<PAGE>
RULE NO. 424(b)(2)
REGISTRATION NO. 333-1682
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+THIS PROSPECTUS SUPPLEMENT RELATES TO AN EFFECTIVE REGISTRATION STATEMENT +
+UNDER THE SECURITIES ACT OF 1933, AND IS SUBJECT TO COMPLETION OR AMENDMENT. +
+THIS PROSPECTUS SUPPLEMENT AND THE ACCOMPANYING PROSPECTUS SHALL NOT +
+CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR SHALL +
+THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH OFFER, +
+SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION +
+UNDER THE SECURITIES LAWS OF ANY SUCH STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION DATED MAY 21, 1996
PRELIMINARY PROSPECTUS SUPPLEMENT TO PROSPECTUS DATED MAY 21, 1996
$153,521,000
CHEVY CHASE HOME LOAN TRUST 1996-1
% Home Loan Asset-Backed Certificates, Series 1996-1
Chevy Chase Bank, F.S.B.
as Transferor and Servicer
--------
Each % Home Loan Asset-Backed Certificate, Series 1996-1 (collectively, the
"Certificates") will represent an undivided interest in the Chevy Chase Home
Loan Trust 1996-1 (the "Trust") to be formed pursuant to a Pooling and
Servicing Agreement (the "Agreement") between Chevy Chase Bank, F.S.B. ("Chevy
Chase"), as transferor (the "Transferor") and as servicer (the "Servicer"),
and Norwest Bank Minnesota, National Association, as trustee (the "Trustee").
The Certificates will be issued in a single class with a certificate rate of
% per annum (the "Certificate Rate") and in an aggregate initial principal
balance of $153,521,000.00. Interest at the Certificate Rate will be
distributed to the extent described herein on the 15th day of each month or,
if such 15th day is not a Business Day (as defined herein), the next
succeeding Business Day (each, a "Monthly Payment Date"), commencing in
June 1996. Principal, from and to the extent of funds available therefor
(to the extent described herein), will be distributed quarterly on each
August 15, November 15, February 15 and May 15 or, if any such day is not
a Business Day, the next succeeding Business Day (each, a "Distribution
Date"), commencing in November, 1997 or, in certain limited
circumstances, earlier and/or monthly, as more fully described herein.
The unpaid principal balance of the Certificates will be due and payable
on the Distribution Date in May, 2015 (the "Stated Maturity Date"). Full
and complete payment of the Insured Payment (as defined herein) on each
Monthly Payment Date and of the unpaid Certificate Principal Balance on
the Stated Maturity Date is unconditionally and irrevocably guaranteed
pursuant to a financial guaranty insurance policy (the "Policy") to be
issued by Capital Markets Assurance Corporation (the "Certificate
Insurer").
(Continued on following page)
--------
POTENTIAL INVESTORS SHOULD CONSIDER, AMONG OTHER THINGS, THE INFORMATION SET
FORTH IN "RISK FACTORS" COMMENCING ON PAGE S-25 HEREIN AND ON PAGE 16 IN THE
PROSPECTUS.
THE CERTIFICATES WILL REPRESENT BENEFICIAL INTERESTS IN THE TRUST ONLY AND WILL
NOT EVIDENCE A SAVINGS ACCOUNT OR DEPOSIT OR OTHER OBLIGATION OF, OR INTEREST
IN, AND ARE NOT GUARANTEED BY, CHEVY CHASE OR ANY AFFILIATE THEREOF. NEITHER
THE CERTIFICATES NOR THE LOANS (AS DEFINED HEREIN) ARE INSURED OR GUARANTEED
BY THE SAVINGS ASSOCIATION INSURANCE FUND, THE FEDERAL DEPOSIT INSURANCE
CORPORATION OR ANY OTHER GOVERNMENTAL AGENCY OR INSTRUMENTALITY.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS SUPPLEMENT OR THE PROSPECTUS.
ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
Underwriting
Price to Discounts and Proceeds to
Public(1) Commissions(2) Transferor(2)
--------- -------------- -------------
<S> <C> <C> <C>
Per Certificate..........................
Total.................................... $ $
</TABLE>
(1) Plus accrued interest, if any, at the applicable rate from , 1996.
(2)Before deducting expenses payable by the Transferor, estimated to be $ .
--------
The Certificates are offered by the several Underwriters when, as and if
issued by the Transferor, delivered to and accepted by the Underwriters, and
subject to their right to reject orders in whole or in part. It is expected
that delivery of the Certificates in book-entry form will be made through the
facilities of The Depository Trust Company on or about , 1996, against
payment in immediately available funds.
CS First Boston Smith Barney Inc.
The date of this Prospectus Supplement is May , 1996.
<PAGE>
(Continued from preceding page)
The property of the Trust will include certain closed-end home equity debt
consolidation loans (the "Initial Closed-End Loans") and conventional home
improvement installment sales contracts and installment loan agreements
(the "Initial Home Improvement Contracts"; together with the Initial
Closed-End Loans, the "Initial Loans"). Most of the Initial Loans
are secured primarily by second or third deeds of trust or
mortgages (the "Initial Mortgages") on one- to four-family
residential properties (the "Initial Mortgaged Properties").
The Trust also will include collections in respect of the
Initial Loans received on and after May 1, 1996 (the
"Initial Cut-off Date") and certain other property as
described more fully herein.
Until the Monthly Collection Period (as defined herein) following the date on
which the Certificate Principal Balance (as defined herein) has been reduced
to 20% or less of the Initial Certificate Principal Balance (as defined
herein) or earlier under certain circumstances and subject to the conditions
described herein, on each Monthly Payment Date specified by the Transferor
(each, a "Subsequent Transfer Date") the Trust will acquire from the
Transferor, with funds on deposit from time to time in the Excess Funding
Account (as defined herein) and available therefor, additional closed-end
home equity debt consolidation loans (the "Subsequent Closed-End Loans";
together with the Initial Closed-End Loans, the "Closed-End Loans") and
additional conventional home improvement installment sales contracts and
installment loan agreements (the "Subsequent Home Improvement Contracts";
together with the Initial Home Improvement Contracts, the "Home
Improvement Contracts") which may be secured primarily by second or
third deeds of trust or mortgages (the "Subsequent Mortgages"; together
with the Initial Mortgages, the "Mortgages") on primarily one-to four-
family residential properties (the "Subsequent Mortgaged Properties";
together with the Initial Mortgaged Properties, the "Mortgaged
Properties"). On the date of issuance of the Certificates, the
Transferor will deposit $ in the Excess Funding Account thereby
creating overcollateralization. Thereafter, the Excess Funding
Account will be funded with certain collections in respect of the
Loans as and to the extent described herein. The Initial Loans were,
and the Subsequent Loans will be, originated or acquired by Chevy
Chase in the ordinary course of its business.
There currently is no secondary market for the Certificates. The
Underwriters intend to make a secondary market in the Certificates, but have
no obligation to do so. The interests of the owners of the Certificates will
be represented by book entries on the records of The Depository Trust Company
("DTC") and participating members thereof.
THIS PROSPECTUS SUPPLEMENT DOES NOT CONTAIN COMPLETE INFORMATION ABOUT THE
OFFERING OF THE CERTIFICATES. ADDITIONAL INFORMATION IS CONTAINED IN THE
PROSPECTUS AND PROSPECTIVE INVESTORS ARE URGED TO READ BOTH THIS PROSPECTUS
SUPPLEMENT AND THE PROSPECTUS IN FULL. SALES OF THE CERTIFICATES MAY NOT BE
CONSUMMATED UNLESS THE PURCHASER HAS RECEIVED A FINAL PROSPECTUS SUPPLEMENT
AND THE FINAL PROSPECTUS. TO THE EXTENT ANY STATEMENTS IN THIS PROSPECTUS
SUPPLEMENT CONFLICT WITH STATEMENTS IN THE PROSPECTUS, THE STATEMENTS IN THIS
PROSPECTUS SUPPLEMENT SHALL CONTROL.
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE CERTIFICATES
AT LEVELS ABOVE THOSE WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH
STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
REPORT TO CERTIFICATEHOLDERS
Unless and until Replacement Certificates (as defined herein) are issued,
unaudited monthly and annual reports containing information concerning the
Loans will be sent to the Trustee and to Cede & Co., as registered holder of
the Certificates and the nominee of DTC. See "THE AGREEMENTS--Reports to
Holders" and "-- Book Entry Securities" in the accompanying Prospectus (the
"Prospectus"). Such reports will not constitute financial statements prepared
in accordance with generally accepted accounting principles. None of the
Transferor, the Servicer, or the Certificate Insurer intends to send any of
its financial reports to Certificateholders. The Servicer, on behalf of the
Trust, will file with the Securities and Exchange Commission (the
"Commission") periodic reports concerning the Trust to the extent required
under the Securities Exchange Act of 1934, as amended (the "Exchange Act"),
and the rules and regulations thereunder.
S-2
<PAGE>
PROSPECTUS SUPPLEMENT SUMMARY OF TERMS
The following summary of certain pertinent information is qualified in its
entirety by reference to the detailed information appearing elsewhere in this
Prospectus Supplement and the accompanying Prospectus. Certain capitalized
terms used herein are defined elsewhere in the Prospectus Supplement or in the
Prospectus. Reference is made to the Index of Principal Terms herein and the
Glossary of Terms in the Prospectus for the definitions of certain capitalized
terms.
Securities Offered........ Each of the % Home Loan Asset-Backed Certificates,
Series 1996-1 offered hereby (the "Certificates")
represents an undivided interest in the Chevy Chase
Home Loan Trust 1996-1 (the "Trust"). Each
Certificate represents the right to receive
payments of interest at the rate of % per annum
(the "Certificate Rate"), payable monthly on the
15th day of each month or, if such 15th day is not
a Business Day, the next succeeding Business Day
(each, a "Monthly Payment Date") and quarterly
payments in respect of principal on each August 15,
November 15, February 15 and May 15 or, if any such
day is not a Business Day, the next succeeding
Business Day (each, a "Distribution Date"),
beginning with the November, 1997 Distribution Date
(or, in certain limited circumstances described
below, earlier and/or monthly), in each case,
calculated as described herein. The Certificate
Principal Balance will be due and payable on the
Distribution Date in May, 2015 (the "Stated
Maturity Date").
The Certificates will be issued in a single class
with an aggregate original principal balance of
$153,521,000 (the "Initial Certificate Principal
Balance"). Following the date of issuance of the
Certificates (the "Closing Date"), the "Certificate
Principal Balance" will equal the Initial
Certificate Principal Balance minus the aggregate
amount of distributions allocable to principal
previously distributed to Certificateholders. See
"THE CERTIFICATES" herein and "DESCRIPTION OF THE
SECURITIES" in the Prospectus.
The Certificates will be available for purchase in
book-entry form only in denominations of $1,000 and
integral multiples thereof, except that one
Certificate may be issued in a different
denomination. Persons acquiring beneficial
interests ("Certificate Owners") in the
Certificates will hold their interests through DTC.
See "RISK FACTORS--Book-Entry Registration May
Affect Liquidity" herein.
Transferor and Servicer... Chevy Chase Bank, F.S.B. ("Chevy Chase"), a
federally chartered stock savings bank, with its
principal executive offices located at 8401
Connecticut Avenue, Chevy Chase, Maryland 20815,
and a telephone number of (301) 986-7000. See "THE
TRANSFEROR" herein and in the Prospectus.
Certificate Insurer....... Capital Markets Assurance Corporation. See "THE
CERTIFICATE INSURER" herein.
S-3
<PAGE>
Trustee.................. Norwest Bank Minnesota, National Association, a
national banking association. The Trustee's
principal corporate trust office is located at
Sixth Street and Marquette Avenue, Minneapolis,
Minnesota 55479.
Trust Fund............... The Trust will be formed pursuant to a pooling and
servicing agreement to be dated as of May 1, 1996
(the "Agreement") between Chevy Chase, as
transferor (the "Transferor") and as servicer
(together with any successor in such capacity, the
"Servicer"), and Norwest Bank Minnesota, National
Association, as trustee (the "Trustee"). The
property of the Trust (the "Trust Fund") initially
will include certain closed-end home equity debt
consolidation loans (the "Initial Closed-End
Loans") and conventional home improvement
installment sales contracts and installment loan
agreements (the "Initial Home Improvement
Contracts"; together with the Initial Closed-End
Loans, the "Initial Loans") most of which are
secured primarily by second or third deeds of trust
or mortgages (the "Initial Mortgages") on primarily
one- to four-family residential properties (the
"Initial Mortgaged Properties") located primarily
in Maryland, Virginia, North Carolina and the
District of Columbia, an assignment of any such
Initial Mortgages, collections in respect of the
Initial Loans received on and after the Initial
Cut-off Date, the Excess Funding Account (as
defined herein), the Reserve Fund (as defined
herein), the Policy (as defined herein), the
interest of the Trust in certain hazard insurance
policies maintained by the borrowers with respect
to the Initial Mortgaged Properties and certain
other property as described more fully herein. On
the Closing Date, the Initial Loans will have an
aggregate unpaid principal balance as of May 1,
1996 (the "Initial Cut-off Date") of
$153,521,961.79 after giving effect to all payments
of principal thereon received prior to the Initial
Cut-off Date (the "Original Pool Balance"). See
"THE HOME LOAN POOL" herein and "THE TRUST FUNDS"
in the Prospectus.
The Trust Fund also will include certain additional
closed-end home equity debt consolidation loans
(the "Subsequent Closed-End Loans"; together with
the Initial Closed-End Loans, the "Closed-End
Loans") and additional conventional home
improvement installment sales contracts and
installment loan agreements (the "Subsequent Home
Improvement Contracts"; together with the Initial
Home Improvement Contracts, the "Home Improvement
Contracts"), which may be secured primarily by
second or third deeds of trust or mortgages (the
"Subsequent Mortgages"; together with the Initial
Mortgages, the "Mortgages") on primarily one- to
four-family residential properties (the "Subsequent
Mortgaged Properties"; together with the Initial
Mortgaged Properties, the "Mortgaged Properties"),
an assignment of any such Subsequent Mortgages,
collections in respect of such Subsequent Closed-
End Loans and Subsequent Home Improvement Contracts
(collectively, the "Subsequent Loans"; together
with the Initial Loans, the "Loans") received on
and after the related Subsequent Cut-off Date, the
interest of the Trust in certain hazard insurance
policies maintained by the borrowers with respect
to the
S-4
<PAGE>
Subsequent Mortgaged Properties and the proceeds of
the foregoing. From time to time until but
excluding the first Monthly Payment Date following
the earliest of (i) the occurrence of an Early
Amortization Event (as defined herein), (ii) the
occurrence of a Rapid Amortization Event (as
defined herein), and (iii) the date on which the
Certificate Principal Balance has been reduced to
20% or less of the Initial Certificate Principal
Balance (the "Subsequent Loan Purchase Termination
Date") the Trust will acquire Subsequent Loans from
the Transferor from monies on deposit in the Excess
Funding Account as and to the extent described
herein. See "THE CERTIFICATES--Excess Funding
Account" herein.
Record Date............... Distributions will be made on each Monthly Payment
Date and Distribution Date to the holders of record
as reflected in the certificate register maintained
by the Trustee on the day prior to such Monthly
Payment Date or Distribution Date, as the case may
be, if the Certificates are book-entry
certificates, and on the last day of the month
preceding the month of the related Monthly Payment
Date or Distribution Date, as the case may be, if
the Certificates are issued in definitive form,
except that the final distribution in respect of
any Certificate will be made only upon presentation
and surrender of such Certificate at the office or
agency appointed by the Trustee for that purpose.
Interest.................. Interest on the Certificates will accrue at the
rate of % per annum (the "Certificate Rate") from
and including the Closing Date (in the case of the
first Monthly Payment Date) or from and including
the most recent Monthly Payment Date on which
interest has been paid to but excluding the
following Monthly Payment Date (each, an "Interest
Period"). On each Monthly Payment Date, the Trustee
will distribute the Interest Distributable Amount
on a pro rata basis to the holders of Certificates
of record (the "Certificateholders") as of the
related Record Date. The "Interest Distributable
Amount" for any Monthly Payment Date means the sum
of (i) interest accrued during the related Interest
Period at the Certificate Rate on the Certificate
Principal Balance immediately preceding such
Monthly Payment Date and (ii) the
Certificateholders' Interest Carryover Shortfall.
"Certificate- holders' Interest Carryover
Shortfall" means, with respect to any Monthly
Payment Date, the excess of the Interest
Distributable Amount for the preceding Monthly
Payment Date over the amount of interest that is
actually distributed to Certificateholders on such
preceding Monthly Payment Date, plus interest on
such excess, to the extent permitted by law, at the
Certificate Rate from and including the preceding
Monthly Payment Date to but excluding the current
Monthly Payment Date. Interest will be calculated
on the basis of a 360-day year comprised of twelve
30-day months. See "THE CERTIFICATES--Interest"
herein.
Principal................. On each Distribution Date relating to the
Amortization Period and on each Monthly Payment
Date relating to an Early Amortization Period
S-5
<PAGE>
or a Rapid Amortization Period, the Trustee will
distribute the Principal Distributable Amount on a
pro rata basis to the Certificateholders of record
as of the related Record Date. The "Principal
Distributable Amount" means (i) with respect to
each Distribution Date relating to the Amortization
Period, an amount equal to the Monthly Allocable
Principal (as defined herein) in respect of each of
the three Monthly Collection Periods preceding such
Distribution Date, (ii) with respect to each
Monthly Payment Date relating to an Early
Amortization Period or a Rapid Amortization Period,
the Monthly Allocable Principal in respect of the
Monthly Collection Period preceding such Monthly
Payment Date and, if an Early Amortization Event or
a Rapid Amortization Event occurs at any time after
the Revolving Period has ended, the Monthly
Allocable Principal for any prior Monthly
Collection Period that was not previously
distributed, plus, on the Monthly Payment Date
relating to the Monthly Collection Period during
which an Early Amortization Event or a Rapid
Amortization Event has occurred, all amounts then
on deposit in the Excess Funding Account, and (iii)
on the first Distribution Date on which the
Certificate Principal Balance as of the preceding
Distribution Date has been reduced to 20% or less
of the Initial Certificate Principal Balance, all
amounts then on deposit in the Excess Funding
Account; provided, however, that on the Stated
Maturity Date, the Principal Distributable Amount
will equal the Certificate Principal Balance;
provided further, however, that in no event will
the aggregate amount distributed to
Certificateholders in respect of principal exceed
the Initial Certificate Principal Balance. See "THE
CERTIFICATES--Principal" herein.
"Monthly Allocable Principal" means, with respect
to each Monthly Payment Date relating to the
Amortization Period, an Early Amortization Period
or a Rapid Amortization Period, an amount equal to
the sum of (i) the Monthly Available Principal (as
defined herein) deposited in the Principal
Distribution Account for such Monthly Payment Date,
(ii) any Excess Interest to the extent deposited in
the Principal Distribution Account to pay for all
prior Excess Funding Interest Transfer Amounts not
previously reimbursed by Interest Collections, to
pay the Liquidation Loss Amount for such Monthly
Payment Date, (iii) any Excess Interest deposited
in the Principal Distribution Account to pay the
Overcollateralization Deposit/Distribution Amount
(as defined herein) for any such Monthly Payment
Date relating to the Amortization Period or an
Early Amortization Period and to pay any
outstanding Certificate Principal Balance for any
such Monthly Payment Date relating to a Rapid
Amortization Period, (iv) the Reserve Fund
Principal Transfer Amount (as defined herein) drawn
from the Reserve Fund for such Monthly Payment Date
and (v) the Principal Deficiency Draw Amount (as
defined herein) made under the Policy for such
Monthly Payment Date.
The "Monthly Available Principal" means, with
respect to each Monthly Collection Period, an
amount equal to the Certificateholders' Percentage
of the Principal Collections received in respect of
such Monthly Collection Period net of any such
Principal Collections
S-6
<PAGE>
allocated to the Expense Distribution Account to
reimburse the Certificate Insurer for unreimbursed
draws on the Policy to the extent described herein
("Net Principal Collections"), minus the
Certificateholders' Percentage of an amount (the
"Excess Overcollateralization Amount") equal to the
lesser of (x) the amount by which the
Overcollateralization Amount for the related
Monthly Payment Date exceeds the Required
Overcollateralization Amount for such Monthly
Payment Date and (y) the Net Principal Collections
received in respect of the related Monthly
Collection Period. The "Certificateholders'
Percentage" means, with respect to any Monthly
Collection Period, a percentage equal to (i) during
the Revolving Period, an Early Amortization Period
and a Rapid Amortization Period, 100% and (ii)
during the Amortization Period, 90% until the first
day of the Monthly Collection Period during which
the Certificate Principal Balance has been reduced
to 20% or less of the Initial Certificate Principal
Balance occurs, and thereafter 100%.
An "Early Amortization Event" occurs (i) upon the
Transferor's failure to deposit in the Collection
Account on the Business Day prior to any
Determination Date the Negative Carry Deposit
Amount for the related Monthly Collection Period ;
(ii) if on any Determination Date, the Cumulative
Realized Loss Ratio (as defined below) as of such
date exceeds (a) in the case of any Determination
Date prior to the June 1997 Determination Date, 5%,
(b) in the case of any Determination Date after the
June 1997 Determination Date but prior to the June
1998 Determination Date, 8.5% and (c) in the case
of any Determination Date on and after the June
1998 Determination Date, 12%; (iii) upon the
Transferor's failure to deliver to the Trust
Subsequent Loans with an aggregate outstanding
unpaid principal balance as of the related
Subsequent Cut-off Dates, to the extent originated
and otherwise satisfying the criteria specified
herein and in the Agreement, (a) no later than the
Monthly Payment Date in February 1997, in an
aggregate amount equal to the lesser of (x) the
amounts deposited in the Excess Funding Principal
Subaccount prior to the November 1996 Monthly
Payment Date which have not previously been applied
to fund Excess Funding Interest Transfer Amounts
prior to such date and (y) $18,750,000, (b) no
later than the Monthly Payment Date in November
1997, in an aggregate amount equal to the lesser of
(x) the amounts deposited in the Excess Funding
Principal Subaccount prior to the August 1997
Monthly Payment Date to fund Excess Funding
Interest Transfer Amounts prior to such date and
(y) $43,385,000, and (c) on each Monthly Payment
Date after November 1997, an amount equal to the
amount deposited in the Excess Funding Principal
Subaccount during the Monthly Collection Period
which occurred 15 months prior to such Monthly
Payment Date which have not previously been used to
acquire Subsequent Loans or to fund Excess Funding
Interest Transfer Amounts, in each case determined
in accordance with the Agreement; (iv) upon a draw
on the Policy with respect to a Monthly Collection
Period during the Revolving Period; and (v) on any
Determination Date the amount on deposit in the
Excess Funding Account exceeds $60,000,000.
S-7
<PAGE>
"Cumulative Realized Loss Ratio" for any
Determination Date will be equal to a fraction,
expressed as a percentage, the numerator of which
is the aggregate unpaid principal balance of all
Liquidated Loans as of the end of the related
Monthly Collection Period and the denominator of
which is the sum of the Original Pool Balance and
the unpaid principal balance of each Subsequent
Loan as of its related Subsequent Cut-off Date that
has been acquired by the Trust on or prior to the
end of the related Monthly Collection Period.
"Negative Carry Deposit Amount" means, with respect
to any Monthly Collection Period, the lesser of (i)
the Negative Carry Amount for such Monthly
Collection Period and (ii) the amount by which
Interest Collections (other than the Negative Carry
Deposit Amount) for such Monthly Collection Period
is less than the amount necessary to satisfy all
allocations of Interest Collections for the related
Monthly Payment Date other than any amounts
allocable to the Transferor Distribution Account.
"Negative Carry Amount" means, with respect to any
Monthly Collection Period, an amount equal to the
excess, if any, of (i) one-twelfth of the product
of (x) the sum of the Certificate Rate plus the
Policy Premium Rate plus the Trustee Fee Rate, and
(y) the sum of the amounts on deposit on the last
day of such Monthly Collection Period in the Excess
Funding Principal Subaccount and the Principal
Distribution Account, over (ii) investment earnings
on amounts on deposit in the Excess Funding
Principal Subaccount and the Principal Distribution
Account (in each case net of losses) for such
Monthly Collection Period.
"Policy Premium Rate" means the per annum rate on
which the premium payable to the Certificate
Insurer is calculated, based on the outstanding
Certificate Principal Balance, as set forth in the
Insurance Agreement.
"Trustee Fee Rate" means the amount of the
Trustee's Fee for such Monthly Collection Period
expressed as a per annum rate, based on the
outstanding Certificate Principal Balance.
The "Monthly Collection Period" for any Monthly
Payment Date is the calendar month preceding such
Monthly Payment Date.
The Loans................. The Loans will consist primarily of (i) closed-end
home equity debt consolidation loans acquired by
Chevy Chase in the ordinary course of its business
from licensed mortgage companies which are secured
primarily by second or third deeds of trust or
mortgages on primarily one- to four-family
residential properties ("Residential Properties"),
(ii) conventional home improvement installment
sales contracts or installment loan agreements
acquired by Chevy Chase in the ordinary course of
its business from Chevy Chase-approved home
improvement contractors which are either unsecured
or secured primarily by second or third deeds of
trust or mortgages on Residential Properties and
(iii)
S-8
<PAGE>
conventional installment loan agreements for the
purpose of financing home improvements originated
by Chevy Chase in the ordinary course of its
business which are secured primarily by second or
third deeds of trust or mortgages on Residential
Properties (such loans and contracts, for the
purposes hereof, the "Home Loans"). All of the
Initial Loans have been, and all of the Subsequent
Loans will be, underwritten to Chevy Chase's
underwriting standards. See "THE CHEVY CHASE HOME
LOAN PROGRAM--Loan Programs" and "--Underwriting
Procedures" herein.
As of the Initial Cut-off Date, the Initial Loans
had an unpaid aggregate principal balance of
$153,521,961.79, a minimum outstanding principal
balance of $1,500.00, a maximum outstanding
principal balance of $73,424.86, a remaining term
to maturity of no less than 11 months and no
greater than 185 months, a weighted average
remaining term to maturity of 104.32 months, the
number of months since the date of origination is
no less than 0 months and no greater than 92
months, the weighted average number of months since
the date of origination is 10.30 months, a
specified per annum interest rate ("Loan Rate") of
no less than 6.00% and no greater than 18.00% and a
weighted average Loan Rate of 14.15%. Approximately
26.44%, 58.81%, 10.51% and 2.58% of the Initial
Loans based upon the Original Pool Balance had
Obligors with mailing addresses in Maryland,
Virginia, North Carolina and the District of
Columbia, respectively. All of the Initial Loans
are, and each of the Subsequent Loans will be,
fixed rate, simple interest loans which generally
provide for equal monthly payments. None of the
Initial Loans are, and none of the Subsequent Loans
will be, insured by the Federal Housing
Administration or guaranteed by the Veterans
Administration. See "THE HOME LOAN POOL" herein.
From time to time after the Closing Date until the
Subsequent Loan Purchase Termination Date, the
Transferor will transfer Subsequent Loans to the
Trust as described herein. Although the transfer of
Subsequent Loans to the Trust will be subject to a
number of conditions described herein and in the
Agreement, including the consent of the Certificate
Insurer, there can be no assurance that the
characteristics of the Loans after giving effect to
the transfer of Subsequent Loans will not vary
materially from the characteristics of the Initial
Loans as of the Initial Cut-off Date. See "RISK
FACTORS--Transfer of Subsequent Loans" and "THE
HOME LOAN POOL" herein.
Collections............... All collections on the Loans will be allocated as
to principal and interest in accordance with the
terms of the applicable Closed-End Loan and Home
Improvement Contract. To the extent described
herein, the Servicer will deposit collections of
interest and principal on the Loans in an account
established for such purpose under the Agreement
(the "Collection Account"). Interest Collections
and Principal Collections deposited in the
Collection Account with respect to each Monthly
Collection Period will be allocated (as described
more fully herein) on the Business Day preceding
the related Monthly Payment Date (the "Deposit
Date") to (i) the Excess Funding Account and
S-9
<PAGE>
further allocated to either the Excess Funding
Principal Subaccount (as defined herein) or the
Excess Funding Interest Subaccount (as defined
herein), (ii) an administrative sub-account of the
Collection Account for the distribution of
principal of the Certificates (the "Principal
Distribution Account"), (iii) an administrative
sub-account of the Collection Account for the
distribution of interest on the Certificates (the
"Interest Distribution Account"), (iv) an
administrative sub-account of the Collection
Account for the payment of the Servicing Fee to the
Servicer, the Trustee's Fee to the Trustee and
amounts owed to the Certificate Insurer (the
"Expense Distribution Account"), and (v) an
administrative sub-account of the Collection
Account for distributions to the Transferor (the
"Transferor Distribution Account"). See "THE
CERTIFICATES--Establishment of Accounts" and "--
Allocations" herein.
"Interest Collections" for any Monthly Payment Date
will equal (i) interest collections received from
or on behalf of borrowers on the Loans (each, an
"Obligor") during the related Monthly Collection
Period (less, with respect to any Loan for which a
Servicer Advance has been made and not previously
reimbursed, such interest collections allocable to
pay any such unreimbursed Servicer Advance), (ii)
the interest portion of Net Liquidation Proceeds
and Insurance Proceeds received during the related
Monthly Collection Period, (iii) Recoveries
received during the related Monthly Collection
Period, (iv) the interest portion of the Retransfer
Deposit Amount received in respect of the related
Monthly Collection Period, (v) investment earnings
(net of losses) on amounts on deposit in the
Collection Account, the Excess Funding Account and
the Reserve Fund for the related Monthly Collection
Period, and (vi) any Negative Carry Deposit Amount
received in respect of the related Monthly
Collection Period. "Principal Collections" for any
Monthly Payment Date will equal (i) principal
collections received from Obligors on the Loans
during the related Monthly Collection Period, (less
with respect to any Loan for which a Servicer
Advance has been made and not reimbursed from
Interest Collections on such Loan or otherwise,
principal collections allocable to pay any
unreimbursed Servicer Advance) (ii) the principal
portion of the Net Liquidation Proceeds and
Insurance Proceeds received during the related
Monthly Collection Period and (iii) the principal
portion of the Retransfer Deposit Amount and the
Substitution Adjustment Amount of any transferred
Loan in respect of the related Monthly Collection
Period.
"Liquidation Proceeds" are proceeds (excluding any
amounts drawn from the Excess Funding Account,
Reserve Fund or on the Policy) received in
connection with the liquidation of Liquidated
Loans. "Net Liquidation Proceeds" with respect to a
Loan are Liquidation Proceeds reduced by related
expenses (including, without limitation, Servicer
Advances, the cost of recordation of assignments
and any amount advanced in respect of the repayment
of a senior mortgage). "Insurance Proceeds" means,
as to any Loan and Monthly Collection Period,
proceeds paid to the Servicer pursuant to any
insurance policy with
S-10
<PAGE>
respect to such Loan, reduced by related expenses,
which proceeds (x) are not Liquidation Proceeds and
(y) are not applied or expected to be applied to
the restoration or repair of the related Mortgaged
Property or released to the related mortgagor in
accordance with the normal servicing procedures of
the Servicer. "Liquidated Loan" means, with respect
to any Determination Date, a Loan (i) with respect
to which the related Obligor is contractually
delinquent for 180 days as of the end of the most
recently completed Monthly Collection Period or
(ii) as to which the Servicer has determined in
accordance with its customary servicing practices
that eventual payment of the scheduled payments is
unlikely.
"Recoveries" means, with respect to any Liquidated
Loan and a Monthly Collection Period, the amount
collected with respect to such Loan from whatever
source (other than from withdrawals from the
Reserve Fund or from draws on the Policy) in a
Monthly Collection Period following the Monthly
Collection Period during which such Loan became a
Liquidated Loan, reduced by related expenses
incurred by the Servicer in connection with the
liquidation of such Loan or the related Mortgaged
Property (including, without limitation, any
Servicer Advances, costs of recording assignments
and any amount advanced in respect of the repayment
of a senior mortgage).
Revolving Period.......... During the period from the Closing Date to the
earlier of (i) July 31, 1997 and (ii) the first day
of the Monthly Collection Period in which an Early
Amortization Event or a Rapid Amortization Event
occurs (the "Revolving Period"), Principal
Collections received with respect to each Monthly
Collection Period will be allocated on each Deposit
Date as follows: (i) to the Transferor Distribution
Account, an amount equal to the Excess
Overcollateralization Amount for such Monthly
Payment Date and (ii) to the Excess Funding
Principal Subaccount, all remaining Principal
Collections. On each Monthly Payment Date during
the Revolving Period, amounts on deposit in the
Transferor Distribution Account will be distributed
to the Transferor.
Interest Collections received during each Monthly
Collection Period during the Revolving Period will
be allocated on the Deposit Date to the extent
available in the following order of priority: (i)
to the Expense Distribution Account, an amount
equal to the Servicing Fee for the related Monthly
Collection Period and all accrued and unpaid
Servicing Fees for prior Monthly Collection
Periods; (ii) to the Expense Distribution Account,
an amount equal to the Trustee's Fee for the
related Monthly Collection Period and all accrued
and unpaid Trustee's Fees for prior Monthly
Collection Periods; (iii) to the Interest
Distribution Account, an amount equal to the
Interest Distributable Amount for such Monthly
Payment Date; (iv) to the Expense Distribution
Account, an amount equal to the monthly premium for
the Policy; (v) to the Excess Funding Principal
Subaccount, an amount equal to the Liquidation Loss
Amount for such Monthly Payment Date; (vi) to the
Expense Distribution Account, an amount equal to
all prior unreimbursed draws made on the Policy
together with accrued interest
S-11
<PAGE>
thereon; (vii) to the Reserve Fund, an amount
sufficient to satisfy the Specified Reserve Fund
Requirement; (viii) to the Excess Funding Interest
Subaccount, an amount equal to all prior Excess
Funding Interest Transfer Amounts not previously
reimbursed from Interest Collections; (ix) to the
Excess Funding Interest Subaccount, an amount equal
to the excess, if any, of the Required
Overcollateralization Amount for the related
Monthly Payment Date over the Overcollateralization
Amount for such Monthly Payment Date (the aggregate
of amounts, if any, paid pursuant to this clause
(ix) being referred to herein as the
"Overcollateralization Deposit/Distribution
Amount"); (x) to the Expense Distribution Account,
any other amounts owed to the Certificate Insurer
pursuant to the Insurance Agreement; and (xi) to
the Transferor Distribution Account, any remaining
amounts. Interest Collections remaining after
allocations of the amounts described in clauses
(i), (ii), (iii) and (iv) above are referred to
herein as "Excess Interest." Interest Collections
remaining after allocation of the amounts described
in clauses (i) through (viii) above (inclusive) are
referred to herein as "Remaining Interest."
On the Monthly Payment Date following each such
Deposit Date, (a) Interest Collections deposited in
the Expense Distribution Account will be
distributed to the Servicer, the Trustee, and the
Certificate Insurer in the same order of priority
as such amounts were allocated to the Expense
Distribution Account as provided in the preceding
paragraph, (b) amounts deposited in the Interest
Distribution Account will be distributed to
Certificateholders in respect of interest on the
Certificates, (c) amounts deposited in the Excess
Funding Account (other than amounts on deposit in
the Excess Funding Interest Subaccount allocated to
fund Excess Funding Interest Transfer Amounts) will
be available to purchase Subsequent Loans as
described herein unless an Early Amortization Event
or Rapid Amortization Event has occurred, in which
case all such amounts on deposit in the Excess
Funding Account will be allocated to the Principal
Distribution Account and distributed to
Certificateholders on the first Monthly Payment
Date following such Early Amortization Event or
Rapid Amortization Event, as the case may be, and
(d) amounts deposited in the Transferor
Distribution Account will be distributed to the
Transferor.
The "Overcollateralization Amount" on any Monthly
Payment Date is the amount, if any, by which the
sum of the Pool Balance as of such Monthly Payment
Date plus amounts on deposit in the Excess Funding
Account (exclusive of investment earnings thereon)
on such Monthly Payment Date (after giving effect
to any deposits thereto on the related Deposit Date
and reductions thereof in respect of (i) Subsequent
Loans, if any, to be acquired on such Monthly
Payment Date and (ii) any reductions thereof in
respect of Excess Funding Interest Transfer
Amounts) (the "Invested Amount") exceeds the
Adjusted Certificate Principal Balance on such
Monthly Payment Date. The "Adjusted Certificate
Principal Balance" means (i) with respect to any
Monthly
S-12
<PAGE>
Payment Date during the Revolving Period, the
Initial Certificate Principal Balance, and (ii)
with respect to any other Monthly Payment Date, an
amount equal to the Certificate Principal Balance
(x) during the Amortization Period, on the prior
Distribution Date (or, if there is no prior
Distribution Date, the Initial Certificate
Principal Balance) and (y) during any Early
Amortization Period or Rapid Amortization Period,
on the prior Monthly Payment Date, in each case
after giving effect to any distributions of
principal thereon on such date minus the sum of (x)
Monthly Allocable Principal for such Monthly
Payment Date (other than (a) the
Overcollateralization Deposit/ Distribution Amounts
for such Monthly Payment Date (b) the Reserve Fund
Principal Transfer Amount for such Monthly Payment
Date, and (c) any Principal Deficiency Draw Amount
for such Monthly Payment Date) and (y) during the
Amortization Period, Monthly Allocable Principal
for each other Monthly Payment Date that has
occurred since the last Distribution Date.
Prior to an Early Amortization Event or a Rapid
Amortization Event, to the extent Remaining
Interest is available therefor,
Overcollateralization Deposit/Distribution Amounts
will be used to create additional
overcollateralization and to provide additional
credit enhancement until the Overcollateralization
Amount equals the amount specified in the Insurance
Agreement (as defined herein) (the "Required
Overcollateralization Amount"). During the
Revolving Period, the Overcollateralization
Deposit/Distribution Amounts will be allocated to
the Excess Funding Account to purchase Subsequent
Loans and to fund Excess Funding Interest Transfer
Amounts. During the Amortization Period, an Early
Amortization Period or a Rapid Amortization Period,
the Overcollateralization Deposit/Distribution
Amount will be distributed in reduction of the
Certificate Principal Balance. These allocations of
Remaining Interest will cease once
the Overcollateralization Amount equals the
Required Overcollateralization Amount unless it
thereafter becomes necessary to maintain the
Overcollateralization Amount at the required level.
Following a Rapid Amortization Event, on each
Monthly Payment Date, all Remaining Interest will
be applied to reduce the Certificate Principal
Balance to zero.
The "Pool Balance" as of any Monthly Payment Date
will equal the aggregate unpaid principal balance
of the Loans as of the last day of the related
Monthly Collection Period plus the aggregate unpaid
principal balance of any Subsequent Loans as of the
related Subsequent Cut-off Date previously
transferred to the Trust on such Monthly Payment
Date, in each case other than Loans which became
Liquidated Loans during or prior to such Monthly
Collection Period and other than Loans that have
been retransferred to the Transferor or transferred
to the Servicer prior to such Monthly Payment Date.
"Liquidation Loss Amount" means, with respect to
any Liquidated Loan, the unrecovered principal
balance thereof at the end of the
S-13
<PAGE>
related Monthly Collection Period in which such
Loan became a Liquidated Loan, after giving effect
to the application of the principal portion of Net
Liquidation Proceeds in connection therewith.
Amortization Period,
Early Amortization
Period and Rapid
Amortization Period......
Beginning with the Monthly Collection Period
following the end of the Revolving Period and
ending on the first to occur of (i) the first day
of a Monthly Collection Period in which an Early
Amortization Event occurs; (ii) the first day of a
Monthly Collection Period in which a Rapid
Amortization Event occurs; (iii) the date when the
Certificate Principal Balance has been reduced to
zero or (iv) the date when the Trust otherwise
terminates (the "Amortization Period"), Interest
Collections will be allocated on each Deposit Date,
to the extent available, in the same manner and
order of priority as described under "--Revolving
Period" above, except that amounts during the
Revolving Period which would have been allocated to
the Excess Funding Account in respect of the
Liquidation Loss Amount for such Monthly Payment
Date pursuant to clause (v) thereunder,
reimbursement of any Excess Funding Interest
Transfer Amount pursuant to clause (viii)
thereunder and the Overcollateralization
Deposit/Distribution Amounts pursuant to clause
(ix) thereunder will instead be allocated to the
Principal Distribution Account. On each Monthly
Payment Date relating to the Amortization Period,
Interest Collections deposited in (a) the Expense
Distribution Account will be distributed to the
Servicer, the Trustee and the Certificate Insurer
in the same order of priority as such amounts were
allocated to the Expense Distribution Account as
provided under "--Revolving Period" above, (b) the
Interest Distribution Account will be distributed
to Certificateholders in respect of interest on the
Certificates, and (c) the Transferor Distribution
Account will be distributed to the Transferor.
Beginning with the first day of a Monthly
Collection Period during which an Early
Amortization Event occurs, and ending on the first
to occur of (i) the first day of a Monthly
Collection Period in which a Rapid Amortization
Event occurs; (ii) the date when the Certificate
Principal Balance has been reduced to zero; and
(iii) the date when the Trust otherwise terminates
(the "Early Amortization Period"), Interest
Collections will be allocated in the same manner
and order of priority as during the Amortization
Period.
Beginning with the first day of a Monthly
Collection Period during which a Rapid Amortization
Event occurs and ending on the first to occur of
(i) the date when the Certificate Principal Balance
has been reduced to zero, and (ii) the date when
the Trust otherwise terminates (the "Rapid
Amortization Period"), Interest Collections will be
allocated in the same manner and order of priority
as during the Amortization Period except that all
Remaining Interest will first be allocated to the
Principal Distribution Account and distributed to
Certificateholders on the related Monthly Payment
Date in respect of principal until the Certificate
Principal Balance is reduced to zero.
S-14
<PAGE>
Principal Collections received with respect to each
Monthly Collection Period relating to an
Amortization Period will be allocated on each
Deposit Date as follows: (i) to the Expense
Distribution Account, to the extent of any
unreimbursed draws made on the Policy together with
accrued interest thereon, to the extent not
satisfied by allocations of Interest Collections
thereto on such Deposit Date, (ii) to the
Transferor Distribution Account, an amount equal to
the Excess Overcollateralization Amount for such
Monthly Payment Date; (iii) to the Principal
Distribution Account, an amount equal to the
Monthly Available Principal for such Monthly
Payment Date; and (iv) to the Excess Funding
Principal Subaccount, an amount equal to the
Funding Principal Amount for such Monthly Payment
Date. On each Monthly Payment Date relating to the
Amortization Period, amounts on deposit in the
Transferor Distribution Account will be distributed
to the Transferor and amounts on deposit in the
Excess Funding Account will be available to fund
Excess Funding Interest Transfer Amounts and
purchase Subsequent Loans as described herein until
the Subsequent Loan Purchase Termination Date. On
the Monthly Payment Date following the Monthly
Collection Period during which the Subsequent Loan
Purchase Termination Date occurs all amounts on
deposit in the Excess Funding Account will be
allocated to the Principal Distribution Account and
distributed to Certificateholders on such Monthly
Payment Date or, if during the Amortization Period,
the next Distribution Date.
On each Distribution Date relating to the
Amortization Period, commencing on the Distribution
Date in November, 1997, amounts on deposit (net of
investment earnings) in the Principal Distribution
Account will be distributed as a payment of
principal as described under "--Principal" above.
The "Funding Principal Amount" means, with respect
to each Monthly Collection Period (i) during the
Revolving Period, an amount equal to the Monthly
Available Principal for such Monthly Collection
Period, (ii) during the Amortization Period, an
amount equal to the Funding Principal Percentage of
the Net Principal Collections received in respect
of such Monthly Collection Period minus the Funding
Principal Percentage of the Excess
Overcollateralization Amount for such Monthly
Collection Period, and (iii) during an Early
Amortization Period or a Rapid Amortization Period,
zero.
"Funding Principal Percentage" means 10% until the
first day of the Monthly Collection Period
following the Distribution Date on which the
Certificate Principal Balance is equal to or less
than 20% of the Initial Certificate Principal
Balance, and thereafter 0%.
On the Deposit Date following the first Monthly
Collection Period in which an Early Amortization
Event has occurred, all Net Principal Collections
(other than amounts allocable to the Transferor)
will be allocated to the Principal Distribution
Account and distributed monthly to
Certificateholders as provided herein beginning
with the first
S-15
<PAGE>
Monthly Payment Date following the month in which
the Early Amortization Event occurs.
On the Deposit Date following the first Monthly
Collection Period in which a Rapid Amortization
Event has occurred, all Net Principal Collections
otherwise allocable to the Excess Funding Account,
together with all available Remaining Interest,
will be allocated on each Deposit Date to the
Principal Distribution Account and distributed
monthly to Certificateholders as provided herein on
the related Monthly Payment Date beginning with the
first Monthly Payment Date following the month in
which the Rapid Amortization Event occurs. See "THE
CERTIFICATES--Rapid Amortization Period; Rapid
Amortization Events" herein for a discussion of the
events which might lead to the commencement of a
Rapid Amortization Period.
Credit Enhancement........ Credit enhancement for the Certificates will be
provided to the extent described herein by the
Policy, overcollateralization, the Excess Funding
Account and the Reserve Fund. While the amount of
overcollateralization may be materially modified
from time to time by the Transferor, the Servicer
and the Certificate Insurer, without the consent
of, or notice to, the Certificateholders, the
obligations of the Certificate Insurer under the
Policy may not be so modified. In addition, the
amount of the initial deposit into the Reserve Fund
is subject to the agreement of the Certificate
Insurer and the Transferor on the Closing Date,
without any assurance of a certain minimum deposit
amount, and the minimum amount required to be on
deposit in the Reserve Fund may be materially
modified (or eliminated) from time to time
thereafter without the consent of, or notice to,
the Certificateholders.
A. Overcollateralization..On the Closing Date the Trust will be
overcollateralized, as the Transferor will deposit
$ on such date in the Excess Funding Account
thereby causing the Invested Amount (as defined
herein) to exceed the Initial Certificate Principal
Balance by the amount of such deposit. It is
expected that the amount of such
overcollateralization will increase to the extent
Excess Interest is available to be deposited in the
Excess Funding Account or the Principal
Distribution Account and applied as described
below.
Excess Interest for any Monthly Payment Date will
arise if and to the extent that Interest
Collections for the related Monthly Collection
Period exceed the sum of the Servicing Fee required
to be paid to the Servicer for such Monthly Payment
Date and any unpaid Servicing Fees from prior
Monthly Payment Dates, the Trustee's Fee required
to be paid to the Trustee for such Monthly Payment
Date and any unpaid Trustee's Fees from prior
Monthly Payment Dates, the Interest Distributable
Amount on such Monthly Payment Date and the premium
required to be paid to the Certificate Insurer for
such Monthly Payment Date.
Excess Interest, if any, for any Monthly Payment
Date will be available to cover Liquidation Loss
Amounts for such Monthly Payment Date as
S-16
<PAGE>
described herein and in the Agreement. Except for
the foregoing, the Agreement does not require the
payment of Liquidation Loss Amounts to the Excess
Funding Account or to Certificateholders on the
Monthly Payment Date or on the Distribution Date,
as the case may be, following the Monthly
Collection Period during which such Liquidation
Loss Amount arose. Excess Interest, if any, with
respect to any Monthly Payment Date after payment
of any Liquidation Loss Amounts for such Monthly
Payment Date and amounts owed to reimburse the
Certificate Insurer for unreimbursed draws under
the Policy will be allocated as and to the extent
provided herein to pay the Overcollateralization
Deposit/Distribution Amount and deposited either
(i) on each Deposit Date relating to the Revolving
Period, in the Excess Funding Account to acquire
Subsequent Loans or to fund Excess Funding Interest
Transfer Amounts to the extent described herein or
(ii) on each Deposit Date relating to the
Amortization Period, an Early Amortization Period
or a Rapid Amortization Period, in the Principal
Distribution Account for distribution to
Certificateholders on the related Distribution Date
or Monthly Payment Date, as the case may be. Any
such application of Excess Interest (other than to
fund Excess Funding Interest Transfers Amounts) is
expected to result in additional
overcollateralization. The payment of the
Overcollateralization Deposit/Distribution Amount
is not covered by the Reserve Fund or the Policy.
If Excess Interest with respect to any Monthly
Payment Date is insufficient to pay the Liquidation
Loss Amount for such Monthly Payment Date, the
Overcollateralization Amount will be reduced. In
addition, if an Excess Funding Interest Transfer
Amount is made, such amount will also reduce the
Overcollateralization Amount. On each Monthly
Payment Date on which the Overcollateralization
Amount is less than the Required
Overcollateralization Amount, Excess Interest will
be allocated as provided above to pay the
Overcollateralization Deposit/Distribution Amount,
thereby increasing the amount of
overcollateralization.
If Liquidation Loss Amounts are so severe so as to
cause a Collateralization Deficiency, an amount
equal to such Collateralization Deficiency will be
required either (i) on each Deposit Date relating
to the Revolving Period, to be paid to the Excess
Funding Account or (ii) on each Deposit Date
relating to the Amortization Period, an Early
Amortization Period or a Rapid Amortization Period,
to be paid to the Principal Distribution Account
and distributed to Certificateholders on the
related Distribution Date or Monthly Payment Date,
as the case may be, first from withdrawals from the
Reserve Fund to the extent of funds available
therefor and then by draws under the Policy, in
each case as further described below.
"Collateralization Deficiency" means, with respect
to each Monthly Payment Date, the amount by which
the Stated Certificate Principal Balance as of such
Monthly Payment Date exceeds the Invested Amount as
of such Monthly Payment Date.
S-17
<PAGE>
The "Stated Certificate Principal Balance" means
(i) with respect to any Monthly Payment Date
relating to the Revolving Period, the Initial
Certificate Principal Balance, and (ii) with
respect to any other Monthly Payment Date, an
amount equal to the Certificate Principal Balance
(x) relating to the Amortization Period, on the
prior Distribution Date (or, if there is no prior
Distribution Date, the Initial Certificate
Principal Balance) and (y) relating to any Early
Amortization Period or any Rapid Amortization
Period, on the prior Monthly Payment Date, in each
case after giving effect to any distributions of
principal thereon on such date minus the sum of (x)
Monthly Allocable Principal for such Monthly
Payment Date (other than the Reserve Fund Principal
Transfer Amount for such Monthly Payment Date and
other than any Principal Deficiency Draw Amount
under the Policy for such Monthly Payment Date) and
(y) relating to the Amortization Period, Monthly
Allocable Principal for each other Monthly Payment
Date that has occurred since the last Distribution
Date.
The Required Overcollateralization Amount will be
determined in accordance with the Agreement and the
Insurance Agreement and may increase or decrease
over time as a result of floors, caps and triggers
set forth in the Agreement and the Insurance
Agreement. The provisions relating to
overcollateralization may be amended in any respect
by the Transferor, the Servicer and the Certificate
Insurer without the consent of, or notice to, the
Certificateholders; provided, however, that no such
amendment will affect the obligations of the
Certificate Insurer under the Policy.
B. Excess Funding On the Closing Date, the Transferor will make an
Account................... initial deposit of $ to the Excess Funding
Account (the "Excess Funding Initial Deposit").
Such amount will be allocated to the Excess Funding
Interest Subaccount. On each Deposit Date following
the Closing Date until the Deposit Date following
the Monthly Collection Period during which a
Subsequent Loan Purchase Termination Date occurs,
certain Interest Collections and Principal
Collections as described under "--Excess Funding
Account" below will be allocated to the Excess
Funding Account and further allocated to either the
Excess Funding Interest Subaccount or Excess
Funding Principal Subaccount. On each such Deposit
Date, the Trustee shall, before making any other
withdrawals from the Excess Funding Account,
withdraw from the Excess Funding Account and
deposit in the Interest Distribution Account an
amount (the "Excess Funding Interest Transfer
Amount") equal to the least of (x) the excess of
(A) the Interest Distributable Amount for such
Monthly Payment Date over (B) the amount on deposit
in the Interest Distribution Account before giving
any effect to such transfer from the Excess Funding
Account, (y) the amount on deposit in the Excess
Funding Account or (z) the amount which when
withdrawn from the Excess Funding Account would
cause the Overcollateralization Amount to equal
zero. Any such withdrawals from the Excess Funding
Account shall be funded first from the Excess
Funding Interest Subaccount until the amount on
deposit therein has
S-18
<PAGE>
been reduced to zero and then from the Excess
Funding Principal Subaccount. Amounts on deposit in
the Excess Funding Account not used to fund the
Excess Funding Interest Transfer Amount will be
available to acquire Subsequent Loans from the
Transferor until the Subsequent Loan Purchase
Termination Date, and then will be distributed as
described below.
C. Reserve Fund......... On the Closing Date, the Transferor will make an
initial deposit of an amount to be agreed upon by
the Transferor and the Certificate Insurer to an
account (the "Reserve Fund") which will be
established with the Trustee. The amount initially
deposited in the Reserve Fund by the Transferor is
referred to herein as the "Initial Reserve Fund
Deposit." On each Monthly Payment Date, the Trustee
will be required to deposit additional amounts in
the Reserve Fund from Excess Interest, if any, as
described under "THE CERTIFICATES--Allocations"
herein. Amounts, if any, on deposit in the Reserve
Fund will be available on each Monthly Payment Date
to fund (i) payment of the Interest Distributable
Amount for such Monthly Payment Date and (ii) the
Collateralization Deficiency for such Monthly
Payment Date. On each Deposit Date the Trustee will
(i) first, withdraw from the Reserve Fund and
deposit in the Interest Distribution Account an
amount (the "Reserve Fund Interest Transfer
Amount") equal to the lesser of (x) the excess of
(A) the Interest Distributable Amount for such
Monthly Payment Date over (B) all amounts on
deposit in the Interest Distribution Account
(including the Excess Funding Interest Transfer
Amount) on such date before giving effect to any
such transfer from the Reserve Fund and (y) the
amount on deposit in the Reserve Fund, and (ii)
withdraw from the Reserve Fund an amount (the
"Reserve Fund Principal Transfer Amount") equal to
the lesser of (x) the Collateralization Deficiency
and (y) the amount remaining in the Reserve Fund
after giving effect to any withdrawals therefrom
pursuant to clause (i). With respect to each
Deposit Date relating to the Revolving Period,
withdrawals from the Reserve Fund to cover the
Collateralization Deficiency for any Monthly
Payment Date will be deposited in the Excess
Funding Account and allocated to the Excess Funding
Principal Subaccount and will be available to
acquire Subsequent Loans from the Transferor or to
fund the Excess Funding Interest Transfer Amount.
With respect to each Deposit Date relating to the
Amortization Period, an Early Amortization Period
or a Rapid Amortization Period, such amounts will
be distributed to Certificateholders and will
reduce the Certificate Principal Balance but will
not reduce the Invested Amount.
In addition, funds on deposit in the Reserve Fund,
if any, will be available to pay the outstanding
Certificate Principal Balance on the Stated
Maturity Date (after giving effect to all other
amounts distributed and allocable to principal on
such Distribution Date).
The aggregate amount required to be on deposit at
any time in the Reserve Fund (the "Specified
Reserve Fund Requirement") will be
S-19
<PAGE>
determined in accordance with the Agreement and the
Insurance Agreement. The Specified Reserve Fund
Requirement may increase or decrease over time as a
result of floors, caps and triggers set forth in
the Agreement and the Insurance Agreement. Amounts
in the Reserve Fund on any Monthly Payment Date
(after giving effect to all distributions made on
such Monthly Payment Date) in excess of the
Specified Reserve Fund Requirement for such Monthly
Payment Date will be distributed as described under
"THE CERTIFICATES--Distributions" herein.
The provisions relating to the Reserve Fund may be
amended in any respect by the Transferor, the
Servicer and the Certificate Insurer without the
consent of, or notice to, the Certificateholders.
Such amendment could reduce or eliminate the
funding requirements of the Reserve Fund or release
such funds for the benefit of persons other than
Certificateholders. Notwithstanding any reduction
in or elimination of the funding requirements of
the Reserve Fund or the depletion thereof, the
Certificate Insurer will be obligated on each
Monthly Payment Date and each Distribution Date to
fund the full amount otherwise required to be paid
on such Monthly Payment Date or Distribution Date,
as the case may be, under the Policy. See "CREDIT
ENHANCEMENT--Reserve Fund" herein.
D. The Policy........... On or before the Closing Date, the Transferor will
cause a financial guaranty insurance policy (the
"Policy") to be issued by the Certificate Insurer
pursuant to the provisions of the Agreement and the
Insurance and Indemnity Agreement (the "Insurance
Agreement"), among the Transferor, the Servicer,
the Certificate Insurer and the Trustee. The Policy
will unconditionally and irrevocably guarantee (i)
the Interest Distributable Amount on each Monthly
Payment Date and (ii) the Collateralization
Deficiency for such Monthly Payment Date or
Distribution Date, as applicable (collectively, the
"Insured Payments"). A draw will be made on the
Policy equal to (i) with respect to each Monthly
Payment Date, the amount by which the Interest
Distributable Amount exceeds all amounts on deposit
in the Interest Distribution Account (including the
Excess Funding Interest Transfer Amount, if any,
and Reserve Fund Interest Transfer Amount, if any)
for such Monthly Payment Date (the "Interest
Deficiency Draw Amount"), plus (ii) (a) during the
Revolving Period, on the first Monthly Payment Date
for which a Collateralization Deficiency exists,
any remaining Collateralization Deficiency after
giving effect to any Reserve Fund Principal
Transfer Amount with respect to such Monthly
Payment Date, (b) during the Amortization Period,
on each Distribution Date, any remaining
Collateralization Deficiency after giving effect to
any Reserve Fund Principal Transfer Amount with
respect to such Distribution Date, and (c) during
an Early Amortization Period or a Rapid
Amortization Period, on each Monthly Payment Date,
any remaining Collateralization Deficiency after
giving effect to any Reserve Fund Principal
Transfer Amount with respect to such Monthly
Payment Date (such amount, the "Principal
Deficiency Draw Amount"). Any draw under the Policy
pursuant to clause (ii) with
S-20
<PAGE>
respect to a Monthly Collection Period during the
Revolving Period will cause an Early Amortization
Event and a Subsequent Loan Purchase Termination
Event as of the date of such draw. The amount of
any such draw will be deposited in the Excess
Funding Account and allocated to the Excess Funding
Principal Subaccount until the Deposit Date
following such draw at which time such amount will
be allocated to the Principal Distribution Account.
With respect to each Distribution Date and Monthly
Payment Date relating to the Amortization Period,
an Early Amortization Period or a Rapid
Amortization Period, such amounts will be paid to
Certificateholders and will reduce the Certificate
Principal Balance but will not reduce the Invested
Amount.
In addition, the Policy will guarantee the payment
of the outstanding Certificate Principal Balance on
the Stated Maturity Date (after giving effect to
all other amounts distributed and allocable to
principal on such Distribution Date).
To the extent that the Excess Funding Account and
the Reserve Fund is exhausted or otherwise unfunded
or unavailable, in the absence of payments under
the Policy, Certificateholders will directly bear
the credit and other risks associated with their
undivided interest in the Trust. See "CREDIT
ENHANCEMENT--The Policy."
Excess Funding Account.... On the Closing Date, the Excess Funding Account
will be established with the Trustee for the
benefit of the Certificateholders and the
Certificate Insurer and will be funded by a deposit
of $ by the Transferor. Such deposit will be
allocated to the Excess Funding Interest
Subaccount. Thereafter the Excess Funding Account
will be funded on each Monthly Payment Date during
the Revolving Period with all Principal Collections
allocated to the Certificateholders and received
with respect to the related Monthly Collection
Period. In addition, on each Deposit Date relating
to the Revolving Period, any Overcollateralization
Deposit/Distribution Amount, Excess Interest
allocated to Liquidation Loss Amounts,
reimbursement of any Excess Funding Interest
Transfer Amounts and any Reserve Fund Principal
Transfer Amount or Principal Deficiency Draw Amount
under the Policy for such Monthly Payment Date will
be deposited in the Excess Funding Account. During
the Amortization Period, the Excess Funding Account
will be funded solely from the Funding Principal
Amount. Amounts deposited in the Excess Funding
Account in respect of Liquidation Loss Amounts to
fund a Collateralization Deficiency or from
Principal Collections will be allocated to the
Excess Funding Principal Subaccount. The initial
deposit in the Excess Funding Account, amounts
deposited in the Excess Funding Account in respect
of Overcollateralization Deposit/Distribution
Amounts and amounts deposited in the Excess Funding
Account to reimburse Excess Funding Interest
Transfer Amounts will be allocated to the Excess
Funding Interest Subaccount. On the Business Day
preceding the first Distribution Date on which the
Certificate Principal Balance as of the preceding
Distribution Date has been reduced to 20% or less
of the Initial Certificate Principal Balance, all
amounts on deposit in the
S-21
<PAGE>
Excess Funding Account will be deposited in the
Principal Distribution Account and distributed on
the related Distribution Date to the
Certificateholders to reduce the Certificate
Principal Balance. In addition, upon the occurrence
of an Early Amortization Event or a Rapid
Amortization Event, all amounts on deposit in the
Excess Funding Account will be allocated to the
Principal Distribution Account and distributed to
Certificateholders on the first Monthly Payment
Date as applicable, following the Monthly
Collection Period during which such Early
Amortization Event or Rapid Amortization Event has
occurred to reduce the Certificate Principal
Balance. Following the occurrence of a Subsequent
Loan Purchase Termination Date, no additional
Subsequent Loans will be acquired by the Trust.
On each Monthly Payment Date specified by the
Transferor (each, a "Subsequent Transfer Date"),
the Transferor will be obligated to transfer
Subsequent Loans to the Trust, and the Trust will
be obligated to accept such transfer, subject to
the satisfaction of certain conditions described in
the Agreement and herein. See "THE CERTIFICATES--
Excess Funding Account" herein. The price to be
paid for any Subsequent Loan (the "Transfer Price")
will equal the unpaid principal balance of such
Subsequent Loan as of the first day of the month
(each, a "Subsequent Cut-off Date") in which such
Subsequent Transfer Date occurs. The Transfer Price
will be funded solely from withdrawals from the
Excess Funding Account to the extent funds are on
deposit therein after giving effect to any Excess
Funding Interest Transfer Amount. Such withdrawals
to fund the acquisition of Subsequent Loans will be
allocated first from the Excess Funding Principal
Subaccount until the amount allocated thereto has
been reduced to zero, and then from the Excess
Funding Interest Subaccount. Pending application
thereof, amounts on deposit in the Excess Funding
Account will be invested solely in Permitted
Investments that mature on or before the Deposit
Date. The Pool Balance will increase on each
Subsequent Transfer Date by the aggregate amount of
the unpaid principal balances of the Subsequent
Loans as of the related Subsequent Cut-off Date
transferred on such Subsequent Transfer Date but
the Invested Amount will not be affected by such
transfer because the Excess Funding Account will be
reduced by the aggregate amount of such unpaid
principal balances.
The Transferor will only be obligated to transfer
Subsequent Loans to the Trust in the principal
amounts specified herein and only to the extent it
originates or acquires such Subsequent Loans which
comply with the requirements for transfer to the
Trust. The failure of the Transferor to transfer
Subsequent Loans during any Monthly Collection
Period that are sufficient to reduce the amounts
allocated to the Excess Funding Principal
Subaccount to zero may result in there being
negative carry with respect to the amounts on
deposit in the Excess Funding Principal Subaccount
as of the last day of such Monthly Collection
Period. In such circumstances, the failure of the
Transferor to deposit the Negative Carry Deposit
Amount with the Trustee will result in an Early
Amortization Event. See "RISK FACTORS--Transfer of
Subsequent Loans" herein.
S-22
<PAGE>
Termination of the Trust;
Optional Termination.....
The Trust will terminate on the Monthly Payment
Date following the later of (a) payment in full of
all amounts owing to the Certificate Insurer and
(b) the earliest of (i) the Monthly Payment Date on
which the Certificate Principal Balance has been
reduced to zero, (ii) the Dissolution Distribution
Date and (iii) the Stated Maturity Date. The
Certificates will be subject to optional retransfer
by the Transferor on any Distribution Date after
the Certificate Principal Balance is reduced to an
amount less than or equal to $7,676,050 (5% of the
Initial Certificate Principal Balance) and all
amounts due and owing to the Certificate Insurer
and unreimbursed draws on the Policy, together with
interest thereon, as provided under the Insurance
Agreement, have been paid. The purchase price will
be equal to the sum of the outstanding Certificate
Principal Balance and accrued and unpaid interest
thereon at the Certificate Rate through the day
preceding the final Distribution Date. See "FURTHER
PROVISIONS OF THE POOLING AND SERVICING AGREEMENT--
Optional Termination; Retirement of the
Certificates" herein.
In addition, the Trust may be liquidated as a
result of certain events of insolvency,
receivership or conservatorship relating to the
Transferor. See "THE CERTIFICATES--Rapid
Amortization Period; Rapid Amortization Events"
herein.
Servicing Fee............. The Servicer will receive a fee on each Monthly
Payment Date (the "Servicing Fee") equal to the
product of one-twelfth of the Servicing Fee Rate
and the Pool Balance as of the opening of business
on the first day of the related Monthly Collection
Period. In addition, the Servicer may retain out of
collections on the Loans any late fees, prepayment
fees, rebates, and other administrative fees and
expenses collected during such month. See "THE
CERTIFICATES--Servicing Fee and Trustee's Fees"
herein.
Mandatory Retransfer or
Substitution of Loans....
The Transferor or the Servicer (in certain
circumstances), as the case may be, has the option
either to accept a retransfer of a Loan, in the
case of the Transferor, or transfer, in the case of
the Servicer, on account of (A) a material breach
of a representation or warranty made by the
Transferor in the Agreement, (B) a material defect
in the related loan documentation or (C) a change
in certain terms of the related Loan unless such
change was permitted as described under "FURTHER
PROVISIONS OF THE POOLING AND SERVICING AGREEMENT--
Collection and Other Servicing Procedures herein
(each Loan described in (A) through (C) above, a
"Defective Loan") or substitute new Loans for such
Loans. Any Loan so substituted (an "Eligible
Substitute Loan") must have an unpaid principal
balance as of its substitution date of not less
than 95% of the unpaid principal balance of the
Defective Loan as of such date, pay interest at a
rate of not less than the current rate of the
Defective Loan and not more than 100 basis points
in excess thereof, have a remaining term to
maturity not later than nor more than six months
earlier than the remaining term to maturity of the
Defective Loan, and have a mortgage in a lien
position
S-23
<PAGE>
not junior to the lien position of the Mortgage of
such Defective Loan. Any such retransfer, transfer
or substitution will take place on the Business Day
prior to the Monthly Payment Date following the
Monthly Collection Period during which the
applicable cure period has expired. See "THE
CERTIFICATES--Assignment of Loans" herein.
Federal Tax In the opinion of special federal tax counsel to
Considerations............ the Transferor, under existing law the Certificates
are properly characterized as debt for federal
income tax purposes as of the Closing Date. Under
the Agreement, the Transferor and the
Certificateholders will agree to treat the
Certificates as indebtedness for federal, state and
local income and franchise tax purposes. See
"FEDERAL INCOME TAX CONSIDERATIONS" herein and in
the Prospectus.
ERISA Considerations...... No Certificates may be purchased for, or on behalf
of, any employee benefit plan or other retirement
arrangement which is subject to Title I of the
Employee Retirement Income Security Act of 1974, as
amended, and/or Section 4975 of the Internal
Revenue Code of 1986, as amended, or any entity
whose underlying assets include plan assets by
reason of such plan or account investing in such
entity (including insurance company separate or
general accounts and collective investment funds).
By its acceptance of a Certificate, each
Certificateholder will be deemed to have
represented and warranted that it is not subject to
the foregoing limitations. See "ERISA
CONSIDERATIONS" herein and in the Prospectus.
Legal Investment Although, as a condition to their issuance, the
Considerations............ Certificates will be rated in the highest rating
category by a Rating Agency, the Certificates will
not constitute "mortgage related securities" for
purposes of the Secondary Mortgage Market
Enhancement Act of 1984 ("SMMEA"), because not all
of the Loans are secured by first liens.
Accordingly, many institutions with legal authority
to invest in comparably rated securities based on
first mortgage loans (i.e., "mortgage related
securities" under SMMEA) may not be legally
authorized to invest in the Certificates. See
"LEGAL INVESTMENT CONSIDERATIONS" herein and "LEGAL
INVESTMENT" in the Prospectus.
Rating.................... It is a condition to the issuance of the
Certificates that they be rated in the highest
rating category by at least one nationally
recognized statistical rating organization (the
"Rating Agency"). The rating of the Certificates
will depend primarily on an assessment by a Rating
Agency of the creditworthiness of the underlying
Loans and the claims paying ability of the
Certificate Insurer and in part on the funds on
deposit in the Reserve Fund and the level of
overcollateralization provided by the
Overcollateralization Amount. There can be no
assurance that the rating assigned to the
Certificates on the Closing Date will not be
reduced, suspended or withdrawn by a Rating Agency
in the future. See "RISK FACTORS--Ratings Are Not
Recommen- dations" in the Prospectus.
S-24
<PAGE>
RISK FACTORS
Prospective investors should consider, in addition to the factors described
under "RISK FACTORS" in the accompanying Prospectus, the following additional
risk factors in connection with a purchase of the Certificates.
APPROACH TO UNDERWRITING MAY AFFECT LIQUIDATION PROCEEDS
Those Initial Loans which are secured primarily by second or third deeds of
trust or mortgages may have combined loan-to-value ratios in excess of 100%.
Loans secured by second or third mortgages are entitled to proceeds that
remain from the sale of the related Mortgaged Property after any related
senior mortgage loan and prior statutory liens have been satisfied. The
Transferor has underwritten the Initial Loans, and will underwrite the
Subsequent Loans, based primarily upon each borrower's ability to repay such
Loan and not on the value of the collateral, if any. In the event of a
borrower default, the Servicer will make a determination as to whether to
foreclose on a particular Mortgaged Property based on the likely recovery of
Net Liquidation Proceeds. As a result of the Transferor's underwriting
standards, there may not be any additional value in the Mortgaged Property. In
addition, the Servicer will not advance any delinquent payments of principal
or interest in respect of the Loans. Due to the foregoing, in the event of a
Certificate Insurer Default, Certificateholders will most likely have to rely
solely on payments from the Obligors for repayment of the Certificates.
Although the Agreement requires the Transferor to deliver to the Trustee,
with respect to each Initial Loan, within 90 days after the Closing Date and,
with respect to each Subsequent Loan, within 30 days after the related
Subsequent Transfer Date, assignments of mortgages in recordable form or, in
certain circumstances, blanket assignments, such assignments will not be
required to be submitted for recordation unless (x) the Certificate Insurer or
the Servicer determines in its reasonable judgment that such recordation is
necessary to foreclose on a Mortgaged Property relating to a Liquidated Loan
and that foreclosing on such Mortgaged Property will maximize the receipt of
Net Liquidation Proceeds with respect to such Liquidated Loan, or (y) the
Transferor fails to be adequately capitalized, as determined pursuant to the
regulations of the Office of Thrift Supervision and as of any Determination
Date following any such failure, (i) if during the Revolving Period, there is
no Overcollateralization Deposit/Distribution Amount (calculated without
including any Negative Carry Deposit Amount in Interest Collections for the
related Monthly Collection Period) for the related Monthly Collection Period
and the Overcollateralization Account for the related Monthly Payment Date is
less than the Required Overcollateralization Amount for such Monthly Payment
Date, and (ii) at any time thereafter, the Overcollateralization Amount is
less than the Required Overcollateralization Amount, in which case the Trustee
shall record all or any portion of such assignments as and when directed by
the Certificate Insurer. Unless and until such assignments are recorded, the
Trustee may not have a perfected lien on the related Mortgaged Properties and
the lack of recording may affect the Trustee's ability to realize on such
Mortgaged Properties. See "RISK FACTORS--Property Values May Be Insufficient"
in the Prospectus.
YIELD AND PREPAYMENT RISKS
The weighted average life of the Certificates will be affected by the
occurrence of an Early Amortization Event, a Rapid Amortization Event, the
operation of the overcollateralization provisions of the Agreement and the
rate of principal payments (including prepayments) of the Loans during the
Amortization Period or the Rapid Amortization Period. All of the Loans may be
prepaid in whole or in part at any time without penalty. Generally, Home Loans
are not viewed by borrowers as permanent financing. Accordingly, the Loans may
experience a higher rate of prepayment than traditional first mortgage loans.
The prepayment experience on the Loans may be affected by a wide variety of
factors, including general economic conditions, interest rates, the
availability of alternative financing and homeowner mobility. In addition, a
substantial portion of the Initial Loans contain, and a substantial portion of
Subsequent Loans are expected to contain, due-on-sale provisions; the Servicer
may enforce such provisions unless such enforcement is not permitted by
applicable law. See "CERTAIN LEGAL ASPECTS OF THE LOANS--Due-on-Sale Clauses
in Mortgage Loans" in the Prospectus. In addition, prepayments (or, for this
purpose, equivalent payments to the Trust) may result from liquidations due to
default,
S-25
<PAGE>
the receipt of Insurance Proceeds, retransfers to the Transferor or transfers
to the Servicer as a result of certain breaches of the Agreement, payments of
a Substitution Adjustment Amount, or the exercise by the Transferor of its
optional purchase.
The overcollateralization provisions of the Agreement may affect the timing
of receipt of payments in reduction of the Certificate Principal Balance
during the Amortization Period, an Early Amortization Period or a Rapid
Amortization Period. The application of Overcollateralization
Deposit/Distribution Amounts, if any, and the reimbursement of prior Excess
Funding Interest Transfer Amounts will shorten the weighted average life of
the Certificates, as will the distribution to Certificateholders of amounts on
deposit in the Excess Funding Account following an Early Amortization Event, a
Rapid Amortization Event and the distribution of such amounts on the first
Distribution Date following the Distribution Date on which the Certificate
Principal Balance has been reduced to 20% or less of the Initial Certificate
Principal Balance. However, if there is an Excess Overcollateralization
Amount, collections in respect of principal otherwise available for
distribution to Certificateholders will be distributed to the Transferor,
thereby extending the weighted average life of the Certificates. In addition,
any Principal Collections allocated to reimburse the Certificate Insurer will
reduce the amount of principal otherwise available to Certificateholders even
during the Amortization Period unless or until the Funding Principal
Percentage is 0%, a portion of the collections on the Loans will be deposited
in the Excess Funding Account to purchase Subsequent Loans.
As a result of the interaction of the foregoing factors, it may be difficult
to predict the weighted average life of, and the resulting yield to maturity
on, the Certificates. None of the Transferor, the Servicer, the Trustee, the
Certificate Insurer or the Underwriters make any representation as to the
weighted average life of, or yield to maturity on, the Certificates.
GEOGRAPHIC CONCENTRATION
As of the Initial Cut-off Date, Obligors with respect to 26.44%, 58.81%,
10.51% and 2.58% of the Loans (based on the Original Pool Balance of the
Initial Loans and mailing addresses of the Obligors thereon as of the date of
origination) were located in Maryland, Virginia, North Carolina and the
District of Columbia, respectively. After giving effect to each transfer of
Subsequent Loans to the Trust, these percentages may vary. Adverse economic
conditions in Maryland, Virginia, North Carolina or the District of Columbia
may affect the delinquency, loan loss and foreclosure experience of the Trust
with respect to the Loans. No predictions, however, can be made regarding
future economic conditions in Maryland, Virginia, North Carolina or the
District of Columbia or any other states where the Obligors reside. See "THE
HOME LOAN POOL" herein.
