<PAGE>
Rule No. 424(b)(5)
File No. 333-28031
PROSPECTUS SUPPLEMENT
(To Prospectus dated July 17, 1997)
HEADLANDS HOME EQUITY LOAN TRUST 1997-1
REVOLVING HOME EQUITY LOAN ASSET-BACKED NOTES
SERIES 1997-1
$189,065,000 Class A Variable Rate Asset-Backed Notes
Class S 1.25% Asset-Backed Notes
HEADLANDS MORTGAGE SECURITIES INC.,
AS SPONSOR
HEADLANDS MORTGAGE COMPANY,
AS SERVICER
Headlands Home Equity Loan Trust 1997-1 (the "Trust" or the "Issuer") will
issue two classes of Asset-Backed Notes (the "Notes"), the Class A Variable Rate
Asset-Backed Notes (the "Class A Notes") and the Class S 1.25% Asset-Backed
Notes (the "Class S Notes"), each of which is being offered hereby. The Notes
are payable only in the circumstances described herein. The Trust was formed
pursuant to a Trust Agreement (the "Trust Agreement") dated as of August 1, 1997
and entered into between Headlands Mortgage Securities Inc., as Sponsor (the
"Sponsor") and Wilmington Trust Company, as Owner Trustee (the "Owner Trustee").
The Class A Notes and the Class S Notes will be issued pursuant to an Indenture,
dated as of August 1, 1997 (the "Indenture") between the Trust and The First
National Bank of Chicago, as Indenture Trustee (the "Indenture Trustee"). The
Trust will also issue a certificate which is not offered hereby but will
initially be retained by the Sponsor (the "Certificates", and together with the
Class A Notes and the Class S Notes, the "Securities"). The Notes represent
limited obligations of the Issuer payable solely from the collateral. Payment on
the Notes will be payable solely from the HELOCs and other collateral pledged to
secure the Notes and the Policy. Neither the Sponsor nor any other person or
entity except the Issuer has guaranteed or is otherwise obligated with respect
to payment of the Notes and no person or entity other than the Issuer is
obligated to pay the Notes, except as specifically set forth herein with regard
to the Policy. The Issuer is not expected to have any significant assets other
than those pledged as collateral to secure the Notes.
The Class A Notes will bear interest at a rate generally equal to LIBOR
plus .18% (the "Class A Note Rate"). The Class S Notes will bear interest on a
notional amount equal to the outstanding principal balance of the Class A Notes
at a rate of 1.25% (the "Class S Note Rate"). The Certificates will initially
represent approximately 2% of the outstanding principal balances of the HELOCs.
Only the Notes are being offered hereby.
(cover continued on next page)
[CAPMAC LOGO]
SEE "RISK FACTORS" ON PAGE S-20 HEREIN AND ON PAGE 14 IN THE PROSPECTUS FOR A
DISCUSSION OF CERTAIN RISK FACTORS WHICH SHOULD BE CONSIDERED BY
PROSPECTIVE INVESTORS IN THE NOTES OFFERED HEREBY.
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THE NOTES DO NOT REPRESENT INTERESTS IN OR OBLIGATIONS OF THE COMPANY, THE
OWNER TRUSTEE, THE INDENTURE TRUSTEE, THE SPONSOR, THE UNDERWRITER
OR ANY AFFILIATE THEREOF, EXCEPT TO THE EXTENT PROVIDED HEREIN.
NEITHER THE NOTES NOR THE HELOCS ARE INSURED OR GUARANTEED
BY THE COMPANY, THE OWNER TRUSTEE, THE INDENTURE TRUSTEE,
THE SPONSOR, THE UNDERWRITER OR ANY AFFILIATE
THEREOF OR BY ANY GOVERNMENTAL AGENCY.
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 OR THE PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
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Greenwich Capital Markets, Inc. (the "Underwriter") has agreed to purchase
the Class A Notes and the Class S Notes from the Sponsor for a purchase price
resulting in aggregate proceeds to the Sponsor of approximately $196,911,828
before deducting expenses payable by the Sponsor estimated at $350,000. The
Underwriter proposes to offer the Class A Notes and the Class S Notes from time
to time for sale in negotiated transactions or otherwise, at prices determined
at the time of sale. For further information with respect to the plan of sale
and any discounts, commissions or profits on resale that may be deemed
underwriting discounts or commissions, see "Underwriting." The Sponsor has
agreed to indemnify the Underwriter against certain liabilities, including
liabilities under the Securities Act of 1933.
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The Notes are offered subject to receipt and acceptance by the Underwriter
and to the Underwriter's right to reject any order in whole or in part and to
withdraw, cancel or modify the offer without notice. It is expected that
delivery of the Notes in book-entry form will be made on or about August 21,
1997 only through The Depository Trust Company ("DTC"), the Euroclear System
("Euroclear") and CEDEL, S.A. ("CEDEL").
GREENWICH CAPITAL MARKETS, INC.
August 18, 1997
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(cover continued from previous page)
Distributions on the Notes will be made on the fifteenth day of each month
or, if such date is not a Business Day, then on the next succeeding Business Day
(each, a "Distribution Date"), commencing September 15, 1997. On each
Distribution Date, holders of the Class A Notes will be entitled to receive,
from and to the limited extent of funds available in the Collection Account (as
defined herein), distributions with respect to interest and principal, and
holders of the Class S Notes will be entitled to receive, from and to the
limited extent of funds in the Collection Account, distributions with respect to
interest calculated as set forth herein. The Notes are not guaranteed by the
Company, the Sponsor, the Indenture Trustee, the Owner Trustee or any affiliate
thereof. However, the Notes will be unconditionally and irrevocably guaranteed
as to the payment of the Guaranteed Distributions (as defined herein) on each
Distribution Date pursuant to the terms of a certificate guaranty insurance
policy (the "Policy") to be issued by Capital Markets Assurance Corporation (the
"Insurer" or "CapMAC").
The property of the Trust will consist primarily of a pool of adjustable
rate home equity revolving credit line loans made or to be made (the "HELOCs")
under certain home equity revolving credit line loan agreements. The HELOCs are
secured by first or second deeds of trust on primarily one-to four-family
residential properties.
The information in this Prospectus Supplement is qualified in its entirety
by the more detailed information appearing or incorporated by reference in the
accompanying Prospectus. Prior to making an investment decision with respect to
the Notes offered hereby, prospective investors should carefully consider the
information contained in the Prospectus Supplement and the Prospectus.
There is currently no secondary market for the Notes. The Underwriter
intends to make a market in the Notes but has no obligation to do so. There can
be no assurance that such a market will develop or if one does develop, that it
will continue until the Notes are paid in full.
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN, OR OTHERWISE AFFECT THE PRICE OF THE NOTES. SUCH
TRANSACTIONS MAY INCLUDE STABILIZING AND THE PURCHASE OF THE NOTES TO COVER
SYNDICATE SHORT POSITIONS. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE
"UNDERWRITING" HEREIN.
Until ninety days after the date of this Prospectus Supplement, all dealers
effecting transactions in the Notes, whether or not participating in this
distribution, may be required to deliver a Prospectus Supplement and the
Prospectus. This is in addition to the obligation of dealers to deliver a
Prospectus Supplement and the Prospectus when acting as underwriters and with
respect to their unsold allotments or subscriptions.
The yields to maturity of the Classes of Notes may vary from the
anticipated yields to the extent such Notes are purchased at a discount or
premium and to the extent the rate and timing of payments thereof are sensitive
to the rate and timing of principal payments (including prepayments) of the
HELOCs. The yield to maturity of the Class A Notes also will be sensitive to,
among other things, the level of the London interbank offered rate for one-month
United States dollar deposits ("One-Month LIBOR"). The yield to maturity of the
Class S Notes will be extremely sensitive to the rate and timing of principal
payments (including prepayments) of the HELOCs. Holders of the Class A Notes
should consider, in the case of any Class A Notes purchased at a discount, the
risk that a lower than anticipated rate of principal payments could result in an
actual yield that is lower than the anticipated yield and, in the case of any
Class A Notes purchased at a premium, the risk that a faster than anticipated
rate of principal payments could result in an actual yield that is lower than
the anticipated yield. Holders of the Class S Notes should carefully consider
the risk that a rapid rate of principal payments on the HELOCs will have a
negative effect on the yield thereon and could result in the failure of such
holders to recover their initial investments.
S-2
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AVAILABLE INFORMATION
The Sponsor has filed a Registration Statement under the Securities Act of
1933, as amended (the "1933 Act"), with the Securities and Exchange Commission
(the "Commission") on behalf of the Trust with respect to the Notes offered
pursuant to the Prospectus dated July 17, 1997 and this Prospectus Supplement.
For further information, reference is made to the Registration Statement and
amendments thereof and to the exhibits thereto, which are available for
inspection without charge at the public reference facilities maintained by the
Commission at 450 Fifth Street, N.W., Washington, D.C. 20549; 7 World Trade
Center, 13th Floor, New York, New York 10048, and at The Northwestern Atrium
Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. The
Commission maintains a site on the World Wide Web at http://www.sec.gov
containing reports, proxy materials, information statements and other items.
Copies of the Registration Statement and amendments thereof and exhibits thereto
may be obtained from the Public Reference Section of the Commission, 450 Fifth
Street, N.W., Washington, D.C. 20549 at prescribed rates.
REPORTS TO THE NOTEHOLDERS
So long as the Notes are in book-entry form, monthly and annual reports
concerning the Notes and the Trust will be sent by the Indenture Trustee to Cede
& Co., as the nominee of DTC and as registered holder of the Notes pursuant to
the Indenture. DTC will supply such reports to beneficial owners in accordance
with its procedures. See "Risk Factors," "Description of the
Securities--Book-Entry Registration of Securities" and "--Reports to
Securityholders" in the Prospectus. The Trust will be formed to own the HELOCs,
and to issue the Notes. The Trust will have no assets or obligations prior to
issuance of the Notes and will engage in no activities other than those
described herein. Accordingly, no financial statements with respect to the Trust
are included in this Prospectus Supplement.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
There are incorporated herein by reference all documents filed by the
Sponsor with the Commission pursuant to Sections 13(a), 13(c), 14 or 15(d) of
the Securities Exchange Act of 1934, as amended (the "1934 Act"), on or
subsequent to the date of this Prospectus Supplement and prior to the
termination of the offering of the Notes. The Sponsor will provide without
charge to each person to whom this Prospectus Supplement and Prospectus are
delivered, on request of such person, a copy of any or all of the documents
incorporated herein by reference other than the exhibits to such documents
(unless such exhibits are specifically incorporated by reference in such
documents). Requests should be made in writing to Headlands Mortgage Securities
Inc., Attention: Peter T. Paul, 700 Larkspur Landing Circle, Suite 240,
Larkspur, California 94939, (415) 461-6790.
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SUMMARY
The following summary of certain pertinent information is qualified in its
entirety by reference to the detailed information appearing elsewhere in this
Prospectus Supplement and the accompanying Prospectus. Certain capitalized terms
used in the Summary are defined elsewhere in this Prospectus Supplement or in
the Prospectus. Reference is made to the Index of Defined Terms herein for the
definitions of certain capitalized terms.
Issuer..................................... Headlands Home Equity Loan Trust
1997-1 (the "Trust" or the
"Issuer").
Sponsor.................................... Headlands Mortgage Securities Inc.,
a Delaware corporation.
Servicer of the HELOCs..................... Headlands Mortgage Company (the
"Company"), a closely held
California corporation, will act as
the servicer (in such capacity, the
"Servicer"). See "HEADLANDS
MORTGAGE COMPANY" herein.
The Insurer................................ Capital Markets Assurance
Corporation ("CapMAC"), a monoline
stock insurance corporation
organized under the laws of the
State of New York. See "THE
INSURER."
Indenture Trustee.......................... The First National Bank of Chicago,
a national banking association.
Owner Trustee.............................. Wilmington Trust Company (the
"Owner Trustee"), a Delaware
banking corporation.
The Trust.................................. The Trust will be a business trust
established under the laws of the
State of Delaware. The activities
of the Trust are limited by the
terms of the Trust Agreement. The
Trust will issue the Class A Notes
in the aggregate original principal
amount of $189,065,000 and the
Class S Notes in the aggregate
notional principal amount of
$189,065,000. The Trust will also
issue the Certificates which are
not offered hereby but will
initially be retained by the
Sponsor. The Notes will be issued
pursuant to the Indenture.
Trust Property............................. The property of the Trust (the
"Trust Property") will include
certain adjustable rate home equity
revolving credit line loans made or
to be made and conveyed to the
Trust on the Closing Date (the
"Initial HELOCs") under certain
home equity revolving credit line
loan agreements and promissory
notes (the "Credit Line
Agreements"); the collections in
respect of the HELOCs received
after the related Cut-Off Date
(except with respect to interest
payments on the Initial HELOCS, an
amount equal to 25 days' interest
on the Original Pool Balance,
calculated at the weighted average
Loan Rate); property that secured a
HELOC that has been acquired by
foreclosure or deed in lieu of
foreclosure; rights of the Sponsor
under hazard insurance policies
covering the Mortgaged Properties;
the Policy; amounts on deposit in
the Collection Account; amounts on
deposit in the Funding Account;
amounts on deposit in the Spread
Account; amounts on deposit in the
Deferred Interest Account; certain
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rights of the Sponsor under the
Purchase Agreement; and certain
other property, as described more
fully herein. The HELOCs are
secured by first or second
mortgages or deeds of trust on
residential properties that are
primarily one- to four-family
properties and also include planned
unit developments and condominiums
(the "Mortgaged Properties"). In
addition, during the Funding
Period, the Trust shall have the
right to purchase additional HELOCs
(the "Subsequent HELOCs") from
amounts on deposit in the Funding
Account. The Initial HELOCs and the
Subsequent HELOCs together
constitute the HELOCs.
The Trust Property will include the
unpaid principal balance of each
HELOC as of the related Cut-Off
Date (the "Cut-Off Date Principal
Balance") plus any additions
thereto as a result of new advances
made pursuant to the applicable
Credit Line Agreements (the
"Additional Balances") during the
life of the Trust. With respect to
any date, the "Pool Balance" will
be equal to the aggregate of the
Principal Balances of all HELOCs as
of such date. The aggregate
Principal Balance of the Initial
HELOCs as of the Initial Cut-Off
Date is $192,924,110.37 (the
"Original Pool Balance"). The
"Principal Balance" of a HELOC
(other than a Liquidated HELOC) on
any day is equal to its Cut-Off
Date Principal Balance, plus any
Additional Balances in respect of
such HELOC, minus, all collections
credited against the Principal
Balance of such HELOC in accordance
with the related Credit Line
Agreement, prior to such day. The
Principal Balance of a Liquidated
HELOC after final recovery of
related Liquidation Proceeds shall
be zero. The "Initial Cut-Off Date"
with respect to any Initial HELOC
shall be July 31, 1997. The
"Subsequent Cut-Off Date" with
respect to each Subsequent HELOC
shall be the date on which such
HELOC is transferred to the Trust.
The "Cut-Off Date" shall mean the
Initial Cut-Off Date with respect
to the Initial HELOCs and the
Subsequent Cut-Off Date with
respect to the Subsequent HELOCs.
Sale of Mortgage Loans..................... The HELOCs will be purchased by the
Sponsor from the Company pursuant
to a purchase agreement (the
"Purchase Agreement") between the
Sponsor and the Company on or prior
to the date of issuance of the
Securities. The Sponsor will then
sell the HELOCs to the Trust
pursuant to the Sale and Servicing
Agreement (the "Sale and Servicing
Agreement") dated as of August 1,
1997 among the Sponsor, the
Servicer, the Issuer and the
Indenture Trustee.
The HELOCs................................. The Initial HELOCs are secured by
second mortgages or deeds of trust
on Mortgaged Properties located in
12 states. As of the Initial
Cut-Off Date, the percentage of the
Original Pool Balance of the
Initial HELOCs secured primarily by
Mortgaged Properties located in the
States of California, Washington
and Oregon is approximately 86.12%,
2.84% and 3.43%. No other state
represented more than 2.27% of the
Original Pool Balance. The
"Combined Loan-to-Value Ratio" of
each HELOC is the ratio of (A) the
sum of (i) the maximum amount the
borrower is permitted to draw down
under the related Credit Line
Agreement (the
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"Credit Limit") and (ii) the
amounts of any related senior
mortgage loans (computed as of the
date of origination of the HELOC)
to (B) the appraised value of the
Mortgaged Property as determined
either by a drive-by inspection or
an appraisal. As of the Initial
Cut-Off Date, the weighted average
Combined Loan-to-Value Ratio of the
Initial HELOCs was approximately
85.10%.
Interest on each HELOC is payable
monthly and computed on the related
daily outstanding Principal Balance
for each day in the billing cycle
at a variable rate per annum (with
respect to the HELOCs, the "Loan
Rate") equal at any time (subject
to maximum rates, as described
herein under "DESCRIPTION OF THE
HELOCs--HELOC Terms," and further
subject to applicable usury
limitations) to the sum of (i) the
highest prime rate published in the
"Money Rates" section of The Wall
Street Journal (such rate, the
"Index Rate") and (ii) a margin
(the "Margin") within the range of
0.00% to 5.75%; provided that the
Loan Rate for HELOCS is subject to
a maximum rate of 18.00%. As of the
Initial Cut-Off Date, the weighted
average Margin for the Initial
HELOCs was approximately 3.08%.
Loan Rates on the HELOCs are
adjusted monthly based on changes
in the Index Rate through the end
of the prior month. The HELOCs are
simple- interest loans under which
the payment is applied first to
interest accrued on the HELOC
through the date of receipt and
then to reduction of the principal
balance. For each HELOC, the "Due
Date" is the twenty-fifth day of
each month. The Cut-Off Date
Principal Balances of the Initial
HELOCs ranged from $0.00 to
$300,000 and averaged approximately
$39,308.09 (excluding those HELOCs
with a $0.00 principal balance).
Credit Limits under the Initial
HELOCs as of the Cut-Off Date
ranged from $8,700 to $500,000 and
had an average Credit Limit of
approximately $50,014.75. As of the
Initial Cut-Off Date, the maximum
Credit Limit Utilization Rate (as
defined below) for any Initial
HELOC was 100% and the HELOCs had a
weighted average Credit Limit
Utilization Rate (weighted by
credit line) of approximately
74.87%. The "Credit Limit
Utilization Rate" of a HELOC is
determined by dividing the Cut-Off
Date Principal Balance by the
Credit Limit of the related Credit
Line Agreement. As of the Initial
Cut-Off Date, all of the Initial
HELOCS represented second liens on
the related Mortgaged Properties.
HELOCs have final scheduled
maturities in fifteen years and
twenty-five years. As of the
Initial Cut-Off Date, the Initial
HELOCs had remaining terms to
scheduled maturity ranging from 170
months to 300 months and had a
weighted average remaining term to
scheduled maturity of approximately
231.8 months. See "DESCRIPTION OF
THE HELOCs" herein.
Following the Closing Date and
subject to the satisfaction of
certain conditions set forth in the
Sale and Servicing Agreement, the
Trust intends to purchase
Subsequent HELOCs for pledge under
the Indenture on any Distribution
Date during the Funding Period for
an amount equal to the Principal
Balance of each such loan as of the
related transfer date. Such amount
will be released from amounts on
deposit in the Funding Account.
Some of the
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HELOCs may be teaser loans with
lower initial Loan Rates at the
time of the sale to the Trust and
such HELOCs may not become fully
indexed until after a period of
time after which they were sold to
the Trust. See "--Interest" and
"--Deferred Interest Account."
Removal of Certain HELOCs;
Additional Balances........................ Subject to certain conditions, on
any Distribution Date the Sponsor
may, but shall not be obligated to,
designate for removal from the
Trust certain HELOCs without notice
to the holders of the Notes (the
"Noteholders"). The Sponsor is
permitted to designate the HELOCs
to be removed. HELOCs so designated
will only be removed upon
satisfaction of certain conditions
specified in the Sale and Servicing
Agreement, including: (i) the
Certificateholders' Interest as of
the transfer date after giving
effect to such removal exceeds the
Minimum Certificateholders'
Interest (as defined below); (ii)
the Sponsor shall have delivered to
the Indenture Trustee a "HELOC
Schedule" containing a list of all
HELOCs remaining in the Trust after
such removal; (iii) the Sponsor
shall represent and warrant that no
selection procedures which are
adverse to the interests of the
Noteholders or the Insurer were
used by the Sponsor in selecting
such HELOCs; (iv) in connection
with each such retransfer of
HELOCs, the Rating Agencies shall
have been notified of the proposed
transfer and prior to the transfer
date, the Rating Agencies shall
have notified the Indenture Trustee
or the Insurer in writing that such
transfer would not result in a
reduction or withdrawal of the
ratings assigned to the Notes
without regard to the Policy; (v)
the proposed retransfer shall not
cause a Rapid Amortization Event to
occur; (vi) the Rapid Amortization
Period shall not have commenced;
and (vii) the Sponsor shall have
delivered to the Indenture Trustee
and the Insurer an officer's
certificate confirming the
conditions set forth in clauses (i)
through (vi) above. In certain
circumstances where the removal of
such HELOCs results in the
Certificateholders' Interest being
reduced below the Minimum
Certificateholders' Interest, the
Sponsor shall be permitted to
remove such HELOCs only if the
Sponsor deposits an amount equal to
the excess of the Minimum
Certificateholders' Interest over
the Certificateholders' Interest
(such amount the "Reimbursement
Amount") in the Collection Account;
the Sponsor shall not remove such
HELOCs if the Reimbursement Amount
would exceed $100,000. See
"DESCRIPTION OF THE NOTES--Optional
Retransfers of HELOCs to the
Sponsor."
The "Certificateholders' Interest"
will be the entire beneficial
ownership interest in the Trust as
represented by the Certificates.
The Certificateholders' Interest
evidenced by the Certificates will
include the right to distributions
on and other proceeds of the
HELOCs, to the extent that those
proceeds are not used to pay the
Notes or other expenses of the
Trust. The Certificateholders'
Interest will be in a principal
amount approximately equal to the
Pool Balance plus the amount of
Principal Collections on deposit
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in the Funding Account minus the
Invested Amount. The "Minimum
Certificateholders' Interest" as of
any date is an amount equal to the
lesser of (a) 4% of the Pool
Balance on such date and (b) the
Certificateholders' Interest as of
the Closing Date.
During the term of the Trust, all
Additional Balances will be
transferred to and held by the
Trust. Funds on deposit in the
Collection Account, to the extent
available, will be used to purchase
such Additional Balances. The Pool
Balance at any time will generally
fluctuate from day to day because
the amount of Additional Balances
and the amount of principal
payments with respect to the HELOCs
will usually differ from day to
day. Because the
Certificateholders' Interest is
equal to the Pool Balance plus the
amount of Principal Collections on
deposit in the Funding Account
minus the Invested Amount, the
amount of the Certificateholders'
Interest will fluctuate from day to
day as draws are made with respect
to the HELOCs and as Principal
Collections are received.
Notes Offered.............................. Each of the Revolving Home Equity
Loan Asset-Backed Notes, Series
1997-1, Class A and Class S offered
hereby represents indebtedness of
the Trust. Each Class A Note
represents the right to receive
payments of interest at the Class A
Note Rate, payable monthly, and
payments of principal at such time
and to the extent provided below.
Each Class S Note represents the
right to receive interest at the
rate of 1.25% per annum on the
Class S Notional Amount for such
Distribution Date (the "Class S
Note Rate"; the Class S Note Rate
and the Class A Note Rate are
sometimes referred to herein as the
"Note Rate"). The "Class S Notional
Amount" for any Distribution Date
shall be the Note Principal Balance
for the Class A Notes on such
Distribution Date (prior to giving
effect to any distributions on such
Distribution Date). The aggregate
obligation of the Trust represented
by the Notes as of the Closing Date
equals $189,065,000 (the "Original
Invested Amount"), which represents
approximately 98% of the Original
Pool Balance. The "Original Class A
Note Principal Balance" will equal
$189,065,000. Following the Closing
Date, the "Invested Amount" with
respect to any date will be an
amount equal to the Original
Invested Amount minus (i) the
amount of Principal Collections
previously distributed to Class A
Noteholders, amounts allocable to
the Certificates that are used to
reimburse Noteholders' Loss Amounts
and amounts distributed as
Guaranteed Principal Distribution
Amounts funded by withdrawals from
the Spread Account or drawn under
the Policy, and minus (ii) an
amount equal to the Noteholders'
Loss Amounts not previously
absorbed by the
Overcollateralization Amount,
funded by collections allocable to
the Certificateholders' Interest or
reallocated to the
Certificateholders' Interest (up to
the Certificateholders'
Subordinated Amount), or funded by
withdrawals from the Spread Account
or draws on the Policy.
The principal amount of the
outstanding Class A Notes (the
"Note Principal Balance") on any
date is equal to the Original Class
A
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Note Principal Balance minus the
aggregate of amounts actually
distributed as principal to the
Noteholders. The Class S Notional
Amount of the outstanding Class S
Notes on any date is equal to the
Note Principal Balance on such
date. See "DESCRIPTION OF THE
NOTES" herein.
Denominations.............................. The Notes will be offered for
purchase in denominations
representing note principal
balances of a minimum of $1,000 in
multiples of $1,000 in excess
thereof. The obligation of the
Trust evidenced by a Note (the
"Percentage Interest") will be
equal to (i) with respect to the
Class A Notes, the percentage
derived by dividing the
denomination of such Note by the
Original Class A Note Principal
Balance and (ii) with respect to
the Class S Notes, the percentage
derived by dividing the notional
amount of such Note by the Class S
Notional Amount on the Closing
Date. The "Original Class A Note
Principal Balance" shall be equal
to $189,065,000.
Registration of Notes...................... The Notes will be issued in
book-entry form. So long as such
Notes are Book-Entry Securities,
such Notes will be evidenced by one
or more certificates registered in
the name of CEDE & Co. ("CEDE"), as
nominee of DTC. No person acquiring
a beneficial ownership interest in
the Notes will be entitled to
receive a Definitive Note (as
defined herein) representing the
corresponding obligation of the
Trust, except in the event
Definitive Notes are issued under
the limited circumstances described
herein.
Collections................................ All collections on the HELOCs will
generally be allocated in
accordance with the Loan Agreements
between amounts collected in
respect of interest and amounts
collected in respect of principal.
As to any Distribution Date,
"Interest Collections" will be
equal to the amounts collected
during the related Collection
Period, including the portion of
Net Liquidation Proceeds (as
defined below) and insurance
proceeds allocated to interest
pursuant to the terms of the Loan
Agreements and earnings received on
funds on deposit in the Funding
Account, less Servicing Fees for
the related Collection Period.
As to any Distribution Date,
"Principal Collections" will be
equal to the sum of (i) the amounts
collected during the related
Collection Period, including the
portion of Net Liquidation Proceeds
and insurance proceeds, allocated
to principal pursuant to the terms
of the Loan Agreements and (ii) any
Transfer Deposit Amounts (as
defined herein).
"Net Liquidation Proceeds" with
respect to a HELOC are the proceeds
received in connection with the
liquidation of any HELOC, whether
through trustee's sale, foreclosure
sale or otherwise, reduced by
related expenses, but not including
the portion, if any, of such amount
that exceeds the Principal Balance
of the HELOC plus any accrued and
unpaid interest thereon to the end
of the Collection Period during
which such HELOC became a
Liquidated HELOC.
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S-9
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With respect to any Distribution
Date, the portion of Interest
Collections allocable to the Notes
("Noteholders' Interest
Collections") will equal the
product of (a) Interest Collections
for such Distribution Date and (b)
the Floating Allocation Percentage
for such Distribution Date. With
respect to any Distribution Date,
the "Floating Allocation
Percentage" is the percentage
equivalent of a fraction determined
by dividing (a) the Invested Amount
at the close of business on the
preceding Distribution Date (or at
the Closing Date in the case of the
first Distribution Date) by (b) the
sum as of the beginning of the
related Collection Period of (i)
the Pool Balance (adjusted for any
HELOCs removed from the Trust or
Additional Balances added to the
Trust during the prior Collection
Period) and (ii) the amount of
Principal Collections on deposit in
the Funding Account. The remaining
amount of Interest Collections will
be allocated to the
Certificateholders' Interest as
more fully described herein.
On each Distribution Date, the
Noteholders' Interest Collections
and amounts transferred from the
Deferred Interest Account and the
Spread Account will be applied in
the following order of priority:
(i) as payment to the Class A
Noteholders for the accrued
interest due and any overdue
accrued interest (with
interest thereon) other than
Deferred Interest on the Note
Principal Balance of the
Class A Notes;
(ii) as payment to the Class S
Noteholders for the accrued
interest due and any overdue
accrued interest (with
interest thereon) on the
Class S Notional Amount;
(iii) to pay any Noteholders' Loss
Amount (as defined herein)
for such Distribution Date;
(iv) as payment for any
Noteholders' Loss Amount for
a previous Distribution Date
that was not previously (a)
funded by Noteholders'
Interest Collections, (b)
funded by Interest
Collections and Principal
Collections allocable to the
Certificateholders' Interest
or reallocated to the
Certificateholders' Interest
up to the Certificateholders'
Subordinated Amount as
described under "--Limited
Subordination of
Certificateholders' Interest"
below, (c) absorbed by the
Overcollateralization Amount,
(d) funded by amounts on
deposit in the Spread
Account, or (e) funded by
draws on the Policy;
(v) as payment to the Insurer for
the monthly premium for the
Policy;
(vi) to reimburse prior draws made
from the Policy (with
interest thereon);
(vii) to deposit to an account (the
"Spread Account") for the
benefit of the Insurer and
Noteholders pursuant to the
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S-10
<PAGE>
- --------------------------------------------------------------------------------
Indenture and the Insurance
Agreement until the funds on
deposit therein equal 0.50%
of the Original Pool Balance;
(viii) to pay principal on the
Class A Notes until the
Invested Amount exceeds the
Note Principal Balance by the
Required
Overcollateralization Amount
(the aggregate of amounts, if
any, paid pursuant to this
clause (viii) being referred
to herein as the "Accelerated
Principal Distribution
Amount");
(ix) to pay any other amounts owed
to the Insurer pursuant to
the Insurance Agreement;
(x) as payment to the Indenture
Trustee for its fee for
services rendered pursuant to
the Indenture and as payment
to the Owner Trustee for its
fee for services rendered
pursuant to the Trust
Agreement;
(xi) to pay certain amounts that
may be required to be paid to
the Servicer pursuant to the
Sale and Servicing Agreement;
(xii) to pay Deferred Interest on
the Class A Notes and
interest thereon at the Class
A Note Rate;
(xiii) to pay to Headlands Mortgage
Company, as Manager (the
"Manager") of the Trust, the
Management Fee (as defined
herein); and
(xiv) to the Certificateholders,
which shall initially be the
Sponsor, to the extent
permitted as described
herein.
Noteholders' Interest Collections
available after the payment of
interest on the Notes may be
insufficient to cover any
Noteholders' Loss Amount. If such
insufficiency exists after (i)
giving effect to the distribution,
if any, of principal to the Class A
Noteholders on such Distribution
Date (including all withdrawals
from the Spread Account and the
application of collections
otherwise allocable to the
Certificateholders' Interest) and
(ii) the Certificateholders'
Subordinated Amount has been
reduced to zero, then if the Note
Principal Balance as of such
Distribution Date exceeds the
Invested Amount, a draw in an
amount equal to such difference
will be made on the Policy in
accordance with the terms of the
Policy.
The "Overcollateralization Amount"
on any date of determination is the
amount, if any, by which the
Invested Amount exceeds the Note
Principal Balance on such day.
Payments to Noteholders pursuant to
clauses (i), (ii) and (xii) will be
interest payments on the Notes.
Payments to Noteholders pursuant to
clauses (iii) and (iv) will be
principal payments on the Class A
Notes and will therefore reduce the
Note Principal Balance and the
Invested Amount; however, payments
pursuant to clause (viii) will
reduce the Note Principal Balance
but will not reduce the Invested
Amount. The Accelerated Principal
Distribution Amount is not
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S-11
<PAGE>
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guaranteed by the Policy. The
"Required Overcollateralization
Amount" as of any Distribution Date
is an amount equal to the excess of
(a) the "Spread Account Maximum"
(as defined in the Insurance
Agreement) as of such Distribution
Date over (b) the sum of (i) the
Certificateholders' Subordinated
Amount as of such Distribution Date
and (ii) the amount of funds on
deposit in the Spread Account as of
such Distribution Date.
"Liquidation Loss Amount" means
with respect to any Liquidated
HELOC, the unrecovered Principal
Balance thereof at the end of the
related Collection Period in which
such HELOC became a Liquidated
HELOC, after giving effect to the
Net Liquidation Proceeds in
connection therewith. The
"Noteholders' Loss Amount" shall be
the product of the Floating
Allocation Percentage and the
aggregate of the Liquidation Loss
Amounts for such Distribution Date.
See "DESCRIPTION OF THE
NOTES--Distributions on the Notes."
Principal Collections will be
allocated between the Noteholders
and the Certificateholders
("Noteholders' Principal
Collections" and
"Certificateholders' Principal
Collections", respectively) as
follows: (i) to the Noteholders in
accordance with the proportion that
the Class A Note Principal Balance
bears to the Original Pool Balance
which shall be approximately 98%
and (ii) the remainder to the
Certificates which shall be
approximately 2%. The respective
allocations shall be determined as
of the Initial Cut-Off Date (the
"Fixed Allocation Percentage"), but
(i) during the Funding Period no
amount of Principal Collections
will be distributed to the
Noteholders and (ii) during the
Managed Amortization Period, a
lesser amount of Principal
Collections may be distributed to
Noteholders, each as described
below. Certificateholders'
Principal Collections will be used
to purchase Additional Balances.
The Servicer will deposit Interest
Collections and Principal
Collections in respect of the
HELOCs in an account established
for such purpose under the
Indenture (the "Collection
Account"). See "DESCRIPTION OF THE
NOTES--Payments on the HELOCs;
Deposits to Collection Account;
Deposits to Funding Account."
Collection Period.......................... As to any Distribution Date, the
"Collection Period" is the calendar
month preceding the month of such
Distribution Date.
Interest................................... Interest on the Notes will be
distributed monthly on the
Distribution Date, commencing on
September 15, 1997, at the related
Note Rate for the related Interest
Period. The Class S Note Rate for
an Interest Period shall be equal
to 1.25% per annum. The Class A
Note Rate for an Interest Period
will generally equal the sum of (a)
the One-Month LIBOR appearing on
the Telerate Screen Page 3750, as
of the second LIBOR Business Day
(as defined herein) prior to the
first day of such Interest Period
(or as of two LIBOR Business Days
prior to the Closing Date, in the
case of the first Interest Period)
and
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S-12
<PAGE>
- --------------------------------------------------------------------------------
(b) .18%. Notwithstanding the
foregoing, in no event will the
amount of interest required to be
distributed in respect of the Class
A Notes on any Distribution Date
exceed a rate (the "Maximum Rate")
equal to the weighted average of
the Loan Rates (net of the Class S
Note Rate, the Servicing Fee Rate,
the fee payable to the Indenture
Trustee and the Owner Trustee
expressed as a rate and the rate at
which the premium payable to the
Insurer is calculated) weighted on
the basis of the average daily
balance of each HELOC during the
related billing cycle prior to the
Collection Period relating to such
Distribution Date (adjusted to an
effective rate reflecting accrued
interest calculated on the basis of
the actual number of days in such
Collection Period and a 360-day
year). To the extent the Maximum
Rate is less than the Class A Note
Rate for any Distribution Date, the
deficiency will be deferred (the
"Deferred Interest"). See
"DESCRIPTION OF THE
NOTES--Distributions on the Notes."
The Policy will not guarantee the
payment of Deferred Interest. In
certain circumstances, the addition
of Subsequent HELOCs to the Trust
may result in the Class A Note Rate
exceeding the Maximum Rate.
Interest on the Notes 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 Notes
(the "Closing Date")) through the
day preceding such Distribution
Date (each such period, an
"Interest Period") on the basis of
the actual number of days in the
Interest Period and a 360-day year.
Interest payments on the Notes will
be funded from Noteholders'
Interest Collections, the Deferred
Interest Account, and, if
necessary, from collections
allocable to the Certificates up to
the then outstanding
Certificateholders' Subordinated
Amount, the Spread Account and from
draws on the Policy. See
"DESCRIPTION OF THE NOTES" herein.
Principal Payments from
Principal Collections...................... During the period commencing on the
Closing Date and ending on the
earlier of (i) the close of
business on the August, 1998
Distribution Date and (ii) the
commencement of the Rapid
Amortization Period (the "Funding
Period"), the Scheduled Principal
Collections Distribution Amount (as
defined below) will be deposited in
the Funding Account. In the event
that not all of the Principal
Collections on deposit in the
Funding Account have been used to
acquire Subsequent HELOCs or
Additional Balances on the last
Distribution Date of the Funding
Period, the remaining amount on
deposit in the Funding Account
shall be used to acquire any
remaining Additional Balances on
such Distribution Date and any
remaining amount on deposit in the
Funding Account thereafter will be
distributed to the Class A
Noteholders on such Distribution
Date as a payment of principal. For
the period beginning on the first
Distribution Date following the end
of the Funding Period and, unless a
Rapid Amortization Event (as
defined herein) shall have earlier
occurred, ending on the
Distribution Date in August, 2003
(such period, the "Managed
Amortization Period"), the amount
of Principal Collections
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S-13
<PAGE>
- --------------------------------------------------------------------------------
payable to Class A Noteholders as
of each Distribution Date during
the Managed Amortization Period
will equal, to the extent funds are
available therefor, the Scheduled
Principal Collections Distribution
Amount for such Distribution Date.
On any Distribution Date, the
"Scheduled Principal Collections
Distribution Amount" shall equal
the lesser of (i) the Maximum
Principal Payment (as defined
herein) and (ii) the Alternative
Principal Payment (as defined
herein). With respect to any
Distribution Date, the "Maximum
Principal Payment" will be equal to
the product of the Fixed Allocation
Percentage and Principal
Collections for such Distribution
Date. "Certificate Principal
Balance" means, as of any date of
determination, the amount equal to
(i) the Pool Balance at the end of
the day next preceding such date of
determination plus (ii) the amount
of Principal Collections on deposit
in the Funding Account, minus (iii)
the Invested Amount. With respect
to any Distribution Date, the
"Alternative Principal Payment"
will equal the amount (but not less
than zero) of Principal Collections
for such Distribution Date less the
aggregate of Additional Balances
created during the related
Collection Period.
Beginning with the first
Distribution Date in the Rapid
Amortization Period, the amount of
Principal Collections payable to
Class A Noteholders on each
Distribution Date will be equal to
the Maximum Principal Payment. See
"DESCRIPTION OF THE
NOTES--Distributions on the Notes"
herein.
In addition, to the extent funds
are available therefor (including
funds on deposit in the Spread
Account and funds available under
the Policy), on the Distribution
Date in August, 2024, Class A
Noteholders will be entitled to
receive as payment of principal an
amount equal to the outstanding
Note Principal Balance.
Distributions of Principal
Collections based upon the Fixed
Allocation Percentage may result in
distributions of principal to Class
A Noteholders in amounts that are
greater relative to the declining
Pool Balance than would be the case
if the Floating Allocation
Percentage were used to determine
the percentage of Principal
Collections distributed in respect
of the Invested Amount. The
aggregate distributions of
principal to Class A Noteholders
will not exceed the Original Class
A Note Principal Balance.
Funding Account............................ The "Funding Account" will be an
Eligible Account (as defined
herein) established with the
Indenture Trustee on the Closing
Date. On each Distribution Date
during the Funding Period the
Scheduled Principal Collections
Distribution Amount for such
Distribution Date will be deposited
in the Funding Account and may be
applied by the Indenture Trustee
(i) as payment to the Sponsor of an
amount equal to the Additional
Balances previously acquired by the
Trust and for which the Sponsor has
not previously been paid, and (ii)
from any remaining amount on
deposit in the Funding Account on
such Distribution Date, to the
purchase of Subsequent HELOCs. In
the event that not all of the
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S-14
<PAGE>
- --------------------------------------------------------------------------------
Principal Collections on deposit in
the Funding Account have been so
applied on the last Distribution
Date in the Funding Period, the
remaining amount on deposit in the
Funding Account will be distributed
to the Class A Noteholders as a
payment of principal on such last
Distribution Date.
Deferred Interest Account.................. On the Closing Date an amount equal
to $600,809.53 will be deposited,
and on each Distribution Date on
which the Trust acquires Subsequent
HELOCs and Eligible Substitute
HELOCs, an amount calculated by the
Sponsor necessary to pay any
Deferred Interest with respect to
such Subsequent HELOCs and Eligible
Substitute HELOCs will be
deposited, in an account (the
"Deferred Interest Account") in the
name of the Indenture Trustee on
behalf of the Trust. On each
Distribution Date, amounts in the
Deferred Interest Account in an
amount equal to the Deferred
Interest for such Distribution Date
will be deposited into the
Collection Account and applied in
accordance with the priority of
payments set forth in
"--Collections." Any amounts
remaining in the Deferred Interest
Account on the later of (i) the
Distribution Date following the end
of the Funding Period and (ii) the
Distribution Date following the
date on which all teaser HELOCs
have become fully indexed, will be
deposited in the Collection Account
for distribution.
Policy..................................... On or before the Closing Date, the
Policy will be issued by the
Insurer pursuant to the provisions
of the Insurance and Reimbursement
Agreement (the "Insurance
Agreement") to be dated as of
August 1, 1997, among the Company,
the Sponsor, the Servicer, the
Indenture Trustee and the Insurer.
The Policy will irrevocably and
unconditionally guarantee on each
Distribution Date to the Indenture
Trustee for the benefit of the
Noteholders the full and complete
payment of (i) the Guaranteed
Principal Distribution Amount (as
defined below) with respect to the
Class A Notes for such Distribution
Date and (ii) after application of
amounts available from Noteholders'
Interest Collections, amounts
transferred from the Deferred
Interest Account, collections
otherwise allocable to the
Certificateholders' Interest up to
the Certificateholders'
Subordinated Amount and amounts on
deposit in the Spread Account and
certain other amounts in the
Collection Account, any shortfall
in accrued and unpaid interest due
on the Notes (other than Deferred
Interest) (together, the
"Guaranteed Distributions"), with
such Guaranteed Distributions
having been calculated in
accordance with the original terms
of the Policy and the Indenture.
Any amendments or modifications to
such terms shall require the
Insurer's prior written consent.
The effect of the Policy is to
guarantee the timely payment of
interest on the Class A and Class S
Notes, and the ultimate payment of
the principal amount of the Class A
Notes.
The "Guaranteed Principal
Distribution Amount" for any
Distribution Date on which the
Certificateholders' Subordinated
Amount has been reduced to zero
shall be the amount, if any, by
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S-15
<PAGE>
- --------------------------------------------------------------------------------
which the Note Principal Balance
(after giving effect to all other
amounts distributable and allocable
to principal on the Notes on such
Distribution Date including
application of any amounts available
therefor in the Spread Account)
exceeds the Invested Amount for such
Distribution Date after giving
effect to distributions of
principal, if any, to the
Noteholders and the allocation of
Noteholders' Loss Amounts on such
Distribution Date. In addition, the
Policy will guarantee the payment of
the outstanding Note Principal
Balance on the Distribution Date in
August, 2024 (after giving effect to
all other amounts distributable and
allocable to principal on such
Distribution Date and after applying
any amounts available in the Spread
Account).
In accordance with the Indenture
and the Insurance Agreement, the
Indenture Trustee will be required
to establish and maintain the
Spread Account for the benefit of
the Insurer and the Noteholders to
be used prior to any draws upon the
Policy. The Indenture Trustee shall
deposit the amounts into the Spread
Account as required by the
Indenture and the Insurance
Agreement.
In the absence of payments from the
Spread Account and under the
Policy, Noteholders will directly
bear the credit and other risks
associated with the Trust
obligations. See "DESCRIPTION OF
THE NOTES--The Policy."
Limited Subordination of
Certificateholders' Interest............... If Noteholders' Interest
Collections and funds payable from
the Deferred Interest Account on
any Distribution Date are
insufficient to pay (i) accrued
interest due and any overdue
accrued interest (with interest
thereon) on the Class A Notes and
then accrued interest due and any
overdue accrued interest (with
interest thereon) on the Class S
Notes, and (ii) the Noteholders'
Loss Amount, allocable to the
Noteholders on such Distribution
Date (such insufficiency being the
"Required Amount"), Interest
Collections and Principal
Collections allocable to the
Certificateholders' Interest (but
not in excess of the then
outstanding Certificateholders'
Subordinated Amount, determined as
provided herein) will be applied to
cover the Required Amount. The
portion of the Required Amount in
respect of clause (ii) above not
covered by such collections (up to
the remaining Certificateholders'
Subordinated Amount and not in
excess of the Noteholders' Loss
Amounts allocable to Noteholders)
will be reallocated to the
Certificateholders' Interest,
thereby reducing the
Certificateholders' Interest. If
such Noteholders' Interest
Collections and funds payable from
the Deferred Interest Account plus
the amount of collections allocable
to the Certificateholders' Interest
which have been so applied to cover
the Required Amount plus the amount
available therefor in the Spread
Account are together insufficient
to pay the amounts set forth in
item (i) of the definition of
Required Amount, then a draw will
be made on the Policy for such
Distribution Date to cover the
amount by which interest owed to
the Class A Noteholders at the
Class A Note Rate and to the Class
S Noteholders at the Class S Note
Rate (other
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S-16
<PAGE>
- --------------------------------------------------------------------------------
than Deferred Interest) exceeds
Noteholders' Interest Collections,
amounts available in the Deferred
Interest Account, collections
allocable to the
Certificateholders' Interest and
amounts on deposit in the Spread
Account. In addition, if on any
Distribution Date on or after the
Certificateholders' Subordinated
Amount is reduced to zero, the Note
Principal Balance exceeds the
Invested Amount (after giving
effect to all allocations and
distributions with respect to
principal to be made on the Class A
Notes on such Distribution Date
including amounts withdrawn from
the Spread Account), a draw will be
made on the Policy for such
Distribution Date in the amount by
which the Note Principal Balance
exceeds the Invested Amount. After
the Certificateholders'
Subordinated Amount has been
reduced to zero, the Required
Amount will no longer be supported
by the Certificateholders'
Subordinated Amount as described
above.
With respect to any Distribution
Date, the "Certificateholders'
Subordinated Amount" equals
$3,859,110.37 minus (i) the
aggregate amount of principal and
interest collections allocable to
the Certificateholders' Interest
that have previously been
distributed to the Noteholders to
cover a Required Amount as
described above and (ii) the
aggregate amount of the
Noteholders' Loss Amounts that have
previously been reallocated to the
Certificateholders' Interest as
described above. The
Certificateholders' Subordinated
Amount at any time may also be
further reduced if such reduction
is consented to by both the Rating
Agencies and the Insurer and upon
satisfaction of certain other
conditions specified in the
Indenture.
Overcollateralization Amount............... The distribution of Accelerated
Principal Distribution Amounts, if
any, to Class A Noteholders may
result in the Invested Amount being
greater than the Note Principal
Balance, thereby creating the
Overcollateralization Amount. The
Overcollateralization Amount, if
any, will be available to absorb
any Noteholders' Loss Amount (a)
not covered by Noteholders'
Interest Collections, available
funds on deposit in the Deferred
Interest Account and collections
otherwise allocable to the
Certificateholders' Interest up to
the Certificateholders'
Subordinated Amount and (b) not
reallocated to the
Certificateholders' Interest up to
the Certificateholders'
Subordinated Amount. Payments of
Accelerated Principal Distribution
Amounts are not covered by the
Policy. Any Noteholders' Loss
Amounts not covered by such
overcollateralization, collections
otherwise payable to the
Certificates up to the
Certificateholders' Subordinated
Amount, amounts on deposit in the
Spread Account and available funds
on deposit in the Deferred Interest
Account, or Noteholders' Interest
Collections and amounts not
reallocated to the
Certificateholders' Interest will
be covered by draws on the Policy
to the extent provided therein.
Record Date................................ The last day preceding a
Distribution Date or, if the Notes
are no longer Book-Entry
Securities, the last day of the
month preceding a Distribution
Date.
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S-17
<PAGE>
Servicing.................................. The Servicer will be responsible
for servicing, managing and making
collections on the HELOCs. The
Servicer will deposit all
collections in respect of the
HELOCs into the Collection Account
as described herein. On or before
the third Business Day prior to
each Distribution Date (the
"Determination Date"), the Servicer
will calculate, and instruct the
Indenture Trustee regarding the
amounts to be paid, as described
herein, to the Noteholders on such
Distribution Date. See "DESCRIPTION
OF THE NOTES--Distributions on the
Notes." With respect to each
Collection Period, the Servicer
will retain from collections in
respect of interest on the HELOCs,
on behalf of itself, a portion of
such collections as a monthly
servicing fee (the "Servicing Fee")
in the amount of 0.50% per annum
(the "Servicing Fee Rate") on the
aggregate Principal Balances of the
HELOCs as of the first day of each
such Collection Period. See
"DESCRIPTION OF THE
NOTES--Servicing Compensation and
Payment of Expenses." In certain
limited circumstances, the Servicer
may resign or be removed, in which
event either the Indenture Trustee
or a third-party servicer will be
appointed as a successor Servicer.
See "DESCRIPTION OF THE
NOTES--Certain Matters Regarding
the Servicer and the Sponsor."
Termination; Optional Redemption........... The Trust will generally terminate
on the later of (A) the
Distribution Date immediately
following the payment in full of
all amounts owing to the Insurer
and (B) the earliest of (i) the
Distribution Date on which the Note
Principal Balance has been reduced
to zero and all other amounts due
and owing to the Noteholders have
been paid, (ii) the Distribution
Date immediately following the
final payment or other liquidation
of the last HELOC in the Trust,
(iii) the Distribution Date
immediately following the optional
redemption to the Sponsor of the
Notes, as described below and (iv)
the Distribution Date in August,
2024. Interest on the Class S Notes
will not accrue after the Note
Principal Balance has been reduced
to zero. The Notes will be subject
to optional redemption by the
Sponsor on any Distribution Date
after the Note Principal Balance is
reduced to an amount less than or
equal to approximately $18,906,500
(10% of the Original Class A Note
Principal Balance) and all amounts
due and owing to the Insurer and
unreimbursed draws on the Policy,
together with interest thereon, as
provided under the Insurance
Agreement, have been paid. The
redemption price will be equal to
the sum of the outstanding Note
Principal Balance and accrued and
unpaid interest thereon at the
Class A Note Rate plus payment of
all amounts due and owing to the
Class S Noteholders through the day
preceding the final Distribution
Date, together with all amounts due
and owing to the Insurer and
unreimbursed draws on the Policy.
See "DESCRIPTION OF THE
NOTES--Termination; Retirement of
the Notes" herein.
In addition, the Trust may be
liquidated as a result of certain
events of bankruptcy, insolvency or
receivership relating to the
Sponsor. See "DESCRIPTION OF THE
NOTES--Rapid Amortization Events"
herein.
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S-18
<PAGE>
- --------------------------------------------------------------------------------
Mandatory Retransfer of
Certain HELOCs............................. The Sponsor will make certain
representations and warranties in
the Sale and Servicing Agreement
with respect to the HELOCs. If the
Sponsor breaches certain of its
representations and warranties with
respect to any HELOC and such
breach materially and adversely
affects the interests of the
Noteholders or the Insurer and is
not cured within the specified
period, the HELOC will be removed
from the Trust upon the expiration
of a specified period from the date
on which the Sponsor becomes aware
or receives notice of such breach
and will be reassigned to the
Sponsor. See "DESCRIPTION OF THE
NOTES--Assignment of HELOCs"
herein.
Tax Status................................. Subject to the qualifications set
forth in "CERTAIN FEDERAL INCOME
TAX CONSEQUENCES" herein, Dewey
Ballantine, special tax counsel to
the Sponsor and counsel to the
Underwriter ("Tax Counsel") is of
the opinion that, for federal
income tax purposes, the Notes will
be characterized as debt. Each
Noteholder, by the acceptance of a
Note, will agree to treat the Notes
as debt. See "CERTAIN FEDERAL
INCOME TAX CONSEQUENCES" herein.
ERISA Considerations....................... Subject to the conditions and
considerations discussed under
"ERISA CONSIDERATIONS," the Notes
are eligible for purchase by
pension, profit-sharing or other
employee benefit plans as well as
individual retirement accounts and
certain types of Keogh Plans (each,
a "Benefit Plan"). See "ERISA
CONSIDERATIONS" herein.
Legal Investment Considerations............ The Notes will not constitute
"mortgage related securities" for
purposes of the Secondary Mortgage
Market Enhancement Act of 1984
("SMMEA"), because not all of the
Mortgages securing the HELOCs are
first mortgages. Accordingly, many
institutions with legal authority
to invest in comparably rated
securities based solely on first
mortgages may not be legally
authorized to invest in the Notes.
See "LEGAL INVESTMENT
CONSIDERATIONS" herein.
Ratings.................................... It is a condition to the issuance
of the Class A and Class S Notes
that they be rated "AAA" and
"AAAr," respectively, by Standard &
Poor's Ratings Group, a division of
The McGraw Hill Companies, Inc.
("Standard & Poor's") and "Aaa" by
Moody's Investors Service, Inc.
("Moody's" and together with
Standard & Poor's, the "Rating
Agencies"). The ratings assigned to
the Class A Notes do not address
the timeliness or likelihood of the
payment of Deferred Interest. In
general, ratings address credit
risk and do not address the
likelihood of prepayments. See
"RATINGS" herein.
- --------------------------------------------------------------------------------
S-19
<PAGE>
RISK FACTORS
Purchasers of the Notes should consider, in addition to the factors
described under "Risk Factors" in the Prospectus, the following factors in
connection with the purchase of the Notes.
Book-Entry Securities. Issuance of the Notes in book-entry form may reduce
the liquidity of such Notes in the secondary trading market since investors may
be unwilling to purchase Notes for which they cannot obtain physical
certificates. See "DESCRIPTION OF THE NOTES--Book-Entry Securities" herein and
"Risk Factors--Book-Entry Registration" in the Prospectus.
Since transactions in the Notes can be effected only through DTC,
participating organizations, indirect participants and certain banks, the
ability of a beneficial owner of Book-Entry Securities (each a "Note Owner") to
pledge a Note to persons or entities that do not participate in the DTC may be
limited due to lack of a physical certificate representing the Notes. See
"DESCRIPTION OF THE NOTES--Book-Entry Securities" herein and "Risk
Factors--Book-Entry Registration" in the Prospectus.
Note Owners may experience some delay in their receipt of distributions of
interest and principal on the Notes since such distributions will be forwarded
by the Indenture Trustee to DTC and DTC will credit such distributions to the
accounts of its participants which will thereafter credit them to the accounts
of Note Owners either directly or indirectly through indirect participants. Note
Owners will not be recognized as Noteholders as such term is used in the
Indenture, and Note Owners will be permitted to exercise the rights of
Noteholders only indirectly through DTC and its participants. See "DESCRIPTION
OF THE NOTES--Book-Entry Securities" herein and "Risk Factors--Book-Entry
Registration" in the Prospectus.
Cash Flow Considerations. Minimum required monthly payments on the HELOCs
will at least equal accrued monthly interest on the Notes. Even assuming that
the Mortgaged Properties provide adequate security for the HELOCs, substantial
delays could be encountered in connection with the liquidation of HELOCs that
are delinquent and resulting shortfalls in distributions to Noteholders could
occur if the Insurer were unable to perform on its obligations under the Policy.
Furthermore, liquidation expenses (such as legal fees, real estate taxes, and
maintenance and preservation expenses) will reduce the security for the HELOCs
and thereby reduce the proceeds payable to Noteholders. In the event any of the
Mortgaged Properties fail to provide adequate security for the related HELOCs,
Noteholders could experience a loss if the Insurer were unable to perform its
obligations under the Policy.
Prepayment Considerations. The HELOCs may be prepaid in whole or in part at
any time without penalty. Home equity loans, such as the HELOCs, have been
originated in significant volume only during the past few years and neither the
Sponsor nor the Servicer is aware of any relevant studies or statistics on the
rate of prepayment of such loans. Generally, home equity loans are not viewed by
borrowers as permanent financing. Accordingly, the HELOCs may experience a
higher rate of prepayment than traditional mortgage loans. 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. In addition, all of the HELOCs contain
due-on-sale provisions and the Servicer intends to enforce such provisions
unless (i) such enforcement is not permitted by applicable law or (ii) the
Servicer, in a manner consistent with reasonable commercial practice, permits
the purchaser of the related Mortgaged Property to assume the HELOC. To the
extent permitted by applicable law, such assumption will not release the
original borrower from its obligation under any such HELOC. See "DESCRIPTION OF
THE NOTES" herein and "CERTAIN LEGAL ASPECTS OF THE LOANS--Due-on-Sale Clauses"
in the Prospectus for a description of certain provisions of the Loan Agreements
that may affect the prepayment experience on the HELOCs.
Note Ratings. The ratings of the Notes will depend primarily on an
assessment by the Rating Agencies of the HELOCs and upon the claims-paying
ability of the Insurer. Any reduction in a rating assigned to the claims-paying
ability of the Insurer below the rating initially given to the Notes may result
in a reduction in the rating of the Notes. The ratings by the Rating Agencies of
the Notes are not a recommendation to purchase, hold or sell the Notes, inasmuch
as such ratings do not address the market price or suitability for a particular
investor.
S-20
<PAGE>
There is no assurance that the ratings will remain in place for any given period
of time or that the ratings will not be lowered or withdrawn by the Rating
Agencies. In general, the ratings address credit risk and do not address the
likelihood of prepayments. The ratings of the Notes do not address the
possibility of the imposition of United States withholding tax with respect to
non-U.S. persons.
Legal Considerations. The HELOCs are secured by first or second mortgages
or deeds of trust (which generally are second mortgages). With respect to HELOCs
that are secured by first mortgages or deeds of trust, the Servicer has the
power under certain circumstances to consent to a new mortgage lien on the
Mortgaged Property having priority over such HELOC. HELOCs secured by second
mortgages or deeds of trust are entitled to proceeds that remain from the sale
of the related Mortgaged Property after any related senior mortgage loan and
prior statutory liens have been satisfied. In the event that such proceeds are
insufficient to satisfy such loans and prior liens in the aggregate and the
Insurer is unable to perform its obligations under the Policy, the Noteholders
will bear (i) the risk of delay in distributions while a deficiency judgment
against the borrower is obtained and (ii) the risk of loss if the deficiency
judgment cannot be obtained or is not realized upon. See "CERTAIN LEGAL ASPECTS
OF THE LOANS" in the Prospectus.
Insolvency Related Matters. The sale of the HELOCs from the Company to the
Sponsor pursuant to the Purchase Agreement will be treated as a sale of the
HELOCs. However, in the event of an insolvency of the Company, the trustee in
bankruptcy of the Company may attempt to recharacterize the sale of the HELOCs
as a borrowing by the Company, secured by a pledge of the applicable HELOCs. If
the trustee in bankruptcy decided to challenge such transfer and if the HELOCs
have not been delivered to the Indenture Trustee, the interest of the Trust in
the HELOCs will be that of an unperfected security interest. Even if the HELOCs
have been delivered to the Indenture Trustee, delays in payments of the Notes
and reductions in the amounts thereof could occur. The Sponsor will warrant in
the Sale and Servicing Agreement that the transfer of the HELOCs by it to the
Trust is either a valid transfer and assignment of such HELOCs to the Trust or
the grant to the Trust of a security interest in such HELOCs.
If a conservator, receiver or trustee were appointed for the Sponsor, or if
certain other events relating to the bankruptcy or insolvency of either the
Company or the Sponsor were to occur, Additional Balances would not be sold to
the Trust. In such an event, the Rapid Amortization Period would commence and
the Indenture Trustee would attempt to sell the HELOCs (unless Noteholders
holding Notes aggregating at least 51% of the Voting Rights instruct otherwise),
thereby causing early payment of the Note Principal Balance. The net proceeds of
such sale will first be paid to the Insurer to the extent of unreimbursed draws
under the Policy and any other amounts owing to the Insurer pursuant to the
Insurance Agreement. The Fixed Allocation Percentage of any remaining amounts
will be distributed to the Class A Noteholders. Such amount may be insufficient
to pay the Note Principal Balance or the interest at the Note Rate in full.
Subject to the prior written consent of the Insurer to the terms of such sale or
other disposition of the HELOCs, the Policy will be available to cover such
shortfalls. Upon termination of the Trust as discussed in this paragraph, the
right of the Holders of the Class S Notes to receive distributions in respect of
interest will be terminated.
In the event of a bankruptcy or insolvency of the Servicer, the bankruptcy
trustee or receiver may have the power to prevent the Indenture Trustee or the
Noteholders from appointing a successor Servicer.
Geographic Concentration. As of the Initial Cut-Off Date, approximately
86.12%, 2.84%, and 3.43% of the Initial HELOCs by Original Pool Balance are
secured by Mortgaged Properties that are located in the States of California,
Washington and Oregon, respectively. An overall decline in the residential real
estate markets in these states could adversely affect the values of the
Mortgaged Properties securing such HELOCs such that the Principal Balances of
the related HELOCs, together with any primary financing on such Mortgaged
Properties, could equal or exceed the value of such Mortgaged Properties. As the
residential real estate market is influenced by many factors, including the
general condition of the economy and interest rates, no assurances may be given
that the residential real estate markets in these states will not weaken. If
these residential real estate markets should experience an overall decline in
property values after the dates of origination of the HELOCs, the rates of
losses on the HELOCs would be expected to increase, and could increase
substantially. In the event of a natural disaster, such as an earthquake, fire
or flood, the values of the Mortgaged Properties may decline. Neither the
Mortgages,
S-21
<PAGE>
the Sale and Servicing Agreement nor the Loan Agreements require natural
disaster insurance such as would insure against earthquake damage.
Servicer's Ability to Change the Terms of the HELOCs. The Servicer may
agree to changes in the terms of a Loan Agreement, provided that such changes
(i) do not adversely affect the interest of the Noteholders or the Insurer, and
(ii) are consistent with prudent business practice. There can be no assurance
that changes in applicable law or the marketplace for home equity loans or
prudent business practice will not result in changes in the terms of the HELOCs.
