, the Certificate Insurance Policy will be
issued by the Certificate Insurer pursuant to the provisions of the Pooling
and Servicing Agreement and the Insurance and Indemnity Agreement (the
"Insurance Agreement"), among the Transferor, the Servicer and the Certificate
Insurer. The Certificate Insurance Policy will unconditionally and irrevocably
guarantee principal and interest payments on the Certificates at the times and
in the amounts described below. On each Distribution Date, a draw will be made
on the Certificate Insurance Policy equal to (i) the amount by which interest
accrued at the Certificate Rate on the outstanding Certificate Principal
Balance exceeds all amounts on deposit in the Certificate Account available to
be distributed therefor on such Distribution Date, plus (ii) the amount, if
any, by which the Certificate Principal Balance (after giving effect to all
other amounts distributable and allocable to principal on the Certificates on
such Distribution Date) exceeds the Invested Amount as of such Distribution
Date (after giving effect to all other amounts distributable and allocable to
principal on the Certificates on such Distribution Date). If the Certificate
Insurer elects to cause a termination of the Trust upon the occurrence of an
Insolvency Event with respect to the Transferor, the Certificate Insurance
Policy will be available to cover the payment of the then-accrued and unpaid
interest on the outstanding Certificate Principal Balance at the Certificate
Rate, as well as the outstanding Certificate Principal Balance, in each case
on the Dissolution Distribution Date after giving effect to the allocation of
all other amounts distributed on or prior to such Dissolution Distribution
Date. In addition, the Certificate Insurer will guarantee the payment of the
outstanding Certificate Principal Balance on the Stated Maturity Date (after
giving effect to all other amounts distributed and allocable to principal on
such Distribution Date). The Certificate Insurance Policy will not cover
payments of Accelerated Principal Distribution Amounts or Basis Risk Payments
(including interest accrued thereon).
In the event that the Certificate Insurer's claims paying ratings have been
reduced by any of the Rating Agencies, the Transferor may, but is not
obligated to, either (i) replace the Certificate Insurance Policy with a
financial guaranty insurance policy issued by another certificate insurer,
provided that the ratings on the claims paying ability of such replacement
certificate insurer are higher than those of the certificate insurer sought to
be replaced (after giving effect to such reduction) or (ii) eliminate or
provide another form of credit enhancement; provided that in the case of
clause (ii), the Rating Agencies consent thereto and the Rating Agencies
confirm that the ratings of the Certificates will be increased from their
current levels (after giving effect to such reduction) as a result of such
action.
REPORTS TO CERTIFICATEHOLDERS
Concurrently with each distribution to the Certificateholders, the Servicer
will forward to the Trustee for mailing to such Certificateholders and the
Certificate Insurer a statement setting forth:
(i) the Certificateholders' Floating Allocation Percentage for the last
day of the Collection Period;
(ii) the amount being distributed to Certificateholders;
(iii) the amount of interest included in such distribution, the related
Certificate Rate and the portion thereof attributable to collections in
respect of the Mortgage Loans;
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(iv) the amount, if any, of overdue accrued interest included in such
distribution (and the amount of interest thereon);
(v) the amount, if any, of the remaining overdue accrued interest after
giving effect to such distribution;
(vi) the amount, if any, of principal included in such distribution and
the portion thereof attributable to collections in respect of the Mortgage
Loans;
(vii) the amount, if any, of the reimbursement of previous Liquidation
Loss Amounts included in such distribution;
(viii) the amount, if any, of the aggregate unreimbursed Liquidation Loss
Amounts after giving effect to such distribution;
(ix) the Servicing Fee for such Distribution Date;
(x) the Invested Amount and the Certificate Principal Balance, each after
giving effect to such distribution;
(xi) the Required Overcollateralization Amount, the Basic
Overcollateralization Amount and the Overcollateralization Amount, if any,
after giving effect to such distribution;
(xii) the Pool Balance as of the end of the preceding Collection Period;
(xiii) the Accelerated Principal Distribution Amount, if any;
(xiv) the number and aggregate Trust Balances of the Mortgage Loans as to
which the minimum monthly payment is delinquent for 30-59 days, 60-89 days
and 90 or more days, respectively, as of the end of the preceding
Collection Period;
(xv) the aggregate Liquidation Loss Amount for all Mortgage Loans that
became Liquidated Mortgage Loans in the preceding Collection Period;
(xvi) the Trust Balance of any Mortgage Loan, the related Mortgaged
Property of which is acquired by the Trust through foreclosure;
(xvii) the amount of any draws on the Certificate Insurance Policy;
(xviii) the amount on deposit in the Pre-Funding Account;
(xix) the amount of Subsequent Mortgage Loans purchased during such
period using the Pre-Funding Account;
(xx) the Capitalized Interest Account balance; and
(xxi) the amount of any Basis Risk Payment (including interest accrued
thereon).
In the case of information furnished pursuant to clauses (ii), (iii), (iv)
and (vi) above, the amounts shall be expressed as a dollar amount per
Certificate with a $1,000 denomination.
Within 90 days after the end of each calendar year, the Servicer will be
required to forward to the Trustee a statement containing the information set
forth in clauses (iii) and (vi) above aggregated for such calendar year.
Unless and until Replacement Certificates are issued, it is anticipated that
the only "holder" of Certificates entitled to receive the foregoing monthly
and annual reports will be CEDE & Co., as nominee of DTC. Certificate Owners
may request copies of such reports from DTC's direct or indirect participating
organizations in accordance with the rules, regulations and procedures
creating and affecting DTC. See "--Registration of Certificates" below.
COLLECTION AND OTHER SERVICING PROCEDURES
The Servicer will make reasonable efforts to collect all payments called for
under the Mortgage Loans and, consistent with the Pooling and Servicing
Agreement, will follow such collection procedures as are customary to the
servicing of mortgage loans that are comparable to the Mortgage Loans.
Consistent with this requirement, the Servicer, in its discretion, may waive
any late payment charge in respect of a late Mortgage Loan payment.
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The Servicer has discretion to extend relief to borrowers whose payments
become delinquent. The Servicer may arrange with a borrower a schedule for the
payment of interest due and unpaid for a period not to exceed 90 days,
provided that any such arrangement is consistent with the Servicer's customary
servicing procedures.
The Servicer may increase the Maximum Credit Limit of up to 10% of the
number of Mortgage Loans in the Pool. In the case of a credit line increase
affecting any Mortgage Loan, the Servicer will be required to purchase such
Mortgage Loan or substitute therefor an Eligible Substitute Mortgage Loan
unless, after giving effect to such increase, the ratio of the new Maximum
Credit Limit plus the principal amount of any related first mortgage loan to
the appraised value of the related Mortgaged Property does not exceed 80%. The
Certificateholders' portion of the Retransfer Deposit Amount or the
Substitution Adjustment Amount, as applicable, paid in connection with such
purchase or substitution will be deposited into the Certificate Account.
Amounts so deposited will be distributed to Certificateholders as a prepayment
of the Trust Balance of the applicable Mortgage Loan. Such prepayment would
accelerate distributions on the Certificates.
In any case in which a Mortgaged Property is being conveyed by the borrower,
the Servicer will be obligated to exercise its rights to accelerate the
maturity of such Mortgage Loan under any due-on-sale clause applicable thereto
unless such exercise is not permitted by applicable law. If the Servicer is
prevented from enforcing such due-on-sale clause under applicable law, the
Servicer will enter into an assumption and modification agreement with the
person to whom such Mortgaged Property has been or is about to be conveyed,
pursuant to which such person becomes liable under the Loan Agreement. To the
extent permitted by applicable law, such assumption will not release the
original borrower from its obligation under the Mortgage Loan. Any fee
collected by the Servicer for entering into an assumption or substitution of
liability agreement will be retained by the Servicer as additional servicing
compensation. See "CERTAIN LEGAL ASPECTS OF THE MORTGAGE LOANS--Due-on-Sale
Clauses" herein and "CERTAIN LEGAL ASPECTS OF THE LOANS--Due-on-Sale Clauses
in Mortgage Loans" in the Prospectus. In connection with any such assumption,
the Loan Rate borne by the related Loan Agreement may not be altered, except
to the extent described herein. See "--Amendments to Loan Agreements" above.
The Pooling and Servicing Agreement generally requires the Servicer to apply
the same servicing standards to the Trust that it applies to Trust 1990, Trust
1991, Trust 1992, Trust 1993 and Trust 1994.
HAZARD INSURANCE
The Pooling and Servicing Agreement requires the Servicer to cause to be
maintained for each Mortgage Loan a hazard insurance policy naming the
Servicer as loss payee thereunder and providing for extended coverage in an
amount equal to the lesser of the combined Loan Balance of such Mortgage Loan
and any mortgage loan senior to such Mortgage Loan or the maximum insurable
value of the improvements securing such Mortgage Loan from time to time. The
Servicer will also maintain on property acquired in foreclosure proceedings
hazard insurance with extended coverage in an amount which is at least equal
to the lesser of (i) the maximum insurable value of the improvements which are
a part of such property or (ii) the sum of the Loan Balance of such Mortgage
Loan and the principal balance of any mortgage loan senior to such Mortgage
Loan at the time of foreclosure, plus accrued interest and the good-faith
estimate of the Servicer of related Liquidation Expenses to be incurred in
connection therewith. The ability of the Servicer to assure that hazard
insurance proceeds are appropriately applied may depend on its being named as
an additional insured under any hazard insurance policy and under any flood
insurance policy, or upon the extent to which information in this regard is
furnished to the Servicer by a borrower. As set forth above, the
Certificateholders' portion of all amounts collected by the Servicer under any
hazard policy (except for amounts applied or expected to be applied to the
restoration or repair of the Mortgaged Property or released to the borrower in
accordance with the Servicer's normal servicing procedures), to the extent
they constitute Net Trust Liquidation Proceeds or Trust Insurance Proceeds,
ultimately will be deposited into the Certificate Account. The Pooling and
Servicing Agreement provides that the Servicer may satisfy its obligation to
cause hazard policies to be maintained by maintaining a blanket policy issued
by an insurer acceptable to the Rating Agencies insuring against hazard losses
to the
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collateral securing the Mortgage Loans. If such blanket policy contains a
deductible clause, the Servicer will deposit into the Certificate Account the
Certificateholders' portion of the Trust Percentage of the amount not
otherwise payable under the blanket policy because of such deductible clause.
See "SERVICING OF LOANS--Maintenance of Insurance Policies and Other Servicing
Procedures" in the Prospectus.
Since residential properties historically have appreciated in value over
time, if the amount of hazard insurance maintained on the improvements
securing the Mortgage Loans were to decline as the principal balances owing
thereon decreased, hazard insurance proceeds could be insufficient to restore
fully the damaged property in the event of a partial loss.
REALIZATION UPON LIQUIDATED MORTGAGE LOANS
In the event that title to any Mortgaged Property securing a Mortgage Loan
is acquired by foreclosure or by deed in lieu of foreclosure, Net Trust
Liquidation Proceeds with respect to such Mortgage Loan will be held by the
Trustee for the benefit of the Certificateholders to the extent of their
interest therein. Such Mortgaged Property will be disposed of by or on behalf
of the Trustee. Notwithstanding any such acquisition of title and cancellation
of the related Mortgage Loan, such Mortgage Loan will be considered for most
purposes to be an outstanding Mortgage Loan held in the Trust to the extent of
the Trust Balance until such time as the Mortgaged Property is sold and such
Mortgage Loan is liquidated or the Mortgage Loan otherwise becomes a
Liquidated Mortgage Loan. Mortgaged Properties which are related to Common
Mortgage Loans must generally be disposed of in two years of the date of
acquisition of the Mortgaged Property.
SERVICING AND OTHER COMPENSATION AND PAYMENT OF EXPENSES
The Servicer will receive a fee (the "Servicing Fee") computed monthly at a
specified annual rate (the "Servicing Fee Rate") on the Invested Amount less
98% of the amount on deposit in the Pre-Funding Account (excluding any net
investment earnings thereon) as of the opening of business on the first day of
the related Collection Period or, with respect to the first Distribution Date,
as of the Closing Date. The "Servicing Fee Rate" will be 0.50%, if Chevy Chase
is the Servicer, and up to a maximum of 0.75%, if any other person is
appointed as successor Servicer pursuant to the Pooling and Servicing
Agreement. On each Distribution Date, the Servicing Fee will be distributed to
the Servicer from amounts on deposit in the Certificate Account prior to
amounts distributed to Certificateholders.
The Servicer will pay certain ongoing expenses associated with the Trust and
incurred by it in connection with its responsibilities under the Pooling and
Servicing Agreement, including, without limitation, payment of the fees and
disbursements of the Trustee, any custodian appointed by the Trustee, the
Certificate Registrar (who initially will be the Trustee) and any Paying
Agent. In addition, the Servicer will be entitled to immediate reimbursement
for certain expenses incurred by it in connection with Liquidated Mortgage
Loans and in connection with the restoration of Mortgaged Properties as a
Servicer Advance. See "--Servicer Advances" below. Such right of reimbursement
will be prior to the rights of the Certificateholders to receive any Principal
Collections.
SERVICER ADVANCES
The Servicer shall be entitled to advance its own funds to pay for any
related expenses of foreclosure and disposition of any Liquidated Mortgage
Loan or related Mortgaged Property (the "Servicer Advance"). The Servicer
shall be entitled to reimbursement for such expenses out of Liquidation
Proceeds prior to such amounts being available to make payments to
Certificateholders.
EVIDENCE AS TO COMPLIANCE
The Pooling and Servicing Agreement will provide that on or before December
31 of each year, beginning in 1997 a firm of independent public accountants
will furnish a statement to the Trustee and the Certificate Insurer to the
effect that such firm has examined, for the preceding 12 months ended
September 30, certain
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documents and records related to the servicing of the Mortgage Loans under the
Pooling and Servicing Agreement and that such examination, which has been
conducted substantially in compliance with either (i) the audit guide for
audits of non-supervised mortgagees approved by the Department of Housing and
Urban Development or (ii) the requirements of the Uniform Single Attestation
Program for Mortgage Bankers, has disclosed no items of non-compliance with
the provisions of the Pooling and Servicing Agreement that, in the opinion of
the firm, are material, except for such items of non-compliance as shall be
referred to in the report.
The Pooling and Servicing Agreement also will provide for delivery (on or
before December 31 of each year beginning in 1997) to the Trustee and the
Certificate Insurer of an annual statement signed by an officer of the
Servicer to the effect that the Servicer has fulfilled its material
obligations under the Pooling and Servicing Agreement throughout the preceding
12 months.
CERTAIN MATTERS REGARDING THE SERVICER AND THE TRANSFEROR
The Pooling and Servicing Agreement will provide that, except in connection
with a permitted transfer of servicing, the Servicer may not resign from its
obligations and duties thereunder unless (i) for so long as the Pool contains
Trust Balances of Common Mortgage Loans under which there are Sold Balances
held by Trust 1990, Trust 1991, Trust 1992, Trust 1993 or Trust 1994, it has
resigned from its obligations and duties as servicer of Trust 1990, Trust
1991, Trust 1992, Trust 1993 or Trust 1994, as the case may be, or (ii) its
duties under the Pooling and Servicing Agreement are no longer permissible
under applicable law or are in material conflict by reason of applicable law
with any other activities of a type and nature presently carried on by it or
its affiliates. For so long as the Pool contains Trust Balances of Common
Mortgage Loans under which there are Sold Balances held by Trust 1990, Trust
1991, Trust 1992, Trust 1993 or Trust 1994, the determination set forth in
clause (ii) will provide the basis for the Servicer's resignation only if the
Servicer simultaneously resigns from its obligations and duties as servicer of
Trust 1990, Trust 1991, Trust 1992, Trust 1993 or Trust 1994, as the case may
be. Further, for so long as the Pool contains Trust Balances of Common
Mortgage Loans under which there are Sold Balances held by Trust 1990, Trust
1991, Trust 1992, Trust 1993 or Trust 1994, the Servicer shall be required to
resign from its obligations and duties under the Pooling and Servicing
Agreement if it resigns from its obligations and duties as servicer of Trust
1990, Trust 1991, Trust 1992, Trust 1993 or Trust 1994, as the case may be. No
such resignation will become effective until the Trustee or a successor
Servicer has assumed the Servicer's obligations and duties under the Pooling
and Servicing Agreement.
The Pooling and Servicing Agreement will provide that the Servicer will not
be under any liability to the Trust or the Certificateholders for taking any
action or for refraining from taking any action in good faith pursuant to the
Pooling and Servicing Agreement, or for errors in judgment; provided, however,
that the Servicer will not be protected against any liability that otherwise
would be imposed by reason of willful misfeasance, bad faith or gross
negligence in the performance of duties or by reason of its reckless disregard
of its obligations and duties thereunder. Under the Pooling and Servicing
Agreement, the Transferor will indemnify all third party creditors for the
entire amount of any losses, claims, damages or liabilities arising out of or
based on the Pooling and Servicing Agreement. The Pooling and Servicing
Agreement further will provide that the Servicer and any director, officer,
employee or agent of the Servicer will be entitled to indemnification by the
Trust and will be held harmless to the extent provided in the Pooling and
Servicing Agreement against any loss, liability or expense incurred in
connection with any legal action relating to the Pooling and Servicing
Agreement or the Certificates, other than any loss, liability or expense
related to any specific Mortgage Loan or Mortgage Loans (except any such loss,
liability or expense otherwise reimbursable pursuant to the Pooling and
Servicing Agreement) and any loss, liability or expense incurred by the
Servicer by reason of its willful misfeasance, bad faith or gross negligence
in the performance of its duties thereunder or by reason of the Servicer's
reckless disregard of its obligations and duties thereunder.
The Pooling and Servicing Agreement will provide that the Servicer will not
be under any obligation to appear in, prosecute or defend any legal action
that is not incidental to its duties under the Pooling and Servicing Agreement
and that in its opinion may involve it in any expense or liability. The
Servicer, however, in its discretion, may undertake any such action that it
may deem necessary or desirable with respect to the Pooling
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and Servicing Agreement and the rights and duties of the parties thereto and
the interest of the Certificateholders and Certificate Insurer thereunder. In
such event, the legal expenses and costs of such action and any liability
resulting therefrom will be expenses, costs and liabilities of the Trust, and
the Servicer will be entitled to be reimbursed therefor to the extent provided
in the Pooling and Servicing Agreement. The Servicer's right to such indemnity
or reimbursement will survive any resignation or termination of the Servicer
with respect to any losses, expenses, costs or liabilities arising prior to
such resignation or termination (or arising from events that occurred prior to
such resignation or termination). Any claims by or on behalf of the
Certificateholders or the Trust will be made only against the Servicer, who
will be liable with respect to its own acts and omissions as well as the acts
and omissions of its directors, officers, employees and agents.
Any corporation into which the Servicer may be merged or consolidated, or
any corporation resulting from any merger, conversion or consolidation to
which the Servicer shall be a party, or any corporation succeeding to the
business of the Servicer, or any corporation that executes an agreement of
assumption to perform every obligation of the Servicer hereunder, will be the
successor of the Servicer under the Pooling and Servicing Agreement and will
be required to execute and deliver to the Trustee and the Certificate Insurer
an agreement in form reasonably satisfactory to the Trustee and the
Certificate Insurer which contains an assumption by such successor entity of
the due and punctual performance and observance of each covenant and condition
to be performed or observed by the Servicer under the Pooling and Servicing
Agreement.
EVENTS OF DEFAULT AND TRIGGER EVENTS
"Events of Default" under the Pooling and Servicing Agreement will consist
of (i) any failure by the Servicer to deposit into the Certificate Account any
deposit required to be made under the Pooling and Servicing Agreement, which
failure continues unremedied for five (5) Business Days after the giving of
written notice of such failure to the Servicer by the Trustee or to the
Servicer and the Trustee by the Certificate Insurer or by notice to the
Servicer, the Trustee and the Certificate Insurer by the Certificateholders
evidencing not less than 51% of the Certificate Principal Balance; (ii) any
failure by the Servicer duly to observe or perform in any material respect any
other of its covenants or agreements in the Insurance Agreement or the Pooling
and Servicing Agreement which failure materially and adversely affects the
interests of the Certificateholders and continues unremedied for 60 days after
the giving of written notice of such failure to the Servicer and the
Certificate Insurer by the Trustee, or to the Servicer and the Trustee by the
Certificate Insurer or to the Servicer, the Certificate Insurer and the
Trustee by holders of the Certificates evidencing not less than 51% of the
Certificate Principal Balance of the Certificates, respectively; and (iii)
certain events of insolvency, readjustment of debt, marshaling of assets and
liabilities or similar proceedings regarding the Servicer and certain actions
by the Servicer indicating its insolvency or inability to pay its obligations.
A "Trigger Event" is the occurrence of any of the following events: (i)
failure by the Servicer to pay the Certificate Insurer amounts payable under
the Insurance Agreement, which failure continues unremedied for five (5)
Business Days after receipt by the Servicer of notice thereof (ii) the
Servicer's failure to pay amounts payable under the Pooling and Servicing
Agreement, which failure continues unremedied for five (5) Business Days after
receipt by the Servicer of notice thereof and results in a draw on the
Certificate Insurance Policy; (iii) the occurrence of an Event of Default; or
(iv) a determination that the performance of the Servicer under the Pooling
and Servicing Agreement is not satisfactory in the reasonable opinion of the
Certificate Insurer.
RIGHTS UPON EVENTS OF DEFAULT AND TRIGGER EVENTS
So long as an Event of Default remains unremedied, either the Certificate
Insurer (unless a Certificate Insurer Default has occurred and is continuing)
or the Trustee or holders of Certificates evidencing not less than 51% of the
Certificate Principal Balance with the consent of the Certificate Insurer
(unless a Certificate Insurer Default has occurred and is continuing), may
terminate all of the rights and obligations of the Servicer under the Pooling
and Servicing Agreement; provided, however, that for so long as the Pool
contains Trust Balances of Common Mortgage Loans under which Sold Balances are
held by Trust 1990, Trust 1991, Trust 1992, Trust 1993 or Trust 1994, the
Servicer may not be terminated in such circumstances if, and for so long as,
the Servicer
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continues to act as servicer of Trust 1990, Trust 1991, Trust 1992, Trust 1993
or Trust 1994, as the case may be. Upon such termination, for so long as the
Pool contains Trust Balances of Common Mortgage Loans under which Sold
Balances are held by Trust 1990, Trust 1991, Trust 1992, Trust 1993 or Trust
1994, and if and for so long as the Trustee also acts as servicer of Trust
1990, Trust 1991, Trust 1992, Trust 1993 or Trust 1994, as the case may be,
the Trustee will succeed to all the responsibilities, duties and liabilities
of the Servicer under the Pooling and Servicing Agreement. In the event that
the Trustee would be obligated to succeed the Servicer but is unable so to
act, it may appoint with the consent of the Certificate Insurer (unless a
Certificate Insurer Default has occurred and is continuing), or petition a
court of competent jurisdiction to appoint, a housing and home finance
institution with a net worth of at least $10,000,000 to act as successor to
the Servicer under the Pooling and Servicing Agreement, provided that, for so
long as the Pool contains Trust Balances of Common Mortgage Loans under which
Sold Balances are held by Trust 1990, Trust 1991, Trust 1992, Trust 1993 or
Trust 1994, such institution is then acting, or has been designated to act, as
servicer of Trust 1990, Trust 1991, Trust 1992, Trust 1993 or Trust 1994, as
the case may be. Pending such appointment, the Trustee is obligated to act in
such capacity. The Trustee, the Certificate Insurer (unless a Certificate
Insurer Default has occurred and is continuing) and such successor may agree
upon the servicing compensation to be paid, which in no event may be greater
than 0.75%.
No Certificateholder will have any right under the Pooling and Servicing
Agreement to institute any proceeding in its name with respect to the Pooling
and Servicing Agreement unless such holder previously has given to the Trustee
and the Certificate Insurer written notice of default and unless holders of
Certificates evidencing not less than 25% of the Certificate Principal Balance
with the consent of the Certificate Insurer have made written request upon the
Trustee to institute such proceeding in its own name as Trustee thereunder and
have offered to the Trustee reasonable indemnity, and the Trustee for 60 days
has neglected or refused to institute any such proceeding. The Trustee will be
under no obligation to exercise any of the trusts or powers vested in it by
the Pooling and Servicing Agreement or to make any investigation of matters
arising thereunder or to institute, conduct or defend any litigation
thereunder or in relation thereto at the request, order or direction of any of
the holders of Certificates or the Certificate Insurer covered by the Pooling
and Servicing Agreement, unless such Certificateholders or the Certificate
Insurer have offered to the Trustee reasonable security or indemnity against
the costs, expenses and liabilities that may be incurred therein or thereby.
Following the occurrence of any Trigger Event, the Certificate Insurer will
have (unless a Certificate Insurer Default has occurred and is continuing),
among other things, the right to require the Trustee to terminate the Servicer
and appoint a successor Servicer pursuant to the Pooling and Servicing
Agreement. Notwithstanding the foregoing, for so long as the Pool contains
Trust Balances of Common Mortgage Loans under which Sold Balances are held by
Trust 1990, Trust 1991, Trust 1992, Trust 1993 or Trust 1994, the Certificate
Insurer may not require the Trustee to terminate the Servicer in such
circumstances if, and for so long as, the Servicer continues to act as
servicer of Trust 1990, Trust 1991, Trust 1992, Trust 1993 or Trust 1994, as
the case may be.
If the Servicer is terminated as servicer of Trust 1990, Trust 1991, Trust
1992, Trust 1993 or Trust 1994, for so long as the Pool contains Trust
Balances of Common Mortgage Loans under which Sold Balances are held by Trust
1990, Trust 1991, Trust 1992, Trust 1993 or Trust 1994, and whether or not
there is an Event of Default under the Pooling and Servicing Agreement, the
Trustee will promptly deliver a notice of termination to the Servicer under
the Pooling and Servicing Agreement and, unless the Trustee assumes the
responsibilities, duties and liabilities of the Servicer as described above,
it will appoint as the successor Servicer such other person as is appointed to
act as servicer of Trust 1990, Trust 1991, Trust 1992, Trust 1993 or Trust
1994, as the case may be.
AMENDMENT OF POOLING AND SERVICING AGREEMENT
The Pooling and Servicing Agreement may be amended from time to time by the
Servicer, the Transferor and the Trustee without the consent of any of the
Certificateholders, to cure any ambiguity; to correct any defective provisions
or to correct or supplement any provisions therein which may be inconsistent
with any other provisions therein; to add or delete any other provisions with
respect to matters or questions arising under the Pooling and Servicing
Agreement, including provisions relating to the Trust's ownership of Trust
Balances of
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Common Mortgage Loans, that are not inconsistent with the provisions of the
Pooling and Servicing Agreement; to add or amend any provision as required by
the Rating Agencies in order to maintain or improve the rating of the
Certificates (it being understood that, after obtaining the ratings in effect
on the Closing Date, neither the Transferor nor the Servicer is obligated to
obtain, maintain or improve any such rating); or to add any other provisions
with respect to matters or questions arising thereunder; provided that such
action will not, as evidenced by an opinion of counsel, materially and
adversely affect the interests of any Certificateholder or the Certificate
Insurer (and provided that any such amendment will be deemed not to materially
and adversely affect the Certificateholders if the person requesting such
amendment obtains a letter from each Rating Agency stating that such amendment
would not result in a downgrading or withdrawal of the rating of the
Certificates and provided further that any such amendment will be deemed not
to materially and adversely affect the Certificate Insurer if each Rating
Agency has confirmed that such amendment would not result in a reduction below
investment grade of the Certificates without regard to the Certificate
Insurance Policy).
The Pooling and Servicing Agreement also may be amended from time to time by
the Servicer, the Transferor and the Trustee, with the consent of the
Certificate Insurer (in certain circumstances) and the holders of Certificates
evidencing not less than 51% of the Certificate Principal Balance, and the
Servicer, the Trustee and the Certificate Insurer may from time to time
consent to the amendment of the Certificate Insurance Policy for the purpose
of adding any provisions to or changing in any manner or eliminating any of
the provisions of the Pooling and Servicing Agreement or the Certificate
Insurance Policy or of modifying in any manner the rights of holders of the
Certificates. No such amendment, however, may (i) reduce in any manner the
amount of, or delay the timing of, collection of payments of Mortgage Loans or
distributions or payments under the Certificate Insurance Policy or
distributions that are required to be made on any Certificate without the
consent of the holder of such Certificate, (ii) reduce the aforesaid
percentage required to consent to any such amendment, without the consent of
the holders of all Certificates affected thereby or (iii) adversely affect in
any material respect the interests of the Certificate Insurer without the
consent of the Certificate Insurer. In connection with any amendment of the
Pooling and Servicing Agreement, an opinion of counsel must be obtained that
such amendment will not adversely affect the federal income tax
characterization of the Certificates.
OPTIONAL TERMINATION; RETIREMENT OF THE CERTIFICATES
The Trust will terminate on the Distribution Date following the later of (A)
the earlier of (i) payment in full of all amounts owing to the Certificate
Insurer and (ii) the final payment or other liquidation of the last Mortgage
Loan in the Trust and (B) the earliest of (i) the Distribution Date on which
the Certificate Principal Balance has been reduced to zero, (ii) the final
payment or other liquidation of the last Mortgage Loan in the Trust and (iii)
the Stated Maturity Date, on which date, the Certificate Insurance Policy will
be available to pay any outstanding Certificate Principal Balance. The
Certificates will be subject to optional repurchase by the Transferor on any
Distribution Date after the Certificate Principal Balance is reduced to an
amount less than or equal to $6,023,000 (5% of the Original Certificate
Principal Balance) and all amounts due and owing to the Certificate Insurer
and unreimbursed draws on the Certificate Insurance Policy, together with
interest thereon, as provided under the Insurance Agreement, have been paid.
The purchase price will be equal to the sum of the outstanding Certificate
Principal Balance and accrued and unpaid interest thereon at the Certificate
Rate through the day preceding the final Distribution Date plus any Basis Risk
Payment then due and interest accrued thereon. In no event, however, will the
Trust created by the Pooling and Servicing Agreement continue in perpetuity.
Written notice of termination of the Pooling and Servicing Agreement will be
given to each Certificateholder, and the final distribution will be made only
upon surrender and cancellation of the Certificates at an office or agency
appointed by the Trustee which will be specified in the notice of termination.
In addition, the Trust may be liquidated as a result of certain events of
insolvency, receivership or conservatorship relating to the Transferor. See
"--Rapid Amortization Period; Rapid Amortization Events" above.
THE TRUSTEE
The Chase Manhattan Bank will serve as Custodial Agent and Trustee under the
Pooling and Servicing Agreement. The Trustee may have normal banking
relationships with the Transferor and the Servicer or their affiliates, or
both. The Chase Manhattan Bank, formerly known as Chemical Bank, serves as
registrar and transfer
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agent for a preferred stock issue of Chevy Chase, as trustee under a pooling
and servicing agreement with respect to a credit card receivables trust
originated by Chevy Chase, and as trustee under the pooling and servicing
agreements for Trust 1990, Trust 1991, Trust 1992, Trust 1993 and Trust 1994.
The Trustee may resign at any time, provided, for so long as the Pool
contains Trust Balances of Common Mortgage Loans under which Sold Balances are
held by Trust 1990, Trust 1991, Trust 1992, Trust 1993 or Trust 1994, that it
simultaneously resign as trustee of Trust 1990, Trust 1991, Trust 1992, Trust
1993 or Trust 1994, as the case may be, and, subject to the same proviso, will
be required to resign if it no longer serves as trustee of Trust 1990, Trust
1991, Trust 1992, Trust 1993 or Trust 1994. The Transferor also may remove the
Trustee if the Trustee ceases to be eligible to continue as such under the
Pooling and Servicing Agreement or if the Trustee becomes insolvent, provided,
in each case, for so long as the Pool contains Trust Balances of Common
Mortgage Loans under which Sold Balances are held by Trust 1990, Trust 1991,
Trust 1992, Trust 1993 or Trust 1994, that the Trustee is no longer serving as
trustee of Trust 1990, Trust 1991, Trust 1992, Trust 1993 or Trust 1994, as
the case may be. In any such event, the Transferor will be obligated to
appoint as successor Trustee the person serving or designated to serve as
trustee of Trust 1990, Trust 1991, Trust 1992, Trust 1993 or Trust 1994, as
the case may be. Any resignation or removal of the Trustee and appointment of
a successor Trustee will not become effective until acceptance of the
appointment by the successor Trustee.
REGISTRATION OF CERTIFICATES
Certificateholders may hold their Certificates through DTC (in the United
States) or Cedel or Euroclear (in Europe) if they are participants of such
systems, or indirectly through organizations that are participants in such
systems.
CEDE & Co., as nominee for DTC, will be the registered holder of the global
Certificates. No Certificateholder will be entitled to receive a certificate
representing such person's interest in the Certificates. Unless and until
Replacement Certificates are issued under the limited circumstances described
below, all references herein to actions by Certificateholders shall refer to
actions taken by DTC upon instructions from DTC Participants (as defined
herein), and all references herein to distributions, notices, reports and
statements to Certificateholders shall refer to distributions, notices,
reports and statements to CEDE & Co., as the registered holder of the
Certificates, for distribution to Certificateholders in accordance with DTC
procedures.
Cedel and Euroclear will hold omnibus positions on behalf of the Cedel
Participants and the Euroclear Participants (each as defined herein),
respectively, through customers' securities accounts in Cedel's and
Euroclear's names on the books of their respective depositaries (collectively,
the "Depositaries") which in turn will hold such positions in customers'
securities accounts in the Depositaries' names on the books of DTC.
DTC is a limited-purpose trust company organized under the New York Banking
Law, a "banking organization" within the meaning of the New York Banking Law,
a member of the Federal Reserve System, a "clearing corporation" within the
meaning of the New York Uniform Commercial Code, and a "clearing agency"
registered pursuant to the provisions of Section 17A of the Exchange Act. DTC
holds securities for its participants ("DTC Participants") and facilitates the
clearance and settlement among DTC Participants of securities transactions,
such as transfers and pledges, in deposited securities through electronic
book-entry changes in DTC Participants' accounts, thereby eliminating the need
for physical movement of securities certificates. DTC Participants include
securities brokers and dealers, banks, trust companies, clearing corporations
and certain other organizations. Indirect access to the DTC system is also
available to others such as securities brokers and dealers, banks, and trust
companies that clear through or maintain a custodial relationship with a DTC
Participant, either directly or indirectly ("Indirect Participants"). The
rules applicable to DTC and its participants are on file with the Commission.
Transfers between DTC Participants will occur in accordance with DTC rules.
Transfers between Cedel Participants and Euroclear Participants will occur in
the ordinary way in accordance with their applicable rules and operating
procedures.
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Cross-market transfers between persons holding directly or indirectly
through DTC, on the one hand, and directly or indirectly through Cedel
Participants or Euroclear Participants, on the other, will be effected in DTC
in accordance with DTC rules on behalf of the relevant European international
clearing system by its Depositary; however, such cross-market transactions
will require delivery of instructions to the relevant European international
clearing system by the counterparty in such system in accordance with its
rules and procedures and within its established deadlines (European time). The
relevant European international clearing system will, if the transaction meets
its settlement requirements, deliver instructions to its Depositary to take
action to effect final settlement on its behalf by delivering or receiving
securities in DTC, and making or receiving payment in accordance with normal
procedures for same-day funds settlement applicable to DTC. Cedel Participants
and Euroclear Participants may not deliver instructions directly to the
Depositaries.
Because of time-zone differences, credits of securities in Cedel or
Euroclear as a result of a transaction with a DTC Participant will be made
during the subsequent securities settlement processing, dated the Business Day
following the DTC settlement date, and such credits or any transactions in
such securities settled during such processing will be reported to the
relevant Cedel Participant or Euroclear Participant on such Business Day. Cash
received in Cedel or Euroclear as a result of sales of securities by or
through a Cedel Participant or a Euroclear Participant to a DTC Participant
will be received with value on the DTC settlement date but will be available
in the relevant Cedel or Euroclear cash account only as of the Business Day
following settlement in DTC.
Purchases of Certificates under the DTC system must be made by or through
DTC Participants, which will receive a credit for the Certificates on DTC's
records. The ownership interest of each actual Certificate Owner is in turn to
be recorded on the DTC Participants' and Indirect Participants' records.
Certificate Owners will not receive written confirmation from DTC of their
purchase, but Certificate Owners are expected to receive written confirmations
providing details of the transaction, as well as periodic statements of their
holdings, from the DTC Participant or Indirect Participant through which the
Certificate Owner entered into the transaction. Transfers of ownership
interests in the Certificates are to be accomplished by entries made on the
books of DTC Participants acting on behalf of Certificate Owners. Certificate
Owners will not receive certificates representing their ownership interest in
Certificates, except in the event that use of the book-entry system for the
Certificates is discontinued.
To facilitate subsequent transfers, all Certificates deposited by DTC
Participants with DTC are registered in the name of DTC's nominee, CEDE & Co.
The deposit of Certificates with DTC and their registration in the name of
CEDE & Co. effects no change in beneficial ownership. DTC has no knowledge of
the actual Certificate Owners of the Certificates; DTC's records reflect only
the identity of the DTC Participants to whose accounts such Certificates are
credited, which may or may not be the Certificate Owners. The DTC Participants
will remain responsible for keeping account of their holdings on behalf of
their customers.
Conveyance of notices and other communications by DTC to DTC Participants,
by DTC Participants to Indirect Participants, and by DTC Participants and
Indirect Participants to Certificate Owners will be governed by arrangements
among them, subject to any statutory or regulatory requirements as may be in
effect from time to time.
Neither DTC nor CEDE & Co. will consent or vote with respect to
Certificates. Under its usual procedures, DTC mails an omnibus proxy to the
issuer as soon as possible after the record date, which assigns CEDE & Co.'s
consenting or voting rights to those DTC Participants to whose accounts the
Certificates are credited on the record date (identified in a listing attached
thereto).
Principal and interest payments on the Certificates will be made to DTC.
DTC's practice is to credit DTC Participants' accounts on the applicable
Distribution Date in accordance with their respective holdings shown on DTC's
records unless DTC has reason to believe that it will not receive payment on
such Distribution Date. Payments by DTC Participants to Certificate Owners
will be governed by standing instructions and customary practices, as is the
case with securities held for the accounts of customers in bearer form or
registered in "street name" and will be the responsibility of such DTC
Participant and not of DTC, the Trustee or the Transferor,
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subject to any statutory or regulatory requirements as may be in effect from
time to time. Payment of principal and interest to DTC is the responsibility
of the Trustee, disbursement of such payments to DTC Participants shall be the
responsibility of DTC, and disbursement of such payments to Certificate Owners
shall be the responsibility of DTC Participants and Indirect Participants.
DTC may discontinue providing its services as securities depository with
respect to the Certificates at any time by giving reasonable notice to the
Transferor or the Trustee. Under such circumstances, in the event that a
successor securities depository is not obtained, Replacement Certificates are
required to be printed and delivered. The Transferor may decide to discontinue
use of the system of book-entry transfers through DTC (or a successor
securities depository). In that event, Replacement Certificates will be
delivered to Certificateholders.
The information in this section concerning DTC and DTC's book-entry system
has been obtained from sources that the Transferor believes to be reliable,
but the Transferor takes no responsibility for the accuracy thereof.
Cedel Bank, societe anonyme ("Cedel") is incorporated under the laws of
Luxembourg as a professional depository. Cedel holds securities for its
participating organizations ("Cedel Participants") and facilitates the
clearance and settlement of securities transactions between Cedel Participants
through electronic book-entry changes in accounts of Cedel Participants,
thereby eliminating the need for physical movement of certificates.
Transactions may be settled in Cedel in any of 28 currencies, including United
States dollars. Cedel provides to its Cedel Participants, among other things,
services for safekeeping, administration, clearance and settlement of
internationally traded securities and securities lending and borrowing. Cedel
interfaces with domestic markets in several countries. As a professional
depository, Cedel is subject to regulation by the Luxembourg Monetary
Institute. Cedel Participants are recognized financial institutions around the
world, including underwriters, securities brokers and dealers, banks, trust
companies, clearing corporations and certain other organizations and may
include the underwriters of any Certificates. Indirect access to Cedel is also
available to others, such as banks, brokers, dealers and trust companies that
clear through or maintain a custodial relationship with a Cedel Participant,
either directly or indirectly.
The Euroclear System was created in 1968 to hold securities for participants
of the Euroclear System ("Euroclear Participants") and to clear and settle
transactions between Euroclear Participants through simultaneous electronic
book-entry delivery against payment, thereby eliminating the need for physical
movement of certificates and any risk from lack of simultaneous transfers of
securities and cash. Transactions may now be settled in any of 27 currencies,
including United States dollars. The Euroclear System includes various other
services, including securities lending and borrowing and interfaces with
domestic markets in several countries generally similar to the arrangements
for cross-market transfers with DTC described above. The Euroclear System is
operated by Morgan Guaranty Trust Company of New York, Brussels, Belgium
office (the "Euroclear Operator" or "Euroclear"), under contract with
Euroclear Clearance System, S.C., a Belgian cooperative corporation (the
"Cooperative"). All operations are conducted by the Euroclear Operator, and
all Euroclear securities clearance accounts and Euroclear cash accounts are
accounts with the Euroclear Operator, not the Cooperative. The Cooperative
establishes policy for the Euroclear System on behalf of Euroclear
Participants. Euroclear Participants include banks (including central banks),
securities brokers and dealers and other professional financial intermediaries
and may include the underwriters of any Certificates. Indirect access to the
Euroclear System is also available to other firms that clear through or
maintain a custodial relationship with a Euroclear Participant, either
directly or indirectly.
The Euroclear Operator is the Belgian branch of a New York banking
corporation which is a member bank of the Federal Reserve System. As such, it
is regulated and examined by the Board of Governors of the Federal Reserve
System and the New York State Banking Department, as well as the Belgian
Banking Commission.
Securities clearance accounts and cash accounts with the Euroclear Operator
are governed by the Terms and Conditions Governing Use of Euroclear and the
related Operating Procedures of the Euroclear System and applicable Belgian
law (collectively, the "Terms and Conditions"). The Terms and Conditions
govern transfers
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of securities and cash within the Euroclear System, withdrawal of securities
and cash from the Euroclear System, and receipts of payments with respect to
securities in the Euroclear System. All securities in the Euroclear System are
held on a fungible basis without attribution of specific certificates to
specific securities clearance accounts. The Euroclear Operator acts under the
Terms and Conditions only on behalf of Euroclear Participants and has no
record of or relationship with persons holding through Euroclear Participants.
Distributions with respect to Certificates held through Cedel or Euroclear
will be credited to the cash accounts of Cedel Participants or Euroclear
Participants in accordance with the relevant system's rules and procedures, to
the extent received by its Depositary. Such distributions will be subject to
tax reporting in accordance with relevant United States tax laws and
regulations. See "CERTAIN FEDERAL INCOME TAX CONSEQUENCES" herein and "FEDERAL
INCOME TAX CONSIDERATIONS" in the Prospectus. Cedel or the Euroclear Operator,
as the case may be, will take any other action permitted to be taken by a
Certificateholder under the Pooling and Servicing Agreement on behalf of a
Cedel Participant or Euroclear Participant only in accordance with its
relevant rules and procedures and subject to its Depositary's ability to
effect such actions on its behalf through DTC.
Although DTC, Cedel and Euroclear have agreed to the foregoing procedures in
order to facilitate transfers of Certificates among participants of DTC, Cedel
and Euroclear, they are under no obligation to perform or continue to perform
such procedures and such procedures may be discontinued at any time.
Certificates will be issued in registered form to Certificate Owners, or
their nominees, rather than to DTC (such Certificates being referred to herein
as "Replacement Certificates"), only if (i) the Transferor advises the Trustee
in writing that DTC is no longer willing or able to discharge properly its
responsibilities as nominee and depository with respect to the Certificates
and the Transferor is unable to locate a qualified successor, (ii) the
Transferor at its option advises the Trustee in writing that it elects to
terminate the book-entry system through DTC or (iii) after the occurrence of
an Event of Default, Certificate Owners having Certificates evidencing not
less than 51% of the Certificate Principal Balance together advise the Trustee
and DTC in writing that the continuation of a book-entry system through DTC
(or a successor thereto) to the exclusion of any physical certificates being
issued to Certificate Owners is no longer in the best interests of Certificate
Owners. Upon issuance of Replacement Certificates to Certificate Owners, such
Certificates will be transferable directly (and not exclusively on a book-
entry basis) and registered holders will deal directly with the Trustee with
respect to transfers, notices and distributions.
CERTAIN LEGAL ASPECTS OF THE MORTGAGE LOANS
LIMITATIONS ON LENDERS
Numerous statutory provisions, including the federal bankruptcy laws and
state laws affording relief to debtors, may interfere with or affect the
ability of the secured lender to realize upon its security. For example, in a
proceeding under Chapter 11 of the federal Bankruptcy Code, if a court
determines that the value of real property is less than the principal balance
of the loan, the court may prevent a lender from foreclosing upon the real
property, and, as part of the rehabilitation plan, may reduce the amount of
the secured indebtedness to the value of the real property as it exists at the
time of the proceeding, leaving the lender as a general unsecured creditor for
the difference between that value and the amount of outstanding indebtedness
(unless the lender elected to be treated as fully secured). Moreover, a
bankruptcy court may grant the debtor a reasonable time within which to cure
accrued arrearages existing under the loan as of the date of bankruptcy, and
also may reduce the periodic payments due under the loan, change the rate of
interest and alter the loan repayment schedule.
Numerous federal and some state consumer protection laws impose substantive
requirements upon mortgage lenders in connection with the origination and the
servicing of mortgage loans. These laws include the Home Equity Loan Consumer
Protection Act of 1988, Truth in Lending Act, Equal Credit Opportunity Act,
Fair Credit Billing Act, Fair Credit Reporting Act, Real Estate Settlement
Procedures Act, the Americans with Disabilities Act and related statutes and
regulations. These federal laws impose specific statutory and regulatory
obligations
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upon lenders. In some cases, liability for failure to comply with the statutes
may affect assignees of such loans. See "CERTAIN LEGAL ASPECTS OF THE LOANS--
Anti-Deficiency Legislation and Other Limitations on Lenders" in the
Prospectus.
DUE-ON-SALE CLAUSES
All of the deeds of trust securing the Mortgage Loans contain due-on-sale
clauses. By virtue of the Garn-St Germain Act, a lender generally may be
permitted to accelerate any conventional loan that contains a "due-on-sale"
clause upon transfer of an interest in the security property. With respect to
any loan secured by a residence occupied or to be occupied by the grantor,
this ability to accelerate will not apply to certain types of transfers,
including (i) the granting of a leasehold interest that has a term of three
years or less and that does not contain an option to purchase, (ii) a transfer
to a relative resulting from the death of a grantor, or a transfer where the
spouse or any child becomes an owner of the property (in each case where the
transferee will occupy the property), (iii) a transfer resulting from a decree
of dissolution of marriage, legal separation agreement or an incidental
property settlement agreement by which the spouse becomes an owner of the
property, (iv) the creation of a lien or other encumbrance subordinate to the
lender's security instrument that does not relate to a transfer of rights of
occupancy in the property (provided that such lien or encumbrance is not
created pursuant to a contract for deed), (v) a transfer by devise, descent or
operation of law on the death of a joint tenant or tenant by the entirety and
(vi) other transfers as set forth in the Garn-St Germain Act and the
regulations thereunder.See "CERTAIN LEGAL ASPECTS OF THE LOANS--Due-on-Sale
Clauses in Mortgage Loans" in the Prospectus.
ERISA CONSIDERATIONS
The Certificates may not be acquired or held by or on behalf of (i) an
employee benefit plan (as defined in Section 3(3) of ERISA) that is subject to
Title I of ERISA, (ii) a plan described in Section 4975(e)(1) of the Code,
(iii) a governmental plan described in Section 3(32) of ERISA subject to any
federal, state or local law which is, to a material extent, similar to the
provisions of Section 406 of ERISA or Section 4975 of the Code or (iv) any
entity whose underlying assets include plan assets by reason of a plan's
investment in such entity. By its acceptance of a Certificate, except as
provided below for insurance company general accounts, each Certificate Owner
will be deemed to have represented and warranted that it is not subject to the
foregoing restriction.
The Small Business Job Protection Act of 1996 added new Section 401(c) of
ERISA relating to the status of the assets of insurance company general
accounts under ERISA and Section 4975 of the Code. Pursuant to Section 401(c),
the Department of Labor is required to issue final regulations (the "General
Account Regulations") not later than December 31, 1997 with respect to
insurance policies issued on or before December 31, 1998 which are supported
by an insurer's general account. The General Account Regulations are to
provide guidance on which assets held by the insurer constitute "plan assets"
for purposes of the fiduciary responsibility provisions of ERISA and Section
4975 of the Code. The assets of a general account which support insurance
policies (other than "guaranteed benefit policies" within the meaning of
Section 401(b)(2) of ERISA) (i) issued to employee benefit or other plans
subject to ERISA or Section 4975 of the Code after December 31, 1998 or (ii)
issued to such plans on or before December 31, 1998 for which the insurance
company does not comply with the General Account Regulations may be treated as
plan assets. However, except in the case of avoidance of the General Account
Regulations and actions brought by the Secretary of Labor relating to certain
breaches of fiduciary duties which also constitute breaches of state or
federal criminal law, until a date which is 18 months after the date the
General Account Regulations become final, no liability under the fiduciary
responsibility and prohibited transaction provisions of ERISA and Section 4975
of the Code may result on the basis of a claim that the assets of the general
account of an insurance company constitute the plan assets of any such plan.
The plan asset status of insurance company separate accounts are unaffected by
new Section 401(c) of ERISA and separate account assets continue to be treated
as the plan assets of any such plan invested in a separate account.
If the assets of a general account invested in Certificates are treated as
plan assets of any such plan or the protections of Section 401(c) of ERISA
become unavailable, certain violations of the prohibited transaction rules may
be deemed to occur as a result of the operation of the Trust. Insurance
companies contemplating the
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investment of general account assets in the Certificates should consult with
their legal advisors concerning the impact of Section 401(c) of ERISA,
including the status of assets of the general account as plan assets of
investing plans after December 31, 1998, and accordingly, the general
account's ability to continue to hold the Certificates after the date which is
18 months after the date the General Account Regulations become final.The
deemed representation and warranty regarding the acquisition and holding of
Certificates by any benefit plan, a plan covered by Section 4975 of the Code
or any entity whose underlying assets constitute "plan assets" will not apply
to the acquisition or holding of Certificates with the assets of a general
account of an insurance company to the extent such acquisition or holding,
respectively, is permitted by Section 401(c) of ERISA and final regulations
thereunder or other exemption under ERISA and does not result in the
contemplated operations of the Trust being treated as violations of the
prohibited transaction rules.
See "ERISA CONSIDERATIONS" in the Prospectus.
CERTAIN FEDERAL INCOME TAX CONSEQUENCES
GENERAL
Set forth below is a discussion of the material federal income tax
consequences of an investment in the Certificates prepared by Shaw, Pittman,
Potts & Trowbridge, federal tax counsel to the Transferor ("Tax Counsel").
This discussion does not address every aspect of the federal income tax laws
that may be relevant to holders of Certificates in light of their personal
investment circumstances or to certain types of Certificateholders subject to
special treatment under the federal income tax laws (for example, banks and
life insurance companies) and is generally limited to investors who will hold
Certificates as capital assets. Accordingly, investors should consult their
own tax advisors regarding federal, state, local and foreign and any other tax
consequences to them of an investment in the Certificates in their own
particular circumstances. This discussion is based upon the provisions of the
Internal Revenue Code of 1986, as amended (the "Code"), the Treasury
Regulations thereunder, and published rulings and court decisions in effect as
of the date hereof, all of which are subject to change, possibly
retroactively. No ruling on any of the issues discussed below will be sought
from the Internal Revenue Service (the "IRS") and no assurance can be given
that the IRS will not take contrary positions.
TREATMENT OF THE CERTIFICATES AS INDEBTEDNESS
Tax Counsel will upon issuance of the Certificates render an opinion,
subject to the assumptions set forth therein, to the effect that, although no
specific authority exists as to the characterization for federal income tax
purposes of securities having the same terms as the certificates, the
Certificates, when issued, will be properly characterized for federal income
tax purposes as indebtedness.
The Transferor and the Certificateholders will express in the Pooling and
Servicing Agreement the intent that, for federal, state and local income and
franchise tax purposes, and for the purposes of any other tax imposed on or
measured by income, the Certificates will be indebtedness secured by the Trust
Balances of the Mortgage Loans. The Transferor, by entering into the Pooling
and Servicing Agreement, each Certificateholder, by the acceptance of a
Certificate, and each Certificate Owner, by virtue of accepting a beneficial
interest in a Certificate, will agree to treat the Certificates (or the
beneficial interests therein) as indebtedness secured by the Trust Balances of
the Mortgage Loans for federal, state and local income and franchise tax
purposes and for the purposes of any other tax imposed on or measured by
income. However, because different criteria are used in determining the nontax
accounting treatment of a transaction, the Transferor will treat the Pooling
and Servicing Agreement for certain regulatory and financial accounting
purposes as a transfer of an ownership interest in the Trust Balances of the
Mortgage Loans and not as creating a debt obligation.
The economic substance of a transaction generally determines its federal
income tax consequences and the form of a transaction, while a relevant
factor, is generally not conclusive evidence of its economic substance. In
appropriate circumstances the courts have allowed taxpayers, as well as the
IRS, to treat a transaction in accordance with its economic substance,
notwithstanding that participants characterized the transaction
differently for nontax purposes. In some instances, however, courts have held
that a taxpayer is bound by the
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particular form it has chosen for a transaction, even if the substance of the
transaction does not accord with its form. As discussed in its opinion, Tax
Counsel believes that the rationale of those cases will not apply to this
transaction.
The determination of whether the economic substance of a transfer of an
interest in property is a sale or a loan secured by the transferred property
depends on numerous factors that indicate whether the transferor has
relinquished (and the transferee has obtained) substantial incidents of
ownership in the property. Among the primary factors considered are whether
the transferee has obtained the opportunity for gain if the property increases
in value, has assumed the risk of loss if the property decreases in value and,
in the case of accounts receivable such as the Mortgage Loans, whether the
transferee, at the time of transfer, has fixed interest in the proceeds of the
receivable when collected. Based upon its analysis of such factors and as set
forth in its opinion, Tax Counsel is of the view that the Certificates, when
issued, will be properly characterized for federal income tax purposes as
indebtedness secured by the Trust Balances of the Mortgage Loans. Contrary
characterizations that could be asserted by the IRS are described under
"Possible Characterizations of the Arrangement as a Partnership or an
Association Taxable as a Corporation" below. Except as otherwise expressly
indicated, the following discussion assumes that the Certificates are properly
treated as debt obligations for federal income tax purposes.
INTEREST INCOME TO CERTIFICATEHOLDERS
It is anticipated that the Certificates will be issued at par value (or at
an insubstantial discount from par value) and, although the matter is not free
from doubt, it appears that stated interest on the Certificates generally will
be taxable as ordinary income for Federal income tax purposes when received or
accrued by Certificateholders in accordance with their respective method of
tax accounting, and except as indicated, no original issue discount ("OID")
will arise with respect to the Certificates. It is possible, however, that
under regulations of the U.S. Treasury Department, interest payable on the
Certificates (or a portion of such interest), as well as any discount from par
value, will constitute OID. Such regulations treat interest as OID unless such
interest is "unconditionally payable." Because the Certificateholders do not
have available default remedies ordinarily available to holders of debt
instruments, the IRS could take the position that the interest payable on the
Certificates is not "unconditionally payable" within the meaning of such
regulations. In such case, all or a portion of the taxable income to be
recognized with respect to the Certificates would not, however, be includible
again when the interest is actually received. If the yield on the Certificates
is not materially different from the coupon, this treatment would have no
significant effect on Certificateholders using the accrual method of
accounting. However, cash method Certificateholders may be required to report
income with respect to the Certificates in advance of the receipt of cash
attributable to such income. The Certificateholders may be required to accrue
any Basis Risk Payment in income in advance of the receipt of cash with
respect to such Basis Risk Payment regardless of whether such
Certificateholders are on the cash or accrual method of accounting.