BOOK-ENTRY REGISTRATION MAY AFFECT LIQUIDITY
Issuance of the Certificates in book-entry form may reduce the liquidity of
such Certificates in the secondary trading market since investors may be
unwilling to purchase Certificates for which they cannot obtain physical
securities.
Since transactions in the Certificates can be effected only through DTC,
participating organizations, indirect participants and certain banks, the
ability of a Certificate Owner to pledge a Certificate to persons or entities
that do not participate in DTC, or otherwise to take actions in respect of
such Certificates, may be limited due to lack of a physical security
representing the Certificates.
Certificate Owners may experience some delay in their receipt of
distributions of interest and principal on the Certificates since such
distributions will be forwarded by the Trustee to DTC, and DTC will credit
such distributions to the accounts of its participating organizations which
will thereafter credit them to the accounts of Certificate Owners either
directly or indirectly through indirect participants. See "CERTAIN INFORMATION
REGARDING THE CERTIFICATES" herein.
TAXATION
In the opinion of special federal tax counsel to the Transferor, the
Certificates are properly characterized as debt for Federal income tax
purposes. If the IRS were to contend successfully that the Certificates were
not debt obligations for Federal income tax purposes, the arrangement among
the Transferor and the Certificateholders might be classified for Federal
income tax purposes as either a partnership (including a publicly traded
partnership) or an association taxable as a corporation that owns the Loans.
See "FEDERAL INCOME TAX CONSIDERATIONS" herein and in the Prospectus.
S-26
<PAGE>
RATING OF CERTIFICATES; POSSIBILITY OF WITHDRAWAL OR DOWNGRADING
The rating of the Certificates will depend primarily on assessment by the
Rating Agency of the creditworthiness of the Loans and upon the claims-paying
ability of the Certificate Insurer and in part on the funds on deposit in the
Reserve Fund and the level of overcollateralization. Any reduction in a rating
assigned to the claims-paying ability of the Certificate Insurer below the
rating initially given to the Certificates may result in a reduction in the
rating of the Certificates. The rating by the Rating Agency of the
Certificates is not a recommendation to purchase, hold or sell the
Certificates, inasmuch as such rating does not comment as to the market price
or suitability for a particular investor. There is no assurance that the
ratings will remain in effect for any given period of time or the ratings will
not be lowered or withdrawn by the Rating Agency. In general, the ratings
address credit risk and do not address the likelihood of prepayments.
TRANSFER OF SUBSEQUENT LOANS
Each Subsequent Loan must satisfy the eligibility criteria set forth in the
Agreement. However, Subsequent Loans may be originated or acquired by the
Transferor using credit criteria different from those which were applied to
the Initial Loans and may be of a different credit quality. Therefore,
following the transfer of Subsequent Loans to the Trust, the aggregate
characteristics of the Loans then held by the Trust may vary materially from
those of the Initial Loans.
The ability of the Trust to invest in Subsequent Loans is largely dependent
upon whether the Transferor is able to originate or acquire Home Loans which
meet the requirements for transfer under the Agreement. The ability of the
Transferor to originate or acquire such Loans is affected by a variety of
social and economic factors, which include interest rates, unemployment
levels, the rate of inflation and consumer perception of economic conditions
generally.
If a Subsequent Loan Purchase Termination Date occurs no additional
Subsequent Loans will be acquired by the Trust, no further deposits will be
made to the Excess Funding Account, and amounts on deposit therein will be
distributed to Certificateholders thereby resulting in an acceleration of
payments of principal to Certificateholders as described herein. Any such
acceleration may adversely affect the yield to maturity of the Certificates.
Since prevailing interest rates are subject to fluctuation, there can be no
assurance that investors will be able to reinvest such payments at yields
equaling or exceeding the yields on the Certificates. It is possible that the
yield on any such reinvestment will be lower, and may be significantly lower,
than the yield on the Certificates.
INSOLVENCY-RELATED MATTERS
Perfection of Security Interest. The Transferor intends that the transfer of
all of the Transferor's right, title and interest in the Loans to the Trust be
treated as a sale by the Transferor to the Trust under New York law and,
accordingly, that such Loans will not be part of the assets of the Transferor
in the event of the appointment of a receiver or conservator for the
Transferor and will not be available to the creditors of the Transferor. In
the event of an insolvency of the Transferor, however, it is possible that a
receiver or a conservator for, or a creditor of, the Transferor may argue that
the transaction between the Transferor and the Trust was a pledge of each such
Loan in connection with a borrowing by the Transferor, rather than a sale. If
the transfer by the Transferor to the Trust of the Loans is deemed to be a
grant to the Trust of a security interest in the Loans, the Trust should have
an enforceable first priority perfected security interest in the Loans (except
with respect to any provisions of the Loans which purport to encumber assets
as collateral for such Loans and any rights to enforcement with respect to
such assets). If a receiver or conservator were appointed for the Transferor,
certain administrative expenses of the receiver or conservator may have
priority over the Trust's right, title and interest in the Loans. For so long
as the Transferor is the Servicer, cash collections on the Loans may be held
by the Transferor and commingled with its funds until transferred to the
Collection Account within two Business Days of receipt thereof, and in an
insolvency proceeding or receivership or conservatorship of the Transferor,
the Trust may not have a perfected interest in such commingled collections.
Intervention of FDIC. In the event that the Transferor's transfer of the
Loans to the Trust is deemed to constitute the creation of a security interest
in the Loans in favor of the Trust such security interest to the extent
S-27
<PAGE>
it was validly perfected before the Transferor's insolvency and was not taken
in contemplation of insolvency of the Transferor, or with the intent to
hinder, delay or defraud the Transferor or the creditors of the Transferor,
the Federal Deposit Insurance Act ("FDIA"), as amended by the Financial
Institutions Reform, Recovery, and Enforcement Act of 1989, as amended
("FIRREA"), provides that such security interest should not be subject to
avoidance by the Federal Deposit Insurance Corporation (the "FDIC"), as
receiver for the Transferor. Subject to clarification by regulations or
interpretations, positions taken by the FDIC staff prior to the passage of
FIRREA do not suggest that the FDIC, as receiver or conservator for the
Transferor, would interfere with the timely transfer to the Trust of payments
collected on the related Loans. If, however, the FDIC were to assert a
contrary position, such as requiring the Trustee to establish its right to
those payments by submitting to and completing the administrative claims
procedure under the FDIA, or the conservator or receiver were to request a
stay of proceedings with respect to the Transferor, as provided under the
FDIA, delays in payments on the Certificates and possible reductions in the
amount of those payments could occur. A receiver or conservator also may
disaffirm or repudiate the Transferor's obligations under the Agreement to
accept reassignment of Defective Loans or to accept reassignment of the Loans
or other provisions of the Agreement. In addition, in the case of an Event of
Default relating to the conservatorship or receivership of the Servicer, the
receiver or conservator may have the power either to terminate the Servicer
and replace it with a successor Servicer or to prevent the termination of the
Servicer and its replacement with a successor Servicer if no Event of Default
exists other than the receivership, conservatorship or insolvency of the
Servicer.
Effect of Insolvency. If a conservator or receiver were appointed for the
Transferor, then a Rapid Amortization Event would occur with respect to the
Certificates then outstanding. Pursuant to the Agreement, Subsequent Loans
would not be transferred to the Trust, and the Trustee would (unless otherwise
instructed by 51% of the Certificateholders and any person designated by the
Transferor to the Trustee prior to the time such conservator or receiver was
appointed) terminate the Trust and sell the Loans. Unless a Certificate
Insurer Default (as defined herein) has occurred, the Certificate Insurer will
have the power to make such instruction to the Trustee on behalf of the
Certificateholders and such person designated by the Transferor to the
Trustee. Certificateholders will suffer a loss if a Certificate Insurer
Default (as defined herein) has previously occurred and the net proceeds of
such sale are insufficient to pay the Certificateholders in full. If a Rapid
Amortization Event occurs involving either the insolvency of the Transferor or
the appointment of a conservator or receiver for the Transferor, the
conservator or receiver may have the power to prevent the early sale,
liquidation or disposition of the Loans and the commencement of the Rapid
Amortization Period. A conservator or receiver may also have the power to
cause the early sale of the Loans and the early retirement of the Certificates
or to prohibit the continued transfer of Subsequent Loans to the Trust.
THE TRANSFEROR
The Transferor is a federally chartered stock savings bank. The Transferor's
executive offices are located at 8401 Connecticut Avenue, Chevy Chase,
Maryland 20815, and the Transferor's telephone number is (301) 986-7000. The
Transferor is subject to comprehensive regulation, examination and supervision
by the Office of Thrift Supervision ("OTS") within the Department of the
Treasury and the FDIC. Deposits at the Transferor are fully insured up to
$100,000 per insured depositor by the Savings Association Insurance Fund
("SAIF"), which is administered by the FDIC.
At March 31, 1996, the Transferor had consolidated assets of approximately
$5.1 billion, deposits of approximately $4.3 billion, and stockholders' equity
of approximately $344.5 million. As a savings bank chartered under the laws of
the United States, the Transferor is subject to certain minimum regulatory
capital requirements imposed under FIRREA. At March 31, 1996, the Transferor
was in compliance with all such regulatory capital requirements in effect at
that date. In addition, the Transferor's capital ratios at March 31, 1996 were
sufficient for the Transferor to meet the ratios established for "well
capitalized" institutions pursuant to "prompt corrective action" regulations
promulgated by the OTS pursuant to the Federal Deposit Insurance Corporation
Improvement Act of 1991. On the basis of its balance sheet at March 31, 1996,
the Transferor also met the FIRREA-mandated fully phased-in capital
requirements (which take into account the phase-out of certain assets from
regulatory capital after June 30, 1996), and on fully phased-in basis, met the
ratios established for "well capitalized" institutions under the prompt
corrective action regulations.
S-28
<PAGE>
Because of the continued improvement in the financial condition of the Bank,
on March 29, 1996, the OTS released the Bank from certain restrictions and
requirements contained in an agreement with the OTS, which had been amended in
October 1993. In connection with the termination of the written agreement at
the request of the OTS, the Board of Directors of the Bank has adopted a
resolution that addresses certain issues previously addressed by the written
agreement. The resolution also provides that the Bank will present a plan
annually to the OTS detailing anticipated consumer loan securitization
activity.
Institutions insured by the SAIF, including the Transferor, pay higher
deposit insurance premiums than similarly-situated institutions insured by the
Bank Insurance Fund ("BIF"). Legislation designed to reduce or eliminate the
disparity between BIF and SAIF insurance premiums by, among other things,
imposing on thrift institutions, including the Transferor, a one-time
assessment estimated to be up to 85 basis points on their SAIF- insured
deposits to capitalize the SAIF was included in budget legislation which
passed Congress in November 1995 and was vetoed for other reasons by President
Clinton in December 1995. This legislation would also eliminate a provision of
the Internal Revenue Code that permits thrifts that meet certain requirements,
including the Transferor, to establish reserves for bad debts and to deduct
each year reasonable additions to those reserves in lieu of taking a deduction
for bad debts actually sustained during the taxable year. Congress is also
considering legislation that would, among other things: (i) abolish the OTS
and transfer its functions to other agencies, and (ii) require federally
chartered thrifts, including the Transferor, to convert to national bank or
state bank or thrift charters. It cannot be determined whether, or in what
form such legislation will eventually be enacted.
THE TRUST
The Trust will be formed in accordance with the laws of the State of New
York pursuant to the Agreement, and will be the issuer of the Certificates.
Prior to its formation, the Trust will have no assets or obligations. The
Trust will not engage in any business activity other than acquiring and
holding the Initial Loans and the Subsequent Loans, issuing the Certificates
and making payments thereon. The Trust does not expect to have any additional
capital resources.
USE OF PROCEEDS
The net proceeds to be received from the sale of the Certificates will be
paid to the Transferor and the Transferor will use such proceeds for its
general corporate purposes.
THE CHEVY CHASE HOME LOAN PROGRAM
Chevy Chase has originated and acquired Home Loans since 1988. All of the
Home Loans are serviced by Chevy Chase.
LOAN PROGRAMS
Chevy Chase operates three loan programs within its Home Improvement Loan
Department: Indirect Home Improvement Loans, Indirect Debt Consolidation
Loans, and Direct Home Improvement Loans (collectively, the "Home Loans").
"Indirect Home Improvement Loans" are installment sales contracts and
installment loan agreements originated by home improvement contractors and
assigned to Chevy Chase. These contractors, operating in the mid-Atlantic
region, have been approved by Chevy Chase based upon a review assessing their
financial condition, industry reputation and trade references. Indirect Home
Improvement Loans are either unsecured or secured by deeds of trust or
mortgages, which are generally subordinate to other mortgages on the same
residential properties.
S-29
<PAGE>
"Indirect Debt Consolidation Loans" are closed-end home equity loans
purchased by Chevy Chase which were originated by licensed mortgage companies.
These mortgage companies, operating in the mid-Atlantic region, have been
approved by Chevy Chase based upon a review assessing their industry
reputation, financial condition and trade references. Indirect Debt
Consolidation Loans are secured by deeds of trust or mortgages, which are
generally subordinate to other mortgages on the same residential properties.
"Direct Home Improvement Loans" are installment loan agreements originated
by Chevy Chase which are secured by deeds of trust or mortgages, which are
generally subordinate to other mortgages on the same residential properties.
Each Initial Loan which is a Direct Home Improvement Loan was originated in
connection with the construction of an in-ground swimming pool; Subsequent
Loans which are Direct Home Improvement Loans may be originated in connection
with other home improvements.
UNDERWRITING PROCEDURES
Each Home Loan was purchased or originated by Chevy Chase after a review in
accordance with its established underwriting procedures.
The underwriting procedures of Chevy Chase are designed to provide a basis
for assessing the borrower's ability and willingness to repay the loan. In
conducting this assessment, Chevy Chase considers the borrower's ratio of debt
to income and evaluates the borrower's credit history through a review of a
written credit report compiled by a recognized consumer credit reporting
bureau. The borrower's equity in the collateral and the terms of the loan are
of secondary importance in Chevy Chase's analysis. For Home Loans secured by
mortgaged properties, Chevy Chase's guidelines provide for financing up to
115% of the value of the mortgaged property. Generally, the value of each
mortgaged property is determined by Chevy Chase based on the purchase price of
the mortgaged property if the Home Loan is originated within two years of such
purchase or, if the Home Loan is originated after two years of such purchase,
based on the purchase price, recent tax assessments and other relevant
factors. Chevy Chase's guidelines are intended only to provide a basis for
lending decisions, and exceptions to such guidelines may, within certain
limits, be made based upon the credit judgment of the lending officer. Chevy
Chase conducts quality audits to ensure compliance with its established
policies and procedures.
FUNDING REQUIREMENTS
Indirect Home Improvement Loans. Prior to funding (to the originating home
improvement contractor) an Indirect Home Improvement Loan, Chevy Chase
requires the borrower to sign a certificate of completion which indicates that
the project has been completed to the borrower's satisfaction. Chevy Chase
then contacts each borrower by phone in order to review the terms and
conditions of the loan and reconfirm that all work was completed according to
the terms of the contractor's agreement with the borrower. Following receipt
of the certificate of completion and telephone validation, Chevy Chase will
fund the loan.
Chevy Chase offers borrowers the option to extend the contractual period
between an Indirect Home Improvement Loan's funding date and its first
scheduled due date (the "Deferral Period") to 90 days for all Indirect Home
Improvement Loans and 180 days for Indirect Home Improvement Loans with
original principal balances of $5,000 or greater. Interest will accrue on the
original principal balance of such Loan during the Deferral Period regardless
of its length. The Loan will be considered current unless the borrower fails
to make the first scheduled payment on its contractual due date. Scheduled
payments will commence on the first contractual due date of the Loan and
continue each month thereafter.
Indirect Debt Consolidation Loans. Prior to funding (to the originating
mortgage company) an Indirect Debt Consolidation Loan, Chevy Chase verifies
that the consolidated debts have been paid off by reconciling copies of the
pay-off checks from the mortgage company to the respective creditors against
those debts listed on the borrower's credit bureau report, the original loan
application and the HUD-1A settlement statement. Chevy Chase re-confirms that
the borrower's resulting ratio of debt to income is within its guidelines.
S-30
<PAGE>
Chevy Chase offers borrowers the option to extend the contractual period
between an Indirect Debt Consolidation Loan's funding date and its first
scheduled due date to 90 days. Interest will accrue on the original principal
balance of such Loan during the Deferral Period regardless of its length. The
Loan will be considered current unless the borrower fails to make the first
scheduled payment on its contractual due date. Scheduled payments will
commence on the first contractual due date of the Loan and continue each month
thereafter.
Direct Home Improvement Loans. Direct Home Improvement Loans are funded with
two-party checks, payable to both the borrower and the home improvement
contractor. Checks are issued in incremental amounts representing completion
of various stages of the construction. The borrower endorses the checks as
these construction stages are completed.
ALL HOME LOANS
Chevy Chase requires the following documents in each Home Loan package (as
applicable):
. Original application;
. Original rescission notice and/or right to cancel;
. Original installment sales contract or installment loan agreement;
. Original deed of trust/mortgage;
. Real Estate Settlement Procedures Act documents;
. Original certificate of completion;
. Copy of contractor's work order; and
. Proof of income documentation.
Funds are disbursed to the home improvement contractors, mortgage companies
and direct loan borrowers by cashier's check. All Chevy Chase loan files are
reviewed for credit quality, documentation and completeness by the
Funding/Compliance Section within the Home Improvement Department. In addition
to this internal review by the Funding/Compliance Section, the Front-End
Quality Control area of the Consumer Loan Servicing Department verifies all
contracts for accuracy and compliance prior to the booking process.
PERFECTION OF SECURITY INTEREST
Each secured Home Loan contract contains, or is accompanied by a security
agreement, deed of trust or mortgage containing a clause granting Chevy Chase
a security interest in the property being improved, which is generally the
borrower's primary residence. This security interest must be perfected by
recordation of the lien in the land records office of the jurisdiction in
which the property is located.
HOMEOWNER'S INSURANCE AND TITLE REQUIREMENTS
Chevy Chase requires that customers insure all collateral against fire and
theft with a physical damage policy naming Chevy Chase as a loss payee. Chevy
Chase obtains a property and judgement report on the mortgaged property from
its title agent, which confirms the last deed of record and any liens filed
against that deed. The property and judgment report is insured under the title
agent's errors and omissions coverage for up to $15,000 for a period of one
year from the date of settlement. If the loan exceeds $60,000, Chevy Chase
generally requires title insurance on the mortgaged property. Chevy Chase will
generally permit subordination of its lien at the request of a borrower
insofar as this action does not result in any additional risk to Chevy Chase.
Most lien subordination requests result from a borrower's interest in
refinancing a first mortgage in order to obtain a lower interest rate on that
mortgage.
S-31
<PAGE>
LOAN REVIEW PROCEDURES
The Consumer Loan Division maintains its own Loan Review Department which
completes a full quality control review of all Home Loans generated through
the Home Improvement Loan Department. The review focuses on adherence to loan
programs, the quality of credit decisions and the thoroughness of
documentation. On a monthly basis, this department issues summary reports to
divisional senior management that list exceptions. These exceptions are
entered into the loan servicing system for tracking purposes and are used to
provide performance feedback to the loan origination staff.
LOAN SERVICING
The Loan Servicing Department performs the following non-collections
oriented functions: (i) front-end quality control of the loan packages, (ii)
validation and discounting of the loan packages, (iii) data input into the
loan servicing system, (iv) validation of system data, (v) filing and control
of all documentation and collateral, (vi) account maintenance, (vii)
balancing, (viii) payoffs, and (ix) release of collateral.
All home improvement loan borrowers are issued coupon books which are mailed
to them within ten working days of booking the loan on the Florida Software
loan servicing system. The borrower may mail payments directly to the Chevy
Chase lockbox facility, the address of which is printed on the coupon book, or
may take payments to any Chevy Chase branch location. Chevy Chase believes
that more than 90% of all payment transactions are processed with payment
coupons.
COLLECTION PROCESS
Chevy Chase's Consumer Loan Division operates collections facilities in
Tysons Corner, Virginia and Greensboro, North Carolina. All home improvement
loan collections and recovery functions are performed from the Virginia
facility.
A loan is considered past due when the borrower fails to make a contractual
payment by its due date. A system-generated delinquency notice is mailed to
the borrower on the 10th day of delinquency. This notice indicates the amount
of the payment and the date on which it was due. Chevy Chase uses an automated
collections system which prioritizes a collector's daily queue of past due
accounts. The typical collections process is as follows:
Between the 10th and 19th day of delinquency, a collector will initiate
contact with the delinquent borrower and attempt to collect the past due
payment. Between the 20th and 29th day of delinquency, a more experienced
collector will contact the borrower and attempt to resolve the problem. On the
30th day of delinquency and thereafter, a unit manager assumes the
responsibility for collecting the account. By the 45th day of delinquency,
Chevy Chase sends a demand letter which notifies the delinquent borrower that
acceleration of the terms of the loan may result if all past due payments are
not received by Chevy Chase within ten days. By the 60th day of delinquency,
Chevy Chase sends an acceleration letter to the borrower. This letter states
that Chevy Chase has elected to accelerate maturity of the note and demands
payment of the entire principal balance within 72 hours following the date of
the letter. By the 70th day of delinquency, Chevy Chase determines whether to
refer the loan to a collections attorney who will initiate legal action. The
attorney will serve process to the borrower and proceed with those remedies
available to Chevy Chase under the terms of the note and applicable laws.
Chevy Chase generally charges off loans between the 90th and 120th day of
delinquency. All charged-off loans are reviewed by the Consumer Loan
Division's Senior Vice President and the Division's Charge-Off Committee.
In the event of a default on a first mortgage that is senior to any Home
Loan, Chevy Chase has the right to satisfy the defaulted senior mortgage in
full or to cure such default and bring the defaulted senior mortgage current.
Chevy Chase may take either of the foregoing actions or may refrain from
taking any action based upon reasonable commercial practice in the industry
and its customary servicing procedures. Chevy Chase has the right to add
amounts expended in connection with any satisfaction or cure of a default to
the outstanding principal
S-32
<PAGE>
balance for such Home Loan. See "CERTAIN LEGAL ASPECTS OF THE LOANS--
Foreclosure on Mortgages and Deeds of Trust" and "--Junior Mortgages; Rights
of Senior Mortgages" in the Prospectus.
DELINQUENCY AND LOSS EXPERIENCE
The following tables set forth the delinquency and loss experience for each
of the periods shown for Chevy Chase's portfolio of Home Loans. Chevy Chase
believes that there have been no material trends or anomalies in the
historical delinquency and loss experience as represented in the following
tables. The Loans have been selected from these Home Loans based upon the
selection criteria shown below in "THE HOME LOAN POOL."
DELINQUENCY EXPERIENCE(1)
CHEVY CHASE HOME LOAN PORTFOLIO
<TABLE>
<CAPTION>
AS OF DECEMBER 31, AS OF
-------------------------------------------------- MARCH 31,
1992 1993 1994 1995 1996
---------- ----------- ----------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Number of Home Loans
Serviced................ 1,064 1,791 6,965 13,298 14,829
Aggregate Principal
Balances of Home Loans
Serviced............... $7,391,788 $11,330,922 $52,345,891 $133,193,889 $155,854,226
Principal Balance of
Home Loans 30-59 Days
Past Due(2)............ 111,708 182,789 712,284 1,405,990 1,745,162
Principal Balance of
Home Loans 60-89 Days
Past Due(2)............ 10,886 9,315 119,188 660,406 694,368
Principal Balance of
Home Loans 90 Days or
more Past Due(2)....... 0 17,679 117,820 444,935 859,306
Total Delinquencies (30
days or more past due)
as a Percentage of
Aggregate Principal
Balances of Home Loans
Serviced............... 1.66% 1.85% 1.81% 1.89% 2.12%
</TABLE>
- --------
(1) All amounts are as of period end. Delinquency figures do not include past
due amounts of $50.00 or less.
(2) Contractually past due.
LOAN LOSS EXPERIENCE CHEVY CHASE HOME LOAN PORTFOLIO
<TABLE>
<CAPTION>
THREE
TWELVE MONTHS ENDED MONTHS
DECEMBER 31, ENDED
---------------------------------------------- MARCH 31,
1992 1993 1994 1995 1996
----------- ---------- ----------- ----------- ------------
<S> <C> <C> <C> <C> <C>
Average Principal
Balance of
Home Loans(1).......... $10,036,482 $7,473,755 $27,517,334 $92,522,276 $148,086,480
Gross Charge Offs....... 149,616 40,993 197,990 1,601,268 733,797
Recoveries on Loans
Previously Charged
Off(2).................. 62,468 27,251 22,632 84,121 26,664
Net Charge Offs......... 87,148 13,742 175,358 1,517,147 707,133
Gross Charge Offs as a
Percentage of Average
Principal Balance....... 1.49% 0.55% 0.72% 1.73% 1.98%
Net Charge Offs as
Percentage of Average
Principal Balance....... 0.87% 0.18% 0.64% 1.64% 1.91%
</TABLE>
- --------
(1) Equals the arithmetic average of the preceding applicable month-end
principal balances.
(2) Includes current recoveries on receivables previously charged off.
S-33
<PAGE>
The above delinquency and loan loss experience represents Chevy Chase's
recent experience and has been provided for illustrative purposes only. Chevy
Chase's delinquency, foreclosure and net loss percentages may be affected by
the rapid growth in the size and relative lack of seasoning of the portfolio.
In addition, Chevy Chase can neither quantify the impact of property value
declines, if any, on the Home Loans nor predict whether, to what extent or how
long such declines may exist. In a period of such decline, the rates of
delinquencies, foreclosures and losses on the Home Loans could be higher than
those heretofore experienced in the mortgage lending industry in general.
Adverse economic conditions (which may or may not affect real property values)
may affect the timely payment by borrowers of scheduled payments of principal
and interest on the Home Loans and, accordingly, the actual rates of
delinquencies, foreclosures and losses. As a result, the information in the
above tables should not be considered as a basis for assessing the likelihood,
amount or severity of delinquencies or losses on the Home Loans and no
assurance can be given that the delinquency and loss experience presented in
the tables will be indicative of such experience on the Home Loans.
THE HOME LOAN POOL
The Trust Fund will initially include 12,966 Initial Loans, an assignment of
the Initial Mortgages, collections in respect of the Initial Loans received on
and after the Initial Cut-off Date, the Excess Funding Account, the Reserve
Fund, the Policy, the interest of the Trust in certain hazard insurance
policies maintained by the borrowers with respect to the Initial Mortgaged
Properties and the proceeds of the foregoing. On the Closing Date the Initial
Loans will have an aggregate unpaid principal balance as of May 1, 1996 (the
"Initial Cut-off Date") of $153,521,961.79, after giving effect to all
payments of principal thereon received prior to the Initial Cut-off Date (the
"Original Pool Balance").
The Trust Fund will also include Subsequent Loans on and after the related
Subsequent Cut-off Dates, assignments of the Subsequent Mortgages, collections
in respect of such Subsequent Loans on and after the related Subsequent Cut-
off Date, the interest of the Trust in certain hazard insurance policies
maintained by Obligors with respect to the Subsequent Mortgaged Properties and
certain other property relating to the Subsequent Loans. The Subsequent Loans
will be acquired by the Trust from the Transferor from monies to be deposited
in the Excess Funding Account as described herein. See "THE CERTIFICATES--
Excess Funding Account" herein. In addition, the Transferor may, subject to
certain limitations and conditions specified in the Agreement, cause the
retransfer from the Trust to it of certain Loans. See "THE CERTIFICATES--
Assignment of Loans" herein.
The obligation of the Trust to purchase the Subsequent Loans is subject to
the satisfaction of the following requirements as of the related Subsequent
Transfer Date, as certified to the Trustee in an officer's certificate of the
Transferor delivered on such Subsequent Transfer Date: (i) such Subsequent
Loans (collectively and individually) satisfy the representations and
warranties specified in the Agreement; (ii) the weighted average Loan Rate of
the Subsequent Loans is not less than 13.65%; (iii) the weighted average
original term of the Subsequent Loans is not greater than 138 months; (iv) not
more than 13.82% of the Subsequent Loans are unsecured; (v) not more than
4.77% of the Subsequent Loans are Paid-Ahead Loans (as defined below) (items
(ii)-(v) being calculated based on the principal balance of each Subsequent
Loan being transferred on such date and each Subsequent Loan previously
transferred as of the related Subsequent Transfer Date, in each case as of the
related Subsequent Cut-off Date); (vi) each Subsequent Loan will have a Loan
Rate of at least 6.00%; (vii) as of the related Subsequent Cut-off Date, no
Subsequent Loan being transferred on such Subsequent Transfer Date was
delinquent more than 29 days; (viii) as of the related Subsequent Cut-off
Date, the Transferor will not have received any notice that an Obligor on a
Subsequent Loan is the subject of a bankruptcy proceeding; (ix) as of the
related Subsequent Cut-off Date, each Subsequent Loan will have a remaining
principal balance of not more than $100,000; (x) the last scheduled payment
date on the Subsequent Loan with the latest scheduled payment date will not be
later than April 30, 2015; (xi) no Subsequent Loan will be paid ahead more
than six payments as of the related Subsequent Cut-off Date; (xii) as of the
related Subsequent Cut-off Date, at least one scheduled payment shall have
been made on each Subsequent Loan or the next payment shall be due during the
month of the Subsequent Cut-off Date, and (xiii) each Subsequent Loan being
transferred on such Subsequent
S-34
<PAGE>
Transfer Date is a fixed rate, Simple Interest Loan, providing for level
monthly payments. Notwithstanding the foregoing, each of the foregoing
conditions other than condition (x) may be waived with the consent of the
Certificate Insurer. Each of the Subsequent Loans will have been originated or
acquired by Chevy Chase using the underwriting standards described under "THE
CHEVY CHASE HOME LOAN PROGRAM," as such standards may be modified from time to
time. In addition, funds may not be released from the Excess Funding Account
to acquire Subsequent Loans unless the conditions set forth under "THE
CERTIFICATES--Excess Funding Account" have been satisfied.
Because the Subsequent Loans may be originated after the Initial Loans,
following their conveyance to the Trust, the characteristics of the Loans,
including the Subsequent Loans, may vary from those of the Initial Loans. Each
Initial Loan which is a Direct Home Improvement Loan was originated in
connection with the construction of an in-ground swimming pool; Subsequent
Loans which are Direct Home Improvement Loans may be originated in connection
with other home improvements.
The Initial Loans were originated or acquired by Chevy Chase in the ordinary
course of its business. The Initial Loans were selected from Chevy Chase's
portfolio of Home Loans based on several criteria, including the following:
(i) as of the Initial Cut-off Date each Initial Loan has twelve or more
payments remaining; (ii) each Initial Loan has an outstanding principal
balance as of the Initial Cut-off Date equal to or greater than $1,500; (iii)
as of the Initial Cut-off Date, no Initial Loan was delinquent more than 29
days; and (iv) with respect to each Initial Loan (x) at least one scheduled
payment shall have been made or (y) such Initial Loan was originated within 45
days of the Initial Cut-off Date.
All of the Initial Loans are, and all of the Subsequent Loans will be,
Simple Interest Loans. A "Simple Interest Loan" is a Loan as to which interest
accrues on a simple interest method (i.e., the interest portion of each
monthly payment equals the interest on the outstanding principal balance of
the related Loan for the number of days since the most recent payment made on
such Loan and the balance, if any, of such monthly payment is applied to
principal).
The Obligors under the Initial Loans have billing addresses in 28 states. As
of the Initial Cut-off Date, approximately 26.44% of the Initial Loans, based
upon the aggregate principal balance of the Initial Loans (the "Original Pool
Balance"), had Obligors with billing addresses in the State of Maryland,
approximately 58.81% had Obligors with billing addresses in the State of
Virginia, approximately 10.51% had Obligors with billing addresses in the
State of North Carolina and approximately 2.58% had Obligors with billing
addresses in the District of Columbia. Each other state accounts for less than
1.66% of the Initial Loans, based upon the Original Pool Balance.
As of the Initial Cut-off Date, the Initial Loans had a minimum outstanding
principal balance of $1,500.00, a maximum outstanding principal balance of
$73,424.86, a remaining term to maturity of no less than 11 months and no
greater than 185 months, a weighted average remaining term to maturity of
104.32 months, the number of months since the date of origination is no less
than 0 months and no greater than 92 months, the weighted average numbers of
months since the date of origination is 10.30 months, a Loan Rate of no less
than 6.00% and no greater than 18.00% and a weighted average Loan Rate of
14.15%.
S-35
<PAGE>
Set forth below is a description of certain characteristics of the Initial
Loans as of the Initial Cut-off Date. All such information is approximate.
Prior to the Closing Date, Home Loans may be removed from the pool of those
Loans described below and other Home Loans may be substituted therefor. In
addition, Home Loans may be prepaid at any time. As a result, certain
characteristics of the Initial Loans may vary from those set forth below. The
columns may not add to 100% due to rounding.
INITIAL LOAN POOL STATISTICS
INITIAL CUT-OFF DATE PRINCIPAL BALANCES
<TABLE>
<CAPTION>
AGGREGATE
INITIAL CUT- % OF
RANGE OF INITIAL OFF DATE ORIGINAL
CUT-OFF DATE NUMBER OF PRINCIPAL POOL
PRINCIPAL BALANCES LOANS BALANCES BALANCE
------------------ --------- --------------- --------
<S> <C> <C> <C>
$ 1,500.00 to $ 2,499.99..................... 1,289 $ 2,624,285.08 1.71%
$ 2,500.00 to $ 4,999.99..................... 2,794 10,219,081.16 6.66
$ 5,000.00 to $ 7,499.99..................... 1,653 10,119,036.72 6.59
$ 7,500.00 to $ 9,999.99..................... 1,005 8,782,437.82 5.72
$10,000.00 to $12,499.99..................... 709 7,931,561.12 5.17
$12,500.00 to $14,999.99..................... 903 12,633,232.60 8.23
$15,000.00 to $17,499.99..................... 779 12,552,701.19 8.18
$17,500.00 to $19,999.99..................... 771 14,514,166.74 9.45
$20,000.00 to $22,499.99..................... 653 13,817,833.44 9.00
$22,500.00 to $24,999.99..................... 1,476 35,780,872.36 23.31
$25,000.00 to $27,499.99..................... 838 21,217,511.94 13.82
$27,500.00 to $29,999.99..................... 38 1,090,890.03 .71
$30,000.00 to $32,499.99..................... 13 399,649.63 .26
$32,500.00 to $34,999.99..................... 15 508,241.48 .33
$35,000.00 to $37,499.99..................... 7 253,034.06 .17
$37,500.00 to $39,999.99..................... 6 228,851.51 .15
$40,000.00 to $42,499.99..................... 2 83,208.53 .05
$42,500.00 to $44,999.99..................... 5 216,932.98 .14
$45,000.00 to $47,499.99..................... 3 139,694.37 .09
$47,500.00 to $49,999.99..................... 2 97,501.37 .06
$50,000.00 to $52,499.99..................... 1 52,431.38 .03
$52,500.00 to $54,999.99..................... 1 52,726.92 .03
$57,500.00 to $59,999.99..................... 1 59,429.49 .04
$72,500.00 to $74,999.99..................... 2 146,649.87 .10
------ --------------- ------
Total..................................... 12,966 $153,521,961.79 100.00%
====== =============== ======
</TABLE>
S-36
<PAGE>
INITIAL CUT-OFF DATE LOAN RATES
<TABLE>
<CAPTION>
AGGREGATE
INITIAL CUT- % OF
RANGE OF INITIAL OFF DATE ORIGINAL
CUT-OFF DATE NUMBER OF PRINCIPAL POOL
PRINCIPAL LOAN RATES LOANS BALANCES BALANCE
-------------------- --------- --------------- --------
<S> <C> <C> <C>
6.0000% to 6.9999%......................... 1 $ 4,756.41 .00%
7.0000% to 7.9999%......................... 2 4,004.32 .00
8.0000% to 8.9999%......................... 108 2,329,504.37 1.52
9.0000% to 9.9999%......................... 258 3,528,659.05 2.30
10.0000% to 10.9999%......................... 493 6,244,841.62 4.07
11.0000% to 11.9999%......................... 661 6,490,897.91 4.23
12.0000% to 12.9999%......................... 1,427 10,066,617.25 6.56
13.0000% to 13.9999%......................... 2,033 10,632,703.74 6.92
14.0000% to 14.9999%......................... 5,029 83,345,150.12 54.29
15.0000% to 15.9999%......................... 2,516 28,326,555.11 18.45
16.0000% to 16.9999%......................... 400 2,331,027.83 1.52
17.0000% to 17.9999%......................... 37 214,634.65 .14
18.0000% to 18.9999%......................... 1 2,609.41 .00
------ --------------- ------
Total..................................... 12,966 $153,521,961.79 100.00%
====== =============== ======
</TABLE>
GEOGRAPHICAL DISTRIBUTION OF INITIAL LOANS (1)
<TABLE>
<CAPTION>
INITIAL CUT-
OFF DATE
NUMBER OF PRINCIPAL % OF ORIGINAL
STATE LOANS BALANCES POOL BALANCE
----- --------- --------------- -------------
<S> <C> <C> <C>
District of Columbia.................... 624 $ 3,961,949.17 2.58%
Maryland................................ 4,012 40,588,585.05 26.44
North Carolina.......................... 797 16,135,166.55 10.51
Virginia................................ 7,121 90,293,687.98 58.81
Other................................... 412 2,542,573.04 1.66
------ --------------- ------
Total................................. 12,966 $153,521,961.79 100.00%
====== =============== ======
</TABLE>
- --------
(1) By billing address
S-37
<PAGE>
INITIAL CUT-OFF DATE REMAINING TERM TO MATURITY
<TABLE>
<CAPTION>
INITIAL CUT-
OFF DATE
RANGE OF REMAINING NUMBER OF PRINCIPAL % OF ORIGINAL
TERMS BY MONTHS LOANS BALANCES POOL BALANCE
------------------ --------- --------------- -------------
<S> <C> <C> <C>
11 to 11 Months...................... 2 $ 5,100.00 .00%
12 to 23 Months...................... 483 1,148,592.46 .75
24 to 35 Months...................... 1,157 3,632,729.75 2.37
36 to 47 Months...................... 1,819 7,091,513.26 4.62
48 to 59 Months...................... 1,207 6,269,489.61 4.08
60 to 71 Months...................... 840 5,392,176.01 3.51
72 to 83 Months...................... 746 5,375,006.80 3.50
84 to 95 Months...................... 248 2,274,025.16 1.48
96 to 107 Months...................... 1,632 26,016,447.19 16.95
108 to 119 Months...................... 3,928 77,845,684.16 50.71
120 to 131 Months...................... 392 8,222,352.78 5.36
132 to 143 Months...................... 20 248,568.91 .16
144 to 155 Months...................... 57 1,018,190.43 .66
156 to 167 Months...................... 179 3,777,673.14 2.46
168 to 179 Months...................... 221 4,481,923.30 2.92
180 to 185 Months...................... 35 722,488.83 .47
------ --------------- ------
Total................................ 12,966 $153,521,961.79 100.00%
====== =============== ======
</TABLE>
ORIGINATION YEAR OF INITIAL LOANS
<TABLE>
<CAPTION>
INITIAL CUT-
OFF DATE
NUMBER OF PRINCIPAL % OF ORIGINAL
ORIGINATION YEAR LOANS BALANCES POOL BALANCE
- ---------------- --------- --------------- -------------
<S> <C> <C> <C>
1988.................................... 15 $ 154,804.35 .10%
1989.................................... 69 798,022.79 .52
1990.................................... 38 316,368.21 .21
1993.................................... 500 3,074,376.59 2.00
1994.................................... 3,513 29,583,663.28 19.27
1995.................................... 6,685 87,302,315.11 56.87
1996.................................... 2,146 32,292,411.46 21.03
------ --------------- ------
Total................................. 12,966 $153,521,961.79 100.00%
====== =============== ======
</TABLE>
S-38
<PAGE>
THE CERTIFICATE INSURER
The following information has been obtained from Capital Markets Assurance
Corporation ("CapMAC") and has not been verified by Chevy Chase or the
Underwriters. No representation or warranty is made by Chevy Chase or the
Underwriters with respect thereto.
CapMAC is a New York-domiciled monoline stock insurance company which
engages only in the business of financial guarantee and surety insurance.
CapMAC is licensed in 50 states in addition to the District of Columbia, the
Commonwealth of Puerto Rico and the territory of Guam. CapMAC insures
structured asset- backed, corporate, municipal and other financial obligations
in the U.S. and international capital markets. CapMAC also provides financial
guarantee reinsurance for structured asset-backed, corporate, municipal and
other financial obligations written by other major insurance companies.
CapMAC's claims-paying ability is rated "Aaa" by Moody's Investor Service,
Inc., "AAA" by Standard & Poor's Structured Finance Ratings, a division of The
McGraw-Hill Companies, Inc., "AAA" by Duff & Phelps Credit Rating Co. and
"AAA" by Nippon Investors Service Inc. Such ratings reflect only the views of
the respective rating agencies, are not recommendations to buy, sell or hold
securities and are subject to revision or withdrawal at any time by such
rating agencies.
CapMAC is a wholly-owned subsidiary of CapMAC Holdings Inc. ("Holdings"). In
December of 1995, in connection with an initial public offering of its common
stock, Holdings became a public company with its common stock listed on the
New York Stock Exchange under the symbol "KAP." NEITHER HOLDINGS NOR ANY OF
ITS STOCKHOLDERS IS OBLIGATED TO PAY ANY CLAIMS UNDER ANY INSURANCE POLICY
ISSUED BY CAPMAC OR ANY DEBTS OF CAPMAC OR TO MAKE ADDITIONAL CAPITAL
CONTRIBUTIONS TO CAPMAC.
CapMAC is regulated by the Superintendent of Insurance of the State of New
York. In addition, CapMAC is subject to regulation by the insurance laws and
regulations of the other jurisdictions in which it is licensed. Such insurance
laws regulate, among other things, the amount of net exposure per risk that
CapMAC may retain, capital transfers, dividends, investment of assets, changes
in control, transactions with affiliates and consolidations and acquisitions.
CapMAC is subject to periodic regulatory examinations by the same regulatory
authorities.
CapMAC's obligations under the Policy may be reinsured. Such reinsurance
does not relieve CapMAC of any of its obligations under the Policy.
THE POLICY IS NOT COVERED BY THE PROPERTY/CASUALTY INSURANCE SECURITY FUND
SPECIFIED IN ARTICLE 76 OF THE NEW YORK INSURANCE LAW.
As at December 31, 1995 and 1994, CapMAC had qualified statutory capital
(which consists of policyholders' surplus and contingency reserve) of
approximately $240 million and $170 million, respectively, and had not
incurred any debt obligations. Article 69 of the New York State Insurance Law
requires CapMAC to establish and maintain the contingency reserve, which is
available to cover claims under insurance policies issued by CapMAC.
The audited financial statements of CapMAC prepared in accordance with
generally accepted accounting principles as of December 31, 1995, 1994 and
1993, and the unaudited financial statements of CapMAC as of March 31, 1996
and 1995 are made part of this Prospectus Supplement. Copies of CapMAC's
financial statements prepared in accordance with statutory accounting
standards, which differ from generally accepted accounting principles, and
filed with the Insurance Department of the State of New York are available
upon request from CapMAC. CapMAC is located at 885 Third Avenue, New York, New
York 10022, and its telephone number is (212) 755-1155.
S-39
<PAGE>
MATURITY AND PREPAYMENT CONSIDERATIONS
The Agreement provides that the Certificateholders will not receive payments
of principal until the Distribution Date in November, 1997 (i.e., the first
Distribution Date after the first Monthly Collection Period following the end
of the Revolving Period) or, if earlier, the first Monthly Payment Date after
the Monthly Collection Period in which an Early Amortization Event or a Rapid
Amortization Event occurs. During the Amortization Period, Certificateholders
will be entitled to receive payments of principal to the extent available on
each Distribution Date until the Certificate Principal Balance is reduced to
zero.
The weighted average life of the Certificates will be affected by the
occurrence of an Early Amortization Event, a Rapid Amortization Event, the
operation of the overcollateralization provisions of the Agreement, the rate
of principal payments (including prepayments) of the Loans during the
Amortization Period, an Early Amortization Period or a Rapid Amortization
Period and the availability of additional Home Loans for transfer as
Subsequent Loans. All of the Loans may be prepaid in whole or in part at any
time without penalty. Generally, Home Loans are not viewed by borrowers as
permanent financing. Accordingly, the Loans may experience a higher rate of
prepayment than traditional first mortgage loans. The prepayment experience on
the Loans may be affected by a wide variety of factors, including general
economic conditions, interest rates, the availability of alternative financing
and homeowner mobility. In addition, a substantial portion of the Loans
contain due-on-sale provisions, and the Servicer may enforce such provisions
unless such enforcement is not permitted by applicable law. See "CERTAIN LEGAL
ASPECTS OF THE LOANS--Due-on-Sale Clauses in Mortgage Loans" in the
Prospectus. In addition, prepayments (or, for this purpose, equivalent
payments to the Trust) may result from liquidations due to default, the
receipt of Insurance Proceeds, retransfers of Loans to the Transferor or
transfers of Loans to the Servicer as a result of certain breaches of the
Agreement, payments of a Substitution Adjustment Amount or the exercise by the
Transferor of its optional purchase.
No assurance can be given as to the level of prepayments that will be
experienced by the Trust and it can be expected that a portion of borrowers
will not prepay their Loans to any significant degree. See "DESCRIPTION OF THE
SECURITIES--Weighted Average Life of the Securities" in the Prospectus.
The overcollateralization provisions of the Agreement may affect the timing
of receipt of payments in reduction of the Certificate Principal Balance
during the Amortization Period, an Early Amortization Period or a Rapid
Amortization Period. The application of Overcollateralization
Deposit/Distribution Amounts, if any, and the reimbursement of prior Excess
Funding Interest Transfer Amounts will shorten the weighted average life of
the Certificates, as will the distribution to Certificateholders of amounts on
deposit in the Excess Funding Account following an Early Amortization Event, a
Rapid Amortization Event and the distribution of such amounts on the first
Distribution Date following the Distribution Date on which the Certificate
Principal Balance has been reduced to 20% or less of the Initial Certificate
Principal Balance. However, if there is an Excess Overcollateralization
Amount, collections in respect of principal otherwise available for
distribution to Certificateholders will be distributed to the Transferor,
thereby extending the weighted average life of the Certificates. In addition,
any Principal Collections allocated to reimburse the Certificate Insurers will
reduce the amount of principal otherwise available to the Certificateholders.
Further, during the Amortization Period unless or until the Funding Principal
Percentage is 0%, a portion of the collections on the Loans will be deposited
in the Excess Funding Account to purchase Subsequent Loans.
As a result of the interaction of the foregoing factors, it may be difficult
to predict the weighted average life of, and the resulting yield to maturity
on, the Certificates. None of the Transferor, the Servicer, the Trustee, the
Certificate Insurer or the Underwriters make any representation as to the
weighted average life of, or yield to maturity on, the Certificates.
PAID-AHEAD LOANS
If, in addition to making the regularly scheduled payment, the obligor under
a Loan (the "Obligor") makes one or more additional scheduled payments in any
Monthly Collection Period (for example, because the Obligor intends to be on
vacation the following month), the additional scheduled payments made in such
Monthly
S-40
<PAGE>
Collection Period will be treated as a principal prepayment and applied to
reduce the principal balance of the related Loan in such Monthly Collection
Period, and unless otherwise requested by the Obligor, the Obligor will not be
required to make any scheduled payment in respect of such Loan (a "Paid-Ahead
Loan") for the number of due dates corresponding to the number of such
additional scheduled payments (the "Paid-Ahead Period"). During the Paid-Ahead
Period, interest will continue to accrue on the principal balance of the Loan,
as reduced by the application of the additional scheduled payments made in the
Monthly Collection Period in which such Loan became a Paid-Ahead Loan. The
Obligor would not be considered delinquent during the Paid-Ahead Period.
When the Obligor resumes his required payments following the Paid-Ahead
Period, the payments so paid may be insufficient to cover the interest that
has accrued since the last payment by the Obligor. Notwithstanding such
insufficiency, the Obligor's Loan would be considered current. This situation
will continue until the regularly scheduled payments are once again sufficient
to cover all accrued interest and to reduce the principal balance of the Loan.
Depending on the principal balance and Loan Rate of the related Loan, and on
the number of payments that were paid-ahead, there may be extended periods of
time during which Loans that are current are not amortizing. During such
periods, no distributions of Principal Collections with respect to such Loans
will be made.
Paid-Ahead Loans will affect the weighted average life of the Certificates.
During the Revolving Period, there will not be any Principal Collections from
Paid-Ahead Loans during the related Paid-Ahead Period to acquire Subsequent
Loans and the Overcollateralization Amount will increase more slowly, which
may have the effect of extending the weighted average life of the
Certificates. During the Amortization Period and a Rapid Amortization Period,
the lack of Principal Collections from Paid-Ahead Loans during the related
Paid-Ahead Period will have the effect of decreasing the amount of principal
that otherwise would have been available to be distributed to
Certificateholders, thereby extending the weighted average life of the
Certificates. However, the distribution of the paid-ahead amount on the
Distribution Date, if during the Amortization Period, or the Monthly Payment
Date, if during a Rapid Amortization Period, following the Monthly Collection
Period in which such amount was received may shorten the weighted average life
of the Certificates. In addition, during the Paid- Ahead Period there will not
be any interest paid with respect to such loans, thereby reducing the amount
of Excess Interest that would otherwise be available.
As of the Initial Cut-off Date, approximately 2.82% of the Initial Loans
(based upon the Original Pool Balance) were Paid-Ahead Loans for which the
next payment is due on or after July, 1996. Chevy Chase's portfolio of Home
Loans has historically included loans which have been paid-ahead by one or
more scheduled monthly payments. Although it is a condition to the transfer of
any Subsequent Loan that it not be paid-ahead more than six scheduled payments
as of the related Subsequent Cut-Off Date, there can be no assurance as to the
number of Loans which may become Paid-Ahead Loans or the number or the
principal amount of the scheduled payments which may be paid-ahead.
DEFERRAL LOANS
As of the Initial Cut-off Date, less than 1.5% of the Initial Loans (based
upon the Original Pool Balance) are Loans for which the related Obligors have
elected to extend the contractual period between the Loans' funding date and
the Loans' first scheduled due date (each a "Deferral Loan") that are
currently in the Deferral Period. As of the Initial Cut-off Date, no Deferral
Loan had an initial scheduled due date beyond October 1996. None of the
Subsequent Loans may be Deferral Loans which are in the Deferral Period as of
the related Subsequent Cut-off Date unless the first payment for such
Subsequent Loan is due during the month of the related Subsequent Cut-off
Date. During the period of deferral (the "Deferral Period"), no payments will
be made on the related Deferral Loan and such Deferral Loan will be considered
current. When the Obligor begins to make its required payments following the
Deferral Period, the payments so paid may be insufficient to cover the
interest that has accrued since the date of origination. Notwithstanding such
deficiency, the Obligor's Loan would be considered current. This situation
will continue until the regularly scheduled payments are once again sufficient
to cover all accrued interest and to reduce the principal balance of the Loan.
Depending on the principal
S-41
<PAGE>
balance and the Loan Rate of the related Loan and on the number of payments
deferred, there will be a period of time during which Loans that are current
are not amortizing. During such periods, no distributions of Principal
Collections with respect to such Loans will be made to the Excess Funding
Account to acquire Subsequent Loans. As a result, the Overcollateralization
Amount will increase more slowly which may have the effect of extending the
weighted average life of the Certificates. In addition, during the Deferral
Period there will not be any interest paid with respect to such Loans, thereby
reducing the amount of Excess Interest that would otherwise be available.
WEIGHTED AVERAGE LIFE OF THE CERTIFICATES
The following information is given solely to illustrate the effect of
prepayments of the Loans on the weighted average life of the Certificates
under the stated assumptions and is not a prediction of the prepayment rate
that might actually be experienced by the Loans.
Weighted average life refers to the average amount of time from the date of
issuance of a security until each dollar of principal of such security will be
repaid to the investor. The weighted average life of the Certificates will be
influenced by the rate at which principal on the Loans is paid. Principal
payments on Loans may be in the form of scheduled amortization or prepayments
(for this purpose, the term "prepayment" includes repayments and liquidations
due to default or other dispositions of the Loans). Prepayments on Loans may
be measured by a prepayment standard or model. The model used in this
Prospectus Supplement is the Constant Prepayment Rate ("CPR") model. The CPR
model assumes that the outstanding principal balance of a pool of loans
prepays at a specified constant annual rate. The Certificates were priced
using a prepayment assumption of 18% CPR.
As used in the following table "0% CPR" assumes that none of the Loans are
prepaid before maturity, "15% CPR" assumes the Loans will prepay at a CPR of
15%, and so forth.
There is no assurance, however, that prepayment of the Loans will conform to
any level of the CPR, and no representation is made that the Loans will prepay
at the prepayment rates shown or any other prepayment rate. The rate of
principal payments on pools of Home Loans is influenced by a variety of
factors, as described above. In addition, in the case of Loans secured by real
estate, in general, if prevailing interest rates fall significantly below the
interest rates on Home Loans, Home Loans are likely to be subject to higher
prepayment rates than if prevailing interest rates remained at or above the
rates borne by such Home Loans. Conversely, if prevailing interest rates rise
above the interest rates on such Home Loans, the rate of prepayment would be
expected to decrease.
The percentages and weighted average lives in the following table were
determined assuming that: (i) scheduled interest and principal payments on the
Loans are received in a timely manner and prepayments are made at the
indicated percentages of the CPR set forth in the table; (ii) the Original
Pool Balance is $153,521,961.79 and the Initial Loans have a weighted average
Loan Rate, as of the Initial Cut-off Date, of 14.15% and a weighted average
remaining term to maturity, as of the Initial Cut-off Date, of 104.00 months;
(iii) the Initial Certificate Principal Balance is $153,521,000 and the
Certificates have a Certificate Rate of 7.50%; (iv) no interest shortfalls
will arise in connection with prepayments in full of the Loans; (v) the
Certificates are issued on May 29, 1996; (vi) the Certificates are priced at
par; (vii) scheduled principal and interest is timely received on a monthly
basis with no deferral or paid-ahead periods; (viii) reinvestment rate of
7.70% per annum on amounts on deposit in the Excess Funding Account, Principal
Distribution Account and the Reserve Fund; (ix) in Scenario 1, (a) the
Subsequent Loans have the same characteristics as the Initial Loans except
that the remaining term is reduced by one month for each elapsed month and (b)
the Subsequent Loans are delivered monthly commencing in the seventh month;
and (x) in Scenario 2, (a) a Rapid Amortization Event occurs in the first
month, (b) no Subsequent Loans are delivered and (c) all Remaining Interest is
used to pay principal to Certificateholders. No representation is made that
the Loans will not experience delinquencies or losses.
S-42
<PAGE>
It is not likely that the Loans will prepay at any constant percentage of
the CPR to maturity or that all of the Loans will prepay at the same rate.
Investors are urged to make their investment decisions on a basis that
includes their determination as to anticipated prepayment rates under a
variety of the assumptions discussed herein.
Based on the foregoing assumption, the following tables indicate the
projected weighted average life, modified duration, first principal payment
date and last principal payment date of the Certificates at the indicated
percentages of the CPR.
<TABLE>
<CAPTION>
CPR
-----------------------------
14% 16% 18% 20% 22%
----- ----- ----- ----- -----
SCENARIO 1: MONTHLY DELIVERY OF SUBSEQUENT LOANS COMMENCING IN THE SEVENTH
MONTH
<S> <C> <C> <C> <C> <C>
To Maturity:
Weighted Average Life (Years)(/1/): 4.39 4.24 4.10 3.97 3.84
Modified Duration (Years)(/2/): 3.50 3.40 3.31 3.21 3.13
First Principal Payment Date: 11/97 11/97 11/97 11/97 11/97
Last Principal Payment Date: 1/05 1/05 1/05 1/05 1/05
To Call:
Weighted Average Life (Years)(/1/): 4.38 4.22 4.08 3.95 3.82
Modified Duration (Years)(/2/): 3.50 3.39 3.30 3.21 3.12
First Principal Payment Date: 11/97 11/97 11/97 11/97 11/97
Last Principal Payment Date: 8/04 5/04 5/04 5/04 2/04
SCENARIO 2: RAPID AMORTIZATION EVENT IN THE FIRST MONTH; NO DELIVERY OF
SUBSEQUENT LOANS
To Maturity:
Weighted Average Life (Years)(/1/): 2.11 2.00 1.90 1.80 1.71
Modified Duration (Years)(/2/): 1.82 1.73 1.65 1.57 1.50
First Principal Payment Date: 6/96 6/96 6/96 6/96 6/96
Last Principal Payment Date: 5/01 3/01 1/01 11/00 9/00
To Call:
Weighted Average Life (Years)(/1/): 2.11 1.99 1.89 1.79 1.70
Modified Duration (Years)(/2/): 1.82 1.73 1.65 1.57 1.50
First Principal Payment Date: 6/96 6/96 6/96 6/96 6/96
Last Principal Payment Date: 1/01 11/00 9/00 7/00 5/00
</TABLE>
- --------
(1) The "Weighted Average Life" of a Certificate is determined by (i)
multiplying the amount of cash distributions in reduction of the principal
balance of such Certificate by the number of years from the date of
issuance to the stated Distribution Date, (ii) adding the results, and
(iii) dividing the sum by the Initial Certificate Principal Balance of
such Certificate.
(2) The "Modified Duration" of a Certificate is determined by (i) multiplying
the amount of cash distributions (both principal and interest) of such
Certificate by the number of years from the date of issuance to the
related Distribution Date and dividing by the Monthly Discount Rate raised
to the power of the number of months from the date of issuance to the
related Distribution Date, (ii) adding the results, and (iii) dividing the
sum by the product of the proceeds from the initial sale of the
Certificate and the Monthly Discount Rate raised to the power of six.
"Monthly Discount Rate" is equal to one plus the Monthly Yield divided by
twelve where the "Monthly Yield" is the monthly equivalent yield that
results in the given proceeds for the assumed coupon.
S-43
<PAGE>
THE CERTIFICATES
The following information supplements the information contained under "THE
DESCRIPTION OF THE SECURITIES" in the accompanying Prospectus. The following
summary does not purport to be complete and is subject to and qualified in its
entirety by reference to the Agreement.
GENERAL
Each of the Certificates represents an undivided interest in the Trust. Each
Certificate represents the right to receive payments of interest at the
Certificate Rate, payable monthly on the 15th day of each month or, if such
15th day is not a Business Day, the next succeeding Business Day (each, a
"Monthly Payment Date") and quarterly payments in respect of principal on each
August 15, November 15, February 15 and May 15 or, if any such day is not a
Business Day, the next succeeding Business Day (each, a "Distribution Date"),
beginning with the November, 1997 Distribution Date (or, in certain limited
circumstances described below, earlier and/or monthly), in each case
calculated as described herein. The Certificate Principal Balance will be due
and payable on the Distribution Date in May, 2015 (the "Stated Maturity
Date"). "Business Day" means a day other than a Saturday, Sunday or other day
on which banking institutions in the states of Minnesota, New York or Maryland
(or such other state in which the Corporate Trust Office of the Trustee or the
main office of the Paying Agent under the Agreement is located) are required
or authorized by law to be closed.
The Certificates will be issued pursuant to the Agreement in a single class
with an aggregate original principal balance of $153,521,000 (the "Initial
Certificate Principal Balance"). Following the Closing Date, the "Certificate
Principal Balance" will equal the Initial Certificate Principal Balance minus
the aggregate amount of distributions allocable to principal previously
distributed to Certificateholders. See "DESCRIPTION OF THE SECURITIES" in the
Prospectus.
The Certificates will initially be represented by a single Certificate
registered in the name of the nominee of The Depository Trust Company ("DTC").
DTC has informed the Transferor that Cede & Co. will be its nominee. The
Certificates will be available for purchase in book-entry form only in
denominations of $1,000 and integral multiples thereof, except that one
Certificate may be issued in a different denomination. Persons acquiring
beneficial interests in the Certificates will hold their interests through
DTC. Unless and until Replacement Certificates are issued under the limited
circumstances described under "CERTAIN INFORMATION REGARDING THE CERTIFICATES"
herein, no Certificateholder will be entitled to receive a physical
certificate representing a Certificate. See "RISK FACTORS--Book-Entry
Registration May Affect Liquidity" herein.
Distributions on the Certificates will be made by the Trustee by check or,
if so instructed by a holder of Certificates representing at least $5,000,000,
by wire transfer except that with respect to Certificates registered on a
Record Date in the name of Cede & Co., payments will be made by wire transfer
in immediately available funds to the account designated by DTC.
Notwithstanding the foregoing, the final distribution on the Certificates will
be made after due notice by the Trustee of the pendency of such distribution
and only upon presentation and surrender of Certificates at the office or
agency maintained for that purpose by the Trustee in the City of Minneapolis,
Minnesota.
Distributions will be made on each Monthly Payment Date and Distribution
Date to the holders of record as reflected in the certificate register
maintained by the Trustee on the day prior to such Monthly Payment Date or
Distribution Date, as the case may be, if the Certificates are book-entry
certificates, and on the last day of the month preceding the month of the
related Monthly Payment Date or Distribution Date, as the case may be, if the
Certificates are issued in definitive form, except that the final distribution
in respect of any Certificate will be made only upon presentation and
surrender of such Certificate at the office or agency appointed by the Trustee
for that purpose (each such day, a "Record Date").
S-44
<PAGE>
INTEREST
Interest on the Certificates will accrue at the rate of % per annum (the
"Certificate Rate") from and including the Closing Date (in the case of the
first Monthly Payment Date) or from and including the most recent Monthly
Payment Date on which interest has been paid to but excluding the following
Monthly Payment Date (each, an "Interest Period"). On each Monthly Payment
Date, the Trustee will distribute the Interest Distributable Amount on a pro
rata basis to the Certificateholders as of the Record Date. The "Interest
Distributable Amount" for any Monthly Payment Date means the sum of (i)
interest accrued during the related Interest Period at the Certificate Rate on
the Certificate Principal Balance immediately preceding such Monthly Payment
Date and (ii) the Certificateholders' Interest Carryover Shortfall.
"Certificateholders' Interest Carryover Shortfall" means, with respect to any
Monthly Payment Date, the excess of the Interest Distributable Amount for the
preceding Monthly Payment Date over the amount of interest that is actually
distributed to Certificateholders on such preceding Monthly Payment Date, plus
interest on such excess, to the extent permitted by law, at the Certificate
Rate from and including the preceding Monthly Payment Date to but excluding
the current Monthly Payment Date. Interest on the Certificates in respect of
any Monthly Payment Date will accrue from the preceding Monthly Payment Date
(or, in the case of the first Monthly Payment Date, from the Closing Date)
through the day preceding such Monthly Payment Date. Interest will be
calculated on the basis of a 360-day year comprised of twelve 30-day months.
PRINCIPAL
On each Distribution Date relating to the Amortization Period and on each
Monthly Payment Date relating to an Early Amortization Period or a Rapid
Amortization Period, the Trustee will distribute the Principal Distributable
Amount on a pro rata basis to the Certificateholders of record as of the
related Record Date. The "Principal Distributable Amount" means (i) with
respect to each Distribution Date relating to the Amortization Period, an
amount equal to the Monthly Allocable Principal in respect of each of the
three Monthly Collection Periods preceding such Distribution Date, (ii) with
respect to each Monthly Payment Date relating to an Early Amortization Period
or a Rapid Amortization Period, the Monthly Allocable Principal in respect of
the Monthly Collection Period preceding such Monthly Payment Date and, if an
Early Amortization Event or a Rapid Amortization Event occurs at any time
after the Revolving Period has ended, the Monthly Allocable Principal for any
prior Monthly Collection Period that was not previously distributed, plus, on
the Monthly Payment Date relating to the Monthly Collection Period during
which an Early Amortization Event or a Rapid Amortization Event has occurred,
all amounts then on deposit in the Excess Funding Account, and (iii) on the
first Distribution Date on which the Certificate Principal Balance as of the
preceding Distribution Date has been reduced to 20% or less of the Initial
Certificate Principal Balance, all amounts then on deposit in the Excess
Funding Account; provided, however, that on the Stated Maturity Date, the
Principal Distributable Amount will equal the Certificate Principal Balance;
provided further, however, that in no event will the aggregate amount
distributed to Certificateholders in respect of principal exceed the Initial
Certificate Principal Balance.
"Monthly Allocable Principal" means, with respect to each Monthly Payment
Date relating to the Amortization Period, Early Amortization Period or Rapid
Amortization Period, an amount equal to the sum of (i) the Monthly Available
Principal deposited in the Principal Distribution Account for such Monthly
Payment Date, (ii) any Excess Interest to the extent deposited in the
Principal Distribution Account to pay the Liquidation Loss Amount for such
Monthly Payment Date, (iii) any Excess Interest deposited in the Principal
Distribution Account to pay for all prior Excess Funding Interest Transfer
Amounts not previously reimbursed by Interest Collections, to pay the
Overcollateralization Deposit/Distribution Amount for any such Monthly Payment
Date relating to the Amortization Period or an Early Amortization Period and
to pay any outstanding Certificate Principal Balance for any such Monthly
Payment Date relating to a Rapid Amortization Period, (iv) the Reserve Fund
Principal Transfer Amount drawn from the Reserve Fund for such Monthly Payment
Date and (v) the Principal Deficiency Draw Amount made under the Policy for
such Monthly Payment Date.
The "Monthly Available Principal" means, with respect to each Monthly
Collection Period, an amount equal to the Certificateholders' Percentage of
the Principal Collections received in respect of such Monthly Collection
Period net of any such Principal Collections allocated to the Expense
Distribution Account to
S-45
<PAGE>
reimburse the Certificate Insurer for unreimbursed draws on the Policy to the
extent described herein ("Net Principal Collections") minus the
Certificateholders' Percentage of an amount (the "Excess Overcollateralization
Amount") equal to the lesser of (x) the amount by which the
Overcollateralization Amount for the related Monthly Payment Date exceeds the
Required Overcollateralization Amount for such Monthly Payment Date and (y)
the Net Principal Collections received in respect of the related Monthly
Collection Period. The "Certificateholders' Percentage" means, with respect to
any Monthly Collection Period, a percentage equal to (i) during the Revolving
Period, an Early Amortization Period and a Rapid Amortization Period, 100% and
(ii) 90% until the first day of the Monthly Collection Period during which the
Distribution Date on which the Certificate Principal Balance has been reduced
to 20% or less of the Initial Certificate Principal Balance occurs, and
thereafter 100%.
An "Early Amortization Event" occurs upon (i) the Transferor's failure to
deposit in the Collection Account on the Business Day prior to any
Determination Date the Negative Carry Deposit Amount for the related Monthly
Collection Period; (ii) if on any Determination Date, the Cumulative Realized
Loss Ratio (as defined below) as of such date exceeds (a) in the case of any
Determination Date prior to the June 1997 Determination Date, 5%, (b) in the
case of any Determination Date after the June 1997 Determination Date but
prior to the June 1998 Determination Date, 8.5% and (c) in the case of any
Determination Date on and after the June 1998 Determination Date, 12%; (iii)
upon the Transferor's failure to deliver to the Trust Subsequent Loans with an
aggregate outstanding unpaid principal balance as of the related Subsequent
Cut-off Date, to the extent originated and otherwise satisfying the criteria
specified herein and in the Agreement, (a) no later than the Monthly Payment
Date in February 1997, in an aggregate amount equal to the lesser of (x) the
amounts deposited in the Excess Funding Principal Subaccount prior to the
November 1996 Monthly Payment Date which have not previously been applied to
fund Excess Funding Interest Transfer Amounts prior to such date and (y)
$18,750,000, (b) no later than the Monthly Payment Date in November 1997, in
an aggregate amount equal to the lesser of (x) the amounts deposited in the
Excess Funding Principal Subaccount prior to the August 1997 Monthly Payment
Date which have not previously been applied to fund Excess Funding Interest
Transfer Amounts prior to such date and (y) $43,385,000, and (c) on each
Monthly Payment Date after November 1997, an amount equal to the amount
deposited in the Excess Funding Principal Subaccount during the Monthly
Collection Period which occurred 15 months prior to such Monthly Payment Date
which have not previously been used to acquire Subsequent Loans or to fund
Excess Funding Interest Transfer Amounts, in each case determined in
accordance with the Agreement; (iv) upon a draw on the Policy with respect to
a Monthly Collection Period during the Revolving Period; and (v) on any
Determination Date the amount on deposit in the Excess Funding Account exceeds
$60,000,000.
"Cumulative Realized Loss Ratio" for any Determination Date will be equal to
a fraction, expressed as a percentage, the numerator of which is the aggregate
unpaid principal balance of all Liquidated Loans as of the end of the related
Monthly Collection Period and the denominator of which is the sum of the
Original Pool Balance and the unpaid principal balance of each Subsequent Loan
as of its related Subsequent Cut-off Date that has been acquired by the Trust
on or prior to the end of the related Monthly Collection Period.
"Negative Carry Deposit Amount" means, with respect to any Monthly
Collection Period, the lesser of (i) the Negative Carry Amount for such
Monthly Collection Period and (ii) the amount by which Interest Collections
(other than the Negative Carry Deposit Amount) for such Monthly Collection
Period is less than the amount necessary to satisfy all allocations of
Interest Collections for the related Monthly Payment Date other than any
amounts allocable to the Transferor Distribution Account.
"Negative Carry Amount" means, with respect to any Monthly Collection
Period, an amount equal to the excess, if any, of (i) one-twelfth of the
product of (x) the sum of the Certificate Rate plus the Policy Premium Rate
plus the Trustee Fee Rate, and (y) the sum of the amounts on deposit on the
last day of such Monthly Collection Period in the Excess Funding Principal
Subaccount and the Principal Distribution Account, over (ii) investment
earnings on amounts on deposit in the Excess Funding Principal Subaccount and
the Principal Distribution Account (in each case net of losses) for such
Monthly Collection Period.
"Policy Premium Rate" means the per annum rate on which the premium payable
to the Certificate Insurer is calculated, based on the outstanding Certificate
Principal Balance, as set forth in the Insurance Agreement.
S-46
<PAGE>
"Trustee Fee Rate" means the amount of the Trustee's Fee for such Monthly
Collection Period expressed as per annum rate, based on the outstanding
Certificate Principal Balance.
The "Monthly Collection Period" is, for any Monthly Payment Date, the
calendar month preceding such Monthly Payment Date.
ASSIGNMENT OF LOANS
At the time of issuance of the Certificates, the Transferor will assign to
the Trustee all of its right, title and interest in and to the Initial Loans,
including all payments of interest and principal, from whatever source
derived, which are received thereon on or after the Initial Cut-off Date,
together with the other assets included or to be included in the Trust Fund,
whether now owned or hereafter acquired and including, without limitation, the
Initial Reserve Fund Deposit. In addition, on or prior to the date the
Certificates are initially issued by the Trust, the Servicer will cause the
Policy to be delivered to the Trustee. Concurrently with such assignment, the
Trustee will deliver the Certificates to the Transferor in exchange for (i)
the Initial Loans in an aggregate principal amount equal to the Initial Cut-
off Date Principal Balance, (ii) the Transferor's deposit of the Initial
Reserve Fund Deposit, and (iii) the Transferor's deposit of $ in the
Excess Funding Account. On each Subsequent Transfer Date, the Transferor will
assign to the Trustee for the benefit of the Trust all of its right, title and
interest in and to the Subsequent Loans to be transferred on such Subsequent
Transfer Date, including all payments of interest and principal, from whatever
source derived, which are received thereon on and after the related Subsequent
Cut-off Date. Each Loan will be identified in a schedule delivered to the
Trustee on the Closing Date or the related Subsequent Transfer Date, as
applicable.
The Agreement requires the Transferor to deliver to the Trustee on the
Closing Date, with respect to each Initial Loan, and on the applicable
Subsequent Transfer Date with respect to each Subsequent Loan, the
documentation specified in the Agreement relating to such Loans (each, a "Loan
File"). The Transferor will be required to deliver as part of each Loan File
(i) the originally executed promissory note or installment sales contract or
installment loan agreement, as applicable, and any intervening endorsements
and/or assignments evidencing a complete chain of title from the originator to
the Transferor and, in the case of any promissory note, an endorsement thereof
by the Transferor in blank without recourse with a facsimile signature as
provided in the Agreement, (ii) with respect to each Loan secured by a
Mortgaged Property, either (a) the original Mortgage with evidence of
recording thereon, (b) a copy of such Mortgage certified as a true copy by an
officer of the Transferor, if the original has been submitted for recording
but has not, as of the Closing Date or related Subsequent Transfer Date, been
returned, or (c) a copy of such Mortgage certified by the public recording
office in those instances where the original recorded Mortgage has been lost
or has been retained by the public recording office, and (iii) originals of
all assumption and modification agreements, if any, or a copy certified as a
true copy by an officer of the Transferor if the original has been transmitted
for recording until such time as the original is returned by the public
recording office. In addition, within 90 days following the Closing Date with
respect to the Initial Loans, and within 30 days following the related
Subsequent Transfer Date with respect to Subsequent Loans, the Agreement
requires the Transferor to deliver to the Trustee as part of each Loan File
with respect to each Loan secured by a Mortgaged Property an assignment in
recordable form or, under certain circumstances a blanket assignment in
recordable form, for the benefit of the Trustee. An assignment of a Mortgage
will not be required to be submitted for recordation unless (x) the Servicer
or the Certificate Insurer determines in its reasonable judgment that such
recordation is necessary to foreclose on a Mortgaged Property related to a
Liquidated Loan and that foreclosing on such Mortgaged Property will maximize
the receipt of Net Liquidation Proceeds with respect to such Liquidated Loan,
or (y) the Transferor fails to be adequately capitalized, as determined
pursuant to the regulations of the Office of Thrift Supervision and as of any
Determination Date following any such failure, (i) if during the Revolving
Period, there is no Overcollateralization Deposit/Distribution Amount
(calculated without including any Negative Carry Deposit Amount in Interest
Collection for the related Monthly Collection Period) for the related Monthly
Collection Period and the Overcollateralization Amount for the related Monthly
Payment Date is less than the Required Overcollateralization Amount for such
Monthly Payment Date, and (ii) at any time thereafter, the
Overcollateralization Amount is less than the Required Overcollateralization
Amount, in which case the Trustee
S-47
<PAGE>
shall record all or any portion of such assignments as and when directed by
the Certificate Insurer. The Trustee will complete its review of the Loan
Files within 30 days following the date such documents are required to be
delivered. If any document required to be included in any Loan File does not
bear the required signatures, has not been received when required to be
delivered or is unrelated to the applicable Loan, and such defect is not cured
as provided in the Agreement following receipt of notification thereof to the
Transferor from the Trustee, the Transferor will be required either to accept
the retransfer of the affected Loan or to replace the affected Loan in the
manner set forth below.