In addition, the Sale and Servicing Agreement permits the Servicer, within
certain limitations described therein, to increase the Credit Limit of the
related HELOC or reduce the Margin for such HELOC.
FORMATION OF THE TRUST
General
Headlands Home Equity Loan Trust 1997-1, is a business trust formed under
the laws of the State of Delaware pursuant to the Trust Agreement. Prior to such
sale and assignment, the Trust will have no assets or obligations or any
operating history. The Trust will not engage in any business other than (i)
acquiring, holding and managing the HELOCs, the other assets of the Trust and
any proceeds therefrom, (ii) issuing the Notes and the Certificates, (iii)
making payments on the Notes and the Certificates and (iv) engaging in other
activities that are necessary, suitable or convenient to accomplish the
foregoing or are incidental thereto.
The Trust will not acquire any assets other than the Trust Property, and it
is not anticipated that the Trust will have any need for additional capital
resources. Because the Trust will have no operating history upon its
establishment and will not engage in any business other than the duties
discussed above, no historical or pro forma financial statements or ratios of
earnings to fixed charges with respect to the Trust have been included herein.
Certain Activities
The Trust will not, except as expressly provided in the Trust Agreement and
the Indenture: (i) borrow money; (ii) make loans; (iii) invest in securities for
the purpose of exercising control; (iv) underwrite securities; (v) engage in the
purchase and sale (or turnover) of investments; (vi) offer securities in
exchange for property; or (vii) repurchase or otherwise reacquire its
securities.
The Owner Trustee
Wilmington Trust Company, the Owner Trustee under the Trust Agreement, is a
Delaware banking corporation and its principal offices are located at Rodney
Square North, 1100 North Market Street, Wilmington, Delaware 19890-0001,
Attention: Corporate Trust Administration. The Owner Trustee will perform
limited administrative functions under the Trust Agreement. The Owner Trustee's
duties in connection with the issuance and sale of the Notes and the
Certificates are limited solely to the express obligations of the Owner Trustee
set forth in the Trust Agreement, the Indenture and the Sale and Servicing
Agreement.
The Indenture Trustee
The First National Bank of Chicago is the Indenture Trustee under the
Indenture. The First National Bank is a national banking association and the
principal offices of which are located in Chicago, Illinois. The Indenture
Trustee's duties in connection with the Notes are limited solely to its express
obligations under the Indenture and the Sale and Servicing Agreement.
S-22
<PAGE>
THE TRUST PROPERTY
The Trust Property will include certain adjustable rate home equity
revolving credit line loans made or to be made and conveyed to the Trust on the
Closing Date under certain home equity revolving credit line loan agreements;
the collections in respect of the HELOCs received after the related Cut-Off Date
(except with respect to interest payments on the Initial HELOCs, an amount equal
to twenty-five days' interest on the Original Pool Balance, calculated at the
weighted average Loan Rate); property that secured a HELOC that has been
acquired by foreclosure or deed in lieu of foreclosure; rights of the Sponsor
under hazard insurance policies covering the Mortgaged Properties; the Policy;
amounts on deposit in the Collection Account; amounts on deposit in the Funding
Account; amounts on deposit in the Spread Account; amounts on deposit in the
Deferred Interest Account; certain rights of the Sponsor under the Purchase
Agreement; and certain other property. The HELOCs are secured by first or second
mortgages or deeds of trust on residential properties that are primarily
one-to-four family properties and also include planned unit developments and
condominiums. During the Funding Period, the Trust shall have the right to
purchase Subsequent HELOCs from amounts on deposit in the Funding Account.
THE INSURER
The following information set forth in this section has been provided by
the Insurer. Accordingly, the Sponsor, the Servicer and the Underwriter make no
representation as to the accuracy and completeness of such information.
CapMAC is a New York-domiciled monoline stock insurance company which
engages only in the business of financial guarantee and surety insurance. CapMAC
is licensed in 50 states in addition to the District of Columbia, the
Commonwealth of Puerto Rico and the territory of Guam. CapMAC insures structured
asset-backed, corporate, municipal and other financial obligations in the U.S.
and international capital markets. CapMAC also provides financial guarantee
reinsurance for structured asset-backed, corporate, municipal and other
financial obligations written by other major insurance companies.
CapMAC's claims-paying ability is rated "Aaa" by Moody's, "AAA" by
Standard & Poor's, "AAA" by Duff & Phelps Credit Rating Co. and "AAA" by Nippon
Investors Service Inc. Such ratings reflect only the views of the respective
rating agencies, are not recommendations to buy, sell or hold securities and are
subject to revision or withdrawal at any time by such rating agencies.
CapMAC is wholly-owned by CapMAC Holdings Inc. ("Holdings"). Neither
Holdings nor any of its stockholders is obligated to pay any claims under any
surety bond issued by CapMAC or any debts of CapMAC or to make additional
capital contributions.
CapMAC is regulated by the Superintendent of Insurance of the State of New
York. In addition, CapMAC is subject to regulation by the insurance laws and
regulations of the other jurisdictions in which it is licensed. Such insurance
laws regulate, among other things, the amount of net exposure per risk that
CapMAC may retain, capital transfers, dividends, investment of assets, changes
in control, transactions with affiliates and consolidations and acquisitions.
CapMAC is subject to periodic regulatory examinations by the same regulatory
authorities.
CapMAC's obligations under the Surety Bond(s) may be reinsured. Such
reinsurance does not relieve CapMAC of any of its obligations under the Surety
Bond(s).
THE SURETY BOND IS NOT COVERED BY THE PROPERTY/CASUALTY INSURANCE SECURITY
FUND SPECIFIED IN ARTICLE 76 OF THE NEW YORK INSURANCE LAW.
As at December 31, 1996 and 1995, CapMAC had qualified statutory capital
(which consists of policyholders' surplus and contingency reserve) of
approximately $260 and $240 million, respectively,and had not incurred any debt
obligations. Article 69 of the New York State Insurance Law requires CapMAC to
establish and maintain the contingency reserve, which is available to cover
claims under surety bonds issued by CapMAC.
S-23
<PAGE>
The audited financial statements of CapMAC prepared in accordance with
generally accepted accounting principles as of December 31, 1996 and 1995 and
for each of the years in the three-year period ended December 31, 1996 and the
unaudited financial statements of CapMAC as of June 30, 1997 and for the three
and six month periods then ended are attached as exhibits to this document as
Annex I. Copies of CapMAC's financial statements prepared in accordance with
statutory accounting standards, which differ from generally accepted accounting
principles, are filed with the Insurance Department of the State of New York and
are available upon request.
CapMAC is located at 885 Third Avenue, New York, New York 10022, and its
telephone number is (212) 755-1155.
HEADLANDS MORTGAGE COMPANY
General
The Company is a closely-held California corporation which was organized in
1981. The common stock of the Company is owned by the Hart and Paul families.
The Company is engaged in the mortgage banking business, which consists of the
origination, acquisition, sale and servicing of residential mortgage loans
secured primarily by one to four-unit family residences, and the purchase and
sale of mortgage servicing rights. As of December 31, 1996 and June 30, 1997,
the Company had total assets of $288,990,472 and $435,826,382, respectively and
shareholders equity of $29,144,240 and $45,894,160, respectively.
The Company is headquartered in Northern California, and has production
branches in California, Washington, Oregon, Idaho, Nevada and Arizona. Loans are
originated primarily on a wholesale basis, through a network of independent
mortgage loan brokers approved by the Company. The HELOCs were acquired by the
Company in one of the three following manners: (i) originated by an independent
broker and purchased by the Company, (ii) originated by a broker and funded by
the Company, or (iii) originated and funded by the Company in the ordinary
course of business.
The Company's executive offices are located at 700 Larkspur Landing Circle,
Suite 250, Larkspur, CA 94939.
Servicing Overview
The Company (in its capacity as servicer) will act as servicer for the
HELOCs pursuant to the Sale and Servicing Agreement. All of the HELOCs are
currently serviced by the Company substantially in accordance with the
procedures described herein and in the accompanying Prospectus. The Company has
only recently started servicing home equity loans. As a result, there is limited
information as to the losses on HELOCs serviced by the Company.
As of June 30, 1997, the Company's mortgage loan servicing portfolio
consisted of 35,083 one to four family residential mortgage loans with an
aggregate principal balance of $3.874 billion. The Company's primary source of
mortgage servicing rights is from mortgage loans originated through mortgage
brokers.
The Company's Servicing Center was established in January 1994. As of June
30, 1997, it had a staff of 58 employees. Prior to January 1994, the Company's
servicing portfolio was subserviced by a third party.
Mortgage loan servicing includes collecting payments from borrowers and
remitting those funds to investors, accounting for mortgage loan principal and
interest, reporting to investors, holding custodial funds for payment of
mortgage and mortgage related expenses such as taxes and insurance, advancing
funds to cover delinquent payments, inspecting foreclosures and property
disposition in the event of unremedied defaults, and otherwise administering the
mortgages.
S-24
<PAGE>
The following table summarizes the delinquency experience including pending
foreclosures on residential mortgage loans originated or acquired as part of the
Company's mortgage banking operations and included in the Company's servicing
portfolio at the dates indicated. As of December 31, 1994, 1995 and 1996 and
June 30, 1997, the total principal balance of loans serviced by the Company was
(in millions) $4,779, $4,149, $4,387 and $3,874, respectively.
HEADLANDS MORTGAGE COMPANY
OVERALL MORTGAGE PORTFOLIO
DELINQUENCY AND FORECLOSURE EXPERIENCE
<TABLE>
<CAPTION>
at December 31
-----------------------------------------------------------------------------
1994 1995 1996 at June 30, 1997
------------------------ ----------------------- ------------------------ -------------------------
Percent of Percent of Percent of Percent of
Servicing Servicing Servicing Servicing
Loans Portfolio Loans Portfolio Loans Portfolio Loans Portfolio
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Total Number** 29,076 100% 27,261 100% 34,363 100% 35,083 100%
========= ======== ========= ======== ========= ======== ======== =======
Period of Delinquency:
30-59 days 327 1.1% 283 1.0% 466 1.4% 298 0.9%
60-89 days 49 0.2% 62 0.2% 43 0.1% 51 0.1%
90 days or more
50 0.2% 47 0.2% 14 0.0% 29 0.1%
--------- -------- --------- -------- --------- -------- -------- -------
Total Delinquencies
(excluding Foreclosures) 426 1.5% 392 1.4% 523 1.5% 378 1.1%
========= ======== ========= ======== ========= ======== ======== =======
Foreclosures Pending 102 0.3% 146 0.5% 197 0.6% 98 0.3%
</TABLE>
** The total portfolio has been reduced by the number of loans pending service
release or that have been foreclosed.
S-25
<PAGE>
HEADLANDS' HOME EQUITY LOAN PROGRAM
The HELOCs will have been purchased by the Company, either directly or
through affiliates, from mortgage loan brokers. The HELOCs have been originated
in accordance with the underwriting criteria specified below under "Underwriting
Standards."
Underwriting Standards
The Company believes that the HELOCs originated were underwritten in
accordance with standards consistent with those utilized by mortgage lenders or
manufactured home lenders generally during the period of origination.
Underwriting standards are applied by or on behalf of a lender to evaluate
the borrower's credit standing and repayment ability, and the value and adequacy
of the Mortgaged Property as collateral. In general, a prospective borrower
applying for a home equity line of credit is required to fill out a detailed
application designed to provide to the underwriting officer pertinent credit
information. As part of the description of the borrower's financial condition,
the borrower generally is required to provide a current list of assets and
liabilities and a statement of income and expenses, as well as an authorization
to apply for a credit report which summarizes the borrower's credit history with
local merchants and lenders and any record of bankruptcy or other public
records. In most cases, an employment verification is obtained from an
independent source (typically the borrower's employer) which verification
reports the length of employment with that organization, the current salary, and
whether it is expected that the borrower will continue such employment in the
future. If a prospective borrower is self-employed, the borrower may be required
to submit copies of signed tax returns. The borrower may also be required to
authorize verification of deposits at financial institutions where the borrower
has demand or savings accounts.
In determining the adequacy of the Mortgaged Property as collateral, an
appraisal is made of each property considered for financing. The appraiser is
required to inspect the property and verify that it is in good condition and
that construction, if new, has been completed. With respect to single family
loans, the appraisal is based on the market value of comparable homes, the
estimated rental income (if considered applicable by the appraiser) and the cost
of replacing the home. With respect to a loan on a two-to-four unit property,
the appraisal must specify whether an income analysis, a market analysis or a
cost analysis, was used. An appraisal employing the income approach to value
analyzes a two-to-four unit project's cash flow, expenses, capitalization and
other operational information in determining the property's value. The market
approach to value focuses its analysis on the prices paid for the purchase of
similar properties in the two-to-four unit project's area, with adjustments made
for variations between these other properties and the multifamily project being
appraised. The cost approach calls for the appraiser to make an estimate of land
value and then determine the current cost of reproducing the building less any
accrued depreciation. In any case, the value of the property being financed, as
indicated by the appraisal, must be such that it currently supports, and is
anticipated to support in the future, the outstanding loan balance. For loan
values to $650,000 appraisers may use either a full appraisal (FNMA 1104/FHLMC
70) or a drive-by appraisal (FHLMC 704); for values between $650,001 to
$1,000,000 with a combined loan-to-value of less than 75%, only a full appraisal
is acceptable; for values between $650,001 to $1,000,000 with a combined
loan-to-value of greater than 75%, only a full appraisal and one field review
ordered by the Company is acceptable; and for loans with values greater than
$1,000,000 with a combined loan-to-value greater than 65%, two full appraisals
are required. The Company may order discretionary reviews at any time to ensure
the value of the properties.
In the case of single family loans, once all applicable employment, credit
and property information is received, a determination generally is made as to
whether the prospective borrower has sufficient monthly income available (a) to
meet the borrower's monthly obligations on the proposed mortgage loan
(determined on the basis of the monthly payments due in the year of origination)
and other expenses related to the mortgaged property (such as property taxes and
hazard insurance) and (b) to meet monthly housing expenses and other financial
obligations and monthly living expenses. The underwriting standards applied by
the Company may be varied in appropriate cases where factors such as low
loan-to-value ratios or other favorable credit exist.
S-26
<PAGE>
The Company requires title insurance for all mortgage loans. Fire and
extended hazard insurance and flood insurance, when applicable, are also
required.
A lender may originate HELOCs under a reduced documentation program. A
reduced documentation program is designed to streamline the loan approval
process and thereby improve the lender's competitive position among other loan
originators. Under a reduced documentation program, relatively more emphasis is
placed on credit score and property underwriting than on certain credit
underwriting documentation concerning income and employment verification is
waived.
In the case of a HELOC secured by a leasehold interest in a real property,
the title to which is held by a third party lessor, the Sponsor will represent
and warrant, among other things, that the remaining term of the lease and any
sublease is at least five years longer than the remaining term of the HELOC.
THE SPONSOR
The Sponsor is a company incorporated in Delaware on November 18, 1996. The
Sponsor is a special purpose corporation organized for limited purposes, with
limited assets and a limited operating history.
DESCRIPTION OF THE HELOCs
General
The HELOCs were originated pursuant to Loan Agreements and promissory notes
and the appropriate state disclosure statements and are secured by first or
second mortgages or deeds of trust, on Mortgaged Properties located in 12
states. The Mortgaged Properties securing the HELOCs consist primarily of
residential properties that are one- to four-family properties. See "--HELOC
Terms" below.
The Original Pool Balance is $192,924,110.37, which is equal to the
aggregate Principal Balances of the Initial HELOCs as of the Initial Cut-Off
Date. The average Cut-Off Date Principal Balance of the Initial HELOCs was
approximately $39,308.09 (excluding those HELOCs with a $0.00 principal
balance), the minimum Cut-Off Date Principal Balance of the Initial HELOCs was
$0.00, the maximum Cut-Off Date Principal Balance of the Initial HELOCs was
$300,000, the minimum Loan Rate and the maximum Loan Rate as of the Initial
Cut-Off Date were 5.875% and 14.00% per annum, respectively, and the weighted
average Loan Rate as of the Initial Cut-Off Date was approximately 7.30% per
annum. As of the Initial Cut-Off Date, the weighted average Credit Limit
Utilization Rate (weighted by credit line) (as defined below) of the Initial
HELOCs was approximately 74.87% and the maximum Credit Limit Utilization Rate
was 100%. The "Credit Limit Utilization Rate" of a HELOC is determined by
dividing the Cut-Off Date Principal Balance by the Credit Limit of the related
Credit Line Agreement. The remaining term to scheduled maturity for the Initial
HELOCs as of the Initial Cut-Off Date ranged from 170 months to 300 months and
the weighted average remaining term to scheduled maturity was approximately
231.8 months. As of the Initial Cut-Off Date, the weighted average Combined
Loan-to-Value Ratio of the Initial HELOCs was approximately 85.10%. Credit
Limits under the Initial HELOCs as of the Cut-Off Date ranged from $8,700 to
$500,000 and averaged approximately $50,014.75. The weighted average second
mortgage ratio (which is the Credit Limit for the related HELOC, provided such
HELOC was in the second lien position, divided by the sum of such Credit Limit
and the outstanding principal balance of any mortgage loan senior to the related
Initial HELOC) was approximately 22.22%. As of the Initial Cut-Off Date, no
Initial HELOCs represented first liens on the related Mortgaged Properties,
while approximately 100% of the Initial HELOCs represented second liens. As of
the Initial Cut-Off Date approximately 80.61% of the Initial HELOCs are secured
by Mortgaged Properties which are single-family residences and approximately
98.00% of the single family residences were owner-occupied. As of the Initial
Cut-Off Date, approximately 86.12%, 2.84% and 3.43% of the Initial HELOCs by
Original Pool Balance are located in the States of California, Washington and
Oregon. No other state represents more than 2.27% of the Original Pool Balance
of the Initial HELOCs.
S-27
<PAGE>
Real estate lenders in California are unable as a practical matter to
obtain a deficiency judgment against the borrower on a loan secured by one- to
four-unit real estate. See "CERTAIN LEGAL ASPECTS OF THE LOANS--Anti-Deficiency
Legislation and Other Limitations on Lenders" in the Prospectus.
HELOC Terms
The HELOCs consist of loans originated under two different loan term
options: a 15-year HELOC and a 25-year HELOC.
The HELOC loan programs have either a 5-year or 15-year draw period, during
which the borrower may make cash withdrawals against the equity line and a
10-year repayment period, during which the balance of the HELOC as of the end of
the draw period is repaid.
A borrower may access a HELOC credit line at any time during the draw
period by writing a check. The minimum payment during the draw period of the
HELOC is the greatest of accrued finance charges on the average daily balance of
the HELOC at the applicable Loan Rate, $100, or 1% of the outstanding principal
balance. The payment during the repayment period of the HELOC is calculated as
accrued interest plus .8333% of principal outstanding as of the last day of the
draw period. HELOCs bear interest at a variable rate which changes monthly with
changes in the applicable Index Rate (as defined below). All HELOCs are subject
to a maximum rate equal to approximately 18% per annum and subject to applicable
usury limitations. The Loan Rate on the HELOCs is the sum of the Index Rate plus
the Margin (subject to "teaser loans") which generally ranges between 0% and
5.75% and had a weighted average, as of the Initial Cut-Off Date, of
approximately 3.08%, divided by 365 days.
The sum of the columns in the tables below may not equal the total
indicated due to rounding. Set forth below is a description of certain
characteristics of the Initial HELOCs as of the Initial Cut-Off Date:
PRINCIPAL BALANCES
<TABLE>
<CAPTION>
Number Aggregate Percent of
of Initial Cut-Off Date Original
Range of Principal Balances HELOCs Principal Balance Pool Balance
- ------------------------------------------- ------------------- ---------------------- ---------------------
<S> <C> <C> <C>
<0.00...................................... 244 $ 0.00 0.00%
$0.01 - 25,000.00................ 1,756 28,349,758.41 14.69
$25,000.01 - 50,000.00................ 2,161 80,596,196.78 41.78
$50,000.01 - 75,000.00................ 526 32,633,526.37 16.92
$75,000.01 - 100,000.00............... 319 28,879,879.16 14.97
$100,000.01>............................... 146 22,464,749.65 11.64
------------------- ---------------------- ---------------------
Total 5,152 $192,924,110.37 100.00%
=================== ====================== =====================
</TABLE>
S-28
<PAGE>
<TABLE>
<CAPTION>
GEOGRAPHIC DISTRIBUTION(1)
Number Aggregate Percent of
of Initial Cut-Off Date Original
State HELOCs Principal Balance Pool Balance
- -------------------------------------- --------------- ---------------------------- --------------
<S> <C> <C> <C>
Arizona............................... 105 $ 3,084,726.22 1.60%
California............................ 4,310 166,137,622.04 86.12
Colorado.............................. 75 2,378,534.89 1.23
Florida............................... 4 109,696.16 0.06
Idaho................................. 61 1,526,623.98 0.79
Montana............................... 33 821,776.60 0.43
Nevada................................ 80 2,193,568.71 1.14
New Mexico............................ 3 152,640.64 0.08
Oregon................................ 185 6,612,372.42 3.43
Utah.................................. 135 4,381,880.93 2.27
Washington............................ 159 5,484,767.78 2.84
Wyoming............................... 2 39,900.00 0.02
--------------- ---------------------------- --------------
Total............................ 5,152 $192,924,110.37 100.00%
=============== ============================ ==============
</TABLE>
- ------------------
(1) Geographic location is determined by the address of the Mortgaged Property
securing the related Initial HELOC.
S-29
<PAGE>
COMBINED LOAN-TO-VALUE RATIOS(1)
<TABLE>
<CAPTION>
Number Aggregate Percent of
Range of of Initial Cut-Off Date Original
Combined Loan-to-Value Ratios HELOCs Principal Balance Pool Balance
- -------------------------------------- -------------- ----------------------- -----------------
<S> <C> <C> <C>
<10.00%............................... 2 $ 30,351.49 0.02%
10.01 to 20.00%....................... 19 709,772.36 0.37
20.01 to 30.00%....................... 33 989,102.91 0.51
30.01 to 40.00%....................... 39 1,215,220.51 0.63
40.01 to 50.00%....................... 55 2,666,429.26 1.38
50.01 to 60.00%....................... 96 3,953,962.06 2.05
60.01 to 70.00%....................... 220 9,304,863.01 4.82
70.01 to 80.00%....................... 828 34,394,083.40 17.83
80.01 to 90.00%....................... 2,804 98,425,905.48 51.02
90.01 to 100.00%...................... 1,056 41,234,419.89 21.37
-------------- ----------------------- -----------------
Total............................ 5,152 $192,924,110.37 100.00%
============== ======================= =================
</TABLE>
- ------------------
(1) The ratio (expressed as a percentage) of (A) the sum of (i) the Credit
Limit of the HELOCs and (ii) any outstanding principal balances of mortgage
loans senior to the HELOCs (calculated at the date of origination of the
HELOCs) to (B) the appraised value of the related Mortgaged Property as set
forth in loan files at such date of origination.
<TABLE>
<CAPTION>
PROPERTY TYPE
Number Aggregate Percent of
of Initial Cut-Off Date Original
Property Type HELOCs Principal Balance Pool Balance
- ------------------------------------ --------------- -------------------------- ---------------
<S> <C> <C> <C>
Two Units........................... 111 $ 3,956,444.87 2.05%
Three Units......................... 21 770,205.74 0.40
Four Units.......................... 36 1,132,431.06 0.59
Condominium/Townhouse............... 283 8,337,283.95 4.32
Single Family....................... 4,109 155,520,939.34 80.61
PUD................................. 592 23,206,805.41 12.03
--------------- -------------------------- ---------------
Total.......................... 5,152 $192,924,110.37 100.00%
=============== ========================== ===============
</TABLE>
S-30
<PAGE>
LOAN RATES AS OF THE INITIAL CUT-OF-DATE
<TABLE>
<CAPTION>
Number Aggregate Percent of
of Initial Cut-Off Date Original
Loan Rates HELOCs Principal Balance Pool Balance
- --------------------------------------------------- ------------ -------------------- ---------------
<S> <C> <C> <C>
5.88 to 6.00....................................... 3,748 $143,142,646.95 74.20%
6.01 to 6.50....................................... 1 262.00 0.00
6.51 to 7.00....................................... 1 56,522.40 0.03
8.51 to 9.00....................................... 3 36,466.77 0.02
9.01 to 9.50....................................... 11 425,743.52 0.22
9.51 to 10.00...................................... 452 15,651,428.35 8.11
10.01 to 10.50..................................... 37 1,106,142.20 0.57
10.51 to 11.00..................................... 50 1,642,959.08 0.85
11.01 to 11.50..................................... 196 5,433,730.29 2.82
11.51 to 12.00..................................... 227 7,663,320.67 3.97
12.01 to 12.50..................................... 218 9,054,960.57 4.69
12.51 to 13.00..................................... 140 4,934,631.37 2.56
13.01 to 13.50..................................... 57 3,075,742.74 1.59
13.51 to 14.00..................................... 11 699,553.46 0.36
------------ -------------------- ---------------
Total......................................... 5,152 $192,924,110.37 100.00%
============ ==================== ===============
</TABLE>
S-31
<PAGE>
MARGIN
<TABLE>
<CAPTION>
Number Aggregate Percent of
of Initial Cut-Off Date Original
Margins HELOCs Principal Balance Pool Balance
- --------------------------------------- ---------------------- ----------------------------- ----------------
<S> <C> <C> <C>
>/- to 0.50.......................... 218 $ 4,389,505.20 2.28%
0.51 to 1.00........................... 448 17,599,486.51 9.12
1.01 to 1.50........................... 173 6,997,756.86 3.63
1.51 to 2.00........................... 172 6,396,370.17 3.32
2.01 to 2.50........................... 806 24,957,094.75 12.94
2.51 to 3.00........................... 709 27,387,677.93 14.20
3.01 to 3.50........................... 839 31,606,793.50 16.38
3.51 to 4.00........................... 513 24,792,561.79 12.85
4.01 to 4.50........................... 815 27,713,984.82 14.37
4.51 to 5.00........................... 399 17,711,925.62 9.18
5.01 to 5.50........................... 55 3,003,757.87 1.56
5.51 to 5.75........................... 5 367,195.35 0.19
---------------------- ----------------------------- ----------------
Total............................. 5,152 $ 192,924,110.37 100.00%
====================== ============================= ================
</TABLE>
<TABLE>
<CAPTION>
CREDIT LIMIT UTILIZATION RATES(1)
Number of Aggregate Percent of
Initial Cut-Off Date Original
Range of Utilization Rates HELOCs Principal Balance Pool Balance
- --------------------------------------- --------------------- ----------------------------- ----------------
<S> <C> <C> <C>
</- to 0.00.......................... 244 $ 0.00 0.00%
0.01 to 10.00.......................... 145 351,442.18 0.18
10.01 to 20.00......................... 98 1,156,454.76 0.60
20.01 to 30.00......................... 101 1,597,215.70 0.83
30.01 to 40.00......................... 124 2,606,570.28 1.35
40.01 to 50.00......................... 197 5,995,685.65 3.11
50.01 to 60.00......................... 199 5,821,378.04 3.02
60.01 to 70.00......................... 198 7,016,749.69 3.64
70.01 to 80.00......................... 228 9,362,933.20 4.85
80.01 to 90.00......................... 249 10,136,136.70 5.25
90.01 to 100.00........................ 3,369 148,879,544.17 77.17
--------------------- ----------------------------- ----------------
Total............................. 5,152 $ 192,924,110.37 100.00%
===================== ============================= ================
</TABLE>
- -------------
(1) The "Credit Limit Utilization Rate" of a HELOC is determined by dividing
the Cut-Off Date Principal Balance of such HELOC by the Credit Limit of the
related Credit Line Agreement.
S-32
<PAGE>
CREDIT LIMITS
<TABLE>
<CAPTION>
Number Aggregate Percent of
of Initial Cut-Off Date Original
Range Credit Limits HELOCs Principal Balance Pool Balance
- --------------------------------------- ---------------------- -------------------- -------------------------
<S> <C> <C> <C>
8,700 - 25,000........................ 1,154 $ 19,369,427.73 10.04%
25,001 - 50,000........................ 2,570 80,997,922.11 41.98
50,001 - 75,000........................ 577 29,494,066.58 15.29
75,001 - 100,000....................... 582 35,572,151.66 18.44
100,001 - 125,000...................... 78 6,268,273.09 3.25
125,001 - 150,000...................... 67 5,954,196.62 3.09
150,001 - 175,000...................... 18 2,220,169.44 1.15
> 175,000.............................. 106 13,047,903.14 6.76
---------------------- -------------------- -------------------------
Total............................. 5,152 $ 192,924,110.37 100.00%
====================== ==================== =========================
</TABLE>
MONTHS REMAINING TO SCHEDULED MATURITY
<TABLE>
<CAPTION>
Number Aggregate Percent of
of Initial Cut-Off Date Original
Scheduled Maturity HELOCs Principal Balance Pool Balance
- --------------------------------------- ---------------------- -------------------- -------------------------
<S> <C> <C> <C> v
170 - 170 ............................. 1 $ 21,600.00 0.01%
171 - 176 ............................. 1,109 39,752,781.53 20.61
177 - 182 ............................. 1,690 64,634,543.68 33.50
183 - 188.............................. 1 21,959.01 0.01
279 - 284.............................. 1 56,522.40 0.03
285 - 290.............................. 1 94,092.84 0.05
291 - 296.............................. 1,078 39,214,869.07 20.33
297 - 300 ............................. 1,271 49,127,741.84 25.46
---------------------- -------------------- -------------------------
Total............................. 5,152 $ 192,924,110.37 100.00%
====================== ==================== =========================
</TABLE>
S-33
<PAGE>
MONTH AND YEAR OF ORIGINATION
<TABLE>
<CAPTION>
Number Aggregate Percent of
of Initial Cut-Off Date Original
Month and Year of Origination HELOCs Principal Balance Pool Balance
- --------------------------------------- ---------------------- -------------------- -------------------------
<S> <C> <C> <C>
March 1996............................. 1 $ 56,522.40 0.03%
August 1996............................ 1 94,092.84 0.05
September 1996......................... 1 21,600.00 0.01
October 1996........................... 3 9,580.54 0.00
November 1996.......................... 60 1,869,137.42 0.97
December 1996.......................... 456 16,291,133.07 8.44
January 1997........................... 479 17,134,096.31 8.88
February 1997 ......................... 521 19,632,449.89 10.18
March 1997............................. 669 24,053,212.38 12.47
April 1997............................. 823 32,061,919.83 16.62
May 1997............................... 844 33,296,902.17 17.26
June 1997.............................. 764 29,589,538.90 15.34
July 1997.............................. 530 18,813,924.62 9.75
---------------------- -------------------- -------------------------
Total............................. 5,152 $ 192,924,110.37 100.00%
====================== ==================== =========================
</TABLE>
S-34
<PAGE>
Conveyance of Subsequent HELOCs
The Sale and Servicing Agreement requires the Trust to purchase Subsequent
HELOCs during the Funding Period for pledge under the Indenture subject to
certain conditions and the availability thereof. Accordingly, the statistical
characteristics of the HELOCs will vary as of any Distribution Date on which the
acquisition of these additional HELOCs occurs.
The obligation of the Trust to purchase all of the Subsequent HELOCs for
pledge under the Indenture is subject to the following aggregate requirements:
(i) the weighted average Margin of all of the Subsequent HELOCs is at least
2.00%; (ii) the weighted average Combined Loan-to-Value Ratio of all of the
Subsequent HELOCs is not more than 90.00%; (iii) 100% of all of the Subsequent
HELOCs are not more than 30 days delinquent on a contractual basis as of their
respective Cut-Off Dates; (iv) the remaining term to maturity of each Subsequent
HELOC may not exceed 300 months; and (v) no Subsequent HELOC will have a Cut-Off
Date Principal Balance greater than $240,000; provided, however, any of the
foregoing requirements may be waived upon the consent of the Rating Agencies and
the Insurer.
MATURITY AND PREPAYMENT CONSIDERATIONS
The Indenture, except as otherwise described herein, provides that the
Class A Noteholders will be entitled to receive on each Distribution Date
distributions of principal, in the amounts described herein, until the Note
Principal Balance is reduced to zero. During the Funding Period, the Scheduled
Principal Collections Distribution Amount will be deposited into the Funding
Account and may be used by the Indenture Trustee to purchase Subsequent HELOCs.
In the event that not all of the Principal Collections on deposit in the Funding
Account have been used to acquire Subsequent HELOCs on the last Distribution
Date of the Funding Period, then such Principal Collections will be used to
acquire any remaining Additional Balances on such Distribution Date and any
remaining amount on deposit therein will be distributed to the Class A
Noteholders as a payment of principal. During the Managed Amortization Period,
Class A Noteholders will receive the lesser of (i) Noteholders' Principal
Collections and (ii) Principal Collections less the aggregate of Additional
Balances created during the applicable Collection Period. During the Rapid
Amortization Period, Class A Noteholders will receive amounts from Principal
Collections based solely upon the Fixed Allocation Percentage. Because prior
distributions of Principal Collections to Class A Noteholders serve to reduce
the Floating Allocation Percentage but do not change the Fixed Allocation
Percentage, allocations of Principal Collections based on the Fixed Allocation
Percentage may result in distributions of principal to the Class A Noteholders
in amounts that are, in most cases, greater relative to the declining balance of
the HELOCs than would be the case if the Floating Allocation Percentage were
used to determine the percentage of Principal Collections distributed to Class A
Noteholders. This is especially true during the Rapid Amortization Period when
the Class A Noteholders are entitled to receive Noteholders' Principal
Collections and not a lesser amount. Moreover, to the extent of losses allocable
to the Class A Noteholders during the Managed Amortization Period and the Rapid
Amortization Period, Class A Noteholders may also receive as payment of
principal the amount of such losses either from Noteholders' Interest
Collections or, in some instances, collections otherwise payable to the
Certificates (as described herein), draws on the Spread Account or under the
Policy. The level of losses may therefore affect the rate of payment of
principal on the Notes.
To the extent obligors make more draws than principal payments, the
Certificateholders' Interest may increase. Because during the Rapid Amortization
Period the Noteholders' share of Principal Collections is based upon the Fixed
Allocation Percentage (without reduction), an increase in the
Certificateholders' Interest due to additional draws may also result in
Noteholders receiving principal at a greater rate. The Sale and Servicing
Agreement permits the Sponsor, at its option, but subject to the satisfaction of
certain conditions specified in the Sale and Servicing Agreement, including the
conditions described below, to remove certain HELOCs from the Trust at any time
during the life of the Trust other than the Rapid Amortization Period, so long
as the Certificateholders' Interest as of the transfer date after giving effect
to such removal exceeds the Minimum Certificateholders' Interest. Such removals
may affect the rate at which principal is distributed to Noteholders by reducing
the overall Pool Balance and thus the amount of Principal Collections. See
"DESCRIPTION OF THE NOTES--Optional Retransfers of HELOCs to the Sponsor"
herein.
S-35
<PAGE>
The HELOCs may be prepaid in full or in part at any time without penalty.
The prepayment experience with respect to the HELOCs will affect the weighted
average life of the Notes.
The rate of prepayment on the HELOCs cannot be predicted. Neither the
Servicer nor the Sponsor is aware of any relevant studies or statistics on the
rate of prepayment of such HELOCs. Generally, home equity loans are not viewed
by borrowers as permanent financing. Accordingly, the HELOCs may experience a
higher rate of prepayment than traditional first mortgage loans. On the other
hand, because the HELOCs amortize as described herein, rates of principal
payment on the HELOCs will generally be slower than those of traditional
fully-amortizing first mortgages in the absence of prepayments on such HELOCs.
The prepayment experience of the Trust with respect to the HELOCs may be
affected by a wide variety of factors, including general economic conditions,
prevailing interest rate levels, the availability of alternative financing,
homeowner mobility, the frequency and amount of any future draws on the Credit
Line Agreements and changes affecting the deductibility for Federal income tax
purposes of interest payments on home equity loans. All of the HELOCs contain
"due-on-sale" provisions and the Servicer intends to enforce such provisions,
unless (i) such enforcement is not permitted by applicable law or (ii) the
Servicer, in a manner consistent with reasonable commercial practice, permits
the purchaser of the related Mortgaged Property to assume the HELOC. The
enforcement of a "due-on-sale" provision will have the same effect as a
prepayment of the related HELOC. See "CERTAIN LEGAL ASPECTS OF THE
LOANS--Due-on-Sale Clauses" in the Prospectus.
The yield to an investor who purchases the Notes in the secondary market at
a price other than par will vary from the anticipated yield if the rate of
prepayment on the HELOCs is actually different than the rate anticipated by such
investor at the time such Notes were purchased.
Collections on the HELOCs 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 HELOCs may vary due to
seasonal purchasing and payment habits of borrowers.
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 HELOCs to any significant degree.
The following table set forth below is based on conditional prepayment rate
and constant draw rate (which for purposes of the assumptions is the amount of
Additional Balances on the HELOCs drawn each month expressed as an annualized
percentage of the total principal of the pool of HELOCs outstanding at the
beginning of such month). For the following table, it was assumed that the
Initial HELOCs have been aggregated into two pools, one pool with a principal
balance of $88,479,119.34 and a second pool with a principal balance of
$104,444,991.03. Further, the HELOCs with respect to the two pools are assumed
to have weighted average initial loan rates of 6.6435% and 7.8575%,
respectively, weighted average margins of 2.3744% and 3.6787%, respectively,
weighted average fully indexed rates, 1 month from the Initial Cut-Off Date, of
10.8744% and 12.1787%, respectively, weighted average credit limit utilization
rates (weighted by credit line) of 71.3852% and 78.1014%, respectively, and as
of the Initial Cut-Off Date, weighted average remaining terms to maturity of 297
months and 177 months, respectively. It was also assumed that the Subsequent
HELOCs are HELOCs and will be purchased at the end of each month during the
Funding Period with an initial loan rate of 5.875%, a margin of 3.0805%, a fully
indexed rate, 3 months from date of purchase, of 11.5805%, credit limit
utilization rate (weighted by credit line) of 74.8708%, and a remaining term to
maturity of 232 months.
In addition, it was assumed that (i) the distributions are made in
accordance with the description set forth under "DESCRIPTION OF THE
NOTES--Distributions on the Notes", (ii) no extension past the scheduled
maturity date of a HELOC is made, (iii) no delinquencies occur, (iv) scheduled
monthly payments on the HELOCs are comprised of interest only payments and the
only principal payments on the HELOCs are those represented by prepayments
calculated under each of the prepayment assumptions as set forth in the tables
below before giving effect to draws, (v) monthly draws are calculated under each
of the assumptions as set forth in the table before giving effect to
prepayments, (vi) each HELOC Loan is subject to a maximum credit utilization
rate of 100%, (vii) the scheduled due date of the HELOCs is the first day of
each month, (viii) each month consists of 30 days, (ix) the Closing Date
S-36
<PAGE>
is August 21, 1997, (x) for each Distribution Date the Class A Note Rate is
5.82453%, (xi) monthly fees (Servicing Fee, Trustee Fees, and the Insurer's
premium fee) comprise, in the aggregate, an amount equal to .71%.
Percentage of Original Class A Note Principal Balance -
Amortization Schedule(1)(2)
Conditional Prepayment Rate (%CPR)
<TABLE>
<CAPTION>
Date 0% 10% 20% 25% 30% 35% 40%
- ---- -- --- --- --- --- --- ---
<S> <C> <C> <C> <C> <C> <C> <C>
Initial Percentage...................... 100 100 100 100 100 100 100
08/15/1998......................... 98 98 98 98 98 98 98
08/15/1999......................... 98 98 96 90 84 78 72
08/15/2000......................... 98 98 94 82 72 62 53
08/15/2001......................... 98 98 91 75 61 49 38
08/15/2002......................... 98 98 89 69 52 39 28
08/15/2003......................... 98 98 87 63 44 30 20
08/15/2004......................... 98 84 68 45 29 18 11
08/15/2005......................... 98 70 49 29 16 0 0
08/15/2006......................... 98 56 30 14 0 0 0
08/15/2007......................... 98 42 12 0 0 0 0
08/15/2008......................... 98 28 0 0 0 0 0
08/15/2009......................... 98 14 0 0 0 0 0
08/15/2010......................... 98 0 0 0 0 0 0
08/15/2011......................... 98 0 0 0 0 0 0
08/15/2012......................... 29 0 0 0 0 0 0
08/15/2013......................... 29 0 0 0 0 0 0
08/15/2014......................... 29 0 0 0 0 0 0
08/15/2015......................... 29 0 0 0 0 0 0
08/15/2016......................... 29 0 0 0 0 0 0
08/15/2017......................... 29 0 0 0 0 0 0
08/15/2018......................... 29 0 0 0 0 0 0
08/15/2019......................... 29 0 0 0 0 0 0
08/15/2020......................... 29 0 0 0 0 0 0
08/15/2021......................... 29 0 0 0 0 0 0
08/15/2022......................... 0 0 0 0 0 0 0
08/15/2023......................... 0 0 0 0 0 0 0
Weighted Average Life Years 17.43 9.36 7.62 6.15 5.08 4.27 3.65
</TABLE>
(1) Assumes (i) that an optional termination is exercised when the outstanding
Note Principal Balance is less than or equal to 10% of the Original Class A
Note Principal Balance and (ii) a constant draw rate of 18%.
(2) All percentages are rounded to the nearest 1%.
POOL FACTOR AND TRADING INFORMATION
The "Pool Factor" is a seven-digit decimal which the Servicer will compute
monthly expressing the Note Principal Balance of the Class A Notes as of each
Distribution Date (after giving effect to any distribution of principal on such
Distribution Date) as a proportion of the Original Note Principal Balance. On
the Closing Date, the Pool Factor will be 1.0000000. See "DESCRIPTION OF THE
NOTES--Distributions on the Notes." Thereafter, the Pool Factor will decline to
reflect reductions in the related Note Principal Balance resulting from
distributions of principal to the Class A Notes.
S-37
<PAGE>
Pursuant to the Indenture, monthly reports concerning the Invested Amount,
the Pool Factor and various other items of information will be made available to
the Noteholders. In addition, within 60 days after the end of each calendar
year, beginning with the 1997 calendar year, information for tax reporting
purposes will be made available to each person who has been a Noteholder of
record at any time during the preceding calendar year. See "DESCRIPTION OF THE
NOTES--Book-Entry Securities" and "--Reports to Noteholders" herein.
DESCRIPTION OF THE NOTES
The Notes will be issued pursuant to the Indenture, a form of which has
been filed as an exhibit to the Registration Statement. The following summaries
describe certain provisions of the Indenture. The summaries do not purport to be
complete and are subject to, and are qualified in their entirety by reference
to, all of the provisions of the Indenture. Wherever particular sections or
defined terms of the Indenture are referred to, such sections or defined terms
are incorporated herein by reference.
General
The Notes will be offered in denominations of $1,000 and multiples of
$1,000 in excess thereof, in book-entry form only. Definitive Notes, if issued,
will be transferable and exchangeable at the corporate trust office of the
Indenture Trustee, which will initially act as certificate registrar (the "Note
Registrar"). See "--Book-Entry Securities" below. No service charge will be made
for any registration of exchange or transfer of Notes, but the Indenture Trustee
may require payment of a sum sufficient to cover any tax or other governmental
charge.
The aggregate obligation of the Trust represented by the Class A Notes as
of the Closing Date will equal $189,065,000, which represents approximately 98%
of the Original Pool Balance and interest thereon generally at a rate equal to
LIBOR plus .18%. The Class S Notes will represent an obligation of the Trust for
interest payable at the Class S Note Rate on the HELOCs in excess of the Class A
Note Rate. The Original Class A Note Principal Balance will equal $189,065,000.
Following the Closing Date, the Invested Amount with respect to any Distribution
Date will be an amount equal to the Original Invested Amount minus (i) the
amount of Principal Collections previously distributed to Class A Noteholders,
amounts allocable to the Certificates that are used to reimburse Noteholders'
Loss Amounts and amounts distributed as Guaranteed Principal Distribution
Amounts funded by withdrawals from the Spread Account or draws under the Policy,
and minus (ii) an amount equal to the Noteholders' Loss Amounts not previously
absorbed by the Overcollateralization Amount, funded by Noteholders' Interest
Collections or collections allocable to the Certificates or reallocated to the
Certificateholders' Interest (up to the Certificateholders' Subordinated
Amount), or funded by withdrawals from the Spread Account or draws on the
Policy. The Note Principal Balance on any Distribution Date is equal to the
Original Class A Note Principal Balance minus the aggregate of amounts actually
distributed as principal to the Class A Noteholders. See "--Distributions on the
Notes" below. Each Class A Note represents the right to receive payments of
interest at the Class A Note Rate and payments of principal as described below.
The Class S Notional Amount as of any Distribution Date will be equal to the
Note Principal Balance of the Class A Notes on such Distribution Date (prior to
giving effect to any distributions on such Distribution Date). On the Closing
Date, the Class S Notional Amount will equal $189,065,000. Each Class S Note
represents the right to receive payments of interest at the Class S Note Rate as
described below.
The Certificate will represent the entire beneficial ownership interest in
the Issuer. The Certificate will initially be retained by the Sponsor and will
generally evidence the right to distributions on and other proceeds of the Trust
Property, to the extent not used to pay the Notes or other obligations and
expenses of the Issuer. Only the Notes are offered hereby. Any information
contained herein with respect to the Certificate is provided only to permit a
better understanding of the Notes.
The Sponsor has the right to sell or pledge the Certificate at any time,
provided (i) the Rating Agencies have notified the Sponsor and the Indenture
Trustee in writing that such action will not result in the reduction or
withdrawal of the ratings assigned to the Notes without regard to the Policy,
(ii) the Insurer consents thereto, and (iii) certain other conditions specified
in the Indenture are satisfied.
S-38
<PAGE>
Book-Entry Securities
The Notes will be Book-Entry Securities. The Notes will be issued in one or
more certificates, and will be held by a nominee of DTC or any successor
depository. Beneficial interests in the Notes will be indirectly held by
investors through the book-entry facilities of DTC, as described herein. The
Sponsor has been informed by DTC that its nominee will be CEDE. Accordingly,
CEDE is expected to be the holder of record of the Notes. Except as described
below, no person acquiring a Note (each, a "beneficial owner") will be entitled
to receive a physical certificate representing such Note (a "Definitive Note").
The beneficial owner's ownership of a Book-Entry Security will be recorded
on the records of the brokerage firm, bank, thrift institution or other
financial intermediary (each, a "Financial Intermediary") that maintains the
beneficial owner's account for such purpose. In turn, the Financial
Intermediary's ownership of such Book-Entry Security will be recorded on the
records of DTC (or of a participating firm that acts as agent for the Financial
Intermediary, whose interest will in turn be recorded on the records of DTC, if
the beneficial owner's Financial Intermediary is not a DTC participant).
Therefore, the beneficial owner must rely on the foregoing procedures to
evidence its beneficial ownership of a Note. Beneficial ownership of a Note may
be transferred only in compliance with the procedures of such Financial
Intermediaries and DTC participants.
DTC, which is a New York-chartered limited purpose trust company, performs
services for its participants, some of which (and/or their representatives) own
DTC. In accordance with its normal procedures, DTC is expected to record the
positions held by each DTC participant in the Notes, whether held for its own
account or as a nominee for another person. In general, beneficial ownership of
the Notes will be subject to the rules, regulations and procedures governing DTC
and DTC participants as in effect from time to time.
Distributions on the Notes will be made on each Distribution Date by the
Indenture Trustee to DTC. DTC will be responsible for crediting the amount of
such payments to the accounts of the applicable DTC participants in accordance
with DTC's normal procedures. Each DTC participant will be responsible for
disbursing such payments to the beneficial owners of the Notes that it
represents and to each Financial Intermediary for which it acts as agent. Each
such Financial Intermediary will be responsible for disbursing funds to the
beneficial owners of the Notes that it represents.
Under a book-entry format, beneficial owners of the Notes may experience
some delay in their receipt of payments, since such payments will be forwarded
by the Indenture Trustee to CEDE. None of the Sponsor, the Servicer, the Insurer
or the Indenture Trustee is responsible or liable for such delays in the
application of such payments to such beneficial owners. Because DTC can only act
on behalf of Financial Intermediaries, the ability of a beneficial owner to
pledge Notes to persons or entities that do not participate in the DTC system,
or otherwise take actions in respect of the Notes, may be limited due to the
absence of physical certificates for the Notes. In addition, issuance of the
Notes in book-entry form may reduce the liquidity of such Notes in the secondary
market since certain potential investors may be unwilling to purchase Notes for
which they cannot obtain physical certificates.
Unless and until Definitive Notes are issued, it is anticipated that the
only "Noteholder" of the Notes within the meaning of the Indenture will be CEDE,
as nominee of DTC. Beneficial owners of the Notes will not be "Noteholders", as
that term is used in the Indenture. Beneficial owners are only permitted to
exercise the rights of Noteholders indirectly through Financial Intermediaries
and DTC. Reports on the Trust provided by the Servicer to CEDE, as nominee of
DTC, may be made available to beneficial owners upon request, in accordance with
the rules, regulations and procedures creating and affecting DTC, and to the
Financial Intermediaries to whose DTC accounts the Notes of such beneficial
owners are credited.
DTC has advised the Sponsor and the Indenture Trustee that, unless and
until Definitive Notes are issued, DTC will take any action permitted to be
taken by the holders of the Notes under the Indenture only at the direction of
one or more Financial Intermediaries to whose DTC accounts the Notes are
credited, to the extent that such actions are taken on behalf of Financial
Intermediaries whose holdings include such Notes.
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Definitive Notes will be issued to beneficial owners of the Notes, or their
nominees, rather than to DTC, only if (a) the Sponsor advises the Indenture
Trustee in writing that DTC is no longer willing, qualified or able to discharge
properly its responsibilities as nominee and depository with respect to the
Notes and the Sponsor or the Indenture Trustee is unable to locate a qualified
successor; (b) the Sponsor, at its sole option, advises the Indenture Trustee
that it elects to terminate a book-entry system through DTC; or (c) with the
consent of the Insurer after the occurrence of an event of default under the
Indenture, beneficial owners of the Notes having not less than 51% of the Voting
Rights evidenced by the Notes advise the Indenture Trustee and DTC through the
Financial Intermediaries in writing that the continuation of a book-entry system
with respect to such Book-Entry Securities through DTC (or a successor thereto)
is no longer in the best interests of beneficial owners. With respect to any
date of determination, "Voting Rights" shall be allocated between the Class A
Notes and the Class S Notes in the proportion of 98% to 2%. Voting Rights
allocated to a Class of Notes shall be allocated among the Notes of such Class
in accordance with their respective Percentage Interests.
Upon the occurrence of any of the events described in the immediately
preceding paragraph, the Indenture Trustee will be required to notify all
beneficial owners of the Notes through DTC of the occurrence of such event and
the availability of Definitive Notes. Upon surrender by DTC of the global
certificate or certificates representing the Notes and instructions for
re-registration, the Indenture Trustee will issue the Definitive Notes, and
thereafter the Indenture Trustee will recognize the holders of such Definitive
Notes as Noteholders under the Indenture.
Assignment of HELOCs
At the time of issuance of the Notes, the Sponsor will transfer to the
Trust all of its right, title and interest in and to each HELOC (including any
Additional Balances arising in the future), related Loan Agreements, mortgages
and other related documents (collectively, the "Related Documents"), including
all collections received on or with respect to each such HELOC after the Initial
Cut-Off Date (except with respect to interest on the Initial HELOCs, an amount
equal to twenty-five days' interest, calculated at the weighted average Loan
Rate). The Issuer will in turn pledge to the Trust under the Indenture all of
its right, title and interest in the foregoing property as collateral for the
Notes. The Indenture Trustee will not have any obligation to make additional
fundings under the Loan Agreements. The Indenture Trustee, concurrently with
such pledge, will deliver the Notes on behalf of the Trust. Each HELOC
transferred to the Trust will be identified on a schedule (the "HELOC Schedule")
delivered to the Indenture Trustee pursuant to the Sale and Servicing Agreement.
Such schedule will include information as to the Cut-Off Date Principal Balance
of each HELOC, as well as information with respect to the Loan Rate. Subject to
the following conditions, among others, Subsequent HELOCs, to the extent of the
availability thereof and the availability of sufficient Principal Collections on
deposit in the Funding Account, will be sold to the Trust on or before the last
Distribution Date of the Funding Period and (i) must meet the general criteria
for eligibility in accordance with the terms of the Sale and Servicing Agreement
(other than statistical information relating to the Initial HELOCs or Eligible
Substitute HELOCs); and (ii) must be selected by the Servicer in a manner it
believes will not materially adversely affect the Noteholders or the Insurer.
The Sale and Servicing Agreement will require that on or prior to the
Closing Date, the Servicer deliver to the Indenture Trustee (or a custodian, as
the Indenture Trustee's agent for such purpose) the Mortgage Notes endorsed in
blank to the Indenture Trustee on behalf of the Trust and the Related Documents.
In lieu of delivery of original mortgages, the Servicer may deliver true and
correct copies thereof which with respect to lost mortgages have been certified
as to the authenticity by the appropriate county recording office where such
mortgage is recorded.
Under the terms of the Sale and Servicing Agreement, the Sponsor will have
30 days after the Closing Date to prepare and submit for recordation assignments
of the mortgages related to each HELOC in favor of the Indenture Trustee.
Within 90 days of the Closing Date with respect to the Initial HELOCs or 90
days of the transfer to the Trust of the Subsequent HELOCs, the Indenture
Trustee will review the HELOCs and the Related Documents and if any HELOC or
Related Document is found to be defective in any material respect and such
defect is not cured within 90 days following notification thereof to the Sponsor
by the Indenture Trustee, the Sponsor will be obligated to accept the transfer
of such HELOC from the Trust. Upon such transfer, the Principal Balance of such
HELOC
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will be deducted from the Pool Balance, thus reducing the amount of the
Certificateholders' Interest. If the deduction would cause the
Certificateholders' Interest to become less than the Minimum Certificateholders'
Interest at such time (a "Transfer Deficiency"), the Sponsor will be obligated
to either substitute an Eligible Substitute HELOC (as defined below) or to make
a deposit into the Collection Account in the amount (the "Transfer Deposit
Amount") equal to the amount by which the Certificateholders' Interest would be
reduced to less than the Minimum Certificateholders' Interest at such time plus
an amount equal to all accrued but unpaid interest on such removed HELOC. Any
such deduction or deposit will be considered a payment in full of such HELOC.
Any Transfer Deposit Amount will be treated as a Principal Collection.
Notwithstanding the foregoing, however, prior to all required deposits to the
Collection Account being made no such transfer shall be considered to have
occurred unless such deposit is actually made. The obligation of the Sponsor to
accept a transfer of a Defective HELOC (as defined below) is the sole remedy
regarding any defects in the HELOCs and Related Documents available to the
Indenture Trustee or the Noteholders.
An "Eligible Substitute HELOC" is a home equity loan substituted by the
Sponsor for a Defective HELOC which must, on the date of such substitution, (i)
have an outstanding Principal Balance (or, in the case of a substitution of more
than one HELOC for a Defective HELOC, an aggregate Principal Balance), not more
than 115%, of the Transfer Deficiency, if any, relating to such Defective HELOC;
(ii) except for HELOCs still in their teaser period, have a Loan Rate not less
than the Loan Rate of the Defective HELOC and not more than 4.00% in excess of
the Loan Rate of such Defective HELOC; (iii) have a Loan Rate based on the same
Index with adjustments to such Loan Rate made on the same date on which the
Defective HELOC's interest rate adjusts (the "Interest Rate Adjustment Date");
(iv) except for HELOCs still in their teaser period, have a Margin that is not
less than the Margin of the Defective HELOC and not more than 100 basis points
higher than the Margin for the Defective HELOC; (v) have a mortgage of the same
or higher level of priority as the HELOC relating to the Defective HELOC at the
time such HELOC was transferred to the Trust; (vi) have a remaining term to
maturity not more than 120 months earlier and not more than 180 months later
than the remaining term to maturity of the Defective HELOC; (vii) comply with
each representation and warranty as to the HELOCs set forth in the Sale and
Servicing Agreement (deemed to be made as of the date of substitution); and
(viii) have an original Combined Loan-to-Value Ratio not greater than that of
the Defective HELOC.
The Sponsor will make certain representations and warranties as to the
accuracy in all material respects of certain information furnished to the
Indenture Trustee with respect to each HELOC (e.g., Cut-Off Date Principal
Balance and the Loan Rate). In addition, the Sponsor will represent and warrant
on the Closing Date that at the time of transfer to the Trust, the Sponsor has
transferred or assigned all of its rights, title and interest in each HELOC and
the Related Documents, free of any lien. Upon discovery of a breach of any such
representation and warranty which materially and adversely affects the interests
of the Noteholders or the Insurer in the related HELOC and Related Documents,
the Sponsor will have a period of 90 days after discovery or notice of the
breach to effect a cure. If the breach cannot be cured within the 90-day period,
the Sponsor will be obligated to accept a transfer of the Defective HELOC from
the Trust. The same procedure and limitations that are set forth for the
transfer of a Defective HELOC in the preceding paragraph will apply to the
transfer of a HELOC that is required to be transferred because of such breach of
a representation or warranty.
HELOCs required to be transferred to the Sponsor as described in the
preceding paragraphs are referred to as "Defective HELOCs."
Amendments to Credit Line Agreements
Subject to applicable law, the Servicer may change the terms of the Credit
Line Agreements at any time provided that such changes (i) do not adversely
affect the interest of the Noteholders or the Insurer, and (ii) are consistent
with prudent business practice. The Servicer may make material changes to the
Credit Line Agreements with the prior written consent of the Insurer. In
addition, the Sale and Servicing Agreement permits the Servicer, within certain
limitations described therein, to increase the Credit Limit of the related HELOC
or reduce the Margin for such HELOC.
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Optional Retransfers of HELOCs to the Sponsor
Subject to the conditions specified in the Sale and Servicing Agreement, on
any Distribution Date the Sponsor may, but shall not be obligated to, designate
for removal on such Distribution Date (the "Transfer Date") from the Trust,
certain HELOCs without notice to the Securityholders. HELOCs so designated will
only be removed upon satisfaction of certain conditions specified in the Sale
and Servicing Agreement, including: (i) the Certificateholders' Interest as of
such Transfer Date (after giving effect to such removal) exceeds the Minimum
Certificateholders' Interest; (ii) the Sponsor shall have delivered to the
Indenture Trustee a HELOC Schedule containing a list of all HELOCs remaining in
the Trust after such removal; (iii) the Sponsor shall represent and warrant that
no selection procedures which the Sponsor reasonably believes are adverse to the
interests of the Noteholders or the Insurer were used by the Sponsor in
selecting such HELOCs; (iv) in connection with each such retransfer of HELOCs,
the Rating Agencies shall have been notified of the proposed transfer and prior
to the Transfer Date shall have notified the Indenture Trustee or the Insurer in
writing that such transfer would not result in a reduction or withdrawal of the
ratings assigned to the Notes without regard to the Policy; (v) the proposed
retransfer shall not cause a Rapid Amortization Event to occur; (vi) the Rapid
Amortization Period shall not have commenced; and (vii) the Sponsor shall have
delivered to the Indenture Trustee and the Insurer an officer's certificate
confirming the conditions set forth in clauses (i) through (vi) above. In
certain circumstances where the removal of such HELOCs results in the
Certificateholders' Interest being reduced below the Minimum Certificateholders'
Interest, the Sponsor shall be permitted to remove such HELOCs only if the
Sponsor deposits the Reimbursement Amount in the Collection Account; the Sponsor
shall not remove such HELOCs if the Reimbursement Amount would exceed $100,000.
Payments on HELOCs; Deposits to Collection Account; Deposits to Funding Account
The Indenture Trustee shall establish and maintain the Collection Account
for the benefit of the Noteholders, the Insurer and the Sponsor, as their
interests may appear. The Collection Account will be an Eligible Account (as
defined below). Subject to the investment provision described in the following
paragraphs, within two Business Days of receipt by the Servicer of amounts in
respect of the HELOCs (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), the Servicer will deposit such amounts in the Collection Account.
Amounts so deposited may be invested in Eligible Investments maturing no later
than one Business Day prior to the next Distribution Date or on such
Distribution Date if approved by the Rating Agencies and the Insurer. Not later
than the Determination Date, the Servicer will notify the Indenture Trustee of
the amount of such deposit to be included in funds available for the related
Distribution Date.
The Funding Account will be an Eligible Account established with the
Indenture Trustee on the Closing Date. Amounts deposited into the Funding
Account will be invested in Eligible Investments at the direction of the
Servicer maturing no later than one Business Day prior to the related
Distribution Date or on the related Distribution Date if approved by the Rating
Agencies and the Insurer. All income or gain realized from any investment in
Eligible Investments shall constitute part of Noteholders' Interest Collections.
On each Distribution Date during the Funding Period the Scheduled Principal
Collections Distribution Amount for such Distribution Date will be deposited in
the Funding Account and may be applied by the Indenture Trustee (i) as payment
to the Sponsor of an amount equal to the Additional Balances previously acquired
by the Trust and for which the Sponsor has not previously been paid, and (ii)
from any remaining amount on deposit in the Funding Account on such Distribution
Date, to the purchase of Subsequent HELOCs. In the event that not all Principal
Collections on deposit in the Funding Account have been so applied on the last
Distribution Date of the Funding Period, the remaining amount of Principal
Collections on deposit in the Funding Account will be distributed to the Class A
Noteholders as a payment of principal on such last Distribution Date.
An "Eligible Account" is an account that is (i) maintained with a
depository institution whose short-term debt obligations at the time of any
deposit therein have the highest short-term debt rating by Standard & Poor's and
Moody's, (ii) one or more accounts maintained with a depository institution
whose long term unsecured debt rating by Standard & Poor's and Moody's is at
least investment grade and 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 established by such fund, (iii) a
segregated trust account maintained with the Indenture Trustee in its
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fiduciary capacity or (iv) otherwise acceptable to each Rating Agency and the
Insurer as evidenced by a letter from each Rating Agency and the Insurer to the
Indenture Trustee, without reduction or withdrawal of their then current ratings
of the Notes without regard to the Policy.
Eligible Investments are specified in the Indenture and may also include
investments which meet the criteria of the Rating Agencies from time to time as
being consistent with their then current ratings of the Notes.
