<PAGE>
PROSPECTUS SUPPLEMENT
(TO PROSPECTUS DATED SEPTEMBER 22, 1997)
$95,000,000
CHEVY CHASE HOME LOAN TRUST 1997-1
6.55% HOME LOAN ASSET-BACKED CERTIFICATES, SERIES 1997-1
CHEVY CHASE BANK, F.S.B.
AS SELLER AND SERVICER
------------
The 6.55% Home Loan Asset-Backed Certificates, Series 1997-1 (the
"Certificates") will evidence in the aggregate an undivided ownership interest
in the Chevy Chase Home Loan Trust 1997-1 (the "Trust") to be formed pursuant
to a Pooling and Servicing Agreement (the "Agreement") between Chevy Chase
Bank, F.S.B. ("Chevy Chase"), as seller (in such capacity, the "Seller") and
as servicer (in such capacity, the "Servicer"), and U.S. Bank National
Association, as trustee (the "Trustee"). The Certificates will be issued in a
single class having an aggregate initial principal balance of $95,000,000, and
will represent the right to receive payments of interest at a pass-through
rate of 6.55% per annum (the "Pass-Through Rate"), and principal as described
herein. The Seller will be entitled to amounts remaining, if any, after
distributions in respect of the Certificates as described herein. Principal
and interest will be distributed on the Certificates to the extent described
herein on the 20th day of each month or, if such 20th day is not a Business
Day (as defined herein), on the next succeeding Business Day (each, a
"Distribution Date"), commencing in October 1997. The Final Distribution Date
with respect to the Certificates will be the Distribution Date in May 2018.
(Continued on following page)
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.
POTENTIAL INVESTORS SHOULD CONSIDER, AMONG OTHER THINGS, THE INFORMATION SET
FORTH IN "RISK FACTORS" COMMENCING ON PAGE S-14 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 DISCOUNT AND PROCEEDS TO
PUBLIC (1) COMMISSIONS SELLER (1)(2)
- -------------------------------------------------------------
<S> <C> <C> <C>
Per Certificate 99.968750% 0.350000% 99.618750%
- -------------------------------------------------------------
Total (2) $94,970,312.50 $332,500.00 $94,637,812.50
- -------------------------------------------------------------
- -------------------------------------------------------------
</TABLE>
(1) Plus accrued interest, if any, from September 20, 1997.
(2) Before deducting expenses payable by the Seller, estimated to be $400,000.
------------
The Certificates are offered by the several Underwriters when, as and if
issued by the Seller, 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 September 29, 1997,
against payment in immediately available funds.
------------
SMITH BARNEY INC. CREDIT SUISSE FIRST BOSTON
------------
The date of this Prospectus Supplement is September 22, 1997.
<PAGE>
(Continued from preceding page)
The property of the Trust will consist primarily of certain closed-end home
equity loans (the "Home Equity Loans"), closed-end debt consolidation loans
(the "Debt Consolidation Loans") and conventional home improvement installment
sales contracts and installment loan agreements (the "Home Improvement
Contracts"; collectively with the Home Equity Loans and the Debt Consolidation
Loans, the "Loans"). Most of the Loans are secured by second or third deeds of
trust or mortgages (the "Mortgages") on one- to four-family residential
properties (the "Mortgaged Properties"). The Trust also will include
collections in respect of the Loans received on and after September 1, 1997
(the "Cut-off Date"), the Policy and certain other property as described more
fully herein. The Reserve Fund (as defined herein) will not be an asset of the
Trust Fund but will be maintained for the benefit of the Certificateholders
and the Certificate Insurer.
Full and complete payment of the Insured Amount (as defined herein) on each
Distribution Date and of the unpaid Certificate Principal Balance on the Final
Distribution 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").
[LOGO OF CAPMAC APPEARS HERE]
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.
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE CERTIFICATES,
INCLUDING OVER-ALLOTMENT TRANSACTIONS, STABILIZING TRANSACTIONS, SYNDICATE
COVERING TRANSACTIONS AND PENALTY BIDS. FOR A DESCRIPTION OF THESE ACTIVITIES,
SEE "UNDERWRITING" HEREIN.
REPORTS 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
Seller, 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.
ISSUER.......................... Chevy Chase Home Loan Trust 1997-1 (the
"Trust"), to be formed pursuant to a Pooling
and Servicing Agreement (the "Agreement"),
dated as of September 1, 1997, between Chevy
Chase, as seller (in such capacity, the
"Seller") and servicer (in such capacity,
the "Servicer"), and the Trustee.
SELLER 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 SELLER" herein and
"THE TRANSFEROR" in the Prospectus.
CERTIFICATE INSURER............. Capital Markets Assurance Corporation. See
"THE CERTIFICATE INSURER" herein.
TRUSTEE......................... U.S. Bank National Association, a national
banking association, doing business as First
Bank National Association. The Trustee's
principal corporate trust office is located
at 180 East Fifth Street, St. Paul,
Minnesota 55101. See "FURTHER PROVISIONS OF
THE POOLING AND SERVICING AGREEMENT--The
Trustee and Paying Agent" herein.
THE CERTIFICATES................ The certificates will consist of a single
class of certificates entitled 6.55% Home
Loan Asset-Backed Certificates, Series 1997-
1 (the "Certificates"). Each Certificate
will represent an undivided ownership
interest in the Trust. The Certificates will
be issued in an aggregate original principal
balance of $95,000,000 (the "Initial
Certificate Principal Balance"). The Seller
will be entitled to amounts, if any,
remaining after distributions in respect of
the Certificates as described herein.
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 ("Certificate
Owners") will hold their interests through
DTC. See "RISK FACTORS--Book-Entry
Registration; Effect on Liquidity" herein.
S-3
<PAGE>
TRUST FUND...................... The property of the Trust (the "Trust Fund")
will consist of (i) certain closed-end home
equity loans (the "Home Equity Loans"),
closed-end debt consolidation loans (the
"Debt Consolidation Loans") and conventional
home improvement installment sales contracts
and installment loan agreements (the "Home
Improvement Contracts"; collectively with
the Home Equity Loans and the Debt
Consolidation Loans, the "Loans"), most of
which are secured by second or third deeds
of trust or mortgages (the "Mortgages") on
one- to four-family residential properties
(the "Mortgaged Properties") located
primarily in Virginia, Maryland, Florida,
Georgia, North Carolina, New Jersey and
Pennsylvania, (ii) collections in respect of
the Loans received on and after the Cut-off
Date, (iii) the Policy, (iv) the interest of
the Trust in certain hazard insurance
policies maintained by the borrowers with
respect to the Mortgaged Properties, (v) the
proceeds of the foregoing and (vi) certain
other property as described more fully
herein. On the Closing Date, the Loans will
have an aggregate unpaid principal balance
as of September 1, 1997 (the "Cut-off Date")
of approximately $95,000,413 after giving
effect to all payments of principal thereon
received prior to the Cut-off Date (the
"Original Pool Balance"). The Reserve Fund
will not be an asset of the Trust Fund but
will be maintained for the benefit of the
Certificateholders and the Certificate
Insurer. See "THE LOAN POOL" herein and "THE
TRUST FUNDS" in the Prospectus.
TERMS OF THE CERTIFICATES....... The principal terms of the Certificates are
as follows:
A. PASS-THROUGH RATE.......... 6.55% per annum, calculated on the basis of a
360-day year consisting of twelve 30 day
months (the "Pass-Through Rate").
B. DISTRIBUTION DATE.......... The 20th day of each month (or if such 20th
day is not a Business Day, the next
succeeding Business Day), commencing October
20, 1997. A "Business Day" is 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 business
office of the paying agent under the
Agreement is located) are required or
authorized by law to be closed.
C. RECORD DATE................ The day prior to each Distribution Date if
the Certificates are book-entry
certificates, and the last day of the month
preceding the month of the related
Distribution Date if the Certificates are
issued in definitive form.
D. FINAL DISTRIBUTION DATE.... The Distribution Date occurring in May 2018
(the "Final Distribution Date").
S-4
<PAGE>
E. INTEREST................... Interest on the Certificates will accrue at
the Pass-Through Rate from and including
September 20, 1997 (in the case of the first
Distribution Date) or from and including the
most recent Distribution Date on which
interest has been paid, to but excluding the
following Distribution Date (each, an
"Interest Period"). On each Distribution
Date, to the extent of funds available
therefor, the Trustee will distribute the
Interest Distributable Amount on a pro rata
basis to the holders of the Certificates
(the "Certificateholders") of record as of
the related Record Date. The "Interest
Distributable Amount" for any Distribution
Date means the sum of (i) interest accrued
during the related Interest Period at the
Pass-Through Rate on the Certificate
Principal Balance immediately preceding such
Distribution Date and (ii) the
Certificateholders' Interest Carryover
Shortfall. "Certificateholders' Interest
Carryover Shortfall" means, with respect to
any Distribution Date, the excess of the
Interest Distributable Amount for the
preceding Distribution Date over the amount
of interest actually distributed to
Certificateholders on such preceding
Distribution Date, plus interest on such
excess, to the extent permitted by law, at
the Pass-Through Rate from and including the
preceding Distribution Date to but excluding
the current Distribution Date. Interest will
be calculated on the basis of a 360-day year
comprised of twelve 30-day months. See "THE
CERTIFICATES--Interest" herein.
The "Certificate Principal Balance" initially
will equal the Initial Certificate Principal
Balance and thereafter will equal the
Initial Certificate Principal Balance
reduced by all principal distributions on
the Certificates.
F. PRINCIPAL.................. On each Distribution Date, to the extent of
Monthly Allocable Principal, 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" for any Distribution
Date means an amount equal to the lesser of
(a) the sum of (i) the Principal Collections
for such Distribution Date, (ii) any
Liquidation Loss Amount for the related
Monthly Collection Period and (iii) any
portion of the Principal Distributable
Amount for any prior Distribution Date that
was not previously distributed and (b) the
outstanding Certificate Principal Balance of
the Certificates; provided, however, that on
the Final Distribution Date, the Principal
Distributable Amount will equal the
Certificate Principal Balance; and 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.
S-5
<PAGE>
"Monthly Allocable Principal" means, with
respect to each Distribution Date, an amount
equal to the sum of (i) the Principal
Collections (as defined below) deposited in
the Principal Distribution Account for such
Distribution Date, (ii) any Excess Interest
to the extent deposited in the Principal
Distribution Account to pay the Liquidation
Loss Amount for such Distribution Date,
(iii) any Reserve Fund Principal Transfer
Amount (as defined herein) drawn from the
Reserve Fund for such Distribution Date and
(iv) any Principal Deficiency Draw Amount
(as defined herein) made under the Policy
for such Distribution Date.
The "Monthly Collection Period" for any
Distribution Date is the calendar month
preceding such Distribution Date.
DISTRIBUTIONS................... The amount on deposit in the Interest
Distribution Account for each Monthly
Collection Period, to the extent available,
will be applied on the related Distribution
Date in the following order of priority: (i)
to payment of the Servicing Fee for the
related Monthly Collection Period (to the
extent not retained by the Servicer from
Interest Collections) and all accrued and
unpaid Servicing Fees for prior Monthly
Collection Periods; (ii) to payment of 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 Certificates, an
amount equal to the Interest Distributable
Amount for such Distribution Date; (iv) to
the payment of the monthly premium for the
Policy; (v) to the Principal Distribution
Account, to be distributed to the
Certificateholders as principal, an amount
equal to the Liquidation Loss Amount for
such Distribution Date; (vi) to payment of
all prior unreimbursed draws made on the
Policy, together with accrued interest
thereon, and any other amounts owed to the
Certificate Insurer pursuant to the
Insurance Agreement; (vii) to the Reserve
Fund in an amount sufficient to satisfy the
Specified Reserve Fund Requirement and
(viii) to the Seller, 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."
"Liquidation Loss Amount" means, with respect
to any Liquidated Loan, the unrecovered
principal balance thereof at the end of the
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.
Monthly Allocable Principal for the related
Monthly Collection Period will be applied on
the related Distribution
S-6
<PAGE>
Date to the extent of available funds as
follows: (i) to the Certificates, in an
amount up to the Principal Distributable
Amount for such Distribution Date and (ii)
to the Seller, any remaining amounts.
THE LOANS....................... The Loans will consist primarily of (i)
closed-end home equity loans originated by
Chevy Chase or a subsidiary of Chevy Chase
and debt consolidation loans originated by
Chevy Chase or acquired by Chevy Chase in
the ordinary course of its business from
licensed mortgage companies, most of which
are secured 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 by
first, second or third deeds of trust or
mortgages on Residential Properties and
(iii) conventional installment loan
agreements for the purpose of financing home
improvements originated by Chevy Chase in
the ordinary course of its business, most of
which are secured by second or third deeds
of trust or mortgages on Residential
Properties. All of the Loans are required to
have been underwritten to Chevy Chase's
underwriting standards. See "THE CHEVY CHASE
HOME LOAN AND HOME EQUITY LOAN PROGRAMS--
Loan Programs" and "--Underwriting
Procedures" herein.
As of the Cut-off Date, the Loans had an
unpaid aggregate principal balance of
approximately $95,000,413, a minimum
outstanding principal balance of $1,500, a
maximum outstanding principal balance of
$99,501, a remaining term to maturity of no
less than 12 months and no greater than 240
months, a weighted average remaining term to
maturity of 138 months, a number of months
since the date of origination of no less
than 0 months and no greater than 102
months, a weighted average number of months
since the date of origination of 5 months, a
specified per annum interest rate (the "Loan
Rate") of no less than 7.80% and no greater
than 17.25% and a weighted average Loan Rate
of 11.87%. Approximately 24.3%, 20.5%,
14.6%, 11.2%, 8.6%, 6.6% and 4.1% of the
Loans based upon the Original Pool Balance
had Obligors with billing addresses in
Virginia, Maryland, Florida, Georgia, North
Carolina, New Jersey and Pennsylvania,
respectively. Approximately 9.9% of the
Loans based upon the Original Pool Balance
were unsecured. All of the Loans are fixed
rate, simple interest loans which generally
provide for equal
S-7
<PAGE>
monthly payments, except for 41 Loans,
representing approximately $1,086,231 in
Cut-off Date principal balance, which
provide for balloon payments at maturity.
None of the Loans are insured by the Federal
Housing Administration or guaranteed by the
Veterans Administration. See "THE 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
fixed-rate home equity loan agreement, sales
contract or installment loan agreement. To
the extent described herein, the Servicer
will deposit Interest Collections and
Principal Collections on the Loans in an
account established for such purpose under
the Agreement (the "Collection Account") as
described herein. See "THE CERTIFICATES--
Establishment of Accounts" and "--
Collections" herein.
"Interest Collections" for any Distribution
Date will consist of (i) interest
collections received from or on behalf of
borrowers on the Loans (each, an "Obligor")
during the related Monthly Collection Period
(less the Servicing Fee and, 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 Repurchase Deposit
Amount received in respect of the related
Monthly Collection Period and (v) investment
earnings (net of losses) on amounts on
deposit in the Collection Account for the
related Monthly Collection Period.
"Principal Collections" for any Distribution
Date will consist of (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
Repurchase Deposit Amount and the
Substitution Adjustment Amount for any
repurchased or substituted Loans received in
respect of the related Monthly Collection
Period.
"Net Liquidation Proceeds" means, with
respect to any Liquidated Loan, Liquidation
Proceeds reduced by related expenses
(including, without limitation, Servicer
Advances,
S-8
<PAGE>
the cost of recordation of assignments and
any amount advanced in respect of the
repayment of a senior mortgage).
"Liquidation Proceeds" means proceeds
(excluding any amounts drawn from the
Reserve Fund or on the Policy) received in
connection with the liquidation of a
Liquidated Loan.
"Insurance Proceeds" means, with respect to
any Loan and a Monthly Collection Period,
proceeds paid to the Seller 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 Obligor 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, any amount that was previously
recognized as a loss but subsequently has
been 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).
THE RESERVE FUND................ On the Closing Date, the Seller will make an
initial deposit of an amount to be agreed
upon by the Seller and the Certificate
Insurer as set forth in the Agreement in an
account (the "Reserve Fund") which will be
established with the Trustee. The amount
initially deposited in the Reserve Fund by
the Seller, which may consist of a portion
of the proceeds of the sale of the
Certificates, is referred to herein as the
"Initial Reserve Fund Deposit." The Reserve
Fund is not an asset of the Trust Fund but
will be
S-9
<PAGE>
maintained by the Trustee for the benefit of
the Certificateholders and the Certificate
Insurer. On each Distribution Date the
Trustee will be required to transfer from
the Interest Distribution Account to the
Reserve Fund, to the extent Interest
Collections are available therefor after
making payments having a higher priority as
described herein, any additional amount
necessary such that the amount on deposit
therein is equal to the Specified Reserve
Fund Requirement as described under "THE
CERTIFICATES--Distributions" herein.
Amounts, if any, on deposit in the Reserve
Fund will be available on each Distribution
Date to fund payment of the Interest
Distributable Amount and the Principal
Distributable Amount for such Distribution
Date. On the Business Day preceding each
Distribution Date (each, a "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 (a) the excess of (1) the Interest
Distributable Amount for such Distribution
Date over (2) the amount on deposit in the
Interest Distribution Account on such date
before giving effect to any such transfer
from the Reserve Fund and (b) the amount on
deposit in the Reserve Fund and (ii) then,
withdraw from the Reserve Fund and deposit
in the Principal Distribution Account an
amount (the "Reserve Fund Principal Transfer
Amount") equal to the lesser of (x) the
excess of (1) the Principal Distributable
Amount for such Distribution Date over (2)
the amount on deposit in the Principal
Distribution Account before giving effect to
such transfer from the Reserve Fund and (y)
the amount remaining in the Reserve Fund
after giving effect to any withdrawals
therefrom pursuant to clause (i).
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.
The provisions relating to the Reserve Fund
may be amended in any respect by the Seller,
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. Under any such
amendments, amounts that are no longer
required to be deposited in the Reserve Fund
will be distributed to the Seller.
Notwithstanding any
S-10
<PAGE>
reduction in or elimination of the funding
requirements of the Reserve Fund or the
depletion thereof, the Certificate Insurer
will be obligated under the Policy to fund
on each Distribution Date the full amount
otherwise required to be paid on such
Distribution Date. See "THE CERTIFICATES--
The Reserve Fund" herein.
THE POLICY...................... On or before the Closing Date, the Seller
will cause a financial guaranty insurance
policy (the "Policy") to be issued by the
Certificate Insurer pursuant to the
provisions of the Agreement and an Insurance
and Indemnity Agreement (the "Insurance
Agreement") among the Seller, the Servicer,
the Certificate Insurer and the Trustee.
Pursuant to the Policy, the Certificate
Insurer will unconditionally and irrevocably
guarantee (i) the Interest Distributable
Amount for each Distribution Date and (ii)
the Principal Distributable Amount for each
Distribution Date and, on the Final
Distribution Date, the payment to the
Certificateholders of the outstanding
Certificate Principal Balance of the
Certificates (collectively, the "Insured
Payments"). A draw will be made on the
Policy equal to, with respect to each
Distribution Date, (i) the amount, if any,
by which the Interest Distributable Amount
exceeds all amounts on deposit in the
Interest Distribution Account (including the
Reserve Fund Interest Transfer Amount, if
any) for such Distribution Date (such
amount, the "Interest Deficiency Draw
Amount") plus (ii) the amount, if any, by
which the Principal Distributable Amount
(or, in the case of the Final Distribution
Date, the outstanding Certificate Principal
Balance of the Certificates) exceeds all
amounts on deposit in the Principal
Distribution Account (including the Reserve
Fund Principal Transfer Amount, if any) for
such Distribution Date (such amount, the
"Principal Deficiency Draw Amount"). The
amount of any such draw will be deposited in
the Collection Account and allocated to the
Interest Distribution Account or the
Principal Distribution Account, as
applicable, on the Deposit Date following
such draw.
To the extent that Excess Interest is
unavailable or amounts in the Reserve Fund
are 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 "THE POLICY" herein.
TERMINATION OF THE TRUST;
OPTIONAL TERMINATION........... The Trust will terminate on the Distribution
Date following the earliest of (i) the
Distribution Date on which the
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Certificate Principal Balance has been
reduced to zero and all amounts owing to the
Certificate Insurer have been paid, (ii) the
final payment or other liquidation of the
last Loan and the disposition of any amounts
received or property acquired upon
liquidation of any remaining Loans and (iii)
the Final Distribution Date.
The Loans will be subject to optional
repurchase by the Seller on any Distribution
Date on or after the date on which the Pool
Balance is reduced to an amount less than or
equal to $4,750,021 (5% of the Original Pool
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 outstanding Pool
Balance, plus accrued interest thereon at
the weighted average of the Loan Rates less,
for so long as Chevy Chase is the Servicer,
the Servicing Fee Rate, through the day
preceding the Distribution Date on which the
Loans are repurchased. See "FURTHER
PROVISIONS OF THE POOLING AND SERVICING
AGREEMENT--Optional Termination; Retirement
of the Certificates" herein.
SERVICING FEE................... The Servicer will receive a fee on each
Distribution Date (the "Servicing Fee")
equal to one-twelfth of the product of 0.75%
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 REPURCHASE OR
SUBSTITUTION OF LOANS.......... The Seller or, in certain circumstances, the
Servicer is required to repurchase (in the
case of the Seller) or purchase (in the case
of the Servicer) each Loan as to which there
exists (A) a material breach of a
representation or warranty made by the
Seller 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, at the option of the
Seller, to substitute new Loans for such
Loans, provided such substitution occurs
before September 1, 1999. See "THE
CERTIFICATES--Assignment of Loans" herein.
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FEDERAL INCOME TAX
CONSIDERATIONS................. The Trust should be characterized as a
grantor trust for federal income tax
purposes, but failing that, it will be
characterized as a partnership and not as an
association taxable as a corporation (or
publicly traded partnership treated as an
association). See "FEDERAL INCOME TAX
CONSIDERATIONS" herein and "FEDERAL INCOME
TAX CONSIDERATIONS" in the Prospectus. No
representation is made regarding
qualification of the Certificates under
Section 856 or 7701(a)(19)(c) of the Code.
Prospective investors should consult their
own tax advisors regarding the federal,
state, local, and other tax consequences of
the ownership and disposition of the
Certificates.
WITHHOLDING ON FOREIGN
CERTIFICATEHOLDERS............. PAYMENTS OF INTEREST (AND ACCRUED ORIGINAL
ISSUE DISCOUNT) MADE TO A NON-U.S. INVESTOR
GENERALLY WILL BE SUBJECT TO A 30% U.S.
FEDERAL WITHHOLDING TAX. SEE "FEDERAL INCOME
TAX CONSIDERATIONS" HEREIN.
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
CONSIDERATIONS................. The Certificates will not constitute
"mortgage related securities" for purposes
of the Secondary Mortgage Market Enhancement
Act of 1984 ("SMMEA"). Accordingly, certain
institutions 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. 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
Recommendations" in the Prospectus.
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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.
NATURE OF SECURITY
Approximately 9.9% of the Loans based on the Original Pool Balance are
unsecured, and the remainder of the Loans are secured by first, second or
third deeds of trust or mortgages. In general, 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. See "CERTAIN LEGAL ASPECTS OF THE LOANS--
Junior Mortgages; Rights of Senior Mortgages" in the Prospectus. The Home
Improvement Contracts and Debt Consolidation Loans were underwritten based
primarily upon the related Obligor's ability to repay such Loan and not on the
value of the collateral, if any. The Home Equity Loans were underwritten based
upon both the related Obligor's ability to repay such Loan and the value of
the related collateral. 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 Seller'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 (as defined
herein), Certificateholders will most likely have to rely primarily on
payments from the Obligors for repayment of the Certificates.
Although the Agreement requires the Seller to deliver to the Trustee, with
respect to each Loan, within 180 days after the Closing 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 (a) 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, in which case the Agreement requires the Trustee to record
all or any portion of such assignments as and when directed by the Servicer;
or (b) the Seller is less than adequately capitalized as determined pursuant
to the regulations of the Office of Thrift Supervision, in which case the
Agreement requires the Trustee to record all or any portion of such
assignments if, 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--
Status of Junior Liens; Property Values May Be Insufficient" in the
Prospectus.
YIELD AND PREPAYMENT RISKS
The weighted average life of the Certificates will be affected by the rate
of principal payments (including prepayments) of the Loans. All of the Loans
may be prepaid in whole or in part at any time without penalty. 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; the Servicer generally
will enforce such provisions unless such enforcement is not permitted by
applicable law, the permissibility of enforcement is in doubt, or such
enforcement would be uneconomic. See "CERTAIN LEGAL ASPECTS OF THE LOANS--Due-
on-Sale Clauses in Mortgage Loans" in the Prospectus. In addition, prepayments
may result from liquidations due to default, the receipt of Insurance
Proceeds, repurchases by the Seller or purchases by the Servicer as a result
of certain breaches of representations and warranties made by the Seller in
the Agreement or certain changes in the terms of the related Loan, payments of
Substitution Adjustment Amounts, or the exercise by the Seller of its optional
repurchase of all of the outstanding Loans in the Loan Pool (as defined
herein) pursuant to the Agreement.
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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 Seller, 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 Cut-off Date, Obligors with respect to 24.3%, 20.5%, 14.6%, 11.2%,
8.6%, 6.6% and 4.1% of the Loans (based on the Original Pool Balance of the
Loans and billing addresses of the Obligors thereon as of the Cut-off Date)
were located in Virginia, Maryland, Florida, Georgia, North Carolina, New
Jersey and Pennsylvania, respectively. Adverse economic conditions in
Virginia, Maryland, Florida, Georgia, North Carolina, New Jersey or
Pennsylvania 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 Virginia, Maryland, Florida, Georgia,
North Carolina, New Jersey or Pennsylvania or any other jurisdictions where
the Obligors reside. See "THE LOAN POOL" herein.
BOOK-ENTRY REGISTRATION; EFFECT ON 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.
WITHHOLDING ON FOREIGN CERTIFICATEHOLDERS
PAYMENTS OF INTEREST (AND ACCRUED ORIGINAL ISSUED DISCOUNT) MADE TO A NON-
U.S. INVESTOR GENERALLY WILL BE SUBJECT TO A 30% U.S. FEDERAL WITHHOLDING TAX.
SEE "FEDERAL INCOME TAX CONSIDERATIONS" HEREIN.
RATING OF CERTIFICATES; POSSIBILITY OF WITHDRAWAL OR DOWNGRADING
The rating of the Certificates will depend primarily on assessment by the
Rating Agency of the claims-paying ability of the Certificate Insurer. 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.
INSOLVENCY-RELATED MATTERS
Perfection of Security Interest. The Seller intends that the transfer of all
of the Seller's right, title and interest in the Loans to the Trust be treated
as a sale by the Seller to the Trust and, accordingly, that such Loans will
not be included in the assets of the Seller in the event of the appointment of
a receiver or conservator for the Seller and will not be available to the
creditors of the Seller. In the event of an insolvency of the Seller, however,
it is possible that a receiver or a conservator for, or a creditor of, the
Seller may argue that the transaction between the Seller and the Trust was a
pledge of each such Loan in connection with a borrowing by the Seller, rather
than a sale. If the transfer by the Seller to the Trust of the Loans is deemed
to be a grant to the Trust of a
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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 Seller, 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 Seller is the
Servicer, cash collections on the Loans may be held by the Seller 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 Seller, the Trust may not have a
perfected interest in such commingled collections.
Intervention of FDIC. To the extent that the Seller'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, and to the extent such security interest was
validly perfected before the Seller's insolvency and was not taken in
contemplation of insolvency of the Seller, or with the intent to hinder, delay
or defraud the Seller or the creditors of the Seller, 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 or conservator for the
Seller. Positions taken by the FDIC staff prior to the passage of FIRREA do
not suggest that the FDIC, as receiver or conservator for the Seller, 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 Seller, as provided under the FDIA, delays in payments on
the Certificates and possible reductions in the amount of those payments could
occur. In addition, the FDIC, if appointed as receiver or conservator for the
Seller, also has the power under FDIA to repudiate contracts, including the
Seller's obligations under the Agreement to repurchase Defective Loans. In
addition, in the case of an Event of Default relating to the receivership or
conservatorship 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 receiver or conservator were appointed for the
Seller, pursuant to the Agreement, the Trustee would sell the Loans (unless
otherwise instructed by 51% of the Certificateholders and any person
designated by the Seller to the Trustee prior to the time such receiver or
conservator was appointed), thereby causing early termination of the Trust.
Unless a Certificate Insurer Default (as defined herein) has occurred, the
Certificate Insurer will have the right to so instruct the Trustee on behalf
of the Certificateholders and such person designated by the Seller.
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 an event occurs
involving either the insolvency of the Seller or the appointment of a receiver
or conservator for the Seller, the receiver or conservator may have the power
to prevent the early sale, liquidation or disposition of the Loans. A receiver
or conservator also may have the power to cause the early sale of the Loans
and the early retirement of the Certificates.
THE SELLER
The Seller is a federally chartered stock savings bank. The Seller's home
office is located at 7926 Jones Branch Drive, McLean, Virginia 22102, and its
executive offices are located at 8401 Connecticut Avenue, Chevy Chase,
Maryland 20815. The Seller's telephone number is (301) 986-7000. The Seller 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 Seller are fully insured up to $100,000 per insured
depositor by the Savings Association Insurance Fund ("SAIF"), which is
administered by the FDIC.
Based on unaudited results, at June 30, 1997, the Seller had consolidated
assets of approximately $6.2 billion, deposits of approximately $4.8 billion
and stockholders' equity of approximately $345.5 million. As a savings bank
chartered under the laws of the United States, the Seller is subject to
certain minimum regulatory capital requirements imposed under FIRREA. At June
30, 1997, the Seller's tangible, core, tier 1 risk-based and total risk-based
regulatory capital ratios were 6.48%, 6.48%, 7.19% and 13.21%, respectively.
As of such date, the Seller's capital ratios exceeded the requirements under
FIRREA as well as the standards established for
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"well-capitalized" institutions under the prompt corrective action regulations
established pursuant to the Federal Deposit Insurance Corporation Improvement
Act of 1991. The OTS has the discretion to treat a "well-capitalized"
institution as an "adequately capitalized" institution for purposes of the
prompt corrective action regulations if after notice and an opportunity for a
hearing, the OTS determines that the institution (i) is being operated in an
unsafe or unsound condition or (ii) has received and has not corrected a less
than satisfactory examination rating for asset quality, management, earnings
or liquidity.
Legislation passed in 1996 requires the merger of the Bank Insurance Fund
("BIF") and the SAIF into a single Deposit Insurance Fund on January 1, 1999
but only if the thrift charter is eliminated by that date. Congress is
considering legislation in various forms that would require federal thrifts
like the Seller to convert their charters to national or state bank charters,
and the House Banking Committee approved a version of such legislation on June
20, 1997. In the absence of appropriate "grandfather" provisions, such
legislation could have an adverse effect on the Seller and its parent company,
the B.F. Saul Real Estate Investment Trust (the "Real Estate Investment
Trust") because, among other things, the Real Estate Investment Trust engages
in activities that are not permissible for bank holding companies and the
regulatory capital and accounting treatment for banks and thrifts differs in
certain significant respects. While the bill approved by the House Banking
Committee contains grandfather provisions that address many of these issues,
the Seller cannot determine at this time whether, or in what form, such
legislation may eventually be enacted, and there can be no assurances that any
such legislation that is enacted will contain adequate grandfather rights for
the Seller or the Real Estate Investment Trust.
USE OF PROCEEDS
The net proceeds to be received from the sale of the Certificates will be
paid to the Seller and the Seller will use such proceeds for its general
corporate purposes.
THE CHEVY CHASE HOME LOAN AND HOME EQUITY LOAN PROGRAMS
LOAN PROGRAMS
Home Improvement Loan Department. The Debt Consolidation Loans and Home
Improvement Contracts are originated or acquired by Chevy Chase through its
Home Improvement Loan Department. 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, "Home Loans"). Chevy Chase began originating and acquiring Home
Loans in 1988.
"Indirect Home Improvement Loans" are installment sales contracts and
installment loan agreements originated by home improvement contractors and
assigned to Chevy Chase. These contractors have been approved by Chevy Chase
based on 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 generally are subordinate to
other mortgages on the same residential properties.
"Indirect Debt Consolidation Loans" are closed-end home equity loans
purchased by Chevy Chase which were originated by licensed mortgage companies.
These mortgage companies have been approved by Chevy Chase based on a review
assessing their industry reputation, financial condition and trade references.
Indirect Debt Consolidation Loans are secured by deeds of trust or mortgages,
which generally are 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
generally are subordinate to other mortgages on the same residential
properties. Direct Home Improvement Loans are originated in connection with
the construction of in-ground swimming pools or other home improvements.
Home Equity Lending Division. The Home Equity Loans are closed-end home
equity loans ("Closed-end Home Equity Loans") originated by Chevy Chase or a
subsidiary of Chevy Chase or acquired by Chevy Chase through its Home Equity
Lending Division. Closed-end Home Equity Loans are secured by deeds of trust
or mortgages, which generally are subordinate to other mortgages on the same
residential properties. Chevy Chase has originated variable-rate home equity
lines since 1983 and has originated fixed rate home equity loans since 1994.
In general, customers can apply for a home equity loan by mail, phone or by
visiting a Chevy Chase branch office.
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UNDERWRITING PROCEDURES
Each Loan was acquired 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 is of secondary importance in
Chevy Chase's analysis. For Home Loans secured by mortgaged properties and for
Closed-end Home Equity Loans, Chevy Chase's guidelines provide for financing
up to 125% of the value of the mortgaged property. Generally, for each Home
Loan, the value of the related mortgaged property is determined by Chevy Chase
based on the purchase price and value of such mortgaged property as
represented by the borrower 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 such purchase price and value, recent tax assessments and
other relevant factors. Generally, most Closed-end Home Equity Loans and all
Home Loans and Closed-end Home Equity Loans for amounts greater than $25,000
require appraisals performed by licensed appraisers to determine the value of
the related Mortgaged Properties. 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 an Indirect Home
Improvement Loan, Chevy Chase requires the borrower to sign a certificate of
completion that 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 to 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 funds the loan. Funds are disbursed to the related
home improvement contractor by cashier's check. For certain large Indirect
Home Improvement Loans, Chevy Chase may offer staged funding in which portions
of the contract amount are payable as the work is completed. Checks for staged
funding are issued to both the contractor and the customer.
Chevy Chase offers borrowers the option to extend the contractual period
between the funding date for an Indirect Home Improvement Loan and the 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 Indirect Home Improvement Loan during the
Deferral Period regardless of its length. The Indirect Home Improvement 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 Indirect Home Improvement
Loan and continue each month thereafter.
Indirect Debt Consolidation Loans. Prior to funding 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 reconfirms that the borrower's resulting ratio of debt
to income is within its guidelines. Funds are disbursed to the related
mortgage company by cashier's check.
Direct Home Improvement Loans. Direct Home Improvement Loans are funded with
two-party checks payable to both the borrower and the home improvement
contractor. Funds are disbursed to the home
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improvement contractors and direct loan borrowers by cashier's check. 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.
Closed-end Home Equity Loans. Closed-end Home Equity Loans are closed by
Chevy Chase employees or by approved title agents. Funds are disbursed after
confirmation that the mortgage or deed of trust has been recorded and that all
underwriting contingencies have been met. Closed-end Home Equity Loans are
funded by wire transfer or by bank check.
DOCUMENTATION
Chevy Chase requires the following documents in each Home Loan file (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.
In addition to the applicable documents required in a Home Loan file, Chevy
Chase also requires an appraisal or other determination of value and title
report or property and judgment report for each Closed-end Home Equity Loan.
All Closed-end Home Equity Loan files are reviewed for completeness by the
HE Quality Control Section within the Home Equity Lending Division.
Documentation is reviewed and recording information is confirmed prior to
funding.
All Home Loan files are reviewed for credit quality, documentation and
completeness by the Funding/Compliance Section within the Home Improvement
Loan 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 and each Closed-end Home Equity Loan
agreement 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 generally is 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 borrowers under a secured Home Loan contract or
Closed-end Home Equity Loan agreement insure the related mortgaged property
against fire and theft with a physical damage policy naming Chevy Chase as a
loss payee. Chevy Chase obtains a property and judgment report on the
mortgaged property from its title agent, which confirms the last deed of
record and any liens filed against that deed. The property and judgment report
generally 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
Home Loan exceeds $60,000, Chevy Chase generally requires title insurance on
the mortgaged property. Chevy Chase generally will 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.
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Chevy Chase requires full title binder and insurance on Closed-end Home
Equity Loans under the following scenarios: (a) when the related mortgage is
in a first lien position; (b) when the related lien is subordinate to a non-
institutional first trust; (c) when the amount of the Closed-end Home Equity
Loan exceeds $200,000; (d) when the title to the related mortgaged property is
held in trust; or (e) when the related mortgaged property is a rental
property.
LOAN SERVICING
Home Loans. The Home Loans currently are serviced by the Chevy Chase
Consumer Loan Servicing Department in Tysons Corner, Virginia. The Consumer
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 Loan borrowers are issued coupon books which are mailed to them
within ten working days of booking the Home Loan using the Florida Software
loan servicing system and, after any delinquency, the On-Line Collections
software. 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 through the lockbox
facility. Chevy Chase intends to transfer servicing of the Home Loan portfolio
to its Home Equity Loan Servicing Center in Bethesda, Maryland in September
1997. All of the servicing functions for the Home Loans (including loan
review, front end quality control, validation, data input, filing of
documentation, account maintenance, balancing, payoff processing, release
preparation, and subordination processing) will then be handled by the Home
Equity Loan Servicing Center.
All Closed-end Home Equity Loans are serviced by Chevy Chase's Home Equity
Loan Servicing Center in Bethesda, Maryland. The Home Equity Loan Servicing
Center performs the same servicing functions and uses the same collections
software systems as the Consumer Loan Servicing Department.
COLLECTION PROCESS
All Home Loan and Closed-end Home Equity Loan collections and recovery
functions are performed from the related servicing 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 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 Home Loans
between the 90th and 120th day of delinquency.
S-20
<PAGE>
When a Closed-end Home Equity Loan reaches 45 days past due, the
acceleration letter also includes notification that Chevy Chase may foreclose
on the mortgaged property if the account is not brought current. Chevy Chase
obtains an updated appraisal (or broker price opinion) of the mortgaged
property and verifies the status of any senior mortgage(s). The acceleration
letter indicates that the Closed-end Home Equity Loan and any related senior
mortgage(s) must be brought current to prevent acceleration of the balance.