On the Closing Date, the Transferor will make certain representations and
warranties as to the accuracy in all material respects of certain information
furnished to the Trustee with respect to each Initial Loan, including the
unpaid principal balance of such Loan as of the Initial Cut-off Date and the
contractual rate of interest (the "Loan Rate") of each such Initial Loan. In
addition, the Transferor will represent and warrant that, as of the Initial
Cut-off Date, no Initial Loan was 30 or more days contractually delinquent.
The Agreement will also require the Transferor to make on each Subsequent
Transfer Date the same representations and warranties with respect to each
individual Subsequent Loan as it is required to make with respect to each
Initial Loan transferred by the Transferor except that each such
representation and warranty will be made as of the related Subsequent Cut-off
Date. In addition, no Subsequent Loan may be transferred to the Trust on a
Subsequent Transfer Date unless such Subsequent Loan satisfies the criteria
specified under the heading "THE HOME LOAN POOL" and the conditions precedent
to such a transfer set forth in "--Excess Funding Account" below are
satisfied. In the event there is a breach of any representation or warranty
made by the Transferor in the Agreement as to a Loan that materially and
adversely affects the interest of the Certificateholders or the Certificate
Insurer in such Loan, the Transferor will be required either to (i) accept the
retransfer of the related Loan from the Trust or (ii) substitute an Eligible
Substitute Loan therefor, in each case in the manner described below.
Any Loan required to be accepted for retransfer from the Trust by the
Transferor as a result of a defect, omission or breach of a representation or
warranty will be retransferred in exchange for the deposit by the Transferor
of an amount equal to such Loan's unpaid principal balance as of the end of
the Monthly Collection Period immediately preceding the date of retransfer,
plus accrued and unpaid interest thereon at the Loan Rate less the Servicing
Fee Rate (the "Net Loan Rate") through the end of the Monthly Collection
Period in which the retransfer date occurs (the "Retransfer Deposit Amount").
The interest portion of the Retransfer Deposit Amount will be deposited into
the Interest Distribution Account and the principal portion of the Retransfer
Deposit Amount will be deposited, if during the Revolving Period, into the
Excess Funding Principal Subaccount, and any time thereafter, into the
Principal Distribution Account, in each case on the Business Day preceding the
Determination Date following expiration of the related cure period.
As to any Eligible Substitute Loan, the Transferor will deposit into the
Principal Distribution Account the amount, if any, by which the unpaid
principal balance of such Eligible Substitute Loan at the end of the Monthly
Collection Period in which the events giving rise to the related substitution
occurred is less than the unpaid principal balance of the related Loan being
removed from the Trust at the end of such Monthly Collection Period (the
"Substitution Adjustment Amount"). The Transferor will substitute any Eligible
Substitute Loan, and deposit any such Substitution Adjustment Amount, if
during the Revolving Period, into the Excess Funding Principal Subaccount, and
any time thereafter, into the Principal Distribution Account, on the Business
Day preceding the Determination Date in the month following such Monthly
Collection Period. Upon substitution, an Eligible Substitute Loan will be
subject to the terms of the Agreement and the Transferor will be deemed to
have made, with respect to such Eligible Substitute Loan, as of the date of
substitution, the representations and warranties made by the Transferor with
respect to all other Loans in the Trust. Upon receipt by the Trustee of
written notification of any such acceptance of retransfer or substitution,
subject to certain conditions set forth in the Agreement, the Trustee will
execute and deliver an instrument of transfer or assignment necessary to vest
in the Transferor legal and beneficial ownership of the retransferred Loan
(including any property acquired in respect thereof or proceeds of any
insurance policy with respect thereto). The obligation of the Transferor to
accept a retransfer or replace any such Loan (each, a "Defective Loan") will
be the sole remedy against the Transferor available to Certificateholders or
the Trustee.
S-48
<PAGE>
An "Eligible Substitute Loan" is a Loan that, as of the substitution date,
(i) has an outstanding unpaid principal balance of not less than 95% of the
unpaid principal balance of the Defective Loan as of the substitution date;
(ii) has a Loan Rate not less than the current Loan Rate of such Defective
Loan and not more than 100 basis points in excess thereof; (iii) has a
remaining term to maturity not later than nor more than six months earlier
than the remaining term to maturity of such Defective Loan; and (iv) has a
Mortgage in a lien position not junior to the lien position of the Mortgage of
such Defective Loan.
Pursuant to the Agreement, the Servicer will service and administer the
Loans, as more fully set forth under "FURTHER PROVISIONS OF THE POOLING AND
SERVICING AGREEMENT--Collection and Other Servicing Procedures" herein.
None of the Initial Loans are, and none of the Subsequent Loans or Eligible
Substitute Loans will be, insured by the Federal Housing Administration or
guaranteed by the Veterans Administration or any other governmental agency or
instrumentality.
SERVICING FEE AND TRUSTEE'S FEES
The Servicer will receive a fee on each Monthly Payment Date (the "Servicing
Fee") equal to the product of one-twelfth of the Servicing Fee Rate and the
Pool Balance as of the opening of business on the first day of the related
Monthly Collection Period. In addition, the Servicer may retain out of
collections on the Loans any late fees, prepayment fees, rebates, and other
administrative fees and expenses collected during such month.
The Servicer will also be entitled to immediate reimbursement for certain
expenses incurred by it in connection with Liquidated Loans and in connection
with the restoration of Mortgaged Properties as a Servicer Advance. See
"FURTHER PROVISIONS OF THE POOLING AND SERVICING AGREEMENT--Servicer
Advances." Such right of reimbursement will be prior to the rights of the
Certificateholders to receive any Interest Collections or Principal
Collections.
On each Monthly Payment Date under the Agreement the Trustee is entitled to
a fee for its services during the prior Monthly Collection Period equal to an
amount agreed on by the Trustee and the Transferor (the "Trustee's Fee").
ESTABLISHMENT OF ACCOUNTS
The Agreement requires the Servicer to establish and maintain a separate
account (the "Collection Account") for the benefit of the Certificateholders
and the Certificate Insurer. The Agreement requires the Collection Account to
be maintained as an Eligible Account. The Trustee will maintain within the
Collection Account administrative sub-accounts for (i) the distribution of
principal of the Certificates (such sub-account, the "Principal Distribution
Account"), (ii) the distribution of interest on the Certificates (such sub-
account, the "Interest Distribution Account"), (iii) the payment of the
Servicing Fee to the Servicer, the Trustee's Fee to the Trustee and amounts
owed to the Certificate Insurer (such sub-account, the "Expense Distribution
Account") and (iv) distributions to the Transferor (such sub-account, the
"Transferor Distribution Account").
The Agreement also requires the Servicer to establish and maintain a
separate trust account (the "Excess Funding Account") for the benefit of the
Certificateholders and the Certificate Insurer into which certain collections
as described below will be deposited and used to acquire Subsequent Loans. The
Agreement requires the Excess Funding Account to be maintained as an Eligible
Account. The Trustee will maintain within the Excess Funding Account two
administrative subaccounts, one designated as the "Excess Funding Principal
Subaccount" and the other designated as the "Excess Funding Interest
Subaccount."
The Agreement also requires the Servicer to establish and maintain a
separate trust account (the "Reserve Fund") for the benefit of the
Certificateholders and the Certificate Insurer. The Agreement requires the
Reserve Fund to be maintained as an Eligible Account.
S-49
<PAGE>
Amounts deposited in the Collection Account, Excess Funding Account and
Reserve Fund will be invested in Permitted Investments maturing no later than
one Business Day prior to the Monthly Payment Date or on such other date as
may be approved by the Rating Agencies and the Certificate Insurer.
An "Eligible Account" is an account that is (i) maintained with a depository
institution which has a short term certificate of deposit rating at the time
of any deposit therein in the highest short-term debt rating category by the
Rating Agencies, (ii) maintained with a depository institution whose accounts
are fully insured by either the Savings Association Insurance Fund ("SAIF") or
the Bank Insurance Fund ("BIF") of the Federal Deposit Insurance Corporation
with a minimum long-term unsecured debt rating of Baa3, (iii) a trust account
maintained with the Trustee in its corporate trust department or (iv)
otherwise acceptable to each Rating Agency as evidenced by a letter from such
Rating Agency to the Trustee, without reduction or withdrawal of their then
current ratings of the Certificates, and acceptable to the Certificate
Insurer.
"Permitted Investments" are specified in the Agreement and are limited to
investments which meet the criteria of the Rating Agencies from time to time
as being consistent with their then current ratings of the Certificates. The
definition of Permitted Investments may be amended from time to time by the
Trustee, the Transferor and the Servicer with the consent of the Certificate
Insurer but without the approval of the Certificateholders so long as such
investments continue to meet the criteria of the Rating Agencies.
COLLECTIONS
All collections on the Loans will be allocated as to principal and interest
in accordance with the terms of the applicable Closed-End Loan and Home
Improvement Contract. The Servicer will be required to remit collections
(other than certain fees and expenses) to the Collection Account within two
Business Days of receipt thereof. Such collections shall be remitted less any
payments owed thereon to the Servicer. Pending deposit into the Collection
Account, collections may be invested by the Servicer at its own risk and for
its own benefit and will not be segregated from its own funds. Upon the
occurrence of a Trigger Event described in clause (v) of the definition
thereof, the Servicer shall at the instruction of the Certificate Insurer mail
a notice to all Obligors directing them to make all payments on the Loans
directly to the Trustee, which shall deposit such payments in the Collection
Account.
On the fifth Business Day immediately preceding each Monthly Payment Date
(the "Determination Date"), the Servicer will be required to deliver a
certificate (the "Servicer's Certificate") to the Trustee and the Certificate
Insurer specifying, among other things, the amount of Interest Collections and
Principal Collections on the Loans, the amounts to be deposited into and/or
withdrawn from the Collection Account and the subaccounts therein, the Excess
Funding Account and the Reserve Fund on the Deposit Date and the amount of any
required claims to be made under the Policy.
"Interest Collections" for any Monthly Payment Date will equal (i) interest
collections received from or on behalf of Obligors during the related Monthly
Collection Period (less, with respect to any Loan for which a Servicer Advance
has been made and not previously reimbursed, such interest collections
allocable to pay any such unreimbursed Servicer Advances), (ii) the interest
portion of Net Liquidation Proceeds and Insurance Proceeds received during the
related Monthly Collection Period, (iii) Recoveries received during the
related Monthly Collection Period, (iv) the interest portion of the Retransfer
Deposit Amount received in respect of the related Monthly Collection Period,
(v) investment earnings (net of losses) on amounts on deposit in the
Collection Account, the Excess Funding Account and the Reserve Fund for the
related Monthly Collection Period and (vi) any Negative Carry Deposit Amount
received in respect of the related Monthly Collection Periods. "Principal
Collections" for any Monthly Payment Date will equal (i) principal collections
received from Obligors on the Loans during the related Monthly Collection
Period (less, with respect to any Loan for which a Servicer Advance has been
made and not previously reimbursed from Interest Collections on such Loan or
otherwise, principal collections allocable to pay any unreimbursed Servicer
Advance), (ii) the principal portion of the Net Liquidation Proceeds and
Insurance Proceeds received during the related Monthly Collection Period
S-50
<PAGE>
and (iii) the principal portion of the Retransfer Deposit Amount and the
Substitution Adjustment Amount of any transferred Loan received in respect of
the related Monthly Collection Period.
"Liquidation Proceeds" are proceeds (excluding any amounts drawn from the
Excess Funding Account, Reserve Fund or on the Policy) received in connection
with the liquidation of Liquidated Loans. "Net Liquidation Proceeds" with
respect to a Loan are Liquidation Proceeds reduced by related expenses
(including, without limitation, Servicer Advances, the cost of recordation of
assignments and any amount advanced in respect of the repayment of a senior
mortgage). "Insurance Proceeds" means, as to any Loan and Monthly Collection
Period, proceeds paid to the Transferor or the Servicer pursuant to any
insurance policy with respect to such Loan, reduced by related expenses, which
proceeds (x) are not Liquidation Proceeds, and (y) are not applied or expected
to be applied to the restoration or repair of the related Mortgaged Property
or released to the related mortgagor in accordance with the normal servicing
procedures of the Servicer.
"Liquidated Loan" means, with respect to any Determination Date, a Loan (i)
with respect to which the related Obligor is contractually delinquent for 180
days as of the end of the most recently completed Monthly Collection Period or
(ii) as to which the Servicer has determined in accordance with its customary
servicing practices that eventual payment of the scheduled payments is
unlikely.
"Recoveries" means, with respect to any Liquidated Loan and a Monthly
Collection Period, the amount collected with respect to such Loan from
whatever source (other than from withdrawals from the Reserve Fund or from
draws on the Policy) in a Monthly Collection Period following the Monthly
Collection Period during which such Loan became a Liquidated Loan, reduced by
related expenses incurred by the Servicer in connection with the liquidation
of such Loan or the related Mortgaged Property (including, without limitation,
any Servicer Advances, costs of recording assignments and any amount advanced
in respect of the repayment of a senior mortgage).
ALLOCATIONS
Allocations During the Revolving Period. During the Revolving Period the
Trustee, based on the written instructions of the Servicer, will allocate
Interest Collections for the related Monthly Collection Period on the Deposit
Date to the extent available in the following order of priority:
(i)to the Expense Distribution Account, an amount equal to the Servicing
Fee for the related Monthly Collection Period and all accrued and unpaid
Servicing Fees for prior Monthly Collection Periods (collectively, the
"Servicer Payment");
(ii)to the Expense Distribution Account, an amount equal to the Trustee's
Fee for the related Monthly Collection Period and all accrued and unpaid
Trustee's Fees for prior Monthly Collection Periods;
(iii)to the Interest Distribution Account, an amount equal to the
Interest Distributable Amount for such Monthly Payment Date;
(iv)to the Expense Distribution Account, an amount equal to the monthly
premium for the Policy;
(v) to the Excess Funding Principal Subaccount, an amount equal to the
Liquidation Loss Amount for such Monthly Payment Date;
(vi) to the Expense Distribution Account, an amount equal to all prior
unreimbursed draws made on the Policy together with accrued interest
thereon;
(vii) to the Reserve Fund, an amount sufficient to satisfy the Specified
Reserve Fund Requirement;
(viii) to the Excess Funding Interest Subaccount, an amount equal to all
prior Excess Funding Interest Transfer Amounts not previously reimbursed
from Interest Collection;
S-51
<PAGE>
(ix) to the Excess Funding Interest Subaccount, an amount equal to the
excess, if any, of the Required Over-collateralization Amount for the re-
lated Monthly Payment Date over the Overcollateralization Amount for such
Monthly Payment Date (the aggregate of amounts, if any, paid pursuant to
this clause (ix) being referred to herein as the "Overcollateralization
Deposit/Distribution Amount");
(x) to the Expense Distribution Account, any other amounts owed to the
Certificate Insurer pursuant to the Insurance Agreement; and
(xi) to the Transferor Distribution Account, any remaining amounts.
Interest Collections remaining after allocation of the amounts described in
clauses (i), (ii), (iii) and (iv) above are referred to herein as "Excess
Interest." Interest Collections remaining after allocation of the amounts
described in clauses (i)-(viii) inclusive are referred to herein as "Remaining
Interest."
The "Overcollateralization Amount" on any Monthly Payment Date is the
amount, if any, by which the sum of the Pool Balance as of such Monthly
Payment Date plus amounts on deposit in the Excess Funding Account (exclusive
of investment earnings thereon) on such Monthly Payment Date (after giving
effect to any deposits thereto on the related Deposit Date and reductions
thereof in respect of (i) Subsequent Loans, if any, to be acquired on such
Monthly Payment Date and (ii) any reductions thereof in respect of Excess
Funding Interest Transfer Amounts) (the "Invested Amount") exceeds the
Adjusted Certificate Principal Balance on such Monthly Payment Date.
"Adjusted Certificate Principal Balance" means (i) with respect to any
Monthly Payment Date relating to the Revolving Period, the Initial Certificate
Principal Balance, and (ii) with respect to any other Monthly Payment Date, an
amount equal to the Certificate Principal Balance (x) during the Amortization
Period, on the prior Distribution Date (or, if there is no prior Distribution
Date, the Initial Certificate Principal Balance) and (y) during any Early
Amortization Period or Rapid Amortization Period, on the prior Monthly Payment
Date, in each case after giving effect to any distributions of principal
thereon on such date minus the sum of (x) Monthly Allocable Principal for such
Monthly Payment Date (other than (a) Overcollateralization
Deposit/Distribution Amounts for such Monthly Payment Date, (b) the Reserve
Fund Principal Transfer Amount for such Monthly Payment Date, and (c) any
Principal Deficiency Draw Amount for such Monthly Payment Date) and (y) during
the Amortization Period, Monthly Allocable Principal for each other Monthly
Payment Date that has occurred since the last Distribution Date.
Prior to a an Early Amortization Event or Rapid Amortization Event, to the
extent Remaining Interest is available therefor, Overcollateralization
Deposit/Distribution Amounts will be used to create additional
overcollateralization and to provide additional credit enhancement until the
Overcollateralization Amount equals the amount specified in the Insurance
Agreement (the "Required Overcollateralization Amount"). During the Revolving
Period, the Overcollateralization Deposit/Distribution Amounts will be
allocated to the Excess Funding Account to purchase Subsequent Loans and to
fund Excess Funding Interest Transfer Amounts. During the Amortization Period,
an Early Amortization Period and a Rapid Amortization Period, the
Overcollateralization Deposit/Distribution Amounts will be distributed in
reduction of the Certificate Principal Balance. These allocations of Remaining
Interest will cease once the Overcollateralization Amount equals the Required
Overcollateralization Amount unless it thereafter becomes necessary to
maintain the Overcollateralization Amount at the required level.
Following a Rapid Amortization Event, on each Monthly Payment Date, all
Remaining Interest will be applied to reduce the Certificate Principal Balance
to zero.
The "Pool Balance" as of any Monthly Payment Date will equal the aggregate
unpaid principal balance of the Loans as of the last day of the related
Monthly Collection Period plus the aggregate unpaid principal balance of any
Subsequent Loans as of the related Subsequent Cut-off Date previously
transferred to the Trust during the month in which such Monthly Payment Date
occurs, in each case other than Loans which became Liquidated
S-52
<PAGE>
Loans during or prior to such Monthly Collection Period and other than Loans
that have been retransferred to the Transferor prior to such Monthly Payment
Date.
"Liquidation Loss Amount" means, with respect to any Liquidated Loan, the
unrecovered principal balance thereof at the end of the related Monthly
Collection Period in which such Loan became a Liquidated Loan, after giving
effect to the application of the principal portion of Net Liquidation Proceeds
in connection therewith.
On each Deposit Date during the Revolving Period, the Trustee shall, in
accordance with the information contained in the Servicer's Certificate,
withdraw from the indicated accounts and deposit the amounts described below
in the following manner and order of priority into the indicated accounts:
(i) from the Excess Funding Interest Account, an amount (the "Excess
Funding Interest Transfer Amount"), equal to the least of (x) the excess of
(A) the Interest Distributable Amount for such Monthly Payment Date over
(B) the amount on deposit in the Interest Distribution Account before
giving any effect to such transfer from the Excess Funding Account (such
excess, the "Interest Deficiency"), (y) the amount on deposit in the Excess
Funding Account, or (z) the amount which when withdrawn from the Excess
Funding Account would cause the Overcollateralization Amount to equal zero;
(ii) from the Reserve Fund, an amount (the "Reserve Fund Interest
Transfer Amount"), equal to the lesser of (x) the excess of (A) the
Interest Distributable Amount for such Monthly Payment Date over (B) all
amounts on deposit in the Interest Distribution Account (including the
Excess Funding Interest Transfer Amount) on such date before giving effect
to any such Transfer from the Reserve Fund and (y) the amount on deposit in
the Reserve Fund on such Deposit Date, shall be deposited in the Interest
Distribution Account; and
(iii) from the Reserve Fund, an amount (the "Reserve Fund Principal
Transfer Amount"), equal to the lesser of (x) the Collateralization
Deficiency and (y) the amount remaining in the Reserve Fund after giving
effect to any withdrawals therefrom pursuant to clause (ii), shall be
deposited in the Excess Funding Account and allocated to the Excess Funding
Principal Subaccount.
"Collateralization Deficiency" means, with respect to each Monthly Payment
Date, the amount by which the Stated Certificate Principal Balance exceeds the
Invested Amount as of such Monthly Payment Date.
The "Stated Certificate Principal Balance" means (i) with respect to any
Monthly Payment Date relating to the Revolving Period, the Initial Certificate
Principal Balance, and (ii) with respect to any other Monthly Payment Date, an
amount equal to the Certificate Principal Balance (x) relating to the
Amortization Period, on the prior Distribution Date (or, if there is no prior
Distribution Date, the Initial Certificate Principal Balance) and (y) relating
to any Early Amortization Period or any Rapid Amortization Period, on the
prior Monthly Payment Date, in each case after giving effect to any
distributions of principal thereon on such date minus the sum of (x) Monthly
Allocable Principal for such Monthly Payment Date (other than the Reserve Fund
Principal Transfer Amount for such Monthly Payment Date and other than any
Principal Deficiency Draw Amount under the Policy for such Monthly Payment
Date) and (y) relating to the Amortization Period, Monthly Allocable Principal
for each other Monthly Payment Date that has occurred since the last
Distribution Date.
In the event that the Servicer's Certificate on any Determination Date
reflects that after giving effect to the deposit of the Excess Funding
Interest Transfer Amount, if any, and the Reserve Fund Interest Transfer
Amount, if any, to the Interest Distribution Account there will still be an
Interest Deficiency on the related Monthly Payment Date, the Trustee shall,
based on such Servicer's Certificate, make a draw on the Policy on the
Business Day following such Determination Date in an amount equal to such
remaining Interest Deficiency (the "Interest Deficiency Draw Amount") and
deposit such amount when received from the Certificate Insurer in the Interest
Distribution Account for distribution to the Certificateholders on the related
Monthly Payment Date as a payment of interest.
S-53
<PAGE>
In the event that the Servicer's Certificate on any Determination Date
reflects that after giving effect to the deposit of the Reserve Fund Principal
Transfer Amount there will still be on the related Monthly Payment Date a
remaining Collateralization Deficiency, the Trustee shall, based on such
Servicer's Certificate, make a draw on the Policy on the Business Day
following such Determination Date in an amount (the "Principal Deficiency Draw
Amount") equal to such remaining Collateralization Deficiency. Any draw under
the Policy with respect to a Monthly Collection Period during the Revolving
Period will cause an Early Amortization Event and a Subsequent Loan Purchase
Termination Event as of the date of such draw. The amount of any such draw
will be deposited in the Excess Funding Account and allocated to the Excess
Funding Principal Subaccount until the Deposit Date following such draw at
which time such amount will be allocated to the Principal Distribution
Account.
During the Revolving Period, no Principal Collections will be paid to the
Certificateholders. On each Deposit Date during the Revolving Period, the
Trustee shall, based on the written instructions of the Servicer, withdraw
from the Collection Account and deposit in the Excess Funding Principal
Subaccount the Funding Principal Amount and withdraw from the Collection
Account and deposit in the Transferor Distribution Account the Excess
Overcollateralization Amount. On each Monthly Payment Date during the
Revolving Period, amounts on deposit in the Transferor Distribution Account
will be distributed to the Transferor.
The "Funding Principal Amount" means, with respect to each Monthly
Collection Period (i) during the Revolving Period, an amount equal to the
Monthly Available Principal for such Monthly Collection Period, (ii) during
the Amortization Period, an amount equal to the Funding Principal Percentage
of Net Principal Collections received in respect of such Monthly Collection
Period minus the Funding Principal Percentage of the Excess
Overcollateralization Amount for such Monthly Collection Period, and (iii)
during an Early Amortization Period or a Rapid Amortization Period, zero.
"Funding Principal Percentage" means 10% until the first day of the Monthly
Collection Period following the Distribution Date on which the Certificate
Principal Balance is equal to or less than 20% of the Initial Certificate
Principal Balance, and thereafter 0%.
Allocations During the Amortization Period, an Early Amortization Period and
a Rapid Amortization Period. Beginning with the Monthly Collection Period
following the end of the Revolving Period and ending on the first to occur of
(i) the first day of a Monthly Collection Period in which an Early
Amortization Event occurs; (ii) the first day of a Monthly Collection Period
in which a Rapid Amortization Event occurs; (iii) the date when the
Certificate Principal Balance has been reduced to zero or (iii) the date when
the Trust otherwise terminates (the "Amortization Period"), Interest
Collections will be allocated on each Deposit Date, to the extent available,
in the same manner and order of priority as described under "Allocations
During the Revolving Period" above, except that amounts during the Revolving
Period which would have been allocated to the Excess Funding Account in
respect of the Liquidation Loss Amount for such Monthly Payment Date pursuant
to clause (v) thereunder, reimbursement of any Excess Funding Interest
Transfer Amount pursuant to clause (viii) thereunder, and the
Overcollateralization Deposit/Distribution Amounts pursuant to clause (ix)
thereunder will instead be allocated to the Principal Distribution Account.
Beginning with the first day of a Monthly Collection Period during which an
Early Amortization Event occurs, and ending on the first to occur of (i) the
first day of a Monthly Collection Period in which a Rapid Amortization Event
occurs; (ii) the date when the Certificate Principal Balance has been reduced
to zero; and (iii) the date when the Trust otherwise terminates (the "Early
Amortization Period"), Interest Collections will be allocated in the same
manner and order of priority as during the Amortization Period.
Beginning with the first day of a Monthly Collection Period during which a
Rapid Amortization Event occurs and ending on the first to occur of (i) the
date when the Certificate Principal Balance has been reduced to zero, and (ii)
the date when the Trust otherwise terminates (the "Rapid Amortization
Period"), Interest Collections will be allocated in the same manner and order
of priority as during the Amortization Period except that all Remaining
Interest will first be allocated to the Principal Distribution Account and
distributed to Certificateholders on the related Monthly Payment Date in
respect of principal until the Certificate Principal Balance has been reduced
to zero.
S-54
<PAGE>
Principal Collections received with respect to each Monthly Collection
Period during an Amortization Period will be allocated on each Deposit Date as
follows: (i) to the Expense Distribution Account, to the extent of any
unreimbursed draws made on the Policy together with accrued interest thereon,
to the extent not satisfied by allocations of Interest Collections thereto on
such Deposit Date; (ii) to the Transferor Distribution Account, an amount
equal to the Excess Overcollateralization Amount for such Monthly Payment
Date; (iii) to the Principal Distribution Account, an amount equal to the
Monthly Available Principal for such Monthly Payment Date; and (iv) to the
Excess Funding Principal Subaccount, an amount equal to the Funding Principal
Amount for such Monthly Payment Date. Upon the occurrence of an Early
Amortization Event, all amounts on deposit in the Excess Funding Account will
be allocated to the Principal Distribution Account on the Deposit Date
relating to the Monthly Collection Period in which such Early Amortization
Event occurs, and will be distributed to Certificateholders on the related
Monthly Payment Date and thereafter all Principal Collections otherwise
allocable to the Excess Funding Account will be allocated on each Deposit Date
to the Principal Distribution Account and distributed monthly to
Certificateholders as provided herein on the related Monthly Payment Date
beginning with the first Monthly Payment Date following the month in which the
Early Amortization Event occurs.
Upon the occurrence of a Rapid Amortization Event, all Principal Collections
otherwise allocable to the Excess Funding Account, together with all available
Remaining Interest, will be allocated on each Deposit Date to the Principal
Distribution Account and distributed monthly to Certificateholders as provided
herein on the related Monthly Payment Date beginning with the first Monthly
Payment Date following the month in which the Rapid Amortization Event occurs.
See "--Rapid Amortization Period; Rapid Amortization Events" herein for a
discussion of the events which might lead to the commencement of a Rapid
Amortization Period. Although payments of such amounts to Certificateholders
will reduce the Certificate Principal Balance, such payments will not reduce
the Invested Amount. The Overcollateralization Deposit/Distribution Amount is
not guaranteed by the Policy.
To the extent necessary to satisfy on each Monthly Payment Date relating to
the Amortization Period, an Early Amortization Period or a Rapid Amortization
Period any Interest Deficiency and/or Collateralization Deficiency, the
Servicer shall instruct the Trustee to withdraw first from the Excess Funding
Account and then from the Reserve Fund and deposit the amounts described below
in the following manner and order of priority into the indicated accounts:
(i) withdraw from the Excess Funding Account the Excess Funding Interest
Transfer Amount, first from the Excess Funding Interest Subaccount until
the amount on deposit therein has been reduced to zero, and then from the
Excess Funding Principal Subaccount;
(ii) withdraw from the Reserve Fund and deposit into the Interest
Distribution Account the Reserve Fund Interest Transfer Amount; and
(iii) withdraw from the Reserve Fund and deposit into the Principal
Distribution Account the Reserve Fund Principal Transfer Amount.
In addition, funds on deposit in the Reserve Fund, if any, will be available
to pay the outstanding Certificate Principal Balance on the Stated Maturity
Date (after giving effect to all other amounts distributed and allocable to
principal on such Distribution Date).
In the event that the Servicer's Certificate on any Determination Date
reflects that after giving effect to the deposit of the Excess Funding
Interest Transfer Amount, if any, and the Reserve Fund Interest Transfer
Amount, if any, to the Interest Distribution Account on the related Deposit
Date there will still be an Interest Deficiency on the related Monthly Payment
Date, the Trustee shall, based on such Servicer's Certificate, make a draw on
the Policy on the Business Day following such Determination Date in an amount
equal to the Interest Deficiency Draw Amount and deposit such amount when
received from the Certificate Insurer in the Interest Distribution Account for
distribution to the Certificateholders on the related Monthly Payment Date as
a payment of interest.
In the event that the Servicer's Certificate on any Determination Date
reflects that after giving effect to the deposit of the Reserve Fund Principal
Transfer Amount, if any, to the Principal Distribution Account there will
S-55
<PAGE>
still be a Collateralization Deficiency on any Distribution Date during the
Amortization Period, or on any Monthly Payment Date, during an Early
Amortization Period or a Rapid Amortization Period, the Trustee shall, based
on such Servicer's Certificate, make a draw on the Policy on the Business Day
following such Determination Date in an amount equal to the Principal
Deficiency Draw Amount and deposit such amount when received from the
Certificate Insurer in the Principal Distribution Account for distribution to
Certificateholders on the related Monthly Payment Date, as a payment in
respect of principal.
The Policy will guarantee the payment of the outstanding Certificate
Principal Balance on the Stated Maturity Date (after giving effect to all
other amounts distributed and allocable to principal on such Distribution
Date).
DISTRIBUTIONS
During the Revolving Period, the Trustee will distribute on the Monthly
Payment Date following each Deposit Date (a) amounts on deposit in the Expense
Distribution Account to the Servicer, the Trustee and the Certificate Insurer
in the same order of priority as such amounts were allocated to the Expense
Distribution Account as provided above, (b) amounts on deposit in the Interest
Distribution Account to Certificateholders in respect of interest on the
Certificates, (c) amounts on deposit in the Excess Funding Account to purchase
Subsequent Loans as described herein, unless an Early Amortization Event or
Rapid Amortization Event has occurred, in which case all amounts on deposit in
the Excess Funding Account will be allocated to the Principal Distribution
Account and distributed to Certificateholders on the first Monthly Payment
Date following the Monthly Collection Period in which such Early Amortization
Event or Rapid Amortization Event, as the case may be, occurs, and (d) amounts
on deposit in the Transferor Distribution Account to the Transferor. Amounts
in the Reserve Fund on any Monthly Payment Date (after giving effect to all
distributions made on such Monthly Payment Date) in excess of the Specified
Reserve Fund Requirement on such Monthly Payment Date during the Revolving
Period will be distributed to the Transferor.
During the Amortization Period, in addition to making the aforesaid
distributions on each Monthly Payment Date, on each Distribution Date amounts
on deposits in the Principal Distribution Account will be distributed to
Certificateholders as a payment of principal as described under "--Principal"
above. During an Early Amortization Period or a Rapid Amortization Period, if
any, amounts on deposit in the Principal Distribution Account will be
distributed to Certificateholders on each Monthly Payment Date in respect of
principal on the Certificates.
During the Amortization Period, an Early Amortization Period and a Rapid
Amortization Period, any amounts in the Reserve Fund on any Monthly Payment
Date (after giving effect to all distributions made on such Monthly Payment
Date) in excess of the Specified Reserve Fund Requirement on such Monthly
Payment Date will be distributed to the Transferor.
EXCESS FUNDING ACCOUNT
On the Closing Date, the Excess Funding Account will be established with the
Trustee for the benefit of the Certificateholders and the Certificate Insurer
and will be funded by a deposit of $ by the Transferor. Such deposit will
be allocated to the Excess Funding Interest Subaccount. Thereafter the Excess
Funding Account will be funded on each Monthly Payment Date during the
Revolving Period with all Principal Collections received with respect to the
related Monthly Collection Period allocated to the Certificateholders. In
addition, on each Deposit Date relating to the Revolving Period, any
Overcollateralization Deposit/Distribution Amount, any reimbursement of Excess
Funding Interest Transfer Amount and any Reserve Fund Principal Transfer
Amount for such Monthly Payment Date will be deposited in the Excess Funding
Account on the Business Day preceding such Monthly Payment Date, and any
Principal Deficiency Draw Amount will be deposited in the Excess Funding
Account on the Business Day preceding the Monthly Payment Date with respect to
which a draw on the Policy to cover a Collateralization Deficiency is made.
During the Amortization Period, the Excess Funding Account will be funded
solely from the Funding Principal Amount. Amounts deposited in the Excess
Funding Account in respect of Liquidation Loss Amounts to fund a
Collateralization Deficiency or
S-56
<PAGE>
from Principal Collections will be allocated to the Excess Funding Principal
Subaccount. The initial deposit in the Excess Funding Account, amounts
deposited in the Excess Funding Account in respect of Overcollateralization
Deposit/Distribution Amounts and amounts deposited in the Excess Funding
Account to reimburse Excess Funding Interest Transfer Amounts will be
allocated to the Excess Funding Interest Subaccount. Upon the occurrence of an
Early Amortization Event or a Rapid Amortization Event, all amounts on deposit
in the Excess Funding Account will be allocated to the Principal Distribution
Account and distributed to Certificateholders on the first Monthly Payment
Date following the Monthly Collection Period during which such Early
Amortization Event or a Rapid Amortization Event, as applicable, occurs to
reduce the Certificate Principal Balance. Following the occurrence of a
Subsequent Loan Purchase Termination Date, no additional Subsequent Loans will
be acquired by the Trust.
On each Subsequent Transfer Date, the Transferor will be obligated to
transfer Subsequent Loans to the Trust, and the Trust will be obligated to
accept such transfer, subject to the satisfaction of certain conditions
described in the Agreement and herein. The price to be paid for any Subsequent
Loan (the "Transfer Price") will equal the unpaid principal balance of such
Subsequent Loan as of the related Subsequent Cut-off Date. The Transfer Price
will be funded solely from withdrawals from the Excess Funding Account to the
extent funds are on deposit therein after giving effect to any Excess Funding
Interest Transfer Amount. Such withdrawals to fund the acquisition of
Subsequent Loans will be allocated first from the Excess Funding Principal
Subaccount until the amount allocated thereto has been reduced to zero, and
then from the amount allocated to the Excess Funding Interest Subaccount.
Pending application thereof, amounts on deposit in the Excess Funding Account
will be invested solely in Permitted Investments that mature on or before the
Business Day preceding each Monthly Payment Date. The Pool Balance will
increase on each Subsequent Transfer Date by the aggregate amount of the
unpaid principal balances of the Subsequent Loans as of the related Subsequent
Cut-off Date transferred on such Subsequent Transfer Date but the Invested
Amount will not be affected by such transfer because the Excess Funding
Account will be reduced by the aggregate amount of such unpaid principal
balances.
The Transferor will only be obligated to transfer Subsequent Loans to the
Trust in the principal amounts specified herein and only to the extent it
originates or acquires such Subsequent Loans which comply with the
requirements for transfer to the Trust to the extent described herein. Under
certain circumstances, the failure of the Transferor to transfer Subsequent
Loans during any Monthly Collection Period that are sufficient to reduce the
amounts allocated to the Excess Funding Principal Subaccount to zero may
result in there being negative carry with respect to the amounts on deposit in
the Excess Funding Account as of the last day of such Monthly Collection
Period. In such circumstances, the failure of the Transferor to deposit the
Negative Carry Deposit Amount with the Trustee will result in an Early
Amortization Event.
The Agreement will provide that the Trustee cannot release any funds from
the Excess Funding Account to purchase Subsequent Loans unless the following
conditions, among others specified in the Agreement, have been satisfied: (i)
the Transferor has certified that each such Subsequent Loan satisfies the
eligibility criteria described under "THE HOME LOAN POOL"; (ii) the Transferor
has delivered a Loan File for each Subsequent Loan to be transferred on such
Subsequent Transfer Date and has certified to the Trustee that each Loan File
is complete; (iii) the Transferor has certified that all of the conditions
precedent to the transfer of the Subsequent Loans have been satisfied; (iv)
the Trustee has inspected each of the certificates, schedules and officers'
certificates, as described above, and determined that each item required to be
delivered pursuant to the Agreement has been so delivered; (v) the Certificate
Insurer has approved the transfer of such Subsequent Loans, such approval
based upon its review of the underwriting of such Subsequent Loans by the
Transferor; and (vi) no Rating Agency, after receiving prior notice of the
transfer of any Subsequent Loans to the Trust, has advised any of the
Transferor, the Certificate Insurer or the Trustee that the conveyance of the
Subsequent Loans would result in a qualification, modification or withdrawal
of its then current rating of the Certificates.
Following a Subsequent Loan Purchase Termination Date, the Agreement
prohibits the Trustee from acquiring any additional Subsequent Loans and
amounts on deposit in the Excess Funding Account will be allocated to the
Principal Distribution Account and distributed to Certificateholders on the
first Distribution Date or Monthly Payment Date, as applicable, following such
Subsequent Loan Purchase Termination Date, to reduce the Certificate Principal
Balance. Upon the termination of the Trust, amounts on deposit in the Excess
Funding
S-57
<PAGE>
Account will be distributed to the Transferor to the extent such amounts are
not necessary to reimburse the Certificate Insurer for any unreimbursed draws
on the Policy and accrued interest therein.
RAPID AMORTIZATION PERIOD; RAPID AMORTIZATION EVENTS
Upon the commencement of the Rapid Amortization Period as described below,
which will occur upon the occurrence of a Rapid Amortization Event, (i) no
additional Subsequent Loans will be acquired by the Trust; (ii) amounts on
deposit in the Excess Funding Account (exclusive of investment earnings) will
be transferred to the Principal Distribution Account and distributed to
Certificateholders as part of the Monthly Allocable Principal on the next
Monthly Payment Date; (iii) all Principal Collections will be distributed to
Certificateholders on each Monthly Payment Date; (iv) Interest Collections
will be allocated on each Monthly Payment Date as provided during the
Amortization Period except that any Excess Interest otherwise allocable to the
Excess Funding Account shall be allocated to, and deposited in, the Principal
Distribution Account for distribution to Certificateholders; and (v) to the
extent any Collateralization Deficiency exists on any Monthly Payment Date
after giving effect to any Reserve Fund Principal Transfer Amount, the Trustee
shall, based on the written instructions of the Servicer, draw on the Policy
in the amount of such deficiency and distribute such amount to the
Certificateholders on such Monthly Payment Date as a payment in respect of
principal. "Rapid Amortization Event" refers to any of the following events:
(a) failure on the part of the Transferor (i) to make a payment or
deposit required under the Agreement and such failure results in a draw on
the Policy, (ii) to make a payment under the Insurance Agreement within
five Business Days after the date such payment is required to be made,
(iii) to observe or perform in any material respect the obligations of the
Transferor to deliver to the Trustee assignments of mortgages and deeds of
trust in recordable form; or (iv) to observe or perform in any material
respect any other covenant or agreement of the Transferor set forth in the
Agreement or the Insurance Agreement, which failure materially and
adversely affects or shall materially and adversely affect the interests of
the Certificateholders or the Certificate Insurer and continues unremedied
and continues to materially adversely affect the interests of the
Certificateholders or the Certificate Insurer for a period of 60 days after
receipt of written notice thereof;
(b) any representation or warranty made by the Transferor in the
Agreement or in the Insurance Agreement proves to have been incorrect in
any material respect when made and continues to be incorrect in any
material respect for a period of 60 days after receipt of written notice
thereof and as a result of which the interests of the Certificateholders or
the Certificate Insurer are materially and adversely affected or will be
materially and adversely affected; provided, however, that a Rapid
Amortization Event shall not be deemed to occur if the Transferor has
accepted the retransfer of the related Loans in accordance with the
provisions of the Agreement;
(c) the occurrence of certain events of insolvency, receivership or
conservatorship of the Transferor or any subsidiary of the Transferor with
total consolidated assets in excess of $100,000,000;
(d) the Trust becomes subject to regulation by the Securities and
Exchange Commission as an investment company within the meaning of the
Investment Company Act of 1940, as amended;
(e) the Agreement or the Insurance Agreement ceases to be in full force
and effect in any material respect;
(f) the aggregate principal amount of all non-reimbursed draws under the
Policy exceed 1.5% of the Initial Certificate Principal Balance;
(g) the Trust fails to have at least a first priority perfected security
interest in the Loans (except with respect to any provisions of the Loans
which purport to encumber assets as collateral for such Loans and any
rights to enforcement with respect to such assets);
(h) a Trigger Event specified in clauses (i)-(iv) of the definition
thereof occurs and a successor Servicer satisfactory to the Certificate
Insurer has not been appointed within the time period specified in the
Agreement; and
S-58
<PAGE>
(i) failure to pay the Interest Distributable Amount on any Monthly
Payment Date and such failure continues unremedied for five Business Days
after receipt of written notice thereof.
In the case of any event described in clause (a), (b), (c) (with respect to
a subsidiary of the Transferor) (e), (f), (g), (h) or (i) a Rapid Amortization
Event will be deemed to have occurred only if, after the applicable grace
period described in such clauses, any of the Certificate Insurer or, with the
Certificate Insurer's consent (so long as no Certificate Insurer Default has
occurred and is continuing), the Trustee or Certificateholders holding
Certificates evidencing more than 51% of the Certificate Principal Balance, by
written notice to the Servicer (and to the Trustee, if given by the
Certificate Insurer or the Certificateholders) declare that a Rapid
Amortization Event has occurred as of the date of such notice. In the case of
any event described in clause (c) (other than with respect to a subsidiary of
the Transferor) or (d), a Rapid Amortization Event will be deemed to have
occurred without any notice or other action on the part of the Trustee, the
Certificate Insurer or the Certificateholders immediately upon the occurrence
of such event.
In addition to the consequences of a Rapid Amortization Event discussed
above, if an Insolvency Event occurs the Transferor will immediately cease to
transfer additional Subsequent Loans to the Trust and the Transferor will
promptly give notice to the Trustee and the Certificate Insurer of any such
Insolvency Event. Unless otherwise instructed within a specified period by 51%
of the Certificateholders and any person designated by the Transferor to the
Trustee prior to the time such conservator or receiver was appointed, the
Trustee will sell, dispose of or otherwise liquidate the Loans in a
commercially reasonable manner and on commercially reasonable terms. Unless a
Certificate Insurer Default has occurred, the Certificate Insurer will have
the power to make such instruction to the Trustee on behalf of the
Certificateholders and such person designated by the Transferor to the
Trustee. The proceeds from the sale, disposition or liquidation of the Loans
will be treated as, and be allocated in the same manner as, Interest
Collections, and will be distributed to the Certificateholders on the date
such proceeds are received (the "Dissolution Distribution Date"). If the
Certificate Insurer elects to cause a termination of the Trust under such
circumstances, the Policy will be available to cover the payment of the then-
accrued and unpaid interest on the outstanding Certificate Principal Balance
at the Certificate Rate, as well as the outstanding Certificate Principal
Balance, in each case on the Dissolution Distribution Date after giving effect
to the allocation of all other amounts distributed on or prior to such
Dissolution Distribution Date.
Notwithstanding the foregoing, if a conservator or receiver is appointed for
the Transferor and no Rapid Amortization Event exists other than such
conservatorship, receivership or insolvency of the Transferor, the conservator
or receiver may have the power to prevent the commencement of the Rapid
Amortization Period or the sale of the Loans described above.
An "Insolvency Event" shall occur if the Transferor shall consent to the
appointment of a conservator or receiver or liquidator or trustee in any
insolvency, receivership, conservatorship, readjustment of debt, marshaling of
assets and liabilities or similar proceedings of or relating to the Transferor
or relating to all or substantially all of its property, or a court or agency
or supervisory authority having jurisdiction in the premises shall issue, or
enter against the Transferor, a decree or order for the appointment of a
conservator or receiver or liquidator or trustee in any insolvency,
receivership, conservatorship, readjustment of debt, marshaling of assets and
liabilities or similar proceedings or for the winding-up or liquidation of its
affairs; or the Transferor shall admit in writing its inability to pay its
debts generally as they become due, file a petition to take advantage of any
applicable insolvency, reorganization, liquidation, receivership, or
conservatorship statute, make any assignment for the benefit of its creditors
or voluntarily suspend payment of its obligations; or a proceeding shall have
been instituted by a court having jurisdiction in the premises seeking a
decree or order for relief in respect of the Transferor in an involuntary case
under any debtor relief law, or for the appointment of a receiver, liquidator,
assignee, trustee, custodian, sequestrator, conservator or other similar
official, of the Transferor for any substantial part of its property, or for
the liquidation and winding up of its affairs and, if instituted against the
Transferor, any such proceeding shall continue undismissed or unstayed and in
effect for a period of 60 consecutive days, or any of the actions sought in
such proceeding shall occur.
S-59
<PAGE>
REPORTS TO CERTIFICATEHOLDERS
Concurrently with each distribution to the Certificateholders, the Servicer
will forward to the Trustee for mailing to such Certificateholders and the
Certificate Insurer a statement setting forth:
(i) the amount being distributed to Certificateholders;
(ii) the amount of interest included in such distribution and the portion
thereof attributable to Interest Collections;
(iii) the amount, if any, of any Certificateholders' Interest Carryover
Shortfall included in such distribution (and the amount of interest
thereon);
(iv) the amount, if any, of the remaining Certificateholders' Interest
Carryover Shortfall after giving effect to such distribution;
(v) the amount, if any, of principal included in such distribution and
the portion thereof attributable to Principal Collections;
(vi) the amount, if any, of the reimbursement of previous Liquidation
Loss Amounts included in such distribution;
(vii) the amount, if any, of the aggregate unreimbursed Liquidation Loss
Amounts after giving effect to such distribution;
(viii) the Servicing Fee for such Monthly Payment Date;
(ix) the Invested Amount and the Certificate Principal Balance, each
after giving effect to such distribution;
(x) the Required Overcollateralization Amount, and the
Overcollateralization Amount, if any, after giving effect to such
distribution;
(xi) the Pool Balance as of the end of the related Monthly Collection
Period;
(xii) the Overcollateralization Deposit/Distribution Amount, if any;
(xiii) the number and aggregate principal balance of the Loans which are
delinquent for 30-59 days, 60-89 days and 90 or more days, respectively, as
of the end of the related Monthly Collection Period;
(xiv) the aggregate Liquidation Loss Amount for all Loans that became
Liquidated Loans in the related Monthly Collection Period;
(xv) the aggregate principal balance of Subsequent Loans to be acquired
by the Trust on the Monthly Payment Date;
(xvi) the aggregate amount on deposit in the Excess Funding Account on
the Monthly Payment Date after giving effect to deposits to and withdrawals
therefrom on such Monthly Payment Date; and
(xvii) the amount of any draws on the Policy.
In the case of information furnished pursuant to clauses (i), (ii), (iii),
(iv) and (v) above, the amounts shall be expressed as a dollar amount per
Certificate with a $1,000 denomination.
Within 90 days after the end of each calendar year, the Servicer will be
required to forward to the Trustee a statement containing the information set
forth in clauses (ii) and (v) above aggregated for such calendar year.
S-60
<PAGE>
Unless and until Replacement Certificates are issued, it is anticipated that
the only "holder" of Certificates entitled to receive the foregoing monthly
and annual reports will be CEDE & Co., as nominee of DTC. Certificate Owners
may request copies of such reports from DTC's direct or indirect participating
organizations in accordance with the rules, regulations and procedures
creating and affecting DTC. See "CERTAIN INFORMATION REGARDING THE
CERTIFICATES."
CREDIT ENHANCEMENT
Credit enhancement for the Certificates will be provided to the extent
described herein by overcollateralization, the Reserve Fund and the Policy.
Overcollateralization. On the Closing Date the Trust will be
overcollateralized, as the Transferor will deposit $ on such date in the
Excess Funding Account thereby causing the Invested Amount to exceed the
Initial Certificate Principal Balance by the amount of such deposit. It is
expected that the amount of such overcollateralization will increase to the
extent Excess Interest is available to be deposited in the Excess Funding
Account or the Principal Distribution Account and applied as described below.
Excess Interest for any Monthly Payment Date will arise if and to the extent
that Interest Collections for the related Monthly Collection Period exceed the
sum of the Servicing Fee required to be paid to the Servicer for such Monthly
Payment Date and any unpaid Servicing Fees from prior Monthly Payment Dates,
the Trustee's Fee required to be paid to the Trustee for such Monthly Payment
Date and any unpaid Trustee's Fees from prior Monthly Payment Dates, the
Interest Distributable Amount on such Monthly Payment Date and the premium
required to be paid to the Certificate Insurer for such Monthly Payment Date.
Excess Interest, if any, for any Monthly Payment Date will be available to
cover Liquidation Loss Amounts for such Monthly Payment Date as described
herein and in the Agreement. Except for the foregoing, the Agreement does not
require the payment of Liquidation Loss Amounts to the Excess Funding Account
or to Certificateholders on the Monthly Payment Date or on the Distribution
Date, as the case may be, following the Monthly Collection Period during which
such Liquidation Loss Amount arose. Excess Interest, if any, with respect to
any Monthly Payment Date after payment of any Liquidation Loss Amounts for
such Monthly Payment Date and amounts owed to reimburse the Certificate
Insurer for unreimbursed draws under the Policy will be allocated as and to
the extent provided herein to pay the Overcollateralization
Deposit/Distribution Amount either (i) on each Deposit Date relating to the
Revolving Period, to the Excess Funding Account to acquire Subsequent Loans or
to fund Excess Funding Interest Transfer Amounts to the extent described
herein, or (ii) on each Deposit Date relating to the Amortization Period, an
Early Amortization Period or a Rapid Amortization Period, to the Principal
Distribution Account for distribution to Certificateholders on the related
Distribution Date or Monthly Payment Date, as the case may be. Any such
application of Excess Interest (other than to fund Excess Funding Interest
Transfer Amounts) is expected to result in the Invested Amount being greater
than the Certificate Principal Balance thereby creating the
Overcollateralization Amount. The payment of the Overcollateralization
Deposit/Distribution Amount is not covered by the Reserve Fund or the Policy.
If Excess Interest with respect to any Monthly Payment Date is insufficient
to pay the Liquidation Loss Amount for such Monthly Payment Date, the
Overcollateralization Amount will be reduced. In addition, if an Excess
Funding Interest Transfer Amount is made, such amount will also reduce the
Overcollateralization Amount. On each Monthly Payment Date on which the
Overcollateralization Amount is less than the Required Overcollateralization
Amount, Excess Interest will be allocated as provided above to pay the
Overcollateralization Deposit/Distribution Amount, thereby further increasing
the amount of overcollateralization.
If Liquidation Loss Amounts are so severe so as to cause a Collateralization
Deficiency, an amount equal to such Collateralization Deficiency will be
required either (i) on each Deposit Date relating to the Revolving Period, to
be paid to the Excess Funding Account or (ii) on each Deposit Date relating to
the Amortization Period, an Early Amortization Period or Rapid Amortization
Period, to be paid to the Principal Distribution Account and distributed to
Certificateholders on the related Distribution Date or Monthly Payment Date,
as the
S-61
<PAGE>
case may be, first from withdrawals from the Reserve Fund to the extent of
funds available therefor and then by draws under the Policy, in each case as
further described below.
The Required Overcollateralization Amount will be determined in accordance
with the Agreement and the Insurance Agreement and may increase or decrease
over time as a result of floors, caps and triggers set forth in the Agreement
and the Insurance Agreement. The provisions relating to overcollateralization
may be amended in any respect by the Transferor, the Servicer and the
Certificate Insurer without the consent of, or notice to, the
Certificateholders; provided, however, that no such amendment will affect the
obligations of the Certificate Insurer under the Policy.
Excess Funding Account. On the Closing Date, the Transferor will make an
initial deposit of $ to the Excess Funding Account (the "Excess
Funding Initial Deposit"). Such amount will be allocated to the Excess Funding
Interest Subaccount. On each Deposit Date following the Closing Date until the
Deposit Date following the Monthly Collection Period during which a Subsequent
Loan Purchase Termination Date occurs, certain Interest Collections and
Principal Collections as described under "DESCRIPTION OF THE CERTIFICATES--
Excess Funding Account" above will be allocated to the Excess Funding Account
and further allocated to either the Excess Funding Interest Subaccount or
Excess Funding Principal Subaccount. On each such Deposit Date, the Trustee
shall, before making any other withdrawals from the Excess Funding Account,
withdraw from the Excess Funding Account and deposit in the Interest
Distribution Account the Excess Funding Interest Transfer Amount. Any such
withdrawals from the Excess Funding Account shall be funded first from the
Excess Funding Interest Subaccount until the amount on deposit therein has
been reduced to zero and then from the Excess Funding Principal Subaccount.
Amounts on deposit in the Excess Funding Account not used to fund the Excess
Funding Interest Transfer Amount will be available to acquire Subsequent Loans
from the Transferor until the Subsequent Loan Purchase Termination Date, and
then will be distributed as described below.
Reserve Fund. On the Closing Date, the Transferor will make an initial
deposit of an amount to be agreed upon by the Transferor and the Certificate
Insurer to the Reserve Fund. The amount initially deposited in the Reserve
Fund by the Transferor is referred to as the "Initial Reserve Fund Deposit."
On each Monthly Payment Date, the Trustee will be required to deposit
additional amounts in the Reserve Fund from Excess Interest, if any, as
described under "THE CERTIFICATES--Allocations" above. Amounts, if any, on
deposit in the Reserve Fund will be available on each Monthly Payment Date to
fund (i) payment of the Interest Distributable Amount for such Monthly Payment
Date, and (ii) the Collateralization Deficiency for such Monthly Payment Date.
During the Revolving Period such withdrawals from the Reserve Fund to cover
Collateralization Deficiencies will be deposited in the Excess Funding Account
and allocated to the Excess Funding Principal Subaccount and will be available
to acquire Subsequent Loans from the Transferor. During the Amortization
Period, Early Amortization Period or Rapid Amortization Period, such amounts
will be distributed to Certificateholders and will reduce the Certificate
Principal Balance.
In addition, funds on deposit in the Reserve Fund, if any, will be available
to pay the outstanding Certificate Principal Balance on the Stated Maturity
Date (after giving effect to all other amounts distributed and allocable to
principal on such Distribution Date).
The aggregate amount required to be on deposit at any time in the Reserve
Fund (the "Specified Reserve Fund Requirement") will be determined in
accordance with the Agreement and the Insurance Agreement. The Specified
Reserve Fund Requirement may increase or decrease over time as a result of
floors, caps and triggers set forth in the Agreement and the Insurance
Agreement. Amounts in the Reserve Fund on any Monthly Payment Date (after
giving effect to all distributions made on such Monthly Payment Date) in
excess of the Specified Reserve Fund Requirement for such Monthly Payment Date
will be distributed as described under "THE CERTIFICATES--Distributions"
above.
The provisions relating to the Reserve Fund may be amended in any respect by
the Transferor, the Servicer and the Certificate Insurer without the consent
of, or notice to, the Certificateholders. Such amendment could reduce or
eliminate the funding requirements of the Reserve Fund or release such funds
for the benefit of Persons
S-62
<PAGE>
other than Certificateholders. Notwithstanding any reduction in or elimination
of the funding requirements of the Reserve Fund or the depletion thereof, the
Certificate Insurer will be obligated on each Monthly Payment Date and each
Distribution Date to fund the full amount otherwise required to be paid on
such Monthly Payment Date or Distribution Date, as the case may be, under the
Policy.
The Policy. On or before the Closing Date, the Transferor will cause the
Policy to be issued by the Certificate Insurer pursuant to the provisions of
the Agreement and the Insurance and Indemnity Agreement (the "Insurance
Agreement") among the Transferor, the Servicer, the Certificate Insurer and
the Trustee. The Policy will unconditionally and irrevocably guarantee (i) the
Interest Distributable Amount on each Monthly Payment Date and (ii) the
Collateralization Deficiency (a) during the Revolving Period, on the first
Monthly Payment Date with respect to which a draw on the Policy to cover a
Collateralization Deficiency is made, (b) during the Amortization Period, on
each Distribution Date and (c) during an Early Amortization Period or a Rapid
Amortization Period, on each Monthly Payment Date (collectively, the "Insured
Payments"). A draw will be made on the Policy equal to (i) with respect to
each Monthly Payment Date, the Interest Deficiency Draw Amount plus (ii) any
Principal Deficiency Draw Amount (a) during the Revolving Period, on the first
Monthly Payment Date for which a Collateralization Deficiency exists (after
giving effect to any Reserve Fund Principal Transfer Amount with respect to
such Monthly Payment Date), (b) during the Amortization Period, on each
Distribution Date, and (c) during an Early Amortization Period and a Rapid
Amortization Period, on each Monthly Payment Date. Any draw on the Policy
pursuant to clause (ii) with respect to a Monthly Collection Period will cause
an Early Amortization Event and a Subsequent Loan Purchase Termination Event
as of the date of such draw. The amount of any such draw will be deposited in
the Excess Funding Account and allocated to the Excess Funding Principal
Subaccount until the Deposit Date following such draw at which time such
amount will be allocated to the Principal Distribution Account. With respect
to each Distribution Date and Monthly Payment Date relating to the
Amortization Period, an Early Amortization Period or any Rapid Amortization
Period, such amounts will be paid to Certificateholders on each Distribution
Date or Monthly Payment Date, as applicable, and will reduce the Certificate
Principal Balance but will not reduce the Invested Amount.
In addition, the Policy will unconditionally guarantee the payment of the
outstanding Certificate Principal Balance on the Stated Maturity Date (after
giving effect to all other amounts distributed and allocable to principal on
such Distribution Date).
In the event the Reserve Fund is exhausted, in the absence of payments under
the Policy, Certificateholders will directly bear the credit and other risks
associated with their undivided interest in the Trust.
In the event the Certificate Insurer's claims paying ratings have been
reduced by any of the Rating Agencies, the Transferor may, but it is not
obligated to, either (i) replace the Policy with a financial guaranty
insurance policy issued by another certificate insurer, provided that the
ratings on the claims paying ability of such replacement certificate insurer
are higher than those of the certificate insurer sought to be replaced (after
giving effect to such reduction) or (ii) eliminate or provide another form of
credit enhancement; provided that in the case of clause (ii), the Rating
Agencies consent thereto and confirm that the ratings of the Certificates will
be increased from their then current levels (after giving effect to such
reduction) as a result of such action.
Payment of claims under the Policy will be made by the Certificate Insurer
following Receipt by the Certificate Insurer of the appropriate notice for
payment on the later to occur of (a) 11:00 a.m. New York City time, on the
second Business Day following Receipt of such notice for payment, and (b)
11:00 a.m., New York City time, on the Business Day immediately preceding the
relevant Monthly Payment Date or Distribution Date, as the case may be.
The terms "Receipt" and "Received," with respect to the Policy, means actual
delivery to the Certificate Insurer, prior to 2:00 p.m., New York City time,
on a Business Day; delivery either on a day that is not a Business Day or
after 2:00 p.m., New York City time, shall be deemed to be Receipt on the next
succeeding Business Day.
If a payment by the Certificate Insurer is voided pursuant to a final and
non-appealable order (a "Preference Event") under any applicable bankruptcy,
insolvency, receivership or similar law in an Insolvency Proceeding, and, as a
result of such a Preference Event, the Trustee is required to return such
voided payment, or any portion of such voided payment, made in respect of the
Certificates (an "Avoided Payment"), the Certificate Insurer
S-63
<PAGE>
will pay an amount equal to such Avoided Payment, upon receipt by the
Certificate Insurer from the Trustee of (x) a certified copy of a final order
of a court exercising jurisdiction in such Insolvency Proceeding to the effect
that the Trustee is required to return any such payment or portion thereof
during the term of the Policy because such payment was voided under applicable
law, with respect to which order the appeal period has expired without an
appeal having been filed (the "Final Order"), (y) an assignment, in form
reasonably satisfactory to the Certificate Insurer, irrevocably assigning to
the Certificate Insurer all rights and claims of the Trustee relating to or
arising under such Avoided Payment and (z) a notice for payment appropriately
completed and executed by the Trustee. Such payment shall be disbursed to the
receiver, conservator, debtor-in-possession or trustee in bankruptcy named in
the Final Order and not to the Trustee directly.
Notwithstanding the foregoing, in no event shall the Certificate Insurer be
obligated to make any payment in respect of any Avoided Payment, which payment
represents a payment of the principal amount of the Certificates, prior to the
time the Certificate Insurer would have been required to make a payment in
respect of such principal in the absence of such Preference Event.
The Certificate Insurer shall make payments due in respect of Avoided
Payments prior to 1:00 p.m., New York City time, on the second Business Day
following the Certificate Insurer's Receipt of the documents required under
clauses (x) through (z) of the second preceding paragraph.
Under the Policy, "Business Day" means any day other than (i) a Saturday or
Sunday or (ii) a day on which banking institutions in the City of New York,
New York and the States of Maryland or Minnesota are authorized or obligated
by law or executive order to be closed.
"Insolvency Proceeding" means the commencement, after the Closing Date, of
any bankruptcy, insolvency, readjustment of debt, reorganization, marshalling
of assets and liabilities or similar proceedings by or against any person, or
the commencement, after the Closing Date, of any proceedings by or against any
Person for the winding up or liquidation of its affairs, or the consent after
the date hereof to the appointment of a trustee, conservator, receiver or
liquidator in any bankruptcy, insolvency, readjustment of debt,
reorganization, marshalling of assets and liabilities or similar proceedings
of or relating to any Person.
The terms of the Policy cannot be modified, altered or affected by any other
agreement or instrument, or by the merger, consolidation or dissolution of the
Transferor or Servicer. The Policy by its terms may not be canceled or
revoked. The Policy is governed by the laws of the State of New York.
Pursuant to the terms of the Agreement, the Certificate Insurer will be
entitled to exercise all rights of the Certificateholders, without the consent
of such Certificateholders, and the Certificateholders may exercise such
rights only with the prior written consent of the Certificate Insurer. In
addition, the Certificate Insurer will, as a third party beneficiary to the
Agreement, have, among others, the following rights: (i) the right to give
notices of breach or to terminate the rights and obligations of the Servicer
under the Agreement in the event of a Trigger Event by the Servicer and to
institute proceedings against the Servicer; (ii) the right to consent to or
direct any waiver of defaults or Trigger Events by the Transferor or Servicer;
(iii) the right to remove the Trustee pursuant to the Agreement; (iv) the
right to direct the actions of the Trustee during the continuation of a
Trigger Event; (v) the right to require the Transferor to accept the
retransfer of Loans for breach of a representation and warranty or defect in
documentation; and (vi) the right to direct the Trustee to investigate certain
matters. So long as no Certificate Insurer Default has occurred and is
continuing, the Certificate Insurer's consent will be required prior to, among
other things, (i) the removal of the Trustee, (ii) the appointment of any
successor Trustee or Servicer or (iii) any amendment to the Agreement, which
consent will not be unreasonably withheld in the circumstances described above
under the heading "--Amendment of Agreement."
S-64
<PAGE>
FURTHER PROVISIONS OF THE POOLING AND SERVICING AGREEMENT
The following summary describes certain terms of the Agreement. A form of
the Agreement has been filed as an exhibit to the Registration Statement. A
copy of the Agreement will be filed with the Commission following the issuance
of the Certificates. This summary of certain provisions does not purport to be
complete and is subject to, and qualified in its entirety by reference to, all
provisions of the Agreement. The following supplements, and to the extent
inconsistent therewith replaces, the description of the general terms and
provisions of the Agreement set forth in the Prospectus, to which description
reference is hereby made.
COLLECTION AND OTHER SERVICING PROCEDURES
The Servicer will make reasonable efforts to collect all payments called for
under the Loans and, consistent with the Agreement, will follow such
collection procedures that it customarily follows in the servicing of closed-
end home equity loans and conventional home improvement contracts that are
comparable to the Loans. Consistent with this requirement, the Servicer, in
its discretion, may waive any late payment charge in respect of a late Loan
payment.
The Agreement requires the Servicer, consistent with its customary servicing
procedures, to act with respect to the Loans in such a manner as to maximize
the receipt of principal and interest on such Loans and Net Liquidation
Proceeds with respect to Liquidated Loans. Under the Agreement the Servicer
may grant extensions or modifications with respect to any Loan if (a) in the
Servicer's good faith judgment, such extension or modification would minimize
the loss that might otherwise be experienced with respect to such Loan, (b)(i)
such Loan is a Liquidated Loan or (ii) a payment default with respect to such
Loan is reasonably foreseeable by the Servicer and (c) such extension or
modification is consistent with the Servicer's customary servicing practice.
Notwithstanding the foregoing, the Servicer may not extend or modify a Loan
such that the stated final maturity date of such Loan would extend beyond the
last day of the Monthly Collection Period preceding the Stated Maturity Date.
The Agreement also requires the Servicer to apply any Insurance Proceeds
received by it with respect to a Loan to reduce the unpaid principal balance
of such Loan.
In any case in which a Mortgaged Property is being conveyed by the borrower,
the Servicer will have the option to exercise its rights to accelerate the
maturity of such Loan under any due-on-sale clause applicable thereto unless
such exercise is not permitted by applicable law. If the Servicer is prevented
from enforcing such due-on-sale clause under applicable law or elects not to
exercise such right, the Servicer will enter into an assumption and
modification agreement with the person to whom such Mortgaged Property has
been or is about to be conveyed, pursuant to which such person becomes liable
under the Loan. To the extent permitted by applicable law, such assumption
will not release the original borrower from its obligation under the Loan. Any
fee collected by the Servicer for entering into an assumption or substitution
of liability agreement will be retained by the Servicer as additional
servicing compensation. See "CERTAIN LEGAL ASPECTS OF THE LOANS--Due-on-Sale
Clauses in Mortgage Loans" in the Prospectus. In connection with any such
assumption, the Loan Rate borne by the related Mortgage Loan may not be
altered, except to the extent described above.
CONSENT TO SENIOR LIENS
The Servicer may consent to the placement of a lien on any Mortgaged
Property senior to that of the related Loan, provided that such action is
consistent with reasonable commercial practice.
REALIZATION UPON LIQUIDATED LOANS
If the Servicer has actual knowledge or reasonably believes that any
Mortgaged Property is contaminated by hazardous or toxic wastes or substances,
then the Servicer will not cause the Trust to acquire title to such Mortgaged
Property in a foreclosure or similar proceeding if such acquisition in the
reasonable opinion of the Servicer is not commercially reasonable. In the
event that title to any Mortgaged Property securing a Loan is
S-65
<PAGE>
acquired by foreclosure or by deed in lieu of foreclosure, Net Liquidation
Proceeds with respect to such Loan will be held by the Trustee for the benefit
of the Certificateholders. Such Mortgaged Property will be disposed of by or
on behalf of the Trustee. Notwithstanding any such acquisition of title and
cancellation of the related Loan, such Loan will be considered for most
purposes to be an outstanding Loan held in the Trust until such time as the
Mortgaged Property is sold and such Loan is liquidated or the Loan otherwise
becomes a Liquidated Loan.
SERVICER ADVANCES
The Servicer shall advance its own funds to pay for any related expenses of
foreclosure and disposition of any Liquidated Loan or related Mortgaged
Property (a "Servicer Advance") to the extent that the Servicer, consistent
with its customary servicing practices, reasonably believes that such Servicer
Advance will be recoverable and will maximize the receipt of principal and
interest on such Loan (including Liquidation Proceeds with respect to such
Loan). The Servicer shall be entitled to reimbursement for an amount equal to
such Servicer Advance out of payments made by the Obligor on the Loan and the
proceeds of disposition of the Liquidated Loan or related Mortgaged Property.
EVIDENCE AS TO COMPLIANCE
The Agreement will provide that on or before December 31 of each year, a
firm of independent public accountants will furnish a statement to the Trustee
and the Certificate Insurer to the effect that such firm has examined, for the
preceding 12 months ended September 30, certain documents and records related
to the servicing of the Loans under the Agreement and that such examination,
which has been conducted substantially in compliance with either (i) the audit
guide for audits of non-supervised mortgagees approved by the Department of
Housing and Urban Development or (ii) the requirements of the Uniform Single
Attestation Program for Mortgage Bankers, has disclosed no items of
noncompliance with the provisions of the Agreement that, in the opinion of the
firm, are material, except for such items of non-compliance as shall be
referred to in the report. The Agreement also will provide for delivery (on or
before December 31 of each year) to the Trustee and the Certificate Insurer of
an annual statement signed by an officer of the Servicer to the effect that
the Servicer has fulfilled its material obligations under the Agreement
throughout the preceding 12 months.
CERTAIN MATTERS REGARDING THE SERVICER AND THE TRANSFEROR
The Agreement will provide that, except in connection with a permitted
transfer of servicing, the Servicer may not resign from its obligations and
duties thereunder unless its duties under the Agreement are no longer
permissible under applicable law or are in material conflict by reason of
applicable law with any other activities of a type and nature presently
carried on by it or its affiliates. No such resignation will become effective
until the Trustee or a successor Servicer has assumed the Servicer's
obligations and duties under the Agreement.
The Agreement will provide that the Servicer will not be under any liability
to the Trust or the Certificateholders for taking any action or for refraining
from taking any action in good faith pursuant to the Agreement, or for errors
in judgment; provided, however, that the Servicer will not be protected
against any liability that otherwise would be imposed by reason of willful
misfeasance, bad faith or gross negligence in the performance of duties or by
reason of its reckless disregard of its obligations and duties thereunder. The
Agreement further will provide that the Servicer and any director, officer,
employee or agent of the Servicer will be entitled to indemnification by the
Trust and will be held harmless to the extent provided in the Agreement
against any loss, liability or expense incurred in connection with any legal
action relating to the Agreement or the Certificates, other than any loss,
liability or expense related to any specific Loan or Loans (except any such
loss, liability or expense otherwise reimbursable pursuant to the Agreement)
and any loss, liability or expense incurred by the Servicer by reason of its
willful misfeasance, bad faith or gross negligence in the performance of its
duties thereunder or by reason of the Servicer's reckless disregard of its
obligations and duties thereunder.
S-66
<PAGE>
The Agreement will provide that the Servicer will not be under any
obligation to appear in, prosecute or defend any legal action that is not
incidental to its duties under the Agreement and that in its opinion may
involve it in any expense or liability. The Servicer, however, in its
discretion, may undertake any such action that it may deem necessary or
desirable with respect to the Agreement and the rights and duties of the
parties thereto and the interest of the Certificateholders and Certificate
Insurer thereunder. In such event, the legal expenses and costs of such action
and any liability resulting therefrom will be expenses, costs and liabilities
of the Trust, and the Servicer will be entitled to be reimbursed therefor to
the extent provided in the Agreement. The Servicer's right to such indemnity
or reimbursement will survive any resignation or termination of the Servicer
with respect to any losses, expenses, costs or liabilities arising prior to
such resignation or termination (or arising from events that occurred prior to
such resignation or termination). Any claims by or on behalf of the
Certificateholders or the Trust will be made only against the Servicer, who
will be liable with respect to its own acts and omissions as well as the acts
and omissions of its directors, officers, employees and agents.
Any corporation into which the Servicer may be merged or consolidated, or
any corporation resulting from any merger, conversion or consolidation to
which the Servicer shall be a party, or any corporation succeeding to the
business of the Servicer, or any corporation that executes an agreement of
assumption to perform every obligation of the Servicer hereunder, will be the
successor of the Servicer under the Agreement and will be required to execute
and deliver to the Trustee and the Certificate Insurer an agreement in form
reasonably satisfactory to the Trustee and the Certificate Insurer which
contains an assumption by such successor entity of the due and punctual
performance and observance of each covenant and condition to be performed or
observed by the Servicer under the Agreement.
The Agreement will require the Transferor to transfer any payments it
receives with respect to a Loan to the Servicer within two Business Days
following receipt thereof.
EVENTS OF DEFAULT AND TRIGGER EVENTS
"Events of Default" under the Agreement will consist of (i) any failure by
the Servicer to deposit into the Collection Account any deposit required to be
made under the Agreement, which failure continues unremedied for five Business
Days after the giving of written notice of such failure to the Servicer by the
Trustee or to the Servicer and the Trustee by the Certificate Insurer or by
notice to the Servicer, the Trustee and the Certificate Insurer by the
Certificateholders evidencing not less than 51% of the Certificate Principal
Balance; (ii) any failure by the Servicer duly to observe or perform in any
material respect any other of its covenants or agreements in the Insurance
Agreement or the Agreement which breach materially and adversely affects the
interests of the Certificateholders or the Certificate Insurer and continues
unremedied for 60 days after the giving of written notice of such failure to
the Servicer and the Certificate Insurer by the Trustee or to the Servicer and
the Trustee by the Certificate Insurer or to the Servicer, the Certificate
Insurer and the Trustee by holders of the Certificates evidencing not less
than 51% of the Certificate Principal Balance of the Certificates,
respectively; and (iii) certain events of insolvency, readjustment of debt,
marshalling of assets and liabilities or similar proceedings regarding the
Servicer and certain actions by the Servicer indicating its insolvency or
inability to pay its obligations.
A "Trigger Event" is the occurrence of any of the following events: (i)
failure by the Servicer to pay the Certificate Insurer amounts payable under
the Insurance Agreement which failure continues unremedied for five Business
Days after notice to the Servicer; (ii) failure of the Servicer to pay amounts
payable under the Agreement, which failure results in a draw on the Policy;
(iii) the occurrence of an Event of Default; (iv) a determination that the
performance of the Servicer under the Agreement is not satisfactory in the
reasonable opinion of the Certificate Insurer or (v) the occurrence of a Rapid
Amortization Event other than a Rapid Amortization Event described in clauses
(d) or (f) of the definition thereof.
RIGHTS UPON EVENTS OF DEFAULT AND TRIGGER EVENTS
So long as an Event of Default remains unremedied, either the Certificate
Insurer (so long as no Certificate Insurer Default has occurred and is
continuing) or the Trustee or holders of Certificates evidencing not less than
S-67
<PAGE>
51% of the Certificate Principal Balance, in each case with the consent of the
Certificate Insurer (if no Certificate Insurer Default has occurred and is
continuing), may terminate all of the rights and obligations of the Servicer
under the Agreement. Upon such termination, the Trustee will succeed to all
the responsibilities, duties and liabilities of the Servicer under the
Agreement. In the event that the Trustee would be obligated to succeed the
Servicer but is unable or unwilling so to act, the Certificate Insurer may
appoint the successor Servicer. If a Certificate Insurer Default shall have
occurred and is continuing or the Certificate Insurer fails to make such
appointment within the period specified in the Agreement, the Trustee may
appoint or petition a court of competent jurisdiction to appoint, a housing
and home finance institution with a net worth of at least $10,000,000 to act
as successor to the Servicer under the Agreement. Pending such appointment,
the Trustee is obligated to act in such capacity. The Trustee, the Certificate
Insurer and such successor may agree upon the servicing compensation to be
paid, which in no event may be greater than the compensation specified for a
successor Servicer under the Agreement.
