<PAGE> 1
$819,278,000 CLASS A CERTIFICATES
HOUSEHOLD REVOLVING HOME EQUITY LOAN TRUST 1996-1
REVOLVING HOME EQUITY LOAN ASSET BACKED CERTIFICATES, SERIES 1996-1
HOUSEHOLD FINANCE CORPORATION
MASTER SERVICER
---------------------
The Revolving Home Equity Loan Asset Backed Certificates, Series 1996-1
represent undivided interests in the Household Revolving Home Equity Loan Trust
1996-1 (the "Trust") consisting of, among other things, a pool of home equity
revolving credit line loans made or to be made in the future (the "Mortgage
Loans") under certain revolving home equity credit line loan agreements. The
Initial Mortgage Loans (as defined herein) are secured by mortgages (the
"Mortgages") (of which approximately 31.27% by principal balance are first
mortgages, 68.30% by principal balance are second mortgages and the remainder
are third mortgages) on residential properties that are primarily one- to
four-family properties. Only a single class of Series 1996-1 certificates is
being offered hereby (the "Class A Certificates", also referred to herein as the
"Certificates"). The aggregate undivided interest in the Trust represented by
the Certificates will initially be equal to $819,278,000, which is 97.50% of the
sum of the Cut-Off Balances of the Initial Mortgage Loans (as defined herein)
and will decline as principal is paid to the Certificateholders, except as
otherwise provided herein. The remaining undivided interest in the Trust not
represented by the Certificates (the "Seller Interest") will initially be equal
to $21,007,463.34, which is 2.50% of the sum of the Cut-Off Balances of the
Initial Mortgage Loans.
The Trust will be created pursuant to a pooling and servicing agreement
dated as of May 1, 1996 (the "Agreement") among HFC Revolving Corporation, as
seller (the "Seller"), Household Finance Corporation, as master servicer (the
"Master Servicer" or "HFC"), and The First National Bank of Chicago, as trustee
(the "Trustee").
Distributions of principal and interest on the Certificates will be made to
the extent described herein on the 20th day of each month or, if such day is not
a Business Day, on the next succeeding Business Day (the "Distribution Date")
beginning June 20, 1996. On each Distribution Date, holders of the Certificates
will be entitled to receive, from and to the limited extent of funds available
in the Collection Account (as defined herein), distributions with respect to
interest and principal paid on the Mortgage Loans calculated as set forth
herein. The Certificates are not guaranteed by HFC or any affiliate thereof.
However, the Certificates will have the benefit of an irrevocable and
unconditional financial guaranty insurance policy (the "Policy") in the initial
amount of $475,000,000 issued by Capital Markets Assurance Corporation (the
"Certificate Insurer"). The Policy will be available to protect
Certificateholders against shortfalls in amounts to be distributed at the times
and to the extent described herein. See "Description of the Certificates -- The
Policy" herein.
There is currently no secondary market for the Certificates. The
Underwriters intend to make a secondary market in the Certificates but have no
obligation to do so. See "Risk Factors" herein.
FOR A DISCUSSION OF CERTAIN RISKS ASSOCIATED WITH AN INVESTMENT IN THE
CERTIFICATES, SEE "RISK FACTORS" ON PAGE 25 HEREIN.
---------------------
THE CERTIFICATES REPRESENT BENEFICIAL INTERESTS IN THE TRUST ONLY AND DO NOT
REPRESENT INTERESTS IN OR OBLIGATIONS OF HFC REVOLVING CORPORATION,
HOUSEHOLD FINANCE CORPORATION OR ANY AFFILIATE THEREOF, EXCEPT TO
THE EXTENT DESCRIBED HEREIN. NEITHER THE CERTIFICATES NOR THE
MORTGAGE LOANS ARE INSURED OR GUARANTEED BY ANY GOVERNMENTAL
AGENCY.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS ANY SUCH
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
THE ATTORNEY GENERAL OF THE STATE OF NEW YORK HAS NOT PASSED ON OR ENDORSED
THE MERITS OF THIS OFFERING. ANY REPRESENTATION TO THE CONTRARY IS UNLAWFUL.
<TABLE>
<CAPTION>
PRICE TO UNDERWRITING PROCEEDS TO
PUBLIC(1) DISCOUNT(2) SELLER(2)(3)
----------------- ----------------- -----------------
<S> <C> <C> <C>
Per Certificate........................... 100% 0.275% 99.725%
Total..................................... $819,278,000 $2,253,015 $817,024,985
</TABLE>
- ---------------
(1) Plus accrued interest, if any, from May 23, 1996.
(2) The Seller and HFC have agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, as
amended.
(3) Before deducting expenses, estimated to be $850,000.
---------------------
The Certificates are offered subject to prior sale and subject to the
Underwriters' right to reject orders in whole or in part. It is expected that
delivery of such Certificates will be made in book-entry form only through the
facilities of The Depository Trust Company, CEDEL S.A. and the Euroclear System
on or about May 23, 1996.
---------------------
GOLDMAN, SACHS & CO.
LEHMAN BROTHERS
MERRILL LYNCH & CO.
MORGAN STANLEY & CO.
INCORPORATED
---------------------
The date of this Prospectus is May 16, 1996.
<PAGE> 2
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE CERTIFICATES AT
LEVELS ABOVE THOSE WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH
STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
Until 90 days after the date of this Prospectus, all dealers effecting
transactions in the Certificates, whether or not participating in this
distribution, may be required to deliver a Prospectus. This is in addition to
the obligation of dealers to deliver a Prospectus when acting as underwriters
and with respect to their unsold allotments or subscriptions.
The address and telephone number of the Seller, the originator of the
Trust, is 2700 Sanders Road, Prospect Heights, Illinois 60070, (847) 564-6335.
AVAILABLE INFORMATION
The Seller, as originator of the Trust, has filed a Registration Statement
under the Securities Act of 1933, as amended, with the Securities and Exchange
Commission (the "Commission") with respect to the Certificates offered pursuant
to this Prospectus. This Prospectus, which forms a part of the Registration
Statement, does not contain all of the information included in the Registration
Statement and the exhibits thereto. For further information, reference is made
to the Registration Statement and amendments thereof and to exhibits thereto,
which are available for inspection without charge at the office of the
Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, and at the
regional offices of the Commission at Seven World Trade Center, New York, New
York 10048 and at 500 W. Madison Street, Suite 1400, Chicago, Illinois 60661.
Copies of the Registration Statement, the amendments thereof and the exhibits
thereto, may be obtained from the Commission at prescribed rates.
2
<PAGE> 3
FINANCIAL INFORMATION
The Seller has determined that its financial statements are not material to
the offering made hereby.
The Trust will be formed to hold the Mortgage Loans and to issue the
Certificates. The Trust will have no assets or obligations prior to the issuance
of the Certificates and will engage in no activities other than those described
herein. Accordingly, no financial statements with respect to the Trust are
included in this Prospectus.
REPORTS TO THE CERTIFICATEHOLDERS
Unless and until Replacement Certificates (as defined herein) are issued,
the Trust will provide to CEDE & Co., as nominee of The Depository Trust Company
("DTC") and registered holder of the Certificates and, upon request, to
Participants (as defined herein), monthly and annual reports concerning the
Certificates pursuant to the Pooling and Servicing Agreement. See "Description
of the Certificates -- Reports to Certificateholders" and "-- Evidence as to
Compliance" herein. Such reports may be made available to the owners of the
Certificates (the "Certificate Owners") upon request to their Participants. Such
reports will not constitute financial statements prepared in accordance with
generally accepted accounting principles. The Trust does not intend to provide
any financial information to any holder of the Certificates which has been
examined and reported upon, with an opinion expressed, by an independent public
accountant. The Master Servicer will file with the Commission such periodic
reports with respect to the Trust as are required by the Securities Exchange Act
of 1934, as amended (the "1934 Act"), and the rules, regulations or orders of
the Commission thereunder.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
CAPTION PAGE
- -------------------------------------------------------------
<S> <C>
Prospectus Summary...................................... 4
Risk Factors............................................ 25
Limited Liquidity..................................... 25
Difficulty in Pledging................................ 25
Potential Delays in Receipt of Distributions.......... 25
Nature of Security.................................... 25
Cash Flow Considerations.............................. 26
Prepayment Considerations............................. 26
Certificate Rating.................................... 26
Change in Loan Terms.................................. 27
Legal Considerations.................................. 27
Insolvency Considerations............................. 28
The Seller and Subservicers............................. 29
The Master Servicer..................................... 30
Use of Proceeds......................................... 30
The HFC Revolving Home Equity Lending Program........... 30
General............................................... 30
Underwriting Procedures Relating to Home Equity
Revolving Credit Line Loans......................... 30
Home Equity Revolving Credit Line Loan Terms.......... 31
Servicing of Home Equity Revolving Credit Line
Loans............................................... 33
The Revolving Home Equity Credit Lines.................. 36
Conveyance of Subsequent Funding Mortgage Loans....... 43
Description of the Certificate Insurer.................. 44
Maturity and Prepayment Considerations.................. 44
Pool Factor and Trading Information..................... 48
Description of the Certificates......................... 49
General............................................... 49
Assignment of Mortgage Loans.......................... 50
Amendments to Credit Line Agreements.................. 52
Consent to Senior Liens............................... 53
Optional Retransfers of Mortgage Loans to the
Seller.............................................. 53
Payments on Mortgage Loans; Deposits to Collection
Account; Deposits to Funding Account................ 54
Allocations and Collections........................... 55
Distributions on the Certificates..................... 57
Distributions of Interest Collections................. 57
Seller Collections.................................... 58
Required Overcollateralization Amount................. 58
Distributions of Principal Collections................ 58
Distribution of Interest and Principal on the
Certificates........................................ 59
Calculation of Certificate Rate; Limitation on
Interest Payments on Certificates................... 59
The Paying Agent...................................... 60
Rapid Amortization Period............................. 60
Rapid Amortization Events............................. 60
The Policy............................................ 61
Reports to Certificateholders......................... 62
Collection and Other Servicing Procedures............. 63
Hazard Insurance...................................... 63
Realization Upon Defaulted Mortgage Loans............. 65
Servicing Compensation and Payment of Expenses........ 65
Evidence as to Compliance............................. 65
<CAPTION>
CAPTION PAGE
- -------------------------------------------------------------
<S> <C>
Certain Matters Regarding the Master Servicer
and the Seller...................................... 66
Servicing Termination Events.......................... 67
Rights Upon a Servicing Termination Event............. 67
Amendment............................................. 68
Termination; Retirement of the Certificates........... 68
The Trustee........................................... 69
Registration of Certificates.......................... 69
Certain Activities.................................... 72
Description of the Receivables Purchase Agreement....... 73
Sale of Mortgage Loans................................ 73
Representations and Warranties........................ 74
Certain Covenants..................................... 74
Amendments............................................ 74
Sale of Credit Line Agreements........................ 75
Termination........................................... 75
Certain Legal Aspects of the Mortgage Loans............. 75
General............................................... 75
Foreclosure........................................... 75
Rights of Redemption.................................. 77
Rights of Senior Mortgagees or Beneficiaries.......... 77
Bankruptcy, Anti-Deficiency Legislation and Other
Limitations on Lenders.............................. 78
"Due-on-Sale" Clauses................................. 80
Applicability of Usury Laws........................... 80
Environmental Legislation............................. 81
Certain Income Tax Consequences......................... 81
General............................................... 81
Treatment of the Certificates as Indebtedness......... 81
Interest Income to Certificateholders................. 82
Disposition of Certificates........................... 83
Possible Characterization of the Arrangement as a
Partnership or Association Taxable as a
Corporation......................................... 84
Possible Classification as a Taxable Mortgage Pool.... 85
Foreign Investors..................................... 85
Information Reporting and Backup Withholding.......... 85
State and Local Tax Consequences...................... 86
ERISA Considerations.................................... 87
General............................................... 87
Availability of Exemptions for Certificates........... 87
Review by Benefit Plan Fiduciaries.................... 88
Legal Investment Considerations......................... 88
Underwriting............................................ 89
Experts................................................. 89
Legal Matters........................................... 89
Index of Defined Terms.................................. 90
Global Clearance, Settlement and Tax Documentation
Procedures............................................ A-1
Initial Settlement.................................... A-1
Secondary Market Trading.............................. A-1
Certain U.S. Federal Income Tax Documentation
Requirements........................................ A-3
Financial Statements of Certificate Insurer............. F-1
</TABLE>
3
<PAGE> 4
PROSPECTUS SUMMARY
The following summary of certain pertinent information is qualified in its
entirety by reference to the detailed information appearing elsewhere in this
Prospectus. Reference is made to the Index of Defined Terms for the location
herein of the definitions of certain capitalized terms.
TRUST............................ The Household Revolving Home Equity Loan
Trust 1996-1 (the "Trust") will be formed
pursuant to a pooling and servicing
agreement to be dated as of May 1, 1996
(the "Agreement") among HFC Revolving
Corporation, as seller (the "Seller"),
Household Finance Corporation, as master
servicer (the "Master Servicer" or "HFC")
and The First National Bank of Chicago,
as trustee (the "Trustee"). The property
of the Trust will include: certain
existing home equity revolving credit
line loans that have been made from time
to time by the Subservicers (as defined
herein) and conveyed to the Trust on the
Closing Date (as defined herein)(the
"Initial Mortgage Loans") and, to the
extent of the availability thereof, newly
originated home equity revolving credit
line loans to be conveyed to the Trust
from time-to-time on or before the last
Distribution Date (as defined herein) of
the Funding Period (as defined herein)
(the "Subsequent Funding Mortgage Loans")
(the Subsequent Funding Mortgage Loans
and the Initial Mortgage Loans and any
replacements for any such loans,
collectively the "Mortgage Loans")
evidenced by certain revolving term home
equity loan notes (the "Credit Line
Agreements") secured primarily by first
and second mortgages on residential
properties that are primarily one- to
four-family properties (the "Mortgaged
Properties"); the collections in respect
of such Mortgage Loans; property that
secured a Mortgage Loan and has been
acquired by foreclosure or deed in lieu
of foreclosure; the funds on deposit in
the Collection Account (as defined
herein), excluding investment earnings
thereon; the funds on deposit in the
account maintained with the Trustee to
purchase the Subsequent Funding Mortgage
Loans (the "Funding Account"); the funds
on deposit in the Spread Account (as
defined herein); an irrevocable and
unconditional financial guaranty
insurance policy (the "Policy"); and
rights under certain hazard insurance
policies covering the Mortgaged
Properties and certain other property, as
described more fully herein. Only the
unpaid principal balance of each Mortgage
Loan at the close of the last billing
cycle thereof prior to May 1, 1996 in the
case of an Initial Mortgage Loan, and
prior to the date upon which each
Subsequent Funding Mortgage Loan and any
Eligible Substitute Mortgage Loan (as
defined herein) is conveyed to the Trust
(in each case the "Cut-Off Balances" and
the "Cut-Off
4
<PAGE> 5
Date"), and any additions to each
Mortgage Loan as a result of new advances
made pursuant to the applicable Credit
Line Agreements (collectively, the
"Additional Balances") during the life of
the Trust shall be property of the Trust.
The Mortgage Loans and any Additional
Balances have been or will be funded by
the appropriate Subservicer (as defined
herein) pursuant to the Credit Line
Agreements and sold to the Seller in
accordance with the Receivables Purchase
Agreement (as defined herein) and then
transferred by the Seller to the Trust
pursuant to the Agreement. The obligation
to fund any of the Mortgage Loans and any
Additional Balances pursuant to the
Credit Line Agreements will not be
transferred to the Trust or the Seller.
With respect to any date, the Pool
Balance will be equal to the sum of the
aggregate of the Trust Balances (as
defined below) of all Mortgage Loans in
the Trust. The Trust Balance of a
Mortgage Loan (other than a Liquidated
Mortgage Loan) on any day is equal to the
Cut-Off Balance of such Mortgage Loan
plus (i) any Additional Balances in
respect of such Mortgage Loan, minus (ii)
all Principal Collections (as defined
herein) credited against the Trust
Balance prior to such day minus (iii) all
related Charge Off Amounts. The Trust
Balance of a Liquidated Mortgage Loan (as
defined herein) after final recovery of
related Liquidation Proceeds (as defined
herein) shall be zero. A Charge Off
Amount is equal to the amount of the
principal balance of a Charged Off
Mortgage Loan (as defined below) that the
Master Servicer has charged off on its
servicing records in such Collection
Period. A Charged Off Mortgage Loan is a
defaulted Mortgage Loan that is not a
Liquidated Mortgage Loan and as to which
(i) collection procedures are ongoing and
(ii) the Master Servicer has charged off
all or a portion of the related Mortgage
Loan principal balance. A Liquidated
Mortgage Loan is, as of any Distribution
Date, any Mortgage Loan in respect of
which the Master Servicer has determined,
in accordance with its servicing
policies, that all Liquidation Proceeds
have been recovered.
SECURITIES OFFERED............... The Trust will offer one class of Revolving
Home Equity Loan Asset Backed
Certificates, Series 1996-1 pursuant to
this Prospectus (the "Class A
Certificates" or "Certificates"). Each
Certificate represents the right to
receive payments of interest at the
variable rate described below (the
"Certificate Rate") payable monthly and
payments of principal at such time and to
the extent provided below. As of the
Closing Date, the principal amount of the
Certificates will be $819,278,000 (the
"Original Certificate Principal
5
<PAGE> 6
Balance" or the "Original Invested
Amount"), representing an undivided
ownership interest in 97.50% of the Pool
Balance on the Closing Date. Thereafter,
the Invested Amount with respect to any
date will be an amount equal to the
Original Invested Amount less the sum of
(a) all payments made in reduction of the
principal of the Certificate Principal
Balance including amounts distributed to
Certificateholders from amounts on
deposit in the Funding Account except (i)
Accelerated Principal Distribution
Amounts (as defined below) and (ii)
payments of the Guaranteed Principal
Distribution Amount (as defined below)
under the Policy, (b) all principal
payments that would be made but for the
Master Servicer's legal inability to
deposit Collections in the Collection
Account due to a final determination of a
court of competent jurisdiction in any
Master Servicer's, Subservicer's or
Seller's insolvency proceeding and (c) an
aggregate amount equal to the product of
the Certificateholders' Floating
Allocation Percentage and Liquidation
Loss Amounts (each as defined herein)
that have not been paid from Interest
Collections (as defined herein). The
principal amount of the outstanding
Certificates (the "Certificate Principal
Balance" or "Investor Certificate
Principal Balance") on any date is equal
to the Original Certificate Principal
Balance less the aggregate of amounts
actually distributed as principal on the
Certificates (including Accelerated
Principal Distribution Amounts and any
Guaranteed Principal Distribution Amounts
drawn under the Policy) to the
Certificateholders. On any Distribution
Date the Seller will hold the remaining
undivided interest in the Pool Balance
(the "Seller Interest"), which is equal
to the percentage interest in the Trust
determined by dividing (a) the Pool
Balance as of the end of the related
Collection Period minus the Invested
Amount reduced by Principal Collections
on deposit in the Funding Account in each
case immediately following such
Distribution Date, by (b) the Pool
Balance as of the end of the related
Collection Period.
The Certificates represent interests in the
Trust and do not represent interests in
or obligations of the Seller, HFC or any
affiliate thereof. Neither the
Certificates nor the Mortgage Loans are
insured or guaranteed by the Federal
Deposit Insurance Corporation (the
"FDIC") or any other governmental agency.
SELLER........................... HFC Revolving Corporation is a corporation
organized under the laws of the State of
Delaware and is a wholly-owned special
purpose subsidiary of HFC. The Seller
intends to transfer the Cut-Off Balances
and Additional Balances purchased from
the Subservicers to the Trust pursuant to
the Agreement.
6
<PAGE> 7
SUBSERVICERS..................... Household Realty Corporation, Household
Finance Corporation of California,
Household Finance Corporation II,
Household Finance Corporation III,
Household Finance Industrial Loan
Company, Household Finance Realty
Corporation of New York, Household
Financial Center Inc., Household Finance
Realty Corporation of Nevada, Household
Industrial Loan Company of Kentucky,
Household Finance Industrial Loan Company
of Iowa, Household Finance Consumer
Discount Company, Household Industrial
Finance Company and Mortgage One
Corporation (collectively, the
"Subservicers" and each individually, a
"Subservicer"), are wholly-owned
subsidiaries of HFC, licensed to make
home equity loans in the states in which
the Mortgage Loans were originated. The
Subservicers will sell the Cut-Off
Balances with respect to the Initial
Mortgage Loans on the Closing Date and
intend to sell the Cut-Off Balances with
respect to the Subsequent Funding
Mortgage Loans, any Eligible Substitute
Mortgage Loans and any Additional
Balances funded pursuant to the Credit
Line Agreements to the Seller pursuant to
the Receivables Purchase Agreement. The
Subservicers will also assign all right,
title and interest in the Related
Documents, other than the right or
obligation to fund additional draws, to
the Trustee. The Credit Line Agreements
will remain in the possession of the
Subservicers, except as provided herein.
MASTER SERVICER.................. Household Finance Corporation, a subsidiary
of Household International, Inc., will be
the master servicer of the Mortgage Loans
and the related notes, mortgages and
other related documents (collectively,
the "Related Documents"). Each Mortgage
Loan will be subserviced by the
appropriate Subservicer on behalf of HFC
as Master Servicer.
TRUSTEE.......................... The First National Bank of Chicago, a
national banking association ("Trustee").
CERTIFICATE INSURER.............. Capital Markets Assurance Corporation, a
monoline stock insurance corporation
organized under the laws of the State of
New York ("CapMAC" or "Certificate
Insurer").
THE MORTGAGE LOANS............... Unless otherwise noted in this Prospectus,
all statistical information included
herein with respect to the Initial
Mortgage Loans is as of the close of the
last billing cycle for each such Mortgage
Loan on or before May 1, 1996 (the "Pool
Date").
The Credit Line Agreements, pursuant to
which the Initial Mortgage Loans are
funded were originated by a Subservicer
in HFC's revolving home equity credit
line program. The Initial Mortgage Loans
will meet the
7
<PAGE> 8
criteria specified in the Agreement as of
their Cut-Off Date. The Initial Mortgage
Loans are secured by mortgages (of which,
approximately 31.27% by principal balance
are first mortgages, approximately 68.30%
by principal balance are second
mortgages, and the remainder are third
mortgages) on residential properties
which are primarily one- to four-family
properties located in 38 states. As of
the Pool Date, the aggregate of the Trust
Balances of the Initial Mortgage Loans
was $840,285,463.34 with approximately
64.01% by principal balance being
adjustable rate mortgages (the
"Adjustable Rate Mortgages") and the
remainder being fixed rate mortgages (the
"Fixed Rate Mortgages"). The combined
loan-to-value ratio of a Mortgage Loan is
computed at the maximum amount the
borrower was permitted to draw down under
the Credit Line Agreement (the "Credit
Limit") and taking into account the
amounts of any related senior mortgage
loans (the "Combined Loan-to-Value
Ratio"). Generally the Combined
Loan-to-Value Ratio of the Initial
Mortgage Loans did not exceed 100%, based
upon an appraisal of the Mortgaged
Property obtained by the Subservicer
which originated the Mortgage Loan at the
time of execution of the Credit Line
Agreement governing such Mortgage Loan.
The weighted average Combined
Loan-to-Value Ratio of the Initial
Mortgage Loans was approximately 81.68%
as of the Pool Date. The term to maturity
for most Initial Mortgage Loans at
origination was fifteen years or, in some
cases, ten years (with a portion of such
Mortgage Loans being subject to call at
the option of the related Subservicer
commencing not earlier than six years or,
in some cases, twelve years after such
date of origination). The weighted
average credit limit utilization rate of
the Initial Mortgage Loans was
approximately 96.06% as of the Pool Date.
See "The HFC Revolving Home Equity
Lending Program" herein.
Each Initial Mortgage Loan falls within one
of fourteen monthly billing cycles of the
Master Servicer, ending on the 4th, 5th,
6th, 8th, 10th, 11th, 12th, 16th, 17th,
18th, 19th, 20th, 25th and 26th days,
respectively, of each calendar month
(each a "Cycle Date"). The Collection
Period for any Mortgage Loan for any
Distribution Date will be the one month
period ending on the Cycle Date for such
Mortgage Loan in the month preceding the
month of the related Distribution Date.
Under the terms of the Credit Line
Agreements, borrowers generally may
obtain advances of principal (up to the
respective Credit Limits, and in certain
cases in excess of the Credit Limit) and
repay such
8
<PAGE> 9
principal from time to time. Billing
statements are generally produced as of
the related Cycle Date reflecting all
payment activity and any additional
borrowings by the borrower since the last
Cycle Date. Minimum monthly payments are
required to be made on each Initial
Mortgage Loan. The minimum monthly
payment (the "Minimum Monthly Payment")
for an Initial Mortgage Loan is generally
equal to the greatest of (x) a specified
percentage (which ranges between 0.85%
and 2.10% depending on the related
interest rate) of the Loan Balance (plus
any late charge fee or bad check fee
("Administrative Charges") and credit
insurance charges), (y) a designated
minimum dollar amount, which is generally
$50, plus any Administrative Charges and
credit insurance charges and (z) the
amount of interest accrued during the
related billing cycle plus any
Administrative Charges and credit
insurance charges. However, in the case
of Adjustable Rate Mortgages in Illinois
which were originated prior to November
6, 1989, the Minimum Monthly Payment is
generally computed solely pursuant to
clause (z) above. Except for any
principal amortization which may result
from such Minimum Monthly Payments, there
are no required payments of principal,
except that the entire outstanding
principal amount for most of the Mortgage
Loans are due fifteen years, or, in some
cases, ten years from the date of
origination (unless the related
Subservicer has and exercises an option
to call, as described above, which option
the Subservicers currently have no
intention of exercising).
The individual principal balances of the
Initial Mortgage Loans at the Pool Date
ranged from approximately $250 to
$589,787, and averaged approximately
$33,495. As of the Pool Date, the highest
Credit Limit of any Initial Mortgage Loan
was $589,786.71, and their average Credit
Limit was approximately $35,714. The
weighted average remaining term to stated
maturity at the Pool Date of the Initial
Mortgage Loans was approximately 145
months. The latest scheduled maturity of
any Initial Mortgage Loan is April 12,
2011. See "The HFC Revolving Home Equity
Lending Program" herein.
All of the Initial Mortgage Loans are
covered by standard hazard insurance
policies insuring against losses due to
fire and various other causes. See
"Description of the Certificates --
Hazard Insurance" herein.
The Subsequent Funding Mortgage Loans will
(subject to the availability thereof and
to certain limitations and conditions) be
conveyed to the Trust and be
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<PAGE> 10
originated by one or more of the
Subservicers. The Subsequent Funding
Mortgage Loans will meet the criteria
specified in the Agreement as of their
Cut-Off Date. The Trust intends to
purchase the Subsequent Funding Mortgage
Loans, if available from time-to-time on
any Distribution Date during the Funding
Period. The Subsequent Funding Mortgage
Loans will be purchased with amounts on
deposit in the Funding Account.
The Seller has entered into a Receivables
Purchase Agreement dated as of May 1,
1996, between the Seller, as purchaser,
and each Subservicer, as a seller
(together with any supplements thereto,
the "Receivables Purchase Agreement").
Pursuant to the Receivables Purchase
Agreement, the Subservicers have sold to
the Seller all of their right, title and
interest in and to the Cut-Off Balances
and all proceeds thereof including from
hazard insurance policies, if any, and
any title insurance relating thereto, and
are obligated to sell to the Seller any
Additional Balances arising under the
Credit Line Agreements from time to time
after the respective Cut-Off Dates.
Pursuant to the Agreement, the Seller has
also assigned to the Trust its rights
under the Receivables Purchase Agreement.
See "Description of the Receivables
Purchase Agreement".
Subject to certain conditions, if on any
Retransfer Notification Date (as defined
herein) the percentage of the Pool
Balance allocable to the Seller Interest
exceeds 2%, the Seller may, but shall not
be obligated to, remove from the Trust
certain Mortgage Loans, without notice to
the Certificateholders (the "Removed
Balances"). The Seller is permitted to
designate which Mortgage Loans will be
Removed Balances only upon satisfaction
of certain conditions, including the
following: (i) the Seller shall have
delivered to the Trustee a computer file
containing a list of all Mortgage Loans
in the Trust after such removal; (ii) the
Seller shall have represented that no
selection procedures reasonably believed
by the Seller to be adverse to the
interests of the Certificateholders or
the Certificate Insurer were utilized in
selecting the Removed Balances; (iii) the
Rating Agencies (as defined herein) shall
have been notified of the proposed
retransfer and prior to the date of
retransfer shall not have notified the
Seller in writing that such retransfer
would result in a reduction or withdrawal
of the then-current ratings assigned to
the Certificates; (iv) the proposed
retransfer shall not, in the reasonable
belief of the Seller, cause a Rapid
Amortization Event (as defined herein) to
occur; (v) the Rapid Amortization Period
(as defined herein) shall not
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<PAGE> 11
have commenced; (vi) the percentage of
the Pool Balance allocated to the Seller
Interest (after giving effect to such
removal) shall be at least equal to 2%
and (vii) the Seller shall have delivered
to the Trustee an officer's certificate
confirming the items set forth in (i)
through (vi) above. In addition, the
Mortgage Loans remaining in the Trust
must meet certain delinquency
requirements. Notwithstanding the
foregoing however, the Seller may, at its
sole discretion, remove Mortgage Loans
from the Trust at any time, provided (x)
the percentage of the Pool Balance
allocated to the Seller Interest (after
giving effect to such removal) shall be
at least equal to 2%, (y) the Seller
shall have delivered a certificate to the
Trustee identifying the Mortgage Loan to
be retransferred as well as confirming
the satisfaction of certain other
conditions, and (z) the Mortgage Loan is
being removed to facilitate the servicing
of the Mortgage Loan, including
modifications to the Credit Line
Agreement.
In addition to the ability of the Seller to
remove the Removed Balances from the
Trust as described above, the Seller
shall, to the extent set forth in the
Agreement, remove all Defective Mortgage
Loans (as defined herein) from the Trust.
In the event that such removal causes the
Seller Interest to be reduced below 2% of
the Pool Balance (after giving effect to
any substitutions as described herein),
the Seller will be obligated to make a
deposit into the Collection Account in an
amount equal to the amount by which the
Seller Interest would have been, but for
such deposit, reduced below 2% of such
Pool Balance (the "Retransfer Deposit
Amount"). See "Description of the
Certificates -- Assignment of Mortgage
Loans" herein.
During the term of the Trust, the Mortgage
Loans and all Additional Balances will be
transferred to and become property of the
Trust in accordance with the terms of the
Agreement. The aggregate amount of the
Pool Balance at any time will fluctuate
from day to day because the amount of the
draws and the amount of principal
payments by borrowers will usually differ
on each day. Because the Seller Interest
represents the interest in the Trust not
represented by the Invested Amount and
the aggregate undivided interest in the
Mortgage Loans of the Trust evidenced by
the Certificates will never exceed the
Original Invested Amount regardless of
the amount of the Pool Balance at any
time, the amount of the Seller Interest
will fluctuate from day to day as draws
are made and principal is paid under the
Credit Line Agreements.
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<PAGE> 12
The Seller Interest will represent the
right to the assets of the Trust not
represented by the Invested Amount. The
Seller has the right to sell, or borrow
against, the Seller Interest at any time,
provided (i) the Rating Agencies have
notified the Seller and the Trustee in
writing that such action will not result
in the reduction or withdrawal of the
ratings assigned to the Certificates and
(ii) certain other conditions are
satisfied. The Subservicers have the
right to transfer their respective
interests in the Credit Line Agreements
and transfer their obligations under the
Receivables Purchase Agreement at any
time, provided (i) the transferee agrees
in writing to assume all obligations of
the affected Subservicer contained in the
Receivables Purchase Agreement, (ii) the
Rating Agencies have notified the Seller
and the Trustee in writing that such
transfer will not result in the reduction
or withdrawal of the ratings assigned to
the Certificates and (iii) certain other
conditions are satisfied.
DENOMINATIONS.................... The Certificates will be issued in the
aggregate principal amount set forth on
the cover page hereof, in fully
registered denominations of $100,000 and
integral multiples of $1,000 in excess
thereof. The Certificates, at the Closing
Date, represent an undivided ownership
interest in 97.50% of the Mortgage Loans.
REGISTRATION OF CERTIFICATES..... Holders of the Certificates may elect to
hold their Certificate interests through
DTC, in the United States, or Centrale de
Livraison de Valeurs Mobilieres S.A.
("CEDEL") or the Euroclear System
("Euroclear"), in Europe. Transfers
within DTC, CEDEL or Euroclear, as the
case may be, will be in accordance with
the usual rules and operating procedures
of the relevant system. Cross-market
transfers between persons holding
directly or indirectly through DTC, on
the one hand, and counterparties holding
directly or indirectly through CEDEL or
Euroclear, on the other, will be effected
in DTC through Citibank, N.A.
("Citibank") or Chemical Bank
("Chemical"), the relevant depositaries
(collectively, the "Depositaries") of
CEDEL or Euroclear, respectively, and
each a participating member of DTC. The
Certificates will initially be registered
in the name of CEDE & Co., the nominee of
DTC. The interests of the
Certificateholders will be represented by
book-entries on the records of DTC and
participating members thereof.
Certificates will be available in
definitive form only under the limited
circumstances described herein. All
references in this Prospectus to
"holders", "Certificateholders" or
"Investor Certificateholders" shall be
deemed, unless the context clearly
requires otherwise, to refer to the
Certificateholders. See "Special
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<PAGE> 13
Considerations" and "Description of the
Certificates -- Registration of
Certificates" herein.
INTEREST......................... Interest on the Certificates will be
distributed monthly on the 20th day of
each month or, if such day is not a
Business Day (as defined herein), on the
next succeeding Business Day (each, a
"Distribution Date"), commencing on June
20, 1996, at the Certificate Rate for the
related Interest Period (as defined
below). The Certificate Rate for each
Distribution Date will equal the London
interbank offered rate for one-month
United States dollar deposits ("LIBOR"),
determined as specified herein, as of the
second LIBOR Business Day prior to the
immediately preceding Distribution Date
(or as of May 21, 1996, in the case of
the first Distribution Date) plus 0.20%
per annum, subject to a maximum rate as
described under "Description of the
Certificates" herein. In addition, if the
Certificate Rate exceeds the weighted
average of the Net Loan Rates, then the
Certificateholders will receive such
difference (the "Carryover Amount") only
from Interest Collections allocable to
Certificateholders as described under
"Payments of Interest Collections"
herein. "Net Loan Rate" with respect to
any Mortgage Loan means the Loan Rate (as
defined herein) of a Mortgage Loan minus
the Servicing Fee (as defined herein).
The Carryover Amount will not bear
interest and will not be paid out of
funds on deposit in the Spread Account or
draws under the Policy. See "Description
of the Certificates -- Distributions on
the Certificates -- Calculation of
Certificate Rate; Limitation on Interest
Payments on Certificates". Interest on
the Certificates in respect of any
Distribution Date will accrue from the
preceding Distribution Date (or in the
case of the first Distribution Date, from
the date of the initial issuance of the
Certificates (the "Closing Date"))
through the day preceding such
Distribution Date (each such period, an
"Interest Period") on the basis of a
360-day year and the actual number of
days in such Interest Period. Interest
for any Distribution Date due but not
paid on such Distribution Date (other
than any Carryover Amounts) will be due
on the next succeeding Distribution Date
together with additional interest on such
amount at a rate equal to the sum of the
Certificate Rate and 2% per annum.
Interest payments will be funded from the
portion of the Certificateholders'
Floating Allocation Percentage of
Interest Collections collected during the
related Collection Period (as defined
herein) and, if necessary, from transfers
from the Spread Account and draws on the
Policy. See "Description of the
Certificates".
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<PAGE> 14
COLLECTIONS...................... All collections on the Mortgage Loans will
be allocated in accordance with the
Credit Line Agreements between amounts
collected in respect of interest,
including Net Liquidation Proceeds (as
defined below) constituting interest and
Recovered Charge Off Amounts (as defined
herein) (together with any earnings
received on the amounts deposited in the
Funding Account, the "Interest
Collections"), and amounts collected in
respect of principal, including
Retransfer Deposit Amounts (as defined
herein) and Net Liquidation Proceeds
constituting principal (exclusive of
Recovered Charge Off Amounts) (the
"Principal Collections"). Net Liquidation
Proceeds with respect to a Mortgage Loan
are equal to the aggregate of all amounts
received upon liquidation of such
Mortgage Loan reduced by related
expenses, but not including the portion,
if any, of such amount that exceeds the
Trust Balance of the Mortgage Loan at the
end of the Collection Period immediately
preceding the Collection Period in which
such Mortgage Loan became a Liquidated
Mortgage Loan plus accrued and unpaid
interest thereon plus any Charge Off
Amounts related thereto. See "Description
of the Certificates -- Allocations and
Collections."
During the Funding Period, the Scheduled
Principal Distribution Amount (as defined
herein) will be deposited in the Funding
Account. However, in the event that the
amount of Principal Collections deposited
in the Funding Account during the Funding
Period prior to the last Distribution
Date thereof exceeds 12% of the sum of
the Cut-Off Balances of the Initial
Mortgage Loans, the amount of such excess
(after giving effect to the acquisition
of any Additional Balances on or prior to
such Distribution Date) will be
distributed to the Certificateholders on
such Distribution Date as payment of
principal. In the event that not all of
the Principal Collections on deposit in
the Funding Account have been used to
acquire the Subsequent Funding Mortgage
Loans on the last Distribution Date of
the Funding Period, then such Collections
will be used to acquire any remaining
Additional Balances on such Distribution
Date and any remaining Principal
Collections on deposit thereafter will be
distributed to the Certificateholders on
such Distribution Date as payment of
principal. Following the expiration of
the Funding Period and prior to the
commencement of the Rapid Amortization
Period, Principal Collections from the
Mortgage Loans will be allocated as
follows: (a) to the Certificateholders,
the Scheduled Principal Distribution
Amount, and (b) to the Seller, all
Principal Collections not distributed to
the Certificateholders. Upon the
commencement of the Rapid
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<PAGE> 15
Amortization Period, the
Certificateholders will receive Principal
Collections in accordance with the Fixed
Allocation Percentage as described below
under "Payments of Principal
Collections." Payments of principal to
Certificateholders over the term of the
Trust will not exceed the Original
Certificate Principal Balance.
Principal Collections distributed to
Certificateholders will reduce both the
Invested Amount and the Certificate
Principal Balance by the amount so
distributed. Payments of the Guaranteed
Principal Distribution Amount from
amounts drawn under the Policy and
Accelerated Principal Distribution
Amounts paid from Interest Collections
allocable to the Certificateholders will
reduce only the Certificate Principal
Balance. In addition, the Invested Amount
and the Certificate Principal Balance
will be reduced by Interest Collections
used to pay losses allocable to the
Certificateholders' interest as described
below. If the Invested Amount has been
reduced below the Certificate Principal
Balance, the Certificateholders will be
protected either by funds in the Spread
Account or draws under the Policy.
The Master Servicer will, except as
otherwise described herein, generally
deposit Interest Collections and
Principal Collections on the Mortgage
Loans allocable and distributable to the
Certificateholders in an account
established for such purpose under the
Agreement (the "Collection Account"). See
"Description of the Certificates --
Payments on Mortgage Loans; Deposits to
Collection Account; Deposits to Funding
Account".
FUNDING ACCOUNT; FUNDING
PERIOD........................... The Funding Account will be an Eligible
Account (as defined herein) established
with the Trustee on the Closing Date. On
each Distribution Date during the Funding
Period the Scheduled Principal
Distribution Amount for such Distribution
Date will be deposited in the Funding
Account and may be used by the Trustee to
purchase up to an aggregate of
$100,834,256 of Subsequent Funding
Mortgage Loans, which is equal to 12% of
the sum of the Cut-Off Balances of the
Initial Mortgage Loans. On any
Distribution Date during the Funding
Period on which the aggregate amount
deposited into the Funding Account
exceeds $100,834,256, such excess will be
distributed to the Certificateholders as
principal. Notwithstanding the
immediately preceding sentence, in the
event that not all of the Principal
Collections on deposit in the Funding
Account have been used to acquire the
Subsequent Funding Mortgage Loans on the
last Distribution Date of the Funding
Period, then such
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<PAGE> 16
Principal Collections will be used to
acquire any remaining Additional Balances
on such Distribution Date and any
remaining Principal Collections on
deposit thereafter will be distributed to
the Certificateholders as principal.
The Funding Period is the period commencing
on the Closing Date and ending on the
earlier of (i) the Distribution Date on
which the Trustee has purchased an
aggregate of $100,834,256 of Subsequent
Funding Mortgage Loans from funds on
deposit in the Funding Account but in no
event later than the 14th Distribution
Date after the Closing Date and (ii) the
commencement of the Rapid Amortization
Period.
PAYMENTS OF INTEREST
COLLECTIONS...................... The portion of Interest Collections
allocable to the Certificates will equal
the aggregate amount of such collections
multiplied by the Certificateholders
Floating Allocation Percentage. For each
Distribution Date, the
"Certificateholders Floating Allocation
Percentage" shall mean the percentage
equivalent determined by dividing the
Invested Amount at the end of the related
Collection Period by the sum of (a) the
Pool Balance as of the end of the
preceding Collection Period (adjusted for
such Subsequent Funding Mortgage Loans or
Additional Balances acquired or Removed
Balances removed for the preceding
Distribution Date) and (b) the amount on
deposit in the Funding Account as of the
end of the related Collection Period. The
remaining amount of Interest Collections
shall be allocated to the Seller Interest
as more fully described herein.
Interest Collections allocated to the
Certificates, will be applied in the
following order of priority: (i) as
payment of the Servicing Fee for the
related Collection Period and any accrued
and unpaid Servicing Fee; (ii) as payment
of the accrued interest due and any
overdue accrued interest (other than the
Carryover Amount) on the Certificates
with interest thereon at the Certificate
Rate and, with respect to any overdue
accrued interest, an additional 2% per
annum; (iii) as payment to
Certificateholders of the product of the
Certificateholders Floating Allocation
Percentage and the Liquidation Loss
Amount for such Collection Period; (iv)
as payment for any Liquidation Loss
Amount allocable to the
Certificateholders for a previous
Collection Period that was not (a) funded
by Interest Collections allocable to the
Certificateholders, (b) absorbed by the
Overcollateralization Amount (as defined
below) or (c) funded by withdrawals from
the Spread Account or by draws on the
Policy; (v) as payment of the premium for
the Policy if not paid directly by the
Master Servicer; (vi) to
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<PAGE> 17
reimburse the Certificate Insurer for
prior draws made from the Policy and
other amounts due under the Insurance
Agreement (as defined herein); (vii) to
the extent of excess Interest Collections
remaining after payment of (i) through
(vi) as a principal payment to
Certificateholders of an amount as
principal such that the Invested Amount
exceeds the Certificate Principal Balance
by the Required Overcollateralization
Amount, as defined herein (the aggregate
of amounts, if any, paid pursuant to this
clause (vii) being referred to herein as
the "Accelerated Principal Distribution
Amount"); (viii) to the Spread Account in
accordance with the Insurance Agreement;
(ix) as payment to the Certificateholders
of the Carryover Amount for any prior
Distribution Dates that has not
previously been paid; (x) fees due to the
Trustee, to the extent not paid by the
Master Servicer; and (xi) to the Seller.
Interest Collections allocated pursuant to
clauses (iii), (iv), (vi) and (vii) above
shall be referred to herein as the
"Certificateholders Excess Interest".
Interest Collections in the amount
described in clause (viii) above shall be
referred to herein as "Certificateholders
Remaining Excess Interest." The
Overcollateralization Amount on any date
of determination is the amount, if any,
by which the Invested Amount exceeds the
Certificate Principal Balance on such
day.