Generally, Chevy Chase initiates foreclosure if the Closed-end Home Equity
Loan is not reinstated or paid in full by the time the account reaches 90 days
past due. In some instances Chevy Chase may elect not to foreclose because of
the relative strength of the equity position.
In the event of a default on a first mortgage that is senior to any Home
Loan or Closed-end Home Equity 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 balance for
such 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 and Closed-end
Home Equity Loans. As of the Cut-off Date, there have been no losses on Chevy
Chase's home equity fixed rate portfolio. The Loans have been selected from
Chevy Chase's portfolio of Home Loans and Closed-end Home Equity Loans based
upon the selection criteria shown below in "THE LOAN POOL."
DELINQUENCY EXPERIENCE(1)
CHEVY CHASE HOME LOAN AND CLOSED-END HOME EQUITY LOAN PORTFOLIO
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------------------------- AS OF
1994 1995 1996 JUNE 30, 1997
----------- ------------ ------------ -------------
<S> <C> <C> <C> <C>
Number of Loans
Serviced............... 6,965 13,298 21,044 23,202
Aggregate Principal
Balance of Loans
Serviced............... $52,345,891 $133,193,889 $250,096,567 $275,270,118
Principal Balance of
Loans
30-59 Days Past
Due(2)................. 712,284 1,405,990 5,030,534 5,779,214
Principal Balance of
Loans
60-89 Days Past
Due(2)................. 119,188 660,406 1,150,694 1,645,566
Principal Balance of
Loans
90 or More Days Past
Due(2)................. 117,820 444,935 1,426,241 1,769,318
Total Delinquencies (30
days or more past due)
as a Percentage of
Aggregate Principal
Balances of Loans
Serviced............... 1.81% 1.89% 3.04% 3.34%
</TABLE>
- --------
(1) Delinquency figures do not include past due amounts of $50.00 or less.
(2) Contractually past due.
S-21
<PAGE>
LOAN LOSS EXPERIENCE
CHEVY CHASE HOME LOAN AND CLOSED-END HOME EQUITY LOAN PORTFOLIO
<TABLE>
<CAPTION>
TWELVE MONTHS ENDED DECEMBER 31, SIX MONTHS
-------------------------------------- ENDED
1994 1995 1996 JUNE 30, 1997
----------- ----------- ------------ -------------
<S> <C> <C> <C> <C>
Average Principal
Balance of Loans(1).... $27,517,334 $92,522,276 $196,103,805 $264,166,743
Gross Charge Offs....... 197,990 1,601,268 5,188,510 4,524,383
Recoveries on Loans
Previously Charged
Off(2)................. 22,632 84,121 280,755 494,281
----------- ----------- ------------ ------------
Net Charge Offs......... 175,358 1,517,147 4,907,755 4,030,102
=========== =========== ============ ============
Gross Charge Offs as a
Percentage of Average
Principal Balance...... 0.72% 1.73% 2.65% 3.43%(3)
Net Charge Offs as a
Percentage of Average
Principal Balance...... 0.64% 1.64% 2.50% 3.05%(3)
</TABLE>
- --------
(1) Equals the arithmetic average of the preceding applicable month-end
principal balances.
(2) Includes current recoveries on receivables previously charged off.
(3) Annualized.
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 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 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 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 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 Loans.
THE LOAN POOL
The Trust Fund will consist of (i) 6,910 Loans (collectively, the "Loan
Pool"), (ii) collections in respect of the Loans received on and after the
Cut-off Date, (iii) the Policy, (iv) the interest of the Trust in certain
hazard insurance policies maintained by the borrowers with respect to the
Mortgaged Properties, (v) the proceeds of the foregoing and (vi) certain other
property relating to the Loans. The Reserve Fund will not be an asset of the
Trust Fund but will be maintained for the benefit of the Certificateholders
and the Certificate Insurer. On the Closing Date the Loans will have an
aggregate unpaid principal balance as of September 1, 1997 (the "Cut-off
Date") of approximately $95,000,413, after giving effect to all payments of
principal thereon received prior to the Cut-off Date (the "Original Pool
Balance").
The Loans were originated or acquired by Chevy Chase in the ordinary course
of its business. The Loans were selected from Chevy Chase's portfolio of Home
Loans and Closed-end Home Equity Loans based on several criteria, including
the following: (i) as of the Cut-off Date each Loan had twelve or more
payments remaining; (ii) each Loan had an outstanding principal balance as of
the Cut-off Date equal to or greater than $1,500; (iii) as of the Cut-off
Date, no Loan was delinquent more than 29 days; and (iv) with respect to each
Loan (x) at least one scheduled payment had been made or (y) such Loan was
originated within 45 days of the Business Day preceding the Cut-off Date.
S-22
<PAGE>
All of the Loans are fixed-rate simple interest Loans as to which interest
accrues on the simple interest method (that is, the interest portion of each
monthly payment is equal to the interest accrued on the outstanding principal
balance of the related Loan for the number of days from the date the most
recent prior payment was made on such Loan to the date of payment, and the
balance, if any, of such monthly payment is applied to principal).
The Obligors under the Loans have billing addresses in 25 states and the
District of Columbia. As of the Cut-off Date, approximately 24.3% of the
Loans, based upon the Original Pool Balance, had Obligors with billing
addresses in the Commonwealth of Virginia, approximately 20.5% had Obligors
with billing addresses in the State of Maryland, approximately 14.6% had
Obligors with billing addresses in the State of Florida, approximately 11.2%
had Obligors with billing addresses in the State of Georgia, approximately
8.6% had Obligors with billing addresses in the State of North Carolina,
approximately 6.6% had Obligors with billing addresses in the State of New
Jersey and approximately 4.1% had Obligors with billing addresses in the State
of Pennsylvania. No other jurisdiction accounts for more than 2.5% of the
Loans, based upon the Original Pool Balance.
As of the Cut-off Date, the Loans had a minimum outstanding principal
balance of $1,500, a maximum outstanding principal balance of $99,501, an
average balance of $13,748, a remaining term to maturity of no less than 12
months and no greater than 240 months, a weighted average remaining term to
maturity of 138 months, a number of months since the date of origination of no
less than 0 months and no greater than 102 months, a weighted average number
of months since the date of origination of 5 months, a Loan Rate of no less
than 7.80% and no greater than 17.25% and a weighted average Loan Rate of
11.87%.
Set forth below is a description of certain characteristics of the Loans as
of the Cut-off Date. All such information is approximate. Prior to the Closing
Date, Loans may be removed from the pool of Loans described below and other
Loans may be substituted therefor. In addition, Loans may be prepaid at any
time. As a result, certain characteristics of the Loans may vary from those
set forth below. The columns may not add to 100% due to rounding.
S-23
<PAGE>
LOAN POOL STATISTICS
CUT-OFF DATE PRINCIPAL BALANCES
<TABLE>
<CAPTION>
CUT-OFF DATE PRINCIPAL AGGREGATE CUT-OFF % OF ORIGINAL
BALANCES NUMBER OF LOANS DATE PRINCIPAL BALANCE POOL BALANCE
- ---------------------- --------------- ---------------------- -------------
<S> <C> <C> <C>
$ 1,500.00 to $
4,999.99................ 1,483 $ 4,842,573 5.1%
$ 5,000.00 to $
9,999.99................ 1,429 10,362,638 10.9%
$10,000.00 to
$14,999.99.............. 1,172 14,795,434 15.6%
$15,000.00 to
$19,999.99.............. 1,110 19,286,795 20.3%
$20,000.00 to
$24,999.99.............. 1,044 23,863,597 25.1%
$25,000.00 to
$29,999.99.............. 359 9,605,136 10.1%
$30,000.00 to
$34,999.99.............. 145 4,665,230 4.9%
$35,000.00 to
$39,999.99.............. 88 3,244,845 3.4%
$40,000.00 to
$44,999.99.............. 21 897,312 1.0%
$45,000.00 to
$49,999.99.............. 24 1,160,372 1.2%
$50,000.00 to
$54,999.99.............. 11 572,109 0.6%
$55,000.00 to
$59,999.99.............. 7 410,293 0.4%
$60,000.00 to
$64,999.99.............. 6 373,474 0.4%
$65,000.00 to
$69,999.99.............. 0 0 0.0%
$70,000.00 to
$74,999.99.............. 3 218,307 0.2%
$75,000.00 to
$79,999.99.............. 1 78,065 0.1%
$80,000.00 to
$84,999.99.............. 2 162,040 0.2%
$85,000.00 to
$89,999.99.............. 3 263,461 0.3%
$90,000.00 to
$94,999.99.............. 0 0 0.0%
$95,000.00 to
$99,999.99.............. 2 198,732 0.2%
----- ------------ -----
Total.................. 6,910 $ 95,000,413 100.0%
===== ============ =====
CUT-OFF DATE LOAN RATES
<CAPTION>
RANGE OF CUT- AGGREGATE CUT-OFF % OF ORIGINAL
OFF DATE LOAN RATES NUMBER OF LOANS DATE PRINCIPAL BALANCE POOL BALANCE
- ------------------- --------------- ---------------------- -------------
<S> <C> <C> <C>
7.000% to 7.999%......... 14 $ 264,650 0.3%
8.000% to 8.999%......... 299 6,366,709 6.7%
9.000% to 9.999%......... 1,313 27,137,422 28.6%
10.000% to 10.999%....... 801 13,716,351 14.4%
11.000% to 11.999%....... 590 7,442,210 7.8%
12.000% to 12.999%....... 935 10,418,351 11.0%
13.000% to 13.999%....... 971 6,682,988 7.0%
14.000% to 14.999%....... 1,220 18,720,670 19.7%
15.000% to 15.999%....... 740 4,106,995 4.3%
16.000% to 16.999%....... 26 140,197 0.2%
17.000% to 17.999%....... 1 3,870 0.0%
----- ------------ -----
Total.................. 6,910 $ 95,000,413 100.0%
===== ============ =====
</TABLE>
S-24
<PAGE>
GEOGRAPHICAL DISTRIBUTION OF LOANS(1)
<TABLE>
<CAPTION>
% OF
NUMBER AGGREGATE CUT-OFF DATE ORIGINAL
STATE OF LOANS PRINCIPAL BALANCE POOL BALANCE
- ----- -------- ---------------------- ------------
<S> <C> <C> <C>
Virginia.......................... 1,768 $23,096,993 24.3%
Maryland.......................... 1,375 19,485,254 20.5%
Florida........................... 695 13,866,624 14.6%
Georgia........................... 783 10,661,432 11.2%
North Carolina.................... 575 8,206,792 8.6%
New Jersey........................ 457 6,298,321 6.6%
Pennsylvania...................... 361 3,874,503 4.1%
Other............................. 896 9,510,494 10.1%
----- ----------- -----
Total........................... 6,910 $95,000,413 100.0%
===== =========== =====
</TABLE>
- --------
(1) By billing address
CUT-OFF DATE REMAINING TERM TO MATURITY
<TABLE>
<CAPTION>
% OF
NUMBER AGGREGATE CUT-OFF DATE ORIGINAL
RANGE OF REMAINING TERMS BY MONTH OF LOANS PRINCIPAL BALANCE POOL BALANCE
- --------------------------------- -------- ---------------------- ------------
<S> <C> <C> <C>
0 to 12 Months.................... 5 $ 16,821 0.0%
13 to 24 Months................... 163 400,431 0.4%
25 to 36 Months................... 375 1,233,190 1.3%
37 to 48 Months................... 584 2,502,322 2.6%
49 to 60 Months................... 781 5,179,145 5.5%
61 to 72 Months................... 274 1,909,513 2.0%
73 to 84 Months................... 582 4,507,871 4.7%
85 to 96 Months................... 67 685,605 0.7%
97 to 108 Months.................. 268 4,341,316 4.6%
109 to 120 Months................. 1,596 26,835,570 28.3%
121 to 132 Months................. 4 60,239 0.1%
133 to 144 Months................. 31 505,752 0.5%
145 to 156 Months................. 5 65,850 0.1%
157 to 168 Months................. 233 4,661,833 4.9%
169 to 180 Months................. 1,761 37,430,694 39.4%
181 to 192 Months................. 0 0 0.0%
193 to 204 Months................. 0 0 0.0%
205 to 216 Months................. 0 0 0.0%
217 to 228 Months................. 0 0 0.0%
229 to 240 Months................. 181 4,664,261 4.9%
----- ----------- -----
Total........................... 6,910 $95,000,413 100.0%
===== =========== =====
</TABLE>
S-25
<PAGE>
ORIGINATION YEAR OF LOANS
<TABLE>
<CAPTION>
AGGREGATE CUT-OFF % OF ORIGINAL
ORIGINATION YEAR NUMBER OF LOANS DATE PRINCIPAL BALANCE POOL BALANCE
- ---------------- --------------- ---------------------- -------------
<S> <C> <C> <C>
1989....................... 1 $ 6,887 0.0%
1990....................... 1 43,531 0.1%
1993....................... 4 22,891 0.0%
1994....................... 16 130,360 0.1%
1995....................... 36 240,508 0.3%
1996....................... 2,310 31,056,962 32.7%
1997....................... 4,542 63,499,274 66.8%
----- ----------- -----
Total.................... 6,910 $95,000,413 100.0%
===== =========== =====
</TABLE>
SECURITY FOR LOANS
<TABLE>
<CAPTION>
AGGREGATE CUT-OFF % OF ORIGINAL
SECURITY STATUS NUMBER OF LOANS DATE PRINCIPAL BALANCE POOL BALANCE
- --------------- --------------- ---------------------- -------------
<S> <C> <C> <C>
Secured.................... 4,792 $85,582,472 90.1%
Unsecured.................. 2,118 9,417,941 9.9%
----- ----------- -----
Total.................... 6,910 $95,000,413 100.0%
===== =========== =====
</TABLE>
S-26
<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 Investors Service,
Inc., "AAA" by Standard & Poor's Ratings Services, "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").
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, 1996 and 1995, CapMAC had qualified statutory capital
(which consists of policyholders' surplus and contingency reserve) of
approximately $260 million and $240 million, respectively, and had not
incurred any debt obligations. Article 69 of the New York State Insurance Law
requires CapMAC to establish and maintain the contingency reserve, which is
available to cover claims under insurance policies issued by CapMAC.
The audited financial statements of CapMAC prepared in accordance with
generally accepted accounting principles as of December 31, 1996 and 1995 and
for each of the years in the three-year period ended December 31, 1996, and
the unaudited financial statements of CapMAC for the six-month periods ended
June 30, 1997 and 1996 are attached to this Prospectus Supplement as Appendix
A and Appendix B, respectively. Copies of CapMAC's financial statements
prepared in accordance with statutory accounting standards, which differ from
generally accepted accounting principles, are filed with the Insurance
Department of the State of New York and are available upon request.
CapMAC is located at 885 Third Avenue, New York, New York 10022, and its
telephone number is (212) 755-1155.
S-27
<PAGE>
MATURITY AND PREPAYMENT CONSIDERATIONS
The weighted average life of the Certificates will be affected by the rate
of principal payments (including prepayments) of the Loans. All of the Loans
may be prepaid in whole or in part at any time without penalty. 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
generally will enforce such provisions unless such enforcement is not
permitted by applicable law, permissibility of enforcement is in doubt, or
such performance would be uneconomical. See "CERTAIN LEGAL ASPECTS OF THE
LOANS--Due-on-Sale Clauses in Mortgage Loans" in the Prospectus. In addition,
prepayments may result from liquidations due to default, the receipt of
Insurance Proceeds, repurchases by the Seller or purchases by the Servicer as
a result of certain breaches of the representations and warranties made by the
Seller in the Agreement or certain changes in the terms of the related Loans,
payments of Substitution Adjustment Amounts or the exercise by the Seller of
its optional repurchase of all of the outstanding Loans in the Loan Pool
pursuant to the Agreement. No assurance can be given as to the level of
prepayments that will be experienced by the Trust. See "DESCRIPTION OF THE
SECURITIES--Weighted Average Life of the Securities" in the Prospectus.
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 Seller, 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 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 Paid-Ahead 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.
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 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 Interest
Collections that otherwise would be available for distribution on the
Certificates.
S-28
<PAGE>
As of the Cut-off Date, approximately 4.7% of the Loans (based upon the
Original Pool Balance) were Paid-Ahead Loans for which the next payment is due
on or after November 1, 1997. Chevy Chase's portfolio of Home Loans and
Closed-end Home Equity Loans historically has included loans which have been
paid ahead by one or more scheduled monthly payments. 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 Cut-off Date, less than 2.2% of the Loans (based upon the Original
Pool Balance) are Loans for which the related Obligors have elected to extend
the contractual period between the funding date for such Loans and the first
scheduled due date for such Loans (each, a "Deferral Loan") that are currently
in the Deferral Period. None of the Home Equity Loans are Deferral Loans. As
of the Cut-off Date, no Deferral Loan had an initial scheduled due date after
February 23, 1998. During 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 made 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 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. The lack of Principal Collections from
Deferral Loans during the related Deferral 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. In addition, during the Deferral Period there will
not be any interest paid with respect to such Loans, thereby reducing the
amount of Interest Collections that otherwise would be available for
distribution on the Certificates.
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 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 loans comparable to the Loans is influenced by
a variety of factors, as described above. In addition, in the case of any
Loans secured by real estate, in general, if prevailing interest rates fall
significantly below the interest rates on such Loans, such Loans are likely to
be subject to higher prepayment rates than if prevailing interest rates
remained at or above the rates borne by such Loans. Conversely, if prevailing
interest rates rise above the interest rates on such Loans, the rate of
prepayment would be expected to decrease.
S-29
<PAGE>
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 $95,000,413; (iii) the Loans will, as of the Cut-off Date, be
grouped into twelve pools having the the additional characteristics set forth
below under "Assumed Loan Characteristics;" (iv) the Initial Certificate
Principal Balance is $95,000,000 and the Certificates have a Pass-Through Rate
of 6.875%; (v) no interest shortfalls will arise in connection with
prepayments in full of the Loans; (vi) the Certificates are issued on
September 24, 1997; and (vii) scheduled principal and interest is timely
received on a monthly basis with no deferral or paid-ahead periods. No
representation is made that the Loans will not experience delinquencies or
losses.
ASSUMED LOAN CHARACTERISTICS
<TABLE>
<CAPTION>
WEIGHTED
WEIGHTED AVERAGE
AVERAGE REMAINING TERM
CUT-OFF DATE POOL LOAN TO MATURITY
POOL PRINCIPAL BALANCE RATE (MONTHS)
- ---- ----------------- -------- --------------
<S> <C> <C> <C>
1. ................................... $ 72,758 14.51% 15
2. ................................... 1,407,886 13.74% 29
3. ................................... 3,811,570 12.92% 46
4. ................................... 5,805,787 12.79% 61
5. ................................... 5,137,533 13.14% 81
6. ................................... 4,273,243 13.56% 105
7. ................................... 28,107,982 13.09% 116
8. ................................... 620,281 10.33% 165
9. ................................... 302,061 9.93% 166
10. .................................. 38,238,890 10.54% 175
11. .................................. 5,569,500 10.81% 212
12. .................................. 1,652,923 10.91% 240
</TABLE>
S-30
<PAGE>
Based on the foregoing assumptions, the following table indicates (i) the
percentages of the Initial Certificate Principal Balance that would be
outstanding after each of the dates shown at various constant percentages of
CPR and (ii) the corresponding projected weighted average life, first
principal payment date and last principal payment date of the Certificates at
the indicated percentages of the CPR.
<TABLE>
<CAPTION>
CPR
------------------------------------------------------------------------------------------
DATE 14% 16% 18% 20% 22%
---- ------------------ ------------------ ----------------- ---------------- -----------------
<S> <C> <C> <C> <C> <C>
Closing Date 100% 100% 100% 100% 100%
September 20, 1998 81% 79% 77% 75% 73%
September 20, 1999 64% 61% 58% 55% 53%
September 20, 2000 50% 47% 44% 41% 38%
September 20, 2001 39% 35% 32% 29% 26%
September 20, 2002 30% 27% 24% 21% 18%
September 20, 2003 23% 20% 17% 15% 13%
September 20, 2004 17% 14% 12% 10% 9%
September 20, 2005 12% 10% 8% 7% 6%
September 20, 2006 8% 7% 5% 4% 3%
September 20, 2007 6% 4% 3% 3% 2%
September 20, 2008 4% 3% 2% 2% 1%
September 20, 2009 3% 2% 2% 1% 1%
September 20, 2010 2% 1% 1% 1% 0%
September 20, 2011 1% 1% 0% 0% 0%
September 20, 2012 0% 0% 0% 0% 0%
September 20, 2013 0% 0% 0% 0% 0%
September 20, 2014 0% 0% 0% 0% 0%
September 20, 2015 0% 0% 0% 0% 0%
September 20, 2016 0% 0% 0% 0% 0%
September 20, 2017 0% 0% 0% 0% 0%
To Maturity:
First Prin Pay: October 20, 1997 October 20, 1997 October 20, 1997 October 20, 1997 October 20, 1997
Last Prin Pay: September 20, 2017 September 20, 2017 August 20, 2017 July 20, 2017 June 20, 2017
Weighted Average
Life (years)(1): 3.91 3.63 3.37 3.15 2.94
To Call:
First Prin Pay: October 20, 1997 October 20, 1997 October 20, 1997 October 20, 1997 October 20, 1997
Last Prin Pay: February 20, 2008 May 20, 2007 December 20, 2006 June 20, 2006 December 20, 2005
Weighted Average
Life (years)(1): 3.80 3.51 3.27 3.05 2.84
</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.
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.
THE CERTIFICATES
The following information supplements the information contained under
"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
The 6.55% Home Loan Asset-Backed Certificates will consist of a single class
of Certificates, which will evidence in the aggregate an undivided ownership
interest in the Trust to be formed pursuant to the Agreement. The property of
the Trust will consist primarily of certain closed-end home equity loans (the
"Home Equity Loans"), closed-end debt consolidation loans (the "Debt
Consolidation Loans") and conventional home
S-31
<PAGE>
improvement installment sales contracts and installment loan agreements (the
"Home Improvement Contracts"; collectively with the Home Equity Loans and the
Debt Consolidation Loans, the "Loans"). Most of the Loans are secured by
second or third deeds of trust or mortgages (the "Mortgages") on one- to four-
family residential properties (the "Mortgaged Properties"). The Trust also
will include collections in respect of the Loans received on and after
September 1, 1997 (the "Cut-off Date"), the Policy and certain other property
as described more fully herein. The Reserve Fund (as defined herein) will not
be an asset of the Trust Fund but will be maintained for the benefit of the
Certificateholders and the Certificate Insurer.
Each Certificate will represent the right to receive payments of interest at
the Pass-Through Rate, and principal as described herein. The Seller will be
entitled to amounts remaining, if any, after distributions in respect of the
Certificates as described herein. Principal and interest will be payable on
the Certificates monthly on the 20th day of each month or, if such 20th day is
not a Business Day, the next succeeding Business Day (each, a "Distribution
Date"), beginning with the October 1997 Distribution Date, in each case
calculated as described herein. The Certificate Principal Balance will be due
and payable on the Distribution Date in May 2018 (the "Final Distribution
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 have an aggregate original principal balance of
$95,000,000 (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 initially will be represented by a single Certificate
registered in the name of Cede & Co., the nominee of The Depository Trust
Company ("DTC"). 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; Effect on 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 St. Paul,
Minnesota.
Distributions will be made on each Distribution Date to the holders of
record as reflected in the certificate register maintained by the Trustee on
the day prior to such Distribution Date if the Certificates are book-entry
certificates, and on the last day of the month preceding the month of the
related Distribution Date, if the Certificates are issued in definitive form,
except that the final distribution in respect of any Certificate will be made
only upon presentation and surrender of such Certificate at the office or
agency appointed by the Trustee for that purpose (each such day, a "Record
Date").
INTEREST
Interest on the Certificates will accrue at the pass-through rate of 6.55%
per annum (the "Pass-Through Rate") from and including September 20, 1997 (in
the case of the first Distribution Date) or from and including the most recent
Distribution Date on which interest has been paid, to but excluding the
following Distribution Date (each, an "Interest Period"). On each Distribution
Date, to the extent of funds available therefor, the Trustee will distribute
the Interest Distributable Amount on a pro rata basis to the
Certificateholders of record as of the Record Date. The "Interest
Distributable Amount" for any Distribution Date means the sum of (i) interest
S-32
<PAGE>
accrued during the related Interest Period at the Pass-Through Rate on the
Certificate Principal Balance immediately preceding such Distribution Date and
(ii) the Certificateholders' Interest Carryover Shortfall.
"Certificateholders' Interest Carryover Shortfall" means, with respect to any
Distribution Date, the excess of the Interest Distributable Amount for the
preceding Distribution Date over the amount of interest actually distributed
to Certificateholders on such preceding Distribution Date, plus interest on
such excess, to the extent permitted by law, at the Pass-Through Rate from and
including the preceding Distribution Date to but excluding the current
Distribution Date. Interest will be calculated on the basis of a 360-day year
comprised of twelve 30-day months.
PRINCIPAL
On each Distribution Date, to the extent of Monthly Allocable Principal, 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" for any Distribution Date means an amount
equal to the lesser of (a) the sum of (i) the Principal Collections for such
Distribution Date, (ii) any Liquidation Loss Amount for the related Monthly
Collection Period and (iii) any portion of the Principal Distributable Amount
for any prior Distribution Date that was not previously distributed and (b)
the outstanding Certificate Principal Balance of the Certificates; provided,
however, that on the Final Distribution Date, the Principal Distributable
Amount will equal the Certificate Principal Balance; and 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 Distribution Date,
an amount equal to the sum of (i) the Principal Collections deposited in the
Principal Distribution Account for such Distribution Date, (ii) any Excess
Interest to the extent deposited in the Principal Distribution Account to pay
the Liquidation Loss Amount for such Distribution Date, (iii) any Reserve Fund
Principal Transfer Amount drawn from the Reserve Fund for such Distribution
Date and (iv) any Principal Deficiency Draw Amount made under the Policy for
such Distribution Date.
The "Monthly Collection Period" is, for any Distribution Date, the calendar
month preceding such Distribution Date.
ASSIGNMENT OF LOANS
At the time of issuance of the Certificates, the Seller will assign to the
Trustee all of its right, title and interest in and to the Loans, including
all payments of interest and principal, from whatever source derived, which
are received thereon on or after the Cut-off Date, together with the other
assets included or to be included in the Trust Fund, whether now owned or
hereafter acquired. Each Loan will be identified in a schedule delivered to
the Trustee on the Closing Date.
The Agreement requires the Seller to deliver to the Trustee on the Closing
Date, with respect to each Loan, the documentation specified in the Agreement
relating to such Loans (each, a "Loan File"), including: (i) the originally
executed promissory note or installment sales contract or installment loan
agreement, as applicable, a copy of such originally executed note, contract or
agreement, or a "lost-note affidavit," and any intervening endorsements and/or
assignments evidencing a complete chain of title from the originator to the
Seller and, in the case of any promissory note, an endorsement thereof by the
Seller 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 Seller, if
the original has been submitted for recording but has not, as of the Closing
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 Seller if the original has been
transmitted for recording until such time as the original is returned by the
public recording office. In addition, within 180 days following the Closing
Date, the Agreement requires the Seller to deliver to the Trustee as part of
each Loan File with respect to each Loan secured by a
S-33
<PAGE>
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 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, in which case the Agreement requires the Trustee to record
all or any portion of such assignments as and when directed by the Servicer,
or (y) the Seller is less than adequately capitalized as determined pursuant
to the regulations of the Office of Thrift Supervision, in which case the
Agreement requires the Trustee to record all or any portion of such
assignments, if, 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 Seller from the Trustee, the Seller will be
required either to repurchase the affected Loan or to replace the affected
Loan in the manner set forth below.
On the Closing Date, the Seller will make certain representations and
warranties as to the completeness of the Loan Files and the accuracy in all
material respects of certain information furnished to the Trustee with respect
to each Loan, including the unpaid principal balance of such Loan as of the
Cut-off Date and the Loan Rate of each such Loan. In addition, the Seller will
represent and warrant that, as of the Cut-off Date, no Loan was 30 or more
days contractually delinquent. In the event there is a breach of any
representation or warranty made by the Seller 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 Seller will be required either to
(i) repurchase the related Loan from the Trust or (ii) provided such
substitution occurs before September 1, 1999, substitute an Eligible
Substitute Loan therefor, in each case in the manner described below.
Any Loan required to be repurchased from the Trust by the Seller pursuant to
the Agreement as a result of a defect, omission or breach of a representation
or warranty (each, a "Defective Loan") will be repurchased in exchange for the
deposit by the Seller 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 repurchase, plus accrued and unpaid interest thereon at the Loan
Rate less, for so long as Chevy Chase is the Servicer, the Servicing Fee Rate
through the end of the Monthly Collection Period in which the repurchase
occurs (the "Repurchase Deposit Amount"). The interest portion of the
Repurchase Deposit Amount will be deposited into the Interest Distribution
Account and the principal portion of the Repurchase Deposit Amount will be
deposited 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 Seller 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 Seller will substitute any Eligible
Substitute Loan and deposit any such Substitution Adjustment Amount into the
Principal Distribution Account on the Business Day preceding the Determination
Date in the month following such Monthly Collection Period. Upon substitution,
each Eligible Substitute Loan will be subject to the terms of the Agreement
and the Seller 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 Seller with respect to all other Loans in the Trust.
Upon receipt by the Trustee of written notification of any such repurchase 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 Seller legal and beneficial ownership of the
repurchased Loan (including any property acquired in respect thereof or
proceeds of any insurance policy with respect thereto). The obligation of the
Seller to repurchase or replace any such Defective Loan will be the sole
remedy against the Seller available to Certificateholders or the Trustee.
S-34
<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; (iv) if
applicable, is secured by a Mortgage in a lien position not junior to the lien
position of the Mortgage of such Defective Loan; (v) complies with each
representation and warranty made by the Seller regarding the Loans as though
such representation and warranty were made as of the substitution date; and
(vi) complies with any other requirements of the Rating Agencies set forth in
the Agreement.
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 Loans are, and none of the 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 Distribution Date (the "Servicing
Fee") equal to one-twelfth of the product of 0.75% 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 also will 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 distributions of interest or principal. The
Servicer will not be required to advance delinquent payments of principal or
interest.
On each Distribution 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 Seller (the "Trustee's Fee"), payable
out of Interest Collections.
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 Servicer will maintain within the
Collection Account administrative subaccounts for (i) the distribution of
principal of the Certificates (such subaccount, the "Principal Distribution
Account"), (ii) the distribution of interest on the Certificates (such
subaccount, the "Interest Distribution Account") and (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 subaccount, the "Expense Distribution
Account").
The Agreement also requires the Servicer to establish and maintain a
separate trust account outside of the Trust (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.
Amounts deposited in the Collection Account and Reserve Fund will be
invested in Permitted Investments maturing no later than one Business Day
prior to the Distribution Date or on such other date as may be approved by the
Rating Agencies and the Certificate Insurer.
S-35
<PAGE>
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 SAIF or BIF 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
without reduction or withdrawal of their then current ratings of the
Certificates as evidenced by a letter from such Rating Agency to the Trustee,
and acceptable to the Certificate Insurer.
"Permitted Investments" are specified in the Agreement and are limited to
investments which meet the criteria of the Certificate Insurer, and are
acceptable to 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 Seller 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 fixed-rate home equity loan
agreement, sales contract or installment loan agreement. The Servicer will be
required to remit collections (other than amounts representing the Servicing
Fee and reimbursements of Servicer Advances) to the Collection Account within
two Business Days of receipt thereof. 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.
On the third Business Day immediately preceding each Distribution 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 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 Distribution Date will consist of (i)
interest collections received from or on behalf of Obligors during the related
Monthly Collection Period (less the Servicing Fee and, 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 Repurchase Deposit Amount received in respect of the
related Monthly Collection Period, and (v) investment earnings (net of losses)
on amounts on deposit in the Collection Account for the related Monthly
Collection Period.
"Principal Collections" for any Distribution Date will consist of (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 and (iii) the principal portion of the Repurchase
Deposit Amount and the Substitution Adjustment Amount for any purchased or
substituted Loans received in respect of the related Monthly Collection
Period.
"Net Liquidation Proceeds" means, with respect to any Liquidated Loan,
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).
"Liquidation Proceeds" means proceeds (excluding any amounts drawn from the
Reserve Fund or on the Policy) received in connection with the liquidation of
a Liquidated Loan.
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<PAGE>
"Insurance Proceeds" means, with respect to any Loan and a Monthly
Collection Period, proceeds paid to the Seller 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 Obligor 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, any amount that was previously recognized as a loss but
subsequently has been 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).
DISTRIBUTIONS
Beginning with the first Distribution Date and ending on the first to occur
of the date when the Certificate Principal Balance has been reduced to zero or
the date when the Trust otherwise terminates, the Trustee, based on the
written instructions of the Servicer, will make the distributions described
below.
Interest Collections. The amount on deposit in the Interest Distribution
Account for the related Monthly Collection Period will be distributed, to the
extent available, on each Distribution Date in the following order of
priority:
(i) to the Servicer, an amount equal to the Servicing Fee for the related
Monthly Collection Period (to the extent not retained by the Servicer from
Interest Collections) and all accrued and unpaid Servicing Fees for prior
Monthly Collection Periods;
(ii) to the Trustee, 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 Certificates, an amount equal to the Interest Distributable
Amount for such Distribution Date;
(iv) to the Certificate Insurer, an amount equal to the monthly premium
for the Policy;
(v) to the Principal Distribution Account, to be distributed to the
Certificateholders as principal, an amount equal to the Liquidation Loss
Amount for such Distribution Date;
(vi) to the Certificate Insurer, an amount equal to all prior
unreimbursed draws made on the Policy, together with accrued interest
thereon, and any other amounts owed to the Certificate Insurer pursuant to
the Insurance Agreement;
(vii) to the Reserve Fund, the amount required to meet the Specified
Reserve Fund Requirement;
(viii) to the Seller, any remaining amounts.
Any amounts released to the Seller pursuant to clause (viii) shall not be
property of the Trust Fund thereafter, and the Seller shall have no obligation
to return such amounts to the Trust in the event insufficient funds are
available on any Distribution Date to distribute to Certificateholders the
Interest Distributable Amount or Principal Distributable Amount.
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Interest Collections remaining after allocation of the amounts described in
clauses (i), (ii), (iii) and (iv) above are referred to herein as "Excess
Interest."
"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.
Principal Collections. Monthly Allocable Principal for the related Monthly
Collection Period will be distributed on each Distribution Date as follows:
(i) on a pro rata basis to the Certificateholders of record as of the related
Record Date, in an amount up to the Principal Distributable Amount for such
Distribution Date and (ii) to the Seller, any remaining amounts. See "THE
CERTIFICATES--Principal" herein.
THE RESERVE FUND
Amounts held from time to time in the Reserve Fund will be held for the
benefit of Certificateholders and the Certificate Insurer. On each
Distribution Date, Excess Interest will be deposited in the Reserve Fund as
described under "--Distributions" above, until the amount in the Reserve Fund
reaches the Specified Reserve Fund Requirement.
The Agreement requires funds in the Reserve Fund to be invested in Permitted
Investments. Investment income on amounts in the Reserve Fund will not be
available for distribution to the Certificateholders or otherwise subject to
any claims or rights of the Certificateholders.
The establishment of the Reserve Fund described above is intended to enhance
the likelihood of receipt by Certificateholders of the full amount of
principal and interest on the Loans due them and to decrease the likelihood
that the Certificateholders will experience losses. However, in certain
circumstances, the Reserve Fund could be depleted and, in the event of a
Certificate Insurer Default, shortfalls on the Certificates could result. The
time necessary for the Reserve Fund to reach and maintain the Specified
Reserve Fund Requirement at any time after the date of issuance of the
Certificates will be affected by the delinquency, default and prepayment
experience of the Loans and, therefore, cannot be accurately predicted.
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.
The provisions relating to the Reserve Fund may be amended in any respect by
the Seller, 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
Distribution Date to fund the full amount otherwise required to be paid on
such Distribution Date under the Policy.
On the Business Day preceding each Distribution Date (each, a "Deposit
Date"), to the extent necessary to satisfy any Interest Deficiency and/or
Principal Deficiency, the Servicer shall instruct the Trustee to withdraw from
the Reserve Fund and deposit the amounts described below in the following
manner and order of priority into the indicated accounts:
(i) an amount (the "Reserve Fund Interest Transfer Amount") equal to the
lesser of (x) the excess of (A) the Interest Distributable Amount for such
Distribution Date over (B) the amount on deposit in the Interest
Distribution Account on such date before giving effect to any such transfer
from the Reserve Fund (such excess, an "Interest Deficiency") and (y) the
amount on deposit in the Reserve Fund on such Deposit Date, shall be
deposited in the Interest Distribution Account; and
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(ii) an amount (the "Reserve Fund Principal Transfer Amount") equal to
the lesser of (x) the excess of (A) the Principal Distributable Amount for
such Distribution Date over (B) the amount on deposit in the Principal
Distribution Account on such date before giving effect to any such transfer
from the Reserve Fund (such excess, the "Principal Deficiency") and (y) the
amount remaining in the Reserve Fund after giving effect to any withdrawals
therefrom pursuant to clause (i), shall be deposited in the Principal
Distribution Account.
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 Distribution Date;
(ix) the Certificate Principal Balance after giving effect to such
distribution and the Pool Balance at the end of the related Monthly
Collection Period;
(x) 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;
(xi) the aggregate Liquidation Loss Amount for any Loans that became
Liquidated Loans in the related Monthly Collection Period;
(xii) the Specified Reserve Fund Requirement and the aggregate amount on
deposit in the Reserve Fund on the Distribution Date after giving effect to
any deposits to and withdrawals therefrom on such Distribution Date;
(xiii) the amount of any draws on the Policy; and
(xiv) the amount of any Reserve Fund Transfers.
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.
Unless and until Replacement Certificates are issued, it is anticipated that
the only Certificateholder 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" herein.
