<PAGE> 1
PROSPECTUS SUPPLEMENT
(TO PROSPECTUS DATED OCTOBER 24, 1997)
$749,160,000
SEQUOIA MORTGAGE TRUST 2
COLLATERALIZED MORTGAGE BONDS
------------------------
Sequoia Mortgage Trust 2 (the "Issuer") will issue two classes of
Collateralized Mortgage Bonds (the "Bonds"), the Class A-1 and Class A-2 Bonds,
each of which is being offered hereby. Interest on each Class of Bonds will be
payable monthly on the 25th day of each month, or if such day is not a business
day, the next succeeding business day (each, a "Payment Date"), commencing on
November 25, 1997. See "DESCRIPTION OF THE BONDS -- Interest" herein. Payments
of principal of each Class of Bonds on each Payment Date will be made in the
manner described herein under "DESCRIPTION OF THE BONDS -- Principal." The Bonds
are redeemable only under the circumstances described herein.
The Issuer is a Delaware business trust established by Sequoia Mortgage
Funding Corporation (the "Company"), a wholly owned subsidiary of Redwood Trust,
Inc., a Maryland corporation ("Redwood Trust"). The Bonds represent limited
obligations of the Issuer payable solely from the collateral pledged to secure
the Bonds and are not insured or guaranteed by any government agency or
instrumentality, the Company, Redwood Trust, the Master Servicer, the Insurer
(except as set forth herein) or any other person or entity. Payments on the
Bonds will be payable solely from approximately $756,727,490 of mortgages
pledged to secure the Bonds ("Pledged Mortgages"), other collateral pledged to
secure the Bonds and the Bond Insurance Policy. None of the Company, Redwood
Trust or the Master Servicer has guaranteed or is otherwise obligated with
respect to payment of the Bonds and no person or entity other than the Issuer is
obligated to pay the Bonds, except as specifically set forth herein with regard
to the Bond Insurance Policy. The Issuer is not expected to have any significant
assets other than those pledged as collateral to secure the Bonds.
The Bonds will be unconditionally and irrevocably guaranteed as to payment
of Insured Payments (as defined herein) pursuant to the terms of a financial
guaranty insurance policy (the "Bond Insurance Policy") to be issued by Ambac
Assurance Corporation (the "Insurer"). See "DESCRIPTION OF THE BONDS -- Bond
Insurance Policy" and "-- The Insurer" herein.
The Pledged Mortgages that will collateralize the Bonds are
adjustable-rate, conventional, primarily 25-year mortgage loans secured by first
liens on one- to four-family residential properties. The Bonds also will be
secured by the Swap Agreement, the Bond Account and the Distribution Account
described herein. Prior to their sale to the Issuer by the Company, the Pledged
Mortgages will be held by Redwood Trust.
[LOGO]
(Cover continued on next page)
------------------------
FOR A DISCUSSION OF CERTAIN RISK FACTORS RELATING TO INVESTMENTS IN THE
BONDS, SEE "RISK FACTORS" COMMENCING ON PAGE S-15 OF THIS PROSPECTUS SUPPLEMENT
AND ON PAGE 19 OF THE PROSPECTUS.
------------------------
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.
<TABLE>
<CAPTION>
========================================================================================================
ORIGINAL PRINCIPAL BOND INTEREST
BALANCE RATE STATED MATURITY(1)
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Class A-1................................... $592,560,000 (2) October 25, 2024
- --------------------------------------------------------------------------------------------------------
Class A-2................................... $156,600,000 (2) October 25, 2024
========================================================================================================
</TABLE>
(1) Calculated as described herein under "DESCRIPTION OF THE BONDS -- Stated
Maturity."
(2) Each Class of Bonds shall bear interest at a variable rate which shall be
based, to the extent described herein, on the One-Year Treasury ARM Index
for the Class A-1 Bonds and One-Month LIBOR for the Class A-2 Bonds (each
such term, as defined herein). See "SUMMARY -- Payments of Interest -- Bond
Interest Rate" herein.
------------------------
The Bonds will be purchased by Merrill Lynch, Pierce, Fenner & Smith
Incorporated (the "Underwriter") from the Issuer and will be offered by the
Underwriter from time to time in negotiated transactions or otherwise at varying
prices to be determined at the time of sale. Proceeds to the Issuer from the
sale of the Bonds are expected to be approximately $753,399,990, plus accrued
interest, before deducting issuance expenses payable by the Issuer.
The Bonds are offered by the Underwriter, subject to prior sale, when, as
and if delivered to and accepted by the Underwriter and subject to its right to
reject orders in whole or in part. It is expected that delivery of the Bonds
will be made in book-entry form only through the facilities of The Depository
Trust Company, CEDEL and Euroclear on or about November 6, 1997.
------------------------
MERRILL LYNCH & CO.
------------------------
THE DATE OF THIS PROSPECTUS SUPPLEMENT IS OCTOBER 24, 1997.
<PAGE> 2
(Cover continued from previous page)
THE YIELD TO INVESTORS IN THE BONDS WILL BE SENSITIVE IN VARYING DEGREES
TO, AMONG OTHER THINGS, THE RATE AND TIMING OF PRINCIPAL PAYMENTS (INCLUDING
PREPAYMENTS) OF THE PLEDGED MORTGAGES AND THE LEVEL OF THE ONE-YEAR TREASURY ARM
INDEX, IN THE CASE OF THE CLASS A-1 BONDS, AND ONE-MONTH LIBOR, IN THE CASE OF
THE CLASS A-2 BONDS, EACH OF WHICH MAY VARY SIGNIFICANTLY OVER TIME. THE YIELD
TO MATURITY OF BONDS PURCHASED AT A DISCOUNT OR PREMIUM WILL BE MORE SENSITIVE
TO THE RATE AND TIMING OF PAYMENTS THEREON. HOLDERS OF THE BONDS SHOULD
CONSIDER, IN THE CASE OF ANY SUCH BONDS PURCHASED AT A DISCOUNT, THE RISK THAT A
SLOWER 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 BONDS
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. THE YIELD TO INVESTORS IN THE BONDS ALSO MAY BE ADVERSELY
AFFECTED BY REALIZED LOSSES (AS DEFINED HEREIN). NO REPRESENTATION IS MADE AS TO
THE ANTICIPATED RATE OF PREPAYMENTS ON THE PLEDGED MORTGAGES, THE AMOUNT AND
TIMING OF REALIZED LOSSES, OR AS TO THE RESULTING YIELD TO MATURITY OF THE
BONDS.
The Underwriter intends to make a secondary market in the Bonds, but has no
obligation to do so. There is currently no secondary market for the Bonds and
there can be no assurance that such a market will develop or, if it does
develop, that it will continue or that it will provide Bondholders with a
sufficient level of liquidity of investment. The Bonds will not be listed on any
national securities exchange.
------------------------
This Prospectus Supplement does not contain complete information about the
offering of the Bonds. Additional information is contained in the Prospectus of
the Company dated October 24, 1997 and purchasers are urged to read both this
Prospectus Supplement and the Prospectus in full. Sales of the Bonds may not be
consummated unless the purchaser has received both this Prospectus Supplement
and the Prospectus.
------------------------
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
In addition to the documents described under "INCORPORATION OF CERTAIN DOCUMENTS
BY REFERENCE" in the Prospectus, the financial statements included in, or as
exhibits to the following documents which have been filed with the Securities
and Exchange Commission by the Insurer, are hereby incorporated by reference in
this Prospectus Supplement:
(a) The consolidated financial statements of the Insurer and its
subsidiaries as of December 31, 1996 and December 31, 1995 and for each of
the three years in the period ended December 31, 1996 included in the
Annual Report on Form 10-K of the Insurer for the year ended December 31,
1996; and
(b) The consolidated financial statements of the Insurer and its
subsidiaries as of June 30, 1997 and for each of the six month periods
ending June 30, 1997 and June 30, 1996 included in the Quarterly Report on
Form 10-Q of the Insurer for the period ended June 30, 1997.
All financial statements included in documents filed by the Insurer and its
subsidiaries pursuant to Section 13(a), 13(c), 14 or 15(d) of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), subsequent to the date of
this Prospectus Supplement and prior to the termination of the offering of the
Bonds shall be deemed to be incorporated by reference into this Prospectus
Supplement and to be a part hereof from the respective dates of filing such
documents.
The Company hereby undertakes that, for purposes of determining any
liability under the Securities Act of 1933, as amended, each filing of the
financial statements of the Insurer and its subsidiaries included in or as an
exhibit to the documents of the Insurer referred to above and filed pursuant to
Section 13(a), 13(c), 14 or Section 15(d) of the Exchange Act that is
incorporated by reference in the Registration Statement of which this Prospectus
Supplement and the accompanying Prospectus is a part shall be deemed to be a new
registration statement relating to the Bonds offered hereby, and the offering of
such Bonds at that time shall be deemed to be the initial bona fide offering
thereof.
The Company will provide without charge to each person to whom this
Prospectus Supplement is delivered, on the written or oral request of such
person, a copy of any or all of the documents referred to above and in the
Prospectus under "INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE" that have
been or may be incorporated by reference in the Prospectus (not including
exhibits to the information that is incorporated by reference unless such
exhibits are specifically incorporated by reference into the information that
the Prospectus incorporates). Such requests should be directed to the Company at
591 Redwood Highway, Suite 3120, Mill Valley, CA 94941, telephone: (415)
381-1765, facsimile number: (415) 381-1773, Attention: Sequoia Mortgage Trust 2
Officer.
S-2
<PAGE> 3
SUMMARY
The following summary is qualified in its entirety by reference to the
detailed information appearing elsewhere in this Prospectus Supplement and in
the accompanying Prospectus. Certain capitalized terms used in this Summary are
defined elsewhere in this Prospectus Supplement or in the Prospectus. See "INDEX
OF CERTAIN DEFINITIONS" on page S-55 of this Prospectus Supplement and page 85
of the Prospectus for the location of the definitions of certain capitalized
terms.
Bonds...................... Sequoia Mortgage Trust 2, Collateralized Mortgage
Bonds (the "Bonds"). The Bonds will be issued
pursuant to the Indenture and will be secured by,
among other things, a pool of adjustable rate,
single-family mortgage loans (the "Pledged
Mortgages"). The Bonds will consist of the
following Classes:
<TABLE>
<CAPTION>
CLASS ORIGINAL PRINCIPAL AMOUNT
---------------------------------------- -------------------------
<S> <C>
Class A-1 Bonds......................... $ 592,560,000
Class A-2 Bonds......................... $ 156,600,000
</TABLE>
The Bonds will constitute "Book-Entry Bonds" as
such term is used in the Prospectus.
Issuer..................... The Issuer, Sequoia Mortgage Trust 2, is a
statutory business trust established under the laws
of the State of Delaware by the Deposit Trust
Agreement (as defined herein) for the sole purpose
of issuing the Bonds and the Investor Certificate.
The settlor and sole beneficiary of the Issuer is
Sequoia Mortgage Funding Corporation, a Delaware
corporation (the "Company"), and a wholly owned
subsidiary of Redwood Trust, Inc., a Maryland
corporation ("Redwood Trust"). The Owner Trustee of
the Issuer is Wilmington Trust Company. Redwood
Trust will be the manager of the Issuer pursuant to
a management agreement (the "Management Agreement")
entered into with the Issuer. None of the Company,
Redwood Trust or the Master Servicer has guaranteed
or is otherwise obligated with respect to payment
of the Bonds, and no person or entity other than
the Issuer is obligated to pay the Bonds, except as
specifically set forth herein with regard to the
Bond Insurance Policy. See "THE ISSUER" herein and
in the Prospectus.
Bond Trustee and
Administrator............ Norwest Bank Minnesota, N.A., a national banking
association, is the bond trustee (in such capacity,
the "Bond Trustee") under an Indenture dated as of
October 1, 1997 (the "Indenture") between the
Issuer and the Bond Trustee, and is the
administrator (in such capacity, the
"Administrator") under an Administration Agreement
dated as of October 1, 1997 (the "Administration
Agreement") among the Issuer, Redwood Trust, the
Bond Trustee and the Administrator.
Owner Trustee.............. Wilmington Trust Company, a banking corporation
organized under the laws of the State of Delaware
(the "Owner Trustee").
Purchase and Servicing
Agreements............... Prior to the Closing Date, Redwood Trust and the
Master Servicer entered into a mortgage loan
purchase agreement, a master servicing agreement
(the "Master Servicing Agreement"), and a pledged
asset mortgage servicing agreement (the "Pledged
Asset Servicing Agreement") pursuant to which
Redwood Trust purchased the Pledged Mortgages and
the Master Servicer agreed to perform certain
servicing functions with respect to the Pledged
Mortgages and certain additional pledged assets.
The Master Servicing Agreement and the Pledged
Asset
S-3
<PAGE> 4
Servicing Agreement are collectively referred to
herein as the "Master Servicing Agreement." See
"SERVICING OF THE PLEDGED MORTGAGES" herein.
On or prior to the Closing Date, all of the Pledged
Mortgages will have been deposited with the Issuer
by the Company which, in turn, will have acquired
them from Redwood Trust pursuant to an agreement
(the "Mortgage Loan Purchase Agreement") between
the Company, the Issuer and Redwood Trust. Redwood
Trust will also assign all of its right, title and
interest in the Master Servicing Agreement to the
Company which will in turn assign all of its rights
thereunder to the Issuer which will in turn assign
its rights thereunder to the Bond Trustee pursuant
to the Indenture.
Master Servicer............ Merrill Lynch Credit Corporation ("MLCC"), a
wholly-owned indirect subsidiary of Merrill Lynch &
Co., Inc. and an affiliate of the Underwriter, will
act as master servicer (the "Master Servicer") for
the Pledged Mortgages.
Deposit Trust Agreement.... The Issuer has been established and the Investor
Certificate will be issued pursuant to a deposit
trust agreement dated as of October 1, 1997 (the
"Deposit Trust Agreement") between the Company and
the Owner Trustee.
Investor Certificate....... One or more Investor Certificates will represent
the entire beneficial ownership interest in the
Issuer. The Investor Certificate or Certificates
will initially be retained by the Company and will
generally evidence the right to distributions on
and other proceeds of the Pledged Mortgages, to the
extent not used to pay the Bonds or other expenses
of the Issuer. See "DESCRIPTION OF THE
BONDS -- Investor Certificate Payment" herein. Only
the Bonds are offered hereby. Any information
contained herein with respect to the Investor
Certificate is provided only to permit a better
understanding of the Bonds.
Cut-off Date............... October 1, 1997.
Closing Date............... On or about November 6, 1997.
Payment Date............... The 25th day of each month or, if such day is not a
business day, the first business day thereafter,
commencing in November 1997 (each, a "Payment
Date"). Payments on each Payment Date will be made
to Bondholders of record as of the related Record
Date, except that the final payment on the Bonds
will be made only upon presentment and surrender of
the Bonds at the Corporate Trust Office of the Bond
Trustee.
Record Date................ The Record Date for any Payment Date will be the
last day of the month preceding the month of such
Payment Date (or in the case of the first Payment
Date, the Closing Date).
Payments of Interest....... On each Payment Date, the Bondholders will be
entitled to receive interest in the amount of the
Interest Payment Amount for such Payment Date. See
"DESCRIPTION OF THE BONDS -- Interest" herein and
"DESCRIPTION OF THE BONDS -- Payments of Interest"
in the Prospectus.
A. Interest Payment
Amount................ Interest on each Class of Bonds will be payable
monthly on each Payment Date in an amount (the
"Interest Payment Amount") equal to interest
accrued on the then outstanding Principal Balance
for such
S-4
<PAGE> 5
Class immediately prior to such Payment Date at the
related Bond Interest Rate for the related Interest
Accrual Period.
The "Interest Accrual Period" for each Payment Date
will be the period commencing on the immediately
preceding Payment Date (or, in the case of the
first Interest Accrual Period, commencing on
October 25, 1997) and ending on the day immediately
preceding such Payment Date. Interest will be
calculated and payable on the basis of a 360-day
year divided into twelve 30-day months.
B. Bond Interest Rate.... The interest rate for the Class A-1 Bonds (the
"Class A-1 Interest Rate") on each Payment Date
after the first and second Payment Dates will be
equal to a per annum floating rate equal to the
One-Year Treasury ARM Index for the related
Interest Accrual Period. The Class A-1 Interest
Rate for the first and second Payment Dates will
equal 6.50% per annum.
The "One-Year Treasury ARM Index" will be equal to
the arithmetic average of twelve reference rates
determined in the manner described under
"DESCRIPTION OF THE BONDS -- Interest -- One-Year
Treasury ARM Index Determination" herein. Each of
the reference rates will be limited to a maximum
rate of 10%.
The interest rate for the Class A-2 Bonds (the
"Class A-2 Interest Rate" and together with the
Class A-1 Interest Rate, the "Bond Interest Rates")
on each Payment Date will be equal to the lesser of
(i) a per annum floating rate equal to One-Month
LIBOR, for the related Interest Accrual Period,
plus 0.34% and (ii) 10% per annum. The Class A-2
Interest Rate for the first Payment Date will equal
5.99625% per annum.
Notwithstanding the foregoing, the Bond Interest
Rate for each Class of Bonds will be subject to
certain additional limitations in the event that a
default under the Bond Insurance Policy has
occurred and is continuing. See "DESCRIPTION OF THE
BONDS -- Interest" herein.
The Bond Interest Rate for each Class of Bonds for
each Payment Date will be determined by the Bond
Trustee as described under "DESCRIPTION OF THE
BONDS -- Interest -- One-Year Treasury ARM Index
Determination" and "-- Interest -- One-Month LIBOR
Rate Determination" herein.
Payments of Principal...... On each Payment Date, to the extent funds are
available therefor, principal payments in reduction
of the then outstanding Principal Balance on each
Class of Bonds will be made on a pro rata basis
according to the outstanding Principal Balance of
each Class, subject to the priorities set forth
herein under "DESCRIPTION OF THE
BONDS -- Principal" in an amount equal to the
Principal Payment Amount for such Payment Date. The
Principal Payment Amount is described under
"DESCRIPTION OF THE BONDS -- Principal" herein. The
"Principal Balance" of each Class of Bonds on any
date of determination is the initial principal
balance thereof as of the Closing Date reduced by
all payments of principal thereon prior to such
date of determination. The "Bond Principal Balance"
on any date of determination is the aggregate of
the Principal Balances of both Classes of Bonds on
such date of determination.
Stated Maturity............ The Stated Maturity for the Bonds is the date
determined by the Company which is the 24th Payment
Date immediately following the latest maturity date
of any Pledged Mortgage. The Stated Maturity for
the Bonds is October 25, 2024. See "DESCRIPTION OF
THE
S-5
<PAGE> 6
BONDS -- Stated Maturity" and "-- Weighted Average
Lives of the Bonds" herein.
Redemption of Bonds........ The Bonds may be redeemed in whole, but not in
part, at the Issuer's option, on any Payment Date
after the earlier of either (a) ten (10) years
after the Closing Date or (b) the Payment Date
after which the Pool Principal Balance with respect
to such Payment Date is 25% or less of the Initial
Pool Principal Balance (each, as defined below), at
a redemption price equal to, in the case of the
Class A-1 Bonds, 101% of the unpaid Principal
Balance for such Class and, in the case of the
Class A-2 Bonds, 100% of the unpaid Principal
Balance for such Class, plus in both cases accrued
and unpaid interest thereon at the applicable Bond
Interest Rate (the "Redemption Price"), plus all
amounts due to the Insurer pursuant to the
Insurance Agreement. At the option of the Issuer,
such an optional redemption of the Bonds can be
effected without retiring such Bonds so that the
Issuer has the ability to own or resell such Bonds.
Upon redemption and retirement of the Bonds the
collateral securing the Bonds will be released from
the lien of the Indenture. See "DESCRIPTION OF THE
BONDS -- Redemption" herein and "DESCRIPTION OF THE
BONDS -- Optional Redemption" in the Prospectus.
The "Pool Principal Balance" with respect to any
Payment Date equals the aggregate of the Stated
Principal Balances of the Pledged Mortgages
outstanding on the Due Date in the month of such
Payment Date. The "Initial Pool Principal Balance"
means the Pool Principal Balance as of the Cut-off
Date. "Stated Principal Balance" means, as to any
Pledged Mortgage and Due Date, the unpaid principal
balance of such Pledged Mortgage as of such Due
Date, as specified in the amortization schedule at
the time relating thereto (before any adjustment to
such amortization schedule by reason of any
moratorium or similar waiver or grace period),
after giving effect to any previous partial
principal prepayments and Liquidation Proceeds
received and to the payment of principal due on
such Due Date and irrespective of any delinquency
in payment by the related Mortgagor.
Credit Enhancement......... The credit enhancement provided for the benefit of
the Bondholders consists solely of excess spread,
overcollateralization and the Bond Insurance
Policy. Excess spread and overcollateralization
will be derived from the internal cash flows of the
Pledged Mortgages.
A. Excess Spread......... Credit support for the Bonds will be provided to
the extent that excess spread exists, i.e., to the
extent (after taking into account any net payment
to, or receipt of a net payment from, the Swap
Provider for the related Payment Date) that a
positive spread may exist between (i) the weighted
average at the beginning of the related Due Period
of the Net Mortgage Rates on the Pledged Mortgages
(the "Weighted Average Net Mortgage Rate") and (ii)
the weighted average of the Bond Interest Rates
(any such positive spread, the "Positive Rate
Differential"). Whether at any time any Positive
Rate Differential exists will depend on a variety
of factors, including the relationship of the
movements in the indices applicable to the Pledged
Mortgages and those applicable to the Bonds, over
which no prediction can be made or assurance given.
The "Net Mortgage Rate" of a Pledged Mortgage is
the Mortgage Rate thereof minus the related Expense
Fee Rate.
S-6
<PAGE> 7
The "Expense Fee Rate" for a Pledged Mortgage for
any calendar month equals the sum of the Servicing
Fee Rate for such Pledged Mortgage, the
Correspondent Trailing Premium rate, if any, for
such Pledged Mortgage and the per annum rate that
represents such Pledged Mortgage's pro rata share,
for such month, of the sum of the Management Fee,
the Bond Insurance Policy premium, and the fees
payable to the Owner Trustee and the Custodian. The
"Servicing Fee Rate" for each Pledged Mortgage
represents the per annum rate at which the
servicing compensation for the Master Servicer (the
"Servicing Fee") accrues and is equal to 0.25% of
the Stated Principal Balance of each Pledged
Mortgage. The "Correspondent Trailing Premium" for
certain of the Pledged Mortgages represents an
additional fee payable by the Master Servicer on a
monthly basis to the correspondent lender which
originated the related Pledged Mortgage. The
"Management Fee" represents the compensation
payable to Redwood Trust as manager under the
Management Agreement and will equal $1,000 per
month. In addition, as compensation for its
services as manager under the Management Agreement,
Redwood Trust will also receive each month any
investment income on the Bond Account.
B. Overcollateralization...Additional credit support for the Bonds will be
provided through limited overcollateralization,
i.e., the pledge to the Bond Trustee on the Closing
Date of Pledged Mortgages having an aggregate
Stated Principal Balance in excess of the Bond
Principal Balance on the Closing Date. Such excess
is the "Overcollateralization Amount" as of the
Closing Date. Thereafter, with respect to any
Payment Date, the "Overcollateralization Amount"
equals the excess, if any, of (x) the Pool
Principal Balance with respect to such Payment
Date, over (y) the Bond Principal Balance as of
such Payment Date (after giving effect to the
making of all payments on such Payment Date). After
the Closing Date, principal distributions on the
Bonds will be made on each Payment Date, to the
extent of Net Available Funds available therefor,
in amounts up to the amount necessary to maintain
the Overcollateralization Amount at a level equal
to the Specified Overcollateralization Amount. The
Specified Overcollateralization Amount may adjust
after the Closing Date, as described herein. See
"DESCRIPTION OF THE BONDS -- Principal" and
"-- Overcollateralization
Provisions -- Overcollateralization Resulting from
Cashflow Structure" herein.
C. Bond Insurance
Policy................ On the Closing Date, Ambac Assurance Corporation
(the "Insurer") will issue a financial guaranty
insurance policy (the "Bond Insurance Policy")
pursuant to which it will irrevocably and
unconditionally guarantee payment of the Insured
Payments, as described herein. See "DESCRIPTION OF
THE BONDS -- Bond Insurance Policy" herein.
On each Payment Date, if necessary, a claim will be
made on the Bond Insurance Policy to cover (a) for
any Payment Date prior to the Stated Maturity, an
amount equal to the sum of (i) the excess, if any,
of the Interest Payment Amount over the Net
Available Funds for such Payment Date and (ii) the
Subordination Deficit, (b) for the Stated Maturity,
an amount equal to the sum of (i) the excess, if
any, of the Interest Payment Amount over the Net
Available Funds for such Payment Date and (ii) the
excess, if any, of the Bond Principal Balance of
the Bonds over Net Available Funds not used to pay
the Interest Payment Amount for such Stated
Maturity and (c) for any date on
S-7
<PAGE> 8
which the acceleration of the Bonds has been
directed or consented to by the Insurer pursuant to
the Administration Agreement or the Indenture, an
amount equal to the excess, if any, of the Bond
Principal Balance, together with accrued and unpaid
interest thereon through the date of payment of
such accelerated Bonds, over the Net Available
Funds for such Payment Date (the "Deficiency
Amount").
The Insurer will be subrogated to the rights of the
Bondholders to receive any payments on the Bonds to
the extent of payments under the Bond Insurance
Policy that remain unreimbursed. In addition, under
the Indenture, absent the existence and
continuation of a default by the Insurer under the
Bond Insurance Policy, the Insurer will be entitled
to exercise certain voting rights of the
Bondholders without the consent of such
Bondholders, and the Bondholders may exercise such
rights only with the prior written consent of the
Insurer. In addition, absent the existence and
continuation of a default by the Insurer, the
Insurer, rather than the Bond Trustee or the
Bondholders, will have the right to direct all
matters relating to the Bonds in any proceeding in
a bankruptcy of the Issuer. See "DESCRIPTION OF THE
BONDS -- The Bond Insurance Policy" herein.
Advances................... The Master Servicer is obligated to make cash
advances ("Monthly Advances") with respect to
delinquent payments of principal and interest on
any Pledged Mortgage serviced by it to the extent
described herein. See "SERVICING OF THE PLEDGED
MORTGAGES" herein.
Certain Prepayment and
Yield Considerations and
Risks.................... The rate of principal payments on the Bonds, the
aggregate amount of payments on the Bonds and the
yields to maturity of the Bonds will be related to
the rate and timing of payments of principal on the
Pledged Mortgages and the level of the applicable
Bond Interest Rate.
Since the rate of payment of principal on the
Pledged Mortgages will depend on future events, no
assurance can be given as to such rate or the rate
of principal prepayments. The extent to which the
yield to maturity of a Bond may vary from the
anticipated yield may depend upon the degree to
which it is purchased at a discount or premium, and
the degree to which the timing of payments thereon
is sensitive to prepayments, liquidations and
purchases of the Pledged Mortgages. Further, an
investor should consider the risk that, in the case
of any Bond purchased at a discount, a slower than
anticipated rate of principal payments (including
prepayments) on the Pledged Mortgages could result
in an actual yield to such investor that is lower
than the anticipated yield and, in the case of any
Bond purchased at a premium, a faster than
anticipated rate of principal payments on the
Pledged Mortgages could result in an actual yield
to such investor that is lower than the anticipated
yield.
Because the Pledged Mortgages may be prepaid at any
time, it is not possible to predict the rate at
which payments of principal of the Bonds will be
received. Since prevailing interest rates are
subject to fluctuation, there can be no assurance
that investors in the Bonds will be able to
reinvest the payments thereon at yields equaling or
exceeding the yields on such Bonds. It is possible
that yields on any such reinvestments will be
lower, and may be significantly lower, than the
yields on the Bonds. See "RISK FACTORS -- Yield,
Prepayment and Maturity Risks"
S-8
<PAGE> 9
herein and "RISK FACTORS -- Prepayment and Yield
Considerations; Reinvestment Risk" in the
Prospectus.
Security for the Bonds..... The Bonds will be secured by collateral consisting
of the items (in addition to the credit enhancement
provided by the Bond Insurance Policy) set forth
below:
A. Pledged Mortgages..... The Pledged Mortgages will consist primarily of a
pool (the "Pledged Mortgage Pool") of adjustable
rate, conventional, primarily 25-year mortgage
loans secured by first liens on one- to four-family
residential properties and having an aggregate
Stated Principal Balance as of the Cut-off Date
equal to approximately $756,727,490 (the "Cut-off
Date Stated Principal Balance"). Payments of
principal and interest on the Bonds will be based
on payments received on the Pledged Mortgages, as
described herein. See "SECURITY FOR THE
BONDS -- The Pledged Mortgages" and "DESCRIPTION OF
THE BONDS -- Payments of Interest" and "-- Payments
of Principal" in the Prospectus.
All of the Pledged Mortgages will have a maximum
Mortgage Rate (the "Maximum Mortgage Rate"). The
Maximum Mortgage Rates range from 12.0% to 14.0%.
None of the Pledged Mortgages will be subject to
periodic interest rate caps. Each Pledged Mortgage
has an original term to maturity of 25 years and is
scheduled to pay only interest for the first 10
years of its term. Commencing in its eleventh year,
each Pledged Mortgage is scheduled to amortize on a
15-year fully amortizing basis.
In the case of substantially all of the Pledged
Mortgages, the per annum interest rate (the
"Mortgage Rate") for the Pledged Mortgages with
Mortgage Rates based on the One-Month LIBOR Index
will be adjusted monthly and the Mortgage Rate for
the Pledged Mortgages with Mortgage Rates based on
the Six-Month LIBOR Index will be adjusted
semi-annually. The date on which the Mortgage Rate
is adjusted is referred to as the "Adjustment
Date." Subject to its Maximum Mortgage Rate, the
Mortgage Rate of a Pledged Mortgage based on the
One-Month LIBOR Index or the Six-Month LIBOR Index
is calculated as follows:
One-Month LIBOR Index. The Mortgage Rate borne by
50.60% of the Pledged Mortgages (by Cut-off Date
Stated Principal Balance) is adjusted every month
to equal the London interbank offered rate for one-
month U.S. dollar deposits as listed under "Money
Rates" in The Wall Street Journal (the "One-Month
LIBOR Index") most recently available as of 25 days
prior to the related Adjustment Date plus a margin
(the "Margin") ranging from 0.88% to 2.63%.
Six-Month LIBOR Index. The Mortgage Rate borne by
49.35% of the Pledged Mortgages (by Cut-off Date
Stated Principal Balance) is adjusted every six
months to equal the London interbank offered rate
for six-month U.S. dollar deposits as listed under
"Money Rates" in The Wall Street Journal (the
"Six-Month LIBOR Index") most recently available as
of 45 days prior to the related Adjustment Date
plus a Margin ranging from 0.75% to 3.25%.
The Pledged Mortgages provide that the related
mortgagor has the option which may be exercised
only one time to convert the adjustable interest
rate on such Pledged Mortgage to a different Index,
provided that certain conditions have been
satisfied (an "Index Convertible Pledged
Mortgage"). The available Indices to which an Index
Convertible Pledged Mortgage with a Mortgage Rate
based on the Six-Month
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<PAGE> 10
LIBOR Index or a Mortgage Rate based on the
One-Month LIBOR Index may be converted are the
Prime Index and the Treasury Index. In connection
with the conversion to a new Index, the frequency
of the Adjustment Date is not changed. Subject to
its Maximum Mortgage Rate, the Mortgage Rate of a
Pledged Mortgage based on the Prime Index or the
Treasury Index is calculated as follows:
Prime Index. The Mortgage Rate borne by 0.01% of
the Pledged Mortgages (by Cut-off Date Stated
Principal Balance) may be adjusted every month or
every six months to equal the highest Prime Rate
listed under "Money Rates" in The Wall Street
Journal (the "Prime Index") most recently available
as of 25 days, in the case of Pledged Mortgages
that adjust monthly, and 45 days, in the case of
Pledged Mortgages that adjust semi- annually, prior
to an Adjustment Date plus a Margin of 0.25%.
Treasury Index. The Mortgage Rate borne by 0.04% of
the Pledged Mortgages (by Cut-off Date Stated
Principal Balance) may be adjusted every month or
every six months to equal the weekly average yield
on the United States Treasury Securities adjusted
to a constant maturity of one year, as made
available by the Federal Reserve board in
Statistical Release H.15 (the "Treasury Index")
most recently available as of 25 days, in the case
of Pledged Mortgages that adjust monthly, and 45
days, in the case of six-month adjustable Pledged
Mortgages that adjust semi-annually, prior to an
Adjustment Date plus a Margin ranging from 2.50% to
2.63%.
Each of the Prime Index, the One-Month LIBOR Index,
the Six-Month LIBOR Index and the Treasury Index is
an "Index" and together, the "Indices."
Approximately 0.73% of the Pledged Mortgages (by
Cut-off Date Stated Principal Balance) provide
that, at the option of the related mortgagor, the
adjustable interest rate on such Pledged Mortgage
may be converted to a fixed interest rate, provided
that certain conditions have been satisfied. Upon
the conversion of any Pledged Mortgage from an
adjustable interest rate to a fixed interest rate,
the Master Servicer will be obligated to repurchase
such Pledged Mortgage from the Issuer. The price to
be paid for such Pledged Mortgage (the "Conversion
Price") will be equal to the outstanding principal
balance thereof plus accrued interest thereon net
of any servicing fee. Index Convertible Pledged
Mortgages will not be subject to repurchase upon
their conversion to another Index.
On each Adjustment Date for a Pledged Mortgage
during the first 10 years of its term, its monthly
payment will be adjusted to equal one month's
interest at the Mortgage Rate determined for such
Adjustment Date. During the last 15 years of its
term, its monthly payment will be adjusted on each
Adjustment Date to equal an amount that will fully
amortize the outstanding principal of the Pledged
Mortgage over its remaining term at the related
Mortgage Rate.
With the exception of 1.73% of the Pledged
Mortgages (by Cut-off Date Stated Principal
Balance), the Pledged Mortgages, including Pledged
Mortgages having a Loan-to-Value Ratio greater than
80%, are not insured under any Primary Mortgage
Insurance Policy (as defined in the Prospectus) or
other credit insurance policy. Pledged Mortgages
having a Loan-to-Value Ratio at origination greater
than 80% are generally
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<PAGE> 11
Mortgage 100(SM) or Parent Power(R) loans, which,
in addition to being secured by real property, are
secured by a security interest in a limited amount
of additional collateral owned by the borrower or
are supported by a third-party guarantee (the
"Additional Collateral Loans"). Such additional
collateral and guarantee are no longer required
when the Loan-to-Value Ratio for such Additional
Collateral Loan is reduced to the Master Servicer's
applicable Loan-to-Value Ratio limit by virtue of a
reduction in the principal balance of the related
Pledged Mortgage or an increase in the appraised
value of the Mortgaged Property as determined by
the Master Servicer. The pledge agreement or
guaranty agreement, as applicable, and the security
interest in such additional collateral (the
"Additional Collateral") will be assigned to the
Bond Trustee. The Insurer has previously issued a
limited purpose surety bond (the "Limited Purpose
Surety Bond"), which is limited in amount and
separate from the Bond Insurance Policy, and will
guarantee receipt by the Bond Trustee of certain
shortfalls in the net proceeds realized from the
liquidation of any required Additional Collateral
(such amount not to exceed 30% of the original
principal amount of the related Additional
Collateral Loan) to the extent any such shortfall
results in a loss of principal upon the liquidation
of the related Additional Collateral Loan. The
Limited Purpose Surety Bond will not cover any
payments on the Bonds that are recoverable or
sought to be recovered as a voidable preference
under applicable law. For information concerning
the Insurer and the Bond Insurance Policy, see
"DESCRIPTION OF THE BONDS -- Bond Insurance Policy"
and "-- The Insurer."
See "SECURITY FOR THE BONDS -- The Pledged
Mortgages" and "MLCC AND ITS MORTGAGE PROGRAMS"
herein.
B. The Swap Agreement.... On the Closing Date the Issuer will enter into an
interest rate swap agreement (the "Swap Agreement")
with Merrill Lynch Capital Services, Inc., as swap
counterparty (the "Swap Provider") as a means to
protect against substantially all of the interest
rate risk that may result from the difference
between the Class A-1 Interest Rate and the
Mortgage Rates of the Pledged Mortgages. Also on
the Closing Date, Merrill Lynch & Co., Inc.
("ML&Co.") will enter into a guarantee whereby
ML&Co. will guarantee amounts payable by the Swap
Provider under the Swap Agreement.
Under the Swap Agreement, not later than the
Business Day immediately preceding each Payment
Date, the Issuer will be entitled to receive from
the Swap Provider an amount (the "Swap 1 Amount")
equal to the amount obtained by multiplying (a) the
Class A-1 Interest Rate, (b) a notional balance
equal to the outstanding Principal Balance of the
Class A-1 Bonds, and (c) a fraction equal to a
30-day month divided by a 360-day year.
Under the Swap Agreement, not later than the
Business Day immediately preceding each Payment
Date, the Issuer will be obligated to pay to the
Swap Provider an amount (the "Swap 2 Amount") equal
to the sum of (i) the amount obtained by
multiplying (a) the Rolling Six-Month LIBOR Index
(as defined below) plus 0.35% (subject to a maximum
rate of 10%), (b) a notional balance (the
"Six-Month LIBOR Notional Balance") equal to the
lesser of (1) the Pool Principal Balance minus the
aggregate Stated Principal Balance of Pledged
Mortgages with Mortgage Rates based on the
One-Month LIBOR Index and (2) the
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<PAGE> 12
outstanding Principal Balance of the Class A-1
Bonds, and (c) a fraction equal to a 30-day month
divided by a 360-day year, and (ii) the amount
obtained by multiplying (a) the Current One-Month
LIBOR Index (as defined below) plus 0.35% (subject
to a maximum rate of 10%), (b) a notional balance
(the "One-Month LIBOR Notional Balance") equal to
the outstanding Principal Balance of the Class A-1
Bonds minus the current Six-Month LIBOR Notional
Balance, and (c) a fraction equal to a 30-day month
divided by a 360-day year.
The "Rolling Six-Month LIBOR Index" with respect to
any Payment Date is the arithmetic average of the
London interbank offered rate for six-month U.S.
dollar deposits as listed under "Money Rates" in
The Wall Street Journal on the 15th day of the
month (or if such day is not a Business Day, the
first Business Day preceding such day) in which
such Payment Date occurs and the London interbank
offered rate for six-month U.S. dollar deposits
determined in a similar manner for each of the five
months immediately preceding the month in which
such Payment Date occurs.
The "Current One-Month LIBOR Index" with respect to
any Payment Date is the London interbank offered
rate for one-month U.S. dollar deposits as listed
under "Money Rates" in The Wall Street Journal as
of the date 25 days before the first day of the
month immediately preceding the month in which such
Payment Date occurs (or if such date is not a
Business Day, the first Business Day preceding such
date).
The obligations of the Issuer and the Swap Provider
will be settled on a net basis. Only the net amount
equal to the excess, if any, of the Swap 1 Amount
over the Swap 2 Amount or the excess, if any, of
the Swap 2 Amount over the Swap 1 Amount will be
payable by the Swap Provider or the Issuer,
respectively, to the other party. See "SECURITY FOR
THE BONDS -- The Swap Agreement" herein.
C. Bond Account.......... On or prior to the Closing Date, the Bond Trustee
will establish and maintain or cause to be
established and maintained a separate account for
the collection of payments on the Pledged Mortgages
(the "Bond Account"). See "DESCRIPTION OF THE
BONDS -- Payments on Pledged Mortgages; Accounts"
herein and "SERVICING OF THE PLEDGED MORTGAGES"
herein and in the Prospectus.
D. Distribution
Account............... On or prior to the Closing Date, an account (the
"Distribution Account") will be established and
maintained with the Bond Trustee for the benefit of
the Bondholders, the Insurer and the Swap Provider.
On the business day immediately prior to each
Payment Date, the Bond Trustee will withdraw from
the Bond Account the Available Funds (as defined
herein) for such Payment Date, and will deposit
such amount in the Distribution Account. See
"DESCRIPTION OF THE BONDS -- Payments on Pledged
Mortgages; Accounts" herein.
Federal Income Tax
Consequences............. The Bonds will be treated as debt for federal
income tax purposes, and will be taxable to
non-exempt Bondholders. The prepayment rate used by
the Issuer for purposes of determining the amount
and rate of accrual of original issue discount on
the Bonds assumes that the Pledged Mortgages are
prepaid at a rate of 15% CPR. Based upon the
assumed prepayment rate and expected price to the
public of the Bonds as of the
S-12
<PAGE> 13
date hereof (including interest accrued before the
Closing Date, if any) the Class A-1 Bonds will be
issued at a premium and the Class A-2 Bonds will
not be issued with original issue discount. The
Issuer intends to treat the Bonds as "Variable Rate
Debt Instruments" and the stated interest on the
Bonds as "qualified stated interest payments" (as
each such term is defined in the Prospectus under
"FEDERAL INCOME TAX CONSEQUENCES").
Notwithstanding the use of the Prepayment
Assumption in pricing the Bonds, no representation
is made that the Pledged Mortgages will actually
prepay at such assumed prepayment rate or at any
other rate. The amount of original issue discount,
if any, and certain other information with respect
to each Bond will be set forth on the face of such
Bond as required by applicable regulations.
Payments on Bonds held by foreign persons will
generally be exempt from United States withholding
tax, subject to compliance with applicable
certification procedures. Tax counsel to the Issuer
has advised the Issuer that in its opinion the
Bonds will be treated as debt for federal income
tax purposes and not as an ownership interest in
the Mortgage Collateral, the Issuer or a separate
association taxable as a corporation. The Issuer
will not elect to treat the segregated pool of
assets securing the Bonds as a "real estate
mortgage investment conduit" for federal income tax
purposes. See "FEDERAL INCOME TAX CONSEQUENCES" in
the Prospectus.
As a result, Bonds owned by a real estate
investment trust will not be treated as "Government
securities" but may qualify as "real estate assets"
and if so interest on the Bonds would be considered
"interest on obligations secured by mortgages on
real property or on interests in real property." In
any event, the Bonds will generate interest income
that qualifies under the 95% income test applicable
to real estate investment trusts. Similarly, the
Bonds will not constitute "qualifying real property
loans" for mutual savings banks or domestic
building and loan associations and will not
constitute "loans secured by an interest in real
property" or "obligations of the United States" for
domestic building and loan associations. In
addition, Bonds held by a regulated investment
company will not constitute "Government
securities." See "FEDERAL INCOME TAX CONSEQUENCES"
in the Prospectus.
ERISA Matters.............. Fiduciaries of employee benefit plans and certain
other retirement plans arrangements that are
subject to the Employee Retirement Income Security
Act of 1974, as amended ("ERISA"), or corresponding
provisions of the Internal Revenue Code of 1986, as
amended (the "Code"), including individual
retirement accounts and annuities, Keogh plans and
collective investment funds in which such plans,
accounts, annuities or arrangements are invested
(any of the foregoing a "Plan"), persons acting on
behalf of a Plan, or persons using the assets of a
Plan ("Plan Investors"), should review carefully
with their legal advisors whether the purchase or
holding of the Bonds could either give rise to a
transaction that is prohibited under ERISA or the
Code or cause the Pledged Mortgages securing the
Bonds to be treated as plan assets for purposes of
regulations of the Department of Labor set forth in
29 C.F.R. 2510.3-101 (the "Plan Asset
Regulations"). Although certain exceptions from the
application of the prohibited transaction rules and
the Plan Asset Regulations exist, there can be no
assurance that any such exception will apply with
respect to the acquisition of the Bonds. See "ERISA
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<PAGE> 14
MATTERS" herein and in the Prospectus. Although not
entirely free from doubt, the Issuer believes that
the Bonds will be treated as debt obligations
without significant equity features for purposes of
the Plan Asset Regulations. Accordingly, a Plan
that acquires the Bonds should not be treated as
having acquired a direct interest in the assets of
the Issuer. See "ERISA MATTERS" herein and in the
Prospectus. However, there can be no complete
assurance that the Bonds will be treated as debt
obligations without significant equity features for
purposes of the Plan Asset Regulations.
Legal Investment........... The Bonds will constitute "mortgage related
securities" for purposes of Secondary Mortgage
Market Enhancement Act of 1984 ("SMMEA") so long as
they are rated in one of the two highest rating
categories by at least one nationally recognized
statistical rating organization and, as such, are
legal investments for certain entities to the
extent provided for in SMMEA. Institutions whose
investment activities are subject to review by
federal or state regulatory authorities should
consult with their counsel or the applicable
authorities to determine whether an investment in
the Bonds complies with applicable guidelines,
policy statements or restrictions. See "LEGAL
INVESTMENT" in the Prospectus.
Ratings.................... It is a condition of the issuance of the Bonds that
they be rated "Aaa" by Moody's Investors Service,
Inc. ("Moody's") and "AAA" by Standard & Poor's
Ratings Services, a division of The McGraw Hill
Companies, Inc. ("S&P") (S&P and Moody's
collectively, the "Rating Agencies"). The ratings
of the Bonds should be evaluated independently from
similar ratings on other types of securities. A
rating is not a recommendation to buy, sell or hold
securities and may be subject to revision or
withdrawal at any time by the Rating Agencies. See
"RATINGS" herein.
The Issuer has not requested a rating of the Bonds
by any rating agency other than the Rating
Agencies; there can be no assurance, however, as to
whether any other rating agency will rate the Bonds
or, if it does, what rating would be assigned by
such other rating agency. The rating assigned by
such other rating agency to the Bonds could be
lower than the respective ratings assigned by the
Rating Agencies.
Use of Proceeds............ The Issuer intends to distribute all of the net
proceeds of the issuance of Bonds to the Company
which will apply such proceeds to the purchase of
the Pledged Mortgages. The Pledged Mortgages will
be purchased by the Company from Redwood Trust and
sold to the Issuer by the Company. See "USE OF
PROCEEDS" herein and in the Prospectus and "METHOD
OF DISTRIBUTION" herein.
Risk Factors............... For a discussion of certain risks associated with
an investment in the see "RISK FACTORS" commencing
on page S-15 herein and on page 19 in the
Prospectus.
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<PAGE> 15
RISK FACTORS
YIELD, PREPAYMENT AND MATURITY RISKS
The rate of principal payments on the Bonds, the aggregate amount of
payments on the Bonds and the yields to maturity of the Bonds will be related to
the rate and timing of payments of principal on the Pledged Mortgages. The rate
of principal payments on the Pledged Mortgages will in turn be affected by the
amortization schedules of the Pledged Mortgages and by the rate of principal
prepayments (including for this purpose prepayments resulting from refinancing,
liquidations of the Pledged Mortgages due to defaults, casualties, condemnations
and other events described below). The Pledged Mortgages may be prepaid by the
Mortgagors at any time without a prepayment penalty. Generally, the Pledged
Mortgages contain "due-on-sale" provisions, subject to applicable law and
standard assumption clauses. See "SECURITY FOR THE BONDS -- The Pledged
Mortgages" herein.
Prepayments, liquidations and purchases of the Pledged Mortgages (including
any optional purchase by Redwood Trust of a Delinquent Pledged Mortgage,
purchases by Redwood Trust or the Issuer of a Defective Pledged Mortgage and any
optional redemption of the Bonds by the Issuer, in each case as described
herein) will result in payments on the Bonds of principal amounts which would
otherwise be distributed over the remaining terms of the Pledged Mortgages.
Optional purchases of Delinquent Pledged Mortgages by Redwood Trust will be at a
price equal to 100% of the Stated Principal Balance of each such Pledged
Mortgage and will not include any redemption premium in excess thereof. Since
the rate of payment of principal on the Pledged Mortgages will depend on future
events, no assurance can be given as to such rate or the rate of principal
prepayments. The extent to which the yield to maturity of a Bond may vary from
the anticipated yield will depend upon the degree to which such Bond is
purchased at a discount or premium, and the degree to which the timing of
payments thereon is sensitive to prepayments, liquidations and purchases of the
Pledged Mortgages. Further, an investor should consider the risk that, in the
case of any Bond purchased at a discount, a slower than anticipated rate of
principal payments (including prepayments) on the Pledged Mortgages could result
in an actual yield to such investor that is lower than the anticipated yield
and, in the case of any Bond purchased at a premium, a faster than anticipated
rate of principal payments on the Pledged Mortgages could result in an actual
yield to such investor that is lower than the anticipated yield.
The rate of principal payments (including prepayments) on pools of mortgage
loans may vary significantly over time and may be influenced by a variety of
economic, geographic, social and other factors, including changes in mortgagors'
housing needs, job transfers, unemployment, mortgagors' net equity in the
mortgaged properties and servicing decisions. In general, if prevailing interest
rates were to fall significantly below the Mortgage Rates on the Pledged
Mortgages, the Pledged Mortgages could be subject to higher prepayment rates
than if prevailing interest rates were to remain at or above the Mortgage Rates
on the Pledged Mortgages. Conversely, if prevailing interest rates were to rise
significantly, the rate of prepayments on the Pledged Mortgages would generally
be expected to decrease. No assurances can be given as to the rate of
prepayments on the Pledged Mortgages in stable or changing interest rate
environments.
The timing of changes in the rate of prepayments on the Pledged Mortgages
may significantly affect an investor's actual yield to maturity, even if the
average rate of principal payments is consistent with an investor's expectation.
In general, the earlier a prepayment of principal on the Pledged Mortgages, the
greater the effect on an investor's yield to maturity. The effect on an
investor's yield as a result of principal payments occurring at a rate higher
(or lower) than the rate anticipated by the investor during the period
immediately following the issuance of the Bonds may not be offset by a
subsequent like decrease (or increase) in the rate of principal payments.
NO REPRESENTATION IS MADE AS TO THE RATE OF PRINCIPAL PAYMENTS ON THE
PLEDGED MORTGAGES OR AS TO THE YIELD TO MATURITY OF THE BONDS. INVESTORS ARE
URGED TO MAKE AN INVESTMENT DECISION WITH RESPECT TO THE BONDS BASED ON THE
ANTICIPATED YIELD TO MATURITY OF SUCH BONDS RESULTING FROM THEIR RESPECTIVE
PRICES AND EACH INVESTOR'S OWN DETERMINATION AS TO ANTICIPATED PLEDGED MORTGAGE
PREPAYMENT RATES.
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<PAGE> 16
CASHFLOW CONSIDERATIONS AND RISKS
Even assuming that the Mortgaged Properties provide adequate security for
the Pledged Mortgages, substantial delays could be encountered in connection
with the liquidation of Pledged Mortgages that are delinquent, which could
result in shortfalls in payments on the Bonds if the credit enhancement created
by the overcollateralization of the Bonds and any Positive Rate Differential
with respect to the Pledged Mortgages is insufficient and if payments under the
Bond Insurance Policy were unavailable. Further, liquidation expenses (such as
legal fees, real estate taxes, and maintenance and preservation expenses) will
reduce the security for the related Pledged Mortgages and could thereby reduce
the proceeds payable to holders of the Bonds. In the event any of the Mortgaged
Properties fail to provide adequate security for the related Pledged Mortgages,
holders of the Bonds could experience a loss if the credit enhancement created
by the overcollateralization of the Bonds and any Positive Rate Differential
with respect to the Pledged Mortgages has been exhausted and if payments under
the Bond Insurance Policy were unavailable.
LIMITED RECOURSE
The Bonds represent limited obligations of the Issuer payable solely by
collateral pledged under the Indenture and are not insured by any governmental
agency or instrumentality, the Company, Redwood Trust, the Master Servicer, the
Owner Trustee, the Bond Trustee, or, except as set forth herein, the Insurer or
any other person or entity.
DELINQUENCIES MAY ADVERSELY AFFECT INVESTMENT
As of the Cut-off Date, 0.81% of the Pledged Mortgages (by Cut-off Date
Stated Principal Balance) were delinquent by one Scheduled Payment and none of
the Pledged Mortgages (by Cut-off Date Stated Principal Balance) were delinquent
by two or more Scheduled Payments. Investors should consider the risk that the
inclusion of such loans in the Pledged Mortgages may affect the rates of
defaults and prepayments on such Pledged Mortgages and the yields on the Bonds.
See "SECURITY FOR THE BONDS -- The Pledged Mortgages" herein.
PLEDGED MORTGAGE CONCENTRATION
Approximately 21.49% and 11.94% of the Pledged Mortgages (by Cut-off Date
Stated Principal Balance) are secured by Mortgaged Properties located in
California and Florida, respectively. Consequently, losses and prepayments on
the Pledged Mortgages and the resultant payments on the Bonds may be affected
significantly by changes in the housing markets and the regional economies in
these areas, and also by the occurrence of natural disasters (such as
earthquakes, hurricanes, tornados, tidal waves, mud slides, fires and floods) in
these areas.
LIMITED LIQUIDITY OF INVESTMENT
There can be no assurance that a secondary market will develop for the
Bonds, or, if one does develop, that it will provide the holders of the Bonds
with liquidity of investment or that it will continue to exist for the term of
the Bonds.
BANKRUPTCY AND INSOLVENCY RISKS
Redwood Trust, the Company and the Issuer will treat the transfer of the
Pledged Mortgages by Redwood Trust to the Company and from the Company to the
Issuer as a sale for all purposes. Nevertheless, in the event of a bankruptcy of
Redwood Trust the trustee in bankruptcy could attempt to recharacterize the sale
of the Pledged Mortgages to the Company as a borrowing secured by a pledge of
mortgage loans, and in the event of a bankruptcy of the Company, the trustee in
bankruptcy could attempt to recharacterize the sale of the Pledged Mortgages to
the Issuer as a borrowing secured by a pledge of mortgage loans.
In either case, if such an attempt to recharacterize the transfer of the
loans were successful, a trustee in bankruptcy could elect to accelerate payment
of the Bonds and liquidate the Pledged Mortgages, with the
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<PAGE> 17
holders of the Bonds entitled to no more than the then outstanding Bond
Principal Balance, if any, of such Bonds together with interest at the Bond
Interest Rate to the date of payment. In the event of an acceleration of the
Bonds, the holders of the Bonds would lose the right to future payments of
interest, might suffer reinvestment losses in a lower interest rate environment
and may fail to recover their initial investment.
BOOK-ENTRY BONDS
LIMITED LIQUIDITY. Issuance of the Bonds in book-entry form may reduce the
liquidity of such Bonds in the secondary trading market since investors may be
unwilling to purchase Bonds for which they cannot obtain physical certificates.
See "DESCRIPTION OF THE BONDS -- Book-Entry Bonds" herein and in the Prospectus
and "RISK FACTORS -- Effects of Book-Entry Registration" in the Prospectus.
DIFFICULTY IN PLEDGING. Since transactions in the Bonds can be effected
only through DTC, CEDEL, Euroclear, participating organizations, indirect
participants and certain banks, the ability of a Bond Owner (as defined herein)
to pledge a Bond to persons or entities that do not participate in the DTC,
CEDEL or Euroclear system may be limited due to lack of a physical certificate
representing the Bonds. See "DESCRIPTION OF THE BONDS -- Book-Entry Bonds"
herein and in the Prospectus and "RISK FACTORS -- Effects of Book-Entry
Registration" in the Prospectus.
POTENTIAL DELAYS IN PAYMENT. Bond Owners may experience some delay in their
receipt of payments of interest and principal on the Bonds since such payments
will be forwarded by the Bond Trustee to DTC and DTC will credit such payments
to the accounts of its Participants (as defined herein) which will thereafter
credit them to the accounts of Bond Owners either directly or indirectly through
indirect participants. Bond Owners will not be recognized as Bondholders as such
term is used in the Indenture, and Bond Owners will be permitted to exercise the
rights of Bondholders only indirectly through DTC and its Participants. See
"DESCRIPTION OF THE BONDS -- Book-Entry Bonds" herein and in the Prospectus and
"RISK FACTORS -- Effects of Book-Entry Registration" in the Prospectus.
RATINGS
The ratings of the Bonds will depend primarily on an assessment by the
Rating Agencies of the claims-paying ability of the Insurer. Any reduction in
the rating assigned to the claims-paying ability of the Insurer below the rating
initially given to the Bonds would likely result in a reduction in the rating of
the Bonds. The rating by the Rating Agencies of the Bonds is not a
recommendation to purchase, hold or sell the Bonds, inasmuch as such rating does
not comment as to the market price or suitability for a particular investor.
There is no assurance that the ratings will remain in place for any given period
of time or that the ratings will not be lowered or withdrawn by the Rating
Agencies. In general, ratings assess credit risk and do not address likelihood
of prepayments.
FOR A DISCUSSION OF CERTAIN ADDITIONAL RISK FACTORS RELATING TO INVESTMENTS
IN THE BONDS, SEE "RISK FACTORS" IN THE PROSPECTUS.
THE ISSUER
The Issuer is a statutory business trust established under the laws of the
State of Delaware on or prior to the Closing Date by a deposit trust agreement.
The Issuer was formed for the sole purpose of issuing the Bonds and the Investor
Certificate. The Company is the settlor and sole beneficiary of the Issuer and
Wilmington Trust Company is the Owner Trustee of the Issuer. The Company is a
limited purpose finance corporation, the capital stock of which is wholly owned
by Redwood Trust, Inc., a Maryland corporation ("Redwood Trust"). Redwood Trust
will be the manager of the Issuer pursuant to a management agreement entered
into with the Issuer. None of the Company, Redwood Trust, Wilmington Trust
Company or any of their respective affiliates has guaranteed or is otherwise
obligated with respect to payment of the Bonds and no person or entity other
than the Issuer is obligated to pay the Bonds, except as specifically set forth
herein with regard to the Bond Insurance Policy. See "DESCRIPTION OF THE
BONDS -- Bond Insurance Policy" herein.
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The Indenture and the Deposit Trust Agreement prohibit the Issuer from
incurring any indebtedness other than the Bonds, or assuming or guaranteeing the
indebtedness of any other person.
DESCRIPTION OF THE BONDS
GENERAL
The Bonds will be issued pursuant to the Indenture. Set forth below are
summaries of the specific terms and provisions pursuant to which the Bonds will
be issued. The following summaries are subject to, and are qualified in their
entirety by reference to, the provisions of the Indenture. When particular
provisions or terms used in the Indenture are referred to, the actual provisions
(including definitions of terms) are incorporated by reference. See "THE
INDENTURE" in the Prospectus.
The Issuer will issue the Sequoia Mortgage Trust 2, Collateralized Mortgage
Bonds (the "Bonds") in two Classes designated as Class A-1 and Class A-2. The
Issuer will also issue a trust certificate evidencing a beneficial interest in
the Issuer (the "Investor Certificate") to the Company as described herein. Only
the Bonds are offered hereby. Each Class of Bonds will bear interest at the
applicable Bond Interest Rate described herein.
BOOK-ENTRY BONDS
The Bonds will be book-entry Bonds ("Book-Entry Bonds"). Persons acquiring
beneficial ownership interests in the Bonds ("Bond Owners") may elect to hold
their Bonds through the Depository Trust Company ("DTC") in the United States,
or CEDEL or Euroclear (in Europe) if they are participants of such systems, or
indirectly through organizations which are participants in such systems. The
Book-Entry Bonds will be issued in one or more certificates which equal the
aggregate principal amount of the Bonds 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
such capacities, individually the "Relevant Depositary" and collectively the
"European Depositaries"). Investors may hold such beneficial interests in the
Book-Entry Bonds in minimum denominations representing Bond Principal Balances
of $1,000 and in multiples of $1,000 in excess thereof. Except as described
below, no person acquiring a Book-Entry Bond (each, a "beneficial owner") will
be entitled to receive a physical certificate representing such Bond (a
"Definitive Bond"). Unless and until Definitive Bonds are issued, it is
anticipated that the only "Bondholders" of the Bonds will be Cede & Co., as
nominee of DTC. Bond Owners will not be Bondholders as that term is used in the
Indenture. Bond Owners are only permitted to exercise their rights indirectly
through the participating organizations that utilize the services of DTC,
including securities brokers and dealers, banks and trust companies and clearing
corporations and certain other organizations ("Participants") and DTC.
The beneficial owner's ownership of a Book-Entry Bond 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 Bond 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). Bond Owners will receive all payments of
principal of, and interest on, the Bonds from the Bond Trustee through DTC and
DTC participants. While the Bonds 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 Bonds and is required to receive and transmit payments of
principal of, and interest on, the Bonds. Participants and indirect participants
which have indirect access to the DTC system, such as banks, brokers, dealers
and trust companies that clear through or maintain a custodial relationship with
a Participant,
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either directly or indirectly ("Indirect Participants"), with whom Bond Owners
have accounts with respect to Bonds are similarly required to make book-entry
transfers and receive and transmit such payments on behalf of their respective
Bond Owners. Accordingly, although Bond Owners will not possess certificates,
the Rules provide a mechanism by which Bond Owners will receive payments and
will be able to transfer their interest.