A "Certificate Insurer Default" occurs upon (i) the Certificate Insurer's
failure to make a payment required under the Policy in accordance with its
terms, or (ii) the insolvency of the Certificate Insurer.
No Certificateholder will have any right under the Agreement to institute
any proceeding in its name with respect to the Agreement unless such holder
previously has given to the Trustee and the Certificate Insurer written notice
of default and unless holders of Certificates evidencing not less than 25% of
the Certificate Principal Balance with the consent of the Certificate Insurer
have made written request upon the Trustee to institute such proceeding in its
own name as Trustee thereunder and have offered to the Trustee reasonable
indemnity, and the Trustee for 60 days has neglected or refused to institute
any such proceeding. The Trustee will be under no obligation to exercise any
of the trusts or powers vested in it by the Agreement or to make any
investigation of matters arising thereunder or to institute, conduct or defend
any litigation thereunder or in relation thereto at the request, order or
direction of any of the holders of Certificates or the Certificate Insurer
covered by the Agreement, unless such Certificateholders or the Certificate
Insurer have offered to the Trustee reasonable security or indemnity against
the costs, expenses and liabilities that may be incurred therein or thereby.
Following the occurrence of any Trigger Event other than as specified in
clause (v) of the definition thereof, so long as no Certificate Insurer
Default has occurred and is continuing, the Certificate Insurer will have the
right to require the Trustee to terminate the Servicer and appoint a successor
Servicer pursuant to the Agreement, all reasonable costs and expenses incurred
in connection with such transfer to be paid out of collections on the Loans.
Such costs shall be paid from (x) Interest Collections received during the
Monthly Collection Period such costs were incurred prior to making any other
allocation of Interest Collections in respect of such Monthly Collection
Period, and (y) to the extent such Interest Collections are insufficient to
cover such costs, from Principal Collections received during such Monthly
Collection Period prior to making any other allocations of Principal
Collections in respect of such Monthly Collection Period. If a Trigger Event
specified in clause (v) of the definition thereof occurs, so long as no
Certificate Insurer Default has occurred and is continuing, the Certificate
Insurer will have the right to redirect payments made by the Obligors on the
Loans to the Trustee, and avail itself of any other remedies available under
the Agreement, the Insurance Agreement or applicable law.
WAIVER OF PAST DEFAULTS
The Certificate Insurer may, on behalf of all holders of Certificates, waive
any default by the Servicer in the performance of its obligations under the
Agreement and its consequences. No such waiver will impair the
Certificateholders' rights with respect to subsequent defaults.
AMENDMENT OF AGREEMENT
The Agreement may be amended from time to time by the Servicer, the
Transferor and the Trustee with the consent of the Certificate Insurer (which
consent may not be unreasonably withheld) without the consent of any
S-68
<PAGE>
of the Certificateholders (i) to cure any ambiguity, (ii) to correct any
defective provisions or to correct or supplement any provisions therein which
may be inconsistent with any other provisions therein, (iii) to add or delete
any other provisions with respect to matters or questions arising under the
Agreement that are not inconsistent with the provisions of the Agreement, (iv)
to add or amend any provision as required by the Rating Agencies in order to
maintain or improve the rating of the Certificates (it being understood that,
after obtaining the ratings in effect on the Closing Date, neither the
Transferor nor the Servicer is obligated to obtain, maintain or improve any
such rating), or (v) to add any other provisions with respect to matters or
questions arising thereunder; provided that such action will not, as evidenced
by an opinion of counsel, materially and adversely affect the interests of any
Certificateholder (and provided that any such amendment will be deemed not to
affect materially and adversely the Certificateholders if the Person
requesting such amendment obtains a letter from each Rating Agency stating
that such amendment would not result in a downgrading or withdrawal of the
rating of the Certificates and provided further that any such amendment will
be deemed not to materially and adversely affect the Certificate Insurer if
each Rating Agency has confirmed that such amendment would not result in a
reduction below investment grade of the Certificates without regard to the
Policy).
The Agreement also may be amended from time to time by the Servicer, the
Transferor and the Trustee with the consent of the Certificate Insurer and the
holders of Certificates evidencing not less than 51% of the Certificate
Principal Balance, for the purpose of adding any provisions to or changing in
any manner or eliminating any of the provisions of the Agreement or of
modifying in any manner the rights of holders of the Certificates. No such
amendment, however, may (i) reduce in any manner the amount of, or delay the
timing of, collection of payments of Loans or distributions that are required
to be made on any Certificate without the consent of the holder of such
Certificate or (ii) reduce the aforesaid percentage required to consent to any
such amendment, without the consent of all Certificateholders. In connection
with any amendment of the Agreement, an opinion of counsel must be obtained
that such amendment will not adversely affect the federal income tax
characterization of the Trust or the Certificates.
OPTIONAL TERMINATION; RETIREMENT OF THE CERTIFICATES
The Trust will terminate on the Monthly Payment Date following the later of
(A) payment in full of all amounts owing to the Certificate Insurer and (B)
the earliest of (i) the Monthly Payment Date on which the Certificate
Principal Balance has been reduced to zero, (ii) the Dissolution Distribution
Date and (iii) the Stated Maturity Date. The Certificates will be subject to
optional repurchase by the Transferor on any Distribution Date after the
Certificate Principal Balance is reduced to an amount less than or equal to
$7,676,050 (5% of the Initial Certificate Principal Balance) and all amounts
due and owing to the Certificate Insurer and unreimbursed draws on the Policy,
together with interest thereon, as provided under the Insurance Agreement,
have been paid. The purchase price will be equal to the sum of the outstanding
Certificate Principal Balance and accrued and unpaid interest thereon at the
Certificate Rate through the day preceding the final Distribution Date. In no
event, however, will the Trust created by the Agreement continue in
perpetuity. Written notice of termination of the Agreement will be given to
each Certificateholder, and the final distribution will be made only upon
surrender and cancellation of the Certificates at an office or agency
appointed by the Trustee which will be specified in the notice of termination.
In addition, the Trust may be liquidated as a result of certain events of
insolvency, receivership or conservatorship relating to the Transferor. See
"--Rapid Amortization Period; Rapid Amortization Events."
THE TRUSTEE AND PAYING AGENT
Trustee. Norwest Bank Minnesota, National Association, will serve as Trustee
under the Agreement. The Trustee may have normal banking relationships with
the Transferor and the Servicer or their affiliates, or both. The Corporate
Trust Office of the Trustee is located at Sixth Street and Marquette Avenue,
Minneapolis, Minnesota 55479.
The Trustee may resign at any time. The Transferor or the Certificate
Insurer also may remove the Trustee if the Trustee ceases to be eligible to
continue as such under the Agreement or if the Trustee becomes insolvent.
S-69
<PAGE>
In any such event, the Transferor will be obligated to appoint a successor
Trustee with the consent of the Certificate Insurer. Any resignation or
removal of the Trustee and appointment of a successor Trustee will not become
effective until acceptance of the appointment by the successor Trustee.
The Paying Agent. The Paying Agent shall initially be the Trustee together
with any successor thereto in such capacity (the "Paying Agent"). The Paying
Agent shall have the revocable power to withdraw funds from the Collection
Account for the purpose of making distributions to the Certificateholders.
CERTAIN INFORMATION REGARDING THE CERTIFICATES
Certificateholders may hold their Certificates through DTC if they are
participants of such system, or indirectly through organizations that are
participants in such system.
CEDE & Co., as nominee for DTC, will be the registered holder of the global
Certificates. No Certificateholder will be entitled to receive a certificate
representing such person's interest in the Certificates. Unless and until
Replacement Certificates are issued under the limited circumstances described
below, all references herein to actions by Certificateholders shall refer to
actions taken by DTC upon instructions from DTC Participants, and all
references herein to distributions, notices, reports and statements to
Certificateholders shall refer to distributions, notices, reports and
statements to CEDE & Co., as the registered holder of the Certificates, for
distribution to Certificateholders in accordance with DTC procedures.
DTC is a limited-purpose trust company organized under the New York Banking
Law, a "banking organization" within the meaning of the New York Banking Law,
a member of the Federal Reserve System, a "clearing corporation" within the
meaning of the New York Uniform Commercial Code, and a "clearing agency"
registered pursuant to the provisions of Section 17A of the Exchange Act. DTC
holds securities for its participants ("DTC Participants") and facilitates the
clearance and settlement among DTC Participants of securities transactions,
such as transfers and pledges, in deposited securities through electronic
book-entry changes in DTC Participants' accounts, thereby eliminating the need
for physical movement of securities certificates. DTC Participants include
securities brokers and dealers, banks, trust companies, clearing corporations
and certain other organizations. Indirect access to the DTC system is also
available to others such as securities brokers and dealers, banks, and trust
companies that clear through or maintain a custodial relationship with a DTC
Participant, either directly or indirectly ("Indirect Participants").
Transfers between DTC Participants will occur in accordance with DTC rules.
The rules applicable to DTC and its Participants are on file with the
Commission.
Purchases of Certificates under the DTC system must be made by or through
DTC Participants, which will receive a credit for the Certificates on DTC's
records. The ownership interest of each actual Certificate Owner is in turn to
be recorded on the DTC Participants' and Indirect Participants' records.
Certificate Owners will not receive written confirmation from DTC of their
purchase, but Certificate Owners are expected to receive written confirmations
providing details of the transaction, as well as periodic statements of their
holdings, from the DTC Participant or Indirect Participant through which the
Certificate Owner entered into the transaction. Transfers of ownership
interests in the Certificates are to be accomplished by entries made on the
books of DTC Participants acting on behalf of Certificate Owners. Certificate
Owners will not receive certificates representing their ownership interest in
Certificates, except in the event that use of the book-entry system for the
Certificates is discontinued.
To facilitate subsequent transfers, all Certificates deposited by DTC
Participants with DTC are registered in the name of DTC's nominee, CEDE & Co.
The deposit of Certificates with DTC and their registration in the name of
CEDE & Co. effects no change in beneficial ownership. DTC has no knowledge of
the actual Certificate Owners of the Certificates; DTC's records reflect only
the identity of the DTC Participants to whose accounts such Certificates are
credited, which may or may not be the Certificate Owners. The DTC Participants
will remain responsible for keeping account of their holdings on behalf of
their customers.
S-70
<PAGE>
Conveyance of notices and other communications by DTC to DTC Participants,
by DTC Participants to Indirect Participants, and by DTC Participants and
Indirect Participants to Certificate Owners will be governed by arrangements
among them, subject to any statutory or regulatory requirements as may be in
effect from time to time.
Neither DTC nor CEDE & Co. will consent or vote with respect to
Certificates. Under its usual procedures, DTC mails an omnibus proxy to the
issuer as soon as possible after the record date, which assigns CEDE & Co.'s
consenting or voting rights to those DTC Participants to whose accounts the
Certificates are credited on the record date (identified in a listing attached
thereto).
Principal and interest payments on the Certificates will be made to DTC.
DTC's practice is to credit DTC Participants' accounts on the applicable
Monthly Payment Date in accordance with their respective holdings shown on
DTC's records unless DTC has reason to believe that it will not receive
payment on such Distribution Date. Payments by DTC Participants to Certificate
Owners will be governed by standing instructions and customary practices as is
the case with securities held for the accounts of customers in bearer form or
registered in "street name and will be the responsibility of such DTC
Participant and not of DTC, the Trustee or the Transferor, subject to any
statutory or regulatory requirements as may be in effect from time to time.
Payment of principal and interest to DTC is the responsibility of the Trustee,
disbursement of such payments to DTC Participants shall be the responsibility
of DTC, and disbursement of such payments to Certificate Owners shall be the
responsibility of DTC Participants and Indirect Participants.
DTC may discontinue providing its services as securities depository with
respect to the Certificates at any time by giving reasonable notice to the
Transferor or the Trustee. Under such circumstances, in the event that a
successor securities depository is not obtained, Replacement Certificates are
required to be printed and delivered. The Transferor may decide to discontinue
use of the system of book-entry transfers through DTC (or a successor
securities depository). In that event, Replacement Certificates will be
delivered to Certificateholders.
The information in this section concerning DTC and DTC's book-entry system
has been obtained from sources that the Transferor believes to be reliable,
but the Transferor takes no responsibility for the accuracy thereof.
Certificates will be issued in registered form to Certificate Owners, or
their nominees, rather than to DTC (such Certificates being referred to herein
as "Replacement Certificates"), only if (i) the Transferor advises the Trustee
in writing that DTC is no longer willing or able to discharge properly its
responsibilities as nominee and depository with respect to the Certificates
and the Transferor is unable to locate a qualified successor, (ii) the
Transferor at its option advises the Trustee in writing that it elects to
terminate the book-entry system through DTC or (iii) after the occurrence of
an Event of Default, Certificate Owners having Certificates evidencing not
less than 51% of the Certificate Principal Balance together advise the Trustee
and DTC in writing that the continuation of a book-entry system through DTC
(or a successor thereto) to the exclusion of any physical certificates being
issued to Certificate Owners is no longer in the best interests of Certificate
Owners. Upon issuance of Replacement Certificates to Certificate Owners, such
Certificates will be transferable directly (and not exclusively on a book-
entry basis) and registered holders will deal directly with the Trustee with
respect to transfers, notices and distributions.
DTC has advised the Transferor and the Trustee that, unless and until
Replacement Certificates are issued, DTC will take any action permitted to be
taken by a Certificateholder under the Agreement only at the direction of one
or more Participants to whose DTC accounts the Certificates are credited. DTC
may take actions, at the direction of the applicable Participants, with
respect to some Certificates that conflict with actions taken with respect to
other Certificates.
S-71
<PAGE>
FEDERAL INCOME TAX CONSIDERATIONS
PROSPECTIVE INVESTORS AND CERTIFICATEHOLDERS ARE ADVISED TO CONSULT THEIR
TAX ADVISORS WITH REGARD TO THE FEDERAL INCOME TAX CONSEQUENCES OF THE
PURCHASE, OWNERSHIP, OR DISPOSITION OF INTERESTS IN THE CERTIFICATES, AS WELL
AS THE TAX CONSEQUENCES ARISING UNDER THE LAWS OF ANY STATE, FOREIGN COUNTRY
OR OTHER TAXING JURISDICTION.
Stroock & Stroock & Lavan, special tax counsel to the Transferor, is of the
opinion, based upon its analysis of the factors discussed in the Prospectus
under "FEDERAL INCOME TAX CONSIDERATIONS-- Certain Certificates Treated as
Indebtedness," that for federal income tax purpose the Certificates will be
characterized as indebtedness that is secured by the Loans. Opinions of
counsel are not binding on the Internal Revenue Service (the "IRS"), however,
and there can be no assurance that the IRS could not successfully challenge
this conclusion. Moreover, no ruling will be sought from the IRS with respect
to the transaction described herein. All potential investors and
Certificateholders are advised to review "FEDERAL INCOME TAX CONSIDERATIONS"
in the Prospectus for a discussion of the anticipated federal income tax
consequences of the purchase, ownership and disposition of the Certificates.
STATE TAX CONSIDERATIONS
Potential investors and Certificateholders should consider the state and
local income tax consequences of the purchase, ownership and disposition of
the Certificates. State and local income tax laws may differ substantially
from the corresponding federal law, and this discussion does not purport to
describe any aspect of the income tax laws of any state or locality.
Therefore, potential investors and Certificateholders should consult their own
tax advisors with respect to the various state and local tax consequences of
an investment in the Certificates.
ERISA CONSIDERATIONS
No Certificates may be purchased for, or on behalf of, any employee benefit
plan or other retirement arrangement which is subject to Title I of the
Employee Retirement Income Security Act of 1974, as amended, and/or Section
4975 of the Internal Revenue Code of 1986, as amended, or any entity whose
underlying assets include plan assets by reason of such plan or account
investing in such entity (including insurance company separate or general
accounts and collective investment funds). Each Certificateholder will be
deemed to have represented and warranted that it is not subject to the
foregoing limitations. See "ERISA CONSIDERATIONS" in the Prospectus.
LEGAL INVESTMENT CONSIDERATIONS
Although, as a condition to their issuance, the Certificates will be rated
in the highest rating category by a Rating Agency, the Certificates will not
constitute "mortgage related securities" for purposes of the Secondary
Mortgage Market Enhancement Act of 1984 ("SMMEA"), because not all of the
Loans are secured by first liens. Accordingly, many institutions with legal
authority to invest in comparably rated securities based on first mortgage
loans (i.e., "mortgage related securities" under SMMEA) may not be legally
authorized to invest in the Certificates.
The appropriate characterization of the Certificates under various legal
investment restrictions, and thus the ability of investors subject to these
restrictions to purchase Certificates, may be subject to significant
interpretive uncertainties. All investors whose investment authority is
subject to legal restrictions should consult their own legal advisors to
determine whether, and to what extent, the Certificates will constitute legal
investments for them. The Transferor makes no representation as to the proper
characterization of the Certificates for legal investment or financial
institution regulatory purposes, or as to the ability of particular investors
to purchase Certificates under applicable legal investment restrictions. The
uncertainties described above (and any unfavorable future determinations
concerning legal investment or financial institution regulatory
characteristics of the Certificates) may adversely affect the liquidity of the
Certificates.
S-72
<PAGE>
UNDERWRITING
Under the terms and subject to the conditions contained in an Underwriting
Agreement dated May , 1996 (the "Underwriting Agreement"), the Underwriters
named below (the "Underwriters") have severally but not jointly agreed to
purchase from the Transferor the following respective principal amounts of the
Certificates:
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT
---------
<S> <C>
CS First Boston Corporation......................................... $
Smith Barney Inc.................................................... $
-----
Total............................................................. $
=====
</TABLE>
The Underwriting Agreement provides that the obligations of the Underwriters
are subject to certain conditions precedent and that the Underwriters will be
obligated to purchase all the Certificates if any are purchased.
The Transferor has been advised by the Underwriters that the Underwriters
propose to offer the Certificates to the public initially at the public
offering price set forth on the cover page of this Prospectus to certain
dealers at such price less a concession of % of the principal amount per
Certificate, and the Underwriters and such dealers may allow a discount of
% of such principal amount per Certificate on sales to certain other
dealers. After the initial public offering, the public offering price and
concession and discount to dealers may be changed by the Underwriters.
The Certificates are a new issue of securities with no established trading
market. The Underwriters have advised the Transferor that they intend to act
as market makers for the Certificates. However, the Underwriters are not
obligated to do so and may discontinue any market making at any time without
notice. No assurance can be given as to the liquidity of the trading market
for the Certificates.
The Transferor has agreed to indemnify the Underwriters against certain
liabilities, including civil liabilities under the Securities Act, or
contribute to payments which the Underwriters may be required to make in
respect thereof.
LEGAL OPINIONS
Certain federal income tax and other matters will be passed upon for the
Transferor by Stroock & Stroock & Lavan. Certain legal matters relating to the
Certificates will be passed upon for the Transferor by Shaw, Pittman, Potts &
Trowbridge, a partnership including professional corporations, and for the
Underwriters by Stroock & Stroock & Lavan. George M. Rogers, Jr., whose
professional corporation is a member of Shaw, Pittman, Potts & Trowbridge, is
a director of the Transferor and the parent of the Transferor. Certain legal
matters will be passed upon for the Certificate Insurer by Sidley & Austin,
special counsel to the Certificate Insurer.
EXPERTS
The balance sheets of Capital Markets Assurance Corporation as of December
31, 1995 and 1994 and the related statements of income, stockholder's equity
and cash flows for each of the years in the three-year period ended December
31, 1995, are attached hereto as Appendix A and have been audited by KPMG Peat
Marwick LLP, independent certified public accountants, as set forth in their
report thereon and are included in reliance upon the authority of such firm as
expert in accounting and auditing.
The report of KPMG Peat Marwick LLP covering the financial statements noted
above refer to Capital Markets Assurance Corporation's adoption at December
31, 1993 of the Financial Accounting Standards Board's Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in Debt and
Equity Securities."
S-73
<PAGE>
RATING
It is a condition to the issuance of the Certificates that they be rated in
the highest rating category by at least one Rating Agency. The rating of the
Certificates will depend primarily on an assessment by a Rating Agency of the
underlying Loans and the claims paying ability of the Certificate Insurer and
in part on the funds on deposit in the Reserve Fund and on the level of
overcollateralization provided by the Overcollateralization Amount. There can
be no assurance that the rating assigned to the Certificates on the Closing
Date will not be reduced, suspended or withdrawn by a Rating Agency in the
future.
S-74
<PAGE>
INDEX OF PRINCIPAL TERMS
<TABLE>
<CAPTION>
DEFINITION PAGE
- ---------- ----
<S> <C>
Adjusted Certificate Principal Balance..................................... S-12
Agreement.................................................................. S-1
Amortization Period........................................................ S-14
Avoided Payment............................................................ S-63
BIF........................................................................ S-29
Business Day............................................................... S-64
CapMac..................................................................... S-39
Certificateholders......................................................... S-5
Certificateholders' Interest Carryover Shortfall........................... S-5
Certificateholders' Percentage............................................. S-7
Certificate Insurer........................................................ S-1
Certificate Insurer Default................................................ S-68
Certificate Owners......................................................... S-3
Certificate Principal Balance.............................................. S-3
Certificate Rate........................................................... S-1
Certificates............................................................... S-1
Chevy Chase................................................................ S-1
Closed-End Loans........................................................... S-2
Closing Date............................................................... S-3
Collateralization Deficiency............................................... S-17
Collection Account......................................................... S-9
Commission................................................................. S-2
CPR........................................................................ S-42
Cumulative Realized Loss Ratio............................................. S-8
Defective Loan............................................................. S-23
Deferral Period............................................................ S-30
Deposit Date............................................................... S-9
Determination Date......................................................... S-50
Direct Home Improvement Loans.............................................. S-30
Dissolution Distribution Date.............................................. S-59
Distribution Date.......................................................... S-1
DTC........................................................................ S-2
DTC Participants........................................................... S-70
Early Amortization Event................................................... S-7
Early Amortization Period.................................................. S-14
Eligible Account........................................................... S-50
Eligible Substitute Loan................................................... S-23
Events of Default.......................................................... S-67
Excess Funding Account..................................................... S-49
Excess Funding Initial Deposit............................................. S-18
Excess Funding Interest Subaccount......................................... S-49
Excess Funding Interest Transfer Amount.................................... S-18
Excess Funding Principal Subaccount........................................ S-49
Excess Interest............................................................ S-12
Excess Overcollateralization Amount........................................ S-46
Exchange Act............................................................... S-2
Expense Distribution Account............................................... S-10
FDIA....................................................................... S-28
FDIC....................................................................... S-28
</TABLE>
S-75
<PAGE>
<TABLE>
<CAPTION>
DEFINITION PAGE
- ---------- ----
<S> <C>
Final Order............................................................... S-64
FIRREA.................................................................... S-28
Funding Principal Amount.................................................. S-15
Funding Principal Percentage.............................................. S-15
Holdings.................................................................. S-39
Home Improvement Contracts................................................ S-2
Home Loans................................................................ S-9
Indirect Debt Consolidation Loans......................................... S-30
Indirect Home Improvement Loans........................................... S-29
Indirect Participants..................................................... S-70
Initial Certificate Principal Balance..................................... S-3
Initial Closed-End Loans.................................................. S-2
Initial Cut-off Date...................................................... S-2
Initial Home Improvement Contracts........................................ S-2
Initial Loans............................................................. S-2
Initial Mortgaged Properties.............................................. S-2
Initial Mortgages......................................................... S-2
Initial Reserve Fund Deposit.............................................. S-19
Insolvency Event.......................................................... S-59
Insolvency Proceeding..................................................... S-64
Insurance Agreement....................................................... S-20
Insurance Proceeds........................................................ S-10
Interest Collections...................................................... S-10
Interest Deficiency....................................................... S-53
Interest Deficiency Draw Amount........................................... S-20
Interest Distributable Amount............................................. S-5
Interest Distribution Account............................................. S-10
Interest Period........................................................... S-5
Insured Payments.......................................................... S-20
Invested Amount........................................................... S-12
IRS....................................................................... S-72
Liquidated Loan........................................................... S-11
Liquidation Loss Amount................................................... S-13
Liquidation Proceeds...................................................... S-10
Loan File................................................................. S-47
Loan Rate................................................................. S-9
Loans..................................................................... S-4
Monthly Allocable Principal............................................... S-6
Monthly Available Principal............................................... S-6
Monthly Collection Period................................................. S-8
Monthly Payment Date...................................................... S-1
Mortgaged Properties...................................................... S-2
Mortgages................................................................. S-2
Negative Carry Amount..................................................... S-8
Negative Carry Deposit Amount............................................. S-8
Net Liquidation Proceeds.................................................. S-10
Net Loan Rate............................................................. S-48
Net Principal Collections................................................. S-7
Obligor................................................................... S-10
Original Pool Balance..................................................... S-4
Overcollateralization Amount.............................................. S-12
</TABLE>
S-76
<PAGE>
<TABLE>
<CAPTION>
DEFINITION PAGE
- ---------- ----
<S> <C>
Overcollateralization Deposit/Distribution Amount.......................... S-12
OTS........................................................................ S-28
Paid-Ahead Loan............................................................ S-41
Paid-Ahead Period.......................................................... S-41
Paying Agent............................................................... S-70
Permitted Investments...................................................... S-50
Policy..................................................................... S-1
Policy Premium Rate........................................................ S-8
Pool Balance............................................................... S-13
Preference Event........................................................... S-63
Principal Collections...................................................... S-10
Principal Deficiency Draw Amount........................................... S-20
Principal Distributable Amount............................................. S-6
Principal Distribution Account............................................. S-10
Prospectus................................................................. S-2
Rapid Amortization Event................................................... S-58
Rapid Amortization Period.................................................. S-14
Rating Agency.............................................................. S-24
Receipt.................................................................... S-63
Received................................................................... S-63
Record Date................................................................ S-44
Recoveries................................................................. S-11
Remaining Interest......................................................... S-12
Replacement Certificates................................................... S-71
Required Overcollateralization Amount...................................... S-13
Reserve Fund............................................................... S-19
Reserve Fund Interest Transfer Amount...................................... S-19
Reserve Fund Principal Transfer Amount..................................... S-19
Residential Properties..................................................... S-8
Retransfer Deposit Amount.................................................. S-48
Revolving Period........................................................... S-11
SAIF....................................................................... S-28
Servicer................................................................... S-1
Servicer Advance........................................................... S-66
Servicer's Certificate..................................................... S-50
Servicing Fee.............................................................. S-49
Servicer Payment........................................................... S-51
Simple Interest Loan....................................................... S-35
SMMEA...................................................................... S-24
Specified Reserve Fund Requirement......................................... S-19
Stated Certificate Principal Balance....................................... S-18
Stated Maturity Date....................................................... S-1
Subsequent Closed-End Loans................................................ S-2
Subsequent Cut-off Date.................................................... S-22
Subsequent Home Improvement Contracts...................................... S-2
Subsequent Loan Purchase Termination Date.................................. S-5
Subsequent Loans........................................................... S-4
Subsequent Mortgaged Properties............................................ S-2
Subsequent Mortgages....................................................... S-2
Subsequent Transfer Date................................................... S-2
</TABLE>
S-77
<PAGE>
<TABLE>
<CAPTION>
DEFINITION PAGE
- ---------- ----
<S> <C>
Substitution Adjustment Amount............................................. S-48
Transfer Price............................................................. S-22
Transferor................................................................. S-1
Transferor Distribution Account............................................ S-10
Trigger Event.............................................................. S-67
Trust...................................................................... S-1
Trust Fund................................................................. S-4
Trustee.................................................................... S-1
Trustee Fee Rate........................................................... S-8
Trustee's Fee.............................................................. S-49
Underwriters............................................................... S-73
Underwriting Agreement..................................................... S-73
</TABLE>
S-78
<PAGE>
APPENDIX A
CAPITAL MARKETS ASSURANCE CORPORATION
FINANCIAL STATEMENTS
DECEMBER 31, 1995, 1994 AND 1993
(WITH INDEPENDENT AUDITORS' REPORT THEREON)
<PAGE>
Independent Auditors' Report
----------------------------
The Board of Directors
Capital Markets Assurance Corporation:
We have audited the accompanying balance sheets of Capital Markets Assurance
Corporation as of December 31, 1995 and 1994 and the related statements of
income, stockholder's equity and cash flows for each of the years in the
three-year period ended December 31, 1995. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Capital Markets Assurance
Corporation as of December 31, 1995 and 1994 and the results of its operations
and its cash flows for each of the years in the three-year period ended
December 31, 1995 in conformity with generally accepted accounting principles.
As discussed in note 2, the Company changed its method of accounting for
investments to adopt the provisions of the Financial Accounting Standards
Board's Statement of Financial Accounting Standards No. 115, "Accounting for
Certain Investments in Debt and Equity Securities," at December 31, 1993.
January 25, 1996
<PAGE>
CAPITAL MARKETS ASSURANCE CORPORATION
BALANCE SHEETS
(DOLLARS IN THOUSANDS)
ASSETS
------
<TABLE>
<CAPTION>
December 31 December 31
1995 1994
- -----------------------------------------------------------------------------------------------
<S> <C> <C>
INVESTMENTS:
Bonds at fair value (amortized cost $210,651 at December 31, $ 215,706 172,016
1995 and $178,882 at December 31, 1994)
Short-term investments (at amortized cost which approximates 68,646 2,083
fair value)
Mutual funds at fair value (cost $16,434 at December 31, 1994) - 14,969
----------- -------
Total investments 284,352 189,068
----------- -------
Cash 344 85
Accrued investment income 3,136 2,746
Deferred acquisition costs 35,162 24,860
Premiums receivable 3,540 3,379
Prepaid reinsurance 13,171 5,551
Other assets 3,428 3,754
----------- -------
TOTAL ASSETS $ 343,133 229,443
=========== =======
<CAPTION>
LIABILITIES AND STOCKHOLDER'S EQUITY
------------------------------------
<S> <C> <C>
LIABILITIES:
Unearned premiums $ 45,767 25,905
Reserve for losses and loss adjustment expenses 6,548 5,191
Ceded reinsurance 2,469 1,497
Accounts payable and other accrued expenses 10,844 10,372
Current income taxes 136 -
Deferred income taxes 11,303 3,599
----------- -------
Total liabilities 77,067 46,564
----------- -------
STOCKHOLDER'S EQUITY:
Common stock 15,000 15,000
Additional paid-in capital 205,808 146,808
Unrealized appreciation (depreciation) on investments, 3,286 (5,499)
net of tax
Retained earnings 41,972 26,570
----------- -------
Total stockholder's equity 266,066 182,879
----------- -------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $ 343,133 229,443
=========== =======
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
<PAGE>
CAPITAL MARKETS ASSURANCE CORPORATION
STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
December 31, 1995 December 31, 1994 December 31, 1993
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C>
REVENUES:
Direct premiums written $ 56,541 43,598 24,491
Assumed premiums written 935 1,064 403
Ceded premiums written (15,992) (11,069) (3,586)
-------- ------- ------
Net premiums written 41,484 33,593 21,308
Increase in unearned premiums (12,242) (10,490) (3,825)
-------- ------- ------
Net premiums earned 29,242 23,103 17,483
-------- ------- ------
Net investment income 11,953 10,072 10,010
Net realized capital gains 1,301 92 1,544
Other income 2,273 120 354
-------- ------- ------
Total revenues 44,769 33,387 29,391
-------- ------- ------
EXPENSES:
Losses and loss adjustment expenses 3,141 1,429 902
Underwriting and operating expenses 13,808 11,833 11,470
Policy acquisition costs 7,203 4,529 2,663
-------- ------- ------
Total expenses 24,152 17,791 15,035
-------- ------- ------
Income before income taxes 20,617 15,596 14,356
-------- ------- ------
INCOME TAXES:
Current income tax 2,113 865 1,002
Deferred income tax 3,102 2,843 2,724
-------- ------- ------
Total income taxes 5,215 3,708 3,726
-------- ------- ------
NET INCOME $ 15,402 11,888 10,630
======== ======= ======
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
<PAGE>
CAPITAL MARKETS ASSURANCE CORPORATION
STATEMENTS OF STOCKHOLDER'S EQUITY
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
December 31, 1995 December 31, 1994 December 31, 1993
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C>
COMMON STOCK:
Balance at beginning of period $ 15,000 15,000 15,000
-------- ------- -------
Balance at end of period 15,000 15,000 15,000
-------- ------- -------
ADDITIONAL PAID-IN CAPITAL:
Balance at beginning of period 146,808 146,808 146,808
Paid-in capital 59,000 - -
-------- ------- -------
Balance at end of period 205,808 146,808 146,808
-------- ------- -------
UNREALIZED (DEPRECIATION) APPRECIATION
ON INVESTMENTS, NET OF TAX:
Balance at beginning of period (5,499) 3,600 -
Unrealized appreciation (depreciation) on
investments 8,785 (9,099) 3,600
-------- ------- -------
Balance at end of period 3,286 (5,499) 3,600
-------- ------- -------
RETAINED EARNINGS:
Balance at beginning of period 26,570 14,682 4,052
Net income 15,402 11,888 10,630
-------- ------- -------
Balance at end of period 41,972 26,570 14,682
-------- ------- -------
TOTAL STOCKHOLDER'S EQUITY $266,066 182,879 180,090
======== ======= =======
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
<PAGE>
CAPITAL MARKETS ASSURANCE CORPORATION
STATEMENTS OF CASH FLOWS
(DOLLAR IN THOUSANDS)
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
December 31, 1995 December 31, 1994 December 31, 1993
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 15,402 11,888 10,630
-------- ------- -------
ADJUSTMENTS TO RECONCILE NET INCOME TO NET
CASH PROVIDED (USED) BY OPERATING ACTIVITIES:
Reserve for losses and loss adjustment 1,357 1,429 902
expenses
Unearned premiums 19,862 15,843 4,024
Deferred acquisition costs (10,302) (9,611) (9,815)
Premiums receivable (161) (2,103) (432)
Accrued investment income (390) (848) (110)
Income taxes payable 3,621 2,611 2,872
Net realized capital gains (1,301) (92) (1,544)
Accounts payable and other accrued 472 3,726 1,079
expenses
Prepaid reinsurance (7,620) (5,352) (199)
Other, net 992 689 1,201
-------- ------- -------
Total adjustments 6,530 6,292 (2,022)
-------- ------- -------
NET CASH PROVIDED BY OPERATING ACTIVITIES 21,932 18,180 8,608
-------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments (158,830) (77,980) (139,061)
Proceeds from sales of investments 49,354 39,967 24,395
Proceeds from maturities of investments 28,803 19,665 106,042
-------- ------- -------
NET CASH USED IN INVESTING ACTIVITIES (80,673) (18,348) (8,624)
-------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Capital contribution 59,000 - -
-------- ------- -------
NET CASH PROVIDED BY FINANCING ACTIVITIES 59,000 - -
-------- ------- -------
Net increase (decrease) in cash 259 (168) (16)
Cash balance at beginning of period 85 253 269
-------- ------- -------
CASH BALANCE AT END OF PERIOD $ 344 85 253
======== ======= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Income taxes paid $ 1,450 1,063 833
======== ======= =======
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
<PAGE>
CAPITAL MARKETS ASSURANCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1995 AND 1994
1) BACKGROUND
Capital Markets Assurance Corporation ("CapMAC" or "the Company") is a New
York-domiciled monoline stock insurance company which engages only in the
business of financial guaranty and surety insurance. CapMAC is a wholly-owned
subsidiary of CapMAC Holdings Inc. ("Holdings"). CapMAC is licensed in all 50
states in addition to the District of Columbia, the Commonwealth of Puerto
Rico and the territory of Guam. CapMAC insures structured asset-backed,
corporate, municipal and other financial obligations in the U.S. and
international capital markets. CapMAC also provides financial guaranty
reinsurance for structured asset-backed, corporate, municipal and other
financial obligations written by other major insurance companies.
CapMAC's claims-paying ability is rated "Aaa" by Moody's Investors Service,
Inc. ("Moody's"), "AAA" by S&P Ratings Group ("S&P"), "AAA" by Duff & Phelps
Credit Rating Co. ("Duff & Phelps"), and "AAA" by Nippon Investors Service,
Inc., a Japanese rating agency. Such ratings reflect only the views of the
respective rating agencies, are not recommendations to buy, sell or hold
securities and are subject to revision or withdrawal at any time by such
rating agencies.
2) SIGNIFICANT ACCOUNTING POLICIES
Significant accounting policies used in the preparation of the accompanying
financial statements are as follows:
a) BASIS OF PRESENTATION
The accompanying financial statements are prepared on the basis of generally
accepted accounting principles ("GAAP"). Such accounting principles differ
from statutory reporting practices used by insurance companies in reporting to
state regulatory authorities.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and the disclosure
of contingent assets and liabilities at the date of the financial statements
and the reported amounts of revenues and expenses during the reporting period.
Management believes the most significant estimates relate to deferred
acquisition costs, reserve for losses and loss adjustment expenses and
disclosures of financial guarantees outstanding. Actual results could differ
from those estimates.
b) INVESTMENTS
At December 31, 1993, the Company adopted the provisions of Statement of
Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." Under SFAS No. 115, the Company
can classify its debt and marketable equity securities in one of three
categories: trading, available-for-sale, or held-to-maturity. Trading
securities are bought and held principally for the purpose of selling them in
the near term. Held-to-maturity securities are those securities in which the
Company has the ability and intent to hold the securities until maturity. All
other securities not included in trading or held-to-maturity are classified as
available-for-sale. As of December 31, 1995 and 1994, all of the Company's
securities have been classified as available-for-sale.
<PAGE>
CAPITAL MARKETS ASSURANCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
Available-for-sale securities are recorded at fair value. Fair value is based
upon quoted market prices. Unrealized holding gains and losses, net of the
related tax effect, on available-for-sale securities are excluded from
earnings and are reported as a separate component of stockholder's equity
until realized. Transfers of securities between categories are recorded at
fair value at the date of transfer.
A decline in the fair value of any available-for-sale security below cost that
is deemed other than temporary is charged to earnings resulting in the
establishment of a new cost basis for the security.
Short-term investments are those investments having a maturity of less than
one year at purchase date. Short-term investments are carried at amortized
cost which approximates fair value.
Premiums and discounts are amortized or accreted over the life of the related
security as an adjustment to yield using the effective interest method.
Dividend and interest income are recognized when earned. Realized gains and
losses are included in earnings and are derived using the FIFO (first-in,
first-out) method for determining the cost of securities sold.
c) REVENUE RECOGNITION
Premiums which are payable monthly to CapMAC are reflected in income when due,
net of amounts payable to reinsurers. Premiums which are payable quarterly,
semi-annually or annually are reflected in income, net of amounts payable to
reinsurers, on an equal monthly basis over the corresponding policy term.
Premiums that are collected as a single premium at the inception of the policy
and have a term longer than one year are earned, net of amounts payable to
reinsurers, by allocating premium to each bond maturity based on the principal
amount and earning it straight-line over the term of each bond maturity. For
the year ended December 31, 1995, 91% of net premiums earned were attributable
to premiums payable in installments and 9% were attributable to premiums
collected on an upfront basis.
d) DEFERRED ACQUISITION COSTS
Certain costs incurred by CapMAC, which vary with and are primarily related to
the production of new business, are deferred. These costs include direct and
indirect expenses related to underwriting, marketing and policy issuance,
rating agency fees and premium taxes. The deferred acquisition costs are
amortized over the period in proportion to the related premium earnings. The
actual amount of premium earnings may differ from projections due to various
factors such as renewal or early termination of insurance contracts or
different run-off patterns of exposure resulting in a corresponding change in
the amortization pattern of the deferred acquisition costs.
e) RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
The reserve for losses and loss adjustment expenses consists of a Supplemental
Loss Reserve ("SLR") and a case basis loss reserve. The SLR is established
based on expected levels of defaults resulting from credit failures on
currently insured issues. This SLR is based on estimates of the portion of
earned premiums required to cover those claims.
2
<PAGE>
CAPITAL MARKETS ASSURANCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
A case basis loss reserve is established for insured obligations
when, in the judgement of management, a default in the timely payment of debt
service is imminent. For defaults considered temporary, a case basis loss
reserve is established in an amount equal to the present value of the
anticipated defaulted debt service payments over the expected period of
default. If the default is judged not to be temporary, the present value of
all remaining defaulted debt service payments is recorded as a case basis loss
reserve. Anticipated salvage recoveries are considered in establishing case
basis loss reserves when such amounts are reasonably estimable.
Management believes that the current level of reserves is adequate to cover
the estimated liability for claims and the related adjustment expenses with
respect to financial guaranties issued by CapMAC. The establishment of the
appropriate level of loss reserves is an inherently uncertain process
involving numerous estimates and subjective judgments by management, and
therefore there can be no assurance that losses in CapMAC's insured portfolio
will not exceed the loss reserves.
f) DEPRECIATION
Leasehold improvements, furniture and fixtures are being depreciated over the
lease term or useful life, whichever is shorter, using the straight-line
method.
g) INCOME TAXES
Deferred income taxes are provided with respect to temporary differences
between the financial statement and tax basis of assets and liabilities using
enacted tax rates in effect for the year in which the differences are expected
to reverse.
h) RECLASSIFICATIONS
Certain prior year balances have been reclassified to conform to the current
year presentation.
3
<PAGE>
CAPITAL MARKETS ASSURANCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
3) INSURED PORTFOLIO
At December 31, 1995 and 1994, the principal amount of financial obligations
insured by CapMAC was $16.9 billion and $11.6 billion, respectively, and net
of reinsurance (net principal outstanding), was $12.6 billion and $9.4
billion, respectively, with a weighted average life of 6.0 years and 5.0
years, respectively. CapMAC's insured portfolio was broadly diversified by
geographic distribution and type of insured obligations, with no single
insured obligation in excess of statutory single risk limits, after giving
effect to any reinsurance and collateral, which are a function of CapMAC's
statutory qualified capital (the sum of statutory capital and surplus and
mandatory contingency reserve). At December 31, 1995 and 1994, the statutory
qualified capital was approximately $240 million and $170 million,
respectively.
<TABLE>
<CAPTION>
Net Principal Outstanding
December 31, 1995 December 31, 1994
----------------- -----------------
Type of Obligations Insured ($ in millions) Amount % Amount %
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Consumer receivables $ 6,959 55.1 $4,740 50.4
Trade and other corporate
obligations 4,912 38.9 4,039 43.0
Municipal/government obligations 757 6.0 618 6.6
------- ----- ------ -----
TOTAL $12,628 100.0 $9,397 100.0
======= ===== ====== =====
</TABLE>
At December 31, 1995, approximately 85% of CapMAC's insured portfolio was
comprised of structured asset-backed transactions. Under these structures, a
pool of assets covering at least 100% of the principal amount guaranteed under
its insurance contract is sold or pledged to a special purpose bankruptcy
remote entity. CapMAC's primary risk from such insurance contracts is the
impairment of cash flows due to delinquency or loss on the underlying assets.
CapMAC, therefore, evaluates all the factors affecting past and future asset
performance by studying historical data on losses, delinquencies and
recoveries of the underlying assets. Each transaction is reviewed to ensure
that an appropriate legal structure is used to protect against the bankruptcy
risk of the originator of the assets. Along with the legal structure, an
additional level of first loss protection is also created to protect against
losses due to credit or dilution. This first level of loss protection is
usually available from reserve funds, excess cash flows,
overcollateralization, or recourse to a third party. The level of first loss
protection depends upon the historical losses and dilution of the underlying
assets, but is typically several times the normal historical loss experience
for the underlying type of assets.
During 1995, the Company sold without recourse its interest in potential cash
flows from transactions included in its insured portfolio and recognized
$2,200,000 of income which has been included in other income in the
accompanying financial statements.
The following entities each accounted for, through referrals and otherwise,
10% or more of total revenues for each of the periods presented:
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
December 31, 1995 December 31, 1994 December 31, 1993
- ---------------------- --------------------------- ---------------------------
% of % of % of
Name Revenues Name Revenues Name Revenues
- ---------------------- --------------------------- ---------------------------
<S> <C> <C> <C> <C> <C>
Citicorp 15.2 Citicorp 16.3 Citicorp 13.7
Merrill Lynch & Co. 14.1
</TABLE>
4
<PAGE>
CAPITAL MARKETS ASSURANCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
4) INVESTMENTS
At December 31, 1995 and 1994, all of the Company's investments were
classified as available-for-sale securities. The amortized cost, gross
unrealized gains, gross unrealized losses and estimated fair value for
available-for-sale securities by major security type at December 31, 1995 and
1994 were as follows ($ in thousands):
<TABLE>
<CAPTION>
December 31, 1995
- ----------------------------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Securities Available-for-Sale Cost Gains Losses Value
- ----------------------------------------------------------------------------------------
<S> <C><C> <C> <C> <C>
U.S. Treasury obligations $ 4,153 55 - 4,208
- ----------------------------------------------------------------------------------------
Mortgage-backed securities of 100,628 313 79 100,862
U.S. government instrumentalities
and agencies
- ----------------------------------------------------------------------------------------
Obligations of states, municipalities 166,010 4,809 82 170,737
and political subdivisions
- ----------------------------------------------------------------------------------------
Corporate and asset-backed 8,506 45 6 8,545
securities
- ----------------------------------------------------------------------------------------
TOTAL $ 279,297 5,222 167 284,352
- ----------------------------------------------------------------------------------------
DECEMBER 31, 1994
- ----------------------------------------------------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
SECURITIES AVAILABLE-FOR-SALE COST GAINS LOSSES VALUE
- ----------------------------------------------------------------------------------------
U.S. TREASURY OBLIGATIONS $ 4,295 - 153 4,142
- ----------------------------------------------------------------------------------------
MORTGAGE-BACKED SECURITIES OF U.S. 40,973 - 2,986 37,987
GOVERNMENT INSTRUMENTALITIES AND
AGENCIES
- ----------------------------------------------------------------------------------------
OBLIGATIONS OF STATES, MUNICIPALITIES 128,856 364 3,994 125,226
AND POLITICAL SUBDIVISIONS
- ----------------------------------------------------------------------------------------
CORPORATE AND ASSET-BACKED 6,841 15 112 6,744
SECURITIES
- ----------------------------------------------------------------------------------------
MUTUAL FUNDS 16,434 - 1,465 14,969
- ----------------------------------------------------------------------------------------
TOTAL $ 197,399 379 8,710 189,068
- ----------------------------------------------------------------------------------------
</TABLE>
THE COMPANY'S INVESTMENT IN MUTUAL FUNDS IN 1994 REPRESENTS AN INVESTMENT IN
AN OPEN-END MANAGEMENT INVESTMENT COMPANY WHICH INVESTS PRIMARILY IN
INVESTMENT-GRADE FIXED-INCOME SECURITIES DENOMINATED IN FOREIGN AND UNITED
STATES CURRENCIES.
5
<PAGE>
CAPITAL MARKETS ASSURANCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
THE AMORTIZED COST AND ESTIMATED FAIR VALUE OF INVESTMENTS IN DEBT SECURITIES
AT DECEMBER 31, 1995 BY CONTRACTUAL MATURITY ARE SHOWN BELOW ($ IN THOUSANDS):
<TABLE>
<CAPTION>
DECEMBER 31, 1995
- --------------------------------------------------------------
AMORTIZED ESTIMATED
SECURITIES AVAILABLE-FOR-SALE COST FAIR VALUE
- --------------------------------------------------------------
<S> <C> <C>
LESS THAN ONE YEAR TO MATURITY $ 5,569 5,572
ONE TO FIVE YEARS TO MATURITY 37,630 38,553
FIVE TO TEN YEARS TO MATURITY 99,567 102,264
GREATER THAN TEN YEARS TO MATURITY 35,903 37,101
SUB-TOTAL 178,669 183,490
MORTGAGE-BACKED SECURITIES 100,628 100,862
---------- -------
TOTAL $ 279,297 284,352
========== =======
</TABLE>
Actual maturities may differ from contractual maturities because borrowers may
call or prepay obligations with or without call or prepayment penalties.
Proceeds from sales of investment securities were approximately $49 million,
$40 million and $24 million in 1995, 1994 and 1993, respectively. Gross
realized capital gains of $1,320,000, $714,000 and $1,621,000, and gross
realized capital losses of $19,000, $622,000 and $77,000 were realized on
those sales for the years ended December 31, 1995, 1994 and 1993,
respectively.
Investments include bonds having a fair value of approximately $3,985,000 and
$3,873,000 (amortized cost of $3,970,000 and $4,011,000) which are on deposit
at December 31, 1995 and 1994, respectively, with state regulators as required
by law.
Investment income is comprised of interest and dividends, net of related
expenses, and is applicable to the following sources:
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
$ In Thousands December 31, 1995 December 31, 1994 December 31, 1993
- -----------------------------------------------------------------------------------
<S> <C> <C> <C>
Bonds $11,105 9,193 7,803
Short-term investments 1,245 484 572
Mutual funds (162) 579 1,801
Investment expenses (235) (184) (166)
------- ------ ------
Total $11,953 10,072 10,010
======= ====== ======
</TABLE>
6
<PAGE>
CAPITAL MARKETS ASSURANCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
The change in unrealized appreciation (depreciation) on available-for-sale
securities is included in a separate component of stockholder's equity as
shown below:
<TABLE>
<CAPTION>
Year Ended Year Ended
$ in thousands December 31, 1995 December 31, 1994
- -----------------------------------------------------------------------------------------
<S> <C> <C>
Balance at beginning of period $(5,499) 3,600
Change in unrealized appreciation (depreciation) 13,386 (13,786)
Income tax effect (4,601) 4,687
Net change 8,785 (9,099)
------- -------
BALANCE AT END OF PERIOD $ 3,286 (5,499)
======= =======
</TABLE>
No single issuer, except for investments in U.S. Treasury and U.S. government
agency securities, exceeds 10% of stockholder's equity as of December 31,
1995.
5) DEFERRED ACQUISITION COSTS
The following table reflects acquisition costs deferred by CapMAC and
amortized in proportion to the related premium earnings:
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
$ in thousands December 31, 1995 December 31, 1994 December 31, 1993
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance at beginning of period $24,860 15,249 5,434
Additions 17,505 14,140 12,478
Amortization (policy
acquisition costs) (7,203) (4,529) (2,663)
------- ------ ------
BALANCE AT END OF PERIOD $35,162 24,860 15,249
======= ====== ======
</TABLE>
6) EMPLOYEE BENEFITS
On June 25, 1992, CapMAC entered into a Service Agreement with CapMAC
Financial Services, Inc. ("CFS"), which was then a newly formed wholly-owned
subsidiary of Holdings. Under the Service Agreement, CFS has agreed to provide
various services, including underwriting, reinsurance, data processing and
other services to CapMAC in connection with the operation of CapMAC's
insurance business. CapMAC pays CFS an arm's length fee for providing such
services, but not in excess of CFS's cost for such services. CFS incurred, on
behalf of CapMAC, total compensation expenses, excluding bonuses, of
$13,484,000, $11,081,000 and $9,789,000 in 1995, 1994 and 1993, respectively.
CFS maintains an incentive compensation plan for its employees. The plan is
an annual discretionary bonus award based upon Holdings' and an individual's
performance. CFS also has a health and welfare plan and a 401(k) plan to
cover substantially all of its employees. CapMAC reimburses CFS for all out-
of-pocket expenses incurred by CFS in providing services to CapMAC, including
awards given under the incentive compensation plan and benefits provided under
the health and welfare plan. For the years ended December 31, 1995, 1994 and
1993, the Company had provided approximately $7,804,000, $5,253,000 and
$3,528,000, respectively, for the annual discretionary bonus plan.
7
<PAGE>
CAPITAL MARKETS ASSURANCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
On June 25, 1992, certain officers of CapMAC were granted 182,633 restricted
stock units ("RSU") at $13.33 a share in respect of certain deferred
compensation. On December 7, 1995, the RSU's were converted to cash in the
amount of approximately $3.7 million, and such officers agreed to defer
receipt of such cash amount in exchange for receiving the same number of new
shares of restricted stock of Holdings as the number of RSU's such officers
previously held. The cash amount will be held by Holdings and invested in
accordance with certain guidelines. Such amount, including the investment
earnings thereon, will be paid to each officer upon the occurrence of certain
events but no later than December, 2000.
7) EMPLOYEE STOCK OWNERSHIP PLAN
On June 25, 1992, Holdings adopted an Employee Stock Ownership Plan ("ESOP")
to provide its employees the opportunity to obtain beneficial interests in
the stock of Holdings through a trust (the "ESOP Trust"). The ESOP Trust
purchased 750,000 shares at $13.33 per share of Holdings' stock. The ESOP
Trust financed its purchase of common stock with a loan from Holdings in the
amount of $10 million. The ESOP loan is evidenced by a promissory note
delivered to Holdings. An amount representing unearned employee compensation,
equivalent in value to the unpaid balance of the ESOP loan, is recorded as a
deduction from stockholder's equity (unallocated ESOP shares).
CFS is required to make contributions to the ESOP Trust, which enables the
ESOP Trust to service its loan to Holdings. The ESOP expense is calculated
using the shares allocated method. Shares are released for allocation to the
participants and held in trust for the employees based upon the ratio of the
current year's principal and interest payment to the sum of principal and
interest payments estimated over the life of the loan. As of December 31,
1995 approximately 262,800 shares were allocated to the participants.
Compensation expense related to the ESOP was approximately $2,087,000,
$2,086,000 and $1,652,000 for the years ended December 31, 1995, 1994 and
1993, respectively.
8) RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
The reserve for losses and loss adjustment expenses consists of a case basis
loss reserve and the SLR.
In 1995 CapMAC incurred its first claim on a financial guaranty policy. Based
on its current estimate, the Company expects the aggregate amount of claims
and related expenses not to exceed $2.7 million, although no assurance can be
given that such claims and related expenses will not exceed that amount. Such
loss amount was covered through a recovery under a quota share reinsurance
agreement of $0.2 million and a reduction in the SLR of $2.5 million. The
portion of such claims and expenses not covered under the quota share
agreement is being funded through payments to CapMAC from the Lureco Trust
Account (see note 12).
8
<PAGE>
CAPITAL MARKETS ASSURANCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
The following is a summary of the activity in the case basis loss reserve
account and the components of the liability for losses and loss adjustment
expenses ($ in thousands):
<TABLE>
<CAPTION>
CASE BASIS LOSS RESERVE:
<S> <C>
Net balance at January 1, 1995 $ -
-------
INCURRED RELATED TO:
Current year 2,473
Prior years -
-------
Total incurred 2,473
-------
PAID INCURRED TO:
Current year 1,853
Prior years -
-------
Total paid 1,853
-------
Balance at December 31, 1995 620
-------
Reinsurance recoverable 69
-------
Supplemental loss reserve 5,859
-------
TOTAL $ 6,548
=======
</TABLE>
9) INCOME TAXES
Pursuant to a tax sharing agreement with Holdings, the Company is included
in Holdings' consolidated U.S. Federal income tax return. The Company's annual
Federal income tax liability is determined by computing its pro rata share of
the consolidated group Federal income tax liability.
Total income tax expense differed from the amount computed by applying the
U.S. Federal income tax rate of 35% in 1995 and 34% in 1994 and 1993:
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
December 31, 1995 December 31, 1994 December 31, 1993
$ in thousands Amount % Amount % Amount %
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Expected tax expense computed
at the statutory rate $ 7,216 35.0 $ 5,303 34.0 $4,881 34.0
Increase (decrease) in tax
resulting from:
Tax-exempt interest (2,335) (11.3) (1,646) (10.6) (1,140) (7.9)
Other, net 334 1.6 51 0.4 (15) (0.1)
------- ----- ------- ----- ------- ----
TOTAL INCOME TAX EXPENSE $ 5,215 25.3 $ 3,708 23.8 $ 3,726 26.0
======= ===== ======= ===== ======= ====
</TABLE>
9
<PAGE>
CAPITAL MARKETS ASSURANCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
THE TAX EFFECTS OF TEMPORARY DIFFERENCES THAT GIVE RISE TO SIGNIFICANT
PORTIONS OF THE DEFERRED FEDERAL INCOME TAX LIABILITY ARE AS FOLLOWS:
<TABLE>
<CAPTION>
$ IN THOUSANDS DECEMBER 31, 1995 DECEMBER 31, 1994
- -----------------------------------------------------------------------------------
<S> <C> <C>
DEFERRED TAX ASSETS:
Unrealized capital losses on investments $ - (2,833)
Deferred compensation (1,901) (1,233)
Losses and loss adjustment expenses (1,002) (936)
Unearned premiums (852) (762)
Other, net (98) (228)
-------- ------
Total gross deferred tax assets (3,853) (5,992)
-------- ------
DEFERRED TAX LIABILITIES:
Deferred acquisition costs 12,307 8,453
Unrealized capital gains on investments 1,769 -
Deferred capital gains on investments 654 726
Other, net 426 412
Total gross deferred tax liabilities 15,156 9,591
-------- ------
NET DEFERRED TAX LIABILITY $ 11,303 3,599
======== ======
</TABLE>
A valuation allowance is provided when it is more likely than not that some
portion of the deferred tax assets will not be realized. Management believes
that the deferred tax assets will be fully realized in the future.
10) INSURANCE REGULATORY RESTRICTIONS
CapMAC is subject to insurance regulatory requirements of the State of New
York and other states in which it is licensed to conduct business. Generally,
New York insurance laws require that dividends be paid from earned surplus and
restrict the amount of dividends in any year that may be paid without
obtaining approval for such dividends from the Superintendent of Insurance to
the lower of (i) net investment income as defined or (ii) 10% of statutory
surplus as of December 31 of the preceding year. No dividends were paid by
CapMAC to Holdings during the years ended December 31, 1995, 1994 and 1993.
No dividends could be paid during these periods because CapMAC had negative
earned surplus. Statutory surplus at December 31, 1995 and 1994 was
approximately $195,018,000 and $139,739,000, respectively. Statutory surplus
differs from stockholder's equity determined under GAAP principally due to
the mandatory contingency reserve required for statutory accounting purposes
and differences in accounting for investments, deferred acquisition costs, SLR
and deferred taxes provided under GAAP. Statutory net income was $9,000,000,
$4,543,000 and $4,528,000 for the years ended December 31, 1995, 1994 and
1993, respectively. Statutory net income differs from net income determined
under GAAP principally due to deferred acquisition costs, SLR and deferred
income taxes.
10
<PAGE>
CAPITAL MARKETS ASSURANCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
11) COMMITMENTS AND CONTINGENCIES
On January 1, 1988, the Company assumed from Citibank, N.A. the obligations of
a sublease agreement for space occupied in New York. On November 21, 1993,
the sublease was terminated and a new lease was negotiated which expires on
November 20, 2008. CapMAC has a lease agreement for its London office
beginning October 1, 1992 and expiring October 1, 2002. As of December 31,
1995, future minimum payments under the lease agreements are as follows:
$ in thousands Payment
--------------------------------------
1996 $ 2,255
1997 2,948
1998 3,027
1999 3,476
2000 and thereafter 36,172
----------
TOTAL $ 47,878
==========
Rent expense, commercial rent taxes and electricity for the years ended
December 31, 1995, 1994 and 1993 amounted to $1,939,000, $2,243,000 and
$2,065,000, respectively.
CapMAC has available a $100,000,000 standby corporate liquidity facility (the
"Liquidity Facility") provided by a consortium of banks, headed by Bank of
Montreal, as agent, which is rated "A-1+" and "P-1" by S&P and Moody's,
respectively. Under the Liquidity Facility, CapMAC will be able, subject to
satisfying certain conditions, to borrow funds from time to time in order to
enable it to fund any claim payments or payments made in settlement or
mitigation of claim payments under its insurance contracts. For the years
ended December 31, 1995, 1994 and 1993, no draws had been made under the
Liquidity Facility.
12) REINSURANCE
In the ordinary course of business, CapMAC cedes exposure under various
treaty, pro rata and excess of loss reinsurance contracts primarily designed
to minimize losses from large risks and protect the capital and surplus of
CapMAC.
The effect of reinsurance on premiums written and earned was as
follows:
<TABLE>
<CAPTION>
Years Ended December 31
----------------------------------------------------------------
1995 1994 1993
-------------------- ------------------ ------------------
$ in thousands Written Earned Written Earned Written Earned
- ----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Direct $ 56,541 36,853 43,598 28,561 24,491 20,510
Assumed 935 761 1,064 258 403 364
Ceded (15,992) (8,372) (11,069) (5,716) (3,586) (3,391)
---------- ------ ------- ------ ------ ------
NET PREMIUMS $ 41,484 29,242 33,593 23,103 21,308 17,483
========== ====== ======= ====== ====== ======
</TABLE>
11
<PAGE>
CAPITAL MARKETS ASSURANCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
Although the reinsurance of risk does not relieve the ceding insurer of its
original liability to its policyholders, it is the industry practice of
insurers for financial statement purposes to treat reinsured risks as though
they were risks for which the ceding insurer was only contingently liable. A
contingent liability exists with respect to the aforementioned reinsurance
arrangements which may become a liability of CapMAC in the event the
reinsurers are unable to meet obligations assumed by them under the
reinsurance contracts. At December 31, 1995 and 1994, CapMAC had ceded loss
reserves of $69,000 and $0, respectively and had ceded unearned premiums of
$13,171,000 and $5,551,000, respectively.
In 1994, CapMAC entered into a reinsurance agreement (the "Lureco Treaty")
with Luxembourg European Reinsurance LURECO S.A. ("Lureco"), a European-based
reinsurer. The agreement is renewable annually at the Company's option,
subject to satisfying certain conditions. The agreement reinsured and
indemnified the Company for any loss incurred by CapMAC during the agreement
period up to the limits of the agreement. The Lureco Treaty provides that the
annual reinsurance premium payable by CapMAC to Lureco, after deduction of the
reinsurer's fee payable to Lureco, be deposited in a trust account (the
"Lureco Trust Account") to be applied by CapMAC, at its option, to offset
losses and loss expenses incurred by CapMAC in connection with incurred
claims. Amounts on deposit in the Lureco Trust Account which have not been
applied against claims are contractually due to CapMAC at the termination of
the treaty.
The premium deposit amounts in the Lureco Trust Account have been reflected as
assets by CapMAC during the term of the agreement. Premiums in excess of the
deposit amounts have been recorded as ceded premiums in the statements of
income. In the 1994 policy year, the agreement provided $5 million of loss
coverage in excess of the premium deposit amounts of $2 million retained in
the Lureco Trust Account. No losses were applied against the Lureco Trust
Account or ceded to the Lureco Treaty in 1994. The agreement was renewed for
the 1995 policy year and provides $5 million of loss coverage in excess of the
premium deposit amount of $4.5 million retained in the Lureco Trust Account.
Additional coverage is provided for losses incurred in excess of 200% of the
net premiums earned up to $4 million for any one agreement year. In September
1995, a claim of approximately $2.5 million on an insurance policy was applied
against the Lureco Trust Account.
In addition to its capital (including statutory contingency reserves) and
other reinsurance available to pay claims under its insurance contracts, on
June 25, 1992, CapMAC entered into a Stop Loss Reinsurance Agreement (the
"Stop-loss Agreement") with Winterthur Swiss Insurance Company ("Winterthur")
which is rated "AAA" by S&P and "Aaa" by Moody's. At the same time, CapMAC and
Winterthur also entered into a Quota Share Reinsurance Agreement (the
"Winterthur Quota Share Agreement") pursuant to which Winterthur had the right
to reinsure on a quota share basis 10% of each policy written by CapMAC.
The Winterthur Stop-loss Agreement had an original term of seven years and was
renewable for successive one-year periods. In April 1995, Winterthur notified
CapMAC that it was canceling the Winterthur Stop-loss Agreement and the
Winterthur Quota Share Agreement effective June 30, 1996.
CapMAC elected to terminate the Winterthur Stop-loss Agreement effective
November 30, 1995 and, on the same date, entered into a Stop-loss Reinsurance
Agreement with Mitsui Marine (the "Mitsui Stop-loss Agreement"). Under the
Mitsui Stop-loss Agreement, Mitsui
12
<PAGE>
CAPITAL MARKETS ASSURANCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
Marine would be required to pay any losses in excess of $100 million in the
aggregate incurred by CapMAC during the term of the Mitsui Stop-loss Agreement
on the insurance policies in effect on December 1, 1995 and written during the
one-year period thereafter, up to an aggregate limit payable under the Mitsui
Stop-loss Agreement of $50 million. The Mitsui Stop-loss Agreement has a term
of seven years and is subject to early termination by CapMAC in certain
circumstances.
The Winterthur Quota Share Agreement was canceled November 30, 1995. On
January 1, 1996, CapMAC will reassume the liability, principally unearned
premium, for all policies reinsured by Winterthur. As a result, CapMAC will
reassume approximately $1.4 billion of principal insured by Winterthur as of
December 31, 1995. In connection with the commutation, Winterthur will return
the unearned premiums as of December 31, 1995, net of ceding commission and
federal excise tax. Such amount is expected to total approximately $2.0
million.
13) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying amounts and estimated fair values of
the Company's financial instruments at December 31, 1995 and 1994. SFAS No.
107, "Disclosures About Fair Value of Financial Instruments," defines the fair
value of a financial instrument as the amount at which the instrument could be
exchanged in a current transaction between willing parties.
<TABLE>
<CAPTION>
December 31, 199 December 31, 1994
Carrying Estimated Carrying Estimated
$ in thousands Amount Fair Value Amount Fair Value
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
FINANCIAL ASSETS:
Investments $ 284,352 284,352 189,068 189,068
OFF-BALANCE-SHEET INSTRUMENTS:
Financial Guarantees Outstanding $ - 147,840 - 93,494
Ceding Commission $ - 44,352 - 28,048
- -------------------------------------------------------------------------------------------
</TABLE>
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments summarized above:
INVESTMENTS
The fair values of fixed maturities and mutual funds are based upon quoted
market prices. The fair value of short-term investments approximates
amortized cost.
13
<PAGE>
CAPITAL MARKETS ASSURANCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
FINANCIAL GUARANTEES OUTSTANDING
The fair value of financial guarantees outstanding consists of (1) the current
unearned premium reserve, net of prepaid reinsurance and (2) the fair value of
installment revenue which is derived by calculating the present value of the
estimated future cash inflow to CapMAC of policies in force having installment
premiums, net of amounts payable to reinsurers, at a discount rate of 7% at
December 31, 1995 and 1994. The amount calculated is equivalent to the
consideration that would be paid under market conditions prevailing at the
reporting dates to transfer CapMAC's financial guarantee business to a third
party under reinsurance and other agreements. Ceding commission represents
the expected amount that would be paid to CapMAC to compensate CapMAC for
originating and servicing the insurance contracts. In constructing estimated
future cash inflows, management makes assumptions regarding prepayments for
amortizing asset-backed securities which are consistent with relevant
historical experience. For revolving programs, assumptions are made regarding
program utilization based on discussions with program users. The amount of
installment premium actually realized by the Company could be reduced in the
future due to factors such as early termination of insurance contracts,
accelerated prepayments of underlying obligations or lower than anticipated
utilization of insured structured programs, such as commercial paper conduits.
Although increases in future installment revenue due to renewals of existing
insurance contracts historically have been greater than reductions in future
installment revenue due to factors such as those described above, there can be
no assurance that future circumstances might not cause a net reduction in
installment revenue, resulting in lower revenues.
14) CAPITALIZATION
The Company's certificate of incorporation authorizes the issuance of
15,000,000 shares of common stock, par value $1.00 per share. Authorized,
issued and outstanding shares at December 31, 1995 and 1994 were 15,000,000 at
$1.00 per share.
In 1995, $59.0 million of the proceeds received by Holdings from the sale of
shares in connection with an Initial Public Offering and private placements
were contributed to CapMAC.
14
<PAGE>
CAPITAL MARKETS ASSURANCE CORPORATION
FINANCIAL STATEMENTS
MARCH 31, 1996
(UNAUDITED)
<PAGE>
CAPITAL MARKETS ASSURANCE CORPORATION
BALANCE SHEETS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
ASSETS
------
March 31, 1996 December 31, 1995
(Unaudited)
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
INVESTMENTS:
Bonds at fair value (amortized cost $258,874 at March 31, 1996
and $210,651 at December 31, 1995) $ 259,226 215,706
Short-term investments (at amortized cost which approximates fair
value) 28,636 68,646
----------- -----------
Total investments 287,862 284,352
----------- -----------
Cash 389 344
Accrued investment income 3,356 3,136
Deferred acquisition costs 37,559 35,162
Premiums receivable 3,463 3,540
Prepaid reinsurance 13,379 13,171
Other assets 3,477 3,428
----------- -----------
TOTAL ASSETS $ 349,485 343,133
=========== ===========
LIABILITIES AND STOCKHOLDER'S EQUITY
------------------------------------
LIABILITIES:
Unearned premiums $ 50,266 45,767
Reserve for losses and loss adjustment expenses 7,261 6,548
Ceded reinsurance 2,773 2,469
Accounts payable and other accrued expenses 7,288 10,844
Current income taxes 260 136
Deferred income taxes 11,657 11,303
----------- -----------
Total liabilities 79,505 77,067
----------- -----------
STOCKHOLDER'S EQUITY:
Common stock 15,000 15,000
Additional paid-in capital 208,475 205,808
Unrealized appreciation on investments, net of tax 229 3,286
Retained earnings 46,276 41,972
----------- -----------
Total stockholder's equity 269,980 266,066
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $ 349,485 343,133
=========== ===========
</TABLE>
See accompanying notes to financial statements
<PAGE>
CAPITAL MARKETS ASSURANCE CORPORATION
STATEMENTS OF INCOME
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED THREE MONTHS ENDED
MARCH 31, 1996 MARCH 31, 1995
- -----------------------------------------------------------------------------
<S> <C> <C>
REVENUES:
Direct premiums written $ 14,155 16,838
Assumed premiums written 874 154
Ceded premiums written (1,910) (3,093)
----------- -----------
Net premiums written 13,119 13,899
Increase in unearned premiums (4,291) (6,798)
----------- -----------
Net premiums earned 8,828 7,101
Net investment income 3,877 2,637
Net realized capital gains 149 65
Other income 54 12
----------- -----------
Total revenues 12,908 9,815
----------- -----------
EXPENSES:
Losses and loss adjustment expenses 1,075 696
Underwriting and operating expenses 3,978 3,738
Policy acquisition costs 2,064 1,725
----------- -----------
Total expenses 7,117 6,159
----------- -----------
Income before income taxes 5,791 3,656
----------- -----------
INCOME TAXES:
Current federal income tax 664 320
Deferred federal income tax 823 519
----------- -----------
Total income taxes 1,487 839
----------- -----------
NET INCOME $ 4,304 2,817
=========== ===========
</TABLE>
<PAGE>
CAPITAL MARKETS ASSURANCE CORPORATION
STATEMENT OF STOCKHOLDER'S EQUITY
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, 1996
- ------------------------------------------------------------------------
<S> <C>
COMMON STOCK:
Balance at beginning of period $ 15,000
-------------
Balance at end of period 15,000
-------------
ADDITIONAL PAID-IN CAPITAL:
Balance at beginning of period 205,808
Capital contribution 2,667
-------------
Balance at end of period 208,475
-------------
UNREALIZED (DEPRECIATION) APPRECIATION
ON INVESTMENTS, NET OF TAX:
Balance at beginning of period 3,286
Unrealized depreciation on investments (3,057)
-------------
Balance at end of period 229
-------------
RETAINED EARNINGS:
Balance at beginning of period 41,972
Net income 4,304
-------------
Balance at end of period 46,276
-------------
TOTAL STOCKHOLDER'S EQUITY $ 269,980
=============
</TABLE>
<PAGE>
CAPITAL MARKETS ASSURANCE CORPORATION
STATEMENTS OF CASH FLOWS
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED THREE MONTHS ENDED
MARCH 31, 1996 MARCH 31, 1995
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 4,304 2,817
----------- -----------
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED
(USED) BY OPERATING ACTIVITIES:
Reserve for losses and loss adjustment expenses 713 696
Unearned premiums 4,499 8,075
Deferred acquisition costs (2,397) (2,662)
Premiums receivable 77 (3,241)
Accrued investment income (220) 400
Income taxes payable 947 839
Net realized capital gains (149) (65)
Accounts payable and other accrued expenses 287 4,364
Prepaid reinsurance (208) (1,277)
Other, net 89 1,355
----------- -----------
Total adjustments 3,638 8,484
----------- -----------
NET CASH PROVIDED BY OPERATING ACTIVITIES 7,942 11,301
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments (87,335) (18,235)
Proceeds from sale of investments 6,158 4,072
Proceeds from maturities of investments 73,280 3,391
----------- -----------
NET CASH USED IN INVESTING ACTIVITIES (7,897) (10,772)
----------- -----------
Net increase in cash 45 529
Cash balance at beginning of period 344 85
----------- -----------
CASH BALANCE AT END OF PERIOD $ 389 614
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Income taxes paid $ 525 -
=========== ===========
</TABLE>
<PAGE>
CAPITAL MARKETS ASSURANCE CORPORATION
NOTES TO UNAUDITED FINANCIAL STATEMENTS
MARCH 31, 1996
1. BACKGROUND
Capital Markets Assurance Corporation ("CapMAC") is a New York-domiciled
monoline stock insurance company which engages only in the business of financial
guaranty and surety insurance. CapMAC is a wholly owned subsidiary of CapMAC
Holdings Inc. ("Holdings"). CapMAC is licensed in all 50 states in addition to
the District of Columbia, the Commonwealth of Puerto Rico and the territory of
Guam. CapMAC insures structured asset-backed, corporate, municipal and other
financial obligations in the U.S. and international capital markets. CapMAC
also provides financial guaranty reinsurance for structured asset-backed,
corporate, municipal and other financial obligations written by other major
insurance companies.
CapMAC's claims-paying ability is rated triple-A by Moody's Investors Service,
Inc., Standard & Poor's Ratings Services, Duff & Phelps Credit Rating Co., and
Nippon Investors Service, Inc., a Japanese rating agency. Such ratings reflect
only the views of the respective rating agencies, are not recommendations to
buy, sell or hold securities and are subject to revision or withdrawal at any
time by such rating agencies.
2. BASIS OF PRESENTATION
CapMAC's unaudited interim financial statements have been prepared on the basis
of generally accepted accounting principles and, in the opinion of management,
reflect all adjustments necessary for a fair presentation of CapMAC's financial
condition, results of operations and cash flows for the periods presented. The
results of operations for the three months ended March 31, 1996 may not be
indicative of the results that may be expected for the full year ending December
31, 1996. These financial statements and notes should be read in conjunction
with the financial statements and notes included in the audited financial
statements of CapMAC as of December 31, 1995 and 1994, and for each of the years
in the three-year period ended December 31, 1995.
3. RECLASSIFICATIONS
Certain prior period balances have been reclassified to conform to the current
period presentation.
<PAGE>
PROSPECTUS
HOME EQUITY AND HOME IMPROVEMENT LOAN TRUSTS
ASSET-BACKED CERTIFICATES
ASSET-BACKED NOTES
(ISSUABLE IN SERIES)
----------------
CHEVY CHASE BANK, F.S.B.