If the Certificates were treated as being issued with OID, the following
rules would apply. The excess of the payments with respect to the Certificates
over their issue price (in this case, the first price at which a substantial
amount of the Certificates is sold, excluding sales to brokers or similar
persons acting in the capacity of underwriters, placement agents or
wholesalers) would constitute OID. A Certificateholder must include OID in
income as interest over the term of the Certificate under a constant yield
method. In general, OID must be included in income in advance of the receipt
of cash representing that income. In the case of a debt instrument as to which
the repayment of principal may be accelerated as a result of the prepayment of
other obligations securing the debt instrument, the periodic inclusion of OID
is determined under a special provision by taking into account prepayment
assumptions used in pricing the debt instrument and actual prepayment
experience. If this provision applies to the Certificate, the amount of OID
which will accrue in any given "accrual period" may either increase or
decrease depending upon the actual prepayment rate. In the event of a Basis
Risk Payment, an accrual basis taxpayer will likely be required to accrue the
amount of each Basis Risk Payment even though such Basis Risk Payment may not
be paid until a later time. The amount and rate of accrual of OID with respect
to securities similar to the Certificates are calculated based on a reasonable
assumed prepayment rate (the "Prepayment Assumption") and adjustments are made
in the amount and rate of accrual of such discount to reflect differences
between the actual prepayment rate and the Prepayment Assumption. It is
anticipated that
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future Treasury regulations will provide that the assumed prepayment rate for
securities such as the Certificates will be the rate used in pricing the
initial offering of the securities. The Prepayment Assumption for the
Certificates will be a 40% conditional prepayment rate ("CPR"), and a 25% draw
rate, but no representation is made that, in fact, the Mortgage Loans will be
prepaid at a rate based on the Prepayment Assumption or at any other rate or
that new draws will be made at the draw rate or any other rate. CPR is the
amount of principal of the pool of Mortgage Loans prepaid each month expressed
as an annualized percentage of the total principal of the pool of Mortgage
Loans outstanding at the beginning of each month and for this purpose all
payments of principal are considered to be prepayments.
A Certificateholder who purchases a Certificate at a market discount may be
subject to the "market discount" rules of the Code. These rules provide, in
part, for the treatment of gain attributable to accrued market discount as
ordinary income upon the receipt of partial principal payments or on the sale
or other disposition of the Certificate, and for the deferral of interest
deductions with respect to debt incurred to acquire or carry the market
discount Certificate.
If a Certificate is purchased by a Certificateholder at a premium, such
premium will be amortized as an offset to interest income (with a
corresponding reduction in the Certificateholder's basis) under a constant
yield method over the term of the Certificate if an election under Section 171
of the Code is made or was previously in effect.
DISPOSITION OF CERTIFICATES
If a Certificate is sold, exchanged or otherwise disposed of, a
Certificateholder generally will recognize gain or loss in an amount equal to
the difference between the amount realized on the sale, exchange or
disposition and the Certificateholder's adjusted basis in the Certificate. The
adjusted basis of a Certificate generally will equal the cost of the
Certificate to the Certificateholder, increased by any OID or market discount
previously includible in the Certificateholder's gross income, and reduced by
the portion of the basis of the Certificate allocable to payments on the
Certificate previously received by the Certificateholder and any amortized
premium. Subject to the market discount rules, gain or loss on the sale or
other disposition of a Certificate will be capital gain or loss if the
Certificate was held by the Certificateholder as a capital asset. Capital gain
or loss will be long-term if the Certificate is held by the Certificateholder
for more than one year and otherwise will be short-term.
POSSIBLE CHARACTERIZATION OF THE ARRANGEMENT AS A PARTNERSHIP OR ASSOCIATION
TAXABLE AS A CORPORATION
Although, as described above, Tax Counsel will render its opinion that the
Certificates are properly characterized as debt for federal income tax
purposes, such opinion is not binding on the IRS or the courts and no
assurance can be given that this characterization would prevail. If the IRS
were to contend successfully that the Certificates were not debt obligations
for federal income tax purposes, the arrangement among the Transferor and the
Certificateholders might be classified for federal income tax purposes as
either a partnership or an association taxable as a corporation that owns the
Trust Balances of the Mortgage Loans.
If the Certificates were treated as interests in a partnership, the
partnership would probably be treated as a "publicly traded partnership." A
publicly traded partnership is taxed in the same manner as a corporation
unless at least 90% of its gross income consists of specified types of
"qualifying income." Such qualifying income includes, among other things,
"interest income" that is "not derived in the conduct of a financial or
insurance business." If a deemed partnership between the Transferor and the
Certificateholders were to qualify for the foregoing exception from taxation
as a corporation, the deemed partnership would not be subject to federal
income tax but each item of income, gain, loss, and deduction generated as a
result of the ownership of the Trust Balances of the Mortgage Loans by the
partnership would be passed through to the Transferor and the
Certificateholders as partners in such a partnership according to their
respective interests therein.
The income reportable by the Certificateholders as partners could differ
from the income reportable by the Certificateholders as holders of debt
obligations of the Transferor. For example, a cash basis Certificateholder
might be required to report income when it accrued to the partnership rather
than when it is received by the
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Certificateholder. Moreover, an individual's share of expenses of the
partnership would be miscellaneous itemized deductions that, in the aggregate,
are allowed as deductions only to the extent they exceed two percent of the
individual's adjusted gross income. As a result, the individual might be taxed
on a greater amount of income than the stated rate on the Certificates.
If, alternatively, the arrangement created by the Agreement were treated as
either an association taxable as a corporation or a "publicly traded
partnership" taxable as a corporation, the resulting entity may be subject to
federal income taxes at corporate tax rates on its taxable income from the
Trust Balances of the Mortgage Loans. Such a tax might result in reduced
distributions to Certificateholders and Certificateholders might be liable for
a share of such a tax. Moreover, distributions by the entity would probably
not be deductible in computing the entity's taxable income and all or part of
the distributions to Certificateholders would generally be treated as dividend
income to the Certificateholders.
Since the Transferor will treat the Certificates as indebtedness for federal
income tax purposes, the Transferor will not comply with the tax reporting
requirements that would apply under these alternative characterizations of the
Certificates.
POSSIBLE CLASSIFICATION AS A TAXABLE MORTGAGE POOL
In relevant part, Section 7701(i) of the Code provides that any entity (or a
portion of an entity) that is a "taxable mortgage pool" will be classified as
a taxable corporation and will not be permitted to file a consolidated federal
income tax return with another corporation. Any entity (or a portion of any
entity) will be a taxable mortgage pool if (i) substantially all of its assets
consist of debt instruments, more than 50% of which are real estate mortgages,
(ii) the entity is the obligor under debt obligations with two or more
maturities, and (iii) under the terms of the entity's debt obligations (or an
underlying arrangement), payment on such debt obligations bear a relationship
to the debt instruments held by the entity.
Tax Counsel will render its opinion that the arrangement created by the
Agreement will not be a taxable mortgage pool under Section 7701(i) of the
Code because only one class of indebtedness secured by the Trust Balances is
being issued.
The opinion of Tax Counsel is not binding on the IRS or the courts. If the
IRS were to contend successfully that the arrangement created by the Agreement
is a taxable mortgage pool, such arrangement would be subject to federal
corporate income tax on its net taxable income generated with respect to
ownership of the Trust Balances of the Mortgage Loans. Such a tax might reduce
amounts available for distributions to Certificateholders. The amount of such
tax would depend upon whether distributions to Certificateholders would be
deductible as interest expense in computing the taxable income of such an
arrangement as a taxable mortgage pool.
FOREIGN INVESTORS
Subject to the discussion of backup withholding below, and assuming the
Certificates represent debt obligations for federal income tax purposes,
interest (including OID) paid to a nonresident alien individual, foreign
corporation or foreign estate or trust will be exempt from U.S. withholding
tax, provided that the Certificateholder complies with applicable
certification requirements (and does not actually or constructively own ten
percent or more of the voting stock of the Transferor and is not a controlled
foreign corporation related to the Transferor or its affiliates).
If the IRS were to contend successfully that the Certificates represent
interests in a partnership (not taxable as a corporation), a Certificateholder
that is a nonresident alien, foreign corporation or foreign estate or trust
might be required to file a U.S. individual or corporate income tax return and
pay tax on its share of partnership income at regular U.S. rates, including
the branch profits tax in the case of a corporation, and would be subject to
withholding tax on its share of partnership income. If the Certificates were
recharacterized as interests in an association taxable as a corporation or a
"publicly traded partnership" taxable as a corporation, to the extent
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distributions under the Agreement were treated as dividends, a nonresident
alien individual or foreign corporation would generally be subject to
withholding tax on the gross amount of such dividends as the rate of 30% (or
lower rate as provided by an applicable treaty). In either case, and assuming
the Certificates are recharacterized as partnership interests or equity
interests in a corporation, a Certificateholder that is a nonresident alien,
foreign corporation or foreign estate or trust might be subject to federal
income tax on any gain from the sale of the Certificates.
INFORMATION REPORTING AND BACKUP WITHHOLDING
The Servicer will be required to report annually to the IRS, and to each
Certificateholder of record, the amount of interest paid (and OID accrued, if
any) on the Certificates (and the amount of interest withheld for federal
income taxes, if any) for each calendar year, except as to exempt holders
(generally, holders that are corporations, certain tax-exempt organizations or
nonresident aliens who provide certification as to their status as
nonresidents). As long as the only "Certificateholder" of record is CEDE &
Co., as nominee for DTC, Certificateholders and the IRS will receive tax and
other information from DTC's direct or indirect participating organizations
rather than from the Servicer. (The Servicer, however, will respond to
requests for necessary information to enable DTC's direct or indirect
participating organizations and certain other persons to complete their
reports). Each nonexempt Certificateholder will be required to provide, under
penalty of perjury, a certificate on IRS Form W-9 containing his or her name,
address, correct federal taxpayer identification number and a statement that
he or she is not subject to backup withholding. Should a nonexempt
Certificateholder fail to provide the required certification, the DTC's direct
or indirect participating organizations (or the Servicer or Paying Agent) will
be required to withhold 31% of the interest (and principal) otherwise payable
to the holder, and remit the withheld amount to the IRS as a credit against
the holder's federal income tax liability.
ALL INVESTORS SHOULD CONSULT THEIR OWN TAX ADVISORS REGARDING THE FEDERAL,
STATE, LOCAL OR FOREIGN INCOME TAX CONSEQUENCES OF THE PURCHASE, OWNERSHIP AND
DISPOSITION OF THE CERTIFICATES.
STATE AND LOCAL TAXATION
The discussion above does not address the tax treatment of the Trust, the
Certificates or the Certificateholders under state or local tax laws.
Certificateholders are urged to consult their own tax advisors with respect to
state and local tax consequences of the purchase, ownership or disposition of
an interest in the Certificates.
LEGAL INVESTMENT CONSIDERATIONS
Although, as a condition to their issuance, the Certificates will be rated
in the highest rating category by at least one Rating Agency, the Certificates
will not constitute "mortgage related securities" for purposes of SMMEA
because most of the deeds of trust securing the Mortgage Loans are not first
deeds of trust. Accordingly, many institutions with legal authority to invest
in comparably rated securities based on first mortgage loans may not be
legally authorized to invest in the Certificates, which, because they evidence
interests in a pool that includes second mortgage loans, are not "mortgage
related securities" under SMMEA.
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UNDERWRITING
Under the terms and subject to the conditions contained in an Underwriting
Agreement dated September , 1996 (the "Underwriting Agreement"), the
Underwriters named below (the "Underwriters") have severally but not jointly
agreed to purchase from the Transferor the following respective principal
amounts of the Certificates:
<TABLE>
<CAPTION>
PRINCIPAL
UNDERWRITERS AMOUNT
------------ ---------
<S> <C>
CS First Boston Corporation........................................ $
Merrill Lynch, Pierce, Fenner & Smith
Incorporated.............................................. $
----
Total.......................................................... $
====
</TABLE>
The Underwriting Agreement provides that the obligations of the Underwriters
are subject to certain conditions precedent and that the Underwriters will be
obligated to purchase all the Certificates, if any are purchased.
The Transferor has been advised by the Underwriters that the Underwriters
propose to offer the Certificates to the public initially at the public
offering price set forth on the cover page of this Prospectus Supplement and
to certain dealers at such price less a concession of % of the principal
amount per Certificate, and the Underwriters and such dealers may allow a
discount of % of such principal amount per Certificate on sales to certain
other dealers. After the initial public offering, the public offering price
and concession and discount to dealers may be changed by the Underwriters.
The Certificates are a new issue of securities with no established trading
market. The Underwriters have advised the Transferor that they intend to act
as market maker for the Certificates. However, the Underwriters are not
obligated to do so and may discontinue any market making at any time without
notice. No assurance can be given as to the liquidity of the trading market
for the Certificates.
The Transferor has agreed to indemnify the Underwriters against certain
liabilities, including civil liabilities under the Securities Act, or
contribute to payments which the Underwriters may be required to make in
respect thereof.
EXPERTS
The consolidated balance sheets of the Certificate Insurer, AMBAC Indemnity
Corporation, at December 31, 1995 and 1994 and the consolidated statements of
operations, stockholder's equity and cash flows of AMBAC Indemnity Corporation
for each of the years in the three year period ended December 31, 1995
appearing in Appendix B of this Prospectus Supplement have been included
herein in reliance upon the report of KPMG Peat Marwick LLP, independent
certified public accountants, appearing elsewhere herein and upon the
authority of said firm as experts in accounting and auditing.
The report of KPMG Peat Marwick LLP covering the consolidated financial
statements referred to above of AMBAC Indemnity Corporation refers to the
adoption of the Financial Accounting Standards Board's Statements of Financial
Accounting Standards No. 109, "Accounting for Income Taxes," No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," No. 106,
"Employers' Accounting for Postretirement Benefits Other Than Pensions," and
No. 112, "Employers' Accounting for Postemployment Benefits" in 1993.
LEGAL MATTERS
Certain matters will be passed upon for the Underwriters by Shaw, Pittman,
Potts & Trowbridge, a partnership including professional corporations. George
M. Rogers, Jr., whose professional corporation is a member of such firm, is a
director of the Transferor and the parent of the Transferor. Attorneys
employed by Shaw, Pittman, Potts & Trowbridge hold securities issued by the
Transferor and certain affiliates in an aggregate amount of approximately $1.0
million. Certain Federal income tax matters and the validity of the
Certificates will be passed upon by Shaw, Pittman, Potts & Trowbridge as
counsel for the Transferor.
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INDEX OF PRINCIPAL TERMS
<TABLE>
<CAPTION>
DEFINITION PAGE
- ---------- ----
<S> <C>
Accelerated Principal Distribution Amount.................................. S-7
Accrual Period............................................................. S-11
Additional Balances........................................................ S-4
Alternative Principal Payment.............................................. S-11
AMBAC...................................................................... S-36
APR........................................................................ S-24
Base Rate.................................................................. S-19
Basic Overcollateralization Amount......................................... S-48
Basis Risk Payment......................................................... S-10
BIF........................................................................ S-23
Capitalized Interest Account............................................... S-9
Capitalized Interest Requirement........................................... S-10
Cedel...................................................................... A-1
Cedel Participants......................................................... S-62
Certificate Account........................................................ S-9
Certificateholders......................................................... S-1
Certificateholders' Excess Interest........................................ S-8
Certificateholders' Fixed Allocation Percentage............................ S-7
Certificateholders' Floating Allocation Percentage......................... S-7
Certificate Insurance Policy............................................... S-1
Certificate Insurer........................................................ S-1
Certificate Insurer Default................................................ S-5
Certificate Interest Collections........................................... S-7
Certificate Owners......................................................... S-17
Certificate Principal Balance.............................................. S-3
Certificate Rate........................................................... S-48
Certificates............................................................... S-1
Chevy Chase................................................................ S-1
Closing Date............................................................... S-11
Code....................................................................... S-65
Collection Period.......................................................... S-11
Combined Loan-to-Value Ratio............................................... S-15
Commission................................................................. S-2
Common Mortgage Loans...................................................... S-37
Cooperative................................................................ S-62
CPR........................................................................ S-67
CreditLine 100 Program..................................................... S-25
Custodial Agent............................................................ S-3
Cut-off Date............................................................... S-4
Cut-off Date Trust Balances................................................ S-4
Cycle Date................................................................. S-15
Daily Certificate Interest Collections..................................... S-7
Daily Certificate Principal Collections.................................... S-44
Defective Mortgage Loan.................................................... S-16
Determination Date......................................................... S-45
Dissolution Distribution Date.............................................. S-51
Distribution Date.......................................................... S-1
Draws...................................................................... S-11
DTC........................................................................ A-1
DTC Participants........................................................... S-60
Eligible Account........................................................... S-45
</TABLE>
S-71
<PAGE>
<TABLE>
<CAPTION>
DEFINITION PAGE
- ---------- ----
<S> <C>
Eligible Substitute Mortgage Loan.......................................... S-16
Euroclear.................................................................. A-1
Euroclear Operator......................................................... S-62
Euroclear Participants..................................................... S-62
Events of Default.......................................................... S-57
FDIA....................................................................... S-22
FDIC....................................................................... S-22
FIRREA..................................................................... S-22
Global Securities.......................................................... A-1
Indirect Participants...................................................... S-60
Initial Cut-off Date....................................................... S-1
Initial Mortgage Loans..................................................... S-1
Insolvency Event........................................................... S-51
Insurance Agreement........................................................ S-12
Insurance Proceeds......................................................... S-6
Interest Period............................................................ S-5
Invested Amount............................................................ S-3
IRS........................................................................ S-65
LIBOR...................................................................... S-10
LIBOR Business Day......................................................... S-49
Liquidated Mortgage Loan................................................... S-48
Liquidation Loss Amount.................................................... S-8
Liquidation Proceeds....................................................... S-6
Loan Agreements............................................................ S-4
Loan Balance............................................................... S-5
Loan Rate.................................................................. S-26
Managed Amortization Period................................................ S-9
Margin..................................................................... S-26
Maximum Credit Limit....................................................... S-15
Maximum Principal Payment.................................................. S-12
Mortgaged Properties....................................................... S-4
Mortgage Files............................................................. S-41
Mortgage Loan Schedule..................................................... S-43
Mortgage Loans............................................................. S-1
Net Liquidation Proceeds................................................... S-6
Net Loan Rate.............................................................. S-42
Net Trust Liquidation Proceeds............................................. S-6
91-1 Mortgage Loans........................................................ S-9
OID........................................................................ S-66
Original Certificate Principal Balance..................................... S-40
Original Invested Amount................................................... S-3
Overall Minimum Amount..................................................... S-44
Overcollateralization Amount............................................... S-8
Overfunded Interest Amount................................................. S-46
OTS........................................................................ S-23
Paying Agent............................................................... S-49
Permitted Investments...................................................... S-45
Pool....................................................................... S-3
Pool Balance............................................................... S-5
Pooling and Servicing Agreement............................................ S-3
Pre-Funded Amount.......................................................... S-1
Pre-Funding Account........................................................ S-9
Pre-Funding Period......................................................... S-9
</TABLE>
S-72
<PAGE>
<TABLE>
<CAPTION>
DEFINITION PAGE
- ---------- ----
<S> <C>
Premium Rate............................................................... S-10
Prepayment Assumption...................................................... S-66
Principal Collections...................................................... S-6
Prior Trusts............................................................... S-4
Prospectus................................................................. S-2
Rapid Amortization Event................................................... S-50
Rapid Amortization Period.................................................. S-50
Rating Agencies............................................................ S-16
Record Date................................................................ S-46
Reference Bank Rate........................................................ S-49
Removal Condition.......................................................... S-44
Replacement Certificate.................................................... S-63
Required Overcollateralization Amount...................................... S-8
Retransfer Date............................................................ S-43
Retransfer Deposit Amount.................................................. S-42
Retransfer Notification Date............................................... S-43
SAIF....................................................................... S-23
Scheduled Principal Collections Distribution Amount........................ S-11
Servicer................................................................... S-3
Servicer Advance........................................................... S-55
Servicing Fee.............................................................. S-14
Servicing Fee Rate......................................................... S-14
SMMEA...................................................................... S-17
Sold Balance............................................................... S-6
Stated Maturity Date....................................................... S-12
Statement 115.............................................................. S-37
Sub-Prime Lending Program.................................................. S-25
Subsequent Mortgage Loans.................................................. S-1
Substitution Adjustment Amount............................................. S-42
Tax Counsel................................................................ S-65
Telerate Page 3750......................................................... S-48
Terms and Conditions....................................................... S-62
Transferor................................................................. S-1
Transferor Interest........................................................ S-1
Trigger Event.............................................................. S-57
Trust...................................................................... S-3
Trust 1990................................................................. S-4
Trust 1991................................................................. S-4
Trust 1992................................................................. S-4
Trust 1993................................................................. S-4
Trust 1994................................................................. S-4
Trust 1995................................................................. S-45
Trust Balance.............................................................. S-4
Trust Fund................................................................. S-1
Trust Interest............................................................. S-5
Trustee.................................................................... S-3
Trust Insurance Proceeds................................................... S-6
Trust Percentage........................................................... S-38
Underwriters............................................................... S-71
Underwriting Agreement..................................................... S-71
United Guaranty............................................................ S-25
U.S. Person................................................................ A-3
Weighted Average Loan Rate................................................. S-48
</TABLE>
S-73
<PAGE>
APPENDIX A
GLOBAL CLEARANCE SETTLEMENT AND TAX DOCUMENTATION PROCEDURES
Except in certain limited circumstances, the globally offered Capitol
Revolving Home Equity Loan Asset Backed Certificates, Series 1996-1 (the
"Global Securities") will be available only in book-entry form. Investors in
the Global Securities may hold such Global Securities through any of The
Depository Trust Company ("DTC"), Cedel Bank, societe anonyme ("Cedel") or
Euroclear. The Global Securities will be tradeable as home market instruments
in both the European and U.S. domestic markets. Initial settlement and all
secondary trades will settle in same-day funds.
Secondary market trading between investors holding Global Securities through
Cedel and the Euroclear System ("Euroclear") will be conducted in the ordinary
way in accordance with their normal rules and operating procedures and in
accordance with conventional eurobond practice (i.e., seven calendar day
settlement).
Secondary market trading between investors holding Global Securities through
DTC will be conducted according to the rules and procedures applicable to U.S.
corporate debt obligations.
Secondary cross-market trading between Cedel or Euroclear and DTC
Participants holding Certificates will be effected on a delivery-against-
payment basis through the respective Depositaries of Cedel and Euroclear (in
such capacity) and as DTC Participants.
Non-U.S. holders (as described below) of Global Securities will be subject
to U.S. withholding taxes unless such holders meet certain requirements and
deliver appropriate U.S. tax documents to the securities clearing
organizations or their participants.
Initial Settlement
All Global Securities will be held in book-entry form by DTC in the name of
CEDE & Co. as nominee of DTC. Investors' interests in the Global Securities
will be represented through financial institutions acting on their behalf as
direct and indirect Participants in DTC. As a result, Cedel and Euroclear will
hold positions on behalf of their participants through their respective
Depositaries, which in turn will hold such positions in accounts as DTC
Participants.
Investor securities custody accounts will be credited with their holdings
against payment in same-day funds on the settlement date.
Investors electing to hold their Global Securities through Cedel or
Euroclear accounts will follow the settlement procedures applicable to
conventional eurobonds, except that there will be no temporary global security
and no "lock-up" or restricted period. Global Securities will be credited to
the securities custody accounts on the settlement date against payment in the
same-day funds.
Secondary Market Trading
Since the purchaser determines the place of delivery, it is important to
establish at the time of the trade where both the purchaser's and seller's
accounts are located to ensure that settlement can be made on the desired
value date.
Trading between DTC Participants. Secondary market trading between DTC
Participants will be settled using the procedures applicable to issues in
same-day funds.
Trading between Cedel and/or Euroclear Participants. Secondary market
trading between Cedel Participants or Euroclear Participants will be settled
using the procedures applicable to conventional eurobonds in same-day funds.
Trading between DTC seller and Cedel or Euroclear purchaser. When Global
Securities are to be transferred from the account of a DTC Participant to the
accounts of a Cedel Participant or a Euroclear
A-1
<PAGE>
Participant, the purchaser will send instructions to Cedel or Euroclear
through a Cedel Participant or Euroclear Participant at least one business day
prior to settlement. Cedel or Euroclear will instruct the respective
Depositary, as the case may be, to receive the Global Securities against
payment. Payment will include interest accrued on the Global Securities from
and including the last coupon payment date to and excluding the settlement
date, on the basis of actual days elapsed and a 360 day year. Payment will
then be made by the respective Depositary to the DTC Participant's account
against delivery of the Global Securities. After settlement has been
completed, the Global Securities will be credited to the respective clearing
system and by the clearing system, in accordance with its usual procedures, to
the Cedel Participant's or Euroclear Participant's account. The Global
Securities credit will appear the next day (European time) and the cash debit
will be back-valued to, and the interest on the Global Securities will accrue
from, the value date (which would be the preceding day when settlement
occurred in New York). If settlement is not completed on the intended value
date (i.e., the trade fails), the Cedel or Euroclear cash debit will be valued
instead as of the actual settlement date.
Cedel Participants and Euroclear Participants will need to make available to
the respective clearing systems the funds necessary to process same-day funds
settlement. The most direct means of doing so is to pre-position funds for
settlement, either from cash on hand or existing lines of credit, as they
would for any settlement occurring within Cedel or Euroclear. Under this
approach, they may take on credit exposure to Cedel or Euroclear until the
Global Securities are credited to their accounts one day later.
As an alternative, if Cedel or Euroclear has extended a line of credit to
them, Cedel Participants or Euroclear Participants can elect not to pre-
position funds and allow that credit line to be drawn upon the finance
settlement. Under this procedure, Cedel Participants or Euroclear Participants
purchasing Global Securities would incur overdraft charges for one day,
assuming they cleared the overdraft when the Global Securities were credited
to their accounts. However, interest on the Global Securities would accrue
from the value date. Therefore, in many cases the investment income on the
Global Securities earned during that one-day period may substantially reduce
or offset the amount of such overdraft charges, although this result will
depend on each Cedel Participant's or Euroclear Participant's particular cost
of funds.
Since the settlement is taking place during New York business hours, DTC
Participants can employ their usual procedures for sending Global Securities
to the respective Depositary for the benefit of Cedel Participants or
Euroclear Participants. The sale proceeds will be available to the DTC seller
on the settlement date. Thus, to the DTC Participants a cross-market
transaction will settle no differently than a trade between two DTC
Participants.
Trading between Cedel or Euroclear seller and DTC purchaser. Due to time
zone differences in their favor, Cedel Participants and Euroclear Participants
may employ their customary procedures for transactions in which Global
Securities are to be transferred by the respective clearing system, through
the respective Depositary, to a DTC Participant. The seller will send
instructions to Cedel to Euroclear through a Cedel Participant or Euroclear
Participant at least one business day prior to settlement. In these cases,
Cedel or Euroclear will instruct the respective Depositary, as appropriate, to
deliver the bonds to the DTC Participant's account against payment. Payment
will include interest accrued on the Global Securities from and including the
last coupon payment date to and excluding the settlement date on the basis of
actual days elapsed and a 360 day year. The payment will then be reflected in
the account of the Cedel Participant or Euroclear Participant the following
day, and receipt of the cash proceeds in the Cedel Participant's or Euroclear
Participant's account would be back-valued to the value date (which would be
the preceding day, when settlement occurred in New York). Should the Cedel
Participant or Euroclear Participant have a line of credit with its respective
clearing system and elect to be in debit in anticipation of receipt of the
sale proceeds in its account, the back-valuation will extinguish any overdraft
charges incurred over that one-day period. If settlement is not completed on
the intended value date (i.e., the trade fails), receipt of the cash proceeds
in the Cedel Participant's or Euroclear Participant's account would instead be
valued as of the actual settlement date.
Finally, day traders that use Cedel or Euroclear and that purchase Global
Securities from DTC Participants for delivery to Cedel Participants or
Euroclear Participants should note that these trades would automatically fall
A-2
<PAGE>
on the sale side unless affirmative action were taken. At lease three
techniques should be readily available to eliminate this potential problem:
(a) borrowing through Cedel or Euroclear for one day (until the purchase
side of the day trade is reflected in their Cedel or Euroclear accounts) in
accordance with the clearing system's customary procedures;
(b) borrowing the Global Securities in the U.S. from a DTC Participant no
later than one day prior to settlement, which would give the Global
Securities sufficient time to be reflected in their Cedel or Euroclear
account in order to settle the sale side of the trade; or
(c) staggering the value dates for the buy and sell sides of the trade so
that the value date for the purchase from the DTC Participant is at least
one day prior to the value date for the sale to the Cedel Participant or
Euroclear Participant.
CERTAIN U.S. FEDERAL INCOME TAX DOCUMENTATION REQUIREMENTS
A beneficial owner of Global Securities holding securities through Cedel or
Euroclear (or through DTC if the holder has an address outside the U.S.) will
be subject to the 30% U.S. withholding tax that generally applies to payments
of interest (including original issue discount) on registered debt issued by
U.S. Persons, unless (i) each clearing system, bank or other financial
institution that holds customers' securities in the ordinary course of its
trade or business in the chain of intermediaries between such beneficial owner
and the U.S. entity required to withhold tax complies with applicable
certification requirements and (ii) such beneficial owner takes one of the
following steps to obtain an exemption or reduced tax rate:
Exemption for non-U.S. Persons (Form W-8). Beneficial owners of Certificates
that are non-U.S. Persons can obtain a complete exemption from the withholding
tax by filing a signed Form W-8 (Certificate of Foreign Status). If the
information shown on Form W-8 changes, a new Form W-8 must be filed within 30
days of such change.
Exemption for non-U.S. Persons with effectively connected income (Form
4224). A non-U.S. Person, including a non-U.S. corporation or bank with a U.S.
branch, for which the interest income is effectively connected with its
conduct of a trade or business in the United States, can obtain an exemption
from the withholding tax by filing Form 4224 (Exemption from Withholding of
Tax on Income Effectively Connected with the Conduct of a Trade or Business in
the United States).
Exemption or reduced rate for non-U.S. persons resident in treaty countries
(Form 1001). Non-U.S. Persons that are Certificate Owners residing in a
country that has a tax treaty with the United States can obtain an exemption
or reduced tax rate (depending on the treaty terms) by filing Form 1001
(Ownership, Exemption or Reduced Rate Certificate). If the treaty provides
only for a reduced rate, withholding tax will be imposed at that rate unless
the filer alternatively files Form W-8. Form 1001 may be filed by the
Certificate Owner or his agent.
Exemption for U.S. Persons (Form W-9). U.S. Persons can obtain a complete
exemption from the withholding tax by filing Form W-9 (Payer's Request for
Taxpayer Identification Number and Certification).
U.S. Federal Income Tax Reporting Procedure. The Certificate Owner of a
Global Security or, in the case of a Form 1001 or a Form 4224 filer, his
agent, files by submitting the appropriate form to the person through whom it
holds (the clearing agency, in the case of persons holding directly on the
books of the clearing agency). Form W-8 and Form 1001 are effective for three
calendar years and Form 4224 is effective for one calendar year.
The term "U.S. Person" means (i) a citizen or resident of the United States,
(ii) a corporation or partnership organized in or under the laws of the United
States or any political subdivision thereof or (iii) an estate or trust the
income of which is includable in gross income for United States tax purposes,
regardless of its source. This summary does not deal with all aspects of U.S.
Federal income tax withholding that may be relevant to foreign holders of the
Global Securities. Investors are advised to consult their own tax advisors for
specific tax advice concerning their holding and disposing of the Global
Securities.
A-3
<PAGE>
APPENDIX B
AMBAC INDEMNITY CORPORATION AND SUBSIDIARIES
(a wholly owned subsidiary of AMBAC Inc.)
Consolidated Financial Statements
December 31, 1995 and 1994
(With Independent Auditors' Report Thereon)
B-1
<PAGE>
Independent Auditors' Report
The Board of Directors
AMBAC Indemnity Corporation:
We have audited the accompanying consolidated balance sheets of AMBAC
Indemnity Corporation and subsidiaries (a wholly owned subsidiary of AMBAC Inc.)
as of December 31, 1995 and 1994, and the related consolidated statements of
operations, stockholder's equity and cash flows for each of the years in the
three-year period ended December 31, 1995. These consolidated financial
statements are the responsibility of AMBAC Indemnity Corporation's management.
Our responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of AMBAC
Indemnity Corporation and subsidiaries as of December 31, 1995 and 1994, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1995 in conformity with generally accepted
accounting principles.
As discussed in Note 2 to the consolidated financial statements, AMBAC
Indemnity Corporation has adopted the provisions of the Financial Accounting
Standards Board's Statements of Financial Accounting Standards No. 109,
"Accounting for Income Taxes," No. 115, "Accounting for Certain Investments in
Debt and Equity Securities," No. 106, "Employers' Accounting for Postretirement
Benefits Other Than Pensions" and No. 112, "Employers' Accounting for
Postemployment Benefits," in 1993.
/s/ KPMG Peat Marwick LLP
New York, New York
January 31, 1996
B-2
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Consolidated Balance Sheets
(Dollars In Thousands Except Share Data)
<TABLE>
<CAPTION>
December 31,
-------------------------
1995 1994
---------- ----------
<S> <C> <C>
Assets
Investments:
Bonds held in available-for-sale account, at fair value
(amortized cost of $2,090,101 in 1995 and $1,865,350
in 1994).............................................. $2,224,528 $1,795,958
Short-term investments, at cost (approximates fair
value)................................................ 163,953 85,202
---------- ----------
Total investments..................................... 2,388,481 1,881,160
Cash....................................................... 6,912 2,117
Securities purchased under agreements to resell............ 4,120 8,011
Receivable for securities.................................. 8,136 21,508
Investment income due and accrued.......................... 38,319 34,902
Investment in affiliate.................................... 25,827 24,976
Deferred acquisition costs................................. 82,620 71,774
Deferred income taxes...................................... -- 1,778
Current income taxes....................................... 2,171 10,544
Prepaid reinsurance........................................ 153,372 139,855
Other assets............................................... 48,472 41,677
---------- ----------
Total assets.......................................... $2,758,430 $2,238,302
========== ==========
Liabilities and Stockholder's Equity
Liabilities:
Unearned premiums........................................ $ 906,136 $ 839,775
Losses and loss adjustment expenses...................... 65,996 65,662
Ceded reinsurance balances payable....................... 14,654 908
Deferred income taxes.................................... 85,008 --
Accounts payable and other liabilities................... 43,625 43,519
Payable for securities................................... 86,304 26,696
---------- ----------
Total liabilities..................................... 1,201,723 976,560
---------- ----------
Stockholder's equity:
Preferred stock, par value $1,000.00 per share.
Authorized shares -- 285,000; issued and outstanding
shares -- none........................................ -- --
Common stock, par value $2.50 per share. Authorized
shares -- 40,000,000; issued and outstanding
shares -- 32,800,000 at December 31, 1995 and 1994.... 82,000 82,000
Additional paid-in capital............................... 481,059 444,258
Unrealized gains (losses) on investments, net of tax..... 87,112 (46,087)
Retained earnings........................................ 906,536 781,571
---------- ----------
Total stockholder's equity............................ 1,556,707 1,261,742
---------- ----------
Total liabilities and stockholder's equity............ $2,758,430 $2,238,302
========== ==========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
B-3
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Consolidated Statements of Operations
(Dollars In Thousands)
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------
1995 1994 1993
-------- -------- --------
<S> <C> <C> <C>
Revenues:
Gross premiums written........................... $195,033 $192,598 $321,490
Ceded premiums written........................... (28,606) 2,815 (35,810)
-------- -------- --------
Net premiums written.......................... 166,427 195,413 285,680
Increase in unearned premiums, net............... (52,844) (76,077) (132,862)
-------- -------- --------
Net premiums earned........................... 113,583 119,336 152,818
Net investment income............................ 131,496 119,737 104,609
Net realized gains (losses)...................... 177 (13,386) 30,145
Other income..................................... 6,777 6,887 1,516
-------- -------- --------
Total revenues................................ 252,033 232,574 289,088
-------- -------- --------
Expenses:
Losses and loss adjustment expenses.............. 3,377 2,593 (1,849)
Underwriting and operating expenses.............. 38,722 35,946 34,746
Interest expense................................. 1,590 1,428 163
-------- -------- --------
Total expenses................................ 43,689 39,967 33,060
-------- -------- --------
Income before income taxes.................... 208,344 192,607 256,028
-------- -------- --------
Income tax expense:
Current taxes.................................... 29,085 26,286 66,386
Deferred taxes................................... 14,461 16,277 4,090
-------- -------- --------
Total income taxes............................ 43,546 42,563 70,476
-------- -------- --------
Income before cumulative effect of changes in
accounting principles......................... 164,798 150,044 185,552
Cumulative effect of changes in accounting
principles.................................... -- -- (98)
-------- -------- --------
Net income.................................... $164,798 $150,044 $185,454
========= ========= =========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
B-4
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Consolidated Statements of Stockholder's Equity
(Dollars In Thousands)
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------------
1995 1994 1993
--------- --------- --------
<S> <C> <C> <C>
Preferred Stock:
Balance at January 1 and December 31........... $ -- $ -- $ --
========== ========== =========
Common Stock:
Balance at January 1 and December 31........... $ 82,000 $ 82,000 $ 82,000
========== ========== =========
Additional Paid-in Capital:
Balance at January 1........................... $ 444,258 $ 444,143 $397,570
Capital contributions.......................... 35,000 -- 40,000
Cumulative effect of changes in accounting
principles.................................. -- -- 4,708
Other paid-in capital.......................... 1,801 115 1,865
--------- --------- --------
Balance at December 31......................... $ 481,059 $ 444,258 $444,143
========== ========== =========
Unrealized Gains (Losses) on Investments, Net of
Tax:
Balance at January 1........................... $ (46,087) $ 68,091 $ 5,285
Unrealized gain from change in accounting
principle................................... -- -- 63,568
Change in unrealized gain (loss)............... 133,199 (114,178) (762)
--------- --------- --------
Balance at December 31......................... $ 87,112 ($ 46,087) $ 68,091
========== ========== =========
Retained Earnings:
Balance at January 1........................... $ 781,571 $ 667,527 $515,073
Net income..................................... 164,798 150,044 185,454
Dividends declared-common stock................ (40,000) (36,000) (33,000)
Other.......................................... 167 -- --
--------- --------- --------
Balance at December 31......................... $ 906,536 $ 781,571 $667,527
========== ========== =========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
B-5
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(Dollars In Thousands)
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------------
1995 1994 1993
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income............................... $ 164,798 $ 150,044 $ 185,454
Adjustments to reconcile net income to
net cash provided by operating
activities:
Depreciation and amortization............ 1,605 1,106 1,080
Amortization of bond premium and
discount.............................. (831) (1,097) (507)
Current income taxes payable............. 8,373 (6,069) (20,844)
Deferred income taxes payable............ 14,462 16,277 (2,463)
Deferred acquisition costs............... (10,846) (20,757) (7,059)
Unearned premiums........................ 52,844 76,077 132,862
Losses and loss adjustment expenses...... 334 1,625 (718)
Ceded reinsurance balances payable....... 13,746 (2,963) (5,147)
(Gain) loss on sales of investments...... (177) 13,386 (30,145)
Proceeds from sales of bonds in trading
account............................... -- -- 2,091,143
Proceeds from maturities of bonds in
trading account....................... -- -- 34,409
Purchases of bonds for trading account... -- -- (2,181,198)
Accounts payable and other liabilities... 106 20,497 9,591
Other, net............................... (11,273) 7,179 (1,622)
----------- ----------- -----------
Net cash provided by operating
activities......................... 233,141 255,305 204,836
----------- ----------- -----------
Cash flows from investing activities:
Proceeds from sales of bonds at amortized
cost.................................. 1,882,485 1,305,011 18,912
Proceeds from maturities of bonds at
amortized cost........................ 163,031 39,126 60,131
Purchases of bonds at amortized cost..... (2,192,824) (1,559,982) (258,832)
Investment in preferred stock of
affiliate............................. -- -- (3,000)
Change in short-term investments......... (78,751) 9,005 (25,252)
Securities purchased under agreements to
resell................................ 3,891 (8,011) --
Other, net............................... (1,178) (3,786) (2,370)
----------- ----------- -----------
Net cash used in investing
activities......................... (223,346) (218,637) (210,411)
----------- ----------- -----------
Cash flows from financing activities:
Dividends paid........................... (40,000) (36,000) (33,000)
Capital contribution..................... 35,000 -- 40,000
----------- ----------- -----------
Net cash (used in) provided by
financing activities............... (5,000) (36,000) 7,000
----------- ----------- -----------
Net cash flow......................... 4,795 668 1,425
Cash at beginning of year.................. 2,117 1,449 24
----------- ----------- -----------
Cash at December 31........................ $ 6,912 $ 2,117 $ 1,449
=========== =========== ===========
Supplemental disclosure of cash flow
information:
Cash paid during the year for:
Income taxes.......................... $ 19,500 $ 32,153 $ 86,781
=========== =========== ===========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
B-6
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands)
1 BACKGROUND
AMBAC Indemnity Corporation ("AMBAC Indemnity") is a leading insurer of
municipal and structured finance obligations. Financial guarantee insurance
underwritten by AMBAC Indemnity guarantees payment when due of the principal of
and interest on the obligation insured. In the case of a default on the insured
bond, payments under the insurance policy may not be accelerated by the
policyholder without AMBAC Indemnity's consent. As of December 31, 1995, AMBAC
Indemnity's net insurance in force (principal and interest) was $199,078,000.
AMBAC Indemnity is a wholly owned subsidiary of AMBAC Inc. (NYSE: ABK), a
holding company that provides financial guarantee insurance and financial
services to both public and private clients through its subsidiaries.
As of December 31, 1995, AMBAC Indemnity owned approximately 26.5% of the
outstanding common stock of an affiliate, HCIA Inc. (NASDAQ: HCIA) ("HCIA"), a
leading health care information content company. AMBAC Inc. owns approximately
19.9% of the outstanding common stock of HCIA. Prior to 1995, AMBAC Inc. and
AMBAC Indemnity combined owned approximately 96% of HCIA. During 1995, HCIA
offered approximately 3.5 million shares of its common stock for sale in two
separate public offerings. In addition, in conjunction with the second public
offering by HCIA, AMBAC Inc. sold approximately 1.1 million shares of HCIA
common stock. As a result of these public offerings, as of December 31, 1995,
AMBAC Indemnity and AMBAC Inc. combined owned 46.4% of the common stock of HCIA.
AMBAC Indemnity, as the sole limited partner, owns a limited partnership
interest representing 90% of the total partnership interests of AMBAC Financial
Services, Limited Partnership ("AFS"), a limited partnership which provides
interest rate swaps primarily to states, municipalities and municipal
authorities. The sole general partner of AFS, AMBAC Financial Services Holdings,
Inc., a wholly owned subsidiary of AMBAC Inc., owns a general partnership
interest representing 10% of the total partnership interest in AFS.
AMBAC Indemnity has one wholly owned subsidiary, American Municipal Bond
Holding Company ("AMBH"), which is a holding company for certain real estate
interests.
2 SIGNIFICANT ACCOUNTING POLICIES
The accompanying consolidated financial statements have been prepared on
the basis of generally accepted accounting principles ("GAAP"). The preparation
of financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosures of contingent assets and liabilities at the date of
the financial statements and the reported revenues and expenses during the
reporting period. Actual results could differ from those estimates. The
significant accounting policies of AMBAC Indemnity and its subsidiaries are as
described below:
CONSOLIDATION:
The consolidated financial statements include the accounts of AMBAC
Indemnity, AFS and AMBH (sometimes collectively referred to as "AMBAC
Indemnity"). All significant intercompany balances have been eliminated.
B-7
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
INVESTMENTS:
AMBAC Indemnity's investment portfolio is accounted for on a trade-date
basis and consists entirely of investments in debt securities which are
considered available-for-sale and are carried at fair value. Fair value is based
on quotes obtained by AMBAC Indemnity from independent market sources.
Short-term investments are carried at cost, which approximates their fair value.
Unrealized gains and losses, net of deferred income taxes, are included as a
separate component of stockholder's equity and are computed using amortized cost
as the basis. For purposes of computing amortized cost, premiums and discounts
are accounted for using the interest method. For bonds purchased at a price
below par value, discounts are accreted over the remaining term of the
securities. For bonds purchased at a price above par value which have call
features, premiums are amortized to the most likely call dates as determined by
management. For premium bonds which do not have call features, such premiums are
amortized over the remaining term of the securities. Premiums and discounts on
mortgage-backed securities are adjusted for the effects of actual and
anticipated prepayments. Realized gains and losses on the sale of investments
are determined on the basis of specific identification.
Effective December 31, 1993, AMBAC Indemnity adopted Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in Debt and
Equity Securities" ("Statement 115"). Pursuant to Statement 115, AMBAC Indemnity
has designated all investments as "available-for-sale" and reports them at fair
value. Unrealized gains and losses are excluded from earnings and reported as a
separate component of stockholder's equity, net of tax. The cumulative effect of
adopting Statement 115 as of December 31, 1993 was to increase AMBAC Indemnity's
stockholder's equity by $63,568, net of tax. The adoption of Statement 115 had
no effect on earnings.
SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL:
Securities purchased under agreements to resell are collateralized
financing transactions, and are recorded at their contracted resale amounts,
plus accrued interest. AMBAC Indemnity takes possession of the collateral
underlying those agreements and monitors its market value on a daily basis and,
when necessary, requires prompt transfer of additional collateral to reflect
current market value.
PREMIUM REVENUE RECOGNITION:
Premiums for municipal new issue and secondary market policies are: (i)
generally computed as a percentage of principal and interest insured; (ii)
typically collected in a single payment at policy inception date; and (iii) are
earned pro rata over the period of risk. Premiums for structured finance
policies can be computed as a percentage of either principal or principal and
interest insured. The timing of the collection of structured finance premiums
varies among individual transactions. For policies where premiums are collected
in a single payment at policy inception date, premiums are earned pro rata over
the period of risk. For policies with premiums that are collected periodically
(i.e., monthly, quarterly or annually), premiums are reflected in income pro
rata over the period covered by the premium payment.
When an AMBAC Indemnity-insured new or secondary market issue has been
refunded or called, the remaining unearned premium is generally earned at that
time, as the risk to AMBAC Indemnity is considered to have been eliminated.
B-8
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
LOSSES AND LOSS ADJUSTMENT EXPENSES:
The liability for losses and loss adjustment expenses consists of the
Active Credit Reserve ("ACR") and case basis loss reserves. The development of
the ACR is based upon estimates of the ultimate aggregate losses inherent in the
obligations insured and reflects the net result of contributions related to the
portion of earnings required to cover those losses, less reductions of ACR no
longer deemed necessary by management. When losses occur (actual monetary
defaults or defaults which are imminent on insured obligations), case basis loss
reserves are established in an amount that is sufficient to cover the present
value of the anticipated defaulted debt service payments over the expected
period of default and estimated expenses associated with settling the claims,
less estimated recoveries under salvage or subrogation rights. All or part of
case basis loss reserves are allocated from any ACR available for such insured
obligation.
AMBAC Indemnity's management believes that the reserves for losses and loss
adjustment expenses are adequate to cover the ultimate net cost of claims, but
the reserves are necessarily based on estimates and there can be no assurance
that the ultimate liability will not exceed such estimates.
DEFERRED ACQUISITION COSTS:
Certain costs incurred which vary with, and are primarily related to, the
production of business have been deferred. These costs include direct and
indirect expenses related to underwriting, marketing and policy issuance, rating
agency fees and premium taxes, net of reinsurance ceding commissions. The
deferred acquisition costs are being amortized over the periods in which the
related premiums are earned, and such amortization amounted to $10,183, $9,348
and $12,120 for 1995, 1994 and 1993, respectively. Deferred acquisition costs,
net of such amortization, amounted to $10,845, $20,757 and $7,059 for 1995, 1994
and 1993, respectively.
DEPRECIATION AND AMORTIZATION:
Depreciation of furniture and fixtures and electronic data processing
equipment is provided over the estimated useful lives of the respective assets
using the straight-line method. Amortization of leasehold improvements and
intangibles, including certain computer software licenses, is provided over the
estimated useful lives of the respective assets using the straight-line method.
INTEREST RATE CONTRACTS:
Interest Rate Contracts Held for Purposes Other Than Trading:
AMBAC Indemnity uses interest rate contracts for hedging purposes as part
of its overall interest rate risk management. Gains and losses on interest rate
futures and options contracts that qualify as accounting hedges of existing
assets or liabilities are included in the carrying amounts and amortized over
the remaining lives of the assets and liabilities as an adjustment to interest
income. When the hedged asset is sold, the unamortized gain or loss on the
related hedge is recognized in income. Gains and losses on interest rate
contracts that do not qualify as accounting hedges are recognized in current
period income.
AMBAC Indemnity accounts for its interest rate futures contracts in
accordance with the provisions of Statement of Financial Accounting Standards
No. 80, "Accounting For Futures Contracts" ("Statement 80"). Statement 80
permits hedge accounting for interest rate futures contracts when the item to be
hedged exposes the Company to price or interest rate risk, and the futures
contract effectively reduces that exposure and is designated as a hedge.
Interest rate futures contracts held for purposes other than trading are used
primarily to hedge interest sensitive assets, and are designated at inception as
a hedge to specific assets.
B-9
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
Interest rate swaps that are linked with existing liabilities are accounted
for like a hedge of those liabilities, using the accrual method as an adjustment
to interest expense. Interest rate swaps that are linked with existing assets
classified as available-for-sale are accounted for like hedges of those assets,
using the accrual method as an adjustment to interest income, with unrealized
gains and losses included in stockholder's equity, net of tax.
Interest Rate Contracts Held for Trading Purposes:
AMBAC Indemnity, in connection with its market making activities as a
provider of interest rate swaps, primarily to states, municipalities, municipal
authorities and other entities in connection with their financings, uses
interest rate contracts which are classified as held for trading purposes.
Interest rate contracts are recorded on trade date at fair value. Changes in
fair value are recorded as a component of other income. The fair value of
interest rate swaps is determined through the use of valuation models. The
portion of the interest rate swap's initial fair value that reflects credit
considerations, on-going servicing and transaction hedging costs is recognized
over the life of the interest rate swap, as an adjustment to other income.
Interest rate swaps are recorded on a gross basis; assets and liabilities are
netted by customer only when a legal right of set-off exists.
INCOME TAXES:
AMBAC Inc., as common parent, files a consolidated Federal income tax
return with its subsidiaries. Effective January 1, 1993, AMBAC Indemnity adopted
Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes" ("Statement 109"). Under Statement 109, deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in the period that includes the enactment
date.
The cumulative effect of this change in accounting for income taxes
resulted in an increase to net income for 1993 of $1,162 and an increase to
additional paid-in capital of $4,708. The adjustment to additional paid-in
capital reflects Statement 109 adjustments for prior business combinations.
The Internal Revenue Code permits municipal bond insurance companies to
deduct from taxable income, subject to certain limitations, the amounts added to
the statutory mandatory contingency reserve during the year. The deduction taken
is allowed only to the extent that U.S. Treasury noninterest-bearing tax and
loss bonds are purchased at their par value prior to the original due date of
AMBAC Inc.'s consolidated Federal tax return and held in an amount equal to the
tax benefit attributable to such deductions. The amounts deducted must be
included in taxable income when the contingency reserve is released, at which
time AMBAC Indemnity may redeem the tax and loss bonds to satisfy the additional
tax liability. The purchases of tax and loss bonds are recorded as payments of
Federal income taxes and are not reflected in AMBAC Indemnity's current tax
provision.
POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS:
AMBAC Inc., through its subsidiaries, provides various postretirement and
postemployment benefits, including pension, and health and life benefits
covering substantially all employees who meet certain age and service
requirements. AMBAC Indemnity accounts for these benefits under the accrual
method of accounting. Amounts related to the defined benefit pension plan and
postretirement health benefits are charged based on actuarial determinations.
B-10
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
Effective January 1, 1993, AMBAC Indemnity adopted Statement of Financial
Accounting Standards No. 106, "Employers' Accounting for Postretirement Benefits
Other Than Pensions" ("Statement 106"). Statement 106 requires that the expected
cost of postretirement benefits, other than pensions, be charged to expense
during the period that the employee renders service. AMBAC Indemnity elected to
recognize the transition obligation immediately and recorded a charge of $465,
after reduction of $240 for income tax benefits, as a cumulative effect of a
change in accounting principle as of the date of adoption.
Effective January 1, 1993, AMBAC Indemnity adopted Statement of Financial
Accounting Standards No. 112, "Employers' Accounting for Postemployment
Benefits" ("Statement 112"), which, similar to Statement 106, requires accrual
of a liability representing the cost of certain benefits earned by employees
over their employment period. Statement 112 applies to vested benefits provided
to former or inactive employees, their beneficiaries and covered dependents,
after employment but before retirement. In adopting Statement 112, AMBAC
Indemnity recorded a charge of $801, after reduction for income tax benefits of
$429, as a cumulative effect of a change in accounting principle as of the date
of adoption.
STOCK COMPENSATION PLANS:
In 1991, AMBAC Inc. adopted the AMBAC Inc. 1991 Stock Incentive Plan. Under
this plan awards are granted to eligible employees of AMBAC Indemnity in the
form of incentive stock options or other stock-based awards. In October 1995,
the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation"
("Statement 123") which must be adopted no later than 1996. Statement 123
applies to all stock-based employee compensation plans (except employee stock
ownership plans) in which an employer grants shares of its stock or other equity
instruments to employees. Statement 123 permits a company to choose either the
fair value based method of accounting as defined in the statement or the
intrinsic value based method of accounting as prescribed by APB Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25") for its stock-based
compensation plans. Companies electing the accounting requirements under APB 25
must also make pro forma disclosures of net income and earnings per share as if
the fair value based method of accounting had been applied. AMBAC Indemnity
currently accounts for its plans under APB 25 and intends to continue to do so
after adopting Statement 123 in 1996. The adoption of Statement 123 is expected
to have no effect on AMBAC Indemnity's results of operations.
RECLASSIFICATIONS:
Certain reclassifications have been made to prior years' amounts to conform
to the current year's presentation.
B-11
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
3 INVESTMENTS
The amortized cost and estimated fair value of investments in debt
securities at December 31, 1995 and 1994 were as follows:
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
1995
Municipal obligations........................ $1,558,754 $ 98,090 $ 2,428 $1,654,416
Corporate securities......................... 261,492 30,785 3,263 289,014
U.S. Government obligations.................. 214,224 8,796 621 222,399
Mortgage-backed securities (including
GNMA)...................................... 55,631 3,362 294 58,699
Other........................................ 163,953 -- -- 163,953
---------- ---------- ---------- ----------
$2,254,054 $ 141,033 $ 6,606 $2,388,481
========= ======== ======== =========
</TABLE>
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
1994
Municipal obligations........................ $1,505,501 $ 23,009 $ 80,935 $1,447,575
Corporate securities......................... 228,992 2,336 11,501 219,827
U.S. Government obligations.................. 61,906 311 1,797 60,420
Mortgage-backed securities (including
GNMA)...................................... 70,251 1,325 2,140 69,436
Other........................................ 83,902 -- -- 83,902
---------- ---------- ---------- ----------
$1,950,552 $ 26,981 $ 96,373 $1,881,160
========= ======== ======== =========
</TABLE>
The amortized cost and estimated fair value of debt securities at December
31, 1995, by contractual maturity, were as follows:
<TABLE>
<CAPTION>
Amortized Estimated
Cost Fair Value
---------- ----------
<S> <C> <C>
1995
Due in one year or less..................................... $ 223,069 $ 223,949
Due after one year through five years....................... 168,417 181,772
Due after five years through ten years...................... 302,601 315,385
Due after ten years......................................... 1,504,336 1,608,676
---------- ----------
2,198,423 2,329,782
Mortgage-backed securities.................................. 55,631 58,699
---------- ----------
$2,254,054 $2,388,481
========= =========
</TABLE>
Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties.
B-12
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
Net investment income comprised the following:
<TABLE>
<CAPTION>
1995 1994 1993
-------- -------- --------
<S> <C> <C> <C>
Bonds.............................................. $127,865 $118,685 $102,020
Short-term investments............................. 6,116 3,512 4,278
-------- -------- --------
Total investment income.......................... 133,981 122,197 106,298
Investment expense................................. (2,485) (2,460) (1,689)
-------- -------- --------
Net investment income............................ $131,496 $119,737 $104,609
======== ======== ========
</TABLE>
Gross realized gains were $27,786, $26,514 and $42,217 for 1995, 1994 and
1993, respectively, and gross realized losses were $27,609, $39,900 and $12,072
for 1995, 1994 and 1993, respectively.