Allocations and Collections
All collections on the HELOCs will generally be allocated in accordance
with the Loan Agreements between amounts collected in respect of interest and
amounts collected in respect of principal. As to any Distribution Date, Interest
Collections will be equal to the amounts collected during the related Collection
Period, including the portion of Net Liquidation Proceeds and insurance proceeds
allocated to interest pursuant to the terms of the Loan Agreements and earnings
received on funds on deposit in the Funding Account, less Servicing Fees for the
related Collection Period.
As to any Distribution Date, Principal Collections will be equal to the sum
of (i) the amounts collected during the related Collection Period, including
such portion of Net Liquidation Proceeds and insurance proceeds, allocated to
principal pursuant to the terms of the Loan Agreements and (ii) any Transfer
Deposit Amounts. Net Liquidation Proceeds with respect to a HELOC are equal to
the Liquidation Proceeds and insurance proceeds, reduced by related expenses,
but not including the portion, if any, of such amount that exceeds the Principal
Balance of the HELOC, and accrued and unpaid interest thereon to the end of the
Collection Period during which such HELOC became a Liquidated HELOC.
"Liquidation Proceeds" are the proceeds received in connection with the
liquidation of any HELOC, whether through trustee's sale, foreclosure sale or
otherwise.
With respect to any Distribution Date, the Noteholders' Interest
Collections will equal the product of (i) Interest Collections for such
Distribution Date and (ii) the Floating Allocation Percentage. With respect to
any Distribution Date, the Floating Allocation Percentage is the percentage
equivalent of a fraction determined by dividing (a) the Invested Amount at the
close of business on the preceding Distribution Date (or the Closing Date in the
case of the first Distribution Date) by (b) the sum as of the beginning of the
related Collection Period of (i) the Pool Balance (adjusted for any HELOCs
removed from the Trust or Additional Balances added to the Trust during the
prior Collection Period) and (ii) the amount of Principal Collections on deposit
in the Funding Account. The remaining amount of Interest Collections will be
allocated to the Certificateholders' Interest.
Principal Collections will be allocated between the Noteholders and the
Sponsor ("Noteholders' Principal Collections" and "Certificateholders' Principal
Collections", respectively) as described herein.
The Indenture Trustee will deposit any amounts drawn under the Policy into
the Collection Account.
Distributions on the Notes
Beginning with the first Distribution Date (which will occur on September
15, 1997), distributions on the Notes will be made by the Indenture Trustee or
the Paying Agent on each Distribution Date to the persons in whose names such
Notes are registered at the close of business on the day prior to each
Distribution Date or, if the Notes are no longer Book-Entry Notes, at the close
of business on the Record Date. Distribution Date means the fifteenth day of
each month or, if such day 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 Noteholder owning Notes having denominations aggregating at
least $1,000,000, by wire transfer or otherwise) to the address of the person
entitled thereto (which, in the case of Book-Entry Notes, will be DTC or its
nominee) as it appears on the Note Register in amounts calculated as described
herein on the Determination Date. However, the final distribution in respect of
the Notes will be made only upon presentation and surrender thereof at the
office or the agency of the Indenture Trustee specified in the notice to
Noteholders of such final distribution. For purposes of the Indenture, a
"Business Day" is any day other than (i) a Saturday or Sunday or (ii) a day on
which banking institutions in New York State or California are required or
authorized by law to be closed.
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Application of Interest Collections. On each Distribution Date, the
Indenture Trustee or the Paying Agent will apply the Noteholders' Interest
Collections, amounts transferred from the Deferred Interest Account, and amounts
transferred from the Spread Account in accordance with the Indenture in the
following manner and order of priority:
(i) for the accrued interest due and any overdue accrued interest (with
interest thereon to the extent permitted by law) (other than Deferred Interest)
on the Note Principal Balance of the Class A Notes;
(ii) as payment for the accrued interest due and any overdue accrued
interest (with interest thereon to the extent permitted by law) on the Class S
Notional Amount;
(iii) to pay Class A Noteholders the Noteholders' Loss Amount for such
Distribution Date;
(iv) as payment for any Noteholders' Loss Amount for a previous
Distribution Date that was not previously (a) funded by Noteholders' Interest
Collections including amounts transferred from the Deferred Interest Account,
(b) funded by Interest Collections and Principal Collections allocable to the
Certificateholders' Interest or reallocated to the Certificateholders' Interest
up to the Certificateholders' Subordinated Amount as described below, (c)
absorbed by the Overcollateralization Amount, (d) funded by amounts on deposit
in the Spread Account, or (e) funded by draws on the Policy;
(v) as payment to the Insurer for the monthly premium for the Policy;
(vi) to reimburse prior draws made from the Policy (with interest thereon);
(vii) to deposit to the Spread Account for the benefit of the Insurer and
Noteholders pursuant to the Indenture and the Insurance Agreement until the
funds on deposit therein equal 0.50% of the Original Pool Balance;
(viii) to pay principal on the Class A Notes until the Invested Amount
exceeds the Note Principal Balance by the Required Overcollateralization Amount
(the aggregate of amounts, if any, paid pursuant to this clause (viii) being
referred to herein as the "Accelerated Principal Distribution Amount");
(ix) to pay any other amounts owed to the Insurer pursuant to the Insurance
Agreement;
(x) as payment to the Indenture Trustee for its fee for services rendered
pursuant to the Indenture and as payment to the Owner Trustee for its fees for
services rendered pursuant to the Trust Agreement;
(xi) to pay certain amounts that may be required to be paid to the Servicer
pursuant to the Sale and Servicing Agreement;
(xii) to pay Deferred Interest on the Class A Notes and interest thereon at
the Class A Note Rate;
(xiii) to pay a fee to the Manager (the "Management Fee") pursuant to the
Management Agreement (the "Management Agreement") dated as of August 1, 1997
between Headlands Mortgage Company, as Manager and the Trust; and
(xiv) to the Certificateholders, which shall initially be the Sponsor, to
the extent permitted as described herein.
The "Overcollateralization Amount" on any date of determination is the
amount, if any, by which the Invested Amount exceeds the Note Principal Balance
on such day. Payments to Noteholders pursuant to clauses (i) and (ii) will be
interest payments on the Notes. Payments to Noteholders pursuant to clauses
(iii) and (iv) will be principal payments on the Notes and will therefore reduce
the Note Principal Balance and the Invested Amount; however, payments pursuant
to clause (viii) will reduce the Note Principal Balance but will not reduce the
Invested Amount. The Accelerated Principal Distribution Amount is not guaranteed
by the Policy. The "Required Overcollateralization Amount" as of any
Distribution Date is an amount equal to the excess of (a) the "Spread
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Account Maximum" (as defined in the Insurance Agreement) as of such Distribution
Date over (b) the sum of (i) the Certificateholders' Subordinated Amount as of
such Distribution Date and (ii) the amount of funds on deposit in the Spread
Account as of such Distribution Date.
To the extent that Noteholders' Interest Collections are applied to pay the
interest on the Notes, available Noteholders' Interest Collections may be
insufficient to cover Noteholders' Loss Amounts. If such insufficiency exists
after (i) giving effect to the distribution, if any, of principal to the Class A
Noteholders on such Distribution Date (including the application of collections
otherwise allocable to the Certificateholders' Interest and all withdrawals from
the Spread Account) and (ii) the Certificateholders' Subordinated Amount has
been reduced to zero, then if the Note Principal Balance as of such Distribution
Date exceeds the Invested Amount, a draw in an amount equal to such difference
will be made on the Policy in accordance with the terms of the Policy.
"Liquidation Loss Amount" means with respect to any Liquidated HELOC, the
unrecovered Principal Balance thereof at the end of the Collection Period in
which such HELOC became a Liquidated HELOC, after giving effect to the Net
Liquidation Proceeds in connection therewith. The "Noteholders' Loss Amount"
shall be the product of the Floating Allocation Percentage and the Liquidation
Loss Amount for such Distribution Date.
A "Liquidated HELOC" means, as to any Distribution Date, any HELOC in
respect of which the Servicer has determined, based on the servicing procedures
specified in the Sale 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. Except as otherwise specified herein, the Noteholders' Loss Amount
will be allocated to the Noteholders.
Interest will be distributed on each Distribution Date at the Note Rate for
the related Interest Period. The Note Rate for the Class S Notes for any
Distribution Date will equal 1.25% per annum. The Note Rate for the Class A
Notes for a Distribution Date 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) .18%
per annum. Notwithstanding the foregoing, in no event will the amount of
interest required to be distributed in respect of the Class A Notes on any
Distribution Date exceed the Maximum Rate. To the extent the Maximum Rate is
less than the Class A Note Rate, the deficiency will be deferred and payable as
Deferred Interest. In certain circumstances, the addition of Subsequent HELOCs
to the Trust may result in the Class A Note Rate exceeding the Maximum Rate.
Interest on the Class A Notes in respect of any Distribution Date will
accrue on the Note Principal Balance, or the Class S Notional Amount in the case
of the Class S Notes, from the preceding Distribution Date (or in the case of
the first Distribution Date, from the date of the initial issuance of the Notes
through the day preceding such Distribution Date (each such period, an "Interest
Period") on the basis of the actual number of days in the Interest Period and a
360-day year. Interest payments on the Notes will be funded from Noteholders'
Interest Collections, transfers from the Deferred Interest Account and from
collections allocable to the Certificateholders' Interest up to the then
outstanding Certificateholders' Subordinated Amount and, if necessary, from
draws on the Spread Account and on the Policy.
Calculation of the LIBOR Rate. On the second LIBOR Business Day prior to
each Distribution Date, LIBOR shall be established by the Indenture Trustee and
as to any Interest Period, LIBOR will equal the rate for United States dollar
deposits for one month which appears on the Telerate Screen Page 3750 as of
11:00 A.M., London time, on the second LIBOR Business Day prior to the first day
of such Interest Period. "Telerate Screen 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 service is
no longer offered, such other service for displaying LIBOR or comparable rates
as may be selected by the Sponsor after consultation with the Indenture
Trustee), 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 two major banks that are
engaged in transactions in the London interbank market, selected by the Sponsor
after consultation with the Indenture Trustee) as of 11:00 A.M., London time, on
the day
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that is two LIBOR Business Days prior to the immediately preceding Distribution
Date to prime banks in the London interbank market for a period of one month in
amounts approximately equal to the principal amount of the Notes then
outstanding. The Indenture 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 Sponsor after consultation with the
Indenture Trustee, 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 principal amount of the Notes then outstanding. If no
such quotations can be obtained, the rate will be LIBOR for the prior
Distribution Date. "LIBOR Business Day" means any day 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.
Certificateholders' Collections. Except as otherwise provided herein,
collections that are not distributed to Noteholders or deposited into the
Funding Account ("Certificateholders' Collections") will be distributed to the
Certificates only to the extent that such distribution will not reduce the
amount of the Certificateholders' Interest as of the related Distribution Date
below the Minimum Certificateholders' Interest. Amounts of the
Certificateholders' Collections not distributed to the Certificates because of
such limitations will be retained in the Collection Account until the
Certificateholders' Interest exceeds the Minimum Certificateholders' Interest,
at which time such excess shall be released to the Certificates. If any such
amounts are still retained in the Collection Account upon the commencement of
the Rapid Amortization Period, such amounts will be paid to the Class A
Noteholders as a reduction of the Note Principal Balance.
Overcollateralization. The distribution of the aggregate Accelerated
Principal Distribution Amount, if any, to Noteholders may result in the Invested
Amount being greater than the Note Principal Balance, thereby creating
overcollateralization. The Overcollateralization Amount, if any, will be
available to absorb any Liquidation Loss Amount that is allocated to Noteholders
and is not covered by the excess interest or the Certificateholders'
Subordinated Amount.
Distributions of Principal Collections. During the Funding Period, the
Scheduled Principal Collections Distribution Amount will be deposited into the
Funding Account. In the event that not all of the Principal Collections
remaining on deposit in the Funding Account have been used to acquire Additional
Balances or Subsequent HELOCs on the last Distribution Date of the Funding
Period, then such Principal Collections will be used to acquire any remaining
Additional Balances on such Distribution Date and any remaining amount on
deposit therein will be distributed to the Noteholders as a payment of
principal. During the Managed Amortization Period, the amount of Principal
Collections payable to Noteholders as of each Distribution Date will equal, to
the extent funds are available therefor, the Scheduled Principal Collections
Distribution Amount for such Distribution Date. On any Distribution Date, the
Scheduled Principal Collections Distribution Amount shall equal the lesser of
(i) the Maximum Principal Payment and (ii) the Alternative Principal Payment.
With respect to any Distribution Date, the Maximum Principal Payment will be
equal to the product of the Fixed Allocation Percentage and Principal
Collections for such Distribution Date. With respect to any Distribution Date,
the Alternative Principal Payment will equal the amount, but not less than zero,
of Principal Collections for such Distribution Date less the aggregate of
Additional Balances created during the related Collection Period.
During the Rapid Amortization Period, the amount of Principal Collections
payable to Class A Noteholders on each Distribution Date will be equal to the
Maximum Principal Payment.
Distributions of Principal Collections based upon the Fixed Allocation
Percentage may result in distributions of principal to Class A Noteholders in
amounts that are greater relative to the declining Pool Balance than would be
the case if the Floating Allocation Percentage were used to determine the
percentage of Principal Collections distributed in respect of the Invested
Amount. Principal Collections not allocated to the Class A Noteholders will be
allocated to the Certificateholders' Interest. The aggregate distributions of
principal to the Class A Noteholders will not exceed the Original Class A Note
Principal Balance.
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In addition, to the extent of funds available therefor (including funds on
deposit in the Spread Account and funds available under the Policy), on the
Distribution Date in August 2024, Class A Noteholders will be entitled to
receive as a payment of principal an amount equal to the outstanding Note
Principal Balance.
The Paying Agent. The Paying Agent shall initially be the Indenture
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 Collection Account for the purpose of making distributions to the
Noteholders.
Limited Subordination of Certificateholders' Interest
If Noteholders' Interest Collections, and funds payable from the Deferred
Interest Account on any Distribution Date are insufficient to pay (i) accrued
interest due and any overdue accrued interest (with interest thereon) (other
than Deferred Interest) on the Notes and (ii) the Noteholders' Loss Amount on
such Distribution Date (such insufficiency being the "Required Amount"), a
portion of the Interest Collections and Principal Collections allocable to the
Certificateholders' Interest (but not in excess of the then outstanding
Certificateholders' Subordinated Amount, determined as provided herein) will be
applied to cover the Required Amount. The portion of the Required Amount in
respect of clause (ii) above not covered by such collections will be reallocated
to the Certificateholders' Interest, thereby reducing the Certificateholders'
Interest (up to the remaining Certificateholders' Subordinated Amount and not in
excess of the Noteholders' Loss Amounts). If such Noteholders' Interest
Collections and funds payable from the Deferred Interest Account plus the amount
of collections allocable to the Certificateholders' Interest which have been so
applied to cover the Required Amount are together insufficient to pay the
amounts set forth in item (i) of the definition of Required Amount, then a draw
will be made on the Policy to cover the amounts by which interest owed to the
Class A Noteholders at the Class A Note Rate and to the Class S Noteholders at
the Class S Note Rate exceeds Noteholders' Interest Collections, amounts payable
from the Deferred Interest Account, collections allocable to the
Certificateholders' Interest applied to cover the Required Amount and amounts on
deposit in the Spread Account. In addition, if on any Distribution Date on or
after the Certificateholders' Subordinated Amount is reduced to zero, the Note
Principal Balance exceeds the Invested Amount (after giving effect to all
allocations and distributions with respect to principal to be made on the Class
A Notes on such Distribution Date including amounts payable from the Spread
Account), a draw will be made on the Policy in the amount of such excess for
such Distribution Date. After the Certificateholders' Subordinated Amount has
been reduced to zero, the Required Amount will no longer be supported by the
Certificateholders' Subordinated Amount as described above.
To the extent the Original Class A Note Principal Balance less all
principal payments actually distributed to Noteholders exceeds the Invested
Amount on a Distribution Date in accordance with the terms of the Policy when
the Certificateholders' Subordinated Amount is equal to zero, a draw will be
made upon the Policy to cover such shortfall in principal to the extent
available under the Policy. See "--The Policy."
With respect to any Distribution Date, the "Certificateholders'
Subordinated Amount" equals $3,859,110.37 minus (i) the aggregate amount of
principal and interest collections allocable to the Certificateholders' Interest
that have previously been distributed to the Class A Noteholders to cover a
Required Amount as described above and (ii) the aggregate amount of the
Noteholders' Loss Amounts that have previously been reallocated to the
Certificateholders' Interest as described above; provided that the
Certificateholders' Subordinated Amount shall not be less the zero. The
Certificateholders' Subordinated Amount at any time may also be further reduced
if such reduction is consented to by both the Rating Agencies and the Insurer
and certain other conditions are satisfied.
Deferred Interest Account
On the Closing Date an amount equal to $600,809.53 will be deposited, and
on each Distribution Date on which the Trust acquires Subsequent HELOCs and
Eligible Substitute HELOCs, an amount calculated by the Sponsor necessary to pay
any Deferred Interest with respect to such Subsequent HELOCs and Eligible
Substitute HELOCs will be deposited, in the Deferred Interest Account in the
name of the Indenture Trustee on behalf of the Trust. On each Distribution Date,
amounts in the Deferred Interest Account in an amount of Deferred Interest for
such Distribution Date will be deposited into the Collection Account and applied
in accordance with the priority of
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payments set forth in "DESCRIPTION OF THE NOTES--Distributions on the Notes."
Any amounts remaining in the Deferred Interest Account on the later of (i) the
Distribution Date following the end of the Funding Period and (ii) the
Distribution Date following the date on which all teaser HELOCs have become
fully indexed, will be deposited in the Collection Account for distribution.
Amounts on deposit in the Deferred Interest Account shall be invested in
Eligible Investments.
Rapid Amortization Events
As described above, the Managed Amortization Period will continue through
the Distribution Date in August, 2003, unless a Rapid Amortization Event occurs
prior to such date in which case the Rapid Amortization Period will commence
prior to such date. The "Rapid Amortization Period" is the period commencing on
the earlier of (x) the end of the Managed Amortization Period and (y) the day,
if any, upon which a Rapid Amortization Event occurs and concluding upon
termination of the Trust. A "Rapid Amortization Event" refers to any of the
following events:
(a) failure on the part of the Company, the Servicer or the Sponsor
(i) to make a payment or deposit required under the Sale and Servicing
Agreement or the Insurance Agreement within two Business Days after
notification that such payment or deposit is required to be made or (ii) to
observe or perform in any material respect any other covenants or
agreements of the Company, the Servicer or of the Sponsor set forth in the
Sale and Servicing Agreement or the Insurance Agreement, which failure
continues unremedied for a period of 60 days after written notice;
(b) any representation or warranty made by the Company, the Servicer
or the Sponsor in the Sale and Servicing Agreement or the Insurance
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
Securityholders or the Insurer are materially and adversely affected;
provided, however, that a Rapid Amortization Event shall not be deemed to
occur if the Company, the Servicer or the Sponsor has purchased the related
HELOC or HELOCs if applicable during such period (or within an additional
60 days with the consent of the Indenture Trustee and the Insurer) in
accordance with the provisions of the Sale and Servicing Agreement;
(c) the occurrence of certain events of bankruptcy, insolvency or
receivership relating to the Company, the Sponsor or relating to the Trust;
(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;
(e) the aggregate of all draws under the Policy exceeds 1% of the
Original Pool Balance;
(f) if any of the transaction documents shall cease to be in full
force and effect or the security interest of the Indenture Trustee in the
Trust shall cease to be a first priority perfected security interest;
(g) the occurrence of a change in control with respect to the Company;
(h) the occurrence of any material breach by the Company of the
provisions of its credit agreements during the term of the Trust;
(i) failure by the Servicer, if the Servicer is the Company, to
maintain a minimum volume in its mortgage servicing portfolio of $2
billion, calculated by outstanding principal balances of mortgage loans
serviced, in accordance with the Servicer's credit and collection policy;
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(j) at the end of each calendar quarter commencing on September 30,
1997, failure by the Company to maintain (a) "shareholder's equity"
according to GAAP, of $15 million or (b) a maximum ratio of total
liabilities to shareholder's equity according to GAAP of 20 to 1;
(k) the failure by the Servicer to implement the CPI servicing system
or a servicing system mutually acceptable to the Servicer and the Insurer
within 90 days after availability of the system.
(l) for each Distribution Date commencing on the third Distribution
Date, the percentage equivalent of a fraction the numerator of which is
equal to the average of the aggregate Principal Balances on such date of
all HELOCs with respect to which principal or interest are at least 60 days
delinquent as of the last day of each of the three immediately preceding
Collection Periods, and the denominator of which is equal to the average of
the Pool Balance as of the last day of each of the three immediately
preceding Collection Periods shall exceed 4%;
(m) for each Distribution Date commencing on the third Distribution
Date, the percentage equivalent of a fraction, the numerator of which is
equal to the average of the aggregate Principal Balances on such date of
all defaulted HELOCs (excluding Liquidated HELOCs) as to which (i)
collection procedures are ongoing and (ii) the Servicer has charged off all
or a portion of the related Principal Balance as of the last day of each of
the three immediately preceding Collection Periods, and the denominator of
which is equal to the average of the Pool Balance as of the last day of
each of the three immediately preceding Collection Periods shall exceed 2%;
(n) default in payment of any interest, principal or any installment
of principal on any Note when the same becomes due and payable, and such
default shall continue for a period of five days;
(o) default in the observance or performance of any covenant or
agreement of the Issuer made in the Indenture, or any representation or
warranty of the Issuer made in the Indenture or in any certificate in
connection therewith proving to have been incorrect in any material respect
as of the time when the same shall have been made, and such default shall
continue or not be cured, or the circumstance or condition in respect of
which such misrepresentation or warranty was incorrect shall not have been
eliminated or otherwise cured, for a period of 30 days (or for such longer
period, not in excess of 90 days, as may be reasonably necessary to remedy
such default; provided that such default is capable of remedy within 90
days or less and the Servicer, on behalf of the Owner Trustee, delivers an
Officer's Certificate to the Indenture Trustee to the effect that the
Issuer has commenced, or will promptly commence and diligently pursue, all
reasonable efforts to remedy such default) after there shall have been
given, by registered or certified mail, to the Issuer by the Indenture
Trustee or to the Issuer and the Indenture Trustee by the Insurer or
Holders of at least 25% of the outstanding amount of the Notes, a written
notice specifying such default or incorrect representation or warranty and
requiring it to be remedied and stating that such notice is a "Notice of
Default" hereunder.
In the case of any event described above, a Rapid Amortization Event will
be deemed to have occurred only if, after the applicable grace period, if any,
described in such clauses, either (i) the Indenture Trustee or Noteholders
holding Notes evidencing in the aggregate more than 51% of the Voting Rights,
with the consent of the Insurer, or (ii) the Insurer (so long as there is no
default by the Insurer in the performance of its obligations under the Policy),
by written notice to the Servicer (and to the Indenture Trustee, if given by the
Noteholders) declare that a Rapid Amortization Event has occurred as of the date
of such notice; provided that with respect to clauses, (c), (d), (e) and (n) a
Rapid Amortization Event shall occur immediately upon the occurrence of such,
without any such notice.
In addition to the consequences of a Rapid Amortization Event discussed
above, if the Sponsor voluntarily files a bankruptcy petition or goes into
liquidation or any person is appointed a receiver or bankruptcy trustee of the
Sponsor, on the day of any such filing or appointment no further Additional
Balances will be transferred to the Trust, the Sponsor will immediately cease to
transfer Additional Balances to the Trust and the Sponsor will promptly give
notice to the Indenture Trustee, the Owner Trustee and the Insurer of any such
filing or appointment. Within 15 days, the Indenture Trustee will publish a
notice of the liquidation or the filing or appointment stating that the
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Indenture Trustee intends to sell, dispose of or otherwise liquidate the HELOCs
in a commercially reasonable manner and to the best of its ability. Unless
otherwise instructed within a specified period by Noteholders evidencing in the
aggregate more than 51% of the Voting Rights, the Indenture Trustee will sell,
dispose of or otherwise liquidate the HELOCs to a purchaser in a commercially
reasonable manner and on commercially reasonable terms; provided, however, that
the Insurer's consent to the terms of any such sale shall be required, which
consent shall not be unreasonably withheld. Any proceeds will be treated as
collections allocable to the Noteholders and will be distributed to the
Noteholders on the date such proceeds are received (the "Dissolution
Distribution Date"). The proceeds from the sale, disposition or liquidation of
the HELOCs will first be paid to the Insurer to the extent of unreimbursed draws
under the Policy and other amounts owing to the Insurer pursuant to the
Insurance Agreement.
Notwithstanding the foregoing, if a conservator, receiver or
trustee-in-bankruptcy is appointed for the Sponsor and no Rapid Amortization
Event exists other than such conservatorship, receivership or insolvency of the
Sponsor, the conservator, receiver or trustee-in-bankruptcy may have the power
to prevent the commencement of the Rapid Amortization Period or the sale of
HELOCs described above.
The Policy
On or before the Closing Date, the Policy will be issued by the Insurer
pursuant to the provisions of the Indenture and the Insurance and Reimbursement
Agreement to be dated as of August 1, 1997, among the Company, the Sponsor, the
Servicer, the Indenture Trustee and the Insurer (the "Insurance Agreement").
The Policy will irrevocably and unconditionally guarantee on each
Distribution Date to the Indenture Trustee for the benefit of the Noteholders
the full and complete payment of (i) the Guaranteed Principal Distribution
Amount with respect to the Class A Notes for such Distribution Date and (ii)
after application of amounts available from Noteholders' Interest Collections,
amounts transferred from the Deferred Interest Account, collections allocable to
the Certificateholders' Interest up to the Certificateholders' Subordinated
Amount and amounts on deposit in the Spread Account, any shortfall in accrued
and unpaid interest due on the Notes other than Deferred Interest (together, the
"Guaranteed Distributions"), with such Guaranteed Distributions having been
calculated in accordance with the original terms of the Policy and the
Indenture. Any amendments or modifications to such terms shall require the
Insurer's prior written consent. The effect of the Policy is to guarantee the
timely payment of interest on the Class A and Class S Notes, and the ultimate
payment of the principal amount of the Class A Notes.
The Guaranteed Principal Distribution Amount for any Distribution Date
on which the Certificateholders' Subordinated Amount has been reduced to zero
shall be the amount, if any, by which the Note Principal Balance (after giving
effect to all other amounts distributable and allocable to principal on the
Notes on such Distribution Date including application of any amounts available
therefor in the Spread Account) exceeds the Invested Amount as of such
Distribution Date (after giving effect to distributions of principal, if any, to
the Noteholders and the allocation of Noteholders' Loss Amounts on such
Distribution Date). In addition, the Policy will guarantee the payment of the
outstanding Note Principal Balance on the Distribution Date in August, 2024
(after giving effect to all other amounts distributable and allocable to
principal on such Distribution Date and after application of amounts on deposit
in the Spread Account).
Payment of claims on the Policy will be made by the Insurer following
Receipt by the Insurer of the appropriate notice for payment on the later to
occur of (i) 11:00 a.m., New York City time, on the Business Day next succeeding
Receipt of such notice for payment and (ii) 11:00 a.m., New York City time, on
the Business Day immediately preceding the relevant Distribution Date.
If payment of any amount guaranteed by the Insurer pursuant to the Policy
is avoided as a preference payment under applicable bankruptcy, insolvency,
receivership or similar law, the Insurer will pay such amount following Receipt
by the Insurer from the Indenture Trustee of (A) a certified copy of the final
order (the "Order") of the court or other governmental body which exercised
jurisdiction to the effect that the Indenture Trustee is required to return the
amount of any Guaranteed Distributions distributed with respect to the Notes
during the term of the related Policy because such distributions were avoidable
preference payments under applicable bankruptcy
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law with respect to which Order the appeal period has expired without an appeal
having been filed, (B) a certificate of the Indenture Trustee on behalf of the
Noteholders that the Order has been entered and is not subject to any stay, (C)
an assignment, in such form as is reasonably required by the Insurer,
irrevocably assigning to the Insurer all rights and claims of the Indenture
Trustee and the Noteholders relating to or arising under the Notes against the
debtor which made such preference payment or otherwise with respect to such
preference payment and (D) a claim for payment as required by the Insurer. Such
payment shall be disbursed to the receiver, conservator, debtor-in-possession or
trustee in bankruptcy named in the Order and not to the Indenture Trustee or any
Noteholder directly.
The terms "Receipt" and "Received," with respect to the Policy, means
actual delivery to the Insurer prior to 2:00 p.m., New York City time, on a
Business Day; delivery either on a day that is not a Business Day or after 2:00
p.m., New York City time, shall be deemed to be Received on the next succeeding
Business Day. If any notice or certificate given under the Policy by the
Indenture Trustee is not in proper form or is not properly completed, executed
or delivered it shall be deemed not to have been Received, and the Insurer shall
promptly so advise the Indenture Trustee and the Indenture Trustee may submit an
amended notice.
Under the Policy, "Business Day" means any day other than (i) a Saturday or
Sunday or (ii) a day on which banking institutions in The City of New York, New
York or the state in which the Indenture Trustee's corporate trust office is
located are authorized or obligated by law or executive order to be closed.
The Insurer's obligations under the Policy in respect of Guaranteed
Distributions shall be discharged to the extent funds are transferred to the
Indenture Trustee as provided in the Policy, whether or not such funds are
properly applied by the Indenture Trustee. On any Distribution Date, the amount
available under the Policy in respect of principal shall be equal to the excess
of the Original Class A Note Principal Balance over the sum of (i) the aggregate
of all amounts theretofore paid by the Insurer in respect of principal on the
Notes and (ii) the aggregate of all amounts withdrawn from the Spread Account in
respect of payments of principal on the Notes. Further, the aggregate amount of
all claims paid under the Policy in respect of principal may not exceed the
Original Class A Note Principal Balance.
The Insurer shall be subrogated to the rights of each Noteholder to receive
payments of principal and interest, as applicable, with respect to distributions
on the Notes to the extent of any payment by the Insurer under the Policy. To
the extent the Insurer makes Guaranteed Distributions, either directly or
indirectly (as by paying through the Indenture Trustee), to the Noteholders, the
Insurer will be subrogated to the rights of the Noteholders, as applicable, with
respect to such Guaranteed Distributions, shall be deemed to the extent of the
payments so made to be a registered Noteholder for purposes of payment and shall
receive all future Guaranteed Distributions until all such Guaranteed
Distributions by the Insurer have been fully reimbursed. The terms of the Policy
cannot be modified, altered or affected by any other agreement or instrument, or
by the merger, consolidation or dissolution of the Sponsor. The Policy by its
terms may not be cancelled or revoked. The Policy is governed by the laws of the
State of New York.
The Policy is not covered by the Property/Casualty Insurance Security fund
specified in Article 76 of the New York Insurance Law.
Pursuant to the terms of the Indenture, the Insurer shall be deemed to be
the Holder of the Notes for certain purposes (other than with respect to payment
on the Notes), will be entitled to exercise all rights of the Noteholders
thereunder, without the consent of such Holders and the Holders of the Notes may
exercise such rights only with the prior written consent of the Insurer. In
addition, the Insurer will have certain additional rights as third party
beneficiary to the Indenture.
In the absence of payments from the Spread Account and under the Policy,
Noteholders will bear directly the credit and other risks associated with their
undivided interest in the Trust.
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Reports to Noteholders
Concurrently with each distribution to the Noteholders, the Servicer will
forward to the Indenture Trustee for mailing to such Noteholder a statement
setting forth among other items:
(i) the Floating Allocation Percentage for the preceding Collection
Period;
(ii) the amount being distributed to each Class of Noteholders;
(iii) the amount of interest included in such distribution and the
related Note Rate;
(iv) the amount, if any, of overdue accrued interest and Deferred
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;
(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 and the amount, if
any, of Liquidation Loss Amounts with respect to the related Collection
Period;
(ix) the Servicing Fee for such Distribution Date;
(x) the Invested Amount, the Note Principal Balance and the Class S
Notional Amount, each after giving effect to such distribution;
(xi) the Pool Balance as of the end of the preceding Collection
Period;
(xii) the number and aggregate Principal Balances of the HELOCs 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;
(xiii) the book value of any real estate which is acquired by the
Trust through foreclosure or grant of deed in lieu of foreclosure;
(xiv) the amount of any draws on the Policy;
(xv) the amount, if any, on deposit in the Spread Account and the
amount, if any, transferred from the Spread Account in respect of such
Distribution Date;
(xvi) the amount of losses, if any, allocated against the
Certificateholders' Subordinated Amount on such Distribution Date and the
amount, if any, of the remaining Certificateholders' Subordinated Amount
(after making distributions in respect of such Distribution Date).
In the case of information furnished pursuant to clauses (iii), (iv), (v),
(vi), (vii) and (viii) above, the amounts shall be expressed as a dollar amount
per Note with a $1,000 denomination.
Within 60 days after the end of each full calendar year beginning in 1997,
the Servicer will be required to forward to the Indenture Trustee a statement
containing the information set forth in clauses (iii) and (vi) above aggregated
for the prior calendar year.
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Collection and Other Servicing Procedures on HELOCs
The Servicer will make reasonable efforts to collect all payments called
for under the HELOCs and will, consistent with the Sale and Servicing Agreement,
follow such collection procedures as it follows from time to time with respect
to the home equity loans in its servicing portfolio comparable to the HELOCs.
Consistent with the above, the Servicer may in its discretion waive any late
payment charge or any assumption or other fee or charge that may be collected in
the ordinary course of servicing the HELOCs.
With respect to the HELOCs, the Servicer may arrange with a borrower a
schedule for the payment of interest due and unpaid for a period, provided that
any such arrangement is consistent with the Servicer's policies with respect to
the home equity mortgage loans it owns or services. In accordance with the terms
of the Sale and Servicing Agreement, the Servicer may consent under certain
circumstances to the placing of a subsequent senior lien in respect of a HELOC.
Hazard Insurance
The Servicer shall cause to be maintained for each HELOC hazard insurance
naming the Servicer or the related subservicer as loss payee thereunder
providing extended coverage in an amount which is at least equal to the lesser
of (i) the maximum insurable value of the improvements securing such HELOC from
time to time or (ii) the combined principal balance owing on such HELOC and any
mortgage loan senior to such HELOC from time to time. The Servicer shall also
maintain on property acquired upon foreclosure, or by deed in lieu of
foreclosure, hazard insurance with extended coverage in an amount which is at
least equal to the lesser of (i) the maximum insurable value from time to time
of the improvements which are a part of such property or (ii) the combined
principal balance owing on such HELOC and any mortgage loan senior to such HELOC
at the time of such foreclosure or deed in lieu of foreclosure. Amounts
collected by the Servicer under any such policies shall be deposited in the
Collection Account net of certain amounts as indicated in the Sale and Servicing
Agreement. In cases in which any Mortgaged Property is located in a federally
designated flood area, the hazard insurance to be maintained for the related
HELOC shall include flood insurance. All such flood insurance shall be in such
amounts as are required under applicable guidelines of the Federal Flood
Emergency Act. The Servicer shall be under no obligation to require that any
Mortgagor maintain earthquake or other additional insurance and shall be under
no obligation itself to maintain any such additional insurance on property
acquired in respect of a HELOC, other than pursuant to such applicable laws and
regulations as shall at any time be in force and as shall require such
additional insurance. If the Servicer shall obtain and maintain a blanket policy
consistent with prudent industry standards insuring against hazard losses on all
of the HELOCs in an aggregate amount prudent under industry standards, it shall
conclusively be deemed to have satisfied its obligations and if there shall have
been a loss which would have been covered by such policy, deposit in the
Collection Account, as the case may be, the amount not otherwise payable under
the blanket policy because of any deductible clause.
In general, the standard form of fire and extended coverage policy covers
physical damage to or destruction of the improvements on the property by fire,
lightning, explosion, smoke, windstorm and hail, and the like, strike and civil
commotion, subject to the conditions and exclusions specified in each policy.
Although the policies relating to the HELOCs will be underwritten by different
insurers and therefore will not contain identical terms and conditions, the
basic terms thereof are dictated by state laws and most of such policies
typically do not cover any physical damage resulting from 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 or an exact
description of the insurance policies relating to the Mortgaged Properties.
Realization Upon Defaulted HELOCs
The Servicer will foreclose upon or otherwise comparably convert to
ownership Mortgaged Properties securing such of the HELOCs as come into default
when, in accordance with applicable servicing procedures under the Sale and
Servicing Agreement, no satisfactory arrangements can be made for the collection
of delinquent payments. In connection with such foreclosure or other conversion,
the Servicer will follow such practices as it
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deems necessary or advisable and as are in keeping with its general subordinate
mortgage servicing activities, provided the Servicer will not be required to
expend its own funds in connection with foreclosure or other conversion,
correction of default on a related senior mortgage loan or restoration of any
property unless, in its sole judgment, such foreclosure, correction or
restoration will increase Net Liquidation Proceeds. The Servicer will be
reimbursed out of Liquidation Proceeds for advances of its own funds as
liquidation expenses before any Net Liquidation Proceeds are distributed to
Noteholders or the Sponsor.
Servicing Compensation and Payment of Expenses
With respect to each Collection Period, the Servicer will receive from
interest collections in respect of the HELOCs a portion of such interest
collections as a monthly Servicing Fee in the amount equal to approximately
0.50% per annum on the aggregate Principal Balances of the HELOCs as of the
first day of the related Collection Period (or at the Cut-Off Date for the first
Collection Period). All assumption fees, late payment charges and other fees and
charges, to the extent collected from borrowers, will be retained by the
Servicer as additional servicing compensation.
The Servicer will pay certain ongoing expenses associated with the Trust
and incurred by it in connection with its responsibilities under the Sale and
Servicing Agreement. In addition, the Servicer will be entitled to reimbursement
for certain expenses incurred by it in connection with defaulted HELOCs and in
connection with the restoration of Mortgaged Properties, such right of
reimbursement being prior to the rights of Noteholders to receive any related
Net Liquidation Proceeds.
Evidence as to Compliance
The Sale and Servicing Agreement provides for delivery on or before May 31
in each year, beginning in May 31, 1998, to the Indenture Trustee and the
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 Sale
and Servicing Agreement throughout the preceding fiscal year, except as
specified in such statement.
On or before May 31 of each year, beginning May 31, 1998, the Servicer will
furnish a report prepared by a firm of nationally recognized independent public
accountants (who may also render other services to the Servicer or the Sponsor)
to the Indenture Trustee, the Insurer and the Rating Agencies to the effect that
such firm has examined certain documents and the records relating to servicing
of the HELOCs under the Sale and Servicing Agreement and that, on the basis of
such examination, such firm believes that such servicing was conducted in
compliance with the Sale and Servicing Agreement except for (a) such exceptions
as such firm believes to be immaterial and (b) such other exceptions as shall be
set forth in such report.
Certain Matters Regarding the Servicer and the Sponsor
The Sale and Servicing Agreement provides that the Servicer may not resign
from its obligations and duties thereunder, (i) unless such duties and
obligations 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 affiliate or (ii) upon the satisfaction
of the following conditions: (a) the Servicer has proposed a successor servicer
to the Indenture Trustee and the Insurer in writing and such proposed successor
servicer is reasonably acceptable to the Indenture Trustee and the Insurer and;
(b) the Rating Agencies have confirmed to the Indenture Trustee that the
appointment of such proposed successor servicer as the Servicer will not result
in the reduction or withdrawal of the then current ratings of the Notes without
regard to the Policy. No such resignation will become effective until the
Indenture Trustee or a successor servicer has assumed the Servicer's obligations
and duties under the Sale and Servicing Agreement.
The Servicer may perform any of its duties and obligations under the Sale
and Servicing Agreement through one or more subservicers or delegates acceptable
to the Insurer, which may be affiliates of the Servicer. Notwithstanding any
such arrangement, the Servicer will remain liable and obligated to the Indenture
Trustee and the Noteholders for the Servicer's duties and obligations under the
Sale and Servicing Agreement, without any diminution of such duties and
obligations and as if the Servicer itself were performing such duties and
obligations.
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The Sale and Servicing Agreement provides that the Servicer will indemnify
the Trust and the Indenture Trustee from and against any loss, liability,
expense, damage or injury suffered or sustained as a result of the Servicer's
actions or omissions in connection with the servicing and administration of the
HELOCs which are not in accordance with the provisions of the Sale and Servicing
Agreement. Under the Sale and Servicing Agreement, the Sponsor will indemnify an
injured party for the entire amount of any losses, claims, damages or
liabilities arising out of or based on the Sale and Servicing Agreement (other
than losses resulting from defaults under the HELOCs). The Sale and Servicing
Agreement provides that neither the Sponsor nor the Servicer nor their
directors, officers, employees or agents will be under any other liability to
the Trust, the Indenture Trustee, the Noteholders or any other person for any
action taken or for refraining from taking any action pursuant to the Sale and
Servicing Agreement. However, neither the Sponsor nor the Servicer will be
protected against any liability which would otherwise be imposed by reason of
willful misconduct, bad faith or gross negligence of the Sponsor or the Servicer
in the performance of its duties under the Sale and Servicing Agreement or by
reason of reckless disregard of its obligations thereunder. In addition, the
Sale and Servicing Agreement provides that the Servicer will not be under any
obligation to appear in, prosecute or defend any legal action which is not
incidental to its servicing responsibilities under the Sale and Servicing
Agreement and which in its opinion may expose it to any expense or liability.
The Servicer may, in its sole discretion, undertake any such legal action which
it may deem necessary or desirable with respect to the Sale and Servicing
Agreement and the rights and duties of the parties thereto and the interest of
the Securityholders thereunder.
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 shall be the successor of the Servicer hereunder, without the
execution or filing of any paper or any further act on the part of any of the
parties hereto, anything in the Sale and Servicing Agreement to the contrary
notwithstanding.
Events of Servicing Termination
"Events of Servicing Termination" will consist of: (i) any failure by the
Servicer to deposit in the Collection Account any deposit required to be made
under the Sale and Servicing Agreement or to make any payment required to be
made under the Insurance Agreement, which failure continues unremedied for two
Business Days after the giving of written notice of such failure to the Servicer
by the Indenture Trustee, or to the Servicer and the Indenture Trustee by the
Insurer or Noteholders evidencing an aggregate, of at least 25% of the Voting
Rights; (ii) any failure by the Servicer duly to observe or perform in any
material respect any other of its covenants or agreements in the Sale and
Servicing Agreement which, in each case, materially and adversely affects the
interests of the Noteholders or the Insurer and continues unremedied for 60 days
after the giving of written notice of such failure to the Servicer by the
Indenture Trustee, or to the Servicer and the Indenture Trustee by the Insurer
or Noteholders evidencing an aggregate of at least 25% of the Voting Rights; or
(iii) certain events of insolvency, readjustment of debt, marshalling of assets
and liabilities or similar proceedings relating to the Servicer and certain
actions by the Servicer indicating insolvency, reorganization or inability to
pay its obligations (each an "Insolvency Event"). Under certain other
circumstances, the Insurer may deliver written notice to the Servicer
terminating all the rights and obligations of the Servicer under the Sale and
Servicing Agreement.
Notwithstanding the foregoing, a delay in or failure of performance
referred to under clause (i) above for a period of five Business Days or
referred to under clause (ii) above for a period of 60 days, shall not
constitute an Event of Servicing Termination if such delay or failure could not
be prevented by the exercise of reasonable diligence by the Servicer and such
delay or failure was caused by an act of God or other similar occurrence. Upon
the occurrence of any such event the Servicer shall not be relieved from using
its best efforts to perform its obligations in a timely manner in accordance
with the terms of the Sale and Servicing Agreement and the Servicer shall
provide the Indenture Trustee, the Sponsor, the Insurer and the Noteholders
prompt notice of such failure or delay by it, together with a description of its
efforts to so perform its obligations.
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Rights Upon an Event of Servicing Termination
So long as an Event of Servicing Termination remains unremedied, either (i)
the Indenture Trustee, or Noteholders evidencing an aggregate of at least 51% of
the Voting Rights in each case with the consent of the Insurer or (ii) the
Insurer, may terminate all of the rights and obligations of the Servicer under
the Sale and Servicing Agreement and in and to the HELOCs, whereupon the
Indenture Trustee will succeed to all the responsibilities, duties and
liabilities of the Servicer under the Sale and Servicing Agreement and will be
entitled to similar compensation arrangements. In the event that the Indenture
Trustee would be obligated to succeed the Servicer but is unwilling or unable so
to act, it may appoint, or petition a court of competent jurisdiction for the
appointment of, a housing and home finance institution or other mortgage loan or
home equity loan servicer with all licenses and permits required to perform its
obligations under the Sale and Servicing Agreement and having a net worth of at
least $15,000,000 and acceptable to the Insurer to act as successor to the
Servicer under the Sale and Servicing Agreement. Pending such appointment, the
Indenture Trustee will be obligated to act in such capacity unless prohibited by
law. Such successor will be entitled to receive the same compensation that the
Servicer would otherwise have received (or such lesser compensation as the
Indenture Trustee and such successor may agree). A receiver or conservator for
the Servicer may be empowered to prevent the termination and replacement of the
Servicer where the only Event of Servicing Termination that has occurred is an
Insolvency Event.
Amendment
The Sale and Servicing Agreement may be amended from time to time by the
Sponsor, the Servicer and the Indenture Trustee and with the consent of the
Insurer, but without the consent of the Noteholders, to cure any ambiguity, to
correct or supplement any provisions therein which may be inconsistent with any
other provisions of the Sale and Servicing Agreement, to add to the duties of
the Sponsor or the Servicer or to add or amend any provisions of the Sale and
Servicing Agreement as required by the Rating Agencies in order to maintain or
improve any rating of the Notes (it being understood that, after obtaining the
ratings in effect on the Closing Date, neither the Sponsor, the Indenture
Trustee 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 under the Sale and Servicing Agreement or the Policy which shall not be
inconsistent with the provisions of the Sale and Servicing Agreement or to
comply with any requirement imposed by the Code; provided that such action will
not, as evidenced by an opinion of counsel, adversely affect in any material
respect the interests of any Noteholder or the Insurer; provided, that any such
amendment will not be deemed to materially and adversely affect the Noteholders
and no such opinion will be required to be delivered if the person requesting
such amendment obtains a letter from the Rating Agencies stating that such
amendment would not result in a downgrading of the then current rating of the
Notes, without regard to the Policy. The Sale and Servicing Agreement may also
be amended from time to time by the Sponsor, the Servicer, and the Indenture
Trustee, with the consent of Noteholders evidencing an aggregate of at least 51%
of the Voting Rights and the Insurer for the purpose of adding any provisions to
or changing in any manner or eliminating any of the provisions of the Sale and
Servicing Agreement or of modifying in any manner the rights of the Noteholders;
provided that no such amendment will (i) reduce in any manner the amount of, or
delay the timing of, collections of payments on the Notes or distributions or
payments under the Policy which are required to be made on any Note without the
consent of the holder of such Note or (ii) reduce the aforesaid percentage
required to consent to any such amendment, without the consent of the holders of
all Notes then outstanding or (iii) adversely affect in any material respect the
interest of the Insurer.
Termination; Retirement of the Notes
The Trust will generally terminate on the later of (A) the Distribution
Date immediately following the payment in full of all amounts owing to the
Insurer and (B) the earliest of (i) the Distribution Date on which the Note
Principal Balance has been reduced to zero and all other amounts due and owing
to the Noteholders have been paid in full, (ii) the Distribution Date
immediately following the final payment or other liquidation of the last HELOC
in the Trust, (iii) the Distribution Date immediately following the optional
redemption by the Sponsor of the Notes, as described below and (iv) the
Distribution Date in August, 2024.
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The Notes will be subject to optional redemption by the Sponsor on any
Distribution Date after the Note Principal Balance is reduced to an amount less
than or equal to 10% of the Original Class A Note Principal Balance and all
amounts due and owing to the Insurer and unreimbursed draws on the Policy,
together with interest thereon, as provided under the Insurance Agreement, have
been paid. The redemption price will be equal to the sum of the outstanding Note
Principal Balance and accrued and unpaid interest thereon at the respective Note
Rates through the day preceding the final Distribution Date and interest accrued
on any unpaid interest, to the extent legally permissible, together with all
amounts due and owing to the Insurer and unreimbursed draws on the Policy. In no
event, however, will the Trust created by the Trust Agreement continue for more
than 21 years after the death of certain individuals named in the Trust
Agreement. Written notice of termination of the Trust Agreement will be given to
each Noteholder, and the final distribution will be made only upon surrender and
cancellation of the Notes at an office or agency designated by the Indenture
Trustee which will be specified in the notice of termination.
In addition, the Trust may be liquidated as a result of certain events of
bankruptcy, insolvency or receivership relating to the Sponsor. See "--Rapid
Amortization Events" herein.
No holder of a Note will have any right under the Indenture to institute
any proceeding with respect to the Indenture unless such holder previously has
given to the Indenture Trustee written notice of default and unless Noteholders
evidencing an aggregate, undivided interest in the Trust of at least 51% of the
Note Principal Balance have made written requests upon the Indenture Trustee to
institute such proceeding in its own name as Indenture Trustee thereunder and
have offered to the Indenture Trustee reasonable indemnity and the Indenture
Trustee for 60 days has neglected or refused to institute any such proceeding.
The Indenture Trustee will be under no obligation to exercise any of the trusts
or powers vested in it by the Indenture 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
Noteholders, unless such Noteholders have offered to the Indenture Trustee
reasonable security or indemnity against the cost, expenses and liabilities
which may be incurred therein or thereby.
USE OF PROCEEDS
The net proceeds to be received from the sale of the Notes will be applied
by the Sponsor toward the purchase of the HELOCs. The Company will use the
proceeds from the sale of the HELOCs to the Sponsor to pay down warehouse lines
and for general corporate purposes.
CERTAIN FEDERAL INCOME TAX CONSEQUENCES
The following discussion, which summarizes certain U.S. federal income tax
aspects of the purchase, ownership and disposition of the Notes, is based on 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. This discussion does not address every aspect of the U.S. federal
income tax laws which may be relevant to Note Owners in light of their personal
investment circumstances or to certain types of Note Owners subject to special
treatment under the U.S. federal income tax laws (for example, banks and life
insurance companies). Accordingly, investors should consult their tax advisors
regarding U.S. federal, state, local, foreign and any other tax consequences to
them of investing in the Notes.
Characterization of the Notes as Indebtedness
Based on the application of existing law to the facts as set forth in the
Indenture and other relevant documents and factors and assuming compliance with
the terms of the Indenture as in effect on the date of issuance of the Notes,
Dewey Ballantine, special tax counsel to the Sponsor and counsel to the
Underwriter ("Tax Counsel"), is of the opinion that, based on the application of
existing law to the facts as set forth in the Indenture and other relevant
documents and such investigations as it deemed appropriate, the Notes will be
treated as debt instruments
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for federal income tax purposes as of such date. Accordingly, upon issuance, the
Notes will be treated as described herein.
The Sponsor and the Noteholders express in the Indenture their intent that,
for applicable tax purposes, the Notes will be indebtedness secured by the
HELOCs. The Sponsor and the Noteholders, by accepting the Notes, and each Note
Owner by its acquisition of a beneficial interest in a Note, have agreed to
treat the Notes as indebtedness for federal, state and local income and
franchise tax purposes. Investors should be aware that no transaction closely
comparable to that contemplated herein has been the subject of any Treasury
regulation, revenue ruling or judicial decision, and therefore the matter is
subject to interpretation. Because different criteria are used to determine the
non-tax accounting characterization of the transaction, the Sponsor intends to
treat this transaction as a sale of an interest in the Principal Balances of the
HELOCs for financial accounting and certain regulatory purposes.
In general, whether for U.S. federal income tax purposes a transaction
constitutes a sale of property or a loan the repayment of which is secured by
property, is a question of fact, the resolution of which is based upon the
economic substance of the transaction rather than its form or the manner in
which it is labeled. While the Internal Revenue Service (the "IRS") and the
courts have set forth several factors to be taken into account in determining
whether the substance of a transaction is a sale of property or a secured loan,
the primary factor in making this determination is whether the transferee has
assumed the risk of loss or other economic burdens relating to the property and
has obtained the benefits of ownership thereof. Tax Counsel has analyzed and
relied on several factors including the Sponsor's economic analyses with respect
to the transaction in reaching its opinion that the weight of the benefits and
burdens of ownership of the HELOCs has been retained by the Sponsor and has not
been transferred to the Note Owners.
In some instances, 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. Tax Counsel believes that the
rationale of those cases will not apply to this transaction, because the form of
the transaction as reflected in the operative provisions of the documents either
accords with the characterization of the Notes as debt or otherwise makes the
rationale of those cases inapplicable to this situation.
Taxation of Interest Income of Note Owners
Interest Income on the Notes. As a general rule, interest paid or accrued
on the Notes will be treated as ordinary income to the holders thereof. A
Noteholder using the accrual method of accounting for federal income tax
purposes is required to include interest paid or accrued on the Notes in
ordinary income as such interest accrues, while a Noteholder using the cash
receipts and disbursements method of accounting for federal income tax purposes
must include such interest in ordinary income when payments are received (or
made available for receipt) by such holder. The following discussion is based in
part on the rules governing "original issue discount" ("OID") which are set
forth in Sections 1271-1275 of the Code and the Treasury regulations issued
thereunder on February 2, 1994, as amended on June 11, 1996 (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 Notes.
It is anticipated that the Class A Notes will not be issued with OID within
the meaning of Section 1273 of the Code, and that the Trust will not take any
OID deduction with respect thereto. If the Class A Notes were issued at more
than a de minimis discount, however, such Notes would be treated as issued with
OID for federal income tax purposes. The amount of OID on a Class A Note will be
considered to be zero if it is less than a de minimis amount determined under
the Code.
The Class S Notes will be issued with OID within the meaning of section
1273(a) of the Code. Payments of interest on the Class S Notes will not be
treated as "qualified stated interest," as defined below. Holders of the Class S
Notes should be aware that for federal income tax purposes they must include in
gross income OID as it accrues under a method that takes account of the
compounding of interest, generally in advance of receipt of the cash
attributable to such income. The Indenture Trustee will supply, at the time and
in the manner required by the IRS to holders of Class S Notes information with
respect to the OID accruing on such Notes.
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In general, OID, if any, will equal the difference between the stated
redemption price at maturity of a Note and its issue price. The issue price of a
Note is the first price at which a substantial amount of Notes is sold to the
public (excluding bond houses, brokers, underwriters or wholesalers). The issue
price of a Note also includes the amount paid by an initial Noteholder for
accrued interest that relates to a period prior to the issue date of the Note.
The stated redemption price at maturity of the Class S Notes is equal to the sum
of all distributions to be made under such Notes. The stated redemption price at
maturity of a Class A Note includes the original principal amount of the Note,
but generally will not include distributions of interest if such distributions
constitute qualified stated interest.
Under the OID Regulations, qualified stated interest generally means
interest payable at a single fixed rate or qualified variable rate provided that
such interest payments are unconditionally payable at intervals of one year or
less during the entire term of the Note. The OID Regulations state that interest
payments are unconditionally payable only if a late payment or nonpayment is
expected to be penalized or reasonable remedies exist to compel payment. Because
the Class A Notes will not be entitled to penalty payments of interest on
interest deficiencies other than interest at the coupon rate on the amount of
such deficiencies and do not provide for default or acceleration rights in the
event of interest shortfalls, the interest payments on the Class A Notes may not
be treated by the IRS as qualified stated interest, and in such event, the
interest payments would be taxed as OID. Holders of Class A Notes should consult
their own tax advisors to determine the issue price and stated redemption price
at maturity of a Class A Note. While the tax treatment of interest on the Class
A Notes is not entirely clear, the Trust intends to treat the stated interest on
the Class A Notes as qualified stated interest for OID purposes.
A Holder of a Note treated as issued with OID is required to include in
gross income, for all days during its taxable year on which it holds such Note,
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. Generally, the amount of OID
includible in income of a Noteholder 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 Note and the adjusted issue price of the Note at
the beginning of the accrual period, reduced by any payments of qualified stated
interest during such accrual period. The adjusted issue price at the beginning
of an accrual period is the sum of its issue price plus prior accruals or OID,
reduced by the total payments made with respect to such Note in all prior
periods, other than qualified stated interest payments.
The amount of OID to be included in income by Noteholders 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 for such Notes is the excess (if any) of the sum
of (a) the present value of all payments remaining to be made on the Notes 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 Notes, over the
adjusted issue price of the Notes 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 Note (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 Noteholder to take into account prepayments with respect to the
HELOCs at a rate that exceeds the Prepayment Assumption, and to decrease (but
not below zero for any period) the portions of original issue discount required
to be included in income by a Noteholder to take into account prepayments with
respect to the HELOCs at a rate that is slower than the Prepayment Assumption.
Although original issue discount will be reported to Noteholders based on the
Prepayment Assumption, no representation is made to Noteholders that HELOCs will
be prepaid at that rate or at any other rate.
A subsequent holder of a Note will also be required to include OID in gross
income, but such a holder who purchases such Note for an amount that exceeds its
adjusted issue price will be entitled (as will an initial holder who pays more
than a Note's issue price) to offset such OID by comparable economic accruals of
portions of such excess.
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Variable Rate Notes. Because the Class A Notes bear interest at a rate that
varies directly, according to a fixed formula, with an objective index, it
appears that the present value of all payments remaining to be made on such
Notes should be calculated as if the interest index remained at its value as of
the issue date of such Notes. Because the proper method of adjusting accruals of
OID on a variable rate Note is uncertain, holders of variable rate Notes should
consult their own tax advisors regarding the appropriate treatment of such Notes
for federal income tax purposes.
Market Discount. Noteholders should be aware that the resale of a Note may
be affected by the market discount rules of the Code. These rules generally
provide that, subject to a de minimis exception, if a holder acquires a Note at
a market discount (i.e., at a price below its "adjusted issue price") and
thereafter recognizes gain upon a disposition of the Note, the lesser of such
gain or the portion of the market discount that accrued while the Note was held
by such holder will be treated as ordinary interest income realized at the time
of the disposition. A taxpayer may instead elect to include market discount
currently in gross income in taxable years to which it is attributable, computed
using either a ratable accrual or a yield to maturity method.
Premium. A Noteholder who purchases a Note for more than its stated
redemption price at maturity will be subject to the premium amortization rules
of the Code. Under those rules, the Noteholder may elect to amortize such
premium on a constant yield method. Amortizable premium reduces interest income
on the Note. If the Noteholder does not make such an election, the premium paid
for the Note generally will be included in the tax basis of the Note in
determining the gain or loss on its disposition.
Election to Treat all Interest as Original Issue Discount. The OID
Regulations permit a holder of a Note to elect to accrue all interest, discount
(including de minimis market or original issue discount) in income (as adjusted
by any amortizable premium) as interest, based on a constant yield method. If
such an election were to be made with respect to a Note with market discount,
the holder of the Note 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 acquires during the year of the election
or thereafter. Similarly, a holder of a Note that makes this election for a Note
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
and discount on a constant yield method with respect to a Note is irrevocable.
Each Noteholder should consult his own tax advisor regarding the impact of
the original issue discount, market discount, and premium amortization rules.
Possible Classification of the Trust as a Partnership or Association Taxable as
a Corporation
Although, as described above, it is the opinion of Tax Counsel that the
Notes are properly characterized as debt for federal income tax purposes, the
opinion of Tax Counsel is not binding on the courts or the IRS and no assurance
can be given that this characterization will prevail. It is possible that the
IRS could assert that, for purposes of the Code, the transaction contemplated by
this Prospectus Supplement with respect to the Notes constitutes a sale of the
HELOCs (or an interest therein) to the Note Owners and that the proper
classification of the legal relationship between the Sponsor and the Note Owners
resulting from this transaction is that of a partnership (including a publicly
traded partnership), a publicly traded partnership treated as a corporation, or
an association taxable as a corporation.
If it were determined that this transaction created an entity classified as
a corporation (including a publicly traded partnership taxable as a
corporation), the Trust would be subject to U.S. federal income tax at corporate
income tax rates on the income it derives from the HELOCs, which would reduce
the amounts available for distribution to the Note Owners. Cash distributions to
the Note Owners generally would be treated as dividends for tax purposes to the
extent of such corporation's earnings and profits. If the transaction were
treated as creating a partnership between the Note Owners and the Certificate
Owners, the partnership itself would not be subject to U.S. federal income tax
(unless it were to be characterized as a publicly traded partnership taxable as
a corporation); rather, each Certificate Owner and each Note Owner would be
taxed individually on their respective distributive
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shares of the partnership's income, gain, loss, deductions and credits. The
amount and timing of items of income and deductions of the Note Owner and the
Certificate Owners could differ if the Notes were held to constitute partnership
interests rather than indebtedness.
The Sponsor will not attempt to comply with U.S. federal income tax
reporting requirements applicable to partnerships or corporations as such
requirements would apply if the Notes were not treated as indebtedness.
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 U.S.
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), payments on such debt obligations bear a
relationship to the debt instruments held by the entity.
Assuming that all of the provisions of the Indenture, as in effect on the
date of issuance, are complied with, although this matter is not free from
doubt, Tax Counsel is of the opinion that the arrangement created by the
Indenture will not be a taxable mortgage pool under Section 7701(i) of the Code
because although two classes of indebtedness secured by the HELOCs are being
issued by the Trust, both classes should be regarded as having the same maturity
since neither class will be outstanding beyond the period the other is
outstanding. Investors should be aware, however, that neither the Code, the
Treasury regulations issued under the Code with respect to taxable mortgage
pools, nor any other relevant authority defines the term "maturity" for this
purpose.
Following the issuance of the Notes, the Sponsor anticipates forming or
causing an affiliate to form a trust (the "Post-Closing Trust") which will issue
an instrument (the "Instrument") entitling the holder thereof to receive
payments under certain circumstances. The original purchasers of the Class S
Notes will be given the opportunity to purchase such Instrument from the
Sponsor. The IRS could take the position that the Trust and the Post-Closing
Trust should be viewed as one arrangement for purposes of applying the taxable
mortgage pool rules. Because the Instruments will have the same maturity as the
Notes, such a recharacterization will not cause either the Trust or the
Post-Closing Trust to be treated as a taxable mortgage pool, although such
conclusion is not free from doubt.
