<PAGE>
Filed Pursuant to Rule 424(b)(5)
Registration Number 333-44099
PROSPECTUS SUPPLEMENT
(TO PROSPECTUS DATED APRIL 23, 1998)
$315,000,000
LOGO
NOVASTAR HOME EQUITY LOAN
ASSET-BACKED BONDS, SERIES 1998-2
NOVASTAR FINANCIAL, INC.
SELLER
NOVASTAR MORTGAGE FUNDING CORPORATION
COMPANY
NovaStar Mortgage Funding Trust, Series 1998-2 (the "Issuer") will be formed
pursuant to a Trust Agreement, dated as of August 1, 1998, between NovaStar
Mortgage Funding Corporation (the "Company") and Wilmington Trust Company, the
Owner Trustee, as amended by the Amended and Restated Trust Agreement, dated
as of August 19, 1998 (the "Trust Agreement"). The Issuer will issue two
classes of NovaStar Home Equity Loan Asset-Backed Bonds (the "Bonds"), the
Class A-1 Bonds in an aggregate principal amount of $115,000,000 and the Class
A-2 Bonds in an aggregate principal amount of $200,000,000. The Bonds will be
issued pursuant to an Indenture to be dated as of August 1, 1998, between the
Issuer and First Union National Bank, the Indenture Trustee.
The Bonds will represent indebtedness of the Issuer and will be secured by
the trust estate (the "Trust Estate") created by the Trust Agreement. The
Trust Estate will consist primarily of fixed and adjustable rate,
conventional, one- to four-family, first lien mortgage loans (the "Initial
Mortgage Loans") and any funds on deposit in the Interest Coverage Account and
Pre-Funding Account (each as defined herein). Additional Mortgage Loans (the
"Subsequent Mortgage Loans" and, together with the Initial Mortgage Loans, the
"Mortgage Loans") having an aggregate unpaid principal balance of up to
$42,639,529 and meeting the criteria set forth herein are intended to be
purchased by the Issuer on or before October 25, 1998 with funds on deposit in
an account (the "Pre-Funding Account"), which will become part of the Trust
Estate.
In addition, the Bonds will have the benefit of an irrevocable and
unconditional financial guaranty insurance policy (the "Bond Insurance
Policy") to be issued by MBIA Insurance Corporation (the "Bond Insurer") as
described under "Description of the Bonds--Bond Insurance Policy" herein.
(continued on next page)
LOGO
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FOR A DISCUSSION OF CERTAIN RISK FACTORS RELATING TO INVESTMENTS IN
THE BONDS, SEE "RISK FACTORS" COMMENCING ON PAGE S-18 OF
THIS PROSPECTUS SUPPLEMENT AND ON PAGE 18 OF
THE PROSPECTUS.
---------------
THE ASSETS PLEDGED TO SECURE THE BONDS AND PROCEEDS FROM THE BOND INSURANCE
POLICY ARE THE SOLE SOURCE OF PAYMENTS ON THE BONDS. THE BONDS WILL
REPRESENT OBLIGATIONS SOLELY OF THE ISSUER AND WILL NOT REPRESENT AN
INTEREST IN OR OBLIGATION OF THE COMPANY, THE SERVICER, THE OWNER
TRUSTEE, THE INDENTURE TRUSTEE OR ANY OF THEIR AFFILIATES, OTHER THAN
THE ISSUER. NEITHER THE BONDS NOR THE UNDERLYING MORTGAGE LOANS ARE
INSURED OR GUARANTEED BY ANY GOVERNMENTAL AGENCY OR
INSTRUMENTALITY.
---------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS SUPPLEMENT OR
THE PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
---------------
There is currently no secondary market for the Bonds. Merrill Lynch, Pierce,
Fenner & Smith Incorporated (the "Underwriter") intends to make a secondary
market in the Bonds, but is not obligated 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 provide Bondholders with sufficient liquidity of
investment. The Bonds will not be listed on any securities exchange.
The Bonds will be purchased by the Underwriter from the Company and will be
offered by the Underwriter from time to time to the public 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 99.78125% of the aggregate principal amount of the Bonds plus
accrued interest, if any, 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 S.A. ("CEDEL") or the Euroclear System
("Euroclear") on or about August 19, 1998.
Upon receipt of a request by an investor for an electronic Prospectus
Supplement from the Underwriter or a request by such investor's representative
within the period during which there is an obligation to deliver a Prospectus
Supplement, the Underwriter will promptly deliver, or cause to be delivered,
in addition to such electronic Prospectus Supplement, without charge, a paper
copy of the Prospectus Supplement.
---------------
MERRILL LYNCH & CO.
---------------
The date of this Prospectus Supplement is August 14, 1998.
<PAGE>
(Continued from previous page)
The Bonds will be issued by NovaStar Mortgage Funding Trust, Series 1998-2
(the "Issuer"), a Delaware business trust established by NovaStar Mortgage
Funding Corporation (the "Company"), a wholly owned subsidiary of NovaStar
Financial, Inc., a Maryland corporation (the "Seller"). The Bonds will
represent indebtedness of the Issuer created by the Trust Agreement. Prior to
their transfer by the Company to the Issuer, the Mortgage Loans will be owned
by the Seller.
The Bonds will be collateralized by fixed and adjustable rate, conventional
mortgage loans secured by first liens on one- to four-family residential
properties. The Initial Mortgage Loans have been sold to the Company by the
Seller. The interest rates on the Initial Mortgage Loans will be fixed or
subject to semi-annual or annual adjustment commencing after the related
Initial Period (as defined herein) based on the related Index (as defined
herein) and the respective Gross Margins described herein, subject to certain
periodic and lifetime limitations as described more fully herein.
The Mortgage Loans securing the Bonds do not meet underwriting standards for
credit quality and documentation sufficient to qualify for guarantee by the
Federal National Mortgage Association ("FNMA") or the Federal Home Loan
Mortgage Corporation ("FHLMC") ("Subprime Mortgage Loans"). The Mortgage Loans
were generally underwritten in accordance with the underwriting standards
described in "Description of the Mortgage Pool--Underwriting Standards for the
Initial Mortgage Loans" herein and "Description of the Assets--Mortgage
Loans--Underwriting Standards for Subprime Mortgage Loans" in the Prospectus.
See also "Risk Factors--Underwriting Standards" herein. Approximately 9.11% of
the Initial Mortgage Loans, by aggregate principal balance as of the Cut-off
Date, are secured by Mortgaged Properties in California. See "Risk Factors--
Delinquencies and Potential Delinquencies" herein.
Payments on the Bonds will be made on the 25th day of each month or, if such
day is not a business day, then on the next business day, commencing on
September 25, 1998 (each, a "Payment Date"). As described herein, interest
will accrue on the Class A-1 Bonds at a floating rate (the "Class A-1 Bond
Interest Rate") equal, on the first Payment Date, to 5.82453%, and thereafter,
equal to the lesser of (i)(a) with respect to each Payment Date up to and
including the earlier of (x) the Payment Date in August 2005 and (y) the
Payment Date which occurs on or prior to the date on which the outstanding
Bond Principal Balance is reduced to less than 25% of the original Bond
Principal Balance, One-Month LIBOR (as defined herein) plus 0.18%, and (b)
with respect to each Payment Date thereafter, One-Month LIBOR plus 0.43% and
(ii) 13.00% per annum (the "Maximum Interest Rate"). As described herein,
interest will accrue on the Class A-2 Bonds at a floating rate (the "Class A-2
Bond Interest Rate") equal, on the first Payment Date, to 5.71453%, and
thereafter equal to the lesser of (i) (a) with respect to each Payment Date up
to and including the earlier of (x) the Payment Date in August 2005 and (y)
the Payment Date which occurs on or prior to the date on which the outstanding
Bond Principal Balance is reduced to less than 25% of the original Bond
Principal Balance, One-Month LIBOR (as defined herein) plus the Applicable
Spread (as defined herein), and (b) with respect to each Payment Date
thereafter, One-Month LIBOR plus 0.40%, and (ii) the Maximum Interest Rate.
The "Applicable Spread" for the first year following the Closing Date will be
0.07% per annum and for each year following each anniversary of the Closing
Date will be a percentage equal to the greater of (i) 0.07% (the "Minimum
Spread") and (ii) the lesser of (a) the Remarketing Spread (as defined herein)
and (b) 0.40% (the "Maximum Spread"). See "Description of the Bonds--Interest
Payments on the Bonds" herein. As described herein, interest payable with
respect to each Payment Date will accrue on the basis of a 360-day year and
the actual number of days elapsed during the period commencing on the Payment
Date immediately preceding the month in which such Payment Date occurs and
ending on the calendar day immediately preceding such Payment Date, except
with respect to the first Payment Date, which has an accrual period from
August 19, 1998 to September 25, 1998, and will be based on the Class A-1 Bond
Principal Balance and the then applicable Class A-1 Bond Interest Rate and the
Class A-2 Bond Principal Balance and the then applicable Class A-2 Bond
Interest Rate, as applicable. Payments in respect of principal of the Bonds
will be made concurrently on the Class A-1 Bonds and the Class A-2 Bonds on a
pro rata basis, as described herein under "Description of the Bonds--Priority
of Payment."
The Bonds may be redeemed in whole, but not in part, by the Issuer on any
Payment Date on or after the earlier of (i) the Payment Date on which the
outstanding Bond Principal Balance (as defined herein) is reduced to less than
25% of the original Bond Principal Balance and (ii) the Payment Date occurring
in August 2005. See "Description of the Bonds--Optional Redemption" herein.
The Bonds initially will be registered in the name of Cede & Co., as nominee
of The Depository Trust Company ("DTC"), as further described herein. The
interests of beneficial owners of the Bonds will be represented by book
entries on the records of DTC and the participating members of DTC. Definitive
certificates will be available for the Bonds only under the limited
circumstances described herein. See "Description of the Bonds--Book-Entry
Bonds" herein.
It is a condition of the issuance of the Bonds that they be rated "AAAr " by
Standard & Poor's Ratings Services, a division of The McGraw-Hill Companies,
Inc. ("S&P") and "Aaa" by Moody's Investors Service, Inc. ("Moody's").
--------------
THE YIELD TO MATURITY ON THE BONDS WILL DEPEND ON, AMONG OTHER THINGS, THE
RATE AND TIMING OF PRINCIPAL PAYMENTS (INCLUDING PREPAYMENTS, REPURCHASES,
DEFAULTS AND LIQUIDATIONS) ON THE MORTGAGE LOANS. THE MORTGAGE LOANS GENERALLY
MAY BE PREPAID IN FULL OR IN PART AT ANY TIME; HOWEVER, PREPAYMENT MAY SUBJECT
THE MORTGAGOR TO A PREPAYMENT CHARGE WITH RESPECT TO APPROXIMATELY 69.08% OF
THE INITIAL MORTGAGE LOANS. IN ADDITION, THE YIELD ON THE BONDS WILL BE
SENSITIVE TO FLUCTUATIONS IN THE LEVEL OF ONE-MONTH LIBOR, WHICH MAY VARY
SIGNIFICANTLY OVER TIME. SEE "CERTAIN YIELD AND PREPAYMENT CONSIDERATIONS"
HEREIN AND "YIELD CONSIDERATIONS" IN THE PROSPECTUS.
THE BONDS OFFERED BY THIS PROSPECTUS SUPPLEMENT CONSTITUTE PART OF A
SEPARATE SERIES OF BONDS BEING OFFERED PURSUANT TO THE COMPANY'S PROSPECTUS,
DATED APRIL 23, 1998, OF WHICH THIS PROSPECTUS SUPPLEMENT IS A PART AND WHICH
ACCOMPANIES THIS PROSPECTUS SUPPLEMENT. THE PROSPECTUS CONTAINS IMPORTANT
INFORMATION REGARDING THIS OFFERING WHICH IS NOT CONTAINED HEREIN, AND
PROSPECTIVE INVESTORS ARE URGED TO READ THE PROSPECTUS AND THIS PROSPECTUS
SUPPLEMENT IN FULL. SALES OF THE BONDS MAY NOT BE CONSUMMATED UNLESS THE
PURCHASER HAS RECEIVED BOTH THIS PROSPECTUS SUPPLEMENT AND THE PROSPECTUS.
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.
S-2
<PAGE>
SUMMARY
The following summary is qualified in its entirety by reference to the
detailed information appearing elsewhere herein and in the Prospectus.
Capitalized terms used herein and not otherwise defined herein have the
meanings assigned to them in the Prospectus.
The Bonds..................... $315,000,000 NovaStar Mortgage Funding Trust,
Series 1998-2, NovaStar Home Equity Loan
Asset-Backed Bonds, Series 1998-2. Only the
Bonds are offered hereby. The Bonds will be
issued pursuant to an Indenture, to be dated
as of August 1, 1998, between the Issuer and
the Indenture Trustee. The Bonds will consist
of the Class A-1 Bonds in an aggregate
principal amount of $115,000,000 and the Class
A-2 Bonds in an aggregate principal amount of
$200,000,000.
Issuer........................ The Bonds will be issued by NovaStar Mortgage
Funding Trust, Series 1998-2 (the "Issuer"), a
Delaware business trust established pursuant
to the Trust Agreement, dated as of August 1,
1998, as amended by the Amended and Restated
Trust Agreement, dated as of August 19, 1998
(the "Trust Agreement"), between the Company
and the Owner Trustee. The Bonds will
represent obligations solely of the Issuer,
and the assets and the proceeds of the assets
of the Issuer (collectively, the "Trust
Estate") and Insured Payments, if any, under
the Bond Insurance Policy will be the sole
source of payments on the Bonds. The Issuer is
not expected to have any significant assets
other than those pledged as collateral to
secure the Bonds.
Company....................... NovaStar Mortgage Funding Corporation (the
"Company"). See "The Issuer--The Company" in
the Prospectus.
Seller........................ NovaStar Financial, Inc. (the "Seller"). See
"The Seller" herein and "The Issuer--NovaStar
Financial" in the Prospectus.
Servicer...................... NovaStar Mortgage, Inc. (the "Servicer"). See
"Description of the Servicing Agreement--The
Servicer" herein.
Owner Trustee................. Wilmington Trust Company, a Delaware banking
corporation.
Indenture Trustee............. First Union National Bank, a national banking
association.
Cut-off Date.................. July 1, 1998.
Closing Date.................. On or about August 19, 1998.
Payment Date.................. The 25th day of each month (or, if such day is
not a business day, the next business day),
beginning on September 25, 1998 (each, a
"Payment Date").
Denominations and The Bonds will be issued, maintained and
Registration.................. transferred on the book-entry records of DTC
and its Participants (as defined in the
Prospectus). The Bonds will be offered in
registered form, in minimum denominations of
$25,000 and integral multiples of $1 in excess
thereof. The Bonds will be represented by one
or more Bonds registered in the name of Cede &
Co., as
S-3
<PAGE>
nominee of DTC. Persons acquiring beneficial
ownership interests in the Bonds may elect to
hold their Bonds through 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. No Beneficial
Owner will be entitled to receive a Bond in
fully registered, certificated form (a
"Definitive Bond"), except under the limited
circumstances described herein. See
"Description of the Bonds--Book-Entry Bonds"
herein and Annex I hereto.
The Mortgage Pool............. The Mortgage Loans are secured by first liens
on one- to four-family residential real
properties (each, a "Mortgaged Property"). As
of the Cut-off Date, the aggregate principal
balance of the Initial Mortgage Loans was
equal to approximately $272,360,471. The
actual principal balances of the Initial
Mortgage Loans as of the Closing Date will be
lower, and may be significantly lower, than
the principal balances thereof as of the Cut-
off Date as shown herein. The Initial Mortgage
Loans have individual principal balances at
origination of at least $16,000 but not more
than $749,900 with an average principal
balance at origination of approximately
$95,089. The Initial Mortgage Loans generally
have terms to maturity of up to 30 years from
the date of origination and a weighted average
remaining term to stated maturity of
approximately 296 months as of the Cut-off
Date. Approximately 29.01% of the Initial
Mortgage Loans (by aggregate principal balance
as of the Cut-off Date) require monthly
payments of principal based on 30-year
amortization schedules, but have scheduled
maturity dates of 15 years from the due date
of the first monthly payment (each such
Mortgage Loan, a "Balloon Loan"), in each case
leaving a substantial portion of the original
principal amount due and payable on the
respective scheduled maturity date.
Approximately 48.83% of the Initial Mortgage
Loans (by aggregate principal balance as of
the Cut-off Date) are Convertible Mortgage
Loans (as defined herein). See "Risk Factors--
Sale of Converted Mortgage Loans" herein.
With respect to approximately 50.73% of the
Initial Mortgage Loans (by aggregate principal
balance as of the Cut-off Date) the related
Mortgage Rate on such Initial Mortgage Loans
(the "Adjustable Rate Mortgage Loans") will be
subject to semi-annual or annual adjustment,
commencing after an initial period from
origination of six months, one year, two years
or three years (such period, the "Initial
Period"), on its Adjustment Date (as defined
herein), to equal the sum (rounded as
described herein) of the related Index
described below and a fixed percentage set
forth in the related Mortgage Note (the "Gross
Margin"). However, (i) on any Adjustment Date
such Mortgage Rate may not increase or
decrease by more than the Periodic Rate Cap
(as defined herein), except as described
S-4
<PAGE>
herein, (ii) over the life of such Adjustable
Rate Mortgage Loan, such Mortgage Rate may not
exceed the related maximum Mortgage Rate (the
"Maximum Mortgage Rate"), which Maximum
Mortgage Rates will range from 13.75% to
20.38% and (iii) over the life of such
Adjustable Rate Mortgage Loan, such Mortgage
Rate may not be lower than a specified minimum
Mortgage Rate (the "Minimum Mortgage Rate"),
which Minimum Mortgage Rates will range from
6.75% to 13.38% per annum. The initial
Adjustable Rate Mortgage Loans will have Gross
Margins ranging from 3.75% to 11.25% with a
weighted average of 5.64% as of the Cut-off
Date.
With respect to approximately 49.27% of the
Initial Mortgage Loans (by aggregate principal
balance as of the Cut-off Date) the related
Mortgage Rate on such Mortgage Loans (the
"Fixed Rate Mortgage Loans") is fixed. None of
the Initial Mortgage Loans (by aggregate
principal balance as of the Cut-off Date)
provide for negative amortization.
As of the Cut-off Date, the Initial Mortgage
Loans in the aggregate will have Mortgage
Rates of at least 6.75% per annum but not more
than 14.00% per annum, with a weighted average
of 9.90%.
Approximately 1.21% of the Initial Mortgage
Loans (by aggregate principal balance as of
the Cut-off Date) were thirty days or more but
less than sixty days delinquent in their
Monthly Payments as of the Cut-off Date.
Approximately 0.11% of the Initial Mortgage
Loans (by aggregate principal balance as of
the Cut-off Date) were sixty days or more but
less than ninety days delinquent as of the
Cut-off Date. Approximately 0.19% of the
Initial Mortgage Loans were ninety days or
more delinquent in their Monthly Payments as
of the Cut-off Date.
For a further description of the Mortgage
Loans, see "Description of the Mortgage Pool"
herein.
Pre-Funding Account........... On the Closing Date, approximately $42,639,529
(the "Original Pre-Funded Amount") will be
deposited in an account (the "Pre-Funding
Account"), which account is in the name of the
Indenture Trustee and is part of the Trust
Estate and will be used to acquire Subsequent
Mortgage Loans. During the Funding Period (as
defined below), the Original Pre-Funded Amount
will be reduced by the amount thereof used to
purchase Subsequent Mortgage Loans. The
"Funding Period" is the period commencing on
the Closing Date and ending generally on the
earlier to occur of (i) the date on which the
amount on deposit in the Pre-Funding Account
is less than $10,000 and (ii) October 25,
1998. See "Description of the Mortgage Pool--
Conveyance of Subsequent Mortgage Loans and
the Pre-Funding Account" herein.
Interest Coverage Account..... On the Closing Date, a portion of the sales
proceeds of the Bonds will be deposited in an
account (the "Interest Coverage
S-5
<PAGE>
Account") for application by the Indenture
Trustee to cover shortfalls in the Interest
Payment Amount (as defined herein)
attributable to the pre-funding feature during
the Funding Period. See "Description of the
Bonds--Interest Coverage Account" herein.
The Indices................... As of any Adjustment Date with respect to any
Adjustable Rate Mortgage Loan, the Index
applicable to the determination of the related
Mortgage Rate will be one of the following:
(i) the average of the interbank offered rates
for six month U.S. dollar deposits in the
London market based on quotations of major
banks as most recently available generally 30
days prior to the Adjustment Date ("Six-Month
LIBOR"); or (ii) the weekly average yield on
U.S. Treasury securities adjusted to a
constant maturity of one year ("One-Year CMT")
as published by the Federal Reserve Board in
Statistical Release H.15(519) and most
recently available as of the first business
day generally 30 days prior to the Adjustment
Date.
The CAP Agreements............ On the Closing Date, the Issuer will enter into
two interest rate CAP agreements (the "First
and Second CAP Agreements") with Merrill Lynch
Capital Services, Inc., as CAP counterparty
(the "First and Second CAP Provider"), to
partially hedge against the interest rate risk
that could result from the difference between
the Class A-1 Bond Interest Rate and/or the
Class A-2 Bond Interest Rate and the weighted-
average Mortgage Rate. Also on the Closing
Date, Merrill Lynch & Co., Inc. ("ML&Co.")
will enter into a guaranty whereby ML&Co. will
guarantee amounts payable by the First and
Second CAP Provider under the First and Second
CAP Agreements and the Bond Insurer will enter
into an interest rate swap insurance policy
for the benefit of the First and Second CAP
Provider whereby the Bond Insurer will
guarantee certain amounts payable by the
Issuer under the First and Second CAP
Agreements.
Under the first CAP Agreement (the "First CAP
Agreement"), on March 23, June 23, September
23 and December 23 of each year (the "First
CAP Payment Dates"), commencing on September
23, 1998 and terminating on March 23, 2001,
the Issuer will be entitled to receive from
the First and Second CAP Provider an amount
(the "First CAP 1 Amount") equal to the amount
obtained by multiplying (i) the amount, if
any, by which the applicable three-month USD-
LIBOR-BBA Rate for the period preceding such
First CAP Payment Date exceeds 5.75%, (ii) a
notional principal amount equal to $60,000,000
(the "First CAP Notional Amount") and (iii) a
fraction equal to the actual number of days
from the preceding First CAP Payment Date (or,
with respect to the initial First CAP Payment
Date, from the Closing Date), divided by a
360-day year. Under the First CAP Agreement,
on each First CAP Payment Date, the First and
Second CAP Provider will be entitled to
receive
S-6
<PAGE>
from the Issuer an amount (the "First CAP 2
Amount") equal to the amount obtained by
multiplying (i) a fixed rate of 0.3690% per
annum, (ii) the First CAP Notional Amount and
(iii) a fraction equal to the actual number of
days from the previous First CAP Payment Date
(or, with respect to the initial First CAP
Payment Date, from the Closing Date), divided
by a 360-day year. As of the Closing Date, the
applicable three-month USD LIBOR BBA rate is
less than 5.75%.
Under the second CAP Agreement (the "Second CAP
Agreement"), on March 13, June 13, September
13 and December 13 of each year (the "Second
CAP Payment Dates"), commencing on September
13, 1998 and terminating on March 13, 2001,
the Issuer will be entitled to receive from
the First and Second CAP Provider an amount
(the "Second CAP 1 Amount"), equal to the
amount obtained by multiplying (i) the amount,
if any, by which the applicable three-month
USD-LIBOR-BBA Rate for the period preceding
such Second CAP Payment Date exceeds 5.75%,
(ii) a notional principal amount equal to
$40,000,000 (the "Second CAP Notional Amount")
and (iii) a fraction equal to the actual
number of days from the preceding Second CAP
Payment Date (or, with respect to the initial
Second CAP Payment Date, from the Closing
Date), divided by a 360-day year. Under the
Second CAP Agreement, on each Second CAP
Payment Date, the First and Second CAP
Provider will be entitled to receive from the
Issuer an amount (the "Second CAP 2 Amount")
equal to the amount obtained by multiplying
(i) a fixed rate of 0.36625% per annum, (ii)
the Second CAP Notional Amount and (iii) a
fraction equal to the actual number of days
from the previous Second CAP Payment Date (or,
with respect to the initial Second CAP Payment
Date, from the Closing Date), divided by a
360-day year. As of the Closing Date, the
applicable three-month USD LIBOR BBA rate is
less than 5.75%.
On the Closing Date, the Issuer will also enter
into a third interest rate CAP agreement (the
"Third CAP Agreement") with National
Westminster Bank PLC, as CAP counterparty (the
"Third CAP Provider"), to partially hedge
against interest rate risks.
Under the Third CAP Agreement, on March 26,
June 26, September 26 and December 26 of each
year (the "Third CAP Payment Dates"),
commencing on March 26, 2001 and terminating
on June 26, 2003, the Issuer will be entitled
to receive from the Third CAP Provider an
amount (the "Third CAP 1 Amount") equal to the
amount obtained by multiplying (i) the amount,
if any, by which the applicable three-month
USD-LIBOR-BBA Rate for the period preceding
such Third CAP Payment Date exceeds 9.00%,
(ii) a notional principal amount equal to
$80,000,000 (the "Third CAP Notional Amount")
and (iii) a fraction equal to the actual
number of
S-7
<PAGE>
days from the preceding Third CAP Payment Date
(or, with respect to the initial Third CAP
Payment Date, from the Closing Date), divided
by a 360-day year. Under the Third CAP
Agreement, no payments are payable by the
Issuer to the Third CAP Provider on any Third
CAP Payment Date. As of the Closing Date, the
applicable three-month USD-LIBOR-BBA rate is
less than 9.00%.
The First CAP Agreement, the Second CAP
Agreement and the Third CAP Agreement are
collectively referred to herein as the "CAP
Agreements." The First and Second CAP Provider
and the Third CAP Provider are together
referred to herein as the "CAP Providers."
The "USD-LIBOR-BBA Rate," which resets on each
Reset Date, is the rate for deposits in U.S.
Dollars for a period of three months which
appears on the Telerate Page 3750 as of 11:00
a.m., London time, on the day that is two
London Banking Days preceding the Reset Date.
"London Banking Day" means any day in which
commercial banks are open for business
(including dealings in foreign exchange and
foreign currency deposits) in London. Under
the CAP Agreements, the Reset Dates are each
First CAP Payment Date, each Second CAP
Payment Date and each Third CAP Payment Date,
respectively, and the reset rate for each CAP
Agreement is then applicable for the following
period.
The obligations of the Issuer and the First and
Second CAP Provider under the First and Second
CAP Agreements will be settled on a net basis.
Under the First CAP Agreement, only the net
amount equal to the excess, if any, of the
First CAP 1 Amount over the First CAP 2 Amount
or the excess, if any, of the First CAP 2
Amount over the First CAP 1 Amount will be
payable by the First and Second CAP Provider
or the Issuer, respectively, to the other
party. Likewise, under the Second CAP
Agreement, only the net amount equal to the
excess, if any, of the Second CAP 1 Amount
over the Second CAP 2 Amount or the excess, if
any, of the Second CAP 2 Amount over the
Second CAP 1 Amount will be payable by the
First and Second CAP Provider or the Issuer,
respectively, to the other party. The CAP
Agreements will be pledged by the Issuer to
the Indenture Trustee as additional collateral
for the Bonds. Under the Indenture, regular
payments payable by the Issuer under the First
and Second CAP Agreements will rank senior to
payments due to Bondholders. No regular
payments are payable by the Issuer under the
Third CAP Agreement. If any amounts are
payable by any CAP Provider to the Issuer
under any CAP Agreement, such amounts will
increase the funds available to make payments
of principal and interest due on the Bonds on
the next Payment Date. If any net amount is
due from the Issuer to the First and Second
CAP Provider under the First and Second CAP
Agreements, such amount will reduce the funds
available to make payments of principal and
interest on the Bonds on the next Payment
Date.
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Upon the occurrence of an event of default
under a CAP Agreement, the defaulting party is
obligated to make a settlement payment to the
other nondefaulting party based upon the then
market value of the CAP Agreement to the other
party. Depending upon then prevailing interest
rates, such a settlement payment could be
substantial. Settlement payments, if any,
payable by the Issuer under the CAP Agreements
will rank junior to payments due to
Bondholders and the Bond Insurer. See
"Description of the Mortgage Pool--The CAP
Agreements" herein.
Interest Payments............. Interest will be payable on the Bonds as
follows:
(a) Class A-1 Bonds........... Interest on the Class A-1 Bonds will be paid
monthly on each Payment Date, commencing on
September 25, 1998, in an amount (the "Class
A-1 Interest Payment Amount") equal to the
lesser of (i) interest accrued on the Class A-
1 Bond Principal Balance immediately prior to
such Payment Date at the Class A-1 Bond
Interest Rate (as defined below) for the
related Interest Period (as defined below) and
(ii) the Class A-1 Guaranteed Interest Payment
Amount (as defined below). The "Class A-1 Bond
Interest Rate" on each Payment Date after the
first Payment Date will be a floating rate
equal to the lesser of (i) (a) with respect to
each Payment Date up to and including the
earlier of (x) the Payment Date in August 2005
and (y) the Payment Date which occurs on or
prior to the date on which the outstanding
Bond Principal Balance is reduced to less than
25% of the original Bond Principal Balance,
One-Month LIBOR (as defined herein) plus
0.18%, and (b) with respect to each Payment
Date thereafter, One-Month LIBOR plus 0.43%
and (ii) 13.00% per annum (the "Maximum
Interest Rate"). The Class A-1 Bond Interest
Rate for the first Payment Date will equal
5.82453% per annum.
As further described herein, with respect to
the Class A-1 Bonds and any Payment Date, to
the extent that the amount calculated pursuant
to clause (i) of the definition of Class A-1
Interest Payment Amount exceeds the Class A-1
Guaranteed Interest Payment Amount (such
excess, the "Class A-1 Carry-Forward Amount"),
the holders of the Class A-1 Bonds will be
paid the amount of such Class A-1 Carry-
Forward Amount on a pro rata basis, in
accordance with the Class A-1 Carry Forward
Amount and the Class A-2 Carry Forward Amount,
with interest thereon at the Class A-1 Bond
Interest Rate applicable from time to time
after certain payments to the holders of the
Bonds and the Bond Insurer to the extent of
Available Funds. The "Class A-1 Guaranteed
Interest Payment Amount" for any Payment Date
is equal to the Class A-1 Bond's pro rata
portion of the Guaranteed Interest Payment
Amount (as defined below), determined by
multiplying the Guaranteed Interest Payment
Amount for such Payment Date by a fraction,
the numerator of
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<PAGE>
which is the amount calculated pursuant to
clause (i) of the definition of Class A-1
Interest Payment Amount and the denominator of
which is the sum of (x) the amount calculated
pursuant to clause (i) of the definition of
Class A-1 Interest Payment Amount and (y) the
amount calculated pursuant to clause (i) of
the definition of Class A-2 Interest Payment
Amount.
(b) Class A-2 Bonds........... Interest on the Class A-2 Bonds will be paid
monthly on each Payment Date, commencing on
September 25, 1998, in an amount (the "Class
A-2 Interest Payment Amount") equal to the
lesser of (i) interest accrued on the Class A-
2 Bond Principal Balance immediately prior to
such Payment Date at the Class A-2 Bond
Interest Rate (as defined below) for the
related Interest Period and (ii) the Class A-2
Guaranteed Interest Payment Amount (as defined
below). The "Class A-2 Bond Interest Rate" on
each Payment Date after the first Payment Date
will be a floating rate equal to the lesser of
(i) (a) with respect to each Payment Date up
to and including the earlier of (x) the
Payment Date in August 2005 and (y) the
Payment Date which occurs on or prior to the
date on which the outstanding Bond Principal
Balance is reduced to less than 25% of the
original Bond Principal Balance, One-Month
LIBOR (as defined herein) plus the Applicable
Spread (as defined herein), and (b) with
respect to each Payment Date thereafter, One-
Month LIBOR plus 0.40%, and (ii) the Maximum
Interest Rate. The Class A-2 Bond Interest
Rate for the first Payment Date will be
5.71453% per annum. The "Applicable Spread"
for the first year following the Closing Date
will be 0.07% per annum (which was determined
in accordance with the following formula) and
for each year following each anniversary of
the Closing Date will be a percentage, equal
to the greater of (i) 0.07% (the "Minimum
Spread") and (ii) the lesser of (a) the
Remarketing Spread (as defined herein) and (b)
0.40% (the "Maximum Spread").
The "Remarketing Spread" on each anniversary of
the Closing Date will be (a) an amount
expressed as a percentage by which (i) the
interest rate then payable on similarly-
structured, monthly floating-rate, taxable
debt securities with a remaining term to
maturity of not more than 397 days rated
either (A) in one of the two highest short
term rating categories by both S&P and Moody's
or (B) if at that time the rating on the Class
A-2 Bonds is lower, then the lowest rating
category assigned at that time to the Class A-
2 Bonds by S&P or Moody's, exceeds (ii) One-
Month LIBOR, or (b) if the amount under clause
(a) cannot be calculated, then an amount
expressed as a percentage by which (i) the
interest rate then payable on similarly-
structured, monthly floating-rate, asset-
backed bonds rated either (A) in the highest
rating category by both S&P and Moody's or (B)
if at that time the rating on the Class A-2
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<PAGE>
Bonds is lower, then the lowest rating
category assigned at that time to the Class A-
2 Bonds by S&P or Moody's, exceeds (ii) One-
Month LIBOR, in either case as reasonably
determined and certified to the Indenture
Trustee by the Remarketing Spread Calculation
Agent (as defined below); provided, that in
determining the rates under clauses (a)(i) and
(b)(i) above, the Remarketing Spread
Calculation Agent shall take into account
prevailing market conditions and current
spreads to LIBOR for such securities, the
principal amount of such securities that
prospective purchasers and/or current holders
of such securities are willing to purchase or
hold, and indications from prospective
purchasers and/or current holders of such
securities of the interest rates at which they
would be willing to purchase and/or hold such
securities. The "Remarketing Spread
Calculation Agent" is Merrill Lynch Capital
Services, Inc.
As further described herein, with respect to
the Class A-2 Bonds and any Payment Date, to
the extent that the amount calculated pursuant
to clause (i) of the definition of Class A-2
Interest Payment Amount exceeds the Class A-2
Guaranteed Interest Payment Amount (such
excess, the "Class A-2 Carry-Forward Amount"),
the holders of the Class A-2 Bonds will be
paid the amount of such Class A-2 Carry-
Forward Amount on a pro rata basis, in
accordance with the Class A-1 Carry Forward
Amount and the Class A-2 Carry Forward Amount,
with interest thereon at the Class A-2 Bond
Interest Rate applicable from time to time
after certain payments to the holders of the
Bonds and the Bond Insurer to the extent of
Available Funds. The "Class A-2 Guaranteed
Interest Payment Amount" for any Payment Date
is equal to the Class A-2 Bond's pro rata
portion of the Guaranteed Interest Payment
Amount, determined by multiplying the
Guaranteed Interest Payment Amount for such
Payment Date by a fraction, the numerator of
which is the amount calculated pursuant to
clause (i) of the definition of Class A-2
Interest Payment Amount and the denominator of
which is the sum of (x) the amount calculated
pursuant to clause (i) of the definition of
Class A-2 Interest Payment Amount and (y) the
amount calculated pursuant to clause (i) of
the definition of Class A-1 Interest Payment
Amount.
(c) General................... Interest on the Bonds in respect of any Payment
Date will accrue from the preceding Payment
Date (or in the case of the first Payment
Date, from the Closing Date) through the day
preceding such Payment Date (each such period,
an "Interest Period") on the basis of the
actual number of days in the Interest Period
and a 360-day year. The "Interest Payment
Amount" for the Bonds on any Payment Date is
the sum of the Class A-1 Interest Payment
Amount and the Class A-2 Interest Payment
Amount. The "Carry Forward Amount" for the
Bonds on any Payment Date is the sum of the
Class A-1 Carry-Forward Amount and the Class
A-2 Carry-Forward Amount.
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<PAGE>
The "Guaranteed Interest Payment Amount" for
any Payment Date is equal to the amount of
interest that accrued on the aggregate
outstanding Principal Balance of the Mortgage
Loans payable on the related Due Date and any
amounts paid by any CAP Provider to the Issuer
under any CAP Agreement, minus the aggregate
amount of the related Servicing Fee, the
Indenture Trustee Fee, the Owner Trustee Fee,
the Bond Insurance Premium, the PMI Premium,
any amounts paid to the First and Second CAP
Provider under the First and Second CAP
Agreements and the Minimum Interest Spread
(each as defined below). With respect to each
Mortgage Loan and each Payment Date, the
Servicer will be entitled to a fee (the
"Servicing Fee") equal to 1/12 of the
Servicing Fee Rate times the Principal Balance
of such Mortgage Loan as of such date. With
respect to each Payment Date, the Indenture
Trustee will be entitled to a fee (the
"Indenture Trustee Fee") equal to 1/12 of the
Indenture Trustee Fee Rate times the sum of
the Principal Balance of the Mortgage Loans
and the Pre-Funded Amount as of such date. For
any Payment Date, the "Servicing Fee Rate" is
equal to 0.50% per annum, the "Indenture
Trustee Fee Rate" is equal to 0.0125% per
annum, the "Owner Trustee Fee" is $4,000 per
annum (payable on the Payment Date in
September of each year) and the "Bond
Insurance Premium" is equal to 1/12 of the per
annum rate specified in the Insurance
Agreement times the Bond Principal Balance
(the Bond Insurance Premium together with the
Owner Trustee Fee, the "Administrative Fee").
The "PMI Premium" is equal to 1/12 of the per
annum rate specified in the PMI Insurance
Agreement times the aggregate original
Principal Balance of each Mortgage Loan
covered by a PMI Policy remaining in the
mortgage pool. With respect to each Mortgage
Loan and each Payment Date, the "Minimum
Interest Spread" is equal to 1/12 of 0.50% per
annum times the Principal Balance of such
Mortgage Loan as of such date. The Bond
Insurance Policy does not cover any Prepayment
Interest Shortfalls, any Relief Act Shortfalls
(each as defined herein) or the Carry-Forward
Amount, nor do the ratings assigned to the
Bonds address the payment of any Prepayment
Interest Shortfalls, any Relief Act Shortfalls
or the Carry-Forward Amount.
Principal Payments............ Principal payments will be payable concurrently
on the Class A-1 Bonds and the Class A-2 Bonds
on a pro rata basis in accordance with the
Class A-1 Bond Principal Balance and the Class
A-2 Bond Principal Balance, on each Payment
Date in an aggregate amount equal to the
Principal Payment Amount for such Payment
Date. The Principal Payment Amount will
include, to the extent of Available Funds (as
defined herein) and except as otherwise
described herein, the principal portion of all
scheduled monthly payments (to the extent
received or advanced) due from Mortgagors on
the related Due Date, and all unscheduled
amounts received during the preceding calendar
month (except with respect to the first
Payment Date, from the Cut-Off Date) that are
allocable to principal
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<PAGE>
(including proceeds of repurchases, principal
and adjustments in the case of substitutions,
prepayments, liquidations and insurance
(excluding proceeds paid in respect of the
Bond Insurance Policy)) and may be reduced as
a result of overcollateralization in excess of
the required level, as described herein. In
addition, on any Payment Date, to the extent
of funds available therefor, Bondholders will
also be entitled to receive payments generally
equal to the amount, if any, necessary to
bring the Subordination Amount up to the
Required Subordination Amount (such amount,
the "Subordination Increase Amount") and with
respect to the Payment Date immediately
following the end of the Funding Period, any
amounts in the Pre-Funding Account after
giving effect to any purchase of Subsequent
Mortgage Loans. The "Class A-1 Bond Principal
Balance" on any date of determination is the
initial principal balance of the Class A-1
Bonds as of the Closing Date, reduced by all
payments of principal thereon prior to such
date of determination. The "Class A-2 Bond
Principal Balance" on any date of
determination is the initial principal balance
of the Class A-2 Bonds as of the Closing Date,
reduced by all payments of principal thereon
prior to such date of determination. The "Bond
Principal Balance" of the Bonds on any date of
determination is the sum of the Class A-1 Bond
Principal Balance and the Class A-2 Bond
Principal Balance.
Final Scheduled Payment Date.. The Final Scheduled Payment Date for the Bonds
is August 25, 2028. It is anticipated that the
actual final Payment Date for the Bonds will
occur significantly earlier than the Final
Scheduled Payment Date. See "Certain Yield and
Prepayment Considerations" herein.
Bond Insurer.................. MBIA Insurance Corporation (the "Bond
Insurer"). See "The Bond Insurer" herein.
Bond Insurance Policy......... On the Closing Date, the Bond Insurer will
issue a Bond Insurance Policy in favor of the
Indenture Trustee for the benefit of the
holders of the Bonds. On each Payment Date, a
claim will be made on the Bond Insurance
Policy to cover (a) any shortfall in amounts
available to make payments of the Interest
Payment Amount (net of any Prepayment Interest
Shortfalls, to the extent not covered by the
Servicer by Compensating Interest (as defined
herein), and any Relief Act Shortfalls) and
(b) the Subordination Deficit (as defined
herein), to the extent described herein. The
Bond Insurance Policy will also cover any
unpaid Preference Amount (as defined herein).
In addition, the Bond Insurance Policy will
guarantee the payment of the outstanding Bond
Principal Balance of each Bond on the Final
Scheduled Payment Date of the Bonds (after
giving effect to all other amounts
distributable and allocable to principal on
such Payment Date, to the extent
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<PAGE>
described herein). The Bond Insurance Policy
does not insure the payment of the Carry-
Forward Amount (as defined herein). See
"Description of the Bonds--Bond Insurance
Policy" herein and "Description of Credit
Support" in the Prospectus.
The Certificates.............. Trust Certificates, Series 1998-2, issued
pursuant to the Trust Agreement, representing
the beneficial ownership interest in the
Issuer. The Certificates are not offered
hereby.
Credit Enhancement............ The credit enhancement provided for the benefit
of the Bondholders consists solely of (a) the
Net Monthly Excess Cashflow (as defined
herein), (b) the overcollateralization, (c)
the NCFC Demand Note and (d) the Bond
Insurance Policy.
Overcollateralization. Initially, the sum of
the aggregate Principal Balance of the Initial
Mortgage Loans as of the Cut-off Date and the
Original Pre-Funded Amount will be equal to
the aggregate Bond Principal Balance of the
Bonds as of the Closing Date. Over time,
however, the aggregate Principal Balance of
the Mortgage Loans (plus the remaining Pre-
Funded Amount, if any) is expected to exceed
the aggregate Bond Principal Balance of the
Bonds as a result of accelerated amortization
of the Bonds. Such amount is expected to
increase until it reaches a target of 3.80%
(the "Target Subordination Amount") of the sum
of the aggregate Principal Balance of the
Initial Mortgage Loans as of the Cut-off Date
and the Original Pre-Funded Amount.
Thereafter, such amount may increase or
decrease, subject to certain trigger tests, in
accordance with the provisions of the
Indenture. In addition, upon the end of the
Funding Period, the Bond Insurer may adjust
the Target Subordination Amount. An increase
would result in a temporary period of
accelerated amortization of the Bonds to
increase the actual level of
overcollateralization to its required level; a
decrease would result in a temporary period of
decelerated amortization to reduce the actual
level of overcollateralization to its required
level. See "Description of the Bonds--
Overcollateralization Provisions."
The NCFC Demand Note. On the Closing Date, a
demand promissory note of NCFC in the
principal amount of $6,300,000 (the "NCFC
Demand Note") will be assigned to the Issuer
and pledged to the Indenture Trustee. The NCFC
Demand Note will be held by the Indenture
Trustee subject to the lien of the Indenture
for the benefit of the Bondholders. The
Indenture Trustee may make a demand for
payment under the NCFC Demand Note only (a) on
the Maturity Date of the Bonds or (b)
following the occurrence of a Bond Insurer
Default or an Event of Default under the
Indenture. On the Closing Date, the Bond
Insurer will issue a surety bond (the "Surety
Bond") in favor of the Indenture Trustee for
the benefit of the Bondholders that guarantees
certain payments under the NCFC Demand Note,
as described herein. The Surety Bond does not
cover payments due under the NCFC Demand Note
that would be used by the Indenture Trustee to
pay any
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<PAGE>
Carry-Forward Amount or to cover shortfalls in
amounts then payable to the Bondholders
resulting from Prepayment Interest Shortfalls
or Civil Relief Act Shortfalls or any
accelerated payments to Bondholders unless
such acceleration of the Bonds is at the
direction of the Bond Insurer. See
"Description of the Bonds--NCFC Demand Note"
herein.
The Bond Insurance Policy. The Bonds will have
the benefit of the Bond Insurance Policy, as
discussed more fully herein. See "Description
of the Bonds--Bond Insurance Policy" herein.
Mandatory Prepayments on the The Bonds will be prepaid in part on the
Bonds......................... Payment Date immediately following the end of
the Funding Period in the event that any
amount remains on deposit in the Pre-Funding
Account on such Payment Date after the
purchase by the Issuer of the Subsequent
Mortgage Loans, if any. Although no assurance
can be given, it is anticipated that the
principal amount of the Subsequent Mortgage
Loans purchased by the Issuer will require the
application of substantially all of the
Original Pre-Funded Amount and that there
should be no material amount of principal
prepaid to the Bonds from the Pre-Funding
Account. However, it is unlikely that the
Seller will be able to deliver Subsequent
Mortgage Loans with an aggregate Principal
Balance identical to the Original Pre-Funded
Amount. See "Description of the Bonds--
Mandatory Prepayments on the Bonds" herein.
Advances...................... The Servicer is required to make advances
("Advances") in respect of delinquent payments
of principal and interest on the Mortgage
Loans, subject to the limitations described
herein. See "Description of the Bonds--
Advances" herein and in the Prospectus.
Optional Redemption of the The Bonds may be redeemed in whole, but not in
Bonds......................... part, by the Issuer on any Payment Date on or
after the earlier of (i) the Payment Date on
which the outstanding Bond Principal Balance
is reduced to less than 25% (the "Clean-Up
Call Percentage") of the original Bond
Principal Balance or (ii) the Payment Date
occurring in August 2005. See "Description of
the Bonds--Optional Redemption" herein and
"Description of the Agreements--Redemption" in
the Prospectus.
Special Prepayment The rate and timing of principal payments on
Considerations................ the Bonds will depend, among other things, on
the rate and timing of principal payments
(including prepayments, defaults, liquidations
and purchases of the Mortgage Loans due to a
breach of a representation or warranty) on the
related Mortgage Loans. As is the case with
home equity loan asset-backed securities
generally, the Bonds are subject to inherent
cash-flow uncertainties because the Mortgage
Loans may be prepaid at any time. Generally,
when prevailing interest rates increase,
prepayment rates on mortgage loans tend to
decrease, resulting
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<PAGE>
in a slower return of principal to investors
at a time when reinvestment at such higher
prevailing rates would be desirable.
Conversely, when prevailing interest rates
decline, prepayment rates on mortgage loans
tend to increase, resulting in a faster return
of principal to investors at a time when
reinvestment at comparable yields may not be
possible. Approximately 69.08% of the Initial
Mortgage Loans (by aggregate principal balance
as of the Cut-off Date) are subject to
prepayment charges. Typically, the Mortgage
Loans with a prepayment charge provision
provide for a prepayment charge for partial
prepayments and full prepayments. Prepayment
charges may be payable for a period of time
ranging from one to five years from the
related origination date. Such prepayment
charges may reduce the rate of prepayment on
the Mortgage Loans.
See "Certain Yield and Prepayment
Considerations" herein, and "Yield
Considerations" in the Prospectus.
Special Yield Considerations.. The yield to maturity on the Bonds will depend
on, among other things, the rate and timing of
principal payments (including prepayments,
defaults, liquidations and purchases of the
Mortgage Loans due to a breach of a
representation or warranty) on the Mortgage
Loans and the allocation thereof to reduce the
Bond Principal Balance thereof.
The yield to maturity on the Bonds will also
depend on the related Bond Interest Rate and
the purchase price for such Bonds.
If the Bonds are purchased at a premium and
principal payments thereon occur at a rate
faster than anticipated at the time of
purchase, the investor's actual yield to
maturity will be lower than that assumed at
the time of purchase. Conversely, if the Bonds
are purchased at a discount and principal
payments thereon occur at a rate slower than
that assumed at the time of purchase, the
investor's actual yield to maturity will be
lower than that assumed at the time of
purchase. The Bonds were structured assuming,
among other things, a prepayment rate and
corresponding weighted average lives as
described herein. The prepayment, yield and
other assumptions to be used for pricing
purposes for the Bonds may vary as determined
at the time of sale.
See "Certain Yield and Prepayment
Considerations" herein and "Yield
Considerations" in the Prospectus.
Federal Income Tax Upon the issuance of the Bonds, Stinson, Mag &
Consequences.................. Fizzell, P.C., counsel to the Company, will
deliver its opinion generally to the effect
that based on the application of existing law
and assuming compliance with the Trust
Agreement, for federal income tax purposes,
the Bonds will be characterized as
indebtedness and not as representing an
ownership interest in the Trust Estate or an
equity interest in the Issuer or the Company.
In addition, for federal income tax purposes,
the Issuer will not be (i) classified as an
association taxable as a
S-16
<PAGE>
corporation for federal income tax purposes,
(ii) a taxable mortgage pool as defined in
Section 7701(i) of the Code, or (iii) a
"publicly traded partnership" as defined in
Treasury Regulation Section 1.7704-1.
For further information regarding certain
federal income tax consequences of an
investment in the Bonds see "Federal Income
Tax Consequences" herein and "Federal Income
Tax Consequences" and "State Tax
Considerations" in the Prospectus.
ERISA Considerations.......... A fiduciary of an employee benefit plan and
certain other retirement plans and
arrangements, including individual retirement
accounts and annuities, Keogh plans, and
collective investment funds and separate
accounts in which such plans, accounts,
annuities or arrangements are invested, that
is subject to the Employee Retirement Income
Security Act of 1974, as amended ("ERISA"), or
Section 4975 of the Code (each, a "Plan")
should carefully review with its legal
advisors whether the purchase or holding of
Bonds could give rise to a transaction that is
prohibited or is not otherwise permissible
either under ERISA or Section 4975 of the
Code.
Legal Investment.............. The Bonds will constitute "mortgage related
securities" for purposes of the Secondary
Mortgage Market Enhancement Act of 1984, as
amended ("SMMEA"), for so long as they are
rated in at least the second highest rating
category by one or more nationally recognized
statistical rating agencies. Institutions
whose investment activities are subject to
legal investment laws and regulations or to
review by certain regulatory authorities may
be subject to restrictions on investment in
the Bonds. See "Legal Investment" herein.
Rating........................ It is a condition to the issuance of the Bonds
that they be rated "AAAr" by Standard & Poor's
Ratings Services, a division of The McGraw-
Hill Companies, Inc. ("S&P") and "Aaa" by
Moody's Investors Service, Inc. ("Moody's"). A
security rating is not a recommendation to
buy, sell or hold securities and may be
subject to revision or withdrawal at any time
by the assigning rating organization. A
security rating does not address the frequency
of prepayments of Mortgage Loans, or the
corresponding effect on yield to investors.
The ratings issued by S&P and Moody's on
payment of principal and interest on the Bonds
do not cover the payment of any Prepayment
Interest Shortfalls, any Relief Act Shortfalls
or the Carry-Forward Amount. See "Certain
Yield and Prepayment Considerations" and
"Ratings" herein.
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<PAGE>
RISK FACTORS
Prospective Bondholders should consider, among other things, the items
discussed under "Risk Factors" in the Prospectus and the following factors in
connection with the purchase of the Bonds:
UNDERWRITING STANDARDS
The Initial Mortgage Loans were underwritten and the Subsequent Mortgage
Loans will be underwritten generally in accordance with underwriting standards
described in "Description of the Mortgage Pools--Underwriting Standards for
Initial Mortgage Loans" herein, which are primarily intended to provide single
family mortgage loans for non-conforming credits which do not satisfy the
requirements of typical "A" credit borrowers. A "non-conforming credit" means
a mortgage loan which is ineligible for purchase by FNMA or FHLMC due to
credit characteristics that do not meet the FNMA or FHLMC underwriting
guidelines, including mortgagors whose creditworthiness and repayment ability
do not satisfy such FNMA or FHLMC underwriting guidelines and mortgagors who
may have a record of credit write-offs, outstanding judgments, prior
bankruptcies and other credit items that do not satisfy such FNMA or FHLMC
underwriting guidelines. Accordingly, Mortgage Loans underwritten to non-
conforming credit underwriting standards or to standards that do not meet the
requirements for typical "A" credit borrowers are likely to experience rates
of delinquency, foreclosure and loss that are higher, and may be substantially
higher, than Mortgage Loans originated in accordance with the FNMA or FHLMC
underwriting guidelines or to typical "A" credit borrowers.
DELINQUENCIES AND POTENTIAL DELINQUENCIES
Approximately 1.21% of the Initial Mortgage Loans (by aggregate principal
balance as of the Cut-off Date) were thirty days or more but less than sixty
days delinquent in their Monthly Payments as of the Cut-off Date.
Approximately 0.11% of the Initial Mortgage Loans (by aggregate principal
balance as of the Cut-off Date) were sixty days or more but less than ninety
days delinquent as of the Cut-off Date. Approximately 0.19% of the Initial
Mortgage Loans were ninety days or more delinquent in their Monthly Payments
as of the Cut-off Date.
Approximately 9.11% of the Initial Mortgage Loans (by aggregate principal
balance as of the Cut-off Date) are secured by Mortgaged Properties located in
the State of California. In the event California experiences a decline in real
estate values, losses on the Mortgage Loans may be greater than otherwise
would be the case.
Approximately 77.88% of the Initial Mortgage Loans (by aggregate principal
balance as of the Cut-off Date) will be covered by a PMI Policy (as defined
herein).
Approximately 53.80% of the Initial Mortgage Loans (by aggregate principal
balance as of the Cut-off Date) will have Loan-to-Value Ratios in excess of
80%. Mortgage Loans with a Loan-to-Value Ratio in excess of 80% will be
affected to a greater extent than Mortgage Loans with a Loan-to-Value Ratio
equal to or less than 80% by any decline in the value of the related Mortgaged
Property. 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 Mortgage Loans. If the residential real estate market should
experience an overall decline in property values such that the outstanding
balances of the Mortgage Loans, and any secondary financing on the Mortgaged
Properties, 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.
Approximately 29.01% of the Initial Mortgage Loans (by aggregate principal
balance as of the Cut-off Date) require monthly payments of principal based on
30 year amortization schedules and have scheduled maturity dates of 15 years
from the due date of the first monthly payment (each such Mortgage Loan, a
"Balloon Loan"), in each case leaving a substantial portion of the original
principal amount due and payable on the respective scheduled maturity date (a
"Balloon Payment"). The Balloon Loans entail a greater degree of risk for
prospective investors because the ability of a mortgagor to make a Balloon
Payment typically will depend upon the mortgagor's ability either to refinance
the related Balloon Loan or to sell the related Mortgaged
S-18
<PAGE>
Property. The mortgagor's ability to sell or refinance will be affected by a
number of factors, including the level of prevailing mortgage rates at the
time of sale or refinancing, the mortgagor's equity in the related Mortgaged
Property, the financial condition and credit profile of the mortgagor,
applicable tax laws and general economic conditions. None of the Company, the
Servicer, the Indenture Trustee, the Seller or any of their respective
affiliates, nor any other person, is obligated to refinance any Balloon Loan.
None of the Initial Mortgage Loans (by aggregate principal balance as of the
Cut-off Date) are secured by junior liens on the related Mortgaged Properties,
which liens will be subordinate to the rights of the mortgagee under the
related first lien. Accordingly, if the mortgagee under a first lien on the
related Mortgaged Property is successful in foreclosure of its mortgage, the
junior lien or encumbrances will not survive such a foreclosure. Also, due to
the priority of the first lien on the related Mortgaged Property, the holder
of a Mortgage Loan secured by a lien may not be able to control the timing,
method or procedure of any foreclosure action relating to the Mortgaged
Property. Investors should be aware that any liquidation, insurance or
condemnation proceeds received in respect of such Mortgage Loans will be
available to satisfy the outstanding balance of such Mortgage Loans only to
the extent that the claims of such first liens have been satisfied in full,
including any related foreclosure costs.
THE SUBSEQUENT MORTGAGE LOANS
Subsequent Mortgage Loans may have characteristics different from those of
the Initial Mortgage Loans. However, each Subsequent Mortgage Loan must
satisfy the eligibility criteria referred to herein under "Description of the
Mortgage Pool--Conveyance of Subsequent Mortgage Loans and the Pre-Funding
Account" at the time of its conveyance to the Trust Estate and must be
underwritten in accordance with the criteria set forth under "Description of
the Assets--Mortgage Loans--Standards for Subprime Mortgage Loans" in the
Prospectus.
MANDATORY PREPAYMENT
To the extent that amounts on deposit in the Pre-Funding Account have not
been fully applied to the purchase of Subsequent Mortgage Loans by the Issuer
by the end of the Funding Period, the Holders of the Bonds will receive, as
described herein, on the Payment Date immediately following the end of the
Funding Period, any amounts in the Pre-Funding Account after giving effect to
any purchase of Subsequent Mortgage Loans. Although no assurances can be
given, the Company intends that the principal amount of Subsequent Mortgage
Loans sold to the Issuer for inclusion in the Trust Estate will require the
application of substantially all amounts on deposit in the Pre-Funding Account
and that there will be no material principal payment to the Bonds on such
Payment Date.
RISK OF MORTGAGE LOAN YIELD REDUCING BOND INTEREST RATE ON THE BONDS
The Class A-1 Bond Interest Rate and the Class A-2 Bond Interest Rate is
based upon, among other factors as described herein under "Description of the
Bonds--Interest Payments on the Bonds," the value of an index (One-Month LIBOR
(as defined herein)) which is different from the value of the indices
applicable to the Adjustable Rate Mortgage Loans (Six-Month LIBOR and One-Year
CMT (each as defined herein)), as described under "Description of the Mortgage
Pool" herein. The Mortgage Rate on each of the Fixed Rate Mortgage Loans will
not adjust and the Mortgage Rate on each Adjustable Rate Mortgage Loan adjusts
semi-annually or annually, commencing after the Initial Period, based upon the
related Index, whereas the Class A-1 Bond Interest Rate and the Class A-2 Bond
Interest Rate on the related Bonds adjusts monthly based upon One-Month LIBOR
plus a spread, as set forth herein, limited by the Maximum Interest Rate (as
defined herein). In addition, One-Month LIBOR and the Indices on the
Adjustable Rate Mortgage Loans may respond differently to economic and market
factors, and there is not necessarily any correlation between them. Moreover,
the Adjustable Rate Mortgage Loans are subject to Periodic Rate Caps, Maximum
Mortgage Rates and Minimum Mortgage Rates (each, as defined herein). Thus, it
is possible, for example, that One-Month LIBOR may rise during periods in
S-19
<PAGE>
which the Indices are stable or falling or that, even if both One-Month LIBOR
and the Indices rise during the same period, One-Month LIBOR may rise much more
rapidly than the Indices. See "Description of the Bonds--Interest Payments on
the Bonds."
CAP AGREEMENTS
To partially reduce interest rate risk, the collateral for the Bonds will
include the CAP Agreements (collectively, the "Cash Flow Agreements"). These
Cash Flow Agreements will not fully hedge against interest rate risk because,
among other reasons, the notional amounts of these Cash Flow Agreements are
less than the aggregate original Bond Principal Balance of the Bonds, the
lengths of the Cash Flow Agreements are less than the term of the Bonds, and
the interest rates payable on the Bonds are the Class A-1 Bond Interest Rate
and the Class A-2 Bond Interest Rate while the rates under the Cash Flow
Agreements are based off of three-month USD-LIBOR-BBA. Any amounts payable by
the CAP Providers to the Issuer under the Cash Flow Agreements will increase
the funds available to make payments of principal and interest on the Bonds.
Any net amounts payable by the Issuer to the First and Second CAP Provider
under the First and Second CAP Agreements, however, will decrease the funds
available to make payments of principal and interest on the Bonds. Under the
Indenture, regular scheduled payments and, under certain circumstances,
settlement payments due under the Cash Flow Agreements by the Issuer rank
senior to payments due to the Bondholders. Other settlement payments, if any,
due under the Cash Flow Agreement by the Issuer rank junior to payments due to
Bondholders and the Bond Insurer. See "Description of the Mortgage Pool--The
CAP Agreements" herein and "Risk Factors--SWAP, CAP and Floor Agreements" in
the Prospectus.
SALE OF CONVERTED MORTGAGE LOANS
Within 30 days after conversion of a Convertible Mortgage Loan (as defined
herein), the Issuer is required to sell and the Servicer is required to
purchase such loan for a purchase price equal to the then outstanding principal
amount of such loan, plus accrued interest. Proceeds of the sale of Converted
Mortgage Loans (as defined herein) must be used to prepay principal and
interest on the Bonds in the same manner as prepayments of Mortgage Loans.
Approximately 48.83% of the Initial Mortgage Loans are, and up to 100% of the
Subsequent Mortgage Loans may be, Convertible Mortgage Loans. Accordingly,
conversion of Convertible Mortgage Loans will have the effect of accelerating
prepayments of principal, and shortening the duration, of the Bonds. No party
other than the Servicer will have any obligation to purchase a Converted
Mortgage Loan. See "The Servicer--Sale of Converted Mortgage Loans" herein.
USE OF PROCEEDS
After deducting the estimated expenses of this Offering, the net proceeds to
the Company from the sale of the Bonds offered hereby are estimated to be
$313,860,938. The Company anticipates that the entire net proceeds will be used
to purchase mortgage loans from its parent corporation, the Seller. The Seller
anticipates that it will use the entire net proceeds to repay indebtedness and
accrued interest under its warehouse lines of credit. The Company believes that
funds provided by the net proceeds of this offering will be sufficient to
accomplish the purposes set forth above.
DESCRIPTION OF THE MORTGAGE POOL
GENERAL
The statistical information presented in this Prospectus Supplement describes
only the mortgage loans included in the Trust Estate as of the Closing Date
(the "Initial Mortgage Loans") and does not include mortgage loans purchased by
the Issuer and included in the Trust Estate after the Closing Date (the
"Subsequent Mortgage Loans" and, together with the Initial Mortgage Loans, the
"Mortgage Loans"). The actual principal balances of the Initial Mortgage Loans
as of the Closing Date will be lower, and may be significantly lower, than the
principal balances thereof as of the Cut-off Date as shown herein.
Subsequent Mortgage Loans are intended to be purchased by the Issuer from the
Seller from time to time on or before October 25, 1998, from funds on deposit
in the Pre-Funding Account. The Subsequent Mortgage
S-20
<PAGE>
Loans, if available, will be sold by the Seller to the Issuer for inclusion in
the Trust Estate. The Purchase Agreement (as defined below) will provide that
the Subsequent Mortgage Loans must conform to certain specified
characteristics described below under "--Conveyance of Subsequent Mortgage
Loans and the Pre-Funding Account." In the sole discretion of the Bond
Insurer, Subsequent Mortgage Loans with characteristics varying from those
described herein may be purchased by the Issuer and included in the Trust
Estate; provided, however, that the addition of such Mortgage Loans will not
materially affect the aggregate characteristics of the Mortgage Loans.
The Mortgage Pool will consist of conventional, fixed and adjustable-rate,
monthly payment, first lien mortgage loans with terms to maturity of not more
than 30 years from the date of origination or modification. As of the Cut-off
Date, the principal balance of the Initial Mortgage Loans was equal to
approximately $272,360,471. The Company will acquire the Initial Mortgage
Loans to be included in the Mortgage Pool pursuant to a mortgage loan purchase
agreement (the "Purchase Agreement") among the Company, NovaStar Financial,
Inc. (the "Seller"), the Issuer and the Indenture Trustee. The Seller acquired
the Initial Mortgage Loans from its affiliate NovaStar Mortgage, Inc. as
further described herein. All of the Mortgage Loans will be serviced by
NovaStar Mortgage, Inc. (in such capacity, the "Servicer") directly or through
subservicers. The Company will convey the Initial Mortgage Loans to the Issuer
on the Closing Date pursuant to the Trust Agreement. The Seller will make
certain representations and warranties with respect to the Mortgage Loans
under the Purchase Agreement and, as more particularly described in the
Prospectus, will have certain repurchase or substitution obligations in
connection with a breach of any such representation or warranty, as well as in
connection with an omission or defect in respect of certain constituent
documents required to be delivered with respect to the Mortgage Loans, in any
event if such breach, omission or defect cannot be cured and it materially and
adversely affects the value of the related Mortgage Loan or the interests of
holders of the Bonds or the Bond Insurer. See "Description of the Agreements--
Representations and Warranties; Repurchases" in the Prospectus.
The representations and warranties made by the Seller to the Company under
the Purchase Agreement will be assigned by the Company to the Issuer, who will
in turn assign such representations and warranties to the Indenture Trustee
for the benefit of the Bondholders and the Bond Insurer.
Approximately 53.80% of the Initial Mortgage Loans (by aggregate principal
balance as of the Cut-off Date), will have Loan-to-Value Ratios in excess of
80%. Approximately 77.88% of the Initial Mortgage Loans (by aggregate
principal balance as of the Cut-off Date) are covered by a lender-paid primary
mortgage insurance policy (each a "PMI Policy") insuring first losses on the
Principal Balance of each such Mortgage Loan. See "Description of the Mortgage
Pool--Primary Mortgage Insurance" herein. The remainder of the Initial
Mortgage Loans will not be covered by a PMI Policy.
As of the Cut-off Date, the minimum and maximum Loan-to-Value Ratios at
origination for the initial Adjustable Rate Mortgage Loans were approximately
26.62% and 95.00%, respectively, and the weighted average Loan-to-Value Ratio
at origination of the initial Adjustable Rate Mortgage Loans was approximately
81.49%. As of the Cut-off Date, the minimum and maximum Loan-to-Value Ratios
at origination for the initial Fixed Rate Mortgage Loans were approximately
19.61% and 100.00%, respectively, and the weighted average Loan-to-Value Ratio
at origination of the initial Fixed Rate Mortgage Loans was approximately
80.08%.
All of the Mortgage Loans will contain a customary "due-on-sale" clause,
although the Mortgage Loans may be assumable if permitted by the Servicer
under certain circumstances. See "Certain Yield and Prepayment Considerations"
herein. Pursuant to the terms of the Servicing Agreement, the Servicer will be
entitled to all late payment charges received on the Mortgage Loans as
additional servicing compensation and such amounts will not be available for
distribution on the Bonds.
MORTGAGE RATE ADJUSTMENT
The Mortgage Rate on each Mortgage Loan is fixed (with respect to 49.27% of
the Initial Mortgage Loans), adjusts semi-annually (with respect to 48.16% of
the Initial Mortgage Loans) or adjusts annually (with respect to 2.56% of the
Initial Mortgage Loans). Adjustments to the Mortgage Rates on the Adjustable
Rate Mortgage
S-21
<PAGE>
Loans commence after an initial period after origination (the "Initial
Period") of six months, one year, two years or three years, in each case on
each applicable Adjustment Date to a rate equal to the sum, generally rounded
up to the nearest one-eighth of one percentage point (12.5 basis points), of
(i) the related Index plus (ii) a fixed percentage (the "Gross Margin"). In
addition, the Mortgage Rate on each Adjustable Rate Mortgage Loan is subject
on its first Adjustment Date following its origination to a cap (the "Initial
Periodic Rate Cap") and on each Adjustment Date thereafter to a periodic rate
cap (the "Periodic Rate Cap"). All of the Adjustable Rate Mortgage Loans are
also subject to specified maximum and minimum lifetime Mortgage Rates
("Maximum Mortgage Rates" and "Minimum Mortgage Rates," respectively). The
initial Adjustable Rate Mortgage Loans were generally originated with an
initial Mortgage Rate below the sum of the current Index and the Gross Margin.
Due to the application of the Periodic Rate Caps, Maximum Mortgage Rates and
Minimum Mortgage Rates, the Mortgage Rate on any initial Adjustable Rate
Mortgage Loan, as adjusted on any related Adjustment Date, may not equal the
sum of the related Index and the Gross Margin. The Due Date for substantially
all the Initial Mortgage Loans is the first day of the month.
Substantially all of the Adjustable Rate Initial Mortgage Loans will not
have reached their first Adjustment Date as of the Closing Date. The initial
Mortgage Rate is generally lower than the rate that would have been produced
if the applicable Gross Margin had been added to the related Index in effect
at origination. Adjustable Rate Mortgage Loans that have not reached their
first Adjustment Date are, therefore, subject to the Periodic Rate Cap on
their first Adjustment Date.
SIX-MONTH LIBOR INDEX
The Index applicable to the determination of the Mortgage Rate on
approximately 48.16% of the Initial Mortgage Loans (by aggregate principal
balance as of the Cut-off Date) will be the average of the interbank offered
rates for six-month United States dollar deposits in the London market based
on quotations of major banks, as published in the Western Edition of The Wall
Street Journal ("Six-Month LIBOR") applicable on any Adjustment Date is the
most recent index figure available as of the date 30 days before such
Adjustment Date.
The table below sets forth historical average rates of Six-Month LIBOR for
the months indicated as made available from FNMA, which values may differ from
those published in the Western Edition of The Wall Street Journal. Such
average rates may fluctuate significantly from month to month as well as over
longer periods and may not increase or decrease in a constant pattern from
period to period. There can be no assurance that levels of Six-Month LIBOR
published by FNMA, or published on a different Reference Date would have been
at the same levels as those set forth below. The following does not purport to
be representative of future levels of Six-Month LIBOR (as published by FNMA).
No assurance can be given as to the level of Six-Month LIBOR on any Adjustment
Date or during the life of any Adjustable Rate Mortgage Loan based on Six-
Month LIBOR.
SIX-MONTH LIBOR
<TABLE>
<CAPTION>
MONTH 1993 1994 1995 1996 1997 1998
----- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
January............................... 3.44% 3.39% 6.69% 5.34% 5.71% 5.75%
February.............................. 3.33 4.00 6.44 5.29 5.68 5.78
March................................. 3.38 4.25 6.44 5.52 5.96 5.80
April................................. 3.31 4.63 6.31 5.42 6.08 5.87
May................................... 3.44 5.00 6.06 5.64 6.01 5.81
June.................................. 3.56 5.25 5.88 5.84 5.94 5.87
July.................................. 3.56 5.33 5.88 5.92 5.83 5.82
August................................ 3.44 5.33 5.94 5.74 5.86
September............................. 3.38 5.69 5.99 5.75 5.85
October............................... 3.50 6.00 5.95 5.58 5.80
November.............................. 3.52 6.44 5.74 5.55 6.04
December.............................. 3.50 7.00 5.56 5.62 6.01
</TABLE>
S-22
<PAGE>
ONE-YEAR CMT INDEX
The Index applicable to the determination of the Mortgage Rate on
approximately 2.56% of the Initial Mortgage Loans (by aggregate principal
balance as of the Cut-off Date) will be the weekly average yield on U.S.
Treasury securities adjusted to a constant maturity of one year as published
by the Federal Reserve Board in Statistical Release H.15(519) and most
recently available as of the first business day generally 30 days prior to the
Adjustment Date ("One-Year CMT").
The table below sets forth historical average rates of One-Year CMT for the
months indicated as made available from Telerate Page 7052. Such average rates
may fluctuate significantly from month to month as well as over longer periods
and may not increase or decrease in a constant pattern from period to period.
There can be no assurance that levels of One-Year CMT published by Telerate
Page 7052, or published on a different Reference Date would have been at the
same levels as those set forth below. The following does not purport to be
representative of future levels of One-Year CMT (as published by Telerate Page
7052). No assurance can be given as to the level of One-Year CMT on any
Adjustment Date or during the life of any Adjustable Rate Mortgage Loan based
on One-Year CMT.