As of December 31, 1995, AMBAC Indemnity did not have any investment
concentrated in any single repayment source (excluding obligations of the U.S.
Government and its agencies) with a fair value greater than 2.0% of its
stockholder's equity.
As of December 31, 1995 and 1994, AMBAC Indemnity held securities subject
to agreements to resell for $4,120 and $8,011, respectively. Such securities
were held as collateral by AMBAC Indemnity. The agreements had terms of less
than 30 days.
As of December 31, 1995 and 1994, investment securities with a fair value
of $4,583 and $3,948, respectively, were pledged to futures brokers for required
margin.
4 REINSURANCE
In the ordinary course of business, AMBAC Indemnity cedes exposures under
various reinsurance contracts primarily designed to minimize losses from large
risks and to protect capital and surplus. The effect of reinsurance on premiums
written and earned was as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------------------------------------
1995 1994 1993
--------------------- --------------------- ---------------------
Written Earned Written Earned Written Earned
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Direct................... $192,277 $127,322 $188,057 $136,632 $321,179 $181,320
Assumed.................. 2,756 1,349 4,541 1,325 311 311
Ceded.................... (28,606) (15,088) 2,815 (18,621) (35,810) (28,813)
-------- -------- -------- -------- -------- --------
Net premiums............. $166,427 $113,583 $195,413 $119,336 $285,680 $152,818
======== ======== ======== ======== ======== ========
</TABLE>
The reinsurance of risk does not relieve the ceding insurer of its original
liability to its policyholders. In the event that all or any of the reinsurers
are unable to meet their obligations to AMBAC Indemnity under the existing
reinsurance agreements, AMBAC Indemnity would be liable for such defaulted
amounts. To minimize its exposure to significant losses from reinsurer
insolvencies, AMBAC Indemnity evaluates the financial condition of its
reinsurers and monitors concentrations of credit risk. There were no reinsurance
receivables as of December 31, 1995 and 1994. As of December 31, 1995, prepaid
reinsurance of approximately $48,120 was associated with a single reinsurer. As
of December 31, 1995, AMBAC Indemnity held letters of credit and collateral
amounting to approximately $90,643 from its reinsurers to cover liabilities
ceded under the aforementioned reinsurance contracts.
AMBAC Indemnity terminated reinsurance contracts, resulting in return
premiums to AMBAC Indemnity of $18,141, $30,482 and $36,461 of which $15,700,
$25,891 and $31,010 were recorded as an
B-13
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
increase to the unearned premium reserve in 1995, 1994 and 1993, respectively,
with the remainder recognized as revenue.
5 LOSSES AND LOSS ADJUSTMENT EXPENSES
AMBAC Indemnity's liability for losses and loss adjustment expenses
includes case basis loss reserves and the ACR. Following is a summary of the
activity in the case basis loss and active credit reserve accounts and the
components of the liability for losses and loss adjustment expenses:
<TABLE>
<CAPTION>
1995 1994 1993
------- ------- --------
<S> <C> <C> <C>
Case basis loss reserves:
Balance at January 1......................... $38,892 $35,155 $ 28,321
------- ------- --------
Incurred related to:
Current year............................... 750 8,073 6,630
Prior years................................ 2,650 (3,368) (926)
------- ------- --------
Total incurred.......................... 3,400 4,705 5,704
------- ------- --------
Paid related to:
Current year............................... 150 275 315
Prior years................................ 2,893 693 (1,445)
------- ------- --------
Total paid.............................. 3,043 968 (1,130)
------- ------- --------
Balance at December 31....................... 39,249 38,892 35,155
------- ------- --------
Active credit reserve:
Balance at January 1......................... 26,770 28,882 36,434
Net provision for losses..................... 4,097 4,422 6,709
ACR transfers to case reserves............... (4,120) (6,534) (14,261)
------- ------- --------
Balance at December 31....................... 26,747 26,770 28,882
------- ------- --------
Total................................... $65,996 $65,662 $ 64,037
======= ======= =========
</TABLE>
The terms "current year" and "prior years" in the foregoing table refer to
the year in which case basis loss reserves were established.
B-14
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
6 COMMITMENTS AND CONTINGENCIES
AMBAC Indemnity is responsible for leases on the rental of office space,
principally in New York City. The lease agreements which expire periodically
through September 2014, contain provisions for scheduled periodic rent increases
and are accounted for as operating leases. An estimate of future net minimum
lease payments in each of the next five years ending December 31, and the
periods thereafter, is as follows:
<TABLE>
<CAPTION>
Year Amount
- --------------- --------
<S> <C>
1996........................................................... $ 3,042
1997........................................................... 3,073
1998........................................................... 3,359
1999........................................................... 3,650
2000........................................................... 3,650
All later years................................................ 53,880
-------
$70,654
=======
</TABLE>
Rent expense for the aforementioned leases amounted to $2,924, $2,719 and
$2,778 for the years ended December 31, 1995, 1994 and 1993, respectively.
7 INSURANCE REGULATORY RESTRICTIONS
AMBAC Indemnity is subject to insurance regulatory requirements of the
States of Wisconsin, New York and the other jurisdictions in which it is
licensed to conduct business.
AMBAC Indemnity's ability to pay dividends is generally restricted by law
and subject to approval by the Office of the Commissioner of Insurance of the
State of Wisconsin (the "Wisconsin Commissioner"). Wisconsin insurance law
restricts the payment of dividends in any 12-month period without regulatory
approval to the lesser of (a) 10% of policyholders' surplus as of the preceding
December 31 and (b) the greater of (i) statutory net income for the calendar
year preceding the date of dividend, minus realized capital gains for that
calendar year and (ii) the aggregate of statutory net income for three calendar
years preceding the date of the dividend, minus realized capital gains for those
calendar years and minus dividends paid or credited within the first two of the
three preceding calendar years. AMBAC Indemnity paid dividends of $40,000,
$36,000 and $33,000 on its common stock in 1995, 1994 and 1993, respectively.
Based upon these restrictions, at December 31, 1995, the maximum amount that
will be available during 1996 for payment of dividends by AMBAC Indemnity
without prior approval is approximately $86,000.
However, as discussed in Note 15, AMBAC Indemnity, upon consummation of the
proposed PRIDES offering will deliver to AMBAC Inc. (in the form of an
extraordinary dividend) its 2,378,672 shares of HCIA common stock, at fair
value. The Wisconsin Commissioner has approved such dividend. The fair value of
such dividend will be determined based on the price per share of HCIA common
stock used to price the PRIDES. As a result, any dividends paid by AMBAC
Indemnity to AMBAC Inc. for the twelve months following the extraordinary
dividend will require pre-approval from the Wisconsin Commissioner. The
Wisconsin Commissioner has stated to AMBAC Indemnity management that it does not
foresee any reason such pre-approval would not be given.
The New York Financial Guarantee Insurance Law establishes single risk
limits applicable to all obligations issued by a single entity and backed by a
single revenue source. Under the limit applicable to
B-15
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
municipal bonds, the insured average annual debt service for a single risk, net
of reinsurance and collateral, may not exceed 10% of the sum of the insurer's
policyholders' surplus and contingency reserves. In addition, insured principal
of municipal bonds attributable to any single risk, net of reinsurance and
collateral, is limited to 75% of the insurer's policyholders' surplus and
contingency reserves. Additional single risk limits, which generally are more
restrictive than the municipal bond single risk limit, are also specified for
several other categories of insured obligations.
Statutory capital and surplus was $862,976 and $781,772 at December 31,
1995 and 1994, respectively. Qualified statutory capital (statutory surplus plus
contingency reserve) was $1,358,769 and $1,218,204 at December 31, 1995 and
1994, respectively. Statutory net income was $142,541, $116,238 and $166,157 for
1995, 1994 and 1993, respectively. Statutory capital and surplus differs from
stockholder's equity determined under GAAP principally due to statutory
accounting rules that treat loss reserves, premiums earned, policy acquisition
costs and deferred income taxes differently.
8 INCOME TAXES
The total effect of income taxes on income and stockholder's equity for the
years ended December 31, 1995 and 1994 was as follows:
<TABLE>
<CAPTION>
1995 1994
-------- --------
<S> <C> <C>
Total income taxes charged to income.................. $ 43,546 $ 42,563
-------- --------
Income taxes charged (credited) to stockholder's
equity:
Unrealized gain (loss) on bonds..................... 71,722 (61,480)
Unrealized gain on investment in affiliate.......... 602 --
Other............................................... (682) (116)
-------- --------
Total charged (credited) to stockholder's
equity................................... 71,642 (61,596)
-------- --------
Total effect of income taxes.......................... $115,188 $(19,033)
======== ========
</TABLE>
The tax provisions in the accompanying consolidated statements of
operations reflect effective tax rates differing from prevailing Federal
corporate income tax rates. The following is a reconciliation of these
differences:
<TABLE>
<CAPTION>
1995 % 1994 % 1993 %
-------- ----- -------- ---- -------- ----
<S> <C> <C> <C> <C> <C> <C>
Computed expected tax at
statutory rate................ $ 72,920 35.0% $ 67,412 35.0% $ 89,610 35.0%
Increases (reductions) in
expected tax resulting from:
Tax-exempt interest........ (28,274) (13.6) (26,336) (13.7) (21,043) (8.2)
Adjustment to deferred tax
assets and liabilities
for enacted changes in
tax laws and rates...... -- -- -- -- 754 0.3
Other, net................. (1,100) (0.5) 1,487 0.8 1,155 0.4
------- ----- ------- ---- ------- ----
Income tax expense on income from
continuing operations.......... $ 43,546 20.9% $ 42,563 22.1% $ 70,476 27.5%
======= ===== ======= ==== ======= ====
</TABLE>
B-16
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
The tax effects of temporary differences that give rise to significant
portions of the deferred tax liabilities and deferred tax assets at December 31,
1995 and 1994 are presented below:
<TABLE>
<CAPTION>
1995 1994
-------- -------
<S> <C> <C>
Deferred tax liabilities:
Unrealized gains on bonds............................ $ 46,906 $ --
Deferred acquisition costs........................... 28,917 25,121
Unearned premiums.................................... 22,079 14,522
Unrealized gain on investment in affiliate........... 602 --
Investments.......................................... 2,911 796
Other................................................ 1,996 1,613
------- -------
Total deferred tax liabilities.............. 103,411 42,052
------- -------
Deferred tax assets:
Unrealized loss on bonds............................. -- 24,816
Loss reserves........................................ 9,631 9,733
Insurance in force................................... 2,870 3,205
Compensation......................................... 2,418 2,812
Other................................................ 3,484 3,264
------- -------
Sub-total deferred tax assets............... 18,403 43,830
Valuation allowance.................................. -- --
------- -------
Total deferred tax assets................... 18,403 43,830
------- -------
Net deferred tax (liabilities) assets....... $(85,008) $ 1,778
======= =======
</TABLE>
AMBAC Indemnity believes that no valuation allowance is necessary in
connection with the deferred tax assets.
9 EMPLOYEE BENEFITS
Pensions:
AMBAC Inc. has a defined benefit pension plan covering substantially all
employees of AMBAC Indemnity and AFS. The benefits are based on years of service
and the employee's compensation during the last five years of employment. AMBAC
Indemnity's funding policy is to contribute annually the maximum amount that can
be deducted for Federal income tax purposes. Contributions are intended to
provide not only for benefits attributed to service-to-date but also for those
expected to be earned in the future.
The actuarial present value of the benefit obligations shown in the table
below sets forth the plan's funded status and amounts recognized by AMBAC Inc.
as of December 31, 1995 and 1994.
B-17
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
Actuarial present value of the benefit obligations:
<TABLE>
<CAPTION>
1995 1994
------- -------
<S> <C> <C>
Accumulated benefit obligation, including vested benefits of
$6,049 and $4,300, respectively................................ $(6,788) $(5,000)
======= =======
Projected benefit obligation for service rendered to date........ (7,800) (5,500)
Plan assets at fair value, primarily listed stocks, commingled
funds and fixed income securities.............................. 7,054 4,898
------- -------
Unfunded projected benefit....................................... (746) (602)
Unrecognized prior service cost.................................. (1,784) (1,950)
Unrecognized net loss............................................ 1,906 1,412
Unrecognized net transition asset................................ (12) (15)
------- -------
Pension liability -- entire plan................................. $ (636) $(1,155)
======= =======
</TABLE>
Net pension costs for 1995, 1994 and 1993 included the following
components:
<TABLE>
<CAPTION>
1995 1994 1993
------- ----- -----
<S> <C> <C> <C>
Service cost............................................. $ 541 $ 558 $ 447
Interest cost on expected benefit obligation............. 456 386 297
Actual return on plan assets............................. (1,333) 30 (390)
Net amortization and deferral............................ 760 (547) (149)
------- ----- -----
Net periodic pension cost................................ $ 424 $ 427 $ 205
======= ===== =====
</TABLE>
The weighted-average discount rate used in the determination of the
actuarial present value for the projected benefit obligation was 7.25% and 8.0%
for 1995 and 1994, respectively. The expected long-term rate of return on assets
was 9.25% for both 1995 and 1994. The rate of increase in future compensation
levels used in determining the actuarial present value of the projected benefit
obligation was 5.0% in both 1995 and 1994.
Substantially all employees of AMBAC Indemnity and AFS are covered by a
defined contribution plan (the "Savings Incentive Plan") for which contributions
and costs are determined as 6% of each covered employee's base salary, plus a
matching company contribution of 50% on contributions up to 6% of base salary
made by eligible employees to the plan. The total cost of the Savings Incentive
Plan to AMBAC Indemnity was $1,435, $1,292 and $1,243 in 1995, 1994 and 1993,
respectively.
Annual Incentive Plan:
AMBAC Indemnity has an annual incentive plan which provides for awards to
key officers and employees based upon predetermined criteria. The cost of the
plan to AMBAC Indemnity for the years ended December 31, 1995, 1994 and 1993 was
$7,669, $8,531 and $6,165, respectively.
Postretirement Health Care and Other Benefits:
AMBAC Indemnity provides certain medical and life insurance benefits for
retired employees and eligible dependents. All plans are contributory. None of
the plans is currently funded.
B-18
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
Postretirement benefits expense was $168, $176 and $500 in 1995, 1994 and
1993, respectively. The unfunded accumulated postretirement benefit obligation
was $1,309 and the accrued postretirement liability was $1,368 as of December
31, 1995.
The assumed weighted average health care cost trend rates range from 13.5%
in 1995, decreasing ratably to 5.5% in 2001, and remaining at that level
thereafter. Increasing the assumed health care cost trend rate by one percentage
point in each future year would increase the accumulated postretirement benefit
obligation at December 31, 1995 by $174 and the 1995 benefit expense by $28. The
weighted average discount rate used to measure the accumulated postretirement
benefit obligation and 1995 expense was 7.25%.
10 INSURANCE IN FORCE
The par amount of bonds insured by AMBAC Indemnity, net of reinsurance, was
$110,997,000 and $93,305,000 at December 31, 1995 and 1994, respectively. As of
December 31, 1995, AMBAC Indemnity's insured portfolio was diversified by type
of insured bond as shown in the following table:
<TABLE>
<CAPTION>
Net Par Amount
Outstanding
--------------------
(Dollars in Millions) As of December 31 1995 1994
-------- -------
<S> <C> <C>
Municipal finance:
General obligation........................... $ 30,546 $26,674
Utility revenue.............................. 21,053 19,597
Tax-backed revenue........................... 18,780 16,279
Health care revenue.......................... 12,553 10,922
Transportation revenue....................... 6,293 5,397
Investor Owned Utilities..................... 4,497 3,500
Higher education............................. 3,973 3,447
Student loan................................. 3,769 2,709
Housing revenue.............................. 3,577 2,567
Other........................................ 483 403
-------- -------
Total Municipal finance................... 105,524 91,495
-------- -------
Structured finance:
Domestic..................................... 3,238 902
International................................ 2,235 908
-------- -------
Total Structured finance.................. 5,473 1,810
-------- -------
$110,997 $93,305
========= =======
</TABLE>
As of December 31, 1995, California was the state with the highest
aggregate net par amount inforce, accounting for 14.3% of the total, and the
highest single insured risk represented 0.6% of aggregate net par amount
insured. AMBAC Indemnity's direct insurance in force (principal and interest)
was $235,118,000 and $205,810,000, at December 31, 1995 and 1994, respectively.
Net insurance in force (after giving effect to reinsurance) was $199,078,000 and
$171,678,000 as of December 31, 1995 and 1994, respectively.
B-19
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
11 FINANCIAL INSTRUMENTS HELD FOR PURPOSES OTHER THAN TRADING
Financial instruments with off-balance-sheet risk:
In the normal course of business, AMBAC Indemnity becomes a party to
various financial transactions to reduce its exposure to fluctuations in
interest rates. These financial instruments include an interest rate swap
agreement and exchange traded interest rate futures contracts. The notional
amounts of AMBAC Indemnity's off-balance-sheet financial instruments which are
held for purposes other than trading were as follows:
<TABLE>
<CAPTION>
As of December 31,
--------------------
1995 1994
------- --------
<S> <C> <C>
Interest rate futures contracts................ $44,500 $164,200
Interest rate swap............................. 20,000 20,000
</TABLE>
Notional principal amounts are often used to express the volume of these
transactions and do not reflect the extent to which positions may offset one
another. These amounts do not represent the much smaller amounts potentially
subject to risk.
Interest rate futures contracts are sold to hedge interest rate risk
inherent in fixed rate investment securities. At December 31, 1995, interest
rate futures contracts with an outstanding notional amount of $44,500 were
designated as hedges of fixed rate investment securities.
The interest rate swap held for purposes other than trading is used to
manage interest rate risk by synthetically changing the nature of certain
floating rate investments.
Fair values of financial instruments held for purposes other than trading:
The following fair value amounts were determined by AMBAC Indemnity using
independent market information when available, and appropriate valuation
methodologies when market quotes were not available. In cases where specific
market quotes are unavailable, interpreting market data and estimating market
values necessarily require considerable judgment by management. Accordingly, the
estimates presented are not necessarily indicative of the amount AMBAC Indemnity
could realize in a current market exchange.
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to estimate
that value:
Investments: The fair values of bonds are based on quoted market prices or
dealer quotes.
Short-term investments and cash: The fair values of short-term investments
and cash are assumed to equal amortized cost.
Securities purchased under agreements to resell: The fair value of
securities purchased under agreements to resell is assumed to approximate
carrying value.
Investment in affiliate: As of December 31, 1995, the fair value of AMBAC
Indemnity's investment in HCIA is based on the quoted market price of HCIA
common stock. As of December 31, 1994, the fair value of AMBAC Indemnity's
investment in HCIA was assumed to equal carrying value.
Interest rate contracts: Fair values of off-balance-sheet interest rate
contracts (futures and swap) are based on quoted market and dealer prices,
current settlement values, or pricing models.
B-20
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
Liability for net financial guarantees written: The fair value of the
liability for those financial guarantees written related to new issue and
secondary market exposures is based on the estimated cost to reinsure those
exposures at current market rates, which amount consists of the current unearned
premium reserve, less an estimated ceding commission thereon.
Certain other financial guarantee insurance policies have been written on
an installment basis, where the future premiums to be received by AMBAC
Indemnity are determined based on the outstanding exposure at the time the
premiums are due. The fair value of AMBAC Indemnity's liability under its
installment premium policies is measured using the present value of estimated
future installment premiums, less an assumed ceding commission. The estimate of
the amounts and timing of the future installment premiums is based on
contractual premium rates, debt service schedules and expected run-off
scenarios. This measure is used as an estimate of the cost to reinsure AMBAC
Indemnity's liability under these policies. The carrying amount and estimated
fair value of these financial instruments are presented below:
<TABLE>
<CAPTION>
As of December 31,
---------------------------------------------------
1995 1994
----------------------- -----------------------
Carrying Estimated Carrying Estimated
(Dollars in Millions) Amount Fair Value Amount Fair Value
-------- ---------- -------- ----------
<S> <C> <C> <C> <C>
Financial assets:
Investments........................ $2,225 $2,225 $1,796 $1,796
Short-term investments............. 164 164 85 85
Securities purchased under
agreements to resell............. 4 4 8 8
Investment in affiliate............ 26 111 25 25
Cash............................... 7 7 2 2
Unrecognized financial instruments:
Interest rate swap................. -- -- -- (1)
Interest rate futures contracts.... -- -- -- --
Liability for net financial
guarantees
Direct........................... -- 655 -- 609
Net of reinsurance............... -- 543 -- 507
Net installment premiums......... -- 80 -- 51
</TABLE>
12 FINANCIAL INSTRUMENTS HELD FOR TRADING PURPOSES
AMBAC Indemnity, through its affiliate AFS, is a provider of interest rate
swaps to states, municipalities, municipal authorities and other entities,
including its affiliate, AMBAC Capital Management, Inc. ("ACMI"), in connection
with their financings. AMBAC Indemnity manages its interest rate swap business
with the goal of being market neutral to changes in overall interest rates,
while retaining "basis risk", the relationship between changes in floating rate
tax-exempt and floating rate taxable interest rates. If actual or projected
floating rate tax-exempt interest rates rise in relation to floating rate
taxable rates, AMBAC Indemnity will experience an unrealized mark-to-market
loss. Conversely, if actual or projected floating rate tax-exempt interest rates
decline in relation to floating rate taxable interest rates, AMBAC Indemnity
will experience an unrealized mark-to-market gain.
B-21
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
In the ordinary course of business, AMBAC Indemnity manages a variety of
risks -- principally credit, market, liquidity, operational and legal. These
risks are identified, measured and monitored through a variety of control
mechanisms, which are in place at different levels throughout the organization.
Credit risk relates to the ability of counterparties to perform according
to the terms of their contractual commitments. Various procedures and controls
are in place to monitor the credit risk of interest rate swaps. These include
the initial credit approval process, the establishment of credit limits,
management approvals and a process that ensures the continuous monitoring of
credit exposure.
Market risk relates to the impact of price changes on future earnings. This
risk is a consequence of AMBAC Indemnity's market-making activities in the
municipal interest rate swap market. The principal market risk is basis risk,
the relationship between changes in floating rate tax-exempt and floating rate
taxable interest rates. Since the third quarter of 1995, all municipal interest
rate swaps transacted contain provisions which are designed to protect AMBAC
Indemnity against certain forms of tax reform, thus mitigating its basis risk.
An independent risk management group monitors trading risk limits and, together
with senior management, is involved in the application of risk measurement
methodologies.
The estimation of potential losses arising from adverse changes in market
relationships, known as "value at risk," is a key element in managing market
risk. AMBAC Indemnity has developed a value at risk methodology to estimate
potential losses over a specified holding period and based on certain
probabilistic assessments. AMBAC Indemnity estimates value at risk utilizing
historical short and long term interest rate volatilities and the relationship
between changes in tax-exempt and taxable interest rates calculated on a
consistent daily basis. For the year ended December 31, 1995, AMBAC Indemnity's
value at risk averaged approximately $1,358, calculated at a ninety-nine percent
confidence level. Since no single measure can capture all dimensions of market
risk, AMBAC Indemnity bolsters its value at risk methodology by performing daily
analyses of parallel and nonparallel shifts in yield curves and stress test
scenarios which measure the potential impact of market conditions, however
improbable, which might cause abnormal volatility swings or disruptions of
market relationships.
Liquidity risk relates to the possible inability to satisfy contractual
obligations when due. This risk is present in interest rate swap agreements and
in futures contracts used to hedge those agreements. AMBAC Indemnity manages
liquidity risk by maintaining cash and cash equivalents, closely matching the
dates swap payments are made and received and limiting the amount of risk hedged
by futures contracts.
Operational risk relates to the potential for loss caused by a breakdown in
information, communication and settlement systems. AMBAC Indemnity mitigates
operational risk by maintaining a comprehensive system of internal controls.
This includes the establishment of systems and procedures to monitor
transactions and positions, documentation and confirmation of transactions,
ensuring compliance with regulations and periodic reviews by auditors.
Legal risk relates to the uncertainty of the enforceability, through legal
or judicial processes, of the obligations of AMBAC Indemnity's counterparties,
including contractual provisions intended to reduce credit exposure by providing
for the offsetting or netting of mutual obligations. AMBAC Indemnity seeks to
remove or minimize such uncertainties through continuous consultation with
internal and external legal advisers to analyze and understand the nature of
legal risk, to improve documentation and to strengthen transaction structure.
B-22
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
The following table summarizes information about AMBAC Indemnity's
financial instruments held for trading purposes as of December 31, 1995 and
1994:
<TABLE>
<CAPTION>
Net Net Average Net Fair Value
Carrying Estimated ----------------------- Notional
Amount Fair Value Assets Liabilities Amount
-------- ---------- ------- ----------- ----------
<S> <C> <C> <C> <C> <C>
1995:
Interest rate
swaps............ $5,207 $5,207 $17,714 $16,667 $2,152,400
Interest rate
futures
contracts........ -- -- -- -- 569,800
1994:
Interest rate
swaps............ $1,681 $1,681 $ 4,441 $ 3,560 $ 771,900
Interest rate
futures
contracts........ -- -- -- -- 443,000
</TABLE>
The aggregate amount of net trading income recognized from interest rate
financial instruments held for trading purposes was $2,602 and $3,051 for 1995
and 1994, respectively. Average net fair values were calculated based on average
daily net fair values. For 1994, average net fair values began from the
commencement of operations in September 1994.
Notional principal amounts are often used to express the volume of these
transactions and do not reflect the extent to which positions may offset one
another. These amounts do not represent the much smaller amounts potentially
subject to risk.
13 LINES OF CREDIT
AMBAC Inc. and AMBAC Indemnity maintain a three-year revolving credit
facility with two major international banks, as co-agents, for $100,000. As of
December 31, 1995, no amounts were outstanding under this credit facility, which
expires in July 1998. This facility amended a one-year revolving credit facility
for $75,000. As of December 31, 1994, no amounts were outstanding under this
credit facility.
AMBAC Indemnity has an agreement with another major international bank, as
agent, for a $300,000 credit facility, expiring in 2002. This facility is a
seven-year stand-by irrevocable limited recourse line of credit, which was
increased from $225,000 to $300,000 and extended for an additional year in
December 1995. The line will provide liquidity to AMBAC Indemnity in the event
claims from municipal obligations exceed specified levels. Repayment of any
amounts drawn under the line will be limited primarily to the amount of any
recoveries of losses related to policy obligations. As of December 31, 1995 and
1994, no amounts were outstanding under this line.
14 RELATED PARTY TRANSACTIONS
During 1995 and 1994, AMBAC Indemnity guaranteed the timely payment of
principal and interest on obligations under municipal investment contracts and
municipal investment repurchase agreements issued by its affiliate, ACMI. As of
December 31, 1995 and 1994, the aggregate amount of municipal investment
contracts and municipal investment repurchase contracts insured was $2,240,959
and $2,042,230, respectively, including accrued interest. These insurance
policies are collateralized by ACMI's investment securities, accrued interest,
securities purchased under agreements to resell and cash and cash equivalents,
which as of December 31, 1995 and 1994 had a fair value of $2,299,687 and
$1,964,830, respectively, in the aggregate.
B-23
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
During 1995 and 1994, AMBAC Indemnity recorded gross premiums written of $1,707
and $2,692, and net premiums earned of $1,764 and $1,872, respectively, related
to these contracts.
During 1995 and 1994, several interest rate swap transactions were executed
between AFS and ACMI. As of December 31, 1995 and 1994, these contracts had an
outstanding notional amount of approximately $359,000 and $478,000,
respectively. As of December 31, 1995 and 1994, AFS recorded a positive fair
value of $6,539 and a negative fair value of $5,492, respectively, related to
these transactions.
15 SUBSEQUENT EVENTS
On January 19, 1996, AMBAC Inc. filed with the Securities and Exchange
Commission a registration statement related to a proposed offering of 3,781,369
PRIDES(SM) (Provisionally Redeemable Income Debt Exchangeable for Stock). The
PRIDES, which constitute senior debt of AMBAC Inc., will mature in 2001 and will
be mandatorily exchanged at maturity into shares of HCIA common stock (or, at
AMBAC Inc.'s option, cash with an equal value) determined in accordance with an
exchange rate formula. AMBAC Inc. may redeem the PRIDES, in whole or in part,
after three years. AMBAC Inc. has also granted the underwriters an option to
purchase up to 378,136 PRIDES to cover any over-allotments.
AMBAC Indemnity, upon consummation of the PRIDES offering, will deliver to
AMBAC Inc. (in the form of an extraordinary dividend) its 2,378,672 shares of
HCIA common stock, at fair value. The fair value of such dividend will be
determined based on the price per share of HCIA common stock used to price the
PRIDES.
B-24
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Consolidated Unaudited Financial Statements
as of June 30, 1996 and December 31, 1995
and for the six months ended June 30, 1996 and 1995
B-25
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Consolidated Balance Sheets
June 30, 1996 and December 31, 1995
(Dollars in Thousands Except Share Data)
<TABLE>
<CAPTION>
June 30, 1996 December 31, 1995
------------- -----------------
(unaudited)
<S> <C> <C>
Assets
- ------
Investments:
Bonds held in available for sale account, at fair value
(amortized cost of $2,162,449 in 1996 and $2,090,101 in 1995) $2,214,817 $2,224,528
Short-term investments, at cost (approximates fair value) 133,629 163,953
---------- ----------
Total investments 2,348,446 2,388,481
Cash 3,888 6,912
Securities purchased under agreements to resell 3,992 4,120
Receivable for securities 64,288 8,136
Investment income due and accrued 40,207 38,319
Investment in affiliate - 25,827
Deferred acquisition costs 88,107 82,620
Current income taxes - 2,171
Prepaid reinsurance 162,166 153,372
Other assets 54,378 48,472
---------- ----------
Total assets $2,765,472 $2,758,430
========== ==========
Liabilities and Stockholder's Equity
Liabilities:
Unearned premiums $936,870 $906,136
Losses and loss adjustment expenses 59,429 65,996
Ceded reinsurance balances payable 6,765 14,654
Deferred income taxes 57,190 85,008
Current income taxes 3,116 -
Accounts payable and other liabilities 47,035 43,625
Payable for securities 112,413 86,304
---------- ----------
Total liabilities 1,222,818 1,201,723
---------- ----------
Stockholder's equity:
Preferred stock, par value $1,000.00 per share; authorized
shares - 285,000; issued and outstanding shares - none - -
Common stock, par value $2.50 per share; authorized shares
- 40,000,000; issued and outstanding shares - 32,800,000
at June 30, 1996 and December 31, 1995 82,000 82,000
Additional paid-in capital 514,305 481,059
Unrealized gains (losses) on investments, net of tax 34,039 87,112
Retained earnings 912,310 906,536
---------- ----------
Total stockholder's equity 1,542,654 1,556,707
---------- ----------
Total liabilities and stockholder's equity $2,765,472 $2,758,430
========== ==========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
B-26
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Consolidated Statements of Operations
(Unaudited)
For The Periods Ended June 30, 1996 and 1995
(Dollars in Thousands)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- ------------------------
1996 1995 1996 1995
------- ------- -------- -------
<S> <C> <C> <C> <C>
Revenues:
Gross premiums written $58,768 $36,893 $110,060 $77,465
Ceded premiums written (9,836) 6,514 (19,448) 3,055
------- ------- -------- -------
Net premiums written 48,932 43,407 90,612 80,520
Increase in unearned premiums (8,870) (15,126) (21,940) (27,563)
------- ------- -------- -------
Net premiums earned 40,062 28,281 68,672 52,957
Net investment income 35,584 32,419 70,489 64,293
Net realized gains (losses) 67,580 (2,202) 69,936 (6,876)
Other income 4,753 (393) 10,805 1,985
------- ------- -------- -------
Total revenues 147,979 58,105 219,902 112,359
------- ------- -------- -------
Expenses:
Losses and loss adjustment expenses 1,700 341 2,510 1,369
Underwriting and operating expenses 11,583 9,916 21,666 19,246
Interest expense 514 306 1,028 637
------- ------- -------- -------
Total expenses 13,797 10,563 25,204 21,252
------- ------- -------- -------
Income before income taxes 134,182 47,542 194,698 91,107
------- ------- -------- -------
Income tax expense:
Current taxes 38,665 6,696 52,313 13,543
Deferred taxes 806 2,458 760 3,666
------- ------- -------- -------
Total income taxes 39,471 9,154 53,073 17,209
------- ------- -------- -------
Net income 94,711 38,388 141,625 73,898
======= ======= ======== =======
</TABLE>
See accompanying Notes to Consolidated Unaudited Financial Statements
B-27
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
For The Periods Ended June 30, 1996 and 1995
(Dollars in Thousands)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
--------------------------
1996 1995
-------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net income $141,625 $73,898
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 950 678
Amortization of bond premium and discount (811) (440)
Current income taxes payable 5,287 574
Deferred income taxes payable 760 3,666
Deferred acquisition costs (5,487) (9,366)
Unearned premiums 21,940 27,563
Losses and loss adjustment expenses (6,567) 45
Ceded reinsurance balances payable (7,889) (422)
(Gain) loss on sales of investments (69,936) 6,876
Other, net (8,685) (6,538)
-------- -----------
Net cash provided by operating activities 71,187 96,534
-------- -----------
Cash flows from investing activities:
Proceeds from sales of bonds at amortized cost 742,407 837,619
Proceeds from maturities of bonds at amortized cost 43,165 70,281
Purchases of bonds at amortized cost (901,331) (1,001,767)
Change in short-term investments 30,324 19,183
Proceeds from sale of affiliate 115,865 -
Securities purchased under agreements to resell 128 (392)
Other, net (1,404) (223)
-------- -----------
Net cash provided by (used in) investing activities 29,154 (75,299)
-------- -----------
Cash flows from financing activities:
Dividends paid (135,865) (20,000)
Capital contribution 32,500 -
-------- -----------
Net cash used in financing activities (103,365) (20,000)
-------- -----------
Net cash flow (3,024) 1,235
Cash at beginning of year 6,912 2,117
-------- -----------
Cash at June 30 $3,888 $3,352
======== ===========
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Income taxes $13,300 $12,700
======== ===========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
B-28
<PAGE>
AMBAC INDEMNITY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
AMBAC Indemnity Corporation ("AMBAC Indemnity") is a leading insurer of
municipal and structured finance obligations. Financial guarantee insurance
underwritten by AMBAC Indemnity guarantees payment when due of the principal of
and interest on the obligation insured. In the case of a default on the insured
obligation, payments under the insurance policy may not be accelerated by the
policyholder without AMBAC Indemnity's consent. As of June 30, 1996, AMBAC
Indemnity's net insurance in force (principal and interest) was $209.3 billion.
AMBAC Indemnity is a wholly-owned subsidiary of AMBAC Inc., which is a holding
company that provides through its affiliates financial guarantee insurance and
financial services to both public and private clients.
AMBAC Indemnity has one wholly-owned subsidiary, American Municipal Bond
Holding Company ("AMBH"), which is a holding company for certain real estate
interests.
On May 6, 1996, AMBAC Inc. sold its 4,159,505 shares of common stock of its
affiliate, HCIA Inc. (NASDAQ:HCIA) ("HCIA") in a secondary public offering.
Prior to consummation of the secondary public offering, AMBAC Indemnity
delivered to AMBAC Inc. (in the form of an extraordinary dividend) its 2,378,672
shares of HCIA common stock, at fair value. The fair value of the HCIA shares
was $115.9 million, based on the offering price per share of HCIA common stock
in the secondary public offering. The carrying value of AMBAC Indemnity's HCIA
shares was $26.2 million, and the resulting gain to AMBAC Indemnity from the
disposition of the shares was $89.7 million. As a result of the secondary public
offering, neither AMBAC Indemnity, nor AMBAC Inc. owned any shares of HCIA.
AMBAC Indemnity, as the sole limited partner, owns 90% of the total
partnership interests of AMBAC Financial Services, Limited Partnership ("AFS"),
a limited partnership which provides interest rate swaps primarily to states,
municipalities and municipal authorities. The sole general partner of AFS, AMBAC
Financial Services Holdings, Inc., a wholly-owned subsidiary of AMBAC Inc., owns
a general partnership interest representing 10% of the total partnership
interest in AFS.
AMBAC Indemnity's consolidated unaudited interim financial statements have
been prepared on the basis of generally accepted accounting principles and, in
the opinion of management, reflect all adjustments necessary for a fair
presentation of the Company's financial condition, results of operations and
cash flows for the periods presented. The results of operations for the six
months ended June 30, 1996 may not be indicative of the results that may be
expected for the full year ending December 31, 1996. These financial statements
and notes should be read in conjunction with the financial statements and notes
included in the audited consolidated financial statements of AMBAC Indemnity
Corporation and its subsidiaries as of December 31, 1995 and 1994, and for each
of the years in the three-year period ended December 31, 1995.
B-29
<PAGE>
AMBAC INDEMNITY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS (CONTINUED)
(2) INCOME TAXES
The tax provisions in the accompanying financial statements reflect
effective tax rates differing from prevailing federal corporate income tax
rates, primarily as a result of tax-exempt interest income.
B-30
<PAGE>
PROSPECTUS
HOME EQUITY AND HOME IMPROVEMENT LOAN TRUSTS
ASSET-BACKED CERTIFICATES
ASSET-BACKED NOTES
(ISSUABLE IN SERIES)
----------------
CHEVY CHASE BANK, F.S.B.
(TRANSFEROR AND SERVICER)
----------------
The Asset-Backed Certificates (the "Certificates") and the Asset-Backed
Notes (the "Notes" and, collectively with the Certificates, the "Securities")
described herein may be sold from time to time in one or more series (each, a
"Series") in amounts, at prices and on terms to be determined at the time of
sale and to be set forth in a supplement to this Prospectus (a "Prospectus
Supplement"). Each Series of Securities will include either one or more
classes of Certificates or, if Notes are issued as part of a Series, one or
more Classes of Notes and one or more Classes of Certificates, as set forth in
the related Prospectus Supplement.
As specified in the related Prospectus Supplement, the Certificates of a
Series will evidence undivided interests in certain assets deposited into a
trust (each, a "Trust Fund") by Chevy Chase Bank, F.S.B. (the "Transferor")
pursuant to a Pooling and Servicing Agreement or a Trust Agreement, as
described herein. As specified in the related Prospectus Supplement, the Notes
of a Series will be issued and secured pursuant to an
(cover continued on next page)
NOTES OF A GIVEN SERIES REPRESENT OBLIGATIONS OF, AND CERTIFICATES OF A SE-
RIES EVIDENCE BENEFICIAL INTERESTS IN, THE RELATED TRUST FUND ONLY AND ARE
NOT GUARANTEED BY ANY GOVERNMENTAL AGENCY OR BY THE TRANSFEROR, THE TRUST-
EE, THE SERVICER OR BY ANY OF THEIR RESPECTIVE AFFILIATES OR, UNLESS
OTHERWISE SPECIFIED IN THE RELATED PROSPECTUS SUPPLEMENT, BY ANY OTHER
PERSON OR ENTITY. THE TRANSFEROR'S ONLY OBLIGATIONS WITH RESPECT TO
ANY SERIES OF SECURITIES WILL BE PURSUANT TO CERTAIN REPRESENTA-
TIONS AND WARRANTIES SET FORTH IN THE RELATED AGREEMENT AS DE-
SCRIBED HEREIN OR IN THE RELATED PROSPECTUS SUPPLEMENT.
----------------
SEE "RISK FACTORS" BEGINNING ON PAGE 16 FOR CERTAIN FACTORS TO BE CONSIDERED
IN PURCHASING THE SECURITIES.
----------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS OR THE
PROSPECTUS SUPPLEMENT. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
----------------
Retain this Prospectus for future reference. This Prospectus may not be used
to consummate sales of securities offered hereby unless accompanied by a
Prospectus Supplement.
The date of this Prospectus is May 21, 1996
<PAGE>
(continued from previous page)
Indenture and will represent indebtedness of the related Trust Fund. The Trust
Fund for a Series of Securities will include (a) Primary Assets, which may
include one or more pools of (i) closed-end and/or revolving credit line home
equity loans or certain balances thereof (collectively, the "Mortgage Loans"),
secured by mortgages on one- to four-family residential or mixed-use
properties, (ii) home improvement installment sales contracts and installment
loan agreements (the "Home Improvement Contracts") which are either unsecured
or secured by mortgages on one- to four-family residential or mixed-use
properties, or by purchase money security interests in the home improvements
financed thereby (the "Home Improvements") and (iii) securities ("Private
Securities") backed or secured by Mortgage Loans and/or Home Improvement
Contracts (the "Underlying Loans"), (b) certain monies received or due
thereunder on or after the date specified in the related Prospectus Supplement
(the "Cut-off Date") net, if and as provided in the related Prospectus
Supplement, of certain amounts payable to Chevy Chase Bank, F.S.B., as
servicer (the "Servicer") of the Mortgage Loans and/or Home Improvement
Contracts (collectively, the "Loans"), (c) if specified in the related
Prospectus Supplement, funds on deposit in one or more pre-funding accounts
and/or capitalized interest accounts and (d) reserve funds, letters of credit,
surety bonds, insurance policies or other forms of credit support as described
herein and in the related Prospectus Supplement. Amounts on deposit in a pre-
funding account for any Series will be used to purchase additional Loans
during the funding period specified in the related Prospectus Supplement in
the manner specified therein. The amount initially deposited in a pre-funding
account for a Series of Securities will not exceed 50% of the aggregate
principal amount of such Series of Securities.
Each Series of Securities will be issued in one or more classes (each, a
"Class"). Interest on and principal of the Securities of a Series will be
payable on the date or dates specified in the related Prospectus Supplement
(each, a "Distribution Date"), at the times, at the rates, in the amounts and
in the order of priority set forth in the related Prospectus Supplement.
If a Series includes multiple Classes, such Classes may vary with respect to
the amount, percentage (which may be 0%) and timing of distributions of
principal, interest or both and one or more Classes may be subordinated to
other Classes with respect to distributions of principal, interest or both as
described herein and in the related Prospectus Supplement. If so specified in
the related Prospectus Supplement, the Primary Assets and other assets
comprising the Trust Fund may be divided into one or more Asset Groups and
each Class of the related Series will evidence beneficial ownership of the
corresponding Asset Group, as applicable.
The rate of reduction of the aggregate principal balance of each Class of a
Series may depend principally upon the rate of payment (including prepayments)
with respect to the Loans or Underlying Loans relating to the Private
Securities, as applicable. A rate of prepayment lower or higher than
anticipated will affect the yield on the Securities of a Series in the manner
described herein and in the related Prospectus Supplement. Under certain
limited circumstances described herein and in the related Prospectus
Supplement, a Series of Securities may be subject to termination or redemption
under the circumstances described herein and in the related Prospectus
Supplement.
If specified in the related Prospectus Supplement, an election may be made
to treat certain assets comprising the Trust Fund for a Series as a "real
estate mortgage investment conduit" (a "REMIC") for federal income tax
purposes. See "FEDERAL INCOME TAX CONSIDERATIONS."
There currently is no secondary market for the Securities. There can be no
assurance that any such market will develop or, if it does develop, that it
will continue.
2
<PAGE>
PROSPECTUS SUPPLEMENT
The Prospectus Supplement relating to a Series of Securities to be offered
hereunder will, among other things, set forth with respect to such Series of
Securities: (i) the aggregate principal amount, interest rate, and authorized
denominations of each Class of such Securities; (ii) certain information
concerning the Primary Assets; (iii) the terms of any Enhancement (as defined
herein) with respect to such Series; (iv) the terms of any insurance related
to the Primary Assets; (v) information concerning any other assets in the
related Trust Fund, including any Reserve Fund; (vi) the Final Scheduled
Distribution Date (as defined herein) of each Class of such Securities; (vii)
the method to be used to calculate the amount of interest and principal
required to be applied to the Securities of each Class of such Series on each
Distribution Date, the timing of the application of interest and principal and
the order of priority of the application of such interest and principal to the
respective Classes and the allocation of interest and principal to be so
applied; (viii) the Distribution Dates and any Assumed Reinvestment Rate (as
defined herein); (ix) the amount, if any, deposited in the Pre-Funding Account
(as defined herein) available to purchase additional Loans, the length of the
Pre-Funding Period (as defined herein) or the Revolving Period (as defined
herein) and the criteria for determining which additional Loans (or balances
thereof) may become part of the Trust Fund; (x) additional information with
respect to the plan of distribution of such Securities; and (xi) whether a
REMIC election will be made with respect to some or all of the Trust Fund for
such Series.
REPORTS TO HOLDERS
Periodic and annual reports concerning the related Trust Fund for a Series
of Securities are required under the related Agreements to be forwarded to
Holders. Unless otherwise specified in the related Prospectus Supplement, such
reports will not be examined and reported on by an independent public
accountant. If so specified in the Prospectus Supplement for a Series of
Securities, such Series or one or more Classes of such Series will be issued
in book-entry form. In such event, (i) owners of beneficial interests in such
Securities will not be considered "Holders" under the Agreements and will not
receive such reports directly from the related Trust Fund; rather, such
reports will be furnished to such owners through the participants and indirect
participants of the applicable book-entry system and (ii) references herein to
the rights of "Holders" shall refer to the rights of such owners as they may
be exercised indirectly through such participants. See "THE AGREEMENTS--
Reports to Holders."
AVAILABLE INFORMATION
The Transferor has filed with the Securities and Exchange Commission (the
"Commission") a Registration Statement under the Securities Act of 1933, as
amended, with respect to the Securities. This Prospectus, which forms a part
of the Registration Statement, and the Prospectus Supplement relating to each
Series of Securities contain summaries of the material terms of the documents
referred to herein and therein, but do not contain all of the information set
forth in the Registration Statement pursuant to the Rules and Regulations of
the Commission. For further information, reference is made to such
Registration Statement and the exhibits thereto. Such Registration Statement
and exhibits can be inspected and copied at prescribed rates at the public
reference facilities maintained by the Commission at its Public Reference
Section, 450 Fifth Street, N.W., Washington, D.C. 20549, and at its Regional
Offices located as follows, Midwest Regional Office, 500 West Madison Street,
Chicago, Illinois 60661; and Northeast Regional Office, Seven World Trade
Center, New York, New York 10048.
Each Trust Fund will be required to file certain reports with the Commission
pursuant to the requirements of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). The Transferor intends to cause each Trust Fund
to suspend filing such reports if and when such reports are no longer required
under the Exchange Act.
3
<PAGE>
No person has been authorized to give any information or to make any
representation other than those contained in this Prospectus and any
Prospectus Supplement with respect hereto and, if given or made, such
information or representations must not be relied upon. This Prospectus and
any Prospectus Supplement with respect hereto do not constitute an offer to
sell or a solicitation of an offer to buy any securities other than the
Securities offered hereby and thereby nor an offer of the Securities to any
person in any state or other jurisdiction in which such offer would be
unlawful. The delivery of this Prospectus at any time does not imply that
information herein is correct as of any time subsequent to its date.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
All documents subsequently filed by or on behalf of the Trust Fund referred
to in the accompanying Prospectus Supplement with the Commission pursuant to
Section 13(a), 13(c), 14 or 15(d) of the Exchange Act, after the date of this
Prospectus and prior to the termination of any offering of the Securities
issued by such Trust Fund shall be deemed to be incorporated by reference in
this Prospectus and to be a part of this Prospectus from the date of the
filing of such documents. Any statement contained in a document incorporated
or deemed to be incorporated by reference herein shall be deemed to be
modified or superseded for all purposes of this Prospectus to the extent that
a statement contained herein (or in the accompanying Prospectus Supplement) or
in any other subsequently filed document which also is or is deemed to be
incorporated by reference modifies or replaces such statement. Any such
statement so modified or superseded shall not be deemed, except as so modified
or superseded, to constitute a part of this Prospectus.
The Transferor on behalf of any Trust Fund will provide without charge to
each person to whom this Prospectus is delivered, on the written or oral
request of such person, a copy of any or all of the documents referred to
above that have been or may be incorporated by reference in this Prospectus
(not including exhibits to the information that is incorporated by reference
unless such exhibits are specifically incorporated by reference into the
information that this Prospectus incorporates). Such requests should be
directed to the Transferor at 8401 Connecticut Avenue, Chevy Chase, Maryland
20815.
4
<PAGE>
SUMMARY OF TERMS
The following summary is qualified in its entirety by reference to the
detailed information appearing elsewhere in this Prospectus and by reference to
the information with respect to each Series of Securities contained in the
Prospectus Supplement to be prepared and delivered in connection with the
offering of Securities of such Series. Capitalized terms used and not otherwise
defined herein or in the related Prospectus Supplement shall have the meanings
set forth in the "GLOSSARY OF TERMS."
SECURITIES OFFERED.......... Asset-Backed Certificates (the "Certificates")
and Asset-Backed Notes (the "Notes"). Certifi-
cates are issuable from time to time in Series
pursuant to a Pooling and Servicing Agreement or
Trust Agreement. Each Certificate of a Series
will evidence an interest in the Trust Fund for
such Series, or in an Asset Group specified in
the related Prospectus Supplement. Notes are is-
suable from time to time in a Series pursuant to
an Indenture. Each Series of Securities will
consist of one or more Classes, one or more of
which may be Classes of Compound Interest Secu-
rities, Planned Amortization Class ("PAC") Secu-
rities, Variable Interest Securities, Zero Cou-
pon Securities, Principal Only Securities, In-
terest Only Securities, Participating Securi-
ties, Senior Securities or Subordinate Securi-
ties. Each Class may differ in, among other
things, the amounts allocated to and the prior-
ity of principal and interest payments, Final
Scheduled Distribution Dates, Distribution Dates
and interest rates. The Securities of each Class
will be issued in fully registered form in the
denominations specified in the related Prospec-
tus Supplement. If so specified in the related
Prospectus Supplement, the Securities or certain
Classes of such Securities offered thereby may
be available in book-entry form only.
TRANSFEROR AND SERVICER..... Chevy Chase Bank, F.S.B. ("Chevy Chase"), a fed-
erally chartered stock savings bank, with its
principal executive offices located at 8401 Con-
necticut Avenue, Chevy Chase, Maryland 20815,
and a telephone number of (301) 986-7000. See
"THE TRANSFEROR."
INTEREST PAYMENTS........... Interest payments on the Securities of a Series
entitled by their terms to receive interest will
be made on each Distribution Date, to the extent
set forth in, and at the applicable rate speci-
fied in (or determined in the manner set forth
in), the related Prospectus Supplement. The in-
terest rate on Securities of a Series may be
variable or change with changes in the rates of
interest on the related Loans or Underlying
Loans relating to the Private Securities, as ap-
plicable and/or as prepayments occur with re-
spect to such Loans or Underlying Loans, as ap-
plicable. Interest Only Securities may be as-
signed a "Notional Amount" set forth in the re-
lated Prospectus Supplement which is used solely
for convenience in expressing the calculation of
interest and for certain other purposes and does
not represent the right to receive any distribu-
tions allocable to principal. Principal Only Se-
curities may not be entitled to receive any in-
terest payments or may be entitled to receive
only nominal interest payments. Interest payable
on the Securities of a Series on a Distribution
Date will include all interest accrued
5
<PAGE>
during the period specified in the related Pro-
spectus Supplement. See "DESCRIPTION OF THE SE-
CURITIES--Payments of Interest."
PRINCIPAL PAYMENTS.......... All payments of principal of a Series of Securi-
ties will be made in an aggregate amount deter-
mined as set forth in the related Prospectus
Supplement and will be paid at the times and
will be allocated among the Classes of such Se-
ries in the order and amounts, and will be ap-
plied either on a pro rata or a random lot basis
among all Securities of any such Class, all as
specified in the related Prospectus Supplement.
REVOLVING PERIOD AND
AMORTIZATION PERIOD;
RETAINED INTEREST..........
If the related Prospectus Supplement so provides,
there may be a period commencing on the date of
issuance of a Class or Classes of Notes or Cer-
tificates of a Series and ending on the date set
forth in the related Prospectus Supplement (the
"Revolving Period") during which no principal
payments will be made to one or more Classes of
Notes or Certificates of the related Series as
are identified in such Prospectus Supplement.
All collections of principal otherwise allocated
to such Classes of Notes or Certificates may be
(i) utilized by the Trust Fund during such pe-
riod to acquire additional Loans (or additional
balances of existing Loans) which satisfy the
criteria described in the related Prospectus
Supplement, (ii) held in an account and invested
in Eligible Investments for later distribution
to Securityholders, (iii) applied to those Class
or Classes of Notes or Certificates, if any, of
the same or different Series as specified in the
related Prospectus Supplement as then are in am-
ortization, or (iv) otherwise applied as speci-
fied in the related Prospectus Supplement.
An "Amortization Period" is the period, if any,
specified as such in the related Prospectus Sup-
plement during which an amount of principal is
payable to holders of one or more Classes of a
Series of Securities. If so specified in the re-
lated Prospectus Supplement, during an Amortiza-
tion Period all or a portion of principal col-
lections on the Primary Assets may be applied as
specified above for a Revolving Period and, to
the extent not so applied, will be distributed
to the Classes of Notes or Certificates of the
same or different Series as specified in the re-
lated Prospectus Supplement as then being enti-
tled to payments of principal. In addition, if
so specified in the related Prospectus Supple-
ment, amounts deposited in certain accounts for
the benefit of one or more Classes of Notes or
Certificates may be released from time to time
or on a specified date and applied as a payment
of principal on such Classes of Notes or Certif-
icates. The related Prospectus Supplement will
set forth the circumstances which will result in
the commencement of an Amortization Period.
6
<PAGE>
Each Trust Fund which has a Revolving Period may
also issue to the Transferor a certificate evi-
dencing an undivided beneficial interest (the
"Transferor Interest") in the Trust Fund not
represented by the other Securities issued by
such Trust Fund. As further described in the re-
lated Prospectus Supplement, the value of such
Transferor Interest will fluctuate as the amount
of the assets of the Trust Fund fluctuates and
the amount of Notes and Certificates of the re-
lated Series of Securities outstanding is re-
duced.
FINAL SCHEDULED
DISTRIBUTION DATE OF THE
SECURITIES.................
The Final Scheduled Distribution Date with re-
spect to each Class of Notes is the date no
later than the date on which principal thereof
will be fully paid and with respect to each
Class of Certificates is the date after which no
Certificates of such Class are expected to re-
main outstanding, in each case calculated on the
basis of the assumptions applicable to such Se-
ries described in the related Prospectus Supple-
ment. The Final Scheduled Distribution Date of a
Class may equal the maturity date of the Primary
Asset in the related Trust Fund which has the
latest stated maturity or will be determined as
described herein and in the related Prospectus
Supplement.
The actual final Distribution Date of the Securi-
ties of a Series will depend primarily upon the
rate of payment (including prepayments, liquida-
tions due to default, the receipt of proceeds
from casualty insurance policies and repur-
chases) of the Loans or Underlying Loans relat-
ing to the Private Securities, as applicable, in
the related Trust Fund. Unless otherwise speci-
fied in the related Prospectus Supplement, the
actual final Distribution Date of any Security
is likely to occur earlier and may occur sub-
stantially earlier or, with respect to a Class
of Certificates, may occur later than its Final
Scheduled Distribution Date as a result of the
application of prepayments to the reduction of
the principal balances of the Securities and as
a result of defaults on the Primary Assets. The
rate of payments on the Loans or Underlying
Loans relating to the Private Securities, as ap-
plicable, in the Trust Fund for a Series will
depend on a variety of factors, including cer-
tain characteristics of such Loans or Underlying
Loans, as applicable, and the prevailing level
of interest rates from time to time, as well as
on a variety of economic, demographic, tax, le-
gal, social and other factors. No assurance can
be given as to the actual prepayment experience
with respect to a Series. See "RISK FACTORS--
Yield May Vary" and "DESCRIPTION OF THE SECURI-
TIES--Weighted Average Life of the Securities."
OPTIONAL TERMINATION........ One or more Classes of Securities of any Series
may be redeemed or repurchased in whole or in
part, at the Transferor's or the Servicer's op-
tion, at such time and under the circumstances
spec-
7
<PAGE>
ified in the related Prospectus Supplement, at
the price set forth therein. If so specified in
the related Prospectus Supplement for a Series
of Securities, the Transferor, the Servicer, or
such other entity that is specified in the re-
lated Prospectus Supplement, may, at its option,
cause an early termination of the related Trust
Fund by repurchasing all of the Primary Assets
remaining in the Trust Fund on or after a speci-
fied date, or on or after such time as the ag-
gregate principal balance of the Securities of
the Series or the Primary Assets relating to
such Series, as specified in the related Pro-
spectus Supplement, is less than the amount or
percentage specified in the related Prospectus
Supplement. See "DESCRIPTION OF THE SECURITIES--
Optional Redemption, Purchase or Termination."