The opinion of Tax Counsel is not binding on the IRS or the courts. If the
IRS were to contend successfully (or future regulations were to provide) that
the arrangement created by the Indenture is a taxable mortgage pool, such
arrangement would be subject to U.S. federal corporate income tax on its taxable
income generated by ownership of the HELOCs. Such a tax would likely reduce
amounts available for distributions to Note Owners. The amount of such a tax
would depend upon whether distributions to Note Owners would be deductible as
interest expense in computing the taxable income of such an arrangement as a
taxable mortgage pool.
Foreign Investors
In general, subject to certain exceptions, interest (including OID) paid on
a Note to a nonresident alien individual, foreign corporation or other
non-United States person is not subject to U.S. federal income tax, provided
that such interest is not effectively connected with a trade or business of the
recipient in the United States and the Note Owner provides the required foreign
person information certification.
If the interests of the Note Owners were deemed to be partnership
interests, the partnership would be required, on a quarterly basis, to pay
withholding tax equal to the product, for each foreign partner, of such foreign
partner's distributive share of "effectively connected" income of the
partnership multiplied by the highest rate of tax applicable to that foreign
partner. In addition, such foreign partner also would be subject to branch
profits tax. Each non-foreign partner would be required to certify to the
partnership that it is not a foreign person. The tax withheld from each foreign
partner would be credited against such foreign partner's U.S. income tax
liability.
S-61
<PAGE>
If the Trust were taxable as a corporation, distributions to foreign
persons, to the extent treated as dividends, would generally be subject to
withholding at the rate of 30%, unless such rate were reduced by an applicable
tax treaty.
The Small Business Job Protection Act of 1996 changed the definition of a
"foreign" trust. Under prior law, the definition was based on whether a trust's
foreign source income would be subject to U.S. tax. The new definition contains
two objective requirements which, if satisfied, will cause a trust to be treated
as a U.S. trust. It looks first to whether the trust's administration is subject
to a U.S. court's "primary supervision" and second to whether U.S. fiduciaries
control all substantial decisions of the trust. If both these requirements are
met, the trust is a U.S. trust. All other trusts are "foreign" trusts.
Backup Withholding
Certain Note Owners may be subject to backup withholding at the rate of 31%
with respect to interest paid on the Notes if the Note Owners, upon issuance,
failed to supply the Indenture Trustee or his broker with his taxpayer
identification number, furnish an incorrect taxpayer identification number,
failed to report interest, dividends, or other "reportable payments" (as defined
in the Code) properly, or, under certain circumstances, failed to provide the
Indenture Trustee or his broker with a certified statement, under penalty of
perjury, that he is not subject to backup withholding.
The Indenture Trustee will be required to report annually to the IRS, and
to each Noteholder of record, the amount of interest paid (and OID accrued, if
any) on the Notes (and the amount of interest withheld for U.S. 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 "Noteholder" of record is Cede, as nominee for DTC, Note Owners and the
IRS will receive tax and other information including the amount of interest paid
on the Notes owned from Participants and Indirect Participants rather than from
the Indenture Trustee. (The Indenture Trustee, however, will respond to requests
for necessary information to enable Participants, Indirect Participants and
certain other persons to complete their reports.) Each non-exempt Note Owner
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 Note Owner fail to provide the required certification, the
Participants or Indirect Participants (or the Paying Agent) will be required to
withhold 31% of the interest and payment with respect to OID (and principal)
otherwise payable to the Noteholder, and remit the withheld amount to the IRS as
a credit against the Noteholder's Federal income tax liability.
STATE TAXES
The Sponsor makes no representations regarding the tax consequences of
purchase, ownership or disposition of the Notes under the tax laws of any state.
Investors considering an investment in the Notes should consult their own tax
advisors regarding such tax consequences.
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 Notes.
ERISA CONSIDERATIONS
Section 406 of ERISA, and/or Section 4975 of the Code, prohibits a pension,
profit-sharing or other employee benefit plan, as well as individual retirement
accounts and certain types of Keogh Plans (each a "Benefit Plan") from engaging
in certain transactions with persons that are "parties in interest" under ERISA
or "disqualified persons" under the Code with respect to such Benefit Plan. A
violation of these "prohibited transaction" rules may result in an excise tax or
other penalties and liabilities under ERISA and the Code for such persons. Title
I of
S-62
<PAGE>
ERISA also requires that fiduciaries of a Benefit Plan subject to ERISA make
investments that are prudent, diversified (except if prudent not to do so) and
in accordance with governing plan documents.
Certain transactions involving the Trust might be deemed to constitute
prohibited transactions under ERISA and the Code if assets of the Trust were
deemed to be assets of a Benefit Plan. Under a regulation issued by the United
States Department of Labor (the "Plan Assets Regulation"), the assets of the
Trust would be treated as plan assets of a Benefit Plan for the purposes of
ERISA and the Code only if the Benefit Plan acquires an "Equity Interest" in the
Trust and none of the exceptions contained in the Plan Assets Regulation is
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. Although
there is little guidance on the subject, the Sponsor believes that the Notes
should be treated as indebtedness without substantial equity features for
purposes of the Plan Assets Regulation. This determination is based in part upon
the traditional debt features of the Notes, including the reasonable expectation
of purchasers of Notes that the Notes will be repaid when due, as well as the
absence of conversion rights, warrants and other typical equity features. The
debt treatment of the Notes for ERISA purposes could change if the Trust
incurred losses. However, without regard to whether the Notes are treated as an
Equity Interest for such purposes, the acquisition or holding of Notes by or on
behalf of a Benefit Plan could be considered to give rise to a prohibited
transaction if the Issuer, or any of its affiliates is or becomes a party in
interest or a disqualified person with respect to such Benefit Plan. In such
case, certain exemptions from the prohibited transaction rules could be
applicable depending on the type and circumstances of the plan fiduciary making
the decision to acquire a Note. Included among these exemptions are: Prohibited
Transaction Class Exemption ("PTCE") 90-1, regarding investments by insurance
company pooled separate accounts; PTCE 95-60, regarding investments by insurance
company general accounts; PTCE 91-38, regarding investments by bank collective
investment funds; PTCE 96-23, regarding transactions affected by in-house asset
managers; and PTCE 84-14, regarding transactions effected by "qualified
professional asset managers." Each investor using the assets of a Benefit Plan
which acquires the Notes, or to whom the Notes are transferred, will be deemed
to have represented that the acquisition and continued holding of the Notes will
be covered by one of the exemptions listed above or by another Department of
Labor Class Exemption.
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, however, such plans may be subject to
comparable state law restrictions.
A plan fiduciary considering the purchase of Notes should consult its tax
and/or legal advisors regarding whether the assets of the Trust would be
considered plan assets, the possibility of exemptive relief from the prohibited
transaction rules and other issues and their potential consequences.
LEGAL INVESTMENT CONSIDERATIONS
Although, as a condition to their issuance, the Notes will be rated in the
highest rating category of the Rating Agencies, the Notes will not constitute
"mortgage related securities" for purposes of the Secondary Mortgage Market
Enhancement Act of 1984 ("SMMEA"), because not all of the Mortgages securing the
HELOCs are first mortgages. 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 Notes, which because they evidence
interests in a pool that includes junior mortgage loans are not "mortgage
related securities" under SMMEA.
UNDERWRITING
Subject to the terms and conditions set forth in the underwriting
agreement, dated August 18, 1997 (the "Underwriting Agreement"), among the
Company, the Sponsor and the Underwriter, the Sponsor has agreed to cause the
Trust to sell to the Underwriter, and the Underwriter has agreed to purchase the
Notes from the Trust.
S-63
<PAGE>
In the Underwriting Agreement, the Underwriter has agreed, subject to the
terms and conditions set forth therein, to purchase all the Notes offered hereby
if any of the Notes are purchased.
The Underwriter has informed the Sponsor that it proposes to offer the
Notes for sale from time to time in one or more negotiated transactions, or
otherwise, at varying prices to be determined, in each case, at the time of the
related sale. The Underwriter may effect such transactions by selling the Notes
to or through dealers, and such dealers may receive compensation in the form of
underwriting discounts, concessions or commissions from the Underwriter. In
connection with the sale of the Notes, the Underwriter may be deemed to have
received compensation from the Sponsor in the form of underwriting compensation.
The Underwriter and any dealers that participate with the Underwriter in the
distribution of the Notes may be deemed to be underwriters and any commissions
received by them and any profit on the resale of the Notes by them may be deemed
to be underwriting discounts and commissions under the 1933 Act.
The Sponsor has agreed to indemnify the Underwriter against certain
liabilities, including liabilities under the 1933 Act.
In connection with this offering and in compliance with applicable law and
industry practice, the Underwriter may overallot or effect transactions which
stabilize, maintain or otherwise affect the market price of the Notes at a level
above that which might otherwise prevail in the open market, including
stabilizing bids, effecting syndicate covering transactions or imposing penalty
bids. A stabilizing bid means the placing of any bid, or the effecting of any
purchase, for the purpose of pegging, fixing or maintaining the price of a
security. A syndicate covering transaction means the placing of any bid on
behalf of the underwriting syndicate or the effecting of any purchase to reduce
a short position created in connection with the offering. A penalty bid means an
arrangement that permits the Underwriter to reclaim a selling concession from a
syndicate member in connection with the offering when Notes originally sold by
the syndicate member are purchased in syndicate covering transactions. The
Underwriter is not required to engage in any of these activities. Any such
activities, if commenced, may be discontinued at any time.
The Sponsor has been advised by the Underwriter that the Underwriter
presently intends to make a market in the Notes, as permitted by applicable laws
and regulations. The Underwriter is not obligated, however, to make a market in
the Notes and such market-making may be discontinued at any time at the sole
discretion of the Underwriter. Accordingly, no assurance can be given as to the
liquidity of any trading markets for the Notes.
LEGAL MATTERS
Certain legal matters with respect to the Notes will be passed upon for the
Trust and the Sponsor by Tobin & Tobin, San Francisco, California, and for the
Underwriter and with regard to the tax characterization of the Notes by Dewey
Ballantine, New York, New York.
EXPERTS
The financial statements of Capital Markets Assurance Corporation as of
December 31, 1996 and 1995 and for each of the years in the three-year period
ended December 31, 1996 are included herein as Annex I and have been audited by
KPMG Peat Marwick LLP, independent certified public accountants, as set forth in
their report thereon and are included in reliance upon the authority of such
firm as experts in accounting and auditing.
RATINGS
It is a condition to issuance that the Notes be rated "AAA" and "AAAr,"
respectively by Standard & Poor's and "Aaa" and by Moody's.
S-64
<PAGE>
A securities rating addresses the likelihood of the receipt by Noteholders
of distributions on the HELOCs. However, the ratings of the Class A Notes do not
address the timeliness or likelihood of the payment of Deferred Interest. The
rating takes into consideration the characteristics of the HELOCs and the
structural and legal aspects associated with the Notes. The ratings on the Notes
do not, however, constitute statements regarding the likelihood or frequency of
prepayments on the HELOCs or the possibility that Noteholders might realize a
lower than anticipated yield.
The ratings assigned to the Notes will depend primarily upon the
creditworthiness of the Insurer. Any reduction in a rating assigned to the
claims-paying ability of the Insurer below the ratings initially assigned to the
Notes may result in a reduction of one or more of the ratings assigned to the
Notes.
A securities rating is not a recommendation to buy, sell or hold securities
and may be subject to revision or withdrawal at any time by the assigning rating
organization. Each securities rating should be evaluated independently of
similar ratings on different securities.
S-65
<PAGE>
INDEX OF DEFINED TERMS
PAGE
1933 Act ..........................................................S-3
1934 Act ..........................................................S-3
Accelerated Principal Distribution Amount............................S-11, S-44
Additional Balances.........................................................S-5
Alternative Principal Payment........................................S-14, S-46
Beneficial owner .........................................................S-39
Benefit Plan ...................................................S-19, S-62
BIF .........................................................S-42
Business Day ...................................................S-43, S-51
CapMAC .....................................................S-2, S-4
CEDE ..........................................................S-9
CEDEL ..........................................................S-1
Certificate ..........................................................S-1
Certificate Principal Balance..............................................S-14
Certificateholders' Collections............................................S-46
Certificateholders' Interest................................................S-7
Certificateholders' Principal Collections............................S-12, S-43
Certificateholders' Subordinated Amount..............................S-17, S-47
Class A Note Rate ..........................................................S-1
Class A Notes ..........................................................S-1
Class S Note Rate .....................................................S-1, S-8
Class S Notes ..........................................................S-1
Class S Notional Amount...............................................S-8, S-38
Closing Date .........................................................S-13
Code .........................................................S-57
Collection Account...................................................S-12, S-42
Collection Period .........................................................S-12
Combined Loan-to-Value Ratio................................................S-5
Commission ..........................................................S-3
Company ....................................................S-4, S-24
Credit Limit ..........................................................S-6
Credit Limit Utilization Rate...................................S-6, S-27, S-32
Credit Line Agreements......................................................S-4
Cut-Off Date ..........................................................S-5
Cut-Off Date Principal Balance..............................................S-5
Defective HELOCs .........................................................S-41
Deferred Interest .........................................................S-13
Deferred Interest Account..................................................S-15
Definitive Note .........................................................S-39
Determination Date...................................................S-18, S-42
Dissolution Distribution Date..............................................S-50
Distribution Date ..............................................S-2, S-12, S-43
DTC ..........................................................S-1
Due Date ..........................................................S-6
Eligible Account .........................................................S-42
Eligible Substitute Mortgage Loan..........................................S-41
Equity Interest .........................................................S-63
Euroclear ..........................................................S-1
Events of Servicing Termination............................................S-55
Financial Intermediary.....................................................S-39
S-66
<PAGE>
PAGE
Fixed Allocation Percentage.................................................S-12
Floating Allocation Percentage........................................S-10, S-43
Funding Account ..........................................................S-14
Funding Period ..........................................................S-13
Guaranteed Distributions..............................................S-15, S-50
Guaranteed Principal Distribution Amount..............................S-15, S-50
Headlands SPC ..........................................................S-27
HELOC Schedule .....................................................S-7, S-40
HELOCs ...........................................................S-2
Holdings ..........................................................S-23
Indenture ...........................................................S-1
Indenture Trustee ...........................................................S-1
Index Rate ...........................................................S-6
Initial Cut-Off Date.........................................................S-5
Initial HELOCs ...........................................................S-4
Insolvency Event ..........................................................S-55
Instrument ..........................................................S-61
Insurance Agreement...................................................S-15, S-50
Insurer ...........................................................S-2
Interest Collections...................................................S-9, S-43
Interest Period ....................................................S-13, S-45
Interest Rate Adjustment Date...............................................S-41
Invested Amount .....................................................S-8, S-38
IRS ..........................................................S-58
Issuer ......................................................S-1, S-4
LIBOR ..........................................................S-12
LIBOR Business Day..........................................................S-46
Liquidated HELOC ..........................................................S-45
Liquidation Loss Amount...............................................S-12, S-45
Liquidation Proceeds........................................................S-43
Loan Rate ...........................................................S-6
Managed Amortization Period.................................................S-13
Management Agreement........................................................S-44
Management Fee ..........................................................S-44
Manager ..........................................................S-11
Margin .....................................................S-6, S-28
Maximum Principal Payment.............................................S-14, S-46
Maximum Rate ..........................................................S-13
Minimum Certificateholders' Interest.........................................S-7
Minimum Sponsor Interest.....................................................S-8
Moody's ..........................................................S-19
Mortgage Loan Schedule......................................................S-42
Mortgage Loans ...........................................................S-5
Mortgaged Properties.........................................................S-5
Net Liquidation Proceeds...............................................S-9, S-43
Note Owner ..........................................................S-20
Note Principal Balance.................................................S-8, S-38
Note Rate .....................................................S-8, S-45
Note Registrar ..........................................................S-38
Noteholders ...........................................................S-7
Noteholders' Interest Collections.....................................S-10, S-43
Noteholders' Loss Amount..............................................S-12, S-45
Noteholders' Principal Collections....................................S-12, S-43
S-67
<PAGE>
PAGE
Notes ..........................................................S-1
OID .........................................................S-58
OID Regulations .........................................................S-58
One-Month LIBOR ..........................................................S-2
Order .........................................................S-50
Original Class A Note Principal Balance................................S-8, S-9
Original Invested Amount....................................................S-8
Original Pool Balance.......................................................S-5
Overcollateralization Amount.........................................S-11, S-44
Owner Trustee .....................................................S-1, S-4
Paying Agent .........................................................S-47
Percentage Interest.........................................................S-9
Plan Assets Regulation.....................................................S-63
Policy ...............................................S-2, S-4, S-23
Pool Balance ..........................................................S-5
Pool Factor .........................................................S-37
Post-Closing Trust.........................................................S-61
Prepayment Assumption......................................................S-59
Principal Balance ..........................................................S-5
Principal Balances.........................................................S-58
Principal Collections.................................................S-9, S-43
PTCE .........................................................S-63
Purchase Agreement..........................................................S-5
Rapid Amortization Event...................................................S-48
Rapid Amortization Period..................................................S-48
Rating Agencies .........................................................S-19
Receipt .........................................................S-51
Received .........................................................S-51
Record Date .........................................................S-43
Reference Bank Rate........................................................S-45
Reimbursement Amount........................................................S-7
Related Documents .........................................................S-40
Required Amount ...................................................S-16, S-47
Required Overcollateralization Amount................................S-12, S-44
SAIF .........................................................S-42
Scheduled Principal Collections Distribution Amount..................S-14, S-46
Securities ..........................................................S-1
Servicer ..........................................................S-4
Servicing Fee .........................................................S-18
Servicing Fee Rate.........................................................S-18
SMMEA ...................................................S-19, S-63
Sponsor ..........................................................S-1
Sponsor Interest ..........................................................S-7
Spread Account ...................................................S-10, S-16
Spread Account Maximum.....................................................S-44
Standard & Poor's .........................................................S-19
Subsequent Cut-Off Date.....................................................S-5
Subsequent Mortgage Loans.............................................S-5, S-23
Tax Counsel ...................................................S-19, S-57
Telerate Screen Page 3750..................................................S-45
Transfer Date .........................................................S-42
Transfer Deficiency........................................................S-41
Transfer Deposit Amount....................................................S-41
S-68
<PAGE>
PAGE
Trust .....................................................S-1, S-4
Trust Agreement ..........................................................S-1
Trust Property ..........................................................S-4
Underwriter ..........................................................S-1
Underwriting Agreement.....................................................S-63
Voting Rights .........................................................S-40
Yield Supplement Account...................................................S-47
S-69
<PAGE>
CAPITAL MARKETS ASSURANCE CORPORATION
FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(With Independent Auditors' Report Thereon)
A-1
<PAGE>
Independent Auditors' Report
The Board of Directors
Capital Markets Assurance Corporation:
We have audited the accompanying balance sheets of Capital Markets Assurance
Corporation as of December 31, 1996 and 1995 and the related statements of
income, stockholder's equity and cash flows for each of the years in the
three-year period ended December 31, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these 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 financial statements referred to above present fairly, in
all material respects, the financial position of Capital Markets Assurance
Corporation as of December 31, 1996 and 1995 and the results of its operations
and its cash flows for each of the years in the three-year period ended December
31, 1996 in conformity with generally accepted accounting principles.
January 29, 1997
A-2
<PAGE>
Capital Markets Assurance Corporation
Balance Sheets
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
ASSETS
December 31 December 31
1996 1995
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Investments:
Bonds at fair value (amortized cost $294,861 at December 31,
1996 and $210,651 at December 31, 1995) $297,893 215,706
Short-term investments (at amortized cost which approximates
fair value) 16,810 68,646
- ---------------------------------------------------------------------------------------------------------------------------
Total investments 314,703 284,352
- ---------------------------------------------------------------------------------------------------------------------------
Cash 371 344
Accrued investment income 3,807 3,136
Deferred acquisition costs 45,380 35,162
Premiums receivable 5,141 3,540
Prepaid reinsurance 18,489 13,171
Other assets 6,424 3,428
- ---------------------------------------------------------------------------------------------------------------------------
Total assets $394,315 343,133
===========================================================================================================================
LIABILITIES AND STOCKHOLDER'S EQUITY
Liabilities:
Unearned premiums $ 68,262 45,767
Reserve for losses and loss adjustment expenses 10,985 6,548
Ceded reinsurance 1,738 2,469
Accounts payable and other accrued expenses 8,019 10,844
Current income taxes 679 136
Deferred income taxes 15,139 11,303
- ---------------------------------------------------------------------------------------------------------------------------
Total liabilities 104,822 77,067
- ---------------------------------------------------------------------------------------------------------------------------
Stockholder's Equity:
Common stock - $1.00 par value per share; 15,000,000 shares are authorized,
issued and outstanding at December 31, 1996
and 1995 15,000 15,000
Additional paid-in capital 208,475 205,808
Unrealized appreciation on investments, net of tax 1,970 3,286
Retained earnings 64,048 41,972
- ---------------------------------------------------------------------------------------------------------------------------
Total stockholder's equity 289,493 266,066
- ---------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholder's equity $394,315 343,133
===========================================================================================================================
</TABLE>
See accompanying notes to financial statements.
A-3
<PAGE>
Capital Markets Assurance Corporation
Statements of Income
(Dollars in thousands)
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
December 31, 1996 December 31, 1995 December 31, 1994
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues:
Direct premiums written $ 71,752 56,541 43,598
Assumed premiums written 1,086 935 1,064
Ceded premiums written (15,104) (15,992) (11,069)
- ----------------------------------------------------------------------------------------------------------
Net premiums written 57,734 41,484 33,593
Increase in unearned premiums (17,177) (12,242) (10,490)
- ----------------------------------------------------------------------------------------------------------
Net premiums earned 40,557 29,242 23,103
Net investment income 16,992 11,953 10,072
Net realized capital gains 236 1,301 92
Other income 146 2,273 120
- ----------------------------------------------------------------------------------------------------------
Total revenues 57,931 44,769 33,387
- ----------------------------------------------------------------------------------------------------------
Expenses:
Losses and loss adjustment expenses 4,815 3,141 1,429
Underwriting and operating expenses 14,613 13,808 11,833
Policy acquisition costs 7,824 7,203 4,529
- ----------------------------------------------------------------------------------------------------------
Total expenses 27,252 24,152 17,791
- ----------------------------------------------------------------------------------------------------------
Income before income taxes 30,679 20,617 15,596
- ----------------------------------------------------------------------------------------------------------
Income Taxes:
Current income tax 5,235 2,113 865
Deferred income tax 3,368 3,102 2,843
- ----------------------------------------------------------------------------------------------------------
Total income taxes 8,603 5,215 3,708
- ----------------------------------------------------------------------------------------------------------
Net Income $ 22,076 15,402 11,888
==========================================================================================================
</TABLE>
See accompanying notes to financial statements.
A-4
<PAGE>
Capital Markets Assurance Corporation
Statements of Stockholder's Equity
(Dollars in thousands)
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
December 31,1996 December 31, 1995 December 31, 1994
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Common stock:
Balance at beginning of year $ 15,000 15,000 15,000
- ----------------------------------------------------------------------------------------------------------------
Balance at end of year 15,000 15,000 15,000
- ----------------------------------------------------------------------------------------------------------------
Additional paid-in capital:
Balance at beginning of year 205,808 146,808 146,808
Capital contribution 2,667 59,000 --
- ----------------------------------------------------------------------------------------------------------------
Balance at end of year 208,475 205,808 146,808
- ----------------------------------------------------------------------------------------------------------------
Unrealized appreciation (depreciation)
on investments, net of tax:
Balance at beginning of year 3,286 (5,499) 3,600
Unrealized appreciation (depreciation)
on investments (1,316) 8,785 (9,099)
- ----------------------------------------------------------------------------------------------------------------
Balance at end of year 1,970 3,286 (5,499)
- ----------------------------------------------------------------------------------------------------------------
Retained earnings:
Balance at beginning of year 41,972 26,570 14,682
Net income 22,076 15,402 11,888
- ----------------------------------------------------------------------------------------------------------------
Balance at end of year 64,048 41,972 26,570
- ----------------------------------------------------------------------------------------------------------------
Total stockholder's equity $ 289,493 266,066 182,879
================================================================================================================
</TABLE>
See accompanying notes to financial statements.
A-5
<PAGE>
Capital Markets Assurance Corporation
Statements of Cash Flows
(Dollar in thousands)
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
December 31, 1996 December 31, 1995 December 31, 1994
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 22,076 15,402 11,888
- -----------------------------------------------------------------------------------------------------------------------
Adjustments to reconcile net income to net
cash provided (used) by operating activities:
Reserve for losses and loss adjustment
expenses 4,437 1,357 1,429
Unearned premiums, net 22,496 19,862 15,843
Deferred acquisition costs (10,218) (10,302) (9,611)
Premiums receivable (1,601) (161) (2,103)
Accrued investment income (671) (390) (848)
Income taxes payable 3,911 3,621 2,611
Net realized capital gains (236) (1,301) (92)
Accounts payable and other accrued
expenses 1,020 472 3,726
Prepaid reinsurance (5,318) (7,620) (5,352)
Other, net (3,396) 992 689
- -----------------------------------------------------------------------------------------------------------------------
Total adjustments 10,424 6,530 6,292
- -----------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 32,500 21,932 18,180
- -----------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Purchases of investments (199,989) (158,830) (77,980)
Proceeds from sales of investments 57,210 49,354 39,967
Proceeds from maturities of investments 110,306 28,803 19,665
- -----------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (32,473) (80,673) (18,348)
- -----------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Capital contribution -- 59,000 --
- -----------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities -- 59,000 --
- -----------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash 27 259 (168)
Cash balance at beginning of year 344 85 253
- -----------------------------------------------------------------------------------------------------------------------
Cash balance at end of year $ 371 344 85
=======================================================================================================================
Supplemental disclosure of cash flow
information:
Income taxes paid $ 4,525 1,450 1,063
=======================================================================================================================
</TABLE>
See accompanying notes to financial statements.
A-6
<PAGE>
Capital Markets Assurance Corporation
Notes to Financial Statements
December 31, 1996 and 1995
1) Background
Capital Markets Assurance Corporation ("CapMAC" or "the Company") is a New
York-domiciled monoline stock insurance company which engages only in the
business of financial guarantee and surety insurance. CapMAC is a wholly
owned subsidiary of CapMAC Holdings Inc. ("Holdings"). CapMAC is licensed
in all 50 states in addition to the District of Columbia, the Commonwealth
of Puerto Rico and the territory of Guam. CapMAC insures structured
asset-backed, corporate, municipal and other financial obligations in the
U.S. and international capital markets. CapMAC also provides financial
guarantee reinsurance for structured asset-backed, corporate, municipal and
other financial obligations written by other major insurance companies.
CapMAC's claims-paying ability is rated "Aaa" by Moody's Investors Service,
Inc. ("Moody's"), "AAA" by Standard & Poor's Ratings Group ("S&P"), "AAA"
by Duff & Phelps Credit Rating Co. ("Duff & Phelps"), and "AAA" by Nippon
Investors Service, Inc., a Japanese rating agency. Such ratings reflect
only the views of the respective rating agencies, are not recommendations
to buy, sell or hold securities and are subject to revision or withdrawal
at any time by such rating agencies.
2) Significant Accounting Policies
Significant accounting policies used in the preparation of the accompanying
financial statements are as follows:
a) Basis of Presentation
The accompanying financial statements are prepared on the basis of
generally accepted accounting principles ("GAAP"). Such accounting
principles differ from statutory reporting practices used by insurance
companies in reporting to state regulatory authorities.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Management believes
the most significant estimates relate to deferred acquisition costs,
reserve for losses and loss adjustment expenses and disclosures of
financial guarantees outstanding. Actual results could differ from
those estimates.
b) Investments
As of December 31, 1996 and 1995, all of the Company's securities have
been classified as available-for-sale. Available-for-sale securities
are recorded at fair value. Fair value is generally based upon quoted
market prices. Unrealized holding gains and losses, net of the related
tax effect, on available-for-sale securities are excluded from
earnings and are reported as a separate component of stockholder's
equity until realized. Transfers of securities between categories are
recorded at fair value at the date of transfer. A decline in the fair
value of any available-for-sale security below cost that is deemed
other than temporary is charged to earnings resulting in the
establishment of a new cost basis for the security.
See accompanying notes to financial statements.
A-7
<PAGE>
Capital Markets Assurance Corporation
Notes to Financial Statements
Short-term investments are those investments having a maturity of less
than one year at purchase date. Short-term investments are carried at
amortized cost which approximates fair value.
Premiums and discounts are amortized or accreted over the life of the
related security as an adjustment to yield using the effective
interest method. Dividend and interest income are recognized when
earned. Realized gains and losses are included in earnings and are
derived using the FIFO (first-in, first-out) method for determining
the cost of securities sold.
c) Premium Revenue Recognition
Premiums which are payable monthly to CapMAC are reflected in income
when due, net of amounts payable to reinsurers. Premiums which are
payable quarterly, semi-annually or annually are reflected in income,
net of amounts payable to reinsurers, on an equal monthly basis over
the corresponding policy term. Premiums that are collected as a single
premium at the inception of the policy and have a term longer than one
year are earned, net of amounts payable to reinsurers, by allocating
premium to each bond maturity based on the principal amount and
earning it straight-line over the term of each bond maturity. For the
years ended December 31, 1996 and 1995, 91% of net premiums earned
were attributable to premiums payable in installments and 9% were
attributable to premiums collected on an up-front basis.
d) Deferred Acquisition Costs
Certain costs incurred by CapMAC, which vary with and are primarily
related to the production of new business, are 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 amortized over the period in proportion to the related premium
earnings. The actual amount of premium earnings may differ from
projections due to various factors such as renewal or early
termination of insurance contracts or different run-off patterns of
exposure resulting in a corresponding change in the amortization
pattern of the deferred acquisition costs.
e) Reserve for Losses and Loss Adjustment Expenses
The reserve for losses and loss adjustment expenses consists of a
supplemental loss reserve ("SLR") and a case basis loss reserve. The
SLR is established for expected levels of losses resulting from credit
failures on currently insured issues and reflects the estimated
portion of earned premiums required to cover those losses.
A case basis loss reserve is established for insured obligations when,
in the judgment of management, a default in the timely payment of debt
service is imminent. For defaults considered temporary, a case basis
loss reserve is established in an amount equal to the present value of
the anticipated defaulted debt service payments over the expected
period of default. If the default is judged not to be temporary, the
present value of all remaining defaulted debt service payments is
recorded as a case basis loss reserve. Anticipated salvage recoveries
are considered in establishing case basis loss reserves when such
amounts are reasonably estimable. Case basis loss reserves may be
allocated from any SLR outstanding at the time the case basis reserves
are established.
A-8
<PAGE>
Capital Markets Assurance Corporation
Notes to Financial Statements
Management believes that the current level of reserves is adequate to
cover the ultimate net cost of claims and the related expenses with
respect to financial guarantees issued by CapMAC. The establishment of
the appropriate level of loss reserves is an inherently uncertain
process involving estimates and subjective judgments by management,
and therefore there can be no assurance that ultimate losses in
CapMAC's insured portfolio will not exceed the current estimate of
loss reserves.
f) Depreciation
Leasehold improvements, furniture, fixtures and electronic data
processing equipment are being amortized or depreciated over the lease
term or useful life, whichever is shorter, using the straight-line
method.
g) Income Taxes
Deferred income taxes are provided with respect to temporary
differences between the financial statement and tax basis of assets
and liabilities using enacted tax rates in effect for the year in
which the differences are expected to reverse. The effect on deferred
tax assets and liabilities of a change in tax rates is recognized in
the period that includes the enactment date.
A-9
<PAGE>
Capital Markets Assurance Corporation
Notes to Financial Statements
3) Insured Portfolio
At December 31, 1996 and 1995, the principal amount of financial
obligations insured by CapMAC was $24.5 billion and $16.9 billion,
respectively, and net of reinsurance (net principal outstanding), was $19.7
billion and $12.6 billion, respectively, with a weighted average life of
6.4 years and 6.0 years, respectively. CapMAC's insured portfolio was
broadly diversified by geographic distribution and type of insured
obligations, with no single insured obligation in excess of statutory
single risk limits, after giving effect to any reinsurance and collateral,
which are a function of CapMAC's statutory qualified capital (the sum of
statutory capital and surplus and mandatory contingency reserve). At
December 31, 1996 and 1995, the statutory qualified capital was
approximately $260 million and $240 million, respectively.
<TABLE>
<CAPTION>
Net Principal Outstanding
December 31, 1996 December 31, 1995
------------------------ -----------------------
Type of Obligations Insured ($ in millions) Amount % Amount %
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Consumer receivables $ 10,362 52.8 $ 6,959 55.1
Trade and other corporate
obligations 8,479 43.1 4,912 38.9
Municipal/government obligations 814 4.1 757 6.0
- -------------------------------------------------------------------------------------------------------------
Total $ 19,655 100.0 $ 12,628 100.0
=============================================================================================================
</TABLE>
At December 31, 1996 and 1995, the principal and interest amount of
financial obligations insured by CapMAC was $29.8 billion and $20.3
billion, respectively, and net of reinsurance (net principal and interest
outstanding) was $23.3 billion and $15.1 billion, respectively. At December
31, 1996, approximately 93% of CapMAC's insured portfolio was comprised of
structured asset-backed transactions. Under these structures, a pool of
assets covering at least 100% of the principal amount guaranteed under its
insurance contract is sold or pledged to a special purpose bankruptcy
remote entity. CapMAC's primary risk from such insurance contracts is the
impairment of cash flows due to delinquency or loss on the underlying
assets. CapMAC, therefore, evaluates all the factors affecting past and
future asset performance by studying historical data on losses,
delinquencies and recoveries of the underlying assets. Each transaction is
reviewed to ensure that an appropriate legal structure is used to protect
against the bankruptcy risk of the originator of the assets. Along with the
legal structure, an additional level of first loss protection is also
created to protect against losses due to credit or dilution. This first
level of loss protection is usually available from reserve funds, excess
cash flows, overcollateralization, or recourse to a third party. The level
of first loss protection depends upon the historical losses and dilution of
the underlying assets, but is typically several times the normal historical
loss experience for the underlying type of assets.
During 1995, the Company sold without recourse its interest in potential
cash flows from transactions included in its insured portfolio and
recognized $2,200,000 of income which has been included in other income in
the accompanying financial statements.
The following entities each accounted for, through referrals and otherwise,
10% or more of total revenues for each of the periods presented:
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
December 31, 1996 December 31, 1995 December 31, 1994
--------------------------- ---------------------------- ----------------------------
% of % of % of
Revenues Revenues Revenues
--------------------------- ---------------------------- ----------------------------
<S> <C> <C> <C>
Citicorp 14.5 15.2 16.3
</TABLE>
A-10
<PAGE>
Capital Markets Assurance Corporation
Notes to Financial Statements
4) Investments
The amortized cost, gross unrealized gains, gross unrealized losses and
estimated fair value for available-for-sale securities by major security
type at December 31, 1996 and 1995 were as follows ($ in thousands):
<TABLE>
<CAPTION>
December 31, 1996
- -----------------------------------------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Securities Available-for-sale Cost Gains Losses Value
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Treasury obligations $ 4,059 10 -- 4,069
Mortgage-backed securities of
U.S. government instrumentalities
and agencies 109,436 265 1,160 108,541
Obligations of states, municipalities
and political subdivisions 177,811 4,602 555 181,858
Corporate and asset-backed
securities 20,365 23 153 20,235
- -----------------------------------------------------------------------------------------------------
Total $ 311,671 4,900 1,868 314,703
=====================================================================================================
<CAPTION>
December 31, 1995
- -----------------------------------------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Securities Available-for-sale Cost Gains Losses Value
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Treasury obligations $ 4,153 55 -- 4,208
Mortgage-backed securities of
U.S. government instrumentalities
and agencies 100,628 313 79 100,862
Obligations of states, municipalities
and political subdivisions 166,010 4,809 82 170,737
Corporate and asset-backed
securities 8,506 45 6 8,545
- -----------------------------------------------------------------------------------------------------
Total $ 279,297 5,222 167 284,352
=====================================================================================================
</TABLE>
A-11
<PAGE>
Capital Markets Assurance Corporation
Notes to Financial Statements
The amortized cost and estimated fair value of investments in debt
securities at December 31, 1996 by contractual maturity are shown below
($ in thousands):
<TABLE>
<CAPTION>
December 31, 1996
- ------------------------------------------------------------------------------------------------------
Amortized Estimated
Securities Available-for-sale Cost Fair Value
- ------------------------------------------------------------------------------------------------------
<S> <C> <C>
Due in one year or less $ 11,627 11,644
Due after one year through five years 31,821 32,815
Due after five years through ten years 76,450 78,200
Due after ten years 82,337 83,503
- ------------------------------------------------------------------------------------------------------
Sub-total 202,235 206,162
Mortgage-backed securities 109,436 108,541
- ------------------------------------------------------------------------------------------------------
Total $ 311,671 314,703
======================================================================================================
</TABLE>
Actual maturities may differ from contractual maturities because borrowers
may call or prepay obligations with or without call or prepayment
penalties.
Proceeds from sales of investment securities were approximately $57.2
million, $49.3 million and $39.9 million in 1996, 1995 and 1994,
respectively. Gross realized capital gains of $772,000, $1,320,000 and
$714,000, and gross realized capital losses of $536,000, $19,000 and
$622,000 were realized on those sales for the years ended December 31,
1996, 1995 and 1994, respectively.
Investments include bonds having a fair value of approximately $3,884,000
and $3,985,000 which are on deposit at December 31, 1996 and 1995,
respectively, with state regulators as required by law.
Investment income is comprised of interest and dividends, net of related
expenses, and is applicable to the following sources:
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
$ in thousands December 31, 1996 December 31, 1995 December 31, 1994
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Bonds $ 15,726 11,105 9,193
Short-term investments 1,534 1,245 484
Mutual funds - (162) 579
Investment expenses (268) (235) (184)
- -----------------------------------------------------------------------------------------------------
Total $ 16,992 11,953 10,072
=====================================================================================================
</TABLE>
A-12
<PAGE>
Capital Markets Assurance Corporation
Notes to Financial Statements
The change in unrealized appreciation (depreciation) on
available-for-sale securities is included as a separate component of
stockholder's equity as shown below:
<TABLE>
<CAPTION>
Year Ended Year Ended
$ in thousands December 31, 1996 December 31, 1995
- ------------------------------------------------------------------------------------------------------
<S> <C> <C>
Balance at beginning of year $ 3,286 (5,499)
Change in unrealized (depreciation) appreciation (2,024) 13,386
Income tax effect 708 (4,601)
- ------------------------------------------------------------------------------------------------------
Net change (1,316) 8,785
- ------------------------------------------------------------------------------------------------------
Balance at end of year $ 1,970 3,286
======================================================================================================
</TABLE>
No single issuer, except for investments in U.S. Treasury and U.S.
government agency securities, exceeds 2% of stockholder's equity as of
December 31, 1996 and 1995, respectively.
5) Deferred Acquisition Costs
The following table reflects acquisition costs deferred by CapMAC and
amortized in proportion to the related premium earnings:
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
$ in thousands December 31, 1996 December 31, 1995 December 31, 1994
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance at beginning of year $ 35,162 24,860 15,249
Additions 18,042 17,505 14,140
Amortization (policy
acquisition costs) (7,824) (7,203) (4,529)
- -----------------------------------------------------------------------------------------------------
Balance at end of year $ 45,380 35,162 24,860
=====================================================================================================
</TABLE>
6) Employee Benefits
CapMAC has a service agreement with CapMAC Financial Services, Inc.
("CFS"). Under the service agreement, CFS has agreed to provide various
services, including underwriting, reinsurance, marketing, data processing
and other services to CapMAC in connection with the operation of CapMAC's
insurance business. CapMAC pays CFS a fee for providing such services, but
not in excess of CFS's cost for such services. CFS incurred, on behalf of
CapMAC, total compensation expenses, excluding bonuses, of $13,374,000,
$13,484,000 and $11,081,000 in 1996, 1995 and 1994, respectively.
The Company, through CFS, maintains an incentive compensation plan for its
employees. The plan is an annual discretionary bonus award. For the years
ended December 31, 1996, 1995 and 1994, the Company had provided
approximately $8,810,000, $7,804,000 and $5,253,000, respectively, for the
plan. CFS also provides health and welfare benefits to substantially all of
its employees. The Company incurred $551,943, $598,530, and $562,508 of
expense for the years ended December 31, 1996, 1995 and 1994, respectively,
for such
A-13
<PAGE>
Capital Markets Assurance Corporation
Notes to Financial Statements
plan. The Company also has a defined contribution retirement plan which
allows participants to make voluntary contributions by salary reduction
pursuant to section 401 (k) of the Internal Revenue Code. The Company
provides for the administrative cost for the 401 (k) plan.
On June 25, 1992, certain officers of CapMAC were granted 182,633
restricted stock units ("RSU") at $13.33 a share in respect of certain
deferred compensation. On December 7, 1995, the RSU's were converted to
cash in the amount of approximately $3.7 million, and such officers agreed
to defer receipt of such cash amount in exchange for receiving the same
number of new shares of restricted stock of Holdings as the number of RSU's
such officers previously held. During 1995 and 1994, the expense was $1.3
million and $0.1 million, respectively. During 1996, Holdings assumed the
liability of $3.7 million less the related deferred tax asset of $1.1
million as capital contribution. The cash amount is held by Holdings and
invested in accordance with certain guidelines. Such amount, including the
investment earnings thereon, will be paid to each officer upon the
occurrence of certain events but no later than December 2000.
7) Employee Stock Ownership Plan
Holdings maintains an Employee Stock Ownership Plan ("ESOP") to provide its
employees the opportunity to obtain beneficial interests in the stock of
Holdings through a trust (the "ESOP Trust"). Compensation expense related
to the ESOP and allocated to CapMAC was approximately $2,764,000,
$2,087,000 and $2,086,000 for the years ended December 31, 1996, 1995 and
1994, respectively.
A-14
<PAGE>
Capital Markets Assurance Corporation
Notes to Financial Statements
8) Reserve for Losses and Loss Adjustment Expenses
The reserve for losses and loss adjustment expenses consists of a case
basis loss reserve and the SLR.
In 1995, CapMAC incurred its first claim on a financial guarantee policy.
Based on its current estimate, the Company expects the aggregate amount of
claims and related expenses not to exceed $2.7 million, although no
assurance can be given that such claims and related expenses will not
exceed that amount. Such loss amount was covered through a recovery under a
quota share reinsurance agreement of $0.2 million and a reduction in the
SLR of $2.5 million. The portion of such claims and expenses not covered
under the quota share agreement is being funded through payments to CapMAC
from the Lureco Trust Account (see note 12).
The following is a summary of the activity in the case basis loss reserve
account and the components of the reserve for losses and loss adjustment
expenses ($ in thousands):
1996 1995 1994
- --------------------------------------------------------------------------------
Case basis loss reserve:
Net balance at January 1 $ 620 -- --
- --------------------------------------------------------------------------------
Incurred related to:
Current year -- 2,473 --
Prior years -- -- --
- --------------------------------------------------------------------------------
Total incurred -- 2,473 --
- --------------------------------------------------------------------------------
Paid related to:
Current year -- 1,853 --
Prior years 309 -- --
- --------------------------------------------------------------------------------
Total paid 309 1,853 --
- --------------------------------------------------------------------------------
Net balance at December 31 311 620 --
Reinsurance recoverable -- 69 --
- --------------------------------------------------------------------------------
Gross balance at December 31 311 689 --
- --------------------------------------------------------------------------------
Supplemental loss reserve
Balance at January 1 5,859 5,191 3,762
- --------------------------------------------------------------------------------
Additions to supplemental loss reserve 4,815 3,141 1,429
Allocated to case basis reserve -- (2,473) --
- --------------------------------------------------------------------------------
Balance at December 31 10,674 5,859 5,191
- --------------------------------------------------------------------------------
Total reserve for losses and loss adjustment
expenses $10,985 6,548 5,191
================================================================================
A-15
<PAGE>
Capital Markets Assurance Corporation
Notes to Financial Statements
9) Income Taxes
Pursuant to a tax sharing agreement with Holdings, the Company is included
in Holdings' consolidated U.S. Federal income tax return. The Company's
annual Federal income tax liability is determined by computing its pro rata
share of the consolidated group Federal income tax liability.
Total income tax expense differed from the amount computed by applying the
U.S. Federal income tax rate of 35% in 1996 and 1995 and 34% in 1994:
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
December 31, 1996 December 31, 1995 December 31, 1994
$ in thousands Amount % Amount % Amount %
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Expected tax expense computed
at the statutory rate $ 10,738 35.0 $7,216 35.0 $5,303 34.0
Increase (decrease) in tax
resulting from:
Tax-exempt interest (2,916) (9.5) (2,335) (11.3) (1,646) (10.6)
Other, net 781 2.5 334 1.6 51 0.4
- -----------------------------------------------------------------------------------------------------
Total income tax expense $ 8,603 28.0 $5,215 25.3 $3,708 23.8
=====================================================================================================
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the deferred Federal income tax liability are as follows:
<TABLE>
<CAPTION>
$ in thousands December 31, 1996 December 31, 1995
- -----------------------------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax assets:
Deferred compensation $ 200 1,901
Losses and loss adjustment expenses 1,527 1,002
Unearned premiums 866 852
Other, net 96 98
- -----------------------------------------------------------------------------------------------------
Total gross deferred tax assets 2,689 3,853
- -----------------------------------------------------------------------------------------------------
Deferred tax liabilities:
Deferred acquisition costs 15,883 12,307
Unrealized capital gains on investments 1,061 1,769
Other, net 884 1,080
- -----------------------------------------------------------------------------------------------------
Total gross deferred tax liabilities 17,828 15,156
- -----------------------------------------------------------------------------------------------------
Net deferred tax liability $ 15,139 11,303
=====================================================================================================
</TABLE>
A valuation allowance is provided when it is more likely than not that some
portion of the deferred tax assets will not be realized. Management
believes that the deferred tax assets will be fully realized in the future.
A-16
<PAGE>
Capital Markets Assurance Corporation
Notes to Financial Statements
10) Insurance Regulatory Restrictions
CapMAC is subject to insurance regulatory requirements of the State of New
York and other states in which it is licensed to conduct business.
Generally, New York insurance laws require that dividends be paid from
earned surplus and restrict the amount of dividends in any year that may be
paid without obtaining approval for such dividends from the Superintendent
of Insurance to the lower of (i) net investment income as defined or (ii)
10% of statutory surplus as of December 31 of the preceding year. No
dividends were paid by CapMAC to Holdings during the years ended December
31, 1996, 1995 and 1994. No dividends could be paid during these periods
because CapMAC had negative earned surplus. Statutory surplus at December
31, 1996 and 1995 was approximately $193,726,000 and $195,018,000,
respectively. Statutory surplus differs from stockholder's equity
determined under GAAP principally due to the mandatory contingency reserve
required for statutory accounting purposes and differences in accounting
for investments, deferred acquisition costs, SLR and deferred taxes
provided under GAAP. Statutory net income was $18,737,000, $9,000,000 and
$4,543,000 for the years ended December 31, 1996, 1995 and 1994,
respectively. Statutory net income differs from net income determined under
GAAP principally due to deferred acquisition costs, SLR and deferred income
taxes.
11) Commitments and Contingencies
The Company's lease agreement for the space occupied in New York expires on
November 20, 2008. CapMAC has a lease agreement for its London office,
which expires on October 1, 2002. As of December 31, 1996, future minimum
payments under the lease agreements are as follows:
$ in thousands Payment
- -------------------------------------------------------------------------------
1997 $ 2,647
1998 2,715
1999 3,077
2000 3,152
2001 and thereafter 28,660
- -------------------------------------------------------------------------------
Total $ 40,251
===============================================================================
Rent expense, commercial rent taxes and electricity for the years ended
December 31, 1996, 1995 and 1994 amounted to $1,618,000, $1,939,000 and
$2,243,000, respectively.
CapMAC has available a $150,000,000 standby corporate liquidity facility
(the "Liquidity Facility") scheduled to terminate in September 1999. The
Liquidity Facility is provided by a consortium of banks, headed by Bank of
Montreal, as agent, which is rated "A-1+" and "P- 1" by S&P and Moody's,
respectively. Under the Liquidity Facility, CapMAC will be able, subject to
satisfying certain conditions, to borrow funds from time to time in order
to enable it to fund any claim payments or payments made in settlement or
mitigation of claim payments under its insurance contracts. There have been
no draws under the Liquidity Facility.
CapMAC has agreed to make an investment of 50 million French Francs
(approximately $10 million U.S. dollars) in CapMAC Assurance, S.A., an
insurance subsidiary to be established in Paris, France. This investment is
anticipated to be made in 1997.
A-17
<PAGE>
Capital Markets Assurance Corporation
Notes to Financial Statements
12) Reinsurance
In the ordinary course of business, CapMAC cedes exposure under various
treaty and facultative reinsurance contracts, both on a pro rata and excess
of loss basis, primarily designed to minimize losses from large risks and
protect the capital and surplus of CapMAC.
The effect of reinsurance on premiums written and earned was as follows:
<TABLE>
<CAPTION>
Years Ended December 31
1996 1995 1994
------------------------ ---------------------- -----------------------
$ in thousands Written Earned Written Earned Written Earned
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Direct $ 71,752 48,835 56,541 36,853 43,598 28,561
Assumed 1,086 1,508 935 761 1,064 258
Ceded (15,104) (9,786) (15,992) (8,372) (11,069) (5,716)
- -----------------------------------------------------------------------------------------------------
Net premiums $ 57,734 40,557 41,484 29,242 33,593 23,103
=====================================================================================================
</TABLE>
The reinsurance of risk does not relieve the ceding insurer of its original
liability to its policyholders. A contingent liability exists with respect
to the aforementioned reinsurance arrangements, which may become a
liability of CapMAC in the event the reinsurers are unable to meet
obligations assumed by them under the reinsurance contracts. At December
31, 1996 and 1995, CapMAC had ceded loss reserves of $0 and $69,000,
respectively, and had ceded unearned premiums of $18,489,000 and
$13,171,000, respectively.
In 1994, CapMAC entered into a reinsurance agreement (the "Lureco Treaty")
with Luxembourg European Reinsurance LURECO S.A. ("Lureco"), a
European-based reinsurer. The agreement is renewable annually at the
Company's option, subject to satisfying certain conditions. The agreement
reinsured and indemnified the Company for any loss incurred by CapMAC
during the agreement period up to the limits of the agreement. The Lureco
Treaty provides that the annual reinsurance premium payable by CapMAC to
Lureco, after deduction of the reinsurer's fee payable to Lureco, be
deposited in a trust account (the "Lureco Trust Account") to be applied by
CapMAC, at its option, to offset losses and loss expenses incurred by
CapMAC in connection with incurred claims. Amounts on deposit in the Lureco
Trust Account which have not been applied against claims are contractually
due to CapMAC at the termination of the treaty.
The premium deposit amounts in the Lureco Trust Account have been reflected
as assets by CapMAC during the term of the agreement. Premiums in excess of
the deposit amounts have been recorded as ceded premiums in the statements
of income. For the 1996 policy year, the agreement provides $7 million of
loss coverage in excess of the premium deposit amount of $5 million
retained in the Lureco Trust Account. Additional coverage is provided for
losses incurred in excess of 200% of the net premiums earned up to $4
million for any one agreement year. In September 1995, a claim of
approximately $2.5 million on an insurance policy was applied against the
Lureco Trust Account.
A-18
<PAGE>
Capital Markets Assurance Corporation
Notes to Financial Statements
In addition to its capital (including statutory contingency reserves),
CapMAC has other reinsurance available to pay claims under its insurance
contracts. Effective November 30, 1995, CapMAC entered into a Stop-loss
Reinsurance Agreement with Mitsui Marine and Fire Insurance Co. (the
"Mitsui Stop-loss Agreement"). Under the Mitsui Stop-loss Agreement, Mitsui
Marine and Fire Insurance Co. ("Mitsui") will be required to pay any losses
in excess of $100 million in the aggregate incurred by CapMAC during the
term of the Mitsui Stop-loss Agreement on the insurance policies in effect
on December 1, 1995 and written during the one-year period thereafter, up
to an aggregate limit payable under the Mitsui Stop-loss Agreement of $50
million. The Mitsui Stop-loss Agreement has a term of seven years and is
subject to early termination by CapMAC in certain circumstances. Effective
January 1, 1997 the stop-loss reinsurance coverage increased to $75 million
in excess of incurred losses of $150 million increasing annually based on
increases in CapMAC's statutory qualified capital. The new stop-loss
reinsurance is provided by Mitsui, AXA Re Finance S.A. ("AXA Re") and
Munchener Ruckversicherungs-Gesellschaft ("Munich Re").
On November 30, 1995, CapMAC canceled the quota share reinsurance agreement
with Winterthur Swiss Insurance Company ("Winterthur") pursuant to which
Winterthur had the right to reinsure on a quota share basis 10% of each
policy written by CapMAC. As a result, CapMAC reassumed approximately $1.4
billion of principal insured by Winterthur on January 1, 1996. In
connection with the commutation, Winterthur returned $2.0 million of
unearned premiums, net of ceding commission and Federal excise tax.
13) Disclosures About Fair Value of Financial Instruments
The following table presents the carrying amounts and estimated fair values
of the Company's financial instruments at December 31, 1996 and 1995. The
fair value amounts were determined by the Company using independent market
information when available, and appropriate valuation methodologies when
market information was not available. Such valuation methodologies require
significant judgment and are not necessarily indicative of the amount the
Company could recognize in a current market exchange.
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
Carrying Estimated Carrying Estimated
$ in thousands Amount Fair Value Amount Fair Value
- --------------------------------------------------------------- --------------------------------------
Financial Assets:
<S> <C> <C> <C> <C>
Available-for-sale securities $ 314,703 314,703 284,352 284,352
- ------------------------------------------------------------------------------------------------------
Off-Balance-Sheet Instruments:
Financial guarantees outstanding $ -- 219,989 -- 147,840
Less: ceding commission -- 65,997 -- 44,352
- ------------------------------------------------------------------------------------------------------
Net financial guarantees outstanding $ -- 153,992 103,488
======================================================================================================
</TABLE>
A-19
<PAGE>
Capital Markets Assurance Corporation
Notes to Financial Statements
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments summarized above:
Available-for-sale Securities
The fair values of fixed maturities are based upon quoted market prices.
The fair value of short-term investments approximates amortized cost.
Financial Guarantees Outstanding
The fair value of financial guarantees outstanding consists of (1) the
current unearned premium reserve, net of prepaid reinsurance and (2) the
fair value of installment revenue which is derived by calculating the
present value of the estimated future cash inflow to CapMAC of policies in
force having installment premiums, net of amounts payable to reinsurers, at
a discount rate of 7% at December 31, 1996 and 1995. The amount calculated
is assumed to be equivalent to the consideration that would be paid by
CapMAC under market conditions prevailing at the reporting dates to
transfer CapMAC's financial guarantee business to a third party under
reinsurance and other agreements. Ceding commission represents the expected
amount that would be paid to CapMAC to compensate CapMAC for originating
and servicing the insurance contracts. In constructing estimated future
cash inflows, management makes assumptions regarding prepayments for
amortizing asset-backed securities which are consistent with relevant
historical experience. For revolving programs, assumptions are made
regarding program utilization based on discussions with program users. The
amount of future installment revenue actually realized by the Company could
be reduced in the future due to factors such as early termination of
insurance contracts, accelerated prepayments of underlying obligations or
lower than anticipated utilization of insured structured programs, such as
commercial paper conduits. Although increases in future installment revenue
earnings due to renewals of existing insurance contracts historically have
been greater than reductions in future installment revenue due to factors
such as those described above, there can be no assurance that future
circumstances might not cause a material net reduction in the future
installment revenue.
14) Capitalization
In 1995, $59.0 million of the proceeds received by Holdings from the sale
of shares in connection with an initial public offering and private
placements were contributed to CapMAC.
A-20
<PAGE>
CAPITAL MARKETS ASSURANCE CORPORATION AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997
(Unaudited)
A-21
<PAGE>
Capital Markets Assurance Corporation and Subsidiary
Consolidated Balance Sheets
(Dollars in thousands)
<TABLE>
<CAPTION>
ASSETS
June 30,
1997 December 31,1996
(Unaudited)
- -------------------------------------------------------------------------------------------------------
<S> <C> <C>
Investments:
Bonds at fair value (amortized cost $307,166 at June 30,
1997 and $294,861 at December 31, 1996) $ 307,821 297,893
Short-term investments (at amortized cost which
approximates fair value) 17,053 16,810
- -------------------------------------------------------------------------------------------------------
Total investments 324,874 314,703
- -------------------------------------------------------------------------------------------------------
Cash 4,506 371
Accrued investment income 3,835 3,807
Deferred acquisition costs 50,327 45,380
Premiums receivable 5,826 5,141
Prepaid reinsurance 20,787 18,489
Other assets 10,464 6,424
- -------------------------------------------------------------------------------------------------------
Total assets $ 420,619 394,315
=======================================================================================================
LIABILITIES AND STOCKHOLDER'S EQUITY
Liabilities:
Unearned premiums $ 71,800 68,262
Reserve for losses and loss adjustment expenses 13,861 10,985
Ceded reinsurance 2,766 1,738
Accounts payable and other accrued expenses 14,433 8,019
Current income taxes 203 679
Deferred income taxes 15,700 15,139
- -------------------------------------------------------------------------------------------------------
Total liabilities 118,763 104,822
- -------------------------------------------------------------------------------------------------------
Stockholder's Equity:
Common stock - $1.00 par value per share; 15,000,000
shares are authorized, issued and outstanding at June 30,
1997 and December 31, 1996 15,000 15,000
Additional paid-in capital 208,475 208,475
Unrealized appreciation on investments, net of tax 425 1,970
Retained earnings 77,956 64,048
- -------------------------------------------------------------------------------------------------------
Total stockholder's equity 301,856 289,493
- -------------------------------------------------------------------------------------------------------
Total liabilities and stockholder's equity $ 420,619 394,315
=======================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
A-22
<PAGE>
Capital Markets Assurance Corporation and Subsidiary
Consolidated Statements of Income
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30 June 30
1997 1996 1997 1996
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues:
Direct premiums written $ 18,726 18,622 35,180 32,777
Assumed premiums written 655 150 916 1,024
Ceded premiums written (6,272) (5,103) (10,621) (7,013)
- ------------------------------------------------------------------------------------------
Net premiums written 13,109 13,669 25,475 26,788
Increase in unearned premiums (877) (3,681) (1,240) (7,972)
- ------------------------------------------------------------------------------------------
Net premiums earned 12,232 9,988 24,235 18,816
Net investment income 4,684 4,112 9,386 7,989
Net realized capital gains 506 19 2,549 168
Other income 45 25 88 79
- ------------------------------------------------------------------------------------------
Total revenues 17,467 14,144 36,258 27,052
- ------------------------------------------------------------------------------------------
Expenses:
Losses and loss adjustment expenses 1,333 1,109 2,876 2,184
Underwriting and operating expenses 4,208 3,385 8,879 7,362
Policy acquisition costs 2,472 2,059 5,053 4,123
- ------------------------------------------------------------------------------------------
Total expenses 8,013 6,553 16,808 13,669
- ------------------------------------------------------------------------------------------
Income before income taxes 9,454 7,591 19,450 13,383
- ------------------------------------------------------------------------------------------
Income Taxes:
Current income tax 2,277 1,316 4,150 1,981
Deferred income tax 473 1,148 1,392 1,971
- ------------------------------------------------------------------------------------------
Total income taxes 2,750 2,464 5,542 3,952
- ------------------------------------------------------------------------------------------
Net Income $ 6,704 5,127 13,908 9,431
==========================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
A-23
<PAGE>
Capital Markets Assurance Corporation and Subsidiary
Consolidated Statement of Stockholder's Equity
(Unaudited)
(Dollars in thousands)
Six Months Ended
June 30, 1997
- -------------------------------------------------------------------------------
Common stock:
Balance at beginning of period $ 15,000
- -------------------------------------------------------------------------------
Balance at end of period 15,000
- -------------------------------------------------------------------------------
Additional paid-in capital:
Balance at beginning of period 208,475
- -------------------------------------------------------------------------------
Balance at end of period 208,475
- -------------------------------------------------------------------------------
Unrealized appreciation (depreciation)
on investments, net of tax:
Balance at beginning of period 1,970
Unrealized depreciation on investments (1,545)
- -------------------------------------------------------------------------------
Balance at end of period 425
- -------------------------------------------------------------------------------
Retained earnings:
Balance at beginning of period 64,048
Net income 13,908
- -------------------------------------------------------------------------------
Balance at end of period 77,956
- -------------------------------------------------------------------------------
Total stockholder's equity $ 301,856
===============================================================================
See accompanying notes to consolidated financial statements.
A-24
<PAGE>
Capital Markets Assurance Corporation and Subsidiary
Consolidated Statements of Cash Flows
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Six Months Ended Six Months Ended
June 30, 1997 June 30, 1996
- -----------------------------------------------------------------------------------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 13,908 9,431
- -----------------------------------------------------------------------------------------
Adjustments to reconcile net income to net
cash provided (used) by operating activities:
Reserve for losses and loss adjustment expenses 2,876 1,821
Unearned premiums, net 3,538 10,977
Deferred acquisition costs (4,947) (4,742)
Premiums receivable (685) 308
Accrued investment income (28) (579)
Income taxes payable 916 2,113
Net realized capital gains (2,549) (168)
Accounts payable and other accrued expenses 6,414 2,581
Prepaid reinsurance (2,298) (3,004)
Other, net (2,765) (183)
- -----------------------------------------------------------------------------------------
Total adjustments 472 9,124
- -----------------------------------------------------------------------------------------
Net cash provided by operating activities 14,380 18,555
- -----------------------------------------------------------------------------------------
Cash flows from investing activities:
Purchases of investments (112,743) (121,115)
Proceeds from sales of investments 74,768 19,875
Proceeds from maturities of investments 27,730 82,800
- -----------------------------------------------------------------------------------------
Net cash used in investing activities (10,245) (18,440)
- -----------------------------------------------------------------------------------------
Net increase in cash 4,135 115
Cash balance at beginning of period 371 344
- -----------------------------------------------------------------------------------------
Cash balance at end of period $ 4,506 459
=========================================================================================
Supplemental disclosures of cash flow
information:
Income taxes paid $ 4,550 1,725
Tax and loss bonds purchased $ 76 112
=========================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
A-25
<PAGE>
Capital Markets Assurance Corporation and Subsidiary
Notes to Unaudited Consolidated Financial Statements
June 30, 1997
1. Background
Capital Markets Assurance Corporation ("CapMAC") is a New York-domiciled
monoline stock insurance company which engages only in the business of
financial guaranty and surety insurance. CapMAC is a wholly owned
subsidiary of CapMAC Holdings Inc. ("Holdings"). In early 1997, CapMAC made
an investment of 50 million French francs (approximately 10 million U.S.
dollars) in CapMAC Assurance, S.A., an insurance subsidiary to be
established in Paris, France. CapMAC Assurance, S.A., is licensed to write
financial guarantee insurance in the European Union member states.