ONE-YEAR CMT
<TABLE>
<CAPTION>
MONTH 1993 1994 1995 1996 1997 1998
----- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
January............................... 3.50% 3.54% 7.08% 5.11% 5.60% 5.24%
February.............................. 3.38 3.85 6.73 4.94 5.52 5.31
March................................. 3.33 4.28 6.43 5.31 5.79 5.39
April................................. 3.25 4.74 6.27 5.53 5.99 5.38
May................................... 3.36 5.31 6.02 5.64 5.87 5.36
June.................................. 3.55 5.24 5.66 5.81 5.69 5.41
July.................................. 3.45 5.47 5.59 5.84 5.54 5.36
August................................ 3.47 5.56 5.72 5.69 5.56
September............................. 3.36 5.74 5.64 5.84 5.52
October............................... 3.38 6.11 5.60 5.57 5.46
November.............................. 3.58 6.48 5.45 5.43 5.46
December.............................. 3.61 7.10 5.32 5.47 5.53
</TABLE>
MORTGAGE LOAN CHARACTERISTICS
All percentages of the Initial Mortgage Loans described herein are
approximate percentages (except as otherwise indicated) by aggregate principal
balance as of the Cut-off Date.
Except with respect to Balloon Loans, the Initial Mortgage Loans generally
have original terms to stated maturity of approximately 30 years.
None of the Initial Mortgage Loans are secured by junior liens on the
related Mortgaged Properties.
Effective with the first payment due on an Adjustable Rate Initial Mortgage
Loan after each related Adjustment Date, the Monthly Payment will be adjusted
to an amount that will fully amortize the outstanding principal balance of the
Mortgage Loan over its remaining term. The weighted average number of months
from the Cut-off Date to the next Adjustment Date for the Adjustable Rate
Mortgage Loans is 22 months.
As of the Cut-off Date, each Initial Mortgage Loan will have an unpaid
principal balance of not less than $16,000 or more than $748,155 and the
average unpaid principal balance of the Initial Mortgage Loans will be
approximately $95,032. The latest stated maturity date of any of the Initial
Mortgage Loans will be August 1, 2028; however, the actual date on which any
Initial Mortgage Loan is paid in full may be earlier than the stated maturity
date due to unscheduled payments of principal.
S-23
<PAGE>
The weighted average remaining term to stated maturity of the Initial
Mortgage Loans will be approximately 296 months. The weighted average original
term to maturity of the Initial Mortgage Loans will be approximately 297
months.
The earliest year of origination of any Initial Mortgage Loan is 1996 and
the latest month and year of origination of any Initial Mortgage Loan will be
July 1998.
Approximately 69.08% of the Mortgage Loans provide for payment of a
prepayment charge. As to each such Mortgage Loan, the prepayment charge
provisions typically provide for payment of a prepayment charge for partial
prepayments and full prepayments. Prepayments may be payable for a period of
time ranging from one to five years from the related origination date.
Prepayment charges received on the Mortgage Loans will be available for
distribution on the Bonds.
Approximately 48.83% of Initial Mortgage Loans are Convertible Mortgage
Loans.
None of the Initial Mortgage Loans are Buydown Mortgage Loans.
Approximately 77.88% of the Initial Mortgage Loans are covered by PMI
Policies.
S-24
<PAGE>
Set forth below is a description of certain additional characteristics of the
Initial Mortgage Loans as of the Cut-off Date (except as otherwise indicated).
Dollar amounts and percentages may not add up to totals due to rounding.
GEOGRAPHIC DISTRIBUTION OF MORTGAGED PROPERTIES
FOR FIXED RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
AGGREGATE UNPAID
NUMBER OF INITIAL PRINCIPAL PERCENTAGE OF CUT-OFF DATE
STATE MORTGAGE LOANS BALANCE AGGREGATE PRINCIPAL BALANCE
----- ----------------- ---------------- ---------------------------
<S> <C> <C> <C>
AK...................... 3 $ 500,613 0.37%
AR...................... 8 536,776 0.40
AZ...................... 16 1,633,574 1.22
CA...................... 79 11,157,677 8.31
CO...................... 7 737,100 0.55
CT...................... 8 599,537 0.45
DC...................... 2 117,235 0.09
DE...................... 2 218,906 0.16
FL...................... 251 21,772,496 16.22
GA...................... 39 3,252,843 2.42
HI...................... 1 159,729 0.12
IA...................... 1 49,300 0.04
ID...................... 2 447,910 0.33
IL...................... 53 4,982,360 3.71
IN...................... 136 9,291,697 6.92
KS...................... 2 185,421 0.14
KY...................... 24 1,572,001 1.17
LA...................... 5 415,076 0.31
MA...................... 4 739,156 0.55
MD...................... 30 3,600,433 2.68
MI...................... 98 7,091,836 5.28
MN...................... 15 1,909,125 1.42
MO...................... 26 1,531,881 1.14
MS...................... 14 1,085,271 0.81
MT...................... 6 298,857 0.22
NC...................... 98 7,536,111 5.62
NE...................... 2 147,850 0.11
NJ...................... 8 849,232 0.63
NM...................... 3 324,927 0.24
NV...................... 41 5,032,922 3.75
OH...................... 107 8,664,841 6.46
OK...................... 9 858,702 0.64
OR...................... 39 4,747,566 3.54
PA...................... 57 3,978,691 2.96
SC...................... 108 7,023,525 5.23
TN...................... 111 7,617,967 5.68
TX...................... 26 2,032,160 1.51
UT...................... 11 1,209,295 0.90
VA...................... 23 3,055,493 2.28
WA...................... 54 5,862,144 4.37
WV...................... 14 1,048,220 0.78
WY...................... 4 323,061 0.24
----- ------------ ------
Total............... 1,547 $134,199,516 100.00%
===== ============ ======
</TABLE>
S-25
<PAGE>
No more than approximately 0.77% of the Fixed Rate Initial Mortgage Loans
will be secured by Mortgaged Properties located in any one zip code.
ORIGINAL LOAN-TO-VALUE RATIOS FOR
FIXED RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
PERCENTAGE OF
NUMBER OF AGGREGATE CUT-OFF DATE
INITIAL UNPAID AGGREGATE
ORIGINAL LOAN-TO- MORTGAGE PRINCIPAL PRINCIPAL
VALUE RATIO (%) LOANS BALANCE BALANCE
- ----------------- --------- ------------ -------------
<S> <C> <C> <C>
15.01- 20.00............................... 1 $ 39,763 0.03%
20.01- 25.00............................... 4 119,927 0.09
25.01- 30.00............................... 4 137,212 0.10
30.01- 35.00............................... 11 621,272 0.46
35.01- 40.00............................... 8 264,127 0.20
40.01- 45.00............................... 8 351,160 0.26
45.01- 50.00............................... 24 1,379,618 1.03
50.01- 55.00............................... 19 1,358,962 1.01
55.01- 60.00............................... 41 2,704,316 2.02
60.01- 65.00............................... 100 6,347,239 4.73
65.01- 70.00............................... 113 9,763,706 7.28
70.01- 75.00............................... 183 15,359,108 11.44
75.01- 80.00............................... 316 26,965,601 20.09
80.01- 85.00............................... 304 27,989,131 20.86
85.01- 90.00............................... 373 36,633,047 27.30
90.01- 95.00............................... 36 4,036,045 3.01
95.01-100.00............................... 2 129,283 0.10
----- ------------ ------
Total.................................... 1,547 $134,199,516 100.00%
===== ============ ======
</TABLE>
As of the Cut-off Date, the minimum and maximum Loan-to-Value Ratios as
origination for the Fixed Rate Initial Mortgage Loans were approximately
19.61% and 100.00%, respectively, and the weighted average Loan-to-Value Ratio
at origination of the Fixed Rate Initial Mortgage Loans was approximately
80.08%.
MORTGAGE RATES FOR
FIXED RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
PERCENTAGE OF
NUMBER AGGREGATE CUT-OFF DATE
OF INITIAL UNPAID AGGREGATE
MORTGAGE MORTGAGE PRINCIPAL PRINCIPAL
RATES (%) LOANS BALANCE BALANCE
- --------- ---------- ------------ -------------
<S> <C> <C> <C>
7.01- 7.50............................... 9 $ 700,344 0.52%
7.51- 8.00............................... 30 3,481,651 2.59
8.01- 8.50............................... 96 8,081,365 6.02
8.51- 9.00............................... 210 19,917,709 14.84
9.01- 9.50............................... 246 25,692,882 19.15
9.51-10.00............................... 298 27,886,902 20.78
10.01-10.50............................... 208 17,416,081 12.98
10.51-11.00............................... 199 15,133,160 11.28
11.01-11.50............................... 89 6,081,902 4.53
11.51-12.00............................... 103 6,588,060 4.91
12.01-12.50............................... 44 2,410,470 1.80
12.51-13.00............................... 11 636,642 0.47
13.01-13.50............................... 2 84,780 0.06
13.51-14.00............................... 2 87,569 0.07
----- ------------ ------
Total................................... 1,547 $134,199,516 100.00%
===== ============ ======
</TABLE>
The weighted average Mortgage Rate of the Fixed Rate Initial Mortgage Loans
will be approximately 9.838% per annum.
S-26
<PAGE>
CURRENT BALANCES OF
FIXED RATE INITIAL MORTGAGE LOANS AT THE CUT-OFF DATE
<TABLE>
<CAPTION>
CURRENT MORTGAGE AGGREGATE UNPAID
LOAN PRINCIPAL BALANCES NUMBER OF INITIAL PRINCIPAL PERCENTAGE OF CUT-OFF DATE
($) MORTGAGE LOANS BALANCE AGGREGATE PRINCIPAL BALANCE
- ----------------------- ----------------- ---------------- ---------------------------
<S> <C> <C> <C>
0.01- 25,000.00... 19 $ 443,762 0.33%
25,000.01- 50,000.00... 355 14,240,762 10.61
50,000.01- 75,000.00... 467 29,289,855 21.83
75,000.01-100,000.00... 305 26,173,565 19.50
100,000.01-125,000.00... 163 18,142,062 13.52
125,000.01-150,000.00... 94 12,815,049 9.55
150,000.01-175,000.00... 52 8,435,464 6.29
175,000.01-200,000.00... 28 5,295,081 3.95
200,000.01-225,000.00... 19 4,027,164 3.00
225,000.01-250,000.00... 9 2,126,179 1.58
250,000.01-275,000.00... 8 2,109,671 1.57
275,000.01-300,000.00... 8 2,298,590 1.71
300,000.01-325,000.00... 3 963,737 0.72
325,000.01-350,000.00... 3 1,025,977 0.76
350,000.01-400,000.00... 4 1,500,949 1.12
400,000.01-450,000.00... 3 1,339,008 1.00
450,000.01-500,000.00... 2 962,282 0.72
550,000.01-600,000.00... 3 1,716,016 1.28
600,000.01-650,000.00... 2 1,294,341 0.96
----- ------------ ------
Total................. 1,547 $134,199,516 100.00%
===== ============ ======
</TABLE>
The average current principal balance of the Fixed Rate Initial Mortgage
Loans will be approximately $86,748.
PRINCIPAL BALANCES OF
FIXED RATE INITIAL MORTGAGE LOANS AT ORIGINATION
<TABLE>
<CAPTION>
ORIGINAL MORTGAGE AGGREGATE UNPAID
LOAN PRINCIPAL BALANCES NUMBER OF INITIAL PRINCIPAL PERCENTAGE OF CUT-OFF DATE
($) MORTGAGE LOANS BALANCE AGGREGATE PRINCIPAL BALANCE
- ----------------------- ----------------- ---------------- ---------------------------
<S> <C> <C> <C>
0.01- 25,000.00... 19 $ 443,762 0.33%
25,000.01- 50,000.00... 355 14,240,762 10.61
50,000.01- 75,000.00... 467 29,289,855 21.83
75,000.01-100,000.00... 305 26,173,565 19.50
100,000.01-125,000.00... 163 18,142,062 13.52
125,000.01-150,000.00... 94 12,815,049 9.55
150,000.01-175,000.00... 51 8,260,533 6.16
175,000.01-200,000.00... 29 5,470,013 4.08
200,000.01-225,000.00... 19 4,027,164 3.00
225,000.01-250,000.00... 9 2,126,179 1.58
250,000.01-275,000.00... 8 2,109,671 1.57
275,000.01-300,000.00... 8 2,298,590 1.71
300,000.01-325,000.00... 3 963,737 0.72
325,000.01-350,000.00... 3 1,025,977 0.76
350,000.01-400,000.00... 4 1,500,949 1.12
400,000.01-450,000.00... 3 1,339,008 1.00
450,000.01-500,000.00... 2 962,282 0.72
550,000.01-600,000.00... 3 1,716,016 1.28
600,000.01-650,000.00... 2 1,294,341 0.96
----- ------------ ------
Total................. 1,547 $134,199,516 100.00%
===== ============ ======
</TABLE>
The average original principal balance of the Fixed Rate Initial Mortgage
Loans will be approximately $86,820.
S-27
<PAGE>
REMAINING TERM TO MATURITY
FOR FIXED RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
PERCENTAGE OF
NUMBER OF AGGREGATE CUT-OFF DATE
INITIAL UNPAID AGGREGATE
MORTGAGE PRINCIPAL PRINCIPAL
REMAINING TERM LOANS BALANCE BALANCE
- -------------- --------- ------------ -------------
<S> <C> <C> <C>
1-120.................................... 5 $ 188,607 0.14%
121-180.................................... 1,078 93,895,548 69.97
181-300.................................... 17 1,129,525 0.84
301-360.................................... 447 38,985,836 29.05
----- ------------ ------
Total.................................... 1,547 $134,199,516 100.00%
===== ============ ======
</TABLE>
The weighted average Remaining Term to Maturity of the Fixed Rate Initial
Mortgage Loans will be approximately 231 months.
ORIGINAL TERM TO MATURITY
FOR FIXED RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
PERCENTAGE OF
NUMBER OF AGGREGATE CUT-OFF DATE
INITIAL UNPAID AGGREGATE
MORTGAGE PRINCIPAL PRINCIPAL
ORIGINAL TERM LOANS BALANCE BALANCE
- ------------- --------- ------------ -------------
<S> <C> <C> <C>
120........................................ 5 $ 188,607 0.14%
180........................................ 1,078 93,895,548 69.97
240........................................ 17 1,129,525 0.84
360........................................ 447 38,985,836 29.05
----- ------------ ------
Total.................................... 1,547 $134,199,516 100.00%
===== ============ ======
</TABLE>
The weighted average Original Term to Maturity at origination of the Fixed
Rate Initial Mortgage Loans will be approximately 233 months.
PROPERTY TYPES FOR
FIXED RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
PERCENTAGE OF
NUMBER OF AGGREGATE CUT-OFF DATE
INITIAL UNPAID AGGREGATE
MORTGAGE PRINCIPAL PRINCIPAL
PROPERTY TYPE LOANS BALANCE BALANCE
- ------------- --------- ------------ -------------
<S> <C> <C> <C>
Two- to Four-Family........................ 69 $ 6,309,309 4.70%
Single-Family Attached..................... 12 852,387 0.64
Condominium................................ 43 2,770,371 2.06
Single-Family Detached..................... 1,243 111,012,009 82.72
Manufactured Housing....................... 157 10,189,575 7.59
Planned Unit Development................... 23 3,065,865 2.28
----- ------------ ------
Total.................................... 1,547 $134,199,516 100.00%
===== ============ ======
</TABLE>
S-28
<PAGE>
PURPOSES OF FIXED RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
PERCENTAGE OF
NUMBER OF AGGREGATE CUT-OFF DATE
INITIAL UNPAID AGGREGATE
MORTGAGE PRINCIPAL PRINCIPAL
PURPOSE LOANS BALANCE BALANCE
- ------- --------- ------------ -------------
<S> <C> <C> <C>
Const-Perm-Cash Out........................ 1 $ 79,100 0.06%
Const-Perm-No Cash......................... 2 147,100 0.11
Purchase-No Cash........................... 353 30,298,689 22.58
Refinance-Cash Out......................... 996 84,345,066 62.85
Refinance-No Cash.......................... 195 19,329,561 14.40
----- ------------ ------
Total.................................... 1,547 $134,199,516 100.00%
===== ============ ======
</TABLE>
In general, in the case of a Mortgage Loan made for "no equity take-out"
refinance purposes, substantially all of the proceeds are used to pay in full
the principal balance of a previous mortgage loan of the mortgagor with
respect to a Mortgaged Property and to pay origination and closing costs
associated with such refinancing. mortgage Loans made for "equity take-out"
refinance purposes may involve the use of the proceeds to pay in full the
principal balance of a previous mortgage loan and related costs except that a
portion of the proceeds are generally retained by the mortgagor for uses
unrelated to the Mortgaged Property. The amount of such proceeds retained by
the mortgagor may be substantial.
OCCUPANCY TYPES OF
FIXED RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
PERCENTAGE OF
NUMBER OF AGGREGATE CUT-OFF DATE
OCCUPANCY INITIAL UNPAID AGGREGATE
(AS INDICATED BY MORTGAGE PRINCIPAL PRINCIPAL
BORROWER) LOANS BALANCE BALANCE
---------------- --------- ------------ -------------
<S> <C> <C> <C>
Investment Non-Owner-Occupied............. 140 $ 8,784,202 6.55%
Investment Owner-Occupied................. 9 831,797 0.62
Primary................................... 1,376 122,847,515 91.54
Secondary................................. 22 1,736,001 1.29
----- ------------ ------
Total................................... 1,547 $134,199,516 100.00%
===== ============ ======
</TABLE>
DOCUMENTATION TYPE
OF FIXED RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
PERCENTAGE OF
NUMBER OF AGGREGATE CUT-OFF DATE
INITIAL UNPAID AGGREGATE
DCUMENTATIONO MORTGAGE PRINCIPAL PRINCIPAL
TYPE LOANS BALANCE BALANCE
- ------------- --------- ------------ -------------
<S> <C> <C> <C>
Full...................................... 1,172 $ 96,218,858 71.70%
Limited................................... 120 13,053,481 9.73
Stated.................................... 255 24,927,177 18.57
----- ------------ ------
Total................................... 1,547 $134,199,516 100.00%
===== ============ ======
</TABLE>
S-29
<PAGE>
RISK CATEGORIES OF
FIXED RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
PERCENTAGE OF
NUMBER OF AGGREGATE CUT-OFF DATE
INITIAL UNPAID AGGREGATE
MORTGAGE PRINCIPAL PRINCIPAL
RISK CATEGORY LOANS BALANCE BALANCE
- ------------- --------- ------------ -------------
<S> <C> <C> <C>
AA......................................... 355 $ 34,695,901 25.85%
A.......................................... 551 52,597,596 39.19
A-......................................... 296 24,267,425 18.08
B.......................................... 197 13,559,466 10.10
C.......................................... 123 7,732,782 5.76
D.......................................... 25 1,346,346 1.00
----- ------------ ------
Total.................................... 1,547 $134,199,516 100.00%
===== ============ ======
</TABLE>
See "--Underwriting Standards for the Initial Mortgage Loans" below for a
description of the risk categories of the Initial Mortgage Loans.
NUMBER OF DAYS DELINQUENT
FOR FIXED RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
PERCENTAGE OF
AGGREGATE CUT-OFF DATE
NUMBER OF UNPAID AGGREGATE
INITIAL PRINCIPAL PRINCIPAL
NUMBER OF DAYS DELINQUENT MORTGAGE LOANS BALANCE BALANCE
- ------------------------- -------------- ------------ -------------
<S> <C> <C> <C>
0-29.................................. 1,531 $132,997,653 99.10%
30-59................................. 12 990,412 0.74
60-89................................. 2 137,100 0.10
90-119................................ 2 74,351 0.06
----- ------------ ------
Total............................... 1,547 $134,199,516 100.00%
===== ============ ======
</TABLE>
S-30
<PAGE>
GEOGRAPHIC DISTRIBUTION OF MORTGAGED PROPERTIES
FOR ADJUSTABLE RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
PERCENTAGE OF
NUMBER OF AGGREGATE CUT-OFF DATE
INITIAL UNPAID AGGREGATE
MORTGAGE PRINCIPAL PRINCIPAL
STATE LOANS BALANCE BALANCE
----- --------- ------------ -------------
<S> <C> <C> <C>
AZ................................... 25 $ 3,518,957 2.55%
CA................................... 85 13,641,374 9.87
CO................................... 7 957,433 0.69
CT................................... 29 2,586,239 1.87
DC................................... 2 393,000 0.28
FL................................... 213 20,779,964 15.04
GA................................... 44 4,728,765 3.42
IA................................... 1 62,900 0.05
ID................................... 5 348,369 0.25
IL................................... 49 4,204,019 3.04
IN................................... 32 2,417,057 1.75
KS................................... 1 91,120 0.07
KY................................... 31 3,079,057 2.23
LA................................... 1 95,200 0.07
MA................................... 1 164,800 0.12
MD................................... 37 4,705,879 3.41
MI................................... 78 7,794,159 5.64
MN................................... 28 3,405,182 2.46
MO................................... 124 8,841,016 6.40
MS................................... 11 1,349,198 0.98
MT................................... 7 584,758 0.42
NC................................... 22 1,720,544 1.25
NM................................... 3 294,200 0.21
NV................................... 32 3,598,819 2.60
OH................................... 70 6,404,022 4.64
OK................................... 7 849,534 0.61
OR................................... 50 6,034,541 4.37
PA................................... 43 3,091,093 2.24
RI................................... 1 102,146 0.07
SC................................... 11 1,102,376 0.80
TN................................... 42 3,862,665 2.80
TX................................... 60 6,313,932 4.57
UT................................... 42 5,921,113 4.29
VA................................... 31 3,122,108 2.26
WA................................... 87 11,444,294 8.28
WI................................... 1 90,000 0.07
WV................................... 4 305,125 0.22
WY................................... 2 156,000 0.11
----- ------------ ------
Total................................ 1,319 $138,160,955 100.00%
===== ============ ======
</TABLE>
No more than approximately 0.94% of the Adjustable Rate Initial Mortgage
Loans will be secured by Mortgaged Properties located in any one zip code.
S-31
<PAGE>
ADJUSTABLE RATE INITIAL MORTGAGE LOAN TYPE
<TABLE>
<CAPTION>
PERCENTAGE OF
NUMBER OF AGGREGATE CUT-OFF DATE
INITIAL UNPAID AGGREGATE
MORTGAGE PRINCIPAL PRINCIPAL
LOAN TYPE LOANS BALANCE BALANCE
--------- --------- ------------ -------------
<S> <C> <C> <C>
One-Year CMT.............................. 49 $ 6,984,385 5.06%
2/28 Six-Month LIBOR...................... 1,132 115,663,044 83.72
3/27 Six-Month LIBOR...................... 81 8,706,912 6.30
Six-Month LIBOR........................... 57 6,806,613 4.93
----- ------------ ------
Total................................. 1,319 $138,160,955 100.00%
===== ============ ======
</TABLE>
ORIGINAL LOAN-TO-VALUE RATIOS
FOR ADJUSTABLE RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
PERCENTAGE OF
NUMBER OF AGGREGATE CUT-OFF DATE
ORIGINAL LOAN- INITIAL UNPAID AGGREGATE
TO-VALUE MORTGAGE PRINCIPAL PRINCIPAL
RATIOS (%) LOANS BALANCE BALANCE
-------------- --------- ------------ -------------
<S> <C> <C> <C>
25.01-30.00............................... 3 $ 163,500 0.12%
30.01-35.00............................... 3 133,300 0.10
35.01-40.00............................... 4 260,000 0.19
40.01-45.00............................... 4 435,875 0.32
45.01-50.00............................... 9 997,985 0.72
50.01-55.00............................... 10 680,520 0.49
55.01-60.00............................... 17 2,366,043 1.71
60.01-65.00............................... 56 5,354,555 3.88
65.01-70.00............................... 65 7,306,456 5.29
70.01-75.00............................... 140 13,461,524 9.74
75.01-80.00............................... 310 29,264,188 21.18
80.01-85.00............................... 316 34,273,685 24.81
85.01-90.00............................... 369 41,649,342 30.15
90.01-95.00............................... 13 1,813,983 1.31
----- ------------ ------
Total................................. 1,319 $138,160,955 100.00%
===== ============ ======
</TABLE>
As of the Cut-off Date, the minimum and maximum Loan-to-Value Ratios at
origination for the Adjustable Rate Initial Mortgage Loans were approximately
26.62% and 95.00%, respectively, and the weighted average Loan-to-Value Ratio
at origination of the Adjustable Rate Initial Mortgage Loans was approximately
81.49%.
S-32
<PAGE>
CURRENT BALANCES OF ADJUSTABLE RATE INITIAL
MORTGAGE LOANS AT THE CUT-OFF DATE
<TABLE>
<CAPTION>
PERCENTAGE OF
NUMBER OF AGGREGATE CUT-OFF DATE
CURRENT MORTGAGE INITIAL UNPAID AGGREGATE
LOAN PRINCIPAL MORTGAGE PRINCIPAL PRINCIPAL
BALANCE LOANS BALANCE BALANCE
---------------- --------- ------------ -------------
<S> <C> <C> <C>
0.01- 25,000.00.................... 2 $ 50,000 0.04%
25,000.01- 50,000.00.................... 170 6,982,389 5.05
50,000.01- 75,000.00.................... 363 22,825,477 16.52
75,000.01-100,000.00.................... 278 24,350,701 17.62
100,000.01-125,000.00.................... 193 21,493,699 15.56
125,000.01-150,000.00.................... 114 15,531,998 11.24
150,000.01-175,000.00.................... 55 8,878,330 6.43
175,000.01-200,000.00.................... 43 8,031,999 5.81
200,000.01-225,000.00.................... 24 5,013,475 3.63
225,000.01-250,000.00.................... 22 5,277,104 3.82
250,000.01-275,000.00.................... 13 3,440,247 2.49
275,000.01-300,000.00.................... 9 2,610,226 1.89
300,000.01-325,000.00.................... 6 1,898,488 1.37
325,000.01-350,000.00.................... 3 1,027,000 0.74
350,000.01-400,000.00.................... 10 3,778,781 2.74
400,000.01-450,000.00.................... 8 3,400,102 2.46
450,000.01-500,000.00.................... 1 500,000 0.36
500,000.01-550,000.00.................... 2 1,051,441 0.76
600,000.01-650,000.00.................... 2 1,271,341 0.92
700,000.01-750,000.00.................... 1 748,155 0.54
----- ------------ ------
Total................................ 1,319 $138,160,955 100.00%
===== ============ ======
</TABLE>
The average current principal balance of the Adjustable Rate Initial
Mortgage Loans will be approximately $104,747.
ORIGINAL TERM TO MATURITY OF ADJUSTABLE RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
PERCENTAGE OF
NUMBER OF AGGREGATE CUT-OFF DATE
INITIAL UNPAID AGGREGATE
MORTGAGE PRINCIPAL PRINCIPAL
REMAINING TERM LOANS BALANCE BALANCE
- -------------- --------- ------------ -------------
<S> <C> <C> <C>
240........................................ 1 $ 70,902 0.05%
360........................................ 1,318 138,090,053 99.95
----- ------------ ------
Total 1,319 $138,160,955 100.00%
===== ============ ======
</TABLE>
The weighted average Original Term to Maturity of the Adjustable Rate
Initial Mortgage Loans will be approximately 360 months.
S-33
<PAGE>
PRINCIPAL BALANCES OF
ADJUSTABLE RATE INITIAL MORTGAGE LOANS AT ORIGINATION
<TABLE>
<CAPTION>
PERCENTAGE OF
ORIGINAL MORTGAGE NUMBER OF AGGREGATE CUT-OFF DATE
LOAN INITIAL UNPAID AGGREGATE
PRINCIPAL BALANCE MORTGAGE PRINCIPAL PRINCIPAL
($) LOANS BALANCE BALANCE
- ----------------- --------- ------------ -------------
<S> <C> <C> <C>
0.01- 25,000.00..................... 2 $ 50,000 0.04%
25,000.01- 50,000.00..................... 170 6,982,389 5.05
50,000.01- 75,000.00..................... 363 22,825,477 16.52
75,000.01-100,000.00..................... 277 24,253,126 17.55
100,000.01-125,000.00..................... 194 21,591,274 15.63
125,000.01-150,000.00..................... 114 15,531,998 11.24
150,000.01-175,000.00..................... 55 8,878,330 6.43
175,000.01-200,000.00..................... 43 8,031,999 5.81
200,000.01-225,000.00..................... 24 5,013,475 3.63
225,000.01-250,000.00..................... 22 5,277,104 3.82
250,000.01-275,000.00..................... 13 3,440,247 2.49
275,000.01-300,000.00..................... 9 2,610,226 1.89
300,000.01-325,000.00..................... 6 1,898,488 1.37
325,000.01-350,000.00..................... 3 1,027,000 0.74
350,000.01-400,000.00..................... 10 3,778,781 2.74
400,000.01-450,000.00..................... 8 3,400,102 2.46
450,000.01-500,000.00..................... 1 500,000 0.36
500,000.01-550,000.00..................... 2 1,051,441 0.76
600,000.01-650,000.00..................... 2 1,271,341 0.92
700,000.01-750,000.00..................... 1 748,155 0.54
----- ------------ ------
Total................................. 1,319 $138,160,955 100.00%
===== ============ ======
</TABLE>
The average original principal balance of the Adjustable Rate Initial
Mortgage Loans will be approximately $104,788.
REMAINING TERM TO MATURITY FOR ADJUSTABLE
RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
PERCENTAGE OF
NUMBER OF AGGREGATE CUT-OFF DATE
INITIAL UNPAID AGGREGATE
MORTGAGE PRINCIPAL PRINCIPAL
REMAINING TERM LOANS BALANCE BALANCE
- -------------- --------- ------------ -------------
<S> <C> <C> <C>
181-240.................................... 1 $ 70,902 0.05%
301-360.................................... 1,318 138,090,053 99.95
----- ------------ ------
Total.................................. 1,319 $138,160,955 100.00%
===== ============ ======
</TABLE>
The weighted average Remaining Term to Maturity of the Adjustable Rate
Initial Mortgage Loans will be approximately 359 months.
S-34
<PAGE>
PROPERTY TYPES FOR
ADJUSTABLE RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
PERCENTAGE OF
NUMBER OF AGGREGATE CUT-OFF DATE
INITIAL UNPAID AGGREGATE
MORTGAGE PRINCIPAL PRINCIPAL
PROPERTY TYPE LOANS BALANCE BALANCE
- ------------- --------- ------------ -------------
<S> <C> <C> <C>
Two- to Four-Family........................ 60 $ 5,795,810 4.19%
Single-family Attached..................... 6 550,467 0.40
Condominium................................ 50 4,768,392 3.45
Single-family Detached..................... 1,086 115,167,310 83.36
Manufactured Housing....................... 86 7,211,150 5.22
Planned Unit Development................... 31 4,667,825 3.38
----- ------------ ------
Total.................................. 1,319 $138,160,955 100.00%
===== ============ ======
</TABLE>
PURPOSES OF ADJUSTABLERATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
NUMBER PERCENTAGE OF
OF AGGREGATE CUT-OFF DATE
INITIAL UNPAID AGGREGATE
MORTGAGE PRINCIPAL PRINCIPAL
PURPOSE LOANS BALANCE BALANCE
- ------- -------- ------------ -------------
<S> <C> <C> <C>
Const-Perm--Cash Out........................ 1 $ 67,020 0.05%
Const-Perm--No Cash Out..................... 10 874,533 0.63
Purchase--No Cash Out....................... 570 55,896,229 40.46
Refinance--Cash Out......................... 594 64,498,553 46.68
Refinance--No Cash Out...................... 144 16,824,620 12.18
----- ------------ ------
Total................................... 1,319 $138,160,955 100.00%
===== ============ ======
</TABLE>
In general, in the case of a Mortgage Loan made for "no equity take-out"
refinance purposes, substantially all of the proceeds are used to pay in full
the principal balance of a previous mortgage loan of the mortgagor with
respect to a Mortgaged Property and to pay origination and closing costs
associated with such refinancing. Mortgage Loans made for "equity take-out"
refinance purposes may involve the use of the proceeds to pay in full the
principal balance of a previous mortgage loan and related costs except that a
portion of the proceeds are generally retained by the mortgagor for uses
unrelated to the Mortgaged Property. The amount of such proceeds retained by
the mortgagor may be substantial.
OCCUPANCY TYPES FOR ADJUSTABLE RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
NUMBER PERCENTAGE OF
OF AGGREGATE CUT-OFF DATE
INITIAL UNPAID AGGREGATE
MORTGAGE PRINCIPAL PRINCIPAL
OCCUPANCY (AS INDICATED BY BORROWER) LOANS BALANCE BALANCE
- ------------------------------------ -------- ------------ -------------
<S> <C> <C> <C>
Investment Non-Owner--Occupied............... 73 $ 6,349,596 4.60%
Investment Owner--Occupied................... 10 867,693 0.63
Primary...................................... 1,216 127,948,349 92.61
Secondary.................................... 20 2,995,317 2.17
----- ------------ ------
Total.................................... 1,319 $138,160,955 100.00%
===== ============ ======
</TABLE>
S-35
<PAGE>
DOCUMENTATION TYPE FOR ADJUSTABLE RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
PERCENTAGE
NUMBER OF CUT-OFF
OF AGGREGATE DATE
INITIAL UNPAID AGGREGATE
MORTGAGE PRINCIPAL PRINCIPAL
DOCUMENTATION TYPE LOANS BALANCE BALANCE
- ------------------ -------- ------------ ----------
<S> <C> <C> <C>
Full........................................... 1,031 $104,555,487 75.68%
Limited........................................ 81 11,028,817 7.98
Stated......................................... 207 22,576,650 16.34
----- ------------ ------
Total...................................... 1,319 $138,160,955 100.00%
===== ============ ======
</TABLE>
RISK CATEGORIES OF ADJUSTABLE RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
NUMBER PERCENTAGE OF
OF AGGREGATE CUT-OFF DATE
INITIAL UNPAID AGGREGATE
MORTGAGE PRINCIPAL PRINCIPAL
RISK CATEGORY LOANS BALANCE BALANCE
- ------------- -------- ------------ -------------
<S> <C> <C> <C>
AA.......................................... 167 $ 21,248,183 15.38%
A........................................... 397 45,939,424 33.25
A-.......................................... 345 36,211,187 26.21
B........................................... 247 22,141,192 16.03
C........................................... 146 11,210,299 8.11
D........................................... 17 1,410,669 1.02
----- ------------ ------
Total................................... 1,319 $138,160,955 100.00%
===== ============ ======
</TABLE>
See "--Underwriting Standards for the Initial Mortgage Loans" below for a
description of the risk categories of the Initial Mortgage Loans.
NUMBER OF DAYS DELINQUENT FOR ADJUSTABLE RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
NUMBER PERCENTAGE OF
OF AGGREGATE CUT-OFF DATE
INITIAL UNPAID AGGREGATE
MORTGAGE PRINCIPAL PRINCIPAL
NUMBER OF DAYS DELINQUENT LOANS BALANCE BALANCE
- ------------------------- -------- ------------ -------------
<S> <C> <C> <C>
0-29....................................... 1,290 $135,244,775 97.89%
30-59....................................... 23 2,310,028 1.67
60-89....................................... 3 175,797 0.13
90-119....................................... 3 430,355 0.31
----- ------------ ------
Total.................................... 1,319 $138,160,955 100.00%
===== ============ ======
</TABLE>
S-36
<PAGE>
MORTGAGE RATES AT ORIGINATION FOR
SIX-MONTH LIBOR INDEXED RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
NUMBER PERCENTAGE OF
OF AGGREGATE CUT-OFF DATE
INITIAL UNPAID AGGREGATE
MORTGAGE PRINCIPAL PRINCIPAL
MORTGAGE RATES (%) LOANS BALANCE BALANCE
- ------------------ -------- ------------ -------------
<S> <C> <C> <C>
6.51- 7.00................................. 2 $ 193,029 0.15%
7.01- 7.50................................. 5 1,021,916 0.78
7.51- 8.00................................. 24 2,714,727 2.07
8.01- 8.50................................. 60 7,998,034 6.10
8.51- 9.00................................. 110 13,056,780 9.95
9.01- 9.50................................. 129 14,159,007 10.79
9.51-10.00................................. 245 26,463,809 20.17
10.01-10.50................................. 246 24,063,923 18.34
10.51-11.00................................. 224 21,990,464 16.76
11.01-11.50................................. 124 10,964,950 8.36
11.51-12.00................................. 73 6,416,809 4.89
12.01-12.50................................. 24 1,802,669 1.37
12.51-13.00................................. 3 266,766 0.20
13.01-13.50................................. 1 63,687 0.05
----- ------------ ------
Total................................... 1,270 $131,176,570 100.00%
===== ============ ======
</TABLE>
The weighted average Mortgage Rate of the Six-Month LIBOR Indexed Rate
Initial Mortgage Loans at origination will be approximately 10.044% per annum.
MINIMUM MORTGAGE RATES AT
CUT-OFF DATE FOR SIX-MONTH LIBOR INDEXED RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
NUMBER PERCENTAGE OF
OF AGGREGATE CUT-OFF DATE
MINIMUM INITIAL UNPAID AGGREGATE
MORTGAGE RATES MORTGAGE PRINCIPAL PRINCIPAL
(%) LOANS BALANCE BALANCE
-------------- -------- ------------ -------------
<S> <C> <C> <C>
6.51- 7.00............................... 2 $ 193,029 0.15%
7.01- 7.50............................... 5 1,021,916 0.78
7.51- 8.00............................... 24 2,714,727 2.07
8.01- 8.50............................... 60 7,998,034 6.10
8.51- 9.00............................... 111 13,141,082 10.02
9.01- 9.50............................... 129 14,159,007 10.79
9.51-10.00............................... 244 26,261,789 20.02
10.01-10.50............................... 246 24,063,923 18.34
10.51-11.00............................... 224 21,990,464 16.76
11.01-11.50............................... 125 11,166,970 8.51
11.51-12.00............................... 73 6,416,809 4.89
12.01-12.50............................... 23 1,718,367 1.31
12.51-13.00............................... 3 266,766 0.20
13.01-13.50............................... 1 63,687 0.05
----- ------------ ------
Total................................. 1,270 $131,176,570 100.00%
===== ============ ======
</TABLE>
The weighted average Minimum Mortgage Rate of the Six-Month LIBOR Indexed
Rate Initial Mortgage Loans as of the Cut-off Date will be approximately
10.044% per annum.
S-37
<PAGE>
INITIAL PERIODIC RATE CAP
FOR SIX-MONTH LIBOR INDEXED RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
NUMBER PERCENTAGE OF
OF AGGREGATE CUT-OFF DATE
INITIAL UNPAID AGGREGATE
INITIAL PERIODIC MORTGAGE PRINCIPAL PRINCIPAL
RATE CAP (%) LOANS BALANCE BALANCE
- ---------------- -------- ------------ -------------
<S> <C> <C> <C>
1.000....................................... 56 $ 6,722,311 5.12%
1.500....................................... 2 118,565 0.09
3.000....................................... 1,212 124,335,693 94.78
----- ------------ ------
Total................................... 1,270 $131,176,570 100.00%
===== ============ ======
</TABLE>
The weighted average Initial Periodic Rate Cap of the Six-Month LIBOR Indexed
Rate Initial Mortgage Loans is 2.896%.
PERIODIC RATE CAP FOR SIX-MONTH LIBOR INDEXED RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
PERCENTAGE OF
NUMBER OF AGGREGATE CUT-OFF DATE
INITIAL UNPAID AGGREGATE
PERIODIC MORTGAGE PRINCIPAL PRINCIPAL
RATE CAP (%) LOANS BALANCE BALANCE
- ------------ --------- ------------ -------------
<S> <C> <C> <C>
1.000...................................... 1,268 $131,058,005 99.91%
1.500...................................... 2 118,565 0.09
----- ------------ ------
Total.................................. 1,270 $131,176,570 100.00%
===== ============ ======
</TABLE>
The weighted average Periodic Rate Cap of the Six-Month LIBOR Indexed Rate
Initial Mortgage Loans is 1.000%.
MAXIMUM MORTGAGE RATE FOR
SIX-MONTH LIBOR INDEXED RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
PERCENTAGE OF
NUMBER OF AGGREGATE CUT-OFF DATE
INITIAL UNPAID AGGREGATE
MAXIMUM MORTGAGE PRINCIPAL PRINCIPAL
MORTGAGE RATE (%) LOANS BALANCE BALANCE
- ----------------- --------- ------------ -------------
<S> <C> <C> <C>
13.51-14.00................................ 3 $ 249,119 0.19%
14.01-14.50................................ 5 1,021,916 0.78
14.51-15.00................................ 24 3,014,379 2.30
15.01-15.50................................ 60 7,998,034 6.10
15.51-16.00................................ 113 13,013,493 9.92
16.01-16.50................................ 131 14,329,552 10.92
16.51-17.00................................ 244 26,619,207 20.29
17.01-17.50................................ 243 23,804,128 18.15
17.51-18.00................................ 223 21,696,164 16.54
18.01-18.50................................ 124 10,964,950 8.36
18.51-19.00................................ 73 6,416,809 4.89
19.01-19.50................................ 23 1,718,367 1.31
19.51-20.00................................ 3 266,766 0.20
20.01-20.50................................ 1 63,687 0.05
----- ------------ ------
Total.................................. 1,270 $131,176,570 100.00%
===== ============ ======
</TABLE>
The weighted average Maximum Mortgage Rate for Six-Month LIBOR Indexed Rate
Initial Mortgage Loans will be approximately 17.033% per annum.
S-38
<PAGE>
NEXT ADJUSTMENT DATE FOR
SIX-MONTH LIBOR INDEXED RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
NUMBER PERCENTAGE OF
OF AGGREGATE CUT-OFF DATE
INITIAL UNPAID AGGREGATE
MORTGAGE PRINCIPAL PRINCIPAL
NEXT ADJUSTMENT DATE LOANS BALANCE BALANCE
- -------------------- -------- ------------ -------------
<S> <C> <C> <C>
08/01/1998.................................. 1 $ 56,090 0.04%
10/01/1998.................................. 5 408,210 0.31
11/01/1998.................................. 11 1,196,279 0.91
12/01/1998.................................. 21 2,575,448 1.96
01/01/1999.................................. 20 2,604,850 1.99
12/01/1999.................................. 4 571,810 0.44
01/01/2000.................................. 4 789,767 0.60
02/01/2000.................................. 12 1,829,023 1.39
03/01/2000.................................. 11 1,026,419 0.78
03/21/2000.................................. 1 108,815 0.08
04/01/2000.................................. 72 7,331,735 5.59
05/01/2000.................................. 233 24,276,173 18.51
06/01/2000.................................. 390 39,801,037 30.34
07/01/2000.................................. 400 39,512,051 30.12
08/01/2000.................................. 4 381,950 0.29
02/01/2001.................................. 2 170,401 0.13
04/01/2001.................................. 2 356,706 0.27
05/01/2001.................................. 3 367,557 0.28
06/01/2001.................................. 36 4,542,708 3.46
07/01/2001.................................. 38 3,269,540 2.49
----- ------------ ------
Total................................... 1,270 $131,176,570 100.00%
===== ============ ======
</TABLE>
The weighted average remaining months to the next Adjustment Date of the Six-
Month LIBOR Indexed Rate Initial Mortgage Loan will be approximately 23 months.
GROSS MARGIN FOR SIX-MONTH LIBOR INDEXED RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
NUMBER PERCENTAGE OF
OF AGGREGATE CUT-OFF DATE
INITIAL UNPAID AGGREGATE
MORTGAGE PRINCIPAL PRINCIPAL
GROSS MARGINS (%) LOANS BALANCE BALANCE
- ----------------- -------- ------------ -------------
<S> <C> <C> <C>
3.51- 4.00................................. 3 $ 232,316 0.18%
4.01- 4.50................................. 46 6,264,901 4.78
4.51- 5.00................................. 157 18,366,418 14.00
5.01- 5.50................................. 397 43,077,530 32.84
5.51- 6.00................................. 360 36,233,312 27.62
6.01- 6.50................................. 149 13,635,114 10.39
6.51- 7.00................................. 38 3,223,103 2.46
7.01- 7.50................................. 41 3,634,714 2.77
7.51- 8.00................................. 52 4,136,448 3.15
8.01- 8.50................................. 23 2,046,010 1.56
8.51- 9.00................................. 2 93,900 0.07
9.01- 9.50................................. 1 30,783 0.02
11.01-11.50................................. 1 202,020 0.15
----- ------------ ------
Total................................... 1,270 $131,176,570 100.00%
===== ============ ======
</TABLE>
The weighted average Gross Margin of the Six-Month LIBOR Index Rate Initial
Mortgage Loans will be approximately 5.672% per annum.
S-39
<PAGE>
MORTGAGE RATES AT ORIGINATION FOR
ONE-YEAR CMT INDEXED RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
NUMBER PERCENTAGE OF
OF AGGREGATE CUT-OFF DATE
INITIAL UNPAID AGGREGATE
MORTGAGE PRINCIPAL PRINCIPAL
MORTGAGE RATES (%) LOANS BALANCE BALANCE
- ------------------ -------- ---------- -------------
<S> <C> <C> <C>
6.51- 7.00................................... 1 $ 649,041 9.29%
7.01- 7.50................................... 4 743,720 10.65
7.51- 8.00................................... 7 1,137,800 16.29
8.01- 8.50................................... 9 1,611,132 23.07
8.51- 9.00................................... 13 1,643,325 23.53
9.01- 9.50................................... 7 574,191 8.22
9.51-10.00................................... 3 254,884 3.65
10.01-10.50................................... 4 323,527 4.63
10.51-11.00................................... 1 46,765 0.67
--- ---------- ------
Total..................................... 49 $6,984,385 100.00%
=== ========== ======
</TABLE>
The weighted average Mortgage Rate of the One-Year CMT Indexed Rate Initial
Mortgage Loans at origination will be approximately 8.355% per annum.
MINIMUM MORTGAGE RATES AT CUT-OFF DATE
FOR ONE-YEAR CMT INDEXED RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
NUMBER PERCENTAGE OF
OF AGGREGATE CUT-OFF DATE
INITIAL UNPAID AGGREGATE
MORTGAGE PRINCIPAL PRINCIPAL
MINIMUM MORTGAGE RATES (%) LOANS BALANCE BALANCE
- -------------------------- -------- ---------- -------------
<S> <C> <C> <C>
6.51- 7.00..................................... 1 $ 649,041 9.29%
7.01- 7.50..................................... 4 743,720 10.65
7.51- 8.00..................................... 7 1,137,800 16.29
8.01- 8.50..................................... 9 1,611,132 23.07
8.51- 9.00..................................... 13 1,643,325 23.53
9.01- 9.50..................................... 7 574,191 8.22
9.51-10.00..................................... 3 254,884 3.65
10.01-10.50..................................... 4 323,527 4.63
10.51-11.00..................................... 1 46,765 0.67
--- ---------- ------
Total....................................... 49 $6,984,385 100.00%
=== ========== ======
</TABLE>
The weighted average Minimum Mortgage Rate of the One-Year CMT Indexed Rate
Initial Mortgage Loans as of the Cut-off Date will be approximately 8.355% per
annum.
MAXIMUM MORTGAGE RATES AT CUT-OFF DATE FOR
ONE-YEAR CMT INDEXED RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
PERCENTAGE OF
NUMBER OF AGGREGATE CUT-OFF DATE
MAXIMUM INITIAL UNPAID AGGREGATE
MORTGAGE RATES MORTGAGE PRINCIPAL PRINCIPAL
(%) LOANS BALANCE BALANCE
-------------- --------- ---------- -------------
<S> <C> <C> <C>
13.51-14.00................................ 1 $ 649,041 9.29%
14.01-14.50................................ 4 743,720 10.65
14.51-15.00................................ 7 1,137,800 16.29
15.01-15.50................................ 9 1,611,132 23.07
15.51-16.00................................ 13 1,643,325 23.53
16.01-16.50................................ 7 574,191 8.22
16.51-17.00................................ 3 254,884 3.65
17.01-17.50................................ 4 323,527 4.63
17.51-18.00................................ 1 46,765 0.67
--- ---------- ------
Total.................................. 49 $6,984,385 100.00%
=== ========== ======
</TABLE>
The weighted average Maximum Mortgage Rate for One-Year CMT Indexed Rate
Initial Mortgage Loans will be approximately 15.355% per annum.
S-40
<PAGE>
NEXT ADJUSTMENT DATE FOR
ONE-YEAR CMT INDEXED RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
PERCENTAGE OF
NUMBER OF AGGREGATE CUT-OFF DATE
NEXT INITIAL UNPAID AGGREGATE
ADJUSTMENT MORTGAGE PRINCIPAL PRINCIPAL
DATE LOANS BALANCE BALANCE
- ---------- ---------- ---------- -------------
<S> <C> <C> <C>
04/01/1999................................. 2 $ 241,605 3.46%
04/05/1999................................. 1 123,184 1.76
05/01/1999................................. 25 3,804,186 54.47
06/01/1999................................. 14 1,714,610 24.55
07/01/1999................................. 7 1,100,800 15.76
--- ---------- ------
Total...................................... 49 $6,984,385 100.00%
=== ========== ======
</TABLE>
The weighted average remaining months to the next Adjustment Date of the
One-Year CMT Indexed Rate Initial Mortgage Loans will be approximately 11
months.
GROSS MARGIN FOR
ONE-YEAR CMT INDEXED RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
PERCENTAGE OF
NUMBER OF AGGREGATE CUT-OFF DATE
INITIAL UNPAID AGGREGATE
MORTGAGE PRINCIPAL PRINCIPAL
GROSS MARGINS (%) LOANS BALANCE BALANCE
- ----------------- --------- ---------- -------------
<S> <C> <C> <C> <C>
4.01-4.50................................ 5 $1,348,069 19.30%
4.51-5.00................................ 13 1,832,602 26.24
5.01-5.50................................ 19 2,896,697 41.47
5.51-6.00................................ 6 593,847 8.50
6.01-6.50................................ 3 201,127 2.88
6.51-7.00................................ 3 112,043 1.60
--- ---------- ------
Total................................ 49 $6,984,385 100.00%
=== ========== ====== ===
</TABLE>
The weighted average Gross Margin of the One-Year CMT Indexed Rate Initial
Mortgage Loans will be approximately 5.107% per annum.
INITIAL PERIODIC RATE CAP FOR
ONE-YEAR CMT INDEXED RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
PERCENTAGE OF
NUMBER OF AGGREGATE CUT-OFF DATE
INITIAL UNPAID AGGREGATE
INITIAL PERIODIC MORTGAGE PRINCIPAL PRINCIPAL
RATE CAP (%) LOANS BALANCE BALANCE
- ---------------- --------- ---------- -------------
<S> <C> <C> <C>
2.000........................................ 49 $6,984,385 100.00%
--- ---------- ------
Total.................................... 49 $6,984,385 100.00%
=== ========== ======
</TABLE>
The weighted average Initial Periodic Rate Cap of the One-Year CMT Indexed
Rate Initial Mortgage Loans is 2.000%.
S-41
<PAGE>
PERIODIC RATE CAP FOR
ONE-YEAR CMT INDEXED RATE INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
PERCENTAGE OF
NUMBER OF AGGREGATE CUT-OFF DATE
INITIAL UNPAID AGGREGATE
PERIODIC RATE MORTGAGE PRINCIPAL PRINCIPAL
CAP (%) LOANS BALANCE BALANCE
- ------------- --------- ---------- -------------
<S> <C> <C> <C>
2.000........................................ 49 $6,984,385 100.00%
--- ---------- ------
Total.................................... 49 $6,984,385 100.00%
=== ========== ======
</TABLE>
The weighted average Periodic Rate Cap of the One-Year CMT Indexed Rate
Initial Mortgage Loans is 2.000%.
CONVEYANCE OF SUBSEQUENT MORTGAGE LOANS AND THE PRE-FUNDING ACCOUNT
Under the Purchase Agreement, following the initial issuance of the Bonds,
the Seller will be obligated to sell to the Company, and the Company will be
obligated to sell to the Issuer for inclusion in the Trust Estate during the
Funding Period, subject to the availability thereof, the Subsequent Mortgage
Loans secured by first liens on fee simple interests in one- to four-family
residential real properties. Each Subsequent Mortgage Loan will have been
underwritten in accordance with the criteria set forth herein under
"Description of the Mortgage Pool--Underwriting." Subsequent Mortgage Loans
will be transferred to the Issuer pursuant to subsequent transfer instruments
(the "Subsequent Transfer Instruments") between the Seller and the Company,
and the Company and the Issuer, respectively. In connection with the purchase
of Subsequent Mortgage Loans on such dates of transfer (the "Subsequent
Transfer Dates"), the Issuer will be required to pay to the Company (and the
Company will be required to pay to the Seller) from amounts on deposit in the
Pre-Funding Account (as defined below) a cash purchase price of 100% of the
principal balance thereof. The Issuer will designate the Subsequent Transfer
Date as the cut-off date (the "Subsequent Cut-off Date") with respect to the
Subsequent Mortgage Loans acquired on such date. The amount paid from the Pre-
Funding Account on each Subsequent Transfer Date will not include accrued
interest on the Subsequent Mortgage Loans. Following each Subsequent Transfer
Date, the aggregate Principal Balance of the Mortgage Loans will increase by
an amount equal to the aggregate Principal Balance of the Subsequent Mortgage
Loans so acquired and the amount in the Pre-Funding Account will decrease
accordingly.
On the Closing Date, approximately $42,639,529 (the "Original Pre-Funded
Amount") will be deposited in an account (the "Pre-Funding Account"), which
account will be in the name of the Indenture Trustee and shall be part of the
Trust Estate and which amount will be used to acquire Subsequent Mortgage
Loans. During the Funding Period (as defined herein), the Original Pre-Funding
Amount will be reduced (on any date of determination, the related Original
Pre-Funded Amount as so reduced, the "Pre-Funded Amount") by the amount
thereof used to purchase Subsequent Mortgage Loans. The "Funding Period" is
the period commencing on the Closing Date and ending on the earlier to occur
of (i) the date on which the amount on deposit in the Funding Account is less
than $10,000 and (ii) October 25, 1998.
Any conveyance of Subsequent Mortgage Loans on a Subsequent Transfer Date is
subject to certain conditions including, but not limited to: (a) each such
Subsequent Mortgage Loan must satisfy the representations and warranties
specified in the related Subsequent Transfer Instrument and the Purchase
Agreement; (b) the Seller will not select such Subsequent Mortgage Loans in a
manner that it reasonably believes is adverse to the interests of the
Bondholders or the Bond Insurer; (c) the Seller and the Company will deliver
certain opinions of counsel acceptable to the Bond Insurer and the Indenture
Trustee with respect to the validity of the conveyance of such Subsequent
Mortgage Loans; and (d) as of each Subsequent Cut-off Date, each Subsequent
Mortgage Loan will satisfy the following criteria: (i) such Subsequent
Mortgage Loan may not be 30 or more days contractually delinquent as of the
related Subsequent Cut-off Date; (ii) the remaining stated term to maturity of
S-42
<PAGE>
such Subsequent Mortgage Loan will not exceed 360 months; (iii) the lien
securing any such Subsequent Mortgage Loan must be first priority; (iv) such
Subsequent Mortgage Loan must have an outstanding Principal Balance of at
least $10,000 as of the Subsequent Cut-off Date; (v) such Subsequent Mortgage
Loan will be underwritten in accordance with the criteria set forth under
"Description of the Mortgage Pool--Underwriting" herein; (vi) such Subsequent
Mortgage Loan must have a Loan-to-Value Ratio of no more than 95%; (vii) the
stated maturity of such Subsequent Mortgage Loan will be no later than October
30, 2028; (viii) such Subsequent Mortgage Loan shall not provide for negative
amortization; (ix) such Subsequent Mortgage Loan must have a fixed Mortgage
Rate of at least 7.375% or, if an adjustable rate loan, a Gross Margin of at
least 3.500% and following the purchase of such Subsequent Mortgage Loans by
the Issuer, the Mortgage Loans included in the Trust Estate must have a
weighted average interest rate, a weighted average remaining term to maturity
and a weighted average Loan-to-Value Ratio as of each respective Subsequent
Cut-off Date which will not vary materially from the Initial Mortgage Loans
included initially in the Trust Estate; (x) each Subsequent Mortgage Loan that
is underwritten to the Seller's underwriting standards for AA, A and A- credit
risks must be covered by a PMI Policy acceptable to the Bond Insurer; and (xi)
any additional criteria in the Insurance Agreement. In addition, the Indenture
Trustee shall not agree to any transfer of Subsequent Mortgage Loans without
(i) a signed certification from the Bond Insurer that the Subsequent Mortgage
Loans are acceptable to the Bond Insurer and (ii) a confirmation from the
rating agencies that the acquisition of such Subsequent Mortgage Loans will
not result in a downgrade, withdrawal or qualification of the ratings then in
effect for the outstanding Bonds, without regard to the Bond Insurance Policy.
In the sole discretion of the Bond Insurer, Subsequent Mortgage Loans with
characteristics varying from those set forth above may be purchased by Issuer
and included in the Trust Estate; provided, however, that the addition of such
Mortgage Loans will not materially affect the aggregate characteristics of the
entire pool of Mortgage Loans. Upon the end of the Funding Period, the Bond
Insurer, in its sole discretion, may adjust the Required Subordination Amount.
UNDERWRITING STANDARDS FOR THE INITIAL MORTGAGE LOANS
All of the Initial Mortgage Loans were purchased by the Seller from its
affiliate, the Servicer. The Servicer originated or purchased such Initial
Mortgage Loans in the ordinary course of business on a loan by loan basis
directly from mortgage brokers and mortgage loan originators.
The underwriting guidelines of the Servicer are intended to evaluate the
credit history of the potential borrower, the capacity and willingness of the
borrower to repay the loan and the adequacy of the collateral securing the
loan. Each loan applicant completes an application that includes information
with respect to the applicant's income, assets, liabilities and employment
history. A credit report is also submitted by the broker along with the loan
application which provides detailed information concerning the payment history
of the borrower on all of their debts. Prior to issuing an approval on the
loan, the underwriter runs an independent credit report to verify that the
information submitted by the broker is still accurate and up to date. An
appraisal is also required on all loans and in many cases a review appraisal
or second appraisal may be required depending on the value of the property and
the underwriters comfort with the original valuation. All appraisals are
required to conform to the Uniform Standards of Professional Appraisal
Practice adopted by the Appraisal Standards Board of the Appraisal Foundation
and are generally on forms acceptable to FNMA and FHLMC. The properties
securing the Mortgage Loans are generally appraised by qualified independent
appraisers who are generally approved by the related originator. The mortgagor
may also include information regarding verification of deposits at financial
institutions where the mortgagor had demand or savings accounts. In the case
of investment properties, income derived from the mortgage property may have
been used for underwriting purposes.
The underwriting guidelines include three levels of applicant documentation
requirements, referred to as "Full Documentation", "Limited Documentation" and
"Stated Income". Under the Full Documentation program applicants generally are
required to submit two written forms of verification of stable income for at
least 12 months. Under the Limited Documentation program, no such verification
is required, however, bank statements for the most recent consecutive 6-month
period are required to evidence cash flow. If business bank statements are
used in lieu of personal statements, an unaudited current profit loss
statement must accompany
S-43
<PAGE>
the bank statements. Under the Stated Income program, an applicant may be
qualified based on monthly income as stated in the loan application. Mortgage
Loans originated under the "Limited Documentation" and "Stated Income"
programs require less documentation and verification than do traditional "Full
Documentation" programs. Generally, under such programs, minimal investigation
into a mortgagor's credit history and income profile would have been
undertaken by the originator and the underwriting for such mortgage loans will
place a greater emphasis on the value of the mortgaged property. Given that
the Servicer primarily lends to subprime borrowers, it places great emphasis
on the ability of collateral to protect against losses in the event of default
by borrowers.
On a case-by-case basis, exceptions to the underwriting guidelines are made
where the Servicer believes compensating factors exist. Compensating factors
may consist of factors like length of time in residence, lowering of the
borrower's monthly debt service payments, the Loan-to-Value Ratio or Combined
Loan-to-Value Ratio on the loan, as applicable, or other criteria that in the
judgement of the underwriter warrants an exception. All loans in excess of
$350,000 currently require the approval of the Chief Credit Officer of the
Servicer. In addition, the President of the Servicer approves all loans in
excess of $750,000.
With respect to each Mortgage Loan secured by a second lien on the related
Mortgaged Property, the "Combined Loan-to-Value Ratio" at any given time
generally will be the ratio, expressed as a percentage, the numerator of which
is the sum of (i) the original principal balance of the Mortgage Loan plus
(ii) the unpaid principal balance of any first lien on the related Mortgaged
Property as of such date, and the denominator of which is the lesser of (i)
the appraised value of the related Mortgaged Property as of the date of the
appraisal used by or on behalf of the Seller to underwrite such Mortgage Loan
or (ii) the sale price of the related Mortgaged Property if such a sale
occurred at origination of the Mortgage Loan.
The Initial Mortgage Loans were underwritten by the Servicer using the
following categories and criteria for grading the credit history of potential
borrowers and the maximum Loan-to-Value ratios and Combined Loan-to-Value
Ratios allowed for each category.
<TABLE>
<CAPTION>
AA RISK A RISK A-RISK B RISK C RISK
------- ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Mortgage History No 30-day Maximum one 30- Maximum two 30- Maximum three 30- Maximum five 30-
late within last day late and no day lates and no day lates and no day lates, two
24 months. 60-day late within 60-day late within 60-day late within 60-day lates and
last 12 months. last 12 months. last 12 months. one 90-day late
within last 12
months.
Other Credit Limited 30 day Limited 30-day Limited 60-day Limited 60-day Limited 90-day
lates within last lates within last lates within lates within lates within
24 months. 12 months. last 12 months. last 12 months. last 12 months.
Bankruptcy Chapter 7: 7 years Chapter 7: 2 years Chapter 7: 2 years Chapter 7: 2 years Chapter 7: 1 year
Filings since filing date. since filing date. since filing date. since filing date. since filing date.
Chapter 13: 7 years Chapter 13: Chapter 13: Chapter 13: Chapter 13:
since discharge date. Discharged 1 year Discharged 1 year Discharged 1 year Minimum 12 month
with re-established with re-established with good credit satisfactory pay
credit. credit. since discharge. history; buy-out required.
Prior Foreclosures/ Not allowed. 36 months. 36 months. 24 months. 24 months.
NOD
Debt to 45% 50% 50% 50% 55%
Service Ratio
Maximum 95% 90% 90% 85% 80%
Loan-to-Value Ratio
Maximum Combined 125% 125% 125% 125% 125%
Loan-to-Value Ratio
<CAPTION>
D RISK
------
<S> <C>
Mortgage History Maximum six 30-
day lates, three 60-
day lates and two
90-day lates within
last 12 months.
Other Credit Discretionary. Credit
is generally expected
to be late pay.
Bankruptcy Chapter 7: 1 year
Filings since filing date.
Chapter 13:
No seasoning
required; buy-out
required.
Prior Foreclosures/ 12 months (current
NOD foreclosures OK to
maximum 60% LTV).
Debt to 60%
Service Ratio
Maximum 65%
Loan-to-Value Ratio
Maximum Combined 100%
Loan-to-Value Ratio
</TABLE>
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<PAGE>
Close attention is paid to geographic diversification in managing credit
risk. The Servicer believes one of the best tools for managing credit risk is
to diversify the markets in which it originates and purchases mortgage loans.
The Servicer has established a diversification policy to be followed in
managing this credit risk which states that no one market can represent a
percentage of total mortgage loans owned by the Servicer higher than twice
that market's percentage of the total national market share.
Quality control reviews are conducted to ensure that all mortgage loans meet
quality standards. The type and extent of the reviews depend on the production
channel through which the mortgage loan was obtained and the characteristics
of the mortgage loan. The Servicer reviews a high percentage of mortgage loans
with (i) principal balances in excess of $450,000, (ii) higher Loan-to-Value
ratios or Combined Loan-to-Value Ratios (in excess of 75%), (iii) limited
documentation, or (iv) made for "cash out' refinance purposes. The Servicer
also performs appraisal reviews and compliance reviews as part of the quality
control process to ensure adherence to state and federal regulations.
PRIMARY MORTGAGE INSURANCE POLICIES
Approximately 77.88% of the Initial Mortgage Loans (by aggregate principal
balance as of the Cut-off Date) are covered by a PMI Policy. The remainder of
the Initial Mortgage Loans will not be covered by a PMI Policy. Each PMI
Policy insures losses on the Principal Balance of each such Mortgage Loan in
an amount generally equal to, at the option of the PMI Insurer, either (a) the
sum of (i) the Principal Balance of the Mortgage Loan, (ii) unpaid accumulated
interest due on the Mortgage Loan at the Mortgage Rate (for a maximum period
of two years) and (iii) the amount of certain advances (such as hazard
insurance, taxes, maintenance expenses and foreclosure costs) made by the
Servicer, reduced by certain mitigating amounts collected with respect thereto
(collectively, the "Loss Amount"), in which case the PMI Insurer would take
title to the Mortgaged Property, or (b) an amount equal to the product of (i)
the Loss Amount and (ii) the percentage of coverage (the "Coverage
Percentage") specified in the PMI Policy, in which case the Issuer would
retain title to (and the proceeds obtained in a foreclosure and sale of) the
Mortgaged Property. The Coverage Percentage specified in each PMI Policy will
be different depending upon the original Loan-to-Value Ratio of the related
Mortgage Loan (Mortgage Loans with higher Loan-to-Value Ratios will generally
have a higher Coverage Percentage and Mortgage Loans with lower Loan-to-Value
Ratios will generally have a lower Coverage Percentage). Each PMI Policy will
remain in place for the life of the related Mortgage Loan (provided that no
PMI Insurer Insolvency Event (as defined herein) has occurred and is
continuing), even if the related Loan-to-Value Ratio decreases below 80%. If a
PMI Insurer Insolvency Event has occurred or is continuing, the Issuer shall,
at the direction of the Bond Insurer, and may in the case of a Bond Insurer
Default, terminate the PMI Policy on any Mortgage Loan that is not then past
due. The insurer that has underwritten the PMI Policies (the "PMI Insurer")
with respect to such Mortgage Loans currently meets FNMA's or FHLMC's
standards and is acceptable to the Rating Agencies.
Claim payments, if any, under a PMI Policy will be made to the Servicer,
deposited in the Collection Account and treated in the same manner as a
prepayment of the related Mortgage Loan. Premiums payable on the PMI Policies
(the "PMI Premiums") will be paid monthly by the Servicer with funds withdrawn
from the Collection Account with respect to the related Mortgage Loans.
ADDITIONAL INFORMATION
Prior to the issuance of the Bonds, Initial Mortgage Loans may be removed
from the Trust Estate as a result of incomplete documentation or otherwise, if
the Company deems such removal necessary or appropriate. A limited number of
other mortgage loans may be included in the Mortgage Pool prior to the
issuance of the Bonds. The Company believes that the information set forth
herein will be substantially representative of the characteristics of the
Mortgage Pool as it will be constituted at the time the Bonds are issued,
although the range of Mortgage Rates and maturities and certain other
characteristics of the Mortgage Loans in the Mortgage Pool may vary, although
such variance will not be material.
THE CAP AGREEMENTS
On the Closing Date, the Issuer will enter into two interest rate CAP
agreements (the "First and Second CAP Agreements") with Merrill Lynch Capital
Services, Inc., as CAP counterparty (the "First and Second CAP
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<PAGE>
Provider"), to partially hedge against the interest rate risk that could
result from the difference between the Class A-1 Bond Interest Rate and/or the
Class A-2 Bond Interest Rate and the weighted-average Mortgage Rate. Also on
the Closing Date, Merrill Lynch & Co., Inc. ("ML&Co.") will enter into a
guaranty whereby ML&Co. will guarantee amounts payable by the First and Second
CAP Provider under the First and Second CAP Agreements and the Bond Insurer
will enter into an interest rate swap insurance policy for the benefit of the
First and Second CAP Provider whereby the Bond Insurer will guarantee certain
amounts payable by the Issuer under the First and Second CAP Agreements. The
interest rate swap insurance policy is not an asset of the Trust Estate.
Under the first CAP Agreement (the "First CAP Agreement"), on March 23, June
23, September 23 and December 23 of each year (the "First CAP Payment Dates"),
commencing on September 23, 1998 and terminating on March 23, 2001, the Issuer
will be entitled to receive from the First and Second CAP Provider an amount
(the "First CAP 1 Amount") equal to the amount obtained by multiplying (i) the
amount, if any, by which the applicable three-month USD-LIBOR-BBA Rate for the
period preceding such First CAP Payment Date exceeds 5.75%, (ii) a notional
principal amount equal to $60,000,000 (the "First CAP Notional Amount") and
(iii) a fraction equal to the actual number of days from the preceding First
CAP Payment Date (or, with respect to the initial First CAP Payment Date, from
the Closing Date), divided by a 360-day year. Under the First CAP Agreement,
on each First CAP Payment Date, the First and Second CAP Provider will be
entitled to receive from the Issuer an amount (the "First CAP 2 Amount") equal
to the amount obtained by multiplying (i) a fixed rate of 0.3690% per annum,
(ii) the First CAP Notional Amount and (iii) a fraction equal to the actual
number of days from the previous First CAP Payment Date (or, with respect to
the initial First CAP Payment Date, from the Closing Date), divided by a 360-
day year. As of the Closing Date, the applicable three-month USD LIBOR BBA
rate is less than 5.75%.
Under the second CAP Agreement (the "Second CAP Agreement"), on March 13,
June 13, September 13 and December 13 of each year (the "Second CAP Payment
Dates"), commencing on September 13, 1998 and terminating on March 13, 2001,
the Issuer will be entitled to receive from the First and Second CAP Provider
an amount (the "Second CAP 1 Amount"), equal to the amount obtained by
multiplying (i) the amount, if any, by which the applicable three-month USD-
LIBOR-BBA Rate for the period preceding such Second CAP Payment Date exceeds
5.75%, (ii) a notional principal amount equal to $40,000,000 (the "Second CAP
Notional Amount") and (iii) a fraction equal to the actual number of days from
the preceding Second CAP Payment Date (or, with respect to the initial Second
CAP Payment Date, from the Closing Date), divided by a 360-day year. Under the
Second CAP Agreement, on each Second CAP Payment Date, the First and Second
CAP Provider will be entitled to receive from the Issuer an amount (the
"Second CAP 2 Amount") equal to the amount obtained by multiplying (i) a fixed
rate of 0.36625% per annum, (ii) the Second CAP Notional Amount and (iii) a
fraction equal to the actual number of days from the previous Second CAP
Payment Date (or, with respect to the initial Second CAP Payment Date, from
the Closing Date), divided by a 360-day year. As of the Closing Date, the
applicable three-month USD LIBOR BBA rate is less than 5.75%.
On the Closing Date, the Issuer will also enter into a third interest rate
CAP agreement (the "Third CAP Agreement") with National Westminster Bank PLC,
as CAP counterparty (the "Third CAP Provider"), to partially hedge against
interest rate risks.
Under the Third CAP Agreement, on March 26, June 26, September 26 and
December 26 of each year (the "Third CAP Payment Dates"), commencing on March
26, 2001 and terminating on June 26, 2003, the Issuer will be entitled to
receive from the Third CAP Provider an amount (the "Third CAP 1 Amount") equal
to the amount obtained by multiplying (i) the amount, if any, by which the
applicable three-month USD-LIBOR-BBA Rate for the period preceding such Third
CAP Payment Date exceeds 9.00% (ii) a notional principal amount equal to
$80,000,000 (the "Third CAP Notional Amount") and (iii) a fraction equal to
the actual number of days from the preceding Third CAP Payment Date (or, with
respect to the initial Third CAP Payment Date, from the Closing Date), divided
by a 360-day year. Under the Third CAP Agreement, no payments are payable by
the Issuer to the Third CAP Provider on any Third CAP Payment Date. As of the
Closing Date, the applicable three-month USD LIBOR BBA rate is less than
9.00%.