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THE POLICY
On or before the Closing Date, the Seller will cause a financial guaranty
insurance policy (the "Policy") to be issued by the Certificate Insurer
pursuant to the provisions of the Agreement and an Insurance and Indemnity
Agreement (the "Insurance Agreement") among the Seller, the Servicer, the
Certificate Insurer and the Trustee. The Policy will unconditionally and
irrevocably guarantee (i) the Interest Distributable Amount for each
Distribution Date and (ii) the Principal Distributable Amount for each
Distribution Date and, on the Final Distribution Date, payment to the
Certificateholders of the outstanding Certificate Principal Balance of the
Certificates (after giving effect to all other amounts distributed and
allocable to principal on such Distribution Date) (collectively, the "Insured
Payments"). A draw will be made on the Policy with respect to each
Distribution Date equal to (i) the amount by which the Interest Distributable
Amount exceeds all amounts on deposit in the Interest Distribution Account
(including the Reserve Fund Interest Transfer Amount, if any) for such
Distribution Date (the "Interest Deficiency Draw Amount") plus (ii) the amount
by which the Principal Distributable Amount (or in the case of the Final
Distribution Date, the outstanding Certificate Principal Balance of the
Certificates) exceeds all amounts on deposit in the Principal Distribution
Account (including the Reserve Fund Principal Transfer Amount, if any) for
such Distribution Date (such amount, the "Principal Deficiency Draw Amount").
The amount of any such draw will be deposited in the Collection Account and
paid to Certificateholders as a distribution of interest or in reduction of
the Certificate Principal Balance, as applicable.
To the extent Excess Interest is unavailable or amounts in the Reserve Fund
are 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.
If the Certificate Insurer's claims paying ratings have been reduced by any
of the Rating Agencies, the Seller 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 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 Distribution Date.
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 representing principal and/or interest on the Certificates 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, a
Certificateholder 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 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 Certificateholder 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 Certificateholder relating to or arising under such
Avoided Payment to the extent of any payments made by the Certificate Insurer
under the Policy 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, unless a Certificateholder or the
Trustee on behalf of the Certificateholder has made a payment to
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such receiver, conservator, debtor-in-possession or trustee in bankruptcy
named in the Final Order, in which case the Certificate Insurer will pay the
Certificateholder or the Trustee on behalf of the Certificateholder, as the
case may be, subject to the delivery of (a) the items referred to in clauses
(x), (y) and (z) above to the Certificate Insurer and (b) evidence
satisfactory to the Certificate Insurer that payment has been made to such
receiver, conservator, debtor-in-possession or trustee in bankruptcy named in
the Final Order.
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
Seller 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.
If the Servicer's Certificate on any Determination Date reflects that, after
giving effect to the deposit of the Reserve Fund Interest Transfer Amount, if
any, to the Interest Distribution Account, there still will be an Interest
Deficiency on the related Distribution 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. The amount of any such draw will be deposited in the
Collection Account when received from the Certificate Insurer to be allocated
to the Interest Distribution Account for distribution to the
Certificateholders on the related Distribution Date as a payment of interest.
If 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 still will be a Principal
Deficiency on the related Distribution 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 Principal
Deficiency Draw Amount. The amount of any such draw will be deposited in the
Collection Account when received from the Certificate Insurer to be allocated
to the Principal Distribution Account for distribution to the
Certificateholders on the related Distribution Date as a payment of principal.
The Policy will unconditionally guarantee the payment of the outstanding
Certificate Principal Balance on the Final Distribution Date (after giving
effect to all other amounts distributed and allocable to principal on such
Distribution Date).
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 require
the Seller to repurchase Loans for breach of a representation and warranty or
defect in documentation and (ii) 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
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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 below under the heading "FURTHER
PROVISIONS OF THE POOLING AND SERVICING AGREEMENT--Amendment of Agreement."
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. The Agreement provides that the
Servicer shall not modify or amend any Loan (or waive any term of any Loan
other than waiving a late payment fee in connection with a late payment on a
Loan), other than to evidence an assumption (as discussed below) unless: (a)
the Loan is in default or default is imminent, (b) the amendment or
modification of the Loan would not cause the Loan to be considered to be
"exchanged" for the modified loan under section 1001 of the Internal Revenue
Code (which excludes from deemed exchanges, among others, modifications and
amendments that (i) do not change the yield on a debt instrument by more than
25 basis points, (ii) do not extend the maturity of a debt instrument by more
than the greater of 5 years or 50 percent of the original weighted average
life of the debt instrument and (iii) do not relate to the timing or amount of
any payment due under the debt instrument and do not (with limited exceptions)
(A) substantially increase or decrease the likelihood of payment, (B) release,
substitute, add or otherwise alter the collateral for a non-recourse debt
instrument, or (C) change the obligor of a recourse debt instrument) or (c)
the modification or amendment would not cause the Trust to fail to qualify as
a grantor trust for federal income tax purposes. 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 Final Distribution Date.
The Agreement also requires the Servicer to dispose of any property acquired
upon the foreclosure, acceptance of a deed-in-lieu of foreclosure or other
conversion of the Loan as soon as possible consistent with commercially
reasonable practices (except that, if more than one year has elapsed since
acquisition of the property, the Servicer will not be required to maximize the
proceeds therefor). Further, Insurance Proceeds received by the Seller or the
Servicer with respect to a Loan will be applied to reduce the unpaid principal
balance of such Loan.
The Agreement requires the Servicer to enforce any due-on-sale clause with
respect to a Loan, unless (a) such enforcement is prohibited by law, (b) there
exists substantial doubt regarding the enforceability of such clause or (c) in
the light of the costs of enforcement and the principal balance of the loan it
would be uneconomic to enforce such clause. If the Servicer is prevented from
enforcing such due-on-sale clause under applicable law, the Servicer will
enter into an assumption and modification agreement with the person to whom
such Mortgaged Property has been or is about to be conveyed, pursuant to which
such person becomes liable under the Loan. 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
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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 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
beginning December 31, 1998, 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 beginning
December 31, 1998) 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 SELLER
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
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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.
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 Seller to transfer any payments it receives
with respect to a Loan to the Servicer within two Business Days following
receipt thereof.
EVENTS OF DEFAULT
"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 and
the Certificate Insurer 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.
RIGHTS UPON EVENTS OF DEFAULT
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
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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 to 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.
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 Seller
and the Trustee with the consent of the Certificate Insurer (which consent may
not be unreasonably withheld) without the consent of any 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 maintain the status
of the Trust as a grantor trust for federal income tax purposes, (iv) 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, (v) 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 Seller nor the Servicer is obligated to obtain, maintain or
improve any such rating) or (vi) 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); provided that no amendment shall be made unless such amendment will
not, as evidenced by an opinion of counsel, materially increase the likelihood
of the Trust failing to be a grantor trust for federal income tax purposes.
S-45
<PAGE>
The Agreement also may be amended from time to time by the Servicer, the
Seller 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 Distribution Date following the earliest of
the Distribution Date on which the Certificate Principal Balance has been
reduced to zero and all amounts owing to the Certificate Insurer have been
paid, (ii) the final payment or other liquidation of the last Loan and the
disposition of any amounts received or property acquired upon liquidation of
any remaining Loans and (iii) and the Final Distribution Date.
The Loans will be subject to optional repurchase by the Seller on any
Distribution Date on or after the Pool Balance is reduced to an amount less
than or equal to $4,750,021 (5% of the Original Pool 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 outstanding Pool
Balance, plus accrued and unpaid interest thereon at the weighted average of
the Loan Rates less, for so long as Chevy Chase is the Servicer, the Servicing
Fee Rate, through the day preceding the Distribution Date on which the Loans
are repurchased. 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.
THE TRUSTEE AND PAYING AGENT
The Trustee. U.S. Bank National Association, doing business as First Bank
National Association, will serve as Trustee under the Agreement. The Trustee
may have normal banking relationships with the Seller and the Servicer or
their affiliates, or both. The Corporate Trust Office of the Trustee is
located at 180 East Fifth Street, St. Paul, Minnesota 55101.
The Trustee may resign at any time. The Seller 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. In any such
event, the Seller 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. See "The AGREEMENTS--
The Trustee"; "--Duties of the Trustee"; and "--Resignation of the Trustee" in
the Prospectus.
The Paying Agent. The Paying Agent initially will 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.
S-46
<PAGE>
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.
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).
S-47
<PAGE>
Principal and interest payments on the Certificates will be made to DTC.
DTC's practice is to credit DTC Participants' accounts on the applicable
Distribution Date in accordance with their respective holdings shown on DTC's
records unless DTC has reason to believe that it will not receive payment on
such Distribution Date. Payments by DTC Participants to Certificate Owners
will be governed by standing instructions and customary practices as is the
case with securities held for the accounts of customers in bearer form or
registered in "street name" and will be the responsibility of such DTC
Participant and not of DTC, the Trustee or the Seller, 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 is the responsibility of
DTC, and disbursement of such payments to Certificate Owners is 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
Seller 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 Seller 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 Seller believes to be reliable, but
the Seller 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 Seller 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 Seller is unable to locate a qualified successor, (ii) the Seller 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 Seller 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.
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.
The characterization of the Trust for federal income tax purposes is not
certain. It is structured as a "grantor trust" and will likely be so treated.
Nonetheless, certain terms of the Trust may be viewed by the Internal Revenue
Service (the "IRS") as inconsistent with the rules for qualification as a
grantor trust. In light of this uncertainty, upon the issuance of the
Certificates, Orrick, Herrington & Sutcliffe LLP, special tax counsel to the
Seller, will deliver its opinion generally to the effect that, assuming
compliance with the Agreement (and certain other documents) and based on
certain representations of the Seller, for federal income tax purposes, the
S-48
<PAGE>
Trust should be treated as a grantor trust, but failing that, it will be
characterized as a partnership and not as an association taxable as a
corporation (or publicly traded partnership treated as an association).
Prospective investors should be aware that no rulings have been sought from
the IRS, and that legal opinions are not binding on the IRS or the courts.
Accordingly, there can be no absolute assurance that the IRS will agree that
the Trust should be a grantor trust. In light of special counsel's opinion,
however, the Trust intends for tax reporting purposes to characterize the
Trust as a grantor trust.
For a discussion of the taxation of the Certificates assuming that they are
taxed as interests in a grantor trust, investors should see "FEDERAL INCOME
TAX CONSIDERATIONS--Tax Status as a Grantor Trust" in the Prospectus. It is
likely that the "stripped bond" rules described therein will apply. Under the
Taxpayer Relief Act of 1997, Section 1272(a)(6) of the Code will apply to the
Certificates for taxable years beginning after August 5, 1997 (except possibly
for Certificates purchased exactly at par). No representation is made that the
Certificates will be qualifying assets under Section 856 or 7701(a)(19)(c) of
the Code.
WITHHOLDING ON FOREIGN CERTIFICATEHOLDERS. THE FOLLOWING SUPERSEDES THE
DISCUSSION UNDER "FEDERAL INCOME TAX CONSIDERATIONS--TAX CONSEQUENCES TO
HOLDERS OF THE CERTIFICATES ISSUED BY A PARTNERSHIP--TAX TREATMENT OF FOREIGN
INVESTORS" IN THE PROSPECTUS. PAYMENTS OF INTEREST (AND ACCRUED ORIGINAL ISSUE
DISCOUNT) MADE TO A NON-U.S. INVESTOR GENERALLY WILL BE SUBJECT TO A 30% U.S.
FEDERAL WITHHOLDING TAX IF THE CERTIFICATES WERE DETERMINED TO BE INTERESTS IN
A PARTNERSHIP FOR U.S. FEDERAL INCOME TAX PURPOSES. ACCORDINGLY, IN ORDER TO
REDUCE THE RISK THAT THE TRUST OR THE TRUSTEE WOULD BE SUBJECT TO PENALTIES
FOR FAILURE TO WITHHOLD, IT IS ANTICIPATED THAT SUCH TAX WILL BE WITHHELD IN
ALL EVENTS.
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
The Certificates will not constitute "mortgage related securities" for
purposes of the Secondary Mortgage Market Enhancement Act of 1984 ("SMMEA").
Accordingly, certain institutions 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 Seller 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-49
<PAGE>
UNDERWRITING
Under the terms and subject to the conditions contained in an Underwriting
Agreement dated September 22, 1997 (the "Underwriting Agreement"), the
Underwriters named below (the "Underwriters") have severally but not jointly
agreed to purchase from the Seller the following respective principal amounts
of the Certificates:
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT
--------------
<S> <C>
Smith Barney Inc. ......................................... $47,500,000.00
Credit Suisse First Boston Corporation..................... $47,500,000.00
--------------
Total.................................................... $95,000,000.00
==============
</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 Seller 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 0.210% of the principal amount per
Certificate, and the Underwriters and such dealers may allow a discount of
0.125% 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 Seller 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 Seller 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.
The Underwriters may engage in over-allotment, stabilizing transactions,
syndicate covering transactions and penalty bids in accordance with Regulation
M under the Exchange Act. Over-allotment involves syndicate sales in excess of
the offering size, which creates a syndicate short position. Stabilizing
transactions permit bids to purchase the underlying security so long as the
stabilizing bids do not exceed a specified maximum. Syndicate covering
transactions involve purchases of the securities in the open market after the
distribution has been completed in order to cover syndicate short positions.
Penalty bids permit the Underwriters to reclaim a selling concession from a
syndicate member when the securities originally sold by such syndicate member
are purchased in a syndicate covering transaction to cover short positions.
Such stabilizing transactions, syndicate covering transactions and penalty
bids may cause the price of the securities to be higher than it would
otherwise be in the absence of such transactions. However, neither the Seller
nor the Underwriters makes any representation or prediction as to the
direction or magnitude of any effect that the transactions described above may
have on the price of the Certificates.
LEGAL MATTERS
Certain federal income tax and other matters will be passed upon for the
Seller by Orrick, Herrington & Sutcliffe LLP. Certain legal matters relating
to the Certificates will be passed upon for the Seller by Shaw, Pittman, Potts
& Trowbridge, a partnership including professional corporations, and for the
Underwriters by Orrick, Herrington & Sutcliffe LLP. George M. Rogers, Jr.,
whose professional corporation is a member of Shaw, Pittman, Potts &
Trowbridge, is a director of the Seller and a trustee of the parent of the
Seller.
S-50
<PAGE>
EXPERTS
The financial statements of CapMAC as of December 31, 1996 and 1995 and for
each of the years in the three-year period ended December 31, 1996, are
attached hereto as Appendix A and have been audited by KPMG Peat Marwick LLP,
independent certified public accountants, as set forth in their audit report
thereon and are included in reliance upon the authority of such firm as
experts in accounting and auditing.
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. 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-51
<PAGE>
INDEX OF PRINCIPAL TERMS
<TABLE>
<CAPTION>
TERM PAGE
- ---- ---------------
<S> <C>
0% CPR.......................................................... S-29
15% CPR......................................................... S-29
Agreement....................................................... S-1, S-3
Avoided Payment................................................. S-40
BIF............................................................. S-17
Business Day.................................................... S-4, S-32, S-41
Certificate Insurer............................................. S-2
Certificate Insurer Default..................................... S-45
Certificate Owners.............................................. S-3
Certificate Principal Balance................................... S-5
Certificateholders.............................................. S-5
Certificateholders' Interest Carryover Shortfall................ S-5, S-33
Certificates.................................................... S-1, S-3
Chevy Chase..................................................... S-1, S-3
Closed-end Home Equity Loans.................................... S-17
Collection Account.............................................. S-8, S-35
Commission...................................................... S-2
CPR............................................................. S-29
Cut-off Date.................................................... S-2, S-22
Debt Consolidation Loans........................................ S-2, S-31
Defective Loan.................................................. S-12, S-34
Deferral Loan................................................... S-29
Deferral Period................................................. S-18
Deposit Date.................................................... S-10, S-38
Determination Date.............................................. S-36
Direct Home Improvement Loans................................... S-17
Distribution Date............................................... S-1, S-32
DTC............................................................. S-2, S-32
DTC Participants................................................ S-47
Eligible Account................................................ S-36
Eligible Substitute Loan........................................ S-35
Events of Default............................................... S-44
Excess Interest................................................. S-6, S-38
Exchange Act.................................................... S-2
Expense Distribution Account.................................... S-35
FDIA............................................................ S-16
FDIC............................................................ S-16
Final Distribution Date......................................... S-32
Final Order..................................................... S-40
FIRREA.......................................................... S-16
Home Equity Loans............................................... S-4, S-31
Home Improvement Contracts...................................... S-4, S-31
Home Loans...................................................... S-17
Indirect Debt Consolidation Loans............................... S-17
Indirect Home Improvement Loans................................. S-17
Indirect Participants........................................... S-47
Initial Certificate Principal Balance........................... S-3, S-32
Initial Reserve Fund Deposit.................................... S-9
</TABLE>
S-52
<PAGE>
<TABLE>
<CAPTION>
TERM PAGE
- ---- ----------
<S> <C>
Insolvency Proceeding................................................ S-41
Insurance Agreement.................................................. S-11, S-40
Insurance Proceeds................................................... S-9, S-37
Insured Payments..................................................... S-11, S-40
Interest Collections................................................. S-8, S-36
Interest Deficiency.................................................. S-38
Interest Deficiency Draw Amount...................................... S-11, S-40
Interest Distributable Amount........................................ S-5, S-32
Interest Distribution Account........................................ S-35
Interest Period...................................................... S-5, S-32
Liquidated Loan...................................................... S-9, S-37
Liquidation Loss Amount.............................................. S-6, S-38
Liquidation Proceeds................................................. S-9, S-36
Loan File............................................................ S-33
Loan Pool............................................................ S-22
Loan Rate............................................................ S-7
Loans................................................................ S-2, S-4
Monthly Allocable Principal.......................................... S-6, S-33
Monthly Collection Period............................................ S-6, S-33
Mortgaged Properties................................................. S-2, S-4
Mortgages............................................................ S-4
Net Liquidation Proceeds............................................. S-8, S-36
Obligor.............................................................. S-8, S-28
Original Pool Balance................................................ S-4, S-22
OTS.................................................................. S-16
Paid-Ahead Loan...................................................... S-28
Paid-Ahead Period.................................................... S-28
Pass-Through Rate.................................................... S-1, S-32
Paying Agent......................................................... S-46
Permitted Investments................................................ S-36
Policy............................................................... S-11, S-40
Preference Event..................................................... S-40
Principal Collections................................................ S-8, S-36
Principal Deficiency................................................. S-39
Principal Deficiency Draw Amount..................................... S-11, S-40
Principal Distributable Amount....................................... S-5, S-33
Principal Distribution Account....................................... S-35
Prospectus........................................................... S-2
Rating Agency........................................................ S-13
Real Estate Investment Trust......................................... S-17
Receipt.............................................................. S-40
Received............................................................. S-40
Record Date.......................................................... S-32
Recoveries........................................................... S-9, S-37
Replacement Certificates............................................. S-48
Repurchase Deposit Amount............................................ S-34
Reserve Fund......................................................... S-9, S-35
Reserve Fund Interest Transfer Amount................................ S-10, S-38
Reserve Fund Principal Transfer Amount............................... S-11, S-39
Residential Properties............................................... S-7
</TABLE>
S-53
<PAGE>
<TABLE>
<CAPTION>
TERM PAGE
- ---- ----------
<S> <C>
SAIF................................................................. S-16
Seller............................................................... S-1, S-3
Servicer............................................................. S-1, S-3
Servicer Advance..................................................... S-43
Servicer's Certificate............................................... S-36
Servicing Fee........................................................ S-12, S-35
SMMEA................................................................ S-13, S-49
Specified Reserve Fund Requirement................................... S-10
Substitution Adjustment Amount....................................... S-34
Trust................................................................ S-1, S-3
Trust Fund........................................................... S-4
Trustee.............................................................. S-1
Trustee's Fee........................................................ S-35
Underwriters......................................................... S-50
Underwriting Agreement............................................... S-50
Weighted Average Life................................................ S-31
</TABLE>
S-54
<PAGE>
APPENDIX A
KPMG
CAPITAL MARKETS ASSURANCE CORPORATION
FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(With Independent Auditors' Report Thereon)
<PAGE>
[LETTERHEAD OF KPMG PEAT MARWICK LLP APPEARS HERE]
Independent Auditors' Report
----------------------------
The Board of Directors
Capital Markets Assurance Corporation:
We have audited the accompanying balance sheets of Capital Markets Assurance
Corporation as of December 31, 1996 and 1995 and the related statements of
income, stockholder's equity and cash flows for each of the years in the
three-year period ended December 31, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Capital Markets Assurance
Corporation as of December 31, 1996 and 1995 and the results of its operations
and its cash flows for each of the years in the three-year period ended December
31, 1996 in conformity with generally accepted accounting principles.
/s/ KPMG Peat Marwick LLP
New York, New York
January 29, 1997
<PAGE>
Capital Markets Assurance Corporation
Balance Sheets
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
ASSETS
------
December 31 December 31
1996 1995
- ------------------------------------------------------------------------------------------------------
<S> <C> <C>
Investments:
Bonds at fair value (amortized cost $294,861 at December 31,
1996 and $210,651 at December 31, 1995) $ 297,893 215,706
Short-term investments (at amortized cost which approximates
fair value) 16,810 68,646
- ------------------------------------------------------------------------------------------------------
Total investments 314,703 284,352
- ------------------------------------------------------------------------------------------------------
Cash 371 344
Accrued investment income 3,807 3,136
Deferred acquisition costs 45,380 35,162
Premiums receivable 5,141 3,540
Prepaid reinsurance 18,489 13,171
Other assets 6,424 3,428
- ------------------------------------------------------------------------------------------------------
Total assets $ 394,315 343,133
======================================================================================================
LIABILITIES AND STOCKHOLDER'S EQUITY
------------------------------------
Liabilities:
Unearned premiums $ 68,262 45,767
Reserve for losses and loss adjustment expenses 10,985 6,548
Ceded reinsurance 1,738 2,469
Accounts payable and other accrued expenses 8,019 10,844
Current income taxes 679 136
Deferred income taxes 15,139 11,303
- ------------------------------------------------------------------------------------------------------
Total liabilities 104,822 77,067
- ------------------------------------------------------------------------------------------------------
Stockholder's Equity:
Common stock - $1.00 par value per share; 15,000,000 shares are
authorized, issued and outstanding at December 31, 1996 and 1995 15,000 15,000
Additional paid-in capital 208,475 205,808
Unrealized appreciation on investments, net of tax 1,970 3,286
Retained earnings 64,048 41,972
- ------------------------------------------------------------------------------------------------------
Total stockholder's equity 289,493 266,066
- ------------------------------------------------------------------------------------------------------
Total liabilities and stockholder's equity $ 394,315 343,133
======================================================================================================
</TABLE>
See accompanying notes to financial statements.
<PAGE>
Capital Markets Assurance Corporation
Statements of Income
(Dollars in thousands)
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
December 31, 1996 December 31,1995 December 31, 1994
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues:
Direct premiums written $ 71,752 56,541 43,598
Assumed premiums written 1,086 935 1,064
Ceded premiums written (15,104) (15,992) (11,069)
- -----------------------------------------------------------------------------------------------------
Net premiums written 57,734 41,484 33,593
Increase in unearned premiums (17,177) (12,242) (10,490)
- -----------------------------------------------------------------------------------------------------
Net premiums earned 40,557 29,242 23,103
Net investment income 16,992 11,953 10,072
Net realized capital gains 236 1,301 92
Other income 146 2,273 120
- -----------------------------------------------------------------------------------------------------
Total revenues 57,931 44,769 33,387
- -----------------------------------------------------------------------------------------------------
Expenses:
Losses and loss adjustment expenses 4,815 3,141 1,429
Underwriting and operating expenses 14,613 13,808 11,833
Policy acquisition costs 7,824 7,203 4,529
- -----------------------------------------------------------------------------------------------------
Total expenses 27,252 24,152 17,791
- -----------------------------------------------------------------------------------------------------
Income before income taxes 30,679 20,617 15,596
- -----------------------------------------------------------------------------------------------------
Income Taxes:
Current income tax 5,235 2,113 865
Deferred income tax 3,368 3,102 2,843
- -----------------------------------------------------------------------------------------------------
Total income taxes 8,603 5,215 3,708
- -----------------------------------------------------------------------------------------------------
Net Income $ 22,076 15,402 11,888
=====================================================================================================
</TABLE>
See accompanying notes to financial statements.
<PAGE>
Capital Markets Assurance Corporation
Statements of Stockholder's Equity
(Dollars in thousands)
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
December 31, 1996 December 31, 1995 December 31, 1994
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Common stock:
Balance at beginning of year $ 15,000 15,000 15,000
- ---------------------------------------------------------------------------------------------------------
Balance at end of year 15,000 15,000 15,000
- ---------------------------------------------------------------------------------------------------------
Additional paid-in capital:
Balance at beginning of year 205,808 146,808 146,808
Capital contribution 2,667 59,000 -
- ---------------------------------------------------------------------------------------------------------
Balance at end of year 208,475 205,808 146,808
- ---------------------------------------------------------------------------------------------------------
Unrealized appreciation (depreciation)
on investments, net of tax:
Balance at beginning of year 3,286 (5,499) 3,600
Unrealized appreciation (depreciation)
on investments (1,316) 8,785 (9,099)
- ---------------------------------------------------------------------------------------------------------
Balance at end of year 1,970 3,286 (5,499)
- ---------------------------------------------------------------------------------------------------------
Retained earnings:
Balance at beginning of year 41,972 26,570 14,682
Net income 22,076 15,402 11,888
- ---------------------------------------------------------------------------------------------------------
Balance at end of year 64,048 41,972 26,570
- ---------------------------------------------------------------------------------------------------------
Total stockholder's equity $ 289,493 266,066 182,879
=========================================================================================================
</TABLE>
See accompanying notes to financial statements.
<PAGE>
Capital Markets Assurance Corporation
Statements of Cash Flows
(Dollar in thousands)
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
December 31, 1996 December 31, 1995 December 31, 1994
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 22,076 15,402 11,888
- ----------------------------------------------------------------------------------------------------------
Adjustments to reconcile net income to net
cash provided (used) by operating activities:
Reserve for losses and loss adjustment expenses 4,437 1,357 1,429
Unearned premiums, net 22,496 19,862 15,843
Deferred acquisition costs (10,218) (10,302) (9,611)
Premiums receivable (1,601) (161) (2,103)
Accrued investment income (671) (390) (848)
Income taxes payable 3,911 3,621 2,611
Net realized capital gains (236) (1,301) (92)
Accounts payable and other accrued expenses 1,020 472 3,726
Prepaid reinsurance (5,318) (7,620) (5,352)
Other, net (3,396) 992 689
- ----------------------------------------------------------------------------------------------------------
Total adjustments 10,424 6,530 6,292
- ----------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 32,500 21,932 18,180
- ----------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Purchases of investments (199,989) (158,830) (77,980)
Proceeds from sales of investments 57,210 49,354 39,967
Proceeds from maturities of investments 110,306 28,803 19,665
- ----------------------------------------------------------------------------------------------------------
Net cash used in investing activities (32,473) (80,673) (18,348)
- ----------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Capital contribution - 59,000 -
- ----------------------------------------------------------------------------------------------------------
Net cash provided by financing activities - 59,000 -
- ----------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash 27 259 (168)
Cash balance at beginning of year 344 85 253
- ----------------------------------------------------------------------------------------------------------
Cash balance at end of year $ 371 344 85
==========================================================================================================
Supplemental disclosure of cash flow information:
Income taxes paid $ 4,525 1,450 1,063
==========================================================================================================
</TABLE>
See accompanying notes to financial statements.
<PAGE>
Capital Markets Assurance Corporation
Notes to Financial Statements
December 31, 1996 and 1995
1) Background
Capital Markets Assurance Corporation ("CapMAC" or "the Company") is a New
York- domiciled monoline stock insurance company which engages only in the
business of financial guarantee and surety insurance. CapMAC is a wholly
owned subsidiary of CapMAC Holdings Inc. ("Holdings"). CapMAC is licensed
in all 50 states in addition to the District of Columbia, the Commonwealth
of Puerto Rico and the territory of Guam. CapMAC insures structured
asset-backed, corporate, municipal and other financial obligations in the
U.S. and international capital markets. CapMAC also provides financial
guarantee reinsurance for structured asset- backed, corporate, municipal
and other financial obligations written by other major insurance companies.
CapMAC's claims-paying ability is rated "Aaa" by Moody's Investors Service,
Inc. ("Moody's"), "AAA" by Standard & Poor's Ratings Group ("S&P"), "AAA"
by Duff & Phelps Credit Rating Co. ("Duff & Phelps"), and "AAA" by Nippon
Investors Service, Inc., a Japanese rating agency. Such ratings reflect
only the views of the respective rating agencies, are not recommendations
to buy, sell or hold securities and are subject to revision or withdrawal
at any time by such rating agencies.
2) Significant Accounting Policies
Significant accounting policies used in the preparation of the accompanying
financial statements are as follows:
a) Basis of Presentation
The accompanying financial statements are prepared on the basis of
generally accepted accounting principles ("GAAP"). Such accounting
principles differ from statutory reporting practices used by insurance
companies in reporting to state regulatory authorities.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Management believes
the most significant estimates relate to deferred acquisition costs,
reserve for losses and loss adjustment expenses and disclosures of
financial guarantees outstanding. Actual results could differ from
those estimates.
b) Investments
As of December 31, 1996 and 1995, all of the Company's securities have
been classified as available-for-sale. Available-for-sale securities
are recorded at fair value. Fair value is generally based upon quoted
market prices. Unrealized holding gains and losses, net of the related
tax effect, on available-for-sale securities are excluded from
earnings and are reported as a separate component of stockholder's
equity until realized. Transfers of securities between categories are
recorded at fair value at the date of transfer. A decline in the fair
value of any available-for-sale security below cost that is deemed
other than temporary is charged to earnings resulting in the
establishment of a new cost basis for the security.
1
<PAGE>
Capital Markets Assurance Corporation
Notes to Financial Statements
Short-term investments are those investments having a maturity of less than
one year at purchase date. Short-term investments are carried at amortized
cost which approximates fair value.
Premiums and discounts are amortized or accreted over the life of the
related security as an adjustment to yield using the effective interest
method. Dividend and interest income are recognized when earned. Realized
gains and losses are included in earnings and are derived using the FIFO
(first-in, first-out) method for determining the cost of securities sold.
c) Premium Revenue Recognition
Premiums which are payable monthly to CapMAC are reflected in income when
due, net of amounts payable to reinsurers. Premiums which are payable
quarterly, semi-annually or annually are reflected in income, net of
amounts payable to reinsurers, on an equal monthly basis over the
corresponding policy term. Premiums that are collected as a single premium
at the inception of the policy and have a term longer than one year are
earned, net of amounts payable to reinsurers, by allocating premium to each
bond maturity based on the principal amount and earning it straight-line
over the term of each bond maturity. For the years ended December 31, 1996
and 1995, 91% of net premiums earned were attributable to premiums payable
in installments and 9% were attributable to premiums collected on an
up-front basis.
d) Deferred Acquisition Costs
Certain costs incurred by CapMAC, which vary with and are primarily related
to the production of new business, are deferred. These costs include direct
and indirect expenses related to underwriting, marketing and policy
issuance, rating agency fees and premium taxes, net of reinsurance ceding
commissions. The deferred acquisition costs are amortized over the period
in proportion to the related premium earnings. The actual amount of premium
earnings may differ from projections due to various factors such as renewal
or early termination of insurance contracts or different run-off patterns
of exposure resulting in a corresponding change in the amortization pattern
of the deferred acquisition costs.
e) Reserve for Losses and Loss Adjustment Expenses
The reserve for losses and loss adjustment expenses consists of a
supplemental loss reserve ("SLR") and a case basis loss reserve. The SLR is
established for expected levels of losses resulting from credit failures on
currently insured issues and reflects the estimated portion of earned
premiums required to cover those losses.
A case basis loss reserve is established for insured obligations when, in
the judgment of management, a default in the timely payment of debt service
is imminent. For defaults considered temporary, a case basis loss reserve
is established in an amount equal to the present value of the anticipated
defaulted debt service payments over the expected period of default. If the
default is judged not to be temporary, the present value of all remaining
defaulted debt service payments is recorded as a case basis loss reserve.
Anticipated salvage recoveries are considered in establishing case basis
loss reserves when such amounts are reasonably estimable. Case basis loss
reserves may be allocated from any SLR outstanding at the time the case
basis reserves are established.
2
<PAGE>
Capital Markets Assurance Corporation
Notes to Financial Statements
Management believes that the current level of reserves is adequate to cover
the ultimate net cost of claims and the related expenses with respect to
financial guarantees issued by CapMAC. The establishment of the appropriate
level of loss reserves is an inherently uncertain process involving
estimates and subjective judgments by management, and therefore there can
be no assurance that ultimate losses in CapMAC's insured portfolio will not
exceed the current estimate of loss reserves.
f) Depreciation
Leasehold improvements, furniture, fixtures and electronic data processing
equipment are being amortized or depreciated over the lease term or useful
life, whichever is shorter, using the straight-line method.
g) Income Taxes
Deferred income taxes are provided with respect to temporary differences
between the financial statement and tax basis of assets and liabilities
using enacted tax rates in effect for the year in which the differences are
expected to reverse. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in the period that includes the enactment
date.
3
<PAGE>
Capital Markets Assurance Corporation
Notes to Financial Statements
3) Insured Portfolio
At December 31, 1996 and 1995, the principal amount of financial
obligations insured by CapMAC was $24.5 billion and $16.9 billion,
respectively, and net of reinsurance (net principal outstanding), was $19.7
billion and $12.6 billion, respectively, with a weighted average life of
6.4 years and 6.0 years, respectively. CapMAC's insured portfolio was
broadly diversified by geographic distribution and type of insured
obligations, with no single insured obligation in excess of statutory
single risk limits, after giving effect to any reinsurance and collateral,
which are a function of CapMAC's statutory qualified capital (the sum of
statutory capital and surplus and mandatory contingency reserve). At
December 31, 1996 and 1995, the statutory qualified capital was
approximately $260 million and $240 million, respectively.
<TABLE>
<CAPTION>
Net Principal Outstanding
December 31, 1996 December 31, 1995
------------------------------ -----------------------------
Type of Obligations Insured ($ in millions) Amount % Amount %
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Consumer receivables $ 10,362 52.8 $ 6,959 55.1
Trade and other corporate
obligations 8,479 43.1 4,912 38.9
Municipal/government obligations 814 4.1 757 6.0
- -------------------------------------------------------------------------------------------------------------
Total $ 19,655 100.0 $ 12,628 100.0
=============================================================================================================
</TABLE>
At December 31, 1996 and 1995, the principal and interest amount of
financial obligations insured by CapMAC was $29.8 billion and $20.3
billion, respectively, and net of reinsurance (net principal and interest
outstanding) was $23.3 billion and $15.1 billion, respectively. At December
31, 1996, approximately 93% of CapMAC's insured portfolio was comprised of
structured asset-backed transactions. Under these structures, a pool of
assets covering at least 100% of the principal amount guaranteed under its
insurance contract is sold or pledged to a special purpose bankruptcy
remote entity. CapMAC's primary risk from such insurance contracts is the
impairment of cash flows due to delinquency or loss on the underlying
assets. CapMAC, therefore, evaluates all the factors affecting past and
future asset performance by studying historical data on losses,
delinquencies and recoveries of the underlying assets. Each transaction is
reviewed to ensure that an appropriate legal structure is used to protect
against the bankruptcy risk of the originator of the assets. Along with the
legal structure, an additional level of first loss protection is also
created to protect against losses due to credit or dilution. This first
level of loss protection is usually available from reserve funds, excess
cash flows, overcollateralization, or recourse to a third party. The level
of first loss protection depends upon the historical losses and dilution of
the underlying assets, but is typically several times the normal historical
loss experience for the underlying type of assets.
During 1995, the Company sold without recourse its interest in potential
cash flows from transactions included in its insured portfolio and
recognized $2,200,000 of income which has been included in other income in
the accompanying financial statements.
The following entities each accounted for, through referrals and otherwise,
10% or more of total revenues for each of the periods presented:
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
December 31, 1996 December 31, 1995 December 31, 1994
------------------------ ------------------------ ------------------------
% of % of % of
Revenues Revenues Revenues
------------------------ ------------------------ ------------------------
<S> <C> <C> <C>
Citicorp 14.5 15.2 16.3
</TABLE>
4
<PAGE>
Capital Markets Assurance Corporation
Notes to Financial Statements
4) Investments
The amortized cost, gross unrealized gains, gross unrealized losses and
estimated fair value for available-for-sale securities by major security
type at December 31, 1996 and 1995 were as follows ($ in thousands):
<TABLE>
<CAPTION>
December 31, 1996
- -----------------------------------------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Securities Available-for-sale Cost Gains Losses Value
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Treasury obligations $ 4,059 10 - 4,069
Mortgage-backed securities of
U.S. government instrumentalities
and agencies 109,436 265 1,160 108,541
Obligations of states, municipalities
and political subdivisions 177,811 4,602 555 181,858
Corporate and asset-backed
securities 20,365 23 153 20,235
- -----------------------------------------------------------------------------------------------------
Total $ 311,671 4,900 1,868 314,703
=====================================================================================================
<CAPTION>
December 31, 1995
- -----------------------------------------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Securities Available-for-sale Cost Gains Losses Value
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Treasury obligations $ 4,153 55 - 4,208
Mortgage-backed securities of
U.S. government instrumentalities
and agencies 100,628 313 79 100,862
Obligations of states, municipalities
and political subdivisions 166,010 4,809 82 170,737
Corporate and asset-backed
securities 8,506 45 6 8,545
- -----------------------------------------------------------------------------------------------------
Total $ 279,297 5,222 167 284,352
=====================================================================================================
</TABLE>
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, 1996 by contractual maturity are shown below ($ in thousands):
<TABLE>
<CAPTION>
December 31, 1996
- -----------------------------------------------------------------------------
Amortized Estimated
Securities Available-for-sale Cost Fair Value
- -----------------------------------------------------------------------------
<S> <C> <C>
Due in one year or less $ 11,627 11,644
Due after one year through five years 31,821 32,815
Due after five years through ten years 76,450 78,200
Due after ten years 82,337 83,503
- -----------------------------------------------------------------------------
Sub-total 202,235 206,162
Mortgage-backed securities 109,436 108,541
- -----------------------------------------------------------------------------
Total $ 311,671 314,703
=============================================================================
</TABLE>
Actual maturities may differ from contractual maturities because borrowers may
call or prepay obligations with or without call or prepayment penalties.