Bond Owners will not receive or be entitled to receive certificates
representing their respective interests in the Bonds, except under the limited
circumstances described below. Unless and until Definitive Bonds are issued,
Bond Owners who are not Participants may transfer ownership of Bonds only
through Participants and Indirect Participants by instructing such Participants
and Indirect Participants to transfer Bonds, by book-entry transfer, through DTC
for the account of the purchasers of such Bonds, which account is maintained
with their respective Participants. Under the Rules and in accordance with DTC's
normal procedures, transfers of ownership of Bonds 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 Bond 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 in DTC. For information relating to tax documentation procedures
relating to the Bonds, see "FEDERAL INCOME TAX CONSEQUENCES -- Withholding with
Respect to Certain Foreign Investors" and "-- Backup Withholding" in the
Prospectus and "GLOBAL CLEARANCE, SETTLEMENT AND TAX DOCUMENTATION
PROCEDURES -- Certain U.S. Federal Income Tax Documentation Requirements" in
Annex I hereto.
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
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 fund settlement applicable to
DTC. CEDEL Participants and Euroclear Participants may not deliver instructions
directly to the European Depositaries.
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 Book-Entry Bonds, whether held for
its own account or as nominee for another person. In general, beneficial
ownership of Book-Entry Bonds will be subject to the rules, regulations and
procedures governing DTC and DTC participants as in effect from time to time.
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
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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 "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.
The Euroclear Operator is the Belgian branch of a New York banking
corporation which is a member bank of the Federal Reserve System. As such, it is
regulated and examined by the Board of Governors of the Federal Reserve System
and the New York State Banking Department, as well as the Belgian Banking
Commission.
Securities clearance accounts and cash accounts with 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.
Payments on the Book-Entry Bonds will be made on each Payment Date by the
Bond 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 Book-Entry Bonds 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 Book-Entry Bonds that it represents.
Under a book-entry format, beneficial owners of the Book-Entry Bonds may
experience some delay in their receipt of payments, since such payments will be
forwarded by the Bond Trustee to Cede & Co., as nominee of DTC. Payments with
respect to Bonds 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 payments will be subject to tax reporting in accordance with
relevant United States tax laws and regulations. See "FEDERAL INCOME TAX
CONSEQUENCES -- Withholding with Respect to Certain Foreign Investors" and
"-- Backup Withholding" in the Prospectus. Because DTC can only act on behalf of
Financial Intermediaries, the ability of a beneficial owner to pledge Book-Entry
Bonds to persons or entities that do not participate in the
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depository system, or otherwise take actions in respect of such Book-Entry Bond,
may be limited due to the lack of physical certificates for such Book-Entry
Bonds. In addition, issuance of the Book-Entry Bonds in book-entry form may
reduce the liquidity of such Bonds in the secondary market since certain
potential investors may be unwilling to purchase Bonds for which they cannot
obtain physical certificates.
Monthly and annual reports on the Issuer 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 DTC or the Relevant Depositary, and to the Financial
Intermediaries to whose DTC accounts the Book-Entry Bonds of such beneficial
owners are credited.
DTC has advised the Issuer and the Bond Trustee that, unless and until
Definitive Bonds are issued, DTC will take any action permitted to be taken by
the holders of the Book-Entry Bonds under the Indenture only at the direction of
one or more Financial Intermediaries to whose DTC accounts the Book-Entry Bonds
are credited, to the extent that such actions are taken on behalf of Financial
Intermediaries whose holdings include such Book-Entry Bonds. CEDEL or the
Euroclear Operator, as the case may be, will take any other action permitted to
be taken by a Bondholder under the Indenture 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 Bonds which conflict with actions taken with
respect to other Bonds.
Definitive Bonds will be issued to beneficial owners of the Book-Entry
Bonds, or their nominees rather than to DTC, only if (a) DTC or the Issuer
advises the Bond Trustee in writing that DTC is no longer willing, qualified or
able to discharge properly its responsibilities as nominee and depositary with
respect to the Book-Entry Bonds and the Issuer or the Bond Trustee is unable to
locate a qualified successor or (b) the Issuer, at its sole option, elects to
terminate a book-entry system through DTC. The Bond Trustee shall notify the
Insurer if the Bonds will no longer be Book-Entry Bonds.
Upon the occurrence of any of the events described in the immediately
preceding paragraph, the Bond Trustee will be required to notify all beneficial
owners of the occurrence of such event and the availability through DTC of the
Definitive Bonds. Upon surrender by DTC of the global certificate or
certificates representing the Book-Entry Bonds and instructions for
re-registration, the Bond Trustee will issue Definitive Bonds, and thereafter
the Bond Trustee will recognize the holders of such Definitive Bonds as
Bondholders under the Indenture.
Although DTC, CEDEL and Euroclear have agreed to the foregoing procedures
in order to facilitate transfers of Bonds 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 Servicer, the Company, the Issuer, the Insurer or the Bond
Trustee will have any responsibility for any aspect of the records relating to
or payments made on account of beneficial ownership interests of the BookEntry
Bonds held by Cede & Co., as nominee of DTC, or for maintaining, supervising or
reviewing any records relating to such beneficial ownership interests.
For a description of the procedures generally applicable to the Book-Entry
Bonds, see "DESCRIPTION OF THE BONDS -- Book-Entry Bonds" in the Prospectus.
PAYMENTS ON PLEDGED MORTGAGES; ACCOUNTS
On or prior to the Closing Date, the Bond Trustee will establish and
maintain a separate account for the collection of payments remitted by the
Master Servicer on the Pledged Mortgages (the "Bond Account"). On or prior to
the Closing Date, an account (the "Distribution Account") will be established
and maintained with the Bond Trustee in trust for the benefit of the
Bondholders, the Insurer and the Swap Provider. Prior to each Payment Date, the
Bond Trustee will withdraw from the Bond Account the Available Funds for such
Payment Date and will deposit such amount in the Distribution Account. The
transfer of Available Funds from the Bond Account to the Distribution Account
will occur on the Business Day immediately preceding each Payment Date. Funds
credited to the Bond Account may be invested at the direction of Redwood Trust
solely
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for the benefit and at the risk of Redwood Trust in certain Permitted
Investments, as defined in the Indenture. Funds credited to the Distribution
Account may be invested at the direction of the Bond Trustee and at the risk of
the Bond Trustee in certain Permitted Investments and any investment income on
such funds will be payable to the Bond Trustee .
PAYMENTS
Payments on the Bonds will be made by the Bond Trustee on the 25th day of
each month, or if such day is not a Business Day, on the first Business Day
thereafter, commencing in November 1997 (each, a "Payment Date"), to the persons
in whose names such Bonds are registered at the close of business on the Record
Date with respect to such Payment Date.
Payments on each Payment Date will be made by check mailed to the address
of the person entitled thereto as it appears on the applicable bond register or,
in the case of a Bondholder who holds Bonds with an aggregate initial Principal
Balance of $1,000,000 or more and who has so notified the Bond Trustee in
writing in accordance with the Indenture, by wire transfer in immediately
available funds to the account of such Bondholder at a bank or other depository
institution having appropriate wire transfer facilities; provided, however, that
the final payment in retirement of the Bonds will be made only upon presentment
and surrender of such Bonds at the Corporate Trust Office of the Bond Trustee.
"Available Funds" for the Payment Date will generally be equal to the sum
of:
(i) the aggregate amount of scheduled payments on the Pledged
Mortgages due on the related Due Date and received by the Master Servicer
on or prior to the related Determination Date (net of the related Servicing
Fees and any related Correspondent Trailing Premiums),
(ii) any amounts representing miscellaneous fees and collections,
including assumption fees collected from Mortgagors, to the extent not paid
to the Master Servicer, and any amounts payable by the Company or the Bond
Trustee as reimbursement of any investment losses,
(iii) any unscheduled payments and receipts on the Pledged Mortgages,
received during the calendar month preceding the month of such Payment Date
including all proceeds of any primary mortgage guaranty insurance policies
and any other insurance policies with respect to the Pledged Mortgages, to
the extent such proceeds are not applied to the restoration of the related
Mortgaged Property or released to the Mortgagor in accordance with the
Master Servicer's normal servicing procedures (collectively, "Insurance
Proceeds"), all other cash amounts received and retained in connection with
the liquidation of defaulted Pledged Mortgages, by foreclosure or otherwise
("Liquidation Proceeds"), (in each case, net of unreimbursed expenses
incurred in connection with a liquidation or foreclosure), all partial or
full prepayments received during such month and compensating interest paid
by the Master Servicer to the extent provided for by the Master Servicing
Agreement,
(iv) amounts received with respect to such Payment Date as the
purchase price in respect of a Defective Pledged Mortgage or Delinquent
Pledged Mortgage repurchased by Redwood Trust, or a Pledged Mortgage that
converted to a fixed interest rate and was repurchased by the Master
Servicer, or any Substitution Adjustment Amount in respect of a Defective
Pledged Mortgage that has been substituted for in lieu of repurchase by
Redwood Trust, and the proceeds of any purchase of a Pledged Mortgage by
the Master Servicer as a result of a breach of a representation, warranty
or covenant by the Master Servicer or of any other such purchase by the
Master Servicer to the extent otherwise required or permitted under the
Master Servicing Agreement,
(v) all Monthly Advances made for such Payment Date in respect of the
Pledged Mortgages, in each case net of amounts reimbursable therefrom to
the Master Servicer for Monthly Advances made with respect to prior Payment
Dates and net of such amount as may be necessary to reimburse the Master
Servicer or the Bond Trustee for certain costs and expenses (including any
indemnification expenses) owed to either pursuant to the Master Servicing
Agreement or the Indenture but only up to an amount set forth in the Master
Servicing Agreement (the "Capped Amount"), and
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(vi) any net amount with respect to such Payment Date exchanged with
the Swap Provider under the terms of the Swap Agreement (any net amount
payable to the Swap Provider under the terms of the Swap Agreement will
reduce the amount of Available Funds).
With respect to any Payment Date, the "Due Date" is the first day of the
month in which such Payment Date occurs; the "Due Period" is the immediately
preceding calendar month; and a "Determination Date" is the fifteenth day of the
month in which such Payment Date occurs.
As more fully described below, the Available Funds for each Payment Date
will be distributed by the Bond Trustee in the following order of priority, to
the payment of the following amounts for such Payment Date: first, the Bond
Insurance Policy premium, the fee payable to Redwood Trust under the Management
Agreement and the fees payable to the Owner Trustee, second, the net amount, if
any, payable to the Swap Provider, third, the Interest Payment Amount to
Bondholders, fourth, the amount of any Bondholders' Interest Carryover, if
applicable, to Bondholders, fifth, the Basic Principal Amount to Bondholders,
sixth, the Insurer Reimbursement Amount, to the Insurer, seventh, the Excess
Cash Flow Principal Amount to Bondholders, eighth, such amount as may be
necessary to reimburse either the Master Servicer or the Bond Trustee for any
amounts that would otherwise have been payable to it, but were in excess of the
Capped Amount and such amount as may be necessary to reimburse the Owner Trustee
for certain expenses not reimbursed by the Company, and ninth, any remaining
amounts for such Payment Date to the holder of the Investor Certificate. The
amount of Available Funds for any Payment Date after payment of the premium,
management fee, trustee fee, custodial fee and swap payment set forth in clauses
first and second, above, is referred to herein as the "Net Available Funds" for
such Payment Date.
INTEREST
The Bond Interest Rate on each Class of Bonds for each Payment Date is
described herein under "Summary -- Bond Interest Rate." Notwithstanding such
description, if as of any Payment Date a default under the Bond Insurance Policy
exists and is continuing and the Class A-1 Interest Rate or Class A-2 Interest
Rate calculated as described under "SUMMARY -- Bond Interest Rate" for such
Payment Date exceeds the Weighted Average Net Mortgage Rate for the related Due
Period, then the Class A-1 Interest Rate or the Class A-2 Interest Rate, as the
case may be, for the related Interest Accrual Period will be equal to the
Weighted Average Net Mortgage Rate (unless such Payment Date would be the
seventh consecutive Payment Date on which at least one of the Bond Interest
Rates would be equal to the Weighted Average Net Mortgage Rate, in which case,
each Bond Interest Rate would be calculated as described under "SUMMARY -- Bond
Interest Rate" regardless of the continuation of such Bond Insurance Policy
default). If the Class A-1 Interest Rate or the Class A-2 Interest Rate for any
Payment Date is based on the Weighted Average Net Mortgage Rate, the excess of
(a) the amount of interest on the Class A-1 Bonds or the Class A-2 Bonds that
would have accrued in respect of the related Interest Accrual Period had
interest been calculated based on the One-Year Treasury ARM Index or One-Month
LIBOR, as the case may be (subject in each case to the applicable fixed-rate
cap) over (b) the amount of interest on the applicable Class of Bonds actually
accrued in respect of such Interest Accrual Period based on the Weighted Average
Net Mortgage Rate, such excess, together with the unpaid portion of any such
excess from prior Payment Dates (and interest accrued thereon at the applicable
rate calculated based on the One-Year Treasury ARM Index or One-Month LIBOR, as
the case may be (subject in each case to the applicable fixed-rate cap) is
referred to as the "Class A-1 Bondholders' Interest Carryover" or the "Class A-2
Bondholders' Interest Carryover", respectively (collectively, the "Bondholders'
Interest Carryover"). Any Bondholders' Interest Carryover will be payable on the
Payment Date when incurred or on any subsequent Payment Date to the extent that
the Net Available Funds for such Payment Date are sufficient after distribution
of the Interest Payment Amount for each Class of Bonds, as described herein
under "-- Payments" above.
On each Payment Date each Class of Bonds will be entitled to receive an
amount allocable to interest (the "Interest Payment Amount") equal to the sum of
(i) interest at the related Bond Interest Rate for the related Interest Accrual
Period for such Class of Bonds on the then outstanding Principal Balance for
such Class immediately prior to such Payment Date, and (ii) the sum of the
amounts, if any, by which the amount
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described in clause (i) above on each prior Payment Date exceeded the amount
actually distributed as interest on such Class of Bonds on such prior Payment
Dates and not subsequently distributed, together with, to the extent permitted
by applicable law, interest on the amount described in clause (ii) at the
related Bond Interest Rate. If the amount of Net Available Funds on any Payment
Date is insufficient to make the Interest Payment Amount for each Class of
Bonds, and the Insurer fails to make payments pursuant to the terms of the Bond
Insurance Policy, any such shortfall shall be allocated pro rata among the Class
A-1 and Class A-2 Bonds in proportion to the respective Interest Payment Amounts
for such Class for such Payment Date. With respect to each Payment Date, the
"Interest Accrual Period" will be the period commencing on the immediately
preceding Payment Date (or, in the case of the first Interest Accrual Period,
commencing on October 25, 1997) and ending on the date immediately preceding
such Payment Date.
Accrued interest to be paid on any Payment Date will be calculated on the
basis of the then outstanding Principal Balance for such Class immediately prior
to such Payment Date. Interest will be calculated and payable on the basis of a
360-day year divided into twelve 30-day months.
ONE-YEAR TREASURY ARM INDEX DETERMINATION
On the tenth business day prior to the commencement of each Interest
Accrual Period after the first two Interest Accrual Periods for the Class A-1
Bonds (each a "One-Year Treasury ARM Index Determination Date"), the Bond
Trustee will determine the One-Year Treasury ARM Index.
The One-Year Treasury ARM Index for the Class A-1 Bonds will be a per annum
floating rate equal to the arithmetic average of twelve rates (each, a
"Reference Rate") determined in the following manner. Each month one of the
twelve Reference Rates will be set and the rate so determined by the Bond
Trustee will remain fixed for the following twelve months. Only one Reference
Rate will be set each month; the other eleven Reference Rates will be the rates
determined during the immediately preceding eleven months. For example, the
Reference Rate for January 1998 will be set on the One-Year Treasury ARM Index
Determination Date occurring in January 1998 and will remain fixed for the
period of January 25, 1998 through January 24, 1999. The Reference Rate for
February 1998 will be set on the One-Year Treasury ARM Index Determination Date
in February 1998 and will remain fixed for the period of February 25, 1998
through February 24, 1999. The Bond Trustee will determine Reference Rates for
March through December of 1998 in a similar manner.
The One-Year Treasury ARM Index for the Class A-1 Bonds for each Interest
Accrual Period will equal the arithmetic average of the twelve Reference Rates
as determined by the Bond Trustee on the related One-Year Treasury ARM Index
Determination Date after giving effect to the determination of the Reference
Rate for that month.
The Reference Rate determined each month will be set to a level equal to
the One-Year Constant Maturity Treasury Index in effect for the week ending on
Friday of the first full week (i.e., the week which includes the first Monday of
the month) of the prior month plus a margin of 1.10%, subject, however, to (i) a
maximum increase not to exceed the sum of the Reference Rate for such month
determined in the immediately preceding year plus 2% and (ii) a maximum rate of
10%. For example, the Reference Rate for January 1999 will be based on the
One-Year Constant Maturity Treasury Index in effect for the week ending on
Friday of the first full week of December 1998, will not be greater than the
Reference Rate for January 1998 plus 2% and will not be greater than 10%.
The "One-Year Constant Maturity Treasury Index" will be the average of the
published yield for each business day during the specified one full week of the
yield on United States Treasury securities adjusted to a constant maturity of
one year. Yields on Treasury securities at "constant maturity" are derived from
the U.S. Treasury's daily yield curve. This curve, which relates the yield on a
security to its time to maturity, is based on the closing market bid yields on
actively traded Treasury securities in the over-the-counter market. These market
yields are calculated from composites of quotations reported by five leading
U.S. Government securities dealers to the Federal Reserve Bank of New York. This
method provides a yield for a given maturity even if no Treasury security with
that exact maturity is outstanding. Such information on yields on Treasury
securities is published by the Federal Reserve Board in its Statistical Release
No. H.15(519). Statistical
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<PAGE> 25
Release No. H.15(519) is published on Monday or Tuesday of each week and may be
obtained by writing or calling the Publications Department at the Board of
Governors of the Federal Reserve System, 21st and C Streets, Washington D.C.
20551, (202) 452-3244.
As of the Closing Date, the initial Reference Rates (which may differ from
the Reference Rates that would have been calculated in the manner described
above on the related One-Year Treasury ARM Index Determination Dates) will be as
follows:
<TABLE>
<CAPTION>
INITIAL
REFERENCE INITIAL REFERENCE
RATE NO. MONTH PERIOD RATE
- --------- --------- --------------------- ----
<C> <S> <C> <C>
1 January ( 1/25/97 - 1/24/98) 6.50%
2 February ( 2/25/97 - 2/24/98) 6.50%
3 March ( 3/25/97 - 3/24/98) 6.50%
4 April ( 4/25/97 - 4/24/98) 6.50%
5 May ( 5/25/97 - 5/24/98) 6.50%
6 June ( 6/25/97 - 6/24/98) 6.50%
7 July ( 7/25/97 - 7/24/98) 6.50%
8 August ( 8/25/97 - 8/24/98) 6.50%
9 September ( 9/25/97 - 9/24/98) 6.50%
10 October (10/25/97 - 10/24/98) 6.50%
11 November (11/25/97 - 11/24/98) 6.50%
12 December (12/25/96 - 12/24/97) 6.50%
</TABLE>
Based on the above Reference Rates, the Class A-1 Interest Rate for the
Payment Dates in November 1997 and December 1997 will be 6.50% per annum.
The Bond Trustee's establishment of the One-Year Constant Maturity Treasury
Index and the Reference Rate for each month and the Bond Trustee's subsequent
calculation of the Bond Interest Rate on the Class A-1 Bonds for any Interest
Accrual Period, in the absence of wilful misconduct, bad faith or manifest
error, will be final and binding. The Bond Interest Rate on the Class A-1 Bonds
for any applicable Interest Accrual Period and the 12 Reference Rates used to
calculate such rate may be obtained by telephoning the Bond Trustee at (410)
884-2000.
ONE-MONTH LIBOR RATE DETERMINATION
On the second business day prior to the commencement of each Interest
Accrual Period for the Class A-2 Bonds (each a "LIBOR Rate Determination Date"),
the Bond Trustee will determine One-Month LIBOR.
"One-Month LIBOR" means, as of any LIBOR Rate Determination Date, the rate
for deposits in United States dollars for a period equal to the relevant
Interest Accrual Period (commencing to the first day of such Interest Accrual
Period) which appears in the Telerate Page 3750 as of 11:00 a.m., London time,
on such date. If such rate does not appear on Telerate Page 3750, the rate for
that day will be determined on the basis of the rates at which deposits in
United States dollars are offered by the Reference Banks at approximately 11:00
a.m., London time, on that day to prime banks in the London interbank market for
a period equal to the relevant Interest Accrual Period (commencing on the first
day of such Interest Accrual Period). The Bond 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 for that day
will be the arithmetic mean of the quotations. If fewer than two quotations are
provided as requested, the rate for that day will be the arithmetic mean of the
rates quoted by major banks in The City of New York, selected by the Bond
Trustee, at approximately 11:00 a.m., New York City time, on that day for loans
in United States dollars to leading European banks for a period equal to the
relevant Interest Accrual Period (commencing on the first day of such Interest
Accrual Period).
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<PAGE> 26
"Telerate Page 3750" means the display page currently so designated on the
Dow Jones Telerate Service (or such other page as may replace that page on that
service for the purpose of displaying comparable rates or prices) and "Reference
Banks" means leading banks selected by the Bond Trustee and engaged in
transactions in Eurodollar deposits in the international Eurocurrency market.
The Class A-2 Interest Rate for the first Payment Date will equal 5.99625%
per annum.
The Bond Trustee's establishment of One-Month LIBOR (or an alternative
index) and the Bond Trustee's subsequent calculation of the Bond Interest Rate
on the Class A-2 Bonds for any Interest Accrual Period, in the absence of wilful
misconduct, bad faith or manifest error, will be final and binding. The Bond
Interest Rate on the Class A-2 Bonds for any applicable Interest Accrual Period
may be obtained by telephoning the Bond Trustee at (410) 884-2000.
PRINCIPAL
On each Payment Date, the "Principal Payment Amount" will equal the sum for
such Payment Date of the Basic Principal Amount, the Excess Cash Flow Principal
Amount, if any, and the amount of any Insured Payment made with respect to any
Subordination Deficit. The Principal Payment Amount will be distributed as
principal of the Class A-1 and Class A-2 Bonds on a pro rata basis according to
the relative Principal Balances thereof. In no event will the Principal Payment
Amount with respect to any Payment Date be greater than the then outstanding
Bond Principal Balance of the Bonds.
The "Basic Principal Amount" for any Payment Date will be equal to the
lesser of (a) the Net Available Funds remaining after distribution of the
Interest Payment Amount and any Bondholders' Interest Carryover for such Payment
Date, (b) the Principal Distributable Amount for such Payment Date and (c) the
amount necessary, if any, to reduce the Bond Principal Balance to the Targeted
Principal Balance for such Payment Date.
The "Principal Distributable Amount" for any Payment Date will be equal to
the sum of:
(i) the principal portion of all scheduled monthly payments on the
Pledged Mortgages received or that were the subject of a Monthly Advance
with respect to the related Due Date;
(ii) the principal portion of all proceeds received with respect to
such Payment Date of (x) the repurchase of a Defective Pledged Mortgage
(or, in the case of a substitution, certain amounts representing a
principal adjustment) or a Delinquent Pledged Mortgage by Redwood Trust,
(y) the repurchase by the Master Servicer of a Pledged Mortgage upon
conversion to a fixed rate or (z) any Pledged Mortgage purchased by the
Master Servicer to the extent required or permitted under the Master
Servicing Agreement, during the preceding calendar month; and
(iii) the principal portion of all other unscheduled collections
received during the preceding calendar month (or deemed to be received
during such month) (including, without limitation, full and partial
principal prepayments made by the respective Mortgagors, Liquidation
Proceeds and Insurance Proceeds), to the extent not distributed in the
preceding month.
The "Targeted Principal Balance" for any Payment Date will mean the Bond
Principal Balance that is equal to (x) the Pool Principal Balance with respect
to such Payment Date minus (y) the Specified Overcollateralization Amount for
such Payment Date.
The "Specified Overcollateralization Amount" will be an amount to be
determined pursuant to the Administration Agreement. For each Payment Date, the
Specified Overcollateralization Amount will adjust pursuant to the parameters
set forth in the Administration Agreement and such parameters may themselves be
amended (i) by agreement of the Issuer and, if no default exists and is
continuing under the Bond Insurance Policy, the Insurer and with the advice of
tax counsel and without the consent of the Bondholders or the Bond Trustee, or
(ii) by the Issuer with the consent of the Bond Trustee and the advice of tax
counsel and without the consent of the Bondholders or, if a default exists and
is continuing under the Bond Insurance Policy, the Insurer.
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<PAGE> 27
The "Excess Cash Flow Principal Amount" for any Payment Date will be equal
to the lesser of (i) the Net Monthly Excess Cashflow, if any, for such Payment
Date and (ii) the amount necessary, if any, after application of the Basic
Principal Amount for such Payment Date, to reduce the Bond Principal Balance to
the Targeted Principal Balance for such Payment Date. The "Net Monthly Excess
Cashflow" for any Payment Date is equal to the amount of Net Available Funds, if
any, remaining after payment of (i) the Interest Payment Amount, (ii) the amount
of any Bondholders' Interest Carryover, (iii) the Basic Principal Amount and
(iv) the Insurer Reimbursement Amount. "Insurer Reimbursement Amount" equals, as
of any Payment Date, the sum of (i) all amounts previously paid by the Insurer
under the Bond Insurance Policy which have not previously been reimbursed, (ii)
all other amounts due to the Insurer under the Insurance Agreement, other than
the insurance premium and (iii) interest on the foregoing at the Late Payment
Rate (as defined in the Insurance Agreement).
The circumstances under which an Insured Payment with respect to any
Subordination Deficit may be made are described under "Overcollateralization
Provisions -- Overcollateralization and the Bond Insurance Policy" and "Bond
Insurance Policy" below.
INVESTOR CERTIFICATE PAYMENT
No payments shall be made on the Investor Certificate on any Payment Date
on which funds available to pay principal on the Bonds are insufficient to
reduce the Bond Principal Balance to the Targeted Principal Balance, i.e., at
any time at which the Overcollateralization Amount is less than the Specified
Overcollateralization Amount or on which any Insurer Reimbursement Amount
remains outstanding. Conversely, on any Payment Date on which Net Available
Funds remain after payment of the amount, if any, required to reduce the Bond
Principal Balance to the Targeted Principal Balance for such Payment Date,
reimbursement to the Insurer of the Insurer Reimbursement Amount and, if
applicable, the payment of any Bondholders' Interest Carryover, and the payment
of costs and expenses to the Master Servicer and the Bond Trustee, respectively,
in excess of the respective Capped Amount, such remaining Net Available Funds
shall be distributed to the holder of the Investor Certificate, which shall
initially be the Company. Any amounts so distributed shall have been released
from the lien of the Indenture and shall no longer be available to make payments
on the Bonds or to the Insurer.
OVERCOLLATERALIZATION PROVISIONS
OVERCOLLATERALIZATION RESULTING FROM CASHFLOW STRUCTURE
As described under "-- Principal," above, after the Closing Date, principal
distributions on the Bonds will be made on each Payment Date, to the extent of
funds available therefor, in amounts up to the amount necessary to maintain the
Overcollateralization Amount at a level equal to the Specified
Overcollateralization Amount.
The Indenture provides that, on any Payment Date, all unscheduled
collections on account of principal with respect to the Pledged Mortgages during
the calendar month preceding the calendar month in which such Payment Date
occurs will be distributed on the Bonds on such Payment Date. If any Pledged
Mortgage becomes a Liquidated Mortgage, the Liquidation Proceeds related thereto
and allocated to principal may be less than the principal balance of the related
Pledged Mortgage; the amount of any such insufficiency is generally defined as a
"Realized Loss." The principal balance of any Pledged Mortgage after it becomes
a Liquidated Mortgage shall equal zero. The Indenture does not contain any rule
which requires that the amount of any Realized Loss be distributed to the
Bondholders on the Payment Date which immediately follows the event of loss;
i.e., the Indenture does not require the current recovery of losses by
Bondholders. However, the occurrence of a Realized Loss will reduce the
Overcollateralization Amount and may therefore increase the required principal
distribution of the Bonds to the extent that such reduction causes the
Overcollateralization Amount to be less than the Specified Overcollateralization
Amount. The effect of the foregoing is to allocate losses to
overcollateralization by reducing payments on the Pledged Mortgages which the
holder of the Investor Certificate would otherwise receive.
S-27
<PAGE> 28
OVERCOLLATERALIZATION AND THE BOND INSURANCE POLICY
The "Subordination Deficit" with respect to a Payment Date is the amount,
if any, by which (x) the Bond Principal Balance of the Bonds as of such Payment
Date, and following the making of all payments to be made on such Payment Date
(except for any payment to be made as to principal from proceeds of the Bond
Insurance Policy), exceeds (y) the Pool Principal Balance with respect to such
Payment Date. The Indenture requires the Bond Trustee to make a claim for an
Insured Payment under the Bond Insurance Policy not later than the second
Business Day prior to any Payment Date as to which the Bond Trustee has
determined that a Subordination Deficit will occur for the purpose of applying
the proceeds of such Insured Payment as a payment of principal to the Holders of
the Bonds on such Payment Date. Investors in the Bonds should realize that,
under extreme loss or delinquency scenarios, they may temporarily receive no
payments of principal.
EXCESS SPREAD
"Excess Spread" refers to the positive spread (after taking into account
any payment to, or receipt of a payment from, the Swap Provider) that may exist
between the Weighted Average Net Mortgage Rate and the weighted average of the
Bond Interest Rates. Whether at any time any such positive spread exists will
depend on a variety of factors, including the relationship of the movements in
the indices applicable to the Pledged Mortgages and those applicable to the
Bonds, over which no prediction can be made or assurance given.
STATED MATURITY
The Stated Maturity for the Bonds is the date determined by the Company as
the 24th Payment Date immediately following the latest maturity date of any
Pledged Mortgage. The Stated Maturity of the Bonds is October 25, 2024. See
"DESCRIPTION OF THE BONDS -- Weighted Average Lives of the Bonds" and "SECURITY
FOR THE BONDS" herein and in the Prospectus.
OPTIONAL PURCHASE OF DELINQUENT PLEDGED MORTGAGES
Redwood Trust may, at its option, purchase from the Issuer any Pledged
Mortgage which is delinquent in payment by 60 days or more (each, a "Delinquent
Pledged Mortgage"). Any such purchase will be at a price equal to 100% of the
Stated Principal Balance of such Pledged Mortgage plus accrued interest thereon
at the applicable Mortgage Rate from the date through which interest was last
paid by the related Mortgagor or advanced to the first day of the month prior to
the month in which such amount is to be distributed. Redwood Trust will notify
the Insurer of any such purchase proposed to be made by it and the Insurer will
be given the opportunity to object to any such purchase.
WEIGHTED AVERAGE LIVES OF THE BONDS
The weighted average life of a Bond is determined by (a) multiplying the
amount of the reduction, if any, of the Principal Balance of such Bond on each
Payment Date by the number of years from the date of issuance to such Payment
Date, (b) summing the results and (c) dividing the sum by the aggregate amount
of the reductions in Principal Balance of such Bond referred to in clause (a).
For a discussion of the factors which may influence the rate of payments
(including prepayments) of the Pledged Mortgages, see "RISK FACTORS -- Yield,
Prepayment and Maturity Risks" herein and "RISK FACTORS -- Prepayment and Yield
Considerations; Reinvestment Risk" in the Prospectus.
In general, the weighted average lives of the Bonds will be shortened if
the level of prepayments of principal of the Pledged Mortgages increases.
However, the weighted average lives of the Bonds will depend upon a variety of
other factors, including the timing of changes in such rate of principal
payments on the Pledged Mortgages. See "DESCRIPTION OF THE BONDS--Principal"
herein. The weighted average lives of the Bonds also will be shortened if the
Issuer redeems the Bonds as described herein under "-- Redemption."
The interaction of the foregoing factors may have different effects on the
Bonds at different times during the life of such Bonds. Accordingly, no
assurance can be given as to the weighted average life of the Bonds.
S-28
<PAGE> 29
For an example of how the weighted average lives of the Bonds may be affected at
various constant Prepayment Assumptions, see the Decrement Tables below.
REDEMPTION
The Bonds may be redeemed in whole, but not in part, at the Issuer's
option, on any Payment Date on or after the earlier of either (a) ten (10) years
after the Closing Date or (b) the Payment Date after which the Pool Principal
Balance with respect to such Payment Date, is 25% or less of the Initial Pool
Principal Balance, at a redemption price equal to, in the case of the Class A-1
Bonds, 101% of the unpaid Principal Balance for such Class and, in the case of
the Class A-2 Bonds, 100% of the unpaid Principal Balance for such Class, plus
in both cases accrued and unpaid interest thereon at the applicable Bond
Interest Rate (the "Redemption Price"), plus all amounts due to the Insurer
pursuant to the Insurance Agreement. In addition, the Redemption Price would
include any then outstanding Bondholders' Interest Carryover Shortfalls. At the
option of the Issuer, such an optional redemption of the Bonds can be effected
without retiring such Bonds so that the Issuer has the ability to own or resell
such Bonds. Upon redemption and retirement of the Bonds the collateral securing
the Bonds will be released from the lien of the Indenture.
Notice of any redemption by the Issuer must be given by the Issuer to the
Bond Trustee not less than 30 days prior to the redemption date and must be
mailed by the Issuer or the Bond Trustee to affected Bondholders at least ten
days prior to the redemption date.
See "DESCRIPTION OF THE BONDS -- Optional Redemption" in the Prospectus.
BOND INSURANCE POLICY
The following information regarding the Bond Insurance Policy has been
supplied by Ambac Assurance Corporation (the "Insurer") for inclusion in this
Prospectus Supplement.
The Insurer, in consideration of the payment of the premium and subject to
the terms of the Bond Insurance Policy, thereby unconditionally and irrevocably
guarantees to any Owner (as defined below) that an amount equal to each full and
complete Insured Payment (as defined below) will be received by the Bond
Trustee, or its successor, as trustee for the Owners, on behalf of the Owners
from the Insurer, for distribution by the Bond Trustee to each Owner of each
Owner's proportionate share of the Insured Payment. The Insurer's obligations
under the Bond Insurance Policy with respect to a particular Insured Payment
shall be discharged to the extent funds equal to the applicable Insured Payment
are received by the Bond Trustee whether or not such funds are properly applied
by the Bond Trustee. Insured Payments shall be made only at the time set forth
in the Bond Insurance Policy and no accelerated Insured Payments shall be made
regardless of any acceleration of the Bonds, unless such acceleration is at the
sole option of the Insurer.
Notwithstanding the foregoing paragraph, the Bond Insurance Policy does not
cover shortfalls, if any, attributable to the liability of the Issuer or the
Bond Trustee for withholding taxes, if any (including interest and penalties in
respect of any such liability).
The Insurer will pay any Insured Payment that is a Preference Amount (as
described below) on the related Payment Date following receipt of (i) a
certified copy of the order requiring the return of a preference payment, (ii)
an opinion of counsel satisfactory to the Insurer that such order is final and
not subject to appeal, (iii) an assignment in such form as is reasonably
required by the Insurer, irrevocably assigning to the Insurer all rights and
claims of the Owner relating to or arising under the Bonds against the debtor
which made such preference payment or otherwise with respect to such preference
payment and (iv) appropriate instruments to effect the appointment of the
Insurer as agent for such Owner in any legal proceeding related to such
preference payment. Such payments shall be disbursed to the receiver or trustee
in bankruptcy named in the final order of the court exercising jurisdiction on
behalf of the Owner and not to any Owner directly unless such Owner has returned
principal or interest paid on the Bonds to such receiver or trustee in
bankruptcy, in which case such payment shall be disbursed to such Owner.
S-29
<PAGE> 30
The Insurer will pay any amount payable under the Bond Insurance Policy no
later than 12:00 noon, New York City time, on the later of the Payment Date on
which the related Insured Payment is due or the second Business Day following
receipt in New York, New York on a Business Day by the Insurer of a Notice (as
described below); provided that if such Notice is received after 12:00 noon New
York City time on such Business Day, it will be deemed to be received on the
following Business Day. If any such Notice received by the Insurer is not in
proper form or is otherwise insufficient for the purpose of making claim under
the Bond Insurance Policy it shall be deemed not to have been received by the
Insurer for purposes of this paragraph, and the Insurer shall promptly so advise
the Bond Trustee and the Bond Trustee may submit an amended Notice.
Insured Payments due under the Bond Insurance Policy unless otherwise
stated therein will be disbursed to the Bond Trustee on behalf of the Owners by
wire transfer of immediately available funds in the amount of the Insured
Payment less, in respect of Insured Payments related to Preference Amounts, any
amount held by the Bond Trustee for the payment of such Insured Payment and
legally available therefor.
Subject to the terms of the Indenture, the Insurer shall be subrogated to
the rights of each Owner to receive payments under the Bonds to the extent of
any payment by the Insurer under the Bond Insurance Policy.
As used in the Bond Insurance Policy, the following terms shall have the
following meanings:
"Agreement" means the Administration Agreement dated as of the Closing
Date, among the Issuer, Redwood Trust, the Administrator and the Bond
Trustee, without regard to any amendment or supplement thereto unless such
amendment or supplement has been approved in writing by the Insurer.
"Business Day" means any day other than a Saturday, a Sunday or a day
on which the Insurer or banking institutions in the State of Maryland and
The City of New York or in the city in which the corporate trust office of
the Bond Trustee under the Agreement is located are authorized or obligated
by law or executive order to close.
"Deficiency Amount" means (A) for any Payment Date prior to the Stated
Maturity, an amount equal to the sum of (i) the excess, if any, of the
Interest Payment Amount over the Net Available Funds for such Payment Date
and (ii) the Subordination Deficit, if any; (B) for the Stated Maturity, an
amount equal to the sum of (i) the excess, if any, of the Interest Payment
Amount over the Net Available Funds for such Payment Date and (ii) the
excess, if any, of the Bond Principal Balance of the Bonds over Net
Available Funds not used to pay the Interest Payment Amount for such Stated
Maturity; and (C) for any date on which the acceleration of the Bonds has
been directed or consented to by the Insurer pursuant to the Agreement or
the Indenture, an amount equal to the excess, if any, of the sum of the
Bond Principal Balance of the Bonds, together with accrued and unpaid
interest thereon through the date of payment of such accelerated Bonds,
over the Net Available Funds for such Payment Date. A Deficiency Amount
does not include any redemption premium in excess of the Bond Principal
Balance of the Bonds.
"Indenture" means the Indenture dated as of October 1, 1997 between
the Issuer and the Bond Trustee.
"Insured Payment" means as of any Payment Date (i) any Deficiency
Amount and (ii) any Preference Amount.
"Notice" means the telephonic or telegraphic notice, promptly
confirmed in writing by telecopy substantially in the form of Exhibit A
attached to the Bond Insurance Policy, the original of which is
subsequently delivered by registered or certified mail, from the Bond
Trustee, specifying the Insured Payment which shall be due and owing on the
applicable Payment Date.
"Owner" means each Bondholder (as defined in the Agreement) who, on
the applicable Payment Date, is entitled under the terms of the applicable
Bonds, to payment thereunder.
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<PAGE> 31
"Preference Amount" means any amount previously distributed to an
Owner on the Bonds that is recoverable and sought to be recovered as a
voidable preference by a trustee in bankruptcy pursuant to the United
States Bankruptcy Code (11 U.S.C.), as amended from time to time, in
accordance with a final nonappealable order of a court having competent
jurisdiction.
Capitalized terms used in the Bond Insurance Policy and not otherwise
defined in the Bond Insurance Policy shall have the respective meanings set
forth in the Indenture as of the date of execution of the Bond Insurance Policy,
without giving effect to any subsequent amendment or modification to the
Agreement unless such amendment or modification has been approved in writing by
the Insurer.
Any notice under the Bond Insurance Policy may be made at such address as
the Insurer shall specify in writing to the Bond Trustee and Master Servicer.
The Bond Insurance Policy is being issued under and pursuant to, and shall
be construed under, the laws of the State of New York, without giving effect to
the conflict of laws principles thereof.
The Bond Insurance Policy is not cancelable for any reason. The premium on
the Bond Insurance Policy is not refundable for any reason including payment, or
provision being made for payment, prior to maturity of the Bonds.
THE BOND INSURANCE POLICY IS NOT COVERED BY THE PROPERTY/CASUALTY INSURANCE
SECURITY FUND SPECIFIED IN ARTICLE 76 OF THE NEW YORK INSURANCE LAW.
THE INSURER
The Insurer is a Wisconsin-domiciled stock insurance corporation regulated
by the Office of the Commissioner of Insurance of the State of Wisconsin and
licensed to do business in 50 states, the District of Columbia, the Commonwealth
of Puerto Rico and Guam. The Insurer primarily insures newly-issued municipal
and structured finance obligations. The Insurer is a wholly-owned subsidiary of
Ambac Financial Group, Inc. (formerly AMBAC Inc.), a 100% publicly-held company.
Moody's, S&P and Fitch Investors Service, L.P. have each assigned a triple-A
claims-paying ability rating to the Insurer.
The consolidated financial statements of the Insurer and its subsidiaries
as of December 31, 1996 and December 31, 1995 and for the three years ended
December 31, 1996 prepared in accordance with generally accepted accounting
principles, included in the Current Report on Form 8-K of AMBAC Inc. (which was
filed with the Securities and Exchange Commission (the "Commission") on March
12, 1997; Commission File No. 1-10777) and the consolidated financial statements
of the Insurer and its subsidiaries as of June 30, 1997 and for the periods
ending June 30, 1997 and June 30, 1996, included in the Quarterly Report on Form
10-Q of Ambac Financial Group, Inc. for the period ended June 30, 1997 (which
was filed with the Commission on August 14, 1997) are hereby incorporated by
reference into this Prospectus Supplement and shall be deemed to be a part
hereof. Any statement contained in a document incorporated herein by reference
shall be modified or superseded for the purposes of this Prospectus Supplement
to the extent that a statement contained herein by reference herein also
modifies or supersedes such statement. Any statement so modified or superseded
shall not be deemed, except as so modified or superseded, to constitute a part
of this Prospectus Supplement.
All financial statements of the Insurer and its subsidiaries included in
documents filed by Ambac Financial Group, Inc. with the Commission pursuant to
Section 13(a), 13(c), 14 or 15 of the Exchange Act subsequent to the date of
this Prospectus Supplement and prior to the termination of the offering of the
Bonds shall be deemed to be incorporated by reference into this Prospectus
Supplement and to be a part hereof from the respective dates of filing such
documents.
S-31
<PAGE> 32
The following table sets forth the capitalization of the Insurer as of
December 31, 1994, December 31, 1995, December 31, 1996 and June 30, 1997,
respectively, in conformity with generally accepted accounting principles.
AMBAC ASSURANCE CORPORATION
CONSOLIDATED CAPITALIZATION TABLE
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, DECEMBER 31, JUNE 30,
1994 1995 1996 1997
------------ ------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C>
Unearned premiums.............................. $ 840 $ 906 $ 995 $1,036
Other liabilities.............................. 136 295 259 284
------ ------ ------ ------
Total liabilities.............................. $ 976 $1,201 $1,254 $1,320
------ ------ ------ ------
Stockholder's equity
Common Stock................................. $ 82 $ 82 $ 82 $ 82
Additional paid-in capital................... 444 481 515 $ 520
Unrealized gains (losses) on investments, net
of tax.................................... (46) 87 66 64
Retained earnings............................ 782 907 992 1,079
------ ------ ------ ------
Total stockholder's equity..................... $1,262 $1,557 $1,655 $1,745
------ ------ ------ ------
Total liabilities and stockholder's equity..... $2,238 $2,758 $2,909 $3,065
====== ====== ====== ======
</TABLE>
For additional financial information concerning the Insurer, see the
audited financial statements of the Insurer incorporated by reference herein.
Copies of the financial statements of the Insurer incorporated herein by
reference and copies of the Insurer's annual statement for the year ended
December 31, 1996 prepared in accordance with statutory accounting standards are
available, without charge, from the Insurer. The address of the insurer's
administrative offices and its telephone number are One State Street Plaza, 17th
Floor, New York, New York 10004 and (212) 668-0340.
The Insurer makes no representation regarding the Bonds or the advisability
of investing in the Bonds and makes no representation regarding, nor has it
participated in the preparation of, this Prospectus Supplement other than the
information supplied by the Insurer and presented under the headings "Bond
Insurance Policy" and "The Insurer" and in the financial statements incorporated
herein by reference.
Each rating of the Insurer should be evaluated independently. The ratings
reflect the respective rating agency's current assessment of the
creditworthiness of the Insurer and its ability to pay claims on its policies of
insurance. Any further explanation as to the significance of the above ratings
may be obtained only from the applicable rating agency.
The above ratings are not recommendations to buy, sell or hold the Bonds,
and such ratings may be subject to revision or withdrawal at any time by the
rating agencies. Any downward revision or withdrawal of any of the above ratings
may have an adverse effect on the market price of the Bonds. The Insurer does
not guaranty the market price of the Bonds nor does it guaranty that the ratings
on the Bonds will not be revised or withdrawn.
S-32
<PAGE> 33
STRUCTURING ASSUMPTIONS
Unless otherwise specified, the decrement tables in this Prospectus
Supplement has been prepared on the basis of the following assumed
characteristics of the Pledged Mortgages and the following additional
assumptions (collectively, the "Structuring Assumptions"): (i) the Pledged
Mortgage Pool consists of Pledged Mortgages with the following characteristics:
<TABLE>
<CAPTION>
CUT-OFF DATE MONTHS TO
STATED CURRENT NEXT
INDEX AND FREQUENCY PRINCIPAL MORTGAGE ADJUSTMENT REMAINING TERM ORIGINAL TERM
OF ADJUSTMENT BALANCE RATE MARGIN DATE (MONTHS) (MONTHS)
- ---------------------------------- --------------- -------- ------ ---------- -------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Treasury Index -- Monthly......... $ 260,000.00 8.125% 2.625% 1 291 300
Treasury Index -- Semi-Annual..... 94,547.93 8.500 2.500 2 290 300
One-Month LIBOR Index............. 382,109,610.40 7.462 1.836 1 296 300
One-Month LIBOR Index............. 780,000.00 7.375 1.750 2 300 300
Six-Month LIBOR Index............. 70,729,681.74 7.902 2.037 1 295 300
Six-Month LIBOR Index............. 62,377,379.10 7.913 1.944 2 295 300
Six-Month LIBOR Index............. 92,508,223.29 7.923 1.995 3 295 300
Six-Month LIBOR Index............. 64,177,718.52 7.804 1.983 4 297 300
Six-Month LIBOR Index............. 41,288,150.70 7.734 1.949 5 298 300
Six-Month LIBOR Index............. 42,347,777.95 7.793 2.045 6 294 300
Prime -- Semi-Annual.............. 54,400.00 8.750 0.250 4 292 300
</TABLE>
(ii) the Pledged Mortgages prepay at the specified CPR, (iii) no defaults in the
payment by Mortgagors of principal of and interest on the Pledged Mortgages are
experienced, (iv) for each Payment Date, the scheduled payments on the Pledged
Mortgages are received on the related Due Date, (v) there are no Net Interest
Shortfalls and prepayments represent prepayments in full of individual Pledged
Mortgages and are received during each Due Period with 30 days of interest
accrued thereon, (vi) the scheduled monthly payment for each Pledged Mortgage
has been calculated based on the assumed mortgage loan characteristics described
in item (i) above such that each such mortgage loan will amortize in amounts
sufficient to repay the principal balance of such assumed mortgage loan by its
remaining term to maturity, (vii) the initial Bond Principal Balance is as set
forth on the cover page hereof, (viii) interest accrues on the Bonds at the
interest rate described herein, (ix) payments in respect of the Bonds are
received in cash on the 25th day of each month commencing in the calendar month
in which the Closing Date occurs regardless of whether such day is a Business
Day, (x) the closing date of the sale of the Bonds is November 6, 1997, (xi)
Redwood Trust does not purchase or substitute for any Pledged Mortgage, (xii)
each Pledged Mortgage will pay interest only for the first ten years from
origination and will fully amortize thereafter until maturity, (xiii) the Issuer
does not redeem the Bonds as described herein under "-- Redemption," and (xiv)
the level of the One-Month LIBOR Index remains constant at 5.6563%, the level of
the Six-Month LIBOR Index remains constant at 5.8789%, the level of the Treasury
Index remains constant at 5.44%, and the level of the Prime Index remains
constant at 8.50%. While it is assumed that each of the Pledged Mortgages
prepays at the specified CPR, this is not likely to be the case. Moreover,
discrepancies exist between the characteristics of the actual Pledged Mortgages
which will be delivered to the Bond Trustee and characteristics of the Pledged
Mortgages assumed in preparing the tables herein.
Prepayments of mortgage loans commonly are measured relative to a
prepayment standard or model. The prepayment assumption model used in this
Prospectus Supplement is based on a Constant Prepayment Rate ("CPR"). CPR
represents a constant rate of prepayment on the Pledged Mortgages each month
relative to the aggregate outstanding principal balance of the Pledged
Mortgages. The Issuer does not make any representations about the
appropriateness of the CPR model.
DECREMENT TABLES
The following tables indicate the percentages of the initial Principal
Balance that would be outstanding after each of the dates shown at various
levels of CPR and the corresponding weighted average lives of each Class of
Bonds. The tables have been prepared on the basis of the Structuring
Assumptions. It is not likely that (i) all of the Pledged Mortgages will have
the characteristics assumed, (ii) all of the Pledged Mortgages
S-33
<PAGE> 34
will prepay at the rates specified in the tables or at any constant prepayment
rate or (iii) all of the Pledged Mortgages will prepay at the same rate.
Moreover, the diverse remaining terms to maturity of the Pledged Mortgages could
produce slower or faster principal payments than indicated in the tables at the
specified constant prepayment rates, even if the weighted average remaining term
to maturity of the Pledged Mortgages is consistent with the remaining terms to
maturity of the Pledged Mortgages specified in the Structuring Assumptions.
PERCENT OF INITIAL BOND PRINCIPAL BALANCES OUTSTANDING
BONDS OUTSTANDING AS A
PERCENTAGE OF ORIGINAL PRINCIPAL BALANCE
<TABLE>
<CAPTION>
DATE 0% CPR 9% CPR 12% CPR 15% CPR 18% CPR 20% CPR 24% CPR
- ------------------------------------------ ------ ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Initial Percentage........................ 100 100 100 100 100 100 100
October 25, 1998.......................... 100 91 88 85 82 80 76
October 25, 1999.......................... 100 83 77 72 67 64 57
October 25, 2000.......................... 100 75 68 61 55 51 43
October 25, 2001.......................... 100 68 60 52 45 41 33
October 25, 2002.......................... 100 62 52 44 37 32 25
October 25, 2003.......................... 100 56 46 37 30 26 0
October 25, 2004.......................... 100 51 40 32 0 0 0
October 25, 2005.......................... 100 47 36 27 0 0 0
October 25, 2006.......................... 100 42 31 0 0 0 0
October 25, 2007.......................... 99 38 27 0 0 0 0
October 25, 2008.......................... 95 33 0 0 0 0 0
October 25, 2009.......................... 91 29 0 0 0 0 0
October 25, 2010.......................... 86 25 0 0 0 0 0
October 25, 2011.......................... 81 0 0 0 0 0 0
October 25, 2012.......................... 76 0 0 0 0 0 0
October 25, 2013.......................... 71 0 0 0 0 0 0
October 25, 2014.......................... 65 0 0 0 0 0 0
October 25, 2015.......................... 58 0 0 0 0 0 0
October 25, 2016.......................... 51 0 0 0 0 0 0
October 25, 2017.......................... 43 0 0 0 0 0 0
October 25, 2018.......................... 35 0 0 0 0 0 0
October 25, 2019.......................... 27 0 0 0 0 0 0
October 25, 2020.......................... 0 0 0 0 0 0 0
Weighted Average Life (yrs)(1)
To Issuer's 25% Optional Redemption..... 18.23 7.43 5.77 4.61 3.77 3.36 2.73
To Maturity............................. 18.52 8.53 6.90 5.69 4.78 4.29 3.53
</TABLE>
- ---------------
(1) The weighted average life of a Bond is determined by (i) multiplying the
amount of the reduction, if any, of the Principal Balance of such Bond on
each Payment Date by the number of years from the date of issuance to such
Payment Date, (ii) summing the results, and (iii) dividing the sum by the
aggregate amount of the reductions in Principal Balance of such Bond.
S-34
<PAGE> 35
SECURITY FOR THE BONDS
GENERAL
The Bonds will be secured by assignments to the Bond Trustee of collateral
consisting of (i) the Pledged Mortgages, (ii) the pledge agreements or guaranty
agreements, as applicable, in respect of the Additional Collateral Loans, (iii)
the Swap Agreement, (iv) funds on deposit in the Bond Account and the
Distribution Account, (v) the Issuer's rights under the Master Servicing
Agreement, (vi) the Issuer's rights under the Mortgage Loan Purchase Agreement,
and (vii) the proceeds of all of the foregoing. In addition, the Bond Insurance
Policy will be issued to the Bond Trustee for the benefit of the Bondholders and
rights under the Limited Purpose Surety Bond with respect to the Additional
Collateral Loans will be assigned to the Bond Trustee for the benefit of the
Bondholders.
The Bonds will be secured by a pool (the "Pledged Mortgage Pool") of
adjustable rate, conventional, primarily 25-year mortgage loans secured by first
liens on one- to four-family residential properties (each, a "Mortgaged
Property"). None of the Pledged Mortgages will be guaranteed by any governmental
agency. All of the Pledged Mortgages will have been deposited with the Issuer by
the Company which, in turn, will have acquired them from Redwood Trust pursuant
to an agreement (the "Mortgage Loan Purchase Agreement") between the Company,
the Issuer and Redwood Trust. All of the Pledged Mortgages will have been
acquired by Redwood Trust in the ordinary course of its business and
substantially in accordance with the underwriting criteria specified herein.
Under the Mortgage Loan Purchase Agreement, Redwood Trust will make certain
representations, warranties and covenants to the Company relating to, among
other things, the due execution and enforceability of the Mortgage Loan Purchase
Agreement and certain characteristics of the Pledged Mortgages and, subject to
the limitations described below under "-- Assignment of the Pledged Mortgages,"
will be obligated to purchase or substitute a similar mortgage loan for any
Pledged Mortgage as to which there exists deficient documentation or an uncured
material breach of any such representation, warranty or covenant (a "Defective
Pledged Mortgage"). See "MORTGAGE LOAN PROGRAM -- Representations by Sellers;
Repurchases" in the Prospectus. Under the Deposit Trust Agreement, the Company
will assign all of its rights under the Mortgage Loan Purchase Agreement to the
Issuer. Under the Indenture, the Issuer will pledge all its right, title and
interest in and to such representations, warranties and covenants (including
Redwood Trust's purchase obligation) to the Bond Trustee for the benefit of the
Bondholders and the Insurer. The Issuer will make no representations or
warranties with respect to the Pledged Mortgages and will have no obligation to
repurchase or substitute for Defective Pledged Mortgages. The obligations of
Redwood Trust with respect to the Bonds are limited to Redwood Trust's
obligation to purchase or substitute for Defective Pledged Mortgages; provided,
however, that Redwood Trust will indemnify the Issuer and the Insurer for any
damages caused by the breach of either of the following two representations: (1)
none of the Pledged Mortgages are "consumer credit contracts" or "purchase money
loans" for goods or services as such terms are defined in 16 C.F.R. section
433.1 and (2) none of the Pledged Mortgages are "mortgages" as such term is
defined in 15 U.S.C. 1602(aa).
THE PLEDGED MORTGAGES
At the Closing Date, the Pledged Mortgage Pool will consist of
approximately 2,288 Pledged Mortgages having an aggregate principal balance as
of the Cut-off Date of approximately $756,727,490. Substantially all of the
Pledged Mortgages were originated by MLCC in the ordinary course of its real
estate lending activities, except for 6.03% (by Cut-off Date Stated Principal
Balance) of the Pledged Mortgages, which were acquired by MLCC in the course of
its Correspondent Lending activities. With respect to approximately 4.00% of the
Pledged Mortgages (by Cut-off Date Stated Principal Balance), the borrowers were
initially solicited by, and the documentation for the Pledged Mortgages was
provided by, mortgage brokers that are not affiliated with MLCC under MLCC's
Third Party Originator program. Personnel of MLCC reviewed the documentation for
each such Mortgage Loan and underwrote such loans in accordance with MLCC's
underwriting standards. See "MLCC AND ITS MORTGAGE PROGRAMS" herein for a
description of MLCC's Third Party Originator and Correspondent Lending
activities.
S-35
<PAGE> 36
Based upon representations obtained from the Mortgagors at the time of
origination of the Pledged Mortgages, approximately 86.86% (by Cut-off Date
Stated Principal Balance) of the related Mortgaged Properties are
owner-occupied. As of the Cut-off Date, none of the Pledged Mortgages will be
delinquent two months or more.
Certain data with respect to the Pledged Mortgages are set forth below.
References herein to percentages of Pledged Mortgages refer in each case to the
percentage of the aggregate Cut-off Date Stated Principal Balance of the Pledged
Mortgages, after giving effect to scheduled monthly payments made by the
Mortgagors ("Scheduled Payments") due on or prior to the Cut-off Date.
The interest rates (the "Mortgage Rates") for approximately 50.60% of the
Pledged Mortgages are based on the One-Month LIBOR Index and the Mortgage Rates
for approximately 49.35% of the Pledged Mortgages are based on the Six-Month
LIBOR Index. All of the Pledged Mortgages are Index Convertible Mortgage Loans.
The Pledged Mortgages were originated from May 1996 through October 1997.
No more than 0.85% of the Mortgaged Properties securing the Pledged Mortgages
are located in any one zip code area. At origination, all of the Pledged
Mortgages had terms to stated maturity of 25 years. The latest month and year in
which any Pledged Mortgage matures is October 2022. The Pledged Mortgages had
remaining terms to stated maturity, calculated as of the Cut-off Date, of
between approximately 287 and 300 months and a weighted average remaining term
to stated maturity as of the Cut-off Date of approximately 295.75 months. The
Mortgage Rates borne by the Pledged Mortgages as of the Cut-off Date ranged from
6.50% per annum to 9.00% per annum and the weighted average Mortgage Rate as of
the Cut-off Date was approximately 7.659% per annum.
Except for 1.73% of the Pledged Mortgages, no Pledged Mortgage is insured
under a Primary Mortgage Insurance Policy or any other credit insurance policy.
Pledged Mortgages having a Loan-to-Value Ratio at origination greater than 80%
are generally Additional Collateral Loans. The Servicer will attempt to realize
on the security interest in the Additional Collateral of a defaulted Pledged
Mortgage in liquidation for the benefit of the Bond Trustee. See "MLCC AND ITS
MORTGAGE PROGRAMS" herein.
Each Pledged Mortgage had an original principal balance of not less than
$17,500 nor more than $3,150,000. The average Stated Principal Balance of the
Pledged Mortgages as of the Cut-off Date was approximately $330,737.54.
The interest payable on the Pledged Mortgages with respect to any Payment
Date will be reduced by the amount of "Net Interest Shortfalls" for such Payment
Date, if any. With respect to any Payment Date, the "Net Interest Shortfall" is
equal to (i) the amount of interest which would otherwise have been received
with respect to any Pledged Mortgage that was the subject of a Relief Act
Reduction and (ii) any Net Prepayment Interest Shortfalls as described under
"SERVICING OF THE PLEDGED MORTGAGES -- Adjustment to Certain Servicing Fees in
Connection with Certain Prepaid Pledged Mortgages" herein. A "Relief Act
Reduction" is a reduction in the amount of monthly interest payment on a Pledged
Mortgage pursuant to the Soldiers' and Sailors' Civil Relief Act of 1940. See
"CERTAIN LEGAL ASPECTS OF PLEDGED MORTGAGES -- Soldiers and Sailors' Civil
Relief Act" in the Prospectus.
The following information sets forth in tabular format certain information
describing the Pledged Mortgages as of the Cut-off Date and may not total 100%
due to rounding. Other than with respect to rates of interest, percentages are
stated by Stated Principal Balance of the Pledged Mortgages as of the Cut-off
Date and have been rounded in order to total 100%.