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<PAGE>
The First CAP Agreement, the Second CAP Agreement and the Third CAP
Agreement are collectively referred to herein as the "CAP Agreements." The
First and Second CAP Provider and the Third CAP Provider are together referred
to herein as the "CAP Providers."
The "USD-LIBOR-BBA-Rate," which resets on each Reset Date, is the rate for
deposits in U.S. Dollars for a period of three months which appears on the
Telerate Page 3750 as of 11:00 a.m., London time, on the day that is two
London Banking Days preceding the Reset Date. "London Banking Day" means any
day in which commercial banks are open for business (including dealings in
foreign exchange and foreign currency deposits) in London. Under the CAP
Agreements, the Reset Dates are each First CAP Payment Date, each Second CAP
Payment Date and each Third CAP Payment Date, respectively, and the reset rate
for each CAP Agreement is then applicable for the following period.
The obligations of the Issuer and the First and Second CAP Provider under
the First and Second CAP Agreements will be settled on a net basis. Under the
First CAP Agreement, only the net amount equal to the excess, if any, of the
First CAP 1 Amount over the First CAP 2 Amount or the excess, if any, of the
First CAP 2 Amount over the First CAP 1 Amount will be payable by the First
and Second CAP Provider or the Issuer, respectively, to the other party.
Likewise, under the Second CAP Agreement, only the net amount equal to the
excess, if any, of the Second CAP 1 Amount over the Second CAP 2 Amount or the
excess, if any, of the Second CAP 2 Amount over the Second CAP 1 Amount will
be payable by the First and Second CAP Provider or the Issuer, respectively,
to the other party. The CAP Agreements will be pledged by the Issuer to the
Indenture Trustee as additional collateral for the Bonds. Under the Indenture,
regular payments under the First and Second CAP Agreements will rank senior to
payments due to Bondholders. No regular payments or termination payments are
payable by the Issuer under the Third CAP Agreement. If any amounts are
payable by any CAP Provider to the Issuer under any CAP Agreement, such
amounts will increase the funds available to make payments of principal and
interest due on the Bonds on the next Payment Date. If any net amount is due
from the Issuer to the First and Second CAP Provider under the First and
Second CAP Agreements, such amount will reduce the funds available to make
payments of principal and interest on the Bonds on the next Payment Date.
Upon occurrence of an event of default under a CAP Agreement, the defaulting
party is obligated to make a settlement payment to the other nondefaulting
party based upon the then market value of the CAP Agreement to the other
party. Depending upon then prevailing interest rates, such a settlement
payment could be substantial. Under certain circumstances, settlement
payments, if any, payable by the Issuer under the CAP Agreements will rank
junior to payments due to Bondholders.
Merrill Lynch Capital Services, Inc., the First and Second CAP Provider, is
a subsidiary of ML&Co. ML&Co., the guarantor of the obligations of the First
and Second CAP Provider, is a publicly held company whose stock is traded on
the New York Stock Exchange. National Westminster Bank PLC, the Third CAP
Provider, is an English bank.
THE SELLER
NovaStar Financial, Inc., a Maryland corporation (the "Seller"), will be the
seller of the Initial Mortgage Loans and the Subsequent Mortgage Loans to the
Company. The common stock of the Seller is registered under the Securities Act
of 1933 and quoted on the New York Stock Exchange. The Seller is subject to
the reporting requirements of the Securities and Exchange Act of 1934, and in
accordance therewith, files reports and other information with the Securities
and Exchange Commission (the "Commission"). The principal executive offices of
the Seller are at 1901 W. 47th Place, Suite 105, Westwood, Kansas 66205. See
"The Issuer--NovaStar Financial" in the Prospectus.
No person other than the Seller is obligated with respect to the
representations and warranties respecting the Mortgage Loans and the remedies
for any breach thereof that are assigned to the Indenture Trustee for the
benefit of the Bondholders and the Bond Insurer. Moreover, as discussed above,
the Seller has only limited assets
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<PAGE>
available to perform its repurchase obligations in respect of any breach of
such representations and warranties, relative to the potential amount of
repurchase liability, and the total potential amount of repurchase liability
is expected to increase over time as the Seller continues to originate,
acquire and sell mortgage loans. There can be no assurance that the Seller
will continue to generate operating earnings, or that it will be successful
under its current business plan. Therefore, prospective investors in the Bonds
should consider the possibility that the Seller will not have sufficient
assets with which to satisfy its repurchase obligations in the event that a
substantial amount of Mortgage Loans are required to be repurchased due to
breaches of representations and warranties.
THE ISSUER
NovaStar Mortgage Funding Trust, Series 1998-2 is a business trust formed
under the laws of the State of Delaware pursuant to the Trust Agreement, dated
as of August 1, 1998, between the Company and Wilmington Trust Company as the
Owner Trustee for the transactions described in this Prospectus Supplement.
The Trust Agreement constitutes the "governing instrument" under the laws of
the State of Delaware relating to business trusts. After its formation, the
Issuer will not engage in any activity other than (i) acquiring and holding
the Mortgage Loans and the other assets of the Issuer and proceeds therefrom,
(ii) issuing the Bonds and the Certificates, (iii) making payments on the
Bonds and the Certificates and (iv) engaging in other activities that are
necessary, suitable or convenient to accomplish the foregoing or are
incidental thereto or connected therewith. The Issuer is not expected to have
any significant assets other than those pledged as collateral to secure the
Bonds.
The assets of the Issuer will consist of the Mortgage Loans, the CAP
Agreements, the NCFC Demand Note, the Surety Bond, the PMI Policies and
certain related assets pledged to secure the Bonds.
The Issuer's principal offices are in Wilmington, Delaware, in care of
Wilmington Trust Company, as Owner Trustee.
THE OWNER TRUSTEE
Wilmington Trust Company is the Owner Trustee under the Trust Agreement. The
Owner Trustee is a Delaware banking corporation and its principal offices are
located in Wilmington, Delaware.
Neither the Owner Trustee nor any director, officer or employee of the Owner
Trustee will be under any liability to the Issuer or the Bondholders under the
Trust Agreement under any circumstances, except for the Owner Trustee's own
misconduct, gross negligence, bad faith or grossly negligent failure to act or
in the case of the inaccuracy of certain representations made by the Owner
Trustee in the Trust Agreement. All persons into which the Owner Trustee may
be merged or with which it may be consolidated or any person resulting from
such merger or consolidation shall be the successor of the Owner Trustee,
provided such person meets the eligibility standards under the Trust
Agreement.
THE INDENTURE TRUSTEE
First Union National Bank, a national banking association, will act as
Indenture Trustee. A copy of the Indenture will be provided by the Issuer
without charge upon written request. Requests should be addressed to the
Indenture Trustee at First Union National Bank, 230 S. Tryon Street, 9th
floor, Charlotte, North Carolina 28288-1179, Attention: NovaStar Mortgage
Funding Trust, Series 1998-2.
THE BOND INSURER
The following information has been supplied by MBIA Insurance Corporation
(the "Bond Insurer") for inclusion in this Prospectus Supplement.
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<PAGE>
The Bond Insurer is the principal operating subsidiary of MBIA Inc., a New
York Stock Exchange listed company ("MBIA Inc."). MBIA Inc. is not obligated
to pay the debts of or claims against the Bond Insurer. The Bond Insurer is
domiciled in the State of New York and licensed to do business in and is
subject to regulation under the laws of all 50 states, the District of
Columbia, the Commonwealth of Puerto Rico, the Commonwealth of Northern
Mariana Islands, the Virgin Islands of the United States and the Territory of
Guam. The Bond Insurer has two European branches, one in the Republic of
France and the other in the Kingdom of Spain. New York has laws prescribing
minimum capital requirements, limiting classes and concentrations of
investments and requiring the approval of policy rates and forms. State laws
also regulate the amount of both the aggregate and individual risks that may
be insured, the payment of dividends by the Bond Insurer, changes in control
and transactions among affiliates. Additionally, the Bond Insurer is required
to maintain contingency reserves on its liabilities in certain amounts and for
certain periods of time.
Effective February 17, 1998, MBIA Inc. acquired all of the outstanding stock
of Capital Markets Assurance Corporation ("CMAC") through a merger with its
parent CapMAC Holdings Inc. Pursuant to a reinsurance agreement, CMAC has
ceded all of its net insured risks (including any amounts due but unpaid from
third party reinsurers), as well as its unearned premiums and contingency
reserves, to the Bond Insurer. MBIA Inc. is not obligated to pay the debts of
or claims against CMAC.
The consolidated financial statements of the Bond Insurer, a wholly owned
subsidiary of MBIA Inc., and its subsidiaries as of December 31, 1997 and
December 31, 1996 and for each of the three years in the period ended December
31, 1997, prepared in accordance with generally accepted accounting
principles, included in the Annual Report on Form 10-K of MBIA Inc. for the
year ended December 31, 1997 and the consolidated financial statements of the
Bond Insurer and its subsidiaries as of March 31, 1998 and for the three month
periods ending March 31, 1998 and March 31, 1997 included in the Quarterly
Report on Form 10-Q of MBIA Inc. for the period ending March 31, 1998, 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
by reference herein shall be modified or superseded for purposes of this
Prospectus Supplement to the extent that a statement contained herein or in
any other subsequently filed document which also is incorporated by reference
herein 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 Bond Insurer and its subsidiaries included
in documents filed by MBIA Inc. pursuant to Section 13(a), 13(c), 14 or 15(d)
of the Securities Exchange Act of 1934, as amended, 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 tables below present selected financial information of the Bond Insurer
determined in accordance with statutory accounting practices prescribed or
permitted by insurance regulatory authorities ("SAP") and generally accepted
accounting principles ("GAAP"):
<TABLE>
<CAPTION>
SAP
------------------------
DECEMBER 31, MARCH 31,
1997 1998
------------ -----------
(AUDITED) (UNAUDITED)
(IN MILLIONS)
<S> <C> <C>
Admitted Assets.................................. $5,256 $5,475
Liabilities...................................... 3,496 3,658
Capital and Surplus.............................. 1,760 1,817
<CAPTION>
GAAP
------------------------
DECEMBER 31, MARCH 31,
1997 1998
------------ -----------
(AUDITED) (UNAUDITED)
(IN MILLIONS)
<S> <C> <C>
Assets........................................... $5,988 $6,196
Liabilities...................................... 2,624 2,725
Shareholder's Equity............................. 3,364 3,471
</TABLE>
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<PAGE>
Copies of the financial statements of the Bond Insurer incorporated by
reference herein and copies of the Bond Insurer's 1997 year-end audited
financial statements prepared in accordance with statutory accounting
practices are available, without charge, from the Bond Insurer. The address of
the Bond Insurer is 113 King Street, Armonk, New York 10504. The telephone
number of the Bond Insurer is (914) 273-4545.
The Bond Insurer does not accept any responsibility for the accuracy or
completeness of this Prospectus Supplement or any information or disclosure
contained herein, or omitted herefrom, other than with respect to the accuracy
of the information regarding the Bond Insurance Policy and the Bond Insurer
set forth under the headings "Description of the Bonds--Bond Insurance Policy"
and "The Bond Insurer." Additionally, the Bond Insurer makes no representation
regarding the Bonds or the advisability of investing in the Bonds.
Moody's Investors Service, Inc. rates the claims paying ability of the Bond
Insurer "Aaa."
Standard & Poor's Ratings Services, a division of The McGraw-Hill Companies,
Inc. rates the claims paying ability of the Bond Insurer "AAA."
Fitch IBCA, Inc. (formerly known as Fitch Investors Service, L.P.) rates the
claims paying ability of the Bond Insurer "AAA."
Each rating of the Bond Insurer should be evaluated independently. The
ratings reflect the respective rating agency's current assessment of the
creditworthiness of the Bond 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 Bond
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.
DESCRIPTION OF THE BONDS
GENERAL
The Bonds will be issued pursuant to the Indenture, to be dated as of August
1, 1998, between the Issuer and First Union National Bank, as Indenture
Trustee. The Bonds will be issued in two classes, the Class A-1 Bonds in an
aggregate principal amount of $115,000,000 and the Class A-2 Bonds in an
aggregate principal amount of $200,000,000. The Certificates (together with
the Bonds, the "Securities") will be issued pursuant to the Amended and
Restated Trust Agreement, dated as of August 19, 1998, between the Company and
Wilmington Trust Company, as Owner Trustee. The following summaries describe
certain provisions of the Securities, the Indenture, the Trust Agreement and
the Servicing Agreement. The summaries do not purport to be complete and are
subject to, and qualified in their entirety by reference to, the provisions of
the applicable agreement. Only the Bonds are offered hereby.
The Bonds will be secured by the pledge by the Issuer of its assets to the
Indenture Trustee pursuant to the Indenture, which assets will consist of the
following (such assets, collectively, the "Trust Estate"): (i) the Mortgage
Loans; (ii) collections in respect of principal and interest of the Mortgage
Loans received after the Cut-off Date or Subsequent Cut-off Date, as
applicable (other than payments due on or before the Cut-off Date or the
Subsequent Cut-off Date, as applicable); (iii) the amounts on deposit in any
Collection Account (as defined in the Prospectus), including the account in
which amounts are deposited prior to payment to the Bondholders (the "Payment
Account"), including net earnings thereon; (iv) PMI Policies and certain other
insurance policies maintained by the Mortgagors or by or on behalf of the
Servicer or any related subservicer in respect of the Mortgage Loans; (v) an
assignment of the Company's rights under the Purchase Agreement; (vi) an
assignment of the Issuer's rights under the Servicing Agreement and any
Subservicing Agreement; (vii) amounts on deposit
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in the Interest Coverage Account and the Pre-Funding Account; (viii) the CAP
Agreements and the ML&Co. guaranty; (ix) the NCFC Demand Note (as defined
herein) and the Surety Bond (as described herein); and (x) proceeds of the
foregoing.
The Bonds will be issued in denominations of $25,000 and integral multiples
of $1 in excess thereof. See "--Book-Entry Bonds" below.
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. Each
Class of Book-Entry Bonds will be issued in one or more certificates which
equal the aggregate principal amount of the Bonds of each Class 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 $25,000 and in
multiples of $1 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.
A Bond 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 interests 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 Indenture
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, 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
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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--Tax Treatment of Foreign Investors" 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 Bond will be subject to the rules,
regulation 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 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 or its participants
("Euroclear Participants") and to clear and settle transactions between
Euroclear Participants through simultaneous electronic book-entry delivery
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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
Indenture Trustee to DTC. DTC will be responsible for crediting the amount of
such payments to the accounts of the applicable DTC participants in accordance
with DTC's normal procedures. Each DTC participant will be responsible for
disbursing such payments to the beneficial owners of the 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, beneficiary owners of the Book-Entry Bonds may
experience some delay in their receipt of payments, since such payments will
be forwarded by the Indenture 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--Tax Treatment of Foreign Investors" and
"--Backup Withholding and Information Reporting" 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 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.
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DTC has advised the Issuer and the Indenture 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 Indenture 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
Indenture 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.
Upon the occurrence of any of the events described in the immediately
preceding paragraph, the Indenture Trustee will be required to notify all
beneficial owners of the 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 Indenture Trustee will issue Definitive Bonds, and
thereafter the Indenture 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 Company, the Servicer, the Bond Insurer, the Owner Trustee, the
Issuer, or the Indenture 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.
For additional information regarding DTC and the Book-Entry Bonds, see Annex
I hereto and "Description of the Bonds -- Book-Entry Registration and
Definitive Bonds" in the Prospectus.
PAYMENTS
Payments on the Bonds will be made by the Indenture Trustee or the Paying
Agent on the 25th day of each month or, if such day is not a Business Day,
then the next succeeding Business Day, commencing on September 25, 1998.
Payments on the Bonds will be made to the persons in whose names such Bonds
are registered at the close of business on the day prior to each Payment Date
or, if the Bonds are no longer Book-Entry Bonds, on the Record Date. See
"Description of the Bonds--Distributions" in the Prospectus. Payments will be
made by check or money order mailed (or upon the request, at least five
Business Days prior to the related Record Date, of a Holder owning a class of
Bonds having denominations aggregating at least $5,000,000, by wire transfer
or otherwise) to the address of the person entitled thereto (which, in the
case of Book-Entry Bonds, will be DTC or its nominee) as it appears on the
Bond Register on the related Record Date. However, the final payment in
respect of the Bonds will be made only upon presentation and surrender thereof
at the office or the agency of the Indenture Trustee specified in the notice
to Holders of such final payment. A "Business Day" is any day other than (i) a
Saturday or Sunday or (ii) a day on which banking institutions in New York
City, California, Kansas or Delaware or in the city in which the corporate
trust offices of the Indenture Trustee or the principal office of the Bond
Insurer are located, are required or authorized by law to be closed.
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AVAILABLE FUNDS
The "Available Funds" for any Payment Date will equal the amount received by
the Indenture Trustee and available in the Payment Account on each Payment
Date. The Available Funds will generally be equal to the sum of (i) the
aggregate amount of scheduled payments on the related Mortgage Loans due on
the related Due Date and received on or prior to the related Determination
Date, (ii) any amounts representing interest on amounts in the Payment Account
and miscellaneous fees and collections, including assumption fees and
prepayment penalties (but excluding late fees), (iii) any unscheduled payments
and receipts, including Mortgagor prepayments on such Mortgage Loans, received
during the related Prepayment Period (as defined herein) and proceeds of
repurchases, and adjustments in the case of substitutions and terminations,
Net Liquidation Proceeds, Insurance Proceeds and proceeds from any PMI Policy
("PMI Insurance Proceeds"), (iv) all Advances made for such Payment Date in
respect of such Mortgage Loans, (v) payments received under the CAP Agreements
and (vi) the amount, if any, of payments received under the NCFC Demand Note
and the Surety Bond, net of amounts reimbursable therefrom to the Servicer and
any subservicer and reduced by Servicing Fees, fees and certain expenses of
the Indenture Trustee and the Owner Trustee, the regular schedule payments to
the First and Second CAP Provider under the First and Second CAP Agreements,
the PMI Premiums and the Bond Insurance Premium. In addition, on the Payment
Date relating to the Due Period in which the termination of the Funding Period
occurred, Available Funds will include the amount on deposit in the Pre-
Funding Account at such time, plus on each Payment Date on or prior to the
Payment Date in October 1998. Available Funds will include the amount, if any,
withdrawn from the Interest Coverage Account. With respect to any Payment
Date, (i) the "Due Date" is the first day of the month in which such Payment
Date occurs, and (ii) the "Determination Date" is the 15th day of the month in
which such Payment Date occurs, or if such day is not a Business Day, the
immediately preceding Business Day.
INTEREST PAYMENTS ON THE BONDS
On each Payment Date, holders of the Class A-1 Bonds will be entitled to
receive an amount (the "Class A-1 Interest Payment Amount") equal to the
lesser of (i) interest accrued on the Class A-1 Bond Principal Balance
immediately prior to such Payment Date at the Class A-1 Bond Interest Rate (as
defined below) for the related Interest Period and (ii) the Class A-1
Guaranteed Interest Payment Amount (as defined below).
The "Class A-1 Bond Interest Rate" on each Payment Date after the first
Payment Date will be a floating rate equal to the lesser of (i)(a) with
respect to each Payment Date up to and including the earlier of (x) the
Payment Date in August 2005 and (y) the Payment Date which occurs on or prior
to the date on which the outstanding Bond Principal Balance is reduced to less
than 25% of the original Bond Principal Balance, One-Month LIBOR (as defined
herein) plus 0.18%, and (b) with respect to each Payment Date thereafter, One-
Month LIBOR plus 0.43% and (ii) 13.00% per annum (the "Maximum Interest
Rate"). On the first Payment Date, the Class A-1 Bond Interest Rate will be
equal to 5.82453% per annum.
As further described herein, with respect to the Class A-1 Bonds and any
Payment Date, to the extent that the amount calculated pursuant to clause (i)
of the definition of Class A-1 Interest Payment Amount exceeds the Class A-1
Guaranteed Interest Payment Amount (such excess, the "Class A-1 Carry-Forward
Amount"), the holders of the Class A-1 Bonds will be paid the amount of such
Class A-1 Carry-Forward Amount on a pro rata basis, in accordance with the
Class A-1 Carry Forward Amount and the Class A-2 Carry Forward Amount, with
interest thereon at the Class A-1 Bond Interest Rate applicable from time to
time after certain payments to the holders of the Bonds and the Bond Insurer
to the extent of Available Funds. The "Class A-1 Guaranteed Interest Payment
Amount" for any Payment Date is equal to the Class A-1 Bond's pro rata portion
of the Guaranteed Interest Payment Amount (as defined below), determined by
multiplying the Guaranteed Interest Payment Amount for such Payment Date by a
fraction, the numerator of which is the amount calculated pursuant to clause
(i) of the definition of Class A-1 Interest Payment Amount and the denominator
of which is the sum of (x) the amount calculated pursuant to clause (i) of the
definition of Class A-1 Interest Payment Amount and (y) the amount calculated
pursuant to clause (i) of the definition of Class A-2 Interest Payment Amount.
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On each Payment Date, holders of the Class A-2 Bonds will be entitled to
receive an amount (the "Class A-2 Interest Payment Amount") equal to the
lesser of (i) interest accrued on the Class A-2 Bond Principal Balance
immediately prior to such Payment Date at the Class A-2 Bond Interest Rate (as
defined below) for the related Interest Period and (ii) the Class A-2
Guaranteed Interest Payment Amount (as defined below).
The "Class A-2 Bond Interest Rate" on each Payment Date after the first
Payment Date will be a floating rate, equal to the lesser of (i) (a) with
respect to each Payment Date up to and including the earlier of (x) the
Payment Date in August 2005 and (y) the Payment Date which occurs on or prior
to the date on which the outstanding Bond Principal Balance is reduced to less
than 25% of the original Bond Principal Balance, One-Month LIBOR (as defined
herein) plus the Applicable Spread (as defined herein), and (b) with respect
to each Payment Date thereafter, One-Month LIBOR plus 0.40%, and (ii) the
Maximum Interest Rate. The Class A-2 Bond Interest Rate for the first Payment
Date will be 5.71453% per annum. The "Applicable Spread" for the first year
following the Closing Date will be 0.07% per annum (which was determined in
accordance with the following formula) and for each year following each
anniversary of the Closing Date will be a percentage, equal to the greater of
(i) 0.07% (the "Minimum Spread") or (ii) the lesser of (a) the Remarketing
Spread (as defined herein) or (b) 0.40% (the "Maximum Spread").
The "Remarketing Spread" on each anniversary of the Closing Date will be (a)
an amount expressed as a percentage by which (i) the interest rate then
payable on similarly-structured, monthly floating-rate, taxable debt
securities with a remaining term to maturity of not more than 397 days rated
either (A) in one of the two highest short term rating categories by both S&P
and Moody's or (B) if at that time the rating on the Class A-2 Bonds is lower,
then the lowest rating category assigned at that time to the Class A-2 Bonds
by S&P or Moody's, exceeds (ii) One-Month LIBOR, or (b) if the amount under
clause (a) cannot be calculated, then an amount expressed as a percentage by
which (i) the interest rate then payable on similarly-structured, monthly
floating-rate, asset-backed bonds rated either (A) in the highest rating
category by both S&P and Moody's or (B) if at that time the rating on the
Class A-2 Bonds is lower, then the lowest rating category assigned at that
time to the Class A-2 Bonds by S&P or Moody's, exceeds (ii) One-Month LIBOR,
in either case as reasonably determined and certified to the Indenture Trustee
by the Remarketing Spread Calculation Agent (as defined herein); provided,
that in determining the rates under clauses (a)(i) and (b)(i) above, the
Remarketing Spread Calculation Agent shall take into account prevailing market
conditions and current spreads to LIBOR for such securities, the principal
amount of such securities that prospective purchasers and/or current holders
of such securities are willing to purchase or hold, and indications from
prospective purchasers and/or current holders of such securities of the
interest rates at which they would be willing to purchase and/or hold such
securities. The "Remarketing Spread Calculation Agent" is Merrill Lynch
Capital Services, Inc.
As further described herein, with respect to the Class A-2 Bonds and any
Payment Date, to the extent that the amount calculated pursuant to clause (i)
of the definition of Class A-2 Interest Payment Amount exceeds the Class A-2
Guaranteed Interest Payment Amount (such excess, the "Class A-2 Carry-Forward
Amount"), the holders of the Class A-2 Bonds will be paid the amount of such
Class A-2 Carry-Forward Amount on a pro rata basis, in accordance with the
Class A-1 Carry Forward Amount and the Class A-2 Carry Forward Amount, with
interest thereon at the Class A-2 Bond Interest Rate applicable from time to
time after certain payments to the holders of the Bonds and the Bond Insurer
to the extent of Available Funds. The "Class A-2 Guaranteed Interest Payment
Amount" for any Payment Date is equal to the Class A-2 Bond's pro rata portion
of the Guaranteed Interest Payment Amount, determined by multiplying the
Guaranteed Interest Payment Amount for such Payment Date by a fraction, the
numerator of which is the amount calculated pursuant to clause (i) of the
definition of Class A-2 Interest Payment Amount and the denominator of which
is the sum of (x) the amount calculated pursuant to clause (i) of the
definition of Class A-2 Interest Payment Amount and (y) the amount calculated
pursuant to clause (i) of the definition of Class A-1 Interest Payment Amount.
Interest on the Bonds in respect of any Payment Date will accrue from the
preceding Payment Date (or in the case of the first Payment Date, from the
Closing Date) through the day preceding such Payment Date (each such period,
an "Interest Period") on the basis of the actual number of days in the
Interest Period and a 360-day year. The "Interest Payment Amount" for the
Bonds on any Payment Date is the sum of Class A-1 Interest
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Payment Amount and the Class A-2 Interest Payment Amount. The "Carry-Forward
Amount" for the Bonds on any Payment Date is the sum of the Class A-1 Carry-
Forward Amount and the Class A-2 Carry-Forward Amount. The "Guaranteed
Interest Payment Amount" for any Payment Date is equal to the amount of
interest that accrued on the aggregate outstanding Principal Balance of the
Mortgage Loans payable on the related Due Date and any amounts paid by any CAP
Provider to the Issuer under any CAP Agreement, minus the aggregate amount of
the related Servicing Fee, the Indenture Trustee Fee, the Owner Trustee Fee,
the Bond Insurance Premium, the PMI Premium, any amounts paid to the First and
Second CAP Provider under the First and Second CAP Agreements and the Minimum
Interest Spread (each as defined below). With respect to each Mortgage Loan
and each Payment Date, the Servicer will be entitled to a fee (the "Servicing
Fee") equal to 1/12 of the Servicing Fee Rate times the Principal Balance of
such Mortgage Loan as of such date. With respect to each Payment Date, the
Indenture Trustee will be entitled to a fee (the "Indenture Trustee Fee")
equal to 1/12 of the Indenture Trustee Fee Rate times the sum of the Principal
Balance of the Mortgage Loans and the Pre-Funded Amount as of such date. For
any Payment Date, the "Servicing Fee Rate" is equal to 0.50% per annum, the
"Indenture Trustee Fee Rate" is equal to 0.0125% per annum, the "Owner Trustee
Fee" is $4,000 per annum (payable on the Payment Date in September of each
year) and the "Bond Insurance Premium" is equal to 1/12 of the per annum rate
specified in the Insurance Agreement times the Bond Principal Balance (the
Bond Insurance Premium together with the Owner Trustee Fee, the
"Administrative Fee"). With respect to each Mortgage Loan and each Payment
Date, the "Minimum Interest Spread" is equal to 1/12 of 0.50% per annum times
the Principal Balance of such Mortgage Loan as of such date. The Bond
Insurance Policy does not cover any Shortfall to the Interest Payment Amount
caused by any Prepayment Interest Shortfalls, and any Relief Act Shortfalls
(each as defined herein) or the Carry-Forward Amount, nor do the ratings
assigned to the Bonds address the payment of any Prepayment Interest
Shortfalls, any Relief Act Shortfalls or the Carry-Forward Amount.
As described herein, the Class A-1 Interest Payment Amount allocable to the
Class A-1 Bonds is based on the Class A-1 Bond Principal Balance and the Class
A-2 Interest Payment Amount allocable to the Class A-2 Bonds is based on the
Class A-2 Bond Principal Balance. The "Class A-1 Bond Principal Balance" on
any date of determination is the initial principal balance of the Class A-1
Bonds as of the Closing Date, reduced by all payments of principal thereon
prior to such date of determination and the "Class A-2 Bond Principal Balance"
is the initial principal balance of the Class A-2 Bonds as of the Closing
Date, reduced by all payments of principal thereon prior to such date of
determination. The "Bond Principal Balance" of the Bonds on any date of
determination is the sum of the Class A-1 Bond Principal Balance and the Class
A-2 Bond Principal Balance.
The "Principal Balance" of any Mortgage Loan is, at any given time, the
Principal Balance as of the Cut-off Date or Subsequent Cut-off Date, as
applicable, of such Mortgage Loan, minus (a) the sum of all amounts paid or
advanced with respect to such Mortgage Loan with respect to principal and (b)
the principal portion of any losses with respect thereto for any previous
Payment Date.
CALCULATION OF ONE-MONTH LIBOR
The Indenture Trustee will determine the London interbank offered rate for
one-month United States dollar deposits ("One-Month LIBOR") for each Interest
Period for the Bonds (other than the first Interest Period) on the second
London Business Day preceding such Interest Period (each such date, an
"Interest Determination Date") on the basis of the offered rates of the
Reference Banks for one-month United States dollar deposits, as such rates
appear on the Telerate Page 3750, as of 11:00 a.m. (London time) on such
Interest Determination 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 Period
(commencing on the first day of such Interest Period). The Indenture Trustee
will request the principal London office of each of the Reference Banks to
provide a quotation of its rate. If at least two such quotations are provided,
the rate 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 New York City,
selected by the Indenture 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 Period (commencing on the first
day of such Interest Period).
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"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 Indenture Trustee and
engaged in transactions in European deposits in the international Eurocurrency
market.
The establishment of One-Month LIBOR on each Interest Determination Date by
the Indenture Trustee and the Indenture Trustee's calculation of the rate of
interest applicable to the Bonds for the related Interest Period shall (in the
absence of manifest error) be final and binding.
PRINCIPAL PAYMENTS ON THE BONDS
Principal payments will be payable concurrently on the Class A-1 Bonds and
the Class A-2 Bonds on a pro rata basis in accordance with the Class A-1 Bond
Principal Balance and the Class A-2 Bond Principal Balance, on each Payment
Date in an aggregate amount equal to the Principal Payment Amount for such
Payment Date. The "Principal Payment Amount" for (a) any Payment Date, other
than the Final Scheduled Payment Date and the first Payment Date following any
acceleration of the Bonds following an Event of Default (as defined herein),
will be equal to the lesser of (x) the sum of the Available Funds remaining
after distributions pursuant to clauses (i) and (ii) of "--Priority of
Payment" below and any portion of any Insured Payment (as defined herein) for
such Payment Date representing a Subordination Deficit and (y) the sum of:
(i) the principal portion of all scheduled monthly payments on the
Mortgage Loans received or Advanced (as defined herein) on the Mortgage
Loans with respect to the related Due Date (and with respect to the first
Payment Date, received from the Cut-Off Date);
(ii) the principal portion of all proceeds of the repurchase of a
Mortgage Loan (or, in the case of a substitution, certain amounts
representing a principal adjustment) pursuant to the Servicing Agreement or
the Purchase Agreement during the preceding calendar month (and with
respect to the first Payment Date, received from the Cut-Off Date);
(iii) the principal portion of all other unscheduled collections received
during the related Prepayment Period (or deemed to be received during the
related Prepayment Period) (and with respect to the first Payment Date,
received from the Cut-Off Date) (including, without limitation, full and
partial Principal Prepayments made by the respective Mortgagors, Net
Liquidation Proceeds and Insurance Proceeds and termination proceeds
(excluding proceeds paid in respect of the Bond Insurance Policy)), to the
extent not distributed in the preceding month;
(iv) any Insured Payment made with respect to any Subordination Deficit;
and
(v) with respect to the Payment Date immediately following the end of the
Funding Period, any amounts in the Pre-Funding Account and the Interest
Coverage Account after giving effect to any purchase of Subsequent Mortgage
Loans;
minus
(vi) the amount of any Subordination Reduction Amount for such Payment
Date;
and (b) with respect to the Final Scheduled Payment Date and the first
Payment Date following any acceleration of the Bonds following an Event of
Default, the amount necessary to reduce the Bond Principal Balance to zero.
In no event will the Principal Payment Amount with respect to any Payment
Date be (x) less than zero or (y) greater than the then outstanding Bond
Principal Balance of the Bonds.
PRIORITY OF PAYMENT
On each Payment Date, Available Funds and any Insured Payment (payable
solely with respect to items (ii) and (iii)) with respect to such Payment Date
will be allocated to the Bonds in the following order of priority, in each
case to the extent of Available Funds remaining:
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(i) to the First and Second CAP Provider, amounts (including termination
payments) due under the First and Second CAP Agreements, but only to the
extent that (A) such amounts have not been paid by the Servicer pursuant to
the Servicing Agreement, and (B) such amounts represent insured amounts
under the interest rate swap insurance policy;
(ii) to the Bondholders, the Interest Payment Amount with respect to such
Payment Date, by paying on a pro rata basis to the Bondholders holding the
Class A-1 Bonds the Class A-1 Interest Payment Amount and to the
Bondholders holding the Class A-2 Bonds the Class A-2 Interest Payment
Amount;
(iii) to the Bondholders, the Principal Payment Amount with respect to
such Payment Date, by concurrently paying such amount to the Bondholders
holding the Class A-1 Bonds and to the Bondholders holding the Class A-2
Bonds on a pro rata basis, in accordance with the Class A-1 Bond Principal
Balance and the Class A-2 Bond Principal Balance;
(iv) to the Bond Insurer, the sum of (a) all amounts previously paid by
the Bond Insurer under the Bond Insurance Policy and the Surety Bond which
have not previously been reimbursed (b) any other amounts due to the Bond
Insurer pursuant to the agreement pursuant to which the Bond Insurance
Policy and the Surety Bond is issued (the "Insurance Agreement") and (c)
interest on the foregoing as set forth in the Insurance Agreement from the
date such amounts became due until paid in full (the "Reimbursement
Amount");
(v) to the Bondholders, the Subordination Increase Amount (as defined in
"--Overcollateralization Provisions" below), in reduction of the Bond
Principal Balance thereof, until the Bond Principal Balance has been
reduced to zero;
(vi) to the Bondholders, any Carry-Forward Amount for such Payment Date;
(vii) to the Indenture Trustee, for any amounts owing to the Indenture
Trustee;
(viii) to the First and Second CAP Provider, any amounts due under the
First and Second CAP Agreements, but only to the extent that such payments
have not been paid by the Servicer pursuant to the Servicing Agreement or
pursuant to clause (i) above;
(ix) to the Servicer, any amounts owing to the Servicer pursuant to the
Servicing Agreement in connection with the indemnity by the Issuer
thereunder, and in the event there is a successor servicer, additional
compensation, if necessary; and
(x) any remaining amounts to the holders of the Certificates.
OVERCOLLATERALIZATION PROVISIONS
Overcollateralization Resulting from Cash Flow Structure.
With respect to any Payment Date, the excess, if any, of (x) the sum of the
aggregate Principal Balances of the Mortgage Loans as of the close of business
on the last day of the period commencing on the second day of the month
preceding the month of such Payment Date (or, with respect to the first
Payment Date, the day following the Cut-Off Date) and ending on the related
Due Date (such period, the "Due Period") and the amount of funds in the Pre-
Funding Account as of such Payment Date over (y) the Bond Principal Balance of
the Bonds as of such Payment Date (and following the making of all payments
made on such Payment Date) is the "Subordination Amount" as of such Payment
Date. The Indenture requires that, on each Payment Date, the Net Monthly
Excess Cashflow, if any, be applied on such Payment Date as an accelerated
payment of principal on the Bonds, but only to the limited extent hereafter
described. The "Net Monthly Excess Cashflow" for any Payment Date is equal to
the amount of Available Funds remaining after application to items (i) through
(iv) under "--Priority of Payment" herein. This application has the effect of
accelerating the amortization of the Bonds relative to the amortization of the
Mortgage Loans. The Indenture requires that the Net Monthly Excess Cashflow
will be applied as an accelerated payment of principal on the Bonds until the
Subordination Amount has increased to the level equal to the Required
Subordination Amount for such Payment Date.
Any amount of Net Monthly Excess Cashflow actually applied as an accelerated
payment of principal is a "Subordination Increase Amount." The required level
of the Subordination Amount with respect to a Payment
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Date is the "Required Subordination Amount" with respect to such Payment Date.
The Indenture generally provides that the Required Subordination Amount may,
over time, decrease, or increase, subject to certain floors, caps and
triggers.
Initially, the sum of the aggregate Principal Balance of the Initial
Mortgage Loans as of the Cut-off Date and the Original Pre-Funded Amount will
be equal to the aggregate Bond Principal Balance of the Bonds as of the
Closing Date. Over time, however, the aggregate Principal Balance of the
Mortgage Loans (plus the remaining Pre-Funded Amount, if any) is expected to
exceed the aggregate Bond Principal Balance of the Bonds as a result of
accelerated amortization of the Bonds. Such amount is expected to increase
until it reaches a target of 3.80% (the "Target Subordination Amount") of the
sum of the aggregate Principal Balance of the Initial Mortgage Loans as of the
Cut-off Date and the Original Pre-Funded Amount. In addition, upon the end of
the Funding Period, the Bond Insurer may adjust the Target Subordination
Amount.
In the event that the Required Subordination Amount is permitted to decrease
or "step down" on a Payment Date in the future, the Indenture provides that a
portion of the payment which would otherwise be distributed to the Holders of
the Bonds on such Payment Date shall be distributed to the Holders of the
Certificates on such Payment Date. This has the effect of decelerating the
amortization of the Bonds relative to the amortization of the Mortgage Loans,
and of reducing the Subordination Amount. With respect to any Payment Date,
the difference, if any, between (a) the Subordination Amount that would result
on such Payment Date after taking into account all payments to be made on such
Payment Date (exclusive of any reductions thereto attributable to
Subordination Reduction Amounts (as described below) on such Payment Date) and
(b) the Required Subordination Amount for such Payment Date is the "Excess
Subordination Amount" with respect to such Payment Date. With respect to any
Payment Date, an amount equal to the lesser of (a) the Excess Subordination
Amount and (b) the principal collections received by the Servicer with respect
to the related Due Period is the "Subordination Reduction Amount." In
addition, a Subordination Reduction Amount may result even prior to the
occurrence of any decrease or "step down" in the Required Subordination
Amount. This is because the Holders of the Bonds will generally be entitled to
receive 100% of collected principal, even though the Bond Principal Balance of
the Bonds may represent less than 100% of the Mortgage Loans' principal
balance. In the absence of the provisions relating to the Subordination
Reduction Amount, the foregoing may otherwise increase the Subordination
Amount above the Required Subordination Amount even without the application of
any Net Monthly Excess Cashflow.
The Indenture provides that, on any Payment Date, all unscheduled
collections on account of principal (other than any such amount applied to the
payment of a Subordination Reduction Amount) with respect to Mortgage Loans
during the calendar month preceding the calendar month in which such Payment
Date occurs (the "Prepayment Period") will be distributed to the Holders of
the Bonds on such Payment Date. If any Mortgage Loan became a Liquidated
Mortgage Loan (as defined below) during such Prepayment Period, the net
Liquidation Proceeds (as defined in the Prospectus) related thereto and
allocated to principal may be less than the Principal Balance of the related
Mortgage Loan; the amount of any such insufficiency is generally defined as a
"Realized Loss." A "Liquidated Mortgage Loan" is, in general, a defaulted
Mortgage Loan as to which the Servicer has determined that all amounts that it
expects to recover on such Mortgage Loan have been recovered (exclusive of any
possibility of a deficiency judgment) and, in addition, shall be deemed to
include any Mortgage Loan secured by a junior lien of which any portion of a
scheduled monthly payment of principal and interest is in excess of 180 days
past due. The principal balance of any Mortgage Loan after it becomes a
Liquidated Mortgage Loan shall equal zero. The Indenture does not contain any
provision which requires that the amount of any Realized Loss should be
distributed to the Holders of the Bonds on the Payment Date which immediately
follows the event of loss; i.e., the Indenture does not require the current
recovery of losses. However, the occurrence of a Realized Loss will reduce the
Subordination Amount, which, to the extent that such reduction causes the
Subordination Amount to be less than the Required Subordination Amount
applicable to the related Payment Date, will require the payment of a
Subordination Increase Amount on such Payment Date (or, if insufficient funds
are available on such Payment Date, on subsequent Payment Dates, until the
Subordination Amount equals the Required Subordination Amount).
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The Indenture provides that on each Payment Date after the Closing Date, all
Net Monthly Excess Cash Flow must be applied as a Subordination Increase
Amount to pay principal on the Bonds until the Subordination Amount reaches
the Target Subordination Amount. During this time the Holders of the
Certificates will not be entitled to receive any distributions of Net Monthly
Excess Cash Flow. On each Payment Date after the Subordination Amount reaches
the Target Subordination Amount, the Holders of the Certificates will be
entitled to receive Net Monthly Excess Cash Flow (excluding payment of item
(iv) and after payment of items (v) through (ix) under "--Priority of Payment"
herein), provided that on such Payment Date the PMI Insurer is not insolvent,
in default of payments due on the PMI Policies and has not had its long term
debt rating reduced below investment grade (collectively, a "PMI Insurer
Insolvency Event"), and no Bond Insurer Default (as defined in the Indenture)
has occurred and is continuing. If the foregoing conditions are met, the
Holders of the Certificates will continue to receive all such monthly cash
flows even if the Subordination Amount decreases, as a result of Realized
Losses, below the Target Subordination Amount. If, however, a PMI Insurer
Insolvency Event or a Bond Insurer Default has occurred and is continuing,
then on each Payment Date such monthly cash flows will be paid to the Bond
Insurer as reimbursement under item (iv) (in case of a PMI Insurer Insolvency
Event) and to Bondholders as a Subordination Increase Amount until the
Subordination Amount reaches the Required Subordination Amount.
Overcollateralization and the Bond Insurance Policy. The Indenture defines a
"Subordination Deficit" with respect to a Payment Date to be the amount, if
any, by which (x) the aggregate 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 sum of the aggregate Principal
Balances of the Mortgage Loans as of the close of business on the Due Date
preceding such Payment Date and the amount of funds in the Pre-Funding Account
on such Due Date. The Indenture requires the Indenture 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 Indenture
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.
After the Subordination Amount reaches the Target Subordination Amount,
unless a PMI Insurer Insolvency Event has occurred and is continuing, monthly
cash flows remaining after payment of items (i) through (iii) under "--
Priority of Payment" herein will generally not be available to absorb Realized
Losses. In such event, Realized Losses will reduce the Subordination Amount
until it reaches zero, and thereafter will be paid by the Bond Insurer under
the Bond Insurance Policy to eliminate any Subordination Deficit. The Bond
Insurer will not be entitled to recover such payments from future monthly cash
flows, unless a PMI Insurer Insolvency Event has occurred and is continuing,
in which case future monthly cash flow will be available to reimburse the Bond
Insurer for prior payments under the Bond Insurance Policy and to cover
additional Realized Losses.
NCFC DEMAND NOTE
On the Closing Date, (i) NCFC will issue to the Company a non-interest
bearing, demand promissory note in the principal amount of $6,300,000 (the
"NCFC Demand Note") pursuant to the Certificates Sale Agreement, (ii) the
Company will assign, without recourse, the NCFC Demand Note to the Issuer
pursuant to the Trust Agreement and (iii) the Issuer will pledge the NCFC
Demand Note to the Indenture Trustee pursuant to the Indenture. The NCFC
Demand Note will be held by the Indenture Trustee subject to the lien of the
Indenture for the benefit of the Bondholders. Under the Indenture, the
Indenture Trustee may make demand for payment of the NCFC Demand Note only in
the event that proceeds of the Mortgage Loans, payments received under the CAP
Agreements and payments received under the Bond Insurance Policy are otherwise
insufficient to pay principal and interest due on the Bonds (including Carry-
Forward Amounts, if any, payable on the Bonds) in accordance with their terms.
The Indenture Trustee may make a demand for payment under the NCFC Demand Note
only (a) on the Maturity Date of the Bonds or (b) following the occurrence of
a Bond Insurer Default or an Event of Default under the Indenture.
On the Closing Date, the Bond Insurer will issue a surety bond (the "Surety
Bond") in favor of the Indenture Trustee for the benefit of the Bondholders
that guarantees certain payments under NCFC Demand
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Note, in accordance with the terms of the Surety Bond. The Surety Bond does
not cover payments due under the NCFC Demand Note that would be used by the
Indenture Trustee to cover shortfalls in amounts then payable to the
Bondholders resulting from Prepayment Interest Shortfalls or Civil Relief Act
Shortfalls or any accelerated payments to Bondholders unless such acceleration
is at the direction of the Bond Insurer. Payments under the Surety Bond may
not exceed the excess, if any, of (i) the amount of the Insured Payment, if
any, due and owing from the Bond Insurer under the Bond Insurance Policy and
(ii) the amount actually received by the Indenture Trustee from the Bond
Insurer pursuant to the Bond Insurance Policy. The insurance provided by the
Surety Bond is not covered by the Property/Casualty Insurance Security Fund
specified in Article 76 of the New York Insurance Law.
BOND INSURANCE POLICY
The following information has been supplied by the Bond Insurer for
inclusion in this Prospectus Supplement.
The Bond 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 that an amount equal to each full and
complete Insured Payment will be received by the Indenture Trustee, or its
successor, as trustee for the Owners, on behalf of the Owners from the Bond
Insurer, for distribution by the Indenture Trustee to each Owner of each
Owner's proportionate share of the Insured Payment. The Bond 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 Indenture Trustee, whether or
not such funds are properly applied by the Indenture 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 Bond Insurer.
Notwithstanding the foregoing paragraph, the Bond Insurance Policy does not
cover shortfalls, if any, attributable to the liability of the Issuer or the
Indenture Trustee for withholding taxes, if any (including interest and
penalties in respect of any such liability). The Bond Insurance Policy does
not cover, and Insured Payments do not include, any Prepayment Interest
Shortfalls, any Relief Act Shortfalls or any Carry-Forward Amounts.
The Bond Insurer will pay any Insured Payment that is a Preference Amount on
the Business Day following receipt on a Business Day by the Fiscal Agent (as
described below) of (i) a certified copy of the order requiring the return of
a preference payment, (ii) an opinion of counsel satisfactory to the Bond
Insurer that such order is final and not subject to appeal, (iii) an
assignment in such form as is reasonably required by the Bond Insurer,
irrevocably assigning to the Bond 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 Bond Insurer as
agent for such Owner in any legal proceeding related to such preference
payment, such instruments being in a form satisfactory to the Bond Insurer,
provided that if such documents are received after 12:00 noon New York City
time on such Business Day, they will be deemed to be received on the following
Business Day. 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.
The Bond Insurer will pay any other 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 Deficiency Amount is due or the second Business Day
following receipt in New York, New York on a Business Day by State Street Bank
and Trust Company, N.A., as Fiscal Agent for the Bond Insurer or any successor
fiscal agent appointed by the Bond Insurer (the "Fiscal Agent") 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 Fiscal Agent
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 Fiscal Agent for purposes of this paragraph, and the Bond
Insurer or the Fiscal Agent, as the case may be, shall promptly so advise the
Indenture Trustee and the Indenture Trustee may submit an amended Notice.
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Insured Payments due under the Bond Insurance Policy unless otherwise stated
therein will be disbursed by the Fiscal Agent to the Indenture 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 Indenture Trustee for the payment
of such Insured Payment and legally available therefor.
The Fiscal Agent is the agent of the Bond Insurer only and the Fiscal Agent
shall in no event be liable to Owners for any acts of the Fiscal Agent or any
failure of the Bond Insurer to deposit or cause to be deposited, sufficient
funds to make payments due under the Bond Insurance Policy.
Subject to the terms of the Agreement, the Bond Insurer shall be subrogated
to the rights of each Owner to receive payments under the Bonds to the extent
of any payment by the Bond Insurer under the Bond Insurance Policy.
As used in the Bond Insurance Policy, the following terms shall have the
following meanings:
"Agreement" means the Indenture dated as of August 1, 1998 between the
Issuer and the Indenture Trustee, without regard to any amendment or
supplement thereto unless such amendment or supplement has been approved in
writing by the Bond Insurer.
"Business Day" means any day other than a Saturday, a Sunday or a day on
which the Bond Insurer or banking institutions in New York City or in the city
in which the corporate trust office of the Indenture Trustee under the
Agreement or the principal office of the Bond Insurer are located are
authorized or obligated by law or executive order to close.
"Deficiency Amount" means (a) with respect to each Payment Date prior to the
Final Scheduled Payment Date, an amount equal to the sum of (i) the excess, if
any, of the Interest Payment Amount (net of any Prepayment Interest
Shortfalls, to the extent not covered by the Servicer by Compensating Interest
(as defined herein), and any Relief Act Shortfalls for such Payment Date) over
the Available Funds for such Payment Date and (ii) any Subordination Deficit;
(b) with respect to the Final Scheduled Payment Date, an amount equal to the
sum of (i) the excess, if any, of the Interest Payment Amount (net of any
Prepayment Interest Shortfalls, to the extent not covered by the Servicer by
Compensating Interest, and any Relief Act Shortfalls for such Payment Date)
over the Available Funds for such Payment Date and (ii) the excess, if any, of
the Bond Principal Balance of all Outstanding Bonds due on such Final
Scheduled Payment Date over Available Funds not used to pay the Interest
Payment Amount (net of any Prepayment Interest Shortfalls, to the extent not
covered by the Servicer by Compensating Interest, and any Relief Act
Shortfalls for such Payment Date) for such Final Scheduled Payment Date; and
(c) for any date on which the acceleration of the Bonds has been directed or
consented to by the Bond Insurer pursuant to Section 5.02 of 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 Available Funds for such
date of payment.
"Insured Payment" means (i) as of any Payment Date, 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 Indenture 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) of a Bond who,
on the applicable Payment Date, is entitled under the terms of the applicable
Bonds to payment thereunder.
"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
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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.
"Relief Act Shortfalls" means for any Payment Date any shortfalls relating
to the Soldiers' and Sailors' Civil Relief Act of 1940, as amended, or similar
legislation or regulations.
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 Agreement 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 Bond Insurer.
Any notice under the Bond Insurance Policy or service of process on the
Fiscal Agent may be made at the address listed below for the Fiscal Agent or
such other address as the Bond Insurer shall specify in writing to the
Indenture Trustee.
The notice address of the Fiscal Agent is 15th Floor, 61 Broadway, New York,
New York 10006 Attention: Municipal Registrar and Paying Agency or such other
address as the Fiscal Agent shall specify to the Indenture Trustee in writing.
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 insurance provided by 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 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.
ADVANCES
Prior to each Payment Date, the Servicer is required under the Servicing
Agreement to make "Advances" (out of its own funds, advances made by any
subservicer, or funds held in the Collection Account (as described in the
Prospectus) for future payment or withdrawal) with respect to any payments of
principal and interest (net of the Servicing Fee Rate) which were due on the
Mortgage Loans on the immediately preceding Due Date and which are delinquent
on the business day next preceding the related Determination Date.
Such Advances are required to be made only to the extent they are deemed by
the Servicer to be recoverable from related late collections, Insurance
Proceeds, or Liquidation Proceeds. The purpose of making such Advances is to
maintain a regular cash flow to the Bondholders, rather than to guarantee or
insure against losses. Any failure by the Servicer to make an Advance as
required under the Servicing Agreement will constitute an Event of Default
thereunder, in which case the Indenture Trustee, as successor Servicer, will
be obligated to make any such Advance, in accordance with the terms of the
Servicing Agreement.
All Advances will be reimbursable to the Servicer on a first priority basis
from late collections, Insurance Proceeds or Liquidation Proceeds from the
Mortgage Loan as to which such unreimbursed Advance was made. In addition, any
Advances previously made which are deemed by the Servicer to be nonrecoverable
from related late collections, Insurance Proceeds and Liquidation Proceeds may
be reimbursed to the Servicer out of any funds in the Collection Account prior
to payments on the Bonds.
THE PAYING AGENT
The Paying Agent shall initially be the Indenture Trustee. The Paying Agent
shall have the revocable power to withdraw funds from the Payment Account for
the purpose of making payments to the Bondholders.
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OPTIONAL REDEMPTION
The Bonds may be redeemed in whole, but not in part, by the Issuer on any
Payment Date on or after the earlier of (i) the Payment Date on which the
outstanding Bond Principal Balance is reduced to less than 25% (the "Clean-Up
Call Percentage") of the original Bond Principal Balance or (ii) the Payment
Date occurring in August, 2005. The purchase price will be equal to 100% of
the aggregate outstanding Bond Principal Balance and accrued and unpaid
interest thereon (including any Carry-Forward Amount) at the Bond Interest
Rate through the date on which the Bonds are redeemed in full together with
all amounts due and owing to the Bond Insurer, the Servicer and the Indenture
Trustee. The "Final Scheduled Payment Date" is the Payment Date occurring in
August, 2028.
MANDATORY PREPAYMENTS ON THE BONDS
The Bonds will be partially prepaid on the Payment Date immediately
following the end of the Funding Period to the extent that any amount remains
on deposit in the Pre-Funding Account on such Payment Date. Although no
assurance can be given, it is anticipated that the principal amount of
Subsequent Mortgage Loans sold to the Issuer and included in the Trust Estate
will require the application of substantially all of the Original Pre-Funded
Amount and that there should be no material amount of principal prepaid to the
Bonds from the Pre-Funding Account. However, it is unlikely that the Seller
will be able to deliver Subsequent Mortgage Loans with an aggregate principal
balance identical to the Original Pre-Funded Amount.
INTEREST COVERAGE ACCOUNT
On the Closing Date, a portion of the sales proceeds of the Bonds will be
deposited in an account (the "Interest Coverage Account") for application by
the Indenture Trustee to cover shortfalls in the Interest Payment Amount
attributable to the pre-funding feature during the Funding Period. Such
shortfall initially will exist during the Funding Period because the aggregate
Principal Balance of the Bonds, and interest accrued thereon, during the
Funding Period will be greater than the aggregate principal balance of the
Mortgage Loans, and interest accrued thereon, during such period. On the first
business day following the termination of the Funding Period, funds on deposit
in the Interest Coverage Account will be deposited in the Payment Account.
CERTAIN YIELD AND PREPAYMENT CONSIDERATIONS
The yield to maturity of the Bonds will depend on the price paid by the
holder for such Bond, the Bond Interest Rate and the rate and timing of
principal payments (including payments in excess of required installments,
prepayments or terminations, liquidations and repurchases) on the Mortgage
Loans and the allocation thereof. Such yield may be adversely affected by a
higher or lower than anticipated rate of principal payments on the Mortgage
Loans and the amount, if any, distributed from the Pre-Funding Account at the
end of the Funding Period. The rate of principal payments on such Mortgage
Loans will in turn be affected by the amortization schedules of the Mortgage
Loans, the rate and timing of principal prepayments thereon by the Mortgagors
and liquidations of defaulted Mortgage Loans, and purchases of Mortgage Loans
due to certain breaches of representations and warranties and optional
repurchases of delinquent loans by the Servicer. The timing of changes in the
rate of prepayments, liquidations and repurchases of the Mortgage Loans may,
and the timing of losses will, significantly affect the yield to an investor,
even if the average rate of principal payments experienced over time is
consistent with an investor's expectation. Since the rate and timing of
principal payments on the Mortgage Loans will depend on future events and on a
variety of factors (as described more fully herein and in the Prospectus under
"Yield Considerations"), no assurance can be given as to such rate or the
timing of principal payments on the Bonds.
The Mortgage Loans generally may be prepaid in full or in part at any time;
however, prepayment may subject the mortgagor to a prepayment charge. None of
the Initial Mortgage Loans are secured by junior liens on the related Mortgage
Properties. Generally, mortgage loans secured by junior liens are not viewed
by Mortgagors
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as permanent financing. Accordingly, such Mortgage Loans may experience a
higher rate of prepayment than the first lien Mortgage Loans. All of the
Mortgage Loans are assumable under certain circumstances if, in the sole
judgment of the Servicer, the prospective purchaser of a Mortgaged Property is
creditworthy and the security for such Mortgage Loan is not impaired by the
assumption. All of the Mortgage Loans contain a customary "due on sale"
provision. The Servicer shall enforce any due-on-sale clause contained in any
Mortgage Note or Mortgage, to the extent permitted under applicable law and
governmental regulation; provided, however, if the Servicer determines that it
is reasonably likely that any Mortgagor will bring, or if any Mortgagor does
bring, legal action to declare invalid or otherwise avoid enforcement of a
due-on-sale clause contained in any Mortgage Note or Mortgage, the Servicer
shall not be required to enforce the due-on-sale clause or to contest such
action. The extent to which the Mortgage Loans are assumed by purchasers of
the Mortgaged Properties rather than prepaid by the related Mortgagors in
connection with the sales of the Mortgaged Properties will affect the weighted
average life of the Bonds and may result in a prepayment experience on the
Mortgage Loans that differs from that on other conventional Mortgage Loans.
See "Yield Considerations" in the Prospectus. Prepayments, liquidations and
purchases of the Mortgage Loans will result in payments to holders of the
Bonds of principal amounts which would otherwise be distributed over the
remaining terms of the Mortgage Loans. Factors affecting prepayment (including
defaults and liquidations) of Mortgage Loans include changes in mortgagors'
housing needs, job transfers, unemployment, mortgagors' net equity in the
mortgaged properties, changes in the value of the mortgaged properties,
mortgage market interest rates and servicing decisions.
The rate of defaults on the Mortgage Loans will also affect the rate and
timing of principal payments on the Mortgage Loans. In general, defaults on
Mortgage Loans are expected to occur with greater frequency in their early
years. Increases in the monthly payments of the Adjustable Rate Mortgage Loans
to an amount in excess of the monthly payment required at the time of
origination may result in a default rate higher than that on level payment
Mortgage Loans, particularly since the Mortgagor under each Adjustable Rate
Mortgage Loan was qualified on the basis of the Mortgage Rate in effect at
origination. The repayment of such Adjustable Rate Mortgage Loans will be
dependent on the ability of the Mortgagor to make larger monthly payments as
the Mortgage Rate increases. With respect to the Mortgage Loans that are
secured by second liens on the related Mortgaged Properties, such Mortgage
Loans are subordinate to the rights of the mortgagee under the related first
lien. Accordingly, if the mortgagee under a first lien on the related
Mortgaged Property is successful in foreclosure of its mortgage, the second
lien or encumbrances will not survive such a foreclosure. Investors should be
aware that any liquidation, insurance or condemnation proceeds received in
respect of such Mortgage Loans will be available to satisfy the outstanding
balance of such Mortgage Loans only to the extent that the claims of such
first liens have been satisfied in full, including any related foreclosure
costs. In addition, the rate of default on Mortgage Loans which are refinance
or limited documentation Mortgage Loans, and on Mortgage Loans with high Loan-
to-Value Ratios, may be higher than for other types of Mortgage Loans.
Furthermore, the rate and timing of prepayments, defaults and liquidations on
the Mortgage Loans will be affected by the general economic condition of the
region of the country in which the related Mortgaged Properties are located.
The risk of delinquencies and loss is greater and prepayments are less likely
in regions where a weak or deteriorating economy exists, as may be evidenced
by, among other factors, increasing unemployment or falling property values.
See "Yield Considerations" in the Prospectus.
To the extent that the Original Pre-Funded Amount has not been fully applied
to the purchase of Subsequent Mortgage Loans by the Issuer by the end of the
Funding Period, the Holders of the Bonds will receive on the first Payment
Date following the termination of the Funding Period a prepayment of principal
in an amount equal to the lesser of (i) the Pre-Funded Amount remaining in the
Pre-Funding Account and (ii) the outstanding Principal Balance of the Bonds.
Although no assurance can be given, it is anticipated by the Company that the
principal amount of Subsequent Mortgage Loans sold to the Issuer for inclusion
in the Trust Estate will require the application of substantially all amounts
on deposit in the Pre-Funding Account and that there will be no material
amount of principal prepaid to such Bondholders. However, it is unlikely that
the Seller will be able to deliver Subsequent Mortgage Loans with an aggregate
principal balance identical to the Original Pre-Funded Amount.
S-66
<PAGE>
In addition, the yield to maturity of the Bonds will depend on, among other
things, the price paid by the holders of the Bonds and the then applicable
Bond Interest Rate. The extent to which the yield to maturity of a Bond is a
sensitive to prepayments will depend, in part, upon the degree to which it is
purchased at a discount or premium. In general, if a Bond is purchased at a
premium and principal payments thereon occur at a rate faster than anticipated
at the time of purchase, the investor's actual yield to maturity will be lower
than that assumed at the time of purchase. Conversely, if a Bond is purchased
at a discount and principal payments thereon occur at a rate slower than that
assumed at the time of purchase, the investor's actual yield to maturity will
be lower than that assumed at the time of purchase. For additional
considerations relating to the yield on the Bonds, see "Yield Considerations"
in the Prospectus.
Furthermore, the yield to maturity on the Bonds may be affected by
shortfalls with respect to interest in the event that the interest accrued on
the Bonds at the Bond Interest Rate is greater than the amount of interest
accrued on the Mortgage Loans at the related Mortgage Rates less the sum of
the Servicing Fee, the Indenture Trustee Fee and the Administrative Fee. In
such event, the resulting shortfall, if not paid under the Bond Insurance
Policy, will only be payable to the extent that on any future Payment Date
interest accrued on the Mortgage Loans at the related Mortgage Rates less such
rates is greater than the interest accrued on the Bonds, and only to the
extent of Available Funds following distributions to the Bondholders pursuant
to clauses (i) through (iv) under "Description of the Bonds--Priority of
Payment."
The Class A-1 Bond Interest Rate and the Class A-2 Bond Interest Rate are
based upon, among other factors as described herein under "Description of the
Bonds--Interest Payments on the Bonds," the value of an index (One-Month LIBOR
(as defined herein) which is different from the value of the indices
applicable to the Mortgage Loans, Six-Month LIBOR and One-Year CMT). The
Mortgage Rate for each Fixed Rate Mortgage Loan is fixed and the Mortgage Rate
for each Adjustable Rate Mortgage Loan adjusts semi-annually or annually,
commencing after the Initial Period, based upon the related Index, whereas the
Bond Interest Rate on the Bonds adjusts monthly based upon One-Month LIBOR
plus a spread as set forth herein, limited by the Maximum Interest Rate (as
defined herein). In addition, One-Month LIBOR and the Indices on the
Adjustable Rate Mortgage Loans may respond differently to economic and market
factors, and there is not necessarily any correlation between them. Moreover,
the Adjustable Rate Mortgage Loans are subject to Periodic Rate Caps, Maximum
Mortgage Rates and Minimum Mortgage Rates (each, as defined herein). Thus, it
is possible, for example, that One-Month LIBOR and the Indices rise during the
same period, One-Month LIBOR may rise much more rapidly than the Indices.
Although the Mortgage Rates on the Adjustable Rate Mortgage Loans will
adjust semi-annually, such increases and decreases may be limited by the
Periodic Rate Cap, the Maximum Mortgage Rate and the Minimum Mortgage Rate, if
applicable, on each such Adjustable Rate Mortgage Loan, and will be based on
the applicable Index (which may not rise and fall consistently with prevailing
mortgage rates) plus the related Gross Margin (which may be different from the
prevailing margins on other Mortgage Loans). As a result, the Mortgage Rates
on the Adjustable Rate Mortgage Loans at any time may not equal the prevailing
rates for other adjustable-rate loans and accordingly, the rate of prepayment
may be lower or higher than would otherwise be anticipated. In addition,
because all of the Adjustable Rate Mortgage Loans have Maximum Mortgage Rates,
if prevailing mortgage rates were to increase above the Maximum Mortgage
Rates, the rate of prepayment on the Adjustable Rate Mortgage Loans may be
slower than would otherwise be the case. In general, if prevailing mortgage
rates fall significantly below the Mortgage Rates on the Adjustable Rate
Mortgage Loans, the rate of prepayments (including refinancings) will be
expected to increase. Conversely, if prevailing mortgage rates rise
significantly above the Mortgage Rates on the Adjustable Rate Mortgage Loans,
the rate of prepayment on the Adjustable Rate Mortgage Loans will be expected
to decrease.
Weighted average life refers to the average amount of time that will elapse
from the date of issuance of a security to the date of payment to the investor
of each dollar distributed in reduction of principal of such security
(assuming no losses). The weighted average life of the Bonds will be
influenced by, among other things, the rate at which principal of the Mortgage
Loans is paid, which may be in the form of scheduled amortization, prepayments
or liquidations. Because the amortization schedule of each Adjustable Rate
Mortgage Loan will be
S-67
<PAGE>
recalculated semi-annually or annually after the initial Adjustment Date for
such Adjustable Rate Mortgage Loan, any partial prepayments thereof will not
reduce the term to maturity of such Adjustable Rate Mortgage Loan. In
addition, an increase in the Mortgage Rate on an Adjustable Rate Mortgage Loan
will result in a larger monthly payment and in a larger percentage of such
monthly payment being allocated to interest and a smaller percentage being
allocated to principal, and conversely, a decrease in the Mortgage Rate on the
Adjustable Rate Mortgage Loan will result in a lower monthly payment and in a
larger percentage of each monthly payment being allocated to principal and a
smaller percentage being allocated to interest.
Prepayments on Mortgage Loans are commonly measured relative to a prepayment
standard or mode. The model used in this Prospectus Supplement, the
Conditional Prepayment Rate model ("CPR"), assumes that the outstanding
principal balance of a pool of Mortgage Loans prepays each month at a
specified annual rate or CPR. In generating monthly cash flows, this annual
rate is converted to an equivalent monthly rate. With respect to the
Adjustable Rate Mortgage Loans, the prepayment model assumes a constant CPR of
28%. With respect to the Fixed Rate Mortgage Loans, the prepayment model
assumes a constant CPR of 2% in the first month of the life of the Fixed Rate
Mortgage Loans and an additional 1.63636% per annum in each month thereafter
until the twelfth month; beginning in the twelfth month and in each month
thereafter, the prepayment model assumes a CPR of 20% (such model, the
"Prepayment Assumption"). The levels of CPR used above in defining the
Prepayment. Assumption represent 100% of the Prepayment Assumption. To assume
a CPR percentage in either prepayment model is to assume that the stated
percentage of the outstanding principal balance of the pool would be prepaid
over the course of a year. No representation is made that the Mortgage Loans
will prepay at the percentages of CPR specified in either prepayment model.
The tables set forth below have been prepared on the basis of certain
assumptions as described below regarding the weighted average characteristics
of the Mortgage Loans that are expected to be included in the Trust Estate as
described under "Description of the Mortgage Pool" herein and the performance
thereof. The tables assume, among other things, that: (i) the Mortgage Pool
consists of Mortgage Loans with the following characteristics:
<TABLE>
<CAPTION>
ORIGINAL REMAINING MONTHS TO
TERM TO TERM TO NEXT RATE GROSS MAXIMUM MINIMUM INITIAL PERIODIC
PRINCIPAL MORTGAGE MATURITY MATURITY ADJUSTMENT MARGIN MORTGAGE MORTGAGE PERIODIC RATE
BALANCE RATE (%) (IN MONTHS) (IN MONTHS) DATE (%) RATE (%) RATE (%) CAP (%) CAP (%)
--------- -------- ----------- ----------- ---------- ------ -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ONE-YEAR CMT
Initial
$ 364,789.43 9.109 360 357 9 5.363 16.109 9.109 2.000 2.000
$ 3,804,186.26 8.167 360 358 10 5.131 15.167 8.167 2.000 2.000
$ 1,714,609.68 8.651 360 359 11 5.180 15.651 8.651 2.000 2.000
$ 1,100,800.00 8.295 360 360 12 4.830 15.295 8.295 2.000 2.000
Subsequent
$ 57,109.79 9.109 360 360 12 5.363 16.109 9.109 2.000 2.000
$ 595,566.27 8.167 360 360 12 5.131 15.167 8.167 2.000 2.000
$ 268,431.57 8.651 360 360 12 5.180 15.651 8.651 2.000 2.000
$ 172,336.29 8.295 360 360 12 4.830 15.295 8.295 2.000 2.000
SIX-MONTH LIBOR
Initial
$ 56,089.62 7.750 360 355 1 4.500 13.750 7.750 1.000 1.000
$ 408,209.83 8.998 339 336 3 5.458 15.824 8.998 1.000 1.000
$ 1,196,278.52 9.186 360 357 4 5.853 15.947 8.947 1.035 1.035
$ 2,541,185.00 9.320 360 359 5 5.751 16.320 9.320 1.000 1.000
$ 34,263.44 13.000 360 341 5 7.950 20.000 13.000 1.500 1.500
$ 2,604,850.00 9.043 360 360 6 5.486 16.043 9.043 1.000 1.000
$ 571,810.02 10.956 360 353 17 7.659 17.956 11.486 3.000 1.000
$ 789,766.93 10.448 360 354 18 5.425 17.297 10.448 3.000 1.000
$ 1,829,022.69 9.710 360 355 19 5.809 16.710 9.710 3.000 1.000
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
ORIGINAL REMAINING MONTHS TO
TERM TO TERM TO NEXT RATE GROSS MAXIMUM MINIMUM INITIAL PERIODIC
PRINCIPAL MORTGAGE MATURITY MATURITY ADJUSTMENT MARGIN MORTGAGE MORTGAGE PERIODIC RATE
BALANCE RATE (%) (IN MONTHS) (IN MONTHS) DATE (%) RATE (%) RATE (%) CAP (%) CAP (%)
--------- -------- ----------- ----------- ---------- ------ -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
$ 1,026,418.76 10.832 360 356 20 6.169 17.832 10.832 3.000 1.000
$ 7,440,550.79 10.520 360 357 21 6.020 17.510 10.520 3.000 1.000
$24,276,173.25 10.009 360 358 22 5.538 16.982 10.009 3.000 1.000
$39,801,037.41 10.103 360 359 23 5.666 17.102 10.103 3.000 1.000
$39,894,001.00 10.102 360 360 24 5.730 17.100 10.102 3.000 1.000
$ 170,400.98 10.890 360 355 31 5.922 17.511 10.890 3.000 1.000
$ 356,706.23 10.380 360 357 33 5.577 17.380 10.380 3.000 1.000
$ 367,556.83 8.290 360 358 34 4.860 15.290 8.290 3.000 1.000
$ 4,542,708.23 9.558 360 359 35 5.265 16.558 9.558 3.000 1.000
$ 3,269,540.00 10.061 360 360 36 5.435 17.061 10.061 3.000 1.000
Subsequent
$ 8,781.14 7.750 360 360 6 4.500 13.750 7.750 1.000 1.000
$ 63,907.49 8.998 339 339 6 5.458 15.824 8.998 1.000 1.000
$ 187,283.98 9.186 360 360 6 5.853 15.947 8.947 1.035 1.035
$ 397,836.48 9.320 360 360 6 5.751 16.320 9.320 1.000 1.000
$ 407,803.59 9.043 360 360 6 5.486 16.043 9.043 1.000 1.000
$ 5,364.13 13.000 360 360 24 7.950 20.000 13.000 1.500 1.500
$ 89,520.00 10.956 360 360 24 7.659 17.956 11.486 3.000 1.000
$ 123,642.35 10.448 360 360 24 5.425 17.297 10.448 3.000 1.000
$ 286,343.56 9.710 360 360 24 5.809 16.710 9.710 3.000 1.000
$ 160,691.50 10.832 360 360 24 6.169 17.832 10.832 3.000 1.000
$ 1,164,859.13 10.520 360 360 24 6.020 17.510 10.520 3.000 1.000
$ 3,800,568.38 10.009 360 360 24 5.538 16.982 10.009 3.000 1.000
$ 6,231,071.22 10.103 360 360 24 5.666 17.102 10.103 3.000 1.000
$ 6,245,625.18 10.102 360 360 24 5.730 17.100 10.102 3.000 1.000
$ 26,677.21 10.890 360 360 36 5.922 17.511 10.890 3.000 1.000
$ 55,844.32 10.380 360 360 36 5.577 17.380 10.380 3.000 1.000
$ 57,543.04 8.290 360 360 36 4.860 15.290 8.290 3.000 1.000
$ 711,185.95 9.558 360 360 36 5.265 16.558 9.558 3.000 1.000
$ 511,864.46 10.061 360 360 36 5.435 17.061 10.061 3.000 1.000
</TABLE>
<TABLE>
<CAPTION>
ORIGINAL REMAINING ORIGINAL
TERM TO TERM TO AMORTIZATION
PRINCIPAL MORTGAGE MATURITY MATURITY TERM AMORTIZATION
BALANCE RATE (%) (IN MONTHS) (IN MONTHS) (IN MONTHS) TYPE
--------- -------- ----------- ----------- ------------ ------------
<S> <C> <C> <C> <C> <C>
FIXED
Initial
$15,070,596.13 9.476 179 178 179 Level Pay
$40,115,360.95 9.804 357 355 357 Level Pay
$79,013,558.97 9.924 180 178 360 Balloon
Subsequent
$ 2,359,384.68 9.476 179 179 179 Level Pay
$ 6,280,280.29 9.804 357 357 357 Level Pay
$12,370,007.04 9.924 180 180 360 Balloon
</TABLE>
(ii) One-Month LIBOR, Six-Month LIBOR and One-Year CMT remain constant at
5.65625%, 5.75% and 5.33%, respectively; (iii) the Applicable Spread on the
Class A-2 Bonds remains constant at 0.07% per annum, (iv) payments on the
Bonds are based upon the actual number of days in the month and a 360-day year
and are received, in cash, on the 25th day of each month, commencing in
September 1998; (v) there are no delinquencies or losses on the Mortgage
Loans, and principal payments on the Mortgage Loans are timely received
together with prepayments, if any, at the respective constant percentages of
CPR or Prepayment Assumption set forth in
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<PAGE>
the following tables; (vi) there are no repurchases of the Mortgage Loans;
(vii) the scheduled monthly payment for each Mortgage Loan is calculated based
on its principal balance, Mortgage Rate and remaining term to maturity such
that such Mortgage Loan will amortize in amounts sufficient to repay the
remaining principal balance of such Mortgage Loan by its remaining term to
maturity; (viii) the Indices remain constant at the rates listed above and the
Mortgage Rate on each Adjustable Rate Mortgage Loan is adjusted on the next
Adjustment Date (and on subsequent Adjustment Dates, as necessary) to equal
the related Index plus the applicable Gross Margin, subject to the Maximum
Mortgage Rate and the related Periodic Rate Cap listed above; (ix) with
respect to each Mortgage Loan (other than the Fixed Rate Mortgage Loans), the
monthly payment on the Mortgage Loan is adjusted on the Due Date immediately
following the next related Adjustment Date (and on subsequent Adjustment
Dates, as necessary) to equal a fully amortizing payment as described in
clause (vii) above; (x) payments on the Mortgage Loans earn no reinvestment
return; (xi) the Bond Insurance Premium is the rate set forth in the Insurance
Agreement, the PMI Premium is set forth in the PMI Insurance Agreement, the
Indenture Trustee Fee Rate is 0.0125% per annum, the Owner Trustee Fee is
$4,000 per annum (payable on the Payment Date in September of each year) and
the Servicing Fee Rate is 0.50% per annum; (xii) there are no additional
ongoing Trust Estate expenses payable out of the Trust Estate; (xiii) premium
payments are made under the First and Second CAP Agreements in accordance with
their terms; (xiv) the Mortgage Loans experience no prepayment charges; (xv)
the reinvestment rate on the Pre-Funded Amount is One-Month LIBOR, and no
other miscellaneous servicing fees are passed through to the Bondholders;
(xvi) the Subsequent Mortgage Loans are acquired on September 25, 1998,
resulting in no mandatory prepayment of the Bonds on the October 25, 1998,
Payment Date; and (xvii) the Bonds will be purchased on August 19, 1998.