In addition, the Prospectus Supplement may pro-
vide other circumstances under which Holders of
Securities of a Series could be fully paid sig-
nificantly earlier than would otherwise be the
case if payments or distributions were solely
based on the payments of the related Primary As-
sets.
THE TRUST FUND.............. The Trust Fund for a Series of Securities will
consist of one or more of the assets described
below, as described in the related Prospectus
Supplement.
A. PRIMARY ASSETS......... The Primary Assets for a Series may consist of
any combination of the following assets, to the
extent and as specified in the related Prospec-
tus Supplement.
(1) LOANS.............. Primary Assets for a Series will consist, in
whole or in part, of Loans. Some Loans may be
delinquent or non-performing as specified in the
related Prospectus Supplement. The Loans will be
originated or acquired by the Transferor in the
ordinary course of its business. The Loans will
be conventional loans or contracts or loans or
contracts insured by the Federal Housing Admin-
istration ("FHA") or partially guaranteed by the
Veterans Administration ("VA"). See "THE TRUST
FUNDS--The Loans" for a discussion of such guar-
antees. To the extent provided in the related
Prospectus Supplement, additional Loans or addi-
tional balances may be periodically added to the
Trust Fund, or may be removed from time to time
if certain asset tests are met, all as described
in the related Prospectus Supplement.
The "Loans" for a Series will consist of (i)
closed-end and/or revolving credit line home eq-
uity loans or certain balances thereof (collec-
tively, the "Mortgage Loans") and (ii) home im-
provement installment sales contracts and in-
stallment loan agreements (the "Home Improvement
Contracts"). The Mortgage Loans and the Home Im-
provement Contracts are collectively referred to
herein as the "Loans." Loans may, as specified
in the related Prospectus Supplement, have vari-
ous payment characteristics, including balloon
or other irregular payment features, and may ac-
crue interest at a fixed rate or an adjustable
rate.
8
<PAGE>
As specified in the related Prospectus Supple-
ment, the Mortgage Loans will and the Home Im-
provement Contracts may be secured by mortgages
and deeds of trust or other similar security in-
struments creating a lien on a Mortgaged Proper-
ty, which may be subordinated to one or more se-
nior liens on such Mortgaged Property, as de-
scribed in the related Prospectus Supplement. As
specified in the related Prospectus Supplement,
Home Improvement Contracts may be unsecured or
secured by purchase money security interests in
the Home Improvements financed thereby. The
Mortgaged Properties and the Home Improvements
are collectively referred to herein as the
"Properties."
The related Prospectus Supplement will describe
certain characteristics of the Loans for a Se-
ries, including, without limitation, and to the
extent relevant: (a) the aggregate unpaid prin-
cipal balance of the Loans (or the aggregate un-
paid principal balance included in the Trust
Fund for the related Series); (b) the range and
weighted average Loan Rate on the Loans and in
the case of adjustable rate Loans, the range and
weighted average of the Current Loan Rates and
the Lifetime Rate Caps, if any; (c) the range
and the average outstanding principal balance of
the Loans; (d) the weighted average original and
remaining term-to-stated maturity of the Loans
and the range of original and remaining terms-
to-stated maturity, if applicable; (e) the range
of Combined Loan-to-Value Ratios or Loan-to-
Value Ratios, as applicable, of the Loans, com-
puted in the manner described in the related
Prospectus Supplement; (f) the percentage (by
principal balance as of the Cut-off Date) of
Loans that accrue interest at adjustable or
fixed interest rates; (g) any enhancement relat-
ing to the Loans; (h) the percentage (by princi-
pal balance as of the Cut-off Date) of Loans
that are secured by Mortgaged Properties, Home
Improvements or are unsecured; (i) the geo-
graphic distribution of any Mortgaged Properties
securing the Loans; (j) the use and type of each
Mortgaged Property securing a Loan; (k) the lien
priority of the Loans; (l) the credit limit uti-
lization rates of any Revolving Credit Line
Loans; and (m) the delinquency status and year
of origination of the Loans.
(2) PRIVATE Primary Assets for a Series may consist, in whole
SECURITIES......... or in part, of Private Securities which include
(a) pass-through certificates representing bene-
ficial interests in loans of the type that would
otherwise be eligible to be Loans (the "Under-
lying Loans") or (b) collateralized obligations
secured by Underlying Loans. Such pass-through
certificates or collateralized obligations will
have previously been (a) offered and distributed
to the public pursuant to an effective registra-
tion statement or (b) purchased in a transaction
not involving any public offering from a person
who is not an affiliate of the issuer of such
securities at the time of sale (nor an affiliate
thereof at any time during the three preceding
months); provided a period of three years has
elapsed since the later of the
9
<PAGE>
date the securities were acquired from the is-
suer or an affiliate thereof. Although individ-
ual Underlying Loans may be insured or guaran-
teed by the United States or an agency or in-
strumentality thereof, they need not be, and the
Private Securities themselves will not be so in-
sured or guaranteed. See "THE TRUST FUNDS--Pri-
vate Securities." Unless otherwise specified in
the Prospectus Supplement relating to a Series
of Securities, payments on the Private Securi-
ties will be distributed directly to the Trustee
as registered owner of such Private Securities.
The related Prospectus Supplement for a Series
will specify (such disclosure may be on an ap-
proximate basis, as described above and will be
as of the date specified in the related Prospec-
tus Supplement) to the extent relevant and to
the extent such information is reasonably avail-
able to the Transferor and the Transferor rea-
sonably believes such information to be reli-
able: (i) the aggregate approximate principal
amount and type of any Private Securities to be
included in the Trust Fund for such Series;
(ii) certain characteristics of the Underlying
Loans including (A) the payment features of such
Underlying Loans (i.e., whether they are fixed
rate or adjustable rate and whether they provide
for fixed level payments, negative amortization
or other payment features), (B) the approximate
aggregate principal amount of such Underlying
Loans which are insured or guaranteed by a gov-
ernmental entity, (C) the servicing fee or range
of servicing fees with respect to such Under-
lying Loans, (D) the minimum and maximum stated
maturities of such Underlying Loans at origina-
tion, (E) the lien priority and the credit uti-
lization rates, if any, of such Underlying
Loans, and (F) the delinquency status and year
of origination of such Underlying Loans; (iii)
the maximum original term-to-stated maturity of
the Private Securities; (iv) the weighted aver-
age term-to-stated maturity of the Private Secu-
rities; (v) the pass-through or certificate rate
or ranges thereof for the Private Securities;
(vi) the sponsor or depositor of the Private Se-
curities (the "PS Sponsor"), the servicer of the
Private Securities (the "PS Servicer") and the
trustee of the Private Securities (the "PS
Trustee"); (vii) certain characteristics of En-
hancement, if any, such as reserve funds, insur-
ance policies, letters of credit or guarantees,
relating to the Underlying Loans, or to such
Private Securities themselves; (viii) the terms
on which the Underlying Loans may, or are re-
quired to, be repurchased prior to stated matu-
rity; and (ix) the terms on which substitute Un-
derlying Loans may be delivered to replace those
initially deposited with the PS Trustee. See
"THE TRUST FUNDS--Private Securities--Additional
Information."
B. COLLECTION,
CERTIFICATE AND
DISTRIBUTION
ACCOUNTS............... Unless otherwise provided in the related Prospec-
tus Supplement, all payments on or with respect
to the Primary Assets for a Series will be re-
mitted by the Servicer within the period speci-
fied in the related Prospectus Supplement di-
rectly to an account (the "Col-
10
<PAGE>
lection Account" or the "Certificate Account")
to be established for such Series. Unless other-
wise provided in the related Prospectus Supple-
ment, the Trustee shall be required to apply a
portion of the amount in the Collection Account
or the Certificate Account to the payment of
certain amounts payable to the Servicer under
the related Agreement and any other person spec-
ified in the Prospectus Supplement, and to de-
posit a portion of the amount in the Collection
Account into one or more separate accounts
(each, a "Distribution Account") to be estab-
lished for such Series, each in the manner and
at the times established in the related Prospec-
tus Supplement. All amounts deposited in such
Distribution Account (or, if there is no Distri-
bution Account, amounts remaining in the Certif-
icate Account) will be available, unless other-
wise specified in the related Prospectus Supple-
ment, for (i) application to the payment of
principal of and interest on such Series of Se-
curities (or such Class or Classes specified in
the related Prospectus Supplement) on the next
Distribution Date, (ii) the making of adequate
provision for future payments on certain Classes
of Securities and (iii) any other purpose speci-
fied in the related Prospectus Supplement. After
applying the funds in the Collection Account or
the Certificate Account as described above, any
funds remaining in such Accounts may be paid
over to the Servicer, the Transferor, any pro-
vider of Enhancement with respect to such Series
(an "Enhancer") or any other person entitled
thereto in the manner and at the times estab-
lished in the related Prospectus Supplement.
C. PRE-FUNDING AND
CAPITALIZED INTEREST
ACCOUNTS...............
If specified in the related Prospectus Supple-
ment, a Trust Fund will include one or more seg-
regated trust accounts (each, a "Pre-Funding Ac-
count") for the related Series. If so specified,
on the closing date for such Series, a portion
of the proceeds of the sale of the Securities of
such Series (such amount, the "Pre-Funded
Amount") will be deposited in the Pre-Funding
Account and may be used to purchase additional
Primary Assets during the period of time speci-
fied in the related Prospectus Supplement (the
"Pre-Funding Period"). The Primary Assets to be
so purchased will be required to have certain
characteristics specified in the related Pro-
spectus Supplement. If any Pre-Funded Amount re-
mains on deposit in the Pre-Funding Account at
the end of the Pre-Funding Period, such amount
will be applied in the manner specified in the
related Prospectus Supplement to prepay the
Classes of Notes and/or the Certificates of the
applicable Series specified in the related Pro-
spectus Supplement. The amount initially depos-
ited in a Pre-Funding Account for a Series of
Securities will not exceed 50% of the aggregate
principal amount of such Series of Securities.
If a Pre-Funding Account is established, one or
more segregated trust accounts (each, a "Capi-
talized Interest Account") may be
11
<PAGE>
established for the related Series. On the clos-
ing date for such Series, a portion of the pro-
ceeds of the sale of the Securities of such Se-
ries may be deposited in the Capitalized Inter-
est Account and used to fund the excess, if any,
of (x) the sum of (i) the amount of interest ac-
crued on the Classes of Securities of such Se-
ries specified in the related Prospectus Supple-
ment and (ii) if specified in the related Pro-
spectus Supplement, certain fees or expenses
during the Pre-Funding Period such as Trustee
fees and credit enhancement fees, over (y) the
amount of interest available therefor from the
Primary Assets in the Trust Fund. If so speci-
fied in the related Prospectus Supplement,
amounts on deposit in the Capitalized Interest
Account may be released to the Transferor prior
to the end of the Pre-Funding Period subject to
the satisfaction of certain tests specified in
the related Prospectus Supplement. Any amounts
on deposit in the Capitalized Interest Account
at the end of the Pre-Funding Period that are
not necessary for such purposes will be distrib-
uted to the person specified in the related Pro-
spectus Supplement.
ENHANCEMENT................. If and to the extent specified in the related
Prospectus Supplement, enhancement with respect
to a Series or any Class of Securities may in-
clude any one or more of the following: a finan-
cial guaranty insurance policy,
overcollateralization, a letter of credit, a
cash reserve fund, insurance policies, one or
more Classes of Subordinate Securities, deriva-
tive products or other forms of credit enhance-
ment, or any combination thereof (collectively,
"Enhancement"). The Enhancement with respect to
any Series or any Class of Securities may be
structured to provide protection against delin-
quencies and/or losses on the Primary Assets,
against changes in interest rates, or other
risks, to the extent and under the conditions
specified in the related Prospectus Supplement.
Unless otherwise specified in the related Pro-
spectus Supplement, any form of Enhancement will
have certain limitations and exclusions from
coverage thereunder, which will be described in
the related Prospectus Supplement. Further in-
formation regarding any Enhancer, including fi-
nancial information when material, will be in-
cluded in the related Prospectus Supplement. See
"ENHANCEMENT."
With respect to any Series of Securities includ-
ing one or more Classes of Notes, distributions
in respect of the Certificates may be subordi-
nated in priority of payment to payments on the
Notes, to the extent specified in the related
Prospectus Supplement.
SERVICING................... The Servicer will be responsible for servicing,
managing and making collections on the Loans for
a Series. In addition, the Servicer, if so spec-
ified in the related Prospectus Supplement, will
act as custodian and will be responsible for
maintaining custody of the Loans and related
documentation on behalf of the Trustee. Advances
with respect to delinquent payments of principal
and/or
12
<PAGE>
interest on a Loan ("Delinquency Advances") will
be made by the Servicer if and only to the ex-
tent described in the related Prospectus Supple-
ment. Such advances will be intended to provide
liquidity only and will be reimbursable to the
Servicer, to the extent specified in the related
Prospectus Supplement, from scheduled payments
of principal and/or interest, late collections,
or from the proceeds of liquidation of the re-
lated Loans or from other recoveries relating to
such Loans (including any insurance proceeds or
payments from other credit support) or, to the
extent specified in the related Prospectus Sup-
plement, from payments or proceeds from other
Loans. If and to the extent specified in the re-
lated Prospectus Supplement, the Servicer shall
be entitled to advance its own funds to pay for
any related expenses of foreclosure and disposi-
tion of any liquidated Mortgage Loan or related
Property (the "Servicer Advances"). See "SERVIC-
ING OF LOANS--Advances and Limitations Thereon."
The Servicer shall be entitled to be reimbursed
for any such Servicer Advances as specified in
the related Prospectus Supplement. In performing
these functions, the Servicer will exercise the
same degree of skill and care that it customar-
ily exercises with respect to similar Loans
owned or serviced by it. Under certain limited
circumstances, the Servicer may resign or be re-
moved, in which event either the Trustee or a
third-party servicer will be appointed as suc-
cessor servicer. The Servicer will receive a pe-
riodic fee as servicing compensation (the "Ser-
vicing Fee") and may, as specified herein and in
the related Prospectus Supplement, receive cer-
tain additional compensation. See "SERVICING OF
LOANS--Servicing Compensation and Payment of Ex-
penses."
FEDERAL INCOME TAX
CONSIDERATIONS
A. DEBT SECURITIES AND
REMIC RESIDUAL
SECURITIES.............
If (i) an election is made to treat all or a por-
tion of a Trust Fund for a Series as a "real es-
tate mortgage investment conduit" (a "REMIC") or
(ii) so provided in the related Prospectus Sup-
plement, a Series of Securities will include one
or more Classes of taxable debt obligations un-
der the Internal Revenue Code of 1986, as
amended (the "Code"), stated interest with re-
spect to such Classes of Securities will be re-
ported by a Holder in accordance with the Hold-
er's method of accounting except that, in the
case of Securities constituting "regular inter-
ests" in a REMIC ("Regular Interests"), such in-
terest will be required to be reported on the
accrual method regardless of a Holder's usual
method of accounting. Securities that are Com-
pound Interest Securities, Zero Coupon Securi-
ties or Interest Only Securities will, and cer-
tain other Classes of Securities may, be issued
with original issue discount that is not de
minimis. In such cases, the Holder will be re-
quired to include original issue discount in
gross income as it accrues, which may be prior
to the receipt of cash attributable to such in-
come. If a Security is issued at a premium, the
Holder
13
<PAGE>
may be entitled to make an election to amortize
such premium on a constant yield method.
In the case of a REMIC election, a Class of Secu-
rities may be treated as REMIC "residual inter-
ests" ("Residual Interest"). A Holder of a Re-
sidual Interest will be required to include in
its income its pro rata share of the taxable in-
come of the REMIC. In certain circumstances, the
Holder of a Residual Interest may have REMIC
taxable income or tax liability attributable to
REMIC taxable income for a particular period in
excess of cash distributions for such period or
have an after-tax return that is less than the
after-tax return on comparable debt instruments.
In addition, a portion (or, in some cases, all)
of the income from a Residual Interest (i) ex-
cept in certain circumstances with respect to a
Holder classified as a thrift institution under
the Code, may not be subject to offset by losses
from other activities or investments, (ii) for a
Holder that is subject to tax under the Code on
unrelated business taxable income, may be
treated as unrelated business taxable income and
(iii) for a foreign holder, may not qualify for
exemption from or reduction of withholding. In
addition, (i) Residual Interests are subject to
transfer restrictions and (ii) certain transfers
of Residual Interests will not be recognized for
federal income tax purposes. Further, individual
holders are subject to limitations on the de-
ductibility of expenses of the REMIC. See "FED-
ERAL INCOME TAX CONSIDERATIONS."
B. NON-REMIC PASS-THROUGH
SECURITIES.............
If so specified in the related Prospectus Supple-
ment, the Trust Fund for a Series will be
treated as a grantor trust and will not be clas-
sified as an association taxable as a corpora-
tion for federal income tax purposes and Holders
of Securities of such Series ("Pass-Through Se-
curities") will be treated as owning directly
rights to receive certain payments of interest
or principal, or both, on the Primary Assets
held in the Trust Fund for such Series. All in-
come with respect to a Stripped Security (as de-
fined herein) will be accounted for as original
issue discount and, unless otherwise specified
in the related Prospectus Supplement, will be
reported by the Trustee on an accrual basis,
which may be prior to the receipt of cash asso-
ciated with such income.
C. OWNER TRUST If so specified in the Prospectus Supplement, the
SECURITIES............. Trust Fund will be treated as a partnership for
purposes of federal and state income tax. Each
Noteholder, by the acceptance of a Note of a
given Series, will agree to treat such Note as
indebtedness, and each Certificateholder, by the
acceptance of a Certificate of a given Series,
will agree to treat the related Trust Fund as a
partnership in which such Certificateholder is a
partner for federal income and state tax purpos-
es. Alternative characterizations of such Trust
Fund and such Certificates are possible, but
would not result in materially adverse tax con-
sequences to Certificateholders. See "FEDERAL
INCOME TAX CONSIDERATIONS."
14
<PAGE>
ERISA CONSIDERATIONS........ The eligibility of Notes and Certificates to be
acquired by employee benefit plans or with the
plan assets of employee benefit plans is subject
to the considerations discussed under "ERISA
CONSIDERATIONS" herein and in the related Pro-
spectus Supplement. The related Prospectus Sup-
plement will provide further information with
respect to the eligibility of a Class of Notes
or Certificates for purchase by employee benefit
plans.
A fiduciary of any employee benefit plan subject
to the Employee Retirement Income Security Act
of 1974, as amended ("ERISA"), or the Code
should carefully review with its own legal advi-
sors whether the purchase or holding of Securi-
ties could give rise to a transaction prohibited
or otherwise impermissible under ERISA or the
Code. See "ERISA CONSIDERATIONS" herein and in
the related Prospectus Supplement.
LEGAL INVESTMENT............ Unless otherwise specified in the related Pro-
spectus Supplement, Securities of each Series
offered by this Prospectus and the related Pro-
spectus Supplement will not constitute "mortgage
related securities" under the Secondary Mortgage
Market Enhancement Act of 1984 ("SMMEA"). In-
vestors whose investment authority is subject to
legal restrictions should consult their own le-
gal advisors to determine whether and to what
extent the Securities constitute legal invest-
ments for them. See "LEGAL INVESTMENT."
RATINGS..................... It will be a requirement for issuance of any Se-
ries that each Class of Securities offered by
this Prospectus and the related Prospectus Sup-
plement be rated by at least one Rating Agency
in one of its four highest applicable rating
categories. The rating or ratings applicable to
Securities of each Series offered hereby and by
the related Prospectus Supplement will be as set
forth in the related Prospectus Supplement.
There is no assurance that the rating initially
assigned to such Securities will not be subse-
quently lowered or withdrawn by the Rating Agen-
cy. In the event the rating initially assigned
to any Securities is subsequently lowered for
any reason, no person or entity will be obli-
gated to provide any credit enhancement in addi-
tion to the Enhancement, if any, specified in
the related Prospectus Supplement.
A securities rating should be evaluated indepen-
dently of similar ratings on different types of
securities. A securities rating is not a recom-
mendation to buy, hold or sell securities and
does not address the effect that the rate of
prepayments on Loans or Underlying Loans relat-
ing to Private Securities, as applicable, for a
Series may have on the yield to investors in the
Securities of such Series. See "RISK FACTORS--
Ratings Are Not Recommendations."
15
<PAGE>
RISK FACTORS
Investors should consider, among other things, the following risk factors in
connection with the purchase of the Securities.
No Secondary Market. There will be no market for the Securities of any
Series prior to the issuance thereof, and there can be no assurance that a
secondary market will develop or, if it does develop, that it will provide
Holders with liquidity of investment or will continue for the life of the
Securities of such Series. See "PLAN OF DISTRIBUTION."
Primary Assets Are Only Source of Repayment. The Securities of a Series will
be payable solely from the assets of the Trust Fund for such Securities and
any related Enhancement. There will be no recourse to the Transferor or any
other person for any default on the Notes or any failure to receive
distributions on the Certificates except to the extent of the obligations, if
any, of the Transferor with respect to certain representations and warranties.
See "THE AGREEMENTS--Assignment of Primary Assets." Further, unless otherwise
stated in the related Prospectus Supplement, at the times set forth in the
related Prospectus Supplement, certain Primary Assets and/or any balance
remaining in the Collection Account, Certificate Account or Distribution
Account immediately after making all payments due on the Securities of such
Series and other payments specified in the related Prospectus Supplement, may
be promptly released or remitted to the Transferor, the Servicer, the Enhancer
or any other person entitled thereto and will no longer be available for
making payments to Holders. Consequently, Holders of Securities of each Series
must rely solely upon payments with respect to the Primary Assets and the
other assets constituting the Trust Fund for a Series of Securities,
including, if applicable, any amounts available pursuant to any Enhancement
for such Series, for the payment of principal of and interest on the
Securities of such Series.
Adverse economic conditions (which may or may not affect real property
values) may affect the timely payment by borrowers of payments of principal
and interest when due on the Loans and, accordingly, the actual rates of
delinquencies, foreclosures and losses with respect to the Loans. For
instance, if a Property secures a senior mortgage or deed of trust for an
adjustable-rate loan, and interest rates have increased since the origination
of the related Loan, the borrower's ability to pay the required monthly
payment on such Loan may be adversely affected by the increase in monthly
payments on the Loan and on such senior loan. Further, application of federal
and state bankruptcy and debtor relief laws would affect the interests of the
Securityholders in the Loans if such laws result in certain Loans being
uncollectible.
Holders of Notes will be required under the Indenture to proceed only
against the Primary Assets and other assets constituting the related Trust
Fund in the case of a default with respect to such Notes and may not proceed
against any assets of the Transferor. There is no assurance that the market
value of the Primary Assets or any other assets for a Series will at any time
be equal to or greater than the aggregate principal amount of the Securities
of such Series then outstanding, plus accrued interest thereon. Moreover, upon
an event of default under the Indenture for a Series of Notes and a sale of
the assets in the Trust Fund or upon a sale of the assets of a Trust Fund for
a Series of Certificates, the Trustee, the Servicer, if any, the Enhancer and
any other service provider specified in the related Prospectus Supplement
generally will be entitled to receive the proceeds of any such sale to the
extent of unpaid fees and other amounts owing to such persons under the
related Agreement prior to distributions to Holders of Securities. Upon any
such sale, the proceeds thereof may be insufficient to pay in full the
principal of and interest on the Securities of such Series. See "THE TRUST
FUNDS."
Limited Protection Against Losses. Although any Enhancement is intended to
reduce the risk of delinquent payments or losses to Holders entitled to the
benefit thereof, the amount of such Enhancement will be limited, as set forth
in the related Prospectus Supplement, and will decline and could be depleted
under certain circumstances prior to the payment in full of the related Series
of Securities, and as a result Holders may suffer losses. See "ENHANCEMENT."
16
<PAGE>
Yield May Vary. The yield to maturity experienced by a Holder of Securities
may be affected by the rate of payment of principal of the Loans or Underlying
Loans relating to the Private Securities, as applicable. The timing of
principal payments of the Securities of a Series will be affected by a number
of factors, including the following: (i) the extent of prepayments of the
Loans or Underlying Loans relating to the Private Securities, as applicable,
which prepayments may be influenced by a variety of factors; (ii) the manner
of allocating principal payments among the Classes of Securities of a Series
as specified in the related Prospectus Supplement; and (iii) the exercise by
the party entitled thereto of any right of optional termination. See
"DESCRIPTION OF THE SECURITIES--Weighted Average Life of the Securities."
Prepayments may also result from repurchases of Loans or Underlying Loans
relating to the Private Securities, as applicable, due to material breaches of
the Transferor's representations and warranties.
Interest payable on the Securities of a Series on a Distribution Date will
include all interest accrued during the period specified in the related
Prospectus Supplement. In the event interest accrues during the calendar month
prior to a Distribution Date, the effective yield to Holders will be reduced
from the yield that would otherwise be obtainable if interest payable on the
Security were to accrue through the day immediately preceding each
Distribution Date, and the effective yield (at par) to Holders will be less
than the indicated coupon rate. See "DESCRIPTION OF THE SECURITIES--Payments
of Interest."
Status of Junior Liens; Property Values May Be Insufficient. If the Loans in
a Trust Fund are secured primarily by junior liens subordinate to the rights
of the mortgagee under the related senior mortgage(s) or deed(s) of trust, the
proceeds from any liquidation, insurance or condemnation proceedings will be
available to satisfy the outstanding balance of such Loans only to the extent
that the claims of such senior mortgagees or beneficiaries have been satisfied
in full, including any related foreclosure costs. In addition, a junior
mortgagee may not foreclose on the Property securing a junior mortgage unless
it forecloses subject to the senior mortgages, in which case it must either
pay the entire amount due on the senior mortgages to the senior mortgagees at
or prior to the foreclosure sale or undertake the obligation to make payments
on the senior mortgages in the event the mortgagor is in default thereunder.
The Trust Fund will not have any source of funds to satisfy the senior
mortgages or deeds of trust or make payments due to the senior mortgagees or
beneficiaries.
There are several factors that could adversely affect the value of
Properties such that the outstanding balance of the related Loan (or the
balances thereof sold to a Trust Fund), together with any senior financing on
the Properties, would equal or exceed the value of the Properties. Among the
factors that could adversely affect the value of the Properties are an overall
decline in the residential real estate market in the areas in which the
Properties are located or a decline in the general condition of the Properties
as a result of failure of borrowers to maintain adequately the Properties or
of natural disasters that are not necessarily covered by insurance, such as
earthquakes and floods. Any such decline could extinguish the value of a
junior interest in a Property before having any effect on the related senior
interest therein. If such a decline occurs, the actual rates of delinquencies,
foreclosure and losses on the junior Loans could be higher than those
currently experienced in the mortgage and home improvement lending industry in
general. See "CERTAIN LEGAL ASPECTS OF THE LOANS--Junior Mortgages; Rights of
Senior Mortgages."
Pre-Funding and Additional Loans May Adversely Affect Investment. If a Trust
Fund includes a Pre-Funding Account and the principal balance of additional
Primary Assets delivered to the Trust Fund during the Pre-Funding Period is
less than the Pre-Funded Amount, the Holders of the Securities of the related
Series will receive a prepayment of principal as and to the extent described
in the related Prospectus Supplement. In addition, if so specified in the
related Prospectus Supplement, an Amortization Period may result from the
failure of the Transferor to sell additional Primary Assets (or balances
thereof) to the Trust Fund during the Revolving Period, thereby resulting in a
prepayment of the related Securities. Any such principal prepayment may
adversely affect the yield to maturity of the applicable Securities. Since
prevailing interest rates are subject to fluctuation, there can be no
assurance that investors will be able to reinvest such a prepayment at yields
equaling or exceeding the yields on the related Securities. It is possible
that the yield on any such reinvestment will be lower, and may be
significantly lower, than the yield on the related Securities.
17
<PAGE>
Each additional Primary Asset must satisfy the eligibility criteria
specified in the related Prospectus Supplement and related Agreements. Such
eligibility criteria will be determined in consultation with each Rating
Agency (and/or any Enhancer) prior to the issuance of the related Series and
are designed to ensure that if such additional Primary Assets were included as
part of the initial Primary Assets, the credit quality of such assets would be
consistent with the initial rating of each Class of Securities of such Series.
The Transferor will certify to the Trustee that all conditions precedent to
the transfer of the additional Primary Assets, including the satisfaction of
the eligibility criteria to the Trust Fund, have been satisfied. It is a
condition to the transfer of any additional Primary Assets to the Trust Fund
that each Rating Agency, after receiving prior notice of the proposed transfer
of the additional Primary Assets to the Trust Fund, shall not have advised the
Transferor or the Trustee or any Enhancer that the conveyance of such
additional Primary Assets will result in a qualification, modification or
withdrawal of its then current rating of any Class of Notes or Certificates of
such Series. Following the transfer of additional Primary Assets to the Trust
Fund, the aggregate characteristics of the Primary Assets then held in the
Trust Fund may vary from those of the initial Primary Assets of such Trust
Fund. As a result, the additional Primary Assets may adversely affect the
performance of the related Securities. See "THE TRUST FUNDS--Accounts."
The ability of a Trust Fund to invest in additional Loans during the related
Pre-Funding Period and/or any Revolving Period will be dependant on the
ability of the Transferor to originate or acquire Loans that satisfy the
requirements for transfer to the Trust Fund specified in the related
Prospectus Supplement. The ability of the Transferor to originate or acquire
such Loans will be affected by a variety of social and economic factors,
including the prevailing level of market interest rates, unemployment levels
and consumer perceptions of general economic conditions.
Potential Liability For Environmental Conditions. Real property pledged as
security to a lender may be subject to certain environmental risks. Under the
laws of certain states, contamination of a property may give rise to a lien on
the property to assure the costs of clean-up. In several states, such a lien
has priority over the lien of an existing mortgage or owner's interest against
such property. In addition, under the laws of some states and under the
federal Comprehensive Environmental Response, Compensation, and Liability Act
of 1980 ("CERCLA"), a lender may be liable, as an "owner" or "operator," for
costs of addressing releases or threatened releases of hazardous substances
that require remedy at a property, if agents or employees of the lender have
become sufficiently involved in the operations of the borrower, regardless of
whether or not the environmental damage or threat was caused by a prior owner.
A lender also risks such liability on foreclosure of the Mortgaged Property.
See "SERVICING OF LOANS--Realization Upon Defaulted Loans."
Consumer Protection Laws May Affect Loans. Applicable state laws generally
regulate interest rates and other charges and require certain disclosures. In
addition, other state laws, public policy and general principles of equity
relating to the protection of consumers, unfair and deceptive practices and
debt collection practices may apply to the origination, servicing and
collection of the Loans. Depending on the provisions of the applicable law and
the specific facts and circumstances involved, violations of these laws,
policies and principles may limit the ability of the Servicer to collect all
or part of the principal of or interest on the Loans, may entitle the borrower
to a refund of amounts previously paid and, in addition, could subject the
owner of the Loan to damages and administrative enforcement.
The Loans are also subject to federal laws, including:
(i) the federal Truth in Lending Act and Regulation Z promulgated
thereunder, which require certain disclosures to the borrowers regarding
the terms of the Loans;
(ii) the Equal Credit Opportunity Act and Regulation B promulgated
thereunder, which prohibit discrimination on the basis of age, race, color,
sex, religion, marital status, national origin, receipt of public
assistance or the exercise of any right under the Consumer Credit
Protection Act, in the extension of credit;
(iii) the Americans with Disabilities Act, which, among other things,
prohibits discrimination on the basis of disability in the full and equal
enjoyment of the goods, services, facilities, privileges, advantages or
accommodations of any place of public accommodation;
18
<PAGE>
(iv) the Fair Credit Reporting Act, which regulates the use and reporting
of information related to the borrower's credit experience; and
(v) for Revolving Credit Line Loans that were originated or closed after
November 7, 1989, the Home Equity Loan Consumer Protection Act of 1988,
which requires additional application disclosures, limits changes that may
be made to loan documents without the borrower's consent and restricts a
lender's ability to declare a default or to suspend or reduce a borrower's
credit limit to certain enumerated events.
The Home Improvement Contracts are also subject to the Preservation of
Consumers' Claims and Defenses regulations of the Federal Trade Commission and
other similar federal and state statutes and regulations (collectively, the
"Holder in Due Course Rules"), which protect the homeowner from defective
craftsmanship or incomplete work by a contractor. These laws permit the
obligor to withhold payment if the work does not meet the quality and
durability standards agreed to by the homeowner and the contractor. The Holder
in Due Course Rules have the effect of subjecting any assignee of the seller
in a consumer credit transaction to all claims and defenses which the obligor
in the credit sale transaction could assert against the seller of the goods.
Violations of certain provisions of these federal laws may limit the ability
of the Servicer to collect all or part of the principal of or interest on the
Loans and in addition could subject the Trust Fund to damages and
administrative enforcement. In addition, numerous other federal and state
statutory provisions, including the federal bankruptcy laws, the Soldiers' and
Sailors' Civil Relief Act of 1940 and state debtor relief laws, may also
adversely affect the Servicer's ability to collect the principal of or
interest on the Loans and also would affect the interests of the
Securityholders in such Loans if such laws result in the Loans being
uncollectible. See "CERTAIN LEGAL ASPECTS OF THE LOANS."
Contracts Will Not Be Stamped. Unless otherwise specified in the related
Prospectus Supplement, in order to give notice of the right, title and
interest of Securityholders to the Home Improvement Contracts that constitute
chattel paper, the Transferor will cause a UCC-1 financing statement to be
executed by the Transferor identifying the Trustee as the secured party and
identifying such Home Improvement Contracts as collateral. Unless otherwise
specified in the related Prospectus Supplement, such Home Improvement
Contracts will not be stamped or otherwise marked to reflect their assignment
to the Trust Fund. Therefore, if, through negligence, fraud or otherwise, a
subsequent purchaser were able to take physical possession of such Home
Improvement Contracts without notice of such assignment, the interest of
Securityholders in such Home Improvement Contracts could be defeated. See
"CERTAIN LEGAL ASPECTS OF THE LOANS--The Home Improvement Contracts."
Ratings Are Not Recommendations. It will be a condition to the issuance of a
Series of Securities that each Class be rated in one of the four highest
rating categories by the Rating Agency identified in the related Prospectus
Supplement. Any such rating would be based on, among other things, the
adequacy of the value of the Primary Assets and any Enhancement with respect
to such Series. Such rating should not be deemed a recommendation to purchase,
hold or sell Securities, inasmuch as it does not address market price or
suitability for a particular investor. There is also no assurance that any
such rating will remain in effect for any given period of time or may not be
lowered or withdrawn entirely by the Rating Agency if in its judgment
circumstances in the future so warrant. In addition to being lowered or
withdrawn due to any erosion in the adequacy of the value of the Primary
Assets, such rating might also be lowered or withdrawn, among other reasons,
because of an adverse change in the financial or other condition of an
Enhancer or a change in the rating of such Enhancer's long term debt.
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DESCRIPTION OF THE SECURITIES
GENERAL
Each Series of Notes will be issued pursuant to an indenture (the
"Indenture") between the related Trust Fund and the entity named in the
related Prospectus Supplement as trustee (the "Trustee") with respect to such
Series. A form of Indenture has been filed as an exhibit to the Registration
Statement of which this Prospectus forms a part. The Certificates will also be
issued in Series pursuant to separate agreements (each, a "Pooling and
Servicing Agreement" or a "Trust Agreement") among the Transferor, the
Servicer, if the Series relates to Loans, and the Trustee. A form of Pooling
and Servicing Agreement has been filed as an exhibit to the Registration
Statement of which this Prospectus forms a part. A Series may consist of both
Notes and Certificates.
The following summaries describe certain provisions in the Agreements common
to each Series of Securities. The summaries do not purport to be complete and
are subject to, and are qualified in their entirety by reference to, the
provisions of the Agreements and the Prospectus Supplement relating to each
Series of Securities. Where particular provisions or terms used in the
Agreements are referred to, the actual provisions (including definitions of
terms) are incorporated herein by reference as part of such summaries.
Each Series of Securities will consist of one or more Classes of Securities,
one or more of which may be Compound Interest Securities, Variable Interest
Securities, PAC Securities, Zero Coupon Securities, Principal Only Securities,
Interest Only Securities or Participating Securities. A Series may also
include one or more Classes of Subordinate Securities. The Securities of each
Series will be issued only in fully registered form, without coupons, in the
authorized denominations for each Class specified in the related Prospectus
Supplement. Upon satisfaction of the conditions, if any, applicable to a Class
of a Series, as described in the related Prospectus Supplement, the transfer
of the Securities may be registered and the Securities may be exchanged at the
office of the Trustee specified in the Prospectus Supplement without the
payment of any service charge other than any tax or governmental charge
payable in connection with such registration of transfer or exchange. If
specified in the related Prospectus Supplement, one or more Classes of a
Series may be available in book-entry form only.
Unless otherwise provided in the related Prospectus Supplement, payments of
principal of and interest on a Series of Securities will be made on the
Distribution Dates specified in the related Prospectus Supplement (which may
be different for each Class or for the payment of principal and interest) by
check mailed to Holders of such Series, registered as such at the close of
business on the record date specified in the related Prospectus Supplement
applicable to such Distribution Dates at their addresses appearing on the
security register, except that (a) payments may be made by wire transfer
(which, unless otherwise specified in the related Prospectus Supplement, shall
be at the expense of the Holder requesting payment by wire transfer) in
certain circumstances described in the related Prospectus Supplement and (b)
final payments of principal in retirement of each Security will be made only
upon presentation and surrender of such Security at the office of the Trustee
specified in the Prospectus Supplement. Notice of the final payment on a
Security will be mailed to the Holder of such Security before the Distribution
Date on which the final principal payment on any Security is expected to be
made to the holder of such Security.
Payments of principal of and interest on the Securities will be made by the
Trustee, or a paying agent on behalf of the Trustee, as specified in the
related Prospectus Supplement. Unless otherwise provided in the related
Prospectus Supplement, all payments with respect to the Primary Assets for a
Series, together with reinvestment income thereon, amounts withdrawn from any
Reserve Fund, and amounts available pursuant to any other Enhancement will be
deposited directly into the Collection Account or the Certificate Account. If
provided in the related Prospectus Supplement, such amounts may be net of
certain amounts payable to the Servicer and any other person specified in the
Prospectus Supplement. Such amounts thereafter may be deposited into the
Distribution Account and will be available to make payments on the Securities
of such Series on the next applicable Distribution Date. See "THE TRUST
FUNDS--Accounts."
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VALUATION OF THE PRIMARY ASSETS
If specified in the related Prospectus Supplement for a Series of Notes,
each Primary Asset included in the related Trust Fund for a Series will be
assigned an initial "Asset Value." Unless otherwise specified in the related
Prospectus Supplement, at any time the Asset Value of the Primary Assets will
be equal to the product of the Asset Value Percentage as set forth in the
Indenture and the lesser of (a) the stream of remaining regularly scheduled
payments on the Primary Assets, net, unless otherwise provided in the related
Prospectus Supplement, of certain amounts payable as expenses, together with
income earned on each such scheduled payment received through the day
preceding the next Distribution Date at the Assumed Reinvestment Rate, if any,
discounted to present value at the highest interest rate on the Notes of such
Series over periods equal to the interval between payments on the Notes, and
(b) the then principal balance of the Primary Assets. Unless otherwise
specified in the related Prospectus Supplement, the initial Asset Value of the
Primary Assets will be at least equal to the principal amount of the Notes of
the related Series at the date of issuance thereof.
The "Assumed Reinvestment Rate," if any, for a Series will be the highest
rate permitted by the Rating Agency or a rate insured by means of a surety
bond, guaranteed investment contract, or other arrangement satisfactory to the
Rating Agency. If the Assumed Reinvestment Rate is so insured, the related
Prospectus Supplement will set forth the terms of such arrangement.
PAYMENTS OF INTEREST
The Securities of each Class by their terms entitled to receive interest
will bear interest (calculated, unless otherwise specified in the related
Prospectus Supplement, on the basis of a 360-day year of twelve 30-day months)
from the date and at the rate per annum specified, or calculated in the method
described, in the related Prospectus Supplement. Interest on such Securities
of a Series will be payable on the Distribution Date specified in the related
Prospectus Supplement. If so specified in the related Prospectus Supplement,
the Distribution Date for the payment of interest of a Class may be different
from, or occur more or less frequently than, the Distribution Date for the
payment of principal of such Class. The rate of interest on Securities of a
Series may be variable or may change with changes in the annual percentage
rates of the Loans or Underlying Loans relating to the Private Securities, as
applicable, included in the related Trust Fund and/or as prepayments occur
with respect to such Loans or Underlying Loans, as applicable. Principal Only
Securities may not be entitled to receive any interest distributions or may be
entitled to receive only nominal interest distributions. Any interest on Zero
Coupon Securities that is not paid on the related Distribution Date will
accrue and be added to the principal thereof on such Distribution Date.
Interest payable on the Securities on a Distribution Date will include all
interest accrued during the period specified in the related Prospectus
Supplement. In the event interest accrues during the calendar month preceding
a Distribution Date, the effective yield to Holders will be reduced from the
yield that would otherwise be obtainable if interest payable on the Securities
were to accrue through the day immediately preceding such Distribution Date.
PAYMENTS OF PRINCIPAL
On each Distribution Date for a Series, principal payments will be made to
the Holders of the Securities of such Series on which principal is then
payable, to the extent set forth in the related Prospectus Supplement. Such
payments will be made in an aggregate amount determined as specified in the
related Prospectus Supplement and will be allocated among the respective
Classes of a Series in the manner, at the times and in the priority (which
may, in certain cases, include allocation by random lot) set forth in the
related Prospectus Supplement. If so specified in the related Prospectus
Supplement, the Distribution Date for the payment of principal of a Class may
be different from, or occur more or less frequently than, the Distribution
Date for the payment of interest for such Class.
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REVOLVING PERIOD AND AMORTIZATION PERIOD; TRANSFEROR INTEREST
If the related Prospectus Supplement so provides, there may be a period
commencing on the date of issuance of a Class or Classes of Notes or
Certificates of a Series and ending on the date set forth in the related
Prospectus Supplement (the "Revolving Period") during which no principal
payments will be made to one or more Classes of Notes or Certificates of the
related Series as are identified in such Prospectus Supplement. Some or all
collections of principal otherwise allocated to such Class or Classes of Notes
or Certificates may be (i) utilized by the Trust Fund during such period to
acquire additional Loans (or additional balances of existing Loans) which
satisfy the criteria described in the related Prospectus Supplement, (ii) held
in an account and invested in Eligible Investments for later distribution to
Securityholders, (iii) applied to those Class or Classes of Notes or
Certificates, if any, of the same or different Series as specified in the
related Prospectus Supplement as then are in amortization, or (iv) otherwise
applied as specified in the related Prospectus Supplement.
An "Amortization Period" is the period, if any, specified as such in the
related Prospectus Supplement during which an amount of principal is payable
to holders of one or more Classes of a Series of Securities. If so specified
in the related Prospectus Supplement, during an Amortization Period all or a
portion of principal collections on the Primary Assets may be applied as
specified above for a Revolving Period and, to the extent not so applied, will
be distributed to the Classes of Notes or Certificates of the same or
different Series as specified in the related Prospectus Supplement as then
being entitled to payments of principal. In addition, if so specified in the
related Prospectus Supplement, amounts deposited in certain accounts for the
benefit of one or more Classes of Notes or Certificates may be released from
time to time or on a specified date and applied as a payment of principal on
such Classes of Notes or Certificates. The related Prospectus Supplement will
set forth the circumstances which will result in the commencement of an
Amortization Period.
Each Trust Fund which has a Revolving Period may also issue to the
Transferor a certificate evidencing a Transferor Interest in the Trust Fund
not represented by the other Securities issued by such Trust Fund. As further
described in the related Prospectus Supplement, the value of such Transferor
Interest will fluctuate as the amount of the assets of the Trust Fund
fluctuates and the amount of the Notes and Certificates of the related Series
of Securities outstanding is reduced.
FINAL SCHEDULED DISTRIBUTION DATE
The Final Scheduled Distribution Date with respect to each Class of Notes is
the date no later than the date on which the principal thereof will be fully
paid and with respect to each Class of Certificates will be the date on which
the entire aggregate principal balance of such Class is expected to be reduced
to zero, in each case calculated on the basis of the assumptions applicable to
such Series described in the related Prospectus Supplement. The Final
Scheduled Distribution Date for each Class of a Series will be specified in
the related Prospectus Supplement. Since, except as described above under "--
Revolving Period and Amortization Period; Transferor Interest," payments on
the Primary Assets will be used to make distributions in reduction of the
outstanding principal amount of the Securities, it is likely that the actual
final Distribution Date of any such Class will occur earlier, and may occur
substantially earlier, than its Final Scheduled Distribution Date.
Furthermore, with respect to a Series of Certificates, unless otherwise
specified in the related Prospectus Supplement, as a result of delinquencies,
defaults and liquidations of the Primary Assets in the Trust Fund, the actual
final Distribution Date of any Certificate may occur later than its Final
Scheduled Distribution Date. No assurance can be given as to the actual
prepayment experience with respect to a Series. See "--Weighted Average Life
of the Securities" below.
SPECIAL REDEMPTION
If so specified in the Prospectus Supplement relating to a Series of
Securities having other than monthly Distribution Dates, one or more Classes
of Securities of such Series may be subject to special redemption, in whole or
in part, on the day specified in the related Prospectus Supplement (a "Special
Redemption Date") if, as a consequence of prepayments on the Loans or
Underlying Loans, as applicable, relating to such Securities or
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low yields then available for reinvestment the entity specified in the related
Prospectus Supplement determines, based on assumptions specified in the
applicable Agreement, that the amount available for the payment of interest
that will have accrued on such Securities (the "Available Interest Amount")
through the designated interest accrual date specified in the related
Prospectus Supplement is less than the amount of interest that will have
accrued on such Securities to such date. In such event and as further
described in the related Prospectus Supplement, the Trustee will redeem a
principal amount of outstanding Securities of such Series as will cause the
Available Interest Amount to equal the amount of interest that will have
accrued through such designated interest accrual date for such Series of
Securities outstanding immediately after such redemption.
OPTIONAL REDEMPTION, PURCHASE OR TERMINATION
The Transferor or the Servicer may, at its option, redeem, in whole or in
part, one or more Classes of Notes or purchase one or more Classes of
Certificates of any Series, on any Distribution Date under the circumstances,
if any, specified in the Prospectus Supplement relating to such Series.
Alternatively, if so specified in the related Prospectus Supplement for a
Series of Securities, the Transferor, the Servicer, or another entity
designated in the related Prospectus Supplement may, at its option, cause an
early termination of a Trust Fund by repurchasing all of the Primary Assets
from such Trust Fund on or after a date specified in the related Prospectus
Supplement, or on or after such time as the aggregate outstanding principal
amount of the Securities or Primary Assets, as specified in the related
Prospectus Supplement, is less than the amount or percentage specified in the
related Prospectus Supplement. In addition, if so specified in the related
Prospectus Supplement upon certain events of insolvency or receivership of the
Transferor or another affiliated entity specified in the related Prospectus
Supplement the related Primary Assets of the Trust Fund will be liquidated and
the Trust Fund will be terminated, subject to the conditions set forth in the
related Prospectus Supplement. In each such event, the Securities of the
related Series will experience a prepayment. The redemption, purchase or
repurchase price will be set forth in the related Prospectus Supplement. If
specified in the related Prospectus Supplement, in the event that a REMIC
election has been made, the Trustee shall receive a satisfactory opinion of
counsel that the optional redemption, purchase or termination will be
conducted so as to constitute a "qualified liquidation" under Section 860F of
the Code.
In addition, the Prospectus Supplement may provide other circumstances under
which Holders of Securities of a Series could be fully paid significantly
earlier than would otherwise be the case if payments or distributions were
solely based on the activity of the related Primary Assets.
WEIGHTED AVERAGE LIFE OF THE SECURITIES
Weighted average life refers to the average amount of time that will elapse
from the date of issue of a security until each dollar of principal of such
security will be repaid to the investor. Unless otherwise specified in the
related Prospectus Supplement, the weighted average life of a Class of the
Securities will be influenced by the rate at which the amount financed under
the Loans (or related balances thereof) or Underlying Loans relating to the
Private Securities, as applicable, included in the Trust Fund for a Series is
paid, which may be in the form of scheduled amortization or prepayments.
Prepayments on loans and other receivables can be measured relative to a
prepayment standard or model. The Prospectus Supplement for a Series of
Securities will describe the prepayment standard or model, if any, used and
may contain tables setting forth the projected weighted average life of each
Class of Securities of such Series and the percentage of the original
principal amount of each Class of Securities of such Series that would be
outstanding on specified Distribution Dates for such Series based on the
assumptions stated in such Prospectus Supplement, including assumptions that
prepayments on the Loans or Underlying Loans relating to the Private
Securities, as applicable, included in the related Trust Fund are made at
rates corresponding to various percentages of the prepayment standard or model
specified in such Prospectus Supplement.
There is, however, no assurance that prepayment of the Loans or Underlying
Loans relating to the Private Securities, as applicable, included in the
related Trust Fund will conform to any level of any prepayment standard
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or model specified in the related Prospectus Supplement. The rate of principal
prepayments on pools of loans may be influenced by a variety of factors,
including job related factors such as transfers, layoffs or promotions and
personal factors such as divorce, disability or prolonged illness. Economic
conditions, either generally or within a particular geographic area or
industry, also may affect the rate of principal prepayments. Demographic and
social factors may influence the rate of principal prepayments in that some
borrowers have greater financial flexibility to move or refinance than do
other borrowers. The deductibility of mortgage interest payments, servicing
decisions and other factors also affect the rate of principal prepayments. As
a result, there can be no assurance as to the rate or timing of principal
prepayments of the Loans or Underlying Loans either from time to time or over
the lives of such Loans or Underlying Loans.
The rate of prepayments of conventional housing loans and other receivables
has fluctuated significantly in recent years. In general, however, if
prevailing interest rates fall significantly below the interest rates on the
Loans or Underlying Loans relating to the Private Securities, as applicable,
for a Series, such loans are likely to prepay at rates higher than if
prevailing interest rates remain at or above the interest rates borne by such
loans. In this regard, it should be noted that the Loans or Underlying Loans,
as applicable, for a Series may have different interest rates. In addition,
the weighted average life of the Securities may be affected by the varying
maturities of the Loans or Underlying Loans relating to the Private
Securities, as applicable. If any Loans or Underlying Loans relating to the
Private Securities, as applicable, for a Series have actual terms-to-stated
maturity of less than those assumed in calculating the Final Scheduled
Distribution Date of the related Securities, one or more Classes of the Series
may be fully paid prior to their respective Final Scheduled Distribution Date,
even in the absence of prepayments.
THE TRUST FUNDS
GENERAL
The Notes of each Series will be secured by the pledge of the assets of the
related Trust Fund, and the Certificates of each Series will represent
interests in the assets of the related Trust Fund. The Trust Fund of each
Series will include (i) the Primary Assets, (ii) amounts available from the
reinvestment of payments on such Primary Assets at the Assumed Reinvestment
Rate, if any, specified in the related Prospectus Supplement, (iii) any
Enhancement or the rights thereto, (iv) any Property that secured a Loan but
which is acquired by foreclosure or deed in lieu of foreclosure or
repossession and (v) the amount, if any, initially deposited in the Pre-
Funding Account, Capitalized Interest Account, Collection Account, Certificate
Account or Distribution Account for a Series as specified in the related
Prospectus Supplement.
The Securities will be non-recourse obligations of the related Trust Fund.
The assets of the Trust Fund specified in the related Prospectus Supplement
for a Series of Securities, unless otherwise specified in the related
Prospectus Supplement, will serve as collateral only for that Series of
Securities. Holders of a Series of Notes may only proceed against such
collateral securing such Series of Notes in the case of a default with respect
to such Series of Notes and may not proceed against any assets of the
Transferor or the related Trust Fund not pledged to secure such Notes.
The Primary Assets for a Series will be transferred by the Transferor to the
Trust Fund. Loans relating to a Series will be serviced by the Servicer
pursuant to a Pooling and Servicing Agreement, with respect to a Series
consisting of only Certificates or a Sale and Servicing Agreement (each, a
"Sale and Servicing Agreement") among the Transferor, the Trust Fund and the
Servicer, with respect to a Series that includes Notes.
As used herein, "Agreement" means, with respect to a Series of Certificates,
the Pooling and Servicing Agreement or Trust Agreement, and with respect to a
Series that includes Notes, the Indenture and the Sale and Servicing
Agreement, as the context requires.
If so specified in the related Prospectus Supplement, a Trust Fund relating
to a Series of Securities may be a business trust formed under the laws of the
state specified in the related Prospectus Supplement pursuant to a
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trust agreement (each, a "Trust Agreement") between the Transferor and the
Trustee of such Trust Fund specified in the related Prospectus Supplement.
With respect to each Trust Fund, prior to the initial offering of the
related Series of Securities, the Trust Fund will have no assets or
liabilities. No Trust Fund is expected to engage in any activities other than
acquiring, managing and holding the related Primary Assets and other assets
contemplated herein and in the related Prospectus Supplement and the proceeds
thereof, issuing Securities and making payments and distributions thereon and
certain related activities. No Trust Fund is expected to have any source of
capital other than its assets and any related Enhancement.
Primary Assets included in the Trust Fund for a Series may consist of any
combination of Loans and Private Securities, to the extent and as specified in
the related Prospectus Supplement.
THE LOANS
Mortgage Loans. The Primary Assets for a Series may consist, in whole or in
part, of closed-end and/or revolving credit line home equity loans or certain
balances thereof (the "Closed-End Loans" and "Revolving Credit Line Loans,"
respectively, and collectively, the "Mortgage Loans") secured by mortgages
primarily on Single Family Properties which may be subordinated to other
mortgages on the same Mortgaged Property. The Mortgage Loans may have fixed
interest rates or adjustable interest rates and may provide for other payment
characteristics as described below and in the related Prospectus Supplement.
As more fully described in the related Prospectus Supplement, interest on
each Revolving Credit Line Loan, is computed and payable monthly on the
average daily outstanding principal balance of such loan. Principal amounts on
the Revolving Credit Line Loans may be drawn down (up to a maximum amount as
set forth in the related Loan Agreement) or repaid under each Revolving Credit
Line Loan from time to time. If specified in the related Prospectus
Supplement, new draws by borrowers under the Revolving Credit Line Loans will
automatically become part of the Trust Fund for a Series. As a result, the
aggregate balance of the Revolving Credit Line Loans will fluctuate from day
to day as new draws by borrowers are added to the Trust Fund and principal
payments are applied to such balances and such amounts will usually differ
each day, as more specifically described in the related Prospectus Supplement.
Unless otherwise specified in the related Prospectus Supplement, a borrower
under a Revolving Credit Line Loan is obligated to pay only the amount of
interest and fees which accrue on the loan during the billing cycle and
principal of the Revolving Credit Line Loan is payable at maturity.
Unless otherwise described in the related Prospectus Supplement, the full
principal amount of a Closed-End Loan is advanced at origination of the loan
and generally is repayable in equal (or substantially equal) installments of
an amount sufficient to fully amortize such loan at its stated maturity. As
more fully described in the related Prospectus Supplement, interest on each
Closed-End Loan is calculated on the basis of the outstanding principal
balance of such loan multiplied by the Loan Rate thereon and further
multiplied by a fraction, the numerator of which is the number of days in the
period elapsed since the preceding payment of interest was made and the
denominator is the number of days in the annual period for which interest
accrues on such loan. Unless otherwise described in the related Prospectus
Supplement, the original terms to stated maturity of Closed-End Loans will not
exceed 360 months.