S-36
<PAGE> 37
<TABLE>
<CAPTION>
GEOGRAPHICAL DISTRIBUTION OF MORTGAGED PROPERTIES
- ---------------------------------------------------------------------
PERCENT
CUT-OFF OF
NUMBER DATE INITIAL
OF STATED POOL
PLEDGED PRINCIPAL PRINCIPAL
STATE OR TERRITORY MORTGAGES BALANCE BALANCE
- ------------------------------- --------- ------------ ---------
<S> <C> <C> <C>
California..................... 294 $162,590,325 21.49%
Connecticut.................... 85 42,033,886 5.55
Florida........................ 296 90,381,806 11.94
Georgia........................ 95 34,908,326 4.61
New Jersey..................... 123 42,360,345 5.60
New York....................... 233 73,586,754 9.72
Texas.......................... 144 37,096,798 4.90
Other.......................... 1.018 273,769,250 36.18
----- ------------ ------
Total....................... 2,288 $756,727,490 100.00%
===== ============ ======
</TABLE>
- ---------------
(1) "Other" includes 42 other States, the District of Columbia, and the Virgin
Islands with under 4% concentrations individually.
<TABLE>
<CAPTION>
RANGE OF CUT-OFF DATE STATED PRINCIPAL BALANCES(1)
- -----------------------------------------------------------------------
PERCENT
CUT-OFF OF
NUMBER DATE INITIAL
OF STATED POOL
RANGE OF CUT-OFF DATE PLEDGED PRINCIPAL PRINCIPAL
STATED PRINCIPAL BALANCE MORTGAGES BALANCE BALANCE
- --------------------------------- --------- ------------ ---------
<S> <C> <C> <C>
$ 0.01 - $ 25,000.00..... 20 $ 410,678 0.05%
$ 25,000.01 - $ 50,000.00..... 90 3,795,951 0.50
$ 50,000.01 - $ 75,000.00..... 145 9,362,644 1.24
$ 75,000.01 - $ 100,000.00.... 168 15,103,289 2.00
$ 100,000.01 - $ 200,000.00.... 587 87,520,000 11.57
$ 200,000.01 - $ 300,000.00.... 406 101,637,615 13.43
$ 300,000.01 - $ 400,000.00.... 302 105,991,217 14.01
$ 400,000.01 - $ 500,000.00.... 168 75,387,511 9.96
$ 500,000.01 - $ 600,000.00.... 113 63,476,280 8.39
$ 600,000.01 - $ 700,000.00.... 76 49,266,151 6.51
$ 700,000.01 - $ 800,000.00.... 45 34,563,130 4.57
$ 800,000.01 - $ 900,000.00.... 27 22,909,730 3.03
$ 900,000.01 - $1,000,000.00.... 53 51,744,089 6.84
$1,000,000.01 - $1,500,000.00.... 58 71,409,597 9.44
$1,500,000.01 - $2,000,000.00.... 14 24,352,109 3.22
$2,000,000.01 - $2,500,000.00.... 10 22,364,999 2.96
$2,500,000.01 - $3,000,000.00.... 5 14,282,500 1.89
$3,000,000.01 - $3,500,000.00.... 1 3,150,000 0.42
----- ------------ ------
Total......................... 2,288 $756,727,490 100.00%
===== ============ ======
</TABLE>
- ---------------
(1) As of the Cut-off Date, the average Stated Principal Balance of the Pledged
Mortgages was approximately $330,737.54.
<TABLE>
<CAPTION>
RANGE OF ORIGINAL CONSTRUCTIVE LOAN-TO-VALUE RATIOS(1)(2)
- ---------------------------------------------------------------------
PERCENT
CUT-OFF OF
NUMBER DATE INITIAL
OF STATED POOL
RANGE OF ORIGINAL CONSTRUCTIVE PLEDGED PRINCIPAL PRINCIPAL
LOAN-TO-VALUE RATIOS MORTGAGES BALANCE BALANCE
- ------------------------------- --------- ------------ ---------
<S> <C> <C> <C>
0.00%.............. 2 $ 554,855 0.07%
0.01% - 10.00%.............. 5 504,863 0.07
10.01% - 20.00%.............. 15 2,134,671 0.28
20.01% - 30.00%.............. 30 4,269,050 0.56
30.01% - 40.00%.............. 79 18,340,963 2.42
40.01% - 50.00%.............. 260 58,197,080 7.69
50.01% - 60.00%.............. 199 72,299,055 9.55
60.01% - 70.00%.............. 1,020 369,525,557 48.83
70.01% - 75.00%.............. 177 78,117,967 10.32
75.01% - 80.00%.............. 422 133,459,547 17.64
80.01% - 85.00%.............. 16 5,479,472 0.72
85.01% - 90.00%.............. 56 12,399,952 1.64
90.01% - 120.00%.............. 6 1,032,473 0.14
120.01% - 125.00%.............. 1 411,985 0.05
----- ------------ ------
Total....................... 2,288 $756,727,490 100.00%
===== ============ ======
</TABLE>
- ---------------
(1) The "Constructive Loan-to-Value Ratio" is calculated as (i) the original
loan amount less the required amount of any required Additional Collateral,
divided by (ii) the lesser of the appraised value of the Mortgaged Property
at origination and, if the Pledged Mortgage is a purchase money loan, the
sales price of the Mortgaged Property. See "MLCC AND ITS MORTGAGE PROGRAMS"
herein for a description of the program requirements for Additional
Collateral Mortgage Loans and the releasing of Additional Collateral during
the term of a Pledged Mortgage.
(2) As of the Cut-off Date, the weighted average Constructive Loan-to-Value
Ratio at origination was approximately 67.34%.
<TABLE>
<CAPTION>
RANGE OF ORIGINAL LOAN-TO-VALUE RATIOS(1)
- --------------------------------------------------------------------
PERCENT
CUT-OFF OF
NUMBER DATE INITIAL
OF STATED POOL
RANGE OF ORIGINAL PLEDGED PRINCIPAL PRINCIPAL
LOAN-TO-VALUE RATIOS MORTGAGES BALANCE BALANCE
- ------------------------------- -------- ------------ ---------
<S> <C> <C> <C>
0.01% - 10.00%.............. 5 $ 504,863 0.07%
10.01% - 20.00%.............. 15 2,134,671 0.28
20.01% - 30.00%.............. 29 4,060,650 0.54
30.01% - 40.00%.............. 75 16,315,963 2.16
40.01% - 50.00%.............. 134 35,447,630 4.68
50.01% - 60.00%.............. 146 51,038,408 6.74
60.01% - 70.00%.............. 264 104,720,854 13.84
70.01% - 75.00%.............. 165 73,706,419 9.74
75.01% - 80.00%.............. 441 138,113,415 18.25
80.01% - 85.00%.............. 42 14,988,593 1.98
85.01% - 90.00%.............. 105 29,283,137 3.87
90.01% - 95.00%.............. 73 26,415,409 3.49
95.01% - 100.00%.............. 777 253,461,012 33.49
100.01% - 105.00%.............. 11 4,351,356 0.58
105.01% - 110.00%.............. 3 1,233,293 0.16
110.01% - 115.00%.............. 1 400,000 0.05
115.01% - 120.00%.............. 1 139,832 0.02
120.01% - 124.99%.............. 1 411,985 0.05
----- ------------ ------
Total....................... 2,288 $756,727,490 100.00%
===== ============ ======
</TABLE>
- ---------------
(1) As of the Cut-off Date, the weighted average Loan-to-Value Ratio at
origination was approximately 80.34%.
S-37
<PAGE> 38
<TABLE>
<CAPTION>
OCCUPANCY STATUS
- ---------------------------------------------------------------------
PERCENT
CUT-OFF OF
NUMBER DATE INITIAL
OF STATED POOL
PLEDGED PRINCIPAL PRINCIPAL
STATUS MORTGAGES BALANCE BALANCE
- ------------------------------- --------- ------------ ---------
<S> <C> <C> <C>
Investment Property............ 170 $ 22,886,009 3.02%
Owner-Occupied................. 1,867 657,321,285 86.86
Second Home.................... 251 76,520,196 10.11
----- ------------ ------
Total......................... 2,288 $756,727,490 100.00%
===== ============ ======
</TABLE>
<TABLE>
<CAPTION>
LOAN PURPOSE
- ---------------------------------------------------------------------
PERCENT
CUT-OFF OF
NUMBER DATE INITIAL
OF STATED POOL
PLEDGED PRINCIPAL PRINCIPAL
LOAN PURPOSE MORTGAGES BALANCE BALANCE
- ------------------------------- --------- ------------ ---------
<S> <C> <C> <C>
Purchase....................... 1,503 $485,126,700 64.11%
Cash-out Refinance(1).......... 526 181,811,395 24.03
Rate and term refinance........ 259 89,789,395 11.87
----- ------------ ------
Total......................... 2,288 $756,727,490 100.00%
===== ============ ======
</TABLE>
- ---------------
(1) MLCC categorizes as cash-out refinance mortgage loans those loans in respect
of which the cash taken out by the mortgagor exceeded the sum of (i) closing
costs and points, (ii) funds applied to pay off a subordinate loan that was
outstanding at least one year and (iii) an amount equal to 1% of the
principal amount of such new loan.
<TABLE>
<CAPTION>
MORTGAGED PROPERTIES
- ---------------------------------------------------------------------
PERCENT
CUT-OFF OF
NUMBER DATE INITIAL
OF STATED POOL
PLEDGED PRINCIPAL PRINCIPAL
PROPERTY TYPE MORTGAGES BALANCE BALANCE
- ------------------------------- --------- ------------ ---------
<S> <C> <C> <C>
Single family.................. 1,488 $522,092,841 68.99%
De minimis Planned Unit
Development................... 362 139,215,328 18.40
Condominium.................... 281 66,928,676 8.84
Cooperative.................... 78 12,526,117 1.66
Planned Unit Development
Project....................... 43 9,490,565 1.25
2-4 Family Residence........... 36 6,473,963 0.86
----- ------------ ------
Total......................... 2,288 $756,727,490 100.00%
===== ============ ======
</TABLE>
<TABLE>
<CAPTION>
RANGE OF CURRENT MORTGAGE RATES(1)
- ---------------------------------------------------------------------
PERCENT
CUT-OFF OF
NUMBER DATE INITIAL
OF STATED POOL
RANGE OF CURRENT PLEDGED PRINCIPAL PRINCIPAL
MORTGAGE RATES MORTGAGES BALANCE BALANCE
- ------------------------------- --------- ------------ ---------
<S> <C> <C> <C>
6.500% - 6.749%................ 5 $ 3,112,649 0.41%
6.750% - 6.999%................ 17 11,769,640 1.56
7.000% - 7.249%................ 97 71,161,958 9.40
7.250% - 7.499%................ 231 139,257,962 18.40
7.500% - 7.749%................ 350 174,620,578 23.08
7.750% - 7.999%................ 486 163,127,358 21.56
8.000% - 8.249%................ 452 107,297,303 14.18
8.250% - 8.499%................ 402 56,967,602 7.53
8.500% - 8.749%................ 151 18,462,589 2.44
8.750% - 8.999%................ 96 10,783,026 1.42
9.000% - 9.249%................ 1 166,825 0.02
----- ------------ ------
Total......................... 2,288 $756,727,490 100.00%
===== ============ ======
</TABLE>
- ---------------
(1) As of the Cut-off Date, the weighted average current Mortgage Rate was
7.659%.
<TABLE>
<CAPTION>
MAXIMUM MORTGAGE RATES(1)
- ---------------------------------------------------------------------
PERCENT
CUT-OFF OF
NUMBER DATE INITIAL
OF STATE POOL
PLEDGED PRINCIPAL PRINCIPAL
MAXIMUM MORTGAGE RATES MORTGAGES BALANCE BALANCE
- ------------------------------- --------- ------------ ---------
<S> <C> <C> <C>
12.000% - 12.249%.............. 136 $ 93,048,041 12.30%
12.250% - 12.499%.............. 260 151,892,980 20.07
12.500% - 12.749%.............. 392 183,423,289 24.24
12.750% - 12.999%.............. 485 153,743,983 20.32
13.000% - 13.249%.............. 441 99,207,711 13.11
13.250% - 13.499%.............. 363 49,586,377 6.55
13.500% - 13.749%.............. 135 16,436,803 2.17
13.750% - 13.999%.............. 75 9,221,481 1.22
14.000% - 14.249%.............. 1 166,825 0.02
----- ------------ -----
Total......................... 2,288 $756,727,490 100%
===== ============ =====
</TABLE>
- ---------------
(1) As of the Cut-off Date, the weighted average Maximum Mortgage Rate was
12.642%.
<TABLE>
<CAPTION>
REMAINING TERMS TO STATED MATURITY(1)
- ---------------------------------------------------------------------
PERCENT
CUT-OFF OF
NUMBER DATE INITIAL
OF STATED POOL
REMAINING TERMS TO PLEDGED PRINCIPAL PRINCIPAL
STATED MATURITY IN MONTHS MORTGAGES BALANCE BALANCE
- ------------------------------- --------- ------------ ---------
<S> <C> <C> <C>
287............................ 3 $ 1,147,107 0.15%
288............................ 1 146,398 0.02
289............................ 15 4,388,904 0.58
290............................ 57 14,732,505 1.95
291............................ 148 52,490,921 6.94
292............................ 34 10,727,756 1.42
293............................ 16 7,752,279 1.02
294............................ 251 75,682,079 10.00
295............................ 404 130,174,466 17.20
296............................ 392 126,471,319 16.71
297............................ 509 170,237,400 22.50
298............................ 313 111,232,314 14.70
299............................ 132 47,431,135 6.27
300............................ 13 4,112,907 0.54
----- ------------ ------
Total 2,288 $756,727,490 100.00%
===== ============ ======
</TABLE>
- ---------------
(1) As of the Cut-off Date, the weighted average remaining term to stated
maturity was 295.75 months.
S-38
<PAGE> 39
<TABLE>
<CAPTION>
NEXT ADJUSTMENT DATE
FOR ALL PLEDGED MORTGAGES
- ---------------------------------------------------------------------
PERCENT
CUT-OFF OF
NUMBER DATE INITIAL
OF STATED POOL
MONTH OF NEXT PLEDGED PRINCIPAL PRINCIPAL
ADJUSTMENT DATE MORTGAGES BALANCE BALANCE
- ------------------------------- --------- ------------ ---------
<S> <C> <C> <C>
November 1, 1997............... 1,248 $453,099,292 59.88%
December 1, 1997............... 225 63,251,927 8.36
January 1, 1998................ 315 92,508,223 12.22
February 1, 1998............... 218 64,232,119 8.49
March 1, 1998.................. 126 41,288,151 5.46
April 1, 1998.................. 156 42,347,778 5.60
----- ------------ ------
Total....................... 2,288 $756,727,490 100.00%
===== ============ ======
</TABLE>
- ---------------
(1) As of the Cut-off Date, the weighted average number of months to the next
Adjustment Date was 2.08 months.
<TABLE>
<CAPTION>
NEXT ADJUSTMENT DATE FOR ONE-YEAR TREASURY INDEX PLEDGED MORTGAGES THAT
ADJUST EVERY SIX MONTHS
- ------------------------------------------------------------------------
PERCENT OF
CUT-OFF SUCH PLEDGED
NUMBER DATE MORTGAGES BY
OF STATED CUT-OFF DATE
MONTH OF NEXT PLEDGED PRINCIPAL STATED PRINCIPAL
ADJUSTMENT DATE MORTGAGES BALANCE BALANCE
- -------------------------- -------- ---------- ----------------
<S> <C> <C> <C>
December 1, 1997.......... 1 $ 94,548 100.00%
-
-------- ------
Total.................... 1 $ 94,548 100.00%
======== ======== ======
</TABLE>
- ---------------
(1) As of the Cut-off Date, the weighted average number of months to the next
Adjustment Date was 2.00 months.
<TABLE>
<CAPTION>
NEXT ADJUSTMENT DATE FOR PRIME INDEX PLEDGED MORTGAGE THAT ADJUST EVERY
SIX MONTHS
- ------------------------------------------------------------------------
PERCENT OF
CUT-OFF SUCH PLEDGED
NUMBER DATE MORTGAGES BY
OF STATED CUT-OFF DATE
MONTH OF NEXT PLEDGED PRINCIPAL STATED PRINCIPAL
ADJUSTMENT DATE MORTGAGES BALANCE BALANCE
- ------------------------- --------- ---------- ----------------
<S> <C> <C> <C>
February 1, 1998......... 1 $ 54,400 100.00%
-
-------- ------
Total................... 1 $ 54,400 100.00%
========= ======== ======
</TABLE>
- ---------------
(1) As of the Cut-off Date, the weighted average number of months to the next
Adjustment Date was 4.00 months.
<TABLE>
<CAPTION>
NEXT ADJUSTMENT DATE FOR
SIX-MONTH LIBOR INDEX PLEDGED MORTGAGES
- ----------------------------------------------------------------------
PERCENT OF
CUT-OFF SUCH PLEDGED
NUMBER DATE MORTGAGES BY
OF STATED CUT-OFF DATE
MONTH OF NEXT PLEDGED PRINCIPAL STATED PRINCIPAL
ADJUSTMENT DATE MORTGAGES BALANCE BALANCE
- --------------------- --------- ------------ ----------------
<S> <C> <C> <C>
November 1, 1997..... 241 $ 70,729,682 18.94%
December 1, 1997..... 223 62,377,379 16.70
January 1, 1998...... 315 92,508,223 24.77
February 1, 1998..... 217 64,177,719 17.19
March 1, 1998........ 126 41,288,151 11.06
April 1, 1998........ 156 42,347,778 11.34
----- ------------ ------
Total............. 1,278 $373,428,931 100.00%
===== ============ ======
</TABLE>
- ---------------
(1) As of the Cut-off Date, the weighted average number of months to the next
Adjustment Date was 3.19 months.
<TABLE>
<CAPTION>
MARGINS FOR ONE-MONTH LIBOR INDEX PLEDGED MORTGAGES (1)
- ----------------------------------------------------------------------
PERCENT OF
CUT-OFF SUCH PLEDGED
NUMBER DATE MORTGAGES BY
OF STATED CUT-OFF DATE
PLEDGED PRINCIPAL STATED PRINCIPAL
MARGIN MORTGAGES BALANCE BALANCE
- --------------------- --------- ------------ ----------------
<S> <C> <C> <C>
0.875%............... 3 $ 2,162,709 0.56%
1.000%............... 1 600,000 0.16
1.125%............... 5 2,988,000 0.78
1.250%............... 2 1,168,435 0.31
1.375%............... 24 26,379,308 6.89
1.500%............... 65 37,529,182 9.80
1.625%............... 136 80,753,976 21.09
1.750%............... 55 33,740,342 8.81
1.875%............... 158 70,379,358 18.38
2.000%............... 63 31,195,913 8.15
2.125%............... 220 50,827,540 13.27
2.250%............... 21 6,417,759 1.68
2.375%............... 94 21,758,022 5.68
2.500%............... 27 3,539,487 0.92
2.625%............... 133 13,449,580 3.51
----- ------------ ------
Total............. 1,007 $382,889,610 100.00%
===== ============ ======
</TABLE>
- ---------------
(1) As of the Cut-off Date, the weighted average current Margin was 1.84%.
S-39
<PAGE> 40
<TABLE>
<CAPTION>
MARGINS FOR SIX-MONTH LIBOR INDEX PLEDGED MORTGAGES(1)
- ----------------------------------------------------------------------
PERCENT OF
CUT-OFF SUCH PLEDGED
NUMBER DATE MORTGAGES BY
OF STATED CUT-OFF DATE
PLEDGED PRINCIPAL STATED PRINCIPAL
MARGIN MORTGAGES BALANCE BALANCE
- ---------------------- -------- ------------ ----------------
<S> <C> <C> <C>
0.750%................ 1 $ 1,232,000 0.33%
1.000%................ 4 2,645,660 0.71
1.125%................ 1 800,000 0.21
1.250%................ 12 5,607,470 1.50
1.375%................ 4 2,252,920 0.60
1.500%................ 24 18,465,223 4.94
1.625%................ 45 31,087,858 8.32
1.750%................ 178 81,918,525 21.94
1.875%................ 41 25,772,121 6.90
2.000%................ 207 64,043,034 17.15
2.125%................ 43 25,703,308 6.88
2.250%................ 385 59,852,686 16.03
2.375%................ 22 7,072,662 1.89
2.500%................ 102 19,118,228 5.12
2.625%................ 19 1,816,735 0.49
2.750%................ 186 22,123,677 5.92
2.875%................ 2 1,550,000 0.42
3.000%................ 1 166,825 0.04
3.250%................ 1 2,200,000 0.59
----- ------------ ------
Total.............. 1,278 $373,428,931 100.00%
===== ============ ======
</TABLE>
- ---------------
(1) As of the Cut-off Date, the weighted average current Margin was 1.99%.
<TABLE>
<CAPTION>
MARGIN FOR ONE-YEAR TREASURY INDEX
PLEDGED MORTGAGE THAT ADJUSTS EVERY MONTH
- ----------------------------------------------------------------------
PERCENT OF
CUT-OFF SUCH PLEDGED
NUMBER DATE MORTGAGES BY
OF STATED CUT-OFF DATE
PLEDGED PRINCIPAL STATED PRINCIPAL
MARGIN MORTGAGES BALANCE BALANCE
- ------------------------- --------- -------- ----------------
<S> <C> <C> <C>
2.625%................... 1 $260,000 100.00%
- -------- ------
Total................. 1 $260,000 100.00%
= ======== ======
</TABLE>
<TABLE>
<CAPTION>
MARGIN FOR ONE-YEAR TREASURY INDEX
PLEDGED MORTGAGE THAT ADJUSTS EVERY SIX MONTHS
- ----------------------------------------------------------------------
PERCENT OF
CUT-OFF SUCH PLEDGED
NUMBER DATE MORTGAGES BY
OF STATED CUT-OFF DATE
PLEDGED PRINCIPAL STATED PRINCIPAL
MARGIN MORTGAGES BALANCE BALANCE
- -------------------------- --------- ------- ----------------
<S> <C> <C> <C>
2.500%.................... 1 $94,548 100.00%
----- ------- ------
Total.................. 1 $94,548 100.00%
===== ======= ======
</TABLE>
<TABLE>
<CAPTION>
MARGIN FOR PRIME INDEX PLEDGED
MORTGAGE THAT ADJUSTS EVERY SIX MONTHS
- ----------------------------------------------------------------------
PERCENT OF
CUT-OFF SUCH PLEDGED
NUMBER DATE MORTGAGES BY
OF STATED CUT-OFF DATE
PLEDGED PRINCIPAL STATED PRINCIPAL
MARGIN MORTGAGES BALANCE BALANCE
- -------------------------- --------- ------- ----------------
<S> <C> <C> <C>
0.250%.................... 1 $54,400 100.00%
- ------- ------
Total.................. 1 $54,400 100.00%
= ======= ======
</TABLE>
S-40
<PAGE> 41
ASSIGNMENT OF THE PLEDGED MORTGAGES
Pursuant to the Indenture, the Issuer on the Closing Date will pledge,
transfer, assign, set over and otherwise convey without recourse to the Bond
Trustee in trust for the benefit of the Bondholders and the Insurer all right,
title and interest of the Issuer in and to each Pledged Mortgage, and all right,
title and interest in and to all other assets included in the Collateral,
including all principal and interest received on or with respect to the Pledged
Mortgages, exclusive of principal and interest due on or prior to the Cut-off
Date.
In connection with the transfer and assignment of the Pledged Mortgages,
the Issuer will deliver or cause to be delivered to the Bond Trustee, or a
custodian for the Bond Trustee, among other things, the original promissory note
(the "Mortgage Note") (and any modification or amendment thereto) endorsed in
blank without recourse, the original instrument creating a first lien on the
related Mortgaged Property (the "Mortgage") with evidence of recording indicated
thereon, an assignment in recordable form of the Mortgage, the title policy with
respect to the related Mortgaged Property and, if applicable, all recorded
intervening assignments of the Mortgage and any riders or modifications to such
Mortgage Note and Mortgage (except for any such document not returned from the
public recording office, which will be delivered to the Bond Trustee as soon as
the same is available to the Issuer) (collectively, the "Mortgage File").
Assignments of the Pledged Mortgages to the Bond Trustee (or its nominee) will
be recorded in the appropriate public office for real property records, except
in states where, in the opinion of local counsel, such recording is not required
to protect the Bond Trustee's interest in the Pledged Mortgages against the
claim of any subsequent transferee or any successor to or creditor of the
Issuer; provided, however, notwithstanding the delivery of any legal opinions,
each assignment of mortgage shall be recorded upon the earliest to occur of (i)
the direction by the Insurer, (ii) the occurrence of an event of default under
the transaction documents, or (iii) any bankruptcy, insolvency or foreclosure
with respect to the related mortgagor.
The Bond Trustee will review or cause to be reviewed the Mortgage File
relating to the Pledged Mortgages within 30 days of the Closing Date (or
promptly after the Bond Trustee's receipt of any document permitted to be
delivered after the Closing Date) and if any document in a Mortgage File is
found to be missing or defective in a material respect and the Issuer does not
cure such defect within 30 days of notice thereof from the Bond Trustee (or
within such longer period not to exceed 30 days after the Closing Date as
provided in the Mortgage Loan Purchase Agreement in the case of missing
documents not returned from the public recording office), Redwood Trust will be
obligated to purchase the related Defective Pledged Mortgage. Rather than
purchase the Defective Pledged Mortgage as provided above or as required in the
case of Defective Pledged Mortgage for which there is an uncured material breach
of a representation, warranty or covenant with respect thereto as described
under "--The Pledged Mortgages" above, Redwood Trust may remove such Defective
Pledged Mortgage from the collateral (a "Deleted Pledged Mortgage") and
substitute in its place another mortgage loan or loans (a "Replacement Pledged
Mortgage"). The Issuer expects that the above review of the Mortgage Files will
be performed for each file by the custodian that will maintain custody of the
Mortgage Files on behalf of the Bond Trustee. Any Replacement Pledged Mortgage
or Mortgages generally will, on the date of substitution, among other
characteristics set forth in the Mortgage Loan Purchase Agreement, (i) have an
aggregate principal balance, after deduction of all Scheduled Payments due in
the month of substitution, not in excess of, and not more than 20.0% less than,
the Stated Principal Balance of the Deleted Pledged Mortgage (the amount of any
shortfall to be deposited in the Bond Account by Redwood and held for
distribution to the Bondholders on the related Payment Date (a "Substitution
Adjustment Amount")), (ii) have a weighted average Mortgage Rate not lower than,
and not more than 1.0% per annum higher than, that of the Deleted Pledged
Mortgage, (iii) have a weighted average current Loan-to-Value Ratio not higher
than that of the Deleted Pledged Mortgage, (iv) have a weighted average
remaining term to maturity not greater than (and not more than 36 months less
than) that of the Deleted Pledged Mortgage, and (v) comply with all of the
representations and warranties set forth in the Mortgage Loan Purchase Agreement
as of the date of substitution. This cure, purchase or substitution obligation
constitutes the sole remedy available to Bondholders or the Bond Trustee for
omission of, or a material defect in, a Pledged Mortgage document.
S-41
<PAGE> 42
THE SWAP AGREEMENT
On the Closing Date the Issuer will enter into the Swap Agreement with
Merrill Lynch Capital Services, Inc., as swap counterparty (the "Swap Provider")
as a means to protect against substantially all of the interest rate risk that
may result from the difference between the Class A-1 Interest Rate and the
Mortgage Rates of the Pledged Mortgages. Also on the Closing Date, ML&Co. will
enter into a guarantee whereby ML&Co. will guarantee amounts payable by the Swap
Provider under the Swap Agreement.
Under the Swap Agreement, not later than the Business Day immediately
preceding each Payment Date, the Issuer will be entitled to receive from the
Swap Provider an amount (the "Swap 1 Amount") equal to the amount obtained by
multiplying (a) the Class A-1 Interest Rate, (b) a notional balance equal to the
outstanding Principal Balance of the Class A-1 Bonds, and (c) a fraction equal
to a 30-day month divided by a 360-day year.
Under the Swap Agreement, not later than the Business Day immediately
preceding each Payment Date, the Issuer will be obligated to pay to the Swap
Provider an amount (the "Swap 2 Amount") equal to the sum of (i) the amount
obtained by multiplying (a) the Rolling Six-Month LIBOR Index plus 0.35%
(subject to a maximum rate of 10%), (b) a notional balance (the "Six-Month LIBOR
Notional Balance") equal to the lesser of (1) the Pool Principal Balance minus
the aggregate Stated Principal Balance of Pledged Mortgages with Mortgage Rates
based on the One-Month LIBOR Index and (2) the outstanding Principal Balance of
the Class A-1 Bonds, and (c) a fraction equal to a 30-day month divided by a
360-day year, and (ii) the amount obtained by multiplying (a) the Current
One-Month LIBOR Index plus 0.35% (subject to a maximum rate of 10%), (b) a
notional balance (the "One-Month LIBOR Notional Balance") equal to the
outstanding Principal Balance of the Class A-1 Bonds minus the current Six-Month
LIBOR Notional Balance, and (c) a fraction equal to a 30-day month divided by a
360-day year.
The obligations of the Issuer and the Swap Provider will be settled on a
net basis. Only the net amount equal to the excess, if any, of the Swap 1 Amount
over the Swap 2 Amount or the excess, if any, of the Swap 2 Amount over the Swap
1 Amount will be payable by the Swap Provider or the Issuer, respectively, to
the other party.
The Swap Agreement will terminate following any redemption and retirement
of the Bonds in whole, but not in part. See "DESCRIPTION OF THE
BONDS -- Redemption" herein. The Swap Agreement may be terminated at any time by
the Issuer with the advice of tax counsel and (i) if no default exists and is
continuing under the Bond Insurance Policy, with the consent of the Insurer, or
(ii) if a default exists and is continuing under the Bond Insurance Policy,
without the consent of the Insurer, and provided that the termination pursuant
to clause (ii) will not result in the downgrading or withdrawal of the rating or
ratings then assigned to the Bonds by each Rating Agency (without taking into
account the Bond Insurance Policy).
MLCC AND ITS MORTGAGE PROGRAMS
MLCC, a wholly-owned indirect subsidiary of ML&Co. and an affiliate of the
Underwriter, is a Delaware corporation qualified to do business in each state
where its mortgage program is offered and such qualification is required. It
maintains licenses in various states as a real estate or mortgage broker, and/or
as a mortgage banker, and/or as a first or second mortgage lender, as
applicable. It also has the following approvals: HUD nonsupervised one- to
four-family mortgagee; FHA approved mortgagee; FNMA first and second mortgage
one- to four-family seller/servicer; FHLMC first and second mortgage one- to
four-family seller/servicer; GNMA mortgage backed securities issuer under the
GNMA I and GNMA II single family programs; and supervised VA lender.
MLCC's offices are located in Jacksonville, Florida. MLCC generally does
not establish local offices in the states where its loans are offered, but has,
in the past, and where required, appointed employees of other Merrill Lynch
companies which do have local offices as officers or agents of MLCC, and has
used the other Merrill Lynch companies' local offices as MLCC's local offices
for licensing purposes. MLCC also maintains an office in San Juan, Puerto Rico.
On July 16, 1991, MLCC changed its name from Merrill Lynch Equity Management,
Inc. to Merrill Lynch Credit Corporation.
S-42
<PAGE> 43
MLCC is in the business of originating, purchasing and servicing real
estate mortgage loans secured by conforming and non-conforming fixed and
adjustable rate mortgage loans (including its PrimeFirst(R) mortgages) and other
loan products. MLCC also originates home equity lines of credit to individuals.
These lines of credit are called "Equity Access(R) credit accounts" or "Equity
Access(R) loans". MLCC currently originates and services loans in fifty states,
the District of Columbia, Puerto Rico and the U.S. Virgin Islands. PrimeFirst(R)
loans are secured by first liens on one- to four-family residences, condominiums
and cooperative apartments (New York State only), most of which are
owner-occupied. Substantially all of the Pledged Mortgages were originated under
MLCC's PrimeFirst(R) mortgage program.
MLCC's mortgage programs are marketed primarily through financial
consultants employed by Merrill Lynch, Pierce, Fenner & Smith Incorporated and
mortgage and credit specialists employed by MLCC, as well as through newspaper
and other print advertising and direct marketing campaigns.
MLCC underwriting guidelines are applied to evaluate an applicant's credit
standing, financial condition and repayment ability, as well as the value and
adequacy of the mortgaged property and Additional Collateral, if any, as
collateral for any loan made by MLCC. As part of the loan application process,
the applicant is required to provide information concerning his or her assets,
liabilities, income and expenses, along with an authorization permitting MLCC to
obtain any necessary third party verifications, including a credit report
summarizing the applicant's credit history. Unless prohibited by applicable
state law, the applicant is typically required to pay an application fee to MLCC
upon the submission of a loan application.
In evaluating the applicant's ability and willingness to repay the proposed
loan, MLCC reviews the applicant's credit history and outstanding debts, as
reported on the credit report. If an existing mortgage or other significant debt
listed on the loan application is not adequately reported on the credit report,
MLCC generally requests a written or verbal verification of the balance and
payment history of such debt from the servicer of such debt.
MLCC also evaluates the applicant's income to determine its stability,
probability of continuation, and adequacy to service the proposed MLCC debt
payment. MLCC's guidelines for verifying an applicant's income and employment
are generally as follows. For salaried applicants, MLCC typically requires a
written verification of employment from the applicant's employer, or a copy of
the applicant's two most recent IRS forms 1040 or W-2, a current pay stub, and
verbal verification of employment. Verbal verification of employment is
typically obtained directly from the applicant's employer, but in certain
circumstances, may be fulfilled by contacting the applicant at his or her place
of business. For non-salaried applicants, including self-employed applicants,
MLCC requires copies of the applicant's two most recent federal income tax
returns, along with all supporting schedules. In some cases, MLCC may waive
submission of such supporting schedules if this income is insignificant in
relation to the applicant's overall income, or does not affect the applicant's
ability to qualify for the proposed loan. A self-employed applicant is generally
required to submit a signed profit and loss statement if the applicant's income
shows significant variations from year to year.
In determining the adequacy of the property as collateral for the loan, a
FNMA/FHLMC conforming appraisal of the property is performed by an independent
appraiser selected by MLCC, except as noted below. The appraiser is required to
inspect the property and verify that it is in good condition and that
construction or renovation, if new, has been completed. The appraisal report
indicates a value for the property and provides information concerning
marketability, the neighborhood, the property site, interior and exterior
improvements, and the condition of the property. Some of the aforementioned
appraisals may have been prepared by Lender's Service, Inc., an affiliate of
MLCC.
The applicant has the option of directly obtaining a title report or may
choose to have MLCC obtain the report. Generally, all liens must be satisfied
and removed prior to or upon the closing of any of the mortgage loans. Title
insurance is required to be obtained for all mortgage loans. Where applicable,
in addition to providing proof of standard hazard insurance on the property, the
applicant is required to obtain, to the extent available, flood insurance when
the subject property is identified as being in a federally designated flood
hazard area.
S-43
<PAGE> 44
Once sufficient employment, credit and property information is obtained,
the decision as to whether to approve the loan is based upon the applicant's
income and credit history, the status of title to the mortgaged property, and
the appraised value of the mortgaged property. MLCC may also consider the level
of an applicant's liquid assets as an indication of creditworthiness. The
approval process generally requires that the applicant have a good credit
history and a total debt service-to-income ratio (DTI) that generally does not
exceed 50% (this ratio may be limited to 38% if certain disposable income
thresholds are not met). The DTI ratio is calculated as the ratio of the
borrower's total monthly debt obligations (including the interest-only payment
on the proposed loan at an interest rate that is 2% to 2.50% higher than the
original rate), divided by the borrower's total verified monthly income. MLCC
also requires that the proposed loan have a Loan-to-Value (LTV) ratio that
generally does not exceed 80%, but under certain circumstances may be up to or
slightly in excess of 100%. MLCC's practice is to continuously review LTV limits
and to adjust such limits where economic conditions dictate that such
adjustments are appropriate. Any negative comments concerning the quality,
condition and current market conditions as noted in the appraisal report may
result in a reduction of the maximum LTV permitted for the loan. In the case of
a loan which is a purchase money mortgage, MLCC computes the loan's LTV as the
original loan balance divided by the appraised value of the property or the
contract sales price, whichever is lower. In certain limited cases, MLCC may
accept verification of borrower assets and/or status of credit history in
addition to or in lieu of income verification, provided that the borrower meets
certain standards with regard to the ratio of liquid assets to the loan amount
and other compensating factors are present.
Loans that have a LTV in excess of 80% are, in general, also either (i)
secured by a security interest in additional collateral (normally securities)
owned by the borrower (such loans being referred to as "Mortgage 100(SM) Loans")
or (ii) supported by a third party guarantee (usually a parent of the borrower),
which in turn is secured by a security interest in collateral (normally
securities) or by a lien on residential real estate of the guarantor and/or
supported by the right to draw on a home equity line of credit extended by MLCC
to the guarantor (such loans being referred to as "Parent Power(R) Loans"). Such
loans are also collectively referred to herein as "Additional Collateral Loans",
and the collateral referred to in clauses (i) and (ii) is herein referred to as
"Additional Collateral". The amount of such Additional Collateral generally does
not exceed 30% of the loan amount, although the amount of the Additional
Collateral may exceed 30% of the loan amount if the original principal amount of
the loan exceeds $1,000,000. In limited cases, MLCC may require Additional
Collateral in excess of 30% of the loan amount as part of the underwriting
decision. The requirement to maintain Additional Collateral generally terminates
when the LTV for such Additional Collateral Loan is reduced to MLCC's applicable
loan-to-value ratio limit for such loan by virtue of a reduction in the
principal balance of such loan or an increase in the appraised value of the
mortgaged property securing such loan as determined by MLCC. The pledge
agreement and the guaranty agreement, as applicable, and the security interest
in such Additional Collateral, if any, provided in the case of an Additional
Collateral Loan will be assigned to the Bond Trustee. To the extent the Pledged
Mortgages include any Additional Collateral Loans that are supported by a
guarantee that is secured by a lien on residential real estate, such lien will
not be transferred to the Bond Trustee. MLCC will, in accordance with its normal
servicing procedures, attempt to realize on any such security interest if the
related Pledged Mortgage is liquidated upon default. No assurance can be given
as to the amount of proceeds, if any, that might be realized from such
Additional Collateral. The Limited Purpose Surety Bond is intended to guarantee
the receipt by the Bond Trustee of certain shortfalls in the net proceeds
realized from the liquidation of any required Additional Collateral (such amount
not to exceed 30% of the original principal amount of the related Additional
Collateral Loan) to the extent any such shortfall results in a loss of principal
on such Additional Collateral Loan that becomes a Liquidated Mortgage, as more
particularly described in, and as limited by, the terms and provisions of the
Limited Purpose Surety Bond. The Limited Purpose Surety Bond will not cover any
payments on the Bonds that are recoverable or sought to be recovered as a
voidable preference under applicable law.
The Pledged Mortgages may include loans made to corporations, partnerships,
limited liability companies and trustees of certain trusts in connection with
applications which have been received from individuals. Such loans are generally
structured as follows: (i) the loan is to the individual and the entity which
owns the real property, and is secured by a mortgage or deed of trust executed
solely by the entity; or (ii) the loan is to the
S-44
<PAGE> 45
entity, secured by a mortgage from the entity and guaranteed by the individual
applicant. In such cases, MLCC applies its standard underwriting criteria to the
property and the individual applicant. Such loans are categorized as
owner-occupied in this Prospectus Supplement if the individual applicant states
in the application that, as of the closing of the related loan, he or she will
occupy the property as his or her primary residence.
On less than 0.61% (by Cut-off Date Stated Principal Balance) of the
Pledged Mortgages, MLCC waived the verification of certain components of income
used to determine the borrower's ability to qualify for the Pledged Mortgage,
based on compensating factors, which may include strong credit history, low DTI,
and/or good liquidity and reserves. Additionally, approximately 0.30% (by
Cut-off Date Stated Principal Balance) of the Pledged Mortgages were originated
under MLCC's PrimeFirst(R) Streamline Refinance program. Under this program, a
borrower who requests the refinancing of an existing MLCC-originated mortgage
loan, in connection with a reduction in his or her monthly payment, may qualify
for a new loan without submitting new income documentation, provided that the
borrower has exhibited a satisfactory payment history on the existing
MLCC-originated loan and demonstrates overall good credit, as reported on a
current credit report. Additionally, the balance of the proposed new loan may
not exceed the outstanding balance of the existing loan plus applicable closing
costs, and the new loan must meet MLCC's standard LTV guidelines, as determined
by a new appraisal of the mortgaged property.
In 1992, MLCC began originating loans under its Third Party Originator
program through mortgage brokers that are not affiliated with MLCC. The mortgage
brokers solicit the prospective borrower and process the documentation described
above for such borrower's loan. Personnel of MLCC review such documentation and
underwrite the loan in accordance with the above described underwriting
standards. In that regard, the related appraisals are either conducted or
reviewed by appraisers who are approved by MLCC. Such loans are closed in the
name of, and funded by, MLCC.
In 1995, MLCC began purchasing mortgage loans from mortgage banking related
entities under its Correspondent Lending program. In order for MLCC to approve a
lender as a seller under its Correspondent Lending program, a lender must meet
certain qualifying criteria. These criteria include requirements that the lender
must: (a) be a bank, savings and loan, or HUD-approved mortgagee which is a FNMA
or FHLMC seller in good standing; (b) demonstrate at least three years
experience in mortgage originations; (c) have a quality control plan in place
which is acceptable to MLCC; (d) show profitability for the prior two years; (e)
demonstrate a residential loan portfolio with delinquency rates at or below
national averages, as published by the Mortgage Bankers Association; and (f)
have a corporate net worth of at least $2.5 million and/or a corporate credit
history acceptable to MLCC.
Under MLCC's Correspondent Lending program, the correspondent lender
processes and closes the mortgage loans in its name and thereafter funds the
mortgage loans from its own funds. Personnel of MLCC, or in certain cases, the
correspondent lender, underwrite the loans in accordance with MLCC's standard
underwriting guidelines, as published in the MLCC Seller Guide. Additionally,
MLCC conducts a post-closing review on each loan prior to purchasing it from the
correspondent lender.
The purchase price that MLCC pays for a correspondent mortgage loan is
typically an amount equal to the principal balance of the loan plus a premium,
which is paid at the time the correspondent lender assigns the loan to MLCC.
This premium is based on the margin of the loan, and is generally capped at a
pre-determined amount set by MLCC. On certain loans, MLCC may agree to pay the
correspondent lender an additional fee (a "Correspondent Trailing Premium" or
"CTP") depending upon the size of the margin pertaining to the underlying
mortgage loan. If applied, the CTP typically ranges from 0.125% to 0.75% of the
annualized principal balance of the applicable mortgage loan, less an
administrative fee. The CTP is paid by MLCC on a monthly basis out of the
monthly mortgage payment it receives from the applicable mortgagor. MLCC is
obligated to pay such fee to the correspondent lender as long as the applicable
mortgage loan remains outstanding and the mortgagor is current in the remittance
of his or her monthly mortgage payment to MLCC. CTP payments are due in
connection with approximately 0.30% (by Cut-off Date Stated Principal Balance)
of the Pledged Mortgages. If a CTP applies to a Pledged Mortgage, the CTP will
be subtracted from its Mortgage Rate as part of the Expense Fee Rate, for
purposes of calculating its Net Mortgage Rate.
S-45
<PAGE> 46
In 1995, MLCC began originating mortgage loans under its construction to
permanent financing program. Such loans have the same terms as other loans under
the PrimeFirst(R) mortgage program but include certain requirements for the
completion of construction, at which time such loans become permanent loans. The
Pledged Mortgages may include such loans, all of which are permanent loans as to
which construction is complete, as evidenced by a certificate of occupancy
and/or appraiser's certification of completion.
Upon the approval of a loan, the borrower obtains the loan by paying an
origination fee (employees of ML & Co. and its affiliates generally pay a lower
origination fee) and reimbursing MLCC for all out-of-pocket closing costs
incurred by MLCC, all or part of which fees or costs may be waived by MLCC from
time to time as part of MLCC's marketing efforts.
The above described underwriting guidelines may be varied in certain cases,
on the basis of compensating factors, as deemed appropriate by MLCC's
underwriting personnel.
MLCC'S PRIMEFIRST(R) SELF-DIRECTED(SM) MORTGAGE PROGRAM
During the first ten years of a PrimeFirst(R) loan, only interest on the
outstanding loan balance is payable monthly along with any other fees that are
due, including late charges. During the 11th through the 25th year, a
PrimeFirst(R) loan is fully amortizing and, as a result, the borrower must pay a
larger monthly payment than the interest only monthly payment. The borrower
receives a monthly statement that reflects any change in the monthly payment.
The borrower may prepay the principal balance of the PrimeFirst(R) loan at any
time without penalty during the term of the loan.
Upon origination, borrowers under the PrimeFirst(R) program select from one
of several different indices upon which to base their interest rate and choose
whether the interest rate on the loan will adjust monthly or semi-annually. A
loan with a one-month adjustment frequency generally carries a lower interest
rate and margin than a comparable loan with a six-month adjustment frequency.
Loans originated under the PrimeFirst(R) mortgage program are convertible to a
different Index and related Margin for a specified period during the life of the
loan. Additionally, borrowers have the option to purchase a fixed rate
conversion option by adding 0.25% to the applicable margin on the loan and may
also elect to purchase a 1% periodic rate cap by adding 0.50% to the margin.
Pricing For Six-Month Adjustment Frequency. The interest rate on a
semi-annually adjustable PrimeFirst(R) loan is equal to either the Prime Index,
the Six-Month LIBOR Index or the Treasury Index (each, an "Index"), plus or
minus the appropriate margin. The interest rate is adjusted every six months
based upon the applicable index rate as of 45 days prior to the Adjustment Date.
The following margins are generally used in calculating the interest rate on a
PrimeFirst(R) loan with a semi-annual adjustment period. The margins set forth
below may be higher for borrowers who elect not to pay origination fees and/or
closing costs. Conversely, the margins may be lower for borrowers who opt to pay
additional points to buy down their margin.
<TABLE>
<CAPTION>
INDEX
-------------------------------------
LOAN AMOUNT PRIME 6-MONTH LIBOR TREASURY
------------------------------------------ ------ ------------- --------
<S> <C> <C> <C>
Less than $199,999........................ +0.250 +2.250 +2.500
$200,000 to $299,999...................... 0.000 +2.000 +2.375
$300,000 to $599,999...................... -0.250 +1.750 +2.125
$600,000 to $999,999...................... -0.375 +1.625 +2.000
$1,000,000 or more........................ -0.500 +1.500 +1.875
</TABLE>
Pricing For One-Month Adjustment Frequency. The interest rate on a monthly
adjustable PrimeFirst(R) loan is equal to either the Prime Index, the One-Month
LIBOR Index or the Treasury Index (each an "Index"), plus or minus the
appropriate margin. The interest rate is adjusted every month based upon the
applicable index rate as of 25 days prior to the Adjustment Date. The following
margins are generally used in
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<PAGE> 47
calculating the interest rate on a PrimeFirst(R) loan with a monthly adjustment
period. These margins may be higher or lower as described in the last two
sentences of the preceding paragraph.
<TABLE>
<CAPTION>
INDEX
-------------------------------------
LOAN AMOUNT PRIME 1-MONTH LIBOR TREASURY
------------------------------------------ ------ ------------- --------
<S> <C> <C> <C>
Less than $199,999........................ 0.000 +2.125 +2.250
$200,000 to $299,999...................... -0.250 +1.875 +2.125
$300,000 to $599,999...................... -0.500 +1.625 +1.875
$600,000 to $999,999...................... -0.625 +1.500 +1.750
$1,000,000 or more........................ -0.750 +1.375 +1.625
</TABLE>
Loans purchased by MLCC in the Correspondent Lending program may have
slightly higher margins than those shown above. Also, loans originated under the
Correspondent Lending program may have teaser rates that are lower than the
fully indexed rate until the first Adjustment Date.
Periodic and Lifetime Rate Caps. PrimeFirst(R) loans may be originated with
a periodic rate cap of 1% (i.e., the interest rate cannot be increased by more
than 1% from one interest period to the next). The Margin for such a loan is
generally 0.50% greater than it would be without this feature. The periodic cap
is only available with six-month adjustable loans. Each loan originated under
the PrimeFirst(R) program has a lifetime rate cap equal to the greater of (i)
its initial interest rate plus 5% or (ii) 12%. None of the Pledged Mortgages
carry a periodic rate cap.
Fixed Rate Conversion Option and Index Conversion Option. Borrowers under
the PrimeFirst(R) mortgage program may purchase a fixed rate conversion option
by adding 0.25% to the margin on the loan. The fixed rate conversion option
gives the borrower the option to convert the interest rate on the loan from an
adjustable rate to a fixed rate. The exercise period for such option begins in
the month in which the 12th scheduled monthly payment is due and ends on the
fifth day of the month in which the 60th scheduled monthly payment is due. The
fixed rate becomes effective on the first day of the month after the conversion
notice is given. The new fixed rate is equal to the Fannie Mae net required
yield for 30-year fixed rate mortgages subject to a 60-day mandatory delivery
requirement (as published in The Wall Street Journal) plus 0.875%, rounded to
the nearest 0.125%. Upon a fixed rate conversion, the new scheduled monthly
payment is adjusted to the amount that is sufficient to fully amortize the loan
in substantially equal installments on the original maturity date.
Generally, loans originated under the PrimeFirst(R) Self-Directed(SM)
mortgage program allow the borrower to convert the loan to a new Index and
related Margin, provided that such Index has the same frequency of adjustment.
The option is exercisable in respect of a six-month adjustable PrimeFirst(R)
loan from its second change date to its tenth change date, and in respect of a
one-month adjustable PrimeFirst(R) loan, from its twelfth change date to its
sixtieth change date, within a certain 21-day period commencing on the 45th day
prior to each such change date. If the loan also carries the fixed rate
conversion option, such option may be exercised whether or not an Index
conversion has occurred. A borrower may not convert the frequency with which the
interest rate adjusts on a PrimeFirst(R) loan and may not add a periodic rate
cap to a loan that did not carry such periodic rate cap upon origination. The
Indices and Margins to which a borrower may convert a PrimeFirst(R) loan are the
same as those described above for PrimeFirst(R) loans for the applicable
adjustment frequency.
The exercise of either option is subject to the satisfaction of the
following conditions: (i) the borrower must be the owner and occupant of the
mortgaged property, (ii) the borrower has not been late on any of the 12
scheduled monthly payments immediately preceding the date on which the
conversion notice is given, (iii) the borrower has not been more than 30 days
late on any scheduled monthly payment, (iv) the borrower is not in default under
the mortgage note and (v) the borrower must pay a $500 conversion fee.
DELINQUENCY AND LOAN LOSS INFORMATION
The following two tables set forth information relating to the delinquency
and loan loss experience on the loans originated in MLCC's PrimeFirst(R)
mortgage program as of and for each of the five years in the period
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<PAGE> 48
ended December 31, 1996, respectively, and the nine-month period ending
September 30, 1997. The delinquency and loan loss experience represents the
historical experience of MLCC, and there can be no assurance that the future
foreclosure, delinquency and loss experience on the Pledged Mortgages will be
the same as, or more favorable than, that of the PrimeFirst(R) loans originated
by MLCC, which loans, because they were first originated in the first quarter of
1990, have not yet exhibited a loss and delinquency experience that is
representative of the losses and delinquencies that may be experienced over a
longer period of time. The tables include information on mortgages which are not
Pledged Mortgages and should not be considered as a basis for assessing the
future foreclosure, delinquency and loss experience on the Pledged Mortgages.
PRIMEFIRST(R) LOAN DELINQUENCY EXPERIENCE
<TABLE>
<CAPTION>
1992 1993 1994 1995
------------------------ ---------------------- ---------------------- ----------------------
NUMBER OF NUMBER OF NUMBER OF NUMBER OF
PRIMEFIRST(R) PRINCIPAL PRIMEFIRST(R) PRINCIPAL PRIMEFIRST(R) PRINCIPAL PRIMEFIRST(R) PRINCIPAL
LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT
----------- ---------- --------- ---------- --------- ---------- --------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
PrimeFirst(R)
loans
outstanding..... 3,265 $1,504,940 4,959 $2,264,421 7,615 $3,351,328 8,272 $3,536,761
Delinquency
period:
30-59 days...... 23 15,446 69 48,509 121 86,279 127 56,370
60-89 days...... 2 6,300 6 3,361 20 18,152 13 7,917
90 days or
more*......... 2 1,635 13 8,565 17 19,257 44 45,749
----- ---------- ----- ---------- ----- ---------- ----- ----------
Total
delinquency..... 27 $ 23,381 88 $ 60,435 158 $ 123,688 184 $ 110,036
Delinquencies as
a percent of
number of
PrimeFirst(R)
loans and
principal amount
outstanding..... 0.83 1.55% 1.77% 2.67% 2.07% 3.69% 2.22% 3.11%
Foreclosures*.... 7 $ 13,592 9 $ 7,899 18 $ 15,637 28 $ 38,209
Foreclosures as a
percent of
number of
PrimeFirst(R)
loans and
principal amount
outstanding..... 0.21% 0.90% 0.18% 0.35% 0.24% 0.47% 0.34% 1.08%
<CAPTION>
NINE MONTHS ENDED
1996 SEPTEMBER 30, 1997
------------------------- ------------------------
NUMBER OF NUMBER OF
PRIMEFIRST(R) PRINCIPAL PRIMEFIRST(R) PRINCIPAL
LOANS AMOUNT LOANS AMOUNT
--------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
PrimeFirst(R)
loans
outstanding..... 11,054 $4,331,131 14,012 $5,295,254
Delinquency
period:
30-59 days...... 180 84,297 138 65,184
60-89 days...... 19 6,583 29 14,638
90 days or
more*......... 29 27,590 19 18,376
----- ---------- ------ ----------
Total
delinquency..... 228 $ 118,470 186 $ 98,198
Delinquencies as
a percent of
number of
PrimeFirst(R)
loans and
principal amount
outstanding..... 2.06% 2.74% 1.33% 1.85%
Foreclosures*.... 29 $ 39,100 39 $ 48,373
Foreclosures as a
percent of
number of
PrimeFirst(R)
loans and
principal amount
outstanding..... 0.26% 0.90% 0.28% 0.91%
</TABLE>
- ---------------
* Does not include loans subject to bankruptcy proceedings and real estate
owned.
PRIMEFIRST(R) LOAN LOSS EXPERIENCE
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------------------------------------------ -------------
1992 1993 1994 1995 1996 1997
---------- ---------- ---------- ---------- ---------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Average principal balance of
PrimeFirst(R) loan
portfolio................. $1,008,493 $1,851,696 $2,807,875 $3,444,045 $3,933,946 $ 4,813,193
Average number of
PrimeFirst(R) loans
outstanding during the
period.................... 2,036 4,091 6,287 7,944 9,663 12,533
Gross charge-offs........... $ 0 $ 2,285 $ 457 $ 1,840 $ 6,157 $ 3,935
Recoveries.................. $ 0 $ 171 $ 0 $ 0 $ 0 $ 99
Net charge-offs............. $ 0 $ 2,114 $ 457 $ 1,840 $ 6,157 $ 3,836
Net charge-offs as a percent
of average principal
balance outstanding....... 0.00% 0.11% 0.02% 0.05% 0.16%(1) 0.08%(1)
</TABLE>
- ---------------
(1) Not annualized.
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<PAGE> 49
There can be no assurance that factors beyond MLCC's control, such as
national or local economic conditions or downturns in the real estate markets of
its lending areas, will not result in increased rates of delinquencies and
foreclosure losses in the future. There can be no assurance that values of the
Mortgaged Properties as of the dates of origination of the related Pledged
Mortgages have remained or will remain constant. In certain regions of the
country, including regions in which Mortgaged Properties are located, real
estate values have recently declined. See "SECURITY FOR THE BONDS -- The Pledged
Mortgages" for a listing of the geographic distribution of the Mortgaged
Properties as of the Cut-off Date. If the residential real estate market in an
area should experience an overall decline in property values such that the
outstanding balances of the Pledged Mortgages in that area equal or exceed the
value of the related Mortgaged Properties, the actual rates of delinquencies,
foreclosures and losses could be higher than those currently experienced in the
mortgage lending industry in general. In addition, adverse economic conditions
(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 Pledged
Mortgages and, accordingly, the actual rates of delinquencies, foreclosures and
losses with respect to the Pledged Mortgage Pool. In addition, primary
residences with above average values may experience greater declines in value
during adverse economic conditions than properties with lower values.
The information set forth above with respect to MLCC and its mortgage
programs has been provided by MLCC, and neither the Company, the Issuer, Redwood
Trust nor the Underwriter makes any representations or warranties as to the
accuracy or completeness of such information
SERVICING OF THE PLEDGED MORTGAGES
SERVICING AND COLLECTION PROCEDURES
Servicing functions to be performed by the Master Servicer under the Master
Servicing Agreement include collection and remittance of principal and interest
payments, administration of mortgage escrow accounts, collection of certain
insurance claims and, if necessary, foreclosure. The Master Servicer may
contract with subservicers to perform some or all of the Master Servicer's
servicing duties, but the Master Servicer will not thereby be released from its
obligations under the Master Servicing Agreement. When used herein with respect
to servicing obligations, the term Master Servicer includes any such
subservicer. The Master Servicer has informed the Issuer that it initially will
be performing the servicing duties without a subservicer.
On or before the Closing Date, the Bond Trustee will establish the Bond
Account into which the Master Servicer will remit collections on the Pledged
Mortgages (net of its related servicing compensation and any Correspondent
Trailing Premium). Not later than the 10th calendar day of each month, the
Master Servicer will furnish to the owner of the Pledged Mortgages information
with respect to loan level remittance data for such month's remittance. Under
the Master Servicing Agreement, the Master Servicer will remit collections on
the Pledged Mortgages due to the owner thereof on the 18th day of each month or,
if not a Business Day, on the first Business Day thereafter. Under the Master
Servicing Agreement, the Master Servicer will deposit collections on the Pledged
Mortgages into one or more custodial accounts established by it. Such accounts
are required to be kept segregated from operating accounts of the Master
Servicer and to meet the eligibility criteria set forth in the Master Servicing
Agreement. Under the Master Servicing Agreement, amounts on deposit in the
custodial account may be invested in permitted investments as therein defined.
Any losses resulting from such investments are required to be reimbursed to the
custodial account by the Master Servicer out of its own funds.
On the Closing Date, the Issuer will assign its rights under the Master
Servicing Agreement with respect to the Pledged Mortgages to the Bond Trustee.
In the event of a default by the Master Servicer under the Master Servicing
Agreement, the Bond Trustee will have the right to remove the Master Servicer
and will exercise that right if it considers such removal to be in the best
interest of the Bondholders and the Insurer. In the event that the Bond Trustee
removes the Master Servicer, the Bond Trustee will appoint a successor Master
Servicer acceptable to the Insurer.
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<PAGE> 50
SERVICING COMPENSATION AND PAYMENT OF EXPENSES
The Servicing Fee payable to the Master Servicer will be a per annum rate
equal to 0.25% of the Stated Principal Balance of the related Pledged Mortgage.
The Servicing Fees and any Correspondent Trailing Premiums with respect to the
Pledged Mortgages are payable out of the interest payments on each Pledged
Mortgage. Under the Master Servicing Agreement, the amount of the Servicing Fee
is subject to adjustment with respect to prepaid Pledged Mortgages, as described
herein under "--Adjustment to the Servicing Fee in Connection with Certain
Prepaid Pledged Mortgages." The Master Servicer will also be entitled to receive
late payment fees, assumption fees and other similar charges. The Bond Trustee
will be entitled to receive a portion of the reinvestment income earned on
amounts on deposit in the Distribution Account.
