<PAGE>
RULE NO. 424(b)(5)
REGISTRATION NO. 33-80419
PROSPECTUS SUPPLEMENT
(To Prospectus dated September 19, 1996)
$198,367,179
Residential Funding Mortgage Securities II, Inc.
Company
Residential Funding Corporation
Master Servicer
Home Equity Loan Pass-Through Certificates, Series 1996-HS2
<TABLE>
<S> <C> <C>
$74,000,000 6.95% Class A-1 Certificates
$15,000,000 6.95% Class A-2 Certificates
$41,000,000 7.20% Class A-3 Certificates
$26,500,000 7.55% Class A-4 Certificates
</TABLE>
<TABLE>
<S> <C> <C>
$ 9,374,000 7.85% Class A-5 Certificates
$12,341,000 7.95%(1) Class A-6 Certificates
$20,152,179 7.60%(1) Class A-L Certificates
$ 0 1.70%(2) Class IO Certificates
</TABLE>
- -------
(1) The Pass-Through Rate on the Class A-6 Certificates and the Class A-L
Certificates will be subject to a maximum of the weighted average of the
Net Mortgage Rates (as defined herein) on the Mortgage Loans.
(2) Based on the Notional Amount as described herein.
---------------
The Series 1996-HS2 Home Equity Loan Pass-Through Certificates will include
the following eight classes (the "Senior Certificates"): (i) Class A-1
Certificates, Class A-2 Certificates, Class A-3 Certificates, Class A-4
Certificates, Class A-5 Certificates and Class A-6 Certificates; (ii) Class A-
L Certificates (the "Lockout Certificates"); and (iii) Class IO Certificates
(the "PAC Strip Certificates"). The Class A-1 Certificates, Class A-2
Certificates, Class A-3 Certificates, Class A-4 Certificates, Class A-5
Certificates, Class A-6 Certificates and Lockout Certificates are referred to
herein collectively as the "Class A Certificates." In addition to the Senior
Certificates, the Series 1996-HS2 Home Equity Loan Pass-Through Certificates
will also include two classes of subordinate certificates which are designated
as the Class R-I Certificates and Class R-II Certificates (together, the
"Class R Certificates" or the "Residual Certificates" and, together with the
Senior Certificates, the "Certificates"). Only the Senior Certificates are
offered hereby. See "Index of Principal Definitions" in the Prospectus for the
meanings of capitalized terms and acronyms not otherwise defined herein.
It is a condition of the issuance of the Class A Certificates that they be
rated "AAA" by Standard & Poor's Rating Services ("Standard & Poor's") and
"Aaa" by Moody's Investors Service, Inc. ("Moody's"). It is a condition to the
issuance of the PAC Strip Certificates that they be rated "AAAr" by Standard &
Poor's and "Aaa" by Moody's.
The Senior Certificates will not constitute "mortgage related securities"
for purposes of the Secondary Mortgage Market Enhancement Act of 1984, as
amended.
On or before the date of issuance of the Certificates, the Company will
obtain from AMBAC Indemnity Corporation (the "Insurer") a certificate guaranty
insurance policy (the "Policy"), which will, subject to its terms, protect the
holders of the Senior Certificates against any interest shortfalls (except as
described herein) allocated to the Senior Certificates and the principal
portion of any Realized Losses allocated to the Class A Certificates. See
"Description of the Certificates--Certificate Guaranty Insurance Policy"
herein.
[LOGO] AMBAC
(Continued on following page)
---------------
PROCEEDS OF THE ASSETS IN THE TRUST FUND AND PROCEEDS FROM THE POLICY (AS
DESCRIBED HEREIN) ARE THE SOLE SOURCE OF PAYMENTS ON THE SENIOR
CERTIFICATES. THE SENIOR CERTIFICATES DO NOT REPRESENT AN INTEREST IN OR
OBLIGATION OF THE COMPANY, THE MASTER SERVICER, GMAC MORTGAGE OR ANY
OF THEIR AFFILIATES. NEITHER THE SENIOR CERTIFICATES NOR THE
UNDERLYING MORTGAGE LOANS ARE INSURED OR GUARANTEED BY ANY
GOVERNMENTAL AGENCY OR INSTRUMENTALITY OR BY THE COMPANY, THE
MASTER SERVICER, GMAC MORTGAGE ANY OF THEIR AFFILIATES.
---------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS SUPPLEMENT OR THE PROSPECTUS. ANY REPRESENTATION
TO THE CONTRARY IS A CRIMINAL OFFENSE.
---------------
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.
---------------
FOR A DISCUSSION OF SIGNIFICANT MATTERS AFFECTING INVESTMENTS IN THE SENIOR
CERTIFICATES, SEE "RISK FACTORS" COMMENCING ON PAGE S-13 HEREIN AND "RISK
FACTORS" IN THE PROSPECTUS COMMENCING ON PAGE 10.
There is currently no secondary market for the Senior Certificates. Morgan
Stanley & Co. Incorporated (the "Underwriter") intends to make a secondary
market in the Senior Certificates, but is not obligated to do so. There can be
no assurance that a secondary market for the Senior Certificates will develop
or, if it does develop, that it will continue. The Senior Certificates will
not be listed on any securities exchange.
The Senior Certificates will be purchased from the Company by the
Underwriter and will be offered by the Underwriter from time to time to the
public in negotiated transactions or otherwise at varying prices to be
determined at the time of sale. The proceeds to the Company from the sale of
the Senior Certificates, before deducting expenses payable by the Company,
will be equal to approximately 100.55% of the initial aggregate principal
balance of the Senior Certificates, plus accrued interest thereon from
September 1, 1996. The Senior Certificates are offered by the Underwriter
subject to prior sale, when, as and if delivered to and accepted by the
Underwriter and subject to certain other conditions. The Underwriter reserves
the right to withdraw, cancel or modify such offer and to reject any order in
whole or in part. It is expected that delivery of the Class A Certificates
will be made only in book-entry form through the Same Day Funds Settlement
System of DTC as discussed herein and that delivery of the PAC Strip
Certificates will be made at the offices of the Underwriter, New York, New
York, on or about September 27, 1996, against payment therefor in immediately
available funds.
---------------
MORGAN STANLEY & CO.
Incorporated
September 19, 1996
<PAGE>
(Continued from previous page)
The Certificates in the aggregate will evidence the entire beneficial
ownership interest in a trust fund (the "Trust Fund") consisting primarily of
a pool of closed end, fixed-rate, one- to four-family, first and second lien
home equity mortgage loans with terms to maturity of approximately five, ten
or fifteen years as described herein (the "Mortgage Loans") to be deposited by
Residential Funding Mortgage Securities II, Inc. (the "Company") into the
Trust Fund. The characteristics of the Mortgage Loans are described herein
under "Description of the Mortgage Pool."
The Senior Certificates, other than PAC Strip Certificates (the "DTC
Registered Certificates"), initially will be represented by certificates
registered in the name of Cede & Co., as nominee of DTC, as further described
herein. The interests of beneficial owners of the DTC Registered Certificates
will be represented by book entries on the records of participating members of
DTC. Definitive certificates will be available for the DTC Registered
Certificates only under the limited circumstances described herein. See
"Description of the Certificates--Book-Entry Registration of Certain of the
Senior Certificates" herein.
As described herein, two separate REMIC elections will be made in connection
with the Trust Fund for federal income tax purposes. Each class of the Senior
Certificates will represent ownership of "regular interests" in the related
REMIC and each class of the Residual Certificates will constitute the sole
class of "residual interests" in the related REMIC. See "Certain Federal
Income Tax Consequences" herein and in the Prospectus.
Distributions on the Senior Certificates will be made on the 25th day of
each month or, if such day is not a business day, then on the next business
day, commencing in October 1996 (each, a "Distribution Date"). As described
herein, interest distributions on the Class A Certificates will be based on
the Certificate Principal Balance thereof (or the Notional Amount thereof in
the case of the PAC Strip Certificates) and the applicable Pass-Through Rate
thereof, which will be fixed for all classes of Certificates, except as
described herein with respect to the Class A-6 Certificates and Lockout
Certificates, and may be reduced by certain interest shortfalls to the extent
not covered by the Policy. The manner in which the Notional Amount of the PAC
Strip Certificates will be calculated is intended to provide for reductions
thereof in accordance with the table set forth herein. Distributions in
respect of principal on the Class A Certificates will be allocated among the
various classes of Class A Certificates as described herein under "Description
of the Certificates--Principal Distributions on the Senior Certificates." The
rights of the holders of the Class R Certificates to receive distributions
with respect to the Mortgage Loans will be subordinate to the rights of the
holders of the Senior Certificates to the extent described herein and in the
Prospectus.
THE YIELD TO MATURITY ON THE SENIOR CERTIFICATES WILL DEPEND ON THE RATE AND
TIMING OF PRINCIPAL PAYMENTS (INCLUDING PREPAYMENTS, DEFAULTS AND
LIQUIDATIONS) ON THE MORTGAGE LOANS. IN GENERAL, DEFAULTS ON MORTGAGE LOANS
ARE EXPECTED TO OCCUR WITH GREATER FREQUENCY IN THEIR EARLY YEARS AND DEFAULTS
ON MORTGAGE LOANS SECURED BY SECOND LIENS MAY BE SUBSTANTIALLY HIGHER THAN
MORTGAGE LOANS SECURED BY FIRST LIENS. SEE "RISK FACTORS" HEREIN AND IN THE
PROSPECTUS. THE MORTGAGE LOANS GENERALLY MAY BE PREPAID IN FULL OR IN PART AT
ANY TIME WITHOUT PENALTY. TO A LIMITED EXTENT, THE YIELD TO INVESTORS ON THE
PAC STRIP CERTIFICATES WILL BE SENSITIVE TO THE RATE AND TIMING OF PRINCIPAL
PAYMENTS (INCLUDING PREPAYMENTS, DEFAULTS AND LIQUIDATIONS) ON THE MORTGAGE
LOANS, WHICH RATE MAY FLUCTUATE SIGNIFICANTLY OVER TIME. AN EXTREMELY RAPID
RATE OF PRINCIPAL PAYMENTS ON THE MORTGAGE LOANS COULD RESULT IN THE FAILURE
OF INVESTORS IN THE PAC STRIP CERTIFICATES TO RECOVER THEIR INITIAL
INVESTMENTS. SEE "SUMMARY--SPECIAL PREPAYMENT CONSIDERATIONS," "--SPECIAL
YIELD AND PREPAYMENT CONSIDERATIONS" AND "CERTAIN YIELD AND PREPAYMENT
CONSIDERATIONS" HEREIN AND "YIELD AND PREPAYMENT CONSIDERATIONS" IN THE
PROSPECTUS.
----------------
THE CERTIFICATES OFFERED BY THIS PROSPECTUS SUPPLEMENT CONSTITUTE PART OF A
SEPARATE SERIES OF CERTIFICATES ISSUED BY THE COMPANY AND ARE BEING OFFERED
PURSUANT TO ITS PROSPECTUS DATED SEPTEMBER 19, 1996, OF WHICH THIS PROSPECTUS
SUPPLEMENT IS A PART AND WHICH ACCOMPANIES THIS PROSPECTUS SUPPLEMENT. THE
PROSPECTUS CONTAINS IMPORTANT INFORMATION REGARDING THIS OFFERING NOT
CONTAINED HEREIN, AND PROSPECTIVE INVESTORS ARE URGED TO READ THE PROSPECTUS
AND THIS PROSPECTUS SUPPLEMENT IN FULL. SALES OF THE SENIOR CERTIFICATES MAY
NOT BE CONSUMMATED UNLESS THE PURCHASER HAS RECEIVED BOTH THIS PROSPECTUS
SUPPLEMENT AND THE PROSPECTUS.
----------------
UNTIL DECEMBER 18, 1996 ALL DEALERS EFFECTING TRANSACTIONS IN THE SENIOR
CERTIFICATES, WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE
REQUIRED TO DELIVER A PROSPECTUS SUPPLEMENT AND THE PROSPECTUS TO WHICH IT
RELATES. THIS DELIVERY REQUIREMENT IS IN ADDITION TO THE OBLIGATION OF DEALERS
TO DELIVER A PROSPECTUS SUPPLEMENT AND PROSPECTUS WHEN ACTING AS UNDERWRITER
AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
S-2
<PAGE>
NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS
SUPPLEMENT AND THE PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR
REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE
COMPANY OR BY THE UNDERWRITER. THIS PROSPECTUS SUPPLEMENT AND THE PROSPECTUS
DO NOT CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, THE
SECURITIES OFFERED HEREBY TO ANYONE IN ANY JURISDICTION IN WHICH THE PERSON
MAKING SUCH OFFER OR SOLICITATION IS NOT QUALIFIED TO DO SO OR TO ANYONE TO
WHOM IT IS UNLAWFUL TO MAKE ANY SUCH OFFER OR SOLICITATION. NEITHER THE
DELIVERY OF THIS PROSPECTUS SUPPLEMENT AND THE PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE AN IMPLICATION THAT
INFORMATION HEREIN OR THEREIN IS CORRECT AS OF ANY TIME SINCE THE DATE OF THIS
PROSPECTUS SUPPLEMENT OR THE PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PROSPECTUS SUPPLEMENT
Summary.................................................................... S-4
Risk Factors............................................................... S-13
Description of the Mortgage Pool........................................... S-14
Description of Certificates................................................ S-21
The Insurer................................................................ S-30
Certain Yield and Prepayment Considerations................................ S-31
Pooling and Servicing Agreement............................................ S-38
Certain Federal Income Tax Consequences.................................... S-40
Method of Distribution..................................................... S-41
Legal Opinions............................................................. S-42
Experts.................................................................... S-42
Ratings.................................................................... S-42
Legal Investment........................................................... S-43
ERISA Considerations....................................................... S-43
Appendix A................................................................. A-1
PROSPECTUS
Additional Information..................................................... 2
Reports to Certificateholders.............................................. 2
Incorporation of Certain Information by Reference.......................... 2
Summary of Prospectus...................................................... 4
Risk Factors............................................................... 10
The Mortgage Pools......................................................... 14
Allocation of Revolving Credit Loan Balances............................... 20
Mortgage Loan Program...................................................... 21
Description of the Certificates............................................ 29
Description of Credit Enhancement.......................................... 44
The Company................................................................ 50
Residential Funding Corporation............................................ 50
The Pooling and Servicing Agreement........................................ 50
Yield and Prepayment Considerations........................................ 55
Certain Legal Aspects of Mortgage Loans and Related Matters................ 60
Certain Federal Income Tax Consequences.................................... 71
State and Other Tax Consequences........................................... 87
ERISA Considerations....................................................... 87
Legal Investment Matters................................................... 93
Use of Proceeds............................................................ 94
Methods of Distribution.................................................... 94
Legal Matters.............................................................. 95
Financial Information...................................................... 95
</TABLE>
S-3
<PAGE>
SUMMARY
The following summary is qualified in its entirety by reference to the
detailed information appearing elsewhere herein and in the Prospectus.
Capitalized terms used herein and not otherwise defined herein have the
meanings assigned in the Prospectus. See "Index of Principal Definitions" in
the Prospectus.
Title of Securities....... Home Equity Loan Pass-Through Certificates, Series
1996-HS2.
Company................... Residential Funding Mortgage Securities II, Inc.,
an affiliate of Residential Funding. See "The
Company" in the Prospectus.
Master Servicer........... Residential Funding Corporation. See "Pooling and
Servicing Agreement--The Master Servicer" herein
and "Residential Funding Corporation" in the
Prospectus.
Trustee................... The First National Bank of Chicago, a national
banking association.
Insurer................... AMBAC Indemnity Corporation. See "The Insurer"
herein.
Delivery Date............. On or about September 27, 1996.
The Mortgage Pool......... The Mortgage Pool will consist of a pool of closed
end, fixed-rate, fully-amortizing and balloon
payment mortgage loans (the "Mortgage Loans"),
acquired by Residential Funding pursuant to its
Home Equity Program with an aggregate unpaid
principal balance as of the close of business on
the business day prior to September 1, 1996 (the
"Cut-off Date Balance" and such date, the "Cut-off
Date") of $198,367,179. 99.8% of the Mortgage Loans
are secured by second liens on fee simple or
leasehold interests in one- to four-family
residential real properties (each, a "Mortgaged
Property") and the remainder are secured by first
liens. At origination, the Mortgage Loans had
individual principal balances of at least $6,124
but not more than $199,600 with an average
principal balance at origination of approximately
$33,112. The Mortgage Loans have terms to maturity
from the date of origination or modification of
approximately five, ten or fifteen years with
respect to 0.2%, 1.1% and 98.7% of the Mortgage
Loans (each, by Cut-off Date Balance),
respectively, and a weighted average remaining term
to stated maturity of approximately 174 months as
of the Cut-off Date. All of the Mortgage Loans with
terms to maturity from the date of origination or
modification of approximately five or ten years and
83.9% of the Mortgage Loans with terms to maturity
from the date of origination or modification of
approximately fifteen years (by Cut-off Date
Balance of such Mortgage Loans) are fully-
amortizing. 16.1% of the Mortgage Loans with terms
to maturity of fifteen years (by Cut-off Date
Balance of such Mortgage Loans) require monthly
payments of principal based on 30-year amortization
schedules and have scheduled maturity dates of
fifteen years from the due date of the first
monthly payment (each such Mortgage Loan, a
"Balloon Mortgage Loan"), in each case leaving a
substantial portion of the original principal
amount due and payable on the respective scheduled
maturity date. All percentages of the Mortgage
Loans described herein are approximate percentages
S-4
<PAGE>
(except as otherwise indicated) by Cut-off Date
Balance of the Mortgage Loans (except as otherwise
indicated). All of the Mortgage Loans are being
subserviced by GMAC Mortgage Corporation of PA.
The Mortgage Loans will bear interest at Mortgage
Rates of at least 8.25% per annum but no more than
15.70% per annum, with a weighted average Mortgage
Rate of 11.9766% per annum as of the Cut-off Date.
The Combined Loan-to-Value Ratio for the Mortgage
Loans range from 7% to 101% and the weighted
average Combined Loan-to-Value Ratio of the
Mortgage Loans as of the Cut-off Date is
approximately 90.79%. 47.9% of the Mortgage Loans
have Combined Loan-to-Value Ratios greater than
90%. 68.1% of the Mortgage Loans are located in
California.
As of the Cut-off Date, 6.9% of the Mortgage Loans
were High Cost Loans.
For a further description of the Mortgage Loans,
see "Description of the Mortgage Pool" herein.
The Senior Certificates...
The Senior Certificates will be issued pursuant to
a Pooling and Servicing Agreement, to be dated as
of September 1, 1996, among the Company, the Master
Servicer and the Trustee. The Senior Certificates
will have the following Pass-Through Rates,
Certificate Principal Balances and other features
as of the Cut-off Date:
<TABLE>
<S> <C> <C> <C>
Class A-1 Certificates 6.95% $74,000,000 Senior
Class A-2 Certificates 6.95% $15,000,000 Senior
Class A-3 Certificates 7.20% $41,000,000 Senior
Class A-4 Certificates 7.55% $26,500,000 Senior
Class A-5 Certificates 7.85% $ 9,374,000 Senior
Class A-6 Certificates 7.95% $12,341,000 Senior
Class A-L Certificates 7.60% $20,152,179 Lockout/Senior
Class IO Certificates 1.70% $ 0 PAC Strip/Senior
</TABLE>
The PAC Strip Certificates will have no Certificate
Principal Balance and will accrue interest at the
related Pass-Through Rate on the Notional Amount
(as defined herein). The Pass-Through Rates on the
Class A-6 Certificates and the Class A-L
Certificates will be subject to a maximum of the
weighted average of the Net Mortgage Rates (as
defined herein) on the Mortgage Loans. The Senior
Certificates are subject to various priorities for
payment of interest and principal as described
herein. For a description of the allocation of
interest and principal distributions among the
Senior Certificates, see "Description of the
Certificates--Interest Distributions," and "--
Principal Distributions on the Senior Certificates"
herein.
Certificate Registration.. The DTC Registered Certificates will be represented
by one or more certificates registered in the name
of Cede & Co., as nominee of DTC. No Beneficial
Owner will be entitled to receive a Certificate of
such class in fully registered, certificated form
(a "Definitive Certificate"), except under the
limited circumstances described herein. The PAC
S-5
<PAGE>
Strip Certificates will be offered in fully
registered certificated form. For further
registration information and denomination amounts,
see "Description of the Certificates" herein.
Interest Distributions.... Holders of each class of Senior Certificates will
be entitled to receive interest distributions in an
amount equal to the Accrued Certificate Interest
(as defined herein) on such class on each
Distribution Date in the manner and priority set
forth herein.
With respect to any Distribution Date, Accrued
Certificate Interest will be equal to, in respect
of each class of Senior Certificates, one month's
interest on the Certificate Principal Balance
thereof (or the Notional Amount thereof in the case
of the PAC Strip Certificates) of the Certificates
of such class at the related Pass-Through Rate on
such class. Interest will be calculated on the
basis of a 360-day year consisting of twelve 30-day
months. Notwithstanding the foregoing, if payments
were not made as required under the Policy,
additional interest shortfalls may be allocated to
the Senior Certificates as described herein.
The Pass-Through Rates on all classes of the Senior
Certificates will be fixed and are set forth on the
cover hereof, except that the Pass-Through Rate on
the Class A-6 Certificates and the Class A-L
Certificates will be subject to a maximum of the
weighted average of the Net Mortgage Rates on the
Mortgage Loans.
The Notional Amount is initially equal to
approximately $58,661,897, which corresponds to
approximately 29.57% of the aggregate initial
Stated Principal Balances (as defined herein) of
all of the Mortgage Loans. The Notional Amount will
be reduced on each Distribution Date to an amount
equal to the greater of (i) the Notional Amount
immediately prior to such Distribution Date minus
the aggregate amount of all principal collections
on the Mortgage Loans related to such Distribution
Date and (ii) the Planned PAC Notional Amount (as
defined herein) for such Distribution Date as
indicated in the table "Planned PAC Notional
Amount" under the caption "Description of the
Certificates--Interest Distributions" herein (the
"Planned PAC Notional Amount") for purposes of
calculating distributions of interest on the PAC
Strip Certificates on the following Distribution
Date. In no event will the Notional Amount exceed
the aggregate Stated Principal Balance of the
Mortgage Loans. References herein to Notional
Amounts are used solely for certain calculations
and do not represent the right of any Class of
Certificates to receive distributions of such
amounts.
See "Description of the Certificates--Interest
Distributions" herein.
Principal Distributions... Holders of the Class A Certificates will be
entitled to receive a distribution of principal on
each Distribution Date, in the manner and priority
set forth herein, to the extent of the portion of
the Available Distribution Amount (as defined
herein) remaining after interest is
S-6
<PAGE>
distributed on each class of the Senior
Certificates (collectively, the "Senior Interest
Distribution Amount"), in an amount equal to the
Class A Principal Distribution Amount (as defined
herein). The Class A Principal Distribution Amount
will include, to the extent of available funds and
except as otherwise described herein, the principal
portion of all scheduled monthly payments received
during the related Collection Period (as defined
herein), all unscheduled amounts received during
the related Collection Period and that are
allocable to principal (including proceeds of
repurchases, prepayments and liquidations) and
certain other amounts described herein allocable to
Realized Losses. The Class A Principal Distribution
Amount may also be adjusted as a result of the
required level of overcollaterization, as described
herein. See "Description of the Certificates--
Principal Distributions on the Senior Certificates"
herein.
The subordination and cash flow provisions of the
Class R-II Certificates will result in a limited
acceleration of the principal payments to the
holders of the Class A Certificates (other than the
Lockout Certificates) subject to the priority set
forth herein; such subordination provisions are
described under "Description of the Certificates--
Overcollateralization Provisions" herein. Such
subordination provisions have the effect of
shortening the weighted average life of the Class A
Certificates by increasing the rate at which
principal is distributed to such Class A
Certificateholders. See "Certain Yield and
Prepayment Considerations" herein and "Yield and
Prepayment Considerations" in the Prospectus.
Credit Enhancement........ The credit enhancement provided for the benefit of
the Senior Certificateholders consists of the
overcollateralization and the Policy, each as
described below.
Overcollateralization: The subordination and cash
flow provisions of the Class R-II Certificates
result in a limited acceleration of certain of the
Class A Certificates relative to the amortization
of the Mortgage Loans. This acceleration feature
creates overcollateralization which results from
the excess of the aggregate principal balance of
the Mortgage Loans over the aggregate Certificate
Principal Balance of the Class A Certificates. Once
the required level of overcollateralization is
reached, the acceleration feature will cease,
unless necessary to maintain the required level of
overcollateralization. Excess Cash Flow, which is
applied to create and maintain overcollaterization,
may also be applied to cover Prepayment Interest
Shortfalls, other interest shortfalls and Realized
Losses as and when incurred, as described herein.
The actual level of overcollateralization may
increase or decrease over time as described herein.
An increase would result in a temporary period of
accelerated amortization of the Senior Certificates
to increase the actual level of
overcollateralization to its required level; a
decrease would result in a temporary period of
decelerated amortization to
S-7
<PAGE>
reduce the actual level of overcollateralization to
its required level. See "Description of the
Certificates--Overcollateralization Provisions"
herein.
The Certificate Guaranty Insurance Policy: The
Senior Certificates will be entitled to the benefit
of the Policy to be issued by the Insurer, which,
subject to its terms, will protect the holders of
the Senior Certificates against any interest
shortfalls allocated to the Senior Certificates,
and against the principal portion of any Realized
Losses allocated to the Senior Certificates. See
"Description of the Certificates--Certificate
Guaranty Insurance Policy."
Certificate Guaranty
Insurance Policy.........
The Insurer will issue the Policy as a means of
providing additional credit enhancement to the
Senior Certificates. Under the Policy, the Insurer
will, subject to the terms of the Policy, pay the
Trustee, for the benefit of the holders of the
Senior Certificates, on each Distribution Date, as
described herein, an amount that will cover any
interest shortfalls allocated to the Senior
Certificates, the principal portion of any Realized
Losses allocated to the Class A Certificates and
the Certificate Principal Balance of the Class A
Certificates to the extent unpaid on the final
Distribution Date. Any payment required to be made
by the Insurer under the Policy is referred to
herein as an "Insured Amount." See "Description of
the Certificates--Certificate Guaranty Insurance
Policy" and "The Insurer" herein.
Advances.................. The Master Servicer is not required to make
advances in respect of delinquent payments of
principal and interest on the Mortgage Loans.
Allocation of Losses; Except as otherwise described herein, Realized
Subordination............. Losses on the Mortgage Loans will be allocated
first to the Excess Cash Flow; second to the Class
R-II Certificates up to an amount equal to the
Certificate Principal Balance thereof; and third to
the Senior Certificates as described in
"Description of the Certificates--Allocation of
Losses; Subordination" herein. Subject to the terms
of the Policy, all Realized Losses allocated to the
Senior Certificates will be covered by the Policy.
See "Description of the Certificates--Certificate
Guaranty Insurance Policy" herein.
Neither the Senior Certificates nor the Mortgage
Loans are insured or guaranteed by any governmental
agency or instrumentality or by the Company, the
Master Servicer, the Trustee, GMAC Mortgage or any
affiliate thereof.
Class R Certificates...... As of the Cut-off Date, the Class R Certificates
will have no Certificate Principal Balance and no
Pass-Through Rate. The Class R Certificates are not
being offered hereby.
Optional Termination...... At its option, on any Distribution Date when the
aggregate Stated Principal Balance of the Mortgage
Loans is less than 3% of the aggregate principal
balance of the Mortgage Loans as of the Cut-off
Date, the Master Servicer or the Company may (i)
purchase from the
S-8
<PAGE>
Trust Fund all remaining Mortgage Loans and other
assets thereof, and thereby effect early retirement
of the Certificates or (ii) purchase in whole, but
not in part, the Certificates. See "Pooling and
Servicing Agreement--Termination" herein and "The
Pooling and Servicing Agreement--Termination;
Retirement of Certificates" in the Prospectus.
Special Prepayment The rate and timing of principal payments on the
Considerations........... Class A Certificates will depend on, among other
things, the rate and timing of principal payments
(including prepayments, defaults, liquidations and
purchases of Mortgage Loans due to a breach of a
representation and warranty) on the Mortgage Loans.
The Senior Certificates are subject to substantial
inherent cash flow uncertainties because the
Mortgage Loans may be prepaid at any time.
Generally, when prevailing interest rates increase,
prepayment rates on mortgage loans tend to
decrease, resulting in a slower return of principal
to investors at a time when reinvestment at such
higher prevailing rates would be desirable.
Conversely, when prevailing interest rates decline,
prepayment rates on mortgage loans tend to
increase, resulting in a faster return of principal
to investors at a time when reinvestment at
comparable yields may not be possible.
In addition, since mortgage loans secured by second
liens are not generally viewed by borrowers as
permanent financing and generally carry a high rate
of interest, the Mortgage Loans may experience a
higher rate of prepayments than traditional
mortgage loans. In addition, the rate of default on
second mortgage loans may be greater than that of
mortgage loans secured by first liens. See "Certain
Yield and Prepayment Considerations--General"
herein.
The multiple class structure of Senior Certificates
results in the allocation of prepayments among
certain classes as follows:
Class A Certificates: The Class A Certificates are
subject to various priorities for payment of
principal as described herein. Distributions of
principal on classes of Class A Certificates having
an earlier priority of payment will be affected by
the rates of prepayment of the Mortgage Loans early
in the life of the Mortgage Pool. The timing of
commencement of principal distributions and the
weighted average lives of the classes of Class A
Certificates with a later priority of payment will
be affected by the rates of prepayment of the
Mortgage Loans experienced both before and after
the commencement of principal distributions on such
classes.
Lockout Certificates: As described herein, during
certain periods all or a disproportionately large
percentage of principal collections on the Mortgage
Loans will be allocated among the classes of Class
A Certificates (other than the Lockout
Certificates) and, during certain periods, no
principal collections or a disproportionately small
percentage of principal collections will be
distributed on the Lockout Certificates.
S-9
<PAGE>
See "Description of the Certificates--Principal
Distributions on the Senior Certificates" and
"Certain Yield and Prepayment Considerations"
herein and "Yield and Prepayment Considerations" in
the Prospectus. For further information regarding
the effect of principal prepayments on the weighted
average lives of the Class A Certificates, see the
table entitled "Percent of Initial Certificate
Principal Balance Outstanding at the Following
Percentages of Prepayment Assumption" herein.
Special Yield The yield to maturity on the Class A Certificates
Considerations........... will depend on, among other things, the rate and
timing of principal payments (including
prepayments, defaults, liquidations and repurchases
of Mortgage Loans due to a breach of a
representation and warranty) on the Mortgage Loans
and the allocation thereof to reduce the
Certificate Principal Balance of such class.
Prepayment Interest Shortfalls resulting from
principal prepayments in full in any calendar month
will not adversely affect the yield to investors in
the Senior Certificates because such Prepayment
Interest Shortfalls will be covered first by Excess
Cash Flow to the extent available and then by the
Policy. See "Description of the Certificates--
Interest Distributions" herein.
In general, if the Class A Certificates are
purchased at a premium and principal distributions
to such class occur at a rate faster than assumed
at the time of purchase, the investor's actual
yield to maturity will be lower than that
anticipated at the time of purchase. Conversely, if
the Class A Certificates are purchased at a
discount and principal distributions thereon occur
at a rate slower than that assumed at the time of
purchase, the investor's actual yield to maturity
will be lower than that anticipated at the time of
purchase.
The Senior Certificates were structured assuming,
among other things, a Prepayment Assumption (as
defined herein) of 100% and corresponding weighted
average lives as described herein. The prepayment,
yield and other assumptions to be used for pricing
purposes for the respective classes that are to be
offered hereunder may vary as determined at the
time of sale.
The multiple class structure of the Senior
Certificates causes the yield of certain classes to
be particularly sensitive to changes in the rates
of prepayment of the Mortgage Loans and other
factors, as follows:
Lockout Certificates: Investors in the Lockout
Certificates should be aware that because the
Lockout Certificates do not receive any collections
of principal prior to the Distribution Date
occurring in October 1999, and prior to the
Distribution Date occurring in October 2003 will
receive a disproportionately small portion of
principal collections with respect to the Mortgage
Loans (unless the Certificate Principal Balances of
the Class A Certificates (other than the Lockout
Certificates) have been reduced to zero), the
weighted average life of the Lockout Certificates
will be longer than would otherwise be the
S-10
<PAGE>
case, and the effect on the market value of the
Lockout Certificates of changes in market interest
rates or market yields for similar securities may
be greater than for other classes of Class A
Certificates entitled to such distributions.
PAC Strip Certificates: The PAC Strip Certificates
have been structured so that the Notional Amount
thereof on any Distribution Date will be reduced to
the Planned PAC Notional Amount for such date as
set forth in the table commencing on page S-24
herein, assuming that prepayments on the Mortgage
Loans occur at a rate between 5% to 50% CPR in each
month. However, if principal prepayments on the
Mortgage Loans occur at a rate below or above such
level, the Notional Amount may deviate from the
described amounts and the weighted average life of
the PAC Strip Certificates may be extended or
shortened relative to the weighted average life
based on the Planned PAC Notional Amount. If
principal prepayments on the Mortgage Loans occur
at a rate above such level, the holders of the PAC
Strip Certificates could fail to recover their
initial investments, and in no event will the
Notional Amount exceed the Stated Principal Balance
of all of the Mortgage Loans on such Distribution
Date. See "Certain Yield and Prepayment
Considerations," especially "Certain Yield and
Prepayment Considerations--PAC Strip Certificate
Yield Considerations" herein.
Certain Federal Income
Tax Consequences.........
Two separate REMIC elections ("REMIC I" and "REMIC
II") will be made with respect to the Trust Fund
for federal income tax purposes. Upon the issuance
of the Senior Certificates, Thacher Proffitt &
Wood, counsel to the Company, will deliver its
opinion generally to the effect that, assuming
compliance with all provisions of the Pooling and
Servicing Agreement, for federal income tax
purposes, REMIC I and REMIC II will each qualify as
a REMIC under Sections 860A through 860G of the
Code.
For federal income tax purposes, (a) the Class R-I
Certificates will be the sole class of "residual
interests" in REMIC I, (b) each class of the Senior
Certificates will represent ownership of "regular
interests" in REMIC II and will generally be
treated as representing ownership of debt
instruments of REMIC II, and (c) the Class R-II
Certificates will constitute the sole class of
"residual interests" in REMIC II.
For further information regarding the federal
income tax consequences of investing in the Senior
Certificates, see "Certain Federal Income Tax
Consequences" herein and in the Prospectus.
Ratings................... It is a condition to the issuance of the Class A
Certificates that they be rated "AAA" by Standard &
Poor's and "Aaa" by Moody's. It is a condition to
the issuance of the PAC Strip Certificates that
they be rated "AAAr" by Standard & Poor's and "Aaa"
by Moody's. A security rating is not a
recommendation to buy, sell or hold securities and
may be subject to revision or withdrawal at any
time by the
S-11
<PAGE>
assigning rating organization. A security rating
does not address the frequency of prepayments of
Mortgage Loans, or the corresponding effect on
yield to investors. The rating of the PAC Strip
Certificates does not address the possibility that
the holders thereof may fail to fully recover their
initial investment. See "Certain Yield and
Prepayment Considerations" and "Ratings" herein and
"Yield and Prepayment Considerations" in the
Prospectus.
Legal Investment.......... THE SENIOR CERTIFICATES WILL NOT CONSTITUTE
"MORTGAGE RELATED SECURITIES" FOR PURPOSES OF
SMMEA, BECAUSE THE MORTGAGE POOL CONSISTS OF
MORTGAGE LOANS THAT ARE SECURED BY SUBORDINATE
LIENS ON THE RELATED MORTGAGED PROPERTIES.
Institutions whose investment activities are
subject to legal investment laws and regulations or
to review by regulatory authorities should consult
with their legal advisors in determining whether
and to what extent the Senior Certificates are
subject to restrictions on investment, capital
requirements or otherwise. See "Legal Investment"
herein and in the Prospectus.
ERISA Considerations...... A fiduciary of any employee benefit plan or other
plan or arrangement subject to ERISA or Section
4975 of the Code (a "Plan") or any insurance
company (whether through its general or separate
accounts) or other person investing "plan assets"
of any Plan, should carefully review with its legal
advisors whether the purchase or holding of Senior
Certificates could give rise to a transaction
prohibited or not otherwise permissible under ERISA
or Section 4975 of the Code. Subject to the
considerations set forth under "ERISA
Considerations" herein and in the Prospectus, the
purchase or holding of the Senior Certificates by,
on behalf of, or with "plan assets" of, a Plan may
qualify for exemptive relief under the Exemption
(as defined in the Prospectus).
S-12
<PAGE>
RISK FACTORS
PROSPECTIVE CERTIFICATEHOLDERS SHOULD CONSIDER, AMONG OTHER THINGS, THE
ITEMS DISCUSSED UNDER "RISK FACTORS" IN THE PROSPECTUS AND THE FOLLOWING
FACTORS IN CONNECTION WITH THE PURCHASE OF THE SENIOR CERTIFICATES:
RISKS ASSOCIATED WITH THE MORTGAGE LOANS
Since substantially all of the Mortgage Loans are subordinate to the rights
of the mortgagee under the related senior mortgage, the proceeds from any
liquidation, insurance or condemnation proceedings will be available to
satisfy the outstanding balance of such Mortgage Loans secured by subordinate
mortgages only to the extent that the claims of such senior mortgages have
been satisfied in full, including any related foreclosure costs. In
circumstances when it is determined to be uneconomical to foreclose on the
Mortgaged Property, the Master Servicer may write off the entire outstanding
balance of such Mortgage Loan as a bad debt. The foregoing considerations will
be particularly applicable to Mortgage Loans secured by junior liens that have
high Combined Loan-to-Value Ratios or low Junior Ratios because it is
comparatively more likely that the Master Servicer would determine foreclosure
to be uneconomical in the case of such Mortgage Loans. Any losses on Mortgage
Loans, to the extent such losses are not covered by overcollaterization or the
Policy will be borne by the Certificateholders.
Defaults on mortgage loans are generally expected to occur with greater
frequency in their early years. The rate of default of second mortgage loans
may be greater than that of mortgage loans secured by first liens on
comparable properties.
15.9% of the Mortgage Loans are not fully amortizing over their terms to
maturity and, thus, will require substantial principal payments (i.e., a
Balloon Payment, as defined herein) at their stated maturity. Mortgage Loans
with Balloon Payments involve a greater degree of risk because the ability of
a Mortgagor to make a Balloon Payment typically will depend upon the
Mortgagor's ability either to timely refinance the loan or to timely sell the
related Mortgaged Property. See "Description of the Mortgage Pool--Balloon
Mortgage Loans" herein.
LIMITATIONS AND REDUCTION AND SUBSTITUTION OF CREDIT ENHANCEMENT
Credit enhancement will be provided for the Senior Certificates in the form
of overcollateralization and by the Policy, each as described herein. None of
the Company, the Master Servicer, the Trustee, the Sellers, the Insurer, GMAC
Mortgage nor any of their affiliates will have any obligation to replace or
supplement such credit enhancement, or to take any other action to maintain
any rating of the Senior Certificates. To the extent that any losses are
incurred on any of the Mortgage Loans that are not covered by
overcollateralization or by the Policy, the holders of the Senior Certificates
will bear all risk of such losses resulting from default by Mortgagors.
S-13
<PAGE>
DESCRIPTION OF THE MORTGAGE POOL
GENERAL
The Mortgage Pool will consist of Mortgage Loans with a Cut-off Date Balance
of $198,367,179. 99.8% of the Mortgage Loans are secured by second liens on
fee simple or leasehold interests in one- to four-family residential real
properties and the remainder are secured by first liens. The Mortgage Loans
will consist of fixed-rate, fully-amortizing and balloon payment Mortgage
Loans with terms to maturity of approximately five, ten or fifteen years with
respect to 0.2%, 1.1% and 98.7% of the Mortgage Loans, respectively, from the
date of origination or modification. With respect to Mortgage Loans which have
been modified, references herein to the date of origination shall be deemed to
be the date of the most recent modification. All percentages of the Mortgage
Loans described herein are approximate percentages (except as otherwise
indicated) by Cut-off Date Balance.
All of the Mortgage Loans were purchased by the Company through its
affiliate Residential Funding under Residential Funding's Home Equity Program
from Unaffiliated Sellers as described herein and in the Prospectus, except in
the case of 8.7% of the Mortgage Loans which were purchased by the Company
through its affiliate Residential Funding from GMAC Mortgage Corporation of PA
(an affiliate of the Company). 10.7% of the Mortgage Loans will have been
purchased from Oakmont Mortgage, an Unaffiliated Seller. Except as described
in the preceding sentence, no Unaffiliated Seller sold more than 7.7% of the
Mortgage Loans to Residential Funding. All of the Mortgage Loans are being
subserviced by GMAC Mortgage Corporation of PA. See "--The Servicer" below.
All of the Mortgage Loans were generally underwritten in conformity with or
in a manner generally consistent with Residential Funding's Home Equity
Program. See "--Underwriting Standards" below.
The Company and Residential Funding will make certain limited
representations and warranties regarding the Mortgage Loans as of the date of
issuance of the Certificates. The Company and Residential Funding will be
required to repurchase or substitute for any Mortgage Loan as to which a
breach of its representations and warranties with respect to such Mortgage
Loan occurs if such breach materially adversely affects the interests of the
Certificateholders or the Insurer in any such Mortgage Loan. Each Seller has
made or will make certain limited representations and warranties regarding the
related Mortgage Loans, as of the date of purchase thereof by Residential
Funding. However, such representations and warranties will not be assigned to
the Trustee for the benefit of the holders of the Certificates, and therefore
a breach of such representations and warranties will not be enforceable on
behalf of the Trust Fund. See "Mortgage Loan Program--Qualifications of
Sellers" and "--Representations Relating to the Mortgage Loans" and
"Description of the Certificates--Review of Mortgage Loans" in the Prospectus.
Neither the Company nor Residential Funding will be required to repurchase or
substitute for any Mortgage Loan in the event of a breach of its
representations and warranties with respect to such Mortgage Loan if the
substance of any such breach also constitutes fraud in the origination of such
affected Mortgage Loan. A limited amount of losses on Mortgage Loans as to
which there was fraud in the origination of such Mortgage Loans will be
covered by the Subordination (as defined herein) provided by the Class R-II
Certificates as described herein under "Description of the Certificates--
Allocation of Losses; Subordination." Subject to the terms of the Policy,
certain fraud losses will be covered by the Policy as described herein.