Payments to Certificateholders pursuant to
clause (ii) will be interest payments on
the Certificates. Payments to
Certificateholders pursuant to clause
(iii) will be principal payments on the
Certificates and will therefore reduce
the Invested Amount and the Certificate
Principal Balance. Although payments to
Certificateholders of previously
unreimbursed Liquidation Loss Amounts and
the Accelerated Principal Distribution
Amount pursuant to clauses (iv) and
(vii), respectively, will reduce the
Certificate Principal Balance, such
payments will not reduce the Invested
Amount. The Accelerated Principal
Distribution Amount is not guaranteed by
the Policy.
The "Required Overcollateralization Amount"
is $4,201,427. "Liquidation Loss Amount"
means with respect to any (i) Charged Off
Mortgage Loan, the Charge Off Amount for
the Collection Period in which all or a
portion of the unpaid principal balance
of the Mortgage Loan was charged off by
the Master Servicer, excluding the
Collection Period in which such Charged
Off Mortgage Loan becomes a Liquidated
Mortgage Loan, and (ii) Liquidated
Mortgage Loan, the unrecovered Trust
Balance thereof at the end of
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<PAGE> 18
the Collection Period in which such
Liquidated Mortgage Loan became a
Liquidated Mortgage Loan, after giving
effect to the Net Liquidation Proceeds in
connection therewith. See "Description of
the Certificates -- Distributions on the
Certificates."
PAYMENTS OF PRINCIPAL
COLLECTIONS...................... Except as described below, if the aggregate
amount deposited into the Funding Account
exceeds $100,834,256 (12% of the sum of
the Cut-Off Date Balances of the Initial
Mortgage Loans), such excess will be
distributed to the Certificateholders as
principal. In the event that not all of
the Principal Collections on deposit in
the Funding Account have been used to
acquire the Subsequent Funding Mortgage
Loans on the last Distribution Date of
the Funding Period, then such Collections
will be used to acquire any remaining
Additional Balances on such Distribution
Date and any remaining Principal
Collections on deposit thereafter will be
distributed to the Certificateholders as
payment of principal. Following the
expiration of the Funding Period and
prior to the commencement of the Rapid
Amortization Period, the amount of
Principal Collections payable to
Certificateholders as of each
Distribution Date will equal, to the
extent funds are available therefore, the
Scheduled Principal Distribution Amount
for such Distribution Date. See
"Description of the Certificates --
Distributions of Principal Collections."
The Scheduled Principal Distribution
Amount is equal to the lesser of (i) the
Maximum Principal Distribution Amount and
(ii) the Alternative Principal
Distribution Amount, which is the amount,
but not less than zero, of Principal
Collections for the related Collection
Period less the aggregate of principal
amounts drawn down under the Credit Line
Agreements during such Collection Period.
On any Distribution Date, the Seller will
then be entitled to receive as a payment
of principal the Principal Collections
for such Distribution Date that are not
distributed to the Certificateholders or
deposited into the Funding Account. With
respect to any Distribution Date, the
Maximum Principal Distribution Amount
will equal the Fixed Allocation
Percentage of Principal Collections for
the related Collection Period. The Fixed
Allocation Percentage is initially 97.50%
and for each Distribution Date will be
reset to the extent that Subsequent
Funding Mortgage Loans were acquired or
Removed Balances were removed with
respect to the immediately preceding
Distribution Date. With respect to such
reset, the Fixed Allocation Percentage
shall be the percentage equivalent
determined by dividing the Invested
Amount at the end of the related
Collection Period by the sum of (a) the
Pool Balance as of the end of the
preceding Collection Period (adjusted for
such Subsequent Funding Mortgage Loans or
Additional
18
<PAGE> 19
Balances acquired or Removed Balances
removed for the preceding Distribution
Date) and (b) the amount on deposit in
the Funding Account as of the end of the
related Collection Period.
Distributions of Principal Collections
based upon the Fixed Allocation
Percentage may result in distributions of
Principal Collections to
Certificateholders in amounts that are
greater relative to the declining balance
of the Pool Balance than would be the
case if the Certificateholders Floating
Allocation Percentage were used to
determine the percentage of Principal
Collections distributed in respect of the
Invested Amount.
Upon the commencement of the Rapid
Amortization Period, the Scheduled
Principal Distribution Amount will no
longer apply, but instead, the amount of
Principal Collections payable to the
Certificateholders will be equal to the
Maximum Principal Distribution Amount.
The Rapid Amortization Period will
commence on the earlier of (x) the
October 20, 2004 Distribution Date and
(y) the day, if any, upon which a Rapid
Amortization Event occurs. See
"Description of the Certificates -- Rapid
Amortization Period" and "-- Rapid
Amortization Events."
POLICY........................... On or before the Closing Date, the Policy
will be issued by the Certificate Insurer
pursuant to the provisions of the
Agreement and the Insurance and
Reimbursement Agreement (the "Insurance
Agreement") to be dated as of May 1, 1996
among the Seller, HFC, as Master
Servicer, the Certificate Insurer and the
Trustee. The Policy will unconditionally
and irrevocably guarantee payment of the
Deficiency Amount up to $475,000,000 in
principal payments plus, until such time
as the Certificate Insurer has made
payments in respect of principal under
the Policy in an amount equal to
$475,000,000, accrued and unpaid interest
on the Certificates. The Deficiency
Amount is equal to the sum of the
following two amounts: (a) any shortfall
in the amount available from Interest
Collections allocable to the Certificates
and amounts on deposit in the Spread
Account to pay interest accrued at the
Certificate Rate (other than the
Carryover Amounts) on the outstanding
principal amounts of the Certificates
after payments of all amounts, if any,
due from the Collection Account relating
to unpaid Servicing Fees and (b) after
applying any amounts available in the
Spread Account, the amount, if any, (the
"Guaranteed Principal Distribution
Amount") which is required to reduce the
Original Certificate Principal Balance
less all payments in respect of principal
previously distributed to
Certificateholders to an amount equal to
the Invested Amount after giving
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<PAGE> 20
effect to (i) the distributions, if any,
to the Certificateholders of principal on
such Distribution Date, and (ii) the
allocation of any Liquidation Loss
Amounts to the Invested Amount on such
Distribution Date.
In accordance with the Insurance Agreement,
the Trust will be required to establish
and maintain an account (the "Spread
Account") for the benefit of the
Certificate Insurer and the
Certificateholders, to be used prior to
any draws upon the Policy. Any amounts on
deposit in the Spread Account will be
available to the Trustee to be
transferred to the Collection Account to
pay any Deficiency Amount prior to a draw
under the Policy. The Insurance Agreement
will require that the Certificateholders'
Remaining Excess Interest be deposited
into the Spread Account until funds in
the Spread Account are equal to an amount
specified by such agreement. Such amount
may be reduced or eliminated by agreement
between the Seller and the Certificate
Insurer and without the consent of the
Certificateholders. Any amounts on
deposit in the Spread Account upon
termination of the Trust and after
reimbursement of amounts drawn under the
Policy to the Certificate Insurer
together with interest thereon will be
distributed to the Seller as provided in
the Insurance Agreement.
In the absence of payments from the Spread
Account or under the Policy,
Certificateholders will directly bear the
credit and other risks associated with
their undivided interest in the Trust.
See "Description of the Certificate
Insurer -- The Policy".
In the event that the Certificate Insurer's
claims paying ratings have been lowered
by any of the Rating Agencies, the Master
Servicer may, but is not obligated to,
upon payment of all amounts due the
Certificate Insurer, replace the Policy
with a financial guaranty insurance
policy or policies issued by another
insurer or arrange for any other form of
credit enhancement, provided that the
ratings on the claims paying ability of
such replacement insurer are higher than
those of the certificate insurer sought
to be replaced (after giving effect to
such downgrade). In the event of such
downgrading, the Master Servicer also
may, but is not obligated to, restructure
the credit enhancement provided to the
Certificates, including eliminating the
Policy without replacement; provided that
the Rating Agencies consent to such
restructuring and the Rating Agencies
confirm that the ratings of the
Certificates will be increased from their
current levels (after giving effect to
such downgrading) as a result of such
restructuring.
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<PAGE> 21
OVERCOLLATERALIZATION............ The distribution of Accelerated Principal
Distribution Amounts, if any, to
Certificateholders may result in the
Invested Amount being greater than the
Certificate Principal Balance, thereby
creating overcollateralization. The
amount, if any, of such
overcollateralization would be available
to absorb any Liquidation Loss Amount
that is allocated to Certificateholders.
Payments of Accelerated Principal
Distribution Amounts are not covered by
the Policy. Any remaining Liquidation
Loss Amounts allocable to the
Certificateholders and not covered by
such overcollateralization will be
covered by funds in the Spread Account or
by draws on the Policy to the extent
provided herein.
RECORD DATE...................... The day immediately preceding a
Distribution Date.
SERVICING........................ The Master Servicer will be responsible for
servicing, managing and making
collections on the Mortgage Loans and the
Related Documents. Each Mortgage Loan and
the Related Documents will be subserviced
by the appropriate Subservicer on behalf
of HFC, as Master Servicer. The Master
Servicer will cause Interest Collections,
together with investment earnings from
the Funding Account, if any, and
Principal Collections to be deposited
into the Collection Account, except
during the Funding Period when certain
Principal Collections will be deposited
into the Funding Account, as described
herein. On the fifth Business Day prior
to any Distribution Date (the
"Determination Date"), the Master
Servicer will calculate, and instruct the
Trustee regarding the amounts to be paid,
as described herein, with respect to the
related Collection Period to the
Certificateholders. See "Description of
the Certificates -- Distributions on the
Certificates."
As long as HFC is the Master Servicer it
will receive, or be entitled to retain
from the Certificateholder's portion of
Interest Collections, on behalf of itself
and the Subservicers, a portion of the
Interest Collections as a monthly
servicing fee (the "Servicing Fee" or
"Investor Servicing Fee") in the amount
of 1.00% per annum of the Invested Amount
(less any amount on deposit in the
Funding Account, exclusive of any
investment earnings thereon), as
servicing compensation from the Trust.
See "Description of the
Certificates -- Servicing Compensation
and Payment of Expenses." In certain
limited circumstances, the Master
Servicer may resign or be removed, in
which event either the Trustee or a
third-party servicer will be appointed as
a successor Master Servicer. See
"Description of the
Certificates -- Certain Matters Regarding
the Master Servicer and the Seller."
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<PAGE> 22
FINAL PAYMENT OF PRINCIPAL;
TERMINATION...................... Upon payment of any amounts due the
Certificate Insurer, the Trust will
terminate on the Distribution Date
following the earlier of (i) the date on
which the Certificate Principal Balance
is zero and after which there are no
unreimbursed Liquidation Loss Amounts
allocable to the Certificateholders, (ii)
the final payment or other liquidation of
the last Mortgage Loan in the Trust and
(iii) the July 20, 2017 Distribution
Date. The Certificateholders' interest in
the Mortgage Loans will be subject to
optional retransfer to the Seller on any
Distribution Date upon the reduction of
the Certificate Principal Balance to an
amount less than or equal to $81,927,800
(10% of the Original Certificate
Principal Balance) and all amounts due
and owing to the Certificate Insurer and
unreimbursed draws on the Policy,
together with interest thereon as
provided under the Insurance Agreement,
have been paid. The Retransfer Price will
be equal to the sum of (a) the
outstanding Certificate Principal
Balance, (b) accrued and unpaid interest
thereon at the applicable Certificate
Rates through the day preceding the final
Distribution Date and (c) any
unreimbursed draws upon the Policy and
other amounts due under the Insurance
Agreement. See "Description of the
Certificates -- Termination; Retirement
of the Certificates."
MANDATORY RETRANSFER OF CERTAIN
MORTGAGE LOANS; SUBSTITUTION OF
MORTGAGE LOANS................... The Seller will make certain
representations and warranties in the
Agreement with respect to the Mortgage
Loans. If the Seller breaches certain of
its representations and warranties with
respect to any Mortgage Loan, then
depending upon the representation or
warranty breached, if such breach has a
material adverse effect on the interests
of the Certificateholders or the
Certificate Insurer and is not cured
within the specified period, the Mortgage
Loan will be removed from the Trust after
the expiration of a specified period from
the date on which the Seller becomes
aware or receives notice of such breach
and will be reassigned to the Seller. In
such event, the Seller will have the
option of substituting a new Mortgage
Loan for any Defective Mortgage Loan. Any
Mortgage Loan so substituted (an
"Eligible Substitute Mortgage Loan")
must, among other things, have a
principal balance that is not
substantially greater or less than the
Trust Balance of the Defective Mortgage
Loan it is replacing and a Loan Rate of
not less than the current Loan Rate of
the Defective Mortgage Loan it replaces
and not more than 500 basis points in
excess thereof unless the Rating Agencies
and the
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Certificate Insurer otherwise consent to
such Eligible Substitute Mortgage Loan.
See "Description of the Certificates --
Assignment of Mortgage Loans" herein. If
the Seller breaches certain of its
representations and warranties with
respect to (a) the ownership of the Trust
Balances and the ability to sell the same
pursuant to the Agreement or (b) the
status of the transfer of the amounts due
under the Mortgage Loans to the Trust as
either a valid transfer and assignment of
such amounts to the Trust or the grant to
the Trust of a security interest in such
Mortgage Loans, which breach, in either
case, materially and adversely affects
the Certificateholders or the Certificate
Insurer, then all of the amounts due
under such Mortgage Loans will be
reassigned to the Seller.
If the Master Servicer fails to comply in
all material respects with certain
representations, warranties or covenants
with respect to any Mortgage Loan, and
such noncompliance is not cured within a
specified period after the Master
Servicer becomes aware or receives notice
thereof and such noncompliance has a
material adverse effect on the
Certificateholders or the Certificate
Insurer, or certain events of insolvency
occur with respect to the Master
Servicer, the Trustee may appoint a
successor Master Servicer with the
consent of the Certificate Insurer or
under certain circumstances, the
Certificate Insurer and
Certificateholders holding not less than
51% of the principal amount of the
outstanding Certificates, by written
notice to the Master Servicer and the
Trustee, may appoint a successor Master
Servicer. In the event of a transfer of
servicing obligations to a successor
Master Servicer, such successor Master
Servicer, rather than HFC, will be
responsible for any failure to comply
with the Master Servicer's covenants
arising thereafter. See "Description of
the Certificates -- Assignment of
Mortgage Loans."
TAX STATUS....................... Special tax counsel to the Seller is of the
opinion that, under existing law, the
Certificates are properly characterized
as indebtedness of the Seller for Federal
income tax purposes and for Illinois
income tax purposes. Under the Agreement,
the Seller and the Certificateholders
will agree to treat the Certificates as
indebtedness of the Seller for Federal,
state and local income and franchise tax
purposes. See "Certain Income Tax
Consequences" for additional information
concerning the application of Federal
income tax laws.
INCOME TAX WITHHOLDING........... Interest on the Certificates held by
non-U.S. persons will be subject to the
United States withholding tax unless the
holder complies with applicable United
States Internal Revenue Service (the
"Service")
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identification requirements. Interest on
the Certificates held by U.S. persons
will be subject to backup withholding
unless such holder complies with
applicable certification requirements of
the Service.
LEGAL INVESTMENT
CONSIDERATIONS................... Although, as a condition to their issuance,
the Certificates will be rated in the
highest rating category by the Rating
Agencies, the Certificates will not
constitute "mortgage related securities"
for purposes of the Secondary Mortgage
Market Enhancement Act of 1984 ("SMMEA")
because not all of the mortgages securing
the Mortgage Loans are first mortgages.
Accordingly, many institutions with legal
authority to invest in comparably rated
securities based on first mortgage loans
(i.e., "mortgage related securities"
(under SMMEA)) may not be legally
authorized to invest in the Certificates.
See "Legal Investment Considerations."
ERISA CONSIDERATIONS............. As more fully described under "ERISA
Considerations", an employee benefit
plan (a "Plan") subject to the
requirements of the fiduciary
responsibility provisions of the
Employee Retirement Income Security Act
of 1974, as amended ("ERISA"), or the
provisions of Section 4975 of the Code,
contemplating the purchase of the
Certificates should consult its counsel
before making a purchase and the
fiduciary and such legal advisors should
consider whether the Certificates will
satisfy all of the requirements of the
"publicly offered securities" exemption
described herein or the possible
application of other ERISA prohibited
transaction exemptions described herein.
CERTIFICATE RATING............... It is a condition to the issuance of the
Certificates that they be rated in the
highest long term rating category by at
least two nationally recognized
statistical rating organizations (the
"Rating Agencies"). See "Special
Considerations -- Certificate Rating."
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RISK FACTORS
Limited Liquidity. There is currently no market for the Certificates. While
the Underwriters currently intend to make a market in the Certificates, they are
under no obligation to do so. There can be no assurance that a secondary market
will develop or, if a secondary market does develop, that it will provide
holders of the Certificates with liquidity of investment or that it will
continue while the Certificates remain outstanding.
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
certificates. See "Description of the Certificates -- Registration of
Certificates" herein.
Difficulty in Pledging. Since transactions in the Certificates can be
effected only through DTC, CEDEL, Euroclear, 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 the DTC,
CEDEL or Euroclear system, or otherwise to take actions in respect of such
Certificates, may be limited due to lack of a physical certificate representing
the Certificates. See "Description of the Certificates -- Registration of
Certificates" herein.
Potential Delays in Receipt of Distributions. 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
Participants (as defined herein) which will thereafter credit them to the
accounts of Certificate Owners either directly or indirectly through indirect
participants. See "Description of Certificates -- Registration of Certificates"
herein.
Nature of Security. Required minimum monthly payments are not, in most
instances, expected to be sufficient to fully amortize principal of a Mortgage
Loan prior to maturity. As a result, a borrower will generally be required to
pay the entire principal amount of the Mortgage Loan at its maturity. The
ability of a borrower to make such a payment may be dependent on the ability to
obtain refinancing of the balance due on the Mortgage Loan. An increase in
interest rates over the Loan Rate applicable at the time the Mortgage Loan was
originated may have an adverse effect on the borrower's ability to pay the
required monthly payment. In addition, such an increase in interest rates may
reduce the borrower's ability to obtain refinancing and to pay the balance of
the Mortgage Loan at its maturity. A borrower's payments in any month may be as
low as the interest payment for such month or as high as the entire outstanding
principal balance (plus accrued interest). Since certain mortgages securing
Mortgage Loans are junior liens subordinate to the rights of the mortgagee or
beneficiary under any related senior mortgage or deed of trust, the proceeds
from any liquidation, insurance or condemnation proceeding will be available to
satisfy the outstanding balance of a Mortgage Loan only to the extent that the
claims of such senior mortgagee or beneficiary have been satisfied in full
(including any related foreclosure costs).
An overall decline in the residential real estate market could adversely
affect the values of the Mortgaged Properties such that the outstanding Mortgage
Loans, together with any senior financing thereon, equal or exceed the value of
the Mortgaged Properties. Such a decline would adversely affect the position of
a junior mortgagee before having such an effect on any related senior mortgagee.
A rise in interest rates over a period of time, the general condition of the
Mortgaged Property as well as other factors may have the effect of reducing the
value of the Mortgaged Property from the appraised value at the time the
Mortgage Loan was originated. Because payments in reduction of the entire
outstanding principal balance of a Mortgage Loan are generally not required
prior to maturity, if there is a subsequent reduction in value of the Mortgaged
Property the ratio of the amount of the Mortgage Loan to the value of the
Mortgaged Property may increase over what it was at the time the Mortgage Loan
was originated. Such an increase may reduce the likelihood of liquidation or
other proceeds being sufficient to satisfy the Mortgage Loan after satisfaction
of any senior liens.
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Cash Flow Considerations. Collections on the Mortgage Loans may vary
because, among other things, borrowers may make payments during any month (other
than the month in which the Mortgage Loan matures) as low as the interest
payment for such month or as high as the outstanding balance plus accrued
interest thereon. Collections on the Mortgage Loans may also vary due to
seasonal purchasing and payment habits of borrowers.
General credit risk may also be greater to Certificateholders than to
holders of instruments representing interests in level payment first mortgage
loans since, except where the minimum required monthly payment exceeds accrued
interest on the Mortgage Loans or, for certain Fixed Rate Mortgages, an even
monthly payment (which includes principal and interest), no payment of principal
is required until final maturity. Generally, minimum monthly payments will at
least equal and may exceed accrued interest. Although most borrowers under home
equity loans originated by the Subservicers historically pay down all or part of
their outstanding principal balances prior to maturity, such borrowers are under
no obligation to do so and, in the event such balances have not been
substantially paid down prior to maturity, some borrowers may find themselves
unable to make the required final payment. Even assuming that the Mortgaged
Properties provide adequate security for the Mortgage Loans, substantial delay
could be encountered in connection with the liquidation of Mortgage Loans that
are delinquent and corresponding delays in the receipt of related proceeds by
Certificateholders could occur if the Certificate Insurer were unable to perform
on its obligations under the Policy. Further, liquidation expenses (such as
legal fees, real estate taxes, and maintenance and preservation expenses) will
reduce the proceeds payable to Certificateholders and thereby reduce the
security for the Mortgage Loans. In the event any Mortgaged Properties fail to
provide adequate security for the related Mortgage Loans, Certificateholders
could experience a loss if the Certificate Insurer were unable to perform on its
obligations under the Policy.
Prepayment Considerations. All of the Mortgage Loans may be prepaid in
whole or in part at any time. Neither the Seller nor HFC is aware of any
publicly generated studies or statistics available on the rate of prepayment of
such loans. Generally, home equity loans are not viewed by borrowers as
permanent financing. Accordingly, the Mortgage Loans may experience a higher
rate of prepayment than traditional mortgage loans. On the other hand, because
most of the Mortgage Loans are not fully amortizing, in the absence of voluntary
borrower prepayments, the Mortgage Loans could experience slower rates of
principal payment than traditional fully amortizing mortgages. The Trust's
prepayment experience may be affected by a wide variety of factors, including
general economic conditions, interest rates, the availability of alternative
financing, homeowner mobility and any prepayment penalty incurred in connection
with the prepayment of a Mortgage Loan. In addition, substantially all of the
Mortgage Loans contain due-on-sale provisions, and the related Subservicer
intends to enforce such provisions unless (i) such enforcement is not permitted
by applicable law or (ii) the related Subservicer, in a manner consistent with
reasonable commercial practice, permits the purchaser of the related Mortgaged
Property to assume the Mortgage Loan. To the extent permitted by applicable law,
such assumption will not release the original borrower from its obligation under
the Mortgage Loan. See "Maturity and Prepayment Considerations" and "Certain
Legal Aspects of the Mortgage Loans -- 'Due-on-Sale' Clauses" for a description
of certain provisions of the Credit Line Agreements that may affect the
prepayment experience on the Mortgage Loans.
Certificate Rating. The ratings of the Certificates will depend primarily
on an assessment by the Rating Agencies of the underlying Mortgage Loans, and
upon 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 ratings initially given to the Certificates will likely result in a
reduction in the ratings of the Certificates. The ratings assigned by the Rating
Agencies to the Certificates are not recommendations to purchase, hold or sell
the Certificates, inasmuch as such ratings do not comment as to the market price
or suitability for a particular investor. There is no assurance that the ratings
will remain in place for any given period of time or that the ratings will not
be lowered or
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<PAGE> 27
withdrawn by the Rating Agencies. The ratings of the Certificates do not address
the possibility of the imposition of United States withholding tax with respect
to non-U.S. persons.
Change in Loan Terms. The Subservicers shall have the right to modify the
terms of the Credit Line Agreements. Changes may reduce the amortization of the
Mortgage Loans.
Legal Considerations. The Mortgage Loans will be primarily secured by
first and second mortgages. With respect to Mortgage Loans that are secured by
first mortgages, the related Subservicer will have the power under certain
circumstances to consent to a new mortgage lien on the Mortgaged Property having
priority over the Mortgage Loan owned by the Trust. Mortgage Loans secured by
second and third mortgages will be entitled to proceeds that remain from the
sale of the related Mortgaged Property after any related senior mortgage loans
and prior statutory liens have been satisfied or, if such were satisfied by the
Master Servicer, after the Master Servicer has been reimbursed. In the event
that such proceeds are insufficient to satisfy such loans and prior liens in the
aggregate and the Certificate Insurer is unable to perform its obligations under
the Policy, the Trust and, accordingly, the Certificateholders, as the holders
of interests in the Trust consisting primarily of junior mortgage loans, bear
(i) the risk of delay in distributions while a deficiency judgment against the
borrower is obtained and (ii) the risk of loss if a deficiency judgment cannot
be obtained or is not realized upon to the extent of the Trust Balance. See
"Certain Legal Aspects of the Mortgage Loans" herein.
Applicable state laws generally regulate interest rates and other charges,
require certain disclosures, and may require licensing of the Subservicers. In
addition, many states have other laws, such as consumer protection laws, unfair
and deceptive practices acts and debt collection practices acts which may apply
to the origination or collection of the Mortgage Loans. Depending on the
provisions of the applicable law, violations of these laws may limit the ability
of the Subservicers and the Trust to collect all or part of the principal of or
interest on the Mortgage Loans, may entitle the borrower to a refund of amounts
previously paid and, in addition, could subject the Subservicers, Seller and
possibly the Trust to damages and administrative enforcement.
The Mortgage Loans will also be subject to federal laws, including:
(i) the Federal Truth in Lending Act and Regulation Z promulgated
thereunder, which require certain disclosures to the borrowers regarding the
terms of the Mortgage Loans and related Credit Line Agreements;
(ii) the Equal Credit Opportunity Act and Regulation B promulgated
thereunder, which prohibit discrimination on the basis of age, race, color, sex,
religion, marital status, national origin, receipt of public assistance or the
exercise of any right under the Consumer Credit Protection Act, in the extension
of credit;
(iii) the Fair Credit Reporting Act, which regulates the use and reporting
of information related to the borrower's credit experience; and
(iv) for Mortgage Loans that were originated or closed after November 7,
1989, the Home Equity Loan Consumer Protection Act of 1988, which requires
additional application disclosures, limits changes that may be made to the loan
documents without the borrower's consent and restricts a lender's ability to
declare a default or to suspend or reduce a borrower's credit limit to certain
enumerated events.
Violations of certain provisions of these federal laws may limit the
ability of the Subservicers and the Trust to collect all or part of the
principal of or interest on the Mortgage Loans and in addition could subject the
Subservicers to damages and administrative enforcement and possibly the Seller
or the Trust.
Numerous 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 adversely affect the Master Servicer's ability to
collect on the Mortgage Loans and would also affect the interests of the
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Certificateholders in the Mortgage Loans if such laws result in Mortgage Loans
being written off as uncollectible (to the extent the consequent losses are not
paid pursuant to the Policy). See "Description of the Certificates" and "Certain
Legal Aspects of the Mortgage Loans -- Bankruptcy, Anti-Deficiency Legislation
and Other Limitations on Lenders".
Insolvency Considerations. Under the terms of the Agreement, so long as
HFC's long-term senior unsecured debt is rated at least A- by Standard & Poor's
Ratings Services ("Standard & Poor's") and A3 by Moody's Investors Service, Inc.
("Moody's"), each Subservicer will be entitled to maintain possession of the
documentation relating to each Mortgage Loan sold by it, including the Credit
Line Agreements and the Related Documents or other evidence of indebtedness
signed by the borrower, and assignments of the related mortgages in favor of the
Seller and subsequently the Trustee will not be required to be recorded. Failure
to deliver the Related Documents to the Seller and the Trustee will have the
result in most, if not all, of the states in which Related Documents will be
held, and failure to record the assignments of the related mortgages in favor of
the Seller and the Trustee will have the result in certain states in which the
Mortgaged Properties are located, of making the sale of the Cut-Off Balances,
Additional Balances and Related Documents potentially ineffective against (i)
any creditors of the Subservicers, who may have been fraudulently or
inadvertently induced to rely on the Mortgage Loans as assets of the
Subservicers, or (ii) a purchaser, in the event a Subservicer fraudulently or
inadvertently resells a Mortgage Loan to such purchaser who had no notice of the
prior sale thereof to the Seller and subsequent conveyance to the Trust and such
purchaser perfects his interest in the Mortgage Loan by taking possession of the
Related Documents or other evidence of indebtedness or otherwise. The Agreement
provides that if any loss is suffered in respect of a Mortgage Loan as a result
of a Subservicer's retention of the Mortgage Loan and Related Documents or the
failure to record the assignment of such Mortgage Loan, such Subservicer or HFC
will purchase such Mortgage Loan from the Trust. In the event that HFC's
long-term senior unsecured debt rating does not satisfy the above referenced
standards, the Related Documents pertaining to each Mortgage Loan will be
delivered to and maintained by the Trustee and assignments of the related
mortgage in favor of the Trustee will be required to be recorded (unless
satisfactory opinions of counsel are delivered to the Trustee and the
Certificate Insurer to the effect that recordation of assignments is not
required in the relevant jurisdiction to protect the interest of the Trustee in
the Mortgage Loans and Related Documents).
The Subservicers intend that the transfer of (a) the Cut-Off Balances and
the Additional Balances to the Seller and (b) ownership of the Related Documents
to the Trustee will be treated as sales. However, in the event of an insolvency
of any Subservicer, the trustee in bankruptcy of such Subservicer may attempt to
recharacterize such transactions as a borrowing by such Subservicer secured by a
pledge of the Cut-Off Balances, the Additional Balances and the Related
Documents. If the receiver decided to challenge such transfer, delays in
payments of the Certificates and possible reductions in the amount thereof could
occur. In connection with the transfer of the Cut-Off Balances, the Seller will
have received an opinion of Sidley & Austin, special counsel to the Seller, to
the effect that although it has found no case directly on point and the
transaction includes some factors which are consistent with a different
characterization, (a) the transfer by the Subservicers of (i) the Cut-Off
Balances and the Additional Balances to the Seller and (ii) ownership of the
Related Documents to the Trustee constitute sales under applicable Illinois law
and (b) the transfer by the Seller to the Trustee of the Cut-Off Balances and
the Additional Balances is either a sale or the grant of a security interest
therein to the Trustee. Such opinion is limited to matters of Illinois and
federal law, and is not binding on any court.
The Seller will, in the event that HFC's long-term unsecured debt rating is
at any time reduced below A-/A3, take certain actions that are required to
perfect the Trust's interest in the Cut-Off Balances and the Additional
Balances. Prior to taking such action, in the event of the insolvency of any
Subservicer, if the bankruptcy court determined that the sales by such
Subservicer to the Seller and to the Trust were each a secured loan, such
security interest may be deemed unperfected and the Seller and the Trustee on
behalf of the Certificateholders would each be an unsecured creditor
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of such Subservicer. Similarly, in the event of the insolvency of the Seller
prior to taking such action, if the transfer by the Seller to the Trust was
deemed by a bankruptcy court to be a secured loan, the security interest may be
deemed unperfected and the Trustee on behalf of the Certificateholders would be
an unsecured creditor of the Seller. The Seller will warrant that if the
transfer by it to the Trust is deemed to be a grant to the Trust of a security
interest in the Cut-Off Balances and the Additional Balances, the Trust will,
after certain actions have been taken regarding perfection, have a first
priority security interest therein.
In the event of a bankruptcy or insolvency of the Master Servicer, the
bankruptcy trustee or receiver may have the power to prevent the Trustee or the
Certificateholders from appointing a successor Master Servicer. If a
conservator, receiver or trustee were appointed by the Seller or a Subservicer,
or if certain other events relating to the bankruptcy or insolvency of the
Seller or Subservicers were to occur, Additional Balances (and Subsequent
Funding Mortgage Loans if such events occurred during the Funding Period) would
not be sold to the Seller by such Subservicer pursuant to the Receivables
Purchase Agreement or transferred by the Seller to the Trust pursuant to the
Agreement. In the event of any such occurrence with respect to the Seller, the
Rapid Amortization Period would commence.
The Seller does not and will not engage in any activities except the
transactions described herein and other similar transactions (some of which have
already been entered into by the Seller) and activities incidental to, or
necessary or convenient to accomplish the foregoing. The Seller has no current
intention of filing a voluntary petition under the Bankruptcy Code of 1984, as
amended (the "Bankruptcy Code"), or any similar applicable state laws.
THE SELLER AND SUBSERVICERS
The Seller was incorporated under the laws of the State of Delaware on May
5, 1994 and is a wholly-owned special purpose subsidiary of HFC. The Seller was
organized for the limited purposes of engaging in the type of transactions
described herein and other similar transactions (some of which have already been
entered into by the Seller) and any activities incidental to and necessary or
convenient for the accomplishment of such purposes. Neither HFC's nor the
Seller's board of directors intends to change the business purpose of the
Seller. The Seller's principal executive office is located at 2700 Sanders Road,
Prospect Heights, Illinois 60070.
The Subservicers are wholly-owned subsidiaries of HFC that are licensed to
make home equity revolving credit line loans in the states in which the Mortgage
Loans are originated and will transfer certain rights to the Mortgage Loans, the
Cut-Off Balances and the Additional Balances to the Seller. These companies
originate home equity revolving credit line loans and, in some cases, other
types of consumer loans from branch offices located in the states in which they
are licensed to do business.
Each Cut-Off Balance will be sold to the Trust by the Seller at a price
equal to its Cut-Off Balance and will be subserviced by the appropriate
Subservicer on behalf of HFC as Master Servicer. The Master Servicer will be
entitled to retain, on behalf of itself and the Subservicers, the Servicing Fee.
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THE MASTER SERVICER
Household Finance Corporation was incorporated in Delaware in 1925, as
successor to an enterprise which traces its origin through the same ownership to
an office established in 1878. HFC will be responsible for acting as the Master
Servicer for the Mortgage Loans. HFC is a subsidiary of Household International,
Inc. The address of its principal executive office is 2700 Sanders Road,
Prospect Heights, Illinois 60070. Its telephone number is (847) 564-5000.
HFC and its subsidiaries offer a diversified range of financial services.
Their principal business is the making of cash loans, including home equity
loans secured by first and second mortgages, directly to consumers in the United
States. Loans are made through branch lending offices and by direct mail or
telemarketing. HFC, through banking subsidiaries, also offers both VISA* and
MasterCard* credit cards to residents throughout the United States.
In conjunction with its consumer finance operations and where applicable
laws permit, HFC makes available to customers credit life, credit accident and
health, and household contents insurance. Credit life and credit accident and
health insurance are generally directly written by or reinsured with HFC's
insurance subsidiary, Household Life Insurance Company.
As of March 31, 1996, HFC had approximately $17.8 billion in total assets,
approximately $15.5 billion in total liabilities and approximately $2.3 billion
in shareholder's equity.
USE OF PROCEEDS
The net proceeds to be received from the sale of the Certificates will be
used by the Seller to purchase the Initial Mortgage Loans from the Subservicers.
The Subservicers will use the net proceeds received from the Seller for general
corporate purposes.
THE HFC REVOLVING HOME EQUITY LENDING PROGRAM
GENERAL
HFC and its subsidiaries have originated closed-end fixed-rate second
mortgages since 1972 and have offered home equity revolving credit line loans
since 1977. As of March 31, 1996, HFC and its subsidiaries had approximately
$6.7 billion aggregate principal amount of outstanding home equity revolving
credit line loans, including loans sold with servicing performed by HFC and its
subsidiaries.
UNDERWRITING PROCEDURES RELATING TO HOME EQUITY REVOLVING CREDIT LINE LOANS
All home equity revolving credit line loan applications received by HFC or
its subsidiaries are subjected to a direct credit investigation by the related
Subservicer. This investigation includes (i) obtaining and reviewing an
independent credit bureau report, (ii) verifying any senior mortgage balance and
payment history, which may be obtained from credit bureau information provided
it has been updated within two months of the application or, if not, obtained in
writing or by telephone from the holder of any senior mortgage, (iii)
verification of employment, which normally includes obtaining a W-2 form or
paystub, a minimum of two years of tax returns for self-employed individuals or
other written or telephone verification with employers, (iv) obtaining a title
search to ensure that all liens, except for any existing senior mortgage lien,
are paid off prior to, or at the time of, the funding of the loan, and (v)
obtaining an appraisal (which may be an appraisal prepared using a statistical
data base) of the property, which must be substantiated by sales data on three
comparable properties.
- ---------------
*VISA and MasterCard are registered trademarks of VISA USA, Inc. and MasterCard
International Incorporated, respectively.
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After this investigation is conducted, a decision is made to accept or
reject the loan application. A Credit Limit is assigned based on the borrower's
ability to pay and an acceptable combined loan-to-value ratio. Generally, all
prospective borrowers must have a debt-to-income ratio of no greater than 45%,
but such requirement may be waived by senior management. In no event, may the
debt to income ratio exceed 60%. For purposes of calculating the debt to income
ratio, debt is defined as the sum of the senior mortgage payment, including
escrow payments for the hazard insurance premium, real estate taxes, mortgage
insurance premium, owners association dues and ground rents, plus payments on
installment and revolving debt (including payments on the home equity loan line
of credit computed based on the Credit Limit applied for at the then current
Loan Rate) that extends beyond 10 months, and alimony, child support or
maintenance payments, and income is defined as stable monthly gross income from
the borrower's primary source of employment, plus acceptable secondary income.
The determination of an acceptable combined loan-to-value ratio is based solely
upon the Credit Limit and does not include certain fees which may be added to
the principal balance of the loan. An acceptable combined loan-to-value ratio is
also a function of the real estate's quality, condition, appreciation history,
and prospective market conditions; however, the combined loan-to-value ratio
generally may not exceed 100%.
HFC and its subsidiaries will not make mortgages behind a negatively
amortizing senior mortgage, except when the senior mortgage is subject to a
maximum permitted indebtedness or the Credit Limit is $25,000 or less.
Generally, title insurance is obtained for all Mortgage Loans that constitute a
first mortgage or have a Credit Limit over $50,000.
HOME EQUITY REVOLVING CREDIT LINE LOAN TERMS
The borrower may access the home equity revolving line of credit by writing
a check and by certain other methods. The Minimum Monthly Payment for each
Mortgage Loan is generally the greatest of (x) a specified percentage (which
ranges between 0.85% and 2.10% depending upon the date the loan was originated,
the related interest rate and certain factors in the borrower's credit profile)
of the principal balance of the Mortgage Loan, plus late charge fees and bad
check fees (the "Administrative Charges") and credit insurance charges, (y) a
designated minimum dollar amount, which is generally $50 plus Administrative
Charges and credit insurance charges and (z) the amount of accrued interest
during the related billing cycle plus Administrative Charges and credit
insurance charges. However, in the case of Adjustable Rate Mortgages in Illinois
which were originated prior to November 6, 1989, generally, the Minimum Monthly
Payment is computed only in accordance with clause (z) above. A borrower's
minimum monthly payment is due on a fixed date each month which is between 22
and 25 days after the Cycle Date for the borrower's particular Mortgage Loan.
Cycle Dates for the Mortgage Loans are the 4th, 5th, 6th, 8th, 10th, 11th, 12th,
16th, 17th, 18th, 19th, 20th, 25th and 26th of every month. For example, if the
Cycle Date for a Mortgage Loan is on the 5th day of the month, an update of the
related account is completed at the close of business on the 5th. A detailed
listing of all debits and credits along with the Minimum Monthly Payment and
available line of credit is listed on the borrower's billing statement. The
billing statement would be sent to the borrower on the 6th and payment would be
due on the 27th of the month.
Adjustable Rate Mortgages bear interest at rates which may change from
month to month subject to maximum and minimum per annum rates, if any, specified
in the Credit Line Agreement. The monthly periodic rate (the "Loan Rate") is
one-twelfth of the sum of the Index Rate (as defined below) plus a certain
spread (the "Margin"). Currently, the Margin range offered by a Subservicer is
from 5.50% to 8.00%. Fixed Rate Mortgages currently offered by a Subservicer
bear interest at rates generally ranging from 14.25% to 16.75%. The variable or
fixed rates of interest charged on a revolving home equity line of credit are
determined by the overall qualification of the borrower, the combined
loan-to-value ratios or equity in the property and market conditions. Interest
on the home equity revolving lines of credit is payable at the Loan Rate monthly
in arrears on the average daily outstanding principal balance.
31
<PAGE> 32
For any Adjustable Rate Mortgage, except for Mortgage Loans originated in
North Carolina prior to August 24, 1992, the "Index Rate" during a billing cycle
is the "prime rate" published by The Wall Street Journal on the first
publication date of the month in which the related billing cycle begins. If a
prime rate range is published, then the average of that range will be used for
Mortgage Loans originated prior to October 1, 1991 and for most other Mortgage
Loans originated after October 1, 1991 the highest rate in such range will be
used. When a change in the prime rate is published, a change in the Loan Rate
will take effect on the first day of the first complete billing cycle following
the date of the published change and the new Loan Rate will apply to new loans
and charges, as well as to the existing Loan Balance. For Adjustable Rate
Mortgages originated in North Carolina prior to August 24, 1992, the "Index
Rate" is the rate for the auction average of six month U.S. Treasury Bills
effective as of the fifteenth day of the prior month. Said rate can be found in
the Federal Reserve Bulletin. Because the billing period regarding North
Carolina Mortgage Loans between Cycle Dates contains portions of two calendar
months, use of this Index Rate may cause two different daily periodic rates to
be used to determine the monthly Loan Rate. The Credit Line Agreements further
provide that in the event of a change in law or any court ruling that prohibits
a Subservicer from using the Index Rate, or if the publication of the Index Rate
is discontinued, the related Subservicer will change the Index Rate upon
notification of such event in accordance with the Credit Line Agreement.
Principal amounts may be drawn upon (up to the Credit Limit of the Mortgage
Loan, and in certain cases in excess of the Credit Limit) or repaid under the
Mortgage Loans from time to time. Except for any amortization of principal which
may occur as a result of the required Minimum Monthly Payments, there are no
required payments of principal, except that the outstanding principal amount of
most Mortgage Loans will be due fifteen years or, in some cases, ten years from
origination or, as described below in certain instances at any time after six
years or, in some cases, ten years from the date of the applicable Credit Line
Agreement upon exercise of the related Subservicer's call option. The Loan Rate
for an Adjustable Rate Mortgage will generally not exceed 24.9% or twelve
percentage points over the initial Index Rate for such Mortgage Loan, depending
on when or where the Mortgage Loan was originated or generally be less than 8%
for a first mortgage and 10% for a second or third mortgage except for certain
Adjustable Rate Mortgage Loans originated in Wisconsin or prior to 1987.
The Subservicers will have the right under each Mortgage Loan, on prior
notice, to change its terms, subject to complying with applicable law. Changes
may apply to both new and outstanding balances unless prohibited by applicable
law. However, termination of a borrower's Credit Limit generally will occur only
as provided below. The Trust will not have the right to amend the Mortgage
Loans.
Most of the home equity revolving credit line loans must be repaid by the
borrower fifteen years, or in some cases, ten years after the date of the Loan
Agreement. For a portion of such Mortgage Loans, however, the Subservicers will
have the right to call for the payment of the entire outstanding balance, plus
all other accrued but unpaid charges, commencing not earlier than six years or,
in some cases, twelve years after the date of the related Credit Line Agreement,
upon at least 90 days' prior notice. The Subservicers do not currently intend to
exercise this right with respect to the Mortgage Loans. The Trust does not have
the ability to exercise this right.