ADJUSTMENT TO THE SERVICING FEE IN CONNECTION WITH CERTAIN PREPAID PLEDGED
MORTGAGES
Subject to the terms thereof, the Bond Insurance Policy permits claims
thereunder to be made for any Deficiency Amount related to shortfalls in
interest due on the Bonds irrespective of the occurrence of any Net Prepayment
Interest Shortfalls. When a borrower prepays a Pledged Mortgage between Due
Dates, the borrower is required to pay interest on the amount prepaid only to
the date of prepayment and not thereafter. Principal prepayments by borrowers
received during a calendar month will be distributed to Bondholders on the
Payment Date in the month following the month of receipt. Thus less than one
month's interest may have been collected on Pledged Mortgages that have prepaid
with respect to any Payment Date. A "Prepayment Interest Shortfall" is the
amount by which interest paid by a borrower in connection with a prepayment of
principal on a Pledged Mortgage is less than one month's interest at the related
Mortgage Rate on the Stated Principal Balance of such Pledged Mortgage. Pursuant
to the Master Servicing Agreement, the related Servicing Fee for any month may
be reduced, but not below zero, by the amount of Prepayment Interest Shortfalls
occurring during such month with respect to the Pledged Mortgages serviced
pursuant to the Master Servicing Agreement, but only to the extent of the
Servicing Fee thereunder. If Prepayment Interest Shortfalls in any month
occurring with respect to the Pledged Mortgages exceed the amount of the related
Servicing Fee for such month that is eligible for reduction as described above,
the amount of funds available from collections to be paid to Bondholders in
respect of interest on the Pledged Mortgages on such Payment Date will be
reduced by the amount of such excess (such excess, the "Net Prepayment Interest
Shortfall"). See "SECURITY FOR THE BONDS--The Pledged Mortgages" herein.
ADVANCES
Subject to the following limitations, the Master Servicer will be required
to advance prior to each Payment Date, from its own funds amounts (net of the
applicable Servicing Fee and any Correspondent Trailing Premium with respect to
the related Pledged Mortgages) which were due on the related Due Date on the
Pledged Mortgages serviced by it and which were delinquent during the related
Due Period (any such advance, a "Monthly Advance").
Monthly Advances are intended to maintain a regular flow of scheduled
interest and principal payments on the Bonds rather than to guarantee or insure
against losses. The Master Servicer is not obligated to make Monthly Advances
(i) to the extent that such Monthly Advances are, in its reasonable judgment,
non-recoverable from future payments and collections or insurance payments or
proceeds of liquidation of the related Pledged Mortgage or (ii) on any Pledged
Mortgage as to which the related Mortgaged Property has been acquired by the
Bond Trustee through foreclosure or deed-in-lieu of foreclosure ("REO
Property"). Any failure by a Master Servicer to advance funds as required under
the Master Servicing Agreement will constitute a default thereunder, and
following the termination of the Master Servicer and the appointment of the Bond
Trustee as successor master servicer under the Master Servicing Agreement, the
Bond Trustee, as successor Master Servicer, will be obligated to make any such
Monthly Advance in accordance with the terms of the Master Servicing Agreement;
provided, however, that in no event will the Bond Trustee be required to make a
Monthly Advance that is not in its reasonable judgment, recoverable from future
payments and collections or insurance payments or proceeds of liquidation of the
related Pledged Mortgage. If the Master Servicer determines to make a Monthly
Advance, such Monthly Advance will be included in Available Funds for the
related Payment Date. Subject to the terms of the Bond Insurance Policy, the
Bond Insurance Policy
S-50
<PAGE> 51
will provide protection to the Bondholders against any shortfall resulting from
delinquencies as to which a required Monthly Advance is not made as described
above or is determined to be nonrecoverable, to the extent such shortfall is not
otherwise covered by Available Funds.
USE OF PROCEEDS
The Issuer intends to distribute all of the net proceeds of the issuance of
the Bonds to the Company which will use such proceeds to pay for the acquisition
of the Pledged Mortgages from Redwood Trust. See "USE OF PROCEEDS" in the
Prospectus.
FEDERAL INCOME TAX CONSEQUENCES
Giancarlo and Gnazzo, A Professional Corporation, has advised the Company
that, in its opinion the Bonds will be treated as debt for federal income tax
purposes, and not as an ownership interest in the Mortgage Collateral, the
Issuer or a separate association taxable as a corporation. Interest will be
taxable to non-exempt Bondholders. The Tax Prepayment Assumption (as defined in
the Prospectus under "FEDERAL INCOME TAX CONSEQUENCES -- Interest and Original
Issue Discount") for the purposes of determining the amount and rate of accrual
of original issue discount on the Bonds assumes that the Pledged Mortgages are
prepaid at a rate of 15% CPR. Based upon the assumed prepayment rate and the
expected price to the public of the Bonds as of the date hereof (including
interest accrued before the Closing Date, if any), the Class A-1 Bonds will be
issued at a premium and the Class A-2 Bonds will not be issued with original
issue discount. The Issuer intends to treat the Bonds as "Variable Rate Debt
Instruments" and the stated interest on the Bonds as "qualified stated interest
payments" (as each term is defined in the Prospectus under "FEDERAL INCOME TAX
CONSEQUENCES").
Notwithstanding the use of the prepayment assumption in pricing the Bonds,
no representation is made that the Pledged Mortgages will actually prepay at 15%
CPR or at any other rate. The amount of any original issue discount and certain
other information with respect to each Bond will be set forth on the face of
such Bond as required by applicable regulations and as described in the
Prospectus. See "DESCRIPTION OF THE BONDS--Weighted Average Lives of the Bonds"
herein and "FEDERAL INCOME TAX CONSEQUENCES" in the Prospectus.
The Issuer will not elect to treat the segregated pool of assets securing
the Bonds as a real estate mortgage investment conduit ("REMIC") for federal
income tax purposes. Giancarlo & Gnazzo, A Professional Corporation, has further
advised the Company that, in its opinion, the Issuer will not be classified as a
taxable mortgage pool.
Foreign investors in the Bonds are urged to consult their tax advisors
concerning recently finalized regulations on withholding and related
certifications generally applicable to payments made after December 31, 1998.
ERISA MATTERS
Fiduciaries of employee benefit plans and certain other retirement plans
and arrangements, including individual retirement accounts and annuities, Keogh
plans, and collective investment funds in which such plans, accounts, annuities
or arrangements are invested, that are subject to the Employee Retirement Income
Security Act of 1974, as amended ("ERISA"), or corresponding provisions of the
Internal Revenue Code of 1986, as amended (the "Code") (any of the foregoing a
"Plan"), persons acting on behalf of a Plan, or persons using the assets of a
Plan ("Plan Investors"), should carefully review with their legal advisors
whether the purchase or holding of the Bonds could give rise to a transaction
that is prohibited under ERISA or the Code or cause the Pledged Mortgages
securing the Bonds to be treated as "plan assets" for purposes of regulations of
the Department of Labor set forth in 29 C.F.R. 2510.3-101 (the "Plan Asset
Regulations"). Prospective investors should be aware that, although certain
exceptions from the application of the prohibited transaction rules and the Plan
Asset Regulations exist, there can be no assurance that any such exception will
apply with respect to the acquisition of the Bonds. See "ERISA MATTERS" in the
Prospectus.
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<PAGE> 52
If the Bonds are treated as equity for purposes of ERISA, the purchaser of
the Bonds could be treated as having acquired a direct interest in the Pledged
Mortgages securing the Bonds. In that event, the purchase, holding, or resale of
the Bonds could result in a transaction that is prohibited under ERISA or the
Code. Furthermore, regardless of whether the Bonds are treated as equity for
purposes of ERISA, the acquisition or holding of the Bonds by or on behalf of a
Plan could still be considered to give rise to a prohibited transaction if the
Issuer, the Trustee, the Master Servicer, any Servicer or any of their
respective Affiliates is or becomes a party in interest or a disqualified person
with respect to such Plan. However, one or more alternative exemptions may be
available with respect to certain prohibited transaction rules of ERISA that
might apply in connection with the initial purchase, holding and resale of the
Bonds, depending in part upon the type of Plan fiduciary making the decision to
acquire the Bonds and the circumstances under which such decision is made. Those
exemptions include, but are not limited to: (i) Prohibited Transaction Class
Exemption ("PTCE") 95-60, regarding investments by insurance company general
accounts; (ii) PTCE 91-38, regarding investments by bank collective investment
funds; (iii) PTCE 90-1, regarding investments by insurance company pooled
separate accounts; (iv) PTCE 84-14, regarding transactions negotiated by
qualified professional asset managers; or (v) PTCE 96-23, regarding transactions
effected by in-house asset managers. Before purchasing the Bonds, a Plan subject
to the fiduciary responsibility provisions of ERISA or described in Section
4975(e)(1) (and not exempt under Section 4975(g)) of the Code should consult
with its counsel to determine whether the conditions of any exemption would be
met. A purchaser of the Bonds should be aware, however, that even if the
conditions specified in one or more exemptions are met, the scope of the relief
provided by an exemption might not cover all acts that might be construed as
prohibited transactions. See "ERISA MATTERS" in the Prospectus.
Although not entirely free from doubt, the Issuer believes that the Bonds
will be treated as debt obligations without significant equity features for
purposes of the Plan Asset Regulations. Accordingly, a Plan that acquires the
Bonds should not be treated as having acquired a direct interest in the assets
of the Issuer. However, there can be no complete assurance that the Bonds will
be treated as debt obligations without significant equity features for purposes
of the Plan Asset Regulations.
METHOD OF DISTRIBUTION
Subject to the terms and conditions set forth in the Underwriting Agreement
between the Company, Redwood Trust and the Underwriter, the Company has agreed
to cause the Issuer to sell to the Underwriter, and the Underwriter has agreed
to purchase from the Issuer, the Bonds. Distribution of the Bonds will be made
by the Underwriter from time to time in negotiated transactions or otherwise at
varying prices to be determined at the time of sale. In connection with the sale
of the Bonds, the Underwriter may be deemed to have received compensation from
the Issuer in the form of underwriting discounts.
The Underwriter intends to make a secondary market in the Bonds, but has no
obligation to do so. There can be no assurance that a secondary market for the
Bonds will develop or, if it does develop, that it will continue or that it will
provide Bondholders with a sufficient level of liquidity of investment. The
Bonds will not be listed on any national securities exchange.
Immediately prior to the sale of the Pledged Mortgages to the Company, the
Pledged Mortgages were subject to financing provided by an affiliate of the
Underwriter. A portion of the proceeds from the sale of the Pledged Mortgages to
the Company will be applied to repay the financing.
The Company and Redwood Trust have agreed to indemnify the Underwriter
against, or make contributions to the Underwriter with respect to, certain
liabilities, including liabilities under the Securities Act of 1933, as amended.
EXPERTS
The consolidated financial statements of Ambac Assurance Corporation as of
December 31, 1996 and 1995 and for the three years ended December 31, 1996 have
been incorporated by reference herein in reliance upon the report of KPMG Peat
Marwick LLP, independent certified public accountants, incorporated by reference
herein, and upon the authority of said firm as experts in accounting and
auditing.
S-52
<PAGE> 53
LEGAL MATTERS
The validity of the Bonds will be passed upon for the Issuer by Tobin &
Tobin, a professional corporation, San Francisco, California. Certain tax
matters will be passed upon by for the Issuer by Giancarlo and Gnazzo, A
Professional Corporation, San Francisco, California. Certain matters of Delaware
law relating to the Owner Trustee will be passed upon for the Issuer by Morris,
James, Hitchens & Williams, Wilmington, Delaware, Delaware counsel to the Owner
Trustee. Brown & Wood LLP, New York, New York will act as counsel for the
Underwriter.
RATINGS
It is a condition of the issuance of the Bonds that they be rated "Aaa" by
Moody's and "AAA" by S&P (Moody's and S&P, together, the "Rating Agencies").
The ratings assigned to collateralized mortgage obligations address the
likelihood of the receipt of all payments on the mortgage loans by the related
bondholders under the agreements pursuant to which such bonds are issued. Such
ratings take into consideration the credit quality of the related mortgage pool,
including any credit support providers, structural and legal aspects associated
with such bonds, and the extent to which the payment stream on the mortgage pool
is adequate to make the payments required by such bonds. Ratings on such bonds
do not, however, constitute a statement regarding frequency of prepayments of
the mortgage loans.
The ratings assigned to the Bonds should be evaluated independently from
similar ratings on other types of securities. A rating is not a recommendation
to buy, sell or hold securities and may be subject to revision or withdrawal at
any time by the Rating Agencies.
The Issuer has not requested a rating of the Bonds by any rating agency
other than the Rating Agencies; there can be no assurance, however, as to
whether any other rating agency will rate the Bonds or, if it does, what rating
would be assigned by such other rating agency. The rating assigned by such other
rating agency to the Bonds could be lower than the respective ratings assigned
by the Rating Agencies.
S-53
<PAGE> 54
INDEX OF CERTAIN DEFINITIONS
<TABLE>
<CAPTION>
PAGE
-----------
<S> <C>
Additional Collateral............................................................. S-11, S-44
Additional Collateral Loans....................................................... S-11, S-44
Adjustment Date................................................................... S-9
Administration Agreement.......................................................... S-3
Administrator..................................................................... S-3
Agreement......................................................................... S-30
Available Funds................................................................... S-22
Basic Principal Amount............................................................ S-26
Beneficial owner.................................................................. S-18
Book-Entry Bonds.................................................................. S-3, S-18
Bond Account...................................................................... S-12, S-21
Bond Insurance Policy............................................................. S-7
Bond Interest Rates............................................................... S-5
Bond Owners....................................................................... S-18
Bond Principal Balance............................................................ S-5
Bondholders' Interest Carryover................................................... S-23
Bonds............................................................................. S-3, S-18
Bond Trustee...................................................................... S-3
Business Day...................................................................... S-30
Capped Amount..................................................................... S-22
CEDEL Participants................................................................ S-19
Class A-1 Bondholders' Interest Carryover......................................... S-23
Class A-2 Bondholders' Interest Carryover......................................... S-23
Class A-1 Interest Rate........................................................... S-5
Class A-2 Interest Rate........................................................... S-5
Code.............................................................................. S-13, S-51
Commission........................................................................ S-31
Company........................................................................... S-3
Conversion Price.................................................................. S-10
Correspondent Trailing Premium.................................................... S-7, S-45
CPR............................................................................... S-33
CTP............................................................................... S-45
Current One-Month LIBOR Index..................................................... S-12
Cut-off Date Stated Principal Balance............................................. S-9
Defective Pledged Mortgage........................................................ S-35
Deficiency Amount................................................................. S-8, S-30
Definitive Bond................................................................... S-18
Deleted Pledged Mortgage.......................................................... S-41
Delinquent Pledged Mortgage....................................................... S-28
Deposit Trust Agreement........................................................... S-4
Determination Date................................................................ S-23
Distribution Account.............................................................. S-12, S-21
DTC............................................................................... S-18, I-1
DTC Participant................................................................... I-1
Due Date.......................................................................... S-23
Due Period........................................................................ S-23
</TABLE>
S-54
<PAGE> 55
<TABLE>
<CAPTION>
PAGE
-----------
<S> <C>
ERISA............................................................................. S-13, S-51
Excess Cash Flow Principal Amount................................................. S-27
Excess Spread..................................................................... S-28
Exchange Act...................................................................... S-2
Expense Fee Rate.................................................................. S-7
Global Bonds...................................................................... I-1
Indenture......................................................................... S-3, S-30
Index............................................................................. S-10, S-46
Index Convertible Pledged Mortgage................................................ S-9
Indices........................................................................... S-10
Indirect Participants............................................................. S-19
Initial Pool Principal Balance.................................................... S-6
Insurance Proceeds................................................................ S-22
Insured Payment................................................................... S-30
Insurer........................................................................... S-7, S-29
Insurer Reimbursement Amount...................................................... S-27
Interest Accrual Period........................................................... S-5, S-24
Interest Payment Amount........................................................... S-4, S-23
Investor Certificate.............................................................. S-18
Issuer............................................................................ S-1
LIBOR Rate Determination Date..................................................... S-25
Limited Purpose Surety Bond....................................................... S-11
Liquidation Proceeds.............................................................. S-22
Management Agreement.............................................................. S-3
Management Fee.................................................................... S-7
Margin............................................................................ S-9
Master Servicer................................................................... S-4
Master Servicing Agreement........................................................ S-3
Maximum Mortgage Rate............................................................. S-9
ML & Co........................................................................... S-11
MLCC.............................................................................. S-4
Monthly Advance................................................................... S-8, S-50
Moody's........................................................................... S-14
Mortgage.......................................................................... S-41
Mortgage File..................................................................... S-41
Mortgage Loan Purchase Agreement.................................................. S-4, S-35
Mortgage Note..................................................................... S-41
Mortgage Rate..................................................................... S-9, S-36
Mortgaged Property................................................................ S-35
Net Available Funds............................................................... S-23
Net Interest Shortfall............................................................ S-36
Net Monthly Excess Cashflow....................................................... S-27
Net Mortgage Rate................................................................. S-6
Net Prepayment Interest Shortfall................................................. S-50
Notice............................................................................ S-30
One-Month LIBOR................................................................... S-25
One-Month LIBOR Index............................................................. S-9
One-Month LIBOR Notional Balance.................................................. S-12, S-42
</TABLE>
S-55
<PAGE> 56
<TABLE>
<CAPTION>
PAGE
-----------
<S> <C>
One-Year Constant Maturity Treasury Index......................................... S-24
One-Year Treasury ARM Index....................................................... S-5
One-Year Treasury ARM Index Determination Date.................................... S-24
Overcollateralization Amount...................................................... S-7
Owner............................................................................. S-30
Owner Trustee..................................................................... S-3
Parent Power(R) Loans............................................................. S-44
Participants...................................................................... S-18
Payment Date...................................................................... S-4, S-22
Plan.............................................................................. S-13, S-51
Plan Asset Regulations............................................................ S-13, S-51
Plan Investors.................................................................... S-13, S-51
Pledged Asset Servicing Agreement................................................. S-3
Pledged Mortgage Pool............................................................. S-9, S-35
Pledged Mortgages................................................................. S-3
Pool Principal Balance............................................................ S-6
Positive Rate Differential........................................................ S-6
Preference Amount................................................................. S-31
Prepayment Interest Shortfall..................................................... S-50
Prime Index....................................................................... S-10
Principal Balance................................................................. S-5
Principal Distributable Amount.................................................... S-26
Principal Payment Amount.......................................................... S-26
Rating Agencies................................................................... S-14, S-53
Realized Loss..................................................................... S-27
Redemption Price.................................................................. S-6, S-29
Redwood Trust..................................................................... S-3, S-17
Reference Banks................................................................... S-26
Reference Rate.................................................................... S-24
Relevant Depositary............................................................... S-18
Relief Act Reduction.............................................................. S-36
REO Property...................................................................... S-50
Replacement Pledged Mortgage...................................................... S-41
Rolling Six-Month LIBOR Index..................................................... S-12
S&P............................................................................... S-14
Servicing Fee..................................................................... S-7
Servicing Fee Rate................................................................ S-7
Scheduled Payments................................................................ S-36
Six-Month LIBOR Index............................................................. S-9
Six-Month LIBOR Notional Balance.................................................. S-11, S-42
SMMEA............................................................................. S-14
Specified Overcollateralization Amount............................................ S-26
Stated Principal Balance.......................................................... S-6
Structuring Assumptions........................................................... S-33
Subordination Deficit............................................................. S-28
Substitution Adjustment Amount.................................................... S-41
Swap Agreement.................................................................... S-11
Swap 1 Amount..................................................................... S-11, S-42
</TABLE>
S-56
<PAGE> 57
<TABLE>
<CAPTION>
PAGE
-----------
<S> <C>
Swap 2 Amount..................................................................... S-11, S-42
Swap Provider..................................................................... S-11, S-42
Targeted Principal Balance........................................................ S-26
Telerate Page 3750................................................................ S-26
Terms and Conditions.............................................................. S-20
Treasury Index.................................................................... S-10
Underwriter....................................................................... S-1
Variable Rate Debt Instruments.................................................... S-13, S-51
Weighted Average Net Mortgage Rate................................................ S-6
</TABLE>
S-57
<PAGE> 58
ANNEX I
GLOBAL CLEARANCE, SETTLEMENT AND TAX DOCUMENTATION PROCEDURES
Except in certain limited circumstances, the globally offered Sequoia
Mortgage Trust 2, Collateralized Mortgage Bonds (the "Global Bonds") will be
available only in book-entry form. Investors in the Global Bonds may hold such
Global Bonds through any of The Depository Trust Company ("DTC"), CEDEL or
Euroclear. The Global Bonds will be tradeable as home market instruments in both
the European and U.S. domestic markets. Initial settlement and all secondary
trades will settle in same-day funds.
Secondary market trading between investors holding Global Bonds through
CEDEL and Euroclear will be conducted in the ordinary way in accordance with
their normal rules and operating procedures and in accordance with conventional
Eurobond practice (i.e., seven calendar day settlement).
Secondary market trading between investors holding Global Bonds through DTC
will be conducted according to the rules and procedures applicable to U.S.
corporate debt obligations and prior collateralized mortgage bond issues.
Secondary cross-market trading between CEDEL or Euroclear and DTC
Participants holding Global Bonds will be effected on a delivery-against-payment
basis through the respective Depositaries of CEDEL and Euroclear (in such
capacity) and as DTC Participants.
Non-U.S. holders (as described below) of Global Bonds will be subject to
U.S. withholding taxes unless such holders meet certain requirements and deliver
appropriate U.S. tax documents to the securities clearing organizations or their
participants.
INITIAL SETTLEMENT
All Global Bonds will be held in book-entry form by DTC in the name of Cede
& Co. as nominee of DTC. Investors' interests in the Global Bonds will be
represented through financial institutions acting on their behalf as direct and
indirect participants in DTC (each, a "DTC Participant"). As a result, CEDEL and
Euroclear will hold positions on behalf of their participants through their
respective Depositaries, which in turn will hold such positions in accounts as
DTC Participants.
Investors electing to hold their Global Bonds through DTC will follow the
settlement practices applicable to other collateralized mortgage bond issues.
Investor securities custody accounts will be credited with their holdings
against payment in same-day funds on the settlement date.
Investors electing to hold their Global Bonds through CEDEL or Euroclear
accounts will follow the settlement procedures applicable to conventional
Eurobonds, except that there will be no temporary global security and no
"lock-up" or restricted period. Global Bonds will be credited to the securities
custody accounts on the settlement date against payment in same-day funds.
SECONDARY MARKET TRADING
Since the purchaser determines the place of delivery, it is important to
establish at the time of the trade where both the purchaser's and seller's
accounts are located to ensure that settlement can be made on the desired value
date.
Trading Between DTC Participants. Secondary market trading between DTC
Participants will be settled using the procedures applicable to prior
collateralized mortgage bond issues in same-day funds.
Trading Between CEDEL and/or Euroclear Participants. Secondary market
trading between CEDEL Participants or Euroclear Participants will be settled
using the procedures applicable to conventional Eurobonds in same-day funds.
Trading Between DTC Seller and Cedel or Euroclear Purchaser. When Global
Bonds are to be transferred from the account of a DTC Participant to the account
of a CEDEL Participant or a Euroclear Participant, the purchaser will send
instructions to CEDEL or Euroclear through a CEDEL Participant or
I-1
<PAGE> 59
Euroclear Participant at least one business day prior to settlement. CEDEL or
Euroclear will instruct the respective Depositary, as the case may be, to
receive the Global Bonds against payment. Payment will include interest accrued
on the Global Bonds from and including the last coupon payment date to and
excluding the settlement date, on the basis of the actual number of days in such
accrual period and a year assumed to consist of 360 days. For transactions
settling on the 31st of the month, payment will include interest accrued to and
excluding the first day of the following month. Payment will then be made by the
respective Depositary of the DTC Participant's account against delivery of the
Global Bonds. After settlement has been completed, the Global Bonds will be
credited to the respective clearing system and by the clearing system, in
accordance with its usual procedures, to the CEDEL Participant's or Euroclear
Participant's account. The securities credit will appear the next day (European
time) and the cash debt will be back-valued to, and the interest on the Global
Bonds will accrue from, the value date (which would be the preceding day when
settlement occurred in New York). If settlement is not completed on the intended
value date (i.e., the trade fails), the CEDEL or Euroclear cash debt will be
valued instead as of the actual settlement date.
CEDEL Participants and Euroclear Participants will need to make available
to the respective clearing systems the funds necessary to process same-day funds
settlement. The most direct means of doing so is to preposition funds for
settlement, either from cash on hand or existing lines of credit, as they would
for any settlement occurring within CEDEL or Euroclear. Under this approach,
they may take on credit exposure to CEDEL or Euroclear until the Global Bonds
are credited to their accounts one day later.
As an alternative, if CEDEL or Euroclear has extended a line of credit to
them, CEDEL Participants or Euroclear Participants can elect not to preposition
funds and allow that credit line to be drawn upon the finance settlement. Under
this procedure, CEDEL Participants or Euroclear Participants purchasing Global
Bonds would incur overdraft charges for one day, assuming they cleared the
overdraft when the Global Bonds were credited to their accounts. However,
interest on the Global Bonds would accrue from the value date. Therefore, in
many cases the investment income on the Global Bonds earned during that one-day
period may substantially reduce or offset the amount of such overdraft charges,
although this result will depend on each CEDEL Participant's or Euroclear
Participant's particular cost of funds. Since the settlement is taking place
during New York business hours, DTC Participants can employ their usual
procedures for sending Global Bonds to the respective European Depository for
the benefit of CEDEL Participants or Euroclear Participants. The sale proceeds
will be available to the DTC seller on the settlement date. Thus, to the DTC
Participants a cross-market transaction will settle no differently than a trade
between two DTC Participants.
Trading Between CEDEL or Euroclear Seller and DTC Purchaser. Due to time
zone differences in their favor, CEDEL Participants and Euroclear Participants
may employ their customary procedures for transactions in which Global Bonds are
to be transferred by the respective clearing system, through the respective
Depositary, to a DTC Participant. The seller will send instructions to CEDEL or
Euroclear through a CEDEL Participant or Euroclear Participant at least one
business day prior to settlement. In these cases CEDEL or Euroclear will
instruct the respective Depositary, as appropriate, to deliver the Global Bonds
to the DTC Participant's account against payment. Payment will include interest
accrued on the Global Bonds from and including the last coupon payment to and
excluding the settlement date on the basis of the actual number of days in such
accrual period and a year assumed to consist of 360 days. For transactions
settling on the 31st of the month, payment will include interest accrued to and
excluding the first day of the following month. The payment will then be
reflected in the account of the CEDEL Participant or Euroclear Participant the
following day, and receipt of the cash proceeds in the CEDEL Participant's or
Euroclear Participant's account would be back-valued to the value date (which
would be the preceding day, when settlement occurred in New York). Should the
CEDEL Participant or Euroclear Participant have a line of credit with its
respective clearing system and elect to be in debt in anticipation of receipt of
the sale proceeds in its account, the back-valuation will extinguish any
overdraft incurred over that one-day period. If settlement is not completed on
the intended valued date (i.e., the trade fails), receipt of the cash proceeds
in the CEDEL Participant's or Euroclear Participant's account would instead be
valued as of the actual settlement date.
Finally, day traders that use CEDEL or Euroclear and that purchase Global
Bonds from DTC Participants for delivery to CEDEL Participants or Euroclear
Participants should note that these trades would
I-2
<PAGE> 60
automatically fail on the sale side unless affirmative action were taken. At
least three techniques should be readily available to eliminate this potential
problem:
(a) borrowing through CEDEL or Euroclear for one day (until the
purchase side of the day trade is reflected in their CEDEL or Euroclear
accounts) in accordance with the clearing system's customary procedures;
(b) borrowing the Global Bonds in the U.S. from a DTC Participant no
later than one day prior to settlement, which would give the Global Bonds
sufficient time to be reflected in their CEDEL or Euroclear account in
order to settle the sale side of the trade; or
(c) staggering the value dates for the buy and sell sides of the trade
so that the value date for the purchase from the DTC Participant is at
least one day prior to the value date for the sale to the CEDEL Participant
or Euroclear Participant.
CERTAIN U.S. FEDERAL INCOME TAX DOCUMENTATION REQUIREMENTS
A beneficial owner of the Global Bonds holding securities through CEDEL or
Euroclear (or through DTC if the holder has an address outside the U.S.) will be
subject to the 30% U.S. withholding tax that generally applies to payments of
interest (including original issue discount) on registered debt issued by U.S.
Persons, unless (i) each clearing system, bank or other financial institution
that holds customers' securities in the ordinary course of its trade or business
in the chain of intermediaries between such beneficial owner and the U.S. entity
required to withhold tax complies with applicable certification requirements and
(ii) such beneficial owner takes one of the following steps to obtain an
exemption or reduced tax rate:
Exemption For Non-U.S. Persons (Form W-8). Beneficial owners of the Global
Bonds that are non-U.S. Persons can obtain a complete exemption from the
withholding tax by filing a signed Form W-8 (Certificate of Foreign Status). If
the information shown on Form W-8 changes, a new Form W-8 must be filed within
30 days of such change.
Exemption For Non-U.S. Persons with Effectively Connected Income (Form
4224). A non-U.S. Person, including a non-U.S. corporation or bank with a U.S.
branch, for which the interest income is effectively connected with its conduct
of a trade or business in the United States, can obtain an exemption from the
withholding tax by filing Form 4224 (Exemption from Withholding of Tax on Income
Effectively Connected with the Conduct of a Trade or Business in the United
States).
Exemption or Reduced Rate For Non-U.S. Persons Resident in Treaty Countries
(Form 1001). Non-U.S. Persons that are Bond Owners residing in a country that
has a tax treaty with the United States can obtain an exemption or reduced tax
rate (depending on the treaty terms) by filing Form 1001 (Ownership, Exemption
or Reduced Rate Certificate). If the treaty provides only for a reduced rate,
withholding tax will be imposed at that rate unless the filer alternatively
files Form W-8. Form 1001 may be filed by the Bond Owner or his agent.
Exemption For U.S. Persons (Form W-9). U.S. Persons can obtain a complete
exemption from the withholding tax by filing Form W-9 (Payer's Request for
Taxpayer Identification Number and Certification).
U.S. Federal Income Tax Reporting Procedure. The Bond Owner of a Bond or,
in the case of a Form 1001 or a Form 4224 filer, his agent, files by submitting
the appropriate form to the person through whom it holds (the clearing agency,
in the case of persons holding directly on the books of the clearing agency).
Form W-8 and Form 1001 are effective for three calendar years and Form 4224 is
effective for one calendar year.
The term "U.S. Person" means 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. This summary does not deal with all aspects of U.S. federal income
tax withholding that may be relevant to foreign holders of the Global Bonds.
Investors are advised to consult their own tax advisors for specific tax advice
concerning their holding and disposing of the Global Bonds.
I-3
<PAGE> 61
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<PAGE> 62
PROSPECTUS
SEQUOIA MORTGAGE FUNDING CORPORATION
DEPOSITOR
$3,000,000,000
(AGGREGATE ORIGINAL AMOUNT)
COLLATERALIZED MORTGAGE BONDS
(ISSUABLE IN SERIES)
------------------------
Sequoia Mortgage Funding Corporation, a Delaware corporation (the
"Company"), proposes to establish one or more trusts to issue and sell from time
to time under this Prospectus and related Prospectus Supplements one or more
Series of Collateralized Mortgage Bonds (the "Bonds"). The Bonds of each Series
will be collateralized by mortgage collateral (the "Mortgage Collateral")
consisting of one or more of the following: (i) fixed-rate, first or junior lien
mortgage loans secured by one- to four-family residential properties (the "Fixed
Rate Pledged Mortgages"), (ii) floating-rate, first or junior lien mortgage
loans secured by one- to four-family residential properties (the "Floating Rate
Pledged Mortgages" and, together with the Fixed Rate Pledged Mortgages, the
"Pledged Mortgages"), (iii) mortgage pass-through securities (the "Agency
Securities") issued or guaranteed by the Government National Mortgage
Association ("GNMA"), the Federal National Mortgage Association ("FNMA") or the
Federal Home Loan Mortgage Corporation ("FHLMC"), (iv) Private Mortgage-Backed
Securities (as defined herein), (v) a combination of such Agency Securities
and/or Private Mortgage-Backed Securities (collectively, the "Certificates") or
(vi) a combination of Certificates and Pledged Mortgages. A Series of Bonds also
may be secured by certain cash accounts, insurance policies, surety bonds,
guaranteed investment contracts, cross-collateralization,
over-collateralization, excess spread reinvestment income, guaranties, letters
of credit or derivative arrangements to the extent described herein and in the
related Prospectus Supplement. Certain capitalized terms used and not otherwise
defined herein shall have the meanings ascribed thereto elsewhere in this
Prospectus. See "INDEX OF CERTAIN DEFINITIONS" on page 85 of this Prospectus for
the location of the definitions of certain capitalized terms.
Each Series of Bonds will consist of one or more Classes of Bonds. Interest
on the Bonds will accrue at a fixed rate, a variable rate or a combination
thereof, as determined in the manner specified in the related Prospectus
Supplement. Principal payments on each Class of Bonds of a Series will be made
in the manner specified in the related Prospectus Supplement. If so specified in
the related Prospectus Supplement, one or more Classes of Bonds of a Series may
be entitled to receive payments of principal, interest or any combination
thereof prior to one or more other Classes of Bonds of such Series either for
the life of such Bonds or during certain periods. A Series of Bonds may include
one or more Classes of Bonds entitled to (i) principal distributions, with
disproportionate, nominal or no interest distributions or (ii) interest
distributions, with disproportionate, nominal or no principal distributions. In
addition, a Series of Bonds may include one or more Classes of Bonds that are
senior in right of payment to one or more other Classes of Bonds of such Series.
Credit enhancement for the Bonds of a Series will be as specified in the related
Prospectus Supplement.
The rate of payment of the principal of each Class of Bonds will generally
depend, among other things, on the rate of payment (including prepayments) of
the Mortgage Collateral pledged as security therefor. Consequently, the actual
maturity of any Class of Bonds could occur substantially sooner than its Stated
Maturity. Each Series of Bonds may be redeemed under the circumstances described
herein and in the related Prospectus Supplement.
FOR A DISCUSSION OF CERTAIN RISK FACTORS RELATING TO INVESTMENTS IN THE
BONDS, SEE "RISK FACTORS" COMMENCING ON PAGE 19 OF THIS PROSPECTUS.
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. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
Each Series of Bonds will be issued by a separate trust (each, an "Issuer")
established by the Company, will represent obligations solely of such Issuer and
will not be insured or guaranteed by GNMA, FNMA or FHLMC or any other
governmental agency or instrumentality or by the Company, any affiliate of the
Company, or, unless otherwise specified in the related Prospectus Supplement,
any other person or entity. No Issuer of any Series of Bonds is expected to have
significant assets other than those pledged as collateral for such Series of
Bonds. Prior to issuance, there will have been no market for the Bonds of any
Series, and there can be no assurance that a secondary market for any Bonds will
develop or, if it does develop that it will continue or provide Bondholders with
a sufficient level of liquidity of investment. This Prospectus may not be used
to consummate sales of a Series of Bonds unless accompanied by a Prospectus
Supplement.
Bonds of each Series will be characterized for federal income tax purposes
as debt instruments. See "FEDERAL INCOME TAX CONSEQUENCES" herein.
Offers of the Bonds of any Series may be made through one or more different
methods, including offerings through underwriters, as more fully described under
"PLAN OF DISTRIBUTION" herein and in the related Prospectus Supplement.
October 24, 1997.
<PAGE> 63
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
The Prospectus Supplement relating to a Series of Bonds to be offered
hereunder will, among other things, set forth with respect to such Series of
Bonds, if applicable: (i) information concerning the Issuer of such Series of
Bonds; (ii) the principal amount and the interest rate, or the method to be used
to determine the interest rate, of each Class of such Series of Bonds; (iii)
certain characteristics of the Mortgage Collateral securing such Series of Bonds
and, if applicable, information as to any insurance policies, surety bonds,
guaranties, derivative arrangements, cross-collateralization,
overcollateralization, excess spread reinvestment income, guaranteed investment
contracts or letters of credit, and the amount and source of any Reserve Fund or
other cash account for the Bonds of such Series; (iv) the circumstances, if any,
under which the Bonds of such Series are subject to special redemption or
optional redemption; (v) the Stated Maturity of each Class of Bonds of such
Series; (vi) the method used to calculate the aggregate amount of principal
required to be applied to the Bonds of such Series on each Payment Date and the
priority in which such payments will be applied among the Classes of Bonds of
such Series; (vii) the principal amount of each Class of Bonds of such Series
that would be outstanding on specified Payment Dates if the Pledged Mortgages or
the mortgage loans underlying the Certificates, as the case may be, pledged as
security for such Bonds, were prepaid at various assumed rates; (viii) the
Payment Dates and the Assumed Reinvestment Rate for such Series of Bonds; (ix)
information as to the nature and extent of subordination with respect to any
Class of Bonds of such Series that is subordinate in right of payment to any
other Class; (x) any minimum principal payment requirements and the terms of any
related minimum principal payment agreement with respect to such Series of
Bonds; (xi) additional information with respect to the plan of distribution of
the Bonds of such Series; and (xii) information as to the Master Servicer and
the Bond Trustee for such Series.
AVAILABLE INFORMATION
The Depositor has filed with the Securities and Exchange Commission (the
"Commission") a Registration Statement under the Securities Act of 1933, as
amended (the "Securities Act"), with respect to the Bonds. This Prospectus,
which forms a part of the Registration Statement, and the Prospectus Supplement
relating to each Series of Bonds contain summaries of the material terms of the
documents referred to herein and therein, but do not contain all of the
information set forth in the Registration Statement pursuant to the Rules and
Regulations of the Commission. For further information, reference is made to
such Registration Statement and the exhibits thereto. Such Registration
Statement and exhibits can be inspected and copied at prescribed rates at the
public reference facilities maintained by the Commission at its Public Reference
Section, 450 Fifth Street, N.W., Washington, D.C. 20549, and at its Regional
Offices located as follows: Midwest Regional Office, 500 West Madison Street,
Suite 1400, Chicago, Illinois 60661; and Northeast Regional Office, Seven World
Trade Center, 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 Bonds offered
hereby and thereby nor an offer of the Bonds 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.
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<PAGE> 64
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
All documents subsequently filed by or on behalf of the Issuer 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 Bonds issued by such Issuer 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. None of the Company, the Master Servicer or the Bond Trustee for any
Series intends to file with the Commission periodic reports with respect to the
related Issuer following completion of the reporting period required by Rule
15d-1 or Regulation 15D under the Exchange Act.
The Bond Trustee or such other entity specified in the related Prospectus
Supplement on behalf of any Issuer 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 Bond 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 Bond
Trustee or such other entity.
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<PAGE> 65
SUMMARY
The following 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 Bonds offered thereby and to
the related Indenture (as defined herein). Certain capitalized terms used and
not otherwise defined herein shall have the meanings ascribed thereto elsewhere
in this Prospectus. See "INDEX OF CERTAIN DEFINITIONS" on page 85 of this
Prospectus for the location of the definitions of certain capitalized terms.
Securities Offered......... The Collateralized Mortgage Bonds (the "Bonds")
offered hereby will be secured by mortgage
collateral (the "Mortgage Collateral") consisting
of one or more of the following: (i) fixed-rate,
first or junior lien mortgage loans secured by one-
to four-family residential properties (the "Fixed
Rate Pledged Mortgages"), (ii) floating-rate, first
or junior lien mortgage loans secured by one-to
four-family residential properties (the "Floating
Rate Pledged Mortgages" and, together with the
Fixed Rate Pledged Mortgages, the "Pledged
Mortgages"), (iii) mortgage pass-through securities
(the "Agency Securities") issued or guaranteed by
the Government National Mortgage Corporation
("GNMA"), the Federal National Mortgage Corporation
("FNMA") or the Federal Home Loan Mortgage
Corporation ("FHLMC"), (iv) other mortgage pass-
through certificates or collateralized mortgage
obligations (the "Private Mortgage-Backed
Securities"), (v) a combination of such Agency
Securities and/or Private Mortgage-Backed
Securities (collectively, the "Certificates") or
(vi) a combination of Certificates and Pledged
Mortgages. A Series of Bonds also may be secured by
certain cash accounts, insurance policies, surety
bonds, guaranteed investment contracts, cross-
collateralization, reinvestment income, guaranties
or letters of credit to the extent described herein
and in the related Prospectus Supplement. See
"SECURITY FOR THE BONDS" herein.
The Bonds will be issued from time to time in one
or more Series pursuant to Indentures (as defined
herein) between each Issuer and a bank or trust
company acting as trustee (the "Bond Trustee") for
the holders of the Bonds of each Series (the
"Bondholders") under the relevant Indenture. Each
Series of Bonds will consist of one or more Classes
of Bonds which may include one or more Classes of
Deferred Interest Bonds (as defined herein). A
Series of Bonds may include one or more Classes of
Senior Bonds (collectively, the "Senior Bonds") and
one or more Classes of Subordinated Bonds
(collectively, the "Subordinated Bonds"). Unless
otherwise specified in the related Prospectus
Supplement, the Bonds represent obligations solely
of the Issuer and are not insured or guaranteed by
any other person or entity. See "DESCRIPTION OF THE
BONDS" herein. Bonds of a Class may differ from
Bonds of other Classes of the same Series in the
amounts allocated to and the priority of principal
payments and interest rate or in such other manner
as specified in the related Prospectus Supplement.
A Series of Bonds may include one or more Classes
of Bonds entitled to (i) principal distributions,
with disproportionate, nominal or no interest
distributions or (ii) interest distributions, with
disproportionate, nominal or no principal
distributions. A Series of Bonds may be insured or
guaranteed as to payment of principal and interest
by a third-party insurer or guarantor, or secured
by certain cash accounts, insurance policies,
surety bonds, guaranteed investment contracts,
cross-collateral-
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<PAGE> 66
ization, reinvestment income, guaranties, letters
of credit or derivative arrangements, in each case
to the extent provided herein and in the related
Prospectus Supplement.
Issuer..................... The Issuer with respect to each Series of Bonds
will be a trust established by Sequoia Mortgage
Funding Corporation, a Delaware corporation (the
"Company"), for the sole purpose of issuing such
Series of Bonds and engaging in transactions
relating thereto. The Company is a wholly owned
limited purpose finance subsidiary of Redwood
Trust, Inc. ("Redwood Trust"). Redwood Trust, a
Maryland corporation, has elected to be taxed as a
real estate investment trust under the Internal
Revenue Code of 1986, as amended (the "Code"). Each
trust that is formed to act as an Issuer will be
created pursuant to a deposit trust agreement
between the Company, acting as depositor (in such
capacity, the "Depositor"), and a bank, trust
company, or other fiduciary acting as owner trustee
(the "Owner Trustee"). Each trust will be
established by the Company solely for the purpose
of issuing one Series of Bonds and engaging in
transactions relating thereto. Neither Redwood
Trust, the Company nor any of their respective
affiliates will guarantee or otherwise be obligated
to make payments on the Bonds. The Bonds will be
obligations solely of their respective Issuers. The
assets of each such Issuer, other than those
pledged as collateral for the Bonds it issues, are
not expected to be significant. See "THE ISSUER"
herein.
Master Servicer............ The entity or entities named as Master Servicer
(each, a "Master Servicer") in the related
Prospectus Supplement will act as master servicer
with respect to all of the Pledged Mortgages
securing a Series of Bonds pursuant to an agreement
(each, a "Master Servicing Agreement") among the
Master Servicer, the related Issuer and the related
Bond Trustee. The Master Servicer will administer
and supervise the performance of the entities
primarily responsible for servicing the Pledged
Mortgages (each, a "Servicer"), who may in turn be
administering and supervising the performance of
one or more subservicers of such Pledged Mortgages,
and will be obligated to perform the obligations of
a terminated Servicer or appoint a successor
Servicer. See "SERVICING OF THE PLEDGED MORTGAGES"
herein.
Special Servicer........... If specified in the related Prospectus Supplement,
the Company may appoint a special servicer (each, a
"Special Servicer") to service, make certain
decisions and take various actions with respect to
delinquent or defaulted Pledged Mortgages pledged
as security for the related Series of Bonds. See
"SERVICING OF THE PLEDGED MORTGAGES -- Special
Servicing Agreement" herein.
Interest Payments.......... Each Class of Bonds of a Series will bear interest
at the rate, or determined in the manner, set forth
for such Class in the related Prospectus
Supplement. Interest on a Series of Bonds or on a
Class of Bonds within a Series may accrue at a
fixed rate, a variable rate or a combination
thereof, as determined in the manner specified in
the related Prospectus Supplement. One or more
Classes of Bonds within a Series may be zero coupon
bonds. Interest on each Class of Bonds of a Series
other than a Class of Deferred Interest Bonds will
be paid on the dates specified in the related
Prospectus Supplement (each, a "Payment Date"), to
holders of record at the close of business on each
of the dates specified in such Prospectus
Supplement (each, a "Record Date").
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Interest on each Class of Deferred Interest Bonds
of a Series will accrue but will not be paid
(except in certain circumstances involving an
optional redemption of the Deferred Interest Bonds
or as otherwise specified in the related Prospectus
Supplement) until the Classes of Bonds specified in
the related Prospectus Supplement have been paid in
full. Interest accrued but not paid on a Class of
Deferred Interest Bonds will be added to the
principal thereof on each Payment Date. Each such
payment or accrual of interest will include all
interest accrued either to, but not including, the
related Payment Date or, if so indicated in the
related Prospectus Supplement, through a date prior
to such Payment Date, as specified in the related
Prospectus Supplement. In the latter case, the
effective yield to the holders of the Bonds will be
reduced to a level below the yield which would
apply if interest were paid or accrued to the
respective Payment Date. One or more Classes of
Bonds of a Series may be subordinated in the right
to receive payments of interest (and/or principal
or any combination thereof) to one or more other
Classes of Bonds of such Series, either throughout
the lives of the Bonds of such Class or during
specified periods, and, in addition, may be
entitled to receive such payments only after the
occurrence of certain events specified in the
related Prospectus Supplement. See "DESCRIPTION OF
THE BONDS -- Payments of Interest" herein.
Principal Payments......... Principal payments on each Series of Bonds will be
made on each Payment Date in an aggregate amount
equal to the sum of (a) if specified in the related
Prospectus Supplement, the amount of interest
accrued but not then payable on the Deferred
Interest Bonds of the Series, if any, from the
prior Payment Date or, if specified in the related
Prospectus Supplement, from a date prior to such
prior Payment Date, and (b) either (i) the
percentage or percentages specified in the related
Prospectus Supplement of the funds available for
such purpose ("Available Funds") for such Payment
Date or (ii) the sum of (x) an amount determined by
reference to the aggregate decline in the bond
values (the "Bond Values") of the Mortgage
Collateral securing the Bonds of such Series in the
period (each, a "Due Period") ending prior to such
Payment Date (collectively, the "Basic Principal
Payment") and (y) the amount, if any, of the spread
(the "Spread") specified in the related Prospectus
Supplement. The Prospectus Supplement for a Series
of Bonds will specify the method or methods used to
determine Available Funds for each related Payment
Date.
Payments of principal of the Bonds of a Series will
be allocated among the Classes of Bonds of such
Series in the manner specified in the related
Prospectus Supplement. One or more Classes of Bonds
of a Series may be subordinated in the right to
receive payments of principal (and/or interest or
any combination thereof) to one or more other
Classes of Bonds of such Series, either throughout
the lives of the Bonds of such Class or during
specified periods, and, in addition, may be
entitled to receive such payments only after the
occurrence of certain events specified in the
related Prospectus Supplement. All payments of
principal of Bonds of a particular Class will be
applied on a pro rata basis among all Bonds of such
Class, unless otherwise specified in the related
Prospectus Supplement. See "DESCRIPTION OF THE
BONDS -- Payments of Principal" herein.
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<PAGE> 68
The "Bond Value" of an item of Mortgage Collateral
represents the principal amount of the Bonds of a
Series that, based on certain assumptions and
irrespective of prepayments on the Mortgage
Collateral, can be supported by scheduled
distributions on the Mortgage Collateral, together
with (depending on the method used to determine the
Bond Value of the Mortgage Collateral) (i)
reinvestment earnings thereon at the Assumed
Reinvestment Rate (as defined herein) specified in
the related Prospectus Supplement and (ii) if
applicable, the cash available to be withdrawn from
any Reserve Fund (as defined herein) established
for such purpose for such Series. The Prospectus
Supplement for a Series of Bonds will specify the
method or methods and related assumptions used to
determine the Bond Values of the Mortgage
Collateral securing the Series.
Unless otherwise provided in the related Prospectus
Supplement, the Spread for a Series of Bonds, if
applicable, will represent the excess, if any, of
the sum of (i) all payments on the related Mortgage
Collateral deposited in the related Bond Account
(as defined herein) in the Due Period preceding a
Payment Date for the Series, (ii) the reinvestment
income thereon and (iii) amounts which are required
or are permitted to be withdrawn from any Reserve
Fund less the sum of (i) all interest payable on
the Bonds of such Series on such Payment Date, (ii)
the Basic Principal Payment required to be made on
the Bonds of such Series on such Payment Date,
(iii) an amount reflecting the redemption price of
certain Bonds of such Series redeemed, and (iv)
certain expenses accrued by the Issuer, during the
preceding Due Period.
The Stated Maturities for the Classes of Bonds
comprising a Series are the dates determined by the
Company to fall a specified period after the dates
on which the Bonds of each such Class will be fully
paid assuming (i) timely receipt of scheduled
payments (with no prepayments) on the Mortgage
Collateral securing such Bonds, (ii) if applicable,
such scheduled payments are, upon deposit in the
Bond Account, reinvested at the Assumed
Reinvestment Rate specified in the related
Prospectus Supplement, (iii) no Mortgage Collateral
is substituted by the Issuer or the Seller for any
of the Mortgage Collateral initially pledged to
secure the Bonds of the Series and (iv) if
applicable, no portion of the Spread is applied to
the payment of the Bonds, unless the related
Prospectus Supplement provides otherwise, in which
event such Stated Maturities will be based on the
assumptions specified in such Prospectus
Supplement. If so provided in the related
Prospectus Supplement, holders of one or more
Classes of Bonds of a Series may have the right, at
their option, to receive full payment in respect of
such Bonds prior to Stated Maturity, in each case
to the extent and subject to the conditions
specified in such Prospectus Supplement.
The Assumed Reinvestment Rate, if applicable, for a
Series of Bonds will be set forth in the related
Prospectus Supplement and may be any rate permitted
by the nationally recognized statistical rating
agency or agencies rating such Series of Bonds
(each, a "Rating Agency") or a rate provided under
a guaranteed investment contract, surety bond or
similar arrangement satisfactory to each Rating
Agency. If the Assumed Reinvestment Rate is so
provided, the related Prospectus Supplement will
describe the terms of such arrangement. The rate of
prepayments
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<PAGE> 69
(including for this purpose prepayments resulting
from refinancing or liquidations of the Pledged
Mortgages or the mortgage loans underlying the
Certificates, as the case may be, due to defaults,
casualties, condemnations and repurchases by the
Seller (as defined herein), the Issuer or Redwood
Trust or purchases by the Master Servicer or the
Company) on the Mortgage Collateral securing any
Series of Bonds will depend on the characteristics
of the Pledged Mortgages or the mortgage loans
underlying the Certificates, as the case may be, as
well as on other factors including, without
limitation, homeowner mobility, economic
conditions, the presence and enforceability of
"due-on-sale" clauses, mortgage market interest
rates and the availability of mortgage funds, and
no assurance can be given as to the actual
prepayment experience of the Mortgage Collateral.
The weighted average life of the Bonds of a Series
may also be affected by the exercise by the Issuer
of its right to substitute other Mortgage
Collateral for the Mortgage Collateral originally
pledged as security for such Bonds. See
"DESCRIPTION OF THE BONDS -- Weighted Average Life
of the Bonds" and "SECURITY FOR THE
BONDS -- Substitution of Mortgage Collateral"
herein.
Redemption of Bonds........ The Bonds of each Series will be redeemable under
the following circumstances:
A. Special Redemption...... The Bonds of a Series or a Class may be subject to
special redemption, in whole or in part, as
specified in the related Prospectus Supplement.
Pursuant to a special redemption, the Issuer will
be required to redeem, on the dates specified in
such Prospectus Supplement, at 100% of their unpaid
principal amount, plus accrued interest,
outstanding Bonds of a Series or Class if, as a
result of substantial payments of principal on the
Pledged Mortgages or on the mortgage loans
underlying the Certificates pledged as security for
such Series or Class of Bonds or low reinvestment
yields, or both, the Bond Trustee determines, based
on the assumptions specified in the Indenture, that
in the absence of such special redemption the
amount of cash expected to be on deposit in the
Bond Account on the next Payment Date for such
Series of Bonds would be insufficient to make
required payments on the Bonds of such Series on
such Payment Date. Any such redemption will not
exceed the principal amount of Bonds that would
otherwise be required to be paid on the next
Payment Date out of the principal payments and
prepayments so received. See "DESCRIPTION OF THE
BONDS -- Special Redemption" herein. Principal
payments on a special redemption will be applied to
Bonds of a Series in accordance with the priorities
specified in the related Prospectus Supplement.
B. Optional Redemption..... If so provided in the related Prospectus
Supplement, the Bonds of each Series may be subject
to redemption at the option of the Issuer. The
Prospectus Supplement for each Series will specify
the circumstances, if any, under which the Bonds of
such Series may be so redeemed, the manner of
effecting such redemption, the conditions to which
such redemption are subject and the redemption
prices for each Class of Bonds to be redeemed. See
"DESCRIPTION OF THE BONDS -- Optional Redemption"
herein.
Security for the Bonds..... Each Series of Bonds will be separately secured by
collateral consisting of the items set forth below.
Unless otherwise provided in the related Prospectus
Supplement, the Issuer may substitute other
Mortgage Col-
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<PAGE> 70
lateral for the Mortgage Collateral originally
pledged as security for the Bonds of a Series so
long as the substitute Mortgage Collateral meets
certain criteria. See "SECURITY FOR THE
BONDS -- Substitution of Mortgage Collateral"
herein.
A. Pledged Mortgages....... In connection with the issuance of a Series of
Bonds secured in whole or in part by Pledged
Mortgages, the Issuer will pledge and assign to the
Bond Trustee a pool of conventional (i.e., not
insured or guaranteed by any governmental agency)
loans secured by first or junior mortgages or deeds
of trust on one- to four-family residential
properties. If so specified in the related
Prospectus Supplement, the Pledged Mortgages may
include cooperative apartment loans ("Cooperative
Loans") secured by security interests in shares
issued by private, nonprofit, cooperative housing
corporations ("Cooperatives") and in the related
proprietary leases or occupancy agreements granting
exclusive rights to occupy specific dwelling units
in such Cooperatives' buildings. See "SECURITY FOR
THE BONDS -- The Pledged Mortgages" herein.
B. General Attributes of
Pledged Mortgages........ The payment terms of the Pledged Mortgages securing
a Series of Bonds, if any, will be described in the
related Prospectus Supplement and may include any
of the following features or combinations thereof
or other features described 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. The loan
agreement or promissory note (the "Mortgage
Note") in respect of a Pledged Mortgage may
provide for the payment of interest at a rate
lower than the interest rate (the "Mortgage
Rate") specified in such Mortgage Note for a
period of time or for the life of the loan, and
the amount of any difference may be contributed
from funds supplied by a third party.
(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 interest rate on the Pledged
Mortgage 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 payments").
Principal may include interest that has been
deferred and added to the principal balance of
the Pledged Mortgage.
(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
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<PAGE> 71
change from period to period. Pledged Mortgages
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) The Pledged Mortgages generally may be prepaid
at any time without payment of any prepayment
fee, unless otherwise specified in the related
Prospectus Supplement. If so specified in the
related Prospectus Supplement, prepayments of
principal may be subject to a prepayment fee,
which may be fixed for the life of any such
Pledged Mortgage or may decline over time, and
may be prohibited for the life of any such
Pledged Mortgage or for certain periods
("lockout periods"). Certain Pledged Mortgages
may permit prepayments after expiration of the
applicable lockout period and may require the
payment of a prepayment fee in connection with
any such subsequent prepayment. All or a
portion of any prepayment fee may be payable as
additional interest on the Bonds, if so
specified in the related Prospectus Supplement.
Other Pledged Mortgages may permit prepayments
without payment of a fee unless the prepayment
occurs during specified time periods. The
Pledged Mortgages may include "due-on-sale"
clauses which permit the mortgagee to demand
payment of the entire Pledged Mortgage in
connection with the sale or certain transfers
of the related Mortgaged Property (as defined
below). Other Pledged Mortgages may be
assumable by persons meeting then applicable
underwriting standards. See "MORTGAGE LOAN
PROGRAM -- Underwriting Standards" herein.
(e) The real property constituting security for
repayment of a Pledged Mortgage (each, a
"Mortgaged Property") may be located in any one
of the fifty states, the District of Columbia,
Guam, Puerto Rico, any other territory of the
United States or such other location as may be
specified in the related Prospectus Supplement.
Unless otherwise specified in the related
Prospectus Supplement, all of the Pledged
Mortgages will be covered by standard hazard
insurance policies insuring against losses due
to fire and various other causes. The Pledged
Mortgages will be covered by Primary Mortgage
Insurance Policies (as defined herein) to the
extent provided in the related Prospectus
Supplement. See "SECURITY FOR THE BONDS -- The
Pledged Mortgages" herein.
C. Agency Securities....... The Agency Securities securing a Series of Bonds
will consist of (i) fully modified pass-through
mortgage-backed certificates guaranteed as to
timely payment of principal and interest by the
Government National Mortgage Association ("GNMA
Certificates"), (ii) certificates ("Guaranteed
Mortgage Pass-Through Certificates") issued and
guaranteed as to timely payment of principal and
interest by the Federal National Mortgage
Association ("FNMA Certificates"), (iii) mortgage
participation certificates issued and guaranteed as
to timely payment of interest and, unless otherwise
specified in the related Prospectus Supplement,
ultimate payment of principal by the Federal Home
Loan Mortgage Corporation ("FHLMC Certificates"),
(iv) stripped mortgage-backed securities
representing an undivided interest in all or a part
of either the principal distributions (but not the
interest distributions) or
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the interest distributions (but not the principal
distributions) or in some specified portion of the
principal and interest distributions (but not all
of such distributions) on certain GNMA, FNMA or
FHLMC Certificates and, unless otherwise specified
in the related Prospectus Supplement, guaranteed to
the same extent as the underlying securities, (v)
another type of pass-through certificate issued or
guaranteed by GNMA, FNMA or FHLMC and described in
the related Prospectus Supplement or (vi) a
combination of such Agency Securities. All GNMA
Certificates will be backed by the full faith and
credit of the United States. No FHLMC or FNMA
Certificates will be backed, directly or
indirectly, by the full faith and credit of the
United States. See "SECURITY FOR THE
BONDS -- Agency Securities" herein.
D. Private Mortgage-Backed
Securities............... Private Mortgage-Backed Securities may include (a)
mortgage pass-through certificates representing
beneficial interests in certain mortgage loans or
(b) collateralized mortgage obligations secured by
such mortgage loans. Private Mortgage-Backed
Securities may include stripped mortgage-backed
securities representing an undivided interest in
all or a part of any of the principal distributions
(but not the interest distributions) or the
interest distributions (but not the principal
distributions) or in some specified portion of the
principal and interest distributions (but not all
of such distributions) on certain mortgage loans.
Although individual mortgage loans underlying a
Private Mortgage-Backed Security may be insured or
guaranteed by the United States or an agency or
instrumentality thereof, they need not be, and the
Private Mortgage-Backed Securities themselves will
not be so insured or guaranteed. Unless otherwise
specified in the Prospectus Supplement relating to
a Series of Bonds, payments on the Private
Mortgage-Backed Securities will be distributed
directly to the Bond Trustee as registered owner of
such Private Mortgage-Backed Securities. See
"SECURITY FOR THE BONDS -- Private Mortgage-Backed
Securities" herein.
The related Prospectus Supplement for a Series of
Bonds will specify, among other things, the
approximate aggregate principal amount and type of
any Private Mortgage-Backed Securities to be
included in the Mortgage Collateral for such Series
and, as to any such Private Mortgage-Backed
Securities comprising a significant portion of the
Mortgage Collateral, to the extent such information
is known to the Issuer, will in general include the
following: (i) certain characteristics of the
mortgage loans that comprise the underlying assets
for the Private Mortgage-Backed Securities
including (A) the payment features of such mortgage
loans, (B) the approximate aggregate principal
amount of the underlying mortgage loans that are
insured or guaranteed by a governmental entity, (C)
the servicing fee or range of servicing fees with
respect to the mortgage loans and (D) the minimum
and maximum stated maturities of the mortgage loans
at origination; (ii) the maximum original term to
stated maturity of the Private Mortgage-Backed
Securities; (iii) the weighted average term to
stated maturity of the Private Mortgage-Backed
Securities; (iv) the pass-through or certificate
rate or ranges thereof for the Private
Mortgage-Backed Securities; (v) the weighted
average pass-through or certificate rate of the
Private Mortgage-Backed Securities; (vi) the issuer
of the Private Mortgage-Backed Securities (the
"PMBS Issuer"), the servicer of the Private
Mortgage-Backed
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Securities (the "PMBS Servicer") and the trustee of
the Private Mortgage-Backed Securities (the "PMBS
Trustee"); (vii) certain characteristics of credit
support, if any, such as reserve funds, insurance
policies, surety bonds, letters of credit or
guaranties relating to the mortgage loans
underlying the Private Mortgage-Backed Securities
or to such Private Mortgage-Backed Securities
themselves; (viii) the terms on which underlying
mortgage loans for such Private Mortgage-Backed
Securities may, or are required to, be repurchased
prior to stated maturity and the terms of any
redemption; and (ix) the terms on which substitute
mortgage loans may be delivered to replace those
initially deposited with the PMBS Trustee. See
"SECURITY FOR THE BONDS -- Private Mortgage-Backed
Securities" herein.