PAYMENTS ON THE SIMPLE INTEREST MORTGAGE LOANS
7.6% of the Mortgage Loans are Simple Interest Mortgage Loans, which require
that each monthly payment consist of an installment of interest which is
calculated according to the simple interest method on the basis of the
outstanding principal balance of the Mortgage Loan multiplied by the Mortgage
Rate and further multiplied by a fraction, the numerator of which is the
number of days in the period elapsed since the preceding payment of interest
was made and the denominator of which is the number of days in the annual
period for which interest accrues on such Mortgage Loan (as opposed to 92.4%
of the Mortgage Loans which are Actuarial Mortgage Loans, on which 30 days of
interest is owed each month irrespective of the day on which the payment is
received). As payments are received, the amount received is applied first to
interest accrued to the date of payment and the balance is applied to reduce
the unpaid principal balance. Accordingly, if a Mortgagor pays a
S-14
<PAGE>
fixed monthly installment before its scheduled due date, the portion of the
payment allocable to interest for the period since the preceding payment was
made will be less than it would have been had the payment been made as
scheduled, and the portion of the payment applied to reduce the unpaid
principal balance will be correspondingly greater. However, the next
succeeding payment will result in an allocation of a greater amount to
interest if such payment is made on its scheduled due date.
Conversely, if a Mortgagor pays a fixed monthly installment after its
scheduled due date, the portion of the payment allocable to interest for the
period since the preceding payment was made will be greater than it would have
been had the payment been made as scheduled, and the remaining portion, if
any, of the payment applied to reduce the unpaid principal balance will be
correspondingly less. If each scheduled payment is made on or prior to its
scheduled due date, the principal balance of the Mortgage Loan will amortize
in the manner described in the preceding paragraph. However, if the Mortgagor
consistently makes scheduled payments after the scheduled due date the
Mortgage Loan will amortize more slowly than scheduled. Any remaining unpaid
principal is payable on the final maturity date of the Mortgage Loan.
BALLOON MORTGAGE LOANS
15.9% of the Mortgage Loans require monthly payments of principal based on a
30-year amortization schedule and have scheduled maturity dates of fifteen
years from the due date of the first monthly payment (each such Mortgage Loan,
a "Balloon Mortgage Loan"), in each case leaving a substantial portion of the
original principal amount due and payable on the respective scheduled maturity
date (a "Balloon Payment"). The existence of a Balloon Payment generally will
require the related Mortgagor to refinance such Mortgage Loan or to sell the
Mortgaged Property on or prior to the scheduled maturity date. The ability of
a Mortgagor to accomplish either of these goals will be affected by a number
of factors, including the level of available mortgage rates at the time of
sale or refinancing, the Mortgagor's equity in the related Mortgaged Property,
the financial condition of the Mortgagor, tax laws, prevailing general
economic conditions and the terms of any related first lien mortgage loan.
None of the Company, the Master Servicer or the Trustee is obligated to
refinance any Balloon Mortgage Loan. Subject to the terms of the Policy, the
Policy will provide coverage on any losses incurred upon liquidation of a
Balloon Mortgage Loan arising out of or in connection with the failure of a
Mortgagor to make the Balloon Payment.
MORTGAGE POOL CHARACTERISTICS
None of the Mortgage Loans were originated prior to May 24, 1994 or will
have a maturity date later than September 1, 2011. No Mortgage Loan will have
a remaining term to stated maturity as of the Cut-off Date of less than 35
months. The weighted average remaining term to stated maturity of the Mortgage
Loans as of the Cut-off Date will be approximately 174 months. The weighted
average original term to stated maturity of the Mortgage Loans as of the Cut-
off Date will be approximately 179 months. 0.3% of the fully-amortizing
Mortgage Loans will have original terms to maturity of approximately five
years, with a weighted average remaining term to stated maturity of such
Mortgage Loans of 55 months. 1.3% of the fully-amortizing Mortgage Loans will
have original terms of maturity of approximately ten years, with a weighted
average remaining term to stated maturity of such Mortgage Loans of 114
months. 98.4% of the fully-amortizing Mortgage Loans will have original terms
to maturity of approximately fifteen years, with a weighted average remaining
term to stated maturity of such Mortgage Loans of 174 months. The Balloon
Mortgage Loans will have original terms to maturity of approximately fifteen
years based on 30-year amortization schedules, with a weighted average
remaining term to stated maturity of 176 months. All of the Mortgage Loans
have principal and interest payable monthly on various days of each month as
specified in the Mortgage Note (the "Due Date").
In connection with each Mortgage Loan that is secured by a leasehold
interest, the related Seller will have represented to Residential Funding
that, among other things: (i) the use of leasehold estates for residential
properties is an accepted practice in the area where the related Mortgaged
Property is located; (ii) residential property in such area consisting of
leasehold estates is readily marketable; (iii) the lease is recorded and no
party is in any way in breach of any provision of such lease; (iv) the
leasehold is in full force and effect and is not
S-15
<PAGE>
subject to any prior lien or encumbrance by which the leasehold could be
terminated or subject to any charge or penalty; and (v) the remaining term of
the lease does not terminate less than ten years after the maturity date of
each such Mortgage Loans.
As of the Cut-off Date, no Mortgage Loan will be 30 days or more delinquent
in payment of principal and interest.
As of the Cut-off Date, 6.9% of the Mortgage Loans were High Cost Loans.
No Mortgage Loan provides for deferred interest, negative amortization or
future advances.
Set forth below is a description of certain additional characteristics of
the Mortgage Loans as of the Cut-off Date (except as otherwise indicated). All
percentages of the Mortgage Loans are approximate percentages by Cut-off Date
Balance (except as otherwise indicated). Unless otherwise specified, all
principal balances of the Mortgage Loans are Cut-off Date Balances and are
rounded to the nearest dollar.
MORTGAGE RATES
<TABLE>
<CAPTION>
NUMBER OF
MORTGAGE CUT-OFF DATE PERCENTAGE OF
MORTGAGE RATES (%) LOANS BALANCE MORTGAGE POOL
- ------------------ --------- ------------ -------------
<S> <C> <C> <C>
8.000- 8.499.............................. 2 176,741 0.09%
9.000- 9.499.............................. 40 1,055,126 0.53
9.500- 9.999.............................. 134 4,366,059 2.20
10.000-10.499.............................. 254 7,749,034 3.91
10.500-10.999.............................. 681 22,143,526 11.16
11.000-11.499.............................. 857 28,185,284 14.21
11.500-11.999.............................. 1,055 35,506,113 17.90
12.000-12.499.............................. 914 29,615,107 14.93
12.500-12.999.............................. 1,203 39,005,882 19.66
13.000-13.499.............................. 432 14,737,756 7.43
13.500-13.999.............................. 371 11,439,720 5.77
14.000-14.499.............................. 96 2,774,328 1.40
14.500-15.499.............................. 44 1,303,637 0.66
15.000-15.499.............................. 7 213,206 0.11
15.500-15.999.............................. 4 95,662 0.05
----- ------------ ------
Total.................................... 6,094 $198,367,179 100.00%
===== ============ ======
</TABLE>
As of the Cut-off Date, the weighted average Mortgage Rate of the Mortgage
Loans was approximately 11.9766% per annum.
ORIGINAL MORTGAGE LOAN PRINCIPAL BALANCES
<TABLE>
<CAPTION>
ORGINAL MORTGAGE LOANI NUMBER OF CUT-OFF DATE PERCENTAGE OF
RINCIPAL BALANCEP MORTGAGE LOANS BALANCE MORTGAGE POOL
- ---------------------- -------------- ------------ -------------
<S> <C> <C> <C>
$ 0.01-$ 25,000.00.............. 2,304 $ 43,988,363 22.18%
$ 25,000.01-$ 50,000.00.............. 3,227 115,276,954 58.11
$ 50,000.01-$ 75,000.00.............. 399 24,074,631 12.14
$ 75,000.01-$100,000.00.............. 143 12,481,917 6.29
$100,000.01-$125,000.00.............. 14 1,612,605 0.81
$125,000.01-$150,000.00.............. 5 555,750 0.28
$175,000.01-$200,000.00.............. 2 376,960 0.19
----- ------------ ------
Total.............................. 6,094 $198,367,179 100.00%
===== ============ ======
</TABLE>
As of the Cut-off Date, the average Cut-off Date Balance of the Mortgage
Loans will be approximately $32,551.
S-16
<PAGE>
ORIGINAL COMBINED LOAN-TO-VALUE RATIOS
<TABLE>
<CAPTION>
COMBINED LOAN-TO-
VALUE NUMBER OF CUT-OFF DATE PERCENTAGE OF
RATIO (%) MORTGAGE LOANS BALANCE MORTGAGE POOL
----------------- -------------- ------------ -------------
<S> <C> <C> <C>
00.01- 10.00....................... 5 $ 138,424 0.07%
10.01- 20.00....................... 4 137,845 0.07
20.01- 30.00....................... 10 349,008 0.18
30.01- 40.00....................... 11 452,730 0.23
40.01- 50.00....................... 24 804,349 0.41
50.01- 60.00....................... 41 1,323,517 0.67
60.01- 70.00....................... 83 2,762,305 1.39
70.01- 75.00....................... 88 2,886,595 1.46
75.01- 80.00....................... 256 8,911,961 4.49
80.01- 85.00....................... 374 10,971,521 5.53
85.01- 90.00....................... 2,195 74,660,752 37.64
90.01- 95.00....................... 1,394 47,818,389 24.11
95.01-100.00....................... 1,593 46,803,213 23.59
100.01-101.00....................... 16 346,571 0.17
----- ------------ ------
Total............................. 6,094 $198,367,179 100.00%
===== ============ ======
</TABLE>
The weighted average Combined Loan-to-Value Ratio at origination of the
Mortgage Loans secured by second liens will be approximately 90.79%.
JUNIOR MORTGAGE RATIOS
<TABLE>
<CAPTION>
JNIOR MORTGAGEU NUMBER OF CUT-OFF DATE PERCENTAGE OF
RATIO (%) MORTGAGE LOANS BALANCE MORTGAGE POOL
- --------------- -------------- ------------ -------------
<S> <C> <C> <C>
0.00- 5.00.......................... 24 $ 361,415 0.18%
5.01- 10.00......................... 420 8,984,711 4.53
10.01- 15.00......................... 1,682 48,538,059 24.47
15.01- 20.00......................... 2,243 74,764,106 37.69
20.01- 25.00......................... 846 29,764,433 15.00
25.01- 30.00......................... 420 16,627,092 8.38
30.01- 40.00......................... 318 12,717,579 6.41
40.01- 50.00......................... 79 3,499,877 1.76
50.01- 60.00......................... 30 1,634,339 0.82
60.01- 70.00......................... 6 306,358 0.15
70.01- 80.00......................... 7 402,746 0.20
80.01- 90.00......................... 1 24,622 0.01
90.01-100.00......................... 18 741,844 0.37
----- ------------ ------
Total.............................. 6,094 $198,367,179 100.00%
===== ============ ======
</TABLE>
The weighted average Junior Mortgage Ratio as of the Cut-off Date will be
approximately 19.40%.
S-17
<PAGE>
GEOGRAPHIC DISTRIBUTION OF MORTGAGED PROPERTIES
<TABLE>
<CAPTION>
NUMBER OF CUT-OFF DATE PERCENTAGE OF
STATE MORTGAGE LOANS BALANCE MORTGAGE POOL
- ----- -------------- ------------ -------------
<S> <C> <C> <C>
California............................ 3,911 $135,166,416 68.14%
Florida............................... 186 4,787,571 2.41
Maryland.............................. 189 6,044,915 3.05
Utah.................................. 304 8,719,629 4.40
Virginia.............................. 172 6,012,865 3.03
Washington............................ 318 9,506,328 4.79
Other................................. 1,014 28,129,455 14.18
----- ------------ ------
Total............................... 6,094 $198,367,179 100.00%
===== ============ ======
</TABLE>
- --------
(1) "Other" includes states and the District of Columbia that contain less than
2.00% of the Mortgage Pool.
MORTGAGED PROPERTY TYPES
<TABLE>
<CAPTION>
NUMBER OF CUT-OFF DATE PERCENTAGE OF
PROPERTY MORTGAGE LOANS BALANCE MORTGAGE POOL
- -------- -------------- ------------ -------------
<S> <C> <C> <C>
Condo 1-4 Stories..................... 230 $ 6,317,523 3.18%
Leasehold............................. 2 47,436 0.02
Planned Unit Development--Detached.... 548 20,218,153 10.19
Single Family--Detached............... 5,157 167,088,827 84.23
Condo--9 or more Stories.............. 4 107,295 0.05
Townhouse/Rowhouse.................... 39 1,177,911 0.59
Mid-rise Condo--5-8 Stories........... 4 113,927 0.06
Planned Unit Developments--Attached... 91 2,677,540 1.35
Two- to-Four-Family Units............. 19 618,567 0.31
----- ------------ ------
Total............................... 6,094 $198,367,179 100.00%
===== ============ ======
</TABLE>
MORTGAGE LOAN DOCUMENTATION
<TABLE>
<CAPTION>
NUMBER OF CUT-OFF DATE PERCENTAGE OF
TYPE OF PROGRAM MORTGAGE LOANS BALANCE MORTGAGE POOL
- --------------- -------------- ------------ -------------
<S> <C> <C> <C>
Full Documentation.................... 6,080 $197,877,556 99.75%
Limited Documentation................. 14 489,623 0.25
----- ------------ ------
Total............................... 6,094 $198,367,179 100.00%
===== ============ ======
</TABLE>
OCCUPANCY TYPES
<TABLE>
<CAPTION>
OCCUPANCY
(AS NUMBER OF CUT-OFF DATE PERCENTAGE OF
IDICATED BY BORROWER)N MORTGAGE LOANS BALANCE MORTGAGE POOL
- ---------------------- -------------- ------------ -------------
<S> <C> <C> <C>
Primary Residence.................... 6,087 $198,126,629 99.88%
Second/Vacation...................... 7 240,550 0.12
----- ------------ ------
Total.............................. 6,094 $198,367,179 100.00%
===== ============ ======
</TABLE>
S-18
<PAGE>
LIEN PRIORITY
<TABLE>
<CAPTION>
PERCENTAGE OF
MORTGAGE POOL
NUMBER OF CUT-OFF DATE BY CUT-OFF
LIEN PRIORITY MORTGAGE LOANS BALANCE DATE BALANCE
- ------------- -------------- ------------ -------------
<S> <C> <C> <C>
First Lien............................ 13 $ 461,453 0.23%
Second Lien........................... 6,081 197,905,726 99.77
----- ------------ ------
Total............................... 6,094 $198,367,179 100.00%
===== ============ ======
</TABLE>
UNDERWRITING STANDARDS
The following is a brief description of the various underwriting standards
and procedures applicable to the Mortgage Loans. For a more detailed
description of the underwriting standards and procedures applicable to the
Mortgage Loans, see "Mortgage Loan Program--Underwriting Standards" in the
Prospectus.
Residential Funding's underwriting standards with respect to the Mortgage
Loans generally will conform to those published in the Seller Guide (together
with its Servicer Guide, the "Guide," as modified from time to time),
including the provisions of the Guide applicable to the Home Equity Program.
The underwriting standards as set forth in the Guide are continuously revised
based on prevailing conditions in the residential mortgage market and the
market for mortgage securities. Under the Guide, the Mortgage Loans are
generally underwritten by the related Seller or by a designated third party,
and Residential Funding or a designated third party may perform only sample
quality assurance reviews to determine whether Mortgage Loans purchased by it
were underwritten in accordance with applicable standards.
Each Seller is an entity approved by Residential Funding for participation
in the Home Equity Program. Each Seller was required at the time of its
approval to meet certain eligibility requirements, including minimum
origination and net worth levels determined by Residential Funding. However,
there can be no assurance that any Seller currently meets such standards.
Generally, the Seller will have originated the Mortgage Loans sold by it to
Residential Funding either directly or through correspondents or loan brokers,
and will have underwritten each Mortgage Loan prior to funding.
The underwriting standards set forth in the Guide with respect to Mortgage
Loans originated under the Home Equity Program generally require that such
Mortgage Loans be fully documented or that such Mortgage Loans be supported by
alternative documentation. For fully documented loans, a prospective borrower
is required to fill out a detailed application providing pertinent credit
information. For alternatively documented loans, a borrower may demonstrate
income and employment directly by providing alternative documentation in the
form of copies of the borrower's own records relating thereto, rather than by
having the originator obtain independent verifications from third parties
(such as the borrower's employer or mortgage servicer).
In determining the adequacy of the mortgaged property as collateral for a
Mortgage Loan originated under the Home Equity Program, an appraisal is made
of each property considered for financing. Except with respect to no more than
0.2% of the Mortgage Loans, which were subject to a maximum CLTV of 101%, the
Mortgage Loans included in the Mortgage Pool generally were originated subject
to a maximum CLTV of 100%. The Mortgage Loans were also subject to a maximum
total monthly debt to income ratio of 55%. There can be no assurance that the
CLTV or the debt to income ratio for any Mortgage Loans will not increase from
the levels established at origination.
The underwriting standards set forth in the Guide with respect to Mortgage
Loans originated under the Home Equity Program may be varied in appropriate
cases. There can be no assurance that every Mortgage Loan was originated in
conformity with the applicable underwriting standards in all material
respects, or that the quality or performance of the Mortgage Loans will be
equivalent under all circumstances.
S-19
<PAGE>
RESIDENTIAL FUNDING
Residential Funding will be responsible for master servicing the Mortgage
Loans. Such responsibilities will include the receipt of funds from
Subservicers, the reconciliation of servicing activity with respect to the
Mortgage Loans, investor reporting, remittances to the Trustee to accommodate
distributions to Certificateholders, consulting with Subservicers with respect
to Mortgage Loans that are delinquent or for which servicing decisions may
need to be made, management and liquidation of Mortgaged Properties acquired
by foreclosure or deed in lieu of foreclosure, notices and other
responsibilities. Residential Funding is not required to make advances in
respect of delinquent payments of principal and interest on the Mortgage
Loans.
For information regarding foreclosure procedures, see "Description of the
Certificates--Realization Upon Defaulted Mortgage Loans" in the Prospectus.
Servicing and charge-off policies and collection practices may change over
time in accordance with the Residential Funding's business judgment, changes
in Residential Funding's portfolio of real estate secured home equity mortgage
loans that it services for its clients and applicable laws and regulations,
and other considerations.
Residential Funding serves as the master servicer for closed-end second lien
mortgage loans. As of June 30, 1996, Residential Funding was master servicing
approximately 7,500 of such mortgage loans, totaling approximately $243.5
million. Residential Funding has not had sufficient experience master
servicing the types of mortgage loans comprising the Mortgage Pool to provide
meaningful disclosure of its delinquency and loss experience with respect to
such mortgage loans.
THE SUBSERVICER
Primary servicing of the Mortgage Loans will be provided by GMAC Mortgage
Corporation of PA (the "Subservicer"). GMAC Mortgage Corporation of PA is
engaged in the mortgage banking business, including the origination, purchase,
sale and servicing of closed-end second lien mortgage loans. As of August 31,
1996, GMAC Mortgage Corporation of PA was servicing approximately 7,900
closed-end second mortgage loans, totalling approximately $255.7 million. GMAC
Mortgage Corporation of PA's executive offices are located at 100 Witmer Road,
Horsham, Pennsylvania 19044. GMAC Mortgage Corporation of PA has not had
sufficient experience servicing the types of mortgage loans comprising the
Mortgage Pool to provide meaningful disclosure of its delinquency and loss
experience with respect to such mortgage loans.
ADDITIONAL INFORMATION
The description in this Prospectus Supplement of the Mortgage Pool and the
Mortgaged Properties is based upon the Mortgage Pool as constituted at the
close of business on the Cut-off Date. Prior to the issuance of the Senior
Certificates, Mortgage Loans may be removed from the Mortgage Pool as a result
of incomplete documentation or otherwise, if the Company deems such removal
necessary or appropriate. A limited number of other mortgage loans may be
added to the Mortgage Pool prior to the issuance of the Senior Certificates.
The Company believes that the information set forth herein will be
substantially representative of the characteristics of the Mortgage Pool as it
will be constituted at the time the Senior Certificates are issued although
the range of Mortgage Rates and maturities and certain other characteristics
of the Mortgage Loans in the Mortgage Pool may vary.
A Current Report on Form 8-K will be available to purchasers of the Senior
Certificates and will be filed, together with the Pooling and Servicing
Agreement, with the Securities and Exchange Commission within fifteen days
after the initial issuance of the Senior Certificates. In the event Mortgage
Loans are removed from or added to the Mortgage Pool as set forth in the
preceding paragraph, such removal or addition will be noted in the Current
Report on Form 8-K.
S-20
<PAGE>
DESCRIPTION OF CERTIFICATES
GENERAL
The Series 1996-HS2 Pass-Through Certificates will include the following
eight classes (the "Senior Certificates"): (i) Class A-1 Certificates, Class
A-2 Certificates, Class A-3 Certificates, Class A-4 Certificates, Class A-5
Certificates and Class A-6 Certificates; (ii) Class A-L Certificates (the
"Lockout Certificates"); and (iii) Class IO Certificates (the "PAC Strip
Certificates"). The Class A-1 Certificates, Class A-2 Certificates, Class A-3
Certificates, Class A-4 Certificates, Class A-5 Certificates, Class A-6
Certificates and Lockout Certificates are referred to herein collectively as
the "Class A Certificates." In addition to the Senior Certificates, the Series
1996-HS2 Home Equity Loan Pass-Through Certificates will also include two
classes of subordinate certificates which are designated as the Class R-I
Certificates and Class R-II Certificates (together, the "Class R Certificates"
or the "Residual Certificates" and, together with the Senior Certificates, the
"Certificates"). Only the Senior Certificates are offered hereby.
The Certificates will evidence the entire beneficial ownership interest in
the Trust Fund. The Trust Fund will consist of: (i) the Mortgage Loans; (ii)
such assets as from time to time are identified as deposited in respect of the
Mortgage Loans in the Custodial Account and in the Certificate Account and
belonging to the Trust Fund; (iii) property acquired by foreclosure of such
Mortgage Loans or deed in lieu of foreclosure; (iv) any applicable insurance
policies; (v) the Policy; and (vi) all proceeds of the foregoing.
The DTC Registered Certificates will be issued in minimum denominations of
$25,000 and integral multiples of $1 in excess thereof. The PAC Strip
Certificates will be issued in minimum denominations of a 20% Percentage
Interest.
The DTC Registered Certificates will be represented by one or more
certificates registered in the name of the nominee of DTC. The Company has
been informed by DTC that DTC's nominee will be Cede & Co. ("Cede"). No
Beneficial Owner will be entitled to receive a Definitive Certificate, except
as set forth in the Prospectus under "Description of the Certificates--Form of
Certificates." Unless and until Definitive Certificates are issued for the DTC
Registered Certificates under the limited circumstances described herein, all
references to actions by Certificateholders with respect to the DTC Registered
Certificates shall refer to actions taken by DTC upon instructions from its
Participants, and all references herein to distributions, notices, reports and
statements to Certificateholders with respect to the DTC Registered
Certificates shall refer to distributions, notices, reports and statements to
DTC or Cede, as the registered holder of the DTC Registered Certificates, for
distribution to Beneficial Owners by DTC in accordance with DTC procedures.
BOOK-ENTRY REGISTRATION OF CERTAIN OF THE SENIOR CERTIFICATES
General. Beneficial Owners that are not Participants or Indirect
Participants but desire to purchase, sell or otherwise transfer ownership of,
or other interests in, the related DTC Registered Certificates may do so only
through Participants and Indirect Participants. In addition, Beneficial Owners
will receive all distributions of principal of and interest on the related DTC
Registered Certificates from the Paying Agent through DTC and Participants.
Accordingly, Beneficial Owners may experience delays in their receipt of
payments. Unless and until Definitive Certificates are issued for the related
DTC Registered Certificates, it is anticipated that the only registered
Certificateholder of such DTC Registered Certificates will be Cede, as nominee
of DTC. Beneficial Owners will not be recognized by the Trustee or the Master
Servicer as Certificateholders, as such term is used in the Pooling and
Servicing Agreement, and Beneficial Owners will be permitted to receive
information furnished to Certificateholders and to exercise the rights of
Certificateholders only indirectly through DTC, its Participants and Indirect
Participants.
Under the rules, regulations and procedures creating and affecting DTC and
its operations (the "Rules"), DTC is required to make book-entry transfers of
DTC Registered Certificates among Participants and to receive and transmit
distributions of principal of, and interest on, such DTC Registered
Certificates. Participants and
S-21
<PAGE>
Indirect Participants with which Beneficial Owners have accounts with respect
to such DTC Registered Certificates similarly are required to make book-entry
transfers and receive and transmit such distributions on behalf of their
respective Beneficial Owners. Accordingly, although Beneficial Owners will not
possess physical certificates evidencing their interests in the DTC Registered
Certificates, the Rules provide a mechanism by which Beneficial Owners,
through their Participants and Indirect Participants, will receive
distributions and will be able to transfer their interests in the DTC
Registered Certificates.
None of the Company, the Master Servicer or the Trustee will have any
liability for any actions taken by DTC or its nominee, including, without
limitation, actions for any aspect of the records relating to or payments made
on account of beneficial ownership interests in the DTC Registered
Certificates held by Cede, as nominee for DTC, or for maintaining, supervising
or reviewing any records relating to such beneficial ownership interests.
Definitive Certificates. Definitive Certificates will be issued to
Beneficial Owners or their nominees, respectively, rather than to DTC or its
nominee, only under the limited conditions set forth in the Prospectus under
"Description of the Certificates--Form of Certificates."
Upon the occurrence of an event described in the Prospectus in the fourth
paragraph under "Description of the Certificates--Form of Certificates," the
Trustee is required to notify, through DTC, Participants who have ownership of
DTC Registered Certificates as indicated on the records of DTC of the
availability of Definitive Certificates for their DTC Registered Certificates.
Upon surrender by DTC of the definitive certificates representing the DTC
Registered Certificates and upon receipt of instructions from DTC for re-
registration, the Trustee will reissue the DTC Registered Certificates as
Definitive Certificates issued in the respective principal amounts owned by
individual Beneficial Owners, and thereafter the Trustee and the Master
Servicer will recognize the holders of such Definitive Certificates as
Certificateholders under the Pooling and Servicing Agreement.
For additional information regarding DTC and the DTC Registered
Certificates, see "Description of the Certificates--Form of Certificates" in
the Prospectus.
AVAILABLE DISTRIBUTION AMOUNT
The "Available Distribution Amount" for any Distribution Date is equal to
(i) the aggregate amount of actual payments on the Mortgage Loans received
during the related Collection Period, after deduction of the related servicing
fees and any subservicing fees (collectively, the "Servicing Fees") and the
premium payable with respect to the Policy and (ii) certain unscheduled
collections, including Mortgagor prepayments on the Mortgage Loans, Insurance
Proceeds, Liquidation Proceeds and proceeds from repurchases of (and certain
amounts received in connection with any substitutions for) the Mortgage Loans,
received during the related Collection Period. In addition to the foregoing
amounts, with respect to unscheduled collections, not including Mortgagor
prepayments, the Master Servicer may elect to treat such amounts as included
in the Available Distribution Amount for the Distribution Date in the month of
receipt, but is not obligated to do so. As described herein under "--Principal
Distributions on the Senior Certificates," any such amount with respect to
which such election is so made shall be treated as having been received on the
last day of the related Collection Period for the purposes of calculating the
amount of principal and interest distributions to any class of Certificates.
With respect to any Distribution Date, the Collection Period is the calendar
month preceding the month of such Distribution Date.
INTEREST DISTRIBUTIONS
Holders of each class of Senior Certificates will be entitled to receive
interest distributions in an amount equal to the Accrued Certificate Interest
on such class on each Distribution Date to the extent described herein. The
aggregate amount of the interest on the Senior Certificates payable on any
Distribution Date is referred to herein as the "Senior Interest Distribution
Amount."
S-22
<PAGE>
Accrued Certificate Interest on any Distribution Date will be equal to one
month's interest accrued on the Certificate Principal Balance of the Class A
Certificates, or in the case of the PAC Strip Certificates, on the Notional
Amount, at the related Pass-Through Rate for such Distribution Date, less
interest shortfalls, if any, allocated to such class for such Distribution
Date, to the extent not covered with respect to the Senior Certificates by
Subordination, including in each case (i) any Prepayment Interest Shortfall
(as defined below) to the extent not covered by Excess Cash Flow, (ii) the
interest portions of Realized Losses, and (iii) any other interest shortfalls
not covered by Subordination, including interest shortfalls relating to the
Relief Act or similar legislation or regulations, all allocated as described
herein; provided, however, that in the event that any shortfall described in
this sentence is allocated to the Senior Certificates, subject to the terms of
the Policy, the amount of such allocated shortfall will be drawn under the
Policy and distributed to the holders of the Senior Certificates.
Notwithstanding the foregoing, if payments are not made as required under the
Policy, any interest shortfalls may be allocated to the Senior Certificates as
described above. See "Description of the Certificates--Certificate Guaranty
Insurance Policy." Interest will be calculated on the basis of a 360-day year
consisting of twelve 30-day months.
The Prepayment Interest Shortfall for any Distribution Date is equal to the
aggregate shortfall, if any, in collections of interest (adjusted to the
related Net Mortgage Rates) resulting from Mortgagor prepayments on the
Mortgage Loans during the related Collection Period. Such shortfalls will
result because interest on prepayments in full is distributed only to the date
of prepayment, and because no interest is distributed on prepayments in part,
as such prepayments in part are applied to reduce the outstanding principal
balance of the related Mortgage Loans as of the Due Date in the month of
prepayment. However, with respect to any Distribution Date, any Prepayment
Interest Shortfalls resulting from prepayments in full during the related
Collection Period will be offset first by Excess Cash Flow to the extent
available and then by the Policy.
The Pass-Through Rates on all classes of Senior Certificates are fixed and
are set forth on the cover hereof, except that the Pass-Through Rate on the
Class A-6 Certificates and the Class A-L Certificates will be subject to a
maximum of the weighted average of the Net Mortgage Rates on the Mortgage
Loans. The Net Mortgage Rate on each Mortgage Loan is equal to the Mortgage
Rate thereon minus the rates per annum at which the master servicing fee and
subservicing fee (collectively, the related "Servicing Fee Rate") accrues and
the per annum rate at which the Premium Fee (as defined below) accrues. The
Net Mortgage Rate with respect to each Mortgage Loan as of the Cut-off Date
will be set forth in the Mortgage Loan Schedule attached to the Pooling and
Servicing Agreement. As of the Cut-off Date, the weighted average Net Mortgage
Rate of the Mortgage Loans is approximately 11.3966% per annum, and is
expected to change thereafter as Mortgage Loans are liquidated or paid off. On
any Distribution Date, the amount of the premium (the "Premium Fee") payable
to the Insurer with respect to the Policy is equal to one-twelfth of the
product of a percentage specified in the Pooling and Servicing Agreement and
the Certificate Principal Balance of the Class A Certificates.
The Certificate Principal Balance of any Class A Certificate as of any date
of determination is equal to the initial Certificate Principal Balance
thereof, reduced by the aggregate of (a) all amounts allocable to principal
previously distributed with respect to such Certificate and (b) any reductions
in the Certificate Principal Balance thereof deemed to have occurred in
connection with allocations of Realized Losses in the manner described herein,
unless such amounts have been paid pursuant to the Policy. The Certificate
Principal Balance of the Class R-II Certificates in the aggregate, as of any
date of determination, is equal to the excess, if any, of (a) the then
aggregate Stated Principal Balance (as defined herein) of the Mortgage Loans
over (b) the then aggregate Certificate Principal Balance of the Class A
Certificates.
The Notional Amount of the PAC Strip Certificates is initially equal to
approximately $58,661,897, which corresponds to approximately 29.57% of the
aggregate initial Stated Principal Balance of all of the Mortgage Loans. The
Notional Amount will be reduced on each Distribution Date to an amount equal
to the greater of (i) the Notional Amount immediately prior to such
Distribution Date minus the aggregate amount of all principal collections on
the Mortgage Loans related to such Distribution Date and (ii) the planned
Notional Amount for such Distribution Date as indicated in the table "Planned
PAC Notional Amount" set forth below (the "Planned
S-23
<PAGE>
PAC Notional Amount") provided, that in no event will the Notional Amount
exceed the aggregate of the Stated Principal Balances of all of the Mortgage
Loans as of such Distribution Date. Reference to the Notional Amount is solely
for convenience in certain calculations and does not represent the right to
receive any distributions allocable to principal.
The "Stated Principal Balance" of any Mortgage Loan as of any date of
determination is equal to the Cut-off Date Balance thereof, reduced by all
amounts allocable to principal that have been distributed to
Certificateholders with respect to such Mortgage Loan, and as further reduced
to the extent that any Realized Loss thereon has been allocated to one or more
classes of Certificates on or before the date of determination.
The following table sets forth the Planned PAC Notional Amount applicable
for purposes of calculating the reduction of the Notional Amount for each
Distribution Date. There is no assurance that reductions in the Notional
Amount will not be greater or less than the amount of the planned reduction
for each Distribution Date based on the Planned PAC Notional Amount set forth
below.
PLANNED PAC NOTIONAL AMOUNT
<TABLE>
<CAPTION>
DISTRIBUTION DATE
- -----------------
<S> <C>
Initial Amount.......... $58,661,897.15
October 1996............ 57,437,098.27
November 1996 .......... 56,215,371.23
December 1996........... 54,996,690.68
January 1997............ 53,781,031.32
February 1997........... 52,568,367.89
March 1997.............. 51,358,675.17
April 1997.............. 50,151,927.97
May 1997................ 48.948,101.13
June 1997............... 47,747,169.54
July 1997............... 46,549,108.12
August 1997............. 45,353,891.82
September 1997.......... 44,161,495.62
October 1997............ 42,971,894.55
November 1997........... 41,785,063.66
December 1997........... 40,600,978.04
January 1998............ 39,419,612.80
February 1998........... 38,240,943.09
March 1998.............. 37,064,944.09
April 1998.............. 35,891,591.02
May 1998................ 34,720,859.11
June 1998............... 33,552,723.62
July 1998............... 32,387,159.86
August 1998............. 31,224,143.15
September 1998.......... 30,063,648.84
October 1998............ 28,905,652.31
November 1998........... 27,750,128.95
December 1998........... 26,597,054.23
January 1999............ 25,446,403.56
February 1999........... 24,298,152.44
</TABLE>
<TABLE>
<CAPTION>
DISTRIBUTION DATE
- -----------------
<S> <C>
March 1999................. 23,152,276.37
April 1999................. 22,008,750.88
May 1999................... 20,867,551.52
June 1999.................. 19,728,653.86
July 1999.................. 18,592,033.50
August 1999................ 17,457,666.05
September 1999............. 16,325,527.14
October 1999............... 15,195,592.43
November 1999.............. 14,067,837.60
December 1999.............. 12,942,238.33
January 2000............... 11,822,730.27
February 2000.............. 10,768,651.81
March 2000................. 9,776,209.42
April 2000................. 8,841,828.16
May 2000................... 7,962,139.13
June 2000.................. 7,133,967.65
July 2000.................. 6,354,322.13
August 2000................ 5,620,383.56
September 2000............. 4,929,495.61
October 2000............... 4,279,155.28
November 2000.............. 3,667,004.11
December 2000.............. 3,090,819.87
January 2001............... 2,548,508.73
February 2001.............. 2,038,097.90
March 2001................. 1,557,728.65
April 2001................. 1,105,649.76
May 2001................... 680,639.41
June 2001.................. 280,670.84
July 2001 and thereafter... 0.00
</TABLE>
PRINCIPAL DISTRIBUTIONS ON THE SENIOR CERTIFICATES
Holders of the Class A Certificates will be entitled to receive on each
Distribution Date, in the priority set forth herein and to the extent of the
portion of the Available Distribution Amount remaining after the Senior
Interest Distribution Amount for such Distribution Date is distributed, a
distribution allocable to principal equal to the lesser of:
(a) the excess of (i) the Available Distribution Amount over (ii) the
Senior Interest Distribution Amount; and
(b) the sum of:
(i) the portion allocable to principal of all scheduled monthly
payments on the Mortgage Loans received with respect to the related
Collection Period;
S-24
<PAGE>
(ii) the principal portion of all proceeds of the repurchase of any
Mortgage Loans (or, in the case of a substitution, certain amounts
representing a principal adjustment) as required by the Pooling and
Servicing Agreement during the related Collection Period;
(iii) the principal portion of all other unscheduled collections
received on the Mortgage Loans during the related Collection Period (or
deemed to be received during the related Collection Period) (including,
without limitation, full and partial Principal Prepayments made by the
respective Mortgagors), to the extent not previously distributed;
(iv) the principal portion of any Realized Losses incurred (or deemed
to have been incurred) on any Mortgage Loans in the related Collection
Period preceding such Distribution Date to the extent covered by Excess
Cash Flow for such Distribution Date; and
(v) the amount of any Subordination Increase Amount (as defined
herein) for such Distribution Date;
minus
(vi) the amount of any Subordination Reduction Amount (as defined
herein) for such Distribution Date.
With respect to any Distribution Date, the lesser of (a) the balance of the
related Available Distribution Amount remaining after the distribution of the
Senior Interest Distribution Amount and (b) the sum of the amounts described
in clauses (i) through (vi) of the immediately preceding paragraph is
hereinafter referred to as the "Class A Principal Distribution Amount". In no
event will the Class A Principal Distribution Amount with respect to any
Distribution Date be (x) less than zero or (y) greater than the then
outstanding Certificate Principal Balances of the Class A Certificates.
On each Distribution Date, the Insurer shall be entitled to receive, after
payment to the Senior Certificateholders of the Senior Interest Distribution
Amount and the Class A Principal Distribution Amount for such Certificates, as
applicable, for such Distribution Date (but before application of any
Subordination Increase Amount), from the Excess Cash Flow after Prepayment
Interest Shortfalls and certain Realized Losses are allocated thereto, the
aggregate of any payment made with respect to the Senior Certificates
("Cumulative Insurance Payments") by the Insurer under the Policy to the
extent not previously reimbursed, plus interest thereon.
The Lockout Distribution Percentage for any Distribution Date occurring
prior to the Distribution Date in October 1999 will be 0%. The Lockout
Distribution Percentage for any Distribution Date occurring in or after
October 1999 and prior to October 2001 will be 45%. The Lockout Distribution
Percentage for any Distribution Date occurring in or after October 2001 and
prior to October 2002 will be 50%. The Lockout Distribution Percentage for any
Distribution Date occurring in or after October 2002 and prior to October 2003
will be 70%. The Lockout Distribution Percentage for any Distribution Date
thereafter will be 100%. On any Distribution Date the Lockout Distribution
Percentage may be disregarded as set forth below.
Distributions of principal on the Class A Certificates on each Distribution
Date will be made (after distribution of the Senior Interest Distribution
Amount as described under "Interest Distributions"), as follows:
(a) Prior to the occurrence of the Credit Support Depletion Date (as
defined below), the Class A Principal Distribution Amount shall be
distributed to the Class A Certificates as follows:
(i) first, to the Lockout Certificates, in reduction of the
Certificate Principal Balance thereof, an amount equal to the Lockout
Distribution Percentage of the Lockout Certificates' pro rata share
(based on the aggregate Certificate Principal Balance thereof relative
to the aggregate Certificate Principal Balance of the Class A
Certificates) of the Class A Principal Distribution Amount;
(ii) the balance of the Class A Principal Distribution Amount
remaining after the distribution, if any, described in clause (i) above
shall be distributed as follows:
S-25
<PAGE>
(1) first, to the Class A-1 Certificates until the Certificate
Principal Balance of the Class A-1 Certificates has been reduced to
zero;
(2) second, to the Class A-2 Certificates, until the Certificate
Principal Balance of the Class A-2 Certificates has been reduced to
zero;
(3) third, to the Class A-3 Certificates, until the Certificate
Principal Balance of the Class A-3 Certificates has been reduced to
zero;
(4) fourth, to the Class A-4 Certificates, until the Certificate
Principal Balance of the Class A-4 Certificates has been reduced to
zero;
(5) fifth, to the Class A-5 Certificates, until the Certificate
Principal Balance of the Class A-5 Certificates has been reduced to
zero; and
(6) sixth, to the Class A-6 Certificates, until the Certificate
Principal Balance of the Class A-6 Certificates has been reduced to
zero;
provided, however, that if on any Distribution Date the Certificate Principal
Balances of the Class A Certificates (other than the Lockout Certificates)
have been reduced to zero, clause (i) above shall no longer apply and 100% of
the Class A Principal Distribution Amount remaining after retirement of the
Class A Certificates (other than the Lockout Certificates) for such
Distribution Date shall be distributed to the Lockout Certificates, until the
Certificate Principal Balance thereof has been reduced to zero; and
(b) On or after the occurrence of the Credit Support Depletion Date, all
priorities relating to distributions as described above in respect of
principal among the various classes of Class A Certificates will be
disregarded, and (i) the Class A Principal Distribution Amount will be
distributed to all classes of Class A Certificates pro rata in accordance with
their respective outstanding Certificate Principal Balances, and (ii) the
Senior Interest Distribution Amount will be distributed as described under
"Interest Distributions."
The "Credit Support Depletion Date" is the first Distribution Date on which
the Certificate Principal Balances of the Class R Certificates have been
reduced to zero and an Insurer Default exists.
The Master Servicer may elect to treat Insurance Proceeds, Liquidation
Proceeds and other unscheduled collections (not including prepayments by the
Mortgagors) received in any calendar month as included in the Available
Distribution Amount and the Class A Principal Distribution Amount for the
Distribution Date in the month of receipt, but is not obligated to do so. If
the Master Servicer so elects, such amounts will be deemed to have been
received (and any related Realized Loss shall be deemed to have occurred) on
the last day of the month prior to the receipt thereof.
OVERCOLLATERALIZATION PROVISIONS
On each Distribution Date, Excess Cash Flow, if any, is applied on such
Distribution Date as an accelerated payment of principal on the Class A
Certificates, but only in the manner and to the extent hereafter described.
"Excess Cash Flow" for a Distribution Date is equal to the excess of (x) the
Available Distribution Amount for such Distribution Date over (y) the sum of
(i) the Senior Interest Distribution Amount payable to the Class A
Certificateholders on such Distribution Date and (ii) the sum of the amounts
relating to the Mortgage Loans described in clauses (b)(i)-(iii) of the
definition of Class A Principal Distribution Amount. The Excess Cash Flow for
any Distribution Date will derive primarily from the amount of interest
accrued on the Mortgage Loans in excess of the sum of (a) the Senior Interest
Distribution Amount, (b) the premium payable on the Policy and (c) accrued
Servicing Fees, in each case in respect of such Distribution Date. Excess Cash
Flow will be applied on any Distribution Date first to pay Prepayment Interest
Shortfalls, second to pay the portion of Realized Losses incurred on the
Mortgage Loans for the related Collection Period, third to the payment of
Cumulative Insurance Payments plus interest thereon, fourth to pay any
Subordination Increase Amount, and last, to pay to the holder of the Class R-
II Certificates.