Proceeds from sales of investment securities were approximately $57.2 million,
$49.3 million and $39.9 million in 1996, 1995 and 1994, respectively. Gross
realized capital gains of $772,000, $1,320,000 and $714,000, and gross realized
capital losses of $536,000, $19,000 and $622,000 were realized on those sales
for the years ended December 31, 1996, 1995 and 1994, respectively.
Investments include bonds having a fair value of approximately $3,884,000 and
$3,985,000 which are on deposit at December 31, 1996 and 1995, respectively,
with state regulators as required by law.
Investment income is comprised of interest and dividends, net of related
expenses, and is applicable to the following sources:
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
$ in thousands December 31, 1996 December 31, 1995 December 31, 1994
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Bonds $ 15,726 11,105 9,193
Short-term investments 1,534 1,245 484
Mutual funds - (162) 579
Investment expenses (268) (235) (184)
- ---------------------------------------------------------------------------------------------
Total $ 16,992 11,953 10,072
=============================================================================================
</TABLE>
6
<PAGE>
Capital Markets Assurance Corporation
Notes to Financial Statements
The change in unrealized appreciation (depreciation) on available-for-sale
securities is included as a separate component of stockholder's equity as
shown below:
<TABLE>
<CAPTION>
Year Ended Year Ended
$ in thousands December 31, 1996 December 31, 1995
- -----------------------------------------------------------------------------------------------
<S> <C> <C>
Balance at beginning of year $ 3,286 (5,499)
Change in unrealized (depreciation) appreciation (2,024) 13,386
Income tax effect 708 (4,601)
- -----------------------------------------------------------------------------------------------
Net change (1,316) 8,785
- -----------------------------------------------------------------------------------------------
Balance at end of year $ 1,970 3,286
===============================================================================================
</TABLE>
No single issuer, except for investments in U.S. Treasury and U.S.
government agency securities, exceeds 2% of stockholder's equity as of
December 31, 1996 and 1995, respectively.
5) Deferred Acquisition Costs
The following table reflects acquisition costs deferred by CapMAC and
amortized in proportion to the related premium earnings:
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
$ in thousands December 31, 1996 December 31, 1995 December 31, 1994
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance at beginning of year $ 35,162 24,860 15,249
Additions 18,042 17,505 14,140
Amortization (policy
acquisition costs) (7,824) (7,203) (4,529)
- -----------------------------------------------------------------------------------------------------
Balance at end of year $ 45,380 35,162 24,860
=====================================================================================================
</TABLE>
6) Employee Benefits
CapMAC has a service agreement with CapMAC Financial Services, Inc.
("CFS"). Under the service agreement, CFS has agreed to provide various
services, including underwriting, reinsurance, marketing, data processing
and other services to CapMAC in connection with the operation of CapMAC's
insurance business. CapMAC pays CFS a fee for providing such services, but
not in excess of CFS's cost for such services. CFS incurred, on behalf of
CapMAC, total compensation expenses, excluding bonuses, of $13,374,000,
$13,484,000 and $11,081,000 in 1996, 1995 and 1994, respectively.
The Company, through CFS, maintains an incentive compensation plan for its
employees. The plan is an annual discretionary bonus award. For the years
ended December 31, 1996, 1995 and 1994, the Company had provided
approximately $8,810,000, $7,804,000 and $5,253,000, respectively, for the
plan. CFS also provides health and welfare benefits to substantially all of
its employees. The Company incurred $551,943, $598,530, and $562,508 of
expense for the years ended December 31, 1996, 1995 and 1994, respectively,
for such plan. The Company also has a defined contribution retirement plan
which allows participants to make voluntary contributions by salary
reduction pursuant to section 401 (k) of the Internal Revenue Code. The
Company provides for the administrative cost for the 401 (k) plan.
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. During 1995 and 1994, the expense was $1.3
million and $0.1 million, respectively. During 1996, Holdings assumed the
liability of $3.7 million less the related deferred tax asset of $1.1
million as capital contribution. The cash amount is held by Holdings and
invested in accordance with certain guidelines. Such amount, including the
investment earnings thereon, will be paid to each officer upon the
occurrence of certain events but no later than December 2000.
7) Employee Stock Ownership Plan
Holdings maintains an Employee Stock Ownership Plan ("ESOP") to provide its
employees the opportunity to obtain beneficial interests in the stock of
Holdings through a trust (the "ESOP Trust"). Compensation expense related
to the ESOP and allocated to CapMAC was approximately $2,764,000,
$2,087,000 and $2,086,000 for the years ended December 31, 1996, 1995 and
1994, respectively.
8
<PAGE>
Capital Markets Assurance Corporation
Notes to Financial Statements
8) Reserve for Losses and Loss Adjustment Expenses
The reserve for losses and loss adjustment expenses consists of a case
basis loss reserve and the SLR.
In 1995, CapMAC incurred its first claim on a financial guarantee policy.
Based on its current estimate, the Company expects the aggregate amount of
claims and related expenses not to exceed $2.7 million, although no
assurance can be given that such claims and related expenses will not
exceed that amount. Such loss amount was covered through a recovery under a
quota share reinsurance agreement of $0.2 million and a reduction in the
SLR of $2.5 million. The portion of such claims and expenses not covered
under the quota share agreement is being funded through payments to CapMAC
from the Lureco Trust Account (see note 12).
The following is a summary of the activity in the case basis loss reserve
account and the components of the reserve for losses and loss adjustment
expenses ($ in thousands):
<TABLE>
<CAPTION>
1996 1995 1994
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Case basis loss reserve:
Net balance at January 1 $ 620 - -
- -------------------------------------------------------------------------------------------------
Incurred related to:
Current year - 2,473 -
Prior years - - -
- -------------------------------------------------------------------------------------------------
Total incurred - 2,473 -
- -------------------------------------------------------------------------------------------------
Paid related to:
Current year - 1,853 -
Prior years 309 - -
- -------------------------------------------------------------------------------------------------
Total paid 309 1,853 -
- -------------------------------------------------------------------------------------------------
Net balance at December 31 311 620 -
Reinsurance recoverable - 69 -
- -------------------------------------------------------------------------------------------------
Gross balance at December 31 311 689 -
- -------------------------------------------------------------------------------------------------
Supplemental loss reserve
Balance at January 1 5,859 5,191 3,762
- -------------------------------------------------------------------------------------------------
Additions to supplemental loss reserve 4,815 3,141 1,429
Allocated to case basis reserve - (2,473) -
- -------------------------------------------------------------------------------------------------
Balance at December 31 10,674 5,859 5,191
- -------------------------------------------------------------------------------------------------
Total reserve for losses and loss adjustment
expenses $ 10,985 6,548 5,191
=================================================================================================
</TABLE>
9
<PAGE>
Capital Markets Assurance Corporation
Notes to Financial Statements
9) Income Taxes
Pursuant to a tax sharing agreement with Holdings, the Company is included
in Holdings' consolidated U.S. Federal income tax return. The Company's
annual Federal income tax liability is determined by computing its pro rata
share of the consolidated group Federal income tax liability.
Total income tax expense differed from the amount computed by applying the
U.S. Federal income tax rate of 35% in 1996 and 1995 and 34% in 1994:
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
December 31, 1996 December 31, 1995 December 31, 1994
$ in thousands Amount % Amount % Amount %
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Expected tax expense computed
at the statutory rate $ 10,738 35.0 $7,216 35.0 $5,303 34.0
Increase (decrease) in tax
resulting from:
Tax-exempt interest (2,916) (9.5) (2,335) (11.3) (1,646) (10.6)
Other, net 781 2.5 334 1.6 51 0.4
- -----------------------------------------------------------------------------------------------------
Total income tax expense $ 8,603 28.0 $5,215 25.3 $3,708 23.8
=====================================================================================================
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the deferred Federal income tax liability are as follows:
<TABLE>
<CAPTION>
$ in thousands December 31, 1996 December 31, 1995
- -----------------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax assets:
Deferred compensation $ 200 1,901
Losses and loss adjustment expenses 1,527 1,002
Unearned premiums 866 852
Other, net 96 98
- -----------------------------------------------------------------------------------------
Total gross deferred tax assets 2,689 3,853
- -----------------------------------------------------------------------------------------
Deferred tax liabilities:
Deferred acquisition costs 15,883 12,307
Unrealized capital gains on investments 1,061 1,769
Other, net 884 1,080
- -----------------------------------------------------------------------------------------
Total gross deferred tax liabilities 17,828 15,156
- -----------------------------------------------------------------------------------------
Net deferred tax liability $ 15,139 11,303
=========================================================================================
</TABLE>
A valuation allowance is provided when it is more likely than not that some
portion of the deferred tax assets will not be realized. Management
believes that the deferred tax assets will be fully realized in the future.
10
<PAGE>
Capital Markets Assurance Corporation
Notes to Financial Statements
10) Insurance Regulatory Restrictions
CapMAC is subject to insurance regulatory requirements of the State of New
York and other states in which it is licensed to conduct business.
Generally, New York insurance laws require that dividends be paid from
earned surplus and restrict the amount of dividends in any year that may be
paid without obtaining approval for such dividends from the Superintendent
of Insurance to the lower of (i) net investment income as defined or (ii)
10% of statutory surplus as of December 31 of the preceding year. No
dividends were paid by CapMAC to Holdings during the years ended December
31, 1996, 1995 and 1994. No dividends could be paid during these periods
because CapMAC had negative earned surplus. Statutory surplus at December
31, 1996 and 1995 was approximately $193,726,000 and $195,018,000,
respectively. Statutory surplus differs from stockholder's equity
determined under GAAP principally due to the mandatory contingency reserve
required for statutory accounting purposes and differences in accounting
for investments, deferred acquisition costs, SLR and deferred taxes
provided under GAAP. Statutory net income was $18,737,000, $9,000,000 and
$4,543,000 for the years ended December 31, 1996, 1995 and 1994,
respectively. Statutory net income differs from net income determined under
GAAP principally due to deferred acquisition costs, SLR and deferred income
taxes.
11) Commitments and Contingencies
The Company's lease agreement for the space occupied in New York expires on
November 20, 2008. CapMAC has a lease agreement for its London office,
which expires on October 1, 2002. As of December 31, 1996, future minimum
payments under the lease agreements are as follows:
<TABLE>
<CAPTION>
$ in thousands Payment
-------------------------------------------------------------------------
<S> <C>
1997 $ 2,647
1998 2,715
1999 3,077
2000 3,152
2001 and thereafter 28,660
-------------------------------------------------------------------------
Total $ 40,251
=========================================================================
</TABLE>
Rent expense, commercial rent taxes and electricity for the years ended
December 31, 1996, 1995 and 1994 amounted to $1,618,000, $1,939,000 and
$2,243,000, respectively.
CapMAC has available a $150,000,000 standby corporate liquidity facility
(the "Liquidity Facility") scheduled to terminate in September 1999. The
Liquidity Facility is provided by a consortium of banks, headed by Bank of
Montreal, as agent, which is rated "A-1+" and "P-1" by S&P and Moody's,
respectively. Under the Liquidity Facility, CapMAC will be able, subject to
satisfying certain conditions, to borrow funds from time to time in order
to enable it to fund any claim payments or payments made in settlement or
mitigation of claim payments under its insurance contracts. There have been
no draws under the Liquidity Facility.
CapMAC has agreed to make an investment of 50 million French Francs
(approximately $10 million U.S. dollars) in CapMAC Assurance, S.A., an
insurance subsidiary to be established in Paris, France. This investment is
anticipated to be made in 1997.
11
<PAGE>
Capital Markets Assurance Corporation
Notes to Financial Statements
12) Reinsurance
In the ordinary course of business, CapMAC cedes exposure under various
treaty and facultative reinsurance contracts, both on a pro rata and excess
of loss basis, primarily designed to minimize losses from large risks and
protect the capital and surplus of CapMAC.
The effect of reinsurance on premiums written and earned was as follows:
<TABLE>
<CAPTION>
Years Ended December 31
1996 1995 1994
------------------------ ---------------------- -----------------------
$ in thousands Written Earned Written Earned Written Earned
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Direct $ 71,752 48,835 56,541 36,853 43,598 28,561
Assumed 1,086 1,508 935 761 1,064 258
Ceded (15,104) (9,786) (15,992) (8,372) (11,069) (5,716)
- -----------------------------------------------------------------------------------------------------
Net premiums $ 57,734 40,557 41,484 29,242 33,593 23,103
=====================================================================================================
</TABLE>
The reinsurance of risk does not relieve the ceding insurer of its original
liability to its policyholders. A contingent liability exists with respect
to the aforementioned reinsurance arrangements, which may become a
liability of CapMAC in the event the reinsurers are unable to meet
obligations assumed by them under the reinsurance contracts. At December
31, 1996 and 1995, CapMAC had ceded loss reserves of $0 and $69,000,
respectively, and had ceded unearned premiums of $18,489,000 and
$13,171,000, respectively.
In 1994, CapMAC entered into a reinsurance agreement (the "Lureco Treaty")
with Luxembourg European Reinsurance LURECO S.A. ("Lureco"), a
European-based reinsurer. The agreement is renewable annually at the
Company's option, subject to satisfying certain conditions. The agreement
reinsured and indemnified the Company for any loss incurred by CapMAC
during the agreement period up to the limits of the agreement. The Lureco
Treaty provides that the annual reinsurance premium payable by CapMAC to
Lureco, after deduction of the reinsurer's fee payable to Lureco, be
deposited in a trust account (the "Lureco Trust Account") to be applied by
CapMAC, at its option, to offset losses and loss expenses incurred by
CapMAC in connection with incurred claims. Amounts on deposit in the Lureco
Trust Account which have not been applied against claims are contractually
due to CapMAC at the termination of the treaty.
The premium deposit amounts in the Lureco Trust Account have been reflected
as assets by CapMAC during the term of the agreement. Premiums in excess of
the deposit amounts have been recorded as ceded premiums in the statements
of income. For the 1996 policy year, the agreement provides $7 million of
loss coverage in excess of the premium deposit amount of $5 million
retained in the Lureco Trust Account. Additional coverage is provided for
losses incurred in excess of 200% of the net premiums earned up to $4
million for any one agreement year. In September 1995, a claim of
approximately $2.5 million on an insurance policy was applied against the
Lureco Trust Account.
12
<PAGE>
Capital Markets Assurance Corporation
Notes to Financial Statements
In addition to its capital (including statutory contingency reserves),
CapMAC has other reinsurance available to pay claims under its insurance
contracts. Effective November 30, 1995, CapMAC entered into a Stop-loss
Reinsurance Agreement with Mitsui Marine and Fire Insurance Co. (the
"Mitsui Stop-loss Agreement"). Under the Mitsui Stop-loss Agreement, Mitsui
Marine and Fire Insurance Co. ("Mitsui") will be required to pay any losses
in excess of $100 million in the aggregate incurred by CapMAC during the
term of the Mitsui Stop-loss Agreement on the insurance policies in effect
on December 1, 1995 and written during the one-year period thereafter, up
to an aggregate limit payable under the Mitsui Stop-loss Agreement of $50
million. The Mitsui Stop-loss Agreement has a term of seven years and is
subject to early termination by CapMAC in certain circumstances. Effective
January 1, 1997 the stop-loss reinsurance coverage increased to $75 million
in excess of incurred losses of $150 million increasing annually based on
increases in CapMAC's statutory qualified capital. The new stop-loss
reinsurance is provided by Mitsui, AXA Re Finance S.A. ("AXA Re") and
Munchener Ruckversicherungs-Gesellschaft ("Munich Re").
On November 30, 1995, CapMAC canceled the quota share reinsurance agreement
with Winterthur Swiss Insurance Company ("Winterthur") pursuant to which
Winterthur had the right to reinsure on a quota share basis 10% of each
policy written by CapMAC. As a result, CapMAC reassumed approximately $1.4
billion of principal insured by Winterthur on January 1, 1996. In
connection with the commutation, Winterthur returned $2.0 million of
unearned premiums, net of ceding commission and Federal excise tax.
13) Disclosures About Fair Value of Financial Instruments
The following table presents the carrying amounts and estimated fair values
of the Company's financial instruments at December 31, 1996 and 1995. The
fair value amounts were determined by the Company using independent market
information when available, and appropriate valuation methodologies when
market information was not available. Such valuation methodologies require
significant judgment and are not necessarily indicative of the amount the
Company could recognize in a current market exchange.
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
Carrying Estimated Carrying Estimated
$ in thousands Amount Fair Value Amount Fair Value
----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Financial Assets:
Available-for-sale securities $ 314,703 314,703 284,352 284,352
----------------------------------------------------------------------------------------------------
Off-Balance-Sheet Instruments:
Financial guarantees outstanding $ - 219,989 - 147,840
Less: ceding commission - 65,997 - 44,352
----------------------------------------------------------------------------------------------------
Net financial guarantees outstanding $ - 153,992 103,488
====================================================================================================
</TABLE>
13
<PAGE>
Capital Markets Assurance Corporation
Notes to Financial Statements
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments summarized above:
Available-for-sale Securities
The fair values of fixed maturities are based upon quoted market prices.
The fair value of short-term investments approximates amortized cost.
Financial Guarantees Outstanding
The fair value of financial guarantees outstanding consists of (1) the
current unearned premium reserve, net of prepaid reinsurance and (2) the
fair value of installment revenue which is derived by calculating the
present value of the estimated future cash inflow to CapMAC of policies in
force having installment premiums, net of amounts payable to reinsurers, at
a discount rate of 7% at December 31, 1996 and 1995. The amount calculated
is assumed to be equivalent to the consideration that would be paid by
CapMAC under market conditions prevailing at the reporting dates to
transfer CapMAC's financial guarantee business to a third party under
reinsurance and other agreements. Ceding commission represents the expected
amount that would be paid to CapMAC to compensate CapMAC for originating
and servicing the insurance contracts. In constructing estimated future
cash inflows, management makes assumptions regarding prepayments for
amortizing asset-backed securities which are consistent with relevant
historical experience. For revolving programs, assumptions are made
regarding program utilization based on discussions with program users. The
amount of future installment revenue actually realized by the Company could
be reduced in the future due to factors such as early termination of
insurance contracts, accelerated prepayments of underlying obligations or
lower than anticipated utilization of insured structured programs, such as
commercial paper conduits. Although increases in future installment revenue
earnings due to renewals of existing insurance contracts historically have
been greater than reductions in future installment revenue due to factors
such as those described above, there can be no assurance that future
circumstances might not cause a material net reduction in the future
installment revenue.
14) Capitalization
In 1995, $59.0 million of the proceeds received by Holdings from the sale
of shares in connection with an initial public offering and private
placements were contributed to CapMAC.
14
<PAGE>
APPENDIX B
CAPITAL MARKETS ASSURANCE CORPORATION AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997
(Unaudited)
<PAGE>
Capital Markets Assurance Corporation and Subsidiary
Consolidated Balance Sheets
(Dollars in thousands)
<TABLE>
<CAPTION>
ASSETS
------
June 30, 1997
(Unaudited) December 31,1996
- -------------------------------------------------------------------------------------------------------
<S> <C> <C>
Investments:
Bonds at fair value (amortized cost $307,166 at June 30,
1997 and $294,861 at December 31, 1996) $ 307,821 297,893
Short-term investments (at amortized cost which
approximates fair value) 17,053 16,810
- -------------------------------------------------------------------------------------------------------
Total investments 324,874 314,703
- -------------------------------------------------------------------------------------------------------
Cash 4,506 371
Accrued investment income 3,835 3,807
Deferred acquisition costs 50,327 45,380
Premiums receivable 5,826 5,141
Prepaid reinsurance 20,787 18,489
Other assets 10,464 6,424
- -------------------------------------------------------------------------------------------------------
Total assets $ 420,619 394,315
=======================================================================================================
LIABILITIES AND STOCKHOLDER'S EQUITY
------------------------------------
Liabilities:
Unearned premiums $ 71,800 68,262
Reserve for losses and loss adjustment expenses 13,861 10,985
Ceded reinsurance 2,766 1,738
Accounts payable and other accrued expenses 14,433 8,019
Current income taxes 203 679
Deferred income taxes 15,700 15,139
- -------------------------------------------------------------------------------------------------------
Total liabilities 118,763 104,822
- -------------------------------------------------------------------------------------------------------
Stockholder's Equity:
Common stock - $1.00 par value per share; 15,000,000
shares are authorized, issued and outstanding at June 30,
1997 and December 31, 1996 15,000 15,000
Additional paid-in capital 208,475 208,475
Unrealized appreciation on investments, net of tax 425 1,970
Retained earnings 77,956 64,048
- -------------------------------------------------------------------------------------------------------
Total stockholder's equity 301,856 289,493
- -------------------------------------------------------------------------------------------------------
Total liabilities and stockholder's equity $ 420,619 394,315
=======================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
Capital Markets Assurance Corporation and Subsidiary
Consolidated Statements of Income
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30 June 30
1997 1996 1997 1996
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues:
Direct premiums written $ 18,726 18,622 35,180 32,777
Assumed premiums written 655 150 916 1,024
Ceded premiums written (6,272) (5,103) (10,621) (7,013)
- -------------------------------------------------------------------------------------------------------------
Net premiums written 13,109 13,669 25,475 26,788
Increase in unearned premiums (877) (3,681) (1,240) (7,972)
- -------------------------------------------------------------------------------------------------------------
Net premiums earned 12,232 9,988 24,235 18,816
Net investment income 4,684 4,112 9,386 7,989
Net realized capital gains 506 19 2,549 168
Other income 45 25 88 79
- -------------------------------------------------------------------------------------------------------------
Total revenues 17,467 14,144 36,258 27,052
- -------------------------------------------------------------------------------------------------------------
Expenses:
Losses and loss adjustment expenses 1,333 1,109 2,876 2,184
Underwriting and operating expenses 4,208 3,385 8,879 7,362
Policy acquisition costs 2,472 2,059 5,053 4,123
- -------------------------------------------------------------------------------------------------------------
Total expenses 8,013 6,553 16,808 13,669
- -------------------------------------------------------------------------------------------------------------
Income before income taxes 9,454 7,591 19,450 13,383
- -------------------------------------------------------------------------------------------------------------
Income Taxes:
Current income tax 2,277 1,316 4,150 1,981
Deferred income tax 473 1,148 1,392 1,971
- -------------------------------------------------------------------------------------------------------------
Total income taxes 2,750 2,464 5,542 3,952
- -------------------------------------------------------------------------------------------------------------
Net Income $ 6,704 5,127 13,908 9,431
=============================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
Capital Markets Assurance Corporation and Subsidiary
Consolidated Statement of Stockholder's Equity
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Six Months Ended
June 30, 1997
- --------------------------------------------------------------------------------------------------------
<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 208,475
- --------------------------------------------------------------------------------------------------------
Balance at end of period 208,475
- --------------------------------------------------------------------------------------------------------
Unrealized appreciation (depreciation)
on investments, net of tax:
Balance at beginning of period 1,970
Unrealized depreciation on investments (1,545)
- --------------------------------------------------------------------------------------------------------
Balance at end of period 425
- --------------------------------------------------------------------------------------------------------
Retained earnings:
Balance at beginning of period 64,048
Net income 13,908
- --------------------------------------------------------------------------------------------------------
Balance at end of period 77,956
- --------------------------------------------------------------------------------------------------------
Total stockholder's equity $ 301,856
========================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
Capital Markets Assurance Corporation and Subsidiary
Consolidated Statements of Cash Flows
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Six Months Ended Six Months Ended
June 30, 1997 June 30, 1996
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 13,908 9,431
- -------------------------------------------------------------------------------------------------------------
Adjustments to reconcile net income to net
cash provided (used) by operating activities:
Reserve for losses and loss adjustment expenses 2,876 1,821
Unearned premiums, net 3,538 10,977
Deferred acquisition costs (4,947) (4,742)
Premiums receivable (685) 308
Accrued investment income (28) (579)
Income taxes payable 916 2,113
Net realized capital gains (2,549) (168)
Accounts payable and other accrued expenses 6,414 2,581
Prepaid reinsurance (2,298) (3,004)
Other, net (2,765) (183)
- -------------------------------------------------------------------------------------------------------------
Total adjustments 472 9,124
- -------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 14,380 18,555
- -------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Purchases of investments (112,743) (121,115)
Proceeds from sales of investments 74,768 19,875
Proceeds from maturities of investments 27,730 82,800
- -------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (10,245) (18,440)
- -------------------------------------------------------------------------------------------------------------
Net increase in cash 4,135 115
Cash balance at beginning of period 371 344
- -------------------------------------------------------------------------------------------------------------
Cash balance at end of period $ 4,506 459
=============================================================================================================
Supplemental disclosures of cash flow
information:
Income taxes paid $ 4,550 1,725
Tax and loss bonds purchased $ 76 112
=============================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
Capital Markets Assurance Corporation and Subsidiary
Notes to Unaudited Consolidated Financial Statements
June 30, 1997
1. Background
Capital Markets Assurance Corporation ("CapMAC") is a New York-domiciled
monoline stock insurance company which engages only in the business of
financial guaranty and surety insurance. CapMAC is a wholly owned
subsidiary of CapMAC Holdings Inc. ("Holdings"). In early 1997, CapMAC made
an investment of 50 million French francs (approximately 10 million U.S.
dollars) in CapMAC Assurance, S.A., an insurance subsidiary to be
established in Paris, France. CapMAC Assurance, S.A., is licensed to write
financial guarantee insurance in the European Union member states.
CapMAC is licensed in all 50 states in addition to the District of
Columbia, the Commonwealth of Puerto Rico and the territory of Guam. CapMAC
insures structured asset-backed, corporate, municipal and other financial
obligations in the U.S. and international capital markets. CapMAC also
provides financial guaranty reinsurance for structured asset-backed,
corporate, municipal and other financial obligations written by other major
insurance companies.
CapMAC's claims-paying ability is rated triple-A by Moody's Investors
Service, Inc., Standard & Poor's Ratings Services, Duff & Phelps Credit
Rating Co., and Nippon Investors Service, Inc., a Japanese rating agency.
Such ratings reflect only the views of the respective rating agencies, are
not recommendations to buy, sell or hold securities and are subject to
revision or withdrawal at any time by such rating agencies.
2. Basis of Presentation
CapMAC's consolidated unaudited interim financial statements have been
prepared on the basis of generally accepted accounting principles and, in
the opinion of management, reflect all adjustments necessary for a fair
presentation of the CapMAC's financial condition, results of operations and
cash flows for the periods presented. The results of operations for the six
months ended June 30, 1997 may not be indicative of the results that may be
expected for the full year ending December 31, 1997. These consolidated
financial statements and notes should be read in conjunction with the
financial statements and notes included in the audited financial statements
of CapMAC as of December 31, 1996 and 1995, and for each of the years in
the three-year period ended December 31, 1996.
3. Reclassifications
Certain prior period balances have been reclassified to conform to the
current period presentation.
<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 September 22, 1997
<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. In addition, the Commission maintains a web
site at "http://www.sec.gov" that contains information regarding registrants
that file electronically with the Commission.
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
SECURITIES......... Primary Assets for a Series may consist, in whole
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
SECURITIES............. If so specified in the Prospectus Supplement, the
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."
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<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."
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<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.
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<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
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low yields then available for reinvestment the entity specified in the related
Prospectus Supplement determines, based on assumptions specified in the
applicable Agreement, that the amount available for the payment of interest
that will have accrued on such Securities (the "Available Interest Amount")
through the designated interest accrual date specified in the related
Prospectus Supplement is less than the amount of interest that will have
accrued on such Securities to such date. In such event and as further
described in the related Prospectus Supplement, the Trustee will redeem a
principal amount of outstanding Securities of such Series as will cause the
Available Interest Amount to equal the amount of interest that will have
accrued through such designated interest accrual date for such Series of
Securities outstanding immediately after such redemption.
OPTIONAL REDEMPTION, PURCHASE OR TERMINATION
The Transferor or the Servicer may, at its option, redeem, in whole or in
part, one or more Classes of Notes or purchase one or more Classes of
Certificates of any Series, on any Distribution Date under the circumstances,
if any, specified in the Prospectus Supplement relating to such Series.
Alternatively, if so specified in the related Prospectus Supplement for a
Series of Securities, the Transferor, the Servicer, or another entity
designated in the related Prospectus Supplement may, at its option, cause an
early termination of a Trust Fund by repurchasing all of the Primary Assets
from such Trust Fund on or after a date specified in the related Prospectus
Supplement, or on or after such time as the aggregate outstanding principal
amount of the Securities or Primary Assets, as specified in the related
Prospectus Supplement, is less than the amount or percentage specified in the
related Prospectus Supplement. In addition, if so specified in the related
Prospectus Supplement upon certain events of insolvency or receivership of the
Transferor or another affiliated entity specified in the related Prospectus
Supplement the related Primary Assets of the Trust Fund will be liquidated and
the Trust Fund will be terminated, subject to the conditions set forth in the
related Prospectus Supplement. In each such event, the Securities of the
related Series will experience a prepayment. The redemption, purchase or
repurchase price will be set forth in the related Prospectus Supplement. If
specified in the related Prospectus Supplement, in the event that a REMIC
election has been made, the Trustee shall receive a satisfactory opinion of
counsel that the optional redemption, purchase or termination will be
conducted so as to constitute a "qualified liquidation" under Section 860F of
the Code.
In addition, the Prospectus Supplement may provide other circumstances under
which Holders of Securities of a Series could be fully paid significantly
earlier than would otherwise be the case if payments or distributions were
solely based on the activity of the related Primary Assets.
WEIGHTED AVERAGE LIFE OF THE SECURITIES
Weighted average life refers to the average amount of time that will elapse
from the date of issue of a security until each dollar of principal of such
security will be repaid to the investor. Unless otherwise specified in the
related Prospectus Supplement, the weighted average life of a Class of the
Securities will be influenced by the rate at which the amount financed under
the Loans (or related balances thereof) or Underlying Loans relating to the
Private Securities, as applicable, included in the Trust Fund for a Series is
paid, which may be in the form of scheduled amortization or prepayments.
Prepayments on loans and other receivables can be measured relative to a
prepayment standard or model. The Prospectus Supplement for a Series of
Securities will describe the prepayment standard or model, if any, used and
may contain tables setting forth the projected weighted average life of each
Class of Securities of such Series and the percentage of the original
principal amount of each Class of Securities of such Series that would be
outstanding on specified Distribution Dates for such Series based on the
assumptions stated in such Prospectus Supplement, including assumptions that
prepayments on the Loans or Underlying Loans relating to the Private
Securities, as applicable, included in the related Trust Fund are made at
rates corresponding to various percentages of the prepayment standard or model
specified in such Prospectus Supplement.
There is, however, no assurance that prepayment of the Loans or Underlying
Loans relating to the Private Securities, as applicable, included in the
related Trust Fund will conform to any level of any prepayment standard
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or model specified in the related Prospectus Supplement. The rate of principal
prepayments on pools of loans may be influenced by a variety of factors,
including job related factors such as transfers, layoffs or promotions and
personal factors such as divorce, disability or prolonged illness. Economic
conditions, either generally or within a particular geographic area or
industry, also may affect the rate of principal prepayments. Demographic and
social factors may influence the rate of principal prepayments in that some
borrowers have greater financial flexibility to move or refinance than do
other borrowers. The deductibility of mortgage interest payments, servicing
decisions and other factors also affect the rate of principal prepayments. As
a result, there can be no assurance as to the rate or timing of principal
prepayments of the Loans or Underlying Loans either from time to time or over
the lives of such Loans or Underlying Loans.
The rate of prepayments of conventional housing loans and other receivables
has fluctuated significantly in recent years. In general, however, if
prevailing interest rates fall significantly below the interest rates on the
Loans or Underlying Loans relating to the Private Securities, as applicable,
for a Series, such loans are likely to prepay at rates higher than if
prevailing interest rates remain at or above the interest rates borne by such
loans. In this regard, it should be noted that the Loans or Underlying Loans,
as applicable, for a Series may have different interest rates. In addition,
the weighted average life of the Securities may be affected by the varying
maturities of the Loans or Underlying Loans relating to the Private
Securities, as applicable. If any Loans or Underlying Loans relating to the
Private Securities, as applicable, for a Series have actual terms-to-stated
maturity of less than those assumed in calculating the Final Scheduled
Distribution Date of the related Securities, one or more Classes of the Series
may be fully paid prior to their respective Final Scheduled Distribution Date,
even in the absence of prepayments.
THE TRUST FUNDS
GENERAL
The Notes of each Series will be secured by the pledge of the assets of the
related Trust Fund, and the Certificates of each Series will represent
interests in the assets of the related Trust Fund. The Trust Fund of each
Series will include (i) the Primary Assets, (ii) amounts available from the
reinvestment of payments on such Primary Assets at the Assumed Reinvestment
Rate, if any, specified in the related Prospectus Supplement, (iii) any
Enhancement or the rights thereto, (iv) any Property that secured a Loan but
which is acquired by foreclosure or deed in lieu of foreclosure or
repossession and (v) the amount, if any, initially deposited in the Pre-
Funding Account, Capitalized Interest Account, Collection Account, Certificate
Account or Distribution Account for a Series as specified in the related
Prospectus Supplement.
The Securities will be non-recourse obligations of the related Trust Fund.
The assets of the Trust Fund specified in the related Prospectus Supplement
for a Series of Securities, unless otherwise specified in the related
Prospectus Supplement, will serve as collateral only for that Series of
Securities. Holders of a Series of Notes may only proceed against such
collateral securing such Series of Notes in the case of a default with respect
to such Series of Notes and may not proceed against any assets of the
Transferor or the related Trust Fund not pledged to secure such Notes.
The Primary Assets for a Series will be transferred by the Transferor to the
Trust Fund. Loans relating to a Series will be serviced by the Servicer
pursuant to a Pooling and Servicing Agreement, with respect to a Series
consisting of only Certificates or a Sale and Servicing Agreement (each, a
"Sale and Servicing Agreement") among the Transferor, the Trust Fund and the
Servicer, with respect to a Series that includes Notes.
As used herein, "Agreement" means, with respect to a Series of Certificates,
the Pooling and Servicing Agreement or Trust Agreement, and with respect to a
Series that includes Notes, the Indenture and the Sale and Servicing
Agreement, as the context requires.
If so specified in the related Prospectus Supplement, a Trust Fund relating
to a Series of Securities may be a business trust formed under the laws of the
state specified in the related Prospectus Supplement pursuant to a
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trust agreement (each, a "Trust Agreement") between the Transferor and the
Trustee of such Trust Fund specified in the related Prospectus Supplement.
With respect to each Trust Fund, prior to the initial offering of the
related Series of Securities, the Trust Fund will have no assets or
liabilities. No Trust Fund is expected to engage in any activities other than
acquiring, managing and holding the related Primary Assets and other assets
contemplated herein and in the related Prospectus Supplement and the proceeds
thereof, issuing Securities and making payments and distributions thereon and
certain related activities. No Trust Fund is expected to have any source of
capital other than its assets and any related Enhancement.
Primary Assets included in the Trust Fund for a Series may consist of any
combination of Loans and Private Securities, to the extent and as specified in
the related Prospectus Supplement.
THE LOANS
Mortgage Loans. The Primary Assets for a Series may consist, in whole or in
part, of closed-end and/or revolving credit line home equity loans or certain
balances thereof (the "Closed-End Loans" and "Revolving Credit Line Loans,"
respectively, and collectively, the "Mortgage Loans") secured by mortgages
primarily on Single Family Properties which may be subordinated to other
mortgages on the same Mortgaged Property. The Mortgage Loans may have fixed
interest rates or adjustable interest rates and may provide for other payment
characteristics as described below and in the related Prospectus Supplement.
As more fully described in the related Prospectus Supplement, interest on
each Revolving Credit Line Loan, is computed and payable monthly on the
average daily outstanding principal balance of such loan. Principal amounts on
the Revolving Credit Line Loans may be drawn down (up to a maximum amount as
set forth in the related Loan Agreement) or repaid under each Revolving Credit
Line Loan from time to time. If specified in the related Prospectus
Supplement, new draws by borrowers under the Revolving Credit Line Loans will
automatically become part of the Trust Fund for a Series. As a result, the
aggregate balance of the Revolving Credit Line Loans will fluctuate from day
to day as new draws by borrowers are added to the Trust Fund and principal
payments are applied to such balances and such amounts will usually differ
each day, as more specifically described in the related Prospectus Supplement.
Unless otherwise specified in the related Prospectus Supplement, a borrower
under a Revolving Credit Line Loan is obligated to pay only the amount of
interest and fees which accrue on the loan during the billing cycle and
principal of the Revolving Credit Line Loan is payable at maturity.
Unless otherwise described in the related Prospectus Supplement, the full
principal amount of a Closed-End Loan is advanced at origination of the loan
and generally is repayable in equal (or substantially equal) installments of
an amount sufficient to fully amortize such loan at its stated maturity. As
more fully described in the related Prospectus Supplement, interest on each
Closed-End Loan is calculated on the basis of the outstanding principal
balance of such loan multiplied by the Loan Rate thereon and further
multiplied by a fraction, the numerator of which is the number of days in the
period elapsed since the preceding payment of interest was made and the
denominator is the number of days in the annual period for which interest
accrues on such loan. Unless otherwise described in the related Prospectus
Supplement, the original terms to stated maturity of Closed-End Loans will not
exceed 360 months.
The Mortgaged Properties will include Single Family Property (i.e., one- to
four-family residential housing, including Condominium Units and Cooperative
Dwellings) and mixed-use property. Mixed-use properties will consist of
structures of no more than three stories, which include one to four
residential dwelling units and space used for retail, professional or other
commercial uses. Such uses, which will not involve more than 50% of the space
in the structure, may include doctor, dentist or law offices, real estate
agencies, boutiques, newsstands, convenience stores or other similar types of
uses intended to cater to individual customers as specified in the related
Prospectus Supplement. The properties may be located in suburban or
metropolitan districts. Any such non-residential use will be in compliance
with local zoning laws and regulations. The Mortgaged Properties may
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consist of detached individual dwellings, individual condominiums, townhouses,
duplexes, row houses, individual units in planned unit developments and other
attached dwelling units. Each Single Family Property will be located on land
owned in fee simple by the borrower or on land leased by the borrower for a
term at least ten years (unless otherwise provided in the related Prospectus
Supplement) greater than the term of the related Loan. Attached dwellings may
include owner-occupied structures where each borrower owns the land upon which
the unit is built, with the remaining adjacent land owned in common or
dwelling units subject to a proprietary lease or occupancy agreement in a
cooperatively owned apartment building.
Unless otherwise specified in the related Prospectus Supplement, Mortgages
on Cooperative Dwellings consist of a lien on the shares issued by such
Cooperative Dwelling and the proprietary lease or occupancy agreement relating
to such Cooperative Dwelling.