(TRANSFEROR AND SERVICER)
----------------
The Asset-Backed Certificates (the "Certificates") and the Asset-Backed
Notes (the "Notes" and, collectively with the Certificates, the "Securities")
described herein may be sold from time to time in one or more series (each, a
"Series") in amounts, at prices and on terms to be determined at the time of
sale and to be set forth in a supplement to this Prospectus (a "Prospectus
Supplement"). Each Series of Securities will include either one or more
classes of Certificates or, if Notes are issued as part of a Series, one or
more Classes of Notes and one or more Classes of Certificates, as set forth in
the related Prospectus Supplement.
As specified in the related Prospectus Supplement, the Certificates of a
Series will evidence undivided interests in certain assets deposited into a
trust (each, a "Trust Fund") by Chevy Chase Bank, F.S.B. (the "Transferor")
pursuant to a Pooling and Servicing Agreement or a Trust Agreement, as
described herein. As specified in the related Prospectus Supplement, the Notes
of a Series will be issued and secured pursuant to an
(cover continued on next page)
NOTES OF A GIVEN SERIES REPRESENT OBLIGATIONS OF, AND CERTIFICATES OF A SE-
RIES EVIDENCE BENEFICIAL INTERESTS IN, THE RELATED TRUST FUND ONLY AND ARE
NOT GUARANTEED BY ANY GOVERNMENTAL AGENCY OR BY THE TRANSFEROR, THE TRUST-
EE, THE SERVICER OR BY ANY OF THEIR RESPECTIVE AFFILIATES OR, UNLESS
OTHERWISE SPECIFIED IN THE RELATED PROSPECTUS SUPPLEMENT, BY ANY OTHER
PERSON OR ENTITY. THE TRANSFEROR'S ONLY OBLIGATIONS WITH RESPECT TO
ANY SERIES OF SECURITIES WILL BE PURSUANT TO CERTAIN REPRESENTA-
TIONS AND WARRANTIES SET FORTH IN THE RELATED AGREEMENT AS DE-
SCRIBED HEREIN OR IN THE RELATED PROSPECTUS SUPPLEMENT.
----------------
SEE "RISK FACTORS" BEGINNING ON PAGE 16 FOR CERTAIN FACTORS TO BE CONSIDERED
IN PURCHASING THE SECURITIES.
----------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS OR THE
PROSPECTUS SUPPLEMENT. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
----------------
Retain this Prospectus for future reference. This Prospectus may not be used
to consummate sales of securities offered hereby unless accompanied by a
Prospectus Supplement.
The date of this Prospectus is May 21, 1996
<PAGE>
(continued from previous page)
Indenture and will represent indebtedness of the related Trust Fund. The Trust
Fund for a Series of Securities will include (a) Primary Assets, which may
include one or more pools of (i) closed-end and/or revolving credit line home
equity loans or certain balances thereof (collectively, the "Mortgage Loans"),
secured by mortgages on one- to four-family residential or mixed-use
properties, (ii) home improvement installment sales contracts and installment
loan agreements (the "Home Improvement Contracts") which are either unsecured
or secured by mortgages on one- to four-family residential or mixed-use
properties, or by purchase money security interests in the home improvements
financed thereby (the "Home Improvements") and (iii) securities ("Private
Securities") backed or secured by Mortgage Loans and/or Home Improvement
Contracts (the "Underlying Loans"), (b) certain monies received or due
thereunder on or after the date specified in the related Prospectus Supplement
(the "Cut-off Date") net, if and as provided in the related Prospectus
Supplement, of certain amounts payable to Chevy Chase Bank, F.S.B., as
servicer (the "Servicer") of the Mortgage Loans and/or Home Improvement
Contracts (collectively, the "Loans"), (c) if specified in the related
Prospectus Supplement, funds on deposit in one or more pre-funding accounts
and/or capitalized interest accounts and (d) reserve funds, letters of credit,
surety bonds, insurance policies or other forms of credit support as described
herein and in the related Prospectus Supplement. Amounts on deposit in a pre-
funding account for any Series will be used to purchase additional Loans
during the funding period specified in the related Prospectus Supplement in
the manner specified therein. The amount initially deposited in a pre-funding
account for a Series of Securities will not exceed 50% of the aggregate
principal amount of such Series of Securities.
Each Series of Securities will be issued in one or more classes (each, a
"Class"). Interest on and principal of the Securities of a Series will be
payable on the date or dates specified in the related Prospectus Supplement
(each, a "Distribution Date"), at the times, at the rates, in the amounts and
in the order of priority set forth in the related Prospectus Supplement.
If a Series includes multiple Classes, such Classes may vary with respect to
the amount, percentage (which may be 0%) and timing of distributions of
principal, interest or both and one or more Classes may be subordinated to
other Classes with respect to distributions of principal, interest or both as
described herein and in the related Prospectus Supplement. If so specified in
the related Prospectus Supplement, the Primary Assets and other assets
comprising the Trust Fund may be divided into one or more Asset Groups and
each Class of the related Series will evidence beneficial ownership of the
corresponding Asset Group, as applicable.
The rate of reduction of the aggregate principal balance of each Class of a
Series may depend principally upon the rate of payment (including prepayments)
with respect to the Loans or Underlying Loans relating to the Private
Securities, as applicable. A rate of prepayment lower or higher than
anticipated will affect the yield on the Securities of a Series in the manner
described herein and in the related Prospectus Supplement. Under certain
limited circumstances described herein and in the related Prospectus
Supplement, a Series of Securities may be subject to termination or redemption
under the circumstances described herein and in the related Prospectus
Supplement.
If specified in the related Prospectus Supplement, an election may be made
to treat certain assets comprising the Trust Fund for a Series as a "real
estate mortgage investment conduit" (a "REMIC") for federal income tax
purposes. See "FEDERAL INCOME TAX CONSIDERATIONS."
There currently is no secondary market for the Securities. There can be no
assurance that any such market will develop or, if it does develop, that it
will continue.
2
<PAGE>
PROSPECTUS SUPPLEMENT
The Prospectus Supplement relating to a Series of Securities to be offered
hereunder will, among other things, set forth with respect to such Series of
Securities: (i) the aggregate principal amount, interest rate, and authorized
denominations of each Class of such Securities; (ii) certain information
concerning the Primary Assets; (iii) the terms of any Enhancement (as defined
herein) with respect to such Series; (iv) the terms of any insurance related
to the Primary Assets; (v) information concerning any other assets in the
related Trust Fund, including any Reserve Fund; (vi) the Final Scheduled
Distribution Date (as defined herein) of each Class of such Securities; (vii)
the method to be used to calculate the amount of interest and principal
required to be applied to the Securities of each Class of such Series on each
Distribution Date, the timing of the application of interest and principal and
the order of priority of the application of such interest and principal to the
respective Classes and the allocation of interest and principal to be so
applied; (viii) the Distribution Dates and any Assumed Reinvestment Rate (as
defined herein); (ix) the amount, if any, deposited in the Pre-Funding Account
(as defined herein) available to purchase additional Loans, the length of the
Pre-Funding Period (as defined herein) or the Revolving Period (as defined
herein) and the criteria for determining which additional Loans (or balances
thereof) may become part of the Trust Fund; (x) additional information with
respect to the plan of distribution of such Securities; and (xi) whether a
REMIC election will be made with respect to some or all of the Trust Fund for
such Series.
REPORTS TO HOLDERS
Periodic and annual reports concerning the related Trust Fund for a Series
of Securities are required under the related Agreements to be forwarded to
Holders. Unless otherwise specified in the related Prospectus Supplement, such
reports will not be examined and reported on by an independent public
accountant. If so specified in the Prospectus Supplement for a Series of
Securities, such Series or one or more Classes of such Series will be issued
in book-entry form. In such event, (i) owners of beneficial interests in such
Securities will not be considered "Holders" under the Agreements and will not
receive such reports directly from the related Trust Fund; rather, such
reports will be furnished to such owners through the participants and indirect
participants of the applicable book-entry system and (ii) references herein to
the rights of "Holders" shall refer to the rights of such owners as they may
be exercised indirectly through such participants. See "THE AGREEMENTS--
Reports to Holders."
AVAILABLE INFORMATION
The Transferor has filed with the Securities and Exchange Commission (the
"Commission") a Registration Statement under the Securities Act of 1933, as
amended, with respect to the Securities. This Prospectus, which forms a part
of the Registration Statement, and the Prospectus Supplement relating to each
Series of Securities contain summaries of the material terms of the documents
referred to herein and therein, but do not contain all of the information set
forth in the Registration Statement pursuant to the Rules and Regulations of
the Commission. For further information, reference is made to such
Registration Statement and the exhibits thereto. Such Registration Statement
and exhibits can be inspected and copied at prescribed rates at the public
reference facilities maintained by the Commission at its Public Reference
Section, 450 Fifth Street, N.W., Washington, D.C. 20549, and at its Regional
Offices located as follows, Midwest Regional Office, 500 West Madison Street,
Chicago, Illinois 60661; and Northeast Regional Office, Seven World Trade
Center, New York, New York 10048.
Each Trust Fund will be required to file certain reports with the Commission
pursuant to the requirements of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). The Transferor intends to cause each Trust Fund
to suspend filing such reports if and when such reports are no longer required
under the Exchange Act.
3
<PAGE>
No person has been authorized to give any information or to make any
representation other than those contained in this Prospectus and any
Prospectus Supplement with respect hereto and, if given or made, such
information or representations must not be relied upon. This Prospectus and
any Prospectus Supplement with respect hereto do not constitute an offer to
sell or a solicitation of an offer to buy any securities other than the
Securities offered hereby and thereby nor an offer of the Securities to any
person in any state or other jurisdiction in which such offer would be
unlawful. The delivery of this Prospectus at any time does not imply that
information herein is correct as of any time subsequent to its date.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
All documents subsequently filed by or on behalf of the Trust Fund referred
to in the accompanying Prospectus Supplement with the Commission pursuant to
Section 13(a), 13(c), 14 or 15(d) of the Exchange Act, after the date of this
Prospectus and prior to the termination of any offering of the Securities
issued by such Trust Fund shall be deemed to be incorporated by reference in
this Prospectus and to be a part of this Prospectus from the date of the
filing of such documents. Any statement contained in a document incorporated
or deemed to be incorporated by reference herein shall be deemed to be
modified or superseded for all purposes of this Prospectus to the extent that
a statement contained herein (or in the accompanying Prospectus Supplement) or
in any other subsequently filed document which also is or is deemed to be
incorporated by reference modifies or replaces such statement. Any such
statement so modified or superseded shall not be deemed, except as so modified
or superseded, to constitute a part of this Prospectus.
The Transferor on behalf of any Trust Fund will provide without charge to
each person to whom this Prospectus is delivered, on the written or oral
request of such person, a copy of any or all of the documents referred to
above that have been or may be incorporated by reference in this Prospectus
(not including exhibits to the information that is incorporated by reference
unless such exhibits are specifically incorporated by reference into the
information that this Prospectus incorporates). Such requests should be
directed to the Transferor at 8401 Connecticut Avenue, Chevy Chase, Maryland
20815.
4
<PAGE>
SUMMARY OF TERMS
The following summary is qualified in its entirety by reference to the
detailed information appearing elsewhere in this Prospectus and by reference to
the information with respect to each Series of Securities contained in the
Prospectus Supplement to be prepared and delivered in connection with the
offering of Securities of such Series. Capitalized terms used and not otherwise
defined herein or in the related Prospectus Supplement shall have the meanings
set forth in the "GLOSSARY OF TERMS."
SECURITIES OFFERED.......... Asset-Backed Certificates (the "Certificates")
and Asset-Backed Notes (the "Notes"). Certifi-
cates are issuable from time to time in Series
pursuant to a Pooling and Servicing Agreement or
Trust Agreement. Each Certificate of a Series
will evidence an interest in the Trust Fund for
such Series, or in an Asset Group specified in
the related Prospectus Supplement. Notes are is-
suable from time to time in a Series pursuant to
an Indenture. Each Series of Securities will
consist of one or more Classes, one or more of
which may be Classes of Compound Interest Secu-
rities, Planned Amortization Class ("PAC") Secu-
rities, Variable Interest Securities, Zero Cou-
pon Securities, Principal Only Securities, In-
terest Only Securities, Participating Securi-
ties, Senior Securities or Subordinate Securi-
ties. Each Class may differ in, among other
things, the amounts allocated to and the prior-
ity of principal and interest payments, Final
Scheduled Distribution Dates, Distribution Dates
and interest rates. The Securities of each Class
will be issued in fully registered form in the
denominations specified in the related Prospec-
tus Supplement. If so specified in the related
Prospectus Supplement, the Securities or certain
Classes of such Securities offered thereby may
be available in book-entry form only.
TRANSFEROR AND SERVICER..... Chevy Chase Bank, F.S.B. ("Chevy Chase"), a fed-
erally chartered stock savings bank, with its
principal executive offices located at 8401 Con-
necticut Avenue, Chevy Chase, Maryland 20815,
and a telephone number of (301) 986-7000. See
"THE TRANSFEROR."
INTEREST PAYMENTS........... Interest payments on the Securities of a Series
entitled by their terms to receive interest will
be made on each Distribution Date, to the extent
set forth in, and at the applicable rate speci-
fied in (or determined in the manner set forth
in), the related Prospectus Supplement. The in-
terest rate on Securities of a Series may be
variable or change with changes in the rates of
interest on the related Loans or Underlying
Loans relating to the Private Securities, as ap-
plicable and/or as prepayments occur with re-
spect to such Loans or Underlying Loans, as ap-
plicable. Interest Only Securities may be as-
signed a "Notional Amount" set forth in the re-
lated Prospectus Supplement which is used solely
for convenience in expressing the calculation of
interest and for certain other purposes and does
not represent the right to receive any distribu-
tions allocable to principal. Principal Only Se-
curities may not be entitled to receive any in-
terest payments or may be entitled to receive
only nominal interest payments. Interest payable
on the Securities of a Series on a Distribution
Date will include all interest accrued
5
<PAGE>
during the period specified in the related Pro-
spectus Supplement. See "DESCRIPTION OF THE SE-
CURITIES--Payments of Interest."
PRINCIPAL PAYMENTS.......... All payments of principal of a Series of Securi-
ties will be made in an aggregate amount deter-
mined as set forth in the related Prospectus
Supplement and will be paid at the times and
will be allocated among the Classes of such Se-
ries in the order and amounts, and will be ap-
plied either on a pro rata or a random lot basis
among all Securities of any such Class, all as
specified in the related Prospectus Supplement.
REVOLVING PERIOD AND
AMORTIZATION PERIOD;
RETAINED INTEREST..........
If the related Prospectus Supplement so provides,
there may be a period commencing on the date of
issuance of a Class or Classes of Notes or Cer-
tificates of a Series and ending on the date set
forth in the related Prospectus Supplement (the
"Revolving Period") during which no principal
payments will be made to one or more Classes of
Notes or Certificates of the related Series as
are identified in such Prospectus Supplement.
All collections of principal otherwise allocated
to such Classes of Notes or Certificates may be
(i) utilized by the Trust Fund during such pe-
riod to acquire additional Loans (or additional
balances of existing Loans) which satisfy the
criteria described in the related Prospectus
Supplement, (ii) held in an account and invested
in Eligible Investments for later distribution
to Securityholders, (iii) applied to those Class
or Classes of Notes or Certificates, if any, of
the same or different Series as specified in the
related Prospectus Supplement as then are in am-
ortization, or (iv) otherwise applied as speci-
fied in the related Prospectus Supplement.
An "Amortization Period" is the period, if any,
specified as such in the related Prospectus Sup-
plement during which an amount of principal is
payable to holders of one or more Classes of a
Series of Securities. If so specified in the re-
lated Prospectus Supplement, during an Amortiza-
tion Period all or a portion of principal col-
lections on the Primary Assets may be applied as
specified above for a Revolving Period and, to
the extent not so applied, will be distributed
to the Classes of Notes or Certificates of the
same or different Series as specified in the re-
lated Prospectus Supplement as then being enti-
tled to payments of principal. In addition, if
so specified in the related Prospectus Supple-
ment, amounts deposited in certain accounts for
the benefit of one or more Classes of Notes or
Certificates may be released from time to time
or on a specified date and applied as a payment
of principal on such Classes of Notes or Certif-
icates. The related Prospectus Supplement will
set forth the circumstances which will result in
the commencement of an Amortization Period.
6
<PAGE>
Each Trust Fund which has a Revolving Period may
also issue to the Transferor a certificate evi-
dencing an undivided beneficial interest (the
"Transferor Interest") in the Trust Fund not
represented by the other Securities issued by
such Trust Fund. As further described in the re-
lated Prospectus Supplement, the value of such
Transferor Interest will fluctuate as the amount
of the assets of the Trust Fund fluctuates and
the amount of Notes and Certificates of the re-
lated Series of Securities outstanding is re-
duced.
FINAL SCHEDULED
DISTRIBUTION DATE OF THE
SECURITIES.................
The Final Scheduled Distribution Date with re-
spect to each Class of Notes is the date no
later than the date on which principal thereof
will be fully paid and with respect to each
Class of Certificates is the date after which no
Certificates of such Class are expected to re-
main outstanding, in each case calculated on the
basis of the assumptions applicable to such Se-
ries described in the related Prospectus Supple-
ment. The Final Scheduled Distribution Date of a
Class may equal the maturity date of the Primary
Asset in the related Trust Fund which has the
latest stated maturity or will be determined as
described herein and in the related Prospectus
Supplement.
The actual final Distribution Date of the Securi-
ties of a Series will depend primarily upon the
rate of payment (including prepayments, liquida-
tions due to default, the receipt of proceeds
from casualty insurance policies and repur-
chases) of the Loans or Underlying Loans relat-
ing to the Private Securities, as applicable, in
the related Trust Fund. Unless otherwise speci-
fied in the related Prospectus Supplement, the
actual final Distribution Date of any Security
is likely to occur earlier and may occur sub-
stantially earlier or, with respect to a Class
of Certificates, may occur later than its Final
Scheduled Distribution Date as a result of the
application of prepayments to the reduction of
the principal balances of the Securities and as
a result of defaults on the Primary Assets. The
rate of payments on the Loans or Underlying
Loans relating to the Private Securities, as ap-
plicable, in the Trust Fund for a Series will
depend on a variety of factors, including cer-
tain characteristics of such Loans or Underlying
Loans, as applicable, and the prevailing level
of interest rates from time to time, as well as
on a variety of economic, demographic, tax, le-
gal, social and other factors. No assurance can
be given as to the actual prepayment experience
with respect to a Series. See "RISK FACTORS--
Yield May Vary" and "DESCRIPTION OF THE SECURI-
TIES--Weighted Average Life of the Securities."
OPTIONAL TERMINATION........ One or more Classes of Securities of any Series
may be redeemed or repurchased in whole or in
part, at the Transferor's or the Servicer's op-
tion, at such time and under the circumstances
spec-
7
<PAGE>
ified in the related Prospectus Supplement, at
the price set forth therein. If so specified in
the related Prospectus Supplement for a Series
of Securities, the Transferor, the Servicer, or
such other entity that is specified in the re-
lated Prospectus Supplement, may, at its option,
cause an early termination of the related Trust
Fund by repurchasing all of the Primary Assets
remaining in the Trust Fund on or after a speci-
fied date, or on or after such time as the ag-
gregate principal balance of the Securities of
the Series or the Primary Assets relating to
such Series, as specified in the related Pro-
spectus Supplement, is less than the amount or
percentage specified in the related Prospectus
Supplement. See "DESCRIPTION OF THE SECURITIES--
Optional Redemption, Purchase or Termination."
In addition, the Prospectus Supplement may pro-
vide other circumstances under which Holders of
Securities of a Series could be fully paid sig-
nificantly earlier than would otherwise be the
case if payments or distributions were solely
based on the payments of the related Primary As-
sets.
THE TRUST FUND.............. The Trust Fund for a Series of Securities will
consist of one or more of the assets described
below, as described in the related Prospectus
Supplement.
A. PRIMARY ASSETS......... The Primary Assets for a Series may consist of
any combination of the following assets, to the
extent and as specified in the related Prospec-
tus Supplement.
(1) LOANS.............. Primary Assets for a Series will consist, in
whole or in part, of Loans. Some Loans may be
delinquent or non-performing as specified in the
related Prospectus Supplement. The Loans will be
originated or acquired by the Transferor in the
ordinary course of its business. The Loans will
be conventional loans or contracts or loans or
contracts insured by the Federal Housing Admin-
istration ("FHA") or partially guaranteed by the
Veterans Administration ("VA"). See "THE TRUST
FUNDS--The Loans" for a discussion of such guar-
antees. To the extent provided in the related
Prospectus Supplement, additional Loans or addi-
tional balances may be periodically added to the
Trust Fund, or may be removed from time to time
if certain asset tests are met, all as described
in the related Prospectus Supplement.
The "Loans" for a Series will consist of (i)
closed-end and/or revolving credit line home eq-
uity loans or certain balances thereof (collec-
tively, the "Mortgage Loans") and (ii) home im-
provement installment sales contracts and in-
stallment loan agreements (the "Home Improvement
Contracts"). The Mortgage Loans and the Home Im-
provement Contracts are collectively referred to
herein as the "Loans." Loans may, as specified
in the related Prospectus Supplement, have vari-
ous payment characteristics, including balloon
or other irregular payment features, and may ac-
crue interest at a fixed rate or an adjustable
rate.
8
<PAGE>
As specified in the related Prospectus Supple-
ment, the Mortgage Loans will and the Home Im-
provement Contracts may be secured by mortgages
and deeds of trust or other similar security in-
struments creating a lien on a Mortgaged Proper-
ty, which may be subordinated to one or more se-
nior liens on such Mortgaged Property, as de-
scribed in the related Prospectus Supplement. As
specified in the related Prospectus Supplement,
Home Improvement Contracts may be unsecured or
secured by purchase money security interests in
the Home Improvements financed thereby. The
Mortgaged Properties and the Home Improvements
are collectively referred to herein as the
"Properties."
The related Prospectus Supplement will describe
certain characteristics of the Loans for a Se-
ries, including, without limitation, and to the
extent relevant: (a) the aggregate unpaid prin-
cipal balance of the Loans (or the aggregate un-
paid principal balance included in the Trust
Fund for the related Series); (b) the range and
weighted average Loan Rate on the Loans and in
the case of adjustable rate Loans, the range and
weighted average of the Current Loan Rates and
the Lifetime Rate Caps, if any; (c) the range
and the average outstanding principal balance of
the Loans; (d) the weighted average original and
remaining term-to-stated maturity of the Loans
and the range of original and remaining terms-
to-stated maturity, if applicable; (e) the range
of Combined Loan-to-Value Ratios or Loan-to-
Value Ratios, as applicable, of the Loans, com-
puted in the manner described in the related
Prospectus Supplement; (f) the percentage (by
principal balance as of the Cut-off Date) of
Loans that accrue interest at adjustable or
fixed interest rates; (g) any enhancement relat-
ing to the Loans; (h) the percentage (by princi-
pal balance as of the Cut-off Date) of Loans
that are secured by Mortgaged Properties, Home
Improvements or are unsecured; (i) the geo-
graphic distribution of any Mortgaged Properties
securing the Loans; (j) the use and type of each
Mortgaged Property securing a Loan; (k) the lien
priority of the Loans; (l) the credit limit uti-
lization rates of any Revolving Credit Line
Loans; and (m) the delinquency status and year
of origination of the Loans.
(2) PRIVATE Primary Assets for a Series may consist, in whole
SECURITIES......... or in part, of Private Securities which include
(a) pass-through certificates representing bene-
ficial interests in loans of the type that would
otherwise be eligible to be Loans (the "Under-
lying Loans") or (b) collateralized obligations
secured by Underlying Loans. Such pass-through
certificates or collateralized obligations will
have previously been (a) offered and distributed
to the public pursuant to an effective registra-
tion statement or (b) purchased in a transaction
not involving any public offering from a person
who is not an affiliate of the issuer of such
securities at the time of sale (nor an affiliate
thereof at any time during the three preceding
months); provided a period of three years has
elapsed since the later of the
9
<PAGE>
date the securities were acquired from the is-
suer or an affiliate thereof. Although individ-
ual Underlying Loans may be insured or guaran-
teed by the United States or an agency or in-
strumentality thereof, they need not be, and the
Private Securities themselves will not be so in-
sured or guaranteed. See "THE TRUST FUNDS--Pri-
vate Securities." Unless otherwise specified in
the Prospectus Supplement relating to a Series
of Securities, payments on the Private Securi-
ties will be distributed directly to the Trustee
as registered owner of such Private Securities.
The related Prospectus Supplement for a Series
will specify (such disclosure may be on an ap-
proximate basis, as described above and will be
as of the date specified in the related Prospec-
tus Supplement) to the extent relevant and to
the extent such information is reasonably avail-
able to the Transferor and the Transferor rea-
sonably believes such information to be reli-
able: (i) the aggregate approximate principal
amount and type of any Private Securities to be
included in the Trust Fund for such Series;
(ii) certain characteristics of the Underlying
Loans including (A) the payment features of such
Underlying Loans (i.e., whether they are fixed
rate or adjustable rate and whether they provide
for fixed level payments, negative amortization
or other payment features), (B) the approximate
aggregate principal amount of such Underlying
Loans which are insured or guaranteed by a gov-
ernmental entity, (C) the servicing fee or range
of servicing fees with respect to such Under-
lying Loans, (D) the minimum and maximum stated
maturities of such Underlying Loans at origina-
tion, (E) the lien priority and the credit uti-
lization rates, if any, of such Underlying
Loans, and (F) the delinquency status and year
of origination of such Underlying Loans; (iii)
the maximum original term-to-stated maturity of
the Private Securities; (iv) the weighted aver-
age term-to-stated maturity of the Private Secu-
rities; (v) the pass-through or certificate rate
or ranges thereof for the Private Securities;
(vi) the sponsor or depositor of the Private Se-
curities (the "PS Sponsor"), the servicer of the
Private Securities (the "PS Servicer") and the
trustee of the Private Securities (the "PS
Trustee"); (vii) certain characteristics of En-
hancement, if any, such as reserve funds, insur-
ance policies, letters of credit or guarantees,
relating to the Underlying Loans, or to such
Private Securities themselves; (viii) the terms
on which the Underlying Loans may, or are re-
quired to, be repurchased prior to stated matu-
rity; and (ix) the terms on which substitute Un-
derlying Loans may be delivered to replace those
initially deposited with the PS Trustee. See
"THE TRUST FUNDS--Private Securities--Additional
Information."
B. COLLECTION,
CERTIFICATE AND
DISTRIBUTION
ACCOUNTS............... Unless otherwise provided in the related Prospec-
tus Supplement, all payments on or with respect
to the Primary Assets for a Series will be re-
mitted by the Servicer within the period speci-
fied in the related Prospectus Supplement di-
rectly to an account (the "Col-
10
<PAGE>
lection Account" or the "Certificate Account")
to be established for such Series. Unless other-
wise provided in the related Prospectus Supple-
ment, the Trustee shall be required to apply a
portion of the amount in the Collection Account
or the Certificate Account to the payment of
certain amounts payable to the Servicer under
the related Agreement and any other person spec-
ified in the Prospectus Supplement, and to de-
posit a portion of the amount in the Collection
Account into one or more separate accounts
(each, a "Distribution Account") to be estab-
lished for such Series, each in the manner and
at the times established in the related Prospec-
tus Supplement. All amounts deposited in such
Distribution Account (or, if there is no Distri-
bution Account, amounts remaining in the Certif-
icate Account) will be available, unless other-
wise specified in the related Prospectus Supple-
ment, for (i) application to the payment of
principal of and interest on such Series of Se-
curities (or such Class or Classes specified in
the related Prospectus Supplement) on the next
Distribution Date, (ii) the making of adequate
provision for future payments on certain Classes
of Securities and (iii) any other purpose speci-
fied in the related Prospectus Supplement. After
applying the funds in the Collection Account or
the Certificate Account as described above, any
funds remaining in such Accounts may be paid
over to the Servicer, the Transferor, any pro-
vider of Enhancement with respect to such Series
(an "Enhancer") or any other person entitled
thereto in the manner and at the times estab-
lished in the related Prospectus Supplement.
C. PRE-FUNDING AND
CAPITALIZED INTEREST
ACCOUNTS...............
If specified in the related Prospectus Supple-
ment, a Trust Fund will include one or more seg-
regated trust accounts (each, a "Pre-Funding Ac-
count") for the related Series. If so specified,
on the closing date for such Series, a portion
of the proceeds of the sale of the Securities of
such Series (such amount, the "Pre-Funded
Amount") will be deposited in the Pre-Funding
Account and may be used to purchase additional
Primary Assets during the period of time speci-
fied in the related Prospectus Supplement (the
"Pre-Funding Period"). The Primary Assets to be
so purchased will be required to have certain
characteristics specified in the related Pro-
spectus Supplement. If any Pre-Funded Amount re-
mains on deposit in the Pre-Funding Account at
the end of the Pre-Funding Period, such amount
will be applied in the manner specified in the
related Prospectus Supplement to prepay the
Classes of Notes and/or the Certificates of the
applicable Series specified in the related Pro-
spectus Supplement. The amount initially depos-
ited in a Pre-Funding Account for a Series of
Securities will not exceed 50% of the aggregate
principal amount of such Series of Securities.
If a Pre-Funding Account is established, one or
more segregated trust accounts (each, a "Capi-
talized Interest Account") may be
11
<PAGE>
established for the related Series. On the clos-
ing date for such Series, a portion of the pro-
ceeds of the sale of the Securities of such Se-
ries may be deposited in the Capitalized Inter-
est Account and used to fund the excess, if any,
of (x) the sum of (i) the amount of interest ac-
crued on the Classes of Securities of such Se-
ries specified in the related Prospectus Supple-
ment and (ii) if specified in the related Pro-
spectus Supplement, certain fees or expenses
during the Pre-Funding Period such as Trustee
fees and credit enhancement fees, over (y) the
amount of interest available therefor from the
Primary Assets in the Trust Fund. If so speci-
fied in the related Prospectus Supplement,
amounts on deposit in the Capitalized Interest
Account may be released to the Transferor prior
to the end of the Pre-Funding Period subject to
the satisfaction of certain tests specified in
the related Prospectus Supplement. Any amounts
on deposit in the Capitalized Interest Account
at the end of the Pre-Funding Period that are
not necessary for such purposes will be distrib-
uted to the person specified in the related Pro-
spectus Supplement.
ENHANCEMENT................. If and to the extent specified in the related
Prospectus Supplement, enhancement with respect
to a Series or any Class of Securities may in-
clude any one or more of the following: a finan-
cial guaranty insurance policy,
overcollateralization, a letter of credit, a
cash reserve fund, insurance policies, one or
more Classes of Subordinate Securities, deriva-
tive products or other forms of credit enhance-
ment, or any combination thereof (collectively,
"Enhancement"). The Enhancement with respect to
any Series or any Class of Securities may be
structured to provide protection against delin-
quencies and/or losses on the Primary Assets,
against changes in interest rates, or other
risks, to the extent and under the conditions
specified in the related Prospectus Supplement.
Unless otherwise specified in the related Pro-
spectus Supplement, any form of Enhancement will
have certain limitations and exclusions from
coverage thereunder, which will be described in
the related Prospectus Supplement. Further in-
formation regarding any Enhancer, including fi-
nancial information when material, will be in-
cluded in the related Prospectus Supplement. See
"ENHANCEMENT."
With respect to any Series of Securities includ-
ing one or more Classes of Notes, distributions
in respect of the Certificates may be subordi-
nated in priority of payment to payments on the
Notes, to the extent specified in the related
Prospectus Supplement.
SERVICING................... The Servicer will be responsible for servicing,
managing and making collections on the Loans for
a Series. In addition, the Servicer, if so spec-
ified in the related Prospectus Supplement, will
act as custodian and will be responsible for
maintaining custody of the Loans and related
documentation on behalf of the Trustee. Advances
with respect to delinquent payments of principal
and/or
12
<PAGE>
interest on a Loan ("Delinquency Advances") will
be made by the Servicer if and only to the ex-
tent described in the related Prospectus Supple-
ment. Such advances will be intended to provide
liquidity only and will be reimbursable to the
Servicer, to the extent specified in the related
Prospectus Supplement, from scheduled payments
of principal and/or interest, late collections,
or from the proceeds of liquidation of the re-
lated Loans or from other recoveries relating to
such Loans (including any insurance proceeds or
payments from other credit support) or, to the
extent specified in the related Prospectus Sup-
plement, from payments or proceeds from other
Loans. If and to the extent specified in the re-
lated Prospectus Supplement, the Servicer shall
be entitled to advance its own funds to pay for
any related expenses of foreclosure and disposi-
tion of any liquidated Mortgage Loan or related
Property (the "Servicer Advances"). See "SERVIC-
ING OF LOANS--Advances and Limitations Thereon."
The Servicer shall be entitled to be reimbursed
for any such Servicer Advances as specified in
the related Prospectus Supplement. In performing
these functions, the Servicer will exercise the
same degree of skill and care that it customar-
ily exercises with respect to similar Loans
owned or serviced by it. Under certain limited
circumstances, the Servicer may resign or be re-
moved, in which event either the Trustee or a
third-party servicer will be appointed as suc-
cessor servicer. The Servicer will receive a pe-
riodic fee as servicing compensation (the "Ser-
vicing Fee") and may, as specified herein and in
the related Prospectus Supplement, receive cer-
tain additional compensation. See "SERVICING OF
LOANS--Servicing Compensation and Payment of Ex-
penses."
FEDERAL INCOME TAX
CONSIDERATIONS
A. DEBT SECURITIES AND
REMIC RESIDUAL
SECURITIES.............
If (i) an election is made to treat all or a por-
tion of a Trust Fund for a Series as a "real es-
tate mortgage investment conduit" (a "REMIC") or
(ii) so provided in the related Prospectus Sup-
plement, a Series of Securities will include one
or more Classes of taxable debt obligations un-
der the Internal Revenue Code of 1986, as
amended (the "Code"), stated interest with re-
spect to such Classes of Securities will be re-
ported by a Holder in accordance with the Hold-
er's method of accounting except that, in the
case of Securities constituting "regular inter-
ests" in a REMIC ("Regular Interests"), such in-
terest will be required to be reported on the
accrual method regardless of a Holder's usual
method of accounting. Securities that are Com-
pound Interest Securities, Zero Coupon Securi-
ties or Interest Only Securities will, and cer-
tain other Classes of Securities may, be issued
with original issue discount that is not de
minimis. In such cases, the Holder will be re-
quired to include original issue discount in
gross income as it accrues, which may be prior
to the receipt of cash attributable to such in-
come. If a Security is issued at a premium, the
Holder
13
<PAGE>
may be entitled to make an election to amortize
such premium on a constant yield method.
In the case of a REMIC election, a Class of Secu-
rities may be treated as REMIC "residual inter-
ests" ("Residual Interest"). A Holder of a Re-
sidual Interest will be required to include in
its income its pro rata share of the taxable in-
come of the REMIC. In certain circumstances, the
Holder of a Residual Interest may have REMIC
taxable income or tax liability attributable to
REMIC taxable income for a particular period in
excess of cash distributions for such period or
have an after-tax return that is less than the
after-tax return on comparable debt instruments.
In addition, a portion (or, in some cases, all)
of the income from a Residual Interest (i) ex-
cept in certain circumstances with respect to a
Holder classified as a thrift institution under
the Code, may not be subject to offset by losses
from other activities or investments, (ii) for a
Holder that is subject to tax under the Code on
unrelated business taxable income, may be
treated as unrelated business taxable income and
(iii) for a foreign holder, may not qualify for
exemption from or reduction of withholding. In
addition, (i) Residual Interests are subject to
transfer restrictions and (ii) certain transfers
of Residual Interests will not be recognized for
federal income tax purposes. Further, individual
holders are subject to limitations on the de-
ductibility of expenses of the REMIC. See "FED-
ERAL INCOME TAX CONSIDERATIONS."
B. NON-REMIC PASS-THROUGH
SECURITIES.............
If so specified in the related Prospectus Supple-
ment, the Trust Fund for a Series will be
treated as a grantor trust and will not be clas-
sified as an association taxable as a corpora-
tion for federal income tax purposes and Holders
of Securities of such Series ("Pass-Through Se-
curities") will be treated as owning directly
rights to receive certain payments of interest
or principal, or both, on the Primary Assets
held in the Trust Fund for such Series. All in-
come with respect to a Stripped Security (as de-
fined herein) will be accounted for as original
issue discount and, unless otherwise specified
in the related Prospectus Supplement, will be
reported by the Trustee on an accrual basis,
which may be prior to the receipt of cash asso-
ciated with such income.
C. OWNER TRUST If so specified in the Prospectus Supplement, the
SECURITIES............. Trust Fund will be treated as a partnership for
purposes of federal and state income tax. Each
Noteholder, by the acceptance of a Note of a
given Series, will agree to treat such Note as
indebtedness, and each Certificateholder, by the
acceptance of a Certificate of a given Series,
will agree to treat the related Trust Fund as a
partnership in which such Certificateholder is a
partner for federal income and state tax purpos-
es. Alternative characterizations of such Trust
Fund and such Certificates are possible, but
would not result in materially adverse tax con-
sequences to Certificateholders. See "FEDERAL
INCOME TAX CONSIDERATIONS."
14
<PAGE>
ERISA CONSIDERATIONS........ The eligibility of Notes and Certificates to be
acquired by employee benefit plans or with the
plan assets of employee benefit plans is subject
to the considerations discussed under "ERISA
CONSIDERATIONS" herein and in the related Pro-
spectus Supplement. The related Prospectus Sup-
plement will provide further information with
respect to the eligibility of a Class of Notes
or Certificates for purchase by employee benefit
plans.
A fiduciary of any employee benefit plan subject
to the Employee Retirement Income Security Act
of 1974, as amended ("ERISA"), or the Code
should carefully review with its own legal advi-
sors whether the purchase or holding of Securi-
ties could give rise to a transaction prohibited
or otherwise impermissible under ERISA or the
Code. See "ERISA CONSIDERATIONS" herein and in
the related Prospectus Supplement.
LEGAL INVESTMENT............ Unless otherwise specified in the related Pro-
spectus Supplement, Securities of each Series
offered by this Prospectus and the related Pro-
spectus Supplement will not constitute "mortgage
related securities" under the Secondary Mortgage
Market Enhancement Act of 1984 ("SMMEA"). In-
vestors whose investment authority is subject to
legal restrictions should consult their own le-
gal advisors to determine whether and to what
extent the Securities constitute legal invest-
ments for them. See "LEGAL INVESTMENT."
RATINGS..................... It will be a requirement for issuance of any Se-
ries that each Class of Securities offered by
this Prospectus and the related Prospectus Sup-
plement be rated by at least one Rating Agency
in one of its four highest applicable rating
categories. The rating or ratings applicable to
Securities of each Series offered hereby and by
the related Prospectus Supplement will be as set
forth in the related Prospectus Supplement.
There is no assurance that the rating initially
assigned to such Securities will not be subse-
quently lowered or withdrawn by the Rating Agen-
cy. In the event the rating initially assigned
to any Securities is subsequently lowered for
any reason, no person or entity will be obli-
gated to provide any credit enhancement in addi-
tion to the Enhancement, if any, specified in
the related Prospectus Supplement.
A securities rating should be evaluated indepen-
dently of similar ratings on different types of
securities. A securities rating is not a recom-
mendation to buy, hold or sell securities and
does not address the effect that the rate of
prepayments on Loans or Underlying Loans relat-
ing to Private Securities, as applicable, for a
Series may have on the yield to investors in the
Securities of such Series. See "RISK FACTORS--
Ratings Are Not Recommendations."
15
<PAGE>
RISK FACTORS
Investors should consider, among other things, the following risk factors in
connection with the purchase of the Securities.
No Secondary Market. There will be no market for the Securities of any
Series prior to the issuance thereof, and there can be no assurance that a
secondary market will develop or, if it does develop, that it will provide
Holders with liquidity of investment or will continue for the life of the
Securities of such Series. See "PLAN OF DISTRIBUTION."
Primary Assets Are Only Source of Repayment. The Securities of a Series will
be payable solely from the assets of the Trust Fund for such Securities and
any related Enhancement. There will be no recourse to the Transferor or any
other person for any default on the Notes or any failure to receive
distributions on the Certificates except to the extent of the obligations, if
any, of the Transferor with respect to certain representations and warranties.
See "THE AGREEMENTS--Assignment of Primary Assets." Further, unless otherwise
stated in the related Prospectus Supplement, at the times set forth in the
related Prospectus Supplement, certain Primary Assets and/or any balance
remaining in the Collection Account, Certificate Account or Distribution
Account immediately after making all payments due on the Securities of such
Series and other payments specified in the related Prospectus Supplement, may
be promptly released or remitted to the Transferor, the Servicer, the Enhancer
or any other person entitled thereto and will no longer be available for
making payments to Holders. Consequently, Holders of Securities of each Series
must rely solely upon payments with respect to the Primary Assets and the
other assets constituting the Trust Fund for a Series of Securities,
including, if applicable, any amounts available pursuant to any Enhancement
for such Series, for the payment of principal of and interest on the
Securities of such Series.
Adverse economic conditions (which may or may not affect real property
values) may affect the timely payment by borrowers of payments of principal
and interest when due on the Loans and, accordingly, the actual rates of
delinquencies, foreclosures and losses with respect to the Loans. For
instance, if a Property secures a senior mortgage or deed of trust for an
adjustable-rate loan, and interest rates have increased since the origination
of the related Loan, the borrower's ability to pay the required monthly
payment on such Loan may be adversely affected by the increase in monthly
payments on the Loan and on such senior loan. Further, application of federal
and state bankruptcy and debtor relief laws would affect the interests of the
Securityholders in the Loans if such laws result in certain Loans being
uncollectible.
Holders of Notes will be required under the Indenture to proceed only
against the Primary Assets and other assets constituting the related Trust
Fund in the case of a default with respect to such Notes and may not proceed
against any assets of the Transferor. There is no assurance that the market
value of the Primary Assets or any other assets for a Series will at any time
be equal to or greater than the aggregate principal amount of the Securities
of such Series then outstanding, plus accrued interest thereon. Moreover, upon
an event of default under the Indenture for a Series of Notes and a sale of
the assets in the Trust Fund or upon a sale of the assets of a Trust Fund for
a Series of Certificates, the Trustee, the Servicer, if any, the Enhancer and
any other service provider specified in the related Prospectus Supplement
generally will be entitled to receive the proceeds of any such sale to the
extent of unpaid fees and other amounts owing to such persons under the
related Agreement prior to distributions to Holders of Securities. Upon any
such sale, the proceeds thereof may be insufficient to pay in full the
principal of and interest on the Securities of such Series. See "THE TRUST
FUNDS."
Limited Protection Against Losses. Although any Enhancement is intended to
reduce the risk of delinquent payments or losses to Holders entitled to the
benefit thereof, the amount of such Enhancement will be limited, as set forth
in the related Prospectus Supplement, and will decline and could be depleted
under certain circumstances prior to the payment in full of the related Series
of Securities, and as a result Holders may suffer losses. See "ENHANCEMENT."
16
<PAGE>
Yield May Vary. The yield to maturity experienced by a Holder of Securities
may be affected by the rate of payment of principal of the Loans or Underlying
Loans relating to the Private Securities, as applicable. The timing of
principal payments of the Securities of a Series will be affected by a number
of factors, including the following: (i) the extent of prepayments of the
Loans or Underlying Loans relating to the Private Securities, as applicable,
which prepayments may be influenced by a variety of factors; (ii) the manner
of allocating principal payments among the Classes of Securities of a Series
as specified in the related Prospectus Supplement; and (iii) the exercise by
the party entitled thereto of any right of optional termination. See
"DESCRIPTION OF THE SECURITIES--Weighted Average Life of the Securities."
Prepayments may also result from repurchases of Loans or Underlying Loans
relating to the Private Securities, as applicable, due to material breaches of
the Transferor's representations and warranties.
Interest payable on the Securities of a Series on a Distribution Date will
include all interest accrued during the period specified in the related
Prospectus Supplement. In the event interest accrues during the calendar month
prior to a Distribution Date, the effective yield to Holders will be reduced
from the yield that would otherwise be obtainable if interest payable on the
Security were to accrue through the day immediately preceding each
Distribution Date, and the effective yield (at par) to Holders will be less
than the indicated coupon rate. See "DESCRIPTION OF THE SECURITIES--Payments
of Interest."
Status of Junior Liens; Property Values May Be Insufficient. If the Loans in
a Trust Fund are secured primarily by junior liens subordinate to the rights
of the mortgagee under the related senior mortgage(s) or deed(s) of trust, the
proceeds from any liquidation, insurance or condemnation proceedings will be
available to satisfy the outstanding balance of such Loans only to the extent
that the claims of such senior mortgagees or beneficiaries have been satisfied
in full, including any related foreclosure costs. In addition, a junior
mortgagee may not foreclose on the Property securing a junior mortgage unless
it forecloses subject to the senior mortgages, in which case it must either
pay the entire amount due on the senior mortgages to the senior mortgagees at
or prior to the foreclosure sale or undertake the obligation to make payments
on the senior mortgages in the event the mortgagor is in default thereunder.
The Trust Fund will not have any source of funds to satisfy the senior
mortgages or deeds of trust or make payments due to the senior mortgagees or
beneficiaries.
There are several factors that could adversely affect the value of
Properties such that the outstanding balance of the related Loan (or the
balances thereof sold to a Trust Fund), together with any senior financing on
the Properties, would equal or exceed the value of the Properties. Among the
factors that could adversely affect the value of the Properties are an overall
decline in the residential real estate market in the areas in which the
Properties are located or a decline in the general condition of the Properties
as a result of failure of borrowers to maintain adequately the Properties or
of natural disasters that are not necessarily covered by insurance, such as
earthquakes and floods. Any such decline could extinguish the value of a
junior interest in a Property before having any effect on the related senior
interest therein. If such a decline occurs, the actual rates of delinquencies,
foreclosure and losses on the junior Loans could be higher than those
currently experienced in the mortgage and home improvement lending industry in
general. See "CERTAIN LEGAL ASPECTS OF THE LOANS--Junior Mortgages; Rights of
Senior Mortgages."
Pre-Funding and Additional Loans May Adversely Affect Investment. If a Trust
Fund includes a Pre-Funding Account and the principal balance of additional
Primary Assets delivered to the Trust Fund during the Pre-Funding Period is
less than the Pre-Funded Amount, the Holders of the Securities of the related
Series will receive a prepayment of principal as and to the extent described
in the related Prospectus Supplement. In addition, if so specified in the
related Prospectus Supplement, an Amortization Period may result from the
failure of the Transferor to sell additional Primary Assets (or balances
thereof) to the Trust Fund during the Revolving Period, thereby resulting in a
prepayment of the related Securities. Any such principal prepayment may
adversely affect the yield to maturity of the applicable Securities. Since
prevailing interest rates are subject to fluctuation, there can be no
assurance that investors will be able to reinvest such a prepayment at yields
equaling or exceeding the yields on the related Securities. It is possible
that the yield on any such reinvestment will be lower, and may be
significantly lower, than the yield on the related Securities.
17
<PAGE>
Each additional Primary Asset must satisfy the eligibility criteria
specified in the related Prospectus Supplement and related Agreements. Such
eligibility criteria will be determined in consultation with each Rating
Agency (and/or any Enhancer) prior to the issuance of the related Series and
are designed to ensure that if such additional Primary Assets were included as
part of the initial Primary Assets, the credit quality of such assets would be
consistent with the initial rating of each Class of Securities of such Series.
The Transferor will certify to the Trustee that all conditions precedent to
the transfer of the additional Primary Assets, including the satisfaction of
the eligibility criteria to the Trust Fund, have been satisfied. It is a
condition to the transfer of any additional Primary Assets to the Trust Fund
that each Rating Agency, after receiving prior notice of the proposed transfer
of the additional Primary Assets to the Trust Fund, shall not have advised the
Transferor or the Trustee or any Enhancer that the conveyance of such
additional Primary Assets will result in a qualification, modification or
withdrawal of its then current rating of any Class of Notes or Certificates of
such Series. Following the transfer of additional Primary Assets to the Trust
Fund, the aggregate characteristics of the Primary Assets then held in the
Trust Fund may vary from those of the initial Primary Assets of such Trust
Fund. As a result, the additional Primary Assets may adversely affect the
performance of the related Securities. See "THE TRUST FUNDS--Accounts."
The ability of a Trust Fund to invest in additional Loans during the related
Pre-Funding Period and/or any Revolving Period will be dependant on the
ability of the Transferor to originate or acquire Loans that satisfy the
requirements for transfer to the Trust Fund specified in the related
Prospectus Supplement. The ability of the Transferor to originate or acquire
such Loans will be affected by a variety of social and economic factors,
including the prevailing level of market interest rates, unemployment levels
and consumer perceptions of general economic conditions.
Potential Liability For Environmental Conditions. Real property pledged as
security to a lender may be subject to certain environmental risks. Under the
laws of certain states, contamination of a property may give rise to a lien on
the property to assure the costs of clean-up. In several states, such a lien
has priority over the lien of an existing mortgage or owner's interest against
such property. In addition, under the laws of some states and under the
federal Comprehensive Environmental Response, Compensation, and Liability Act
of 1980 ("CERCLA"), a lender may be liable, as an "owner" or "operator," for
costs of addressing releases or threatened releases of hazardous substances
that require remedy at a property, if agents or employees of the lender have
become sufficiently involved in the operations of the borrower, regardless of
whether or not the environmental damage or threat was caused by a prior owner.
A lender also risks such liability on foreclosure of the Mortgaged Property.
See "SERVICING OF LOANS--Realization Upon Defaulted Loans."
Consumer Protection Laws May Affect Loans. Applicable state laws generally
regulate interest rates and other charges and require certain disclosures. In
addition, other state laws, public policy and general principles of equity
relating to the protection of consumers, unfair and deceptive practices and
debt collection practices may apply to the origination, servicing and
collection of the Loans. Depending on the provisions of the applicable law and
the specific facts and circumstances involved, violations of these laws,
policies and principles may limit the ability of the Servicer to collect all
or part of the principal of or interest on the Loans, may entitle the borrower
to a refund of amounts previously paid and, in addition, could subject the
owner of the Loan to damages and administrative enforcement.
The Loans are also subject to federal laws, including:
(i) the federal Truth in Lending Act and Regulation Z promulgated
thereunder, which require certain disclosures to the borrowers regarding
the terms of the Loans;
(ii) the Equal Credit Opportunity Act and Regulation B promulgated
thereunder, which prohibit discrimination on the basis of age, race, color,
sex, religion, marital status, national origin, receipt of public
assistance or the exercise of any right under the Consumer Credit
Protection Act, in the extension of credit;
(iii) the Americans with Disabilities Act, which, among other things,
prohibits discrimination on the basis of disability in the full and equal
enjoyment of the goods, services, facilities, privileges, advantages or
accommodations of any place of public accommodation;
18
<PAGE>
(iv) the Fair Credit Reporting Act, which regulates the use and reporting
of information related to the borrower's credit experience; and
(v) for Revolving Credit Line Loans that were originated or closed after
November 7, 1989, the Home Equity Loan Consumer Protection Act of 1988,
which requires additional application disclosures, limits changes that may
be made to loan documents without the borrower's consent and restricts a
lender's ability to declare a default or to suspend or reduce a borrower's
credit limit to certain enumerated events.
The Home Improvement Contracts are also subject to the Preservation of
Consumers' Claims and Defenses regulations of the Federal Trade Commission and
other similar federal and state statutes and regulations (collectively, the
"Holder in Due Course Rules"), which protect the homeowner from defective
craftsmanship or incomplete work by a contractor. These laws permit the
obligor to withhold payment if the work does not meet the quality and
durability standards agreed to by the homeowner and the contractor. The Holder
in Due Course Rules have the effect of subjecting any assignee of the seller
in a consumer credit transaction to all claims and defenses which the obligor
in the credit sale transaction could assert against the seller of the goods.
Violations of certain provisions of these federal laws may limit the ability
of the Servicer to collect all or part of the principal of or interest on the
Loans and in addition could subject the Trust Fund to damages and
administrative enforcement. In addition, numerous other federal and state
statutory provisions, including the federal bankruptcy laws, the Soldiers' and
Sailors' Civil Relief Act of 1940 and state debtor relief laws, may also
adversely affect the Servicer's ability to collect the principal of or
interest on the Loans and also would affect the interests of the
Securityholders in such Loans if such laws result in the Loans being
uncollectible. See "CERTAIN LEGAL ASPECTS OF THE LOANS."
Contracts Will Not Be Stamped. Unless otherwise specified in the related
Prospectus Supplement, in order to give notice of the right, title and
interest of Securityholders to the Home Improvement Contracts that constitute
chattel paper, the Transferor will cause a UCC-1 financing statement to be
executed by the Transferor identifying the Trustee as the secured party and
identifying such Home Improvement Contracts as collateral. Unless otherwise
specified in the related Prospectus Supplement, such Home Improvement
Contracts will not be stamped or otherwise marked to reflect their assignment
to the Trust Fund. Therefore, if, through negligence, fraud or otherwise, a
subsequent purchaser were able to take physical possession of such Home
Improvement Contracts without notice of such assignment, the interest of
Securityholders in such Home Improvement Contracts could be defeated. See
"CERTAIN LEGAL ASPECTS OF THE LOANS--The Home Improvement Contracts."
Ratings Are Not Recommendations. It will be a condition to the issuance of a
Series of Securities that each Class be rated in one of the four highest
rating categories by the Rating Agency identified in the related Prospectus
Supplement. Any such rating would be based on, among other things, the
adequacy of the value of the Primary Assets and any Enhancement with respect
to such Series. Such rating should not be deemed a recommendation to purchase,
hold or sell Securities, inasmuch as it does not address market price or
suitability for a particular investor. There is also no assurance that any
such rating will remain in effect for any given period of time or may not be
lowered or withdrawn entirely by the Rating Agency if in its judgment
circumstances in the future so warrant. In addition to being lowered or
withdrawn due to any erosion in the adequacy of the value of the Primary
Assets, such rating might also be lowered or withdrawn, among other reasons,
because of an adverse change in the financial or other condition of an
Enhancer or a change in the rating of such Enhancer's long term debt.
19
<PAGE>
DESCRIPTION OF THE SECURITIES
GENERAL
Each Series of Notes will be issued pursuant to an indenture (the
"Indenture") between the related Trust Fund and the entity named in the
related Prospectus Supplement as trustee (the "Trustee") with respect to such
Series. A form of Indenture has been filed as an exhibit to the Registration
Statement of which this Prospectus forms a part. The Certificates will also be
issued in Series pursuant to separate agreements (each, a "Pooling and
Servicing Agreement" or a "Trust Agreement") among the Transferor, the
Servicer, if the Series relates to Loans, and the Trustee. A form of Pooling
and Servicing Agreement has been filed as an exhibit to the Registration
Statement of which this Prospectus forms a part. A Series may consist of both
Notes and Certificates.
The following summaries describe certain provisions in the Agreements common
to each Series of Securities. The summaries do not purport to be complete and
are subject to, and are qualified in their entirety by reference to, the
provisions of the Agreements and the Prospectus Supplement relating to each
Series of Securities. Where particular provisions or terms used in the
Agreements are referred to, the actual provisions (including definitions of
terms) are incorporated herein by reference as part of such summaries.
Each Series of Securities will consist of one or more Classes of Securities,
one or more of which may be Compound Interest Securities, Variable Interest
Securities, PAC Securities, Zero Coupon Securities, Principal Only Securities,
Interest Only Securities or Participating Securities. A Series may also
include one or more Classes of Subordinate Securities. The Securities of each
Series will be issued only in fully registered form, without coupons, in the
authorized denominations for each Class specified in the related Prospectus
Supplement. Upon satisfaction of the conditions, if any, applicable to a Class
of a Series, as described in the related Prospectus Supplement, the transfer
of the Securities may be registered and the Securities may be exchanged at the
office of the Trustee specified in the Prospectus Supplement without the
payment of any service charge other than any tax or governmental charge
payable in connection with such registration of transfer or exchange. If
specified in the related Prospectus Supplement, one or more Classes of a
Series may be available in book-entry form only.
Unless otherwise provided in the related Prospectus Supplement, payments of
principal of and interest on a Series of Securities will be made on the
Distribution Dates specified in the related Prospectus Supplement (which may
be different for each Class or for the payment of principal and interest) by
check mailed to Holders of such Series, registered as such at the close of
business on the record date specified in the related Prospectus Supplement
applicable to such Distribution Dates at their addresses appearing on the
security register, except that (a) payments may be made by wire transfer
(which, unless otherwise specified in the related Prospectus Supplement, shall
be at the expense of the Holder requesting payment by wire transfer) in
certain circumstances described in the related Prospectus Supplement and (b)
final payments of principal in retirement of each Security will be made only
upon presentation and surrender of such Security at the office of the Trustee
specified in the Prospectus Supplement. Notice of the final payment on a
Security will be mailed to the Holder of such Security before the Distribution
Date on which the final principal payment on any Security is expected to be
made to the holder of such Security.
Payments of principal of and interest on the Securities will be made by the
Trustee, or a paying agent on behalf of the Trustee, as specified in the
related Prospectus Supplement. Unless otherwise provided in the related
Prospectus Supplement, all payments with respect to the Primary Assets for a
Series, together with reinvestment income thereon, amounts withdrawn from any
Reserve Fund, and amounts available pursuant to any other Enhancement will be
deposited directly into the Collection Account or the Certificate Account. If
provided in the related Prospectus Supplement, such amounts may be net of
certain amounts payable to the Servicer and any other person specified in the
Prospectus Supplement. Such amounts thereafter may be deposited into the
Distribution Account and will be available to make payments on the Securities
of such Series on the next applicable Distribution Date. See "THE TRUST
FUNDS--Accounts."
20
<PAGE>
VALUATION OF THE PRIMARY ASSETS
If specified in the related Prospectus Supplement for a Series of Notes,
each Primary Asset included in the related Trust Fund for a Series will be
assigned an initial "Asset Value." Unless otherwise specified in the related
Prospectus Supplement, at any time the Asset Value of the Primary Assets will
be equal to the product of the Asset Value Percentage as set forth in the
Indenture and the lesser of (a) the stream of remaining regularly scheduled
payments on the Primary Assets, net, unless otherwise provided in the related
Prospectus Supplement, of certain amounts payable as expenses, together with
income earned on each such scheduled payment received through the day
preceding the next Distribution Date at the Assumed Reinvestment Rate, if any,
discounted to present value at the highest interest rate on the Notes of such
Series over periods equal to the interval between payments on the Notes, and
(b) the then principal balance of the Primary Assets. Unless otherwise
specified in the related Prospectus Supplement, the initial Asset Value of the
Primary Assets will be at least equal to the principal amount of the Notes of
the related Series at the date of issuance thereof.
The "Assumed Reinvestment Rate," if any, for a Series will be the highest
rate permitted by the Rating Agency or a rate insured by means of a surety
bond, guaranteed investment contract, or other arrangement satisfactory to the
Rating Agency. If the Assumed Reinvestment Rate is so insured, the related
Prospectus Supplement will set forth the terms of such arrangement.
PAYMENTS OF INTEREST
The Securities of each Class by their terms entitled to receive interest
will bear interest (calculated, unless otherwise specified in the related
Prospectus Supplement, on the basis of a 360-day year of twelve 30-day months)
from the date and at the rate per annum specified, or calculated in the method
described, in the related Prospectus Supplement. Interest on such Securities
of a Series will be payable on the Distribution Date specified in the related
Prospectus Supplement. If so specified in the related Prospectus Supplement,
the Distribution Date for the payment of interest of a Class may be different
from, or occur more or less frequently than, the Distribution Date for the
payment of principal of such Class. The rate of interest on Securities of a
Series may be variable or may change with changes in the annual percentage
rates of the Loans or Underlying Loans relating to the Private Securities, as
applicable, included in the related Trust Fund and/or as prepayments occur
with respect to such Loans or Underlying Loans, as applicable. Principal Only
Securities may not be entitled to receive any interest distributions or may be
entitled to receive only nominal interest distributions. Any interest on Zero
Coupon Securities that is not paid on the related Distribution Date will
accrue and be added to the principal thereof on such Distribution Date.
Interest payable on the Securities on a Distribution Date will include all
interest accrued during the period specified in the related Prospectus
Supplement. In the event interest accrues during the calendar month preceding
a Distribution Date, the effective yield to Holders will be reduced from the
yield that would otherwise be obtainable if interest payable on the Securities
were to accrue through the day immediately preceding such Distribution Date.
PAYMENTS OF PRINCIPAL
On each Distribution Date for a Series, principal payments will be made to
the Holders of the Securities of such Series on which principal is then
payable, to the extent set forth in the related Prospectus Supplement. Such
payments will be made in an aggregate amount determined as specified in the
related Prospectus Supplement and will be allocated among the respective
Classes of a Series in the manner, at the times and in the priority (which
may, in certain cases, include allocation by random lot) set forth in the
related Prospectus Supplement. If so specified in the related Prospectus
Supplement, the Distribution Date for the payment of principal of a Class may
be different from, or occur more or less frequently than, the Distribution
Date for the payment of interest for such Class.
21
<PAGE>
REVOLVING PERIOD AND AMORTIZATION PERIOD; TRANSFEROR INTEREST
If the related Prospectus Supplement so provides, there may be a period
commencing on the date of issuance of a Class or Classes of Notes or
Certificates of a Series and ending on the date set forth in the related
Prospectus Supplement (the "Revolving Period") during which no principal
payments will be made to one or more Classes of Notes or Certificates of the
related Series as are identified in such Prospectus Supplement. Some or all
collections of principal otherwise allocated to such Class or Classes of Notes
or Certificates may be (i) utilized by the Trust Fund during such period to
acquire additional Loans (or additional balances of existing Loans) which
satisfy the criteria described in the related Prospectus Supplement, (ii) held
in an account and invested in Eligible Investments for later distribution to
Securityholders, (iii) applied to those Class or Classes of Notes or
Certificates, if any, of the same or different Series as specified in the
related Prospectus Supplement as then are in amortization, or (iv) otherwise
applied as specified in the related Prospectus Supplement.
An "Amortization Period" is the period, if any, specified as such in the
related Prospectus Supplement during which an amount of principal is payable
to holders of one or more Classes of a Series of Securities. If so specified
in the related Prospectus Supplement, during an Amortization Period all or a
portion of principal collections on the Primary Assets may be applied as
specified above for a Revolving Period and, to the extent not so applied, will
be distributed to the Classes of Notes or Certificates of the same or
different Series as specified in the related Prospectus Supplement as then
being entitled to payments of principal. In addition, if so specified in the
related Prospectus Supplement, amounts deposited in certain accounts for the
benefit of one or more Classes of Notes or Certificates may be released from
time to time or on a specified date and applied as a payment of principal on
such Classes of Notes or Certificates. The related Prospectus Supplement will
set forth the circumstances which will result in the commencement of an
Amortization Period.
Each Trust Fund which has a Revolving Period may also issue to the
Transferor a certificate evidencing a Transferor Interest in the Trust Fund
not represented by the other Securities issued by such Trust Fund. As further
described in the related Prospectus Supplement, the value of such Transferor
Interest will fluctuate as the amount of the assets of the Trust Fund
fluctuates and the amount of the Notes and Certificates of the related Series
of Securities outstanding is reduced.
FINAL SCHEDULED DISTRIBUTION DATE
The Final Scheduled Distribution Date with respect to each Class of Notes is
the date no later than the date on which the principal thereof will be fully
paid and with respect to each Class of Certificates will be the date on which
the entire aggregate principal balance of such Class is expected to be reduced
to zero, in each case calculated on the basis of the assumptions applicable to
such Series described in the related Prospectus Supplement. The Final
Scheduled Distribution Date for each Class of a Series will be specified in
the related Prospectus Supplement. Since, except as described above under "--
Revolving Period and Amortization Period; Transferor Interest," payments on
the Primary Assets will be used to make distributions in reduction of the
outstanding principal amount of the Securities, it is likely that the actual
final Distribution Date of any such Class will occur earlier, and may occur
substantially earlier, than its Final Scheduled Distribution Date.
Furthermore, with respect to a Series of Certificates, unless otherwise
specified in the related Prospectus Supplement, as a result of delinquencies,
defaults and liquidations of the Primary Assets in the Trust Fund, the actual
final Distribution Date of any Certificate may occur later than its Final
Scheduled Distribution Date. No assurance can be given as to the actual
prepayment experience with respect to a Series. See "--Weighted Average Life
of the Securities" below.
SPECIAL REDEMPTION
If so specified in the Prospectus Supplement relating to a Series of
Securities having other than monthly Distribution Dates, one or more Classes
of Securities of such Series may be subject to special redemption, in whole or
in part, on the day specified in the related Prospectus Supplement (a "Special
Redemption Date") if, as a consequence of prepayments on the Loans or
Underlying Loans, as applicable, relating to such Securities or
22
<PAGE>
low yields then available for reinvestment the entity specified in the related
Prospectus Supplement determines, based on assumptions specified in the
applicable Agreement, that the amount available for the payment of interest
that will have accrued on such Securities (the "Available Interest Amount")
through the designated interest accrual date specified in the related
Prospectus Supplement is less than the amount of interest that will have
accrued on such Securities to such date. In such event and as further
described in the related Prospectus Supplement, the Trustee will redeem a
principal amount of outstanding Securities of such Series as will cause the
Available Interest Amount to equal the amount of interest that will have
accrued through such designated interest accrual date for such Series of
Securities outstanding immediately after such redemption.
OPTIONAL REDEMPTION, PURCHASE OR TERMINATION
The Transferor or the Servicer may, at its option, redeem, in whole or in
part, one or more Classes of Notes or purchase one or more Classes of
Certificates of any Series, on any Distribution Date under the circumstances,
if any, specified in the Prospectus Supplement relating to such Series.
Alternatively, if so specified in the related Prospectus Supplement for a
Series of Securities, the Transferor, the Servicer, or another entity
designated in the related Prospectus Supplement may, at its option, cause an
early termination of a Trust Fund by repurchasing all of the Primary Assets
from such Trust Fund on or after a date specified in the related Prospectus
Supplement, or on or after such time as the aggregate outstanding principal
amount of the Securities or Primary Assets, as specified in the related
Prospectus Supplement, is less than the amount or percentage specified in the
related Prospectus Supplement. In addition, if so specified in the related
Prospectus Supplement upon certain events of insolvency or receivership of the
Transferor or another affiliated entity specified in the related Prospectus
Supplement the related Primary Assets of the Trust Fund will be liquidated and
the Trust Fund will be terminated, subject to the conditions set forth in the
related Prospectus Supplement. In each such event, the Securities of the
related Series will experience a prepayment. The redemption, purchase or
repurchase price will be set forth in the related Prospectus Supplement. If
specified in the related Prospectus Supplement, in the event that a REMIC
election has been made, the Trustee shall receive a satisfactory opinion of
counsel that the optional redemption, purchase or termination will be
conducted so as to constitute a "qualified liquidation" under Section 860F of
the Code.
In addition, the Prospectus Supplement may provide other circumstances under
which Holders of Securities of a Series could be fully paid significantly
earlier than would otherwise be the case if payments or distributions were
solely based on the activity of the related Primary Assets.
WEIGHTED AVERAGE LIFE OF THE SECURITIES
Weighted average life refers to the average amount of time that will elapse
from the date of issue of a security until each dollar of principal of such
security will be repaid to the investor. Unless otherwise specified in the
related Prospectus Supplement, the weighted average life of a Class of the
Securities will be influenced by the rate at which the amount financed under
the Loans (or related balances thereof) or Underlying Loans relating to the
Private Securities, as applicable, included in the Trust Fund for a Series is
paid, which may be in the form of scheduled amortization or prepayments.
Prepayments on loans and other receivables can be measured relative to a
prepayment standard or model. The Prospectus Supplement for a Series of
Securities will describe the prepayment standard or model, if any, used and
may contain tables setting forth the projected weighted average life of each
Class of Securities of such Series and the percentage of the original
principal amount of each Class of Securities of such Series that would be
outstanding on specified Distribution Dates for such Series based on the
assumptions stated in such Prospectus Supplement, including assumptions that
prepayments on the Loans or Underlying Loans relating to the Private
Securities, as applicable, included in the related Trust Fund are made at
rates corresponding to various percentages of the prepayment standard or model
specified in such Prospectus Supplement.
There is, however, no assurance that prepayment of the Loans or Underlying
Loans relating to the Private Securities, as applicable, included in the
related Trust Fund will conform to any level of any prepayment standard
23
<PAGE>
or model specified in the related Prospectus Supplement. The rate of principal
prepayments on pools of loans may be influenced by a variety of factors,
including job related factors such as transfers, layoffs or promotions and
personal factors such as divorce, disability or prolonged illness. Economic
conditions, either generally or within a particular geographic area or
industry, also may affect the rate of principal prepayments. Demographic and
social factors may influence the rate of principal prepayments in that some
borrowers have greater financial flexibility to move or refinance than do
other borrowers. The deductibility of mortgage interest payments, servicing
decisions and other factors also affect the rate of principal prepayments. As
a result, there can be no assurance as to the rate or timing of principal
prepayments of the Loans or Underlying Loans either from time to time or over
the lives of such Loans or Underlying Loans.
The rate of prepayments of conventional housing loans and other receivables
has fluctuated significantly in recent years. In general, however, if
prevailing interest rates fall significantly below the interest rates on the
Loans or Underlying Loans relating to the Private Securities, as applicable,
for a Series, such loans are likely to prepay at rates higher than if
prevailing interest rates remain at or above the interest rates borne by such
loans. In this regard, it should be noted that the Loans or Underlying Loans,
as applicable, for a Series may have different interest rates. In addition,
the weighted average life of the Securities may be affected by the varying
maturities of the Loans or Underlying Loans relating to the Private
Securities, as applicable. If any Loans or Underlying Loans relating to the
Private Securities, as applicable, for a Series have actual terms-to-stated
maturity of less than those assumed in calculating the Final Scheduled
Distribution Date of the related Securities, one or more Classes of the Series
may be fully paid prior to their respective Final Scheduled Distribution Date,
even in the absence of prepayments.
THE TRUST FUNDS
GENERAL
The Notes of each Series will be secured by the pledge of the assets of the
related Trust Fund, and the Certificates of each Series will represent
interests in the assets of the related Trust Fund. The Trust Fund of each
Series will include (i) the Primary Assets, (ii) amounts available from the
reinvestment of payments on such Primary Assets at the Assumed Reinvestment
Rate, if any, specified in the related Prospectus Supplement, (iii) any
Enhancement or the rights thereto, (iv) any Property that secured a Loan but
which is acquired by foreclosure or deed in lieu of foreclosure or
repossession and (v) the amount, if any, initially deposited in the Pre-
Funding Account, Capitalized Interest Account, Collection Account, Certificate
Account or Distribution Account for a Series as specified in the related
Prospectus Supplement.
The Securities will be non-recourse obligations of the related Trust Fund.
The assets of the Trust Fund specified in the related Prospectus Supplement
for a Series of Securities, unless otherwise specified in the related
Prospectus Supplement, will serve as collateral only for that Series of
Securities. Holders of a Series of Notes may only proceed against such
collateral securing such Series of Notes in the case of a default with respect
to such Series of Notes and may not proceed against any assets of the
Transferor or the related Trust Fund not pledged to secure such Notes.
The Primary Assets for a Series will be transferred by the Transferor to the
Trust Fund. Loans relating to a Series will be serviced by the Servicer
pursuant to a Pooling and Servicing Agreement, with respect to a Series
consisting of only Certificates or a Sale and Servicing Agreement (each, a
"Sale and Servicing Agreement") among the Transferor, the Trust Fund and the
Servicer, with respect to a Series that includes Notes.
As used herein, "Agreement" means, with respect to a Series of Certificates,
the Pooling and Servicing Agreement or Trust Agreement, and with respect to a
Series that includes Notes, the Indenture and the Sale and Servicing
Agreement, as the context requires.
If so specified in the related Prospectus Supplement, a Trust Fund relating
to a Series of Securities may be a business trust formed under the laws of the
state specified in the related Prospectus Supplement pursuant to a
24
<PAGE>
trust agreement (each, a "Trust Agreement") between the Transferor and the
Trustee of such Trust Fund specified in the related Prospectus Supplement.
With respect to each Trust Fund, prior to the initial offering of the
related Series of Securities, the Trust Fund will have no assets or
liabilities. No Trust Fund is expected to engage in any activities other than
acquiring, managing and holding the related Primary Assets and other assets
contemplated herein and in the related Prospectus Supplement and the proceeds
thereof, issuing Securities and making payments and distributions thereon and
certain related activities. No Trust Fund is expected to have any source of
capital other than its assets and any related Enhancement.
Primary Assets included in the Trust Fund for a Series may consist of any
combination of Loans and Private Securities, to the extent and as specified in
the related Prospectus Supplement.
THE LOANS
Mortgage Loans. The Primary Assets for a Series may consist, in whole or in
part, of closed-end and/or revolving credit line home equity loans or certain
balances thereof (the "Closed-End Loans" and "Revolving Credit Line Loans,"
respectively, and collectively, the "Mortgage Loans") secured by mortgages
primarily on Single Family Properties which may be subordinated to other
mortgages on the same Mortgaged Property. The Mortgage Loans may have fixed
interest rates or adjustable interest rates and may provide for other payment
characteristics as described below and in the related Prospectus Supplement.
As more fully described in the related Prospectus Supplement, interest on
each Revolving Credit Line Loan, is computed and payable monthly on the
average daily outstanding principal balance of such loan. Principal amounts on
the Revolving Credit Line Loans may be drawn down (up to a maximum amount as
set forth in the related Loan Agreement) or repaid under each Revolving Credit
Line Loan from time to time. If specified in the related Prospectus
Supplement, new draws by borrowers under the Revolving Credit Line Loans will
automatically become part of the Trust Fund for a Series. As a result, the
aggregate balance of the Revolving Credit Line Loans will fluctuate from day
to day as new draws by borrowers are added to the Trust Fund and principal
payments are applied to such balances and such amounts will usually differ
each day, as more specifically described in the related Prospectus Supplement.
Unless otherwise specified in the related Prospectus Supplement, a borrower
under a Revolving Credit Line Loan is obligated to pay only the amount of
interest and fees which accrue on the loan during the billing cycle and
principal of the Revolving Credit Line Loan is payable at maturity.
Unless otherwise described in the related Prospectus Supplement, the full
principal amount of a Closed-End Loan is advanced at origination of the loan
and generally is repayable in equal (or substantially equal) installments of
an amount sufficient to fully amortize such loan at its stated maturity. As
more fully described in the related Prospectus Supplement, interest on each
Closed-End Loan is calculated on the basis of the outstanding principal
balance of such loan multiplied by the Loan Rate thereon and further
multiplied by a fraction, the numerator of which is the number of days in the
period elapsed since the preceding payment of interest was made and the
denominator is the number of days in the annual period for which interest
accrues on such loan. Unless otherwise described in the related Prospectus
Supplement, the original terms to stated maturity of Closed-End Loans will not
exceed 360 months.