32
<PAGE> 33
The Subservicers will have the right to require the borrower to pay the
entire balance plus all other accrued but unpaid charges immediately and to
cancel any credit privileges under the Credit Line Agreement if, among other
things, the borrower fails to make two or more payments when due under the
Credit Line Agreement, the borrower has provided false, misleading or incorrect
material information to the Subservicer, the borrower dies, a bankruptcy
petition is filed by or against the borrower, the borrower sells any interest in
the property securing the Credit Line Agreement (including the creation of a
subordinate lien), foreclosure or condemnation proceedings are instituted on the
property by any lienholder or governmental agency, the borrower incurs any lien
on the property which adversely affects the property or the Subservicer's rights
in the property or the borrower fails to maintain the property, fails to pay the
real estate taxes on the property, fails to keep the property insured, abandons
the property or defaults on the Credit Line Agreement. Additionally, the
Subservicers will have the right to reduce the Credit Limit or prohibit
additional advances under the Credit Line Agreement if, among other things, a
material change in the financial condition of the borrower has occurred, the
borrower fails to use or occupy the property as his primary residence, frequent
advances are requested by the borrower over the Credit Limit, the maximum annual
percentage rate under the Credit Line Agreement is attained, or any borrower
under the Credit Line Agreement so requests.
In the event of a default on a mortgage that is senior to any Mortgage
Loan, the related Subservicer will have the right in many states to satisfy the
defaulted senior mortgage in full or cure such default and bring the defaulted
senior mortgage current, in either event adding any amounts expended in
connection with such satisfaction or cure to the then current loan balance for
such Mortgage Loan. In such event, the Subservicers will either take the action
described above or may refrain from taking any action based upon reasonable
commercial practice in the home equity revolving credit line loan industry
generally. See "Certain Legal Aspects of the Mortgage Loans -- Foreclosure" and
"-- Rights of Senior Mortgagees or Beneficiaries" herein.
SERVICING OF HOME EQUITY REVOLVING CREDIT LINE LOANS
HFC will be responsible for servicing the Mortgage Loans as agent for the
Trust. The Subservicers will perform the servicing activities on behalf of HFC
in accordance with HFC's policies and procedures for servicing real estate
secured revolving loans.
With respect to real estate secured loans, the general policy of HFC is to
initiate foreclosure on the underlying property only after such loan is more
than two months delinquent, any notices required by law have been sent to the
borrower and the foreclosure is authorized by operating management. Foreclosure
proceedings may be terminated if the delinquency is cured. However, under
certain circumstances, the Subservicers may elect not to commence foreclosure if
the borrower's default is due to special circumstances which are temporary and
are not expected to last beyond a specified period. Similarly, the Subservicers
may treat such loans as current if the borrower has made one standard payment,
has, in the opinion of the Master Servicer, demonstrated an ability to pay in
the future and met such other criteria, if any, established by the Master
Servicer from time to time. All amounts delinquent, however, will remain due and
owing by the borrower. The loans of borrowers in bankruptcy proceedings will be
restructured in accordance with law and with a view to maximizing recovery of
such loans, including any deficiencies.
The operating policy of HFC with respect to charged-off amounts is to
generally recognize losses on past due accounts that reach six months
contractually overdue or when HFC obtains title to the property. The charge-off
period may be extended from six months to forty-eight months after the loan has
been written down to its net realizable value if it is clear that the principal
balance thereof will be collected.
Amounts of the principal balance of real estate secured loans which the
Master Servicer may charge-off will generally be computed by comparing the
estimated fair market value of the property
33
<PAGE> 34
securing such loan (the "Property Value") to the amount of any senior
indebtedness thereon and any unpaid property taxes, realized or forecasted
foreclosure expenses and other related expenses (the "Senior Indebtedness
Expenses"). Property Value may be determined by (i) drive-by appraisals, (ii) a
full interior/exterior appraisal, (iii) an opinion rendered by a local real
estate broker chosen by the Master Servicer, or (iv) the Master Servicer's
appraisal which may be prepared using a statistical database system.
To the extent the Property Value less the Senior Indebtedness Expenses (the
"Net Property Value") is less than the principal balance of such loan, the
Master Servicer may, but is not required to, write down such principal balance
to such Net Property Value. Further charge-offs may be taken from time-to-time
based upon the Master Servicer's current estimate of Net Property Value.
Once the Mortgaged Property has been liquidated, any final charge-off or
recovery of a previous charge-off is recognized.
Servicing and charge-off policies and collection practices may change over
time in accordance with HFC's business judgment, changes in HFC's real estate
secured revolving credit line loans and applicable laws and regulations, and
other considerations.
The information in the tables below has not been adjusted to eliminate the
effect of the unseasoned nature of the home equity revolving credit line loan
portfolio during the periods shown. Accordingly, loss and delinquency as
percentages of aggregate principal balance of Mortgage Loans serviced for each
period would be higher than those shown if a group of Mortgage Loans were
artificially isolated at a point in time and the information showed the activity
only in that isolated group. However, since most of the mortgage loans in HFC's
and its subsidiaries' home equity revolving credit line loan portfolio will not
be fully seasoned and since the terms of most Mortgage Loans will not call for
payment of principal in full prior to maturity, the delinquency and loss
information for such an isolated group would also be distorted to some degree.
The tables below present real estate revolving credit line loan data applicable
to substantially all of the United States operations of HFC, including loans
managed in states which are not represented in the mortgage pool consisting of
the Mortgage Loans, and include loans sold with servicing performed by HFC and
its subsidiaries, and real estate acquired through foreclosure.
34
<PAGE> 35
REVOLVING REAL ESTATE SECURED LOANS
MORTGAGE LOAN DELINQUENCY EXPERIENCE
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED DECEMBER 31, ENDED
------------------------------------------------------------------------------ MARCH 31,
1991 1992 1993 1994 1995(3) 1996(3)
---------- ---------- ---------- ---------- ---------- ------------
<S> <C> <C> <C> <C> <C> <C>
Number of mortgage loans
managed(1)............ 153,027 149,796 151,513 148,964 147,448 144,335
Aggregate loan balance
of mortgage
loans managed......... $5,166,013 $5,198,702 $5,285,796 $5,169,786 $4,878,161 $4,788,989
Loan balance of mortgage
loans
2-3 payments past
due(2)................ $ 59,096 $ 44,168 $ 52,321 $ 57,356 $ 34,078 $ 34,505
Loan balance of mortgage
loans 3+ payments
past due(2)........... $ 221,337 $ 236,412 $ 193,466 $ 164,751 $ 162,584 $ 155,043
Loan balance of mortgage
loans 2+ payments
past due(2)........... $ 280,433 $ 280,580 $ 245,787 $ 222,107 $ 196,662 $ 189,548
Loan balance of mortgage
loans
2+ payments
past due as a
percentage of
aggregate loan
balance of
mortgage loans
managed............... 5.43% 5.40% 4.65% 4.30% 4.03% 3.96%
</TABLE>
- ---------------
(1) "loans managed" included loans owned and loans serviced with limited
recourse.
(2) Contractually past due.
(3) Prior to 1995, information was reported as of the end of the borrower's
cycle date. Due to system enhancements, beginning in 1995 all payment
activity from the end of the borrower's cycle date until the immediately
succeeding month end are included and reported. If the previous reporting
system had been utilized the "aggregate loan balance of mortgage loans
managed" would have been $4,777,800 for December 31, 1995 and $4,696,229
for March 31, 1996. The percentage of loans 2+ delinquent would have been
4.84% for December 31, 1995 and 4.87% for March 31, 1996.
35
<PAGE> 36
REVOLVING REAL ESTATE SECURED LOANS
MORTGAGE LOAN LOSS EXPERIENCE
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED DECEMBER 31, ENDED
------------------------------------------------------------------------------ MARCH 31,
1991 1992 1993 1994 1995(3) 1996(3)
---------- ---------- ---------- ---------- ---------- ------------
<S> <C> <C> <C> <C> <C> <C>
Number of mortgage loans
managed(1)............ 153,027 149,796 151,513 148,964 147,448 144,335
Aggregate loan balance
of mortgage loans
managed............... $5,166,013 $5,198,702 $5,285,796 $5,169,786 $4,878,161 $4,788,989
Gross charge-offs....... $ 37,573 $ 43,477 $ 59,060 $ 52,760 $ 49,489 $ 12,699
Percentage(2)........... 0.74% 0.85% 1.12% 1.00% 0.97% 1.05%
</TABLE>
- ---------------
(1) "loans managed" included loans owned and loans serviced with limited
recourse.
(2) As a percentage of average balance of mortgage loans managed during the
period, annualized for partial periods.
(3) Prior to 1995, information was reported as of the end of the borrower's
cycle date. Due to system enhancements, beginning in 1995 all payment
activity from the end of the borrower's cycle date until the immediately
succeeding month end are included and reported. If the previous reporting
system had been utilized the "aggregate loan balance of mortgage loans
managed" would have been $4,777,800 for December 31, 1995 and $4,696,229
for March 31, 1996. The percentage of gross charge-offs would have been
1.02% for December 31, 1995 and 0.95% for March 31, 1996.
THE REVOLVING HOME EQUITY CREDIT LINES
Unless otherwise noted in this Prospectus all statistical information
included herein with respect to the Initial Mortgage Loans is as of the close of
the last billing cycle for each such Loan on or before May 1, 1996 (the "Pool
Date").
The Initial Mortgage Loans are evidenced by loan agreements (each, a
"Credit Line Agreement") secured by mortgages or deeds of trust (of which
approximately 31.27% by principal balance are first mortgages, approximately
68.30% by principal balance are second mortgages, and the remainder are third
mortgages) on Mortgaged Properties originated in 38 states. The term to maturity
of most of the Mortgage Loans at origination will be either fifteen years or, in
some cases, ten years (a portion of such Mortgage Loans being subject to an
optional call exercisable by the related Subservicer commencing not less than
six years or, in some cases, twelve years after the date of origination). As of
the Pool Date, approximately 64.01% of the Initial Mortgage Loans by principal
balance were Adjustable Rate Mortgages, with the remainder being Fixed Rate
Mortgages.
Each of the Initial Mortgage Loans owned by a Subservicer as of the Pool
Date had a current principal balance outstanding that was less than 90 days
contractually delinquent, had a Combined Loan-to-Value Ratio which was generally
not greater than 100%, represented a first, second or third lien position and,
if an Adjustable Rate Mortgage, had an Index Rate equal to the prime rate or the
rate for the auction average of six month U.S. Treasury Bills. All Initial
Mortgage Loans originated in Massachusetts had a principal balance as of the
Pool Date of at least $6,000. Each Initial Mortgage Loan was originated between
May 23, 1983 and April 12, 1996 in the ordinary course of the related
Subservicer's home equity revolving credit line loan program. The Initial
Mortgage Loans had individual Combined Loan-to-Value Ratios at the Pool Date
based upon the appraisal of the Mortgaged Property obtained by the related
Subservicer at origination generally ranging from 0% to not more than 100%. The
Combined Loan-to-Value Ratio for purposes hereof is the ratio of the principal
balance of all senior liens plus the Credit Limit of the Mortgage Loan to the
value of the Mortgaged Property as such value was determined in an appraisal
made at the time the Mortgage
36
<PAGE> 37
Loan was originated. Such value may have declined or increased from the time of
the appraisal to the Pool Date.
Not more than 3.10% of the aggregate principal balances of the Initial
Mortgage Loans at the Pool Date consisted of Mortgage Loans secured by attached
properties (excluding planned unit developments). As of the Pool Date, the
average principal balance of the Initial Mortgage Loans was approximately
$33,495 with the weighted average Combined Loan-to-Value Ratio of the Initial
Mortgage Loans being approximately 81.68%. As of the Pool Date the weighted
average credit limit utilization rate (computed by dividing the Cut-Off Balance
for each Initial Mortgage Loan by the related Credit Limit, which, in cases
where credit privileges have been terminated, may be the Cut-Off Balance) was
approximately 96.06% and the weighted average junior mortgage ratio (computed by
dividing the Cut-Off Balance for each Initial Mortgage Loan by the sum of such
Cut-Off Balance and the outstanding balances of all senior mortgage loans
affecting the related Mortgaged Property) was approximately 60%. The latest
scheduled maturity of any Initial Mortgage Loan is April 12, 2011.
Set forth below is a description of certain characteristics of the Initial
Mortgage Loans as of the Pool Date:
BALANCES OF INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
NUMBER OF AGGREGATE PERCENT OF
PRINCIPAL BALANCES LOANS PRINCIPAL BALANCE BALANCE
- ------------------------------------------------- --------- ----------------- ----------
<S> <C> <C> <C>
$ 0 to $ 5,000............................. 302 $ 867,671.90 0.10%
$ 5,001 to $ 10,000............................. 1,224 10,040,239.25 1.19
$ 10,001 to $ 15,000............................. 3,138 40,098,198.40 4.77
$ 15,001 to $ 20,000............................. 3,623 63,785,798.16 7.59
$ 20,001 to $ 25,000............................. 3,498 79,189,666.91 9.43
$ 25,001 to $ 30,000............................. 2,810 77,098,235.18 9.19
$ 30,001 to $ 35,000............................. 2,148 69,755,763.35 8.30
$ 35,001 to $ 40,000............................. 1,667 62,517,264.25 7.44
$ 40,001 to $ 45,000............................. 1,254 53,288,118.81 6.34
$ 45,001 to $ 50,000............................. 1,175 56,067,388.16 6.67
$ 50,001 to $ 55,000............................. 710 37,176,008.13 4.42
$ 55,001 to $ 60,000............................. 613 35,364,613.27 4.21
$ 60,001 to $ 65,000............................. 508 31,769,278.83 3.78
$ 65,001 to $ 70,000............................. 437 29,547,198.94 3.52
$ 70,001 to $ 75,000............................. 384 27,899,040.27 3.32
$ 75,001 to $ 80,000............................. 253 19,609,409.08 2.33
$ 80,001 to $ 85,000............................. 232 19,151,517.19 2.28
$ 85,001 to $ 90,000............................. 193 16,905,562.41 2.01
$ 90,001 to $ 95,000............................. 129 11,937,664.89 1.42
$ 95,001 to $100,000............................. 161 15,726,107.77 1.87
$100,001 to $105,000............................. 90 9,218,086.34 1.10
$105,001 to $110,000............................. 73 7,856,993.70 0.94
$110,001 to $115,000............................. 63 7,092,315.64 0.84
$115,001 to $120,000............................. 72 8,475,951.26 1.01
$120,001 to $125,000............................. 58 7,120,122.12 0.85
$125,001 and above............................... 272 42,727,249.13 5.08
------ ---------------- ------
Total....................................... 25,087 $ 840,285,463.34 100.00%
====== ================ ======
</TABLE>
37
<PAGE> 38
CREDIT LIMIT UTILIZATION RANGES OF INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
NUMBER OF AGGREGATE PERCENT OF
RANGE OF CREDIT LIMIT UTILIZATION RATES LOANS PRINCIPAL BALANCE BALANCE
- ------------------------------------------------- --------- ----------------- ----------
<S> <C> <C> <C>
0.001% to 9.99%.................................. 81 $ 154,507.68 0.02%
10.00% to 19.99%................................. 90 543,123.13 0.06
20.00% to 29.99%................................. 140 1,337,215.26 0.16
30.00% to 39.99%................................. 202 2,371,043.58 0.28
40.00% to 49.99%................................. 262 4,073,950.98 0.48
50.00% to 59.99%................................. 388 6,857,612.88 0.82
60.00% to 69.99%................................. 558 11,878,220.69 1.41
70.00% to 79.99%................................. 882 21,191,195.32 2.52
80.00% to 89.99%................................. 1,724 48,203,712.12 5.74
90.00% to 99.99%................................. 10,964 377,348,275.38 44.91
100% Utilization................................. 6,456 258,386,212.67 30.75
100.01 to 110.00%(1)............................. 3,340 107,940,393.65 12.85
------ --------------- ------
Total....................................... 25,087 $ 840,285,463.34 100.00%
====== =============== ======
</TABLE>
- ---------------
(1) Within parameters established from time to time by the Subservicers,
borrowers may exceed their Credit Limits by up to 10%.
LOAN RATES OF INITIAL MORTGAGE LOANS(1)(2)
<TABLE>
<CAPTION>
NUMBER OF AGGREGATE PERCENT OF
LOAN RATES LOANS PRINCIPAL BALANCE BALANCE
- ------------------------------------------------- --------- ----------------- ----------
<S> <C> <C> <C>
9.00% to 9.49%.................................. 2 $ 142,158.02 0.02%
9.50% to 9.99%.................................. 9 798,074.67 0.09
10.00% to 10.49%................................. 388 28,117,817.22 3.35
10.50% to 10.99%................................. 106 7,269,983.09 0.87
11.00% to 11.49%................................. 657 34,599,682.13 4.12
11.50% to 11.99%................................. 1,665 49,926,769.74 5.94
12.00% to 12.49%................................. 6,208 207,232,717.75 24.65
12.50% to 12.99%................................. 1,312 67,779,342.13 8.07
13.00% to 13.49%................................. 2,254 74,248,992.71 8.84
13.50% to 13.99%................................. 1,562 60,423,282.40 7.19
14.00% to 14.49%................................. 1,019 29,857,538.91 3.55
14.50% to 14.99%................................. 2,103 65,234,029.03 7.76
15.00% to 15.49%................................. 1,127 35,747,003.50 4.25
15.50% to 15.99%................................. 1,096 30,889,386.62 3.68
16.00% to 16.49%................................. 2,637 71,329,875.03 8.49
16.50% to 16.99%................................. 1,414 36,759,142.41 4.37
17.00% to 17.49%................................. 1,092 29,240,006.57 3.48
17.50% to 17.99%................................. 227 5,876,614.66 0.70
18.00% to 18.49%................................. 171 4,088,460.71 0.49
18.50% to 18.99%................................. 19 401,896.24 0.05
19.00% to 19.49%................................. 8 167,525.67 0.02
19.50% to 19.99%................................. 5 71,224.30 0.01
20.00% and Above................................. 6 83,939.83 0.01
------ --------------- ------
Total....................................... 25,087 $ 840,285,463.34 100.00%
====== =============== ======
</TABLE>
- ---------------
(1) The Loan Rates for Initial Mortgage Loans with an Index Rate based on the
prime rate are based on the prime rate as of May 1, 1996, which was 8.25%.
(2) The Loan Rates for Initial Mortgage Loans with an Index Rate based on the
auction average of six-month Treasury Bills, which represent approximately
0.02% of the principal balance of Initial Mortgage Loans, range from 11.00%
to 15.50%.
38
<PAGE> 39
TYPE OF LOAN RATES OF INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
NUMBER OF AGGREGATE PERCENT OF
TYPE OF LOAN RATES LOANS PRINCIPAL BALANCE BALANCE
- ------------------------------------------------- --------- ----------------- ----------
<S> <C> <C> <C>
Adjustable....................................... 17,065 $ 537,879,191.88 64.01%
Fixed............................................ 8,022 302,406,271.46 35.99
------ ---------------- ------
Total....................................... 25,087 $ 840,285,463.34 100.00%
====== ================ ======
</TABLE>
MARGIN RANGES OF ADJUSTABLE RATE INITIAL MORTGAGE LOANS(1)(2)
<TABLE>
<CAPTION>
NUMBER OF AGGREGATE PERCENT OF
MARGIN RANGES LOANS PRINCIPAL BALANCE BALANCE
- ------------------------------------------------- --------- ----------------- ----------
<S> <C> <C> <C>
Below 2.00%...................................... 5 $ 233,921.98 0.03%
2.00% to 2.99%................................... 514 37,381,743.08 4.45
3.00% to 3.49%................................... 529 18,119,008.61 2.16
3.50% to 3.99%................................... 6,332 200,334,800.03 23.83
4.00% to 4.49%................................... 1,119 37,308,752.00 4.44
4.50% to 4.99%................................... 1,215 37,112,566.04 4.42
5.00% to 5.49%................................... 986 30,502,756.85 3.63
5.50% to 5.99%................................... 919 29,415,641.65 3.50
6.00% to 6.49%................................... 666 18,161,013.50 2.16
6.50% to 6.99%................................... 1,016 28,681,832.63 3.41
7.00% to 7.49%................................... 341 10,160,709.08 1.21
7.50% to 7.99%................................... 674 17,960,538.80 2.14
8.00% to 8.49%................................... 2,129 56,464,624.15 6.72
8.50% to 8.99%................................... 324 7,846,019.44 0.93
9.00+%........................................... 296 8,195,264.04 0.98
------ ---------------- -----
Total....................................... 17,065 $ 537,879,191.88 64.01%
====== ================ =====
</TABLE>
- ---------------
(1) The margins for the Initial Mortgage Loans with an Index Rate based on the
auction average of six-month Treasury Bills, represent approximately 0.02%
of the principal balance of Initial Mortgage Loans and range from 6.00% to
10.50%.
(2) The weighted average margin of the Adjustable Rate Mortgages which are part
of the Initial Mortgage Loans is 5.04%.
MAXIMUM LOAN RATES OF ADJUSTABLE RATE INITIAL MORTGAGE LOANS(1)
<TABLE>
<CAPTION>
NUMBER OF AGGREGATE PERCENT OF
MAXIMUM RATE LOANS PRINCIPAL BALANCE BALANCE
- ------------------------------------------------- --------- ----------------- ----------
<S> <C> <C> <C>
Not Available.................................... 103 $ 2,335,689.87 0.28%
No Maximum Rate.................................. 601 17,767,237.53 2.11
Less than 16.00%................................. 136 5,151,231.37 0.61
16.00% to 16.99%................................. 225 7,552,925.62 0.90
17.00% to 17.99%................................. 4 141,082.34 0.02
18.00% to 18.99%................................. 3,704 105,024,772.70 12.50
20.00% to 20.99%................................. 1,454 35,541,931.57 4.23
21.00% to 21.99%................................. 6,718 241,853,246.19 28.79
22.00% to 22.99%................................. 300 9,255,072.20 1.10
23.00% to 23.99%................................. 2 98,886.04 0.01
24.00% to 24.99%................................. 2,327 73,556,485.06 8.75
25.00% to 25.99%................................. 1,190 31,028,965.22 3.69
26.00% & Above................................... 301 8,571,666.17 1.02
------ ---------------- ------
Total....................................... 17,065 $ 537,879,191.88 64.01%
====== ================ ======
</TABLE>
- ---------------
(1) The weighted average maximum loan rate of the Adjustable Rate Mortgages
which are part of the Initial Mortgage Loans (excluding those Adjustable
Rate Mortgages for which the maximum rate is "not available" or "no maximum
rate") is 21.09%.
39
<PAGE> 40
FIXED RATE LOAN RATES OF INITIAL MORTGAGE LOANS(1)
<TABLE>
<CAPTION>
NUMBER OF AGGREGATE PERCENT OF
LOAN RATES LOANS PRINCIPAL BALANCE BALANCE
- ------------------------------------------------- --------- ----------------- ----------
<S> <C> <C> <C>
9.00% to 9.49%................................. 2 $ 142,158.02 0.02%
9.50% to 9.99%................................. 9 798,074.67 0.09
10.00% to 10.49%................................. 54 3,706,370.68 0.44
10.50% to 10.99%................................. 63 4,938,024.36 0.59
11.00% to 11.49%................................. 231 15,745,283.93 1.87
11.50% to 11.99%................................. 106 5,781,090.91 0.69
12.00% to 12.49%................................. 141 7,834,541.20 0.93
12.50% to 12.99%................................. 1,103 57,972,163.75 6.90
13.00% to 13.49%................................. 301 16,048,823.27 1.91
13.50% to 13.99%................................. 639 30,623,730.35 3.64
14.00% to 14.49%................................. 481 16,295,404.33 1.94
14.50% to 14.99%................................. 1,005 32,506,255.67 3.87
15.00% to 15.49%................................. 662 21,173,172.08 2.52
15.50% to 15.99%................................. 795 22,775,206.22 2.71
16.00% to 16.49%................................. 385 10,391,676.35 1.24
16.50% to 16.99%................................. 750 20,724,290.42 2.47
17.00% to 17.49%................................. 941 25,870,968.87 3.08
17.50% to 17.99%................................. 203 5,347,744.72 0.64
18.00% to 18.49%................................. 126 3,214,209.28 0.38
18.50% to 18.99%................................. 15 325,481.96 0.04
19.00% to 19.49%................................. 7 154,225.67 0.02
19.50% to 19.99%................................. 2 27,522.79 0.00
20% and Above.................................... 1 9,851.96 0.00
----- ---------------- -----
Total....................................... 8,022 $ 302,406,271.46 35.99%
===== ================ =====
</TABLE>
- ---------------
(1) The weighted average Loan Rate for the Fixed Rate Mortgages which are part
of the Initial Mortgage Loans is 14.17%.
COMBINED LOAN-TO-VALUE RATIOS OF INITIAL MORTGAGE LOANS(1)
<TABLE>
<CAPTION>
RANGE OF
ORIGINAL COMBINED NUMBER OF AGGREGATE PERCENT OF
LOAN-TO-VALUE RATIOS LOANS PRINCIPAL BALANCE BALANCE
- ------------------------------------------------- --------- ----------------- ----------
<S> <C> <C> <C>
Up to 30%........................................ 597 $ 12,348,212.06 1.47%
30.001% to 35.00%................................ 218 5,261,989.01 0.63
35.001% to 40.00%................................ 294 8,013,701.84 0.95
40.001% to 45.00%................................ 407 11,617,488.19 1.38
45.001% to 50.00%................................ 453 13,835,998.17 1.65
50.001% to 55.00%................................ 624 18,217,236.22 2.17
55.001% to 60.00%................................ 1,236 38,280,359.23 4.56
60.001% to 65.00%................................ 667 25,183,369.42 3.00
65.001% to 70.00%................................ 1,119 39,816,342.79 4.74
70.001% to 75.00%................................ 1,260 52,963,570.74 6.30
75.001% to 80.00%................................ 4,802 161,634,320.03 19.24
80.001% to 85.00%................................ 2,091 69,511,905.02 8.27
85.001% to 90.00%................................ 2,442 88,926,044.52 10.58
90.001% to 95.00%................................ 1,721 61,072,593.31 7.27
95.001% to 96.00%................................ 355 12,354,130.57 1.47
96.001% to 100.00%............................... 6,380 209,893,046.52 24.97
100% +........................................... 421 11,355,155.70 1.35
------ ---------------- ------
Total.................................. 25,087 $ 840,285,463.34 100.00%
====== ================ ======
</TABLE>
- ---------------
(1) Defined to be the ratio (expressed as a percentage) of the sum of (i) the
greater of the current principal balance or the Credit Limit of the Initial
Mortgage Loans and (ii) any outstanding principal balances of mortgage loans
senior to the Initial Mortgage Loans (computed at the date of origination of
the Initial Mortgage Loans) to the value of the related Mortgaged Property
based upon an appraisal at such date of origination.
40
<PAGE> 41
GEOGRAPHIC DISTRIBUTION OF THE MORTGAGED PROPERTIES(1)(2)
<TABLE>
<CAPTION>
NUMBER OF AGGREGATE PERCENT OF
STATE LOANS PRINCIPAL BALANCE BALANCE
- ------------------------------------------------- --------- ----------------- ----------
<S> <C> <C> <C>
Arizona.......................................... 613 $ 18,860,061.81 2.24%
California....................................... 3,643 143,727,681.37 17.09
Colorado......................................... 288 8,637,569.35 1.03
Connecticut...................................... 408 16,114,159.70 1.92
Delaware......................................... 180 6,458,762.64 0.77
Florida.......................................... 1,697 49,055,414.07 5.84
Georgia.......................................... 1,057 30,764,658.65 3.66
Idaho............................................ 50 2,150,584.52 0.26
Illinois......................................... 902 27,744,621.65 3.30
Indiana.......................................... 440 12,489,117.48 1.49
Iowa............................................. 66 1,751,303.01 0.21
Kansas........................................... 440 11,237,502.22 1.34
Kentucky......................................... 77 2,093,384.52 0.25
Louisiana........................................ 48 2,425,514.31 0.29
Maryland......................................... 1,374 49,154,780.19 5.85
Massachusetts.................................... 683 25,547,833.53 3.04
Michigan......................................... 1,921 52,503,420.30 6.25
Minnesota........................................ 185 5,317,547.96 0.63
Mississippi...................................... 22 871,929.50 0.10
Missouri......................................... 1,082 25,785,188.58 3.07
Nebraska......................................... 89 2,881,809.94 0.34
Nevada........................................... 216 6,569,522.75 0.78
New Hampshire.................................... 129 4,253,771.91 0.51
New Jersey....................................... 864 34,630,259.46 4.12
New Mexico....................................... 74 2,131,142.31 0.25
New York......................................... 2,052 79,307,873.99 9.44
North Carolina................................... 523 20,132,455.49 2.40
Ohio............................................. 1,785 49,151,864.65 5.85
Oklahoma......................................... 85 2,453,803.21 0.29
Oregon........................................... 226 8,062,543.02 0.96
Pennsylvania..................................... 1,651 61,340,446.79 7.30
Rhode Island..................................... 69 1,955,796.36 0.23
South Carolina................................... 190 4,861,144.85 0.58
Tennessee........................................ 224 6,894,558.40 0.82
Utah............................................. 49 1,782,640.71 0.21
Virginia......................................... 630 22,328,237.70 2.66
Washington....................................... 873 33,911,776.94 4.04
Wisconsin........................................ 182 4,944,779.50 0.59
------ --------------- ------
Total....................................... 25,087 $ 840,285,463.34 100.00%
====== =============== ======
</TABLE>
- ---------------
(1) No more than 0.18% of the Initial Mortgage Loans by principal balance are
secured by Mortgaged Properties located in any one postal zip code.
(2) The state is determined by the location of the applicable Subservicer's
branch office which originated the loan. In a small number of cases, the
property securing the loan may not be located in the same state as the
branch office.
41
<PAGE> 42
PROPERTY TYPE OF INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
NUMBER OF AGGREGATE PERCENT OF
PROPERTY TYPE LOANS PRINCIPAL BALANCE BALANCE
- ------------------------------------------------- --------- ----------------- ----------
<S> <C> <C> <C>
Detached......................................... 22,293 $ 755,514,079.98 89.91%
Non-Detached..................................... 806 25,938,098.97 3.09
PUD.............................................. 1,988 58,833,284.39 7.00
------ --------------- ------
Total.................................. 25,087 $ 840,285,463.34 100.00%
====== =============== ======
</TABLE>
PROPERTY USE FOR INITIAL MORTGAGE LOANS(1)
<TABLE>
<CAPTION>
NUMBER OF AGGREGATE PERCENT OF
PROPERTY USE LOANS PRINCIPAL BALANCE BALANCE
- ------------------------------------------------- --------- ----------------- ----------
<S> <C> <C> <C>
Owner-Occupied................................... 24,723 $ 827,282,817.85 98.45%
Second Home...................................... 364 13,002,645.49 1.55
------ --------------- ------
Total.................................. 25,087 $ 840,285,463.34 100.00%
====== =============== ======
</TABLE>
- ---------------
(1) Based on information supplied by borrower in loan application.
MONTHS REMAINING TO SCHEDULED MATURITY OF INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
MONTHS REMAINING TO NUMBER OF AGGREGATE PERCENT OF
SCHEDULED MATURITY LOANS PRINCIPAL BALANCE BALANCE
- ------------------------------------------------- --------- ----------------- ----------
<S> <C> <C> <C>
0 to 60......................................... 1,054 $ 24,128,323.36 2.87%
61 to 66......................................... 929 22,216,044.20 2.64
67 to 72......................................... 731 19,244,299.08 2.29
73 to 78......................................... 984 25,854,912.09 3.08
79 to 84......................................... 838 22,764,221.52 2.71
85 to 90......................................... 1,156 34,772,841.01 4.14
91 to 96......................................... 119 3,930,393.62 0.47
97 to 102........................................ 229 6,627,333.66 0.79
103 to 108....................................... 258 7,917,113.05 0.94
109 to 114....................................... 2,499 97,669,178.16 11.62
115 to 117....................................... 1,336 53,770,325.19 6.40
118 to 120....................................... 13 216,009.78 0.03
121 to 123....................................... 6 48,183.74 0.01
124 to 126....................................... 7 77,821.29 0.01
127 to 129....................................... 5 61,503.56 0.01
130 to 132....................................... 6 181,442.27 0.02
133 to 135....................................... 10 79,561.36 0.01
136 to 138....................................... 11 92,073.95 0.01
139 to 141....................................... 12 116,443.18 0.01
142 to 144....................................... 16 403,983.36 0.05
145 to 147....................................... 17 159,675.45 0.02
148 to 150....................................... 20 455,279.44 0.05
151 to 153....................................... 7 166,874.75 0.02
154 to 156....................................... 2 26,394.73 0.00
157 to 159....................................... 4 230,570.46 0.03
160 to 162....................................... 4 207,284.15 0.02
163 to 165....................................... 6 181,095.08 0.02
166 to 168....................................... 505 13,317,255.99 1.58
169 to 171....................................... 819 21,535,897.24 2.56
172 to 174....................................... 3,311 105,539,696.63 12.56
175 to 177....................................... 5,850 211,131,842.07 25.14
178 to 180....................................... 4,323 167,161,589.92 19.89
------ --------------- ------
Total....................................... 25,087 $ 840,285,463.34 100.00%
====== =============== ======
</TABLE>
42
<PAGE> 43
DAYS DELINQUENT FOR INITIAL MORTGAGE LOANS
<TABLE>
<CAPTION>
NUMBER OF AGGREGATE PERCENT OF
DAYS DELINQUENT LOANS PRINCIPAL BALANCE BALANCE
- ------------------------------------------------- --------- ----------------- ----------
<S> <C> <C> <C>
0-29............................................. 24,098 $ 803,524,358.04 95.63%
30-59............................................ 845 31,509,512.36 3.75
60-89............................................ 144 5,251,592.94 0.62
------ --------------- ------
Totals................................. 25,087 $ 840,285,463.34 100.00%
====== =============== ======
</TABLE>
No assurance can be given that the values of the Mortgaged Properties as of
the dates of origination of the related Credit Line Agreements have remained or
will remain constant or have not declined. If residential real estate markets
generally should experience an overall decline in property values such that the
outstanding Pool Balance related to the Mortgage Loans, together with any senior
financing on the Mortgaged Properties, equal or exceed the value of the
Mortgaged Properties, the actual rates of delinquencies, foreclosures and losses
could be higher than those currently experienced in the mortgage lending
industry in general. For information concerning possible declines in value of
the Mortgaged Properties, see "Special Considerations -- Nature of Security." In
addition, adverse economic conditions (which may or may not affect real property
values) may affect the timely payment by borrowers of the minimum monthly
payments under the Mortgage Loans and, accordingly, the actual rates of
delinquencies, foreclosures and losses with respect to the Trust. To the extent
that such losses are not covered by the Overcollateralization Amount, if any,
payments from the Spread Account or draws on the Policy, they will be borne by
Certificateholders.
The Subservicers have sold and assigned to the Seller, and the Seller has
sold and assigned to the Trustee for the benefit of the holders of the
Certificates, all right, title and interest in the Trust Balances of the Initial
Mortgage Loans as of their Cut-Off Date (the "Cut-Off Date Pool Balance"). In
addition, Subsequent Funding Mortgage Loans acquired by the Trust and new
advances on the Mortgage Loans made during the life of the Trust pursuant to the
Credit Line Agreements (the "Additional Balances") will be funded by the
appropriate Subservicer and sold to the Seller pursuant to the Receivables
Purchase Agreement and will then be transferred by the Seller to the Trust
pursuant to the Agreement. The Subservicers will continue to service, and the
Master Servicer will master service, the Mortgage Loans, pursuant to the
Agreement, and the Master Servicer will receive a monthly servicing fee for such
services. See "Description of the Certificates -- Assignment of Mortgage Loans"
and "-- Servicing Compensation and Payment of Expenses" herein.
CONVEYANCE OF SUBSEQUENT FUNDING MORTGAGE LOANS
The Agreement permits the Trust to acquire approximately $100,834,256 of
Subsequent Funding Mortgage Loans for addition to the Trust. Accordingly, the
statistical characteristics of the Mortgage Loans will vary as of any
Distribution Date on which the acquisition of these additional Mortgage Loans
occurs.
The obligation of the Trust to purchase the Subsequent Funding Mortgage
Loans for addition to the Trust is subject to certain requirements, including:
(i) such Mortgage Loans may not be 90 or more days contractually delinquent as
of the Cut-Off Date immediately preceding the related Distribution Date; (ii)
the remaining term to maturity of such Mortgage Loan may not exceed 15 years;
(iii) no such Mortgage Loan will have a Combined Loan-to-Value Ratio at its
Cut-Off Date greater than 100%; and (iv) if an Adjustable Rate Mortgage, had an
Index Rate equal to the prime rate or rate for the auction average of six month
U.S. Treasury Bills.
43
<PAGE> 44
DESCRIPTION OF THE CERTIFICATE INSURER
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 United
States and international capital markets. CapMAC also provides financial
guarantee reinsurance for structured asset-backed, corporate, municipal and
other financial obligations written by other major insurance companies.
CapMAC's claims-paying ability is rated "Aaa" by Moody's, "AAA" by Standard
& Poor's, "AAA" by Duff & Phelps Credit Rating Co. ("Duff & Phelps") 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 SURETY BOND ISSUED BY CAPMAC OR ANY DEBTS OF CAPMAC OR TO MAKE
ADDITIONAL CAPITAL CONTRIBUTIONS.
CapMAC is regulated by the Superintendent of Insurance of the State of New
York. In addition, CapMAC is subject to regulation by the insurance laws and
regulations of the other jurisdictions in which it is licensed. Such insurance
laws regulate, among other things, the amount of net exposure per risk that
CapMAC may retain, capital transfers, dividends, investment of assets, changes
in control, transactions with affiliates and consolidations and acquisitions.
CapMAC is subject to periodic regulatory examinations by the same regulatory
authorities.
CapMAC's obligations under the Policy may be reinsured. Such reinsurance
does not relieve CapMAC of any of its obligations under the Policy.
THE POLICY IS NOT COVERED BY THE PROPERTY/CASUALTY INSURANCE SECURITY FUND
SPECIFIED IN ARTICLE 76 OF THE NEW YORK INSURANCE LAW.
As at December 31, 1995 and 1994, CapMAC had qualified statutory capital
(which consists of policyholders' surplus and contingency reserve) of
approximately $240 million and $170 million, respectively, and had not incurred
any debt obligations. Article 69 of the New York State Insurance Law requires
CapMAC to establish and maintain the contingency reserve, which is available to
cover claims under surety bonds issued by CapMAC.
The audited financial statements of CapMAC prepared in accordance with
generally accepted accounting principles as of December 31, 1995 and 1994 and
for each of the years in the three-year period ended December 31, 1995, and the
unaudited financial statements of CapMAC as of March 31, 1996 and 1995 and for
each of the three month periods then ended are made a part of this Prospectus
under Annex II. Copies of CapMAC's financial statements prepared in accordance
with statutory accounting standards, which differ from generally accepted
accounting principles, and filed with the Insurance Department of the State of
New York are available upon request. CapMAC is located at 885 Third Avenue, New
York, New York 10022, and its telephone number is (212) 755-1155.
MATURITY AND PREPAYMENT CONSIDERATIONS
The Agreement, except as otherwise described herein, provides that the
Certificateholders will be entitled to receive on each Distribution Date
distributions of Principal Collections, in the amounts described herein, until
the Certificate Principal Balance is reduced to zero. During the Funding Period,
the Scheduled Principal Distribution Amount will be deposited into the Funding
Account and may be used by the Trustee to purchase up to an aggregate of
$100,834,256 of Subsequent Funding Mortgage Loans, which is equal to 12% of the
sum of the Cut-Off Balances of the Initial Mortgage
44
<PAGE> 45
Loans. In the event that the sum of all Principal Collections deposited in the
Funding Account during the Funding Period exceeds $100,834,256, or such
Collections are not used to acquire the Subsequent Funding Mortgage Loans on any
Distribution Date during the Funding Period, then such Collections will be used
to acquire any remaining Additional Balances and any remaining Principal
Collections on deposit thereafter will be distributed to the Certificateholders
as payment of principal. Following the expiration of the Funding Period and
prior to the commencement of the Rapid Amortization Period, Certificateholders
will receive, to the extent of the availability thereof, amounts from Principal
Collections either based upon the Fixed Allocation Percentage of principal
received or the principal received less amounts drawn under the Credit Line
Agreements, whichever is less. Upon the commencement of the Rapid Amortization
Period, Certificateholders will receive amounts from Principal Collections based
solely upon the Fixed Allocation Percentage. Because prior principal
distributions to Certificateholders serve to reduce the Certificateholders'
Floating Allocation Percentage but do not change the Fixed Allocation
Percentage, allocations of Principal Collections based on the Fixed Allocation
Percentage may result in distributions of principal to the Certificateholders in
amounts that are, in most cases, greater relative to the declining balance of
the Pool Balance than would be the case if the Certificateholders' Floating
Allocation Percentage were used to determine the percentage of Principal
Collections distributed to Certificateholders. This is especially true during
the Rapid Amortization Period when the Maximum Principal Distribution Amount is
distributed. In addition, Interest Collections allocable to the Certificates may
be distributed to Certificateholders as part of the Accelerated Principal
Distribution Amount. Furthermore, to the extent of losses allocable to the
Certificateholders, Certificateholders will also receive as principal reduction
the amount of such losses from Certificateholders' Excess Interest, and, if
necessary, and to the extent not covered by the Overcollateralization Amount,
from any amounts on deposit in the Spread Account and draws under the Policy.
The level of losses may therefore affect the rate of payment of principal on the
Certificates.
To the extent obligors make more draws than principal payments, the
Seller's Interest may grow. Because during the Rapid Amortization Period the
Certificateholders' share of Principal Collections is based upon the Fixed
Allocation Percentage, an increase in the Seller's Interest due to additional
draws may also result in Certificateholders receiving principal at a greater
rate. The Agreement permits the Seller, at its option, but subject to the
satisfaction of certain conditions specified in the Agreement, including the
conditions described below, to remove certain Mortgage Loans from the Trust at
any time during the life of the Trust, so long as the aggregate principal
balance of the Mortgage Loans to be removed will not result in the percentage of
the Pool Balance allocable to the Seller Interest (after giving effect to such
removal) being less than the percentage of the Pool Balance allocable to the
Seller Interest as of the Closing Date. Such removals may affect the rate at
which principal is distributed to Certificateholders by reducing the overall
Pool Balance and thus the amount of Principal Collections. See "Description of
the Certificates -- Optional Retransfers of Mortgage Loans to the Seller."
As described herein, the actual maturity of the Certificates will depend in
part on the availability of Subsequent Funding Mortgage Loans, the timing of the
acquisition of such loans and the receipt of principal on the Mortgage Loans or
the extent of Liquidated Mortgage Loans, which will result in principal payments
on the Certificates equal to the sum of the applicable Allocation Percentage of
(i) the related net liquidation proceeds included in Principal Collections and
(ii) the related Liquidation Loss Amount of such Mortgage Loans to the extent of
funds collected on the Mortgage Loans, less the Servicing Fee, together with any
funds withdrawn from the Spread Account or draws under the Policy. All of the
Mortgage Loans may be prepaid in full or in part at any time. The Subservicers,
for certain Mortgage Loans originated in Arizona, California, Connecticut,
Florida, Indiana, Missouri, Nevada, New Hampshire, Ohio and Oregon, have a right
to assess a prepayment penalty if that Mortgage Loan is prepaid in full within
the first three years of its origination date and the Subservicers have such
right if a Mortgage Loan originated in Rhode Island is prepaid in full within
one year of the origination date. The prepayment penalty varies and may be (i) a
percentage of the original Credit Limit, (ii) a percentage of the amount of the
unpaid balance, (iii) an amount
45
<PAGE> 46
equal to six months' interest on the principal balance that was prepaid, or (iv)
an amount equal to six months' interest on the amount prepaid in excess of 20%
of original principal balance. The prepayment experience with respect to the
Mortgage Loans will affect the actual maturity of the Certificates.