The Mortgaged Properties will include Single Family Property (i.e., one- to
four-family residential housing, including Condominium Units and Cooperative
Dwellings) and mixed-use property. Mixed-use properties will consist of
structures of no more than three stories, which include one to four
residential dwelling units and space used for retail, professional or other
commercial uses. Such uses, which will not involve more than 50% of the space
in the structure, may include doctor, dentist or law offices, real estate
agencies, boutiques, newsstands, convenience stores or other similar types of
uses intended to cater to individual customers as specified in the related
Prospectus Supplement. The properties may be located in suburban or
metropolitan districts. Any such non-residential use will be in compliance
with local zoning laws and regulations. The Mortgaged Properties may
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consist of detached individual dwellings, individual condominiums, townhouses,
duplexes, row houses, individual units in planned unit developments and other
attached dwelling units. Each Single Family Property will be located on land
owned in fee simple by the borrower or on land leased by the borrower for a
term at least ten years (unless otherwise provided in the related Prospectus
Supplement) greater than the term of the related Loan. Attached dwellings may
include owner-occupied structures where each borrower owns the land upon which
the unit is built, with the remaining adjacent land owned in common or
dwelling units subject to a proprietary lease or occupancy agreement in a
cooperatively owned apartment building.
Unless otherwise specified in the related Prospectus Supplement, Mortgages
on Cooperative Dwellings consist of a lien on the shares issued by such
Cooperative Dwelling and the proprietary lease or occupancy agreement relating
to such Cooperative Dwelling.
The aggregate principal balance of Revolving Credit Line Loans secured by
Mortgaged Properties that are owner-occupied will be disclosed in the related
Prospectus Supplement. Unless otherwise specified in the Prospectus
Supplement, the sole basis for a representation that a given percentage of the
Loans are secured by Single Family Property that is owner-occupied will be
either (i) the making of a representation by the Mortgagor at origination of
the Loan either that the underlying Mortgaged Property will be used by the
Mortgagor for a period of at least six months every year or that the Mortgagor
intends to use the Mortgaged Property as a primary residence, or (ii) a
finding that the address of the underlying Mortgaged Property is the
Mortgagor's mailing address as reflected in the Servicer's records. To the
extent specified in the related Prospectus Supplement, the Mortgaged
Properties may include non-owner occupied investment properties and vacation
and second homes.
Unless otherwise specified in the related Prospectus Supplement, the initial
Combined Loan-to-Value Ratio of a Revolving Credit Line Loan is computed in
the manner described in the related Prospectus Supplement, taking into account
the amounts of any related senior mortgage loans.
Home Improvement Contracts. The Primary Assets for a Series may consist, in
whole or part, of home improvement installment sales contracts and installment
loan agreements (the "Home Improvement Contracts") originated by a home
improvement contractor in the ordinary course of business. As specified in the
related Prospectus Supplement, the Home Improvement Contracts will either be
unsecured or secured by the Mortgages primarily on Single Family Properties
which are generally subordinate to other mortgages on the same Mortgaged
Property or by purchase money security interests in the Home Improvements
financed thereby. Unless otherwise specified in the applicable Prospectus
Supplement, the Home Improvement Contracts will be fully amortizing and may
have fixed interest rates or adjustable interest rates and may provide for
other payment characteristics as described below and in the related Prospectus
Supplement.
Unless otherwise specified in the related Prospectus Supplement, the home
improvements (the "Home Improvements") securing the Home Improvement Contracts
include, but are not limited to, replacement windows, house siding, new roofs,
swimming pools, satellite dishes, kitchen and bathroom remodeling goods and
solar heating panels. The initial Loan-to-Value Ratio of a Home Improvement
Contract will be computed in the manner described in the related Prospectus
Supplement.
Additional Information. The selection criteria which will apply with respect
to the Loans will be specified in the related Prospectus Supplement. Such
criteria may include one or more of the following: the Combined Loan-to-Value
Ratios or Loan-to-Value Ratios, as applicable, original terms to maturity and
delinquency information, the geographical distribution of Loans and the Loan
Rates for such Loans.
The Loans for a Series may include Loans that do not amortize their entire
principal balance by their stated maturity in accordance with their terms and
require a balloon payment of the remaining principal balance at maturity, as
specified in the related Prospectus Supplement. As further described in the
related Prospectus Supplement, the Loans for a Series may include Loans that
do not have a specified stated maturity.
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The Loans will be conventional contracts or contracts insured by the Federal
Housing Administration ("FHA") or partially guaranteed by the Veterans
Administration ("VA"). Loans designated in the related Prospectus Supplement
as insured by the FHA will be insured by the FHA as authorized under the
United States Housing Act of 1937, as amended. Such Loans will be insured
under various FHA programs. These programs generally limit the principal
amount and interest rates of the mortgage loans insured. Loans insured by the
FHA generally require a minimum down payment of approximately 5% of the
original principal amount of the loan. No FHA-insured Loans relating to a
Series may have an interest rate or original principal amount exceeding the
applicable FHA limits at the time of origination of such Loan.
The insurance premiums for Loans insured by the FHA are collected by lenders
approved by the Department of Housing and Urban Development ("HUD") and are
paid to the FHA. The regulations governing FHA single-family mortgage
insurance programs provide that insurance benefits are payable either upon
foreclosure (or other acquisition of possession) and conveyance of the
mortgaged premises to HUD or upon assignment of the defaulted Loan to HUD.
With respect to a defaulted FHA-insured Loan, the Servicer is limited in its
ability to initiate foreclosure proceedings. When it is determined, either by
the Servicer or HUD, that default was caused by circumstances beyond the
mortgagor's control, the Servicer is expected to make an effort to avoid
foreclosure by entering, if feasible, into one of a number of available forms
of forbearance plans with the mortgagor. Such plans may involve the reduction
or suspension of regular mortgage payments for a specified period, with such
payments to be made upon or before the maturity date of the mortgage, or the
recasting of payments due under the mortgage up to or beyond the maturity
date. In addition, when a default caused by such circumstances is accompanied
by certain other criteria, HUD may provide relief by making payments to the
Servicer in partial or full satisfaction of amounts due under the Loan (which
payments are to be repaid by the mortgagor to HUD) or by accepting assignment
of the loan from the Servicer. With certain exceptions, at least three full
monthly installments must be due and unpaid under the Loan and HUD must have
rejected any request for relief from the mortgagor before the Servicer may
initiate foreclosure proceedings.
HUD has the option, in most cases, to pay insurance claims in cash or in
debentures issued by HUD. Currently, claims are being paid in cash, and claims
have not been paid in debentures since 1965. HUD debentures issued in
satisfaction of FHA insurance claims bear interest at the applicable HUD
debenture interest rate. The Servicer of each FHA-insured Loan will be
obligated to purchase any such debenture issued in satisfaction of such Loan
upon default for an amount equal to the principal amount of any such
debenture.
The amount of insurance benefits generally paid by the FHA is equal to the
entire unpaid principal amount of the defaulted Loan adjusted to reimburse the
Servicer for certain costs and expenses and to deduct certain amounts received
or retained by the Servicer after default. When entitlement to insurance
benefits results from foreclosure (or other acquisition of possession) and
conveyance to HUD, the Servicer is compensated for no more than two-thirds of
its foreclosure costs, and is compensated for interest accrued and unpaid
prior to such date but in general only to the extent it was allowed pursuant
to a forbearance plan approved by HUD. When entitlement to insurance benefits
results from assignment of the Loan to HUD, the insurance payment includes
full compensation for interest accrued and unpaid to the assignment date. The
insurance payment itself, upon foreclosure of an FHA-insured Loan, bears
interest from a date 30 days after the mortgagor's first uncorrected failure
to perform any obligation to make any payment due under the Loan and, upon
assignment, from the date of assignment to the date of payment of the claim,
in each case at the same interest rate as the applicable HUD debenture
interest rate as described above.
Loans designated in the related Prospectus Supplement as guaranteed by the
VA will be partially guaranteed by the VA under the Serviceman's Readjustment
Act of 1944, as amended (a "VA Guaranty"). The Serviceman's Readjustment Act
of 1944, as amended, permits a veteran (or in certain instances the spouse of
a veteran) to obtain a mortgage loan guaranty by the VA covering mortgage
financing of the purchase of a one- to four-family dwelling unit at interest
rates permitted by the VA. The program has no mortgage loan limits, requires
no down payment from the purchaser and permits the guarantee of mortgage loans
of up to 30 years' duration.
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The maximum guaranty that may be issued by the VA under a VA guaranteed
mortgage loan depends upon the original principal amount of the mortgage loan,
as further described in 38 United States Code Section 1803(a), as amended. The
liability on the guaranty is reduced or increased pro rata with any reduction
or increase in the amount of indebtedness, but in no event will the amount
payable on the guaranty exceed the amount of the original guaranty. The VA
may, at its option and without regard to the guaranty, make full payment to a
mortgage holder of unsatisfied indebtedness on a mortgage upon its assignment
to the VA.
With respect to a defaulted VA guaranteed Loan, the Servicer is, absent
exceptional circumstances, authorized to announce its intention to foreclose
only when the default has continued for three months. Generally, a claim for
the guaranty is submitted after liquidation of the Mortgaged Property.
The amount payable under the guaranty will be the percentage of the VA-
insured Loan originally guaranteed applied to indebtedness outstanding as of
the applicable date of computation specified in the VA regulations. Payments
under the guaranty will be equal to the unpaid principal amount of the loan,
interest accrued on the unpaid balance of the loan to the appropriate date of
computation and limited expenses of the mortgagee, but in each case only to
the extent that such amounts have not been recovered through liquidation of
the Mortgaged Property. The amount payable under the guaranty may in no event
exceed the amount of the original guaranty.
The related Prospectus Supplement for each Series will provide information
with respect to the Loans that are Primary Assets as of the Cut-off Date,
including, among other things, and to the extent relevant: (a) the aggregate
unpaid principal balance of the Loans (or the aggregate unpaid principal
balance included in the Trust Fund for the related Series); (b) the range and
weighted average Loan Rate on the Loans, and, in the case of adjustable rate
Loans, the range and weighted average of the current Loan Rates and the
Lifetime Rate Caps, if any; (c) the range and average outstanding principal
balance of the Loans; (d) the weighted average original and remaining term-to-
stated maturity of the Loans and the range of original and remaining terms-to-
stated maturity, if applicable; (e) the range and weighted average of Combined
Loan-to-Value Ratios or Loan-to-Value Ratios for the Revolving Credit Line
Loans, as applicable; (f) the percentage (by outstanding principal balance as
of the Cut-off Date) of Loans that accrue interest at adjustable or fixed
interest rates; (g) any special hazard insurance policy or bankruptcy bond or
other enhancement relating to the Loans; (h) the percentage (by principal
balance as of the Cut-off Date) of Loans that are secured by Mortgaged
Properties, Home Improvements or are unsecured; (i) the geographic
distribution of any Mortgaged Properties securing the Loans; (j) the
percentage of Revolving Credit Line Loans (by principal balance as of the Cut-
off Date) that are secured by Single Family Properties, shares relating to
Cooperative Dwellings, Condominium Units, investment property and vacation or
second homes; (k) the lien priority of the Loans; (l) the credit limit
utilization rate of any Revolving Credit Line Loans; and (m) the delinquency
status and year of origination of the Loans. The related Prospectus Supplement
will also specify any other limitations on the types or characteristics of
Loans for a Series.
If information of the nature described above respecting the Loans is not
known to the Transferor at the time the Securities are initially offered,
approximate or more general information of the nature described above will be
provided in the Prospectus Supplement and additional information will be set
forth in a Current Report on Form 8-K to be available to investors on the date
of issuance of the related Series and to be filed with the Commission within
15 days after the initial issuance of such Securities.
PRIVATE SECURITIES
General. Primary Assets for a Series may consist, in whole or in part, of
Private Securities which include pass-through certificates representing
beneficial interests in loans of the type that would otherwise be eligible to
be Loans (the "Underlying Loans") or (b) collateralized obligations secured by
Underlying Loans. Such pass-through certificates or collateralized obligations
will have previously been (a) offered and distributed to the public pursuant
to an effective registration statement or (b) purchased in a transaction not
involving any public offering from a person who is not an affiliate of the
issuer of such securities at the time of sale (nor an affiliate thereof at any
time during the three preceding months); provided a period of three years
elapsed since the later of the date the securities were acquired from the
issuer or an affiliate thereof. Although individual Underlying
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Loans may be insured or guaranteed by the United States or an agency or
instrumentality thereof, they need not be, and Private Securities themselves
will not be so insured or guaranteed.
Private Securities will have been issued pursuant to a pooling and servicing
agreement, a trust agreement or similar agreement (a "PS Agreement"). The
seller/servicer of the Underlying Loans will have entered into the PS
Agreement with the trustee under such PS Agreement (the "PS Trustee"). The PS
Trustee or its agent, or a custodian, will possess the Underlying Loans.
Underlying Loans will be serviced by a servicer (the "PS Servicer") directly
or by one or more sub-servicers who may be subject to the supervision of the
PS Servicer.
The sponsor of the Private Securities (the "PS Sponsor") will be a financial
institution or other entity engaged generally in the business of lending; a
public agency or instrumentality of a state, local or federal government; or a
limited purpose corporation organized for the purpose of, among other things,
establishing trusts and acquiring and selling loans to such trusts, and
selling beneficial interests in such trusts. If so specified in the Prospectus
Supplement, the PS Sponsor may be an affiliate of the Transferor. The
obligations of the PS Sponsor will generally be limited to certain
representations and warranties with respect to the assets conveyed by it to
the related trust. Unless otherwise specified in the related Prospectus
Supplement, the PS Sponsor will not have guaranteed any of the assets conveyed
to the related trust or any of the Private Securities issued under the PS
Agreement. Additionally, although the Underlying Loans may be guaranteed by an
agency or instrumentality of the United States, the Private Securities
themselves will not be so guaranteed.
Distributions of principal and interest will be made on the Private
Securities on the dates specified in the related Prospectus Supplement. The
Private Securities may be entitled to receive nominal or no principal
distributions or nominal or no interest distributions. Principal and interest
distributions will be made on the Private Securities by the PS Trustee or the
PS Servicer. The PS Sponsor or the PS Servicer may have the right to
repurchase the Underlying Loans after a certain date or under other
circumstances specified in the related Prospectus Supplement.
The Underlying Loans may be fixed rate, level payment, fully amortizing
loans or adjustable rate loans or loans having balloon or other irregular
payment features. Such Underlying Loans will be secured by mortgages on
Mortgaged Properties.
Credit Support Relating to Private Securities. Credit support in the form of
Reserve Funds, subordination of other private securities issued under the PS
Agreement, guarantees, letters of credit, cash collateral accounts, insurance
policies or other types of credit support may be provided with respect to the
Underlying Loans or with respect to the Private Securities themselves. The
type, characteristics and amount of credit support will be a function of
certain characteristics of the Underlying Loans and other factors and will
have been established for the Private Securities on the basis of requirements
of the nationally recognized statistical rating organization that rated the
Private Securities.
Additional Information. The Prospectus Supplement for a Series for which the
Primary Assets include Private Securities will specify (such disclosure may be
on an approximate basis and will be as of the date specified in the related
Prospectus Supplement), to the extent relevant and to the extent such
information is reasonably available to the Transferor and the Transferor
reasonably believes such information to be reliable: (i) the aggregate
approximate principal amount and type of the Private Securities to be included
in the Trust Fund for such Series; (ii) certain characteristics of the
Underlying Loans including (A) the payment features of such Underlying Loans
(i.e., whether they are fixed rate or adjustable rate and whether they provide
for fixed level payments or other payment features), (B) the approximate
aggregate principal balance, if known, of such Underlying Loans insured or
guaranteed by a governmental entity, (C) the servicing fee or range of
servicing fees with respect to the Underlying Loans, (D) the minimum and
maximum stated maturities of such Underlying Loans at origination, (E) the
lien priority and the credit utilization rates, if any, of such Underlying
Loans, and (F) the delinquency status and year of origination of such
Underlying Loans; (iii) the maximum original term-to-stated maturity of the
Private Securities; (iv) the weighted average term-to-stated maturity of the
Private Securities; (v) the pass-through or certificate rate or ranges thereof
for the Private Securities; (vi) the PS Sponsor,
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the PS Servicer (if other than the PS Sponsor) and the PS Trustee for such
Private Securities; (vii) certain characteristics of credit support if any,
such as Reserve Funds, insurance policies, letters of credit or guarantees
relating to such Loans underlying the Private Securities or to such Private
Securities themselves; (viii) the terms on which Underlying Loans may, or are
required to, be purchased prior to their stated maturity or the stated
maturity of the Private Securities; and (ix) the terms on which Underlying
Loans may be substituted for those originally underlying the Private
Securities.
If information of the nature described above representing the Private
Securities is not known to the Transferor at the time the Securities are
initially offered, approximate or more general information of the nature
described above will be provided in the Prospectus Supplement and the
additional information, if available, will be set forth in a Current Report on
Form 8-K to be available to investors on the date of issuance of the related
Series and to be filed with the Commission within 15 days of the initial
issuance of such Securities.
ACCOUNTS
A separate Collection Account or Certificate Account will be established for
each Series of Securities for receipt of the amount of cash, if any, specified
in the related Prospectus Supplement to be initially deposited therein by the
Transferor and/or the Servicer, all amounts received on or with respect to the
Primary Assets and, unless otherwise specified in the related Prospectus
Supplement, income earned thereon. Certain amounts on deposit in such
Collection Account and certain amounts available pursuant to any Enhancement,
as provided in the related Prospectus Supplement, may be deposited in one or
more Distribution Accounts. Unless otherwise specified in the related
Prospectus Supplement, the Trustee will invest the funds in the Collection,
Certificate and Distribution Accounts in Eligible Investments maturing, with
certain exceptions, not later, in the case of funds in the Collection Account,
than the day preceding the date such funds are due to be deposited in the
Distribution Account or otherwise distributed and, in the case of funds in the
Distribution Account and the Certificate Account, than the day preceding the
next Distribution Date for the related Series of Securities. "Eligible
Investments" include, among other investments, obligations of the United
States and certain agencies thereof, federal funds, certificates of deposit,
commercial paper, demand and time deposits and banker's acceptances, certain
repurchase agreements of United States government securities and certain
guaranteed investment contracts, in each case, acceptable to the Rating
Agency.
If specified in the related Prospectus Supplement, a Trust Fund will include
one or more segregated trust accounts (each, a "Pre-Funding Account")
established and maintained with the Trustee for the related Series. If so
specified, on the closing date for such Series, a portion of the proceeds of
the sale of the Securities of such Series (such amount, the "Pre-Funded
Amount") may be deposited in the Pre-Funding Account and may be used to
purchase additional Primary Assets during the period of time specified in the
related Prospectus Supplement (the "Pre-Funding Period"). If any Pre-Funded
Amount remains on deposit in the Pre-Funding Account at the end of the Pre-
Funding Period, such amount will be applied in the manner specified in the
related Prospectus Supplement to prepay the Notes and/or the Certificates of
the applicable Series.
Each additional Primary Asset must satisfy the eligibility criteria
specified in the related Prospectus Supplement and related Agreements. Such
eligibility criteria will be determined in consultation with each Rating
Agency (and/or any Enhancer) prior to the issuance of the related Series and
are designed to ensure that if such additional Primary Assets were included as
part of the initial Primary Assets, the credit quality of such assets would be
consistent with the initial rating of the Securities of such Series. The
Transferor will certify to the Trustee that all conditions precedent to the
transfer of the additional Primary Assets, including the satisfaction of the
eligibility criteria to the Trust Fund, have been satisfied. It is a condition
to the transfer of any additional Primary Assets to the Trust Fund that each
Rating Agency, after receiving prior notice of the proposed transfer of the
additional Primary Assets to the Trust Fund, shall not have advised the
Transferor or the Trustee or any Enhancer that the conveyance of such
additional Primary Assets will result in a qualification, modification or
withdrawal of its then current rating of any Class of Notes or Certificates of
such Series. Following the transfer of additional Primary Assets to the Trust
Fund, the aggregate characteristics of the Primary Assets then held in the
Trust Fund may vary from those of the initial Primary Assets of such Trust
Fund. As a result, the additional Primary Assets may adversely affect the
performance of the related Securities.
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If a Pre-Funding Account is established, one or more segregated trust
accounts (each, a "Capitalized Interest Account") may be established and
maintained with the Trustee for the related Series. On the closing date for
such Series, a portion of the proceeds of the sale of the Securities of such
Series will be deposited in the Capitalized Interest Account and used to fund
the excess, if any, of the sum of (i) the amount of interest accrued on the
Securities of such Series and (ii) if specified in the related Prospectus
Supplement, certain fees or expenses during the Pre-Funding Period, over the
amount of interest available therefor from the Primary Assets in the Trust
Fund. If so specified in the related Prospectus Supplement, amounts on deposit
in the Capitalized Interest Account may be released to the Transferor prior to
the end of the Pre-Funding Period subject to the satisfaction of certain tests
specified in the related Prospectus Supplement. Any amounts on deposit in the
Capitalized Interest Account at the end of the Pre-Funding Period that are not
necessary for such purposes will be distributed to the person specified in the
related Prospectus Supplement.
ENHANCEMENT
The amounts and types of enhancement arrangements and the provider thereof,
if applicable, with respect to a Series or any Class of Securities will be set
forth in the related Prospectus Supplement. If and to the extent provided in
the related Prospectus Supplement, enhancement may be in the form of a
financial guaranty insurance policy, overcollateralization, a letter of
credit, cash reserve fund, insurance policies, one or more Classes of
Subordinated Securities, derivative products, or other form of enhancement, or
any combination thereof, as may be described in the related Prospectus
Supplement (collectively, "Enhancement"). If specified in the applicable
Prospectus Supplement, Enhancement for any Series of Securities may cover one
or more Classes of Notes or Certificates, and accordingly may be exhausted for
the benefit of a particular Class of Notes or Certificates and thereafter be
unavailable to such other Classes of Notes or Certificates. Further
information regarding any provider of credit enhancement, including financial
information when material, will be included in the related Prospectus
Supplement.
The presence of Enhancement is intended to increase the likelihood of
receipt by the Certificateholders and the Noteholders of the full amount of
principal and interest due thereon and to decrease the likelihood that the
Certificateholders and the Noteholders will experience losses, or may be
structured to provide protection against changes in interest rates or against
other risks, to the extent and under the conditions specified in the related
Prospectus Supplement. Unless otherwise specified in the related Prospectus
Supplement, the Enhancement for a Class of Securities will not provide
protection against all risks of loss and will not guarantee repayment of the
entire principal and interest thereon. If losses occur which exceed the amount
covered by any Enhancement or which are not covered by any Enhancement,
Securityholders will bear their allocable share of deficiencies. In addition,
if a form of Enhancement covers more than one Class of Securities of a Series,
Securityholders of any such Class will be subject to the risk that such
Enhancement will be exhausted by the claims of Securityholders of other
Classes.
SERVICING OF LOANS
GENERAL
Customary servicing functions with respect to Loans comprising the Primary
Assets in the Trust Fund will be provided by the Servicer directly pursuant to
the related Sale and Servicing Agreement or Pooling and Servicing Agreement,
as the case may be, with respect to a Series of Securities.
COLLECTION PROCEDURES; ESCROW ACCOUNTS
The Servicer will make reasonable efforts to collect all payments required
to be made under the Loans and will, consistent with the terms of the related
Agreement for a Series and any applicable Enhancement, follow such collection
procedures as it follows with respect to comparable loans held in its own
portfolio. Consistent
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with the above, the Servicer may, in its discretion, (i) waive any assumption
fee, late payment charge, or other charge in connection with a Loan and (ii)
to the extent provided in the related Agreement, arrange with an obligor a
schedule for the liquidation of delinquencies by extending the Due Dates for
Scheduled Payments on such Loan.
If specified in the related Prospectus Supplement, the Servicer, to the
extent permitted by law, will establish and maintain escrow or impound
accounts ("Escrow Accounts") with respect to Loans in which payments by
obligors with respect to taxes, assessments, mortgage and hazard insurance
premiums, and other comparable items will be deposited. Loans may not require
such payments under the loan related documents, in which case the Servicer
would not be required to establish any Escrow Account with respect to such
Loans. Withdrawals from the Escrow Accounts are to be made to effect timely
payment of taxes, assessments and mortgage and hazard insurance, to refund to
obligors amounts determined to be overages, to pay interest to obligors on
balances in the Escrow Account to the extent required by law, to repair or
otherwise protect the property securing the related Loan and to clear and
terminate such Escrow Account. The Servicer will be responsible for the
administration of the Escrow Accounts and generally will make advances to such
accounts when a deficiency exists therein.
DEPOSITS TO AND WITHDRAWALS FROM THE COLLECTION ACCOUNT OR THE CERTIFICATE
ACCOUNT
Unless otherwise specified in the related Prospectus Supplement, the Trustee
or the Servicer will establish a separate account (the "Collection Account" or
the "Certificate Account") in the name of the Trustee. The Collection Account
and/or Certificate Account will be an account maintained (i) at a depository
institution, the long-term unsecured debt obligations of which at the time of
any deposit therein are rated by each Rating Agency rating the Securities of
such Series at levels satisfactory to each such Rating Agency or (ii) in an
account or accounts the deposits in which are insured to the maximum extent
available by the Federal Deposit Insurance Corporation (the "FDIC") or which
are secured in a manner meeting requirements established by each Rating
Agency.
Unless otherwise specified in the related Prospectus Supplement, the funds
held in the Collection Account or the Certificate Account may be invested,
pending remittance to the Trustee, in Eligible Investments. If so specified in
the related Prospectus Supplement, the Servicer will be entitled to receive as
additional compensation any interest or other income earned on funds in the
Collection Account or Certificate Account.
Unless otherwise specified in the related Prospectus Supplement, the
Servicer, the Transferor or the Trustee will deposit into the Collection
Account or the Certificate Account for each Series on the Business Day
following the Closing Date any amounts representing payments received on or
after the related Cut-off Date and received by the Servicer on or before the
Closing Date, and thereafter, within the period specified in the related
Prospectus Supplement, the following payments and collections received or made
by it (other than, unless otherwise provided in the related Prospectus
Supplement, in respect of principal of and interest on the related Primary
Assets due or, in the case of simple interest Loans, received, on or before
such Cut-off Date):
(i) all payments on account of principal, including prepayments, on such
Primary Assets;
(ii) all payments on account of interest on such Primary Assets after
deducting therefrom, at the discretion of the Servicer but only to the
extent of the amount permitted to be withdrawn or withheld from the
Collection Account or the Certificate Account in accordance with the
related Agreement, the Servicing Fee in respect of such Primary Assets;
(iii) all amounts received by the Servicer in connection with the
liquidation of Primary Assets or property acquired in respect thereof,
whether through foreclosure sale, repossession or otherwise, including
payments in connection with such Primary Assets received from the obligor,
other than amounts required to be paid or refunded to the obligor pursuant
to the terms of the applicable loan documents or otherwise pursuant to law
("Liquidation Proceeds"), exclusive of, in the discretion of the Servicer,
but only to the extent of the amount permitted to be withdrawn from the
Collection Account or the Certificate Account in
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accordance with the related Agreement, the Servicing Fee, if any, in
respect of the related Primary Asset and, to the extent specified in the
related Prospectus Supplement, net of reimbursements for Servicer Advances;
(iv) all proceeds under any title insurance, hazard insurance or other
insurance policy covering any such Primary Asset, other than proceeds to be
applied to the restoration or repair of the related Property or released to
the obligor in accordance with the related Agreement;
(v) all amounts required to be deposited therein from any applicable
Reserve Fund for such Series pursuant to the related Agreement;
(vi) all Delinquency Advances made by the Servicer required pursuant to
the related Agreement; and
(vii) all repurchase prices of any such Primary Assets repurchased by the
Servicer or the Transferor pursuant to the related Agreement.
If specified in the related Prospectus Supplement, each balance of a
Revolving Credit Line Loan may be conveyed to a separate Trust Fund and
payments and proceeds of such Revolving Credit Line Loan will be allocated
among such Trust Funds as specified in the related Prospectus Supplement.
Unless otherwise specified in the related Prospectus Supplement, the
Servicer is permitted, from time to time, to make withdrawals from the
Collection Account or the Certificate Account for each Series for the
following purposes:
(i) to reimburse itself for Servicer Advances and Delinquency Advances
for such Series made by it pursuant to the related Agreement; the
Servicer's right to reimburse itself for Delinquency Advances is limited to
amounts received on or in respect of particular Loans (including, for this
purpose, Liquidation Proceeds and amounts representing proceeds of
insurance policies covering the related Property) which represent late
recoveries of Scheduled Payments respecting which any such Delinquency
Advance was made;
(ii) to the extent provided in the related Agreement, to reimburse itself
for any Delinquency Advances for such Series that the Servicer determines
in good faith it will be unable to recover from amounts representing late
recoveries of Scheduled Payments respecting which such Delinquency Advance
was made or from Liquidation Proceeds or the proceeds of insurance
policies;
(iii) to reimburse itself for Servicer Advances to the extent provided in
the related Prospectus Supplement;
(iv) in the event it has elected not to pay itself the Servicing Fee out
of the interest component of any Scheduled Payment, late payment or other
recovery with respect to a particular Loan prior to the deposit of such
Scheduled Payment, late payment or recovery into the Collection Account or
the Certificate Account, to pay to itself the Servicing Fee, as adjusted
pursuant to the related Agreement, from any such Scheduled Payment, late
payment or such other recovery, to the extent permitted by the related
Agreement;
(v) to reimburse itself for expenses incurred by and recoverable by or
reimbursable to it pursuant to the related Agreement;
(vi) to pay to the applicable person with respect to each Primary Asset
or REO Property acquired in respect thereof that has been repurchased or
removed from the Trust Fund by the Transferor or the Servicer pursuant to
the related Agreement, all amounts received thereon and not distributed as
of the date on which the related repurchase price was determined;
(vii) to make payments to the Trustee of such Series for deposit into the
Distribution Account, if any, or for remittance to the Holders of such
Series in the amounts and in the manner provided for in the related
Agreement; and
(viii) to clear and terminate the Collection Account or the Certificate
Account pursuant to the related Agreement.
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In addition, if the Servicer deposits in the Collection Account or the
Certificate Account for a Series any amount not required to be deposited
therein, it may, at any time, withdraw such amount from such Collection
Account or the Certificate Account.
ADVANCES AND LIMITATIONS THEREON
The related Prospectus Supplement will describe the circumstances, if any,
under which the Servicer will make advances with respect to delinquent
payments of principal and/or interest on Loans ("Delinquency Advances"). If
specified in the related Prospectus Supplement, the Servicer will be obligated
to make Delinquency Advances, and such obligation may be limited in amount, or
may not be activated until a certain portion of a specified Reserve Fund is
depleted. Such advances are intended to provide liquidity and, except to the
extent specified in the related Prospectus Supplement, not to guarantee or
insure against losses. Accordingly, to the extent specified in the related
Prospectus Supplement, any funds advanced are recoverable by the Servicer out
of amounts received on particular Loans which represent late recoveries of
principal or interest, proceeds of insurance policies or Liquidation Proceeds
respecting which any such Delinquency Advance was made or, to the extent
provided in the Prospectus Supplement, from payments or proceeds from other
Loans. If and to the extent specified in the related Prospectus Supplement,
the Servicer shall be entitled to advance its own funds to pay for any related
expenses of foreclosure and disposition of any liquidated Mortgage Loan or
related Property (the "Servicer Advances"). The Servicer shall be entitled to
be reimbursed for any such Servicer Advances to the extent provided in the
Prospectus Supplement. If a Servicer Advance is made and subsequently
determined to be nonrecoverable from late collections, proceeds of insurance
policies, or Liquidation Proceeds from the related Loan, the Servicer may be
entitled to reimbursement from other funds in the Collection Account,
Certificate Account or Distribution Account, as the case may be, or from a
specified Reserve Fund as applicable, to the extent specified in the related
Prospectus Supplement.
MAINTENANCE OF INSURANCE POLICIES AND OTHER SERVICING PROCEDURES
Standard Hazard Insurance; Flood Insurance. Except as otherwise specified in
the related Prospectus Supplement, the Servicer will be required to maintain
or to cause the obligor on each Real Estate Loan to maintain a hazard
insurance policy naming the Servicer as loss payee thereunder. Hazard
insurance policies for Real Estate Loans must include extended coverage in an
amount equal to the lesser of (a) the maximum insurable value of the
improvements securing such Real Estate Loan and (b) either (i) the principal
balance of the Real Estate Loan if it is a Home Improvement Contract or a
closed-end Mortgage Loan or (ii) the combined principal balance of the Real
Estate Loan and any mortgage loan senior to the Real Estate Loan if such Real
Estate Loan is a Revolving Credit Line Loan. The ability of the Servicer to
assure that hazard insurance proceeds are appropriately applied may depend on
its being named as an additional insured under any hazard insurance policy and
under any flood insurance policy referred to below, or upon the extent to
which information in this regard is furnished to the Servicer by a borrower.
Except as described below, all amounts collected by the Servicer under any
hazard policy (except for amounts applied or expected to be applied to the
restoration or repair of the Property or released to the borrower in
accordance with the Servicer's normal servicing procedures), will be deposited
in the Collection Account or the Certificate Account. If so specified in the
related Prospectus Supplement, the portion of such proceeds allocable to
Securityholders of a Series may be limited to the extent specified in the
related Prospectus Supplement in the event that more than one Trust Fund has
an interest in the balances of a Revolving Credit Line Loan. The Agreement
provides that the Servicer may satisfy its obligation to cause hazard policies
to be maintained by maintaining a blanket policy issued by an insurer
acceptable to the Rating Agencies insuring against hazard losses to the
collateral securing the Real Estate Loans. If such blanket policy contains a
deductible clause, the Servicer will deposit into the Collection Account the
amount not otherwise payable under the blanket policy because of such
deductible clause. If so specified in the related Prospectus Supplement, the
amount so required to be deposited by the Servicer with respect to a
particular Series may be limited to the extent specified in the related
Prospectus Supplement in the event that more than one Trust Fund has an
interest in the balances of a Mortgage Loan.
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In general, the standard form of fire and extended coverage insurance policy
covers physical damage to or destruction of the improvements on the property
by fire, lightning, explosion, smoke, windstorm and hail, and riot, strike and
civil commotion, subject to the conditions and exclusions specified in each
policy. Although the policies relating to the Mortgage Loans will be
underwritten by different insurers under different state laws in accordance
with different applicable state forms and therefore will not contain identical
terms and conditions, the basic terms thereof are dictated by respective state
laws, and most such policies typically do not cover any physical damage
resulting from any of the following: war, revolution, governmental actions,
floods and other water-related causes, earth movement (including earthquakes,
landslides and mudflows), nuclear reactions, wet or dry rot, vermin, rodents,
insects or domestic animals, theft and, in certain cases, vandalism. The
foregoing list is merely indicative of certain kinds of uninsured risks and is
not intended to be all-inclusive. When a Mortgaged Property is located in a
federally designated special flood hazard area at the time of origination of
the related Real Estate Loan, the Agreement requires the Servicer to cause to
be maintained, for each such Real Estate Loan, flood insurance (to the extent
available) in an amount equal in general to the lesser of (a) the maximum
insurance available under the federal flood insurance program and (b) either
(i) the principal balance of the Real Estate Loan if it is a Home Improvement
Contract or a closed-end Mortgage Loan or (ii) the combined principal balance
of the Real Estate Loan and any mortgage loan senior to the Real Estate Loan
if such Real Estate Loan is a Revolving Credit Line Loan.
The hazard insurance policies covering the Mortgaged Properties typically
contain a co-insurance clause that in effect requires the insured at all times
to carry insurance of a specified percentage (generally 80% to 90%) of the
full replacement value of the improvements on the property in order to recover
the full amount of any partial loss. If the insured's coverage falls below
this specified percentage, such clause generally provides that the insurer's
liability in the event of partial loss does not exceed the greater of (i) the
replacement cost of the improvements less physical depreciation or (ii) such
proportion of the loss as the amount of insurance carried bears to the
specified percentage of the full replacement cost of such improvements.
Unless otherwise specified in the related Prospectus Supplement, the
Servicer will also maintain on REO Property that secured a defaulted Real
Estate Loan and that has been acquired upon foreclosure, deed in lieu of
foreclosure, or repossession, a standard hazard insurance policy in an amount
that is equal to the maximum insurable value of such REO Property. No
earthquake or other additional insurance will be required of any obligor or
will be maintained on REO Property acquired in respect of a defaulted Real
Estate Loan, other than pursuant to such applicable laws and regulations as
shall at any time be in force and shall require such additional insurance.
If the amount of hazard insurance maintained on the Mortgaged Properties
were to decline as the principal balances owing thereon decreased, hazard
insurance proceeds could be insufficient to restore fully the damaged property
in the event of a partial loss.
Under the terms of the Real Estate Loans, the borrowers generally are
required to present claims to insurers under hazard insurance policies
maintained on the Mortgaged Properties. The Servicer, on behalf of the Trustee
and Securityholders, is obligated to present claims under any blanket
insurance policy insuring against hazard losses on the Mortgaged Properties.
However, the ability of the Servicer to present such claims depends upon the
extent to which information in this regard is furnished to the Servicer by the
borrowers.
REALIZATION UPON DEFAULTED LOANS
Unless otherwise specified in the related Prospectus Supplement the Servicer
has the discretion to foreclose upon, repossess or otherwise comparably
convert the ownership of the Properties securing the related Loans as come
into and continue in default and as to which no satisfactory arrangements can
be made for collection of delinquent payments in the same manner it forecloses
upon, repossesses or otherwise converts the ownership of properties securing
loans in the applicable portfolio of Loans; provided that if the Servicer has
actual knowledge or reasonably believes that any Mortgaged Property is
contaminated by hazardous or toxic wastes or substances, then the Servicer
will not cause a Trust to acquire title to such Mortgaged Property in a
foreclosure or similar proceeding if such acquisition in the reasonable
opinion of the Servier is not commercially reasonable. In connection with such
foreclosure or other conversion, the Servicer will follow such practices and
procedures as it deems necessary or advisable and as are normal and usual in
its servicing activities with respect to comparable
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loans serviced by it. However, the Servicer will not be required to expend its
own funds in connection with any foreclosure or towards the restoration of the
Property unless it determines that (i) such restoration or foreclosure will
increase the Liquidation Proceeds in respect of the related Loan available to
the Holders after reimbursement to itself for such expenses and (ii) such
expenses will be recoverable by it either through Liquidation Proceeds or the
proceeds of insurance. Notwithstanding anything to the contrary herein, in the
case of a Trust Fund for which a REMIC election has been made, the Servicer
will be required to liquidate any Property acquired through foreclosure within
two years after the acquisition of the beneficial ownership of such Property.
While the holder of a Property acquired through foreclosure can often maximize
its recovery by providing financing to a new purchaser, the Trust Fund, if
applicable, will have no ability to do so and neither the Servicer nor the
Transferor will be required to do so.
The Servicer may arrange with the obligor on a defaulted Loan a modification
of such Loan (a "Modification") to the extent provided in the related
Prospectus Supplement. Such Modifications may only be entered into if they
meet the underwriting policies and procedures employed by the Servicer in
servicing receivables for its own account and meet the other conditions set
forth in the related Prospectus Supplement.
ENFORCEMENT OF DUE-ON-SALE CLAUSES
Unless otherwise specified in the related Prospectus Supplement for a
Series, when any Property is being conveyed by the obligor, the Servicer will
have the option to exercise its rights to accelerate the maturity of the
related Loan under the applicable "due-on-sale" clause, if any, unless such
exercise is not permitted under applicable law. In such event, the Servicer is
authorized to accept from or enter into an assumption agreement with the
person to whom such property has been or is about to be conveyed, pursuant to
which such person becomes liable under the Loan. To the extent permitted by
applicable law, such assumption will not release the original borrower from
its obligation under the Loan. Any fee collected in connection with an
assumption will be retained by the Servicer as additional servicing
compensation. The terms of a Loan may not be changed in connection with an
assumption except to the extent specified in the related Prospectus
Supplement.
SERVICING COMPENSATION AND PAYMENT OF EXPENSES
Except as otherwise provided in the related Prospectus Supplement, the
Servicer will be entitled to a periodic fee as servicing compensation (the
"Servicing Fee") in an amount to be determined as specified in the related
Prospectus Supplement. The Servicing Fee may be fixed or variable, as
specified in the related Prospectus Supplement. In addition, unless otherwise
specified in the related Prospectus Supplement, the Servicer will be entitled
to servicing compensation in the form of assumption fees, late payment charges
and similar items, or excess proceeds following disposition of Properties in
connection with defaulted Loans.
Except to the extent otherwise specified in the related Prospectus
Supplement, the Servicer will pay certain expenses incurred in connection with
the servicing of the Loans, including, without limitation, the payment of the
fees and expenses of the Trustee and independent accountants, payment of
insurance policy premiums and the cost of credit support, if any, and payment
of expenses incurred in preparation of reports to Holders.
When an obligor makes a principal prepayment in full between Due Dates on
the related Loan, the obligor will generally be required to pay interest on
the amount prepaid only to the date of prepayment. If and to the extent
provided in the related Prospectus Supplement in order that one or more
Classes of the Holders of a Series will not be adversely affected by any
resulting shortfall in interest, the amount of the Servicing Fee may be
reduced to the extent necessary to include in the Servicer's remittance to the
Trustee for distribution to Securityholders an amount equal to one month's
interest on the related Loan (less the Servicing Fee). If the aggregate amount
of such shortfalls in a month exceeds the Servicing Fee for such month, a
shortfall to Holders may occur.
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Unless otherwise specified in the related Prospectus Supplement, the
Servicer will be entitled to reimbursement for Servicer Advances. The related
Holders will suffer no loss by reason of such Servicer Advances to the extent
expenses are covered under related insurance policies or from excess
Liquidation Proceeds. If claims are either not made or paid under the
applicable insurance policies or if coverage thereunder has been exhausted,
the related Holders will suffer a loss to the extent that Liquidation
Proceeds, after reimbursement of the Servicer Advances, are less than the
outstanding principal balance of and unpaid interest on the related Loan which
would be distributable to Holders. The Servicer is generally also entitled to
reimbursement from the Collection Account or the Certificate Account for
Servicer Advances. In addition, the Servicer will be entitled to reimbursement
for Delinquency Advances as described above under "--Advances and Limitations
Thereon."
Unless otherwise specified in the related Prospectus Supplement, the rights
of the Servicer to receive funds from the Collection Account or the
Certificate Account for a Series, whether as the Servicing Fee or other
compensation, or for the reimbursement of Advances, expenses or otherwise, are
not subordinate to the rights of Holders of such Series.
EVIDENCE AS TO COMPLIANCE
If so specified in the related Prospectus Supplement, the applicable
Agreement for each Series will provide that each year, a firm of independent
public accountants will furnish a statement to the Trustee to the effect that
such firm has examined certain documents and records relating to the servicing
of the Loans by the Servicer and that such examination, which has been
conducted substantially in compliance with either (i) the audit guide for
audits of non-supervised mortgagees approved by the Department of Housing and
Urban Development or (ii) the requirements of the Uniform Single Attestation
Program for Mortgage Bankers, has disclosed no items of non-compliance with
the provisions of the applicable Agreement that, in the opinion of the firm,
are material, except for such items of non-compliance as shall be referred to
in the report.
If so specified in the related Prospectus Supplement, the applicable
Agreement for each Series will also provide for delivery to the Trustee for
such Series of an annual statement signed by an officer of the Servicer to the
effect that the Servicer has fulfilled its material obligations under such
Agreement throughout the preceding calendar year.
CERTAIN MATTERS REGARDING THE SERVICER
If an Event of Default occurs under either a Sale and Servicing Agreement or
a Pooling and Servicing Agreement, the Servicer may be replaced by the Trustee
or a successor Servicer. Unless otherwise specified in the related Prospectus
Supplement, such Events of Default and the rights of the Trustee upon such a
default under the Agreement for the related Series will be substantially
similar to those described under "THE AGREEMENTS--Events of Default; Rights
Upon Event of Default--Pooling and Servicing Agreement; Sale and Servicing
Agreement."
Unless otherwise specified in the related Prospectus Supplement, the
Servicer does not have the right to assign its rights and delegate its duties
and obligations under the related Agreement for each Series unless the
successor Servicer accepting such assignment or delegation (i) services
similar loans in the ordinary course of its business, (ii) is reasonably
satisfactory to the Trustee for the related Series, (iii) would not cause any
Rating Agency's rating of the Securities for such Series in effect immediately
prior to such assignment, sale or transfer to be qualified, downgraded or
withdrawn as a result of such assignment, sale or transfer and (iv) executes
and delivers to the Trustee and the Enhancer, if any, an agreement, in form
and substance reasonably satisfactory to the Trustee, and the Enhancer, if
any, which contains an assumption by such Servicer of the due and punctual
performance and observance of each covenant and condition to be performed or
observed by the Servicer under the related Agreement from and after the date
of such agreement. No such assignment will become effective until the Trustee
or a successor Servicer has assumed the servicer's obligations and duties
under the related Agreement. To the extent that the Servicer transfers its
obligations to a wholly-owned subsidiary or affiliate, such
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subsidiary or affiliate need not satisfy the criteria set forth above;
however, in such instance, the assigning Servicer will remain liable for the
servicing obligations under the related Agreement. Any entity into which the
Servicer is merged or consolidated or any successor corporation resulting from
any merger, conversion or consolidation will succeed to the Servicer's
obligations under the related Agreement provided that such successor or
surviving entity meets the requirements for a successor Servicer set forth
above.
The Servicer will not be under any liability to the Trust Fund or the
Securityholders for taking any action or for refraining from taking any action
in good faith pursuant to the Agreement, or for errors in judgment; provided,
however, that the Servicer will not be protected against any liability that
otherwise would be imposed by reason of willful misfeasance, bad faith or
gross negligence in the performance of duties or by reason of its reckless
disregard of its obligations and duties thereunder. Except to the extent
otherwise provided therein, each Agreement further will provide that the
Servicer and any director, officer, employee or agent of the Servicer will be
entitled to indemnification by the Trust Fund and will be held harmless to the
extent provided in the Agreement against any loss, liability or expense
incurred in connection with any legal action relating to the Agreement or the
Securities, other than any loss, liability or expense related to any specific
Loan or Loans (or balances thereof) (except any such loss, liability or
expense otherwise reimbursable pursuant to the Agreement) and any loss,
liability or expense incurred by the Servicer by reason of its willful
misfeasance, bad faith or gross negligence in the performance of its duties
thereunder or by reason of the Servicer's reckless disregard of its
obligations and duties thereunder.
Each Agreement will provide that the Servicer will not be under any
obligation to appear in, prosecute or defend any legal action that is not
incidental to its duties under the Agreement and that in its opinion may
involve it in any expense or liability. The Servicer, however, in its
discretion, may undertake any such action that it may deem necessary or
desirable with respect to the Agreement and the rights and duties of the
parties thereto and the interest of the Securityholders and the Enhancer, if
any, thereunder. In such event, the legal expenses and costs of such action
and any liability resulting therefrom will be expenses, costs and liabilities
of the Trust Fund and the Servicer will be entitled to be reimbursed therefor
to the extent provided in the Agreement. The Servicer's right to such
indemnity or reimbursement will survive any resignation or termination of the
Servicer with respect to any losses, expenses, costs or liabilities arising
prior to such resignation or termination (or arising from events that occurred
prior to such resignation or termination). Any claims by or on behalf of the
Securityholders or the Trust Fund will be made only against the Servicer, who
will be liable with respect to its own acts and omissions as well as the acts
and omissions of its directors, officer, employees and agents.
THE AGREEMENTS
The following summaries describe certain provisions of the Agreements. The
summaries do not purport to be complete and are subject to, and qualified in
their entirety by reference to, the provisions of the Agreements. Where
particular provisions or terms used in the Agreements are referred to, such
provisions or terms are as specified in the related Agreements.
ASSIGNMENT OF PRIMARY ASSETS
General. At the time of issuance of the Securities of a Series, the
Transferor will transfer, convey and assign to the Trust Fund all right, title
and interest of the Transferor in the Primary Assets and other property to be
transferred to the Trust Fund for a Series. Such assignment will include all
principal and interest due or received on or with respect to the Primary
Assets on or after the Cut-off Date to the extent specified in the related
Prospectus Supplement (except for any Retained Interests). The Trustee will,
concurrently with such assignment, execute and deliver the Securities.
Assignment of Loans. Unless otherwise specified in the related Prospectus
Supplement, the Transferor will, as to each Loan, deliver or cause to be
delivered to the Trustee, or, as specified in the related Prospectus
Supplement, a custodian on behalf of the Trustee (the "Custodian"), the
Mortgage Note endorsed without
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recourse to the order of the Trustee or in blank, the original Mortgage with
evidence of recording indicated thereon (except for any Mortgage not returned
from the public recording office, in which case a copy of such Mortgage will
be delivered, together with a certificate that the original of such Mortgage
was delivered to such recording office) and an assignment of the Mortgage in
recordable form. The Trustee, or, if so specified in the related Prospectus
Supplement, the Custodian, will hold such documents in trust for the benefit
of the Holders.
Unless otherwise specified in the related Prospectus Supplement, the
Transferor will as to each Home Improvement Contract deliver or cause to be
delivered to the Trustee (or the Custodian) the original Home Improvement
Contract and copies of documents and instruments related to each Home
Improvement Contract and, other than in the case of unsecured Home Improvement
Contracts, the security interest in the property securing such Home
Improvement Contract. In order to give notice of the right, title and interest
of Securityholders to the Home Improvement Contracts, the Transferor will
cause a UCC-1 financing statement to be executed by the Transferor identifying
the Trustee as the secured party and identifying all Home Improvement
Contracts as collateral. Unless otherwise specified in the related Prospectus
Supplement, the Home Improvement Contracts will not be stamped or otherwise
marked to reflect their assignment to the Trust Fund. Therefore, if, through
negligence, fraud or otherwise, a subsequent purchaser were able to take
physical possession of the Home Improvement Contracts without notice of such
assignment, the interest of Securityholders in the Home Improvement Contracts
could be defeated. See "CERTAIN LEGAL ASPECTS OF THE LOANS--The Home
Improvement Contracts."
With respect to Loans secured by Mortgages, if so specified in the related
Prospectus Supplement, the Transferor will, at the time of issuance of the
Securities, cause assignments to the Trustee of the Mortgages relating to the
Loans for a Series to be recorded in the appropriate public office for real
property records, except in states where, in the opinion of counsel acceptable
to the Trustee, such recording is not required to protect the Trustee's
interest in the related Loans. If specified in the related Prospectus
Supplement, the Transferor will cause such assignments to be so recorded
within the time after issuance of the Securities as is specified in the
related Prospectus Supplement, in which event, the Agreement may, as specified
in the related Prospectus Supplement, require the Transferor to repurchase
from the Trustee any Loan the related Mortgage of which is not recorded within
such time, at the price described below with respect to repurchases by reason
of defective documentation. Unless otherwise provided in the related
Prospectus Supplement, the enforcement of the repurchase obligation would
constitute the sole remedy available to the Holders or the Trustee for the
failure of a Mortgage to be recorded.
Each Loan will be identified in a schedule appearing as an exhibit to the
related Agreement (the "Loan Schedule"). Such Loan Schedule will specify with
respect to each Loan: the original principal amount and unpaid principal
balance as of the Cut-off Date; the current interest rate; the current
Scheduled Payment of principal and interest; the maturity date, if any, of the
related Mortgage Note; if the Loan is an adjustable rate Loan, the Lifetime
Rate Cap, if any, and the current index.
Assignment of Private Securities. The Transferor will cause Private
Securities to be registered in the name of the Trustee (or its nominee or
correspondent). The Trustee (or its nominee or correspondent) will have
possession of any certificated Private Securities. Unless otherwise specified
in the related Prospectus Supplement, the Trustee will not be in possession of
or be assignee of record of any underlying assets for a Private Security. See
"THE TRUST FUNDS--Private Securities." Each Private Security will be
identified in a schedule appearing as an exhibit to the related Agreement (the
"Certificate Schedule"), which will specify the original principal amount,
outstanding principal balance as of the Cut-off Date, annual pass-through rate
or interest rate and maturity date for each Private Security conveyed to the
Trust Fund. In the Agreement, the Transferor will represent and warrant to the
Trustee regarding the Private Securities: (i) that the information contained
in the Certificate Schedule is true and correct in all material respects; (ii)
that, immediately prior to the conveyance of the Private Securities, the
Transferor had good title thereto, and was the sole owner thereof (subject to
any Retained Interest); (iii) that there has been no other sale by it of such
Private Securities; and (iv) that there is no existing lien, charge, security
interest or other encumbrance (other than any Retained Interest) on such
Private Securities.
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Repurchase and Substitution of Non-Conforming Primary Assets. Unless
otherwise provided in the related Prospectus Supplement, if any document in
the file relating to the Primary Assets delivered by the Transferor to the
Trustee (or Custodian) is found by the Trustee within 90 days of the execution
of the related Agreement (or promptly after the Trustee's receipt of any
document permitted to be delivered after the Closing Date) to be defective in
any material respect and the Transferor does not cure such defect within 90
days, or within such other period specified in the related Prospectus
Supplement, the Transferor will, not later than 90 days or within such other
period specified in the related Prospectus Supplement, after the Trustee's
notice to the Transferor of the defect, repurchase the related Primary Asset
or any property acquired in respect thereof from the Trustee at a price equal
to, unless otherwise specified in the related Prospectus Supplement, the sum
of (a) the lesser of (i) the outstanding principal balance of such Primary
Asset and (ii) the Trust Fund's federal income tax basis in the Primary Asset
and (b) accrued and unpaid interest to the date of the repurchase/substitution
of such Primary Asset at the rate set forth in the related Agreement;
provided, however, the purchase price shall not be limited in (i) above to the
Trust Fund's federal income tax basis if the repurchase at a price equal to
the outstanding principal balance of such Primary Asset will not result in any
prohibited transaction tax under Section 860F(a) of the Code.
If provided in the related Prospectus Supplement, the Transferor, may,
rather than repurchase the Primary Asset as described above, remove such
Primary Asset from the Trust Fund (the "Deleted Primary Asset") and substitute
in its place one or more other Primary Assets (each, a "Qualifying Substitute
Primary Asset") provided, however, that with respect to a Trust Fund for which
a REMIC election is made, after a specified time period, the Trustee must have
received a satisfactory opinion of counsel that such substitution will not
cause the Trust Fund to lose its status as a REMIC or otherwise subject the
Trust Fund to a prohibited transaction tax.
Unless otherwise specified in the related Prospectus Supplement, any
Qualifying Substitute Primary Asset will have, on the date of substitution,
(i) an outstanding principal balance, after deduction of all Scheduled
Payments due in the month of substitution, not in excess of the outstanding
principal balance of the Deleted Primary Asset (the amount of any shortfall to
be deposited to the Collection Account in the month of substitution for
distribution to Holders), (ii) an interest rate not less than (and not more
than 2% greater than) the interest rate or Margin of the Deleted Primary
Asset, (iii) a remaining term-to-stated maturity not greater than (and not
more than two years less than) that of the Deleted Primary Asset, and will
comply with all of the representations and warranties set forth in the
applicable Agreement as of the date of substitution.
Unless otherwise provided in the related Prospectus Supplement, the above-
described cure, repurchase or substitution obligations constitute the sole
remedies available to the Holders or the Trustee for a material defect in a
document for a Primary Asset.
The Transferor will make representations and warranties with respect to
Primary Assets for a Series. If the Transferor or such entity cannot cure a
breach of any such representations and warranties in all material respects
within the time period specified in the related Prospectus Supplement after
notification by the Trustee of such breach, and if such breach is of a nature
that materially and adversely affects the value of such Primary Asset, the
Transferor is obligated to repurchase the affected Primary Asset or, if
provided in the related Prospectus Supplement, provide a Qualifying Substitute
Primary Asset therefor, subject to the same conditions and limitations on
purchases and substitutions as described above.
Unless otherwise provided in the related Prospectus Supplement, no Holder of
Securities of a Series, solely by virtue of such Holder's status as a Holder,
will have any right under the applicable Agreement for such Series to
institute any proceeding with respect to such Agreement, unless such Holder
previously has given to the Trustee for such Series written notice of default
and unless the Holders of Securities evidencing not less than 51% of the
aggregate voting rights of the Securities for such Series have made written
request upon the Trustee to institute such proceeding in its own name as
Trustee thereunder and have offered to the Trustee reasonable indemnity, and
the Trustee for 60 days has neglected or refused to institute any such
proceeding.