The aggregate principal balance of Revolving Credit Line Loans secured by
Mortgaged Properties that are owner-occupied will be disclosed in the related
Prospectus Supplement. Unless otherwise specified in the Prospectus
Supplement, the sole basis for a representation that a given percentage of the
Loans are secured by Single Family Property that is owner-occupied will be
either (i) the making of a representation by the Mortgagor at origination of
the Loan either that the underlying Mortgaged Property will be used by the
Mortgagor for a period of at least six months every year or that the Mortgagor
intends to use the Mortgaged Property as a primary residence, or (ii) a
finding that the address of the underlying Mortgaged Property is the
Mortgagor's mailing address as reflected in the Servicer's records. To the
extent specified in the related Prospectus Supplement, the Mortgaged
Properties may include non-owner occupied investment properties and vacation
and second homes.
Unless otherwise specified in the related Prospectus Supplement, the initial
Combined Loan-to-Value Ratio of a Revolving Credit Line Loan is computed in
the manner described in the related Prospectus Supplement, taking into account
the amounts of any related senior mortgage loans.
Home Improvement Contracts. The Primary Assets for a Series may consist, in
whole or part, of home improvement installment sales contracts and installment
loan agreements (the "Home Improvement Contracts") originated by a home
improvement contractor in the ordinary course of business. As specified in the
related Prospectus Supplement, the Home Improvement Contracts will either be
unsecured or secured by the Mortgages primarily on Single Family Properties
which are generally subordinate to other mortgages on the same Mortgaged
Property or by purchase money security interests in the Home Improvements
financed thereby. Unless otherwise specified in the applicable Prospectus
Supplement, the Home Improvement Contracts will be fully amortizing and may
have fixed interest rates or adjustable interest rates and may provide for
other payment characteristics as described below and in the related Prospectus
Supplement
Unless otherwise specified in the related Prospectus Supplement, the home
improvements (the "Home Improvements") securing the Home Improvement Contracts
include, but are not limited to, replacement windows, house siding, new roofs,
swimming pools, satellite dishes, kitchen and bathroom remodeling goods and
solar heating panels. The initial Loan-to-Value Ratio of a Home Improvement
Contract will be computed in the manner described in the related Prospectus
Supplement.
Additional Information. The selection criteria which will apply with respect
to the Loans will be specified in the related Prospectus Supplement. Such
criteria may include one or more of the following: the Combined Loan-to-Value
Ratios or Loan-to-Value Ratios, as applicable, original terms to maturity and
delinquency information, the geographical distribution of Loans and the Loan
Rates for such Loans.
The Loans for a Series may include Loans that do not amortize their entire
principal balance by their stated maturity in accordance with their terms and
require a balloon payment of the remaining principal balance at maturity, as
specified in the related Prospectus Supplement. As further described in the
related Prospectus Supplement, the Loans for a Series may include Loans that
do not have a specified stated maturity.
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The Loans will be conventional contracts or contracts insured by the Federal
Housing Administration ("FHA") or partially guaranteed by the Veterans
Administration ("VA"). Loans designated in the related Prospectus Supplement
as insured by the FHA will be insured by the FHA as authorized under the
United States Housing Act of 1937, as amended. Such Loans will be insured
under various FHA programs. These programs generally limit the principal
amount and interest rates of the mortgage loans insured. Loans insured by the
FHA generally require a minimum down payment of approximately 5% of the
original principal amount of the loan. No FHA-insured Loans relating to a
Series may have an interest rate or original principal amount exceeding the
applicable FHA limits at the time of origination of such Loan.
The insurance premiums for Loans insured by the FHA are collected by lenders
approved by the Department of Housing and Urban Development ("HUD") and are
paid to the FHA. The regulations governing FHA single-family mortgage
insurance programs provide that insurance benefits are payable either upon
foreclosure (or other acquisition of possession) and conveyance of the
mortgaged premises to HUD or upon assignment of the defaulted Loan to HUD.
With respect to a defaulted FHA-insured Loan, the Servicer is limited in its
ability to initiate foreclosure proceedings. When it is determined, either by
the Servicer or HUD, that default was caused by circumstances beyond the
mortgagor's control, the Servicer is expected to make an effort to avoid
foreclosure by entering, if feasible, into one of a number of available forms
of forbearance plans with the mortgagor. Such plans may involve the reduction
or suspension of regular mortgage payments for a specified period, with such
payments to be made upon or before the maturity date of the mortgage, or the
recasting of payments due under the mortgage up to or beyond the maturity
date. In addition, when a default caused by such circumstances is accompanied
by certain other criteria, HUD may provide relief by making payments to the
Servicer in partial or full satisfaction of amounts due under the Loan (which
payments are to be repaid by the mortgagor to HUD) or by accepting assignment
of the loan from the Servicer. With certain exceptions, at least three full
monthly installments must be due and unpaid under the Loan and HUD must have
rejected any request for relief from the mortgagor before the Servicer may
initiate foreclosure proceedings.
HUD has the option, in most cases, to pay insurance claims in cash or in
debentures issued by HUD. Currently, claims are being paid in cash, and claims
have not been paid in debentures since 1965. HUD debentures issued in
satisfaction of FHA insurance claims bear interest at the applicable HUD
debenture interest rate. The Servicer of each FHA-insured Loan will be
obligated to purchase any such debenture issued in satisfaction of such Loan
upon default for an amount equal to the principal amount of any such
debenture.
The amount of insurance benefits generally paid by the FHA is equal to the
entire unpaid principal amount of the defaulted Loan adjusted to reimburse the
Servicer for certain costs and expenses and to deduct certain amounts received
or retained by the Servicer after default. When entitlement to insurance
benefits results from foreclosure (or other acquisition of possession) and
conveyance to HUD, the Servicer is compensated for no more than two-thirds of
its foreclosure costs, and is compensated for interest accrued and unpaid
prior to such date but in general only to the extent it was allowed pursuant
to a forbearance plan approved by HUD. When entitlement to insurance benefits
results from assignment of the Loan to HUD, the insurance payment includes
full compensation for interest accrued and unpaid to the assignment date. The
insurance payment itself, upon foreclosure of an FHA-insured Loan, bears
interest from a date 30 days after the mortgagor's first uncorrected failure
to perform any obligation to make any payment due under the Loan and, upon
assignment, from the date of assignment to the date of payment of the claim,
in each case at the same interest rate as the applicable HUD debenture
interest rate as described above.
Loans designated in the related Prospectus Supplement as guaranteed by the
VA will be partially guaranteed by the VA under the Serviceman's Readjustment
Act of 1944, as amended (a "VA Guaranty"). The Serviceman's Readjustment Act
of 1944, as amended, permits a veteran (or in certain instances the spouse of
a veteran) to obtain a mortgage loan guaranty by the VA covering mortgage
financing of the purchase of a one- to four-family dwelling unit at interest
rates permitted by the VA. The program has no mortgage loan limits, requires
no down payment from the purchaser and permits the guarantee of mortgage loans
of up to 30 years' duration.
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The maximum guaranty that may be issued by the VA under a VA guaranteed
mortgage loan depends upon the original principal amount of the mortgage loan,
as further described in 38 United States Code Section 1803(a), as amended. The
liability on the guaranty is reduced or increased pro rata with any reduction
or increase in the amount of indebtedness, but in no event will the amount
payable on the guaranty exceed the amount of the original guaranty. The VA
may, at its option and without regard to the guaranty, make full payment to a
mortgage holder of unsatisfied indebtedness on a mortgage upon its assignment
to the VA.
With respect to a defaulted VA guaranteed Loan, the Servicer is, absent
exceptional circumstances, authorized to announce its intention to foreclose
only when the default has continued for three months. Generally, a claim for
the guaranty is submitted after liquidation of the Mortgaged Property.
The amount payable under the guaranty will be the percentage of the VA-
insured Loan originally guaranteed applied to indebtedness outstanding as of
the applicable date of computation specified in the VA regulations. Payments
under the guaranty will be equal to the unpaid principal amount of the loan,
interest accrued on the unpaid balance of the loan to the appropriate date of
computation and limited expenses of the mortgagee, but in each case only to
the extent that such amounts have not been recovered through liquidation of
the Mortgaged Property. The amount payable under the guaranty may in no event
exceed the amount of the original guaranty.
The related Prospectus Supplement for each Series will provide information
with respect to the Loans that are Primary Assets as of the Cut-off Date,
including, among other things, and to the extent relevant: (a) the aggregate
unpaid principal balance of the Loans (or the aggregate unpaid principal
balance included in the Trust Fund for the related Series); (b) the range and
weighted average Loan Rate on the Loans, and, in the case of adjustable rate
Loans, the range and weighted average of the current Loan Rates and the
Lifetime Rate Caps, if any; (c) the range and average outstanding principal
balance of the Loans; (d) the weighted average original and remaining term-to-
stated maturity of the Loans and the range of original and remaining terms-to-
stated maturity, if applicable; (e) the range and weighted average of Combined
Loan-to-Value Ratios or Loan-to-Value Ratios for the Revolving Credit Line
Loans, as applicable; (f) the percentage (by outstanding principal balance as
of the Cut-off Date) of Loans that accrue interest at adjustable or fixed
interest rates; (g) any special hazard insurance policy or bankruptcy bond or
other enhancement relating to the Loans; (h) the percentage (by principal
balance as of the Cut-off Date) of Loans that are secured by Mortgaged
Properties, Home Improvements or are unsecured; (i) the geographic
distribution of any Mortgaged Properties securing the Loans; (j) the
percentage of Revolving Credit Line Loans (by principal balance as of the Cut-
off Date) that are secured by Single Family Properties, shares relating to
Cooperative Dwellings, Condominium Units, investment property and vacation or
second homes; (k) the lien priority of the Loans; (l) the credit limit
utilization rate of any Revolving Credit Line Loans; and (m) the delinquency
status and year of origination of the Loans. The related Prospectus Supplement
will also specify any other limitations on the types or characteristics of
Loans for a Series.
If information of the nature described above respecting the Loans is not
known to the Transferor at the time the Securities are initially offered,
approximate or more general information of the nature described above will be
provided in the Prospectus Supplement and additional information will be set
forth in a Current Report on Form 8-K to be available to investors on the date
of issuance of the related Series and to be filed with the Commission within
15 days after the initial issuance of such Securities.
PRIVATE SECURITIES
General. Primary Assets for a Series may consist, in whole or in part, of
Private Securities which include pass-through certificates representing
beneficial interests in loans of the type that would otherwise be eligible to
be Loans (the "Underlying Loans") or (b) collateralized obligations secured by
Underlying Loans. Such pass-through certificates or collateralized obligations
will have previously been (a) offered and distributed to the public pursuant
to an effective registration statement or (b) purchased in a transaction not
involving any public offering from a person who is not an affiliate of the
issuer of such securities at the time of sale (nor an affiliate thereof at any
time during the three preceding months); provided a period of three years
elapsed since the later of the date the securities were acquired from the
issuer or an affiliate thereof. Although individual Underlying
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Loans may be insured or guaranteed by the United States or an agency or
instrumentality thereof, they need not be, and Private Securities themselves
will not be so insured or guaranteed.
Private Securities will have been issued pursuant to a pooling and servicing
agreement, a trust agreement or similar agreement (a "PS Agreement"). The
seller/servicer of the Underlying Loans will have entered into the PS
Agreement with the trustee under such PS Agreement (the "PS Trustee"). The PS
Trustee or its agent, or a custodian, will possess the Underlying Loans.
Underlying Loans will be serviced by a servicer (the "PS Servicer") directly
or by one or more sub-servicers who may be subject to the supervision of the
PS Servicer.
The sponsor of the Private Securities (the "PS Sponsor") will be a financial
institution or other entity engaged generally in the business of lending; a
public agency or instrumentality of a state, local or federal government; or a
limited purpose corporation organized for the purpose of, among other things,
establishing trusts and acquiring and selling loans to such trusts, and
selling beneficial interests in such trusts. If so specified in the Prospectus
Supplement, the PS Sponsor may be an affiliate of the Transferor. The
obligations of the PS Sponsor will generally be limited to certain
representations and warranties with respect to the assets conveyed by it to
the related trust. Unless otherwise specified in the related Prospectus
Supplement, the PS Sponsor will not have guaranteed any of the assets conveyed
to the related trust or any of the Private Securities issued under the PS
Agreement. Additionally, although the Underlying Loans may be guaranteed by an
agency or instrumentality of the United States, the Private Securities
themselves will not be so guaranteed.
Distributions of principal and interest will be made on the Private
Securities on the dates specified in the related Prospectus Supplement. The
Private Securities may be entitled to receive nominal or no principal
distributions or nominal or no interest distributions. Principal and interest
distributions will be made on the Private Securities by the PS Trustee or the
PS Servicer. The PS Sponsor or the PS Servicer may have the right to
repurchase the Underlying Loans after a certain date or under other
circumstances specified in the related Prospectus Supplement.
The Underlying Loans may be fixed rate, level payment, fully amortizing
loans or adjustable rate loans or loans having balloon or other irregular
payment features. Such Underlying Loans will be secured by mortgages on
Mortgaged Properties.
Credit Support Relating to Private Securities. Credit support in the form of
Reserve Funds, subordination of other private securities issued under the PS
Agreement, guarantees, letters of credit, cash collateral accounts, insurance
policies or other types of credit support may be provided with respect to the
Underlying Loans or with respect to the Private Securities themselves. The
type, characteristics and amount of credit support will be a function of
certain characteristics of the Underlying Loans and other factors and will
have been established for the Private Securities on the basis of requirements
of the nationally recognized statistical rating organization that rated the
Private Securities.
Additional Information. The Prospectus Supplement for a Series for which the
Primary Assets include Private Securities will specify (such disclosure may be
on an approximate basis and will be as of the date specified in the related
Prospectus Supplement), to the extent relevant and to the extent such
information is reasonably available to the Transferor and the Transferor
reasonably believes such information to be reliable: (i) the aggregate
approximate principal amount and type of the Private Securities to be included
in the Trust Fund for such Series; (ii) certain characteristics of the
Underlying Loans including (A) the payment features of such Underlying Loans
(i.e., whether they are fixed rate or adjustable rate and whether they provide
for fixed level payments or other payment features), (B) the approximate
aggregate principal balance, if known, of such Underlying Loans insured or
guaranteed by a governmental entity, (C) the servicing fee or range of
servicing fees with respect to the Underlying Loans, (D) the minimum and
maximum stated maturities of such Underlying Loans at origination, (E) the
lien priority and the credit utilization rates, if any, of such Underlying
Loans, and (F) the delinquency status and year of origination of such
Underlying Loans; (iii) the maximum original term-to-stated maturity of the
Private Securities; (iv) the weighted average term-to-stated maturity of the
Private Securities; (v) the pass-through or certificate rate or ranges thereof
for the Private Securities; (vi) the PS Sponsor,
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the PS Servicer (if other than the PS Sponsor) and the PS Trustee for such
Private Securities; (vii) certain characteristics of credit support if any,
such as Reserve Funds, insurance policies, letters of credit or guarantees
relating to such Loans underlying the Private Securities or to such Private
Securities themselves; (viii) the terms on which Underlying Loans may, or are
required to, be purchased prior to their stated maturity or the stated
maturity of the Private Securities; and (ix) the terms on which Underlying
Loans may be substituted for those originally underlying the Private
Securities.
If information of the nature described above representing the Private
Securities is not known to the Transferor at the time the Securities are
initially offered, approximate or more general information of the nature
described above will be provided in the Prospectus Supplement and the
additional information, if available, will be set forth in a Current Report on
Form 8-K to be available to investors on the date of issuance of the related
Series and to be filed with the Commission within 15 days of the initial
issuance of such Securities.
ACCOUNTS
A separate Collection Account or Certificate Account will be established for
each Series of Securities for receipt of the amount of cash, if any, specified
in the related Prospectus Supplement to be initially deposited therein by the
Transferor and/or the Servicer, all amounts received on or with respect to the
Primary Assets and, unless otherwise specified in the related Prospectus
Supplement, income earned thereon. Certain amounts on deposit in such
Collection Account and certain amounts available pursuant to any Enhancement,
as provided in the related Prospectus Supplement, may be deposited in one or
more Distribution Accounts. Unless otherwise specified in the related
Prospectus Supplement, the Trustee will invest the funds in the Collection,
Certificate and Distribution Accounts in Eligible Investments maturing, with
certain exceptions, not later, in the case of funds in the Collection Account,
than the day preceding the date such funds are due to be deposited in the
Distribution Account or otherwise distributed and, in the case of funds in the
Distribution Account and the Certificate Account, than the day preceding the
next Distribution Date for the related Series of Securities. "Eligible
Investments" include, among other investments, obligations of the United
States and certain agencies thereof, federal funds, certificates of deposit,
commercial paper, demand and time deposits and banker's acceptances, certain
repurchase agreements of United States government securities and certain
guaranteed investment contracts, in each case, acceptable to the Rating
Agency.
If specified in the related Prospectus Supplement, a Trust Fund will include
one or more segregated trust accounts (each, a "Pre-Funding Account")
established and maintained with the Trustee for the related Series. If so
specified, on the closing date for such Series, a portion of the proceeds of
the sale of the Securities of such Series (such amount, the "Pre-Funded
Amount") may be deposited in the Pre-Funding Account and may be used to
purchase additional Primary Assets during the period of time specified in the
related Prospectus Supplement (the "Pre-Funding Period"). If any Pre-Funded
Amount remains on deposit in the Pre-Funding Account at the end of the Pre-
Funding Period, such amount will be applied in the manner specified in the
related Prospectus Supplement to prepay the Notes and/or the Certificates of
the applicable Series.
Each additional Primary Asset must satisfy the eligibility criteria
specified in the related Prospectus Supplement and related Agreements. Such
eligibility criteria will be determined in consultation with each Rating
Agency (and/or any Enhancer) prior to the issuance of the related Series and
are designed to ensure that if such additional Primary Assets were included as
part of the initial Primary Assets, the credit quality of such assets would be
consistent with the initial rating of the Securities of such Series. The
Transferor will certify to the Trustee that all conditions precedent to the
transfer of the additional Primary Assets, including the satisfaction of the
eligibility criteria to the Trust Fund, have been satisfied. It is a condition
to the transfer of any additional Primary Assets to the Trust Fund that each
Rating Agency, after receiving prior notice of the proposed transfer of the
additional Primary Assets to the Trust Fund, shall not have advised the
Transferor or the Trustee or any Enhancer that the conveyance of such
additional Primary Assets will result in a qualification, modification or
withdrawal of its then current rating of any Class of Notes or Certificates of
such Series. Following the transfer of additional Primary Assets to the Trust
Fund, the aggregate characteristics of the Primary Assets then held in the
Trust Fund may vary from those of the initial Primary Assets of such Trust
Fund. As a result, the additional Primary Assets may adversely affect the
performance of the related Securities.
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If a Pre-Funding Account is established, one or more segregated trust
accounts (each, a "Capitalized Interest Account") may be established and
maintained with the Trustee for the related Series. On the closing date for
such Series, a portion of the proceeds of the sale of the Securities of such
Series will be deposited in the Capitalized Interest Account and used to fund
the excess, if any, of the sum of (i) the amount of interest accrued on the
Securities of such Series and (ii) if specified in the related Prospectus
Supplement, certain fees or expenses during the Pre-Funding Period, over the
amount of interest available therefor from the Primary Assets in the Trust
Fund. If so specified in the related Prospectus Supplement, amounts on deposit
in the Capitalized Interest Account may be released to the Transferor prior to
the end of the Pre-Funding Period subject to the satisfaction of certain tests
specified in the related Prospectus Supplement. Any amounts on deposit in the
Capitalized Interest Account at the end of the Pre-Funding Period that are not
necessary for such purposes will be distributed to the person specified in the
related Prospectus Supplement.
ENHANCEMENT
The amounts and types of enhancement arrangements and the provider thereof,
if applicable, with respect to a Series or any Class of Securities will be set
forth in the related Prospectus Supplement. If and to the extent provided in
the related Prospectus Supplement, enhancement may be in the form of a
financial guaranty insurance policy, overcollateralization, a letter of
credit, cash reserve fund, insurance policies, one or more Classes of
Subordinated Securities, derivative products, or other form of enhancement, or
any combination thereof, as may be described in the related Prospectus
Supplement (collectively, "Enhancement"). If specified in the applicable
Prospectus Supplement, Enhancement for any Series of Securities may cover one
or more Classes of Notes or Certificates, and accordingly may be exhausted for
the benefit of a particular Class of Notes or Certificates and thereafter be
unavailable to such other Classes of Notes or Certificates. Further
information regarding any provider of credit enhancement, including financial
information when material, will be included in the related Prospectus
Supplement.
The presence of Enhancement is intended to increase the likelihood of
receipt by the Certificateholders and the Noteholders of the full amount of
principal and interest due thereon and to decrease the likelihood that the
Certificateholders and the Noteholders will experience losses, or may be
structured to provide protection against changes in interest rates or against
other risks, to the extent and under the conditions specified in the related
Prospectus Supplement. Unless otherwise specified in the related Prospectus
Supplement, the Enhancement for a Class of Securities will not provide
protection against all risks of loss and will not guarantee repayment of the
entire principal and interest thereon. If losses occur which exceed the amount
covered by any Enhancement or which are not covered by any Enhancement,
Securityholders will bear their allocable share of deficiencies. In addition,
if a form of Enhancement covers more than one Class of Securities of a Series,
Securityholders of any such Class will be subject to the risk that such
Enhancement will be exhausted by the claims of Securityholders of other
Classes.
SERVICING OF LOANS
GENERAL
Customary servicing functions with respect to Loans comprising the Primary
Assets in the Trust Fund will be provided by the Servicer directly pursuant to
the related Sale and Servicing Agreement or Pooling and Servicing Agreement,
as the case may be, with respect to a Series of Securities.
COLLECTION PROCEDURES; ESCROW ACCOUNTS
The Servicer will make reasonable efforts to collect all payments required
to be made under the Loans and will, consistent with the terms of the related
Agreement for a Series and any applicable Enhancement, follow such collection
procedures as it follows with respect to comparable loans held in its own
portfolio. Consistent
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with the above, the Servicer may, in its discretion, (i) waive any assumption
fee, late payment charge, or other charge in connection with a Loan and (ii)
to the extent provided in the related Agreement, arrange with an obligor a
schedule for the liquidation of delinquencies by extending the Due Dates for
Scheduled Payments on such Loan.
If specified in the related Prospectus Supplement, the Servicer, to the
extent permitted by law, will establish and maintain escrow or impound
accounts ("Escrow Accounts") with respect to Loans in which payments by
obligors with respect to taxes, assessments, mortgage and hazard insurance
premiums, and other comparable items will be deposited. Loans may not require
such payments under the loan related documents, in which case the Servicer
would not be required to establish any Escrow Account with respect to such
Loans. Withdrawals from the Escrow Accounts are to be made to effect timely
payment of taxes, assessments and mortgage and hazard insurance, to refund to
obligors amounts determined to be overages, to pay interest to obligors on
balances in the Escrow Account to the extent required by law, to repair or
otherwise protect the property securing the related Loan and to clear and
terminate such Escrow Account. The Servicer will be responsible for the
administration of the Escrow Accounts and generally will make advances to such
accounts when a deficiency exists therein.
DEPOSITS TO AND WITHDRAWALS FROM THE COLLECTION ACCOUNT OR THE CERTIFICATE
ACCOUNT
Unless otherwise specified in the related Prospectus Supplement, the Trustee
or the Servicer will establish a separate account (the "Collection Account" or
the "Certificate Account") in the name of the Trustee. The Collection Account
and/or Certificate Account will be an account maintained (i) at a depository
institution, the long-term unsecured debt obligations of which at the time of
any deposit therein are rated by each Rating Agency rating the Securities of
such Series at levels satisfactory to each such Rating Agency or (ii) in an
account or accounts the deposits in which are insured to the maximum extent
available by the Federal Deposit Insurance Corporation (the "FDIC") or which
are secured in a manner meeting requirements established by each Rating
Agency.
Unless otherwise specified in the related Prospectus Supplement, the funds
held in the Collection Account or the Certificate Account may be invested,
pending remittance to the Trustee, in Eligible Investments. If so specified in
the related Prospectus Supplement, the Servicer will be entitled to receive as
additional compensation any interest or other income earned on funds in the
Collection Account or Certificate Account.
Unless otherwise specified in the related Prospectus Supplement, the
Servicer, the Transferor or the Trustee will deposit into the Collection
Account or the Certificate Account for each Series on the Business Day
following the Closing Date any amounts representing payments received on or
after the related Cut-off Date and received by the Servicer on or before the
Closing Date, and thereafter, within the period specified in the related
Prospectus Supplement, the following payments and collections received or made
by it (other than, unless otherwise provided in the related Prospectus
Supplement, in respect of principal of and interest on the related Primary
Assets due or, in the case of simple interest Loans, received, on or before
such Cut-off Date):
(i) all payments on account of principal, including prepayments, on such
Primary Assets;
(ii) all payments on account of interest on such Primary Assets after
deducting therefrom, at the discretion of the Servicer but only to the
extent of the amount permitted to be withdrawn or withheld from the
Collection Account or the Certificate Account in accordance with the
related Agreement, the Servicing Fee in respect of such Primary Assets;
(iii) all amounts received by the Servicer in connection with the
liquidation of Primary Assets or property acquired in respect thereof,
whether through foreclosure sale, repossession or otherwise, including
payments in connection with such Primary Assets received from the obligor,
other than amounts required to be paid or refunded to the obligor pursuant
to the terms of the applicable loan documents or otherwise pursuant to law
("Liquidation Proceeds"), exclusive of, in the discretion of the Servicer,
but only to the extent of the amount permitted to be withdrawn from the
Collection Account or the Certificate Account in
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accordance with the related Agreement, the Servicing Fee, if any, in
respect of the related Primary Asset and, to the extent specified in the
related Prospectus Supplement, net of reimbursements for Servicer Advances;
(iv) all proceeds under any title insurance, hazard insurance or other
insurance policy covering any such Primary Asset, other than proceeds to be
applied to the restoration or repair of the related Property or released to
the obligor in accordance with the related Agreement;
(v) all amounts required to be deposited therein from any applicable
Reserve Fund for such Series pursuant to the related Agreement;
(vi) all Delinquency Advances made by the Servicer required pursuant to
the related Agreement; and
(vii) all repurchase prices of any such Primary Assets repurchased by the
Servicer or the Transferor pursuant to the related Agreement.
If specified in the related Prospectus Supplement, each balance of a
Revolving Credit Line Loan may be conveyed to a separate Trust Fund and
payments and proceeds of such Revolving Credit Line Loan will be allocated
among such Trust Funds as specified in the related Prospectus Supplement.
Unless otherwise specified in the related Prospectus Supplement, the
Servicer is permitted, from time to time, to make withdrawals from the
Collection Account or the Certificate Account for each Series for the
following purposes:
(i) to reimburse itself for Servicer Advances and Delinquency Advances
for such Series made by it pursuant to the related Agreement; the
Servicer's right to reimburse itself for Delinquency Advances is limited to
amounts received on or in respect of particular Loans (including, for this
purpose, Liquidation Proceeds and amounts representing proceeds of
insurance policies covering the related Property) which represent late
recoveries of Scheduled Payments respecting which any such Delinquency
Advance was made;
(ii) to the extent provided in the related Agreement, to reimburse itself
for any Delinquency Advances for such Series that the Servicer determines
in good faith it will be unable to recover from amounts representing late
recoveries of Scheduled Payments respecting which such Delinquency Advance
was made or from Liquidation Proceeds or the proceeds of insurance
policies;
(iii) to reimburse itself for Servicer Advances to the extent provided in
the related Prospectus Supplement;
(iv) in the event it has elected not to pay itself the Servicing Fee out
of the interest component of any Scheduled Payment, late payment or other
recovery with respect to a particular Loan prior to the deposit of such
Scheduled Payment, late payment or recovery into the Collection Account or
the Certificate Account, to pay to itself the Servicing Fee, as adjusted
pursuant to the related Agreement, from any such Scheduled Payment, late
payment or such other recovery, to the extent permitted by the related
Agreement;
(v) to reimburse itself for expenses incurred by and recoverable by or
reimbursable to it pursuant to the related Agreement;
(vi) to pay to the applicable person with respect to each Primary Asset
or REO Property acquired in respect thereof that has been repurchased or
removed from the Trust Fund by the Transferor or the Servicer pursuant to
the related Agreement, all amounts received thereon and not distributed as
of the date on which the related repurchase price was determined;
(vii) to make payments to the Trustee of such Series for deposit into the
Distribution Account, if any, or for remittance to the Holders of such
Series in the amounts and in the manner provided for in the related
Agreement; and
(viii) to clear and terminate the Collection Account or the Certificate
Account pursuant to the related Agreement.
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In addition, if the Servicer deposits in the Collection Account or the
Certificate Account for a Series any amount not required to be deposited
therein, it may, at any time, withdraw such amount from such Collection
Account or the Certificate Account.
ADVANCES AND LIMITATIONS THEREON
The related Prospectus Supplement will describe the circumstances, if any,
under which the Servicer will make advances with respect to delinquent
payments of principal and/or interest on Loans ("Delinquency Advances"). If
specified in the related Prospectus Supplement, the Servicer will be obligated
to make Delinquency Advances, and such obligation may be limited in amount, or
may not be activated until a certain portion of a specified Reserve Fund is
depleted. Such advances are intended to provide liquidity and, except to the
extent specified in the related Prospectus Supplement, not to guarantee or
insure against losses. Accordingly, to the extent specified in the related
Prospectus Supplement, any funds advanced are recoverable by the Servicer out
of amounts received on particular Loans which represent late recoveries of
principal or interest, proceeds of insurance policies or Liquidation Proceeds
respecting which any such Delinquency Advance was made or, to the extent
provided in the Prospectus Supplement, from payments or proceeds from other
Loans. If and to the extent specified in the related Prospectus Supplement,
the Servicer shall be entitled to advance its own funds to pay for any related
expenses of foreclosure and disposition of any liquidated Mortgage Loan or
related Property (the "Servicer Advances"). The Servicer shall be entitled to
be reimbursed for any such Servicer Advances to the extent provided in the
Prospectus Supplement. If a Servicer Advance is made and subsequently
determined to be nonrecoverable from late collections, proceeds of insurance
policies, or Liquidation Proceeds from the related Loan, the Servicer may be
entitled to reimbursement from other funds in the Collection Account,
Certificate Account or Distribution Account, as the case may be, or from a
specified Reserve Fund as applicable, to the extent specified in the related
Prospectus Supplement.
MAINTENANCE OF INSURANCE POLICIES AND OTHER SERVICING PROCEDURES
Standard Hazard Insurance; Flood Insurance. Except as otherwise specified in
the related Prospectus Supplement, the Servicer will be required to maintain
or to cause the obligor on each Real Estate Loan to maintain a hazard
insurance policy naming the Servicer as loss payee thereunder. Hazard
insurance policies for Real Estate Loans must include extended coverage in an
amount equal to the lesser of (a) the maximum insurable value of the
improvements securing such Real Estate Loan and (b) either (i) the principal
balance of the Real Estate Loan if it is a Home Improvement Contract or a
closed-end Mortgage Loan or (ii) the combined principal balance of the Real
Estate Loan and any mortgage loan senior to the Real Estate Loan if such Real
Estate Loan is a Revolving Credit Line Loan. The ability of the Servicer to
assure that hazard insurance proceeds are appropriately applied may depend on
its being named as an additional insured under any hazard insurance policy and
under any flood insurance policy referred to below, or upon the extent to
which information in this regard is furnished to the Servicer by a borrower.
Except as described below, all amounts collected by the Servicer under any
hazard policy (except for amounts applied or expected to be applied to the
restoration or repair of the Property or released to the borrower in
accordance with the Servicer's normal servicing procedures), will be deposited
in the Collection Account or the Certificate Account. If so specified in the
related Prospectus Supplement, the portion of such proceeds allocable to
Securityholders of a Series may be limited to the extent specified in the
related Prospectus Supplement in the event that more than one Trust Fund has
an interest in the balances of a Revolving Credit Line Loan. The Agreement
provides that the Servicer may satisfy its obligation to cause hazard policies
to be maintained by maintaining a blanket policy issued by an insurer
acceptable to the Rating Agencies insuring against hazard losses to the
collateral securing the Real Estate Loans. If such blanket policy contains a
deductible clause, the Servicer will deposit into the Collection Account the
amount not otherwise payable under the blanket policy because of such
deductible clause. If so specified in the related Prospectus Supplement, the
amount so required to be deposited by the Servicer with respect to a
particular Series may be limited to the extent specified in the related
Prospectus Supplement in the event that more than one Trust Fund has an
interest in the balances of a Mortgage Loan.
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In general, the standard form of fire and extended coverage insurance policy
covers physical damage to or destruction of the improvements on the property
by fire, lightning, explosion, smoke, windstorm and hail, and riot, strike and
civil commotion, subject to the conditions and exclusions specified in each
policy. Although the policies relating to the Mortgage Loans will be
underwritten by different insurers under different state laws in accordance
with different applicable state forms and therefore will not contain identical
terms and conditions, the basic terms thereof are dictated by respective state
laws, and most such policies typically do not cover any physical damage
resulting from any of the following: war, revolution, governmental actions,
floods and other water-related causes, earth movement (including earthquakes,
landslides and mudflows), nuclear reactions, wet or dry rot, vermin, rodents,
insects or domestic animals, theft and, in certain cases, vandalism. The
foregoing list is merely indicative of certain kinds of uninsured risks and is
not intended to be all-inclusive. When a Mortgaged Property is located in a
federally designated special flood hazard area at the time of origination of
the related Real Estate Loan, the Agreement requires the Servicer to cause to
be maintained, for each such Real Estate Loan, flood insurance (to the extent
available) in an amount equal in general to the lesser of (a) the maximum
insurance available under the federal flood insurance program and (b) either
(i) the principal balance of the Real Estate Loan if it is a Home Improvement
Contract or a closed-end Mortgage Loan or (ii) the combined principal balance
of the Real Estate Loan and any mortgage loan senior to the Real Estate Loan
if such Real Estate Loan is a Revolving Credit Line Loan.
The hazard insurance policies covering the Mortgaged Properties typically
contain a co-insurance clause that in effect requires the insured at all times
to carry insurance of a specified percentage (generally 80% to 90%) of the
full replacement value of the improvements on the property in order to recover
the full amount of any partial loss. If the insured's coverage falls below
this specified percentage, such clause generally provides that the insurer's
liability in the event of partial loss does not exceed the greater of (i) the
replacement cost of the improvements less physical depreciation or (ii) such
proportion of the loss as the amount of insurance carried bears to the
specified percentage of the full replacement cost of such improvements.
Unless otherwise specified in the related Prospectus Supplement, the
Servicer will also maintain on REO Property that secured a defaulted Real
Estate Loan and that has been acquired upon foreclosure, deed in lieu of
foreclosure, or repossession, a standard hazard insurance policy in an amount
that is equal to the maximum insurable value of such REO Property. No
earthquake or other additional insurance will be required of any obligor or
will be maintained on REO Property acquired in respect of a defaulted Real
Estate Loan, other than pursuant to such applicable laws and regulations as
shall at any time be in force and shall require such additional insurance.
If the amount of hazard insurance maintained on the Mortgaged Properties
were to decline as the principal balances owing thereon decreased, hazard
insurance proceeds could be insufficient to restore fully the damaged property
in the event of a partial loss.
Under the terms of the Real Estate Loans, the borrowers generally are
required to present claims to insurers under hazard insurance policies
maintained on the Mortgaged Properties. The Servicer, on behalf of the Trustee
and Securityholders, is obligated to present claims under any blanket
insurance policy insuring against hazard losses on the Mortgaged Properties.
However, the ability of the Servicer to present such claims depends upon the
extent to which information in this regard is furnished to the Servicer by the
borrowers.
REALIZATION UPON DEFAULTED LOANS
Unless otherwise specified in the related Prospectus Supplement the Servicer
has the discretion to foreclose upon, repossess or otherwise comparably
convert the ownership of the Properties securing the related Loans as come
into and continue in default and as to which no satisfactory arrangements can
be made for collection of delinquent payments in the same manner it forecloses
upon, repossesses or otherwise converts the ownership of properties securing
loans in the applicable portfolio of Loans; provided that if the Servicer has
actual knowledge or reasonably believes that any Mortgaged Property is
contaminated by hazardous or toxic wastes or substances, then the Servicer
will not cause a Trust to acquire title to such Mortgaged Property in a
foreclosure or similar proceeding if such acquisition in the reasonable
opinion of the Servier is not commercially reasonable. In connection with such
foreclosure or other conversion, the Servicer will follow such practices and
procedures as it deems necessary or advisable and as are normal and usual in
its servicing activities with respect to comparable
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loans serviced by it. However, the Servicer will not be required to expend its
own funds in connection with any foreclosure or towards the restoration of the
Property unless it determines that (i) such restoration or foreclosure will
increase the Liquidation Proceeds in respect of the related Loan available to
the Holders after reimbursement to itself for such expenses and (ii) such
expenses will be recoverable by it either through Liquidation Proceeds or the
proceeds of insurance. Notwithstanding anything to the contrary herein, in the
case of a Trust Fund for which a REMIC election has been made, the Servicer
will be required to liquidate any Property acquired through foreclosure within
two years after the acquisition of the beneficial ownership of such Property.
While the holder of a Property acquired through foreclosure can often maximize
its recovery by providing financing to a new purchaser, the Trust Fund, if
applicable, will have no ability to do so and neither the Servicer nor the
Transferor will be required to do so.
The Servicer may arrange with the obligor on a defaulted Loan a modification
of such Loan (a "Modification") to the extent provided in the related
Prospectus Supplement. Such Modifications may only be entered into if they
meet the underwriting policies and procedures employed by the Servicer in
servicing receivables for its own account and meet the other conditions set
forth in the related Prospectus Supplement.
ENFORCEMENT OF DUE-ON-SALE CLAUSES
Unless otherwise specified in the related Prospectus Supplement for a
Series, when any Property is being conveyed by the obligor, the Servicer will
have the option to exercise its rights to accelerate the maturity of the
related Loan under the applicable "due-on-sale" clause, if any, unless such
exercise is not permitted under applicable law. In such event, the Servicer is
authorized to accept from or enter into an assumption agreement with the
person to whom such property has been or is about to be conveyed, pursuant to
which such person becomes liable under the Loan. To the extent permitted by
applicable law, such assumption will not release the original borrower from
its obligation under the Loan. Any fee collected in connection with an
assumption will be retained by the Servicer as additional servicing
compensation. The terms of a Loan may not be changed in connection with an
assumption except to the extent specified in the related Prospectus
Supplement.