The actual characteristics and performance of the Mortgage Loans will differ
from the assumptions used in constructing the table set forth below, which is
hypothetical in nature and is provided only to give a general sense of how the
principal cash flows might behave under varying prepayment scenarios. For
example, it is very unlikely that the Mortgage Loans will prepay at a constant
level of CPR until maturity or that all of the Mortgage Loans will prepay at
the same level of CPR or Prepayment Assumption. Moreover, the diverse
remaining terms to stated maturity of the Mortgage Loans could produce slower
or faster principal payments than indicated in the table at the various
constant percentages of CPR specified, even if the weighted average remaining
term to stated maturity of the Mortgage Loans is as assumed. Any difference
between such assumptions and the actual characteristics and performance of the
Mortgage Loans, or actual prepayment experience, will affect the percentages
of initial Bond Principal Balance outstanding over time and the weighted
average life of the Bonds. Subject to the foregoing discussion and
assumptions, the following table indicates the weighted average life of the
Bonds, and sets forth the percentages of the initial Bond Principal Balance of
the Bonds that would be outstanding after each of the dates shown at various
percentages of CPR.
PERCENT OF INITIAL BOND PRINCIPAL BALANCE OF THE CLASS A-1 BONDS OUTSTANDING
AT THE SPECIFIED PERCENTAGES OF CPR OR THE PREPAYMENT ASSUMPTION
<TABLE>
<CAPTION>
SCENARIO(1)(5)
-----------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Fixed Rate Mortgage Loans(2)........ 0% 50% 75% 100% 125% 150% 200%
Adjustable Rate Mortgage Loans(3)... 0% 14% 21% 28% 35% 42% 56%
----- ---- ---- ---- ---- ---- ----
<CAPTION>
PAYMENT DATE
- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Initial Percentage.................. 100% 100% 100% 100% 100% 100% 100%
August 25, 1999..................... 96 85 79 74 69 63 52
August 25, 2000..................... 95 73 63 54 46 39 26
August 25, 2001..................... 94 63 51 40 31 0 0
August 25, 2002..................... 93 55 41 30 0 0 0
August 25, 2003..................... 92 47 33 0 0 0 0
August 25, 2004..................... 91 41 26 0 0 0 0
August 25, 2005..................... 0 0 0 0 0 0 0
Weighted Average Life in
Years(4)(5)........................ 6.57 4.35 3.38 2.52 1.99 1.63 1.18
Weighted Average Life in
Years(4)(6)........................ 17.68 5.94 4.22 3.16 2.50 2.05 1.47
</TABLE>
- --------
(1) Rounded to the nearest whole percentage.
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<PAGE>
(2) As a percentage of the Prepayment Assumption.
(3) As conditional prepayment rate (CPR) percentage.
(4) The weighted average life of a Bond is determined by (i) multiplying the
amount of each distribution of principal on a Bond by the number of years
from the date of issuance of the Bond to the related Payment Date, (ii)
adding the results, and (iii) dividing the sum by the Initial Bond
Principal Balance of the Bond.
(5) Assumes the Issuer exercises its option to redeem the Bonds at the earlier
of: (a) when outstanding Bond Principal Balance is less than 25% of the
original Bond Principal Balance or (b) the August 2005 Payment Date. See
"Description of the Bonds--Optional Redemption" herein.
(6) Assumes that the Bonds remain outstanding to their maturity date.
PERCENT OF INITIAL BOND PRINCIPAL BALANCE OF THE CLASS A-2 BONDS OUTSTANDING
AT THE SPECIFIED PERCENTAGES OF CPR OR THE PREPAYMENT ASSUMPTION
<TABLE>
<CAPTION>
SCENARIO(1)(5)
-----------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Fixed Rate Mortgage Loans(2)................ 0% 50% 75% 100% 125% 150% 200%
Adjustable Rate Mortgage Loans(3)........... 0% 14% 21% 28% 35% 42% 56%
----- ---- ---- ---- ---- ---- ----
<CAPTION>
PAYMENT DATE
- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Initial Percentage.......................... 100% 100% 100% 100% 100% 100% 100%
August 25, 1999............................. 96 85 79 74 69 63 52
August 25, 2000............................. 95 73 63 54 46 39 26
August 25, 2001............................. 94 63 51 40 31 0 0
August 25, 2002............................. 93 55 41 30 0 0 0
August 25, 2003............................. 92 47 33 0 0 0 0
August 25, 2004............................. 91 41 26 0 0 0 0
August 25, 2005............................. 0 0 0 0 0 0 0
Weighted Average Life in Years(4)(5)........ 6.57 4.35 3.38 2.52 1.99 1.63 1.18
Weighted Average Life in Years(4)(6)........ 17.68 5.94 4.22 3.16 2.50 2.05 1.47
</TABLE>
- --------
(1) Rounded to the nearest whole percentage.
(2) As a percentage of the Prepayment Assumption.
(3) As conditional prepayment rate (CPR) percentage.
(4) The weighted average life of a Bond is determined by (i) multiplying the
amount of each distribution of principal on a Bond by the number of years
from the date of issuance of the Bond to the related Payment Date, (ii)
adding the results, and (iii) dividing the sum by the Initial Bond
Principal Balance of the Bond.
(5) Assumes the Issuer exercises its option to redeem the Bonds at the earlier
of: (a) when outstanding Bond Principal Balance is less than 25% of the
original Bond Principal Balance or (b) the August 2005 Payment Date. See
"Description of the Bonds--Optional Redemption" herein.
(6) Assumes that the Bonds remain outstanding to their maturity date.
THESE TABLES HAVE BEEN PREPARED BASED ON THE ASSUMPTIONS DESCRIBED IN THE
SECOND PARAGRAPH PRECEDING THESE TABLES (INCLUDING THE ASSUMPTIONS REGARDING
THE CHARACTERISTICS AND PERFORMANCE OF THE MORTGAGE LOANS WHICH DIFFER FROM
THE ACTUAL CHARACTERISTICS AND PERFORMANCE THEREOF) AND SHOULD BE READ IN
CONJUNCTION THEREWITH.
S-71
<PAGE>
DESCRIPTION OF THE SERVICING AGREEMENT
The following summary describes certain terms of the Servicing Agreement,
dated as of August 1, 1998, between the Issuer, the Indenture Trustee and the
Servicer (the "Servicing Agreement"). The summary does not purport to be
complete and is subject to, and qualified in its entirety by reference to, the
provisions of the Servicing Agreement. Whenever particular sections or defined
terms of the Servicing Agreement are referred to, such sections or defined
terms are thereby incorporated herein by reference.
THE SERVICER
NovaStar Mortgage, Inc., a Virginia corporation (the "Servicer"), will act
as Servicer for the Mortgage Loans pursuant to the Servicing Agreement. The
Servicer is a wholly-owned subsidiary of NFI Holding Corporation, Inc., a
Delaware corporation ("Holding"). The Seller owns one hundred percent of the
preferred stock of Holding. The Servicer serves as a loan servicer and a
vehicle for loan origination--a primary source of mortgage assets for the
Seller. The Servicer is an approved HUD lender. See "The Issuer--NovaStar
Mortgage" in the Prospectus.
The Servicer originates subprime residential mortgage loans through a
network of unaffiliated wholesale loan brokers, and the mortgage loans it
originates are generally sold to the Seller on a servicing-retained basis. The
Servicer utilizes a network of approximately 600 wholesale loan brokers in 35
different states. In addition, the Servicer services loans nationwide, and is
qualified to do business as a foreign corporation in more than 45 states. The
Servicer's servicing portfolio currently includes only subprime residential
mortgage loans. The Servicer's principal executive offices are located at 1900
W. 47th Place, Suite 205, Westwood, Kansas 66205. The principal office for the
Servicer's mortgage lending operations are in Irvine, California. See "The
Issuer--NovaStar Mortgage" in the Prospectus.
The Servicer believes that its servicing and loan origination software
applications and the internal information systems are Year 2000 compliant. As
a result, the Servicer does not currently anticipate any material disruption
in its operations as a result of any failure of the Servicer to be in
compliance.
FORECLOSURE AND DELINQUENCY EXPERIENCE WITH SUBPRIME MORTGAGE LOANS
The following table summarizes the delinquency and foreclosure experience,
respectively, as of the date indicated, of the Subprime Mortgage Loans
originated and serviced by the Servicer. The information should not be
considered as a basis for assessing the likelihood, amount or severity of
delinquencies or foreclosures on the Mortgage Loans securing the Bonds and no
assurances can be given that the foreclosure and delinquency experience
presented in the table below will be indicative of such experience on the
Mortgage Loans securing the Bonds:
DELINQUENCY AND FORECLOSURE
<TABLE>
<CAPTION>
AS OF JUNE 30, 1998
-------------------------
PRINCIPAL
BALANCE PERCENTAGE
-------------- ----------
<S> <C> <C>
Subprime Mortgage Loan Portfolio................ $ 873,663,010 100%
Delinquency Percentage(1)
30--59 Days................................... 8,238,946.84 .94%
60--89 Days................................... 4,872,118.56 .56%
90+ Days...................................... 18,432,687.98 2.11%
-------------- -----
Total....................................... 31,543,753.34 3.61%
-------------- -----
Foreclosure Rate(2)............................. $16,983,229.05 1.94%
============== =====
</TABLE>
S-72
<PAGE>
- --------
(1) The period of delinquency is based on the number of days payments are
contractually past due.
(2) "Foreclosure Rate" is the dollar amount of the mortgage loans in
foreclosure as a percentage of the total principal balance of the mortgage
loans outstanding as of the date indicated. These amounts are also
included in the line titled "Total."
There can be no assurance that the delinquency experience of the Mortgage
Loans securing the Bonds will correspond to the delinquency and foreclosure
experience of the servicing portfolio of the Servicer set forth in the
foregoing table. The statistics shown above represent the respective
delinquency and foreclosure experiences only at the date presented, whereas
the aggregate delinquency and foreclosure experience on the Mortgage Loans
securing the Bonds will depend on the results obtained over the life of the
Bonds. The Servicer's servicing portfolio may include Subprime Mortgage Loans
underwritten pursuant to guidelines not necessarily representative of those
applicable to the Mortgage Loans securing the Bonds. It should be noted that
if the residential real estate market should experience an overall decline in
property values, the actual rates of delinquencies and foreclosures could be
higher than those previously experienced by the Servicer. In addition, adverse
economic conditions may affect the timely payment by mortgagors of scheduled
payments of principal and interest on Mortgage Loans and, accordingly, the
actual rates of delinquencies and foreclosures with respect to Mortgage Loans.
SERVICING AND OTHER COMPENSATION
The Servicing Fee for each Mortgage Loan is payable out of the interest
payments on such Mortgage Loan. The Servicing Fee Rate in respect of each
Mortgage Loan will be equal to 0.50% per annum of the outstanding principal
balance of such Mortgage Loan. The Servicer will not be entitled to any
additional servicing compensation (other than late payment charges) such as
prepayment penalties and any such amount, to the extent received by the
Servicer, will be included in Available Funds.
With respect to any Payment Date, any Prepayment Interest Shortfalls during
the preceding calendar month will be covered by the Servicer, but only to the
extent such Prepayment Interest Shortfalls do not exceed an amount equal to
the total servicing fee payable to the Servicer and any subservicer with
respect to such Payment Date (any such payments, "Compensating Interest"). The
"Prepayment Interest Shortfall" for any Payment Date is equal to the aggregate
shortfall, if any, in collections of interest resulting from Mortgagor
prepayments in full or in part on the Mortgage Loans during the preceding
calendar month. Such shortfalls will result because interest on prepayments in
full is distributed only to the date of prepayment, and because no interest is
distributed on prepayments in part, as such prepayments in part are applied to
reduce the outstanding principal balance of the related Mortgage Loans as of
the Due Date in the month of prepayment. No assurance can be given that
Compensating Interest will be sufficient to cover Prepayment Interest
Shortfalls for any Payment Date.
SALE OF CONVERTED MORTGAGE LOANS
The Initial Mortgage Loans include loans that are convertible, subject to
certain conditions, from a variable-rate loan to a fixed-rate loan at the
option of the borrower (the "Convertible Mortgage Loans"). Approximately
48.83% of the Initial Mortgage Loans are, and up to 100% of the Subsequent
Mortgage Loans may be, Convertible Mortgage Loans. The Convertible Mortgage
Loans generally give the borrower the option on an interest rate change date
(which is generally the anniversary of the loan), after an initial period
(typically 2 or 3 years) and upon payment of a conversion fee, to convert the
loan from a variable-rate to a fixed-rate loan, provided that the loan is not
past due or otherwise in default. Conversion fees are payable to and retained
by the Servicer.
The following is a summary of the conversion features of the Convertible
Initial Mortgage Loans. The 2/28 Six-Month LIBOR Mortgage Loans permit the
borrower to convert on the first through sixth interest rate change dates. The
3/27 Six-Month LIBOR Mortgage Loans permit the borrower to convert on the
first through fourth interest rate change dates. The Six-Month LIBOR Mortgage
Loans permit the borrower to convert on the fourth through tenth interest rate
change dates. The One-Year CMT Mortgage Loans permit the borrower to convert
on the second through fifth interest rate change dates.
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Under the terms of the Servicing Agreement, within 30 days after the
conversion of a Convertible Mortgage Loan from a variable-rate to a fixed-rate
Mortgage Loan (a "Converted Mortgage Loan"), the Issuer is obligated to sell
and the Servicer is obligated to purchase (and the Indenture Trustee is
obligated to release from the lien of the Indenture) the Converted Mortgage,
for a purchase price equal to the then outstanding principal balance of the
Converted Mortgage Loan, plus accrued and unpaid interest. The purchase
obligations of the Servicer is assignable, but the Servicer remains liable for
such obligation. The cash proceeds of such sale must be deposited in the
Collection Account and used on the next Payment Date to pay principal and
interest due on the Bonds. Mandatory sale of Converted Mortgage Loans will
have the same effect as prepayments of Mortgage Loans, and will result in
prepayments of principal of the Bonds. No party other than the Servicer will
have any obligation to purchase a Converted Mortgage Loan.
THE INDENTURE
The following summary describes certain terms of the Indenture. The summary
does not purport to be complete and is subject to, and qualified in its
entirety by reference to, the provisions of the Trust Agreement and Indenture.
Whenever particular defined terms of the Indenture are referred to, such
defined terms are thereby incorporated herein by reference. See "Description
of the Agreements" in the Prospectus.
CONTROL BY BOND INSURER
Pursuant to the Indenture, unless a Bond Insurer Default exists (i) the Bond
Insurer shall have the right to direct the time, method and place of
conducting any proceeding for any remedy available to the Indenture Trustee or
exercising any trust or power conferred on the Indenture Trustee, subject to
certain limitations, and (ii) the Indenture Trustee may take actions which
would otherwise be at its option or within its discretion, including the
actions referred to under "--Events of Default" and "--Rights Upon Event of
Default," only at the direction of the Bond Insurer and (iii) the Bond Insurer
shall be deemed to be the holder of the Bonds for certain purposes (other than
with respect to payment on the Bonds), and will be entitled to exercise all
rights of the Bondholders thereunder, without the consent of such Bondholders,
and the Bondholders may exercise such rights only with the prior written
consent of the Bond Insurer. A "Bond Insurer Default" means the existence and
continuation of (i) a failure of the Bond Insurer to make a payment under the
Bond Insurance Policy in accordance with its terms or (ii) certain bankruptcy
or insolvency actions by or against the Bond Insurer.
EVENTS OF DEFAULT
An "Event of Default" with respect to the Bonds is defined in the Indenture
as follows: (a) the failure of the Issuer to pay (i) the Interest Payment
Amount or the Principal Payment Amount with respect to a Payment Date on such
Payment Date (provided that for purposes of this clause, payment by the
Indenture Trustee from proceeds of the Bond Insurance Policy shall not be
considered payment by the Issuer with respect to the Bonds), or (ii) any
Subordination Increase Amount or Carry-Forward Amount, but only to the extent
funds are available to make such payment as described under "Description of
the Bonds--Priority of Payment" (provided that for purposes of this clause,
payment by the Indenture Trustee from proceeds of the Bond Insurance Policy
shall not be considered payment by the Issuer with respect to the Bonds); (b)
the failure by the Issuer on the Final Scheduled Payment Date to reduce the
Bond Principal Balance to zero; (c) a default in the observance or performance
of any covenant or agreement of the Issuer in the Indenture, and the
continuation of any such default for a period of thirty days after notice to
the Issuer by the Indenture Trustee or to the Issuer and the Indenture Trustee
by the Bond Insurer, or if a Bond Insurer Default exists, by the Holders of at
least 25% of the Bond Principal Balance of the Bonds; (d) any representation
or warranty made by the Issuer in the Indenture or in any certificate or other
writing delivered pursuant thereto having been incorrect in a material respect
as of the time made, and the circumstance in respect of which such
representation or warranty is incorrect not having been cured within thirty
days after notice thereof is given to the Issuer by the Indenture Trustee or
to the Issuer and the Indenture Trustee by the Bond Insurer, or, if a Bond
Insurer Default exists, by Bondholders representing at least 25% of the Bond
Principal Balance of the Bonds; or (e) certain events of bankruptcy,
insolvency, receivership or reorganization of the Issuer.
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RIGHTS UPON EVENT OF DEFAULT
In case an Event of Default should occur and be continuing with respect to
the Bonds, the Indenture Trustee may (with the prior written consent of the
Bond Insurer) and, upon the written direction of the Bond Insurer or, if a
Bond Insurer Default exists, Bondholders representing more than 50% of the
Bond Principal Balance of the Bonds shall, declare the principal of such Bonds
to be immediately due and payable. Such declaration may under certain
circumstances be rescinded by the Bond Insurer, or if a Bond Insurer Default
exists, Bondholders representing more than 50% of the Bond Principal Balance
of the Bonds.
If, following an Event of Default, the Bonds have been declared to be due
and payable, the Indenture Trustee may, in its discretion (provided that the
Bond Insurer or Bondholders representing more than 50% of the Bond Principal
Balance of the Bonds have not directed the Indenture Trustee to sell the
assets included in the Trust Estate), refrain from selling such assets and
continue to apply all amounts received on such assets to payments due on the
Bonds in accordance with their terms, notwithstanding the acceleration of the
maturity of such Bonds. In addition, upon an Event of Default the Indenture
Trustee may, with the consent of the Bond Insurer, sell all or part of the
assets included in the Trust Estate, in which event the collections on, or the
proceeds from the sale of, such assets will be applied as provided below;
provided, however, that any proceeds of a claim under the Bond Insurance
Policy shall be used only to pay interest and principal on the Bonds as
provided in clauses (iii) and (iv): (i) to the payment of the fees of the
Indenture Trustee which have not been previously paid; (ii) to the Bond
Insurer, any premium then due, provided no Bond Insurer Default exists; (iii)
to the Bondholders, the amount of interest then due and unpaid on the Bonds
(but not including any Carry-Forward Amount), without preference or priority
of any kind; (iv) to the Bondholders, the amount of principal then due and
unpaid on the Bonds, without preference or priority of any kind; (v) to the
payment of the amounts due and owing to the Bond Insurer, to the extent not
previously reimbursed; (vi) to the Bondholders, the amount of any Carry-
Forward Amount not previously paid; and (vii) to the holder of the
Certificates.
Subject to the provisions of the Indenture relating to the duties of the
Indenture Trustee, in case an Event of Default shall occur and be continuing,
the Indenture Trustee shall be under no obligation to exercise any of the
rights and powers under the Indenture at the request or direction of any of
the Bondholders, unless such Bondholders shall have offered to the Indenture
Trustee reasonable security or indemnity satisfactory to it against the costs,
expenses and liabilities which might be incurred by it in complying with such
request or direction. Subject to such provisions for indemnification and
certain limitations contained in the Indenture, the Bond Insurer, or if a Bond
Insurer Default exists, Bondholders representing more than 50% of the Bond
Principal Balance of the Bonds shall have the right to direct the time,
method, and place of conducting any proceeding or any remedy available to the
Indenture Trustee or exercising any trust or power conferred on the Indenture
Trustee with respect to the Bonds; and the Bond Insurer, or if a Bond Insurer
Default exists, Bondholders representing more than 50% of the Bond Principal
Balance of the Bonds may, in certain cases, waive any default with respect
thereto, except a default in the payment of principal or interest or a default
in respect of a covenant or provision of the Indenture that cannot be modified
without the waiver or consent of the holder of each outstanding Bond affected
thereby.
LIMITATION ON SUITS
No Bondholder will have any right to institute any proceedings with respect
to the Indenture unless (1) such Bondholder has previously given written
notice to the Indenture Trustee of a continuing Event of Default; (2)
Bondholders representing not less than 25% of the Bond Principal Balance of
the Bonds have made written request to the Indenture Trustee to institute
proceedings in respect of such Event of Default in its own name as Indenture
Trustee; (3) such Bondholders have offered to the Indenture Trustee reasonable
indemnity satisfactory to it against the costs, expenses and liabilities to be
incurred in compliance with such request; (4) for 60 days after its receipt of
such notice of, request and offer of indemnity the Indenture Trustee has
failed to institute any such proceedings; (5) no direction inconsistent with
such written request has been given to the Indenture Trustee during such 60-
day period by the Bondholders representing more than 50% of the Bond Principal
Balance of the Bonds; and (6) such Bondholders have the consent of the Bond
Insurer, unless a Bond Insurer Default exists.
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THE INDENTURE TRUSTEE
The Indenture Trustee may resign at any time, in which event the Issuer will
be obligated to appoint, with the consent of the Bond Insurer, a successor
Indenture Trustee. The Indenture Trustee also may be removed at any time by
the Bond Insurer, or if a Bond Insurer Default exists, then by Bondholders
representing more than 50% of the Bond Principal Balance of the Bonds. The
Issuer shall, with the consent of the Bond Insurer, so long as no Bond Insurer
Default exists, remove the Indenture Trustee if the Indenture Trustee ceases
to be eligible to continue as such under the Indenture or if the Indenture
Trustee becomes incapable of acting, bankrupt, insolvent or if a receiver or
public officer takes charge of the Indenture Trustee or its property. Any
resignation or removal of the Indenture Trustee and appointment of a successor
Indenture Trustee will not become effective until acceptance of the
appointment by the successor Indenture Trustee.
FEDERAL INCOME TAX CONSEQUENCES
Upon the issuance of the Bonds, Stinson, Mag & Fizzell, P.C., counsel to the
Company, will deliver its opinion generally to the effect that based on the
application of existing law and assuming compliance with the Trust Agreement,
for federal income tax purposes, the Bonds will be characterized as
indebtedness and not as representing an ownership interest in the Trust Estate
or an equity interest in the Issuer or the Company. In addition, for federal
income tax purposes, the Issuer will not be (i) classified as an association
taxable as a corporation for federal income tax purposes, (ii) a taxable
mortgage pool as defined in Section 7701(i) of the Code, or (iii) a "publicly
traded partnership" as defined in Treasury Regulation Section 1.7704-1.
The Bonds will not be treated as having been issued with "original issue
discount" (as defined in the Prospectus). The prepayment assumption that will
be used in determining the rate of amortization of market discount and
premium, if any, for federal income tax purposes will be based on the
assumption that, subsequent to the date of any determination the Adjustable
Rate Mortgage Loans will prepay at a rate equal to 28% CPR and the Fixed Rate
Mortgage Loans will prepay at a rate equal to 2% CPR in the first month of the
life of the Fixed Rate Mortgage Loans and an additional 1.63636% CPR per annum
in each month thereafter until the twelfth month; beginning in the twelfth
month and in each month thereafter, the Fixed Rate Mortgage Loans will prepay
at a rate equal to 20% CPR. No representation is made that the Mortgage Loans
will prepay at that rate or at any other rate. See "Federal Income Tax
Consequences" in the Prospectus.
The Bonds will not be treated as assets described in Section 7701(a)(19)(C)
of the Code or "real estate assets" under Section 856(c)(4)(A) of the Code. In
addition, interest on the Bonds will not be treated as "interest on
obligations secured by mortgages on real property" under Section 856(c)(3)(B)
of the Code. The Bonds will also not be treated as "qualified mortgages" under
Section 860G(a)(3)(C) of the Code.
Prospective investors in the Bonds should see "Federal Income Tax
Consequences" and "State Tax Considerations" in the Prospectus for a
discussion of the application of certain federal income and state and local
tax laws to the Issuer and purchasers of the Bonds.
METHOD OF DISTRIBUTION
Subject to the terms and conditions set forth in an Underwriting Agreement,
dated August 14, 1998 (the "Underwriting Agreement"), between Merrill Lynch,
Pierce, Fenner & Smith Incorporated (the "Underwriter"), the Company and the
Seller, the Underwriter has agreed to purchase and the Company has agreed to
sell to the Underwriter the Bonds. It is expected that delivery of the Bonds
will be made only in book-entry form through the Same Day Funds Settlement
System of DTC, CEDEL S.A. and the Euroclear System, on or about August 19,
1998, against payment therefor in immediately available funds.
The Bonds will be purchased from the Company by the Underwriter and will be
offered by the Underwriter from time to time to the public in negotiated
transactions or otherwise at varying prices to be determined at the
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time of sale. The Underwriter may sell some or all of the Bonds to one or more
trusts with respect to which the Underwriter or an affiliate will act as
depositor. The proceeds to the Company from the sale of the Bonds are expected
to be approximately $314,310,938, before the deduction of expenses. The
Underwriter may effect such transactions by selling the Bonds to or through
dealers, and such dealers may receive compensation in the form of underwriting
discounts, concessions or commissions from the Underwriter. In connection with
the sale of the Bonds, the Underwriter may be deemed to have received
compensation from the Company in the form of underwriting compensation. The
Underwriter and any dealers that participate with the Underwriter in the
distribution of the Bonds may be deemed to be underwriters and any profit on
the resale of the Bonds purchased by them may be deemed to be underwriting
discounts and commissions under the Securities Act of 1933.
The Underwriting Agreement provides that the Company and the Seller will
jointly and severally indemnify the Underwriter, and that under limited
circumstances, the Underwriter will indemnify the Company, against certain
civil liabilities under the Securities Act of 1933, or contribute to payments
required to be made in respect thereof.
There can be no assurance that a secondary market for the Bonds will develop
or, if it does develop, that it will continue or provide the Bondholders with
sufficient liquidity of investment. The primary source of information
available to investors concerning the Bonds will be the monthly statements
discussed in the Prospectus under "Description of the Bonds--Reports to
Bondholders," which will include information as to the outstanding principal
balance of the Bonds. There can be no assurance that any additional
information regarding the Bonds will be available through any other source. In
addition, the Company is not aware of any source through which price
information about the Bonds will be generally available on an ongoing basis.
The limited nature of such information regarding the Bonds may adversely
affect the liquidity of the Bonds, even if a secondary market for the Bonds
becomes available.
LEGAL OPINIONS
Certain legal matters relating to the Bonds will be passed upon for the
Seller, the Servicer and the Company by Stinson, Mag & Fizzell, P.C., Kansas
City, Missouri, and for the Underwriter by Thacher Proffitt & Wood, New York,
New York. Certain legal matters regarding the enforceability of the Bond
Insurance Policy will be passed upon for the Bond Insurer by Kutak Rock,
Omaha, Nebraska.
RATINGS
It is a condition of the issuance of the Bonds that they be rated "AAAr" by
Standard & Poor's Ratings Services, a division of The McGraw-Hill Companies,
Inc. ("S&P") and "Aaa" by Moody's Investors Service, Inc. ("Moody's").
S&P's ratings on mortgage pass-through certificates address the likelihood
of the receipt by Bondholders of payments required under the Indenture. S&P's
ratings take into consideration the credit quality of the mortgage pool,
structural and legal aspects associated with the Bonds, and the extent to
which the payment stream in the mortgage pool is adequate to make payments
required under the Bonds. S&P's rating on the Bonds does not, however,
constitute a statement regarding frequency of prepayments on the mortgages.
See "Certain Yield and Prepayment Considerations" herein. The ratings issued
by S&P on payment of principal and interest do not cover the payment of any
Prepayment Interest Shortfalls, any Relief Act Shortfalls or the Carry-Forward
Amount.
The rating process of Moody's addresses the structural and legal aspects
associated with the Bonds, including the nature of the underlying Mortgage
Loans. The ratings assigned to the Bonds do not represent any assessment of
the likelihood or rate of principal prepayments. The ratings do not address
the possibility that Bondholders might suffer a lower than anticipated yield.
The ratings do not address the likelihood that Bondholders will be paid the
Carry-Forward Amount.
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The Company has not requested a rating on the Bonds by any rating agency
other than S&P and Moody's. However, there can be no assurance as to whether
any other rating agency will rate the Bonds, or, if it does, what rating would
be assigned by any such other rating agency. A rating on the Bonds by another
rating agency, if assigned at all, may be lower than the ratings assigned to
the Bonds by S&P and Moody's.
A security rating is not a recommendation to buy, sell or hold securities
and may be subject to revision or withdrawal at any time by the assigning
rating organization. Each security rating should be evaluated independently of
any other security rating. In the event that the ratings initially assigned to
the Bonds are subsequently lowered for any reason, no person or entity is
obligated to provide any additional support or credit enhancement with respect
to the Bonds.
LEGAL INVESTMENT\
The Bonds will constitute "mortgage related securities" for the purposes of
the Secondary Mortgage Market Enhancement Act of 1984 ("SMMEA") for so long as
they are rated in at least the second highest rating category by one or more
nationally recognized statistical rating agencies, and, as such, are legal
investments for certain entities to the extent provided in SMMEA. SMMEA
provides, however, that states could override its provision on legal
investment and restrict or condition investment in mortgage related securities
by taking statutory action on or prior to October 3, 1991.
The Company makes no representations as to the proper characterization of
the Bonds for legal investment or other purposes, or as to the ability of
particular investors to purchase the Bonds under applicable legal investment
restrictions. These uncertainties may adversely affect the liquidity of the
Bonds. Accordingly, all institutions whose investment activities are subject
to legal investment laws and regulations, regulatory capital requirements or
review by regulatory authorities should consult with their legal advisors in
determining whether and to what extent the Bonds constitute a legal investment
or are subject to investment, capital or other restrictions.
See "Legal Investment" in the Prospectus.
ERISA CONSIDERATIONS
A fiduciary of any employee benefit plan or any other plan or arrangement
subject to the Employee Retirement Income Security Act of 1974, as amended
("ERISA"), or Section 4975 of the Code (each, a "Plan") or any person
investing "Plan Assets" of any Plan (as defined in the Prospectus under "ERISA
Considerations") should carefully review with its legal advisors whether the
purchase, sale or holding of the Bonds will give rise to a prohibited
transaction under ERISA or Section 4975 of the Code.
EXPERTS
The consolidated balance sheets of MBIA Insurance Corporation and
Subsidiaries as of December 31, 1997 and December 31, 1996 and the related
consolidated statements of income, changes in shareholder's equity, and cash
flows for each of the three years in the period ended December 31, 1997,
incorporated by reference in this Prospectus Supplement, have been
incorporated herein in reliance on the report of PricewaterhouseCoopers LLP,
independent accountants, given on the authority of that firm as experts in
accounting and auditing.
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ANNEX I
GLOBAL CLEARANCE, SETTLEMENT AND TAX DOCUMENTATION PROCEDURES
Except in certain limited circumstances, the globally offered NovaStar Home
Equity Loan Asset-Backed Bonds, Series 1998-2 (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 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 Depositories 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.
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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
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 is 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 is 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
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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 value date
(i.e., the trade fails), receipt of the cash proceeds in the CEDEL
Participant's or Euroclear Participant's account would instead be valued as of
the actual settlement date.
Finally, day traders that use CEDEL or Euroclear and that purchase Global
Bonds from DTC Participants for delivery to CEDEL Participants or Euroclear
Participants should note that these trades would 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
I-3
<PAGE>
(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-4
<PAGE>
PROSPECTUS
NOVASTAR MORTGAGE FUNDING CORPORATION
(DEPOSITOR)
$1,250,000,000
(AGGREGATE AMOUNT)
HOME EQUITY LOAN ASSET-BACKED BONDS
(ISSUABLE IN SERIES)
---------------
NovaStar Mortgage Funding Corporation, a Delaware corporation (the "Company"
or the "Depositor"), 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 Home Equity Loan Asset-Backed Bonds (the
"Bonds"). The Bonds of each series will be collateralized by one or more
segregated pools of mortgage collateral (the "Mortgage Collateral" or the
"Assets") consisting of one or more of the following: (i) fixed or variable
rate, first or junior lien mortgage loans secured by one- to four-family
residential properties ("Mortgage Loans"), (ii) mortgage participations,
mortgage pass-through certificates or mortgage-backed 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") (collectively, "Agency Securities"); (iii)
other mortgage participations, mortgage pass-through certificates or mortgage
backed securities evidencing interests in mortgage loans or secured thereby
("Private Mortgage-Backed Securities") (Agency Securities and Private
Mortgage-Backed Securities are collectively referred to as "MBS"), (iv)
manufactured housing installment sale contracts or installment loan agreements
("Contracts"), (v) certain direct obligations of the United States, agencies
thereof or agencies created thereby ("Government Bonds"), (vi) certain debt
obligations of corporations or other nongovernmental entities ("Corporate
Bonds") or (vii) a combination of Mortgage Loans, MBS, Contracts, Government
Bonds and Corporate Bonds. The Mortgage Loans and MBS are collectively
referred to herein as the "Mortgage Assets." If so specified in the related
Prospectus Supplement, a series of Bonds may also be secured by certain cash
accounts, overcollateralization, excess spread, crosscollateralization,
subordination, reserve funds, insurance policies, surety bonds, guarantees,
letters of credit or other types of credit support, or any combination thereof
(with respect to any series, collectively, "Credit Support"), and guaranteed
investment contracts or currency or interest rate exchange agreements and
other financial assets, or any combination thereof (with respect to any
series, collectively, "Cash Flow Agreements"). See "Description of Credit
Support" and "Description of the Assets--Cash Flow Agreements." Each series of
Bonds will be issued and secured pursuant to an indenture and will represent
indebtedness of the Issuer thereof (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 Principal Definitions" at
the end of this Prospectus for the location of the definitions of certain
capitalized terms.
The residential Mortgage Loans securing the Bonds will generally be Subprime
Mortgage Loans. "Subprime Mortgage Loans" are Mortgage Loans that do not meet
underwriting standards for credit quality and documentation sufficient to
qualify for guarantee by FNMA or FHLMC. As such, Subprime Mortgage Loans tend
to have higher delinquency and loss rates than prime loans.
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. 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 Assets 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
18 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.
The date of this Prospectus is April 23, 1998.
<PAGE>
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 generally will not be insured or guaranteed by any governmental agency or
instrumentality or by the Company, any affiliate of the Company, or any other
person or entity. The related Prospectus Supplement will specify whether or
not a series of Bonds is insured or guaranteed by 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.
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 Assets securing such series of Bonds and,
if applicable, information as to any insurance policies, surety bonds,
guarantees, letters of credit, guaranteed investment contracts,
overcollateralization or excess spread reinvestment income, 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 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 Mortgage Assets 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 (as defined herein) and the
Indenture Trustee (as defined herein) for such series.
2
<PAGE>
AVAILABLE INFORMATION
The Company 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.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
All documents subsequently filed by or on behalf of the Issuer of a series
of Bonds 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"), shall be
deemed to be incorporated by reference in this Prospectus and to be a part of
this Prospectus. Any subsequent statement made in a document incorporated by
reference and made a part hereof that is inconsistent with a statement
previously made herein shall be deemed to supersede, modify and amend such
prior statement. None of the Company, the Master Servicer or the Indenture
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 Indenture 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 Indenture 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 Indenture Trustee or such other
entity.
3
<PAGE>
TABLE OF CONTENTS
<TABLE>
<S> <C>
PROSPECTUS SUPPLEMENT....................................................... 2
AVAILABLE INFORMATION....................................................... 3
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE............................. 3
SUMMARY..................................................................... 5
RISK FACTORS................................................................ 18
Bonds Secured By Subprime Mortgage Loans................................... 18
Limited Assets............................................................. 18
Mortgage Loans and Mortgaged Properties In General......................... 19
Balloon Payments........................................................... 21
Junior Mortgage Loans...................................................... 21
Contracts and Manufactured Homes In General................................ 22
Security Interests and Certain Other Legal Aspects of the Contracts........ 22
Credit Support Limitations................................................. 23
Subordination of the Subordinated Bonds; Effect of Losses on the Assets.... 23
Bankruptcy and Insolvency Risks............................................ 24
Book-Entry Registration.................................................... 24
Limited Nature of Ratings.................................................. 25
Prepayment and Yield Considerations; Reinvestment Risk..................... 25
Pre-funding Accounts May Result in Reinvestment Risk....................... 26
Pre-funding Accounts May Adversely Affect Investment....................... 26
Consequences of Owning Original Issue Discount Bonds....................... 27
Tax Status of Issuer....................................................... 27
Environmental Risks........................................................ 27
Limited Liquidity of Investment............................................ 28
SWAP, Cap and Floor Agreements............................................. 28
INTRODUCTION................................................................ 29
THE ISSUER.................................................................. 29
General.................................................................... 29
The Company................................................................ 30
NovaStar Financial......................................................... 30
NovaStar Mortgage.......................................................... 31
Foreclosure and Delinquency Experience with Subprime Mortgage Loans........ 31
USE OF PROCEEDS............................................................. 32
DESCRIPTION OF THE ASSETS................................................... 32
Assets..................................................................... 32
Mortgage Loans............................................................. 33
MBS........................................................................ 38
Contracts.................................................................. 39
Government Bonds........................................................... 39
Corporate Bonds............................................................ 39
Pre-Funding Account........................................................ 40
Accounts................................................................... 40
Credit Support............................................................. 40
Cash Flow Agreements....................................................... 40
YIELD CONSIDERATIONS........................................................ 41
General.................................................................... 41
Bond Interest Rate......................................................... 41
Timing of Payment of Interest.............................................. 41
Payments of Principal; Prepayments......................................... 41
Prepayments--Maturity and Weighted Average Life............................ 42
Other Factors Affecting Weighted Average Life.............................. 43
DESCRIPTION OF THE BONDS.................................................... 46
General.................................................................... 46
Distributions.............................................................. 47
Available Funds............................................................ 47
Distributions of Interest on the Bonds..................................... 48
Distributions of Principal of the Bonds.................................... 48
Components................................................................. 48
Distributions on the Bonds of Prepayment Premiums.......................... 49
Allocation of Losses and Shortfalls........................................ 49
Advances in Respect of Delinquencies....................................... 49
Reports to Bondholders..................................................... 49
Redemption................................................................. 51
Put Option................................................................. 52
Book-Entry Registration and Definitive Bonds............................... 52
DESCRIPTION OF THE AGREEMENTS............................................... 53
Agreements Applicable to a Series.......................................... 53
Assignment of Assets; Repurchases.......................................... 54
Representations and Warranties; Repurchases................................ 55
Collection Account and Related Accounts.................................... 57
Collection and Other Servicing Procedures.................................. 59
Sub-Servicers.............................................................. 60
</TABLE>
<TABLE>
<S> <C>
Realization Upon Defaulted Whole Loans..................................... 60
Hazard Insurance Policies.................................................. 62
Fidelity Bonds and Errors and Omissions Insurance.......................... 64
Due-on-Sale Provisions..................................................... 64
Retained Interest; Servicing Compensation and Payment of Expenses.......... 64
Evidence as to Compliance.................................................. 65
Certain Matters Regarding a Master Servicer and the Company................ 65
Events of Default under the Agreement...................................... 66
Rights Upon Event of Default under the Agreement........................... 66
Amendment.................................................................. 67
The Indenture Trustee...................................................... 67
Duties of the Indenture Trustee............................................ 67
Certain Matters Regarding the Indenture Trustee............................ 67
Resignation and Removal of the Indenture Trustee........................... 68
Certain Terms of the Indenture............................................. 68
DESCRIPTION OF CREDIT SUPPORT............................................... 70
General.................................................................... 70
Overcollateralization...................................................... 71
Crosscollateralization..................................................... 71
Excess Spread.............................................................. 71
Subordination.............................................................. 71
Reserve Funds.............................................................. 72
Bond Insurance Policies, Surety Bonds and Guarantees....................... 73
Letter of Credit........................................................... 73
Credit Support with Respect to MBS......................................... 73
CERTAIN LEGAL ASPECTS OF MORTGAGE LOANS.................................... 74
General.................................................................... 74
Types of Mortgage Instruments.............................................. 74
Interest in Real Property.................................................. 74
Cooperative Loans.......................................................... 75
Tax Aspects of Cooperative Ownership....................................... 76
Foreclosure................................................................ 76
Junior Mortgages........................................................... 79
Anti-Deficiency Legislation and Other Limitations on Lenders............... 80
Environmental Legislation.................................................. 81
Due-on-Sale Clauses........................................................ 82
Prepayment Charges......................................................... 83
Subordinate Financing...................................................... 83
Applicability of Usury Laws................................................ 83
Alternative Mortgage Instruments........................................... 84
Soldiers' and Sailors' Civil Relief Act of 1940............................ 84
Forfeitures in Drug and RICO Proceedings................................... 85
CERTAIN LEGAL ASPECTS OF THE CONTRACTS...................................... 85
General.................................................................... 85
Bond Interests in the Manufactured Homes................................... 85
Enforcement of Security Interests in Manufactured Homes.................... 87
Consumer Protection Laws................................................... 89
Anti-Deficiency Legislation and Other Limitations on Lenders............... 89
Transfers of Manufactured Homes; Enforceability of "Due-on-Sale" Clauses... 90
Applicability of Usury Laws................................................ 90
Formaldehyde Litigation with Respect to Contracts.......................... 90
FEDERAL INCOME TAX CONSEQUENCES............................................. 91
General.................................................................... 91
Classification of the Issuer and the Bonds................................. 91
Interest and Original Issue Discount....................................... 92
Market Discount............................................................ 94
Premium.................................................................... 95
Election to Treat All Interest as Original Issue Discount.................. 96
Realized Losses............................................................ 96
Sales of Bonds............................................................. 96
Backup Withholding and Information Reporting............................... 97
Tax Treatment of Foreign Investors......................................... 97
STATE AND OTHER TAX CONSEQUENCES............................................ 98
ERISA CONSIDERATIONS........................................................ 98
LEGAL INVESTMENT............................................................ 99
RATING...................................................................... 101
PLAN OF DISTRIBUTION........................................................ 102
LEGAL MATTERS............................................................... 102
INDEX OF PRINCIPAL DEFINITIONS.............................................. 103
</TABLE>
4
<PAGE>
SUMMARY
The following summary of certain pertinent information is qualified in its
entirety by reference to the more detailed information appearing elsewhere in
this Prospectus and by reference to the information with respect to each series
of Bonds contained in the Prospectus Supplement to be prepared and delivered in
connection with the offering of such series. An Index of Principal Definitions
is included at the end of this Prospectus.
The Issuer with respect to each series of Bonds will be a trust established
by 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 subsidiary of NovaStar Financial, Inc., a Maryland corporation
("NovaStar Financial"), and is an affiliate of NovaStar Mortgage, Inc., a
Virginia corporation ("NovaStar Mortgage").
Each trust that is formed to act as an Issuer will be created pursuant to a
trust agreement between the Company, acting as 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 NovaStar
Financial, NovaStar Mortgage, the Company nor any of their 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.
Company......................... NovaStar Mortgage Funding Corporation (the
"Company" or the "Depositor"), a Delaware
corporation and wholly-owned subsidiary of
NovaStar Financial. The Company is a limited
purpose finance company incorporated to
create the Delaware business trusts that will
issue each series of Bonds and to act as a
conduit for the Mortgage Assets that will
secure the Bonds. It has no operating
business and does not have, and in the future
is not expected to have, any significant
assets. See "The Issuer--The Company."
NovaStar Financial.............. NovaStar Financial, Inc. ("NovaStar
Financial"), a Maryland corporation and a
publicly traded REIT, is primarily engaged in
subprime residential mortgage lending on a
nationwide basis. NovaStar Financial is the
primary source of the Mortgage Assets that
will secure the Bonds. See "The Issuer--
NovaStar financial."
Issuer.......................... The Delaware business trust (the "Issuer") to
be created by the Company and the Owner
Trustee will be identified in the related
Prospectus Supplement. A separate Issuer will
be created for each series of Bonds. See "The
Issuer--General."
Master Servicer................. The master servicer or master servicers
(each, a "Master Servicer"), if any, or a
servicer (the "Servicer") for substantially
all the Mortgage Loans for a series of Bonds,
which servicer or master servicer(s) may be
affiliates of the Company, will be named in
the related Prospectus Supplement. See
"Description of the Agreements--Agreements
Applicable to a Series" and "--Collection
Account and Related Accounts."
5
<PAGE>
Indenture Trustee............... The trustee (the "Indenture Trustee") for
each series of Bonds will be named in the
related Prospectus Supplement. See
"Description of the Agreements--The Indenture
Trustee."
Owner Trustee................... The Owner Trustee for each trust that is an
Issuer of a series of Bonds will be named in
the related Prospectus Supplement. See "The
Issuer--General."
Offered Bonds................... The Bonds offered hereby ("Offered Bonds")
will be secured by any of the following
assets (the Mortgage Loans, MBS, Contracts
and Government Bonds described herein may be
referred to collectively or individually as
the "Assets"):
(a) Mortgage Assets........... The Mortgage Assets with respect to a series
of Bonds will consist of a pool of single
family, multifamily and/or mixed-use loans
(collectively, the "Mortgage Loans"),
mortgage participations, mortgage pass-
through certificates or other mortgage-backed
securities evidencing interests in or secured
by mortgage loans (collectively, the "MBS")
or a combination of Mortgage Loans and MBS
("Mortgage Assets"). The Mortgage Loans will
not be guaranteed or insured by the Company
or any of its affiliates. The related
Prospectus Supplement will indicate if the
Mortgage Loans are guaranteed or insured by
any governmental agency or instrumentality or
other person. The Mortgage Loans will be
secured by first and/or junior liens on one-
to-four family residential properties or
security interests in shares issued by
cooperative housing corporations ("Single
Family Properties"). The Mortgage Loans may
include closed-end and/or revolving home
equity loans or certain balances thereof
("Home Equity Loans"). The Mortgaged
Properties may be located in any one of the
fifty states, the District of Columbia or the
Commonwealth of Puerto Rico. The Mortgage
Loans generally will have individual
principal balances at origination of not less
than $1,000 and original terms to maturity of
not more than 40 years. All Mortgage Loans
will have been originated by persons other
than the Company, and all Mortgage Assets
will have been purchased, either directly or
indirectly, by the Company. The related
Prospectus Supplement will indicate if any
such persons are affiliates of the Company.
Each Mortgage Loan may provide for accrual of
interest thereon at an interest rate (a
"Mortgage Rate") that is fixed over its term
or that adjusts from time to time, or that
may be converted from an adjustable to a
fixed Mortgage Rate, or from a fixed to an
adjustable Mortgage Rate, from time to time
at the mortgagor's election, in each case as
described in the related Prospectus
Supplement. Adjustable Mortgage Rates on the
Mortgage Loans may be based on one or more
indices. Each Mortgage Loan may provide for
scheduled payments to maturity, payments that
adjust from time to time to
6
<PAGE>
accommodate changes in the Mortgage Rate or
to reflect the occurrence of certain events,
and may provide for negative amortization or
accelerated amortization, in each case as
described in the related Prospectus
Supplement. Each Mortgage Loan may be fully
amortizing or require a balloon payment due
on its stated maturity date, in each case as
described in the related Prospectus
Supplement. Each Mortgage Loan may contain
prohibitions on prepayment or require payment
of a premium or a yield maintenance penalty
in connection with a prepayment, in each case
as described in the related Prospectus
Supplement. The Mortgage Loans may provide
for payments of principal, interest or both,
on due dates that occur monthly, quarterly,
semi-annually or at such other interval as is
specified in the related Prospectus
Supplement. See "Description of the Assets--
Assets."
(b) 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 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 the
principal distributions (but not the interest
distributions) or all or a part of the
interest distributions (but not the principal
distributions) on certain GNMA, FNMA or FHLMC
Certificates that may not be 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 "Description of the Assets--
Government Bonds" herein.
(c) Private Mortgage-Backed Private Mortgage-Backed Securities may
Securities...................... include (a) mortgage pass-through
certificates representing beneficial
interests in mortgage loans or in Agency
Securities or (b) collateralized mortgage
obligations secured by mortgage loans or by
Agency Securities. 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 all or a part of the
interest
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distributions (but not the principal
distributions) on the mortgage loans or the
Agency Securities. Stripped Private Mortgage-
Backed Securities that are collateralized by
Agency Securities will not, themselves, be
insured or guaranteed by the United States or
any agency or instrumentality thereof. The
Private Mortgage-Backed Securities will have
been previously registered under the
Securities Act of 1933, as amended (the "'33
Act"), will be exempt from registration under
the '33 Act or will be eligible for resale
under Rule 144(k) promulgated under the '33
Act. In addition, such Private Mortgage-
Backed Securities will have been acquired in
a bona fide secondary market transaction and
not from the issuer of such securities or any
affiliate thereof. The Prospectus Supplement
relating to a series of Bonds, will indicate
whether payments on the Private Mortgage-
Backed Securities will be distributed
directly to the Indenture Trustee as
registered owner of such Private Mortgage-
Backed Securities. See "Description of the
Assets--MBS" 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 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
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<PAGE>
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
"Description of the Assets--MBS" herein.
(d) Contracts................. The Contracts with respect to a series of
Bonds will consist of manufactured housing
installment sale contracts and installment
loan agreements secured by a security
interest in a new or used manufactured home
(each, a "Manufactured Home"), and, to the
extent, if any, indicated in the related
Prospectus Supplement, by real property. The
Contracts will not be insured or guaranteed
by the Company or any of its affiliates. The
related Prospectus Supplement will indicate
if the Contracts are insured or guaranteed by
any governmental agency or instrumentality or
any other person. The Manufactured Homes may
be located in any of the fifty states or any
other jurisdiction specified in the related
Prospectus Supplement. All Contracts will
have been originated by persons other than
the Company, and all Contracts will have been
purchased, either directly or indirectly, by
the Company on or before the date of initial
issuance of the related series of Bonds. The
related Prospectus Supplement will indicate
if any such persons are affiliates of the
Company. Each Contract may provide for an
annual percentage rate thereon (a "Contract
Rate") that is fixed over its terms or that
adjusts as described in the related
Prospectus Supplement. The manner of
determining scheduled payments due on the
Contract will be described in the Prospectus
Supplement. The Prospectus Supplement will
describe the minimum principal balance of the
Contracts at origination and the maximum
original term to maturity of the Contracts.
(e) Government Bonds.......... If so provided in the related Prospectus
Supplement, the Assets of the related Issuer
may include, in addition to Mortgage Assets,
certain direct obligations of the United
States, agencies thereof or agencies created
thereby which provide for payment of interest
and/or principal (collectively, "Government
Bonds").
(f) Corporate Bonds........... If so provided in the related Prospectus
Supplement, the Assets of the related Issuer
may include, in addition to Mortgage Assets,
certain debt obligations of corporations or
other non-governmental entities which provide
for the payment of interest and principal
(collectively, "Corporate Bonds"). If
specified in the related Prospectus
Supplement, Corporate Bonds may be deposited
into a reserve fund for purposes of Credit
Support for a series of Bonds.
(g) Collection Accounts....... Each Issuer will maintain one or more
accounts established on behalf of the
Bondholders into which the person or persons
designated in the related Prospectus
Supplement will, to the extent described
herein and in such Prospectus Supplement,
deposit all payments and collections received
or advanced with
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respect to the Assets and other assets of the
Issuer. Such an account may be maintained as
an interest bearing or a non-interest bearing
account, and funds held therein may be held
as cash or invested in certain short-term,
investment grade obligations, in each case as
described in the related Prospectus
Supplement. See "Description of the
Agreements--Collection Account and Related
Accounts."
(h) Credit Support............ If so provided in the related Prospectus
Supplement, partial or full protection
against certain defaults and losses on the
Assets of the related Issuer may be provided
to one or more classes of Bonds of the
related series in the form of various types
of credit support, such as a cash account,
overcollateralization, excess spread,
crosscollateralization, subordination,
reserve fund, insurance policy, surety bond,
guarantee, letter of credit or another type
of credit support, or a combination thereof
(any such coverage with respect to the Bonds
of any series, "Credit Support"). The amount
and types of coverage, the identity of the
entity providing the coverage (if applicable)
and related information with respect to each
type of Credit Support, if any, will be
described in the Prospectus Supplement for a
series of Bonds. The Prospectus Supplement
for any series of Bonds that includes MBS
will describe any similar forms of credit
support that are provided by or with respect
to, or are included as part of such MBS. See
"Risk Factors--Credit Support Limitations"
and "Description of Credit Support."
If so specified in the Prospectus Supplement,
a series of Bonds may consist of one or more
classes of senior Bonds (the "Senior Bonds")
and one or more classes of subordinated Bonds
(the "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 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
described in the related Prospectus
Supplement. If so specified in the related
Prospectus Supplement, subordination may
apply
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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. See "Description of
Credit Support--Subordination" herein.
If so specified in the related Prospectus
Supplement, credit enhancement may consist of
overcollateralization whereby the aggregate
principal balance of the related Mortgage
Loans exceeds the aggregate principal balance
of the Bonds of the related series. Such
overcollateralization may exist on the
related closing date or may develop
thereafter. The amount of such
overcollateralization will generally be in
the range of 3% to 6%, but may fall outside
such range either on the related closing date
or thereafter while the Bonds are
outstanding. The amount of
overcollateralization, if any, on the closing
date for a series of Bonds will be set forth
in the related Prospectus Supplement. See
"Description of Credit Support--
Overcollateralization" herein.
"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 Loans 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 Loans bear interest at adjustable
rates, the relationship of the movements in
the indices applicable to the Mortgage Loans
and those applicable to the Bonds, over which
no prediction can be made or assurance given.
See "Description of Credit Support--Excess
Spread" herein.
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 crosscollateralization
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 of
Bonds. See "Description of Credit Support--
Crosscollateralization" herein.
If so specified in the related Prospectus
Supplement, credit enhancement may consist of
one or more reserve funds ("Reserve Funds")
into which cash, Government Bonds,
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<PAGE>
Corporate Bonds or other Assets may be
deposited at the time the Bonds are issued. A
Reserve Fund may also be funded over time by
depositing therein distributions received on
the Assets, as may be specified in the
related Prospectus Supplement. See
"Description of Credit Support--Reserve
Funds" herein.
If so specified in the related Prospectus
Supplement, credit enhancement for one or
more classes of Bonds of a related series may
be provided by insurance policies or surety
bonds (each, a "Bond Insurance Policy")
issued by one or more insurance companies or
sureties (each a "Bond Insurer"). Such
insurance policy 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 insurance policies, surety bonds or
third-party guarantees may be used to provide
coverage for the risks of default or types of
losses set forth in such Prospectus
Supplement. See "Description of Credit
Support--Bond Insurance Policies, Surety
Bonds and Guarantees" herein.
If so specified in the related Prospectus
Supplement, credit enhancement may be
provided for a series of Bonds secured by
Mortgage Loans 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 Mortgage Loans
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
Mortgage Loan. 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. See "Description of Credit
Support--Letter of Credit" herein.
(i) Cash Flow Agreements...... If so provided in the related Prospectus
Supplement, the Assets may include guaranteed
investment contracts pursuant to which moneys
held in the funds and accounts established
for the related series will be invested at a
specified rate. The Assets may also include
certain other agreements, such as interest
rate exchange agreements, interest rate cap
or floor agreements, or similar agreements
provided to reduce the
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<PAGE>
effects of interest rate fluctuations on the
Assets or on one or more classes of Bonds.
The principal terms of any such guaranteed
investment contract or other agreement (any
such agreement, a "Cash Flow Agreement"),
including, without limitation, provisions
relating to the timing, manner and amount of
payments thereunder and provisions relating
to the termination thereof, will be described
in the Prospectus Supplement for the related
series. In addition, the related Prospectus
Supplement will identify the counterparty to
each Cash Flow Agreement and will identify
the counterparty to each Cash Flow Agreement
and will provide certain financial
information with respect to such
counterparty. The Prospectus Supplement for
any series of Bonds that includes MBS will
describe any cash flow agreements that are
included as part of such MBS. See
"Description of the Assets--Cash Flow
Agreements."
(j) Pre-Funding Account....... To the extent provided in the related
Prospectus Supplement, the Company will be
obligated (subject only to the availability
thereof) to sell at a predetermined price,
and the related Issuer for the related series
of Bonds will be obligated to purchase
(subject to the satisfaction of certain
conditions described in the applicable
Agreement), additional Assets (the
"Subsequent Assets") from time to time (as
frequently as daily) within the period (the
"Pre-Funding Period") specified in the
related Prospectus Supplement having an
aggregate principal balance approximately
equal to the amount on deposit (the "Pre-
Funded Amount") in an account (the "Pre-
Funding Account") established by the
Indenture Trustee and funded on the date of
such issuance. The Pre-Funded Amount to be
deposited in the Pre-Funding Account, which
will not exceed 25% of the gross offering
proceeds of the series of Bonds, will be set
forth in the related Prospectus Supplement.
The Pre-Funding Period will not exceed 90
days after the date of issuance of the Bonds.
During the Pre-Funding Period, funds held in
the Pre-Funding Account will be invested only
in short- term, cash equivalent investments,
including (i) short-term obligations of (or
granted by) the United States, or any agency
or instrumentality thereof, that mature
during the Pre-Funding Period and that are
held to maturity, (ii) short-term
certificates of deposit in a bank or trust
company and (iii) short-term money market
mutual funds. Subsequent Assets to be
acquired with funds held in the Pre-Funded
Account must be substantially similar to the
other Assets securing the series of Bonds,
and must be underwritten consistent with the
underwriting standards for such Assets set
forth in the related Prospectus Supplement.
All funds remaining in the Pre-Funding
Account at the end of the Pre-Funding Period
will be distributed to Bondholders on the
next Distribution Date as pre-payments of
principal. The inability to invest funds held
in
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<PAGE>
the Pre-Funded Account in Subsequent Assets
that meet the specified underwriting will
result in principal pre-payments that will
shorten the duration of the Bonds. See
"Description of the Assets--Pre-Funding
Account."
(k) Description of Bonds...... The Bonds will be issued from time to time in
one or more series pursuant to Indentures (as
defined herein) between each Issuer and the
Indenture 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. The Bonds will generally represent
obligations solely of the Issuer. The related
Prospectus Supplement will indicate if the
Bonds are 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.
Distributions on Bonds.......... Each series of Bonds will consist of one or
more classes of Bonds that may provide for
the accrual of interest thereon based on
fixed, variable or adjustable rates and
provide for distributions of principal as
described in the related Prospectus
Supplement to the extent of available funds,
as described in the related Prospectus
Supplement. If so specified in the related
Prospectus Supplement, distributions on one
or more classes of a series of Bonds may be
limited to collections from a designated
portion of the Mortgage Loans in the related
pool (each such portion of Mortgage Loans, a
"Mortgage Loan Group"). See "Description of
the Bonds--General." Any such classes may
include classes of Offered Bonds.
The Bonds generally will not be guaranteed or
insured by the Company or any of its
affiliates, by any governmental agency or
instrumentality or by any other person,
unless otherwise provided in the related
Prospectus Supplement. See "Risk Factors--
Limited Assets" and "Description of the
Bonds."
(a) Interest.................. Interest on each class of Offered Bonds of
each series will accrue at the applicable
interest rate on the outstanding Bond
Principal Balance thereof and will be
distributed to Bondholders as provided in the
related Prospectus Supplement. The specified
date on which distributions are to be made is
a "Payment Date." Distributions of interest
with respect to one or more classes of Bonds
may be reduced to the extent of certain
delinquencies, losses, and other
contingencies described herein and in the
related Prospectus Supplement. See
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<PAGE>
"Yield Considerations" and "Description of
the Bonds--Distributions of Interest on the
Bonds."
(b) Principal................. The Bonds of each series initially will have
an aggregate Bond Principal Balance no
greater than the outstanding principal
balance of the Assets, generally as of the
close of business on the first day of a
specified month (the "Cut-off Date"), after
application of scheduled payments due on or
before such date, whether or not received.
The related Prospectus Supplement will
indicate if the Cut-off Date is not the close
of business on the first day of a specified
month. With respect to any Bond, the "Bond
Principal Balance" means the initial
principal balance thereof on the closing date
minus all distributions in respect of
principal with respect to such Bond.
Distributions of principal generally will be
made on each Payment Date to the class or
classes of Bonds entitled thereto until the
Bond Principal Balances of such Bonds have
been reduced to zero. The related Prospectus
Supplement will specify if distributions of
principal are made in any other manner.
Distributions of principal of any class of
Bonds generally will be made on a pro rata
basis among all of the Bonds of such class or
by random selection, as described in the
related Prospectus Supplement or otherwise
established by the related Indenture Trustee.
"Description of the Bonds--Distributions of
Principal of the Bonds."
Advances........................ The servicer or Master Servicer generally
will be obligated as part of its servicing
responsibilities to make certain advances
that in its good faith judgment it deems
recoverable with respect to delinquent
scheduled payments on the Mortgage Loans. The
related Prospectus Supplement will indicate
if the servicer or Master Servicer is not
obligated to make such advances. Neither the
Company nor any of its affiliates will have
any responsibility to make such advances,
unless it is the servicer or Master Servicer.
Advances made by a servicer or Master
Servicer are reimbursable generally from
subsequent recoveries in respect of such
Mortgage Loan and otherwise to the extent
described herein and in the related
Prospectus Supplement. If and to the extent
provided in the Prospectus Supplement for any
series, the servicer or Master Servicer will
be entitled to receive interest on its
outstanding advances. The Prospectus
Supplement for any series of Bonds that is
secured by MBS will describe any
corresponding advancing obligation of any
person in connection with such MBS. See
"Description of the Bonds--Advances in
Respect of Delinquencies."
Redemption...................... If so specified in the related Prospectus
Supplement, a series of Bonds may be subject
to optional early redemption by the Issuer,
under the circumstances and in the manner set
forth therein. If so provided in the related
Prospectus Supplement, upon the reduction of
the Bond Principal Balance of a specified
15
<PAGE>
class or classes of Bonds to a specified
percentage or amount or on and after a date
specified in such Prospectus Supplement, the
Bonds may be subject to optional early
redemption by the related Issuer. In most
cases, a series of Bonds will be redeemable
by the Issuer when the outstanding Bond
Principal Balance is reduced to a percentage
(the "Clean-Up Call Percentage") of the
original Bond Principal Balance. The Clean-Up
Call Percentage, which will be set forth in
the related Prospectus Supplement, may range
between 10% and 25% of the original Bond
Principal Balance, depending upon the type
and characteristics of the collateral, the
level of over collateralization, the amount
of credit enhancement, rating agency concerns
and other factors. The Clean-Up Call
Percentage will not exceed 25%. The price at
which the Bonds will be callable by the
Issuer, which will be at least equal to the
outstanding principal amount thereof plus
accrued interest thereon, will also be set
forth in the related Prospectus Supplement.
See "Description of the Bonds--Redemption."
Registration of Bonds........... If so provided in the related Prospectus
Supplement, one or more classes of the
Offered Bonds will initially be represented
by one or more certificates or notes, as
applicable, registered in the name of Cede &
Co., as the nominee of DTC. No person
acquiring an interest in Offered Bonds so
registered will be entitled to receive a
definitive certificate or note, as
applicable, representing such person's
interest except in the event that definitive
certificates or notes, as applicable, are
issued under the limited circumstances
described herein. See "Risk Factors--Book-
Entry Registration" and "Description of the
Bonds--Book-Entry Registration and Definitive
Bonds."
Tax Status of Bonds............. Bonds of a series, when beneficially owned by
someone other than NovaStar Financial or one
of its qualified REIT subsidiaries (as
defined in section 856(i) of the Code), will
constitute indebtedness for federal and state
income tax purposes and the Bondholder, in
accepting the Bond, will agree to treat the
Bond as indebtedness. See "Federal Income Tax
Consequences" herein and in such Prospectus
Supplement.
Investors are advised to consult their tax
advisors as to the tax consequences of an
investment in the Bonds in light of
investors' individual circumstances and to
review "Federal Income Tax Consequences"
herein and in the related Prospectus
Supplement for a more general discussion of
tax matters related to the Bonds.
ERISA Matters................... A fiduciary of an employee benefit plan and
certain other retirement plans and
arrangements, including individual retirement
accounts, annuities, Keogh plans, and
collective investment funds and separate
accounts in which such plans, accounts,
annuities or arrangements are invested, that
is subject to the Employee Retirement Income
Security Act of 1974, as
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<PAGE>
amended ("ERISA"), or Section 4975 of the
Code should carefully review with its legal
advisors whether the purchase or holding of
Offered Bonds could give rise to a
transaction that is prohibited or is not
otherwise permissible either under ERISA or
Section 4975 of the Code. See "ERISA
Considerations" herein and in the related
Prospectus Supplement. See "Description of
the Bonds--General" and "ERISA
Considerations."
Legal Investment................ Each Prospectus Supplement will specify which
class or classes of Offered Bonds, if any,
will constitute "mortgage-related securities"
for purposes of the Secondary Mortgage Market
Enhancement Act of 1984 ("SMMEA").
Institutions whose investment activities are
subject to legal investment laws and
regulations or review by certain regulatory
authorities may be subject to restrictions on
investment in certain classes of the Offered
Bonds. See "Legal Investment" herein and in
the related Prospectus Supplement.
Rating.......................... 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 (each a "Rating Agency").
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
"Rating" herein and in the related Prospectus
Supplement.
Risk Factors.................... For a discussion of certain risks associated
with an investment in the Bonds, see "Risk
Factors" commencing on page 18 herein and in
the related Prospectus Supplement.
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RISK FACTORS
Investors should consider, in connection with an investment in the Bonds,
among other things, the factors described below. The material risks associated
with an investment in the Bonds are discussed in this section and in the "Risk
Factors" section of the Prospectus Supplement.
BONDS SECURED BY SUBPRIME MORTGAGE LOANS
Subprime Mortgage Loans. To the extent set forth in the related Prospectus
Supplement, the Mortgage Loans securing the Bonds may be Subprime Mortgage
Loans. "Subprime Mortgage Loans", which are also referred to as non-conforming
loans, are Mortgage Loans that do not meet underwriting standards for credit
quality and documentation sufficient to qualify for guarantee by FMNA and
FHLMC. The principal differences between Subprime Mortgage Loans and
conforming Mortgage Loans include the applicable loan-to-value ratios, the
credit and income histories of the borrowers, the type of properties securing
the Mortgage Loans, the sizes of the Mortgage Loans and the borrowers
occupancy status with respect to the Mortgaged Property. Subprime Mortgage
Loans are generally made to borrowers who have impaired or limited credit
histories, limited documentation of income and higher debt-to-income ratios
than conforming Mortgage Loans. As a result of these and other factors, the
interest rates charged on Subprime Mortgage Loans are generally higher than
those charged for conforming Mortgage Loans.