HFC is not aware of any publicly generated studies or statistics available
on the rate of prepayment of home equity loans. Generally, home equity loans are
not viewed by mortgagors as permanent financing. Accordingly, the Mortgage Loans
may experience a higher rate of prepayment than traditional mortgage loans. On
the other hand, because most of the Mortgage Loans are not fully amortizing, in
the absence of voluntary borrower prepayments they could experience slower rates
of principal payment than traditional fully amortizing first mortgages. The
Trust's prepayment experience may be affected by a wide variety of factors,
including general economic conditions, interest rates, the availability of
alternative financing and homeowner mobility.
In addition, the Trust's prepayment experience and the rate at which the
Certificates amortize will be affected by any repurchases of Mortgage Loans by
the Master Servicer or the Subservicers pursuant to the Agreement. Substantially
all of the Mortgage Loans contain due-on-sale provisions, and the Subservicers
intend to enforce such provisions unless (i) such enforcement is not permitted
by applicable law or (ii) the related Subservicer, in a manner consistent with
reasonable commercial practice, permits the purchaser of the related Mortgaged
Property to assume the Mortgage Loan. To the extent permitted by applicable law,
such assumption will not release the original borrower from its obligations
under the Mortgage Loan. The enforcement of a due-on-sale provision will have
the same effect as a prepayment of the related Mortgage Loan. See "Description
of the Certificates -- Collection and Other Servicing Procedures" and "Certain
Legal Aspects of the Mortgage Loans -- 'Due-on-Sale' Clauses" for a description
of certain provisions of the Agreement referred to below that may affect the
prepayment experience on the Mortgage Loans. The yield to an investor in
Certificates who purchased such Certificates in the secondary market at a price
that is different from par will be different if the rate of prepayment on the
Mortgage Loans is actually different than the rate anticipated by such investor
at the time such Certificates were purchased.
Collections on the Mortgage Loans may vary because, among other things,
borrowers may make payments during any month as low as the Minimum Monthly
Payment for such month or as high as the entire outstanding principal balance
plus accrued interest and the fees and charges thereon and, in addition,
borrowers may borrow additional amounts under their respective Credit Line
Agreements. It is possible that borrowers may fail to make scheduled payments.
In addition, collections on the Mortgage Loans may also vary due to seasonal
purchasing and payment habits of borrowers.
No assurance can be given as to the level of prepayments that will be
experienced by the Trust and it can be expected that a portion of borrowers will
not prepay their Mortgage Loans to any significant degree.
The following tables set forth below are based on conditional prepayment
rate, constant draw rate (which for purposes of the assumptions is the amount of
Additional Balances on the Mortgage Loans drawn each month expressed as an
annualized percentage of the total principal of the pool of Mortgage Loans
outstanding at the beginning of such month) and optional termination assumptions
as indicated in the tables below. For the following tables, it was assumed that
the Initial Mortgage Loans have been aggregated into two pools, one pool with a
principal balance of $518,716,918.73 and a second pool with a principal balance
of $321,568,544.61. Further, Mortgage Loans with respect to the two pools are
assumed to have interest rates of 14.41% and 12.15%, respectively, and interest
rates net of the Servicing Fee, the insurance premium, and a certain amount
calculated to absorb losses related to defaults on the Mortgage Loans (the "net
interest rates") of 12.41% and 10.15%, respectively, credit limit utilization
rates of 98% and 94%, respectively, and as of the Pool Date, remaining terms to
maturity of 176 months and 94 months, respectively.
In addition, it was assumed that (i) the distributions are made in
accordance with the description set forth under "Description of the Certificates
- -- Distributions on the Certificates," (ii) distributions of principal and
interest on the Certificates will be made on the 20th day of each
46
<PAGE> 47
calendar month regardless of the day on which the Distribution Date actually
occurs, (iii) no extension past the scheduled maturity date of a Mortgage Loan
is made, (iv) no delinquencies occur, (v) scheduled monthly payments on the
Mortgage Loans are comprised of interest only payments and the only principal
payments on the Mortgage Loans are those represented by prepayments calculated
under each of the prepayment assumptions as set forth in the tables below before
giving effect to draws, (vi) monthly draws are calculated under each of the
assumptions as set forth in the tables below before giving effect to
prepayments, (vii) each Mortgage Loan is subject to a maximum credit utilization
rate of 110%, (viii) the scheduled due date for each of the Mortgage Loans is
the first day of each month, (ix) each month consists of 30 days, (x) the
Closing Date is May 23, 1996, (xi) the Funding Period begins on the Closing Date
and expires on the earlier of the 14th Distribution Date or the month in which
the balance in the Funding Account is equal to 12% of the sum of the Cut-Off
Balances of the Initial Mortgage Loans, (xii) all the aggregate principal
collections in the Funding Account, up to 12% of the sum of the Cut-Off Balances
of the Initial Mortgage Loans, will be used to purchase Subsequent Funding
Mortgage Loans at the end of the Funding Period, (xiii) the Subsequent Funding
Mortgage Loans are purchased at the end of the Funding Period and will have an
identical interest rate, net interest rate and remaining term to maturity as of
the Pool Date as the first pool described above, and (xiv) for each Distribution
Date the Certificate Rate is equal to 5.6375%.
PERCENTAGE OF ORIGINAL CERTIFICATE PRINCIPAL BALANCE -- AMORTIZATION
SCHEDULE(1)(2)
<TABLE>
<CAPTION>
CONDITIONAL PREPAYMENT RATE (% CPR)
----------------------------------------------------------------
PAYMENT DATE 0% 10% 18% 22% 26% 30% 34%
- ----------------------------------------- ---- --- --- --- --- --- ---
<S> <C> <C> <C> <C> <C> <C> <C>
The Closing Date......................... 100 100 100 100 100 100 100
May 20, 1997............................. 99 99 98 93 88 83 78
May 20, 1998............................. 99 95 84 76 68 61 54
May 20, 1999............................. 99 90 72 62 52 44 36
May 20, 2000............................. 99 85 62 50 40 32 24
May 20, 2001............................. 99 80 53 41 31 22 16
May 20, 2002............................. 99 76 45 33 23 16 10
May 20, 2003............................. 99 72 39 26 17 11 0
May 20, 2004............................. 57 43 21 13 0 0 0
May 20, 2005............................. 57 39 17 10 0 0 0
May 20, 2006............................. 57 35 13 0 0 0 0
May 20, 2007............................. 57 31 10 0 0 0 0
May 20, 2008............................. 57 27 0 0 0 0 0
May 20, 2009............................. 57 23 0 0 0 0 0
May 20, 2010............................. 57 20 0 0 0 0 0
May 20, 2011............................. 0 0 0 0 0 0 0
Weighted Average Life (years)............ 11.7 8.8 5.7 4.5 3.8 3.2 2.7
</TABLE>
- ---------------
(1) Assumes (i) that an optional termination is exercised when the outstanding
Certificate Principal Balance is less than or equal to 10% of the Original
Certificate Principal Balance and (ii) a constant draw rate of 5%.
(2) All percentages are rounded to the nearest 1%.
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<PAGE> 48
WEIGHTED AVERAGE LIFE(1) AND FINAL SCHEDULED PAYMENT DATE(2)
SENSITIVITY OF THE CLASS A CERTIFICATES TO PAYMENTS AND DRAWS
<TABLE>
<CAPTION>
CONDITIONAL PREPAYMENT RATE (% CPR)(3)
---------------------------------------------------------------------------------------------------
0% 10% 18% 22% 26% 30% 34%
----------- ----------- ----------- ---------- ----------- ---------- -----------
CONSTANT DRAW RATE WAL DATE WAL DATE WAL DATE WAL DATE WAL DATE WAL DATE WAL DATE
- ---------------------------- ---- ---- ---- ---- --- ----- --- ---- --- ----- --- ---- --- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
0%......................... 12.0 1/11 7.5 1/11 4.8 6/06 3.9 6/04 3.4 4/04 2.9 3/03 2.5 3/02
3%......................... 11.6 1/11 8.2 1/11 5.2 11/06 4.2 9/04 3.6 4/04 3.0 3/03 2.5 3/02
5%......................... 11.7 1/11 8.8 1/11 5.7 7/07 4.5 6/05 3.8 4/04 3.2 9/03 2.7 7/02
8%......................... 11.8 1/11 9.8 1/11 6.5 6/08 5.2 6/06 4.2 10/04 3.5 4/04 3.0 2/03
10%......................... 11.9 1/11 10.7 1/11 7.0 9/08 5.7 1/07 4.6 5/05 3.8 4/04 3.2 8/03
</TABLE>
<TABLE>
<CAPTION>
CONDITIONAL PREPAYMENT RATE (% CPR)(4)
--------------------------------------------------------------------------------------------------
0% 10% 18% 22% 26% 30% 34%
----------- ----------- ---------- ----------- ---------- ---------- -----------
CONSTANT DRAW RATE WAL DATE WAL DATE WAL DATE WAL DATE WAL DATE WAL DATE WAL DATE
- ----------------------------- ---- ---- ---- ---- --- ---- --- ----- --- ---- --- ---- --- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
0%.......................... 12.0 1/11 7.5 1/11 5.0 1/11 4.2 1/11 3.6 1/11 3.1 6/10 2.6 6/08
3%.......................... 11.6 1/11 8.2 1/11 5.4 1/11 4.4 2/10 3.7 1/08 3.1 4/06 2.7 11/04
5%.......................... 11.7 1/11 8.8 1/11 5.9 1/11 4.7 2/10 3.9 5/08 3.3 9/06 2.8 8/05
8%.......................... 11.8 1/11 9.8 1/11 6.7 1/11 5.3 1/10 4.4 8/08 3.6 3/07 3.1 11/05
10%.......................... 11.9 1/11 10.7 1/11 7.2 1/11 5.8 11/09 4.7 9/08 3.9 7/07 3.3 4/06
</TABLE>
- ---------------
(1) The weighted average life of the Certificates is determined by (i)
multiplying the amount of each principal payment by the number of years
from the date of issuance to the related Distribution Date, (ii) adding the
results, and (iii) dividing the sum by the Original Certificate Principal
Balance.
(2) The final scheduled payment date of the Certificates is the date on which
the Certificate Principal Balance is reduced to zero.
(3) Assumes that an optional termination is exercised when the outstanding
Certificate Principal Balance is less than or equal to 10% of the Original
Certificate Principal Balance.
(4) Assumes no optional termination is exercised.
POOL FACTOR AND TRADING INFORMATION
The "Pool Factor" is a seven-digit decimal which the Master Servicer will
compute monthly expressing the Certificate Principal Balance as of each
Distribution Date (after giving effect to the distribution on such Distribution
Date) as a proportion of the Original Certificate Principal Balance. On the
Closing Date, the Pool Factor will be 1.0000000 and will decline to reflect
reductions in the Certificate Principal Balance resulting from distributions
allocated to principal. A Certificateholder's outstanding Certificate Principal
Balance for a given month can be determined by multiplying the denomination of
the holder's Certificate by the Pool Factor for that month.
Pursuant to the Agreement, monthly reports concerning the Invested Amount,
the Pool Factor and various other items of information will be made available to
the Certificateholders. In addition, within 60 days after the start of each
calendar year, beginning in 1997, information for tax reporting purposes will be
made available to each person who has been a registered Certificateholder
(expected to be Cede) during the preceding calendar year. See "Description of
the Certificates -- Registration of Certificates" and "-- Reports to
Certificateholders."
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<PAGE> 49
DESCRIPTION OF THE CERTIFICATES
The Certificates will be issued pursuant to the Agreement. A form of the
Agreement has been filed as an exhibit to the Registration Statement of which
this Prospectus is a part. The following summaries describe certain provisions
of the Agreement. The summaries do not purport to be complete and are subject
to, and are qualified in their entirety by reference to, all of the provisions
of the Agreement. Wherever particular sections or defined terms of the Agreement
(not otherwise defined herein) are referred to, such sections or defined terms
are hereby incorporated herein by reference. Additionally, capitalized terms
used herein that are not defined herein shall have the meanings ascribed to them
in the Agreement.
GENERAL
The Certificates will be issued only in fully registered form, in
denominations of $100,000 and integral multiples of $1,000 in excess thereof and
will evidence specified undivided beneficial ownership interests in the Trust.
(Section 6.01) The property of the Trust will consist of, to the extent provided
in the Agreement: (i) the Mortgage Loans, including any Subsequent Funding
Mortgage Loans and any Eligible Substitute Mortgage Loans acquired by the Trust,
and Additional Balances that from time to time are subject to the Agreement;
(ii) collections in respect of such Mortgage Loans and Additional Balances;
(iii) Mortgaged Properties acquired by foreclosure or deed in lieu of
foreclosure; (iv) the Collection Account (excluding net earnings thereon); (v)
the Funding Account; (vi) the Spread Account (for the benefit of the Certificate
Insurer and the Certificateholders); (vii) the Policy; and (viii) an assignment
of the Seller's interest in certain hazard insurance policies maintained by the
borrowers with respect to the Mortgaged Properties. (Article I) Definitive
Certificates, if issued, will be transferable and exchangeable at the corporate
trust office of the Trustee, which will initially act as Certificate Registrar.
See "Registration of Certificates" below. No service charge will be made for any
registration, exchange or transfer of Certificates, but the Trustee may require
payment of a sum sufficient to cover any tax or other governmental charge.
(Section 6.02)
The aggregate amount of the Certificateholder's undivided interest in the
Trust represented by the Certificates on the Closing Date with respect to the
Initial Mortgage Loans will equal $819,278,000 of principal (the "Original
Certificate Principal Balance" or the "Original Invested Amount"). Thereafter,
the Invested Amount with respect to any date will be an amount equal to the
Original Invested Amount minus the sum of (a) the amount, without duplication,
of principal payments previously distributed to Certificateholders (excluding
Accelerated Principal Distribution Amounts and payments of the Guaranteed
Principal Distribution Amounts paid out of draws under the Policy), (b) all
principal payments that would be made but for the Master Servicer's legal
inability to deposit collections in the Collection Account due to a final
determination of a court of competent jurisdiction in any Master Servicer's,
Subservicer's or Seller's insolvency proceeding and (c) the aggregate amount
equal to the product of the Certificateholders' Floating Allocation Percentage
and the Liquidation Loss Amounts that have not been previously distributed to
the Certificateholders out of Interest Collections. The aggregate principal
amount of the outstanding Certificates (the "Certificate Principal Balance") on
any date is equal to the Original Certificate Principal Balance less the
aggregate of amounts actually distributed as principal to the Certificateholders
(including Accelerated Principal Distribution Amounts and any Guaranteed
Principal Distribution Amount paid out of draws under the Policy). See
"Distributions on the Certificates" below. Each Certificate represents the right
to receive payments of interest at the applicable Certificate Rate and payments
of principal as described below funded from Interest Collections and Principal
Collections, respectively, allocated to the Certificates and, if necessary, from
draws on the Policy. The Seller will own initially the remaining undivided
interest in the Trust (the "Seller Interest") not represented by the Invested
Amount.
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<PAGE> 50
ASSIGNMENT OF MORTGAGE LOANS
Each of the Subservicers will transfer to the Seller and the Seller will
transfer to the Trust all of its right, title and interest in and to the amounts
owing under each Mortgage Loan (including any Additional Balances thereon
arising in the future), including all Principal Collections to the extent
described herein, if any, and Interest Collections due with respect to each such
Mortgage Loan subsequent to the Cut-Off Date therefor (other than any amounts
received in respect of taxes, insurance premiums, assessments and similar items,
as provided in the Agreement). The Funding Account will also be established with
the Trustee. In addition, on or prior to the date the Certificates are initially
issued by the Trust, the Master Servicer shall cause the Policy to be delivered
to and the Spread Account to be created with the Trustee. (Section 2.01) The
Trustee, concurrently with the transfer of the Initial Mortgage Loans, will
deliver the Certificates and the Seller Certificates (as defined in the
Agreement) to the Seller. (Section 2.08) Subject to the following conditions,
among others, Subsequent Funding Mortgage Loans, to the extent of the
availability thereof and the availability of sufficient Principal Collections on
deposit in the Funding Account, will be sold to the Trust on or before the last
Distribution Date of the Funding Period and: (i) must meet the general criteria
for eligibility in accordance with the terms of the Agreement (other than
statistical information relating to the Initial Mortgage Loans or Eligible
Substitute Mortgage Loans); (ii) must be selected by the Master Servicer in a
manner it believes will not materially adversely affect the Certificateholders
or the Certificate Insurer and (iii) the Trustee shall have received written
confirmation from the Rating Agencies that such addition will not result in a
reduction or withdrawal of the then current rating of the Certificates and
written consent (not to be unreasonably withheld or delayed) from the
Certificate Insurer. (Section 2.06) In addition, any Additional Balances in
respect of such Mortgage Loans arising in the future will be transferred to the
Trust. Each Mortgage Loan transferred to the Trust will be identified on a
magnetic tape (the "Mortgage Loan Schedule") delivered to the Trustee pursuant
to the Agreement. Such schedule will include information as to the applicable
Cut-Off Balance of each Mortgage Loan, as well as information respecting the
applicable Loan Rate. (Article I) In addition, the Subservicers will assign all
right, title and interest to the Related Documents, consisting of the Credit
Line Agreements, Mortgages and other related documents to the Trustee directly.
However, the Credit Line Agreements and the other Related Documents will remain
in the possession of the applicable Subservicer, except as set forth below.
Notwithstanding the foregoing, the related Subservicer will retain all right,
title and interest in the Credit Line Agreements with respect to the right or
obligation to make future advances to the borrowers.
Under the terms of the Agreement, during the period that the Certificates
are outstanding and so long as HFC's long-term senior unsecured debt is rated at
least A3 by Moody's and A- by Standard & Poor's, or such lower ratings as are
deemed acceptable by Moody's and Standard & Poor's in order to maintain their
then current ratings on the Certificates and acceptable to the Certificate
Insurer, the Subservicers shall be entitled to maintain possession of the
Related Documents with respect to each Mortgage Loan and shall not be required
to record assignments of the related mortgage either to the Seller or the
Trustee. In the event, however, that possession of any Related Documents is
required by the Master Servicer, the Master Servicer will be entitled to request
delivery thereof and to retain the same for as long as necessary for servicing
purposes. Any such Related Documents will be returned to the applicable
Subservicer (unless returned to the related borrower in connection with the
payment in full of the related Mortgage Loan) when possession thereof is no
longer required. In the event that HFC's long-term senior unsecured debt rating
does not satisfy the above-described standards or any of the Subservicers ceases
to be an HFC affiliate, such Subservicer and the Seller will have 90 days to
record assignments of the mortgages for each related Mortgage Loan in favor of
the Trustee and 60 days to deliver the Related Documents pertaining to each such
Mortgage Loan to the Trustee (unless opinions of counsel satisfactory to the
Trustee, the Rating Agencies and the Certificate Insurer are delivered to the
Trustee and the Certificate Insurer to the effect that recordation of such
assignments or delivery of such documentation is not required in the relevant
jurisdiction to protect the interests of the Seller
50
<PAGE> 51
and the Trustee in the Mortgage Loans). Under the Agreement, the Trustee is
appointed attorney-in-fact for the Subservicers and the Seller with power to
prepare, execute and record assignments of the mortgages in the event that the
Subservicers and the Seller fail to do so on a timely basis. (Section 2.01) In
lieu of delivery of original documentation, the Master Servicer may deliver
documents which have been imaged optically upon delivery of an opinion of
counsel that such documents do not impair the enforceability or the transfer to
the Trust of the Mortgage Loans.
In the event the Related Documents are delivered to the Trustee with regard
to any Mortgage Loan, the Trustee will review such Related Documents and if any
Related Documents are found to be defective in any material respect and such
defect is not cured within 30 days following notification thereof to the Master
Servicer by the Trustee, the Seller will be obligated to accept the retransfer
of all affected Mortgage Loans from the Trust. Upon such retransfer, such
Mortgage Loans will be deducted from the Pool Balance, thus reducing the amount
of the Seller Interest, provided that interest accrued on the aggregate
principal balance on the Mortgage Loans to the date of such retransfer shall be
property of the Trust. Upon the occurrence of any such retransfer, the Seller
may designate and sell to the Trust an Eligible Substitute Mortgage Loan to
replace such defective Mortgage Loan. If after giving effect to any such
deduction or transfer of an Eligible Substitute Mortgage Loan to the Trust the
Seller Interest would be reduced below 2% of the Pool Balance at such time, the
Seller shall deposit an amount into the Collection Account equal to the amount
that would have, but for such deposit, reduced the Seller Interest below 2% of
such Pool Balance (the "Retransfer Deposit Amount"). The Retransfer Deposit
Amount will be a Principal Collection. Any such deduction and/or deposit will be
considered a repayment in full of such Mortgage Loan. Notwithstanding the
foregoing, however, no such retransfer shall be considered to have occurred
unless any such required deposit is actually made. The obligation of the Seller
to accept a retransfer of a defective Mortgage Loan is the sole remedy regarding
any defects in the Related Documents available to the Trustee or the
Certificateholders. (Section 2.02)
The Seller will make certain representations and warranties as to the
accuracy in all material respects of certain information furnished to the
Trustee with respect to each Mortgage Loan (e.g., principal balance thereof as
of the applicable Cut-Off Date and the Loan Rate). In addition, the Seller will
represent and warrant, on the Closing Date, that, among other things: (i) at the
time of transfer to the Trust, the Seller has transferred all of its right,
title and interest in each Initial Mortgage Loan and its corresponding Related
Documents, free of any lien; and (ii) each Initial Mortgage Loan was generated
under a Credit Line Agreement that complied, at the time of origination, unless
otherwise noted in the Agreement, in all material respects with applicable state
and Federal laws. Such representations and warranties will be repeated for the
Subsequent Funding Mortgage Loans and any Eligible Substitute Mortgage Loans as
of the date they are transferred to the Trust. Upon discovery of a breach of any
such representation and warranty which materially and adversely affects the
interests of the Certificateholders or the Certificate Insurer in the related
Mortgage Loan and Related Documents, the Seller will have a period of 60 days
after discovery or notice of the breach, or, with the prior written consent of
the Trustee and the Certificate Insurer, such longer period not to exceed 90
days, to effect a cure. If the breach cannot be cured within such period, the
Seller will be obligated to accept a retransfer of the Mortgage Loan from the
Trust and may substitute an Eligible Substitute Mortgage Loan therefor. To the
extent that such retransfer (after giving effect to any such substitution) would
reduce the Seller Interest below 2% of the Pool Balance at such time, the Seller
shall deposit into the Collection Account the Retransfer Deposit Amount.
Furthermore, if the Seller breaches certain of its representations and
warranties with respect to (a) the ownership of the Trust Balances and the
ability to sell the same pursuant to the Agreement or (b) the status of the
transfer of the amounts due under the Mortgage Loans to the Trust as either a
valid transfer and assignment of such amounts to the Trust or the grant to the
Trust of a security interest in such Mortgage Loans, the Seller shall accept a
retransfer of all Mortgage Loans from the Trust in accordance with the terms of
the Agreement. In the event of such retransfer, the Seller shall deposit into
the Collection Account, as the Retransfer Deposit Amount, an amount equal to the
Certificate Principal Balance plus all unpaid and accrued interest thereon
preceding the
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<PAGE> 52
date of such retransfer together with any unreimbursed amounts then due and
owing to the Certificate Insurer under the terms of the Insurance Agreement. The
same procedure and limitations that are set forth in the preceding paragraph for
the retransfer of a Mortgage Loan respecting which there is a defect in the
Related Documents will apply to the replacement or retransfer of a Mortgage Loan
that is required to be retransferred because of a breach of a representation or
warranty in the Agreement that materially and adversely affects the interests of
the Certificateholders, including that the obligation of the Seller to accept a
retransfer of a Defective Mortgage Loan is the sole remedy regarding any such
defects available to the Trustee or the Certificateholders. (Section 2.04)
Mortgage Loans required to be retransferred to the Seller as described in
the preceding two paragraphs are referred to as "Defective Mortgage Loans."
An Eligible Substitute Mortgage Loan is a Mortgage Loan which: (i) has an
outstanding principal balance not substantially in excess of, and not
substantially less than, the Trust Balance of such Defective Mortgage Loan; (ii)
has a Loan Rate of not less than the Loan Rate of the Defective Mortgage Loan
and not more than 500 basis points in excess thereof; (iii) if the Defective
Mortgage Loan was an Adjustable Rate Mortgage, has a Margin that is not less
than the Margin of the Defective Mortgage Loan and not more than 500 basis
points higher than the Margin for the Defective Mortgage Loan; (iv) has a
remaining term to maturity not more than six months earlier or later than the
remaining term to maturity of the Defective Mortgage Loan; (v) conforms to
certain of the representations and warranties of the Seller in the Agreement as
applicable to Eligible Substitute Mortgage Loans; (vi) has a Combined
Loan-to-Value Ratio that is not in excess of the Combined Loan-to-Value Ratio of
the Defective Mortgage Loan; (vii) has a Mortgage which has a lien position at
least equal to the lien position of the Mortgage relating to the Defective
Mortgage Loan; (viii) has a borrower with characteristics substantially similar
to the borrower under the Defective Mortgage Loan; and (ix) if the Defective
Mortgage Loan has an adjustable Loan Rate, has a maximum Loan Rate no lower than
the maximum Loan Rate applicable to the Defective Mortgage Loan and has a
minimum Loan Rate no lower than the minimum Loan Rate applicable to the
Defective Mortgage Loan, or each of the Rating Agencies and the Certificate
Insurer consents to such Eligible Substitute Mortgage Loan.
All representations and warranties of the Seller described above relating
to each Defective Mortgage Loan will be deemed to have been made with respect to
each such Eligible Substitute Mortgage Loan except as modified to the extent
described in the Agreement. Each such representation and warranty with respect
to conditions on the Cut-Off Date shall be deemed to have been made as of the
date of substitution, except as modified to the extent described in the
Agreement. The remedies in the event of a breach of representation or warranty
with respect to an Eligible Substitute Mortgage Loan will be similar to those
described above with respect to Defective Mortgage Loans. (Sections 2.02 and
2.04)
Pursuant to the Agreement, the Master Servicer will service and administer
the Mortgage Loans as more fully set forth below.
AMENDMENTS TO CREDIT LINE AGREEMENTS
Subject to applicable law, the applicable Subservicer may change the terms
of the Credit Line Agreements at any time. Changes to the terms of a Mortgage
Loan may be agreed to by a Subservicer or the Master Servicer in the event that
such Subservicer or Master Servicer has determined that such changes are
necessary (provided that such changes will not have a material adverse effect on
the interests of the Certificateholders, the Certificate Insurer or the Trust).
In addition, certain changes may be made to the terms of a Mortgage Loan that
will have a material adverse effect on the interests of the Certificateholders
provided that any such Mortgage Loan will be retransferred to such Subservicer
or the Master Servicer pursuant to the terms of the Agreement prior to the
effectiveness of any such change.
52
<PAGE> 53
CONSENT TO SENIOR LIENS
The Master Servicer, acting as agent for the Trust, may permit the
placement of a subsequent senior mortgage on any Mortgaged Property, provided
that (a)(i) the Mortgage relating to the Mortgage Loan was in a first lien
position as of the applicable Cut-Off Date and (ii) such action is consistent
with prudent commercial practice; (b) such Mortgage succeeded to a first or
second lien position after the related Mortgage Loan was conveyed to the Trust
and, immediately following the placement of such senior lien, such Mortgage is
in a second or third lien position and the outstanding principal amount of the
mortgage loan secured by such senior lien and the rate at which interest accrues
thereon are no greater than those of the senior mortgage loan secured by the
Mortgaged Property as of the date the related Mortgage Loan was conveyed to the
Trust; (c) the Mortgage relating to such Mortgage Loan was in a second or third
lien position as of the applicable Cut-Off Date, the new senior lien secures a
mortgage loan that refinances an existing first or second mortgage loan and the
outstanding principal amount of the replacement first or second mortgage loan
immediately following such refinancing and the interest rate on the replacement
first or second mortgage loan are not greater than that of the existing first or
second mortgage loan at the date of such refinancing; or (d) the Mortgage
relating to such Mortgage Loan was in a second or third lien position as of the
applicable Cut-Off Date, the new senior lien secures a mortgage loan that
refinances an existing first or second mortgage loan and the then current
Combined Loan-to-Value Ratio of the senior liens and the Mortgage does not
exceed such ratio as of the applicable Cut-Off Date and the ratio of the
Mortgage to the Mortgage plus all senior liens immediately following such
refinancing is at least equal to such ratio as of the applicable Cut-Off Date.
Should a Mortgage Loan which had a first lien on the applicable Cut-Off Date and
as to which the Master Servicer consents to a senior lien pursuant to clause (a)
above be foreclosed upon (a "Special Foreclosed Mortgage Loan"), the Master
Servicer shall repurchase the Trust Balance of such Mortgage Loan, subject to
the conditions described under "Assignment of Mortgage Loans" above.
OPTIONAL RETRANSFERS OF MORTGAGE LOANS TO THE SELLER
Subject to the conditions specified in the Agreement, if on the 27th day of
any calendar month or the following Business Day if such is not a Business Day
(the "Retransfer Notification Date") the percentage (after giving effect to
distributions on such date) of the Pool Balance allocated to the Seller Interest
(after giving effect to the following described proposed removal) exceeds 2%,
the Seller may, but shall not be obligated to, remove on the last Business Day
of such month from the Trust, Mortgage Loans (which may have been generated
under a Credit Line Agreement in any billing cycle) without notice to the
Certificateholders (the "Removed Balances"). The Seller will be required to
satisfy the following conditions in order to designate which Mortgage Loans will
be Removed Balances: (i) the Seller shall have represented that no selection
procedures reasonably believed by the Seller to be adverse to the interests of
the Certificateholders or the Certificate Insurer were used to select the
Removed Balances; (ii) the Seller shall have delivered to the Trustee a computer
file containing a list of all Mortgage Loans in the Trust after such removal;
(iii) the Rating Agencies shall have been notified of the proposed retransfer
and prior to the date of retransfer shall not have notified the Seller in
writing that such retransfer would result in a reduction or withdrawal of their
respective then-current ratings of the Certificates; (iv) the Rapid Amortization
Period shall not have commenced; (v) the proposed retransfer shall not, in the
reasonable belief of the Seller, cause a Rapid Amortization Event to occur; (vi)
the percentage of the Pool Balance allocated to the Seller Interest (after
giving effect to such removal) shall be at least equal to 2% and (vii) the
Seller shall have delivered an officer's certificate to the Trustee and the
Certificate Insurer confirming the items set forth in (i) through (vi) above. In
addition, the Mortgage Loans remaining in the Trust must meet certain
delinquency requirements. Notwithstanding the foregoing however, the Seller may,
at its sole discretion, remove Mortgage Loans from the Trust at any time,
provided (x) the percentage of the Pool Balance allocated to the Seller Interest
(after giving effect to such removal) shall be at least equal to 2% (y) the
Seller shall have delivered a certificate to the Trustee identifying the
Mortgage Loan to be retransferred as well as confirming the satisfaction of
certain
53
<PAGE> 54
other conditions, and (z) the Mortgage Loan is being removed to facilitate the
servicing of the Mortgage Loan, including modifications to the Credit Line
Agreement. (Section 2.07)
PAYMENTS ON MORTGAGE LOANS; DEPOSITS TO COLLECTION ACCOUNT; DEPOSITS TO FUNDING
ACCOUNT
The Master Servicer has established and will maintain with the Trustee a
single separate trust account (the "Collection Account") for the benefit of the
Certificateholders and the Seller as the owner of the Seller Interest, as their
interests may appear. The Collection Account will be an Eligible Account (as
defined herein). Except as otherwise described herein and subject to the
investment provision described in the following paragraphs, within two Business
Days following receipt by the Master Servicer or a Subservicer of amounts in
respect of the Mortgage Loans, excluding amounts representing administrative
charges, annual fees, taxes, assessments, credit insurance charges, insurance
proceeds to be applied to the restoration or repair of a Mortgaged Property or
similar items, the Master Servicer or Subservicer will deposit such amounts in
the Collection Account. Amounts so deposited will be invested in Permitted
Investments (as described in the Agreement) maturing no later than one Business
Day prior to the related Distribution Date or on the related Distribution Date
if approved by the Rating Agencies and the Certificate Insurer. On the fifth
Business Day prior to each Distribution Date (the "Determination Date"), the
Master Servicer will notify the Trustee of the amount of such deposit to be
included in funds available for the related Distribution Date. On or prior to
each Distribution Date, the Master Servicer will deposit to the Collection
Account amounts which are to be included in the funds available for the related
Distribution Date and which are invested in the HFC Note as provided below.
(Section 3.02)
The deposit to the Collection Account of amounts received in respect of a
Mortgage Loan within two Business Days of such receipt referred to above and the
amount of any deposits to the Funding Account during the Funding Period may be
effected through investment of such receipts in a demand note issued by HFC and
payable to the Trustee (the "HFC Note") so long as either (i) the commercial
paper issued by HFC is rated at least A-1 by Standard & Poor's and P-1 by
Moody's (as is currently the case) or (ii) a Servicer Credit Facility (as
defined below) is maintained in form and substance satisfactory to the Rating
Agencies and the Certificate Insurer. In such event, the Master Servicer will
notify the Trustee of the amounts that would otherwise be so deposited and the
Trustee will record a corresponding increase of the amount owing to the Trust
under the HFC Note. Amounts owing under the HFC Note will be reduced by the
amount of, and upon the deposit to the Collection Account on or prior to the
related Distribution Date, such receipts to be included in the funds available
for the related Distribution Date.
At any time that the commercial paper issued by HFC does not satisfy the
rating requirements specified above, HFC may effect the deposit of collections
through investment in the HFC Note referred to above so long as HFC causes to be
maintained an irrevocable letter of credit or surety bond or other credit
enhancement instrument in form and substance satisfactory to each Rating Agency
and the Certificate Insurer (a "Servicer Credit Facility"), issued by a
depository institution or insurance company acceptable to the Certificate
Insurer having a rating on its (A) short-term obligations of at least P-1 and
long-term obligations of at least A2 by Moody's and (B) short-term obligations
of A-1 and long-term obligations of A by Standard & Poor's or other ratings if
approved by the Rating Agencies and the Certificate Insurer (a "Servicer Credit
Facility Issuer") and providing that the Trustee may draw thereon in the event
that HFC, as Master Servicer, fails to make any deposit or payment required
under the Agreement (prior to any draw under the Policy).
During the Funding Period all Principal Collections for the related
Collection Period during such Collection Period will, subject to the foregoing,
initially be deposited within two Business Days following receipt by the Master
Servicer or Subservicer into the Collection Account. On each Determination Date
during the Funding Period, the Master Servicer will notify the Trustee of the
amount of the Scheduled Principal Distribution Amount to be withdrawn from the
Collection Account and deposited into the Funding Account on the related
Distribution Date. The Funding Account will
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be an Eligible Account established with the Trustee as a separate trust account
for the benefit of the Certificateholders and the Seller, as their interests may
appear. Amounts so deposited into the Funding Account will be invested in
Permitted Investments maturing no later than one Business Day prior to the
related Distribution Date or on the related Distribution Date if approved by the
Rating Agencies and the Certificate Insurer. On any Determination Date during
the Funding Period, the Master Servicer will also notify the Trustee of (i) the
amount of any earnings from such Permitted Investments, which earnings shall be
deposited into the Collection Account on the related Distribution Date to be
included in Interest Collections available for the related Distribution Date and
(ii) any Principal Collections in excess of $100,834,256 (or 12% of the sum of
the Cut-Off Balances of the Initial Mortgage Loans) which were deposited in the
Funding Account, which excess will be distributed to Certificateholders as
principal on the related Distribution Date. In the event that not all of the
Principal Collections on deposit in the Funding Account have been used to
acquire the Subsequent Funding Mortgage Loans on the last Distribution Date of
the Funding Period, then such Principal Collections will be used to acquire any
remaining Additional Balances on such Distribution Date and any remaining
Principal Collections on deposit thereafter will be distributed to the
Certificateholders as payment of principal. The deposit to the Funding Account
of the Principal Collections referred to above may be effected through
investment of such Collections in the HFC Note to the same extent and in the
same manner provided above with respect to amounts to be deposited in the
Collection Account.
An Eligible Account is an account that is (i) maintained with a depository
institution whose debt obligations at the time of any deposit therein are rated
in the highest short-term debt rating category by the Rating Agencies or (ii)
one or more accounts with a depository institution which accounts are fully
insured by either the Savings Association Insurance Fund ("SAIF") or the Bank
Insurance Fund ("BIF") of the Federal Deposit Insurance Corporation established
by such fund with a minimum long-term unsecured debt rating of Baa3 or
equivalent rating or (iii) a trust account maintained with the Trustee or (iv)
otherwise acceptable to each Rating Agency as evidenced by a letter from such
Rating Agency to the Trustee, without reduction or withdrawal of their
then-current ratings of the Certificates and acceptable to the Certificate
Insurer. (Article I)
Permitted Investments are specified in the Agreement and are limited to
investments which meet the criteria of the Rating Agencies from time to time as
being consistent with their then-current ratings of the Certificates.
If for any Distribution Date the amount of cash available on deposit in the
Collection Account plus amounts available to be withdrawn from the Spread
Account are less than the amount of funds required to be distributed, the
Trustee, no later than 12:00 noon New York City time on the second Business Day
preceding such Distribution Date, shall notify the Certificate Insurer of the
amount to be drawn on the Policy for such Distribution Date. The amount drawn on
the Policy will be equal to the amount of such deficiency, to the extent
permitted as set forth below under the heading "The Policy." (Section 4.02)
ALLOCATIONS AND COLLECTIONS
All collections on the Mortgage Loans will be allocated in accordance with
the Credit Line Agreements between amounts collected in respect of interest
(together with any earnings received on amounts on deposit in the Funding
Account, the "Interest Collections") and amounts collected in respect of
principal, including Retransfer Deposit Amounts and Net Liquidation Proceeds
constituting principal (the "Principal Collections"). Notwithstanding the
requirements of the Credit Line Agreements, however, for purposes hereof, Net
Liquidation Proceeds constituting interest and all Recovered Charge Off Amounts
(whether interest or principal) shall be treated as Interest Collections and not
Principal Collections. Net Liquidation Proceeds with respect to a Mortgage Loan
are equal to the aggregate of all amounts received upon liquidation of such
Mortgage Loan reduced by related expenses, but not including the Foreclosure
Profit (defined below), if any.
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The portion of Interest Collections allocable to the Certificates will
equal the aggregate amount of such collections multiplied by the
Certificateholders' Floating Allocation Percentage. For each Distribution Date,
the "Certificateholders' Floating Allocation Percentage" is the percentage
equivalent of a fraction determined by dividing the Invested Amount as of the
end of the related Collection Period by the sum of (a) the Pool Balance as of
the end of the preceding Collection Period (adjusted for such Subsequent Funding
Mortgage Loans or Additional Balances acquired or Removed Balances removed for
the preceding Distribution Date) and (b) the amount on deposit in the Funding
Account in respect of Principal Collections as of the end of the related
Collection Period. The remaining amount of Interest Collections shall be
allocated to the Seller Interest.
During the Funding Period, the Scheduled Principal Distribution Amount will
be deposited into the Funding Account. During the Funding Period if an aggregate
amount in respect of Principal Collections is deposited in excess of 12% of the
sum of the Cut-Off Balances of the Initial Mortgage Loans such excess will be
distributed to the Certificateholders as principal. In the event that not all of
the Principal Collections remaining on deposit in the Funding Account have been
used to acquire the Subsequent Funding Mortgage Loans on the last Distribution
Date of the Funding Period, then such Collections will be used to acquire any
remaining Additional Balances on such Distribution Date and any remaining
Principal Collections on deposit thereafter will be distributed to the
Certificateholders as payment of principal. Following the expiration of the
Funding Period and prior to the commencement of the Rapid Amortization Period,
Principal Collections from the Mortgage Loans will be allocated as follows: (a)
to the Certificateholders, the Scheduled Principal Distribution Amount and (b)
to the Seller, all Principal Collections not distributed to the
Certificateholders. Upon the commencement of the Rapid Amortization Period, the
Certificateholders will receive Principal Collections in accordance with their
Fixed Allocation Percentage. The Fixed Allocation Percentage is initially 97.50%
and for each Distribution Date will be reset to the extent that Subsequent
Funding Mortgage Loans were acquired or Removed Balances were removed with
respect to the immediately preceding Distribution Date. With respect to such
reset, the Fixed Allocation Percentage shall be the percentage equivalent
determined by dividing the Invested Amount at the end of the related Collection
Period by the sum of (a) the Pool Balance as of the end of the preceding
Collection Period (adjusted for such Subsequent Funding Mortgage Loans or
Additional Balances acquired or Removed Balances removed for the preceding
Distribution Date) and (b) the amount on deposit in the Funding Account as of
the end of the related Collection Period. Payments of principal to
Certificateholders over the term of the Trust will not exceed the Original
Certificate Principal Balance.
The Trustee will deposit in the Collection Account any Deficiency Amount
drawn under the Policy.
The "Recovered Charge Off Amount," with respect to any Mortgage Loan that
became a Liquidated Mortgage Loan in a Collection Period is the lesser of (a)
the amount by which Net Liquidation Proceeds allocable to principal exceeds the
Trust Balance immediately prior to foreclosure and (b) the amount equal to the
aggregate of the Charge Off Amounts that had reduced the Trust Balance of the
Mortgage Loan. "Foreclosure Profit" with respect to a Liquidated Mortgage Loan
is the amount, if any, by which (i) the aggregate of its Liquidation Proceeds
less related expenses exceeds (ii) the sum of the Trust Balance of such Mortgage
Loan immediately prior to the final recovery of its Liquidation Proceeds plus
accrued and unpaid interest thereon plus the related Charge Off Amounts.
With respect to any date, the Pool Balance will be equal to the aggregate
of the Trust Balances of all Mortgage Loans in the Trust as of such date. The
Trust Balance of a Mortgage Loan (other than a Liquidated Mortgage Loan) on any
date is equal to the Cut-Off Balance thereof, plus (i) any Additional Balance in
respect of such Mortgage Loan, minus (ii) all Principal Collections credited
against the Trust Balance prior to such day, minus (iii) all related Charge Off
Amounts. The Trust Balance of a Liquidated Mortgage Loan (as defined herein)
after final recovery of related Liquidation Proceeds (as defined herein) shall
be zero. A Charge Off Amount is the amount equal to
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the amount of the Trust Balance of a Charged Off Mortgage Loan that the Master
Servicer has charged off on its servicing records in such Collection Period. A
Charged Off Mortgage Loan is a defaulted Mortgage Loan that is not a Liquidated
Mortgage Loan and as to which (i) collection procedures are ongoing and (ii) the
Master Servicer has charged off all or a portion of the related Trust Balance.
DISTRIBUTIONS ON THE CERTIFICATES
Beginning with the Distribution Date occurring on June 20, 1996,
distributions on the Certificates will be made by the Trustee or the Paying
Agent on each Distribution Date to the persons in whose names such Certificates
are registered at the close of business on the day prior to each Distribution
Date (the "Record Date"), except as provided in "Registration of Certificates"
below. The term "Distribution Date" means the 20th day of each month (or if such
day is not a Business Day, the next succeeding Business Day). Distributions will
be made by check or money order mailed (or upon the request of a
Certificateholder owning Certificates having denominations aggregating at least
$5,000,000, by wire transfer or otherwise) to the address of the person entitled
thereto (which, in the case of book-entry certificates, will be DTC or its
nominee) as it appears on the Certificate Register in amounts calculated as
described herein on the fifth Business Day prior to the related Distribution
Date (the "Determination Date"). However, the final distribution in respect of
the Certificates will be made only upon presentation and surrender thereof at
the office or the agency of the Trustee specified in the notice to
Certificateholders of such final distribution. (Sections 5.01 and 10.01) For
purposes of the Agreement a "Business Day" is any day other than (i) a Saturday
or Sunday or (ii) a day on which banking institutions in the states of New York
or Illinois are required or authorized by law to be closed.