CapMAC is licensed in all 50 states in addition to the District of
Columbia, the Commonwealth of Puerto Rico and the territory of Guam. CapMAC
insures structured asset-backed, corporate, municipal and other financial
obligations in the U.S. and international capital markets. CapMAC also
provides financial guaranty reinsurance for structured asset-backed,
corporate, municipal and other financial obligations written by other major
insurance companies.
CapMAC's claims-paying ability is rated triple-A by Moody's Investors
Service, Inc., Standard & Poor's Ratings Services, Duff & Phelps Credit
Rating Co., and Nippon Investors Service, Inc., a Japanese rating agency.
Such ratings reflect only the views of the respective rating agencies, are
not recommendations to buy, sell or hold securities and are subject to
revision or withdrawal at any time by such rating agencies.
2. Basis of Presentation
CapMAC'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 CapMAC's financial condition, results of operations and
cash flows for the periods presented. The results of operations for the six
months ended June 30, 1997 may not be indicative of the results that may be
expected for the full year ending December 31, 1997. These consolidated
financial statements and notes should be read in conjunction with the
financial statements and notes included in the audited financial statements
of CapMAC as of December 31, 1996 and 1995, and for each of the years in
the three-year period ended December 31, 1996.
3. Reclassifications
Certain prior period balances have been reclassified to conform to the
current period presentation.
A-26
<PAGE>
PROSPECTUS
HEADLANDS MORTGAGE SECURITIES INC.
Sponsor
Asset Backed Securities
(Issuable in Series)
------------------
This Prospectus relates to the issuance of Asset Backed Certificates (the
"Certificates") and Asset Backed Notes (the "Notes" and, together with the
Certificates, the "Securities"), which may be sold from time to time in one or
more series (each, a "Series") by a Trust Fund (as defined below) on terms
determined at the time of sale and described in this Prospectus and the related
Prospectus Supplement. The Securities of a Series will consist of Certificates
which evidence beneficial ownership of a trust (each, a "Trust Fund")
established by Headlands Mortgage Securities Inc. (the "Sponsor") and/or Notes
secured by the assets of a Trust Fund. As specified in the related Prospectus
Supplement, the Trust Fund for a Series of Securities will include certain
assets (the "Trust Fund Assets") which will consist of the following types of
single family mortgage loans (the "Loans"): (i) mortgage loans secured by first
and/or subordinate liens on one- to four-family residential properties (the
"Mortgage Loans"), (ii) closed-end loans (the "Closed End Loans") and/or
revolving home equity loans or certain balances thereof (the "Revolving Credit
Line Loans", and together with the Closed End Loans, the "Home Equity Loans")
secured by first or subordinate liens on one- to four-family residential
properties and (iii) home improvement installment sale contracts and installment
loan agreements (the "Home Improvement Contracts") that are either unsecured or
secured by subordinate liens on one- to four-family residential properties, or
by purchase money security interests in the home improvements financed thereby
(the "Home Improvements"). The Trust Fund Assets will be acquired by the
Sponsor, either directly or indirectly, from one or more institutions (each, a
"Seller"), which may be affiliates of the Sponsor, and conveyed by the Sponsor
to the related Trust Fund. A Trust Fund also may include insurance policies,
surety bonds, cash accounts, reinvestment income, guaranties or letters of
credit to the extent described in the related Prospectus Supplement. See "Index
of Defined Terms" on page 89 of this Prospectus for the location of the
definitions of certain capitalized terms.
Each Series of Securities will be issued in one or more classes. Each class
of Certificates of a Series will evidence beneficial ownership of a specified
percentage (which may be 0%) or portion of future interest payments and a
specified percentage (which may be 0%) or portion of future principal payments
on the related Trust Fund Assets. Each class of Notes of a Series will be
secured by the related Trust Fund Assets or, if so specified in the related
Prospectus Supplement, a portion thereof. A Series of Securities may include one
or more classes that are senior in right of payment to one or more other classes
of Securities of such Series. One or more classes of Securities of a Series may
be entitled to receive distributions of principal, interest or any combination
thereof prior to one or more other classes of Securities of such Series or after
the occurrence of specified events, in each case as specified in the related
Prospectus Supplement.
Distributions to Securityholders will be made monthly, quarterly,
semi-annually or at such other intervals and on the dates specified in the
related Prospectus Supplement. Distributions on the Securities of a Series will
be made from the related Trust Fund Assets or proceeds thereof pledged for the
benefit of the Securityholders as specified in the related Prospectus
Supplement.
The related Prospectus Supplement will describe any insurance or guarantee
provided with respect to the related Series of Securities including, without
limitation, any insurance or guarantee provided by the Department of Housing and
Urban Development, the United States Department of Veterans' Affairs or any
private insurer or guarantor. The only obligations of the Sponsor with respect
to a Series of Securities will be to obtain certain representations and
warranties from each Seller and to assign to the Trustee for the related Series
of Securities the Sponsor's rights with respect to such representations and
warranties. The principal obligations of the Master Servicer named in the
related Prospectus Supplement with respect to the related Series of Securities
will be limited to obligations pursuant to certain representations and
warranties and to its contractual servicing obligations, including any
obligation it may have to advance delinquent payments on the related Trust Fund
Assets.
The yield on each class of Securities of a Series will be affected by,
among other things, the rate of payments of principal (including prepayments) on
the related Trust Fund Assets and the timing of receipt of such payments as
described under "Risk Factors--Prepayment and Yield Considerations" and "Yield
and Prepayment Considerations" herein and in the related Prospectus Supplement.
A Trust Fund may be subject to early termination under the circumstances
described under "The Agreements--Termination; Optional Termination herein and in
the related Prospectus Supplement.
If specified in the related Prospectus Supplement, one or more elections
may be made to treat a Trust Fund or specified portions thereof as a "real
estate mortgage investment conduit" ("REMIC") for federal income tax purposes.
See "Federal Income Tax Consequences."
------------------
FOR A DISCUSSION OF CERTAIN RISKS ASSOCIATED WITH AN INVESTMENT IN THE
SECURITIES, SEE THE INFORMATION UNDER "RISK FACTORS" ON PAGE 14.
THE CERTIFICATES OF A GIVEN SERIES WILL REPRESENT BENEFICIAL INTERESTS IN, AND
THE NOTES OF A GIVEN SERIES WILL REPRESENT OBLIGATIONS OF, THE RELATED TRUST
FUND ONLY AND WILL NOT REPRESENT INTERESTS IN OR OBLIGATIONS OF THE SPONSOR,
THE MASTER SERVICER, ANY SELLER OR ANY AFFILIATES THEREOF, EXCEPT TO THE
EXTENT DESCRIBED IN THE RELATED PROSPECTUS SUPPLEMENT. THE SECURITIES
AND THE LOANS WILL NOT BE INSURED OR GUARANTEED BY ANY GOVERNMENTAL
AGENCY OR INSTRUMENTALITY OR BY THE SPONSOR OR ANY OTHER PERSON
OR ENTITY, EXCEPT IN EACH CASE TO THE EXTENTDESCRIBED IN THE
RELATED PROSPECTUS SUPPLEMENT.
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 RELATED PROSPECTUS SUPPLEMENT. ANY
REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
------------------
Prior to issuance there will have been no market for the Securities of any
Series and there can be no assurance that a secondary market for any Securities
will develop, or if it does develop, that it will continue or provide
Securityholders with a sufficient level of liquidity of investment. This
Prospectus may not be used to consummate sales of Securities of any Series
unless accompanied by a Prospectus Supplement. Offers of the Securities may be
made through one or more different methods, including offerings through
underwriters, as more fully described under "Method of Distribution" herein and
in the related Prospectus Supplement.
July 17, 1997
<PAGE>
Until 90 days after the date of each Prospectus Supplement, all dealers
effecting transactions in the securities covered by such Prospectus Supplement,
whether or not participating in the distribution thereof, may be required to
deliver such Prospectus Supplement and this Prospectus. This is in addition to
the obligation of dealers to deliver a Prospectus and Prospectus Supplement when
acting as underwriters and with respect to their unsold allotments or
subscriptions.
PROSPECTUS SUPPLEMENT OR CURRENT REPORT ON FORM 8-K
The Prospectus Supplement or Current Report on Form 8-K relating to the
Securities of each Series to be offered hereunder will, among other things, set
forth with respect to such Securities, as appropriate: (i) the aggregate
principal amount, interest rate and authorized denominations of each class of
such Series of Securities; (ii) information as to the assets comprising the
Trust Fund, including the general characteristics of the related Trust Fund
Assets included therein and, if applicable, the insurance policies, surety
bonds, guaranties, letters of credit or other instruments or agreements included
in the Trust Fund or otherwise, and the amount and source of any reserve account
or other cash account; (iii) the circumstances, if any, under which the Trust
Fund may be subject to early termination; (iv) the circumstances, if any, under
which the Notes of such Series are subject to redemption; (v) the method used to
calculate the amount of principal to be distributed or paid with respect to each
class of Securities; (vi) the order of application of distributions or payments
to each of the classes within such Series, whether sequential, pro rata, or
otherwise; (vii) the Distribution Dates with respect to such Series; (viii)
additional information with respect to the method of distribution of such
Securities; (ix) whether one or more REMIC elections will be made with respect
to the Trust Fund and, if so, the designation of the regular interests and the
residual interests; (x) the aggregate original percentage ownership interest in
the Trust Fund to be evidenced by each class of Certificates; (xi) the stated
maturity of each class of Notes of such Series; (xii) information as to the
nature and extent of subordination with respect to any class of Securities that
is subordinate in right of payment to any other class; and (xiii) information as
to the Seller, the Master Servicer and the Trustee.
AVAILABLE INFORMATION
The Sponsor 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 descriptions 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, Suite 1400, Chicago, Illinois
60661; and Northeast Regional Office, Seven World Trade Center, Suite 1300, New
York, New York 10048. The Commission also maintains a Web site at
http://www.sec.gov from which such Registration Statement and exhibits may be
obtained.
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.
2
<PAGE>
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 Securities Exchange Act of 1934, as
amended (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. Neither the Sponsor nor the Master Servicer for any Series intends
to file with the Commission periodic reports with respect to the related Trust
Fund following completion of the reporting period required by Rule 15d-1 or
Regulation 15D under the Exchange Act.
The Trustee or such other entity specified in the related Prospectus
Supplement 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 Corporate
Trust Office of the Trustee or the address of such other entity specified in the
accompanying Prospectus Supplement. Included in the accompanying Prospectus
Supplement is the name, address, telephone number, and, if available, facsimile
number of the office or contact person at the Corporate Trust Office of the
Trustee or such other entity.
REPORTS TO SECURITYHOLDERS
Periodic and annual reports concerning the related Trust Fund for a Series
of Securities will be forwarded to Securityholders. However, such reports will
neither be examined nor reported on by an independent public accountant. See
"Description of the Securities--Reports to Securityholders".
3
<PAGE>
- --------------------------------------------------------------------------------
SUMMARY OF TERMS
This summary is qualified in its entirety by reference to the detailed
information appearing elsewhere in this Prospectus and in the related Prospectus
Supplement with respect to the Series of Securities offered thereby and to the
related Agreement (as such term is defined below) which will be prepared in
connection with each Series of Securities. Unless otherwise specified,
capitalized terms used and not defined in this Summary of Terms have the
meanings given to them in this Prospectus and in the related Prospectus
Supplement. See "Index of Defined Terms" on Page 81 of this Prospectus for the
location of the definitions of certain capitalized terms.
Title of Securities............. Asset Backed Certificates (the
"Certificates") and Asset Backed Notes
(the "Notes" and, together with the
Certificates, the "Securities"), which
are issuable in Series.
Sponsor......................... Headlands Mortgage Securities Inc., a
Delaware corporation.
Trustee......................... The trustee(s) (the "Trustee") for each
Series of Securities will be specified
in the related Prospectus Supplement.
See "The Agreements" herein for a
description of the Trustee's rights and
obligations.
Master Servicer................. The entity or entities named as Master
Servicer (the "Master Servicer") in the
related Prospectus Supplement, which may
be an affiliate of the Sponsor. See "The
Agreements--Certain Matters Regarding
the Master Servicer and the Sponsor".
Trust Fund Assets............... Assets of the Trust Fund for a Series of
Securities will include certain assets
(the "Trust Fund Assets") which will
consist of the Loans, together with
payments in respect of such Trust Fund
Assets, as specified in the related
Prospectus Supplement. At the time of
issuance of the Securities of the
Series, the Sponsor will assign the
Loans comprising the related Trust Fund
to the Trustee, without recourse. The
Loans will be collected in a pool (each,
a "Pool") as of the first day of the
month of the issuance of the related
Series of Securities or such other date
specified in the related Prospectus
Supplement (the "Cut-off Date"). Trust
Fund Assets also may include insurance
policies, surety bonds, cash accounts,
reinvestment income, guaranties or
letters of credit to the extent
described in the related Prospectus
Supplement. See "Credit Enhancement". In
addition, if the related Prospectus
Supplement so provides, the related
Trust Fund Assets will include the funds
on deposit in an account (a "Pre-Funding
Account") which will be used to purchase
additional Loans during the period
specified in such Prospectus Supplement.
See "The Agreements--Pre- Funding
Account".
Loans........................... The Loans will consist of (i) mortgage
loans secured by first and/or
subordinate liens on one- to four-family
residential properties (each, a
"Mortgage Loan"), (ii) closed-end loans
(the "Closed-End Loans") and/or
revolving home equity loans or certain
balances thereof (the "Revolving Credit
Line Loans", together with the
Closed-End Loans,
- --------------------------------------------------------------------------------
4
<PAGE>
- --------------------------------------------------------------------------------
the "Home Equity Loans"), and (iii) home
improvement installment sales contracts
and installment loan agreements (the
"Home Improvement Contracts"). All Loans
will have been purchased by the Sponsor,
either directly or through an affiliate,
from one or more Sellers.
As specified in the related Prospectus
Supplement, the Mortgage Loans and the
Home Equity Loans will, and the Home
Improvement Contracts may, be secured by
mortgages or deeds of trust or other
similar security instruments creating a
lien on a Mortgaged Property, which may
be subordinated to one or more senior
liens on the Mortgaged Property, as
described 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".
Description of
the Securities................ Each Security will represent a
beneficial ownership interest in, or be
secured by the assets of, a Trust Fund
created by the Sponsor pursuant to an
Agreement among the Sponsor, the Master
Servicer and the Trustee for the related
Series. The Securities of any Series may
be issued in one or more classes as
specified in the related Prospectus
Supplement. A Series of Securities may
include one or more classes of senior
Securities (collectively, the "Senior
Securities") and one or more classes of
subordinate Securities (collectively,
the "Subordinated Securities"). Certain
Series or classes of Securities may be
covered by insurance policies or other
forms of credit enhancement, in each
case as described under "Credit
Enhancement" herein and in the related
Prospectus Supplement.
One or more classes of Securities of
each Series (i) may be entitled to
receive distributions allocable only to
principal, only to interest or to any
combination thereof; (ii) may be
entitled to receive distributions only
of prepayments of principal throughout
the lives of the Securities or during
specified periods; (iii) may be
subordinated in the right to receive
distributions of scheduled payments of
principal, prepayments of principal,
interest or any combination thereof to
one or more other classes of Securities
of such Series throughout the lives of
the Securities or during specified
periods; (iv) may be entitled to receive
such distributions only after the
occurrence of events specified in the
related Prospectus Supplement; (v) may
be entitled to receive distributions in
accordance with a schedule or formula or
on the basis of collections from
designated portions of the related Trust
Fund Assets; (vi) as to Securities
entitled to distributions allocable to
interest, may be entitled to receive
interest at a fixed rate or a rate that
is subject to change from time to time;
and (vii) as to Securities entitled to
distributions allocable to interest, may
be entitled to distributions allocable
to interest only
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5
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after the occurrence of events specified
in the related Prospectus Supplement and
may accrue interest until such events
occur, in each case as specified in the
related Prospectus Supplement. The
timing and amounts of such distributions
may vary among classes or over time, as
specified in the related Prospectus
Supplement.
Distributions on
the Securities................ Distributions on the Securities entitled
thereto will be made monthly, quarterly,
semi-annually or at such other intervals
and on the dates specified in the
related Prospectus Supplement (each, a
"Distribution Date") out of the payments
received in respect of the assets of the
related Trust Fund or Funds or other
assets pledged for the benefit of the
Securities as described under "Credit
Enhancement" herein to the extent
specified in the related Prospectus
Supplement. The amount allocable to
payments of principal and interest on
any Distribution Date will be determined
as specified in the related Prospectus
Supplement. The Prospectus Supplement
for a Series of Securities will describe
the method for allocating distributions
among Securities of different classes as
well as the method for allocating
distributions among Securities for any
particular class.
Unless otherwise specified in the
related Prospectus Supplement, the
aggregate original principal balance of
the Securities will not exceed the
aggregate distributions allocable to
principal that such Securities will be
entitled to receive. If specified in the
related Prospectus Supplement, the
Securities will have an aggregate
original principal balance equal to the
aggregate unpaid principal balance of
the Trust Fund Assets as of the related
Cut-off Date and will bear interest in
the aggregate at a rate equal to the
interest rate borne by the underlying
Loans (the "Loan Rate") net of the
aggregate servicing fees and any other
amounts specified in the related
Prospectus Supplement or at such other
interest rate as may be specified in
such Prospectus Supplement.
The rate (each, a "Pass-Through Rate")
at which interest will be passed through
or paid to holders of each class of
Securities entitled thereto may be a
fixed rate or a rate that is subject to
change from time to time from the time
and for the periods, in each case, as
specified in the related Prospectus
Supplement. Any such rate may be
calculated on a loan-by-loan or weighted
average basis or calculated based on a
notional amount, in each case, as
described in the related Prospectus
Supplement.
Compensating Interest........... If so specified in the related
Prospectus Supplement, the Master
Servicer will be required to remit to
the Trustee, with respect to each Loan
in the related Trust Fund as to which a
principal prepayment in full or a
principal payment which is in excess of
the scheduled monthly payment and is not
intended to cure a delinquency was
received during any Due Period, an
amount, from and to the extent of
amounts otherwise payable to the
Master Servicer as servicing
compensation, equal
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to (i) the excess, if any, of (a) 30
days' interest on the principal balance
of the related Loan at the Loan Rate net
of the per annum rate at which the
Master Servicer's servicing fee accrues,
over (b) the amount of interest actually
received on such Loan during such Due
Period, net of the Master Servicer's
servicing fee or (ii) such other amount
as described in the related Prospectus
Supplement. See "Description of the
Securities--Compensating Interest".
Credit Enhancement.............. The Trust Fund Assets or the Securities
of one or more classes in the related
Series may have the benefit of one or
more types of credit enhancement as
described in the related Prospectus
Supplement. The protection against
losses afforded by any such credit
support may be limited. The type,
characteristics and amount of credit
enhancement will be determined based on
the characteristics of the Loans
comprising the Trust Fund Assets and
other factors and will be established on
the basis of requirements of each Rating
Agency rating the Securities of such
Series. See "Credit Enhancement."
If specified in the related Prospectus
Supplement, the coverage provided by one
or more of the forms of credit
enhancement described in this Prospectus
may apply concurrently to two or more
separate Trust Funds. If applicable, the
related Prospectus Supplement will
identify the Trust Funds to which such
credit enhancement relates and the
manner of determining the amount of
coverage provided to such Trust Funds
thereby and of the application of such
coverage to the identified Trust Funds.
A. Subordination................ A Series of Securities may consist of
one or more classes of Senior Securities
and one or more classes of Subordinated
Securities. The rights of the holders of
the Subordinated Securities of a Series
to receive distributions with respect to
the related Trust Fund Assets will be
subordinated to such rights of the
holders of the Senior Securities of the
same Series to the extent described in
the related Prospectus Supplement. This
subordination is intended to enhance the
likelihood of regular receipt by holders
of Senior Securities of such Series of
the full amount of monthly payments of
principal and interest due them. The
protection afforded to the holders of
Senior Securities of a Series by means
of the subordination feature will be
accomplished by (i) the preferential
right of such holders to receive, prior
to any distribution being made in
respect of the related Subordinated
Securities, the amounts of interest
and/or principal due them on each
Distribution Date out of the funds
available for distribution on such date
in the related Security Account and, to
the extent described in the related
Prospectus Supplement, by the right of
such holders to receive future
distributions on the related Trust Fund
Assets that would otherwise have been
payable to the holders of Subordinated
Securities; (ii) reducing the ownership
interest (if applicable) of the related
Subordinated Securities; or (iii) a
combination of clauses (i) and (ii)
above. If so specified in the related
Prospectus Supplement, subordination may
apply only in the
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7
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event of certain types of losses not
covered by other forms of credit
support, such as hazard losses not
covered by standard hazard insurance
policies or losses due to the bankruptcy
or fraud of the borrower. The related
Prospectus Supplement will set forth
information concerning, among other
things, the amount of subordination of a
class or classes of Subordinated
Securities in a Series, the
circumstances in which such
subordination will be applicable, and
the manner, if any, in which the amount
of subordination will decrease over
time.
B. Reserve Account.............. One or more reserve accounts or other
cash accounts (each, a "Reserve
Account") may be established and
maintained for each Series of
Securities. The related Prospectus
Supplement will specify whether or not
such Reserve Accounts will be included
in the corpus of the Trust Fund for such
Series and will also specify the manner
of funding such Reserve Accounts and the
conditions under which the amounts in
any such Reserve Accounts will be used
to make distributions to holders of
Securities of a particular class or
released from such Reserve Accounts.
C. Letter of Credit............. If so specified in the related
Prospectus Supplement, credit support
for a Series may be provided by one or
more letters of credit. A letter of
credit may provide limited protection
against certain losses in addition to or
in lieu of other credit support. The
issuer of the letter of credit (the "L/C
Bank") will be obligated to honor
demands with respect to such letter of
credit, to the extent of the amount
available thereunder to provide funds
under the circumstances and subject to
such conditions as are specified in the
related Prospectus Supplement. The
liability of the L/C Bank under its
letter of credit will be reduced by the
amount of unreimbursed payments
thereunder.
The maximum liability of a L/C Bank
under its letter of credit will be an
amount equal to a percentage specified
in the related Prospectus Supplement of
the initial aggregate outstanding
principal balance of the Loans in the
related Trust Fund or one or more
Classes of Securities of the related
Series. The maximum amount available at
any time to be paid under a letter of
credit will be determined in the manner
specified therein and in the related
Prospectus Supplement.
D. Insurance Policies;
Surety Bonds and
Guarantees................... If so specified in the related
Prospectus Supplement, credit support
for a Series may be provided by an
insurance policy and/or a surety bond
issued by one or more insurance
companies or sureties. Such certificate
guarantee insurance or surety bond will
guarantee timely distributions of
interest and/or full distributions of
principal on the basis of a schedule of
principal distributions set forth in or
determined in the manner specified in
the related Prospectus Supplement. If
specified in the related Prospectus
Supplement, one or more bankruptcy
bonds, special hazard insurance
policies, other insurance or third-party
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8
<PAGE>
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guarantees may be used to provide
coverage for the risks of default or
types of losses set forth in such
Prospectus Supplement.
E. Over-Collateralization....... If so provided in the Prospectus
Supplement for a Series of Securities, a
portion of the interest payment on each
Loan may be applied as an additional
distribution in respect of principal to
reduce the principal balance of a
certain class or classes of such Series
of Securities and, thus, accelerate the
rate of payment of principal on such
class or classes of such Series of
Securities.
F. Loan Pool
Insurance Policy............. A mortgage pool insurance policy or
policies may be obtained and maintained
for Loans relating to any Series of
Securities, which shall be limited in
scope and shall cover defaults on the
related Loans in an initial amount equal
to a specified percentage of the
aggregate principal balance of all Loans
included in the Pool as of the related
Cut-off Date.
G. FHA Insurance................ If specified in the related Prospectus
Supplement, all or a portion of the
Loans in a Pool may be (i) insured by
the Federal Housing Administration
(the "FHA") and/or (ii) partially
guaranteed by the Department of
Veterans' Affairs (the "VA").
H. Cross-Support................ If specified in the related Prospectus
Supplement, separate classes of a Series
of Securities may evidence the
beneficial ownership of, or be secured
by, separate groups of assets included
in a Trust Fund. In such case, credit
support may be provided by a cross
support feature which requires that
distributions be made with respect to
Securities evidencing a beneficial
ownership interest in, or secured by,
one or more asset groups prior to
distributions to Subordinated Securities
evidencing a beneficial ownership
interest in, or secured by, other asset
groups within the same Trust Fund. See
"Credit Enhancement--Cross Support."
Advances........................ The Master Servicer and, if applicable,
each mortgage servicing institution that
services a Loan in a Pool on behalf of
the Master Servicer (each, a
"Sub-Servicer") may be obligated to
advance amounts (each, an "Advance")
corresponding to delinquent interest
and/or principal payments on such Loan
until the date, as specified in the
related Prospectus Supplement, following
the date on which the related Property
is sold at a foreclosure sale or the
related Loan is otherwise liquidated.
Any obligation to make Advances may be
subject to limitations as specified in
the related Prospectus Supplement. If so
specified in the related Prospectus
Supplement, Advances may be drawn from a
cash account available for such purpose
as described in such Prospectus
Supplement. Advances will be
reimbursable to the extent described
under "Description of the
Securities--Advances" herein and in the
related Prospectus Supplement.
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In the event the Master Servicer or
Sub-Servicer fails to make a required
Advance, the Trustee may be obligated to
advance such amounts otherwise required
to be advanced by the Master Servicer or
Sub-Servicer. See "Description of the
Securities--Advances."
Optional Termination............ The Master Servicer or the party
specified in the related Prospectus
Supplement, including the holder of the
residual interest in a REMIC, may have
the option to effect early retirement of
a Series of Securities through the
purchase of the Trust Fund Assets. The
Master Servicer will deposit the
proceeds of any such purchase in the
Security Account for each Trust Fund as
described under "The
Agreements--Payments on Loans; Deposit
to Security Account." Any such purchase
of Trust Fund Assets and property
acquired in respect of Trust Fund Assets
evidenced by a Series of Securities will
be made at the option of the Master
Servicer, such other person or, if
applicable, such holder of the REMIC
residual interest, at a price specified
in the related Prospectus Supplement.
The exercise of such right will effect
early retirement of the Securities of
that Series, but the right of the Master
Servicer, such other person or, if
applicable, such holder of the REMIC
residual interest, to so purchase is
subject to the principal balance of the
related Trust Fund Assets being less
than the percentage specified in the
related Prospectus Supplement of the
aggregate principal balance of the Trust
Fund Assets at the Cut-off Date for the
Series. The foregoing is subject to the
provision that if a REMIC election is
made with respect to a Trust Fund, any
such purchase will be made only in
connection with a "qualified
liquidation" of the REMIC within the
meaning of Section 860F(g)(4) of the
Internal Revenue Code of 1986, as
amended (the "Code").
Legal Investment................ The Prospectus Supplement for each
Series of Securities will specify which,
if any, of the classes of Securities
offered thereby constitute "mortgage
related securities" for purposes of the
Secondary Mortgage Market Enhancement
Act of 1984 ("SMMEA"). Classes of
Securities that qualify as "mortgage
related securities" will be legal
investments for certain types of
institutional investors to the extent
provided in SMMEA, subject, in any case,
to any other regulations which may
govern investments by such institutional
investors. Institutions whose investment
activities are subject to review by
federal or state authorities should
consult with their counsel or the
applicable authorities to determine
whether an investment in a particular
class of Securities (whether or not such
class constitutes a "mortgage related
security") complies with applicable
guidelines, policy statements or
restrictions. See "Legal Investment."
Federal Income Tax
Consequences.................. The federal income tax consequences to
Securityholders will vary depending on
whether one or more elections are made
to treat the Trust Fund or specified
portions thereof as a REMIC under the
provisions of the Code or as a
"financial asset securitization
investment trust"
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10
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("FASIT") within the meaning of Section
860L of the Code. The Prospectus
Supplement for each Series of Securities
will specify whether such an election
will be made.
If a REMIC election is made, Securities
representing regular interests in a
REMIC will generally be taxable to
holders in the same manner as evidences
of indebtedness issued by the REMIC.
Stated interest on such regular
interests will be taxable as ordinary
income and taken into account using the
accrual method of accounting, regardless
of the holder's normal accounting
method. If a FASIT election is made, the
material federal income tax consequences
for investors associated with the
purchase, ownership and disposition of
such Securities will be set forth under
the heading "Federal Income Tax
Consequences" in the related Prospectus
Supplement.
If no REMIC or FASIT election is made,
interest (other than original issue
discount ("OID")) on Securities that are
characterized as indebtedness for
federal income tax purposes will be
includible in income by holders thereof
in accordance with their usual method of
accounting.
Certain classes of Securities may be
issued with OID. A Securityholder should
be aware that the Code and the Treasury
regulations promulgated thereunder do
not adequately address certain issues
relevant to prepayable securities, such
as the Securities.
Securityholders that will be required to
report income with respect to the
related Securities under the accrual
method of accounting will do so 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
Securityholder in any period could
significantly exceed the amount of cash
distributed to such Securityholder in
that period.
In the opinion of Brown & Wood LLP or
Dewey Ballantine, as special tax counsel
to the Sponsor (each, a "Special Tax
Counsel"), if a REMIC election is made
with respect to a Series of Securities,
then the arrangement by which such
Securities 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. A REMIC will not be subject to
entity-level tax. Rather, the taxable
income or net loss of a REMIC will be
taken into account by the holders of
residual interests. Such holders will
report their proportionate share of the
taxable income of the REMIC whether or
not they receive cash distributions from
the REMIC attributable to such income.
The portion of the REMIC taxable income
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consisting of "excess inclusions" may
not be offset against other deductions
or losses of the holder, including the
net operating losses.
In the opinion of Special Tax Counsel,
if a REMIC, FASIT or a partnership
election is not made with respect to a
Series of Securities, then the
arrangement by which such Securities are
issued will be classified as a grantor
trust under Subpart E, Part I of
Subchapter J of the Code and not as an
association taxable as a corporation. If
so provided in the Prospectus Supplement
for a Series, there will be no
separation of the principal and interest
payments on the Loans. In such
circumstances, the Securityholder will
be considered to have purchased a pro
rata undivided interest in each of the
Loans. In other cases, sale of the
Securities will produce a separation in
the ownership of all or a portion of the
principal payments from all or a portion
of the interest payments on the Loans.
In the opinion of Special Tax Counsel,
if a partnership election is made, the
Trust Fund will not be treated as an
association or a publicly traded
partnership taxable as a corporation as
long as all of the provisions of the
applicable Agreement are complied with
and the statutory and regulatory
requirements are satisfied. The holders
of the Certificates issued by such Trust
Fund, if any, will agree to treat the
Certificates as equity interests in a
partnership. If there is only one holder
of the Certificates issued by such Trust
Fund, the Trust Fund will not be treated
as a partnership. Instead, it will be
treated as an entity not distinct from
its owner, the holder of the
Certificates. If Notes are issued by
such Trust Fund, such Notes will be
treated as indebtedness for federal
income tax purposes. The federal income
tax consequences to the holders of the
Notes will be the same regardless of the
number of Certificateholders.
The Securities will be treated as assets
described in Section 7701(a)(19)(C) of
the Code and as real estate assets
described in Section 856(c) of the Code.
Generally, gain or loss will be
recognized on a sale of Securities in
the amount equal to the difference
between the amount realized and the
seller's tax basis in the Securities
sold.
The material federal income tax
consequences for investors associated
with the purchase, ownership and
disposition of the Securities are set
forth herein under "Federal Income Tax
Consequences". The material federal
income tax consequences for investors
associated with the purchase, ownership
and disposition of Securities of any
particular Series will be set forth
under the heading "Federal Income Tax
Consequences" in the related Prospectus
Supplement. See "Federal Income Tax
Consequences".
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ERISA Considerations............ A fiduciary of any employee benefit plan
or other retirement plan or arrangement
subject to the Employee Retirement
Income Security Act of 1974, as amended
("ERISA"), or the Code should carefully
review with its legal advisors whether
the purchase or holding of Securities
could give rise to a transaction
prohibited or not otherwise permissible
under ERISA or the Code. See "ERISA
Considerations". Certain classes of
Securities may not be transferred unless
the Trustee is furnished with a letter
of representation or an opinion of
counsel to the effect that such transfer
will not result in a violation of the
prohibited transaction provisions of
ERISA and the Code and will not subject
the Trustee, the Sponsor, the Seller or
the Master Servicer to additional
obligations. See "Description of the
Securities--General" and "ERISA
Considerations".
Risk Factors.................... For a discussion of certain risks
associated with an investment in the
Securities, see "Risk Factors" on page
12 herein and in the related Prospectus
Supplement.
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RISK FACTORS
Investors should consider the following factors in connection with the
purchase of the Securities.
Limited Liquidity
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 Securityholders with
liquidity of investment or will continue for the life of the Securities of such
Series.
Limited Source of Payments - No Recourse to Sponsor, Seller, Master Servicer or
Trustee
The Sponsor does not have, nor is it expected to have, any significant
assets. Unless otherwise specified in the related Prospectus Supplement, the
Securities of a Series will be payable solely from the Trust Fund for such
Securities and will not have any claim against or security interest in the Trust
Fund for any other Series. There will be no recourse to the Sponsor or any other
person for any failure to receive distributions on the Securities. Further, at
the times set forth in the related Prospectus Supplement, certain Trust Fund
Assets and/or any balance remaining in the Security Account immediately after
making all payments due on the Securities of such Series, after making adequate
provision for future payments on certain classes of Securities and after making
any other payments specified in the related Prospectus Supplement, may be
promptly released or remitted to the Sponsor, the Master Servicer, any credit
enhancement provider or any other person entitled thereto and will no longer be
available for making payments to Securityholders. Consequently, holders of
Securities of each Series must rely solely upon payments with respect to the
Trust Fund Assets and the other assets constituting the Trust Fund for a Series
of Securities, including, if applicable, any amounts available pursuant to any
credit enhancement for such Series, for the payment of principal of and interest
on the Securities of such Series.
The Securities will not represent an interest in or obligation of the
Sponsor, the Master Servicer, the Trustee, any Seller or any of their respective
affiliates. The only obligations, if any, of the Sponsor with respect to the
Trust Fund Assets or the Securities of any Series will be pursuant to certain
representations and warranties and certain document delivery requirements. The
Sponsor does not have, and is not expected in the future to have, any
significant assets with which to meet any obligation to repurchase Trust Fund
Assets with respect to which there has been a breach of any representation or
warranty. If, for example, the Sponsor were required to repurchase a Loan, its
only sources of funds to make such repurchase would be from funds obtained (i)
from the enforcement of a corresponding obligation, if any, on the part of the
related Seller or originator of such Loan, or (ii) to the extent provided in the
related Prospectus Supplement, from a Reserve Account or similar credit
enhancement established to provide funds for such repurchases.
The only obligations of any Seller with respect to Trust Fund Assets or the
Securities of any Series will be pursuant to certain representations and
warranties and certain document delivery requirements. A Seller may be required
to repurchase or substitute for any Loan with respect to which such
representations and warranties or document delivery requirements are breached.
There is no assurance, however, that such Seller will have the financial ability
to effect such repurchase or substitution.
Credit Enhancement
Although credit enhancement is intended to reduce the risk of delinquent
payments or losses to holders of Securities entitled to the benefit thereof, the
amount of such credit enhancement will be limited, as set forth in the related
Prospectus Supplement, and may be subject to periodic reduction in accordance
with a schedule or formula or otherwise decline, and could be depleted under
certain circumstances prior to the payment in full of the related Series of
Securities, and as a result Securityholders of the related Series may suffer
losses. Moreover, such credit enhancement may not cover all potential losses or
risks. For example, credit enhancement may or may not cover
14
<PAGE>
fraud or negligence by a loan originator or other parties. In addition, the
Trustee will generally be permitted to reduce, terminate or substitute all or a
portion of the credit enhancement for any Series of Securities, provided the
applicable Rating Agency indicates that the then-current rating of the
Securities of such Series will not be adversely affected. See "Credit
Enhancement".
Prepayment and Yield Considerations
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 (including for this purpose prepayments resulting from refinancing
or liquidations of the Loans due to defaults, casualties, condemnations and
repurchases by the Sponsor or the Master Servicer) of the Loans comprising the
Trust Fund, which prepayments may be influenced by a variety of factors
including general economic conditions, prevailing interest rate levels, the
availability of alternative financing and homeowner mobility, (ii) the manner of
allocating principal and/or payments among the classes of Securities of a Series
as specified in the related Prospectus Supplement, (iii) the exercise by the
party entitled thereto of any right of optional termination and (iv) the rate
and timing of payment defaults and losses incurred with respect to the Trust
Fund Assets. The repurchase of Loans by the Sponsor or the Seller may result
from repurchases of Trust Fund Assets due to material breaches of the Sponsor's
or the Seller's representations and warranties, as applicable. The yields to
maturity and weighted average lives of the Securities will be affected primarily
by the rate and timing of prepayment of the Loans comprising the Trust Fund
Assets. In addition, the yields to maturity and weighted average lives of the
Securities will be affected by the distribution of amounts remaining in any
Pre-Funding Account following the end of the related Funding Period. Any
reinvestment risks resulting from a faster or slower incidence of prepayment of
Loans held by a Trust Fund will be borne entirely by the holders of one or more
classes of the related Series of Securities. See "Yield and Prepayment
Considerations" and "The Agreements--Pre-Funding Account."
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 over a period ending two or
more days prior to a Distribution Date, the effective yield to Securityholders
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
each Distribution Date, and the effective yield (at par) to Securityholders will
be less than the indicated coupon rate. See "Description of the Securities --
Distributions on Securities -- Distributions of Interest".
Balloon Payments
Certain of the Loans as of the related Cut-off Date may not be fully
amortizing over their terms to maturity and, thus, will require substantial
principal payments (i.e., balloon payments) at their stated maturity. Loans with
balloon payments involve a greater degree of risk because the ability of a
borrower to make a balloon payment typically will depend upon its ability either
to timely refinance the loan or to timely sell the related Property. The ability
of a borrower to accomplish either of these goals will be affected by a number
of factors, including the level of available mortgage interest rates at the time
of sale or refinancing, the borrower's equity in the related Property, the
financial condition of the borrower and tax laws. Losses on such Loans that are
not otherwise covered by the credit enhancement described in the applicable
Prospectus Supplement will be borne by the holders of one or more classes of
Securities of the related Series.
Nature of Mortgages
Property Values. There are several factors that could adversely affect the
value of Properties such that the outstanding balance of the related Loans,
together with any senior financing on the Properties, if applicable, 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
15
<PAGE>
Properties or of natural disasters that are not necessarily covered by
insurance, such as earthquakes and floods. Such decline could extinguish the
value of the interest of a junior mortgagee in the Property before having any
effect on the interest of the related senior mortgagee. If such a decline
occurs, the actual rates of delinquencies, foreclosures and losses on all Loans
could be higher than those currently experienced in the mortgage lending
industry in general. Losses on such Loans that are not otherwise covered by the
credit enhancement described in the applicable Prospectus Supplement will be
borne by the holder of one or more classes of Securities of the related Series.
Delays Due to Liquidation. Even assuming that the Properties provide
adequate security for the Loans, substantial delays could be encountered in
connection with the liquidation of defaulted Loans and corresponding delays in
the receipt of related proceeds by Securityholders could occur. An action to
foreclose on a Property securing a Loan is regulated by state statutes and rules
and is subject to many of the delays and expenses of other lawsuits if defenses
or counterclaims are interposed, sometimes requiring several years to complete.
Furthermore, in some states an action to obtain a deficiency judgment is not
permitted following a nonjudicial sale of a Property. In the event of a default
by a borrower, these restrictions, among other things, may impede the ability of
the Master Servicer to foreclose on or sell the Property or to obtain
liquidation proceeds sufficient to repay all amounts due on the related Loan. In
addition, the Master Servicer will be entitled to deduct from related
liquidation proceeds all expenses reasonably incurred in attempting to recover
amounts due on defaulted Loans and not yet repaid, including payments to senior
lienholders, legal fees and costs of legal action, real estate taxes and
maintenance and preservation expenses.
Disproportionate Effect of Liquidation Expenses. Liquidation expenses with
respect to defaulted Loans do not vary directly with the outstanding principal
balance of the Loan at the time of default. Therefore, assuming that a servicer
took the same steps in liquidating a defaulted Loan having a small remaining
principal balance as it would in the case of a defaulted Loan having a large
remaining principal balance, the amount realized after expenses of liquidation
would be smaller as a percentage of the outstanding principal balance of the
small Loan than would be the case with the defaulted Loan having a large
remaining principal balance.
Junior Liens. Since the mortgages and deeds of trust, if any, securing the
Loans will be primarily 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 proceeds will be available to satisfy the
outstanding balance of such junior lien only to the extent that the claims of
such senior mortgagees 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 any senior
mortgage, in which case it must either pay the entire amount due on any senior
mortgage to the related senior mortgagee at or prior to the foreclosure sale or
undertake the obligation to make payments on any such senior mortgage in the
event the mortgagor is in default thereunder. The Trust Fund will not have any
source of funds to satisfy any senior mortgages or make payments due to any
senior mortgagees and may therefore be prevented from foreclosing on the related
property.
Consumer Protection Laws. Applicable state laws generally regulate interest
rates and other charges, require certain disclosures, and require licensing of
certain originators and servicers of Loans. In addition, most states have other
laws, public policy and general principles of equity relating to the protection
of consumers, unfair and deceptive practices and practices which 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 Master 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 Master Servicer to damages
and administrative sanctions. See "Certain Legal Aspects of the Loans".
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Environmental Risks
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 cleanup.
In several states, such a lien has priority over the lien of an existing
mortgage 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 the environmental damage or threat was caused by a prior
owner. Such costs could result in a loss to the holders of one or more classes
of Securities of the related Series. A lender also risks such liability on
foreclosure of the related property. See "Certain Legal Aspects of the
Loans--Environmental Risks".
Certain Other Legal Aspects of the Loans
Consumer Protection Laws. Applicable state laws generally regulate interest
rates and other charges and require certain disclosures. In addition, other
state laws, public policy and generally 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 Master 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 may also be 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 Fair Credit Reporting Act, which regulates the use and
reporting of information related to the borrower's credit experience; and
(iv) for 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 the
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 Riegle Act. Certain Loans may be subject to the Riegle Community
Development and Regulatory Improvement Act of 1994 (the "Riegle Act") which
incorporates the Home Ownership and Equity Protection Act of 1994. These
provisions impose additional disclosure and other requirements on creditors with
respect to nonpurchase money mortgage loans with high interest rates or high
up-front fees and charges. The provisions of the Riegle Act apply on a mandatory
basis to all Loans originated on or after October 1, 1995. These provisions can
impose specific statutory liabilities upon creditors who fail to comply with
their provisions and may affect the enforceability of the related Loans. In
addition, any assignee of the creditor would generally be subject to all claims
and defenses that the consumer could assert against the creditor, including,
without limitation, the right to rescind the Loan.
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Holder in Due Course Rules. 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.
Rating of the Securities
It will be a condition to the issuance of a class of Securities offered
hereby that they 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 related
Trust Fund Assets and any credit enhancement with respect to such class and will
represent such Rating Agency's assessment solely of the likelihood that holders
of such class of Securities will receive payments to which such Securityholders
are entitled under the related Agreement. Such rating will not constitute an
assessment of the likelihood that principal prepayments on the related Loans
will be made, the degree to which the rate of such prepayments might differ from
that originally anticipated or the likelihood of early optional termination of
the Series of Securities. Such rating shall 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. Such rating will not address the
possibility that prepayment at higher or lower rates than anticipated by an
investor may cause such investor to experience a lower than anticipated yield or
that an investor purchasing a Security at a significant premium might fail to
recoup its initial investment under certain prepayment scenarios.
There is also no assurance that any such rating will remain in effect for
any given period of time or that it may not be lowered or withdrawn entirely by
the Rating Agency in the future 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 Trust Fund Assets or any credit enhancement with
respect to a Series of Securities, such rating might also be lowered or
withdrawn because of, among other reasons, an adverse change in the financial or
other condition of a credit enhancement provider or a change in the rating of
such credit enhancement provider's long term debt.
The amount, type and nature of credit enhancement, if any, established with
respect to a class of Securities will be determined on the basis of criteria
established by each Rating Agency rating classes of such Series. Such criteria
are sometimes based upon an actuarial analysis of the behavior of similar loans
in a larger group. Such analysis is often the basis upon which each Rating
Agency determines the amount of credit enhancement required with respect to each
such class. There can be no assurance that the historical data supporting any
such actuarial analysis will accurately reflect future experience nor any
assurance that the data derived from a large pool of similar loans accurately
predicts the delinquency, foreclosure or loss experience of any particular pool
of Loans. No assurance can be given that the values of any Properties have
remained or will remain at their levels on the respective dates of origination
of the related Loans. If the residential real estate markets should experience
an overall decline in property values such that the outstanding principal
balances of the Loans in a particular Trust Fund and any other financing on the
related Properties become equal to or greater than the value of the Properties,
the rates of delinquencies, foreclosures and losses could be higher than those
now generally experienced in the mortgage lending industry. In addition, adverse
economic conditions (which may or may not affect real property values) may
affect the timely payment by mortgagors of scheduled payments of principal and
interest on the Loans and, accordingly, the rates of delinquencies, foreclosures
and losses with respect to any Trust Fund. To the extent that such losses are
not covered by credit enhancement, such losses will be borne, at least in part,
by the holders of one or more classes of Securities of the related Series. See
"Rating".
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Book-Entry Registration
If issued in book-entry form, such registration may reduce the liquidity of
the Securities in the secondary trading market since investors may be unwilling
to purchase Securities for which they cannot obtain physical certificates. Since
transactions in Book-Entry Securities can be effected only through the
Depository Trust Company ("DTC"), participating organizations, Financial
Intermediaries and certain banks, the ability of a Securityholder to pledge a
Book-Entry Security to persons or entities that do not participate in the DTC
system may be limited due to lack of a physical certificate representing such
Securities. Security Owners will not be recognized as Securityholders as such
term is used in the related Agreement, and Security Owners will be permitted to
exercise the rights of Securityholders only indirectly through DTC and its
Participants.
In addition, Securityholders may experience some delay in their receipt of
distributions of interest and principal on Book-Entry Securities since
distributions are required to be forwarded by the Trustee to DTC and DTC will
then be required to credit such distributions to the accounts of Sponsors
participants which thereafter will be required to credit them to the accounts of
Securityholders either directly or indirectly through Financial Intermediaries.
See "Description of the Securities--Book-Entry Registration of Securities".
Pre-Funding Accounts
If so provided in the related Prospectus Supplement, on the related Closing
Date the Sponsor will deposit cash in an amount (the "Pre-Funded Amount")
specified in such Prospectus Supplement into an account (the "PreFunding
Account"). In no event shall the Pre-Funded Amount exceed 50% of the initial
aggregate principal amount of the Certificates and/or Notes of the related
Series of Securities. The Pre-Funded Amount will be used to purchase Loans
("Subsequent Loans") in a period from the related Closing Date to a date not
more than one year after such Closing Date (such period, the "Funding Period")
from the Sponsor (which, in turn, will acquire such Subsequent Loans from the
Seller or Sellers specified in the related Prospectus Supplement). The
Pre-Funding Account will be maintained with the Trustee for the related Series
of Securities and is designed solely to hold funds to be applied by such Trustee
during the Funding Period to pay to the Sponsor the purchase price for
Subsequent Loans. Monies on deposit in the Pre-Funding Account will not be
available to cover losses on or in respect of the related Loans. To the extent
that the entire Pre-Funded Amount has not been applied to the purchase of
Subsequent Loans by the end of the related Funding Period, any amounts remaining
in the Pre-Funding Account will be distributed as a prepayment of principal to
Securityholders on the Distribution Date immediately following the end of the
Funding Period, in the amounts and pursuant to the priorities set forth in the
related Prospectus Supplement. Any reinvestment risk resulting from such
prepayment will be borne entirely by the holders of one or more classes of the
related Series of Securities.
Bankruptcy and Insolvency Risks
The Seller and the Sponsor will treat the transfer of the Loans by the
Seller to the Sponsor as a sale for accounting purposes. The Sponsor and the
Trust Fund will treat the transfer of Loans from the Sponsor to the Trust Fund
as a sale for accounting purposes. As a sale of the Loans by the Seller to the
Sponsor, the Loans would not be part of the Seller's bankruptcy estate and would
not be available to the Seller's creditors. However, in the event of the
insolvency of the Seller, it is possible that the bankruptcy trustee or a
creditor of the Seller may attempt to recharacterize the sale of the Loans as a
borrowing by the Seller, secured by a pledge of the Loans. Similarly, as a sale
of the Loans by the Sponsor to the Trust Fund, the Loans would not be part of
the Sponsor's bankruptcy estate and would not be available to the Sponsor's
creditors. However, in the event of the insolvency of the Sponsor, it is
possible that the bankruptcy trustee or a creditor of the Sponsor may attempt to
recharacterize the sale of the Loans as a borrowing by the Sponsor, secured by a
pledge of the Loans. In either case, this position, if argued before and/or
accepted by a court, could prevent timely payments of amounts due on the
Securities and result in a reduction of payments due on the Securities.
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In the event of a bankruptcy or insolvency of the Master Servicer, the
bankruptcy trustee or receiver may have the power to prevent the Trustee or the
Securityholders from appointing a successor Servicer. The time period during
which cash collections may be commingled with the Master Servicer's own funds
prior to each Distribution Date will be specified in the related Prospectus
Supplement. In the event of the insolvency of the Master Servicer and if such
cash collections are commingled with the Master Servicer's own funds for at
least ten days, the Trust Fund will likely not have a perfected interest in such
collections since such collections would not have been deposited in a segregated
account within ten days after the collection thereof, and the inclusion thereof
in the bankruptcy estate of the Master Servicer may result in delays in payment
and failure to pay amounts due on the Securities of the related Series.
In addition, federal and state statutory provisions, including the federal
bankruptcy laws and state laws affording relief to debtors, may interfere with
or affect the ability of the secured mortgage lender to realize upon its
security. For example, in a proceeding under the federal Bankruptcy Code, a
lender may not foreclose on a mortgaged property without the permission of the
bankruptcy court. The rehabilitation plan proposed by the debtor may provide, if
the mortgaged property is not the debtor's principal residence and the court
determines that the value of the mortgaged property is less than the principal
balance of the mortgage loan, for the reduction of the secured indebtedness to
the value of the mortgaged property as of the date of the commencement of the
bankruptcy, rendering the lender a general unsecured creditor for the
difference, and also may reduce the monthly payments due under such mortgage
loan, change the rate of interest and alter the mortgage loan repayment
schedule. The effect of any such proceedings under the federal Bankruptcy Code,
including but not limited to any automatic stay, could result in delays in
receiving payments on the Loans underlying a Series of Securities and possible
reductions in the aggregate amount of such payments.
Value of Trust Fund Assets
There is no assurance that the market value of the Trust Fund Assets or any
other assets relating to a Series of Securities described under "Credit
Enhancement" herein will at any time be equal to or greater than the principal
amount of the Securities of such Series then outstanding, plus accrued interest
thereon. Moreover, upon an event of default under the Agreement for a Series of
Securities and a sale of the related Trust Fund Assets or upon a sale of the
assets of a Trust Fund for a Series of Securities, the Trustee, the Master
Servicer, the credit enhancer, if any, 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
Securityholders. 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.
THE TRUST FUND
General
The Securities of each Series will represent interests in the assets of the
related Trust Fund, and the Notes of each Series will be secured by the pledge
of the assets of the related Trust Fund. The Trust Fund for each Series will be
held by the Trustee for the benefit of the related Securityholders. Each Trust
Fund will consist of certain assets (the "Trust Fund Assets") consisting of a
pool (each, a "Pool") comprised of Loans as specified in the related Prospectus
Supplement, together with payments in respect of such Loans, as specified in the
related Prospectus Supplement.* The Pool will be created on the first day of the
month of the issuance of the related Series of
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* Whenever the terms "Pool", "Certificates", "Notes" and "Securities"
are used in this Prospectus, such terms will be deemed to apply, unless the
context indicates otherwise, to one specific Pool and the Securities of one
Series including the Certificates representing certain undivided interests
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Securities or such other date specified in the related Prospectus Supplement
(the "Cut-off Date"). The Securities will be entitled to payment from the assets
of the related Trust Fund or Funds or other assets pledged for the benefit of
the Securityholders, as specified in the related Prospectus Supplement and will
not be entitled to payments in respect of the assets of any other trust fund
established by the Sponsor.
The Trust Fund Assets will be acquired by the Sponsor, either directly or
through affiliates, from originators or sellers which may be affiliates of the
Sponsor (the "Sellers"), and conveyed without recourse by the Sponsor to the
related Trust Fund. Loans acquired by the Sponsor will have been originated in
accordance with the underwriting criteria specified below under "Loan
Program--Underwriting Standards" or as otherwise described in the related
Prospectus Supplement. See "Loan Program--Underwriting Standards".
The Sponsor will cause the Trust Fund Assets to be assigned to the Trustee
named in the related Prospectus Supplement for the benefit of the holders of the
Securities of the related Series. The Master Servicer named in the related
Prospectus Supplement will service the Trust Fund Assets, either directly or
through other servicing institutions ("Sub-Servicers"), pursuant to a Pooling
and Servicing Agreement among the Sponsor, the Master Servicer and the Trustee
with respect to a Series consisting of Certificates, or a master servicing
agreement (each, a "Master Servicing Agreement") between the Trustee and the
Master Servicer with respect to a Series consisting of Certificates and Notes,
and will receive a fee for such services. See "Loan Program" and "The
Agreements". With respect to Loans serviced by the Master Servicer through a
Sub-Servicer, the Master Servicer will remain liable for its servicing
obligations under the related Agreement as if the Master Servicer alone were
servicing such Loans.
As used herein, "Agreement" means, with respect to a Series consisting of
Certificates, the Pooling and Servicing Agreement, and with respect to a Series
consisting of Certificates and Notes, the Trust Agreement, the Indenture and the
Master 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 trust
agreement (each, a "Trust Agreement") between the Sponsor and the trustee of
such Trust Fund.
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 Trust Fund Assets and other assets contemplated
herein specified 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 credit enhancement.
Unless otherwise specified in the related Prospectus Supplement, the only
obligations of the Sponsor with respect to a Series of Securities will be to
obtain certain representations and warranties from the Sellers and to assign to
the Trustee for such Series of Securities the Sponsor's rights with respect to
such representations and warranties. See "The Agreements--Assignment of the
Trust Fund Assets". The obligations of the Master Servicer with respect to the
Loans will consist principally of its contractual servicing obligations under
the related Agreement (including its obligation to enforce the obligations of
the Sub-Servicers or Sellers, or both, as more fully described herein under
"Loan Program--Representations by Sellers; Repurchases" and "The
Agreements--Sub-Servicing By
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*(...continued)
in, and/or Notes secured by the assets of, a single Trust Fund consisting
primarily of the Loans in such Pool. Similarly, the term "Pass-Through
Rate" will refer to the Pass-Through Rate borne by the Certificates and the
term "interest rate" will refer to the interest rate borne by the Notes of
one specific Series, as applicable, and the term "Trust Fund" will refer to
one specific Trust Fund.
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Sellers" and "--Assignment of the Trust Fund Assets") and its obligation, if
any, to make certain cash advances in the event of delinquencies in payments on
or with respect to the Loans in the amounts described herein under "Description
of the Securities--Advances". The obligations of the Master Servicer to make
advances may be subject to limitations, to the extent provided herein and in the
related Prospectus Supplement.
The following is a brief description of the assets expected to be included
in the Trust Funds. If specific information respecting the Trust Fund Assets is
not known at the time the related Series of Securities initially is offered,
more general information of the nature described below will be provided in the
related Prospectus Supplement, and specific information will be set forth in a
report on Form 8-K to be filed with the Securities and Exchange Commission
within fifteen days after the initial issuance of such Securities (the "Detailed
Description"). A copy of the Agreement with respect to each Series of Securities
will be available for inspection at the corporate trust office of the Trustee
specified in the related Prospectus Supplement. A schedule of the Loans relating
to such Series will be attached to the Agreement delivered to the Trustee upon
delivery of the Securities.
The Loans
General. Loans will consist of Mortgage Loans, Home Equity Loans or Home
Improvement Contracts. For purposes hereof, "Home Equity Loans" includes
"Closed-End Loans" and "Revolving Credit Line Loans". As more fully described in
the related Prospectus Supplement, the Loans may be "conventional" loans or
loans that are insured or guaranteed by a governmental agency such as the FHA or
VA.
The Loans in a Pool will have monthly payments due on the first day of each
month or on such other day of the month specified in the related Prospectus
Supplement. The payment terms of the Loans to be included in a Trust Fund will
be described in the related Prospectus Supplement and may include any of the
following features (or combination thereof), all as described below or in the
related Prospectus Supplement:
(a) Interest may be payable at a fixed rate, a rate adjustable from
time to time in relation to an index (which will be specified in the
related Prospectus Supplement), a rate that is fixed for a period of time
or under certain circumstances and is followed by an adjustable rate, a
rate that otherwise varies from time to time, or a rate that is convertible
from an adjustable rate to a fixed rate. Changes to an adjustable rate may
be subject to periodic limitations, maximum rates, minimum rates or a
combination of such limitations. Accrued interest may be deferred and added
to the principal of a Loan for such periods and under such circumstances as
may be specified in the related Prospectus Supplement.
(b) Principal may be payable on a level debt service basis to fully
amortize the Loan over its term, may be calculated on the basis of an
assumed amortization schedule that is significantly longer than the
original term to maturity or on an interest rate that is different from the
Loan Rate or may not be amortized during all or a portion of the original
term. Payment of all or a substantial portion of the principal may be due
on maturity ("balloon payment"). Principal may include interest that has
been deferred and added to the principal balance of the Loan.
(c) Monthly payments of principal and interest may be fixed for the
life of the Loan, may increase over a specified period of time or may
change from period to period. Loans may include limits on periodic
increases or decreases in the amount of monthly payments and may include
maximum or minimum amounts of monthly payments.
(d) Prepayments of principal may be subject to a prepayment fee, which
may be fixed for the life of the Loan or may decline over time. Certain
Loans may permit prepayments after expiration of certain periods ("lockout
periods"). Other Loans may permit prepayments without payment of a fee
unless the prepayment occurs during specified time periods. The Loans may
include "due on sale" clauses which permit the mortgagee to demand payment
of the entire Loan in connection with the sale or certain transfers
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of the related Property. Other Loans may be assumable by persons meeting
the then applicable standards set forth in the Agreement.
A Trust Fund may contain certain Loans ("Buydown Loans") that include
provisions whereby a third party partially subsidizes the monthly payments of
the borrowers on such Loans during the early years of such Loans, the difference
to be made up from a fund (a "Buydown Fund") contributed by such third party at
the time of origination of the Loan. A Buydown Fund will be in an amount equal
either to the discounted value or full aggregate amount of future payment
subsidies. The underlying assumption of buydown plans is that the income of the
borrower will increase during the buydown period as a result of normal increases
in compensation and inflation, so that the borrower will be able to meet the
full loan payments at the end of the buydown period. To the extent that this
assumption as to increased income is not fulfilled, the possibility of defaults
on Buydown Loans is increased. The related Prospectus Supplement will contain
information with respect to any Buydown Loan concerning limitations on the
interest rate paid by the borrower initially, on annual increases in the
interest rate and on the length of the buydown period.
The real property which secures repayment of the Loans is referred to as
the "Mortgaged Properties". Home Improvement Contracts may, and the other Loans
will, be secured by mortgages or deeds of trust or other similar security
instruments creating a lien on a Mortgaged Property. In the case of Home Equity
Loans, such liens generally will be subordinated to one or more senior liens on
the related Mortgaged Properties as described 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
Properties relating to Loans will consist of detached or semi-detached one- to
four-family dwelling units, townhouses, rowhouses, individual condominium units,
manufactured homes, individual units in planned unit developments, and certain
other dwelling units ("Single Family Properties"). Such Properties may include
vacation and second homes, investment properties and dwellings situated on
leasehold estates. In the case of leasehold interests, the term of the leasehold
will exceed the scheduled maturity of the Loan by at least five years, unless
otherwise specified in the related Prospectus Supplement. The Properties may be
located in any one of the fifty states, the District of Columbia, Guam, Puerto
Rico or any other territory of the United States.
Loans with certain Loan-to-Value Ratios and/or certain principal balances
may be covered wholly or partially by primary mortgage guaranty insurance
policies (each, a "Primary Mortgage Insurance Policy"). The existence, extent
and duration of any such coverage will be described in the applicable Prospectus
Supplement.
The aggregate principal balance of Loans secured by Properties that are
owner-occupied may be disclosed in the related Prospectus Supplement. The basis
for a representation that a given percentage of the Loans is secured by Single
Family Properties that are owner-occupied will be either (i) the making of a
representation by the borrower at origination of the Loan either that the
underlying Property will be used by the borrower for a period of at least six
months every year or that the borrower intends to use the Property as a primary
residence or (ii) a finding that the address of the underlying Property is the
borrower's mailing address.
Home Equity Loans. As more fully described in the related Prospectus
Supplement, interest on each Revolving Credit Line Loan, excluding introduction
rates offered from time to time during promotional periods, is computed and
payable monthly on the average daily outstanding principal balance of such Loan.
Principal amounts on a Revolving Credit Line Loan may be drawn down (up to a
maximum amount as set forth in the related Prospectus Supplement) or repaid
under each Revolving Credit Line Loan from time to time, but may be subject to a
minimum periodic payment. As specified in the related Prospectus Supplement, the
Trust Fund may include any amounts borrowed under a Revolving Credit Line Loan
after the Cut-Off Date.