E. Bond and Distribution
Accounts................. All scheduled monthly principal and interest
payments and all prepayments received with respect
to the Mortgage Collateral for a Series of Bonds,
other than amounts not required to be remitted to
the Bond Trustee, such as amounts retained by the
Master Servicer, any Servicer or any subservicer of
Pledged Mortgages as servicing compensation, to pay
certain insurance premiums or to reimburse the
Master Servicer or any Servicer for certain
advances it has made, will be remitted to an
account (the "Bond Account") to be established as
an Eligible Account (as defined herein) on the
closing date for the sale of such Series of Bonds
(the "Closing Date"). All principal and interest
distributions received from the Mortgage Collateral
and remitted to the Bond Account, other than
amounts, if any, subsequently withdrawn to
reimburse the Master Servicer or any Servicer for
certain non-recoverable advances it has made,
together with (i) the amount of cash, if any,
initially deposited in the Bond Account by the
Issuer, (ii) if applicable, all amounts withdrawn
from any related Reserve Funds, (iii) any Insurance
Proceeds and Liquidation Proceeds (as such terms
are defined herein) and (iv) if so specified in the
related Prospectus Supplement, all reinvestment
income earned thereon, will be available transfer
to the Distribution Account (as defined herein) for
application to the payment of the principal of, and
interest on, such Series of Bonds as described in
the related Prospectus Supplement.
On or prior to the Closing Date, the Bond Trustee
will establish an account (the "Distribution
Account") which shall be an Eligible Account (as
defined herein) maintained with the Bond Trustee
for the benefit of the Bondholders of the related
Series. On or prior to a date specified in the
related Prospectus Supplement and preceding each
related Payment Date (each, a "Distribution Account
Deposit Date"), the Master Servicer shall withdraw
from the Bond Account the amount required to be
distributed to Bondholders on such Payment Date
(the "Bond Distribution Amount"), to the extent of
funds available for such purpose on deposit
therein, and will deposit such amount in the
Distribution Account.
Any funds remaining in the Bond Account on a
Payment Date, other than amounts not constituting
Available Funds, if so specified in the related
Prospectus Supplement, after (i) the reimbursement
of the Master Servicer or any Servicer for
non-recoverable advances made by it, (ii) each
required payment of interest and principal to
Bondholders of
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the related Series has been paid in full, (iii) if
applicable, any Reserve Fund has been funded in the
manner described in the related Prospectus
Supplement and (iv) the payment of certain expenses
relating to such Series of Bonds, will be subject
to withdrawal upon the order of the Issuer. See
"SECURITY FOR THE BONDS -- Bond and Distribution
Accounts" and "SERVICING OF THE PLEDGED MORTGAGES"
herein.
Pre-Funding Accounts....... If so specified in the related Prospectus
Supplement, the assets of the Issuer will include
the funds on deposit in an account (a "Pre-Funding
Account") which will be used to purchase additional
Mortgage Collateral during a period specified in
such Prospectus Supplement (such period, the
"Funding Period"). See "SECURITY FOR THE
BONDS -- Pre-Funding Accounts" herein.
Credit Enhancement......... The Mortgage Collateral securing a Series of Bonds
or the Bonds 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 enhancement may
be limited. The type, characteristics and amount of
credit enhancement will be determined based on the
characteristics of the Pledged Mortgages underlying
or comprising the Mortgage Collateral and will be
established on the basis of requirements of each
Rating Agency. In addition, one or more Classes of
Bonds of a Series may be guaranteed as to payment
of principal and interest by a third party insurer
or guarantor, to the extent provided in the related
Prospectus Supplement. See "CREDIT ENHANCEMENT"
herein.
A. Subordination........... A Series of Bonds may consist of one or more
Classes of Senior Bonds and one or more Classes of
Subordinated Bonds. The rights of the holders of
the Subordinated Bonds of a Series (the
"Subordinated Bondholders") to receive payments of
principal and/or interest (or any combination
thereof) will be subordinated to such rights of the
holders of the Senior Bonds of the same Series (the
"Senior Bondholders") to the extent described in
the related Prospectus Supplement. This
subordination is intended to enhance the likelihood
of regular receipt by the Senior Bondholders of the
full amount of their scheduled payments of
principal and/or interest. The protection afforded
to the Senior Bondholders 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 payment being made on the
related Subordinated Bonds, the amounts of
principal and/or interest due them on each Payment
Date out of the funds available for payment on such
date in the related Distribution Account and, to
the extent described in the related Prospectus
Supplement, by the right of such holders to receive
future payments that would otherwise have been
payable to the Subordinated Bondholders; or (ii) as
otherwise described in the related Prospectus
Supplement. If so specified in the related
Prospectus Supplement, subordination may apply only
in the 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 Bonds in a Series, the
circumstances in which such
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subordination will be applicable and the manner, if
any, in which the amount of subordination will
decrease over time. See "CREDIT
ENHANCEMENT -- Subordination" herein.
B. Reserve Funds........... If so specified in the related Prospectus
Supplement, the Issuer will deposit in one or more
Reserve Funds to be established with the Bond
Trustee, cash, certificates of deposit, letters of
credit, surety bonds, guaranteed investment
contracts, reinvestment income or any combination
thereof, which may be used by the Bond Trustee to
make payments on such Series of Bonds to the extent
funds are not otherwise available. The related
Prospectus Supplement will specify the manner of
funding the related Reserve Fund and the conditions
under which the amounts in any such Reserve Fund
will be used to make payments to holders of Bonds
of a particular Class or released from the lien of
the related Indenture. See "CREDIT
ENHANCEMENT -- Reserve Funds" herein.
C. Mortgage Pool Insurance
Policy................... If so specified in the related Prospectus
Supplement, a mortgage pool insurance policy or
policies (the "Mortgage Pool Insurance Policy") may
be obtained and maintained for a Series of Bonds
secured by Pledged Mortgages, which shall be
limited in scope, covering defaults on such Pledged
Mortgages in an initial amount equal to a specified
percentage of the aggregate principal balance of
all Pledged Mortgages included in the related
mortgage pool as of the first day of the month of
issuance of the related Series of Bonds or such
other date as is specified in the related
Prospectus Supplement (the "Cut-off Date"). See
"CREDIT ENHANCEMENT -- Mortgage Pool Insurance
Policies" herein.
D. Special Hazard Insurance
Policy................... If so specified in the related Prospectus
Supplement, a special hazard insurance policy or
policies (the "Special Hazard Insurance Policy")
may be obtained and maintained for a Series of
Bonds secured by Pledged Mortgages, covering
certain physical risks that are not otherwise
insured against by standard hazard insurance
policies. Each Special Hazard Insurance Policy will
be limited in scope and will cover losses pursuant
to the provisions of each such Special Hazard
Insurance Policy as described in the related
Prospectus Supplement. See "CREDIT
ENHANCEMENT -- Special Hazard Insurance Policies"
herein.
E. Bankruptcy Bond......... If so specified in the related Prospectus
Supplement, a bankruptcy bond or bonds (the
"Bankruptcy Bond") may be obtained for a Series of
Bonds secured by Pledged Mortgages to cover certain
losses resulting from action that may be taken by a
bankruptcy court in connection with a Pledged
Mortgage. The level of coverage and the limitations
in scope of each Bankruptcy Bond will be specified
in the related Prospectus Supplement. See "CREDIT
ENHANCEMENT -- Bankruptcy Bonds" herein.
F. Bond Insurance Policies,
Surety Bonds and
Guarantees............... If so specified in the related Prospectus
Supplement, credit enhancement for one or more
Classes of Bonds of a Series may be provided by
insurance policies or surety bonds (each, a "Bond
Insurance Policy")
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<PAGE> 76
issued by one or more insurance companies or
sureties. Such bond guarantee insurance or surety
bond will guarantee timely payments of interest
and/or full payment of principal on the basis of a
schedule of principal payments set forth in or
determined in the manner specified in the related
Prospectus Supplement. If specified in the related
Prospectus Supplement, one or more surety bonds,
insurance policies or third-party guarantees may be
used to provide coverage for the risks of default
or types of loses set forth in such Prospectus
Supplement. See "CREDIT ENHANCEMENT -- Bond
Insurance Policies, Surety Bonds and Guarantees"
herein.
G. Letter of Credit........ If so specified in the related Prospectus
Supplement, credit enhancement may be provided for
a Series of Bonds secured by Pledged Mortgages 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
enhancement, such as losses resulting from
delinquent payments on the Pledged Mortgages
securing the related Series of Bonds, losses from
risks not covered by standard hazard insurance
policies, losses due to bankruptcy of a borrower
and application of certain provisions of the
federal Bankruptcy Code, and losses due to denial
of insurance coverage due to misrepresentations
made in connection with the origination or sale of
a Pledged Mortgage. The issuer of the letter of
credit (the "L/C Bank") will be obligated to honor
demands with respect to such letter or 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 Pledged Mortgages securing
the related Series of Bonds or one or more Classes
of Bonds of such Series (the "L/C Percentage"). 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. See "CREDIT
ENHANCEMENT -- Letter of Credit" herein.
H. Cross-Collateralization...If so specified in the related Prospectus
Supplement, separate Classes of such Series may be
secured by separate groups of Mortgage Collateral.
In such case, credit support may be provided by a
cross-collateralization feature which requires that
payments be made with respect to Bonds secured by
one or more groups of Mortgage Collateral prior to
payments to Bonds secured by other groups of
Mortgage Collateral within the same Series. See
"CREDIT ENHANCEMENT -- Cross-Collateralization"
herein.
If so 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 Series of Bonds. If applicable, the
related Prospectus Supplement will identify the
Series of Bonds to which such credit enhancement
relates and the manner of determining the amount of
coverage provided to such Series of Bonds thereby
and of the application of such coverage to the
identified
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<PAGE> 77
Series of Bonds. See "CREDIT
ENHANCEMENT -- Cross-Collateralization" herein.
I. Over-Collateralization... If so specified in the related Prospectus
Supplement, credit enhancement may consist of
over-collateralization whereby the aggregate
principal balance of the related Mortgage
Collateral exceeds the aggregate principal balance
of the Bonds of the related Series. Such
over-collateralization may exist on the related
Closing Date or develop thereafter as a result of
the application of a portion of the interest
payment on each Pledged Mortgage or Certificate, as
the case may be, as an additional payment in
respect of principal to reduce the principal
balance of a certain Class or Classes of Bonds of
such Series and, thus, accelerate the rate of
payment of principal on such Class or Classes of
Bonds. See "CREDIT
ENHANCEMENT -- Over-Collateralization" herein.
J. Excess Spread........... "Excess Spread" refers to the positive spread that
may exist, to the extent specified in the related
Prospectus Supplement, between the weighted average
of the interest rates (less servicing or other
applicable fees) on the Mortgage Collateral and the
weighted average of the interest rates on the
Bonds. Whether at any time such positive spread
exists will depend on a variety of factors,
including, with respect to a Series of Bonds with
respect to which both the Bonds and the Mortgage
Collateral bear interest at adjustable rates, the
relationship of the movements in the indices
applicable to the Mortgage Collateral and those
applicable to the Bonds, over which no prediction
can be made or assurance given.
If so 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 Series of Bonds. If applicable, the
related Prospectus Supplement will identify the
Series of Bonds to which such credit enhancement
relates and the manner of determining the amount of
coverage provided to such Series of Bonds thereby
and of the application of such coverage to the
identified Series of Bonds.
K. Minimum Principal
Payment Agreement....... If so specified in the related Prospectus
Supplement, an Issuer may enter into an agreement
with an institution pursuant to which such
institution will provide such funds as may be
necessary to enable such Issuer to make principal
payments on the Bonds of the related Series at a
minimum rate set forth in such Prospectus
Supplement. See "CREDIT ENHANCEMENT -- Minimum
Principal Payment Agreement" herein.
L. Derivative
Arrangements............... If so specified and to the extent described in the
related Prospectus Supplement, one or more
derivative arrangements may be used to support
payments on the Bonds. A derivative arrangement is
a contract or agreement, the price of which is
directly dependent upon (i.e., "derived from") the
value of one or more underlying assets. Derivatives
involve rights or obligations based on the
underlying asset, but do not necessarily result in
a transfer of the underlying asset. Derivative
arrangements include swap agreements, interest rate
swaps, interest rate caps, interest rate floors,
interest rate collars and currency swap agree-
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<PAGE> 78
ments. See "CREDIT ENHANCEMENT -- Derivative
Arrangements" herein.
Advances................... The Master Servicer and each Servicer may be
obligated to advance amounts (each, an "Advance")
corresponding to delinquent interest and/or
principal payments on the Pledged Mortgages
securing a Series of Bonds (including, in the case
of Cooperative Loans, unpaid maintenance fees or
other charges under the related proprietary lease)
until the date, as specified in the related
Prospectus Supplement, following the date on which
the related Mortgaged Property is sold at a
foreclosure sale or the related Pledged Mortgages
are 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 "SERVICING OF THE PLEDGED
MORTGAGES -- Advances and Other Amounts Payable by
Master Servicer" herein and " -- Advances" in the
related Prospectus Supplement.
In the event the Master Servicer or Servicer fails
to make a required Advance, the Bond Trustee may be
obligated to advance such amounts otherwise
required to be advanced by the Master Servicer or
Servicer. See "SERVICING OF PLEDGED
MORTGAGES -- Advances and Other Amounts Payable by
Master Servicer and Servicers" herein.
Tax Status of the Bonds.... The Bonds, when beneficially owned by someone other
than Redwood Trust or one of its qualified real
estate investment trust ("REIT") subsidiaries (as
defined in section 856(i) of the Code), will
constitute indebtedness for federal income tax
purposes and not an ownership interest in the
Issuer or the Collateral. See "FEDERAL INCOME TAX
CONSEQUENCES" herein and in the related Prospectus
Supplement for information concerning the material
federal tax consequences of an investment in the
Bonds.
Use of Proceeds............ The net proceeds to be received from the sale of
the Bonds of each Series will be applied by the
Company to the purchase or acquisition of the
related Mortgage Collateral or will be used by the
Company for general corporate purposes. The
Mortgage Collateral pledged to secure a Series of
Bonds will either be contributed to the Company's
capital by Redwood Trust (or an affiliate) or
acquired by the Company from Redwood Trust (or an
affiliate) and deposited with the Issuer of such
Series by the Company. See "USE OF PROCEEDS"
herein.
Ratings.................... It is a condition to the issuance of each Series of
Bonds that the Bonds of such Series to be offered
hereunder be rated in one of the four highest
rating categories by at least one nationally
recognized statistical rating organization. A
rating is not a recommendation to purchase, hold or
sell Bonds inasmuch as such rating does not comment
as to market price or suitability for a particular
investor. Ratings of Bonds will address the
likelihood of the payment of principal and interest
thereon pursuant to their terms. There can be no
assurance that a rating will remain for a given
period of time or that a rating will not be lowered
or withdrawn entirely by a rating agency if in its
judgment circumstances in the future so warrant.
See "RATINGS" herein. For more detailed information
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<PAGE> 79
regarding the ratings assigned to any Class of a
particular Series of Bonds, see "SUMMARY OF
TERMS -- Ratings" and "RATINGS" in the related
Prospectus Supplement.
Legal Investment........... The Prospectus Supplement for each Series of Bonds
will specify which, if any, of the Classes of Bonds
offered thereby will constitute "mortgage related
securities" for purposes of the Secondary Mortgage
Market Enhancement Act of 1984 ("SMMEA"). Classes
of Bonds 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 that 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 Bonds of a Series (whether or not such
Class constitutes a "mortgage-related security")
complies with applicable guidelines, policy
statements or restrictions. See "LEGAL INVESTMENT"
herein.
ERISA Matters.............. Generally, plans that are subject to the
requirements of the Employee Retirement Income
Security Act of 1974, as amended ("ERISA"), and the
Internal Revenue Code of 1986, as amended (the
"Code"), are permitted to purchase instruments,
like the Bonds, that are debt under applicable
state law and have no "substantial equity
features". If the Bonds are deemed to be equity
interests and no statutory, regulatory or
administrative exemption applies, the Issuer will
hold plan assets by reason of a Plan's investment
in the Bonds. Accordingly, any Plan fiduciary
considering whether to purchase the Bonds on behalf
of a Plan should consult with its counsel regarding
the applicability of the provisions of ERISA and
the Code and the availability of any exemptions.
See "ERISA MATTERS" herein.
Risk Factors............... For a discussion of certain risks associated with
an investment in the Bonds, see "RISK FACTORS"
commencing on page 19 herein and in the related
Prospectus Supplement.
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<PAGE> 80
RISK FACTORS
Investors should consider, among other things, the following factors in
connection with an investment in the Bonds.
RISKS ASSOCIATED WITH NATURE OF PLEDGED MORTGAGES
FACTORS WHICH MAY ADVERSELY AFFECT PROPERTY VALUES. There are several
factors that could adversely affect the value of Mortgaged Properties such that
the outstanding balance of the related Pledged Mortgages would equal or exceed
the value of the Mortgaged Properties. Among the factors that could adversely
affect the value of the Mortgaged Properties are an overall decline in the
residential real estate market in the areas in which the Mortgaged Properties
are located or a decline in the general condition of the Mortgaged Properties as
a result of failure of borrowers to maintain adequately the Mortgaged Properties
or of natural disasters that are not necessarily covered by insurance, such as
earthquakes and floods. If such a decline occurs, the actual rates of
delinquencies, foreclosures and losses on the Pledged Mortgages could be higher
than those currently experienced in the mortgage lending industry in general.
Losses on such Pledged Mortgages 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 Bonds of the related Series.
DELAYS DUE TO LIQUIDATION. Even assuming that the Mortgaged Properties
provide adequate security for the Pledged Mortgages, substantial delays could be
encountered in connection with the liquidation of defaulted Pledged Mortgages
and corresponding delays in the receipt of related proceeds by Bondholders could
occur. An action to foreclose on a Mortgaged Property securing a Pledged
Mortgage 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 Mortgaged 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 Mortgaged Property or to obtain
liquidation proceeds sufficient to repay all amounts due on the related Pledged
Mortgage. 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 Pledged Mortgages and not yet repaid, including
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 realizing upon 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.
NATURE OF SECURITY PROVIDED BY JUNIOR LIENS. Certain Pledged Mortgages may
be secured by second liens on the related Mortgaged Properties. As to Pledged
Mortgages secured by second mortgages, the proceeds from any liquidation,
insurance or condemnation proceedings will be available to satisfy the
outstanding balance of such Pledged Mortgages only to the extent that the claims
of such senior mortgages have been satisfied in full, including any related
foreclosure costs. In addition, the holder of a Pledged Mortgage secured by a
junior mortgage may not foreclose on the Mortgaged Property unless it forecloses
subject to the senior mortgages, in which case it must either pay the entire
amount due on the senior mortgages to the senior mortgagees at or prior to the
foreclosure sale or undertake the obligation to make payments on the senior
mortgages in the event the mortgagor is in default thereunder. The Issuer will
not have any source of funds to satisfy the senior mortgages or make payments
due to the senior mortgagees, although the Master Servicer or Servicer may, at
its option, advance such amounts to the extent deemed recoverable and prudent.
In the event that such proceeds from a foreclosure or similar sale of the
related Mortgaged Property are insufficient to satisfy all senior liens and the
Pledged Mortgage in the aggregate, the Issuer, as the holder of the junior lien,
and, accordingly, Holders of one or more Classes of the Bonds, to the extent not
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<PAGE> 81
covered by credit enhancement, are likely to (i) incur losses in jurisdictions
in which a deficiency judgment against the borrower is not available, and (ii)
incur losses if any deficiency judgment obtained is not realized upon. In
addition, the rate of default of second mortgage loans may be greater than that
of mortgage loans secured by first liens on comparable properties.
PREPAYMENT AND YIELD CONSIDERATIONS; REINVESTMENT RISK
The rate of payments of principal, including prepayments (including for
this purpose prepayments resulting from refinancing or liquidations of the
Pledged Mortgages or the mortgage loans underlying the Certificates, as the case
may be, due to defaults, casualties, condemnations and repurchases by the
Seller, the Issuer or Redwood Trust or purchases by the Master Servicer or the
Company), on the Mortgage Collateral securing a Series of Bonds will directly
affect the weighted average life of such Series of Bonds. The "weighted average
life" of a security refers to the average length of time, weighted by principal,
that will elapse from the date of issuance to the date each dollar of principal
is repaid to the investor. The yields to maturity and weighted average lives of
the Bonds will be affected primarily by the amount and timing of principal
payments received on or in respect of the Mortgage Collateral securing the
related Series of Bonds. The "yield to maturity" of a security refers to the
investment rate of return on such security if held to maturity. A Series of
Bonds may include one or more Classes of Deferred Interest Bonds with respect to
which certain accrued interest will not be paid but rather will be added to the
principal balance thereof and, as a result, yields on such Bonds will be
sensitive to (a) the provisions of such Deferred Interest Bonds relating to the
timing of payments of interest thereon and (b) if such Deferred Interest Bonds
accrue interest at a variable or adjustable rate, changes in such rate.
The rate of prepayments with respect to conventional mortgage loans has
fluctuated significantly in recent years. The rate of payment of principal,
including prepayments, on the Pledged Mortgages or the mortgage loans underlying
the Certificates, as the case may be, may be influenced by a variety of
economic, geographic, social, tax, legal and other factors. In general, if
prevailing interest rates fall significantly below the Mortgage Rates borne by
the mortgage loans underlying the Certificates or the Pledged Mortgages, such
mortgage loans or Pledged Mortgages are likely to be subject to higher
prepayment rates than if prevailing interest rates remain at or above such
Mortgage Rates. Conversely, if prevailing interest rates rise appreciably above
the Mortgage Rates borne by the mortgage loans underlying the Certificates or
the Pledged Mortgages, such mortgage loans or the Pledged Mortgages are likely
to experience a lower prepayment rate than if prevailing interest rates remain
at or below such Mortgage Rates. However, there can be no assurance that such
will be the case. In addition, the yields to maturity and weighted average lives
of the Bonds of a Series will be affected by the distribution of amounts
remaining in any Pre-Funding Account following the end of the related Funding
Period. In each case, Bondholders may be unable to reinvest such payments in
securities of comparable quality having interest rates similar to those borne by
such Bonds. It is possible that yields on any such reinvestments will be lower,
and may be significantly lower, than the yields on such Bonds.
The extent to which the yields to maturity of the Bonds of a Series may
vary from the anticipated yields will depend upon the degree to which such Bonds
are purchased at a discount or premium, and the degree to which the timing of
payments thereon is sensitive to the rate of payments of principal, including
prepayments, on the related Mortgage Collateral. The timing of changes in the
rate of prepayments on such Mortgage Collateral may significantly affect an
investor's actual yield to maturity, even if the average rate of principal
payments is consistent with an investor's expectation. The Prospectus Supplement
relating to a Series of Bonds 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 Bonds.
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",
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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 a Series
of Bonds. A lender also risks such liability on foreclosure of the related
property. See "CERTAIN LEGAL ASPECTS OF PLEDGED MORTGAGES -- Environmental
Risks" herein.
LIMITED LIQUIDITY OF INVESTMENT
Prior to issuance, there will have been no market for the Bonds of any
Series, and there can be no assurance that a secondary market for any Bonds will
develop or, if it does develop, that it will provide Bondholders with a
sufficient level of liquidity of investment or will continue while Bonds of such
Series remain outstanding. In addition, the market value of Bonds of any Series
may fluctuate with changes in prevailing rates of interest and prepayments,
spreads and other factors. Consequently, the sale of Bonds by a Bondholder in
any secondary market that may develop may be at a discount from their purchase
price. Issuance of the Bonds of a Series in book-entry form may also reduce the
liquidity of such Bonds since investors may be unwilling to purchase Bonds for
which they cannot obtain physical certificates. See "-- Effects of Book-Entry
Registration" herein. No Issuer is expected to apply to have the Bonds issued by
it listed on any exchange.
BANKRUPTCY AND INSOLVENCY RISKS
EFFECTS OF BANKRUPTCY OF REDWOOD TRUST OR DEPOSITOR. Redwood Trust and the
Depositor will treat the transfer of the Mortgage Collateral by Redwood Trust to
the Depositor as a sale for accounting purposes. The Depositor and each Issuer
will treat the transfer of Mortgage Collateral from the Depositor to such Issuer
as a sale for accounting purposes. As a sale of the Mortgage Collateral by
Redwood Trust to the Depositor, the Mortgage Collateral would not be part of
Redwood Trust's bankruptcy estate and would not be available to Redwood Trust's
creditors. However, in the event of the insolvency of Redwood Trust, it is
possible that the bankruptcy trustee or a creditor of Redwood Trust may attempt
to recharacterize the sale of the Mortgage Collateral as a borrowing by Redwood
Trust, secured by a pledge of the Mortgage Collateral. Similarly, as a sale of
the Mortgage Collateral by the Depositor to an Issuer, the Mortgage Collateral
would not be part of the Depositor's bankruptcy estate and would not be
available to the Depositor's creditors. However, in the event of the insolvency
of the Depositor, it is possible that the bankruptcy trustee or a creditor of
the Depositor may attempt to recharacterize the sale of the Mortgage Collateral
as a borrowing by the Depositor, secured by a pledge of the Mortgage Collateral.
In either case, in the event the transfer is recharacterized as a pledge, unless
otherwise provided in the related Prospectus Supplement, the Depositor or the
Issuer, as the case may be, will have a perfected security interest in the
related Mortgage Collateral. Nonetheless, a court could prevent timely payments
of amounts due on the Bonds and result in a reduction of payments due on the
Bonds.
EFFECTS OF BANKRUPTCY OF THE MASTER SERVICER. In the event of a bankruptcy
or insolvency of the Master Servicer, the bankruptcy trustee or receiver may
have the power to prevent the Bond Trustee or the Bondholders from appointing a
successor Master 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 Bond Trustee
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 Bonds of the related Series.
EFFECTS OF BANKRUPTCY OF OBLIGORS ON THE MORTGAGE COLLATERAL. 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 reduce the secured
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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 Mortgage Collateral securing a Series of
Bonds and possible reductions in the aggregate amount of such payments.
EFFECTS OF BOOK-ENTRY REGISTRATION
LIMITED LIQUIDITY. If the Bonds of a Series are issued in book-entry form,
such registration may reduce the liquidity of such Bonds in the secondary
trading market since investors may be unwilling to purchase Bonds for which they
cannot obtain physical certificates. Since transactions in book-entry Bonds can
be effected only through the Depository Trust Company ("DTC") in the United
States, CEDEL or Euroclear in Europe, participating organizations and Financial
Intermediaries (as defined herein), the ability of a Bondholder to pledge a
book-entry Bond to persons or entities that do not participate in the DTC, CEDEL
or Euroclear systems may be limited due to lack of a physical certificate
representing such Bonds. Bond Owners will not be recognized as Bondholders as
such term is used in the related Indenture, and Bond Owners will be permitted to
exercise the rights of Bondholders only indirectly through DTC and its
Participants.
POTENTIAL DELAYS IN PAYMENTS. In addition, Bond Owners may experience some
delay in their receipt of distributions of interest and principal on book-entry
Bonds since distributions are required to be forwarded by the Bond Trustee to
DTC and DTC will then be required to credit such distributions to the accounts
of depository participants which thereafter will be required to credit them to
the account of Bond Owners either directly or indirectly through Financial
Intermediaries. See "DESCRIPTION OF THE BONDS -- Book-Entry Bonds" herein.
RATINGS OF THE BONDS
RATINGS NOT A RECOMMENDATION. It will be a condition to the issuance of a
Class of Bonds offered hereby that they be rated in one of the four highest
rating categories by each Rating Agency identified as rating such Class in the
related Prospectus Supplement. Any such rating would be based on, among other
things, the adequacy of the value of the related Mortgage Collateral 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 Bonds
will receive payments to which such Bondholders are entitled under the
Indenture. Such rating will not constitute an assessment of the likelihood that
principal prepayments on mortgages underlying the related Mortgage Collateral
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 Bonds. Such rating shall not be deemed a recommendation to
purchase, hold or sell Bonds, 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 Bond at a significant premium might fail to recoup
its initial investment under certain prepayment scenarios.
RATINGS MAY BE LOWERED OR WITHDRAWN. There is also no assurance that any
such rating will remain in effect for any given period of time or may not be
lowered or withdrawn entirely by the applicable Rating Agency in the future if
in its judgment circumstances so warrant. In addition to being lowered or
withdrawn due to any erosion in the adequacy of the value of the assets of the
Issuer or any credit enhancement with respect to a Series of Bonds, 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.
LIMITATIONS OF ANALYSIS PERFORMED BY RATING AGENCIES. The amount, type and
nature of credit enhancement, if any, established with respect to a Class of
Bonds of a Series will be determined on the basis of criteria established by
each Rating Agency. 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
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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 mortgages
underlying the Mortgage Collateral. No assurance can be given that the values of
any Mortgaged Properties have remained or will remain at their levels on the
respective dates of origination of the related mortgages. If the residential
real estate markets should experience an overall decline in values such that the
outstanding principal balances of the mortgages underlying the Mortgage
Collateral securing a particular Series of Bonds and any secondary financing on
the related Mortgaged Properties become equal to or greater than the value of
the Mortgaged 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 Mortgage Collateral and, accordingly,
the rates of delinquencies, foreclosures and losses with respect to any Mortgage
Collateral securing a Series of Bonds. 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 Bonds of the related Series.
CREDIT CONSIDERATIONS AND RISKS
LIMITED SOURCE OF PAYMENTS. The Company does not have, nor is it expected
to have, any significant assets. Although the Bonds will be obligations of their
respective Issuers, no Issuer is expected to have significant assets other than
those pledged to secure separately the Series of Bonds issued by it. Unless
otherwise provided in the related Prospectus Supplement, the Bonds of a Series
will be payable solely from the assets pledged to secure such Series and will
not have any claim against or security interest in the assets pledged to secure
any other Series. There will be no recourse to the Company or Redwood Trust, or
any other person for any failure to make payments on the Bonds. In addition, at
the times set forth in the related Prospectus Supplement, certain Mortgage
Collateral and/or any balance remaining in the Bond Account for a Series of
Bonds immediately after making all payments due on such Bonds, after making any
other payments specified in the related Prospectus Supplement, may be promptly
released or remitted to the Company, Redwood Trust, any credit enhancement
provider or any other person entitled thereto and will no longer be available
for making payments on such Bonds. Consequently, investors in the Bonds of a
Series must rely solely upon payments of principal and interest on the Mortgage
Collateral pledged to secure such Series, the security therefor and the sources
of credit enhancement identified in the related Prospectus Supplement to provide
for payments on such Bonds.
NO RECOURSE TO COMPANY OR REDWOOD TRUST. The Bonds will not represent an
interest in or obligation of the Company or Redwood Trust or any affiliate
thereof. The only obligations, if any, of the Company with respect to the
Mortgage Collateral or the Bonds of any Series will be pursuant to certain
representations and warranties. The Company does not have, and is not expected
in the future to have, any significant assets with which to meet any obligation
to repurchase Mortgage Collateral with respect to which there has been a breach
of any representation or warranty. If, for example, the Company were required to
repurchase a Pledged Mortgage, 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 Redwood Trust or other Seller or (ii) to the
extent provided in the related Prospectus Supplement, from a Reserve Fund or
similar credit enhancement established to provide funds for such repurchases.
The only obligations of Redwood Trust or other Seller with respect to the
Mortgage Collateral or the Bonds of any Series will be pursuant to certain
representations and warranties. Redwood Trust or such other Seller may be
required to repurchase or substitute for any Pledged Mortgage with respect to
which such representations and warranties are breached. There is no assurance,
however, that Redwood Trust or such other Seller will have the financial ability
to effect any such repurchase or substitution.
LIMITATIONS OF DIRECT OR INDIRECT BACKING FOR BONDS. Only Agency
Certificates are guaranteed by any agency or instrumentality of the United
States and only the guarantee by GNMA of GNMA Certificates is entitled to the
full faith and credit of the United States. The guarantees by FNMA and FHLMC of
FNMA
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Certificates and FHLMC Certificates, respectively, are backed only by the credit
of FNMA, a federally chartered, privately owned corporation or by the credit of
FHLMC, a federally chartered corporation controlled by the Federal Home Loan
Banks. Neither the United States nor any agency thereof will be obligated to
finance the operations of FNMA or FHLMC or to assist either FNMA or FHLMC in any
other way. See "SECURITY FOR THE BONDS -- Agency Securities" herein. Although
payment of principal of, and interest on, any Agency Certificate securing all or
part of a Series of Bonds will be guaranteed by either GNMA, FNMA or FHLMC, such
guarantee will run only to such Agency Certificate and will not guarantee the
payment of principal or interest on the Bonds of such Series. The Prospectus
Supplement for a Series of Bonds which is secured in whole or in part by
Mortgage Collateral other than Agency Certificates may describe certain
arrangements through which such Bonds, such Private Mortgage-Backed Certificates
and/or the mortgage loans underlying such Private Mortgage-Backed Certificates
are insured, guaranteed or otherwise backed. Any such backing may be subject to
contingencies described in the applicable Prospectus Supplement and will be
limited to the credit and assets of the particular specified insurer or
guarantor and will not be entitled to the full faith and credit of the United
States or to any agency or instrumentality thereof.
DEFICIENCY ON SALE OF MORTGAGE COLLATERAL. In the event of an acceleration
of the payment of the Bonds of a Series, upon an Event of Default (as defined
herein) under the Indenture with respect to such Series, there is no assurance
that the proceeds from any sale of the Mortgage Collateral would be sufficient
to pay in full the outstanding principal amount of such Series of Bonds together
with interest accrued thereon. The market value of such Mortgage Collateral
generally will fluctuate with changes in prevailing rates of interest.
Consequently, such Mortgage Collateral may be liquidated at a discount, in which
case the proceeds of liquidation might be less than the aggregate outstanding
principal amount and interest payable on the Bonds of such Series. Although the
Bonds will be obligations of their respective Issuers, no Issuer is expected to
have significant assets other than those pledged to secure separately the Series
of Bonds issued by it. It is therefore unlikely that the Issuer will have
sufficient other assets available for payment of any such deficiency. If,
following an Event of Default, a Series of Bonds has been declared to be due and
payable, the Bond Trustee may, in its discretion, but subject to the direction
of the Bondholders, refrain from selling the collateral for such Series of Bonds
and continue to apply amounts received on the collateral to payments due on the
Bonds of such Series in accordance with their terms, notwithstanding the
acceleration of the maturity of such Bonds. See "THE INDENTURE -- Rights Upon
Events of Default" herein.
EFFECT OF SUBORDINATION. If so specified in the related Prospectus
Supplement, the rights of the holders of one or more Classes of Subordinated
Bonds will be subordinate to the rights of one or more Classes of Senior Bonds
of such Series to payments of principal and/or interest (or any combination
thereof) to the extent specified in the related Prospectus Supplement. Although
subordination is intended to reduce the risk to holders of Senior Bonds of
delinquent payments or ultimate losses, the amount of subordination will be
limited. In addition, if principal payments on one or more Classes of Bonds of a
Series are made in a specified order of priority, any limits with respect to the
aggregate amount of claims under any related credit enhancement may be exhausted
before the principal of the lower priority Classes of Bonds of such Series has
been repaid. As a result, the impact of significant losses on the Mortgage
Collateral may be borne first by any Class of Subordinated Bonds of a Series and
thereafter by the Classes of Senior Bonds of such Series, in each case to the
extent described in the related Prospectus Supplement.
LIMITATIONS, REDUCTION AND SUBSTITUTION OF CREDIT ENHANCEMENT. The
Prospectus Supplement for a Series of Bonds will describe any credit enhancement
for such Series, which may include cash accounts, insurance policies, surety
bonds, guaranteed investment contracts, cross-collateralization,
overcollateralization, excess spread, reinvestment income, guarantees, letters
of credit or derivative arrangements to the extent described herein and therein.
Although credit enhancement is intended to reduce the risk of delinquent
payments or losses to holders of Bonds 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
Bonds, and as a result Bondholders 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 fraud or negligence by a
loan originator or other parties.
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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 Bonds,
provided each applicable Rating Agency indicates that the then-current rating of
the Bonds of such Series will not be adversely affected. See "CREDIT
ENHANCEMENT" herein.
The amount of applicable credit enhancement supporting one or more Classes
of Bonds of a Series, including the subordination of one or more Classes of
Bonds, will be determined on the basis of criteria established by each Rating
Agency rating such Classes of Bonds based on, among other things, assumptions
regarding levels of defaults, delinquencies and losses. There can be no
assurance that the default, delinquency and loss experience on the related
Mortgage Collateral will not exceed such assumed levels. See "-- Ratings of the
Bonds" herein.
DELINQUENT LOANS MAY ADVERSELY AFFECT INVESTMENT. Certain of the Pledged
Mortgages or mortgage loans underlying the Certificates securing a Series of
Bonds may be past due or non-performing as of the related Cut-off Date.
Investors should consider the risk that the inclusion of such loans in the
Mortgage Collateral for a Series of Bonds may affect the rate of defaults and
prepayments on such Mortgage Collateral and the yield on the Bonds of such
Series.
PRE-FUNDING ACCOUNTS MAY RESULT IN REINVESTMENT RISK
If so specified in the related Prospectus Supplement, on the related
Closing Date the Depositor will deposit cash in an amount (the "Pre-Funded
Amount") specified in such Prospectus Supplement into an account (the
"Pre-Funding Account"). The Pre-Funded Amount will be used to purchase
additional Pledged Mortgages and/or Certificates ("Subsequent Mortgage
Collateral") during 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 Depositor (which, in turn, will acquire such Subsequent Mortgage Collateral
from Redwood Trust). The Pre-Funding Account will be maintained with the Bond
Trustee for the related Series of Bonds and is designed solely to hold funds to
be applied by such Bond Trustee during the Funding Period to pay to the
Depositor the purchase price for Subsequent Mortgage Collateral. Monies on
deposit in the Pre-Funding Account will not be available to cover losses on or
in respect of the related Mortgage Collateral. To the extent that the entire
Pre-Funded Amount has not been applied to the purchase of Subsequent Mortgage
Collateral 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
Bondholders 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 Bonds. See "SECURITY FOR THE BONDS -- Pre-Funding Account"
herein.
PRE-FUNDING ACCOUNTS MAY ADVERSELY AFFECT INVESTMENT
The ability of the Issuer to acquire Subsequent Mortgage Collateral during
the Funding Period will be dependent upon the ability of the Depositor to
acquire Subsequent Mortgage Collateral that satisfies the requirements described
in the related Prospectus Supplement. Although such Subsequent Mortgage
Collateral must satisfy the characteristics described in the related Prospectus
Supplement, such Subsequent Mortgage Collateral may have certain different
characteristics, including, without limitation, a more recent origination date
than the initial Mortgage Collateral. As a result, the addition of such
Subsequent Mortgage Collateral pursuant to the Pre-Funding Account may adversely
affect the performance of the related Bonds. See "SECURITY FOR THE
BONDS -- Pre-Funding Account" herein.
CONSEQUENCES OF OWNING ORIGINAL ISSUE DISCOUNT BONDS
All of the Deferred Interest Bonds will be, and certain of the other Bonds
may be, issued with original issue discount for federal income tax purposes. A
holder of a Bond issued with original issue discount will be required to include
original issue discount in ordinary gross income for federal income tax purposes
as it accrues, in advance of receipt of the cash attributable to such income.
Accrued but unpaid interest on the
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Deferred Interest Bonds generally will be treated as original issue discount for
this purpose. See "FEDERAL INCOME TAX CONSEQUENCES -- Interest and Original
Issue Discount" and "-- Market Discount" herein.
CONSOLIDATED TAX RETURN
Whether or not the Bonds are treated as debt for federal income tax
purposes, so long as such Bonds are not deemed to have two or more maturities,
the Issuer will be treated as a branch of Redwood Trust or a partnership for
federal income tax purposes. However, if the Issuer is deemed to have issued
debt with two or more maturities, it will be treated as a taxable mortgage pool
that is a "qualified REIT subsidiary" of Redwood Trust. If such an Issuer were
to fail to be treated for federal income tax purposes as a "qualified REIT
subsidiary" by reason of Redwood Trust's failure to continue to qualify as a
real estate investment trust ("REIT") for federal income tax purposes or for any
other reason, the net income of the Issuer would be subject to corporate income
tax and the Issuer would not be permitted to be included on a consolidated
income tax return of another corporate entity. No assurance can be given with
regard to the prospective qualification of an Issuer as a qualified REIT
subsidiary or of Redwood Trust as a REIT for federal income tax purposes. See
"FEDERAL INCOME TAX CONSEQUENCES" herein.
INTRODUCTION
Sequoia Mortgage Funding Corporation, a Delaware corporation (the
"Company"), proposes to establish one or more trusts to issue and sell Bonds
from time to time under this Prospectus and related Prospectus Supplements. The
Company is a limited purpose finance corporation whose capital stock is wholly
owned by Redwood Trust, Inc. ("Redwood Trust"). Redwood Trust, a Maryland
corporation, has elected to be treated as a real estate investment trust under
the Internal Revenue Code of 1986, as amended (the "Code"). The Company was
formed for the sole purpose of acting as the depositor of one or more trusts to
be formed for the purpose of issuing the Bonds offered hereby and by the related
Prospectus Supplements. Each trust that is formed to act as an Issuer will be
created pursuant to an agreement between the Company acting as depositor (in
such capacity, the "Depositor"), and a bank, trust company or other fiduciary,
acting as owner trustee (the "Owner Trustee"). Each trust will be established
solely for the purpose of issuing one Series of Bonds and engaging in
transactions relating thereto. Each Series of Bonds will be separately secured
by the collateral described in the Prospectus Supplement relating to such
Series, which collateral will constitute the only significant assets available
to make payments on the Bonds of such Series. Accordingly, the investment
characteristics of a Series of Bonds will be determined by the collateral
pledged to secure such Series and will not be affected by the identity of the
obligor with respect to such Series of Bonds. The term "Issuer," as used herein,
with respect to a Series of Bonds refers to the trust established by the Company
for the sole purpose of issuing such Series of Bonds.
Each Series of Bonds will be issued pursuant to a separate Indenture (the
"Indenture") between the Issuer of such Series and a bank or trust company
acting as trustee for the holders of such Bonds (the "Bond Trustee"). A form of
the Indenture has been filed as an exhibit to the Registration Statement of
which this Prospectus forms a part. The Indenture relating to each Series of
Bonds will be filed with the Securities and Exchange Commission as soon as
practicable following the issuance of such Series of Bonds.
THE ISSUER
GENERAL
Any trust established to act as Issuer of a Series of Bonds will be created
pursuant to a deposit trust agreement between the Company and a bank, trust
company or other fiduciary acting as Owner Trustee. Under the terms of each
deposit trust agreement, the Company initially will retain the entire beneficial
interest in the trust created thereunder unless otherwise specified in the
related Prospectus Supplement. The Company may thereafter sell or assign all or
a portion of such beneficial ownership to another entity or entities unless
prohibited from doing so by the related deposit trust agreement. The beneficial
owners of each Issuer will have no liability for the obligations of the Issuer
under the Bonds issued by it. Unless otherwise specified in the related
Prospectus Supplement, each Issuer will be managed by Redwood Trust.
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The Mortgage Collateral for each Series of Bonds will have been deposited
with the Issuer of such Series by the Company which, in turn, will have either
(i) received such collateral from Redwood Trust (or an affiliate) as a
contribution to the Company's capital or (ii) acquired such collateral from
Redwood Trust (or an affiliate) or another entity or entities (in such capacity,
each a "Seller"), as provided in the related Prospectus Supplement, in exchange
for the net proceeds from the issuance of such Series plus the beneficial
interest in the Issuer issuing such Series. (References herein to Redwood Trust
in its capacity as Seller shall be deemed to include any affiliate of Redwood
Trust acting in such capacity.) Redwood Trust acquires mortgage loans in the
normal course of its business from persons who have originated or otherwise
acquired such loans.
Upon the issuance of each Series of Bonds, the related Mortgage Collateral
will be deposited by the Company with the Issuer of such Series and pledged by
such Issuer to the Bond Trustee under the related Indenture to secure such
Series of Bonds. The Indenture with respect to each Series of Bonds will
prohibit the incurrence of further indebtedness by the Issuer of such Series of
Bonds. The Bond Trustee will hold the Mortgage Collateral for a Series of Bonds
as security pledged only for that Series, and holders of the Bonds of that
Series will be entitled to the equal and proportionate benefits of such
security.
Each deposit trust agreement will provide that the related trust may not
conduct any activities other than those related to the issuance and sale of the
Bonds of the particular Series issued by it and such other limited activities as
may be required in connection with reports and distributions to holders of
beneficial interests in the trust. No deposit trust agreement will be subject to
amendment without the prior written consent of the Bond Trustee for the related
Series, which consent may not be unreasonably withheld if such amendment would
not adversely affect the interests of the Bondholders of such Series. The
holders of the beneficial interest in each Issuer will not be liable for payment
of principal and interest on the Bonds, and holders of Bonds of each Series will
be deemed to have released the holders of beneficial interest from any claim,
liability or obligation on or with respect to the Bonds of such Series.
THE COMPANY
The Company was incorporated in the State of Delaware on January 31, 1997
and is a limited purpose finance subsidiary of Redwood Trust. The Company is a
qualified real estate investment trust subsidiary. Redwood Trust is a publicly
owned real estate investment trust. The Company's principal executive offices
are located at 591 Redwood Highway, Suite 3125, Mill Valley, California 94941.
The Company's telephone number is 415-381-1765.
Redwood Trust has agreed with the Company that Redwood Trust will not file
or cause to be filed any voluntary petition in bankruptcy against the Company or
any trust created by it until at least one year after the date on which the
Bonds have been paid in full, if at all.
USE OF PROCEEDS
The net proceeds to be received from the sale of the Bonds of each Series
will be applied by the Company to the purchase or acquisition of the related
Mortgage Collateral or the payment of expenses incurred in connection with the
issuance of Bonds and otherwise incurred in connection with the conduct of the
Company's operations. The Mortgage Collateral pledged to secure a Series of
Bonds will either be contributed to the Company's capital by Redwood Trust (or
an affiliate) or acquired by the Company from Redwood Trust (or an affiliate) or
another Seller and deposited with the Issuer of such Series by the Company.
MORTGAGE LOAN PROGRAM
The Pledged Mortgages will have been purchased by the Depositor, either
directly or through affiliates, from Sellers. The Pledged Mortgages so acquired
by the Depositor will have been originated substantially in accordance with the
underwriting criteria specified below under "Underwriting Standards."
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UNDERWRITING STANDARDS
Unless otherwise specified in the related Prospectus Supplement, each
Seller will represent and warrant that all Pledged Mortgages originated and/or
sold by it to the Depositor or one of its affiliates will have been underwritten
in accordance with standards consistent with those utilized by mortgage lenders
generally during the period of origination. The related Prospectus Supplement
will include detailed information with respect to the underwriting standards
employed by the applicable originators of the Pledged Mortgages, to the extent
such information is reasonably available to the Depositor. Such information may
include, as applicable, underwriting guidelines with respect to required
borrower income, debt to income ratios, credit histories, loan-to-value ratios
and documentation and verification requirements.
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 Mortgaged Property as collateral. In general, a prospective
borrower applying for a 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 conditions, 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. In most cases, an employment
verification is obtained from an independent source (typically the borrower's
employer) which verification reports, among other things, 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. 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. 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. The maximum Loan-to-Value Ratio is generally not expected to
exceed 95%. Most loans with Loan-to-Value Ratios in excess of 80% at origination
must be covered by private mortgage insurance insuring the balance thereof down
to a 75% Loan-to-Value Ratio. The method of calculating the "Loan-to-Value
Ratio" of a Pledged Mortgage will be described in the Prospectus Supplement for
a Series of Bonds secured by Pledged Mortgages.
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 (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 (ii)
to meet monthly housing expenses and other financial obligations and monthly
living expenses. The maximum housing expense to income ratio referred to in (i)
is generally not expected to exceed 40% and the maximum debt to income ratio
described in (ii) is generally not expected to exceed 55%. The underwriting
standards applied by Sellers may be varied in appropriate cases where factors
such as low Loan-to-Value Ratios or other favorable credit issues exist.
The Depositor expects that a substantial portion of the Pledged Mortgages
it purchases will be "jumbo" loans, i.e., loans that exceed the maximum balance
for purchase by FNMA or FHLMC. Under current regulations, the maximum principal
balance allowed on loans eligible for purchase by FNMA or FHLMC ranges from
$214,600 ($321,900 for mortgage loans secured by mortgaged properties located in
either Alaska or Hawaii) for one-unit to $412,450 ($618,675 for mortgage loans
secured by mortgaged properties located in either Alaska or Hawaii) for
four-unit residential loans. The maximum loan amount is generally not expected
to exceed $1,500,000 in the case of any of the foregoing types of loans.
A lender may originate mortgage loans under a reduced documentation
program. A reduced documentation program is designed to facilitate the loan
approval process and thereby improve the lender's competitive
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position among other loan originators. Under a reduced documentation program,
relatively more emphasis is placed on property underwriting than on credit
underwriting and certain underwriting documentation concerning income and
employment verification is waived.
In the case of a loan secured by a leasehold interest in a real property,
the title to which is held by a third party lessor, generally, the Seller will
be required to 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 mortgage loan.
Certain of the types of loans which may be included in the Mortgage
Collateral are recently developed and may involve additional uncertainties not
present in traditional types of loans. For example, certain of such Pledged
Mortgages may provide for escalating or variable payments by the mortgagor or
obligor. These types of Pledged Mortgages are underwritten on the basis of a
judgment that mortgagors or obligors will have the ability to make monthly
payments required initially. In some instances, however, a mortgagor's or
obligor'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 Loan-to-Value Ratios or other favorable credit factors.
QUALITY CONTROL
The Depositor's parent, Redwood Trust, has developed a quality control
program to monitor the quality of loan underwriting at the time of acquisition
and on an ongoing basis. All loans purchased by the Depositor will be subject to
this quality control program. A legal document review of each loan acquired will
be conducted to verify the accuracy and completeness of the information
contained in the mortgage notes, security instruments and other pertinent
documents in the file. A sample of loans to be acquired, selected by focusing on
those loans with higher risk characteristics, will normally be submitted to a
third party nationally recognized underwriting review firm for a compliance
check of underwriting and review of income, asset and appraisal information.
REPRESENTATIONS BY SELLERS; REPURCHASES
Each Seller will have made representations and warranties in respect of the
mortgage loans sold by such Seller and included in the Pledged Mortgages
securing a Series of Bonds. Such representations and warranties generally
include, among other things: (i) that title insurance (or in the case of
Mortgaged Properties located in areas where such policies are generally not
available, an attorney's certificate of title) and any required hazard insurance
policy and Primary Mortgage Insurance Policy (as defined herein) were effective
at the origination of each mortgage loan other than Cooperative Loans, and that
each policy (or certificate of title as applicable) remained in effect on the
date of purchase of the mortgage loan from the Seller by or on behalf of the
Company; (ii) that the Seller had good title to each such mortgage loan and such
mortgage loan was subject to no offsets, defenses, counterclaims or rights of
rescission except to the extent that any buydown agreement described herein may
forgive certain indebtedness of the obligors on such Pledged Mortgages (each, a
"Mortgagor"); (iii) that each mortgage loan constituted a valid first or junior
lien, as the case may be, on the Mortgaged Property (subject only to permissible
title insurance exceptions, if applicable, and certain other exceptions
described in the Master Servicing Agreement) and that the Mortgaged Property was
free from damage and was in good repair; (iv) that there were no delinquent tax
or assessment liens against the Mortgaged Property; (v) that no required payment
on a mortgage loan was 60 or more days delinquent at any time during the twelve
months prior to the date it is pledged to secure the related Series of Bonds;
and (vi) that each mortgage loan was made in compliance with, and is enforceable
under, all applicable local, state and federal laws and regulations in all
material respects.
If the Seller cannot cure a breach of any representation or warranty made
by it in respect of a Pledged Mortgage that materially and adversely affects the
interests of the Bondholders in such Pledged Mortgage within 90 days after
notice of such breach, then such Seller will be obligated to either (i)
substitute a similar mortgage loan for such Pledged Mortgage under the
conditions specified in the related Prospectus Supplement or (ii) repurchase
such Pledged Mortgage from the Issuer at a price (the "Purchase Price") equal to
100% of
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the outstanding principal balance thereof as of the date of the repurchase plus
accrued interest thereon to the first day of the month following the month in
which such Pledged Mortgage is repurchased at the Mortgage Rate (less any
unrelinquished advances or amount payable as related master servicing
compensation if the Seller is the Master Servicer with respect to such Pledged
Mortgage). The Master Servicer will be required under the applicable Master
Servicing Agreement and Indenture to enforce this obligation for the benefit of
the Bond Trustee and the Bondholders, following the practices it would employ in
its good faith business judgment were it the owner of such Pledged Mortgage.
These substitution or repurchase obligations will constitute the sole remedies
available to Bondholders or the Bond Trustee for a breach of representation by a
Seller.
DESCRIPTION OF THE BONDS
GENERAL
Each Series of Bonds offered hereby and by the related Prospectus
Supplement will be issued pursuant to a separate Indenture between the Issuer of
such Series and the Bond Trustee for such Series. The following summaries
describe certain provisions common to each Series of Bonds. The summaries are
subject to, and are qualified in their entirety by reference to, the Prospectus
Supplement and the provisions of the Indenture relating to each Series of Bonds.
Summaries of particular provisions or terms used in the Indenture incorporate by
reference the actual provisions (including definitions of terms) as part of such
summaries, and are qualified in their entirety by reference to the actual
provisions of the Indenture.
The Bonds are issuable in Series. Each Series may include one or more
Classes of Bonds ("Deferred Interest Bonds") upon which interest will accrue but
will not be payable, except in certain circumstances upon the optional
redemption thereof or as otherwise provided in the related Prospectus
Supplement. Prior to such time, the amount of interest so accrued will be added
to the principal of such Class of Deferred Interest Bonds on each Payment Date.
(Indenture, Section 2.03) A Series of Bonds may include one or more Classes that
are senior in right of payment to one or more other Classes of Bonds of such
Series. A Series of Bonds may also include one or more Classes of zero coupon
bonds. The Bonds of each Series will be issued in either fully registered or
book-entry form in the authorized denominations specified in the related
Prospectus Supplement. (Indenture, Section 2.04) The transfer of the Bonds will
be registered and the Bonds may be exchanged without the payment of any service
charge other than any tax or governmental charge payable in connection with such
registration of transfer or exchange. (Indenture, Section 2.07)
Payments of principal of, and interest on, each Series of Bonds will be
made on the Payment Dates set forth in the Prospectus Supplement relating to
such Series by check mailed to Bondholders of such Series registered as such on
the related Record Date preceding such Payment Date at their addresses appearing
on the Bond Register, except that final payments of principal in retirement of
each Bond will be made only upon presentation and surrender of such Bond at the
office or agency of the Issuer maintained for that purpose. (Indenture, Section
2.09(a) and (b)) Notice will be mailed before the Payment Date on which the
final principal payment on any Bond is expected to be made by the Bond Trustee
to the holder of such Bond. (Indenture, Section 2.09(b)) Payments in respect of
interest and principal on the Bonds will be made by the Bond Trustee, or such
other bank, trust company or other fiduciary identified in the related
Prospectus Supplement, as the paying agent of the Issuer. (Indenture, Section
3.03)
The Bond Trustee will include with each payment on a Bond which includes
principal and interest a statement showing the allocation of such payment to
principal and interest and the remaining unpaid principal amount of such Bond.
Payments on Bonds which include only interest will be accompanied by a statement
showing the aggregate unpaid principal amount of the Bonds of each Class of the
same Series. On each Payment Date before payments of principal are first made on
a particular Class of Deferred Interest Bonds of a Series, the Bond Trustee for
such Series will furnish to each holder of a Bond of such Class a statement
showing the aggregate unpaid principal amount of such Class of Bonds and the new
principal balance of such holder's Deferred Interest Bond.
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PAYMENTS OF INTEREST
The Bonds of each Class will bear interest on their unpaid principal
amounts from the date and at the rates per annum specified or determined in the
manner set forth in the related Prospectus Supplement (calculated on the basis
of a 360-day year of twelve 30-day months unless otherwise specified in the
related Prospectus Supplement) until the principal amount of the Bonds of such
Class is paid in full. Interest on a Series of Bonds or on a Class of Bonds
within a Series may accrue at a fixed rate, a variable rate or a combination
thereof, as determined or reset in the manner specified in the related
Prospectus Supplement. Interest on the Bonds other than Deferred Interest Bonds
will be due and payable on the Payment Dates specified in the related Prospectus
Supplement. Payments of interest on each Class of Deferred Interest Bonds will
commence as specified in the related Prospectus Supplement. Prior to such time,
interest on such Class of Deferred Interest Bonds will accrue and the amount of
interest so accrued will be added to the principal thereof on each Payment Date.
Such Class of Deferred Interest Bonds will thereafter accrue interest on the
outstanding principal amount thereof as so adjusted. Each such payment or
accrual of interest will include all interest accrued either to, but not
including, the related Payment Date or through a date prior to such Payment Date
as specified in the related Prospectus Supplement. In the latter case, the
effective yield to the Bondholders will be reduced to a level below the yield
that would apply if interest were accrued to, but not including, the respective
Payment Date.
A Series of Bonds or one or more Classes of Bonds within a Series may bear
interest at a variable rate (the "Floating Rate Bonds") which may have an
interest rate cap or an interest rate floor, or both, as specified in the
related Prospectus Supplement. The interest payment dates on Floating Rate Bonds
will be set forth in the related Prospectus Supplement and may not be the same
as the interest payment dates for the other Bonds of such Series, but may be
either more or less frequent. The variable interest rate formula for any Series
or Class of Floating Rate Bonds will generally be based off a financial index
recognized in the national or international financial markets. The Prospectus
Supplement for any Series or Class within a Series of Floating Rate Bonds will
set forth the initial interest rate, the index upon which adjustments thereto
will be computed, the formula for such computation, the intervals at which such
computations will be made, the maximum and minimum interest rates, if any, and
other characteristics common to such Bonds.
PAYMENTS OF PRINCIPAL
Principal payments on each Series of Bonds will be made on each Payment
Date in an amount equal to the sum of (a) if specified in the related Prospectus
Supplement, the amount of interest, if any, accrued but not then payable on the
Deferred Interest Bonds of such Series from the prior Payment Date or, if
specified in the related Prospectus Supplement, from a date prior to such prior
Payment Date and (b) either (i) the percentage or percentages specified in the
related Prospectus Supplement of the funds available for such purpose
("Available Funds") for such Payment Date or (ii) the sum of (x) an amount
determined by reference to the aggregate decline in the Bond Values of the
Mortgage Collateral securing such Series of Bonds in the related Due Period and
(y) the amount, if any, of the Spread specified in such Prospectus Supplement.
The Prospectus Supplement for each Series of Bonds will specify the manner in
which the Available Funds or the Bond Values, as applicable, will be determined.
The aggregate amount of principal payments required to be made on a Series of
Bonds on any Payment Date will be reduced by the principal amount of the Bonds
of such Series redeemed pursuant to any special redemption and certain optional
redemptions occurring subsequent to the preceding Payment Date. See "DESCRIPTION
OF THE BONDS -- Special Redemption" and " -- Optional Redemption" herein.