The Mortgaged Properties will include Single Family Property (i.e., one- to
four-family residential housing, including Condominium Units and Cooperative
Dwellings) and mixed-use property. Mixed-use properties will consist of
structures of no more than three stories, which include one to four
residential dwelling units and space used for retail, professional or other
commercial uses. Such uses, which will not involve more than 50% of the space
in the structure, may include doctor, dentist or law offices, real estate
agencies, boutiques, newsstands, convenience stores or other similar types of
uses intended to cater to individual customers as specified in the related
Prospectus Supplement. The properties may be located in suburban or
metropolitan districts. Any such non-residential use will be in compliance
with local zoning laws and regulations. The Mortgaged Properties may
25
<PAGE>
consist of detached individual dwellings, individual condominiums, townhouses,
duplexes, row houses, individual units in planned unit developments and other
attached dwelling units. Each Single Family Property will be located on land
owned in fee simple by the borrower or on land leased by the borrower for a
term at least ten years (unless otherwise provided in the related Prospectus
Supplement) greater than the term of the related Loan. Attached dwellings may
include owner-occupied structures where each borrower owns the land upon which
the unit is built, with the remaining adjacent land owned in common or
dwelling units subject to a proprietary lease or occupancy agreement in a
cooperatively owned apartment building.
Unless otherwise specified in the related Prospectus Supplement, Mortgages
on Cooperative Dwellings consist of a lien on the shares issued by such
Cooperative Dwelling and the proprietary lease or occupancy agreement relating
to such Cooperative Dwelling.
The aggregate principal balance of Revolving Credit Line Loans secured by
Mortgaged Properties that are owner-occupied will be disclosed in the related
Prospectus Supplement. Unless otherwise specified in the Prospectus
Supplement, the sole basis for a representation that a given percentage of the
Loans are secured by Single Family Property that is owner-occupied will be
either (i) the making of a representation by the Mortgagor at origination of
the Loan either that the underlying Mortgaged Property will be used by the
Mortgagor for a period of at least six months every year or that the Mortgagor
intends to use the Mortgaged Property as a primary residence, or (ii) a
finding that the address of the underlying Mortgaged Property is the
Mortgagor's mailing address as reflected in the Servicer's records. To the
extent specified in the related Prospectus Supplement, the Mortgaged
Properties may include non-owner occupied investment properties and vacation
and second homes.
Unless otherwise specified in the related Prospectus Supplement, the initial
Combined Loan-to-Value Ratio of a Revolving Credit Line Loan is computed in
the manner described in the related Prospectus Supplement, taking into account
the amounts of any related senior mortgage loans.
Home Improvement Contracts. The Primary Assets for a Series may consist, in
whole or part, of home improvement installment sales contracts and installment
loan agreements (the "Home Improvement Contracts") originated by a home
improvement contractor in the ordinary course of business. As specified in the
related Prospectus Supplement, the Home Improvement Contracts will either be
unsecured or secured by the Mortgages primarily on Single Family Properties
which are generally subordinate to other mortgages on the same Mortgaged
Property or by purchase money security interests in the Home Improvements
financed thereby. Unless otherwise specified in the applicable Prospectus
Supplement, the Home Improvement Contracts will be fully amortizing and may
have fixed interest rates or adjustable interest rates and may provide for
other payment characteristics as described below and in the related Prospectus
Supplement
Unless otherwise specified in the related Prospectus Supplement, the home
improvements (the "Home Improvements") securing the Home Improvement Contracts
include, but are not limited to, replacement windows, house siding, new roofs,
swimming pools, satellite dishes, kitchen and bathroom remodeling goods and
solar heating panels. The initial Loan-to-Value Ratio of a Home Improvement
Contract will be computed in the manner described in the related Prospectus
Supplement.
Additional Information. The selection criteria which will apply with respect
to the Loans will be specified in the related Prospectus Supplement. Such
criteria may include one or more of the following: the Combined Loan-to-Value
Ratios or Loan-to-Value Ratios, as applicable, original terms to maturity and
delinquency information, the geographical distribution of Loans and the Loan
Rates for such Loans.
The Loans for a Series may include Loans that do not amortize their entire
principal balance by their stated maturity in accordance with their terms and
require a balloon payment of the remaining principal balance at maturity, as
specified in the related Prospectus Supplement. As further described in the
related Prospectus Supplement, the Loans for a Series may include Loans that
do not have a specified stated maturity.
26
<PAGE>
The Loans will be conventional contracts or contracts insured by the Federal
Housing Administration ("FHA") or partially guaranteed by the Veterans
Administration ("VA"). Loans designated in the related Prospectus Supplement
as insured by the FHA will be insured by the FHA as authorized under the
United States Housing Act of 1937, as amended. Such Loans will be insured
under various FHA programs. These programs generally limit the principal
amount and interest rates of the mortgage loans insured. Loans insured by the
FHA generally require a minimum down payment of approximately 5% of the
original principal amount of the loan. No FHA-insured Loans relating to a
Series may have an interest rate or original principal amount exceeding the
applicable FHA limits at the time of origination of such Loan.
The insurance premiums for Loans insured by the FHA are collected by lenders
approved by the Department of Housing and Urban Development ("HUD") and are
paid to the FHA. The regulations governing FHA single-family mortgage
insurance programs provide that insurance benefits are payable either upon
foreclosure (or other acquisition of possession) and conveyance of the
mortgaged premises to HUD or upon assignment of the defaulted Loan to HUD.
With respect to a defaulted FHA-insured Loan, the Servicer is limited in its
ability to initiate foreclosure proceedings. When it is determined, either by
the Servicer or HUD, that default was caused by circumstances beyond the
mortgagor's control, the Servicer is expected to make an effort to avoid
foreclosure by entering, if feasible, into one of a number of available forms
of forbearance plans with the mortgagor. Such plans may involve the reduction
or suspension of regular mortgage payments for a specified period, with such
payments to be made upon or before the maturity date of the mortgage, or the
recasting of payments due under the mortgage up to or beyond the maturity
date. In addition, when a default caused by such circumstances is accompanied
by certain other criteria, HUD may provide relief by making payments to the
Servicer in partial or full satisfaction of amounts due under the Loan (which
payments are to be repaid by the mortgagor to HUD) or by accepting assignment
of the loan from the Servicer. With certain exceptions, at least three full
monthly installments must be due and unpaid under the Loan and HUD must have
rejected any request for relief from the mortgagor before the Servicer may
initiate foreclosure proceedings.
HUD has the option, in most cases, to pay insurance claims in cash or in
debentures issued by HUD. Currently, claims are being paid in cash, and claims
have not been paid in debentures since 1965. HUD debentures issued in
satisfaction of FHA insurance claims bear interest at the applicable HUD
debenture interest rate. The Servicer of each FHA-insured Loan will be
obligated to purchase any such debenture issued in satisfaction of such Loan
upon default for an amount equal to the principal amount of any such
debenture.
The amount of insurance benefits generally paid by the FHA is equal to the
entire unpaid principal amount of the defaulted Loan adjusted to reimburse the
Servicer for certain costs and expenses and to deduct certain amounts received
or retained by the Servicer after default. When entitlement to insurance
benefits results from foreclosure (or other acquisition of possession) and
conveyance to HUD, the Servicer is compensated for no more than two-thirds of
its foreclosure costs, and is compensated for interest accrued and unpaid
prior to such date but in general only to the extent it was allowed pursuant
to a forbearance plan approved by HUD. When entitlement to insurance benefits
results from assignment of the Loan to HUD, the insurance payment includes
full compensation for interest accrued and unpaid to the assignment date. The
insurance payment itself, upon foreclosure of an FHA-insured Loan, bears
interest from a date 30 days after the mortgagor's first uncorrected failure
to perform any obligation to make any payment due under the Loan and, upon
assignment, from the date of assignment to the date of payment of the claim,
in each case at the same interest rate as the applicable HUD debenture
interest rate as described above.
Loans designated in the related Prospectus Supplement as guaranteed by the
VA will be partially guaranteed by the VA under the Serviceman's Readjustment
Act of 1944, as amended (a "VA Guaranty"). The Serviceman's Readjustment Act
of 1944, as amended, permits a veteran (or in certain instances the spouse of
a veteran) to obtain a mortgage loan guaranty by the VA covering mortgage
financing of the purchase of a one- to four-family dwelling unit at interest
rates permitted by the VA. The program has no mortgage loan limits, requires
no down payment from the purchaser and permits the guarantee of mortgage loans
of up to 30 years' duration.
27
<PAGE>
The maximum guaranty that may be issued by the VA under a VA guaranteed
mortgage loan depends upon the original principal amount of the mortgage loan,
as further described in 38 United States Code Section 1803(a), as amended. The
liability on the guaranty is reduced or increased pro rata with any reduction
or increase in the amount of indebtedness, but in no event will the amount
payable on the guaranty exceed the amount of the original guaranty. The VA
may, at its option and without regard to the guaranty, make full payment to a
mortgage holder of unsatisfied indebtedness on a mortgage upon its assignment
to the VA.
With respect to a defaulted VA guaranteed Loan, the Servicer is, absent
exceptional circumstances, authorized to announce its intention to foreclose
only when the default has continued for three months. Generally, a claim for
the guaranty is submitted after liquidation of the Mortgaged Property.
The amount payable under the guaranty will be the percentage of the VA-
insured Loan originally guaranteed applied to indebtedness outstanding as of
the applicable date of computation specified in the VA regulations. Payments
under the guaranty will be equal to the unpaid principal amount of the loan,
interest accrued on the unpaid balance of the loan to the appropriate date of
computation and limited expenses of the mortgagee, but in each case only to
the extent that such amounts have not been recovered through liquidation of
the Mortgaged Property. The amount payable under the guaranty may in no event
exceed the amount of the original guaranty.
The related Prospectus Supplement for each Series will provide information
with respect to the Loans that are Primary Assets as of the Cut-off Date,
including, among other things, and to the extent relevant: (a) the aggregate
unpaid principal balance of the Loans (or the aggregate unpaid principal
balance included in the Trust Fund for the related Series); (b) the range and
weighted average Loan Rate on the Loans, and, in the case of adjustable rate
Loans, the range and weighted average of the current Loan Rates and the
Lifetime Rate Caps, if any; (c) the range and average outstanding principal
balance of the Loans; (d) the weighted average original and remaining term-to-
stated maturity of the Loans and the range of original and remaining terms-to-
stated maturity, if applicable; (e) the range and weighted average of Combined
Loan-to-Value Ratios or Loan-to-Value Ratios for the Revolving Credit Line
Loans, as applicable; (f) the percentage (by outstanding principal balance as
of the Cut-off Date) of Loans that accrue interest at adjustable or fixed
interest rates; (g) any special hazard insurance policy or bankruptcy bond or
other enhancement relating to the Loans; (h) the percentage (by principal
balance as of the Cut-off Date) of Loans that are secured by Mortgaged
Properties, Home Improvements or are unsecured; (i) the geographic
distribution of any Mortgaged Properties securing the Loans; (j) the
percentage of Revolving Credit Line Loans (by principal balance as of the Cut-
off Date) that are secured by Single Family Properties, shares relating to
Cooperative Dwellings, Condominium Units, investment property and vacation or
second homes; (k) the lien priority of the Loans; (l) the credit limit
utilization rate of any Revolving Credit Line Loans; and (m) the delinquency
status and year of origination of the Loans. The related Prospectus Supplement
will also specify any other limitations on the types or characteristics of
Loans for a Series.
If information of the nature described above respecting the Loans is not
known to the Transferor at the time the Securities are initially offered,
approximate or more general information of the nature described above will be
provided in the Prospectus Supplement and additional information will be set
forth in a Current Report on Form 8-K to be available to investors on the date
of issuance of the related Series and to be filed with the Commission within
15 days after the initial issuance of such Securities.
PRIVATE SECURITIES
General. Primary Assets for a Series may consist, in whole or in part, of
Private Securities which include pass-through certificates representing
beneficial interests in loans of the type that would otherwise be eligible to
be Loans (the "Underlying Loans") or (b) collateralized obligations secured by
Underlying Loans. Such pass-through certificates or collateralized obligations
will have previously been (a) offered and distributed to the public pursuant
to an effective registration statement or (b) purchased in a transaction not
involving any public offering from a person who is not an affiliate of the
issuer of such securities at the time of sale (nor an affiliate thereof at any
time during the three preceding months); provided a period of three years
elapsed since the later of the date the securities were acquired from the
issuer or an affiliate thereof. Although individual Underlying
28
<PAGE>
Loans may be insured or guaranteed by the United States or an agency or
instrumentality thereof, they need not be, and Private Securities themselves
will not be so insured or guaranteed.
Private Securities will have been issued pursuant to a pooling and servicing
agreement, a trust agreement or similar agreement (a "PS Agreement"). The
seller/servicer of the Underlying Loans will have entered into the PS
Agreement with the trustee under such PS Agreement (the "PS Trustee"). The PS
Trustee or its agent, or a custodian, will possess the Underlying Loans.
Underlying Loans will be serviced by a servicer (the "PS Servicer") directly
or by one or more sub-servicers who may be subject to the supervision of the
PS Servicer.
The sponsor of the Private Securities (the "PS Sponsor") will be a financial
institution or other entity engaged generally in the business of lending; a
public agency or instrumentality of a state, local or federal government; or a
limited purpose corporation organized for the purpose of, among other things,
establishing trusts and acquiring and selling loans to such trusts, and
selling beneficial interests in such trusts. If so specified in the Prospectus
Supplement, the PS Sponsor may be an affiliate of the Transferor. The
obligations of the PS Sponsor will generally be limited to certain
representations and warranties with respect to the assets conveyed by it to
the related trust. Unless otherwise specified in the related Prospectus
Supplement, the PS Sponsor will not have guaranteed any of the assets conveyed
to the related trust or any of the Private Securities issued under the PS
Agreement. Additionally, although the Underlying Loans may be guaranteed by an
agency or instrumentality of the United States, the Private Securities
themselves will not be so guaranteed.
Distributions of principal and interest will be made on the Private
Securities on the dates specified in the related Prospectus Supplement. The
Private Securities may be entitled to receive nominal or no principal
distributions or nominal or no interest distributions. Principal and interest
distributions will be made on the Private Securities by the PS Trustee or the
PS Servicer. The PS Sponsor or the PS Servicer may have the right to
repurchase the Underlying Loans after a certain date or under other
circumstances specified in the related Prospectus Supplement.
The Underlying Loans may be fixed rate, level payment, fully amortizing
loans or adjustable rate loans or loans having balloon or other irregular
payment features. Such Underlying Loans will be secured by mortgages on
Mortgaged Properties.
Credit Support Relating to Private Securities. Credit support in the form of
Reserve Funds, subordination of other private securities issued under the PS
Agreement, guarantees, letters of credit, cash collateral accounts, insurance
policies or other types of credit support may be provided with respect to the
Underlying Loans or with respect to the Private Securities themselves. The
type, characteristics and amount of credit support will be a function of
certain characteristics of the Underlying Loans and other factors and will
have been established for the Private Securities on the basis of requirements
of the nationally recognized statistical rating organization that rated the
Private Securities.
Additional Information. The Prospectus Supplement for a Series for which the
Primary Assets include Private Securities will specify (such disclosure may be
on an approximate basis and will be as of the date specified in the related
Prospectus Supplement), to the extent relevant and to the extent such
information is reasonably available to the Transferor and the Transferor
reasonably believes such information to be reliable: (i) the aggregate
approximate principal amount and type of the Private Securities to be included
in the Trust Fund for such Series; (ii) certain characteristics of the
Underlying Loans including (A) the payment features of such Underlying Loans
(i.e., whether they are fixed rate or adjustable rate and whether they provide
for fixed level payments or other payment features), (B) the approximate
aggregate principal balance, if known, of such Underlying Loans insured or
guaranteed by a governmental entity, (C) the servicing fee or range of
servicing fees with respect to the Underlying Loans, (D) the minimum and
maximum stated maturities of such Underlying Loans at origination, (E) the
lien priority and the credit utilization rates, if any, of such Underlying
Loans, and (F) the delinquency status and year of origination of such
Underlying Loans; (iii) the maximum original term-to-stated maturity of the
Private Securities; (iv) the weighted average term-to-stated maturity of the
Private Securities; (v) the pass-through or certificate rate or ranges thereof
for the Private Securities; (vi) the PS Sponsor,
29
<PAGE>
the PS Servicer (if other than the PS Sponsor) and the PS Trustee for such
Private Securities; (vii) certain characteristics of credit support if any,
such as Reserve Funds, insurance policies, letters of credit or guarantees
relating to such Loans underlying the Private Securities or to such Private
Securities themselves; (viii) the terms on which Underlying Loans may, or are
required to, be purchased prior to their stated maturity or the stated
maturity of the Private Securities; and (ix) the terms on which Underlying
Loans may be substituted for those originally underlying the Private
Securities.
If information of the nature described above representing the Private
Securities is not known to the Transferor at the time the Securities are
initially offered, approximate or more general information of the nature
described above will be provided in the Prospectus Supplement and the
additional information, if available, will be set forth in a Current Report on
Form 8-K to be available to investors on the date of issuance of the related
Series and to be filed with the Commission within 15 days of the initial
issuance of such Securities.
ACCOUNTS
A separate Collection Account or Certificate Account will be established for
each Series of Securities for receipt of the amount of cash, if any, specified
in the related Prospectus Supplement to be initially deposited therein by the
Transferor and/or the Servicer, all amounts received on or with respect to the
Primary Assets and, unless otherwise specified in the related Prospectus
Supplement, income earned thereon. Certain amounts on deposit in such
Collection Account and certain amounts available pursuant to any Enhancement,
as provided in the related Prospectus Supplement, may be deposited in one or
more Distribution Accounts. Unless otherwise specified in the related
Prospectus Supplement, the Trustee will invest the funds in the Collection,
Certificate and Distribution Accounts in Eligible Investments maturing, with
certain exceptions, not later, in the case of funds in the Collection Account,
than the day preceding the date such funds are due to be deposited in the
Distribution Account or otherwise distributed and, in the case of funds in the
Distribution Account and the Certificate Account, than the day preceding the
next Distribution Date for the related Series of Securities. "Eligible
Investments" include, among other investments, obligations of the United
States and certain agencies thereof, federal funds, certificates of deposit,
commercial paper, demand and time deposits and banker's acceptances, certain
repurchase agreements of United States government securities and certain
guaranteed investment contracts, in each case, acceptable to the Rating
Agency.
If specified in the related Prospectus Supplement, a Trust Fund will include
one or more segregated trust accounts (each, a "Pre-Funding Account")
established and maintained with the Trustee for the related Series. If so
specified, on the closing date for such Series, a portion of the proceeds of
the sale of the Securities of such Series (such amount, the "Pre-Funded
Amount") may be deposited in the Pre-Funding Account and may be used to
purchase additional Primary Assets during the period of time specified in the
related Prospectus Supplement (the "Pre-Funding Period"). If any Pre-Funded
Amount remains on deposit in the Pre-Funding Account at the end of the Pre-
Funding Period, such amount will be applied in the manner specified in the
related Prospectus Supplement to prepay the Notes and/or the Certificates of
the applicable Series.
Each additional Primary Asset must satisfy the eligibility criteria
specified in the related Prospectus Supplement and related Agreements. Such
eligibility criteria will be determined in consultation with each Rating
Agency (and/or any Enhancer) prior to the issuance of the related Series and
are designed to ensure that if such additional Primary Assets were included as
part of the initial Primary Assets, the credit quality of such assets would be
consistent with the initial rating of the Securities of such Series. The
Transferor will certify to the Trustee that all conditions precedent to the
transfer of the additional Primary Assets, including the satisfaction of the
eligibility criteria to the Trust Fund, have been satisfied. It is a condition
to the transfer of any additional Primary Assets to the Trust Fund that each
Rating Agency, after receiving prior notice of the proposed transfer of the
additional Primary Assets to the Trust Fund, shall not have advised the
Transferor or the Trustee or any Enhancer that the conveyance of such
additional Primary Assets will result in a qualification, modification or
withdrawal of its then current rating of any Class of Notes or Certificates of
such Series. Following the transfer of additional Primary Assets to the Trust
Fund, the aggregate characteristics of the Primary Assets then held in the
Trust Fund may vary from those of the initial Primary Assets of such Trust
Fund. As a result, the additional Primary Assets may adversely affect the
performance of the related Securities.
30
<PAGE>
If a Pre-Funding Account is established, one or more segregated trust
accounts (each, a "Capitalized Interest Account") may be established and
maintained with the Trustee for the related Series. On the closing date for
such Series, a portion of the proceeds of the sale of the Securities of such
Series will be deposited in the Capitalized Interest Account and used to fund
the excess, if any, of the sum of (i) the amount of interest accrued on the
Securities of such Series and (ii) if specified in the related Prospectus
Supplement, certain fees or expenses during the Pre-Funding Period, over the
amount of interest available therefor from the Primary Assets in the Trust
Fund. If so specified in the related Prospectus Supplement, amounts on deposit
in the Capitalized Interest Account may be released to the Transferor prior to
the end of the Pre-Funding Period subject to the satisfaction of certain tests
specified in the related Prospectus Supplement. Any amounts on deposit in the
Capitalized Interest Account at the end of the Pre-Funding Period that are not
necessary for such purposes will be distributed to the person specified in the
related Prospectus Supplement.
ENHANCEMENT
The amounts and types of enhancement arrangements and the provider thereof,
if applicable, with respect to a Series or any Class of Securities will be set
forth in the related Prospectus Supplement. If and to the extent provided in
the related Prospectus Supplement, enhancement may be in the form of a
financial guaranty insurance policy, overcollateralization, a letter of
credit, cash reserve fund, insurance policies, one or more Classes of
Subordinated Securities, derivative products, or other form of enhancement, or
any combination thereof, as may be described in the related Prospectus
Supplement (collectively, "Enhancement"). If specified in the applicable
Prospectus Supplement, Enhancement for any Series of Securities may cover one
or more Classes of Notes or Certificates, and accordingly may be exhausted for
the benefit of a particular Class of Notes or Certificates and thereafter be
unavailable to such other Classes of Notes or Certificates. Further
information regarding any provider of credit enhancement, including financial
information when material, will be included in the related Prospectus
Supplement.
The presence of Enhancement is intended to increase the likelihood of
receipt by the Certificateholders and the Noteholders of the full amount of
principal and interest due thereon and to decrease the likelihood that the
Certificateholders and the Noteholders will experience losses, or may be
structured to provide protection against changes in interest rates or against
other risks, to the extent and under the conditions specified in the related
Prospectus Supplement. Unless otherwise specified in the related Prospectus
Supplement, the Enhancement for a Class of Securities will not provide
protection against all risks of loss and will not guarantee repayment of the
entire principal and interest thereon. If losses occur which exceed the amount
covered by any Enhancement or which are not covered by any Enhancement,
Securityholders will bear their allocable share of deficiencies. In addition,
if a form of Enhancement covers more than one Class of Securities of a Series,
Securityholders of any such Class will be subject to the risk that such
Enhancement will be exhausted by the claims of Securityholders of other
Classes.
SERVICING OF LOANS
GENERAL
Customary servicing functions with respect to Loans comprising the Primary
Assets in the Trust Fund will be provided by the Servicer directly pursuant to
the related Sale and Servicing Agreement or Pooling and Servicing Agreement,
as the case may be, with respect to a Series of Securities.
COLLECTION PROCEDURES; ESCROW ACCOUNTS
The Servicer will make reasonable efforts to collect all payments required
to be made under the Loans and will, consistent with the terms of the related
Agreement for a Series and any applicable Enhancement, follow such collection
procedures as it follows with respect to comparable loans held in its own
portfolio. Consistent
31
<PAGE>
with the above, the Servicer may, in its discretion, (i) waive any assumption
fee, late payment charge, or other charge in connection with a Loan and (ii)
to the extent provided in the related Agreement, arrange with an obligor a
schedule for the liquidation of delinquencies by extending the Due Dates for
Scheduled Payments on such Loan.
If specified in the related Prospectus Supplement, the Servicer, to the
extent permitted by law, will establish and maintain escrow or impound
accounts ("Escrow Accounts") with respect to Loans in which payments by
obligors with respect to taxes, assessments, mortgage and hazard insurance
premiums, and other comparable items will be deposited. Loans may not require
such payments under the loan related documents, in which case the Servicer
would not be required to establish any Escrow Account with respect to such
Loans. Withdrawals from the Escrow Accounts are to be made to effect timely
payment of taxes, assessments and mortgage and hazard insurance, to refund to
obligors amounts determined to be overages, to pay interest to obligors on
balances in the Escrow Account to the extent required by law, to repair or
otherwise protect the property securing the related Loan and to clear and
terminate such Escrow Account. The Servicer will be responsible for the
administration of the Escrow Accounts and generally will make advances to such
accounts when a deficiency exists therein.
DEPOSITS TO AND WITHDRAWALS FROM THE COLLECTION ACCOUNT OR THE CERTIFICATE
ACCOUNT
Unless otherwise specified in the related Prospectus Supplement, the Trustee
or the Servicer will establish a separate account (the "Collection Account" or
the "Certificate Account") in the name of the Trustee. The Collection Account
and/or Certificate Account will be an account maintained (i) at a depository
institution, the long-term unsecured debt obligations of which at the time of
any deposit therein are rated by each Rating Agency rating the Securities of
such Series at levels satisfactory to each such Rating Agency or (ii) in an
account or accounts the deposits in which are insured to the maximum extent
available by the Federal Deposit Insurance Corporation (the "FDIC") or which
are secured in a manner meeting requirements established by each Rating
Agency.
Unless otherwise specified in the related Prospectus Supplement, the funds
held in the Collection Account or the Certificate Account may be invested,
pending remittance to the Trustee, in Eligible Investments. If so specified in
the related Prospectus Supplement, the Servicer will be entitled to receive as
additional compensation any interest or other income earned on funds in the
Collection Account or Certificate Account.
Unless otherwise specified in the related Prospectus Supplement, the
Servicer, the Transferor or the Trustee will deposit into the Collection
Account or the Certificate Account for each Series on the Business Day
following the Closing Date any amounts representing payments received on or
after the related Cut-off Date and received by the Servicer on or before the
Closing Date, and thereafter, within the period specified in the related
Prospectus Supplement, the following payments and collections received or made
by it (other than, unless otherwise provided in the related Prospectus
Supplement, in respect of principal of and interest on the related Primary
Assets due or, in the case of simple interest Loans, received, on or before
such Cut-off Date):
(i) all payments on account of principal, including prepayments, on such
Primary Assets;
(ii) all payments on account of interest on such Primary Assets after
deducting therefrom, at the discretion of the Servicer but only to the
extent of the amount permitted to be withdrawn or withheld from the
Collection Account or the Certificate Account in accordance with the
related Agreement, the Servicing Fee in respect of such Primary Assets;
(iii) all amounts received by the Servicer in connection with the
liquidation of Primary Assets or property acquired in respect thereof,
whether through foreclosure sale, repossession or otherwise, including
payments in connection with such Primary Assets received from the obligor,
other than amounts required to be paid or refunded to the obligor pursuant
to the terms of the applicable loan documents or otherwise pursuant to law
("Liquidation Proceeds"), exclusive of, in the discretion of the Servicer,
but only to the extent of the amount permitted to be withdrawn from the
Collection Account or the Certificate Account in
32
<PAGE>
accordance with the related Agreement, the Servicing Fee, if any, in
respect of the related Primary Asset and, to the extent specified in the
related Prospectus Supplement, net of reimbursements for Servicer Advances;
(iv) all proceeds under any title insurance, hazard insurance or other
insurance policy covering any such Primary Asset, other than proceeds to be
applied to the restoration or repair of the related Property or released to
the obligor in accordance with the related Agreement;
(v) all amounts required to be deposited therein from any applicable
Reserve Fund for such Series pursuant to the related Agreement;
(vi) all Delinquency Advances made by the Servicer required pursuant to
the related Agreement; and
(vii) all repurchase prices of any such Primary Assets repurchased by the
Servicer or the Transferor pursuant to the related Agreement.
If specified in the related Prospectus Supplement, each balance of a
Revolving Credit Line Loan may be conveyed to a separate Trust Fund and
payments and proceeds of such Revolving Credit Line Loan will be allocated
among such Trust Funds as specified in the related Prospectus Supplement.
Unless otherwise specified in the related Prospectus Supplement, the
Servicer is permitted, from time to time, to make withdrawals from the
Collection Account or the Certificate Account for each Series for the
following purposes:
(i) to reimburse itself for Servicer Advances and Delinquency Advances
for such Series made by it pursuant to the related Agreement; the
Servicer's right to reimburse itself for Delinquency Advances is limited to
amounts received on or in respect of particular Loans (including, for this
purpose, Liquidation Proceeds and amounts representing proceeds of
insurance policies covering the related Property) which represent late
recoveries of Scheduled Payments respecting which any such Delinquency
Advance was made;
(ii) to the extent provided in the related Agreement, to reimburse itself
for any Delinquency Advances for such Series that the Servicer determines
in good faith it will be unable to recover from amounts representing late
recoveries of Scheduled Payments respecting which such Delinquency Advance
was made or from Liquidation Proceeds or the proceeds of insurance
policies;
(iii) to reimburse itself for Servicer Advances to the extent provided in
the related Prospectus Supplement;
(iv) in the event it has elected not to pay itself the Servicing Fee out
of the interest component of any Scheduled Payment, late payment or other
recovery with respect to a particular Loan prior to the deposit of such
Scheduled Payment, late payment or recovery into the Collection Account or
the Certificate Account, to pay to itself the Servicing Fee, as adjusted
pursuant to the related Agreement, from any such Scheduled Payment, late
payment or such other recovery, to the extent permitted by the related
Agreement;
(v) to reimburse itself for expenses incurred by and recoverable by or
reimbursable to it pursuant to the related Agreement;
(vi) to pay to the applicable person with respect to each Primary Asset
or REO Property acquired in respect thereof that has been repurchased or
removed from the Trust Fund by the Transferor or the Servicer pursuant to
the related Agreement, all amounts received thereon and not distributed as
of the date on which the related repurchase price was determined;
(vii) to make payments to the Trustee of such Series for deposit into the
Distribution Account, if any, or for remittance to the Holders of such
Series in the amounts and in the manner provided for in the related
Agreement; and
(viii) to clear and terminate the Collection Account or the Certificate
Account pursuant to the related Agreement.
33
<PAGE>
In addition, if the Servicer deposits in the Collection Account or the
Certificate Account for a Series any amount not required to be deposited
therein, it may, at any time, withdraw such amount from such Collection
Account or the Certificate Account.
ADVANCES AND LIMITATIONS THEREON
The related Prospectus Supplement will describe the circumstances, if any,
under which the Servicer will make advances with respect to delinquent
payments of principal and/or interest on Loans ("Delinquency Advances"). If
specified in the related Prospectus Supplement, the Servicer will be obligated
to make Delinquency Advances, and such obligation may be limited in amount, or
may not be activated until a certain portion of a specified Reserve Fund is
depleted. Such advances are intended to provide liquidity and, except to the
extent specified in the related Prospectus Supplement, not to guarantee or
insure against losses. Accordingly, to the extent specified in the related
Prospectus Supplement, any funds advanced are recoverable by the Servicer out
of amounts received on particular Loans which represent late recoveries of
principal or interest, proceeds of insurance policies or Liquidation Proceeds
respecting which any such Delinquency Advance was made or, to the extent
provided in the Prospectus Supplement, from payments or proceeds from other
Loans. If and to the extent specified in the related Prospectus Supplement,
the Servicer shall be entitled to advance its own funds to pay for any related
expenses of foreclosure and disposition of any liquidated Mortgage Loan or
related Property (the "Servicer Advances"). The Servicer shall be entitled to
be reimbursed for any such Servicer Advances to the extent provided in the
Prospectus Supplement. If a Servicer Advance is made and subsequently
determined to be nonrecoverable from late collections, proceeds of insurance
policies, or Liquidation Proceeds from the related Loan, the Servicer may be
entitled to reimbursement from other funds in the Collection Account,
Certificate Account or Distribution Account, as the case may be, or from a
specified Reserve Fund as applicable, to the extent specified in the related
Prospectus Supplement.
MAINTENANCE OF INSURANCE POLICIES AND OTHER SERVICING PROCEDURES
Standard Hazard Insurance; Flood Insurance. Except as otherwise specified in
the related Prospectus Supplement, the Servicer will be required to maintain
or to cause the obligor on each Real Estate Loan to maintain a hazard
insurance policy naming the Servicer as loss payee thereunder. Hazard
insurance policies for Real Estate Loans must include extended coverage in an
amount equal to the lesser of (a) the maximum insurable value of the
improvements securing such Real Estate Loan and (b) either (i) the principal
balance of the Real Estate Loan if it is a Home Improvement Contract or a
closed-end Mortgage Loan or (ii) the combined principal balance of the Real
Estate Loan and any mortgage loan senior to the Real Estate Loan if such Real
Estate Loan is a Revolving Credit Line Loan. The ability of the Servicer to
assure that hazard insurance proceeds are appropriately applied may depend on
its being named as an additional insured under any hazard insurance policy and
under any flood insurance policy referred to below, or upon the extent to
which information in this regard is furnished to the Servicer by a borrower.
Except as described below, all amounts collected by the Servicer under any
hazard policy (except for amounts applied or expected to be applied to the
restoration or repair of the Property or released to the borrower in
accordance with the Servicer's normal servicing procedures), will be deposited
in the Collection Account or the Certificate Account. If so specified in the
related Prospectus Supplement, the portion of such proceeds allocable to
Securityholders of a Series may be limited to the extent specified in the
related Prospectus Supplement in the event that more than one Trust Fund has
an interest in the balances of a Revolving Credit Line Loan. The Agreement
provides that the Servicer may satisfy its obligation to cause hazard policies
to be maintained by maintaining a blanket policy issued by an insurer
acceptable to the Rating Agencies insuring against hazard losses to the
collateral securing the Real Estate Loans. If such blanket policy contains a
deductible clause, the Servicer will deposit into the Collection Account the
amount not otherwise payable under the blanket policy because of such
deductible clause. If so specified in the related Prospectus Supplement, the
amount so required to be deposited by the Servicer with respect to a
particular Series may be limited to the extent specified in the related
Prospectus Supplement in the event that more than one Trust Fund has an
interest in the balances of a Mortgage Loan.
34
<PAGE>
In general, the standard form of fire and extended coverage insurance policy
covers physical damage to or destruction of the improvements on the property
by fire, lightning, explosion, smoke, windstorm and hail, and riot, strike and
civil commotion, subject to the conditions and exclusions specified in each
policy. Although the policies relating to the Mortgage Loans will be
underwritten by different insurers under different state laws in accordance
with different applicable state forms and therefore will not contain identical
terms and conditions, the basic terms thereof are dictated by respective state
laws, and most such policies typically do not cover any physical damage
resulting from any of the following: war, revolution, governmental actions,
floods and other water-related causes, earth movement (including earthquakes,
landslides and mudflows), nuclear reactions, wet or dry rot, vermin, rodents,
insects or domestic animals, theft and, in certain cases, vandalism. The
foregoing list is merely indicative of certain kinds of uninsured risks and is
not intended to be all-inclusive. When a Mortgaged Property is located in a
federally designated special flood hazard area at the time of origination of
the related Real Estate Loan, the Agreement requires the Servicer to cause to
be maintained, for each such Real Estate Loan, flood insurance (to the extent
available) in an amount equal in general to the lesser of (a) the maximum
insurance available under the federal flood insurance program and (b) either
(i) the principal balance of the Real Estate Loan if it is a Home Improvement
Contract or a closed-end Mortgage Loan or (ii) the combined principal balance
of the Real Estate Loan and any mortgage loan senior to the Real Estate Loan
if such Real Estate Loan is a Revolving Credit Line Loan.
The hazard insurance policies covering the Mortgaged Properties typically
contain a co-insurance clause that in effect requires the insured at all times
to carry insurance of a specified percentage (generally 80% to 90%) of the
full replacement value of the improvements on the property in order to recover
the full amount of any partial loss. If the insured's coverage falls below
this specified percentage, such clause generally provides that the insurer's
liability in the event of partial loss does not exceed the greater of (i) the
replacement cost of the improvements less physical depreciation or (ii) such
proportion of the loss as the amount of insurance carried bears to the
specified percentage of the full replacement cost of such improvements.
Unless otherwise specified in the related Prospectus Supplement, the
Servicer will also maintain on REO Property that secured a defaulted Real
Estate Loan and that has been acquired upon foreclosure, deed in lieu of
foreclosure, or repossession, a standard hazard insurance policy in an amount
that is equal to the maximum insurable value of such REO Property. No
earthquake or other additional insurance will be required of any obligor or
will be maintained on REO Property acquired in respect of a defaulted Real
Estate Loan, other than pursuant to such applicable laws and regulations as
shall at any time be in force and shall require such additional insurance.
If the amount of hazard insurance maintained on the Mortgaged Properties
were to decline as the principal balances owing thereon decreased, hazard
insurance proceeds could be insufficient to restore fully the damaged property
in the event of a partial loss.
Under the terms of the Real Estate Loans, the borrowers generally are
required to present claims to insurers under hazard insurance policies
maintained on the Mortgaged Properties. The Servicer, on behalf of the Trustee
and Securityholders, is obligated to present claims under any blanket
insurance policy insuring against hazard losses on the Mortgaged Properties.
However, the ability of the Servicer to present such claims depends upon the
extent to which information in this regard is furnished to the Servicer by the
borrowers.
REALIZATION UPON DEFAULTED LOANS
Unless otherwise specified in the related Prospectus Supplement the Servicer
has the discretion to foreclose upon, repossess or otherwise comparably
convert the ownership of the Properties securing the related Loans as come
into and continue in default and as to which no satisfactory arrangements can
be made for collection of delinquent payments in the same manner it forecloses
upon, repossesses or otherwise converts the ownership of properties securing
loans in the applicable portfolio of Loans; provided that if the Servicer has
actual knowledge or reasonably believes that any Mortgaged Property is
contaminated by hazardous or toxic wastes or substances, then the Servicer
will not cause a Trust to acquire title to such Mortgaged Property in a
foreclosure or similar proceeding if such acquisition in the reasonable
opinion of the Servier is not commercially reasonable. In connection with such
foreclosure or other conversion, the Servicer will follow such practices and
procedures as it deems necessary or advisable and as are normal and usual in
its servicing activities with respect to comparable
35
<PAGE>
loans serviced by it. However, the Servicer will not be required to expend its
own funds in connection with any foreclosure or towards the restoration of the
Property unless it determines that (i) such restoration or foreclosure will
increase the Liquidation Proceeds in respect of the related Loan available to
the Holders after reimbursement to itself for such expenses and (ii) such
expenses will be recoverable by it either through Liquidation Proceeds or the
proceeds of insurance. Notwithstanding anything to the contrary herein, in the
case of a Trust Fund for which a REMIC election has been made, the Servicer
will be required to liquidate any Property acquired through foreclosure within
two years after the acquisition of the beneficial ownership of such Property.
While the holder of a Property acquired through foreclosure can often maximize
its recovery by providing financing to a new purchaser, the Trust Fund, if
applicable, will have no ability to do so and neither the Servicer nor the
Transferor will be required to do so.
The Servicer may arrange with the obligor on a defaulted Loan a modification
of such Loan (a "Modification") to the extent provided in the related
Prospectus Supplement. Such Modifications may only be entered into if they
meet the underwriting policies and procedures employed by the Servicer in
servicing receivables for its own account and meet the other conditions set
forth in the related Prospectus Supplement.
ENFORCEMENT OF DUE-ON-SALE CLAUSES
Unless otherwise specified in the related Prospectus Supplement for a
Series, when any Property is being conveyed by the obligor, the Servicer will
have the option to exercise its rights to accelerate the maturity of the
related Loan under the applicable "due-on-sale" clause, if any, unless such
exercise is not permitted under applicable law. In such event, the Servicer is
authorized to accept from or enter into an assumption agreement with the
person to whom such property has been or is about to be conveyed, pursuant to
which such person becomes liable under the Loan. To the extent permitted by
applicable law, such assumption will not release the original borrower from
its obligation under the Loan. Any fee collected in connection with an
assumption will be retained by the Servicer as additional servicing
compensation. The terms of a Loan may not be changed in connection with an
assumption except to the extent specified in the related Prospectus
Supplement.
SERVICING COMPENSATION AND PAYMENT OF EXPENSES
Except as otherwise provided in the related Prospectus Supplement, the
Servicer will be entitled to a periodic fee as servicing compensation (the
"Servicing Fee") in an amount to be determined as specified in the related
Prospectus Supplement. The Servicing Fee may be fixed or variable, as
specified in the related Prospectus Supplement. In addition, unless otherwise
specified in the related Prospectus Supplement, the Servicer will be entitled
to servicing compensation in the form of assumption fees, late payment charges
and similar items, or excess proceeds following disposition of Properties in
connection with defaulted Loans.
Except to the extent otherwise specified in the related Prospectus
Supplement, the Servicer will pay certain expenses incurred in connection with
the servicing of the Loans, including, without limitation, the payment of the
fees and expenses of the Trustee and independent accountants, payment of
insurance policy premiums and the cost of credit support, if any, and payment
of expenses incurred in preparation of reports to Holders.
When an obligor makes a principal prepayment in full between Due Dates on
the related Loan, the obligor will generally be required to pay interest on
the amount prepaid only to the date of prepayment. If and to the extent
provided in the related Prospectus Supplement in order that one or more
Classes of the Holders of a Series will not be adversely affected by any
resulting shortfall in interest, the amount of the Servicing Fee may be
reduced to the extent necessary to include in the Servicer's remittance to the
Trustee for distribution to Securityholders an amount equal to one month's
interest on the related Loan (less the Servicing Fee). If the aggregate amount
of such shortfalls in a month exceeds the Servicing Fee for such month, a
shortfall to Holders may occur.
36
<PAGE>
Unless otherwise specified in the related Prospectus Supplement, the
Servicer will be entitled to reimbursement for Servicer Advances. The related
Holders will suffer no loss by reason of such Servicer Advances to the extent
expenses are covered under related insurance policies or from excess
Liquidation Proceeds. If claims are either not made or paid under the
applicable insurance policies or if coverage thereunder has been exhausted,
the related Holders will suffer a loss to the extent that Liquidation
Proceeds, after reimbursement of the Servicer Advances, are less than the
outstanding principal balance of and unpaid interest on the related Loan which
would be distributable to Holders. The Servicer is generally also entitled to
reimbursement from the Collection Account or the Certificate Account for
Servicer Advances. In addition, the Servicer will be entitled to reimbursement
for Delinquency Advances as described above under "--Advances and Limitations
Thereon."
Unless otherwise specified in the related Prospectus Supplement, the rights
of the Servicer to receive funds from the Collection Account or the
Certificate Account for a Series, whether as the Servicing Fee or other
compensation, or for the reimbursement of Advances, expenses or otherwise, are
not subordinate to the rights of Holders of such Series.
EVIDENCE AS TO COMPLIANCE
If so specified in the related Prospectus Supplement, the applicable
Agreement for each Series will provide that each year, a firm of independent
public accountants will furnish a statement to the Trustee to the effect that
such firm has examined certain documents and records relating to the servicing
of the Loans by the Servicer and that such examination, which has been
conducted substantially in compliance with either (i) the audit guide for
audits of non-supervised mortgagees approved by the Department of Housing and
Urban Development or (ii) the requirements of the Uniform Single Attestation
Program for Mortgage Bankers, has disclosed no items of non-compliance with
the provisions of the applicable Agreement that, in the opinion of the firm,
are material, except for such items of non-compliance as shall be referred to
in the report.
If so specified in the related Prospectus Supplement, the applicable
Agreement for each Series will also provide for delivery to the Trustee for
such Series of an annual statement signed by an officer of the Servicer to the
effect that the Servicer has fulfilled its material obligations under such
Agreement throughout the preceding calendar year.
CERTAIN MATTERS REGARDING THE SERVICER
If an Event of Default occurs under either a Sale and Servicing Agreement or
a Pooling and Servicing Agreement, the Servicer may be replaced by the Trustee
or a successor Servicer. Unless otherwise specified in the related Prospectus
Supplement, such Events of Default and the rights of the Trustee upon such a
default under the Agreement for the related Series will be substantially
similar to those described under "THE AGREEMENTS--Events of Default; Rights
Upon Event of Default--Pooling and Servicing Agreement; Sale and Servicing
Agreement."
Unless otherwise specified in the related Prospectus Supplement, the
Servicer does not have the right to assign its rights and delegate its duties
and obligations under the related Agreement for each Series unless the
successor Servicer accepting such assignment or delegation (i) services
similar loans in the ordinary course of its business, (ii) is reasonably
satisfactory to the Trustee for the related Series, (iii) would not cause any
Rating Agency's rating of the Securities for such Series in effect immediately
prior to such assignment, sale or transfer to be qualified, downgraded or
withdrawn as a result of such assignment, sale or transfer and (iv) executes
and delivers to the Trustee and the Enhancer, if any, an agreement, in form
and substance reasonably satisfactory to the Trustee, and the Enhancer, if
any, which contains an assumption by such Servicer of the due and punctual
performance and observance of each covenant and condition to be performed or
observed by the Servicer under the related Agreement from and after the date
of such agreement. No such assignment will become effective until the Trustee
or a successor Servicer has assumed the servicer's obligations and duties
under the related Agreement. To the extent that the Servicer transfers its
obligations to a wholly-owned subsidiary or affiliate, such
37
<PAGE>
subsidiary or affiliate need not satisfy the criteria set forth above;
however, in such instance, the assigning Servicer will remain liable for the
servicing obligations under the related Agreement. Any entity into which the
Servicer is merged or consolidated or any successor corporation resulting from
any merger, conversion or consolidation will succeed to the Servicer's
obligations under the related Agreement provided that such successor or
surviving entity meets the requirements for a successor Servicer set forth
above.
The Servicer will not be under any liability to the Trust Fund or the
Securityholders for taking any action or for refraining from taking any action
in good faith pursuant to the Agreement, or for errors in judgment; provided,
however, that the Servicer will not be protected against any liability that
otherwise would be imposed by reason of willful misfeasance, bad faith or
gross negligence in the performance of duties or by reason of its reckless
disregard of its obligations and duties thereunder. Except to the extent
otherwise provided therein, each Agreement further will provide that the
Servicer and any director, officer, employee or agent of the Servicer will be
entitled to indemnification by the Trust Fund and will be held harmless to the
extent provided in the Agreement against any loss, liability or expense
incurred in connection with any legal action relating to the Agreement or the
Securities, other than any loss, liability or expense related to any specific
Loan or Loans (or balances thereof) (except any such loss, liability or
expense otherwise reimbursable pursuant to the Agreement) and any loss,
liability or expense incurred by the Servicer by reason of its willful
misfeasance, bad faith or gross negligence in the performance of its duties
thereunder or by reason of the Servicer's reckless disregard of its
obligations and duties thereunder.
Each Agreement will provide that the Servicer will not be under any
obligation to appear in, prosecute or defend any legal action that is not
incidental to its duties under the Agreement and that in its opinion may
involve it in any expense or liability. The Servicer, however, in its
discretion, may undertake any such action that it may deem necessary or
desirable with respect to the Agreement and the rights and duties of the
parties thereto and the interest of the Securityholders and the Enhancer, if
any, thereunder. In such event, the legal expenses and costs of such action
and any liability resulting therefrom will be expenses, costs and liabilities
of the Trust Fund and the Servicer will be entitled to be reimbursed therefor
to the extent provided in the Agreement. The Servicer's right to such
indemnity or reimbursement will survive any resignation or termination of the
Servicer with respect to any losses, expenses, costs or liabilities arising
prior to such resignation or termination (or arising from events that occurred
prior to such resignation or termination). Any claims by or on behalf of the
Securityholders or the Trust Fund will be made only against the Servicer, who
will be liable with respect to its own acts and omissions as well as the acts
and omissions of its directors, officer, employees and agents.
THE AGREEMENTS
The following summaries describe certain provisions of the Agreements. The
summaries do not purport to be complete and are subject to, and qualified in
their entirety by reference to, the provisions of the Agreements. Where
particular provisions or terms used in the Agreements are referred to, such
provisions or terms are as specified in the related Agreements.
ASSIGNMENT OF PRIMARY ASSETS
General. At the time of issuance of the Securities of a Series, the
Transferor will transfer, convey and assign to the Trust Fund all right, title
and interest of the Transferor in the Primary Assets and other property to be
transferred to the Trust Fund for a Series. Such assignment will include all
principal and interest due or received on or with respect to the Primary
Assets on or after the Cut-off Date to the extent specified in the related
Prospectus Supplement (except for any Retained Interests). The Trustee will,
concurrently with such assignment, execute and deliver the Securities.
Assignment of Loans. Unless otherwise specified in the related Prospectus
Supplement, the Transferor will, as to each Loan, deliver or cause to be
delivered to the Trustee, or, as specified in the related Prospectus
Supplement, a custodian on behalf of the Trustee (the "Custodian"), the
Mortgage Note endorsed without
38
<PAGE>
recourse to the order of the Trustee or in blank, the original Mortgage with
evidence of recording indicated thereon (except for any Mortgage not returned
from the public recording office, in which case a copy of such Mortgage will
be delivered, together with a certificate that the original of such Mortgage
was delivered to such recording office) and an assignment of the Mortgage in
recordable form. The Trustee, or, if so specified in the related Prospectus
Supplement, the Custodian, will hold such documents in trust for the benefit
of the Holders.
Unless otherwise specified in the related Prospectus Supplement, the
Transferor will as to each Home Improvement Contract deliver or cause to be
delivered to the Trustee (or the Custodian) the original Home Improvement
Contract and copies of documents and instruments related to each Home
Improvement Contract and, other than in the case of unsecured Home Improvement
Contracts, the security interest in the property securing such Home
Improvement Contract. In order to give notice of the right, title and interest
of Securityholders to the Home Improvement Contracts, the Transferor will
cause a UCC-1 financing statement to be executed by the Transferor identifying
the Trustee as the secured party and identifying all Home Improvement
Contracts as collateral. Unless otherwise specified in the related Prospectus
Supplement, the Home Improvement Contracts will not be stamped or otherwise
marked to reflect their assignment to the Trust Fund. Therefore, if, through
negligence, fraud or otherwise, a subsequent purchaser were able to take
physical possession of the Home Improvement Contracts without notice of such
assignment, the interest of Securityholders in the Home Improvement Contracts
could be defeated. See "CERTAIN LEGAL ASPECTS OF THE LOANS--The Home
Improvement Contracts."
With respect to Loans secured by Mortgages, if so specified in the related
Prospectus Supplement, the Transferor will, at the time of issuance of the
Securities, cause assignments to the Trustee of the Mortgages relating to the
Loans for a Series to be recorded in the appropriate public office for real
property records, except in states where, in the opinion of counsel acceptable
to the Trustee, such recording is not required to protect the Trustee's
interest in the related Loans. If specified in the related Prospectus
Supplement, the Transferor will cause such assignments to be so recorded
within the time after issuance of the Securities as is specified in the
related Prospectus Supplement, in which event, the Agreement may, as specified
in the related Prospectus Supplement, require the Transferor to repurchase
from the Trustee any Loan the related Mortgage of which is not recorded within
such time, at the price described below with respect to repurchases by reason
of defective documentation. Unless otherwise provided in the related
Prospectus Supplement, the enforcement of the repurchase obligation would
constitute the sole remedy available to the Holders or the Trustee for the
failure of a Mortgage to be recorded.
Each Loan will be identified in a schedule appearing as an exhibit to the
related Agreement (the "Loan Schedule"). Such Loan Schedule will specify with
respect to each Loan: the original principal amount and unpaid principal
balance as of the Cut-off Date; the current interest rate; the current
Scheduled Payment of principal and interest; the maturity date, if any, of the
related Mortgage Note; if the Loan is an adjustable rate Loan, the Lifetime
Rate Cap, if any, and the current index.
Assignment of Private Securities. The Transferor will cause Private
Securities to be registered in the name of the Trustee (or its nominee or
correspondent). The Trustee (or its nominee or correspondent) will have
possession of any certificated Private Securities. Unless otherwise specified
in the related Prospectus Supplement, the Trustee will not be in possession of
or be assignee of record of any underlying assets for a Private Security. See
"THE TRUST FUNDS--Private Securities." Each Private Security will be
identified in a schedule appearing as an exhibit to the related Agreement (the
"Certificate Schedule"), which will specify the original principal amount,
outstanding principal balance as of the Cut-off Date, annual pass-through rate
or interest rate and maturity date for each Private Security conveyed to the
Trust Fund. In the Agreement, the Transferor will represent and warrant to the
Trustee regarding the Private Securities: (i) that the information contained
in the Certificate Schedule is true and correct in all material respects; (ii)
that, immediately prior to the conveyance of the Private Securities, the
Transferor had good title thereto, and was the sole owner thereof (subject to
any Retained Interest); (iii) that there has been no other sale by it of such
Private Securities; and (iv) that there is no existing lien, charge, security
interest or other encumbrance (other than any Retained Interest) on such
Private Securities.
39
<PAGE>
Repurchase and Substitution of Non-Conforming Primary Assets. Unless
otherwise provided in the related Prospectus Supplement, if any document in
the file relating to the Primary Assets delivered by the Transferor to the
Trustee (or Custodian) is found by the Trustee within 90 days of the execution
of the related Agreement (or promptly after the Trustee's receipt of any
document permitted to be delivered after the Closing Date) to be defective in
any material respect and the Transferor does not cure such defect within 90
days, or within such other period specified in the related Prospectus
Supplement, the Transferor will, not later than 90 days or within such other
period specified in the related Prospectus Supplement, after the Trustee's
notice to the Transferor of the defect, repurchase the related Primary Asset
or any property acquired in respect thereof from the Trustee at a price equal
to, unless otherwise specified in the related Prospectus Supplement, the sum
of (a) the lesser of (i) the outstanding principal balance of such Primary
Asset and (ii) the Trust Fund's federal income tax basis in the Primary Asset
and (b) accrued and unpaid interest to the date of the repurchase/substitution
of such Primary Asset at the rate set forth in the related Agreement;
provided, however, the purchase price shall not be limited in (i) above to the
Trust Fund's federal income tax basis if the repurchase at a price equal to
the outstanding principal balance of such Primary Asset will not result in any
prohibited transaction tax under Section 860F(a) of the Code.
If provided in the related Prospectus Supplement, the Transferor, may,
rather than repurchase the Primary Asset as described above, remove such
Primary Asset from the Trust Fund (the "Deleted Primary Asset") and substitute
in its place one or more other Primary Assets (each, a "Qualifying Substitute
Primary Asset") provided, however, that with respect to a Trust Fund for which
a REMIC election is made, after a specified time period, the Trustee must have
received a satisfactory opinion of counsel that such substitution will not
cause the Trust Fund to lose its status as a REMIC or otherwise subject the
Trust Fund to a prohibited transaction tax.
Unless otherwise specified in the related Prospectus Supplement, any
Qualifying Substitute Primary Asset will have, on the date of substitution,
(i) an outstanding principal balance, after deduction of all Scheduled
Payments due in the month of substitution, not in excess of the outstanding
principal balance of the Deleted Primary Asset (the amount of any shortfall to
be deposited to the Collection Account in the month of substitution for
distribution to Holders), (ii) an interest rate not less than (and not more
than 2% greater than) the interest rate or Margin of the Deleted Primary
Asset, (iii) a remaining term-to-stated maturity not greater than (and not
more than two years less than) that of the Deleted Primary Asset, and will
comply with all of the representations and warranties set forth in the
applicable Agreement as of the date of substitution.
Unless otherwise provided in the related Prospectus Supplement, the above-
described cure, repurchase or substitution obligations constitute the sole
remedies available to the Holders or the Trustee for a material defect in a
document for a Primary Asset.
The Transferor will make representations and warranties with respect to
Primary Assets for a Series. If the Transferor or such entity cannot cure a
breach of any such representations and warranties in all material respects
within the time period specified in the related Prospectus Supplement after
notification by the Trustee of such breach, and if such breach is of a nature
that materially and adversely affects the value of such Primary Asset, the
Transferor is obligated to repurchase the affected Primary Asset or, if
provided in the related Prospectus Supplement, provide a Qualifying Substitute
Primary Asset therefor, subject to the same conditions and limitations on
purchases and substitutions as described above.
Unless otherwise provided in the related Prospectus Supplement, no Holder of
Securities of a Series, solely by virtue of such Holder's status as a Holder,
will have any right under the applicable Agreement for such Series to
institute any proceeding with respect to such Agreement, unless such Holder
previously has given to the Trustee for such Series written notice of default
and unless the Holders of Securities evidencing not less than 51% of the
aggregate voting rights of the Securities for such Series have made written
request upon the Trustee to institute such proceeding in its own name as
Trustee thereunder and have offered to the Trustee reasonable indemnity, and
the Trustee for 60 days has neglected or refused to institute any such
proceeding.
40
<PAGE>
REPORTS TO HOLDERS
The Trustee or other entity specified in the related Prospectus Supplement
will prepare and forward to each Holder on each Distribution Date, or as soon
thereafter as is practicable, a statement setting forth, to the extent
applicable to any Series and set forth in the related Prospectus Supplement,
among other things:
(i) the amount of principal distributed to Holders of the related
Securities and the outstanding principal balance of such Securities
following such distribution;
(ii) the amount of interest distributed to Holders of the related
Securities and the current interest on such Securities;
(iii) the amounts of (a) any overdue accrued interest included in such
distribution, (b) any remaining overdue accrued interest with respect to
such Securities or (c) any current shortfall in amounts to be distributed
as accrued interest to Holders of such Securities;
(iv) the amounts of (a) any overdue payments of scheduled principal
included in such distribution, (b) any remaining overdue principal amounts
with respect to such Securities, (c) any current shortfall in receipt of
scheduled principal payments on the related Primary Assets or (d) any
realized losses or Liquidation Proceeds to be allocated as reductions in
the outstanding principal balances of such Securities;
(v) the amount received under any related Enhancement, and the remaining
amount available under such Enhancement;
(vi) the amount of any delinquencies with respect to payments on the
related Primary Assets;
(vii) the book value of any REO Property acquired by the related Trust
Fund;
(viii) during the Pre-Funding Period, the remaining Pre-Funded Amount and
the portion of the Pre-Funding Amount used to acquire additional Primary
Assets since the preceding Distribution Date;
(ix) during the Pre-Funding Period, the amount remaining in the
Capitalized Interest Account; and
(x) such other information as specified in the related Agreement.
In addition, within a reasonable period of time after the end of each
calendar year the Trustee, unless otherwise specified in the related
Prospectus Supplement, will furnish to each Holder of record at any time
during such calendar year (a) the aggregate of amounts reported pursuant to
(i), (ii), and (iv)(d) above for such calendar year and (b) such information
specified in the related Agreement to enable Holders to prepare their tax
returns including, without limitation, the amount of original issue discount
accrued on the Securities, if applicable. Information in the Distribution Date
and annual statements provided to the Holders will not have been examined and
reported upon by an independent public accountant. However, the Servicer will
provide to the Trustee a report by independent public accountants with respect
to the Servicer's servicing of the Loans. See "SERVICING OF LOANS--Evidence as
to Compliance."
If so specified in the Prospectus Supplement for a Series of Securities,
such Series or one or more Classes of such Series will be issued in book-entry
form. In such event, owners of beneficial interests in such Securities will
not be considered Holders and will not receive such reports directly from the
Trustee. The Trustee will forward such reports only to the entity or its
nominee which is the registered holder of the global certificate which
evidences such book-entry securities. Beneficial owners will receive such
reports from the participants and indirect participants of the applicable
book-entry system in accordance with the practices and procedures of such
entities.
EVENTS OF DEFAULT; RIGHTS UPON EVENT OF DEFAULT
Pooling and Servicing Agreement; Sale and Servicing Agreement. Unless
otherwise specified in the related Prospectus Supplement, Events of Default
under the Pooling and Servicing Agreement or Sale and Servicing Agreement for
each Series of Securities relating to Loans include (i) any failure by the
Servicer to deposit amounts in the Collection Account and/or Certificate
Account and/or Distribution Account required to be made thereunder, which
failure continues unremedied for the number of days specified in the related
Prospectus
41
<PAGE>
Supplement after the giving of written notice of such failure to the Servicer
by the Trustee for such Series, or to the Servicer and the Trustee by the
Enhancer or by the Holders of such Series evidencing not less than 51% of the
aggregate voting rights of the Securities for such Series, (ii) any failure by
the Servicer duly to observe or perform in any material respect any other of
its covenants or agreements in the applicable Agreement which continues
unremedied for the number of days specified in the related Prospectus
Supplement after the giving of written notice of such failure to the Servicer
by the Trustee, or to the Servicer and the Trustee by the Enhancer or by the
Holders of such Series evidencing not less than 51% of the aggregate voting
rights of the Securities for such Series, and (iii) certain events of
insolvency, readjustment of debt, marshalling of assets and liabilities or
similar proceedings and certain actions by the Servicer indicating its
insolvency, reorganization or inability to pay its obligations.
So long as an Event of Default remains unremedied under the applicable
Agreement for a Series of Securities relating to the servicing of Loans,
unless otherwise specified in the related Prospectus Supplement, the Trustee
for such Series or Holders of Securities of such Series evidencing not less
than 51% of the aggregate voting rights of the Securities for such Series
with, if specified in the related Prospectus Supplement, the consent of the
Enhancer, may terminate all of the rights and obligations of the Servicer as
servicer under the applicable Agreement (other than its right to recovery of
other expenses and amounts advanced pursuant to the terms of such Agreement
which rights the Servicer will retain under all circumstances), whereupon the
Trustee will succeed to all the responsibilities, duties and liabilities of
the Servicer under such Agreement and will be entitled to reasonable servicing
compensation not to exceed the applicable servicing fee, together with other
servicing compensation in the form of assumption fees, late payment charges or
otherwise as provided in such Agreement.
In the event that the Trustee is unwilling or unable so to act, it may
select, or petition a court of competent jurisdiction to appoint, a finance
institution, bank or loan servicing institution with a net worth specified in
the related Prospectus Supplement to act as successor Servicer under the
provisions of the applicable Agreement. The successor Servicer would be
entitled to reasonable servicing compensation in an amount not to exceed the
Servicing Fee as set forth in the related Prospectus Supplement, together with
the other servicing compensation in the form of assumption fees, late payment
charges or otherwise, as provided in such Agreement.
During the continuance of any Event of Default of a Servicer under an
Agreement for a Series of Securities, the Trustee for such Series will have
the right to take action to enforce its rights and remedies and to protect and
enforce the rights and remedies of the Holders of such Series, and, unless
otherwise specified in the related Prospectus Supplement, Holders of
Securities evidencing not less than 51% of the aggregate voting rights of the
Securities for such Series may direct the time, method and place of conducting
any proceeding for any remedy available to the Trustee or exercising any trust
or power conferred upon that Trustee. However, the Trustee will not be under
any obligation to pursue any such remedy or to exercise any of such trusts or
powers unless such Holders have offered the Trustee reasonable security or
indemnity against the cost, expenses and liabilities which may be incurred by
the Trustee therein or thereby. The Trustee may decline to follow any such
direction if the Trustee determines that the action or proceeding so directed
may not lawfully be taken or would involve it in personal liability or be
unjustly prejudicial to the nonassenting Holders.
Indenture. Unless otherwise specified in the related Prospectus Supplement,
Events of Default under the Indenture for each Series of Notes include: (i) a
default for 30 days or more in the payment of any principal of or interest on
any Note of such Series; (ii) failure to perform any other covenant of the
Transferor or the Trust Fund in the Indenture which continues for a period of
60 days after notice thereof is given in accordance with the procedures
described in the related Prospectus Supplement; (iii) any representation or
warranty made by the Transferor or the Trust Fund in the Indenture or in any
certificate or other writing delivered pursuant thereto or in connection
therewith with respect to or affecting such Series having been incorrect in a
material respect as of the time made, and such breach is not cured within 60
days after notice thereof is given in accordance with the procedures described
in the related Prospectus Supplement; (iv) certain events of bankruptcy,
insolvency, receivership or liquidation of the Transferor or the Trust Fund;
or (v) any other Event of Default provided with respect to Notes of that
Series.
42
<PAGE>
If an Event of Default with respect to the Notes of any Series at the time
outstanding occurs and is continuing, either the Trustee or the Holders of a
majority of the then aggregate outstanding amount of the Notes of such Series
with, if specified in the related Prospectus Supplement, the consent of the
Enhancer, may declare the principal amount (or, if the Notes of that Series
are Zero Coupon Securities, such portion of the principal amount as may be
specified in the terms of that Series, as provided in the related Prospectus
Supplement) of all the Notes of such Series to be due and payable immediately.
Such declaration may, under certain circumstances, be rescinded and annulled
by the Holders of a majority in aggregate outstanding amount of the Notes of
such Series.
If, following an Event of Default with respect to any Series of Notes, the
Notes of such Series have been declared to be due and payable, the Trustee
may, in its discretion, notwithstanding such acceleration, elect to maintain
possession of the collateral securing the Notes of such Series and to continue
to apply distributions on such collateral as if there had been no declaration
of acceleration if such collateral continues to provide sufficient funds for
the payment of principal of and interest on the Notes of such Series as they
would have become due if there had not been such a declaration. In addition,
unless otherwise specified in the related Prospectus Supplement, the Trustee
may not sell or otherwise liquidate the collateral securing the Notes of a
Series following an Event of Default other than a default in the payment of
any principal or interest on any Note of such Series for 30 days or more,
unless (a) the Holders of 100% of the then aggregate outstanding amount of the
Notes of such Series consent to such sale, (b) the proceeds of such sale or
liquidation are sufficient to pay in full the principal of and accrued
interest due and unpaid on the outstanding Notes of such Series at the date of
such sale or (c) the Trustee determines that such collateral would not be
sufficient on an ongoing basis to make all payments on such Notes as such
payments would have become due if such Notes had not been declared due and
payable, and the Trustee obtains the consent of the Holders of 66 2/8% of the
then aggregate outstanding amount of the Notes of such Series.
In the event that the Trustee liquidates the collateral in connection with
an Event of Default involving a default for 30 days or more in the payment of
principal of or interest on the Notes of a Series, the Indenture provides that
the Trustee will have a prior lien on the proceeds of any such liquidation for
unpaid fees and expenses. As a result, upon the occurrence of such an Event of
Default, the amount available for distribution to the Noteholders may be less
than would otherwise be the case. However, the Trustee may not institute a
proceeding for the enforcement of its lien except in connection with a
proceeding for the enforcement of the lien of the Indenture for the benefit of
the Noteholders after the occurrence of such an Event of Default.
Unless otherwise specified in the related Prospectus Supplement, in the
event the principal of the Notes of a Series is declared due and payable, as
described above, the Holders of any such Notes issued at a discount from par
may be entitled to receive no more than an amount equal to the unpaid
principal amount thereof less the amount of such discount which is
unamortized.
Subject to the provisions of the Indenture relating to the duties of the
Trustee, in case an Event of Default shall occur and be continuing with
respect to a Series of Notes, the Trustee will be under no obligation to
exercise any of the rights or powers under the Indenture at the request or
direction of any of the Holders of Notes of such Series, unless such Holders
offered to the Trustee security or indemnity satisfactory to it against the
costs, expenses and liabilities which might be incurred by it in complying
with such request or direction. Subject to such provisions for indemnification
and certain limitations contained in the Indenture, the Holders of a majority
of the then aggregate outstanding amount of the Notes of such Series shall
have the right to direct the time, method and place of conducting any
proceeding for any remedy available to the Trustee or exercising any trust or
power conferred on the Trustee with respect to the Notes of such Series, and
the Holders of a majority of the then aggregate outstanding amount of the
Notes of such Series may, in certain cases, waive any default with respect
thereto, except a default in the payment of principal or interest or a default
in respect of a covenant or provision of the Indenture that cannot be modified
without the waiver or consent of all the Holders of the outstanding Notes of
such Series affected thereby.
43
<PAGE>
THE TRUSTEE
The identity of the commercial bank, savings and loan association or trust
company named as the Trustee for each Series of Securities will be set forth
in the related Prospectus Supplement. The entity serving as Trustee may have
normal banking relationships with the Transferor. In addition, for the purpose
of meeting the legal requirements of certain local jurisdictions, the Trustee
will have the power to appoint co-trustees or separate trustees of all or any
part of the Trust Fund relating to a Series of Securities. In the event of
such appointment, all rights, powers, duties and obligations conferred or
imposed upon the Trustee by the Agreement relating to such Series will be
conferred or imposed upon the Trustee and each such separate trustee or co-
trustee jointly, or, in any jurisdiction in which the Trustee shall be
incompetent or unqualified to perform certain acts, singly upon such separate
trustee or co-trustee who will exercise and perform such rights, powers,
duties and obligations solely at the direction of the Trustee. The Trustee may
also appoint agents to perform any of the responsibilities of the Trustee,
which agents will have any or all of the rights, powers, duties and
obligations of the Trustee conferred on them by such appointment; provided
that the Trustee will continue to be responsible for its duties and
obligations under the Agreement. In the event a Series includes both Notes and
Certificates, a separate Trustee identified in the related Prospectus
Supplement will serve as Trustee for the Certificateholders and for the Notes.
DUTIES OF THE TRUSTEE
The Trustee will not make any representations as to the validity or
sufficiency of the Agreement, the Securities or of any Primary Asset or
related documents. If no Event of Default (as defined in the related
Agreement) has occurred, the Trustee is required to perform only those duties
specifically required of it under the Agreement. Upon receipt of the various
certificates, statements, reports or other instruments required to be
furnished to it, the Trustee is required to examine them to determine whether
they are in the form required by the related Agreement. However, the Trustee
will not be responsible for the accuracy or content of any such documents
furnished to it by the Holders or the Servicer under the Agreement.
The Trustee may be held liable for its own negligent action or failure to
act, or for its own misconduct; provided, however, that the Trustee will not
be personally liable with respect to any action taken, suffered or omitted to
be taken by it in good faith in accordance with the direction of the Holders
in an Event of Default. The Trustee is not required to expend or risk its own
funds or otherwise incur any financial liability in the performance of any of
its duties under the Agreement, or in the exercise of any of its rights or
powers, if it has reasonable grounds for believing that repayment of such
funds or adequate indemnity against such risk or liability is not reasonably
assured to it.
RESIGNATION OF TRUSTEE
The Trustee may, upon written notice to the Transferor, and if specified in
the related Prospectus Supplement, the Enhancer, if any, resign at any time,
in which event the Transferor will be obligated to use its best efforts to
appoint a successor Trustee. If no successor Trustee has been appointed and
has accepted the appointment within the period specified in the Agreement
after the giving of such notice of resignation, the resigning Trustee may
petition any court of competent jurisdiction for appointment of a successor
Trustee. The Trustee may also be removed at any time (i) if the Trustee ceases
to be eligible to continue as such under the Agreement, (ii) if the Trustee
becomes insolvent or (iii) by the Holders of Securities evidencing over 50% of
the aggregate voting rights of the Securities in the Trust Fund upon written
notice to the Trustee and to the Transferor. Any resignation or removal of the
Trustee and appointment of a successor Trustee will not become effective until
acceptance of the appointment by the successor Trustee.
AMENDMENT OF AGREEMENT
Unless otherwise specified in the Prospectus Supplement, the Agreement for
each Series of Securities may be amended by the Transferor, the Servicer and
the Trustee with respect to such Series, without notice to or consent of the
Holders, (i) to cure any ambiguity, (ii) to correct any defective provisions
or to correct or
44
<PAGE>
supplement any provision therein, (iii) to add to the duties of the
Transferor, the Trust Fund or the Servicer, (iv) to add any other provisions
with respect to matters or questions arising under such Agreement or related
Enhancement, (v) to add or amend any provisions of such Agreement as required
by a Rating Agency in order to maintain or improve the rating of the
Securities (it being understood that none of the Transferor, the Servicer or
the Trustee is obligated to maintain or improve such rating), or (vi) to
comply with any requirements imposed by the Code; provided that any such
amendment except pursuant to clause (vi) above will not materially and
adversely affect the interests of any Holders of such Series or, if specified
in the related Prospectus Supplement, the Enhancer, as evidenced by an opinion
of counsel. Any such amendment except pursuant to clause (vi) of the preceding
sentence shall be deemed not to adversely affect in any material respect the
interests of any Holder if the Trustee receives written confirmation from each
Rating Agency rating such Securities that such amendment will not cause such
Rating Agency to withdraw or reduce the then current rating thereof. Unless
otherwise specified in the Prospectus Supplement, the Agreement for each
Series may also be amended by the Trustee, the Servicer, if applicable, and
the Transferor with respect to such Series with the consent of the Enhancer,
if specified in the related Prospectus Supplement or the Holders possessing
not less than 51% of the aggregate outstanding principal amount of the
Securities of such Series or, if only certain Classes of such Series are
affected by such amendment, 51% of the aggregate outstanding principal amount
of the Securities of each Class of such Series affected thereby, for the
purpose of adding any provisions to or changing in any manner or eliminating
any of the provisions of such Agreement or modifying in any manner the rights
of Holders of such Series; provided, however, that no such amendment may (a)
reduce the amount or delay the timing of payments on any Security without the
consent of the Holder of such Security; or (b) reduce the aforesaid percentage
of the aggregate outstanding principal amount of Securities of each Class, the
Holders of which are required to consent to any such amendment or (c) if
specified in the related Prospectus Supplement, adversely affect the interests
of the Enhancer, without, in the case of clauses (a) or (b), the consent of
the Holders of 100% of the aggregate outstanding principal amount of each
Class of Securities affected thereby.
VOTING RIGHTS
The related Prospectus Supplement will set forth the method of determining
allocation of voting rights with respect to a Series.
LIST OF HOLDERS
Upon written request of three or more Holders of record of a Series for
purposes of communicating with other Holders with respect to their rights
under the Agreement, which request is accompanied by a copy of the
communication which such Holders propose to transmit, the Trustee will afford
such Holders access during business hours to the most recent list of Holders
of that Series held by the Trustee.
No Agreement will provide for the holding of any annual or other meeting of
Holders.
BOOK-ENTRY SECURITIES
If specified in the Prospectus Supplement for a Series of Securities, such
Series or one or more Classes of such Series may be issued in book-entry form.
In such event, beneficial owners of such Securities will not be considered
"Holders" under the Agreements and may exercise the rights of Holders only
indirectly through the participants in the applicable book-entry system.
REMIC ADMINISTRATOR
For any Series with respect to which a REMIC election is made, preparation
of certain reports and certain other administrative duties with respect to the
Trust Fund may be performed by a REMIC administrator, who may be the
Transferor or an affiliate of the Transferor.