Higher Delinquency and Foreclosure Rates. Credit risk associated with
Subprime Mortgage Loans are generally greater than those associated with
Mortgage Loans that conform to FNMA and FHLMC guidelines. Subprime Mortgage
Loans generally entail a higher risk of delinquency and foreclosure than loans
made to borrowers with better credit. Most Subprime Mortgage Loans are made to
borrowers who do not qualify for loans from conventional mortgage lenders. The
combination of different underwriting criteria and higher rates of interest
may lead to higher levels of realized losses on Subprime Mortgage Loans
compared to conforming Mortgage Loans. No assurances can given that the
standards used to underwrite the Subprime Mortgage Loans will afford adequate
protection against the higher risks associated with Subprime Mortgage Loans.
Delinquency rates and credit losses from Subprime Mortgage Loans, to the
extent they are not covered by credit enhancement, may affect the yield to
maturity of the Bonds and could result in losses to Bondholders.
Higher Losses from Foreclosures and Liquidations. Ownership of Bonds secured
by Subprime Mortgage Loans involves many of the credit risks of owning the
Subprime Mortgage Loans themselves, including the risk of investing directly
in the real estate securing the underlying Subprime Mortgage Loans. This may
be especially true in the case of Bonds secured by relatively small or less
diverse pools of Subprime Mortgage Loans. In the event of a default on the
underlying Subprime Mortgage Loan, the ultimate extent of the loss, if any,
may only be determined after a foreclosure of the Mortgage Property, and if
the title to the Mortgaged Property is taken, upon liquidation of the
Mortgaged Property. Losses incurred in foreclosure or liquidation of such
Mortgaged Properties, if not covered by credit enhancements, will decrease the
amount of funds available to pay principal and interest due on the Bonds and
could result in losses to Bondholders.
LIMITED ASSETS
Only Assets of the Issuer Secure the Bonds. Only the Bonds will not
represent an interest in or obligation of the Company, the Master Servicer or
any of their affiliates. The only obligations with respect to the Bonds or the
Assets will be the obligations (if any) of the Warranting Party pursuant to
certain limited representations and warranties made with respect to the
Mortgage Loans or Contracts, the Master Servicer's and any Sub-Servicer's
servicing obligations under the related Agreement (including the limited
obligation to make certain advances in the event of delinquencies on the
Mortgage Loans or Contracts, but only to the extent deemed recoverable) and,
if and to the extent expressly described in the related Prospectus Supplement,
certain limited obligations of the Master Servicer in connection with an
agreement to purchase or act as remarketing agent with respect to a
convertible ARM Loan (as defined herein) upon conversion to a fixed rate or a
different index. The "Warranting
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Party" will be NovaStar Financial, the entity that will sell to the Company
the Mortgage Loans that will become the collateral for a series of Bonds. Such
Mortgage Loans will have been acquired by NovaStar Financial from its
affiliate, NovaStar Mortgage, or from unrelated third parties. The
representations and warranties made by the Warranting party with respect to
the Mortgage Loans or Contracts cover the following types of matters: (i) the
accuracy of the information set forth for such Whole Loan or Contract on the
schedule of Assets appearing as an exhibit to the related Agreement; (ii) in
the case of a Whole Loan, the existence of title insurance insuring the lien
priority of the Whole Loan and, in the case of a Contract, that the Contract
creates a valid first security interest in or lien on the related Manufactured
Home; (iii) the authority of the Warranting Party to sell the Whole Loan or
Contract; (iv) the payment status of the Whole Loan or Contract; (v) in the
case of a Whole Loan, the existence of customary provisions in the related
Mortgage Note and Mortgage to permit realization against the Mortgaged
Property of the benefit of the security of the Mortgage; and (vi) the
existence of hazard and extended perils insurance coverage on the Mortgaged
Property or Manufactured Home. Since certain representations and warranties
with respect to the Mortgage Loans or Contracts may have been made and/or
assigned in connection with transfers of such Mortgage Loans or Contracts
prior to the closing date, the rights of the Indenture Trustee and the
Bondholders with respect to such representations or warranties will be limited
to their rights as an assignee thereof. Generally, none of the Company, the
Master Servicer or any affiliate thereof will have any obligation with respect
to representations or warranties made by any other entity. Generally, neither
the Bonds nor the underlying Assets will be guaranteed or insured by any
governmental agency or instrumentality, or by the Company, the Master
Servicer, any Sub-Servicer or any of their affiliates. Proceeds of the assets
of the related Issuer for each series of Bonds (including the Assets and any
form of credit enhancement) will be the sole source of payments on the Bonds,
and there will be no recourse to the Company or any other entity in the event
that such proceeds are insufficient to make all payments of principal and
interest due on the Bonds.
No Cross Collateralization Between Series of Bonds. A series of Bonds
generally will not have any claim against or security interest in the Issuer
of or the Assets securing any other series of Bonds. If the Issuer of a series
of Bonds has insufficient funds to make payments on such Bonds, no other
assets will be available for payment of the deficiency. Additionally, certain
amounts remaining in certain funds or accounts, including the Collection
Account and any accounts maintained as Credit Support, may be withdrawn under
certain conditions, as described in the related Prospectus Supplement. In the
event of such withdrawal, such amounts will not be available for future
payment of principal of or interest on the Bonds.
Shortfalls Absorbed by Subordinated Bonds. If so provided in the Prospectus
Supplement for a series of Bonds consisting of one or more classes of
Subordinated Bonds, on any Payment Date in respect of which losses or
shortfalls in collections on the Assets have been incurred, the amount of such
losses or shortfalls will be borne first by one or more classes of the
Subordinated Bonds, and, thereafter, by the remaining classes of Bonds in the
priority and manner and subject to the limitations specified in such
Prospectus Supplement. If losses and shortfalls cannot be fully absorbed by
the Subordinated Bonds, then there could be insufficient funds available to
pay principal and interest due on the senior classes of Bonds.
MORTGAGE LOANS AND MORTGAGED PROPERTIES IN GENERAL
Effects of Declining Real Estate Values. An investment in securities such as
the Bonds which generally represent interests in Mortgage Loans may be
affected by, among other things, a decline in real estate values and changes
in the mortgagors' financial condition. No assurance can be given that values
of the real property constituting security for repayment of a Mortgage Loan
(the "Mortgaged Properties") have remained or will remain at their levels on
the dates of origination of the related Mortgage Loans. If the residential
real estate market should experience an overall decline in property values
such that the outstanding balances of the Mortgage Loans, and any secondary
financing on the Mortgaged Properties, 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, in the case of Mortgage Loans
that are subject to negative amortization, due to the addition to principal
balance of deferred interest, the principal balances of such Mortgage Loans
could be increased to an amount equal to or in excess of the value of the
underlying Mortgaged Properties, thereby increasing the likelihood of default.
To the extent that such losses are
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not covered by the applicable Credit Support, if any, holders of Bonds of the
series evidencing interests in the related Mortgage Loans will bear all risk
of loss resulting from default by mortgagors and will have to look primarily
to the value of the Mortgaged Properties for recovery of the outstanding
principal and unpaid interest on the defaulted Mortgage Loans. Certain of the
types of Mortgage Loans may involve additional uncertainties not present in
traditional types of loans. For example, certain of the Mortgage Loans provide
for escalating or variable payments by the mortgagor under the Mortgage Loan,
as to which the mortgagor is generally qualified on the basis of the initial
payment amount. In some instances the mortgagors' income may not be sufficient
to enable them to continue to make their loan payments as such payments
increase and thus the likelihood of default will increase. In addition to the
foregoing, certain geographic regions of the United States from time to time
will experience weaker regional economic conditions and housing markets, and,
consequently, will experience higher rates of loss and delinquency than will
be experienced on mortgage loans generally. The Mortgage Loans underlying
certain series of Bonds may be concentrated in these regions, and such
concentration may present risk considerations in addition to those generally
present for similar mortgage-backed securities without such concentration.
Furthermore, the rate of default on Mortgage Loans that are refinance or
limited and stated documentation mortgage loans, and on Mortgage Loans with
high Loan-to-Value Ratios, may be higher than for other types of Mortgage
Loans. Additionally, a decline in the value of the Mortgaged Properties will
increase the risk of loss particularly with respect to any related junior
Mortgage Loans. See "--Junior Mortgage Loans." During periods of declining
real estate values, the foregoing facts could result in significant losses on
the Mortgage Loans, which result in insufficient funds to pay principal and
interest due on the Bonds.
Risk of Multifamily Properties. Mortgage Loans secured by Multifamily
Properties may entail risks of delinquency and foreclosure, and risks of loss
in the event thereof, that are greater than similar risks associated with
loans secured by Single Family Properties. The ability of a borrower to repay
a loan secured by an income-producing property typically is dependent
primarily upon the successful operation of such property rather than upon the
existence of independent income or assets of the borrower; thus, the value of
an income-producing property typically is directly related to the net
operating income derived from such property. If the net operating income of
the property is reduced (for example, if rental or occupancy rates decline or
real estate tax rates or other operating expenses increase), the borrower's
ability to repay the loan may be impaired. In addition, the concentration of
default, foreclosure and loss risk for a pool of Mortgage Loans secured by
Multifamily Properties may be greater than for a pool of Mortgage Loans
secured by Single Family Properties of comparable aggregate unpaid principal
balance because the pool of Mortgage Loans secured by Multifamily Properties
is likely to consist of a smaller number of higher balance loans. Bonds that
are secured in whole or in part by Multifamily Properties would generally have
a higher risk of default than Bonds secured only by Single Family Properties.
Risk of High LTV Loans. Some or all of the Mortgage Loans may be High LTV
Loans. High LTV Loans with Loan-to-Value Ratios or Combined Loan-to-Value
Ratios in excess of 100% may have been originated with a limited expectation
of recovering any amounts from the foreclosure of the related Mortgaged
Property and are underwritten with an emphasis on the creditworthiness of the
related borrower. If such Mortgage Loans go into foreclosure and are
liquidated, there may be no amounts recovered from the related Mortgaged
Property unless the value of the property increases or the principal amount of
the related senior liens have been reduced such as to reduce the current Loan-
to-Value Ratio or Combined Loan-to-Value Ratio of the related Mortgage Loan to
below 100%. Any such losses, to the extent not covered by credit enhancement,
may affect the yield to maturity of the Bond, and if severe, could result in
losses to Bondholders.
Effects of Foreclosure Delays and Expenses. Even assuming that the Mortgaged
Properties provide adequate security for the Mortgage Loans, substantial
delays could be encountered in connection with the liquidation of defaulted
Mortgage Loans and corresponding delays in the receipt of related proceeds by
Bondholders could occur. An action to foreclose on a Mortgaged Property
securing a Mortgage Loan is regulated by state statutes and rules and is
subject to many of the delays and expenses of other lawsuits if defenses or
counterclaims are interposed, sometimes requiring several years to complete.
Furthermore, in some states an action to obtain a deficiency judgment is not
permitted following a nonjudicial sale of a Mortgaged Property. In the event
of a
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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 Mortgage Loan. In addition, the Master Servicer will be entitled to
deduct from related liquidation proceeds all expenses reasonably incurred in
attempting to recover amounts due on defaulted Mortgage Loans and not yet
repaid, including legal fees and costs of legal action, real estate taxes and
maintenance and preservation expenses. If significant foreclosure delays occur
on a substantial number of Mortgage Loans, payments on the Bonds may be
delayed, which would lengthen the duration and affect the yield to maturity of
the Bonds. If expenses occasioned by such delays are severe and are not
covered by credit enhancement, funds may not be available to make all payments
of principal and interest due on the Bonds.
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.
If applicable, certain legal aspects of the Mortgage Loans for a series of
Bonds may be described in the related Prospectus Supplement. See also "Certain
Legal Aspects of Mortgage Loans" herein.
BALLOON PAYMENTS
Certain of the Mortgage Loans (the "Balloon Mortgage Loans") as of the Cut-
off Date may not be fully amortizing over their terms to maturity and, thus,
will require substantial principal payments (i.e., balloon payments) at their
stated maturity. Mortgage Loans with balloon payments involve a greater degree
of risk because the ability of a mortgagor to make a balloon payment typically
will depend upon its ability either to timely refinance the loan or to timely
sell the related Mortgaged Property. The ability of a mortgagor to accomplish
either of these goals will be affected by a number of factors, including the
level of available mortgage interest rates at the time of sale or refinancing,
the mortgagor's equity in the related Mortgaged Property, the financial
condition of the mortgagor, the value of the Mortgaged Property, tax laws,
prevailing general economic conditions and the availability of credit for
single family or multifamily real properties generally. Bonds secured in whole
or in part by Balloon Mortgage Loans have a higher risk of default than Bonds
secured by fully-amortizing mortgage loans.
JUNIOR MORTGAGE LOANS
Certain of the Mortgage Loans may be secured by junior liens and the related
first and other Senior Liens, if any (collectively, the "Senior Lien"), may
not be included in the Assets. The primary risk to holders of Mortgage Loans
secured by junior liens is the possibility that adequate funds will not be
received in connection with a foreclosure of the related Senior Lien to
satisfy fully both the Senior Lien and the Mortgage Loan. In the event that a
holder of the 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 Lien. The claims of the holder of the Senior Lien will be
satisfied in full out of proceeds of the liquidation of the Mortgage Loan, if
such proceeds are sufficient, before the Issuer as holder of the junior lien
receives any payments in respect of the Mortgage Loan. If the Master Servicer
were to foreclose on any Mortgage Loan, it would do so subject to any related
Senior Lien. In order for the debt related to the Mortgage Loan to be paid in
full at such sale, a bidder at the foreclosure sale of such Mortgage Loan
would have to bid an amount sufficient to pay off all sums due under the
Mortgage Loan and the Senior Lien or purchase the Mortgaged Property subject
to the Senior Lien. In the event that such proceeds from a foreclosure or
similar sale of the related Mortgaged Property were insufficient to satisfy
both loans in the aggregate, the Issuer, as the holder of the junior lien,
would bear the risk of delay in distributions while a deficiency judgment
against the borrower was being obtained and the risk of loss if the deficiency
judgment were
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not realized upon. Moreover, deficiency judgments may not be available in
certain jurisdictions. In addition, a junior mortgagee may not foreclose on
the property securing a junior mortgage unless it forecloses subject to the
senior mortgage. Accordingly, Bonds secured in whole or in part by junior
Mortgage Loans have a higher risk of default than Bonds secured only by Senior
Liens. To the extent not that losses and foreclosure of junior Mortgage Loans
are not covered by credit enhancement, there may be insufficient funds to pay
all principal and interest due on the Bonds. See "Description of Credit
Support."
CONTRACTS AND MANUFACTURED HOMES IN GENERAL
An investment in Bonds secured by Assets including Contracts may be affected
by, among other things, a downturn in national, regional or local economic
conditions. The geographic location of the Manufactured Homes in any pool at
origination of the related Contract will be set forth in the related
Prospectus Supplement. Regional and local economic conditions are often
volatile and, historically, regional and local economic conditions, as well as
national economic conditions, have affected the delinquency, loan loss and
repossession experience of manufactured housing installment sales contracts
and/or installment loan contracts. Moreover, regardless of its location,
manufactured housing generally depreciates in value. Thus, such Bondholders
should expect that, as a general matter, the market value of any Manufactured
Home will be lower than the outstanding principal balance of the related
Contract. Sufficiently high delinquencies and liquidation losses on the
Contracts will have the effect of reducing, and could eliminate, the
protection against loss afforded by any credit enhancement supporting any
class of the related Bonds. If such protection is eliminated with respect to a
class of Bonds, the holders of such Bonds will bear all risk of loss on the
related Contracts and will have to rely on the value of the related
Manufactured Homes for recovery of the outstanding principal of and unpaid
interest on any defaulted Contracts. See "Description of Credit Support."
SECURITY INTERESTS AND CERTAIN OTHER LEGAL ASPECTS OF THE CONTRACTS
The Asset Seller in respect of a Contract will represent that such Contract
is secured by a security interest in a Manufactured Home. Perfection of
security interests in the Manufactured Homes and enforcement of rights to
realize upon the value of the Manufactured Homes as collateral for the
Contracts are subject to a number of Federal and state laws, including the
Uniform Commercial Code as adopted in each state and each state's certificate
of title statutes. The steps necessary to perfect the security interest in a
Manufactured Home will vary from state to state. Because of the expense and
administrative inconvenience involved, the Master Servicer will not amend any
certificates of title to change the lienholder specified therein from the
Asset Seller to the Indenture Trustee and will not deliver any certificate of
title to the Indenture Trustee or note thereon the Indenture Trustee's
interest. Consequently, in some states, in the absence of such an amendment,
the assignment to the Indenture Trustee of the security interest in the
Manufactured Home may not be effective or such security interest may not be
perfected and, in the absence of such notation or delivery to the Indenture
Trustee, the assignment of the security interest in the Manufactured Home may
not be effective against creditors of the Asset Seller or a trustee in
bankruptcy of the Asset Seller. In addition, numerous federal and state
consumer protection laws impose requirements on lending under installment
sales contracts and installment loan agreements such as the Contracts, and the
failure by the lender or seller of goods to comply with such requirements
could give rise to liabilities of assignees for amounts due under such
agreements and claims by such assignees may be subject to set-off as result of
such lender's or seller's noncompliance. These laws would apply to the
Indenture Trustee as assignee of the Contracts. The Asset Seller of the
Contracts to the Company will warrant that each Contract complies with all
requirements of law and will make certain warranties relating to the validity,
subsistence, perfection and priority of the security interest in each
Manufactured Home securing a Contract. A breach of any such warranty that
materially adversely affects any Contract would create an obligation of the
Asset Seller to repurchase such Contract unless such breach is cured. If the
Credit Support is exhausted and recovery of amounts due on the Contracts is
dependent on repossession and resale of Manufactured Homes securing Contracts
that are in default, the foregoing factors may limit the ability of the
Bondholders to realize upon the Manufactured Home or may limit the amount
realized to less than the amount due. See "Certain Legal Aspects of the
Contracts." For the foregoing reasons, Bonds secured in whole or in part by
Contracts will generally have a higher risk of default than Bonds secured only
by Mortgage Loans.
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CREDIT SUPPORT LIMITATIONS
The Prospectus Supplement for a series of Bonds will describe any Credit
Support of the related Issuer, which may include letters of credit, insurance
policies, surety bonds, guarantees, reserve funds or other types of credit
support, or combinations thereof. Use of Credit Support will be subject to the
conditions and limitations described herein and in the related Prospectus
Supplement. Moreover, such Credit Support may not cover all potential losses
or risks; for example, Credit Support may or may not cover fraud or negligence
by a mortgage loan or contract originator or other parties. If Credit Support
for any series of Bonds is exhausted, the Bondholders could experience losses
on their investment in the Bonds.
The amount of any applicable Credit Support supporting one or more classes
of Offered Bonds, 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 an assumed level of defaults,
delinquencies, other losses or other factors. There can, however, be no
assurance that the loss experience on the related Assets will not exceed such
assumed levels. See "--Limited Nature of Ratings," "Description of the Bonds"
and "Description of Credit Support."
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.
Regardless of the form of credit enhancement provided, the amount of
coverage will be limited in amount and in most cases will be subject to
periodic reduction in accordance with a schedule or formula. The rating of any
series of Bonds by any applicable Rating Agency may be lowered following the
initial issuance thereof as a result of the downgrading of the obligations of
any applicable Credit Support provider, or as a result of losses on the
related Assets substantially in excess of the levels contemplated by such
Rating Agency at the time of its initial rating analysis. None of the Company,
the Master Servicer or any of their affiliates will have any obligation to
replace or supplement any Credit Support or to take any other action to
maintain any rating of any series of Bonds.
SUBORDINATION OF THE SUBORDINATED BONDS; EFFECT OF LOSSES ON THE ASSETS
The rights of Subordinated Bondholders to receive distributions to which
they would otherwise be entitled with respect to the Assets will be
subordinate to the rights of the Master Servicer (to the extent that the
Master Servicer is paid its servicing fee, including any unpaid servicing fees
with respect to one or more prior Due Periods, and is reimbursed for certain
unreimbursed advances and unreimbursed liquidation expenses) and the Senior
Bondholders to the extent described in the related Prospectus Supplement. As a
result of the foregoing, investors must be prepared to bear the risk that they
may be subject to delays in payment and may not recover their initial
investments in the Subordinated Bonds. See "Description of the Bonds--General"
and "--Allocation of Losses and Shortfalls."
The yields on the Subordinated Bonds may be extremely sensitive to the loss
experience of the Assets and the timing of any such losses. If the actual rate
and amount of losses experienced by the Assets exceed the rate and amount of
such losses assumed by an investor, the yields to maturity on the Subordinated
Bonds may be lower than anticipated, and funds may not be available to pay all
principal and interest due on the Subordinated Bonds.
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BANKRUPTCY AND INSOLVENCY RISKS
Effects of Bankruptcy of NovaStar Financial or the Company. NovaStar
Financial and the Company generally will treat the transfer of the Assets by
NovaStar Financial to the Company as a secured financing for federal income
tax and generally accepted accounting principles ("GAAP") accounting purposes,
but as a sale for bankruptcy law purposes. The Company generally will treat
the transfer of Mortgage Assets from the Company to such Issuer as a secured
financing for federal income tax and GAAP accounting purposes, but as a sale
for bankruptcy law purposes. As a sale of the Mortgage Assets by NovaStar
Financial to the Company, the Mortgage Assets would not be part of NovaStar
Financial's bankruptcy estate and would not be available to NovaStar
Financial's creditors. However, in the event of the insolvency of NovaStar
Financial, it is possible that the bankruptcy trustee or a creditor of
NovaStar Financial may attempt to recharacterize the sale of the Mortgage
Assets as a borrowing by NovaStar Financial, secured by a pledge of the
Mortgage Assets. Similarly, as a sale of the Mortgage Assets by the Company to
an Issuer, the Mortgage Assets would not be part of the Company's bankruptcy
estate and would not be available to the Company's creditors. However, in the
event of the insolvency of the Company, it is possible that the bankruptcy
trustee or a creditor of the Company may attempt to recharacterize the sale of
the Mortgage Assets as a borrowing by the Company, secured by a pledge of the
Mortgage Assets. In either case, in the event the transfer is recharacterized
as a pledge, the Company or the Issuer, as the case may be, generally will
have a perfected security interest in the related Mortgage Assets.
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 Indenture 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 Payment 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 Indenture 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 Assets. 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
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.
BOOK-ENTRY REGISTRATION
If so provided in the Prospectus Supplement, one or more classes of the
Bonds will be initially represented by one or more certificates registered in
the name of Cede, the nominee for DTC, and will not be registered in the names
of the Bondholders or their nominees. Because of this, unless and until
Definitive Bonds are issued, Bondholders will not be recognized by the
Indenture Trustee as "Bondholders" (as that term is to be used in the related
Agreement). Hence, until such time, Bondholders will be able to exercise the
rights of Bondholders only indirectly through DTC and its participating
organizations. 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
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be forwarded by the Indenture 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. See "Description of Bonds--Book-Entry
Registration and Definitive Bonds."
LIMITED NATURE OF RATINGS
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 Assets and any
credit enhancement with respect to such class and will represent such Rating
Agency's assessment solely of the likelihood that holders of such class of
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 Assets
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. Each Prospectus Supplement will identify any payment to which
holders of Bonds of the related series are entitled that is not covered by the
applicable rating.
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 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 Assets.
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 Mortgage
Loans or the mortgage loans underlying the MBS, as the case may be, due to
defaults, casualties, condemnations and repurchases by the Seller, or
purchases by the Master Servicer), on the Mortgage Loans 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 Loans 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.
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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 Mortgage Loans or the mortgage loans underlying
the MBS, 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, such Mortgage Loans 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, such Mortgage Loans 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 Loans. The timing of changes in the rate
of prepayments on such Mortgage Loans 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.
PRE-FUNDING ACCOUNTS MAY RESULT IN REINVESTMENT RISK
If so specified in the related Prospectus Supplement, on the related closing
date the Company will deposit the Pre-Funded Amount specified in such
Prospectus Supplement into the Pre-Funding Account. The Pre-Funded Amount will
be used to purchase Subsequent Assets during a period from the related closing
date to a date specified in the related Prospectus Supplement, but not more
than 90 days after such closing date (such period, the "Funding Period"), from
the Company (which, in turn, will acquire such Subsequent Assets from NovaStar
Financial). The Pre-Funding Account will be maintained with the Indenture
Trustee for the related series of Bonds and is designed solely to hold funds
to be applied by such Indenture Trustee during the Funding Period to pay to
the Company the purchase price for Subsequent Assets. Monies on deposit in the
Pre-Funding Account will not be available to cover losses on or in respect of
the related Mortgage Assets. To the extent that the entire Pre-Funded Amount
has not been applied to the purchase of Subsequent Assets 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 Payment 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
"Description of the Assets--Pre-Funding Account" herein.
PRE-FUNDING ACCOUNTS MAY ADVERSELY AFFECT INVESTMENT
The ability of the Issuer to acquire Subsequent Assets during the Funding
Period will be dependent upon the ability of the Company to acquire Subsequent
Assets that satisfy the requirements described in the related Prospectus
Supplement. Although such Subsequent Assets must satisfy the characteristics
described in the related Prospectus Supplement, such Subsequent Assets may
have certain different characteristics, including, without limitation, a more
recent origination date than the initial Mortgage Assets. As a result, the
addition of such Subsequent Assets pursuant to the Pre-Funding Account may
adversely affect the performance of the related Bonds. See "Description of the
Assets--Pre-Funding Account" herein.
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CONSEQUENCES OF OWNING ORIGINAL ISSUE DISCOUNT BONDS
Certain of the 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 deferred
interest Bonds generally will be treated as original issue discount for this
purpose. See "Federal Income Tax Consequences" herein.
TAX STATUS OF ISSUER
A possibility exists that an Issuer may be classified as a taxable mortgage
pool ("TMP") for federal income tax purposes. If so classified, the TMP should
constitute a "qualified REIT subsidiary" of NovaStar Financial and not be
subject to a corporate income tax. If such an Issuer were to fail to be
treated for federal income tax purposes as a "qualified REIT subsidiary" by
reason of NovaStar Financial's failure to continue to qualify as a real estate
investment trust ("REIT") for federal income tax purposes, or for any other
reason, then 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 any Issuer as a "qualified REIT
subsidiary" or of NovaStar Financial as a REIT for federal income tax
purposes. If the Issuer of series of Bonds were classified as a TMP and for
any reason did not constitute a "qualified REIT Subsidiary," then funds that
would otherwise have been used to pay principal and interest on the Bonds
would be used to pay federal income taxes. This would result in significant
losses to Bondholders of such series of Bonds. See "Federal Income Tax
Consequences" herein.
ENVIRONMENTAL RISKS
Under the federal Comprehensive Environmental Response, Compensation and
Liability Act, as amended ("CERCLA"), and under state law in certain states, a
secured party which takes a deed in lieu of foreclosure, purchases a mortgaged
property at a foreclosure sale, or operates a mortgaged property, may become
liable in certain circumstances for the costs of cleaning up hazardous
substances regardless of whether they have contaminated the property, CERCLA
imposes strict, as well as joint and several, liability on several classes of
potentially responsible parties, including current owners and operators of the
property who did not cause or contribute to the contamination. Furthermore,
liability under CERCLA is not limited to the original or unamortized principal
balance of a loan or to the value of the property securing a loan. Lenders may
be held liable under CERCLA as owners or operators unless they qualify for the
secured creditor exemption to CERCLA. This exemption exempts from the
definition of owners and operators those who, without participating in the
management of a facility, hold indicia of ownership primarily to protect a
security interest in the facility.
The Asset Conservation, Lender Liability and Deposit Insurance Act of 1996
(the "Conservation Act") amended, among other things, the provisions of CERCLA
with respect to lender liability and the secured creditor exemption. The
Conservation Act offers substantial protection to lenders by defining the
activities in which a lender can engage and still have the benefit of the
secured creditor exemption. In order for lender to be deemed to have
participated in the management of a mortgaged property, the lender must
actually participate in the operational affairs of the property of the
borrower. A lender will lose the protection of the secured creditor exemption
only if it exercises decision-making control over the borrower's environmental
compliance and hazardous substance handling and disposal practices, or assumes
day-to-day management of all operational functions of the mortgaged property.
The Conservation Act also provides that a lender will continue to have the
benefit of the secured creditor exemption even if it forecloses on a mortgaged
property, purchases it at a foreclosure sale or accepts a deed-in-lieu of
foreclosure provided that the lender seeks to sell the mortgaged property at
the earliest practicable commercially reasonable time on commercially
reasonable terms.
Other federal and state laws in certain circumstances may impose liability
on a secured party which takes a deed-in-lieu of foreclosure, purchases a
mortgaged property at a foreclosure sale, or operates a mortgaged property on
which contaminants other than CERCLA hazardous substances are present,
including petroleum, agricultural chemicals, hazardous wastes, asbestos,
radon, and lead-based paint. Such cleanup costs may be
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<PAGE>
substantial. It is possible that such cleanup costs could become a liability
of the Indenture Trustee and reduce the amounts otherwise distributable to the
holders of the related series of Bonds. Moreover, certain federal statutes and
certain states by statute impose a lien for any cleanup costs incurred by such
state on the property that is the subject of such cleanup costs (an
"Environmental Lien"). All subsequent liens on such property generally are
subordinated to such an Environmental Lien and, in some states, even prior
recorded liens are subordinated to Environmental Liens. In the latter states,
the security interest of the Indenture Trustee in a related parcel of real
property that is subject to such an Environmental Lien could be adversely
affected.
The Company has not made and will not make evaluations regarding
environmental liabilities prior to the origination of the Bonds. Neither the
Company nor any replacement Servicer will be required by any Agreement to
undertake any such evaluations prior to foreclosure or accepting a deed-in-
lieu of foreclosure. The Company does not make any representations or
warranties or assume any liability with respect to the absence or effect of
contaminants on any related real property or any casualty resulting from the
presence or effect of contaminants. However, the Company will not be obligated
to foreclose on related real property or accept a deed-in-lieu of foreclosure
if it knows or reasonably believes that there are material contaminated
conditions on such property. A failure so to foreclose may reduce the amounts
otherwise available to holders of the related series of Bonds.
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 "--
Book-Entry Registration" herein. No Issuer is expected to apply to have the
Bonds issued by it listed on any exchange.
SWAP, CAP AND FLOOR AGREEMENTS
If so specified in the Prospectus Supplement for a series of Bonds, the
related Assets may include interest rate SWAP agreements or interest rate cap
or floor agreements. These Cash Flow Agreements may be used to hedge the
exposure of the Issuer or Bondholders to fluctuations in interest rates and to
situations where interest rates become higher or lower than specified
thresholds. Generally, a SWAP agreement is a contract between two parties to
pay and receive, with a set frequency, interest payments determined by
applying the differential between two interest rates to an agreed-upon
notional principal amount. Generally, an interest rate cap agreement is a
contract pursuant to which one party agrees to reimburse another party for a
floating rate interest payment obligation, to the extent that the rate payable
at any time exceeds a specified cap. Generally, an interest rate floor
agreement is a contract pursuant to which one party agrees to reimburse
another party in the event that amounts owing to the latter party under a
floating rate interest payment obligation are payable at a rate which is less
than a specified floor. The specific provisions of these types of Cash Flow
Agreements will be described in the related Prospectus Supplement.
Such Cash Flow Agreements involve certain risks, including basic risks,
counterparty credit risks, and, in some cases, legal enforceability risks. A
Cash Flow Agreement may involve basis risk if the interest rate to be hedged
(for example, 1 month LIBOR) is not identical to the interest rate specified
in the Cash Flow Agreement (such as the 30 day Treasury rate). The timing of
changes and the magnitude of the changes in such different interest rates may
not be the same, which may leave the Issuer and the Bondholders in a partially
unhedged position. Similarly, differences between the notional principal
amount of the Cash Flow Agreement and the principal amount to be hedged (such
as might result from higher than expected prepayments on the Mortgage Loans)
may leave the Issuer and the Bondholders in a partially unhedged position.
Cash Flow Agreements also expose the Issuer and the Bondholders to the credit
risk of the counterparty to the agreement. Cash Flow Agreements typically
expose one party to a theoretically unlimited risk in the event of wide
fluctuations in
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interest rates. If a counterparty is unable to meet its financial obligations
under a Cash Flow Agreement as a result of extreme changes in interest rates
or for other reasons, the Issuer and the Bondholders may experience losses
that were thought to be hedged. In addition, in certain instances courts have
ruled that a SWAP agreement is not legally enforceable against a counterparty
on the grounds that the agreement was ultra vires or an illegal gambling
contract. These cases have generally involved governmental entities. Although
the Issuer does not intend to enter into a Cash Flow Agreement that is not
legally enforceable against the counterparty, there is a risk that a court
could rule that such an agreement is not legally enforceable.
INTRODUCTION
NovaStar 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 NovaStar Financial, Inc., a Maryland corporation ("NovaStar
Financial"). NovaStar Financial 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, 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 Mortgage 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 "Indenture 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 trust agreement between the Company and the Owner Trustee.
Generally, under the terms of each trust agreement, the Company initially will
receive the entire beneficial interest in the trust created thereunder. 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 trust agreement. The beneficial owners of each Issuer will have no
liability for the obligations of the Issuer under the Bonds issued by it. Each
Issuer generally will be managed by NovaStar Financial or an affiliate
thereof. The related Prospectus Supplement will indicate if an Issuer is
managed by someone other than NovaStar Financial or an affiliate.
The Assets for each series of Bonds will have been sold or otherwise
transferred to the Issuer of such series by the Company which, in turn, will
have either (i) received such collateral from NovaStar Financial (or an
affiliate) as a contribution to the Company's capital or (ii) purchased such
collateral from NovaStar Financial (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 of Bonds, and in some cases, proceeds from the sale or financing
of the beneficial interest in the Issuer issuing such series. (References
herein to NovaStar Financial in its capacity as Seller shall be deemed to
include any affiliate of NovaStar Financial acting in such capacity.) NovaStar
Financial acquires mortgage loans in the normal course of its business from
persons, including affiliates, who have originated or otherwise acquired such
loans.
Upon the issuance of each series of Bonds, the related Assets will be
deposited by the Company with the Issuer of such series and pledged by such
Issuer to the Indenture Trustee under the related Indenture to secure
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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 Indenture Trustee will hold the Assets 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 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 trust agreement will be subject to amendment
without the prior written consent of the Indenture 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.
THE COMPANY
The Company which was incorporated in the State of Delaware on January 7,
1998, is a limited purpose finance company, and a direct, wholly-owned
subsidiary of NovaStar Financial. The Company is a "qualified REIT
subsidiary", as defined in the Code. The Company's principal executive offices
are located at 1900 West 47th Place, Suite 205, Westwood, Kansas 66205. The
Company's telephone number is 913-362-1090.
NovaStar Financial has agreed with the Company that NovaStar Financial 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.
The Company was incorporated to create the Delaware business trusts that
will be the Issuer of each series of Bonds and to act as a conduit for the
Mortgage Assets that will secure each series of Bonds. The Company has no
operating business and does not have, and in the future is not expected to
have, any significant assets.
The Company has no computer software applications or internal information
systems and, therefore, has no direct Year 2000 issues. However, the Company
may be indirectly affected by the Year 2000 issues of the Master Servicer. The
Year 2000 issues of the Master Servicer, if any, will be disclosed in the
Prospectus Supplement.
NOVASTAR FINANCIAL
NovaStar Financial, Inc. ("NovaStar Financial") was incorporated in the
State of Maryland on September 13, 1996. The common stock of NovaStar
financial is registered under the Securities Act of 1933 and traded on the New
York Stock Exchange. NovaStar Financial is subject to the reporting
requirements of the Securities and Exchange Act of 1934, and in accordance
therewith, files reports and other information with the Securities and
Exchange Commission (the "Commission"). Copies of such material may 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.
NovaStar Financial is a specialty finance company which (i) originates,
acquires, and services residential Subprime Mortgage Loans; (ii) leverages its
assets using bank warehouse lines and repurchase agreements; (iii) issues
collateralized debt obligations through special purpose subsidiaries to
finance its Subprime Mortgage Loans on a long-term basis; (iv) purchases high
quality mortgage securities in the secondary mortgage market; and (v) manages
the resulting combined portfolio of Mortgage Assets in its structure as a real
estate investment trust (a "REIT"). NovaStar Financial purchases substantially
all of the Subprime Mortgage Loans originated by its affiliate, NovaStar
Mortgage. From time to time, NovaStar Financial may also purchase Mortgage
Loans, individually or in pools, from unrelated third parties. NovaStar
Mortgage services NovaStar Financial's entire portfolio of Subprime Mortgage
Loans.
NovaStar Financial has elected to be taxed for federal income tax purposes
as a REIT. As a result, NovaStar Financial is generally not subject to federal
income tax to the extent that it distributes its earnings to stockholders and
maintains its qualification as a REIT. NovaStar Financial has elected REIT
status primarily for the tax advantages associated with that structure.
Management of NovaStar Financial believes the REIT structure is most desirable
for owning Mortgage Assets due to the elimination of corporate-level income
taxation. NovaStar Financial is self-advised and self-managed.
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The principal executive offices of NovaStar Financial are at 1901 W. 47th
Place, Suite 105, Westwood, Kansas 66205. Principal Officers for the Seller's
mortgage lending operations are in Irvine, California. Novastar Financial and
its subsidiaries have more than 150 employees located primarily in Kansas and
California. As of December 31, 1997, NovaStar Financial had total consolidated
assets of $1,126,252,000, total consolidated liabilities of $1,009,763,000,
and stockholders' equity of $116,489,000. For the twelve months ended December
31, 1997, NovaStar Financial had a net consolidated loss of $1,135,000.
The Mortgage Loans that will secure each series of Bonds will be acquired
primarily from NovaStar Financial. Such Mortgage Loans will generally be
Subprime Mortgage Loans.
NOVASTAR MORTGAGE
NovaStar Mortgage, Inc. ("NovaStar Mortgage"), which was incorporated in the
State of Virginia on May 16, 1996, is a wholly-owned subsidiary of NFI Holding
Corporation, Inc., a Delaware corporation ("Holding"). NovaStar financial owns
one hundred percent of the preferred stock of Holding. NovaStar Mortgage is an
approved HUD lender. NovaStar Mortgage originates and services Subprime
Mortgage Loans. Substantially all the Subprime Mortgage Loans originated by
NovaStar Mortgage are sold to NovaStar Financial on a servicing-retained
basis. NovaStar Mortgage's principal executive offices are located at 1900 W.
47th Place, Suite 205, Westwood, Kansas 66205. The principal office for
NovaStar Mortgage's mortgage lending operations are in Irvine, California.
NovaStar Mortgage originates Subprime Mortgage Loans through a network of
approximately 600 unaffiliated wholesale loan brokers located in 35 different
states. In addition, NovaStar Mortgage services Subprime Mortgage Loans on a
nationwide basis, and is qualified to do business as a foreign corporation in
more than 45 states. NovaStar Mortgage's servicing portfolio currently
includes only Subprime Mortgage Loans. NovaStar Mortgage services all of
NovaStar Financial's portfolio of Subprime Mortgage Loans and all of Novastar
Financial's Subprime Mortgage Loans that were previously securitized as
mortgage-backed securities. If so specified in the related Prospectus
Supplement for a series of Bonds, NovaStar Mortgage will be the Master
Servicer for the Mortgage Loans securing such series of Bonds.
FORECLOSURE AND DELINQUENCY EXPERIENCE WITH SUBPRIME MORTGAGE LOANS
The Assets securing a series of Bonds may include Subprime Mortgage Loans.
The following table summarizes the delinquency and foreclosure experience,
respectively, as of the date indicated, of the Subprime Mortgage Loans
originated and serviced by NovaStar Mortgage. The information should not be
considered as a basis for assessing the likelihood, amount or severity of
delinquencies or foreclosures on the Subprime Mortgage Loans securing any
series of Bonds and no assurances can be given that the foreclosure and
delinquency experience presented in the table below will be indicative of such
experience on the Subprime Mortgage Loans securing any series of Bonds:
DELINQUENCY AND FORECLOSURE
<TABLE>
<CAPTION>
AS OF FEBRUARY 28, 1998
-----------------------
PRINCIPAL
BALANCE PERCENTAGE
------------ ----------
<S> <C> <C>
Subprime Mortgage Loan Portfolio........................ $513,153,207 100%
Delinquency Percentage (1)
30-59 Days............................................ 6,190,042 1.21%
60-89 Days............................................ 4,626,483 0.90%
90+ Days.............................................. 6,697,134 1.31%
------------ -----
Total (2)........................................... $ 17,513,659 3.42%
------------ -----
Foreclosure Rate (3).................................... $ 7,686,334 1.50%
------------ -----
</TABLE>
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- --------
(1) The period of delinquency is based on the number of days payments are
contractually past due.
(2) The total percentages and dollar amounts include the dollar amounts and
percentages included in the line titled "Foreclosure Rate."
(3) "Foreclosure Rate" is the dollar amount of the mortgage loans in
foreclosure as a percentage of the total principal balance of the mortgage
loans outstanding as of the date indicated. These amounts are also
included in the line titled "Total."
USE OF PROCEEDS
The net proceeds to be received from the sale of the Bonds will be applied
by the Company to the purchase or acquisitions of Assets, or the payment of
the financing incurred in such purchase, and to pay for certain expenses
incurred in connection with such purchase of Assets and sale of Bonds. The
Assets pledged to secure a series of Bonds will either be contributed to the
Company's capital by NovaStar Financial (or an affiliate) or purchased from
NovaStar Financial (or an affiliate) or another seller and deposited with the
Issuer of such series by the Company. The Company expects to sell the Bonds
from time to time, but the timing and amount of offerings of Bonds will depend
on a number of factors, including the volume of Assets acquired by the
Company, prevailing interest rates, availability of funds and general market
conditions.
DESCRIPTION OF THE ASSETS
ASSETS
The primary assets of each Issuer (the "Assets") may include (i) fixed or
variable rate, first or junior lien mortgages loans secured by one- to four-
family residential properties ("Mortgage Loans"); (ii) mortgage
participations, mortgage pass-through certificates or mortgage-backed
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") (collectively, "Agency
Securities"); (iii) other mortgage participations, mortgage pass-through
certificates or mortgage backed securities evidencing interests in mortgage
loans or secured thereby ("Private Mortgage-Backed Securities") (Agency
Securities and Private Mortgage-Backed Securities are collectively referred to
as "MBS"); (iv) manufactured housing installment sale contracts or installment
loan agreements ("Contracts"); (v) certain direct obligations of the United
States, agencies thereof or agencies created thereby ("Government Bonds");
(vi) certain debt obligations of corporations or other nongovernmental
entities ("Corporate Bonds") or (vii) a combination of Mortgage Loans, MBS,
Contracts, Government Bonds and Corporate Bonds. Mortgage loans that secure,
or interests in which are evidenced by, MBS are herein sometimes referred to
as "Underlying Mortgage Loans." Mortgage Loans that are not Underlying
Mortgage Loans are sometimes referred to as "Whole Loans." Mortgage Loans and
MBS are sometimes referred to herein as "Mortgage Assets." The Mortgage Assets
will not be guaranteed or insured by the Company or any of its affiliates. The
Prospectus Supplement, will specify if the Mortgage Assets are guaranteed or
insured by any governmental agency or instrumentality or by any other person.
Each Asset will be selected by the Company for inclusion from among those
purchased, either directly or indirectly, from a prior holder thereof (an
"Asset Seller"), which may be an affiliate of the Company and, with respect to
Assets, which prior holder may or may not be the originator of such Mortgage
Loan or Contract or the issuer of such MBS. The Company will not include 20%
or more of delinquent Assets in any series of Bonds. See "Mortgage Loan
Characteristics" in the Prospectus Supplement for specific information
regarding the percentage of delinquent Assets included in a series of Bonds.
The Bonds generally will be entitled to payment only from the assets of the
related Issuer and will not be entitled to payments in respect of the assets
of any other Issuer. The related Prospectus Supplement will indicate if the
Bonds are entitled to payments in respect of the assets of any other Issuer.
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MORTGAGE LOANS
General
Each Mortgage Loan generally will be secured by (i) a lien on a Mortgaged
Property consisting of a one- to four-family residential property (a "Single
Family Property" and the related Mortgage Loan a "Single Family Mortgage
Loan") or (ii) a security interest in shares issued by private cooperative
housing corporations ("Cooperatives"). Mortgaged Properties will be located in
any one of the fifty states, the District of Columbia or the Commonwealth of
Puerto Rico. The Mortgage Loans may be "equity refinance" Mortgage Loans, as
to which a portion of the proceeds are used to refinance an existing mortgage
loan, and the remaining proceeds may be retained by the mortgagor or used for
purposes unrelated to the Mortgaged Property. Alternatively, the Mortgage
Loans may be "rate and term refinance" Mortgage Loans, as to which
substantially all of the proceeds (net of related costs incurred by the
mortgagor) are used to refinance an existing mortgage loan or loans (which may
include a junior lien) primarily in order to change the interest rate or other
terms thereof. To the extent specified in the related Prospectus Supplement,
the Mortgage Loans will be secured by first and/or junior mortgages or deeds
of trust or other similar security instruments creating a first or junior lien
on Mortgaged Property. In addition, certain or all of the Single Family
Mortgage Loans may have Loan-to-Value Ratios in excess of 80% and as high as
125% (such Mortgage Loans, "High LTV Loans"). The Mortgaged Properties may
include apartments owned by Cooperatives. The Mortgaged Properties may include
leasehold interests in properties, the title to which is held by third party
lessors. The term of any such leasehold will generally exceed the term of the
related mortgage note by at least five years. Each Mortgage Loan will have
been originated by a person (the "Originator") other than the Company. The
related Prospectus Supplement will indicate if any Originator is an affiliate
of the Company. The Mortgage Loans will be evidenced by promissory notes (the
"Mortgage Notes") secured by mortgages, deeds of trust or other security
instruments (the "Mortgages") creating a lien on the Mortgaged Properties.
Loan-to-Value Ratio
The "Loan-to-Value Ratio" of a Mortgage Loan at any given time is the ratio
(expressed as a percentage) of the then outstanding principal balance of the
Mortgage Loan to the Value of the related Mortgaged Property. The "Combined
Loan-to-Value Ratio" of a Mortgage Loan which is secured by a second lien on
the related Mortgaged Property at any given time generally will be the ratio,
expressed as a percentage, the numerator of which is the sum of (i) the
original principal balance of the Mortgage Loan plus (ii) the unpaid principal
balance of any first lien on the related Mortgaged property as of such date,
and the denominator of which is the Value of the Mortgage Loan. The "Value" of
a Mortgaged Property, other than with respect to Refinance Loans, is generally
the lesser of (a) the appraised value determined in an appraisal obtained by
the Originator at origination of such loan and (b) the sales price for such
property. "Refinance Loans" are loans made to refinance existing loans. The
Value of the Mortgaged Property securing a Refinance Loan will generally be
the appraised value thereof determined in an appraisal obtained at the time of
origination of the Refinance Loan. The Value of a Mortgaged Property as of the
date of initial issuance of the related series of Bonds may be less than the
value at origination and will fluctuate from time to time based upon changes
in economic conditions and the real estate market.
Mortgage Loan Information in Prospectus Supplements
Each Prospectus Supplement will contain information, as of the dates
specified in such Prospectus Supplement and to the extent then applicable and
specifically known to the Company, with respect to the Mortgage Loans,
including (i) the aggregate outstanding principal balance and the largest,
smallest and average outstanding principal balance of the Mortgage Loans as of
the applicable Cut-off Date, (ii) the type of property securing the Mortgage
Loans, (iii) the weighted average (by principal balance) of the original and
remaining terms to maturity of the Mortgage Loans, (iv) the earliest and
latest origination date and maturity date of the Mortgage Loans, (v) the range
of the Loan-to-Value Ratios at origination of the Mortgage Loans, (vi) the
Mortgage Rates or range of Mortgage Rates and the weighted average Mortgage
Rate borne by the Mortgage Loans, (vii) the state or states in which most of
the Mortgaged Properties are located, (viii) information with respect to the
prepayment provisions, if any, of the Mortgage Loans, (ix) with respect to
Mortgage Loans with
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adjustable Mortgage Rates ("ARM Loans"), the index, the frequency of the
adjustment dates, the range of margins added to the index, and the maximum
Mortgage Rate or monthly payment variation at the time of any adjustment
thereof and over the life of the ARM Loan and (x) information regarding the
payment characteristics of the Mortgage Loans, including without limitation
balloon payment and other amortization provisions. If specific information
respecting the Mortgage Loans is not known to the Company at the time Bonds
are initially offered, more general information of the nature described above
will be provided in the Prospectus Supplement, and specific information will
be set forth in a report which will be available to purchasers of the related
Bonds at or before the initial issuance thereof and will be filed as part of a
Current Report on Form 8-K with the Securities and Exchange Commission within
fifteen days after such initial issuance.
The related Prospectus Supplement may specify whether the Mortgage Loans
include closed-end and/or revolving home equity loans or certain balances
thereof ("Closed-End Loans" and "Revolving Credit Loans" and collectively
"Home Equity Loans"), which may be secured by Mortgages primarily on Single
Family Properties that are subordinate or junior to other liens on the related
Mortgaged Property.
The full principal amount of a Closed-End Loan generally is advanced at
origination of the loan and generally is repayable in equal (or substantially
equal) installments of an amount sufficient to fully amortize such loan at its
stated maturity. As more fully described in the related Prospectus Supplement,
interest on each Closed-End Loan is calculated on the basis of the outstanding
principal balance of such loan multiplied by the Mortgage Rate thereon.
As more fully described in the related Prospectus Supplement, interest on
each Revolving Credit Loan, excluding introductory rates offered from time to
time during promotional periods, may be computed at the Mortgage Rate and
payable monthly on the average daily outstanding principal balance of such
loan. Principal amounts on the Revolving Credit Loans may be drawn down (up to
a maximum amount as set forth in the related Prospectus Supplement) or repaid
under each Revolving Credit Loan from time to time. If specified in the
related Prospectus Supplement, new draws by borrowers under the Revolving
Credit Loans will automatically become part of the Assets for a series of
Bonds. As a result, the aggregate balance of the Revolving Credit Loans will
fluctuate from day to day as new draws by borrowers are added to the Assets
and principal payments are applied to such balances and such amounts will
usually differ each day, as more specifically described in the related
Prospectus Supplement.
Payment Provisions of the Mortgage Loans
All of the Mortgage Loans will generally (i) have individual principal
balances at origination of not less than $1,000, (ii) have original terms to
maturity of not more than 40 years and (iii) provide for payments of
principal, interest or both, on due dates that occur monthly, quarterly or
semi-annually or at such other interval as is specified in the related
Prospectus Supplement. Each Mortgage Loan may provide for no accrual of
interest or for accrual of interest thereon at an interest rate (a "Mortgage
Rate") that is fixed over its term or that adjusts from time to time, or that
may be converted from an adjustable to a fixed Mortgage Rate or a different
adjustable Mortgage Rate, or from a fixed to an adjustable Mortgage Rate, from
time to time pursuant to an election or as otherwise specified on the related
Mortgage Note, in each case as described in the related Prospectus Supplement.
Each Mortgage Loan may provide for scheduled payments to maturity or payments
that adjust from time to time to accommodate changes in the Mortgage Rate or
to reflect the occurrence of certain events or that adjust on the basis of
other methodologies, and may provide for negative amortization or accelerated
amortization, in each case as described in the related Prospectus Supplement.
Each Mortgage Loan may be fully amortizing or require a balloon payment due on
its stated maturity date, in each case as described in the related Prospectus
Supplement. Each Mortgage Loan may contain prohibitions on prepayment (a
"Lock-out Period" and, the date of expiration thereof, a "Lock-out Date") or
require payment of a premium or a yield maintenance penalty (a "Prepayment
Premium") in connection with a prepayment, in each case as described in the
related Prospectus Supplement. In the event that holders of any class or
classes of Offered Bonds will be entitled to all or a portion of any
Prepayment Premiums collected in respect of Mortgage Loans, the related
Prospectus Supplement will specify the method or methods by which any such
amounts will be allocated.
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Underwriting Standards
Mortgage Loans to be included in the Assets will generally have been
originated in accordance with underwriting standards acceptable to NovaStar
Financial (or an affiliate) or alternative underwriting criteria. The general
underwriting standards for the Mortgage Loans are described herein. However,
in some cases, particularly those involving unaffiliated sellers, NovaStar
Financial (or an affiliate) may not be able to establish the underwriting
standards used in the origination of the related Mortgage Loans. In those
cases, the related Prospectus Supplement will include a statement to such
effect and will reflect what, if any, re-underwriting of the related Mortgage
Loans was done by NovaStar Financial or any of its affiliates.
The underwriting standards to be used in originating the Mortgage Loans are
primarily intended to assess the creditworthiness of the mortgagor, the value
of the Mortgaged Property and the adequacy of such property as collateral for
the Mortgage Loan.
The primary considerations in underwriting a Single Family Mortgage Loan or
Contract are the mortgagor's employment stability and whether the mortgagor
has sufficient monthly income available (i) to meet the mortgagor's monthly
payments due in the year of origination) and other expenses related to the
home (such as property taxes and hazard insurance) and (ii) to meet monthly
housing expenses and other financial obligations and monthly living expenses.
However, the Loan-to-Value Ratio of the Mortgage Loan is another critical
factor. In addition, a mortgagor's credit history and repayment ability, as
well as the type and use of the Mortgaged Property, are also considerations.
High LTV Loans are underwritten with an emphasis on the creditworthiness of
the related mortgagor. Such Mortgage Loans are underwritten with a limited
expectation of recovering any amounts from the foreclosure of the related
Mortgaged Property.
It is expected that each prospective mortgagor will complete a mortgage loan
application that includes information with respect to the applicant's
liabilities, income, credit history, employment history and personal
information. One or more credit reports on each applicant from national credit
reporting companies will generally be required. The report typically contains
information relating to such matters as credit history with local and national
merchants and lenders, installment debt payments and any record of defaults,
bankruptcies, repossessions or judgments.
Mortgaged Properties will generally be appraised by licensed appraisers. The
appraiser will generally address neighborhood conditions, site and zoning
status and condition and valuation of improvements. In the case of Single
Family Properties, the appraisal report will generally include a reproduction
cost analysis (when appropriate) based on the current cost of constructing a
similar home and a market value analysis based on recent sales of comparable
homes in the area. The market approach to value analyzes the prices paid for
the purchase of similar properties in the property's area, with adjustments
made for variations between those other properties and the property being
appraised. The costs approach to value requires the appraiser to make an
estimate of land value and then determine the current cost of reproducing the
improvements less any accrued depreciation. In any case, the value of the
property being financed, as indicated by the appraisal, must be such that it
currently supports, and is anticipated to support in the future, the
outstanding loan balance. Appraisals usually conform to the Uniform Standards
of Professional Appraisal Practice and the Financial Institutions Reform,
Recovery and Enforcement Act of 1989 ("FIRREA").
Notwithstanding the foregoing, Loan-to-Value Ratios will not necessarily
constitute an accurate measure of the risk of liquidation loss in a pool of
Mortgage Loans. For example, the value of a Mortgaged Property as of the date
of initial issuance of the related series of Bonds may be less than the Value
determined at loan origination, and will likely continue to fluctuate from
time to time based upon changes in economic conditions and the real estate
market. As stated above, appraised values are generally based on the market
analysis, the cost analysis, the income analysis, or upon a selection from or
interpolation of the values derived from such
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<PAGE>
approaches. Each of these appraisal methods can present analytical
difficulties. It is often difficult to find truly comparable properties that
have recently been sold; the replacement cost of a property may have little to
do with its current market value; and income capitalization is inherently
based on inexact projections of income and expenses and the selection of an
appropriate capitalization rate. Where more than one of these appraisal
methods are used and provide significantly different results, an accurate
determination of value and, correspondingly, a reliable analysis of default
and loss risks, is even more difficult.
Underwriting Standards for Subprime Mortgage Loans
The Subprime Mortgage Loans securing a series of Bonds will generally have
been originated using underwriting criteria described herein. Any material
deviation from or adjustment to such underwriting criteria for Subprime
Mortgage Loans that secure a series of Bonds will be described in the related
Prospectus Supplement. NovaStar Financial currently acquires substantially all
its Mortgage Loans from its affiliate, NovaStar Mortgage, which Mortgage Loans
have been originated by NovaStar Mortgage using the following underwriting
criteria. From time to time, NovaStar Financial may also purchase Mortgage
Loans, individually or in pools, from unrelated third parties, which Mortgage
Loans will have been reunderwritten by NovaStar Financial using the following
underwriting guidelines. The criteria that NovaStar Financial will use to
select and screen unrelated third parties from which to acquire Mortgage Loans
include consistent underwriting standards, high levels of quality control,
accurate and complete loan files, history of regulatory compliance, servicing
technology and resources, absence of excessive delinquencies and foreclosures,
and attractive pricing of loans relative to the market. With respect to any
loan purchased by NovaStar Financial from an unrelated third party that is
included in the collateral for a series of Bonds, NovaStar Financial will be
the owner of and the seller of such loan, and NovaStar Financial (not the
third party) will be the Warranting Party with respect to such loan.
The underwriting guidelines for Subprime Mortgage Loans are intended to
evaluate the credit history of the potential borrower, the capacity and
willingness of the borrower to repay the loan and the adequacy of the
collateral securing the loan. Each loan applicant completes an application
that includes information with respect to the applicant's income, assets,
liabilities and employment history. A credit report is also submitted by the
broker along with the loan application, which provides detailed information
concerning the payment history of the borrower on all of the borrower's debts.
Prior to issuing an approval on the loan, the underwriter runs an independent
credit report to verify that the information submitted by the broker is still
accurate and up to date. An appraisal is also required on all loans and in
many cases a review appraisal or second appraisal may be required depending on
the value of the property and the underwriter's comfort with the original
valuation. All appraisals are required to conform to the Uniform Standards of
Professional Appraisal Practice adopted by the Appraisal Standards Board of
the Appraisal Foundation and are generally on forms acceptable to FNMA and
FHLMC. The properties securing the mortgage loans are generally appraised by
qualified independent appraisers who are generally approved by the related
originator. The mortgagor may also include information regarding verification
of deposits at financial institutions where the mortgagor had demand or
savings accounts. In the case of investment properties, income derived from
the mortgage property may have been used for underwriting purposes.
The underwriting guidelines include three levels of applicant documentation
requirements, referred to as "Full Documentation", "Limited Documentation" and
"Stated Income". Under the Full Documentation program, applicants generally
are required to submit two written forms of verification of stable income for
at least 12 months. Under the Limited Documentation program, no such
verification is required; however, bank statements for the most recent
consecutive 6-month period are required to evidence cash flow. If business
bank statements are used in lieu of personal statements, an unaudited current
profit loss statement must accompany the bank statements. Under the Stated
Income program, an applicant may be qualified based on monthly income as
stated in the loan application. Mortgage Loans originated under the "Limited
Documentation" and "Stated Income" programs require less documentation and
verification than do traditional "Full Documentation" programs. Generally,
under such programs, minimal investigation into a mortgagor's credit history
and income profile would have been undertaken by the originator and the
underwriting for such mortgage loans will place a greater emphasis on the
value of the mortgaged property. Given that the Servicer primarily lends to
subprime borrowers, it places great emphasis on the ability of collateral to
protect against losses in the event of default by borrowers.
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<PAGE>
On a case-by-case basis, exceptions to the underwriting guidelines are made
where compensating factors exist. Compensating factors may consist of factors
like length of time in residence, lowering of the borrower's monthly debt
service payments, the Loan-to-Value ratio or Combined Loan-to-Value Ratio on
the loan, as applicable, or other criteria that in the judgement of the
underwriter warrants an exception. All loans in excess of $350,000 currently
require the approval of the Chief Credit Officer of NovaStar Mortgage. In
addition, the President of NovaStar Mortgage approves all loans in excess of
$750,000.
NovaStar Mortgage's current categories and criteria for grading the credit
history of potential borrowers and the maximum Loan-to-Value Ratios and
Combined Loan-to-Value Ratios allowed for each category are shown in the
following table.
<TABLE>
<CAPTION>
AA RISK A RISK A- RISK B RISK C RISK D RISK
------- ------ ------- ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Mortgage History No 30-day Maximum one Maximum two Maximum Maximum five Maximum six
lates 30-day late 30- three 30- 30- 30-
within last and no 60- day lates day lates day lates, day lates,
24 day lates and no and one two three 60-day
months. within last 60-day lates 60-day late 60-day lates lates and two
12 months. within last within last and one 90- 90-day lates
12 months. 12 months. day late within last 12
within last months.
12 months.
Other Credit Limited 30- Limited 30 Limited 60- Limited 60- Limited 90- Discretionary.
day day lates day lates day lates day lates Credit is gen-
lates within within last within last within last within last erally ex-
last 24 12 months. 12 months. 12 months. 12 months. pected to be
months. late pay.
Bankruptcy Filings Chapter 7: 7 Chapter 7: 2 Chapter 7: 2 Chapter 7: 2 Chapter 7: 1 Chapter 7: 1
years years since years since years since year since year since
since filing filing date. filing date. filing date. filing date. filing date.
date. Chapter 13: Chapter 13: Chapter 13: Chapter 13: Chapter 13: No
Chapter 13: Discharged 1 Discharged 1 Discharged 1 1 year sat- seasoning re-
Discharged 1 year with year with year with isfactory quired: buy-
year re-estab- re-estab- good credit pay history: out required.
with re-es- lished cred- lished cred- since dis- buy-out
tablished it. it. charge. required.
credit.
Debt to Service Ratio 45% 50% 50% 50% 55% 60%
Maximum Loan-to- 95% 90% 90% 85% 80% 65%
Value Ratio
Maximum Combined 125%-owner 125%-owner 125%-owner 125%-owner 100%-owner Not allowed
Loan-to-Value Ratio occ. occ. occ. occ. occ.
90%-in- 100%-manu- 100%-manu- 100%-manu- 90%-manu-
vestor factured factured factured factured
100%-foreign 100%-foreign 90%-in- 90%-in-
nat'l nat'l vestor vestor
90%-in- 90%-in-
vestor vestor
</TABLE>
Close attention is paid to geographic diversification in managing credit
risk. NovaStar Mortgage believes one of the best tools for managing credit
risk is to diversify the markets in which it originates mortgage loans.
NovaStar Mortgage has established a diversification policy to be followed in
managing this credit risk which states that no one market can represent a
percentage of total mortgage loans owned by NovaStar Mortgage higher than
twice that market's percentage of the total national market share.
Quality control reviews are conducted to ensure that all mortgage loans meet
quality standards. The type and extent of the reviews depend on the production
channel through which the mortgage loan was obtained and the characteristics
of the mortgage loan. NovaStar Mortgage reviews a high percentage of mortgage
loans with (i) principal balances in excess of $450,000, (ii) higher Loan-to-
Value Ratios or Combined Loan-to-Value Ratios (in excess of 75%), (iii)
limited documentation, or (iv) made for "cash out" refinance purposes.
NovaStar Mortgage also performs appraisal reviews and compliance reviews as
part of the quality control process to ensure adherence to state and federal
regulations.
Mortgage Participations
Mortgage participations will evidence an undivided participation interest in
Underlying Mortgage Loans. To the extent available to the Company, the related
Prospectus Supplement will contain information in respect of the Underlying
Mortgage Loans substantially similar to the information described above in
respect of Mortgage Loans. Such Prospectus Supplement will also specify the
amount of the participation and servicing agreements.
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MBS
Any MBS will have been issued pursuant to a pooling and servicing agreement,
a trust agreement, an indenture or similar agreement (an "MBS Agreement"). A
seller (the "MBS Issuer") and/or servicer (the "MBS Servicer") of the
Underlying Mortgage Loans will have entered into the MBS Agreement with a
trustee or a custodian under the MBS Agreement (the "MBS Indenture Trustee"),
if any, or with the original purchaser of the interest in the underlying
Mortgage Loans or MBS evidenced by the MBS.
Private MBS may include (a) mortgage pass-through certificates representing
beneficial interests in mortgage loans or in Agency Securities or (b)
collateralized mortgage obligations secured by mortgage loans or by Agency
Securities. Private MBS 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) on the mortgage loans or
the Agency Securities. Stripped Private MBS that are collateralized by Agency
Securities will not, themselves, be insured or guaranteed by the United State
or any agency or instrumentality thereof.
The Private MBS will have been previously registered under the '33 Act, will
be exempt from registration under the '33 Act or will be eligible for resale
under Rule 144(k) promulgated under the '33 Act. In addition, such Private MBS
will have been acquired in a bona fide secondary market transaction and not
from the issuer of such securities or any affiliate thereof.
Distributions of any principal or interest, as applicable, will be made on
MBS on the dates specified in the related Prospectus Supplement. The MBS may
be issued in one or more classes with characteristics similar to the classes
of Bonds described in this Prospectus. Any principal or interest distributions
will be made on the MBS by the MBS Indenture Trustee or the MBS Servicer. The
MBS Issuer or the MBS Servicer or another person specified in the related
Prospectus Supplement may have the right or obligation to repurchase or
substitute assets underlying the MBS after a certain date or under other
circumstances specified in the related Prospectus Supplement.
Enhancement in the form of reserve funds, subordination or other forms of
credit support similar to that described for the Bonds under "Description of
Credit Support" may be provided with respect to the MBS. The type,
characteristics and amount of such credit support, if any, will be a function
of certain characteristics of the Underlying Mortgage Loans or underlying MBS
evidenced by or securing such MBS and other factors and generally will have
been established for the MBS on the basis of requirements of either any Rating
Agency that may have assigned a rating to the MBS or the initial purchasers of
the MBS.
The Prospectus Supplement for a series of Bonds evidencing interests in
Mortgage Assets that include MBS will specify, to the extent available to the
Company, (i) the aggregate approximate initial and outstanding principal
amount or notional amount, as applicable, and type of the MBS to be included
in the related Assets, (ii) the original and remaining term to stated maturity
of the MBS, if applicable, (iii) whether such MBS is entitled only to interest
payments, only to principal payments or to both, (iv) the pass-through or bond
rate of the MBS or formula for determining such rates, if any, (v) the
applicable payment provisions for the MBS, including, but not limited to, any
priorities, payment schedules and subordination features, (vi) the MBS Issuer,
MBS Servicer and MBS Indenture Trustee, as applicable, (vii) certain
characteristics of the credit support, if any, such as subordination, reserve
funds, insurance policies, letters of credit or guarantees relating to the
related Underlying Mortgage Loans, the underlying MBS or directly to such MBS,
(viii) the terms on which the related Underlying Mortgage Loans or underlying
MBS for such MBS or the MBS may, or are required to, be purchased prior to
their maturity, (ix) the terms on which Mortgage Loans or underlying MBS may
be substituted for those originally underlying the MBS, (x) the servicing fees
payable under the MBS Agreement, (xi) the type of information in respect of
the Underlying Mortgage Loans described under "--Mortgage Loans--Mortgage Loan
Information in Prospectus Supplements" above, and the type of information in
respect of the underlying MBS described in this paragraph, (xii) the
characteristics of any cash flow agreements that are included as part of the
trust fund evidenced or secured by the MBS and (xiii) whether the MBS is in
certificated form or held through a depository.
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CONTRACTS
General
Each Contract will generally be secured by a security interest in a new or
used Manufactured Home. Such Prospectus Supplement will specify the states or
other jurisdictions in which the Manufactured Homes are located as of the
related Cut-off Date. The method of computing the "Loan-to-Value Ratio" of a
Contract will be described in the related Prospectus Supplement.
Contract Information in Prospectus Supplements
Each Prospectus Supplement will contain certain information, as of the dates
specified in such Prospectus Supplement and to the extent then applicable and
specifically known to the Company, with respect to the Contracts, including
(i) the aggregate outstanding principal balance and the largest, smallest and
average outstanding principal balance of the Contracts as of the applicable
Cut-off Date, (ii) whether the Manufactured Homes were new or used as of the
origination of the related Contracts, (iii) the weighted average (by principal
balance) of the original and remaining terms to maturity of the Contracts,
(iv) the earliest and latest origination date and maturity date of the
Contracts, (v) the range of the Loan-to-Value Ratios at origination of the
Contracts, (vi) the Contract Rates or range of Contract Rates and the weighted
average Contract Rate borne by the Contracts, (vii) the state or states in
which most of the Manufactured Homes are located at origination, (viii)
information with respect to the prepayment provisions, if any, of the
Contracts, (ix) with respect to Contracts with adjustable Contract Rates ("ARM
Contracts"), the index, the frequency of the adjustment dates, and the maximum
Contract Rate or monthly payment variation at the time of any adjustment
thereof and over the life of the ARM Contract, and (x) information regarding
the payment characteristics of the Contracts. If specific information
respecting the Contracts is not known to the Company at the time Bonds are
initially offered, more general information of the nature described above will
be provided in the Prospectus Supplement, and specific information will be set
forth in a report which will be available to purchasers of the related Bonds
at or before the initial issuance thereof and will be filed as part of a
Current Report on Form 8-K with the Securities and Exchange Commission within
fifteen days after such initial issuance.
Payment Provisions of the Contracts
The Contracts will generally (i) have individual principal balances at
origination of not less than $1,000, (ii) have original terms to maturity of
not more than 40 years and (iii) provide for payments of principal, interest
or both, on due dates that occur monthly or at such other interval as is
specified in the related Prospectus Supplement. Each Contract may provide for
no accrual of interest or for accrual of interest thereon at an annual
percentage rate (a "Contract Rate") that is fixed over its term or that
adjusts from time to time, or as otherwise specified in the related Prospectus
Supplement. Each Contract may provide for scheduled payments to maturity or
payments that adjust from time to time to accommodate changes in the Contract
Rate as described in the related Prospectus Supplement.
GOVERNMENT BONDS
The Prospectus Supplement for a series of Bonds secured by Assets of the
related Issuer that include Government Bonds will specify, to the extent
available, (i) the aggregate approximate initial and outstanding principal
amounts or notional amounts, as applicable, and types of the Government Bonds
to be included, (ii) the original and remaining terms to stated maturity of
the Government Bonds, (iii) whether such Government Bonds are entitled only to
interest payments, only to principal payments or to both, (iv) the interest
rates of the Government Bonds or the formula to determine such rates, if any,
(v) the applicable payment provisions for the Government Bonds and (vi) to
what extent, if any, the obligation evidenced thereby is backed by the full
faith and credit of the United States.
CORPORATE BONDS
The Prospectus Supplement for a Series of Bonds secured by Assets of the
related Issuer that includes Corporate Bonds will specify, to the extent
available, (i) the aggregate outstanding principal amounts of the Corporate
Bonds to be included, (ii) the original and remaining terms to maturity of
such Corporate Bonds, (iii) the interest rates, or the formula for determining
such rates, payable on such Corporate Bonds, (iv) the applicable
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<PAGE>
payment and prepayment provisions of such Corporation Bonds, (v) the obligors
on such Corporate Bonds, and (vi) if rated by a nationally recognized
statistical rating agency, the ratings of such Corporate Bonds. If so
specified in the related Prospectus Supplement, Corporate Bonds may be
deposited in a reserve fund for purposes of Credit Support for the series of
Bonds.