SERVICING COMPENSATION AND PAYMENT OF EXPENSES
Except as otherwise provided in the related Prospectus Supplement, the
Servicer will be entitled to a periodic fee as servicing compensation (the
"Servicing Fee") in an amount to be determined as specified in the related
Prospectus Supplement. The Servicing Fee may be fixed or variable, as
specified in the related Prospectus Supplement. In addition, unless otherwise
specified in the related Prospectus Supplement, the Servicer will be entitled
to servicing compensation in the form of assumption fees, late payment charges
and similar items, or excess proceeds following disposition of Properties in
connection with defaulted Loans.
Except to the extent otherwise specified in the related Prospectus
Supplement, the Servicer will pay certain expenses incurred in connection with
the servicing of the Loans, including, without limitation, the payment of the
fees and expenses of the Trustee and independent accountants, payment of
insurance policy premiums and the cost of credit support, if any, and payment
of expenses incurred in preparation of reports to Holders.
When an obligor makes a principal prepayment in full between Due Dates on
the related Loan, the obligor will generally be required to pay interest on
the amount prepaid only to the date of prepayment. If and to the extent
provided in the related Prospectus Supplement in order that one or more
Classes of the Holders of a Series will not be adversely affected by any
resulting shortfall in interest, the amount of the Servicing Fee may be
reduced to the extent necessary to include in the Servicer's remittance to the
Trustee for distribution to Securityholders an amount equal to one month's
interest on the related Loan (less the Servicing Fee). If the aggregate amount
of such shortfalls in a month exceeds the Servicing Fee for such month, a
shortfall to Holders may occur.
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Unless otherwise specified in the related Prospectus Supplement, the
Servicer will be entitled to reimbursement for Servicer Advances. The related
Holders will suffer no loss by reason of such Servicer Advances to the extent
expenses are covered under related insurance policies or from excess
Liquidation Proceeds. If claims are either not made or paid under the
applicable insurance policies or if coverage thereunder has been exhausted,
the related Holders will suffer a loss to the extent that Liquidation
Proceeds, after reimbursement of the Servicer Advances, are less than the
outstanding principal balance of and unpaid interest on the related Loan which
would be distributable to Holders. The Servicer is generally also entitled to
reimbursement from the Collection Account or the Certificate Account for
Servicer Advances. In addition, the Servicer will be entitled to reimbursement
for Delinquency Advances as described above under "--Advances and Limitations
Thereon."
Unless otherwise specified in the related Prospectus Supplement, the rights
of the Servicer to receive funds from the Collection Account or the
Certificate Account for a Series, whether as the Servicing Fee or other
compensation, or for the reimbursement of Advances, expenses or otherwise, are
not subordinate to the rights of Holders of such Series.
EVIDENCE AS TO COMPLIANCE
If so specified in the related Prospectus Supplement, the applicable
Agreement for each Series will provide that each year, a firm of independent
public accountants will furnish a statement to the Trustee to the effect that
such firm has examined certain documents and records relating to the servicing
of the Loans by the Servicer and that such examination, which has been
conducted substantially in compliance with either (i) the audit guide for
audits of non-supervised mortgagees approved by the Department of Housing and
Urban Development or (ii) the requirements of the Uniform Single Attestation
Program for Mortgage Bankers, has disclosed no items of non-compliance with
the provisions of the applicable Agreement that, in the opinion of the firm,
are material, except for such items of non-compliance as shall be referred to
in the report.
If so specified in the related Prospectus Supplement, the applicable
Agreement for each Series will also provide for delivery to the Trustee for
such Series of an annual statement signed by an officer of the Servicer to the
effect that the Servicer has fulfilled its material obligations under such
Agreement throughout the preceding calendar year.
CERTAIN MATTERS REGARDING THE SERVICER
If an Event of Default occurs under either a Sale and Servicing Agreement or
a Pooling and Servicing Agreement, the Servicer may be replaced by the Trustee
or a successor Servicer. Unless otherwise specified in the related Prospectus
Supplement, such Events of Default and the rights of the Trustee upon such a
default under the Agreement for the related Series will be substantially
similar to those described under "THE AGREEMENTS--Events of Default; Rights
Upon Event of Default--Pooling and Servicing Agreement; Sale and Servicing
Agreement."
Unless otherwise specified in the related Prospectus Supplement, the
Servicer does not have the right to assign its rights and delegate its duties
and obligations under the related Agreement for each Series unless the
successor Servicer accepting such assignment or delegation (i) services
similar loans in the ordinary course of its business, (ii) is reasonably
satisfactory to the Trustee for the related Series, (iii) would not cause any
Rating Agency's rating of the Securities for such Series in effect immediately
prior to such assignment, sale or transfer to be qualified, downgraded or
withdrawn as a result of such assignment, sale or transfer and (iv) executes
and delivers to the Trustee and the Enhancer, if any, an agreement, in form
and substance reasonably satisfactory to the Trustee, and the Enhancer, if
any, which contains an assumption by such Servicer of the due and punctual
performance and observance of each covenant and condition to be performed or
observed by the Servicer under the related Agreement from and after the date
of such agreement. No such assignment will become effective until the Trustee
or a successor Servicer has assumed the servicer's obligations and duties
under the related Agreement. To the extent that the Servicer transfers its
obligations to a wholly-owned subsidiary or affiliate, such
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subsidiary or affiliate need not satisfy the criteria set forth above;
however, in such instance, the assigning Servicer will remain liable for the
servicing obligations under the related Agreement. Any entity into which the
Servicer is merged or consolidated or any successor corporation resulting from
any merger, conversion or consolidation will succeed to the Servicer's
obligations under the related Agreement provided that such successor or
surviving entity meets the requirements for a successor Servicer set forth
above.
The Servicer will not be under any liability to the Trust Fund or the
Securityholders for taking any action or for refraining from taking any action
in good faith pursuant to the Agreement, or for errors in judgment; provided,
however, that the Servicer will not be protected against any liability that
otherwise would be imposed by reason of willful misfeasance, bad faith or
gross negligence in the performance of duties or by reason of its reckless
disregard of its obligations and duties thereunder. Except to the extent
otherwise provided therein, each Agreement further will provide that the
Servicer and any director, officer, employee or agent of the Servicer will be
entitled to indemnification by the Trust Fund and will be held harmless to the
extent provided in the Agreement against any loss, liability or expense
incurred in connection with any legal action relating to the Agreement or the
Securities, other than any loss, liability or expense related to any specific
Loan or Loans (or balances thereof) (except any such loss, liability or
expense otherwise reimbursable pursuant to the Agreement) and any loss,
liability or expense incurred by the Servicer by reason of its willful
misfeasance, bad faith or gross negligence in the performance of its duties
thereunder or by reason of the Servicer's reckless disregard of its
obligations and duties thereunder.
Each Agreement will provide that the Servicer will not be under any
obligation to appear in, prosecute or defend any legal action that is not
incidental to its duties under the Agreement and that in its opinion may
involve it in any expense or liability. The Servicer, however, in its
discretion, may undertake any such action that it may deem necessary or
desirable with respect to the Agreement and the rights and duties of the
parties thereto and the interest of the Securityholders and the Enhancer, if
any, thereunder. In such event, the legal expenses and costs of such action
and any liability resulting therefrom will be expenses, costs and liabilities
of the Trust Fund and the Servicer will be entitled to be reimbursed therefor
to the extent provided in the Agreement. The Servicer's right to such
indemnity or reimbursement will survive any resignation or termination of the
Servicer with respect to any losses, expenses, costs or liabilities arising
prior to such resignation or termination (or arising from events that occurred
prior to such resignation or termination). Any claims by or on behalf of the
Securityholders or the Trust Fund will be made only against the Servicer, who
will be liable with respect to its own acts and omissions as well as the acts
and omissions of its directors, officer, employees and agents.
THE AGREEMENTS
The following summaries describe certain provisions of the Agreements. The
summaries do not purport to be complete and are subject to, and qualified in
their entirety by reference to, the provisions of the Agreements. Where
particular provisions or terms used in the Agreements are referred to, such
provisions or terms are as specified in the related Agreements.
ASSIGNMENT OF PRIMARY ASSETS
General. At the time of issuance of the Securities of a Series, the
Transferor will transfer, convey and assign to the Trust Fund all right, title
and interest of the Transferor in the Primary Assets and other property to be
transferred to the Trust Fund for a Series. Such assignment will include all
principal and interest due or received on or with respect to the Primary
Assets on or after the Cut-off Date to the extent specified in the related
Prospectus Supplement (except for any Retained Interests). The Trustee will,
concurrently with such assignment, execute and deliver the Securities.
Assignment of Loans. Unless otherwise specified in the related Prospectus
Supplement, the Transferor will, as to each Loan, deliver or cause to be
delivered to the Trustee, or, as specified in the related Prospectus
Supplement, a custodian on behalf of the Trustee (the "Custodian"), the
Mortgage Note endorsed without
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recourse to the order of the Trustee or in blank, the original Mortgage with
evidence of recording indicated thereon (except for any Mortgage not returned
from the public recording office, in which case a copy of such Mortgage will
be delivered, together with a certificate that the original of such Mortgage
was delivered to such recording office) and an assignment of the Mortgage in
recordable form. The Trustee, or, if so specified in the related Prospectus
Supplement, the Custodian, will hold such documents in trust for the benefit
of the Holders.
Unless otherwise specified in the related Prospectus Supplement, the
Transferor will as to each Home Improvement Contract deliver or cause to be
delivered to the Trustee (or the Custodian) the original Home Improvement
Contract and copies of documents and instruments related to each Home
Improvement Contract and, other than in the case of unsecured Home Improvement
Contracts, the security interest in the property securing such Home
Improvement Contract. In order to give notice of the right, title and interest
of Securityholders to the Home Improvement Contracts, the Transferor will
cause a UCC-1 financing statement to be executed by the Transferor identifying
the Trustee as the secured party and identifying all Home Improvement
Contracts as collateral. Unless otherwise specified in the related Prospectus
Supplement, the Home Improvement Contracts will not be stamped or otherwise
marked to reflect their assignment to the Trust Fund. Therefore, if, through
negligence, fraud or otherwise, a subsequent purchaser were able to take
physical possession of the Home Improvement Contracts without notice of such
assignment, the interest of Securityholders in the Home Improvement Contracts
could be defeated. See "CERTAIN LEGAL ASPECTS OF THE LOANS--The Home
Improvement Contracts."
With respect to Loans secured by Mortgages, if so specified in the related
Prospectus Supplement, the Transferor will, at the time of issuance of the
Securities, cause assignments to the Trustee of the Mortgages relating to the
Loans for a Series to be recorded in the appropriate public office for real
property records, except in states where, in the opinion of counsel acceptable
to the Trustee, such recording is not required to protect the Trustee's
interest in the related Loans. If specified in the related Prospectus
Supplement, the Transferor will cause such assignments to be so recorded
within the time after issuance of the Securities as is specified in the
related Prospectus Supplement, in which event, the Agreement may, as specified
in the related Prospectus Supplement, require the Transferor to repurchase
from the Trustee any Loan the related Mortgage of which is not recorded within
such time, at the price described below with respect to repurchases by reason
of defective documentation. Unless otherwise provided in the related
Prospectus Supplement, the enforcement of the repurchase obligation would
constitute the sole remedy available to the Holders or the Trustee for the
failure of a Mortgage to be recorded.
Each Loan will be identified in a schedule appearing as an exhibit to the
related Agreement (the "Loan Schedule"). Such Loan Schedule will specify with
respect to each Loan: the original principal amount and unpaid principal
balance as of the Cut-off Date; the current interest rate; the current
Scheduled Payment of principal and interest; the maturity date, if any, of the
related Mortgage Note; if the Loan is an adjustable rate Loan, the Lifetime
Rate Cap, if any, and the current index.
Assignment of Private Securities. The Transferor will cause Private
Securities to be registered in the name of the Trustee (or its nominee or
correspondent). The Trustee (or its nominee or correspondent) will have
possession of any certificated Private Securities. Unless otherwise specified
in the related Prospectus Supplement, the Trustee will not be in possession of
or be assignee of record of any underlying assets for a Private Security. See
"THE TRUST FUNDS--Private Securities." Each Private Security will be
identified in a schedule appearing as an exhibit to the related Agreement (the
"Certificate Schedule"), which will specify the original principal amount,
outstanding principal balance as of the Cut-off Date, annual pass-through rate
or interest rate and maturity date for each Private Security conveyed to the
Trust Fund. In the Agreement, the Transferor will represent and warrant to the
Trustee regarding the Private Securities: (i) that the information contained
in the Certificate Schedule is true and correct in all material respects; (ii)
that, immediately prior to the conveyance of the Private Securities, the
Transferor had good title thereto, and was the sole owner thereof (subject to
any Retained Interest); (iii) that there has been no other sale by it of such
Private Securities; and (iv) that there is no existing lien, charge, security
interest or other encumbrance (other than any Retained Interest) on such
Private Securities.
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Repurchase and Substitution of Non-Conforming Primary Assets. Unless
otherwise provided in the related Prospectus Supplement, if any document in
the file relating to the Primary Assets delivered by the Transferor to the
Trustee (or Custodian) is found by the Trustee within 90 days of the execution
of the related Agreement (or promptly after the Trustee's receipt of any
document permitted to be delivered after the Closing Date) to be defective in
any material respect and the Transferor does not cure such defect within 90
days, or within such other period specified in the related Prospectus
Supplement, the Transferor will, not later than 90 days or within such other
period specified in the related Prospectus Supplement, after the Trustee's
notice to the Transferor of the defect, repurchase the related Primary Asset
or any property acquired in respect thereof from the Trustee at a price equal
to, unless otherwise specified in the related Prospectus Supplement, the sum
of (a) the lesser of (i) the outstanding principal balance of such Primary
Asset and (ii) the Trust Fund's federal income tax basis in the Primary Asset
and (b) accrued and unpaid interest to the date of the repurchase/substitution
of such Primary Asset at the rate set forth in the related Agreement;
provided, however, the purchase price shall not be limited in (i) above to the
Trust Fund's federal income tax basis if the repurchase at a price equal to
the outstanding principal balance of such Primary Asset will not result in any
prohibited transaction tax under Section 860F(a) of the Code.
If provided in the related Prospectus Supplement, the Transferor, may,
rather than repurchase the Primary Asset as described above, remove such
Primary Asset from the Trust Fund (the "Deleted Primary Asset") and substitute
in its place one or more other Primary Assets (each, a "Qualifying Substitute
Primary Asset") provided, however, that with respect to a Trust Fund for which
a REMIC election is made, after a specified time period, the Trustee must have
received a satisfactory opinion of counsel that such substitution will not
cause the Trust Fund to lose its status as a REMIC or otherwise subject the
Trust Fund to a prohibited transaction tax.
Unless otherwise specified in the related Prospectus Supplement, any
Qualifying Substitute Primary Asset will have, on the date of substitution,
(i) an outstanding principal balance, after deduction of all Scheduled
Payments due in the month of substitution, not in excess of the outstanding
principal balance of the Deleted Primary Asset (the amount of any shortfall to
be deposited to the Collection Account in the month of substitution for
distribution to Holders), (ii) an interest rate not less than (and not more
than 2% greater than) the interest rate or Margin of the Deleted Primary
Asset, (iii) a remaining term-to-stated maturity not greater than (and not
more than two years less than) that of the Deleted Primary Asset, and will
comply with all of the representations and warranties set forth in the
applicable Agreement as of the date of substitution.
Unless otherwise provided in the related Prospectus Supplement, the above-
described cure, repurchase or substitution obligations constitute the sole
remedies available to the Holders or the Trustee for a material defect in a
document for a Primary Asset.
The Transferor will make representations and warranties with respect to
Primary Assets for a Series. If the Transferor or such entity cannot cure a
breach of any such representations and warranties in all material respects
within the time period specified in the related Prospectus Supplement after
notification by the Trustee of such breach, and if such breach is of a nature
that materially and adversely affects the value of such Primary Asset, the
Transferor is obligated to repurchase the affected Primary Asset or, if
provided in the related Prospectus Supplement, provide a Qualifying Substitute
Primary Asset therefor, subject to the same conditions and limitations on
purchases and substitutions as described above.
Unless otherwise provided in the related Prospectus Supplement, no Holder of
Securities of a Series, solely by virtue of such Holder's status as a Holder,
will have any right under the applicable Agreement for such Series to
institute any proceeding with respect to such Agreement, unless such Holder
previously has given to the Trustee for such Series written notice of default
and unless the Holders of Securities evidencing not less than 51% of the
aggregate voting rights of the Securities for such Series have made written
request upon the Trustee to institute such proceeding in its own name as
Trustee thereunder and have offered to the Trustee reasonable indemnity, and
the Trustee for 60 days has neglected or refused to institute any such
proceeding.
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REPORTS TO HOLDERS
The Trustee or other entity specified in the related Prospectus Supplement
will prepare and forward to each Holder on each Distribution Date, or as soon
thereafter as is practicable, a statement setting forth, to the extent
applicable to any Series and set forth in the related Prospectus Supplement,
among other things:
(i) the amount of principal distributed to Holders of the related
Securities and the outstanding principal balance of such Securities
following such distribution;
(ii) the amount of interest distributed to Holders of the related
Securities and the current interest on such Securities;
(iii) the amounts of (a) any overdue accrued interest included in such
distribution, (b) any remaining overdue accrued interest with respect to
such Securities or (c) any current shortfall in amounts to be distributed
as accrued interest to Holders of such Securities;
(iv) the amounts of (a) any overdue payments of scheduled principal
included in such distribution, (b) any remaining overdue principal amounts
with respect to such Securities, (c) any current shortfall in receipt of
scheduled principal payments on the related Primary Assets or (d) any
realized losses or Liquidation Proceeds to be allocated as reductions in
the outstanding principal balances of such Securities;
(v) the amount received under any related Enhancement, and the remaining
amount available under such Enhancement;
(vi) the amount of any delinquencies with respect to payments on the
related Primary Assets;
(vii) the book value of any REO Property acquired by the related Trust
Fund;
(viii) during the Pre-Funding Period, the remaining Pre-Funded Amount and
the portion of the Pre-Funding Amount used to acquire additional Primary
Assets since the preceding Distribution Date;
(ix) during the Pre-Funding Period, the amount remaining in the
Capitalized Interest Account; and
(x) such other information as specified in the related Agreement.
In addition, within a reasonable period of time after the end of each
calendar year the Trustee, unless otherwise specified in the related
Prospectus Supplement, will furnish to each Holder of record at any time
during such calendar year (a) the aggregate of amounts reported pursuant to
(i), (ii), and (iv)(d) above for such calendar year and (b) such information
specified in the related Agreement to enable Holders to prepare their tax
returns including, without limitation, the amount of original issue discount
accrued on the Securities, if applicable. Information in the Distribution Date
and annual statements provided to the Holders will not have been examined and
reported upon by an independent public accountant. However, the Servicer will
provide to the Trustee a report by independent public accountants with respect
to the Servicer's servicing of the Loans. See "SERVICING OF LOANS--Evidence as
to Compliance."
If so specified in the Prospectus Supplement for a Series of Securities,
such Series or one or more Classes of such Series will be issued in book-entry
form. In such event, owners of beneficial interests in such Securities will
not be considered Holders and will not receive such reports directly from the
Trustee. The Trustee will forward such reports only to the entity or its
nominee which is the registered holder of the global certificate which
evidences such book-entry securities. Beneficial owners will receive such
reports from the participants and indirect participants of the applicable
book-entry system in accordance with the practices and procedures of such
entities.
EVENTS OF DEFAULT; RIGHTS UPON EVENT OF DEFAULT
Pooling and Servicing Agreement; Sale and Servicing Agreement. Unless
otherwise specified in the related Prospectus Supplement, Events of Default
under the Pooling and Servicing Agreement or Sale and Servicing Agreement for
each Series of Securities relating to Loans include (i) any failure by the
Servicer to deposit amounts in the Collection Account and/or Certificate
Account and/or Distribution Account required to be made thereunder, which
failure continues unremedied for the number of days specified in the related
Prospectus
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Supplement after the giving of written notice of such failure to the Servicer
by the Trustee for such Series, or to the Servicer and the Trustee by the
Enhancer or by the Holders of such Series evidencing not less than 51% of the
aggregate voting rights of the Securities for such Series, (ii) any failure by
the Servicer duly to observe or perform in any material respect any other of
its covenants or agreements in the applicable Agreement which continues
unremedied for the number of days specified in the related Prospectus
Supplement after the giving of written notice of such failure to the Servicer
by the Trustee, or to the Servicer and the Trustee by the Enhancer or by the
Holders of such Series evidencing not less than 51% of the aggregate voting
rights of the Securities for such Series, and (iii) certain events of
insolvency, readjustment of debt, marshalling of assets and liabilities or
similar proceedings and certain actions by the Servicer indicating its
insolvency, reorganization or inability to pay its obligations.
So long as an Event of Default remains unremedied under the applicable
Agreement for a Series of Securities relating to the servicing of Loans,
unless otherwise specified in the related Prospectus Supplement, the Trustee
for such Series or Holders of Securities of such Series evidencing not less
than 51% of the aggregate voting rights of the Securities for such Series
with, if specified in the related Prospectus Supplement, the consent of the
Enhancer, may terminate all of the rights and obligations of the Servicer as
servicer under the applicable Agreement (other than its right to recovery of
other expenses and amounts advanced pursuant to the terms of such Agreement
which rights the Servicer will retain under all circumstances), whereupon the
Trustee will succeed to all the responsibilities, duties and liabilities of
the Servicer under such Agreement and will be entitled to reasonable servicing
compensation not to exceed the applicable servicing fee, together with other
servicing compensation in the form of assumption fees, late payment charges or
otherwise as provided in such Agreement.
In the event that the Trustee is unwilling or unable so to act, it may
select, or petition a court of competent jurisdiction to appoint, a finance
institution, bank or loan servicing institution with a net worth specified in
the related Prospectus Supplement to act as successor Servicer under the
provisions of the applicable Agreement. The successor Servicer would be
entitled to reasonable servicing compensation in an amount not to exceed the
Servicing Fee as set forth in the related Prospectus Supplement, together with
the other servicing compensation in the form of assumption fees, late payment
charges or otherwise, as provided in such Agreement.
During the continuance of any Event of Default of a Servicer under an
Agreement for a Series of Securities, the Trustee for such Series will have
the right to take action to enforce its rights and remedies and to protect and
enforce the rights and remedies of the Holders of such Series, and, unless
otherwise specified in the related Prospectus Supplement, Holders of
Securities evidencing not less than 51% of the aggregate voting rights of the
Securities for such Series may direct the time, method and place of conducting
any proceeding for any remedy available to the Trustee or exercising any trust
or power conferred upon that Trustee. However, the Trustee will not be under
any obligation to pursue any such remedy or to exercise any of such trusts or
powers unless such Holders have offered the Trustee reasonable security or
indemnity against the cost, expenses and liabilities which may be incurred by
the Trustee therein or thereby. The Trustee may decline to follow any such
direction if the Trustee determines that the action or proceeding so directed
may not lawfully be taken or would involve it in personal liability or be
unjustly prejudicial to the nonassenting Holders.
Indenture. Unless otherwise specified in the related Prospectus Supplement,
Events of Default under the Indenture for each Series of Notes include: (i) a
default for 30 days or more in the payment of any principal of or interest on
any Note of such Series; (ii) failure to perform any other covenant of the
Transferor or the Trust Fund in the Indenture which continues for a period of
60 days after notice thereof is given in accordance with the procedures
described in the related Prospectus Supplement; (iii) any representation or
warranty made by the Transferor or the Trust Fund in the Indenture or in any
certificate or other writing delivered pursuant thereto or in connection
therewith with respect to or affecting such Series having been incorrect in a
material respect as of the time made, and such breach is not cured within 60
days after notice thereof is given in accordance with the procedures described
in the related Prospectus Supplement; (iv) certain events of bankruptcy,
insolvency, receivership or liquidation of the Transferor or the Trust Fund;
or (v) any other Event of Default provided with respect to Notes of that
Series.
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If an Event of Default with respect to the Notes of any Series at the time
outstanding occurs and is continuing, either the Trustee or the Holders of a
majority of the then aggregate outstanding amount of the Notes of such Series
with, if specified in the related Prospectus Supplement, the consent of the
Enhancer, may declare the principal amount (or, if the Notes of that Series
are Zero Coupon Securities, such portion of the principal amount as may be
specified in the terms of that Series, as provided in the related Prospectus
Supplement) of all the Notes of such Series to be due and payable immediately.
Such declaration may, under certain circumstances, be rescinded and annulled
by the Holders of a majority in aggregate outstanding amount of the Notes of
such Series.
If, following an Event of Default with respect to any Series of Notes, the
Notes of such Series have been declared to be due and payable, the Trustee
may, in its discretion, notwithstanding such acceleration, elect to maintain
possession of the collateral securing the Notes of such Series and to continue
to apply distributions on such collateral as if there had been no declaration
of acceleration if such collateral continues to provide sufficient funds for
the payment of principal of and interest on the Notes of such Series as they
would have become due if there had not been such a declaration. In addition,
unless otherwise specified in the related Prospectus Supplement, the Trustee
may not sell or otherwise liquidate the collateral securing the Notes of a
Series following an Event of Default other than a default in the payment of
any principal or interest on any Note of such Series for 30 days or more,
unless (a) the Holders of 100% of the then aggregate outstanding amount of the
Notes of such Series consent to such sale, (b) the proceeds of such sale or
liquidation are sufficient to pay in full the principal of and accrued
interest due and unpaid on the outstanding Notes of such Series at the date of
such sale or (c) the Trustee determines that such collateral would not be
sufficient on an ongoing basis to make all payments on such Notes as such
payments would have become due if such Notes had not been declared due and
payable, and the Trustee obtains the consent of the Holders of 66 2/8% of the
then aggregate outstanding amount of the Notes of such Series.
In the event that the Trustee liquidates the collateral in connection with
an Event of Default involving a default for 30 days or more in the payment of
principal of or interest on the Notes of a Series, the Indenture provides that
the Trustee will have a prior lien on the proceeds of any such liquidation for
unpaid fees and expenses. As a result, upon the occurrence of such an Event of
Default, the amount available for distribution to the Noteholders may be less
than would otherwise be the case. However, the Trustee may not institute a
proceeding for the enforcement of its lien except in connection with a
proceeding for the enforcement of the lien of the Indenture for the benefit of
the Noteholders after the occurrence of such an Event of Default.
Unless otherwise specified in the related Prospectus Supplement, in the
event the principal of the Notes of a Series is declared due and payable, as
described above, the Holders of any such Notes issued at a discount from par
may be entitled to receive no more than an amount equal to the unpaid
principal amount thereof less the amount of such discount which is
unamortized.
Subject to the provisions of the Indenture relating to the duties of the
Trustee, in case an Event of Default shall occur and be continuing with
respect to a Series of Notes, the Trustee will be under no obligation to
exercise any of the rights or powers under the Indenture at the request or
direction of any of the Holders of Notes of such Series, unless such Holders
offered to the Trustee security or indemnity satisfactory to it against the
costs, expenses and liabilities which might be incurred by it in complying
with such request or direction. Subject to such provisions for indemnification
and certain limitations contained in the Indenture, the Holders of a majority
of the then aggregate outstanding amount of the Notes of such Series shall
have the right to direct the time, method and place of conducting any
proceeding for any remedy available to the Trustee or exercising any trust or
power conferred on the Trustee with respect to the Notes of such Series, and
the Holders of a majority of the then aggregate outstanding amount of the
Notes of such Series may, in certain cases, waive any default with respect
thereto, except a default in the payment of principal or interest or a default
in respect of a covenant or provision of the Indenture that cannot be modified
without the waiver or consent of all the Holders of the outstanding Notes of
such Series affected thereby.
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THE TRUSTEE
The identity of the commercial bank, savings and loan association or trust
company named as the Trustee for each Series of Securities will be set forth
in the related Prospectus Supplement. The entity serving as Trustee may have
normal banking relationships with the Transferor. In addition, for the purpose
of meeting the legal requirements of certain local jurisdictions, the Trustee
will have the power to appoint co-trustees or separate trustees of all or any
part of the Trust Fund relating to a Series of Securities. In the event of
such appointment, all rights, powers, duties and obligations conferred or
imposed upon the Trustee by the Agreement relating to such Series will be
conferred or imposed upon the Trustee and each such separate trustee or co-
trustee jointly, or, in any jurisdiction in which the Trustee shall be
incompetent or unqualified to perform certain acts, singly upon such separate
trustee or co-trustee who will exercise and perform such rights, powers,
duties and obligations solely at the direction of the Trustee. The Trustee may
also appoint agents to perform any of the responsibilities of the Trustee,
which agents will have any or all of the rights, powers, duties and
obligations of the Trustee conferred on them by such appointment; provided
that the Trustee will continue to be responsible for its duties and
obligations under the Agreement. In the event a Series includes both Notes and
Certificates, a separate Trustee identified in the related Prospectus
Supplement will serve as Trustee for the Certificateholders and for the Notes.
DUTIES OF THE TRUSTEE
The Trustee will not make any representations as to the validity or
sufficiency of the Agreement, the Securities or of any Primary Asset or
related documents. If no Event of Default (as defined in the related
Agreement) has occurred, the Trustee is required to perform only those duties
specifically required of it under the Agreement. Upon receipt of the various
certificates, statements, reports or other instruments required to be
furnished to it, the Trustee is required to examine them to determine whether
they are in the form required by the related Agreement. However, the Trustee
will not be responsible for the accuracy or content of any such documents
furnished to it by the Holders or the Servicer under the Agreement.
The Trustee may be held liable for its own negligent action or failure to
act, or for its own misconduct; provided, however, that the Trustee will not
be personally liable with respect to any action taken, suffered or omitted to
be taken by it in good faith in accordance with the direction of the Holders
in an Event of Default. The Trustee is not required to expend or risk its own
funds or otherwise incur any financial liability in the performance of any of
its duties under the Agreement, or in the exercise of any of its rights or
powers, if it has reasonable grounds for believing that repayment of such
funds or adequate indemnity against such risk or liability is not reasonably
assured to it.
RESIGNATION OF TRUSTEE
The Trustee may, upon written notice to the Transferor, and if specified in
the related Prospectus Supplement, the Enhancer, if any, resign at any time,
in which event the Transferor will be obligated to use its best efforts to
appoint a successor Trustee. If no successor Trustee has been appointed and
has accepted the appointment within the period specified in the Agreement
after the giving of such notice of resignation, the resigning Trustee may
petition any court of competent jurisdiction for appointment of a successor
Trustee. The Trustee may also be removed at any time (i) if the Trustee ceases
to be eligible to continue as such under the Agreement, (ii) if the Trustee
becomes insolvent or (iii) by the Holders of Securities evidencing over 50% of
the aggregate voting rights of the Securities in the Trust Fund upon written
notice to the Trustee and to the Transferor. Any resignation or removal of the
Trustee and appointment of a successor Trustee will not become effective until
acceptance of the appointment by the successor Trustee.
AMENDMENT OF AGREEMENT
Unless otherwise specified in the Prospectus Supplement, the Agreement for
each Series of Securities may be amended by the Transferor, the Servicer and
the Trustee with respect to such Series, without notice to or consent of the
Holders, (i) to cure any ambiguity, (ii) to correct any defective provisions
or to correct or
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supplement any provision therein, (iii) to add to the duties of the
Transferor, the Trust Fund or the Servicer, (iv) to add any other provisions
with respect to matters or questions arising under such Agreement or related
Enhancement, (v) to add or amend any provisions of such Agreement as required
by a Rating Agency in order to maintain or improve the rating of the
Securities (it being understood that none of the Transferor, the Servicer or
the Trustee is obligated to maintain or improve such rating), or (vi) to
comply with any requirements imposed by the Code; provided that any such
amendment except pursuant to clause (vi) above will not materially and
adversely affect the interests of any Holders of such Series or, if specified
in the related Prospectus Supplement, the Enhancer, as evidenced by an opinion
of counsel. Any such amendment except pursuant to clause (vi) of the preceding
sentence shall be deemed not to adversely affect in any material respect the
interests of any Holder if the Trustee receives written confirmation from each
Rating Agency rating such Securities that such amendment will not cause such
Rating Agency to withdraw or reduce the then current rating thereof. Unless
otherwise specified in the Prospectus Supplement, the Agreement for each
Series may also be amended by the Trustee, the Servicer, if applicable, and
the Transferor with respect to such Series with the consent of the Enhancer,
if specified in the related Prospectus Supplement or the Holders possessing
not less than 51% of the aggregate outstanding principal amount of the
Securities of such Series or, if only certain Classes of such Series are
affected by such amendment, 51% of the aggregate outstanding principal amount
of the Securities of each Class of such Series affected thereby, for the
purpose of adding any provisions to or changing in any manner or eliminating
any of the provisions of such Agreement or modifying in any manner the rights
of Holders of such Series; provided, however, that no such amendment may (a)
reduce the amount or delay the timing of payments on any Security without the
consent of the Holder of such Security; or (b) reduce the aforesaid percentage
of the aggregate outstanding principal amount of Securities of each Class, the
Holders of which are required to consent to any such amendment or (c) if
specified in the related Prospectus Supplement, adversely affect the interests
of the Enhancer, without, in the case of clauses (a) or (b), the consent of
the Holders of 100% of the aggregate outstanding principal amount of each
Class of Securities affected thereby.
VOTING RIGHTS
The related Prospectus Supplement will set forth the method of determining
allocation of voting rights with respect to a Series.
LIST OF HOLDERS
Upon written request of three or more Holders of record of a Series for
purposes of communicating with other Holders with respect to their rights
under the Agreement, which request is accompanied by a copy of the
communication which such Holders propose to transmit, the Trustee will afford
such Holders access during business hours to the most recent list of Holders
of that Series held by the Trustee.
No Agreement will provide for the holding of any annual or other meeting of
Holders.
BOOK-ENTRY SECURITIES
If specified in the Prospectus Supplement for a Series of Securities, such
Series or one or more Classes of such Series may be issued in book-entry form.
In such event, beneficial owners of such Securities will not be considered
"Holders" under the Agreements and may exercise the rights of Holders only
indirectly through the participants in the applicable book-entry system.
REMIC ADMINISTRATOR
For any Series with respect to which a REMIC election is made, preparation
of certain reports and certain other administrative duties with respect to the
Trust Fund may be performed by a REMIC administrator, who may be the
Transferor or an affiliate of the Transferor.
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TERMINATION
Pooling and Servicing Agreement; Trust Agreement. The obligations created by
the Pooling and Servicing Agreement or Trust Agreement for a Series will
terminate upon the distribution to Holders of all amounts distributable to
them pursuant to such Agreement after the earlier of (i) the later of (a) the
final payment or other liquidation of the last Primary Asset remaining in the
Trust Fund for such Series and (b) the disposition of all property acquired
upon foreclosure or deed in lieu of foreclosure or repossession in respect of
any Primary Asset or (ii) the repurchase, as described below, by the Servicer
or other entity specified in the related Prospectus Supplement from the
Trustee for such Series of all Primary Assets and other property at that time
subject to such Agreement. The Agreement for each Series permits, but does not
require, the Servicer or other entity specified in the related Prospectus
Supplement to purchase from the Trust Fund for such Series all remaining
Primary Assets at a price equal to, unless otherwise specified in the related
Prospectus Supplement, 100% of the aggregate Principal Balance of such Primary
Assets plus, with respect to any property acquired in respect of a Primary
Asset, if any, the outstanding Principal Balance of the related Primary Asset
at the time of foreclosure, less, in either case, related unreimbursed
Servicer Advances (in the case of the Primary Assets, only to the extent not
already reflected in the computation of the aggregate Principal Balance of
such Primary Assets) and unreimbursed expenses (that are reimbursable pursuant
to the terms of the Pooling and Servicing Agreement) plus, in either case,
accrued interest thereon at the weighted average rate on the related Primary
Assets through the last day of the Due Period in which such repurchase occurs;
provided, however, that if an election is made for treatment as a REMIC under
the Code, the repurchase price may equal the greater of (a) 100% of the
aggregate Principal Balance of such Primary Assets, plus accrued interest
thereon at the applicable net rates on the Primary Assets through the last day
of the month of such repurchase and (b) the aggregate fair market value of
such Primary Assets plus the fair market value of any property acquired in
respect of a Primary Asset and remaining in the Trust Fund. The exercise of
such right will effect early retirement of the Securities of such Series, but
such entity's right to so purchase is subject to the aggregate Principal
Balance of the Primary Assets at the time of repurchase being less than a
fixed percentage, to be set forth in the related Prospectus Supplement, of the
aggregate Principal Balance of the Primary Assets as of the Cut-off Date. In
no event, however, will the trust created by the Agreement continue beyond the
expiration of 21 years from the death of the last survivor of certain persons
identified therein. For each Series, the Servicer or the Trustee, as
applicable, will give written notice of termination of the Agreement to each
Holder, and the final distribution will be made only upon surrender and
cancellation of the Securities at an office or agency specified in the notice
of termination. If so provided in the related Prospectus Supplement for a
Series, the Transferor or another entity may effect an optional termination of
the Trust Fund under the circumstances described in such Prospectus
Supplement. See "DESCRIPTION OF THE SECURITIES--Optional Redemption, Purchase
or Termination."
Indenture. The Indenture will be discharged with respect to a Series of
Notes (except with respect to certain continuing rights specified in the
Indenture) upon the delivery to the Trustee for cancellation of all the Notes
of such Series or, with certain limitations, upon deposit with the Trustee of
funds sufficient for the payment in full of all of the Notes of such Series.
In addition to such discharge with certain limitations, the Indenture will
provide that, if so specified with respect to the Notes of any Series, the
related Trust Fund will be discharged from any and all obligations in respect
of the Notes of such Series (except for certain obligations relating to
temporary Notes and exchange of Notes, to register the transfer of or exchange
Notes of such Series, to replace stolen, lost or mutilated Notes of such
Series, to maintain paying agencies and to hold monies for payment in trust)
upon the deposit with the Trustee, in trust, of money and/or direct
obligations of or obligations guaranteed by the United States of America
which, through the payment of interest and principal in respect thereof in
accordance with their terms, will provide money in an amount sufficient to pay
the principal of and each installment of interest on the Notes of such Series
on the Final Scheduled Distribution Date for such Notes and any installment of
interest on such Notes in accordance with the terms of the Indenture and the
Notes of such Series. In the event of any such defeasance and discharge of
Notes of such Series, holders of Notes of such Series would be able to look
only to such money and/or direct obligations for payment of principal and
interest, if any, on their Notes until maturity.