Distributions of Interest Collections. On each Distribution Date, the
Trustee or the Paying Agent will distribute the Certificateholders' Floating
Allocation Percentage of all Interest Collections collected during the preceding
Collection Period, in the following manner and order of priority:
(i) as payment of the Servicing Fee for the related Collection Period
and any accrued and unpaid Servicing Fee;
(ii) as payment of the accrued interest due and any overdue accrued
interest (other than the related Carryover Amount) on the Certificates with
interest thereon at the Certificate Rate and, with respect to any overdue
accrued interest, an additional 2% per annum;
(iii) as payment to Certificateholders of the product of the
Certificateholders Floating Allocation Percentage and the Liquidation Loss
Amount;
(iv) as payment to Certificateholders of any Liquidation Loss Amount
allocable to the Certificateholders for a previous Collection Period that
was not previously (a) funded by Interest Collections allocable to the
Certificateholders, (b) absorbed by the Overcollateralization Amount, or
(c) funded by withdrawals from the Spread Account or by draws on the
Policy;
(v) as payment of the premium for the Policy to the extent not paid by
the Master Servicer;
(vi) to reimburse the Certificate Insurer for prior draws made from
the Policy and other amounts due under the Insurance Agreement;
(vii) to the extent of excess Interest Collections remaining after
payment of (i) through (vi), as payment to Certificateholders of an amount
as principal such that the Invested Amount exceeds the Certificate
Principal Balance by the Required Overcollateralization Amount (the amount
distributable pursuant to this clause being the "Accelerated Principal
Distribution Amount");
(viii) to the Spread Account in accordance with the Insurance
Agreement;
(ix) as payment to Certificateholders of any Carryover Amount for any
prior Distribution Dates that has not previously been paid;
(x) fees due to the Trustee (to the extent not paid by the Master
Servicer); and
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(xi) to the Seller.
Payment pursuant to clause (iii) will be a payment of principal to the
Certificateholders reducing both the Invested Amount and the Certificate
Principal Balance by the amount of such distributions. Payments pursuant to
clauses (iv) and (vii) will be payments of principal, reducing the Certificate
Principal Balance but not the Invested Amount.
Interest Collections allocated pursuant to clauses (iii), (iv), (vi) and
(vii) above shall be referred to herein as the "Certificateholders' Excess
Interest." Interest Collections in the amount described in clause (viii) above
shall be referred to herein as "Certificateholders' Remaining Excess Interest."
The Overcollateralization Amount on any date of determination is the amount, if
any, by which the Invested Amount exceeds the Certificate Principal Balance on
such day.
The "Required Overcollateralization Amount" is $4,201,427. "Liquidation
Loss Amount" means with respect to any (i) Charged Off Mortgage Loan, the Charge
Off Amount for the Collection Period in which all or a portion of the unpaid
principal balance of the Mortgage Loan was charged off by the Master Servicer,
excluding the Collection Period in which such Charged Off Mortgage Loan becomes
a Liquidated Mortgage Loan, and (ii) Liquidated Mortgage Loan, the unrecovered
Trust Balance thereof at the end of the Collection Period in which such
Liquidated Mortgage Loan became a Liquidated Mortgage Loan, after giving effect
to the Net Liquidation Proceeds in connection therewith. A "Liquidated Mortgage
Loan" means, as to any Distribution Date, any Mortgage Loan in respect of which
the Master Servicer has determined, in accordance with the servicing procedures
specified in the Agreement, as of the end of the preceding Collection Period
that all Liquidation Proceeds which it expects to recover with respect to the
disposition of the related Mortgaged Property have been recovered. Liquidation
Proceeds are the proceeds (excluding any amounts drawn on the Policy) received
in connection with the liquidation of any Mortgage Loan, whether through
trustee's sale, foreclosure sale or otherwise. The Certificateholders' Floating
Allocation Percentage of the Liquidation Loss Amount will be allocated to the
Certificateholders. Although payment of Liquidation Loss Amounts will be paid
from Certificateholders' Excess Interest, such payments are payments of
principal for purposes of calculating the Invested Amount and the Certificate
Principal Balance. No interest will accrue on any Liquidated Loss Amount not
paid to Certificateholders.
Each Mortgage Loan falls within one of fourteen monthly billing cycles of
the Master Servicer, ending on the 4th, 5th, 6th, 8th, 10th, 11th, 12th, 16th,
17th, 18th, 19th, 20th, 25th and 26th days, respectively, of each calendar month
(each a "Cycle Date"). The Collection Period for any Mortgage Loan for any
Distribution Date is the one month period ending on the Cycle Date for such
Mortgage Loan in the month preceding the month of the related Distribution Date.
Seller Collections. Prior to the commencement of the Rapid Amortization
Period, Principal Collections not distributed to the Certificateholders or
deposited to the Funding Account as a Scheduled Principal Distribution Amount
will become part of Seller Collections. Such Seller Collections may then, to the
extent described herein, be used to purchase the Additional Balances.
Required Overcollateralization Amount. The distribution of the aggregate
Accelerated Principal Distribution Amount, if any, to Certificateholders may
result in the Invested Amount being greater than the Certificate Principal
Balance, thereby creating overcollateralization. The amount, if any, of such
overcollateralization would be available to absorb any Liquidation Loss Amount
that is allocated to Certificateholders and is not covered by the
Certificateholders' Excess Interest. Payments of Accelerated Principal
Distribution Amounts are not covered by the Policy. To the extent that
overcollateralization, amounts (if any) on deposit in the Spread Account, and
available amounts under the Policy are insufficient to absorb such Liquidation
Loss Amounts, a Certificateholder may incur a loss in respect of its
Certificates.
Distributions of Principal Collections. During the Funding Period, the
Scheduled Principal Distribution Amount will be deposited into the Funding
Account. During the Funding Period, if there
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is deposited an aggregate amount in respect of Principal Collections in excess
of $100,834,256 (12% of the sum of the Cut-Off Balances of the Initial Mortgage
Loans) in the Funding Account, such excess will be distributed to the
Certificateholders as principal. In the event that not all of the Principal
Collections on deposit in the Funding Account have been used to acquire the
Subsequent Funding Mortgage Loans on the last Distribution Date of the Funding
Period, then such Principal Collections will be used to acquire any remaining
Additional Balances on such Distribution Date and any remaining Principal
Collections on deposit thereafter will be distributed to the Certificateholders
as payment of principal. Following the expiration of the Funding Period and
prior to the commencement of the Rapid Amortization Period, the amount of
Principal Collections payable to Certificateholders as of each Distribution Date
will equal, to the extent funds are available therefore, the Scheduled Principal
Distribution Amount for such Distribution Date. The Scheduled Principal
Distribution Amount shall equal the lesser of (i) the Maximum Principal
Distribution Amount and (ii) the Alternative Principal Distribution Amount. The
Alternative Principal Distribution Amount is the amount, but not less than zero,
of Principal Collections for the related Collection Period less the aggregate of
principal amounts drawn down under the Credit Line Agreements during such
Collection Period. Following the expiration of the Funding Period and prior to
the commencement of the Rapid Amortization Period, the Seller will be entitled
to receive the Principal Collections for such Distribution Dates that are not
distributed to the Certificateholders as described above, which will be used to
acquire Additional Balances on such Distribution Dates and any remaining amount
after acquiring Additional Balances will be distributed to the Seller as payment
of principal. With respect to any Distribution Date, the Maximum Principal
Distribution Amount will equal the Fixed Allocation Percentage of Principal
Collections for the related Collection Period. Distributions of principal based
upon the Fixed Allocation Percentage may result in distributions of principal to
Certificateholders in amounts that are greater relative to the declining balance
of the Pool Balance than would be the case if the Certificateholders' Floating
Allocation Percentage were used to determine the percentage of Principal
Collections distributed in respect of the Invested Amount. The aggregate
distributions of principal to the Certificateholders will not exceed the
Original Certificate Principal Balance.
Beginning with the first Distribution Date with respect to the Rapid
Amortization Period, the Maximum Principal Distribution Amount shall be payable
to Certificateholders.
Distribution of Interest and Principal on the Certificates. As described
above, Certificateholders will receive distributions of interest to the extent
funds are available therefore equal to the amount described in clause (ii) under
"Distributions of Interest Collections" above. In addition to the distribution
of Principal Collections, to the extent and at the times described above under
"Distributions of Principal Collections," Certificateholders will receive
distributions allocable to principal, to the extent Interest Collections are
available therefore, equal to the amount described in clauses (iii), (iv) and
(vii) under "Distributions of Interest Collections" above. Any such application
of Interest Collections will reduce the Certificate Principal Balance by a
corresponding amount.
Calculation of Certificate Rate; Limitation on Interest Payments on
Certificates. As of any Distribution Date, interest will accrue on the
Certificates from the preceding Distribution Date (or the Closing Date in the
case of the first Distribution Date) through the day preceding such Distribution
Date (each, an "Interest Period"). All calculations of interest on the
Certificates will be made on the basis of the actual number of days in the
Interest Period and a year assumed to consist of 360 days. (Section 1.02)
The Certificate Rate for each Distribution Date will be equal to LIBOR as
of the second LIBOR Business Day prior to the immediately preceding Distribution
Date (or as of May 21, 1996, in the case of the first Distribution Date) plus
0.20% per annum subject to a rate cap equal to the weighted average of the
maximum Loan Rates less the Servicing Fee, as may be amended from time to time.
Interest for any Distribution Date due but not paid on such Distribution Date
(other than any Carryover Amounts) will be due on the next succeeding
Distribution Date together with additional interest on such amount at a rate
equal to the sum of the Certificate Rate and 2% per annum.
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"LIBOR" means, with respect to each Distribution Date, the rate for
deposits in U.S. Dollars for a period of one month which appears on the Dow
Jones Telerate Service at Page 3750 as of 11:00 a.m., London time, on the day
that is two LIBOR Business Days prior to the preceding Distribution Date. A
"LIBOR Business Day" means any day other than a Saturday, Sunday or any other
day on which banks in the States of Illinois or New York or the City of London
may, or are required to, remain closed. If such rate does not appear on such
page (or such other page as may replace that page on that service, or if such
service is no longer offered, such other service for displaying LIBOR or
comparable rates as may be selected by the Trustee after consultation with the
Seller), the rate will be the Reference Bank Rate. The "Reference Bank Rate"
will be determined on the basis of the rates at which deposits in U.S. Dollars
are offered by the reference banks (which shall be three major banks that are
engaged in transactions in the London interbank market, selected by the Trustee
after consultation with the Seller) as of 11:00 a.m., London time, on the day
that is two LIBOR Business Days prior to the immediately preceding Distribution
Date to prime banks in the London interbank market for a period of one month in
amounts approximately equal to the principal amount of the Certificates then
outstanding. The Trustee will request the principal London office of each of the
reference banks to provide a quotation of its rate. If at least two such
quotations are provided, the rate will be the arithmetic mean of the quotations.
If on such date fewer than two quotations are provided as requested, the rate
will be the arithmetic mean of the rates quoted by one or more major banks in
New York City, selected by the Trustee after consultation with the Seller, as of
11:00 a.m., New York City time, on such date for loans in U.S. Dollars to
leading European banks for a period of one month in amounts approximately equal
to the principal amount of the Certificates then outstanding. If no such
quotations can be obtained, the rate will be LIBOR for the prior Distribution
Date.
If the Certificate Rate exceeds the weighted average of the Net Loan Rates,
then the Certificateholders will receive such difference (the "Carryover
Amount") only from Interest Collections allocable to Certificateholders as
described under "Description of the Certificates -- Distributions on the
Certificates -- Distributions of Interest Collections." The Carryover Amount
will not bear interest and will not be supported by the Spread Account or the
Policy.
The Paying Agent. The Paying Agent shall initially be the Trustee,
together with any successor thereto in such capacity (the "Paying Agent"). The
Paying Agent shall have the revocable power to withdraw funds from the
Collection Account for the purpose of making distributions to the
Certificateholders.
RAPID AMORTIZATION PERIOD
The Rapid Amortization Period will commence on the earlier of (x) the
October 20, 2004 Distribution Date and (y) the day, if any, upon which a Rapid
Amortization Event occurs. Upon the commencement of the Rapid Amortization
Period, the Principal Collections payable to the Certificateholders will be
equal to the Maximum Principal Distribution Amount.
RAPID AMORTIZATION EVENTS
A "Rapid Amortization Event" will be deemed to occur:
(a) upon failure on the part of the Seller (i) to make any payment or
deposit required under the Agreement within five Business Days after the
date such payment or deposit is required to be made; (ii) to deliver
possession of files and record assignments when required or (iii) to
observe or perform in any material respect any covenants or agreements
(other than the covenants or agreements set forth in (i) and (ii) above) of
the Seller set forth in the Agreement, which failure materially and
adversely affects the interests of the Certificateholders and continues
unremedied for a period of 60 days after written notice;
(b) if any representation or warranty made by the Seller in the
Agreement proves to have been incorrect in any material respect when made,
as a result of which the interests of the
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Certificateholders or the Certificate Insurer are materially and adversely
affected, and which continues to be incorrect in any material respect and
continues to materially and adversely affect the interests of the
Certificateholders or the Certificate Insurer for a period of 60 days after
written notice; provided, however, that a Rapid Amortization Event shall
not be deemed to occur if the Seller has repurchased the related Mortgage
Loan or all Mortgage Loans, if applicable, during such period (or within an
additional 60 days with the consent of the Trustee and the Certificate
Insurer) in accordance with the provisions of the Agreement;
(c) upon the occurrence of certain events of bankruptcy, insolvency or
receivership relating to the Seller or any Subservicer;
(d) if the Trust becomes subject to regulation by the Commission as an
investment company within the meaning of the Investment Company Act of
1940, as amended;
(e) if a Servicing Termination Event relating to the Master Servicer
occurs under the Agreement; or
(f) if the aggregate principal of all draws under the Policy exceed 1%
of the sum of (i) the Cut-Off Date Pool Balance and (ii) the amount by
which the Pool Balance as of any date that Subsequent Funding Mortgage
Loans are transferred to the Trust exceeds the Cut-Off Date Pool Balance.
In the case of any event described in (a), (b) or (e), a Rapid Amortization
Event will be deemed to have occurred only if, after any applicable grace period
described in such clauses, either the Trustee, the Certificate Insurer (so long
as no default by the Certificate Insurer has occurred and is continuing) or,
with the consent of the Certificate Insurer (so long as no default by the
Certificate Insurer has occurred and is continuing) Certificateholders holding
Certificates evidencing not less than 51% in outstanding principal amount, by
written notice to the Seller and the Master Servicer (and to the Trustee, if
given by the Certificate Insurer or the Certificateholders) declare that a Rapid
Amortization Event has occurred as of the date of such notice. In the case of
any event described in clauses (c), (d) or (f), a Rapid Amortization Event will
be deemed to have occurred without any notice or other action on the part of the
Trustee, the Certificateholders or the Certificate Insurer immediately upon the
occurrence of such event.
Notwithstanding the foregoing, if a conservator, receiver or
trustee-in-bankruptcy is appointed for the Seller and no Rapid Amortization
Event exists other than such conservatorship, receivership or insolvency of the
Seller, the conservator, receiver or trustee-in-bankruptcy may have the power to
prevent the commencement of the Rapid Amortization Period.
THE POLICY
On or before the Closing Date, the Policy will be issued by the Certificate
Insurer pursuant to the provisions of the Agreement and the Insurance and
Reimbursement Agreement (the "Insurance Agreement") to be dated as of May 1,
1996, among the Seller, HFC as Master Servicer, the Certificate Insurer and the
Trustee. The Policy will unconditionally and irrevocably guarantee payment of
the Deficiency Amount up to $475,000,000 in principal payments plus, until such
time as the Certificate Insurer has made payments in respect of principal under
the Policy in an amount equal to $475,000,000, accrued and unpaid interest on
the Certificates.
In accordance with the Insurance Agreement, the Trust will be required to
establish and maintain an account (the "Spread Account") for the benefit of the
Certificate Insurer and the Certificateholders, any amounts on deposit in which
will be available to the Trustee to be transferred to the Collection Account to
be used to pay any shortfall in interest and principal to the Certificates as
provided in the Agreement prior to any draw on the Policy. The Insurance
Agreement will require that the Certificateholders' Remaining Excess Interest be
deposited into the Spread Account until funds in the Spread Account are equal to
an amount specified by such agreement. Such amount can be reduced or eliminated
without the consent of the Certificateholders. Any amounts on deposit in
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the Spread Account upon termination of the Trust and after reimbursement of
amounts drawn under the Policy to the Certificate Insurer plus interest will be
distributed to the Seller as provided in the Insurance Agreement.
In the absence of payments from the Spread Account or draws under the
Policy, Certificateholders will bear directly the credit and other risks
associated with their undivided interest in the Trust.
In the event that the Certificate Insurer's claims paying ratings have been
lowered by any of the Rating Agencies, the Master Servicer may, but is not
obligated to, upon payment of all amounts due the Certificate Insurer, replace
the Policy with a financial guaranty insurance policy or policies issued by
another insurer or arrange for any other form of credit enhancement, provided
that the ratings on the claims paying ability of such replacement insurer are
higher than those of the certificate insurer sought to be replaced (after giving
effect to such downgrade). In the event of such downgrading, the Master Servicer
also may, but is not obligated to, restructure the credit enhancement provided
to the Certificates, including by eliminating the Policy without replacement;
provided that the Rating Agencies consent to such restructuring and the Rating
Agencies confirm that the ratings of the Certificates will be increased from
their current levels (after giving effect to such downgrading) as a result of
such restructuring.
REPORTS TO CERTIFICATEHOLDERS
Concurrently with each distribution to the Certificateholders, the Master
Servicer will forward to the Trustee for mailing to each Certificateholder a
statement setting forth certain information, including the following:
(i) the Certificateholders' Floating Allocation Percentage for the
preceding Collection Period;
(ii) the amount being distributed to Certificateholders;
(iii) the amount allocable to interest included in such distribution
and the Certificate Rate;
(iv) the amount, if any, allocable to overdue accrued interest (and
the amount of interest thereon) and the Carryover Amount, if any, included
in such distribution;
(v) the amount, if any, of remaining overdue accrued interest and
remaining Carryover Amount, if any, after giving effect to such
distribution;
(vi) the amount, if any, allocable to principal in reduction of the
principal amount included in such distribution;
(vii) the amount, if any, of the reimbursement of previous Liquidation
Loss Amounts included in such distribution which amounts are allocable to
principal in reduction of the principal amount;
(viii) the amount, if any, of the aggregate of unreimbursed
Liquidation Loss Amounts after giving effect to such distribution;
(ix) the Servicing Fee for such Distribution Date;
(x) the Invested Amount, the Certificate Principal Balance and the
Pool Factor, each after giving effect to such distribution;
(xi) the amount of Principal Collections on deposit in the Funding
Account;
(xii) the Pool Balance as of the end of the preceding Collection
Period;
(xiii) the number and aggregate Trust Balances of Mortgage Loans as to
which the minimum monthly payment is delinquent for 30-59 days, 60-89 days
and 90 or more days, respectively, as of the end of the preceding
Collection Period;
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(xiv) the aggregate Liquidation Loss Amount for all Mortgage Loans
that became Liquidated Mortgage Loans in the preceding Collection Period;
(xv) the Certificate Rate applicable during the Interest Period
commencing on such Distribution Date;
(xvi) the book value (within the meaning of 12 C.F.R. sec.571.13 or
comparable provision) of any Mortgaged Property acquired by the Trust
through foreclosure or grant of deed in lieu of foreclosure;
(xvii) the amount of any draws on the Policy; and
(xviii) earnings on all accounts.
In the case of information furnished pursuant to clauses (ii), (iii), (iv)
and (vi) above, the amounts shall be expressed as a dollar amount per
Certificate with a $1,000 denomination.
Within 60 days after the end of each calendar year, the Master Servicer
will be required to forward to the Trustee a statement containing the
information set forth in clauses (iii) and (vi) above aggregated for such
calendar year. (Section 5.03)
COLLECTION AND OTHER SERVICING PROCEDURES
The Master Servicer will make reasonable efforts to collect all payments
called for under the Mortgage Loans and will, consistent with the Agreement,
follow such collection procedures as it follows from time to time with respect
to the home equity loans in its servicing portfolio which are comparable to the
Mortgage Loans. Consistent with the above, the Master Servicer may in its
discretion waive any late payment charge or any assumption or other fee or
charge that may be collected in the ordinary course of servicing the Mortgage
Loans. (Section 3.02)
The Master Servicer may arrange with a borrower a schedule for the payment
of interest due and unpaid for a period, including treating loans as current if
the borrower has made one standard payment and met such other conditions, if
any, required by the Master Servicer from time to time, provided that such
change will not have a material adverse effect on the interests of the
Certificateholders, the Certificate Insurer or the Trust. In accordance with the
terms of the Agreement, the Master Servicer may consent under certain
circumstances to the placing of a subsequent senior lien in respect of a
Mortgage Loan.
In any case in which a Mortgaged Property is being conveyed by the
borrower, the Master Servicer generally shall not be obligated, to the extent it
has knowledge of such conveyance, to exercise its rights to accelerate the
maturity of such Mortgage Loan under any due-on-sale clause applicable thereto,
and shall not exercise such rights if such exercise is not permitted by
applicable law. If the Master Servicer elects not to enforce such due-on-sale
clause or is prevented from enforcing such due-on-sale clause under applicable
law, the Master Servicer may 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 applicable
Credit Line Agreement. To the extent permitted by applicable law, such
assumption will not release the original borrower from its obligation under the
Mortgage Loan. Any fee collected by the Master Servicer for entering into an
assumption or substitution of liability agreement will be retained by the Master
Servicer as additional servicing compensation. See "Certain Legal Aspects of
Mortgage Loans -- 'Due-on-Sale' Clauses" herein. In connection with any such
assumption, the Master Servicer may not change the terms of the related Credit
Line Agreement if such changes would not be permitted in respect of the original
Credit Line Agreement. (Section 3.05)
HAZARD INSURANCE
The Agreement requires the Master Servicer to insure each Mortgaged
Property acquired upon foreclosure of a Mortgage Loan, or by grant of deed in
lieu of such foreclosure, in an amount equal
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to the lesser of (a) the maximum insurable value of such Mortgaged Property or
(b) the unpaid principal balance of the Mortgage Loan plus the outstanding
balance of any mortgage loan senior to such Mortgage Loan at the time of
foreclosure or grant of deed in lieu of foreclosure, plus accrued interest
thereon. The Agreement provides that the Master Servicer may satisfy its
obligation by self insuring Mortgaged Properties for which the unpaid principal
balance of the related Mortgage Loans plus the outstanding balance of any
mortgage loan senior to such Mortgage Loan at the time title was acquired, plus
accrued interest (the "Combined Exposure"), was less than $500,000 (or such
other amount as the Master Servicer may in good faith determine from time to
time) and by causing hazard policies to be maintained with respect to Mortgaged
Properties for which the Combined Exposure equals or exceeds the self insurance
threshold established from time to time by the Master Servicer by maintaining a
blanket policy consistent with prudent industry standards insuring against
hazard losses on the Mortgaged Properties. If such blanket policy contains a
deductible clause, the Master Servicer will be obligated to deposit in the
Collection Account the sums which would have been deposited therein but for such
clause. (Section 3.04) The Master Servicer will initially satisfy these
requirements by maintaining a blanket policy. As set forth above, all amounts
collected by the Master Servicer (net of any reimbursements to the Master
Servicer) under any hazard policy (except for amounts to be applied to the
restoration or repair of the Mortgaged Property or released to the borrower in
accordance with the Master Servicer's normal servicing procedures) will
ultimately be deposited in the Collection Account.
In general, the standard form of fire and extended coverage policy covers
physical damage to or destruction of the improvements on the property by fire,
lightning, explosion, smoke, windstorm and hail, and 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 and therefore will not contain identical terms and
conditions, the basic terms thereof are dictated by state laws, and most of such
policies typically do not cover any physical damage resulting from the
following: war, revolution, governmental actions, floods and other water-related
causes, earth movement (including earthquakes, landslides and mudflows), nuclear
reactions, wet or dry rot, vermin, rodents, insects or domestic animals, theft
and, in certain cases, vandalism. The foregoing list is merely indicative of
certain kinds of uninsured risks and is not intended to be all-inclusive or an
exact description of the insurance policies relating to the Mortgaged
Properties. In addition, some states preclude lenders from requiring borrowers
to obtain insurance coverage in excess of the replacement cost of the underlying
mortgaged property on the borrower's homeowners' insurance policy. When a
Mortgaged Property is located in a federally designated flood area at the time
of origination of the related Mortgage Loan, the Agreement requires the Master
Servicer to cause to be maintained for each such Mortgage Loan serviced, flood
insurance (to the extent available) in an amount equal in general to the lesser
of the amount required to compensate for any loss or damage on a replacement
cost basis or the maximum insurance available under the federal flood insurance
program.
The hazard insurance policies covering the Mortgaged Properties typically
contain a co-insurance clause which 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.
Since residential properties have historically appreciated in value over
time, if the amount of hazard insurance maintained on the improvements securing
the Mortgage Loans 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.
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Under the terms of the Mortgage Loans, the borrowers are generally required
to present claims to insurers under hazard insurance policies maintained on the
Mortgaged Properties. The Master Servicer, on behalf of the Trustee and
Certificateholders, is obligated to present claims under any blanket insurance
policy insuring against hazard losses on the Mortgaged Properties. However, the
ability of the Master Servicer to present such claims is dependent upon the
extent to which information in this regard is furnished to the Master Servicer
by the borrowers.
REALIZATION UPON DEFAULTED MORTGAGE LOANS
The Master Servicer will foreclose upon or otherwise comparably convert to
ownership Mortgaged Properties securing such of the Mortgage Loans as come into
default when, in accordance with applicable servicing procedures under the
Agreement, no satisfactory arrangements can be made for the collection of
delinquent payments; provided that if the Master Servicer has actual knowledge
or reasonably believes that any Mortgaged Property is contaminated by hazardous
or toxic wastes or substances, then the Master 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 Master Servicer
is not commercially reasonable. In connection with such foreclosure or other
conversion, the Master Servicer will follow such practices as it deems necessary
or advisable and as are in keeping with its general mortgage servicing
activities, provided the Master Servicer will not be required to expend its own
funds in connection with foreclosure or other conversion, correction of default
on a related senior mortgage loan or restoration of any Mortgaged Property
unless, in its sole judgment, such foreclosure, correction or restoration will
increase Net Liquidation Proceeds. (Section 3.06) The Master Servicer will be
reimbursed out of liquidation proceeds for advances of its own funds as
liquidation expenses before any Net Liquidation Proceeds are distributed to
Certificateholders or the Seller. Net Liquidation Proceeds with respect to a
Liquidated Mortgage Loan is the amount received upon liquidation of such
Mortgage Loan reduced by related expenses, which may include the amount advanced
in respect of a senior mortgage, but not including the portion, if any, of such
amount that exceeds the unpaid Trust Balance of the Mortgage Loan plus accrued
and unpaid interest thereon plus the related Charge Off Amounts.
SERVICING COMPENSATION AND PAYMENT OF EXPENSES
The servicing compensation (the "Servicing Fee") to be paid to the Master
Servicer will be paid to it from Interest Collections allocable to the
Certificateholders at a rate per annum equal to 1.00% of the Invested Amount
(less any amount in the Funding Account exclusive of any investment earnings
thereon) on the first day succeeding the preceding Distribution Date. The
Servicing Fee will be paid as described under "Description of the Certificates
- -- Distributions on the Certificates -- Distributions of Interest Collections"
above. All assumption fees, late payment charges, prepayment penalties and other
fees and charges, to the extent collected from borrowers, will be retained by
the Master Servicer as additional servicing compensation. In addition, the
Master Servicer will retain any benefits from the investment of funds in the
Collection Account.
The Master Servicer will pay certain ongoing expenses associated with the
Trust and incurred by it in connection with its responsibilities under the
Agreement, including, without limitation, payment of the fees and disbursements
of the Trustee, any custodian appointed by the Trustee, the Certificate
Registrar and any Paying Agent. In addition, the Master Servicer will be
entitled to reimbursement for certain expenses incurred by it in connection with
defaulted Mortgage Loans and in connection with the restoration of Mortgaged
Properties, such right of reimbursement being prior to the rights of
Certificateholders to receive any related Net Liquidation Proceeds.
EVIDENCE AS TO COMPLIANCE
The Agreement provides for delivery on or before April 30 in each year,
beginning April 30, 1997, to the Trustee, the Certificate Insurer and the Rating
Agencies of an annual statement signed
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by an officer of the Master Servicer to the effect that the Master Servicer has
fulfilled its material obligations under the Agreement throughout the preceding
calendar year, except as specified in such statement. (Section 3.09)
On or before April 30 of each year, beginning with April 30, 1997, the
Master Servicer will furnish a report prepared by a firm of independent public
accountants to the Trustee, the Certificate Insurer and the Rating Agencies to
the effect that such accountants have examined certain documents and the records
relating to servicing of mortgage loans under agreements (including the
Agreement) substantially similar to the Agreement and such examination, which
has been conducted substantially in compliance with the audit guide for audits
of non-supervised mortgagees approved by the Department of Housing and Urban
Development, has disclosed no items of non-compliance with the provisions of the
Agreement which, in the opinion of the firm, are material, except for such items
of non-compliance as shall be referred to in the report. (Section 3.10)
CERTAIN MATTERS REGARDING THE MASTER SERVICER AND THE SELLER
The Agreement provides that the Master Servicer may not resign from its
obligations and duties thereunder, except in connection with a permitted
transfer of servicing, unless (i) such duties and obligations are no longer
permissible under applicable law or are in material conflict by reason of
applicable law with any other activities of a type and nature presently carried
on by it or its affiliates or (ii) upon the satisfaction of the following
conditions: (a) the Master Servicer has proposed a successor servicer to the
Trustee in writing and such proposed successor servicer is reasonably acceptable
to the Trustee; (b) the Rating Agencies have confirmed to the Trustee that the
appointment of such proposed successor servicer as the Master Servicer will not
result in the reduction or withdrawal of the then-current rating of the
Certificates; and (c) the proposed successor servicer has agreed in writing to
assume the obligations of the Master Servicer under the Agreement. No such
resignation will become effective until the Trustee or a successor servicer has
assumed the Master Servicer's obligations and duties under the Agreement.
(Section 7.04)
The Master Servicer may perform any of its duties and obligations under the
Agreement through one or more subservicers or delegates, which may be affiliates
of the Master Servicer. Notwithstanding any such arrangement, the Master
Servicer will remain liable and obligated to the Trustee, the Certificate
Insurer, and the Certificateholders for the Master Servicer's duties and
obligations under the Agreement, without any diminution of such duties and
obligations and as if the Master Servicer itself were performing such duties and
obligations. (Section 7.05)
The Agreement will also provide that neither the Master Servicer, the
Seller, nor any director, officer, employee or agent of the Master Servicer or
the Seller will be under any liability to the Trust or the Certificateholders
for any action taken or for refraining from the taking of any action in good
faith pursuant to the Agreement, or for errors in judgment; provided, however,
that neither the Master Servicer, the Seller nor any such person will be
protected against any liability which would otherwise be imposed by reason of
willful misfeasance, bad faith or gross negligence in the performance of duties
or by reason of reckless disregard of obligations and duties thereunder. The
Agreement will further provide that the Master Servicer, the Seller and any
director, officer, employee or agent of the Master Servicer or the Seller is
entitled to indemnification by the Trust and will be held harmless 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 Mortgage Loan or Mortgage Loans (except any such loss,
liability or expense otherwise reimbursable pursuant to the Agreement) and any
loss, liability or expense incurred by reason of willful misfeasance, bad faith
or gross negligence in the performance of duties thereunder or by reason of
reckless disregard of obligations and duties thereunder. In addition, the
Agreement will provide that neither the Master Servicer nor the Seller will be
under any obligation to appear in, prosecute or defend any legal action which is
not incidental to its respective duties under the Agreement and which in its
opinion may involve it in any expense or liability. The Master Servicer or the
Seller may, however, in its or their discretion undertake any such action which
it or they may
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deem necessary or desirable with respect to the Agreement and the rights and
duties of the parties thereto and the interests of the Certificateholders
thereunder. In such event, the legal expenses and costs of such action and any
liability resulting therefrom and any claims by the Master Servicer or the
Seller for indemnification will be expenses, costs and liabilities of the Trust
and the Master Servicer or the Seller, as the case may be, will be entitled to
be reimbursed therefor and indemnified pursuant to the terms of the Agreement
out of funds otherwise distributable to Certificateholders. The Master
Servicer's and the Seller's right to such indemnity or reimbursement shall
survive any resignation or termination of the Master 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). (Section 7.03)
Any corporation into which the Master Servicer or the Seller may be merged
or consolidated, or any corporation resulting from any merger, conversion or
consolidation to which the Master Servicer or the Seller shall be a party, or
any corporation succeeding to the business of the Master Servicer or the Seller
shall be the successor of the Master Servicer or the Seller hereunder, without
the execution or filing of any paper or any further act on the part of any of
the parties hereto, anything in the Agreement to the contrary notwithstanding.
(Section 7.02)
SERVICING TERMINATION EVENTS
"Servicing Termination Events" will consist of: (i) any failure by the
Master Servicer to deposit in the Collection Account or Funding Account, as
applicable, 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 Master Servicer by the Trustee or the Certificate
Insurer, or to the Master Servicer and the Trustee by Certificateholders holding
Certificates evidencing not less than 51% of the then-outstanding principal
amount; (ii) any failure by the Master Servicer duly to observe or perform in
any material respect any other of its covenants or agreements in the Agreement
which 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 Master Servicer by the Trustee or the
Certificate Insurer, or to the Master Servicer and the Trustee by
Certificateholders evidencing not less than 51% of the then-outstanding
principal amount; or (iii) the occurrence of certain events of bankruptcy,
insolvency or receivership relating to the Master Servicer as set forth in the
Agreement which, in the case of the occurrence of such events without the
consent of the Master Servicer, continue unremedied for 60 days; or (iv) a
determination by the Certificate Insurer that the Master Servicer has failed to
service in accordance with historical or industry standards or in a manner which
is consistent for all mortgage loans serviced by the Master Servicer.
Notwithstanding the foregoing, a delay in or failure of performance
referred to under clause (i) above for a period of five Business Days or
referred to under clause (ii) above, if applicable, for a period of 60 days,
shall not constitute a Servicing Termination Event if such delay or failure
could not be prevented by the exercise of reasonable diligence by the Master
Servicer and such delay or failure was caused by an act of God or other similar
occurrence. Upon the occurrence of any such event the Master Servicer shall not
be relieved from using its best efforts to perform its obligations in a timely
manner in accordance with the terms of the Agreement and the Master Servicer
shall provide the Trustee, the Seller, the Certificate Insurer and the
Certificateholders prompt notice of such failure or delay by it, together with a
description of its efforts to so perform its obligations.
RIGHTS UPON A SERVICING TERMINATION EVENT
So long as a Servicing Termination Event remains unremedied, either (a) the
Trustee or (b) (so long as no default by the Certificate Insurer has occurred
and is continuing) (i) the Certificate Insurer or (ii) with the consent of the
Certificate Insurer, the holders of Certificates evidencing not less than 51% of
the then-outstanding principal amount may terminate all of the rights and
obligations of the Master Servicer under the Agreement and in and to the
Mortgage
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Loans, whereupon the Trustee will succeed to all the responsibilities, duties
and liabilities of the Master Servicer under such Agreement and will be entitled
to similar compensation arrangements. In the event that the Trustee would be
obligated to succeed the Master Servicer but is unwilling or unable so to act,
it may appoint, or petition a court of competent jurisdiction for the
appointment of, a housing and home finance institution or other mortgage loan or
home equity loan servicer with all licenses and permits required to perform its
obligations under the Agreement and having a net worth of at least $50,000,000
and reasonably acceptable to the Certificate Insurer and the Rating Agencies to
act as successor to the Master Servicer under the Agreement. Pending such
appointment, the Trustee will be obligated to act in such capacity unless
prohibited by law. Such successor will be entitled to receive the same
compensation that the Master Servicer would otherwise have received (or such
lesser compensation as the Trustee and such successor may agree). (Sections 8.01
and 8.02) A receiver or conservator for the Master Servicer may be empowered to
prevent the termination and replacement of the Master Servicer where the only
Servicing Termination Event that has occurred is an Insolvency Event (as defined
in the Agreement).
AMENDMENT
The Agreement may be amended from time to time by the Master Servicer, the
Seller, the Trustee and with the consent of the Certificate Insurer and the
Servicer Credit Facility Issuer, if any, (which consent shall not be
unreasonably withheld) but without the consent of the Certificateholders to (i)
cure any ambiguity, to correct or supplement any provisions therein which may be
defective or inconsistent with any other provisions of the Agreement, (ii) add
to the duties of the Seller or the Master Servicer, (iii) add or amend any
provisions of the Agreement as required by the Rating Agencies in order to
maintain or improve any rating of the Certificates (it being understood that,
after obtaining the ratings in effect on the Closing Date, neither the Seller,
the Trustee nor the Master Servicer is obligated to obtain, maintain or improve
any such rating), (iv) add any other provisions with respect to matters or
questions arising under the Agreement or the Policy, as the case may be,
including provisions relating to the issuance of definitive Certificates to
Certificateholders provided that book-entry registration of the Certificates is
no longer permitted, which provisions shall not be inconsistent with the
provisions of the Agreement or the Policy, as the case may be; or (v) modify or
eliminate certain provisions of the Agreement relative to the Policy or the
Spread Account.
The Agreement may also be amended from time to time by the Master Servicer,
the Seller, and the Trustee, and the Master Servicer, the Certificate Insurer
and the Servicer Credit Facility Issuer, if any, may from time to time consent
to the amendment of the Policy or the Servicer Credit Facility, as the case may
be, with the consent of Certificateholders evidencing not less than 51% of the
then-outstanding aggregate principal amount of Certificates and in the case of
an amendment to the Agreement, with the consent of the Certificate Insurer and
the Servicer Credit Facility Issuer, if any, for the purpose of adding any
provisions to or changing in any manner or eliminating any of the provisions of
the Agreement or of modifying in any manner the rights of the
Certificateholders, provided that no such amendment will (i) reduce in any
manner the amount of, or delay the timing of, collections of payments on
Mortgage Loans or distributions which 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 the holders of all Certificates then outstanding or (iii) materially
adversely affect the interests of the Certificate Insurer or any Servicer Credit
Facility Issuer without the consent of the Certificate Insurer or any Servicer
Credit Facility Issuer so affected. (Section 12.01)
TERMINATION; RETIREMENT OF THE CERTIFICATES
Upon payment of any amounts due the Certificate Insurer, the Trust will
terminate on the Distribution Date following the earlier of (i) the date
immediately following the date on which the Certificate Principal Balance is
reduced to zero and after which there are no unreimbursed
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Liquidation Loss Amounts allocable to the Certificateholders, (ii) the final
payment or other liquidation of the last Mortgage Loan in the Trust and (iii)
the Distribution Date on July 20, 2017. The remaining Mortgage Loans will be
subject to optional retransfer to the Seller for an amount equal to the
Retransfer Price on any Distribution Date after the Certificate Principal
Balance is reduced to an amount less than or equal to 10% of the Original
Certificate Principal Balance and all amounts due and owing to the Certificate
Insurer and unreimbursed draws on the Policy, together with interest thereon, as
provided under the Insurance Agreement have been paid. The Retransfer Price will
be equal to the sum of (a) the outstanding Certificate Principal Balance, (b)
accrued and unpaid interest thereon at the applicable Certificate Rate through
the day preceding the final Distribution Date, (c) any unreimbursed draws upon
the Policy and other amounts due under the Insurance Agreement. 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. (Section 10.01). The right of the Seller
to accept any transfer referred to above is conditioned upon the Certificate
Principal Balance being less than or equal to 10% of the Original Certificate
Principal Balance. The Retransfer Price will be distributed to the
Certificateholders in lieu of the amount that would otherwise be distributed if
such optional retransfer were not exercised, which will be applied as provided
in the Agreement.
THE TRUSTEE
The commercial bank or trust company serving as Trustee may have normal
banking relationships with the Seller and/or its affiliates, including the
Master Servicer. The Trustee in its individual or any other capacity may become
an owner of the Certificates with the same rights as it would have if it were
not the Trustee.
The Trustee may resign at any time, in which event the Seller will be
obligated to appoint a successor Trustee, as approved by the Certificate
Insurer. The Seller or the Certificate Insurer may also remove the Trustee if
the Trustee ceases to be eligible to continue as such under the Agreement or if
the Trustee becomes insolvent. Upon becoming aware of such circumstances, the
Seller will be obligated to appoint a successor Trustee, as approved by the
Certificate Insurer and the Servicer Credit Facility Issuer, if any. 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. (Section 9.07)
REGISTRATION OF CERTIFICATES
Holders of Certificates may hold their Certificates through DTC (in the
United States) or CEDEL or Euroclear (in Europe) if they are participants of
such systems, or indirectly through organizations which are participants in such
systems.
The Certificates will initially be registered in the name of CEDE & Co.,
the nominee of DTC. CEDEL and Euroclear will hold omnibus positions on behalf of
their participants through customers' securities accounts in CEDEL's and
Euroclear's names on the books of their respective depositaries which in turn
will hold such positions in customers' securities accounts in the depositaries'
names on the books of DTC. Citibank will act as depositary for CEDEL and
Chemical will act as depositary for Euroclear (in such capacities, individually
the "Depositary" and collectively the "Depositaries").
Transfers between Participants will occur in accordance with DTC rules.
Transfers between CEDEL Participants and Euroclear Participants will occur in
accordance with their respective rules and operating procedures.
Cross-market transfers between persons holding directly or indirectly
through DTC, on the one hand, and directly or indirectly through CEDEL
Participants or Euroclear Participants, on the other, will be effected in DTC in
accordance with DTC rules on behalf of the relevant European
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international clearing system by its Depositary; however, such cross-market
transactions will require delivery of instructions to the relevant European
international clearing system by the counterparty in such system in accordance
with its rules and procedures and within its established deadlines (European
time). The relevant European international clearing system will, if the
transaction meets its settlement requirements, deliver instructions to its
Depositary to take action to effect final settlement on its behalf by delivering
or receiving securities in DTC, and making or receiving payment in accordance
with normal procedures for same-day funds settlement applicable to DTC. CEDEL
Participants and Euroclear Participants may not deliver instructions directly to
the Depositaries.
Because of time-zone differences, credits of securities received in CEDEL
or Euroclear as a result of a transaction with a Participant will be made during
subsequent securities settlement processing and dated the business day following
the DTC settlement date. Such credits or any transactions in such securities
settled during such processing will be reported to the relevant Euroclear or
CEDEL Participants on such business day. Cash received in CEDEL or Euroclear as
a result of sales of securities by or through a CEDEL Participant or Euroclear
Participant to a Participant will be received with value on the DTC settlement
date but will be available in the relevant CEDEL or Euroclear cash account only
as of the business day following settlement in DTC. For information with respect
to tax documentation procedures relating to the Certificates, see "Certain
Income Tax Consequences -- Foreign Investors" and "-- Information Reporting and
Backup Withholding" and "Global Clearance, Settlement and Tax Documentation
Procedures" in Annex I hereto.
Certificateholders who are not Participants but desire to purchase, sell or
otherwise transfer ownership of Certificates may do so only through Participants
or indirect participants (unless and until Replacement Certificates, as defined
below, are issued). In addition, Certificateholders will receive all
distributions of principal of, and interest on, the Certificates from the
Trustee through DTC and Participants. Certificateholders will not receive or be
entitled to receive certificates representing their respective interests in the
Certificates, except under the limited circumstances described below.