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REPORTS TO HOLDERS
The Trustee or other entity specified in the related Prospectus Supplement
will prepare and forward to each Holder on each Distribution Date, or as soon
thereafter as is practicable, a statement setting forth, to the extent
applicable to any Series and set forth in the related Prospectus Supplement,
among other things:
(i) the amount of principal distributed to Holders of the related
Securities and the outstanding principal balance of such Securities
following such distribution;
(ii) the amount of interest distributed to Holders of the related
Securities and the current interest on such Securities;
(iii) the amounts of (a) any overdue accrued interest included in such
distribution, (b) any remaining overdue accrued interest with respect to
such Securities or (c) any current shortfall in amounts to be distributed
as accrued interest to Holders of such Securities;
(iv) the amounts of (a) any overdue payments of scheduled principal
included in such distribution, (b) any remaining overdue principal amounts
with respect to such Securities, (c) any current shortfall in receipt of
scheduled principal payments on the related Primary Assets or (d) any
realized losses or Liquidation Proceeds to be allocated as reductions in
the outstanding principal balances of such Securities;
(v) the amount received under any related Enhancement, and the remaining
amount available under such Enhancement;
(vi) the amount of any delinquencies with respect to payments on the
related Primary Assets;
(vii) the book value of any REO Property acquired by the related Trust
Fund;
(viii) during the Pre-Funding Period, the remaining Pre-Funded Amount and
the portion of the Pre-Funding Amount used to acquire additional Primary
Assets since the preceding Distribution Date;
(ix) during the Pre-Funding Period, the amount remaining in the
Capitalized Interest Account; and
(x) such other information as specified in the related Agreement.
In addition, within a reasonable period of time after the end of each
calendar year the Trustee, unless otherwise specified in the related
Prospectus Supplement, will furnish to each Holder of record at any time
during such calendar year (a) the aggregate of amounts reported pursuant to
(i), (ii), and (iv)(d) above for such calendar year and (b) such information
specified in the related Agreement to enable Holders to prepare their tax
returns including, without limitation, the amount of original issue discount
accrued on the Securities, if applicable. Information in the Distribution Date
and annual statements provided to the Holders will not have been examined and
reported upon by an independent public accountant. However, the Servicer will
provide to the Trustee a report by independent public accountants with respect
to the Servicer's servicing of the Loans. See "SERVICING OF LOANS--Evidence as
to Compliance."
If so specified in the Prospectus Supplement for a Series of Securities,
such Series or one or more Classes of such Series will be issued in book-entry
form. In such event, owners of beneficial interests in such Securities will
not be considered Holders and will not receive such reports directly from the
Trustee. The Trustee will forward such reports only to the entity or its
nominee which is the registered holder of the global certificate which
evidences such book-entry securities. Beneficial owners will receive such
reports from the participants and indirect participants of the applicable
book-entry system in accordance with the practices and procedures of such
entities.
EVENTS OF DEFAULT; RIGHTS UPON EVENT OF DEFAULT
Pooling and Servicing Agreement; Sale and Servicing Agreement. Unless
otherwise specified in the related Prospectus Supplement, Events of Default
under the Pooling and Servicing Agreement or Sale and Servicing Agreement for
each Series of Securities relating to Loans include (i) any failure by the
Servicer to deposit amounts in the Collection Account and/or Certificate
Account and/or Distribution Account required to be made thereunder, which
failure continues unremedied for the number of days specified in the related
Prospectus
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Supplement after the giving of written notice of such failure to the Servicer
by the Trustee for such Series, or to the Servicer and the Trustee by the
Enhancer or by the Holders of such Series evidencing not less than 51% of the
aggregate voting rights of the Securities for such Series, (ii) any failure by
the Servicer duly to observe or perform in any material respect any other of
its covenants or agreements in the applicable Agreement which continues
unremedied for the number of days specified in the related Prospectus
Supplement after the giving of written notice of such failure to the Servicer
by the Trustee, or to the Servicer and the Trustee by the Enhancer or by the
Holders of such Series evidencing not less than 51% of the aggregate voting
rights of the Securities for such Series, and (iii) certain events of
insolvency, readjustment of debt, marshalling of assets and liabilities or
similar proceedings and certain actions by the Servicer indicating its
insolvency, reorganization or inability to pay its obligations.
So long as an Event of Default remains unremedied under the applicable
Agreement for a Series of Securities relating to the servicing of Loans,
unless otherwise specified in the related Prospectus Supplement, the Trustee
for such Series or Holders of Securities of such Series evidencing not less
than 51% of the aggregate voting rights of the Securities for such Series
with, if specified in the related Prospectus Supplement, the consent of the
Enhancer, may terminate all of the rights and obligations of the Servicer as
servicer under the applicable Agreement (other than its right to recovery of
other expenses and amounts advanced pursuant to the terms of such Agreement
which rights the Servicer will retain under all circumstances), whereupon the
Trustee will succeed to all the responsibilities, duties and liabilities of
the Servicer under such Agreement and will be entitled to reasonable servicing
compensation not to exceed the applicable servicing fee, together with other
servicing compensation in the form of assumption fees, late payment charges or
otherwise as provided in such Agreement.
In the event that the Trustee is unwilling or unable so to act, it may
select, or petition a court of competent jurisdiction to appoint, a finance
institution, bank or loan servicing institution with a net worth specified in
the related Prospectus Supplement to act as successor Servicer under the
provisions of the applicable Agreement. The successor Servicer would be
entitled to reasonable servicing compensation in an amount not to exceed the
Servicing Fee as set forth in the related Prospectus Supplement, together with
the other servicing compensation in the form of assumption fees, late payment
charges or otherwise, as provided in such Agreement.
During the continuance of any Event of Default of a Servicer under an
Agreement for a Series of Securities, the Trustee for such Series will have
the right to take action to enforce its rights and remedies and to protect and
enforce the rights and remedies of the Holders of such Series, and, unless
otherwise specified in the related Prospectus Supplement, Holders of
Securities evidencing not less than 51% of the aggregate voting rights of the
Securities for such Series may direct the time, method and place of conducting
any proceeding for any remedy available to the Trustee or exercising any trust
or power conferred upon that Trustee. However, the Trustee will not be under
any obligation to pursue any such remedy or to exercise any of such trusts or
powers unless such Holders have offered the Trustee reasonable security or
indemnity against the cost, expenses and liabilities which may be incurred by
the Trustee therein or thereby. The Trustee may decline to follow any such
direction if the Trustee determines that the action or proceeding so directed
may not lawfully be taken or would involve it in personal liability or be
unjustly prejudicial to the nonassenting Holders.
Indenture. Unless otherwise specified in the related Prospectus Supplement,
Events of Default under the Indenture for each Series of Notes include: (i) a
default for 30 days or more in the payment of any principal of or interest on
any Note of such Series; (ii) failure to perform any other covenant of the
Transferor or the Trust Fund in the Indenture which continues for a period of
60 days after notice thereof is given in accordance with the procedures
described in the related Prospectus Supplement; (iii) any representation or
warranty made by the Transferor or the Trust Fund in the Indenture or in any
certificate or other writing delivered pursuant thereto or in connection
therewith with respect to or affecting such Series having been incorrect in a
material respect as of the time made, and such breach is not cured within 60
days after notice thereof is given in accordance with the procedures described
in the related Prospectus Supplement; (iv) certain events of bankruptcy,
insolvency, receivership or liquidation of the Transferor or the Trust Fund;
or (v) any other Event of Default provided with respect to Notes of that
Series.
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If an Event of Default with respect to the Notes of any Series at the time
outstanding occurs and is continuing, either the Trustee or the Holders of a
majority of the then aggregate outstanding amount of the Notes of such Series
with, if specified in the related Prospectus Supplement, the consent of the
Enhancer, may declare the principal amount (or, if the Notes of that Series
are Zero Coupon Securities, such portion of the principal amount as may be
specified in the terms of that Series, as provided in the related Prospectus
Supplement) of all the Notes of such Series to be due and payable immediately.
Such declaration may, under certain circumstances, be rescinded and annulled
by the Holders of a majority in aggregate outstanding amount of the Notes of
such Series.
If, following an Event of Default with respect to any Series of Notes, the
Notes of such Series have been declared to be due and payable, the Trustee
may, in its discretion, notwithstanding such acceleration, elect to maintain
possession of the collateral securing the Notes of such Series and to continue
to apply distributions on such collateral as if there had been no declaration
of acceleration if such collateral continues to provide sufficient funds for
the payment of principal of and interest on the Notes of such Series as they
would have become due if there had not been such a declaration. In addition,
unless otherwise specified in the related Prospectus Supplement, the Trustee
may not sell or otherwise liquidate the collateral securing the Notes of a
Series following an Event of Default other than a default in the payment of
any principal or interest on any Note of such Series for 30 days or more,
unless (a) the Holders of 100% of the then aggregate outstanding amount of the
Notes of such Series consent to such sale, (b) the proceeds of such sale or
liquidation are sufficient to pay in full the principal of and accrued
interest due and unpaid on the outstanding Notes of such Series at the date of
such sale or (c) the Trustee determines that such collateral would not be
sufficient on an ongoing basis to make all payments on such Notes as such
payments would have become due if such Notes had not been declared due and
payable, and the Trustee obtains the consent of the Holders of 66 2/8% of the
then aggregate outstanding amount of the Notes of such Series.
In the event that the Trustee liquidates the collateral in connection with
an Event of Default involving a default for 30 days or more in the payment of
principal of or interest on the Notes of a Series, the Indenture provides that
the Trustee will have a prior lien on the proceeds of any such liquidation for
unpaid fees and expenses. As a result, upon the occurrence of such an Event of
Default, the amount available for distribution to the Noteholders may be less
than would otherwise be the case. However, the Trustee may not institute a
proceeding for the enforcement of its lien except in connection with a
proceeding for the enforcement of the lien of the Indenture for the benefit of
the Noteholders after the occurrence of such an Event of Default.
Unless otherwise specified in the related Prospectus Supplement, in the
event the principal of the Notes of a Series is declared due and payable, as
described above, the Holders of any such Notes issued at a discount from par
may be entitled to receive no more than an amount equal to the unpaid
principal amount thereof less the amount of such discount which is
unamortized.
Subject to the provisions of the Indenture relating to the duties of the
Trustee, in case an Event of Default shall occur and be continuing with
respect to a Series of Notes, the Trustee will be under no obligation to
exercise any of the rights or powers under the Indenture at the request or
direction of any of the Holders of Notes of such Series, unless such Holders
offered to the Trustee security or indemnity satisfactory to it against the
costs, expenses and liabilities which might be incurred by it in complying
with such request or direction. Subject to such provisions for indemnification
and certain limitations contained in the Indenture, the Holders of a majority
of the then aggregate outstanding amount of the Notes of such Series shall
have the right to direct the time, method and place of conducting any
proceeding for any remedy available to the Trustee or exercising any trust or
power conferred on the Trustee with respect to the Notes of such Series, and
the Holders of a majority of the then aggregate outstanding amount of the
Notes of such Series may, in certain cases, waive any default with respect
thereto, except a default in the payment of principal or interest or a default
in respect of a covenant or provision of the Indenture that cannot be modified
without the waiver or consent of all the Holders of the outstanding Notes of
such Series affected thereby.
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THE TRUSTEE
The identity of the commercial bank, savings and loan association or trust
company named as the Trustee for each Series of Securities will be set forth
in the related Prospectus Supplement. The entity serving as Trustee may have
normal banking relationships with the Transferor. In addition, for the purpose
of meeting the legal requirements of certain local jurisdictions, the Trustee
will have the power to appoint co-trustees or separate trustees of all or any
part of the Trust Fund relating to a Series of Securities. In the event of
such appointment, all rights, powers, duties and obligations conferred or
imposed upon the Trustee by the Agreement relating to such Series will be
conferred or imposed upon the Trustee and each such separate trustee or co-
trustee jointly, or, in any jurisdiction in which the Trustee shall be
incompetent or unqualified to perform certain acts, singly upon such separate
trustee or co-trustee who will exercise and perform such rights, powers,
duties and obligations solely at the direction of the Trustee. The Trustee may
also appoint agents to perform any of the responsibilities of the Trustee,
which agents will have any or all of the rights, powers, duties and
obligations of the Trustee conferred on them by such appointment; provided
that the Trustee will continue to be responsible for its duties and
obligations under the Agreement. In the event a Series includes both Notes and
Certificates, a separate Trustee identified in the related Prospectus
Supplement will serve as Trustee for the Certificateholders and for the Notes.
DUTIES OF THE TRUSTEE
The Trustee will not make any representations as to the validity or
sufficiency of the Agreement, the Securities or of any Primary Asset or
related documents. If no Event of Default (as defined in the related
Agreement) has occurred, the Trustee is required to perform only those duties
specifically required of it under the Agreement. Upon receipt of the various
certificates, statements, reports or other instruments required to be
furnished to it, the Trustee is required to examine them to determine whether
they are in the form required by the related Agreement. However, the Trustee
will not be responsible for the accuracy or content of any such documents
furnished to it by the Holders or the Servicer under the Agreement.
The Trustee may be held liable for its own negligent action or failure to
act, or for its own misconduct; provided, however, that the Trustee will not
be personally liable with respect to any action taken, suffered or omitted to
be taken by it in good faith in accordance with the direction of the Holders
in an Event of Default. The Trustee is not required to expend or risk its own
funds or otherwise incur any financial liability in the performance of any of
its duties under the Agreement, or in the exercise of any of its rights or
powers, if it has reasonable grounds for believing that repayment of such
funds or adequate indemnity against such risk or liability is not reasonably
assured to it.
RESIGNATION OF TRUSTEE
The Trustee may, upon written notice to the Transferor, and if specified in
the related Prospectus Supplement, the Enhancer, if any, resign at any time,
in which event the Transferor will be obligated to use its best efforts to
appoint a successor Trustee. If no successor Trustee has been appointed and
has accepted the appointment within the period specified in the Agreement
after the giving of such notice of resignation, the resigning Trustee may
petition any court of competent jurisdiction for appointment of a successor
Trustee. The Trustee may also be removed at any time (i) if the Trustee ceases
to be eligible to continue as such under the Agreement, (ii) if the Trustee
becomes insolvent or (iii) by the Holders of Securities evidencing over 50% of
the aggregate voting rights of the Securities in the Trust Fund upon written
notice to the Trustee and to the Transferor. Any resignation or removal of the
Trustee and appointment of a successor Trustee will not become effective until
acceptance of the appointment by the successor Trustee.
AMENDMENT OF AGREEMENT
Unless otherwise specified in the Prospectus Supplement, the Agreement for
each Series of Securities may be amended by the Transferor, the Servicer and
the Trustee with respect to such Series, without notice to or consent of the
Holders, (i) to cure any ambiguity, (ii) to correct any defective provisions
or to correct or
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supplement any provision therein, (iii) to add to the duties of the
Transferor, the Trust Fund or the Servicer, (iv) to add any other provisions
with respect to matters or questions arising under such Agreement or related
Enhancement, (v) to add or amend any provisions of such Agreement as required
by a Rating Agency in order to maintain or improve the rating of the
Securities (it being understood that none of the Transferor, the Servicer or
the Trustee is obligated to maintain or improve such rating), or (vi) to
comply with any requirements imposed by the Code; provided that any such
amendment except pursuant to clause (vi) above will not materially and
adversely affect the interests of any Holders of such Series or, if specified
in the related Prospectus Supplement, the Enhancer, as evidenced by an opinion
of counsel. Any such amendment except pursuant to clause (vi) of the preceding
sentence shall be deemed not to adversely affect in any material respect the
interests of any Holder if the Trustee receives written confirmation from each
Rating Agency rating such Securities that such amendment will not cause such
Rating Agency to withdraw or reduce the then current rating thereof. Unless
otherwise specified in the Prospectus Supplement, the Agreement for each
Series may also be amended by the Trustee, the Servicer, if applicable, and
the Transferor with respect to such Series with the consent of the Enhancer,
if specified in the related Prospectus Supplement or the Holders possessing
not less than 51% of the aggregate outstanding principal amount of the
Securities of such Series or, if only certain Classes of such Series are
affected by such amendment, 51% of the aggregate outstanding principal amount
of the Securities of each Class of such Series affected thereby, for the
purpose of adding any provisions to or changing in any manner or eliminating
any of the provisions of such Agreement or modifying in any manner the rights
of Holders of such Series; provided, however, that no such amendment may (a)
reduce the amount or delay the timing of payments on any Security without the
consent of the Holder of such Security; or (b) reduce the aforesaid percentage
of the aggregate outstanding principal amount of Securities of each Class, the
Holders of which are required to consent to any such amendment or (c) if
specified in the related Prospectus Supplement, adversely affect the interests
of the Enhancer, without, in the case of clauses (a) or (b), the consent of
the Holders of 100% of the aggregate outstanding principal amount of each
Class of Securities affected thereby.
VOTING RIGHTS
The related Prospectus Supplement will set forth the method of determining
allocation of voting rights with respect to a Series.
LIST OF HOLDERS
Upon written request of three or more Holders of record of a Series for
purposes of communicating with other Holders with respect to their rights
under the Agreement, which request is accompanied by a copy of the
communication which such Holders propose to transmit, the Trustee will afford
such Holders access during business hours to the most recent list of Holders
of that Series held by the Trustee.
No Agreement will provide for the holding of any annual or other meeting of
Holders.
BOOK-ENTRY SECURITIES
If specified in the Prospectus Supplement for a Series of Securities, such
Series or one or more Classes of such Series may be issued in book-entry form.
In such event, beneficial owners of such Securities will not be considered
"Holders" under the Agreements and may exercise the rights of Holders only
indirectly through the participants in the applicable book-entry system.
REMIC ADMINISTRATOR
For any Series with respect to which a REMIC election is made, preparation
of certain reports and certain other administrative duties with respect to the
Trust Fund may be performed by a REMIC administrator, who may be the
Transferor or an affiliate of the Transferor.
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TERMINATION
Pooling and Servicing Agreement; Trust Agreement. The obligations created by
the Pooling and Servicing Agreement or Trust Agreement for a Series will
terminate upon the distribution to Holders of all amounts distributable to
them pursuant to such Agreement after the earlier of (i) the later of (a) the
final payment or other liquidation of the last Primary Asset remaining in the
Trust Fund for such Series and (b) the disposition of all property acquired
upon foreclosure or deed in lieu of foreclosure or repossession in respect of
any Primary Asset or (ii) the repurchase, as described below, by the Servicer
or other entity specified in the related Prospectus Supplement from the
Trustee for such Series of all Primary Assets and other property at that time
subject to such Agreement. The Agreement for each Series permits, but does not
require, the Servicer or other entity specified in the related Prospectus
Supplement to purchase from the Trust Fund for such Series all remaining
Primary Assets at a price equal to, unless otherwise specified in the related
Prospectus Supplement, 100% of the aggregate Principal Balance of such Primary
Assets plus, with respect to any property acquired in respect of a Primary
Asset, if any, the outstanding Principal Balance of the related Primary Asset
at the time of foreclosure, less, in either case, related unreimbursed
Servicer Advances (in the case of the Primary Assets, only to the extent not
already reflected in the computation of the aggregate Principal Balance of
such Primary Assets) and unreimbursed expenses (that are reimbursable pursuant
to the terms of the Pooling and Servicing Agreement) plus, in either case,
accrued interest thereon at the weighted average rate on the related Primary
Assets through the last day of the Due Period in which such repurchase occurs;
provided, however, that if an election is made for treatment as a REMIC under
the Code, the repurchase price may equal the greater of (a) 100% of the
aggregate Principal Balance of such Primary Assets, plus accrued interest
thereon at the applicable net rates on the Primary Assets through the last day
of the month of such repurchase and (b) the aggregate fair market value of
such Primary Assets plus the fair market value of any property acquired in
respect of a Primary Asset and remaining in the Trust Fund. The exercise of
such right will effect early retirement of the Securities of such Series, but
such entity's right to so purchase is subject to the aggregate Principal
Balance of the Primary Assets at the time of repurchase being less than a
fixed percentage, to be set forth in the related Prospectus Supplement, of the
aggregate Principal Balance of the Primary Assets as of the Cut-off Date. In
no event, however, will the trust created by the Agreement continue beyond the
expiration of 21 years from the death of the last survivor of certain persons
identified therein. For each Series, the Servicer or the Trustee, as
applicable, will give written notice of termination of the Agreement to each
Holder, and the final distribution will be made only upon surrender and
cancellation of the Securities at an office or agency specified in the notice
of termination. If so provided in the related Prospectus Supplement for a
Series, the Transferor or another entity may effect an optional termination of
the Trust Fund under the circumstances described in such Prospectus
Supplement. See "DESCRIPTION OF THE SECURITIES--Optional Redemption, Purchase
or Termination."
Indenture. The Indenture will be discharged with respect to a Series of
Notes (except with respect to certain continuing rights specified in the
Indenture) upon the delivery to the Trustee for cancellation of all the Notes
of such Series or, with certain limitations, upon deposit with the Trustee of
funds sufficient for the payment in full of all of the Notes of such Series.
In addition to such discharge with certain limitations, the Indenture will
provide that, if so specified with respect to the Notes of any Series, the
related Trust Fund will be discharged from any and all obligations in respect
of the Notes of such Series (except for certain obligations relating to
temporary Notes and exchange of Notes, to register the transfer of or exchange
Notes of such Series, to replace stolen, lost or mutilated Notes of such
Series, to maintain paying agencies and to hold monies for payment in trust)
upon the deposit with the Trustee, in trust, of money and/or direct
obligations of or obligations guaranteed by the United States of America
which, through the payment of interest and principal in respect thereof in
accordance with their terms, will provide money in an amount sufficient to pay
the principal of and each installment of interest on the Notes of such Series
on the Final Scheduled Distribution Date for such Notes and any installment of
interest on such Notes in accordance with the terms of the Indenture and the
Notes of such Series. In the event of any such defeasance and discharge of
Notes of such Series, holders of Notes of such Series would be able to look
only to such money and/or direct obligations for payment of principal and
interest, if any, on their Notes until maturity.
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CERTAIN LEGAL ASPECTS OF THE LOANS
The following discussion contains summaries of certain legal aspects of
mortgage loans, home improvement installment sales contracts and home
improvement installment loan agreements which are general in nature. Because
certain of such legal aspects are governed by applicable state law (which laws
may differ substantially), the summaries do not purport to be complete nor
reflect the laws of any particular state (other than, in some cases, the
states of Maryland, Virginia and the District of Columbia (the "Mortgage Loan
Jurisdictions") where it is anticipated most of the Properties will be
located), nor encompass the laws of all states in which the properties
securing the Loans are situated.
MORTGAGES
The Loans for a Series will, and certain Home Improvement Contracts for a
Series may, be secured by either mortgages or deeds of trust or deeds to
secure debt (such Mortgage Loans and Home Improvement Contracts are
hereinafter referred to in this section as "mortgage loans"), depending upon
the prevailing practice in the state in which the property subject to a
mortgage loan is located. The filing of a mortgage, deed of trust or deed to
secure debt creates a lien or title interest upon the real property covered by
such instrument and represents the security for the repayment of an obligation
that is customarily evidenced by a promissory note and, with respect to Home
Improvement Contracts, the related contract. The priority of the liens is
important because, among other things, the foreclosure of a senior lien will
extinguish a junior lien, and because the holder of a senior lien generally
will have a right to receive insurance, condemnation or other proceeds before
the holder of a junior lien.
Priority between mortgages and deeds of trust (or other instruments of
record) generally depends in the first instance on the order of filing with
the appropriate government records office. Priority also may be affected by
the express terms of the mortgage or deed of trust.
Although priority among liens on the same property generally depends in the
first instance on the order of filing, there are a number of ways in which a
lien that is a senior lien when it is filed can become subordinate to a lien
filed at a later date. The trustee's title under a deed of trust is not prior
to any liens for real estate taxes and assessments, certain federal liens
(including certain federal criminal liens, environmental liens and tax liens),
certain mechanics and materialmen's liens, and other liens given priority by
applicable law. For example, in some jurisdictions, if advances are made under
the deed of trust after another lien (such as a judgment or mechanics lien) is
filed, the advances made after the filing of the intervening lien may be
subordinate to the intervening lien. In addition, in Virginia, the priority of
a mechanics lien may relate back to a date that substantially precedes the
date on which the mechanics lien is actually filed. Therefore, since a title
report or title policy only is accurate as of the date it is issued, it
provides no assurance that a deed of trust will retain perpetually the lien
priority it had when it was filed. The mortgages and deeds of trust securing
the Real Estate Loans include a requirement that each borrower maintain the
lien priority of each deed of trust.
There are two parties to a mortgage: the mortgagor, who is the
borrower/property owner or the land trustee (as described below), and the
mortgagee, who is the lender. Under the mortgage instrument, the mortgagor
delivers to the mortgagee a note or bond and the mortgage. In the case of a
land trust, there are three parties because title to the property is held by a
land trustee under a land trust agreement of which the borrower/property owner
is the beneficiary; at origination of a mortgage loan, the borrower executes a
separate undertaking to make payments on the mortgage note. Under a deed of
trust, the homeowner or borrower, called the "grantor," grants the security
property to a third-party grantee, called the "trustee," for the benefit of
the lender, usually called the "beneficiary." The deed of trust gives the
trustee the authority, if the borrower defaults, to sell the security property
in a "foreclosure" or "trustee's sale" and to apply the sale proceeds to the
secured debt. The mortgagee's authority under a mortgage and the trustee's
authority under a deed of trust are governed by the law of the state in which
the real property is located, the express provisions of the mortgage or deed
of trust, and, in some cases, in deed of trust transactions, the directions of
the beneficiary.
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FORECLOSURE ON MORTGAGES AND DEEDS OF TRUST
Foreclosure of a mortgage is generally accomplished by judicial action.
Generally, the action is initiated by the service of legal pleadings upon all
parties having an interest of record in the real property. Delays in
completion of the foreclosure occasionally may result from difficulties in
locating necessary parties defendant. When the mortgagee's right to
foreclosure is contested, the legal proceedings necessary to resolve the issue
can be time-consuming and expensive. After the completion of a judicial
foreclosure proceeding, the court may issue a judgment of foreclosure and
appoint a receiver or other officer to conduct the sale of the property. In
some states, mortgages may also be foreclosed without a judicial proceeding,
pursuant to a power of sale provided in the mortgage. Foreclosure of a
mortgage by using an advertisement is essentially similar to foreclosure of a
deed of trust by nonjudicial power of sale.
If a borrower defaults under a loan secured by a deed of trust, the lender
generally may bring suit against the borrower. The lender generally also may
attempt to collect the loan by causing the deed of trust to be enforced
against the property it encumbers. Enforcement of a deed of trust is
accomplished in most cases by a trustee's sale in which the trustee, upon
default of the grantor, and subject to the expiration of applicable cure
periods, sells the security property at a public sale under the terms of the
loan documents and subject to the applicable procedural provisions of state
law.
In Maryland, a summary court proceeding must be commenced (and a bond must
be filed) to effect a trustee's sale, even under a deed of trust that includes
a power of sale. In Virginia and the District of Columbia, a trustee's sale
generally is non-judicial, although foreclosure may be accomplished by
judicial action in all of the Mortgage Loan Jurisdictions. The term
"foreclosure" often is used as a shorthand way of referring to a trustee's
sale as well as to judicial foreclosure.
In Maryland and the District of Columbia, prior to a trustee's sale, the
trustee must record a notice of sale in the public records. In all of the
Mortgage Loan Jurisdictions, the trustee must give notice of the sale to the
grantor and/or to any successor in interest to the grantor. The trustee also
generally will give notice of the sale to the beneficiary of any junior deed
of trust or other lien and to certain other interested persons. This notice to
junior lien holders is required in Maryland and Virginia. In the Mortgage Loan
Jurisdictions, in addition to the notice to the grantor and others described
above, notice of sale must be published periodically in a local newspaper for
a prescribed period prior to the trustee's sale.
The trustee's sale generally must be conducted by public auction in the
county or city in which all or some part of the security property is located.
At the sale, the trustee generally requires a bidder to deposit with the
trustee a set amount or a percentage of the full amount of the bidder's final
bid in cash (or an equivalent thereto satisfactory to the trustee) prior to
and as a condition to recognizing such bid, and may conditionally accept and
hold these amounts for the duration of the sale. The beneficiary of the deed
of trust generally need not bid cash at the sale, but may instead make a
"credit bid" up to the extent of the total amount due under the deed of trust,
including costs and expenses actually incurred in enforcing the deed of trust,
as well as the trustee's fees and expenses. The trustee will sell the security
property to the highest proper bidder at the sale. Other than in Maryland,
judicial confirmation typically is not required after a sale conducted in
accordance with a power of sale in the Mortgage Loan Jurisdictions.
A sale conducted in accordance with the terms of the power of sale contained
in the deed of trust generally is presumed to be conducted regularly and
fairly, and, on a conveyance of the property by trustee's deed, confers
absolute legal title to the property to the purchaser, free of all junior
deeds of trust and free of all other liens and claims subordinate to the deed
of trust under which the sale is made. The purchaser's title, however, is
subject to all senior liens and other senior claims. Thus, if the deed of
trust being enforced is a junior deed of trust such as the deeds of trust
securing most of the Mortgage Loans, the trustee will convey title to the
property to the purchaser subject to the first deed of trust and any other
prior liens and claims. A trustee's sale or judicial foreclosure under a
junior deed of trust generally has no effect on any senior deed of trust, with
the possible exception of the right of a senior beneficiary to accelerate its
indebtedness under a default clause or a "due-on-sale" clause contained in the
senior deed of trust.
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Because a potential buyer at the sale may find it difficult to determine the
exact status of title and other facts about the security property, and because
the physical condition of the security property may have deteriorated, it
generally is more common for the lender, rather than an unrelated third party,
to purchase the security property at a trustee's sale or judicial foreclosure
sale. The lender (or other purchaser at the trustee's sale) will be subject to
the burdens of ownership, including the obligations to service any senior
mortgage or deed of trust, to obtain hazard insurance and to make such repairs
at its own expense as are necessary to render the security property suitable
for resale. The lender commonly will attempt to resell the security property
and obtain the services of a real estate broker and agree to pay the broker
commission in connection with the resale. Depending upon market conditions,
the ultimate proceeds of the resale of the security property may not be high
enough to equal the lender's investment. Property securing a Mortgage Loan
held by a Trust Fund for which a REMIC election has been made that is acquired
through a trustee's sale or judicial foreclosure must be sold by the Trustee
within two years after the date on which it is acquired, unless the IRS has
granted permission to sell such Property at a later date, in order to satisfy
certain Federal income tax requirements.
The proceeds received by the lender or trustee from the sale generally are
applied first to the costs, fees and expenses of sale and then in satisfaction
of the indebtedness secured by the mortgage or deed of trust under which the
sale was conducted. Any remaining proceeds generally are payable to the
holders of junior mortgages or deeds of trust and other liens and claims in
order of their priority. Any balance remaining generally is payable to the
borrower or grantor. Following the sale, if there are insufficient proceeds to
repay the secured debt, the lender or beneficiary under the foreclosed lien
generally may obtain a deficiency judgment against the grantor.
Some courts have been faced with the issue of whether federal or state
constitutional due process requires that borrowers under mortgages or deeds of
trust receive notices in addition to the statutorily prescribed minimum. For
the most part, the courts in these cases have upheld the notice provisions and
procedures described above.
An action to foreclose a mortgage or deed of trust is an action to recover
the secured debt by enforcing the mortgagee's or trustee's rights under the
mortgage or deed of trust. It is regulated by statutes and rules and subject
throughout to the court's equitable powers. Generally, a mortgagor or grantor
is bound by the terms of the related mortgage note and the mortgage or deed of
trust as made and cannot be relieved from his default if the mortgagee or
trustee has exercised its rights in a commercially reasonable manner. However,
since a foreclosure action historically was equitable in nature, the court may
exercise equitable powers to relieve a borrower of a default and deny the
foreclosure on proof that either the borrower's default was neither willful
nor in bad faith or the lender's action established a waiver, fraud, bad
faith, or oppressive or unconscionable conduct such as to warrant a court of
equity to refuse affirmative relief to the lender. Under certain circumstances
a court of equity may relieve the borrower from an entirely technical default
where such default was not willful.
A foreclosure action is subject to most of the delays and expenses of other
lawsuits if defenses or counterclaims are interposed, sometimes requiring up
to several years to complete. Moreover, a non-collusive, regularly conducted
foreclosure sale may be challenged as a fraudulent conveyance, regardless of
the parties' intent, if a court determines that the sale was for less than
fair consideration and such sale occurred while the borrower was insolvent and
within one year (or within the state statute of limitations if the trustee in
bankruptcy elects to proceed under state fraudulent conveyance law) of the
filing of bankruptcy. Similarly, a suit against the debtor on the related
mortgage note may take several years and, generally (although not with respect
to the Mortgage Loan Jurisdictions), is a remedy alternative to foreclosure,
the mortgagee being precluded from pursuing both at the same time.
In the case of foreclosure under either a mortgage or a deed of trust, the
sale by the referee or other designated officer or by the trustee is a public
sale. However, because of the difficulty potential third party purchasers at
the sale have in determining the exact status of title and because the
physical condition of the property may have deteriorated during the
foreclosure proceedings, it is uncommon for a third party to purchase the
property at a foreclosure sale. Rather, it is common for the lender to
purchase the property from the trustee
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or referee for an amount which may be equal to the unpaid principal amount of
the mortgage note secured by the mortgage or deed of trust plus accrued and
unpaid interest and the expenses of foreclosure, in which event the borrower's
debt will be extinguished or the lender may purchase for a lesser amount in
order to preserve its right against a borrower to seek a deficiency judgment
in states where such a judgment is available. Thereafter, subject to the right
of the borrower in some states to remain in possession during the redemption
period, the lender will assume the burdens of ownership, including obtaining
hazard insurance, paying taxes and making such repairs at its own expense as
are necessary to render the property suitable for sale. The lender will
commonly obtain the services of a real estate broker and pay the broker's
commission in connection with the sale of the property. Depending upon market
conditions, the ultimate proceeds of the sale of the property may not equal
the lender's investment in the property. Any loss may be reduced by the
receipt of any mortgage guaranty insurance proceeds.
RIGHTS OF REDEMPTION
In some states, after sale pursuant to a deed of trust or foreclosure of a
mortgage, the trustor or mortgagor and foreclosed junior lienors are given a
statutory period in which to redeem the property from the foreclosure sale.
The right of redemption should be distinguished from the equity of redemption,
which is a non-statutory right that must be exercised prior to the foreclosure
sale. In some states, redemption may occur only upon payment of the entire
principal balance of the loan, accrued interest and expenses of foreclosure.
In other states, redemption may be authorized if the former borrower pays only
a portion of the sums due. The effect of a statutory right of redemption is to
diminish the ability of the lender to sell the foreclosed property. The
exercise of a right of redemption would defeat the title of any purchaser at a
foreclosure sale, or of any purchaser from the lender subsequent to
foreclosure or sale under a deed of trust. Consequently the practical effect
of a right of redemption is to force the lender to retain the property and pay
the expenses of ownership until the redemption period has run. In some states,
there is no right to redeem property after a trustee's sale under a deed of
trust.
In the District of Columbia, the debtor under a residential deed of trust
(or anyone on the debtor's behalf) may cure a default during a reinstatement
period by paying the entire amount of the debt then due, exclusive of amounts
due solely to acceleration upon default, plus costs and expenses actually
incurred in enforcing the obligation and statutorily limited attorneys' and
trustee's fees. In all of the Mortgage Loan Jurisdictions, the grantor (or the
grantor's successor), any beneficiary under a junior deed of trust or any
other persons having a subordinate lien or encumbrance may discharge the deed
of trust on the security property by paying the entire principal due as a
result of the acceleration, together with interest and costs, expenses and
fees.
When the lender under a junior mortgage or deed of trust cures the default
and reinstates or redeems the senior mortgage or deed of trust, the amount
paid by the beneficiary for such cure generally becomes a part of the
indebtedness secured by the junior deed of trust.
State laws may control the amount of foreclosure expenses and costs,
including attorneys' fees, which may be recovered by a lender. In the Mortgage
Loan Jurisdictions, there generally is no right to redeem the security
property after the completion of a proper trustee's or foreclosure sale.
JUNIOR MORTGAGES; RIGHTS OF SENIOR MORTGAGES
The Mortgage Loans comprising or underlying the Primary Assets included in
the Trust Fund for a Series will be secured by mortgages or deeds of trust
which may be second or more junior mortgages to other mortgages held by other
lenders or institutional investors. The rights of the Trust Fund (and
therefore the Holders), under a junior mortgage or deed of trust, are
subordinate to those of the holder of the senior mortgage or deed of trust,
including the prior rights of the senior mortgagee or trustee to receive
hazard insurance and condemnation proceeds and to cause the property securing
the mortgage loan to be sold upon default of the borrower, thereby
extinguishing the junior mortgagee's lien unless the junior mortgagee or
trustee asserts its subordinate interest in the property in foreclosure
litigation and, possibly, satisfies the defaulted senior mortgage or deed of
trust. A junior lender may satisfy a defaulted senior loan in full and, in
some states, may cure such default and bring the
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senior loan current, in either event adding the amounts expended to the
balance due on the junior loan. In most states, absent a provision in the
mortgage or deed of trust, no notice of default is required to be given to a
junior mortgagee. In addition, as described above, the rights of the Trust
Fund may be or become subject to liens for real estate taxes and other
obligations. Although the Transferor generally does not cure defaults under a
senior deed of trust or other lien, it is the Transferor's standard practice
to protect its interest by monitoring any such sale of which it is aware and
bidding for property if it determines that it is in the Transferor's best
interests to do so.
The standard form of the mortgage or deed of trust used by most
institutional lenders, like that used by the Transferor, confers on the lender
the right both to receive all proceeds collected under any hazard insurance
policy and all awards made in connection with condemnation proceedings. The
lender generally has the right, subject to the specific provisions of the
mortgage or deed of trust securing its loan, to apply such proceeds and awards
to repair of any damage to the security property or to payment of any
indebtedness secured by the mortgage or deed of trust, in such order as the
lender may determine. Thus, in the event improvements on the property are
damaged or destroyed by fire or other casualty, or in the event the property
is taken by condemnation, the mortgagee or beneficiary under underlying senior
loans will have the prior right to collect any insurance proceeds payable
under a hazard insurance policy and any award of damages in connection with
the condemnation and to apply the same to the indebtedness secured by the
senior mortgages or deeds of trust. If available, proceeds in excess of the
amount of senior mortgage indebtedness, in most cases, will be applied to the
indebtedness of a junior mortgage.
The form of deed of trust or mortgage used by most institutional lenders
which make revolving home equity loans typically contains a "future advance"
clause, which provides, in essence, that additional amounts advanced to or on
behalf of the borrower by the beneficiary or lender are to be secured by the
deed of trust or mortgage. In Maryland, a future advance may be entitled to
receive the same priority as amounts initially advanced under the deed of
trust, notwithstanding that there may be intervening junior deeds of trust and
other liens between the date of recording of the deed of trust and the date of
the future advance, and notwithstanding that the beneficiary had actual
knowledge of such intervening deeds of trust and other liens at the time of
the advance so long as the additional amounts are within the maximum principal
amount stated in the deed of trust. In Virginia and the District of Columbia,
an intervening lien may gain priority, even if the lender had no knowledge of
the intervening lien at the time of an additional advance. The priority of
future advances over intervening liens may be affected in some states by
whether the beneficiary is obligated to advance the additional amount or has
notice or actual knowledge of the intervening junior deeds of trust and other
liens. In Maryland, priority of advances under the clause rests on a statute
giving priority to all advances or readvances made under the loan agreement to
a "credit limit" amount stated in the recorded deed of trust.
Other provisions typically found in the form of the mortgage or deed of
trust used by institutional lenders obligate the grantor or mortgagor to pay
before delinquency all taxes and assessments on the property and, when due,
all encumbrances, charges and liens on the property which appear prior to the
mortgage or deed of trust, to provide and maintain fire insurance on the
property, to maintain and repair the property and not to commit or permit any
waste thereof, and to appear in and defend any action or proceeding purporting
to affect the property or the rights of the mortgagee under the mortgage. Upon
a failure of the grantor or mortgagor to perform any of these obligations, the
mortgagee, trustee or beneficiary is given the right under certain mortgages
and deeds of trust to perform the obligation itself, at its election, with the
mortgagor agreeing to reimburse any sums so expended. The mortgage or deed of
trust typically provides that all sums so expended by the mortgagee,
beneficiary or trustee become part of the indebtedness secured by the
mortgage.
ANTI-DEFICIENCY LEGISLATION AND OTHER LIMITATIONS ON LENDERS
Certain states have imposed statutory prohibitions which limit the remedies
of a beneficiary under a deed of trust or a mortgagee under a mortgage. In
some states, statutes limit the right of the beneficiary or mortgagee to
obtain a deficiency judgment against the borrower following foreclosure or
sale under a deed of trust. A deficiency judgment is a personal judgment
against the former borrower equal in most cases to the difference
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between the net amount realized upon the public sale of the real property and
the amount due to the lender. Other statutes require the beneficiary or
mortgagee to exhaust the security afforded under a deed of trust or mortgage
by foreclosure in an attempt to satisfy the full debt before bringing a
personal action against the borrower. In certain other states, the lender has
the option of bringing a personal action against the borrower on the debt
without first exhausting such security; however, in some of these states, the
lender, following judgment on such personal action, may be deemed to have
elected a remedy and may be precluded from exercising remedies with respect to
the security. Consequently, the practical effect of the election requirement,
when applicable, is that lenders will usually proceed first against the
security rather than bringing a personal action against the borrower. Finally,
other statutory provisions limit any deficiency judgment against the former
borrower following a foreclosure sale to the excess of the outstanding debt
over the fair market value of the property at the time of the public sale. The
purpose of these statutes is generally to prevent a beneficiary or a mortgagee
from obtaining a large deficiency judgment against the former borrower as a
result of low or no bids at the foreclosure sale.
In addition to laws limiting or prohibiting deficiency judgments, numerous
other statutory provisions, including the federal bankruptcy laws, the Federal
Soldiers' and Sailors' Relief Act and state laws affording relief to debtors,
may interfere with or affect the ability of the secured lender to realize upon
collateral and/or enforce a deficiency judgment. For example, with respect to
federal bankruptcy law, the filing of a petition acts as a stay against the
enforcement of remedies for collection of a debt. Moreover, a court with
federal bankruptcy jurisdiction may permit a debtor through a Chapter 13
Bankruptcy Code rehabilitative plan to cure a monetary default with respect to
a loan on a debtor's residence by paying arrearages within a reasonable time
period and reinstating the original loan payment schedule even though the
lender accelerated the loan and the lender has taken all steps to realize upon
its security (provided no sale of the property has yet occurred) prior to the
filing of the debtor's Chapter 13 petition. Some courts with federal
bankruptcy jurisdiction have approved plans, based on the particular facts of
the reorganization case, that effected the curing of a loan default by
permitting the obligor to pay arrearages over a number of years.
Courts with federal bankruptcy jurisdiction have also indicated that the
terms of a mortgage loan may be modified if the borrower has filed a petition
under Chapter 13. These courts have suggested that such modifications may
include reducing the amount of each monthly payment, changing the rate of
interest, altering the repayment schedule and reducing the lender's security
interest to the value of the residence, thus leaving the lender a general
unsecured creditor for the difference between the value of the residence and
the outstanding balance of the loan. Federal bankruptcy law and limited case
law indicate that the foregoing modifications could not be applied to the
terms of a loan secured by property that is the principal residence of the
debtor. In all cases, the secured creditor is entitled to the value of its
security plus post-petition interest, attorney's fees and costs to the extent
the value of the security exceeds the debt.
In a Chapter 11 case under the Bankruptcy Code, the lender is precluded from
foreclosing without authorization from the bankruptcy court. The lender's lien
may be transferred to other collateral and/or be limited in amount to the
value of the lender's interest in the collateral as of the date of the
bankruptcy. The loan term may be extended, the interest rate may be adjusted
to market rates and the priority of the loan may be subordinated to bankruptcy
court-approved financing. The bankruptcy court can, in effect, invalidate due-
on-sale clauses through confirmed Chapter 11 plans of reorganization.
The Bankruptcy Code provides priority to certain tax liens over the lender's
security. This may delay or interfere with the enforcement of rights in
respect of a defaulted Loan. In addition, substantive requirements are imposed
upon lenders in connection with the origination and the servicing of mortgage
loans by numerous federal and some state consumer protection laws. The laws
include the federal Truth-in-Lending Act, Real Estate Settlement Procedures
Act, Equal Credit Opportunity Act, Fair Credit Billing Act, Fair Credit
Reporting Act and related statutes and regulations. These federal laws impose
specific statutory liabilities upon lenders who originate loans and who fail
to comply with the provisions of the law. In some cases, this liability may
affect assignees of the loans.
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DUE-ON-SALE CLAUSES IN MORTGAGE LOANS
Due-on-sale clauses permit the lender to accelerate the maturity of the loan
if the borrower sells or transfers, whether voluntarily or involuntarily, all
or part of the real property securing the loan without the lender's prior
written consent. The enforceability of these clauses has been the subject of
legislation or litigation in many states, and in some cases, typically
involving single family residential mortgage transactions, their
enforceability has been limited or denied. In any event, the Garn-St Germain
Depository Institutions Act of 1982 (the "Garn-St Germain Act") preempts state
constitutional, statutory and case law that prohibits the enforcement of due-
on-sale clauses and permits lenders to enforce these clauses in accordance
with their terms, subject to certain exceptions. As a result, due-on-sale
clauses have become generally enforceable except in those states whose
legislatures exercised their authority to regulate the enforceability of such
clauses with respect to mortgage loans that were (i) originated or assumed
during the "window period" under the Garn-St Germain Act which ended in all
cases not later than October 15, 1982, and (ii) originated by lenders other
than national banks, federal savings institutions and federal credit unions.
FHLMC has taken the position in its published mortgage servicing standards
that, out of a total of eleven "window period states," five states (Arizona,
Michigan, Minnesota, New Mexico and Utah) have enacted statutes extending, on
various terms and for varying periods, the prohibition on enforcement of due-
on-sale clauses with respect to certain categories of window period loans.
Also, the Garn-St Germain Act does "encourage" lenders to permit assumption of
loans at the original rate of interest or at some other rate less than the
average of the original rate and the market rate.
In addition, under federal bankruptcy law, due-on-sale clauses may not be
enforceable in bankruptcy proceedings and may, under certain circumstances, be
eliminated in any modified mortgage resulting from such bankruptcy proceeding.
ENFORCEABILITY OF PREPAYMENT AND LATE PAYMENT FEES
Forms of notes, mortgages and deeds of trust used by lenders may contain
provisions obligating the borrower to pay a late charge if payments are not
timely made, and in some circumstances may provide for prepayment fees or
penalties if the obligation is paid prior to maturity. In certain states,
there are or may be specific limitations upon the late charges which a lender
may collect from a borrower for delinquent payments. Certain states also limit
the amounts that a lender may collect from a borrower as an additional charge
if the loan is prepaid. Late charges and prepayment fees are typically
retained by servicers as additional servicing compensation.
EQUITABLE LIMITATIONS ON REMEDIES
In connection with lenders' attempts to realize upon their security, courts
have invoked general equitable principles. The equitable principles are
generally designed to relieve the borrower from the legal effect of his
defaults under the loan documents. Examples of judicial remedies that have
been fashioned include judicial requirements that the lender undertake
affirmative and expensive actions to determine the causes of the borrower's
default and the likelihood that the borrower will be able to reinstate the
loan. In some cases, courts have substituted their judgment for the lender's
judgment and have required that lenders reinstate loans or recast payment
schedules in order to accommodate borrowers who are suffering from temporary
financial disability. In other cases, courts have limited the right of a
lender to realize upon his security if the default under the security
agreement is not monetary, such as the borrower's failure adequately to
maintain the property or the borrower's execution of secondary financing
affecting the property. Finally, some courts have been faced with the issue of
whether or not federal or state constitutional provisions reflecting due
process concerns for adequate notice require that borrowers under security
agreements receive notices in addition to the statutorily-prescribed minimums.
For the most part, these cases have upheld the notice provisions as being
reasonable or have found that, in cases involving the sale by a trustee under
a deed of trust or by a mortgagee under a mortgage having a power of sale,
there is insufficient state action to afford constitutional protections to the
borrower.
Most conventional single-family mortgage loans may be prepaid in full or in
part without penalty. The regulations of the Office of Thrift Supervision (the
"OTS") prohibit the imposition of a prepayment penalty or
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equivalent fee for or in connection with the acceleration of a loan by
exercise of a due-on-sale clause. A mortgagee to whom a prepayment in full has
been tendered may be compelled to give either a release of the mortgage or an
instrument assigning the existing mortgage. The absence of a restraint on
prepayment, particularly with respect to mortgage loans having higher mortgage
rates, may increase the likelihood of refinancing or other early retirements
of such mortgage loans.
APPLICABILITY OF USURY LAWS
Each Mortgage Loan Jurisdiction has usury laws which limit the interest and
other amounts that may be charged under certain loans. Title V of the
Depository Institutions Deregulation and Monetary Control Act of 1980, enacted
in March 1980 ("Title V"), provides that state usury limitations shall not
apply to certain types of residential first mortgage loans originated by
certain lenders after March 31, 1980. Similar federal statutes were in effect
with respect to mortgage loans made during the first three months of 1980. The
OTS, as successor to the Federal Home Loan Bank Board, is authorized to issue
rules and regulations and to publish interpretations governing implementation
of Title V. Title V authorizes any state to reimpose interest rate limits by
adopting, before April 1, 1983, a state law, or by certifying that the voters
of such state have voted in favor of any provision, constitutional or
otherwise, which expressly rejects an application of the federal law. Any
contract which is secured by a first lien on certain kinds of consumer goods
would be covered if they satisfy certain conditions, among other things,
governing the terms of any prepayments, late charges and deferral fees and
requiring a 30-day notice period prior to instituting any action leading to
repossession of the related unit. Fifteen states adopted such a law prior to
the April 1, 1983 deadline. In addition, even where Title V is not so
rejected, any state is authorized by the law to adopt a provision limiting
discount points or other charges on mortgage loans covered by Title V.
THE HOME IMPROVEMENT CONTRACTS
General
The Home Improvement Contracts, other than those Home Improvement Contracts
that are unsecured or secured by mortgages on real estate (such Home
Improvement Contracts are hereinafter referred to in this section as
"contracts"), generally are "chattel paper" or constitute "purchase money
security interests" each as defined in the Uniform Commercial Code (the
"UCC"). Pursuant to the UCC, the sale of chattel paper is treated in a manner
similar to perfection of a security interest in chattel paper. Under the
related Agreement, the Transferor will transfer physical possession of the
contracts to the Trustee or a designated custodian or may retain possession of
the contracts as custodian for the Trustee. In addition, the Transferor will
make an appropriate filing of a UCC-1 financing statement in the appropriate
states to give notice of the Trustee's ownership of the contracts. Unless
otherwise specified in the related Prospectus Supplement, the contracts will
not be stamped or otherwise marked to reflect their assignment from the
Transferor to the Trustee. Therefore, if through negligence, fraud or
otherwise, a subsequent purchaser were able to take physical possession of the
contracts without notice of such assignment, the Trustee's interest in the
contracts could be defeated.
Security Interests in Home Improvements
The contracts that are secured by the Home Improvements financed thereby
grant to the originator of such contracts a purchase money security interest
in such Home Improvements to secure all or part of the purchase price of such
Home Improvements and related services. A financing statement generally is not
required to be filed to perfect a purchase money security interest in consumer
goods. Such purchase money security interests are assignable. In general, a
purchase money security interest grants to the holder a security interest that
has priority over a conflicting security interest in the same collateral and
the proceeds of such collateral. However, to the extent that the collateral
subject to a purchase money security interest becomes a fixture, in order for
the related purchase money security interest to take priority over a
conflicting interest in the fixture, the holder's interest in such Home
Improvement must generally be perfected by a timely fixture filing. In
general, a security interest does not exist under the UCC in ordinary building
material incorporated into an improvement on land.
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Home Improvement Contracts that finance lumber, bricks, other types of
ordinary building material or other goods that are deemed to lose such
characterization, upon incorporation of such materials into the related
property, will not be secured by a purchase money security interest in the
Home Improvement being financed.
Enforcement of Security Interest in Home Improvements
So long as the Home Improvement has not become subject to the real estate
law, a creditor can repossess a Home Improvement securing a contract by
voluntary surrender, by "self-help" repossession that is "peaceful" (i.e.,
without breach of the peace) or, in the absence of voluntary surrender and the
ability to repossess without breach of the peace, by judicial process. The
holder of a contract must give the debtor a number of days' notice, which
varies from 10 to 30 days depending on the state, prior to commencement of any
repossession. The UCC and consumer protection laws in most states place
restrictions on repossession sales, including requiring prior notice to the
debtor and commercial reasonableness in effecting such a sale. The law in most
states also requires that the debtor be given notice of any sale prior to
resale of the unit so that the debtor may redeem it at or before such resale.
Under the laws applicable in most states, a creditor is entitled to obtain a
deficiency judgment from a debtor for any deficiency on repossession and
resale of the property securing the debtor's loan. However, some states impose
prohibitions or limitations on deficiency judgments, and in many cases the
defaulting borrower would have no assets with which to pay a judgment.
Certain other statutory provisions, including federal and state bankruptcy
and insolvency laws and general equitable principles, may limit or delay the
ability of a lender to repossess and resell collateral or enforce a deficiency
judgment.
Consumer Protection Laws
The so-called "Holder-in-Due-Course" rule of the Federal Trade Commission is
intended to defeat the ability of the transferor of a consumer credit contract
which is the seller of goods which gave rise to the transaction (and certain
related lenders and assignees) to transfer such contract free of notice of
claims by the debtor thereunder. The effect of this rule is to subject the
assignee of such a contract to all claims and defenses which the debtor could
assert against the seller of goods. Liability under this rule is limited to
amounts paid under a contract; however, the obligor also may be able to assert
the rule to set off remaining amounts due as a defense against a claim brought
by the Trustee against such obligor. Numerous other federal and state consumer
protection laws impose requirements applicable to the origination and lending
pursuant to the contracts, including the Truth in Lending Act, the Federal
Trade Commission Act, the Fair Credit Billing Act, the Fair Credit Reporting
Act, the Equal Credit Opportunity Act, the Fair Debt Collection Practices Act
and the Uniform Consumer Credit Code. In the case of some of these laws, the
failure to comply with their provisions may affect the enforceability of the
related contract.
INSTALLMENT SALES CONTRACTS
The Loans may also consist of installment sales contracts. Under an
installment sales contract ("Installment Sales Contract") the seller
(hereinafter referred to in this section as the "lender") retains legal title
to the property and enters into an agreement with the purchaser (hereinafter
referred to in this section as the "borrower") for the payment of the purchase
price, plus interest, over the term of such contract. Only after full
performance by the borrower of the contract is the lender obligated to convey
title to the property to the purchaser. As with mortgage or deed of trust
financing, during the effective period of the Installment Sales Contract, the
borrower is generally responsible for maintaining the property in good
condition and for paying real estate taxes, assessments and hazard insurance
premiums associated with the property.
The method of enforcing the rights of the lender under an Installment Sales
Contract varies on a state-by-state basis depending upon the extent to which
state courts are willing, or able pursuant to state statute, to enforce
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the contract strictly according to the terms. The terms of Installment Sales
Contracts generally provide that upon a default by the borrower, the borrower
loses his or her right to occupy the property, the entire indebtedness is
accelerated, and the buyer's equitable interest in the property is forfeited.
The lender in such a situation does not have to foreclose in order to obtain
title to the property, although in some cases a quiet title action is in order
if the borrower has filed the Installment Sales Contract in local land
records, and an ejectment action may be necessary to recover possession. In a
few states, particularly in cases of borrower default during the early years
of an Installment Sales Contract, the courts will permit ejectment of the
buyer and a forfeiture of his or her interest in the property. However, most
state legislatures have enacted provisions by analogy to mortgage law
protecting borrowers under Installment Sales Contracts from the harsh
consequences of forfeiture. Under such statutes, a judicial or nonjudicial
foreclosure may be required, the lender may be required to give notice of
default and the borrower may be granted some grace period during which the
Installment Sales Contract may be reinstated upon full payment of the default
amount and the borrower may have a post-foreclosure statutory redemption
right. In other states, courts in equity may permit a borrower with
significant investment in the property under an Installment Sales Contract for
the sale of real estate to share in the proceeds of sale of the property after
the indebtedness is repaid or may otherwise refuse to enforce the forfeiture
clause. Nevertheless, generally speaking, the lender's procedures for
obtaining possession and clear title under an Installment Sales Contract in a
given state are simpler and less time-consuming and costly than are the
procedures for foreclosing and obtaining clear title to a property subject to
one or more liens.