PRE-FUNDING ACCOUNT
To the extent provided in the related Prospectus Supplement, the Company
will be obligated (subject only to the availability thereof) to sell at a
predetermined price, and the related Issuer for the related series of Bonds
will be obligated to purchase (subject to the satisfaction of certain
conditions described in the applicable Agreement), additional Assets (the
"Subsequent Assets") from time to time (as frequently as daily) within the
period (the "Pre-Funding Period") specified in the related Prospectus
Supplement having an aggregate principal balance approximately equal to the
amount on deposit (the "Pre-Funded Amount") in an account (the "Pre-Funding
Account") established by the Indenture Trustee and funded on the date of such
issuance. The Pre-Funded Amount to be deposited in the Pre-Funding Account,
which will not exceed 25% of the gross offering proceeds of the series of
Bonds, will be set forth in the related Prospectus Supplement. The Pre-Funding
Period will not exceed 90 days after the date of issuance of the Bonds. During
the Pre-Funding Period, funds held in the Pre-Funding Account will be invested
only in short-term, cash equivalent investments, including (i) short-term
obligations of (or granted by) the United States, or any agency or
instrumentality thereof, that mature during the Pre-Funding Period and that
are held to maturity, (ii) short-term certificates of deposit in a bank or
trust company and (iii) short-term money market mutual funds. Subsequent
Assets to be acquired with funds held in the Pre-Funded Account must be
substantially similar to the other Assets securing the series of Bonds, and
must be underwritten consistent with the underwriting standards for such
Assets set forth in the related Prospectus Supplement. All funds remaining in
the Pre-Funding Account at the end of the Pre-Funding Period will be
distributed to Bondholders on the next Distribution Date as pre-payments of
principal. The inability to invest funds held in the Pre-Funded Account in
Subsequent Assets that meet the specified underwriting criteria will result in
principal pre-payments that will shorten the duration of the Bonds.
ACCOUNTS
Each Issuer will maintain one or more accounts established on behalf of the
Bondholders into which the person or persons designated in the related
Prospectus Supplement will, to the extent described herein and in such
Prospectus Supplement, deposit all payments and collections received or
advanced with respect to the Assets and other assets of the Issuer. Such an
account may be maintained as an interest bearing or a non-interest bearing
account, and funds held therein may be held as cash or invested in certain
short-term, investment grade obligations, in each case as described in the
related Prospectus Supplement. See "Description of the Agreements--Collection
Account and Related Accounts."
CREDIT SUPPORT
If so provided in the related Prospectus Supplement, partial or full
protection against certain defaults and losses on the Assets of the related
Issuer may be provided to one or more classes of Bonds in the related series
in the form of subordination of one or more other classes of Bonds in such
series or by one or more other types of credit support, such as a cash
accounts, overcollateralization, excess spread, crosscollateralization,
subordination, reserve funds, insurance policies, surety bonds, guarantees,
letters of credit or another type of credit support, or a combination thereof
(any such coverage with respect to the Bonds of any series, "Credit Support").
The amount and types of coverage, the identification of the entity providing
the coverage (if applicable) and related information with respect to each type
of Credit Support, if any, will be described in the Prospectus Supplement for
a series of Bonds. See "Risk Factors--Credit Support Limitations" and
"Description of Credit Support."
CASH FLOW AGREEMENTS
If so provided in the related Prospectus Supplement, the Assets may include
guaranteed investment contracts pursuant to which moneys held in the funds and
accounts established for the related series will be invested at a specified
rate. The Assets may also include certain other agreements, such as interest
rate exchange agreements,
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interest rate cap or floor agreements, or similar agreements provided to
reduce the effects of interest rate fluctuations on the Assets or on one or
more classes of Bonds. The principal terms of any such guaranteed investment
contract or other agreement (any such agreement, a "Cash Flow Agreement"),
including, without limitation, provisions relating to the timing, manner and
amount of payments thereunder and provisions relating to the termination
thereof, will be described in the Prospectus Supplement for the related
series. In addition, the related Prospectus Supplement will provide certain
information with respect to the obligor under any such Cash Flow Agreement.
YIELD CONSIDERATIONS
GENERAL
The yield on any Offered Bond will depend on the price paid by the
Bondholder, the Bond Interest Rate, the receipt and timing of receipt of
distributions on the Bond and the weighted average life of the Assets of the
related Issuer (which may be affected by prepayments, defaults, liquidations
or repurchases). See "Risk Factors."
BOND INTEREST RATE
Bonds of any class within a series may have fixed, variable or adjustable
Bond Interest Rates, which may or may not be based upon the interest rates
borne by the Assets of the related Issuer. The Prospectus Supplement with
respect to any series of Bonds will specify the Bond Interest Rate for each
class of such Bonds or, in the case of a variable or adjustable Bond Interest
Rate, the method of determining the Bond Interest Rate; the effect, if any, of
the prepayment of any Asset on the Bond Interest Rate of one or more classes
of Bonds; and whether the distributions of interest on the Bonds of any class
will be dependent, in whole or in part, on the performance of any obligor
under a Cash Flow Agreement.
If so specified in the related Prospectus Supplement, the effective yield to
maturity to each holder of Bonds entitled to payments of interest will be
below that otherwise produced by the applicable Bond Interest Rate and
purchase price of such Bond because, while interest may accrue on each Asset
during a certain period, the distribution of such interest will be made on a
day which may be several days, weeks or months following the period of
accrual.
TIMING OF PAYMENT OF INTEREST
Each payment of interest on the Bonds on a Payment Date will include
interest accrued during interest accrual period set forth in the related
Prospectus Supplement (the "Interest Accrual Period") for such Payment Date.
As indicated above under "--Bond Interest Rate," if the Interest Accrual
Period ends on a date other than the day before a Payment Date for the related
series, the yield realized by the holders of such Bonds may be lower than the
yield that would result if the Interest Accrual Period ended on such day
before the Payment Date.
PAYMENTS OF PRINCIPAL; PREPAYMENTS
The yield to maturity on the Bonds will be affected by the rate of principal
payments on the Assets (including principal prepayments on Mortgage Loans and
Contracts resulting from both voluntary prepayments by the borrowers and
involuntary liquidations). The rate at which principal prepayments occur on
the Mortgage Loans and Contracts will be affected by a variety of factors,
including, without limitation, the terms of the Mortgage Loans and Contracts,
the level of prevailing interest rates, the availability of mortgage credit
and economic, demographic, geographic, tax, legal and other factors. In
general, however, if prevailing interest rates fall significantly below the
Mortgage Rates on the Mortgage Loans comprising or underlying the Assets of a
particular Issuer, such Mortgage Loans are likely to be the subject of higher
principal prepayments than if prevailing rates remain at or above the rates
borne by such Mortgage Loans. In this regard, it should be noted
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that certain Assets may consist of Mortgage Loans with different Mortgage
Rates and the stated pass-through or pay-through interest rate of certain MBS
may be a number of percentage points higher or lower than certain of the
Underlying Mortgage Loans. The rate of principal payments on some or all of
the classes of Bonds of a series will correspond to the rate of principal
payments on the Assets of the related Issuer and is likely to be affected by
the existence of Lock-out Periods and Prepayment Premium provisions of the
Mortgage Loans underlying or comprising such Assets, and by the extent to
which the servicer of any such Mortgage Loan is able to enforce such
provisions. Mortgage Loans with a Lock-out Period or a Prepayment Premium
provision, to the extent enforceable, generally would be expected to
experience a lower rate of principal prepayments than otherwise identical
Mortgage Loans without such provisions, with shorter Lock-out Periods or with
lower Prepayment Premiums.
Because of the depreciating nature of manufactured housing, which limits the
possibilities for refinancing, and because the terms and principal amounts of
manufactured housing contracts are generally shorter and smaller than the
terms and principal amounts of mortgage loans secured by site-built homes,
changes in interest rates have a correspondingly smaller effect on the amount
of the monthly payments on manufactured housing contracts than on the amount
of the monthly payments on mortgage loans secured by site-built homes.
Consequently, changes in interest rates may play a smaller role in prepayment
behavior of manufactured housing contracts than they do in the prepayment
behavior of loans secured by mortgages on site-built homes. Conversely, local
economic conditions and certain of the other factors mentioned above may play
a larger role in the prepayment behavior of manufactured housing contracts
than they do in the prepayment behavior of loans secured by mortgages on site-
built homes.
If the purchaser of a Bond offered at a discount calculates its anticipated
yield to maturity based on an assumed rate of distributions of principal that
is faster than that actually experienced on the Assets, the actual yield to
maturity will be lower than that so calculated. Conversely, if the purchaser
of a Bond offered at a premium calculates its anticipated yield to maturity
based on an assumed rate of distributions of principal that is slower than
that actually experienced on the Assets, the actual yield to maturity will be
lower than that so calculated. In either case, if so provided in the
Prospectus Supplement for a series of Bonds, the effect on yield on one or
more classes of the Bonds of such series of prepayments of the Assets of the
related Issuer may be mitigated or exacerbated by any provisions for
sequential or selective distribution of principal to such classes.
When a full prepayment is made on a Mortgage Loan or a Contract, the obligor
is generally charged interest on the principal amount of the Mortgage Loan or
Contract so prepaid for the number of days in the month actually elapsed up to
the date of the prepayment. A partial prepayment of principal is generally
applied so as to reduce the outstanding principal balance of the related
Mortgage Loan or Contract in the month in which such partial prepayment is
received.
The timing of changes in the rate of principal payments on the Assets may
significantly affect an investor's actual yield to maturity, even if the
average rate of distributions of principal is consistent with an investor's
expectation. In general, the earlier a principal payment is received on the
Mortgage Assets and distributed on a Bond, the greater the effect on such
investor's yield to maturity. The effect on an investor's yield of principal
payments occurring at a rate higher (or lower) than the rate anticipated by
the investor during a given period may not be offset by a subsequent like
decrease (or increase) in the rate of principal payments.
The Bondholder will bear the risk of being able to reinvest principal
received in respect of a Bond at a yield at least equal to the yield on such
Bond.
PREPAYMENTS--MATURITY AND WEIGHTED AVERAGE LIFE
The rates at which principal payments are received on the Assets of the
related Issuer and the rate at which payments are made from any Credit Support
or Cash Flow Agreement for the related series of Bonds may affect the ultimate
maturity and the weighted average life of each class of such series.
Prepayments on the Mortgage Loans or Contracts comprising or underlying the
Assets of a particular Issuer will generally accelerate the rate at which
principal is paid on some or all of the classes of the Bonds of the related
series.
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If so provided in the Prospectus Supplement for a series of Bonds, one or
more classes of Bonds may have a final scheduled Payment Date, which is the
date on or prior to which the Bond Principal Balance thereof is scheduled to
be reduced to zero, calculated on the basis of the assumptions applicable to
such series set forth therein.
Weighted average life refers to the average amount of time that will elapse
from the date of issue of a security until each dollar of principal of such
security will be repaid to the investor. The weighted average life of a class
of Bonds of a series will be influenced by the rate at which principal on the
Mortgage Loans or Contracts comprising or underlying the Assets is paid to
such class, which may be in the form of scheduled amortization or prepayments
(for this purpose, the term "prepayment" includes prepayments, in whole or in
part, and liquidations due to default).
In addition, the weighted average life of the Bonds may be affected by the
varying maturities of the Mortgage Loans or Contracts comprising or underlying
the Assets of an Issuer. If any Mortgage Loans or Contracts comprising or
underlying the Assets of a particular Issuer have actual terms to maturity
less than those assumed in calculating final scheduled Payment Dates for the
classes of Bonds of the related series, one or more classes of such Bonds may
be fully paid prior to their respective final scheduled Payment Dates, even in
the absence of prepayments. Accordingly, the prepayment experience of the
Assets will, to some extent, be a function of the mix of Mortgage Rates or
Contract Rates and maturities of the Mortgage Loans or Contracts comprising or
underlying such Assets.
Prepayments on loans are also commonly measured relative to a prepayment
standard or model, such as the Constant Prepayment Rate ("CPR") prepayment
model or the Standard Prepayment Assumption ("SPA") prepayment model, each as
described below. CPR represents a constant assumed rate of prepayment each
month relative to the then outstanding principal balance of a pool of loans
for the life of such loans. SPA represents an assumed rate of prepayment each
month relative to the then outstanding principal balance of a pool of loans. A
prepayment assumption of 100% of SPA assumes prepayment rates of 0.2% per
annum of the then outstanding principal balance of such loans in the first
month of the life of the loans and an additional 0.2% per annum in each month
thereafter until the thirtieth month. Beginning in the thirtieth month and in
each month thereafter during the life of the loans, 100% of SPA assumes a
constant prepayment rate of 6% per annum each month.
Neither CPR nor SPA nor any other prepayment model or assumption purports to
be a historical description of prepayment experience or a prediction of the
anticipated rate of prepayment of any pool of loans, including the Mortgage
Loans or Contracts underlying or comprising the Assets.
The Prospectus Supplement with respect to each series of Bonds may contain
tables, if applicable, setting forth the projected weighted average life of
each class of Offered Bonds of such series and the percentage of the initial
Bond Principal Balance of each such class that would be outstanding on
specified Payment Dates based on the assumptions stated in such Prospectus
Supplement, including assumptions that prepayments on the Mortgage Loans
comprising or underlying the related Assets are made at rates corresponding to
various percentages of CPR, SPA or such other standard specified in such
Prospectus Supplement. Such tables and assumptions are intended to illustrate
the sensitivity of the weighted average life of the Bonds to various
prepayment rates and will not be intended to predict or to provide information
that will enable investors to predict the actual weighted average life of the
Bonds. It is unlikely that prepayment of any Mortgage Loans or Contracts
comprising or underlying the Assets for any series will conform to any
particular level of CPR, SPA or any other rate specified in the related
Prospectus Supplement.
OTHER FACTORS AFFECTING WEIGHTED AVERAGE LIFE
Type of Mortgage Asset or Contract
If so specified in the related Prospectus Supplement, a number of Mortgage
Loans may have balloon payments due at maturity, and because the ability of a
mortgagor to make a balloon payment typically will
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depend upon its ability either to refinance the loan or to sell the related
Mortgaged Property, there is a risk that a number of Mortgage Loans having
balloon payments may default at maturity. In the case of defaults, recovery of
proceeds may be delayed by, among other things, bankruptcy of the mortgagor or
adverse conditions in the market where the property is located. In order to
minimize losses on defaulted Mortgage Loans, the servicer may, to the extent
and under the circumstances set forth in the related Prospectus Supplement, be
permitted to modify Mortgage Loans that are in default or as to which a
payment default is imminent. Any defaulted balloon payment or modification
that extends the maturity of a Mortgage Loan will tend to extend the weighted
average life of the Bonds, thereby lengthening the period of time elapsed from
the date of issuance of a Bond until it is retired.
With respect to certain Mortgage Loans, including ARM Loans, the Mortgage
Rate at origination may be below the rate that would result if the index and
margin relating thereto were applied at origination. With respect to certain
Contracts, the Contract Rate may be "stepped up" during its term or may
otherwise vary or be adjusted. Under the applicable placement standards, the
mortgagor under each Mortgage Loan or Contract generally will be qualified on
the basis of the Mortgage Rate or Contract Rate in effect at origination. The
repayment of any such Mortgage Loan or Contract may thus be dependent on the
ability of the mortgagor or obligor to make larger level monthly payments
following the adjustment of the Mortgage Rate or Contract Rate. In addition,
certain Mortgage Loans may be subject to temporary buydown plans ("Buydown
Mortgage Loans") pursuant to which the monthly payments made by the mortgagor
during the early years of the Mortgage Loan will be less than the scheduled
monthly payments thereon (the "Buydown Period"). The periodic increase in the
amount paid by the mortgagor of a Buydown Mortgage Loan during or at the end
of the applicable Buydown Period may create a greater financial burden for the
mortgagor, who might not have otherwise qualified for a mortgage, and may
accordingly increase the risk of default with respect to the related Mortgage
Loan.
The Mortgage Rates on certain ARM Loans subject to negative amortization
generally adjust monthly and their amortization schedules adjust less
frequently. During a period of rising interest rates as well as immediately
after origination (initial Mortgage Rates are generally lower than the sum of
the applicable index at origination and the related margin over such index at
which interest accrues), the amount of interest accruing on the principal
balance of such Mortgage Loans may exceed the amount of the minimum scheduled
monthly payment thereon. As a result, a portion of the accrued interest on
negatively amortizing Mortgage Loans may be added to the principal balance
thereof and will bear interest at the applicable Mortgage Rate. The addition
of any such deferred interest to the principal balance of any related class or
classes of Bonds will lengthen the weighted average life thereof and may
adversely affect yield to holders thereof, depending upon the price at which
such Bonds were purchased. In addition, with respect to certain ARM Loans
subject to negative amortization, during a period of declining interest rates,
it might be expected that each minimum scheduled monthly payment on such a
Mortgage Loan would exceed the amount of scheduled principal and accrued
interest on the principal balance thereof, and since such excess will be
applied to reduce the principal balance of the related class or classes of
Bonds, the weighted average life of such Bonds will be reduced and may
adversely affect yield to holders thereof, depending upon the price at which
such Bonds were purchased.
Defaults
The rate of defaults on the Mortgage Loans or Contracts will also affect the
rate, timing and amount of principal payments on the Assets and thus the yield
on the Bonds. In general, defaults on mortgage loans or contracts are expected
to occur with greater frequency in their early years. The rate of default on
Mortgage Loans which are refinance or limited documentation mortgage loans,
and on Mortgage Loans with high Loan-to-Value Ratios, may be higher than for
other types of Mortgage Loans. Furthermore, the rate and timing of
prepayments, defaults and liquidations on the Mortgage Loans and Contracts
will be affected by the general economic condition of the region of the
country in which the related Mortgage Properties or Manufactured Homes are
located. The risk of delinquencies and loss is greater and prepayments are
less likely in regions where a weak or deteriorating economy exists, as may be
evidenced by, among other factors, increasing unemployment or falling property
values.
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Foreclosures
The number of foreclosures or repossessions and the principal amount of the
Mortgage Loans or Contracts comprising or underlying the Assets that are
foreclosed or repossessed in relation to the number and principal amount of
Mortgage Loans or Contracts that are repaid in accordance with their terms
will affect the weighted average life of the Mortgage Loans or Contracts
comprising or underlying the Assets and that of the related series of Bonds.
Refinancing
The Master Servicer or a Sub-Servicer may permit or solicit the refinancing
of a Mortgage Loan or Contract by applying the proceeds of a new loan secured
by a mortgage on the same property to prepay the Mortgage Loan or Contract. In
such event, the refinanced loan would not be included in the Assets. Such a
refinancing would generally result in a prepayment of principal on the Bonds.
The Master Servicer or Sub-Servicer may develop specific programs designed to
encourage such refinancing of Mortgage Loans. These programs may include,
without limitation, targeted solicitations, the offering of pre-approved
applications, modifications of the existing loan and various financial
incentives, such as reduced origination fees or closing costs. Such programs
may also encourage the refinancing of defaulted or near defaulted Mortgage
Loans or Contracts by creditworthy borrowers who assume the outstanding
indebtedness of such Mortgage Loans or Contracts.
Modifications
If set forth in the related Prospectus Supplement, the Master Servicer may
have the right under the terms of the Agreement to purchase certain Mortgage
Loans from the Issuer for purposes of effecting a modification of the terms of
such loan, including a reduction in the interest rate thereof, in lieu of a
complete refinancing of such loan. The purchase price for such a Mortgage Loan
will not be less than the outstanding principal amount of such Mortgage Loan,
plus annual interest thereon through the purchase date. In such event the
modified loan will not be a part of the Assets, but may be owned by the Master
Servicer or an affiliate thereof. This will have the same effect as a
prepayment of the Mortgage Loan and will generally result in prepayment of
principal on the Bonds. In addition, if set forth in the related Prospectus
Supplement, the Master Servicer may have the right under the Agreement to
modify the terms, including the interest rate, of certain Mortgage Loans
included in the Assets without purchasing such loan from the Issuer. Such
modifications will be primarily focused on Mortgage Loans that are in default
or danger of default and the credit quality of which the Master Servicer
reasonably believes will be enhanced by such modification. The terms,
conditions, limitation and consents required or imposed upon the Master
Servicer in connection with the purchase of Mortgage Loans from the Issuer for
purposes of modification and modification of Mortgage Loans retained by the
Issuer as part of the Assets will be set forth in the related Prospectus
Supplement.
Conversions
The Mortgage Loans may include loans that are convertible, upon fulfillment
of certain conditions, from an adjustable rate to a fixed rate loan at the
option of the mortgagor (the "Convertible Mortgage Loans"). If interest rates
decline so that the fixed rate applicable on conversion is significantly lower
than the current variable rate, or is significantly lower than the maximum
lifetime variable rate, the mortgagor may have a significant financial
incentive to effect such a conversion. If set forth in the related Prospectus
Supplement, the Master Servicer may have the right or the obligation to
purchase such Convertible Mortgage Loans from the Issuer. The purchase price
for such a Convertible Mortgage Loan will not be less than the outstanding
principal amount of such Convertible Mortgage Loan plus accrued interest
thereon through the purchase date. The terms, conditions, limitations and
consents required or imposed upon the Master Servicer in connection with the
purchase of Convertible Mortgage Loans will be set forth in the related
Prospectus Supplement.
Due-on-Sale Clauses
Acceleration of mortgage payments as a result of certain transfers of
underlying Mortgaged Property is another factor affecting prepayment rates
that may not be reflected in the prepayment standards or models used
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in the relevant Prospectus Supplement. A number of the Mortgage Loans
comprising or underlying the Assets may include "due-on-sale" clauses that
allow the holder of the Mortgage Loans to demand payment in full of the
remaining principal balance of the Mortgage Loans upon sale, transfer or
conveyance of the related Mortgaged Property. With respect to any Whole Loans,
unless otherwise provided in the related Prospectus Supplement, the Master
Servicer will generally enforce any due-on-sale clause to the extent it has
knowledge of the conveyance or proposed conveyance of the underlying Mortgaged
Property and it is entitled to do so under applicable law; provided, however,
that the Master Servicer will not take any action in relation to the
enforcement of any due-on-sale provision which would adversely affect or
jeopardize coverage under any applicable insurance policy. See "Certain Legal
Aspects of Mortgage Loans--Due-on-Sale Clauses" and "Description of the
Agreements--Due-on-Sale Provisions." The Contracts generally prohibit the sale
or transfer of the related Manufactured Homes without the consent of the
Master Servicer and permit the acceleration of the maturity of the Contracts
by the Master Servicer upon any such sale or transfer that is not consented
to. It is expected that the Master Servicer will generally permit most
transfers of Manufactured Homes and not accelerate the maturity of the related
Contracts. In certain cases, the transfer may be made by a delinquent obligor
in order to avoid a repossession of the Manufactured Home. In the case of a
transfer of a Manufactured Home after which the Master Servicer desires to
accelerate the maturity of the related Contract, the Master Servicer's ability
to do so will depend on the enforceability under state law of the "due-on-
sale" clause. See "Certain Legal Aspects of the Contracts--Transfers of
Manufactured Homes; Enforceability of "Due-on-Sale" Clauses."
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 Indenture 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.
Each series of Bonds will consist of one or more classes of Bonds that may
(i) provide for the accrual of interest thereon based on fixed, variable or
adjustable rates; (ii) be senior (collectively, "Senior Bonds") or subordinate
(collectively, "Subordinated Bonds") to one or more other classes of Bonds in
respects of certain distributions on the Bonds and (iii) provide for payments
of principal as described in the related Prospectus Supplement, from all or
only a portion of the Assets of such Issuer, to the extent of available funds,
in each case as described in the related Prospectus Supplement. If specified
in the related Prospectus Supplement, the Assets securing a series of Bonds
may include (i) Subsequent Assets transferred to the Issuer during the Pre-
Funding Period; (ii) eligible substitute Mortgage Loans transferred to the
Issuer in exchange for Mortgage Loans that are the subject of a breach of a
transferor representation or warranty; and (iii) in the case of revolving Home
Equity loans, additional balances advanced to the borrowers under such loans.
If so specified in the related Prospectus Supplement, distributions on one or
more classes of a series of Bonds may be limited to collections from a
designated portion of the Whole Loans in the related pool (each such portion
of Whole Loans, a "Mortgage Loan Group") or a designated portion of Contracts
in the related pool (each such portion of Contracts, a "Contract Group"). Any
such classes may include classes of Offered Bonds.
Each class of Offered Bonds of a series will be issued in minimum
denominations corresponding to the Bond Principal Balances. The transfer of
any Offered Bonds may be registered and such Bonds may be exchanged without
the payment of any service charge payable in connection with such registration
of transfer or exchange, but the Company or the Indenture Trustee or any agent
thereof may require payment of a sum sufficient to cover any tax or other
governmental charge. One or more classes of Bonds of a series may be issued in
definitive form ("Definitive Bonds") or in book-entry form ("Book-Entry
Bonds"), as provided in the related
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Prospectus Supplement. See "Risk Factors--Book-Entry Registration" and
"Description of the Bonds--Book-Entry Registration and Definitive Bonds."
Definitive Bonds will be exchangeable for other Bonds of the same class and
series of a like aggregate Bond Principal Balance, notional amount or
percentage interest but of different authorized denominations. See "Risk
Factors--Limited Liquidity of Investment" and "--Limited Assets."
DISTRIBUTIONS
Distributions on the Bonds of each series will be made by or on behalf of
the Indenture Trustee on each Payment Date as specified in the related
Prospectus Supplement from the Available Funds, as hereinafter defined, for
such series and such Payment Date. Except as otherwise specified in the
related Prospectus Supplement, distributions (other than the final
distribution) will be made to the persons in whose names the Bonds are
registered at the close of business on the last business day of the month
preceding the month in which the Payment Date occurs (the "Record Date"), and
the amount of each distribution will be determined as of the close of business
on the date specified in the related Prospectus Supplement (the "Determination
Date"). All distributions with respect to each class of Bonds on each Payment
Date will be allocated pro rata among the outstanding Bonds in such class or
by random selection, as described in the related Prospectus Supplement or
otherwise established by the related Indenture Trustee. Payments will be made
either by wire transfer in immediately available funds to the account of a
Bondholder at a bank or other entity having appropriate facilities therefor,
if such Bondholder has so notified the Indenture Trustee or other person
required to make such payments no later than the date specified in the related
Prospectus Supplement (and, if so provided in the related Prospectus
Supplement, holds Bonds in the requisite amount specified therein), or by
check mailed to the address of the person entitled thereto as it appears on
the Bond register; provided, however, that the final distribution in
retirement of the Bonds (whether Definitive Bonds or Book-Entry Bonds) will be
made only upon presentation and surrender of the Bonds at the location
specified in the notice to Bondholders of such final distribution.
AVAILABLE FUNDS
All distributions on the Bonds of each series on each Payment Date will be
made from the Available Funds described below, in accordance with the terms
described in the related Prospectus Supplement. The "Available Funds" for each
Payment Date will generally equal the sum of the following amounts:
(i) the total amount of all cash on deposit in the related Collection
Account as of the corresponding Determination Date, exclusive of:
(a) all scheduled payments of principal and interest collected but
due on a date subsequent to the related Due Period, (a "Due Period"
with respect to any Payment Date will generally commence on the second
day of the month in which the immediately preceding Payment Date
occurs, or the day after the Cut-off Date in the case of the first Due
Period, and will end on the first day of the month of the related
Payment Date),
(b) if the related Prospectus Supplement so specifies, all
prepayments, together with related payments of the interest thereon and
related Prepayment Premiums, Liquidation Proceeds, Insurance Proceeds
and other unscheduled recoveries received subsequent to the related Due
Period, and
(c) all amounts in the Collection Account that are due or
reimbursable to the Company, the Indenture Trustee, an Asset Seller, a
Sub-Servicer, the Master Servicer or any other entity as specified in
the related Prospectus Supplement or that are payable in respect of
certain expenses of the related Issuer;
(ii) if the related Prospectus Supplement so provides, interest or
investment income on amounts on deposit in the Collection Account,
including any net amounts paid under any Cash Flow Agreements;
(iii) all advances made by a Master Servicer or any other entity as
specified in the related Prospectus Supplement with respect to such Payment
Date;
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(iv) if and to the extent the related Prospectus Supplement so provides,
amounts paid by a Master Servicer or any other entity as specified in the
related Prospectus Supplement with respect to interest shortfalls resulting
from prepayments; and
(v) if the related Prospectus Supplement so provides, to the extent not
on deposit in the related Collection Account as of the corresponding
Determination Date, any amounts collected under, from or in respect of any
Credit Support with respect to such Payment Date.
As described below, the entire Available Funds will be distributed among the
related Bonds (including any Bonds not offered hereby) on each Payment Date,
and accordingly will be released and will not be available for any future
distributions.
DISTRIBUTIONS OF INTEREST ON THE BONDS
Each class of Bonds may have a different interest rate, which will be a
fixed, variable or adjustable rate at which interest will accrue on such class
of Bonds (the "Bond Interest Rate"). The related Prospectus Supplement will
specify the Bond Interest Rate for each class or, in the case of a variable or
adjustable Bond Interest Rate, the method for determining the Bond Interest
Rate. Interest on the Bonds will generally be calculated on the basis of a
360-day year consisting of twelve 30-day months. The related Prospectus
Supplement will indicate if the interest on the Bonds is calculated
differently.
Distributions of interest in respect of the Bonds of any class will be made
on each Payment Date based on the Accrued Bond Interest for such class and
such Payment Date, subject to the sufficiency of the portion of the Available
Funds allocable to such class on such Payment Date. With respect to each class
of Bonds and each Payment Date, "Accrued Bond Interest" will be equal to
interest accrued for a specified period on the outstanding Bond Principal
Balance thereof immediately prior to the Payment Date, at the applicable Bond
Interest Rate, reduced as described below. The related Prospectus Supplement
will also describe the extent to which the amount of Accrued Bond Interest
that is otherwise distributable on a class of Offered Bonds may be reduced as
a result of any other contingencies, including delinquencies, losses and
deferred interest on or in respect of the Mortgage Loans or Contracts
comprising or underlying the Assets of the related Issuer. Any reduction in
the amount of Accrued Bond Interest otherwise distributable on a class of
Bonds by reason of the allocation to such class of a portion of any deferred
interest on the Mortgage Loans or Contracts comprising or underlying the
Assets of the related Issuer will generally result in a corresponding increase
in the Bond Principal Balance of such class. See "Yield Considerations."
DISTRIBUTIONS OF PRINCIPAL OF THE BONDS
The Bonds of each series will have a principal balance (a "Bond Principal
Balance") which, at any time, will equal the initial principal balance thereof
on the closing date minus all distributions in respect of principal on the
Bonds. The outstanding Bond Principal Balance of a Bond will be reduced to the
extent of distributions of principal thereon from time to time. The initial
aggregate Bond Principal Balance of all classes of Bonds of a series generally
will not be greater than the outstanding aggregate principal balance of the
related Assets as of the applicable Cut-off Date. The initial aggregate Bond
Principal Balance of a series and each class thereof will be specified in the
related Prospectus Supplement. Distributions of principal will generally be
made on each Payment Date to the class or classes of Bonds entitled thereto in
accordance with the provisions described in such Prospectus Supplement until
the Bond Principal Balance of such class has been reduced to zero.
COMPONENTS
To the extent specified in the related Prospectus Supplement, distribution
on a class of Bonds may be based on a combination of two or more different
components as described under "--General" above. To such extent, the
descriptions set forth under "--Distributions of Interest on the Bonds" and
"--Distributions of Principal of the Bonds" above also relate to components of
such a class of Bonds. In such case, reference in such sections to Bond
Principal Balance and Bond Interest Rate refer to the principal balance, if
any, of any such component and the Bond Interest Rate, if any, on any such
component, respectively.
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DISTRIBUTIONS ON THE BONDS OF PREPAYMENT PREMIUMS
If so provided in the related Prospectus Supplement, Prepayment Premiums
that are collected on the Mortgage Assets of the related Issuer will be
distributed on each Payment Date to the class or classes of Bonds entitled
thereto in accordance with the provisions described in such Prospectus
Supplement.
ALLOCATION OF LOSSES AND SHORTFALLS
If so provided in the Prospectus Supplement for a series of Bonds consisting
of one or more classes of Subordinated Bonds on any Payment Date in respect of
which losses or shortfalls and collections on the Assets have been incurred,
the amount of such losses or shortfalls will be borne first by a class of
Subordinated Bonds in the priority and manner and subject to the limitations
specified in such Prospectus Supplement. See "Description of Credit Support"
for a description of the types of protection that an Issuer may have against
losses and shortfalls on Assets of such Issuer.
ADVANCES IN RESPECT OF DELINQUENCIES
The Master Servicer's (or another entity's) advance obligation will
generally be subject to the Master Servicer's (or another entity's) good faith
determination that such advances will generally be reimbursable from Related
Proceeds (as defined below). See "Description of Credit Support."
Advances are intended to maintain a regular flow of scheduled interest and
principal payments to holders of the class or classes of Bonds entitled
thereto, rather than to guarantee or insure against losses. Advances of the
Master Servicer's (or another entity's) funds will generally be reimbursable
only out of related recoveries on the Mortgage Loans or Contracts (including
amounts received under any form of Credit Support) respecting which such
advances were made (as to any Mortgage Loan or Contract, "Related Proceeds")
and, if so provided in the Prospectus Supplement, out of any amounts otherwise
distributable on one or more classes of Subordinated Bonds of such series;
provided, however, that any such advance will be reimbursable from any amounts
in the Collection Account prior to any distributions being made on the Bonds
to the extent that the Master Servicer (or such other entity) shall determine
in good faith that such advance (a "Nonrecoverable Advance") is not ultimately
recoverable from Related Proceeds or, if applicable, from collections on other
Assets otherwise distributable on such Subordinated Bonds. If advances have
been made by the Master Servicer from excess funds in the Collection Account,
the Master Servicer is required to replace such funds in the Collection
Account on any future Payment Date to the extent that funds in the Collection
Account on such Payment Date are less than payments required to be made to
Bondholders on such date. If so specified in the related Prospectus
Supplement, the obligations of the Master Servicer (or another entity) to make
advances may be secured by a cash advance reserve fund, a surety bond, a
letter of credit or another form of limited guaranty. If applicable,
information regarding the characteristics of, and the identity of any obligor
on, any such surety bond, will be set forth in the related Prospectus
Supplement.
If and to the extent so provided in the related Prospectus Supplement, the
Master Servicer (or another entity) will be entitled to receive interest at
the rate specified therein on its outstanding advances and will be entitled to
pay itself such interest periodically from general collections on the Assets
prior to any payment to Bondholders or as otherwise provided in the related
Agreement and described in such Prospectus Supplement.
REPORTS TO BONDHOLDERS
Generally, with each distribution to holders of any class of Bonds of a
series, the Master Servicer or the Indenture Trustee, as provided in the
related Prospectus Supplement, will forward or cause to be forwarded to each
such holder, to the Company and to such other parties as may be specified in
the related Agreement, a statement setting forth, in each case, to the extent
applicable and available, substantially the following:
(i) the amount of such distribution to holders of Bonds of such class
applied to reduce the Bond Principal Balance thereof;
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(ii) the amount of such distribution to holders of Bonds of such class
allocable to accrued interest;
(iii) the amount of such distribution allocable to Prepayment Premiums;
(iv) the amount of related servicing compensation received by a Master
Servicer (and, if payable directly out of the related Assets, by any Sub-
Servicer) and such other customary information as any such Master Servicer
or the Indenture Trustee deems necessary or desirable, or that a Bondholder
reasonably requests, to enable Bondholders to prepare their tax returns;
(v) the aggregate amount of advances included in such distribution, and
the aggregate amount of unreimbursed advances at the close of business on
such Payment Date;
(vi) the aggregate principal balance of the Assets at the close of
business on such Payment Date;
(vii) the number and aggregate principal balance of Whole Loans or
Contracts in respect of which (a) one scheduled payment is delinquent, (b)
two scheduled payments are delinquent, (c) three or more scheduled payments
are delinquent and (d) foreclosure proceedings have been commenced;
(viii) with respect to any Whole Loan or Contract liquidated during the
related Due Period, (a) the portion of such liquidation proceeds payable or
reimbursable to the Master Servicer (or any other entity) in respect of
such Mortgage Loan and (b) the amount of any loss to Bondholders;
(ix) with respect to each Mortgaged Property that is acquired by the
Issuer by foreclosure or deed in lieu of foreclosure (an "REO Property")
relating to a Whole Loan or Contract and included in the related Assets as
of the end of the related Due Period, (a) the loan number of the related
Mortgage Loan or Contract and (b) the date of acquisition;
(x) with respect to each REO Property relating to a Whole Loan or
Contract and included in the related Assets as of the end of the related
Due Period, (a) the book value, (b) the principal balance of the related
Mortgage Loan or Contract immediately following such Payment Date
(calculated as if such Mortgage Loan or Contract were still outstanding
taking into account certain limited modifications to the terms thereof
specified in the Agreement), (c) the aggregate amount of unreimbursed
servicing expenses and unreimbursed advances in respect thereof and (d) if
applicable, the aggregate amount of interest accrued and payable on related
servicing expenses and related advances;
(xi) with respect to any such REO Property sold during the related Due
Period (a) the aggregate amount of sale proceeds, (b) the portion of such
sales proceeds payable or reimbursable to the Master Servicer in respect of
such REO Property or the related Mortgage Loan or Contract and (c) the
amount of any loss to Bondholders in respect of the related Mortgage Loan;
(xii) the aggregate Bond Principal Balance of each class of Bonds at the
close of business on such Payment Date, separately identifying any
reduction in such Bond Principal Balance due to the allocation of any loss;
(xiii) the aggregate amount of principal prepayments made during the
related Due Period;
(xiv) the amount deposited in the reserve fund, if any, on such Payment
Date;
(xv) the amount remaining in the reserve fund, if any, as of the close of
business on such Payment Date;
(xvi) the aggregate unpaid Accrued Bond Interest, if any, on each class
of Bonds at the close of business on such Payment Date;
(xvii) in the case of Bonds with a variable Bond Interest Rate, the Bond
Interest Rate applicable to such Payment Date, and, if available, the
immediately succeeding Payment Date, as calculated in accordance with the
method specified in the related Prospectus Supplement;
(xviii) in the case of Bonds with an adjustable Bond Interest Rate, for
statements to be distributed in any month in which an adjustment date
occurs, the adjustable Bond Interest Rate applicable to such Payment Date,
if available, and the immediately succeeding Payment Date as calculated in
accordance with the method specified in the related Prospectus Supplement;
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(xix) as to any series which includes Credit Support, the amount of
coverage of each instrument of Credit Support included therein as of the
close of business on such Payment Date; and
(xx) the aggregate amount of payments by the obligors of (a) default
interest, (b) late charges and (c) assumption and modification fees
collected during the related Due Period.
In the case of information furnished pursuant to subclauses (i)-(iv) above,
the amounts shall be expressed as a dollar amount per minimum denomination of
Bonds or for such other specified portion thereof. In addition, in the case of
information furnished pursuant to subclauses (i), (ii), (xii), (xvi) and
(xvii) above, such amounts shall also be provided with respect to each
component, if any, of a class of Bonds. The Master Servicer or the Indenture
Trustee, as specified in the related Prospectus Supplement, will forward or
cause to be forwarded to each holder, to the Company and to such other parties
as may be specified in the Agreement, a copy of any statements or reports
received by the Master Servicer or the Indenture Trustee, as applicable, with
respect to any MBS. The Prospectus Supplement for each series of Offered Bonds
will describe any additional information to be included in reports to the
holders of such Bonds.
Within a reasonable period of time after the end of each calendar year, the
Master Servicer or the Indenture Trustee, as provided in the related
Prospectus Supplement, shall furnish to each person who at any time during the
calendar year was a holder of a Bond a statement containing the information
set forth in subclauses (i)-(iv) above, aggregated for such calendar year or
the applicable portion thereof during which such person was a Bondholder. Such
obligation of the Master Servicer or the Indenture Trustee shall be deemed to
have been satisfied to the extent that substantially comparable information
shall be provided by the Master Servicer or the Indenture Trustee pursuant to
any requirements of the Code as are from time to time in force. See
"Description of the Bonds--Book-Entry Registration and Definitive Bonds."
REDEMPTION
If so specified in the related Prospectus Supplement, a series of Bonds may
be subject to optional early redemption by the Issuer, under the circumstances
and in the manner set forth therein. If so provided in the related Prospectus
Supplement, upon the reduction of the Bond Principal Balance of a specified
class or classes of Bonds by a specified percentage or amount, or on or after
a date specified in such Prospectus Supplement, the Bonds may be subject to
optional early redemption by the related Issuer. In most cases a series of
Bonds will be redeemable by the Issuer when the outstanding Bond Principal
Balance is reduced to a percentage (the "Clean-Up Call Percentage") of the
original Bond Principal Balance. The Clean-Up Call Percentage, which will be
set forth in the related Prospectus Supplement, may range between 10% and 25%
of the original Bond Principal Balance, depending upon the type and
characteristics of the collateral, the level of over collateralization, the
amount of credit enhancement, rating agency concerns and other factors. The
Clean-Up Call Percentage will not exceed 25%. The price at which the bonds
will be callable by the Issuer, which will be at least equal to the
outstanding principal amount thereof plus accrued interest thereon, will also
be set forth in the related Prospectus Supplement.
Notice of redemption must be given by the Issuer or by the Indenture Trustee
as provided in the related Prospectus Supplement. The redemption price for any
Bond (or portion thereof) so redeemed will be the percentage of the unpaid
principal amount of such Bond specified in the related Prospectus Supplement,
together with accrued interest thereon to the date specified in the related
Prospectus Supplement, or such other price as may be specified in the related
Prospectus Supplement. At the option of the Issuer, an optional redemption of
a class of Bonds may be effected without retiring such class of Bonds so that
the Issuer or a designee has the ability to own or resell such class of Bonds.
Upon redemption and retirement of all the Bonds, the Collateral securing the
Bonds will be released from the lien of the Indenture.
If set forth in the related Prospectus Supplement, the Issuer may redeem a
class of the Bonds in whole, but not in part, at any time upon a determination
by the Issuer, based upon an opinion of counsel, that a substantial risk
exists that the Bonds of the class to be redeemed will not be treated for
federal income tax purposes as evidences of indebtedness. Any such redemption
will be paid in cash at a price equal to 100% of the aggregate outstanding
principal balance of the class of Bonds so redeemed, plus accrued and unpaid
interest.
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PUT OPTION
If set forth in the related Prospectus Supplement, the holders of a class of
Bonds may have the right to put the Bonds to the Issuer or a designee at
certain limited times and under certain limited circumstances. The put rights
of Bondholders, if any, including the price at which the Bonds may be put, the
times at which such put may be exercised and other conditions and limitations
on the exercise of such put, will be set forth in the related Prospectus
Supplement. A class of bonds may be issued with a fixed interest rate that, on
a specific date set forth in the related Prospectus Supplement or on the
occurrence of a specified event set forth in the related Prospectus
Supplement, would convert to a variable interest rate. Similarly, a class of
Bonds may be issued with variable interest rates that would convert to a fixed
interest rate. In either case, for a very limited time set forth in the
related Prospectus Supplement following any such conversion of the interest
rate, a Bondholder that did not want to retain the Bond at the converted
interest rate would have the right to put the Bond to the Issuer or its
designee and receive the unpaid principal balance plus accrued interest on the
Bond. The date on which any such conversion of the interest rate on a Bond may
occur will generally be a date one or several years after the original issue
date of the Bond and will be set forth in the related Prospectus Supplement.
The event on which any such conversion of the interest rate on a Bond may
occur will generally be the conversion of a specified dollar amount or a
specified percentage of the Mortgage Loans securing the Bonds, in accordance
with the terms of such loans, from a variable rate to a fixed rate, or a fixed
rate to a variable rate, and will be set forth in the related Prospectus
Supplement. The Issuer will provide written notice to Bondholders of any such
conversion of the interest rate payable on the Bonds, and of the Bondholder's
right to put the Bonds in accordance with the procedures set forth in the
related Prospectus Supplement.
BOOK-ENTRY REGISTRATION AND DEFINITIVE BONDS
If so provided in the related Prospectus Supplement, one or more classes of
the Offered Bonds of any series will be issued as Book-Entry Bonds, and each
such class will be represented by one or more single Bonds registered in the
name of a nominee for the depository, The Depository Trust Company ("DTC"),
and such additional depositories as may be set forth in such Prospectus
Supplement.
DTC is a limited-purpose trust company organized under the laws of the State
of New York, a member of the Federal Reserve System, a "clearing corporation"
within the meaning of the Uniform Commercial Code ("UCC") and a "clearing
agency" registered pursuant to the provisions of Section 17A of the Securities
Exchange Act of 1934, as amended. DTC was created to hold securities for its
participating organizations ("Participants") and facilitate the clearance and
settlement of securities transactions between Participants through electronic
book-entry changes in their accounts, thereby eliminating the need for
physical movement of certificates. Participants include securities brokers and
dealers, banks, trust companies and clearing corporations and may include
certain other organizations. Indirect access to the DTC system also is
available to others such as banks, brokers, dealers and trust companies that
clear through or maintain a custodial relationship with a Participant, either
directly or indirectly ("Indirect Participants").
Investors that are not Participants or Indirect Participants but desire to
purchase, sell or otherwise transfer ownership of, or other interests in,
Book-Entry Bonds may generally do so only through Participants and Indirect
Participants. In addition, such investors ("Bond Owners") will receive all
distributions on the Book-Entry Bonds through DTC and its Participants. Under
a book-entry format, Bond Owners will receive payments after the related
Payment Date because, while payments are required to be forwarded to Cede &
Co., as nominee for DTC ("Cede"), on each such date, DTC will forward such
payments to its Participants which thereafter will be required to forward them
to Indirect Participants or Bond Owners. The only "Bondholder" (as such term
is used in the Agreement) will generally be Cede, as nominee of DTC, and the
Bond Owners generally will not be recognized by the Indenture Trustee as
Bondholders under the Agreement. Bond Owners will be permitted to exercise the
rights of Bondholders under the related Agreement, trust agreement or,
Indenture, as applicable, only indirectly through the Participants who in turn
will exercise their rights through DTC.
Under the rules, regulations and procedures creating and affecting DTC and
its operations, DTC is required to make book-entry transfers among
Participants on whose behalf it acts with respect to the Book-Entry Bonds
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and is required to receive and transmit distributions of principal of and
interest on the Book-Entry Bonds. Participants and Indirect Participants with
which Bond Owners have accounts with respect to the Book-Entry Bonds similarly
are required to make book-entry transfers and receive and transmit such
payments on behalf of their respective Bond Owners.
Because DTC can act only on behalf of Participants, who in turn act on
behalf of Indirect Participants and certain banks, the ability of a Bond Owner
to pledge its interest in the Book-Entry Bonds to persons or entities that do
not participate in the DTC system, or otherwise take actions in respect of its
interest in the Book-Entry Bonds, may be limited due to the lack of a physical
certificate evidencing such interest.
DTC has advised the Company that it will take any action permitted to be
taken by a Bondholder under an Agreement only at the direction of one or more
Participants to whose account with DTC interests in the Book-Entry Bonds are
credited.
Bonds initially issued in book-entry form will generally be issued in fully
registered, certificated form to Bond Owners or their nominees ("Definitive
Bonds"), rather than to DTC or its nominee only if (i) the Company advises the
Indenture Trustee in writing that DTC is no longer willing or able to properly
discharge its responsibilities as depository with respect to the Bonds and the
Company is unable to locate a qualified successor or (ii) the Company, at its
option, elects to terminate the book-entry system through DTC.
Upon the occurrence of either of the events described in the immediately
preceding paragraph, DTC is required to notify all Participants of the
availability through DTC of Definitive Bonds for the Bond Owners. Upon
surrender by DTC of the certificate or certificates representing the Book-
Entry Bonds, together with instructions for reregistration, the Indenture
Trustee will issue (or cause to be issued) to the Bond Owners identified in
such instructions the Definitive Bonds to which they are entitled, and
thereafter the Indenture Trustee will recognize the holders of such Definitive
Bonds as Bondholders under the Agreement.
DESCRIPTION OF THE AGREEMENTS
The following disclosure contains a description of all material aspects of
the agreements discussed.
AGREEMENTS APPLICABLE TO A SERIES
General. Any Master Servicer and the Indenture Trustee with respect to any
series of Bonds will be named in the related Prospectus Supplement. In any
series of Bonds for which there are multiple Master Servicers, there may also
be multiple Mortgage Loan Groups or Contract Groups, each corresponding to a
particular Master Servicer; and, if the related Prospectus Supplement so
specifies, the servicing obligations of each such Master Servicer will be
limited to the Whole Loans in such corresponding Mortgage Loan Group or the
Contracts in the corresponding Contract Group. Such servicer will service all
or a significant number of Whole Loans or Contracts directly without a Sub-
Servicer. The obligations of any such servicer will generally be commensurate
with those of the Master Servicer described herein. References in this
Prospectus to Master Servicer and its rights and obligations will generally be
deemed to also be references to any servicer servicing Whole Loans or
Contracts directly.
The Assets of each Issuer will be serviced in accordance with the terms of a
servicing agreement among the Company, the Master Servicer and the Indenture
Trustee (the "Agreement"). The following summaries describe certain provisions
that may appear in each Agreement. The Prospectus Supplement for a series of
Bonds will describe any provision of the Agreement relating to such series
that materially differs from the description thereof contained in this
Prospectus. The summaries do not purport to be complete and are subject to,
and are qualified in their entirety by reference to, all of the provisions of
the Agreement for each Issuer and the description of such provisions in the
related Prospectus Supplement. As used herein with respect to any series, the
term "Bond" refers to all of the Bonds of that series, whether or not offered
hereby and by the related Prospectus Supplement, unless the context otherwise
requires. The Company will provide a copy of the Agreement (without
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exhibits) relating to any series of Bonds without charge upon written request
of a holder of a Bond of such series addressed to NovaStar Mortgage Funding
Corporation, 1900 West 47th Place, Suite 205, Westwood, Kansas 66205,
Attention: David J. Lee, Vice President.
ASSIGNMENT OF ASSETS; REPURCHASES
At the time of issuance of any series of Bonds, the Company will assign (or
cause to be assigned) to the designated Indenture Trustee the Assets of the
related Issuer, together with all principal and interest to be received on or
with respect to such Assets after the Cut-off Date, other than principal and
interest due on or before the Cut-off Date and other than any Retained
Interest. The Indenture Trustee will, concurrently with such assignment,
deliver a certificate to the Company in exchange for the Assets and the other
assets of the Issuer for such series. Each Asset will be identified in a
schedule appearing as an exhibit to the related Agreement. Such schedule will
generally include detailed information (i) in respect of each Whole Loan of
the Issuer, including without limitation, the address of the related Mortgaged
Property and type of such property, the Mortgage Rate and, if applicable, the
applicable index, margin, adjustment date and any rate cap information, the
original and remaining term to maturity, the original and outstanding
principal balance and balloon payment, if any, the Value and Loan-to-Value
Ratio as of the date indicated and payment and prepayment provisions, if
applicable; (ii) in respect of each Contract of the related Issuer, including
without limitation the Contract number, the outstanding principal amount and
the Contract Rate; and (iii) in respect of each MBS of the related Issuer,
including without limitation, the MBS Issuer, MBS Servicer and MBS Indenture
Trustee, the pass-through or bond rate or formula for determining such rate,
the issue date and original and remaining term to maturity, if applicable, the
original and outstanding principal amount and payment provisions, if
applicable.
With respect to each Whole Loan, the Company will generally deliver or cause
to be delivered to the Indenture Trustee (or to the custodian hereinafter
referred to) certain loan documents, which will generally include the original
Mortgage Note endorsed, without recourse, in blank or to the order of the
Indenture Trustee, the original Mortgage (or a certified copy thereof) with
evidence of recording indicated thereon and an assignment of the Mortgage to
the Indenture Trustee in recordable form. Notwithstanding the foregoing, an
Issuer may hold Mortgage Loans where the original Mortgage Note is not
delivered to the Indenture Trustee if the Company delivers to the Indenture
Trustee or the custodian a copy or a duplicate original of the Mortgage Note,
together with an affidavit certifying that the original thereof has been lost
or destroyed. With respect to such Mortgage Loans, the Indenture Trustee (or
its nominee) may not be able to enforce the Mortgage Note against the related
borrower. The Asset Seller will be required to agree to repurchase, or
substitute for, each such Mortgage Loan that is subsequently in default if the
enforcement thereof or of the related Mortgage is materially adversely
affected by the absence of the original Mortgage Note. The related Agreement
will generally require the Company or another party specified therein to
promptly cause each such assignment of Mortgage to be recorded in the
appropriate public office for real property records, except in the State of
California or in other states where, in the opinion of counsel acceptable to
the Indenture Trustee, such recording is not required to protect the Indenture
Trustee's interest in the related Whole Loan against the claim of any
subsequent transferee or any successor to or creditor of the Company, the
Master Servicer, the relevant Asset Seller or any other prior holder of the
Whole Loan.
The Indenture Trustee (or a custodian) will review such Whole Loan documents
within a specified period of days after receipt thereof, and the Indenture
Trustee (or a custodian) will hold such documents in trust for the benefit of
the Bondholders. If any such document is found to be missing or defective in
any material respect, the Indenture Trustee (or such custodian) shall
immediately notify the Master Servicer and the Company, and the Master
Servicer shall immediately notify the relevant Asset Seller. If the Asset
Seller cannot cure the omission or defect within a specified number of days
after receipt of such notice, then the Asset Seller will be obligated, within
a specified number of days of receipt of such notice, to repurchase the
related Whole Loan from the Indenture Trustee at the Purchase Price or
substitute for such Mortgage Loan. There can be no assurance that an Asset
Seller will fulfill this repurchase or substitution obligation, and neither
the Master Servicer nor the Company will be obligated to repurchase or
substitute for such Mortgage Loan if the Asset Seller defaults on its
obligation. This repurchase or substitution obligation generally constitutes
the sole remedy available to the
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Bondholders or the Indenture Trustee for omission of, or a material defect in,
a constituent document. To the extent specified in the related Prospectus
Supplement, in lieu of curing any omission or defect in the Asset or
repurchasing or substituting for such Asset, the Asset Seller may agree to
cover any losses suffered by the Issuer as a result of such breach or defect.
Notwithstanding the preceding two paragraphs, the documents with respect to
Home Equity Loans generally will not be delivered to the Indenture Trustee (or
a custodian), but will be retained by the Master Servicer, which may also be
the Asset Seller. In addition, assignments of the related Mortgages to the
Indenture Trustee generally will not be recorded.
With respect to each Contract, the Master Servicer (which may also be the
Asset Seller) will generally maintain custody of the original Contract and
copies of documents and instruments related to each Contract and the security
interest in the Manufactured Home securing each Contract. In order to give
notice of the right, title and interest of the Indenture Trustee in the
Contracts, the Company will cause UCC-1 financing statements to be executed by
the related Asset Seller identifying the Company as secured party and by the
Company identifying the Indenture Trustee as the secured party and, in each
case, identifying all Contracts as collateral. The Contracts generally will
not be stamped or otherwise marked to reflect their assignment from the
Company to the Issuer. Therefore, if, through negligence, fraud or otherwise,
a subsequent purchaser were able to take physical possession of the Contracts
without notice of such assignment, the interest of the Indenture Trustee in
the Contracts could be defeated. See "Certain Legal Aspects of the Contracts."
While the Contract documents will not be reviewed by the Indenture Trustee
or the Master Servicer, if the Master Servicer finds that any such document is
missing or defective in any material respect, the Master Servicer shall
immediately notify the Company and the relevant Asset Seller. If the Asset
Seller cannot cure the omission or defect within a specified number of days
after receipt of such notice, then the Asset Seller will be obligated, within
a specified number of days of receipt of such notice, to repurchase the
related Contract from the Indenture Trustee at the Purchase Price or
substitute for such Contract. There can be no assurance that an Asset Seller
will fulfill this repurchase or substitution obligation, and neither the
Master Servicer nor the Company will be obligated to repurchase or substitute
for such Contract if the Asset Seller defaults on its obligation. This
repurchase or substitution obligation generally constitutes the sole remedy
available to the Bondholders or the Indenture Trustee for omission of, or a
material defect in, a constituent document. To the extent specified in the
related Prospectus Supplement, in lieu of curing any omission or defect in the
Asset or repurchasing or substituting for such Asset, the Asset Seller may
agree to cover any losses suffered by the Issuer as a result of such breach or
defect.
With respect to each Government Bond or MBS in certificated form, the
Company will deliver or cause to be delivered to the Indenture Trustee (or the
custodian) the original certificate or other definitive evidence of such
Government Bond or MBS, as applicable, together with bond power or other
instruments, certifications or documents required to transfer fully such
Government Bond or MBS, as applicable, to the Indenture Trustee for the
benefit of the Bondholders. With respect to each Government Bond or MBS in
uncertificated or book-entry form or held through a "clearing corporation"
within the meaning of the UCC, the Company and the Indenture Trustee will
cause such Government Bond or MBS to be registered directly or on the books of
such clearing corporation or of a financial intermediary in the name of the
Indenture Trustee for the benefit of the Bondholders. The related Agreement
will generally require that either the Company or the Indenture Trustee
promptly cause any MBS and Government Bonds in certificated form not
registered in the name of the Indenture Trustee to be re-registered, with the
applicable persons, in the name of the Indenture Trustee.
REPRESENTATIONS AND WARRANTIES; REPURCHASES
With respect to each Whole Loan or Contract, the Company will generally
assign certain representations and warranties, as of a specified date (the
person making such representations and warranties, the "Warranting Party")
covering, by way of example, the following types of matters: (i) the accuracy
of the information set forth for such Whole Loan or Contract on the schedule
of Assets appearing as an exhibit to the related
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Agreement; (ii) in the case of a Whole Loan, the existence of title insurance
insuring the lien priority of the Whole Loan and, in the case of a Contract,
that the Contract creates a valid first security interest in or lien on the
related Manufactured Home; (iii) the authority of the Warranting Party to sell
the Whole Loan or Contract; (iv) the payment status of the Whole Loan or
Contract; (v) in the case of a Whole Loan, the existence of customary
provisions in the related Mortgage Note and Mortgage to permit realization
against the Mortgaged Property of the benefit of the security of the Mortgage;
and (vi) the existence of hazard and extended perils insurance coverage on the
Mortgaged Property or Manufactured Home.
Any Warranting Party shall be an Asset Seller or an affiliate thereof or
such other person acceptable to the Company and shall be identified in the
related Prospectus Supplement.
Representations and warranties made in respect of a Whole Loan or Contract
may have been made as of a date prior to the applicable Cut-off Date. A
substantial period of time may have elapsed between such date and the date of
initial issuance of the related series of Bonds. In the event of a breach of
any such representation or warranty, the Warranting Party will generally be
obligated to reimburse the Issuer for losses caused by any such breach or
either cure such breach or repurchase or replace the affected Whole Loan or
Contract as described below. Since the representations and warranties may not
address events that may occur following the date as of which they were made,
the Warranting Party will have a reimbursement, cure, repurchase or
substitution obligation in connection with a breach of such a representation
and warranty only if the relevant event that causes such breach occurs prior
to such date. Such party would have no such obligations if the relevant event
that causes such breach occurs after such date.
Each Agreement will generally provide that the Master Servicer and/or
Indenture Trustee will be required to notify promptly the relevant Warranting
Party of any breach of any representation or warranty made by it in respect of
a Whole Loan or Contract that materially and adversely affects the value of
such Whole Loan or Contract or the interests therein of the Bondholders. If
such Warranting Party cannot cure such breach within a specified period
following the date on which such party was notified of such breach, then such
Warranting Party will be obligated to repurchase such Whole Loan or Contract
from the Indenture Trustee within a specified period from the date on which
the Warranting Party was notified of such breach, at the Purchase Price
therefor. As to any Whole Loan or Contract the "Purchase Price" will generally
be equal to the sum of the unpaid principal balance thereof, plus unpaid
accrued interest thereon at the Mortgage Rate or Contract Rate from the date
as to which interest was last paid to the due date in the Due Period in which
the relevant purchase is to occur, plus certain servicing expenses that are
reimbursable to the Master Servicer. A Warranting Party, rather than
repurchase a Whole Loan or Contract as to which a breach has occurred, will
have the option, within a specified period after initial issuance of such
series of Bonds, to cause the removal of such Whole Loan or Contract from the
related Assets of the Issuer and substitute in its place one or more other
Whole Loans or Contracts, as applicable, in accordance with the standards
described in the related Agreement. If so provided in the Prospectus
Supplement for a series, a Warranting Party, rather than repurchase or
substitute a Whole Loan or Contract as to which a breach has occurred, will
have the option to reimburse the Issuer or the Bondholders for any losses
caused by such breach. This reimbursement, repurchase or substitution
obligation will generally constitute the sole remedy available to holders of
Bonds or the Indenture Trustee for a breach of representation by a Warranting
Party.
Neither the Company (except to the extent that it is the Warranting Party)
nor the Master Servicer will be obligated to purchase or substitute for a
Whole Loan or Contract if a Warranting Party defaults on its obligation to do
so, and no assurance can be given that Warranting Parties will carry out such
obligations with respect to Whole Loans or Contracts.
With respect to an Issuer that holds Government Bonds or MBS, the Warranting
Party will generally make or assign certain representations or warranties, as
of a specified date, with respect to such Government Bonds or MBS, covering
(i) the accuracy of the information set forth therefor on the schedule of
Assets appearing as an exhibit to the related Agreement and (ii) the authority
of the Warranting Party to sell such Assets. The related Prospectus Supplement
will describe the remedies for a breach thereof.
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COLLECTION ACCOUNT AND RELATED ACCOUNTS
General
The Master Servicer and/or the Indenture Trustee will, as to each Issuer,
establish and maintain or cause to be established and maintained one or more
separate accounts for the collection of payments on the related Assets
(collectively, the "Collection Account"), which must be either (i) an account
or accounts the deposits in which are insured by the Bank Insurance Fund or
the Savings Association Insurance Fund of the Federal Deposit Insurance
Corporation ("FDIC") (to the limits established by the FDIC) and the uninsured
deposits in which are otherwise secured such that the Bondholders have a claim
with respect to the funds in the Collection Account or a perfected first
priority security interest against any collateral securing such funds that is
superior to the claims of any other depositors or general creditors of the
institution with which the Collection Account is maintained or (ii) otherwise
maintained with a bank or trust company, and in a manner, satisfactory to the
Rating Agency or Agencies rating any class of Bonds of such series. The
collateral eligible to secure amounts in the Collection Account is limited to
United States government securities and other investment grade obligations
specified in the Agreement ("Permitted Investments"). A Collection Account may
be maintained as an interest bearing or a non-interest bearing account and the
funds held therein may be invested pending each succeeding Payment Date in
certain short-term Permitted Investments. The Collection Account may be
maintained with an institution that is an affiliate of the Master Servicer, if
applicable, provided that such institution meets the standards imposed by the
Rating Agency or Agencies. If permitted by the Rating Agency or Agencies and
so specified in the related Prospectus Supplement, a Collection Account may
contain funds relating to more than one series of mortgage pass-through
certificates and may contain other funds respecting payments on mortgage loans
belonging to the Master Servicer or serviced or master serviced by it on
behalf of others.
Deposits
A Master Servicer or the Indenture Trustee will deposit or cause to be
deposited in the Collection Account for one or more Issuers within two
Business Days, unless otherwise provided in the related Agreement, the
following payments and collections received, or advances made, by the Master
Servicer or the Indenture Trustee or on its behalf subsequent to the Cut-off
Date (other than payments due on or before the Cut-off Date, and exclusive of
any amounts representing a Retained Interest):
(i) all payments on account of principal, including principal
prepayments, on the Assets;
(ii) all payments on account of interest on the Assets, including any
default interest collected, in each case net of any portion thereof
retained by a Master Servicer or a Sub-Servicer as its servicing
compensation and net of any Retained Interest;
(iii) all proceeds of the hazard insurance policies to be maintained in
respect of each Mortgaged Property securing a Whole Loan (to the extent
such proceeds are not applied to the restoration of the property or
released to the mortgagor in accordance with the normal servicing
procedures of a Master Servicer or the related Sub-Servicer, subject to the
terms and conditions of the related Mortgage and Mortgage Note)
(collectively, "Insurance Proceeds") and all other amounts received and
retained in connection with the liquidation of defaulted Mortgage Loans, by
foreclosure or otherwise ("Liquidation Proceeds"), together with the net
proceeds on a monthly basis with respect to any Mortgaged Properties
acquired for the benefit of Bondholders by foreclosure or by deed in lieu
of foreclosure or otherwise;
(iv) any amounts paid under any instrument or drawn from any fund that
constitutes Credit Support for the related series of Bonds as described
under "Description of Credit Support";
(v) any advances made as described under "Description of the Bonds--
Advances in Respect of Delinquencies";
(vi) any amounts paid under any Cash Flow Agreement, as described under
"Description of the Assets--Cash Flow Agreements";
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(vii) all proceeds of any Asset or, with respect to a Whole Loan,
property acquired in respect thereof purchased by the Company, any Asset
Seller or any other specified person as described under "--Assignment of
Assets; Repurchases" and "--Representations and Warranties; Repurchases,"
all proceeds of any defaulted Mortgage Loan purchased as described under
"--Realization Upon Defaulted Whole Loans," and all proceeds of any Asset
purchased as described under "Description of the Bonds--Termination" (also,
"Liquidation Proceeds");
(viii) any amounts paid by a Master Servicer to cover certain interest
shortfalls arising out of the prepayment of Whole Loans or Contracts as
described under "Description of the Agreements--Retained Interest;
Servicing Compensation and Payment of Expenses";
(ix) to the extent that any such item does not constitute additional
servicing compensation to a Master Servicer, any payments on account of
modification or assumption fees, late payment charges or Prepayment
Premiums on the Mortgage Assets;
(x) all payments required to be deposited in the Collection Account with
respect to any deductible clause in any blanket insurance policy described
under "Hazard Insurance Policies";
(xi) any amount required to be deposited by a Master Servicer or the
Indenture Trustee in connection with losses realized on investments for the
benefit of the Master Servicer or the Indenture Trustee, as the case may
be, of funds held in the Collection Account; and
(xii) any other amounts required to be deposited in the Collection
Account as provided in the related Agreement and described in the related
Prospectus Supplement.
Withdrawals
A Master Servicer or the Indenture Trustee may generally make withdrawals,
from time to time, from the Collection Account for each Issuer for any of the
following purposes:
(i) to make distributions to the Bondholders on each Payment Date;
(ii) to reimburse a Master Servicer for unreimbursed amounts advanced as
described under "Description of the Bonds--Advances in Respect of
Delinquencies," such reimbursement to be made out of amounts received which
were identified and applied by the Master Servicer as late collections of
interest (net of related servicing fees and Retained Interest) on and
principal of the particular Whole Loans or Contracts with respect to which
the advances were made or out of amounts drawn under any form of Credit
Support with respect to such Whole Loans or Contracts;
(iii) to reimburse a Master Servicer for unpaid servicing fees earned and
certain unreimbursed servicing expenses incurred with respect to Whole
Loans or Contracts and properties acquired in respect thereof, such
reimbursement to be made out of amounts that represent Liquidation Proceeds
and Insurance Proceeds collected on the particular Whole Loans or Contracts
and properties, and net income collected on the particular properties, with
respect to which such fees were earned or such expenses were incurred or
out of amounts drawn under any form of Credit Support with respect to such
Whole Loans or Contracts and properties;
(iv) to reimburse a Master Servicer for any advances described in clause
(ii) above and any servicing expenses described in clause (iii) above
which, in the Master Servicer's good faith judgment, will not be
recoverable from the amounts described in clauses (ii) and (iii),
respectively, such reimbursement to be made from amounts collected on other
Assets;
(v) if and to the extent described in the related Prospectus Supplement,
to pay a Master Servicer interest accrued on the advances described in
clause (ii) above and the servicing expenses described in clause (iii)
above while such remain outstanding and unreimbursed or, if and to the
extent provided by the related Agreement and described in the related
Prospectus Supplement, just from that portion of amounts collected on other
Assets that is otherwise distributable on one or more classes of
Subordinated Bonds, if any, remaining outstanding, and otherwise any
outstanding class of Bonds, of the related series;
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(vi) to reimburse a Master Servicer, the Company, or any of their
respective directors, officers, employees and agents, as the case may be,
for certain expenses, costs and liabilities incurred thereby, as and to the
extent described under "--Certain Matters Regarding a Master Servicer and
the Company";
(vii) if and to the extent described in the related Prospectus
Supplement, to pay (or to transfer to a separate account for purposes of
escrowing for the payment of) the Indenture Trustee's fees;
(viii) to reimburse the Indenture Trustee or any of its directors,
officers, employees and agents, as the case may be, for certain expenses,
costs and liabilities incurred thereby, as and to the extent described
under "--Certain Matters Regarding the Indenture Trustee";
(ix) to pay a Master Servicer, as additional servicing compensation,
interest and investment income earned in respect of amounts held in the
Collection Account;
(x) to pay the person entitled thereto any amounts deposited in the
Collection Account that were identified and applied by the Master Servicer
as recoveries of Retained Interest;
(xi) to pay for costs reasonably incurred in connection with the proper
management and maintenance of any Mortgaged Property acquired for the
benefit of Bondholders by foreclosure or by deed in lieu of foreclosure or
otherwise, such payments to be made out of income received on such
property;
(xii) to pay for the cost of an independent appraiser or other expert in
real estate matters retained to determine a fair sale price for a defaulted
Whole Loan or a property acquired in respect thereof in connection with the
liquidation of such Whole Loan or property;
(xiii) to pay for the cost of various opinions of counsel obtained
pursuant to the related Agreement for the benefit of Bondholders;
(xiv) to pay for the costs of recording the related Agreement if such
recordation materially and beneficially affects the interests of
Bondholders, provided that such payment shall not constitute a waiver with
respect to the obligation of the Warranting Party to remedy any breach of
representation or warranty under the Agreement;
(xv) to pay the person entitled thereto any amounts deposited in the
Collection Account in error, including amounts received on any Asset after
its removal from the Issuer whether by reason of purchase or substitution
as contemplated by "--Assignment of Assets; Repurchases" and "--
Representations and Warranties; Repurchases" or otherwise;
(xvi) to make any other withdrawals permitted by the related Agreement;
and
(xvii) to clear and terminate the Collection Account at the termination
of the Issuer.
The related Prospectus Supplement or the related Agreement will specify if
the Master Servicer or the Indenture Trustee may not make withdrawals from the
Collection Account for any of the purposes named above.
Other Collection Accounts
Notwithstanding the foregoing, if so specified in the related Prospectus
Supplement, the Agreement for any series of Bonds may provide for the
establishment and maintenance of a separate collection account into which the
Master Servicer or any related Sub-Servicer will deposit within two Business
Days the amounts described under "--Deposits" above, for one or more series of
Bonds. Any amounts on deposit in any such collection account will be withdrawn
therefrom and deposited into the appropriate Collection Account by a time
specified in the related Prospectus Supplement. to the extent specified in the
related Prospectus Supplement, any amounts which could be withdrawn from the
Collection Account as described under "--Withdrawals" above, may also be
withdrawn from any such collection account. The Prospectus Supplement will set
forth any restrictions with respect to any such collection account, including
investment restrictions and any restrictions with respect to financial
institutions with which any such collection account may be maintained.
COLLECTION AND OTHER SERVICING PROCEDURES
The Master Servicer, directly or through Sub-Servicers, is required to make
reasonable efforts to collect all scheduled payments under the Whole Loans and
will follow or cause to be followed such collection procedures
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as it would follow with respect to mortgage loans that are comparable to the
Whole Loans or manufactured housing contracts comparable to the Contracts and
held for its own account, provided such procedures are consistent with (i) the
terms of the related Agreement and any related hazard insurance policy or
instrument of Credit Support, if any, held by the related Issuer described
herein or under "Description of Credit Support," (ii) applicable law and (iii)
the general servicing standard specified in the related Prospectus Supplement
or, if no such standard is so specified, its normal servicing practices (in
either case, the "Servicing Standard"). In connection therewith, the Master
Servicer will be permitted in its discretion to waive any late payment charge
or penalty interest in respect of a late payment on a Whole Loan or Contract.