Unless and until Replacement Certificates are issued, it is anticipated
that the only "Certificateholder" of the Certificates will be CEDE & Co., as
nominee of DTC. Certificateholders will not be Certificateholders as that term
is used in the Agreement. "Certificate Owners" are only permitted to exercise
the rights of Certificateholders indirectly through Participants and DTC.
While the Certificates are outstanding (except under the circumstances
described below), under the rules, regulations and procedures creating and
affecting DTC and its operations (the "Rules"), DTC is required to make
book-entry transfers among Participants on whose behalf it acts with respect to
the Certificates and is required to receive and transmit distributions of
principal of, and interest on, the Certificates. Participants and indirect
participants with whom Certificate Owners have accounts with respect to
Certificates are similarly required to make book-entry transfers and receive and
transmit such distributions on behalf of their respective Certificate Owners.
Accordingly, although Certificate Owners will not possess certificates, the
Rules provide a mechanism by which Certificate Owners will receive distributions
and will be able to transfer their interests.
Unless and until Replacement Certificates are issued, Certificate Owners
who are not Participants may transfer ownership of Certificates only through
Participants and indirect participants by instructing such Participants and
indirect participants to transfer Certificates, by book-entry transfer, through
DTC for the account of the purchasers of such Certificates, which account is
maintained with their respective Participants. Under the Rules and in accordance
with DTC's normal procedures, transfers of ownership of Certificates will be
executed through DTC and the accounts of the respective Participants at DTC will
be debited and credited. Similarly, the Participants and indirect participants
will make debits or credits, as the case may be, on their records on behalf of
the selling and purchasing Certificate Owners.
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DTC is a limited-purpose trust company organized under the laws of the
State of New York, a member of the Federal Reserve System, a "clearing
corporation" within the meaning of the New York Uniform Commercial Code, and a
"clearing agency" registered pursuant to the provisions of Section 17A of the
1934 Act. DTC accepts securities for deposit from its participating
organizations ("Participants") and facilitates the clearance and settlement of
securities transactions between Participants in such securities through
electronic book-entry changes in accounts of Participants, thereby eliminating
the need for physical movement of certificates. Participants include securities
brokers and dealers, banks and trust companies and clearing corporations and may
include certain other organizations. Indirect access to the DTC system is also
available to others such as banks, brokers, dealers and trust companies that
clear through or maintain a custodial relationship with a Participant, either
directly or indirectly ("indirect participants").
CEDEL is incorporated under the laws of Luxembourg as a professional
depository. CEDEL holds securities for its participating organizations ("CEDEL
Participants") and facilitates the clearance and settlement of securities
transactions between CEDEL Participants through electronic book-entry changes in
accounts of CEDEL Participants, thereby eliminating the need for physical
movement of certificates. Transactions may be settled in CEDEL in any of 28
currencies, including United States dollars. CEDEL provides to its CEDEL
Participants, among other things, services for safekeeping, administration,
clearance and settlement of internationally traded securities and securities
lending and borrowing. CEDEL interfaces with domestic markets in several
countries. As a professional depository, CEDEL is subject to regulation by the
Luxembourg Monetary Institute. CEDEL Participants are recognized financial
institutions around the world, including underwriters, securities brokers and
dealers, banks, trust companies, clearing corporations and certain other
organizations. Indirect access to CEDEL is also available to others, such as
banks, brokers, dealers and trust companies that clear through or maintain a
custodial relationship with a CEDEL Participant, either directly or indirectly.
Euroclear was created in 1968 to hold securities for participants of
Euroclear ("Euroclear Participants") and to clear and settle transactions
between Euroclear Participants through simultaneous electronic book-entry
delivery against payment, thereby eliminating the need for physical movement of
certificates and any risk from lack of simultaneous transfers of securities and
cash. Transactions may now be settled in any of 32 currencies, including United
States dollars. Euroclear includes various other services, including securities
lending and borrowing and interfaces with domestic markets in several countries
generally similar to the arrangements for cross-market transfers with DTC
described above. Euroclear is operated by the Brussels, Belgium office of Morgan
Guaranty Trust Company of New York (the "Euroclear Operator"), under contract
with Euroclear Clearance Systems S.C., a Belgian cooperative corporation (the
"Cooperative"). All operations are conducted by the Euroclear Operator, and all
Euroclear securities clearance accounts and Euroclear cash accounts are accounts
with the Euroclear Operator, not the Cooperative. The Cooperative establishes
policy for Euroclear on behalf of Euroclear Participants. Euroclear Participants
include banks (including central banks), securities brokers and dealers and
other professional financial intermediaries. Indirect access to Euroclear is
also available to other firms that clear through or maintain a custodial
relationship with a Euroclear Participant, either directly or indirectly.
The Euroclear Operator is the Belgian branch of a New York banking
corporation which is a member bank of the Federal Reserve System. As such, it is
regulated and examined by the Board of Governors of the Federal Reserve System
and the New York State Banking Department, as well as the Belgian Banking
Commission.
Securities clearance accounts and cash accounts with the Euroclear Operator
are governed by the Terms and Conditions Governing Use of Euroclear and the
related Operating Procedures of the Euroclear System and applicable Belgian law
(collectively, the "Terms and Conditions"). The Terms and Conditions govern
transfers of securities and cash within Euroclear, withdrawals of securities and
cash from Euroclear, and receipts of payments with respect to securities in
Euroclear. All securities in Euroclear are held on a fungible basis without
attribution of specific certificates to
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specific securities clearance accounts. The Euroclear Operator acts under the
Terms and Conditions only on behalf of Euroclear Participants, and has no record
of or relationship with persons holding through Euroclear Participants.
Distributions with respect to Certificates held through CEDEL or Euroclear
will be credited to the cash accounts of CEDEL Participants or Euroclear
Participants in accordance with the relevant system's rules and procedures, to
the extent received by its Depositary. Such distributions will be subject to tax
reporting in accordance with relevant United States tax laws and regulations.
See "Certain Income Tax Consequences". CEDEL or the Euroclear Operator, as the
case may be, will take any other action permitted to be taken by a
Certificateholder under the Agreement on behalf of a CEDEL Participant or
Euroclear Participant only in accordance with its relevant rules and procedures
and subject to its Depositary's ability to effect such actions on its behalf
through DTC.
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) DTC or HFC 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
HFC or the Trustee is unable to locate a qualified successor, (ii) HFC, at its
sole option and with the consent of the Trustee, elects to terminate the
book-entry system through DTC or (iii) after the occurrence of a Servicing
Termination Event, DTC, at the direction of Certificateholders holding
Certificates evidencing not less than 51% of the then-outstanding principal
balance, advises the Trustee 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 HFC 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 related Participants, with respect to some
Certificates which conflict with actions taken with respect to other
Certificates.
Because DTC can only act on behalf of Participants, who in turn act on
behalf of indirect participants and certain banks, the ability of holders of
beneficial interests in the Certificates to pledge such Certificates to persons
or entities that do not participate in the DTC system, or otherwise take actions
in respect of such Certificates, may be limited due to the lack of a definitive
certificate for such Certificates.
Although DTC, CEDEL and Euroclear have agreed to the foregoing procedures
in order to facilitate transfers of Certificates among participants of DTC,
CEDEL and Euroclear, they are under no obligation to perform or continue to
perform such procedures and such procedures may be discontinued at any time.
CERTAIN ACTIVITIES
No Certificateholder will have any right under the Agreement to institute
any proceeding in its name with respect to such Agreement unless such holder
previously has given to the Trustee written notice of default and unless holders
of Certificates evidencing not less than 51% of the then-outstanding principal
amount have made written requests 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. (Section 12.03) However, 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
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or defend any litigation thereunder or in relation thereto at the request, order
or direction of any of the holders of Certificates covered by such Agreement,
unless such Certificateholders have offered to the Trustee reasonable security
or indemnity against the costs, expenses and liabilities which may be incurred
therein or thereby. (Section 9.02)
The Trust will not: (i) borrow money; (ii) make loans (other than pursuant
to the HFC Note); (iii) invest in securities for the purpose of exercising
control; (iv) underwrite securities; (v) except as provided in the Agreement,
engage in the purchase and sale (or turnover) of investments; (vi) offer
securities in exchange for property (except Certificates for the Mortgage
Loans); or (vii) repurchase or otherwise reacquire its securities. See
"-- Evidence as to Compliance" above for information regarding reports as to the
compliance by the Master Servicer with the terms of the Agreement.
DESCRIPTION OF THE RECEIVABLES PURCHASE AGREEMENT
The Mortgage Loans to be transferred to the Trust by the Seller will be
acquired by the Seller from the Subservicers pursuant to the Receivables
Purchase Agreement entered into by and between the Seller, as purchaser of the
Mortgage Loans, and the Subservicers, as owners of the Credit Line Agreements
and sellers of the Mortgage Loans (a form of the Receivables Purchase Agreement
is filed as an exhibit to the Registration Statement of which this Prospectus is
a part). Under the Receivables Purchase Agreement, the Subservicers have agreed
to sell or transfer the Mortgage Loans in accordance with the terms set forth
therein, including the applicable Cut-Off Balances and the Additional Balances
created in specified Credit Line Agreements, to the Seller. Pursuant to the
Agreement, such balances are immediately transferred by the Seller to the Trust,
and the Seller has assigned its rights in, to and under the Receivables Purchase
Agreement with respect to such balances to the Trust. The following summary
describes certain terms of the Receivables Purchase Agreement and is qualified
in its entirety by reference to the Receivables Purchase Agreement.
SALE OF MORTGAGE LOANS
Pursuant to the Receivables Purchase Agreement, the Subservicers will sell
to the Seller all their right, title and interest in and to all of the Mortgage
Loans, consisting of the applicable Cut-Off Balances arising from the Credit
Line Agreements and all of the Additional Balances thereafter created from such
Credit Line Agreements. The purchase price of the purchased Mortgage Loans will
not be less than the principal amount thereof as of the time of sale.
In connection with such sale of the Mortgage Loans to the Seller, the
Subservicers have agreed to assign all right, title and interest in and to the
Related Documents, consisting of the Credit Line Agreements, the Mortgages and
other related documents, to the Trustee, but will maintain possession of such
documents unless HFC fails to maintain certain ratings. The Subservicers have or
will indicate in their computer files that the Mortgage Loans have been sold to
the Seller by the Subservicers and that such Mortgage Loans have been sold or
transferred by the Seller to the Trust. In addition, the Subservicers have or
will provide to the Seller a computer file or a microfiche list containing a
true and complete list showing each Mortgage Loan, identified by account number
and by total outstanding balance on the applicable Cut-Off Date. The records and
agreements relating to the Mortgage Loans, including the promissory notes,
related mortgage and other Related Documents, are not segregated by the
Subservicers from other documents and agreements relating to other home equity
credit line accounts and receivables and are not stamped or marked to reflect
the sale or transfer of the Mortgage Loans to the Seller, but the computer
records of the Subservicers are or will be marked to evidence such sale or
transfer. The Subservicers have filed or will file a UCC financing statement
meeting the requirements of state law in Illinois and in each of the
jurisdictions in which the books and records relating to the Mortgage Loans are
maintained. See "Risk Factors -- Insolvency Considerations" and "Certain Legal
Aspects of the Mortgage Loans".
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REPRESENTATIONS AND WARRANTIES
In the Receivables Purchase Agreement, each Subservicer represents and
warrants to the Seller to the effect that, among other things, as of the Closing
Date, it is duly chartered and in good standing and that it has the authority to
consummate the transactions contemplated by the Receivables Purchase Agreement.
Each Subservicer also represents and warrants to the Seller relating to the
Mortgage Loans to the effect, among other things, that in the event of a breach
of any representation and warranty set forth in the Agreement which results in
the requirement that the Seller accept retransfer of a Mortgage Loan from the
Trust, then the applicable Subservicer shall repurchase such Mortgage Loan from
the Seller on the date of such transfer. The purchase price for such a Mortgage
Loan shall be the principal balance thereof and the accrued and unpaid interest
thereon and any premium paid by the Seller therefor.
Each Subservicer also represents and warrants to the Seller to the effect,
among other things, that as of the Closing Date and each date when the
Subsequent Funding Mortgage Loans, any Eligible Substitute Mortgage Loans and
any Additional Balances are sold to the Seller, that (a) the Receivables
Purchase Agreement constitutes a legal, valid and binding obligation of the
Subservicers and (b) the transfer of the amounts owing under the Mortgage Loans
under the Receivables Purchase Agreement constitutes a valid sale to the Seller
of all right, title and interest of the Subservicers in and to the Mortgage
Loans, the Cut-Off Balances and the Additional Balances, whether then existing
or thereafter created in the Credit Line Agreements and in the proceeds thereof.
If the breach of any of the representations and warranties described in this
paragraph results in the obligation of the Seller under the Agreement to accept
retransfer of the Mortgage Loans, the Subservicers will repurchase the Mortgage
Loans retransferred to the Seller.
CERTAIN COVENANTS
In the Receivables Purchase Agreement, the Subservicers covenant to perform
their obligations under the Credit Line Agreements and the Subservicers'
policies and procedures relating to the Credit Line Agreements unless the
failure to do so would not have a material adverse effect on the rights of the
Trust, as assignee of the Mortgage Loans, the Certificate Insurer or the
Certificateholders. In that regard, the Subservicers may change the terms and
provisions of such Credit Line Agreements or policies and procedures at any time
in any respect (including, without limitation, the calculation of the amount, or
the timing, of charge-offs and changes in the Loan Rates) so long as any such
changes are made in accordance with all applicable laws and such changes will
not have a material adverse effect on the interests of the Certificateholders,
the Certificate Insurer or the Trust, or in any other respect as provided in the
Agreement.
In addition, the Subservicers expressly acknowledge and consent to the
Seller's assignment of its rights relating to the Mortgage Loans under the
Receivables Purchase Agreement to the Trustee for the benefit of the
Certificateholders and the Certificate Insurer. The Subservicers also agree, for
the benefit of the Trust, that any amounts payable by the Subservicers to the
Seller pursuant to the Receivables Purchase Agreement that are to be paid by the
Seller to the Trustee for the benefit of the Certificateholders will be paid by
the Subservicers, on behalf of the Seller, directly to the Trustee.
AMENDMENTS
The Receivables Purchase Agreement may be amended by the Seller and the
Subservicers without the consent of the Certificateholders (i) to cure any
ambiguity, (ii) to correct or supplement any provision therein which may be
inconsistent with any other provision therein, (iii) to add any other provisions
with respect to matters or questions arising under the Receivables Purchase
Agreement which are not inconsistent with the provisions of the Receivables
Purchase Agreement, (iv) to change or modify the purchase price to be paid for
the Mortgage Loans, and (v) to change,
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modify, delete, or add any other obligation or duty of the Subservicers or the
Seller. No amendment pursuant to clause (v) above shall be effective unless the
Rating Agencies have notified the Subservicers and the Seller in writing that
such amendment will not result in a reduction or withdrawal of the rating of the
Certificates and the Certificate Insurer has consented thereto as required by
the Insurance Agreement.
SALE OF CREDIT LINE AGREEMENTS
The Subservicers have the right to transfer their respective interests in
the Credit Line Agreements provided that if such transferee is not an affiliate
of the Master Servicer, (i) the consent of the Certificate Insurer is obtained
and (ii) the Rating Agencies have notified the Seller and the Subservicers that
such transfer will not result in a reduction or withdrawal of the rating of the
Certificates.
TERMINATION
The Receivables Purchase Agreement will terminate immediately after the
Trust terminates. In addition, if a conservator, trustee or receiver is
appointed for the Subservicers, the Subservicers will immediately cease to sell
or transfer Subsequent Funding Mortgage Loans, Eligible Substitute Mortgage
Loans and Additional Balances to the Seller and promptly give notice of such
event to the Seller and to the Trustee.
CERTAIN LEGAL ASPECTS OF THE MORTGAGE LOANS
GENERAL
The Mortgage Loans will be secured either by trust deeds or mortgages,
depending upon the prevailing practice in the state in which the Mortgaged
Property is located. A mortgage creates a lien upon the real property encumbered
by the mortgage. It is not prior to the lien for real estate taxes and
assessments. Priority between mortgages depends on their terms and generally on
the order of filing with a state or county office. There are two parties to a
mortgage, the mortgagor, who is the homeowner or borrower, and the mortgagee,
who is the lender. Under the mortgage instrument, the mortgagor delivers to the
mortgagee a note or bond and the mortgage. A deed of trust formally has three
parties: the homeowner or borrower called the trustor (similar to a mortgagor),
a lender (similar to the mortgagee) called the beneficiary, and a third-party
grantee, called the trustee. Under a deed of trust, the trustor grants the
property, irrevocably until the debt is paid, "in trust, with the power of sale"
to the trustee to secure payment of the obligation. The trustee's authority
under a deed of trust and the mortgagee's authority under a mortgage are
governed by law, the express provisions of the deed of trust or the mortgage,
and, in some cases under a trust deed, the direction of the beneficiary.
FORECLOSURE
Foreclosure of a deed of trust is accomplished in most cases by a
non-judicial trustee's sale under the power-of-sale provision in the deed of
trust. Prior to such sale, the trustee must record a notice of default and send
a copy to the trustor, to any person who has recorded a request for a copy of a
notice of default and notice of sale, to any successor in interest to the
trustor, to the beneficiary of any junior deed of trust and to certain other
persons. In certain states where a beneficiary under a junior deed of trust has
recorded a request for a notice of default, a copy of the notice must be sent to
the beneficiary following recordation of such notice of default. The Seller may
not always record a request for a notice of default. The trustor, any successor
in interest to the trustor, or any beneficiary under a junior deed of trust or
any other persons having a subordinate lien or encumbrance of record may
generally, during a reinstatement period, cure the default by paying the entire
amount of the debt then due, exclusive of principal due only because of
acceleration upon default, plus costs and expenses actually incurred in
enforcing the obligation and statutorily limited
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attorney's and trustee's fees. When the beneficiary under a junior deed of trust
cures the default and reinstates the senior deed of trust, the amount paid by
the beneficiary so to cure generally becomes a part of the indebtedness secured
by the junior deed of trust. After expiration of the applicable reinstatement
period, and before the trustee's sale, notice of sale must generally be posted
in a public place and published at certain intervals for a prescribed period
prior to the sale. A copy of the notice of sale must generally be posted on the
property, and sent to the trustor, to each person who has requested a copy, to
any successor in interest to the trustor, to the beneficiary of any junior deed
of trust and to any other person to whom a notice of default must be sent,
before the sale, and must generally be recorded in the county in which the
property is located before the sale.
Foreclosure of a mortgage is generally accomplished by judicial action. The
action is initiated by the service of legal pleadings upon the mortgagor(s) and
all parties having a subordinate interest in the real property. Delays in
completion of the foreclosure may occasionally result from difficulties in
locating necessary parties defendant. Judicial foreclosure proceedings are
generally not contested by any of the parties defendant due to the lack of
mortgagor's equity in the property. However, when the mortgagee's right to
foreclose is contested, the legal proceedings necessary to resolve the issue can
be time consuming. After the completion of judicial foreclosure, the court would
issue a judgment of foreclosure and would generally appoint a referee, sheriff,
or other court officer to conduct the sale of the property.
The referee's or trustee's sale must be conducted by public auction and
must be held in the county where all or some part of the property subject to the
mortgage or the deed of trust is located. At the sale, the referee or trustee
may require a bidder to show evidence of ability to deposit with the referee or
trustee 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 mortgagee or the beneficiary of the mortgage or deed of trust
under foreclosure generally need not bid cash at the sale, but may instead make
a "credit bid" to the extent of the total amount due under the mortgage or deed
of trust, including costs and expenses actually incurred in enforcing the
mortgage, as well as referee's or trustee's fees and expenses.
After judicial confirmation of the sale and subject to the mortgagor's or
trustor's right of redemption, if any, under state law, the referee or trustee
will execute and deliver a deed or trustee's deed to the purchaser of the
property. A sale conducted in accordance with a judicial foreclosure or the
terms of the power of sale contained in the deed of trust is generally presumed
to be conducted regularly and fairly and, on a conveyance of the property by
deed or trustee's deed, confers absolute legal title to the property to the
purchaser, free of all junior mortgages or deeds of trust and free of all other
liens and claims subordinate to the mortgage or deed of trust under which the
sale is made (with the exception of certain governmental liens). The purchaser's
title is, however, subject to all senior liens and other senior claims. Thus, if
the mortgage or deed of trust being foreclosed is a junior mortgage or deed of
trust such as some of the Mortgage Loans, the referee or trustee will convey
title to the property to the purchaser, subject to the underlying first mortgage
or deed of trust and any other prior liens and claims. A foreclosure under a
junior mortgage or deed of trust has no effect on the first mortgage or deed of
trust, with the possible exception of the right of a senior mortgagee or
beneficiary to accelerate its indebtedness under a "due-on-sale" clause
contained in the senior mortgage or deed of trust. See " 'Due-on-Sale' Clauses"
below.
The proceeds received by the referee or trustee from the sale are applied
first to the costs, fees and expenses of sale and then in satisfaction of the
indebtedness secured by the mortgage or deed of trust under which the sale was
conducted. Any remaining proceeds are generally payable to the holders of junior
mortgages or deeds of trust and other liens and claims in order of their
priority, whether or not the obligor is in default. Any additional proceeds are
generally payable to the mortgagor or trustor. Following the sale, in some
states the mortgagee or beneficiary under the foreclosed lien generally may not
obtain a deficiency judgment against the mortgagor or trustor.
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A judicial foreclosure (which is the only form of foreclosure allowed in
some states and is necessary to obtain a deficiency judgment in others) is
subject to most of the delays and expenses of other lawsuits, sometimes
requiring up to several years to complete. Following a judicial foreclosure
sale, the mortgagor or trustor or his successor in interest may redeem by paying
the amount of the sale plus statutory interest, for a period established by
state statute, which may vary from three months to two years, depending on state
law and the circumstances of the sale. Foreclosed junior lien holders may also
redeem by paying the amount of the sale or other amount established by the
judgment of foreclosure, plus statutory interest, subject to the mortgagor's or
trustor's superior right to redeem from them.
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 deeds of trust or mortgages receive
notices in addition to the statutorily prescribed minimum. For the most part,
these cases have upheld the notice provisions as being reasonable or have found
that the sale by a trustee under a deed of trust, or under a mortgage having a
power of sale, does not involve sufficient state action to afford constitutional
protections to the borrower.
RIGHTS OF REDEMPTION
In some states, after sale pursuant to a deed of trust or judicial
foreclosure of a mortgage, the borrower and foreclosed junior lienors are given
a statutory time period in which to redeem the property from the foreclosure
sale. In some states, redemption may occur only upon payment of the entire
principal balance of the loan, accrued statutory 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 generally to diminish the ability of the lender to sell the
foreclosed property. Exercise of the right of redemption would defeat the title
of any purchaser from the lender subsequent to foreclosure or sale under a deed
of trust and before expiration of the redemption period. Consequently, the
practical effect of the redemption right is to force the lender to retain the
property and pay the expenses of maintenance until the redemption period has
expired.
RIGHTS OF SENIOR MORTGAGEES OR BENEFICIARIES
The Mortgage Loans will be secured by mortgages or deeds of trust most of
which are second mortgages or deeds of trust and the remainder of which are
first, or to a very limited extent, third mortgages or deeds of trust. The
rights of the Trust (and therefore the Certificateholders), as beneficiary under
a junior deed of trust or as mortgagee under a junior mortgage, are subordinate
to those of the mortgagee or beneficiary under the senior mortgage or deed of
trust, including the prior rights of the senior mortgagee or beneficiary to
receive hazard insurance and condemnation proceeds and to cause the property
securing the Mortgage Loan to be sold upon default of the mortgagor or trustor,
thereby extinguishing the junior mortgagee's or junior beneficiary's lien unless
the Subservicers assert their subordinate interest in a Mortgaged Property in
foreclosure litigation or satisfy the defaulted senior loan. As discussed more
fully below, in many states a junior mortgagee or beneficiary may satisfy a
defaulted senior loan in full, or may cure such default and bring the senior
loan current, in either event adding the amounts expended to the balance due on
the junior loan. Although the Subservicers generally do not cure defaults under
a senior deed of trust, it is the Subservicers' standard practice to protect
their interest by attending any such sale and bidding for property if it is in
the Subservicers' best interests to do so.
The standard form of the mortgage or deed of trust used by most
institutional lenders, like that of the Subservicers, confers on the mortgagee
or beneficiary the right both to receive all proceeds collected under any hazard
insurance policy and all awards made in connection with any condemnation
proceedings, and to apply such proceeds and awards to any indebtedness secured
by the mortgage or deed of trust, in such order as the mortgagee or beneficiary
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 the underlying
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first mortgage or deed of trust 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 first mortgage or deed of trust. Proceeds, however,
may be used by the mortgagee to repair or rebuild. In cases where proceeds are
utilized to repay indebtedness, proceeds in excess of the amount of senior
mortgage indebtedness will be applied to the indebtedness of a junior mortgage
or trust deed.
The form of mortgage or deed of trust used by most institutional lenders
typically contains a "future advance" clause, which provides, in essence, that
additional amounts advanced to or on behalf of the mortgagor or trustor by the
mortgagee or beneficiary are to be secured by the mortgage or deed of trust.
While such a clause is valid under the laws in most states, the priority of any
advance made under the clause depends, in some states, on whether the advance
was an "obligatory" or "optional" advance. If the mortgagee or beneficiary is
obligated to advance the additional amounts, the advance may be entitled to
receive the same priority as amounts initially made under the mortgage or deed
of trust, notwithstanding that there may be intervening junior mortgages or
deeds of trust and other liens between the date of recording of the mortgage or
deed of trust and the date of the future advance, and notwithstanding that the
mortgagee or beneficiary had actual knowledge of such intervening junior
mortgages or deeds of trust and other liens at the time of the advance. Where
the mortgagee or beneficiary is not obligated to advance the additional amounts
and has actual knowledge of the intervening junior mortgages or deeds of trust
and other liens, the advance may be subordinate to such intervening junior
mortgages or deeds of trust and other liens. Priority of advances under the
clause rests, in many other states, on state statutes giving priority to all
advances made under the loan agreement to a "credit limit" amount stated in the
recorded mortgage.
Another provision typically found in the form of the mortgage or deed of
trust used by most institutional lenders obligates the mortgagor or trustor 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 or beneficiary under the
mortgage or deed of trust. Upon a failure of the mortgagor or trustor to perform
any of these obligations, the mortgagee or beneficiary is given the right under
the mortgage or deed of trust to perform the obligation itself, at its election,
with the mortgagor or trustor agreeing to reimburse the mortgagee or beneficiary
for any sums expended by the mortgagee or beneficiary on behalf of the mortgagor
or trustor. All sums so expended by the mortgagee or beneficiary become part of
the indebtedness secured by the mortgage or deed of trust.
BANKRUPTCY, ANTI-DEFICIENCY LEGISLATION AND OTHER LIMITATIONS ON LENDERS
Numerous state and federal laws, including the Soldiers' and Sailors' Civil
Relief Act of 1940, as amended (the "Civil Relief Act") and the federal
bankruptcy code, may adversely affect a lender's ability to realize the full
value of its security. Under the terms of the Civil Relief Act, a borrower who
enters military service after the origination of such borrower's home equity
line of credit (including a borrower who is a member of the National Guard or is
in reserve status at the time of the origination of the home equity credit line
account and is later called to active duty) may not be charged interest above an
annual rate of 6% during the period of such borrower's active duty status,
unless a court orders otherwise upon application of the lender. Any shortfall
resulting from the application of the Civil Relief Act, to the extent not
covered by collections on the Mortgage Loans, disbursements from the Spread
Account or amounts drawn under the Policy could result in losses to the holders
of the Certificates. In addition, the Civil Relief Act imposes limitations which
would impair the ability of a lender to foreclose on a home equity loan during
the borrower's period of active duty status. Thus, in the event that such
Mortgage Loan goes into default, there may be delays and losses occasioned by
the inability to realize upon the Mortgaged Property in a timely fashion. Under
the federal bankruptcy
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code, the filing of a petition in bankruptcy will stay the exercise of a power
of sale and the commencement or continuation of a foreclosure action. Moreover,
a court which determines the value of a mortgaged property to be less than the
principal balance of the loan it secures may (subject to certain protections
available to the lender) stop a lender from foreclosing on the mortgaged
property and, as a part of a rehabilitation plan, reduce the amount of secured
indebtedness to the appraised value of the mortgaged property as it exists at
the time of the proceeding (leaving the lender as a general unsecured creditor
for the difference between that value and the amount of its outstanding mortgage
indebtedness). A bankruptcy court may also grant a debtor a reasonable time to
cure a payment default, reduce monthly payments due under a mortgage loan, or
change the rate of interest on a mortgage loan.
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 mortgagee or beneficiary to obtain a
deficiency judgment against the mortgagor or trustor following foreclosure
pursuant to a mortgage or sale under a deed of trust. A deficiency judgment is a
personal judgment against the former mortgagor or trustor equal in most cases to
the difference between the net amount realized upon the foreclosure or sale of
the real property and the amount due to the mortgagee or beneficiary. Other
statutes may require the mortgagee or beneficiary to exhaust the security
afforded under the mortgage or deed of trust by foreclosure in an attempt to
satisfy the full debt before bringing a personal action against the mortgagor or
trustor. Finally, other statutory provisions may limit any deficiency judgment
against the former mortgagor or trustor following a judicial sale to the excess
of the outstanding debt over the fair market value of the property at the time
of the public sale. The purpose of these statutes is to prevent a mortgagee or
beneficiary from obtaining a large deficiency judgment against the former
mortgagor or trustor as a result of low or no bids at the sale.
In addition to anti-deficiency and related legislation, numerous other
statutory provisions, including state laws affording relief to debtors, may
interfere with or affect the ability of the secured mortgage lender to realize
upon its security. Federal law and certain state laws provide priority to
certain tax liens over the lien of mortgages or deeds of trust. Numerous federal
and some state consumer protection laws impose substantive requirements upon
mortgage lenders in connection with the origination and the servicing of
mortgage loans. These laws include the Home Equity Loan Consumer Protection Act
of 1988, Federal Truth-in-Lending Act, Real Estate Settlement Procedures Act,
Equal Credit Opportunity Act, Fair Credit Billing Act, Fair Credit Reporting Act
and related statutes. These federal laws impose specific statutory liabilities
upon lenders who originate mortgage loans and who fail to comply with the
provisions of the law. In some cases this liability may affect transferees of
such mortgage loans.
Upon foreclosure, courts have imposed general equitable principles. These
equitable principles are generally designed to relieve the borrower from the
legal effect of its 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 for the
borrower's default and the likelihood that the borrower will be able to
reinstate the loan. In some cases, courts 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 the lender to foreclose if the default under the mortgage
instrument is not monetary, such as the borrower failing to adequately maintain
the property or the borrower executing a second mortgage or deed of trust
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 the borrowers under deeds of trust or
mortgages receive notices in addition to the statutorily prescribed minimum. For
the most part, these cases have upheld the notice provisions as being reasonable
or have found that the sale by a trustee under a deed of trust, or under a
mortgage having power of sale, does not involve sufficient state action to
afford constitutional protections to the borrower.
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"DUE-ON-SALE" CLAUSES
Substantially all of the Credit Line Agreements contain due-on-sale
clauses. These clauses permit the related Subservicer to accelerate the maturity
of the loan on notice, which is usually thirty days, if the borrower sells,
transfers or conveys the property. The enforceability of these clauses has been
the subject of legislation or litigation in many states, and in some cases the
enforceability of these clauses was limited or denied. However, sec.341 of the
Garn-St Germain Depository Institutions Act of 1982 (the "Garn-St Germain Act")
preempts state constitutional, statutory and case law that prohibit the
enforcement of many due-on-sale clauses and permits lenders to enforce most of
these clauses in accordance with their terms, subject to certain limited
exceptions.
Exempted from the general rule of enforceability of due-on-sale clauses are
mortgage loans (originated other than by federal savings and loan associations
and federal savings banks) that were made during the period beginning on the
date a state, by statute or final appellate court decision having statewide
effect, prohibited the exercise of due-on-sale clauses and ending October 15,
1982 ("Window Period Loans"). However, this exception applies only to transfers
of property which secures Window Period Loans occurring between October 15, 1982
and October 15, 1985 and does not restrict enforcement of a due-on-sale clause
in connection with transfers of property which secures Window Period Loans
occurring after October 15, 1985 unless the property which secures such Window
Period Loans is located in one of the five states identified below.
Therefore, most standard due-on-sale clauses have become generally
enforceable except in those states whose legislatures exercised their authority
after October 15, 1982 to restrict the enforceability of such clauses with
respect to mortgage loans that were (i) originated or assumed after the date a
state prohibited enforcement of due-on-sale clauses and before October 15, 1982,
and (ii) originated by lenders other than national banks, federal savings
institutions and federal credit unions. The Federal Home Loan Mortgage
Corporation has taken the position in its published mortgage servicing standards
that 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.
The Garn-St Germain Act also sets forth nine specific instances in which a
mortgage lender covered by the Garn-St Germain Act may not exercise a
due-on-sale clause, notwithstanding the fact that a transfer of the property may
have occurred. These include intrafamily transfers, certain transfers by
operation of law, leases of fewer than three years with no option to purchase,
and the creation of a junior encumbrance.
The inability to enforce a due-on-sale clause may result in a mortgage loan
bearing an interest rate below the current market rate being assumed by a new
home buyer rather than being paid off, which may have an impact upon the average
life of the Mortgage Loans and the number of Mortgage Loans which may be
outstanding until maturity.
APPLICABILITY OF USURY LAWS
Title V of the Depository Institutions Deregulation and Monetary Control
Act of 1980, enacted in March, 1980 ("Title V"), provides that state usury
limitations shall not apply to certain types of residential first mortgage loans
originated by certain lenders after March 31, 1980. As of the Pool Date,
approximately 31.27% of the Initial Mortgage Loans by principal balance were
first mortgage loans. A similar federal statute was in effect with respect to
certain mortgage loans made during the first three months of 1980. The Office of
Thrift Supervision is authorized to issue rules and regulations and to publish
interpretations governing implementation of Title V. The statute authorized any
state to reimpose interest rate limits by adopting, before April 1, 1983, a law
or constitutional provision which expressly rejects application of the federal
law. In addition, even where Title V is not so rejected, any state is authorized
by the law to adopt a provision limiting discount points or other charges on
mortgage loans covered by Title V. Certain states have taken action to reimpose
interest rate limits and/or to limit discount points or other charges. In the
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Agreement, the Seller represents and warrants that each Mortgage Loan was
originated in compliance with applicable state law in all material respects.
ENVIRONMENTAL LEGISLATION
Certain states impose a statutory lien for associated costs on property
that is the subject of a cleanup action by the state on account of hazardous
wastes or hazardous substances released or disposed of on the property. Such a
lien will generally 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 mortgage. In addition, under federal environmental
legislation and possibly under state law in a number of states, a secured party
which takes a deed in lieu of foreclosure or acquires a mortgaged property at a
foreclosure sale may be liable for the costs of cleaning up a contaminated site.
Although such costs could be substantial, it is uncertain whether they would be
imposed on a secured lender (such as the Trust). In the event that title to a
Mortgaged Property securing a Mortgage Loan was acquired on behalf of the Trust
and cleanup costs were incurred in respect of the Mortgaged Property, the
Certificateholders may incur a loss if such costs were required to be paid by
the Trust.
CERTAIN INCOME TAX CONSEQUENCES
GENERAL
Set forth below is a general discussion of the anticipated material Federal
income tax consequences of the purchase, ownership and disposition of the
Certificates. This discussion does not address every aspect of the Federal
income tax laws that may be relevant to Certificateholders in light of their
personal investment circumstances or to certain types of Certificateholders
subject to special treatment under the Federal income tax laws (for example,
banks and life insurance companies) and is generally limited to investors who
will hold Certificates as capital assets. Accordingly, investors should consult
their own tax advisors regarding Federal, state, local, foreign and any other
tax consequences to them of the purchase, ownership and disposition of the
Certificates in their own particular circumstances. This discussion is based
upon the provisions of the Internal Revenue Code of 1986, as amended (the
"Code"), the Treasury regulations thereunder, and rulings and court decisions in
effect as of the date hereof, all of which are subject to change, possibly
retroactively. No ruling on any of the issues discussed below has been or will
be sought from the Internal Revenue Service (the "IRS") and no assurance can be
given that the IRS will not take contrary positions. It is anticipated that the
Trust will not be indemnified for any Federal income tax that may be imposed
upon it, and the imposition of any such taxes on the Trust could result in a
reduction in the amounts available for distribution to the Certificateholders.
TREATMENT OF THE CERTIFICATES AS INDEBTEDNESS
Sidley & Austin, special tax counsel to the Seller ("Tax Counsel"), is of
the opinion that, although no transaction closely comparable to that
contemplated herein has been the subject of any Treasury regulation, revenue
ruling or judicial decision, based upon its analysis of the factors discussed
below and in the opinion letter filed as an Exhibit hereto (the "Opinion
Letter") the Seller is properly treated as the owner of the Mortgage Loans for
Federal income tax purposes and, accordingly, the Certificates, when issued,
will be properly characterized for Federal income tax purposes as indebtedness
of the Seller that is secured by the Mortgage Loans.
Based on the foregoing, for Federal income tax purposes (i) Certificates
held by a thrift institution taxed as a "mutual savings bank" or "domestic
building and loan association" will not represent interests in "qualifying real
property loans" within the meaning of Section 593(d) of the Code; (ii)
Certificates held by a thrift institution taxed as a domestic building and loan
association will not constitute "loans . . . secured by an interest in real
property" within the meaning of Code Section 7701(a)(19)(C)(v); (iii) interest
on Certificates held by a real estate investment trust will
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not be treated as "interest on obligations secured by mortgages on real property
or on interests in real property" within the meaning of Code Section
856(c)(3)(B); (iv) Certificates held by a real estate investment trust will not
constitute "real estate assets" or "Government securities" within the meaning of
Code Section 856(c)(5)(A); (v) Certificates held by a real estate mortgage
investment conduit will not constitute "qualified mortgages" within the meaning
of Code Section 860G(a)(3); and (vi) Certificates held by a regulated investment
company will not constitute "Government securities" within the meaning of Code
Section 851(b)(4)(A)(i).
The Seller and Certificateholders will express in the Agreement the intent
that, for Federal, state and local income and franchise tax purposes, and for
the purposes of any other tax imposed on or measured by income, the Certificates
will be indebtedness of the Seller secured by the Mortgage Loans. The Seller, by
entering into the Agreement, each Certificateholder, by the acceptance of a
Certificate, and each Certificate Owner, by virtue of accepting a beneficial
interest in a Certificate, will agree to treat the Certificates (or the
beneficial interests therein) as indebtedness of the Seller secured by the
Mortgage Loans for Federal, state and local income and franchise tax purposes
and for the purposes of any other tax imposed on or measured by income. However,
because different criteria are used in determining the non-tax accounting
treatment of a transaction, the Seller will treat the Agreement for financial
accounting purposes as a transfer of an ownership interest in the Mortgage Loans
and not as creating a debt obligation of the Seller.
The economic substance of a transaction generally determines its Federal
income tax consequences and the form of a transaction, while a relevant factor,
is generally 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, notwithstanding that
participants characterized the transaction differently for nontax 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. As set forth more fully in the
Opinion Letter, Tax Counsel believes that the rationale of those cases will not
apply to this transaction.
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, has assumed the risk of loss if the property decreases in value and, in
the case of accounts receivable such as the Mortgage Loans, whether the
transferee, at the time of transfer, has a fixed interest in the proceeds of the
receivable when collected. Based upon its analysis of such factors, as described
more fully in the Opinion Letter, Tax Counsel is of the opinion that the
Certificates are properly characterized for Federal income tax purposes as
indebtedness of the Seller secured by the Mortgage Loans. Contrary
characterizations that could be asserted by the IRS are described under
"Possible Characterization of the Arrangement as a Partnership or Association
Taxable as a Corporation" below. Except as otherwise expressly indicated, the
following discussion assumes that the Certificates are properly treated as debt
obligations of the Seller for Federal income tax purposes.
INTEREST INCOME TO CERTIFICATEHOLDERS
It is anticipated that the Certificates will be issued at par value (or at
an insubstantial discount from par value) and, although the matter is not free
from doubt, it appears that stated interest on the Certificates generally will
be taxable as ordinary income for Federal income tax purposes when received or
accrued by Certificateholders in accordance with their respective method of tax
accounting, and except as indicated, no original issue discount ("OID") will
arise with respect to the Certificates. It is possible, however, that under
regulations of the U.S. Treasury Department, interest payable on the
Certificates (or a portion of such interest), as well as any discount from par
value, will constitute OID. Such regulations treat interest as OID unless such
interest is "unconditionally
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payable." Because the Certificateholders do not have available default remedies
ordinarily available to holders of debt instruments, the IRS could take the
position that the interest payable on the Certificates is not "unconditionally
payable" within the meaning of such regulations. In such case, all or a portion
of the taxable income to be recognized with respect to the Certificates would be
includible in the income of a Certificateholder as received. Any amount treated
as OID would not, however, be includible again when the interest is actually
received. If the yield on the Certificates is not materially different from the
coupon, this treatment would have no significant effect on Certificateholders
using the accrual method of accounting. However, cash method Certificateholders
may be required to report income with respect to the Certificates in advance of
the receipt of cash attributable to such income. The Certificateholders may be
required to accrue any Carryover Amount in income in advance of the receipt of
cash with respect to such Carryover Amount regardless of whether such
Certificateholders are on the cash or accrual method of accounting.
If the Certificates were treated as being issued with OID, the following
rules would apply. The excess of the payments with respect to the Certificates
over their issue price (in this case, the first price at which a substantial
amount of the Certificates is sold, excluding sales to brokers or similar
persons acting in the capacity of underwriters, placement agents or wholesalers)
would constitute OID. A Certificateholder must include OID in income as interest
over the term of the Certificate under a constant yield method. In general, OID
must be included in income in advance of the receipt of cash representing that
income. In the case of a debt instrument as to which the repayment of principal
may be accelerated as a result of the prepayment of other obligations securing
the debt instrument, the periodic inclusion of OID is determined under a special
provision by taking into account prepayment assumptions used in pricing the debt
instrument and actual prepayment experience. If this provision applies to the
Certificates, the amount of OID which will accrue in any given "accrual period"
may either increase or decrease depending upon the actual prepayment rate. In
the event of a Carryover Amount, an accrual basis taxpayer will likely be
required to accrue the amount of each Carryover Amount even though such
Carryover Amount will not be paid until a later time. The amount and rate of
accrual of OID with respect to securities similar to the Certificates are
calculated based on a reasonable assumed prepayment rate (the "Prepayment
Assumption") and adjustments are made in the amount and rate of accrual of such
discount to reflect differences between the actual prepayment rate and the
Prepayment Assumption. It is anticipated that future Treasury regulations will
provide that the assumed prepayment rate for securities such as the Certificates
will be the rate used in pricing the initial offering of the securities. The
Prepayment Assumption for the Certificates will be a 26% conditional prepayment
rate ("CPR"), but no representation is made that, in fact, the Mortgage Loans
will be prepaid at a rate based on the Prepayment Assumption or at any other
rate. CPR is the amount of principal of the pool of Mortgage Loans prepaid each
month expressed as an annualized percentage of the total principal of the pool
of Mortgage Loans outstanding at the beginning of each month and for this
purpose all payments of principal are considered to be prepayments.
A Certificateholder who purchases a Certificate at a market discount may be
subject to the "market discount" rules of the Code. These rules provide, in
part, for the treatment of gain attributable to accrued market discount as
ordinary income upon the receipt of partial principal payments or on the sale or
other disposition of the Certificate, and for the deferral of interest
deductions with respect to debt incurred to acquire or carry the market discount
Certificate.