S-26
<PAGE>
With respect to any Distribution Date, the excess, if any, of (a) the
aggregate Stated Principal Balances of the Mortgage Loans immediately
following such Distribution Date over (b) the Certificate Principal Balance of
the Class A Certificates as of such date (after taking into account the
payment to the Class A Certificates of the amounts described in clauses
(b)(i)-(iv) of the definition of Class A Principal Distribution Amount on such
Distribution Date) is the "Subordinated Amount" as of such Distribution Date.
The Excess Cash Flow, to the extent available therefor as described above,
will be applied as an accelerated payment of principal on the Class A
Certificates to the extent that the Required Subordinated Amount exceeds the
Subordinated Amount as of such Distribution Date. Any amount of Excess Cash
Flow actually applied as an accelerated payment of principal on the Class A
Certificates is a "Subordination Increase Amount." The required level of the
Subordinated Amount with respect to a Distribution Date is the "Required
Subordinated Amount" with respect to such Distribution Date. The Required
Subordinated Amount will be set at an amount equal to approximately 2.85% of
the initial Stated Principal Balance of the Mortgage Loans as of the Cut-off
Date until the later to occur of (a) the 31st month following the Cut-off Date
and (b) the first Distribution Date on which the Stated Principal Balance of
the Mortgage Loans is equal to or less than 50% of the Stated Principal
Balance of the Mortgage Loans as of the Cut-off Date. Thereafter, the Required
Subordinated Amount with respect to a Distribution Date will be equal to the
lesser of (a) the initial Required Subordinated Amount or (b) as set forth in
the Pooling and Servicing Agreement, at least 5.70% of the Stated Principal
Balance of the Mortgage Loans immediately preceding such Distribution Date but
not less than $991,836.
In the event that the Required Subordinated Amount is permitted to decrease
or "step down" on a Distribution Date in the future, a portion of the
principal which would otherwise be distributed to the holders of the Class A
Certificates on such Distribution Date shall not be distributed to the holders
of the Class A Certificates on such Distribution Date. This has the effect of
decelerating the amortization of the Class A Certificates relative to the
amortization of the Mortgage Loans, and of reducing the Subordinated Amount.
With respect to any Distribution Date, the excess, if any, of (a) the
Subordinated Amount on such Distribution Date over (b) the Required
Subordinated Amount is the "Excess Subordinated Amount" with respect to such
Distribution Date. If, on any Distribution Date, the Excess Subordinated
Amount is, or, after taking into account all other distributions to be made on
such Distribution Date would be, greater than zero (i.e., the Subordinated
Amount is or would be greater than the related Required Subordinated Amount),
then any amounts relating to principal which would otherwise be distributed to
the holders of the Class A Certificates on such Distribution Date shall
instead be distributed to the holders of the Class R-II Certificates in an
amount equal to the lesser of (x) the Excess Subordinated Amount and (y) the
amount available for distribution specified in clauses (b)(i)-(iii) of the
definition of Principal Distribution Amount on such Distribution Date; such
amount being the "Subordination Reduction Amount" for such Distribution Date.
CERTIFICATE GUARANTY INSURANCE POLICY
The following summary of the terms of the Policy does not purport to be
complete and is qualified in its entirety by reference to the Policy. The
following information regarding the Policy has been supplied by the Insurer
for inclusion herein.
The Insurer, in consideration of the payment of the premium and subject to
the terms of the Policy, thereby unconditionally and irrevocably guarantees to
any Holder (as defined below) that an amount equal to each full and complete
Insured Amount will be received by the Trustee, or its successor, as trustee
for the Holders. The Insurer's obligations under the Policy with respect to a
particular Insured Amount shall be discharged to the extent funds equal to the
applicable Insured Amount are paid to the Trustee, whether or not such funds
are properly applied by the Trustee. Payments of Insured Amounts shall be made
only at the time set forth in the Policy, and no accelerated payments of
Insured Amounts shall be made regardless of any acceleration of the Senior
Certificates, unless such acceleration is at the sole option of the Insurer.
Notwithstanding the foregoing paragraph, the Policy does not cover
shortfalls, if any, attributable to the liability of the Trust Fund, REMIC I,
REMIC II or the Trustee for withholding taxes, if any (including interest and
penalties in respect of any such liability).
S-27
<PAGE>
The Insurer will pay any amounts payable under the Policy no later than
12:00 noon, New York City time, on the later of the Distribution Date on which
the related Deficiency Amount (as defined below) is due or the Business Day
following receipt in New York, New York on a Business Day of a Notice (as
described below); provided that if such Notice is received after 12:00 noon,
New York City time, on such Business Day, it will be deemed to be received on
the following Business Day. If any such Notice received is not in proper form
or is otherwise insufficient for the purpose of making a claim under the
Policy, it shall be deemed not to have been received for purposes of this
paragraph, and the Insurer shall promptly so advise the Trustee and the
Trustee may submit an amended Notice.
Insured Amounts due under the Policy, unless otherwise stated therein, are
to be disbursed by the Insurer to the Trustee on behalf of the Holders by wire
transfer of immediately available funds in the amount of the Insured Amount.
As used in this section and in the Policy, the following terms shall have
the following meanings:
"Agreement" means the Pooling and Servicing Agreement, dated as of September
1, 1996, among the Company, the Master Servicer and the Trustee, without
regard to any amendment or supplement thereto unless such amendment or
supplement has been approved in writing by the Insurer.
"Business Day" means any day other than a Saturday, a Sunday or a day on
which banking institutions in New York City or in the city in which the
corporate trust office of the Trustee under the Agreement or the Insurer is
located are authorized or obligated by law or executive order to close.
"Deficiency Amount" means, with respect to the Senior Certificates as of any
Distribution Date, (i) any shortfall in amounts available in the Certificate
Account to pay one month's interest on the Certificate Principal Balance or
the Notional Amount, as applicable, of the Senior Certificates at the related
Pass-Through Rate, (ii) the principal portion of any Realized Loss allocated
to the Class A Certificates and (iii) the Certificate Principal Balance of the
Class A Certificates to the extent unpaid on the final Distribution Date or
earlier termination of the Trust Fund pursuant to the terms of the Agreement.
"Holder" means any person who is the registered or beneficial owner of any
Senior Certificate and who, on the applicable Distribution Date, is entitled
under the terms of the Senior Certificates to payment thereunder.
"Insured Amount" means, as of any Distribution Date, any Deficiency Amount.
"Notice" means the telephonic or telegraphic notice, promptly confirmed in
writing by telecopy substantially in the form of Exhibit A attached to the
Policy, the original of which is subsequently delivered by registered or
certified mail from the Trustee specifying the Insured Amount which shall be
due and owing on the applicable Distribution Date.
Capitalized terms used in the Policy and not otherwise defined in the Policy
shall have the respective meanings set forth in the Agreement as of the date
of execution of the Policy, without giving effect to any subsequent amendment
to or modification of the Agreement unless such amendment or modification has
been approved in writing by the Insurer.
The Policy is being issued under and pursuant to and shall be construed
under, the laws of the State of Illinois, without giving effect to the
conflict of laws principles thereof.
The Policy is not cancelable for any reason. The premium on the Policy is
not refundable for any reason including payment, or provision being made for
payment, prior to maturity of the Senior Certificates.
S-28
<PAGE>
ALLOCATION OF LOSSES; SUBORDINATION
The Subordination provided to the Senior Certificates by the Class R-II
Certificates will cover Realized Losses on the Mortgage Loans that are
Defaulted Loan Losses, Fraud Losses, Bankruptcy Losses, Extraordinary Losses
(each as defined in the Prospectus) and Special Hazard Losses (as defined
herein), subject to the limitations set forth in the Pooling and Servicing
Agreement. Any Realized Losses will be allocated first, by application of
clause (b)(iv) of the definition of Class A Principal Distribution Amount, to
the Excess Cash Flow for the related Distribution Date; second, to the Class
R-II Certificates up to an amount equal to the Certificate Principal Balance
of the Class R-II Certificates; and third, to the Senior Certificates on a pro
rata basis. Subject to the terms of the Policy, the Policy will cover all
Realized Losses allocated to the Senior Certificates. Any allocation of a
Realized Loss (other than a Debt Service Reduction) to a Certificate will be
made by reducing the Certificate Principal Balance thereof, in the case of the
principal portion of such Realized Loss, and the Accrued Certificate Interest
thereon, in the case of the interest portion of such Realized Loss, by the
amount so allocated as of the Distribution Date occurring in the month
following the calendar month in which such Realized Loss was incurred. As used
herein, "Debt Service Reduction" means a reduction in the amount of the
monthly payment due to certain bankruptcy proceedings, but does not include
any permanent forgiveness of principal. As used herein, "Subordination" refers
to the provisions discussed above for the sequential allocation of Realized
Losses among the various classes, as well as all provisions effecting such
allocations including the priorities for distribution of cash flows in the
amounts described herein. As used herein, "Special Hazard Losses" has the same
meaning set forth in the Prospectus, except that Special Hazard Losses will
not include Extraordinary Losses, and Special Hazard Losses will not exceed
the lesser of the cost of repair or replacement of the related Mortgaged
Properties.
With respect to any defaulted Mortgage Loan that is finally liquidated,
through foreclosure sale, disposition of the related Mortgaged Property if
acquired on behalf of the Certificateholders by deed in lieu of foreclosure,
or otherwise, the amount of loss realized, if any, will equal the portion of
the Stated Principal Balance remaining, if any, plus interest thereon through
the last day of the month in which such Mortgage Loan was finally liquidated,
after application of all amounts recovered (net of amounts reimbursable to the
Master Servicer or the Subservicer for expenses, including attorneys' fees)
towards interest and principal owing on the Mortgage Loan. The Master Servicer
will treat any Mortgage Loan that is 180 days or more delinquent as having
been finally liquidated. Such amount of loss realized and any Special Hazard
Losses, Fraud Losses, Bankruptcy Losses (except for Bankruptcy Losses that
result from an extension of the maturity of a Mortgage Loan) and Extraordinary
Losses are referred to herein as "Realized Losses."
In order to maximize the likelihood of distribution in full of amounts of
interest and principal to be distributed to holders of the Senior Certificates
on each applicable Distribution Date, holders of Senior Certificates have a
right to distributions of the Available Distribution Amount that is prior to
the rights of the holders of the Class R Certificates. In addition, the
overcollateralization described herein will also maximize the likelihood of
distribution of full amounts of interest and principal to the Senior
Certificates on each Distribution Date.
Notwithstanding the foregoing, the provisions relating to Subordination will
not be applicable in connection with a Bankruptcy Loss so long as the Master
Servicer has notified the Trustee in writing that the Master Servicer is
diligently pursuing any remedies that may exist in connection with the
representations and warranties made regarding the related Mortgage Loan and
the related Mortgage Loan is not in default with regard to payments due
thereunder.
S-29
<PAGE>
THE INSURER
The following information has been supplied by AMBAC Indemnity Corporation
(the "Insurer") for inclusion in this Prospectus Supplement. No representation
is made by the Company, the Underwriter or any of their affiliates as to the
accuracy or completeness of such information.
The Insurer is a Wisconsin-domiciled stock insurance corporation regulated
by the Office of the Commissioner of Insurance of the State of Wisconsin and
licensed to do business in 50 states, the District of Columbia, the
Commonwealth of Puerto Rico and Guam. The Insurer primarily insures newly
issued municipal bonds. The Insurer is a wholly owned subsidiary of AMBAC
Inc., a 100% publicly held company. Moody's, Standard & Poor's and Fitch
Investors Service, L.P. have each assigned a triple-A claims-paying ability
rating to the Insurer.
The Insurer has entered into pro rata reinsurance agreements under which a
percentage of the insurance underwritten pursuant to certain of the Insurer's
municipal bond insurance programs has been and will be assumed by a number of
foreign and domestic unaffiliated reinsurers.
The following table sets forth the Insurer's capitalization as of December
31, 1993, December 31, 1994, December 31, 1995 and June 30, 1996,
respectively, on the basis of generally accepted accounting principles.
AMBAC INDEMNITY CORPORATION
CAPITALIZATION TABLE
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, DECEMBER 31, JUNE 30,
1993 1994 1995 1996
------------ ------------ ------------ ---------
UNAUDITED
<S> <C> <C> <C> <C>
Unearned premiums............. $ 785 $ 840 $ 906 $ 937
Other liabilities............. 192 136 295 286
Stockholder's equity:
Common stock................ 82 82 82 82
Additional paid-in capital.. 444 444 481 514
Unrealized gain (loss) on
bonds; net of tax.......... 68 (46) 87 34
Retained earnings........... 668 782 907 912
------ ------ ------ ------
Total stockholder's equity.... $1,262 $1,262 $1,557 $1,542
------ ------ ------ ------
Total liabilities and stock-
holder's equity.............. $2,239 $2,238 $2,758 $2,765
====== ====== ====== ======
</TABLE>
For additional financial information concerning the Insurer, see the audited
financial statements of the Insurer included in Appendix A of this Prospectus
Supplement.
Effective December 31, 1993, the Insurer adopted Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Debt and Equity
Securities" ("Statement 115") with all investments designated as available-
for-sale. As required under Statement 115, prior years' financial statements
have not been restated. The cumulative effect of adopting Statement 115 as of
December 31, 1993 was to increase the Insurer's stockholder's equity $63.6
million, net of tax. The adoption of Statement 115 had no effect on earnings.
The Insurer makes no representation regarding the Certificates or the
advisability of investing in the Certificates and makes no representation
regarding, nor has it participated in the preparation of, the Prospectus
Supplement other than the information supplied by the Insurer and presented
under the heading "THE INSURER" and "DESCRIPTION OF THE CERTIFICATES--
Certificate Guaranty Insurance Policy" and in the financial statements hereto.
THE POLICY IS NOT COVERED BY THE PROPERTY/CASUALTY INSURANCE SECURITY FUND
SPECIFIED IN ARTICLE 76 OF THE NEW YORK INSURANCE LAW.
S-30
<PAGE>
CERTAIN YIELD AND PREPAYMENT CONSIDERATIONS
GENERAL
The yields to maturity and the aggregate amount of distributions on the
Senior Certificates will be affected by the rate and timing of principal
payments on the Mortgage Loans and the amount and timing of Mortgagor defaults
resulting in Realized Losses. The rate of default of mortgage loans secured by
second liens may be greater than that of mortgage loans secured by first
liens. In addition, such yields may be adversely affected by a higher or lower
than anticipated rate of principal payments on the Mortgage Loans in the Trust
Fund. The rate of principal payments on such Mortgage Loans will in turn be
affected by the amortization schedules of the Mortgage Loans, the rate and
timing of principal prepayments thereon by the Mortgagors, liquidations of
defaulted Mortgage Loans and repurchases of Mortgage Loans due to certain
breaches of representations. The timing of changes in the rate of prepayments,
liquidations and repurchases of the Mortgage Loans may, and the timing of
Realized Losses will, significantly affect the yield to an investor, even if
the average rate of principal payments experienced over time is consistent
with an investor's expectation. Since the rate and timing of principal
payments on the Mortgage Loans will depend on future events and on a variety
of factors (as described more fully herein and in the Prospectus under "Yield
and Prepayment Considerations"), no assurance can be given as to such rate or
the timing of principal payments on the Class A Certificates.
The Mortgage Loans generally may be prepaid by the Mortgagors at any time
without payment of any prepayment fee or penalty. The Mortgage Loans generally
contain due-on-sale clauses. As described under "Description of the
Certificates--Principal Distributions on the Senior Certificates" herein,
during certain periods all or a disproportionately large percentage of
principal collections on the Mortgage Loans will be allocated among the Class
A Certificates (other than the Lockout Certificates), and during certain
periods no principal collections or a disproportionately small portion of
principal collections will be distributed on the Lockout Certificates.
Prepayments, liquidations and purchases of the Mortgage Loans will result in
distributions to holders of the Class A Certificates of principal amounts
which would otherwise be distributed over the remaining terms of the Mortgage
Loans. Factors affecting prepayment (including defaults and liquidations) of
mortgage loans include changes in Mortgagors' housing needs, job transfers,
unemployment, Mortgagors' net equity in the mortgaged properties, changes in
the value of the mortgaged properties, mortgage market interest rates,
solicitations and servicing decisions. In addition, if prevailing mortgage
rates fell significantly below the Mortgage Rates on the Mortgage Loans, the
rate of prepayments (including refinancings) would be expected to increase.
Conversely, if prevailing mortgage rates rose significantly above the Mortgage
Rates on the Mortgage Loans, the rate of prepayments on the Mortgage Loans
would be expected to decrease. Furthermore, since mortgage loans secured by
second liens are not generally viewed by borrowers as permanent financing and
generally carry a high rate of interest, the Mortgage Loans may experience a
higher rate of prepayments than traditional mortgage loans. Prepayment of the
related first lien may also affect the rate of prepayments on the Mortgage
Loans.
The Class A Certificates are subject to various priorities for payment of
principal as described herein. Distributions of principal on classes of Class
A Certificates having an earlier priority of payment will be affected by the
rates of prepayment of the Mortgage Loans early in the life of the Mortgage
Pool. The timing of commencement of principal distributions and the weighted
average lives of classes of Class A Certificates with a later priority of
payment will be affected by the rates of prepayment of the Mortgage Loans both
before and after the commencement of principal distributions on such classes.
In addition, the yield to maturity of the Class A Certificates will depend on
whether, to what extent, and the timing with respect to which, Excess Cash
Flow is used to accelerate payments of principal on the Class A Certificates
or any Subordination Reduction Amount is released. See "Description of the
Certificates--Overcollaterization" herein.
The rate of defaults on the Mortgage Loans will also affect the rate and
timing of principal payments on the Mortgage Loans. In general, defaults on
mortgage loans are expected to occur with greater frequency in their early
years. The rate of default of mortgage loans secured by second liens is likely
to be greater than that of mortgage loans secured by first liens on comparable
properties. The rate of default on Mortgage Loans which
S-31
<PAGE>
are refinance or limited documentation mortgage loans, and on Mortgage Loans
with high Combined Loan-to-Value Ratios, may be higher than for other types of
Mortgage Loans. Furthermore, the rate and timing of prepayments, defaults and
liquidations on the Mortgage Loans will be affected by the general economic
condition of the region of the country in which the related Mortgaged
Properties are located. The risk of delinquencies and loss is greater and
prepayments are less likely in regions where a weak or deteriorating economy
exists, as may be evidenced by, among other factors, increasing unemployment
or falling property values. See "Yield and Prepayment Considerations" and
"Risk Factors" in the Prospectus. In addition, because borrowers of Balloon
Mortgage Loans are required to make a relatively large single payment upon
maturity, it is possible that the default risk associated with Balloon
Mortgage Loans is greater than that associated with fully-amortizing mortgage
loans. See "Risk Factors" herein.
Because the Mortgage Rates on the Mortgage Loans and the Pass-Through Rates
on the Senior Certificates are fixed, except as described herein with respect
to the Class A-6 and Lockout Certificates, such rates will not change in
response to changes in market interest rates. Accordingly, if market interest
rates or market yields for securities similar to the Senior Certificates were
to rise, the market value of the Senior Certificates may decline.
Investors in the Lockout Certificates should be aware that because the
Lockout Certificates do not receive any payments of principal prior to the
Distribution Date occurring in October 1999 and prior to the Distribution Date
occurring in October 2003 will receive a disproportionately small portion of
payments of principal (unless the Certificate Principal Balances of the Class
A Certificates (other than the Lockout Certificates) have been reduced to
zero), the weighted average lives of the Lockout Certificates will be longer
than would otherwise be the case, and the effect on the market value of the
Lockout Certificates of changes in market interest rates or market yields for
similar securities will be greater than for other classes of Class A
Certificates entitled to such distributions.
In addition, the yield to maturity on each class of the Senior Certificates
will depend on, among other things, the price paid by the holders of the
Senior Certificates and the related Pass-Through Rate. The extent to which the
yield to maturity of a Senior Certificate is sensitive to prepayments will
depend, in part, upon the degree to which it is purchased at a discount or
premium. In general, if a class of Senior Certificates is purchased at a
premium and principal distributions thereon occur at a rate faster than
assumed at the time of purchase, the investor's actual yield to maturity will
be lower than that anticipated at the time of purchase. Conversely, if a class
of Senior Certificates is purchased at a discount and principal distributions
thereon occur at a rate slower than that assumed at the time of purchase, the
investor's actual yield to maturity will be lower than that anticipated at the
time of purchase. For additional considerations relating to the yield on the
Certificates, see "Yield and Prepayment Considerations" in the Prospectus.
Assumed Final Distribution Date: The assumed final Distribution Date with
respect to the Senior Certificates is September 25, 2012, which date is the
first anniversary of the Distribution Date immediately following the latest
scheduled maturity date for any Mortgage Loan. No event of default, change in
the priorities for distribution among the various classes or other provisions
under the Pooling and Servicing Agreement will arise or become applicable
solely by reason of the failure to retire the entire Certificate Principal
Balance of any class of Certificates on or before its assumed final
Distribution Date.
The actual final Distribution Date with respect to each class of Class A
Certificates could occur significantly earlier than the assumed final
Distribution Date for such class because (i) Excess Cash Flow will be used to
make accelerated payments of principal (i.e. Subordination Increase Amounts)
to the holders of the Class A Certificates, which payments will have the
effect of shortening the weighted average lives of the Class A Certificates of
each class, (ii) prepayments are likely to occur, which will also have the
effect of shortening the weighted average lives of the Class A Certificates
and (iii) the Master Servicer or the Company may cause a termination of the
Trust Fund when the aggregate Stated Principal Balance of the Mortgage Loans
in the Trust Fund is less than 3% of the aggregate principal balance of the
Mortgage Loans in the Trust Fund as of the Cut-Off Date.
S-32
<PAGE>
Weighted Average Life: Weighted average life refers to the average amount of
time that will elapse from the date of issuance of a security to the date of
distribution to the investor of each dollar distributed in reduction of
principal of such security (assuming no losses). The weighted average life of
the Senior Certificates will be influenced by, among other things, the rate at
which principal of the Mortgage Loans is paid, which may be in the form of
scheduled amortization, prepayments or liquidations.
The prepayment model used in this Prospectus Supplement (the "Prepayment
Assumption") represents an assumed rate of prepayment each month relative to
the then outstanding principal balance of a pool of mortgage loans. A 100%
Prepayment Assumption assumes a constant prepayment rate ("CPR") of 4% per
annum of the then outstanding principal balance of such mortgage loans in the
first month of the life of the mortgage loans and an additional 17/12% annum
in each month thereafter until the thirteenth month. Beginning in the
thirteenth month and in each month thereafter during the life of the mortgage
loans, a 100% Prepayment Assumption assumes a CPR of 21% per annum each month.
As used in the table below, a 50% Prepayment Assumption assumes prepayment
rates equal to 50% of the Prepayment Assumption. Correspondingly, a 150%
Prepayment Assumption assumes prepayment rates equal to 150% of the Prepayment
Assumption, and so forth. The Prepayment Assumption does not purport to be a
historical description of prepayment experience or a prediction of the
anticipated rate of prepayment of any pool of mortgage loans, including the
Mortgage Loans.
The table set forth below has been prepared on the basis of certain
assumptions as described below regarding the weighted average characteristics
of the Mortgage Loans that are expected to be included in the Trust Fund as
described under "Description of the Mortgage Pool" herein and the performance
thereof. The table assumes, among other things, that: (i) as of the date of
issuance of the Class A Certificates, (a) with respect to the Mortgage Loans
with original terms to maturity of less than or equal to 5 years, the
aggregate principal balance of such Mortgage Loans is $466,817 and each such
Mortgage Loan has a Mortgage Rate of 11.1211% per annum and an aggregate
initial Servicing Fee Rate and Policy premium rate of 0.7500% per annum, an
original term to maturity of 60 months and a remaining term to maturity of 55
months, (b) with respect to the Mortgage Loans with original terms to maturity
of less than or equal to 10 years, the aggregate principal balance of such
Mortgage Loans is $2,178,646 and each such Mortgage Loan has a Mortgage Rate
of 11.7907% per annum and an aggregate initial Servicing Fee Rate and Policy
premium rate of 0.7500% per annum, an original term to maturity of 119 months
and a remaining term to maturity of 114 months, (c) with respect to the
Mortgage Loans with original terms to maturity of more than 15 years, the
aggregate principal balance of such Mortgage Loans is $164,131,019 and each
such Mortgage Loan has a Mortgage Rate of 12.0179% per annum and an aggregate
initial Servicing Fee Rate and Policy premium rate of 0.7500% per annum, an
original term to maturity of 180 months and a remaining term to maturity of
174 months; and (d) with respect to the Mortgage Loans with a balloon feature,
the aggregate principal balance of such Mortgage Loans is $31,590,697 and each
such Mortgage Loan has a Mortgage Rate of 11.7874% per annum and an aggregate
initial Servicing Fee Rate and Policy premium rate of 0.7500% per annum, an
amortizing original term to maturity of 351 months, an amortizing remaining
term to maturity of 347 months and a remaining term to stated maturity of 176
months; (ii) except with respect to the Balloon Mortgage Loans, the scheduled
monthly payment for each Mortgage Loan has been based on its outstanding
balance, interest rate and remaining term to maturity, such that the Mortgage
Loan will amortize in amounts sufficient for repayment thereof over its
remaining term to maturity; (iii) none of the Sellers, the Master Servicer or
the Company will repurchase any Mortgage Loan, as described under "Mortgage
Loan Program--Representations Relating to Mortgage Loans" and "Description of
the Certificates--Assignment of the Trust Fund Assets" in the Prospectus, and
neither the Master Servicer nor the Company exercises any option to purchase
the Mortgage Loans and thereby cause a termination of the Trust Fund; (iv)
there are no delinquencies or Realized Losses on the Mortgage Loans, and
principal payments on the Mortgage Loans will be timely received together with
prepayments, if any, at the respective constant percentages of the Prepayment
Assumption set forth in the table; (v) there is no Prepayment Interest
Shortfall or any other interest shortfall in any month; (vi) payments on the
Certificates will be received on the 25th day of each month, commencing
October 25, 1996; (vii) payments on the Mortgage Loans earn no reinvestment
return; (viii) there are no additional ongoing Trust Fund expenses payable out
of the Trust Fund; and (ix) the Certificates will be purchased on September
27, 1996 (collectively, the "Structuring Assumptions").
S-33
<PAGE>
The actual characteristics and performance of the Mortgage Loans will differ
from the assumptions used in constructing the table set forth below, which is
hypothetical in nature and is provided only to give a general sense of how the
principal cash flows might behave under varying prepayment scenarios. For
example, it is very unlikely that the Mortgage Loans will prepay at a constant
level of the Prepayment Assumption until maturity or that all of the Mortgage
Loans will prepay at the same level of the Prepayment Assumption. Moreover,
the diverse remaining terms to maturity of the Mortgage Loans could produce
slower or faster principal distributions than indicated in the table at the
various constant percentages of the Prepayment Assumption specified, even if
the weighted average remaining term to maturity of the Mortgage Loans is as
assumed. Any difference between such assumptions and the actual
characteristics and performance of the Mortgage Loans, or actual prepayment or
loss experience, will affect the percentages of initial Certificate Principal
Balances outstanding over time and the weighted average lives of the classes
of Class A Certificates.
Subject to the foregoing discussion and assumptions, the following table
indicates the weighted average life of each class of Class A Certificates, and
sets forth the percentages of the initial Certificate Principal Balance of
each such class of Class A Certificates that would be outstanding after each
of the dates shown at various percentages of the Prepayment Assumption.
S-34
<PAGE>
PERCENT OF INITIAL PRINCIPAL BALANCE OUTSTANDING AT THE FOLLOWING PERCENTAGES
OF PREPAYMENT ASSUMPTION
<TABLE>
<CAPTION>
CLASS A-1 CLASS A-2 CLASS A-3 CLASS A-4
---------------------- ---------------------- ----------------------- -----------------------
DISTRIBUTION
DATE 0% 50% 100% 150% 200% 0% 50% 100% 150% 200% 0% 50% 100% 150% 200% 0% 50% 100% 150% 200%
- ------------ --- --- ---- ---- ---- --- --- ---- ---- ---- ---- --- ---- ---- ---- ---- --- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Initial
Percentage...... 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100
September 25,
1997............ 86 62 38 14 0 100 100 100 100 49 100 100 100 100 100 100 100 100 100 100
September 25,
1998............ 78 31 0 0 0 100 100 43 0 0 100 100 100 47 0 100 100 100 100 81
September 25,
1999............ 70 3 0 0 0 100 100 0 0 0 100 100 46 0 0 100 100 100 62 0
September 25,
2000............ 61 0 0 0 0 100 3 0 0 0 100 100 1 0 0 100 100 100 0 0
September 25,
2001............ 52 0 0 0 0 100 0 0 0 0 100 64 0 0 0 100 100 48 0 0
September 25,
2002............ 41 0 0 0 0 100 0 0 0 0 100 34 0 0 0 100 100 9 0 0
September 25,
2003............ 29 0 0 0 0 100 0 0 0 0 100 8 0 0 0 100 100 0 0 0
September 25,
2004............ 16 0 0 0 0 100 0 0 0 0 100 0 0 0 0 100 79 0 0 0
September 25,
2005............ 1 0 0 0 0 100 0 0 0 0 100 0 0 0 0 100 49 0 0 0
September 25,
2006............ 0 0 0 0 0 26 0 0 0 0 100 0 0 0 0 100 23 0 0 0
September 25,
2007............ 0 0 0 0 0 0 0 0 0 0 77 0 0 0 0 100 0 0 0 0
September 25,
2008............ 0 0 0 0 0 0 0 0 0 0 43 0 0 0 0 100 0 0 0 0
September 25,
2009............ 0 0 0 0 0 0 0 0 0 0 4 0 0 0 0 100 0 0 0 0
September 25,
2010............ 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 38 0 0 0 0
September 25,
2011............ 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
Weighted Average
Life in
Years**......... 4.9 1.5 0.9 0.6 0.5 9.7 3.6 2.0 1.4 1.0 11.8 5.6 3.0 2.0 1.5 13.9 9.1 5.1 3.2 2.3
</TABLE>
- ----
(*) Indicates a number that is greater than zero but less than 0.5%.
(**) The weighted average life of a Certificate of any class is determined by
(i) multiplying the amount of each net distribution in reduction of
Certificate Principal Balance by the number of years from the date of
issuance of the Certificate to the related Distribution Date, (ii) adding
the results, and (iii) dividing the sum by the aggregate of the net
distributions described in (i) above.
THIS TABLE HAS BEEN PREPARED BASED ON THE ASSUMPTIONS DESCRIBED IN THE THIRD
PARAGRAPH PRECEDING THIS TABLE (INCLUDING THE ASSUMPTIONS REGARDING THE
CHARACTERISTICS AND PERFORMANCE OF THE MORTGAGE LOANS WHICH DIFFER FROM THE
ACTUAL CHARACTERISTICS AND PERFORMANCE THEREOF) AND SHOULD BE READ IN
CONJUNCTION THEREWITH.
(Table continued on next page.)
S-35
<PAGE>
PERCENT OF INITIAL PRINCIPAL BALANCE OUTSTANDING AT THE FOLLOWING PERCENTAGES
OF PREPAYMENT ASSUMPTION
<TABLE>
<CAPTION>
CLASS A-5 CLASS A-6 CLASS A-L
------------------------ ------------------------ -----------------------
DISTRIBUTION DATE 0% 50% 100% 150% 200% 0% 50% 100% 150% 200% 0% 50% 100% 150% 200%
- ----------------- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- --- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Initial Percentage...... 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100
September 25, 1997...... 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100
September 25, 1998...... 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100
September 25, 1999...... 100 100 100 100 42 100 100 100 100 100 100 100 100 100 100
September 25, 2000...... 100 100 100 100 0 100 100 100 100 39 98 93 88 83 77
September 25, 2001...... 100 100 100 0 0 100 100 100 92 0 96 87 78 69 55
September 25, 2002...... 100 100 100 0 0 100 100 100 42 0 94 80 68 56 28
September 25, 2003...... 100 100 48 0 0 100 100 100 17 0 89 71 55 40 13
September 25, 2004...... 100 100 0 0 0 100 100 100 10 0 83 59 40 24 5
September 25, 2005...... 100 100 0 0 0 100 100 72 6 0 75 48 29 13 *
September 25, 2006...... 100 100 0 0 0 100 100 49 3 0 66 38 20 7 0
September 25, 2007...... 100 97 0 0 0 100 100 32 1 0 57 29 13 2 0
September 25, 2008...... 100 37 0 0 0 100 100 19 0 0 47 22 8 0 0
September 25, 2009...... 100 0 0 0 0 100 86 9 0 0 35 15 4 0 0
September 25, 2010...... 100 0 0 0 0 100 47 2 0 0 23 8 1 0 0
September 25, 2011...... 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
Weighted Average
Life in Years**......... 14.7 11.8 7.1 4.4 3.0 14.7 13.9 10.3 6.2 3.9 11.2 9.0 7.5 6.4 5.3
</TABLE>
- ----
(*) Indicates a number that is greater than zero but less than 0.5%.
(**) The weighted average life of a Certificate of any class is determined by
(i) multiplying the amount of each net distribution in reduction of
Certificate Principal Balance by the number of years from the date of
issuance of the Certificate to the related Distribution Date, (ii) adding
the results, and (iii) dividing the sum by the aggregate of the net
distributions described in (i) above.
THIS TABLE HAS BEEN PREPARED BASED ON THE ASSUMPTIONS DESCRIBED IN THE THIRD
PARAGRAPH PRECEDING THIS TABLE (INCLUDING THE ASSUMPTIONS REGARDING THE
CHARACTERISTICS AND PERFORMANCE OF THE MORTGAGE LOANS WHICH DIFFER FROM THE
ACTUAL CHARACTERISTICS AND PERFORMANCE THEREOF) AND SHOULD BE READ IN
CONJUNCTION THEREWITH.
(Table continued from previous page.)
S-36
<PAGE>
PAC STRIP CERTIFICATE YIELD CONSIDERATIONS
To a limited extent, the yield to maturity on the PAC Strip Certificates
will be sensitive to both the timing of receipt of prepayments and the overall
rate of principal prepayments and defaults on the Mortgage Loans, which rate
may fluctuate significantly over time. Investors in the PAC Strip Certificates
should fully consider the risk that an extremely rapid rate of prepayments on
the Mortgage Loans could result in the failure of such investors to fully
recover their investments.
The PAC Strip Certificates have been structured so that the Notional Amount
thereof on any Distribution Date will be reduced to the Planned PAC Notional
Amount for such date as set forth in the table herein assuming that
prepayments on the Mortgage Loans occur at a rate between 5% to 50% CPR in
each month. However, if principal prepayments on the Mortgage Loans occur at a
rate below or above such level, the Notional Amount may deviate from the
described amounts and the weighted average life of the PAC Strip Certificates
may be extended or shortened relative to the weighted average life based on
the Planned PAC Notional Amount. If principal prepayments on the Mortgage
Loans occur at a rate above such level, the Notional Amount thereof may be
reduced at a faster rate and the holders of the PAC Strip Certificates could
fail to recover fully their initial investments, and in no event will the
Notional Amount exceed the related Stated Principal Balance of the Mortgage
Loans.
The following table indicates the sensitivity of the pre-tax yield to
maturity on the PAC Strip Certificates to various constant rates of prepayment
on the Mortgage Loans by projecting the monthly aggregate payments of interest
on the PAC Strip Certificates and computing the corresponding pre-tax yields
to maturity on a corporate bond equivalent basis, based on the Structuring
Assumptions, including the assumptions regarding the characteristics and
performance of the Mortgage Loans which differ from the actual characteristics
and performance thereof and assuming the aggregate purchase prices set forth
below. Any differences between such assumptions and the actual characteristics
and performance of the Mortgage Loans and of the PAC Strip Certificates may
result in yields being different from those shown in such table. Discrepancies
between assumed and actual characteristics and performance underscore the
hypothetical nature of the table, which is provided only to give a general
sense of the sensitivity of yields in varying prepayment scenarios.
PRE-TAX YIELD TO MATURITY OF THE PAC STRIP CERTIFICATES
AT THE FOLLOWING PERCENTAGES OF PREPAYMENT ASSUMPTION
<TABLE>
<CAPTION>
ASSUMED PURCHASE PRICE 0% 50% 100% 150% 200%
- ---------------------- ----- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
$1,930,785 41.9% 7.3% 7.3% 7.3% 7.3%
</TABLE>
Each pre-tax yield to maturity set forth in the preceding table was
calculated by determining the monthly discount rate which, when applied to the
assumed stream of cash flows to be paid on the PAC Strip Certificates, would
cause the discounted present value of such assumed stream of cash flows to
equal the assumed purchase price listed in the table. Accrued interest is
included in the assumed purchase price and is used in computing the corporate
bond equivalent yields shown. These yields do not take into account the
different interest rates at which investors may be able to reinvest funds
received by them as distributions on the PAC Strip Certificates, and thus do
not reflect the return on any investment in the PAC Strip Certificates when
any reinvestment rates other than the discount rates are considered.
Notwithstanding the assumed prepayment rates reflected in the preceding
table, it is highly unlikely that the Mortgage Loans will be prepaid according
to one particular pattern. For this reason, and because the timing of cash
flows is critical to determining yields, the pre-tax yield to maturity on the
PAC Strip Certificates is likely to differ from those shown in the table, even
if all of the Mortgage Loans prepay at the indicated constant percentages of
SPA over any given time period or over the entire life of the Certificates.
There can be no assurance that the Mortgage Loans will prepay at any
particular rate or that the yield on the PAC Strip Certificates will conform
to the yields described herein. Moreover, the various remaining terms to
maturity of the Mortgage Loans could produce slower or faster principal
distributions than indicated in the
S-37
<PAGE>
preceding table at the various constant percentages of Prepayment Assumption
specified, even if the weighted average remaining term to maturity of the
Mortgage Loans is as assumed. Investors are urged to make their investment
decisions based on their determinations as to anticipated rates of prepayment
under a variety of scenarios. Investors in the PAC Strip Certificates should
fully consider the risk that an extremely rapid rate of prepayments on the
Mortgage Loans could result in the failure of such investors to fully recover
their investments.
For additional considerations relating to the yield on the Certificates, see
"Yield Considerations and Prepayment Considerations" in the Prospectus.
POOLING AND SERVICING AGREEMENT
GENERAL
The Certificates will be issued pursuant to the Pooling and Servicing
Agreement dated as of September 1, 1996, among the Company, the Master
Servicer and the Trustee. Reference is made to the Prospectus for important
information in addition to that set forth herein regarding the terms and
conditions of the Pooling and Servicing Agreement and the Senior Certificates.
The Trustee, or any of its affiliates, in its individual or any other
capacity, may become the owner or pledgee of Certificates with the same rights
as it would have if it were not Trustee. The Trustee will appoint Norwest Bank
Minnesota, National Association to serve as Custodian in connection with the
Certificates. The Senior Certificates will be transferable and exchangeable at
the corporate trust office of the Trustee, which will serve as Certificate
Registrar and Paying Agent. The Company will provide a prospective or actual
Certificateholder, without charge, on written request, a copy (without
exhibits) of the Pooling and Servicing Agreement. Requests should be addressed
to the President, Residential Funding Mortgage Securities, II, Inc., 8400
Normandale Lake Boulevard, Suite 700, Minneapolis, Minnesota 55437. In
addition to the circumstances described in the Prospectus, the Company may
terminate the Trustee for cause under certain circumstances. See "The Pooling
and Servicing Agreement--The Trustee" in the Prospectus.
THE MASTER SERVICER
Residential Funding, an indirect wholly-owned subsidiary of GMAC Mortgage
and an affiliate of the Company, will act as Master Servicer for the
Certificates pursuant to the Pooling and Servicing Agreement. For a general
description of Residential Funding and its activities, see "Residential
Funding Corporation" in the Prospectus and "The Mortgage Pool--Residential
Funding" herein.
SERVICING AND OTHER COMPENSATION AND PAYMENT OF EXPENSES
The Servicing Fee for each Mortgage Loan is payable out of the interest
payments on such Mortgage Loan. The Servicing Fees in respect of each Mortgage
Loan will be at least 0.58% per annum of the outstanding principal balance of
such Mortgage Loan. The Servicing Fees consist of (a) servicing compensation
payable to the Master Servicer in respect of its master servicing activities,
and (b) subservicing and other related compensation payable to the Subservicer
(including such compensation paid to the Master Servicer as the direct
servicer of a Mortgage Loan for which there is no Subservicer). The primary
compensation to be paid to the Master Servicer in respect of its master
servicing activities will be 0.08% per annum of the outstanding principal
balance of each Mortgage Loan. As described in the Prospectus, a Subservicer
is entitled to servicing compensation in a minimum amount equal to 0.50% per
annum of the outstanding principal balance of each Mortgage Loan serviced by
it. The Master Servicer is obligated to pay certain ongoing expenses
associated with the Trust Fund and incurred by the Master Servicer in
connection with its responsibilities under the Pooling and Servicing
Agreement. See "Pooling and Servicing Agreement--Servicing and Administration"
in the Prospectus for information regarding other possible compensation to the
Master Servicer and the Subservicer and for information regarding expenses
payable by the Master Servicer.
S-38
<PAGE>
VOTING RIGHTS
Certain actions specified in the Prospectus that may be taken by holders of
Certificates evidencing a specified percentage of all undivided interests in
the Trust Fund may be taken by holders of Certificates entitled in the
aggregate to such percentage of the Voting Rights. 98% of all Voting Rights
will be allocated among all holders of the Class A Certificates in proportion
to their then outstanding Certificate Principal Balances, and 1%, 1/2% and
1/2% of all Voting Rights will be allocated among holders of the PAC Strip
Certificates, the Class R-I Certificates and the Class R-II Certificates,
respectively, in proportion to the Percentage Interests (as defined in the
Prospectus) evidenced by their respective Certificates. So long as there does
not exist a failure by the Insurer to make a required payment under the Policy
(such event, an "Insurer Default"), the Insurer shall have the right to
exercise all rights of the holders of the Senior Certificates under the
Pooling and Servicing Agreement without any consent of such holders, and such
holders may exercise such rights only with the prior written consent of the
Insurer except as provided in the Pooling and Servicing Agreement.