ENVIRONMENTAL LEGISLATION
A federal statute, the Comprehensive Environmental Response, Compensation,
and Liability Act of 1980, and a growing number of state laws impose a
statutory lien for associated costs on property that is the subject of a
clean-up action on account of hazardous wastes or hazardous substances
released or disposed of on the property. Such a lien generally will have
priority over all subsequent liens on the property and, in certain of these
states, will have priority over prior recorded liens, including the lien of a
deed of trust. The priority of the environmental lien under federal law
depends on the time of perfection of the federal lien compared to the time of
perfection of any competing liens under applicable state law. In addition,
under federal environmental legislation and possibly under state law in a
number of states, a secured party that takes a deed in lieu of foreclosure or
acquires a property at a foreclosure sale may be liable for the costs of
cleaning up a contaminated site. Although such costs could be substantial,
they would probably not be imposed on a secured lender (such as the applicable
Trust Fund) if it promptly marketed the foreclosed property for resale. In the
event that a Trust Fund acquired title to a property securing a Mortgage Loan
and cleanup costs were incurred in respect of the property, the holders of the
Securities might incur a delay in the payment if such costs were required to
be paid by such Trust Fund.
SOLDIERS' AND SAILORS' CIVIL RELIEF ACT OF 1940
Under the Soldiers' and Sailors' Civil Relief Act of 1940, members of all
branches of the military on active duty, including draftees and reservists in
military service, (i) are entitled to have interest rates reduced and capped
at 6% per annum, on obligations (including Loans) incurred prior to the
commencement of military service for the duration of military service, (ii)
may be entitled to a stay of proceedings on any kind of foreclosure or
repossession action in the case of defaults on such obligations entered into
prior to military service for the duration of military service and (iii) may
have the maturity of such obligations incurred prior to military service
extended, the payments lowered and the payment schedule readjusted for a
period of time after the completion of military service. However, the benefits
of (i), (ii), or (iii) above are subject to challenge by creditors and if, in
the opinion of the court, the ability of a person to comply with such
obligations is not materially impaired by military service, the court may
apply equitable principles accordingly. If a borrower's obligation to repay
amounts otherwise due on a Loan included in a Trust Fund for a Series is
relieved pursuant to the Soldiers' and Sailors' Civil Relief Act of 1940, none
of the Trust Fund, the Servicer, the Transferor nor the Trustee will be
required to advance such amounts, and any loss in respect thereof may reduce
the amounts available to be paid to the Holders of the Securities of such
Series. Unless otherwise specified in the related Prospectus Supplement,
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any shortfalls in interest collections on Loans or Underlying Loans relating
to the Private Securities, as applicable, included in a Trust Fund for a
Series resulting from application of the Soldiers' and Sailors' Civil Relief
Act of 1940 will be allocated to each Class of Securities of such Series that
is entitled to receive interest in respect of such Loans or Underlying Loans
in proportion to the interest that each such Class of Securities would have
otherwise been entitled to receive in respect of such Loans or Underlying
Loans had such interest shortfall not occurred.
THE TRANSFEROR
The Transferor is a federally chartered stock savings bank. The Transferor's
executive offices are located at 8401 Connecticut Avenue, Chevy Chase,
Maryland 20815, and the Transferor's telephone number is (301) 986-7000. The
Transferor is subject to comprehensive regulation, examination and supervision
by the OTS within the Department of the Treasury and the FDIC. Deposits at the
Transferor are fully insured up to $100,000 per insured depositor by the
Savings Association Insurance Fund, which is administered by the FDIC. For
further information regarding the Transferor, see "THE TRANSFEROR" in the
related Prospectus Supplement.
USE OF PROCEEDS
The Transferor will apply all or substantially all of the net proceeds from
the sale of each Series of Certificates for one or more of the following
purposes: (i) to establish any Reserve Fund, Pre-Funding Account or
Capitalized Interest Account, (ii) to pay costs of structuring and issuing
such Securities, including the costs of obtaining Enhancement and (iii) for
its general corporate purposes.
FEDERAL INCOME TAX CONSIDERATIONS
GENERAL
The following summary is based on the opinion of Stroock & Stroock & Lavan,
special counsel to the Transferor ("Federal Tax Counsel"), as to the material
federal income tax consequences of the purchase, ownership and disposition of
Securities. The summary does not purport to deal with all aspects of federal
income taxation that may affect particular investors in light of their
individual circumstances, nor with certain types of investors subject to
special treatment under the federal income tax laws. This summary focuses
primarily upon investors who will hold Securities as "capital assets"
(generally, property held for investment) within the meaning of Section 1221
of the Internal Revenue Code of 1986, as amended (the "Code"), but much of the
discussion is applicable to other investors as well. Because tax consequences
may vary based on the status or tax attributes of the owner of a Security,
prospective investors are advised to consult their own tax advisors concerning
the federal, state, local and any other tax consequences to them of the
purchase, ownership and disposition of the Securities. For purposes of this
tax discussion (except with respect to information reporting, or where the
context indicates otherwise), any reference to the "Holder" means the
beneficial owner of a Security.
The summary is based upon the provisions of the Code, the regulations
promulgated thereunder, including, where applicable, proposed regulations, and
the judicial and administrative rulings and decisions now in effect, all of
which are subject to change or possible differing interpretations. The
statutory provisions, regulations, and interpretations on which this
interpretation is based are subject to change, and such a change could apply
retroactively.
The federal income tax consequences to Holders will vary depending on
whether (i) the Securities of a Series are classified as indebtedness for
federal income tax purposes; (ii) an election is made to treat the Trust Fund
(or certain assets of the Trust Fund) relating to a particular Series of
Securities as a real estate mortgage investment conduit ("REMIC") under the
Code; (iii) the Securities represent an ownership interest for federal income
tax purposes in some or all of the assets included in the Trust Fund for a
Series; or (iv) for federal income
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tax purposes the Trust Fund relating to a particular Series of Certificates is
classified as a partnership. The Prospectus Supplement for each Series of
Securities will specify how the Securities will be treated for federal income
tax purposes and will discuss whether a REMIC election, if any, will be made
with respect to such Series.
TAXATION OF DEBT SECURITIES (INCLUDING REGULAR INTEREST SECURITIES)
Interest and Acquisition Discount. Securities representing regular interest
in a REMIC ("Regular Interest Securities") are generally taxable to Holders in
the same manner as evidences of indebtedness issued by the REMIC. Stated
interest on the Regular Interest Securities will be taxable as ordinary income
and taken into account using the accrual method of accounting, regardless of
the Holder's normal accounting method. Interest (other than original issue
discount) on Securities (other than Regular Interest Securities) that are
characterized as indebtedness for federal income tax purposes will be
includible in income by Holders thereof in accordance with their usual methods
of accounting. Securities characterized as debt for federal income tax
purposes and Regular Interest Securities will be referred to hereinafter
collectively as "Debt Securities." For Certificates treated as debt for
federal income tax purposes, see "Certain Certificates Treated as
Indebtedness."
Debt Securities that are Compound Interest Securities will, and certain of
the other Debt Securities may, be issued with "original issue discount"
("OID"). The following discussion is based in part on the rules governing OID
which are set forth in Sections 1271-1275 of the Code and the Treasury
regulations issued thereunder on February 2, 1994 (the "OID Regulations"). A
Holder should be aware, however, that the OID Regulations do not adequately
address certain issues relevant to prepayable securities, such as the Debt
Securities.
In general, OID, if any, will equal the difference between the stated
redemption price at maturity of a Debt Security and its issue price. A Holder
of a Debt Security must include such OID in gross income as ordinary interest
income as it accrues under a prescribed method which takes into account an
economic accrual of the discount. In general, OID must be included in income
in advance of the receipt of the cash representing that income. The amount of
OID on a Debt Security will be considered to be zero if it is less than a de
minimis amount determined under the Code.
The issue price of a Debt Security is the first price at which a substantial
amount of Debt Securities of that class are sold to the public (excluding bond
houses, brokers, underwriters or wholesalers). If less than a substantial
amount of a particular class of Debt Securities is sold for cash on or prior
to the Closing Date, the issue price for such class will be treated as the
fair market value of such class on the Closing Date. The stated redemption
price at maturity of a Debt Security includes the original principal amount of
the Debt Security, but generally will not include distributions of interest if
such distributions constitute "qualified stated interest."
Under the OID Regulations, interest payments will not be qualified stated
interest unless the interest payments are "unconditionally payable." The OID
Regulations state that interest is unconditionally payable if late payment of
interest (other than late payment that occurs within a reasonable grace
period) or nonpayment of interest is expected to be penalized or reasonable
remedies exist to compel payment. The meaning of "penalized" under the OID
regulations is unclear particularly in the case of obligations based on other
debt obligations. Interest payments on Debt Securities which do not have
reasonable remedies to compel timely payment of interest may not be qualified
stated interest, and such Debt Securities may have original issue discount.
Certain Debt Securities will provide for distributions of interest based on
a period that is the same length as the interval between Distribution Dates
but ends prior to each Distribution Date. Any interest that accrues prior to
the Closing Date may be treated under the OID Regulations either (i) as part
of the issue price and the stated redemption price at maturity of the Debt
Securities or (ii) as not included in the issue price or stated redemption
price. The OID Regulations provide a special application of the de minimis
rule for debt instruments with long first accrual periods where the interest
payable for the first period is at a rate which is effectively less than that
which applies in all other periods. In such cases, for the sole purpose of
determining whether original issue discount is de minimis, the OID Regulations
provide that the stated redemption price is equal to the instrument's
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issue price plus the greater of the amount of foregone interest or the excess
(if any) of the instrument's stated principal amount over its issue price.
Under the de minimis rule, OID on a Debt Security will be considered to be
zero if such OID is less than 0.25% of the stated redemption price at maturity
of the Debt Security multiplied by the weighted average maturity of the Debt
Security. For this purpose, the weighted average maturity of the Debt Security
is computed as the sum of the amounts determined by multiplying the number of
full years (i.e., rounding down partial years) from the issue date until each
distribution in reduction of stated redemption price at maturity is scheduled
to be made by a fraction, the numerator of which is the amount of each
distribution included in the stated redemption price at maturity of the Debt
Security and the denominator of which is the stated redemption price at
maturity of the Debt Security. Holders generally must report de minimis OID
pro rata as principal payments are received, and such income will be capital
gain if the Debt Security is held as a capital asset. However, accrual method
Holders may elect to accrue all de minimis OID as well as market discount
under a constant interest method. See "--Election to Treat All Interest as
Original Issue Discount".
The Holder of a Debt Security issued with OID must include in gross income,
for all days during its taxable year on which it holds such Debt Security, the
sum of the "daily portions" of such original issue discount. The amount of OID
includible in income by a Holder will be computed by allocating to each day
during a taxable year a pro rata portion of the original issue discount that
accrued during the relevant accrual period. In the case of a Debt Security
that is not a Regular Interest Security and the principal payments on which
are not subject to acceleration resulting from prepayments on the Loans, the
amount of OID includible in income of a Holder for an accrual period
(generally the period over which interest accrues on the debt instrument) will
equal the product of the yield to maturity of the Debt Security and the
adjusted issue price of the Debt Security, reduced by any payments of
qualified stated interest. The adjusted issue price is the sum of its issue
price plus prior accruals of OID, reduced by the total payments made with
respect to such Debt Security in all prior periods, other than qualified
stated interest payments.
The amount of OID to be included in income by a Holder of a debt instrument,
such as certain Classes of the Debt Securities, that is subject to
acceleration due to prepayments on other debt obligations securing such
instruments (a "Pay-Through Security"), is computed by taking into account the
anticipated rate of prepayments assumed in pricing the debt instrument (the
"Prepayment Assumption"). The amount of OID that will accrue during an accrual
period on a Pay-Through Security is the excess (if any) of the sum of (a) the
present value of all payments remaining to be made on the Pay-Through Security
as of the close of the accrual period and (b) the payments during the accrual
period of amounts included in the stated redemption price of the Pay-Through
Security, over the adjusted issue price of the Pay-Through Security at the
beginning of the accrual period. The present value of the remaining payments
is to be determined on the basis of three factors: (i) the original yield to
maturity of the Pay-Through Security (determined on the basis of compounding
at the end of each accrual period and properly adjusted for the length of the
accrual period), (ii) events which have occurred before the end of the accrual
period and (iii) the assumption that the remaining payments will be made in
accordance with the original Prepayment Assumption. The effect of this method
is to increase the portions of OID required to be included in income by a
Holder to take into account prepayments with respect to the Loans at a rate
that exceeds the Prepayment Assumption, and to decrease (but not below zero
for any period) the portions of OID required to be included in income by a
Holder of a Pay-Through Security to take into account prepayments with respect
to the Loans at a rate that is slower than the Prepayment Assumption. Although
OID will be reported to Holders of Pay-Through Securities based on the
Prepayment Assumption, no representation is made to Holders that Loans will be
prepaid at that rate or at any other rate.
The Transferor may adjust the accrual of OID on a Class of Regular Interest
Securities (or other regular interests in a REMIC) in a manner that it
believes to be appropriate, to take account of realized losses on the Loans,
although the OID Regulations do not provide for such adjustments. If the
Internal Revenue Service were to require that OID be accrued without such
adjustments, the rate of accrual of OID for a Class of Regular Interest
Securities could increase.
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Certain classes of Regular Interest Securities may represent more than one
class of REMIC regular interests. Unless the applicable Prospectus Supplement
specifies otherwise, the Trustee intends, based on the OID Regulations, to
calculate OID on such Securities as if, solely for the purposes of computing
OID, the separate regular interests were a single debt instrument.
A subsequent Holder of a Debt Security will also be required to include OID
in gross income, but such a Holder who purchases such Debt Security for an
amount that exceeds its adjusted issue price will be entitled (as will an
initial Holder who pays more than a Debt Security's issue price) to offset
such OID by comparable economic accruals of portions of such excess.
Effects of Defaults and Delinquencies. Holders will be required to report
income with respect to the related Securities under an accrual method without
giving effect to delays and reductions in distributions attributable to a
default or delinquency on the Loans, except possibly to the extent that it can
be established that such amounts are uncollectible. As a result, the amount of
income (including OID) reported by a Holder of such a Security in any period
could significantly exceed the amount of cash distributed to such Holder in
that period. The Holder will eventually be allowed a loss (or will be allowed
to report a lesser amount of income) to the extent that the aggregate amount
of distributions on the Securities is reduced as a result of a Loan default.
However, the timing and character of such losses or reductions in income are
uncertain and, accordingly, Holders of Securities should consult their own tax
advisors on this point.
Interest-Only Debt Securities. The Trust Fund intends to report income from
interest-only classes of Debt Securities to the Internal Revenue Service and
to Holders of interest-only Debt Securities based on the assumption that the
stated redemption price at maturity is equal to the sum of all payments
determined under the applicable prepayment assumption. As a result, such
interest-only Debt Securities Certificates will be treated as having original
issue discount.
Variable Rate Debt Securities. Under the OID Regulations, Debt Securities
paying interest at a variable rate (a "Variable Rate Debt Security") are
subject to special rules. A Variable Rate Debt Security will qualify as a
"variable rate debt instrument" if (i) its issue price does not exceed the
total noncontingent principal payments due under the Variable Rate Debt
Security by more than a specified de minimis amount and (ii) it provides for
stated interest, paid or compounded at least annually, at (a) one or more
qualified floating rates, (b) a single fixed rate and one or more qualified
floating rates, (c) a single objective rate or (d) a single fixed rate and a
single objective rate that is a qualified inverse floating rate.
A "qualified floating rate" is any variable rate where variations in the
value of such rate can reasonably be expected to measure contemporaneous
variations in the cost of newly borrowed funds in the currency in which the
Variable Rate Debt Security is denominated. A multiple of a qualified floating
rate will generally not itself constitute a qualified floating rate for
purposes of the OID Regulations. However, a variable rate equal to (i) the
product of a qualified floating rate and a fixed multiple that is greater than
zero but not more than 1.35 or (ii) the product of a qualified floating rate
and a fixed multiple that is greater than zero but not more than 1.35,
increased or decreased by a fixed rate will constitute a qualified floating
rate for purposes of the OID Regulations. In addition, under the OID
Regulations, two or more qualified floating rates that can reasonably be
expected to have approximately the same values throughout the term of the
Variable Rate Debt Security will be treated as a single qualified floating
rate (a "Presumed Single Qualified Floating Rate"). Two or more qualified
floating rates with values within 25 basis points of each other as determined
on the Variable Rate Debt Security's issue date will be conclusively presumed
to be a Presumed Single Qualified Floating Rate. Notwithstanding the
foregoing, a variable rate that would otherwise constitute a qualified
floating rate but which is subject to one or more restrictions such as a cap
or floor, will not be a qualified floating rate for purposes of the OID
Regulations unless the restriction is fixed throughout the term of the
Variable Rate Debt Security or the restriction will not significantly affect
the yield of the Variable Rate Debt Security.
An "objective rate" is a rate that is not itself a qualified floating rate
but which is determined using a single fixed formula and which is based upon
(i) one or more qualified floating rates, (ii) one or more rates where each
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rate would be a qualified floating rate for a debt instrument denominated in a
currency other than the currency in which the Variable Rate Debt Security is
denominated, (iii) either the yield or changes in the price of one or more
items of actively traded personal property or (iv) a combination of rates
described in (i), (ii) and (iii). The OID Regulations also provide that other
variable rates may be treated as objective rates if so designated by the
Internal Revenue Service in the future. Despite the foregoing, a variable rate
of interest on a Variable Rate Debt Security will not constitute an objective
rate if it is reasonably expected that the average value of such rate during
the first half of the Variable Rate Debt Security's term will be either
significantly less than or significantly greater than the average value of the
rate during the final half of the Variable Rate Debt Security's term. An
objective rate will qualify as a "qualified inverse floating rate" if such
rate is equal to a fixed rate minus a qualified floating rate, and variations
in the rate can reasonably be expected to reflect inversely contemporaneous
variations in the cost of newly borrowed funds. The OID Regulations also
provide that if a Variable Rate Debt Security provides for stated interest at
a fixed rate for an initial period of less than one year followed by a
variable rate that is either a qualified floating rate or an objective rate
and if the variable rate on the Variable Rate Debt Security's issue date is
intended to approximate the fixed rate, then the fixed rate and the variable
rate together will constitute either a single qualified floating rate or
objective rate, as the case may be (a "Presumed Single Variable Rate"). If the
value of the variable rate and the initial fixed rate are within 25 basis
points of each other as determined on the Variable Rate Debt Security's issue
date, the variable rate will be conclusively presumed to approximate the fixed
rate.
For Variable Rate Debt Securities that qualify as a "variable rate debt
instrument" under the OID Regulations and provide for interest at either a
single qualified floating rate, a single objective rate, a Presumed Single
Qualified Floating Rate or a Presumed Single Variable Rate throughout the term
(a "Single Variable Rate Debt Security"), original issue discount is computed
as described above based on the following: (i) stated interest on the Single
Variable Rate Debt Security which is unconditionally payable in cash or
property (other than debt instruments of the issuer) at least annually will
constitute qualified stated interest and (ii) by assuming that the variable
rate on the Single Variable Debt Security is a fixed rate equal to: (a) in the
case of a Single Variable Rate Debt Security with a qualified floating rate or
a qualified inverse floating rate, the value of, as of the issue date, the
qualified floating rate or the qualified inverse floating rate or (b) in the
case of a Single Variable Rate Debt Security with an objective rate (other
than a qualified inverse floating rate), a fixed rate which reflects the
reasonably expected yield for such Single Variable Debt Security.
In general, any Variable Rate Debt Security other than a Single Variable
Rate Debt Security (a "Multiple Variable Rate Debt Security") that qualifies
as a "variable rate debt instrument" will be converted into an "equivalent"
fixed rate debt instrument for purposes of determining the amount and accrual
of original issue discount and qualified stated interest on the Multiple
Variable Rate Debt Security. The OID Regulations generally require that such a
Multiple Variable Rate Debt Security be converted into an "equivalent" fixed
rate debt instrument by substituting any qualified floating rate or qualified
inverse floating rate provided for under the terms of the Multiple Variable
Rate Debt Security with a fixed rate equal to the value of the qualified
floating rate or qualified inverse floating rate, as the case may be, as of
the Multiple Variable Rate Debt Security's issue date. Any objective rate
(other than a qualified inverse floating rate) provided for under the terms of
the Multiple Variable Rate Debt Security is converted into a fixed rate that
reflects the yield that is reasonably expected for the Multiple Variable Rate
Debt Security. In the case of a Multiple Variable Rate Debt Security that
qualifies as a "variable rate debt instrument" and provides for stated
interest at a fixed rate in addition to either one or more qualified floating
rates or a qualified inverse floating rate, the fixed rate is initially
converted into a qualified floating rate (or a qualified inverse floating
rate, if the Multiple Variable Rate Debt Security provides for a qualified
inverse floating rate). Under such circumstances, the qualified floating rate
or qualified inverse floating rate that replaces the fixed rate must be such
that the fair market value of the Multiple Variable Rate Debt Security as of
the Multiple Variable Rate Debt Security's issue date is approximately the
same as the fair market value of an otherwise identical debt instrument that
provides for either the qualified floating rate or qualified inverse floating
rate rather than the fixed rate. Subsequent to converting the fixed rate into
either a qualified floating rate or a qualified inverse floating rate, the
Multiple Variable Rate Debt Security is then converted into an "equivalent"
fixed rate debt instrument in the manner described above.
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Once the Multiple Variable Rate Debt Security is converted into an
"equivalent" fixed rate debt instrument pursuant to the foregoing rules, the
amount of original issue discount and qualified stated interest, if any, are
determined for the "equivalent" fixed rate debt instrument by applying the
original issue discount rules to the "equivalent" fixed rate debt instrument
in the manner described above. A Holder of the Multiple Variable Rate Debt
Security will account for such original issue discount and qualified stated
interest as if the Holder held the "equivalent" fixed rate debt instrument.
Each accrual period appropriate adjustments will be made to the amount of
qualified stated interest or original issue discount assumed to have been
accrued or paid with respect to the "equivalent" fixed rate debt instrument in
the event that such amounts differ from the accrual amount of interest accrued
or paid on the Multiple Variable Rate Debt Security during the accrual period.
The OID Regulations do not clearly address the treatment of a Variable Rate
Debt Security that is based on a weighted average of the interest rates on
underlying Loans. Under the OID Regulations, interest payments on such a
Variable Rate Debt Security may be characterized as qualified stated interest
which is includible in income in a manner similar to that described in the
previous paragraph. However, it is also possible that interest payments on
such a Variable Rate Debt Security would be treated as contingent interest
(possibly includible in income when the payments become fixed) or in some
other manner.
If a Variable Rate Debt Security does not qualify as a "variable rate debt
instrument" under the OID Regulations, then the Variable Rate Debt Security
would be treated as a contingent payment debt obligation. It is not clear
under current law how a Variable Rate Debt Security would be taxed if such
Debt Security were treated as a contingent payment debt obligation.
Market Discount. A purchaser of a Security may be subject to the market
discount rules of Sections 1276-1278 of the Code. A Holder that acquires a
Debt Security with more than a prescribed de minimis amount of "market
discount" (generally, the excess of the principal amount of the Debt Security
over the purchaser's purchase price) will be required to include accrued
market discount in income as ordinary income in each month, but limited to an
amount not exceeding the principal payments on the Debt Security received in
that month and, if the Securities are sold, the gain realized. Such market
discount would accrue in a manner to be provided in Treasury regulations but,
until such regulations are issued, such market discount would in general
accrue either (i) on the basis of a constant yield (in the case of a Pay-
Through Security, taking into account a prepayment assumption) or (ii) in the
ratio of (a) in the case of Securities (or in the case of a Pass-Through
Security, as set forth below, the Loans underlying such Security) not
originally issued with original issue discount, stated interest payable in the
relevant period to total stated interest remaining to be paid at the beginning
of the period or (b) in the case of Securities (or, in the case of a Pass-
Through Security, as described below, the Loans underlying such Security)
originally issued at a discount, OID in the relevant period to total OID
remaining to be paid.
Section 1277 of the Code provides that, regardless of the origination date
of the Debt Security (or, in the case of a Pass-Through Security, the Loans),
the excess of interest paid or accrued to purchase or carry a Security (or, in
the case of a Pass-Through Security, as described below, the underlying Loans)
with market discount over interest received on such Security is allowed as a
current deduction only to the extent such excess is greater than the market
discount that accrued during the taxable year in which such interest expense
was incurred. In general, the deferred portion of any interest expense will be
deductible when such market discount is included in income, including upon the
sale, disposition, or repayment of the Security (or in the case of a Pass-
Through Security, an underlying Loan). A Holder may elect to include market
discount in income currently as it accrues, on all market discount obligations
acquired by such Holder during the taxable year such election is made and
thereafter, in which case the interest deferral rule will not apply.
Premium. A Holder who purchases a Debt Security (other than an Interest
Weighted Security to the extent described above) at a cost greater than its
stated redemption price at maturity, generally will be considered to have
purchased the Security at a premium, which it may elect to amortize as an
offset to interest income on such Security (and not as a separate deduction
item) on a constant yield method. Although no regulations addressing the
computation of premium accrual on securities similar to the Securities have
been issued, the legislative
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history of the 1986 Act indicates that premium is to be accrued in the same
manner as market discount. Accordingly, it appears that the accrual of premium
on a Class of Pay-Through Securities will be calculated using the prepayment
assumption used in pricing such Class. If a Holder makes an election to
amortize premium on a Debt Security, such election will apply to all taxable
debt instruments (including all REMIC regular interests and all pass-through
certificates representing ownership interests in a trust holding debt
obligations) held by the Holder at the beginning of the taxable year in which
the election is made, and to all taxable debt instruments acquired thereafter
by such Holder, and will be irrevocable without the consent of the Internal
Revenue Service. Purchasers who pay a premium for the Securities should
consult their tax advisors regarding the election to amortize premium and the
method to be employed.
Election to Treat All Interest as Original Issue Discount. The OID
Regulations permit a Holder Debt Security to elect to accrue all interest,
discount (including de minimis market or original issue discount) and premium
in income as interest, based on a constant yield method for Debt Securities
acquired on or after April 4, 1994. If such an election were to be made with
respect to a Debt Security with market discount, the Holder of the Debt
Security would be deemed to have made an election to include in income
currently market discount with respect to all other debt instruments having
market discount that such Holder of the Debt Security acquires during the year
of the election or thereafter. Similarly, a Holder of a Debt Security that
makes this election for a Debt Security that is acquired at a premium will be
deemed to have made an election to amortize bond premium with respect to all
debt instruments having amortizable bond premium that such Holder owns or
acquires. The election to accrue interest, discount and premium on a constant
yield method with respect to a Debt Security is irrevocable.
Sale or Exchange. A Holder's tax basis in its Debt Security is the price
such Holder pays for a Debt Security, plus amounts of OID or market discount
included in income and reduced by any payments received (other than qualified
stated interest payments) and any amortized premium. Gain or loss recognized
on a sale, exchange, or redemption of a Debt Security, measured by the
difference between the amount realized and the Debt Security's basis as so
adjusted, will generally be capital gain or loss, assuming that the Debt
Security is held as a capital asset. In the case of a Debt Security held by a
bank, thrift, or similar institution described in Section 582 of the Code,
however, gain or loss realized on the sale or exchange of a Debt Security will
be taxable as ordinary income or loss. In addition, gain from the disposition
of a Regular Interest Security that might otherwise be capital gain will be
treated as ordinary income to the extent of the excess, if any, of (i) the
amount that would have been includible in the Holder's income if the yield on
such Regular Interest Security had equaled 110% of the applicable federal rate
as of the beginning of such Holder's holding period, over the amount of
ordinary income actually recognized by the Holder with respect to such Regular
Interest Security. Currently, the maximum tax rate on ordinary income for
individual taxpayers is 39.6% and the maximum tax rate on long-term capital
gains for such taxpayers is 28%. The maximum tax rate on both ordinary income
and long-term capital gains of corporate taxpayers is 35%.
TAXATION OF THE REMIC AND ITS HOLDERS
General. In the opinion of Federal Tax Counsel, if a REMIC election is made
with respect to a Series of Securities, then the arrangement by which the
Securities of that Series are issued will be treated as a REMIC as long as all
of the provisions of the applicable Agreement are complied with and the
statutory and regulatory requirements are satisfied. Securities will be
designated as "Regular Interests" or "Residual Interests" in a REMIC, as
specified in the related Prospectus Supplement.
Status of Regular Interest Securities as Real Property Loans. Regular
Interest Securities and Securities representing a residual interest in a REMIC
(both types of securities collectively referred to as "REMIC Securities") will
be "qualifying real property loans" within the meaning of Section 593(d) of
the Code, "real estate assets" for purposes of Section 856(c)(5)(A) of the
Code and assets described in Section 7701(a)(19)(C) of the Code (assets
qualifying under one or more of those sections, applying each section
separately, "qualifying assets") to the extent that the REMIC's assets are
qualifying assets. However, if at least 95% of the REMIC's
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assets are qualifying assets, then 100% of the REMIC Securities will be
qualifying assets. Similarly, income on the REMIC Securities will be treated
as "interest on obligations secured by mortgages on real property" within the
meaning of Section 856(c)(3)(B) of the Code, subject to the limitations of the
preceding two sentences. In addition to Loans, the REMIC's assets will include
payments on Loans held pending distribution to Holders of REMIC Securities,
amounts in reserve accounts (if any), other credit enhancements (if any) and
possibly buydown funds ("Buydown Funds"). The Loans generally will be
qualifying assets under all three of the foregoing sections of the Code.
However, Loans that are not secured by residential real property or real
property used primarily for church purposes may not constitute qualifying
assets under Section 7701(a)(19)(C)(v) of the Code, and Loans that are not
secured by improved real property or real property which is to be improved
using Loan proceeds will not constitute qualifying assets under Section 593(d)
of the Code. In addition, to the extent that the principal amount of a Loan
exceeds the value of the property securing the Loan, it is unclear and Federal
Tax Counsel is unable to opine whether the Loans will be qualifying assets.
The regulations under Sections 860A through 860G of the Code (the "REMIC
Regulations") treat credit enhancements as part of the mortgage or pool of
mortgages to which they relate, and therefore credit enhancements generally
should be qualifying assets. Regulations issued in conjunction with the REMIC
Regulations provide that amounts paid on Loans and held pending distribution
to Holders of Regular Interest Securities ("cash flow investments") will be
treated as qualifying assets. It is unclear whether reserve funds or Buydown
Funds would also constitute qualifying assets under any of those provisions.
REMIC EXPENSES; SINGLE CLASS REMICS
As a general rule, all of the expenses of a REMIC will be taken into account
by Holders of the Residual Interest Securities. In the case of a "single class
REMIC," however, the expenses will be allocated, under Treasury regulations,
among the Holders of the Regular Interest Securities and the Holders of the
Residual Interest Securities on a daily basis in proportion to the relative
amounts of income accruing to each Holder on that day. In the case of a Holder
of a Regular Interest Security who is an individual or a "pass-through
interest Holder" (including certain pass-through entities but not including
real estate investment trusts), such expenses will be deductible only to the
extern that such expenses, plus other "miscellaneous itemized deductions" of
the Holder, exceed 2% of such Holder's adjusted gross income and such Holder
may not be able to deduct such fees and expenses to any extent in computing
such Holder's alternative minimum tax liability. In addition, the amount of
itemized deductions otherwise allowable for the taxable year for an individual
whose adjusted gross income exceeds the applicable amount (for 1996, such
amount is $117,950 for all taxpayers except married taxpayers filling
separately, for whom such amount is $58,975) will be reduced by the lesser of
(i) 3% of the excess of adjusted gross income over the applicable amount, or
(ii) 80% of the amount of itemized deductions otherwise allowable for such
taxable year. The reduction or disallowance of this deduction may have a
significant impact on the yield of the Regular Interest Security to such a
Holder. In general terms, a single class REMIC is one that either (i) would
qualify, under existing Treasury regulations, as a grantor trust if it were
not a REMIC (treating all interests as ownership interests, even if they would
be classified as debt for federal income tax purposes) or (ii) is similar to
such a trust and which is structured with the principal purpose of avoiding
the single class REMIC rules. Unless otherwise stated in the applicable
Prospectus Supplement, the expenses of the REMIC will be allocated to Holders
of the related Residual Interest Securities.
TAXATION OF THE REMIC
General. Although a REMIC is a separate entity for federal income tax
purposes, a REMIC is not generally subject to entity-level tax. Rather, the
taxable income or net loss of a REMIC is taken into account by the Holders of
residual interests. As described above, the regular interests are generally
taxable as debt of the REMIC.
Tiered REMIC Structures. For certain Series of Securities, two or more
separate elections may be made to treat designated portions of the related
Trust Fund as REMICs ("Tiered REMICs") for federal income tax purposes. Upon
the issuance of any such Series of Securities, counsel to the Transferor will
deliver its opinion
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generally to the effect that, assuming compliance with all provisions of the
related Pooling and Servicing Agreement, the Tiered REMICs will each qualify
as a REMIC and the REMIC Certificates issued by the Tiered REMICs,
respectively, will be considered to evidence ownership of Regular Certificates
or Residual Certificates in the related REMIC within the meaning of the REMIC
Provisions.
Solely for purposes of determining whether the REMIC Certificates will be
"qualifying real property loans" under Section 593(d) of the Code, "real
estate assets" within the meaning of Section 856(c)(5)(A) of the Code, and
"loans secured by an interest in real property" under Section 7701(a)(19)(C)
of the Code, and whether the income on such Certificates is interest described
in Section 856(c)(3)(B) of the Code, the Tiered REMICs will be treated as one
REMIC.
Calculation of REMIC Income. The taxable income or net loss of a REMIC is
determined under an accrual method of accounting and in the same manner as in
the case of an individual, with certain adjustments. In general, the taxable
income or net loss will be the difference between (i) the gross income
produced by the REMIC's assets, including stated interest and any original
issue discount or market discount on loans and other assets, and (ii)
deductions, including stated interest and original issue discount accrued on
Regular Interest Securities, amortization of any premium with respect to
Loans, and servicing fees and other expenses of the REMIC. A Holder of a
Residual Interest Security that is an individual or a "pass-through interest
Holder" (including certain pass-through entities, but not including real
estate investment trusts) will be unable to deduct servicing fees payable on
the Loans or other administrative expenses of the REMIC for a given taxable
year, to the extent that such expenses, when aggregated with such Holder's
other miscellaneous itemized deductions for that year, do not exceed 2% of
such Holder's adjusted gross income and such Holder may not be able to deduct
such fees and expenses to any extent in computing such holders alternative
minimum tax liability.
For purposes of computing its taxable income or net loss, the REMIC should
have an initial aggregate tax basis in its assets equal to the aggregate fair
market value of the regular interests and the residual interests on the
Startup Day (generally, the day that the interests are issued). Such aggregate
basis will be allocated among the assets of the REMIC in proportion to their
respective fair market values.
The OID provisions of the Code apply to loans of individuals originated on
or after March 2, 1984, and the market discount provisions apply to loans.
Subject to possible application of the de minimis rules, the method of accrual
by the REMIC of OID income on such loans will be equivalent to the method
under which Holders of Pay-Through Securities accrue original issue discount
(i.e., under the constant yield method taking into account the Prepayment
Assumption). The REMIC will deduct OID on the Regular Interest Securities in
the same manner that the Holders of the Regular Interest Securities include
such discount in income, but without regard to the de minimis rules. See
"Taxation of Debt Securities (Including Regular Interest Securities)" above.
However, a REMIC that acquires loans at a market discount must include such
market discount in income currently, as it accrues, on a constant interest
basis.
To the extent that the REMIC's basis allocable to loans that it holds
exceeds their principal amounts, the resulting premium, if attributable to
mortgages originated after September 27, 1985, will be amortized over the life
of the loans (presumably taking into account the Prepayment Assumption) on a
constant yield method. Although the law is somewhat unclear regarding recovery
of premium attributable to loans originated on or before such date, it is
possible that such premium may be recovered in proportion to payments of loan
principal.
Prohibited Transactions and Contributions Tax. The REMIC will be subject to
a 100% tax on any net income derived from a "prohibited transaction." For this
purpose, net income will be calculated without taking into account any losses
from prohibited transactions or any deductions attributable to any prohibited
transaction that resulted in a loss. In general, prohibited transactions
include: (i) subject to limited exceptions, the sale or other disposition of
any qualified mortgage transferred to the REMIC; (ii) subject to a limited
exception, the sale or other disposition of a cash flow investment; (iii) the
receipt of any income from assets not permitted to be held by the REMIC
pursuant to the Code; or (iv) the receipt of any fees or other compensation
for services rendered by the REMIC. It is anticipated that a REMIC will not
engage in any prohibited transactions in which
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it would recognize a material amount of net income. In addition, subject to a
number of exceptions, a tax is imposed at the rate of 100% on amounts
contributed to a REMIC after the Startup Day. The Holders of Residual Interest
Securities will generally be responsible for the payment of any such taxes
imposed on the REMIC. To the extent not paid by such Holders or otherwise,
however, such taxes will be paid out of the Trust Fund and will be allocated
pro rata to all outstanding Classes of Securities of such REMIC.
TAXATION OF HOLDERS OF RESIDUAL INTEREST SECURITIES
The Holder of a Security representing a residual interest (a "Residual
Interest Security") will take into account the "daily portion" of the taxable
income or net loss of the REMIC for each day during the taxable year on which
such Holder held the Residual Interest Security. The daily portion is
determined by allocating to each day in any calendar quarter its ratable
portion of the taxable income or net loss of the REMIC for such quarter, and
by allocating that amount among the Holders (on such day) of the Residual
Interest Securities in proportion to their respective holdings on such day.
The Holder of a Residual Interest Security must report its proportionate
share of the taxable income of the REMIC whether or not it receives cash
distributions from the REMIC attributable to such income or loss. The
reporting of taxable income without corresponding distributions could occur,
for example, in certain REMIC issues in which the Loans held by the REMIC were
issued or acquired at a discount, since mortgage prepayments cause recognition
of discount income, while the corresponding portion of the prepayment could be
used in whole or in part to make principal payments on REMIC Regular Interests
issued without any discount or at an insubstantial discount. (If this occurs,
it is likely that cash distributions will exceed taxable income in later
years.) Taxable income may also be greater in earlier years of certain REMIC
issues as a result of the fact that interest expense deductions, as a
percentage of outstanding principal on REMIC Regular Interest Securities, will
typically increase over time as lower yielding Securities are paid, whereas
interest income with respect to loans will generally remain constant over time
as a percentage of loan principal.
In any event, because the Holder of a residual interest is taxed on the net
income of the REMIC, the taxable income derived from a Residual Interest
Security in a given taxable year will not be equal to the taxable income
associated with investment in a corporate bond or stripped instrument having
similar cash flow characteristics and pretax yield. Therefore, the after-tax
yield on the Residual Interest Security may be less than that of such a bond
or instrument.
Limitation on Losses. The amount of the REMIC's net loss that a Holder may
take into account currently is limited to the Holder's adjusted basis at the
end of the calendar quarter in which such loss arises. A Holder's basis in a
Residual Interest Security will initially equal such Holder's purchase price,
and will subsequently be increased by the amount of the REMIC's taxable income
allocated to the Holder, and decreased (but not below zero) by the amount of
distributions made and the amount of the REMIC's net loss allocated to the
Holder. Any disallowed loss may be carried forward indefinitely, but may be
used only to offset income of the REMIC generated by the same REMIC. The
ability of Holders of Residual Interest Securities to deduct net losses may be
subject to additional limitations under the Code, as to which such Holders
should consult their tax advisors.
Distributions. Distributions on a Residual Interest Security (whether at
their scheduled times or as a result of prepayments) will generally not result
in any additional taxable income or loss to a Holder of a Residual Interest
Security. If the amount of such payment exceeds a Holder's adjusted basis in
the Residual Interest Security, however, the Holder will recognize gain
(treated as gain from the sale of the Residual Interest Security) to the
extent of such excess.
Sale or Exchange. A Holder of a Residual Interest Security will recognize
gain or loss on the sale or exchange of a Residual Interest Security equal to
the difference, if any, between the amount realized and such Holder's adjusted
basis in the Residual Interest Security at the time of such sale or exchange.
Except to the extent provided in regulations, which have not yet been issued,
any loss upon disposition of a Residual Interest Security will be disallowed
if the selling Holder acquires any residual interest in a REMIC or similar
mortgage pool within six months before or after such disposition.
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Excess Inclusions. The portion of the REMIC taxable income of a Holder of a
Residual Interest Security consisting of "excess inclusion" income may not be
offset by other deductions or losses, including net operating losses, on such
Holder's federal income tax return. An exception applies to organizations to
which Code Section 593 applies (generally, certain thrift institutions);
however, such exception will not apply if the aggregate value of the Residual
Interest Securities is not considered to be "significant," as described below.
Further, if the Holder of a Residual Interest Security is an organization
subject to the tax on unrelated business income imposed by Code Section 511,
such Holder's excess inclusion income will be treated as unrelated business
taxable income of such Holder. In addition, under Treasury regulations yet to
be issued, if a real estate investment trust, a regulated investment company,
a common trust fund, or certain cooperatives were to own a Residual Interest
Security, a portion of dividends (or other distributions) paid by the real
estate investment trust (or other entity) would be treated as excess inclusion
income. If a Residual Security is owned by a foreign person, excess inclusion
income is subject to tax at a rate of 30% which may not be reduced by treaty,
is not eligible for treatment as "portfolio interest" and is subject to
certain additional limitations. See "Tax Treatment of Foreign Investors."
Regulations provide that a Residual Interest Security has significant value
only if (i) the aggregate issue price of the Residual Interest Security is at
least 2% of the aggregate of the issue prices of all Regular Interest
Securities and Residual Interest Securities in the REMIC and (ii) the
anticipated weighted average life (determined as specified in the Proposed
Regulations) of the Residual Interest Securities is at least 20% of the
weighted average life of the REMIC.
The excess inclusion portion of a REMIC's income is generally equal to the
excess, if any, of REMIC taxable income for the quarterly period allocable to
a Residual Interest Security, over the daily accruals for such quarterly
period of (i) 120% of the long term applicable federal rate on the Startup
Date multiplied by (ii) the adjusted issue price of such Residual Interest
Security at the beginning of such quarterly period. The adjusted issue price
of a Residual Interest Security at the beginning of each calendar quarter will
equal its issue price (calculated in a manner analogous to the determination
of the issue price of a Regular Interest Security), increased by the aggregate
of the daily accruals for prior calendar quarters, and decreased (but not
below zero) by the amount of loss allocated to a Holder and the amount of
distributions made on the Residual Interest Security before the beginning of
the quarter. The long-term federal rate, which is announced monthly by the
Treasury Department, is an interest rate that is based on the average market
yield of outstanding marketable obligations of the United States government
having remaining maturities in excess of nine years.
Under the REMIC Regulations, in certain circumstances, transfers of Residual
Interest Securities may be disregarded. See "--Restrictions on Ownership and
Transfer of Residual Interest Securities" and "Tax Treatment of Foreign
Investors" below.
Restrictions on Ownership and Transfer of Residual Interest Securities. As a
condition to qualification as a REMIC, reasonable arrangements must be made to
prevent the ownership of a REMIC residual interest by any "Disqualified
Organization." Disqualified Organizations include the United States, any State
or political subdivision thereof, any foreign government, any international
organization, or any agency or instrumentality of any of the foregoing, a
rural electric or telephone cooperative described in Section 1381(a)(2)(C) of
the Code, or any entity exempt from the tax imposed by Sections 1-1399 of the
Code, if such entity is not subject to tax on its unrelated business income.
Accordingly, the applicable Pooling and Servicing Agreement will prohibit
Disqualified Organizations from owning a Residual Interest Security. In
addition, no transfer of a Residual Interest Security will be permitted unless
the proposed transferee shall have furnished to the Trustee an affidavit
representing and warranting that it is neither a Disqualified Organization nor
an agent or nominee acing on behalf of a Disqualified Organization.
If a Residual Interest Security is transferred to a Disqualified
Organization (in violation of the restrictions set forth above), a substantial
tax will be imposed on the transferor of such Residual Interest Security at
the time of the transfer. In addition, if a Disqualified Organization holds an
interest in a pass-through entity (including, among others, a partnership,
trust, real estate investment trust, regulated investment company, or any
person holding as nominee an interest in a pass-through entity) that owns a
Residual Interest Security, the pass-through entity will be required to pay an
annual tax on its allocable share of the excess inclusion income of the REMIC.
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The REMIC Regulations provide that a transfer of a "noneconomic residual
interest" will be disregarded for all federal income tax purposes unless
impeding the assessment or collection of tax was not a significant purpose of
the transfer. A residual interest will be treated as a "noneconomic residual
interest" unless, at the time of the transfer (1) the present value of the
expected future distributions on the residual interest at least equals the
product of (x) the present value of all anticipated excess inclusions with
respect to the residual interest and (y) the highest corporate tax rate,
currently 35%, and (2) the transferor reasonably expects that for each
anticipated excess inclusion, the transferee will receive distributions from
the REMIC, at or after the time at which taxes on such excess inclusion
accrue, sufficient to pay the taxes thereon. A significant purpose to impede
the assessment or collection of tax exists if the transferor, at the time of
the transfer, either knew or should have known (had "improper knowledge") that
the transferee would be unwilling or unable to pay taxes due on its share of
the taxable income of the REMIC. A transferor will be presumed not to have
improper knowledge if (i) the transferor conducts, at the time of the
transfer, a reasonable investigation of the financial condition of the
transferee and, as a result of the investigation, the transferor finds that
the transferee has historically paid its debts as they came due and finds no
significant evidence to indicate that the transferee will not continue to pay
its debts as they come due in the future, and (ii) the transferee represents
to the transferor that (A) the transferee understands that it might incur tax
liabilities in excess of any cash received with respect to the residual
interest and (B) the transferee intends to pay the taxes associated with
owning the residual interest as they come due. A different formulation of this
rule applies to transfers of Residual Interest Security by or to foreign
transferees. See "Tax Treatment to Foreign Investors."
Mark to Market Rules. Prospective purchasers of a Residual Interest Security
should be aware that on December 28, 1993, the Internal Revenue Service
released temporary regulations (the "Temporary Mark-to-Market Regulations")
relating to the requirement that a securities dealer mark to market securities
held for sale to customers. This mark-to-market requirement applies to all
securities of a dealer, except to the extent that the dealer has specifically
identified a security as held for investment. The Temporary Mark-to-Market
Regulations provide that for purposes of this mark-to-market requirement, a
"negative value" Residual Interest Security is not treated as a security and
thus may not be marked to market. In addition, a dealer is not required to
identify such Residual Interest Security as held for investment. In general, a
Residual Interest Security has negative value if, as of the date a taxpayer
acquires the Residual Interest Security, the present value of the tax
liabilities associated with holding the Residual Interest Security exceeds the
sum of (i) the present value of the expected future distributions on the
Residual Interest Security, and (ii) the present value of the anticipated tax
savings associated with holding the Residual Interest Security as the REMIC
generates losses. The amounts and present values of the anticipated tax
liabilities, expected future distributions and anticipated tax savings are all
to be determined using (i) the prepayment and reinvestment assumptions adopted
under Section 1272(a)(6), or that would have been adopted had the REMIC's
regular interests been issued with OID, (ii) any required or permitted clean
up calls, or required qualified liquidation provided for in the REMIC's
organizational documents and (iii) a discount rate equal to the "applicable
Federal rate" (as specified in Section 1274(d)(1)), that would apply to a debt
instrument issued on the date of acquisition of the Residual Interest
Security. Furthermore, the Temporary Mark-to-Market Regulations provide the
IRS with the authority to treat any Residual Interest Security having
substantially the same economic effect as a "negative value" residual interest
as a "negative value" residual interest.
On January 3, 1995, the IRS released proposed regulations under Section 475
(the "Proposed Mark-to-Market Regulations"). The Proposed Mark-to-Market
Regulations provide that any REMIC Residual Interest acquired after January 3,
1995 cannot be marked to market, regardless of the value of such REMIC
residual interest. The Temporary Mark-to-Market Regulations described above
still apply to any REMIC Residual Interest acquired on or prior to January 3,
1995.
ADMINISTRATIVE MATTERS
The REMIC's books must be maintained on a calendar year basis and the REMIC
must file an annual federal income tax return. The REMIC will also be subject
to the procedural and administrative rules of the Code
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applicable to partnerships, including the determination of any adjustments to,
among other things, items of REMIC income, gain, loss, deduction, or credit,
by the IRS in a unified administrative proceeding.
TAX STATUS AS A GRANTOR TRUST
General. As specified in the related Prospectus Supplement, if a REMIC or
partnership election is not made and the Certificates are not treated as debt
for federal income tax purposes, in the opinion of Federal Tax Counsel, the
Trust Fund relating to a Series of Securities will be classified for federal
income tax purposes as a grantor trust under Subpart E, Part 1 of Subchapter J
of the Code and not as an association taxable as a corporation (the Securities
of such Series, "Pass-Through Securities"). Accordingly, each Holder of a
Pass-Through Security is treated for federal income tax purposes as the owner
of an undivided interest in the Loans included in the Trust Fund. As further
described below, each Holder of a Pass-Through Security therefore must report
on its federal income tax return the gross income from the portion of the
Loans that is allocable to such Pass-Through Security and may deduct the
portion of the expenses incurred or accrued by the Trust Fund that is
allocable to such Pass-Through Security, at the same time and to the same
extent as such items would be reported by such Holder if it had purchased and
held directly such interest in the Loans and received or accrued directly its
share of the payments on the Loans and incurred or accrued directly its share
of expenses incurred or accrued by the Trust Fund when those amounts are
received, incurred or accrued by the Trust Fund.
A Holder of a Pass-Through Security that is an individual, estate, or trust
will be allowed deductions for such expenses only to the extent that the sum
of those expenses and the Holder's other miscellaneous itemized deductions
exceeds 2% of such Holder's adjusted gross income. Moreover, a Holder of a
Pass-Through Security that is not a corporation cannot deduct such expenses
for purposes of the alternative minimum tax (if applicable). Such deductions
will include servicing, guarantee and administrative fees paid to the servicer
of the Loans. As a result, the Trust Fund will report additional taxable
income to Holders of Pass-Through Securities in an amount equal to their
allocable share of such deductions, and individuals, estates, or trusts
holding Pass-Through Securities may have taxable income in excess of the cash
received.
Status of the Pass-Through Securities as Real Property Loans. The Pass-
Through Securities will be "qualifying real property loans" within the meaning
of Section 593(d) of the Code, "real estate assets" for purposes of Section
856(c)(5)(A) of the Code and "loans . . . secured by an interest in real
property" within the meaning of Section 7701(a)(19)(C)(v) of the Code (assets
qualifying under one or more of those sections, applying each section
separately, "qualifying assets") to the extent that the Trust Fund's assets
are qualifying assets. The Pass-Through Securities may not be qualifying
assets under any of the foregoing sections of the Code to the extent that the
Trust Fund's assets include Buydown Funds, reserve funds, or payments on
mortgages held pending distribution to CertificateHolders. Further, the Pass-
Through Securities may not be "qualifying real property loans" to the extent
Loans held by the Trust Fund are not secured by improved real property or real
property which is to be improved using the Loan proceeds, may not be "real
estate assets" to the extent Loans held by the trust are not secured by real
property, and may not be "loans . . . secured by an interest in real property"
to the extent Loans held by the trust are not secured by residential real
property or real property used primarily for church purposes. In addition, to
the extent that the principal amount of a Loan exceeds the value of the
property securing the Loan, it is unclear and Federal Tax Counsel is unable to
opine whether the Loans will be qualifying assets.
Taxation of Pass-Through Securities Under Stripped Bond Rules. The federal
income tax treatment of the Pass-Through Securities will depend on whether
they are subject to the rules of Section 1286 of the Code (the "stripped bond
rules"). The Pass-Through Securities will be subject to those rules if
stripped interest-only Certificates are issued. In addition, whether or not
stripped interest-only Certificates are issued, the Internal Revenue Service
may contend that the stripped bond rules apply on the ground that the
Servicer's servicing fee, or other amounts, if any, paid to (or retained by)
the Servicer or its affiliates, as specified in the applicable Prospectus
Supplement, represent greater than an arm's length consideration for servicing
the Loans and should be characterized for federal income tax purposes as an
ownership interest in the Loans. The Internal Revenue
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Service has taken the position in Revenue Ruling 91-46 that a retained
interest in excess of reasonable compensation for servicing is treated as a
"stripped coupon" under the rules of Code Section 1286.
If interest retained for the Servicer's servicing fee or other interest is
treated as a "stripped coupon," the Pass-Through Securities will be subject to
the OID rules and/or the market discount rules. A Holder of a Pass-Through
Security generally will account for any discount on the Pass-Through Security
that is attributable to a Loan that is secured by real property as market
discount rather than OID if either (i) the amount of OID attributable to such
Loan was treated as zero under the OID de minimis rule when such Loan was
stripped or (ii) no more than 100 basis points (including any amount of
servicing in excess of reasonable servicing) is stripped off from such Loan.
If neither of the above exceptions applies, the OID rules will apply to such
discount. Discount attributable to an unsecured Loan will not be eligible for
treatment as market discount, and it is unclear whether discount attributable
to a stripped Loan the principal amount of which exceeds the value of real
property securing the Loan will be eligible for treatment as market discount.
If the OID rules apply, the Holder of a Pass-Through Security (whether a
cash or accrual method taxpayer) will be required to report interest income
from the Pass-Through Security in each taxable year equal to the income that
accrues on the Pass-Through Security in that year calculated under a constant
yield method based on the yield of the Pass-Through Security (or, possibly,
the yield of each Loan underlying such Pass-Through Security) to such Holder.
Such yield would be computed at the rate (assuming monthly compounding) that,
if used in discounting the Holder's share of the payments on the Loans, would
cause the present value of those payments to equal the price at which the
Holder purchased the Pass-Through Security. With respect to certain categories
of debt instruments, Section 1272(a)(6) of the Code requires that OID be
accrued based on a prepayment assumption determined in a manner prescribed by
forthcoming regulations. It is unclear whether such regulations would apply
this rule to the Pass-Through Securities, whether Section 1272(a)(6) might
apply to the Pass-Through Securities in the absence of such regulations, or
whether the Internal Revenue Service could require use of a reasonable
prepayment assumption based on other tax law principles, and Federal Tax
Counsel is unable to opine with respect to this issue. If required to report
interest income on the Pass-Through Securities to the Internal Revenue Service
under the stripped bond rules, it is anticipated that the Trustee will
calculate the yield of the Pass-Through Securities based on a representative
initial offering price of the Pass-Through Securities and a reasonable assumed
rate of prepayment of the Loans (although such yield may differ from the yield
to any particular Holder that would be used in calculating the interest income
of such Holder). The Prospectus Supplement for each series of Pass-Through
Securities will describe the prepayment assumption that will be used for this
purpose, but no representation is made that the Loans will prepay at that rate
or at any other rate.
Assuming that Holders are not taxed as directly owning the Loans, in the
case of a Pass-Through Security acquired at a price equal to the principal
amount of the Loans allocable to the Pass-Through Security, the use of a
reasonable prepayment assumption would not have any significant effect on the
yield used in calculating accruals of interest income. In the case, however,
of a Pass-Through Security acquired at a discount or premium (that is, at a
price less than or greater than such principal amount, respectively), the use
of a reasonable prepayment assumption would increase or decrease such yield,
and thus accelerate or decelerate the reporting of interest income,
respectively.
If a Loan is prepaid in full, the Holder of a Pass-Through Security acquired
at a discount or premium generally will recognize ordinary income or loss
equal to the difference between the portion of the prepaid principal amount of
the Loan that is allocable to the Pass-Through Security and the portion of the
adjusted basis of the Pass-Through Security (see "Sales of Pass-Through
Securities" below) that is allocable to the Loan. The method of allocating
such basis among the Loans may differ depending on whether a reasonable
prepayment assumption is used in calculating the yield of the Pass-Through
Securities for purposes of accruing OID. It is not clear whether any other
adjustments would be required to reflect differences between the prepayment
rate that was assumed in calculating yield and the actual rate of prepayments.