The Bond Value of Mortgage Collateral securing the Bonds of a Series
represents the principal amount of Bonds of such Series that, based on certain
assumptions and irrespective of prepayments on such Mortgage Collateral, can be
supported by scheduled distributions on such Mortgage Collateral, together with
(depending on the method used to determine the Bond Value of the Mortgage
Collateral) the reinvestment earnings thereon at the rate described in the
related Prospectus Supplement (the "Assumed Reinvestment Rate") and, if
applicable, the cash available to be withdrawn from a related Reserve Fund, if
any. For convenience of calculation with respect to each Series of Bonds,
Certificates securing a Series of Bonds that are backed by a pool of mortgage
loans sharing similar payment characteristics, or Pledged Mortgages which secure
a Series of
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Bonds and share similar payment characteristics, may be aggregated into one or
more groups (each, a "Collateral Group") each of which will be assigned an
aggregate Bond Value.
If so specified in the related Prospectus Supplement, the aggregate Bond
Value of a Collateral Group consisting of Pledged Mortgages or Certificates
sharing similar payment characteristics will be calculated as if such Pledged
Mortgages or the mortgage loans underlying such Certificates constituted a
single mortgage loan having such of the payment characteristics of such Pledged
Mortgages or of the mortgage loans underlying the Certificates included in such
Collateral Group as would result in the lowest Bond Value being assigned to the
Pledged Mortgages or Certificates included in such Collateral Group. There are a
number of alternative means of determining the Bond Value of a mortgage loan or
of collateral backed by mortgage loans, including determinations based on the
discounted present value of the remaining scheduled distributions on such
mortgage loans and determinations based on the relationship of the interest rate
borne by such mortgage loans and by the related Bonds. If applicable, the
Prospectus Supplement for a Series of Bonds will specify the method or methods
used to determine the Bond Values of the Collateral Groups securing such Series
of Bonds. The aggregate of the Bond Values on any Payment Date of all such
Collateral Groups will be at least equal to the outstanding principal amount of
the Bonds of such Series.
If applicable, the Assumed Reinvestment Rate for a Series of Bonds will be
described in the related Prospectus Supplement and may be any rate permitted by
each applicable Rating Agency or a rate provided under a guaranteed investment
contract, surety bond or similar arrangement satisfactory to each applicable
Rating Agency. If the Assumed Reinvestment Rate is so provided, the related
Prospectus Supplement will describe the terms of such arrangement.
Unless the related Prospectus Supplement provides otherwise, the Spread, if
applicable, for each Series of Bonds as of any Payment Date will be the excess,
if any, of the sum of (i) all distributions received with respect to the
Mortgage Collateral securing such Series of Bonds in the related Due Period,
(ii) the reinvestment income thereon and (iii) amounts which are required or are
permitted to be withdrawn from a Reserve Fund, if any, less the sum of (i) all
interest payable on the Bonds of such Series on such Payment Date, (ii) the
Basic Principal Payment required to be made on such Series of Bonds on such
Payment Date and (iii) an amount reflecting the redemption price of any Bonds of
such Series redeemed during the related Due Period and the expenses accrued by
the Issuer during the related Due Period relating to the administration of such
Series of Bonds.
Payments of principal will be allocated among the Classes of Bonds
comprising a Series in the manner specified in the related Prospectus Supplement
and, with respect to a particular Class of Bonds, will be applied on a pro rata
basis, unless otherwise specified in the related Prospectus Supplement. Each
Class of Bonds will be scheduled to be fully paid no later than the Stated
Maturity for such Class of Bonds specified in the related Prospectus Supplement.
If so specified in the related Prospectus Supplement, holders of one or more
Classes of Bonds of a Series may have the right, at their option, to receive
full payment in respect of such Bonds prior to Stated Maturity, in each case to
the extent and under the circumstances specified in their related Prospectus
Supplement.
SPECIAL REDEMPTION
If so specified in the related Prospectus Supplement, the Bonds of each
Series or Class may be subject to special redemption, in whole or in part, under
the circumstances and in the manner described below or in the related Prospectus
Supplement. If applicable, the Issuer will be required to redeem, on the day of
any month specified in the related Prospectus Supplement, outstanding Bonds of a
Series in the amount described below if, as a result of substantial payments of
principal on the Pledged Mortgages or the mortgage loans underlying the
Certificates pledged as security for such Series of Bonds or low reinvestment
yields, or both, the Bond Trustee determines, based on the procedures and
assumptions specified in the Indenture, that, in the absence of such special
redemption, the amount of cash to be on deposit in the related Bond Account on
the next Payment Date for such Series of Bonds would be insufficient to make
required payments on the Bonds of such Series on such Payment Date. (Indenture,
Section 10.01) The amount of Bonds required to be so redeemed will not exceed
the distributions on the Mortgage Collateral securing such Series of Bonds
received during the
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Due Period that would otherwise be required to be applied to the payment of
principal of such Series of Bonds on the following Payment Date.
All payments of principal pursuant to any special redemption will be made
in the priority and manner specified in the related Prospectus Supplement. Bonds
of the same Class will be redeemed in the manner specified in the related
Prospectus Supplement. Notice of any such redemption must be mailed by the
Issuer or the Bond Trustee at least five days prior to the special redemption
date. (Indenture, Section 10.02) The redemption price required to be paid for
any Bond to be so redeemed will be equal to 100% of the principal amount thereof
together with accrued interest. (Indenture, Section 10.01)
OPTIONAL REDEMPTION
If so provided in the related Prospectus Supplement, the Bonds of any Class
of a Series may be subject to redemption at the option of the Issuer. Unless
otherwise provided in the related Prospectus Supplement, notice of any such
redemption must be given by the Issuer to the Bond Trustee not less than 30 days
prior to the redemption date and must be mailed by the Issuer or the Bond
Trustee to affected Bondholders at least five days prior to the redemption date.
(Indenture, Sections 10.01 and 10.02) The Prospectus Supplement for each Series
will specify the circumstances, if any, under which the Bonds of such Series may
be so redeemed, the manner of effecting such redemption, the conditions to which
such redemption are subject and the redemption prices for each Class of Bonds to
be redeemed.
CALL PROTECTION AND GUARANTEES
The Issuer also may, at its option, obtain for any Series of Bonds one or
more guarantees from a company or companies acceptable to each applicable Rating
Agency, which guarantees may provide for (i) call protection (which may include
yield maintenance) for any Class of Bonds of such Series or (ii) a guarantee of
a certain prepayment rate with respect to some or all of the Pledged Mortgages
or mortgage loans underlying the Certificates pledged as collateral for such
Series. Any call protection or guarantees may affect the weighted average life
of the Bonds of such Series.
WEIGHTED AVERAGE LIFE OF THE BONDS
All of the Pledged Mortgages securing a Series of Bonds will consist of
mortgage loans which are neither insured nor guaranteed by any governmental
agency ("Conventional Loans"). See "SECURITY FOR THE BONDS -- The Pledged
Mortgages" herein. The mortgage loans underlying the Private Mortgage-Backed
Securities, FHLMC Certificates and FNMA Certificates securing a Series of Bonds
will consist of either Conventional Loans, FHA Loans (as defined herein) or VA
Loans (as defined herein), or any combination thereof. The mortgage loans
underlying the GNMA Certificates securing a Series of Bonds will consist of FHA
Loans or VA Loans. Each Pledged Mortgage and each Certificate will provide by
its terms for monthly payments (or, in the case of Private Mortgage-Backed
Securities, such other period as may be specified in the related Prospectus
Supplement) of principal and interest in the amounts described in "SECURITY FOR
THE BONDS -- The Pledged Mortgages," " -- Agency Securities," and " -- Private
Mortgage-Backed Securities" herein.
Since the aggregate amount of the principal payment required to be made on
a Series of Bonds on a Payment Date will depend on the amount of the principal
payments (including for this purpose prepayments resulting from refinancing or
liquidations due to defaults, casualties, condemnations and repurchases by the
Seller, the Issuer or Redwood Trust or purchases by the Master Servicer or the
Company) received on the related Pledged Mortgages or Certificates, as the case
may be, in the related Due Period, the prepayment experience on the underlying
mortgage loans (with respect to a Series of Bonds secured by Certificates) or on
the Pledged Mortgages (with respect to a Series of Bonds secured by Pledged
Mortgages) will affect (i) the weighted average life of each Class of Bonds and
(ii) the extent to which such Class is paid prior to its Stated Maturity. The
prepayment experience on the Pledged Mortgages which secure a Series of Bonds
may be affected by recoveries on foreclosures or other liquidations of Pledged
Mortgages and by losses from defaults and delinquencies on Pledged Mortgages.
See "SERVICING OF THE PLEDGED MORTGAGES" herein.
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The weighted average life of each outstanding Class of Bonds also may be
affected by the actual reinvestment income earned on the payments on the
Mortgage Collateral, if applicable, if a portion of the Spread is paid as a
principal payment on such Bonds and by the exercise by the Issuer of its right
to substitute other Mortgage Collateral for the Mortgage Collateral originally
pledged as security for such Bonds. Although any substitute Mortgage Collateral
will have payment terms anticipated to result in a cash flow substantially
similar to, but in no event less than, the anticipated cash flow of the Mortgage
Collateral it replaces, such substitutions may, individually or in the
aggregate, affect the weighted average life of such Bonds. See "SECURITY FOR THE
BONDS -- Substitution of Mortgage Collateral" herein. Further, the weighted
average life of each Class of a Series of Bonds secured by FNMA Certificates may
be affected by the exercise by FNMA of its right to repurchase the mortgage
loans backing such FNMA Certificates, as described under "SECURITY FOR THE
BONDS -- Agency Securities" herein. Any Private Mortgage-Backed Securities may
also be redeemed or otherwise subject to early prepayment in accordance with
their terms. The Stated Maturity for each Class of Bonds is the date determined
by the Company to fall a specified period after the date on which the principal
thereof will be fully paid, assuming (i) timely receipt of scheduled payments
(with no prepayments) on the Mortgage Collateral, (ii) if applicable, such
scheduled payments are reinvested at the Assumed Reinvestment Rate for such
Series, (iii) no Mortgage Collateral is substituted by the Issuer or the Seller
in place of the Mortgage Collateral initially pledged to secure such Bonds and
(iv) if applicable, no portion of the Spread is applied to the payment of the
Bonds, unless the related Prospectus Supplement provides otherwise, in which
event such Stated Maturities will be based on the assumptions specified in such
Prospectus Supplement. If so provided in the related Prospectus Supplement,
holders of one or more Classes of Bonds of a Series may have the right, at their
option, to receive full payment in respect of such Bonds prior to Stated
Maturity, in each case to the extent and subject to the conditions specified in
such Prospectus Supplement.
The rate of principal prepayments on pools of mortgage loans is influenced
by a variety of economic, geographic, social and other factors including,
without limitation, homeowner mobility, economic conditions, the presence and
enforceability of "due-on-sale" clauses, mortgage market interest rates and the
availability of mortgage funds, and no assurance can be given as to the actual
prepayment experience of the Mortgage Collateral. In general, however, if
interest rates vary significantly from those prevailing when the Pledged
Mortgages or the mortgage loans underlying the Certificates pledged as security
for a Series of Bonds were originated, such Pledged Mortgages and mortgage loans
are likely to be subject to higher or lower principal prepayments than if
interest rates remain at or near those prevailing when such Pledged Mortgages
and mortgage loans were originated. It should be noted that certain Certificates
pledged as security for a Series of Bonds may be backed by mortgage loans with
different interest rates, and, similarly, that not all of the Pledged Mortgages
securing a Series of Bonds are likely to bear the same interest rate.
Accordingly, the prepayment experience of these Certificates and Pledged
Mortgages will to some extent be a function of the mix of interest rates of the
underlying mortgage loans and of the Pledged Mortgages. Furthermore, the stated
certificate rate on certain Certificates may be less than the weighted average
interest rate of the underlying mortgage loans. See "SECURITY FOR THE BONDS"
herein.
BOOK-ENTRY BONDS
As described in the related Prospectus Supplement, if not issued in fully
registered form, one or more Classes of Bonds of any Series (each, a Class of
"Book-Entry Bonds") will be registered as book-entry certificates. Persons
acquiring beneficial ownership interests in the Bonds ("Bond Owners") will hold
their Bonds through the Depository Trust Company ("DTC") in the United States,
or CEDEL or Euroclear (in Europe) if they are participants of such systems, or
indirectly through organizations which are participants in such systems. The
Book-Entry Bonds will be issued in one or more certificates which equal the
aggregate principal balance of the Bonds 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
such capacities, individually the "Relevant Depositary" and collectively the
"European Depositaries"). Except as described below, no person acquiring a
Book-Entry Bond (each, a "beneficial
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owner") will be entitled to receive a physical certificate representing such
Bond (a "Definitive Bond"). Unless and until Definitive Bonds are issued, it is
anticipated that the only "Bondholders" of the Bonds will be Cede & Co., as
nominee of DTC. Bond Owners are only permitted to exercise their rights
indirectly through Participants and DTC.
The beneficial owner's ownership of a Book-Entry Bond 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 Bond 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).
Bond Owners will receive all distributions of principal of, and interest
on, the Bonds from the Bond Trustee through DTC and DTC participants. While the
Bonds 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 Bonds and is required
to receive and transmit distributions of principal of, and interest on, the
Bonds. Participants and indirect participants with whom Bond Owners have
accounts with respect to Bonds are similarly required to make book-entry
transfers and receive and transmit such distributions on behalf of their
respective Bond Owners. Accordingly, although Bond Owners will not possess
certificates, the Rules provide a mechanism by which Bond Owners will receive
distributions and will be able to transfer their interest.
Bond Owners will not receive or be entitled to receive certificates
representing their respective interests in the Bonds, except under the limited
circumstances described below. Unless and until Definitive Bonds are issued,
Bond Owners who are not Participants may transfer ownership of Bonds only
through Participants and indirect participants by instructing such Participants
and indirect participants to transfer Bonds, by book-entry transfer, through DTC
for the account of the purchasers of such Bonds, which account is maintained
with their respective Participants. Under the Rules and in accordance with DTC's
normal procedures, transfers of ownership of Bonds 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 Bond 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 in 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
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 fund
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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 Bonds may
experience some delay in their receipt of payments, since such payments will be
forwarded by the Bond Trustee to Cede & Co., as nominee of DTC. Distributions
with respect to Bonds 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 in
accordance with relevant United States tax laws and regulations. See "FEDERAL
INCOME TAX CONSEQUENCES -- Withholding with Respect to Certain Foreign
Investors" and " -- Backup Withholding" herein. Because DTC can only act on
behalf of Financial Intermediaries, the ability of a beneficial owner to pledge
Book-Entry Bonds to persons or entities that do not participate in the
depository
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system may be limited due to the lack of physical certificates for such
Book-Entry Bonds. In addition, issuance of the Book-Entry Bonds in book-entry
form may reduce the liquidity of such Bonds in the secondary market since
certain potential investors may be unwilling to purchase Bonds for which they
cannot obtain physical certificates.
Monthly and annual reports on the Issuer 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 DTC, and to the Financial Intermediaries to whose DTC accounts the
Book-Entry Bonds or such beneficial owners are credited.
DTC has advised the Bond Trustee that, unless and until Definitive Bonds
are issued, DTC will take any action permitted to be taken by the holders of the
Book-Entry Bonds under the Indenture only at the direction of one or more
Financial Intermediaries to whose DTC accounts the Book-Entry Bonds are
credited, to the extent that such actions are taken on behalf of Financial
Intermediaries whose holdings include such Book-Entry Bonds. CEDEL or the
Euroclear Operator, as the case may be, will take any other action permitted to
be taken by a Bondholder under the Indenture 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 with respect to some Bonds, at the
direction of the related Participants, which conflict with actions taken with
respect to other Bonds.
Upon the occurrence of any of the events described in the immediately
preceding paragraph, the Bond Trustee will be required to notify all beneficial
owners of the occurrence of such event and the availability through DTC of the
Definitive Bonds. Upon surrender by DTC of the global certificate or
certificates representing the Book-Entry Bonds and instructions for
re-registration, the Bond Trustee will issue Definitive Bonds, and thereafter
the Bond Trustee will recognize the holders of such Definitive Bonds as
Bondholders under the Indenture.
Although DTC, CEDEL and Euroclear have agreed to the foregoing procedures
in order to facilitate transfers of Bonds 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 Depositor, the Issuer or the Bond 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
Bonds held by Cede & Co., as nominee of DTC, or for maintaining, supervising or
reviewing any records relating to such beneficial ownership interests.
SECURITY FOR THE BONDS
GENERAL
Each Series of Bonds will be secured by assignments to the Bond Trustee of
collateral (the "Collateral") consisting of (i) the Mortgage Collateral pledged
as security for such Series of Bonds, (ii) funds on deposit in the Bond Account
and the Distribution Account under the Indenture for such Series of Bonds
representing payments and prepayments on Mortgage Collateral, including, to the
extent applicable, all payments which may become due under any applicable
hazard, mortgage guaranty, mortgagor bankruptcy, title insurance and bond
insurance policies (collectively, the "Insurance Proceeds") and the proceeds
(the "Liquidation Proceeds") of foreclosure or settlement of defaulted Pledged
Mortgages each as required to be remitted to the Bond Trustee, (iii) cash,
certificates of deposit, letters of credit, surety bonds, reinvestment income,
guaranteed investment contracts or any combination thereof in the aggregate
amount, if any, specified in the related Prospectus Supplement to be deposited
by the Issuer in a related Reserve Fund, (iv) the amount of cash, if any,
specified in the related Prospectus Supplement, to be initially deposited by the
Issuer in the related Bond Account, (v) certain cash accounts, insurance
policies, surety bonds, reinvestment income, guarantees, letters of credit,
crosscollateralization, overcollateralization, excess spread or derivative
arrangements, as specified herein and in the related Prospectus Supplement, (vi)
to the extent applicable, the reinvestment income on all of the foregoing, (vii)
the Issuer's rights under the Master Servicing Agreement
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with respect to the Series of Bonds, (viii) the Issuer's rights under the
Mortgage Loan Purchase Agreement with respect to the Series of Bonds, (ix)
amounts (excluding any reinvestment income thereon) deposited in the related
early remittance account, if any, under the Indenture for such Series of Bonds
and (x) the Issuer's rights under certain of the Mortgage Pool Insurance
Policies and/or Bond Insurance Policies obtained for such Series of Bonds.
Scheduled payments on the Mortgage Collateral securing a Series of Bonds and
amounts, if any, initially deposited in the related Bond Account, together with,
to the extent applicable, the earnings thereon at the Assumed Reinvestment Rate
for such Series specified in the related Prospectus Supplement and, if
applicable, amounts available to be withdrawn from any related Reserve Fund,
will be sufficient to make timely payments of interest on the Bonds of such
Series and to retire each Class of Bonds comprising such Series not later than
the Stated Maturity of such Class of Bonds specified in the related Prospectus
Supplement.
Each Prospectus Supplement relating to a Series of Bonds will include
information as to (i) the approximate aggregate principal amount of the Mortgage
Collateral securing such Series and whether the Mortgage Collateral consists of
Pledged Mortgages, GNMA Certificates, FNMA Certificates, FHLMC Certificates,
Private Mortgage-Backed Securities or some combination of Pledged Mortgages and
Certificates and (ii) the approximate weighted average terms to maturity of such
Mortgage Collateral.
The Collateral securing each Series of Bonds will equally and ratably
secure each Class of the Bonds of such Series, and the Collateral securing such
Series will serve as collateral only for that Series of Bonds, except to the
extent that any Mortgage Pool Insurance Policies, Special Hazard Insurance
Policies, Bankruptcy Bonds or other form of credit enhancement specified herein
may, if specified in the related Prospectus Supplement, be pledged to secure
more than one Series of Bonds. See "CREDIT ENHANCEMENT" herein.
The following is a brief description of the Mortgage Collateral expected to
secure a Series of Bonds. If specific information respecting the Mortgage
Collateral is not known at the time the related Series of Bonds 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 Bonds (the "Detailed
Description"). A schedule of the Mortgage Collateral relating to such Series of
Bonds will be attached to the Indenture delivered to the Bond Trustee upon
delivery of the Bonds.
THE PLEDGED MORTGAGES
General. All of the Pledged Mortgages will be contributed to the Company's
capital by Redwood Trust (or an affiliate) or acquired by the Company from
Redwood Trust (or an affiliate) or another Seller and will be master serviced by
the Master Servicer specified in the related Prospectus Supplement. See
"SERVICING OF THE PLEDGED MORTGAGES" herein. Pledged Mortgages contributed to or
acquired by the Company will have been originated in accordance with the
underwriting criteria specified under "MORTGAGE LOAN PROGRAM -- Underwriting
Standards" herein and in the related Prospectus Supplement. The Pledged
Mortgages securing a Series of Bonds will consist solely of conventional loans
secured by first or junior liens on one- to four-family residential properties.
See "CERTAIN LEGAL ASPECTS OF PLEDGED MORTGAGES -- General" herein. The real
property constituting security for repayment of a Pledged Mortgage (each, a
"Mortgaged Property") may be located in any one of the fifty states, the
District of Columbia, Guam, Puerto Rico, any other territory of the United
States or such other location as may be specified in the related Prospectus
Supplement. Pledged Mortgages with certain Loan-to-Value Ratios and/or certain
principal balances may be covered wholly or partially by primary mortgage
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.
Unless otherwise specified in the related Prospectus Supplement, all of the
Pledged Mortgages securing a Series of Bonds will have monthly payments due on
the first day of each month. Such monthly installments on each such Pledged
Mortgage, net of (i) applicable servicing compensation or master servicing
compensation, (ii) amounts retained by the Master Servicer or Servicer (as
defined herein) to be applied to the payment of premiums for certain Mortgage
Pool Insurance Policies and, if applicable, bond insurance policies and (iii)
amounts retained to reimburse the Master Servicer or Servicer for certain
advances it has made, will be
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payable to the Bond Trustee by the Master Servicer on or before the monthly
remittance date specified in the Prospectus Supplement relating to the Series of
Bonds secured by such Pledged Mortgages (each, a "Remittance Date"). See
"SERVICING OF THE PLEDGED MORTGAGES -- Payments on Pledged Mortgages" and
" -- Advances and Other Amounts Payable by Master Servicer" herein. The payment
terms of the Pledged Mortgages securing a Series of Bonds will be described in
the related Prospectus Supplement and may include any of the following features
or combination thereof or other features described 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 as set forth in the related Mortgage Note.
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. A Mortgage Note may provide for the payment
of interest at a rate lower than the Mortgage Rate specified in such
Mortgage Note for a period of time or for the life of the loan and the
amount of any difference may be contributed from funds supplied by the
seller of the Mortgaged Property or another source.
(b) Principal may be payable on a level debt service basis to fully
amortize the Pledged Mortgage 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
Mortgage 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 payments"). Principal may include interest
that has been deferred and added to the principal balance of the Pledged
Mortgage.
(c) Monthly payments of principal and interest may be fixed for the
life of the Pledged Mortgage, may increase over a specified period of time
or may change from period to period. The terms of a Pledged Mortgage 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) The Pledged Mortgages may be prepaid (i) at any time without the
payment of any prepayment fee or (ii) subject to a prepayment fee, which
may be fixed for the life of any such Pledged Mortgage or may decline over
time, and may be prohibited for the life of such Pledged Mortgage or for
certain periods ("lockout periods"). Certain Pledged Mortgages may permit
prepayments after expiration of the applicable lockout period and may
require the payment of a prepayment fee in connection with any such
subsequent prepayment. Other Pledged Mortgages may permit prepayments
without payment of a fee unless the prepayment occurs during specified time
periods. The loans may include "due-on-sale" clauses that permit the
mortgagee to demand payment of the entire Pledged Mortgage in connection
with the sale or certain transfers of the related Mortgaged Property. Other
Pledged Mortgages may be assumable by persons meeting the then applicable
underwriting standards. See "MORTGAGE LOAN PROGRAM -- Underwriting
Standards" herein.
The Mortgage Collateral securing a Series of Bonds may include certain
Pledged Mortgages ("Buydown Loans") that include provisions whereby a third
party partially subsidizes the monthly payments of the Mortgagors during the
early years of such Pledged Mortgages, the difference to be made up from a fund
(a "Buydown Fund") contributed by such third party at the time of origination of
the Pledged Mortgage. 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 Mortgagor will
increase during the buydown period as a result of normal increases in
compensation and inflation, so that the Mortgagor will be able to meet the full
mortgage 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
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concerning limitations on the interest rate paid by the Mortgagor initially, on
annual increases in the interest rate and on the length of the buydown period.
Each Prospectus Supplement will contain information, as of the date or
dates set forth in such Prospectus Supplement and to the extent then
specifically known to the Company, with respect to the Pledged Mortgages
securing the related Series of Bonds, including (i) the aggregate outstanding
principal balance and the average outstanding principal balance of the Pledged
Mortgages as of the date pledged to secure the related Series of Bonds, (ii) the
types of property securing the Pledged Mortgages, (iii) the original terms to
maturity of the Pledged Mortgages, (iv) the earliest origination date and latest
maturity date of any of the Pledged Mortgages, (v) the maximum and minimum per
annum Mortgage Rates and (vi) the geographical distribution of the Pledged
Mortgages.
No assurance can be given that values of the Mortgaged Properties have
remained or will remain at their levels on the dates of origination of the
related Pledged Mortgages. If the residential real estate market should
experience an overall decline in property values such that the outstanding
principal balances of the Pledged Mortgages, and any secondary financing on the
Mortgaged Properties, securing a Series of Bonds become equal to or greater than
the value of the Mortgaged 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 Mortgagors of scheduled payments of principal and interest on
the Pledged Mortgages and, accordingly, the actual rates of delinquencies,
foreclosures and losses with respect to any Mortgage Collateral. To the extent
that such losses are not covered by subordination provisions, any other credit
enhancement or alternative arrangements described herein and in the related
Prospectus Supplement, such losses will be borne, at least in part, by the
holders of the Bonds of the related Series.
The Issuer will cause the Pledged Mortgages securing each Series of Bonds
to be pledged to the Bond Trustee named in the related Prospectus Supplement for
the benefit of the Bondholders of such Series. The Master Servicer will service
the Pledged Mortgages, or enforce the servicing obligations of other mortgage
servicing institutions ("Servicers"), pursuant to a Master Servicing Agreement
(as defined herein), and will receive a fee for such services. See "MORTGAGE
LOAN PROGRAM" and "SERVICING OF THE PLEDGED MORTGAGES" herein. With respect to
Pledged Mortgages serviced by the Master Servicer through a Servicer, the Master
Servicer will remain liable for its servicing obligations under the related
Master Servicing Agreement as if the Master Servicer alone were servicing such
Pledged Mortgages.
The obligations of the Master Servicer with respect to the Pledged
Mortgages will consist principally of its contractual master servicing
obligations under the related Master Servicing Agreement (including its
obligation to enforce the obligations of the Servicers) as more fully described
herein under "MORTGAGE LOAN PROGRAM -- Representations by Sellers; Repurchases"
and its obligation to make certain cash advances in the event of delinquencies
in payments on or with respect to the Pledged Mortgages in the amounts described
herein under "SERVICING OF THE PLEDGED MORTGAGES -- Advances and Other Amounts
Payable by Master Servicer" herein. 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.
Pledged Mortgages will consist of mortgage loans or deeds of trust secured
by first or junior liens on one-to four-family residential properties. If
provided in the related Prospectus Supplement, certain of the Pledged Mortgages
may be secured by junior liens where the related senior liens ("Senior Liens")
are not to be included as part of the Mortgage Collateral. Holders of such
Pledged Mortgages secured by junior liens are subject to the risk that adequate
funds will not be received in connection with a foreclosure of the related
Senior Liens to satisfy fully both the Senior Liens and the Pledged Mortgages.
In the event that a holder of a Senior Lien forecloses on a Mortgaged Property,
the proceeds of the foreclosure or similar sale will be applied first to the
payment of court costs and fees in connection with the foreclosure, second to
real estate taxes, third in satisfaction of all principal, interest, prepayment
or acceleration penalties, if any, and any other sums due and owing to the
holder of the Senior Liens. The claims of the holders of the Senior Liens will
be satisfied in full out of proceeds of the liquidation of the related Mortgaged
Property, if such proceeds are sufficient, before the Issuer as holder of the
junior lien receives any payments in respect of the Pledged Mortgage. If the
Master
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Servicer or a Servicer were to foreclose on any such Pledged Mortgage, it would
do so subject to any related Senior Liens. In order for the debt related to the
Pledged Mortgage to be paid in full at such sale, a bidder at the foreclosure
sale of such Pledged Mortgage would have to bid an amount sufficient to pay off
all sums due under the Pledged Mortgage and the Senior Liens or purchase the
Mortgaged Property subject to the Senior Liens. In the event that such proceeds
from a foreclosure or similar sale of the related Mortgaged Property are
insufficient to satisfy all Senior Liens and the Pledged Mortgage in the
aggregate, the Issuer, as the holder of the junior liens, and, accordingly,
holders of one or more classes of the Bonds of the related Series, 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 is not realized
upon or if a deficiency judgment cannot be pursued. Moreover, deficiency
judgments may not be available in certain jurisdictions or the Pledged Mortgage
may be nonrecourse. In addition, a junior mortgagee may not foreclose on the
property securing a junior mortgage unless it forecloses subject to the senior
mortgages.
If so specified in the related Prospectus Supplement, the Pledged Mortgages
may include cooperative apartment loans ("Cooperative Loans") secured by
security interests in shares issued by private, non-profit, cooperative housing
corporations ("Cooperatives") and in the related proprietary leases or occupancy
agreements granting exclusive rights to occupy specific dwelling units in such
Cooperatives' buildings.
The Mortgaged Properties relating to Pledged Mortgages will consist of
detached or semi-detached one-family dwelling units, two- to four-family
dwelling units, townhouses, rowhouses, individual condominium units, individual
units in planned unit developments and certain other dwelling units. Such
Mortgaged Properties may include vacation and second homes, investment
properties and leasehold interests. In the case of leasehold interests, the term
of the leasehold will exceed the scheduled maturity of the Pledged Mortgages by
at least five years, or such other period specified in the related Prospectus
Supplement.
ASSIGNMENT OF PLEDGED MORTGAGES TO BOND TRUSTEE. Assignments of the
mortgages or deeds of trust in recordable form, naming the Bond Trustee as
assignee, will be executed and, subject to release for recording purposes,
delivered to the Bond Trustee along with certain other original documents
evidencing the Pledged Mortgages, including the related Mortgage Notes. The
original mortgage documents will be held by the Bond Trustee or its custodian,
except to the extent released to the Master Servicer or any Servicer from time
to time in connection with its respective servicing activities. Except as
otherwise specified in the related Prospectus Supplement, the Issuer will
promptly cause the assignments of the related Pledged Mortgages to be recorded
in the appropriate public office for real property records, except in states in
which, in the opinion of counsel acceptable to the Bond Trustee, such recording
is not required to protect the Bond Trustee's interest in such Pledged Mortgages
against the claim of any subsequent transferee or any successor to or creditor
of the Issuer or the originator of such Pledged Mortgage. In the event an
assignment of a Pledged Mortgage to the Bond Trustee is not recorded or the
opinion referred to above is not delivered to the Bond Trustee within the period
specified in the related Prospectus Supplement, Redwood Trust, may, if required
by the Bond Trustee in accordance with the terms of the Indenture, be obligated
to (i) purchase such Pledged Mortgage at a price equal to the outstanding
principal balance thereof on the date of such purchase plus accrued and unpaid
interest thereon to the first day of the month following the month in which such
Pledged Mortgage is purchased and deposit such amount in the Bond Account for
such Series of Bonds or (ii) if permitted by the applicable provisions of the
Indenture and the Mortgage Loan Purchase Agreement with respect to such Series
of Bonds, replace such Pledged Mortgage with an eligible substitute mortgage
loan (an "Eligible Substitute Pledged Mortgage"). See " -- Substitution of
Mortgage Collateral" herein.
AGENCY SECURITIES
GENERAL. The Agency Securities securing a Series of Bonds will consist of
(i) fully modified pass-through mortgage-backed certificates guaranteed as to
timely payment of principal and interest by the Government National Mortgage
Association ("GNMA Certificates"), (ii) certificates ("Guaranteed Mortgage
Pass-Through Certificates") issued and guaranteed as to timely payment of
principal and interest by the Federal National Mortgage Association ("FNMA
Certificates"), (iii) mortgage participation certificates issued and guaranteed
as to timely payment of interest and, unless otherwise specified in the related
Prospectus Supplement, ultimate payment of principal by the Federal Home Loan
Mortgage Corporation
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("FHLMC Certificates"), (iv) stripped mortgage-backed securities representing an
undivided interest in all or a part of either the principal distributions (but
not the interest distributions) or the interest distributions (but not the
principal distributions) or in some specified portion of the principal and
interest distributions (but not all of such distributions) on certain GNMA, FNMA
or FHLMC Certificates and, unless otherwise specified in the related Prospectus
Supplement, guaranteed to the same extent as the underlying securities, (v)
another type of pass-through certificate issued or guaranteed by GNMA, FNMA or
FHLMC and described in the related Prospectus Supplement or (vi) a combination
of such Agency Securities.
GNMA CERTIFICATES. GNMA is a wholly-owned corporate instrumentality of the
United States with the Department of Housing and Urban Development. Section
306(g) of Title III of the National Housing Act of 1934, as amended (the
"Housing Act"), authorizes GNMA to guarantee the timely payment of the principal
of, and interest on, GNMA Certificates that represent an interest in a pool of
mortgage loans insured by the FHA under the Housing Act or Title V of the
Housing Act of 1949 ("FHA Loans"), or partially guaranteed by the VA under the
Servicemen's Readjustment Act of 1944, as amended, or Chapter 37 of Title 38,
United States Code ("VA Loans").
Section 306(g) of the Housing Act provides that "the full faith and credit
of the United States is pledged to the payment of all amounts which may be
required to be paid under any guaranty under this subsection." In order to meet
its obligations under such guaranty, GNMA may, under Section 306(d) of the
Housing Act, borrow from the United States Treasury in an unlimited amount which
is at any time sufficient to enable GNMA to perform its obligations under its
guaranty.
Each GNMA Certificate pledged to secure a Series of Bonds (which may be
issued under either the GNMA I program (each such certificate, a "GNMA I
Certificate") or the GNMA II program (each such certificate, a "GNMA II
Certificate")) will be a "fully modified pass-through" mortgage-backed
certificate issued and serviced by a mortgage banking company or other financial
concern ("GNMA Issuer") approved by GNMA or by FNMA as a seller-servicer of FHA
Loans and/or VA Loans. The mortgage loans underlying the GNMA Certificates will
consist of FHA Loans and/or VA Loans. Each such mortgage loan is secured by a
one- to four-family or multifamily residential property. GNMA will approve the
issuance of each such GNMA Certificate in accordance with a guaranty agreement
(a "Guaranty Agreement") between GNMA and the GNMA Issuer. Pursuant to its
Guaranty Agreement, a GNMA Issuer will be required to advance its own funds in
order to make timely payments of all amounts due on each such GNMA Certificate
if the payments received by the GNMA Issuer on the FHA Loans or VA Loans
underlying each such GNMA Certificate are less than the amounts due on each such
GNMA Certificate.
The full and timely payment of principal of and interest on each GNMA
Certificate will be guaranteed by GNMA, which obligation is backed by the full
faith and credit of the United States. Each such GNMA Certificate will have an
original maturity of not more than 30 years (but may have original maturities of
substantially less than 30 years). Each such GNMA Certificate will be based on
and backed by a pool of FHA Loans or VA Loans secured by one- to four-family
residential properties and will provide for the payment by or on behalf of the
GNMA Issuer to the registered holder of such GNMA Certificate of scheduled
monthly payments of principal and interest equal to the registered holder's
proportionate interest in the aggregate amount of the monthly principal and
interest payment on each FHA Loan or VA Loan underlying such GNMA Certificate,
less the applicable servicing and guaranty fee, which together equal the
difference between the interest on the FHA Loan or VA Loan and the pass-through
rate on the GNMA Certificate. In addition, each payment will include
proportionate pass-through payments of any prepayments of principal on the FHA
Loans or VA Loans underlying such GNMA Certificate and liquidation proceeds in
the event of a foreclosure or other disposition of any such FHA Loans or VA
Loans.
If a GNMA Issuer is unable to make the payments on a GNMA Certificate as it
becomes due, it must promptly notify GNMA and request GNMA to make such payment.
Upon notification and request, GNMA will make such payments directly to the
registered holder of such GNMA Certificate. In the event no payment is made by a
GNMA Issuer and the GNMA Issuer fails to notify and request GNMA to make such
payment, the holder of such GNMA Certificate will have recourse only against
GNMA to obtain such payment. The Bond Trustee or its nominee, as registered
holder of the GNMA Certificates securing a Series of Bonds will
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have the right to proceed directly against GNMA under the terms of the Guaranty
Agreements relating to such GNMA Certificates for any amounts that are not paid
when due.
All mortgage loans underlying a particular GNMA I Certificate must have the
same interest rate (except for pools of mortgage loans secured by manufactured
homes) over the term of the loan. The interest rate on such GNMA I Certificate
will equal the interest rate on the mortgage loans included in the pool of
mortgage loans underlying such GNMA I Certificate, less one-half percentage
point per annum of the unpaid principal balance of the mortgage loans.
Mortgage loans underlying a particular GNMA II Certificate may have per
annum interest rates that vary from each other by up to one percentage point.
The interest rate on each GNMA II Certificate will be between one-half
percentage point and one and one-half percentage points lower than the highest
interest rate on the mortgage loans included in the pool of mortgage loans
underlying such GNMA II Certificate (except for pools of mortgage loans secured
by manufactured homes).
Regular monthly installment payments on each GNMA Certificate securing a
Series of Bonds will be comprised of interest due as specified on such GNMA
Certificate plus the scheduled principal payments on the FHA Loans or VA Loans
underlying such GNMA Certificate due on the first day of the month in which the
scheduled monthly installments on such GNMA Certificate are due. Such regular
monthly installments on each such GNMA Certificate are required to be paid to
the registered holder by the 15th day of each month in the case of a GNMA I
Certificate and are required to be mailed to the registered holder by the 20th
day of each month in the case of a GNMA II Certificate. Any principal
prepayments on any FHA Loans or VA Loans underlying a GNMA Certificate securing
a Series of Bonds or any other early recovery of principal on such loans will be
passed through to the registered holder of such GNMA Certificate.
GNMA Certificates may be backed by graduated payment mortgage loans or by
Buydown Loans for which funds will have been provided (and deposited into escrow
accounts) for application to the payment of a portion of the borrowers' monthly
payments during the early years of such mortgage loan. Payments due the
registered holders of GNMA Certificates backed by pools containing Buydown Loans
will be computed in the same manner as payments derived from other GNMA
Certificates and will include amounts to be collected from both the borrower and
the related escrow account. The graduated payment mortgage loans will provide
for graduated interest payments that, during the early years of such mortgage
loans, will be less than the amount of stated interest on such mortgage loans.
The interest not so paid will be added to the principal of such graduated
payment mortgage loans and, together with interest thereon, will be paid in
subsequent years. The obligations of GNMA and of a GNMA Issuer will be the same
irrespective of whether the GNMA Certificates are backed by graduated payment
mortgage loans or Buydown Loans. No statistics comparable to the FHA's
prepayment experience on level payment, non-"buydown" mortgage loans are
available in respect of graduated payment or Buydown Loans. GNMA Certificates
related to a Series of Bonds may he held in book-entry form.
The GNMA Certificates securing a Series of Bonds, and the related
underlying mortgage loans, may have characteristics and terms different from
those described above. Any such different characteristics and terms will be
described in the related Prospectus Supplement.
FNMA CERTIFICATES. FNMA is a federally chartered and privately owned
corporation organized and existing under the Federal National Mortgage
Association Charter Act, as amended. FNMA originally was established in 1938 as
a United States government agency to provide supplemental liquidity to the
mortgage market and was transformed into a stockholder-owned and
privately-managed corporation by legislation enacted in 1968.
FNMA provides funds to the mortgage market primarily by purchasing mortgage
loans from lenders, thereby replenishing their funds for additional lending.
FNMA acquires funds to purchase mortgage loans from many capital market
investors that may not ordinarily invest in mortgages, thereby expanding the
total amount of funds available for housing. Operating nationwide, FNMA helps to
redistribute mortgage funds from capital-surplus to capital-short areas.
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FNMA Certificates are Guaranteed Mortgage Pass-Through Certificates
representing fractional undivided interests in a pool of mortgage loans formed
by FNMA. Each mortgage loan generally must meet the applicable standards of the
FNMA purchase program. Mortgage loans comprising a pool are either provided by
FNMA from its own portfolio or purchased pursuant to the criteria of the FNMA
purchase program.
Mortgage loans underlying FNMA Certificates securing a Series of Bonds will
consist of conventional loans, FHA Loans or VA Loans. Original maturities of
substantially all of the conventional, level payment mortgage loans underlying a
FNMA Certificate are expected to be between either 8 to 15 years or 20 to 40
years. The original maturities of substantially all of the fixed rate, level
payment FHA Loans or VA Loans are expected to be 30 years.
Mortgage loans underlying a FNMA Certificate may have annual interest rates
that vary by as much as two percentage points from each other. The rate of
interest payable on a FNMA Certificate is equal to the lowest interest rate of
any mortgage loan in the related pools, less a specified minimum annual
percentage representing servicing compensation and FNMA's guaranty fee. Under a
regular servicing option (pursuant to which the mortgagee or each other servicer
assumes the entire risk of foreclosure losses), the annual interest rates on the
mortgage loans underlying a FNMA Certificate will be between 50 basis points and
250 basis points greater than is its annual pass-through rate and under a
special servicing option (pursuant to which FNMA assumes the entire risk for
foreclosure losses), the annual interest rates on the mortgage loans underlying
a FNMA Certificate will generally be between 55 basis points and 255 basis
points greater than the annual FNMA Certificate pass-through rate. One "basis
point" is equal to one-hundredth of a percentage point (0.01%). If specified in
the related Prospectus Supplement, FNMA Certificates may be backed by adjustable
rate mortgages.
FNMA guarantees to each registered holder of a FNMA Certificate that it
will distribute amounts representing such holder's proportionate share of
scheduled principal and interest payments at the applicable pass-through rate
provided for by such FNMA Certificate on the underlying mortgage loans, whether
or not received, and such holder's proportionate share of the full principal
amount of any foreclosed or other finally liquidated mortgage loan, whether or
not such principal amount is actually recovered. The obligations of FNMA under
its guaranties are obligations solely of FNMA and are not backed by, or entitled
to, the full faith and credit of the United States. Although the Secretary of
the Treasury of the United States has discretionary authority to lend FNMA up to
$2.25 billion outstanding at any time, neither the United States nor any agency
thereof is obligated to finance FNMA's operations or to assist FNMA in any other
manner. If FNMA were unable to satisfy its obligations, distributions to holders
of FNMA Certificates would consist solely of payments and other recoveries on
the underlying mortgage loans and accordingly, monthly distributions to holders
of FNMA Certificates would be affected by delinquent payments and defaults on
such mortgage loans.
FNMA Certificates evidencing interests in pools of mortgage loans formed on
or after May 1, 1985 (other than FNMA Certificates backed by pools containing
graduated payment mortgage loans or mortgage loans secured by multifamily
projects) are available in book-entry form only. Distributions of principal and
interest on each FNMA Certificate will be made by FNMA on the 25th day of each
month to the persons in whose name the FNMA Certificate is entered in the books
of the Federal Reserve Banks (or registered on the FNMA Certificate register in
the case of fully registered FNMA Certificates) as of the close of business on
the last day of the preceding month. With respect to FNMA Certificates issued in
book-entry form, distributions thereon will be made by wire, and with respect to
fully registered FNMA Certificates, distributions thereon will be made by check.
The FNMA Certificates securing a Series of Bonds, and the related
underlying mortgage loans, may have characteristics and terms different from
those described above. Any such different characteristics and terms will be
described in the related Prospectus Supplement.
FHLMC CERTIFICATES. FHLMC is a corporate instrumentality of the United
States created pursuant to Title III of the Emergency Home Finance Act of 1970,
as amended (the "FHLMC Act"). The common stock of FHLMC is owned by the Federal
Home Loan Banks and its preferred stock is owned by stockholders of the Federal
Home Loan Banks. FHLMC was established primarily for the purpose of increasing
the availability of mortgage credit for the financing of urgently needed
housing. It seeks to provide an enhanced
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degree of liquidity for residential mortgage investments primarily by assisting
in the development of secondary markets for conventional mortgages. The
principal activity of FHLMC currently consists of the purchase of first lien,
conventional mortgage loans or participation interests in such mortgage loans
and the sale of the mortgage loans or participations so purchased in the form of
guaranteed mortgage securities, primarily FHLMC Certificates. FHLMC is confined
to purchasing, so far as practicable, mortgage loans that it deems to be of such
quality, type and class as to meet generally the purchase standards imposed by
private institutional mortgage investors.
Each FHLMC Certificate represents an undivided interest in a pool of
mortgage loans that may consist of first lien Conventional Loans, FHA Loans or
VA Loans. FHLMC Certificates are sold under the terms of a Mortgage
Participation Certificate Agreement. A FHLMC Certificate may be issued under
either FHLMC's Cash Program or Guarantor Program.
Mortgage loans underlying the FHLMC Certificates securing a Series of Bonds
will generally consist of mortgage loans with original terms to maturity of
between 10 and 40 years. Each such mortgage loan must meet the applicable
standards set forth in the FHLMC Act. A FHLMC Certificate group may include
whole loans, participation interests in whole loans and undivided interests in
whole loans and/or participations comprising another FHLMC Certificate group.
Under the Guarantor Program, any such FHLMC Certificate group may include only
whole loans or participation interests in whole loans.
FHLMC guarantees to each registered holder of a FHLMC Certificate the
timely payment of interest on the underlying mortgage loans to the extent of the
applicable certificate interest rate on the registered holder's pro rata share
of the unpaid principal balance outstanding on the underlying mortgage loans in
the FHLMC Certificate group represented by such FHLMC Certificate, whether or
not received. FHLMC also guarantees to each registered holder of a FHLMC
Certificate collection by such holder of all principal on the underlying
mortgage loans, without any offset or deduction, to the extent of such holder's
pro rata share thereof, but does not, except if and to the extent specified in
the related Prospectus Supplement for a Series of Bonds, guarantee the timely
payment of scheduled principal. Under FHLMC's Gold PC Program, FHLMC guarantees
the timely payment of principal based on the difference between the pool factor
published in the month preceding the month of distribution and the pool factor
published in such month of distribution. Pursuant to its guaranties, FHLMC
indemnifies holders of FHLMC Certificates against any diminution in principal by
reason of charges for property repairs, maintenance and foreclosure. FHLMC may
remit the amount due on account of its guaranty of collection of principal at
any time after default on an underlying mortgage loan, but not later than (i) 30
days following foreclosure sale, (ii) 30 days following payment of the claim by
any mortgage insurer or (iii) 30 days following the expiration of any right of
redemption, whichever occurs later, but in any event no later than one year
after demand has been made upon the mortgagor for accelerated payment of
principal. In taking actions regarding the collection of principal after default
on the mortgage loans underlying FHLMC Certificates, including the timing of any
demand for acceleration, FHLMC reserves the right to exercise its judgment with
respect to the mortgage loans in the same manner as for mortgage loans that it
has purchased but not sold. The length of time necessary for FHLMC to determine
that a mortgage loan should be accelerated varies with the particular
circumstances of each mortgagor and FHLMC has not adopted standards which
require that the demand be made within any specified period.
FHLMC Certificates are not guaranteed by the United States or by any
Federal Home Loan Bank and do not constitute debts or obligations of the United
States or any Federal Home Loan Bank. The obligations of FHLMC under its
guaranty are obligations solely of FHLMC and are not backed by, or entitled to,
the full faith and credit of the United States. If FHLMC were unable to satisfy
such obligations, distributions to holders of FHLMC Certificates would consist
solely of payments and other recoveries on the underlying mortgage loans and,
accordingly, monthly distributions to holders of FHLMC Certificates would be
affected by delinquent payments and defaults on such mortgage loans.
Registered holders of FHLMC Certificates are entitled to receive their
monthly pro rata share of all principal payments on the underlying mortgage
loans received by FHLMC, including any scheduled principal payments, full and
partial prepayments of principal and principal received by FHLMC by virtue of
condemnation, insurance, liquidation or foreclosure and repurchases of the
mortgage loans by FHLMC or the
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seller thereof. FHLMC is required to remit each registered FHLMC
Certificateholder's pro rata share of principal payments on the underlying
mortgage loans, interest at the FHLMC pass-through rate and any other sums such
as prepayment fees, within 60 days of the date on which such payments are deemed
to have been received by FHLMC.
Under FHLMC's Cash Program, there is no limitation on the amount by which
interest rates on the mortgage loans underlying a FHLMC Certificate may exceed
the pass-through rate on the FHLMC Certificate. Under such program, FHLMC
purchases groups of whole mortgage loans from sellers at specified percentages
of their unpaid principal balances, adjusted for accrued or prepaid interest,
which when applied to the interest rate of the mortgage loans and participations
purchased results in the yield (expressed as a percentage) required by FHLMC.
The required yield, which includes a minimum servicing fee retained by the
servicer, is calculated using the outstanding principal balance. The range of
interest rates on the mortgage loans and participations in a FHLMC Certificate
group under the Cash Program will vary since mortgage loans and participations
are purchased and assigned to a FHLMC Certificate group based upon their yield
to FHLMC rather than on the interest rate on the underlying mortgage loans.
Under FHLMC's Guarantor Program, the pass-through rate on a FHLMC Certificate is
established based upon the lowest interest rate on the underlying mortgage
loans, minus a minimum servicing fee and the amount of FHLMC's management and
guaranty income as agreed upon between the seller and FHLMC.
FHLMC Certificates duly presented for registration of ownership on or
before the last business day of a month are registered effective as of the first
day of the month. The first remittance to a registered holder of a FHLMC
Certificate will be distributed so as to be received normally by the 15th day of
the second month following the month in which the purchaser became a registered
holder of such FHLMC Certificate. Thereafter, such remittance will be
distributed monthly to the registered holder so as to be received normally by
the 15th day of each month. The Federal Reserve Bank of New York maintains
book-entry accounts with respect to FHLMC Certificates sold by FHLMC on or after
January 2, 1985, and makes payments of principal and interest each month to the
registered holders thereof in accordance with such holders' instructions.
PRIVATE MORTGAGE-BACKED SECURITIES
Private Mortgage-Backed Securities may consist of (a) mortgage pass-through
certificates evidencing an undivided interest in a pool of mortgage loans or (b)
collateralized mortgage obligations secured by mortgage loans. Private
Mortgage-Backed Securities may include stripped mortgage-backed securities
representing an undivided interest in all or part of either the principal
distributions (but not the interest distributions) or the interest distributions
(but not the principal distributions) or in some specified portion of the
principal and interest distributions (but not all of such distributions) on
certain mortgage loans. Private Mortgage-Backed Securities will have been issued
pursuant to a pooling and servicing agreement, an indenture or similar agreement
(a "PMBS Agreement"). Unless otherwise specified in the related Prospectus
Supplement, the seller/servicer of the underlying mortgage loans will have
entered into the PMBS Agreement with the trustee under such PMBS Agreement (the
"PMBS Trustee"). The PMBS Trustee or its agent, or a custodian will possess the
mortgage loans underlying such Private Mortgage-Backed Security. Mortgage loans
underlying a Private Mortgage-Backed Security will be serviced by a servicer
(the "PMBS Servicer") directly or by one or more subservicers who may be subject
to the supervision of the PMBS Servicer. Private Mortgage-Backed Securities must
(i) either (a) have been previously registered under the Securities Act or (b)
if not so registered, held for at least the holding period required by Rule
144(k) under the Securities Act and (ii) be acquired in bona fide secondary
market transactions.
The issuer of the Private Mortgage-Backed Securities (the "PMBS Issuer")
will be a financial institution or other entity engaged generally in the
business of mortgage lending, a public agency or instrumentality of a state,
local or federal government, or a limited purpose corporation organized for the
purpose of, among other things, establishing trusts and acquiring and selling
housing loans to such trusts and selling beneficial interests in such trusts. If
so specified in the related Prospectus Supplement, the PMBS Issuer may be an
affiliate of the Depositor. The obligations of the PMBS Issuer will generally be
limited to certain representations and warranties with respect to the assets
conveyed by it to the related trust. Unless otherwise specified in the
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related Prospectus Supplement, the PMBS Issuer will not have guaranteed any of
the assets conveyed to the related trust or any of the Private Mortgage-Backed
Securities issued under the PMBS Agreement. Additionally, although the mortgage
loans underlying the Private Mortgage-Backed Securities may be guaranteed by an
agency or instrumentality of the United States, the Private Mortgage-Backed
Securities themselves will generally not be so guaranteed.
Distributions of principal and interest will be made on the Private
Mortgage-Backed Securities on the dates specified in the related Prospectus
Supplement. The Private Mortgage-Backed Securities may be entitled to receive
nominal or no principal distributions or nominal or no interest distributions.
Principal and interest distributions will be made on the Private Mortgage-Backed
Securities by the PMBS Trustee or the PMBS Servicer. The PMBS Issuer or the PMBS
Servicer may have the right to repurchase assets underlying the Private
Mortgage-Backed Securities after a certain date or under the circumstances
specified in the related Prospectus Supplement.
The mortgage loans underlying the Private Mortgage-Backed Securities may
consist of fixed rate, level payment, fully amortizing loans or graduated
payment mortgage loans, Buydown Loans, adjustable mortgage loans or loans having
balloon or other special payment features. Such mortgage loans may be secured by
single (one- to four-) family property or multifamily property or by an
assignment of the proprietary lease or occupancy agreement relating to a
specific dwelling within a Cooperative and the related shares issued by such
Cooperative.
The Prospectus Supplement for a Series of Bonds for which the Mortgage
Collateral includes Private Mortgage-Backed Securities will specify the
aggregate approximate principal amount and type of the Private Mortgage-Backed
Securities to be included in the Mortgage Collateral and, as to any such Private
Mortgage-Backed Securities comprising a significant part of the Mortgage
Collateral, to the extent such information is known to the Issuer, will in
general include the following: (i) certain characteristics of the mortgage loans
that comprise the underlying assets for the Private Mortgage-Backed Securities
including (A) the payment features of such mortgage loans, (B) the approximate
aggregate principal balance of underlying mortgage loans insured or guaranteed
by a governmental entity, (C) the servicing fee or range of servicing fees with
respect to the mortgage loans and (D) the minimum and maximum stated maturities
of the underlying mortgage loans at origination; (ii) the maximum original term
to stated maturity of the Private Mortgage-Backed Securities; (iii) the weighted
average term to stated maturity of the Private Mortgage-Backed Securities; (iv)
the pass-through or interest rate of the Private Mortgage-Backed Securities; (v)
the weighted average pass-through or interest rate of the Private
Mortgage-Backed Securities; (vi) the PMBS Issuer, the PMBS Servicer (if other
than the PMBS Issuer) and the PMBS Trustee for such Private Mortgage-Backed
Securities; (vii) certain characteristics of credit support, if any, such as
reserve funds, insurance policies, surety bonds, letters of credit or guaranties
relating to the mortgage loans underlying the Private Mortgage-Backed Securities
or to such Private Mortgage-Backed Securities themselves; (viii) the terms on
which the underlying mortgage loans for such Private Mortgage-Backed Securities
may, or are required to, be purchased prior to their stated maturity or the
stated maturity of the Private Mortgage-Backed Securities and the terms of any
redemption or other call feature; and (ix) the terms on which mortgage loans may
be substituted for those originally underlying the Private Mortgage-Backed
Securities.
SUBSTITUTION OF MORTGAGE COLLATERAL
Substitution of Mortgage Collateral (the "Substitute Collateral") will be
permitted in the event of breaches of representations and warranties with
respect to any original Mortgage Collateral or in the event the documentation
with respect to any Mortgage Collateral is determined by the Bond Trustee to be
incomplete. The period during which such substitution will be permitted
generally will be indicated in the Prospectus Supplement for a Series of Bonds.
The Prospectus Supplement for a Series of Bonds will describe the conditions
upon which Mortgage Collateral may be substituted for Mortgage Collateral
initially securing such Series.
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OPTIONAL PURCHASE OF DEFAULTED PLEDGED MORTGAGES
If so provided in the related Prospectus Supplement, the Master Servicer
and/or the Company may, at its option, purchase from the Issuer any Pledged
Mortgage which is delinquent in payment by more than the number of days
specified in such Prospectus Supplement, at a price specified in such Prospectus
Supplement.
BOND AND DISTRIBUTION ACCOUNTS
A separate Bond Account will be established with the Bond Trustee for each
Series of Bonds for receipt of (i) all interest and principal payments
(including, to the extent applicable, any required advances by the Master
Servicer and any Servicers) and all prepayments on the Mortgage Collateral
securing such Series required to be remitted to the Bond Trustee (including, to
the extent applicable, Insurance Proceeds required to be remitted to the Bond
Trustee and Liquidation Proceeds); (ii) the amount of cash, if any, withdrawn
from any related Reserve Fund; and (iii) if so specified in the related
Prospectus Supplement, the reinvestment income on all of the foregoing. On or
prior to the date specified in the related Prospectus Supplement (each, a
"Distribution Account Deposit Date"), the Master Servicer shall withdraw from
the Bond Account the Bond Distribution Amount for such Payment Date, to the
extent of funds available for such purpose on deposit therein, and will deposit
such amount in the Distribution Account.
The Bond Trustee will invest the funds in the Bond Account and the
Distribution Account in Permitted Investments maturing no later than the next
Payment Date for the related Series of Bonds. (Indenture, Section 8.02(b))
"Permitted Investments" may include (i) obligations of the United States or any
agency thereof, provided such obligations are backed by the full faith and
credit of the United States; (ii) general obligations of or obligations
guaranteed by any state of the United States or the District of Columbia
receiving the highest long-term debt rating of each applicable Rating Agency,
(iii) commercial paper which is then receiving the highest commercial rating of
each applicable Rating Agency; (iv) certificates of deposit, demand or time
deposits, or bankers' acceptances issued by any depository institution or trust
company incorporated under the laws of the United States or of any state thereof
and subject to supervision and examination by federal and/or state banking
authorities, provided that the commercial paper and/or long term unsecured debt
obligations of such depository institution or trust company (or in the case of
the principal depository institution in a holding company system, the commercial
paper or long-term unsecured debt obligations of such holding company, but only
if Moody's Investors Service, Inc. ("Moody's") is not an applicable Rating
Agency) are then rated one of the two highest long-term and the highest
short-term ratings of each such Rating Agency for such securities; (v) demand or
time deposits or certificates of deposit issued by any bank or trust company or
savings institution to the extent such deposits are fully insured by the FDIC;
(vi) repurchase obligations with respect to any security described in clause (i)
above, in either case entered into with a depository institution or trust
company (acting as principal) described in clause (iv) above; (viii) securities
(other than stripped bonds, stripped coupons or instruments sold at a purchase
price in excess of 115% of the face amount thereof) bearing interest or sold at
a discount issued by any corporation incorporated under the laws of the United
States or any state thereof which, have the highest ratings of each applicable
Rating Agency (except if the Rating Agency is Moody's, such rating shall be the
highest commercial paper rating of Moody's for any such securities); (ix)
interests in any money market fund which invests only in other Permitted
Investments which at the date of acquisition of the interests in such fund and
throughout the time such interests are held in such fund has the highest
applicable rating by each applicable Rating Agency or such lower rating as will
not result in a change in the rating then assigned to each and (x) short term
investment funds sponsored by any trust company or national banking association
incorporated under the laws of the United States or any state thereof which are
rated by each applicable Rating Agency in their respective highest applicable
rating category and invest only in other Permitted Investments; provided that no
such instrument shall be a Permitted Investment if such instrument evidences the
right to receive interest only payments with respect to the obligations
underlying such instrument; and provided, further, that no investment specified
in clause (ix) or clause (x) above shall be a Permitted Investment for any
Pre-Funding Account or any related Capitalized Interest Account (as defined
herein). If a letter of credit is deposited with the Bond Trustee, such letter
of credit will be irrevocable, will name the Bond Trustee, in its capacity as
trustee for the
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Bondholders, as the sole beneficiary and will be issued by a bank acceptable to
each applicable Rating Agency. (Indenture, Section 1.01)
Unless an Event of Default or an event which if not timely cured will
constitute an Event of Default with respect to a Series of Bonds has occurred
and is continuing, funds remaining in the related Bond Account following a
Payment Date for such Bonds (other than certain amounts not constituting
Available Funds if so specified in the related Prospectus Supplement or any
funds required to be deposited in a related Reserve Fund) will be subject to
withdrawal upon the order of the Issuer free from the lien of the Indenture.