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CERTAIN LEGAL ASPECTS OF THE LOANS
The following discussion contains summaries of certain legal aspects of
mortgage loans, home improvement installment sales contracts and home
improvement installment loan agreements which are general in nature. Because
certain of such legal aspects are governed by applicable state law (which laws
may differ substantially), the summaries do not purport to be complete nor
reflect the laws of any particular state (other than, in some cases, the
states of Maryland, Virginia and the District of Columbia (the "Mortgage Loan
Jurisdictions") where it is anticipated most of the Properties will be
located), nor encompass the laws of all states in which the properties
securing the Loans are situated.
MORTGAGES
The Loans for a Series will, and certain Home Improvement Contracts for a
Series may, be secured by either mortgages or deeds of trust or deeds to
secure debt (such Mortgage Loans and Home Improvement Contracts are
hereinafter referred to in this section as "mortgage loans"), depending upon
the prevailing practice in the state in which the property subject to a
mortgage loan is located. The filing of a mortgage, deed of trust or deed to
secure debt creates a lien or title interest upon the real property covered by
such instrument and represents the security for the repayment of an obligation
that is customarily evidenced by a promissory note and, with respect to Home
Improvement Contracts, the related contract. The priority of the liens is
important because, among other things, the foreclosure of a senior lien will
extinguish a junior lien, and because the holder of a senior lien generally
will have a right to receive insurance, condemnation or other proceeds before
the holder of a junior lien.
Priority between mortgages and deeds of trust (or other instruments of
record) generally depends in the first instance on the order of filing with
the appropriate government records office. Priority also may be affected by
the express terms of the mortgage or deed of trust.
Although priority among liens on the same property generally depends in the
first instance on the order of filing, there are a number of ways in which a
lien that is a senior lien when it is filed can become subordinate to a lien
filed at a later date. The trustee's title under a deed of trust is not prior
to any liens for real estate taxes and assessments, certain federal liens
(including certain federal criminal liens, environmental liens and tax liens),
certain mechanics and materialmen's liens, and other liens given priority by
applicable law. For example, in some jurisdictions, if advances are made under
the deed of trust after another lien (such as a judgment or mechanics lien) is
filed, the advances made after the filing of the intervening lien may be
subordinate to the intervening lien. In addition, in Virginia, the priority of
a mechanics lien may relate back to a date that substantially precedes the
date on which the mechanics lien is actually filed. Therefore, since a title
report or title policy only is accurate as of the date it is issued, it
provides no assurance that a deed of trust will retain perpetually the lien
priority it had when it was filed. The mortgages and deeds of trust securing
the Real Estate Loans include a requirement that each borrower maintain the
lien priority of each deed of trust.
There are two parties to a mortgage: the mortgagor, who is the
borrower/property owner or the land trustee (as described below), and the
mortgagee, who is the lender. Under the mortgage instrument, the mortgagor
delivers to the mortgagee a note or bond and the mortgage. In the case of a
land trust, there are three parties because title to the property is held by a
land trustee under a land trust agreement of which the borrower/property owner
is the beneficiary; at origination of a mortgage loan, the borrower executes a
separate undertaking to make payments on the mortgage note. Under a deed of
trust, the homeowner or borrower, called the "grantor," grants the security
property to a third-party grantee, called the "trustee," for the benefit of
the lender, usually called the "beneficiary." The deed of trust gives the
trustee the authority, if the borrower defaults, to sell the security property
in a "foreclosure" or "trustee's sale" and to apply the sale proceeds to the
secured debt. The mortgagee's authority under a mortgage and the trustee's
authority under a deed of trust are governed by the law of the state in which
the real property is located, the express provisions of the mortgage or deed
of trust, and, in some cases, in deed of trust transactions, the directions of
the beneficiary.
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FORECLOSURE ON MORTGAGES AND DEEDS OF TRUST
Foreclosure of a mortgage is generally accomplished by judicial action.
Generally, the action is initiated by the service of legal pleadings upon all
parties having an interest of record in the real property. Delays in
completion of the foreclosure occasionally may result from difficulties in
locating necessary parties defendant. When the mortgagee's right to
foreclosure is contested, the legal proceedings necessary to resolve the issue
can be time-consuming and expensive. After the completion of a judicial
foreclosure proceeding, the court may issue a judgment of foreclosure and
appoint a receiver or other officer to conduct the sale of the property. In
some states, mortgages may also be foreclosed without a judicial proceeding,
pursuant to a power of sale provided in the mortgage. Foreclosure of a
mortgage by using an advertisement is essentially similar to foreclosure of a
deed of trust by nonjudicial power of sale.
If a borrower defaults under a loan secured by a deed of trust, the lender
generally may bring suit against the borrower. The lender generally also may
attempt to collect the loan by causing the deed of trust to be enforced
against the property it encumbers. Enforcement of a deed of trust is
accomplished in most cases by a trustee's sale in which the trustee, upon
default of the grantor, and subject to the expiration of applicable cure
periods, sells the security property at a public sale under the terms of the
loan documents and subject to the applicable procedural provisions of state
law.
In Maryland, a summary court proceeding must be commenced (and a bond must
be filed) to effect a trustee's sale, even under a deed of trust that includes
a power of sale. In Virginia and the District of Columbia, a trustee's sale
generally is non-judicial, although foreclosure may be accomplished by
judicial action in all of the Mortgage Loan Jurisdictions. The term
"foreclosure" often is used as a shorthand way of referring to a trustee's
sale as well as to judicial foreclosure.
In Maryland and the District of Columbia, prior to a trustee's sale, the
trustee must record a notice of sale in the public records. In all of the
Mortgage Loan Jurisdictions, the trustee must give notice of the sale to the
grantor and/or to any successor in interest to the grantor. The trustee also
generally will give notice of the sale to the beneficiary of any junior deed
of trust or other lien and to certain other interested persons. This notice to
junior lien holders is required in Maryland and Virginia. In the Mortgage Loan
Jurisdictions, in addition to the notice to the grantor and others described
above, notice of sale must be published periodically in a local newspaper for
a prescribed period prior to the trustee's sale.
The trustee's sale generally must be conducted by public auction in the
county or city in which all or some part of the security property is located.
At the sale, the trustee generally requires a bidder to deposit with the
trustee a set amount or a percentage of the full amount of the bidder's final
bid in cash (or an equivalent thereto satisfactory to the trustee) prior to
and as a condition to recognizing such bid, and may conditionally accept and
hold these amounts for the duration of the sale. The beneficiary of the deed
of trust generally need not bid cash at the sale, but may instead make a
"credit bid" up to the extent of the total amount due under the deed of trust,
including costs and expenses actually incurred in enforcing the deed of trust,
as well as the trustee's fees and expenses. The trustee will sell the security
property to the highest proper bidder at the sale. Other than in Maryland,
judicial confirmation typically is not required after a sale conducted in
accordance with a power of sale in the Mortgage Loan Jurisdictions.
A sale conducted in accordance with the terms of the power of sale contained
in the deed of trust generally is presumed to be conducted regularly and
fairly, and, on a conveyance of the property by trustee's deed, confers
absolute legal title to the property to the purchaser, free of all junior
deeds of trust and free of all other liens and claims subordinate to the deed
of trust under which the sale is made. The purchaser's title, however, is
subject to all senior liens and other senior claims. Thus, if the deed of
trust being enforced is a junior deed of trust such as the deeds of trust
securing most of the Mortgage Loans, the trustee will convey title to the
property to the purchaser subject to the first deed of trust and any other
prior liens and claims. A trustee's sale or judicial foreclosure under a
junior deed of trust generally has no effect on any senior deed of trust, with
the possible exception of the right of a senior beneficiary to accelerate its
indebtedness under a default clause or a "due-on-sale" clause contained in the
senior deed of trust.
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Because a potential buyer at the sale may find it difficult to determine the
exact status of title and other facts about the security property, and because
the physical condition of the security property may have deteriorated, it
generally is more common for the lender, rather than an unrelated third party,
to purchase the security property at a trustee's sale or judicial foreclosure
sale. The lender (or other purchaser at the trustee's sale) will be subject to
the burdens of ownership, including the obligations to service any senior
mortgage or deed of trust, to obtain hazard insurance and to make such repairs
at its own expense as are necessary to render the security property suitable
for resale. The lender commonly will attempt to resell the security property
and obtain the services of a real estate broker and agree to pay the broker
commission in connection with the resale. Depending upon market conditions,
the ultimate proceeds of the resale of the security property may not be high
enough to equal the lender's investment. Property securing a Mortgage Loan
held by a Trust Fund for which a REMIC election has been made that is acquired
through a trustee's sale or judicial foreclosure must be sold by the Trustee
within two years after the date on which it is acquired, unless the IRS has
granted permission to sell such Property at a later date, in order to satisfy
certain Federal income tax requirements.
The proceeds received by the lender or trustee from the sale generally are
applied first to the costs, fees and expenses of sale and then in satisfaction
of the indebtedness secured by the mortgage or deed of trust under which the
sale was conducted. Any remaining proceeds generally are payable to the
holders of junior mortgages or deeds of trust and other liens and claims in
order of their priority. Any balance remaining generally is payable to the
borrower or grantor. Following the sale, if there are insufficient proceeds to
repay the secured debt, the lender or beneficiary under the foreclosed lien
generally may obtain a deficiency judgment against the grantor.
Some courts have been faced with the issue of whether federal or state
constitutional due process requires that borrowers under mortgages or deeds of
trust receive notices in addition to the statutorily prescribed minimum. For
the most part, the courts in these cases have upheld the notice provisions and
procedures described above.
An action to foreclose a mortgage or deed of trust is an action to recover
the secured debt by enforcing the mortgagee's or trustee's rights under the
mortgage or deed of trust. It is regulated by statutes and rules and subject
throughout to the court's equitable powers. Generally, a mortgagor or grantor
is bound by the terms of the related mortgage note and the mortgage or deed of
trust as made and cannot be relieved from his default if the mortgagee or
trustee has exercised its rights in a commercially reasonable manner. However,
since a foreclosure action historically was equitable in nature, the court may
exercise equitable powers to relieve a borrower of a default and deny the
foreclosure on proof that either the borrower's default was neither willful
nor in bad faith or the lender's action established a waiver, fraud, bad
faith, or oppressive or unconscionable conduct such as to warrant a court of
equity to refuse affirmative relief to the lender. Under certain circumstances
a court of equity may relieve the borrower from an entirely technical default
where such default was not willful.
A foreclosure action is subject to most of the delays and expenses of other
lawsuits if defenses or counterclaims are interposed, sometimes requiring up
to several years to complete. Moreover, a non-collusive, regularly conducted
foreclosure sale may be challenged as a fraudulent conveyance, regardless of
the parties' intent, if a court determines that the sale was for less than
fair consideration and such sale occurred while the borrower was insolvent and
within one year (or within the state statute of limitations if the trustee in
bankruptcy elects to proceed under state fraudulent conveyance law) of the
filing of bankruptcy. Similarly, a suit against the debtor on the related
mortgage note may take several years and, generally (although not with respect
to the Mortgage Loan Jurisdictions), is a remedy alternative to foreclosure,
the mortgagee being precluded from pursuing both at the same time.
In the case of foreclosure under either a mortgage or a deed of trust, the
sale by the referee or other designated officer or by the trustee is a public
sale. However, because of the difficulty potential third party purchasers at
the sale have in determining the exact status of title and because the
physical condition of the property may have deteriorated during the
foreclosure proceedings, it is uncommon for a third party to purchase the
property at a foreclosure sale. Rather, it is common for the lender to
purchase the property from the trustee
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or referee for an amount which may be equal to the unpaid principal amount of
the mortgage note secured by the mortgage or deed of trust plus accrued and
unpaid interest and the expenses of foreclosure, in which event the borrower's
debt will be extinguished or the lender may purchase for a lesser amount in
order to preserve its right against a borrower to seek a deficiency judgment
in states where such a judgment is available. Thereafter, subject to the right
of the borrower in some states to remain in possession during the redemption
period, the lender will assume the burdens of ownership, including obtaining
hazard insurance, paying taxes and making such repairs at its own expense as
are necessary to render the property suitable for sale. The lender will
commonly obtain the services of a real estate broker and pay the broker's
commission in connection with the sale of the property. Depending upon market
conditions, the ultimate proceeds of the sale of the property may not equal
the lender's investment in the property. Any loss may be reduced by the
receipt of any mortgage guaranty insurance proceeds.
RIGHTS OF REDEMPTION
In some states, after sale pursuant to a deed of trust or foreclosure of a
mortgage, the trustor or mortgagor and foreclosed junior lienors are given a
statutory period in which to redeem the property from the foreclosure sale.
The right of redemption should be distinguished from the equity of redemption,
which is a non-statutory right that must be exercised prior to the foreclosure
sale. In some states, redemption may occur only upon payment of the entire
principal balance of the loan, accrued interest and expenses of foreclosure.
In other states, redemption may be authorized if the former borrower pays only
a portion of the sums due. The effect of a statutory right of redemption is to
diminish the ability of the lender to sell the foreclosed property. The
exercise of a right of redemption would defeat the title of any purchaser at a
foreclosure sale, or of any purchaser from the lender subsequent to
foreclosure or sale under a deed of trust. Consequently the practical effect
of a right of redemption is to force the lender to retain the property and pay
the expenses of ownership until the redemption period has run. In some states,
there is no right to redeem property after a trustee's sale under a deed of
trust.
In the District of Columbia, the debtor under a residential deed of trust
(or anyone on the debtor's behalf) may cure a default during a reinstatement
period by paying the entire amount of the debt then due, exclusive of amounts
due solely to acceleration upon default, plus costs and expenses actually
incurred in enforcing the obligation and statutorily limited attorneys' and
trustee's fees. In all of the Mortgage Loan Jurisdictions, the grantor (or the
grantor's successor), any beneficiary under a junior deed of trust or any
other persons having a subordinate lien or encumbrance may discharge the deed
of trust on the security property by paying the entire principal due as a
result of the acceleration, together with interest and costs, expenses and
fees.
When the lender under a junior mortgage or deed of trust cures the default
and reinstates or redeems the senior mortgage or deed of trust, the amount
paid by the beneficiary for such cure generally becomes a part of the
indebtedness secured by the junior deed of trust.
State laws may control the amount of foreclosure expenses and costs,
including attorneys' fees, which may be recovered by a lender. In the Mortgage
Loan Jurisdictions, there generally is no right to redeem the security
property after the completion of a proper trustee's or foreclosure sale.
JUNIOR MORTGAGES; RIGHTS OF SENIOR MORTGAGES
The Mortgage Loans comprising or underlying the Primary Assets included in
the Trust Fund for a Series will be secured by mortgages or deeds of trust
which may be second or more junior mortgages to other mortgages held by other
lenders or institutional investors. The rights of the Trust Fund (and
therefore the Holders), under a junior mortgage or deed of trust, are
subordinate to those of the holder of the senior mortgage or deed of trust,
including the prior rights of the senior mortgagee or trustee to receive
hazard insurance and condemnation proceeds and to cause the property securing
the mortgage loan to be sold upon default of the borrower, thereby
extinguishing the junior mortgagee's lien unless the junior mortgagee or
trustee asserts its subordinate interest in the property in foreclosure
litigation and, possibly, satisfies the defaulted senior mortgage or deed of
trust. A junior lender may satisfy a defaulted senior loan in full and, in
some states, may cure such default and bring the
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senior loan current, in either event adding the amounts expended to the
balance due on the junior loan. In most states, absent a provision in the
mortgage or deed of trust, no notice of default is required to be given to a
junior mortgagee. In addition, as described above, the rights of the Trust
Fund may be or become subject to liens for real estate taxes and other
obligations. Although the Transferor generally does not cure defaults under a
senior deed of trust or other lien, it is the Transferor's standard practice
to protect its interest by monitoring any such sale of which it is aware and
bidding for property if it determines that it is in the Transferor's best
interests to do so.
The standard form of the mortgage or deed of trust used by most
institutional lenders, like that used by the Transferor, confers on the lender
the right both to receive all proceeds collected under any hazard insurance
policy and all awards made in connection with condemnation proceedings. The
lender generally has the right, subject to the specific provisions of the
mortgage or deed of trust securing its loan, to apply such proceeds and awards
to repair of any damage to the security property or to payment of any
indebtedness secured by the mortgage or deed of trust, in such order as the
lender may determine. Thus, in the event improvements on the property are
damaged or destroyed by fire or other casualty, or in the event the property
is taken by condemnation, the mortgagee or beneficiary under underlying senior
loans will have the prior right to collect any insurance proceeds payable
under a hazard insurance policy and any award of damages in connection with
the condemnation and to apply the same to the indebtedness secured by the
senior mortgages or deeds of trust. If available, proceeds in excess of the
amount of senior mortgage indebtedness, in most cases, will be applied to the
indebtedness of a junior mortgage.
The form of deed of trust or mortgage used by most institutional lenders
which make revolving home equity loans typically contains a "future advance"
clause, which provides, in essence, that additional amounts advanced to or on
behalf of the borrower by the beneficiary or lender are to be secured by the
deed of trust or mortgage. In Maryland, a future advance may be entitled to
receive the same priority as amounts initially advanced under the deed of
trust, notwithstanding that there may be intervening junior deeds of trust and
other liens between the date of recording of the deed of trust and the date of
the future advance, and notwithstanding that the beneficiary had actual
knowledge of such intervening deeds of trust and other liens at the time of
the advance so long as the additional amounts are within the maximum principal
amount stated in the deed of trust. In Virginia and the District of Columbia,
an intervening lien may gain priority, even if the lender had no knowledge of
the intervening lien at the time of an additional advance. The priority of
future advances over intervening liens may be affected in some states by
whether the beneficiary is obligated to advance the additional amount or has
notice or actual knowledge of the intervening junior deeds of trust and other
liens. In Maryland, priority of advances under the clause rests on a statute
giving priority to all advances or readvances made under the loan agreement to
a "credit limit" amount stated in the recorded deed of trust.
Other provisions typically found in the form of the mortgage or deed of
trust used by institutional lenders obligate the grantor or mortgagor to pay
before delinquency all taxes and assessments on the property and, when due,
all encumbrances, charges and liens on the property which appear prior to the
mortgage or deed of trust, to provide and maintain fire insurance on the
property, to maintain and repair the property and not to commit or permit any
waste thereof, and to appear in and defend any action or proceeding purporting
to affect the property or the rights of the mortgagee under the mortgage. Upon
a failure of the grantor or mortgagor to perform any of these obligations, the
mortgagee, trustee or beneficiary is given the right under certain mortgages
and deeds of trust to perform the obligation itself, at its election, with the
mortgagor agreeing to reimburse any sums so expended. The mortgage or deed of
trust typically provides that all sums so expended by the mortgagee,
beneficiary or trustee become part of the indebtedness secured by the
mortgage.
ANTI-DEFICIENCY LEGISLATION AND OTHER LIMITATIONS ON LENDERS
Certain states have imposed statutory prohibitions which limit the remedies
of a beneficiary under a deed of trust or a mortgagee under a mortgage. In
some states, statutes limit the right of the beneficiary or mortgagee to
obtain a deficiency judgment against the borrower following foreclosure or
sale under a deed of trust. A deficiency judgment is a personal judgment
against the former borrower equal in most cases to the difference
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between the net amount realized upon the public sale of the real property and
the amount due to the lender. Other statutes require the beneficiary or
mortgagee to exhaust the security afforded under a deed of trust or mortgage
by foreclosure in an attempt to satisfy the full debt before bringing a
personal action against the borrower. In certain other states, the lender has
the option of bringing a personal action against the borrower on the debt
without first exhausting such security; however, in some of these states, the
lender, following judgment on such personal action, may be deemed to have
elected a remedy and may be precluded from exercising remedies with respect to
the security. Consequently, the practical effect of the election requirement,
when applicable, is that lenders will usually proceed first against the
security rather than bringing a personal action against the borrower. Finally,
other statutory provisions limit any deficiency judgment against the former
borrower following a foreclosure sale to the excess of the outstanding debt
over the fair market value of the property at the time of the public sale. The
purpose of these statutes is generally to prevent a beneficiary or a mortgagee
from obtaining a large deficiency judgment against the former borrower as a
result of low or no bids at the foreclosure sale.
In addition to laws limiting or prohibiting deficiency judgments, numerous
other statutory provisions, including the federal bankruptcy laws, the Federal
Soldiers' and Sailors' Relief Act and state laws affording relief to debtors,
may interfere with or affect the ability of the secured lender to realize upon
collateral and/or enforce a deficiency judgment. For example, with respect to
federal bankruptcy law, the filing of a petition acts as a stay against the
enforcement of remedies for collection of a debt. Moreover, a court with
federal bankruptcy jurisdiction may permit a debtor through a Chapter 13
Bankruptcy Code rehabilitative plan to cure a monetary default with respect to
a loan on a debtor's residence by paying arrearages within a reasonable time
period and reinstating the original loan payment schedule even though the
lender accelerated the loan and the lender has taken all steps to realize upon
its security (provided no sale of the property has yet occurred) prior to the
filing of the debtor's Chapter 13 petition. Some courts with federal
bankruptcy jurisdiction have approved plans, based on the particular facts of
the reorganization case, that effected the curing of a loan default by
permitting the obligor to pay arrearages over a number of years.
Courts with federal bankruptcy jurisdiction have also indicated that the
terms of a mortgage loan may be modified if the borrower has filed a petition
under Chapter 13. These courts have suggested that such modifications may
include reducing the amount of each monthly payment, changing the rate of
interest, altering the repayment schedule and reducing the lender's security
interest to the value of the residence, thus leaving the lender a general
unsecured creditor for the difference between the value of the residence and
the outstanding balance of the loan. Federal bankruptcy law and limited case
law indicate that the foregoing modifications could not be applied to the
terms of a loan secured by property that is the principal residence of the
debtor. In all cases, the secured creditor is entitled to the value of its
security plus post-petition interest, attorney's fees and costs to the extent
the value of the security exceeds the debt.
In a Chapter 11 case under the Bankruptcy Code, the lender is precluded from
foreclosing without authorization from the bankruptcy court. The lender's lien
may be transferred to other collateral and/or be limited in amount to the
value of the lender's interest in the collateral as of the date of the
bankruptcy. The loan term may be extended, the interest rate may be adjusted
to market rates and the priority of the loan may be subordinated to bankruptcy
court-approved financing. The bankruptcy court can, in effect, invalidate due-
on-sale clauses through confirmed Chapter 11 plans of reorganization.
The Bankruptcy Code provides priority to certain tax liens over the lender's
security. This may delay or interfere with the enforcement of rights in
respect of a defaulted Loan. In addition, substantive requirements are imposed
upon lenders in connection with the origination and the servicing of mortgage
loans by numerous federal and some state consumer protection laws. The laws
include the federal Truth-in-Lending Act, Real Estate Settlement Procedures
Act, Equal Credit Opportunity Act, Fair Credit Billing Act, Fair Credit
Reporting Act and related statutes and regulations. These federal laws impose
specific statutory liabilities upon lenders who originate loans and who fail
to comply with the provisions of the law. In some cases, this liability may
affect assignees of the loans.
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DUE-ON-SALE CLAUSES IN MORTGAGE LOANS
Due-on-sale clauses permit the lender to accelerate the maturity of the loan
if the borrower sells or transfers, whether voluntarily or involuntarily, all
or part of the real property securing the loan without the lender's prior
written consent. The enforceability of these clauses has been the subject of
legislation or litigation in many states, and in some cases, typically
involving single family residential mortgage transactions, their
enforceability has been limited or denied. In any event, the Garn-St Germain
Depository Institutions Act of 1982 (the "Garn-St Germain Act") preempts state
constitutional, statutory and case law that prohibits the enforcement of due-
on-sale clauses and permits lenders to enforce these clauses in accordance
with their terms, subject to certain exceptions. As a result, due-on-sale
clauses have become generally enforceable except in those states whose
legislatures exercised their authority to regulate the enforceability of such
clauses with respect to mortgage loans that were (i) originated or assumed
during the "window period" under the Garn-St Germain Act which ended in all
cases not later than October 15, 1982, and (ii) originated by lenders other
than national banks, federal savings institutions and federal credit unions.
FHLMC has taken the position in its published mortgage servicing standards
that, out of a total of eleven "window period states," five states (Arizona,
Michigan, Minnesota, New Mexico and Utah) have enacted statutes extending, on
various terms and for varying periods, the prohibition on enforcement of due-
on-sale clauses with respect to certain categories of window period loans.
Also, the Garn-St Germain Act does "encourage" lenders to permit assumption of
loans at the original rate of interest or at some other rate less than the
average of the original rate and the market rate.
In addition, under federal bankruptcy law, due-on-sale clauses may not be
enforceable in bankruptcy proceedings and may, under certain circumstances, be
eliminated in any modified mortgage resulting from such bankruptcy proceeding.
ENFORCEABILITY OF PREPAYMENT AND LATE PAYMENT FEES
Forms of notes, mortgages and deeds of trust used by lenders may contain
provisions obligating the borrower to pay a late charge if payments are not
timely made, and in some circumstances may provide for prepayment fees or
penalties if the obligation is paid prior to maturity. In certain states,
there are or may be specific limitations upon the late charges which a lender
may collect from a borrower for delinquent payments. Certain states also limit
the amounts that a lender may collect from a borrower as an additional charge
if the loan is prepaid. Late charges and prepayment fees are typically
retained by servicers as additional servicing compensation.
EQUITABLE LIMITATIONS ON REMEDIES
In connection with lenders' attempts to realize upon their security, courts
have invoked general equitable principles. The equitable principles are
generally designed to relieve the borrower from the legal effect of his
defaults under the loan documents. Examples of judicial remedies that have
been fashioned include judicial requirements that the lender undertake
affirmative and expensive actions to determine the causes of the borrower's
default and the likelihood that the borrower will be able to reinstate the
loan. In some cases, courts have substituted their judgment for the lender's
judgment and have required that lenders reinstate loans or recast payment
schedules in order to accommodate borrowers who are suffering from temporary
financial disability. In other cases, courts have limited the right of a
lender to realize upon his security if the default under the security
agreement is not monetary, such as the borrower's failure adequately to
maintain the property or the borrower's execution of secondary financing
affecting the property. Finally, some courts have been faced with the issue of
whether or not federal or state constitutional provisions reflecting due
process concerns for adequate notice require that borrowers under security
agreements receive notices in addition to the statutorily-prescribed minimums.
For the most part, these cases have upheld the notice provisions as being
reasonable or have found that, in cases involving the sale by a trustee under
a deed of trust or by a mortgagee under a mortgage having a power of sale,
there is insufficient state action to afford constitutional protections to the
borrower.
Most conventional single-family mortgage loans may be prepaid in full or in
part without penalty. The regulations of the Office of Thrift Supervision (the
"OTS") prohibit the imposition of a prepayment penalty or
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equivalent fee for or in connection with the acceleration of a loan by
exercise of a due-on-sale clause. A mortgagee to whom a prepayment in full has
been tendered may be compelled to give either a release of the mortgage or an
instrument assigning the existing mortgage. The absence of a restraint on
prepayment, particularly with respect to mortgage loans having higher mortgage
rates, may increase the likelihood of refinancing or other early retirements
of such mortgage loans.
APPLICABILITY OF USURY LAWS
Each Mortgage Loan Jurisdiction has usury laws which limit the interest and
other amounts that may be charged under certain loans. Title V of the
Depository Institutions Deregulation and Monetary Control Act of 1980, enacted
in March 1980 ("Title V"), provides that state usury limitations shall not
apply to certain types of residential first mortgage loans originated by
certain lenders after March 31, 1980. Similar federal statutes were in effect
with respect to mortgage loans made during the first three months of 1980. The
OTS, as successor to the Federal Home Loan Bank Board, is authorized to issue
rules and regulations and to publish interpretations governing implementation
of Title V. Title V authorizes any state to reimpose interest rate limits by
adopting, before April 1, 1983, a state law, or by certifying that the voters
of such state have voted in favor of any provision, constitutional or
otherwise, which expressly rejects an application of the federal law. Any
contract which is secured by a first lien on certain kinds of consumer goods
would be covered if they satisfy certain conditions, among other things,
governing the terms of any prepayments, late charges and deferral fees and
requiring a 30-day notice period prior to instituting any action leading to
repossession of the related unit. Fifteen states adopted such a law prior to
the April 1, 1983 deadline. In addition, even where Title V is not so
rejected, any state is authorized by the law to adopt a provision limiting
discount points or other charges on mortgage loans covered by Title V.
THE HOME IMPROVEMENT CONTRACTS
General
The Home Improvement Contracts, other than those Home Improvement Contracts
that are unsecured or secured by mortgages on real estate (such Home
Improvement Contracts are hereinafter referred to in this section as
"contracts"), generally are "chattel paper" or constitute "purchase money
security interests" each as defined in the Uniform Commercial Code (the
"UCC"). Pursuant to the UCC, the sale of chattel paper is treated in a manner
similar to perfection of a security interest in chattel paper. Under the
related Agreement, the Transferor will transfer physical possession of the
contracts to the Trustee or a designated custodian or may retain possession of
the contracts as custodian for the Trustee. In addition, the Transferor will
make an appropriate filing of a UCC-1 financing statement in the appropriate
states to give notice of the Trustee's ownership of the contracts. Unless
otherwise specified in the related Prospectus Supplement, the contracts will
not be stamped or otherwise marked to reflect their assignment from the
Transferor to the Trustee. Therefore, if through negligence, fraud or
otherwise, a subsequent purchaser were able to take physical possession of the
contracts without notice of such assignment, the Trustee's interest in the
contracts could be defeated.
Security Interests in Home Improvements
The contracts that are secured by the Home Improvements financed thereby
grant to the originator of such contracts a purchase money security interest
in such Home Improvements to secure all or part of the purchase price of such
Home Improvements and related services. A financing statement generally is not
required to be filed to perfect a purchase money security interest in consumer
goods. Such purchase money security interests are assignable. In general, a
purchase money security interest grants to the holder a security interest that
has priority over a conflicting security interest in the same collateral and
the proceeds of such collateral. However, to the extent that the collateral
subject to a purchase money security interest becomes a fixture, in order for
the related purchase money security interest to take priority over a
conflicting interest in the fixture, the holder's interest in such Home
Improvement must generally be perfected by a timely fixture filing. In
general, a security interest does not exist under the UCC in ordinary building
material incorporated into an improvement on land.
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Home Improvement Contracts that finance lumber, bricks, other types of
ordinary building material or other goods that are deemed to lose such
characterization, upon incorporation of such materials into the related
property, will not be secured by a purchase money security interest in the
Home Improvement being financed.
Enforcement of Security Interest in Home Improvements
So long as the Home Improvement has not become subject to the real estate
law, a creditor can repossess a Home Improvement securing a contract by
voluntary surrender, by "self-help" repossession that is "peaceful" (i.e.,
without breach of the peace) or, in the absence of voluntary surrender and the
ability to repossess without breach of the peace, by judicial process. The
holder of a contract must give the debtor a number of days' notice, which
varies from 10 to 30 days depending on the state, prior to commencement of any
repossession. The UCC and consumer protection laws in most states place
restrictions on repossession sales, including requiring prior notice to the
debtor and commercial reasonableness in effecting such a sale. The law in most
states also requires that the debtor be given notice of any sale prior to
resale of the unit so that the debtor may redeem it at or before such resale.
Under the laws applicable in most states, a creditor is entitled to obtain a
deficiency judgment from a debtor for any deficiency on repossession and
resale of the property securing the debtor's loan. However, some states impose
prohibitions or limitations on deficiency judgments, and in many cases the
defaulting borrower would have no assets with which to pay a judgment.
Certain other statutory provisions, including federal and state bankruptcy
and insolvency laws and general equitable principles, may limit or delay the
ability of a lender to repossess and resell collateral or enforce a deficiency
judgment.
Consumer Protection Laws
The so-called "Holder-in-Due-Course" rule of the Federal Trade Commission is
intended to defeat the ability of the transferor of a consumer credit contract
which is the seller of goods which gave rise to the transaction (and certain
related lenders and assignees) to transfer such contract free of notice of
claims by the debtor thereunder. The effect of this rule is to subject the
assignee of such a contract to all claims and defenses which the debtor could
assert against the seller of goods. Liability under this rule is limited to
amounts paid under a contract; however, the obligor also may be able to assert
the rule to set off remaining amounts due as a defense against a claim brought
by the Trustee against such obligor. Numerous other federal and state consumer
protection laws impose requirements applicable to the origination and lending
pursuant to the contracts, including the Truth in Lending Act, the Federal
Trade Commission Act, the Fair Credit Billing Act, the Fair Credit Reporting
Act, the Equal Credit Opportunity Act, the Fair Debt Collection Practices Act
and the Uniform Consumer Credit Code. In the case of some of these laws, the
failure to comply with their provisions may affect the enforceability of the
related contract.
INSTALLMENT SALES CONTRACTS
The Loans may also consist of installment sales contracts. Under an
installment sales contract ("Installment Sales Contract") the seller
(hereinafter referred to in this section as the "lender") retains legal title
to the property and enters into an agreement with the purchaser (hereinafter
referred to in this section as the "borrower") for the payment of the purchase
price, plus interest, over the term of such contract. Only after full
performance by the borrower of the contract is the lender obligated to convey
title to the property to the purchaser. As with mortgage or deed of trust
financing, during the effective period of the Installment Sales Contract, the
borrower is generally responsible for maintaining the property in good
condition and for paying real estate taxes, assessments and hazard insurance
premiums associated with the property.
The method of enforcing the rights of the lender under an Installment Sales
Contract varies on a state-by-state basis depending upon the extent to which
state courts are willing, or able pursuant to state statute, to enforce
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the contract strictly according to the terms. The terms of Installment Sales
Contracts generally provide that upon a default by the borrower, the borrower
loses his or her right to occupy the property, the entire indebtedness is
accelerated, and the buyer's equitable interest in the property is forfeited.
The lender in such a situation does not have to foreclose in order to obtain
title to the property, although in some cases a quiet title action is in order
if the borrower has filed the Installment Sales Contract in local land
records, and an ejectment action may be necessary to recover possession. In a
few states, particularly in cases of borrower default during the early years
of an Installment Sales Contract, the courts will permit ejectment of the
buyer and a forfeiture of his or her interest in the property. However, most
state legislatures have enacted provisions by analogy to mortgage law
protecting borrowers under Installment Sales Contracts from the harsh
consequences of forfeiture. Under such statutes, a judicial or nonjudicial
foreclosure may be required, the lender may be required to give notice of
default and the borrower may be granted some grace period during which the
Installment Sales Contract may be reinstated upon full payment of the default
amount and the borrower may have a post-foreclosure statutory redemption
right. In other states, courts in equity may permit a borrower with
significant investment in the property under an Installment Sales Contract for
the sale of real estate to share in the proceeds of sale of the property after
the indebtedness is repaid or may otherwise refuse to enforce the forfeiture
clause. Nevertheless, generally speaking, the lender's procedures for
obtaining possession and clear title under an Installment Sales Contract in a
given state are simpler and less time-consuming and costly than are the
procedures for foreclosing and obtaining clear title to a property subject to
one or more liens.
ENVIRONMENTAL LEGISLATION
A federal statute, the Comprehensive Environmental Response, Compensation,
and Liability Act of 1980, and a growing number of state laws impose a
statutory lien for associated costs on property that is the subject of a
clean-up action on account of hazardous wastes or hazardous substances
released or disposed of on the property. Such a lien generally will have
priority over all subsequent liens on the property and, in certain of these
states, will have priority over prior recorded liens, including the lien of a
deed of trust. The priority of the environmental lien under federal law
depends on the time of perfection of the federal lien compared to the time of
perfection of any competing liens under applicable state law. In addition,
under federal environmental legislation and possibly under state law in a
number of states, a secured party that takes a deed in lieu of foreclosure or
acquires a property at a foreclosure sale may be liable for the costs of
cleaning up a contaminated site. Although such costs could be substantial,
they would probably not be imposed on a secured lender (such as the applicable
Trust Fund) if it promptly marketed the foreclosed property for resale. In the
event that a Trust Fund acquired title to a property securing a Mortgage Loan
and cleanup costs were incurred in respect of the property, the holders of the
Securities might incur a delay in the payment if such costs were required to
be paid by such Trust Fund.
SOLDIERS' AND SAILORS' CIVIL RELIEF ACT OF 1940
Under the Soldiers' and Sailors' Civil Relief Act of 1940, members of all
branches of the military on active duty, including draftees and reservists in
military service, (i) are entitled to have interest rates reduced and capped
at 6% per annum, on obligations (including Loans) incurred prior to the
commencement of military service for the duration of military service, (ii)
may be entitled to a stay of proceedings on any kind of foreclosure or
repossession action in the case of defaults on such obligations entered into
prior to military service for the duration of military service and (iii) may
have the maturity of such obligations incurred prior to military service
extended, the payments lowered and the payment schedule readjusted for a
period of time after the completion of military service. However, the benefits
of (i), (ii), or (iii) above are subject to challenge by creditors and if, in
the opinion of the court, the ability of a person to comply with such
obligations is not materially impaired by military service, the court may
apply equitable principles accordingly. If a borrower's obligation to repay
amounts otherwise due on a Loan included in a Trust Fund for a Series is
relieved pursuant to the Soldiers' and Sailors' Civil Relief Act of 1940, none
of the Trust Fund, the Servicer, the Transferor nor the Trustee will be
required to advance such amounts, and any loss in respect thereof may reduce
the amounts available to be paid to the Holders of the Securities of such
Series. Unless otherwise specified in the related Prospectus Supplement,
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any shortfalls in interest collections on Loans or Underlying Loans relating
to the Private Securities, as applicable, included in a Trust Fund for a
Series resulting from application of the Soldiers' and Sailors' Civil Relief
Act of 1940 will be allocated to each Class of Securities of such Series that
is entitled to receive interest in respect of such Loans or Underlying Loans
in proportion to the interest that each such Class of Securities would have
otherwise been entitled to receive in respect of such Loans or Underlying
Loans had such interest shortfall not occurred.