Pass-Through Securities of certain series ("Variable Rate Pass-Through
Securities") may provide for a Pass-Through Rate based on the weighted average
of the interest rates of the Loans held by the Trust Fund,
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which interest rates may be fixed or variable. In the case of a Variable Rate
Pass-Through Security that is subject to the OID rules, the daily portions of
OID generally will be calculated under the principles discussed in "--Taxation
of Debt Securities (Including Regular Interest Securities)--Variable Rate Debt
Securities."
Taxation of Pass-Through Securities If Stripped Bond Rules Do Not Apply. If
the stripped bond rules do not apply to a Pass-Through Security, then the
Holder will be required to include in income its share of the interest
payments on the Loans in accordance with its tax accounting method. In
addition, if the Holder purchased the Pass-Through Security at a discount or
premium, the Holder will be required to account for such discount or premium
in the manner described below. The treatment of any discount will depend on
whether the discount is OID as defined in the Code and, in the case of
discount other than OID, whether such other discount exceeds a de minimis
amount. In the case of OID, the Holder (whether a cash or accrual method
taxpayer) will be required to report as additional interest income in each
month the portion of such discount that accrues in that month, calculated
based on a constant yield method. In general it is not anticipated that the
amount of OID to be accrued in each month, if any, will be significant
relative to the interest paid currently on the Loans. However, OID could arise
with respect to a Loan ("ARM") that provides for interest at a rate equal to
the sum of an index of market interest rates and a fixed number. The OID for
ARMs generally will be determined under the principles discussed in "Taxation
of Debt Securities (Including Regular Interest Securities)--Variable Rate Debt
Securities."
If discount other than OID exceeds a de minimis amount (described below),
the Holder will also generally be required to include in income in each month
the amount of such discount accrued through such month and not previously
included in income, but limited, with respect to the portion of such discount
allocable to any Loan, to the amount of principal on such Loan received by the
Trust Fund in that month. Because the Loans will provide for monthly principal
payments, such discount may be required to be included in income at a rate
that is not significantly slower than the rate at which such discount accrues
(and therefore at a rate not significantly slower than the rate at which such
discount would be included in income if it were OID). The Holder may elect to
accrue such discount under a constant yield method based on the yield of the
Pass-Through Security to such Holder (or possibly based on the yields of each
Loan). In the absence of such an election, it may be necessary to accrue such
discount under a more rapid straight-line method. Under the de minimis rule,
market discount with respect to a Pass-Through Security will be considered to
be zero if it is less than the product of (i) 0.25% of the principal amount of
the Loans allocable to the Pass-Through Security and (ii) the weighted average
life (in complete years) of the Loans remaining at the time of purchase of the
Pass-Through Security.
If a Holder purchases a Pass-Through Security at a premium, such Holder may
elect under Section 171 of the Code to amortize the portion of such premium
that is allocable to a Loan under a constant yield method based on the yield
of the Loan to such Holder, provided that such Loan was originated after
September 27, 1985. Premium allocable to a Loan originated on or before that
date should be allocated among the principal payments on the Loan and allowed
as an ordinary deduction as principal payments are made or, perhaps, upon
termination.
It is not clear whether the foregoing adjustments for discount or premium
would be made based on the scheduled payments on the Loans or taking account
of a reasonable prepayment assumption, and Federal Tax Counsel is unable to
opine on this issue.
If a Loan is prepaid in full, the Holder of a Pass-Through Security acquired
at a discount or premium will recognize ordinary income or loss equal to the
difference between the portion of the prepaid principal amount of the Loan
that is allocable to the Pass-Through Security and the portion of the adjusted
basis of the Pass-Through Security (see "Sales of Pass-Through Securities"
below) that is allocable to the Loan. The method of allocating such basis
among the Loans may differ depending on whether a reasonable prepayment
assumption is used in calculating the yield of the Pass-Through Securities for
purposes of accruing OID. Other adjustments might be required to reflect
differences between the prepayment rate that was assumed in accounting for
discount or premium and the actual rate of prepayments.
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MISCELLANEOUS TAX ASPECTS
Backup Withholding. A Holder, other than a Holder of a Residual Interest
Security, may, under certain circumstances, be subject to "backup withholding"
at a rate of 31% with respect to distributions or the proceeds of a sale of
certificates to or through brokers that represent interest or original issue
discount on the Securities. This withholding generally applies if the Holder
of a Security (i) fails to furnish the Trustee with its taxpayer
identification number ("TIN"); (ii) furnishes the Trustee an incorrect TIN;
(iii) fails to report properly interest, dividends or other "reportable
payments" as defined in the Code; or (iv) under certain circumstances, fails
to provide the Trustee or such Holder's securities broker with a certified
statement, signed under penalty of perjury, that the TIN provided is its
correct number and that the Holder is not subject to backup withholding.
Backup withholding will not apply, however, with respect to certain payments
made to Holders, including payments to certain exempt recipients (such as
exempt organizations) and to certain Nonresidents (as defined below). Holders
should consult their tax advisors as to their qualification for exemption from
backup withholding and the procedure for obtaining the exemption.
The Trustee will report to the Holders and to the Servicer for each calendar
year the amount of any "reportable payments" during such year and the amount
of tax withheld, if any, with respect to payments on the Securities.
TAX TREATMENT OF FOREIGN INVESTORS
Subject to the discussion below with respect to Trust Funds which are
treated as partnerships for federal income tax purposes and with respect to
Certificates treated as debt for federal income tax purposes, unless interest
(including OID) paid on a Security (other than a Residual Interest Security)
is considered to be "effectively connected" with a trade or business conducted
in the United States by a nonresident alien individual, foreign partnership or
foreign corporation ("foreign investors"), such interest will normally qualify
as portfolio interest (except where (i) the recipient is a Holder, directly or
by attribution, of 10% or more of the capital or profits interest in the
issuer, or (ii) the recipient is a controlled foreign corporation to which the
issuer is a related person) and will be exempt from federal income tax. See
"--Tax Consequences to Holders of the Certificates Issued by a Partnership-Tax
Consequences to Foreign Certificateholders" and "--Certain Certificates
Treated as Indebtedness-Foreign Investors". Upon receipt of appropriate
ownership statements, the issuer normally will be relieved of obligations to
withhold tax from such interest payments. These provisions supersede the
generally applicable provisions of United States law that would otherwise
require the issuer to withhold at a 30% rate (unless such rate were reduced or
eliminated by an applicable tax treaty) on, among other things, interest and
other fixed or determinable, annual or periodic income paid to Nonresidents.
Holders of Pass-Through Securities however, may be subject to withholding to
the extent that the Loans were originated on or before July 18, 1984.
Interest and OID of Holders who are foreign persons are not subject to
withholding if they are effectively connected with a United States business
conducted by the Holder and timely provide an IRS Form 4224. They will,
however, generally be subject to the regular United States income tax.
Payments to Holders of Residual Interest Securities who are foreign persons
will generally be treated as interest for purposes of the 30% (or lower treaty
rate) United States withholding tax. Holders should assume that such income
does not qualify for exemption from United States withholding tax as
"portfolio interest." It is clear that, to the extent that a payment
represents a portion of REMIC taxable income that constitutes excess inclusion
income, a Holder of a Residual Interest Security will not be entitled to an
exemption from or reduction of the 30% (or lower treaty rate) withholding tax
rule. If the payments are subject to United States withholding tax, they
generally will be taken into account for withholding tax purposes only when
paid or distributed (or when the Residual Interest Security is disposed of).
The Treasury has statutory authority, however, to promulgate regulations which
would require such amounts to be taken into account at an earlier time in
order to prevent the avoidance of tax. Such regulations could, for example,
require withholding prior to the distribution of cash in the case of Residual
Interest Securities that do not have significant value. Under the REMIC
Regulations, if a
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Residual Interest Security has tax avoidance potential, a transfer of a
Residual Interest Security to a Nonresident will be disregarded for all
federal tax purposes. A Residual Interest Security has tax avoidance potential
unless, at the time of the transfer, the transferor reasonably expects that
the REMIC will distribute to the transferee residual interest Holder amounts
that will equal at least 30% of each excess inclusion, and that such amounts
will be distributed at or after the time at which the excess inclusions accrue
and not later than the calendar year following the calendar year of accrual.
If a Nonresident transfers a Residual Interest Security to a United States
person, and if the transfer has the effect of allowing the transferor to avoid
tax on accrued excess inclusions, then the transfer is disregarded and the
transferor continues to be treated as the owner of the Residual Interest
Security for purposes of the withholding tax provisions of the Code. See
"Taxation of Holders of Residual Interest Securities--Excess Inclusions."
Subject to the discussion in the previous paragraph, any capital gain
realized on the sale, redemption, retirement or other taxable disposition of a
Security by a foreign person will be exempt from United States federal income
and withholding tax, provided that (i) such gain is not effectively connected
with the conduct of a trade or business in the United States by the foreign
person and (ii) in the case of an individual foreign person, the foreign
person is not present in the United States for 183 days or more in the taxable
year.
TAX CHARACTERIZATION OF THE TRUST AS A PARTNERSHIP
Federal Tax Counsel will deliver its opinion that a Trust Fund which is
intended to be a partnership for federal income tax purposes will not be an
association (or publicly traded partnership) taxable as a corporation for
federal income tax purposes. This opinion will be based on the assumption that
the terms of the Trust Agreement and related documents will be complied with,
and on counsel's conclusions that (1) the Trust Fund will not have certain
characteristics necessary for a business trust to be classified as an
association taxable as a corporation and (2) the nature of the income of the
Trust Fund will exempt it from the rule that certain publicly traded
partnerships are taxable as corporations or the issuance of the Certificates
has been structured as a private placement under an IRS safe harbor, so that
the Trust Fund will not be characterized as a publicly traded partnership
taxable as a corporation.
If the Trust Fund were taxable as a corporation for federal income tax
purposes, the Trust Fund would be subject to corporate income tax on its
taxable income. The Trust Fund's taxable income would include all its income,
possibly reduced by its interest expense on the Notes. Any such corporate
income tax could materially reduce cash available to make payments on the
Notes and distributions on the Certificates, and CertificateHolders could be
liable for any such tax that is unpaid by the Trust Fund. In additions, all
distributions to the Certificateholders would be taxable as dividends.
TAX CONSEQUENCES TO HOLDERS OF THE NOTES ISSUED BY A PARTNERSHIP
Treatment of the Notes as Indebtedness. The Trust Fund will agree, and the
NoteHolders will agree by their purchase of Notes, to treat the Notes as debt
for federal income tax purposes. Except as otherwise provided in the related
Prospectus Supplement, Federal Tax Counsel will advise the Transferor that the
Notes will be classified as debt for federal income tax purposes.
Consequently, Holders of Notes will be subject to taxation as described in
"Taxation of Debt Securities (Including Regular Interest Securities)" above
for Debt Securities which are not Regular Interest Securities.
Possible Alternative Treatments of the Notes. If, contrary to the opinion of
Federal Tax Counsel, the IRS successfully asserted that one or more of the
Notes did not represent debt for federal income tax purposes, the Notes might
be treated as equity interests in the Trust Fund. If so treated, the Trust
Fund might be taxable as a corporation with the adverse consequences described
above (and the taxable corporation would not be able to reduce its taxable
income by deductions for interest expense on Notes recharacterized as equity).
Alternatively, and most likely in the view of Federal Tax Counsel, the Trust
Fund might be treated as a publicly traded partnership that would not be
taxable as a corporation because it would meet certain qualifying income
tests. Nonetheless, treatment of the Notes as equity interests in such a
publicly traded partnership could have adverse
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tax consequences to certain Holders. For example, income to foreign Holders
generally would be subject to U.S. federal income tax and U.S. federal income
tax return filing and withholding requirements, and individual Holders might
be subject to certain limitations on their ability to deduct their share of
the Trust Fund's expenses.
TAX CONSEQUENCES TO HOLDERS OF THE CERTIFICATES ISSUED BY A PARTNERSHIP
Treatment of the Trust Fund as a Partnership. In the case of a Trust Fund
intended to qualify as a partnership for federal income tax purposes, the
Trust Fund and the Transferor will agree, and the CertificateHolders will
agree by their purchase of Certificates, to treat the Trust Fund as a
partnership for purposes of federal and state income tax, franchise tax and
any other tax measured in whole or in part by income, with the assets of the
partnership being the assets held by the Trust Fund, the partners of the
partnership being the CertificateHolders, and the Notes, if any, being debt of
the partnership. However, the proper characterization of the arrangement
involving the Trust Fund, the Certificates, the Notes, the Trust Fund and the
Servicer is not clear because there is no authority on transactions closely
comparable to that contemplated herein.
A variety of alternative characterizations are possible. For example,
because the Certificates have certain features characteristic of debt, the
Certificates might be considered debt of the Trust Fund. Any such
characterization would not result in materially adverse tax consequences to
CertificateHolders as compared to the consequences from treatment of the
Certificates as equity in a partnership, described below. The following
discussion assumes that the Certificates represent equity interests in a
partnership.
Indexed Securities, etc. The following discussion assumes that all payments
on the Certificates are denominated in U.S. dollars, none of the Certificates
have interest rates which would qualify as contingent interest under the OID
regulations, and that a Series of Securities includes a single Class of
Certificates. If these conditions are not satisfied with respect to any given
Series of Certificates, additional tax considerations with respect to such
Certificates will be disclosed in the applicable Prospectus Supplement.
Partnership Taxation. As a partnership, the Trust Fund will not be subject
to federal income tax. Rather, each CertificateHolder will be required to
separately take into account such Holder's allocated share of income, gains,
losses, deductions and credits of the Trust Fund. The Trust Fund's income will
consist primarily of interest and finance charges earned on the Loans
(including appropriate adjustments for market discount, OID and bond premium)
and any gain upon collection or disposition of Loans. The Trust Fund's
deductions will consist primarily of interest and OID accruing with respect to
the Notes, servicing and other fees, and losses or deductions upon collection
or disposition of Loans.
The tax items of a partnership are allocable to the partners in accordance
with the Code, Treasury regulations and the partnership agreement (here, the
Trust Agreement and related documents). The Trust Agreement will provide, in
general, that the CertificateHolders will be allocated taxable income of the
Trust Fund for each month equal to the sum of (i) the interest that accrues on
the Certificates in accordance with their terms for such month, including
interest accruing at the Pass Through Rate for such month and interest on
amounts previously due on the Certificates but not yet distributed; (ii) any
Trust Fund income attributable to discount on the Loans that corresponds to
any excess of the principal amount of the Certificates over their initial
issue price; (iii) prepayment premium payable to the CertificateHolders for
such month; and (iv) any other amounts of income payable to the
CertificateHolders for such month. Such allocation will be reduced by any
amortization by the Trust Fund of premium on Loans that corresponds to any
excess of the issue price of Certificates over their principal amount. All
remaining taxable income of the Trust Fund will be allocated to the
Transferor. Based on the economic arrangement of the parties, this approach
for allocating Trust Fund income should be permissible under applicable
Treasury regulations, although no assurance can be given that the IRS would
not require a greater amount of income to be allocated to CertificateHolders.
Moreover, even under the foregoing method of allocation, CertificateHolders
may be allocated income equal to the entire Pass-Through Rate plus the other
items described above even though the Trust Fund might not have sufficient
cash to make current cash distributions of such amount. Thus, cash basis
Holders will in effect be required to report income from the Certificates on
the accrual basis and CertificateHolders may become liable for taxes on Trust
Fund income even
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if they have not received cash from the Trust Fund to pay such taxes. In
addition, because tax allocations and tax reporting will be done on a uniform
basis for all CertificateHolders but CertificateHolders may be purchasing
Certificates at different times and at different prices, CertificateHolders
may be required to report on their tax returns taxable income that is greater
or less than the amount reported to them by the Trust Fund.
If Notes are also issued, all of the taxable income allocated to a
CertificateHolder that is a pension, profit sharing or employee benefit plan
or other tax-exempt entity (including an individual retirement account) will
constitute "unrelated business taxable income" generally taxable to such a
Holder under the Code.
An individual taxpayer's share of expenses of the Trust Fund (including fees
to the Servicer but not interest expense) would be miscellaneous itemized
deductions. Such deductions might be disallowed to the individual in whole or
in part and might result in such Holder being taxed on an amount of income
that exceeds the amount of cash actually distributed to such Holder over the
life of the Trust Fund.
The Trust Fund intends to make all tax calculations relating to income and
allocations to CertificateHolders on an aggregate basis. If the IRS were to
require that such calculations be made separately for each Loan, the Trust
Fund might be required to incur additional expense, but it is believed that
there would not be a material adverse effect on CertificateHolders.
Discount and Premium. It is believed that the Loans were not issued with OID
and, therefore, the Trust should not have OID income. However, the purchase
price paid by the Trust Fund for the Loans may be greater or less than the
remaining principal balance of the Loans at the time of purchase. If so, the
Loan will have been acquired at a premium or discount, as the case may be. (As
indicated above, the Trust Fund will make this calculation on an aggregate
basis, but might be required to recompute it on a Loan by Loan basis.)
If the Trust Fund acquires the Loans at a market discount or premium, the
Trust Fund will elect to include any such discount in income currently as it
accrues over the life of the Loans or to offset any such premium against
interest income on the Loans. As indicated above, a portion of such market
discount income or premium deduction may be allocated to CertificateHolders.
Section 708 Termination. Under Section 708 of the Code, the Trust Fund will
be deemed to terminate for federal income tax purposes if 50% or more of the
capital and profits interests in the Trust Fund are sold or exchanged within a
12-month period. If such a termination occurs, the Trust Fund will be
considered to distribute its assets to the partners, who would then be treated
as recontributing those assets to the Trust Fund as a new partnership. The
Trust Fund will not comply with certain technical requirements that might
apply when such a constructive termination occurs. As a result, the Trust Fund
may be subject to certain tax penalties and may incur additional expenses if
it is required to comply with those requirements. Furthermore, the Trust Fund
might not be able to comply due to lack of data.
Disposition of Certificates. Generally, capital gain or loss will be
recognized on a sale of Certificates in an amount equal to the difference
between the amount realized and the seller's tax basis in the Certificates
sold. A CertificateHolder's tax basis in a Certificate will generally equal
the Holder's cost increased by the Holder's share of Trust Fund income
(includible in income) and decreased by any distributions received with
respect to such Certificate. In addition, both the tax basis in the
Certificates and the amount realized on a sale of a Certificate would include
the Holder's share of the Notes and other liabilities of the Trust Fund. A
Holder acquiring Certificates at different prices may be required to maintain
a single aggregate adjusted tax basis in such Certificates, and, upon sale or
other disposition of some of the Certificates, allocate a portion of such
aggregate tax basis to the Certificates sold (rather than maintaining a
separate tax basis in each Certificate for purposes of computing gain or loss
on a sale of that Certificate).
Any gain on the sale of a Certificate attributable to the Holder's share of
unrecognized accrued market discount on the Loans would generally be treated
as ordinary income to the Holder and would give rise to special
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tax reporting requirements. The Trust Fund does not expect to have any other
assets that would give rise to such special reporting requirements. Thus, to
avoid those special reporting requirements, the Trust Fund will elect to
include market discount in income as it accrues.
If a CertificateHolder is required to recognize an aggregate amount of
income (not including income attributable to disallowed itemized deductions
described above) over the life of the Certificates that exceeds the aggregate
cash distributions with respect thereto, such excess will generally give rise
to a capital loss upon the retirement of the Certificates.
Allocations Between Transferors and Transferees. In general, the Trust
Fund's taxable income and losses will be determined monthly and the tax items
for a particular calendar month will be apportioned among the
CertificateHolders in proportion to the principal amount of Certificates owned
by them as of the close of the last day of such month. As a result, a Holder
purchasing Certificates may be allocated tax items (which will affect its tax
liability and tax basis) attributable to periods before the actual
transaction.
The use of such a monthly convention may not be permitted by existing
regulations. If a monthly convention is not allowed (or only applies to
transfers of less than all of the partner's interest), taxable income or
losses of the Trust Fund might be reallocated among the CertificateHolders.
The Trust Fund's method of allocation between transferors and transferees may
be revised to conform to a method permitted by future regulations.
Section 754 Election. In the event that a CertificateHolder sells its
Certificates at a profit (loss), the purchasing CertificateHolder will have a
higher (lower) basis in the Certificates than the selling CertificateHolder
had. The tax basis of the Trust Fund's assets will not be adjusted to reflect
that higher (or lower) basis unless the Trust Fund were to file an election
under Section 754 of the Code. In order to avoid the administrative
complexities that would be involved in keeping accurate accounting records, as
well as potentially onerous information reporting requirements, the Trust Fund
currently does not intend to make such election. As a result,
CertificateHolders might be allocated a greater or lesser amount of Trust Fund
income than would be appropriate based on their own purchase price for
Certificates.
Administrative Matters. The Owner Trustee is required to keep or have kept
complete and accurate books of the Trust Fund. Such books will be maintained
for financial reporting and tax purposes on an accrual basis and the fiscal
year of the Trust Fund will be the calendar year. The Trustee will file a
partnership information return (IRS Form 1065) with the IRS for each taxable
year of the Trust Fund and will report each CertificateHolder's allocable
share of items of Trust Fund income and expense to Holders and the IRS on
Schedule K-1. The Trust Fund will provide the Schedule K-1 information to
nominees that fail to provide the Trust Fund with the information statement
described below and such nominees will be required to forward such information
to the beneficial owners of the Certificates. Generally, Holders must file tax
returns that are consistent with the information return filed by the Trust
Fund or be subject to penalties unless the Holder notifies the IRS of all such
inconsistencies.
Under Section 6031 of the Code, any person that holds Certificates as a
nominee at any time during a calendar year is required to furnish the Trust
Fund with a statement containing certain information on the nominee, the
beneficial owners and the Certificates so held. Such information includes (i)
the name, address and taxpayer identification number of the nominee and (ii)
as to each beneficial owner (x) the name, address and identification number of
such person, (y) whether such person is a United States person, a tax-exempt
entity or a foreign government, an international organization, or any wholly
owned agency or instrumentality of either of the foregoing, and (z) certain
information on Certificates that were held, bought or sold on behalf of such
person throughout the year. In addition, brokers and financial institutions
that hold Certificates through a nominee are required to furnish directly to
the Trust Fund information as to themselves and their ownership of
Certificates. A clearing agency registered under Section 17A of the Exchange
Act is not required to furnish any such information statement to the Trust
Fund. The information referred to above for any calendar year must be
furnished to the Trust Fund on or before the following January 31. Nominees,
brokers and financial institutions that fail to provide the Trust Fund with
the information described above may be subject to penalties.
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The Transferor will be designated as the tax matters partner in the related
Trust Agreement and, as such, will be responsible for representing the
CertificateHolders in any dispute with the IRS. The Code provides for
administrative examination of a partnership as if the partnership were a
separate and distinct taxpayer. Generally, the statute of limitations for
partnership items does not expire before three years after the date on which
the partnership information return is filed. Any adverse determination
following an audit of the return of the Trust Fund by the appropriate taxing
authorities could result in an adjustment of the returns of the
CertificateHolders, and, under certain circumstances, a CertificateHolder may
be precluded from separately litigating a proposed adjustment to the items of
the Trust Fund. An adjustment could also result in an audit of a
CertificateHolder's returns and adjustments of items not related to the income
and losses of the Trust Fund.
Tax Consequences to Foreign CertificateHolders. It is not clear whether the
Trust Fund would be considered to be engaged in a trade or business in the
United States for purposes of federal withholding taxes with respect to non-
U.S. persons because there is no clear authority dealing with that issue under
facts substantially similar to those described herein. Although it is not
expected that the Trust Fund would be engaged in a trade or business in the
United States for such purposes, the Trust Fund will withhold as if it were so
engaged in order to protect the Trust Fund from possible adverse consequences
of a failure to withhold. The Trust Fund expects to withhold on the portion of
its taxable income that is allocable to foreign CertificateHolders pursuant to
Section 1446 of the Code, as if such income were effectively connected to a
U.S. trade or business, at a rate of 35% for foreign Holders that are taxable
as corporations and 39.6% for all other foreign Holders. Subsequent adoption
of Treasury regulations or the issuance of other administrative pronouncements
may require the Trust Fund to change its withholding procedures.
Each foreign Holder might be required to file a U.S. individual or corporate
income tax return (including, in the case of a corporation, the branch profits
tax) on its share of the Trust Fund's income. Each foreign Holder must obtain
a taxpayer identification number from the IRS and submit that number to the
Trust Fund on Form W-8 in order to assure appropriate crediting of the taxes
withheld. A foreign Holder generally would be entitled to file with the IRS a
claim for refund with respect to taxes withheld by the Trust Fund taking the
position that no taxes were due because the Trust Fund was not engaged in a
U.S. trade or business. However, interest payments made (or accrued) to a
CertificateHolder who is a foreign person generally will be considered
guaranteed payments to the extent such payments are determined without regard
to the income of the Trust Fund. If these interest payments are properly
characterized as guaranteed payments, then the interest probably will not be
considered "portfolio interest." As a result, CertificateHolders will be
subject to United States federal income tax and withholding tax at a rate of
30%, unless reduced or eliminated pursuant to an applicable treaty. In such
case, a foreign Holder would only be entitled to claim a refund for that
portion of the taxes, if any, in excess of the taxes that should be withheld
with respect to the guaranteed payments.
Backup Withholding. Distributions made on the Certificates and proceeds from
the sale of the Certificates will be subject to a "backup" withholding tax of
31% if, in general, the CertificateHolder fails to comply with certain
identification procedures, unless the Holder is an exempt recipient under
applicable provisions of the Code.
CERTAIN CERTIFICATES TREATED AS INDEBTEDNESS
Upon the issuance of Certificates which are intended to be treated as
indebtedness for federal income tax purposes, Federal Tax Counsel will opine
that based upon its analysis of the factors discussed below, the Certificates
will be characterized as indebtedness for federal income tax purposes of the
Transferor that is secured by the Loans. Opinions of counsel are not binding
on the Internal Revenue Service, however, and there can be no assurance that
the IRS could not successfully challenge this conclusion.
The Transferor will express in the Pooling and Servicing Agreement its
intent that the Certificates be indebtedness secured by the Loans for federal,
state and local income or franchise tax purposes. The Transferor, by entering
into the Pooling and Servicing Agreement, has agreed and each
CertificateHolder, by the acceptance
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of a Certificate, will agree to treat the Certificates as indebtedness for
federal, state and local income or franchise tax purposes. However, because
different criteria are used to determine the non-tax accounting
characterization of the transactions contemplated by the Pooling and Servicing
Agreements, the Transferor expects to treat such transactions, for regulatory
and financial accounting purposes, as a transfer of an ownership interest in
the Loans and not as a debt obligation.
A basic premise of federal income tax law is that the economic substance of
a transaction generally determines the tax consequences. The form of a
transaction, while a relevant factor, is not conclusive evidence of its
economic substance. In appropriate circumstances, the courts have allowed
taxpayers, as well as the IRS, to treat a transaction in accordance with its
economic substance, as determined under federal income tax law,
notwithstanding that the participants characterize the transaction differently
for non-tax purposes. In some instances, however, courts have held that a
taxpayer is bound by the particular form it has chosen for a transaction, even
if the substance of the transaction does not accord with its form. Federal Tax
Counsel believes that the rationale of those cases will not apply to the
issuance of the Certificates.
The determination of whether the economic substance of a transfer of an
interest in property is a sale or a loan secured by the transferred property
depends on numerous factors that indicate whether the transferor has
relinquished (and the transferee has obtained) substantial incidents of
ownership in the property. Among the primary factors considered are whether
the transferee has obtained the opportunity for gain if the property increases
in value and has assumed the risk of loss if the property decreases in value.
Based upon its analysis of such factors, Federal Tax Counsel will conclude
that the CertificateHolders do not own or have an equity interest in the Loans
for federal income tax purposes. As a result, Federal Tax Counsel will opine
that the Certificates will properly be characterized for federal income tax
purposes as indebtedness. Contrary characterizations that could be asserted by
the IRS are described below under "--Possible Characterization of the
Transaction as a Partnership or as an Association Taxable as a Corporation."
In this regard, it should be noted that the IRS has recently issued a notice
stating that, upon examination, it will scrutinize instruments treated as debt
for federal income tax purposes but as equity for regulatory, rating agency or
financial accounting purposes to determine if their purported status as debt
for federal income tax purposes is appropriate.
CertificateHolders as the Holders of debt instruments for federal tax
purposes will be taxed in the manner described above in "--Taxation of Debt
Securities (Including Regular Interest Securities)" for Debt Securities which
are not Regular Interest Securities.
Possible Characterization of the Transaction as a Partnership or as
Association Taxable as a Corporation. As stated above, the opinion of Federal
Tax Counsel with respect to the Certificates will not be binding on the courts
or the IRS, and no assurance can be given that the characterization of the
Certificates as debt would prevail. It is possible that the IRS would assert
that, for purposes of the Code, the transaction described herein constitutes a
transfer of the Loans (or an interest therein) to the CertificateHolders and
that the proper classification of the legal relationship between the
Transferor and the CertificateHolders resulting from the transaction is that
of a partnership, a publicly traded partnership taxed as a corporation, or an
association taxable as a corporation. Since Federal Tax Counsel will advise
that the Certificates will be treated as indebtedness for federal income tax
purposes, the Transferor generally will not attempt to comply with the federal
income tax reporting requirements that would apply if Certificates were
treated as interests in a partnership, a publicly traded partnership or a
corporation.
If a partnership were deemed to be created between the Transferor and the
CertificateHolders, the partnership itself would not be subject to federal
income tax (unless it were to be characterized as a publicly traded
partnership taxable as a corporation); rather, the partners of such
partnership, including the CertificateHolders, would be taxed individually on
their respective distributive shares of the partnership's income, gain, loss,
deductions and credits. The amount and timing of items of income and deduction
of a CertificateHolder could differ if the Certificates were held to
constitute partnership interests, rather than indebtedness. Moreover, an
individual's share of expenses of the partnership would be miscellaneous
itemized deductions that, in the aggregate, are allowed as deductions only to
the extent they exceed 2% of the individual's
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adjusted gross income, and would be subject to reduction under Section 68 of
the Code if the individual's adjusted gross income exceeded certain limits. As
a result, the individual might be taxed on a greater amount of income than
would be the case if the Certificates were treated as a debt instrument.
If it were determined that the transaction created an entity classified as
an association or as a publicly traded partnership taxable as a corporation,
the Trust Fund would be subject to federal income tax at corporate income tax
rates on the income it derives from the Loans, which would reduce the amounts
available for distribution to the CertificateHolders. Such classification may
also have adverse state and local tax consequences that would reduce amounts
available for distribution to CertificateHolders. Moreover, distributions on
the Certificates would most likely not be deductible in computing the entity's
taxable income, and cash distributions to the CertificateHolders generally
would be treated as dividends for tax purposes to the extent of such entity's
earnings and profits.
Foreign Investors. If the IRS were to contend successfully that the
Certificates are interests in a partnership and if such partnership were
considered to be engaged in a trade or business in the United States, the
partnership would be subject to a withholding tax on distributions to (or, at
its election, income allocable to) a foreign investor; and such Holder would
be credited for his or her share of the withholding tax paid by the
partnership. In such case, the Holder generally would be subject to United
States federal income tax at regular federal income tax rates, and possibly a
branch profits tax in the case of a corporate Holder.
Alternatively, although there may be arguments to the contrary, if such a
partnership is not considered to be engaged in a trade or business within the
United States and if income with respect to the Certificates is not otherwise
effectively connected with the conduct of a trade or business in the United
States by the foreign investor, the foreign investor would be subject to
United States federal income tax and withholding at a rate of 30% (unless
reduced by an applicable tax treaty) on the Holder's distributive share of the
partnership's interest income.
If the Trust Fund were taxable as a corporation, distributions to foreign
investors, to the extent treated as dividends, would generally be subject to
withholding at the rate of 30%, unless such rate were reduced or eliminated by
an applicable income tax treaty.
STATE TAX CONSIDERATIONS
In addition to the federal income tax consequences described in "Federal
Income Tax Considerations," potential investors should consider the state and
local income tax consequences of the acquisition, ownership, and disposition
of the Securities. State and local income tax law may differ substantially
from the corresponding federal law, and this discussion does not purport to
describe any aspect of the income tax laws of any state or locality.
Therefore, potential investors should consult their own tax advisors with
respect to the various state and local tax consequences of an investment in
the Securities.
ERISA CONSIDERATIONS
Section 406 of the Employee Retirement Income Security Act of 1974, as
amended ("ERISA"), and Section 4975 of the Code prohibit pension, profit
sharing or other employee benefit plans, individual retirement accounts or
annuities, employee annuity plans and Keogh plans subject to ERISA or Section
4975 of the Code (each, a "Benefit Plan") from engaging in certain
transactions involving "plan assets" with persons that are "parties in
interest" under ERISA or "disqualified persons" under the Code with respect to
the plan. ERISA also imposes certain duties and certain prohibitions on
persons who are fiduciaries of plans subject to ERISA. Under ERISA, generally
any person who exercises any authority or control with respect to the
management or disposition of the assets of a plan is considered to be a
fiduciary of such plan. A violation of these "prohibited transaction" rules
may generate excise tax and other liabilities under ERISA and the Code for
fiduciaries, "parties in interest," and "disqualified persons."
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Unless a statutory, regulatory or administrative exemption is available, a
violation of these prohibited transaction rules could occur if any Notes or
Certificates were to be acquired by a Benefit Plan or with "plan assets" of
any Benefit Plan, and if any of the Transferor, the Trustee, any underwriter
of such Series or any of their affiliates were a "party in interest" or a
"disqualified person" with respect to such Benefit Plan. The Transferor, the
Trustee and any underwriters of a Series are likely to be "parties in
interest" or "disqualified persons" with respect to many Benefit Plans.
Certain transactions involving the related Trust Fund might be deemed to
constitute prohibited transactions under ERISA and the Code with respect to a
Benefit Plan that purchased Securities if assets of the related Trust Fund
were deemed to be plan assets of the Benefit Plan. Under a regulation issued
by the United States Department of Labor (the "Plan Assets Regulation"), the
assets of a Trust Fund would be treated as plan assets of a Benefit Plan for
the purposes of ERISA and the Code only if the Benefit Plan acquired an
"equity interest" in the Trust Fund and none of the exceptions contained in
the Plan Assets Regulation was applicable. An equity interest is defined under
the Plan Assets Regulation as an interest other than an instrument which is
treated as indebtedness under applicable local law and which has no
substantial equity features. If Notes or Certificates are available for
purchase by Benefit Plans or the "plan assets" of Benefit Plans, the likely
treatment under the Plan Assets Regulation of Notes and Certificates will be
discussed in the related Prospectus Supplement.
Employee benefit plans that are governmental plans (as defined in Section
3(32) of ERISA) and certain church plans (as defined in Section 3(33) of
ERISA) are not subject to ERISA requirements.
Additional information with respect to the eligibility of Notes or
Certificates for purchase by a Benefit Plan or "plan assets" of a Benefit Plan
is provided in the related Prospectus Supplement. A plan fiduciary considering
the purchase of Securities should consult its tax and/or legal advisors
regarding whether the assets of the Trust Fund would be considered plan
assets, the possibility of exemptive relief from the prohibited transaction
rules and other issues and their potential consequences.
LEGAL INVESTMENT
Unless otherwise specified in the related Prospectus Supplement, the
Securities will not constitute "mortgage-related securities" within the
meaning of SMMEA. Accordingly, investors whose investment authority is subject
to legal restrictions should consult their own legal advisors to determine
whether and to what extent the Securities constitute legal investments for
them.
PLAN OF DISTRIBUTION
On the terms and conditions set forth in an underwriting agreement (the
"Underwriting Agreement") with respect to each Trust Fund, the Transferor will
agree to sell to each of the underwriters named therein and in the related
Prospectus Supplement, and each of such underwriters will severally agree to
purchase from the Transferor, the principal amount of each Class of Securities
of the related Series set forth therein and in the related Prospectus
Supplement.
In each Underwriting Agreement, the several underwriters will agree, subject
to the terms and conditions set forth therein, to purchase all of the
Securities described therein which are offered hereby and by the related
Prospectus Supplement if any of such Securities are purchased. In the event of
a default by any such underwriter, each Underwriting Agreement will provide
that, in certain circumstances, purchase commitments of the nondefaulting
underwriters may be increased, or the Underwriting Agreement may be
terminated.
Each Prospectus Supplement will either (i) set forth the price at which each
Class of Securities being offered thereby will be offered to the public and
any concessions that may be offered to certain dealers participating in the
offering of such Securities or (ii) specify that the related Securities are to
be resold by the underwriters in negotiated transactions at varying prices to
be determined at the time of such sale. After the initial public offering of
any Securities, the public offering price and such concessions may be changed.
Each Underwriting Agreement will provide that Chevy Chase will indemnify
underwriters against certain liabilities, including liabilities under the
Securities Act.
Under each Underwriting Agreement, the closing of the sale of any Class of
Securities subject thereto will be conditioned on the closing of the sale of
all other such Classes.
The place and time of delivery for the Securities in respect of which this
Prospectus is delivered will be set forth in the related Prospectus
Supplement.
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LEGAL MATTERS
Unless otherwise specified in the related Prospectus Supplement, certain
legal matters in connection with the Securities will be passed upon for the
Transferor by Shaw, Pittman, Potts & Trowbridge, counsel to the Transferor,
and for any underwriters, agents or dealers, Stroock & Stroock & Lavan. Unless
otherwise specified in the related Prospectus Supplement, certain federal
income tax matters will be passed upon for the Transferor by Stroock & Stroock
& Lavan.
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GLOSSARY OF TERMS
The following are abbreviated definitions of certain capitalized terms used
in this Prospectus. Unless otherwise provided in a "Supplemental Glossary" in
the Prospectus Supplement for a Series, such definitions shall apply to
capitalized terms used in such Prospectus Supplement. The definitions may vary
from those in the related Agreement for a Series and the related Agreement for
a Series generally provides a more complete definition of certain of the
terms. Reference should be made to the related Agreement for a Series for a
more complete definition of such terms.
"Accrual Termination Date" means, with respect to a Class of Compound
Interest Securities, the Distribution Date specified in the related Prospectus
Supplement.
"Agreement" means, with respect to a Series of Certificates, the Pooling and
Servicing Agreement or Trust Agreement, and, with respect to a Series of
Notes, the Indenture and the Sale and Servicing Agreement, as the context
requires.
"Appraised Value" means, with respect to property securing a Loan, the
lesser of the appraised value determined in an appraisal obtained at
origination of the Loan or sales price of such property at such time.
"Asset Group" means, with respect to the Primary Assets and other assets
comprising the Trust Fund of a Series, a group of such Primary Assets and
other assets having the characteristics described in the related Prospectus
Supplement.
"Assumed Reinvestment Rate" means, with respect to a Series, the per annum
rate or rates specified in the related Prospectus Supplement for a particular
period or periods as the "Assumed Reinvestment Rate" for funds held in any
fund or account for the Series.
"Available Distribution Amount" means the amount in the Distribution Account
(including amounts deposited therein from any reserve fund or other fund or
account) eligible for distribution to Holders on a Distribution Date.
"Bankruptcy Code" means the federal bankruptcy code, 11 United States Code
101 et seq., and related rules and regulations promulgated thereunder.
"Business Day" means a day that, in the City of New York or in the city or
cities in which the corporate trust office of the Trustee are located, is
neither a legal holiday nor a day on which banking institutions are authorized
or obligated by law, regulations or executive order to be closed.
"Certificate" means the Asset-Backed Certificates.
"Certificate Account" or "Collection Account" means, with respect to a
Series, the account established for the deposit by the Servicer of payments
received from the Primary Assets.
"Class" means a class of Securities of a Series.
"Closing Date" means, with respect to a Series, the date specified in the
related Prospectus Supplement as the date on which Securities of such Series
are first issued.
"Code" means the Internal Revenue Code of 1986, as amended, and regulations
(including proposed regulations) or other pronouncements of the Internal
Revenue Service promulgated thereunder.
"Combined Loan-to-Value Ratio" means, with respect to a Loan, the ratio
determined as set forth in the related Prospectus Supplement taking into
account the amounts of any related senior mortgage loans on the related
Mortgaged Property.
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"Commission" means the Securities and Exchange Commission.
"Compound Interest Security" means any Security of a Series on which all or
a portion of the interest accrued thereon is added to the principal balance of
such Security on each Distribution Date, through the Accrual Termination Date,
and with respect to which no interest shall be payable until such Accrual
Termination Date, after which interest payments will be made on the Compound
Value thereof.
"Compound Value" means, with respect to a Class of Compound Interest
Securities, the original principal balance of such Class, plus all accrued and
unpaid interest, if any, previously added to the principal balance thereof and
reduced by any payments of principal previously made on such Class of Compound
Interest Securities.
"Condominium" means a form of ownership of real property wherein each owner
is entitled to the exclusive ownership and possession of his or her individual
Condominium Unit and also owns a proportionate undivided interest in all parts
of the Condominium Building (other than the individual Condominium Units) and
all areas or facilities, if any, for the common use of the Condominium Units.
"Condominium Association" means the person(s) appointed or elected by the
Condominium Unit owners to govern the affairs of the Condominium.
"Condominium Building" means a multi-unit building or buildings, or a group
of buildings whether or not attached to each other, located on property
subject to Condominium ownership.
"Condominium Loan" means a Loan secured by a Mortgage on a Condominium Unit
(together with its appurtenant interest in the common elements).
"Condominium Unit" means an individual housing unit in a Condominium
Building.
"Cooperative" means a corporation owned by tenant-stockholders who, through
the ownership of stock, shares or membership securities in the corporation,
receive proprietary leases or occupancy agreements which confer exclusive
rights to occupy specific units and which is described in Section 216 of the
Code.
"Cooperative Dwelling" means an individual housing unit in a building owned
by a Cooperative.
"Cooperative Loan" means a housing loan made with respect to a Cooperative
Dwelling and secured by an assignment by the borrower (tenant-stockholder) or
security interest in shares issued by the applicable Cooperative.
"Cut-off Date" means the date designated as such in the related Prospectus
Supplement for a Series.
"Debt Securities" means Securities characterized as indebtedness for federal
income tax purposes, and Regular Interest Securities.
"Deferred Interest" means the excess of the interest accrued on the
outstanding principal balance of a Loan during a specified period over the
amount of interest required to be paid by an obligor on such Loan on the
related Due Date.
"Delinquency Advance" means cash advanced by the Servicer in respect of
delinquent payments of principal of and/or interest on a Loan to the extent
specified in the related Prospectus Supplement.
"Disqualified Organization" means the United States, any State or political
subdivision thereof, any possession of the United States, any foreign
government, any international organization, or any agency or instrumentality
of any of the foregoing, a rural electric or telephone cooperative described
in section 1381(a)(2)(C) of the Code, or any entity exempt from the tax
imposed by sections 1-1399 of the Code, if such entity is not subject to tax
on its unrelated business income.
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"Distribution Account" means, with respect to a Series, the account or
accounts established for the deposit of remittances from the Collection
Account for distribution to Securityholders.
"Distribution Date" means, with respect to a Series or Class of Securities,
each date specified as a distribution date for such Series or Class in the
related Prospectus Supplement.
"Due Date" means each date, as specified in the related Prospectus
Supplement for a Series, on which any payment of principal or interest is due
and payable by the obligor on any Primary Asset pursuant to the terms thereof.
"Eligible Investments" means any one or more of the obligations or
securities described as such in the related Agreement.
"Enhancement" means the enhancement for a Series, if any, specified in the
related Prospectus Supplement.
"Enhancer" means the provider of the Enhancement for a Series specified in
the related Prospectus Supplement.
"ERISA" means the Employee Retirement Income Security Act of 1974, as
amended.
"Escrow Account" means an account, established and maintained by the
Servicer for a Loan, into which payments by borrowers to pay taxes,
assessments, mortgage and hazard insurance premiums and other comparable items
required to be paid to the mortgagee are deposited.
"FDIC" means the Federal Deposit Insurance Corporation.
"FHLMC" means the Federal Home Loan Mortgage Corporation.
"Final Scheduled Distribution Date" means, with respect to a Class of Notes
of a Series, the date no later than which principal thereof will be fully paid
and with respect to a Class of Certificates of a Series, the date after which
no Certificates of such Class will remain outstanding, in each case based on
the assumptions set forth in the related Prospectus Supplement.
"FNMA" means the Federal National Mortgage Association.
"Holder" or "Securityholder" means the person or entity in whose name a
Security is registered.
"Home Improvements" means the home improvements financed by a Home
Improvement Contract.
"Home Improvement Contract" means any home improvement installment sales
contracts and installment loan agreement which may be unsecured or secured by
a purchase money security interest in the Home Improvement financed thereby.
"HUD" means the United States Department of Housing and Urban Development.
"Indenture" means the indenture relating to a Series of Notes between the
Trust Fund and the Trustee.
"Insurance Policies" means certain mortgage insurance, hazard insurance and
other insurance policies required to be maintained with respect to Loans.
"Insurance Proceeds" means amount paid by the insurer under any of the
Insurance Policies covering any Loan or Mortgaged Property.
"Interest Only Securities" means a Class of Securities entitled solely or
primarily to distributions of interest and which is identified as such in the
related Prospectus Supplement.
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"IRS" means the Internal Revenue Service.
"Lifetime Rate Cap" means the lifetime limit if any, on the Loan Rate during
the life of each adjustable rate Loan.
"Liquidation Proceeds" means amounts received by the Servicer in connection
with the liquidation of a Loan, net of liquidation expenses.
"Loan Rate" means, unless otherwise indicated herein or in the Prospectus
Supplement, the interest rate borne by a Loan.
"Loans" mean Mortgage Loans and/or Home Improvement Contracts, collectively.
A Loan refers to a specific Mortgage Loan or Home Improvement Contract, as the
context requires.
"Loan-to-Value Ratio" means, with respect to a Loan, the ratio determined as
set forth in the related Prospectus Supplement.
"Minimum Rate" means the lifetime minimum Loan Rate during the life of each
adjustable rate Loan.
"Modification" means a change in any term of a Loan.
"Mortgage" means the mortgage, deed of trust or other similar security
instrument securing a Mortgage Note.
"Mortgage Loan" means a closed-end and/or revolving credit line home equity
loan or balance thereof secured by a Mortgaged Property.
"Mortgage Note" means the note or other evidence of indebtedness of a
Mortgagor under the Loan.
"Mortgaged Property" means any real estate securing a Mortgage Loan and/or a
Home Improvement Contract.
"Mortgagor" means the obligor on a Mortgage Note.
"1986 Act" means the Tax Reform Act of 1986.
"Notes" means the Asset-Backed Notes.
"Notional Amount" means the amount set forth in the related Prospectus
Supplement for a Class of Interest Only Securities.
"OTS" means the Office of Thrift Supervision.
"PAC" ("Planned Amortization Class Securities") means a Class of Securities
of a Series on which payments of principal are made in accordance with a
schedule specified in the related Prospectus Supplement, based on certain
assumptions stated therein.
"Participating Securities" means Securities entitled to receive payments of
principal and interest and an additional return on investment as described in
the related Prospectus Supplement.
"Pass-Through Security" means a security representing an undivided
beneficial interest in a pool of assets, including the right to receive a
portion of all principal and interest payments relating to those assets.
"Pay Through Security" means Regular Interest Securities and certain Debt
Securities that are subject to acceleration due to prepayment on the
underlying Primary Assets.
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"Person" means any individual, corporation, partnership, joint venture,
association, joint stock company, trust (including any beneficiary thereof),
unincorporated organization, or government or any agency or political
subdivision thereof.
"Pooling and Servicing Agreement" means the pooling and servicing agreement
relating to a Series of Certificates among the Transferor, the Servicer (if
such Series relates to Loans) and the Trustee.
"Primary Assets" means the Private Securities and/or Loans, as the case may
be, which are included in the Trust Fund for such Series. A Primary Asset
refers to a specific Private Security or Loan, as the case may be.
"Principal Balance" means, with respect to a Primary Asset and as of a Due
Date, the original principal amount of the Primary Asset, plus the amount of
any Deferred Interest added to such principal amount, reduced by all payments,
both scheduled or otherwise, received on such Primary Asset prior to such Due
Date and applied to principal in accordance with the terms of the Primary
Asset.
"Principal Only Securities" means a Class of Securities entitled solely or
primarily to distributions of principal and identified as such in the
Prospectus Supplement.
"Private Security" means a participation or pass-through certificate
representing a fractional, undivided interest in Underlying Loans or
collateralized obligations secured by Underlying Loans.
"Property" means either a Home Improvement or a Mortgaged Property securing
a Loan, as the context requires.
"PS Agreement" means the pooling and servicing agreement, indenture, trust
agreement or similar agreement pursuant to which a Private Security is issued.
"PS Servicer" means the servicer of the Underlying Loans.
"PS Sponsor" means, with respect to Private Securities, the sponsor or
depositor under a PS Agreement.
"PS Trustee" means the trustee designated under a PS Agreement.
"Qualified Insurer" means a mortgage guarantee or insurance company duly
qualified as such under the laws of the states in which the Mortgaged
Properties are located duly authorized and licensed in such states to transact
the applicable insurance business and to write the insurance provided.
"Rating Agency" means the nationally recognized statistical rating
organization (or organizations) which was (or were) requested by the
Transferor to rate the Securities upon the original issuance thereof.
"Real Estate Loans" means Mortgage Loans and Home Improvement Contracts
secured by Mortgaged Property.
"Regular Interest" means a regular interest in a REMIC.
"REMIC" means a real estate mortgage investment conduit.
"REMIC Administrator" means the Person, if any, specified in the related
Prospectus Supplement for a Series for which a REMIC election is made, to
serve as administrator of the Series.
"REMIC Provisions" means the provisions of the federal income tax law
relating to real estate mortgage investment conduits, which appear at sections
860A through 860G of Subchapter M of Chapter 1 of the Code, and related
provisions, and regulations, including proposed regulations and rulings, and
administrative pronouncements promulgated thereunder, as the foregoing may be
in effect from time to time.
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"REO Property" means real property which secured a defaulted Loan,
beneficial ownership of which has been acquired upon foreclosure, deed in lieu
of foreclosure, repossession or otherwise.
"Reserve Fund" means, with respect to a Series, any Reserve Fund established
pursuant to the related Agreement.
"Residual Interest" means a residual interest in a REMIC.
"Retained Interest" means, with respect to a Primary Asset, the amount or
percentage specified in the related Prospectus Supplement which is not
included in the Trust Fund for the related Series.
"Scheduled Payments" means the scheduled payments of principal and interest
to be made by the borrower on a Primary Asset.
"Securities" means the Notes or the Certificates.
"Senior Securityholder" means a holder of a Senior Security.
"Senior Securities" means a Class of Securities as to which the holders'
rights to receive distributions of principal and interest are senior to the
rights of holders of Subordinated Securities, to the extent specified in the
related Prospectus Supplement.
"Series" means a separate series of Securities sold pursuant to this
Prospectus and the related Prospectus Supplement.
"Servicer" means Chevy Chase Bank, F.S.B., or the successors or assigns of
such Person.
"Single Family Property" means property securing a Loan consisting of one-
to four-family attached or detached residential housing, including Cooperative
Dwellings.
"Stripped Securities" means Pass-Through Securities representing interests
in Primary Assets with respect to which all or a portion of the principal
payments have been separated from all or a portion of the interest payments.
"Subordinated Securities" means a Class of Securities as to which the rights
of holders to receive distributions of principal, interest or both is
subordinated to the rights of holders of Senior Securities, and may be
allocated losses and shortfalls prior to the allocation thereof to other
Classes of Securities, to the extent and under the circumstances specified in
the related Prospectus Supplement.
"Transferor" means Chevy Chase Bank, F.S.B.
"Trustee" means the trustee under the applicable Agreement and its
successors.
"Trust Fund" means, with respect to any Series of Securities, the trust
holding all money, instruments, securities and other property, including all
proceeds thereof, which are, with respect to a Series of Certificates, held
for the benefit of the Holders by the Trustee under the Pooling and Servicing
Agreement or Trust Agreement or, with respect to a Series of Notes, pledged to
the Trustee under the Indenture as security for such Notes, including, without
limitation, the Primary Assets (except any Retained Interests), rights to all
amounts in the Distribution Account, Collection Account, Certificate Account,
Pre-Funding Account, Capitalized Interest Account or Reserve Funds, if any,
distributions on the Primary Assets (net of servicing fees) and rights to any
Enhancement and all other property and interest held by or pledged to the
Trustee pursuant to the related Agreement for such Series.
"UCC" means the Uniform Commercial Code.
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"Underlying Loans" means loans of the type eligible to be Loans underlying
or securing Private Securities.
"Variable Interest Security" means a Security on which interest accrues at a
rate that is adjusted, based upon a predetermined index, at fixed periodic
intervals, all as set forth in the related Prospectus Supplement.
"Zero Coupon Security" means a Security entitled to receive payments of
principal only.
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NO DEALER, SALES PERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY IN-
FORMATION OR MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS SUPPLE-
MENT OR THE PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTA-
TION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE TRANSFEROR OR
ANY UNDERWRITERS. THIS PROSPECTUS SUPPLEMENT AND THE PROSPECTUS DO NOT CONSTI-
TUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY OF THE SECURI-
TIES OFFERED HEREBY IN ANY JURISDICTION TO ANY PERSON TO WHOM IT IS UNLAWFUL
TO MAKE SUCH OFFER IN SUCH JURISDICTION. NEITHER THE DELIVERY OF THIS PROSPEC-
TUS SUPPLEMENT OR THE PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY
CIRCUMSTANCES, CREATE AN IMPLICATION THAT THE INFORMATION CONTAINED HEREIN IS
CORRECT AS OF A TIME SUBSEQUENT TO THE DATE HEREOF OR THAT THERE HAS BEEN NO
CHANGE IN THE AFFAIRS OF THE TRANSFEROR SINCE SUCH DATE.
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TABLE OF CONTENTS
PROSPECTUS SUPPLEMENT
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Reports to Certificateholders............................................ S-2
Available Information.................................................... S-2
Prospectus Supplement Summary of Terms................................... S-3
Risk Factors............................................................. S-18
The Transferor........................................................... S-22
Formation of the Trust................................................... S-23
Use of Proceeds.......................................................... S-23
The Chevy Chase Home Equity Lending Program.............................. S-23
The Mortgage Loan Pool................................................... S-29
Description of Certificate Insurer....................................... S-36
Allocations of Payments on the Common Mortgage Loans Between the Trust
and Trust 1990, Trust 1991, Trust 1992, Trust 1993 and Trust 1994....... S-37
Maturity and Prepayment Considerations................................... S-38
Description of the Certificates.......................................... S-40
Certain Legal Aspects of the Mortgage Loans.............................. S-63
ERISA Considerations..................................................... S-64
Certain Federal Income Tax Consequences.................................. S-65
State and Local Taxation................................................. S-69
Legal Investment Considerations.......................................... S-69
Underwriting............................................................. S-70
Experts.................................................................. S-70
Legal Matters............................................................ S-70
Index of Principal Terms................................................. S-71
Appendix A............................................................... A-1
Appendix B............................................................... B-1
PROSPECTUS
Prospectus Supplement.................................................... 3
Reports to Holders....................................................... 3
Available Information.................................................... 3
Incorporation of Certain Documents by Reference.......................... 4
Summary of Terms......................................................... 5
Risk Factors............................................................. 16
Description of the Securities............................................ 20
The Trust Funds.......................................................... 24
Enhancement.............................................................. 31
Servicing of Loans....................................................... 31
The Agreements........................................................... 38
Certain Legal Aspects of the Loans....................................... 47
The Transferor........................................................... 57
Use of Proceeds.......................................................... 57
Federal Income Tax Considerations........................................ 57
State Tax Considerations................................................. 79
ERISA Considerations..................................................... 79
Legal Investment......................................................... 80
Plan of Distribution..................................................... 80
Legal Matters............................................................ 81
Glossary of Terms........................................................ 82
</TABLE>
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UNTIL DECEMBER , 1996 (90 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEAL-
ERS EFFECTING TRANSACTIONS IN THE CERTIFICATES, WHETHER OR NOT PARTICIPATING
IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN AD-
DITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UN-
DERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
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$120,460,000
Capitol Revolving
Home Equity Loan
Asset Backed Certificates,
Series 1996-1
Chevy Chase Bank, F.S.B.,
as Transferor and Servicer
PROSPECTUS SUPPLEMENT
CS First Boston
Merrill Lynch & Co.
September , 1996
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