TERMINATION
The circumstances under which the obligations created by the Pooling and
Servicing Agreement will terminate in respect of the Senior Certificates are
described in "The Pooling and Servicing Agreement--Termination; Retirement of
Certificates" in the Prospectus. The Master Servicer or the Company will have
the option on any Distribution Date on which the aggregate Stated Principal
Balance of the Mortgage Loans is less than 3% of the aggregate principal
balance of the Mortgage Loans as of the Cut-off Date, (i) to purchase all
remaining Mortgage Loans and other assets in the Trust Fund (except for the
Policy) thereby effecting early retirement of the Senior Certificates, or (ii)
to purchase in whole, but not in part, the Certificates. Any such purchase of
Mortgage Loans and other assets of the Trust Fund shall be made at a price
equal to the sum of (a) 100% of the unpaid principal balance of each Mortgage
Loan (or the fair market value of the related underlying Mortgaged Properties
with respect to defaulted Mortgage Loans as to which title to such Mortgaged
Properties has been acquired if such fair market value is less than such
unpaid principal balance) as of the date of repurchase plus (b) accrued
interest thereon at the Net Mortgage Rate to, but not including, the first day
of the month in which such repurchase price is distributed and (c) any amounts
due to the Insurer pursuant to the Insurance and Indemnity Agreement.
Distributions on the Certificates in respect of any such optional termination
will be paid, first, to the Senior Certificates, and second, except as set
forth in the Pooling and Servicing Agreement, to the Class R Certificates. The
proceeds of any such distribution may not be sufficient to distribute the full
amount to the Senior Certificates if the purchase price is based in part on
the fair market value of any underlying Mortgaged Property and such fair
market value is less than 100% of the unpaid principal balance of the related
Mortgage Loan; provided, however, with respect to the Senior Certificates, if
such amount is an Insured Amount, such amount will be paid under the Policy,
subject to the terms thereof. Any such purchase of Mortgage Loans and
termination of the Trust Fund requires the consent of the Insurer if it would
result in a draw on the Policy. Any such purchase of the Certificates, will be
made at a price equal to 100% of the Certificate Principal Balance thereof
plus the sum of one month's interest accrued thereon at the applicable Pass-
Through Rate and any previously unpaid Accrued Certificate Interest. Upon the
purchase of the Certificates or at any time thereafter, at the option of the
Master Servicer or the Company, the Mortgage Loans may be sold, thereby
effecting a retirement of the Certificates and the termination of the Trust
Fund, or the Certificates so purchased may be held or resold by the Master
Servicer or the Company.
Upon presentation and surrender of the Senior Certificates in connection
with the termination of the Trust Fund or a purchase of Certificates under the
circumstances described above, the holders of the Class A Certificates will
receive an amount equal to the Certificate Principal Balance of such class
plus one month's interest accrued thereon at the related Pass-Through Rate,
plus any previously unpaid Accrued Certificate Interest (reduced, as described
above, in the case of the termination of the Trust Fund resulting from a
purchase of all the assets of the Trust Fund).
S-39
<PAGE>
CERTAIN FEDERAL INCOME TAX CONSEQUENCES
Upon the issuance of the Senior Certificates, Thacher Proffitt & Wood,
counsel to the Company, will deliver its opinion generally to the effect that,
assuming compliance with all provisions of the Pooling and Servicing
Agreement, for federal income tax purposes, REMIC I and REMIC II will each
qualify as a REMIC under the Code.
For federal income tax purposes, (a) the Class R-I Certificates will
constitute the sole class of "residual interests" in REMIC I, (b) each class
of Senior Certificates will represent ownership of "regular interests" in
REMIC II and will generally be treated as debt instruments of REMIC II and (c)
the Class R-II Certificates will constitute the sole class of "residual
certificates" in REMIC II. See "Certain Federal Income Tax Consequences--
REMICs" in the Prospectus.
For federal income tax reporting purposes, the Class A Certificates will not
and the PAC Strip Certificates will be treated as having been issued with
original issue discount. The prepayment assumption that will be used in
determining the rate of accrual of original issue discount, market discount
and premium, if any, for federal income tax purposes will be based on the
assumption that, subsequent to the date of any determination the Mortgage
Loans will prepay at a rate equal to 100% Prepayment Assumption. No
representation is made that the Mortgage Loans will prepay at that rate or at
any other rate. See "Certain Federal Income Tax Consequences--General" and "--
REMICs--Taxation of Owners of REMIC Regular Certificates--Original Issue
Discount" in the Prospectus.
If the method for computing original issue discount described in the
Prospectus results in a negative amount for any period with respect to a
Certificateholder, in particular the Class IO Certificates, the amount of
original issue discount allocable to such period would be zero and such
Certificateholder will be permitted to offset such negative amount only
against future original issue discount (if any) attributable to such
Certificates.
In certain circumstances OID Regulations permit the holder of a debt
instrument to recognize original issue discount under a method that differs
from that used by the issuer. Accordingly, it is possible that the holder of a
Certificate may be able to select a method for recognizing original issue
discount that differs from that used by the Master Servicer in preparing
reports to the Certificateholders and the IRS.
Certain classes of the Senior Certificates may be treated for federal income
tax purposes as having been issued at a premium. Whether any holder of such a
class of Certificates will be treated as holding a certificate with
amortizable bond premium will depend on such Certificateholder's purchase
price and the distributions remaining to be made on such Certificate at the
time of its acquisition by such Certificateholder. Holders of such classes of
Certificates should consult their tax advisors regarding the possibility of
making an election to amortize such premium. See "Certain Federal Income Tax
Consequences--REMICs--Taxation of Owners of REMIC Regular Certificates" and
"--Premium" in the Prospectus.
The Senior Certificates will be treated as assets described in Section
7701(a)(19)(C) of the Code and "real estate assets" under Section 856(c)(5)(A)
of the Code generally in the same proportion that the assets of the Trust Fund
would be so treated. In addition, interest on the Senior Certificates will be
treated as "interest on obligations secured by mortgages on real property"
under Section 856(c)(3)(B) of the Code generally to the extent that such
Senior Certificates are treated as "real estate assets" under Section
856(c)(5)(A) of the Code. Moreover, the Senior Certificates (other than the
Residual Certificates) will be "qualified mortgages" within the meaning of
Section 860G(a)(3) of the Code if transferred to another REMIC on its startup
day in exchange for a regular or residual interest therein. However,
prospective investors in Senior Certificates that will be generally treated as
assets described in Section 860G(a)(3) of the Code should note that,
notwithstanding such treatment, any repurchase of such a Certificate pursuant
to the right of the Master Servicer or the Company to repurchase such Senior
Certificates may adversely affect any REMIC that holds such Senior
Certificates if such repurchase is made under circumstances giving rise to a
Prohibited Transaction Tax. See "The Pooling and Servicing Agreement--
Termination" herein and "Certain Federal Income Tax Consequences--REMICs--
Characterization of Investments in REMIC Certificates" in the Prospectus.
S-40
<PAGE>
Residential Funding will be designated as the "tax matters person" with
respect to REMIC I and REMIC II as defined in the REMIC Provisions (as defined
in the Prospectus), and in connection therewith will be required to hold not
less than 0.01% of each of the Class R-I Certificates and Class R-II
Certificates.
For further information regarding federal income tax consequences of
investing in the Senior Certificates, see "Certain Federal Income Tax
Consequences--REMICs" in the Prospectus.
METHOD OF DISTRIBUTION
Subject to the terms and conditions set forth in an Underwriting Agreement,
dated September 19, 1996 (the "Underwriting Agreement"), the Underwriter has
agreed to purchase and the Company has agreed to sell the Senior Certificates.
It is expected that delivery of the Class A Certificates will be made only
in book-entry form through the Same Day Funds Settlement System of DTC, and
that delivery of the PAC Strip Certificates will be made at the offices of the
Underwriter, New York, New York on or about September 27, 1996, against
payment therefor in immediately available funds.
The Underwriting Agreement provides that the obligation of the Underwriter
to pay for and accept delivery of the Senior Certificates is subject to, among
other things, the receipt of certain legal opinions and to the conditions,
among others, that no stop order suspending the effectiveness of the Company's
Registration Statement shall be in effect, and that no proceedings for such
purpose shall be pending before or threatened by the Securities and Exchange
Commission.
The distribution of the Senior Certificates by the Underwriter may be
effected from time to time in one or more negotiated transactions, or
otherwise, at varying prices to be determined at the time of sale. Proceeds to
the Company from the sale of the Senior Certificates, before deducting
expenses payable by the Company, will be approximately 100.55% of the
aggregate Certificate Principal Balance of the Senior Certificates plus
accrued interest thereon from the Cut-off Date. The Underwriter may effect
such transactions by selling its Certificates to or through dealers, and such
dealers may receive compensation in the form of underwriting discounts,
concessions or commissions from the Underwriter for whom they act as agent. In
connection with the sale of the Senior Certificates, the Underwriter may be
deemed to have received compensation from the Company in the form of
underwriting compensation. The Underwriter and any dealers that participate
with the Underwriter in the distribution of the Senior Certificates may be
deemed to be underwriters and any profit on the resale of the Senior
Certificates positioned by them may be deemed to be underwriting discounts and
commissions under the Securities Act of 1933.
The Underwriting Agreement provides that the Company will indemnify the
Underwriter, and under limited circumstances the Underwriter will indemnify
the Company, against certain civil liabilities under the Securities Act of
1933 or contribute to payments required to be made in respect thereof.
There can be no assurance that a secondary market for the Senior
Certificates will develop or, if it does develop, that it will continue. The
primary source of information available to investors concerning the Senior
Certificates will be the monthly statements discussed in the Prospectus under
"Description of the Certificates--Reports to Certificateholders," which will
include information as to the outstanding principal balance of the Senior
Certificates and the status of the applicable form of credit enhancement.
There can be no assurance that any additional information regarding the Senior
Certificates will be available through any other source. In addition, the
Company is not aware of any source through which price information about the
Senior Certificates will be generally available on an ongoing basis. The
limited nature of such information regarding the Senior Certificates may
adversely affect the liquidity of the Senior Certificates, even if a secondary
market for the Senior Certificates becomes available.
S-41
<PAGE>
LEGAL OPINIONS
Certain legal matters relating to the Senior Certificates will be passed
upon for the Company by Thacher Proffitt & Wood, New York, New York and for
the Underwriter by Brown & Wood LLP, New York, New York.
EXPERTS
The consolidated balance sheets of the Insurer, AMBAC Indemnity Corporation,
at December 31, 1995 and 1994 and the consolidated statements of operations,
stockholder's equity and cash flows of AMBAC Indemnity Corporation for each of
the years in the three year period ended December 31, 1995 appearing in
Appendix A of this Prospectus Supplement have been included herein in reliance
upon the report of KPMG Peat Marwick LLP, independent certified public
accountants, appearing elsewhere herein and upon the authority of said firm as
experts in accounting and auditing.
The report of KPMG Peat Marwick LLP covering the consolidated financial
statements referred to above of AMBAC Indemnity Corporation refers to the
adoption of the Financial Accounting Standards Board's Statements of Financial
Accounting Standards No. 109, "Accounting for Income Taxes," No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," No. 106,
"Employers' Accounting for Postretirement Benefits Other Than Pensions," and
No. 112, "Employers' Accounting for Postemployment Benefits" in 1993.
RATINGS
It is a condition of the issuance of the Class A Certificates offered hereby
that they be rated "AAA" by Standard & Poor's and "Aaa" by Moody's. It is a
condition of the issuance of the PAC Strip Certificates that they be rated
"AAAr" by Standard & Poor's and "Aaa" by Moody's.
Standard & Poor's ratings on mortgage pass-through certificates address the
likelihood of the receipt by Certificateholders of payments required under the
Pooling and Servicing Agreement. Standard & Poor's ratings take into
consideration the credit quality of the mortgage pool, structural and legal
aspects associated with the Certificates, and the extent to which the payment
stream in the mortgage pool is adequate to make payments required under the
Certificates. Standard & Poor's rating on the Certificates does not, however,
constitute a statement regarding frequency of prepayments on the mortgages.
See "Certain Yield and Prepayment Considerations" herein. The "r" of the
"AAAr" rating of the PAC Strip Certificates by Standard & Poor's is attached
to highlight derivative, hybrid, and certain other obligations that Standard &
Poor's believes may experience high volatility or high variability in expected
returns due to non-credit risks. Examples of such obligations are: securities
whose principal or interest return is indexed to equities, commodities, or
currencies; certain swaps and options; and interest only and principal only
mortgage securities. The absence of an "r" symbol should not be taken as an
indication that an obligation will exhibit no volatility or variability in
total return.
The ratings assigned by Moody's to mortgage pass-through certificates also
address the likelihood of the receipt by Certificateholders of all
distributions to which such Certificateholders are entitled. The rating
process addresses the structural and legal aspects associated with the
Certificates, including the nature of the underlying mortgage loans. The
ratings assigned to mortgage pass-through certificates do not represent any
assessment of the likelihood or rate of principal prepayments. The ratings do
not address the possibility that Certificateholders might suffer a lower than
anticipated yield.
The Company has not requested a rating on the Senior Certificates by any
rating agency other than Standard & Poor's and Moody's. However, there can be
no assurance as to whether any other rating agency will rate the Senior
Certificates, or, if it does, what rating would be assigned by any such other
rating agency. A rating on the Certificates by another rating agency, if
assigned at all, may be lower than the ratings assigned to the Senior
Certificates by Standard & Poor's and Moody's.
S-42
<PAGE>
A security rating is not a recommendation to buy, sell or hold securities
and may be subject to revision or withdrawal at any time by the assigning
rating organization. Each security rating should be evaluated independently of
any other security rating. In the event that the ratings initially assigned to
the Senior Certificates are subsequently lowered for any reason, no person or
entity is obligated to provide any additional support or credit enhancement
with respect to the Senior Certificates.
LEGAL INVESTMENT
The Senior Certificates will not constitute "mortgage related securities"
for purposes of SMMEA because the Mortgage Pool includes Mortgage Loans that
are secured by subordinate liens on the related Mortgaged Properties.
Institutions whose investment activities are subject to legal investment laws
and regulations or to review by regulatory authorities should consult with
their own legal advisors in determining whether and to what extent the Senior
Certificates are subject to restrictions on investment, capital requirements
or otherwise. See "Legal Investment Matters" in the Prospectus.
See "Legal Investment Matters" in the Prospectus.
ERISA CONSIDERATIONS
A fiduciary of any employee benefit plan or other plan or arrangement
subject to ERISA, or Section 4975 of the Code (a "Plan") or any insurance
company (whether through its general or separate accounts) or other person
investing "plan assets" of any Plan should carefully review with its legal
advisors whether the purchase or holding of Senior Certificates could give
rise to a transaction prohibited or not otherwise permissible under ERISA or
Section 4975 of the Code. The purchase or holding of the Senior Certificates
by, on behalf of or with "plan assets" of a Plan may qualify for exemptive
relief under the Exemption; however, the Exemption contains a number of
conditions including the requirement that any such Plan must be an "accredited
investor" as defined in Rule 501(a)(1) of Regulation D under the Securities
Act of 1933, as amended. See "ERISA Considerations" in the Prospectus.
S-43
<PAGE>
APPENDIX A
AMBAC INDEMNITY CORPORATION AND SUBSIDIARIES
(a wholly owned subsidiary of AMBAC Inc.)
Consolidated Financial Statements
December 31, 1995 and 1994
(With Independent Auditors' Report Thereon)
A-1
<PAGE>
Independent Auditors' Report
The Board of Directors
AMBAC Indemnity Corporation:
We have audited the accompanying consolidated balance sheets of AMBAC
Indemnity Corporation and subsidiaries (a wholly owned subsidiary of AMBAC Inc.)
as of December 31, 1995 and 1994, and the related consolidated statements of
operations, stockholder's equity and cash flows for each of the years in the
three-year period ended December 31, 1995. These consolidated financial
statements are the responsibility of AMBAC Indemnity Corporation's management.
Our responsibility is to express an opinion on these consolidated 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 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of AMBAC
Indemnity Corporation and subsidiaries as of December 31, 1995 and 1994, and the
results of their operations and their 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 to the consolidated financial statements, AMBAC
Indemnity Corporation has adopted the provisions of the Financial Accounting
Standards Board's Statements of Financial Accounting Standards No. 109,
"Accounting for Income Taxes," No. 115, "Accounting for Certain Investments in
Debt and Equity Securities," No. 106, "Employers' Accounting for Postretirement
Benefits Other Than Pensions" and No. 112, "Employers' Accounting for
Postemployment Benefits," in 1993.
/s/ KPMG Peat Marwick LLP
KPMG Peat Marwick LLP
New York, New York
January 31, 1996
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Consolidated Balance Sheets
(Dollars In Thousands Except Share Data)
<TABLE>
<CAPTION>
December 31,
-------------------------
1995 1994
---------- ----------
Assets
Investments:
<S> <C> <C>
Bonds held in available-for-sale account, at fair value
(amortized cost of $2,090,101 in 1995 and $1,865,350
in 1994).............................................. $2,224,528 $1,795,958
Short-term investments, at cost (approximates fair
value)................................................ 163,953 85,202
---------- ----------
Total investments..................................... 2,388,481 1,881,160
Cash....................................................... 6,912 2,117
Securities purchased under agreements to resell............ 4,120 8,011
Receivable for securities.................................. 8,136 21,508
Investment income due and accrued.......................... 38,319 34,902
Investment in affiliate.................................... 25,827 24,976
Deferred acquisition costs................................. 82,620 71,774
Deferred income taxes...................................... -- 1,778
Current income taxes....................................... 2,171 10,544
Prepaid reinsurance........................................ 153,372 139,855
Other assets............................................... 48,472 41,677
---------- ----------
Total assets.......................................... $2,758,430 $2,238,302
========== ==========
Liabilities and Stockholder's Equity
Liabilities:
Unearned premiums........................................ $ 906,136 $ 839,775
Losses and loss adjustment expenses...................... 65,996 65,662
Ceded reinsurance balances payable....................... 14,654 908
Deferred income taxes.................................... 85,008 --
Accounts payable and other liabilities................... 43,625 43,519
Payable for securities................................... 86,304 26,696
---------- ----------
Total liabilities..................................... 1,201,723 976,560
---------- ----------
Stockholder's equity:
Preferred stock, par value $1,000.00 per share.
Authorized shares -- 285,000; issued and outstanding
shares -- none........................................ -- --
Common stock, par value $2.50 per share. Authorized
shares -- 40,000,000; issued and outstanding
shares -- 32,800,000 at December 31, 1995 and 1994.... 82,000 82,000
Additional paid-in capital............................... 481,059 444,258
Unrealized gains (losses) on investments, net of tax..... 87,112 (46,087)
Retained earnings........................................ 906,536 781,571
---------- ----------
Total stockholder's equity............................ 1,556,707 1,261,742
---------- ----------
Total liabilities and stockholder's equity............ $2,758,430 $2,238,302
========== ==========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
1
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Consolidated Statements of Operations
(Dollars In Thousands)
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------
1995 1994 1993
-------- -------- --------
Revenues:
<S> <C> <C> <C>
Gross premiums written........................... $195,033 $192,598 $321,490
Ceded premiums written........................... (28,606) 2,815 (35,810)
-------- -------- --------
Net premiums written.......................... 166,427 195,413 285,680
Increase in unearned premiums, net............... (52,844) (76,077) (132,862)
-------- -------- --------
Net premiums earned........................... 113,583 119,336 152,818
Net investment income............................ 131,496 119,737 104,609
Net realized gains (losses)...................... 177 (13,386) 30,145
Other income..................................... 6,777 6,887 1,516
-------- -------- --------
Total revenues................................ 252,033 232,574 289,088
-------- -------- --------
Expenses:
Losses and loss adjustment expenses.............. 3,377 2,593 (1,849)
Underwriting and operating expenses.............. 38,722 35,946 34,746
Interest expense................................. 1,590 1,428 163
-------- -------- --------
Total expenses................................ 43,689 39,967 33,060
-------- -------- --------
Income before income taxes.................... 208,344 192,607 256,028
-------- -------- --------
Income tax expense:
Current taxes.................................... 29,085 26,286 66,386
Deferred taxes................................... 14,461 16,277 4,090
-------- -------- --------
Total income taxes............................ 43,546 42,563 70,476
-------- -------- --------
Income before cumulative effect of changes in
accounting principles......................... 164,798 150,044 185,552
Cumulative effect of changes in accounting
principles.................................... -- -- (98)
-------- -------- --------
Net income.................................... $164,798 $150,044 $185,454
========= ========= =========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
2
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Consolidated Statements of Stockholder's Equity
(Dollars In Thousands)
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------------
1995 1994 1993
--------- --------- --------
Preferred Stock:
<S> <C> <C> <C>
Balance at January 1 and December 31........... $ -- $ -- $ --
========== ========== =========
Common Stock:
Balance at January 1 and December 31........... $ 82,000 $ 82,000 $ 82,000
========== ========== =========
Additional Paid-in Capital:
Balance at January 1........................... $ 444,258 $ 444,143 $397,570
Capital contributions.......................... 35,000 -- 40,000
Cumulative effect of changes in accounting
principles.................................. -- -- 4,708
Other paid-in capital.......................... 1,801 115 1,865
--------- --------- --------
Balance at December 31......................... $ 481,059 $ 444,258 $444,143
========== ========== =========
Unrealized Gains (Losses) on Investments, Net of
Tax:
Balance at January 1........................... $ (46,087) $ 68,091 $ 5,285
Unrealized gain from change in accounting
principle................................... -- -- 63,568
Change in unrealized gain (loss)............... 133,199 (114,178) (762)
--------- --------- --------
Balance at December 31......................... $ 87,112 ($ 46,087) $ 68,091
========== ========== =========
Retained Earnings:
Balance at January 1........................... $ 781,571 $ 667,527 $515,073
Net income..................................... 164,798 150,044 185,454
Dividends declared-common stock................ (40,000) (36,000) (33,000)
Other.......................................... 167 -- --
--------- --------- --------
Balance at December 31......................... $ 906,536 $ 781,571 $667,527
========== ========== =========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
3
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(Dollars In Thousands)
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------------
1995 1994 1993
----------- ----------- -----------
Cash flows from operating activities:
<S> <C> <C> <C>
Net income............................... $ 164,798 $ 150,044 $ 185,454
Adjustments to reconcile net income to
net cash provided by operating
activities:
Depreciation and amortization............ 1,605 1,106 1,080
Amortization of bond premium and
discount.............................. (831) (1,097) (507)
Current income taxes payable............. 8,373 (6,069) (20,844)
Deferred income taxes payable............ 14,462 16,277 (2,463)
Deferred acquisition costs............... (10,846) (20,757) (7,059)
Unearned premiums........................ 52,844 76,077 132,862
Losses and loss adjustment expenses...... 334 1,625 (718)
Ceded reinsurance balances payable....... 13,746 (2,963) (5,147)
(Gain) loss on sales of investments...... (177) 13,386 (30,145)
Proceeds from sales of bonds in trading
account............................... -- -- 2,091,143
Proceeds from maturities of bonds in
trading account....................... -- -- 34,409
Purchases of bonds for trading account... -- -- (2,181,198)
Accounts payable and other liabilities... 106 20,497 9,591
Other, net............................... (11,273) 7,179 (1,622)
----------- ----------- -----------
Net cash provided by operating
activities......................... 233,141 255,305 204,836
----------- ----------- -----------
Cash flows from investing activities:
Proceeds from sales of bonds at amortized
cost.................................. 1,882,485 1,305,011 18,912
Proceeds from maturities of bonds at
amortized cost........................ 163,031 39,126 60,131
Purchases of bonds at amortized cost..... (2,192,824) (1,559,982) (258,832)
Investment in preferred stock of
affiliate............................. -- -- (3,000)
Change in short-term investments......... (78,751) 9,005 (25,252)
Securities purchased under agreements to
resell................................ 3,891 (8,011) --
Other, net............................... (1,178) (3,786) (2,370)
----------- ----------- -----------
Net cash used in investing
activities......................... (223,346) (218,637) (210,411)
----------- ----------- -----------
Cash flows from financing activities:
Dividends paid........................... (40,000) (36,000) (33,000)
Capital contribution..................... 35,000 -- 40,000
----------- ----------- -----------
Net cash (used in) provided by
financing activities............... (5,000) (36,000) 7,000
----------- ----------- -----------
Net cash flow......................... 4,795 668 1,425
Cash at beginning of year.................. 2,117 1,449 24
----------- ----------- -----------
Cash at December 31........................ $ 6,912 $ 2,117 $ 1,449
=========== =========== ===========
Supplemental disclosure of cash flow
information:
Cash paid during the year for:
Income taxes.......................... $ 19,500 $ 32,153 $ 86,781
=========== =========== ===========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
4
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands)
1 BACKGROUND
AMBAC Indemnity Corporation ("AMBAC Indemnity") is a leading insurer of
municipal and structured finance obligations. Financial guarantee insurance
underwritten by AMBAC Indemnity guarantees payment when due of the principal of
and interest on the obligation insured. In the case of a default on the insured
bond, payments under the insurance policy may not be accelerated by the
policyholder without AMBAC Indemnity's consent. As of December 31, 1995, AMBAC
Indemnity's net insurance in force (principal and interest) was $199,078,000.
AMBAC Indemnity is a wholly owned subsidiary of AMBAC Inc. (NYSE: ABK), a
holding company that provides financial guarantee insurance and financial
services to both public and private clients through its subsidiaries.
As of December 31, 1995, AMBAC Indemnity owned approximately 26.5% of the
outstanding common stock of an affiliate, HCIA Inc. (NASDAQ: HCIA) ("HCIA"), a
leading health care information content company. AMBAC Inc. owns approximately
19.9% of the outstanding common stock of HCIA. Prior to 1995, AMBAC Inc. and
AMBAC Indemnity combined owned approximately 96% of HCIA. During 1995, HCIA
offered approximately 3.5 million shares of its common stock for sale in two
separate public offerings. In addition, in conjunction with the second public
offering by HCIA, AMBAC Inc. sold approximately 1.1 million shares of HCIA
common stock. As a result of these public offerings, as of December 31, 1995,
AMBAC Indemnity and AMBAC Inc. combined owned 46.4% of the common stock of HCIA.
AMBAC Indemnity, as the sole limited partner, owns a limited partnership
interest representing 90% of the total partnership interests of AMBAC Financial
Services, Limited Partnership ("AFS"), a limited partnership which provides
interest rate swaps primarily to states, municipalities and municipal
authorities. The sole general partner of AFS, AMBAC Financial Services Holdings,
Inc., a wholly owned subsidiary of AMBAC Inc., owns a general partnership
interest representing 10% of the total partnership interest in AFS.
AMBAC Indemnity has one wholly owned subsidiary, American Municipal Bond
Holding Company ("AMBH"), which is a holding company for certain real estate
interests.
2 SIGNIFICANT ACCOUNTING POLICIES
The accompanying consolidated financial statements have been prepared on
the basis of generally accepted accounting principles ("GAAP"). The preparation
of financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosures of contingent assets and liabilities at the date of
the financial statements and the reported revenues and expenses during the
reporting period. Actual results could differ from those estimates. The
significant accounting policies of AMBAC Indemnity and its subsidiaries are as
described below:
CONSOLIDATION:
The consolidated financial statements include the accounts of AMBAC
Indemnity, AFS and AMBH (sometimes collectively referred to as "AMBAC
Indemnity"). All significant intercompany balances have been eliminated.
5
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
INVESTMENTS:
AMBAC Indemnity's investment portfolio is accounted for on a trade-date
basis and consists entirely of investments in debt securities which are
considered available-for-sale and are carried at fair value. Fair value is based
on quotes obtained by AMBAC Indemnity from independent market sources.
Short-term investments are carried at cost, which approximates their fair value.
Unrealized gains and losses, net of deferred income taxes, are included as a
separate component of stockholder's equity and are computed using amortized cost
as the basis. For purposes of computing amortized cost, premiums and discounts
are accounted for using the interest method. For bonds purchased at a price
below par value, discounts are accreted over the remaining term of the
securities. For bonds purchased at a price above par value which have call
features, premiums are amortized to the most likely call dates as determined by
management. For premium bonds which do not have call features, such premiums are
amortized over the remaining term of the securities. Premiums and discounts on
mortgage-backed securities are adjusted for the effects of actual and
anticipated prepayments. Realized gains and losses on the sale of investments
are determined on the basis of specific identification.
Effective December 31, 1993, AMBAC Indemnity adopted Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in Debt and
Equity Securities" ("Statement 115"). Pursuant to Statement 115, AMBAC Indemnity
has designated all investments as "available-for-sale" and reports them at fair
value. Unrealized gains and losses are excluded from earnings and reported as a
separate component of stockholder's equity, net of tax. The cumulative effect of
adopting Statement 115 as of December 31, 1993 was to increase AMBAC Indemnity's
stockholder's equity by $63,568, net of tax. The adoption of Statement 115 had
no effect on earnings.
SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL:
Securities purchased under agreements to resell are collateralized
financing transactions, and are recorded at their contracted resale amounts,
plus accrued interest. AMBAC Indemnity takes possession of the collateral
underlying those agreements and monitors its market value on a daily basis and,
when necessary, requires prompt transfer of additional collateral to reflect
current market value.
PREMIUM REVENUE RECOGNITION:
Premiums for municipal new issue and secondary market policies are: (i)
generally computed as a percentage of principal and interest insured; (ii)
typically collected in a single payment at policy inception date; and (iii) are
earned pro rata over the period of risk. Premiums for structured finance
policies can be computed as a percentage of either principal or principal and
interest insured. The timing of the collection of structured finance premiums
varies among individual transactions. For policies where premiums are collected
in a single payment at policy inception date, premiums are earned pro rata over
the period of risk. For policies with premiums that are collected periodically
(i.e., monthly, quarterly or annually), premiums are reflected in income pro
rata over the period covered by the premium payment.
When an AMBAC Indemnity-insured new or secondary market issue has been
refunded or called, the remaining unearned premium is generally earned at that
time, as the risk to AMBAC Indemnity is considered to have been eliminated.
6
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
LOSSES AND LOSS ADJUSTMENT EXPENSES:
The liability for losses and loss adjustment expenses consists of the
Active Credit Reserve ("ACR") and case basis loss reserves. The development of
the ACR is based upon estimates of the ultimate aggregate losses inherent in the
obligations insured and reflects the net result of contributions related to the
portion of earnings required to cover those losses, less reductions of ACR no
longer deemed necessary by management. When losses occur (actual monetary
defaults or defaults which are imminent on insured obligations), case basis loss
reserves are established in an amount that is sufficient to cover the present
value of the anticipated defaulted debt service payments over the expected
period of default and estimated expenses associated with settling the claims,
less estimated recoveries under salvage or subrogation rights. All or part of
case basis loss reserves are allocated from any ACR available for such insured
obligation.
AMBAC Indemnity's management believes that the reserves for losses and loss
adjustment expenses are adequate to cover the ultimate net cost of claims, but
the reserves are necessarily based on estimates and there can be no assurance
that the ultimate liability will not exceed such estimates.
DEFERRED ACQUISITION COSTS:
Certain costs incurred which vary with, and are primarily related to, the
production of business have been deferred. These costs include direct and
indirect expenses related to underwriting, marketing and policy issuance, rating
agency fees and premium taxes, net of reinsurance ceding commissions. The
deferred acquisition costs are being amortized over the periods in which the
related premiums are earned, and such amortization amounted to $10,183, $9,348
and $12,120 for 1995, 1994 and 1993, respectively. Deferred acquisition costs,
net of such amortization, amounted to $10,845, $20,757 and $7,059 for 1995, 1994
and 1993, respectively.
DEPRECIATION AND AMORTIZATION:
Depreciation of furniture and fixtures and electronic data processing
equipment is provided over the estimated useful lives of the respective assets
using the straight-line method. Amortization of leasehold improvements and
intangibles, including certain computer software licenses, is provided over the
estimated useful lives of the respective assets using the straight-line method.
INTEREST RATE CONTRACTS:
Interest Rate Contracts Held for Purposes Other Than Trading:
AMBAC Indemnity uses interest rate contracts for hedging purposes as part
of its overall interest rate risk management. Gains and losses on interest rate
futures and options contracts that qualify as accounting hedges of existing
assets or liabilities are included in the carrying amounts and amortized over
the remaining lives of the assets and liabilities as an adjustment to interest
income. When the hedged asset is sold, the unamortized gain or loss on the
related hedge is recognized in income. Gains and losses on interest rate
contracts that do not qualify as accounting hedges are recognized in current
period income.
AMBAC Indemnity accounts for its interest rate futures contracts in
accordance with the provisions of Statement of Financial Accounting Standards
No. 80, "Accounting For Futures Contracts" ("Statement 80"). Statement 80
permits hedge accounting for interest rate futures contracts when the item to be
hedged exposes the Company to price or interest rate risk, and the futures
contract effectively reduces that exposure and is designated as a hedge.
Interest rate futures contracts held for purposes other than trading are used
primarily to hedge interest sensitive assets, and are designated at inception as
a hedge to specific assets.
7
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
Interest rate swaps that are linked with existing liabilities are accounted
for like a hedge of those liabilities, using the accrual method as an adjustment
to interest expense. Interest rate swaps that are linked with existing assets
classified as available-for-sale are accounted for like hedges of those assets,
using the accrual method as an adjustment to interest income, with unrealized
gains and losses included in stockholder's equity, net of tax.
Interest Rate Contracts Held for Trading Purposes:
AMBAC Indemnity, in connection with its market making activities as a
provider of interest rate swaps, primarily to states, municipalities, municipal
authorities and other entities in connection with their financings, uses
interest rate contracts which are classified as held for trading purposes.
Interest rate contracts are recorded on trade date at fair value. Changes in
fair value are recorded as a component of other income. The fair value of
interest rate swaps is determined through the use of valuation models. The
portion of the interest rate swap's initial fair value that reflects credit
considerations, on-going servicing and transaction hedging costs is recognized
over the life of the interest rate swap, as an adjustment to other income.
Interest rate swaps are recorded on a gross basis; assets and liabilities are
netted by customer only when a legal right of set-off exists.
INCOME TAXES:
AMBAC Inc., as common parent, files a consolidated Federal income tax
return with its subsidiaries. Effective January 1, 1993, AMBAC Indemnity adopted
Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes" ("Statement 109"). Under Statement 109, deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in the period that includes the enactment
date.
The cumulative effect of this change in accounting for income taxes
resulted in an increase to net income for 1993 of $1,162 and an increase to
additional paid-in capital of $4,708. The adjustment to additional paid-in
capital reflects Statement 109 adjustments for prior business combinations.
The Internal Revenue Code permits municipal bond insurance companies to
deduct from taxable income, subject to certain limitations, the amounts added to
the statutory mandatory contingency reserve during the year. The deduction taken
is allowed only to the extent that U.S. Treasury noninterest-bearing tax and
loss bonds are purchased at their par value prior to the original due date of
AMBAC Inc.'s consolidated Federal tax return and held in an amount equal to the
tax benefit attributable to such deductions. The amounts deducted must be
included in taxable income when the contingency reserve is released, at which
time AMBAC Indemnity may redeem the tax and loss bonds to satisfy the additional
tax liability. The purchases of tax and loss bonds are recorded as payments of
Federal income taxes and are not reflected in AMBAC Indemnity's current tax
provision.
POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS:
AMBAC Inc., through its subsidiaries, provides various postretirement and
postemployment benefits, including pension, and health and life benefits
covering substantially all employees who meet certain age and service
requirements. AMBAC Indemnity accounts for these benefits under the accrual
method of accounting. Amounts related to the defined benefit pension plan and
postretirement health benefits are charged based on actuarial determinations.
8
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
Effective January 1, 1993, AMBAC Indemnity adopted Statement of Financial
Accounting Standards No. 106, "Employers' Accounting for Postretirement Benefits
Other Than Pensions" ("Statement 106"). Statement 106 requires that the expected
cost of postretirement benefits, other than pensions, be charged to expense
during the period that the employee renders service. AMBAC Indemnity elected to
recognize the transition obligation immediately and recorded a charge of $465,
after reduction of $240 for income tax benefits, as a cumulative effect of a
change in accounting principle as of the date of adoption.
Effective January 1, 1993, AMBAC Indemnity adopted Statement of Financial
Accounting Standards No. 112, "Employers' Accounting for Postemployment
Benefits" ("Statement 112"), which, similar to Statement 106, requires accrual
of a liability representing the cost of certain benefits earned by employees
over their employment period. Statement 112 applies to vested benefits provided
to former or inactive employees, their beneficiaries and covered dependents,
after employment but before retirement. In adopting Statement 112, AMBAC
Indemnity recorded a charge of $801, after reduction for income tax benefits of
$429, as a cumulative effect of a change in accounting principle as of the date
of adoption.
STOCK COMPENSATION PLANS:
In 1991, AMBAC Inc. adopted the AMBAC Inc. 1991 Stock Incentive Plan. Under
this plan awards are granted to eligible employees of AMBAC Indemnity in the
form of incentive stock options or other stock-based awards. In October 1995,
the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation"
("Statement 123") which must be adopted no later than 1996. Statement 123
applies to all stock-based employee compensation plans (except employee stock
ownership plans) in which an employer grants shares of its stock or other equity
instruments to employees. Statement 123 permits a company to choose either the
fair value based method of accounting as defined in the statement or the
intrinsic value based method of accounting as prescribed by APB Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25") for its stock-based
compensation plans. Companies electing the accounting requirements under APB 25
must also make pro forma disclosures of net income and earnings per share as if
the fair value based method of accounting had been applied. AMBAC Indemnity
currently accounts for its plans under APB 25 and intends to continue to do so
after adopting Statement 123 in 1996. The adoption of Statement 123 is expected
to have no effect on AMBAC Indemnity's results of operations.
RECLASSIFICATIONS:
Certain reclassifications have been made to prior years' amounts to conform
to the current year's presentation.
9
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
<TABLE>
<CAPTION>
3 INVESTMENTS
The amortized cost and estimated fair value of investments in debt
securities at December 31, 1995 and 1994 were as follows:
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
---------- ---------- ---------- ----------
1995
<S> <C> <C> <C> <C>
Municipal obligations........................ $1,558,754 $ 98,090 $ 2,428 $1,654,416
Corporate securities......................... 261,492 30,785 3,263 289,014
U.S. Government obligations.................. 214,224 8,796 621 222,399
Mortgage-backed securities (including
GNMA)...................................... 55,631 3,362 294 58,699
Other........................................ 163,953 -- -- 163,953
---------- ---------- ---------- ----------
$2,254,054 $ 141,033 $ 6,606 $2,388,481
========= ======== ======== =========
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
---------- ---------- ---------- ----------
1994
<S> <C> <C> <C> <C>
Municipal obligations........................ $1,505,501 $ 23,009 $ 80,935 $1,447,575
Corporate securities......................... 228,992 2,336 11,501 219,827
U.S. Government obligations.................. 61,906 311 1,797 60,420
Mortgage-backed securities (including
GNMA)...................................... 70,251 1,325 2,140 69,436
Other........................................ 83,902 -- -- 83,902
---------- ---------- ---------- ----------
$1,950,552 $ 26,981 $ 96,373 $1,881,160
========= ======== ======== =========
</TABLE>
The amortized cost and estimated fair value of debt securities at December
31, 1995, by contractual maturity, were as follows:
<TABLE>
<CAPTION>
Amortized Estimated
Cost Fair Value
---------- ----------
1995
<S> <C> <C>
Due in one year or less..................................... $ 223,069 $ 223,949
Due after one year through five years....................... 168,417 181,772
Due after five years through ten years...................... 302,601 315,385
Due after ten years......................................... 1,504,336 1,608,676
---------- ----------
2,198,423 2,329,782
Mortgage-backed securities.................................. 55,631 58,699
---------- ----------
$2,254,054 $2,388,481
========= =========
</TABLE>
Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties.
10
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
<TABLE>
<CAPTION>
Net investment income comprised the following:
1995 1994 1993
-------- -------- --------
<S> <C> <C> <C>
Bonds.............................................. $127,865 $118,685 $102,020
Short-term investments............................. 6,116 3,512 4,278
-------- -------- --------
Total investment income.......................... 133,981 122,197 106,298
Investment expense................................. (2,485) (2,460) (1,689)
-------- -------- --------
Net investment income............................ $131,496 $119,737 $104,609
======== ======== ========
</TABLE>
Gross realized gains were $27,786, $26,514 and $42,217 for 1995, 1994 and
1993, respectively, and gross realized losses were $27,609, $39,900 and $12,072
for 1995, 1994 and 1993, respectively.
As of December 31, 1995, AMBAC Indemnity did not have any investment
concentrated in any single repayment source (excluding obligations of the U.S.
Government and its agencies) with a fair value greater than 2.0% of its
stockholder's equity.
As of December 31, 1995 and 1994, AMBAC Indemnity held securities subject
to agreements to resell for $4,120 and $8,011, respectively. Such securities
were held as collateral by AMBAC Indemnity. The agreements had terms of less
than 30 days.
As of December 31, 1995 and 1994, investment securities with a fair value
of $4,583 and $3,948, respectively, were pledged to futures brokers for required
margin.
4 REINSURANCE
In the ordinary course of business, AMBAC Indemnity cedes exposures under
various reinsurance contracts primarily designed to minimize losses from large
risks and to protect capital and surplus. The effect of reinsurance on premiums
written and earned was as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------------------------------------
1995 1994 1993
--------------------- --------------------- ---------------------
Written Earned Written Earned Written Earned
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Direct................... $192,277 $127,322 $188,057 $136,632 $321,179 $181,320
Assumed.................. 2,756 1,349 4,541 1,325 311 311
Ceded.................... (28,606) (15,088) 2,815 (18,621) (35,810) (28,813)
-------- -------- -------- -------- -------- --------
Net premiums............. $166,427 $113,583 $195,413 $119,336 $285,680 $152,818
======== ======== ======== ======== ======== ========
</TABLE>
The reinsurance of risk does not relieve the ceding insurer of its original
liability to its policyholders. In the event that all or any of the reinsurers
are unable to meet their obligations to AMBAC Indemnity under the existing
reinsurance agreements, AMBAC Indemnity would be liable for such defaulted
amounts. To minimize its exposure to significant losses from reinsurer
insolvencies, AMBAC Indemnity evaluates the financial condition of its
reinsurers and monitors concentrations of credit risk. There were no reinsurance
receivables as of December 31, 1995 and 1994. As of December 31, 1995, prepaid
reinsurance of approximately $48,120 was associated with a single reinsurer. As
of December 31, 1995, AMBAC Indemnity held letters of credit and collateral
amounting to approximately $90,643 from its reinsurers to cover liabilities
ceded under the aforementioned reinsurance contracts.