If a Certificate is purchased by a Certificateholder at a premium, such
premium will be amortized as an offset to interest income (with a corresponding
reduction in the Certificateholder's basis) under a constant yield method over
the term of the Certificate if an election under Section 171 of the Code is made
or is previously in effect.
DISPOSITION OF CERTIFICATES
If a Certificate is sold, exchanged or otherwise disposed of, a
Certificateholder generally will recognize gain or loss in an amount equal to
the difference between the amount realized on the sale,
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exchange or disposition and the Certificateholder's adjusted tax basis in the
Certificate. The adjusted tax basis of a Certificate generally will equal the
cost of the Certificate to the Certificateholder, increased by any OID or market
discount previously includible in the Certificateholder's gross income, and
reduced by the portion of the basis of the Certificate allocable to payments on
the Certificate previously received by the Certificateholder and any amortized
premium. Subject to the market discount rules, gain or loss on the sale or other
disposition of a Certificate will generally be capital gain or loss if the
Certificate is held by the Certificateholder as a capital asset. Capital gain or
loss will be long-term if the Certificate is held by the Certificateholder for
more than one year and otherwise will be short-term.
POSSIBLE CHARACTERIZATION OF THE ARRANGEMENT AS A PARTNERSHIP OR ASSOCIATION
TAXABLE AS A CORPORATION
Although, as described above, it is the opinion of Tax Counsel that the
Certificates are properly characterized as debt of the Seller for Federal income
tax purposes, such opinion is not binding on the IRS or the courts and no
assurance can be given that this characterization would prevail. If the IRS were
to contend successfully that the Certificates were not debt obligations of the
Seller for Federal income tax purposes, the arrangement among the Seller and the
Certificateholders might be classified for Federal income tax purposes as either
a partnership (including a publicly traded partnership) or an association
taxable as a corporation that owns the Mortgage Loans.
If the Certificates were treated as interests in a partnership, the
partnership would probably be treated as a "publicly traded partnership." A
publicly traded partnership is taxed in the same manner as a corporation unless
at least 90% of its gross income consists of specified types of "qualifying
income." Such qualifying income includes, among other things, "interest" that is
not "derived in the conduct of a financial or insurance business." If a deemed
partnership between the Seller and the Certificateholders were to qualify for
the foregoing exception from taxation as a corporation, the deemed partnership
would not be subject to Federal income tax but each item of income, gain, loss,
and deduction generated as a result of the ownership of the Mortgage Loans by
the partnership would be passed through to the Seller and the Certificateholders
as partners in such a partnership according to their respective interests
therein.
The income reportable by the Certificateholders as partners could differ
from the income reportable by the Certificateholders as holders of debt
obligations of the Seller. For example, a cash basis Certificateholder might be
required to report income when it accrued to the partnership rather than when it
is received by the Certificateholder. 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 two
percent of the individual's adjusted gross income, and an individual
Certificateholder's deduction for such holder's share of expenses of the
partnership 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 the stated rate on
the Certificates.
If, alternatively, the arrangement created by the Agreement were treated as
either an association taxable as a corporation or a "publicly traded
partnership" taxable as a corporation, the resulting entity may be subject to
Federal income taxes at corporate tax rates on its taxable income from the
Mortgage Loans. Because the Seller will not provide any indemnity for income
taxes such a tax might result in reduced distributions to Certificateholders and
Certificateholders might be liable for a share of such a tax. Moreover,
distributions by the entity would probably not be deductible in computing the
entity's taxable income and all or part of the distributions to
Certificateholders would generally be treated as dividend income to the
Certificateholders.
Since the Seller will treat the Certificates as indebtedness for Federal
income tax purposes, the Seller will not comply with the tax reporting
requirements that would apply under these alternative characterizations of the
Certificates.
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POSSIBLE CLASSIFICATION AS A TAXABLE MORTGAGE POOL
In relevant part, Section 7701(i) of the Code provides that any entity (or
a portion of an entity) that is a "taxable mortgage pool" will be classified as
a taxable corporation and will not be permitted to file a consolidated federal
income tax return with another corporation. Any entity (or a portion of any
entity) will be a taxable mortgage pool if (i) substantially all of its assets
consist of debt instruments, more than 50% of which are real estate mortgages,
(ii) the entity is the obligor under debt obligations with two or more
maturities, and (iii) under the terms of the entity's debt obligations (or an
underlying arrangement), payments on such debt obligations bear a relationship
to payments on the debt instruments held by the entity.
Tax Counsel is of the opinion that the arrangement created by the Agreement
will not be a taxable mortgage pool under Section 7701(i) of the Code because,
in Tax Counsel's opinion, such arrangement would not be viewed as the obligor
under debt obligations with two or more maturities, payments on which
obligations bear a relationship to payments on the Mortgage Loans.
The opinion of Tax Counsel is not binding on the IRS or the courts. If the
IRS were to contend successfully that the arrangement created by the Agreement
is a taxable mortgage pool, such arrangement would be subject to Federal
corporate income tax on its taxable income generated by ownership of the
Mortgage Loans. Such a tax might reduce amounts available for distributions to
Certificateholders. The amount of such a tax would depend upon whether
distributions to Certificateholders would be deductible as interest expense in
computing the taxable income of such an arrangement as a taxable mortgage pool.
FOREIGN INVESTORS
Subject to the discussion of backup withholding below, and assuming the
Certificates represent debt obligations of the Seller for Federal income tax
purposes, interest (including OID) paid to a nonresident alien individual,
foreign corporation, foreign partnership or foreign estate or trust will be
exempt from U.S. withholding tax, provided that the Certificateholder complies
with applicable certification requirements (and does not actually or
constructively own ten percent or more of the voting stock of the Seller and is
not a controlled foreign corporation related to the Seller or its affiliates).
If the IRS were to contend successfully that the Certificates represent
interests in a partnership (not taxable as a corporation), a Certificateholder
that is a nonresident alien, foreign corporation or foreign estate or trust
might be required to file a U.S. individual or corporate income tax return and
pay tax on its share of partnership income at regular U.S. rates, including the
branch profits tax in the case of a corporation, and would be subject to
withholding tax on its share of partnership income. If the Certificates were
recharacterized as interests in an association taxable as a corporation or a
"publicly traded partnership" taxable as a corporation, to the extent
distributions under the Agreement were treated as dividends, a nonresident alien
individual or foreign corporation would generally be subject to withholding tax
on the gross amount of such dividends at the rate of 30% (or lower rate as
provided by an applicable treaty). In either case, and assuming the Certificates
are recharacterized as partnership interests or equity interests in a
corporation, a Certificateholder that is a nonresident alien, foreign
corporation, foreign partnership or foreign estate or trust might be subject to
Federal income tax on any gain from the sale of the Certificates.
INFORMATION REPORTING AND BACKUP WITHHOLDING
The Master Servicer will be required to report annually to the IRS, and to
each Certificateholder of record, the amount of interest paid (and OID accrued,
if any) on the Certificates (and the amount of interest withheld for Federal
income taxes, if any) for each calendar year, except as to exempt holders
(generally, holders that are corporations, certain tax-exempt organizations or
nonresident aliens who provide certification as to their status as
nonresidents). As long as the only "Certificateholder" of record is Cede, as
nominee for DTC, Certificateholders and the IRS will receive tax and
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other information from Participants and Indirect Participants rather than from
the Master Servicer. (The Master Servicer, however, will respond to requests for
necessary information to enable Participants, Indirect Participants and certain
other persons to complete their reports.) Each non-exempt Certificateholder will
be required to provide, under penalty of perjury, a certificate on IRS Form W-9
containing his or her name, address, correct Federal taxpayer identification
number and a statement that he or she is not subject to backup withholding.
Should a non-exempt Certificateholder fail to provide the required
certification, the Participants or Indirect Participants (or the Master Servicer
or Paying Agent) will be required to withhold 31% of the interest (and
principal) otherwise payable to the holder, and remit the withheld amount to the
IRS as a credit against the holder's Federal income tax liability.
ALL INVESTORS SHOULD CONSULT THEIR OWN TAX ADVISORS REGARDING THE FEDERAL,
STATE, LOCAL OR FOREIGN INCOME TAX CONSEQUENCES OF THE PURCHASE, OWNERSHIP AND
DISPOSITION OF THE CERTIFICATES.
STATE AND LOCAL TAX CONSEQUENCES
General. State tax consequences to each Certificateholder will depend upon
the provisions of the state tax laws to which the Certificateholder is subject.
Most states modify or adjust the taxpayer's Federal adjusted gross or taxable
income to arrive at the amount of income potentially subject to state tax.
Individuals generally are subject to state tax on 100% of such state-modified
income in the state in which they are residents, and to tax in states in which
they are not residents on income earned in or derived from sources in those
states. Corporations and other business taxpayers generally pay state tax only
on that portion of state-modified income assigned to the taxing state under the
state's own apportionment and allocation rules. Because each state's tax law
varies, it is impossible to predict the tax consequences to the
Certificateholders in all of the state taxing jurisdictions in which they are
already subject to tax.
Illinois. The activities to be undertaken by the Master Servicer and the
Subservicers in servicing and collecting the Mortgage Loans will take place in
Illinois. Illinois imposes an income tax on corporations doing business in
Illinois measured by their net income apportioned to Illinois. This discussion
is based upon present provisions of Illinois law and regulations, and applicable
judicial or ruling authority, all of which are subject to change, which change
may be retroactive. No ruling on any of the issues discussed below will be
sought from the Illinois Department of Revenue.
Assuming the Certificates are treated as indebtedness for Federal income
tax purposes, this treatment will also apply for Illinois tax purposes. Pursuant
to this treatment, Certificateholders not otherwise subject to Illinois tax
would not become subject to such tax solely because of their ownership of the
Certificates. Certificateholders already subject to taxation in Illinois as
corporations, however, could be required to pay tax on the income generated from
ownership of these Certificates.
In the alternative, if the Certificates are treated as interests in a
partnership (not taxable as a corporation) for Federal income tax purposes, the
same treatment should also apply for Illinois tax purposes. In such case,
Illinois could view the partnership as doing business in Illinois, and the
entity could be subject to Illinois personal property replacement income taxes.
Such taxes could result in reduced distributions to Certificateholders. Also, a
Certificateholder not otherwise subject to taxation in Illinois could become
subject to Illinois income taxes as a result of its mere ownership of
Certificates.
If the Certificates are instead treated as ownership interests in an
association taxable as a corporation or a "publicly traded partnership" taxable
as a corporation, then the entity could be subject to Illinois income tax. Such
taxes could result in reduced distributions to Certificateholders. A
Certificateholder not otherwise subject to tax in Illinois would not become
subject to Illinois taxes as a result of its mere ownership of such an interest.
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Because each state's income tax laws vary, it is impossible to predict the
income tax consequences to the Certificateholders in all of the state taxing
jurisdictions in which they are already subject to tax. There can be no
assurance that other states will not claim that the Master Servicer or
Subservicers have not undertaken activities in such states. If such a claim were
made, no assurances can be given as to whether the Certificates would be treated
as indebtedness by any particular state. Certificateholders are urged to consult
their own tax advisors with respect to state taxes.
ERISA CONSIDERATIONS
GENERAL
Section 406 of ERISA and Section 4975 of the Code prohibit a pension,
profit-sharing or other employee benefit plan from engaging in certain
transactions involving "plan assets" with persons that are "parties in
interests" under ERISA or "disqualified persons" under the Code with respect to
the Plan. A violation of these "prohibited transactions" rules may generate
excise tax and other liabilities under ERISA and the Code for such person. For
example, a prohibited transaction would arise, unless an exemption were
available, if the Certificates were viewed as debt of the Seller and the Seller
were a disqualified person or party in interest with respect to a plan that
acquired Certificates.
Moreover, additional prohibited transactions could arise if the assets of
the Trust were deemed to constitute assets of any plan that owned Certificates.
The Department of Labor ("DOL") has issued a final regulation (the "Plan Assets
Regulation") concerning the definition of what constitutes the "plan assets" of
an employee benefit plan subject to ERISA or the Code, or an individual
retirement account ("IRA") (collectively referred to as "Benefit Plans"). Under
the Plan Assets Regulation the assets and properties of certain corporations,
partnerships and certain other entities in which a Benefit Plan acquires an
"equity interest" could be deemed to hold plan assets of each Benefit Plan
unless one of the exceptions under the Plan Assets Regulations is applicable to
the Trust.
AVAILABILITY OF EXEMPTIONS FOR CERTIFICATES
The Plan Assets Regulation contains an exception (the "Publicly-Offered
Securities Exemption") that provides that if a Benefit Plan acquires a
"publicly-offered security", the issuer of the security is not deemed to hold
plan assets. A publicly-offered security is a security that is (i) freely
transferable, (ii) part of a class of securities that is owned by 100 or more
investors independent of the issuer and of one another and (iii) either is (A)
part of a class of securities registered under Section 12(g) of the Exchange Act
or (B) sold to the plan as part of an offering of securities to the public
pursuant to an effective registration statement under the Securities Act and the
class of securities of which such security is a part is registered under the
Exchange Act within 120 days (or such later time as may be allowed by the
Commission) after the end of the fiscal year of the issuer during which the
offering of such securities to the public occurred.
It is anticipated that the Certificates will meet the criteria of the
Publicly-Offered Securities Exemptions as set forth above. The Underwriters
expect (although no assurance can be given) that the Certificates will be held
by at least 100 independent persons at the conclusion of the offering; there are
no restrictions imposed on the transfer of the Certificates; and the
Certificates will be sold as part of an offering pursuant to an effective
registration statement under the Securities Act, and then will be timely
registered under the Exchange Act. The Underwriters will notify the Trustee as
to whether or not the Certificates will be held by 100 independent persons at
the conclusion of the offering. The Seller will not, however, determine whether
the 100-investor requirement of the Publicly-Offered Securities Exemption is
satisfied with respect to the Certificates.
87
<PAGE> 88
If the Certificates fail to meet the criteria of the Publicly-Offered
Securities Exemption and the Trust's assets are deemed to include assets of
Benefit Plans that are holders of Certificates, transactions involving the Trust
and "parties in interest" or "disqualified persons" with respect to such plans
might be prohibited under Section 406 of ERISA and Section 4975 of the Code
unless another ERISA prohibited transaction exemption is applicable. Thus, for
example, if a participant in any Benefit Plan is an obligor or guarantor of one
of the Mortgage Loans under DOL interpretations the purchase of the Certificates
by such plan could constitute a prohibited transaction. There are four class
exemptions issued by the DOL that may apply in such event; DOL Prohibited
Transaction Exemption 84-14 (Class Exemption for Certain Transactions Involving
Bank Collective Investment Funds), 90-1 (Class Exemptions for Transactions
Involving Insurance Company Pooled Separate Accounts) and 95-60 (Class Exemption
for Transactions Involving Insurance Company General Accounts). There is no
assurance that these exemptions, even if all of the conditions specified therein
are satisfied, will apply to all transactions involving the Trust's assets.
REVIEW BY BENEFIT PLAN FIDUCIARIES
Due to the complexity of these rules and the penalties imposed upon persons
involved in prohibited transactions, it is especially important that any Benefit
Plan fiduciary who proposes to cause a Benefit Plan to purchase Certificates
should consult with its own counsel with respect to the potential consequences
under ERISA and the Code of the Benefit Plan's acquisition and ownership of
Certificates. Assets of a Benefit Plan should not be invested in the
Certificates unless it is clear that the assets of the Trust will not be plan
assets or unless it is clear that a prohibited transaction class exemption will
apply and exempt all potential prohibited transactions.
LEGAL INVESTMENT CONSIDERATIONS
Although, as a condition to their issuance, the Certificates will be rated
in the highest rating category by the Rating Agencies, the Certificates will not
constitute "mortgage related securities" for purposes of SMMEA because not all
the mortgages securing the Mortgage Loans are first mortgages. Accordingly, many
institutions with legal authority to invest in comparably rated securities based
on first mortgage loans may not be legally authorized to invest in the
Certificates, which because they evidence interests in a pool that includes
second mortgage loans are not "mortgage related securities" under SMMEA.
88
<PAGE> 89
UNDERWRITING
Subject to the terms and conditions set forth in the Underwriting Agreement
dated May 16, 1996 (the "Underwriting Agreement") among the Seller, the
Subservicers, HFC and the Underwriters named below (the "Underwriters"), the
Seller has agreed to sell to the Underwriters and each of the Underwriters has
agreed to purchase, the principal amount of the Certificates set forth opposite
its name below.
<TABLE>
<CAPTION>
PRINCIPAL AMOUNT
UNDERWRITERS OF CERTIFICATES
- ---------------------------------------------------------------------------- ----------------
<S> <C>
Goldman, Sachs & Co. ....................................................... $204,878,000
Lehman Brothers Inc. ....................................................... 204,800,000
Merrill Lynch & Co. ........................................................ 204,800,000
Morgan Stanley & Co. Incorporated........................................... 204,800,000
------------
Total....................................................................... $819,278,000
============
</TABLE>
The Underwriters propose to offer all of the Certificates in part directly
to retail and institutional purchasers at the initial public offering prices set
forth on the cover page of this Prospectus and in part to certain securities
dealers at such prices less concessions not to exceed 0.20% of the Original
Certificate Principal Balance. The Underwriters may allow, and such dealers may
reallow, concessions not to exceed 0.125% of the Original Certificate Principal
Balance to certain brokers and dealers. After the Certificates are released for
sale to the public, the offering price and other selling terms may be varied by
the Underwriters.
The Seller and HFC have agreed to indemnify the Underwriters against
certain liabilities, including liabilities under the Securities Act of 1933, as
amended.
EXPERTS
The financial statements of Capital Markets Assurance Corporation as of
December 31, 1995 and 1994 and for each of the years in the three-year period
ended December 31, 1995 are attached hereto as Annex II and have been audited by
KPMG Peat Marwick LLP, independent certified public accountants, as set forth in
their report thereon and are included in reliance upon the authority of said
firm as experts in accounting and auditing.
The report of KPMG Peat Marwick LLP covering the financial statements noted
above refers to Capital Markets Assurance Corporation's adoption at December 31,
1993 of Financial Accounting Standards Board's Statement of Financial Accounting
Standards No. 115, "Accounting for Certain Investments in Debt and Equity
Securities."
LEGAL MATTERS
Certain legal matters relating to the Certificates will be passed upon for
the Seller by John W. Blenke, Vice President -- Corporate Law for Household
International, Inc., the parent company of HFC and the Seller, and by Sidley &
Austin, Chicago, Illinois, special counsel to the Seller. Certain legal matters
will be passed upon for the Underwriters by Brown & Wood, New York, New York.
Certain legal matters will be passed upon for the Certificate Insurer by Shaw,
Pittman, Potts & Trowbridge, New York, New York. As of the date of this
Prospectus, Mr. Blenke is a full-time employee and an officer of Household
International, Inc. and beneficially owns, and holds options to purchase, shares
of Common Stock of Household International, Inc.
89
<PAGE> 90
INDEX OF DEFINED TERMS
<TABLE>
<CAPTION>
PAGE(S)
----------
<S> <C>
1934 Act........................................................................ 3
Accelerated Principal Distribution Amount....................................... 17, 57
Additional Balances............................................................. 5, 43
Adjustable Rate Mortgages....................................................... 8
Administrative Charges.......................................................... 9, 31
Agreement....................................................................... 1, 4
Alternative Principal Distribution Amount....................................... 18, 59
Bankruptcy Code................................................................. 29
Benefit Plans................................................................... 87
BIF............................................................................. 55
Business Day.................................................................... 57
CapMAC.......................................................................... 7
Carryover Amount................................................................ 13, 60
CEDEL........................................................................... 12
CEDEL Participants.............................................................. 71
Certificate Insurer............................................................. 1, 7
Certificate Owners.............................................................. 3
Certificate Principal Balance................................................... 6, 49
Certificate Rate................................................................ 5, 13
Certificateholders.............................................................. 12
Certificateholders' Excess Interest............................................. 17, 58
Certificateholders' Floating Allocation Percentage.............................. 16, 56
Certificateholders' Remaining Excess Interest................................... 17, 58
Certificates.................................................................... 1, 5
Charge Off Amount............................................................... 5, 56
Charged Off Mortgage Loan....................................................... 5, 57
Chemical........................................................................ 12
Citibank........................................................................ 12
Civil Relief Act................................................................ 78
Class A Certificates............................................................ 1, 5
Closing Date.................................................................... 13
Code............................................................................ 81
Collection Account.............................................................. 15, 54
Collection Period............................................................... 8, 58
Combined Exposure............................................................... 64
Combined Loan-to-Value Ratio.................................................... 8, 36
Commission...................................................................... 2
Cooperative..................................................................... 71
CPR............................................................................. 83
Credit Limit.................................................................... 8
Credit Line Agreements.......................................................... 4, 36
Cut-Off Balances................................................................ 4
Cut-Off Date.................................................................... 4
Cut-Off Date Pool Balance....................................................... 43
Cycle Date...................................................................... 8, 58
</TABLE>
90
<PAGE> 91
<TABLE>
<CAPTION>
PAGE(S)
----------
<S> <C>
Defective Mortgage Loans........................................................ 52
Deficiency Amount............................................................... 19
Depositary(ies)................................................................. 12, 69
Determination Date.............................................................. 21, 54, 57
Distribution Date............................................................... 1, 13, 57
DOL............................................................................. 87
DTC............................................................................. 3, A-1
due-on-sale..................................................................... 80
Duff & Phelps................................................................... 44
Eligible Account................................................................ 55
Eligible Substitute Mortgage Loan............................................... 22, 52
ERISA........................................................................... 24
Euroclear....................................................................... 12
Euroclear Operator.............................................................. 71
Euroclear Participants.......................................................... 71
FDIC............................................................................ 6
Fixed Allocation Percentage..................................................... 18, 56
Fixed Rate Mortgages............................................................ 8
Foreclosure Profit.............................................................. 56
Funding Account................................................................. 4, 15, 54
Funding Period.................................................................. 16
Garn-St. Germain Act............................................................ 80
Global Securities............................................................... A-1
Guaranteed Principal Distribution Amount........................................ 19
HFC............................................................................. 1, 4
HFC Note........................................................................ 54
holders......................................................................... 12
Holdings........................................................................ 44
Index Rate...................................................................... 32
indirect participants........................................................... 71
Initial Mortgage Loans.......................................................... 4
Insurance Agreement............................................................. 19, 61
Interest Collections............................................................ 14, 55
Interest Period................................................................. 13, 59
Invested Amount................................................................. 6, 49
Investor Certificate Principal Balance.......................................... 6
Investor Certificateholders..................................................... 12
Investor Servicing Fee.......................................................... 21
IRA............................................................................. 87
IRS............................................................................. 81
LIBOR........................................................................... 13, 60
LIBOR Business Day.............................................................. 60
Liquidated Mortgage Loan........................................................ 5, 58
Liquidation Loss Amount......................................................... 17, 58
Liquidation Proceeds............................................................ 58
Loan Rate....................................................................... 31
Margin.......................................................................... 31
Master Servicer................................................................. 1, 4, 30
</TABLE>
91
<PAGE> 92
<TABLE>
<CAPTION>
PAGE(S)
----------
<S> <C>
Maximum Principal Distribution Amount........................................... 18, 59
Minimum Monthly Payment......................................................... 9, 31
Moody's......................................................................... 28
Mortgages....................................................................... 1
Mortgage Loan Schedule.......................................................... 50
Mortgage Loans.................................................................. 1, 4
Mortgaged Properties............................................................ 4
net interest rate............................................................... 46
Net Liquidation Proceeds........................................................ 14, 55, 65
Net Loan Rate................................................................... 13
Net Property Value.............................................................. 34
OID............................................................................. 82
Opinion Letter.................................................................. 81
Original Certificate Principal Balance.......................................... 5, 49
Original Invested Amount........................................................ 6, 49
Overcollateralization Amount.................................................... 17, 58
Participants.................................................................... 71
Paying Agent.................................................................... 60
Permitted Investments........................................................... 55
Plan............................................................................ 24
Plan Assets Regulation.......................................................... 87
Policy.......................................................................... 1, 4
Pool Balance.................................................................... 5, 56
Pool Date....................................................................... 7, 36
Pool Factor..................................................................... 48
Prepayment Assumption........................................................... 83
Principal Collections........................................................... 14, 55
Property Value.................................................................. 34
publicly-offered securities..................................................... 87
Publicly-Offered Securities Exemption........................................... 87
Rapid Amortization Event........................................................ 60
Rapid Amortization Period....................................................... 19, 60
Rating Agencies................................................................. 24
Receivables Purchase Agreement.................................................. 10
Record Date..................................................................... 57
Recovered Charge Off Amount..................................................... 56
Reference Bank Rate............................................................. 60
Related Documents............................................................... 7
Removed Balances................................................................ 10, 53
Replacement Certificates........................................................ 72
Required Overcollateralization Amount........................................... 17, 58
Retransfer Deposit Amount....................................................... 11, 51
Retransfer Notification Date.................................................... 53
Retransfer Price................................................................ 22, 69
Rules........................................................................... 70
SAIF............................................................................ 55
Scheduled Principal Distribution Amount......................................... 18, 59
Seller.......................................................................... 1, 4
</TABLE>
92
<PAGE> 93
<TABLE>
<CAPTION>
PAGE(S)
----------
<S> <C>
Seller Collections.............................................................. 58
Seller Interest................................................................. 1, 6, 49
Senior Indebtedness Expenses.................................................... 34
Service......................................................................... 23
Servicer Credit Facility........................................................ 54
Servicer Credit Facility Issuer................................................. 54
Servicing Fee................................................................... 21, 65
Servicing Termination Events.................................................... 67
SMMEA........................................................................... 24
Special Foreclosed Mortgage Loan................................................ 53
Spread Account.................................................................. 20, 61
Standard & Poor's............................................................... 28
Subsequent Funding Mortgage Loans............................................... 4
Subservicer..................................................................... 7, 29
Tax Counsel..................................................................... 81
Terms and Conditions............................................................ 71
Title V......................................................................... 80
Trust........................................................................... 1, 4
Trust Balance................................................................... 5, 56
Trustee......................................................................... 1, 4, 7
Underwriters.................................................................... 89
Underwriting Agreement.......................................................... 89
U.S. Person..................................................................... A-4
Window Period Loans............................................................. 80
</TABLE>
93
<PAGE> 94
ANNEX I
GLOBAL CLEARANCE, SETTLEMENT AND TAX DOCUMENTATION PROCEDURES
Except in certain limited circumstances, the globally offered Revolving
Home Equity Loan Asset Backed Certificates, Series 1996-1 (the "Global
Securities") will be available only in book-entry form. Investors in the Global
Securities may hold such Global Securities through any of The Depository Trust
Company ("DTC"), CEDEL or Euroclear. The Global Securities will be tradeable as
home market instruments in both the European and U.S. domestic markets. Initial
settlement and all secondary trades will settle in same-day funds.
Secondary market trading between investors holding Global Securities
through CEDEL and Euroclear will be conducted in the ordinary way in accordance
with their normal rules and operating procedures and in accordance with
conventional eurobond practice (i.e., seven calendar day settlement).
Secondary market trading between investors holding Global Securities
through DTC will be conducted according to the rules and procedures applicable
to U.S. corporate debt obligations and prior Home Equity Loan Asset Backed
Certificates issues.
Secondary cross-market trading between CEDEL or Euroclear and DTC
Participants holding Certificates will be effected on a delivery-against-payment
basis through the respective Depositaries of CEDEL and Euroclear (in such
capacity) and as DTC Participants.
Non-U.S. holders (as described below) of Global Securities will be subject
to U.S. withholding taxes unless such holders meet certain requirements and
deliver appropriate U.S. tax documents to the securities clearing organizations
or their participants.
INITIAL SETTLEMENT
All Global Securities will be held in book-entry form by DTC in the name of
CEDE & Co. as nominee of DTC. Investors' interests in the Global Securities will
be represented through financial institutions acting on their behalf as direct
and indirect Participants in DTC. As a result, CEDEL and Euroclear will hold
positions on behalf of their participants through their respective Depositaries,
which in turn will hold such positions in accounts as DTC Participants.
Investors electing to hold their Global Securities through DTC will follow
the settlement practices applicable to prior Home Equity Loan Asset Backed
Certificates issues. Investor securities custody accounts will be credited with
their holdings against payment in same-day funds on the settlement date.
Investors electing to hold their Global Securities through CEDEL or
Euroclear accounts will follow the settlement procedures applicable to
conventional eurobonds, except that there will be no temporary global security
and no "lock-up" or restricted period. Global Securities will be credited to the
securities custody accounts on the settlement date against payment in same-day
funds.
SECONDARY MARKET TRADING
Since the purchaser determines the place of delivery, it is important to
establish at the time of the trade where both the purchaser's and seller's
accounts are located to ensure that settlement can be made on the desired value
date.
Trading between DTC Participants. Secondary market trading between DTC
Participants will be settled using the procedures applicable to prior Home
Equity Loan Asset Backed Certificates issues in same-day funds.
A-1
<PAGE> 95
Trading between CEDEL and/or Euroclear Participants. Secondary market
trading between CEDEL Participants or Euroclear Participants will be settled
using the procedures applicable to conventional eurobonds in same-day funds.
Trading between DTC seller and CEDEL or Euroclear purchaser. When Global
Securities are to be transferred from the account of a DTC Participant to the
account of a CEDEL Participant or a Euroclear Participant, the purchaser will
send instructions to CEDEL or Euroclear through a CEDEL Participant or Euroclear
Participant at least one business day prior to settlement. CEDEL or Euroclear
will instruct the respective Depositary, as the case may be, to receive the
Global Securities against payment. Payment will include interest accrued on the
Global Securities from and including the last coupon payment date to and
excluding the settlement date, on the basis of (i) the actual number of days in
such accrual period and a year assumed to consist of 360 days. For transactions
settling on the 31st of the month, payment will include interest accrued to and
excluding the first day of the following month. Payment will then be made by the
respective Depositary of the DTC Participant's account against delivery of the
Global Securities. After settlement has been completed, the Global Securities
will be credited to the respective clearing system and by the clearing system,
in accordance with its usual procedures, to the CEDEL Participant's or Euroclear
Participant's account. The securities credit will appear the next day (European
time) and the cash debt will be back-valued to, and the interest on the Global
Securities will accrue from, the value date (which would be the preceding day
when settlement occurred in New York). If settlement is not completed on the
intended value date (i.e., the trade fails), the CEDEL or Euroclear cash debt
will be valued instead as of the actual settlement date.
CEDEL Participants and Euroclear Participants will need to make available
to the respective clearing systems the funds necessary to process same-day funds
settlement. The most direct means of doing so is to preposition funds for
settlement, either from cash on hand or existing lines of credit, as they would
for any settlement occurring within CEDEL or Euroclear. Under this approach,
they may take on credit exposure to CEDEL or Euroclear until the Global
Securities are credited to their accounts one day later.
As an alternative, if CEDEL or Euroclear has extended a line of credit to
them, CEDEL Participants or Euroclear Participants can elect not to preposition
funds and allow that credit line to be drawn upon to finance the settlement.
Under this procedure, CEDEL Participants or Euroclear Participants purchasing
Global Securities would incur overdraft charges for one day, assuming they
cleared the overdraft when the Global Securities were credited to their
accounts. However, interest on the Global Securities would accrue from the value
date. Therefore, in many cases the investment income on the Global Securities
earned during that one-day period may substantially reduce or offset the amount
of such overdraft charges, although this result will depend on each CEDEL
Participant's or Euroclear Participant's particular cost of funds.
Since the settlement is taking place during New York business hours, DTC
Participants can employ their usual procedures for sending Global Securities to
the respective Depositary for the benefit of CEDEL Participants or Euroclear
Participants. The sale proceeds will be available to the DTC seller on the
settlement date. Thus, to the DTC Participant a cross-market transaction will
settle no differently than a trade between two DTC Participants.
Trading between CEDEL or Euroclear seller and DTC purchaser. Due to time
zone differences in their favor, CEDEL Participants and Euroclear Participants
may employ their customary procedures for transactions in which Global
Securities are to be transferred by the respective clearing system, through the
respective Depositary, to a DTC Participant. The seller will send instructions
to CEDEL or Euroclear through a CEDEL Participant or Euroclear Participant at
least one business day prior to settlement. In these cases, CEDEL or Euroclear
will instruct the respective Depositary, as appropriate, to deliver the Global
Securities to the DTC Participant's account against payment. Payment will
include interest accrued on the Global Securities from and including the last
coupon payment to and
A-2
<PAGE> 96
excluding the settlement date on the basis of (i) the actual number of days in
such accrual period and a year assumed to consist of 360 days. For transactions
settling on the 31st of the month, payment will include interest accrued to and
excluding the first day of the following month. The payment will then be
reflected in the account of the CEDEL Participant or Euroclear Participant the
following day, and receipt of the cash proceeds in the CEDEL Participant's or
Euroclear Participant's account would be backed-valued to the value date (which
would be the preceding day, when settlement occurred in New York). Should the
CEDEL Participant or Euroclear Participant have a line of credit with its
respective clearing system and elect to be in debt in anticipation of receipt of
the sale proceeds in its account, the back-valuation will extinguish any
overdraft incurred over that one-day period. If settlement is not completed on
the intended value date (i.e., the trade fails), receipt of the cash proceeds in
the CEDEL Participant's or Euroclear Participant's account would instead be
valued as of the actual settlement date.
Finally, day traders that use CEDEL or Euroclear and that purchase Global
Securities from DTC Participants for delivery to CEDEL Participants or Euroclear
Participants should note that these trades would automatically fail on the sale
side unless affirmative action were taken. At least three techniques should be
readily available to eliminate this potential problem:
(a) borrowing through CEDEL or Euroclear for one day (until the purchase
side of the day trade is reflected in their CEDEL or Euroclear accounts) in
accordance with the clearing system's customary procedures;
(b) borrowing the Global Securities in the U.S. from a DTC Participant no
later than one day prior to settlement, which would give the Global Securities
sufficient time to be reflected in their CEDEL or Euroclear account in order to
settle the sale side of the trade; or
(c) staggering the value dates for the buy and sell sides of the trade so
that the value date for the purchase from the DTC Participant is at least one
day prior to the value date for the sale to the CEDEL Participant or Euroclear
Participant.
CERTAIN U.S. FEDERAL INCOME TAX DOCUMENTATION REQUIREMENTS
A beneficial owner of Global Securities holding securities through CEDEL or
Euroclear (or through DTC if the holder has an address outside the U.S.) will be
subject to the 30% U.S. withholding tax that generally applies to payments of
interest (including original issue discount) on registered debt issued by U.S.
Persons, unless (i) each clearing system, bank or other financial institution
that holds customers' securities in the ordinary course of its trade or business
in the chain of intermediaries between such beneficial owner and the U.S. entity
required to withhold tax complies with applicable certification requirements and
(ii) such beneficial owner takes one of the following steps to obtain an
exemption or reduced tax rate:
Exemption for non-U.S. Persons (Form W-8). Beneficial owners of Global
Securities that are non-U.S. Persons can obtain a complete exemption from the
withholding tax by filing a signed Form W-8 (Certificate of Foreign Status). If
the information shown on Form W-8 changes, a new Form W-8 must be filed within
30 days of such change.
Exemption for non-U.S. Persons with effectively connected income (Form
4224). A non-U.S. Person, including a non-U.S. corporation or bank with a U.S.
branch, for which the interest income is effectively connected with its conduct
of a trade or business in the United States, can obtain an exemption from the
withholding tax by filing Form 4224 (Exemption from Withholding of Tax on Income
Effectively Connected with the Conduct of a Trade or Business in the United
States).
Exemption or reduced rate for non-U.S. Persons resident in treaty countries
(Form 1001). Non-U.S. Persons that are Certificate Owners residing in a country
that has a tax treaty with the United States can obtain an exemption or reduced
tax rate (depending on the treaty terms) by filing
A-3
<PAGE> 97
Form 1001 (Ownership, Exemption or Reduced Rate Certificate). If the treaty
provides only for a reduced rate, withholding tax will be imposed at that rate
unless the filer alternatively files Form W-8. Form 1001 may be filed by the
Certificate Owner or his agent.
Exemption for U.S. Persons (Form W-9). U.S. Persons can obtain a complete
exemption from the withholding tax by filing Form W-9 (Payer's Request for
Taxpayer Identification Number and Certification).
U.S. Federal Income Tax Reporting Procedure. The Certificate Owner of a
Global Security or, in the case of a Form 1001 or a Form 4224 filer, his agent,
files by submitting the appropriate form to the person through whom it holds
(the clearing agency, in the case of persons holding directly on the books of
the clearing agency). Form W-8 and Form 1001 are effective for three calendar
years and Form 4224 is effective for one calendar year.
The term "U.S. Person" means (i) a citizen or resident of the United
States, (ii) a corporation or partnership organized in or under the laws of the
United States or any political subdivision thereof or (iii) an estate or trust
the income of which is includible in gross income for United States tax
purposes, regardless of its source. This summary does not deal with all aspects
of U.S. Federal income tax withholding that may be relevant to foreign holders
of the Global Securities. Investors are advised to consult their own tax
advisors for specific tax advice concerning their holding and disposing of the
Global Securities.
A-4
<PAGE> 98
[LOGO]
ANNEX II
CAPITAL MARKETS ASSURANCE CORPORATION
FINANCIAL STATEMENTS
DECEMBER 31, 1995, 1994 AND 1993
(WITH INDEPENDENT AUDITORS' REPORT THEREON)
F-1
<PAGE> 99
[PEAT MARWICK LETTERHEAD]
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Capital Markets Assurance Corporation:
We have audited the accompanying balance sheets of Capital Markets Assurance
Corporation as of December 31, 1995 and 1994 and the related statements of
income, stockholder's equity and cash flows for each of the years in the
three-year period ended December 31, 1995. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Capital Markets Assurance
Corporation as of December 31, 1995 and 1994 and the results of its operations
and its cash flows for each of the years in the three-year period ended December
31, 1995 in conformity with generally accepted accounting principles.
As discussed in note 2, the Company changed its method of accounting for
investments to adopt the provisions of the Financial Accounting Standards
Board's Statement of Financial Accounting Standards No. 115, "Accounting for
Certain Investments in Debt and Equity Securities," at December 31, 1993.
[KPMG Peat Marwick LLP SIG]
January 25, 1996
[COPYWHITE]
F-2
<PAGE> 100
CAPITAL MARKETS ASSURANCE CORPORATION
BALANCE SHEETS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31, 1995 DECEMBER 31, 1994
----------------- -----------------
<S> <C> <C>
ASSETS
INVESTMENTS:
Bonds at fair value (amortized cost $210,651 at December
31, 1995 and $178,882 at December 31, 1994)............. $ 215,706 172,016
Short-term investments (at amortized cost which
approximates fair value)................................ 68,646 2,083
Mutual funds at fair value (cost $16,434 at December 31,
1994)................................................... -- 14,969
-------- --------
Total investments....................................... 284,352 189,068
-------- --------
Cash...................................................... 344 85
Accrued investment income................................. 3,136 2,746
Deferred acquisition costs................................ 35,162 24,860
Premiums receivable....................................... 3,540 3,379
Prepaid reinsurance....................................... 13,171 5,551
Other assets.............................................. 3,428 3,754
-------- --------
TOTAL ASSETS............................................ $ 343,133 229,443
======== ========
LIABILITIES AND STOCKHOLDER'S EQUITY
LIABILITIES:
Unearned premiums......................................... $ 45,767 25,905
Reserve for losses and loss adjustment expenses........... 6,548 5,191
Ceded reinsurance......................................... 2,469 1,497
Accounts payable and other accrued expenses............... 10,844 10,372
Current income taxes...................................... 136 --
Deferred income taxes..................................... 11,303 3,599
-------- --------
Total liabilities....................................... 77,067 46,564
-------- --------
STOCKHOLDER'S EQUITY:
Common stock.............................................. 15,000 15,000
Additional paid-in capital................................ 205,808 146,808
Unrealized appreciation (depreciation) on investments, net
of tax.................................................. 3,286 (5,499)
Retained earnings......................................... 41,972 26,570
-------- --------
Total stockholder's equity.............................. 266,066 182,879
-------- --------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY.............. $ 343,133 229,443
======== ========
</TABLE>
See accompanying notes to financial statements.
F-3
<PAGE> 101
CAPITAL MARKETS ASSURANCE CORPORATION
STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 1995 DECEMBER 31, 1994 DECEMBER 31, 1993
----------------- ----------------- -----------------
<S> <C> <C> <C>
REVENUES:
Direct premiums written.................... $ 56,541 43,598 24,491
Assumed premiums written................... 935 1,064 403
Ceded premiums written..................... (15,992) (11,069) (3,586)
-------- -------- --------
Net premiums written..................... 41,484 33,593 21,308
Increase in unearned premiums.............. (12,242) (10,490) (3,825)
-------- -------- --------
Net premiums earned...................... 29,242 23,103 17,483
Net investment income...................... 11,953 10,072 10,010
Net realized capital gains................. 1,301 92 1,544
Other income............................... 2,273 120 354
-------- -------- --------
Total revenues........................... 44,769 33,387 29,391
-------- -------- --------
EXPENSES:
Losses and loss adjustment expenses........ 3,141 1,429 902
Underwriting and operating expenses........ 13,808 11,833 11,470
Policy acquisition costs................... 7,203 4,529 2,663
-------- -------- --------
Total expenses........................... 24,152 17,791 15,035
-------- -------- --------
Income before income taxes............... 20,617 15,596 14,356
-------- -------- --------
INCOME TAXES:
Current income tax......................... 2,113 865 1,002
Deferred income tax........................ 3,102 2,843 2,724
-------- -------- --------
Total income taxes....................... 5,215 3,708 3,726
-------- -------- --------
NET INCOME............................... $ 15,402 11,888 10,630
======== ======== ========
</TABLE>
See accompanying notes to financial statements.
F-4
<PAGE> 102
CAPITAL MARKETS ASSURANCE CORPORATION
STATEMENTS OF STOCKHOLDER'S EQUITY
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 1995 DECEMBER 31, 1994 DECEMBER 31, 1993
----------------- ----------------- -----------------
<S> <C> <C> <C>
COMMON STOCK:
Balance at beginning of period............. $ 15,000 15,000 15,000
-------- -------- --------
Balance at end of period................. 15,000 15,000 15,000
-------- -------- --------
ADDITIONAL PAID-IN CAPITAL:
Balance at beginning of period............. 146,808 146,808 146,808
Paid-in capital............................ 59,000 -- --
-------- -------- --------
Balance at end of period................. 205,808 146,808 146,808
-------- -------- --------
UNREALIZED (DEPRECIATION) APPRECIATION ON
INVESTMENTS, NET OF TAX:
Balance at beginning of period............. (5,499) 3,600 --
Unrealized appreciation (depreciation) on
investments.............................. 8,785 (9,099) 3,600
-------- -------- --------
Balance at end of period................. 3,286 (5,499) 3,600
-------- -------- --------
RETAINED EARNINGS:
Balance at beginning of period............. 26,570 14,682 4,052
Net income................................. 15,402 11,888 10,630
-------- -------- --------
Balance at end of period................. 41,972 26,570 14,682
-------- -------- --------
TOTAL STOCKHOLDER'S EQUITY............... $ 266,066 182,879 180,090
======== ======== ========
</TABLE>
See accompanying notes to financial statements.