45
<PAGE>
TERMINATION
Pooling and Servicing Agreement; Trust Agreement. The obligations created by
the Pooling and Servicing Agreement or Trust Agreement for a Series will
terminate upon the distribution to Holders of all amounts distributable to
them pursuant to such Agreement after the earlier of (i) the later of (a) the
final payment or other liquidation of the last Primary Asset remaining in the
Trust Fund for such Series and (b) the disposition of all property acquired
upon foreclosure or deed in lieu of foreclosure or repossession in respect of
any Primary Asset or (ii) the repurchase, as described below, by the Servicer
or other entity specified in the related Prospectus Supplement from the
Trustee for such Series of all Primary Assets and other property at that time
subject to such Agreement. The Agreement for each Series permits, but does not
require, the Servicer or other entity specified in the related Prospectus
Supplement to purchase from the Trust Fund for such Series all remaining
Primary Assets at a price equal to, unless otherwise specified in the related
Prospectus Supplement, 100% of the aggregate Principal Balance of such Primary
Assets plus, with respect to any property acquired in respect of a Primary
Asset, if any, the outstanding Principal Balance of the related Primary Asset
at the time of foreclosure, less, in either case, related unreimbursed
Servicer Advances (in the case of the Primary Assets, only to the extent not
already reflected in the computation of the aggregate Principal Balance of
such Primary Assets) and unreimbursed expenses (that are reimbursable pursuant
to the terms of the Pooling and Servicing Agreement) plus, in either case,
accrued interest thereon at the weighted average rate on the related Primary
Assets through the last day of the Due Period in which such repurchase occurs;
provided, however, that if an election is made for treatment as a REMIC under
the Code, the repurchase price may equal the greater of (a) 100% of the
aggregate Principal Balance of such Primary Assets, plus accrued interest
thereon at the applicable net rates on the Primary Assets through the last day
of the month of such repurchase and (b) the aggregate fair market value of
such Primary Assets plus the fair market value of any property acquired in
respect of a Primary Asset and remaining in the Trust Fund. The exercise of
such right will effect early retirement of the Securities of such Series, but
such entity's right to so purchase is subject to the aggregate Principal
Balance of the Primary Assets at the time of repurchase being less than a
fixed percentage, to be set forth in the related Prospectus Supplement, of the
aggregate Principal Balance of the Primary Assets as of the Cut-off Date. In
no event, however, will the trust created by the Agreement continue beyond the
expiration of 21 years from the death of the last survivor of certain persons
identified therein. For each Series, the Servicer or the Trustee, as
applicable, will give written notice of termination of the Agreement to each
Holder, and the final distribution will be made only upon surrender and
cancellation of the Securities at an office or agency specified in the notice
of termination. If so provided in the related Prospectus Supplement for a
Series, the Transferor or another entity may effect an optional termination of
the Trust Fund under the circumstances described in such Prospectus
Supplement. See "DESCRIPTION OF THE SECURITIES--Optional Redemption, Purchase
or Termination."
Indenture. The Indenture will be discharged with respect to a Series of
Notes (except with respect to certain continuing rights specified in the
Indenture) upon the delivery to the Trustee for cancellation of all the Notes
of such Series or, with certain limitations, upon deposit with the Trustee of
funds sufficient for the payment in full of all of the Notes of such Series.
In addition to such discharge with certain limitations, the Indenture will
provide that, if so specified with respect to the Notes of any Series, the
related Trust Fund will be discharged from any and all obligations in respect
of the Notes of such Series (except for certain obligations relating to
temporary Notes and exchange of Notes, to register the transfer of or exchange
Notes of such Series, to replace stolen, lost or mutilated Notes of such
Series, to maintain paying agencies and to hold monies for payment in trust)
upon the deposit with the Trustee, in trust, of money and/or direct
obligations of or obligations guaranteed by the United States of America
which, through the payment of interest and principal in respect thereof in
accordance with their terms, will provide money in an amount sufficient to pay
the principal of and each installment of interest on the Notes of such Series
on the Final Scheduled Distribution Date for such Notes and any installment of
interest on such Notes in accordance with the terms of the Indenture and the
Notes of such Series. In the event of any such defeasance and discharge of
Notes of such Series, holders of Notes of such Series would be able to look
only to such money and/or direct obligations for payment of principal and
interest, if any, on their Notes until maturity.
46
<PAGE>
CERTAIN LEGAL ASPECTS OF THE LOANS
The following discussion contains summaries of certain legal aspects of
mortgage loans, home improvement installment sales contracts and home
improvement installment loan agreements which are general in nature. Because
certain of such legal aspects are governed by applicable state law (which laws
may differ substantially), the summaries do not purport to be complete nor
reflect the laws of any particular state (other than, in some cases, the
states of Maryland, Virginia and the District of Columbia (the "Mortgage Loan
Jurisdictions") where it is anticipated most of the Properties will be
located), nor encompass the laws of all states in which the properties
securing the Loans are situated.
MORTGAGES
The Loans for a Series will, and certain Home Improvement Contracts for a
Series may, be secured by either mortgages or deeds of trust or deeds to
secure debt (such Mortgage Loans and Home Improvement Contracts are
hereinafter referred to in this section as "mortgage loans"), depending upon
the prevailing practice in the state in which the property subject to a
mortgage loan is located. The filing of a mortgage, deed of trust or deed to
secure debt creates a lien or title interest upon the real property covered by
such instrument and represents the security for the repayment of an obligation
that is customarily evidenced by a promissory note and, with respect to Home
Improvement Contracts, the related contract. The priority of the liens is
important because, among other things, the foreclosure of a senior lien will
extinguish a junior lien, and because the holder of a senior lien generally
will have a right to receive insurance, condemnation or other proceeds before
the holder of a junior lien.
Priority between mortgages and deeds of trust (or other instruments of
record) generally depends in the first instance on the order of filing with
the appropriate government records office. Priority also may be affected by
the express terms of the mortgage or deed of trust.
Although priority among liens on the same property generally depends in the
first instance on the order of filing, there are a number of ways in which a
lien that is a senior lien when it is filed can become subordinate to a lien
filed at a later date. The trustee's title under a deed of trust is not prior
to any liens for real estate taxes and assessments, certain federal liens
(including certain federal criminal liens, environmental liens and tax liens),
certain mechanics and materialmen's liens, and other liens given priority by
applicable law. For example, in some jurisdictions, if advances are made under
the deed of trust after another lien (such as a judgment or mechanics lien) is
filed, the advances made after the filing of the intervening lien may be
subordinate to the intervening lien. In addition, in Virginia, the priority of
a mechanics lien may relate back to a date that substantially precedes the
date on which the mechanics lien is actually filed. Therefore, since a title
report or title policy only is accurate as of the date it is issued, it
provides no assurance that a deed of trust will retain perpetually the lien
priority it had when it was filed. The mortgages and deeds of trust securing
the Real Estate Loans include a requirement that each borrower maintain the
lien priority of each deed of trust.
There are two parties to a mortgage: the mortgagor, who is the
borrower/property owner or the land trustee (as described below), and the
mortgagee, who is the lender. Under the mortgage instrument, the mortgagor
delivers to the mortgagee a note or bond and the mortgage. In the case of a
land trust, there are three parties because title to the property is held by a
land trustee under a land trust agreement of which the borrower/property owner
is the beneficiary; at origination of a mortgage loan, the borrower executes a
separate undertaking to make payments on the mortgage note. Under a deed of
trust, the homeowner or borrower, called the "grantor," grants the security
property to a third-party grantee, called the "trustee," for the benefit of
the lender, usually called the "beneficiary." The deed of trust gives the
trustee the authority, if the borrower defaults, to sell the security property
in a "foreclosure" or "trustee's sale" and to apply the sale proceeds to the
secured debt. The mortgagee's authority under a mortgage and the trustee's
authority under a deed of trust are governed by the law of the state in which
the real property is located, the express provisions of the mortgage or deed
of trust, and, in some cases, in deed of trust transactions, the directions of
the beneficiary.
47
<PAGE>
FORECLOSURE ON MORTGAGES AND DEEDS OF TRUST
Foreclosure of a mortgage is generally accomplished by judicial action.
Generally, the action is initiated by the service of legal pleadings upon all
parties having an interest of record in the real property. Delays in
completion of the foreclosure occasionally may result from difficulties in
locating necessary parties defendant. When the mortgagee's right to
foreclosure is contested, the legal proceedings necessary to resolve the issue
can be time-consuming and expensive. After the completion of a judicial
foreclosure proceeding, the court may issue a judgment of foreclosure and
appoint a receiver or other officer to conduct the sale of the property. In
some states, mortgages may also be foreclosed without a judicial proceeding,
pursuant to a power of sale provided in the mortgage. Foreclosure of a
mortgage by using an advertisement is essentially similar to foreclosure of a
deed of trust by nonjudicial power of sale.
If a borrower defaults under a loan secured by a deed of trust, the lender
generally may bring suit against the borrower. The lender generally also may
attempt to collect the loan by causing the deed of trust to be enforced
against the property it encumbers. Enforcement of a deed of trust is
accomplished in most cases by a trustee's sale in which the trustee, upon
default of the grantor, and subject to the expiration of applicable cure
periods, sells the security property at a public sale under the terms of the
loan documents and subject to the applicable procedural provisions of state
law.
In Maryland, a summary court proceeding must be commenced (and a bond must
be filed) to effect a trustee's sale, even under a deed of trust that includes
a power of sale. In Virginia and the District of Columbia, a trustee's sale
generally is non-judicial, although foreclosure may be accomplished by
judicial action in all of the Mortgage Loan Jurisdictions. The term
"foreclosure" often is used as a shorthand way of referring to a trustee's
sale as well as to judicial foreclosure.
In Maryland and the District of Columbia, prior to a trustee's sale, the
trustee must record a notice of sale in the public records. In all of the
Mortgage Loan Jurisdictions, the trustee must give notice of the sale to the
grantor and/or to any successor in interest to the grantor. The trustee also
generally will give notice of the sale to the beneficiary of any junior deed
of trust or other lien and to certain other interested persons. This notice to
junior lien holders is required in Maryland and Virginia. In the Mortgage Loan
Jurisdictions, in addition to the notice to the grantor and others described
above, notice of sale must be published periodically in a local newspaper for
a prescribed period prior to the trustee's sale.
The trustee's sale generally must be conducted by public auction in the
county or city in which all or some part of the security property is located.
At the sale, the trustee generally requires a bidder to deposit with the
trustee a set amount or a percentage of the full amount of the bidder's final
bid in cash (or an equivalent thereto satisfactory to the trustee) prior to
and as a condition to recognizing such bid, and may conditionally accept and
hold these amounts for the duration of the sale. The beneficiary of the deed
of trust generally need not bid cash at the sale, but may instead make a
"credit bid" up to the extent of the total amount due under the deed of trust,
including costs and expenses actually incurred in enforcing the deed of trust,
as well as the trustee's fees and expenses. The trustee will sell the security
property to the highest proper bidder at the sale. Other than in Maryland,
judicial confirmation typically is not required after a sale conducted in
accordance with a power of sale in the Mortgage Loan Jurisdictions.
A sale conducted in accordance with the terms of the power of sale contained
in the deed of trust generally is presumed to be conducted regularly and
fairly, and, on a conveyance of the property by trustee's deed, confers
absolute legal title to the property to the purchaser, free of all junior
deeds of trust and free of all other liens and claims subordinate to the deed
of trust under which the sale is made. The purchaser's title, however, is
subject to all senior liens and other senior claims. Thus, if the deed of
trust being enforced is a junior deed of trust such as the deeds of trust
securing most of the Mortgage Loans, the trustee will convey title to the
property to the purchaser subject to the first deed of trust and any other
prior liens and claims. A trustee's sale or judicial foreclosure under a
junior deed of trust generally has no effect on any senior deed of trust, with
the possible exception of the right of a senior beneficiary to accelerate its
indebtedness under a default clause or a "due-on-sale" clause contained in the
senior deed of trust.
48
<PAGE>
Because a potential buyer at the sale may find it difficult to determine the
exact status of title and other facts about the security property, and because
the physical condition of the security property may have deteriorated, it
generally is more common for the lender, rather than an unrelated third party,
to purchase the security property at a trustee's sale or judicial foreclosure
sale. The lender (or other purchaser at the trustee's sale) will be subject to
the burdens of ownership, including the obligations to service any senior
mortgage or deed of trust, to obtain hazard insurance and to make such repairs
at its own expense as are necessary to render the security property suitable
for resale. The lender commonly will attempt to resell the security property
and obtain the services of a real estate broker and agree to pay the broker
commission in connection with the resale. Depending upon market conditions,
the ultimate proceeds of the resale of the security property may not be high
enough to equal the lender's investment. Property securing a Mortgage Loan
held by a Trust Fund for which a REMIC election has been made that is acquired
through a trustee's sale or judicial foreclosure must be sold by the Trustee
within two years after the date on which it is acquired, unless the IRS has
granted permission to sell such Property at a later date, in order to satisfy
certain Federal income tax requirements.
The proceeds received by the lender or trustee from the sale generally are
applied first to the costs, fees and expenses of sale and then in satisfaction
of the indebtedness secured by the mortgage or deed of trust under which the
sale was conducted. Any remaining proceeds generally are payable to the
holders of junior mortgages or deeds of trust and other liens and claims in
order of their priority. Any balance remaining generally is payable to the
borrower or grantor. Following the sale, if there are insufficient proceeds to
repay the secured debt, the lender or beneficiary under the foreclosed lien
generally may obtain a deficiency judgment against the grantor.
Some courts have been faced with the issue of whether federal or state
constitutional due process requires that borrowers under mortgages or deeds of
trust receive notices in addition to the statutorily prescribed minimum. For
the most part, the courts in these cases have upheld the notice provisions and
procedures described above.
An action to foreclose a mortgage or deed of trust is an action to recover
the secured debt by enforcing the mortgagee's or trustee's rights under the
mortgage or deed of trust. It is regulated by statutes and rules and subject
throughout to the court's equitable powers. Generally, a mortgagor or grantor
is bound by the terms of the related mortgage note and the mortgage or deed of
trust as made and cannot be relieved from his default if the mortgagee or
trustee has exercised its rights in a commercially reasonable manner. However,
since a foreclosure action historically was equitable in nature, the court may
exercise equitable powers to relieve a borrower of a default and deny the
foreclosure on proof that either the borrower's default was neither willful
nor in bad faith or the lender's action established a waiver, fraud, bad
faith, or oppressive or unconscionable conduct such as to warrant a court of
equity to refuse affirmative relief to the lender. Under certain circumstances
a court of equity may relieve the borrower from an entirely technical default
where such default was not willful.
A foreclosure action is subject to most of the delays and expenses of other
lawsuits if defenses or counterclaims are interposed, sometimes requiring up
to several years to complete. Moreover, a non-collusive, regularly conducted
foreclosure sale may be challenged as a fraudulent conveyance, regardless of
the parties' intent, if a court determines that the sale was for less than
fair consideration and such sale occurred while the borrower was insolvent and
within one year (or within the state statute of limitations if the trustee in
bankruptcy elects to proceed under state fraudulent conveyance law) of the
filing of bankruptcy. Similarly, a suit against the debtor on the related
mortgage note may take several years and, generally (although not with respect
to the Mortgage Loan Jurisdictions), is a remedy alternative to foreclosure,
the mortgagee being precluded from pursuing both at the same time.
In the case of foreclosure under either a mortgage or a deed of trust, the
sale by the referee or other designated officer or by the trustee is a public
sale. However, because of the difficulty potential third party purchasers at
the sale have in determining the exact status of title and because the
physical condition of the property may have deteriorated during the
foreclosure proceedings, it is uncommon for a third party to purchase the
property at a foreclosure sale. Rather, it is common for the lender to
purchase the property from the trustee
49
<PAGE>
or referee for an amount which may be equal to the unpaid principal amount of
the mortgage note secured by the mortgage or deed of trust plus accrued and
unpaid interest and the expenses of foreclosure, in which event the borrower's
debt will be extinguished or the lender may purchase for a lesser amount in
order to preserve its right against a borrower to seek a deficiency judgment
in states where such a judgment is available. Thereafter, subject to the right
of the borrower in some states to remain in possession during the redemption
period, the lender will assume the burdens of ownership, including obtaining
hazard insurance, paying taxes and making such repairs at its own expense as
are necessary to render the property suitable for sale. The lender will
commonly obtain the services of a real estate broker and pay the broker's
commission in connection with the sale of the property. Depending upon market
conditions, the ultimate proceeds of the sale of the property may not equal
the lender's investment in the property. Any loss may be reduced by the
receipt of any mortgage guaranty insurance proceeds.
RIGHTS OF REDEMPTION
In some states, after sale pursuant to a deed of trust or foreclosure of a
mortgage, the trustor or mortgagor and foreclosed junior lienors are given a
statutory period in which to redeem the property from the foreclosure sale.
The right of redemption should be distinguished from the equity of redemption,
which is a non-statutory right that must be exercised prior to the foreclosure
sale. In some states, redemption may occur only upon payment of the entire
principal balance of the loan, accrued interest and expenses of foreclosure.
In other states, redemption may be authorized if the former borrower pays only
a portion of the sums due. The effect of a statutory right of redemption is to
diminish the ability of the lender to sell the foreclosed property. The
exercise of a right of redemption would defeat the title of any purchaser at a
foreclosure sale, or of any purchaser from the lender subsequent to
foreclosure or sale under a deed of trust. Consequently the practical effect
of a right of redemption is to force the lender to retain the property and pay
the expenses of ownership until the redemption period has run. In some states,
there is no right to redeem property after a trustee's sale under a deed of
trust.
In the District of Columbia, the debtor under a residential deed of trust
(or anyone on the debtor's behalf) may cure a default during a reinstatement
period by paying the entire amount of the debt then due, exclusive of amounts
due solely to acceleration upon default, plus costs and expenses actually
incurred in enforcing the obligation and statutorily limited attorneys' and
trustee's fees. In all of the Mortgage Loan Jurisdictions, the grantor (or the
grantor's successor), any beneficiary under a junior deed of trust or any
other persons having a subordinate lien or encumbrance may discharge the deed
of trust on the security property by paying the entire principal due as a
result of the acceleration, together with interest and costs, expenses and
fees.
When the lender under a junior mortgage or deed of trust cures the default
and reinstates or redeems the senior mortgage or deed of trust, the amount
paid by the beneficiary for such cure generally becomes a part of the
indebtedness secured by the junior deed of trust.
State laws may control the amount of foreclosure expenses and costs,
including attorneys' fees, which may be recovered by a lender. In the Mortgage
Loan Jurisdictions, there generally is no right to redeem the security
property after the completion of a proper trustee's or foreclosure sale.
JUNIOR MORTGAGES; RIGHTS OF SENIOR MORTGAGES
The Mortgage Loans comprising or underlying the Primary Assets included in
the Trust Fund for a Series will be secured by mortgages or deeds of trust
which may be second or more junior mortgages to other mortgages held by other
lenders or institutional investors. The rights of the Trust Fund (and
therefore the Holders), under a junior mortgage or deed of trust, are
subordinate to those of the holder of the senior mortgage or deed of trust,
including the prior rights of the senior mortgagee or trustee to receive
hazard insurance and condemnation proceeds and to cause the property securing
the mortgage loan to be sold upon default of the borrower, thereby
extinguishing the junior mortgagee's lien unless the junior mortgagee or
trustee asserts its subordinate interest in the property in foreclosure
litigation and, possibly, satisfies the defaulted senior mortgage or deed of
trust. A junior lender may satisfy a defaulted senior loan in full and, in
some states, may cure such default and bring the
50
<PAGE>
senior loan current, in either event adding the amounts expended to the
balance due on the junior loan. In most states, absent a provision in the
mortgage or deed of trust, no notice of default is required to be given to a
junior mortgagee. In addition, as described above, the rights of the Trust
Fund may be or become subject to liens for real estate taxes and other
obligations. Although the Transferor generally does not cure defaults under a
senior deed of trust or other lien, it is the Transferor's standard practice
to protect its interest by monitoring any such sale of which it is aware and
bidding for property if it determines that it is in the Transferor's best
interests to do so.
The standard form of the mortgage or deed of trust used by most
institutional lenders, like that used by the Transferor, confers on the lender
the right both to receive all proceeds collected under any hazard insurance
policy and all awards made in connection with condemnation proceedings. The
lender generally has the right, subject to the specific provisions of the
mortgage or deed of trust securing its loan, to apply such proceeds and awards
to repair of any damage to the security property or to payment of any
indebtedness secured by the mortgage or deed of trust, in such order as the
lender may determine. Thus, in the event improvements on the property are
damaged or destroyed by fire or other casualty, or in the event the property
is taken by condemnation, the mortgagee or beneficiary under underlying senior
loans will have the prior right to collect any insurance proceeds payable
under a hazard insurance policy and any award of damages in connection with
the condemnation and to apply the same to the indebtedness secured by the
senior mortgages or deeds of trust. If available, proceeds in excess of the
amount of senior mortgage indebtedness, in most cases, will be applied to the
indebtedness of a junior mortgage.
The form of deed of trust or mortgage used by most institutional lenders
which make revolving home equity loans typically contains a "future advance"
clause, which provides, in essence, that additional amounts advanced to or on
behalf of the borrower by the beneficiary or lender are to be secured by the
deed of trust or mortgage. In Maryland, a future advance may be entitled to
receive the same priority as amounts initially advanced under the deed of
trust, notwithstanding that there may be intervening junior deeds of trust and
other liens between the date of recording of the deed of trust and the date of
the future advance, and notwithstanding that the beneficiary had actual
knowledge of such intervening deeds of trust and other liens at the time of
the advance so long as the additional amounts are within the maximum principal
amount stated in the deed of trust. In Virginia and the District of Columbia,
an intervening lien may gain priority, even if the lender had no knowledge of
the intervening lien at the time of an additional advance. The priority of
future advances over intervening liens may be affected in some states by
whether the beneficiary is obligated to advance the additional amount or has
notice or actual knowledge of the intervening junior deeds of trust and other
liens. In Maryland, priority of advances under the clause rests on a statute
giving priority to all advances or readvances made under the loan agreement to
a "credit limit" amount stated in the recorded deed of trust.
Other provisions typically found in the form of the mortgage or deed of
trust used by institutional lenders obligate the grantor or mortgagor to pay
before delinquency all taxes and assessments on the property and, when due,
all encumbrances, charges and liens on the property which appear prior to the
mortgage or deed of trust, to provide and maintain fire insurance on the
property, to maintain and repair the property and not to commit or permit any
waste thereof, and to appear in and defend any action or proceeding purporting
to affect the property or the rights of the mortgagee under the mortgage. Upon
a failure of the grantor or mortgagor to perform any of these obligations, the
mortgagee, trustee or beneficiary is given the right under certain mortgages
and deeds of trust to perform the obligation itself, at its election, with the
mortgagor agreeing to reimburse any sums so expended. The mortgage or deed of
trust typically provides that all sums so expended by the mortgagee,
beneficiary or trustee become part of the indebtedness secured by the
mortgage.
ANTI-DEFICIENCY LEGISLATION AND OTHER LIMITATIONS ON LENDERS
Certain states have imposed statutory prohibitions which limit the remedies
of a beneficiary under a deed of trust or a mortgagee under a mortgage. In
some states, statutes limit the right of the beneficiary or mortgagee to
obtain a deficiency judgment against the borrower following foreclosure or
sale under a deed of trust. A deficiency judgment is a personal judgment
against the former borrower equal in most cases to the difference
51
<PAGE>
between the net amount realized upon the public sale of the real property and
the amount due to the lender. Other statutes require the beneficiary or
mortgagee to exhaust the security afforded under a deed of trust or mortgage
by foreclosure in an attempt to satisfy the full debt before bringing a
personal action against the borrower. In certain other states, the lender has
the option of bringing a personal action against the borrower on the debt
without first exhausting such security; however, in some of these states, the
lender, following judgment on such personal action, may be deemed to have
elected a remedy and may be precluded from exercising remedies with respect to
the security. Consequently, the practical effect of the election requirement,
when applicable, is that lenders will usually proceed first against the
security rather than bringing a personal action against the borrower. Finally,
other statutory provisions limit any deficiency judgment against the former
borrower following a foreclosure sale to the excess of the outstanding debt
over the fair market value of the property at the time of the public sale. The
purpose of these statutes is generally to prevent a beneficiary or a mortgagee
from obtaining a large deficiency judgment against the former borrower as a
result of low or no bids at the foreclosure sale.
In addition to laws limiting or prohibiting deficiency judgments, numerous
other statutory provisions, including the federal bankruptcy laws, the Federal
Soldiers' and Sailors' Relief Act and state laws affording relief to debtors,
may interfere with or affect the ability of the secured lender to realize upon
collateral and/or enforce a deficiency judgment. For example, with respect to
federal bankruptcy law, the filing of a petition acts as a stay against the
enforcement of remedies for collection of a debt. Moreover, a court with
federal bankruptcy jurisdiction may permit a debtor through a Chapter 13
Bankruptcy Code rehabilitative plan to cure a monetary default with respect to
a loan on a debtor's residence by paying arrearages within a reasonable time
period and reinstating the original loan payment schedule even though the
lender accelerated the loan and the lender has taken all steps to realize upon
its security (provided no sale of the property has yet occurred) prior to the
filing of the debtor's Chapter 13 petition. Some courts with federal
bankruptcy jurisdiction have approved plans, based on the particular facts of
the reorganization case, that effected the curing of a loan default by
permitting the obligor to pay arrearages over a number of years.
Courts with federal bankruptcy jurisdiction have also indicated that the
terms of a mortgage loan may be modified if the borrower has filed a petition
under Chapter 13. These courts have suggested that such modifications may
include reducing the amount of each monthly payment, changing the rate of
interest, altering the repayment schedule and reducing the lender's security
interest to the value of the residence, thus leaving the lender a general
unsecured creditor for the difference between the value of the residence and
the outstanding balance of the loan. Federal bankruptcy law and limited case
law indicate that the foregoing modifications could not be applied to the
terms of a loan secured by property that is the principal residence of the
debtor. In all cases, the secured creditor is entitled to the value of its
security plus post-petition interest, attorney's fees and costs to the extent
the value of the security exceeds the debt.
In a Chapter 11 case under the Bankruptcy Code, the lender is precluded from
foreclosing without authorization from the bankruptcy court. The lender's lien
may be transferred to other collateral and/or be limited in amount to the
value of the lender's interest in the collateral as of the date of the
bankruptcy. The loan term may be extended, the interest rate may be adjusted
to market rates and the priority of the loan may be subordinated to bankruptcy
court-approved financing. The bankruptcy court can, in effect, invalidate due-
on-sale clauses through confirmed Chapter 11 plans of reorganization.
The Bankruptcy Code provides priority to certain tax liens over the lender's
security. This may delay or interfere with the enforcement of rights in
respect of a defaulted Loan. In addition, substantive requirements are imposed
upon lenders in connection with the origination and the servicing of mortgage
loans by numerous federal and some state consumer protection laws. The laws
include the federal Truth-in-Lending Act, Real Estate Settlement Procedures
Act, Equal Credit Opportunity Act, Fair Credit Billing Act, Fair Credit
Reporting Act and related statutes and regulations. These federal laws impose
specific statutory liabilities upon lenders who originate loans and who fail
to comply with the provisions of the law. In some cases, this liability may
affect assignees of the loans.
52
<PAGE>
DUE-ON-SALE CLAUSES IN MORTGAGE LOANS
Due-on-sale clauses permit the lender to accelerate the maturity of the loan
if the borrower sells or transfers, whether voluntarily or involuntarily, all
or part of the real property securing the loan without the lender's prior
written consent. The enforceability of these clauses has been the subject of
legislation or litigation in many states, and in some cases, typically
involving single family residential mortgage transactions, their
enforceability has been limited or denied. In any event, the Garn-St Germain
Depository Institutions Act of 1982 (the "Garn-St Germain Act") preempts state
constitutional, statutory and case law that prohibits the enforcement of due-
on-sale clauses and permits lenders to enforce these clauses in accordance
with their terms, subject to certain exceptions. As a result, due-on-sale
clauses have become generally enforceable except in those states whose
legislatures exercised their authority to regulate the enforceability of such
clauses with respect to mortgage loans that were (i) originated or assumed
during the "window period" under the Garn-St Germain Act which ended in all
cases not later than October 15, 1982, and (ii) originated by lenders other
than national banks, federal savings institutions and federal credit unions.
FHLMC has taken the position in its published mortgage servicing standards
that, out of a total of eleven "window period states," five states (Arizona,
Michigan, Minnesota, New Mexico and Utah) have enacted statutes extending, on
various terms and for varying periods, the prohibition on enforcement of due-
on-sale clauses with respect to certain categories of window period loans.
Also, the Garn-St Germain Act does "encourage" lenders to permit assumption of
loans at the original rate of interest or at some other rate less than the
average of the original rate and the market rate.
In addition, under federal bankruptcy law, due-on-sale clauses may not be
enforceable in bankruptcy proceedings and may, under certain circumstances, be
eliminated in any modified mortgage resulting from such bankruptcy proceeding.
ENFORCEABILITY OF PREPAYMENT AND LATE PAYMENT FEES
Forms of notes, mortgages and deeds of trust used by lenders may contain
provisions obligating the borrower to pay a late charge if payments are not
timely made, and in some circumstances may provide for prepayment fees or
penalties if the obligation is paid prior to maturity. In certain states,
there are or may be specific limitations upon the late charges which a lender
may collect from a borrower for delinquent payments. Certain states also limit
the amounts that a lender may collect from a borrower as an additional charge
if the loan is prepaid. Late charges and prepayment fees are typically
retained by servicers as additional servicing compensation.
EQUITABLE LIMITATIONS ON REMEDIES
In connection with lenders' attempts to realize upon their security, courts
have invoked general equitable principles. The equitable principles are
generally designed to relieve the borrower from the legal effect of his
defaults under the loan documents. Examples of judicial remedies that have
been fashioned include judicial requirements that the lender undertake
affirmative and expensive actions to determine the causes of the borrower's
default and the likelihood that the borrower will be able to reinstate the
loan. In some cases, courts have substituted their judgment for the lender's
judgment and have required that lenders reinstate loans or recast payment
schedules in order to accommodate borrowers who are suffering from temporary
financial disability. In other cases, courts have limited the right of a
lender to realize upon his security if the default under the security
agreement is not monetary, such as the borrower's failure adequately to
maintain the property or the borrower's execution of secondary financing
affecting the property. Finally, some courts have been faced with the issue of
whether or not federal or state constitutional provisions reflecting due
process concerns for adequate notice require that borrowers under security
agreements receive notices in addition to the statutorily-prescribed minimums.
For the most part, these cases have upheld the notice provisions as being
reasonable or have found that, in cases involving the sale by a trustee under
a deed of trust or by a mortgagee under a mortgage having a power of sale,
there is insufficient state action to afford constitutional protections to the
borrower.
Most conventional single-family mortgage loans may be prepaid in full or in
part without penalty. The regulations of the Office of Thrift Supervision (the
"OTS") prohibit the imposition of a prepayment penalty or
53
<PAGE>
equivalent fee for or in connection with the acceleration of a loan by
exercise of a due-on-sale clause. A mortgagee to whom a prepayment in full has
been tendered may be compelled to give either a release of the mortgage or an
instrument assigning the existing mortgage. The absence of a restraint on
prepayment, particularly with respect to mortgage loans having higher mortgage
rates, may increase the likelihood of refinancing or other early retirements
of such mortgage loans.
APPLICABILITY OF USURY LAWS
Each Mortgage Loan Jurisdiction has usury laws which limit the interest and
other amounts that may be charged under certain loans. Title V of the
Depository Institutions Deregulation and Monetary Control Act of 1980, enacted
in March 1980 ("Title V"), provides that state usury limitations shall not
apply to certain types of residential first mortgage loans originated by
certain lenders after March 31, 1980. Similar federal statutes were in effect
with respect to mortgage loans made during the first three months of 1980. The
OTS, as successor to the Federal Home Loan Bank Board, is authorized to issue
rules and regulations and to publish interpretations governing implementation
of Title V. Title V authorizes any state to reimpose interest rate limits by
adopting, before April 1, 1983, a state law, or by certifying that the voters
of such state have voted in favor of any provision, constitutional or
otherwise, which expressly rejects an application of the federal law. Any
contract which is secured by a first lien on certain kinds of consumer goods
would be covered if they satisfy certain conditions, among other things,
governing the terms of any prepayments, late charges and deferral fees and
requiring a 30-day notice period prior to instituting any action leading to
repossession of the related unit. Fifteen states adopted such a law prior to
the April 1, 1983 deadline. In addition, even where Title V is not so
rejected, any state is authorized by the law to adopt a provision limiting
discount points or other charges on mortgage loans covered by Title V.
THE HOME IMPROVEMENT CONTRACTS
General
The Home Improvement Contracts, other than those Home Improvement Contracts
that are unsecured or secured by mortgages on real estate (such Home
Improvement Contracts are hereinafter referred to in this section as
"contracts"), generally are "chattel paper" or constitute "purchase money
security interests" each as defined in the Uniform Commercial Code (the
"UCC"). Pursuant to the UCC, the sale of chattel paper is treated in a manner
similar to perfection of a security interest in chattel paper. Under the
related Agreement, the Transferor will transfer physical possession of the
contracts to the Trustee or a designated custodian or may retain possession of
the contracts as custodian for the Trustee. In addition, the Transferor will
make an appropriate filing of a UCC-1 financing statement in the appropriate
states to give notice of the Trustee's ownership of the contracts. Unless
otherwise specified in the related Prospectus Supplement, the contracts will
not be stamped or otherwise marked to reflect their assignment from the
Transferor to the Trustee. Therefore, if through negligence, fraud or
otherwise, a subsequent purchaser were able to take physical possession of the
contracts without notice of such assignment, the Trustee's interest in the
contracts could be defeated.
Security Interests in Home Improvements
The contracts that are secured by the Home Improvements financed thereby
grant to the originator of such contracts a purchase money security interest
in such Home Improvements to secure all or part of the purchase price of such
Home Improvements and related services. A financing statement generally is not
required to be filed to perfect a purchase money security interest in consumer
goods. Such purchase money security interests are assignable. In general, a
purchase money security interest grants to the holder a security interest that
has priority over a conflicting security interest in the same collateral and
the proceeds of such collateral. However, to the extent that the collateral
subject to a purchase money security interest becomes a fixture, in order for
the related purchase money security interest to take priority over a
conflicting interest in the fixture, the holder's interest in such Home
Improvement must generally be perfected by a timely fixture filing. In
general, a security interest does not exist under the UCC in ordinary building
material incorporated into an improvement on land.
54
<PAGE>
Home Improvement Contracts that finance lumber, bricks, other types of
ordinary building material or other goods that are deemed to lose such
characterization, upon incorporation of such materials into the related
property, will not be secured by a purchase money security interest in the
Home Improvement being financed.
Enforcement of Security Interest in Home Improvements
So long as the Home Improvement has not become subject to the real estate
law, a creditor can repossess a Home Improvement securing a contract by
voluntary surrender, by "self-help" repossession that is "peaceful" (i.e.,
without breach of the peace) or, in the absence of voluntary surrender and the
ability to repossess without breach of the peace, by judicial process. The
holder of a contract must give the debtor a number of days' notice, which
varies from 10 to 30 days depending on the state, prior to commencement of any
repossession. The UCC and consumer protection laws in most states place
restrictions on repossession sales, including requiring prior notice to the
debtor and commercial reasonableness in effecting such a sale. The law in most
states also requires that the debtor be given notice of any sale prior to
resale of the unit so that the debtor may redeem it at or before such resale.
Under the laws applicable in most states, a creditor is entitled to obtain a
deficiency judgment from a debtor for any deficiency on repossession and
resale of the property securing the debtor's loan. However, some states impose
prohibitions or limitations on deficiency judgments, and in many cases the
defaulting borrower would have no assets with which to pay a judgment.
Certain other statutory provisions, including federal and state bankruptcy
and insolvency laws and general equitable principles, may limit or delay the
ability of a lender to repossess and resell collateral or enforce a deficiency
judgment.
Consumer Protection Laws
The so-called "Holder-in-Due-Course" rule of the Federal Trade Commission is
intended to defeat the ability of the transferor of a consumer credit contract
which is the seller of goods which gave rise to the transaction (and certain
related lenders and assignees) to transfer such contract free of notice of
claims by the debtor thereunder. The effect of this rule is to subject the
assignee of such a contract to all claims and defenses which the debtor could
assert against the seller of goods. Liability under this rule is limited to
amounts paid under a contract; however, the obligor also may be able to assert
the rule to set off remaining amounts due as a defense against a claim brought
by the Trustee against such obligor. Numerous other federal and state consumer
protection laws impose requirements applicable to the origination and lending
pursuant to the contracts, including the Truth in Lending Act, the Federal
Trade Commission Act, the Fair Credit Billing Act, the Fair Credit Reporting
Act, the Equal Credit Opportunity Act, the Fair Debt Collection Practices Act
and the Uniform Consumer Credit Code. In the case of some of these laws, the
failure to comply with their provisions may affect the enforceability of the
related contract.
INSTALLMENT SALES CONTRACTS
The Loans may also consist of installment sales contracts. Under an
installment sales contract ("Installment Sales Contract") the seller
(hereinafter referred to in this section as the "lender") retains legal title
to the property and enters into an agreement with the purchaser (hereinafter
referred to in this section as the "borrower") for the payment of the purchase
price, plus interest, over the term of such contract. Only after full
performance by the borrower of the contract is the lender obligated to convey
title to the property to the purchaser. As with mortgage or deed of trust
financing, during the effective period of the Installment Sales Contract, the
borrower is generally responsible for maintaining the property in good
condition and for paying real estate taxes, assessments and hazard insurance
premiums associated with the property.
The method of enforcing the rights of the lender under an Installment Sales
Contract varies on a state-by-state basis depending upon the extent to which
state courts are willing, or able pursuant to state statute, to enforce
55
<PAGE>
the contract strictly according to the terms. The terms of Installment Sales
Contracts generally provide that upon a default by the borrower, the borrower
loses his or her right to occupy the property, the entire indebtedness is
accelerated, and the buyer's equitable interest in the property is forfeited.
The lender in such a situation does not have to foreclose in order to obtain
title to the property, although in some cases a quiet title action is in order
if the borrower has filed the Installment Sales Contract in local land
records, and an ejectment action may be necessary to recover possession. In a
few states, particularly in cases of borrower default during the early years
of an Installment Sales Contract, the courts will permit ejectment of the
buyer and a forfeiture of his or her interest in the property. However, most
state legislatures have enacted provisions by analogy to mortgage law
protecting borrowers under Installment Sales Contracts from the harsh
consequences of forfeiture. Under such statutes, a judicial or nonjudicial
foreclosure may be required, the lender may be required to give notice of
default and the borrower may be granted some grace period during which the
Installment Sales Contract may be reinstated upon full payment of the default
amount and the borrower may have a post-foreclosure statutory redemption
right. In other states, courts in equity may permit a borrower with
significant investment in the property under an Installment Sales Contract for
the sale of real estate to share in the proceeds of sale of the property after
the indebtedness is repaid or may otherwise refuse to enforce the forfeiture
clause. Nevertheless, generally speaking, the lender's procedures for
obtaining possession and clear title under an Installment Sales Contract in a
given state are simpler and less time-consuming and costly than are the
procedures for foreclosing and obtaining clear title to a property subject to
one or more liens.
ENVIRONMENTAL LEGISLATION
A federal statute, the Comprehensive Environmental Response, Compensation,
and Liability Act of 1980, and a growing number of state laws impose a
statutory lien for associated costs on property that is the subject of a
clean-up action on account of hazardous wastes or hazardous substances
released or disposed of on the property. Such a lien generally will have
priority over all subsequent liens on the property and, in certain of these
states, will have priority over prior recorded liens, including the lien of a
deed of trust. The priority of the environmental lien under federal law
depends on the time of perfection of the federal lien compared to the time of
perfection of any competing liens under applicable state law. In addition,
under federal environmental legislation and possibly under state law in a
number of states, a secured party that takes a deed in lieu of foreclosure or
acquires a property at a foreclosure sale may be liable for the costs of
cleaning up a contaminated site. Although such costs could be substantial,
they would probably not be imposed on a secured lender (such as the applicable
Trust Fund) if it promptly marketed the foreclosed property for resale. In the
event that a Trust Fund acquired title to a property securing a Mortgage Loan
and cleanup costs were incurred in respect of the property, the holders of the
Securities might incur a delay in the payment if such costs were required to
be paid by such Trust Fund.
SOLDIERS' AND SAILORS' CIVIL RELIEF ACT OF 1940
Under the Soldiers' and Sailors' Civil Relief Act of 1940, members of all
branches of the military on active duty, including draftees and reservists in
military service, (i) are entitled to have interest rates reduced and capped
at 6% per annum, on obligations (including Loans) incurred prior to the
commencement of military service for the duration of military service, (ii)
may be entitled to a stay of proceedings on any kind of foreclosure or
repossession action in the case of defaults on such obligations entered into
prior to military service for the duration of military service and (iii) may
have the maturity of such obligations incurred prior to military service
extended, the payments lowered and the payment schedule readjusted for a
period of time after the completion of military service. However, the benefits
of (i), (ii), or (iii) above are subject to challenge by creditors and if, in
the opinion of the court, the ability of a person to comply with such
obligations is not materially impaired by military service, the court may
apply equitable principles accordingly. If a borrower's obligation to repay
amounts otherwise due on a Loan included in a Trust Fund for a Series is
relieved pursuant to the Soldiers' and Sailors' Civil Relief Act of 1940, none
of the Trust Fund, the Servicer, the Transferor nor the Trustee will be
required to advance such amounts, and any loss in respect thereof may reduce
the amounts available to be paid to the Holders of the Securities of such
Series. Unless otherwise specified in the related Prospectus Supplement,
56
<PAGE>
any shortfalls in interest collections on Loans or Underlying Loans relating
to the Private Securities, as applicable, included in a Trust Fund for a
Series resulting from application of the Soldiers' and Sailors' Civil Relief
Act of 1940 will be allocated to each Class of Securities of such Series that
is entitled to receive interest in respect of such Loans or Underlying Loans
in proportion to the interest that each such Class of Securities would have
otherwise been entitled to receive in respect of such Loans or Underlying
Loans had such interest shortfall not occurred.
THE TRANSFEROR
The Transferor is a federally chartered stock savings bank. The Transferor's
executive offices are located at 8401 Connecticut Avenue, Chevy Chase,
Maryland 20815, and the Transferor's telephone number is (301) 986-7000. The
Transferor is subject to comprehensive regulation, examination and supervision
by the OTS within the Department of the Treasury and the FDIC. Deposits at the
Transferor are fully insured up to $100,000 per insured depositor by the
Savings Association Insurance Fund, which is administered by the FDIC. For
further information regarding the Transferor, see "THE TRANSFEROR" in the
related Prospectus Supplement.
USE OF PROCEEDS
The Transferor will apply all or substantially all of the net proceeds from
the sale of each Series of Certificates for one or more of the following
purposes: (i) to establish any Reserve Fund, Pre-Funding Account or
Capitalized Interest Account, (ii) to pay costs of structuring and issuing
such Securities, including the costs of obtaining Enhancement and (iii) for
its general corporate purposes.
FEDERAL INCOME TAX CONSIDERATIONS
GENERAL
The following summary is based on the opinion of Stroock & Stroock & Lavan,
special counsel to the Transferor ("Federal Tax Counsel"), as to the material
federal income tax consequences of the purchase, ownership and disposition of
Securities. The summary does not purport to deal with all aspects of federal
income taxation that may affect particular investors in light of their
individual circumstances, nor with certain types of investors subject to
special treatment under the federal income tax laws. This summary focuses
primarily upon investors who will hold Securities as "capital assets"
(generally, property held for investment) within the meaning of Section 1221
of the Internal Revenue Code of 1986, as amended (the "Code"), but much of the
discussion is applicable to other investors as well. Because tax consequences
may vary based on the status or tax attributes of the owner of a Security,
prospective investors are advised to consult their own tax advisors concerning
the federal, state, local and any other tax consequences to them of the
purchase, ownership and disposition of the Securities. For purposes of this
tax discussion (except with respect to information reporting, or where the
context indicates otherwise), any reference to the "Holder" means the
beneficial owner of a Security.
The summary is based upon the provisions of the Code, the regulations
promulgated thereunder, including, where applicable, proposed regulations, and
the judicial and administrative rulings and decisions now in effect, all of
which are subject to change or possible differing interpretations. The
statutory provisions, regulations, and interpretations on which this
interpretation is based are subject to change, and such a change could apply
retroactively.
The federal income tax consequences to Holders will vary depending on
whether (i) the Securities of a Series are classified as indebtedness for
federal income tax purposes; (ii) an election is made to treat the Trust Fund
(or certain assets of the Trust Fund) relating to a particular Series of
Securities as a real estate mortgage investment conduit ("REMIC") under the
Code; (iii) the Securities represent an ownership interest for federal income
tax purposes in some or all of the assets included in the Trust Fund for a
Series; or (iv) for federal income
57
<PAGE>
tax purposes the Trust Fund relating to a particular Series of Certificates is
classified as a partnership. The Prospectus Supplement for each Series of
Securities will specify how the Securities will be treated for federal income
tax purposes and will discuss whether a REMIC election, if any, will be made
with respect to such Series.
TAXATION OF DEBT SECURITIES (INCLUDING REGULAR INTEREST SECURITIES)
Interest and Acquisition Discount. Securities representing regular interest
in a REMIC ("Regular Interest Securities") are generally taxable to Holders in
the same manner as evidences of indebtedness issued by the REMIC. Stated
interest on the Regular Interest Securities will be taxable as ordinary income
and taken into account using the accrual method of accounting, regardless of
the Holder's normal accounting method. Interest (other than original issue
discount) on Securities (other than Regular Interest Securities) that are
characterized as indebtedness for federal income tax purposes will be
includible in income by Holders thereof in accordance with their usual methods
of accounting. Securities characterized as debt for federal income tax
purposes and Regular Interest Securities will be referred to hereinafter
collectively as "Debt Securities." For Certificates treated as debt for
federal income tax purposes, see "Certain Certificates Treated as
Indebtedness."
Debt Securities that are Compound Interest Securities will, and certain of
the other Debt Securities may, be issued with "original issue discount"
("OID"). The following discussion is based in part on the rules governing OID
which are set forth in Sections 1271-1275 of the Code and the Treasury
regulations issued thereunder on February 2, 1994 (the "OID Regulations"). A
Holder should be aware, however, that the OID Regulations do not adequately
address certain issues relevant to prepayable securities, such as the Debt
Securities.
In general, OID, if any, will equal the difference between the stated
redemption price at maturity of a Debt Security and its issue price. A Holder
of a Debt Security must include such OID in gross income as ordinary interest
income as it accrues under a prescribed method which takes into account an
economic accrual of the discount. In general, OID must be included in income
in advance of the receipt of the cash representing that income. The amount of
OID on a Debt Security will be considered to be zero if it is less than a de
minimis amount determined under the Code.
The issue price of a Debt Security is the first price at which a substantial
amount of Debt Securities of that class are sold to the public (excluding bond
houses, brokers, underwriters or wholesalers). If less than a substantial
amount of a particular class of Debt Securities is sold for cash on or prior
to the Closing Date, the issue price for such class will be treated as the
fair market value of such class on the Closing Date. The stated redemption
price at maturity of a Debt Security includes the original principal amount of
the Debt Security, but generally will not include distributions of interest if
such distributions constitute "qualified stated interest."
Under the OID Regulations, interest payments will not be qualified stated
interest unless the interest payments are "unconditionally payable." The OID
Regulations state that interest is unconditionally payable if late payment of
interest (other than late payment that occurs within a reasonable grace
period) or nonpayment of interest is expected to be penalized or reasonable
remedies exist to compel payment. The meaning of "penalized" under the OID
regulations is unclear particularly in the case of obligations based on other
debt obligations. Interest payments on Debt Securities which do not have
reasonable remedies to compel timely payment of interest may not be qualified
stated interest, and such Debt Securities may have original issue discount.
Certain Debt Securities will provide for distributions of interest based on
a period that is the same length as the interval between Distribution Dates
but ends prior to each Distribution Date. Any interest that accrues prior to
the Closing Date may be treated under the OID Regulations either (i) as part
of the issue price and the stated redemption price at maturity of the Debt
Securities or (ii) as not included in the issue price or stated redemption
price. The OID Regulations provide a special application of the de minimis
rule for debt instruments with long first accrual periods where the interest
payable for the first period is at a rate which is effectively less than that
which applies in all other periods. In such cases, for the sole purpose of
determining whether original issue discount is de minimis, the OID Regulations
provide that the stated redemption price is equal to the instrument's
58
<PAGE>
issue price plus the greater of the amount of foregone interest or the excess
(if any) of the instrument's stated principal amount over its issue price.
Under the de minimis rule, OID on a Debt Security will be considered to be
zero if such OID is less than 0.25% of the stated redemption price at maturity
of the Debt Security multiplied by the weighted average maturity of the Debt
Security. For this purpose, the weighted average maturity of the Debt Security
is computed as the sum of the amounts determined by multiplying the number of
full years (i.e., rounding down partial years) from the issue date until each
distribution in reduction of stated redemption price at maturity is scheduled
to be made by a fraction, the numerator of which is the amount of each
distribution included in the stated redemption price at maturity of the Debt
Security and the denominator of which is the stated redemption price at
maturity of the Debt Security. Holders generally must report de minimis OID
pro rata as principal payments are received, and such income will be capital
gain if the Debt Security is held as a capital asset. However, accrual method
Holders may elect to accrue all de minimis OID as well as market discount
under a constant interest method. See "--Election to Treat All Interest as
Original Issue Discount".
The Holder of a Debt Security issued with OID must include in gross income,
for all days during its taxable year on which it holds such Debt Security, the
sum of the "daily portions" of such original issue discount. The amount of OID
includible in income by a Holder will be computed by allocating to each day
during a taxable year a pro rata portion of the original issue discount that
accrued during the relevant accrual period. In the case of a Debt Security
that is not a Regular Interest Security and the principal payments on which
are not subject to acceleration resulting from prepayments on the Loans, the
amount of OID includible in income of a Holder for an accrual period
(generally the period over which interest accrues on the debt instrument) will
equal the product of the yield to maturity of the Debt Security and the
adjusted issue price of the Debt Security, reduced by any payments of
qualified stated interest. The adjusted issue price is the sum of its issue
price plus prior accruals of OID, reduced by the total payments made with
respect to such Debt Security in all prior periods, other than qualified
stated interest payments.
The amount of OID to be included in income by a Holder of a debt instrument,
such as certain Classes of the Debt Securities, that is subject to
acceleration due to prepayments on other debt obligations securing such
instruments (a "Pay-Through Security"), is computed by taking into account the
anticipated rate of prepayments assumed in pricing the debt instrument (the
"Prepayment Assumption"). The amount of OID that will accrue during an accrual
period on a Pay-Through Security is the excess (if any) of the sum of (a) the
present value of all payments remaining to be made on the Pay-Through Security
as of the close of the accrual period and (b) the payments during the accrual
period of amounts included in the stated redemption price of the Pay-Through
Security, over the adjusted issue price of the Pay-Through Security at the
beginning of the accrual period. The present value of the remaining payments
is to be determined on the basis of three factors: (i) the original yield to
maturity of the Pay-Through Security (determined on the basis of compounding
at the end of each accrual period and properly adjusted for the length of the
accrual period), (ii) events which have occurred before the end of the accrual
period and (iii) the assumption that the remaining payments will be made in
accordance with the original Prepayment Assumption. The effect of this method
is to increase the portions of OID required to be included in income by a
Holder to take into account prepayments with respect to the Loans at a rate
that exceeds the Prepayment Assumption, and to decrease (but not below zero
for any period) the portions of OID required to be included in income by a
Holder of a Pay-Through Security to take into account prepayments with respect
to the Loans at a rate that is slower than the Prepayment Assumption. Although
OID will be reported to Holders of Pay-Through Securities based on the
Prepayment Assumption, no representation is made to Holders that Loans will be
prepaid at that rate or at any other rate.
The Transferor may adjust the accrual of OID on a Class of Regular Interest
Securities (or other regular interests in a REMIC) in a manner that it
believes to be appropriate, to take account of realized losses on the Loans,
although the OID Regulations do not provide for such adjustments. If the
Internal Revenue Service were to require that OID be accrued without such
adjustments, the rate of accrual of OID for a Class of Regular Interest
Securities could increase.
59
<PAGE>
Certain classes of Regular Interest Securities may represent more than one
class of REMIC regular interests. Unless the applicable Prospectus Supplement
specifies otherwise, the Trustee intends, based on the OID Regulations, to
calculate OID on such Securities as if, solely for the purposes of computing
OID, the separate regular interests were a single debt instrument.
A subsequent Holder of a Debt Security will also be required to include OID
in gross income, but such a Holder who purchases such Debt Security for an
amount that exceeds its adjusted issue price will be entitled (as will an
initial Holder who pays more than a Debt Security's issue price) to offset
such OID by comparable economic accruals of portions of such excess.
Effects of Defaults and Delinquencies. Holders will be required to report
income with respect to the related Securities under an accrual method without
giving effect to delays and reductions in distributions attributable to a
default or delinquency on the Loans, except possibly to the extent that it can
be established that such amounts are uncollectible. As a result, the amount of
income (including OID) reported by a Holder of such a Security in any period
could significantly exceed the amount of cash distributed to such Holder in
that period. The Holder will eventually be allowed a loss (or will be allowed
to report a lesser amount of income) to the extent that the aggregate amount
of distributions on the Securities is reduced as a result of a Loan default.
However, the timing and character of such losses or reductions in income are
uncertain and, accordingly, Holders of Securities should consult their own tax
advisors on this point.
Interest-Only Debt Securities. The Trust Fund intends to report income from
interest-only classes of Debt Securities to the Internal Revenue Service and
to Holders of interest-only Debt Securities based on the assumption that the
stated redemption price at maturity is equal to the sum of all payments
determined under the applicable prepayment assumption. As a result, such
interest-only Debt Securities Certificates will be treated as having original
issue discount.
Variable Rate Debt Securities. Under the OID Regulations, Debt Securities
paying interest at a variable rate (a "Variable Rate Debt Security") are
subject to special rules. A Variable Rate Debt Security will qualify as a
"variable rate debt instrument" if (i) its issue price does not exceed the
total noncontingent principal payments due under the Variable Rate Debt
Security by more than a specified de minimis amount and (ii) it provides for
stated interest, paid or compounded at least annually, at (a) one or more
qualified floating rates, (b) a single fixed rate and one or more qualified
floating rates, (c) a single objective rate or (d) a single fixed rate and a
single objective rate that is a qualified inverse floating rate.
A "qualified floating rate" is any variable rate where variations in the
value of such rate can reasonably be expected to measure contemporaneous
variations in the cost of newly borrowed funds in the currency in which the
Variable Rate Debt Security is denominated. A multiple of a qualified floating
rate will generally not itself constitute a qualified floating rate for
purposes of the OID Regulations. However, a variable rate equal to (i) the
product of a qualified floating rate and a fixed multiple that is greater than
zero but not more than 1.35 or (ii) the product of a qualified floating rate
and a fixed multiple that is greater than zero but not more than 1.35,
increased or decreased by a fixed rate will constitute a qualified floating
rate for purposes of the OID Regulations. In addition, under the OID
Regulations, two or more qualified floating rates that can reasonably be
expected to have approximately the same values throughout the term of the
Variable Rate Debt Security will be treated as a single qualified floating
rate (a "Presumed Single Qualified Floating Rate"). Two or more qualified
floating rates with values within 25 basis points of each other as determined
on the Variable Rate Debt Security's issue date will be conclusively presumed
to be a Presumed Single Qualified Floating Rate. Notwithstanding the
foregoing, a variable rate that would otherwise constitute a qualified
floating rate but which is subject to one or more restrictions such as a cap
or floor, will not be a qualified floating rate for purposes of the OID
Regulations unless the restriction is fixed throughout the term of the
Variable Rate Debt Security or the restriction will not significantly affect
the yield of the Variable Rate Debt Security.
An "objective rate" is a rate that is not itself a qualified floating rate
but which is determined using a single fixed formula and which is based upon
(i) one or more qualified floating rates, (ii) one or more rates where each
60
<PAGE>
rate would be a qualified floating rate for a debt instrument denominated in a
currency other than the currency in which the Variable Rate Debt Security is
denominated, (iii) either the yield or changes in the price of one or more
items of actively traded personal property or (iv) a combination of rates
described in (i), (ii) and (iii). The OID Regulations also provide that other
variable rates may be treated as objective rates if so designated by the
Internal Revenue Service in the future. Despite the foregoing, a variable rate
of interest on a Variable Rate Debt Security will not constitute an objective
rate if it is reasonably expected that the average value of such rate during
the first half of the Variable Rate Debt Security's term will be either
significantly less than or significantly greater than the average value of the
rate during the final half of the Variable Rate Debt Security's term. An
objective rate will qualify as a "qualified inverse floating rate" if such
rate is equal to a fixed rate minus a qualified floating rate, and variations
in the rate can reasonably be expected to reflect inversely contemporaneous
variations in the cost of newly borrowed funds. The OID Regulations also
provide that if a Variable Rate Debt Security provides for stated interest at
a fixed rate for an initial period of less than one year followed by a
variable rate that is either a qualified floating rate or an objective rate
and if the variable rate on the Variable Rate Debt Security's issue date is
intended to approximate the fixed rate, then the fixed rate and the variable
rate together will constitute either a single qualified floating rate or
objective rate, as the case may be (a "Presumed Single Variable Rate"). If the
value of the variable rate and the initial fixed rate are within 25 basis
points of each other as determined on the Variable Rate Debt Security's issue
date, the variable rate will be conclusively presumed to approximate the fixed
rate.
For Variable Rate Debt Securities that qualify as a "variable rate debt
instrument" under the OID Regulations and provide for interest at either a
single qualified floating rate, a single objective rate, a Presumed Single
Qualified Floating Rate or a Presumed Single Variable Rate throughout the term
(a "Single Variable Rate Debt Security"), original issue discount is computed
as described above based on the following: (i) stated interest on the Single
Variable Rate Debt Security which is unconditionally payable in cash or
property (other than debt instruments of the issuer) at least annually will
constitute qualified stated interest and (ii) by assuming that the variable
rate on the Single Variable Debt Security is a fixed rate equal to: (a) in the
case of a Single Variable Rate Debt Security with a qualified floating rate or
a qualified inverse floating rate, the value of, as of the issue date, the
qualified floating rate or the qualified inverse floating rate or (b) in the
case of a Single Variable Rate Debt Security with an objective rate (other
than a qualified inverse floating rate), a fixed rate which reflects the
reasonably expected yield for such Single Variable Debt Security.
In general, any Variable Rate Debt Security other than a Single Variable
Rate Debt Security (a "Multiple Variable Rate Debt Security") that qualifies
as a "variable rate debt instrument" will be converted into an "equivalent"
fixed rate debt instrument for purposes of determining the amount and accrual
of original issue discount and qualified stated interest on the Multiple
Variable Rate Debt Security. The OID Regulations generally require that such a
Multiple Variable Rate Debt Security be converted into an "equivalent" fixed
rate debt instrument by substituting any qualified floating rate or qualified
inverse floating rate provided for under the terms of the Multiple Variable
Rate Debt Security with a fixed rate equal to the value of the qualified
floating rate or qualified inverse floating rate, as the case may be, as of
the Multiple Variable Rate Debt Security's issue date. Any objective rate
(other than a qualified inverse floating rate) provided for under the terms of
the Multiple Variable Rate Debt Security is converted into a fixed rate that
reflects the yield that is reasonably expected for the Multiple Variable Rate
Debt Security. In the case of a Multiple Variable Rate Debt Security that
qualifies as a "variable rate debt instrument" and provides for stated
interest at a fixed rate in addition to either one or more qualified floating
rates or a qualified inverse floating rate, the fixed rate is initially
converted into a qualified floating rate (or a qualified inverse floating
rate, if the Multiple Variable Rate Debt Security provides for a qualified
inverse floating rate). Under such circumstances, the qualified floating rate
or qualified inverse floating rate that replaces the fixed rate must be such
that the fair market value of the Multiple Variable Rate Debt Security as of
the Multiple Variable Rate Debt Security's issue date is approximately the
same as the fair market value of an otherwise identical debt instrument that
provides for either the qualified floating rate or qualified inverse floating
rate rather than the fixed rate. Subsequent to converting the fixed rate into
either a qualified floating rate or a qualified inverse floating rate, the
Multiple Variable Rate Debt Security is then converted into an "equivalent"
fixed rate debt instrument in the manner described above.
61
<PAGE>
Once the Multiple Variable Rate Debt Security is converted into an
"equivalent" fixed rate debt instrument pursuant to the foregoing rules, the
amount of original issue discount and qualified stated interest, if any, are
determined for the "equivalent" fixed rate debt instrument by applying the
original issue discount rules to the "equivalent" fixed rate debt instrument
in the manner described above. A Holder of the Multiple Variable Rate Debt
Security will account for such original issue discount and qualified stated
interest as if the Holder held the "equivalent" fixed rate debt instrument.
Each accrual period appropriate adjustments will be made to the amount of
qualified stated interest or original issue discount assumed to have been
accrued or paid with respect to the "equivalent" fixed rate debt instrument in
the event that such amounts differ from the accrual amount of interest accrued
or paid on the Multiple Variable Rate Debt Security during the accrual period.
The OID Regulations do not clearly address the treatment of a Variable Rate
Debt Security that is based on a weighted average of the interest rates on
underlying Loans. Under the OID Regulations, interest payments on such a
Variable Rate Debt Security may be characterized as qualified stated interest
which is includible in income in a manner similar to that described in the
previous paragraph. However, it is also possible that interest payments on
such a Variable Rate Debt Security would be treated as contingent interest
(possibly includible in income when the payments become fixed) or in some
other manner.
If a Variable Rate Debt Security does not qualify as a "variable rate debt
instrument" under the OID Regulations, then the Variable Rate Debt Security
would be treated as a contingent payment debt obligation. It is not clear
under current law how a Variable Rate Debt Security would be taxed if such
Debt Security were treated as a contingent payment debt obligation.
Market Discount. A purchaser of a Security may be subject to the market
discount rules of Sections 1276-1278 of the Code. A Holder that acquires a
Debt Security with more than a prescribed de minimis amount of "market
discount" (generally, the excess of the principal amount of the Debt Security
over the purchaser's purchase price) will be required to include accrued
market discount in income as ordinary income in each month, but limited to an
amount not exceeding the principal payments on the Debt Security received in
that month and, if the Securities are sold, the gain realized. Such market
discount would accrue in a manner to be provided in Treasury regulations but,
until such regulations are issued, such market discount would in general
accrue either (i) on the basis of a constant yield (in the case of a Pay-
Through Security, taking into account a prepayment assumption) or (ii) in the
ratio of (a) in the case of Securities (or in the case of a Pass-Through
Security, as set forth below, the Loans underlying such Security) not
originally issued with original issue discount, stated interest payable in the
relevant period to total stated interest remaining to be paid at the beginning
of the period or (b) in the case of Securities (or, in the case of a Pass-
Through Security, as described below, the Loans underlying such Security)
originally issued at a discount, OID in the relevant period to total OID
remaining to be paid.
Section 1277 of the Code provides that, regardless of the origination date
of the Debt Security (or, in the case of a Pass-Through Security, the Loans),
the excess of interest paid or accrued to purchase or carry a Security (or, in
the case of a Pass-Through Security, as described below, the underlying Loans)
with market discount over interest received on such Security is allowed as a
current deduction only to the extent such excess is greater than the market
discount that accrued during the taxable year in which such interest expense
was incurred. In general, the deferred portion of any interest expense will be
deductible when such market discount is included in income, including upon the
sale, disposition, or repayment of the Security (or in the case of a Pass-
Through Security, an underlying Loan). A Holder may elect to include market
discount in income currently as it accrues, on all market discount obligations
acquired by such Holder during the taxable year such election is made and
thereafter, in which case the interest deferral rule will not apply.
Premium. A Holder who purchases a Debt Security (other than an Interest
Weighted Security to the extent described above) at a cost greater than its
stated redemption price at maturity, generally will be considered to have
purchased the Security at a premium, which it may elect to amortize as an
offset to interest income on such Security (and not as a separate deduction
item) on a constant yield method. Although no regulations addressing the
computation of premium accrual on securities similar to the Securities have
been issued, the legislative
62
<PAGE>
history of the 1986 Act indicates that premium is to be accrued in the same
manner as market discount. Accordingly, it appears that the accrual of premium
on a Class of Pay-Through Securities will be calculated using the prepayment
assumption used in pricing such Class. If a Holder makes an election to
amortize premium on a Debt Security, such election will apply to all taxable
debt instruments (including all REMIC regular interests and all pass-through
certificates representing ownership interests in a trust holding debt
obligations) held by the Holder at the beginning of the taxable year in which
the election is made, and to all taxable debt instruments acquired thereafter
by such Holder, and will be irrevocable without the consent of the Internal
Revenue Service. Purchasers who pay a premium for the Securities should
consult their tax advisors regarding the election to amortize premium and the
method to be employed.
Election to Treat All Interest as Original Issue Discount. The OID
Regulations permit a Holder Debt Security to elect to accrue all interest,
discount (including de minimis market or original issue discount) and premium
in income as interest, based on a constant yield method for Debt Securities
acquired on or after April 4, 1994. If such an election were to be made with
respect to a Debt Security with market discount, the Holder of the Debt
Security would be deemed to have made an election to include in income
currently market discount with respect to all other debt instruments having
market discount that such Holder of the Debt Security acquires during the year
of the election or thereafter. Similarly, a Holder of a Debt Security that
makes this election for a Debt Security that is acquired at a premium will be
deemed to have made an election to amortize bond premium with respect to all
debt instruments having amortizable bond premium that such Holder owns or
acquires. The election to accrue interest, discount and premium on a constant
yield method with respect to a Debt Security is irrevocable.
Sale or Exchange. A Holder's tax basis in its Debt Security is the price
such Holder pays for a Debt Security, plus amounts of OID or market discount
included in income and reduced by any payments received (other than qualified
stated interest payments) and any amortized premium. Gain or loss recognized
on a sale, exchange, or redemption of a Debt Security, measured by the
difference between the amount realized and the Debt Security's basis as so
adjusted, will generally be capital gain or loss, assuming that the Debt
Security is held as a capital asset. In the case of a Debt Security held by a
bank, thrift, or similar institution described in Section 582 of the Code,
however, gain or loss realized on the sale or exchange of a Debt Security will
be taxable as ordinary income or loss. In addition, gain from the disposition
of a Regular Interest Security that might otherwise be capital gain will be
treated as ordinary income to the extent of the excess, if any, of (i) the
amount that would have been includible in the Holder's income if the yield on
such Regular Interest Security had equaled 110% of the applicable federal rate
as of the beginning of such Holder's holding period, over the amount of
ordinary income actually recognized by the Holder with respect to such Regular
Interest Security. Currently, the maximum tax rate on ordinary income for
individual taxpayers is 39.6% and the maximum tax rate on long-term capital
gains for such taxpayers is 28%. The maximum tax rate on both ordinary income
and long-term capital gains of corporate taxpayers is 35%.
TAXATION OF THE REMIC AND ITS HOLDERS
General. In the opinion of Federal Tax Counsel, if a REMIC election is made
with respect to a Series of Securities, then the arrangement by which the
Securities of that Series are issued will be treated as a REMIC as long as all
of the provisions of the applicable Agreement are complied with and the
statutory and regulatory requirements are satisfied. Securities will be
designated as "Regular Interests" or "Residual Interests" in a REMIC, as
specified in the related Prospectus Supplement.
Status of Regular Interest Securities as Real Property Loans. Regular
Interest Securities and Securities representing a residual interest in a REMIC
(both types of securities collectively referred to as "REMIC Securities") will
be "qualifying real property loans" within the meaning of Section 593(d) of
the Code, "real estate assets" for purposes of Section 856(c)(5)(A) of the
Code and assets described in Section 7701(a)(19)(C) of the Code (assets
qualifying under one or more of those sections, applying each section
separately, "qualifying assets") to the extent that the REMIC's assets are
qualifying assets. However, if at least 95% of the REMIC's
63
<PAGE>
assets are qualifying assets, then 100% of the REMIC Securities will be
qualifying assets. Similarly, income on the REMIC Securities will be treated
as "interest on obligations secured by mortgages on real property" within the
meaning of Section 856(c)(3)(B) of the Code, subject to the limitations of the
preceding two sentences. In addition to Loans, the REMIC's assets will include
payments on Loans held pending distribution to Holders of REMIC Securities,
amounts in reserve accounts (if any), other credit enhancements (if any) and
possibly buydown funds ("Buydown Funds"). The Loans generally will be
qualifying assets under all three of the foregoing sections of the Code.
However, Loans that are not secured by residential real property or real
property used primarily for church purposes may not constitute qualifying
assets under Section 7701(a)(19)(C)(v) of the Code, and Loans that are not
secured by improved real property or real property which is to be improved
using Loan proceeds will not constitute qualifying assets under Section 593(d)
of the Code. In addition, to the extent that the principal amount of a Loan
exceeds the value of the property securing the Loan, it is unclear and Federal
Tax Counsel is unable to opine whether the Loans will be qualifying assets.
The regulations under Sections 860A through 860G of the Code (the "REMIC
Regulations") treat credit enhancements as part of the mortgage or pool of
mortgages to which they relate, and therefore credit enhancements generally
should be qualifying assets. Regulations issued in conjunction with the REMIC
Regulations provide that amounts paid on Loans and held pending distribution
to Holders of Regular Interest Securities ("cash flow investments") will be
treated as qualifying assets. It is unclear whether reserve funds or Buydown
Funds would also constitute qualifying assets under any of those provisions.
REMIC EXPENSES; SINGLE CLASS REMICS
As a general rule, all of the expenses of a REMIC will be taken into account
by Holders of the Residual Interest Securities. In the case of a "single class
REMIC," however, the expenses will be allocated, under Treasury regulations,
among the Holders of the Regular Interest Securities and the Holders of the
Residual Interest Securities on a daily basis in proportion to the relative
amounts of income accruing to each Holder on that day. In the case of a Holder
of a Regular Interest Security who is an individual or a "pass-through
interest Holder" (including certain pass-through entities but not including
real estate investment trusts), such expenses will be deductible only to the
extern that such expenses, plus other "miscellaneous itemized deductions" of
the Holder, exceed 2% of such Holder's adjusted gross income and such Holder
may not be able to deduct such fees and expenses to any extent in computing
such Holder's alternative minimum tax liability. In addition, the amount of
itemized deductions otherwise allowable for the taxable year for an individual
whose adjusted gross income exceeds the applicable amount (for 1996, such
amount is $117,950 for all taxpayers except married taxpayers filling
separately, for whom such amount is $58,975) will be reduced by the lesser of
(i) 3% of the excess of adjusted gross income over the applicable amount, or
(ii) 80% of the amount of itemized deductions otherwise allowable for such
taxable year. The reduction or disallowance of this deduction may have a
significant impact on the yield of the Regular Interest Security to such a
Holder. In general terms, a single class REMIC is one that either (i) would
qualify, under existing Treasury regulations, as a grantor trust if it were
not a REMIC (treating all interests as ownership interests, even if they would
be classified as debt for federal income tax purposes) or (ii) is similar to
such a trust and which is structured with the principal purpose of avoiding
the single class REMIC rules. Unless otherwise stated in the applicable
Prospectus Supplement, the expenses of the REMIC will be allocated to Holders
of the related Residual Interest Securities.
TAXATION OF THE REMIC
General. Although a REMIC is a separate entity for federal income tax
purposes, a REMIC is not generally subject to entity-level tax. Rather, the
taxable income or net loss of a REMIC is taken into account by the Holders of
residual interests. As described above, the regular interests are generally
taxable as debt of the REMIC.
Tiered REMIC Structures. For certain Series of Securities, two or more
separate elections may be made to treat designated portions of the related
Trust Fund as REMICs ("Tiered REMICs") for federal income tax purposes. Upon
the issuance of any such Series of Securities, counsel to the Transferor will
deliver its opinion
64
<PAGE>
generally to the effect that, assuming compliance with all provisions of the
related Pooling and Servicing Agreement, the Tiered REMICs will each qualify
as a REMIC and the REMIC Certificates issued by the Tiered REMICs,
respectively, will be considered to evidence ownership of Regular Certificates
or Residual Certificates in the related REMIC within the meaning of the REMIC
Provisions.
Solely for purposes of determining whether the REMIC Certificates will be
"qualifying real property loans" under Section 593(d) of the Code, "real
estate assets" within the meaning of Section 856(c)(5)(A) of the Code, and
"loans secured by an interest in real property" under Section 7701(a)(19)(C)
of the Code, and whether the income on such Certificates is interest described
in Section 856(c)(3)(B) of the Code, the Tiered REMICs will be treated as one
REMIC.
Calculation of REMIC Income. The taxable income or net loss of a REMIC is
determined under an accrual method of accounting and in the same manner as in
the case of an individual, with certain adjustments. In general, the taxable
income or net loss will be the difference between (i) the gross income
produced by the REMIC's assets, including stated interest and any original
issue discount or market discount on loans and other assets, and (ii)
deductions, including stated interest and original issue discount accrued on
Regular Interest Securities, amortization of any premium with respect to
Loans, and servicing fees and other expenses of the REMIC. A Holder of a
Residual Interest Security that is an individual or a "pass-through interest
Holder" (including certain pass-through entities, but not including real
estate investment trusts) will be unable to deduct servicing fees payable on
the Loans or other administrative expenses of the REMIC for a given taxable
year, to the extent that such expenses, when aggregated with such Holder's
other miscellaneous itemized deductions for that year, do not exceed 2% of
such Holder's adjusted gross income and such Holder may not be able to deduct
such fees and expenses to any extent in computing such holders alternative
minimum tax liability.
For purposes of computing its taxable income or net loss, the REMIC should
have an initial aggregate tax basis in its assets equal to the aggregate fair
market value of the regular interests and the residual interests on the
Startup Day (generally, the day that the interests are issued). Such aggregate
basis will be allocated among the assets of the REMIC in proportion to their
respective fair market values.
The OID provisions of the Code apply to loans of individuals originated on
or after March 2, 1984, and the market discount provisions apply to loans.
Subject to possible application of the de minimis rules, the method of accrual
by the REMIC of OID income on such loans will be equivalent to the method
under which Holders of Pay-Through Securities accrue original issue discount
(i.e., under the constant yield method taking into account the Prepayment
Assumption). The REMIC will deduct OID on the Regular Interest Securities in
the same manner that the Holders of the Regular Interest Securities include
such discount in income, but without regard to the de minimis rules. See
"Taxation of Debt Securities (Including Regular Interest Securities)" above.
However, a REMIC that acquires loans at a market discount must include such
market discount in income currently, as it accrues, on a constant interest
basis.
To the extent that the REMIC's basis allocable to loans that it holds
exceeds their principal amounts, the resulting premium, if attributable to
mortgages originated after September 27, 1985, will be amortized over the life
of the loans (presumably taking into account the Prepayment Assumption) on a
constant yield method. Although the law is somewhat unclear regarding recovery
of premium attributable to loans originated on or before such date, it is
possible that such premium may be recovered in proportion to payments of loan
principal.
Prohibited Transactions and Contributions Tax. The REMIC will be subject to
a 100% tax on any net income derived from a "prohibited transaction." For this
purpose, net income will be calculated without taking into account any losses
from prohibited transactions or any deductions attributable to any prohibited
transaction that resulted in a loss. In general, prohibited transactions
include: (i) subject to limited exceptions, the sale or other disposition of
any qualified mortgage transferred to the REMIC; (ii) subject to a limited
exception, the sale or other disposition of a cash flow investment; (iii) the
receipt of any income from assets not permitted to be held by the REMIC
pursuant to the Code; or (iv) the receipt of any fees or other compensation
for services rendered by the REMIC. It is anticipated that a REMIC will not
engage in any prohibited transactions in which
65
<PAGE>
it would recognize a material amount of net income. In addition, subject to a
number of exceptions, a tax is imposed at the rate of 100% on amounts
contributed to a REMIC after the Startup Day. The Holders of Residual Interest
Securities will generally be responsible for the payment of any such taxes
imposed on the REMIC. To the extent not paid by such Holders or otherwise,
however, such taxes will be paid out of the Trust Fund and will be allocated
pro rata to all outstanding Classes of Securities of such REMIC.