THE TRANSFEROR
The Transferor is a federally chartered stock savings bank. The Transferor's
executive offices are located at 8401 Connecticut Avenue, Chevy Chase,
Maryland 20815, and the Transferor's telephone number is (301) 986-7000. The
Transferor is subject to comprehensive regulation, examination and supervision
by the OTS within the Department of the Treasury and the FDIC. Deposits at the
Transferor are fully insured up to $100,000 per insured depositor by the
Savings Association Insurance Fund, which is administered by the FDIC. For
further information regarding the Transferor, see "THE TRANSFEROR" in the
related Prospectus Supplement.
USE OF PROCEEDS
The Transferor will apply all or substantially all of the net proceeds from
the sale of each Series of Certificates for one or more of the following
purposes: (i) to establish any Reserve Fund, Pre-Funding Account or
Capitalized Interest Account, (ii) to pay costs of structuring and issuing
such Securities, including the costs of obtaining Enhancement and (iii) for
its general corporate purposes.
FEDERAL INCOME TAX CONSIDERATIONS
GENERAL
The following is a summary of the material federal income tax consequences
of the purchase, ownership and disposition of Securities. The summary does not
purport to deal with all aspects of federal income taxation that may affect
particular investors in light of their individual circumstances, nor with
certain types of investors subject to special treatment under the federal
income tax laws. This summary focuses primarily upon investors who will hold
Securities as "capital assets" (generally, property held for investment)
within the meaning of Section 1221 of the Internal Revenue Code of 1986, as
amended (the "Code"), but much of the discussion is applicable to other
investors as well. Because tax consequences may vary based on the status or
tax attributes of the owner of a Security, prospective investors are advised
to consult their own tax advisors concerning the federal, state, local and any
other tax consequences to them of the purchase, ownership and disposition of
the Securities. For purposes of this tax discussion (except with respect to
information reporting, or where the context indicates otherwise), any
reference to the "Holder" means the beneficial owner of a Security.
The summary is based upon the provisions of the Code, the regulations
promulgated thereunder, including, where applicable, proposed regulations, and
the judicial and administrative rulings and decisions now in effect, all of
which are subject to change or possible differing interpretations. The
statutory provisions, regulations, and interpretations on which this
interpretation is based are subject to change, and such a change could apply
retroactively.
The federal income tax consequences to Holders will vary depending on
whether (i) the Securities of a Series are classified as indebtedness for
federal income tax purposes; (ii) an election is made to treat the Trust Fund
(or certain assets of the Trust Fund) relating to a particular Series of
Securities as a real estate mortgage investment conduit ("REMIC") under the
Code; (iii) the Securities represent an ownership interest for federal income
tax purposes in some or all of the assets included in the Trust Fund for a
Series; or (iv) for federal income
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tax purposes the Trust Fund relating to a particular Series of Certificates is
classified as a partnership. The Prospectus Supplement for each Series of
Securities will specify how the Securities will be treated for federal income
tax purposes and will discuss whether a REMIC election, if any, will be made
with respect to such Series.
TAXATION OF DEBT SECURITIES (INCLUDING REGULAR INTEREST SECURITIES)
Interest and Acquisition Discount. Securities representing regular interest
in a REMIC ("Regular Interest Securities") are generally taxable to Holders in
the same manner as evidences of indebtedness issued by the REMIC. Stated
interest on the Regular Interest Securities will be taxable as ordinary income
and taken into account using the accrual method of accounting, regardless of
the Holder's normal accounting method. Interest (other than original issue
discount) on Securities (other than Regular Interest Securities) that are
characterized as indebtedness for federal income tax purposes will be
includible in income by Holders thereof in accordance with their usual methods
of accounting. Securities characterized as debt for federal income tax
purposes and Regular Interest Securities will be referred to hereinafter
collectively as "Debt Securities." For Certificates treated as debt for
federal income tax purposes, see "Certain Certificates Treated as
Indebtedness."
Debt Securities that are Compound Interest Securities will, and certain of
the other Debt Securities may, be issued with "original issue discount"
("OID"). The following discussion is based in part on the rules governing OID
which are set forth in Sections 1271-1275 of the Code and the Treasury
regulations issued thereunder on February 2, 1994 (the "OID Regulations"). A
Holder should be aware, however, that the OID Regulations do not adequately
address certain issues relevant to prepayable securities, such as the Debt
Securities.
In general, OID, if any, will equal the difference between the stated
redemption price at maturity of a Debt Security and its issue price. A Holder
of a Debt Security must include such OID in gross income as ordinary interest
income as it accrues under a prescribed method which takes into account an
economic accrual of the discount. In general, OID must be included in income
in advance of the receipt of the cash representing that income. The amount of
OID on a Debt Security will be considered to be zero if it is less than a de
minimis amount determined under the Code.
The issue price of a Debt Security is the first price at which a substantial
amount of Debt Securities of that class are sold to the public (excluding bond
houses, brokers, underwriters or wholesalers). If less than a substantial
amount of a particular class of Debt Securities is sold for cash on or prior
to the Closing Date, the issue price for such class will be treated as the
fair market value of such class on the Closing Date. The stated redemption
price at maturity of a Debt Security includes the original principal amount of
the Debt Security, but generally will not include distributions of interest if
such distributions constitute "qualified stated interest."
Under the OID Regulations, interest payments will not be qualified stated
interest unless the interest payments are "unconditionally payable." The OID
Regulations state that interest is unconditionally payable if late payment of
interest (other than late payment that occurs within a reasonable grace
period) or nonpayment of interest is expected to be penalized or reasonable
remedies exist to compel payment. The meaning of "penalized" under the OID
regulations is unclear particularly in the case of obligations based on other
debt obligations. Interest payments on Debt Securities which do not have
reasonable remedies to compel timely payment of interest may not be qualified
stated interest, and such Debt Securities may have original issue discount.
Certain Debt Securities will provide for distributions of interest based on
a period that is the same length as the interval between Distribution Dates
but ends prior to each Distribution Date. Any interest that accrues prior to
the Closing Date may be treated under the OID Regulations either (i) as part
of the issue price and the stated redemption price at maturity of the Debt
Securities or (ii) as not included in the issue price or stated redemption
price. The OID Regulations provide a special application of the de minimis
rule for debt instruments with long first accrual periods where the interest
payable for the first period is at a rate which is effectively less than that
which applies in all other periods. In such cases, for the sole purpose of
determining whether original issue discount is de minimis, the OID Regulations
provide that the stated redemption price is equal to the instrument's
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issue price plus the greater of the amount of foregone interest or the excess
(if any) of the instrument's stated principal amount over its issue price.
Under the de minimis rule, OID on a Debt Security will be considered to be
zero if such OID is less than 0.25% of the stated redemption price at maturity
of the Debt Security multiplied by the weighted average maturity of the Debt
Security. For this purpose, the weighted average maturity of the Debt Security
is computed as the sum of the amounts determined by multiplying the number of
full years (i.e., rounding down partial years) from the issue date until each
distribution in reduction of stated redemption price at maturity is scheduled
to be made by a fraction, the numerator of which is the amount of each
distribution included in the stated redemption price at maturity of the Debt
Security and the denominator of which is the stated redemption price at
maturity of the Debt Security. Holders generally must report de minimis OID
pro rata as principal payments are received, and such income will be capital
gain if the Debt Security is held as a capital asset. However, accrual method
Holders may elect to accrue all de minimis OID as well as market discount
under a constant interest method. See "--Election to Treat All Interest as
Original Issue Discount".
The Holder of a Debt Security issued with OID must include in gross income,
for all days during its taxable year on which it holds such Debt Security, the
sum of the "daily portions" of such original issue discount. The amount of OID
includible in income by a Holder will be computed by allocating to each day
during a taxable year a pro rata portion of the original issue discount that
accrued during the relevant accrual period. In the case of a Debt Security
that is not a Regular Interest Security and the principal payments on which
are not subject to acceleration resulting from prepayments on the Loans, the
amount of OID includible in income of a Holder for an accrual period
(generally the period over which interest accrues on the debt instrument) will
equal the product of the yield to maturity of the Debt Security and the
adjusted issue price of the Debt Security, reduced by any payments of
qualified stated interest. The adjusted issue price is the sum of its issue
price plus prior accruals of OID, reduced by the total payments made with
respect to such Debt Security in all prior periods, other than qualified
stated interest payments.
The amount of OID to be included in income by a Holder of a debt instrument,
such as certain Classes of the Debt Securities, that is subject to
acceleration due to prepayments on other debt obligations securing such
instruments or the yield on which may be affected by reason of prepayments (a
"Pay-Through Security"), is computed by taking into account the anticipated
rate of prepayments assumed in pricing the debt instrument (the "Prepayment
Assumption"). The amount of OID that will accrue during an accrual period on a
Pay-Through Security is the excess (if any) of the sum of (a) the present
value of all payments remaining to be made on the Pay-Through Security as of
the close of the accrual period and (b) the payments during the accrual period
of amounts included in the stated redemption price of the Pay-Through
Security, over the adjusted issue price of the Pay-Through Security at the
beginning of the accrual period. The present value of the remaining payments
is to be determined on the basis of three factors: (i) the original yield to
maturity of the Pay-Through Security (determined on the basis of compounding
at the end of each accrual period and properly adjusted for the length of the
accrual period), (ii) events which have occurred before the end of the accrual
period and (iii) the assumption that the remaining payments will be made in
accordance with the original Prepayment Assumption. The effect of this method
is to increase the portions of OID required to be included in income by a
Holder to take into account prepayments with respect to the Loans at a rate
that exceeds the Prepayment Assumption, and to decrease (but not below zero
for any period) the portions of OID required to be included in income by a
Holder of a Pay-Through Security to take into account prepayments with respect
to the Loans at a rate that is slower than the Prepayment Assumption. Although
OID will be reported to Holders of Pay-Through Securities based on the
Prepayment Assumption, no representation is made to Holders that Loans will be
prepaid at that rate or at any other rate.
The Transferor may adjust the accrual of OID on a Class of Regular Interest
Securities (or other regular interests in a REMIC) in a manner that it
believes to be appropriate, to take account of realized losses on the Loans,
although the OID Regulations do not provide for such adjustments. If the
Internal Revenue Service were to require that OID be accrued without such
adjustments, the rate of accrual of OID for a Class of Regular Interest
Securities could increase.
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Certain classes of Regular Interest Securities may represent more than one
class of REMIC regular interests. Unless the applicable Prospectus Supplement
specifies otherwise, the Trustee intends, based on the OID Regulations, to
calculate OID on such Securities as if, solely for the purposes of computing
OID, the separate regular interests were a single debt instrument.
A subsequent Holder of a Debt Security will also be required to include OID
in gross income, but such a Holder who purchases such Debt Security for an
amount that exceeds its adjusted issue price will be entitled (as will an
initial Holder who pays more than a Debt Security's issue price) to offset
such OID by comparable economic accruals of portions of such excess.
Effects of Defaults and Delinquencies. Holders will be required to report
income with respect to the related Securities under an accrual method without
giving effect to delays and reductions in distributions attributable to a
default or delinquency on the Loans, except possibly to the extent that it can
be established that such amounts are uncollectible. As a result, the amount of
income (including OID) reported by a Holder of such a Security in any period
could significantly exceed the amount of cash distributed to such Holder in
that period. The Holder will eventually be allowed a loss (or will be allowed
to report a lesser amount of income) to the extent that the aggregate amount
of distributions on the Securities is reduced as a result of a Loan default.
However, the timing and character of such losses or reductions in income are
uncertain and, accordingly, Holders of Securities should consult their own tax
advisors on this point.
Interest-Only Debt Securities. The Trust Fund intends to report income from
interest-only classes of Debt Securities to the Internal Revenue Service and
to Holders of interest-only Debt Securities based on the assumption that the
stated redemption price at maturity is equal to the sum of all payments
determined under the applicable prepayment assumption. As a result, such
interest-only Debt Securities Certificates will be treated as having original
issue discount.
Variable Rate Debt Securities. Under the OID Regulations, Debt Securities
paying interest at a variable rate (a "Variable Rate Debt Security") are
subject to special rules. A Variable Rate Debt Security will qualify as a
"variable rate debt instrument" if (i) its issue price does not exceed the
total noncontingent principal payments due under the Variable Rate Debt
Security by more than a specified de minimis amount and (ii) it provides for
stated interest, paid or compounded at least annually, at (a) one or more
qualified floating rates, (b) a single fixed rate and one or more qualified
floating rates, (c) a single objective rate or (d) a single fixed rate and a
single objective rate that is a qualified inverse floating rate.
A "qualified floating rate" is any variable rate where variations in the
value of such rate can reasonably be expected to measure contemporaneous
variations in the cost of newly borrowed funds in the currency in which the
Variable Rate Debt Security is denominated. A multiple of a qualified floating
rate will generally not itself constitute a qualified floating rate for
purposes of the OID Regulations. However, a variable rate equal to (i) the
product of a qualified floating rate and a fixed multiple that is greater than
zero but not more than 1.35 or (ii) the product of a qualified floating rate
and a fixed multiple that is greater than zero but not more than 1.35,
increased or decreased by a fixed rate will constitute a qualified floating
rate for purposes of the OID Regulations. In addition, under the OID
Regulations, two or more qualified floating rates that can reasonably be
expected to have approximately the same values throughout the term of the
Variable Rate Debt Security will be treated as a single qualified floating
rate (a "Presumed Single Qualified Floating Rate"). Two or more qualified
floating rates with values within 25 basis points of each other as determined
on the Variable Rate Debt Security's issue date will be conclusively presumed
to be a Presumed Single Qualified Floating Rate. Notwithstanding the
foregoing, a variable rate that would otherwise constitute a qualified
floating rate but which is subject to one or more restrictions such as a cap
or floor, will not be a qualified floating rate for purposes of the OID
Regulations unless the restriction is fixed throughout the term of the
Variable Rate Debt Security or the restriction will not significantly affect
the yield of the Variable Rate Debt Security.
An "objective rate" is a rate that is not itself a qualified floating rate
but which is determined using a single fixed formula and which is based upon
(i) one or more qualified floating rates, (ii) one or more rates where each
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rate would be a qualified floating rate for a debt instrument denominated in a
currency other than the currency in which the Variable Rate Debt Security is
denominated, (iii) either the yield or changes in the price of one or more
items of actively traded personal property or (iv) a combination of rates
described in (i), (ii) and (iii). The OID Regulations also provide that other
variable rates may be treated as objective rates if so designated by the
Internal Revenue Service in the future. Despite the foregoing, a variable rate
of interest on a Variable Rate Debt Security will not constitute an objective
rate if it is reasonably expected that the average value of such rate during
the first half of the Variable Rate Debt Security's term will be either
significantly less than or significantly greater than the average value of the
rate during the final half of the Variable Rate Debt Security's term. An
objective rate will qualify as a "qualified inverse floating rate" if such
rate is equal to a fixed rate minus a qualified floating rate, and variations
in the rate can reasonably be expected to reflect inversely contemporaneous
variations in the cost of newly borrowed funds. The OID Regulations also
provide that if a Variable Rate Debt Security provides for stated interest at
a fixed rate for an initial period of less than one year followed by a
variable rate that is either a qualified floating rate or an objective rate
and if the variable rate on the Variable Rate Debt Security's issue date is
intended to approximate the fixed rate, then the fixed rate and the variable
rate together will constitute either a single qualified floating rate or
objective rate, as the case may be (a "Presumed Single Variable Rate"). If the
value of the variable rate and the initial fixed rate are within 25 basis
points of each other as determined on the Variable Rate Debt Security's issue
date, the variable rate will be conclusively presumed to approximate the fixed
rate.
For Variable Rate Debt Securities that qualify as a "variable rate debt
instrument" under the OID Regulations and provide for interest at either a
single qualified floating rate, a single objective rate, a Presumed Single
Qualified Floating Rate or a Presumed Single Variable Rate throughout the term
(a "Single Variable Rate Debt Security"), original issue discount is computed
as described above based on the following: (i) stated interest on the Single
Variable Rate Debt Security which is unconditionally payable in cash or
property (other than debt instruments of the issuer) at least annually will
constitute qualified stated interest and (ii) by assuming that the variable
rate on the Single Variable Debt Security is a fixed rate equal to: (a) in the
case of a Single Variable Rate Debt Security with a qualified floating rate or
a qualified inverse floating rate, the value of, as of the issue date, the
qualified floating rate or the qualified inverse floating rate or (b) in the
case of a Single Variable Rate Debt Security with an objective rate (other
than a qualified inverse floating rate), a fixed rate which reflects the
reasonably expected yield for such Single Variable Debt Security.
In general, any Variable Rate Debt Security other than a Single Variable
Rate Debt Security (a "Multiple Variable Rate Debt Security") that qualifies
as a "variable rate debt instrument" will be converted into an "equivalent"
fixed rate debt instrument for purposes of determining the amount and accrual
of original issue discount and qualified stated interest on the Multiple
Variable Rate Debt Security. The OID Regulations generally require that such a
Multiple Variable Rate Debt Security be converted into an "equivalent" fixed
rate debt instrument by substituting any qualified floating rate or qualified
inverse floating rate provided for under the terms of the Multiple Variable
Rate Debt Security with a fixed rate equal to the value of the qualified
floating rate or qualified inverse floating rate, as the case may be, as of
the Multiple Variable Rate Debt Security's issue date. Any objective rate
(other than a qualified inverse floating rate) provided for under the terms of
the Multiple Variable Rate Debt Security is converted into a fixed rate that
reflects the yield that is reasonably expected for the Multiple Variable Rate
Debt Security. In the case of a Multiple Variable Rate Debt Security that
qualifies as a "variable rate debt instrument" and provides for stated
interest at a fixed rate in addition to either one or more qualified floating
rates or a qualified inverse floating rate, the fixed rate is initially
converted into a qualified floating rate (or a qualified inverse floating
rate, if the Multiple Variable Rate Debt Security provides for a qualified
inverse floating rate). Under such circumstances, the qualified floating rate
or qualified inverse floating rate that replaces the fixed rate must be such
that the fair market value of the Multiple Variable Rate Debt Security as of
the Multiple Variable Rate Debt Security's issue date is approximately the
same as the fair market value of an otherwise identical debt instrument that
provides for either the qualified floating rate or qualified inverse floating
rate rather than the fixed rate. Subsequent to converting the fixed rate into
either a qualified floating rate or a qualified inverse floating rate, the
Multiple Variable Rate Debt Security is then converted into an "equivalent"
fixed rate debt instrument in the manner described above.
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Once the Multiple Variable Rate Debt Security is converted into an
"equivalent" fixed rate debt instrument pursuant to the foregoing rules, the
amount of original issue discount and qualified stated interest, if any, are
determined for the "equivalent" fixed rate debt instrument by applying the
original issue discount rules to the "equivalent" fixed rate debt instrument
in the manner described above. A Holder of the Multiple Variable Rate Debt
Security will account for such original issue discount and qualified stated
interest as if the Holder held the "equivalent" fixed rate debt instrument.
Each accrual period appropriate adjustments will be made to the amount of
qualified stated interest or original issue discount assumed to have been
accrued or paid with respect to the "equivalent" fixed rate debt instrument in
the event that such amounts differ from the accrual amount of interest accrued
or paid on the Multiple Variable Rate Debt Security during the accrual period.
The OID Regulations do not clearly address the treatment of a Variable Rate
Debt Security that is based on a weighted average of the interest rates on
underlying Loans. Under the OID Regulations, interest payments on such a
Variable Rate Debt Security may be characterized as qualified stated interest
which is includible in income in a manner similar to that described in the
previous paragraph. However, it is also possible that interest payments on
such a Variable Rate Debt Security would be treated as contingent interest
(possibly includible in income when the payments become fixed) or in some
other manner.
If a Variable Rate Debt Security does not qualify as a "variable rate debt
instrument" under the OID Regulations, then the Variable Rate Debt Security
would be treated as a contingent payment debt obligation. It is not clear
under current law how a Variable Rate Debt Security would be taxed if such
Debt Security were treated as a contingent payment debt obligation.
Market Discount. A purchaser of a Security may be subject to the market
discount rules of Sections 1276-1278 of the Code. A Holder that acquires a
Debt Security with more than a prescribed de minimis amount of "market
discount" (generally, the excess of the principal amount of the Debt Security
over the purchaser's purchase price) will be required to include accrued
market discount in income as ordinary income in each month, but limited to an
amount not exceeding the principal payments on the Debt Security received in
that month and, if the Securities are sold, the gain realized. Such market
discount would accrue in a manner to be provided in Treasury regulations but,
until such regulations are issued, such market discount would in general
accrue either (i) on the basis of a constant yield (in the case of a Pay-
Through Security, taking into account a prepayment assumption) or (ii) in the
ratio of (a) in the case of Securities (or in the case of a Pass-Through
Security, as set forth below, the Loans underlying such Security) not
originally issued with original issue discount, stated interest payable in the
relevant period to total stated interest remaining to be paid at the beginning
of the period or (b) in the case of Securities (or, in the case of a Pass-
Through Security, as described below, the Loans underlying such Security)
originally issued at a discount, OID in the relevant period to total OID
remaining to be paid.
Section 1277 of the Code provides that, regardless of the origination date
of the Debt Security (or, in the case of a Pass-Through Security, the Loans),
the excess of interest paid or accrued to purchase or carry a Security (or, in
the case of a Pass-Through Security, as described below, the underlying Loans)
with market discount over interest received on such Security is allowed as a
current deduction only to the extent such excess is greater than the market
discount that accrued during the taxable year in which such interest expense
was incurred. In general, the deferred portion of any interest expense will be
deductible when such market discount is included in income, including upon the
sale, disposition, or repayment of the Security (or in the case of a Pass-
Through Security, an underlying Loan). A Holder may elect to include market
discount in income currently as it accrues, on all market discount obligations
acquired by such Holder during the taxable year such election is made and
thereafter, in which case the interest deferral rule will not apply.
Premium. A Holder who purchases a Debt Security (other than an Interest
Weighted Security to the extent described above) at a cost greater than its
stated redemption price at maturity, generally will be considered to have
purchased the Security at a premium, which it may elect to amortize as an
offset to interest income on such Security (and not as a separate deduction
item) on a constant yield method. Although no regulations addressing the
computation of premium accrual on securities similar to the Securities have
been issued, the legislative
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history of the 1986 Act indicates that premium is to be accrued in the same
manner as market discount. Accordingly, it appears that the accrual of premium
on a Class of Pay-Through Securities will be calculated using the prepayment
assumption used in pricing such Class. If a Holder makes an election to
amortize premium on a Debt Security, such election will apply to all taxable
debt instruments (including all REMIC regular interests and all pass-through
certificates representing ownership interests in a trust holding debt
obligations) held by the Holder at the beginning of the taxable year in which
the election is made, and to all taxable debt instruments acquired thereafter
by such Holder, and will be irrevocable without the consent of the Internal
Revenue Service. Purchasers who pay a premium for the Securities should
consult their tax advisors regarding the election to amortize premium and the
method to be employed.
Election to Treat All Interest as Original Issue Discount. The OID
Regulations permit a Holder Debt Security to elect to accrue all interest,
discount (including de minimis market or original issue discount) and premium
in income as interest, based on a constant yield method for Debt Securities
acquired on or after April 4, 1994. If such an election were to be made with
respect to a Debt Security with market discount, the Holder of the Debt
Security would be deemed to have made an election to include in income
currently market discount with respect to all other debt instruments having
market discount that such Holder of the Debt Security acquires during the year
of the election or thereafter. Similarly, a Holder of a Debt Security that
makes this election for a Debt Security that is acquired at a premium will be
deemed to have made an election to amortize bond premium with respect to all
debt instruments having amortizable bond premium that such Holder owns or
acquires. The election to accrue interest, discount and premium on a constant
yield method with respect to a Debt Security may not be revoked without the
consent of the Internal Revenue Service.
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 (other than amounts treated as accrued
interest, which will be treated as such) 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.
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 "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 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
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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. 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 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 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
"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
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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 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.
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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.
Excess Inclusions. The portion of the REMIC taxable income of a Holder of a
Residual Interest Security consisting of "excess inclusion" income may not be
offset by other deductions or losses, including net operating losses, on such
Holder's federal income tax return. Further, if the Holder of a Residual
Interest Security is an organization subject to the tax on unrelated business
income imposed by Code Section 511, such Holder's excess inclusion income will
be treated as unrelated business taxable income of such Holder. In addition,
under Treasury
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regulations yet to be issued, if a real estate investment trust, a regulated
investment company, a common trust fund, or certain cooperatives were to own a
Residual Interest Security, a portion of dividends (or other distributions)
paid by the real estate investment trust (or other entity) would be treated as
excess inclusion income. If a Residual Security is owned by a foreign person,
excess inclusion income is subject to tax at a rate of 30% which may not be
reduced by treaty, is not eligible for treatment as "portfolio interest" and is
subject to certain additional limitations. See "Tax Treatment of Foreign
Investors."
The 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.
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 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
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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 24, 1996, the Internal Revenue Service
released final regulations (the "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 Mark-to-Market Regulations provide that
for purposes of this mark-to-market requirement, a Residual Interest Security
acquired on or after January 4, 1995 is not treated as a security and thus may
not be marked to market. Prospective purchasers of a Residual Interest
Security should consult their tax advisors regarding the possible application
of the mark-to-market requirement to Residual Interest Securities.
ADMINISTRATIVE MATTERS
The REMIC's books must be maintained on a calendar year basis and the REMIC
must file an annual federal income tax return. The REMIC will also be subject
to the procedural and administrative rules of the Code applicable to
partnerships, including the determination of any adjustments to, among other
things, items of REMIC income, gain, loss, deduction, or credit, by the IRS in
a unified administrative proceeding.
TAX STATUS AS A GRANTOR TRUST
General. As specified in the related Prospectus Supplement, if a REMIC 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 "real estate assets" for purposes of Section
856(c)(5)(A) of the Code and "loans . . . secured by an interest in real
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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 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. Section 1272(a)(6) applies to a pool of debt instruments the yield
on which may be affected by reason of prepayments. Accordingly, it appears that
Section 1272(a)(2)(6) would apply to a Pass-Through Security. 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
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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, 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.
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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.
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
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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 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 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.
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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 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
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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 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 a new partnership and then distribute
its interest in such new partnership to the partners. 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
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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 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
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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.
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.
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Backup Withholding. Distributions made on the Certificates and proceeds from
the sale of the Certificates will be subject to a "backup" withholding tax of
31% if, in general, the CertificateHolder fails to comply with certain
identification procedures, unless the Holder is an exempt recipient under
applicable provisions of the Code.
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 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
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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 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
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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."
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.
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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.
LEGAL MATTERS
Unless otherwise specified in the related Prospectus Supplement, certain
legal matters in connection with the Securities will be passed upon for the
Transferor by Shaw, Pittman, Potts & Trowbridge, counsel to the Transferor, and
for any underwriters, agents or dealers, Stroock & Stroock & Lavan. Unless
otherwise specified in the related Prospectus Supplement, certain federal
income tax matters will be passed upon for the Transferor by Stroock & Stroock
& Lavan.
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GLOSSARY OF TERMS
The following are abbreviated definitions of certain capitalized terms used
in this Prospectus. Unless otherwise provided in a "Supplemental Glossary" in
the Prospectus Supplement for a Series, such definitions shall apply to
capitalized terms used in such Prospectus Supplement. The definitions may vary
from those in the related Agreement for a Series and the related Agreement for
a Series generally provides a more complete definition of certain of the terms.
Reference should be made to the related Agreement for a Series for a more
complete definition of such terms.
"Accrual Termination Date" means, with respect to a Class of Compound
Interest Securities, the Distribution Date specified in the related Prospectus
Supplement.
"Agreement" means, with respect to a Series of Certificates, the Pooling and
Servicing Agreement or Trust Agreement, and, with respect to a Series of Notes,
the Indenture and the Sale and Servicing Agreement, as the context requires.
"Appraised Value" means, with respect to property securing a Loan, the lesser
of the appraised value determined in an appraisal obtained at origination of
the Loan or sales price of such property at such time.
"Asset Group" means, with respect to the Primary Assets and other assets
comprising the Trust Fund of a Series, a group of such Primary Assets and other
assets having the characteristics described in the related Prospectus
Supplement.
"Assumed Reinvestment Rate" means, with respect to a Series, the per annum
rate or rates specified in the related Prospectus Supplement for a particular
period or periods as the "Assumed Reinvestment Rate" for funds held in any fund
or account for the Series.
"Available Distribution Amount" means the amount in the Distribution Account
(including amounts deposited therein from any reserve fund or other fund or
account) eligible for distribution to Holders on a Distribution Date.
"Bankruptcy Code" means the federal bankruptcy code, 11 United States Code
101 et seq., and related rules and regulations promulgated thereunder.
"Business Day" means a day that, in the City of New York or in the city or
cities in which the corporate trust office of the Trustee are located, is
neither a legal holiday nor a day on which banking institutions are authorized
or obligated by law, regulations or executive order to be closed.
"Certificate" means the Asset-Backed Certificates.
"Certificate Account" or "Collection Account" means, with respect to a
Series, the account established for the deposit by the Servicer of payments
received from the Primary Assets.
"Class" means a class of Securities of a Series.
"Closing Date" means, with respect to a Series, the date specified in the
related Prospectus Supplement as the date on which Securities of such Series
are first issued.
"Code" means the Internal Revenue Code of 1986, as amended, and regulations
(including proposed regulations) or other pronouncements of the Internal
Revenue Service promulgated thereunder.
"Combined Loan-to-Value Ratio" means, with respect to a Loan, the ratio
determined as set forth in the related Prospectus Supplement taking into
account the amounts of any related senior mortgage loans on the related
Mortgaged Property.
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"Commission" means the Securities and Exchange Commission.
"Compound Interest Security" means any Security of a Series on which all or a
portion of the interest accrued thereon is added to the principal balance of
such Security on each Distribution Date, through the Accrual Termination Date,
and with respect to which no interest shall be payable until such Accrual
Termination Date, after which interest payments will be made on the Compound
Value thereof.
"Compound Value" means, with respect to a Class of Compound Interest
Securities, the original principal balance of such Class, plus all accrued and
unpaid interest, if any, previously added to the principal balance thereof and
reduced by any payments of principal previously made on such Class of Compound
Interest Securities.
"Condominium" means a form of ownership of real property wherein each owner
is entitled to the exclusive ownership and possession of his or her individual
Condominium Unit and also owns a proportionate undivided interest in all parts
of the Condominium Building (other than the individual Condominium Units) and
all areas or facilities, if any, for the common use of the Condominium Units.
"Condominium Association" means the person(s) appointed or elected by the
Condominium Unit owners to govern the affairs of the Condominium.
"Condominium Building" means a multi-unit building or buildings, or a group
of buildings whether or not attached to each other, located on property subject
to Condominium ownership.
"Condominium Loan" means a Loan secured by a Mortgage on a Condominium Unit
(together with its appurtenant interest in the common elements).
"Condominium Unit" means an individual housing unit in a Condominium
Building.
"Cooperative" means a corporation owned by tenant-stockholders who, through
the ownership of stock, shares or membership securities in the corporation,
receive proprietary leases or occupancy agreements which confer exclusive
rights to occupy specific units and which is described in Section 216 of the
Code.
"Cooperative Dwelling" means an individual housing unit in a building owned
by a Cooperative.
"Cooperative Loan" means a housing loan made with respect to a Cooperative
Dwelling and secured by an assignment by the borrower (tenant-stockholder) or
security interest in shares issued by the applicable Cooperative.
"Cut-off Date" means the date designated as such in the related Prospectus
Supplement for a Series.
"Debt Securities" means Securities characterized as indebtedness for federal
income tax purposes, and Regular Interest Securities.
"Deferred Interest" means the excess of the interest accrued on the
outstanding principal balance of a Loan during a specified period over the
amount of interest required to be paid by an obligor on such Loan on the
related Due Date.
"Delinquency Advance" means cash advanced by the Servicer in respect of
delinquent payments of principal of and/or interest on a Loan to the extent
specified in the related Prospectus Supplement.
"Disqualified Organization" means the United States, any State or political
subdivision thereof, any possession of the United States, any foreign
government, any international organization, or any agency or instrumentality of
any of the foregoing, a rural electric or telephone cooperative described in
section 1381(a)(2)(C) of the Code, or any entity exempt from the tax imposed by
sections 1-1399 of the Code, if such entity is not subject to tax on its
unrelated business income.
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"Distribution Account" means, with respect to a Series, the account or
accounts established for the deposit of remittances from the Collection Account
for distribution to Securityholders.
"Distribution Date" means, with respect to a Series or Class of Securities,
each date specified as a distribution date for such Series or Class in the
related Prospectus Supplement.
"Due Date" means each date, as specified in the related Prospectus Supplement
for a Series, on which any payment of principal or interest is due and payable
by the obligor on any Primary Asset pursuant to the terms thereof.
"Eligible Investments" means any one or more of the obligations or securities
described as such in the related Agreement.
"Enhancement" means the enhancement for a Series, if any, specified in the
related Prospectus Supplement.
"Enhancer" means the provider of the Enhancement for a Series specified in
the related Prospectus Supplement.
"ERISA" means the Employee Retirement Income Security Act of 1974, as
amended.
"Escrow Account" means an account, established and maintained by the Servicer
for a Loan, into which payments by borrowers to pay taxes, assessments,
mortgage and hazard insurance premiums and other comparable items required to
be paid to the mortgagee are deposited.
"FDIC" means the Federal Deposit Insurance Corporation.
"FHLMC" means the Federal Home Loan Mortgage Corporation.
"Final Scheduled Distribution Date" means, with respect to a Class of Notes
of a Series, the date no later than which principal thereof will be fully paid
and with respect to a Class of Certificates of a Series, the date after which
no Certificates of such Class will remain outstanding, in each case based on
the assumptions set forth in the related Prospectus Supplement.
"FNMA" means the Federal National Mortgage Association.
"Holder" or "Securityholder" means the person or entity in whose name a
Security is registered.
"Home Improvements" means the home improvements financed by a Home
Improvement Contract.
"Home Improvement Contract" means any home improvement installment sales
contracts and installment loan agreement which may be unsecured or secured by a
purchase money security interest in the Home Improvement financed thereby.
"HUD" means the United States Department of Housing and Urban Development.
"Indenture" means the indenture relating to a Series of Notes between the
Trust Fund and the Trustee.
"Insurance Policies" means certain mortgage insurance, hazard insurance and
other insurance policies required to be maintained with respect to Loans.
"Insurance Proceeds" means amount paid by the insurer under any of the
Insurance Policies covering any Loan or Mortgaged Property.
"Interest Only Securities" means a Class of Securities entitled solely or
primarily to distributions of interest and which is identified as such in the
related Prospectus Supplement.
"IRS" means the Internal Revenue Service.
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"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.
"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.
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"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.
"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.
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"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.
"Underlying Loans" means loans of the type eligible to be Loans underlying or
securing Private Securities.
"Variable Interest Security" means a Security on which interest accrues at a
rate that is adjusted, based upon a predetermined index, at fixed periodic
intervals, all as set forth in the related Prospectus Supplement.
"Zero Coupon Security" means a Security entitled to receive payments of
principal only.
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NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS IN CONNECTION WITH THE OFFER CONTAINED HEREIN, AND, IF GIVEN OR
MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING
BEEN AUTHORIZED BY CHEVY CHASE OR BY ANY OF THE UNDERWRITERS. THIS PROSPECTUS
DOES NOT CONSTITUTE AN OFFER OF ANY SECURITIES OTHER THAN THOSE TO WHICH IT
RELATES OR AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, THOSE TO
WHICH IT RELATES IN ANY STATE TO ANY PERSON TO WHOM IT IS NOT LAWFUL TO MAKE
SUCH OFFER IN SUCH STATE. THE DELIVERY OF THIS PROSPECTUS AT ANY TIME DOES NOT
IMPLY THAT THE INFORMATION HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS
DATE.
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PROSPECTUS SUPPLEMENT
REPORTS TO CERTIFICATEHOLDERS.............................................. S-2
PROSPECTUS SUPPLEMENT SUMMARY OF TERMS..................................... S-3
RISK FACTORS............................................................... S-14
THE SELLER................................................................. S-16
USE OF PROCEEDS............................................................ S-17
THE CHEVY CHASE HOME LOAN AND HOME EQUITY LOAN PROGRAMS.................... S-17
THE LOAN POOL.............................................................. S-22
THE CERTIFICATE INSURER.................................................... S-27
MATURITY AND PREPAYMENT CONSIDERATIONS..................................... S-28
THE CERTIFICATES........................................................... S-31
THE POLICY................................................................. S-40
FURTHER PROVISIONS OF THE POOLING AND SERVICING AGREEMENT.................. S-42
CERTAIN INFORMATION REGARDING THE CERTIFICATES............................. S-47
FEDERAL INCOME TAX CONSIDERATIONS.......................................... S-48
STATE TAX CONSIDERATIONS................................................... S-49
ERISA CONSIDERATIONS....................................................... S-49
LEGAL INVESTMENT CONSIDERATIONS............................................ S-49
UNDERWRITING............................................................... S-50
LEGAL MATTERS.............................................................. S-50
EXPERTS.................................................................... S-51
RATING..................................................................... S-51
INDEX OF PRINCIPAL TERMS................................................... S-52
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................................................... 78
ERISA CONSIDERATIONS....................................................... 79
LEGAL INVESTMENT........................................................... 79
PLAN OF DISTRIBUTION....................................................... 80
LEGAL MATTERS.............................................................. 80
GLOSSARY OF TERMS.......................................................... 81
</TABLE>
UNTIL DECEMBER 21, 1997 (90 DAYS AFTER THE DATE OF THIS PROSPECTUS SUPPLE-
MENT), ALL DEALERS EFFECTING TRANSACTIONS IN THE CERTIFICATES, WHETHER OR NOT
PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS
AND A PROSPECTUS SUPPLEMENT. THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS
TO DELIVER A PROSPECTUS AND A PROSPECTUS SUPPLEMENT WHEN ACTING AS UNDERWRIT-
ERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
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CHEVY CHASE HOME
LOAN TRUST 1997-1
$95,000,000
6.55% HOME LOAN
ASSET-BACKED CERTIFICATES,
SERIES 1997-1
CHEVY CHASE BANK, F.S.B.
SELLER AND SERVICER
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PROSPECTUS SUPPLEMENT
SEPTEMBER 22, 1997
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SMITH BARNEY INC.
CREDIT SUISSE FIRST BOSTON
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