AMBAC Indemnity terminated reinsurance contracts, resulting in return
premiums to AMBAC Indemnity of $18,141, $30,482 and $36,461 of which $15,700,
$25,891 and $31,010 were recorded as an
11
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
increase to the unearned premium reserve in 1995, 1994 and 1993, respectively,
with the remainder recognized as revenue.
5 LOSSES AND LOSS ADJUSTMENT EXPENSES
AMBAC Indemnity's liability for losses and loss adjustment expenses
includes case basis loss reserves and the ACR. Following is a summary of the
activity in the case basis loss and active credit reserve accounts and the
components of the liability for losses and loss adjustment expenses:
<TABLE>
<CAPTION>
1995 1994 1993
------- ------- --------
Case basis loss reserves:
<S> <C> <C> <C>
Balance at January 1......................... $38,892 $35,155 $ 28,321
------- ------- --------
Incurred related to:
Current year............................... 750 8,073 6,630
Prior years................................ 2,650 (3,368) (926)
------- ------- --------
Total incurred.......................... 3,400 4,705 5,704
------- ------- --------
Paid related to:
Current year............................... 150 275 315
Prior years................................ 2,893 693 (1,445)
------- ------- --------
Total paid.............................. 3,043 968 (1,130)
------- ------- --------
Balance at December 31....................... 39,249 38,892 35,155
------- ------- --------
Active credit reserve:
Balance at January 1......................... 26,770 28,882 36,434
Net provision for losses..................... 4,097 4,422 6,709
ACR transfers to case reserves............... (4,120) (6,534) (14,261)
------- ------- --------
Balance at December 31....................... 26,747 26,770 28,882
------- ------- --------
Total................................... $65,996 $65,662 $ 64,037
======= ======= =========
</TABLE>
The terms "current year" and "prior years" in the foregoing table refer to
the year in which case basis loss reserves were established.
12
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
6 COMMITMENTS AND CONTINGENCIES
AMBAC Indemnity is responsible for leases on the rental of office space,
principally in New York City. The lease agreements which expire periodically
through September 2014, contain provisions for scheduled periodic rent increases
and are accounted for as operating leases. An estimate of future net minimum
lease payments in each of the next five years ending December 31, and the
periods thereafter, is as follows:
Year Amount
- --------------- --------
1996........................................................... $ 3,042
1997........................................................... 3,073
1998........................................................... 3,359
1999........................................................... 3,650
2000........................................................... 3,650
All later years................................................ 53,880
-------
$70,654
=======
Rent expense for the aforementioned leases amounted to $2,924, $2,719 and
$2,778 for the years ended December 31, 1995, 1994 and 1993, respectively.
7 INSURANCE REGULATORY RESTRICTIONS
AMBAC Indemnity is subject to insurance regulatory requirements of the
States of Wisconsin, New York and the other jurisdictions in which it is
licensed to conduct business.
AMBAC Indemnity's ability to pay dividends is generally restricted by law
and subject to approval by the Office of the Commissioner of Insurance of the
State of Wisconsin (the "Wisconsin Commissioner"). Wisconsin insurance law
restricts the payment of dividends in any 12-month period without regulatory
approval to the lesser of (a) 10% of policyholders' surplus as of the preceding
December 31 and (b) the greater of (i) statutory net income for the calendar
year preceding the date of dividend, minus realized capital gains for that
calendar year and (ii) the aggregate of statutory net income for three calendar
years preceding the date of the dividend, minus realized capital gains for those
calendar years and minus dividends paid or credited within the first two of the
three preceding calendar years. AMBAC Indemnity paid dividends of $40,000,
$36,000 and $33,000 on its common stock in 1995, 1994 and 1993, respectively.
Based upon these restrictions, at December 31, 1995, the maximum amount that
will be available during 1996 for payment of dividends by AMBAC Indemnity
without prior approval is approximately $86,000.
However, as discussed in Note 15, AMBAC Indemnity, upon consummation of the
proposed PRIDES offering will deliver to AMBAC Inc. (in the form of an
extraordinary dividend) its 2,378,672 shares of HCIA common stock, at fair
value. The Wisconsin Commissioner has approved such dividend. The fair value of
such dividend will be determined based on the price per share of HCIA common
stock used to price the PRIDES. As a result, any dividends paid by AMBAC
Indemnity to AMBAC Inc. for the twelve months following the extraordinary
dividend will require pre-approval from the Wisconsin Commissioner. The
Wisconsin Commissioner has stated to AMBAC Indemnity management that it does not
foresee any reason such pre-approval would not be given.
The New York Financial Guarantee Insurance Law establishes single risk
limits applicable to all obligations issued by a single entity and backed by a
single revenue source. Under the limit applicable to
13
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
municipal bonds, the insured average annual debt service for a single risk, net
of reinsurance and collateral, may not exceed 10% of the sum of the insurer's
policyholders' surplus and contingency reserves. In addition, insured principal
of municipal bonds attributable to any single risk, net of reinsurance and
collateral, is limited to 75% of the insurer's policyholders' surplus and
contingency reserves. Additional single risk limits, which generally are more
restrictive than the municipal bond single risk limit, are also specified for
several other categories of insured obligations.
Statutory capital and surplus was $862,976 and $781,772 at December 31,
1995 and 1994, respectively. Qualified statutory capital (statutory surplus plus
contingency reserve) was $1,358,769 and $1,218,204 at December 31, 1995 and
1994, respectively. Statutory net income was $142,541, $116,238 and $166,157 for
1995, 1994 and 1993, respectively. Statutory capital and surplus differs from
stockholder's equity determined under GAAP principally due to statutory
accounting rules that treat loss reserves, premiums earned, policy acquisition
costs and deferred income taxes differently.
8 INCOME TAXES
The total effect of income taxes on income and stockholder's equity for the
years ended December 31, 1995 and 1994 was as follows:
<TABLE>
<CAPTION>
1995 1994
-------- --------
<S> <C> <C>
Total income taxes charged to income.................. $ 43,546 $ 42,563
-------- --------
Income taxes charged (credited) to stockholder's
equity:
Unrealized gain (loss) on bonds..................... 71,722 (61,480)
Unrealized gain on investment in affiliate.......... 602 --
Other............................................... (682) (116)
-------- --------
Total charged (credited) to stockholder's
equity................................... 71,642 (61,596)
-------- --------
Total effect of income taxes.......................... $115,188 $(19,033)
======== ========
</TABLE>
The tax provisions in the accompanying consolidated statements of
operations reflect effective tax rates differing from prevailing Federal
corporate income tax rates. The following is a reconciliation of these
differences:
<TABLE>
<CAPTION>
1995 % 1994 % 1993 %
-------- ----- -------- ---- -------- ----
Computed expected tax at
<S> <C> <C> <C> <C> <C> <C>
statutory rate................ $ 72,920 35.0% $ 67,412 35.0% $ 89,610 35.0%
Increases (reductions) in
expected tax resulting from:
Tax-exempt interest........ (28,274) (13.6) (26,336) (13.7) (21,043) (8.2)
Adjustment to deferred tax
assets and liabilities
for enacted changes in
tax laws and rates...... -- -- -- -- 754 0.3
Other, net................. (1,100) (0.5) 1,487 0.8 1,155 0.4
------- ----- ------- ---- ------- ----
Income tax expense on income from
continuing operations.......... $ 43,546 20.9% $ 42,563 22.1% $ 70,476 27.5%
======= ===== ======= ==== ======= ====
</TABLE>
14
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
The tax effects of temporary differences that give rise to significant
portions of the deferred tax liabilities and deferred tax assets at December 31,
1995 and 1994 are presented below:
<TABLE>
<CAPTION>
1995 1994
-------- -------
Deferred tax liabilities:
<S> <C> <C>
Unrealized gains on bonds............................ $ 46,906 $ --
Deferred acquisition costs........................... 28,917 25,121
Unearned premiums.................................... 22,079 14,522
Unrealized gain on investment in affiliate........... 602 --
Investments.......................................... 2,911 796
Other................................................ 1,996 1,613
------- -------
Total deferred tax liabilities.............. 103,411 42,052
------- -------
Deferred tax assets:
Unrealized loss on bonds............................. -- 24,816
Loss reserves........................................ 9,631 9,733
Insurance in force................................... 2,870 3,205
Compensation......................................... 2,418 2,812
Other................................................ 3,484 3,264
------- -------
Sub-total deferred tax assets............... 18,403 43,830
Valuation allowance.................................. -- --
------- -------
Total deferred tax assets................... 18,403 43,830
------- -------
Net deferred tax (liabilities) assets....... $(85,008) $ 1,778
======= =======
</TABLE>
AMBAC Indemnity believes that no valuation allowance is necessary in
connection with the deferred tax assets.
9 EMPLOYEE BENEFITS
Pensions:
AMBAC Inc. has a defined benefit pension plan covering substantially all
employees of AMBAC Indemnity and AFS. The benefits are based on years of service
and the employee's compensation during the last five years of employment. AMBAC
Indemnity's funding policy is to contribute annually the maximum amount that can
be deducted for Federal income tax purposes. Contributions are intended to
provide not only for benefits attributed to service-to-date but also for those
expected to be earned in the future.
The actuarial present value of the benefit obligations shown in the table
below sets forth the plan's funded status and amounts recognized by AMBAC Inc.
as of December 31, 1995 and 1994.
15
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
Actuarial present value of the benefit obligations:
<TABLE>
<CAPTION>
1995 1994
------- -------
Accumulated benefit obligation, including vested benefits of
<S> <C> <C>
$6,049 and $4,300, respectively................................ $(6,788) $(5,000)
======= =======
Projected benefit obligation for service rendered to date........ (7,800) (5,500)
Plan assets at fair value, primarily listed stocks, commingled
funds and fixed income securities.............................. 7,054 4,898
------- -------
Unfunded projected benefit....................................... (746) (602)
Unrecognized prior service cost.................................. (1,784) (1,950)
Unrecognized net loss............................................ 1,906 1,412
Unrecognized net transition asset................................ (12) (15)
------- -------
Pension liability -- entire plan................................. $ (636) $(1,155)
======= =======
</TABLE>
Net pension costs for 1995, 1994 and 1993 included the following
components:
<TABLE>
<CAPTION>
1995 1994 1993
------- ----- -----
<S> <C> <C> <C>
Service cost............................................. $ 541 $ 558 $ 447
Interest cost on expected benefit obligation............. 456 386 297
Actual return on plan assets............................. (1,333) 30 (390)
Net amortization and deferral............................ 760 (547) (149)
------- ----- -----
Net periodic pension cost................................ $ 424 $ 427 $ 205
======= ===== =====
</TABLE>
The weighted-average discount rate used in the determination of the
actuarial present value for the projected benefit obligation was 7.25% and 8.0%
for 1995 and 1994, respectively. The expected long-term rate of return on assets
was 9.25% for both 1995 and 1994. The rate of increase in future compensation
levels used in determining the actuarial present value of the projected benefit
obligation was 5.0% in both 1995 and 1994.
Substantially all employees of AMBAC Indemnity and AFS are covered by a
defined contribution plan (the "Savings Incentive Plan") for which contributions
and costs are determined as 6% of each covered employee's base salary, plus a
matching company contribution of 50% on contributions up to 6% of base salary
made by eligible employees to the plan. The total cost of the Savings Incentive
Plan to AMBAC Indemnity was $1,435, $1,292 and $1,243 in 1995, 1994 and 1993,
respectively.
Annual Incentive Plan:
AMBAC Indemnity has an annual incentive plan which provides for awards to
key officers and employees based upon predetermined criteria. The cost of the
plan to AMBAC Indemnity for the years ended December 31, 1995, 1994 and 1993 was
$7,669, $8,531 and $6,165, respectively.
Postretirement Health Care and Other Benefits:
AMBAC Indemnity provides certain medical and life insurance benefits for
retired employees and eligible dependents. All plans are contributory. None of
the plans is currently funded.
16
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
Postretirement benefits expense was $168, $176 and $500 in 1995, 1994 and
1993, respectively. The unfunded accumulated postretirement benefit obligation
was $1,309 and the accrued postretirement liability was $1,368 as of December
31, 1995.
The assumed weighted average health care cost trend rates range from 13.5%
in 1995, decreasing ratably to 5.5% in 2001, and remaining at that level
thereafter. Increasing the assumed health care cost trend rate by one percentage
point in each future year would increase the accumulated postretirement benefit
obligation at December 31, 1995 by $174 and the 1995 benefit expense by $28. The
weighted average discount rate used to measure the accumulated postretirement
benefit obligation and 1995 expense was 7.25%.
10 INSURANCE IN FORCE
The par amount of bonds insured by AMBAC Indemnity, net of reinsurance, was
$110,997,000 and $93,305,000 at December 31, 1995 and 1994, respectively. As of
December 31, 1995, AMBAC Indemnity's insured portfolio was diversified by type
of insured bond as shown in the following table:
Net Par Amount
Outstanding
--------------------
(Dollars in Millions) As of December 31 1995 1994
-------- -------
Municipal finance:
General obligation........................... $ 30,546 $26,674
Utility revenue.............................. 21,053 19,597
Tax-backed revenue........................... 18,780 16,279
Health care revenue.......................... 12,553 10,922
Transportation revenue....................... 6,293 5,397
Investor Owned Utilities..................... 4,497 3,500
Higher education............................. 3,973 3,447
Student loan................................. 3,769 2,709
Housing revenue.............................. 3,577 2,567
Other........................................ 483 403
-------- -------
Total Municipal finance................... 105,524 91,495
-------- -------
Structured finance:
Domestic..................................... 3,238 902
International................................ 2,235 908
-------- -------
Total Structured finance.................. 5,473 1,810
-------- -------
$110,997 $93,305
========= =======
As of December 31, 1995, California was the state with the highest
aggregate net par amount inforce, accounting for 14.3% of the total, and the
highest single insured risk represented 0.6% of aggregate net par amount
insured. AMBAC Indemnity's direct insurance in force (principal and interest)
was $235,118,000 and $205,810,000, at December 31, 1995 and 1994, respectively.
Net insurance in force (after giving effect to reinsurance) was $199,078,000 and
$171,678,000 as of December 31, 1995 and 1994, respectively.
17
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
11 FINANCIAL INSTRUMENTS HELD FOR PURPOSES OTHER THAN TRADING
Financial instruments with off-balance-sheet risk:
In the normal course of business, AMBAC Indemnity becomes a party to
various financial transactions to reduce its exposure to fluctuations in
interest rates. These financial instruments include an interest rate swap
agreement and exchange traded interest rate futures contracts. The notional
amounts of AMBAC Indemnity's off-balance-sheet financial instruments which are
held for purposes other than trading were as follows:
As of December 31,
--------------------
1995 1994
------- --------
Interest rate futures contracts................ $44,500 $164,200
Interest rate swap............................. 20,000 20,000
Notional principal amounts are often used to express the volume of these
transactions and do not reflect the extent to which positions may offset one
another. These amounts do not represent the much smaller amounts potentially
subject to risk.
Interest rate futures contracts are sold to hedge interest rate risk
inherent in fixed rate investment securities. At December 31, 1995, interest
rate futures contracts with an outstanding notional amount of $44,500 were
designated as hedges of fixed rate investment securities.
The interest rate swap held for purposes other than trading is used to
manage interest rate risk by synthetically changing the nature of certain
floating rate investments.
Fair values of financial instruments held for purposes other than trading:
The following fair value amounts were determined by AMBAC Indemnity using
independent market information when available, and appropriate valuation
methodologies when market quotes were not available. In cases where specific
market quotes are unavailable, interpreting market data and estimating market
values necessarily require considerable judgment by management. Accordingly, the
estimates presented are not necessarily indicative of the amount AMBAC Indemnity
could realize in a current market exchange.
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to estimate
that value:
Investments: The fair values of bonds are based on quoted market prices or
dealer quotes.
Short-term investments and cash: The fair values of short-term investments
and cash are assumed to equal amortized cost.
Securities purchased under agreements to resell: The fair value of
securities purchased under agreements to resell is assumed to approximate
carrying value.
Investment in affiliate: As of December 31, 1995, the fair value of AMBAC
Indemnity's investment in HCIA is based on the quoted market price of HCIA
common stock. As of December 31, 1994, the fair value of AMBAC Indemnity's
investment in HCIA was assumed to equal carrying value.
Interest rate contracts: Fair values of off-balance-sheet interest rate
contracts (futures and swap) are based on quoted market and dealer prices,
current settlement values, or pricing models.
18
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
Liability for net financial guarantees written: The fair value of the
liability for those financial guarantees written related to new issue and
secondary market exposures is based on the estimated cost to reinsure those
exposures at current market rates, which amount consists of the current unearned
premium reserve, less an estimated ceding commission thereon.
Certain other financial guarantee insurance policies have been written on
an installment basis, where the future premiums to be received by AMBAC
Indemnity are determined based on the outstanding exposure at the time the
premiums are due. The fair value of AMBAC Indemnity's liability under its
installment premium policies is measured using the present value of estimated
future installment premiums, less an assumed ceding commission. The estimate of
the amounts and timing of the future installment premiums is based on
contractual premium rates, debt service schedules and expected run-off
scenarios. This measure is used as an estimate of the cost to reinsure AMBAC
Indemnity's liability under these policies. The carrying amount and estimated
fair value of these financial instruments are presented below:
<TABLE>
<CAPTION>
As of December 31,
---------------------------------------------------
1995 1994
----------------------- -----------------------
Carrying Estimated Carrying Estimated
(Dollars in Millions) Amount Fair Value Amount Fair Value
-------- ---------- -------- ----------
Financial assets:
<S> <C> <C> <C> <C>
Investments........................ $2,225 $2,225 $1,796 $1,796
Short-term investments............. 164 164 85 85
Securities purchased under
agreements to resell............. 4 4 8 8
Investment in affiliate............ 26 111 25 25
Cash............................... 7 7 2 2
Unrecognized financial instruments:
Interest rate swap................. -- -- -- (1)
Interest rate futures contracts.... -- -- -- --
Liability for net financial
guarantees
Direct........................... -- 655 -- 609
Net of reinsurance............... -- 543 -- 507
Net installment premiums......... -- 80 -- 51
</TABLE>
12 FINANCIAL INSTRUMENTS HELD FOR TRADING PURPOSES
AMBAC Indemnity, through its affiliate AFS, is a provider of interest rate
swaps to states, municipalities, municipal authorities and other entities,
including its affiliate, AMBAC Capital Management, Inc. ("ACMI"), in connection
with their financings. AMBAC Indemnity manages its interest rate swap business
with the goal of being market neutral to changes in overall interest rates,
while retaining "basis risk", the relationship between changes in floating rate
tax-exempt and floating rate taxable interest rates. If actual or projected
floating rate tax-exempt interest rates rise in relation to floating rate
taxable rates, AMBAC Indemnity will experience an unrealized mark-to-market
loss. Conversely, if actual or projected floating rate tax-exempt interest rates
decline in relation to floating rate taxable interest rates, AMBAC Indemnity
will experience an unrealized mark-to-market gain.
19
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
In the ordinary course of business, AMBAC Indemnity manages a variety of
risks -- principally credit, market, liquidity, operational and legal. These
risks are identified, measured and monitored through a variety of control
mechanisms, which are in place at different levels throughout the organization.
Credit risk relates to the ability of counterparties to perform according
to the terms of their contractual commitments. Various procedures and controls
are in place to monitor the credit risk of interest rate swaps. These include
the initial credit approval process, the establishment of credit limits,
management approvals and a process that ensures the continuous monitoring of
credit exposure.
Market risk relates to the impact of price changes on future earnings. This
risk is a consequence of AMBAC Indemnity's market-making activities in the
municipal interest rate swap market. The principal market risk is basis risk,
the relationship between changes in floating rate tax-exempt and floating rate
taxable interest rates. Since the third quarter of 1995, all municipal interest
rate swaps transacted contain provisions which are designed to protect AMBAC
Indemnity against certain forms of tax reform, thus mitigating its basis risk.
An independent risk management group monitors trading risk limits and, together
with senior management, is involved in the application of risk measurement
methodologies.
The estimation of potential losses arising from adverse changes in market
relationships, known as "value at risk," is a key element in managing market
risk. AMBAC Indemnity has developed a value at risk methodology to estimate
potential losses over a specified holding period and based on certain
probabilistic assessments. AMBAC Indemnity estimates value at risk utilizing
historical short and long term interest rate volatilities and the relationship
between changes in tax-exempt and taxable interest rates calculated on a
consistent daily basis. For the year ended December 31, 1995, AMBAC Indemnity's
value at risk averaged approximately $1,358, calculated at a ninety-nine percent
confidence level. Since no single measure can capture all dimensions of market
risk, AMBAC Indemnity bolsters its value at risk methodology by performing daily
analyses of parallel and nonparallel shifts in yield curves and stress test
scenarios which measure the potential impact of market conditions, however
improbable, which might cause abnormal volatility swings or disruptions of
market relationships.
Liquidity risk relates to the possible inability to satisfy contractual
obligations when due. This risk is present in interest rate swap agreements and
in futures contracts used to hedge those agreements. AMBAC Indemnity manages
liquidity risk by maintaining cash and cash equivalents, closely matching the
dates swap payments are made and received and limiting the amount of risk hedged
by futures contracts.
Operational risk relates to the potential for loss caused by a breakdown in
information, communication and settlement systems. AMBAC Indemnity mitigates
operational risk by maintaining a comprehensive system of internal controls.
This includes the establishment of systems and procedures to monitor
transactions and positions, documentation and confirmation of transactions,
ensuring compliance with regulations and periodic reviews by auditors.
Legal risk relates to the uncertainty of the enforceability, through legal
or judicial processes, of the obligations of AMBAC Indemnity's counterparties,
including contractual provisions intended to reduce credit exposure by providing
for the offsetting or netting of mutual obligations. AMBAC Indemnity seeks to
remove or minimize such uncertainties through continuous consultation with
internal and external legal advisers to analyze and understand the nature of
legal risk, to improve documentation and to strengthen transaction structure.
20
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
The following table summarizes information about AMBAC Indemnity's
financial instruments held for trading purposes as of December 31, 1995 and
1994:
<TABLE>
<CAPTION>
Net Net Average Net Fair Value
Carrying Estimated ----------------------- Notional
Amount Fair Value Assets Liabilities Amount
-------- ---------- ------- ----------- ----------
1995:
Interest rate
<S> <C> <C> <C> <C> <C>
swaps............ $5,207 $5,207 $17,714 $16,667 $2,152,400
Interest rate
futures
contracts........ -- -- -- -- 569,800
1994:
Interest rate
swaps............ $1,681 $1,681 $ 4,441 $ 3,560 $ 771,900
Interest rate
futures
contracts........ -- -- -- -- 443,000
</TABLE>
The aggregate amount of net trading income recognized from interest rate
financial instruments held for trading purposes was $2,602 and $3,051 for 1995
and 1994, respectively. Average net fair values were calculated based on average
daily net fair values. For 1994, average net fair values began from the
commencement of operations in September 1994.
Notional principal amounts are often used to express the volume of these
transactions and do not reflect the extent to which positions may offset one
another. These amounts do not represent the much smaller amounts potentially
subject to risk.
13 LINES OF CREDIT
AMBAC Inc. and AMBAC Indemnity maintain a three-year revolving credit
facility with two major international banks, as co-agents, for $100,000. As of
December 31, 1995, no amounts were outstanding under this credit facility, which
expires in July 1998. This facility amended a one-year revolving credit facility
for $75,000. As of December 31, 1994, no amounts were outstanding under this
credit facility.
AMBAC Indemnity has an agreement with another major international bank, as
agent, for a $300,000 credit facility, expiring in 2002. This facility is a
seven-year stand-by irrevocable limited recourse line of credit, which was
increased from $225,000 to $300,000 and extended for an additional year in
December 1995. The line will provide liquidity to AMBAC Indemnity in the event
claims from municipal obligations exceed specified levels. Repayment of any
amounts drawn under the line will be limited primarily to the amount of any
recoveries of losses related to policy obligations. As of December 31, 1995 and
1994, no amounts were outstanding under this line.
14 RELATED PARTY TRANSACTIONS
During 1995 and 1994, AMBAC Indemnity guaranteed the timely payment of
principal and interest on obligations under municipal investment contracts and
municipal investment repurchase agreements issued by its affiliate, ACMI. As of
December 31, 1995 and 1994, the aggregate amount of municipal investment
contracts and municipal investment repurchase contracts insured was $2,240,959
and $2,042,230, respectively, including accrued interest. These insurance
policies are collateralized by ACMI's investment securities, accrued interest,
securities purchased under agreements to resell and cash and cash equivalents,
which as of December 31, 1995 and 1994 had a fair value of $2,299,687 and
$1,964,830, respectively, in the aggregate.
21
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Financial Statements -- (Continued)
(Dollar Amounts in Thousands)
During 1995 and 1994, AMBAC Indemnity recorded gross premiums written of $1,707
and $2,692, and net premiums earned of $1,764 and $1,872, respectively, related
to these contracts.
During 1995 and 1994, several interest rate swap transactions were executed
between AFS and ACMI. As of December 31, 1995 and 1994, these contracts had an
outstanding notional amount of approximately $359,000 and $478,000,
respectively. As of December 31, 1995 and 1994, AFS recorded a positive fair
value of $6,539 and a negative fair value of $5,492, respectively, related to
these transactions.
15 SUBSEQUENT EVENTS
On January 19, 1996, AMBAC Inc. filed with the Securities and Exchange
Commission a registration statement related to a proposed offering of 3,781,369
PRIDES(SM) (Provisionally Redeemable Income Debt Exchangeable for Stock). The
PRIDES, which constitute senior debt of AMBAC Inc., will mature in 2001 and will
be mandatorily exchanged at maturity into shares of HCIA common stock (or, at
AMBAC Inc.'s option, cash with an equal value) determined in accordance with an
exchange rate formula. AMBAC Inc. may redeem the PRIDES, in whole or in part,
after three years. AMBAC Inc. has also granted the underwriters an option to
purchase up to 378,136 PRIDES to cover any over-allotments.
AMBAC Indemnity, upon consummation of the PRIDES offering, will deliver to
AMBAC Inc. (in the form of an extraordinary dividend) its 2,378,672 shares of
HCIA common stock, at fair value. The fair value of such dividend will be
determined based on the price per share of HCIA common stock used to price the
PRIDES.
22
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
(a wholly-owned subsidiary of AMBAC Inc.)
Consolidated Unaudited Financial Statements
as of June 30, 1996 and December 31, 1995
and for the periods ended June 30, 1996 and 1995
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Consolidated Balance Sheets
June 30, 1996 and December 31, 1995
(Dollars in Thousands Except Share Data)
<TABLE>
<CAPTION>
June 30, 1996 December 31, 1995
------------- -----------------
(unaudited)
<S> <C> <C>
Assets
- ------
Investments:
Bonds held in available for sale account, at fair value
(amortized cost of $2,162,449 in 1996 and $2,090,101 in 1995) $2,214,817 $2,224,528
Short-term investments, at cost (approximates fair value) 133,629 163,953
---------- ----------
Total investments 2,348,446 2,388,481
Cash 3,888 6,912
Securities purchased under agreements to resell 3,992 4,120
Receivable for securities 64,288 8,136
Investment income due and accrued 40,207 38,319
Investment in affiliate - 25,827
Deferred acquisition costs 88,107 82,620
Current income taxes - 2,171
Prepaid reinsurance 162,166 153,372
Other assets 54,378 48,472
---------- ----------
Total assets $2,765,472 $2,758,430
========== ==========
Liabilities and Stockholder's Equity
Liabilities:
Unearned premiums $936,870 $906,136
Losses and loss adjustment expenses 59,429 65,996
Ceded reinsurance balances payable 6,765 14,654
Deferred income taxes 57,190 85,008
Current income taxes 3,116 -
Accounts payable and other liabilities 47,035 43,625
Payable for securities 112,413 86,304
---------- ----------
Total liabilities 1,222,818 1,201,723
---------- ----------
Stockholder's equity:
Preferred stock, par value $1,000.00 per share; authorized
shares - 285,000; issued and outstanding shares - none - -
Common stock, par value $2.50 per share; authorized shares
- 40,000,000; issued and outstanding shares - 32,800,000
at June 30, 1996 and December 31, 1995 82,000 82,000
Additional paid-in capital 514,305 481,059
Unrealized gains (losses) on investments, net of tax 34,039 87,112
Retained earnings 912,310 906,536
---------- ----------
Total stockholder's equity 1,542,654 1,556,707
---------- ----------
Total liabilities and stockholder's equity $2,765,472 $2,758,430
========== ==========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Consolidated Statements of Operations
(Unaudited)
For The Periods Ended June 30, 1996 and 1995
(Dollars in Thousands)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- ------------------------
1996 1995 1996 1995
------- ------- -------- -------
<S> <C> <C> <C> <C>
Revenues:
Gross premiums written $58,768 $36,893 $110,060 $77,465
Ceded premiums written (9,836) 6,514 (19,448) 3,055
------- ------- -------- -------
Net premiums written 48,932 43,407 90,612 80,520
Increase in unearned premiums (8,870) (15,126) (21,940) (27,563)
------- ------- -------- -------
Net premiums earned 40,062 28,281 68,672 52,957
Net investment income 35,584 32,419 70,489 64,293
Net realized gains (losses) 67,580 (2,202) 69,936 (6,876)
Other income 4,753 (393) 10,805 1,985
------- ------- -------- -------
Total revenues 147,979 58,105 219,902 112,359
------- ------- -------- -------
Expenses:
Losses and loss adjustment expenses 1,700 341 2,510 1,369
Underwriting and operating expenses 11,583 9,916 21,666 19,246
Interest expense 514 306 1,028 637
------- ------- -------- -------
Total expenses 13,797 10,563 25,204 21,252
------- ------- -------- -------
Income before income taxes 134,182 47,542 194,698 91,107
------- ------- -------- -------
Income tax expense:
Current taxes 38,665 6,696 52,313 13,543
Deferred taxes 806 2,458 760 3,666
------- ------- -------- -------
Total income taxes 39,471 9,154 53,073 17,209
------- ------- -------- -------
Net income 94,711 38,388 141,625 73,898
======= ======= ======== =======
</TABLE>
See accompanying Notes to Consolidated Unaudited Financial Statements
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
For The Periods Ended June 30, 1996 and 1995
(Dollars in Thousands)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
--------------------------
1996 1995
-------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net income $141,625 $73,898
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 950 678
Amortization of bond premium and discount (811) (440)
Current income taxes payable 5,287 574
Deferred income taxes payable 760 3,666
Deferred acquisition costs (5,487) (9,366)
Unearned premiums 21,940 27,563
Losses and loss adjustment expenses (6,567) 45
Ceded reinsurance balances payable (7,889) (422)
(Gain) loss on sales of investments (69,936) 6,876
Other, net (8,685) (6,538)
-------- -----------
Net cash provided by operating activities 71,187 96,534
-------- -----------
Cash flows from investing activities:
Proceeds from sales of bonds at amortized cost 742,407 837,619
Proceeds from maturities of bonds at amortized cost 43,165 70,281
Purchases of bonds at amortized cost (901,331) (1,001,767)
Change in short-term investments 30,324 19,183
Proceeds from sale of affiliate 115,865 -
Securities purchased under agreements to resell 128 (392)
Other, net (1,404) (223)
-------- -----------
Net cash provided by (used in) investing activities 29,154 (75,299)
-------- -----------
Cash flows from financing activities:
Dividends paid (135,865) (20,000)
Capital contribution 32,500 -
-------- -----------
Net cash used in financing activities (103,365) (20,000)
-------- -----------
Net cash flow (3,024) 1,235
Cash at beginning of year 6,912 2,117
-------- -----------
Cash at June 30 $3,888 $3,352
======== ===========
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Income taxes $13,300 $12,700
======== ===========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
<PAGE>
AMBAC INDEMNITY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
AMBAC Indemnity Corporation ("AMBAC Indemnity") is a leading insurer of
municipal and structured finance obligations. Financial guarantee insurance
underwritten by AMBAC Indemnity guarantees payment when due of the principal of
and interest on the obligation insured. In the case of a default on the insured
obligation, payments under the insurance policy may not be accelerated by the
policyholder without AMBAC Indemnity's consent. As of June 30, 1996, AMBAC
Indemnity's net insurance in force (principal and interest) was $209.3 billion.
AMBAC Indemnity is a wholly-owned subsidiary of AMBAC Inc., which is a holding
company that provides through its affiliates financial guarantee insurance and
financial services to both public and private clients.
AMBAC Indemnity has one wholly-owned subsidiary, American Municipal Bond
Holding Company ("AMBH"), which is a holding company for certain real estate
interests.
On May 6, 1996, AMBAC Inc. sold its 4,159,505 shares of common stock of its
affiliate, HCIA Inc. (NASDAQ:HCIA) ("HCIA") in a secondary public offering.
Prior to consummation of the secondary public offering, AMBAC Indemnity
delivered to AMBAC Inc. (in the form of an extraordinary dividend) its 2,378,672
shares of HCIA common stock, at fair value. The fair value of the HCIA shares
was $115.9 million, based on the offering price per share of HCIA common stock
in the secondary public offering. The carrying value of AMBAC Indemnity's HCIA
shares was $26.2 million, and the resulting gain to AMBAC Indemnity from the
disposition of the shares was $89.7 million. As a result of the secondary public
offering, neither AMBAC Indemnity, nor AMBAC Inc. owned any shares of HCIA.
AMBAC Indemnity, as the sole limited partner, owns 90% of the total
partnership interests of AMBAC Financial Services, Limited Partnership ("AFS"),
a limited partnership which provides interest rate swaps primarily to states,
municipalities and municipal authorities. The sole general partner of AFS, AMBAC
Financial Services Holdings, Inc., a wholly-owned subsidiary of AMBAC Inc., owns
a general partnership interest representing 10% of the total partnership
interest in AFS.
AMBAC Indemnity's consolidated unaudited interim financial statements have
been prepared on the basis of generally accepted accounting principles and, in
the opinion of management, reflect all adjustments necessary for a fair
presentation of the Company's financial condition, results of operations and
cash flows for the periods presented. The results of operations for the six
months ended June 30, 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 consolidated financial statements of AMBAC Indemnity
Corporation and its subsidiaries as of December 31, 1995 and 1994, and for each
of the years in the three-year period ended December 31, 1995.
<PAGE>
AMBAC INDEMNITY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS (CONTINUED)
(2) INCOME TAXES
The tax provisions in the accompanying financial statements reflect
effective tax rates differing from prevailing federal corporate income tax
rates, primarily as a result of tax-exempt interest income.
<PAGE>
PROSPECTUS
HOME EQUITY LOAN PASS-THROUGH CERTIFICATES
RESIDENTIAL FUNDING MORTGAGE SECURITIES II, INC.
Depositor
The Home Equity Loan Pass-Through Certificates (the "CERTIFICATES") offered
hereby may be sold from time to time in series, as described in the related
Prospectus Supplement. Each series of Certificates will represent in the
aggregate the entire beneficial ownership interest, excluding any interest
retained by Residential Funding Mortgage Securities II, Inc. (the "COMPANY")
or any other entity specified in the related Prospectus Supplement, in a trust
fund consisting primarily of a segregated pool of one- to four-family, first
or junior lien home equity mortgage loans (the "MORTGAGE LOANS"), including
home equity revolving lines of credit ("REVOLVING CREDIT LOANS") or loans
where the principal amount is advanced in full at origination ("CLOSED-END
LOANS"), or certain balances thereof or interests therein (which may include
Mortgage Securities, as defined herein), acquired by the Company from one or
more affiliated or unaffiliated institutions. See "The Mortgage Pools." See
"Index of Principal Definitions" for the meanings of capitalized terms and
acronyms.
The Mortgage Loans and certain other assets described herein under "The
Mortgage Pools" and in the related Prospectus Supplement will be held in trust
(collectively, a "TRUST FUND") for the benefit of the holders of the related
series of Certificates and the Excess Spread, if any, pursuant to a pooling
and servicing agreement (the "POOLING AND SERVICING AGREEMENT") as described
herein under "The Mortgage Pools." Each Mortgage Pool will consist of one or
more types of Mortgage Loans described under "The Mortgage Pools." Information
regarding each class of Certificates of a series, and the general
characteristics of the Mortgage Loans to be evidenced by such Certificates,
will be set forth in the related Prospectus Supplement.
Each series of Certificates will include one or more classes. Each class of
Certificates of any series will represent the right, which right may be senior
or subordinate to the rights of one or more of the other classes of the
Certificates or other interests in the related Trust Fund, to receive a
specified portion of payments of principal or interest (or both) on the
Mortgage Loans in the related Trust Fund in the manner described herein and in
the related Prospectus Supplement. See "Description of the Certificates--
Distributions." A series may include one or more classes of Certificates
entitled to principal distributions, with disproportionate, nominal or no
interest distributions, or to interest distributions, with disproportionate,
nominal or no principal distributions. A series may include two or more
classes of Certificates which differ as to the timing, sequential order,
priority of payment, pass-through rate or amount of distributions of principal
or interest or both.
If so specified in the related Prospectus Supplement, the Trust Fund for a
series of Certificates may include any one or any combination of a financial
guaranty insurance policy, letter of credit, bankruptcy bond, special hazard
insurance policy, reserve fund, surety bond or other form of credit support.
In addition to or in lieu of the foregoing, credit enhancement may be provided
by means of subordination. See "Description of Credit Enhancement."
The rate of payment of principal of each class of Certificates entitled to a
portion of principal payments on the Mortgage Loans in the Mortgage Pool will
depend on the priority of payment of such class and the rate and timing of
principal payments (including payments in excess of required installments,
prepayments or terminations, liquidations and repurchases) on the Mortgage
Loans and other assets in the Trust Fund and the rate and timing of Draws (as
defined herein) in the case of Revolving Credit Loans. A rate of principal
payment lower or higher than that anticipated may affect the yield on each
class of Certificates in the manner described herein and in the related
Prospectus Supplement. See "Yield and Prepayment Considerations."
FOR A DISCUSSION OF SIGNIFICANT MATTERS AFFECTING INVESTMENTS IN THE
CERTIFICATES, SEE "RISK FACTORS," COMMENCING HEREIN ON PAGE 10.
One or more separate elections may be made to treat a Trust Fund as a "real
estate mortgage investment conduit" (a "REMIC") for federal income tax
purposes. The Prospectus Supplement for a series of Certificates will specify
which class or classes of the related series of Certificates will be
considered to be regular interests in the related REMIC and which class of
Certificates or other interests will be designated as the residual interest in
the related REMIC, if applicable. See "Certain Federal Income Tax
Consequences."
PROCEEDS OF THE ASSETS IN THE TRUST FUND ARE THE SOLE SOURCE OF PAYMENTS ON
THE CERTIFICATES. THE CERTIFICATES DO NOT REPRESENT AN INTEREST IN OR
OBLIGATION OF THE COMPANY, RESIDENTIAL FUNDING, GMAC MORTGAGE CORPORATION
("GMAC MORTGAGE") OR ANY OF THEIR AFFILIATES. NEITHER THE CERTIFICATES NOR THE
UNDERLYING MORTGAGE LOANS OR MORTGAGE SECURITIES WILL BE GUARANTEED OR INSURED
BY ANY GOVERNMENTAL AGENCY OR INSTRUMENTALITY OR BY THE COMPANY, RESIDENTIAL
FUNDING, GMAC MORTGAGE OR ANY OF THEIR AFFILIATES. NONE OF SUCH ENTITIES WILL
HAVE ANY OBLIGATIONS IN RESPECT OF THE CERTIFICATES, EXCEPT AS EXPRESSLY SET
FORTH HEREIN OR IN THE RELATED PROSPECTUS SUPPLEMENT.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.
Offers of the Certificates may be made through one or more different methods,
including offerings through underwriters, as described under "Methods of
Distribution" and in the related Prospectus Supplement.
There will be no secondary market for any series of Certificates prior to the
offering thereof. There can be no assurance that a secondary market for any of
the Certificates will develop or, if it does develop, that it will continue.
The Certificates will not be listed on any securities exchange.
Retain this Prospectus for future reference. This Prospectus may not be used
to consummate sales of securities offered hereby unless accompanied by a
Prospectus Supplement.
The date of this Prospectus is September 19, 1996.
<PAGE>
ADDITIONAL INFORMATION
The Company has filed with the Commission a Registration Statement under the
Securities Act of 1933, as amended, with respect to the Certificates (the
"REGISTRATION STATEMENT"). The Company is also subject to certain of the
information requirements of the Securities Exchange Act of 1934, as amended
(the "EXCHANGE ACT"), and, accordingly, will file reports thereunder with the
Commission. The Registration Statement and the exhibits thereto, and reports
and other information filed by the Company pursuant to the Exchange Act can be
inspected and copied at the public reference facilities maintained by the
Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, and at certain
of its Regional Offices located as follows: Midwest Regional Office, Citicorp
Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661-2511; and
Northeast Regional Office, 7 World Trade Center, Suite 1300, New York, New
York 10048, at prescribed rates and electronically through the Commission's
Electronic Data Gathering, Analysis and Retrieval system at the Commission's
Web site (http: www.sec.gov).
REPORTS TO CERTIFICATEHOLDERS
Monthly reports which contain information concerning the Trust Fund for a
series of Certificates will be sent by the Master Servicer or the Trustee, to
each holder of record of the Certificates of the related Series. See
"Description of the Certificates--Reports to Certificateholders." The Company
will file with the Commission such periodic reports with respect to the Trust
Fund for a series of Certificates as are required under the Exchange Act, and
the rules and regulations of the Commission thereunder.
INCORPORATION OF CERTAIN INFORMATION BY REFERENCE
With respect to each series of Certificates offered hereby, there are
incorporated herein and in the related Prospectus Supplement by reference all
documents and reports filed or caused to be filed by the Company pursuant to
Section 13(a), 13(c), 14 or 15(d) of the Exchange Act, prior to the
termination of the offering of the related series of Certificates, that relate
specifically to such related series of Certificates. The Company will provide
or cause to be provided without charge to each person to whom this Prospectus
and related Prospectus Supplement is delivered in connection with the offering
of one or more classes of such series of Certificates, upon written or oral
request of such person, a copy of any or all such reports incorporated herein
by reference, in each case to the extent such reports relate to one or more of
such classes of such series of Certificates, other than the exhibits to such
documents, unless such exhibits are specifically incorporated by reference in
such documents. Requests should be directed in writing to Residential Funding
Mortgage Securities II, Inc., 8400 Normandale Lake Boulevard, Suite 700,
Minneapolis, Minnesota 55437, or by telephone at (612) 832-7000.
2
<PAGE>
No dealer, salesman, or any other person has been authorized to give any
information, or to make any representations, other than those contained in
this Prospectus or the related Prospectus Supplement and, if given or made,
such information or representations must not be relied upon as having been
authorized by the Company or any dealer, salesman, or any other person.