Each Master Servicer will also be required to perform other customary
functions of a servicer of comparable loans, including maintaining hazard
insurance policies as described herein and in any related Prospectus
Supplement, and filing and settling claims thereunder; maintaining escrow or
impoundment accounts of mortgagors for payment of taxes, insurance and other
items required to be paid by any mortgagor pursuant to a Whole Loan;
processing assumptions or substitutions in those cases where the Master
Servicer has determined not to enforce any applicable due-on-sale clause;
attempting to cure delinquencies; supervising foreclosures or repossessions;
inspecting and managing Mortgaged Properties or Manufactured Homes under
certain circumstances; and maintaining accounting records relating to the
Whole Loans or Contracts. The Master Servicer will generally be responsible
for filing and settling claims in respect of particular Whole Loans or
Contracts under any applicable instrument of Credit Support. See "Description
of Credit Support."
The Master Servicer may agree to modify, waive or amend any term of any
Whole Loan or Contract in a manner consistent with the Servicing Standard so
long as the modification, waiver or amendment will not (i) affect the amount
or timing of any scheduled payments of principal or interest on the Whole Loan
or Contract or (ii) in its judgment, materially impair the security for the
Whole Loan or Contract or reduce the likelihood of timely payment of amounts
due thereon. The Master Servicer also may agree to any modification, waiver or
amendment that would so affect or impair the payments on, or the security for,
a Whole Loan or Contract if (i) in its judgment, a material default on the
Whole Loan or Contract has occurred or a payment default is imminent and (ii)
in its judgment, such modification, waiver or amendment is reasonably likely
to produce a greater recovery with respect to the Whole Loan or Contract on a
present value basis than would liquidation. The Master Servicer is required to
notify the Indenture Trustee in the event of any modification, waiver or
amendment of any Whole Loan or Contract.
SUB-SERVICERS
A Master Servicer may delegate its servicing obligations in respect of the
Whole Loans or Contracts to third-party servicers (each, a "Sub-Servicer"),
but such Master Servicer will remain obligated under the related Agreement.
Each sub-servicing agreement between a Master Servicer and a Sub-Servicer (a
"Sub-Servicing Agreement") must be consistent with the terms of the related
Agreement and must provide that, if for any reason the Master Servicer for the
related series of Bonds is no longer acting in such capacity, the Indenture
Trustee or any successor Master Servicer may assume the Master Servicer's
rights and obligations under such Sub-Servicing Agreement.
The Master Servicer will generally be solely liable for all fees owed by it
to any Sub-Servicer, irrespective of whether the Master Servicer's
compensation pursuant to the related Agreement is sufficient to pay such fees.
However, a Sub-Servicer may be entitled to a Retained Interest in certain
Whole Loans or Contracts. Each Sub-Servicer will be reimbursed by the Master
Servicer for certain expenditures which it makes, generally to the same extent
the Master Servicer would be reimbursed under an Agreement. See "--Retained
Interest; Servicing Compensation and Payment of Expenses."
REALIZATION UPON DEFAULTED WHOLE LOANS
The Master Servicer will generally be required to monitor any Whole Loan or
Contract which is in default, initiate corrective action in cooperation with
the mortgagor or obligor if cure is likely, inspect the Mortgaged
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Property or Manufactured Home and take such other actions as are consistent
with the Servicing Standard. A significant period of time may elapse before
the Master Servicer is able to assess the success of such corrective action or
the need for additional initiatives.
Any Agreement relating to an Issuer that holds Whole Loans or Contracts may
grant to the Master Servicer a right of first refusal to purchase from the
Issuer at a predetermined purchase price any such Whole Loan or Contract as to
which a specified number of scheduled payments thereunder are delinquent. Any
such right granted to the holder of an Offered Bond will be described in the
related Prospectus Supplement. The related Prospectus Supplement will also
describe any such right granted to any person if the predetermined purchase
price is less than the Purchase Price described under "--Representations and
Warranties; Repurchases."
If so specified in the related Prospectus Supplement, the Master Servicer
may offer to sell any defaulted Whole Loan or Contract described in the
preceding paragraph and not otherwise purchased by any person having a right
of first refusal with respect thereto, if and when the Master Servicer
determines, consistent with the Servicing Standard, that such a sale would
produce a greater recovery on a present value basis than would liquidation
through foreclosure, repossession or similar proceedings. The related
Agreement will provide that any such offering be made in a commercially
reasonable manner for a specified period and that the Master Servicer accept
the highest cash bid received from any person (including itself, or an
affiliate of the Master Servicer) that constitutes a fair price for such
defaulted Whole Loan or Contract. In the absence of any bid determined in
accordance with the related Agreement to be fair, the Master Servicer shall
proceed with respect to such defaulted Mortgage Loan or Contract as described
below. Any bid in an amount at least equal to the Purchase Price described
under "--Representations and Warranties; Repurchases" will in all cases be
deemed fair.
The Master Servicer, on behalf of the Indenture Trustee, may at any time
institute foreclosure proceedings, exercise any power of sale contained in any
mortgage, obtain a deed in lieu of foreclosure, or otherwise acquire title to
a Mortgaged Property securing a Whole Loan by operation of law or otherwise
and may at any time repossess and realize upon any Manufactured Home, if such
action is consistent with the Servicing Standard and a default on such Whole
Loan or Contract has occurred or, in the Master Servicer's judgment, is
imminent.
If recovery on a defaulted Whole Loan or Contract under any related
instrument of Credit Support is not available, the Master Servicer
nevertheless will be obligated to follow or cause to be followed such normal
practices and procedures as it deems necessary or advisable to realize upon
the defaulted Whole Loan or Contract. If the proceeds of any liquidation of
the property securing the defaulted Whole Loan or Contract are less than the
outstanding principal balance of the defaulted Whole Loan or Contract plus
interest accrued thereon at the Mortgage Rate or Contract Rate, as applicable,
plus the aggregate amount of expenses incurred by the Master Servicer in
connection with such proceedings and which are reimbursable under the
Agreement, the Issuer will realize a loss in the amount of such difference.
The Master Servicer will be entitled to withdraw or
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cause to be withdrawn from the Collection Account out of the Liquidation
Proceeds recovered on any defaulted Whole Loan or Contract amounts
representing its normal servicing compensation on the Whole Loan or Contract,
unreimbursed servicing expenses incurred with respect to the Whole Loan or
Contract and any unreimbursed advances of delinquent payments made with
respect to the Whole Loan or Contract.
If any property securing a defaulted Whole Loan or Contract is damaged the
Master Servicer is not required to expend its own funds to restore the damaged
property unless it determines (i) that such restoration will increase the
proceeds on liquidation of the Whole Loan or Contract after reimbursement of
the Master Servicer for its expenses and (ii) that such expenses will be
recoverable by it from related Insurance Proceeds or Liquidation Proceeds.
As servicer of the Whole Loans or Contracts, a Master Servicer, on behalf of
itself, the Indenture Trustee and the Bondholders, will present claims to the
obligor under each instrument of Credit Support, and will take such reasonable
steps as are necessary to receive payment or to permit recovery thereunder
with respect to defaulted Whole Loans or Contracts.
If a Master Servicer or its designee recovers payments under any instrument
of Credit Support with respect to any defaulted Whole Loan or Contract, the
Master Servicer will be entitled to withdraw or cause to be withdrawn from the
Collection Account out of such proceeds amounts representing its normal
servicing compensation on such Whole Loan or Contract, unreimbursed servicing
expenses incurred with respect to the Whole Loan or Contract and any
unreimbursed advances of delinquent payments made with respect to the Whole
Loan or Contract. See "--Hazard Insurance Policies" and "Description of Credit
Support."
HAZARD INSURANCE POLICIES
Whole Loans
Each Agreement for an Issuer holding Whole Loans will generally require the
Master Servicer to cause the mortgagor on each Whole Loan to maintain a hazard
insurance policy providing for such coverage as is required under the related
Mortgage or, if any Mortgage permits the holder thereof to dictate to the
mortgagor the insurance coverage to be maintained on the related Mortgaged
Property, then such coverage as is consistent with the Servicing Standard.
Such coverage will generally be in an amount equal to the lesser of the
principal balance owing on such Mortgage Loan and the amount necessary to
fully compensate for any damage or loss to the improvements on the Mortgaged
Property on a replacement cost basis, but in either case not less than the
amount necessary to avoid the application of any co-insurance clause contained
in the hazard insurance policy. In the case of High LTV Loans, such hazard
insurance policy may not cover the principal balance owning on such loan. The
ability of the Master Servicer to assure that hazard insurance proceeds are
appropriately applied may be dependent upon its being named as an additional
insured under any hazard insurance policy and under any other insurance policy
referred to below, or upon the extent to which information in this regard is
furnished by mortgagors. All amounts collected by the Master Servicer under
any such policy (except for amounts to be applied to the restoration or repair
of the Mortgaged Property or released to the mortgagor in accordance with the
Master Servicer's normal servicing procedures, subject to the terms and
conditions of the related Mortgage and Mortgage Note) will be deposited in the
Collection Account. The Agreement will provide that the Master Servicer may
satisfy its obligation to cause each mortgagor to maintain such a hazard
insurance policy by the Master Servicer's maintaining a blanket policy
insuring against hazard losses on the Whole Loans. If such blanket policy
contains a deductible clause, the Master Servicer will be required to deposit
in the Collection Account all sums that would have been deposited therein but
for such clause.
In general, the standard form of fire and extended coverage policy covers
physical damage to or destruction of the improvements of the property by fire,
lightning, explosion, smoke, windstorm and hail, and riot, strike and civil
commotion, subject to the conditions and exclusions specified in each policy.
Although the policies relating to the Whole Loans will be underwritten by
different insurers under different state laws in accordance with different
applicable state forms, and therefore will not contain identical terms and
conditions, the basic terms
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thereof are dictated by respective state laws, and most such policies
typically do not cover any physical damage resulting from war, revolution,
governmental actions, floods and other water-related causes, earth movement
(including earthquakes, landslides and mudflows), wet or dry rot, vermin,
domestic animals and certain other kinds of uninsured risks.
The hazard insurance policies covering the Mortgaged Properties securing the
Whole Loans will typically contain a co-insurance clause that in effect
requires the insured at all times to carry insurance of a specified percentage
(generally 80% to 90%) of the full replacement value of the improvements on
the property in order to recover the full amount of any partial loss. If the
insured's coverage falls below this specified percentage, such clause
generally provides that the insurer's liability in the event of partial loss
does not exceed the lesser of (i) the replacement cost of the improvements
less physical depreciation and (ii) such proportion of the loss as the amount
of insurance carried bears to the specified percentage of the full replacement
cost of such improvements.
Each Agreement for an Issuer holding Whole Loans will require the Master
Servicer to cause the mortgagor on each Whole Loan to maintain all such other
insurance coverage with respect to the related Mortgaged Property as is
consistent with the terms of the related Mortgage and the Servicing Standard,
which insurance may include flood insurance (if the related Mortgaged Property
was located at the time of origination in a federally designated flood area).
Any cost incurred by the Master Servicer in maintaining any such insurance
policy will be added to the amount owing under the Mortgage Loan where the
terms of the Mortgage Loan so permit. Such costs may be recovered by the
Master Servicer or Sub-Servicer, as the case may be, from the Collection
Account, with interest thereon, as provided by the Agreement.
Under the terms of the Whole Loans, mortgagors will generally be required to
present claims to insurers under hazard insurance policies maintained on the
related Mortgaged Properties. The Master Servicer, on behalf of the Indenture
Trustee, is obligated to present or cause to be presented claims under any
blanket insurance policy insuring against hazard losses on Mortgaged
Properties securing the Whole Loans. However, the ability of the Master
Servicer to present or cause to be presented such claims is dependent upon the
extent to which information in this regard is furnished to the Master Servicer
by mortgagors.
Contracts
The terms of the Agreement for an Issuer holding Contracts will generally
require the Master Servicer to cause to be maintained with respect to each
Contract one or more hazard insurance policies which provide, at a minimum,
the same coverage as a standard form fire and extended coverage insurance
policy that is customary for manufactured housing, issued by a company
authorized to issue such policies in the state in which the Manufactured Home
is located, and in an amount which is not less than the maximum insurable
value of such Manufactured Home or the principal balance due from the obligor
on the related Contract, whichever is less; provided, however, that the amount
of coverage provided by each such hazard insurance policy shall be sufficient
to avoid the application of any co-insurance clause contained therein. When a
Manufactured Home's location was, at the time of origination of the related
Contract, within a federally designated special flood hazard area, the Master
Servicer shall cause such flood insurance to be maintained, which coverage
shall be at least equal to the minimum amount specified in the preceding
sentence or such lesser amount as may be available under the federal flood
insurance program. Each hazard insurance policy caused to be maintained by the
Master Servicer shall contain a standard loss payee clause in favor of the
Master Servicer and its successors and assigns. If any obligor is in default
in the payment of premiums on its hazard insurance policy or policies, the
Master Servicer shall pay such premiums out of its own funds, and may add
separately such premium to the obligor's obligation as provided by the
Contract, but may not add such premium to the remaining principal balance of
the Contract.
The Master Servicer may maintain, in lieu of causing individual hazard
insurance policies to be maintained with respect to each Manufactured Home,
and shall maintain, to the extent that the related Contract does not require
the obligor to maintain a hazard insurance policy with respect to the related
Manufactured Home, one or
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more blanket insurance policies covering losses on the obligor's interest in
the Contracts resulting from the absence or insufficiency of individual hazard
insurance policies. The Master Servicer shall pay the premium for such blanket
policy on the basis described therein and shall pay any deductible amount with
respect to claims under such policy relating to the Contracts.
FIDELITY BONDS AND ERRORS AND OMISSIONS INSURANCE
Each Agreement will generally require that the Master Servicer obtain and
maintain in effect a fidelity bond or similar form of insurance coverage
(which may provide blanket coverage) or any combination thereof insuring
against loss occasioned by fraud, theft or other intentional misconduct of the
officers, employees and agents of the Master Servicer. The related Agreement
will allow the Master Servicer to self-insure against loss occasioned by the
errors and omissions of the officers, employees and agents of the Master
Servicer so long as certain criteria set forth in the Agreement are met.
DUE-ON-SALE PROVISIONS
The Whole Loans may contain clauses requiring the consent of the mortgagee
to any sale or other transfer of the related Mortgaged Property, or due-on-
sale clauses entitling the mortgagee to accelerate payment of the Whole Loan
upon any sale, transfer or conveyance of the related Mortgaged Property. The
Master Servicer will generally enforce any due-on-sale clause to the extent it
has knowledge of the conveyance or proposed conveyance of the underlying
Mortgaged Property and it is entitled to do so under applicable law; provided,
however, that the Master Servicer will not take any action in relation to the
enforcement of any due-on-sale provision which would adversely affect or
jeopardize coverage under any applicable insurance policy. Any fee collected
by or on behalf of the Master Servicer for entering into an assumption
agreement will generally be retained by or on behalf of the Master Servicer as
additional servicing compensation. See "Certain Legal Aspects of Mortgage
Loans--Due-on-Sale Clauses." The Contracts may also contain such clauses. The
Master Servicer will generally permit such transfer so long as the transferee
satisfies the Master Servicer's then applicable placement standards. The
purpose of such transfers is often to avoid a default by the transferring
obligor. See "Certain Legal Aspects of the Contracts--Transfers of
Manufactured Homes; Enforceability of "Due-on-Sale" Clauses".
RETAINED INTEREST; SERVICING COMPENSATION AND PAYMENT OF EXPENSES
The Prospectus Supplement for a series of Bonds will specify if there will
be any Retained Interest in the Assets, and, if so, the initial owner thereof.
If so, the Retained Interest will be established on a loan-by-loan basis and
will be specified on an exhibit to the related Agreement. A "Retained
Interest" in an Asset represents a specified portion of the interest payable
thereon. The Retained Interest will be deducted from mortgagor payments as
received and will not be held by the related Issuer.
The Master Servicer's and a Sub-Servicer's primary servicing compensation
with respect to a series of Bonds will generally come from the periodic
payment to it of a portion of the interest payment on each Asset. Since any
Retained Interest and a Master Servicer's primary compensation are percentages
of the principal balance of each Asset, such amounts will decrease in
accordance with the amortization of the Assets. The Prospectus Supplement with
respect to a series of Bonds secured by Whole Loans or Contracts may provide
that, as additional compensation, the Master Servicer or the Sub-Servicers may
retain all or a portion of assumption fees, modification fees, late payment
charges or Prepayment Premiums collected from mortgagors and any interest or
other income which may be earned on funds held in the Collection Account or
any account established by a Sub-Servicer pursuant to the Agreement.
The Master Servicer may, to the extent provided in the related Prospectus
Supplement, pay from its servicing compensation certain expenses incurred in
connection with its servicing and managing of the Assets, including, without
limitation, payment of the fees and disbursements of the Indenture Trustee and
independent accountants, payment of expenses incurred in connection with
distributions and reports to Bondholders, and
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payment of any other expenses described in the related Prospectus Supplement.
Certain other expenses, including certain expenses relating to defaults and
liquidations on the Whole Loans or Contracts and, to the extent so provided in
the related Prospectus Supplement, interest thereon at the rate specified
therein may be borne by the Issuer.
If and to the extent provided in the related Prospectus Supplement, the
Master Servicer may be required to apply a portion of the servicing
compensation otherwise payable to it in respect of any Due Period to certain
interest shortfalls resulting from the voluntary prepayment of any Whole Loans
or Contracts of the related Issuer during such period prior to their
respective due dates therein.
EVIDENCE AS TO COMPLIANCE
Each Agreement relating to Assets which include Whole Loans or Contracts
will provide that on or before a specified date in each year, beginning with
the first such date at least six months after the related Cut-off Date, a firm
of independent public accountants will furnish a statement to the Indenture
Trustee to the effect that, on the basis of the examination by such firm
conducted substantially in compliance with either the Uniform Single
Attestation Program for Mortgage Bankers, the Audit Program for Mortgages
serviced for the Federal Home Loan Mortgage Corporation ("FHLMC") or such
other program used by the Master Servicer, the servicing by or on behalf of
the Master Servicer of mortgage loans under agreements substantially similar
to each other (including the related Agreement) was conducted in compliance
with the terms of such agreements or such program except for any significant
exceptions or errors in records that, in the opinion of the firm, either the
Audit Program for Mortgages serviced for FHLMC, or paragraph 4 of the Uniform
Single Attestation Program for Mortgage Bankers, or such other program,
requires it to report. In rendering its statement such firm may rely, as to
matters relating to the direct servicing of mortgage loans by Sub-Servicers,
upon comparable statements for examinations conducted substantially in
compliance with the Uniform Single Attestation Program for Mortgage Bankers or
the Audit Program for Mortgages serviced for FHLMC or such other program used
by such Sub-Servicer (rendered within one year of such statement) of firms of
independent public accountants with respect to the related Sub-Servicer.
Each such Agreement will also provide for delivery to the Indenture 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 Agreement throughout the preceding
calendar year or other specified twelve-month period.
Copies of such annual accountants' statement and such statements of officers
will generally be obtainable by Bondholders without charge upon written
request to the Master Servicer at the address set forth in the related
Prospectus Supplement. The related Prospectus Supplement will specify if such
statements will be obtainable upon request to someone other than the Master
Servicer.
CERTAIN MATTERS REGARDING A MASTER SERVICER AND THE COMPANY
The Master Servicer, if any, or a servicer for substantially all the Whole
Loans or Contracts under each Agreement will be named in the related
Prospectus Supplement. The entity serving as Master Servicer (or as such
servicer) may be an affiliate of the Company and may have other normal
business relationships with the Company or the Company's affiliates. Reference
herein to the Master Servicer shall be deemed to be to the servicer of
substantially all of the Whole Loans or Contracts, if applicable.
The related Agreement will generally provide that the Master Servicer may
resign from its obligations and duties thereunder only upon a determination
that the performance of its obligations or duties under the Agreement are no
longer permissible under applicable law. No such resignation will become
effective until the Indenture Trustee or a successor servicer has assumed the
Master Servicer's obligations and duties under the Agreement.
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Each Agreement will generally further provide that neither any Master
Servicer, the Company nor any director, officer, employee, or agent of a
Master Servicer or the Company will be under any liability to the related
Issuer or Bondholders for any action taken, or for refraining from the taking
of any action, in good faith pursuant to the Agreement; provided, however,
that neither a Master Servicer, the Company nor any such person will be
protected against any liability which would otherwise be imposed by reason of
willful misfeasance, bad faith or gross negligence in the performance of
obligations or duties thereunder or by reason of reckless disregard of
obligations and duties thereunder. Each Agreement will generally further
provide that any Master Servicer and any director, officer, employee or agent
of a Master Servicer 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 Agreement or the Bonds;
provided, however, that such indemnification will not extend to any loss,
liability or expense (i) related to any specific Mortgage Loan or Mortgage
Loans (except as any such loss, liability or expense shall be otherwise
reimbursable pursuant to such Agreement) or (ii) incurred by reason of willful
misfeasance, bad faith or negligence in the performance of obligations or
duties thereunder, or by reason of reckless disregard of such obligation or
duties. In addition, each Agreement will provide that the Master Servicer will
not be under any obligation to appear in, prosecute or defend any legal action
which is not incidental to its responsibilities under the Agreement and which
in its opinion may involve it in any expense or liability. Any such Master
Servicer may, however, in its discretion undertake any such action which it
may deem necessary or desirable with respect to the Agreement and the rights
and duties of the parties thereto and the interests of the Bondholders
thereunder. In such event, the legal expenses and costs of such action and any
liability resulting therefrom will be expenses, costs and liabilities of the
Issuer will be entitled to be reimbursed therefor.
Any person into which the Master Servicer or the Company 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 the
related Agreement.
EVENTS OF DEFAULT UNDER THE AGREEMENT
For an Issuer holding Whole Loans or Contracts, "Events of Default" under
the related Agreement will generally include (i) any failure by the Master
Servicer to distribute or cause to be distributed to Bondholders, or to remit
to the Indenture Trustee for distribution to Bondholders, any required payment
that continues after a grace period, if any; (ii) any failure by the Master
Servicer duly to observe or perform in any material respect any of its other
covenants or obligations under the Agreement which continues unremedied for 30
days after written notice of such failure has been given to the Master
Servicer by the Indenture Trustee or the Company, or to the Master Servicer,
the Company and the Indenture Trustee by the Bond Insurer; (iii) any breach of
a representation or warranty made by the Master Servicer under the Agreement
which materially and adversely affects the interests of Bondholders and which
continues unremedied for 30 days after written notice of such breach has been
given to the Master Servicer by the Indenture Trustee or the Company, or to
the Master Servicer, the Company and the Indenture Trustee by the Bond
Insurer; and (iv) certain events of insolvency, readjustment of debt,
marshaling of assets and liabilities or similar proceedings and certain
actions by or on behalf of the Master Servicer indicating its insolvency or
inability to pay its obligations. Material variations to the foregoing Events
of Default (other than to shorten cure periods or eliminate notice
requirements) will be specified in the related Prospectus Supplement. The
Master Servicer will generally be required to immediately notify the Indenture
Trustee and the Bond Insurer in writing of any Event of Default under the
related Agreement.
RIGHTS UPON EVENT OF DEFAULT UNDER THE AGREEMENT
So long as an Event of Default under an Agreement remains unremedied, either
the Issuer with the consent of the Bond Insurer or the Bond Insurer, or if a
default exists under the Bond Insurance Policy, the holders of at least 51% of
the aggregate Bond Principal Balance of such series may, by notice to the
Master Servicer, terminate all of the rights and obligations of the Master
Servicer under the Agreement (other than its right to receive servicing
compensation and expenses for servicing the Mortgage Loans), whereupon the
Indenture Trustee will succeed to all of the authority and power of the Master
Servicer under the Agreement (except that if
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the Indenture Trustee is prohibited by law from obligating itself to make
advances regarding delinquent Mortgage Loans or Contracts, or if the related
Prospectus Supplement so specifies, then the Indenture Trustee will not be
obligated to make such advances) and will be entitled to similar compensation
arrangements. In the event that the Indenture Trustee is unwilling or unable
so to act, it may or, at the written request of the holders of Bonds entitled
to at least 51% (or such other percentage specified in the related Prospectus
Supplement) of the Bond Principal Balances of such series, it shall appoint,
or petition a court of competent jurisdiction for the appointment of, a loan
servicing institution acceptable to the Rating Agency with a net worth at the
time of such appointment of at least $10,000,000 (or such other amount
specified in the related Prospectus Supplement) to act as successor to the
Master Servicer under the Agreement. Pending such appointment, the Indenture
Trustee is obligated to act in such capacity. The Indenture Trustee and any
such successor may agree upon the servicing compensation to be paid, which in
no event may be greater than the compensation payable to the Master Servicer
under the Agreement.
Unless otherwise described in the related Prospectus Supplement, the Bond
Insurer, or if a Bond Insurer default exits, the holders of Bonds representing
at least 51% (or such other percentage specified in the related Prospectus
Supplement) aggregate Bond Principal Balance of such series affected by any
Event of Default will generally be entitled to waive such Event of Default,
except a default in the making of or the causing to be made any required
distribution on the Bonds. Upon any such waiver of an Event of Default, such
Event of Default shall cease to exist and shall be deemed to have been
remedied for every purpose under the Agreement.
AMENDMENT
Each Agreement may be amended by the Master Servicer, the Indenture Trustee
and the Issuer with the prior written consent of the Bond Insurer, provided
that any amendment be accompanied by a letter from the Rating Agencies to the
effect that the amendment will not result in the downgrading or withdrawal of
the rating then assigned to the Bonds, or the rating then assigned to the
Bonds without taking into account the Bond Insurance Policy.
THE INDENTURE TRUSTEE
The Indenture Trustee under each Indenture will be named in the related
Prospectus Supplement. The commercial bank, national banking association,
banking corporation or trust company serving as Indenture Trustee may have a
banking relationship with the Company and its affiliates and with any Master
Servicer and its affiliates.
DUTIES OF THE INDENTURE TRUSTEE
The Indenture Trustee will make no representations as to the validity or
sufficiency of any Agreement or Indenture, the Bonds or any Asset or related
document and is not accountable for the use or application by or on behalf of
any Master Servicer of any funds paid to the Master Servicer or its designee
in respect of the Bonds or the Assets, or deposited into or withdrawn from the
Collection Account or any other account by or on behalf of the Master
Servicer. If no Event of Default has occurred and is continuing, the Indenture
Trustee is required to perform only those duties specifically required under
the related Agreement or Indenture, as applicable. However, upon receipt of
the various certificates, reports or other instruments required to be
furnished to it, the Indenture Trustee is required to examine such documents
and to determine whether they conform to the requirements of the Agreement or
Indenture, as applicable.
CERTAIN MATTERS REGARDING THE INDENTURE TRUSTEE
The Indenture Trustee and any director, officer, employee or agent of the
Indenture Trustee will generally be entitled to indemnification out of the
Collection Account for any loss, liability or expense (including costs and
expenses of litigation, and of investigation, counsel fees, damages, judgments
and amounts paid in settlement) incurred in connection with the Indenture
Trustee's (i) enforcing its rights and remedies and
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protecting the interests, of the Bondholders during the continuance of an
Event of Default, (ii) defending or prosecuting any legal action in respect of
the related Agreement or series of Bonds (iii) being the mortgagee of record
with respect to the Mortgage Loans held by an Issuer and the owner of record
with respect to any Mortgaged Property acquired in respect thereof for the
benefit of Bondholders, or (iv) acting or refraining from acting in good faith
at the direction of the holders of the related series of Bonds entitled to not
less than 25% (or such other percentage as is specified in the related
Agreement with respect to any particular matter) of the Bond Principal Balance
for such series; provided, however, that such indemnification will not extend
to any loss, liability or expense that constitutes a specific liability of the
Indenture Trustee pursuant to the related Agreement, or to any loss, liability
or expense incurred by reason of willful misfeasance, bad faith or negligence
on the part of the Indenture Trustee in the performance of its obligations and
duties thereunder, or by reason of its reckless disregard of such obligations
or duties, or as may arise from a breach of any representation, warranty or
covenant of the Indenture Trustee made therein.
RESIGNATION AND REMOVAL OF THE INDENTURE TRUSTEE
The Indenture Trustee may at any time resign from its obligations and duties
under an Indenture by giving written notice thereof to the Company, the Master
Servicer, if any, and all Bondholders. Upon receiving such notice of
resignation, the Company or the Issuer is required promptly to appoint a
successor trustee acceptable to the Master Servicer, if any. If no successor
trustee shall have been so appointed and have accepted appointment within 30
days after the giving of such notice of resignation, the resigning Indenture
Trustee may petition any court of competent jurisdiction for the appointment
of a successor trustee.
If at any time the Indenture Trustee shall cease to be eligible to continue
as such under the related Indenture, or if at any time the Indenture Trustee
shall become incapable of acting, or shall be adjudged bankrupt or insolvent,
or a receiver of the Indenture Trustee or of its property shall be appointed,
or any public officer shall take charge or control of the Indenture Trustee or
of its property or affairs for the purpose of rehabilitation, conservation or
liquidation, or if a change in the financial condition of the Indenture
Trustee has adversely affected or will adversely affect the rating on any
class of the Bonds, then the Company or the Issuer may remove the Indenture
Trustee and appoint a successor trustee acceptable to the Master Servicer, if
any. Holders of the Bonds of any series entitled to at least 51% (or such
other percentage specified in the related Prospectus Supplement) of the voting
rights for such series may at any time remove the Indenture Trustee without
cause and appoint a successor trustee.
Any resignation or removal of the Indenture Trustee and appointment of a
successor trustee shall not become effective until acceptance of appointment
by the successor trustee.
CERTAIN TERMS OF THE INDENTURE
Events of Default. "Events of Default" under the Indenture for each series
of Bonds will generally include: (a) a default for thirty (30) days (or such
other number of days specified in such Prospectus Supplement) or more in the
payment of any principal of or interest due on any Bonds of such series; (b)
failure to perform any other covenant of the Issuer in the Indenture which
continues for a period of sixty (60) days (or such other number of days
specified in such Prospectus Supplement) after notice thereof is given in
accordance with the procedures described in the related Prospectus
Supplement); (c) any representation or warranty made by the Issuer in the
Indenture or in any certificate or other writing delivered pursuant thereto or
in connection therewith with respect to or affecting such series having been
incorrect in a material respect as of the time made, and such breach is not
cured within sixty (60) days (or such other number of days specified in such
Prospectus Supplement) after notice thereof is given in accordance with the
procedures described in the related Prospectus Supplement; (d) certain events
of bankruptcy, insolvency, receivership or liquidation of the Issuer; or (e)
any other event of default provided in the Indenture with respect to the Bonds
of that series. The related Prospectus Supplement will indicate if "Events of
Default" include any events other than those named above.
If an Event of Default with respect to the Bonds of any series at the time
outstanding occurs and is continuing, the Indenture Trustee may and, at the
written direction of the Bond Insurer, or if a Bond Insurer
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default exists, the holders of a majority of the then aggregate outstanding
amount of the Bonds of such series, shall declare the Bond Principal Balance
of all the Bonds of such series to be due and payable immediately. Such
declaration may, under certain circumstances, be rescinded and annulled by the
holders of a majority in aggregate outstanding Bond Principal Balance of the
Bonds of such series.
If, following an Event of Default with respect to any series of Bonds, the
Bonds of such series have been declared to be due and payable, the Indenture
Trustee may, in its discretion (provided that the Bond Insurer or Bondholders
representing more than 50% of the Bond Principal Balances of the Bonds have
not directed the Indenture Trustee to sell the Assets), notwithstanding such
acceleration, elect to maintain possession of the collateral securing the
Bonds of such series and to continue to apply distributions on such collateral
as if there had been no declaration of acceleration if such collateral
continues to provide sufficient funds for the payment of principal of and
interest on the Bonds of such series as they would have become due if there
had not been such a declaration. In addition, the Indenture Trustee may not
sell or otherwise liquidate the Assets securing the Bonds of a series
following an Event of Default, unless (a) the holders of 100% (or such other
percentage specified in the related Prospectus Supplement) of the then
aggregate outstanding Bond Principal Balance of such series consent to such
sale, (b) the proceeds of such sale or liquidation distributable to the
Bondholders are sufficient to pay in full the principal of and accrued
interest, due and unpaid, on the outstanding Bonds of such series at the date
of such sale and to reimburse the Bond Insurer for any amounts drawn under the
Bond Insurance Policy and any other amounts due to the Bond Insurer under the
insurance agreement or (c) the Indenture Trustee determines that such
collateral would not be sufficient on an ongoing basis to make all payments on
such Bonds as such payments would have become due if such Bonds had not been
declared due and payable, and the Indenture Trustee obtains the consent of a
majority of the aggregate Bond Principal Balance (or such other percentage
specified in the related Prospectus Supplement).
In the event that the Indenture Trustee liquidates the collateral in
connection with an Event of Default involving a default for thirty (30) days
(or such other number of days specified in the related Prospectus Supplement)
or more in the payment of principal of or interest on the Bonds of a series,
the Indenture provides that the Indenture Trustee will have a prior lien on
the proceeds of any such liquidation for unpaid fees and expenses. As a
result, upon the occurrence of such an Event of Default, the amount available
for distribution to the Bondholders would be less than would otherwise be the
case. However, the Indenture Trustee may not institute a proceeding for the
enforcement of its lien except in connection with a proceeding for the
enforcement of the lien of the Indenture for the benefit of the Bondholders
after the occurrence of such an Event of Default.
Subject to the provisions of the Indenture relating to the duties of the
Indenture Trustee, in case an Event of Default shall occur and be continuing,
the Indenture Trustee shall be under no obligation to exercise any of the
rights or powers under the Indenture at the request or direction of any of the
Bondholders of such series, unless such holders offered to the Indenture
Trustee security or indemnity satisfactory to it against the costs, expenses
and liabilities which might be incurred by it in complying with such request
or direction. Subject to such provisions for indemnification and certain
limitations contained in the Indenture, the holders of a majority of the Bond
Principal Balance of the Bonds shall have the right to direct the time, method
and place of conducting any proceeding for any remedy available to the
Indenture Trustee or exercising any trust or power conferred on the Indenture
Trustee with respect to the Bonds of such series, and the holders of a
majority of the Bond Principal Balance of the Bonds may, in certain cases,
waive any default with respect thereto, except a default in the payment of
principal or interest or a default in respect of a covenant or provision of
the Indenture that cannot be modified without the waiver or consent of all the
holders of the outstanding Bonds of such series affected thereby.
Discharge of the Indenture. The Indenture will be discharged with respect to
a series of Bonds (except with respect to certain continuing rights specified
in the Indenture) upon the delivery to the Indenture Trustee for cancellation
of all the Bonds of such series or, with certain limitations, upon deposit
with the Indenture Trustee of funds sufficient for the payment in full of all
of the Bonds of such series.
In addition to such discharge with certain limitations, the Indenture will
provide that, if so specified with respect to the Bonds of any series, the
related Issuer will be discharged from any and all obligations in respect of
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the Bonds of such series (except for certain obligations relating to temporary
Bonds and exchange of Bonds, to register the transfer of or exchange Bonds of
such series, to replace stolen, lost or mutilated Bonds of such series, to
maintain paying agencies and to hold monies for payment in trust) upon the
deposit with the Indenture Trustee, in trust, of money and/or direct
obligations of or obligations guaranteed by the United States of America which
through the payment of interest and principal in respect thereof in accordance
with their terms will provide money in an amount sufficient to pay the
principal of and each installment of interest on the Bonds of such series on
the maturity date for such Bonds and any installment of interest on such Bonds
in accordance with the terms of the Indenture and the Bonds of such series. In
the event of any such defeasance and discharge of Bonds of such series,
holders of Bonds of such series would be able to look only to such money
and/or direct obligations for payment of principal and interest, if any, on
their Bonds until maturity.
Indenture Trustee's Annual Report. The Indenture Trustee for each series of
Bonds will be required to mail each year to all related Bondholders a brief
report relating to its eligibility and qualification to continue as Indenture
Trustee under the related Indenture, any amounts advanced by it under the
Indenture, the amount, interest rate and maturity date of certain indebtedness
owing by such trust to the applicable Indenture Trustee in its individual
capacity, the property and funds physically held by such Indenture Trustee as
such and any action taken by it that materially affects such Bonds and that
has not been previously reported.
The Indenture Trustee. The Indenture Trustee for a series of Bonds will be
specified in the related Prospectus Supplement. The Indenture Trustee for any
series may resign at any time, in which event the Company will be obligated to
appoint, with the consent of the Bond Insurer, a successor trustee for such
series. The Company may also remove any such Indenture Trustee if such
Indenture Trustee ceases to be eligible to continue as such under the related
Indenture or if such Indenture Trustee becomes insolvent. In such
circumstances the Company will be obligated to appoint a successor trustee for
the applicable series of Bonds. Any resignation or removal of the Indenture
Trustee and appointment of a successor trustee for any series of Bonds does
not become effective until acceptance of the appointment by the successor
trustee for such series.
The bank or trust company serving as Indenture Trustee may have a banking
relationship with the Company or any of its affiliates or the Master Servicer
or any of its affiliates.
DESCRIPTION OF CREDIT SUPPORT
GENERAL
For any series of Bonds, Credit Support may be provided with respect to one
or more classes of Bonds or the related Assets. Credit Support may be in the
form of certain cash accounts, overcollateralization, excess spread, reserve
funds, insurance policies, surety bonds, guarantees, letters of credit or
another method of Credit Support described in the related Prospectus
Supplement, or any combination of the foregoing. If so provided in the related
Prospectus Supplement, any form of Credit Support may be structured so as to
be drawn upon by more than one series to the extent described therein.
Credit Support will not provide protection against all risks of loss and
will not guarantee repayment of the entire Bond Principal Balance of the Bonds
and interest thereon. If losses or shortfalls occur that exceed the amount
covered by Credit Support or that are not covered by Credit Support,
Bondholders will bear their allocable share of deficiencies. Moreover, if a
form of Credit Support covers more than one series of Bonds (each, a "Covered
Trust"), holders of Bonds evidencing interests in any of such Covered Trusts
will be subject to the risk that such Credit Support will be exhausted by the
claims of other Covered Trusts prior to such Covered Trust receiving any of
its intended share of such coverage.
If Credit Support is provided with respect to one or more classes of Bonds
of a series, or the related Assets, the related Prospectus Supplement will
include a description of (a) the nature and amount of coverage under such
Credit Support, (b) any conditions to payment thereunder not otherwise
described herein, (c) the conditions (if any) under which the amount of
coverage under such Credit Support may be reduced and under which such
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Credit Support may be terminated or replaced and (d) the material provisions
relating to such Credit Support. Additionally, the related Prospectus
Supplement will set forth certain information with respect to the obligor
under any instrument of Credit Support, including (i) a brief description of
its principal business activities, (ii) its principal place of business, place
of incorporation and the jurisdiction under which it is chartered or licensed
to do business, (iii) if applicable, the identity of regulatory agencies that
exercise primary jurisdiction over the conduct of its business and (iv) its
total assets, and its stockholders' or policyholders' surplus, if applicable,
as of the date specified in the Prospectus Supplement. See "Risk Factors--
Credit Support Limitations."
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 Loans 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 Mortgage Loan 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. The amount of such
overcollateralization will generally be in the range of 3% to 6%, but may fall
outside such range either on the related closing date or thereafter while the
Bonds are outstanding. The amount of overcollateralization, if any, on the
closing date for a series of Bonds will be set forth in the related Prospectus
Supplement.
CROSSCOLLATERALIZATION
If so specified in the related Prospectus Supplement, separate groups of
Mortgage Loans may be pledged to secure separate classes of the related series
of Bonds. In such case, credit support may be provided by a
crosscollateralization feature which requires that payments be made with
respect to Bonds secured by one or more groups of Mortgage Loans prior to
distributions to Bonds secured by one or more other groups of Mortgage Loans.
Crosscollateralization may be provided by (i) the allocation of certain excess
amounts generated by one or more groups of Mortgage Loans to one or more other
groups of Mortgage Loans or (ii) the allocation of losses with respect to one
or more groups of Mortgage Loans to one or more other groups of Mortgage
Loans. Such excess amounts will be applied and/or such losses will be
allocated to the class or classes of Bonds of the related series then
outstanding having 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.
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
Loans 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 Loans bear interest at adjustable rates, the
relationship of the movements in the indices applicable to the Mortgage Loans
and those applicable to the Bonds, over which no prediction can be made or
assurance given.
SUBORDINATION
If so specified in the related Prospectus Supplement, a series of Bonds may
consist of one or more classes of Senior Bonds (the "Senior Bonds") and one or
more classes of Subordinated Bonds (the "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
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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 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.
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 provided in the Prospectus Supplement for a series of Bonds,
deficiencies in amounts otherwise payable on such Bonds or certain classes
thereof will be covered by one or more reserve funds in which cash, a letter
of credit, Permitted Investments, Government Bonds, Corporate Bonds or a
combination thereof will be deposited, in the amounts so specified in such
Prospectus Supplement. The reserve funds for a series may also be funded over
time by depositing therein a specified amount of the distributions received on
the related Assets as specified in the related Prospectus Supplement.
Amounts on deposit in any reserve fund for a series, together with the
reinvestment income thereon, if any, will be applied for the purposes, in the
manner, and to the extent specified in the related Prospectus Supplement. A
reserve fund may be provided to increase the likelihood of timely
distributions of principal of and interest on the Bonds. If so specified in
the related Prospectus Supplement, reserve funds may be established to provide
limited protection against only certain types of losses and shortfalls.
Following each Payment Date amounts in a reserve fund in excess of any amount
required to be maintained therein may be released from the reserve fund under
the conditions and to the extent specified in the related Prospectus
Supplement and will not be available for further application to the Bonds.
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Moneys deposited in any Reserve Funds will generally be invested in
Permitted Investments. The Prospectus Supplement will indicate if moneys
deposited in any Reserve Funds are invested in investments other than
Permitted Investments. Any reinvestment income or other gain from such
investments will generally be credited to the related Reserve Fund for such
series, and any loss resulting from such investments will generally be charged
to such Reserve Fund. However, such income may be payable to any related
Master Servicer or another service provider as additional compensation.
Additional information concerning any Reserve Fund will be set forth in the
related Prospectus Supplement, including the initial balance of such Reserve
Fund, the balance required to be maintained in the Reserve Fund, the manner in
which such required balance will decrease over time, the manner of funding
such Reserve Fund, the purposes for which funds in the Reserve Fund may be
applied to make distributions to Bondholders and use of investment earnings
from the Reserve Fund, if any.
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 (a "Bond Insurance Policy")
provided by one or more insurance companies or sureties (a "Bond Insurer").
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 Indenture 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 Loans 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 Mortgage Loan. The amount available under the letter of
credit will, in all cases, be reduced to the extent of the unreimbursed
payments thereunder. The obligations of the L/C Bank under the letter of
credit for each series of Bonds will expire at the date specified in the
related Prospectus Supplement.
CREDIT SUPPORT WITH RESPECT TO MBS
If so provided in the Prospectus Supplement for a series of Bonds, the MBS
of the related Issuer and/or the Mortgage Loans underlying such MBS may be
covered by one or more of the types of Credit Support described herein. The
related Prospectus Supplement will specify as to each such form of Credit
Support the information indicated above with respect thereto, to the extent
such information is material and available.
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CERTAIN LEGAL ASPECTS OF MORTGAGE LOANS
The following discussion contains summaries, which are general in nature, of
all material legal aspects of loans secured by single-family or multi-family
residential properties. Because such legal aspects are governed primarily by
applicable state law (which laws may differ substantially), 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 the security for the Mortgage
Loans is situated. The summaries are qualified in their entirety by reference
to the applicable federal and state laws governing the Mortgage Loans. See
"Description of the Assets--Assets."
GENERAL
All of the Mortgage Loans are loans evidenced by a note or bond and secured
by instruments granting a security interest in real property which may be
mortgages, deeds of trust, security deeds or deeds to secure debt, depending
upon the prevailing practice and law in the state in which the Mortgaged
Property is located. Mortgages, deeds of trust and deeds to secure debt are
herein collectively referred to as "mortgages." Any of the foregoing types of
mortgages will create a lien upon, or grant a title interest in, the subject
property, the priority of which will depend on the terms of the particular
security instrument, as well as separate, recorded, contractual arrangements
with others holding interests in the mortgaged property, the knowledge of the
parties to such instrument as well as the order of recordation of the
instrument in the appropriate public recording office. However, recording does
not generally establish priority over governmental claims for real estate
taxes and assessments and other charges imposed under governmental police
powers.
TYPES OF MORTGAGE INSTRUMENTS
A mortgage either creates a lien against or constitutes a conveyance of real
property between two parties--a mortgagor (the borrower and usually the owner
of the subject property) and a mortgagee (the lender). In contrast, a deed of
trust is a three-party instrument, among a trustor (the equivalent of a
mortgagor), a trustee to whom the mortgaged property is conveyed, and a
beneficiary (the lender) for whose benefit the conveyance is made. As used in
this Prospectus, unless the context otherwise requires, "mortgagor" includes
the trustor under a deed of trust and a grantor under a security deed or a
deed to secure debt. Under a deed of trust, the mortgagor grants the property,
irrevocably until the debt is paid, in trust, generally with a power of sale
as security for the indebtedness evidenced by the related note. A deed to
secure debt typically has two parties. By executing a deed to secure debt, the
grantor conveys title to, as opposed to merely creating a lien upon, the
subject property to the grantee until such time as the underlying debt is
repaid, generally with a power of sale as security for the indebtedness
evidenced by the related mortgage note. In case the mortgagor under a mortgage
is a land trust, there would be an additional party because legal title to the
property is held by a land trustee under a land trust agreement for the
benefit of the mortgagor. At origination of a mortgage loan involving a land
trust, the mortgagor executes a separate undertaking to make payments on the
mortgage note. The mortgagee's authority under a mortgage, the trustee's
authority under a deed of trust and the grantee's authority under a deed to
secure debt are governed by the express provisions of the mortgage, the law of
the state in which the real property is located, certain federal laws
(including, without limitation, the Soldiers' and Sailors' Civil Relief Act of
1940, as hereinafter defined) and, in some cases, in deed of trust
transactions, the directions of the beneficiary.
The Mortgages that encumber Multifamily Properties may contain an assignment
of rents and leases, pursuant to which the mortgagor assigns to the lender the
mortgagor's right, title and interest as landlord under each lease and the
income derived therefrom, while retaining a revocable license to collect the
rents for so long as there is no default unless rents are to be paid directly
to the lender. If the mortgagor defaults, the license terminates and the
lender is entitled to collect the rents. Local law may require that the lender
take possession of the property and/or obtain a court-appointed receiver
before becoming entitled to collect the rents.
INTEREST IN REAL PROPERTY
The real property covered by a mortgage, deed of trust, security deed or
deed to secure debt is most often the fee estate in land and improvements.
However, such an instrument may encumber other interests in real
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property such as a tenant's interest in a lease of land or improvements, or
both, and the leasehold estate created by such lease. An instrument covering
an interest in real property other than the fee estate requires special
provisions in the instrument creating such interest or in the mortgage, deed
of trust, security deed or deed to secure debt, to protect the mortgagee
against termination of such interest before the mortgage, deed of trust,
security deed or deed to secure debt is paid. The Company or the Asset Seller
will generally make certain representations and warranties in the Agreement
with respect to any Mortgage Loans that are secured by an interest in a
leasehold estate. Such representation and warranties, if applicable, will be
set forth in the Prospectus Supplement.
COOPERATIVE LOANS
If specified in the Prospectus Supplement relating to a series of Offered
Bonds, the Mortgage Loans may also consist of cooperative apartment loans
("Cooperative Loans") secured by security interests in shares issued by a
cooperative housing corporation (a "Cooperative") and in the related
proprietary leases or occupancy agreements granting exclusive rights to occupy
specific dwelling units in the cooperatives' buildings. The security agreement
will create a lien upon, or grant a title interest in, the property which it
covers, the priority of which will depend on the terms of the particular
security agreement as well as the order of recordation of the agreement in the
appropriate recording office. Such a lien or title interest is not prior to
the lien for real estate taxes and assessments and other charges imposed under
governmental police powers.
Each cooperative owns in fee or has a leasehold interest in all the real
property and owns in fee or leases the building and all separate dwelling
units therein. The cooperative is directly responsible for property management
and, in most cases, payment of real estate taxes, other governmental
impositions and hazard and liability insurance. If there is a blanket mortgage
or mortgages on the cooperative apartment building or underlying land, as is
generally the case, or an underlying lease of the land, as is the case in some
instances, the cooperative, as property mortgagor, or lessee, as the case may
be, is also responsible for meeting these mortgage or rental obligations. A
blanket mortgage is ordinarily incurred by the cooperative in connection with
either the construction or purchase of the cooperative's apartment building or
obtaining of capital by the cooperative. The interest of the occupant under
proprietary leases or occupancy agreements as to which that cooperative is the
landlord are generally subordinate to the interest of the holder of a blanket
mortgage and to the interest of the holder of a land lease. If the cooperative
is unable to meet the payment obligations (i) arising under a blanket
mortgage, the mortgagee holding a blanket mortgage could foreclose on that
mortgage and terminate all subordinate proprietary leases and occupancy
agreements or (ii) arising under its land lease, the holder of the landlord's
interest under the land lease could terminate it and all subordinate
proprietary leases and occupancy agreements. Also, a 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 final
payment at maturity. The inability of the cooperative to refinance a mortgage
and its consequent inability to make such final payment could lead to
foreclosure by the mortgagee. Similarly, a land lease has an expiration date
and the inability of the cooperative to extend its term or, in the
alternative, to purchase the land could lead to termination of the
cooperatives's interest in the property and termination of all proprietary
leases and occupancy agreement. In either event, a foreclosure by the holder
of a blanket mortgage or the termination of the underlying lease could
eliminate or significantly diminish the value of any collateral held by the
lender that financed the purchase by an individual tenant stockholder of
cooperative shares or, in the case of the Mortgage Loans, the collateral
securing the Cooperative Loans.
The cooperative is owned by tenant-stockholders who, through ownership of
stock or shares in the corporation, receive proprietary lease 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 occupancy rights are financed
through a cooperative share loan evidenced by a promissory note and secured by
an assignment of and a security interest in the occupancy agreement or
proprietary lease and a security interest in the related cooperative shares.
The lender generally takes possession
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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 is 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. See "Foreclosure--Cooperative
Loans" below.
TAX ASPECTS OF COOPERATIVE OWNERSHIP
In general, a "tenant-stockholder" (as defined in Section 216(b)(2) of the
Code) of a corporation that qualifies as a "cooperative housing corporation"
within the meaning of Section 216(b)(1) of the Code 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 Section 216(a) of the Code to
the corporation under Sections 163 and 164 of the Code. In order for a
corporation to qualify under Section 216(b)(1) of the Code 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. By virtue of this
requirement, the status of a corporation for purposes of Section 216(b)(1) of
the Code 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
Section 216(a) of the Code with respect to those years. In view of the
significance of the tax benefits accorded tenant-stockholders of a corporation
that qualifies under Section 216(b)(1) of the Code, the likelihood that such a
failure would be permitted to continue over a period of years appears remote.
FORECLOSURE
General
Foreclosure is a legal procedure that allows the mortgagee to recover its
mortgage debt by enforcing its rights and available legal remedies under the
mortgage. If the mortgagor defaults in payment or performance of its
obligations under the note or mortgage, the mortgagee has the right to
institute foreclosure proceedings to sell the mortgaged property at public
auction to satisfy the indebtedness.
Foreclosure procedures with respect to the enforcement of a mortgage vary
from state to state. Two primary methods of foreclosing a mortgage are
judicial foreclosure and non-judicial foreclosure pursuant to a power of sale
granted in the mortgage instrument. There are several other foreclosure
procedures available in some states that are either infrequently used or
available only in certain limited circumstances, such as strict foreclosure.
Judicial Foreclosure
A judicial foreclosure proceeding is conducted in a court having
jurisdiction over the mortgaged property. Generally, the action is initiated
by the service of legal pleadings upon all parties having an interest of
record in the real property. Delays in completion of the foreclosure may
occasionally result from difficulties in locating defendants. When the
lender's right to foreclose is contested, the legal proceedings can be time-
consuming. Upon successful completion of a judicial foreclosure proceeding,
the court generally issues a judgment of foreclosure and appoints a referee or
other officer to conduct a public sale of the mortgaged property, the proceeds
of which are used to satisfy the judgment. Such sales are made in accordance
with procedures that vary from state to state.
Equitable Limitations on Enforceability of Certain Provisions
United States courts have traditionally imposed general equitable principles
to limit the remedies available to a mortgagee in connection with foreclosure.
These equitable principles are generally designed to relieve the
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mortgagor from the legal effect of mortgage defaults, to the extent that such
effect is perceived as harsh or unfair. Relying on such principles, a court
may alter the specific terms of a loan to the extent it considers necessary to
prevent or remedy an injustice, undue oppression or overreaching, or may
require the lender to undertake affirmative and expensive actions to determine
the cause of the mortgagor's default and the likelihood that the mortgagor
will be able to reinstate the loan. In some cases, courts have substituted
their judgment for the lender's and have required that lenders reinstate loans
or recast payment schedules in order to accommodate mortgagors who are
suffering from a temporary financial disability. In other cases, courts have
limited the right of the lender to foreclose if the default under the mortgage
is not monetary, e.g., the mortgagor failed to maintain the mortgaged property
adequately or the mortgagor executed a junior mortgage on the mortgaged
property. The exercise by the court of its equity powers will depend on the
individual circumstances of each case presented to it. Finally, some courts
have been faced with the issue of whether federal or state constitutional
provisions reflecting due process concerns for adequate notice require that a
mortgagor receive notice in addition to statutorily-prescribed minimum notice.
For the most part, these cases have upheld the reasonableness of the notice
provisions or have found that a public sale under a mortgage providing for a
power of sale does not involve sufficient state action to afford
constitutional protections to the mortgagor.
Non-Judicial Foreclosure/Power of Sale
Foreclosure of a deed of trust is generally accomplished by a non-judicial
trustee's sale pursuant to the power of sale granted in the deed of trust. A
power of sale is typically granted in a deed of trust. It may also be
contained in any other type of mortgage instrument. A power of sale allows a
non-judicial public sale to be conducted generally following a request from
the beneficiary/lender to the trustee to sell the property upon any default by
the mortgagor under the terms of the mortgage note or the mortgage instrument
and after notice of sale is given in accordance with the terms of the mortgage
instrument, as well as applicable state law. In some states, prior to such
sale, the trustee under a deed of trust must record a notice of default and
notice of sale and send a copy to the mortgagor and to any other party who has
recorded a request for a copy of a notice of default and notice of sale. In
addition, in some states the trustee must provide notice to any other party
having an interest of record in the real property, including junior
lienholders. A notice of sale must be posted in a public place and, in most
states, published for a specified period of time in one or more newspapers.
The mortgagor or junior lienholder may then have the right, during a
reinstatement period required in some states, to cure the default by paying
the entire actual amount in arrears (without acceleration) plus the expenses
incurred in enforcing the obligation. In other states, the mortgagor or the
junior lienholder is not provided a period to reinstate the loan, but has only
the right to pay off the entire debt to prevent the foreclosure sale.
Generally, the procedure for public sale, the parties entitled to notice, the
method of giving notice and the applicable time periods are governed by state
law and vary among the states. Foreclosure of a deed to secure debt is also
generally accomplished by a non-judicial sale similar to that required by a
deed of trust, except that the lender or its agent, rather than a trustee, is
typically empowered to perform the sale in accordance with the terms of the
deed to secure debt and applicable law.
Public Sale
A third party may be unwilling to purchase a mortgaged property at a public
sale because of the difficulty in determining the value of such property at
the time of sale, due to, among other things, redemption rights which may
exist and the possibility of physical deterioration of the property during the
foreclosure proceedings. For these reasons, it is common for the lender to
purchase the mortgaged property for an amount equal to or less than the
underlying debt and accrued and unpaid interest plus the expenses of
foreclosure, in which case the mortgagor's debt will be extinguished unless
the lender purchases the property for a lesser amount in order to preserve its
right against a borrower to seek a deficiency judgment and such remedy is
available under state law and the related loan documents. In the same states,
there is a statutory minimum purchase price which the lender may offer for the
property and generally, state law controls the amount of foreclosure costs and
expenses which may be recovered by a lender. Thereafter, subject to the
mortgagor's right in some states to remain in possession during a redemption
period, if applicable, the lender will become the owner of the property and
have both the
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benefits and burdens of ownership of the mortgaged property. For example, the
lender will become obligated to pay taxes, obtain casualty insurance and to
make 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 and
in some states, the lender may be entitled to a deficiency judgment. Moreover,
a lender commonly incurs substantial legal fees and court costs in acquiring a
mortgaged property through contested foreclosure and/or bankruptcy
proceedings. Generally, state law controls the amount of foreclosure expenses
and costs, including attorneys' fees, that may be recovered by a lender.
A junior mortgagee may not foreclose on the property securing the junior
mortgage unless it forecloses subject to senior mortgages and any other prior
liens, in which case it may be obliged to make payments on the senior
mortgages to avoid their foreclosure. In addition, in the event that the
foreclosure of a junior mortgage triggers the enforcement of a "due-on-sale"
clause contained in a senior mortgage, the junior mortgagee may be required to
pay the full amount of the senior mortgage to avoid its foreclosure.
Accordingly, with respect to those Mortgage Loans, if any, that are junior
mortgage loans, if the lender purchases the property the lender's title will
be subject to all senior mortgages, prior liens 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 under which the sale was conducted. Any
proceeds remaining after satisfaction of senior mortgage debt are generally
payable to the holders of junior mortgages and other liens and claims in order
of their priority, whether or not the mortgagor is in default. Any additional
proceeds are generally payable to the mortgagor. The payment of the proceeds
to the holders of junior mortgages may occur in the foreclosure action of the
senior mortgage or a subsequent ancillary proceeding or may require the
institution of separate legal proceedings by such holders.
Rights of Redemption
The purposes of a foreclosure action are to enable the mortgagee to realize
upon its security and to bar the mortgagor, and all persons who have an
interest in the property which is subordinate to the mortgage being
foreclosed, from exercise of their "equity of redemption." The doctrine of
equity of redemption provides that, until the property covered by a mortgage
has been sold in accordance with a properly conducted foreclosure and
foreclosure sale, those having an interest which is subordinate to that of the
foreclosing mortgagee have an equity of redemption and may redeem the property
by paying the entire debt with interest. In addition, in some states, when a
foreclosure action has been commenced, the redeeming party must pay certain
costs of such action. Those having an equity of redemption must generally be
made parties and joined in the foreclosure proceeding in order for their
equity of redemption to be cut off and terminated.
The equity of redemption is a common-law (non-statutory) right which exists
prior to completion of the foreclosure, is not waivable by the mortgagor, must
be exercised prior to foreclosure sale and should be distinguished from the
post-sale statutory rights of redemption. In some states, after sale pursuant
to a deed of trust or foreclosure of a mortgage, the mortgagor and foreclosed
junior lienors are given a statutory period in which to redeem the property
from the foreclosure sale. In some states, statutory redemption may occur only
upon payment of the foreclosure sale price. In other states, redemption may be
authorized if the former mortgagor pays only a portion of the sums due. The
effect of a statutory right of redemption is to diminish the ability of the
lender to sell the foreclosed property. The exercise of a right of redemption
would defeat the title of any purchaser from a foreclosure sale or sale under
a deed of trust. Consequently, the practical effect of the redemption right is
to force the lender to maintain the property and pay the expenses of ownership
until the redemption period has expired. In some states, a post-sale statutory
right of redemption may exist following a judicial foreclosure, but not
following a trustee's sale under a deed of trust.
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 By-laws, as
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well as the proprietary lease or occupancy agreement, and may be canceled 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 permit 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 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.
Because of the nature of Cooperative Loans, lenders do not require the
tenant-stockholder (i.e., the borrower) to obtain title insurance of any type.
Consequently, the existence of any prior liens or other imperfections of title
affecting the cooperative's building or real estate also may adversely affect
the marketability of the shares allocated to the dwelling unit in the event of
foreclosure.
In some states, foreclosure on the Cooperative shares is accomplished by a
sale in accordance with the provisions of Article 9 of the UCC and the
security agreement relating to 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 Cooperatives 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.
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 a building so converted.
JUNIOR MORTGAGES
Some of the Mortgage Loans may be secured by junior mortgages or deeds of
trust, which are subordinate to first or other senior mortgages or deeds of
trust held by other lenders. The rights of the Issuer as the holder of
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a junior deed of trust or a junior mortgage are subordinate in lien and in
payment 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" herein.
Furthermore, because the terms of the junior mortgage or deed of trust are
subordinate to the terms of the first mortgage or deed of trust, in the event
of a conflict between the terms of the first mortgage or deed of trust and the
junior mortgage or deed of trust, the terms of the first mortgage or deed of
trust will generally govern. 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 right 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 first mortgagee expends such sums,
such sums will generally have priority over all sums due under the junior
mortgage.
ANTI-DEFICIENCY LEGISLATION AND OTHER LIMITATIONS ON LENDERS
Statutes in some states limit the right of a beneficiary under a deed of
trust or a mortgagee under a mortgage to obtain a deficiency judgment against
the mortgagor following foreclosure or sale under a deed of trust. A
deficiency judgment would be a personal judgment against the former mortgagor
equal to the difference between the net amount realized upon the public sale
of the real property and the amount due to the lender. Some states require the
lender to exhaust the security afforded under a mortgage by foreclosure in an
attempt to satisfy the full debt before bringing a personal action against the
mortgagor. In certain other states, the lender has the option of bringing a
personal action against the mortgagor 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. In
some cases, a lender will be precluded from exercising any additional rights
under the note or mortgage if it has taken any prior enforcement action.
Consequently, the practical effect of the election requirement, in those
states permitting such election, is that lenders will usually proceed against
the security first rather than bringing a personal action against the
mortgagor. Finally, other statutory provisions limit any deficiency judgment
against the former mortgagor following a judicial 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 lender
from obtaining a large deficiency judgment against the former mortgagor as a
result of low or no bids at the judicial sale.
In addition to laws limiting or prohibiting deficiency judgments, numerous
other federal and state statutory provisions, including the federal bankruptcy
laws and state laws affording relief to debtors, may interfere with or affect
the ability of the secured mortgage lender to realize upon collateral or
enforce a deficiency judgment. For example, under the federal Bankruptcy Code,
as amended from time to time (Title 11 of the United States Code) (the
"Bankruptcy Code"), virtually all actions (including foreclosure actions and
deficiency judgment proceedings) to collect a debt are automatically stayed
upon the filing of the bankruptcy petition and, often, no interest or
principal payments are made during the course of the bankruptcy case. The
delay and the consequences thereof caused by such automatic stay can be
significant. Also, under the Bankruptcy Code, the filing of a petition in a
bankruptcy by or on behalf of a union lender may stay the senior lender from
taking action to foreclose out of such junior lien. Moreover, with respect to
federal bankruptcy law, a court with federal bankruptcy jurisdiction may
permit a debtor through his or her Chapter 11 or Chapter 13 rehabilitative
plan to cure a monetary default in respect of a mortgage loan on a debtor's
residence by paying arrearages within a reasonable time period and reinstating
the original mortgage loan payment schedule even though the lender accelerated
the mortgage loan and final judgment of foreclosure had been entered in state
court (provided no sale of the residence had yet occurred) prior to the filing
of the debtor's petition. Some courts with federal
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bankruptcy jurisdiction have approved plans, based on the particular facts of
the reorganization case, that effected the curing of a mortgage loan default
by paying arrearages over a number of years.
Courts with federal bankruptcy jurisdiction have also indicated that the
terms of a mortgage loan secured by property of the debtor may be modified.
These courts have allowed modifications that include reducing the amount of
each monthly payment, changing the rate of interest, altering the repayment
schedule, forgiving all or a portion of the debt and reducing the lender's
security interest to the value of the residence, thus leaving the lender a
general unsecured creditor for the difference between the value of the
residence and the outstanding balance of the loan. Generally, however, the
terms of a mortgage loan secured only by a mortgage on real property that is
the debtor's principal residence may not be modified pursuant to a plan
confirmed pursuant to Chapter 11 or Chapter 13 except with respect to mortgage
payment arrearages, which may be cured within a reasonable time period.
In the case of income-producing Multifamily Properties, federal bankruptcy
law may also have the effect of interfering with or affecting the ability of
the secured lender to enforce the borrower's assignment of rents and leases
related to the mortgaged property. Under Section 362 of the Bankruptcy Code,
the lender will be stayed from enforcing the assignment, and the legal
proceedings necessary to resolve the issue could be time-consuming, with
resulting delays in the lender's receipt of the rents.
Certain tax liens arising under the Internal Revenue Code of 1986, as
amended, may in certain circumstances provide priority over the lien of a
mortgage or deed of trust. In addition, substantive requirements are imposed
upon mortgage lenders in connection with the origination and the servicing of
mortgage loans by numerous federal and some state consumer protection laws.
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. These federal laws impose specific
statutory liabilities upon lenders who originate mortgage loans and who fail
to comply with the provisions of the law. In some cases this liability may
affect assignees of the mortgage 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 LEGISLATION
Under the federal Comprehensive Environmental Response, Compensation and
Liability Act, as amended ("CERCLA"), and under state law in certain states, a
secured party which takes a deed in lieu of foreclosure, purchases a mortgaged
property at a foreclosure sale, or operates a mortgaged property may become
liable in certain circumstances for the costs of cleaning up hazardous
substances regardless of whether they have contaminated the property. CERCLA
imposes strict, as well as joint and several, liability on several classes of
potentially hazardous substances regardless of whether they have contaminated
the property, CERCLA imposes strict, as well as joint and several, liability
on several classes of potentially responsible parties, including current
owners and operators of the property who did not cause or contribute to the
contamination. Furthermore, liability under CERCLA is not limited to the
original or unamortized principal balance of a loan or to the value of the
property securing a loan. Lenders may be held liable under CERCLA as owners or
operators unless they qualify for the secured creditor exemption to CERCLA.
This exemption exempts from the definition of owners and operators those who,
without participating in the management of a facility, hold indicia of
ownership primarily to protect a security interest in the facility.
The Asset Conservation, Lender Liability and Deposit Insurance Act of 1996
(the "Conservation Act") amended, among other things, the provisions of CERCLA
with respect to lender liability and the secured creditor exemption. The
Conservation Act offers substantial protection to lenders by defining the
activities in which a
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lender can engage and still have the benefit of the secured creditor
exemption. In order for lender to be deemed to have participated in the
management of a mortgaged property, the lender must actually participate in
the operational affairs of the property of the borrower. The Conservation Act
provides that "merely having the capacity to influence, or unexercised right
to control" operations does not constitute participation in management. A
lender will lose the protection of the secured creditor exemption only if it
exercises decision-making control over the borrower's environmental compliance
and hazardous substance handling and disposal practices, or assumes day-to-day
management of all operational functions of the mortgaged property. The
Conservation Act also provides that a lender will continue to have the benefit
of the secured creditor exemption even if it forecloses on a mortgaged
property, purchases it at a foreclosure sale or accepts a deed-in-lieu of
foreclosure provided that the lender seeks to sell the mortgaged property at
the earliest practicable commercially reasonable time on commercially
reasonable terms.
Other federal and state laws in certain circumstances may impose liability
on a secured party which takes a deed-in-lieu of foreclosure, purchases a
mortgaged property at a foreclosure sale, or operates a mortgaged property on
which contaminants other than CERCLA hazardous substances are present,
including petroleum, agricultural chemicals, hazardous wastes, asbestos,
radon, and lead-based paint. Such cleanup costs may be substantial. It is
possible that such cleanup costs could become a liability of the Indenture
Trustee and reduce the amounts otherwise distributable to the holders of the
related series of Bonds. Moreover, certain federal statutes and certain states
by statute impose a lien for any cleanup costs incurred by such state on the
property that is the subject of such cleanup costs (an "Environmental Lien").
All subsequent liens on such property generally are subordinated to such an
Environmental Lien and, in some states, even prior recorded liens are
subordinated to Environmental Liens. In the latter states, the security
interest of the Indenture Trustee in a related parcel of real property that is
subject to such an Environmental Lien could be adversely affected.
Traditionally, many residential mortgage lenders have not taken steps to
evaluate whether contaminants are present with respect to any mortgaged
property prior to the origination of the mortgage loan or prior to foreclosure
or accepting a deed-in-lieu of foreclosure. Accordingly, the Company has not
made and will not make such evaluations prior to the origination of the Bonds.
Neither the Company nor any replacement Servicer will be required by any
Agreement to undertake any such evaluations prior to foreclosure or accepting
a deed-in-lieu of foreclosure. The Company does not make any representations
or warranties or assume any liability with respect to the absence or effect of
contaminants on any related real property or any casualty resulting from the
presence or effect of contaminants. However, the Company will not be obligated
to foreclose on related real property or accept a deed-in-lieu of foreclosure
if it knows or reasonably believes that there are material contaminated
conditions on such property. A failure so to foreclose may reduce the amounts
otherwise available to holders of the related series of Bonds.
DUE-ON-SALE CLAUSES
The Mortgage Loans will generally contain due-on-sale clauses. These clauses
generally provide that the lender may accelerate the maturity of the loan if
the mortgagor sells, transfers or conveys the related Mortgaged Property. The
enforceability of due-on-sale clauses has been the subject of legislation or
litigation in many states and, in some cases, the enforceability of these
clauses was limited or denied. However, with respect to certain loans the
Garn-St Germain Depository Institutions Act of 1982 (the "Garn-St. Germain
Act") preempts state constitutional, statutory and case law that prohibits the
enforcement of due-on-sale clauses and permits lenders to enforce these
clauses in accordance with their terms, subject to certain limited exceptions.
Due-on-sale clauses contained in mortgage loans originated by federal savings
and loan associations or federal savings banks are fully enforceable pursuant
to regulations of the United States Federal Home Loan Bank Board, as succeeded
by the Office of Thrift Supervision, which preempt state law restrictions on
the enforcement of such clauses. Similarly, "due-on-sale" clauses in mortgage
loans made by national banks and federal credit unions are now fully
enforceable pursuant to preemptive regulations of the Comptroller of the
Currency and the National Credit Union Administration, respectively.
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The Garn-St Germain Act also sets forth nine specific instances in which a
mortgage lender covered by the act (including federal savings and loan
associations and federal savings banks) may not exercise a "due-on-sale"
clause, notwithstanding the fact that a transfer of the property may have
occurred. These include intra-family transfers, certain transfers by operation
of law, leases of fewer than three years and the creation of a junior
encumbrance. Regulations promulgated under the Garn-St Germain Act also
prohibit the imposition of a prepayment penalty upon the acceleration of a
loan pursuant to a due-on-sale clause. The inability to enforce a "due-on-
sale" clause may result in a mortgage that bears an interest rate below the
current market rate being assumed by a new home buyer rather than being paid
off, which may affect the average life of the Mortgage Loans and the number of
Mortgage Loans which may extend to maturity.
PREPAYMENT CHARGES
Under certain state laws, prepayment charges may not be imposed after a
certain period of time following the origination of mortgage loans secured by
liens encumbering owner-occupied residential properties, if such loans are
paid prior to maturity. With respect to Mortgaged Properties that are owner-
occupied, it is anticipated that prepayment charges may not be imposed with
respect to many of the Mortgage Loans. The absence of such a restraint on
prepayment, particularly with respect to fixed rate Mortgage Loans having
higher Mortgage Rates, may increase the likelihood of refinancing or other
early retirement of such loans.
SUBORDINATE FINANCING
Where a 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 any 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 proceedings by the senior lender.
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. A similar federal
statute was in effect with respect to mortgage loans made during the first
three months of 1980. The Office of Thrift Supervision is authorized to issue
rules and regulations and to publish interpretations governing implementation
of Title V. The statute authorized any state to reimpose interest rate limits
by adopting, before April 1, 1983, a law or constitutional provision that
expressly rejects 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.