The full amount of a Closed-End Loan is advanced at the origination of the
Loan and generally is repayable in equal (or substantially equal) installments
of an amount to fully amortize such Loan at its stated maturity or is
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a Balloon Loan. 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 either 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 of which is the number of days in the annual period for which
interest accrues on such Loan, or a fraction which is 30 over 360. Except to the
extent provided in the related Prospectus Supplement, the original terms to
stated maturity of Closed-End Loans generally will not exceed 360 months.
Under certain circumstances, under either a Revolving Credit Line Loan or a
Closed-End Loan, a borrower may choose an interest only payment option and is
obligated to pay only the amount of interest which accrues on the Loan during
the billing cycle. An interest only payment option may be available for a
specified period before the borrower must begin paying at least the minimum
monthly payment of a specified percentage of the average outstanding balance of
the Loan.
Home Improvement Contracts. The Trust Fund Assets for a Series of
Securities may consist, in whole or in part, of Home Improvement Contracts
originated by a home improvement contractor, a thrift or a commercial mortgage
banker in the ordinary course of business. The Home Improvements securing the
Home Improvement Contracts may 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. As specified in the related
Prospectus Supplement, the Home Improvement Contracts will either be unsecured
or secured by mortgages on Single Family Properties which are generally
subordinate to other mortgages on the same Property, or secured by purchase
money security interests in the Home Improvements financed thereby. Except as
otherwise specified in the related 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. The initial
Loan-to-Value Ratio of a Home Improvement Contract is computed in the manner
described in the related Prospectus Supplement.
Additional Information. Each Prospectus Supplement will contain
information, as of the date of such Prospectus Supplement and to the extent then
specifically known to the Sponsor, with respect to the Loans contained in the
related Pool, including (i) the aggregate outstanding principal balance and the
average outstanding principal balance of the Loans as of the applicable Cut-off
Date, (ii) the type of property securing the Loan (e.g., single family
residences, individual units in condominium apartment buildings, two- to
four-family dwelling units, other real property or Home Improvements), (iii) the
original terms to maturity of the Loans, (iv) the largest principal balance and
the smallest principal balance of any of the Loans, (v) the earliest origination
date and latest maturity date of any of the Loans, (vi) the Loan-to-Value Ratios
or Combined Loan-to-Value Ratios, as applicable, of the Loans, (vii) the Loan
Rates or annual percentage rates ("APR") or range of Loan Rates or APR's borne
by the Loans, (viii) the maximum and minimum per annum Loan Rates, and (ix) the
geographical location of the Loans. If specific information regarding the Loans
is not known to the Sponsor at the time the related Securities are initially
offered, more general information of the nature described above will be provided
in the related Prospectus Supplement, and specific information will be set forth
in the Detailed Description.
Generally, the "Loan-to-Value Ratio" (or "LTV") of a Loan at any given time
is the fraction, expressed as a percentage, the numerator of which is the
original principal balance of the related Loan and the denominator of which is
the Collateral Value of the related Property. Generally, the "Combined
Loan-to-Value Ratio" (or "CLTV") of a Loan at any given time is the ratio,
expressed as a percentage, of (i) the sum of (a) the original principal balance
of the Loan (or, in the case of a Revolving Credit Line Loan, the maximum amount
thereof available) and (b) the outstanding principal balance at the date of
origination of the Loan of any senior mortgage loan(s) or, in the case of any
open-ended senior mortgage loan, the maximum available line of credit with
respect to such mortgage loan, regardless of any lesser amount actually
outstanding at the date of origination of the Loan, to (ii) the Collateral Value
of the related Property. The "Collateral Value" of the Property, other than with
respect to certain Loans the proceeds of which were used to refinance an
existing mortgage loan (each, a "Refinance
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Loan"), is the lesser of (a) the appraised value determined in an appraisal
obtained at origination of such Loan and (b) the sales price for such Property
if the proceeds of such Loan are used to purchase the related Property. In the
case of Refinance Loans, the "Collateral Value" of the related Property is the
appraised value thereof determined in an appraisal obtained at the time of
refinancing.
No assurance can be given that values of the Properties have remained or
will remain at their levels on the dates of origination of the related Loans. If
the residential real estate market should experience an overall decline in
property values such that the sum of the outstanding principal balances of the
Loans and any primary or secondary financing on the Properties, as applicable,
in a particular Pool become equal to or greater than the value of the
Properties, the actual rates of delinquencies, foreclosures and losses could be
higher than those now generally experienced in the mortgage lending industry. In
addition, adverse economic conditions and other factors (which may or may not
affect real property values) may affect the timely payment by borrowers of
scheduled payments of principal and interest on the Loans and, accordingly, the
actual rates of delinquencies, foreclosures and losses with respect to any Pool.
To the extent that such losses are not covered by subordination provisions or
alternative arrangements, such losses will be borne by the holders of the
Securities of the related Series.
Substitution of Trust Fund Assets
Substitution of Trust Fund Assets may be permitted in the event of breaches
of representations and warranties with respect to certain Trust Fund Assets or
in the event the documentation with respect to any Trust Fund Asset is
determined by the Trustee to be incomplete or as further specified in the
related Prospectus Supplement. The period during which such substitution will be
permitted generally will be indicated in the related Prospectus Supplement.
USE OF PROCEEDS
The net proceeds to be received from the sale of the Securities will be
applied by the Sponsor to the purchase of Trust Fund Assets or will be used by
the Sponsor for general corporate purposes. The Sponsor expects to sell
Securities in Series from time to time, but the timing and amount of offerings
of Securities will depend on a number of factors, including the volume of Trust
Fund Assets acquired by the Sponsor, prevailing interest rates, availability of
funds and general market conditions.
THE SPONSOR
Headlands Mortgage Securities Inc., a Delaware corporation (the "Sponsor"),
was organized on November 18, 1996 for the limited purpose of acquiring, owning
and transferring Trust Fund Assets and selling interests therein or bonds
secured thereby. The Sponsor is a subsidiary of Headlands Mortgage Company, a
closely-held California S-corporation ("Headlands"). The Sponsor maintains its
principal office at 700 Larkspur Landing Circle, Suite 240, Larkspur, California
94939. Its telephone number is (415) 925-5442.
Neither the Sponsor nor any of the Sponsor's affiliates will insure or
guarantee distributions on the Securities of any Series.
LOAN PROGRAM
The Loans will have been purchased by the Sponsor, either directly or
through affiliates, from Sellers. Unless otherwise specified in the related
Prospectus Supplement, the Loans so acquired by the Sponsor will have been
originated in accordance with the underwriting criteria specified below under
"Underwriting Standards".
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Underwriting Standards
Each Seller will represent and warrant that all Loans originated and/or
sold by it to the Sponsor will have been underwritten in accordance with
standards consistent with those utilized by mortgage lenders generally during
the period of origination for similar types of loans. As to any Loan insured by
the FHA or partially guaranteed by the VA, the Seller will represent that it has
complied with underwriting policies of the FHA or the VA, as the case may be.
Underwriting standards are applied by or on behalf of a lender to evaluate
the borrower's credit standing and repayment ability, and the value and adequacy
of the related Property mortgaged property as collateral. In general, a
prospective borrower applying for a mortgage loan is required to fill out a
detailed application designed to provide to the underwriting officer pertinent
credit information. As part of the description of the borrower's financial
condition, the borrower generally is required to provide a current list of
assets and liabilities and a statement of income and expenses, as well as an
authorization to apply for a credit report which summarizes the borrower's
credit history with local merchants and lenders and any record of bankruptcy or
other significant public records. In most cases, an employment verification is
obtained from an independent source (typically the borrower's employer), which
verification reports the length of employment with that organization, the
borrower's current salary and whether it is expected that the borrower will
continue such employment in the future. If a prospective borrower is
self-employed, the borrower may be required to submit copies of signed tax
returns. The borrower may also be required to authorize verification of deposits
at financial institutions where the borrower has demand or savings accounts.
In determining the adequacy of the Property as collateral, an appraisal
will generally be made of each property considered for financing. The appraiser
is required to inspect the property and verify that it is in good repair and
that construction, if new, has been completed. The appraisal is based on the
market value of comparable homes, the estimated rental income (if considered
applicable by the appraiser) and the cost of replacing the home.
Once all applicable employment, credit and property information is
received, a determination generally is made as to whether the prospective
borrower has sufficient monthly income available (i) to meet the borrower's
monthly obligations on the proposed mortgage loan (generally determined on the
basis of the monthly payments due in the year of origination) and other expenses
related to the property (such as property taxes and hazard insurance) and (ii)
to meet monthly housing expenses and other financial obligations and monthly
living expenses. The underwriting standards applied by a Seller, particularly
with respect to the level of loan documentation and the borrower's income and
credit history, may be varied in appropriate cases where factors such as low
Combined Loan-to-Value Ratios or other favorable credit aspects exist.
If specified in the related Supplement, a portion of the Loans in a Pool
may have been originated under a limited documentation program. Under a limited
documentation program, more emphasis is placed on the value and adequacy of the
property as collateral and other assets of the borrower than on credit
underwriting. Under a limited documentation program, certain credit underwriting
documentation concerning income or income verification and/or employment
verification is waived. The Prospectus Supplement for each Series of Securities
will indicate the types of limited documentation programs pursuant to which the
related Loans were originated and the underwriting standards applicable to such
limited documentation programs.
In the case of a Loan secured by a leasehold interest in real property, the
title to which is held by a third party lessor, the Seller will represent and
warrant, among other things, that the remaining term of the lease and any
sublease is at least five years longer than the remaining term on the related
mortgage note.
Certain of the types of Loans that may be included in a Trust may involve
additional uncertainties not present in traditional types of loans. For example,
certain of such Loans may provide for escalating or variable payments by the
borrower. These types of Loans are underwritten on the basis of a judgment that
the borrowers
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have the ability to make the monthly payments required initially. In some
instances, however, a borrower's income may not be sufficient to permit
continued loan payments as such payments increase. These types of Loans may also
be underwritten primarily upon the basis of Combined Loan to Value Ratios or
other favorable credit factors.
Qualifications of Sellers
Each Seller must be an institution experienced in originating and servicing
loans of the type contained in the related Pool in accordance with accepted
practices and prudent guidelines, and must maintain satisfactory facilities to
originate and service those loans. Each Seller must be a seller/servicer
approved by either FNMA or FHLMC. Each Seller must be a mortgagee approved by
the FHA or an institution the deposit accounts of which are insured by the
Federal Deposit Insurance Corporation.
Representations by Sellers; Repurchases
Each Seller will have made representations and warranties in respect of the
Loans sold by such Seller and evidenced by all, or a part, of a Series of
Securities. Such representations and warranties may include, among other things:
(i) that title insurance (or in the case of Properties located in areas where
such policies are generally not available, an attorney's certificate of title)
and any required hazard insurance policy were effective at origination of each
Loan and that each policy (or certificate of title as applicable) remained in
effect on the date of purchase of the Loan from the Seller by or on behalf of
the Sponsor; (ii) that the Seller had good title to each such Loan and such Loan
was subject to no offsets, defenses, counterclaims or rights of rescission
except to the extent that any buydown agreement may forgive certain indebtedness
of a borrower; (iii) that each Loan constituted a valid lien on, or a perfected
security interest with respect to, the Property (subject only to permissible
liens disclosed, if applicable, title insurance exceptions, if applicable, and
certain other exceptions described in the Agreement) and that the Property was
free from damage and was in acceptable condition; (iv) that there were no
delinquent tax or assessment liens against the Property; (v) that no required
payment on a Loan was delinquent more than the number of days specified in the
related Prospectus Supplement; and (vi) that each Loan was made in compliance
with, and is enforceable under, all applicable state and federal laws and
regulations in all material respects.
The Master Servicer or the Trustee will promptly notify the relevant Seller
of any breach of any representation or warranty made by it in respect of a Loan
which materially and adversely affects the interests of the Securityholders in
such Loan. Unless otherwise specified in the related Prospectus Supplement, if
such Seller cannot cure such breach within the time period specified in the
related Prospectus Supplement following notice from the Master Servicer or the
Trustee, as the case may be, then such Seller will be obligated either (i) to
repurchase such Loan from the Trust Fund at a price (the "Purchase Price") equal
to 100% of the unpaid principal balance thereof as of the date of the repurchase
plus accrued interest thereon to the first day of the month following the month
of repurchase at the Loan Rate (less any Advances or amount payable as related
servicing compensation if the Seller is the Master Servicer) or (ii) substitute
for such Loan a replacement loan that satisfies the criteria specified in the
related Prospectus Supplement. If a REMIC election is to be made with respect to
a Trust Fund the Master Servicer or a holder of the related residual certificate
generally will be obligated to pay any prohibited transaction tax which may
arise in connection with any such repurchase or substitution and the Trustee
must have received a satisfactory opinion of counsel that any 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. This repurchase or substitution
obligation will constitute the sole remedy available to holders of Securities or
the Trustee for a breach of representation by a Seller.
Neither the Sponsor nor the Master Servicer (unless the Master Servicer is
the Seller) will be obligated to purchase or substitute a Loan if a Seller
defaults on its obligation to do so, and no assurance can be given that Sellers
will carry out their respective repurchase or substitution obligations with
respect to Loans.
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DESCRIPTION OF THE SECURITIES
Each Series of Certificates will be issued pursuant to separate agreements
(each, a "Pooling and Servicing Agreement" or a "Trust Agreement") among the
Sponsor, the Master Servicer and the Trustee. A form of Pooling and Servicing
Agreement and Trust Agreement has been filed as an exhibit to the Registration
Statement of which this Prospectus forms a part. 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, and the related Loans will be serviced
by the Master Servicer pursuant to a Master Servicing Agreement. A form of
Indenture and Master Servicing Agreement has been filed as an exhibit to the
Registration Statement of which this Prospectus forms a part.
A Series of Securities may consist of both Notes and Certificates. Each
Agreement, dated as of the related Cut-off Date, will be among the Seller, the
Sponsor, the Master Servicer and the Trustee for the benefit of the holders of
the Securities of such Series. The provisions of each Agreement will vary
depending upon the nature of the Securities to be issued thereunder and the
nature of the related Trust Fund. The following are descriptions of the material
provisions which may appear in each Agreement. The descriptions are subject to,
and are qualified in their entirety by reference to, all of the provisions of
the Agreement for each Series of Securities and the applicable Prospectus
Supplement. The Sponsor will provide a copy of the Agreement (without exhibits)
relating to any Series without charge upon written request of a holder of record
of a Security of such Series addressed to Headlands Mortgage Securities Inc.,
700 Larkspur Landing Circle, Suite 240, Larkspur, California 94939, Attention:
Secretary.
General
Unless otherwise described in the related Prospectus Supplement, the
Securities of each Series will be issued in book-entry or fully registered form,
in the authorized denominations specified in the related Prospectus Supplement,
will, in the case of Certificates, evidence specified beneficial ownership
interests in, and in the case of Notes, be secured by, the assets of the related
Trust Fund created pursuant to each Agreement and will not be entitled to
payments in respect of the assets included in any other Trust Fund established
by the Sponsor. Unless otherwise specified in the related Prospectus Supplement,
the Securities will not represent obligations of the Sponsor or any affiliate of
the Sponsor. Certain of the Loans may be guaranteed or insured as set forth in
the related Prospectus Supplement. Each Trust Fund will consist of, to the
extent provided in the related Agreement, (i) the Trust Fund Assets as are
subject to the related Agreement (exclusive of any amounts specified in the
related Prospectus Supplement ("Retained Interest")), including all payments of
interest and principal received with respect to the Loans after the Cut-off Date
(to the extent not applied in computing the principal balance of such Loans as
of the Cut-off Date (the "Cut-off Date Principal Balance")); (ii) such assets as
from time to time are required to be deposited in the related Security Account,
as described below under "The Agreements--Payments on Loans; Deposits to
Security Account"; (iii) property which secured a Loan and which is acquired on
behalf of the Securityholders by foreclosure or deed in lieu of foreclosure and
(iv) any insurance policies or other forms of credit enhancement required to be
maintained pursuant to the related Agreement. If so specified in the related
Prospectus Supplement, a Trust Fund may also include one or more of the
following: reinvestment income on payments received on the Trust Fund Assets, a
Reserve Account, a mortgage pool insurance policy, a special hazard insurance
policy, a bankruptcy bond, one or more letters of credit, a surety bond,
guaranties or similar instruments.
Each Series of Securities will be issued in one or more classes. Each class
of Certificates of a Series will evidence beneficial ownership of a specified
percentage (which may be 0%) or portion of future interest payments and a
specified percentage (which may be 0%) or portion of future principal payments
on, and each class of Notes of a Series will be secured by, the related Trust
Fund Assets. A Series of Securities may include one or more classes that are
senior in right to payment to one or more other classes of Securities of such
Series. Certain Series or classes of Securities may be covered by insurance
policies, surety bonds or other forms of credit enhancement, in each case as
described under "Credit Enhancement" herein and in the related Prospectus
Supplement. One or
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more classes of Securities of a Series may be entitled to receive distributions
of principal, interest or any combination thereof. Distributions on one or more
classes of a Series of Securities may be made prior to one or more other
classes, after the occurrence of specified events, in accordance with a schedule
or formula or on the basis of collections from designated portions of the
related Trust Fund Assets, in each case as specified in the related Prospectus
Supplement. The timing and amounts of such distributions may vary among classes
or over time as specified in the related Prospectus Supplement.
Distributions of principal and interest (or, where applicable, of principal
only or interest only) on the related Securities will be made by the Trustee on
each Distribution Date (i.e., monthly, quarterly, semi-annually or at such other
intervals and on the dates as are specified in the related Prospectus
Supplement) in proportion to the percentages specified in the related Prospectus
Supplement. Distributions will be made to the persons in whose names the
Securities are registered at the close of business on the dates specified in the
related Prospectus Supplement (each, a "Record Date"). Distributions will be
made in the manner specified in the related Prospectus Supplement to the persons
entitled thereto at the address appearing in the register maintained for
Securityholders (the "Security Register"); provided, however, that the final
distribution in retirement of the Securities will be made only upon presentation
and surrender of the Securities at the office or agency of the Trustee or other
person specified in the notice to Securityholders of such final distribution.
The Securities will be freely transferable and exchangeable at the
Corporate Trust Office of the Trustee as set forth in the related Prospectus
Supplement. No service charge will be made for any registration of exchange or
transfer of Securities of any Series, but the Trustee may require payment of a
sum sufficient to cover any related tax or other governmental charge.
Under current law the purchase and holding of a class of Securities
entitled only to a specified percentage of payments of either interest or
principal or a notional amount of other interest or principal on the related
Loans or a class of Securities entitled to receive payments of interest and
principal on the Loans only after payments to other classes or after the
occurrence of certain specified events by or on behalf of any employee benefit
plan or other retirement arrangement (including individual retirement accounts
and annuities, Keogh plans and collective investment funds in which such plans,
accounts or arrangements are invested) subject to provisions of ERISA or the
Code may result in prohibited transactions within the meaning of ERISA and the
Code. See "ERISA Considerations". Unless otherwise specified in the related
Prospectus Supplement, the transfer of Securities of such a class will not be
registered unless the transferee (i) represents that it is not, and is not
purchasing on behalf of, any such plan, account or arrangement or (ii) provides
an opinion of counsel satisfactory to the Trustee and the Depositor that the
purchase of Securities of such a class by or on behalf of such plan, account or
arrangement is permissible under applicable law and will not subject the
Trustee, the Master Servicer or the Depositor to any obligation or liability in
addition to those undertaken in the Agreements.
As to each Series, an election may be made to treat the related Trust Fund
or designated portions thereof as a "real estate mortgage investment conduit" or
"REMIC" as defined in the Code. The related Prospectus Supplement will specify
whether a REMIC election is to be made. Alternatively, the Agreement for a
Series of Securities may provide that a REMIC election may be made at the
discretion of the Sponsor or the Master Servicer and may only be made if certain
conditions are satisfied. As to any such Series, the terms and provisions
applicable to the making of a REMIC election will be set forth in the related
Prospectus Supplement. If such an election is made with respect to a Series of
Securities, one of the classes will be designated as evidencing the sole class
of "residual interests" in the related REMIC, as defined in the Code. All other
classes of Securities in such a Series will constitute "regular interests" in
the related REMIC, as defined in the Code. As to each Series of Securities with
respect to which a REMIC election is to be made, the Master Servicer, the
Trustee or a holder of the related residual certificate will be obligated to
take all actions required in order to comply with applicable laws and
regulations.
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Distributions on Securities
General. In general, the method of determining the amount of distributions
on a particular Series of Securities will depend on the type of credit support,
if any, that is used with respect to such Series. See "Credit Enhancement". Set
forth below are descriptions of various methods that may be used to determine
the amount of distributions on the Securities of a particular Series. The
Prospectus Supplement for each Series of Securities will describe the method to
be used in determining the amount of distributions on the Securities of such
Series.
Distributions allocable to principal and interest on the Securities will be
made by the Trustee out of, and only to the extent of, funds in the related
Security Account, including any funds transferred from any Reserve Account (a
"Reserve Account"). As between Securities of different classes and as between
distributions of principal (and, if applicable, between distributions of
Principal Prepayments, as defined below, and scheduled payments of principal)
and interest, distributions made on any Distribution Date will be applied as
specified in the related Prospectus Supplement. The Prospectus Supplement will
also describe the method for allocating distributions among Securities of a
particular class.
Available Funds. All distributions on the Securities of each Series on each
Distribution Date will be made from the Available Funds described below, in
accordance with the terms described in the related Prospectus Supplement and
specified in the Agreement. "Available Funds" for each Distribution Date will
generally equal the amount on deposit in the related Security Account on such
Distribution Date (net of related fees and expenses payable by the related Trust
Fund) other than amounts to be held therein for distribution on future
Distribution Dates.
Distributions of Interest. Interest will accrue on the aggregate principal
balance of the Securities (or, in the case of Securities entitled only to
distributions allocable to interest, the aggregate notional amount) of each
class of Securities (the "Class Security Balance") entitled to interest from the
date, at the Pass-Through Rate or interest rate, as applicable (which in either
case may be a fixed rate or rate adjustable as specified in such Prospectus
Supplement), and for the periods specified in such Prospectus Supplement. To the
extent funds are available therefor, interest accrued during each such specified
period on each class of Securities entitled to interest (other than a class of
Securities that provides for interest that accrues, but is not currently
payable, referred to hereafter as "Accrual Securities") will be distributable on
the Distribution Dates specified in the related Prospectus Supplement until the
aggregate Class Security Balance of the Securities of such class has been
distributed in full or, in the case of Securities entitled only to distributions
allocable to interest, until the aggregate notional amount of such Securities is
reduced to zero or for the period of time designated in the related Prospectus
Supplement. Except in the case of the Accrual Securities, the original Class
Security Balance of each Security will equal the aggregate distributions
allocable to principal to which such Security is entitled. Distributions
allocable to interest on each Security that is not entitled to distributions
allocable to principal will be calculated based on the notional amount of such
Security. The notional amount of a Security will not evidence an interest in or
entitlement to distributions allocable to principal but will be used solely for
convenience in expressing the calculation of interest and for certain other
purposes.
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 over a period ending two or
more days prior to a Distribution Date, the effective yield to Securityholders
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
such Distribution Date, and the effective yield (at par) to Securityholders will
be less than the indicated coupon rate.
With respect to any class of Accrual Securities, if specified in the
related Prospectus Supplement, any interest that has accrued but is not paid on
a given Distribution Date will be added to the aggregate Class Security Balance
of such class of Securities on that Distribution Date. Distributions of interest
on any class of Accrual
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Securities will commence only after the occurrence of the events specified
in such Prospectus Supplement. Prior to such time, the beneficial ownership
interest in the Trust Fund or the principal balance, as applicable, of such
class of Accrual Securities, as reflected in the aggregate Class Security
Balance of such class of Accrual Securities, will increase on each Distribution
Date by the amount of interest that accrued on such class of Accrual Securities
during the preceding interest accrual period but that was not required to be
distributed to such class on such Distribution Date. Any such class of Accrual
Securities will thereafter accrue interest on its outstanding Class Security
Balance as so adjusted.
Distributions of Principal. The related Prospectus Supplement will specify
the method by which the amount of principal to be distributed on the Securities
on each Distribution Date will be calculated and the manner in which such amount
will be allocated among the classes of Securities entitled to distributions of
principal. The aggregate Class Security Balance of any class of Securities
entitled to distributions of principal generally will be the aggregate original
Class Security Balance of such class of Securities specified in such Prospectus
Supplement, reduced by all distributions reported to the holders of such
Securities as allocable to principal and, (i) in the case of Accrual Securities,
as specified in the related Prospectus Supplement, increased by all interest
accrued but not then distributable on such Accrual Securities and (ii) in the
case of adjustable rate Securities, subject to the effect of negative
amortization, if applicable.
If so provided in the related Prospectus Supplement, one or more classes of
Securities will be entitled to receive all or a disproportionate percentage of
the payments of principal which are received from borrowers in advance of their
scheduled due dates and are not accompanied by amounts representing scheduled
interest due after the month of such payments ("Principal Prepayments") in the
percentages and under the circumstances or for the periods specified in such
Prospectus Supplement. Any such allocation of Principal Prepayments to such
class or classes of Securities will have the effect of accelerating the
amortization of such Securities while increasing the interests evidenced by one
or more other classes of Securities in the Trust Fund. Increasing the interests
of the other classes of Securities relative to that of certain Securities is
intended to preserve the availability of the subordination provided by such
other Securities. See "Credit Enhancement--Subordination".
Unscheduled Distributions. If specified in the related Prospectus
Supplement, the Securities will be subject to receipt of distributions before
the next scheduled Distribution Date under the circumstances and in the manner
described below and in such Prospectus Supplement. If applicable, the Trustee
will be required to make such unscheduled distributions on the day and in the
amount specified in the related Prospectus Supplement if, due to substantial
payments of principal (including Principal Prepayments) on the Trust Fund
Assets, the Trustee or the Master Servicer determines that the funds available
or anticipated to be available from the Security Account and, if applicable, any
Reserve Account, may be insufficient to make required distributions on the
Securities on such Distribution Date. Unless otherwise specified in the related
Prospectus Supplement, the amount of any such unscheduled distribution that is
allocable to principal will not exceed the amount that would otherwise have been
required to be distributed as principal on the Securities on the next
Distribution Date. Unless otherwise specified in the related Prospectus
Supplement, the unscheduled distributions will include interest at the
applicable Pass-Through Rate (if any) or interest rate (if any) on the amount of
the unscheduled distribution allocable to principal for the period and to the
date specified in such Prospectus Supplement.
Advances
To the extent provided in the related Prospectus Supplement, the Master
Servicer will be required to advance on or before each Distribution Date (from
its own funds, funds advanced by Sub-Servicers or funds held in the Security
Account for future distributions to the holders of Securities of the related
Series), an amount equal to the aggregate of payments of interest and/or
principal that were delinquent on the related Determination Date (as such term
is defined in the related Prospectus Supplement) and were not advanced by any
Sub-Servicer, subject to the Master Servicer's determination that such advances
may be recoverable out of late payments by borrowers, Liquidation Proceeds,
Insurance Proceeds or otherwise.
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In making Advances, the Master Servicer will endeavor to maintain a regular
flow of scheduled interest and principal payments to Securityholders, rather
than to guarantee or insure against losses. If Advances are made by the Master
Servicer from cash being held for future distribution to Securityholders, the
Master Servicer will replace such funds on or before any future Distribution
Date to the extent that funds in the applicable Security Account on such
Distribution Date would be less than the amount required to be available for
distributions to Securityholders on such date. Any Master Servicer funds
advanced will be reimbursable to the Master Servicer out of recoveries on the
specific Loans with respect to which such Advances were made (e.g., late
payments made by the related borrower, any related Insurance Proceeds,
Liquidation Proceeds or proceeds of any Loan purchased by the Sponsor, a
Sub-Servicer or a Seller pursuant to the related Agreement). Advances by the
Master Servicer (and any advances by a Sub-Servicer) also will be reimbursable
to the Master Servicer (or Sub-Servicer) from cash otherwise distributable to
Securityholders (including the holders of Senior Securities) to the extent that
the Master Servicer determines that any such Advances previously made are not
ultimately recoverable as described above. To the extent provided in the related
Prospectus Supplement, the Master Servicer also will be obligated to make
Advances, to the extent recoverable out of Insurance Proceeds, Liquidation
Proceeds or otherwise, in respect of certain taxes and insurance premiums not
paid by borrowers on a timely basis. Funds so advanced are reimbursable to the
Master Servicer to the extent permitted by the related Agreement. The
obligations of the Master Servicer to make advances may be supported by a cash
advance reserve fund, a surety bond or other arrangement of the type described
herein under "Credit Enhancement", in each case as described in the related
Prospectus Supplement.
If specified in the related Prospectus Supplement, in the event the Master
Servicer or a Sub-Servicer fails to make a required Advance, the Trustee will be
obligated to make such Advance in its capacity as successor servicer. If the
Trustee makes such an Advance, it will be entitled to be reimbursed for such
Advance to the same extent and degree as the Master Servicer or a Sub-Servicer
is entitled to be reimbursed for Advances. See "Description of the
Securities--Distributions on Securities".
Compensating Interest
If so specified in the related Prospectus Supplement, the Master Servicer
will be required to remit to the Trustee, with respect to each Loan in the
related Trust Fund as to which a principal prepayment in full or a principal
payment which is in excess of the scheduled monthly payment and is not intended
to cure a delinquency was received during any Due Period, an amount, from and to
the extent of amounts otherwise payable to the Master Servicer as servicing
compensation, equal to (i) the excess, if any, of (a) 30 days' interest on the
principal balance of the related Loan at the Loan Rate net of the per annum rate
at which the Master Servicer's servicing fee accrues, over (b) the amount of
interest actually received on such Loan during such Due Period, net of the
Master Servicer's servicing fee or (ii) such other amount as described in the
related Prospectus Supplement.
Reports to Securityholders
Prior to or concurrently with each distribution on a Distribution Date the
Master Servicer or the Trustee will furnish to each Securityholder of record of
the related Series a statement setting forth, to the extent applicable to such
Series of Securities, among other things:
(i) the amount of such distribution allocable to principal, separately
identifying the aggregate amount of any Principal Prepayments and if so
specified in the related Prospectus Supplement, any applicable prepayment
penalties included therein;
(ii) the amount of such distribution allocable to interest;
(iii) the amount of any Advance;
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(iv) the aggregate amount (a) otherwise allocable to the
Subordinated Securityholders on such Distribution Date, and (b)
withdrawn from the Reserve Account, if any, that is included in the
amounts distributed to the Senior Securityholders;
(v) the outstanding principal balance or notional amount of each
class of the related Series after giving effect to the distribution of
principal on such Distribution Date;
(vi) the percentage of principal payments on the Loans (excluding
prepayments), if any, which each such class will be entitled to
receive on the following Distribution Date;
(vii) the percentage of Principal Prepayments on the Loans, if
any, which each such class will be entitled to receive on the
following Distribution Date;
(viii) the related amount of the servicing compensation retained
or withdrawn from the Security Account by the Master Servicer, and the
amount of additional servicing compensation received by the Master
Servicer attributable to penalties, fees, excess Liquidation Proceeds
and other similar charges and items;
(ix) the number and aggregate principal balances of Loans (A)
delinquent (exclusive of Loans in foreclosure) (1) 1 to 30 days, (2)
31 to 60 days, (3) 61 to 90 days and (4) 91 or more days and (B) in
foreclosure and delinquent (1) 1 to 30 days, (2) 31 to 60 days, (3) 61
to 90 days and (4) 91 or more days, as of the close of business on the
last day of the calendar month preceding such Distribution Date;
(x) the book value of any real estate acquired through
foreclosure or grant of a deed in lieu of foreclosure;
(xi) the Pass-Through Rate or interest rate, as applicable, if
adjusted from the date of the last statement, of any such class
expected to be applicable to the next distribution to such class;
(xii) if applicable, the amount remaining in any Reserve Account
at the close of business on the Distribution Date;
(xiii) the Pass-Through Rate or interest rate, as applicable, as
of the day prior to the immediately preceding Distribution Date; and
(xiv) any amounts remaining under letters of credit, Pool
policies or other forms of credit enhancement.
Where applicable, any amount set forth above may be expressed as a dollar
amount per single Security of the relevant class specified in the related
Prospectus Supplement. The report to Securityholders for any Series of
Securities may include additional or other information of a similar nature to
that specified above.
In addition, within a reasonable period of time after the end of each
calendar year, the Master Servicer or the Trustee will mail to each
Securityholder of record at any time during such calendar year a report (a) as
to the aggregate of amounts reported pursuant to (i) and (ii) above for such
calendar year or, in the event such person was a Securityholder of record during
a portion of such calendar year, for the applicable portion of such year and (b)
such other customary information as may be deemed necessary or desirable for
Securityholders to prepare their tax returns.
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Categories of Classes of Securities
The Securities of any Series may be comprised of one or more classes. Such
classes, in general, fall into different categories. The following chart
identifies and generally defines certain of the more typical categories. The
Prospectus Supplement for a Series of Securities may identify the classes which
comprise such Series by reference to the following categories.
Categories of Classes Definition
PRINCIPAL TYPES
Accretion Directed................... A class that receives principal payments
from the accredit interest from
specified classes of Accrual Securities.
An Accretion Directed Class also may
receive principal payments from
principal paid on the underlying Trust
Fund Assets for the related Series.
Component Securities................. A class consisting of "Components." The
Components of a class of Component
Securities may have different principal
and/or interest payment characteristics
but together constitute a single class.
Each Component of a class of Component
Securities may be identified as falling
into one or more of the categories in
this chart.
Notional Amount
Securities......................... A class having no principal balance and
bearing interest on the related notional
amount. The notional amount is used for
purposes of the determination of
interest distributions.
Planned Principal Class
(also sometimes
referred to as "PACs")............. A class that is designed to receive
principal payments using a predetermined
principal balance schedule derived by
assuming two constant prepayment rates
for the underlying Trust Fund Assets.
These two rates are the endpoints for
the "structuring range" for the Planned
Principal Class. The Planned Principal
Classes in any Series of Securities may
be subdivided into different categories
(e.g., Primary Planned Principal
Classes, Secondary Planned Principal
Classes and so forth) having different
effective structuring ranges and
different principal payment priorities.
The structuring range for the Secondary
Planned Principal Class of a Series of
Securities will be narrower than that
for the Primary Planned Principal Class
of such Series.
Scheduled Principal Class............ A class that is designed to receive
principal payments using a predetermined
principal balance schedule but is not
designated as a Planned Principal Class
or Targeted Principal Class. In many
cases, the schedule is derived by
assuming two constant prepayment rates
for the underlying
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Categories of Classes Definition
Trust Fund Assets. These two rates are
the endpoints for the "structuring
range" for the Scheduled Principal
Class.
Sequential Pay....................... Classes that receive principal payments
in a prescribed sequence, that do not
have predetermined principal balance
schedules and that under all
circumstances receive payments of
principal continuously from the first
Distribution Date on which they receive
principal until they are retired. A
single class that receives principal
payments before or after all other
classes in the same Series of Securities
may be identified as a Sequential Pay
Class.
Strip................................ A class that receives a constant
proportion, or "strip," of the principal
payments on the underlying Trust Fund
Assets. The constant proportion of such
principal payments may or may not vary
for each Mortgage Asset included in the
Trust Fund and will be calculated in the
manner described in the related
Prospectus Supplement. Such Classes may
also receive payments of interest.
Support Class (also
sometimes referred to
as "Companion Classes")............ A class that receives principal payments
on any Distribution Date only if
scheduled payments have been made on
specified Planned Principal Classes,
Targeted Principal Classes and/or
Scheduled Principal Classes.
Targeted Principal Class
(also sometimes
referred to as "TACs")............. A class that is designed to receive
principal payments using a predetermined
principal balance schedule derived by
assuming a single constant prepayment
rate for the underlying Trust Fund
Assets.
INTEREST TYPES
Accrual.............................. A class that accretes the amount of
accrued interest otherwise distributable
on such class, which amount will be
added as principal to the principal
balance of such class, which amount will
be added as principal to the principal
balance of such class on each applicable
Distribution Date. Such accretion may
continue until some specified event has
occurred or until such Accrual Class is
retired.
Fixed Rate........................... A class with a Pass-Through Rate that is
fixed throughout the life of the class.
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Floating Rate........................ A class with a Pass-Through Rate that
resets periodically based upon a
designated index and that varies
directly with changes in such index.
Inverse Floating Rate................ A class with a Pass-Through Rate that
resets periodically based upon a
designated index and that varies
inversely with changes in such index.
Interest Only........................ A class that receives some or all of the
interest payments made on the underlying
Trust Fund Assets and little or no
principal. Interest Only Classes have
either a nominal principal balance or a
notional amount. A nominal principal
balance represents actual principal that
will be paid on the class. It is
referred to as nominal since it is
extremely small compared to other
classes. A notional amount is the amount
used as a reference to calculate the
amount of interest due on an Interest
Only Class that is not entitled to any
distributions in respect of principal.
Variable Rate........................ A class with an interest rate that
resets periodically and is calculated by
reference to the rate or rates of
interest applicable to specified assets
or instruments (e.g., the Loan Rates
borne by the underlying Loans).
Principal Only....................... A class that does not bear interest and
is entitled to receive only
distributions in respect of principal.
Partial Accrual...................... A class that accretes a portion of the
amount of accrued interest thereon,
which amount will be added to the
principal balance of such class on each
applicable Distribution Date, with the
remainder of such accrued interest to be
distributed currently as interest on
such class. Such accretion may continue
until a specified event has occurred or
until such Partial Accrual Class is
retired.
Book-Entry Registration of Securities
As described in the related Prospectus Supplement, if not issued in fully
registered form, each class of Securities will be registered as book-entry
certificates (the "Book-Entry Securities"). Persons acquiring beneficial
ownership interests in the Securities ("Security Owners") will hold their
Securities through the Depository Trust Company ("DTC") in the United States, or
Cedel Bank, societe anonyme ("CEDEL") or the Euroclear System ("Euroclear") in
Europe, if they are participants of such systems, or indirectly through
organizations which are participants in such systems. The Book-Entry Securities
will be issued in one or more certificates which equal the aggregate principal
balance of the Securities and will initially be registered in the name of Cede &
Co., the nominee of DTC. CEDEL and Euroclear will hold omnibus positions on
behalf of their participants through customers' securities accounts in CEDEL's
and Euroclear's names on the books of their respective depositaries which in
turn will hold such positions in customers' securities accounts in the
depositaries' names on the books of DTC. Citibank, N.A., will act as depositary
for CEDEL and The Chase Manhattan Bank will act as depositary for Euroclear (in
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such capacities, individually the "Relevant Depositary" and collectively the
"European Depositaries"). Except as described below, no person acquiring a
Book-Entry Security (each, a "beneficial owner") will be entitled to receive a
physical certificate representing such Security (a "Definitive Security").
Unless and until Definitive Securities are issued, it is anticipated that the
only "Securityholder" of the Securities will be Cede & Co., as nominee of DTC.
Security Owners are only permitted to exercise their rights indirectly through
Participants and DTC.
The beneficial owner's ownership of a Book-Entry Security will be recorded
on the records of the brokerage firm, bank, thrift institution or other
financial intermediary (each, a "Financial Intermediary") that maintains the
beneficial owner's account for such purpose. In turn, the Financial
Intermediary's ownership of such Book-Entry Security will be recorded on the
records of DTC (or of a participating firm that acts as agent for the Financial
Intermediary, whose interest will in turn be recorded on the records of DTC, if
the beneficial owner's Financial Intermediary is not a DTC participant, and on
the records of CEDEL or Euroclear, as appropriate).
Security Owners will receive all distributions of principal of, and
interest on, the Securities from the Trustee through DTC and DTC participants.
While the Securities are outstanding (except under the circumstances described
below), under the rules, regulations and procedures creating and affecting DTC
and its operations (the "Rules"), DTC is required to make book-entry transfers
among Participants on whose behalf it acts with respect to the Securities and is
required to receive and transmit distributions of principal of, and interest on,
the Securities. Participants and indirect participants with whom Security Owners
have accounts with respect to Securities are similarly required to make
book-entry transfers and receive and transmit such distributions on behalf of
their respective Security Owners. Accordingly, although Security Owners will not
possess certificates, the Rules provide a mechanism by which Security Owners
will receive distributions and will be able to transfer their interest.
Security Owners will not receive or be entitled to receive certificates
representing their respective interests in the Securities, except under the
limited circumstances described below. Unless and until Definitive Securities
are issued, Security Owners who are not Participants may transfer ownership of
Securities only through Participants and indirect participants by instructing
such Participants and indirect participants to transfer Securities, by
book-entry transfer, through DTC for the account of the purchasers of such
Securities, which account is maintained with their respective Participants.
Under the Rules and in accordance with DTC's normal procedures, transfers of
ownership of Securities will be executed through DTC and the accounts of the
respective Participants at DTC will be debited and credited. Similarly, the
Participants and indirect participants will make debits or credits, as the case
may be, on their records on behalf of the selling and purchasing Security
Owners.
Because of time zone differences, credits of securities received in CEDEL
or Euroclear as a result of a transaction with a Participant will be made during
subsequent securities settlement processing and dated the business day following
the DTC settlement date. Such credits or any transactions in such securities
settled during such processing will be reported to the relevant Euroclear or
CEDEL Participants on such business day. Cash received in CEDEL or Euroclear as
a result of sales of securities by or through a CEDEL Participant (as defined
herein) or Euroclear Participant (as defined herein) 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 with DTC.
Transfers between Participants will occur in accordance with DTC rules.
Transfers between CEDEL Participants and Euroclear Participants will occur in
accordance with their respective rules and operating procedures.
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 the Relevant 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
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transaction meets its settlement requirements, deliver instructions to the
Relevant 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 European Depositaries.
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. 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.
Euroclear was created in 1968 to hold securities for its participants
("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 be settled in any of 32 currencies, including United
States dollars. Euroclear 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. Euroclear is operated by the Brussels, Belgium office of Morgan
Guaranty Trust Company of New York ("Morgan" and in such capacity, the
"Euroclear Operator"), under contract with Euroclear Clearance Systems S.C., a
Belgian cooperative corporation (the "Belgian Cooperative"). All operations are
conducted by Morgan, and all Euroclear securities clearance accounts and
Euroclear cash accounts are accounts with the Euroclear Operator, not the
Belgian Cooperative. The Belgian Cooperative establishes policy for Euroclear on
behalf of Euroclear Participants. Euroclear Participants include banks
(including central banks), securities brokers and dealers and other professional
financial intermediaries. Indirect access to Euroclear is also available to
other firms that clear through or maintain a custodial relationship with a
Euroclear Participant, either directly or indirectly.
Morgan 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 Morgan 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 of securities
and cash within Euroclear, withdrawals of securities and cash from Euroclear,
and receipts of payments with respect to securities in Euroclear. All securities
in Euroclear 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.
Under a book-entry format, beneficial owners of the Book-Entry Securities
may experience some delay in their receipt of payments, since such payments will
be forwarded by the Trustee to Cede & Co., as nominee of DTC. Distributions with
respect to Securities 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 the
Relevant Depositary. Such distributions will be subject to tax reporting
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in accordance with relevant United States tax laws and regulations. See "Federal
Income Tax Consequences -Tax Treatment of Foreign Investors" and "--Tax
Consequences to Holders of the Notes--Backup Withholding" herein. Because DTC
can only act on behalf of Financial Intermediaries, the ability of a beneficial
owner to pledge Book-Entry Securities to persons or entities that do not
participate in the Depository system may be limited due to the lack of physical
certificates for such Book-Entry Securities. In addition, issuance of the
Book-Entry Securities in book-entry form may reduce the liquidity of such
Securities in the secondary market since certain potential investors may be
unwilling to purchase Securities for which they cannot obtain physical
certificates.
Monthly and annual reports on the Trust will be provided to Cede & Co., as
nominee of DTC, and may be made available by Cede & Co. to beneficial owners
upon request, in accordance with the rules, regulations and procedures creating
and affecting the Depository, and to the Financial Intermediaries to whose DTC
accounts the Book-Entry Securities of such beneficial owners are credited.
DTC has advised the Trustee that, unless and until Definitive Securities
are issued, DTC will take any action permitted to be taken by the holders of the
Book-Entry Securities under the applicable Agreement only at the direction of
one or more Financial Intermediaries to whose DTC accounts the Book-Entry
Securities are credited, to the extent that such actions are taken on behalf of
Financial Intermediaries whose holdings include such Book-Entry Securities.
CEDEL or the Euroclear Operator, as the case may be, will take any other action
permitted to be taken by a Securityholder under the Agreement on behalf of a
CEDEL Participant or Euroclear Participant only in accordance with its relevant
rules and procedures and subject to the ability of the Relevant Depositary to
effect such actions on its behalf through DTC. DTC may take actions, at the
direction of the related Participants, with respect to some Securities which
conflict with actions taken with respect to other Securities.
Upon the occurrence of any of the events described in the immediately
preceding paragraph, the Trustee will be required to notify all beneficial
owners of the occurrence of such event and the availability through DTC of
Definitive Securities. Upon surrender by DTC of the global certificate or
certificates representing the Book-Entry Securities and instructions for
re-registration, the Trustee will issue Definitive Securities, and thereafter
the Trustee will recognize the holders of such Definitive Securities as
Securityholders under the applicable Agreement.
Although DTC, CEDEL and Euroclear have agreed to the foregoing procedures
in order to facilitate transfers of Securities 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.
None of the Master Servicer, the Sponsor or the Trustee will have any
responsibility for any aspect of the records relating to or payments made on
account of beneficial ownership interests of the Book-Entry Securities held by
Cede & Co., as nominee of DTC, or for maintaining, supervising or reviewing any
records relating to such beneficial ownership interests.
CREDIT ENHANCEMENT
General
Credit enhancement may be provided with respect to one or more classes of a
Series of Securities or with respect to the related Trust Fund Assets. Credit
enhancement may be in the form of a limited financial guaranty policy issued by
an entity named in the related Prospectus Supplement, the subordination of one
or more classes of the Securities of such Series, the establishment of one or
more Reserve Accounts, the use of a cross-collateralization feature, use of a
mortgage pool insurance policy, FHA Insurance, VA Guarantee, bankruptcy bond,
special hazard insurance policy, surety bond, letter of credit, guaranteed
investment contract, overcollateralization, or another method of credit
enhancement contemplated herein and described in the related Prospectus
Supplement, or any combination of the foregoing. Unless otherwise specified in
the related Prospectus Supplement, credit enhancement will not provide
protection against all risks of loss and will not guarantee repayment
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of the entire principal balance of the Securities and interest thereon. If
losses occur which exceed the amount covered by credit enhancement or which are
not covered by the credit enhancement, Securityholders will bear their allocable
share of any deficiencies.
If specified in the related Prospectus Supplement, the coverage provided by
one or more of the forms of credit enhancement described in this Prospectus may
apply concurrently to two or more separate Trust Funds. If applicable, the
related Prospectus Supplement will identify the Trust Funds to which such credit
enhancement relates and the manner of determining the amount of coverage
provided to such Trust Funds thereby and of the application of such coverage to
the identified Trust Funds.
Subordination
If so specified in the related Prospectus Supplement, protection afforded
to holders of one or more classes of Securities of a Series by means of the
subordination feature may be accomplished by the preferential right of holders
of one or more other classes of such Series (the "Senior Securities") to
distributions in respect of scheduled principal, Principal Prepayments, interest
or any combination thereof that otherwise would have been payable to holders of
Subordinated Securities under the circumstances and to the extent specified in
the related Prospectus Supplement. Protection may also be afforded to the
holders of Senior Securities of a Series by: (i) reducing the ownership interest
(if applicable) of the related Subordinated Securities; (ii) a combination of
the immediately preceding sentence and clause (i) above; or (iii) as otherwise
described in the related Prospectus Supplement. If so specified in the related
Prospectus Supplement, delays in receipt of scheduled payments on the Loans and
losses on defaulted Loans may be borne first by the various classes of
Subordinated Securities and thereafter by the various classes of Senior
Securities, in each case under the circumstances and subject to the limitations
specified in such Prospectus Supplement. The aggregate distributions in respect
of delinquent payments on the Loans over the lives of the Securities or at any
time, the aggregate losses in respect of defaulted Loans which must be borne by
the Subordinated Securities by virtue of subordination and the amount of the
distributions otherwise distributable to the Subordinated Securityholders that
will be distributable to Senior Securityholders on any Distribution Date may be
limited as specified in the related Prospectus Supplement. If aggregate
distributions in respect of delinquent payments on the Loans or aggregate losses
in respect of such Loans were to exceed an amount specified in the related
Prospectus Supplement, holders of Senior Securities would experience losses on
their Securities.
In addition to or in lieu of the foregoing, if so specified in the related
Prospectus Supplement, all or any portion of distributions otherwise payable to
holders of Subordinated Securities on any Distribution Date may instead be
deposited into one or more Reserve Accounts established with the Trustee or
distributed to holders of Senior Securities. Such deposits may be made on each
Distribution Date, for specified periods or until the balance in the Reserve
Account has reached a specified amount and, following payments from the Reserve
Account to holders of Senior Securities or otherwise, thereafter to the extent
necessary to restore the balance in the Reserve Account to required levels, in
each case as specified in the related Prospectus Supplement. Amounts on deposit
in the Reserve Account may be released to the holders of certain classes of
Securities at the times and under the circumstances specified in such Prospectus
Supplement.
If specified in the related Prospectus Supplement, various classes of
Senior Securities and Subordinated Securities may themselves be subordinate in
their right to receive certain distributions to other classes of Senior and
Subordinated Securities, respectively, through a cross-collateralization
mechanism or otherwise. As between classes of Senior Securities and as between
classes of Subordinated Securities, distributions may be allocated among such
classes (i) in the order of their scheduled final Distribution Dates, (ii) in
accordance with a schedule or formula, (iii) in relation to the occurrence of
events, or (iv) otherwise, in each case as specified in the related Prospectus
Supplement. As between classes of Subordinated Securities, payments to holders
of Senior Securities on account of delinquencies or losses and payments to any
Reserve Account will be allocated as specified in the related Prospectus
Supplement.
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Letter of Credit
The letter of credit, if any, with respect to a Series of Securities will
be issued by the bank or financial institution specified in the related
Prospectus Supplement (the "L/C Bank"). Under the letter of credit, the L/C Bank
will be obligated to honor drawings thereunder in an aggregate fixed dollar
amount, net of unreimbursed payments thereunder, equal to the percentage
specified in the related Prospectus Supplement of the aggregate principal
balance of the Loans on the related Cut-off Date or of one or more Classes of
Securities. If so specified in the related Prospectus Supplement, the letter of
credit may permit drawings in the event of losses not covered by insurance
policies or other credit support, such as losses arising from damage not covered
by standard hazard insurance policies, losses resulting from the bankruptcy of a
borrower and the application of certain provisions of the federal Bankruptcy
Code, or losses resulting from denial of insurance coverage due to
misrepresentations in connection with the origination of a Loan. The amount
available under the letter of credit will, in all cases, be reduced to the
extent of the unreimbursed payments thereunder. The obligations of the L/C Bank
under the letter of credit for each Series of Securities will expire at the
earlier of the date specified in the related Prospectus Supplement or the
termination of the Trust Fund. See "The Agreements--Termination: Optional
Termination." A copy of the letter of credit for a Series, if any, will be filed
with the Commission as an exhibit to a Current Report on Form 8-K to be filed
within 15 days of issuance of the Securities of the related Series.
Insurance Policies, Surety Bonds and Guaranties
If so provided in the Prospectus Supplement for a Series of Securities,
deficiencies in amounts otherwise payable on such Securities or certain classes
thereof will be covered by insurance policies and/or surety bonds provided by
one or more insurance companies or sureties. Such instruments may cover, with
respect to one or more classes of Securities of the related Series, timely
distributions of interest and/or full distributions of principal on the basis of
a schedule of principal distributions set forth in or determined in the manner
specified in the related Prospectus Supplement. In addition, if specified in the
related Prospectus Supplement, a Trust Fund may also include bankruptcy bonds,
special hazard insurance policies, other insurance or guaranties for the purpose
of (i) maintaining timely payments or providing additional protection against
losses on the assets included in such Trust Fund, (ii) paying administrative
expenses or (iii) establishing a minimum reinvestment rate on the payments made
in respect of such assets or principal payment rate on such assets. Such
arrangements may include agreements under which Securityholders are entitled to
receive amounts deposited in various accounts held by the Trustee upon the terms
specified in such Prospectus Supplement. A copy of any such instrument for a
Series will be filed with the Commission as an exhibit to a Current Report on
Form 8-K to be filed with the Commission within 15 days of issuance of the
Securities of the related Series.
Over-Collateralization
If so provided in the Prospectus Supplement for a Series of Securities, a
portion of the interest payment on each Loan may be applied as an additional
distribution in respect of principal to reduce the principal balance of a
certain class or classes of Securities and, thus, accelerate the rate of payment
of principal on such class or classes of Securities relative to the principal
balance of the Loans in the related Trust Fund.
Reserve Accounts
If specified in the related Prospectus Supplement, credit support with
respect to a Series of Securities will be provided by the establishment and
maintenance with the Trustee for such Series of Securities, in trust, of one or
more Reserve Accounts for such Series. The related Prospectus Supplement will
specify whether or not any such Reserve Accounts will be included in the Trust
Fund for such Series.
The Reserve Account for a Series will be funded (i) by the deposit therein
of cash, United States Treasury securities, instruments evidencing ownership of
principal or interest payments thereon, letters of credit, demand
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notes, certificates of deposit or a combination thereof in the aggregate amount
specified in the related Prospectus Supplement, (ii) by the deposit therein from
time to time of certain amounts, as specified in the related Prospectus
Supplement to which the Subordinated Securityholders, if any, would otherwise be
entitled or (iii) in such other manner as may be specified in the related
Prospectus Supplement.
Any amounts on deposit in the Reserve Fund and the proceeds of any other
instrument deposited therein upon maturity will be held in cash or will be
invested in investments consisting of United States government securities and
other high-quality investments ("Eligible Investments"). Any instrument
deposited therein will name the Trustee, in its capacity as trustee for
Securityholders, or such other entity as is specified in the related Prospectus
Supplement, as beneficiary and will be issued by an entity acceptable to each
rating agency that rates the Securities. Additional information with respect to
such instruments deposited in the Reserve Funds will be set forth in the related
Prospectus Supplement.
Any amounts so deposited and payments on instruments so deposited will be
available for withdrawal from the Reserve Account for distribution to the
holders of Securities of the related Series for the purposes, in the manner and
at the times specified in the related Prospectus Supplement.
Pool Insurance Policies
If specified in the related Prospectus Supplement, a separate pool
insurance policy ("Pool Insurance Policy") will be obtained for the Pool and
issued by the insurer (the "Pool Insurer") named in such Prospectus Supplement.
Each Pool Insurance Policy will, subject to the limitations described below,
cover loss by reason of default in payment on Loans in the Pool in an amount
equal to a percentage specified in such Prospectus Supplement of the aggregate
principal balance of such Loans on the Cut-off Date. As more fully described
below, the Master Servicer will present claims thereunder to the Pool Insurer on
behalf of itself, the Trustee and the holders of the Securities of the related
Series. The Pool Insurance Policies, however, are not blanket policies against
loss, since claims thereunder may only be made respecting particular defaulted
Loans and only upon satisfaction of certain conditions precedent described
below. The Pool Insurance Policies generally will not cover losses due to a
failure to pay or denial of a claim under a Primary Mortgage Insurance Policy.
The Pool Insurance Policies generally will provide that no claims may be
validly presented unless (i) any required Primary Mortgage Insurance Policy is
in effect for the defaulted Loan and a claim thereunder has been submitted and
settled; (ii) hazard insurance on the related Property has been kept in force
and real estate taxes and other protection and preservation expenses have been
paid; (iii) if there has been physical loss or damage to the Property, it has
been restored to its physical condition (reasonable wear and tear excepted) at
the time of issuance of the policy; and (iv) the insured has acquired good and
merchantable title to the Property free and clear of liens except certain
permitted encumbrances. Upon satisfaction of these conditions, the Pool Insurer
will have the option either (a) to purchase the Property securing the defaulted
Loan at a price equal to the principal balance thereof plus accrued and unpaid
interest at the Loan Rate to the date of such purchase and certain expenses
incurred by the Master Servicer on behalf of the Trustee and Securityholders, or
(b) to pay the amount by which the sum of the principal balance of the defaulted
Loan plus accrued and unpaid interest at the Loan Rate to the date of payment of
the claim and the aforementioned expenses exceeds the proceeds received from an
approved sale of the Property, in either case net of certain amounts paid or
assumed to have been paid under the related Primary Mortgage Insurance Policy.
If any Property securing a defaulted Loan is damaged and proceeds, if any, from
the related hazard insurance policy or the applicable special hazard insurance
policy are insufficient to restore the damaged Property to a condition
sufficient to permit recovery under the Pool Insurance Policy, the Master
Servicer will not be required to expend its own funds to restore the damaged
Property unless it determines that (i) such restoration will increase the
proceeds to Securityholders on liquidation of the Loan after reimbursement of
the Master Servicer for its expenses and (ii) such expenses will be recoverable
by it through proceeds of the sale of the Property or proceeds of the related
Pool Insurance Policy or any related Primary Mortgage Insurance Policy.
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The Pool Insurance Policies generally will not insure (and many Primary
Mortgage Insurance Policies do not insure) against loss sustained by reason of a
default arising from, among other things, (i) fraud or negligence in the
origination or servicing of a Loan, including misrepresentation by the borrower,
the originator or persons involved in the origination thereof, or (ii) failure
to construct a Property in accordance with plans and specifications. A failure
of coverage attributable to one of the foregoing events might result in a breach
of the related Seller's representations described above, and, in such events
might give rise to an obligation on the part of such Seller to repurchase the
defaulted Loan if the breach cannot be cured by such Seller. No Pool Insurance
Policy will cover (and many Primary Mortgage Insurance Policies do not cover) a
claim in respect of a defaulted Loan occurring when the servicer of such Loan,
at the time of default or thereafter, was not approved by the applicable
insurer.
The original amount of coverage under each Pool Insurance Policy generally
will be reduced over the life of the related Securities by the aggregate dollar
amount of claims paid less the aggregate of the net amounts realized by the Pool
Insurer upon disposition of all foreclosed properties. The amount of claims paid
will include certain expenses incurred by the Master Servicer as well as accrued
interest on delinquent Loans to the date of payment of the claim or such other
date set forth in the related Prospectus Supplement. Accordingly, if aggregate
net claims paid under any Pool Insurance Policy reach the original policy limit,
coverage under that Pool Insurance Policy will be exhausted and any further
losses will be borne by the related Securityholders.
Cross Support
If specified in the related Prospectus Supplement, the beneficial ownership
of separate groups of assets included in a Trust Fund may be evidenced by
separate classes of the related Series of Securities. In such case, credit
support may be provided by a cross support feature which requires that
distributions be made to Securities evidencing a beneficial ownership interest
in, or secured by, one or more asset groups within the same Trust Fund prior to
distributions to Subordinated Securities evidencing a beneficial ownership
interest in, or secured by, one or more other asset groups within such Trust
Fund. The Prospectus Supplement for a Series of Securities which includes a
cross support feature will describe the manner and conditions for applying such
cross support feature.
Other Insurance, Guaranties, Letters of Credit and Similar Instruments or
Agreements
If specified in the related Prospectus Supplement, a Trust Fund may also
include insurance, guaranties, letters of credit or similar arrangements for the
purpose of (i) maintaining timely payments or providing additional protection
against losses on the assets included in such Trust Fund, (ii) paying
administrative expenses or (iii) establishing a minimum reinvestment rate on the
payments made in respect of such assets or principal payment rate on such
assets. Such arrangements may include agreements under which Securityholders are
entitled to receive amounts deposited in various accounts held by the Trustee
upon the terms specified in such Prospectus Supplement.
YIELD AND PREPAYMENT CONSIDERATIONS
The yields to maturity and weighted average lives of the Securities will be
affected primarily by the amount and timing of principal payments received on or
in respect of the Trust Fund Assets included in the related Trust Fund. The
original terms to maturity of the Loans in a given Pool will vary depending upon
the type of Loans included therein. Each Prospectus Supplement will contain
information with respect to the type and maturities of the Loans in the related
Pool. The related Prospectus Supplement will specify the circumstances, if any,
under which the related Loans will be subject to prepayment penalties. The
prepayment experience on the Loans in a Pool will affect the weighted average
life of the related Series of Securities.
The rate of prepayments with respect to conventional mortgage loans has
fluctuated significantly in recent years. In general, if prevailing rates fall
significantly below the Loan Rates borne by the Loans, such Loans are more
likely to be subject to higher prepayment rates than if prevailing interest
rates remain at or above such Loan Rates. Conversely, if prevailing interest
rates rise appreciably above the Loan Rates borne by the Loans, such
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Loans are more likely to experience a lower prepayment rate than if prevailing
rates remain at or below such Loan Rates. However, there can be no assurance
that such will be the case.
The rate of prepayment on the Loans cannot be predicted. Home equity loans
and home improvement contracts have been originated in significant volume only
during the past few years and the Sponsor is not aware of any publicly available
studies or statistics on the rate of prepayment of such loans. Generally, home
equity loans and home improvement contracts are not viewed by borrowers as
permanent financing. Accordingly, such Loans may experience a higher rate of
prepayment than traditional first mortgage loans. On the other hand, because
home equity loans such as the Revolving Credit Line Loans generally are not
fully amortizing, the absence of voluntary borrower prepayments could cause
rates of principal payments lower than, or similar to, those of traditional
fully-amortizing first mortgage loans. The prepayment experience of the related
Trust Fund may be affected by a wide variety of factors, including general
economic conditions, prevailing interest rate levels, the availability of
alternative financing, homeowner mobility and the frequency and amount of any
future draws on any Revolving Credit Line Loans. Other factors that might be
expected to affect the prepayment rate of a pool of home equity mortgage loans
or home improvement contracts include the amounts of, and interest rates on, the
underlying senior mortgage loans, and the use of first mortgage loans as
long-term financing for home purchase and subordinate mortgage loans as
shorter-term financing for a variety of purposes, including home improvement,
education expenses and purchases of consumer durables such as automobiles.