PRE-FUNDING ACCOUNT
If so specified in the related Prospectus Supplement, the Master Servicer
will establish and maintain a Pre-Funding Account, in the name of the related
Bond Trustee on behalf of the related Bondholders, into which the Depositor 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 Bond Trustee for the
related Series of Bond and is designed solely to hold funds to be applied by
such Bond Trustee during the Funding Period to pay to the Depositor the purchase
price for Subsequent Mortgage Collateral. Prior to inclusion in the Collateral
securing a Series of Bonds, in accordance with the provisions of the related
Indenture, the Subsequent Mortgage Collateral will be subject to review by the
same parties as reviewed the initial Mortgage Collateral. Specifically, the Bond
Trustee (or a custodian on its behalf) will be required to perform a document
review and an independent firm will certify the fair value of the Subsequent
Mortgage Collateral. In addition, the Issuer will be required to deliver to the
Bond Trustee a legal opinion to the effect that all Indenture requirements have
been met for including the Subsequent Mortgage Collateral in the Collateral.
Monies on deposit in the Pre-Funding Account will not be available to cover
losses on or in respect of the related Mortgage Collateral. The Pre-Funded
Amount will not exceed 50% of the initial aggregate principal amount of the
Bonds of the related Series. The Pre-Funded Amount will be used by the related
Bond Trustee to purchase Subsequent Mortgage Collateral from the Depositor from
time to time during the Funding Period. The Funding Period, if any, for a Series
of Bonds 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 (as such
term is defined above under "-- Bond and Distribution Accounts") 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 Bond 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 paid to the related Bondholders in the manner
and priority specified in the related Prospectus Supplement, as a prepayment of
principal of the related Bonds. Certain information with respect to the
Subsequent Mortgage Collateral will be filed with the Commission on Form 8-K
within fifteen days after the date such Subsequent Mortgage Collateral is
conveyed to the related Trust.
In addition, if so specified in the related Prospectus Supplement, on the
related Closing Date the Depositor 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 Bonds 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 Bond Trustee for the related
Series of Bonds 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 Mortgage Collateral.
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 Bonds by the end of the Funding Period, any amounts remaining in the
Capitalized Interest Account will be paid to the Depositor.
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CREDIT ENHANCEMENT
GENERAL
Credit enhancement may be provided with respect to one or more Classes of a
Series of Bonds or with respect to the related Mortgage Collateral for the
purpose of (i) maintaining timely payments or providing additional protection
against losses on the Collateral securing such Series of Bonds, (ii) paying
administrative expenses or (iii) establishing a minimum reinvestment rate on the
payments made in respect of such Collateral or principal payment rate on such
Collateral. Credit enhancement may be in the form of the subordination of one or
more Classes of such Series, the establishment of one or more Reserve Funds, use
of a Mortgage Pool Insurance Policy, a Special Hazard Insurance Policy,
Bankruptcy Bond, cash account, insurance policy, surety bond, guaranteed
investment contract, cross-collateralization, overcollaterlization, excess
spread, reinvestment income, guaranty, letter of credit or derivative
arrangement as described herein and in the related Prospectus Supplement, or any
combination of the foregoing. Unless otherwise specified in the related
Prospectus Supplement, no credit enhancement will provide protection against all
risks of loss or guarantee repayment of the entire principal balance of the
Bonds and interest thereon. If losses occur which exceed the amount covered by
credit enhancement or which are not covered by the credit enhancement,
Bondholders will bear their allocable share of any deficiencies.
SUBORDINATION
If so specified in the related Prospectus Supplement, a Series of Bonds may
consist of one or more Classes of Senior Bonds and one or more Classes of
Subordinated Bonds. The rights of the holders of the Subordinated Bonds of a
Series (the "Subordinated Bondholders") to receive payments of principal and/or
interest (or any combination thereof) will be subordinated to such rights of the
holders of the Senior Bonds of the same Series (the "Senior Bondholders") to the
extent described in the related Prospectus Supplement. This subordination is
intended to enhance the likelihood of regular receipt by the Senior Bondholders
of the full amount of their scheduled payments of principal and/or interest. The
protection afforded to the Senior Bondholders 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 payment being made on the related Subordinated
Bonds, the amounts of principal and/or interest due them on each Payment Date
out of the funds available for payment on such date in the related Distribution
Account and, to the extent described in the related Prospectus Supplement, by
the right of such holders to receive future payments that would otherwise have
been payable to the Subordinated Bondholders; or (ii) as otherwise described in
the related Prospectus Supplement. If so specified in the related Prospectus
Supplement, subordination may apply only in the 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 Bonds 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.
If so specified in the related Prospectus Supplement, delays in receipt of
scheduled payments on the Mortgage Collateral and losses with respect to the
Mortgage Collateral will be borne first by the various Classes of Subordinated
Bonds and thereafter by the various Classes of Senior Bonds, in each case under
the circumstances and subject to the limitations specified in such Prospectus
Supplement. The aggregate payments in respect of delinquent payments on the
Mortgage Collateral over the lives of the Bonds or at any time, the aggregate
losses in respect of Mortgage Collateral which must be borne by the Subordinated
Bonds by virtue of subordination and the amount of payments otherwise
distributable to the Subordinated Bondholders that will be distributable to
Senior Bondholders on any Payment Date may be limited as specified in the
related Prospectus Supplement. If aggregate payments in respect of delinquent
payments on the Mortgage Collateral or aggregate losses in respect of such
Mortgage Collateral were to exceed the amount specified in the related
Prospectus Supplement, Senior Bondholders would experience losses on the Bonds.
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If so specified in the related Prospectus Supplement, various Classes of
Senior Bonds and Subordinated Bonds may themselves be subordinate in their right
to receive certain payments to other Classes of Senior and Subordinated Bonds,
respectively.
As between Classes of Senior Bonds and as between Classes of Subordinated
Bonds, payments may be allocated among such Classes (i) in accordance with a
schedule or formula, (ii) in relation to the occurrence of events or (iii)
otherwise, in each case as specified in the related Prospectus Supplement. As
between Classes of Subordinated Bonds, payments to Senior Bondholders on account
of delinquencies or losses and payments to the Reserve Fund will be allocated as
specified in the related Prospectus Supplement.
RESERVE FUNDS
If so specified in the related Prospectus Supplement, the Issuer will
deposit in one or more accounts to be established with the Bond Trustee (each, a
"Reserve Fund") cash, certificates of deposit, letters of credit, surety bonds,
guaranteed investment contracts or any combination thereof, which may be used by
the Bond Trustee to make payments on such Series of Bonds to the extent funds
are not otherwise available. Reserve Funds will be established if they are
deemed by the Issuer to be required to assure timely payment of principal of,
and interest on, its Series of Bonds or are otherwise required as a condition to
the rating of such Bonds by any Rating Agency, or if the Issuer chooses to
reduce the likelihood of a special redemption of such Bonds. The Bond Trustee
will invest any cash in any Reserve Fund in Permitted Investments maturing no
later than the dates specified in the related Prospectus Supplement. If a letter
of credit is deposited with the Bond Trustee, such letter of credit will be
irrevocable, will name the Bond Trustee, in its capacity as trustee for the
Bondholders, as the sole beneficiary and will be issued by a bank acceptable to
each Rating Agency. If a surety bond is deposited with the Bond Trustee, such
surety bond will represent an obligation of an insurance company or other
corporation whose credit standing is acceptable to each Rating Agency and will
provide that the Bond Trustee may exercise all of the rights of the Issuer under
such surety bond without the necessity of the taking of any action by the
Issuer. Following each Payment Date for such Series of Bonds, amounts may be
withdrawn from the related Reserve Funds and remitted to the Issuer free from
the lien of the Indenture under the conditions and to the extent specified in
the related Prospectus Supplement. Additional information concerning any Reserve
Fund securing a Series of Bonds, including without limitation the manner in
which such Reserve Fund shall be funded and the conditions under which the
amounts on deposit therein will be used to make payments to holders of Bonds of
a particular Class of the related Series will be set forth in the related
Prospectus Supplement.
MORTGAGE POOL INSURANCE POLICIES
If so specified in the related Prospectus Supplement, a separate mortgage
pool insurance policy or policies ("Mortgage Pool Insurance Policy") may be
obtained for a Series of Bonds secured by Pledged Mortgages and issued by the
insurer (the "Pool Insurer") named in such Prospectus Supplement. Each Mortgage
Pool Insurance Policy will, subject to the limitations described below, cover
loss by reason of default in payment on the related Pledged Mortgages in an
amount equal to a percentage specified in such Prospectus Supplement of the
aggregate principal balance of such Pledged Mortgages on the Cut-off Date which
are not covered as to their entire outstanding principal balances by Primary
Mortgage Insurance Policies. As more fully described below, the Master Servicer
will present claims thereunder to the Pool Insurer on behalf of itself, the Bond
Trustee and the Bondholders. The Mortgage Pool Insurance Policies, however, are
not blanket policies against loss, since claims thereunder may be made only
respecting particular defaulted Pledged Mortgages and only upon satisfaction of
certain conditions precedent described below. Unless otherwise specified in the
related Prospectus Supplement, the Mortgage Pool Insurance Policies will not
cover losses due to a failure to pay or denial of a claim under a Primary
Mortgage Insurance Policy.
Unless otherwise specified in the related Prospectus Supplement, each
Mortgage Pool Insurance Policy will provide that no claims may be validly
presented unless (i) any required Primary Mortgage Insurance Policy is in effect
for the defaulted Pledged Mortgage and a claim thereunder has been submitted and
settled; (ii) hazard insurance on the related Mortgaged 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
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Mortgaged 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 Mortgaged 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 Mortgaged Property at a price equal to the principal balance of the related
Pledged Mortgage plus accrued and unpaid interest at the Mortgage Rate to the
date of such purchase and certain expenses incurred by the Master Servicer on
behalf of the Bond Trustee and Bondholders or (b) to pay the amount by which the
sum of the principal balance of the defaulted Pledged Mortgage plus accrued and
unpaid interest at the Mortgage Rate to the date of payment of the claim and the
aforementioned expenses exceeds the proceeds received from an approved sale of
the Mortgaged Property, in either case net of certain amounts paid or assumed to
have been paid under the related Primary Mortgage Insurance Policy. If any
Mortgaged Property is damaged, and proceeds, if any, from the related standard
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 Mortgage 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 Bondholders
on liquidation of the Pledged Mortgage 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 Mortgaged Property or proceeds of the
related Mortgage Pool Insurance Policy or any related Primary Mortgage Insurance
Policy.
Unless otherwise specified in the related Prospectus Supplement, no
Mortgage Pool Insurance Policy will 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 Pledged Mortgage, including misrepresentation by the Mortgagor,
the originator or persons involved in the origination thereof, or (ii) failure
to construct a Mortgaged 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
event, might give rise to an obligation on the part of such Seller to repurchase
the defaulted Pledged Mortgage if the breach cannot be cured by such Seller. No
Mortgage Pool Insurance Policy will cover (and many Primary Mortgage Insurance
Policies do not cover) a claim in respect of a defaulted Pledged Mortgage
occurring when the servicer of such Pledged Mortgage, at the time of default or
thereafter, was not approved by the applicable insurer.
Unless otherwise specified in the related Prospectus Supplement, the
original amount of coverage under each Mortgage Pool Insurance Policy will be
reduced over the life of the related Bonds 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 Pledged Mortgages to the date of payment of the claim,
unless otherwise specified in the related Prospectus Supplement. Accordingly, if
aggregate net claims paid under any Mortgage Pool Insurance Policy reach the
original policy limit, coverage under that Mortgage Pool Insurance Policy will
be exhausted and any further losses will be borne by the Bondholders.
SPECIAL HAZARD INSURANCE POLICIES
If so specified in the related Prospectus Supplement, a separate Special
Hazard Insurance Policy may be obtained for a Series of Bonds secured by Pledged
Mortgages and will be issued by the insurer (the "Special Hazard Insurer") named
in such Prospectus Supplement. Each Special Hazard Insurance Policy will,
subject to limitations described below, protect holders of the related Bonds
from (i) loss by reason of damage to Mortgaged Properties caused by certain
hazards (including earthquakes and, to a limited extent, tidal waves and related
water damage or as otherwise specified in the related Prospectus Supplement) not
insured against under the standard form of hazard insurance policy for the
respective states in which the Mortgaged Properties are located or under a flood
insurance policy (unless the Mortgaged Property is located in a federally
designated flood area) and (ii) loss caused by reason of the application of the
coinsurance clause contained in standard hazard insurance policies. No Special
Hazard Insurance Policy will cover losses occasioned by fraud or conversion by
the Bond Trustee or Master Servicer, war, insurrection, civil war, certain
governmental action, errors in design, faulty workmanship or materials (except
under certain circumstances), nuclear or
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chemical reaction, flood (if the Mortgaged Property is located in a federally
designated flood area), nuclear or chemical contamination and certain other
risks. The amount of coverage under any Special Hazard Insurance Policy will be
specified in the related Prospectus Supplement. Each Special Hazard Insurance
Policy will provide that no claim may be paid unless hazard and, if applicable,
flood insurance on the property securing the Pledged Mortgage have been kept in
force and other protection and preservation expenses have been paid.
Subject to the foregoing limitations, and unless otherwise specified in the
related Prospectus Supplement, each Special Hazard Insurance Policy will provide
that where there has been damage to property securing a foreclosed Pledged
Mortgage (title to which has been acquired by the insured) and to the extent
such damage is not covered by the standard hazard insurance policy or flood
insurance policy, if any, maintained by the mortgagor or the Master Servicer,
the Special Hazard Insurer will pay the lesser of (i) the cost of repair or
replacement of such property or (ii) upon transfer of the property to the
Special Hazard Insurer, the unpaid principal balance of such Pledged Mortgage at
the time of acquisition of such property by foreclosure or deed in lieu of
foreclosure, plus accrued interest to the date of claim settlement and certain
expenses incurred by the Master Servicer with respect to such property. If the
unpaid principal balance of a Pledged Mortgage plus accrued interest and certain
expenses is paid by the Special Hazard Insurer, the amount of further coverage
under the related Special Hazard Insurance Policy will be reduced by such amount
less any net proceeds from the sale of the property. Any amount paid as the cost
of repair of such property will further reduce coverage by such amount. So long
as a Mortgage Pool Insurance Policy remains in effect, the payment by the
Special Hazard Insurer of the cost of repair or of the unpaid principal balance
of the related Pledged Mortgage plus accrued interest and certain expenses will
not affect the total insurance proceeds paid to Bondholders, but will affect the
relative amounts of coverage remaining under the related Special Hazard
Insurance Policy and Mortgage Pool Insurance Policy.
To the extent specified in the related Prospectus Supplement, the Master
Servicer may deposit cash, an irrevocable letter of credit or a guaranteed
investment contract in a special trust account to provide protection in lieu of
or in addition to that provided by a Special Hazard Insurance Policy. The amount
of any Special Hazard Insurance Policy or of the deposit to the special trust
account in lieu thereof relating to such Bonds may be reduced so long as any
such reduction will not result in a downgrading of the rating of such Bonds by
any applicable Rating Agency.
BANKRUPTCY BONDS
If so specified in the related Prospectus Supplement, a bankruptcy bond or
bonds (the "Bankruptcy Bond") may be obtained for a Series of Bonds secured by
Pledged Mortgages to cover losses resulting from proceedings under the federal
Bankruptcy Code with respect to a Pledged Mortgage will be issued by an insurer
named in such Prospectus Supplement. Each Bankruptcy Bond will cover, to the
extent specified in the related Prospectus Supplement, certain losses resulting
from a reduction by a bankruptcy court of scheduled payments of principal and
interest on a Pledged Mortgage or a reduction by such court of the principal
amount of a Pledged Mortgage and will cover certain unpaid interest on the
amount of such a principal reduction from the date of the filing of a bankruptcy
petition. The required amount of coverage under each Bankruptcy Bond will be set
forth in the related Prospectus Supplement. Coverage under a Bankruptcy Bond may
be cancelled or reduced by the Master Servicer if such cancellation or reduction
would not adversely affect the then current rating or ratings of the related
Bonds. See "CERTAIN LEGAL ASPECTS OF THE PLEDGED MORTGAGES -- Anti-Deficiency
Legislation and Other Limitations on Lenders" herein.
To the extent specified in the related Prospectus Supplement, the Master
Servicer may deposit cash, an irrevocable letter of credit or a guaranteed
investment contract in a special trust account to provide protection in lieu of
or in addition to that provided by a Bankruptcy Bond. The amount of any
Bankruptcy Bond or of the deposit to the special trust account in lieu thereof
relating to such Bonds may be reduced so long as any such reduction will not
result in a downgrading of the then current rating of such Bonds by any such
Rating Agency.
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BOND INSURANCE POLICIES, SURETY BONDS AND GUARANTEES
If specified in the related Prospectus Supplement, deficiencies in amounts
otherwise payable on Bonds of a Series 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 Bonds of the related Series, timely payments of interest
and/or full payments of principal on the basis of a schedule of principal
payments set forth in or determined in the manner specified in the related
Prospectus Supplement. In addition, if specified in the related Prospectus
Supplement, a Series of Bonds may also be covered by insurance or guarantees for
the purpose of (i) maintaining timely payments or providing additional
protection against losses on the Mortgage Collateral pledged to secure such
Series, (ii) paying administrative expenses or (iii) establishing a minimum
reinvestment rate on the payments made in respect of such Mortgage Collateral or
principal payment rate on such Mortgage Collateral. Such arrangements may
include agreements under which Bondholders are entitled to receive amounts
deposited in various accounts held by the Bond 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 within 15 days of issuance of the Bonds of the related Series.
LETTER OF CREDIT
If so specified in the related Prospectus Supplement, credit enhancement
may be provided by a letter of credit. The letter of credit, if any, with
respect to a Series of Bonds 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 Mortgage Collateral pledged to secure the
related Series of Bonds on the related Cut-off Date or of one or more Classes of
Bonds (the "L/C Percentage"). 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
Pledged Mortgage. 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 Bonds
will expire at the date specified in the related Prospectus Supplement. 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.
CROSS-COLLATERALIZATION
If so specified in the related Prospectus Supplement, separate groups of
Mortgage Collateral may be pledged to secure separate Classes of the related
Series of Bonds. In such case, credit support may be provided by a
cross-collateralization feature which requires that payments be made with
respect to Bonds secured by one or more groups of Mortgage Collateral prior to
distributions to Subordinated Bonds secured by one or more other groups of
Mortgage Collateral. Cross-collateralization may be provided by (i) the
allocation of certain excess amounts generated by one or more groups of Mortgage
Collateral to one or more other groups of Mortgage Collateral or (ii) the
allocation of losses with respect to one or more groups of Mortgage Collateral,
to one or more other groups of Mortgage Collateral. Such excess amounts will be
applied and/or such losses will be allocated to the Class or Classes of
Subordinated Bonds of the related Series then outstanding having the lowest
rating assigned by any applicable Rating Agency or the lowest payment priority,
in each case to the extent and in the manner more specifically described in the
related Prospectus Supplement. The Prospectus Supplement for a Series which
includes a cross-collateralization feature will describe the manner and
conditions for applying such cross-collateralization feature.
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OVERCOLLATERALIZATION
If so specified in the related Prospectus Supplement, credit enhancement
may consist of over-collateralization whereby the aggregate principal balance of
the related Mortgage Collateral exceeds the aggregate principal balance of the
Bonds of the related Series. Such over-collateralization may exist on the
related Closing Date and/or develop thereafter as a result of the application of
a portion of the interest payments on each Pledged Mortgage or Certificate, as
the case may be, as an additional payment in respect of principal to reduce the
principal balance of a certain Class or Classes of Bonds and, thus, accelerate
the rate of payment of principal on such Class or Classes of Bonds.
EXCESS SPREAD
"Excess Spread" refers to the positive spread that may exist to the extent
specified in the related Prospectus Supplement between the weighted average of
the interest rates (less servicing or other applicable fees) on the Mortgage
Collateral and the weighted average of the Bond Interest Rates. Whether at any
time any such positive spread exists will depend on a variety of factors,
including, with respect to a Series of Bonds with respect to which both the
Bonds and the Mortgage Collateral bear interest at adjustable rates, the
relationship of the movements in the indices applicable to the Mortgage
Collateral and those applicable to the Bonds, over which no prediction can be
made or assurance given.
If so 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 Series of Bonds. If applicable,
the related Prospectus Supplement will identify the Series of Bonds to which
such credit enhancement relates and the manner of determining the amount of
coverage provided to such Series of Bonds thereby and of the application of such
coverage to the identified Series of Bonds.
MINIMUM PRINCIPAL PAYMENT AGREEMENT
If so specified in the related Prospectus Supplement, an Issuer may enter
into an agreement with an institution pursuant to which such institution will
provide such funds as may be necessary to enable such Issuer to make principal
payments on the Bonds of the related Series at a minimum rate set forth in such
Prospectus Supplement.
DERIVATIVE ARRANGEMENTS
If so specified in the related Prospectus Supplement, credit enhancement
may be provided with respect to one or more Classes of Bonds of a Series or with
respect to the Mortgage Collateral securing a Series of Bonds in the form of one
or more derivative arrangements. A derivative arrangement is a contract or
agreement, the price of which is directly dependent upon (i.e., "derived from")
the value of one or more underlying assets, including securities, equity
indices, debt instruments, commodities, other derivative instruments, or any
agreed upon pricing index or arrangement (e.g., the movement over time of the
Consumer Price Index or interest rates). Derivatives involve rights or
obligations based on the underlying asset, but do not necessarily result in a
transfer of the underlying asset. Derivative arrangements include swap
agreements, interest rate swaps, interest rate caps, interest rate floors,
interest rate collars and currency swap agreements. A "swap agreement" is a
contractual agreement providing for a series of exchanges of principal and/or
interest in the same or different currencies. At a more general level, the term
"swap agreement" includes the exchange of fixed-for-floating payments on a given
quantity of a specified commodity, security or other asset. An "interest rate
swap" is a swap agreement between two parties to engage in a series of exchanges
of interest payments on the same notional principal amount denominated in the
same currency based, respectively, on variable and fixed rates of interest. An
"interest rate cap" is an agreement providing for multi-period cash settled
options on interest rates. The cap purchaser receives a cash payment whenever
the reference rate exceeds the ceiling rate on a fixing date. An "interest rate
floor" is an agreement providing for a multi-period interest rate option that
provides a cash payment to the holder of the option whenever the reference rate
is below the floor on a fixing date. An "interest rate collar" is an agreement
providing for a combination of an interest rate cap and an interest rate floor
such that a cap is purchased and a floor is sold or vice versa. The effect of an
interest rate
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collar is to place upper and lower bounds on the cost of funds. A "currency swap
agreement" is a swap agreement between two parties for the exchange of a future
series of interest and principal payments in which one party pays in one
currency and the other party pays in a different currency. The exchange rate is
fixed over the life of the currency swap agreement.
The derivative arrangements described above will support the payments on
the Bonds to the extent and under the conditions specified in the related
Prospectus Supplement. Unless otherwise specified in the related Prospectus
Supplement, no credit enhancement will provide protection against all risks of
loss or guarantee repayment of the entire principal balance of the Bonds and
interest thereon. If losses occur which exceed the amount covered by credit
enhancement or which are not covered by the credit enhancement, Bondholders will
bear their allocable share of any deficiencies.
SERVICING OF THE PLEDGED MORTGAGES
GENERAL
The Master Servicer of the Pledged Mortgages, if any, securing a Series of
Bonds will be responsible for servicing such Pledged Mortgages in accordance
with the terms set forth in a master servicing agreement (the "Master Servicing
Agreement") among the Issuer, the Master Servicer and the Bond Trustee. The
Master Servicer with respect to a Series of Bonds will be identified in the
related Prospectus Supplement. The Master Servicer may perform certain of its
servicing obligations under the Master Servicing Agreement through one or more
servicers (each, a "Servicer") pursuant to one or more mortgage servicing
agreements (each, a "Servicing Agreement"). Notwithstanding any such servicing
arrangements, 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.
No Servicing Agreement will contain any terms inconsistent with the related
Master Servicing Agreement. While each Servicing Agreement will typically be a
contract solely between Redwood Trust and the Servicer, Redwood Trust will
assign all of its rights under each Servicing Agreement to the Depositor under
the related Mortgage Loan Purchase Agreement and such rights will be assigned to
the Bond Trustee pursuant to the Indenture. The Master Servicing Agreement
relating to a Series of Bonds will provide that the Master Servicer and, if for
any reason such Master Servicer is no longer the Master Servicer of the related
Pledged Mortgages, the Bond Trustee or any successor Master Servicer must
recognize the Servicer's rights and obligations under such Servicing Agreement.
As an independent contractor, each Servicer will perform servicing functions for
the Pledged Mortgages including collection and remittance of principal and
interest payments, administration of mortgage escrow accounts, collection of
certain insurance claims and, if necessary, foreclosure.
The Master Servicer may permit Servicers to contract with subservicers to
perform some or all of the Servicer's servicing duties, but the Servicer will
not thereby be released from its obligations under the related Servicing
Agreement. The Master Servicer also may enter into servicing contracts directly
with an affiliate of a Servicer or permit a Servicer to transfer its servicing
rights and obligations to a third party. In such instances, the affiliate or
third party, as the case may be, will perform servicing functions comparable to
those normally performed by the Servicer as described above, and the Servicer
will not be obligated to perform such servicing functions. When used herein with
respect to servicing obligations, the term Servicer includes any such
subservicer. The Master Servicer may perform certain supervisory functions with
respect to servicing by the Servicers directly or through an agent or
independent contractor.
On or before the related Closing Date, the Master Servicer will establish
one or more accounts (the "Custodial Account") into which each Servicer will
remit collections on the Pledged Mortgages serviced by it (net of its related
servicing compensation, amounts retained to pay certain insurance premiums and
amounts retained by such Servicer as reimbursement for certain advances it has
made). For purposes of the Master Servicing Agreement, the Master Servicer will
be deemed to have received any amounts with respect to the Pledged Mortgages
that are received by a Servicer regardless of whether such amounts are remitted
by the Servicer to the Master Servicer. The Master Servicer will have the right
under the Master Servicing
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Agreement to remove the Servicer servicing any Pledged Mortgages in the event
such Servicer defaults under its Servicing Agreement and will exercise that
right (subject to the consent of any applicable Bond Insurer). if the Master
Servicer considers such removal to be in the best interest of the Bondholders or
at the direction of one applicable Bond Insurer. In the event that the Master
Servicer removes a Servicer, the Master Servicer will continue to be responsible
for servicing the related Pledged Mortgages.
A form of Master Servicing Agreement has been filed as an exhibit to the
Registration Statement of which this Prospectus forms a part and the definitive
form of Master Servicing Agreement for each issuance of Bonds will be filed on
Form 8-K following the applicable closing date. The Master Servicing Agreement
with respect to a Series of Bonds secured by Pledged Mortgages will be assigned
to the Bond Trustee as security for such Series. The following summaries
describe certain provisions of the form of Master Servicing Agreement. The
summaries are qualified in their entirety by reference to the form of Master
Servicing Agreement. Where particular provisions or terms used in the form of
Master Servicing Agreement are referred to, the actual provisions (including
definitions of terms) are incorporated by reference as part of such summaries.
PAYMENTS ON PLEDGED MORTGAGES
Pursuant to the Master Servicing Agreement with respect to a Series of
Bonds, the Master Servicer will be required to establish and maintain the Bond
Account as a separate Eligible Account or Eligible Accounts into which it will
deposit or cause to be deposited on a daily basis, or such other basis as may be
specified in the related Prospectus Supplement, payments of principal and
interest (net of servicing compensation, amounts retained to pay certain
insurance premiums and amounts retained by the Master Servicer or any Servicer
as reimbursement for certain advances it has made) received with respect to the
related Pledged Mortgages. Such amounts will include principal prepayments,
certain Insurance Proceeds and Liquidation Proceeds and amounts paid by the
Servicer or the Company in connection with any optional purchase by the Servicer
or the Company of any defaulted Pledged Mortgages.
An "Eligible Account" is a segregated account either (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, but only if
Moody's is not an applicable Rating Agency) are rated in the highest short-term
rating category by each applicable Rating Agency, and the long-term unsecured
debt obligations of which shall be rated one of the two highest long-term
ratings by each applicable Rating Agency (ii) an account or accounts the
deposits in which are fully insured by either the BIF or SAIF, (iii) a
segregated trust account or accounts maintained with the trust department of a
federal or a state chartered depository institution or trust company, acting in
a fiduciary capacity or (iv) an account or accounts otherwise acceptable to each
applicable Rating Agency and any applicable Bond Insurer. The collateral
eligible to secure amounts in the Bond Account is limited to Permitted
Investments. A Bond Account may be maintained as an interest bearing account or
the funds held therein may be invested pending each succeeding Payment Date in
Permitted Investments. If so specified in the related Prospectus Supplement, the
Master Servicer or its designee will be entitled to receive any such interest or
other income earned on funds in the Bond Account as additional compensation and
will be obligated to deposit in the Bond Account the amount of any loss
immediately as realized.
Pursuant to the Master Servicing Agreement, the Master Servicer will be
required to remit to the Bond Trustee (to the extent not previously remitted),
on or before each Distribution Account Deposit Date, the Bond Distribution
Amount for the related Payment Date for deposit in the Distribution Account for
such Series of Bonds maintained with the Bond Trustee.
Any amounts received by the Master Servicer as Insurance Proceeds or as
Liquidation Proceeds, net of any expenses and other amounts reimbursable to the
Master Servicer pursuant to the Master Servicing Agreement, will (unless applied
to the repair or restoration of a Mortgaged Property) be deemed to be payments
received with respect to the Pledged Mortgages securing the related Series of
Bonds and will be deposited in the related Bond Account.
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Prior to each Payment Date for a Series of Bonds, the Master Servicer will
furnish to the Bond Trustee and any applicable Bond Insurer a statement setting
forth certain information with respect to payments received with respect to the
Pledged Mortgages.
COLLECTION PROCEDURES
The Master Servicer, directly or through one or more Servicers, will make
reasonable efforts to collect all payments called for under the Pledged
Mortgages and will, consistent with each Master Servicing Agreement and any
Mortgage Pool Insurance Policy, Primary Mortgage Insurance Policy and Bankruptcy
Bond or alternative arrangements, follow such collection procedures as are
customary with respect to mortgage loans that are comparable to the Pledged
Mortgages. Consistent with the above, the Master Servicer or applicable Servicer
may, in its discretion, (i) waive any assumption fee, late payment or other
charge in connection with a Pledged Mortgage and (ii) to the extent not
inconsistent with the coverage of such Pledged Mortgage by a Mortgage Pool
Insurance Pool Policy, Primary Mortgage Insurance Policy or Bankruptcy Bond or
alternative arrangements, if applicable, arrange with a Mortgagor a schedule for
the liquidation of delinquencies running for no more than 180 days (unless a
longer period is specified in the related Prospectus Supplement) after the
applicable due date for each payment. To the extent the Master Servicer is
obligated to make or to cause to be made advances, such obligation will remain
during any period of such an arrangement.
Unless otherwise specified in the related Prospectus Supplement, in any
case in which property securing a Pledged Mortgage has been, or is about to be,
conveyed by the Mortgagor, the Master Servicer will, to the extent it has
knowledge of such conveyance or proposed conveyance, exercise or cause to be
exercised its rights to accelerate the maturity of such Pledged Mortgage under
any due-on-sale clause applicable thereto, but only if the exercise of such
rights is permitted by applicable law and will not impair or threaten to impair
any recovery under any related Primary Mortgage Insurance Policy. If these
conditions are not met or if the Master Servicer reasonably believes it is
unable under applicable law to enforce such due-on-sale clause, the Master
Servicer will enter into or cause to be entered into an assumption and
modification agreement with the person to whom such property has been or is
about to be conveyed, pursuant to which such person becomes liable for repayment
of the Pledged Mortgage and, to the extent permitted by applicable law, the
Mortgagor also remains liable thereon. If a Mortgaged Property is sold or
transferred, the Master Servicer will be required promptly to notify the Bond
Trustee and the respective issuers of any hazard insurance policies, mortgagor
bankruptcy insurance and mortgage insurance policies to assure that all required
endorsements to each insurance policy are obtained and that coverage under each
such policy will remain in effect after the occurrence of such sale or transfer.
Any fee collected by or on behalf of the Master Servicer for entering into an
assumption agreement will be retained by or on behalf of the Master Servicer as
additional servicing compensation. See "CERTAIN LEGAL ASPECTS OF PLEDGED
MORTGAGES -- 'Due-on-Sale' Clauses" herein. In connection with any such
assumption, the terms of the related Pledged Mortgage may not be changed.
With respect to Cooperative Loans, any prospective purchaser will generally
have to obtain the approval of the board of directors of the relevant
Cooperative before purchasing the shares and acquiring rights under the related
proprietary lease or occupancy agreement. See "CERTAIN LEGAL ASPECTS OF PLEDGED
MORTGAGES" herein. This approval is usually based on the purchaser's income and
net worth and numerous other factors. Although the Cooperative's approval is
unlikely to be unreasonably withheld or delayed, the necessity of acquiring such
approval could limit the number of potential purchasers for those shares and
otherwise limit the ability to sell and realize the value of those shares.
In general, a "tenant-stockholder" (as defined in Code Section 216(b)(2))
of a corporation that qualifies as a "cooperative housing corporation" within
the meaning of Code Section 216(b)(1) is allowed a deduction for amounts paid or
accrued within his taxable year to the corporation representing his
proportionate share of certain interest expenses and certain real estate taxes
allowable as a deduction under Code Section 216(a) to the corporation under Code
Sections 163 and 164. In order for a corporation to qualify under Code Section
216(b)(1) for its taxable year in which such items are allowable as a deduction
to the corporation, such Section requires, among other things, that at least 80%
of the gross income of the corporation be derived from its tenant-stockholders
(as defined in Code Section 216(b)(2)). By virtue of this requirement, the
status of a
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corporation for purposes of Code Section 216(b)(1) must be determined on a
year-to-year basis. Consequently, there can be no assurance that Cooperatives
relating to the Cooperative Loans will qualify under such Section for any
particular year. In the event that such a Cooperative fails to qualify for one
or more years, the value of the collateral securing any related Cooperative
Loans could be significantly impaired because no deduction would be allowable to
tenant-stockholders under Code Section 216(a) with respect to those years. In
view of the significance of the tax benefits accorded tenant-stockholders of a
corporation that qualifies under Code Section 216(b)(1), the likelihood that
such a failure would be permitted to continue over a period of years appears
remote.
JUNIOR MORTGAGES
In the case of single family loans secured by junior liens on the related
Mortgaged Properties, for the protection of the related Bond Trustee's interest
the Master Servicer will be required to file (or cause to be filed) of record a
request for notice of any action by a superior lienholder under the Senior Lien,
where permitted by local law and whenever applicable state law does not require
that a junior lienholder be named as a party defendant in foreclosure
proceedings in order to foreclose such junior lienholder's equity of redemption.
The Master Servicer also will be required to notify any superior lienholder in
writing of the existence of the Pledged Mortgage and request notification of any
action (as described below) to be taken against the Mortgagor or the Mortgaged
Property by the superior lienholder. If the Master Servicer is notified that any
superior lienholder has accelerated or intends to accelerate the obligations
secured by the related Senior Lien, or has declared or intends to declare a
default under the mortgage or the promissory note secured thereby, or has filed
or intends to file an election to have the related Mortgaged Property sold or
foreclosed, then the Master Servicer or Servicer will be required to take, on
behalf of the related Issuer, whatever actions are necessary to protect the
interests of the related Bondholders, and/or to preserve the security of the
related Pledged Mortgage. The Master Servicer will generally be required to
advance the necessary funds to cure the default or reinstate the superior lien,
if such advance is in the best interests of the related Bondholders and the
Master Servicer or Servicer determines such advances are recoverable out of
payments on or proceeds of the related Pledged Mortgage.
SERVICING AND OTHER COMPENSATION AND PAYMENT OF EXPENSES
The principal servicing compensation to be paid to the Master Servicer in
respect of its master servicing activities for each Series of Bonds will be
equal to the percentage per annum described in the related Prospectus Supplement
(which may vary under certain circumstances) of the outstanding principal
balance of each Pledged Mortgage securing such Series of Bonds or such other
amounts as may be described in the Prospectus Supplement and such compensation
will be retained by it from collections of interest on such Pledged Mortgage or
other sources described in the Prospectus Supplement (the "Master Servicing
Fee"). As compensation for its servicing duties, any Servicer or subservicer
will generally be entitled to a monthly servicing fee as described in the
related Prospectus Supplement. In addition, the Master Servicer, any Servicer or
any subservicer will retain as additional compensation all prepayment charges,
assumption fees and late payment charges, to the extent collected from
Mortgagors, and any benefit that may accrue as a result of the investment of
funds in the applicable Bond 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 Series of Bonds and incurred by it in connection with its
responsibilities under the related Master Servicing Agreement, including,
without limitation, payment of any fee or other amount payable in respect of any
credit enhancement arrangements, payment of the fees and disbursements of the
Bond Trustee, any custodian appointed by the Bond Trustee, the certificate
registrar and any paying agent, and payment of expenses incurred in enforcing
the obligations of Servicers and Sellers. The Master Servicer will be entitled
to reimbursement of expenses incurred in enforcing the obligations of Servicers
under certain limited circumstances. In addition, as indicated in the preceding
section, the Master Servicer will be entitled to reimbursement of expenses
incurred by it in connection with any defaulted Pledged Mortgage as to which it
has determined that all recoverable Liquidation Proceeds and Insurance Proceeds
have been received (a
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"Liquidated Mortgage"), and in connection with the restoration of Mortgaged
Properties, such right of reimbursement being prior to the rights of Bondholders
to receive any related Liquidation Proceeds (including Insurance Proceeds).
PREPAYMENTS
In general, when a borrower prepays a mortgage loan between due dates, the
borrower is required to pay interest on the amount prepaid only to the date of
prepayment and not thereafter. In the event such prepayments, together with
other prepayments (including for this purpose prepayments resulting from
refinancing or liquidations of the Pledged Mortgages or the mortgage loans
underlying the Certificates, as the case may be, due to defaults, casualties,
condemnations, repurchases by the Seller, the Issuer or Redwood Trust or
purchases thereof by the Master Servicer or the Company), result in a shortfall
in the amount of interest available on a Payment Date for the Bonds of a Series,
the Master Servicer may be required to cover the shortfall, but only if and to
the extent specified in the related Prospectus Supplement.
EVIDENCE AS TO COMPLIANCE
Each Master Servicing Agreement and Indenture will provide that on or
before a specified date in each year, a firm of independent public accountants
will furnish a statement to the Issuer and the Bond Trustee to the effect that,
on the basis of the examination by such firm conducted substantially in
compliance with the Uniform Single Attestation Program for Mortgage Bankers, the
Audit Program for Mortgages serviced for FHLMC or such other procedures as may
be specified in the related Prospectus Supplement, the servicing by or on behalf
of each Servicer of Pledged Mortgages under agreements substantially similar to
each other (including the related Master Servicing Agreement) was conducted in
compliance with such agreements except for any significant exceptions or errors
in records that, in the opinion of the firm, the Audit Program for Mortgages
serviced for FHLMC, the Uniform Single Attestation Program for Mortgage Bankers
or such other procedure, requires it to report. In rendering its statement such
firm may rely, as to matters relating to the direct servicing of Pledged
Mortgages by Servicers, upon comparable statements for examinations conducted
substantially in compliance with the Uniform Single Attestation Program for
Mortgage Bankers, the Audit Program for Mortgages serviced for FHLMC or such
other procedure, (rendered within one year of such statement) of firms of
independent public accountants with respect to the related Servicer.
Each Master Servicing Agreement and Indenture will also provide for
delivery to the Issuer and the Bond Trustee, on or before a specified date in
each year, of an annual statement signed by two officers of the Master Servicer
to the effect that the Master Servicer has fulfilled its obligations under the
Master Servicing Agreement throughout the preceding year.
Copies of the annual accountants' statement and the statement of officers
of the Master Servicer may be obtained by Bondholders of the related Series
without charge upon written request to the Issuer at its principal executive
offices.
ADVANCES AND OTHER AMOUNTS PAYABLE BY MASTER SERVICER AND SERVICERS
Subject to any limitations set forth in the related Prospectus Supplement,
each Master Servicing Agreement will require the Master Servicer to advance on
or before each Payment Date (from its own funds, funds advanced by Servicers or
funds held in the Bond Account for future distribution to Bondholders), an
amount equal to the aggregate of payments of principal and interest that were
delinquent on the related Determination Date, subject to the Master Servicer's
determination that such advances will be recoverable out of late payments by
obligors on the Mortgage Collateral, Liquidation Proceeds, Insurance Proceeds or
otherwise. In the case of Cooperative Loans, the Master Servicer also will be
required to advance any unpaid maintenance fees and other charges under the
related proprietary leases as specified in the related Prospectus Supplement. To
the extent described in the related Prospectus Supplement, each Servicer may
have a comparable obligation to advance under its Servicing Agreement.
In making Advances, the Master Servicer will endeavor to maintain a regular
flow of scheduled interest and principal payments to Bondholders, rather than to
guarantee or insure against losses. If Advances are
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made by the Master Servicer from cash being held for future distribution to
Bondholders, the Master Servicer will replace such funds on or before any future
Payment Date to the extent that funds in the applicable Bond Account on such
Payment Date would be less than the amount required to be available for
distributions to Bondholders on such date. Any Advances will be reimbursable to
the Master Servicer out of recoveries on the specific Mortgage Collateral with
respect to which such Advances were made (e.g., late payments made by the
related obligors, any related Insurance Proceeds, Liquidation Proceeds or
proceeds of any Pledged Mortgage repurchased pursuant to the related Master
Servicing Agreement). In addition, Advances by the Master Servicer (and any
advances by a Servicer) also will be reimbursable to the Master Servicer (or
Servicer) from cash otherwise distributable to Bondholders to the extent that
the Master Servicer determines that any such Advances previously made are not
ultimately recoverable as described in the immediately preceding sentence. 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 Mortgagors on a
timely basis. Funds so advanced are reimbursable to the Master Servicer to the
extent permitted by the Master Servicing Agreement. If specified in the related
Prospectus Supplement, the obligations of the Master Servicer to make Advances
may be supported by a cash advance reserve fund, a surety bond or a letter of
credit, in each case as described in such Prospectus Supplement.
RESIGNATION OF MASTER SERVICER
A Master Servicer may not resign from its obligations and duties under a
Master Servicing Agreement or assign or transfer such duties or obligations
except (i) upon a determination that its duties thereunder are no longer
permissible under applicable law or (ii) upon a sale of its servicing rights
with respect to the Pledged Mortgages with the prior written consents of the
Bond Trustee, the Issuer and any applicable Pool Insurer or Bond Insurer (a
"Bond Insurer"). No such resignation will become effective until the Bond
Trustee, as Stand-by Master Servicer, or a Successor Master Servicer (as such
terms are defined below) has assumed the Master Servicer's obligations and
duties under such Master Servicing Agreement.
Each Master Servicing Agreement will provide that such a successor master
servicer (the "Successor Master Servicer") must be satisfactory to the Issuer,
the Bond Trustee and any applicable Pool Insurer or Bond Insurer, in the
exercise of their reasonable discretion and must be approved to act as a
mortgage servicer for FHLMC or FNMA.
STAND-BY SERVICER
If so specified in the related Prospectus Supplement, the Bond Trustee will
act as stand-by Master Servicer (the "Stand-by Master Servicer") with respect to
each Series of Bonds secured by Pledged Mortgages. As Stand-by Master Servicer,
the Bond Trustee will succeed to the rights and obligations of the Master
Servicer with respect to the Pledged Mortgages securing such Series upon a
default by the Master Servicer or upon resignation by the Master Servicer until
the appointment of a Successor Master Servicer.
SPECIAL SERVICING AGREEMENT
The Company may appoint (subject to the consent of any applicable Bond
Insurer) a Special Servicer to undertake certain responsibilities with respect
to certain defaulted Pledged Mortgages securing a Series. The Special Servicer
may engage various independent contractors to perform certain of its
responsibilities, provided, however, the Special Servicer remains fully
responsible and liable for all its requirements under the special servicing
agreement (the "Special Servicing Agreement"). As may be further specified in
the related Prospectus Supplement, the Special Servicer, if any, may be entitled
to various fees, including, but not limited to, (i) a monthly engagement fee
applicable to each Pledged Mortgage, (ii) a special servicing fee, or (iii) a
performance fee applicable to each liquidated Pledged Mortgage, in each case
calculated as set forth in the related Prospectus Supplement.
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CERTAIN MATTERS REGARDING THE MASTER SERVICER AND THE COMPANY
Unless otherwise specified in the related Prospectus Supplement, each
Master Servicing Agreement will provide that neither the Master Servicer, the
Company, the Owner Trustee nor any director, officer, employee or agent of the
Master Servicer, the Company or the Owner Trustee will be under any liability to
the related Bondholders for any action taken or for refraining from the taking
of any action in good faith pursuant to the Master Servicing Agreement, or for
errors in judgment; provided, however, that neither the Master Servicer, the
Company, the Owner Trustee nor any such person will be protected against any
liability that would otherwise be imposed by reason of willful misfeasance, bad
faith or gross negligence in the performance of duties thereunder or by reason
of reckless disregard of obligations and duties thereunder. Each Master
Servicing Agreement will further provide that the Master Servicer, the Company,
the Owner Trustee and any director, officer, employee or agent of the Master
Servicer, the Company or the Owner Trustee will be entitled to indemnification
by the related Issuer and will be held harmless against any loss, liability or
expense incurred in connection with any legal action relating to the Master
Servicing Agreement or the Bonds, other than any loss, liability or expense
related to any specific Mortgage Collateral (except any such loss, liability or
expense otherwise reimbursable pursuant to the Master Servicing Agreement) and
any loss, liability or expense incurred by reason of willful misfeasance, bad
faith or negligence in the performance of duties thereunder or by reason of
reckless disregard of obligations and duties thereunder. In addition, each
Master Servicing Agreement will provide that neither the Master Servicer, the
Company nor the Owner Trustee will be under any obligation to appear in,
prosecute or defend any legal action which is not incidental to its respective
responsibilities under the Master Servicing Agreement and which in its opinion
may involve it in any expense or liability. The Master Servicer, the Company or
the Owner Trustee may, however, in its discretion undertake any such action
which it may deem necessary or desirable with respect to the Master Servicing
Agreement and the rights and duties of the parties thereto and the interests of
the Bondholders thereunder. In such event, unless otherwise specified in the
related Prospectus Supplement, the legal expenses and costs of such action and
any liability resulting therefrom will be expenses, costs and liabilities of the
related Issuer, and the Master Servicer, the Company or the Owner Trustee, as
the case may be, will be entitled to be reimbursed therefor out of funds
otherwise distributable to Bondholders.
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 Master
Servicing 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 Bonds of such Series.
SERVICING DEFAULTS
Events of default under the Master Servicing Agreement (each, a "Servicing
Default") for a Series of Bonds will include (i) any failure of the Master
Servicer to deposit in the Bond Account or remit to the Bond Trustee any
required payment (other than an Advance) which continues unremedied for one
business day after the giving of written notice of such failure to the Master
Servicer by the Bond Trustee or the Issuer; (ii) any failure by the Master
Servicer to make an Advance as required under the Master Servicing Agreement,
unless cured as specified therein; (iii) any failure by the Master Servicer duly
to observe or perform in any material respect any of its other covenants or
agreements in the Master Servicing Agreement or any related Bond Insurance
Policy which continues unremedied for thirty days after the giving of written
notice of such failure to the Master Servicer by the Bond Trustee or the Issuer;
and (iv) certain events of insolvency, readjustment of debt, marshalling of
assets and liabilities or similar proceeding and certain actions by or on behalf
of the Master Servicer indicating its insolvency, reorganization or inability to
pay its obligations.
RIGHTS UPON SERVICING DEFAULT
If a Servicing Default under a Master Servicing Agreement shall have
occurred and be continuing, the Bond Trustee may, with the consent of any
applicable Bond Insurer, and shall, at the direction of any such
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Bond Insurer, terminate all of the rights and obligations of the Master Servicer
under such Master Servicing Agreement, including the Master Servicer's rights to
receive any Master Servicing Fees. Upon such termination, the Bond Trustee, as
Stand-by Master Servicer, or any Successor Master Servicer duly appointed by the
Bond Trustee will succeed to all the responsibilities, duties and liabilities of
the Master Servicer under such Master Servicing Agreement and will be entitled
to similar compensation arrangements. Neither the Issuer nor the Bond Trustee
shall have any right to waive any Servicing Default, except under certain
circumstances specified in the Master Servicing Agreement, but any applicable
Bond Insurer may waive a Servicing Default.
AMENDMENT OF MASTER SERVICING AGREEMENT
A Master Servicing Agreement with respect to any Series of Bonds secured by
Pledged Mortgages may not be amended, changed, modified, terminated or
discharged, except by an instrument in writing signed by all parties thereto,
with the prior written consent of any applicable Bond Insurer and with prior
written notice to any applicable Pool Insurer.
THE INDENTURE
The following is a general summary of certain provisions of the Indenture
for each Series of Bonds not described elsewhere in this Prospectus. The
summaries are qualified in their entirety by reference to the provisions of the
Indenture. Where particular provisions or terms used in the Indenture are
referred to, the actual provisions (including definitions of terms) are
incorporated by reference as part of such summaries. The Indenture relating to
each Series of Bonds will be filed with the Securities and Exchange Commission
within fifteen days of the closing of the sale of such Series of Bonds.
GENERAL
Unless otherwise specified in the related Prospectus Supplement, the
Indenture for each Series of Bonds will limit the amount of Bonds that can be
issued thereunder and will provide that Bonds may be issued only up to the
aggregate principal amount authorized by the Issuer.
MODIFICATION OF INDENTURE
With the consent of the holders of not less than 66 2/3% of the then
outstanding principal amount of the Class of Bonds of the related Series
specified in the related Prospectus Supplement to be the "Controlling Class" and
any applicable Bond Insurer, the Bond Trustee and the Issuer may execute a
supplemental indenture to add provisions to, or change in any manner or
eliminate any provisions of, the Indenture with respect to the Bonds of such
Series or modify (except as provided below) in any manner the rights of the
Bondholders.
Without the consent of the holder of each outstanding Bond affected,
however, no supplemental indenture shall (a) change the Stated Maturity of the
principal of, or any installment of interest on, any Bond or reduce the
principal amount thereof, the interest rate specified thereon or the redemption
price with respect thereto, or change the earliest date on which any Bond may be
redeemed at the option of the Issuer, or any place of payment where, or the coin
or currency in which, any affected Bond or any interest thereon is payable, or
impair the right to institute suit for the enforcement of the provisions of the
Indenture regarding payment, (b) reduce the percentage of the aggregate amount
of the outstanding Bonds, the consent of the holders of which is required for
any such supplemental indenture, or the consent of the holders of which is
required for any waiver of compliance with certain provisions of the Indenture
or certain defaults thereunder and their consequences provided for in the
Indenture, (c) modify the provisions of the Indenture specifying the
circumstances under which such a supplemental indenture may not change the
provisions of the Indenture without the consent of each outstanding Bond
affected thereby, or the provisions of the Indenture with respect to certain
remedies available in an Event of Default (as defined herein), except to
increase any percentage specified therein or to provide that certain other
provisions of the Indenture cannot be modified or waived without the consent of
the holder of each outstanding Bond affected thereby, (d) modify or alter the
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provisions of the Indenture defining when Bonds are outstanding, (e) permit the
creation of any lien (other than certain permitted liens) ranking prior to or on
a parity with the lien of the Indenture with respect to any part of the property
subject to lien under the Indenture, or terminate the lien of the Indenture on
any property at any time subject thereto or deprive the holder of any Bond of
the security afforded by the lien of the Indenture (other than in connection
with a permitted substitution of Mortgage Collateral) or (f) modify any of the
provisions of the Indenture in such manner as to affect the calculation of the
debt service requirement for any Bond or the rights of the Bondholders to the
benefits of any provisions for the mandatory redemption of Bonds contained
therein. (Indenture, Section 9.02)
The Issuer and the Bond Trustee may also enter into supplemental indentures
(subject to the consent of any applicable Bond Insurer), without obtaining the
consent of Bondholders, to cure ambiguities or make minor corrections, and to do
such other things as would not adversely affect the interests of Bondholders.
(Indenture, Section 9.01)
EVENTS OF DEFAULT
Unless otherwise specified in the related Prospectus Supplement, an event
of default (an "Event of Default") with respect to any Series of Bonds is
defined in the Indenture as being: (a) the failure (i) to pay any principal of,
or interest on, any Bond of such Series then due, (ii) if applicable, to call
for special redemption any Bonds that are required to be so redeemed or (iii) to
pay the redemption price of any Bonds called for redemption; (b) a default in
the observance of certain negative covenants in the Indenture; (c) a material
default in the observance of any other covenant of the Issuer (including
covenants in any applicable Bond Insurance Agreement) and the continuation of
any such default for a period of 30 days after notice thereof is given to the
Issuer by the Bond Trustee or any applicable Insurer or by the holders of more
than 50% in outstanding principal amount of the Controlling Class of Bonds of
such Series; (d) any representation or warranty made by the Issuer in the
Indenture (or any applicable Bond Insurance Agreement) or in any certificate
delivered pursuant thereto being incorrect in a material respect as of the time
made, and the circumstances in respect of which such representation or warranty
is incorrect are not cured within 30 days after notice thereof is given to the
Issuer by the Bond Trustee or applicable Bond Insurer or by the holders of more
than 50% in outstanding principal amount of the Controlling Class of Bonds of
such Series; or (e) certain events of bankruptcy, insolvency, receivership or
reorganization of the Issuer. Notwithstanding the foregoing, the failure of the
Issuer to pay when and as due any installment of principal of any Bond shall
generally not constitute an Event of Default under the related Indenture unless
the outstanding principal amount of the Bonds exceeds the principal amount of
the related Mortgage Collateral after giving effect to all distributions on the
related Payment Date or the Bonds are not otherwise paid in full by their
maturity date (Indenture, Section 5.01)
RIGHTS UPON EVENTS OF DEFAULT
In case an Event of Default shall occur and be continuing with respect to a
Series of Bonds, any applicable Bond Insurer may, and the Bond Trustee or the
Holders of Bonds representing more than 50% of the Controlling Class of Bonds of
such Series (subject to the prior written consent of any applicable Bond
Insurer) may declare all the Bonds to be immediately due and payable, provided
however, that if the applicable Bond Insurer is in default under the terms of
the Bond Insurance Policy ("Bond Insurer Default"), and such default is
continuing, such declaration may not have occurred prior to the 45th day after
the occurrence of the applicable Event of Default, by a notice in writing to the
Issuer (and to the Bond Trustee if given by Bondholders), and upon any such
declaration, such Bonds shall become immediately due and payable. Such
declaration may under certain circumstances be rescinded by the holders of a
majority in principal amount of the outstanding Bonds of such Series (with the
consent of the applicable Bond Insurer) or by the applicable Bond Insurer.
(Indenture, Section 5.02) With respect to any Series of Bonds covered by a Bond
Insurance Policy, the Bond Insurer may be entitled (absent a Bond Insurer
Default) to exercise the voting rights of the holders of Bonds as to the above
and other actions under the Indenture. (Indenture, Section 12.01)
Upon an Event of Default the Bond Trustee may, in its discretion, with the
prior written consent of any applicable Bond Insurer, and shall at the direction
of any applicable Bond Insurer, sell the Collateral for such
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Series, in which event the Bonds of such Series will be payable pro rata,
without regard to their Stated Maturities, or in such other manner as is
specified in the related Prospectus Supplement, out of the collections on, or
the proceeds from the sale of, such Collateral and will, to the extent permitted
by applicable law, bear interest at the interest rate specified in the
Indenture. (Indenture, Section 5.08) If so specified in the related Prospectus
Supplement, following an Event of Default, if a Series of Bonds has been
declared to be due and payable, the Bond Trustee may, in its discretion (subject
to prior consent of any applicable Bond Insurer), refrain from selling the
Collateral, including the Mortgage Collateral, for such Series and continue to
apply all amounts received on the Collateral to payments due on the Bonds of
such Series in accordance with their terms, notwithstanding the acceleration of
the maturity of such Bonds.
In case an Event of Default shall occur and be continuing, the Bond Trustee
shall be under no obligation to expend or risk its own funds or otherwise incur
any financial liability in the performance of its duties under the Indenture if
it has reasonable grounds for believing that it has not been assured of adequate
security or indemnity. (Indenture, Section 6.01(e)) Subject to such provisions
for indemnification and certain limitations contained in the Indenture any
applicable Bond Insurer or, the holders of a majority in principal amount
outstanding of the Controlling Class of outstanding Bonds of a Series (subject
to prior consent of any applicable Bond Insurer) shall have the right to direct
the time, method and place of conducting any proceeding for any remedy available
to the Bond Trustee or exercising any trust or power conferred on the Bond
Trustee with respect to the Bonds of such Series; and any applicable Bond
Insurer or the holders of a majority in principal amount of the Controlling
Class of Bonds of a Series then outstanding (subject to prior consent of any
applicable Bond Insurer) may, in certain cases, waive any default with respect
thereto, except a default in payment of principal or interest or a default in
respect of a covenant or provision of the Indenture that cannot be modified
without the consent of each holder of Bonds affected. (Indenture, Sections 5.14
and 5.15)
No holder of Bonds will have the right to institute any proceeding with
respect to the Indenture, unless (a) such holder previously has given to the
Bond Trustee any applicable Bond Insurer or written notice of an Event of
Default, (b) the holders of more than 50% in outstanding principal amount of the
Controlling Class of Bonds of the Series have made written request upon the Bond
Trustee to institute such proceedings in its own name as Bond Trustee and have
offered the Bond Trustee indemnity in full, (c) the Bond Trustee has for 60 days
neglected or refused to institute any such proceeding (d) no direction
inconsistent with such written request has been given to the Bond Trustee during
such 60-day period by the holders of a majority in principal amount of the
outstanding Bonds of such Series and (e) any applicable Bond Insurer has given
its prior written consent. (Indenture, Section 5.09)
CERTAIN COVENANTS OF THE ISSUER
The Issuer covenants in the Indenture, among other matters, that it will
not (a) sell, exchange or otherwise dispose of any portion of the Collateral for
a Series of Bonds except as expressly permitted by the Indenture or the Master
Servicing Agreement, (b) amend Sections 2.03 or 10.01 of the Issuer's Deposit
Trust Agreement without the consent of the holders of 66 2/3% in outstanding
principal amount of each Class of Bonds affected thereby and any applicable Bond
Insurer or (c) incur, assume or guarantee any indebtedness other than in
connection with the issuance of the Bonds. (Indenture, Section 3.09) Section
2.03 of the Issuer's Deposit Trust Agreement provides that the trust shall not
have the power to perform any act or engage in any business whatsoever except to
issue and administer the Bonds of a Series, to receive and own the Collateral,
to maintain and administer the Collateral, to pledge the Collateral to support
such Bonds pursuant to the Indenture and to take certain other actions
incidental thereto. Section 10.01 of the Issuer's Deposit Trust Agreement
prohibits the amendment of the Deposit Trust Agreement if the Owner Trustee
determines that such amendment will adversely affect any right, duty or
liability of, or immunity or indemnity in favor of, the Owner Trustee under the
Issuer's Deposit Trust Agreement, or will cause or result in any conflict with
or breach of any terms of, or default under, the charter documents or bylaws of
the Owner Trustee or any document to which the Owner Trustee is a party and may
prohibit any amendment of the Deposit Trust Agreement without the consent of any
applicable Bond Insurer.
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ISSUER'S ANNUAL COMPLIANCE STATEMENT
The Issuer will be required to file annually with the Bond Trustee and any
applicable Bond Insurer a written statement as to fulfillment of its obligations
under the Indenture. (Indenture, Section 3.10)
BOND TRUSTEE'S ANNUAL REPORT
The Bond Trustee will be required to mail each year to all Bondholders and
any applicable Bond Insurer a brief report relating to its eligibility and
qualifications to continue as the Bond Trustee under the Indenture, any amounts
advanced by it under the Indenture, the amount, interest rate and maturity date
of certain indebtedness owing by the Issuer to the Bond Trustee in its
individual capacity, the property and funds physically held by the Bond Trustee
as such, and any action taken by it which materially affects the Bonds and which
has not been previously reported. (Indenture, Section 7.03)
SATISFACTION AND DISCHARGE OF INDENTURE
The Indenture will be discharged with respect to the Collateral securing
the Bonds of a Series upon the delivery to the Bond Trustee for cancellation of
all of the Bonds of such Series or, with certain limitations, upon deposit with
the Bond Trustee of funds sufficient for the payment in full of all of the Bonds
of such Series and all amounts due to any applicable Bond Insurer. (Indenture,
Section 4.01)
REPORT BY BOND TRUSTEE TO BONDHOLDERS
On each Payment Date, the Bond Trustee will send a report to each
Bondholder and any applicable Bond Insurer setting forth the amount of such
payment representing interest, the amount thereof, if any, representing
principal, the amount of any related Advance and the outstanding principal
amount of Bonds of each Class (the aggregate principal amount of the Bonds of
each Class in the case of holders of Bonds on which payments of interest only
are then being made) after giving effect to the payments made on such Payment
Date. (Indenture, Section 8.06)
THE BOND TRUSTEE
The Bond Trustee under each Indenture will be identified in the related
Prospectus Supplement.