The Company believes that a court interpreting Title V would hold that
residential first mortgage loans that are originated on or after January 1,
1980 are subject to federal preemption. Therefore, in a state that has not
taken the requisite action to reject application of Title V or to adopt a
provision limiting discount points or other charges prior to origination of
such mortgage loans, any such limitation under such state's usury law would
not apply to such mortgage loans.
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In any state in which application of Title V has been expressly rejected or
a provision limiting discount points or other charges is adopted, no mortgage
loan originated after the date of such state action will be eligible for
inclusion in the Assets unless (i) such mortgage loan provides for such
interest rate, discount points and charges as are permitted in such state or
(ii) such mortgage loan provides that the terms thereof shall be construed in
accordance with the laws of another state under which such interest rate,
discount points and charges would not be usurious and the mortgagor's counsel
has rendered an opinion that such choice of law provision would be given
effect.
Statutes differ in their provisions as to the consequences of a usurious
loan. One group of statutes requires the lender to forfeit the interest due
above the applicable limit or impose a specified penalty. Under this statutory
scheme, the mortgagor may cancel the recorded mortgage or deed of trust upon
paying its debt with lawful interest, and the lender may foreclose, but only
for the debt plus lawful interest. A second group of statutes is more severe.
A violation of this type of usury law results in the invalidation of the
transaction, thereby permitting the mortgagor to cancel the recorded mortgage
or deed of trust without any payment or prohibiting the lender from
foreclosing.
ALTERNATIVE MORTGAGE INSTRUMENTS
Alternative mortgage instruments, including adjustable rate mortgage loans
and early ownership mortgage loans, originated by non-federally chartered
lenders have historically been subject to a variety of restrictions. Such
restrictions differed from state to state, resulting in difficulties in
determining whether a particular alternative mortgage instrument originated by
a state-chartered lender was in compliance with applicable law. These
difficulties were alleviated substantially as a result of the enactment of
Title VIII of the Garn-St Germain Act ("Title VIII"). Title VIII provides
that, notwithstanding any state law to the contrary, state-chartered banks may
originate alternative mortgage instruments in accordance with regulations
promulgated by the Comptroller of the Currency with respect to origination of
alternative mortgage instruments by national banks; state-chartered credit
unions may originate alternative mortgage instruments in accordance with
regulations promulgated by the National Credit Union Administration with
respect to origination of alternative mortgage instruments by federal credit
unions; and all other non-federally chartered housing creditors, including
state-chartered savings and loan associations, state-chartered savings banks
and mutual savings banks and mortgage banking companies, may originate
alternative mortgage instruments in accordance with the regulations
promulgated by the Federal Home Loan Bank Board, predecessor to the Office of
Thrift Supervision, with respect to origination of alternative mortgage
instruments by federal savings and loan associations. Title VIII provides that
any state may reject applicability of the provisions of Title VIII by
adopting, prior to October 15, 1985, a law or constitutional provision
expressly rejecting the applicability of such provisions. Certain states have
taken such action.
SOLDIERS' AND SAILORS' CIVIL RELIEF ACT OF 1940
Under the terms of the Soldiers' and Sailors' Civil Relief Act of 1940, as
amended (the "Relief Act"), a mortgagor who enters military service after the
origination of such mortgagor's Mortgage Loan (including a mortgagor who was
in reserve status and is called to active duty after origination of the
Mortgage Loan), may not be charged interest (including fees and charges) above
an annual rate of 6% during the period of such mortgagor's active duty status,
unless a court orders otherwise upon application of the lender. The Relief Act
applies to mortgagors who are members of the Army, Navy, Air Force, Marines,
National Guard, Reserves, Coast Guard and officers of the U.S. Public Health
Service assigned to duty with the military. Because the Relief Act applies to
mortgagors who enter military service (including reservists who are called to
active duty) after origination of the related Mortgage Loan, no information
can be provided as to the number of loans that may be affected by the Relief
Act. Application of the Relief Act would adversely affect, for an
indeterminate period of time, the ability of any servicer to collect full
amounts of interest on certain of the Mortgage Loans. Any shortfalls in
interest collections resulting from the application of the Relief Act would
result in a reduction of the amounts distributable to the holders of the
related series of Bonds, and would not be covered by advances or, unless
otherwise specified in the related Prospectus Supplement, any form of Credit
Support provided in connection with such Bonds. In addition, the Relief Act
imposes limitations that would impair the ability of the
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servicer to foreclose on an affected Mortgage Loan during the mortgagor's
period of active duty status, and, under certain circumstances, during an
additional three month period thereafter. Thus, in the event that the Relief
Act or similar legislation or regulations applies to any Mortgage Loan which
goes into default, there may be delays in payment and losses on the related
bonds in connection therewith. Any other interest shortfalls, deferrals or
forgiveness of payments on the Mortgage Loans resulting from similar
legislation or regulations may result in delays in payments or losses to
holders of the related series of Bonds.
FORFEITURES IN DRUG AND RICO PROCEEDINGS
Federal law provides that property owned by persons convicted of drug-
related crimes or of criminal violations of the Racketeer Influenced and
Corrupt Organizations ("RICO") statute can be seized by the government if the
property was used in, or purchased with the proceeds of, such crimes. Under
procedures contained in the Comprehensive Crime Control Act of 1984 (the
"Crime Control Act"), the government may seize the property even before
conviction. The government must publish notice of the forfeiture proceeding
and may give notice to all parties "known to have an alleged interest in the
property," including the holders of mortgage loans.
A lender may avoid forfeiture of its interest in the property if it
establishes that: (i) its mortgage was executed and recorded before commission
of the crime upon which the forfeiture is based, or (ii) the lender was, at
the time of execution of the mortgage, "reasonably without cause to believe"
that the property was used in, or purchased with the proceeds of, illegal drug
or RICO activities.
CERTAIN LEGAL ASPECTS OF THE CONTRACTS
The following discussion contains summaries, which are general in nature, of
all material legal matters relating to the Contracts. Because such legal
aspects are governed primarily by applicable state law (which laws may differ
substantially), 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
the security for the Contracts is situated. The summaries are qualified in
their entirety by reference to the appropriate laws of the states in which
Contracts may be originated.
GENERAL
As a result of the assignment of the Contracts to the Indenture Trustee, the
Indenture Trustee will succeed collectively to all of the rights (including
the right to receive payment on the Contracts) of the obligee under the
Contracts. Each Contract evidences both (a) the obligation of the obligor to
repay the loan evidenced thereby, and (b) the grant of a security interest in
the Manufactured Home to secure repayment of such loan. Certain aspects of
both features of the Contracts are described more fully below.
The Contracts generally are "chattel paper" as defined in the Uniform
Commercial Code (the "UCC") in effect in the states in which the Manufactured
Homes initially were registered. Pursuant to the UCC, the sale of chattel
paper is treated in a manner similar to perfection of a security interest in
chattel paper. Under the Agreement, the Master Servicer will transfer physical
possession of the Contracts to the Indenture Trustee or its custodian or may
retain possession of the Contracts as custodian for the Indenture Trustee. In
addition, the Master Servicer will make an appropriate filing of a UCC-1
financing statement in the appropriate states to give notice of the Indenture
Trustee's ownership of the Contracts. The Contracts generally will not be
stamped or marked otherwise to reflect their assignment from the Company to
the Indenture Trustee. Therefore, if, through negligence, fraud or otherwise,
a subsequent purchaser were able to take physical possession of the Contracts
without notice of such assignment, the Indenture Trustee's interest in
Contracts could be defeated.
BOND INTERESTS IN THE MANUFACTURED HOMES
Except as set forth below, under the laws of most states, manufactured
housing constitutes personal property and is subject to the motor vehicle
registration laws of the state or other jurisdiction in which the unit is
located.
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In a few states, where certificates of title are not required for manufactured
homes, security interests are perfected by the filing of a financing statement
under Article 9 of the UCC which has been adopted by all states. Such
financing statements are effective for five years and must be renewed prior to
the end of each five year period. The certificate of title laws adopted by the
majority of states provide that ownership of motor vehicles and manufactured
housing shall be evidenced by a certificate of title issued by the motor
vehicles department (or a similar entity) of such state. In the states that
have enacted certificate of title laws, a security interest in a unit of
manufactured housing, so long as it is not attached to land in so permanent a
fashion as to become a fixture, is generally perfected by the recording of
such interest on the certificate of title to the unit in the appropriate motor
vehicle registration office or by delivery of the required documents and
payment of a fee to such office, depending on state law.
The Manufactured Homes securing the Contracts may be located in all 50
states. Bond interests in manufactured homes may be perfected either by
notation of the secured party's lien on the certificate of title or by
delivery of the required documents and payment of a fee to the state motor
vehicle authority, depending on state law. In some nontitle states, perfection
pursuant to the provisions of the UCC is required. The Asset Seller may effect
such notation or delivery of the required documents and fees, and obtain
possession of the certificate of title, as appropriate under the laws of the
state in which any manufactured home securing a manufactured housing
conditional sales contract is registered. In the event the Asset Seller fails,
due to clerical error, to effect such notation or delivery, or files the
security interest under the wrong law (for example, under a motor vehicle
title statute rather than under the UCC, in a few states), the Asset Seller
may not have a first priority security interest in the Manufactured Home
securing a Contract. As manufactured homes have become larger and often have
been attached to their sites without any apparent intention to move them,
courts in many states have held that manufactured homes, under certain
circumstances, may become subject to real estate title and recording laws. As
a result, a security interest in a manufactured home could be rendered
subordinate to the interests of other parties claiming an interest in the home
under applicable state real estate law. In order to perfect a security
interest in a manufactured home under real estate laws, the holder of the
security interest must file either a "fixture filing" under the provisions of
the UCC or a real estate mortgage under the real estate laws of the state
where the home is located. These filings must be made in the real estate
records office of the county where the home is located. Substantially all of
the Contracts contain provisions prohibiting the borrower from permanently
attaching the Manufactured Home to its site. So long as the borrower does not
violate this agreement, a security interest in the Manufactured Home will be
governed by the certificate of title laws or the UCC, and the notation of the
security interest on the certificate of title or the filing of a UCC financing
statement will be effective to maintain the priority of the security interest
in the Manufactured Home. If, however, a Manufactured Home is permanently
attached to its site, other parties could obtain an interest in the
Manufactured Home which is prior to the security interest originally retained
by the Asset Seller and transferred to the Company. With respect to a series
of Bonds and if so described in the related Prospectus Supplement, the Master
Servicer may be required to perfect a security interest in the Manufactured
Home under applicable real estate laws. The Warranting Party will represent
that as of the date of the sale to the Company it has obtained a perfected
first priority security interest by proper notation or delivery of the
required documents and fees with respect to substantially all of the
Manufactured Homes securing the Contracts.
The Company will cause the security interests in the Manufactured Homes to
be assigned to the Indenture Trustee on behalf of the Bondholders. However,
the Company and the Indenture Trustee generally will not amend the
certificates of title (or file UCC-3 statements) to identify the Indenture
Trustee as the new secured party, and the Company and the Master Servicer
generally will not deliver the certificates of title to the Indenture Trustee
or note thereon the interest of the Indenture Trustee. Accordingly, the Asset
Seller (or other originator of the Contracts) will continue to be named as the
secured party on the certificates of title relating to the Manufactured Homes.
In some states, such assignment is an effective conveyance of such security
interest without amendment of any lien noted on the related certificate of
title and the new secured party succeeds to Master Servicer's rights as the
secured party. However, in some states, in the absence of an amendment to the
certificate of title (or the filing of a UCC-3 statement), such assignment of
the security interest in the Manufactured Home may not be held effective or
such security interests may not be perfected and in the absence
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of such notation or delivery to the Indenture Trustee, the assignment of the
security interest in the Manufactured Home may not be effective against
creditors of the Asset Seller (or such other originator of the Contracts) or a
trustee in bankruptcy of the Asset Seller (or such other originator).
In the absence of fraud, forgery or permanent affixation of the Manufactured
Home to its site by the Manufactured Home owner, or administrative error by
state recording officials, the notation of the lien of the Asset Seller (or
other originator of the Contracts) on the certificate of title or delivery of
the required documents and fees will be sufficient to protect the Bondholders
against the rights of subsequent purchasers of a Manufactured Home or
subsequent lenders who take a security interest in the Manufactured Home. If
there are any Manufactured Homes as to which the security interest assigned to
the Indenture Trustee is not perfected, such security interest would be
subordinate to, among others, subsequent purchasers for value of Manufactured
Homes and holders of perfected security interests. There also exists a risk in
not identifying the Indenture Trustee as the new secured party on the
certificate of title that, through fraud or negligence, the security interest
of the Indenture Trustee could be released.
In the event that the owner of a Manufactured Home moves it to a state other
than the state in which such Manufactured Home initially is registered, under
the laws of most states the perfected security interest in the Manufactured
Home would continue for four months after such relocation and thereafter only
if and after the owner re-registers the Manufactured Home in such state. If
the owner were to relocate a Manufactured Home to another state and not re-
register the Manufactured Home in such state, and if steps are not taken to
re-perfect the Indenture Trustee's security interest in such state, the
security interest in the Manufactured Home would cease to be perfected. A
majority of states generally require surrender of a certificate of title to
re-register a Manufactured Home; accordingly, the Master Servicer must
surrender possession if it holds the certificate of title to such Manufactured
Home or, in the case of Manufactured Homes registered in states which provide
for notation of lien, the Asset Seller (or other originator) would receive
notice of surrender if the security interest in the Manufactured Home is noted
on the certificate of title. Accordingly, the Indenture Trustee would have the
opportunity to re-perfect its security interest in the Manufactured Home in
the state of relocation. In states which do not require a certificate of title
for registration of a manufactured home, re-registration could defeat
perfection. In the ordinary course of servicing the manufactured housing
contracts, the Master Servicer takes steps to effect such re-perfection upon
receipt of notice of re-registration or information from the obligor as to
relocation. Similarly, when an obligor under a manufactured housing contract
sells a manufactured home, the Master Servicer must surrender possession of
the certificate of title or, if it is noted as lienholder on the certificate
of title, will receive notice as a result of its lien noted thereon and
accordingly will have an opportunity to require satisfaction of the related
manufactured housing conditional sales contract before release of the lien.
Under the Agreement, the Master Servicer is obligated to take such steps, at
the Master Servicer's expense, as are necessary to maintain perfection of
security interests in the Manufactured Homes.
Under the laws of most states, liens for repairs performed on a Manufactured
Home and liens for personal property taxes take priority even over a perfected
security interest. The Warranting Party will represent in the Agreement that
it has no knowledge of any such liens with respect to any Manufactured Home
securing payment on any Contract. However, such liens could arise at any time
during the term of a Contract. No notice will be given to the Indenture
Trustee or Bondholders in the event such a lien arises.
ENFORCEMENT OF SECURITY INTERESTS IN MANUFACTURED HOMES
General. Repossession of manufactured housing is governed by state law. A
few states have enacted legislation that requires that the debtor be given an
opportunity to cure its default (typically 30 days to bring the account
current) before repossession can commence. So long as a manufactured home has
not become so attached to real estate that it would be treated as a part of
the real estate under the law of the state where it is located, repossession
of such home in the event of a default by the obligor will generally be
governed by the UCC (except in Louisiana), Article 9 of the UCC provides the
statutory framework for the repossession of
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manufactured housing. While the UCC as adopted by the various states may vary
in certain small particulars, the general repossession procedure established
by the UCC is as follows:
(i) Except in those states where the debtor must receive notice of the
right to cure a default, repossession can commence immediately upon default
without prior notice. Repossession may be effected either through self-help
(peaceable retaking without court order), voluntary repossession or through
judicial process (repossession pursuant to court-issued writ of replevin).
The self-help and/or voluntary repossession methods are more commonly
employed, and are accomplished simply by retaking possession of the
manufactured home. In cases in which the debtor objects or raises a defense
to repossession, a court order must be obtained from the appropriate state
court, and the manufactured home must then be repossessed in accordance
with that order. Whether the method employed is self-help, voluntary
repossession or judicial repossession, the repossession can be accomplished
either by an actual physical removal of the manufactured home to a secure
location for refurbishment and resale or by removing the occupants and
their belongings from the manufactured home and maintaining possession of
the manufactured home on the location where the occupants were residing.
Various factors may affect whether the manufactured home is physically
removed or left on location, such as the nature and term of the lease of
the site on which it is located and the condition of the unit. In many
cases, leaving the manufactured home on location is preferable, in the
event that the home is already set up, because the expenses of retaking and
redelivery will be saved. However, in those cases where the home is left on
location, expenses for site rentals will usually be incurred.
(ii) Once repossession has been achieved, preparation for the subsequent
disposition of the manufactured home can commence. The disposition may be
by public or private sale provided the method, manner, time, place and
terms of the sale are commercially reasonable.
(iii) Sale proceeds are to be applied first to repossession expenses
(expenses incurred in retaking, storage, preparing for sale to include
refurbishing costs and selling) and then to satisfaction of the
indebtedness. While some states impose prohibitions or limitations on
deficiency judgments if the net proceeds from resale do not cover the full
amount of the indebtedness, the remainder may be sought from the debtor in
the form of a deficiency judgment in those states that do not prohibit or
limit such judgments. The deficiency judgment is a personal judgment
against the debtor for the shortfall. Occasionally, after resale of a
manufactured home and payment of all expenses and indebtedness, there is a
surplus of funds. In that case, the UCC requires the party suing for the
deficiency judgment to remit the surplus to the debtor. Because the
defaulting owner of a manufactured home generally has very little capital
or income available following repossession, a deficiency judgment may not
be sought in many cases or, if obtained, will be settled at a significant
discount in light of the defaulting owner's strained financial condition.
Louisiana Law. Any contract secured by a manufactured home located in
Louisiana will be governed by Louisiana law rather than Article 9 of the UCC.
Louisiana laws provide similar mechanisms for perfection and enforcement of
security interests in manufactured housing used as collateral for an
installment sale contract or installment loan agreement.
Under Louisiana law, a manufactured home that has been permanently affixed
to real estate will nevertheless remain subject to the motor vehicle
registration laws unless the obligor and any holder of a security interest in
the property execute and file in the real estate records for the parish in
which the property is located a document converting the unit into real
property. A manufactured home that is converted into real property but is then
removed from its site can be converted back to personal property governed by
the motor vehicle registration laws if the obligor executes and files various
documents in the appropriate real estate records and all mortgagees under real
estate mortgages on the property and the land to which it was affixed file
releases with the motor vehicle commission.
So long as a manufactured home remains subject to the Louisiana motor
vehicle laws, liens are recorded on the certificate of title by the motor
vehicle commissioner and repossession can be accomplished by voluntary consent
of the obligor, executory process (repossession proceedings which must be
initiated through the courts
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but which involve minimal court supervision) or a civil suit for possession.
In connection with a voluntary surrender, the obligor must be given a full
release from liability for all amounts due under the contract. In executing
process repossessions, a sheriff's sale (without court supervision) is
permitted, unless the obligor brings suit to enjoin the sale, and the lender
is prohibited from seeking a deficiency judgment against the obligor unless
the lender obtained an appraisal of the manufactured home prior to the sale
and the property was sold for at least two-thirds of its appraised value.
Under the terms of the federal Soldiers' and Sailors' Civil Relief Act of
1940, as amended (the "Relief Act"), an obligor who enters military service
after the origination of such obligor's Contract (including an obligor who is
a member of the National Guard or is in reserve status at the time of the
origination of the Contract and is later called to active duty) may not be
charged interest above an annual rate of 6% during the period of such
obligor's active duty status, unless a court orders otherwise upon application
of the lender. It is possible that such action could have an effect, for an
indeterminate period of time, on the ability of the Master Servicer to collect
full amounts of interest on certain of the Contracts. Any shortfall in
interest collections resulting from the application of the Relief Act, to the
extent not covered by the subordination of a class of Subordinated Bonds,
could result in losses to the holders of a series of Bonds. In addition, the
Relief Act imposes limitations which would impair the ability of the Master
Servicer to foreclose on an affected Contract during the obligor's period of
active duty status. Thus, in the event that such a Contract goes into default,
there may be delays and losses occasioned by the inability to realize upon the
Manufactured Home in a timely fashion.
CONSUMER PROTECTION LAWS
The so-called "Holder-in-Due-Course" Rule of the Federal Trade Commission
(the "FTC Rule") has the effect of subjecting a seller (and certain related
creditors and their assignees) in a consumer credit transaction and any
assignee of the creditor to all claims and defenses which the debtor in the
transaction could assert against the seller of the goods. Liability under the
FTC Rule is limited to the amounts paid by a debtor on the contract, and the
holder of the contract may also be unable to collect amounts still due
thereunder. Most of the Contracts assigned to the Indenture Trustee will be
subject to the requirements of the FTC Rule. Accordingly, the Indenture
Trustee, as holder of the Contracts, will be subject to any claims or defenses
that the purchaser of the related manufactured home may assert against the
seller of the manufactured home, subject to a maximum liability equal to the
amounts paid by the obligor on the Contract. If an obligor is successful in
asserting any such claim or defense, and if the seller had or should have had
knowledge of such claim or defense, the Master Servicer will have the right to
require the seller to repurchase the Contract because of a breach of its
seller's representation and warranty that no claims or defenses exist that
would affect the obligor's obligation to make the required payments under the
Contract. The seller would then have the right to require the originating
dealer to repurchase the Contract from it and might also have the right to
recover from the dealer any losses suffered by the seller with respect to
which the dealer would have been primarily liable to the obligor. Numerous
other federal and state consumer protection laws impose requirements
applicable to the origination and lending pursuant to the Contracts, including
the Truth in Lending Act, the Federal Trade Commission Act, the Fair Credit
Billing Act, the Fair Credit Reporting Act, the Equal Credit Opportunity Act,
the Fair Debt Collection Practices Act and the Uniform Consumer Credit Code.
In the case of some of these laws, the failure to comply with their provisions
may affect the enforceability of the related Contract.
ANTI-DEFICIENCY LEGISLATION AND OTHER LIMITATIONS ON LENDERS
Contracts. In addition to the laws limiting or prohibiting deficiency
judgments, numerous other statutory provisions, including federal bankruptcy
laws and related state laws, may interfere with or affect the ability of a
lender to realize upon collateral and/or enforce a deficiency judgment. For
example, in a Chapter 13 proceeding under the federal bankruptcy law, a court
may prevent a lender from repossessing a home, and, as part of the
rehabilitation plan, reduce the amount of the secured indebtedness to the
market value of the home at the time of bankruptcy (as determined by the
court), leaving the party providing financing as a general unsecured creditor
for the remainder of the indebtedness. A bankruptcy court may also reduce the
monthly payments due under a contract or change the rate of interest and time
of repayment of the indebtedness.
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TRANSFERS OF MANUFACTURED HOMES; ENFORCEABILITY OF "DUE-ON-SALE" CLAUSES
The Contracts, in general, prohibit the sale or transfer of the related
Manufactured Homes without the consent of the Master Servicer and permit the
acceleration of the maturity of the Contracts by the Master Servicer upon any
such sale or transfer that is not consented to. The Master Servicer expects
that it will generally permit most transfers of Manufactured Homes and not
accelerate the maturity of the related Contracts. In certain cases, the
transfer may be made by a delinquent obligor in order to avoid a repossession
proceeding with respect to a Manufactured Home.
In the case of a transfer of a Manufactured Home after which the Master
Servicer desires to accelerate the maturity of the related Contract, the
Master Servicer's ability to do so will depend on the enforceability under
state law of the "due-on-sale" clause. The Garn-St Germain Depositary
Institutions Act of 1982 preempts, subject to certain exceptions and
conditions, state laws prohibiting enforcement of "due-on-sale" clauses
applicable to the Manufactured Homes. Consequently, in some states the Master
Servicer may be prohibited from enforcing a "due-on-sale" clause in respect of
certain Manufactured Homes.
APPLICABILITY OF USURY LAWS
Title V of the Company Institutions Deregulation and Monetary Control Act of
1980, as amended ("Title V"), provides that, subject to the following
conditions, state usury limitations shall not apply to any loan which is
secured by a first lien on certain kinds of manufactured housing. The
Contracts would be covered if they satisfy certain conditions, among other
things, governing the terms of any prepayments, late charges and deferral fees
and requiring a 30-day notice period prior to instituting any action leading
to repossession of or foreclosure with respect to the related unit.
Title V authorized any state to reimpose limitations on interest rates and
finance charges by adopting before April 1, 1983 a law or constitutional
provision which expressly rejects application of the federal law. Fifteen
states adopted such a law prior to the April 1, 1983 deadline. In addition,
even where Title V was not so rejected, any state is authorized by the law to
adopt a provision limiting discount points or other charges on loans covered
by Title V. In any state in which application of Title V was expressly
rejected or a provision limiting discount points or other charges has been
adopted, no Contract which imposes finance charges or provides for discount
points or charges in excess of permitted levels has been included in the
Assets. The related Asset Seller will represent that all of the Contracts
comply with applicable usury law.
FORMALDEHYDE LITIGATION WITH RESPECT TO CONTRACTS
A number of lawsuits are pending in the United States alleging personal
injury from exposure to the chemical formaldehyde, which is present in many
building materials, including such components of manufactured housing as
plywood flooring and wall paneling. Some of these lawsuits are pending against
manufacturers of manufactured housing, suppliers of component parts, and
related persons in the distribution process. The Company is aware of a limited
number of cases in which plaintiffs have won judgments in these lawsuits.
Under the FTC Rule, which is described above under "Consumer Protection
Laws", the holder of any Contract secured by a Manufactured Home with respect
to which a formaldehyde claim has been successfully asserted may be liable to
the obligor for the amount paid by the obligor on the related Contract and may
be unable to collect amounts still due under the Contract. In the event an
obligor is successful in asserting such a claim, the related Bondholders could
suffer a loss if (i) the related seller fails or cannot be required to
repurchase the affected Contract for a breach of representation and warranty
and (ii) the Master Servicer or the Indenture Trustee were unsuccessful in
asserting any claim of contribution or subrogation on behalf of the
Bondholders against the manufacturer or other persons who were directly liable
to the plaintiff for the damages. Typical products liability insurance
policies held by manufacturers and component suppliers of manufactured homes
may not cover liabilities arising from formaldehyde in manufactured housing,
with the result that recoveries from such manufacturers, suppliers or other
persons may be limited to their corporate assets without the benefit of
insurance.
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FEDERAL INCOME TAX CONSEQUENCES
GENERAL
The following represents the opinion of Stinson, Mag & Fizzell, P.C. as to
the anticipated material federal income tax consequences of the purchase,
ownership, and disposition of the Bonds offered hereunder, and is subject to
the limitations set forth herein and in the related Prospectus Supplement.
This opinion is based on the Internal Revenue Code of 1986, as amended to date
(the "Code"), the regulations promulgated thereunder, the position of the
Internal Revenue Service ("IRS") set forth in its published revenue rulings,
revenue procedures and other announcements and court decisions as in effect on
the date of this Prospectus. These authorities are subject to change or
differing interpretations, which could apply retroactively. Prospective
investors should note that no rulings have been or will be sought from the IRS
with respect to any of the federal income tax consequences discussed below,
and no assurance can be given the IRS will not take contrary positions. This
discussion is directed to Bondholders that hold the Bonds as capital assets
within the meaning of Section 1221 of the Code. It does not purport to discuss
all federal income tax consequences that may be applicable to particular
categories of investors, some of which (such as banks, insurance companies and
foreign investors) may be subject to special rules. In addition to the federal
income tax consequences described herein, potential investors should consider
the state, local and foreign tax consequences, if any, of the purchase,
ownership and disposition of the Bonds. See "State and Other Tax
Consequences." Bondholders are urged to consult their tax advisors concerning
the state, local and foreign tax consequences to them of the purchase,
ownership and disposition of the Bonds offered hereunder.
CLASSIFICATION OF THE ISSUER AND THE BONDS
Taxable mortgage pool ("TMP") rules enacted as part of the Tax Reform Act of
1986 treat certain arrangements that securitize real estate mortgages as
taxable corporations. An entity will be characterized as a TMP if it does not
make an election to be classified as a "real estate mortgage investment
conduit" (a "REMIC") or a "financial asset securitization investment trust" (a
"FASIT") and (i) substantially all of its assets are debt obligations or
interests therein and more than 50 percent of such debt obligations or
interests consist of real estate mortgages or interests therein, (ii) the
entity is the obligor under debt obligations with two or more maturities, and
(iii) payments on the debt obligations referred to in (ii) bear a relationship
to payments on the debt obligations or interests referred to in (i).
Furthermore, in certain circumstances, a group of assets held by an entity can
be treated as a separate TMP if the above requirements are met with respect to
such assets.
The Company does not intend to make an election for any Issuer to be a REMIC
or FASIT. It is possible, therefore, that an Issuer or a portion of an Issuer
relating to the ownership of certain Assets and the Bonds related thereto
could be treated as a TMP for federal income tax purposes. The related
Prospectus Supplement for each series of Bonds will discuss whether the Issuer
is anticipated to be characterized as a TMP. It is anticipated that each
Issuer will be one hundred percent owned by the Company, which is a "qualified
REIT subsidiary" (as defined in Section 856(i)(2) of the Code) of NovaStar
Financial, which itself is a REIT. As a result, if the Issuer does not
constitute a TMP, all of the assets of the Issuer should be treated as owned
by NovaStar Financial for federal income tax purposes. If an Issuer is
classified as a TMP, it is anticipated that it would qualify as a "qualified
REIT subsidiary" of NovaStar Financial. Such characterization would result
only in the shareholders of NovaStar Financial being required to include in
income certain "excess inclusion" income generated by the TMP and would not
result in entity-level, corporate income taxation with respect to the Issuer.
On the other hand, if the Issuer constitutes a TMP but fails to qualify or
continue to be treated as a "qualified REIT subsidiary" by reason of NovaStar
Financial's failure to continue to qualify as a 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 whether the assets of any Issuer will be
treated as owned by NovaStar Financial or to the prospective qualification of
any Issuer as a "qualified REIT subsidiary" or of NovaStar Financial as a REIT
for federal income tax purposes.
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Upon the issuance of a series of Bonds, Stinson, Mag & Fizzell, P.C.,
counsel to the Company, will deliver its opinion generally to the effect that,
for federal income tax purposes, assuming compliance with all provisions of
the Indenture and certain related documents, the Bonds will be treated as
indebtedness.
Because the Bonds will be treated as indebtedness of the Issuer, among other
things, (i) Bonds held by 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) Bonds held by a real estate
investment trust will not constitute "real estate assets" within the meaning
of Code Section 856(c)(4)(A) and interest on Bonds will not be considered
"interest on obligations secured by mortgages on real property" within the
meaning of Code Section 856(c)(3)(B), 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 following general discussion is based in part upon the rules
governing original issue discount that are set forth in Sections 1271-1273 and
1275 of the Code and in the Treasury regulations issued thereunder (the "OID
Regulations"). The related Prospectus Supplement for a series of Bonds will
disclose whether such Bonds are anticipated to be issued with "original issue
discount" within the meaning of Code Section 1273(a). Interest on any class of
Bonds other than Bonds issued with original issue discount generally will be
includible in income of the Bondholder thereof in accordance with such
holder's applicable method of accounting. Any holders of Bonds issued with
original issue discount generally will be required to include original issue
discount in income as it accrues, in accordance with the method described
below, in advance of the receipt of the cash attributable to such income.
Original Issue Discount Defined. Original issue discount, if any, on a Bond
generally will equal the excess of the Bond's stated redemption price at
maturity over its issue price. The issue price of a particular class of Bonds
will be the first cash price at which a substantial amount of Bonds of that
class is sold (excluding sales to bond houses, brokers or similar persons or
organizations), which generally will be set forth on the cover page of the
Prospectus Supplement for each series of Bonds. Under the OID Regulations, the
stated redemption price at maturity of a Bond generally will equal the total
of all payments to be made on such Bond other than "qualified stated
interest." "Qualified stated interest" includes interest that is
unconditionally payable at least annually at a single fixed rate, or in the
case of a variable rate debt instrument, at one or more "qualified floating
rates," a single "objective rate," a combination of a single fixed rate and
one or more "qualified floating rates" or a "qualified inverse floating rate."
In general, a variable rate debt instrument is an instrument (i) the issue
price of which does not exceed the total noncontingent principal payments by
more than the lessor of (A) .015 multiplied by the product of the total
noncontingent principal payments and the number of complete years to maturity
from the issue date (or, in the case of an installment obligation, the
weighted average maturity), or (B) 15 percent of the total noncontingent
principal payments, (ii) that does not provide for any stated interest other
than that described above, (iii) that provides for any qualified floating rate
or objective rate to be set at the current value of that rate, and (iv) that
provides for no contingent principal payments.
In the case of Bonds constituting variable rate debt instruments, the
determination of the total amount of original issue discount and the timing of
the inclusion thereof will vary according to the characteristics of such
Bonds. If the original issue discount rules apply to such Bonds, the related
Prospectus Supplement will describe the manner in which such rules will be
applied by the Issuer with respect to those Bonds in preparing information
returns to the Bondholders and the IRS. Additionally , in certain cases, Bonds
may constitute contingent payment debt instruments, in which case the related
Prospectus Supplement will also describe the application of the original issue
discount rules to such instruments.
If the accrued interest to be paid to a Bondholder on the first Payment Date
is computed with respect to a period that begins prior to the closing date, a
portion of the purchase price paid for a Bond will reflect such accrued
interest. In such cases, information returns to the Bondholders and the IRS
will be based on the position
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that the portion of the purchase price paid for the interest accrued with
respect to periods prior to the closing date is treated as part of the overall
purchase price of such Bond (and not as a separate asset the purchase price of
which is recovered entirely out of interest received on the next Payment Date)
and that portion of the interest paid on the first Payment Date in excess of
interest accrued for a number of days corresponding to the number of days from
the closing date to the first Payment Date should be included in the stated
redemption price of such Bond. However, the OID Regulations state that all or
some portion of such accrued interest in certain situations may be treated as
a separate asset the cost of which is recovered entirely out of interest paid
on the first Payment Date. It is unclear how an election to do so would be
made under the OID Regulations and whether such an election could be made
unilaterally by a Bondholder.
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 the number
of full years from the issue date to the maturity date of the Bond (a "de
minimis amount"). With respect to installment obligations, the above
calculation is modified by using the weighted average maturity of the Bond
rather than the number of years to maturity. For this purpose, the weighted
average maturity of a Bond is computed as the sum of the following amounts
determined for each payment under the instrument other than qualified stated
interest (i) the number of complete years from the issue date until such
payment is expected to be made (presumably taking into account a prepayment
assumption, as described below), multiplied by (ii) a fraction, the numerator
of which is the amount of the payment, and the denominator of which is the
stated redemption price at maturity of such Bond. An installment obligation is
defined as a debt instrument that provides for the payment of any amount other
than qualified stated interest before maturity. Under the OID Regulations,
original issue discount of only a de minimis amount (other than de minimis
original issue discount attributable to a so-called "teaser" interest rate or
an initial interest holiday) will be included in income as each payment of
stated principal is made, based on the product of the total amount of such de
minimis original issue discount and a fraction, the numerator of which is the
amount of such principal payment and the denominator of which is the
outstanding stated principal amount of the Bond. The OID Regulations also
would permit a Bondholder to elect to accrue de minimis original issue
discount into income currently based on a constant yield method. See "--
Election to Treat All Interest as Original Issue Discount" for a description
of such election under the OID Regulations.
Accrual of Original Issue Discount. If original issue discount on a Bond is
in excess of a de minimis amount, the holder of such Bond generally must
include in ordinary gross income the sum of the "daily portions" of original
issue discount for each day during its taxable year on which it held such
Bond. 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 generally 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).
Generally, the amount of original issue discount includible for each accrual
period is calculated using a constant yield method, under which the includible
amount equals the increase during such accrual period in the adjusted issue
price of a Bond. The increase in a Bond's adjusted issue price equals (i) the
excess, if any, of (A) the product of the adjusted issue price of the Bond at
the beginning of such accrual period and (B) the yield to maturity of the Bond
over (ii) the amount of any qualified stated interest allocable to the accrual
period. The adjusted issue price of a Bond at the beginning of the first
accrual period is the Bond's issue price. The adjusted issue price of a Bond
at the beginning of any subsequent accrual period will equal the issue price
of such Bond, increased by the aggregate amount of original issue discount
that accrued with respect to such Bond in prior accrual periods, and reduced
by the amount of any payments made on such Bond in prior accrual periods of
amounts other than qualified stated interest. The original issue discount
accruing during any accrual period, computed as described above, will be
allocated ratably to each day during the accrual period to determine the daily
portion of original issue discount for such day.
Section 1272(a)(6) of the Code requires that a prepayment assumption (the
"Prepayment Assumption") be used in computing the accrual of original issue
discount for debt instruments if payments under such instruments may be
accelerated by reason of prepayments of other obligations securing such debt
instruments or for any pool
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of debt instruments the yield on which may be affected by reason of
prepayments, and that adjustments be made in the amount and rate of accrual of
such discount to reflect differences between the actual prepayment rate and
the Prepayment Assumption. The Prepayment Assumption is to be determined in a
manner prescribed in Treasury regulations which have not yet been issued. The
Conference Committee Report (the "Committee Report") accompanying the Tax
Reform Act of 1986, however, indicates that the regulations will provide that
the Prepayment Assumption used with respect to a Bond must be the same as that
used in pricing the initial offering of such Bond. The Prepayment Assumption
used by an Issuer in determining the existence of original issue discount and
in reporting original issue discount for each series of Bonds which is issued
with original issue discount will be consistent with this standard and will be
disclosed in the related Prospectus Supplement. However, no representation
will be made that the Assets will in fact prepay at a rate conforming to the
Prepayment Assumption or at any other rate.
In the case of such debt instruments, the portion of original issue discount
that accrues in any accrual period will equal the excess, if any, of (i) the
sum of (A) the present value, as of the end of the accrual period, of all of
the payments remaining to be made on the Bond, if any, in future periods and
(B) the payments made on such Bond during the accrual period of amounts
included in the stated redemption price of the Bond, over (ii) the adjusted
issue price of such Bond at the beginning of the accrual period. The present
value of the remaining payments referred to in the preceding sentence will be
calculated (1) assuming that payments on the Bond will be received in future
periods based on the Assets being prepaid at a rate equal to the Prepayment
Assumption, (2) taking into account events that have occurred prior to the end
of the accrual period and (3) using a discount rate equal to the yield to
maturity of the Bond at the issue date.
A subsequent purchaser of a Bond whose adjusted basis in the Bond,
immediately after his or her purchase, is less than or equal to the Bond's
stated redemption price at maturity generally will also be required to include
in gross income the daily portions of any original issue discount with respect
to such Bond. However, each such daily portion will be reduced, if the
holder's adjusted basis is in excess of the Bond's adjusted issue price, in
proportion to the ratio such excess bears to the aggregate original issue
discount remaining to be accrued on such Bond. The adjusted issue price of a
Bond generally equals the issue price of the Bond (i) increased by any
original issue discount previously included in the gross income of any holder
with respect to such Bond and (ii) decreased by payments previously made on
the Bond other than qualified stated interest.
MARKET DISCOUNT
The market discount provisions of Code Sections 1276 through 1278 generally
provide that if a subsequent holder of a Bond purchases the Bond 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. In
addition, in certain cases, the market discount provisions will be applicable
to Bonds acquired at original issue. Market discount on a Bond not issued with
original issue discount means the excess, if any, of the stated redemption
price of the Bond at maturity over the price paid by the holder for the Bond.
Market discount on a Bond issued with original issue discount 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. Generally, under Code Section 1276, 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 the 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 holder
of a market discount Bond, however, may elect to include market discount in
gross income currently in the tax year to which it is attributable. If made,
such election will apply to all market discount Bonds acquired by such
Bondholder on or after the first day of the first taxable year to which such
election applies. The amount of market discount generally is accrued using a
ratable accrual method, unless the Bondholder elects to determine the accrued
market discount on the basis of a constant interest rate as provided in Code
Section 1272(a). The election to use the constant interest method is
irrevocable and is made on a Bond-by-Bond basis.
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Notwithstanding the general definition above, any market discount with
respect to a Bond will be considered to be zero if such market discount is
less than 0.25% of the remaining stated redemption price of such Bond
multiplied by the number of complete years to maturity remaining after the
date of its purchase (a "de minimis amount"). In interpreting a similar rule
with respect to original issue discount on obligations payable in
installments, the OID Regulations refer to the weighted average maturity of
obligations, and it is likely that the same rule will be applied with respect
to market discount, presumably taking into account the Prepayment Assumption.
If market discount is treated as a de minimis amount under this rule, it
appears that the actual discount would be treated in a manner similar to
original issue discount of a de minimis amount. See "--De Minimus Original
Issue Discount" above.
Section 1276(b)(3) of the Code specifically authorizes the Treasury
Department to issue regulations providing for the method for accruing market
discount on debt instruments, the principal of which is payable in more than
one installment. Until regulations are issued by the Treasury Department,
certain rules described in the legislative history accompanying Code Section
1276(b)(3) will apply. Such legislative history indicates that 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 will 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 will equal 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 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 will likely
apply.
A Bondholder who acquired the Bond at a market discount also may be required
to defer 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
holder held the Bond. Any expense that is not deductible under the above rule
is deferred and deducted in the year of disposition, or, if a special election
is made, in a year prior to the disposition year. If market discount Bonds are
disposed of in nonrecognition transaction, the deferred deduction generally is
limited to the amount of gain recognized on the disposition. These deferral
rules do 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 referred to above have not been issued, it is not
possible to predict what effect such regulations might have on the tax
treatment of a Bond purchased at a discount in the secondary market.
PREMIUM
A Bond purchased at a cost greater than its stated redemption price at
maturity will be considered to be purchased at a premium. The holder of such a
Bond generally may elect under Section 171 of the Code to amortize such
premium under the constant yield method over the remaining term of the Bond.
If made, such an election generally would apply to all debt instruments having
amortizable Bond premium that the holder owns or subsequently acquires.
Amortizable premium will be treated as an offset to interest income on the
related Bond, rather than as a separate interest deduction. Although no
regulations addressing the computation of premium accrual on instruments that
provide for payments that may be accelerated by reason of prepayments of other
obligations securing such instrument have been issued, the legislative history
of the Tax Reform Act of
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1986 indicates that such 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 in such cases will be calculated using the Prepayment
Assumption used in pricing such class. Until regulations are issued, however,
such tax treatment is uncertain.
ELECTION TO TREAT ALL INTEREST AS ORIGINAL ISSUE DISCOUNT
The OID Regulations permit a holder of a Bond in certain circumstances 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 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
Under Section 166 of the Code, both corporate holders of the Bonds and
noncorporate holders of the Bonds that acquire such Bonds in connection with a
trade or business should be allowed to deduct, as ordinary losses, any losses
sustained during a taxable year in which their Bonds become wholly or
partially worthless as the result of one or more realized losses on the
Assets. However, it appears that a noncorporate holder that does not acquire a
Bond in connection with a trade or business will not be entitled to deduct a
loss under Section 166 of the Code until such holder's Bond becomes wholly
worthless (i.e., until its outstanding principal balance has been reduced to
zero) and that the loss will be characterized as a short-term capital loss.
Each holder of a Bond generally will be required to accrue interest and
original issue discount with respect to such Bond, without giving effect to
any reductions in distributions attributable to defaults or delinquencies on
the Assets until it can be established that any such reduction ultimately will
not be recoverable. As a result, the amount of taxable income reported in any
period by the holder of a Bond could exceed the amount of economic income
actually realized by the holder in such period. Although the holder of a Bond
eventually will recognize a loss or reduction in income attributable to
previously accrued and included income that, as the result of a realized loss,
ultimately will not be realized, the law is unclear with respect to the timing
and character of such loss or reduction in income.
SALES OF BONDS
If a Bond is sold, the selling Bondholder generally will recognize gain or
loss equal to the difference between the amount realized on the sale and the
holder's adjusted basis in the Bond. The adjusted basis of a Bond generally
will equal the cost of such Bond to the Bondholder, increased by any original
issue discount and market discount income included in gross income with
respect to the Bond and reduced by any amortized premium and any payments on
the Bond received by the Bondholder, other than payments of qualified stated
interest. Any such gain or loss should be capital gain or loss, provided such
Bond is held by the Bondholder as a capital asset (generally, property held
for investment) within the meaning of Section 1221 of the Code.
Gain recognized on the sale of a Bond by a seller who purchased the Bond at
a market discount will likely be taxable as ordinary income in an amount not
exceeding the portion of the discount that accrued during the period such Bond
was held by such holder, reduced by any market discount included in income, in
accordance with the rules described above under "--Market Discount."
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A portion of any gain from the sale of a Bond that might otherwise be
capital gain may be treated as ordinary income to the extent that such Bond is
held as part of a "conversion transaction" within the meaning of Section 1258
of the Code. A conversion transaction generally is one in which the taxpayer
has taken two or more positions in the same or similar property that reduce or
eliminate market risk, if substantially all of the taxpayer's expected return
is attributable to the time value of the taxpayer's net investment in such
transaction. The amount of gain so realized in a conversion transaction that
is recharacterized as ordinary income generally will not exceed the amount of
interest that would have accrued on the taxpayer's net investment in the
conversion transaction at 120% of the appropriate "applicable Federal rate"
(which rate is computed and published monthly by the IRS) for the period
ending on the date of disposition, subject to appropriate reduction for
amounts previously recaptured as ordinary income on the transaction.
In certain situations, a taxpayer may elect to have net capital gain taxed
at ordinary income rates rather than capital gains rates in order to include
such net capital gain in total net investment income for the taxable year, for
purposes of the rule that limits the deduction of interest on indebtedness
incurred to purchase or carry property held for investment to a taxpayer's net
investment income.
BACKUP WITHHOLDING AND INFORMATION REPORTING
Certain "reportable payments," which generally include payments of interest
and principal, as well as payments of proceeds from the sale of Bonds, may be
subject to the "backup withholding tax" under Section 3406 of the Code at a
rate of 31%. Backup withholding generally applies only if (1) the recipient
fails to furnish a social security number or other taxpayer identification
number ("TIN") to the payor, (2) the IRS notifies the payor that the TIN
furnished by the recipient is incorrect, (3) the IRS notifies the payor that
backup withholding should be commenced because the recipient has failed to
properly report interest or dividends, or (4) under certain circumstances, the
recipient fails to provide to the payor a statement, signed under penalty of
perjury, that the TIN number furnished is the correct number and that such
recipient is not subject to backup withholding. Any amounts deducted and
withheld from a distribution to a recipient would be allowed as a credit
against such recipient's federal income tax. Furthermore, certain penalties
may be imposed by the IRS on a recipient of payments that is required to
supply information but that does not do so in the proper manner.
Backup withholding will not apply, however, with respect to certain payments
made to certain Bondholders, including payments to certain exempt recipients
and to certain foreign persons. Bondholders should consult their tax advisors
regarding their qualification from backup withholding and the procedure for
obtaining such an exemption.
The Issuer will report to the Bondholders and to the IRS for each calendar
year the amount of any "reportable payments" during such year and the amount
of tax withheld, if any, with respect to payments on the Bonds.
TAX TREATMENT OF FOREIGN INVESTORS
In the case of interest paid on a Bond to a nonresident alien individual,
foreign partnership or foreign corporation that has no connection with the
United States other than holding Bonds ("Nonresidents"), such interest will
normally qualify as portfolio interest (except where (i) the recipient is a
holder, directly or by the application of the attribution rules of Code
Section 871(h)(3)(C), of 10% or more of the total voting power of all classes
of voting stock or 10% or more of the capital or profits interest in the
Issuer, or (ii) the recipient is a controlled foreign corporation to which the
Issuer is a related person pursuant to Code Section 881(c)(3)(C)) and will be
exempt from U.S. federal income tax. Upon receipt of the ownership statements
from the Nonresident which qualify under Code Section 871(h)(5), the Issuer
normally will be relieved of obligations to withhold tax from such interest
payments. These provisions supersede the generally applicable provisions of
United States
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law that would otherwise require the Issuer to withhold at a 30% rate (unless
such rate were reduced or eliminated by an applicable tax treaty) on, among
other things, interest and other fixed or determinable, annual or periodic
income paid to Nonresidents. The 30% withholding tax will apply, however, in
certain situations where contingent interest is paid to a Nonresident or the
IRS determines that withholding is required in order to prevent tax evasion by
United States persons.
STATE AND OTHER TAX CONSEQUENCES
In addition to the federal income tax consequences described in "Federal
Income Tax Consequences," potential investors should consider the state, local
and other tax consequences of the acquisition, ownership, and disposition of
the Bonds offered hereunder. State tax law may differ substantially from the
corresponding federal tax law, and the discussion above does not purport to
describe any aspect of the tax laws of any state or other jurisdiction.
Therefore, prospective investors should consult their own tax advisors with
respect to the various state, local and other tax consequences of investments
in the Bonds offered hereunder.
ERISA CONSIDERATIONS
The Employee Retirement Income Security Act of 1974, as amended ("ERISA"),
and the Code impose certain requirements on employee benefit plans and on
certain other retirement plans and arrangements, including individual
retirement accounts and annuities, Keogh plans and collective investment funds
and separate accounts (and, as applicable, insurance company general accounts)
in which such plans, accounts or arrangements are invested that are subject to
the fiduciary responsibility provisions of ERISA and Section 4975 of the Code
("Plans") and on persons who are fiduciaries with respect to such Plans in
connection with the investment of Plan assets. Certain employee benefit plans,
such as governmental plans (as defined in ERISA Section 3 (32)), and, if no
election has been made under Section 410(d) of the Code, church plans (as
defined in Section 3(33) of ERISA) are not subject to ERISA requirements.
Accordingly, assets of such plans may be invested in Bonds without regard to
the ERISA considerations described below, subject to the provisions of other
applicable federal and state law. Any such plan which is qualified and exempt
from taxation under Sections 401(a) and 501(a) of the Code, however, is
subject to the prohibited transaction rules set forth in Section 503 of the
Code.
ERISA generally imposes on Plan fiduciaries certain general fiduciary
requirements, including those of investment prudence and diversification and
the requirement that a Plan's investments be made in accordance with the
documents governing the Plan. In addition, Section 406 of ERISA and Section
4975 of the Code prohibit a broad range of transactions involving assets of a
Plan and persons (parties in interest under ERISA and disqualified persons
under the Code, collectively, "Parties in Interest") who have certain
specified relationships to the Plan unless a statutory or administrative
exemption is available. Certain Parties in Interest that participate in a
prohibited transaction may be subject to an excise tax imposed pursuant to
Section 4975 of the Code or a penalty imposed pursuant to Section 502(i) of
ERISA, unless a statutory or administrative exemption is available. These
prohibited transactions generally are set forth in Section 406 of ERISA and
Section 4975 of the Code.
The Trust fund, the Company, any underwriter, the Indenture Trustee, the
Master Servicer, any Administrator, any provider of credit support or any of
their affiliates may be considered to be or may become Parties in Interest (or
Disqualified Persons) with respect to certain Plans. Prohibited transactions
under Section 406 of ERISA and Section 4975 of the Code may arise if a Bond is
acquired by a Plan with respect to which such persons are Parties in Interest
(or Disqualified Persons) unless such transactions are subject to one or more
statutory or administrative exemptions, such as: Prohibited Transaction Class
Exemption ("PTCE") 75-1, which exempts certain transactions involving Plans
and certain broker-dealers, reporting dealers and banks; PTCE 83-1, regarding
transactions involving mortgage pool investment trusts; PTCE 84-14, which
exempts certain transactions effected on behalf of a Plan by a "qualified
professional asset manager"; PTCE 90-1, which exempts certain transactions
between insurance company separate accounts and Parties in Interest (or
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Disqualified Persons); PTCE 91-38, which exempts certain transactions between
bank collective investment funds and Parties in Interest (or Disqualified
Persons); PTCE 95-60, which exempts certain transactions between insurance
company general accounts and Parties in Interest (or Disqualified Persons); or
PTCE 96-23, regarding transactions effected by an "in-house asset manager".
There can be no assurance that any of these class exemptions will apply with
respect to any particular Plan investment in Bonds, or even if it were deemed
to apply, that any exemption would apply to all prohibited transactions that
may occur in connection with such investment. Accordingly, prior to making an
investment in the Bonds, investing Plans should determine whether the Trust
Fund, the Company, any underwriter, the Indenture Trustee, the Master
Servicer, any Administrator, any provider of credit support or any of their
affiliates is a Party in Interest (or Disqualified Person) with respect to
such Plan and, if so, whether such transaction is subject to one or more
statutory or administrative exemptions.
Any Plan fiduciary considering whether to invest in 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. Each Plan fiduciary also should determine
whether, under the general fiduciary standards of investment prudence and
diversification, an investment in the Bonds is appropriate for the Plan
considering the overall investment policy of the Plan and the composition of
the Plan's investment portfolio as well as whether such investment is
permitted under the governing Plan instruments.
LEGAL INVESTMENT
Each class of Offered Bonds will be rated at the date of issuance. Each
class of Offered Bonds will be rated by Standard & Poor's, Moody's Investors
Service, Inc., Duff & Phelps Credit Rating Co., or Fitch Investors Service,
L.P., and will be rated within one of the four highest rating categories of
such rating agencies. The four highest rating categories for Standard & Poor's
are AAA, AA, A and BBB. The four highest rating categories for Moody's
Investors Service, Inc. are Aaa, Aa, A and Baa. The four highest rating
categories for Duff & Phelps Credit Rating Co. are AAA, AA, A, and BBB. The
four highest rating categories for Fitch Investors Service, L.P. are AAA, AA,
A and BBB. If any other rating agencies are used, the name and four highest
rating categories of such rating agency will be disclosed in the Prospectus
Supplement relating to such Offered Bonds. The related Prospectus Supplement
also will specify which classes of the Bonds, if any, will constitute
"mortgage related securities" ("SMMEA Bonds") for purposes of the Secondary
Mortgage Market Enhancement Act of 1984 ("SMMEA"). If any of the Bonds
constitute SMMEA Bonds, they will be rated within one of the two highest
rating categories of the rating agencies, as identified above. SMMEA Bonds
will constitute legal investments for persons, trusts, corporations,
partnerships, associations, business trusts and business entities (including,
but not limited to, state chartered savings banks, commercial banks, savings
and loan associations and insurance companies, as well as trustees and state
government employee retirement systems) created pursuant to or existing under
the laws of the United States or of any state (including the District of
Columbia and Puerto Rico) whose authorized investments are subject to state
regulation to the same extent that, under applicable law, obligations issued
by or guaranteed as to principal and interest by the United States or any
agency or instrumentality thereof constitute legal investments for such
entities. Alaska, Arkansas, Colorado, Connecticut, Delaware, Florida, Georgia,
Illinois, Kansas, Maryland, Michigan, Missouri, Nebraska, New Hampshire, New
York, North Carolina, Ohio, South Dakota, Utah, Virginia and West Virginia
enacted legislation before the October 4, 1991 cutoff established by SMMEA for
such enactments, limiting to varying extents the ability of certain entities
(in particular, insurance companies) to invest in mortgage related securities,
in most cases by requiring the affected investors to rely solely upon existing
state law, and not SMMEA. Investors affected by such legislation will be
authorized to invest in SMMEA Certificates only to the extent provided in such
legislation. 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 "mortgage related securities," or require the sale
or other disposition of such securities, so long as such contractual
commitment was made or such securities 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
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with "mortgage related securities" without limitation as to the percentage of
their assets represented thereby, federal credit unions may invest in such
securities, and national banks may purchase such securities for their own
account without regard to the limitations generally applicable to investment
securities set forth in 12 U.S.C. 24 (Seventh), subject in each case to such
regulations as the applicable federal regulatory authority may prescribe. In
this connection, federal credit unions should review the National Credit Union
Administration ("NCUA") Letter to Credit Unions No. 96, as modified by Letter
to Credit Unions No. 108, which includes guidelines to assist federal credit
unions in making investment decisions for mortgage related securities, and the
NCUA's regulation "Investment and Deposit Activities" (12 C.F.R. Part 703),
which sets forth certain restrictions on investment by federal credit unions
in mortgage related securities.
Institutions where investment activities are subject to legal investment
laws or regulations or review by certain regulatory authorities may be subject
to restrictions on investment in certain classes of Offered Bonds. Any
financial institution which is subject to the jurisdiction of the Comptroller
of the Currency, the Board of Governors of the Federal Reserve System, the
Federal Deposit Insurance Corporation ("FDIC"), the Office of Thrift
Supervision ("OTS"), the NCUA or other federal or state agencies with similar
authority should review any applicable rules, guidelines and regulations prior
to purchasing any Offered Bond. The Federal Financial Institutions Examination
Council, for example, has issued a Supervisory Policy Statement on Bonds
Activities effective February 10, 1992 (the "Policy Statement") setting forth
guidelines for and significant restrictions on investments in "high-risk
mortgage securities." The Policy Statement has been adopted by the Comptroller
of the Currency, the Federal Reserve Board, the FDIC, the OTS and the NCUA
(with certain modifications), with respect to the depository institutions that
they regulate. The Policy Statement generally indicates that a mortgage
derivative product will be deemed to be high risk if it exhibits greater price
volatility than a standard fixed rate thirty-year mortgage security. According
to the Policy Statement, prior to purchase, a depository institution will be
required to determine whether a mortgage derivative product that it is
considering acquiring is high-risk, and if so that the proposed acquisition
would reduce the institution's overall interest rate risk. Reliance on
analysis and documentation obtained from a securities dealer or other outside
party without internal analysis by the institution would be unacceptable.
There can be no assurance that any classes of Offered Bonds will not be
treated as high-risk under the Policy Statement.
The predecessor to the OTS issued a bulletin, entitled, "Mortgage Derivative
Products and Mortgage Swaps," which is applicable to thrift institutions
regulated by the OTS. The bulletin established guidelines for the investment
by savings institutions in certain "high-risk" mortgage derivative securities
and limitations on the use of such securities by insolvent, undercapitalized
or otherwise "troubled" institutions. According to the bulletin, such "high-
risk" mortgage derivative securities include securities having certain
specified characteristics, which may include certain classes of Bonds. In
accordance with Section 402 of the Financial Institutions Reform, Recovery and
Enhancement Act of 1989, the foregoing bulletin will remain in effect unless
and until modified, terminated, set aside or superseded by the FDIC. Similar
policy statements have been issued by regulators having jurisdiction over the
types of depository institutions.
In September 1993 the National Association of Insurance Commissioners
released a draft model investment law (the "Model Law") which sets forth model
investment guidelines for the insurance industry. Institutions subject to
insurance regulatory authorities may be subject to restrictions on investment
similar to those set forth in the Model Law and other restrictions.
If specified in the related Prospectus Supplement, other classes of Offered
Bonds offered pursuant to this Prospectus will not constitute "mortgage
related securities" under SMMEA. The appropriate characterization of this
Offered Bond under various legal investment restrictions, and thus the ability
of investors subject to these restrictions to purchase such Offered Bonds, may
be subject to significant interpretive uncertainties.
Except as to the status of SMMEA Bonds identified in the Prospectus
Supplement for a series as "mortgage related securities" under SMMEA, the
Company will make no representations as to the proper characterization of the
Offered Certificates for legal investment or financial institution regulatory
purposes, or as to the ability of particular investors to purchase any Offered
Certificates under applicable legal investment restrictions. The
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uncertainties described above (and any unfavorable future determinations
concerning legal investment or financial institution regulatory
characteristics of the Offered Bonds) may adversely affect the liquidity of
the Offered Bonds.
The foregoing does not take into consideration the applicability of
statutes, rules, regulations, orders, guidelines or agreements generally
governing investments made by a particular investor, including, but not
limited to, "prudent investor" provisions, percentage-of-assets limits and
provisions which may restrict or prohibit investment in securities which are
not "interest bearing" or "income paying."
There may be other restrictions on the ability of certain investors,
including depository institutions, either to purchase Offered Bonds or to
purchase Offered Bonds representing more than a specified percentage of the
investor's assets. Accordingly, all investors whose investment activities are
subject to legal investment laws and regulations, regulatory capital
requirements or review by regulatory authorities should consult with their own
legal advisors in determining whether and to what extent the Offered Bonds of
any class constitute legal investments or are subject to investment, capital
or other restrictions, and, if applicable, whether SMMEA has been overridden
in any jurisdiction relevant to such investor.
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 Assets securing a series of Bonds and any credit enhancement with
respect to such Bonds. Ratings on the Bonds will reflect such Rating Agency's
assessment of the likelihood that Bondholders will receive payments to which
such Bondholders are entitled under the related Bonds. Such rating will not
constitute an assessment of the likelihood that principal prepayments on the
related Mortgage Loans will be made, the degree to which the rate of such
prepayments might differ from that originally anticipated or the likelihood of
early optional termination of the series of 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 Assets 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 such 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 enhancement required with respect to
each class of Bonds. 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
Loans.
101
<PAGE>
No assurance can be given that values of any Mortgaged Properties 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 Loans 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 Loans and, accordingly, the rates of delinquencies,
foreclosures and losses with respect to any Mortgage Loans 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
Bondholders.
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.
The Company currently plans to issue Bonds off of its shelf registration in
an underwritten offering in late April or early May 1998.
LEGAL MATTERS
Unless otherwise set forth in the related Prospectus Supplement, the
validity of the Bonds will be passed upon for the Issuer by Stinson, Mag &
Fizzell, P.C., Kansas City, Missouri, and Thacher, Proffitt & Wood, New York,
New York, will act as counsel for the underwriters.
102
<PAGE>
INDEX OF PRINCIPAL DEFINITIONS
<TABLE>
<CAPTION>
PAGE(S) ON WHICH
TERM IS DEFINED
TERMS IN THE PROSPECTUS
- ----- -----------------
<S> <C>
'33 Act....................................................... 8
Accrued Bond Interest......................................... 48
Agency Securities............................................. 1, 32
Agreement..................................................... 53
ARM Contracts................................................. 39
ARM Loans..................................................... 34
Asset Seller.................................................. 32
Assets........................................................ 1, 6, 32
Available Funds............................................... 47
Balloon Mortgage Loans........................................ 21
Bankruptcy Code............................................... 80
Bond Insurance Policy......................................... 12, 73
Bond Insurer.................................................. 12, 73
Bond Interest Rate............................................ 48
Bond Owners................................................... 52
Bond Principal Balance........................................ 15, 48
Bondholders................................................... 14, 24
Bonds......................................................... 1
Book-Entry Bonds.............................................. 46
Buydown Mortgage Loans........................................ 44
Buydown Period................................................ 44
Cash Flow Agreement........................................... 13, 41
Cash Flow Agreements.......................................... 1
Cede.......................................................... 52
CERCLA........................................................ 27, 81
Clean-Up Call Percentage...................................... 16, 51
Closed-End Loans.............................................. 34
Code.......................................................... 29, 91
Collection Account............................................ 57
Combined Loan-to-Value Ratio.................................. 33
Commission.................................................... 3, 30
Committee Report.............................................. 94
Company....................................................... 1, 5, 29
Conservation Act.............................................. 27, 81
Contract Group................................................ 46
Contract Rate................................................. 9, 39
Contracts..................................................... 1, 32
Convertible Mortgage Loans.................................... 45
Cooperative................................................... 33, 75
Cooperative Loans............................................. 75
Corporate Bonds............................................... 1, 9, 32
Covered Trust................................................. 70
CPR........................................................... 43
Credit Support................................................ 1, 10, 40
Crime Control Act............................................. 85
Cut-off Date.................................................. 15
Definitive Bonds.............................................. 46, 53
Depositor..................................................... 1, 5
</TABLE>
103
<PAGE>
<TABLE>
<CAPTION>
PAGE(S) ON WHICH
TERM IS DEFINED
TERMS IN THE PROSPECTUS
- ----- -----------------
<S> <C>
Determination Date............................................ 47
DTC........................................................... 52
Due Period.................................................... 47
Environmental Lien............................................ 28, 82
ERISA......................................................... 17, 98
Events of Default............................................. 66, 68
Excess Spread................................................. 11, 71
Exchange Act.................................................. 3
FASIT......................................................... 91
FDIC.......................................................... 57, 100
FHLMC......................................................... 1, 32, 65
FHLMC Certificates............................................ 7
FIRREA........................................................ 35
FNMA.......................................................... 1, 32
FNMA Certificates............................................. 7
Foreclosure Rate.............................................. 32
FTC Rule...................................................... 89
Full Documentation............................................ 36
Funding Period................................................ 26
GAAP.......................................................... 24
Garn-St. Germain Act.......................................... 82
GNMA.......................................................... 1, 32
GNMA Certificates............................................. 7
Government Bonds.............................................. 1, 9, 32
Government Securities......................................... 92
Guaranteed Mortgage Pass-Through Certificates................. 7
High LTV Loans................................................ 33
Holding....................................................... 31
Home Equity Loans............................................. 6, 34
Indenture..................................................... 29
Indenture Trustee............................................. 6, 29
Indirect Participants......................................... 52
Insurance Proceeds............................................ 57
Interest Accrual Period....................................... 41
IRS........................................................... 91
Issuer........................................................ 2, 5
L/C Bank...................................................... 12, 73
L/C Percentage................................................ 73
Liquidation Proceeds.......................................... 57, 58
Limited Documentation......................................... 36
Loan-to-Value Ratio........................................... 33
Lock-out Date................................................. 34
Lock-out Period............................................... 34
Manufactured Home............................................. 9
Master Servicer............................................... 5
MBS........................................................... 1, 6, 32
MBS Agreement................................................. 38
MBS Indenture Trustee......................................... 38
MBS Issuer.................................................... 38
MBS Servicer.................................................. 38
</TABLE>
104
<PAGE>
<TABLE>
<CAPTION>
PAGE(S) ON WHICH
TERM IS DEFINED
TERMS IN THE PROSPECTUS
- ----- -----------------
<S> <C>
Model Law..................................................... 100
Mortgage Assets............................................... 1, 6, 32
Mortgage Collateral........................................... 1
Mortgage Loan Group........................................... 14, 46
Mortgage Loans................................................ 1, 6, 32
Mortgage Notes................................................ 33
Mortgage Rate................................................. 6, 34
Mortgaged Properties.......................................... 19
Mortgages..................................................... 33
NCUA.......................................................... 100
Nonrecoverable Advance........................................ 49
Nonresidents.................................................. 97
NovaStar Financial............................................ 5, 29, 30
NovaStar Mortgage............................................. 5, 31
Offered Bonds................................................. 6
OID Regulations............................................... 92
Originator.................................................... 33
OTS........................................................... 100
Owner Trustee................................................. 5, 29
Participants.................................................. 52
Parties in Interest........................................... 98
Payment Date.................................................. 14
Permitted Investments......................................... 57
Plans......................................................... 98
PMBS Issuer................................................... 8
PMBS Servicer................................................. 8
PMBS Trustee.................................................. 8
Policy Statement.............................................. 100
Pre-Funded Amount............................................. 13, 40
Pre-Funding Account........................................... 13, 40
Pre-Funding Period............................................ 13, 40
Prepayment Assumption......................................... 93
Prepayment Premium............................................ 34
Private Mortgage-Backed Securities............................ 1, 32
PTCE.......................................................... 98
Purchase Price................................................ 56
Rating Agency................................................. 17, 101
Record Date................................................... 47
Refinance Loans............................................... 33
REIT.......................................................... 27, 30
Related Proceeds.............................................. 49
Relief Act.................................................... 84, 89
REMIC......................................................... 91
REO Property.................................................. 50
Reserve Funds................................................. 11
Retained Interest............................................. 64
Revolving Credit Loans........................................ 34
RICO.......................................................... 85
</TABLE>
105
<PAGE>
<TABLE>
<CAPTION>
PAGE(S) ON WHICH
TERM IS DEFINED
TERMS IN THE PROSPECTUS
- ----- -----------------
<S> <C>
Securities Act................................................ 3
Seller........................................................ 29
Senior Bondholders............................................ 10, 71
Senior Bonds.................................................. 10, 46, 71
Senior Lien................................................... 21
Servicer...................................................... 5
Servicing Standard............................................ 60
Single Family Mortgage Loan................................... 33
Single Family Property........................................ 6, 33
SMMEA......................................................... 17, 99
SMMEA Bonds................................................... 99
SPA........................................................... 43
Stated Income................................................. 36
Sub-Servicer.................................................. 60
Sub-Servicing Agreement....................................... 61
Subordinated Bondholders...................................... 10, 71
Subordinated Bonds............................................ 10, 46, 71
Subprime Mortgage Loans....................................... 1, 18
Subsequent Assets............................................. 13, 40
TIN........................................................... 97
Title V....................................................... 83, 90
Title VIII.................................................... 84
TMP........................................................... 27, 91
UCC........................................................... 52, 85
Underlying Mortgage Loans..................................... 32
Value......................................................... 33
Warranting Party.............................................. 19, 55
Whole Loans................................................... 32
</TABLE>
106
<PAGE>
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NO DEALER, SALESMAN OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMA-
TION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS SUPPLEMENT
AND THE PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR BY THE UN-
DERWRITER. THIS PROSPECTUS SUPPLEMENT AND THE PROSPECTUS DO NOT CONSTITUTE AN
OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, THE SECURITIES OFFERED
HEREBY TO ANYONE IN ANY JURISDICTION IN WHICH THE PERSON MAKING SUCH OFFER OR
SOLICITATION IS NOT QUALIFIED TO DO SO OR TO ANYONE TO WHOM IT IS UNLAWFUL TO
MAKE ANY SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS
SUPPLEMENT AND THE PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIR-
CUMSTANCES, CREATE AN IMPLICATION THAT INFORMATION HEREIN OR THEREIN IS CORRECT
AS OF ANY TIME SINCE THE DATE OF THIS PROSPECTUS SUPPLEMENT OR THE PROSPECTUS.
----------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
PROSPECTUS SUPPLEMENT
<S> <C>
Summary.................................................................... S-3
Risk Factors............................................................... S-18
Use of Proceeds............................................................ S-20
Description of the Mortgage Pool........................................... S-20
The Seller................................................................. S-47
The Issuer................................................................. S-48
The Owner Trustee.......................................................... S-48
The Indenture Trustee...................................................... S-48
The Bond Insurer........................................................... S-48
Description of the Bonds................................................... S-50
Certain Yield and Prepayment Considerations................................ S-65
Description of the Servicing Agreement..................................... S-72
The Indenture.............................................................. S-74
Federal Income Tax Consequences............................................ S-76
Method of Distribution..................................................... S-76
Legal Opinions............................................................. S-77
Ratings.................................................................... S-77
Legal Investment........................................................... S-78
ERISA Considerations....................................................... S-78
Experts.................................................................... S-78
PROSPECTUS
Prospectus Supplement...................................................... 2
Available Information...................................................... 3
Incorporation of Certain Documents by Reference............................ 3
Summary.................................................................... 5
Risk Factors............................................................... 18
Introduction............................................................... 29
The Issuer................................................................. 29
Use of Proceeds............................................................ 32
Description of the Assets.................................................. 32
Yield Considerations....................................................... 41
Description of the Bonds................................................... 46
Description of the Agreements.............................................. 53
Description of Credit Support.............................................. 70
Certain Legal Aspects of Mortgage Loans.................................... 74
Certain Legal Aspects of the Contracts..................................... 85
Federal Income Tax Consequences............................................ 91
State and Other Tax Consequences........................................... 98
ERISA Considerations....................................................... 98
Legal Investment........................................................... 99
Rating..................................................................... 101
Plan of Distributions...................................................... 102
Legal Matters.............................................................. 102
Index of Principal Definitions............................................. 103
</TABLE>
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$315,000,000
LOGO
NOVASTAR HOME EQUITY LOAN
ASSET-BACKED BONDS,
SERIES 1998-2
NOVASTAR FINANCIAL, INC.
SELLER
NOVASTAR MORTGAGE
FUNDING CORPORATION
COMPANY
----------------
PROSPECTUS SUPPLEMENT
----------------
MERRILL LYNCH & CO.
AUGUST 14, 1998
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