F-5
<PAGE> 103
CAPITAL MARKETS ASSURANCE CORPORATION
STATEMENTS OF CASH FLOWS
(DOLLAR IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 1995 DECEMBER 31, 1994 DECEMBER 31, 1993
----------------- ----------------- -----------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................... $ 15,402 11,888 10,630
--------- -------- --------
ADJUSTMENTS TO RECONCILE NET INCOME TO NET
CASH PROVIDED (USED) BY OPERATING ACTIVITIES:
Reserve for losses and loss adjustment
expenses................................ 1,357 1,429 902
Unearned premiums.......................... 19,862 15,843 4,024
Deferred acquisition costs................. (10,302) (9,611) (9,815)
Premiums receivable........................ (161) (2,103) (432)
Accrued investment income.................. (390) (848) (110)
Income taxes payable....................... 3,621 2,611 2,872
Net realized capital gains................. (1,301) (92) (1,544)
Accounts payable and other accrued
expenses................................ 472 3,726 1,079
Prepaid reinsurance........................ (7,620) (5,352) (199)
Other, net................................. 992 689 1,201
--------- -------- --------
Total adjustments....................... 6,530 6,292 (2,022)
--------- -------- --------
NET CASH PROVIDED BY OPERATING
ACTIVITIES.............................. 21,932 18,180 8,608
--------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments..................... (158,830) (77,980) (139,061)
Proceeds from sales of investments........... 49,354 39,967 24,395
Proceeds from maturities of investments...... 28,803 19,665 106,042
--------- -------- --------
NET CASH USED IN INVESTING ACTIVITIES...... (80,673) (18,348) (8,624)
--------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Capital contribution......................... 59,000 -- --
--------- -------- --------
NET CASH PROVIDED BY FINANCING
ACTIVITIES.............................. 59,000 -- --
--------- -------- --------
Net increase (decrease) in cash.............. 259 (168) (16)
Cash balance at beginning of period.......... 85 253 269
--------- -------- --------
CASH BALANCE AT END OF PERIOD.............. $ 344 85 253
========= ======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Income taxes paid............................ $ 1,450 1,063 833
========= ======== ========
</TABLE>
See accompanying notes to financial statements.
F-6
<PAGE> 104
CAPITAL MARKETS ASSURANCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1995 AND 1994
1) BACKGROUND
Capital Markets Assurance Corporation ("CapMAC" or "the Company") is a New
York-domiciled monoline stock insurance company which engages only in the
business of financial guaranty and surety insurance. CapMAC is a wholly-owned
subsidiary of CapMAC Holdings Inc. ("Holdings"). CapMAC is licensed in all 50
states in addition to the District of Columbia, the Commonwealth of Puerto Rico
and the territory of Guam. CapMAC insures structured asset-backed, corporate,
municipal and other financial obligations in the U.S. and international capital
markets. CapMAC also provides financial guaranty reinsurance for structured
asset-backed, corporate, municipal and other financial obligations written by
other major insurance companies.
CapMAC's claims-paying ability is rated "Aaa" by Moody's Investors Service,
Inc. ("Moody's"), "AAA" by S&P Ratings Group ("S&P"), "AAA" by Duff & Phelps
Credit Rating Co. ("Duff & Phelps"), and "AAA" by Nippon Investors Service,
Inc., a Japanese rating agency. Such ratings reflect only the views of the
respective rating agencies, are not recommendations to buy, sell or hold
securities and are subject to revision or withdrawal at any time by such rating
agencies.
2) SIGNIFICANT ACCOUNTING POLICIES
Significant accounting policies used in the preparation of the accompanying
financial statements are as follows:
A) BASIS OF PRESENTATION
The accompanying financial statements are prepared on the basis of
generally accepted accounting principles ("GAAP"). Such accounting
principles differ from statutory reporting practices used by insurance
companies in reporting to state regulatory authorities.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
the disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Management believes the most significant
estimates relate to deferred acquisition costs, reserve for losses and loss
adjustment expenses and disclosures of financial guarantees outstanding.
Actual results could differ from those estimates.
B) INVESTMENTS
At December 31, 1993, the Company adopted the provisions of Statement
of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." Under SFAS No. 115, the Company
can classify its debt and marketable equity securities in one of three
categories: trading, available-for-sale, or held-to-maturity. Trading
securities are bought and held principally for the purpose of selling them
in the near term. Held-to-maturity securities are those securities in which
the Company has the ability and intent to hold the securities until
maturity. All other securities not included in trading or held-to-maturity
are classified as available-for-sale. As of December 31, 1995 and 1994, all
of the Company's securities have been classified as available-for-sale.
F-7
<PAGE> 105
CAPITAL MARKETS ASSURANCE CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Available-for-sale securities are recorded at fair value. Fair value
is based upon quoted market prices. Unrealized holding gains and losses,
net of the related tax effect, on available-for-sale securities are
excluded from earnings and are reported as a separate component of
stockholder's equity until realized. Transfers of securities between
categories are recorded at fair value at the date of transfer.
A decline in the fair value of any available-for-sale security below
cost that is deemed other than temporary is charged to earnings resulting
in the establishment of a new cost basis for the security.
Short-term investments are those investments having a maturity of less
than one year at purchase date. Short-term investments are carried at
amortized cost which approximates fair value.
Premiums and discounts are amortized or accreted over the life of the
related security as an adjustment to yield using the effective interest
method. Dividend and interest income are recognized when earned. Realized
gains and losses are included in earnings and are derived using the FIFO
(first-in, first-out) method for determining the cost of securities sold.
C) REVENUE RECOGNITION
Premiums which are payable monthly to CapMAC are reflected in income
when due, net of amounts payable to reinsurers. Premiums which are payable
quarterly, semi-annually or annually are reflected in income, net of
amounts payable to reinsurers, on an equal monthly basis over the
corresponding policy term. Premiums that are collected as a single premium
at the inception of the policy and have a term longer than one year are
earned, net of amounts payable to reinsurers, by allocating premium to each
bond maturity based on the principal amount and earning it straight-line
over the term of each bond maturity. For the year ended December 31, 1995,
91% of net premiums earned were attributable to premiums payable in
installments and 9% were attributable to premiums collected on an 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. The deferred
acquisition costs are amortized over the period in proportion to the
related premium earnings. The actual amount of premium earnings may differ
from projections due to various factors such as renewal or early
termination of insurance contracts or different run-off patterns of
exposure resulting in a corresponding change in the amortization pattern of
the deferred acquisition costs.
E) RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
The reserve for losses and loss adjustment expenses consists of a
Supplemental Loss Reserve ("SLR") and a case basis loss reserve. The SLR is
established based on expected levels of defaults resulting from credit
failures on currently insured issues. This SLR is based on estimates of the
portion of earned premiums required to cover those claims.
F-8
<PAGE> 106
CAPITAL MARKETS ASSURANCE CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
A case basis loss reserve is established for insured obligations when,
in the judgement of management, a default in the timely payment of debt
service is imminent. For defaults considered temporary, a case basis loss
reserve is established in an amount equal to the present value of the
anticipated defaulted debt service payments over the expected period of
default. If the default is judged not to be temporary, the present value
of all remaining defaulted debt service payments is recorded as a case
basis loss reserve. Anticipated salvage recoveries are considered in
establishing case basis loss reserves when such amounts are reasonably
estimable.
Management believes that the current level of reserves is adequate to
cover the estimated liability for claims and the related adjustment
expenses with respect to financial guaranties issued by CapMAC. The
establishment of the appropriate level of loss reserves is an inherently
uncertain process involving numerous estimates and subjective judgments by
management, and therefore there can be no assurance that losses in CapMAC's
insured portfolio will not exceed the loss reserves.
F) DEPRECIATION
Leasehold improvements, furniture and fixtures are being depreciated
over the lease term or useful life, whichever is shorter, using the
straight-line method.
G) INCOME TAXES
Deferred income taxes are provided with respect to temporary
differences between the financial statement and tax basis of assets and
liabilities using enacted tax rates in effect for the year in which the
differences are expected to reverse.
H) RECLASSIFICATIONS
Certain prior year balances have been reclassified to conform to the
current year presentation.
F-9
<PAGE> 107
CAPITAL MARKETS ASSURANCE CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
3) INSURED PORTFOLIO
At December 31, 1995 and 1994, the principal amount of financial
obligations insured by CapMAC was $16.9 billion and $11.6 billion, respectively,
and net of reinsurance (net principal outstanding), was $12.6 billion and $9.4
billion, respectively, with a weighted average life of 6.0 years and 5.0 years,
respectively. CapMAC's insured portfolio was broadly diversified by geographic
distribution and type of insured obligations, with no single insured obligation
in excess of statutory single risk limits, after giving effect to any
reinsurance and collateral, which are a function of CapMAC's statutory qualified
capital (the sum of statutory capital and surplus and mandatory contingency
reserve). At December 31, 1995 and 1994, the statutory qualified capital was
approximately $240 million and $170 million, respectively.
<TABLE>
<CAPTION>
NET PRINCIPAL OUTSTANDING
----------------------------------------
DECEMBER 31,
DECEMBER 31, 1995 1994
----------------- ----------------
TYPE OF OBLIGATIONS INSURED AMOUNT % AMOUNT %
- ---------------------------------------------------- ------- ----- ------ -----
$ IN MILLIONS
<S> <C> <C> <C> <C>
Consumer receivables................................ $ 6,959 55.1 $4,740 50.4
Trade and other corporate obligations............... 4,912 38.9 4,039 43.0
Municipal/government obligations.................... 757 6.0 618 6.6
------- ----- ------ -----
TOTAL.......................................... $12,628 100.0 $9,397 100.0
======= ===== ====== =====
</TABLE>
At December 31, 1995, approximately 85% of CapMAC's insured portfolio was
comprised of structured asset-backed transactions. Under these structures, a
pool of assets covering at least 100% of the principal amount guaranteed under
its insurance contract is sold or pledged to a special purpose bankruptcy
remote entity. CapMAC's primary risk from such insurance contracts is the
impairment of cash flows due to delinquency or loss on the underlying assets.
CapMAC, therefore, evaluates all the factors affecting past and future asset
performance by studying historical data on losses, delinquencies and recoveries
of the underlying assets. Each transaction is reviewed to ensure that an
appropriate legal structure is used to protect against the bankruptcy risk of
the originator of the assets. Along with the legal structure, an additional
level of first loss protection is also created to protect against losses due to
credit or dilution. This first level of loss protection is usually available
from reserve funds, excess cash flows, overcollateralization, or recourse to a
third party. The level of first loss protection depends upon the historical
losses and dilution of the underlying assets, but is typically several times
the normal historical loss experience for the underlying type of assets.
During 1995, the Company sold without recourse its interest in potential
cash flows from transactions included in its insured portfolio and recognized
$2,200,000 of income which has been included in other income in the accompanying
financial statements.
The following entities each accounted for, through referrals and otherwise,
10% or more of total revenues for each of the periods presented:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1995 YEAR ENDED DECEMBER 31, 1994 YEAR ENDED DECEMBER 31, 1993
- ------------------------------ ------------------------------ ------------------------------
% OF % OF % OF
NAME REVENUES NAME REVENUES NAME REVENUES
- --------------------- -------- --------------------- -------- --------------------- --------
<S> <C> <C> <C> <C> <C>
Citicorp 15.2 Citicorp 16.3 Citicorp 13.7
Merrill Lynch & Co. 14.1
</TABLE>
F-10
<PAGE> 108
CAPITAL MARKETS ASSURANCE CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
4) INVESTMENTS
At December 31, 1995 and 1994, all of the Company's investments were
classified as available-for-sale securities. The amortized cost, gross
unrealized gains, gross unrealized losses and estimated fair value for
available-for-sale securities by major security type at December 31, 1995 and
1994 were as follows ($ in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1995
--------------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
SECURITIES AVAILABLE-FOR-SALE COST GAINS LOSSES VALUE
- -------------------------------------------------- --------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
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>
<TABLE>
<CAPTION>
DECEMBER 31, 1994
--------------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
SECURITIES AVAILABLE-FOR-SALE COST GAINS LOSSES VALUE
- -------------------------------------------------- --------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
U.S. Treasury obligations......................... $ 4,295 -- 153 4,142
Mortgage-backed securities of U.S. government
instrumentalities and agencies.................. 40,973 -- 2,986 37,987
Obligations of states, municipalities and
political subdivisions.......................... 128,856 364 3,994 125,226
Corporate and asset-backed securities............. 6,841 15 112 6,744
Mutual funds...................................... 16,434 -- 1,465 14,969
-------- ----- --- -------
TOTAL........................................ $ 197,399 379 8,710 189,068
======== ===== === =======
</TABLE>
The Company's investment in mutual funds in 1994 represents an investment
in an open-end management investment company which invests primarily in
investment-grade fixed-income securities denominated in foreign and United
States currencies.
F-11
<PAGE> 109
CAPITAL MARKETS ASSURANCE CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The amortized cost and estimated fair value of investments in debt
securities at December 31, 1995 by contractual maturity are shown below ($ in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1995
-----------------------
AMORTIZED ESTIMATED
SECURITIES AVAILABLE-FOR-SALE COST FAIR VALUE
- ----------------------------------------------------------------------- --------- ----------
<S> <C> <C>
Less than one year to maturity......................................... $ 5,569 5,572
One to five years to maturity.......................................... 37,630 38,553
Five to ten years to maturity.......................................... 99,567 102,264
Greater than ten years to maturity..................................... 35,903 37,101
-------- -------
Sub-total............................................................ 178,669 183,490
Mortgage-backed securities............................................. 100,628 100,862
-------- -------
TOTAL............................................................. $ 279,297 284,352
======== =======
</TABLE>
Actual maturities may differ from contractual maturities because borrowers
may call or prepay obligations with or without call or prepayment penalties.
Proceeds from sales of investment securities were approximately $49
million, $40 million and $24 million in 1995, 1994 and 1993, respectively. Gross
realized capital gains of $1,320,000, $714,000 and $1,621,000, and gross
realized capital losses of $19,000, $622,000 and $77,000 were realized on those
sales for the years ended December 31, 1995, 1994 and 1993, respectively.
Investments include bonds having a fair value of approximately $3,985,000
and $3,873,000 (amortized cost of $3,970,000 and $4,011,000) which are on
deposit at December 31, 1995 and 1994, respectively, with state regulators as
required by law.
Investment income is comprised of interest and dividends, net of related
expenses, and is applicable to the following sources:
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 1995 DECEMBER 31, 1994 DECEMBER 31, 1993
----------------- ----------------- -----------------
$ IN THOUSANDS
<S> <C> <C> <C>
Bonds.................................... $11,105 9,193 7,803
Short-term investments................... 1,245 484 572
Mutual funds............................. (162) 579 1,801
Investment expenses...................... (235) (184) (166)
------- ------ ------
TOTAL............................... $11,953 10,072 10,010
======= ====== ======
</TABLE>
F-12
<PAGE> 110
CAPITAL MARKETS ASSURANCE CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The change in unrealized appreciation (depreciation) on available-for-sale
securities is included in a separate component of stockholder's equity as shown
below:
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
DECEMBER 31, 1995 DECEMBER 31, 1994
----------------- -----------------
$ IN THOUSANDS
<S> <C> <C>
Balance at beginning of period............................ $(5,499) 3,600
Change in unrealized appreciation (depreciation).......... 13,386 (13,786)
Income tax effect......................................... (4,601) 4,687)
------- -------
Net change................................................ 8,785 (9,099)
------- -------
BALANCE AT END OF PERIOD............................. $ 3,286 (5,499)
======= =======
</TABLE>
No single issuer, except for investments in U.S. Treasury and U.S.
government agency securities, exceeds 10% of stockholder's equity as of December
31, 1995.
5) DEFERRED ACQUISITION COSTS
The following table reflects acquisition costs deferred by CapMAC and
amortized in proportion to the related premium earnings:
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 1995 DECEMBER 31, 1994 DECEMBER 31, 1993
----------------- ----------------- -----------------
$ IN THOUSANDS
<S> <C> <C> <C>
Balance at beginning of period........... $24,860 15,249 5,434
Additions................................ 17,505 14,140 12,478
Amortization (policy acquisition
costs)................................. (7,203) (4,529) (2,663)
------- ------ ------
BALANCE AT END OF PERIOD............ $35,162 24,860 15,249
======= ====== ======
</TABLE>
6) EMPLOYEE BENEFITS
On June 25, 1992, CapMAC entered into a Service Agreement with CapMAC
Financial Services, Inc. ("CFS"), which was then a newly formed wholly owned
subsidiary of Holdings. Under the Service Agreement, CFS has agreed to provide
various services, including underwriting, reinsurance, data processing and other
services to CapMAC in connection with the operation of CapMAC's insurance
business. CapMAC pays CFS an arm's length fee for providing such services, but
not in excess of CFS's cost for such services. CFS incurred, on behalf of
CapMAC, total compensation expenses, excluding bonuses, of $13,484,000,
$11,081,000 and $9,789,000 in 1995, 1994 and 1993, respectively.
CFS maintains an incentive compensation plan for its employees. The plan is
an annual discretionary bonus award based upon Holdings' and an individual's
performance. CFS also has a health and welfare plan and a 401(k) plan to cover
substantially all of its employees. CapMAC reimburses CFS for all out-of-pocket
expenses incurred by CFS in providing services to CapMAC, including awards given
under the incentive compensation plan and benefits provided under the health and
welfare plan. For the years ended December 31, 1995, 1994 and 1993, the Company
had provided approximately $7,804,000, $5,253,000 and $3,528,000, respectively,
for the annual discretionary bonus plan.
F-13
<PAGE> 111
On June 25, 1992, certain officers of CapMAC were granted 182,633
restricted stock units ("RSU") at $13.33 a share in respect of certain deferred
compensation. On December 7, 1995, the RSU's were converted to cash in the
amount of approximately $3.7 million, and such officers agreed to defer receipt
of such cash amount in exchange for receiving the same number of new shares of
restricted stock of Holdings as the number of RSU's such officers previously
held. The cash amount will be held by Holdings and invested in accordance with
certain guidelines. Such amount, including the investment earnings thereon, will
be paid to each officer upon the occurrence of certain events but no later than
December, 2000.
7) EMPLOYEE STOCK OWNERSHIP PLAN
On June 25, 1992, Holdings adopted an Employee Stock Ownership Plan
("ESOP") to provide its employees the opportunity to obtain beneficial interests
in the stock of Holdings through a trust (the "ESOP Trust"). The ESOP Trust
purchased 750,000 shares at $13.33 per share of Holdings' stock. The ESOP Trust
financed its purchase of common stock with a loan from Holdings in the amount of
$10 million. The ESOP loan is evidenced by a promissory note delivered to
Holdings. An amount representing unearned employee compensation, equivalent in
value to the unpaid balance of the ESOP loan, is recorded as a deduction from
stockholder's equity (unallocated ESOP shares).
CFS is required to make contributions to the ESOP Trust, which enables the
ESOP Trust to service its loan to Holdings. The ESOP expense is calculated using
the shares allocated method. Shares are released for allocation to the
participants and held in trust for the employees based upon the ratio of the
current year's principal and interest payment to the sum of principal and
interest payments estimated over the life of the loan. As of December 31, 1995
approximately 262,800 shares were allocated to the participants. Compensation
expense related to the ESOP was approximately $2,087,000, $2,086,000 and
$1,652,000 for the years ended December 31, 1995, 1994 and 1993, respectively.
8) RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
The reserve for losses and loss adjustment expenses consists of a case
basis loss reserve and the SLR.
In 1995 CapMAC incurred its first claim on a financial 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 $2.5 million. The
portion of such claims and expenses not covered under the quota share agreement
is being funded through payments to CapMAC from the Lureco Trust Account (see
note 12).
F-14
<PAGE> 112
CAPITAL MARKETS ASSURANCE CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The following is a summary of the activity in the case basis loss reserve
account and the components of the liability for losses and loss adjustment
expenses ($ in thousands):
<TABLE>
<S> <C>
CASE BASIS LOSS RESERVE:
Net balance at January 1, 1995..................................................... $ --
------
INCURRED RELATED TO:
Current year..................................................................... 2,473
Prior years...................................................................... --
------
Total incurred..................................................................... 2,473
------
PAID INCURRED TO:
Current year..................................................................... 1,853
Prior years...................................................................... --
------
Total paid......................................................................... 1,853
------
Balance at December 31, 1995....................................................... 620
------
Reinsurance recoverable............................................................ 69
------
Supplemental loss reserve.......................................................... 5,859
------
TOTAL......................................................................... $6,548
======
</TABLE>
9) INCOME TAXES
Pursuant to a tax sharing agreement with Holdings, the Company is included
in Holdings' consolidated U.S. Federal income tax return. The Company's annual
Federal income tax liability is determined by computing its pro rata share of
the consolidated group Federal income tax liability.
Total income tax expense differed from the amount computed by applying the
U.S. Federal income tax rate of 35% in 1995 and 34% in 1994 and 1993:
<TABLE>
<CAPTION>
YEAR ENDED
YEAR ENDED YEAR ENDED DECEMBER 31,
DECEMBER 31, 1995 DECEMBER 31, 1994 1993
----------------- ----------------- ----------------
AMOUNT % AMOUNT % AMOUNT %
------- ----- ------- ----- ------- ----
$ IN THOUSANDS
<S> <C> <C> <C> <C> <C> <C>
Expected tax expense computed at
the statutory rate.............. $ 7,216 35.0 $ 5,303 34.0 $ 4,881 34.0
Increase (decrease) in tax
resulting from:
Tax-exempt interest............. (2,335) (11.3) (1,646) (10.6) (1,140) (7.9)
Other, net...................... 334 1.6 51 0.4 (15) (0.1)
------- ----- ------- ----- ------- -----
TOTAL INCOME TAX EXPENSE..... $ 5,215 25.3 $ 3,708 23.8 $ 3,726 26.0
======= ===== ======= ===== ======= =====
</TABLE>
F-15
<PAGE> 113
CAPITAL MARKETS ASSURANCE CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The tax effects of temporary differences that give rise to significant
portions of the deferred Federal income tax liability are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1995 DECEMBER 31, 1994
----------------- -----------------
$ IN THOUSANDS
<S> <C> <C>
DEFERRED TAX ASSETS:
Unrealized capital losses on investments................. $ -- (2,833)
Deferred compensation.................................... (1,901) (1,233)
Losses and loss adjustment expenses...................... (1,002) (936)
Unearned premiums........................................ (852) (762)
Other, net............................................... (98) (228)
------- ------
Total gross deferred tax assets........................ (3,853) (5,992)
------- ------
DEFERRED TAX LIABILITIES:
Deferred acquisition costs............................... 12,307 8,453
Unrealized capital gains on investments.................. 1,769 --
Deferred capital gains on investments.................... 654 726
Other, net............................................... 426 412
------- ------
Total gross deferred tax liabilities................... 15,156 9,591
------- ------
NET DEFERRED TAX LIABILITY............................. $11,303 3,599
======= ======
</TABLE>
A valuation allowance is provided when it is more likely than not that some
portion of the deferred tax assets will not be realized. Management believes
that the deferred tax assets will be fully realized in the future.
10) INSURANCE REGULATORY RESTRICTIONS
CapMAC is subject to insurance regulatory requirements of the State of New
York and other states in which it is licensed to conduct business. Generally,
New York insurance laws require that dividends be paid from earned surplus and
restrict the amount of dividends in any year that may be paid without obtaining
approval for such dividends from the Superintendent of Insurance to the lower of
(i) net investment income as defined or (ii) 10% of statutory surplus as of
December 31 of the preceding year. No dividends were paid by CapMAC to Holdings
during the years ended December 31, 1995, 1994 and 1993. No dividends could be
paid during these periods because CapMAC had negative earned surplus. Statutory
surplus at December 31, 1995 and 1994 was approximately $195,018,000 and
$139,739,000, respectively. Statutory surplus differs from stockholder's equity
determined under GAAP principally due to the mandatory contingency reserve
required for statutory accounting purposes and differences in accounting for
investments, deferred acquisition costs, SLR and deferred taxes provided under
GAAP. Statutory net income was $9,000,000, $4,543,000 and $4,528,000 for the
years ended December 31, 1995, 1994 and 1993, respectively. Statutory net income
differs from net income determined under GAAP principally due to deferred
acquisition costs, SLR and deferred income taxes.
F-16
<PAGE> 114
CAPITAL MARKETS ASSURANCE CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
11) COMMITMENTS AND CONTINGENCIES
On January 1, 1988, the Company assumed from Citibank, N.A. the obligations
of a sublease agreement for space occupied in New York. On November 21, 1993,
the sublease was terminated and a new lease was negotiated which expires on
November 20, 2008. CapMAC has a lease agreement for its London office
beginning October 1, 1992 and expiring October 1, 2002. As of December 31,
1995, future minimum payments under the lease agreements are as follows:
<TABLE>
<CAPTION>
PAYMENT
--------------
$ IN THOUSANDS
<S> <C>
1996.......................................................................... $ 2,255
1997.......................................................................... 2,948
1998.......................................................................... 3,027
1999.......................................................................... 3,476
2000 and thereafter........................................................... 36,172
-------
TOTAL....................................................................... $ 47,878
=======
</TABLE>
Rent expense, commercial rent taxes and electricity for the years ended
December 31, 1995, 1994 and 1993 amounted to $1,939,000, $2,243,000 and
$2,065,000, respectively.
CapMAC has available a $100,000,000 standby corporate liquidity facility
(the "Liquidity Facility") provided by a consortium of banks, headed by Bank of
Montreal, as agent, which is rated "A-1+" and "P-1" by S&P and Moody's,
respectively. Under the Liquidity Facility, CapMAC will be able, subject to
satisfying certain conditions, to borrow funds from time to time in order to
enable it to fund any claim payments or payments made in settlement or
mitigation of claim payments under its insurance contracts. For the years ended
December 31, 1995, 1994 and 1993, no draws had been made under the Liquidity
Facility.
12) REINSURANCE
In the ordinary course of business, CapMAC cedes exposure under various
treaty, pro rata and excess of loss reinsurance contracts primarily designed to
minimize losses from large risks and protect the capital and surplus of CapMAC.
The effect of reinsurance on premiums written and earned was as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
------------------------------------------------------------
1995 1994 1993
------------------ ----------------- -----------------
WRITTEN EARNED WRITTEN EARNED WRITTEN EARNED
-------- ------ ------- ------ ------- ------
$ IN THOUSANDS
<S> <C> <C> <C> <C> <C> <C>
Direct............................... $ 56,541 36,853 43,598 28,561 24,491 20,510
Assumed.............................. 935 761 1,064 258 403 364
Ceded................................ (15,992) (8,372) (11,069) (5,716) (3,586) (3,391)
-------- ------ ------- ------ ------ ------
NET PREMIUMS....................... $ 41,484 29,242 33,593 23,103 21,308 17,483
======== ====== ======= ====== ====== ======
</TABLE>
F-17
<PAGE> 115
CAPITAL MARKETS ASSURANCE CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Although the reinsurance of risk does not relieve the ceding insurer of its
original liability to its policyholders, it is the industry practice of insurers
for financial statement purposes to treat reinsured risks as though they were
risks for which the ceding insurer was only contingently liable. A contingent
liability exists with respect to the aforementioned reinsurance arrangements
which may become a liability of CapMAC in the event the reinsurers are unable to
meet obligations assumed by them under the reinsurance contracts. At December
31, 1995 and 1994, CapMAC had ceded loss reserves of $69,000 and $0,
respectively and had ceded unearned premiums of $13,171,000 and $5,551,000,
respectively.
In 1994, CapMAC entered into a reinsurance agreement (the "Lureco
Treaty") with Luxembourg European Reinsurance LURECO S.A. ("Lureco"), a
European-based reinsurer. The agreement is renewable annually at the Company's
option, subject to satisfying certain conditions. The agreement reinsured and
indemnified the Company for any loss incurred by CapMAC during the agreement
period up to the limits of the agreement. The Lureco Treaty provides that the
annual reinsurance premium payable by CapMAC to Lureco, after deduction of the
reinsurer's fee payable to Lureco, be deposited in a trust account (the "Lureco
Trust Account") to be applied by CapMAC, at its option, to offset losses and
loss expenses incurred by CapMAC in connection with incurred claims. Amounts on
deposit in the Lureco Trust Account which have not been applied against claims
are contractually due to CapMAC at the termination of the treaty.
The premium deposit amounts in the Lureco Trust Account have been reflected
as assets by CapMAC during the term of the agreement. Premiums in excess of the
deposit amounts have been recorded as ceded premiums in the statements of
income. In the 1994 policy year, the agreement provided $5 million of loss
coverage in excess of the premium deposit amounts of $2 million retained in the
Lureco Trust Account. No losses were applied against the Lureco Trust Account or
ceded to the Lureco Treaty in 1994. The agreement was renewed for the 1995
policy year and provides $5 million of loss coverage in excess of the premium
deposit amount of $4.5 million retained in the Lureco Trust Account. Additional
coverage is provided for losses incurred in excess of 200% of the net premiums
earned up to $4 million for any one agreement year. In September 1995, a claim
of approximately $2.5 million on an insurance policy was applied against the
Lureco Trust Account.
In addition to its capital (including statutory contingency reserves) and
other reinsurance available to pay claims under its insurance contracts, on June
25, 1992, CapMAC entered into a Stop Loss Reinsurance Agreement (the "Stop-loss
Agreement") with Winterthur Swiss Insurance Company ("Winterthur") which is
rated "AAA" by S&P and "Aaa" by Moody's. At the same time, CapMAC and Winterthur
also entered into a Quota Share Reinsurance Agreement (the "Winterthur Quota
Share Agreement") pursuant to which Winterthur had the right to reinsure on a
quota share basis 10% of each policy written by CapMAC.
The Winterthur Stop-loss Agreement had an original term of seven years and
was renewable for successive one-year periods. In April 1995, Winterthur
notified CapMAC that it was canceling the Winterthur Stop-loss Agreement and the
Winterthur Quota Share Agreement effective June 30, 1996.
CapMAC elected to terminate the Winterthur Stop-loss Agreement effective
November 30, 1995 and, on the same date, entered into a Stop-loss Reinsurance
Agreement with Mitsui Marine (the "Mitsui Stop-loss Agreement"). Under the
Mitsui Stop-loss Agreement, Mitsui
F-18
<PAGE> 116
CAPITAL MARKETS ASSURANCE CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Marine would be required to pay any losses in excess of $100 million in the
aggregate incurred by CapMAC during the term of the Mitsui Stop-loss Agreement
on the insurance policies in effect on December 1, 1995 and written during the
one-year period thereafter, up to an aggregate limit payable under the Mitsui
Stop-loss Agreement of $50 million. The Mitsui Stop-loss Agreement has a term
of seven years and is subject to early termination by CapMAC in certain
circumstances.
The Winterthur Quota Share Agreement was canceled November 30, 1995. On
January 1, 1996, CapMAC reassumed the liability, principally unearned premium,
for all policies reinsured by Winterthur. As a result, CapMAC reassumed
approximately $1.4 billion of principal insured by Winterthur as of December 31,
1995. In connection with the commutation, Winterthur will return the unearned
premiums as of December 31, 1995, net of ceding commission and federal excise
tax. Such amount is expected to total approximately $2.0 million.
13) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying amounts and estimated fair values
of the Company's financial instruments at December 31, 1995 and 1994. SFAS No.
107, "Disclosures About Fair Value of Financial Instruments," define the fair
value of a financial instrument as the amount at which the instrument could be
exchanged in a current transaction between willing parties.
<TABLE>
<CAPTION>
DECEMBER 31, 1995 DECEMBER 31, 1994
----------------------- -----------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
-------- ---------- -------- ----------
$ IN THOUSANDS
<S> <C> <C> <C> <C>
FINANCIAL ASSETS:
Investments.................................... $284,352 284,352 189,068 189,068
OFF-BALANCE-SHEET INSTRUMENTS:
Financial Guarantees Outstanding............... $ -- 147,840 -- 93,494
Ceding Commission.............................. $ -- 44,352 -- 28,048
-------- ------- ------- -------
</TABLE>
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments summarized above:
INVESTMENTS
The fair values of fixed maturities and mutual funds are based upon quoted
market prices. The fair value of short-term investments approximates amortized
cost.
F-19
<PAGE> 117
FINANCIAL GUARANTEES OUTSTANDING
The fair value of financial guarantees outstanding consists of (1) the
current unearned premium reserve, net of prepaid reinsurance and (2) the fair
value of installment revenue which is derived by calculating the present value
of the estimated future cash inflow to CapMAC of policies in force having
installment premiums, net of amounts payable to reinsurers, at a discount rate
of 7% at December 31, 1995 and 1994. The amount calculated is equivalent to the
consideration that would be paid under market conditions prevailing at the
reporting dates to transfer CapMAC's financial guarantee business to a third
party under reinsurance and other agreements. Ceding commission represents the
expected amount that would be paid to CapMAC to compensate CapMAC for
originating and servicing the insurance contracts. In constructing estimated
future cash inflows, management makes assumptions regarding prepayments for
amortizing asset-backed securities which are consistent with relevant historical
experience. For revolving programs, assumptions are made regarding program
utilization based on discussions with program users. The amount of installment
premium actually realized by the Company could be reduced in the future due to
factors such as early termination of insurance contracts, accelerated
prepayments of underlying obligations or lower than anticipated utilization of
insured structured programs, such as commercial paper conduits. Although
increases in future installment revenue due to renewals of existing insurance
contracts historically have been greater than reductions in future installment
revenue due to factors such as those described above, there can be no assurance
that future circumstances might not cause a net reduction in installment
revenue, resulting in lower revenues.
14) CAPITALIZATION
The Company's certificate of incorporation authorizes the issuance of
15,000,000 shares of common stock, par value $1.00 per share. Authorized, issued
and outstanding shares at December 31, 1995 and 1994 were 15,000,000 at $1.00
per share.
In 1995, $59.0 million of the proceeds received by Holdings from the sale
of shares in connection with an Initial Public Offering and private placements
were contributed to CapMAC.
F-20
<PAGE> 118
CAPITAL MARKETS ASSURANCE CORPORATION
FINANCIAL STATEMENTS
MARCH 31, 1996
(UNAUDITED)
F-21
<PAGE> 119
CAPITAL MARKETS ASSURANCE CORPORATION
BALANCE SHEETS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
MARCH 31, 1996 DECEMBER 31, 1995
-------------- -----------------
(UNAUDITED)
<S> <C> <C>
ASSETS
INVESTMENTS:
Bonds at fair value (amortized cost $258,874 at March 31,
1996 and $210,651 at December 31, 1995).................... $259,226 215,706
Short-term investments (at amortized cost which approximates
fair value................................................. 28,636 68,646
-------- --------
Total investments.......................................... 287,862 284,352
-------- --------
Cash......................................................... 389 344
Accrued investment income.................................... 3,356 3,136
Deferred acquisition costs................................... 37,559 35,162
Premiums receivable.......................................... 3,463 3,540
Prepaid reinsurance.......................................... 13,379 13,171
Other assets................................................. 3,477 3,428
-------- --------
TOTAL ASSETS............................................... $349,485 343,133
======== ========
LIABILITIES AND STOCKHOLDER'S EQUITY
LIABILITIES:
Unearned premiums............................................ $ 50,266 45,767
Reserve for losses and loss adjustment expenses.............. 7,261 6,548
Ceded reinsurance............................................ 2,773 2,469
Accounts payable and other accrued expenses.................. 7,288 10,844
Current income taxes......................................... 260 136
Deferred income taxes........................................ 11,657 11,303
-------- --------
Total liabilities.......................................... 79,505 77,067
-------- --------
STOCKHOLDER'S EQUITY:
Common stock................................................. 15,000 15,000
Additional paid-in capital................................... 208,475 205,808
Unrealized appreciation on investments, net of tax........... 229 3,286
Retained earnings............................................ 46,276 41,972
-------- --------
Total stockholder's equity................................. 269,980 266,066
-------- --------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY................. $349,485 343,133
======== ========
</TABLE>
See accompanying notes to financial statements.
F-22
<PAGE> 120
CAPITAL MARKETS ASSURANCE CORPORATION
STATEMENTS OF INCOME
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED THREE MONTHS ENDED
MARCH 31, 1996 MARCH 31, 1995
------------------ ------------------
<S> <C> <C>
REVENUES:
Direct premiums written................................ $ 14,155 16,838
Assumed premiums written............................... 874 154
Ceded premiums written................................. (1,910) (3,093)
------- -------
Net premiums written................................. 13,119 13,899
Increase in unearned premiums.......................... (4,291) (6,798)
------- -------
Net premiums earned.................................. 8,828 7,101
Net investment income.................................. 3,877 2,637
Net realized capital gains............................. 149 65
Other income........................................... 54 12
------- -------
Total revenues....................................... 12,908 9,815
------- -------
EXPENSES:
Losses and loss adjustment expenses.................... 1,075 696
Underwriting and operating expenses.................... 3,978 3,738
Policy acquisition costs............................... 2,064 1,725
------- -------
Total expenses....................................... 7,117 6,159
------- -------
Income before income taxes........................... 5,791 3,656
------- -------
INCOME TAXES:
Current federal income tax............................. 664 320
Deferred federal income tax............................ 823 519
------- -------
Total income taxes................................... 1,487 839
------- -------
NET INCOME........................................... $ 4,304 2,817
======= =======
</TABLE>
See accompanying notes to financial statements.
F-23
<PAGE> 121
CAPITAL MARKETS ASSURANCE CORPORATION
STATEMENT OF STOCKHOLDER'S EQUITY
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, 1996
------------------
<S> <C>
COMMON STOCK:
Balance at beginning of period........................................... $ 15,000
-------
Balance at end of period............................................... 15,000
-------
ADDITIONAL PAID-IN CAPITAL:
Balance at beginning of period........................................... 205,808
Capital contribution..................................................... 2,667
-------
Balance at end of period............................................... 208,475
-------
UNREALIZED (DEPRECIATION) APPRECIATION ON INVESTMENTS, NET OF TAX:
Balance at beginning of period........................................... 3,286
Unrealized depreciation on investments................................... (3,057)
-------
Balance at end of period............................................... 229
-------
RETAINED EARNINGS:
Balance at beginning of period........................................... 41,972
Net income............................................................... 4,304
-------
Balance at end of period............................................... 46,276
-------
TOTAL STOCKHOLDER'S EQUITY............................................. $269,980
=======
</TABLE>
See accompanying notes to financial statements.
F-24
<PAGE> 122
CAPITAL MARKETS ASSURANCE CORPORATION
STATEMENTS OF CASH FLOWS
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED THREE MONTHS ENDED
MARCH 31, 1996 MARCH 31, 1995
------------------ ------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................. $ 4,304 2,817
------- -------
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH
PROVIDED (USED) BY OPERATING ACTIVITIES:
Reserve for losses and loss adjustment expenses...... 713 696
Unearned premiums.................................... 4,499 8,075
Deferred acquisition costs........................... (2,397) (2,662)
Premiums receivable.................................. 77 (3,241)
Accrued investment income............................ (220) 400
Income taxes payable................................. 947 839
Net realized capital gains........................... (149) (65)
Accounts payable and other accrued expenses.......... 287 4,364
Prepaid reinsurance.................................. (208) (1,277)
Other, net........................................... 89 1,355
------- -------
Total adjustments................................. 3,638 8,484
------- -------
NET CASH PROVIDED BY OPERATING ACTIVITIES............ 7,942 11,301
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments............................... (87,335) (18,235)
Proceeds from sale of investments...................... 6,158 4,072
Proceeds from maturities of investments................ 73,280 3,391
------- -------
NET CASH USED IN INVESTING ACTIVITIES................ (7,897) (10,772)
------- -------
Net increase in cash................................... 45 529
Cash balance at beginning of period.................... 344 85
------- -------
CASH BALANCE AT END OF PERIOD........................ $ 389 614
======= =======
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Income taxes paid...................................... $ 525 --
======= =======
</TABLE>
See accompanying notes to financial statements.
F-25
<PAGE> 123
CAPITAL MARKETS ASSURANCE CORPORATION
NOTES TO UNAUDITED FINANCIAL STATEMENTS
MARCH 31, 1996
1. BACKGROUND
Capital Markets Assurance Corporation ("CapMAC" or "the Company") is a New
York-domiciled monoline stock insurance company which engages only in the
business of financial guaranty and surety insurance. CapMAC is a wholly-owned
subsidiary of CapMAC Holdings Inc. ("Holdings"). CapMAC is licensed in all 50
states in addition to the District of Columbia, the Commonwealth of Puerto Rico
and the territory of Guam. CapMAC insures structured asset-backed, corporate,
municipal and other financial obligations in the U.S. and international capital
markets. CapMAC also provides financial guaranty reinsurance for structured
asset-backed, corporate, municipal and other financial obligations written by
other major insurance companies.
CapMAC's claims-paying ability is rated triple-A by Moody's Investors
Service, Inc., Standard & Poor's Ratings Group, 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
The Company's unaudited interim financial statements have been prepared on
the basis of generally accepted accounting principles and, in the opinion of
management, reflect all adjustments necessary for a fair presentation of the
Company's financial condition, results of operations and cash flows for the
periods presented. The results of operations for the three months ended March
31, 1996 may not be indicative of the results that may be expected for the full
year ending December 31, 1996. These financial statements and notes should be
read in conjunction with the financial statements and notes included in the
audited financial statements of CapMAC as of December 31, 1995 and 1994, and for
each of the years in the three-year period ended December 31, 1995.
3. RECLASSIFICATIONS
Certain prior period balances have been reclassified to conform to the
current period presentation.
F-26
<PAGE> 124
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------------------------------------------------------
NO DEALER, SALESMAN OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS AND,
IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED BY THE SELLER, HFC OR THE UNDERWRITERS. THIS PROSPECTUS
DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY OF
THE SECURITIES OFFERED HEREBY IN ANY JURISDICTION TO ANY PERSON TO WHOM IT IS
UNLAWFUL TO MAKE SUCH OFFER IN SUCH JURISDICTION. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE MADE HEREUNDER, SHALL, UNDER ANY CIRCUMSTANCES, CREATE
ANY IMPLICATION THAT THE INFORMATION HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT
TO THE DATE HEREOF OR THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE
SELLER, HFC OR THE TRUST SINCE SUCH DATE.
------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Available Information................... 2
Financial Information................... 3
Reports to the Certificateholders....... 3
Table of Contents....................... 3
Prospectus Summary...................... 4
Risk Factors............................ 25
The Seller and Subservicers............. 29
The Master Servicer..................... 30
Use of Proceeds......................... 30
The HFC Revolving Home Equity
Lending Program....................... 30
The Revolving Home Equity Credit
Lines................................. 36
Description of the Certificate
Insurer............................... 44
Maturity and Prepayment
Considerations........................ 44
Pool Factor and Trading Information..... 48
Description of the Certificates......... 49
Description of the Receivables Purchase
Agreement............................. 73
Certain Legal Aspects of the Mortgage
Loans................................. 75
Certain Income Tax Consequences......... 81
ERISA Considerations.................... 87
Legal Investment Considerations......... 88
Underwriting............................ 89
Experts................................. 89
Legal Matters........................... 89
Index of Defined Terms.................. 90
Global Clearance, Settlement and Tax
Documentation Procedures.............. A-1
Financial Statements of Certificate
Insurer............................... F-1
</TABLE>
------------------
UNTIL 90 DAYS AFTER THE DATE OF THIS PROSPECTUS, ALL DEALERS EFFECTING
TRANSACTIONS IN THE CERTIFICATES, WHETHER OR NOT PARTICIPATING IN THIS
DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO
THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS
AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
------------------------------------------------------
------------------------------------------------------
------------------------------------------------------
------------------------------------------------------
$819,278,000
CLASS A CERTIFICATES
HOUSEHOLD REVOLVING
HOME EQUITY
LOAN TRUST 1996-1
REVOLVING HOME
EQUITY LOAN
ASSET BACKED CERTIFICATES,
SERIES 1996-1
HOUSEHOLD FINANCE
CORPORATION
MASTER SERVICER
------------------
PROSPECTUS
------------------
GOLDMAN, SACHS & CO.
LEHMAN BROTHERS
MERRILL LYNCH & CO.
MORGAN STANLEY & CO.
INCORPORATED
MAY 16, 1996
------------------------------------------------------
------------------------------------------------------