Accordingly, such Loans may experience a higher rate of prepayment than
traditional fixed-rate mortgage loans. In addition, any future limitations on
the right of borrowers to deduct interest payments on home equity loans for
federal income tax purposes may further increase the rate of prepayments of the
Loans. The enforcement of a "due-on-sale" provision (as described below) will
have the same effect as a prepayment of the related Loan. See "Certain Legal
Aspects of the Loans--Due-on-Sale Clauses".
The yield to an investor who purchases Securities in the secondary market
at a price other than par will vary from the anticipated yield if the rate of
prepayment on the Loans is actually different than the rate anticipated by such
investor at the time such Securities were purchased.
Collections on Home Equity Loans may vary because, among other things,
borrowers may (i) make payments during any month as low as the minimum monthly
payment for such month or, during the interest-only period for certain Revolving
Credit Line Loans and, in more limited circumstances, Closed-End Loans, with
respect to which an interest-only payment option has been selected, the interest
and the fees and charges for such month or (ii) make payments 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 the required
periodic payments. In addition, collections on the Loans may vary due to
seasonal purchasing and the payment habits of borrowers.
As specified in the related Prospectus Supplement, certain of the
conventional Loans will contain "due-on-sale" provisions permitting the
mortgagee to accelerate the maturity of the Loan upon sale or certain transfers
by the borrower of the related Property. Loans insured by the FHA, and single
family loans partially guaranteed by the VA, are assumable with the consent of
the FHA and the VA, respectively. Thus, the rate of prepayments on such Loans
may be lower than that of conventional Loans bearing comparable interest rates.
The Master Servicer generally will enforce any due-on-sale or due-on-encumbrance
clause, to the extent it has knowledge of the conveyance or further encumbrance
or the proposed conveyance or proposed further encumbrance of the Property and
reasonably believes that it is entitled to do so under applicable law; provided,
however, that the Master Servicer will not take any enforcement action that
would impair or threaten to impair any recovery under any related insurance
policy. See "The Agreements--Collection Procedures" and "Certain Legal Aspects
of the Loans" for a description of certain provisions of each Agreement and
certain legal developments that may affect the prepayment experience on the
Loans.
When a full prepayment is made on a Loan, the borrower is charged interest
on the principal amount of the Loan so prepaid only for the number of days in
the month actually elapsed up to the date of the prepayment, rather than for a
full month. The effect of prepayments in full will be to reduce the amount of
interest passed
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through or paid in the following month to holders of Securities because interest
on the principal amount of any Loan so prepaid will generally be paid only to
the date of prepayment. Partial prepayments in a given month may be applied to
the outstanding principal balances of the Loans so prepaid on the first day of
the month of receipt or the month following receipt. In the latter case, partial
prepayments will not reduce the amount of interest passed through or paid in
such month. Generally, neither full nor partial prepayments will be passed
through or paid until the month following receipt.
Even assuming that the Properties provide adequate security for the Loans,
substantial delays could be encountered in connection with the liquidation of
defaulted Loans and corresponding delays in the receipt of related proceeds by
Securityholders could occur. An action to foreclose on a Property securing a
Loan is regulated by state statutes and rules and is subject to many of the
delays and expenses of other lawsuits if defenses or counterclaims are
interposed, sometimes requiring several years to complete. Furthermore, in some
states an action to obtain a deficiency judgment is not permitted following a
nonjudicial sale of a property. In the event of a default by a borrower, these
restrictions among other things, may impede the ability of the Master Servicer
to foreclose on or sell the Property or to obtain liquidation proceeds
sufficient to repay all amounts due on the related Loan. In addition, the Master
Servicer will be entitled to deduct from related liquidation proceeds all
expenses reasonably incurred in attempting to recover amounts due on defaulted
Loans and not yet repaid, including payments to senior lienholders, legal fees
and costs of legal action, real estate taxes and maintenance and preservation
expenses.
Liquidation expenses with respect to defaulted mortgage loans do not vary
directly with the outstanding principal balance of the loan at the time of
default. Therefore, assuming that a servicer took the same steps in realizing
upon a defaulted mortgage loan having a small remaining principal balance as it
would in the case of a defaulted mortgage loan having a large remaining
principal balance, the amount realized after expenses of liquidation would be
smaller as a percentage of the remaining principal balance of the small mortgage
loan than would be the case with the other defaulted mortgage loan having a
large remaining principal balance.
If the rate at which interest is passed through or paid to the holders of
Securities of a Series is calculated on a Loan-by-Loan basis, disproportionate
principal prepayments among Loans with different Loan Rates will affect the
yield on such Securities. In most cases, the effective yield to Securityholders
will be lower than the yield otherwise produced by the applicable Pass-Through
Rate and purchase price, because while interest will accrue on each Loan from
the first day of the month (unless otherwise specified in the related Prospectus
Supplement), the distribution of such interest will not be made earlier than the
month following the month of accrual.
Under certain circumstances, the Master Servicer, the holders of the
residual interests in a REMIC or any person specified in the related Prospectus
Supplement may have the option to purchase the assets of a Trust Fund and
thereby effect earlier retirement of the related Series of Securities. See "The
Agreements--Termination; Optional Termination".
The relative contribution of the various factors affecting prepayment may
vary from time to time. There can be no assurance as to the rate of payment of
principal of the Trust Fund Assets at any time or over the lives of the
Securities.
The Prospectus Supplement relating to a Series of Securities will discuss
in greater detail the effect of the rate and timing of principal payments
(including prepayments), delinquencies and losses on the yield, weighted average
lives and maturities of such Securities.
THE AGREEMENTS
Set forth below is a description of the material provisions of each
Agreement which are not described elsewhere in this Prospectus. The description
is subject to, and qualified in its entirety by reference to, the
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provisions of each Agreement. Where particular provisions or terms used in the
Agreements are referred to, such provisions or terms are as specified in the
Agreements.
Assignment of the Trust Fund Assets
Assignment of the Loans. At the time of issuance of the Securities of a
Series, the Sponsor will assign the Loans comprising the related Trust Fund to
the Trustee, without recourse, together with all principal and interest received
by or on behalf of the Sponsor on or with respect to such Loans after the
Cut-off Date, other than principal and interest due on or before the Cut-off
Date and other than any Retained Interest specified in the related Prospectus
Supplement. The Trustee will, concurrently with such assignment, deliver such
Securities to the Sponsor in exchange for the Loans. Each Loan will be
identified in a schedule appearing as an exhibit to the related Agreement. Such
schedule will include information as to the outstanding principal balance of
each Loan after application of payments due on or before the Cut-off Date, as
well as information regarding the Loan Rate or APR, the maturity of the Loan,
the Loan-to-Value Ratios or Combined Loan-to-Value Ratios, as applicable, at
origination and certain other information.
Unless otherwise specified in the related Prospectus Supplement, the
Agreement will require that, within the time period specified therein, the
Sponsor will also deliver or cause to be delivered to the Trustee (or to the
custodian hereinafter referred to) as to each Mortgage Loan or Home Equity Loan,
among other things, (i) the mortgage note or contract endorsed without recourse
in blank or to the order of the Trustee, (ii) the mortgage, deed of trust or
similar instrument (a "Mortgage") with evidence of recording indicated thereon
(except for any Mortgage not returned from the public recording office, in which
case the Sponsor will deliver or cause to be delivered a copy of such Mortgage
together with a certificate that the original of such Mortgage was delivered to
such recording office), (iii) an assignment of the Mortgage to the Trustee,
which assignment will be in recordable form in the case of a Mortgage
assignment, and (iv) such other security documents, including those relating to
any senior interests in the Property, as may be specified in the related
Prospectus Supplement or the related Agreement. Unless otherwise specified in
the related Prospectus Supplement, the Sponsor will promptly cause the
assignments of the related Loans to be recorded in the appropriate public office
for real property records. If specified in the related Prospectus Supplement,
some or all of the Loan documents may not be delivered to the Trustee until
after the occurrence of certain events specified in the related Prospectus
Supplement.
Unless otherwise specified in the related Prospectus Supplement, the
Sponsor will as to each Home Improvement Contract, deliver or cause to be
delivered to the Trustee 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 Sponsor will cause a UCC-1 financing statement to be executed by
the Sponsor or the Seller 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
Trustee. 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."
The Trustee (or the custodian hereinafter referred to) will review such
Loan documents within the time period specified in the related Prospectus
Supplement after receipt thereof to ascertain that all required documents have
been properly executed and received, and the Trustee will hold such documents in
trust for the benefit of the related Securityholders. Unless otherwise specified
in the related Prospectus Supplement, if any such document is found to be
missing or defective in any material respect, the Trustee (or such custodian)
will notify the Master Servicer and the Sponsor, and the Master Servicer will
notify the related Seller. If such Seller cannot cure the omission or defect
within the time period specified in the related Prospectus Supplement after
receipt of such notice,
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such Seller will be obligated to either (i) purchase the related Loan from the
Trust Fund at the Purchase Price or (ii) if so specified in the related
Prospectus Supplement, remove such Loan from the Trust Fund and substitute in
its place one or more other Loans that meets certain requirements set forth
therein. There can be no assurance that a Seller will fulfill this purchase or
substitution obligation. Unless otherwise specified in the related Prospectus
Supplement, this obligation to cure, purchase or substitute constitutes the sole
remedy available to the Securityholders or the Trustee for omission of, or a
material defect in, a constituent document.
The Trustee will be authorized to appoint a custodian pursuant to a
custodial agreement to maintain possession of and, if applicable, to review the
documents relating to the Loans as agent of the Trustee.
Notwithstanding the foregoing provisions, with respect to a Trust Fund for
which a REMIC election is to be made, no purchase or substitution of a Loan will
be made if such purchase or substitution would result in a prohibited
transaction tax under the Code.
No Recourse to Sellers; Sponsor or Master Servicer. As described above
under "--Assignment of the Loans," the Sponsor will assign the Loans comprising
the related Trust Fund to the Trustee, without recourse. However, each Seller
will be obligated to repurchase or substitute for any Loan as to which certain
representations and warranties are breached or for failure to deliver certain
documents relating to the Loans as described herein under "Assignment of the
Loans" and "Loan Program--Representations by Sellers; Repurchases." These
obligations to purchase or substitute constitute the sole remedy available to
the Securityholders or the Trustee for a breach of any such representation or
warranty or failure to deliver a constituent document.
Payments on Loans; Deposits to Security Account
The Master Servicer will establish and maintain or cause to be established
and maintained with respect to the related Trust Fund a separate account or
accounts for the collection of payments on the related Trust Fund Assets in the
Trust Fund (the "Security Account") which must be an Eligible Account. An
"Eligible Account" is an account or accounts which is (i) maintained with a
depository institution the short-term debt obligations of which (or, in the case
of a depository institution that is the principal subsidiary of a holding
company, the short-term debt obligations of such holding company) are rated in
one of the two highest short-term rating categories by the Rating Agency that
rated one or more classes of the related Series of Securities, (ii) an account
or accounts the deposits in which are fully insured by the FDIC, (iii) an
account or accounts the deposits in which are insured by the FDIC to the limits
established by the FDIC and the uninsured deposits in which are otherwise
secured such that, as evidenced by an opinion of counsel, Securityholders have a
claim with respect to the funds in such account or accounts, or a perfected
first-priority security interest against any collateral securing such funds,
that is superior to the claims of any other depositors or general creditors of
the depository institution with which such account or accounts are maintained or
(iv) an account or accounts otherwise acceptable to such Rating Agency. The
collateral eligible to secure amounts in the Security Account is limited to
Permitted Investments. A Security Account may be maintained as an interest
bearing account or the funds held therein may be invested pending each
succeeding Distribution Date in Permitted Investments. The Master Servicer or
its designee will be entitled to receive any such interest or other income
earned on funds in the Security Account as additional compensation and will be
obligated to deposit in the Security Account the amount of any loss immediately
as realized. The Security Account may be maintained with the Master Servicer or
with a depository institution that is an affiliate of the Master Servicer,
provided it meets the standards set forth above.
The Master Servicer will deposit or cause to be deposited in the Security
Account for each Trust Fund, to the extent applicable and unless otherwise
specified in the related Prospectus Supplement and provided in the Agreement,
the following payments and collections received or advances made by or on behalf
of it subsequent to the Cut-off Date (other than certain payments due on or
before the Cut-off Date and exclusive of any amounts representing Retained
Interest):
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(i) all payments on account of principal and interest (which, at its
option, may be net of the applicable servicing compensation), including
Principal Prepayments and, if specified in the related Prospectus
Supplement, any applicable prepayment penalties, on the Loans;
(ii) all proceeds (net of unreimbursed payments of property taxes,
insurance premiums and similar items ("Insured Expenses") incurred, and
unreimbursed Advances made, by the Master Servicer, if any) of the hazard
insurance policies and any Primary Mortgage Insurance Policies, to the
extent such proceeds are not applied to the restoration of the property or
released to the Mortgagor in accordance with the Master Servicer's normal
servicing procedures (collectively, "Insurance Proceeds") and all other
cash amounts (net of unreimbursed expenses incurred in connection with
liquidation or foreclosure ("Liquidation Expenses") and unreimbursed
Advances made, by the Master Servicer, if any) received and retained in
connection with the liquidation of defaulted Loans, by foreclosure or
otherwise ("Liquidation Proceeds"), together with any net proceeds received
on a monthly basis with respect to any properties acquired on behalf of the
Securityholders by foreclosure or deed in lieu of foreclosure;
(iii) all advances as described herein under "Advances";
(iv) all proceeds of any Loan or property in respect thereof
repurchased by any Seller as described under "Loan Program--Representations
by Sellers; Repurchases" or "--Assignment of Trust Fund Assets" above and
all proceeds of any Loan repurchased as described under "--Termination;
Optional Termination" below;
(v) all payments required to be deposited in the Security Account with
respect to any deductible clause in any blanket insurance policy described
under "--Hazard Insurance" below;
(vi) any amount required to be deposited by the Master Servicer in
connection with losses realized on investments for the benefit of the
Master Servicer of funds held in the Security Account and, to the extent
specified in the related Prospectus Supplement, any payments required to be
made by the Master Servicer in connection with prepayment interest
shortfalls; and
(vii) all other amounts required to be deposited in the Security
Account pursuant to the Agreement.
The Master Servicer (or the Sponsor, as applicable) may from time to time
direct the institution that maintains the Security Account to withdraw funds
from the Security Account for the following purposes:
(i) to pay to the Master Servicer the servicing fees described in the
related Prospectus Supplement and, as additional servicing compensation,
earnings on or investment income with respect to funds in the Security
Account credited thereto;
(ii) to reimburse the Master Servicer for Advances, such right of
reimbursement with respect to any Loan being limited to amounts received
that represent late recoveries of payments of principal and/or interest on
such Loan (or Insurance Proceeds or Liquidation Proceeds with respect
thereto) with respect to which such Advance was made;
(iii) to reimburse the Master Servicer for any Advances previously
made which the Master Servicer has determined to be nonrecoverable;
(iv) to reimburse the Master Servicer from Insurance Proceeds for
expenses incurred by the Master Servicer and covered by the related
insurance policies;
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(v) to reimburse the Master Servicer for unpaid master servicing fees
and unreimbursed out-of-pocket costs and expenses incurred by the Master
Servicer in the performance of its servicing obligations, such right of
reimbursement being limited to amounts received representing late
recoveries of the payments for which such advances were made;
(vi) to pay to the Master Servicer, with respect to each Loan or
property acquired in respect thereof that has been purchased by the Master
Servicer pursuant to the Agreement, all amounts received thereon and not
taken into account in determining the principal balance of such repurchased
Loan;
(vii) to reimburse the Master Servicer or the Sponsor for expenses
incurred and reimbursable pursuant to the Agreement;
(viii) to withdraw any amount deposited in the Security Account and
not required to be deposited therein; and
(ix) to clear and terminate the Security Account upon termination of
the Agreement.
In addition, unless otherwise specified in the related Prospectus
Supplement, on or prior to the business day immediately preceding each
Distribution Date, the Master Servicer shall withdraw from the Security Account
the amount of Available Funds, to the extent on deposit, for deposit in an
account maintained by the Trustee for the related Series of Securities.
The applicable Agreement may require the Master Servicer to establish and
maintain one or more escrow accounts into which mortgagors deposit amounts
sufficient to pay taxes, assessments, hazard insurance premiums or comparable
items. Withdrawals from the escrow accounts maintained for mortgagors may be
made to effect timely payment of taxes, assessments and hazard insurance
premiums or comparable items, to reimburse the Master Servicer out of related
assessments for maintaining hazard insurance, to refund to mortgagors amounts
determined to be overages, to remit to mortgagors, if required, interest earned,
if any, on balances in any of the escrow accounts, to repair or otherwise
protect the Property and to clear and terminate any of the escrow accounts. The
Master Servicer will be solely responsible for administration of the escrow
accounts and will be expected to make advances to such account when a deficiency
exists therein.
Pre-Funding Account
If so provided in the related Prospectus Supplement, the Master Servicer
will establish and maintain a Pre-Funding Account, in the name of the related
Trustee on behalf of the related Securityholders, into which the Sponsor will
deposit cash in an amount equal to the Pre-Funded Amount on the related Closing
Date. The Pre-Funding Account will be maintained with the Trustee for the
related Series of Securities and is designed solely to hold funds to be applied
by such Trustee during the Funding Period to pay to the Sponsor the purchase
price for Subsequent Loans. Monies on deposit in the Pre-Funding Account will
not be available to cover losses on or in respect of the related Loans. The
Pre-Funded Amount will not exceed 50% of the initial aggregate principal amount
of the Securities of the related Series. The Pre-Funded Amount will be used by
the related Trustee to purchase Subsequent Loans from the Sponsor from time to
time during the Funding Period. The Funding Period, if any, for a Trust Fund
will begin on the related Closing Date and will end on the date specified in the
related Prospectus Supplement, which in no event will be later than the date
that is one year after the related Closing Date. Monies on deposit in the
Pre-Funding Account may be invested in Permitted Investments under the
circumstances and in the manner described in the related Agreement. Earnings on
investment of funds in the Pre-Funding Account will be deposited into the
related Security Account or such other trust account as is specified in the
related Prospectus Supplement and losses will be charged against the funds on
deposit in the Pre-Funding Account. Any amounts remaining in the Pre-Funding
Account at the end of the Funding Period will be distributed to the related
Securityholders in the
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manner and priority specified in the related Prospectus Supplement, as a
prepayment of principal of the related Securities.
In addition, if so provided in the related Prospectus Supplement, on the
related Closing Date the Sponsor will deposit in an account (the "Capitalized
Interest Account") cash in such amount as is necessary to cover shortfalls in
interest on the related Series of Securities that may arise as a result of
utilization of the Pre-Funding Account as described above. The Capitalized
Interest Account shall be maintained with the Trustee for the related Series of
Securities and is designed solely to cover the above-mentioned interest
shortfalls. Monies on deposit in the Capitalized Interest Account will not be
available to cover losses on or in respect of the related Loans. To the extent
that the entire amount on deposit in the Capitalized Interest Account has not
been applied to cover shortfalls in interest on the related Series of Securities
by the end of the Funding Period, any amounts remaining in the Capitalized
Interest Account will be paid to the Sponsor.
Sub-Servicing by Sellers
The Master Servicer may enter into an agreement (each, a "Sub-Servicing
Agreement") with any servicing entity which will act as the Sub-Servicer for the
related Loans, which will not contain any terms inconsistent with the related
Agreement. While each Sub-Servicing Agreement will be a contract solely between
the Master Servicer and the Sub-Servicer, the Agreement pursuant to which a
Series of Securities is issued will provide that, if for any reason the Master
Servicer for such Series of Securities is no longer the Master Servicer of the
related Loans, the Trustee or any successor Master Servicer must recognize the
Sub-Servicer's rights and obligations under such Sub-Servicing Agreement.
Notwithstanding any such subservicing arrangement, unless otherwise provided in
the related Prospectus Supplement, the Master Servicer will remain liable for
its servicing duties and obligations under the Master Servicing Agreement as if
the Master Servicer alone were servicing the Loans.
Collection Procedures
The Master Servicer, directly or through one or more Sub-Servicers, will
make reasonable efforts to collect all payments called for under the Loans and
will, consistent with each Agreement and any Pool Insurance Policy, Primary
Mortgage Insurance Policy, FHA Insurance, VA Guaranty, bankruptcy bond or
alternative arrangements, follow such collection procedures as are customary
with respect to loans that are comparable to the Loans. Consistent with the
above, the Master Servicer may, in its discretion, (i) waive any prepayment
charge, assumption fee, late payment or other charge in connection with a Loan
and (ii) to the extent not inconsistent with the coverage of such Loan by a Pool
Insurance Policy, Primary Mortgage Insurance Policy, FHA Insurance, VA Guaranty,
bankruptcy bond or alternative arrangements, if applicable, suspend or reduce
regular monthly payment for a period of up to six months, or arrange with a
borrower a schedule for the liquidation of delinquencies. To the extent the
Master Servicer is obligated to make or cause to be made Advances, such
obligation will remain during any period of such an arrangement.
Under the Agreement, the Master Servicer will be required to enforce
"due-on-sale" clauses with respect to any Loans to the extent contemplated by
the terms of such Loans and permitted by applicable law. Where an assumption of,
or substitution of liability with respect to, a Loan is required by law, upon
receipt of assurance that the Primary Mortgage Insurance Policy covering such
Loan will not be affected, the Master Servicer may permit the assumption of a
Loan, pursuant to which the borrower would remain liable on the related loan
note, or a substitution of liability with respect to such Loan, pursuant to
which the new borrower would be substituted for the original borrower as being
liable on the loan note. Any fees collected for entering into an assumption or
substitution of liability agreement may be retained by the Master Servicer as
additional servicing compensation. In connection with any assumption or
substitution, the Loan Rate borne by the related loan note may not be changed.
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Hazard Insurance
Except as otherwise specified in the related Prospectus Supplement, the
Master Servicer will require the mortgagor or obligor on each Loan to maintain a
hazard insurance policy providing coverage against loss by fire and other
hazards which are covered under the standard extended coverage endorsement
customary for the type of Property in the state in which such Property is
located. Such coverage will be in an amount that is at least equal to the lesser
of (i) the maximum insurable value of the improvements securing such Loan from
time to time, or (ii) the greater of (y) the combined principal balance owing on
such Loan and any mortgage loan senior to such Loan and (z) an amount such that
the proceeds of such policy shall be sufficient to prevent the mortgagor or
obligor and/or the lender from becoming a co-insurer. All amounts collected by
the Master Servicer under any hazard policy (except for amounts to be applied to
the restoration or repair of the Property or released to the mortgagor or
obligor in accordance with the Master Servicer's normal servicing procedures)
will be deposited in the related Security Account. In the event that the Master
Servicer maintains a blanket policy insuring against hazard losses on all the
Loans comprising part of a Trust Fund, it will conclusively be deemed to have
satisfied its obligation relating to the maintenance of hazard insurance. Such
blanket policy may contain a deductible clause, in which case the Master
Servicer will be required to deposit from its own funds into the related
Security Account the amounts which would have been deposited therein but for
such clause.
In general, the standard form of fire and extended coverage policy covers
physical damage to or destruction of the improvements securing a Loan by fire,
lightning, explosion, smoke, windstorm and hail, riot, strike and civil
commotion, subject to the conditions and exclusions particularized in each
policy. Although the policies relating to the Loans may have been underwritten
by different insurers under different state laws in accordance with different
applicable forms and therefore may not contain identical terms and conditions,
the basic terms thereof are dictated by respective state laws, and most such
policies typically do not cover (among other things) any physical damage
resulting from the following: war, revolution, governmental actions, floods and
other water-related causes, earth movement (including earthquakes, landslides
and mud flows), 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.
If, however, any Mortgaged Property at the time of origination of the
related Loan is located in an area identified by the Flood Emergency Management
Agency as having special flood hazards and flood insurance has been made
available, the Master Servicer will cause to be maintained with a generally
acceptable insurance carrier a flood insurance policy in accordance with
mortgage servicing industry practice. Such flood insurance policy will provide
coverage in an amount not less than the lesser of (i) the principal balance of
the Loan or (ii) the minimum amount required under the terms of coverage to
compensate for any damage or loss on a replacement cost basis, but not more than
the maximum amount of such insurance available for the related Mortgaged
Property under either the regular or emergency programs of the National Flood
Insurance Program.
The hazard insurance policies covering properties securing the Loans
typically contain a clause which in effect requires the insured at all time to
carry insurance of a specified percentage (generally 80% to 90%) of the full
replacement value of the insured property in order to recover the full amount of
any partial loss. If the insured's coverage falls below this specified
percentage, then the insurer's liability in the event of partial loss will not
exceed the larger of (i) the replacement costs of the improvements less physical
depreciation and (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. Since the amount of hazard insurance the Master Servicer may cause
to be maintained on the improvements securing the Loans declines as the
principal balances owing thereon decrease, and since improved real estate
generally has appreciated in value over time in the past, the effect of this
requirement in the event of partial loss may be that hazard insurance proceeds
will be insufficient to restore fully the damaged property.
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Primary Mortgage Insurance
The Master Servicer will maintain or cause to be maintained, as the case
may be, in full force and effect, to the extent specified in the related
Prospectus Supplement, a Primary Mortgage Insurance Policy with regard to each
Loan for which such coverage is required. The Master Servicer will not cancel or
refuse to renew any such Primary Mortgage Insurance Policy in effect at the time
of the initial issuance of a Series of Securities that is required to be kept in
force under the applicable Agreement unless the replacement Primary Mortgage
Insurance Policy for such cancelled or nonrenewed policy is maintained with an
insurer (a "Primary Insurer") whose claims-paying ability is sufficient to
maintain the current rating of the classes of Securities of such Series that
have been rated.
Although the terms and conditions of primary mortgage insurance vary, the
amount of a claim for benefits under a Primary Mortgage Insurance Policy
covering a Mortgage Loan will consist of the insured percentage of the unpaid
principal amount of the covered Loan and accrued and unpaid interest thereon and
reimbursement of certain expenses, less (i) all rents or other payments
collected or received by the insured (other than the proceeds of hazard
insurance) that are derived from or in any way related to the Property, (ii)
hazard insurance proceeds in excess of the amount required to restore the
Property and which have not been applied to the payment of the Loan, (iii)
amounts expended but not approved by the Primary Insurer of the related Primary
Mortgage Insurance Policy, (iv) claim payments previously made by the Primary
Insurer and (v) unpaid premiums.
Primary Mortgage Insurance Policies reimburse certain losses sustained by
reason of default in payments by borrowers. Primary Mortgage Insurance Policies
will not insure against, and exclude from coverage, a loss sustained by reason
of a default arising from or involving certain matters, including (i) fraud or
negligence in ordination or servicing of the Loans, including misrepresentation
by the originator, mortgagor (or obligor) or other persons involved in the
origination of the Loan; (ii) failure to construct the Property subject to the
Loan in accordance with specified plans; (iii) physical damage to the Property;
and (iv) the related sub-servicer not being approved as a servicer by the
Primary Insurer.
Evidence of each Primary Mortgage Insurance Policy will be provided to the
Trustee simultaneously with the transfer to the Trustee of the related Loan. The
Master Servicer, on behalf of itself, the Trustee and Securityholders, is
required to present claims to the insurer under any Primary Mortgage Insurance
Policy and to take such reasonable steps as are necessary to permit recovery
thereunder with respect to defaulted Loans. Amounts collected by the Master
Servicer on behalf of the Master Servicer, the Trustee and Securityholders shall
be deposited in the related Security Account for distribution as set forth
above. The Master Servicer will not cancel or refuse to renew any Primary
Mortgage Insurance Policy required to be kept in force by the Agreement.
Claims Under Insurance Policies and Other Realization Upon Defaulted Loans
The Master Servicer, on behalf of the Trustee and Securityholders, will
present claims to the insurer under any applicable Insurance Policies. If the
Property securing a defaulted Loan is damaged and proceeds, if any, from the
related hazard insurance policy are insufficient to restore the damaged
Property, the Master Servicer is not required to expend its own funds to restore
the damaged Property unless it determines (i) that such restoration will
increase the proceeds to Securityholders on liquidation of the Loan after
reimbursement of the Master Servicer for its expenses and (ii) that such
expenses will be recoverable by it from related Insurance Proceeds or
Liquidation Proceeds.
If recovery on a defaulted Loan under any related Insurance Policy is not
available, or if the defaulted Loan is not covered by an Insurance Policy, the
Master Servicer will be obligated to follow or cause to be followed such normal
practices and procedures as it deems necessary or advisable to realize upon the
defaulted Loan. If the proceeds of any liquidation of the Property securing the
defaulted Loan are less than the principal balance of such Loan plus interest
accrued thereon that is payable to Securityholders, the Trust Fund will realize
a loss in the
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amount of such difference plus the aggregate of expenses incurred by the Master
Servicer in connection with such proceedings and which are reimbursable under
the Agreement.
The proceeds from any liquidation of a Loan will be applied in the
following order of priority: first, to reimburse the Master Servicer for any
unreimbursed expenses incurred by it to restore the related Property and any
unreimbursed servicing compensation payable to the Master Servicer with respect
to such Loan; second, to reimburse the Master Servicer for any unreimbursed
Advances with respect to such Loan; third, to accrued and unpaid interest (to
the extent no Advance has been made for such amount) on such Loan; and fourth,
as a recovery of principal of such Loan.
Servicing and Other Compensation and Payment of Expenses
The Master Servicer's primary compensation for its activities as Master
Servicer will come from the payment to it, with respect to each interest payment
on a Loan, of the amount specified in the related Prospectus Supplement (the
"Master Servicing Fee"). As principal payments are made on the Loans, the
portion of each monthly payment which represents interest will decline, and thus
servicing compensation to the Master Servicer will decrease as the Loans
amortize. Prepayments and liquidations of Loans prior to maturity will also
cause servicing compensation to the Master Servicer to decrease. As compensation
for its servicing duties, a Sub-Servicer, if any, will be entitled to a monthly
servicing fee as described in the related Prospectus Supplement. In addition,
the Master Servicer or Sub-Servicer will retain all prepayment charges,
assumption fees and late payment charges, to the extent collected from
borrowers, and any benefit that may accrue as a result of the investment of
funds in the applicable Security Account (unless otherwise specified in the
related Prospectus Supplement).
The Master Servicer will pay or cause to be paid certain ongoing expenses
associated with each Trust Fund and incurred by it in connection with its
responsibilities under the related Agreement, including, without limitation, and
if so specified in the related Prospectus Supplement, payment of any fee or
other amount payable in respect of any credit enhancement arrangements, payment
of the fees and disbursements of the Trustee, any custodian appointed by the
Trustee, the certificate registrar and any paying agent, and payment of expenses
incurred in enforcing the obligations of Sub-Servicers and Sellers. The Master
Servicer will be entitled to reimbursement of expenses incurred in enforcing the
obligations of Sub-Servicers and Sellers under certain limited circumstances.
Evidence as to Compliance
Each Agreement will provide that the Master Servicer at its expense shall
cause a firm of independent public accountants to furnish a report annually to
the Trustee to the effect that such firm has performed certain procedures
specified in the Agreement and that such review has disclosed no items of
noncompliance with the provisions of such Agreement which, in the opinion of
such firm, are material, except for such items of noncompliance as shall be set
forth in such report.
Each Agreement will also provide for delivery to the Trustee, on or before
a specified date in each year, of an annual statement signed by an officer of
the Master Servicer to the effect that the Master Servicer has fulfilled its
obligations under the Agreement throughout the preceding year.
Certain Matters Regarding the Master Servicer and the Sponsor
The Master Servicer under each Pooling and Servicing Agreement or Master
Servicing Agreement, as applicable, will be named in the related Prospectus
Supplement. The entity serving as Master Servicer may have normal business
relationships with the Sponsor or the Sponsor's affiliates.
Each Agreement will provide that the Master Servicer may not resign from
its obligations and duties under the Agreement except upon (a) appointment of a
successor servicer and receipt by the Trustee of a letter from the
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Rating Agency that such resignation and appointment will not result in a
downgrade of the Securities and (b) a determination that its duties thereunder
are no longer permissible under applicable law. The Master Servicer may,
however, be removed from its obligations and duties as set forth in the
Agreement. No such resignation will become effective until the Trustee or a
successor servicer has assumed the Master Servicer's obligations and duties
under the Agreement.
Each Agreement will further provide that neither the Master Servicer, the
Sponsor nor any director, officer, employee, or agent of the Master Servicer or
the Sponsor (collectively, the "Indemnified Parties") will be under any
liability to the related Trust Fund or Securityholders for any action taken or
for refraining from the taking of any action in good faith pursuant to the
Agreement, or for errors in judgment; provided, however, that neither the Master
Servicer, the Sponsor nor any such person will be protected against any
liability which would otherwise be imposed by reason of wilful misfeasance, bad
faith or gross negligence in the performance of duties thereunder or by reason
of reckless disregard of obligations and duties thereunder. Each Agreement will
further provide that each Indemnified Party will be entitled to indemnification
by the related Trust Fund and will be held harmless against any loss, liability
or expense incurred in connection with any legal action relating to the
Agreement or the Securities for such Series, other than any loss, liability or
expense related to any specific Loan or Loans (except any such loss, liability
or expense otherwise reimbursable pursuant to the Agreement) and any loss,
liability or expense incurred by reason of willful misfeasance, bad faith or
gross negligence in the performance of such Indemnified Party's duties
thereunder or by reason of reckless disregard by such Indemnified Party of
obligations and duties thereunder. In addition, each Agreement will provide that
neither the Master Servicer nor the Sponsor will be under any obligation to
appear in, prosecute or defend any legal action which is not incidental to its
respective responsibilities under the Agreement and which in its opinion may
involve it in any expense or liability. The Master Servicer or the Sponsor may,
however, in its discretion undertake any such action which it may deem necessary
or desirable with respect to the Agreement and the rights and duties of the
parties thereto and the interests of the Securityholders 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
Master Servicer or the Sponsor, as the case may be, will be entitled to be
reimbursed therefor out of funds otherwise distributable to Securityholders.
Except as otherwise specified in the related Prospectus Supplement, any
person into which the Master Servicer may be merged or consolidated, or any
person resulting from any merger or consolidation to which the Master Servicer
is a party, or any person succeeding to the business of the Master Servicer,
will be the successor of the Master Servicer under each Agreement, provided that
such person is qualified to sell mortgage loans to, and service mortgage loans
on behalf of, FNMA or FHLMC and further provided that such merger, consolidation
or succession does not adversely affect the then current rating or ratings of
the class or classes of Securities of such Series that have been rated.
Events of Default; Rights Upon Event of Default
Pooling and Servicing Agreement; Master Servicing Agreement. Except as
otherwise specified in the related Prospectus Supplement, Events of Default
under each Agreement will consist of (i) (a) any failure by the Master Servicer
to make an Advance which continues unremedied for one business day or (b) any
failure by the Master Servicer to make or cause to be made any other required
payment pursuant to the Agreement which continues unremedied for five days after
written notice of such failure to the Master Servicer in the manner specified in
the Agreement; (ii) any failure by the Master Servicer duly to observe or
perform in any material respect any of its other covenants or agreements in the
Agreement which continues unremedied for sixty days after written notice of such
failure to the Master Servicer in the manner specified in the Agreement; and
(iii) certain events of insolvency, readjustments of debt, marshalling of assets
and liabilities or similar proceedings and certain actions by or on behalf of
the Master Servicer indicating its insolvency, reorganization or inability to
pay its obligations.
If specified in the related Prospectus Supplement, the Agreement will
permit the Trustee to sell the Trust Fund Assets and the other assets of the
Trust Fund described under "Credit Enhancement" herein in the event that
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payments in respect thereto are insufficient to make payments required in the
Agreement. The Trust Fund Assets will be sold only under the circumstances and
in the manner specified in the related Prospectus Supplement.
Unless otherwise provided in the related Prospectus Supplement, so long as
an Event of Default under an Agreement remains unremedied, the Trustee may, and
at the direction of holders of Securities evidencing not less than 25% of the
aggregate voting rights of such Series and under such other circumstances as may
be specified in such Agreement, the Trustee shall terminate all of the rights
and obligations of the Master Servicer under the Agreement relating to such
Trust Fund and in and to the related Trust Fund Assets, whereupon the Trustee
will succeed to all of the responsibilities, duties and liabilities of the
Master Servicer under the Agreement, including, if specified in the related
Prospectus Supplement, the obligation to make Advances, and will be entitled to
similar compensation arrangements. In the event that the Trustee is unwilling or
unable so to act, it may appoint, or petition a court of competent jurisdiction
for the appointment of, a housing and home finance institution which is a FNMA
or FHLMC approved servicer with a net worth of a least $10,000,000 to act as
successor to the Master Servicer under the Agreement. Pending such appointment,
the Trustee is obligated to act in such capacity. The Trustee and any such
successor may agree upon the servicing compensation to be paid, which in no
event may be greater than the compensation payable to the Master Servicer under
the Agreement.
Unless otherwise provided in the related Prospectus Supplement, no
Securityholder, solely by virtue of such holder's status as a Securityholder,
will have any right under any Agreement to institute any proceeding with respect
to such Agreement, unless such holder previously has given to the Trustee
written notice of default and unless the holders of Securities evidencing not
less than 25% of the aggregate voting rights 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. However,
the Trustee is under no obligation to exercise any of the trusts or powers
vested in it by the Agreement for any Series 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
Securityholders, unless such Securityholders have offered and provided to the
Trustee reasonable security or indemnity against the costs, expenses and
liabilities which may be incurred therein or thereby.
Indenture. Except as otherwise specified in the related Prospectus
Supplement, Events of Default under the Indenture for each Series of Notes
include: (i) a default in the payment of any principal of or interest on any
Note of such Series which continues unremedied for no more than five days after
the giving of written notice of such default is given as specified in the
related Prospectus Supplement; (ii) failure to perform in any material respect
any other covenant of the Sponsor or the Trust Fund in the Indenture which
continues for a period of sixty (60) days after notice thereof is given in
accordance with the procedures described in the related Prospectus Supplement;
(iii) certain events of bankruptcy, insolvency, receivership or liquidation of
the Sponsor or the Trust Fund; or (iv) any other Event of Default provided with
respect to Notes of that Series including but not limited to certain defaults on
the part of the issuer, if any, of a credit enhancement instrument supporting
such Notes.
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
may declare the principal amount (or, if the Notes of that Series have an
interest rate of 0%, 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
more than 50% of the aggregate voting rights 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
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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 which continues unremedied
for no more than five days after written notice of such default is given as
specified in the related Prospectus Supplement, unless (a) the holders of 100%
of the aggregate voting rights 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
662/3% of the aggregate voting rights 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 in the payment of principal of or
interest on the Notes of a Series which continues unremedied for no more than
five days after written notice of such default is given as specified in the
related Prospectus Supplement, 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 would 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.
Except as 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 shall 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.
Amendment
Except as otherwise specified in the related Prospectus Supplement, each
Agreement may be amended by the Sponsor, the Master Servicer and the Trustee,
without the consent of any of the Securityholders, (i) to cure any ambiguity;
(ii) to correct a defective provision or correct or supplement any provision
therein which may be inconsistent with any other provision therein; (iii) to
make any other revisions with respect to matters or questions arising under the
Agreement which are not inconsistent with the provisions thereof; or (iv) to
comply with any requirements imposed by the Code or any regulation thereunder,
provided, however, that no such amendments (except those pursuant to clause
(iv)) will adversely affect in any material respect the interests of any
Securityholder of that Series. An amendment will be deemed not to adversely
affect in any material respect the interests of the Securityholders if the
Trustee receives a letter from each Rating Agency requested to rate the class or
classes of
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Securities of such Series stating that such amendment will not result in the
downgrading or withdrawal of the respective ratings then assigned to such
Securities. Each Agreement may also be amended by the Sponsor, the Master
Servicer and the Trustee with consent of holders of Securities of such Series
evidencing not less than 66 2/3% of the aggregate voting rights of each class
affected thereby for the purpose of adding any provisions to or changing in any
manner or eliminating any of the provisions of the Agreement or of modifying in
any manner the rights of the holders of the related Securities; provided,
however, that no such amendment may (i) reduce in any manner the amount of, or
delay the timing of, payments received on Loans which are required to be
distributed on any Security without the consent of the holder of such Security,
or (ii) with respect to any Series of Certificates, reduce the aforesaid
percentage of Securities of any class the holders of which are required to
consent to any such amendment without the consent of the holders of all
Securities of such class covered by such Agreement then outstanding. If a REMIC
election is made with respect to a Trust Fund, the Trustee will not be entitled
to consent to an amendment to the related Agreement without having first
received an opinion of counsel to the effect that such amendment will not cause
such Trust Fund to fail to qualify as a REMIC.
Termination; Optional Termination
Pooling and Servicing Agreement; Trust Agreement. Unless otherwise
specified in the related Agreement, the obligations created by each Pooling and
Servicing Agreement and Trust Agreement for each Series of Securities will
terminate upon the payment to the related Securityholders of all amounts held in
the Security Account or by the Master Servicer and required to be paid to them
pursuant to such Agreement following the later of (i) the final payment of or
other liquidation of the last of the Trust Fund Assets subject thereto or the
disposition of all property acquired upon foreclosure of any such Trust Fund
Assets remaining in the Trust Fund and (ii) the purchase by the Master Servicer
or, if REMIC treatment has been elected and if specified in the related
Prospectus Supplement, by the holder of the Residual Interest Security or any
other party specified to have such rights (see "Federal Income Tax Consequences"
below), from the related Trust Fund of all of the remaining Trust Fund Assets
and all property acquired in respect of such Trust Fund Assets.
Unless otherwise specified by the related Prospectus Supplement, any such
purchase of Trust Fund Assets and property acquired in respect of Trust Fund
Assets evidenced by a Series of Securities will be made at the option of the
Master Servicer, such other person or, if applicable, such holder of the REMIC
residual interest, at a price specified in the related Prospectus Supplement.
The exercise of such right will effect early retirement of the Securities of
that Series, but the right of the Master Servicer, such other person or, if
applicable, such holder of the REMIC residual interest, to so purchase is
subject to the principal balance of the related Trust Fund Assets being less
than the percentage specified in the related Prospectus Supplement of the
aggregate principal balance of the Trust Fund Assets at the Cut-off Date for the
Series. The foregoing is subject to the provision that if a REMIC election is
made with respect to a Trust Fund, any repurchase pursuant to clause (ii) above
will be made only in connection with a "qualified liquidation" of the REMIC
within the meaning of Section 860F(g)(4) of the Code.
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 last scheduled
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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.
The Trustee
The Trustee under each Agreement will be named in the applicable Prospectus
Supplement. The commercial bank, savings and loan association or trust company
serving as Trustee may have normal banking relationships with the Sponsor, the
Master Servicer and any of their respective affiliates.
CERTAIN LEGAL ASPECTS OF THE LOANS
The following discussion contains summaries, which are general in nature,
of certain legal matters relating to the Loans. Because such legal aspects are
governed primarily by applicable state law (which laws may differ
substantially), the descriptions do not, except as expressly provided below,
reflect the laws of any particular state, nor do they encompass the laws of all
states in which the security for the Loans is situated. The descriptions are
qualified in their entirety by reference to the applicable federal laws and the
appropriate laws of the states in which Loans may be originated.
General
The Loans for a Series may be secured by deeds of trust, mortgages,
security deeds or deeds to secure debt, depending upon the prevailing practice
in the state in which the property subject to the loan is located. Deeds of
trust are used almost exclusively in California instead of mortgages. A mortgage
creates a lien upon the real property encumbered by the mortgage, which lien is
generally not prior to the lien for real estate taxes and assessments. Priority
between mortgages depends on their terms and generally on the order of recording
with a state or county office. There are two parties to a mortgage, the
mortgagor, who is the borrower and owner of the mortgaged property, and the
mortgagee, who is the lender. Under the mortgage instrument, the mortgagor
delivers to the mortgagee a note or bond and the mortgage. Although a deed of
trust is similar to a mortgage, a deed of trust formally has three parties, the
borrower-property owner called the trustor (similar to a mortgagor), a lender
(similar to a mortgagee) called the beneficiary, and a third-party grantee
called the trustee. Under a deed of trust, the borrower grants the property,
irrevocably until the debt is paid, in trust, generally with a power of sale, to
the trustee to secure payment of the obligation. A security deed and a deed to
secure debt are special types of deeds which indicate on their face that they
are granted to secure an underlying debt. By executing a security deed or deed
to secure debt, the grantor conveys title to, as opposed to merely creating a
lien upon, the subject property to the grantee until such time as the underlying
debt is repaid. The trustee's authority under a deed of trust, the mortgagee's
authority under a mortgage and the grantee's authority under a security deed or
deed to secure debt are governed by law and, with respect to some deeds of
trust, the directions of the beneficiary.
Foreclosure/Repossession
Deed of Trust. Foreclosure of a deed of trust is generally accomplished by
a non-judicial sale under a specific provision in the deed of trust which
authorizes the trustee to sell the property at public auction upon any default
by the borrower under the terms of the note or deed of trust. In certain states,
such foreclosure also may be accomplished by judicial action in the manner
provided for foreclosure of mortgages. In addition to any notice requirements
contained in a deed of trust, in some states (such as California), the trustee
must record a notice of default and send a copy to the borrower-trustor, to any
person who has recorded a request for a copy of any notice of default and notice
of sale, to any successor in interest to the borrower-trustor, to the
beneficiary of any junior deed of trust and to certain other persons. In some
states (including California), the borrower-trustor has the right to reinstate
the loan at any time following default until shortly before the trustee's sale.
In general, the borrower,
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or any other person having a junior encumbrance on the real estate, may, during
a statutorily prescribed reinstatement period, cure a monetary default by paying
the entire amount in arrears plus other designated costs and expenses incurred
in enforcing the obligation. Generally, state law controls the amount of
foreclosure expenses and costs, including attorney's fees, which may be
recovered by a lender. After the reinstatement period has expired without the
default having been cured, the borrower or junior lienholder no longer has the
right to reinstate the loan and must pay the loan in full to prevent the
scheduled foreclosure sale. If the deed of trust is not reinstated within any
applicable cure period, a notice of sale must be posted in a public place and,
in most states (including California), published for a specific period of time
in one or more newspapers. In addition, some state laws require that a copy of
the notice of sale be posted on the property and sent to all parties having an
interest of record in the real property. In California, the entire process from
recording a notice of default to a non-judicial sale usually takes four to five
months.
Mortgages. Foreclosure of a mortgage is generally accomplished by judicial
action. The action is initiated by the service of legal pleadings upon all
parties having an interest in the real property. Delays in completion of the
foreclosure may occasionally result from difficulties in locating necessary
parties. Judicial foreclosure proceedings are often not contested by any of the
parties. When the mortgagee's right to foreclosure is contested, the legal
proceedings necessary to resolve the issue can be time consuming. After the
completion of a judicial foreclosure proceeding, the court generally issues a
judgment of foreclosure and appoints a referee or other court officer to conduct
the sale of the property. In some states, mortgages may also be foreclosed by
advertisement, pursuant to a power of sale provided in the mortgage.
Although foreclosure sales are typically public sales, frequently no third
party purchaser bids in excess of the lender's lien because of the difficulty of
determining the exact status of title to the property, the possible
deterioration of the property during the foreclosure proceedings and a
requirement that the purchaser pay for the property in cash or by cashier's
check. Thus the foreclosing lender often purchases the property from the trustee
or referee for an amount equal to the principal amount outstanding under the
loan, accrued and unpaid interest and the expenses of foreclosure in which event
the mortgagor'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 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 burden of ownership,
including obtaining hazard insurance 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.
Courts have imposed general equitable principles upon foreclosure, which
are generally designed to mitigate the legal consequences to the borrower of the
borrower's defaults under the loan documents. Some courts have been faced with
the issue of whether federal or state constitutional provisions reflecting due
process concerns for fair notice require that borrowers under deeds of trust
receive notice longer than that prescribed by statute. For the most part, these
cases have upheld the notice provisions as being reasonable or have found that
the sale by a trustee under a deed of trust does not involve sufficient state
action to afford constitutional protection to the borrower.
When the beneficiary under a junior mortgage or deed of trust cures the
default and reinstates or redeems by paying the full amount of the senior
mortgage or deed of trust, the amount paid by the beneficiary so to cure or
redeem becomes a part of the indebtedness secured by the junior mortgage or deed
of trust. See "Junior Mortgages; Rights of Senior Mortgagees" below.
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Environmental Risks
Real property pledged as security to a lender may be subject to unforeseen
environmental risks. Under the laws of certain states, contamination of a
property may give risks to a lien on the property to assure the payment of the
costs of clean-up. In several states such a lien has priority over the lien of
an existing mortgage against such property. In addition, under CERCLA, the
United States Environmental Protection Agency ("EPA") may impose a lien on
property where EPA has incurred clean-up costs. However, a CERCLA lien is
subordinate to pre-existing, perfected security interests.
Under the laws of some states, and under CERCLA, it is conceivable that a
secured lender may be held liable as an "owner" or "operator" for the costs of
addressing releases or threatened releases of hazardous substances at a
property, even though the environmental damage or threat was caused by a prior
or current owner or operator. CERCLA imposes liability for such costs on any and
all "responsible parties," including owners or operators. However, CERCLA
excludes from the definition of "owner or operator" a secured creditor who holds
indicia of ownership primarily to protect its security interest but without
"participating in the management" of the Property (the "Secured Creditor
Exclusion"). Thus, if a lender's activities begin to encroach on the actual
management of a contaminated facility or property, the lender may incur
liability as an "owner or operator" under CERCLA. Similarly, if a lender
forecloses and takes title to a contaminated facility or property, the lender
may incur CERCLA liability in various circumstances, including, but not limited
to, when it holds the facility or property as an investment (including leasing
the facility or property to third party), or fails to market the property in a
timely fashion.
Whether actions taken by a lender would constitute participation in the
management of a mortgaged property or the business of a borrower so as to render
the secured creditor exemption unavailable to a lender has been a matter of
judicial interpretation of the statutory language, and court decisions have been
inconsistent. In 1990, the Court of Appeals for the Eleventh Circuit suggested
that the mere capacity of the lender to influence a borrower's decisions
regarding disposal of hazardous substances was sufficient participation in the
management of the borrower's business to deny the protection of the Secured
Creditor Exclusion to the lender.
This ambiguity appears to have been resolved by the enactment of the Asset
Conservation, Lender Liability and Deposit Insurance Protection Act of 1996,
which was signed into law by President Clinton on September 30, 1996. The new
legislation provides that in order to be deemed to have participated in the
management of a mortgaged property, a lender must actually participate in the
operational affairs of the property or the borrower. The legislation also
provides that participation in the management of the property does not include
"merely having the capacity to influence, or unexercised right to control"
operations. Rather, a lender will lose the protection of the Secured Creditor
Exclusion only if it exercises decision-making control over the borrower's
environmental compliance and hazardous substance handling and disposal
practices, or assumes day-to-day management of all operational functions of the
mortgaged property.
If a lender is or becomes liable, it can bring an action for contribution
against any other "responsible parties," including a previous owner or operator,
who created the environmental hazard, but those persons or entities may be
bankrupt or otherwise judgment proof. The costs associated with environmental
cleanup may be substantial. It is conceivable that such costs arising from the
circumstances set forth above would result in a loss to Securityholders.
CERCLA does not apply to petroleum products, and the Secured Creditor
Exclusion does not govern liability for cleanup costs under federal laws other
than CERCLA, in particular Subtitle I of the federal Resource Conservation and
Recovery Act ("RCRA"), which regulates underground petroleum storage tanks
(except heating oil tanks). The EPA has adopted a lender liability rule for
underground storage tanks under Subtitle I of RCRA. Under such rule, a holder of
a security interest in an underground storage tank or real property containing
an underground storage tank is not considered an operator of the underground
storage tank as long as petroleum is not
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added to, stored in or dispensed from the tank. In addition, under the Asset
Conservation, Lender Liability and Deposit Insurance Protection Act of 1996, the
protections accorded to lenders under CERCLA are also accorded to the holders of
security interests in underground storage tanks. Liability for cleanup of
petroleum contamination may, however, be governed by state law, which may not
provide for any specific protection for secured creditors.
Except as otherwise specified in the related Prospectus Supplement, at the
time the Loans were originated, no environmental assessments or very limited
environmental assessments of the Properties were conducted.
Rights of Redemption
In some states, after sale pursuant to a deed of trust or foreclosure of a
mortgage, the borrower and foreclosed junior lienors are given a statutory
period in which to redeem the property from the foreclosure sale. In certain
other states (including California), this right of redemption applies only to
sales following judicial foreclosure, and not to sales pursuant to a
non-judicial power of sale. In most states where the right of redemption is
available, statutory redemption may occur upon payment of the foreclosure
purchase price, accrued interest and taxes. 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 from the lender subsequent to
foreclosure or sale under a deed of trust. Consequently, the practical effect of
the redemption right 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.
Anti-Deficiency Legislation; Bankruptcy Laws; Tax Liens
Certain states have imposed statutory and judicial restrictions that limit
the remedies of a beneficiary under a deed of trust or a mortgagee under a
mortgage. In some states, including California, statutes and case law limit the
right of the beneficiary or mortgagee to obtain a deficiency judgment against
borrowers financing the purchase of their residence or following sale under a
deed of trust or certain other foreclosure proceedings. A deficiency judgment is
a personal judgment against the borrower equal in most cases to the difference
between the amount due to the lender and the fair market value of the real
property at the time of the foreclosure sale. As a result of these prohibitions,
it is anticipated that in most instances the Master Servicer will utilize the
non-judicial foreclosure remedy and will not seek deficiency judgments against
defaulting borrowers.
Some state 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. In some states, exceptions to the anti-deficiency
statutes are provided for in certain instances where the value of the lender's
security has been impaired by acts or omissions of the borrower, for example, in
the event of waste of the property. 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 anti-deficiency and related legislation, numerous other
federal and state statutory provisions, including the federal bankruptcy laws,
and state laws affording relief to debtors, may interfere with or affect the
ability of the secured mortgage lender to realize upon its security. For
example, in a proceeding under the federal Bankruptcy Code, a lender may not
foreclose on a mortgaged property without the permission of the bankruptcy
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court. The rehabilitation plan proposed by the debtor may provide, if the
mortgaged property is not the debtor's principal residence and the court
determines that the value of the mortgaged property is less than the principal
balance of the mortgage loan, for the reduction of the secured indebtedness to
the value of the mortgaged property as of the date of the commencement of the
bankruptcy, rendering the lender a general unsecured creditor for the
difference, and also may reduce the monthly payments due under such mortgage
loan, change the rate of interest and alter the mortgage loan repayment
schedule. The effect of any such proceedings under the federal Bankruptcy Code,
including but not limited to any automatic stay, could result in delays in
receiving payments on the Loans underlying a Series of Securities and possible
reductions in the aggregate amount of such payments.
The federal tax laws provide priority to certain tax liens over the lien of
a mortgage or secured party.
Due-on-Sale Clauses
Each conventional Loan generally will contain a due-on-sale clause which
will generally provide that if the mortgagor or obligor sells, transfers or
conveys the Property, the Loan or contract may be accelerated by the mortgagee
or secured party. Court decisions and legislative actions have placed
substantial restrictions on the right of lenders to enforce such clauses in many
states. For instance, the California Supreme Court in August 1978 held that
due-on-sale clauses were generally unenforceable. However, the Garn-St Germain
Depository Institutions Act of 1982 (the "Garn-St Germain Act"), subject to
certain exceptions, preempts state constitutional, statutory and case law
prohibiting the enforcement of due-on-sale clauses. As a result, due-on-sale
clauses are 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.
As to loans secured by an owner-occupied residence, the Garn-St Germain Act
sets forth nine specific instances in which a mortgagee covered by the Act may
not exercise its rights under a due-on-sale clause, notwithstanding the fact
that a transfer of the property may have occurred. The inability to enforce a
due-on-sale clause may result in transfer of the related Property to an
uncreditworthy person, which could increase the likelihood of default or may
result in a mortgage bearing an interest rate below the current market rate
being assumed by a new home buyer, which may affect the average life of the
Loans and the number of Loans which may extend to maturity.
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. Under certain state laws, prepayment charges may not be imposed
after a certain period of time following the origination of mortgage loans with
respect to prepayments on loans secured by liens encumbering
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owner-occupied residential properties. Since many of the Properties will be
owner-occupied, it is anticipated that prepayment charges may not be imposed
with respect to many of the Loans. The absence of such a restraint on
prepayment, particularly with respect to fixed rate Loans having higher Loan
Rates, may increase the likelihood of refinancing or other early retirement of
such Loans or contracts. Late charges and prepayment fees are typically retained
by servicers as additional servicing compensation.
Applicability of Usury Laws
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. The Office of Thrift
Supervision, 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 authorized the states to reimpose interest
rate limits by adopting, before April 1, 1983, a law or constitutional provision
which expressly rejects application of the federal law. Fifteen states adopted
such a law prior to the April 1, 1983 deadline. In addition, even where Title V
was 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.
Certain states have taken action to reimpose interest rate limits and/or to
limit discount points or other charges.
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 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 Sponsor 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 Sponsor will make an appropriate filing of a UCC-1
financing statement in the appropriate states to, among other things, give
notice of the Trust Fund'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 Sponsor 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 Trust Fund'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. 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
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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 that the debtor may redeem 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.
Applicability of Usury Laws. Title V of the Depository Institutions
Deregulation and Monetary Control Act of 1980, as amended ("Title V"), provides
that, subject to the following conditions, state usury limitations shall not
apply to any contract which is secured by a first lien on certain kinds of
consumer goods. The contracts would be covered if they satisfy certain
conditions governing, among other things, 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.
Title V authorized any state to reimpose limitations on interest rates and
finance charges by adopting before April 1, 1983 a law or constitutional
provision which expressly rejects application of the federal law. Fifteen states
adopted such a law prior to the April 1, 1983 deadline. In addition, even where
Title V was not so rejected, any state is authorized by the law to adopt a
provision limiting discount points or other charges on loans covered by Title V.
Installment Contracts
The Loans may also consist of installment contracts. Under an installment
contract ("Installment 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 Contract, the borrower is generally responsible for
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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
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 the
contract strictly according to its terms. The terms of Installment 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 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 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 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 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 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 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.
Soldiers' and Sailors' Civil Relief Act
Generally, under the terms of the Soldiers' and Sailors' Civil Relief Act
of 1940, as amended (the "Relief Act"), a borrower who enters military service
after the origination of such borrower's Loan (including a borrower who is a
member of the National Guard or is in reserve status at the time of the
origination of the Loan and is later called to active duty) may not be charged
interest above an annual rate of 6% during the period of such borrower's active
duty status, unless a court orders otherwise upon application of the lender. It
is possible that such interest rate limitation could have an effect, for an
indeterminate period of time, on the ability of the Master Servicer to collect
full amounts of interest on certain of the Loans. Unless otherwise provided in
the related Prospectus Supplement, any shortfall in interest collections
resulting from the application of the Relief Act could result in losses to
Securityholders. The Relief Act also imposes limitations which would impair the
ability of the Master Servicer to foreclose on an affected Loan during the
borrower's period of active duty status. Moreover, the Relief Act permits the
extension of a Loan's maturity and the re-adjustment of its payment schedule
beyond the completion of military service. Thus, in the event that such a Loan
goes into default, there may be delays and losses occasioned by the inability to
realize upon the Property in a timely fashion.
Junior Mortgages; Rights of Senior Mortgagees
To the extent that the Loans comprising the Trust Fund for a Series are
secured by mortgages which are junior to other mortgages held by other lenders
or institutional investors, the rights of the Trust Fund (and therefore the
Securityholders), as mortgagee under any such junior mortgage, are subordinate
to those of any mortgagee under any senior mortgage. The senior mortgagee has
the right to receive hazard insurance and condemnation proceeds and to cause the
property securing the Loan to be sold upon default of the mortgagor, thereby
extinguishing the junior mortgagee's lien unless the junior mortgagee asserts
its subordinate interest in the property in foreclosure litigation and,
possibly, satisfies the defaulted senior mortgage. A junior mortgagee may
satisfy a defaulted senior loan in full and, in some states, may cure a default
and bring the 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.
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The standard form of the mortgage used by most institutional lenders
confers on the mortgagee the right both to receive all proceeds collected under
any hazard insurance policy and all awards made in connection with condemnation
proceedings, and to apply such proceeds and awards to any indebtedness secured
by the mortgage, in such order as the mortgagee 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 a senior mortgage 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 mortgage. Proceeds in excess of the amount of
senior mortgage indebtedness, in most cases, may be applied to the indebtedness
of a junior mortgage.
Another provision sometimes found in the form of the mortgage or deed of
trust used by institutional lenders obligates the 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 mortgagor to perform any of these obligations, the mortgagee is
given the right under certain mortgages to perform the obligation itself, at its
election, with the mortgagor reimbursing the mortgagee for any sums expended by
the mortgagee on behalf of the mortgagor. All sums so expended by the mortgagee
become part of the indebtedness secured by the mortgage.
The form of credit line trust deed or mortgage generally used by most
institutional lenders which make Revolving Credit Line 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. Any amounts so advanced after the
Cut-off Date with respect to any Mortgage will not be included in the Trust
Fund. The priority of the lien securing any advance made under the clause may
depend in most states on whether the deed of trust or mortgage is called and
recorded as a credit line deed of trust or mortgage. If the beneficiary or
lender advances additional amounts, the advance is entitled to receive the same
priority as amounts initially advanced under the trust deed or mortgage,
notwithstanding the fact that there may be junior trust deeds or mortgages and
other liens which intervene between the date of recording of the trust deed or
mortgage and the date of the future advance, and notwithstanding that the
beneficiary or lender had actual knowledge of such intervening junior trust
deeds or mortgages and other liens at the time of the advance. In most states,
the trust deed or mortgage lien securing mortgage loans of the type which
includes home equity credit lines applies retroactively to the date of the
original recording of the trust deed or mortgage, provided that the total amount
of advances under the home equity credit line does not exceed the maximum
specified principal amount of the recorded trust deed or mortgage, except as to
advances made after receipt by the lender of a written notice of lien from a
judgment lien creditor of the trustor.