Neither the delivery of this Prospectus or the related Prospectus Supplement
nor any sale made hereunder or thereunder shall under any circumstances create
an implication that there has been no change in the information herein or
therein since the date hereof. This Prospectus and the related Prospectus
Supplement are not an offer to sell or a solicitation of an offer to buy any
security in any jurisdiction in which it is unlawful to make such offer or
solicitation.
TABLE OF CONTENTS
<TABLE>
<S> <C>
ADDITIONAL INFORMATION...................................................... 2
REPORTS TO CERTIFICATEHOLDERS............................................... 2
INCORPORATION OF CERTAIN INFORMATION BY REFERENCE........................... 2
SUMMARY OF PROSPECTUS....................................................... 4
RISK FACTORS................................................................ 10
Special Features of the Mortgage Loans..................................... 10
Limitations, Reduction and Substitution of Credit Enhancement.............. 12
Yield and Prepayment Considerations........................................ 13
Limited Liquidity.......................................................... 14
Limited Obligations........................................................ 14
THE MORTGAGE POOLS.......................................................... 14
General.................................................................... 14
Closed-End Loans........................................................... 17
Revolving Credit Loans..................................................... 19
ALLOCATION OF REVOLVING CREDIT LOAN BALANCES................................ 20
MORTGAGE LOAN PROGRAM....................................................... 21
Underwriting Standards..................................................... 21
Qualifications of Sellers.................................................. 24
Representations Relating to Mortgage Loans................................. 25
Subservicing............................................................... 27
DESCRIPTION OF THE CERTIFICATES............................................. 29
General.................................................................... 29
Form of Certificates....................................................... 30
Assignment of Trust Fund Assets............................................ 32
Review of Mortgage Loans................................................... 33
Spread..................................................................... 34
Payments on Mortgage Loans; Deposits to Certificate Account................ 34
Withdrawals from the Custodial Account..................................... 36
Distributions.............................................................. 37
Principal and Interest on the Certificates................................. 37
Advances on Closed-End Loans............................................... 38
Funding Account............................................................ 39
Reports to Certificateholders.............................................. 39
Collection and Other Servicing Procedures.................................. 40
Realization Upon Defaulted Mortgage Loans.................................. 41
Hazard Insurance; Claims Thereunder........................................ 43
DESCRIPTION OF CREDIT ENHANCEMENT........................................... 44
Financial Guaranty Insurance Policy........................................ 45
Letter of Credit........................................................... 45
Special Hazard Insurance Policies.......................................... 46
Bankruptcy Bonds........................................................... 46
Subordination.............................................................. 46
Overcollateralization...................................................... 47
Reserve Funds.............................................................. 48
</TABLE>
<TABLE>
<S> <C>
Maintenance of Credit Enhancement......................................... 48
Reduction or Substitution of Credit Enhancement........................... 49
THE COMPANY................................................................ 50
RESIDENTIAL FUNDING CORPORATION............................................ 50
THE POOLING AND SERVICING AGREEMENT........................................ 50
Servicing and Administration.............................................. 50
Evidence as to Compliance................................................. 51
Certain Matters Regarding the Master Servicer............................. 51
Events of Default......................................................... 52
Rights Upon Event of Default.............................................. 53
Amendment................................................................. 53
Termination; Retirement of Certificates................................... 54
The Trustee............................................................... 55
YIELD AND PREPAYMENT CONSIDERATIONS........................................ 55
CERTAIN LEGAL ASPECTS OF MORTGAGE LOANS AND RELATED MATTERS................ 60
General................................................................... 60
Cooperative Loans......................................................... 61
Tax Aspects of Cooperative Ownership...................................... 62
Foreclosure on Mortgage Loans............................................. 62
Foreclosure on Shares of Cooperatives..................................... 63
Rights of Redemption...................................................... 64
Anti-Deficiency Legislation and Other Limitations on Lenders.............. 65
Environmental Legislation................................................. 66
Enforceability of Certain Provisions...................................... 67
Applicability of Usury Laws............................................... 68
Alternative Mortgage Instruments.......................................... 68
Soldiers' and Sailors' Civil Relief Act of 1940........................... 69
Forfeitures in Drug and RICO Proceedings.................................. 69
Junior Mortgages; Rights of Senior Mortgagees............................. 69
CERTAIN FEDERAL INCOME TAX CONSEQUENCES.................................... 71
General................................................................... 71
REMICs.................................................................... 71
STATE AND OTHER TAX CONSEQUENCES........................................... 87
ERISA CONSIDERATIONS....................................................... 87
Plan Asset Regulations.................................................... 88
Prohibited Transaction Exemptions......................................... 89
Insurance Company General Accounts........................................ 91
Representation From Plans Investing in Certificates Backed by Revolving
Credit Loans or Subordinated Certificates................................ 92
Tax Exempt Investors...................................................... 92
Consultation with Counsel................................................. 92
LEGAL INVESTMENT MATTERS................................................... 93
USE OF PROCEEDS............................................................ 94
METHODS OF DISTRIBUTION.................................................... 94
LEGAL MATTERS.............................................................. 95
FINANCIAL INFORMATION...................................................... 95
INDEX OF PRINCIPAL DEFINITIONS............................................. 96
</TABLE>
3
<PAGE>
SUMMARY OF PROSPECTUS
The following summary is qualified in its entirety by reference to the
detailed information appearing elsewhere in this Prospectus and by reference to
the information with respect to each series of Certificates contained in the
Prospectus Supplement to be prepared and delivered in connection with the
offering of such series. Capitalized terms used in this summary that are not
otherwise defined shall have the meanings ascribed thereto in this Prospectus.
An index indicating where certain terms used herein are defined appears at the
end of this Prospectus.
Securities Offered.......... Home Equity Loan Pass-Through Certificates.
Company..................... Residential Funding Mortgage Securities II, Inc.,
the depositor. See "The Company."
Master Servicer............. The entity identified as Master Servicer in the
related Prospectus Supplement, which may be
Residential Funding Corporation, an affiliate of
the Company ("RESIDENTIAL FUNDING"). See
"Residential Funding Corporation" and "The
Pooling and Servicing Agreement--Certain Matters
Regarding the Master Servicer and the Company."
Certificate Administrator... An entity may be named as the Certificate
Administrator in the related Prospectus
Supplement, if required in addition to or in lieu
of the Master Servicer or Servicer for a series
of Certificates.
Trustee..................... The trustee (the "TRUSTEE") for each series of
Certificates will be specified in the related
Prospectus Supplement.
The Certificates............ Each series of Certificates will represent in the
aggregate the entire beneficial ownership
interest, excluding any interest retained by the
Company or any other entity specified in the
related Prospectus Supplement, in a pool (the
"MORTGAGE POOL") of certain Mortgage Loans or
interests therein (which may include Mortgage
Securities as defined herein), and certain other
assets as described below. Each series of
Certificates will be issued pursuant to a pooling
and servicing agreement among the Company, the
Trustee and the Master Servicer (each, a "POOLING
AND SERVICING AGREEMENT"). As specified in the
related Prospectus Supplement, each series of
Certificates, or class of Certificates in the
case of a series consisting of two or more
classes, may have a stated principal balance, no
stated principal balance or a notional amount and
may be entitled to distributions of interest
based on a specified interest rate or rates
(each, a "PASS-THROUGH RATE"). Each series or
class of Certificates may have a different Pass-
Through Rate, which may be a fixed, variable or
adjustable Pass-Through Rate, or any combination
of two or more of such Pass-Through Rates. The
related Prospectus Supplement will specify the
Pass-Through Rate or Rates for each series or
class of Certificates, or the initial Pass-
Through Rate or Rates and the method for
determining subsequent changes to the Pass-
Through Rate or Rates.
4
<PAGE>
A series may include one or more classes of
Certificates (each, a "STRIP CERTIFICATE")
entitled to (i) principal distributions, with
disproportionate, nominal or no interest
distributions, or (ii) interest distributions,
with disproportionate, nominal or no principal
distributions. In addition, a series may include
classes of Certificates which differ as to
timing, sequential order, priority of payment,
Pass-Through Rate or amount of distributions of
principal or interest or both, or as to which
distributions of principal or interest or both on
any class may be made upon the occurrence of
specified events, in accordance with a schedule
or formula, or on the basis of collections from
designated portions of the Mortgage Pool. In
addition, a series may include one or more
classes of Certificates ("ACCRUAL CERTIFICATES"),
as to which certain accrued interest will not be
distributed but rather will be added to the
principal balance thereof in the manner described
in the related Prospectus Supplement. One or more
classes of Certificates in a series may be
entitled to receive principal payments pursuant
to an amortization schedule under the
circumstances described in the related Prospectus
Supplement.
If so specified in the related Prospectus
Supplement, a series of Certificates may include
one or more classes of Certificates
(collectively, the "SENIOR CERTIFICATES") which
are senior to one or more classes of Certificates
(collectively, the "SUBORDINATE CERTIFICATES") in
respect of certain distributions of principal and
interest and allocations of losses on Mortgage
Loans. See "Description of Credit Enhancement--
Subordination." If so specified in the related
Prospectus Supplement, a series of Certificates
may include one or more classes of Certificates
(collectively, the "MEZZANINE CERTIFICATES")
which are Subordinate Certificates but which are
senior to other classes of Subordinate
Certificates in respect of such distributions or
losses. In addition, certain classes of Senior
Certificates may be senior to other classes of
Senior Certificates in respect of such
distributions or losses. The Certificates will be
issued in fully-registered certificated or book-
entry form in the authorized denominations
specified in the related Prospectus Supplement.
See "Description of the Certificates."
Neither the Certificates nor the underlying
Mortgage Loans or Mortgage Securities will be
guaranteed or insured by any governmental agency
or instrumentality or by the Company, Residential
Funding, GMAC Mortgage Corporation or any of
their affiliates. See "Risk Factors--Limited
Obligations."
The Mortgage Pools.......... As specified in the related Prospectus
Supplement, each Trust Fund will consist
primarily of Revolving Credit Loans or certain
balances thereof or interests therein, or Closed-
End Loans or interests therein, secured by first
or junior liens on one- to four-family
residential properties located in any one of the
50 states, the District of Columbia or the
Commonwealth of Puerto Rico (the "MORTGAGED
5
<PAGE>
PROPERTIES"). All Mortgage Loans will have been
purchased by the Company, either directly or
through Residential Funding, from mortgage loan
originators or sellers who, as specified in the
related Prospectus Supplement, may or may not be
affiliated with the Company including GMAC
Mortgage Corporation of PA and Homecomings
Financial Network, Inc., each affiliates of the
Company. See "Mortgage Loan Program." For a
description of the types of Mortgage Loans that
may be included in the Mortgage Pools, see "The
Mortgage Pools--The Closed End Loans."
With respect to any series of Certificates backed
by Revolving Credit Loans, the related Trust Fund
may include the entire balance of such loans
including Draws made after the Cut-off Date, or
may include only the Trust Balances (as defined
herein) thereof which generally will exclude
Draws made after the Cut-off Date and may exclude
Draws made prior to the Cut-off Date. See
"Allocation of Revolving Credit Loan Balances"
herein.
If specified in the related Prospectus
Supplement, a Trust Fund may include mortgage
pass-through certificates or other instruments
evidencing interests in or secured by Mortgage
Loans ("MORTGAGE SECURITIES"), as described
herein. See "The Mortgage Pools--General" herein.
Interest Distributions...... Except as otherwise specified herein or in the
related Prospectus Supplement, interest on each
class of Certificates of each series, other than
Strip Certificates or Accrual Certificates (prior
to the time when accrued interest becomes payable
thereon), will be remitted at the applicable
Pass-Through Rate on the outstanding principal
balance of such class, on the day specified as a
distribution date for such Series or Class in the
related Prospectus Supplement (each, a
"DISTRIBUTION DATE"). If the Prospectus
Supplement so specifies, interest distributions
on any class of Certificates may be reduced on
account of negative amortization on the Mortgage
Loans, with the Deferred Interest (as defined
herein) allocable to such class added to the
principal balance thereof, which Deferred
Interest will thereafter bear interest at the
applicable Pass-Through Rate. Distributions, if
any, with respect to interest on Strip
Certificates will be made on each Distribution
Date as described herein and in the related
Prospectus Supplement. See "Description of the
Certificates--Distributions." Strip Certificates
that are entitled to distributions of principal
only will not receive distributions in respect of
interest. Interest that has accrued but is not
yet payable on any Accrual Certificates will be
added to the principal balance of such class on
the related Distribution Date, and will
thereafter bear interest at the applicable Pass-
Through Rate. Distributions of interest with
respect to any series of Certificates (or
accruals thereof in the case of Accrual
Certificates), or with respect to one or more
classes included therein, may be reduced to the
extent of interest shortfalls not
6
<PAGE>
covered by principal and interest advances or the
applicable form of credit support, including
shortfalls ("PREPAYMENT INTEREST SHORTFALLS") in
collections of a full month's interest in
connection with prepayments on Closed-End Loans
which are Actuarial Mortgage Loans (as defined
herein). See "Yield and Prepayment
Considerations" and "Description of the
Certificates."
Principal Distributions..... Except as otherwise specified in the related
Prospectus Supplement, principal distributions on
the Certificates of each series will be payable
on each Distribution Date, commencing with the
Distribution Date in the month following the
month in which the Cut-off Date occurs, to the
holders of the Certificates of such series, or of
the class or classes of Certificates then
entitled thereto, on a pro rata basis among all
such Certificates or among the Certificates of
any such class, in proportion to their respective
outstanding principal balances or the percentage
interests represented by such class, in the
priority and manner specified in the related
Prospectus Supplement. Strip Certificates with no
principal balance will not receive distributions
in respect of principal. Distributions of
principal with respect to any class of
Certificates may be reduced to the extent of
certain delinquencies not covered by principal
advances or losses not covered by the applicable
form of credit enhancement. For a series of
Certificates backed by Revolving Credit Loans, as
a result of the payment terms of the Mortgage
Loans or of the Certificate provisions relating
to future Draws, there may be no principal
distributions on such Certificates in any given
month. See "The Mortgage Pools," "Yield and
Prepayment Considerations" and "Description of
the Certificates."
Funding Account............. If so specified in the related Prospectus
Supplement, a portion of the proceeds of the sale
of one or more Classes of Certificates of a
Series or a portion of collections on the
Mortgage Loans in respect of principal may be
deposited in a segregated account to be applied
to acquire additional Mortgage Loans from the
Sellers, subject to the limitations set forth
herein under "Description of the Certificates--
Funding Account." The times and requirements for
the acquisition of such Mortgage Loans will be
set forth in the related Pooling and Servicing
Agreement or other agreement with the Sellers.
Monies on deposit in the Funding Account and not
applied to acquire such additional Mortgage Loans
within the time set forth in the related Pooling
and Servicing Agreement or other applicable
agreement may be treated as principal and applied
in the manner described in the related Prospectus
Supplement.
Yield and Prepayment The Mortgage Loans supporting a series of
Considerations............. Certificates will have unique characteristics
that will affect the yield to maturity and the
rate of payment of principal on such
Certificates. See "Risk Factors" herein and
"Yield and Prepayment Considerations" herein and
in the related Prospectus Supplement.
7
<PAGE>
Credit Enhancement.......... If so specified in the related Prospectus
Supplement, the Trust Fund with respect to any
series of Certificates may include any one or any
combination of a letter of credit, financial
guaranty insurance policy, special hazard
insurance policy, bankruptcy bond, reserve fund,
surety bond or other type of credit support to
provide full or partial coverage for certain
defaults and losses relating to the Mortgage
Loans. Credit support also may be provided in the
form of subordination of one or more classes of
Certificates in a series under which certain
losses are first allocated to any Subordinate
Certificates up to a specified limit or in the
form of Overcollateralization (as defined
herein). Any form of credit enhancement may have
certain limitations and exclusions from coverage
thereunder, which will be described in the
related Prospectus Supplement. Losses not covered
by any form of credit enhancement will be borne
by the holders of the related Certificates (or
certain classes thereof). To the extent not set
forth herein, the amount and types of coverage,
the identification of any entity providing the
coverage, the terms of any subordination and
related information will be set forth in the
Prospectus Supplement relating to a series of
Certificates. See "Description of Credit
Enhancement."
Advances on Closed-End If so specified in the related Prospectus
Loans...................... Supplement, the Master Servicer will be obligated
(pursuant to the terms of the related Mortgage
Securities, if applicable) to make certain
principal and interest advances with respect to
delinquent scheduled payments on the Closed-End
Loans, but only to the extent that the Master
Servicer believes that such amounts will be
recoverable by it. Any such advance made by the
Master Servicer with respect to a Mortgage Loan
is recoverable by it as provided herein under
"Description of the Certificates--Advances on
Closed-End Loans" either from recoveries on the
specific Mortgage Loan or, with respect to any
such advance subsequently determined to be
nonrecoverable, out of funds otherwise
distributable to the holders of the related
series of Certificates.
Optional Termination........ The Master Servicer, the Company or, if specified
in the related Prospectus Supplement, the holder
of the residual interest in a REMIC, may at its
option either (i) effect early retirement of a
series of Certificates through the purchase of
the assets in the related Trust Fund or (ii)
purchase, in whole but not in part, the
Certificates specified in the related Prospectus
Supplement; in each case under the circumstances
and in the manner set forth herein under "The
Pooling and Servicing Agreement--Termination;
Retirement of Certificates" and in the related
Prospectus Supplement.
Rating...................... At the date of issuance, as to each series, each
class of Certificates offered hereby will be
rated at the request of the Company in one of the
four highest rating categories by one or more
nationally
8
<PAGE>
recognized statistical rating agencies (each, a
"RATING AGENCY"). See "Ratings" in the related
Prospectus Supplement.
Legal Investment............
Unless otherwise specified in the related
Prospectus Supplement, the Certificates offered
hereby will not constitute "mortgage related
securities" for purposes of the Secondary
Mortgage Market Enhancement Act of 1984, as
amended ("SMMEA"). See "Legal Investment
Matters."
ERISA Considerations........ A fiduciary of an employee benefit plan and
certain other plans and arrangements, including
individual retirement accounts and annuities,
Keogh plans, and collective investment funds,
insurance company general or separate accounts
and certain other entities in which such plans,
accounts, annuities or arrangements are invested,
which is subject to the Employee Retirement
Income Security Act of 1974, as amended
("ERISA"), or Section 4975 of the Internal
Revenue Code of 1986 (the "CODE"), and any other
person contemplating purchasing a Certificate
with Plan Assets (as defined herein), should
review with its legal counsel whether the
purchase or holding of Certificates could give
rise to a transaction that is prohibited or is
not otherwise permissible either under ERISA or
Section 4975 of the Code. See "ERISA
Considerations" herein and in the related
Prospectus Supplement.
Certain Federal Income Tax
Consequences............... Certificates of each series offered hereby will
constitute "regular interests" or "residual
interests" in a Trust Fund, or a portion thereof,
treated as a REMIC under Sections 860A through
860G of the Code, unless otherwise specified in
the related Prospectus Supplement. See "Certain
Federal Income Tax Consequences" herein and in
the related Prospectus Supplement.
9
<PAGE>
RISK FACTORS
Investors should consider, among other things, the following factors in
connection with the purchase of the Certificates:
SPECIAL FEATURES OF THE MORTGAGE LOANS
Adequacy of Mortgage Collateral
Although all of the Mortgage Loans will be secured by liens on Mortgaged
Properties, such collateral may not provide assurance of repayment of the
Mortgage Loan comparable to that provided under many first lien lending
programs, and the Mortgage Loans (especially those with high Combined Loan-to-
Value ratios) may have risk of repayment characteristics more similar to
unsecured consumer loans.
Since the Mortgage Loans are interests in Revolving Credit Loans or Closed-
End Loans which may be subordinate to the rights of the mortgagee under the
related senior mortgage or mortgages, the proceeds from any liquidation,
insurance or condemnation proceedings will be available to satisfy the
outstanding balance of such Mortgage Loans secured by junior mortgages only to
the extent that the claims of such senior mortgages have been satisfied in
full, including any related foreclosure costs. For Mortgage Loans secured by
junior liens that have low Junior Ratios (as defined herein), foreclosure
costs may be substantial relative to the outstanding balance of the Mortgage
Loan upon default, and therefore the amount of any liquidation proceeds
distributable to Certificateholders may be smaller as a percentage of the
outstanding balance of the Mortgage Loan than would be the case in a typical
pool of first lien residential loans. In addition, the holder of a Revolving
Credit Loan or Closed-End Loan secured by a junior mortgage may not foreclose
on the Mortgaged Property unless it forecloses subject to the senior
mortgages, in which case it must either pay the entire amount due on the
senior mortgages to the senior mortgagees at or prior to the foreclosure sale
or undertake the obligation to make payments on the senior mortgages in the
event the mortgagor is in default thereunder. The Trust Fund will not have any
source of funds to satisfy the senior mortgages or make payments due to the
senior mortgagees, although the Master Servicer or Subservicer may, at its
option, advance such amounts to the extent deemed recoverable and prudent, but
will not be obligated to do so. In the event that such proceeds from a
foreclosure or similar sale of the related Mortgaged Property are insufficient
to satisfy all senior liens and the Mortgage Loan in the aggregate, the Trust
Fund, as the holder of the junior lien, and, accordingly, Holders of one or
more classes of the Certificates are likely to (i) incur losses in
jurisdictions in which a deficiency judgment against the borrower is not
available, or in the Master Servicer's discretion, seeking such judgment is
not advisable and (ii) incur losses if any deficiency judgment obtained is not
realized upon. See "Certain Legal Aspects of Mortgage Loans and Related
Matters."
No assurance can be given that the values of the Mortgaged Properties have
remained or will remain at their levels on the dates of origination of the
related Mortgage Loans. If the residential real estate market should
experience an overall decline in value (including as a result of the general
economic factors discussed below under "Special Features of the Mortgage
Loans--Mortgagor Credit Risks"), any such decline could extinguish the value
of the interest of a junior mortgagee in the Mortgaged Property before having
any adverse effect on the interest of the related senior mortgagees.
With respect to Mortgage Loans secured by junior liens that have high
Combined Loan-to-Value Ratios (as defined herein) or low Junior Ratios, many
circumstances exist, including those described above under which it would be
uneconomical to foreclose on the Mortgaged Property in the event of a default.
For purposes of the foregoing, the actual Junior Ratio for a Mortgage Loan at
any time may be lower than indicated in the Prospectus Supplement as a result
of any reductions in the Stated Principal Balance thereof. In addition, the
actual Combined Loan-to-Value Ratio for a Mortgage Loan at any time may be
higher than indicated in the Prospectus Supplement if such Mortgage Loan is
subject to negative amortization or the value of the Mortgaged Property
declines after the date of origination. In such circumstances, repayment of
the Mortgage Loan would be dependent solely on the credit of the borrower
under the Mortgage Loan (the "MORTGAGOR"), and the ability to obtain repayment
of
10
<PAGE>
the Mortgage Loan may be generally similar to that which would be experienced
if the Mortgage Loan were an unsecured consumer loan. Moreover, while in most
jurisdictions a mortgagee would be permitted to elect to either foreclose or
sue to collect the debt evidenced by the Mortgage Note, in some jurisdictions
that prohibit suits to collect the debt until the mortgagee has sought to
foreclose against the security, the mortgagee may be forced to foreclose first
and obtain a deficiency judgment. In addition, in some jurisdictions, where
the mortgagee has chosen to sue on the debt in lieu of foreclosure, the
mortgagee will be barred from foreclosing against the security. See "--Anti-
Deficiency Legislation and other Limitations on Lenders."
Mortgagor Credit
As a result of the foregoing considerations, for certain types of Mortgage
Loans, the underwriting standards and procedures applicable thereto, as well
as the repayment prospects thereof, may be more dependent on the
creditworthiness of the Mortgagor and less dependent on the adequacy of the
Mortgaged Property as collateral than would be the case under many first lien
lending programs. As to such Mortgage Loans, future changes in the Mortgagor's
economic circumstances will have a significant effect on the likelihood of
repayment.
This is particularly so with respect to Revolving Credit Loans, since
additional Draws may be made by the Mortgagor in the future up to the
applicable Credit Limit. Although Revolving Credit Loans are generally subject
to provisions whereby the Credit Limit may be reduced as a result of a
material adverse change in the Mortgagor's economic circumstances, the
Servicer or Master Servicer generally will not monitor for such changes and
may not become aware of them until after the Mortgagor has defaulted. Under
certain circumstances, a Mortgagor may draw his entire Credit Limit in
response to personal financial needs resulting from an adverse change in
circumstances. For a series of Certificates backed by the Trust Balances of
Revolving Credit Loans, even though the Trust Balance of a Revolving Credit
Loan will not increase as a result of Draws after the Certificates are issued,
the foregoing considerations are relevant because such Trust Balance will
share pro rata in any losses incurred on such Revolving Credit Loan unless
otherwise specified in the related Prospectus Supplement.
Future changes in a Mortgagor's economic circumstances may result from a
variety of unforeseeable personal factors, including loss of employment,
reduction in income, illness and divorce. Any increase in prevailing market
interest rates may adversely affect a Mortgagor, by increasing debt service on
any Revolving Credit Loans, on Closed-End Loans having adjustable rates or on
any other floating rate debt of the Mortgagor. In addition, for any Revolving
Credit Loans or Closed-End Loans secured by junior mortgages, changes in the
payment terms of any related senior mortgage loan may adversely affect the
Mortgagor's ability to pay principal and interest on such senior mortgage
loan. For example, such changes may result if the senior mortgage loan is an
adjustable rate loan and the interest rate thereon increases, which may occur
with or without an increase in prevailing market interest rates if the
increase is due to the phasing out of a reduced initial rate. Specific
information about such senior mortgage loans, other than the amount thereof at
origination of the corresponding Mortgage Loan, generally will not be
available and will not be included in the related Prospectus Supplement.
General economic conditions, both on a national and regional basis, will
also have an impact on the ability of Mortgagors to repay the Mortgage Loans.
Certain geographic regions of the United States from time to time will
experience weaker regional economic conditions and housing markets, and,
consequently, will experience higher rates of loss and delinquency than will
be experienced on mortgage loans generally. For example, a region's economic
condition and housing market may be directly, or indirectly, adversely
affected by natural disasters or civil disturbances such as earthquakes,
hurricanes, floods, eruptions or riots. The economic impact of any of these
types of events may also be felt in areas beyond the region immediately
affected by the disaster or disturbance. The Mortgage Loans underlying a
series of Certificates may be concentrated in these regions, and such
concentration may present risk considerations in addition to those generally
present for similar mortgage-backed securities without such concentration. Any
change in the deductibility for federal income tax purposes of interest
payments on home equity loans may also have an impact on the ability of
Mortgagors to repay the Mortgage Loans.
11
<PAGE>
Mortgage Loan Characteristics
Certain of the types of Mortgage Loans which may be included in the Mortgage
Pools may involve additional uncertainties not present in traditional types of
mortgage loans, or in home equity loans originated under other programs.
For example, certain of the Closed-End Loans may provide for escalating or
variable payments by the Mortgagor, as to which the Mortgagor is generally
qualified on the basis of the initial payment amount, or may be ARM Loans with
an initial Mortgage Rate less than the sum of the then-applicable Index and
Gross Margin, as to which the Mortgagor generally will be qualified on the
basis of the Mortgage Rate in effect at origination. In some instances,
Mortgagors may find it difficult to make their loan payments as their monthly
payments increase and thus, the likelihood of default will increase. An even
greater likelihood of default may exist as monthly payments increase with a
Mortgage Loan secured by a second lien if monthly payments are also increasing
on the related first lien ARM Loan. Some of the Closed-End Loans may be
Balloon Loans, and the ability of the Mortgagor to pay the related Balloon
Amount may depend on the Mortgagor's ability to refinance the Mortgage Loan or
to sell the related Mortgaged Property. In addition, in the case of Closed-End
Loans that are subject to negative amortization, due to the addition to the
principal balance of Deferred Interest, the principal balances of such
Mortgage Loans could be increased to an amount equal to or in excess of the
value of the underlying Mortgaged Properties, thereby increasing the
likelihood of default.
With respect to Revolving Credit Loans, except for certain programs under
which the Draw Period is less than the full term thereof, required minimum
monthly payments are generally equal to or not significantly larger than the
amount of interest currently accruing thereon, and therefore are not expected
to significantly amortize the outstanding principal amount of such Mortgage
Loan prior to maturity, which amount may include substantial Draws recently
made. As a result, a borrower will generally be required to pay a substantial
principal amount at the maturity of a Revolving Credit Loan. The ability of a
borrower to make such a payment may be dependent on the ability to obtain
refinancing of the balance due on such Revolving Credit Loan or to sell the
related Mortgaged Property. Furthermore, Revolving Credit Loans generally have
adjustable rates that are subject to much higher maximum rates than typically
apply to adjustable rate first mortgage loans, and which may be as high as
applicable usury limitations. Mortgagors under Revolving Credit Loans are
generally qualified based on an assumed payment which reflects either the
initial interest rate or a rate significantly lower than the maximum rate. An
increase in the interest rate over the Mortgage Rate applicable at the time
the Revolving Credit Loan was originated may have an adverse effect on the
Mortgagor's ability to pay the required monthly payment. In addition, an
increase in prevailing market interest rates may reduce the borrower's ability
to obtain refinancing and to pay the balance of a Revolving Credit Loan at its
maturity.
To the extent that any losses are incurred on any of the Mortgage Loans that
are not covered by the applicable credit enhancement, holders of Certificates
of the series evidencing interests in the related Mortgage Pool (or certain
classes thereof) will bear all risk of such losses resulting from default by
Mortgagors.
LIMITATIONS, REDUCTION AND SUBSTITUTION OF CREDIT ENHANCEMENT
With respect to each series of Certificates, credit enhancement may be
provided to cover delinquencies and losses on the underlying Mortgage Loans,
subject to any applicable limitations. Credit enhancement will be provided in
one or more of the forms referred to herein, including, but not limited to:
subordination of other classes of Certificates of the same series;
Overcollateralization; a Financial Guaranty Insurance Policy; a Letter of
Credit; a Special Hazard Insurance Policy; a Bankruptcy Bond; a Reserve Fund;
a Surety Bond; or any combination thereof. See "Description of Credit
Enhancement" herein.
As to any series of Certificates, the amount of coverage under the
applicable credit enhancement may be limited in amount, and if limited may be
subject to periodic reduction in accordance with a schedule or formula.
Furthermore, such credit enhancement may provide only very limited coverage as
to certain types of losses or risks, and may provide no coverage as to certain
other types of losses or risks. For any type of credit enhancement which is
generated in whole or in part by cash flows on the underlying Mortgage Loans
(as may be
12
<PAGE>
the case for a Reserve Fund or Overcollateralization, for example), the amount
of coverage provided thereby may be adversely affected under a variety of
scenarios by factors such as the prepayment and draw experience of the
Mortgage Loans, changes in the Mortgage Rates or Gross Margins applicable to
the Mortgage Loans pursuant to the terms thereof, and changes in the
relationship between the Mortgage Rates on the Mortgage Loans and the Pass-
Through Rates on the Certificates (which changes may result, in part, from
changes in the relationship between different indexes respectively used to
determine the Mortgage Rates and the Pass-Through Rates). In the event losses
exceed the amount of coverage provided by any credit enhancement or losses of
a type not covered by any credit enhancement occur, such losses will be borne
by the holders of the related Certificates (or certain classes thereof).
The Master Servicer will generally be permitted to reduce, terminate or
substitute all or a portion of the credit enhancement for any series of
Certificates, if the applicable Rating Agency, as set forth in the related
Prospectus Supplement, indicates that the then-current rating thereof will not
be adversely affected. The rating of any series of Certificates by any Rating
Agency may be lowered following the initial issuance thereof as a result of
the downgrading or nonperformance of the obligations of any applicable credit
support provider, or as a result of losses on the related Mortgage Loans in
excess of the levels contemplated by such Rating Agency at the time of its
initial rating analysis. None of the Company, the Master Servicer, GMAC
Mortgage or any of their affiliates will have any obligation to replace or
supplement any credit enhancement, or to take any other action to maintain any
rating of any series of Certificates. See "Description of Credit Enhancement--
Reduction or Substitution of Credit Enhancement."
YIELD AND PREPAYMENT CONSIDERATIONS
The yield to maturity of the Certificates of each series will depend on the
rate and timing of principal payments (including payments in excess of
required installments, prepayments or terminations, liquidations and
repurchases) on the Mortgage Loans, the rate and timing of Draws in the case
of Revolving Credit Loans, and the price paid by Certificateholders. Such
yield may be adversely affected by a higher or lower than anticipated rate of
principal payments (or Draws if applicable) on the related Mortgage Loans. The
yield to maturity on any Strip Certificates will be extremely sensitive to the
rate and timing of principal payments (or Draws if applicable) on the related
Mortgage Loans. In addition, the yield to maturity on certain other types of
classes of Certificates, including Accrual Certificates, Certificates with a
Pass-Through Rate which fluctuates inversely with an index or certain other
classes in a series including more than one class of Certificates, may be
relatively more sensitive to the rate and timing of principal payments (or
Draws if applicable) on the related Mortgage Loans than other classes of
Certificates. Principal payments (or Draws if applicable) are influenced by a
number of factors, including prevailing market interest rates, national and
regional economic conditions and changes in Mortgagors' personal and economic
circumstances. See "Yield and Prepayment Considerations" herein. The yield to
maturity of the Certificates of each series will also be affected by the rate
and timing of defaults on the related Mortgage Loans. See "Risk Factors--
Special Features of the Mortgage Loans" above.
The yield to maturity of the Certificates of any series, or the rate and
timing of principal payments (or Draws if applicable) on the related Mortgage
Loans, may be affected by a wide variety of specific terms and conditions
applicable to the respective programs under which the Mortgage Loans were
originated. For example, Revolving Credit Loans may provide for future Draws
to be made only in specified minimum amounts, or alternatively may permit
Draws to be made by check or through a credit card in any amount. A pool of
Revolving Credit Loans subject to the latter provisions may be likely to
remain outstanding longer with a higher aggregate principal balance than a
pool of Revolving Credit Loans with the former provisions, because of the
relative ease of making new Draws. Furthermore, Revolving Credit Loans may
provide for interest rate changes on a daily or monthly basis, or may have
Gross Margins that may vary under certain circumstances over the term of the
loan. In extremely high market interest rate scenarios, Certificates backed by
Revolving Credit Loans with adjustable rates subject to substantially higher
maximum rates than typically apply to adjustable rate first mortgage loans may
experience rates of default and liquidation substantially higher than those
that have been experienced on other adjustable rate mortgage loan pools.
13
<PAGE>
For any series of Certificates backed by Revolving Credit Loans, provisions
governing whether future Draws on the Revolving Credit Loans will be included
in the Trust Fund will have a significant effect on the rate and timing of
principal distributions on the Certificates. For a series of Certificates
backed by the Trust Balances of Revolving Credit Loans, the specific
provisions applicable to the allocation of payments, Draws and losses on the
Revolving Credit Loans between the Trust Balances and the Excluded Balances
thereof will also have a significant effect on the rate and timing of
principal distributions on the Certificates.
LIMITED LIQUIDITY
There can be no assurance that a secondary market for the Certificates of
any series will develop or, if it does develop, that it will provide
Certificateholders with liquidity of investment or that it will continue for
the life of the Certificates of any series. Although the Prospectus Supplement
for any series of Certificates may indicate that an underwriter specified
therein intends to establish a secondary market in such Certificates, no
underwriter will be obligated to do so. The Certificates will not be listed on
any securities exchange.
LIMITED OBLIGATIONS
The Certificates will not represent an interest in or obligation of the
Company, Residential Funding, GMAC Mortgage or any of their affiliates. The
only obligations of the foregoing entities with respect to the Certificates,
the Mortgage Loans or any Mortgage Securities will be the obligations (if any)
of Residential Funding pursuant to certain limited representations and
warranties made with respect to the Mortgage Loans, the obligation of
Residential Funding (or such other entity specified in the related Prospectus
Supplement) to advance funds to Mortgagors in respect of Draws on Revolving
Credit Loans (if applicable), the servicing obligations of Residential Funding
as Master Servicer (if applicable) under the related Pooling and Servicing
Agreement (including its limited obligation to make certain Advances, if
applicable, in the event of delinquencies on the Mortgage Loans, but only to
the extent deemed recoverable) and pursuant to the terms of any Mortgage
Securities, and, if and to the extent expressly described in the related
Prospectus Supplement, certain limited obligations of Residential Funding in
connection with an agreement to purchase or act as remarketing agent with
respect to a Convertible Mortgage Loan upon conversion to a fixed rate. If an
affiliate of the Company has originated any Mortgage Loan, such affiliate will
only have an obligation with respect to the representations and warranties of
the Seller, as described herein. Neither the Certificates nor the underlying
Mortgage Loans or Mortgage Securities will be guaranteed or insured by any
governmental agency or instrumentality, or by the Company, Residential
Funding, GMAC Mortgage or any of their affiliates. Proceeds of the assets
included in the related Trust Fund (including the Mortgage Loans or Mortgage
Securities and any form of credit enhancement) will be the sole source of
payments on the Certificates, and there will be no recourse to the Company,
Residential Funding, GMAC Mortgage or any other entity in the event that such
proceeds are insufficient or otherwise unavailable to make all payments
provided for under the Certificates.
THE MORTGAGE POOLS
GENERAL
Unless otherwise specified in the related Prospectus Supplement, each
Mortgage Pool will consist primarily of Mortgage Loans, or certain balances
thereof, excluding any interest retained by the Company or any other entity
specified in the Prospectus Supplement, evidenced by promissory notes (the
"MORTGAGE NOTES") secured by mortgages or deeds of trust or other similar
security instruments creating first or junior liens on one- to four-family
residential properties, or interests in such Mortgage Loans (which may include
Mortgage Securities). The Mortgage Loans will either be (i) Closed-End Loans
or (ii) Revolving Credit Loans. The Mortgaged Properties will consist
primarily of owner-occupied attached or detached one-family dwelling units,
two- to four-family dwelling units, condominiums, townhouses, row houses,
individual units in planned-unit developments and certain other dwelling
units, and the fee, leasehold or other interests in the underlying real
property. The Mortgaged Properties may include vacation, second and non-owner-
occupied homes. If specified in the related
14
<PAGE>
Prospectus Supplement relating to a series of Certificates, a Mortgage Pool
may contain cooperative apartment loans ("COOPERATIVE LOANS") evidenced by
promissory notes ("COOPERATIVE NOTES") secured by security interests in shares
issued by Cooperatives and in the related proprietary leases or occupancy
agreements granting exclusive rights to occupy specific dwelling units in the
related buildings. As used herein, unless the context indicates otherwise,
"MORTGAGE LOANS" includes Cooperative Loans, "MORTGAGED PROPERTIES" includes
shares in the related Cooperative and the related proprietary leases or
occupancy agreements securing Cooperative Notes, "MORTGAGE NOTES" includes
Cooperative Notes and "MORTGAGES" includes a security agreement with respect
to a Cooperative Note. In connection with a series of Certificates backed by
Revolving Credit Loans, if the related Prospectus Supplement indicates that
the Mortgage Pool consists of certain balances of such Revolving Credit Loans,
then the term "MORTGAGE LOANS" as used herein refers only to such balances
where the context so requires.
Each Mortgage Loan will be selected by the Company for inclusion in a
Mortgage Pool from among those purchased by the Company, either directly or
through its affiliates, including Residential Funding, Homecomings Financial
Network, Inc. and GMAC Mortgage Corporation of PA ("AFFILIATED SELLERS"), or
from banks, savings and loan associations, mortgage bankers, investment
banking firms, the FDIC and other mortgage loan originators or sellers not
affiliated with the Company ("UNAFFILIATED SELLERS"; Unaffiliated Sellers and
Affiliated Sellers are collectively referred to herein as "SELLERS"), all as
described below under "Mortgage Loan Program." If a Mortgage Pool is composed
of Mortgage Loans acquired by the Company directly from Sellers other than
Residential Funding, the related Prospectus Supplement will specify the extent
of Mortgage Loans so acquired. The characteristics of the Mortgage Loans are
as described in the related Prospectus Supplement. Other mortgage loans
available for purchase by the Company may have characteristics which would
make them eligible for inclusion in a Mortgage Pool but were not selected for
inclusion in such Mortgage Pool.
Under certain circumstances, the Mortgage Loans will be delivered either
directly or indirectly to the Company by one or more Sellers identified in the
related Prospectus Supplement, concurrently with the issuance of the related
series of Certificates (a "DESIGNATED SELLER TRANSACTION"). Such Certificates
may be sold in whole or in part to any such Seller in exchange for the related
Mortgage Loans, or may be offered under any of the other methods described
herein under "Methods of Distribution." The related Prospectus Supplement for
a Mortgage Pool composed of Mortgage Loans acquired by the Company pursuant to
a Designated Seller Transaction will generally include information, provided
by the related Seller (the "DESIGNATED SELLER"), about the Designated Seller,
the Mortgage Loans and the underwriting standards applicable to the Mortgage
Loans. None of the Company, Residential Funding, GMAC Mortgage or any of their
affiliates will make any representation or warranty with respect to such
Mortgage Loans, or any representation as to the accuracy or completeness of
such information provided by the Seller.
Any Seller (including any Designated Seller) or Residential Funding may
retain or acquire any Excluded Balances with respect to any related Revolving
Credit Loans, or any loan secured by a mortgage senior or subordinate to any
Mortgage Loan included in any Mortgage Pool.
If specified in the related Prospectus Supplement, the Trust Fund underlying
a series of Certificates may include Mortgage Securities. The Mortgage
Securities may have been issued previously by the Company or an affiliate
thereof, a financial institution or other entity engaged generally in the
business of mortgage lending or a limited purpose corporation organized for
the purpose of, among other things, acquiring and depositing mortgage loans
into such trusts, and selling beneficial interests in such trusts. Except as
otherwise set forth in the related Prospectus Supplement, such Mortgage
Securities will be generally similar to Certificates offered hereunder. As to
any such series of Certificates, the related Prospectus Supplement will
include a description of such Mortgage Securities and any related credit
enhancement, and the Mortgage Loans underlying such Mortgage Securities will
be described together with any other Mortgage Loans included in the Mortgage
Pool relating to such series. As to any such series of Certificates, as used
herein the term "MORTGAGE POOL" includes the Mortgage Loans underlying such
Mortgage Securities. Notwithstanding any other reference herein to the Master
Servicer, with respect to a series of Certificates as to which the Trust Fund
includes Mortgage Securities, the entity that services and administers such
Mortgage Securities on behalf of the holders of such Certificates may be
referred to as the
15
<PAGE>
"MANAGER," if so specified in the related Prospectus Supplement. Unless
otherwise specified in the related Prospectus Supplement, Residential Funding
initially will act as Manager with respect to such Mortgage Securities as well
as the related Certificates, and references herein to advances to be made and
other actions to be taken by the Master Servicer in connection with the
Mortgage Loans may include such advances made and other actions taken pursuant
to the terms of such Mortgage Securities.