CERTAIN LEGAL ASPECTS OF PLEDGED MORTGAGES
The following discussion contains general summaries of certain legal
aspects of Pledged Mortgages. Because such legal aspects are governed primarily
by applicable state law (which laws may differ substantially from state to
state), the summaries do not purport to be complete nor to reflect the laws of
any particular state, nor to encompass the laws of all states in which Mortgaged
Properties may be located. The summaries are qualified in their entirety by
reference to the applicable federal and state laws governing the Pledged
Mortgages.
GENERAL
The Pledged Mortgages will consist of notes and either mortgages, deeds of
trust, security deeds or deeds to secure debts, depending upon the prevailing
practice in the state in which the underlying Mortgaged Property 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 a mortgage instrument, the mortgagor
delivers to the mortgagee (i) a note or bond evidencing the loan and (ii) the
mortgage. Although a deed of trust is similar to a mortgage, a deed of trust 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
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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 a debt are governed by law,
and, with respect to some deeds of trust, the directions of the beneficiary.
COOPERATIVES. Certain of the Pledged Mortgages may be Cooperative Loans.
The Cooperative owns all the real property that comprises the project, including
the land, separate dwelling units and all common areas. The Cooperative is
directly responsible for project management and, in most cases, payment of real
estate taxes and hazard and liability insurance. If there is a blanket mortgage
on the Cooperative and/or underlying land, as is generally the case, the
Cooperative, as project mortgagor, is also responsible for meeting these
mortgage obligations. A blanket mortgage is ordinarily incurred by the
Cooperative in connection with the construction or purchase of the Cooperative's
apartment building. The interest of the occupant under proprietary leases or
occupancy agreements to which that Cooperative is a party are generally
subordinate to the interest of the holder of the blanket mortgage in that
building. If the Cooperative is unable to meet the payment obligations arising
under its blanket mortgage, the mortgagee holding the blanket mortgage could
foreclose on that mortgage and terminate all subordinate proprietary leases and
occupancy agreements. In addition, the blanket mortgage on a Cooperative may
provide financing in the form of a mortgage that does not fully amortize with a
significant portion of principal being due in one lump sum at final maturity.
The inability of the Cooperative to refinance this mortgage and its consequent
inability to make such final payment could lead to foreclosure by the mortgagee
providing the financing. A foreclosure in either event by the holder of the
blanket mortgage could eliminate or significantly diminish the value of any
collateral held by the lender who financed the purchase by an individual
tenant-stockholder of Cooperative shares or, in the case of any Mortgage
Collateral securing a Series of Bonds that includes Cooperative Loans, the
collateral securing the Cooperative Loans.
The Cooperative is owned by tenant-stockholders who, through ownership of
stock, shares or membership certificates in the corporation, receive proprietary
leases or occupancy agreements which confer exclusive rights to occupy specific
units. Generally, a tenant-stockholder of a Cooperative must make a monthly
payment to the Cooperative representing such tenant-stockholder's pro rata share
of the Cooperative's payments for its blanket mortgage, real property taxes,
maintenance expenses and other capital or ordinary expenses. An ownership
interest in a Cooperative and accompanying rights is financed through a
Cooperative share loan evidenced by a promissory note and secured by a security
interest in the occupancy agreement or proprietary lease and in the related
Cooperative shares. The lender takes possession of the share certificate and a
counterpart of the proprietary lease or occupancy agreement, and a financing
statement covering the proprietary lease or occupancy agreement and the
Cooperative shares if filed in the appropriate state and local offices to
perfect the lender's interest in its collateral. Subject to the limitations
discussed below, upon default of the tenant-stockholder, the lender may sue for
judgment on the promissory note, dispose of the collateral at a public or
private sale or otherwise proceed against the collateral or tenant-stockholder
as an individual as provided in the security agreement covering the assignment
of the proprietary lease or occupancy agreement and the pledge of Cooperative
shares.
JUNIOR MORTGAGES
Certain of the Pledged Mortgages may be secured by junior mortgages or
deeds of trust, which are junior to senior mortgages or deeds of trust which are
not part of the Mortgage Collateral. The rights of the Bondholders as the
holders of a junior deed of trust or a junior mortgage are subordinate in lien
priority and in payment priority to those of the holder of the senior mortgage
or deed of trust, including the prior rights of the senior mortgagee or
beneficiary to receive and apply hazard insurance and condemnation proceeds and,
upon default of the mortgagor, to cause a foreclosure on the property. Upon
completion of the foreclosure proceedings by the holder of the senior mortgage
or the sale pursuant to the deed of trust, the junior mortgagee's or junior
beneficiary's lien will be extinguished unless the junior lienholder satisfies
the defaulted senior loan or asserts its subordinate interest in a property in
foreclosure proceedings. See " -- Foreclosure/Repossession" below.
Furthermore, the terms of the junior mortgage or deed of trust are
subordinate to the terms of the senior mortgage or deed of trust. In the event
of a conflict between the terms of the senior mortgage or deed of trust
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and the junior mortgage or deed of trust, the terms of the senior mortgage or
deed of trust will govern generally. Upon a failure of the mortgagor or trustor
to perform any of its obligations, the senior mortgagee or beneficiary, subject
to the terms of the senior mortgage or deed of trust, may have the rights to
perform the obligation itself. Generally, all sums so expended by the mortgagee
or beneficiary become part of the indebtedness secured by the mortgage or deed
of trust. To the extent a senior mortgagee expends such sums, such sums will
generally have priority over all sums due under the junior mortgage.
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 and 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, 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. See "SECURITY FOR THE BONDS" herein.
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A junior mortgagee may not foreclose on the property securing a junior
mortgage unless it forecloses subject to the senior mortgages, in which case it
must either pay the entire amount due on the senior mortgages to the senior
mortgagees prior to or at the time of the foreclosure sale or undertake the
obligation to make payments on the senior mortgages in the event the mortgagor
is in default thereunder, in either event adding the amounts expended to the
balance due on the junior loan, and may be subrogated to the rights of the
senior mortgagees. In addition, in the event that the foreclosure of a junior
mortgage triggers the enforcement of a "due-on-sale" clause, the junior
mortgagee may be required to pay the full amount of the senior mortgages to the
senior mortgagees. Accordingly, with respect to those mortgage loans which are
junior mortgage loans, if the lender purchases the property, the lender's title
will be subject to all senior liens and claims and certain governmental liens.
The proceeds received by the referee or trustee from the sale are applied first
to the costs, fees and expenses of sale and then in satisfaction of the
indebtedness secured by the mortgage or deed of trust under which the sale was
conducted. Any remaining proceeds are generally payable to the holders of junior
mortgages or deeds of trust and other liens and claims in order of their
priority, whether or not the borrower is in default. Any additional proceeds are
generally payable to the mortgagor or trustor. The payment of the proceeds to
the holders of junior mortgages may occur in the foreclosure action of the
senior mortgagee or may require the institution of separate legal proceedings.
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.
COOPERATIVE LOANS. The Cooperative shares owned by the tenant-stockholder
and pledged to the lender are, in almost all cases, subject to restrictions on
transfer as set forth in the Cooperative's certificate of incorporation and
bylaws, as well as the proprietary lease or occupancy agreement, and may be
cancelled by the Cooperative for failure by the tenant-stockholder to pay rent
or other obligations or charges owed by such tenant-stockholder, including
mechanics' liens against the cooperative apartment building incurred by such
tenant-stockholder. The proprietary lease or occupancy agreement generally
permits the Cooperative to terminate such lease or agreement in the event an
obligor fails to make payments or defaults in the performance of covenants
required thereunder. Typically, the lender and the Cooperative enter into a
recognition agreement which establishes the rights and obligations of both
parties in the event of a default by the tenant-stockholder on its obligations
under the proprietary lease or occupancy agreement. A default by the
tenant-stockholder under the proprietary lease or occupancy agreement will
usually constitute a default under the security agreement between the lender and
the tenant-stockholder.
The recognition agreement generally provides that, in the event that the
tenant-stockholder has defaulted under the proprietary lease or occupancy
agreement, the Cooperative will take no action to terminate such lease or
agreement until the lender has been provided with an opportunity to cure the
default. The recognition agreement typically provides that if the proprietary
lease or occupancy agreement is terminated, the Cooperative will recognize the
lender's lien against proceeds from the sale of the Cooperative apartment,
subject, however, to the Cooperative's right to sums due under such proprietary
lease or occupancy agreement. The total amount owed to the Cooperative by the
tenant-stockholder, which the lender generally cannot restrict and does not
monitor, could reduce the value of the collateral below the outstanding
principal balance of the Cooperative Loan and accrued and unpaid interest
thereon.
Recognition agreements also provide that in the event of a foreclosure on a
Cooperative Loan, the lender must obtain the approval or consent of the
Cooperative as required by the proprietary lease before transferring the
Cooperative shares or assigning the proprietary lease. Generally, the lender is
not limited in any rights it may have to dispossess the tenant-stockholders.
In some states, foreclosure on the Cooperative shares is accomplished by a
sale in accordance with the provisions of Article 9 of the Uniform Commercial
Code (the "UCC") and the security agreement relating to
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those shares. Article 9 of the UCC requires that a sale be conducted in a
"commercially reasonable" manner. Whether a foreclosure sale has been conducted
in a "commercially reasonable" manner will depend on the facts in each case. In
determining commercial reasonableness, a court will look to the notice given the
debtor and the method, manner, time, place and terms of the foreclosure.
Generally, a sale conducted according to the usual practice of banks selling
similar collateral will be considered reasonably conducted.
Article 9 of the UCC provides that the proceeds of the sale will be applied
first to pay the costs and expenses of the sale and then to satisfy the
indebtedness secured by the lender's security interest. The recognition
agreement, however, generally provides that the lender's right to reimbursement
is subject to the right of the Cooperative to receive sums due under the
proprietary lease or occupancy agreement. If there are proceeds remaining, the
lender must account to the tenant-stockholder for the surplus. Conversely, if a
portion of the indebtedness remains unpaid, the tenant-stockholder is generally
responsible for the deficiency. See " -- Anti-Deficiency Legislation and Other
Limitations on Lenders" below.
In the case of foreclosure on a building which was converted from a rental
building to a building owned by a Cooperative under a non-eviction plan, some
states require that a purchaser at a foreclosure sale take the property subject
to rent control and rent stabilization laws which apply to certain tenants who
elected to remain in the building but who did not purchase shares in the
Cooperative when the building was so converted.
RIGHTS OF REDEMPTION
In some states, after sale pursuant to a deed of trust or foreclosure of a
mortgage, the borrower and certain foreclosed junior lienholders 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 a payment of the foreclosure
purchase price, accrued interest and taxes. In some states, the right to redeem
is an equitable right. The effect of a right of redemption is to diminish the
ability of the lender to sell the foreclosed property. The exercise of a right
of redemption would defeat the title of any purchaser at a foreclosure sale, or
of any purchaser from the lender subsequent to judicial 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.
ANTI-DEFICIENCY LEGISLATION AND OTHER LIMITATIONS ON LENDERS
Certain states have imposed statutory 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 limit the right of the beneficiary or
mortgagee to obtain a deficiency judgment against the borrower following
foreclosure or sale under a deed of trust. A deficiency judgment is a personal
judgment against the former borrower equal in most cases to the difference
between the amount due to the lender and the current fair market value of the
property at the time of the foreclosure sale. As a result of these prohibitions,
it is anticipated that in most instances the Master Servicer or applicable
Servicer will utilize the non-judicial foreclosure remedy and will not seek
deficiency judgments against defaulting mortgagors.
Some state statutes may 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
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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,
the federal Soldiers' and Sailors' Civil Relief Act of 1940 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. In certain
instances, a rehabilitation plan proposed by the debtor may reduce 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 Pledged Mortgages securing a Series of
Bonds 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. Numerous federal and state consumer protection laws
impose substantive requirements upon mortgage lenders in connection with the
origination, servicing and enforcement of mortgage loans. These laws include the
federal Truth-in-Lending Act, Real Estate Settlement Procedures Act, Equal
Credit Opportunity Act, Fair Credit Billing Act, Fair Credit Reporting Act and
related statutes and regulations. These federal and state laws impose specific
statutory liabilities upon lenders who fail to comply with the provisions of the
law. In some cases, this liability may affect assignees of the loans.
Generally, Article 9 of the UCC governs foreclosure on Cooperative shares
and the related proprietary lease or occupancy agreement. Some courts have
interpreted section 9-504 of the UCC to prohibit a deficiency award unless the
creditor establishes that the sale of the collateral (which, in the case of a
Cooperative Loan, would be the shares of the Cooperative and the related
proprietary lease or occupancy agreement) was conducted in a commercially
reasonable manner.
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 rise 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 the federal
Comprehensive Environmental Response, Compensation and Liability Act of 1980
("CERCLA"), the United States Environmental Protection Agency ("EPA") may impose
a lien on property where the EPA has incurred cleanup 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
Mortgaged Property even though the environmental damage or threat was caused by
a prior or current owner or operator or a third-party. 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 without participating in the management of the
facility," holds indicia of ownership primarily to protect its security interest
(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 a third party), or fails to market the
property in a timely fashion.
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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 exemption 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
exemption only if it exercises decision-making control over the 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 become a liability of the Issuer and
occasion a loss to Bondholders.
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 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. It should be noted, however, that liability for
cleanup of petroleum contamination may be governed by state law, which may not
provide for any specific protection for secured creditors.
Except as otherwise specified in the applicable Prospectus Supplement, at
the time the Pledged Mortgages or the mortgage loans underlying the
Certificates, as the case may be, were originated, no environmental assessment
or a very limited environmental assessment of the Mortgaged Properties or the
real property constituting security for such mortgage loans, respectively, was
conducted.
DUE-ON-SALE CLAUSES
Unless otherwise provided in the related Prospectus Supplement, each
Pledged Mortgage will contain a due-on-sale clause which will generally provide
that if the mortgagor or obligor sells, transfers or conveys the Mortgaged
Property, the loan may be accelerated by the mortgagee. In recent years, court
decisions and legislative actions have placed substantial restriction 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 have become generally
enforceable except in those states whose legislatures exercised their authority
to regulate the enforceability of such clauses with respect to mortgage loans
that were (i) originated or assumed during the "window period" under the Garn-St
Germain Act which ended in all cases not later than October 15, 1982, and (ii)
originated by lenders other than national banks, federal savings institutions
and federal credit unions. FHLMC has taken the position in its published
mortgage servicing standards that, out of a total of eleven "window period
states,"
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five states (Arizona, Michigan, Minnesota, New Mexico and Utah) have enacted
statutes extending, for 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 Garn-St
Germain 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
Mortgaged 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 Pledged Mortgages and the number of Pledged Mortgages which
may extend to maturity.
ENFORCEABILITY OF PREPAYMENT CHARGES 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 owner-occupied residential
properties. Since many of the Mortgaged Properties will be owner-occupied, it is
anticipated that prepayment charges may not be imposed with respect to many of
the Pledged Mortgages. The absence of such a restraint on prepayment,
particularly with respect to Fixed Rate Pledged Mortgages having higher interest
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. The statute authorized the states to reimpose
interest rate limits by adopting, before April 1, 1983, a law or constitutional
provision which expressly rejects an application of the federal law. In
addition, even where Title V is not so rejected, any state is authorized by the
law to adopt a provision limiting discount points or other charges on mortgage
loans covered by Title V. Certain states have taken action to reimpose interest
rate limits and/or to limit discount points or other charges.
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 mortgage 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 mortgage 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 or
applicable Servicer to collect full amounts of interest on certain of the
Pledged Mortgages. Any shortfall in interest collections resulting from the
application of the Relief Act could result in losses to the holders of the
Bonds. In addition, the Relief Act
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imposes limitations which would impair the ability of the Master Servicer to
foreclose on an affected Pledged Mortgage during the borrower's period of active
duty status. Thus, in the event that such a Pledged Mortgage goes into default,
there may be delays and losses occasioned by the inability to realize upon the
Mortgaged Property in a timely fashion.
SUBORDINATE FINANCING
When the mortgagor encumbers mortgaged property with one or more junior
liens, the senior lender is subjected to additional risk. First, the mortgagor
may have difficulty servicing and repaying multiple loans. In addition, if the
junior loan permits recourse to the mortgagor (as junior loans often do) and the
senior loan does not, a mortgagor may be more likely to repay sums due on the
junior loan than those on the senior loan. Second, acts of the senior lender
that prejudice the junior lender or impair the junior lender's security may
create a superior equity in favor of the junior lender. For example, if the
mortgagor and the senior lender agree to an increase in the principal amount of
or the interest rate payable on the senior loan, the senior lender may lose its
priority to the extent an existing junior lender is harmed or the mortgagor is
additionally burdened. Third, if the mortgagor defaults on the senior loan
and/or any junior loan or loans, the existence of junior loans and actions taken
by junior lenders can impair the security available to the senior lender and can
interfere with or delay the taking of action by the senior lender. Moreover, the
bankruptcy of a junior lender may operate to stay foreclosure or similar
proceeds by the senior lender.
FEDERAL INCOME TAX CONSEQUENCES
The following is a summary of the anticipated material federal income tax
consequences of the purchase, ownership and disposition of the Bonds. This
summary has been reviewed by Giancarlo & Gnazzo, A Professional Corporation, tax
counsel to the Company and the Issuer, and, to the extent that it states legal
conclusions, represents the opinion of such tax counsel, subject to the
limitations and qualifications set forth herein and in the applicable Prospectus
Supplement. The summary is based on the Internal Revenue Code of 1986, as
amended (the "Code"), regulations, rulings and decisions in effect as of the
date of this Prospectus, all of which are subject to change. The summary also
takes into account regulations issued on February 2, 1994, regarding the
taxation of debt instruments with original issue discount (the "OID
Regulations"). The summary does not purport to address federal income tax
consequences applicable to all categories of investors, some of which may be
subject to special rules. In addition, the summary is limited to investors who
will hold the Bonds as "capital assets" (generally, property held for
investment) as defined in Section 1221 of the Code. Investors should consult
their own tax advisors in determining the federal, state, local and any other
tax consequences to them of the purchase, ownership and disposition of the
Bonds. As applied to any particular Bond, the summary is subject to further
discussion or change as provided in the related Prospectus Supplement.
CLASSIFICATION OF THE ISSUER AND THE BONDS
No regulations, published rulings or judicial decisions discuss the
characterization for federal income tax purposes of securities with terms
substantially the same as the Bonds. Upon the issuance of each Series of Bonds,
however, Giancarlo & Gnazzo, A Professional Corporation, tax counsel to the
Issuer, will advise the Issuer that in its opinion such Bonds will be treated
for federal income tax purposes as indebtedness and not as an ownership interest
in the Collateral, or an equity interest in the Issuer or in a separate
association taxable as a corporation.
Under the taxable mortgage pool ("TMP") rules in the Code, certain entities
that issue debt secured by real estate mortgages are subject to special tax
treatment that can result in entity level federal income taxation. An entity
will be classified as a TMP if it does not make an election to be classified as
a "real estate mortgage investment conduit" (a "REMIC") and (i) substantially
all of its assets consist of debt obligations and more than 50% of such debt
obligations are real estate mortgages or interests therein, (ii) the entity
issues debt obligations with two or more maturities and (iii) payments on the
debt obligations issued by it bear a
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relationship to payments received on the debt obligations owned by it. In
certain situations, pools of assets within an entity can also be treated as
separate TMPs.
The Company does not intend to make an election for any Issuer to be
classified as a REMIC. Further, the Company intends to structure all issuances
of Bonds, unless otherwise specified in the related Prospectus Supplement, so as
to not constitute a TMP. However, it is possible that the Issuer or a portion of
the Issuer relating to a specific pool of Mortgage Collateral and the Bonds
related thereto could be treated as a TMP. If an Issuer was classified as a TMP,
it is anticipated that it would nonetheless qualify as a "qualified REIT
subsidiary" (within the meaning of Section 856 (i) of the Code) and thus would
not be subject to entity level federal income taxes. If so, only Redwood Trust
or its shareholders would be required to include in income any "excess inclusion
income" generated by the TMP. On the other hand, if the Issuer was classified as
a TMP but did not maintain its status as a "qualified REIT subsidiary", it would
not be permitted to be included in the consolidated federal income tax return of
any other corporation and its net income would be subject to entity level
federal income taxes. Each Prospectus Supplement will specify whether or not the
Issuer for that Series of Bonds is expected to be classified as a TMP. No
assurance can be given that any Issuer classified as a TMP will continue to
qualify as a "qualified REIT subsidiary" or that Redwood Trust will continue to
qualify as a REIT for federal income tax purposes.
Because the Bonds will be treated as indebtedness of the Issuer for federal
income tax purposes, (i) Bonds held by a thrift institution taxed as a domestic
building and loan association will not constitute "loans . . . secured by an
interest in real property" within the meaning of Code Section 7701(a)(19)(C)(v),
(ii) interest on Bonds held by a real estate investment trust may not be treated
as "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), and
Bonds may not constitute "real estate assets" and will not constitute
"Government securities" within the meaning of Code Section 856(c)(5)(A), and
(iii) Bonds held by a regulated investment company will not constitute
"Government securities" within the meaning of Code Section 851(b)(4)(A)(i).
INTEREST AND ORIGINAL ISSUE DISCOUNT
GENERAL. The Prospectus Supplement for each Series of Bonds will disclose
whether any Class of such Bonds is anticipated to be issued with "original issue
discount" within the meaning of Code Section 1273(a). Interest on any Class of
Bonds other than original issue discount will be includible in income by the
Holder thereof in accordance with such Holder's applicable method of accounting.
Holders of any Class of Bonds having original issue discount must generally
include original issue discount in ordinary gross income for federal income tax
purposes as it accrues, in advance of receipt of the cash attributable to such
income. Each Issuer will indicate on the face of each Bond issued by it
information concerning the application of the original issue discount rules to
such Bond and certain other information that may be required. The Issuer will
report annually to the Internal Revenue Service (the "IRS") and to holders of
record of such Bonds information with respect to the original issue discount
accruing on such Bonds during the reporting period.
Rules governing original issue discount are set forth in Code Sections 1271
through 1273, 1275 and 1281 through 1283. In addition, the discussion of federal
income tax consequences set forth below is based in part on the OID Regulations.
The Code or the OID Regulations either do not address, or are subject to varying
interpretations with respect to, several issues relevant to obligations, such as
the Bonds, that are subject to prepayment. Therefore, there is some uncertainty
as to the manner in which the original issue discount rules of the Code will be
applied to the Bonds.
ORIGINAL ISSUE DISCOUNT DEFINED. In general, each Bond will be treated as
a single installment obligation for purposes of determining the original issue
discount includible in a Bondholder's income. The amount of original issue
discount on such a Bond is the excess of the stated redemption price at maturity
of the Bond over its issue price. The issue price of a Bond is the initial
offering price to the public at which a substantial amount of the Bonds of that
Class are first sold to the public (excluding bond houses, brokers, underwriters
or wholesalers), generally as set forth on the cover page of the Prospectus
Supplement for a Series of Bonds. (The portion of the initial offering price
which consists of interest accrued on the Bonds from the date of issuance to the
Closing Date may, at the option of the Bondholder, be subtracted from the issue
price of the Bonds and treated as an
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offset of interest received on the first Payment Date.) The stated redemption
price at maturity of a Bond is equal to the total of all payments to be made on
the Bond other than "qualified stated interest payments." "Qualified stated
interest payments" are payments on the Bonds which are paid at least annually
and are based on either a fixed rate or 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 Bond 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 Bond. Generally, the stated
redemption price at maturity of a Bond (other than a Deferred Interest Bond or a
Payment Lag Bond, as defined below) is its stated principal amount; the stated
redemption price at maturity of a Deferred Interest Bond is the sum of all
payments (regardless of how denominated) scheduled to be received on such Bond
under the Tax Prepayment Assumption (as defined below). Any payment of interest
that is not a qualified stated interest payment is a "contingent interest
payment." The related Prospectus Supplement will discuss whether the payments of
interest on a Bond are qualified stated interest payments and the treatment for
federal income tax purposes of any contingent interest payments.
DE MINIMIS ORIGINAL ISSUE DISCOUNT. Notwithstanding the general definition
of original issue discount above, any original issue discount with respect to a
Bond will be considered to be zero if such discount is less than 0.25% of the
stated redemption price at maturity of the Bond multiplied by its weighted
average life (a "de minimis" amount). The weighted average life of a Bond for
this purpose is the sum of the following amounts (computed for each payment
included in the stated redemption price at maturity of the Bond): (i) the number
of complete years (rounded down for partial years) from the Closing Date until
the date on which each such payment is scheduled to be made under the Tax
Prepayment Assumption, multiplied by (ii) a fraction, the numerator of which is
the amount of the payment, and the denominator of which is the Bond's stated
redemption price at maturity. Bondholders generally must report de minimis
original issue discount pro rata as principal payments are received, and such
income will be capital gain if the Bond is held as a capital asset. However,
accrual method holders may elect to accrue all interest on a Bond, including de
minimis original issue discount and market discount and as adjusted by any
premium, under a constant yield method.
ACCRUAL OF ORIGINAL ISSUE DISCOUNT. The amount and rate of accrual of
original issue discount must be calculated based on a reasonable assumed
prepayment rate for the Pledged Mortgages, the mortgage loans underlying the
Certificates and/or other Mortgage Collateral securing the Bonds (the "Tax
Prepayment Assumption") and to prescribe a method for adjusting the amount and
rate of accrual of such discount. However, if such mortgage loans prepay at a
rate slower than the Tax Prepayment Assumption, no deduction for original issue
discount previously accrued, based on the Tax Prepayment Assumption, is allowed.
The Tax Prepayment Assumption will be determined in the manner prescribed by
regulations that have not yet been issued. It is anticipated that the
regulations will require that the Tax Prepayment Assumption be the prepayment
assumption that is used in determining the initial offering price of such Bonds.
The related Prospectus Supplement for each Series of Bonds will specify the Tax
Prepayment Assumption determined by the Issuer for the purposes of determining
the amount and rate of accrual of original issue discount. No representation is
made that the Mortgage Collateral will prepay at the Tax Prepayment Assumption
or at any other rate.
Generally, a Bondholder must include in gross income the sum of the "daily
portions," as determined below, of the original issue discount that accrues on a
Bond for each day the Bondholder holds that Bond, including the purchase date
but excluding the disposition date. In the case of an original holder of a Bond,
a calculation will be made of the portion of the original issue discount that
accrues during each successive period (or shorter period from date of original
issue) (an "accrual period") that ends on the day in the calendar year
corresponding to each of the Payment Dates on the Bonds (or the date prior to
each such date). This will be done, in the case of each full accrual period, by
adding (A) the present value at the end of the accrual period of all remaining
payments to be received (based on (i) the yield to maturity of the Bond at the
issue date, (ii) events (including actual prepayments) that have occurred prior
to the end of the accrual period, and (iii) the Tax Prepayment Assumption) and
(B) any payments received during such accrual period, other than
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payments of qualified stated interest, and subtracting from that total the
"adjusted issue price" of the Bonds at the beginning of such accrual period. The
adjusted issue price of a Bond at the beginning of the initial accrual period is
its issue price; the adjusted issue price of a Bond at the beginning of a
subsequent accrual period is the adjusted issue price at the beginning of the
immediately preceding accrual period plus the amount of original issue discount
allocable to the accrual period and reduced by the amount of any payment other
than a payment of qualified stated interest made at the end of or during that
accrual period. The original issue discount accrued during such accrual period
will then be divided by the number of days in the period to determine the daily
portion of original issue discount for each day in the period. With respect to
an initial accrual period shorter than a full accrual period, the daily portions
of original issue discount must be determined according to any reasonable
method, provided that such method is consistent with the method used to
determine yield on the Bonds.
With respect to any Bond that is a Variable Rate Debt Instrument, the sum
of the daily portions of original issue discount that is includible in the
holder's gross income is determined under the same principles described above,
with the following modifications: the yield to maturity on the Bonds should be
calculated as if the interest index remained at its value as of the issue date
of such Bonds. Because the proper method of adjusting accruals of OID on a
Variable Rate Debt Instrument as a result of prepayments is uncertain, holders
of such instruments should consult their own tax advisors regarding the
appropriate treatment of such Bonds for federal income tax purposes.
Purchasers of Bonds with the above key features for which the period
between the Closing Date and the first Payment Date does not exceed the Payment
Date Interval would nevertheless pay upon purchase of the Bonds an additional
amount of accrued interest as compared with the accrued interest that would be
paid if interest accrued from Payment Date to Payment Date. This accrued
interest (together with any accrued interest with respect to which the
Bondholder chooses not to treat as an offset to interest paid on the first
Payment Date, as described above) should be treated for federal income tax
purposes as part of the initial purchase price of the Bonds. Bonds described in
this paragraph issued or purchased at a discount would be treated as being
issued or purchased at a smaller discount or at a premium, and such Bonds issued
or purchased at a premium would be treated as being issued or purchased at a
larger premium.
SUBSEQUENT PURCHASERS. A subsequent purchaser of a Deferred Interest Bond
or a subsequent purchaser of any other Bond issued with original issue discount
who purchases the Bond at a cost less than the remaining stated redemption price
at maturity, will also be required to include in gross income for all days
during his or her taxable year on which such Bond is held, the sum of the daily
portions of original issue discount on the Bond. In computing the daily portions
of original issue discount with respect to a Bond for such a subsequent
purchaser, however, the daily portion for any day shall be reduced by the amount
that would be the daily portion for such day (computed in accordance with the
rules set forth above) multiplied by a fraction, the numerator of which is the
amount, if any, by which the price paid by such holder for the Bond exceeds its
adjusted issue price (the "acquisition premium"), and the denominator of which
is the amount by which the remaining stated redemption price at maturity exceeds
the adjusted issue price.
PREMIUM
A holder who purchases a Bond at a cost greater than its stated redemption
price at maturity generally will be considered to have purchased the Bond at a
premium, which it may elect to amortize as an offset to interest income on such
Bond (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 Bonds have been issued, the legislative history of the Tax Reform
Act of 1986 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
Bonds of a Series will be calculated using the prepayment assumption used in
pricing such Class. If a holder makes an election to amortize premium on a Bond,
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
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the Internal Revenue Service. Purchasers who pay a premium for the Bonds should
consult their tax advisers regarding the election to amortize premium and the
method to be employed.
ELECTION TO TREAT ALL INTEREST AS ORIGINAL ISSUE DISCOUNT
The OID Regulations permit a holder of a Bond to elect to accrue all
interest, discount (including de minimis market or original issue discount) and
premium in income as interest, based on a constant yield method for Bonds
acquired on or after April 4, 1994. If such an election were to be made with
respect to a Bond with market discount, the holder of the Bond 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 Bonds acquires during the year of the election or thereafter. Similarly, a
holder of a Bond that makes this election for a Bond 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 Bond is irrevocable.
REALIZED LOSSES
Bondholders generally are required to accrue interest and original issue
discount with respect to the Bonds without giving effect to any reductions in
distributions attributable to defaults or delinquencies on the Mortgage
Collateral until it can be established that any such reductions ultimately will
not be recoverable. Although a holder of a Bond will eventually be entitled to
recognize a loss or reduce income attributable to the Bonds if distribution
reductions are ultimately not recovered, the law is unclear with respect to the
timing and the character thereof and mismatches may result that further compound
the economic losses associated with reduced distributions on the Bonds.
SALE OR REDEMPTION
If a Bond is sold, the seller will recognize gain or loss equal to the
difference between the amount realized on the sale and the seller's adjusted
basis in the Bond. Such adjusted basis generally will equal the cost of the Bond
to the seller, increased by any original issue discount and market discount
included in the seller's gross income with respect to the Bond and reduced by
payments, other than payments of qualified stated interest, previously received
by the seller and by any amortized premium. If a Bondholder is a bank, thrift or
similar institution described in Section 582(c) of the Code, gain or loss
realized on the sale or exchange of a Bond will be taxable as ordinary income or
loss. Any such gain or loss recognized by any other seller will be capital gain
or loss, provided that the Bond is held by the seller as a "capital asset"
(generally, property held for investment) within the meaning of Code Section
1221.
MARKET DISCOUNT
The Bonds are subject to the market discount provisions of Code Sections
1276 through 1278. These rules provide that if a subsequent holder of a Bond
purchases it at a market discount, some or all of any principal payment or of
any gain recognized upon the disposition of the Bond will be taxable as ordinary
interest income. Market discount on a Bond means the excess, if any, of (1) the
sum of its issue price and the aggregate amount of original issue discount
includible in the gross income of all holders of the Bond prior to the
acquisition by the subsequent holder (presumably adjusted to reflect prior
principal payments), over (2) the price paid by the holder for the Bond. Market
discount on a Bond will be considered to be zero if such discount is less than
.25% of the stated redemption price at maturity of such Bond multiplied by its
weighted average life, which presumably would be calculated in a manner similar
to weighted average life (described above), taking into account distributions
(including prepayments) prior to the date of acquisition of such Bond by the
subsequent purchaser. If market discount on a Bond is treated as zero under this
rule, the actual amount of such discount must be allocated to the remaining
principal distributions on such Bond and when each such distribution is made,
gain equal to the discount allocated to such distribution will be recognized.
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Any principal payment (whether a scheduled payment or a prepayment) or any
gain on the disposition of a market discount bond is to be treated as ordinary
income to the extent that it does not exceed the accrued market discount at the
time of such payment or disposition. The amount of accrued market discount for
purposes of determining the tax treatment of subsequent principal payments or
dispositions of the Bonds is to be reduced by the amount so treated as ordinary
income.
The Tax Reform Act of 1986 grants authority to the U.S. Treasury to issue
regulations providing for the computation of accrued market discount on debt
instruments, the principal of which is payable in more than one installment.
Until such time as regulations are issued by the U.S. Treasury, certain rules
described in the legislative history accompanying the Tax Reform Act of 1986
will apply. Under those rules, the holder of a market discount bond may elect to
accrue market discount either on the basis of a constant interest rate or using
one of the following methods. For bonds issued with original issue discount, the
amount of market discount that accrues during a period is equal to the product
of (i) the total remaining market discount, multiplied by (ii) a fraction, the
numerator of which is the original issue discount accruing during the period and
the denominator of which is the total remaining original issue discount at the
beginning of the period. For bonds issued without original issue discount, the
amount of market discount that accrues during a period is equal to the product
of (i) the total remaining market discount, multiplied by (ii) a fraction, the
numerator of which is the amount of stated interest paid during the accrual
period and the denominator of which is the total amount of stated interest
remaining to be paid at the beginning of the period. For purposes of calculating
market discount under any of the above methods in the case of instruments (such
as the Bonds) that provide for payments that may be accelerated by reason of
prepayments of other obligations securing such instruments, the same prepayment
assumption applicable to calculating the accrual of original issue discount
shall apply. Regulations are to provide similar rules for computing the accrual
of amortizable bond premium on instruments payable in more than one principal
installment. As an alternative to the inclusion of market discount in income on
the foregoing basis, the holder may elect to include such market discount in
income currently as it accrues on all market discount instruments acquired by
such holder in that taxable year or thereafter. In addition, accrual method
holders may elect to accrue all interest on a Bond, including de minimis
original issue discount and market discount and as adjusted by any premium,
under a constant yield method.
A subsequent holder of a Bond who acquired the Bond at a market discount
also may be required to defer, until the maturity date of the Bond or the
earlier disposition of the Bond in a taxable transaction, the deduction of a
portion of the amount of interest that the holder paid or accrued during the
taxable year on indebtedness incurred or maintained to purchase or carry the
Bond in excess of the aggregate amount of interest (including original issue
discount) includible in his or her gross income for the taxable year with
respect to such Bond. The amount of such net interest expense deferred in a
taxable year may not exceed the amount of market discount accrued on the Bond
for the days during the taxable year on which the subsequent holder held the
Bond, and the amount of such deferred deduction to be taken into account in the
taxable year in which the Bond is disposed of in a transaction in which gain or
loss is not recognized in whole or in part is limited to the amount of gain
recognized on the disposition. This deferral rule does not apply to a holder
that elects to include market discount in income currently as it accrues on all
market discount instruments acquired by such holder in that taxable year or
thereafter.
Because the regulations described above with respect to market discounts
and premiums have not been issued, it is impossible to predict what effect those
regulations might have on the tax treatment of a Bond purchased at a discount or
premium in the secondary market.
WITHHOLDING WITH RESPECT TO CERTAIN FOREIGN INVESTORS
Pursuant to Code Sections 871(h), 881(c), 1441(c)(9) and 1442(a), interest
and original issue discount income received with respect to the Bonds by
Bondholders who are nonresident alien individuals, foreign corporations or other
non-United States persons unrelated to the Issuer ("foreign persons") generally
will not be subject to the 30% withholding tax imposed by Code Sections 1441 and
1442 on certain income of foreign persons, provided the procedural requirements
of Code Section 871(h)(5) are met. The 30% withholding tax
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will apply, however, in certain situations where contingent interest is paid or
the IRS determines that withholding is required in order to prevent tax evasion
by United States persons.
If the 30% withholding tax is applicable, interest payments made to
Bondholders who are foreign persons will be subject to withholding. In addition,
a tax equal to 30% of the original issue discount accrued with respect to a Bond
since the last payment of interest thereon will be withheld from each interest
payment made to a foreign person. The Code provides, for purposes of determining
the amount of original issue discount subject to the withholding tax on foreign
persons, that original issue discount shall accrue at a constant interest rate
pursuant to the rules applicable to United States persons described above,
rather than on a straight-line basis as under previous law.
Bondholders to whom withholding with respect to foreign persons applies
also will be subject to a 30% tax on a portion of the gain, if any, recognized
upon the payment by the Issuer of principal on a Bond or upon the sale or
exchange of a Bond. Code Sections 871 and 881 provide, for purposes of
determining the amount of original issue discount subject to the withholding
tax, that the 30% tax will apply to the amount of gain not in excess of the
original issue discount that accrued, on a constant interest basis, while the
foreign person held the Bond (reduced by the accrued original issue discount on
account of which the tax had already been withheld).
The 30% withholding tax imposed on a foreign person is subject to reduction
or elimination under applicable tax treaties and does not apply if the interest,
original issue discount or gain treated as ordinary income, as the case may be,
is effectively connected with the conduct by such foreign person of a trade or
business within the United States. Foreign persons who hold a Bond should
consult their tax advisors regarding their qualification for reduced rate of, or
exemption from, withholding and the procedure for obtaining such a reduction or
exemption.
BACKUP WITHHOLDING
Federal income tax law provides for "backup withholding" of tax at a rate
of 31% in certain circumstances on "reportable payments," which include payments
of principal, interest and original issue discount (determined in any case as if
the Bondholder were the original holder of the Bond), but not market discount,
on a Bond and of the proceeds of the disposition of a Bond. Persons subject to
the requirement to backup withhold include, in certain circumstances, the
Issuer, the paying agent of the Issuer, a person who collects a payment of
interest or original issue discount as a custodian or nominee on behalf of the
Bondholder, and a "broker" (as defined in applicable Treasury regulations)
through which the Bondholder receives the proceeds of the retirement or other
disposition of a Bond. Backup withholding applies only if the Bondholder, among
other things, (1) fails to furnish a social security number or other taxpayer
identification number ("TIN") to the person subject to the requirement to backup
withhold, (2) furnishes an incorrect TIN to such person, (3) fails to report
properly interest or dividends or (4) under certain circumstances, fails to
provide to such person a certified statement, signed under penalty of perjury,
that the TIN furnished is the correct number and that such Bondholder is not
subject to backup withholding.
Backup withholding will not apply, however, with respect to certain
payments made to Bondholders, including payments to certain exempt recipients
(such as corporations and tax-exempt organizations) and to certain foreign
persons. Bondholders should consult their tax advisors regarding their
qualification for exemption from backup withholding and the procedure for
obtaining such an exemption.
Each Issuer will report to the Bondholders and the IRS for each calendar
year the amount of any "reportable payments" by the Issuer during such year and
the amount of tax withheld, if any, with respect to payments on the Bonds issued
by it.
DUE TO THE COMPLEXITY OF THE FEDERAL INCOME TAX RULES APPLICABLE TO
BONDHOLDERS AND THE CONSIDERABLE UNCERTAINTY THAT EXISTS WITH RESPECT TO MANY
ASPECTS OF THOSE RULES, POTENTIAL INVESTORS SHOULD CONSULT THEIR OWN TAX
ADVISORS REGARDING THE TAX TREATMENT OF THE ACQUISITION, OWNERSHIP, AND
DISPOSITION OF THE BONDS.
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STATE TAX CONSIDERATIONS
In addition to the federal income tax consequences described above under
"FEDERAL INCOME TAX CONSEQUENCES," potential investors should consider the state
income tax consequences of the acquisition, ownership, and disposition of the
Bonds. State 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. Therefore, potential investors should consult
their own tax advisors with respect to the various state tax consequences of an
investment in the Bonds.
LEGAL INVESTMENT
The Prospectus Supplement for each Series of Bonds will specify which, if
any, of the Classes of Bonds offered thereby will constitute "mortgage related
securities" for purposes of SMMEA. Classes of Bonds 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 any state
(including the District of Columbia and Puerto Rico) whose authorized
investments are subject to state regulation 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 enacts
legislation prior to October 4, 1991 specifically limiting the legal investment
authority of any of such entities with respect to "mortgage related securities,"
the Bonds 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 Bonds, or
require the sale or other disposition of Bonds, so long as such contractual
commitment was made or such Bonds 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 Bonds 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 Bonds 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) (whether or not the Class of Bonds under consideration for purchase
constitutes a "mortgage related security").
All depository institutions considering an investment in the Bonds (whether
or not the Class of Bonds under consideration for purchase constitutes a
"mortgage related security") should review the Federal Financial Institutions
Examination Council's Supervisory Policy Statement on 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" that 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 Bonds not entitled to
distributions allocated to principal or interest, or Subordinated Bonds. 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
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limited to, "prudent investor" provisions, percentage-of-assets limits and
provisions that may restrict or prohibit investment in securities that are not
"interest bearing" or "income paying."
There may be other restrictions on the ability of certain investors,
including depository institutions, either to purchase Bonds or to purchase Bonds
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 Bonds constitute legal investments for such investors.
ERISA MATTERS
GENERAL
The Employee Retirement Income Security Act of 1974, as amended ("ERISA")
and section 4975 of the Code impose certain restrictions on employee benefit
plans subject to ERISA or plans or arrangements subject to Section 4975 of the
Code ("Plans") and on persons who are parties in interest or disqualified
persons ("parties in interest") with respect to such Plans. Certain employee
benefit plans, such as governmental plans and church plans (if no election has
been made under section 410(d) of the Code), are not subject to the restrictions
of ERISA, and assets of such plans may be invested in the Bonds without regard
to the ERISA considerations described below, subject to other applicable federal
and state law. However, any such governmental or church plan which is qualified
under section 401(a) of the Code and exempt from taxation under section 501(a)
of the Code is subject to the prohibited transaction rules set forth in section
503 of the Code. Any Plan fiduciary which proposes to cause a Plan to acquire
any of the Bonds should consult with its counsel with respect to the potential
consequences under ERISA, and the Code, of the Plan's acquisition and ownership
of the Bonds. Investments by Plans are also subject to ERISA's general fiduciary
requirements, including the requirement of investment prudence and
diversification and the requirement that a Plan's investments be made in
accordance with the documents governing the Plan.
PROHIBITED TRANSACTIONS
GENERAL. Section 406 of ERISA prohibits parties in interest with respect
to a Plan from engaging in certain transactions (including loans) involving a
Plan and its assets unless a statutory or administrative exemption applies to
the transaction. Section 4975 of the Code imposes certain excise taxes (or, in
some cases, a civil penalty may be assessed pursuant to section 502(i) of ERISA)
on parties in interest which engage in non-exempt prohibited transactions.
PLAN ASSET REGULATION. The United States Department of Labor ("Labor") has
issued final regulations concerning the definition of what constitutes the
assets of a Plan for purposes of ERISA and the prohibited transaction provisions
of the Code (the "Plan Asset Regulation"). The Plan Asset Regulation describes
the circumstances under which the assets of an entity in which a Plan invests
will be considered to be "plan assets" such that any person who exercises
control over such assets would be subject to ERISA's fiduciary standards. Under
the Plan Asset Regulation, generally when a Plan invests in another entity, the
Plan's assets do not include, solely by reason of such investment, any of the
underlying assets of the entity. However, the Plan Asset Regulation provides
that, if a Plan acquires an "equity interest" in an entity that is neither a
"publicly-offered security" (as defined therein) nor a security issued by an
investment company registered under the Investment Company Act of 1940, the
assets of the entity will be treated as assets of the Plan investor unless
certain exceptions apply. If the Bonds were deemed to be equity interests and no
statutory, regulatory or administrative exemption applies, the Issuer could be
considered to hold plan assets by reason of a Plan's investment in the Bonds.
Such plan assets would include an undivided interest in any assets held by the
Issuer. In such an event, the Bond Trustee and other persons, in providing
services with respect to the Issuer's assets, may be parties in interest with
respect to such Plans, subject to the fiduciary responsibility provisions of
Title I of ERISA, including the prohibited transaction provisions of section 406
of ERISA, and section 4975 of the Code with respect to transactions involving
the Issuer's assets. Under the Plan Asset Regulation, the term "equity interest"
is defined as any interest in an entity other than an instrument that is treated
as indebtedness under "applicable local law" and which has no "substantial
equity features." Although
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the Plan Assets Regulation is silent with respect to the question of which law
constitutes "applicable local law" for this purpose, Labor has stated that this
determination should be made under the state law governing interpretation of the
instrument in question. In the preamble to the Plan Assets Regulation, Labor
declined to provide a precise definition of what features are equity features or
the circumstances under which such features would be considered "substantial,"
noting that the question of whether a plan's interest has substantial equity
features is an inherently factual one, but that in making a determination it
would be appropriate to take into account whether the equity features are such
that a Plan's investment would be a practical vehicle for the indirect provision
of investment management services. If the Bonds are deemed to be equity
interests in the Issuer and no statutory, regulatory or administrative exemption
applies, the Issuer could be considered to hold plan assets by reason of a
Plan's investment in the Bonds. Those exemptions potentially include Prohibited
Transaction Class Exemption ("PTCE") 90-1, regarding investments by insurance
company pooled separate accounts, PTCE 91-38, regarding investments by bank
collective investment funds, PTCE 84-14, regarding transactions effected by a
"qualified professional asset manager," PTCE 95-60, regarding investments by
insurance company general accounts, or PTCE 96-23, regarding transactions
effected by an "in-house asset manager".
REVIEW BY PLAN FIDUCIARIES. Any Plan fiduciary considering whether to
purchase any Bonds on behalf of a Plan should consult with its counsel regarding
the applicability of the fiduciary responsibility and prohibited transaction
provisions of ERISA and the Code to such investment. Among other things, before
purchasing any Bonds, a fiduciary of a Plan should make its own determination as
to whether the Issuer, as obligor on the Bonds, is a party in interest with
respect to the Plan, the availability of the exemptive relief provided in the
Plan Asset Regulations and the availability of any other prohibited transaction
exemptions.
RATING
It is a condition to the issuance of the Bonds 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 Mortgage Collateral securing a Series of Bonds 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 Bonds will
receive payments to which such Bondholders are entitled under the related Bond.
Such rating will not constitute an assessment of the likelihood that principal
prepayments on the related Mortgage Collateral 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 Bonds. Such rating
should not be deemed a recommendation to purchase, hold or sell Bonds, 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 applicable 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 Mortgage Collateral securing a
Series of Bonds or any credit enhancement with respect to a Series of Bonds,
such rating might also be lowered or withdrawn among other reasons, because of
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 Bonds will be determined on the basis of criteria
established by each Rating Agency rating Classes of such Series of Bonds. 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
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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
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
Mortgage Collateral. No assurance can be given that values of any Mortgaged
Properties or mortgaged properties securing the mortgage loans underlying any
Certificates, as the case may be, have remained or will remain at their levels
on the respective dates of origination of the related mortgage loans. If the
residential real estate markets should experience an overall decline in property
values such that the outstanding principal balances of the Mortgage Collateral
securing a particular Series of Bonds and any secondary financing on the related
Mortgaged Properties become equal to or greater than the value of the Mortgaged
Properties or mortgaged properties securing the mortgage loans underlying any
Certificates, as the case may be, 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 Mortgage Collateral and,
accordingly, the rates of delinquencies, foreclosures and losses with respect to
any Mortgage Collateral securing a particular Series of Bonds. 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 Bonds.
PLAN OF DISTRIBUTION
The Issuer may sell the Bonds offered hereby either directly or through an
underwriter or underwriters or through underwriting syndicates managed by an
underwriter or underwriters. The Prospectus Supplement for each Series will set
forth the terms of the offering of such Series and of each Class within such
Series, including the name or names of the underwriters, the proceeds to and
their use by the Issuer, and either the initial public offering price, the
discounts and commissions to the underwriters and any discounts or concessions
allowed or reallowed to certain dealers or the method by which the price at
which the underwriters will sell the Bonds will be determined.
The Bonds of a Series may be acquired by underwriters for their own account
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. The obligations of any underwriters will be
subject to certain conditions precedent, and such underwriters will be severally
obligated to purchase all the Bonds of a Series described in the related
Prospectus Supplement, if any are purchased. If Bonds of a Series are offered
other than through underwriters, the related Prospectus Supplement will contain
information regarding the nature of such offering and any agreements to be
entered into between the Issuer and purchasers of Bonds of such Series.
The place and time of delivery for the Bonds of a Series in respect of
which this Prospectus is delivered will be set forth in the related Prospectus
Supplement.
LEGAL MATTERS
The validity of the Bonds will be passed upon for the Issuer by Tobin &
Tobin, a professional corporation, San Francisco, California. Certain tax
matters will be passed upon by Giancarlo & Gnazzo, A Professional Corporation,
San Francisco, California. Brown & Wood LLP, New York, New York will act as
counsel for the underwriters.
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INDEX OF CERTAIN DEFINITIONS
Set forth below is a list of certain terms used in this Prospectus,
together with the pages on which the terms are defined herein.
<TABLE>
<S> <C>
Accrual Period....................................................................... 76
Advance.............................................................................. 16
Agency Securities.................................................................... 1, 4
Assumed Reinvestment Rate............................................................ 31
Available Funds...................................................................... 6, 31
Balloon payments..................................................................... 9, 39
Bankruptcy Bond...................................................................... 14, 53
Basic Principal Payment.............................................................. 6
Belgian Cooperative.................................................................. 36
Beneficial owner..................................................................... 34
Bond Account......................................................................... 12
Bond Distribution Amount............................................................. 12
Bond Insurance Policy................................................................ 14
Bond Insurer......................................................................... 61
Bond Owners.......................................................................... 34
Bond Trustee......................................................................... 4, 26
Bond Value........................................................................... 7
Bond Values.......................................................................... 6
Bondholders.......................................................................... 4, 35
Bonds................................................................................ 1, 4
Book-Entry Bonds..................................................................... 34
Buydown Fund......................................................................... 39
Buydown Loans........................................................................ 39
Capitalized Interest Account......................................................... 49
CEDEL Participants................................................................... 36
CERCLA............................................................................... 20, 71
Certificates......................................................................... 1, 4
Closing Date......................................................................... 12
Code............................................................................5, 18, 26, 74
Collateral........................................................................... 37
Collateral Group..................................................................... 32
Commission........................................................................... 2
Company.............................................................................. 1, 5, 26
Controlling Class.................................................................... 63
Conventional Loans................................................................... 33
Cooperative Loans.................................................................... 9, 41
Cooperatives......................................................................... 9, 41
Custodial Account.................................................................... 56
Cut-off Date......................................................................... 14
Deferred Interest Bonds.............................................................. 30
Definitive Bond...................................................................... 35
Depositor............................................................................ 5, 26
Detailed Description................................................................. 38
Distribution Account................................................................. 12
Distribution Account Deposit Date.................................................... 12, 48
</TABLE>
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<TABLE>
<S> <C>
DTC.................................................................................. 22, 34
Due Period........................................................................... 6
Eligible Account..................................................................... 57
Eligible Substitute Pledged Mortgage................................................. 41
EPA.................................................................................. 71
ERISA................................................................................ 17, 81
Euroclear Operator................................................................... 36
Euroclear Participants............................................................... 36
European Depositaries................................................................ 34
Event of Default..................................................................... 63
Excess Spread........................................................................ 54
Exchange Act......................................................................... 3
FHA Loans............................................................................ 42
FHLMC................................................................................ 1, 4
FHLMC Act............................................................................ 44
FHLMC Certificates................................................................... 10, 41
Financial Intermediary............................................................... 35
Fixed Rate Pledged Mortgages......................................................... 1, 4
Floating Rate Bonds.................................................................. 31
Floating Rate Pledged Mortgages...................................................... 1, 4
FNMA................................................................................. 1, 4
FNMA Certificates.................................................................... 10, 41
Funding Period....................................................................... 13, 25
Garn-St Germain Act.................................................................. 72
GNMA................................................................................. 1, 4
GNMA Certificates.................................................................... 10, 41
GNMA I Certificate................................................................... 42
GNMA II Certificate.................................................................. 42
GNMA Issuer.......................................................................... 42
Guaranteed Mortgage Pass-Through Certificates........................................ 10, 41
Guaranty Agreement................................................................... 42
Housing Act.......................................................................... 42
Indenture............................................................................ 26
Insurance Proceeds................................................................... 37
IRS.................................................................................. 75
Issuer............................................................................... 1, 26
L/C Bank............................................................................. 15, 54
L/C Percentage....................................................................... 15, 54
Labor................................................................................ 82
Liquidated Mortgage.................................................................. 59
Liquidation Proceeds................................................................. 37
Lockout periods...................................................................... 10, 39
Master Servicer...................................................................... 5
Master Servicing Agreement........................................................... 5, 56
Master Servicing Fee................................................................. 59
Moody's.............................................................................. 48
Morgan............................................................................... 36
Mortgage Collateral.................................................................. 1, 4
Mortgage Note........................................................................ 9
</TABLE>
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<TABLE>
<S> <C>
Mortgage Pool Insurance Policy....................................................... 14, 51
Mortgage Rate........................................................................ 9
Mortgaged Property................................................................... 10, 38
Mortgagor............................................................................ 29
NCUA................................................................................. 81
OID Regulations...................................................................... 73
Owner Trustee........................................................................ 5, 26
Parties in interest.................................................................. 81
Payment Date......................................................................... 5
Permitted Investments................................................................ 48
Plan Asset Regulation................................................................ 82
Plans................................................................................ 81
Pledged Mortgages.................................................................... 1, 4
PMBS Agreement....................................................................... 46
PMBS Issuer.......................................................................... 11, 46
PMBS Servicer........................................................................ 12, 46
PMBS Trustee......................................................................... 12, 46
Policy Statement..................................................................... 81
Pool Insurer......................................................................... 51
Pre-Funded Amount.................................................................... 25
Pre-Funding Account.................................................................. 13, 25
Primary Mortgage Insurance Policy.................................................... 38
Private Mortgage-Backed Securities................................................... 4
PTCE................................................................................. 82
Purchase Price....................................................................... 29
Qualified REIT subsidiary............................................................ 26
Rating Agency........................................................................ 7, 83
RCRA................................................................................. 72
Record Date.......................................................................... 5
Redwood Trust........................................................................ 5, 26
REIT................................................................................. 17, 26
REMIC................................................................................ 74
Relevant Depositary.................................................................. 34
Relief Act........................................................................... 73
Remittance Date...................................................................... 39
Reserve Fund......................................................................... 51
Rules................................................................................ 35
Securities Act....................................................................... 2
Seller............................................................................... 27
Senior Bondholders................................................................... 13, 50
Senior Bonds......................................................................... 4
Senior Liens......................................................................... 40
Servicer............................................................................. 5, 56
Servicers............................................................................ 40
Servicing Agreement.................................................................. 56
Servicing Default.................................................................... 62
SMMEA................................................................................ 17
Special Hazard Insurance Policy...................................................... 14
Special Hazard Insurer............................................................... 52
</TABLE>
87
<PAGE> 149
<TABLE>
<S> <C>
Special Servicer..................................................................... 5
Special Servicing Agreement.......................................................... 61
Spread............................................................................... 6
Stand-by Master Servicer............................................................. 61
Subordinated Bondholders............................................................. 13, 50
Subordinated Bonds................................................................... 4
Subsequent Mortgage Collateral....................................................... 25
Substitute Collateral................................................................ 47
Successor Master Servicer............................................................ 61
Tax Prepayment Assumption............................................................ 76
Terms and Conditions................................................................. 36
TIN.................................................................................. 80
TMP.................................................................................. 74
Title V.............................................................................. 73
UCC.................................................................................. 69
VA Loans............................................................................. 42
</TABLE>
88
<PAGE> 150
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89
<PAGE> 151
======================================================
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS SUPPLEMENT OR THE
PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT
BE RELIED UPON. THIS PROSPECTUS SUPPLEMENT AND THE PROSPECTUS DO NOT CONSTITUTE
AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY OF THE SECURITIES
OFFERED HEREBY, NOR AN OFFER OF BONDS IN ANY STATE OR JURISDICTION IN WHICH, OR
TO ANY PERSON TO WHOM, SUCH OFFER WOULD BE UNLAWFUL. THE DELIVERY OF THIS
PROSPECTUS SUPPLEMENT OR THE PROSPECTUS AT ANY TIME DOES NOT IMPLY THAT THE
INFORMATION CONTAINED HEREIN OR THEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO
ITS DATE; HOWEVER, IF ANY MATERIAL CHANGE OCCURS WHILE THIS PROSPECTUS
SUPPLEMENT OR THE PROSPECTUS IS REQUIRED BY LAW TO BE DELIVERED, THIS PROSPECTUS
SUPPLEMENT OR THE PROSPECTUS WILL BE AMENDED OR SUPPLEMENTED ACCORDINGLY.
------------------------
TABLE OF CONTENTS
PROSPECTUS SUPPLEMENT
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Incorporation of Certain Documents by
Reference............................... S-2
Summary................................... S-3
Risk Factors.............................. S-15
The Issuer................................ S-17
Description of the Bonds.................. S-18
Security for the Bonds.................... S-35
Servicing of the Pledged Mortgages........ S-49
Use of Proceeds........................... S-51
Federal Income Tax Consequences........... S-51
ERISA Matters............................. S-51
Method of Distribution.................... S-52
Experts................................... S-52
Legal Matters............................. S-53
Ratings................................... S-53
Index of Certain Definitions.............. S-54
PROSPECTUS
Prospectus Supplement..................... 2
Available Information..................... 2
Incorporation of Certain Documents by
Reference............................... 3
Summary................................... 4
Risk Factors.............................. 19
Introduction.............................. 26
The Issuer................................ 26
Use of Proceeds........................... 27
Mortgage Loan Program..................... 27
Description of the Bonds.................. 30
Security for the Bonds.................... 37
Credit Enhancement........................ 50
Servicing of the Pledged Mortgages........ 56
The Indenture............................. 63
Certain Legal Aspects of Pledged
Mortgages............................... 66
Federal Income Tax Consequences........... 74
State Tax Considerations.................. 81
Legal Investment.......................... 81
ERISA Matters............................. 82
Rating.................................... 83
Plan of Distribution...................... 84
Legal Matters............................. 84
Index of Certain Definitions.............. 85
</TABLE>
UNTIL 90 DAYS AFTER THE DATE OF THIS PROSPECTUS SUPPLEMENT, ALL DEALERS
EFFECTING TRANSACTIONS IN THE BONDS, WHETHER OR NOT PARTICIPATING IN THIS
DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS SUPPLEMENT AND PROSPECTUS.
THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS
SUPPLEMENT AND PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR
UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
======================================================
======================================================
$749,160,000
SEQUOIA MORTGAGE TRUST 2
COLLATERALIZED MORTGAGE BONDS
------------------------
PROSPECTUS SUPPLEMENT
------------------------
MERRILL LYNCH & CO.
OCTOBER 24, 1997
======================================================