TAXATION OF HOLDERS OF RESIDUAL INTEREST SECURITIES
The Holder of a Security representing a residual interest (a "Residual
Interest Security") will take into account the "daily portion" of the taxable
income or net loss of the REMIC for each day during the taxable year on which
such Holder held the Residual Interest Security. The daily portion is
determined by allocating to each day in any calendar quarter its ratable
portion of the taxable income or net loss of the REMIC for such quarter, and
by allocating that amount among the Holders (on such day) of the Residual
Interest Securities in proportion to their respective holdings on such day.
The Holder of a Residual Interest Security must report its proportionate
share of the taxable income of the REMIC whether or not it receives cash
distributions from the REMIC attributable to such income or loss. The
reporting of taxable income without corresponding distributions could occur,
for example, in certain REMIC issues in which the Loans held by the REMIC were
issued or acquired at a discount, since mortgage prepayments cause recognition
of discount income, while the corresponding portion of the prepayment could be
used in whole or in part to make principal payments on REMIC Regular Interests
issued without any discount or at an insubstantial discount. (If this occurs,
it is likely that cash distributions will exceed taxable income in later
years.) Taxable income may also be greater in earlier years of certain REMIC
issues as a result of the fact that interest expense deductions, as a
percentage of outstanding principal on REMIC Regular Interest Securities, will
typically increase over time as lower yielding Securities are paid, whereas
interest income with respect to loans will generally remain constant over time
as a percentage of loan principal.
In any event, because the Holder of a residual interest is taxed on the net
income of the REMIC, the taxable income derived from a Residual Interest
Security in a given taxable year will not be equal to the taxable income
associated with investment in a corporate bond or stripped instrument having
similar cash flow characteristics and pretax yield. Therefore, the after-tax
yield on the Residual Interest Security may be less than that of such a bond
or instrument.
Limitation on Losses. The amount of the REMIC's net loss that a Holder may
take into account currently is limited to the Holder's adjusted basis at the
end of the calendar quarter in which such loss arises. A Holder's basis in a
Residual Interest Security will initially equal such Holder's purchase price,
and will subsequently be increased by the amount of the REMIC's taxable income
allocated to the Holder, and decreased (but not below zero) by the amount of
distributions made and the amount of the REMIC's net loss allocated to the
Holder. Any disallowed loss may be carried forward indefinitely, but may be
used only to offset income of the REMIC generated by the same REMIC. The
ability of Holders of Residual Interest Securities to deduct net losses may be
subject to additional limitations under the Code, as to which such Holders
should consult their tax advisors.
Distributions. Distributions on a Residual Interest Security (whether at
their scheduled times or as a result of prepayments) will generally not result
in any additional taxable income or loss to a Holder of a Residual Interest
Security. If the amount of such payment exceeds a Holder's adjusted basis in
the Residual Interest Security, however, the Holder will recognize gain
(treated as gain from the sale of the Residual Interest Security) to the
extent of such excess.
Sale or Exchange. A Holder of a Residual Interest Security will recognize
gain or loss on the sale or exchange of a Residual Interest Security equal to
the difference, if any, between the amount realized and such Holder's adjusted
basis in the Residual Interest Security at the time of such sale or exchange.
Except to the extent provided in regulations, which have not yet been issued,
any loss upon disposition of a Residual Interest Security will be disallowed
if the selling Holder acquires any residual interest in a REMIC or similar
mortgage pool within six months before or after such disposition.
66
<PAGE>
Excess Inclusions. The portion of the REMIC taxable income of a Holder of a
Residual Interest Security consisting of "excess inclusion" income may not be
offset by other deductions or losses, including net operating losses, on such
Holder's federal income tax return. An exception applies to organizations to
which Code Section 593 applies (generally, certain thrift institutions);
however, such exception will not apply if the aggregate value of the Residual
Interest Securities is not considered to be "significant," as described below.
Further, if the Holder of a Residual Interest Security is an organization
subject to the tax on unrelated business income imposed by Code Section 511,
such Holder's excess inclusion income will be treated as unrelated business
taxable income of such Holder. In addition, under Treasury regulations yet to
be issued, if a real estate investment trust, a regulated investment company,
a common trust fund, or certain cooperatives were to own a Residual Interest
Security, a portion of dividends (or other distributions) paid by the real
estate investment trust (or other entity) would be treated as excess inclusion
income. If a Residual Security is owned by a foreign person, excess inclusion
income is subject to tax at a rate of 30% which may not be reduced by treaty,
is not eligible for treatment as "portfolio interest" and is subject to
certain additional limitations. See "Tax Treatment of Foreign Investors."
Regulations provide that a Residual Interest Security has significant value
only if (i) the aggregate issue price of the Residual Interest Security is at
least 2% of the aggregate of the issue prices of all Regular Interest
Securities and Residual Interest Securities in the REMIC and (ii) the
anticipated weighted average life (determined as specified in the Proposed
Regulations) of the Residual Interest Securities is at least 20% of the
weighted average life of the REMIC.
The excess inclusion portion of a REMIC's income is generally equal to the
excess, if any, of REMIC taxable income for the quarterly period allocable to
a Residual Interest Security, over the daily accruals for such quarterly
period of (i) 120% of the long term applicable federal rate on the Startup
Date multiplied by (ii) the adjusted issue price of such Residual Interest
Security at the beginning of such quarterly period. The adjusted issue price
of a Residual Interest Security at the beginning of each calendar quarter will
equal its issue price (calculated in a manner analogous to the determination
of the issue price of a Regular Interest Security), increased by the aggregate
of the daily accruals for prior calendar quarters, and decreased (but not
below zero) by the amount of loss allocated to a Holder and the amount of
distributions made on the Residual Interest Security before the beginning of
the quarter. The long-term federal rate, which is announced monthly by the
Treasury Department, is an interest rate that is based on the average market
yield of outstanding marketable obligations of the United States government
having remaining maturities in excess of nine years.
Under the REMIC Regulations, in certain circumstances, transfers of Residual
Interest Securities may be disregarded. See "--Restrictions on Ownership and
Transfer of Residual Interest Securities" and "Tax Treatment of Foreign
Investors" below.
Restrictions on Ownership and Transfer of Residual Interest Securities. As a
condition to qualification as a REMIC, reasonable arrangements must be made to
prevent the ownership of a REMIC residual interest by any "Disqualified
Organization." Disqualified Organizations include the United States, any State
or political subdivision thereof, any foreign government, any international
organization, or any agency or instrumentality of any of the foregoing, a
rural electric or telephone cooperative described in Section 1381(a)(2)(C) of
the Code, or any entity exempt from the tax imposed by Sections 1-1399 of the
Code, if such entity is not subject to tax on its unrelated business income.
Accordingly, the applicable Pooling and Servicing Agreement will prohibit
Disqualified Organizations from owning a Residual Interest Security. In
addition, no transfer of a Residual Interest Security will be permitted unless
the proposed transferee shall have furnished to the Trustee an affidavit
representing and warranting that it is neither a Disqualified Organization nor
an agent or nominee acing on behalf of a Disqualified Organization.
If a Residual Interest Security is transferred to a Disqualified
Organization (in violation of the restrictions set forth above), a substantial
tax will be imposed on the transferor of such Residual Interest Security at
the time of the transfer. In addition, if a Disqualified Organization holds an
interest in a pass-through entity (including, among others, a partnership,
trust, real estate investment trust, regulated investment company, or any
person holding as nominee an interest in a pass-through entity) that owns a
Residual Interest Security, the pass-through entity will be required to pay an
annual tax on its allocable share of the excess inclusion income of the REMIC.
67
<PAGE>
The REMIC Regulations provide that a transfer of a "noneconomic residual
interest" will be disregarded for all federal income tax purposes unless
impeding the assessment or collection of tax was not a significant purpose of
the transfer. A residual interest will be treated as a "noneconomic residual
interest" unless, at the time of the transfer (1) the present value of the
expected future distributions on the residual interest at least equals the
product of (x) the present value of all anticipated excess inclusions with
respect to the residual interest and (y) the highest corporate tax rate,
currently 35%, and (2) the transferor reasonably expects that for each
anticipated excess inclusion, the transferee will receive distributions from
the REMIC, at or after the time at which taxes on such excess inclusion
accrue, sufficient to pay the taxes thereon. A significant purpose to impede
the assessment or collection of tax exists if the transferor, at the time of
the transfer, either knew or should have known (had "improper knowledge") that
the transferee would be unwilling or unable to pay taxes due on its share of
the taxable income of the REMIC. A transferor will be presumed not to have
improper knowledge if (i) the transferor conducts, at the time of the
transfer, a reasonable investigation of the financial condition of the
transferee and, as a result of the investigation, the transferor finds that
the transferee has historically paid its debts as they came due and finds no
significant evidence to indicate that the transferee will not continue to pay
its debts as they come due in the future, and (ii) the transferee represents
to the transferor that (A) the transferee understands that it might incur tax
liabilities in excess of any cash received with respect to the residual
interest and (B) the transferee intends to pay the taxes associated with
owning the residual interest as they come due. A different formulation of this
rule applies to transfers of Residual Interest Security by or to foreign
transferees. See "Tax Treatment to Foreign Investors."
Mark to Market Rules. Prospective purchasers of a Residual Interest Security
should be aware that on December 28, 1993, the Internal Revenue Service
released temporary regulations (the "Temporary Mark-to-Market Regulations")
relating to the requirement that a securities dealer mark to market securities
held for sale to customers. This mark-to-market requirement applies to all
securities of a dealer, except to the extent that the dealer has specifically
identified a security as held for investment. The Temporary Mark-to-Market
Regulations provide that for purposes of this mark-to-market requirement, a
"negative value" Residual Interest Security is not treated as a security and
thus may not be marked to market. In addition, a dealer is not required to
identify such Residual Interest Security as held for investment. In general, a
Residual Interest Security has negative value if, as of the date a taxpayer
acquires the Residual Interest Security, the present value of the tax
liabilities associated with holding the Residual Interest Security exceeds the
sum of (i) the present value of the expected future distributions on the
Residual Interest Security, and (ii) the present value of the anticipated tax
savings associated with holding the Residual Interest Security as the REMIC
generates losses. The amounts and present values of the anticipated tax
liabilities, expected future distributions and anticipated tax savings are all
to be determined using (i) the prepayment and reinvestment assumptions adopted
under Section 1272(a)(6), or that would have been adopted had the REMIC's
regular interests been issued with OID, (ii) any required or permitted clean
up calls, or required qualified liquidation provided for in the REMIC's
organizational documents and (iii) a discount rate equal to the "applicable
Federal rate" (as specified in Section 1274(d)(1)), that would apply to a debt
instrument issued on the date of acquisition of the Residual Interest
Security. Furthermore, the Temporary Mark-to-Market Regulations provide the
IRS with the authority to treat any Residual Interest Security having
substantially the same economic effect as a "negative value" residual interest
as a "negative value" residual interest.
On January 3, 1995, the IRS released proposed regulations under Section 475
(the "Proposed Mark-to-Market Regulations"). The Proposed Mark-to-Market
Regulations provide that any REMIC Residual Interest acquired after January 3,
1995 cannot be marked to market, regardless of the value of such REMIC
residual interest. The Temporary Mark-to-Market Regulations described above
still apply to any REMIC Residual Interest acquired on or prior to January 3,
1995.
ADMINISTRATIVE MATTERS
The REMIC's books must be maintained on a calendar year basis and the REMIC
must file an annual federal income tax return. The REMIC will also be subject
to the procedural and administrative rules of the Code
68
<PAGE>
applicable to partnerships, including the determination of any adjustments to,
among other things, items of REMIC income, gain, loss, deduction, or credit,
by the IRS in a unified administrative proceeding.
TAX STATUS AS A GRANTOR TRUST
General. As specified in the related Prospectus Supplement, if a REMIC or
partnership election is not made and the Certificates are not treated as debt
for federal income tax purposes, in the opinion of Federal Tax Counsel, the
Trust Fund relating to a Series of Securities will be classified for federal
income tax purposes as a grantor trust under Subpart E, Part 1 of Subchapter J
of the Code and not as an association taxable as a corporation (the Securities
of such Series, "Pass-Through Securities"). Accordingly, each Holder of a
Pass-Through Security is treated for federal income tax purposes as the owner
of an undivided interest in the Loans included in the Trust Fund. As further
described below, each Holder of a Pass-Through Security therefore must report
on its federal income tax return the gross income from the portion of the
Loans that is allocable to such Pass-Through Security and may deduct the
portion of the expenses incurred or accrued by the Trust Fund that is
allocable to such Pass-Through Security, at the same time and to the same
extent as such items would be reported by such Holder if it had purchased and
held directly such interest in the Loans and received or accrued directly its
share of the payments on the Loans and incurred or accrued directly its share
of expenses incurred or accrued by the Trust Fund when those amounts are
received, incurred or accrued by the Trust Fund.
A Holder of a Pass-Through Security that is an individual, estate, or trust
will be allowed deductions for such expenses only to the extent that the sum
of those expenses and the Holder's other miscellaneous itemized deductions
exceeds 2% of such Holder's adjusted gross income. Moreover, a Holder of a
Pass-Through Security that is not a corporation cannot deduct such expenses
for purposes of the alternative minimum tax (if applicable). Such deductions
will include servicing, guarantee and administrative fees paid to the servicer
of the Loans. As a result, the Trust Fund will report additional taxable
income to Holders of Pass-Through Securities in an amount equal to their
allocable share of such deductions, and individuals, estates, or trusts
holding Pass-Through Securities may have taxable income in excess of the cash
received.
Status of the Pass-Through Securities as Real Property Loans. The Pass-
Through Securities will be "qualifying real property loans" within the meaning
of Section 593(d) of the Code, "real estate assets" for purposes of Section
856(c)(5)(A) of the Code and "loans . . . secured by an interest in real
property" within the meaning of Section 7701(a)(19)(C)(v) of the Code (assets
qualifying under one or more of those sections, applying each section
separately, "qualifying assets") to the extent that the Trust Fund's assets
are qualifying assets. The Pass-Through Securities may not be qualifying
assets under any of the foregoing sections of the Code to the extent that the
Trust Fund's assets include Buydown Funds, reserve funds, or payments on
mortgages held pending distribution to CertificateHolders. Further, the Pass-
Through Securities may not be "qualifying real property loans" to the extent
Loans held by the Trust Fund are not secured by improved real property or real
property which is to be improved using the Loan proceeds, may not be "real
estate assets" to the extent Loans held by the trust are not secured by real
property, and may not be "loans . . . secured by an interest in real property"
to the extent Loans held by the trust are not secured by residential real
property or real property used primarily for church purposes. In addition, to
the extent that the principal amount of a Loan exceeds the value of the
property securing the Loan, it is unclear and Federal Tax Counsel is unable to
opine whether the Loans will be qualifying assets.
Taxation of Pass-Through Securities Under Stripped Bond Rules. The federal
income tax treatment of the Pass-Through Securities will depend on whether
they are subject to the rules of Section 1286 of the Code (the "stripped bond
rules"). The Pass-Through Securities will be subject to those rules if
stripped interest-only Certificates are issued. In addition, whether or not
stripped interest-only Certificates are issued, the Internal Revenue Service
may contend that the stripped bond rules apply on the ground that the
Servicer's servicing fee, or other amounts, if any, paid to (or retained by)
the Servicer or its affiliates, as specified in the applicable Prospectus
Supplement, represent greater than an arm's length consideration for servicing
the Loans and should be characterized for federal income tax purposes as an
ownership interest in the Loans. The Internal Revenue
69
<PAGE>
Service has taken the position in Revenue Ruling 91-46 that a retained
interest in excess of reasonable compensation for servicing is treated as a
"stripped coupon" under the rules of Code Section 1286.
If interest retained for the Servicer's servicing fee or other interest is
treated as a "stripped coupon," the Pass-Through Securities will be subject to
the OID rules and/or the market discount rules. A Holder of a Pass-Through
Security generally will account for any discount on the Pass-Through Security
that is attributable to a Loan that is secured by real property as market
discount rather than OID if either (i) the amount of OID attributable to such
Loan was treated as zero under the OID de minimis rule when such Loan was
stripped or (ii) no more than 100 basis points (including any amount of
servicing in excess of reasonable servicing) is stripped off from such Loan.
If neither of the above exceptions applies, the OID rules will apply to such
discount. Discount attributable to an unsecured Loan will not be eligible for
treatment as market discount, and it is unclear whether discount attributable
to a stripped Loan the principal amount of which exceeds the value of real
property securing the Loan will be eligible for treatment as market discount.
If the OID rules apply, the Holder of a Pass-Through Security (whether a
cash or accrual method taxpayer) will be required to report interest income
from the Pass-Through Security in each taxable year equal to the income that
accrues on the Pass-Through Security in that year calculated under a constant
yield method based on the yield of the Pass-Through Security (or, possibly,
the yield of each Loan underlying such Pass-Through Security) to such Holder.
Such yield would be computed at the rate (assuming monthly compounding) that,
if used in discounting the Holder's share of the payments on the Loans, would
cause the present value of those payments to equal the price at which the
Holder purchased the Pass-Through Security. With respect to certain categories
of debt instruments, Section 1272(a)(6) of the Code requires that OID be
accrued based on a prepayment assumption determined in a manner prescribed by
forthcoming regulations. It is unclear whether such regulations would apply
this rule to the Pass-Through Securities, whether Section 1272(a)(6) might
apply to the Pass-Through Securities in the absence of such regulations, or
whether the Internal Revenue Service could require use of a reasonable
prepayment assumption based on other tax law principles, and Federal Tax
Counsel is unable to opine with respect to this issue. If required to report
interest income on the Pass-Through Securities to the Internal Revenue Service
under the stripped bond rules, it is anticipated that the Trustee will
calculate the yield of the Pass-Through Securities based on a representative
initial offering price of the Pass-Through Securities and a reasonable assumed
rate of prepayment of the Loans (although such yield may differ from the yield
to any particular Holder that would be used in calculating the interest income
of such Holder). The Prospectus Supplement for each series of Pass-Through
Securities will describe the prepayment assumption that will be used for this
purpose, but no representation is made that the Loans will prepay at that rate
or at any other rate.
Assuming that Holders are not taxed as directly owning the Loans, in the
case of a Pass-Through Security acquired at a price equal to the principal
amount of the Loans allocable to the Pass-Through Security, the use of a
reasonable prepayment assumption would not have any significant effect on the
yield used in calculating accruals of interest income. In the case, however,
of a Pass-Through Security acquired at a discount or premium (that is, at a
price less than or greater than such principal amount, respectively), the use
of a reasonable prepayment assumption would increase or decrease such yield,
and thus accelerate or decelerate the reporting of interest income,
respectively.
If a Loan is prepaid in full, the Holder of a Pass-Through Security acquired
at a discount or premium generally will recognize ordinary income or loss
equal to the difference between the portion of the prepaid principal amount of
the Loan that is allocable to the Pass-Through Security and the portion of the
adjusted basis of the Pass-Through Security (see "Sales of Pass-Through
Securities" below) that is allocable to the Loan. The method of allocating
such basis among the Loans may differ depending on whether a reasonable
prepayment assumption is used in calculating the yield of the Pass-Through
Securities for purposes of accruing OID. It is not clear whether any other
adjustments would be required to reflect differences between the prepayment
rate that was assumed in calculating yield and the actual rate of prepayments.
Pass-Through Securities of certain series ("Variable Rate Pass-Through
Securities") may provide for a Pass-Through Rate based on the weighted average
of the interest rates of the Loans held by the Trust Fund,
70
<PAGE>
which interest rates may be fixed or variable. In the case of a Variable Rate
Pass-Through Security that is subject to the OID rules, the daily portions of
OID generally will be calculated under the principles discussed in "--Taxation
of Debt Securities (Including Regular Interest Securities)--Variable Rate Debt
Securities."
Taxation of Pass-Through Securities If Stripped Bond Rules Do Not Apply. If
the stripped bond rules do not apply to a Pass-Through Security, then the
Holder will be required to include in income its share of the interest
payments on the Loans in accordance with its tax accounting method. In
addition, if the Holder purchased the Pass-Through Security at a discount or
premium, the Holder will be required to account for such discount or premium
in the manner described below. The treatment of any discount will depend on
whether the discount is OID as defined in the Code and, in the case of
discount other than OID, whether such other discount exceeds a de minimis
amount. In the case of OID, the Holder (whether a cash or accrual method
taxpayer) will be required to report as additional interest income in each
month the portion of such discount that accrues in that month, calculated
based on a constant yield method. In general it is not anticipated that the
amount of OID to be accrued in each month, if any, will be significant
relative to the interest paid currently on the Loans. However, OID could arise
with respect to a Loan ("ARM") that provides for interest at a rate equal to
the sum of an index of market interest rates and a fixed number. The OID for
ARMs generally will be determined under the principles discussed in "Taxation
of Debt Securities (Including Regular Interest Securities)--Variable Rate Debt
Securities."
If discount other than OID exceeds a de minimis amount (described below),
the Holder will also generally be required to include in income in each month
the amount of such discount accrued through such month and not previously
included in income, but limited, with respect to the portion of such discount
allocable to any Loan, to the amount of principal on such Loan received by the
Trust Fund in that month. Because the Loans will provide for monthly principal
payments, such discount may be required to be included in income at a rate
that is not significantly slower than the rate at which such discount accrues
(and therefore at a rate not significantly slower than the rate at which such
discount would be included in income if it were OID). The Holder may elect to
accrue such discount under a constant yield method based on the yield of the
Pass-Through Security to such Holder (or possibly based on the yields of each
Loan). In the absence of such an election, it may be necessary to accrue such
discount under a more rapid straight-line method. Under the de minimis rule,
market discount with respect to a Pass-Through Security will be considered to
be zero if it is less than the product of (i) 0.25% of the principal amount of
the Loans allocable to the Pass-Through Security and (ii) the weighted average
life (in complete years) of the Loans remaining at the time of purchase of the
Pass-Through Security.
If a Holder purchases a Pass-Through Security at a premium, such Holder may
elect under Section 171 of the Code to amortize the portion of such premium
that is allocable to a Loan under a constant yield method based on the yield
of the Loan to such Holder, provided that such Loan was originated after
September 27, 1985. Premium allocable to a Loan originated on or before that
date should be allocated among the principal payments on the Loan and allowed
as an ordinary deduction as principal payments are made or, perhaps, upon
termination.
It is not clear whether the foregoing adjustments for discount or premium
would be made based on the scheduled payments on the Loans or taking account
of a reasonable prepayment assumption, and Federal Tax Counsel is unable to
opine on this issue.
If a Loan is prepaid in full, the Holder of a Pass-Through Security acquired
at a discount or premium will recognize ordinary income or loss equal to the
difference between the portion of the prepaid principal amount of the Loan
that is allocable to the Pass-Through Security and the portion of the adjusted
basis of the Pass-Through Security (see "Sales of Pass-Through Securities"
below) that is allocable to the Loan. The method of allocating such basis
among the Loans may differ depending on whether a reasonable prepayment
assumption is used in calculating the yield of the Pass-Through Securities for
purposes of accruing OID. Other adjustments might be required to reflect
differences between the prepayment rate that was assumed in accounting for
discount or premium and the actual rate of prepayments.
71
<PAGE>
MISCELLANEOUS TAX ASPECTS
Backup Withholding. A Holder, other than a Holder of a Residual Interest
Security, may, under certain circumstances, be subject to "backup withholding"
at a rate of 31% with respect to distributions or the proceeds of a sale of
certificates to or through brokers that represent interest or original issue
discount on the Securities. This withholding generally applies if the Holder
of a Security (i) fails to furnish the Trustee with its taxpayer
identification number ("TIN"); (ii) furnishes the Trustee an incorrect TIN;
(iii) fails to report properly interest, dividends or other "reportable
payments" as defined in the Code; or (iv) under certain circumstances, fails
to provide the Trustee or such Holder's securities broker with a certified
statement, signed under penalty of perjury, that the TIN provided is its
correct number and that the Holder is not subject to backup withholding.
Backup withholding will not apply, however, with respect to certain payments
made to Holders, including payments to certain exempt recipients (such as
exempt organizations) and to certain Nonresidents (as defined below). Holders
should consult their tax advisors as to their qualification for exemption from
backup withholding and the procedure for obtaining the exemption.
The Trustee will report to the Holders and to the Servicer for each calendar
year the amount of any "reportable payments" during such year and the amount
of tax withheld, if any, with respect to payments on the Securities.
TAX TREATMENT OF FOREIGN INVESTORS
Subject to the discussion below with respect to Trust Funds which are
treated as partnerships for federal income tax purposes and with respect to
Certificates treated as debt for federal income tax purposes, unless interest
(including OID) paid on a Security (other than a Residual Interest Security)
is considered to be "effectively connected" with a trade or business conducted
in the United States by a nonresident alien individual, foreign partnership or
foreign corporation ("foreign investors"), such interest will normally qualify
as portfolio interest (except where (i) the recipient is a Holder, directly or
by attribution, of 10% or more of the capital or profits interest in the
issuer, or (ii) the recipient is a controlled foreign corporation to which the
issuer is a related person) and will be exempt from federal income tax. See
"--Tax Consequences to Holders of the Certificates Issued by a Partnership-Tax
Consequences to Foreign Certificateholders" and "--Certain Certificates
Treated as Indebtedness-Foreign Investors". Upon receipt of appropriate
ownership statements, the issuer normally will be relieved of obligations to
withhold tax from such interest payments. These provisions supersede the
generally applicable provisions of United States law that would otherwise
require the issuer to withhold at a 30% rate (unless such rate were reduced or
eliminated by an applicable tax treaty) on, among other things, interest and
other fixed or determinable, annual or periodic income paid to Nonresidents.
Holders of Pass-Through Securities however, may be subject to withholding to
the extent that the Loans were originated on or before July 18, 1984.
Interest and OID of Holders who are foreign persons are not subject to
withholding if they are effectively connected with a United States business
conducted by the Holder and timely provide an IRS Form 4224. They will,
however, generally be subject to the regular United States income tax.
Payments to Holders of Residual Interest Securities who are foreign persons
will generally be treated as interest for purposes of the 30% (or lower treaty
rate) United States withholding tax. Holders should assume that such income
does not qualify for exemption from United States withholding tax as
"portfolio interest." It is clear that, to the extent that a payment
represents a portion of REMIC taxable income that constitutes excess inclusion
income, a Holder of a Residual Interest Security will not be entitled to an
exemption from or reduction of the 30% (or lower treaty rate) withholding tax
rule. If the payments are subject to United States withholding tax, they
generally will be taken into account for withholding tax purposes only when
paid or distributed (or when the Residual Interest Security is disposed of).
The Treasury has statutory authority, however, to promulgate regulations which
would require such amounts to be taken into account at an earlier time in
order to prevent the avoidance of tax. Such regulations could, for example,
require withholding prior to the distribution of cash in the case of Residual
Interest Securities that do not have significant value. Under the REMIC
Regulations, if a
72
<PAGE>
Residual Interest Security has tax avoidance potential, a transfer of a
Residual Interest Security to a Nonresident will be disregarded for all
federal tax purposes. A Residual Interest Security has tax avoidance potential
unless, at the time of the transfer, the transferor reasonably expects that
the REMIC will distribute to the transferee residual interest Holder amounts
that will equal at least 30% of each excess inclusion, and that such amounts
will be distributed at or after the time at which the excess inclusions accrue
and not later than the calendar year following the calendar year of accrual.
If a Nonresident transfers a Residual Interest Security to a United States
person, and if the transfer has the effect of allowing the transferor to avoid
tax on accrued excess inclusions, then the transfer is disregarded and the
transferor continues to be treated as the owner of the Residual Interest
Security for purposes of the withholding tax provisions of the Code. See
"Taxation of Holders of Residual Interest Securities--Excess Inclusions."
Subject to the discussion in the previous paragraph, any capital gain
realized on the sale, redemption, retirement or other taxable disposition of a
Security by a foreign person will be exempt from United States federal income
and withholding tax, provided that (i) such gain is not effectively connected
with the conduct of a trade or business in the United States by the foreign
person and (ii) in the case of an individual foreign person, the foreign
person is not present in the United States for 183 days or more in the taxable
year.
TAX CHARACTERIZATION OF THE TRUST AS A PARTNERSHIP
Federal Tax Counsel will deliver its opinion that a Trust Fund which is
intended to be a partnership for federal income tax purposes will not be an
association (or publicly traded partnership) taxable as a corporation for
federal income tax purposes. This opinion will be based on the assumption that
the terms of the Trust Agreement and related documents will be complied with,
and on counsel's conclusions that (1) the Trust Fund will not have certain
characteristics necessary for a business trust to be classified as an
association taxable as a corporation and (2) the nature of the income of the
Trust Fund will exempt it from the rule that certain publicly traded
partnerships are taxable as corporations or the issuance of the Certificates
has been structured as a private placement under an IRS safe harbor, so that
the Trust Fund will not be characterized as a publicly traded partnership
taxable as a corporation.
If the Trust Fund were taxable as a corporation for federal income tax
purposes, the Trust Fund would be subject to corporate income tax on its
taxable income. The Trust Fund's taxable income would include all its income,
possibly reduced by its interest expense on the Notes. Any such corporate
income tax could materially reduce cash available to make payments on the
Notes and distributions on the Certificates, and CertificateHolders could be
liable for any such tax that is unpaid by the Trust Fund. In additions, all
distributions to the Certificateholders would be taxable as dividends.
TAX CONSEQUENCES TO HOLDERS OF THE NOTES ISSUED BY A PARTNERSHIP
Treatment of the Notes as Indebtedness. The Trust Fund will agree, and the
NoteHolders will agree by their purchase of Notes, to treat the Notes as debt
for federal income tax purposes. Except as otherwise provided in the related
Prospectus Supplement, Federal Tax Counsel will advise the Transferor that the
Notes will be classified as debt for federal income tax purposes.
Consequently, Holders of Notes will be subject to taxation as described in
"Taxation of Debt Securities (Including Regular Interest Securities)" above
for Debt Securities which are not Regular Interest Securities.
Possible Alternative Treatments of the Notes. If, contrary to the opinion of
Federal Tax Counsel, the IRS successfully asserted that one or more of the
Notes did not represent debt for federal income tax purposes, the Notes might
be treated as equity interests in the Trust Fund. If so treated, the Trust
Fund might be taxable as a corporation with the adverse consequences described
above (and the taxable corporation would not be able to reduce its taxable
income by deductions for interest expense on Notes recharacterized as equity).
Alternatively, and most likely in the view of Federal Tax Counsel, the Trust
Fund might be treated as a publicly traded partnership that would not be
taxable as a corporation because it would meet certain qualifying income
tests. Nonetheless, treatment of the Notes as equity interests in such a
publicly traded partnership could have adverse
73
<PAGE>
tax consequences to certain Holders. For example, income to foreign Holders
generally would be subject to U.S. federal income tax and U.S. federal income
tax return filing and withholding requirements, and individual Holders might
be subject to certain limitations on their ability to deduct their share of
the Trust Fund's expenses.
TAX CONSEQUENCES TO HOLDERS OF THE CERTIFICATES ISSUED BY A PARTNERSHIP
Treatment of the Trust Fund as a Partnership. In the case of a Trust Fund
intended to qualify as a partnership for federal income tax purposes, the
Trust Fund and the Transferor will agree, and the CertificateHolders will
agree by their purchase of Certificates, to treat the Trust Fund as a
partnership for purposes of federal and state income tax, franchise tax and
any other tax measured in whole or in part by income, with the assets of the
partnership being the assets held by the Trust Fund, the partners of the
partnership being the CertificateHolders, and the Notes, if any, being debt of
the partnership. However, the proper characterization of the arrangement
involving the Trust Fund, the Certificates, the Notes, the Trust Fund and the
Servicer is not clear because there is no authority on transactions closely
comparable to that contemplated herein.
A variety of alternative characterizations are possible. For example,
because the Certificates have certain features characteristic of debt, the
Certificates might be considered debt of the Trust Fund. Any such
characterization would not result in materially adverse tax consequences to
CertificateHolders as compared to the consequences from treatment of the
Certificates as equity in a partnership, described below. The following
discussion assumes that the Certificates represent equity interests in a
partnership.
Indexed Securities, etc. The following discussion assumes that all payments
on the Certificates are denominated in U.S. dollars, none of the Certificates
have interest rates which would qualify as contingent interest under the OID
regulations, and that a Series of Securities includes a single Class of
Certificates. If these conditions are not satisfied with respect to any given
Series of Certificates, additional tax considerations with respect to such
Certificates will be disclosed in the applicable Prospectus Supplement.
Partnership Taxation. As a partnership, the Trust Fund will not be subject
to federal income tax. Rather, each CertificateHolder will be required to
separately take into account such Holder's allocated share of income, gains,
losses, deductions and credits of the Trust Fund. The Trust Fund's income will
consist primarily of interest and finance charges earned on the Loans
(including appropriate adjustments for market discount, OID and bond premium)
and any gain upon collection or disposition of Loans. The Trust Fund's
deductions will consist primarily of interest and OID accruing with respect to
the Notes, servicing and other fees, and losses or deductions upon collection
or disposition of Loans.
The tax items of a partnership are allocable to the partners in accordance
with the Code, Treasury regulations and the partnership agreement (here, the
Trust Agreement and related documents). The Trust Agreement will provide, in
general, that the CertificateHolders will be allocated taxable income of the
Trust Fund for each month equal to the sum of (i) the interest that accrues on
the Certificates in accordance with their terms for such month, including
interest accruing at the Pass Through Rate for such month and interest on
amounts previously due on the Certificates but not yet distributed; (ii) any
Trust Fund income attributable to discount on the Loans that corresponds to
any excess of the principal amount of the Certificates over their initial
issue price; (iii) prepayment premium payable to the CertificateHolders for
such month; and (iv) any other amounts of income payable to the
CertificateHolders for such month. Such allocation will be reduced by any
amortization by the Trust Fund of premium on Loans that corresponds to any
excess of the issue price of Certificates over their principal amount. All
remaining taxable income of the Trust Fund will be allocated to the
Transferor. Based on the economic arrangement of the parties, this approach
for allocating Trust Fund income should be permissible under applicable
Treasury regulations, although no assurance can be given that the IRS would
not require a greater amount of income to be allocated to CertificateHolders.
Moreover, even under the foregoing method of allocation, CertificateHolders
may be allocated income equal to the entire Pass-Through Rate plus the other
items described above even though the Trust Fund might not have sufficient
cash to make current cash distributions of such amount. Thus, cash basis
Holders will in effect be required to report income from the Certificates on
the accrual basis and CertificateHolders may become liable for taxes on Trust
Fund income even
74
<PAGE>
if they have not received cash from the Trust Fund to pay such taxes. In
addition, because tax allocations and tax reporting will be done on a uniform
basis for all CertificateHolders but CertificateHolders may be purchasing
Certificates at different times and at different prices, CertificateHolders
may be required to report on their tax returns taxable income that is greater
or less than the amount reported to them by the Trust Fund.
If Notes are also issued, all of the taxable income allocated to a
CertificateHolder that is a pension, profit sharing or employee benefit plan
or other tax-exempt entity (including an individual retirement account) will
constitute "unrelated business taxable income" generally taxable to such a
Holder under the Code.
An individual taxpayer's share of expenses of the Trust Fund (including fees
to the Servicer but not interest expense) would be miscellaneous itemized
deductions. Such deductions might be disallowed to the individual in whole or
in part and might result in such Holder being taxed on an amount of income
that exceeds the amount of cash actually distributed to such Holder over the
life of the Trust Fund.
The Trust Fund intends to make all tax calculations relating to income and
allocations to CertificateHolders on an aggregate basis. If the IRS were to
require that such calculations be made separately for each Loan, the Trust
Fund might be required to incur additional expense, but it is believed that
there would not be a material adverse effect on CertificateHolders.
Discount and Premium. It is believed that the Loans were not issued with OID
and, therefore, the Trust should not have OID income. However, the purchase
price paid by the Trust Fund for the Loans may be greater or less than the
remaining principal balance of the Loans at the time of purchase. If so, the
Loan will have been acquired at a premium or discount, as the case may be. (As
indicated above, the Trust Fund will make this calculation on an aggregate
basis, but might be required to recompute it on a Loan by Loan basis.)
If the Trust Fund acquires the Loans at a market discount or premium, the
Trust Fund will elect to include any such discount in income currently as it
accrues over the life of the Loans or to offset any such premium against
interest income on the Loans. As indicated above, a portion of such market
discount income or premium deduction may be allocated to CertificateHolders.
Section 708 Termination. Under Section 708 of the Code, the Trust Fund will
be deemed to terminate for federal income tax purposes if 50% or more of the
capital and profits interests in the Trust Fund are sold or exchanged within a
12-month period. If such a termination occurs, the Trust Fund will be
considered to distribute its assets to the partners, who would then be treated
as recontributing those assets to the Trust Fund as a new partnership. The
Trust Fund will not comply with certain technical requirements that might
apply when such a constructive termination occurs. As a result, the Trust Fund
may be subject to certain tax penalties and may incur additional expenses if
it is required to comply with those requirements. Furthermore, the Trust Fund
might not be able to comply due to lack of data.
Disposition of Certificates. Generally, capital gain or loss will be
recognized on a sale of Certificates in an amount equal to the difference
between the amount realized and the seller's tax basis in the Certificates
sold. A CertificateHolder's tax basis in a Certificate will generally equal
the Holder's cost increased by the Holder's share of Trust Fund income
(includible in income) and decreased by any distributions received with
respect to such Certificate. In addition, both the tax basis in the
Certificates and the amount realized on a sale of a Certificate would include
the Holder's share of the Notes and other liabilities of the Trust Fund. A
Holder acquiring Certificates at different prices may be required to maintain
a single aggregate adjusted tax basis in such Certificates, and, upon sale or
other disposition of some of the Certificates, allocate a portion of such
aggregate tax basis to the Certificates sold (rather than maintaining a
separate tax basis in each Certificate for purposes of computing gain or loss
on a sale of that Certificate).
Any gain on the sale of a Certificate attributable to the Holder's share of
unrecognized accrued market discount on the Loans would generally be treated
as ordinary income to the Holder and would give rise to special
75
<PAGE>
tax reporting requirements. The Trust Fund does not expect to have any other
assets that would give rise to such special reporting requirements. Thus, to
avoid those special reporting requirements, the Trust Fund will elect to
include market discount in income as it accrues.
If a CertificateHolder is required to recognize an aggregate amount of
income (not including income attributable to disallowed itemized deductions
described above) over the life of the Certificates that exceeds the aggregate
cash distributions with respect thereto, such excess will generally give rise
to a capital loss upon the retirement of the Certificates.
Allocations Between Transferors and Transferees. In general, the Trust
Fund's taxable income and losses will be determined monthly and the tax items
for a particular calendar month will be apportioned among the
CertificateHolders in proportion to the principal amount of Certificates owned
by them as of the close of the last day of such month. As a result, a Holder
purchasing Certificates may be allocated tax items (which will affect its tax
liability and tax basis) attributable to periods before the actual
transaction.
The use of such a monthly convention may not be permitted by existing
regulations. If a monthly convention is not allowed (or only applies to
transfers of less than all of the partner's interest), taxable income or
losses of the Trust Fund might be reallocated among the CertificateHolders.
The Trust Fund's method of allocation between transferors and transferees may
be revised to conform to a method permitted by future regulations.
Section 754 Election. In the event that a CertificateHolder sells its
Certificates at a profit (loss), the purchasing CertificateHolder will have a
higher (lower) basis in the Certificates than the selling CertificateHolder
had. The tax basis of the Trust Fund's assets will not be adjusted to reflect
that higher (or lower) basis unless the Trust Fund were to file an election
under Section 754 of the Code. In order to avoid the administrative
complexities that would be involved in keeping accurate accounting records, as
well as potentially onerous information reporting requirements, the Trust Fund
currently does not intend to make such election. As a result,
CertificateHolders might be allocated a greater or lesser amount of Trust Fund
income than would be appropriate based on their own purchase price for
Certificates.
Administrative Matters. The Owner Trustee is required to keep or have kept
complete and accurate books of the Trust Fund. Such books will be maintained
for financial reporting and tax purposes on an accrual basis and the fiscal
year of the Trust Fund will be the calendar year. The Trustee will file a
partnership information return (IRS Form 1065) with the IRS for each taxable
year of the Trust Fund and will report each CertificateHolder's allocable
share of items of Trust Fund income and expense to Holders and the IRS on
Schedule K-1. The Trust Fund will provide the Schedule K-1 information to
nominees that fail to provide the Trust Fund with the information statement
described below and such nominees will be required to forward such information
to the beneficial owners of the Certificates. Generally, Holders must file tax
returns that are consistent with the information return filed by the Trust
Fund or be subject to penalties unless the Holder notifies the IRS of all such
inconsistencies.
Under Section 6031 of the Code, any person that holds Certificates as a
nominee at any time during a calendar year is required to furnish the Trust
Fund with a statement containing certain information on the nominee, the
beneficial owners and the Certificates so held. Such information includes (i)
the name, address and taxpayer identification number of the nominee and (ii)
as to each beneficial owner (x) the name, address and identification number of
such person, (y) whether such person is a United States person, a tax-exempt
entity or a foreign government, an international organization, or any wholly
owned agency or instrumentality of either of the foregoing, and (z) certain
information on Certificates that were held, bought or sold on behalf of such
person throughout the year. In addition, brokers and financial institutions
that hold Certificates through a nominee are required to furnish directly to
the Trust Fund information as to themselves and their ownership of
Certificates. A clearing agency registered under Section 17A of the Exchange
Act is not required to furnish any such information statement to the Trust
Fund. The information referred to above for any calendar year must be
furnished to the Trust Fund on or before the following January 31. Nominees,
brokers and financial institutions that fail to provide the Trust Fund with
the information described above may be subject to penalties.
76
<PAGE>
The Transferor will be designated as the tax matters partner in the related
Trust Agreement and, as such, will be responsible for representing the
CertificateHolders in any dispute with the IRS. The Code provides for
administrative examination of a partnership as if the partnership were a
separate and distinct taxpayer. Generally, the statute of limitations for
partnership items does not expire before three years after the date on which
the partnership information return is filed. Any adverse determination
following an audit of the return of the Trust Fund by the appropriate taxing
authorities could result in an adjustment of the returns of the
CertificateHolders, and, under certain circumstances, a CertificateHolder may
be precluded from separately litigating a proposed adjustment to the items of
the Trust Fund. An adjustment could also result in an audit of a
CertificateHolder's returns and adjustments of items not related to the income
and losses of the Trust Fund.
Tax Consequences to Foreign CertificateHolders. It is not clear whether the
Trust Fund would be considered to be engaged in a trade or business in the
United States for purposes of federal withholding taxes with respect to non-
U.S. persons because there is no clear authority dealing with that issue under
facts substantially similar to those described herein. Although it is not
expected that the Trust Fund would be engaged in a trade or business in the
United States for such purposes, the Trust Fund will withhold as if it were so
engaged in order to protect the Trust Fund from possible adverse consequences
of a failure to withhold. The Trust Fund expects to withhold on the portion of
its taxable income that is allocable to foreign CertificateHolders pursuant to
Section 1446 of the Code, as if such income were effectively connected to a
U.S. trade or business, at a rate of 35% for foreign Holders that are taxable
as corporations and 39.6% for all other foreign Holders. Subsequent adoption
of Treasury regulations or the issuance of other administrative pronouncements
may require the Trust Fund to change its withholding procedures.
Each foreign Holder might be required to file a U.S. individual or corporate
income tax return (including, in the case of a corporation, the branch profits
tax) on its share of the Trust Fund's income. Each foreign Holder must obtain
a taxpayer identification number from the IRS and submit that number to the
Trust Fund on Form W-8 in order to assure appropriate crediting of the taxes
withheld. A foreign Holder generally would be entitled to file with the IRS a
claim for refund with respect to taxes withheld by the Trust Fund taking the
position that no taxes were due because the Trust Fund was not engaged in a
U.S. trade or business. However, interest payments made (or accrued) to a
CertificateHolder who is a foreign person generally will be considered
guaranteed payments to the extent such payments are determined without regard
to the income of the Trust Fund. If these interest payments are properly
characterized as guaranteed payments, then the interest probably will not be
considered "portfolio interest." As a result, CertificateHolders will be
subject to United States federal income tax and withholding tax at a rate of
30%, unless reduced or eliminated pursuant to an applicable treaty. In such
case, a foreign Holder would only be entitled to claim a refund for that
portion of the taxes, if any, in excess of the taxes that should be withheld
with respect to the guaranteed payments.
Backup Withholding. Distributions made on the Certificates and proceeds from
the sale of the Certificates will be subject to a "backup" withholding tax of
31% if, in general, the CertificateHolder fails to comply with certain
identification procedures, unless the Holder is an exempt recipient under
applicable provisions of the Code.
CERTAIN CERTIFICATES TREATED AS INDEBTEDNESS
Upon the issuance of Certificates which are intended to be treated as
indebtedness for federal income tax purposes, Federal Tax Counsel will opine
that based upon its analysis of the factors discussed below, the Certificates
will be characterized as indebtedness for federal income tax purposes of the
Transferor that is secured by the Loans. Opinions of counsel are not binding
on the Internal Revenue Service, however, and there can be no assurance that
the IRS could not successfully challenge this conclusion.
The Transferor will express in the Pooling and Servicing Agreement its
intent that the Certificates be indebtedness secured by the Loans for federal,
state and local income or franchise tax purposes. The Transferor, by entering
into the Pooling and Servicing Agreement, has agreed and each
CertificateHolder, by the acceptance
77
<PAGE>
of a Certificate, will agree to treat the Certificates as indebtedness for
federal, state and local income or franchise tax purposes. However, because
different criteria are used to determine the non-tax accounting
characterization of the transactions contemplated by the Pooling and Servicing
Agreements, the Transferor expects to treat such transactions, for regulatory
and financial accounting purposes, as a transfer of an ownership interest in
the Loans and not as a debt obligation.
A basic premise of federal income tax law is that the economic substance of
a transaction generally determines the tax consequences. The form of a
transaction, while a relevant factor, is not conclusive evidence of its
economic substance. In appropriate circumstances, the courts have allowed
taxpayers, as well as the IRS, to treat a transaction in accordance with its
economic substance, as determined under federal income tax law,
notwithstanding that the participants characterize the transaction differently
for non-tax purposes. In some instances, however, courts have held that a
taxpayer is bound by the particular form it has chosen for a transaction, even
if the substance of the transaction does not accord with its form. Federal Tax
Counsel believes that the rationale of those cases will not apply to the
issuance of the Certificates.
The determination of whether the economic substance of a transfer of an
interest in property is a sale or a loan secured by the transferred property
depends on numerous factors that indicate whether the transferor has
relinquished (and the transferee has obtained) substantial incidents of
ownership in the property. Among the primary factors considered are whether
the transferee has obtained the opportunity for gain if the property increases
in value and has assumed the risk of loss if the property decreases in value.
Based upon its analysis of such factors, Federal Tax Counsel will conclude
that the CertificateHolders do not own or have an equity interest in the Loans
for federal income tax purposes. As a result, Federal Tax Counsel will opine
that the Certificates will properly be characterized for federal income tax
purposes as indebtedness. Contrary characterizations that could be asserted by
the IRS are described below under "--Possible Characterization of the
Transaction as a Partnership or as an Association Taxable as a Corporation."
In this regard, it should be noted that the IRS has recently issued a notice
stating that, upon examination, it will scrutinize instruments treated as debt
for federal income tax purposes but as equity for regulatory, rating agency or
financial accounting purposes to determine if their purported status as debt
for federal income tax purposes is appropriate.
CertificateHolders as the Holders of debt instruments for federal tax
purposes will be taxed in the manner described above in "--Taxation of Debt
Securities (Including Regular Interest Securities)" for Debt Securities which
are not Regular Interest Securities.
Possible Characterization of the Transaction as a Partnership or as
Association Taxable as a Corporation. As stated above, the opinion of Federal
Tax Counsel with respect to the Certificates will not be binding on the courts
or the IRS, and no assurance can be given that the characterization of the
Certificates as debt would prevail. It is possible that the IRS would assert
that, for purposes of the Code, the transaction described herein constitutes a
transfer of the Loans (or an interest therein) to the CertificateHolders and
that the proper classification of the legal relationship between the
Transferor and the CertificateHolders resulting from the transaction is that
of a partnership, a publicly traded partnership taxed as a corporation, or an
association taxable as a corporation. Since Federal Tax Counsel will advise
that the Certificates will be treated as indebtedness for federal income tax
purposes, the Transferor generally will not attempt to comply with the federal
income tax reporting requirements that would apply if Certificates were
treated as interests in a partnership, a publicly traded partnership or a
corporation.
If a partnership were deemed to be created between the Transferor and the
CertificateHolders, the partnership itself would not be subject to federal
income tax (unless it were to be characterized as a publicly traded
partnership taxable as a corporation); rather, the partners of such
partnership, including the CertificateHolders, would be taxed individually on
their respective distributive shares of the partnership's income, gain, loss,
deductions and credits. The amount and timing of items of income and deduction
of a CertificateHolder could differ if the Certificates were held to
constitute partnership interests, rather than indebtedness. Moreover, an
individual's share of expenses of the partnership would be miscellaneous
itemized deductions that, in the aggregate, are allowed as deductions only to
the extent they exceed 2% of the individual's
78
<PAGE>
adjusted gross income, and would be subject to reduction under Section 68 of
the Code if the individual's adjusted gross income exceeded certain limits. As
a result, the individual might be taxed on a greater amount of income than
would be the case if the Certificates were treated as a debt instrument.
If it were determined that the transaction created an entity classified as
an association or as a publicly traded partnership taxable as a corporation,
the Trust Fund would be subject to federal income tax at corporate income tax
rates on the income it derives from the Loans, which would reduce the amounts
available for distribution to the CertificateHolders. Such classification may
also have adverse state and local tax consequences that would reduce amounts
available for distribution to CertificateHolders. Moreover, distributions on
the Certificates would most likely not be deductible in computing the entity's
taxable income, and cash distributions to the CertificateHolders generally
would be treated as dividends for tax purposes to the extent of such entity's
earnings and profits.
Foreign Investors. If the IRS were to contend successfully that the
Certificates are interests in a partnership and if such partnership were
considered to be engaged in a trade or business in the United States, the
partnership would be subject to a withholding tax on distributions to (or, at
its election, income allocable to) a foreign investor; and such Holder would
be credited for his or her share of the withholding tax paid by the
partnership. In such case, the Holder generally would be subject to United
States federal income tax at regular federal income tax rates, and possibly a
branch profits tax in the case of a corporate Holder.
Alternatively, although there may be arguments to the contrary, if such a
partnership is not considered to be engaged in a trade or business within the
United States and if income with respect to the Certificates is not otherwise
effectively connected with the conduct of a trade or business in the United
States by the foreign investor, the foreign investor would be subject to
United States federal income tax and withholding at a rate of 30% (unless
reduced by an applicable tax treaty) on the Holder's distributive share of the
partnership's interest income.
If the Trust Fund were taxable as a corporation, distributions to foreign
investors, to the extent treated as dividends, would generally be subject to
withholding at the rate of 30%, unless such rate were reduced or eliminated by
an applicable income tax treaty.
STATE TAX CONSIDERATIONS
In addition to the federal income tax consequences described in "Federal
Income Tax Considerations," potential investors should consider the state and
local income tax consequences of the acquisition, ownership, and disposition
of the Securities. State and local income tax law may differ substantially
from the corresponding federal law, and this discussion does not purport to
describe any aspect of the income tax laws of any state or locality.
Therefore, potential investors should consult their own tax advisors with
respect to the various state and local tax consequences of an investment in
the Securities.
ERISA CONSIDERATIONS
Section 406 of the Employee Retirement Income Security Act of 1974, as
amended ("ERISA"), and Section 4975 of the Code prohibit pension, profit
sharing or other employee benefit plans, individual retirement accounts or
annuities, employee annuity plans and Keogh plans subject to ERISA or Section
4975 of the Code (each, a "Benefit Plan") from engaging in certain
transactions involving "plan assets" with persons that are "parties in
interest" under ERISA or "disqualified persons" under the Code with respect to
the plan. ERISA also imposes certain duties and certain prohibitions on
persons who are fiduciaries of plans subject to ERISA. Under ERISA, generally
any person who exercises any authority or control with respect to the
management or disposition of the assets of a plan is considered to be a
fiduciary of such plan. A violation of these "prohibited transaction" rules
may generate excise tax and other liabilities under ERISA and the Code for
fiduciaries, "parties in interest," and "disqualified persons."
79
<PAGE>
Unless a statutory, regulatory or administrative exemption is available, a
violation of these prohibited transaction rules could occur if any Notes or
Certificates were to be acquired by a Benefit Plan or with "plan assets" of
any Benefit Plan, and if any of the Transferor, the Trustee, any underwriter
of such Series or any of their affiliates were a "party in interest" or a
"disqualified person" with respect to such Benefit Plan. The Transferor, the
Trustee and any underwriters of a Series are likely to be "parties in
interest" or "disqualified persons" with respect to many Benefit Plans.
Certain transactions involving the related Trust Fund might be deemed to
constitute prohibited transactions under ERISA and the Code with respect to a
Benefit Plan that purchased Securities if assets of the related Trust Fund
were deemed to be plan assets of the Benefit Plan. Under a regulation issued
by the United States Department of Labor (the "Plan Assets Regulation"), the
assets of a Trust Fund would be treated as plan assets of a Benefit Plan for
the purposes of ERISA and the Code only if the Benefit Plan acquired an
"equity interest" in the Trust Fund and none of the exceptions contained in
the Plan Assets Regulation was applicable. An equity interest is defined under
the Plan Assets Regulation as an interest other than an instrument which is
treated as indebtedness under applicable local law and which has no
substantial equity features. If Notes or Certificates are available for
purchase by Benefit Plans or the "plan assets" of Benefit Plans, the likely
treatment under the Plan Assets Regulation of Notes and Certificates will be
discussed in the related Prospectus Supplement.
Employee benefit plans that are governmental plans (as defined in Section
3(32) of ERISA) and certain church plans (as defined in Section 3(33) of
ERISA) are not subject to ERISA requirements.
Additional information with respect to the eligibility of Notes or
Certificates for purchase by a Benefit Plan or "plan assets" of a Benefit Plan
is provided in the related Prospectus Supplement. A plan fiduciary considering
the purchase of Securities should consult its tax and/or legal advisors
regarding whether the assets of the Trust Fund would be considered plan
assets, the possibility of exemptive relief from the prohibited transaction
rules and other issues and their potential consequences.
LEGAL INVESTMENT
Unless otherwise specified in the related Prospectus Supplement, the
Securities will not constitute "mortgage-related securities" within the
meaning of SMMEA. Accordingly, investors whose investment authority is subject
to legal restrictions should consult their own legal advisors to determine
whether and to what extent the Securities constitute legal investments for
them.
PLAN OF DISTRIBUTION
On the terms and conditions set forth in an underwriting agreement (the
"Underwriting Agreement") with respect to each Trust Fund, the Transferor will
agree to sell to each of the underwriters named therein and in the related
Prospectus Supplement, and each of such underwriters will severally agree to
purchase from the Transferor, the principal amount of each Class of Securities
of the related Series set forth therein and in the related Prospectus
Supplement.
In each Underwriting Agreement, the several underwriters will agree, subject
to the terms and conditions set forth therein, to purchase all of the
Securities described therein which are offered hereby and by the related
Prospectus Supplement if any of such Securities are purchased. In the event of
a default by any such underwriter, each Underwriting Agreement will provide
that, in certain circumstances, purchase commitments of the nondefaulting
underwriters may be increased, or the Underwriting Agreement may be
terminated.
Each Prospectus Supplement will either (i) set forth the price at which each
Class of Securities being offered thereby will be offered to the public and
any concessions that may be offered to certain dealers participating in the
offering of such Securities or (ii) specify that the related Securities are to
be resold by the underwriters in negotiated transactions at varying prices to
be determined at the time of such sale. After the initial public offering of
any Securities, the public offering price and such concessions may be changed.
Each Underwriting Agreement will provide that Chevy Chase will indemnify
underwriters against certain liabilities, including liabilities under the
Securities Act.
Under each Underwriting Agreement, the closing of the sale of any Class of
Securities subject thereto will be conditioned on the closing of the sale of
all other such Classes.
The place and time of delivery for the Securities in respect of which this
Prospectus is delivered will be set forth in the related Prospectus
Supplement.
80
<PAGE>
LEGAL MATTERS
Unless otherwise specified in the related Prospectus Supplement, certain
legal matters in connection with the Securities will be passed upon for the
Transferor by Shaw, Pittman, Potts & Trowbridge, counsel to the Transferor,
and for any underwriters, agents or dealers, Stroock & Stroock & Lavan. Unless
otherwise specified in the related Prospectus Supplement, certain federal
income tax matters will be passed upon for the Transferor by Stroock & Stroock
& Lavan.
81
<PAGE>
GLOSSARY OF TERMS
The following are abbreviated definitions of certain capitalized terms used
in this Prospectus. Unless otherwise provided in a "Supplemental Glossary" in
the Prospectus Supplement for a Series, such definitions shall apply to
capitalized terms used in such Prospectus Supplement. The definitions may vary
from those in the related Agreement for a Series and the related Agreement for
a Series generally provides a more complete definition of certain of the
terms. Reference should be made to the related Agreement for a Series for a
more complete definition of such terms.
"Accrual Termination Date" means, with respect to a Class of Compound
Interest Securities, the Distribution Date specified in the related Prospectus
Supplement.
"Agreement" means, with respect to a Series of Certificates, the Pooling and
Servicing Agreement or Trust Agreement, and, with respect to a Series of
Notes, the Indenture and the Sale and Servicing Agreement, as the context
requires.
"Appraised Value" means, with respect to property securing a Loan, the
lesser of the appraised value determined in an appraisal obtained at
origination of the Loan or sales price of such property at such time.
"Asset Group" means, with respect to the Primary Assets and other assets
comprising the Trust Fund of a Series, a group of such Primary Assets and
other assets having the characteristics described in the related Prospectus
Supplement.
"Assumed Reinvestment Rate" means, with respect to a Series, the per annum
rate or rates specified in the related Prospectus Supplement for a particular
period or periods as the "Assumed Reinvestment Rate" for funds held in any
fund or account for the Series.
"Available Distribution Amount" means the amount in the Distribution Account
(including amounts deposited therein from any reserve fund or other fund or
account) eligible for distribution to Holders on a Distribution Date.
"Bankruptcy Code" means the federal bankruptcy code, 11 United States Code
101 et seq., and related rules and regulations promulgated thereunder.
"Business Day" means a day that, in the City of New York or in the city or
cities in which the corporate trust office of the Trustee are located, is
neither a legal holiday nor a day on which banking institutions are authorized
or obligated by law, regulations or executive order to be closed.
"Certificate" means the Asset-Backed Certificates.
"Certificate Account" or "Collection Account" means, with respect to a
Series, the account established for the deposit by the Servicer of payments
received from the Primary Assets.
"Class" means a class of Securities of a Series.
"Closing Date" means, with respect to a Series, the date specified in the
related Prospectus Supplement as the date on which Securities of such Series
are first issued.
"Code" means the Internal Revenue Code of 1986, as amended, and regulations
(including proposed regulations) or other pronouncements of the Internal
Revenue Service promulgated thereunder.
"Combined Loan-to-Value Ratio" means, with respect to a Loan, the ratio
determined as set forth in the related Prospectus Supplement taking into
account the amounts of any related senior mortgage loans on the related
Mortgaged Property.
82
<PAGE>
"Commission" means the Securities and Exchange Commission.
"Compound Interest Security" means any Security of a Series on which all or
a portion of the interest accrued thereon is added to the principal balance of
such Security on each Distribution Date, through the Accrual Termination Date,
and with respect to which no interest shall be payable until such Accrual
Termination Date, after which interest payments will be made on the Compound
Value thereof.
"Compound Value" means, with respect to a Class of Compound Interest
Securities, the original principal balance of such Class, plus all accrued and
unpaid interest, if any, previously added to the principal balance thereof and
reduced by any payments of principal previously made on such Class of Compound
Interest Securities.
"Condominium" means a form of ownership of real property wherein each owner
is entitled to the exclusive ownership and possession of his or her individual
Condominium Unit and also owns a proportionate undivided interest in all parts
of the Condominium Building (other than the individual Condominium Units) and
all areas or facilities, if any, for the common use of the Condominium Units.
"Condominium Association" means the person(s) appointed or elected by the
Condominium Unit owners to govern the affairs of the Condominium.
"Condominium Building" means a multi-unit building or buildings, or a group
of buildings whether or not attached to each other, located on property
subject to Condominium ownership.
"Condominium Loan" means a Loan secured by a Mortgage on a Condominium Unit
(together with its appurtenant interest in the common elements).
"Condominium Unit" means an individual housing unit in a Condominium
Building.
"Cooperative" means a corporation owned by tenant-stockholders who, through
the ownership of stock, shares or membership securities in the corporation,
receive proprietary leases or occupancy agreements which confer exclusive
rights to occupy specific units and which is described in Section 216 of the
Code.
"Cooperative Dwelling" means an individual housing unit in a building owned
by a Cooperative.
"Cooperative Loan" means a housing loan made with respect to a Cooperative
Dwelling and secured by an assignment by the borrower (tenant-stockholder) or
security interest in shares issued by the applicable Cooperative.
"Cut-off Date" means the date designated as such in the related Prospectus
Supplement for a Series.
"Debt Securities" means Securities characterized as indebtedness for federal
income tax purposes, and Regular Interest Securities.
"Deferred Interest" means the excess of the interest accrued on the
outstanding principal balance of a Loan during a specified period over the
amount of interest required to be paid by an obligor on such Loan on the
related Due Date.
"Delinquency Advance" means cash advanced by the Servicer in respect of
delinquent payments of principal of and/or interest on a Loan to the extent
specified in the related Prospectus Supplement.
"Disqualified Organization" means the United States, any State or political
subdivision thereof, any possession of the United States, any foreign
government, any international organization, or any agency or instrumentality
of any of the foregoing, a rural electric or telephone cooperative described
in section 1381(a)(2)(C) of the Code, or any entity exempt from the tax
imposed by sections 1-1399 of the Code, if such entity is not subject to tax
on its unrelated business income.
83
<PAGE>
"Distribution Account" means, with respect to a Series, the account or
accounts established for the deposit of remittances from the Collection
Account for distribution to Securityholders.
"Distribution Date" means, with respect to a Series or Class of Securities,
each date specified as a distribution date for such Series or Class in the
related Prospectus Supplement.
"Due Date" means each date, as specified in the related Prospectus
Supplement for a Series, on which any payment of principal or interest is due
and payable by the obligor on any Primary Asset pursuant to the terms thereof.
"Eligible Investments" means any one or more of the obligations or
securities described as such in the related Agreement.
"Enhancement" means the enhancement for a Series, if any, specified in the
related Prospectus Supplement.
"Enhancer" means the provider of the Enhancement for a Series specified in
the related Prospectus Supplement.
"ERISA" means the Employee Retirement Income Security Act of 1974, as
amended.
"Escrow Account" means an account, established and maintained by the
Servicer for a Loan, into which payments by borrowers to pay taxes,
assessments, mortgage and hazard insurance premiums and other comparable items
required to be paid to the mortgagee are deposited.
"FDIC" means the Federal Deposit Insurance Corporation.
"FHLMC" means the Federal Home Loan Mortgage Corporation.
"Final Scheduled Distribution Date" means, with respect to a Class of Notes
of a Series, the date no later than which principal thereof will be fully paid
and with respect to a Class of Certificates of a Series, the date after which
no Certificates of such Class will remain outstanding, in each case based on
the assumptions set forth in the related Prospectus Supplement.
"FNMA" means the Federal National Mortgage Association.
"Holder" or "Securityholder" means the person or entity in whose name a
Security is registered.
"Home Improvements" means the home improvements financed by a Home
Improvement Contract.
"Home Improvement Contract" means any home improvement installment sales
contracts and installment loan agreement which may be unsecured or secured by
a purchase money security interest in the Home Improvement financed thereby.
"HUD" means the United States Department of Housing and Urban Development.
"Indenture" means the indenture relating to a Series of Notes between the
Trust Fund and the Trustee.
"Insurance Policies" means certain mortgage insurance, hazard insurance and
other insurance policies required to be maintained with respect to Loans.
"Insurance Proceeds" means amount paid by the insurer under any of the
Insurance Policies covering any Loan or Mortgaged Property.
"Interest Only Securities" means a Class of Securities entitled solely or
primarily to distributions of interest and which is identified as such in the
related Prospectus Supplement.
84
<PAGE>
"IRS" means the Internal Revenue Service.
"Lifetime Rate Cap" means the lifetime limit if any, on the Loan Rate during
the life of each adjustable rate Loan.
"Liquidation Proceeds" means amounts received by the Servicer in connection
with the liquidation of a Loan, net of liquidation expenses.
"Loan Rate" means, unless otherwise indicated herein or in the Prospectus
Supplement, the interest rate borne by a Loan.
"Loans" mean Mortgage Loans and/or Home Improvement Contracts, collectively.
A Loan refers to a specific Mortgage Loan or Home Improvement Contract, as the
context requires.
"Loan-to-Value Ratio" means, with respect to a Loan, the ratio determined as
set forth in the related Prospectus Supplement.
"Minimum Rate" means the lifetime minimum Loan Rate during the life of each
adjustable rate Loan.
"Modification" means a change in any term of a Loan.
"Mortgage" means the mortgage, deed of trust or other similar security
instrument securing a Mortgage Note.
"Mortgage Loan" means a closed-end and/or revolving credit line home equity
loan or balance thereof secured by a Mortgaged Property.
"Mortgage Note" means the note or other evidence of indebtedness of a
Mortgagor under the Loan.
"Mortgaged Property" means any real estate securing a Mortgage Loan and/or a
Home Improvement Contract.
"Mortgagor" means the obligor on a Mortgage Note.
"1986 Act" means the Tax Reform Act of 1986.
"Notes" means the Asset-Backed Notes.
"Notional Amount" means the amount set forth in the related Prospectus
Supplement for a Class of Interest Only Securities.
"OTS" means the Office of Thrift Supervision.
"PAC" ("Planned Amortization Class Securities") means a Class of Securities
of a Series on which payments of principal are made in accordance with a
schedule specified in the related Prospectus Supplement, based on certain
assumptions stated therein.
"Participating Securities" means Securities entitled to receive payments of
principal and interest and an additional return on investment as described in
the related Prospectus Supplement.
"Pass-Through Security" means a security representing an undivided
beneficial interest in a pool of assets, including the right to receive a
portion of all principal and interest payments relating to those assets.
"Pay Through Security" means Regular Interest Securities and certain Debt
Securities that are subject to acceleration due to prepayment on the
underlying Primary Assets.
85
<PAGE>
"Person" means any individual, corporation, partnership, joint venture,
association, joint stock company, trust (including any beneficiary thereof),
unincorporated organization, or government or any agency or political
subdivision thereof.
"Pooling and Servicing Agreement" means the pooling and servicing agreement
relating to a Series of Certificates among the Transferor, the Servicer (if
such Series relates to Loans) and the Trustee.
"Primary Assets" means the Private Securities and/or Loans, as the case may
be, which are included in the Trust Fund for such Series. A Primary Asset
refers to a specific Private Security or Loan, as the case may be.
"Principal Balance" means, with respect to a Primary Asset and as of a Due
Date, the original principal amount of the Primary Asset, plus the amount of
any Deferred Interest added to such principal amount, reduced by all payments,
both scheduled or otherwise, received on such Primary Asset prior to such Due
Date and applied to principal in accordance with the terms of the Primary
Asset.
"Principal Only Securities" means a Class of Securities entitled solely or
primarily to distributions of principal and identified as such in the
Prospectus Supplement.
"Private Security" means a participation or pass-through certificate
representing a fractional, undivided interest in Underlying Loans or
collateralized obligations secured by Underlying Loans.
"Property" means either a Home Improvement or a Mortgaged Property securing
a Loan, as the context requires.
"PS Agreement" means the pooling and servicing agreement, indenture, trust
agreement or similar agreement pursuant to which a Private Security is issued.
"PS Servicer" means the servicer of the Underlying Loans.
"PS Sponsor" means, with respect to Private Securities, the sponsor or
depositor under a PS Agreement.
"PS Trustee" means the trustee designated under a PS Agreement.
"Qualified Insurer" means a mortgage guarantee or insurance company duly
qualified as such under the laws of the states in which the Mortgaged
Properties are located duly authorized and licensed in such states to transact
the applicable insurance business and to write the insurance provided.
"Rating Agency" means the nationally recognized statistical rating
organization (or organizations) which was (or were) requested by the
Transferor to rate the Securities upon the original issuance thereof.
"Real Estate Loans" means Mortgage Loans and Home Improvement Contracts
secured by Mortgaged Property.
"Regular Interest" means a regular interest in a REMIC.
"REMIC" means a real estate mortgage investment conduit.
"REMIC Administrator" means the Person, if any, specified in the related
Prospectus Supplement for a Series for which a REMIC election is made, to
serve as administrator of the Series.
"REMIC Provisions" means the provisions of the federal income tax law
relating to real estate mortgage investment conduits, which appear at sections
860A through 860G of Subchapter M of Chapter 1 of the Code, and related
provisions, and regulations, including proposed regulations and rulings, and
administrative pronouncements promulgated thereunder, as the foregoing may be
in effect from time to time.
86
<PAGE>
"REO Property" means real property which secured a defaulted Loan,
beneficial ownership of which has been acquired upon foreclosure, deed in lieu
of foreclosure, repossession or otherwise.
"Reserve Fund" means, with respect to a Series, any Reserve Fund established
pursuant to the related Agreement.
"Residual Interest" means a residual interest in a REMIC.
"Retained Interest" means, with respect to a Primary Asset, the amount or
percentage specified in the related Prospectus Supplement which is not
included in the Trust Fund for the related Series.
"Scheduled Payments" means the scheduled payments of principal and interest
to be made by the borrower on a Primary Asset.
"Securities" means the Notes or the Certificates.
"Senior Securityholder" means a holder of a Senior Security.
"Senior Securities" means a Class of Securities as to which the holders'
rights to receive distributions of principal and interest are senior to the
rights of holders of Subordinated Securities, to the extent specified in the
related Prospectus Supplement.
"Series" means a separate series of Securities sold pursuant to this
Prospectus and the related Prospectus Supplement.
"Servicer" means Chevy Chase Bank, F.S.B., or the successors or assigns of
such Person.
"Single Family Property" means property securing a Loan consisting of one-
to four-family attached or detached residential housing, including Cooperative
Dwellings.
"Stripped Securities" means Pass-Through Securities representing interests
in Primary Assets with respect to which all or a portion of the principal
payments have been separated from all or a portion of the interest payments.
"Subordinated Securities" means a Class of Securities as to which the rights
of holders to receive distributions of principal, interest or both is
subordinated to the rights of holders of Senior Securities, and may be
allocated losses and shortfalls prior to the allocation thereof to other
Classes of Securities, to the extent and under the circumstances specified in
the related Prospectus Supplement.
"Transferor" means Chevy Chase Bank, F.S.B.
"Trustee" means the trustee under the applicable Agreement and its
successors.
"Trust Fund" means, with respect to any Series of Securities, the trust
holding all money, instruments, securities and other property, including all
proceeds thereof, which are, with respect to a Series of Certificates, held
for the benefit of the Holders by the Trustee under the Pooling and Servicing
Agreement or Trust Agreement or, with respect to a Series of Notes, pledged to
the Trustee under the Indenture as security for such Notes, including, without
limitation, the Primary Assets (except any Retained Interests), rights to all
amounts in the Distribution Account, Collection Account, Certificate Account,
Pre-Funding Account, Capitalized Interest Account or Reserve Funds, if any,
distributions on the Primary Assets (net of servicing fees) and rights to any
Enhancement and all other property and interest held by or pledged to the
Trustee pursuant to the related Agreement for such Series.
"UCC" means the Uniform Commercial Code.
87
<PAGE>
"Underlying Loans" means loans of the type eligible to be Loans underlying
or securing Private Securities.
"Variable Interest Security" means a Security on which interest accrues at a
rate that is adjusted, based upon a predetermined index, at fixed periodic
intervals, all as set forth in the related Prospectus Supplement.
"Zero Coupon Security" means a Security entitled to receive payments of
principal only.
88
<PAGE>
- -------------------------------------------------------------------------------
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRE-
SENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS SUPPLEMENT OR THE
PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT
BE RELIED UPON. THIS PROSPECTUS SUPPLEMENT AND THE PROSPECTUS DO NOT CONSTI-
TUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY OF THE SECURI-
TIES OFFERED HEREBY, NOR AN OFFER OF SUCH SECURITIES IN ANY STATE OR JURISDIC-
TION IN WHICH, OR TO ANY PERSON TO WHOM, SUCH OFFER WOULD BE UNLAWFUL. THE DE-
LIVERY OF THIS PROSPECTUS SUPPLEMENT OR THE PROSPECTUS AT ANY TIME DOES NOT
IMPLY THAT THE INFORMATION CONTAINED HEREIN OR THEREIN IS CORRECT AS OF ANY
TIME SUBSEQUENT TO ITS DATE.
------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PROSPECTUS SUPPLEMENT
Report to Certificateholders............................................... S-2
Prospectus Supplement Summary of Terms..................................... S-3
Risk Factors............................................................... S-25
The Transferor............................................................. S-28
The Trust.................................................................. S-29
Use of Proceeds............................................................ S-29
The Chevy Chase Home Loan Program.......................................... S-29
The Home Loan Pool......................................................... S-34
The Certificate Insurer.................................................... S-39
Maturity and Prepayment Considerations..................................... S-40
The Certificates........................................................... S-44
Credit Enhancement......................................................... S-61
Further Provisions of the Pooling and
Servicing Agreement....................................................... S-65
Certain Information Regarding
the Certificates.......................................................... S-70
Federal Income Tax Considerations.......................................... S-72
State Tax Considerations................................................... S-72
ERISA Considerations....................................................... S-72
Legal Investment Considerations............................................ S-72
Underwriting............................................................... S-73
Legal Opinions............................................................. S-73
Experts.................................................................... S-73
Rating..................................................................... S-74
Index of Principal Terms................................................... S-75
Appendix A................................................................. A-1
Appendix B................................................................. B-1
PROSPECTUS
Prospectus Supplement...................................................... 3
Reports to Holders......................................................... 3
Available Information...................................................... 3
Incorporation of Certain Documents by Reference............................ 4
Summary of Terms........................................................... 5
Risk Factors............................................................... 16
Description of the Securities.............................................. 20
The Trust Funds............................................................ 24
Enhancement................................................................ 31
Servicing of Loans......................................................... 31
The Agreements............................................................. 38
Certain Legal Aspects of the Loans......................................... 47
The Transferor............................................................. 57
Use of Proceeds............................................................ 57
Federal Income Tax Considerations.......................................... 57
State Tax Considerations................................................... 79
ERISA Considerations....................................................... 79
Legal Investment........................................................... 80
Plan of Distribution....................................................... 80
Legal Matters.............................................................. 81
Glossary of Terms.......................................................... 82
</TABLE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
$153,521,000
CHEVY CHASE HOME LOAN TRUST 1996-1
Chevy Chase Bank, F.S.B
Transferor and Servicer
% HOME LOAN
ASSET-BACKED CERTIFICATES,
SERIES 1996-1
PROSPECTUS SUPPLEMENT
CS First Boston
Smith Barney Inc.
May , 1996
- -------------------------------------------------------------------------------