The Prospectus Supplement for each series of Certificates will contain
information as to the type of Mortgage Loans which will be included in the
related Mortgage Pool. Each Prospectus Supplement applicable to a series of
Certificates will include certain information, generally as of the Cut-off
Date and to the extent then available to the Company, on an approximate basis,
as to (i) the aggregate principal balance of the Mortgage Loans, (ii) the type
of property securing the Mortgage Loans and related lien priority, (iii) the
original or modified terms to maturity of the Mortgage Loans, (iv) the range
of principal balances of the Closed-End Loans at origination or modification,
(v) the earliest origination or modification date and latest maturity date of
the Mortgage Loans, (vi) the Loan-to-Value Ratios or Combined Loan-to-Value
Ratios of the Mortgage Loans, as applicable, (vii) the Mortgage Rate or range
of Mortgage Rates borne by the Mortgage Loans, (viii) if the Mortgage Loans
are ARM Loans or Revolving Credit Loans, the applicable Index, the range of
Gross Margins, the weighted average Gross Margin, the frequency of adjustments
and maximum loan rate, (ix) the geographical distribution of the Mortgaged
Properties, (x) the percent of ARM Loans, (xi) if the Mortgage Loans are
Revolving Credit Loans, the aggregate Credit Limits of the related Credit Line
Agreements and (xii) if applicable, the weighted average Junior Ratio and
Credit Utilization Rate. A Current Report on Form 8-K will be available upon
request to holders of the related series of Certificates and will be filed,
together with the related Pooling and Servicing Agreement, with the Securities
and Exchange Commission (the "COMMISSION") within fifteen days after the
initial issuance of such Certificates. The composition and characteristics of
a Mortgage Pool containing Revolving Credit Loans may change from time to time
as a result of any Draws made after the related Cut-off Date under the related
Credit Line Agreements that are included in the Mortgage Pool. In the event
that Mortgage Loans are added to or deleted from the Trust Fund after the date
of the related Prospectus Supplement other than as a result of any such Draws,
such addition or deletion will be noted in the Current Report on Form 8-K.
With respect to each Mortgage Loan, the "COMBINED LOAN-TO-VALUE RATIO" or
"CLTV" generally will be the ratio, expressed as a percentage, of the sum of
(i) the greater of the Cut-off Date Principal Balance or the Credit Limit, if
applicable, and (ii) the principal balance of any related senior mortgage loan
at origination of such Mortgage Loan together with any mortgage loan
subordinate thereto, to the lesser of (x) the appraised value of the related
Mortgaged Property determined in the appraisal used in the origination of such
Mortgage Loan and (y) if applicable under the corresponding program, the sales
price of each Mortgaged Property. With respect to each Mortgage Loan, the
"JUNIOR RATIO" generally will be the ratio, expressed as a percentage, of the
greater of the Cut-off Date Principal Balance or the Credit Limit, if
applicable, of such Mortgage Loan to the sum of (i) the greater of the Cut-off
Date Principal Balance or the Credit Limit, if applicable, of such Mortgage
Loan and (ii) the principal balance of any related senior mortgage loan at
origination of such Mortgage Loan. The "CREDIT UTILIZATION RATE" is determined
by dividing the Cut-off Date Principal Balance of a Revolving Credit Loan by
the Credit Limit of the related Credit Line Agreement.
The Company will cause the Mortgage Loans or Trust Balances thereof
constituting each Mortgage Pool (or Mortgage Securities evidencing interests
therein) to be assigned to the Trustee named in the related Prospectus
Supplement, for the benefit of the holders of all of the Certificates of a
series. The Master Servicer named in the related Prospectus Supplement will
service the Mortgage Loans, either directly or through other mortgage
servicing institutions ("SUBSERVICERS"), pursuant to a Pooling and Servicing
Agreement and will receive a fee for such services. See "Mortgage Loan
Program" and "Description of the Certificates." With respect to those Mortgage
Loans serviced by the Master Servicer through a Subservicer, the Master
Servicer will remain liable for its servicing obligations under the related
Pooling and Servicing Agreement as if the Master Servicer alone were servicing
such Mortgage Loans. In addition to or in lieu of the Master Servicer for a
series of Certificates, the related Prospectus Supplement may identify a
certificate administrator (the "CERTIFICATE ADMINISTRATOR") for the Trust
Fund. The Certificate Administrator may be an affiliate of the Company. All
16
<PAGE>
references herein to "Master Servicer" and any discussions of the servicing
and administration functions of the Master Servicer will also apply to the
Certificate Administrator to the extent applicable.
The Company's assignment of the Mortgage Loans or the Trust Balances to the
Trustee will be without recourse. See "Description of the Certificates--
Assignment of Trust Fund Assets." The Master Servicer's obligations with
respect to the Mortgage Loans will consist principally of its contractual
servicing obligations under the related Pooling and Servicing Agreement
(including its obligation to enforce certain purchase obligations of
Residential Funding or any Designated Seller and other obligations of
Subservicers, as described herein under "Mortgage Loan Program--
Representations Relating to Mortgage Loans," and "--Subservicing" and
"Description of the Certificates--Assignment of Trust Fund Assets," and its
obligation to make certain Advances, if applicable, in the event of
delinquencies in payments on or with respect to the Mortgage Loans in amounts
described herein under "Description of the Certificates--Advances on Closed-
End Loans") or pursuant to the terms of any Mortgage Securities. With respect
to Revolving Credit Loans, Residential Funding (or such other entity specified
in the related Prospectus Supplement) will be obligated to advance funds to
Mortgagors in respect of Draws made after the related Cut-off Date. The
obligation of the Master Servicer to make principal and interest advances on
the Closed-End Loans in certain circumstances will be limited to amounts which
the Master Servicer believes ultimately would be reimbursable out of the
proceeds of liquidation of the Mortgage Loans or any applicable form of credit
support. See "Description of the Certificates--Advances on Closed-End Loans."
The proceeds of the Mortgage Loans may be used by the borrower to purchase
or improve the related Mortgaged Properties, may be retained by the related
Mortgagors or may be used for purposes unrelated to such Mortgaged Properties.
A Mortgaged Property securing a Mortgage Loan may be subject to the senior
liens of one or more conventional mortgage loans at the time of origination
and may be subject to one or more junior liens at the time of origination or
thereafter. A mortgage loan secured by any such junior lien or senior lien
will likely not be included in the related Mortgage Pool, and the Company, an
affiliate of the Company or an Unaffiliated Seller may have an interest in
such mortgage loan. Since the Mortgage Loans are primarily Revolving Credit
Loans and Closed-End Loans secured by junior liens, such loans generally will
not be required by the Company to be covered by a primary mortgage guaranty
insurance policy insuring against default on such Mortgage Loan.
CLOSED-END LOANS
Unless otherwise specified below or in the related Prospectus Supplement,
all of the Closed-End Loans in a Mortgage Pool will (i) be secured by
Mortgaged Properties located in any of the 50 states, the District of Columbia
or the Commonwealth of Puerto Rico and (ii) be of only one type of the
following types of mortgage loans described or referred to in paragraphs
numbered (1) through (5):
(1) Fixed-rate, fully-amortizing Closed-End Loans providing for level
monthly payments of principal and interest and terms to maturity of
generally 5, 10 or 15 years at origination or modification as specified in
the related Prospectus Supplement;
(2) Fully-amortizing adjustable-rate Closed-End Loans ("ARM LOANS")
having an original or modified term to maturity of not more than 30 years
with a related interest rate (a "MORTGAGE RATE") which generally adjusts
initially after a specified period subsequent to the initial payment date,
and thereafter at either one-month, six-month, one-year or other intervals
(with corresponding adjustments in the amount of monthly payments) over the
term of the mortgage loan to equal the sum of a fixed percentage set forth
in the related Mortgage Note (the "GROSS MARGIN") and an index*. The
related Prospectus Supplement will
- --------
* The index (the "INDEX") for a particular Mortgage Pool will be specified in
the related Prospectus Supplement and may include one of the following
indexes: (i) the weekly average yield on U.S. Treasury securities adjusted to
a constant maturity of either six months or one year, (ii) the weekly auction
average investment yield of U.S. Treasury bills of six months, (iii) the daily
Bank Prime Loan rate made available by the Federal Reserve Board, (iv) the
cost of funds of member institutions for the Federal Home Loan Bank of San
Francisco, (v) the interbank offered rates for U.S. dollar deposits in the
London market, each calculated as of a date prior to each scheduled interest
rate adjustment date which will be specified in the related Prospectus
Supplement or (vi) the weekly average of secondary market interest rates on
six-month negotiable certificates of deposit.
17
<PAGE>
set forth the relevant index and the highest, lowest and weighted average
Gross Margin with respect to the ARM Loans in the related Mortgage Pool.
The related Prospectus Supplement will also indicate any periodic or
lifetime limitations on changes in any per annum Mortgage Rate at the time
of any adjustment. If specified in the related Prospectus Supplement, an
ARM Loan may include a provision that allows the Mortgagor to convert the
adjustable Mortgage Rate to a fixed rate at specified times during the term
of such ARM Loan;
(3) Negatively-amortizing adjustable-rate Closed-End Loans having
original or modified terms to maturity of not more than 30 years with
Mortgage Rates which generally adjust initially on the payment date
referred to in the related Prospectus Supplement, and thereafter monthly on
each payment date to equal the sum of the Gross Margin and the index. The
scheduled monthly payment will be adjusted as and when described in the
related Prospectus Supplement to an amount that would fully amortize the
mortgage loan over its remaining term on a level debt service basis;
provided that increases in the scheduled monthly payment may be subject to
certain limitations as specified in the related Prospectus Supplement. If
an adjustment to the Mortgage Rate on a mortgage loan causes the amount of
interest accrued thereon in any month to exceed the scheduled monthly
payment on such mortgage loan, the resulting amount of interest that has
accrued but is not then payable ("DEFERRED INTEREST") will be added to the
principal balance of such mortgage loan;
(4) Balloon mortgage loans ("BALLOON LOANS"), which are fixed-rate
Closed-End Loans having original or modified terms to maturity of generally
15 years as described in the related Prospectus Supplement, with level
monthly payments of principal and interest based on a 30-year amortization
schedule. The amount of the monthly payment will remain constant until the
maturity date, upon which date the full outstanding principal balance on
such Balloon Loan will be due and payable (such amount, the "BALLOON
AMOUNT"); or
(5) Similar Mortgage Loans with other payment characteristics as
described in the related Prospectus Supplement.
If so specified in the related Prospectus Supplement, a portion of the
Closed-End Loans underlying a Series of Certificates may provide for payments
that are allocated to principal and interest according to the daily simple
interest method (a "SIMPLE INTEREST MORTGAGE LOAN"). Other Closed-End Loans
may provide for payments in monthly installments including interest equal to
one-twelfth of the applicable Mortgage Rate times the unpaid principal
balance, with any remainder of such payment applied to principal (an
"ACTUARIAL MORTGAGE LOAN").
A Simple Interest Mortgage Loan provides the amortization of the amount
financed under the Mortgage Loan over a series of equal monthly payments
(except, in the case of a Balloon Loan, the final payment). Each monthly
payment consists of an installment of interest which is calculated on the
basis of the outstanding principal balance of the Mortgage Loan multiplied by
the stated Mortgage Rate and further multiplied by a fraction, the numerator
of which is the number of days in the period elapsed since the preceding
payment of interest was made and the denominator of which is the number of
days in the annual period for which interest accrues on such Mortgage Loan. As
payments are received under a Simple Interest Mortgage Loan, the amount
received is applied first to interest accrued to the date of payment and then
the remaining amount is applied to pay any unpaid fees and then to reduce the
unpaid principal balance. Accordingly, if a borrower pays a fixed monthly
installment on a Simple Interest Mortgage Loan before its scheduled due date,
the portion of the payment allocable to interest for the period since the
preceding payment was made will be less than it would have been had the
payment been made as scheduled, and the portion of the payment applied to
reduce the unpaid principal balance will be correspondingly greater.
Conversely, if a borrower pays a fixed monthly installment after its scheduled
due date, the portion of the payment allocable to interest for the period
since the preceding payment was made will be greater than it would have been
had the payment been made as scheduled, and the remaining portion, if any, of
the payment applied to reduce the unpaid principal balance will be
correspondingly less. If each scheduled payment under a Simple Interest
Mortgage Loan is made on or prior to its scheduled due date, the principal
balance of the Mortgage Loan will amortize in the manner described above.
However, if the
18
<PAGE>
borrower consistently makes scheduled payments after the scheduled due date,
the Mortgage Loan will amortize more slowly than scheduled. If a Simple
Interest Mortgage Loan is prepaid, the borrower is required to pay interest
only to the date of prepayment. Such variable allocations among principal and
interest of a Simple Interest Mortgage Loan may effect the distributions of
principal and interest on the Certificates, as specified in the related
Prospectus Supplement.
If provided for in the related Prospectus Supplement, a Mortgage Pool may
contain ARM Loans which allow the Mortgagors to convert the adjustable rates
on such Mortgage Loans to a fixed rate at some point during the life of such
Mortgage Loans (each such Mortgage Loan, a "CONVERTIBLE MORTGAGE LOAN"),
generally, not later than six to ten years subsequent to the date of
origination, depending upon the length of the initial adjustment period. If
specified in the related Prospectus Supplement, upon any conversion, the
Company will repurchase or Residential Funding, the applicable Designated
Seller or a third party will purchase the converted Mortgage Loan as and to
the extent set forth in the related Prospectus Supplement. Alternatively, if
specified in the related Prospectus Supplement, the Company or Residential
Funding (or another party specified therein) may agree to act as remarketing
agent with respect to such converted Mortgage Loans and, in such capacity, to
use its best efforts to arrange for the sale of converted Mortgage Loans under
specified conditions. Upon the failure of any party so obligated to purchase
any such converted Mortgage Loan, the inability of any remarketing agent to
arrange for the sale of the converted Mortgage Loan and the unwillingness of
such remarketing agent to exercise any election to purchase the converted
Mortgage Loan for its own account, the related Mortgage Pool will thereafter
include both fixed rate and adjustable rate Mortgage Loans. If so specified in
the related Prospectus Supplement, the inclusion of a converted Mortgage Loan
in a Mortgage Pool may adversely affect the holders of the Certificates by
restricting the ability of the related Pass-Through Rate or Rates to adjust to
the extent intended by the adjustable Pass-Through Rate.
REVOLVING CREDIT LOANS
The Revolving Credit Loans will be originated pursuant to loan agreements
(the "CREDIT LINE AGREEMENTS"). Interest on each Revolving Credit Loan will be
calculated according to the daily simple interest method, and with respect to
each Revolving Credit Loan, the billing cycle generally will be the calendar
month preceding a Due Date. Each Revolving Credit Loan will have a Mortgage
Rate that is subject to adjustment on the day specified in the related
Mortgage Note, which may be daily or monthly, equal to the sum of (a) the
Index on such day as specified in the related Prospectus Supplement, and (b)
the Gross Margin specified in the related Mortgage Note (which may vary under
circumstances if so specified in the related Prospectus Supplement), subject
to the Maximum Rate set forth in the Mortgage Note and the maximum rate
permitted by applicable law. Notwithstanding the forgoing, if so specified in
the related Prospectus Supplement, a Mortgage Loan may have an introductory
rate that is lower than the rate that would be in effect if the applicable
Index and Gross Margin were used to determine the Mortgage Rate and as a
result of such introductory rate, interest distributions on the Certificates
may initially be lower than expected. See "Risk Factors--Special Features of
the Mortgage Loans--Mortgage Loan Characteristics" herein.
Unless otherwise specified in the related Prospectus Supplement, each
Revolving Credit Loan will have a term to maturity from the date of
origination of not more than 25 years. The Mortgagor for each Revolving Credit
Loan may draw money (each, an "ADDITIONAL BALANCE" or a "DRAW") under the
related Credit Line Agreement at any time during the period specified therein
(such period as to any Mortgage Loan, the "DRAW PERIOD"). Unless otherwise
specified in the related Prospectus Supplement, the Draw Period generally will
not be more than 15 years. Unless otherwise specified in the related
Prospectus Supplement, with respect to each Revolving Credit Loan, if the Draw
Period is less than the full term thereof, the related Mortgagor will not be
permitted to make any Draw during the period from the end of the related Draw
Period to the related maturity date. The Mortgagor for each Revolving Credit
Loan will be obligated to make monthly payments thereon in a minimum amount as
specified in the related Mortgage Note, which generally will be the greater of
(i) 1% of the outstanding principal balance of the Mortgage Loan, (ii) the
accrued interest or (iii) $100. The Mortgagor for each Mortgage Loan will be
obligated to make a payment on the related maturity date in an amount equal to
the Account Balance thereof on such maturity date, which may be a substantial
principal amount. The maximum amount of
19
<PAGE>
any Draw with respect to any Revolving Credit Loan is equal to the excess, if
any, of the Credit Limit over the principal balance outstanding under such
Mortgage Note at the time of such Draw. Unless otherwise provided in the
related Prospectus Supplement, Draws made after the related Cut-off Date will
be excluded from the Mortgage Pool.
Unless otherwise specified in the related Prospectus Supplement, with
respect to each Revolving Credit Loan, (a) the Finance Charge (the "FINANCE
CHARGE") for any billing cycle generally will be equal to interest accrued on
the average daily principal balance of such Mortgage Loan for such billing
cycle at the related Mortgage Rate, (b) the Account Balance (the "ACCOUNT
BALANCE") on any day generally will be the aggregate of all related Draws
funded on such day and outstanding at the beginning of such day, plus the sum
of any unpaid Finance Charges and any unpaid fees, insurance premiums and
other charges (collectively, "ADDITIONAL CHARGES") that are due on such
Mortgage Loan minus the aggregate of all payments and credits that are applied
to the repayment of any such Draws on such day, and (c) the "principal
balance" on any day generally will be the related Account Balance minus the
sum of any unpaid Finance Charges and Additional Charges that are due on such
Revolving Credit Loan. Payments made by or on behalf of the Mortgagor for each
Mortgage Loan will be applied, first, to any unpaid Finance Charges that are
due thereon, second, to any unpaid Additional Charges that are due thereon,
and third, to any related Draws outstanding.
The Mortgaged Property securing each Revolving Credit Loan will be subject
to the lien created by the related mortgage (the "MORTGAGE") in respect of the
outstanding principal balance of each related Draw or portion thereof that is
not included in the related Mortgage Pool, whether made on or prior to the
related Cut-off Date or thereafter. Such lien will be the same rank as the
lien created by such Mortgage in respect of such Revolving Credit Loan, and
monthly payments, collections and other recoveries under the Credit Line
Agreement related to such Revolving Credit Loan will be allocated as described
in the related Prospectus Supplement among such Revolving Credit Loan and the
outstanding principal balance of each Draw or portion thereof excluded from
the Mortgage Pool. The Company, an affiliate of the Company or an Unaffiliated
Seller may have an interest in any Draw or portion thereof excluded from the
Mortgage Pool.
Unless otherwise specified in the related Prospectus Supplement, each
Revolving Credit Loan may be prepaid in full or in part at any time and
without penalty, but with respect to each Revolving Credit Loan, the related
Mortgagor will have the right during the related Draw Period to make a Draw in
the amount of any prepayment theretofore made with respect to such Mortgage
Loan. The Mortgage Note or Mortgage related to each Revolving Credit Loan will
contain a customary "due-on-sale" clause.
As to each Mortgage Loan, the Mortgagor's rights to receive Draws during the
Draw Period may be suspended, or the Credit Limit may be reduced, for cause
under a limited number of circumstances, including, but not limited to: a
materially adverse change in the Mortgagor's financial circumstances or a non-
payment default by the Mortgagor. However, with respect to each Mortgage Loan,
generally such suspension or reduction will not affect the payment terms for
previously drawn balances. In the event of default under a Mortgage Loan, at
the discretion of the Master Servicer, the Mortgage Loan may be terminated and
declared immediately due and payable in full. For this purpose, a default
includes, but is not limited to: the Mortgagor's failure to make any payment
as required; any action or inaction by the Mortgagor that materially and
adversely affects the Mortgaged Property or the rights in the Mortgaged
Property; or fraud or material misrepresentation by a Mortgagor in connection
with the Loan.
ALLOCATION OF REVOLVING CREDIT LOAN BALANCES
With respect to any series of Certificates backed by Revolving Credit Loans,
the related Trust Fund may include either (i) the entire principal balance of
each Revolving Credit Loan outstanding at any time, including balances
attributable to Draws made after the related Cut-off Date, or (ii) only a
specified portion (the "TRUST BALANCE") of the total principal balance of each
Revolving Credit Loan outstanding at any time, which except as otherwise
indicated in the related Prospectus Supplement will consist of the principal
balance thereof as of
20
<PAGE>
the Cut-off Date minus the portion of all payments and losses thereafter that
are allocated to the Trust Balance, and will not include any portion of the
principal balance attributable to Draws made after the Cut-off Date.
In the latter case, that portion of the principal balance of any Revolving
Credit Loan not included in the Trust Balance at any time is referred to as
the "EXCLUDED BALANCE," which will include balances attributable to Draws
after the Cut-off Date and may include, if so specified in the related
Prospectus Supplement, a portion of the principal balance outstanding as of
the Cut-off Date (such as any such portion included in a different Trust
Fund). The related Prospectus Supplement will set forth the specific
provisions by which payments and losses on any such Revolving Credit Loan will
be allocated as between the Trust Balance and any Excluded Balance. Generally,
except as otherwise so specified, such provisions (i) may provide that
principal payments made by the Mortgagor will be allocated as between the
Trust Balance and any Excluded Balance either (a) on a pro rata basis, (b)
first to the Trust Balance until reduced to zero, then to the Excluded
Balance, or (c) in accordance with other specified priorities, and (ii) will
provide that interest payments, as well as liquidation proceeds or similar
proceeds following a default and any Realized Losses, will be allocated as
between the Trust Balance and any Excluded Balance on a pro rata basis.
Even where a Trust Fund initially includes the entire principal balance of
the Revolving Credit Loans, the Pooling and Servicing Agreement may provide
that after a specified date or upon the occurrence of specified events, the
Trust Fund may not include balances attributable to additional Draws made
thereafter. The related Prospectus Supplement will describe such provisions as
well as the allocation provisions that would be applicable thereto.
MORTGAGE LOAN PROGRAM
The Mortgage Loans will have been purchased by the Company, either directly
or indirectly through Residential Funding from Sellers. The Mortgage Loans
will generally have been originated in accordance with the Company's
underwriting standards or alternative underwriting criteria as described below
under "Underwriting Standards" or as described in the related Prospectus
Supplement.
UNDERWRITING STANDARDS
General Standards
The Company's underwriting standards with respect to certain Mortgage Loans
will generally conform to those published in Residential Funding's Seller
Guide (together with Residential Funding's Servicer Guide, the "GUIDE," as
modified from time to time), including, the provisions of the Guide applicable
to the Company's Home Equity Program (the "HOME EQUITY PROGRAM"). The
underwriting standards as set forth in the Guide are continuously revised
based on opportunities and prevailing conditions in the residential mortgage
market, the consumer lending market and the market for mortgage securities.
The Mortgage Loans may be underwritten by Residential Funding or by a
designated third party. In certain circumstances, however, the Mortgage Loans
may be underwritten only by the Seller with little or no review performed by
Residential Funding. See "Underwriting Standards--Guide Standards" and
"Qualifications of Sellers." Residential Funding or a designated third party
may perform only sample quality assurance reviews to determine whether the
Mortgage Loans in any Mortgage Pool were underwritten in accordance with
applicable standards.
With respect to the Company's underwriting standards, as well as any other
underwriting standards that may be applicable to any Mortgage Loans, such
underwriting standards generally include a set of specific criteria pursuant
to which the underwriting evaluation is made. However, the application of such
underwriting standards does not imply that each specific criterion was
satisfied individually. Rather, a Mortgage Loan will be considered to be
originated in accordance with a given set of underwriting standards if, based
on an overall qualitative evaluation, the loan is in substantial compliance
with such underwriting standards. For example, a Mortgage Loan may be
considered to comply with a set of underwriting standards, even if one or more
specific criteria
21
<PAGE>
included in such underwriting standards were not satisfied, if other factors
compensated for the criteria that were not satisfied or if the Mortgage Loan
is considered to be in substantial compliance with the underwriting standards.
In addition, the Company purchases Mortgage Loans which do not conform to
the underwriting standards set forth in the Guide. Certain of the Mortgage
Loans will be purchased in negotiated transactions, and such negotiated
transactions may be governed by agreements ("MASTER COMMITMENTS") relating to
ongoing purchases of Mortgage Loans by Residential Funding, from Sellers who
will represent that the Mortgage Loans have been originated in accordance with
underwriting standards agreed to by Residential Funding. Residential Funding,
on behalf of the Company or a designated third party, will generally review
only a limited portion of the Mortgage Loans in any delivery of such Mortgage
Loans from the related Seller for conformity with the applicable underwriting
standards. Certain other Mortgage Loans will be purchased from Sellers who
will represent that the Mortgage Loans were originated pursuant to
underwriting standards acceptable to Residential Funding.
The level of review, if any, by Residential Funding or the Company of any
Mortgage Loan for conformity with the applicable underwriting standards will
vary depending on any one of a number of factors, including (i) factors
relating to the experience and status of the Seller, and (ii) factors relating
to the specific Mortgage Loan, including the principal amount or Credit Limit,
the Combined Loan-to-Value Ratio, the loan type or loan program, and the
applicable credit score of the related Mortgagor used in connection with the
origination of the Mortgage Loan (as determined based on a credit scoring
model acceptable to the Company). Generally, such credit scoring models
provide a means for evaluating the information about a prospective borrower
that is available from a credit reporting agency. The underwriting criteria
applicable to any program under which the Mortgage Loans may be originated may
provide that qualification for the loan, the level of review of the loan's
documentation, or the availability of certain loan features (such as maximum
loan amount, maximum Loan-to-Value Ratio, property type and use, and
documentation level) may depend on the mortgagor's credit score.
The underwriting standards utilized in negotiated transactions and Master
Commitments and the underwriting standards applicable to Mortgage Loans
underlying Mortgage Securities may vary substantially from the underwriting
standards set forth in the Guide. Such underwriting standards are generally
intended to provide an underwriter with information to evaluate the borrower's
repayment ability and the value of the Mortgaged Property as collateral. Due
to the variety of underwriting standards and review procedures that may be
applicable to the Mortgage Loans included in any Mortgage Pool, the related
Prospectus Supplement generally will not distinguish among the various
underwriting standards applicable to the Mortgage Loans nor describe any
review for compliance with applicable underwriting standards performed by the
Company or Residential Funding. Moreover, there can be no assurance that every
Mortgage Loan was originated in conformity with the applicable underwriting
standards in all material respects, or that the quality or performance of
Mortgage Loans underwritten pursuant to varying standards as described above
will be equivalent under all circumstances. In the case of a Designated Seller
Transaction, the applicable underwriting standards will be those of the
Designated Seller or of the originator of the Mortgage Loans, and will be
described in the related Prospectus Supplement.
The Company, either directly or indirectly through Residential Funding, will
also purchase Mortgage Loans from its affiliates, including GMAC Mortgage
Corporation of PA and Homecomings Financial Network, Inc., with underwriting
standards generally in accordance with the Guide or as otherwise agreed to by
the Company. However, in certain limited circumstances, such Mortgage Loans
may be employee or preferred customer loans with respect to which, in
accordance with such affiliate's mortgage loan programs, income, asset and
employment verifications and appraisals may not have been required. With
respect to Mortgage Loans made under any employee loan program maintained by
Residential Funding, or its affiliates, in certain limited circumstances
preferential interest rates may be allowed. Neither the Company nor
Residential Funding will review any affiliate's mortgage loans for conformity
with the underwriting standards set forth in the Guide.
Guide Standards
The following is a brief description of the underwriting standards set forth
in the Guide for full documentation loan programs. Initially, a prospective
borrower (other than a trust if the trust is the borrower) is
22
<PAGE>
required to fill out a detailed application providing pertinent credit
information. As part of the application, the borrower is required to provide a
statement of income and expenses, as well as an authorization to apply for a
credit report which summarizes the borrower's credit history with merchants
and lenders and any record of bankruptcy. Under the Home Equity Program, the
borrower generally must show, among other things, a minimum of one year credit
history reported on the credit report and that no mortgage delinquencies
(thirty days or greater) in the past 12 months existed. Borrowers who have
less than a 12 month first mortgage payment history may be subject to certain
additional lending restrictions. In addition, under the Home Equity Program,
borrowers with a previous foreclosure or bankruptcy within the past seven
years may not be allowed and a borrower generally must satisfy all judgments,
liens and other legal actions with an original amount of $1,000 or greater
prior to closing. In addition, an employment verification is obtained which
reports the borrower's current salary and may contain the length of employment
and an indication as to whether it is expected that the borrower will continue
such employment in the future. If a prospective borrower is self-employed, the
borrower may be required to submit copies of signed tax returns. The borrower
may also be required to authorize verification of deposits at financial
institutions where the borrower has accounts. In the case of a Mortgage Loan
secured by a property owned by a trust, the foregoing procedures may be waived
where the Mortgage Note is executed on behalf of the trust.
Unless otherwise specified in the related Prospectus Supplement, an
appraisal is made of the Mortgaged Property securing each Mortgage Loan. Such
appraisals may be performed by appraisers independent from or affiliated with
the Company, Residential Funding or their affiliates. Such appraisals,
however, will not establish that the Mortgaged Properties provide assurance of
repayment of the Mortgage Loans. See "Risk Factors--Special Features of the
Mortgage Loans--Adequacy of Mortgage Collateral" and "Description of the
Certificates--Realization Upon Defaulted Mortgage Loans" herein. The appraiser
is required to inspect the property and verify that it is in good condition
and that construction, if new, has been completed. In certain circumstances,
the appraiser is only required to perform an exterior inspection of the
property. The appraisal is based on various factors, including the market
value of comparable homes and the cost of replacing the improvements. Except
as otherwise provided in the related Prospectus Supplement, under the Home
Equity Program, each appraisal is required to be dated no more than 180 days
prior to the date of origination of the Mortgage Loan; provided, that
depending on the principal amount or Credit Limit an earlier appraisal may be
utilized if such appraisal was made not earlier than two years prior to the
date of origination of the mortgage loan and the related appraiser certifies
that the value of the related mortgaged property has not declined since the
date of the original appraisal or if a field review or statistical property
valuation is obtained. Title searches are undertaken in most cases, and title
insurance is required on all Mortgage Loans with Credit Limits in excess of
$100,000.
Under the Home Equity Program, the CLTV is generally calculated by reference
to the lower of the appraised value as so determined or the sales price, if
the Mortgage Loan is originated concurrently with or not more than 12 months
after the origination of a first mortgage loan. In all other cases, the value
used is generally the appraised value as so determined.
Once all applicable employment, credit and property information is received,
a determination is made as to whether the prospective borrower has sufficient
monthly income available to meet the borrower's monthly obligations on the
proposed mortgage loan and other expenses related to the home (such as
property taxes and hazard insurance) and other financial obligations
(including debt service on any related mortgage loan secured by a senior lien
on the related Mortgaged Property). With respect to a Revolving Credit Loan,
unless otherwise provided in the related Prospectus Supplement, for
qualification purposes the monthly payment will be assumed to be an amount
equal to 1.00% times the applicable Credit Limit. The Mortgage Rate in effect
from the origination date of an ARM Loan, a Revolving Credit Loan and certain
other types of loans to the first adjustment date generally will be lower, and
may be significantly lower, than the sum of the then applicable Index and
Gross Margin. Similarly, the amount of the monthly payment on graduated
payment Mortgage Loans will increase periodically. If the borrowers' incomes
do not increase in an amount commensurate with the increases in monthly
payments, the likelihood of default will increase. In addition, in the case of
ARM Loans that are subject to
23
<PAGE>
negative amortization, due to the addition of Deferred Interest the principal
balances of such mortgage loans are more likely to equal or exceed the value
of the underlying mortgaged properties, thereby increasing the likelihood of
defaults and losses. Unless otherwise specified in the related Prospectus
Supplement, Revolving Credit Loans will not provide for negative amortization.
With respect to Balloon Loans and Revolving Credit Loans, payment of the full
outstanding principal balance at maturity may depend on the borrower's ability
to obtain refinancing or to sell the Mortgaged Property prior to the maturity
of the mortgage loan, and there can be no assurance that such refinancing will
be available to the borrower or that such a sale will be possible.
The underwriting standards set forth in the Guide may be varied in
appropriate cases, including in "limited" or "reduced loan documentation"
mortgage loan programs. Limited documentation programs generally permit fewer
supporting documents to be obtained or waive income, asset and employment
documentation requirements, and limited documentation programs generally
compensate for increased credit risk by placing greater emphasis on either the
review of the property to be financed or the borrower's ability to repay the
Mortgage Loan. For example, under Residential Funding's EasyDocs limited
mortgage loan documentation program, certain submission requirements regarding
income verification and debt-to-income ratios are removed, but the Seller is
still required to perform a thorough credit underwriting of the mortgage loan
and the Combined Loan-to-Value Ratio may not exceed 75%. Generally, in order
to be eligible for a reduced loan documentation program, a Mortgagor must have
a good credit history, and other compensating factors (such as a relatively
low Combined Loan-to-Value Ratio, or other favorable underwriting factors)
must be present and the borrower's eligibility for such program may be
determined by use of a credit scoring model.
The Home Equity Program sets forth certain limitations with respect to the
CLTV for the Mortgage Loans and certain restrictions with respect to any
related underlying first mortgage loan. The underwriting guidelines for the
Home Equity Program generally permit CLTV's as high as 100% except as
otherwise provided in the related Prospectus Supplement; however, the maximum
permitted CLTV may be reduced due to a variety of underwriting criteria. In
areas where property values are considered to be declining, the maximum
permitted CLTV is 75%. The underwriting guidelines also include restrictions
based on the borrower's debt-to-income ratio. In addition to the foregoing, an
evaluation of the prospective borrower's credit quality will be made based on
a credit scoring model approved by the Company. The Home Equity Program
underwriting guidelines include minimum credit score levels that may apply
depending on certain factors of the Mortgage Loan. The required yields for
fixed-rate Closed End Loans and required Gross Margins for Revolving Credit
Loans purchased under the Home Equity Program, as announced from time to time,
vary based on a number of factors including CLTV, Credit Limit, documentation
level, property type, and borrower debt-to-income ratio and credit score.
In its evaluation of mortgage loans which have twenty-four or more months of
payment experience, Residential Funding generally places greater weight on
payment history and may take into account market and other economic trends
while placing less weight on underwriting factors generally applied to newly
originated mortgage loans.
QUALIFICATIONS OF SELLERS
Except with respect to Designated Seller Transactions, each Seller (other
than the Federal Deposit Insurance Corporation (the "FDIC") and investment
banking firms) will have been approved by Residential Funding for
participation in Residential Funding's loan purchase program. In determining
whether to approve a seller for participation in the loan purchase program,
Residential Funding generally will consider, among other things, the financial
status (including the net worth) of the seller, the previous experience of the
seller in originating home equity or first mortgage loans, the prior
delinquency and loss experience of the seller, the underwriting standards
employed by the seller and the quality control and, if applicable, servicing
operations established by the seller. There can be no assurance that any
Seller presently meets any qualifications or will continue to meet any
qualifications at the time of inclusion of mortgage loans sold by it in the
Trust Fund for a series of Certificates, or thereafter. If a Seller becomes
subject to the direct or indirect control of the FDIC, or if a Seller's net
worth, financial performance or delinquency and foreclosure rates deteriorate,
such institution may continue to be treated as a Seller. Any such event may
adversely affect the ability of any such Seller to repurchase the Mortgage
Loans in the event of a breach of a representation or warranty which has not
been cured.
24
<PAGE>
Residential Funding generally monitors which Sellers are under control of
the FDIC or are insolvent, otherwise in receivership or conservatorship or
financially distressed. Such Seller may make no representations and warranties
with respect to Mortgage Loans sold by it. The FDIC (either in its corporate
capacity or as receiver for a depository institution) may also be a Seller of
the Mortgage Loans, in which event neither the FDIC nor the related depository
institution may make representations and warranties with respect to the
Mortgage Loans sold, or only limited representations and warranties may be
made (for example, that the related legal documents are enforceable). The FDIC
may have no obligation to repurchase any Mortgage Loan for a breach of a
representation and warranty.
Unless otherwise specified in the related Prospectus Supplement, the
qualifications required of Sellers for approval by Residential Funding as
participants in its loan purchase programs may not apply to Designated
Sellers. To the extent the Designated Seller fails to or is unable to
repurchase the Mortgage Loan due to a breach of representation and warranty,
neither the Company, Residential Funding nor any other entity will have
assumed the representations and warranties, and any related losses will be
borne by the Certificateholders or by the credit enhancement, if any.
REPRESENTATIONS RELATING TO MORTGAGE LOANS
Each Seller generally will make certain representations and warranties to
Residential Funding with respect to the Mortgage Loans sold by such Seller.
However, except in the case of a Designated Seller Transaction or as otherwise
provided in the related Prospectus Supplement, the representations and
warranties of the Seller will not be assigned to the Trustee for the benefit
of the holders of the related series of Certificates, and therefore a breach
of the representations and warranties of the Seller generally will not be
enforceable on behalf of the Trust Fund.
In the case of a Mortgage Pool consisting of Mortgage Loans purchased by the
Company from Sellers through Residential Funding, Residential Funding, except
in the case of a Designated Seller Transaction or as to Mortgage Loans
underlying any Mortgage Securities or unless otherwise specified in the
related Prospectus Supplement, will have made certain limited representations
and warranties regarding the Mortgage Loans to the Company at the time (just
prior to the initial issuance of the related series of Certificates) that they
are sold to the Company. Such representations and warranties will generally
include, among other things, that: (i) as of the Cut-off Date, the information
set forth in a listing of the related Mortgage Loans is true and correct in
all material respects; (ii) Residential Funding was the sole holder and owner
of the Mortgage Loan free and clear of any and all liens and security
interests; (iii) each Mortgage Loan complied in all material respects with all
applicable local, state and federal laws; (iv) except as otherwise indicated
in the related Prospectus Supplement, no Mortgage Loan is one month or more
delinquent in payment of principal and interest; and (v) there is no
delinquent tax or, to the best of the Residential Funding's knowledge,
assessment lien against any Mortgaged Property. In the event of a breach of a
representation or warranty made by Residential Funding that materially
adversely affects the interests of the Certificateholders in a Mortgage Loan,
Residential Funding will be obligated to repurchase or substitute for such
Mortgage Loan as described below. In addition, Residential Funding will be
obligated to repurchase or substitute for any Mortgage Loan as to which it is
discovered that the related Mortgage is not a valid lien on the related
Mortgaged Property having at least the priority set forth with respect to such
Mortgage Loan in the listing of related Mortgage Loans, subject only to (a)
liens of real property taxes and assessments not yet due and payable, (b)
covenants, conditions and restrictions, rights of way, easements and other
matters of public record as of the date of recording of such Mortgage and
certain other permissible title exceptions, (c) other matters to which like
properties are commonly subject which do not materially adversely affect the
value, use, enjoyment or marketability of the Mortgaged Property, and (d) if
applicable, the liens of the related senior mortgage loans. In addition, with
respect to any Mortgage Loan as to which the Company delivers to the Trustee
or the custodian an affidavit certifying that the original Mortgage Note has
been lost or destroyed, if such Mortgage Loan subsequently is in default and
the enforcement thereof or of the related Mortgage is materially adversely
affected by the absence of the original Mortgage Note, Residential Funding
will be obligated to repurchase or substitute for such Mortgage Loan, in the
manner described below. However, Residential Funding will not be required to
repurchase or substitute for any Mortgage Loan as described above
25
<PAGE>
if the circumstances giving rise to such requirement also constitute fraud in
the origination of the related Mortgage Loan. Furthermore, because the listing
of the related Mortgage Loans generally contains information with respect to
the Mortgage Loans as of the Cut-off Date, prepayments and, in certain limited
circumstances, modifications to the interest rate and principal and interest
payments may have been made with respect to one or more of the related
Mortgage Loans between the Cut-off Date and the Closing Date. Residential
Funding will not be required to purchase or substitute for any Mortgage Loan
as a result of such prepayment or modification.
In a Designated Seller Transaction, unless otherwise specified in the
related Prospectus Supplement, the Designated Seller will have made certain
representations and warranties regarding the Mortgage Loans to the Company
generally similar to those made in the preceding paragraph by Residential
Funding.
The Company will assign to the Trustee for the benefit of the holders of the
related series of Certificates all of its right, title and interest in each
agreement by which it purchased a Mortgage Loan from Residential Funding or a
Designated Seller, insofar as such agreement relates to the representations
and warranties made by a Designated Seller or Residential Funding, as the case
may be, in respect of such Mortgage Loan and any remedies provided for with
respect to any breach of such representations and warranties. If a Designated
Seller or Residential Funding, as the case may be, cannot cure a breach of any
representation or warranty made by it in respect of a Mortgage Loan which
materially and adversely affects the interests of the Certificateholders in
such Mortgage Loan, within 90 days after notice from the Master Servicer, such
Designated Seller or Residential Funding, as the case may be, will be
obligated to purchase such Mortgage Loan at a price (the "PURCHASE PRICE") set
forth in the related Pooling and Servicing Agreement, which Purchase Price
generally will be equal to the principal balance thereof as of the date of
purchase plus accrued and unpaid interest to the first day of the month
following the month of repurchase at the Mortgage Rate (less the amount,
expressed as a percentage per annum, payable in respect of master servicing
compensation or subservicing compensation, as applicable, and, if applicable,
the Excluded Spread).