Consumer Protection Laws
Numerous federal and state consumer protection laws impose substantive
requirements upon mortgage lenders in connection with the originating, servicing
and enforcing of loans secured by Single Family Properties. These laws include
the federal Truth-in-Lending Act and Regulation Z promulgated thereunder, Real
Estate Settlement Procedures Act and Regulation B promulgated thereunder, Equal
Credit Opportunity Act, Fair Credit Billing Act, Fair Credit Reporting Act and
related statutes and regulations. In particular, Regulation Z requires certain
disclosures to borrowers regarding the terms of the Loans; the Equal Credit
Opportunity Act and Regulation B promulgated thereunder prohibit discrimination
in the extension of credit 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; and, the Fair Credit
Reporting Act regulates the use and reporting of information related to the
borrower's credit experience. Certain provisions of these laws impose specific
statutory liabilities upon lenders who fail to comply therewith. In addition,
violations of such laws may limit the ability of the Sellers to collect all
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or part of the principal of or interest on the Loans and could subject the
Sellers and in some cases their assignees to damages and administrative
enforcement.
FEDERAL INCOME TAX CONSEQUENCES
General
The following is a summary of the anticipated material federal income tax
consequences of the purchase, ownership, and disposition of the Securities and
is based on advice of Special Tax Counsel. 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 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 Code, but much of the
discussion is applicable to other investors as well. Prospective investors are
advised to consult their own tax advisers concerning the federal, state, local
and any other tax consequences to them of the purchase, ownership and
disposition of the Securities.
The federal income tax consequences to Holders will vary depending on
whether (i) the Securities of a Series are classified as indebtedness; (ii) an
election is made to treat the Trust Fund relating to a particular Series of
Securities as a REMIC or a FASIT under the Internal Revenue Code of 1986, as
amended (the "Code"); (iii) the Securities represent an ownership interest in
some or all of the assets included in the Trust Fund for a Series; or (iv) an
election is made to treat the Trust Fund relating to a particular Series of
Certificates 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 or FASIT election, if any, will be
made with respect to such Series.
Taxation of Debt Securities
Status as Real Property Loans. Except to the extent otherwise provided in
the related Prospectus Supplement, Special Tax Counsel will have advised the
Sponsor that: (i) Securities held by a domestic building and loan association
will constitute "loans... secured by an interest in real property" within the
meaning of Code section 7701(a)(19)(C)(v); and (ii) Securities held by a real
estate investment trust will constitute "real estate assets" within the meaning
of Code section 856(c)(5)(A) and interest on such Securities will be considered
"interest on obligations secured by mortgages on real property or on interests
in real property" within the meaning of Code section 856(c)(3)(B).
The Small Business Job Protection Act of 1996, as part of the repeal of the
bad debt reserve method for thrift institutions, repealed the application of
Code section 593(d) to any taxable year beginning after December 31, 1995.
Interest and Acquisition Discount. Securities representing regular
interests 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
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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." If a FASIT election is made, the material
federal tax income consequences for investors associated with the purchase,
ownership and disposition of such Securities will be set forth under the heading
"Federal Income Tax Consequences" in the related Prospectus Supplement.
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 method taking 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 related Closing Date, the issue price for such class will be
treated as the fair market value of such class on such Closing Date. The issue
price of a Debt Security also includes the amount paid by an initial Debt
Security holder for accrued interest that relates to a period prior to the issue
date of the Debt Security. 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, qualified stated interest generally means
interest payable at a single fixed rate or qualified variable rate (as described
below) provided that such interest payments are unconditionally payable at
intervals of one year or less during the entire term of the Debt Security. The
OID Regulations state that interest payments are unconditionally payable only if
a late payment or nonpayment is expected to be penalized or reasonable remedies
exist to compel payment. Certain Debt Securities may provide for default
remedies in the event of late payment or nonpayment of interest. The interest on
such Debt Securities will be unconditionally payable and constitute qualified
stated interest, not OID. However, absent clarification of the OID Regulations,
where Debt Securities do not provide for default remedies, the interest payments
will be included in the Debt Security's stated redemption price at maturity and
taxed as OID. Interest is payable at a single fixed rate only if the rate
appropriately takes into account the length of the interval between payments.
Distributions of interest on Debt Securities with respect to which deferred
interest will accrue, will not constitute qualified stated interest payments, in
which case the stated redemption price at maturity of such Debt Securities
includes all distributions of interest as well as principal thereon. Where the
interval between the issue date and the first Distribution Date on a Debt
Security is either longer or shorter than the interval between subsequent
Distribution Dates, all or part of the interest foregone, in the case of the
longer interval, and all of the additional interest, in the case of the shorter
interval, will be included in the stated redemption price at maturity and tested
under the de minimis rule described below. In the case of a Debt Security with a
long first period which has non-de minimis OID, all stated interest in excess of
interest payable at the effective interest rate for the long first period will
be included in the stated redemption price at maturity and the Debt Security
will generally have OID. Holders of Debt Securities should consult their own tax
advisors to determine the issue price and stated redemption price at maturity of
a Debt Security.
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
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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.
Debt Securities may provide for interest based on a qualified variable
rate. Under the OID Regulations, interest is treated as payable at a qualified
variable rate and not as contingent interest if, generally, (i) such interest is
unconditionally payable at least annually, (ii) the issue price of the debt
instrument does not exceed the total noncontingent principal payments and (iii)
interest is based on a "qualified floating rate," an "objective rate," or a
combination of "qualified floating rates" that do not operate in a manner that
significantly accelerates or defers interest payments on such Debt Security. In
the case of Compound Interest Securities, certain Interest Weighted Securities
(as defined herein under "--Interest Weighted Securities"), and certain of the
other Debt Securities, none of the payments under the instrument will be
considered qualified stated interest, and thus the aggregate amount of all
payments will be included in the stated redemption price.
The Internal Revenue Service (the "IRS") recently issued final regulations
(the "Contingent Regulations") governing the calculation of OID on instruments
having contingent interest payments. The Contingent Regulations specifically do
not apply for purposes of calculating OID on debt instruments subject to Code
Section 1272(a)(6), such as the Debt Security. Additionally, the OID Regulations
do not contain provisions specifically interpreting Code Section 1272(a)(6).
Until the Treasury issues guidance to the contrary, the Trustee intends to base
its computation on Code Section 1272(a)(6) and the OID Regulations as described
in this Prospectus. However, because no regulatory guidance currently exists
under Code Section 1272(a)(6), there can be no assurance that such methodology
represents the correct manner of calculating OID.
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 OID. 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 OID 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 or 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
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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 Sponsor 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 IRS 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.
Certain classes of Regular Interest Securities may represent more than one
class of REMIC regular interests. Unless otherwise provided in the related
Prospectus Supplement, 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 deducted 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 Weighted Securities. It is not clear how income should be accrued
with respect to Regular Interest Securities or Stripped Securities (as defined
under "--Tax Status as a Grantor Trust; General" herein) the payments on which
consist solely or primarily of a specified portion of the interest payments on
qualified mortgages held by the REMIC or on Loans underlying Pass-Through
Securities ("Interest Weighted Securities"). The Issuer intends to take the
position that all of the income derived from an Interest Weighted Security
should be treated as OID and that the amount and rate of accrual of such OID
should be calculated by treating the Interest Weighted Security as a Compound
Interest Security. However, in the case of Interest Weighted Securities that are
entitled to some payments of principal and that are Regular Interest Securities
the IRS could assert that income derived from an Interest Weighted Security
should be calculated as if the Security were a security purchased at a premium
equal to the excess of the price paid by such holder for such Security over its
stated principal amount, if any. Under this approach, a holder would be entitled
to amortize such premium only if it has in effect an election under Section 171
of the Code with respect to all taxable debt instruments held by such holder, as
described below. Alternatively, the IRS could assert that an Interest Weighted
Security should be taxable under the rules governing bonds issued with
contingent payments. Such treatment may be more likely in the case of Interest
Weighted Securities that are Stripped Securities as described below. See "--Tax
Status as a Grantor Trust--Discount or Premium on Pass-Through Securities."
Variable Rate Debt Securities. In the case of Debt Securities bearing
interest at a rate that varies directly, according to a fixed formula, with an
objective index, it appears that (i) the yield to maturity of such Debt
Securities
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and (ii) in the case of Pay-Through Securities, the present value of all
payments remaining to be made on such Debt Securities, should be calculated as
if the interest index remained at its value as of the issue date of such
Securities. Because the proper method of adjusting accruals of OID on a variable
rate Debt Security is uncertain, holders of variable rate Debt Securities should
consult their own tax advisers regarding the appropriate treatment of such
Securities for federal income tax purposes.
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 defined herein), as
set forth below, the Loans underlying such Security) not originally issued with
OID, 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 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 IRS. Purchasers
who pay a premium for the Securities should consult their tax advisers regarding
the election to amortize premium and the method to be employed.
On June 27, 1996 the IRS issued proposed regulations (the "Amortizable Bond
Premium Regulations") dealing with amortizable bond premium. These regulations
specifically do not apply to prepayable debt instruments subject to Code Section
1272(a)(6) such as the Securities. Absent further guidance from the IRS, the
Trustee intends to account for amortizable bond premium in the manner described
above. Prospective purchasers of the Securities should consult their tax
advisors regarding the possible application of the Amortizable Bond Premium
Regulations.
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Election to Treat All Interest as Original Issue Discount. The OID
Regulations permit a holder of a Debt Security to elect to accrue all interest,
discount (including de minimis market or OID) and premium 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.
Taxation of the REMIC and its Holders
General. In the opinion of Special 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.
Except to the extent specified otherwise in a Prospectus Supplement, if a
REMIC election is made with respect to a Series of Securities, (i) Securities
held by a domestic building and loan association will constitute "a regular or a
residual interest in a REMIC" within the meaning of Code Section
7701(a)(19)(C)(xi) (assuming that at least 95% of the REMIC's assets consist of
cash, government securities, "loans secured by an interest in real property,"
and other types of assets described in Code Section 7701(a)(19)(C)); and (ii)
Securities held by a real estate investment trust will constitute "real estate
assets" within the meaning of Code Section 856(c)(6)(B), and income with respect
to the Securities will be considered "interest on obligations secured by
mortgages on real property or on interests in real property" within the meaning
of Code Section 856(c)(3)(B) (assuming, for both purposes, that at least 95% of
the REMIC's assets are qualifying assets). If less than 95% of the REMIC's
assets consist of assets described in (i) or (ii) above, then a Security will
qualify for the tax treatment described in (i), (ii) or (iii) in the proportion
that such REMIC assets are qualifying assets.
The Small Business Job Protection Act of 1996, as part of the repeal of the
bad debt reserve method for thrift institutions, repealed the application of
Code Section 593(d) to any taxable year beginning after December 31, 1995.
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 (as defined herein) 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 extent that such expenses, plus other "miscellaneous itemized
deductions" of the Holder, exceed 2% of such Holder's adjusted gross income. In
addition, for taxable years beginning after December 31, 1990, the amount of
itemized deductions otherwise allowable for the taxable year for an individual
whose adjusted gross income exceeds the applicable amount (which amount will be
adjusted for inflation for taxable years beginning after 1990) 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
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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 specified in the related 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.
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 OID or market discount
on loans and other assets, and (ii) deductions, including stated interest and
OID 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 two percent of
such holder's adjusted gross income.
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). That 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
originated after July 18, 1984. 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 OID (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" 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 (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 limited exceptions,
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
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REMIC. It is anticipated that a REMIC will not engage in any prohibited
transactions in which 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 close of the three-month period
beginning on 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 Security 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 advisers.
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
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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.
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. 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." The Small Business Job Protection Act of 1996 has
eliminated the special rule permitting Section 593 institutions ("thrift
institutions") to use net operating losses and other allowable deductions to
offset their excess inclusion income from REMIC residual certificates that have
"significant value" within the meaning of the REMIC Regulations, effective for
taxable years beginning after December 31, 1995, except with respect to residual
certificates continuously held by a thrift institution since November 1, 1995.
In addition, the Small Business Job Protection Act of 1996 provides three
rules for determining the effect of excess inclusions on the alternative minimum
taxable income of a residual holder. First, alternative minimum taxable income
for such residual holder is determined without regard to the special rule that
taxable income cannot be less than excess inclusions. Second, a residual
holder's alternative minimum taxable income for a tax year cannot be less than
excess inclusions for the year. Third, the amount of any alternative minimum tax
net operating loss deductions must be computed without regard to any excess
inclusions. These rules are effective for tax years beginning after December 31,
1986, unless a residual holder elects to have such rules apply only to tax years
beginning after August 20, 1996.
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 Day 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 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), 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 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 Residual Interest Security 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
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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 acting 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), 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.
Under the REMIC Regulations, if a Residual Interest Security is a
"noneconomic residual interest," as described below, a transfer of a Residual
Interest Security to a United States person will be disregarded for all Federal
tax purposes unless no significant purpose of the transfer was to impede the
assessment or collection of tax. A Residual Interest Security is a "noneconomic
residual interest" unless, at the time of the transfer (i) the present value of
the expected future distributions on the Residual Interest Security at least
equals the product of the present value of the anticipated excess inclusions and
the highest rate of tax for the year in which the transfer occurs, and (ii) the
transferor reasonably expects that the transferee will receive distributions
from the REMIC at or after the time at which the taxes accrue on the anticipated
excess inclusions in an amount sufficient to satisfy the accrued taxes. If a
transfer of a residual interest is disregarded, the transferor would be liable
for any Federal income tax imposed upon taxable income derived by the transferee
from the REMIC. The REMIC Regulations provide no guidance as to how to determine
if a significant purpose of a transfer is to impede the assessment or collection
of tax. A similar type of limitation exists with respect to certain transfers of
Residual Interest Securities by foreign persons to United States persons. See
"--Tax Treatment of Foreign Investors."
Mark to Market Rules. Prospective purchasers of a Residual Interest
Security should be aware that the IRS recently released proposed regulations
(the "Proposed Mark-to-Market Regulations") which provide that a Residual
Interest Security acquired after January 3, 1995 cannot be marked-to-market. The
Proposed Mark-to-Market Regulations replace the temporary regulations which
allowed a Residual Interest Security to be marked-to-market provided that it was
not a negative value residual interest and did not have the same economic effect
as a negative value residual interest. The IRS could issue subsequent
regulations, which could apply retroactively, providing additional or different
requirements with respect to such deemed negative value residual interests.
Prospective purchasers of a Residual Interest Security should consult their tax
advisors regarding the possible application of the Proposed Mark-to-Market
Regulations.
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 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
election is not made, in the opinion of Special 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 I of Subchapter J of the Code
and not as an association taxable as a corporation (the Securities of such
Series, "Pass-Through Securities"). In some Series there will be no
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separation of the principal and interest payments on the Loans. In such
circumstances, a Holder will be considered to have purchased a pro rata
undivided interest in each of the Loans. In other cases ("Stripped Securities"),
sale of the Securities will produce a separation in the ownership of all or a
portion of the principal payments from all or a portion of the interest payments
on the Loans.
Each Holder must report on its federal income tax return its share of the
gross income derived from the Loans (not reduced by the amount payable as fees
to the Trustee and the Servicer and similar fees (collectively, the "Servicing
Fee")), at the same time and in the same manner as such items would have been
reported under the Holder's tax accounting method had it held its interest in
the Loans directly, received directly its share of the amounts received with
respect to the Loans, and paid directly its share of the Servicing Fees. In the
case of Pass-Through Securities other than Stripped Securities, such income will
consist of a pro rata share of all of the income derived from all of the Loans
and, in the case of Stripped Securities, such income will consist of a pro rata
share of the income derived from each stripped bond or stripped coupon in which
the Holder owns an interest. The holder of a Security will generally be entitled
to deduct such Servicing Fees under Section 162 or Section 212 of the Code to
the extent that such Servicing Fees represent "reasonable" compensation for the
services rendered by the Trustee and the Servicer (or third parties that are
compensated for the performance of services). In the case of a noncorporate
holder, however, Servicing Fees (to the extent not otherwise disallowed, e.g.,
because they exceed reasonable compensation) will be deductible in computing
such holder's regular tax liability only to the extent that such fees, when
added to other miscellaneous itemized deductions, exceed 2% of adjusted gross
income and may not be deductible 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 (which amount will be
adjusted for inflation) 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.
Discount or Premium on Pass-Through Securities. The holder's purchase price
of a Pass-Through Security is to be allocated among the Loans in proportion to
their fair market values, determined as of the time of purchase of the
Securities. In the typical case, the Trustee (to the extent necessary to fulfill
its reporting obligations) will treat each Loan as having a fair market value
proportional to the share of the aggregate principal balances of all of the
Loans that it represents, since the Securities, unless otherwise specified in
the related Prospectus Supplement, will have a relatively uniform interest rate
and other common characteristics. To the extent that the portion of the purchase
price of a Pass-Through Security allocated to a Loan (other than to a right to
receive any accrued interest thereon and any undistributed principal payments)
is less than or greater than the portion of the principal balance of the Loan
allocable to the Security, the interest in the Loan allocable to the
Pass-Through Security will be deemed to have been acquired at a discount or
premium, respectively.
The treatment of any discount will depend on whether the discount
represents OID or market discount. In the case of a Loan with OID in excess of a
prescribed de minimis amount or a Stripped Security, a holder of a Security will
be required to report as interest income in each taxable year its share of the
amount of OID that accrues during that year in the manner described above. OID
with respect to a Loan could arise, for example, by virtue of the financing of
points by the originator of the Loan, or by virtue of the charging of points by
the originator of the Loan in an amount greater than a statutory de minimis
exception, in circumstances under which the points are not currently deductible
pursuant to applicable Code provisions. Any market discount or premium on a Loan
will be includible in income, generally in the manner described above, except
that in the case of Pass-Through Securities, market discount is calculated with
respect to the Loans underlying the Certificate, rather than with respect to the
Security. A Holder that acquires an interest in a Loan originated after July 18,
1984 with more than a de minimis amount of market discount (generally, the
excess of the principal amount of the Loan over the purchaser's allocable
purchase price) will be required to include accrued market discount in income in
the manner set forth above. See "--Taxation of Debt Securities; Market Discount"
and "--Premium" above.
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In the case of market discount on a Pass-Through Security attributable to
Loans originated on or before July 18, 1984, the holder generally will be
required to allocate the portion of such discount that is allocable to a Loan
among the principal payments on the Loan and to include the discount allocable
to each principal payment in ordinary income at the time such principal payment
is made. Such treatment would generally result in discount being included in
income at a slower rate than discount would be required to be included in income
using the method described in the preceding paragraph.
Stripped Securities. A Stripped Security may represent a right to receive
only a portion of the interest payments on the Loans, a right to receive only
principal payments on the Loans, or a right to receive certain payments of both
interest and principal. Certain Stripped Securities ("Ratio Strip Securities")
may represent a right to receive differing percentages of both the interest and
principal on each Loan. Pursuant to Section 1286 of the Code, the separation of
ownership of the right to receive some or all of the interest payments on an
obligation from ownership of the right to receive some or all of the principal
payments results in the creation of "stripped bonds" with respect to principal
payments and "stripped coupons" with respect to interest payments. Section 1286
of the Code applies the OID rules to stripped bonds and stripped coupons. For
purposes of computing OID, a stripped bond or a stripped coupon is treated as a
debt instrument issued on the date that such stripped interest is purchased with
an issue price equal to its purchase price or, if more than one stripped
interest is purchased, the ratable share of the purchase price allocable to such
stripped interest.
Servicing Fees in excess of reasonable servicing fees ("Excess Servicing
Fees") will be treated under the stripped bond rules. If the Excess Servicing
Fees are less than 100 basis points (i.e., 1% interest on the Loan principal
balance) or the Securities are initially sold with a de minimis discount
(assuming no Prepayment Assumption is required), any non-de minimis discount
arising from a subsequent transfer of the Securities should be treated as market
discount. The IRS appears to require that reasonable Servicing Fees be
calculated on a Loan by Loan basis, which could result in some Loans being
treated as having more than 100 basis points of interest stripped off.
The Code, OID Regulations and judicial decisions provide no direct guidance
as to how the interest and OID rules are to apply to Stripped Securities and
other Pass-Through Securities. Under the method described above for Pay-Through
Securities (the "Cash Flow Bond Method"), a Prepayment Assumption is used and
periodic recalculations are made which take into account with respect to each
accrual period the effect of prepayments during such period. However, the 1986
Act does not, absent Treasury regulations, appear specifically to cover
instruments such as the Stripped Securities which technically represent
ownership interests in the underlying Loans, rather than being debt instruments
"secured by" those Loans. Nevertheless, it is believed that the Cash Flow Bond
Method is a reasonable method of reporting income for such Securities, and it is
expected that OID will be reported on that basis unless otherwise specified in
the related Prospectus Supplement. In applying the calculation to Pass-Through
Securities, the Trustee will treat all payments to be received by a holder with
respect to the underlying Loans as payments on a single installment obligation.
The IRS could, however, assert that OID must be calculated separately for each
Loan underlying a Security.
Under certain circumstances, if the Loans prepay at a rate faster than the
Prepayment Assumption, the use of the Cash Flow Bond Method may accelerate a
Holder's recognition of income. If, however, the Loans prepay at a rate slower
than the Prepayment Assumption, in some circumstances the use of this method may
decelerate a Holder's recognition of income.
In the case of a Stripped Security that is an Interest Weighted Security,
the Trustee intends, absent contrary authority, to report income to
Securityholders as OID, in the manner described above for Interest Weighted
Securities.
Possible Alternative Characterizations. The characterizations of the
Stripped Securities described above are not the only possible interpretations of
the applicable Code provisions. Among other possibilities, the IRS could
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contend that (i) in certain Series, each non-Interest Weighted Security is
composed of an unstripped undivided ownership interest in Loans and an
installment obligation consisting of stripped principal payments; (ii) the
non-Interest Weighted Securities are subject to the contingent payment
provisions of the Contingent Regulations; or (iii) each Interest Weighted
Stripped Security is composed of an unstripped undivided ownership interest in
Loans and an installment obligation consisting of stripped interest payments.
Given the variety of alternatives for treatment of the Stripped Securities
and the different federal income tax consequences that result from each
alternative, potential purchasers are urged to consult their own tax advisers
regarding the proper treatment of the Securities for federal income tax
purposes.
Character as Qualifying Loans. In the case of Stripped Securities, there is
no specific legal authority existing regarding whether the character of the
Securities, for federal income tax purposes, will be the same as the Loans. The
IRS could take the position that the Loans' character is not carried over to the
Securities in such circumstances. Pass-Through Securities will be, and, although
the matter is not free from doubt, Stripped Securities should be considered to
represent "real estate assets" within the meaning of Section 856(c)(6)(B) 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; and interest income attributable to the
Securities should be considered to represent "interest on obligations secured by
mortgages on real property or on interests in real property" within the meaning
of Section 856(c)(3)(B) of the Code. Reserves or funds underlying the Securities
may cause a proportionate reduction in the above-described qualifying status
categories of Securities.
Sale or Exchange
Subject to the discussion below with respect to Trust Funds as to which a
partnership election is made, a Holder's tax basis in its Security is the price
such holder pays for a Security, plus amounts of original issue 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 Security, measured by the
difference between the amount realized and the Security's basis as so adjusted,
will generally be capital gain or loss, assuming that the Security is held as a
capital asset. In the case of a 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 Regular Interest 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. For taxable years beginning after December 31, 1993, the maximum tax
rate on ordinary income for individual taxpayers is 39.6% and the maximum tax
rate on long-term capital gains reported after December 31, 1990 for such
taxpayers is 28%. The maximum tax rate on both ordinary income and long-term
capital gains of corporate taxpayers is 35%.
Miscellaneous Tax Aspects
Backup Withholding. Subject to the discussion below with respect to Trust
Funds as to which a partnership election is made, 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 OID 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
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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 advisers 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 as to which a
partnership election is made, under the Code, 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
("Nonresidents"), 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. 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 and Stripped Securities, including Ratio Strip
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. 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 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 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 "--Excess Inclusions."
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Tax Characterization of the Trust Fund as a Partnership
Special Tax Counsel will deliver its opinion that a Trust Fund will not be
treated as a 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 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 Securities 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.
Tax Consequences to Holders of the Notes
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. Special Tax Counsel will, except as otherwise
provided in the related Prospectus Supplement, advise the Sponsor that the Notes
will be classified as debt for federal income tax purposes. The discussion below
assumes this characterization of the Notes is correct.
OID, Indexed Securities, etc. The discussion below assumes that all
payments on the Notes are denominated in U.S. dollars, and that the Notes are
not Indexed Securities or Strip Notes. Moreover, the discussion assumes that the
interest formula for the Notes meets the requirements for "qualified stated
interest" under the OID Regulations, and that any OID on the Notes (i.e., any
excess of the principal amount of the Notes over their issue price) does not
exceed a de minimis amount (i.e., 0.25% of their principal amount multiplied by
the number of full years included in their term), all within the meaning of the
OID Regulations. If these conditions are not satisfied with respect to any given
series of Notes, additional tax considerations with respect to such Notes will
be disclosed in the applicable Prospectus Supplement.
Interest Income on the Notes. Based on the above assumptions, except as
discussed in the following paragraph, the Notes will not be considered issued
with OID. The stated interest thereon will be taxable to a Noteholder as
ordinary interest income when received or accrued in accordance with such
Noteholder's method of tax accounting. Under the OID Regulations, a holder of a
Note issued with a de minimis amount of OID must include such OID in income, on
a pro rata basis, as principal payments are made on the Note. It is believed
that any prepayment premium paid as a result of a mandatory redemption will be
taxable as contingent interest when it becomes fixed and unconditionally
payable. A purchaser who buys a Note for more or less than its principal amount
will generally be subject, respectively, to the premium amortization or market
discount rules of the Code.
A holder of a Note that has a fixed maturity date of not more than one year
from the issue date of such Note (a "Short-Term Note") may be subject to special
rules. An accrual basis holder of a Short-Term Note (and certain cash method
holders, including regulated investment companies, as set forth in Section 1281
of the Code) generally would be required to report interest income as interest
accrues on a straight-line basis over the term of each interest period. Other
cash basis holders of a Short-Term Note would, in general, be required to report
interest income as interest is paid (or, if earlier, upon the taxable
disposition of the Short-Term Note). However, a cash basis holder of a
Short-Term Note reporting interest income as it is paid may be required to defer
a portion of any interest expense otherwise deductible on indebtedness incurred
to purchase or carry the Short-Term Note until the taxable disposition of the
Short-Term Note. A cash basis taxpayer may elect under Section 1281 of the Code
to accrue interest income on all nongovernment debt obligations with a term of
one year or less, in which case the
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taxpayer would include interest on the Short-Term Note in income as it accrues,
but would not be subject to the interest expense deferral rule referred to in
the preceding sentence. Certain special rules apply if a Short-Term Note is
purchased for more or less than its principal amount.
Sale or Other Disposition. If a Noteholder sells a Note, the holder will
recognize gain or loss in an amount equal to the difference between the amount
realized on the sale and the holder's adjusted tax basis in the Note. The
adjusted tax basis of a Note to a particular Noteholder will equal the holder's
cost for the Note, increased by any market discount, acquisition discount, OID
and gain previously included by such Noteholder in income with respect to the
Note and decreased by the amount of bond premium (if any) previously amortized
and by the amount of principal payments previously received by such Noteholder
with respect to such Note. Any such gain or loss will be capital gain or loss if
the Note was held as a capital asset, except for gain representing accrued
interest and accrued market discount not previously included in income. Capital
losses generally may be used only to offset capital gains.
Foreign Holders. Interest payments made (or accrued) to a Noteholder who is
a nonresident alien, foreign corporation or other non-United States person (a
"foreign person") generally will be considered "portfolio interest", and
generally will not be subject to United States federal income tax and
withholding tax, if the interest is not effectively connected with the conduct
of a trade or business within the United States by the foreign person and the
foreign person (i) is not actually or constructively a "10 percent shareholder"
of the Trust Fund or the Seller (including a holder of 10% of the outstanding
Certificates) or a "controlled foreign corporation" with respect to which the
Trust Fund or the Seller is a "related person" within the meaning of the Code
and (ii) provides the Owner Trustee or other person who is otherwise required to
withhold U.S. tax with respect to the Notes with an appropriate statement (on
Form W-8 or a similar form), signed under penalties of perjury, certifying that
the beneficial owner of the Note is a foreign person and providing the foreign
person's name and address. If a Note is held through a securities clearing
organization or certain other financial institutions, the organization or
institution may provide the relevant signed statement to the withholding agent;
in that case, however, the signed statement must be accompanied by a Form W-8 or
substitute form provided by the foreign person that owns the Note. If such
interest is not portfolio interest, then it will be subject to United States
federal income and withholding tax at a rate of 30 percent, unless reduced or
eliminated pursuant to an applicable tax treaty.
Any capital gain realized on the sale, redemption, retirement or other
taxable disposition of a Note 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.
Backup Withholding. Each holder of a Note (other than an exempt holder such
as a corporation, tax-exempt organization, qualified pension and profit-sharing
trust, individual retirement account or nonresident alien who provides
certification as to status as a nonresident) will be required to provide, under
penalties of perjury, a certificate containing the holder's name, address,
correct federal taxpayer identification number and a statement that the holder
is not subject to backup withholding. Should a nonexempt Noteholder fail to
provide the required certification, the Trust Fund will be required to withhold
31 percent of the amount otherwise payable to the holder, and remit the withheld
amount to the IRS as a credit against the holder's federal income tax liability.
Possible Alternative Treatments of the Notes. If, contrary to the opinion
of Special 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 treated as a publicly traded partnership 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
special counsel to the Sponsor, the Trust Fund might be treated as a publicly
traded partnership that would not be taxable as a corporation because it would
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meet certain qualifying income tests. Nonetheless, treatment of the Notes as
equity interests in such a publicly traded partnership could have adverse tax
consequences to certain holders. For example, income to certain tax-exempt
entities (including pension funds) would be "unrelated business taxable income",
income to foreign holders generally would be subject to U.S. tax and U.S. 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
Treatment of the Trust Fund as a Partnership. The Trust Fund and the Master
Servicer 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 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
are Indexed Securities or Strip Certificates, 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 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 Sponsor. 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
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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 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.
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 Fund 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
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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 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 will not 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-l 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
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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.
The Sponsor 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. In determining a holder's
withholding status, the Trust Fund may rely on IRS Form W-8, IRS Form W-9 or the
holder's certification of nonforeign status signed under penalties of perjury.
The term "U.S. Person" means a citizen or resident of the United States, a
corporation, partnership or other entity created or organized in or under the
laws of the United States or any political subdivision thereof, or an estate
whose income is subject to U.S. federal income tax regardless of its source of
income, or a trust if a court within the United States is able to exercise
primary supervision of the administration of the trust and one or more United
States fiduciaries have the authority to control all substantial decisions of
the trust.
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 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 percent, 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 in
excess of the taxes that should be withheld with respect to the guaranteed
payments.
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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.
STATE TAX CONSIDERATIONS
In addition to the federal income tax consequences described in "Federal
Income Tax Consequences," 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
The following describes certain considerations under ERISA and the Code,
which apply only to Securities of a Series that are not divided into subclasses.
If Securities are divided into subclasses the related Prospectus Supplement will
contain information concerning considerations relating to ERISA and the Code
that are applicable to such Securities.
ERISA imposes requirements on employee benefit plans (and on certain other
retirement plans and arrangements, including individual retirement accounts and
annuities, Keogh plans and collective investment funds and separate accounts in
which such plans, accounts or arrangements are invested) (collectively "Plans")
subject to ERISA and on persons who are fiduciaries with respect to such Plans.
Generally, ERISA applies to investments made by Plans. Among other things, ERISA
requires that the assets of Plans be held in trust and that the trustee, or
other duly authorized fiduciary, have exclusive authority and discretion to
manage and control the assets of such Plans. ERISA also imposes certain duties
on persons who are fiduciaries of Plans. Under ERISA, any person who exercises
any authority or control respecting the management or disposition of the assets
of a Plan is considered to be a fiduciary of such Plan (subject to certain
exceptions not here relevant). Certain employee benefit plans, such as
governmental plans (as defined in ERISA Section 3(32)) and, if no election has
been made under Section 410(d) of the Code, church plans (as defined in ERISA
Section 3(33)), are not subject to ERISA requirements. Accordingly, assets of
such plans may be invested in Securities without regard to the ERISA
considerations described above and below, subject to the provisions of
applicable state law. Any such plan which is qualified and exempt from taxation
under Code Sections 401(a) and 501(a), however, is subject to the prohibited
transaction rules set forth in Code Section 503.
On November 13, 1986, the United States Department of Labor (the "DOL")
issued final regulations concerning the definition of what constitutes the
assets of a Plan. (Labor Reg. Section 2510.3-101) Under this regulation, the
underlying assets and properties of corporations, partnerships and certain other
entities in which a Plan makes an "equity" investment could be deemed for
purposes of ERISA to be assets of the investing Plan in certain circumstances.
However, the regulation provides that, generally, the assets of a corporation or
partnership in which a Plan invests will not be deemed for purposes of ERISA to
be assets of such Plan if the equity interest acquired by the investing Plan is
a publicly-offered security. A publicly-offered security, as defined in the
Labor Reg. Section 2510.3-101, is a security that is widely held, freely
transferable and registered under the Securities Exchange Act of 1934, as
amended.
In addition to the imposition of general fiduciary standards of investment
prudence and diversification, ERISA prohibits a broad range of transactions
involving Plan assets and persons ("Parties in Interest") having certain
specified relationships to a Plan and imposes additional prohibitions where
Parties in Interest are fiduciaries with respect to such Plan. Because the Loans
may be deemed Plan assets of each Plan that purchases Securities, an
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investment in the Securities by a Plan might be a prohibited transaction under
ERISA Sections 406 and 407 and subject to an excise tax under Code Section 4975
unless a statutory or administrative exemption applies.
In Prohibited Transaction Exemption 83-1 ("PTE 83-1"), which amended
Prohibited Transaction Exemption 81-7, the DOL exempted from ERISA's prohibited
transaction rules certain transactions relating to the operation of residential
mortgage pool investment trusts and the purchase, sale and holding of "mortgage
pool pass-through certificates" in the initial issuance of such certificates.
PTE 83-1 permits, subject to certain conditions, transactions which might
otherwise be prohibited between Plans and Parties in Interest with respect to
those Plans related to the origination, maintenance and termination of mortgage
pools consisting of mortgage loans secured by first or second mortgages or deeds
of trust on single-family residential property, and the acquisition and holding
of certain mortgage pool pass-through certificates representing an interest in
such mortgage pools by Plans. If the general conditions (discussed below) of PTE
83-1 are satisfied, investments by a Plan in Securities that represent interests
in a Pool consisting of Loans ("Single Family Securities") will be exempt from
the prohibitions of ERISA Sections 406(a) and 407 (relating generally to
transactions with Parties in Interest who are not fiduciaries) if the Plan
purchases the Single Family Securities at no more than fair market value and
will be exempt from the prohibitions of ERISA Sections 406(b)(1) and (2)
(relating generally to transactions with fiduciaries) if, in addition, the
purchase is approved by an independent fiduciary, no sales commission is paid to
the pool sponsor, the Plan does not purchase more than 25% of all Single Family
Securities, and at least 50% of all Single Family Securities are purchased by
persons independent of the pool sponsor or pool trustee. PTE 83-1 does not
provide an exemption for transactions involving Subordinate Securities.
Accordingly, no transfer of a Subordinate Security or a Security which is not a
Single Family Security may be made to a Plan unless specified in the related
Prospectus Supplement.
The discussion in this and the next succeeding paragraph applies only to
Single Family Securities. The Sponsor believes that, for purposes of PTE 83-1,
the term "mortgage pass-through certificate" would include: (i) Securities
issued in a Series consisting of only a single class of Securities; and (ii)
Securities issued in a Series in which there is only one class of such
Securities; provided that the Securities in the case of clause (i), or the
Securities in the case of clause (ii), evidence the beneficial ownership of both
a specified percentage of future interest payments (greater than 0%) and a
specified percentage (greater than 0%) of future principal payments on the
Loans. It is not clear whether a class of Securities that evidences the
beneficial ownership in a Trust Fund divided into Loan groups, beneficial
ownership of a specified percentage of interest payments only or principal
payments only, or a notional amount of either principal or interest payments, or
a class of Securities entitled to receive payments of interest and principal on
the Loans only after payments to other classes or after the occurrence of
certain specified events would be a "mortgage pass-through certificate" for
purposes of PTE 83-1.
PTE 83-1 sets forth three general conditions which must be satisfied for
any transaction to be eligible for exemption: (i) the maintenance of a system of
insurance or other protection for the pooled mortgage loans and property
securing such loans, and for indemnifying Securityholders against reductions in
pass-through payments due to property damage or defaults in loan payments in an
amount not less than the greater of one percent of the aggregate principal
balance of all covered pooled mortgage loans or the principal balance of the
largest covered pooled mortgage loan; (ii) the existence of a pool trustee who
is not an affiliate of the pool sponsor; and (iii) a limitation on the amount of
the payment retained by the pool sponsor, together with other funds inuring to
its benefit, to not more than adequate consideration for selling the mortgage
loans plus reasonable compensation for services provided by the pool sponsor to
the pool. The Sponsor believes that the first general condition referred to
above will be satisfied with respect to the Securities in a Series issued
without a subordination feature, or the Securities only in a Series issued with
a subordination feature, provided that the subordination and Reserve Account,
subordination by shifting of interests, the pool insurance or other form of
credit enhancement described under "Credit Enhancement" herein (such
subordination, pool insurance or other form of credit enhancement being the
system of insurance or other protection referred to above) with respect to a
Series of Securities is maintained in an amount not less than the greater of one
percent of the aggregate principal balance of the Loans or the principal balance
of the largest Loan. See "Description of the Securities" herein. In the absence
of a ruling that the system of insurance or other protection with respect to a
Series of Securities satisfies the first general condition referred
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to above, there can be no assurance that these features will be so viewed by the
DOL. The Trustee will not be affiliated with the Sponsor.
Each Plan fiduciary who is responsible for making the investment decisions
whether to purchase or commit to purchase and to hold Single Family Securities
must make its own determination as to whether the first and third general
conditions, and the specific conditions described briefly in the preceding
paragraphs, of PTE 83-1 have been satisfied, or as to the availability of any
other prohibited transaction exemptions. Each Plan fiduciary should also
determine whether, under the general fiduciary standards of investment prudence
and diversification, an investment in the Securities is appropriate for the
Plan, taking into account the overall investment policy of the Plan and the
composition of the Plan's investment portfolio.
The DOL has granted to certain underwriters individual administrative
exemptions (the "Underwriter Exemptions") from certain of the prohibited
transaction rules of ERISA and the related excise tax provisions of Section 4975
of the Code with respect to the initial purchase, the holding and the subsequent
resale by Plans of certificates in pass-through trusts that consist of certain
receivables, loans and other obligations that meet the conditions and
requirements of the Underwriter Exemptions.
While each Underwriter Exemption is an individual exemption separately
granted to a specific underwriter, the terms and conditions which generally
apply to the Underwriter Exemptions are substantially the following:
(1) the acquisition of the certificates by a Plan is on terms
(including the price for the certificates) that are at least as favorable
to the Plan as they would be in an arm's-length transaction with an
unrelated party;
(2) the rights and interests evidenced by the certificates acquired by
the Plan are not subordinated to the rights and interests evidenced by
other certificates of the trust fund;
(3) the certificates required by the Plan have received a rating at
the time of such acquisition that is one of the three highest generic
rating categories from Standard & Poor's Ratings Group, a Division of The
McGraw-Hill Companies ("S&P"), Moody's Investors Service, Inc. ("Moody's"),
Duff & Phelps Credit Rating Co. ("DCR") or Fitch Investors Service, Inc.
("Fitch");
(4) the trustee must not be an affiliate of any other member of the
Restricted Group as defined below;
(5) the sum of all payments made to and retained by the underwriters
in connection with the distribution of the certificates represents not more
than reasonable compensation for underwriting the certificates; the sum of
all payments made to and retained by the seller pursuant to the assignment
of the loans to the trust fund represents not more than the fair market
value of such loans; the sum of all payments made to and retained by the
servicer and any other servicer represents not more than reasonable
compensation for such person's services under the agreement pursuant to
which the loans are pooled and reimbursements of such person's reasonable
expenses in connection therewith; and
(6) the Plan investing in the certificates is an "accredited investor"
as defined in Rule 501(a)(1) of Regulation D of the Securities and Exchange
Commission under the Securities Act of 1933 as amended.
The trust fund must also meet the following requirements:
(i) the corpus of the trust fund must consist solely of assets of the
type that have been included in other investment pools;
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(ii) certificates in such other investment pools must have been rated
in one of the three highest rating categories of S&P, Moody's, Fitch or DCR
for at least one year prior to the Plan's acquisition of certificates; and
(iii) certificates evidencing interests in such other investment pools
must have been purchased by investors other than Plans for at least one
year prior to any Plan's acquisition of certificates.
Moreover, the Underwriter Exemptions generally provide relief from certain
self-dealing/conflict of interest prohibited transactions that may occur when
the Plan fiduciary causes a Plan to acquire certificates in a trust as to which
the fiduciary (or its affiliate) is an obligor on the receivables held in the
trust provided that, among other requirements: (i) in the case of an acquisition
in connection with the initial issuance of certificates, at least fifty percent
(50%) of each class of certificates in which Plans have invested is acquired by
persons independent of the Restricted Group (as defined below), (ii) such
fiduciary (or its affiliate) is an obligor with respect to five percent (5%) or
less of the fair market value of the obligations contained in the trust; (iii)
the Plan's investment in certificates of any class does not exceed twenty-five
percent (25%) of all of the certificates of that class outstanding at the time
of the acquisition; and (iv) immediately after the acquisition, no more than
twenty-five percent (25%) of the assets of the Plan with respect to which such
person is a fiduciary is invested in certificates representing an interest in
one or more trusts containing assets sold or serviced by the same entity. The
Underwriter Exemptions do not apply to Plans sponsored by the Seller, the
related Underwriter, the Trustee, the Master Servicer, any insurer with respect
to the Loans, any obligor with respect to Loans included in the Trust Fund
constituting more than five percent (5%) of the aggregate unamortized principal
balance of the assets in the Trust Fund, or any affiliate of such parties (the
"Restricted Group").
The Prospectus Supplement for each Series of Securities will indicate the
classes of Securities, if any, offered thereby as to which it is expected that
an Underwriter Exemption will apply.
The Underwriter Exemption contains several requirements, some of which
differ from those in PTE 83-l. The Underwriter Exemption contains an expanded
definition of "certificate" which includes an interest which entitles the holder
to pass-through payments of principal, interest and/or other payments. The
Underwriter Exemption contains an expanded definition of "trust" which permits
the trust corpus to consist of secured consumer receivables. The definition of
"trust", however, does not include any investment pool unless, inter alia, (i)
the investment pool consists only of assets of the type which have been included
in other investment pools, (ii) certificates evidencing interests in such other
investment pools have been purchased by investors other than Plans for at least
one year prior to the Plan's acquisition of certificates pursuant to the
Underwriter Exemption, and (iii) certificates in such other investment pools
have been rated in one of the three highest generic rating categories of the
four credit rating agencies noted below. Generally, the Underwriter Exemption
holds that the acquisition of the certificates by a Plan must be on terms
(including the price for the certificates) that are at least as favorable to the
Plan as they would be in an arm's length transaction with an unrelated party.
The Underwriter Exemption requires that the rights and interests evidenced by
the certificates not be "subordinated" to the rights and interests evidenced by
other certificates of the same trust. The Underwriter Exemption requires that
certificates acquired by a Plan have received a rating at the time of their
acquisition that is in one of the three highest generic rating categories of
S&P, Moody's, Fitch or DCR. The Underwriter Exemption specifies that the pool
trustee must not be an affiliate of the pool sponsor, nor an affiliate of the
Underwriter, the pool servicer, any obligor with respect to mortgage loans
included in the trust constituting more than five percent of the aggregate
unamortized principal balance of the assets in the trust, or any affiliate of
such entities. Finally, the Underwriter Exemption stipulates that any Plan
investing in the certificates must be an "accredited investor" as defined in
Rule 501(a)(1) of Regulation D of the Securities and Exchange Commission under
the Securities Act of 1933, as amended.
Any Plan fiduciary which proposes to cause a Plan to purchase Securities
should consult with their counsel concerning the impact of ERISA and the Code,
the applicability of PTE 83-1 and the Underwriter Exemption, and the potential
consequences in their specific circumstances, prior to making such investment.
Moreover, each Plan
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<PAGE>
fiduciary should determine whether under the general fiduciary standards of
investment prudence and diversification an investment in the Securities is
appropriate for the Plan, taking into account the overall investment policy of
the Plan and the composition of the Plan's investment portfolio.
LEGAL INVESTMENT
The Prospectus Supplement for each series of Securities will specify which,
if any, of the classes of Securities offered thereby constitute "mortgage
related securities" for purposes of the Secondary Mortgage Market Enhancement
Act of 1984 ("SMMEA"). Classes of Securities that qualify as "mortgage related
securities" will be legal investments for persons, trusts, corporations,
partnerships, associations, business trusts, and business entities (including
depository institutions, life insurance companies and pension funds) created
pursuant to or existing under the laws of the United States or of any state
(including the District of Columbia and Puerto Rico) whose authorized
investments are subject to state regulations to the same extent as, under
applicable law, obligations issued by or guaranteed as to principal and interest
by the United States or any such entities. Under SMMEA, if a state enacted
legislation prior to October 4, 1991 specifically limiting the legal investment
authority of any such entities with respect to "mortgage related securities",
Securities will constitute legal investments for entities subject to such
legislation only to the extent provided therein. Approximately twenty-one states
adopted such legislation prior to the October 4, 1991 deadline. SMMEA provides,
however, that in no event will the enactment of any such legislation affect the
validity of any contractual commitment to purchase, hold or invest in
securities, or require the sale or other disposition of securities, so long as
such contractual commitment was made or such securities were acquired prior to
the enactment of such legislation.
SMMEA also amended the legal investment authority of federally-chartered
depository institutions as follows: federal savings and loan associations and
federal savings banks may invest in, sell or otherwise deal in Securities
without limitations as to the percentage of their assets represented thereby,
federal credit unions may invest in mortgage related securities, and national
banks may purchase securities for their own account without regard to the
limitations generally applicable to investment securities set forth in 12 U.S.C.
24 (Seventh), subject in each case to such regulations as the applicable federal
authority may prescribe. In this connection, federal credit unions should review
the National Credit Union Administration ("NCUA") Letter to Credit Unions No.
96, as modified by Letter to Credit Unions No. 108, which includes guidelines to
assist federal credit unions in making investment decisions for mortgage related
securities and the NCUA's regulation "Investment and Deposit Activities" (12
C.F.R. Part 703), which sets forth certain restrictions on investments by
federal credit unions in "mortgage related securities" (in each case whether or
not the class of Securities under consideration for purchase constituted a
"mortgage related security").
All depository institutions considering an investment in the Securities
(whether or not the class of Securities under consideration for purchase
constitutes a "mortgage related security") should review the Federal Financial
Institutions Examination Council's Supervisory Policy Statement on the
Securities Activities (to the extent adopted by their respective regulators)
(the "Policy Statement") setting forth, in relevant part, certain securities
trading and sales practices deemed unsuitable for an institution's investment
portfolio, and guidelines for (and restrictions on) investing in mortgage
derivative products, including "mortgage related securities", which are
"high-risk mortgage securities" as defined in the Policy Statement. According to
the Policy Statement, such "high-risk mortgage securities" include securities
such as Securities not entitled to distributions allocated to principal or
interest, or Subordinated Securities. Under the Policy Statement, it is the
responsibility of each depository institution to determine, prior to purchase
(and at stated intervals thereafter), whether a particular mortgage derivative
product is a "high-risk mortgage security", and whether the purchase (or
retention) of such a product would be consistent with the Policy Statement.
The foregoing does not take into consideration the applicability of
statutes, rules, regulations, orders guidelines or agreements generally
governing investments made by a particular investor, including, but not limited
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<PAGE>
to "prudent investor" provisions which may restrict or prohibit investment in
securities which are not "interest bearing" or "income paying".
There may be other restrictions on the ability of certain investors,
including depository institutions, either to purchase Securities or to purchase
Securities representing more than a specified percentage of the investor's
assets. Investors should consult their own legal advisors in determining whether
and to what extent the Securities constitute legal investments for such
investors.
METHOD OF DISTRIBUTION
Securities are being offered hereby in Series from time to time (each
Series evidencing or relating to a separate Trust Fund) through any of the
following methods:
1. By negotiated firm commitment underwriting and public reoffering by
underwriters;
2. By agency placements through one or more placement agents primarily
with institutional investors and dealers; and
3. By placement directly by the Sponsor with institutional investors.
A Prospectus Supplement will be prepared for each Series which will
describe the method of offering being used for that Series and will set forth
the identity of any underwriters thereof and either the price at which such
Series is being offered, the nature and amount of any underwriting discounts or
additional compensation to such underwriters and the proceeds of the offering to
the Sponsor, or the method by which the price at which the underwriters will
sell the Securities will be determined. Each Prospectus Supplement for an
underwritten offering will also contain information regarding the nature of the
underwriters' obligations, any material relationship between the Sponsor and any
underwriter and, where appropriate, information regarding any discounts or
concessions to be allowed or reallowed to dealers or others and any arrangements
to stabilize the market for the Securities so offered. In firm commitment
underwritten offerings, the underwriters will be obligated to purchase all of
the Securities of such Series if any such Securities are purchased. Securities
may be acquired by the underwriters for their own accounts and may be resold
from time to time in one or more transactions, including negotiated
transactions, at a fixed public offering price or at varying prices determined
at the time of sale.
Underwriters and agents may be entitled under agreements entered into with
the Sponsor to indemnification by the Sponsor against certain civil liabilities,
including liabilities under the Securities Act of 1933, as amended, or to
contribution with respect to payments which such underwriters or agents may be
required to make in respect thereof.
If a Series is offered other than through underwriters, the Prospectus
Supplement relating thereto will contain information regarding the nature of
such offering and any agreements to be entered into between the Sponsor and
purchasers of Securities of such Series.
LEGAL MATTERS
The validity of the Certificates will be passed upon for the Sponsor by
Tobin & Tobin, a professional corporation, San Francisco, California. Certain
federal income tax consequences with respect to the Certificates will be passed
upon for the Sponsor by Brown & Wood LLP, New York, New York or Dewey
Ballantine, New York, New York. Brown & Wood LLP, New York, New York or Dewey
Ballantine, New York, New York will act as counsel for the Underwriter.
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FINANCIAL INFORMATION
A new Trust Fund will be formed with respect to each Series of Securities
and no Trust Fund will engage in any business activities or have any assets or
obligations prior to the issuance of the related Series of Securities.
Accordingly, no financial statements with respect to any Trust Fund will be
included in this Prospectus or in the related Prospectus Supplement.
RATING
It is a condition to the issuance of the Securities of each Series offered
hereby and by the Prospectus Supplement that they shall have been rated in one
of the four highest rating categories by the nationally recognized statistical
rating agency or agencies (each, a "Rating Agency") specified in the related
Prospectus Supplement.
Any such rating would be based on, among other things, the adequacy of the
value of the Trust Fund Assets and any credit enhancement with respect to such
class and will reflect such Rating Agency's assessment solely of the likelihood
that holders of a class of Securities will receive payments to which such
Securityholders are entitled under the related Agreement. Such rating will not
constitute an assessment of the likelihood that principal prepayments on the
related Loans will be made, the degree to which the rate of such prepayments
might differ from that originally anticipated or the likelihood of early
optional termination of the Series of Securities. 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. Each
security rating should be evaluated independently of any other security rating.
Such rating will not address the possibility that prepayment at higher or lower
rates than anticipated by an investor may cause such investor to experience a
lower than anticipated yield or that an investor purchasing a Security at a
significant premium might fail to recoup its initial investment under certain
prepayment scenarios.
There is also no assurance that any such rating will remain in effect for
any given period of time or that it may not be lowered or withdrawn entirely by
the Rating Agency in the future 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 Trust Fund Assets or any credit enhancement with
respect to a Series, such rating might also be lowered or withdrawn for other
reasons, including, but not limited to, an adverse change in the financial or
other condition of a credit enhancement provider or a change in the rating of
such credit enhancement provider's long term debt.
The amount, type and nature of credit enhancement, if any, established with
respect to a Series of Securities will be determined on the basis of criteria
established by each Rating Agency rating classes of such Series. Such criteria
are sometimes based upon an actuarial analysis of the behavior of mortgage loans
in a larger group. Such analysis is often the basis upon which each Rating
Agency determines the amount of credit enhancement required with respect to each
such class. There can be no assurance that the historical data supporting any
such actuarial analysis will accurately reflect future experience nor any
assurance that the data derived from a large pool of mortgage loans accurately
predicts the delinquency, foreclosure or loss experience of any particular pool
of Loans. No assurance can be given that values of any Properties have remained
or will remain at their levels on the respective dates of origination of the
related Loans. If the residential real estate markets should experience an
overall decline in property values such that the outstanding principal balances
of the Loans in a particular Trust Fund and any secondary financing on the
related Properties become equal to or greater than the value of the Properties,
the rates of delinquencies, foreclosures and losses could be higher than those
now generally experienced in the mortgage lending industry. In additional,
adverse economic conditions (which may or may not affect real property values)
may affect the timely payment by mortgagors of scheduled payments of principal
and interest on the Loans and, accordingly, the rates of delinquencies,
foreclosures and losses with respect to any Trust Fund. To the extent that such
losses are not covered by credit enhancement, such losses will be borne, at
least in part, by the holders of one or more classes of the Securities of the
related Series.
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INDEX OF DEFINED TERMS
Term Page
Accretion Directed...........................................................34
Accrual Securities...........................................................30
Advance ............................................................9
Agreement ...........................................................21
Amortizable Bond Premium Regulations.........................................71
APR ...........................................................24
Available Funds ...........................................................30
balloon payment ...........................................................22
Belgian Cooperative..........................................................38
Beneficial owner ...........................................................37
Book-Entry Securities........................................................36
borrower ...........................................................64
Buydown Fund ...........................................................23
Buydown Loans ...........................................................23
Capitalized Interest Account.................................................50
Cash Flow Bond Method........................................................78
CEDEL ...........................................................36
CEDEL Participants...........................................................38
CERCLA .......................................................17, 60
Certificates .........................................................1, 4
Class Security Balance.......................................................30
Closed End Loans ............................................................1
Closed-End Loans ............................................................4
CLTV ...........................................................24
Code ...................................................10, 11, 67
Collateral Value ...........................................................25
Combined Loan-to-Value Ratio.................................................24
Commission ............................................................2
Companion classes ...........................................................35
Component Securities.........................................................34
Contingent Regulations.......................................................69
contracts ...........................................................63
Cut-off Date ........................................................4, 21
Cut-off Date Principal Balance...............................................28
DCR ...........................................................89
Debt Securities ...........................................................68
Definitive Certificate.......................................................37
Detailed Description.........................................................22
Distribution Date ............................................................6
DOL ...........................................................87
DTC .......................................................19, 36
Eligible Account ...........................................................47
Eligible Investments.........................................................42
EPA ...........................................................60
ERISA ...........................................................13
Euroclear ...........................................................36
Euroclear Operator...........................................................38
Euroclear Participants.......................................................38
94
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Page
European Depositaries........................................................37
Excess servicing ...........................................................78
Exchange Act ............................................................3
FHA ............................................................9
Financial Intermediary.......................................................37
Fitch ...........................................................89
Fixed Rate ...........................................................35
Floating Rate ...........................................................36
Foreign person ...........................................................82
Funding Period ...........................................................19
Garn-St Germain Act..........................................................62
Headlands ...........................................................25
Holder in Due Course Rules...................................................18
Home Equity Loans .........................................................1, 5
Home Improvement Contracts.............................................1, 5, 24
Home Improvements ............................................................1
Indenture ...........................................................28
Installment Contract.........................................................64
Insurance Proceeds...........................................................48
Insured Expenses ...........................................................48
Interest Only ...........................................................36
Interest Weighted Securities.................................................70
Inverse Floating Rate........................................................36
IRS ...........................................................69
L/C Bank ........................................................8, 41
L/C Percentage ........................................................8, 41
Lender ...........................................................64
Liquidation Expenses.........................................................48
Liquidation Proceeds.........................................................48
Loan Rate ............................................................6
Loan-to-Value Ratio..........................................................24
Loans ............................................................1
lockout periods ...........................................................23
LTV ...........................................................24
Master Servicer ............................................................4
Master Servicing Agreement...................................................21
Moody's ...........................................................89
Morgan ...........................................................38
Mortgage ...........................................................46
Mortgage Loan ............................................................4
Mortgage Loans ............................................................1
Mortgaged Properties.........................................................23
NCUA ...........................................................91
Nonresidents ...........................................................80
Notes .........................................................1, 4
Notional Amount Securities...................................................34
OID .......................................................11, 68
OID Regulations ...........................................................68
PACs ...........................................................34
95
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Page
Partial Accrual ...........................................................36
Parties in Interest..........................................................87
Pass-Through Rate ............................................................6
Pass-Through Securities......................................................76
Pay-Through Security.........................................................69
Planned Principal Class......................................................34
Plans ...........................................................87
Policy Statement ...........................................................91
Pool ........................................................4, 20
Pool Insurance Policy........................................................42
Pool Insurer ...........................................................42
Pooling and Servicing Agreement..............................................28
Pre-Funded Amount ...........................................................19
Pre-Funding Account.......................................................4, 19
Prepayment Assumption........................................................69
Primary Mortgage Insurance Policy............................................23
Principal Only ...........................................................36
Principal Prepayments........................................................31
Properties ........................................................5, 23
Proposed Mark-to-Market Regulations..........................................76
PTE 83-1 ...........................................................88
Purchase Price ...........................................................27
Rating Agency ...........................................................93
Ratio Strip Securities.......................................................78
RCRA ...........................................................60
Record Date ...........................................................29
Refinance Loan ...........................................................25
Regular Interest Securities..................................................67
Relevant Depositary..........................................................37
Relief Act ...........................................................65
REMIC ....................................................1, 29, 67
Reserve Account ........................................................8, 30
Residual Interest Security...................................................74
Restricted Group ...........................................................90
Retained Interest ...........................................................28
Revolving Credit Line Loans................................................1, 4
Riegle Act ...........................................................17
Rules ...........................................................37
S&P ...........................................................89
Scheduled Principal Class....................................................35
Secured Creditor Exclusion...................................................60
Securities .........................................................1, 4
Security Account ...........................................................47
Security Owners ...........................................................36
Security Register ...........................................................29
Securityholders ...........................................................37
Seller ............................................................1
Sellers ...........................................................21
Senior Securities ........................................................5, 40
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Page
Sequential Pay ...........................................................35
Series ............................................................1
Servicing Fee ...........................................................77
Short-Term Note ...........................................................81
Single Family Properties.....................................................23
Single Family Securities.....................................................88
SMMEA .......................................................10, 91
Sponsor ........................................................1, 25
Strip ...........................................................35
Stripped Securities..........................................................77
Sub-Servicer ............................................................9
Sub-Servicers ...........................................................21
Sub-Servicing Agreement......................................................50
Subordinated Securities.......................................................5
Subsequent Loans ...........................................................19
Support Class ...........................................................35
TACs ...........................................................35
Targeted Principal Class.....................................................35
Terms and Conditions.........................................................38
Thrift institutions..........................................................75
TIN ...........................................................79
Title V .......................................................63, 64
Trust Agreement .......................................................21, 28
Trust Fund ............................................................1
Trust Fund Assets .....................................................1, 4, 20
Trustee ........................................................4, 28
U.S. Person ...........................................................86
Underwriter Exemptions.......................................................89
VA ............................................................9
Variable Rate ...........................................................36
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======================================= =======================================
No dealer, salesman or other person HEADLANDS HOME EQUITY
has been authorized to give any LOAN TRUST 1997-1
information or to make any
representation not contained in this
Prospectus Supplement or the
Prospectus and, if given or made, such
information or representation must not
be relied upon as having been
authorized by the Sponsor or the $189,065,000 Class A
Underwriter. This Prospectus Variable Rate
Supplement or the Prospectus does not Asset-Backed Notes
constitute an offer of any securities
other than those to which they relate
or an offer to sell, or a solicitation
of an offer to buy, to any person in
any jurisdiction where such an offer
or solicitation would be unlawful.
Neither the delivery of this Class S 1.25%
Prospectus Supplement or the Asset-Backed Notes
Prospectus nor any sale made hereunder
shall, under any circumstances, create
any implication that the information
contained herein is correct as of any
time subsequent to their respective
dates.
---------------------
TABLE OF CONTENTS REVOLVING HOME EQUITY LOAN
PAGE ASSET-BACKED NOTES
---- 1997-1
Prospectus Supplement
Available Information.............S-3
Reports to the Noteholders........S-3
Incorporation of Certain
Documents by Reference..........S-3
Summary...........................S-4
Risk Factors.....................S-20
Formation of the Trust...........S-22
The Trust Property...............S-23 HEADLANDS MORTGAGE
The Insurer......................S-23 SECURITIES INC.
Headlands Mortgage Company.......S-24
Headlands' Home Equity Loan
Program.......................S-26
The Sponsor .....................S-27
Description of the HELOCs........S-27 ---------------------------------
Maturity and Prepayment
Considerations................S-35
Pool Factor and Trading PROSPECTUS SUPPLEMENT
Information...................S-37
Description of the Notes.........S-38 ---------------------------------
Use of Proceeds..................S-57
Certain Federal Income Tax
Consequences..................S-57
State Taxes......................S-62
ERISA Considerations.............S-62
Legal Investment
Considerations................S-63
Underwriting.....................S-63
Legal Matters....................S-64
Experts..........................S-64 GREENWICH CAPITAL
Ratings..........................S-64 MARKETS, INC.
Index of Defined Terms...........S-66
Annex I...........................A-1
Prospectus
Prospectus Supplement
or Current Report
on Form 8-K.......................2
Available Information...............2
Incorporation of Certain
Documents
by Reference......................3 August 18, 1997
Reports to Securityholders..........3
Summary of Terms....................4
Risk Factors.......................14
The Trust Fund.....................20
Use of Proceeds....................25
The Sponsor........................25
Loan Program.......................25
Description of the Securities......28
Credit Enhancement.................39
Yield and Prepayment
Considerations...................43
The Agreements.....................45
Certain Legal Aspects of the
Loans............................58
Federal Income Tax Consequences....67
State Tax Considerations...........87
ERISA Considerations...............87
Legal Investment...................91
Method of Distribution.............92
Legal Matters......................92
======================================= =======================================