Unless otherwise specified in the related Prospectus Supplement, as to any
such Mortgage Loan required to be purchased by Residential Funding as provided
above, rather than purchase the Mortgage Loan, Residential Funding may, at its
sole option, remove such Mortgage Loan (a "DELETED MORTGAGE LOAN") from the
Trust Fund and cause the Company to substitute in its place another Mortgage
Loan of like kind (a "QUALIFIED SUBSTITUTE MORTGAGE LOAN"); however, such
substitution must be effected within 120 days of the date of the initial
issuance of the Certificates with respect to a Trust Fund treated as a grantor
trust for federal income tax purposes. With respect to a Trust Fund for which
a REMIC election is to be made, except as otherwise provided in the Prospectus
Supplement relating to a series of Certificates, such substitution of a
defective Mortgage Loan must be effected within two years of the date of the
initial issuance of the Certificates, and may not be made if such substitution
would cause the Trust Fund to not qualify as a REMIC or result in a prohibited
transaction tax under the Code. Except as otherwise provided in the related
Prospectus Supplement, any Qualified Substitute Mortgage Loan generally will,
on the date of substitution, (i) have an outstanding principal balance, after
deduction of the principal portion of the monthly payment due in the month of
substitution, not in excess of the outstanding principal balance of the
Deleted Mortgage Loan (the amount of any shortfall to be deposited in a
custodial account (the "CUSTODIAL ACCOUNT") in the month of substitution for
distribution to the Certificateholders), (ii) have a Mortgage Rate and a Net
Mortgage Rate not less than (and not more than one percentage point greater
than) the Mortgage Rate and Net Mortgage Rate, respectively, of the Deleted
Mortgage Loan as of the date of substitution, (iii) have a Combined Loan-to-
Value Ratio at the time of substitution no higher than that of the Deleted
Mortgage Loan at the time of substitution, (iv) have a remaining term to
maturity not greater than (and not more than one year less than) that of the
Deleted Mortgage Loan, and (v) comply with all of the representations and
warranties set forth in the related Pooling and Servicing Agreement as of the
date of substitution. The related Pooling and Servicing Agreement may include
additional requirements relating to ARM Loans, Revolving Credit Loans or other
specific types of Mortgage Loans, or additional provisions relating to meeting
the foregoing requirements on an aggregate basis where a number of
substitutions occur contemporaneously. Unless otherwise specified in the
related Prospectus Supplement, a Designated Seller will have no option to
substitute for a Mortgage Loan that it is obligated to repurchase in
connection with a breach of a representation and warranty.
26
<PAGE>
The Master Servicer will be required under the applicable Pooling and
Servicing Agreement to use its best reasonable efforts to enforce this
purchase or substitution obligation for the benefit of the Trustee and the
Certificateholders, using practices it would employ in its good faith business
judgment and which are normal and usual in its general mortgage servicing
activities; provided, however, that this purchase or substitution obligation
will not become an obligation of the Master Servicer in the event the
Designated Seller or Residential Funding, as the case may be, fails to honor
such obligation. The Master Servicer will be entitled to reimbursement for any
costs and expenses incurred in pursuing such a purchase or substitution
obligation, including but not limited to any costs or expenses associated with
litigation. In instances where a Designated Seller is unable, or disputes its
obligation, to purchase affected Mortgage Loans, the Master Servicer,
employing the standards set forth in the preceding sentence, may negotiate and
enter into one or more settlement agreements with such Designated Seller that
could provide for, among other things, the purchase of only a portion of the
affected Mortgage Loans or coverage of certain loss amounts. Any such
settlement could lead to losses on the Mortgage Loans which would be borne by
the related credit enhancement, and to the extent not available, on the
related Certificates. Furthermore, the Master Servicer may pursue foreclosure
(or similar remedies) concurrently with pursuing any remedy for a breach of a
representation and warranty. However, the Master Servicer is not required to
continue to pursue both such remedies if it determines that one such remedy is
more likely to result in a greater recovery. In accordance with the above
described practices, the Master Servicer will not be required to enforce any
purchase of a Designated Seller arising from any misrepresentation by the
Designated Seller, if the Master Servicer determines in the reasonable
exercise of its business judgment that the matters related to such
misrepresentation did not directly cause or are not likely to directly cause a
loss on the related Mortgage Loan. If the Designated Seller fails to
repurchase and no breach of either the Company's or Residential Funding's
representations has occurred, the Designated Seller's purchase obligation will
not become an obligation of the Company or Residential Funding. Unless
otherwise specified in the related Prospectus Supplement, the foregoing
obligations will constitute the sole remedies available to Certificateholders
or the Trustee for a breach of any representation by a Designated Seller or by
Residential Funding in its capacity as a seller of Mortgage Loans to the
Company, or for any other event giving rise to such obligations as described
above.
Neither the Company nor the Master Servicer will be obligated to purchase a
Mortgage Loan if a Designated Seller defaults on its obligation to do so, and
no assurance can be given that the Designated Sellers will carry out such
obligations with respect to Mortgage Loans. Such a default by a Designated
Seller is not a default by the Company or by the Master Servicer. Any Mortgage
Loan not so purchased or substituted for shall remain in the related Trust
Fund and any losses related thereto shall be allocated to the related credit
enhancement, and to the extent not available, to the related Certificates.
Notwithstanding the foregoing, with respect to any Designated Seller that
requests Residential Funding's consent to the transfer of subservicing rights
relating to any Mortgage Loans to a successor servicer, Residential Funding
may release such Designated Seller from liability under its representations
and warranties described above, upon the assumption of such successor servicer
of the Designated Seller's liability for such representations and warranties
as of the date they were made. In that event, Residential Funding's rights
under the instrument by which such successor servicer assumes the Designated
Seller's liability will be assigned to the Trustee, and such successor
servicer shall be deemed to be the "Designated Seller" for purposes of the
foregoing provisions.
SUBSERVICING
The servicing for each Mortgage Loan will generally either be retained by
the Seller (or its designee approved by the Master Servicer) as Subservicer,
or will be released by the Seller to the Master Servicer and will be
subsequently transferred to a Subservicer approved by the Master Servicer, and
in either case will thereafter be serviced by the Subservicer pursuant to an
agreement between the Master Servicer and the Subservicer (a "SUBSERVICING
AGREEMENT"). The Master Servicer may, but is not obligated to, assign such
subservicing to designated subservicers which will be qualified Sellers and
which may include GMAC Mortgage Corporation of PA or its affiliates. While
such Subservicing Agreement will be a contract solely between the Master
Servicer and the Subservicer, the Pooling and Servicing Agreement pursuant to
which a series of
27
<PAGE>
Certificates is issued will provide that, if for any reason the Master
Servicer for such series of Certificates is no longer the master servicer of
the related Mortgage Loans, the Trustee or any successor Master Servicer must
recognize the Subservicer's rights and obligations under such Subservicing
Agreement.
Each Subservicer generally will be required to perform the customary
functions of a servicer, including but not limited to, collection of payments
from Mortgagors and remittance of such collections to the Master Servicer;
maintenance of escrow or impoundment accounts of Mortgagors for payment of
taxes, insurance and other items required to be paid by the Mortgagor pursuant
to the Mortgage Loan, if applicable; processing of assumptions or
substitutions (although, unless otherwise specified in the related Prospectus
Supplement, the Master Servicer is generally required to exercise due-on-sale
clauses to the extent such exercise is permitted by law and would not
adversely affect insurance coverage); attempting to cure delinquencies;
supervising foreclosures; inspection and management of Mortgaged Properties
under certain circumstances; and maintaining accounting records relating to
the Mortgage Loans. The Subservicer may be required to make advances to the
holder of any related first mortgage loan to avoid or cure any delinquencies
to the extent that doing so would be prudent and necessary to protect the
interests of the Certificateholders. A Subservicer also may be obligated to
make advances to the Master Servicer in respect of delinquent installments of
principal and interest (net of any subservicing or other compensation) on
Closed-End Loans, as described under "Description of the Certificates--
Advances on Closed-End Loans," and in respect of certain taxes and insurance
premiums not paid on a timely basis by Mortgagors. The Subservicer generally
shall be responsible for performing all collection and other servicing
functions with respect to any delinquent loan or foreclosure proceeding. In
addition, the Subservicer is required to advance funds to cover any Draws made
on a Revolving Credit Loan subject to reimbursement by the entity specified in
the related Prospectus Supplement. No assurance can be given that the
Subservicers will carry out their advance or payment obligations with respect
to the Mortgage Loans. Unless otherwise specified in the related Prospectus
Supplement, a Subservicer may transfer its servicing obligations to another
entity that has been approved for participation in Residential Funding's loan
purchase programs, but only with the approval of the Master Servicer.
As compensation for its servicing duties, the Subservicer will be entitled
to a monthly servicing fee (to the extent the related Mortgage Loan payment
has been collected) in a minimum amount set forth in the related Prospectus
Supplement. The Subservicer or Master Servicer may also be entitled to collect
and retain, as part of its servicing compensation, all or a portion of any
late charges, if any, provided in the Mortgage Note or related instruments and
in the case of the Master Servicer, any penalties enforced against a
Subservicer. The remaining portion of such late charges will be remitted to
the Master Servicer. The Subservicer will be reimbursed by the Master Servicer
for certain expenditures which it makes, generally to the same extent that the
Master Servicer would be reimbursed under the applicable Pooling and Servicing
Agreement. See "The Pooling and Servicing Agreement--Servicing and
Administration."
Each Subservicer will be required to agree to indemnify the Master Servicer
for any liability or obligation sustained by the Master Servicer in connection
with any act or failure to act by the Subservicer in its servicing capacity.
Each Subservicer is required to maintain a fidelity bond and an errors and
omissions policy with respect to its officers, employees and other persons
acting on its behalf or on behalf of the Master Servicer.
Each Subservicer will be required to service each Mortgage Loan pursuant to
the terms of the Subservicing Agreement for the entire term of such Mortgage
Loan, unless the Subservicing Agreement is earlier terminated by the Master
Servicer or unless servicing is released to the Master Servicer. Subject to
applicable law, the Master Servicer may have the right to terminate a
Subservicing Agreement immediately upon the giving of notice upon certain
stated events, including the violation of such Subservicing Agreement by the
Subservicer, or up to ninety days' notice to the Subservicer without cause
upon payment of certain amounts set forth in the Subservicing Agreement. Upon
termination of a Subservicing Agreement, the Master Servicer may act as
servicer of the related Mortgage Loans or enter into one or more new
Subservicing Agreements. The Master Servicer may agree with a Subservicer to
amend a Subservicing Agreement. Any amendments to a Subservicing Agreement or
to a new Subservicing Agreement may contain provisions different from those
described above which are in effect in the original Subservicing Agreements.
However, the Pooling and Servicing Agreement for each Trust Fund will provide
that any such amendment or new agreement may not be inconsistent with or
violate
28
<PAGE>
such Pooling and Servicing Agreement in a manner which would materially and
adversely affect the interests of the Certificateholders.
DESCRIPTION OF THE CERTIFICATES
GENERAL
The Certificates will be issued in series. Each series of Certificates (or,
in certain instances, two or more series of Certificates) will be issued
pursuant to a Pooling and Servicing Agreement, similar to one of the forms
filed as an exhibit to the Registration Statement of which this Prospectus is
a part. Each Pooling and Servicing Agreement will be filed with the Commission
as an exhibit to a Form 8-K. The following summaries (together with additional
summaries under "The Pooling and Servicing Agreement" below as well as other
pertinent information included elsewhere in this Prospectus, and subject to
the related Prospectus Supplement) do not describe all terms thereof but
reflect the material provisions relating to the Certificates common to each
Pooling and Servicing Agreement.
Unless otherwise specified in the Prospectus Supplement with respect to a
series, Certificates of each series covered by a particular Pooling and
Servicing Agreement will evidence specified beneficial ownership interests in
a separate Trust Fund created pursuant to such Pooling and Servicing
Agreement. A Trust Fund will consist of, to the extent provided in the Pooling
and Servicing Agreement: (i) such Mortgage Loans (and the related mortgage
documents) or interests therein (including any Mortgage Securities) underlying
a particular series of Certificates as from time to time are subject to the
Pooling and Servicing Agreement, exclusive of, if specified in the related
Prospectus Supplement, any Excluded Spread or other interest retained by the
Company or any of its affiliates with respect to each such Mortgage Loan; (ii)
such assets including, without limitation, all payments and collections in
respect of the Mortgage Loans or Mortgage Securities due after the related
Cut-off Date, as from time to time are identified as deposited in respect
thereof in the Custodial Account and in the related Certificate Account; (iii)
property acquired by foreclosure of such Mortgage Loans or deed in lieu of
foreclosure; (iv) hazard insurance policies and certain proceeds thereof; and
(v) any combination, as and to the extent specified in the related Prospectus
Supplement, of a Letter of Credit, Purchase Obligation, Special Hazard
Insurance Policy, Bankruptcy Bond, Financial Guaranty Insurance Policy, Surety
Bond or other type of credit enhancement as described under "Description of
Credit Enhancement." To the extent that any Trust Fund includes certificates
of interest or participations in Mortgage Loans, the related Prospectus
Supplement will describe the material terms and conditions of such
certificates or participations.
Each series of Certificates may consist of any one or a combination of the
following: (i) a single class of Certificates; (ii) two or more classes of
Certificates, one or more classes of which may be Senior Certificates that are
senior in right of payment to any class or classes of Mezzanine Certificates
and to any other class or classes of Subordinate Certificates, and as to which
certain classes of Senior Certificates may be senior to other classes of
Senior Certificates, as described in the respective Prospectus Supplement (any
such series, a "SENIOR/SUBORDINATE SERIES"); (iii) one or more classes of
Strip Certificates which will be entitled to (a) principal distributions, with
disproportionate, nominal or no interest distributions or (b) interest
distributions, with disproportionate, nominal or no principal distributions;
(iv) two or more classes of Certificates which differ as to the timing,
sequential order, rate, pass-through rate or amount of distributions of
principal or interest or both, or as to which distributions of principal or
interest or both on any class may be made upon the occurrence of specified
events, in accordance with a schedule or formula (including "planned
amortization classes" and "targeted amortization classes" and "very accurately
defined maturity classes"), or on the basis of collections from designated
portions of the Mortgage Pool, which series may include one or more classes of
Accrual Certificates with respect to which certain accrued interest will not
be distributed but rather will be added to the principal balance thereof on
each Distribution Date for the period described in the related Prospectus
Supplement; or (v) similar classes of Certificates with other payment
characteristics, as described in the related Prospectus Supplement. Credit
support for each series of Certificates will be provided by a Financial
Guaranty Insurance Policy, Special Hazard Insurance Policy, Bankruptcy Bond,
Letter of Credit, Reserve Fund, Surety
29
<PAGE>
Bond, by the subordination of one or more classes of Certificates,
Overcollateralization or other credit enhancement as described under
"Description of Credit Enhancement," or by any combination of the foregoing.
FORM OF CERTIFICATES
As specified in the related Prospectus Supplement, the Certificates of each
series will be issued either as physical certificates or in book-entry form.
If issued as physical certificates, the Certificates will be in fully
registered form only in the denominations specified in the related Prospectus
Supplement, and will be transferrable and exchangeable at the corporate trust
office of the person appointed under the related Pooling and Servicing
Agreement to register the Certificates (the "CERTIFICATE REGISTRAR"). No
service charge will be made for any registration of exchange or transfer of
Certificates, but the Trustee may require payment of a sum sufficient to cover
any tax or other governmental charge. The term "CERTIFICATEHOLDER" as used
herein refers to the entity whose name appears on the records of the
Certificate Registrar (or, if applicable, a transfer agent) as the registered
holder thereof, except as otherwise indicated in the related Prospectus
Supplement.
If issued in book-entry form certain classes of a series of Certificates
will be initially issued through the book-entry facilities of The Depository
Trust Company ("DTC"), or Cedel Bank, societe anonyme ("CEDEL") or the
Euroclear System ("EUROCLEAR") (in Europe) if they are participants of such
systems, or indirectly through organizations which are participants in such
systems, or through such other depository or facility as may be specified in
the related Prospectus Supplement. As to any such class of Certificates so
issued ("BOOK-ENTRY CERTIFICATES"), the record holder of such Certificates
will be DTC's nominee. 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 (the
"DEPOSITARIES"), which in turn will hold such positions in customers'
securities accounts in the depositaries' names on the books of DTC.
DTC is a limited-purpose trust company organized under the laws of the State
of New York, which holds securities for its participating organizations ("DTC
PARTICIPANTS," and together with the CEDEL and Euroclear participating
organizations "PARTICIPANTS") and facilitates the clearance and settlement of
securities transactions between Participants through electronic book-entry
changes in the accounts of Participants. Participants include securities
brokers and dealers, banks, trust companies and clearing corporations and may
include certain other organizations. Other institutions that are not
Participants but clear through or maintain a custodial relationship with
Participants (such institutions, "INDIRECT PARTICIPANTS") have indirect access
to DTC's clearance system.
Unless otherwise specified in the related Prospectus Supplement, no person
acquiring an interest in any Book-Entry Certificate (each such person, a
"BENEFICIAL OWNER") will be entitled to receive a Certificate representing
such interest in registered, certificated form, unless either (i) DTC ceases
to act as depository in respect thereof and a successor depository is not
obtained or (ii) the Trustee elects in its sole discretion to discontinue the
registration of such Certificates through DTC. Prior to any such event,
Beneficial Owners will not be recognized by the Trustee or the Master Servicer
as holders of the related Certificates for purposes of the Pooling and
Servicing Agreement, and Beneficial Owners will be able to exercise their
rights as owners of such Certificates only indirectly through DTC,
Participants and Indirect Participants. Any Beneficial Owner that desires to
purchase, sell or otherwise transfer any interest in Book-Entry Certificates
may do so only through DTC, either directly if such Beneficial Owner is a
Participant or indirectly through Participants and, if applicable, Indirect
Participants. Pursuant to the procedures of DTC, transfers of the beneficial
ownership of any Book-Entry Certificates will be required to be made in
minimum denominations specified in the related Prospectus Supplement. The
ability of a Beneficial Owner to pledge Book-Entry Certificates to persons or
entities that are not Participants in the DTC system, or to otherwise act with
respect to such Certificates, may be limited because of the lack of physical
certificates evidencing such Certificates and because DTC may act only on
behalf of Participants.
Because of time zone differences, the securities account of a CEDEL or
Euroclear participant as a result of a transaction with a DTC Participant
(other than a depositary holding on behalf of CEDEL or Euroclear) will be
credited during subsequent securities settlement processing day (which must be
a business day for CEDEL or
30
<PAGE>
Euroclear, as the case may be) immediately following the DTC settlement date.
Such credits or any transactions in such securities settled during such
processing will be reported to the relevant Euroclear Participant 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 DTC Participant (other than the depositary for CEDEL or
Euroclear) will be received with value on the DTC settlement date, but will be
available in the relevant CEDEL or Euroclear cash account only as of the
business day following settlement in DTC.
Transfers between Participants will occur in accordance with DTC rules.
Transfers between CEDEL Participants and Euroclear Participants will occur in
accordance with their respective rules and operating procedures.
Cross-market transfers between persons holding directly or indirectly
through DTC, on the one hand, and directly or indirectly through CEDEL
Participants or Euroclear Participants, on the other, will be effected in DTC
in accordance with DTC rules on behalf of the relevant European international
clearing system by the relevant Depositaries; 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.
CEDEL, as a professional depository, 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. As a professional
depository, CEDEL is subject to regulation by the Luxembourg Monetary
Institute.
Euroclear was created 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. 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 co-operative corporation (the
"CLEARANCE 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 Clearance
Cooperative. The Clearance Cooperative establishes policy for Euroclear on
behalf of Euroclear Participants. 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 specific securities clearance accounts.
Distributions in respect of the Book-Entry Certificates will be forwarded by
the Trustee to DTC, and DTC will be responsible for forwarding such payments
to Participants, each of which will be responsible for disbursing such
payments to the Beneficial Owners it represents or, if applicable, to Indirect
Participants. Accordingly, Beneficial Owners may experience delays in the
receipt of payments in respect of their Certificates. Under DTC's procedures,
DTC will take actions permitted to be taken by holders of any class of Book-
Entry Certificates under the Pooling and Servicing Agreement only at the
direction of one or more Participants to whose account the
31
<PAGE>
Book-Entry Certificates are credited and whose aggregate holdings represent no
less than any minimum amount of Percentage Interests or voting rights required
therefor. DTC may take conflicting actions with respect to any action of
Certificateholders of any Class to the extent that Participants authorize such
actions. None of the Master Servicer, the Company, the Trustee or any of their
respective affiliates will have any liability for any aspect of the records
relating to or payments made on account of beneficial ownership interests in
the Book-Entry Certificates, or for maintaining, supervising or reviewing any
records relating to such beneficial ownership interests.
ASSIGNMENT OF TRUST FUND ASSETS
At the time of issuance of a series of Certificates, the Company will cause
the Mortgage Loans (or Trust Balances thereof, if applicable) or Mortgage
Securities and any other assets being included in the related Trust Fund to be
assigned without recourse to the Trustee or its nominee (which may be the
Custodian) together with, if specified in the related Prospectus Supplement,
all principal and interest received on or with respect to such Mortgage Loans
(or Trust Balances thereof, if applicable) or Mortgage Securities after the
Cut-off Date (other than principal and interest due on or before the Cut-off
Date and any Excluded Spread). The Trustee will, concurrently with such
assignment, deliver a series of Certificates to the Company in exchange for
the Mortgage Loans (or Trust Balances thereof, if applicable) or Mortgage
Securities. Each Mortgage Loan, Trust Balance or Mortgage Security will be
identified in a schedule appearing as an exhibit to the related Pooling and
Servicing Agreement. Such schedule will include, among other things,
information as to the principal balance of each Mortgage Loan as of the Cut-
off Date, as well as information respecting the Mortgage Rate, the currently
scheduled monthly payment of principal and interest, the maturity of the
Mortgage Note and the Combined Loan-to-Value Ratio at origination or
modification.
In addition, except as provided below with respect to certain series of
Certificates backed by Trust Balances of Revolving Credit Loans, the Company
will, as to each Mortgage Loan other than Mortgage Loans underlying any
Mortgage Securities, deliver to the Trustee (or to the Custodian) the legal
documents relating to such Mortgage Loan that are in possession of the
Company, which may include: (i) the Mortgage Note (and any modification or
amendment thereto) endorsed without recourse either in blank or to the order
of the Trustee (or its nominee); (ii) the Mortgage (except for any Mortgage
not returned from the public recording office) with evidence of recording
indicated thereon or, in the case of a Cooperative Loan, the respective
security agreements and any applicable UCC financing statements; (iii) an
assignment in recordable form of the Mortgage (or, with respect to a
Cooperative Loan, an assignment of the respective security agreements, any
applicable UCC financing statements, recognition agreements, relevant stock
certificates, related blank stock powers and the related proprietary leases or
occupancy agreements); and (iv) if applicable, any riders or modifications to
such Mortgage Note and Mortgage, together with certain other documents at such
times as set forth in the related Pooling and Servicing Agreement. Such
assignments may be blanket assignments covering Mortgages secured by Mortgaged
Properties located in the same county, if permitted by law. If so specified in
the related Prospectus Supplement, the Company may not be required to deliver
one or more of such documents if such documents are missing from the files of
the party from whom such Mortgage Loans were purchased.
In the event that, with respect to any Mortgage Loan (except as provided
below), the Company cannot deliver the Mortgage or any assignment with
evidence of recording thereon concurrently with the execution and delivery of
the related Pooling and Servicing Agreement because of a delay caused by the
public recording office, the Company will deliver or cause to be delivered to
the Trustee or the Custodian a true and correct photocopy of such Mortgage or
assignment. The Company will deliver or cause to be delivered to the Trustee
or the Custodian such Mortgage or assignment with evidence of recording
indicated thereon after receipt thereof from the public recording office or
from the related Subservicer.
Assignments of the Mortgage Loans to the Trustee will be recorded in the
appropriate public recording office, except in states where, in the opinion of
counsel acceptable to the Trustee, such recording is not required to protect
the Trustee's interests in the Mortgage Loan against the claim of any
subsequent transferee or any
32
<PAGE>
successor to or creditor of the Company or the originator of such Mortgage
Loan, or except as otherwise specified in the related Prospectus Supplement.
Notwithstanding the preceding three paragraphs, with respect to any series
of Certificates backed by Trust Balances of Revolving Credit Loans, the
foregoing documents generally will have been delivered to an entity specified
in the related Prospectus Supplement which may be the Trustee, a Custodian or
another entity appointed by the Trustee, and such entity shall hold such
documents as or on behalf of the Trustee for the benefit of the
Certificateholders, with respect to the Trust Balances thereof, and on behalf
of any other applicable entity with respect to any Excluded Balance thereof,
as their respective interests may appear.
REVIEW OF MORTGAGE LOANS
The Trustee will be authorized to appoint one or more custodians (each, a
"CUSTODIAN") pursuant to a custodial agreement to maintain possession of and
review documents relating to the Mortgage Loans as the agent of the Trustee
(except as provided below). The identity of such Custodian, if any, will be
set forth in the related Prospectus Supplement.
The Trustee or the Custodian will hold such documents in trust for the
benefit of the Certificateholders and, generally will review such documents
within 45 days after receipt thereof. If any such document is found to be
defective in any material respect, the Trustee or such Custodian shall notify
the Master Servicer and the Company, and if so specified in the related
Prospectus Supplement, the Master Servicer, the Servicer or the Trustee shall
notify Residential Funding or the Designated Seller. If Residential Funding
or, in a Designated Seller Transaction, the Designated Seller cannot cure such
defect within 60 days (or within such other period specified in the related
Prospectus Supplement) after notice of the defect is given to Residential
Funding (or, if applicable, the Designated Seller), Residential Funding (or,
if applicable, the Designated Seller) is required to, not later than 90 days
after such notice (or within such other period specified in the related
Prospectus Supplement), either repurchase the related Mortgage Loan or any
property acquired in respect thereof from the Trustee, or if permitted
substitute for such Mortgage Loan a new Mortgage Loan in accordance with the
standards set forth herein. The Master Servicer will be obligated to enforce
this obligation of Residential Funding or the Designated Seller to the extent
described above under "Mortgage Loan Program--Representations Relating to
Mortgage Loans," but such obligation is subject to the provisions described
below under "--Realization Upon Defaulted Mortgage Loans." There can be no
assurance that the applicable Designated Seller will fulfill its obligation to
purchase any Mortgage Loan as described above. Unless otherwise specified in
the related Prospectus Supplement, neither Residential Funding, the Master
Servicer nor the Company will be obligated to purchase or substitute for such
Mortgage Loan if the Designated Seller defaults on its obligation to do so.
Unless otherwise specified in the related Prospectus Supplement, the
obligation to repurchase or substitute for a Mortgage Loan constitutes the
sole remedy available to the Certificateholders or the Trustee for a material
defect in a constituent document. Any Mortgage Loan not so purchased or
substituted for shall remain in the related Trust Fund.
Notwithstanding the foregoing, with respect to the Trust Balance of a
Revolving Credit Loan, such review of the related documents need not be
performed if a similar review has previously been performed by the entity
holding such documents with respect to an Excluded Balance and such review
covered all documentation with respect to any Trust Balance.
The Master Servicer will make certain representations and warranties
regarding its authority to enter into, and its ability to perform its
obligations under, the Pooling and Servicing Agreement. Upon a breach of any
such representation of the Master Servicer which materially adversely affects
the interests of the Certificateholders in a Mortgage Loan, the Master
Servicer will be obligated either to cure the breach in all material respects
or to purchase the Mortgage Loan at its Purchase Price (less unreimbursed
advances, if applicable, made by the Master Servicer with respect to such
Mortgage Loan) or, unless otherwise specified in the related Prospectus
Supplement, to substitute for such Mortgage Loan a Qualified Substitute
Mortgage Loan in accordance with the provisions for such substitution
described above under "Mortgage Loan Program--Representations Relating to
33
<PAGE>
Mortgage Loans." Unless otherwise specified in the related Prospectus
Supplement, this purchase obligation will constitute the sole remedy available
to Certificateholders or the Trustee for such a breach of representation by
the Master Servicer. Any Mortgage Loan not so purchased or substituted for
shall remain in the related Trust Fund.
SPREAD
The Company, the Master Servicer or any of their affiliates, or such other
entity as may be specified in the related Prospectus Supplement may retain or
be paid a portion of interest due with respect to the related Mortgage Loans
or Mortgage Securities. The payment of any such portion of interest will be
disclosed in the related Prospectus Supplement. This payment may be in
addition to any other payment (such as the servicing fee) that any such entity
is otherwise entitled to receive with respect to the Mortgage Loans or
Mortgage Securities. Any such payment in respect of the Mortgage Loans or
Mortgage Securities will represent a specified portion of the interest payable
thereon and as specified in the related Prospectus Supplement, will either be
part of the assets transferred to the related Trust Fund (the "EXCESS SPREAD")
or will be excluded from the assets transferred to the related Trust Fund (the
"EXCLUDED SPREAD"). The interest portion of a Realized Loss or Extraordinary
Loss and any partial recovery of interest in respect of the Mortgage Loans or
Mortgage Securities will be allocated between the owners of any Excess Spread
or Excluded Spread and the Certificateholders entitled to payments of interest
as provided in the applicable Pooling and Servicing Agreement.
PAYMENTS ON MORTGAGE LOANS; DEPOSITS TO CERTIFICATE ACCOUNT
Each Subservicer servicing a Mortgage Loan pursuant to a Subservicing
Agreement will establish and maintain an account (the "SUBSERVICING ACCOUNT")
which generally meets the requirements set forth in the Guide from time to
time. A Subservicer is required to deposit into its Subservicing Account on a
daily basis all amounts that are received by it in respect of the Mortgage
Loans, less its servicing or other compensation. As specified in the
Subservicing Agreement, the Subservicer must remit or cause to be remitted to
the Master Servicer all funds held in the Subservicing Account with respect to
Mortgage Loans that are required to be so remitted on a periodic basis not
less frequently than monthly. If so specified in the related Prospectus
Supplement, the Subservicer may also be required to advance on the scheduled
date of remittance any monthly installment of principal and interest (or
interest only, with respect to Simple Interest Mortgage Loans), less its
servicing or other compensation, on any Mortgage Loan for which payment was
not received from the Mortgagor.
The Master Servicer will deposit or will cause to be deposited into the
Custodial Account certain payments and collections received by it subsequent
to the Cut-off Date (other than payments due on or before the Cut-off Date),
as specifically set forth in the related Pooling and Servicing Agreement,
which (except as otherwise provided therein) generally will include the
following:
(i) payments on account of principal of the Mortgage Loans or on the
Mortgage Securities comprising a Trust Fund;
(ii) payments on account of interest on the Mortgage Loans or on the
Mortgage Securities comprising such Trust Fund, net of the portion of each
payment thereof retained by the Subservicer, if any, as its servicing or
other compensation;
(iii) amounts (net of unreimbursed liquidation expenses and insured
expenses incurred, and unreimbursed Servicing Advances, if any, made by the
related Subservicer) received and retained in connection with the
liquidation of any defaulted Mortgage Loan, by foreclosure or otherwise
("LIQUIDATION PROCEEDS"), including all proceeds of any Special Hazard
Insurance Policy, Bankruptcy Bond, hazard or other insurance policy or
guaranty covering any Mortgage Loan in such Mortgage Pool (together with
any payments under any Letter of Credit, "INSURANCE PROCEEDS") or proceeds
from any alternative arrangements established in lieu of any such insurance
and described in the applicable Prospectus Supplement, other than proceeds
to be applied to the restoration of the related property or released to the
Mortgagor in accordance with the Master Servicer's normal servicing
procedures;
34
<PAGE>
(iv) proceeds of any Mortgage Loan in such Trust Fund purchased (or, in
the case of a substitution, certain amounts representing a principal
adjustment) by the Master Servicer, the Company, Residential Funding, any
Subservicer or Seller or any other person pursuant to the terms of the
Pooling and Servicing Agreement. See "Mortgage Loan Program--
Representations Relating to Mortgage Loans," and "Description of the
Certificates--Assignment of Trust Fund Assets" above;
(v) any amount required to be deposited by the Master Servicer in
connection with losses realized on investments of funds held in the
Custodial Account, as described below; and
(vi) any amounts required to be transferred from the Certificate Account
to the Custodial Account.
In addition to the Custodial Account, the Master Servicer will establish and
maintain, in the name of the Trustee for the benefit of the holders of each
series of Certificates, an account for the disbursement of payments on the
Mortgage Loans evidenced by each series of Certificates (the "CERTIFICATE
ACCOUNT"). Both the Custodial Account and the Certificate Account must be
either (i) maintained with a depository institution whose debt obligations at
the time of any deposit therein are rated by any Rating Agency that rated any
Certificates of the related series not less than a specified level comparable
to the rating category of such Certificates, (ii) an account or accounts the
deposits in which are fully insured to the limits established by the FDIC,
provided that any deposits not so insured shall be otherwise maintained such
that, as evidenced by an opinion of counsel, the Certificateholders have a
claim with respect to the funds in such accounts or a perfected first priority
security interest in any collateral securing such funds that is superior to
the claims of any other depositors or creditors of the depository institution
with which such accounts are maintained, (iii) in the case of the Custodial
Account, a trust account or accounts maintained in either the corporate trust
department or the corporate asset services department of a financial
institution which has debt obligations that meet certain rating criteria, (iv)
in the case of the Certificate Account, a trust account or accounts maintained
with the Trustee, or (v) such other account or accounts acceptable to any
applicable Rating Agency (an "ELIGIBLE ACCOUNT"). The collateral that is
eligible to secure amounts in an Eligible Account is limited to certain
permitted investments, which are generally limited to United States government
securities and other investments that are rated, at the time of acquisition,
in one of the categories permitted by the related Pooling and Servicing
Agreement ("PERMITTED INVESTMENTS").
Unless otherwise set forth in the related Prospectus Supplement, not later
than the business day preceding each Distribution Date, the Master Servicer
will withdraw from the Custodial Account and deposit into the applicable
Certificate Account, in immediately available funds, the amount to be
distributed therefrom to Certificateholders on such Distribution Date. The
Master Servicer or the Trustee will also deposit or cause to be deposited into
the Certificate Account: (i) the amount of any Advances on Closed-End Loans,
if applicable, made by the Master Servicer as described herein under "--
Advances on Closed-End Loans," (ii) any payments under any Letter of Credit,
Financial Guaranty Insurance Policy and any amounts required to be transferred
to the Certificate Account from a Reserve Fund, as described under "Credit
Enhancement" below or (iii) any amounts required to be paid by the Master
Servicer out of its own funds due to the operation of a deductible clause in
any blanket policy maintained by the Master Servicer to cover hazard losses on
the Mortgage Loans as described under "Description of the Certificates--Hazard
Insurance; Claims Thereunder" below, (iv) any distributions received on any
Mortgage Securities included in the Trust Fund and (v) any other amounts as
set forth in the related Pooling and Servicing Agreement.
The portion of any payment received by the Master Servicer in respect of a
Mortgage Loan that is allocable to Excess Spread or Excluded Spread, as
applicable, will generally be deposited into the Custodial Account, but any
Excluded Spread will not be deposited in the Certificate Account for the
related series of Certificates and will be distributed as provided in the
related Pooling and Servicing Agreement.
Funds on deposit in the Custodial Account may be invested in Permitted
Investments maturing in general not later than the business day preceding the
next Distribution Date, and funds on deposit in the related Certificate
Account may be invested in Permitted Investments maturing, in general, no
later than the Distribution Date. Unless otherwise specified in the related
Prospectus Supplement, all income and gain realized from any such investment
will be for the account of the Master Servicer as additional servicing
compensation. The amount
35
<PAGE>
of any loss incurred in connection with any such investment must be deposited
in the Custodial Account or in the Certificate Account, as the case may be, by
the Master Servicer out of its own funds upon realization of such loss.
WITHDRAWALS FROM THE CUSTODIAL ACCOUNT
The Master Servicer may, from time to time, make withdrawals from the
Custodial Account for certain purposes, as specifically set forth in the
related Pooling and Servicing Agreement, which (except as otherwise provided
therein) generally will include the following:
(i) to make deposits to the Certificate Account in the amounts and in the
manner provided in the Pooling and Servicing Agreement and described above
under "--Payments on Mortgage Loans; Deposits to Certificate Account;"
(ii) to reimburse itself or any Subservicer for Advances, if applicable,
or for amounts advanced in respect of taxes, insurance premiums or similar
expenses ("SERVICING ADVANCES") as to any Mortgaged Property, out of late
payments, Insurance Proceeds, Liquidation Proceeds or collections on the
Mortgage Loan with respect to which such Advances or Servicing Advances
were made;
(iii) to pay to itself or any Subservicer unpaid Servicing Fees and
Subservicing Fees, out of payments or collections of interest on each
Mortgage Loan;
(iv) to pay to itself as additional servicing compensation any investment
income on funds deposited in the Custodial Account, any amounts remitted by
Subservicers as interest in respect of partial prepayments on the Mortgage
Loans, and, if so provided in the Pooling and Servicing Agreement, any
profits realized upon disposition of a Mortgaged Property acquired by deed
in lieu of foreclosure or repossession or otherwise allowed under the
Pooling and Servicing Agreement;
(v) to pay to itself, a Subservicer, Residential Funding, the Company or
the Seller all amounts received with respect to each Mortgage Loan
purchased, repurchased or removed pursuant to the terms of the Pooling and
Servicing Agreement and not required to be distributed as of the date on
which the related Purchase Price is determined;
(vi) to pay the Company or its assignee, or any other party named in the
related Prospectus Supplement all amounts allocable to the Excluded Spread,
if any, out of collections or payments which represent interest on each
Mortgage Loan (including any Mortgage Loan as to which title to the
underlying Mortgaged Property was acquired);
(vii) to reimburse itself or any Subservicer for any Advance, if
applicable, previously made which the Master Servicer has determined to not
be ultimately recoverable from Liquidation Proceeds, Insurance Proceeds or
otherwise (a "NONRECOVERABLE ADVANCE"), subject to any limitations set
forth in the Pooling and Servicing Agreement as described in the related
Prospectus Supplement;
(viii) to reimburse itself or the Company for certain other expenses
incurred for which it or the Company is entitled to reimbursement
(including reimbursement in connection with enforcing any repurchase,
substitution or indemnification obligation of any Designated Seller) or
against which it or the Company is indemnified pursuant to the Pooling and
Servicing Agreement;
(ix) to withdraw any amount deposited in the Custodial Account that was
not required to be deposited therein;
(x) to pay to itself or any Subservicer for the funding of any Draws made
on the Mortgage Loans, if applicable; and
(xi) to make deposits to the Funding Account in the amounts and in the
manner provided in the Pooling and Servicing Agreement, if applicable.
36
<PAGE>
DISTRIBUTIONS
Distributions of principal and interest (or, where applicable, of principal
only or interest only) on each class of Certificates entitled thereto will be
made on each Distribution Date either by the Trustee, the Master Servicer
acting on behalf of the Trustee or a paying agent appointed by the Trustee
(the "PAYING AGENT"). Such distributions will be made to the persons who are
registered as the holders of such Certificates at the close of business on the
last business day of the preceding month (the "RECORD DATE"). Distributions
will be made in immediately available funds (by wire transfer or otherwise) to
the account of a Certificateholder at a bank or other entity having
appropriate facilities therefor, if such Certificateholder has so notified the
Trustee, the Master Servicer or the Paying Agent, as the case may be, and the
applicable Pooling and Servicing Agreement provides for such form of payment,
or by check mailed to the address of the person entitled thereto as it appears
on the Certificate Register. The final distribution in retirement of the
Certificates will be made only upon presentation and surrender of the
Certificates at the office or agency of the Trustee specified in the notice to
Certificateholders. Distributions will be made to each Certificateholder in
accordance with such holder's Percentage Interest in a particular class. The
("PERCENTAGE INTEREST") represented by a Certificate of a particular class
will be equal to the percentage obtained by dividing the initial principal
balance or notional amount of such Certificate by the aggregate initial amount
or notional balance of all the Certificates of such class.
PRINCIPAL AND INTEREST ON THE CERTIFICATES
The method of determining, and the amount of, distributions of principal and
interest (or, where applicable, of principal only or interest only) on a
particular series of Certificates will be described in the related Prospectus
Supplement. Distributions of interest on each class of Certificates will be
made prior to distributions of principal thereon. Each class of Certificates
(other than certain classes of Strip Certificates) may have a different Pass-
Through Rate, which may be a fixed, variable or adjustable Pass-Through Rate,
or any combination of two or more such Pass-Through Rates. The related
Prospectus Supplement will specify the Pass-Through Rate or Rates for each
class, or the initial Pass-Through Rate or Rates and the method for
determining the Pass-Through Rate or Rates. Unless otherwise specified in the
related Prospectus Supplement, interest on the Certificates will be calculated
on the basis of a 360-day year consisting of twelve 30-day months.
On each Distribution Date for a series of Certificates, the Trustee or the
Master Servicer on behalf of the Trustee will distribute or cause the Paying
Agent to distribute, as the case may be, to each holder of record on the
Record Date of a class of Certificates, an amount equal to the Percentage
Interest represented by the Certificate held by such holder multiplied by such
class's Distribution Amount. The "DISTRIBUTION AMOUNT" for a class of
Certificates for any Distribution Date will be the portion, if any, of the
Principal Distribution Amount (as defined in the related Prospectus
Supplement) allocable to such class for such Distribution Date, plus, if such
class is entitled to payments of interest on such Distribution Date, one
month's interest at the applicable Pass-Through Rate on the principal balance
or notional amount of such class specified in the applicable Prospectus
Supplement, less certain interest shortfalls, which generally will include (i)
any Deferred Interest added to the principal balance of the Mortgage Loans
and/or the outstanding balance of one or more classes of Certificates on the
related Due Date, (ii) any other interest shortfalls (including, without
limitation, shortfalls resulting from application of the Relief Act or similar
legislation or regulations as in effect from time to time) allocable to
Certificateholders which are not covered by advances or the applicable credit
enhancement and (iii) if so specified in the related Prospectus Supplement,
Prepayment Interest Shortfalls (as defined herein) in collections of interest
on Closed-End Loans resulting from Mortgagor prepayments during the month
preceding the month of distribution, in each case in such amount that is
allocated to such class on the basis set forth in the Prospectus Supplement.
In the case of a series of Certificates which includes two or more classes
of Certificates, the timing, sequential order, priority of payment or amount
of distributions in respect of principal, and any schedule or formula or other
provisions applicable to the determination thereof (including distributions
among multiple classes of Senior Certificates or Subordinate Certificates)
shall be as set forth in the related Prospectus Supplement. Distributions in
respect of principal of any class of Certificates will be made on a pro rata
basis
37
<PAGE>
among all of the Certificates of such class unless otherwise set forth in the
related Prospectus Supplement. In addition, unless otherwise specified in the
related Prospectus Supplement, distributions of principal on the Certificates
will be limited to monthly principal payments on the Mortgage Loans, any
Excess Interest, if applicable, applied as principal distributions on the
Certificates and any amount distributed as a payment of principal under the
related form of Credit Enhancement. To the extent the Trust Fund contains
Balloon Loans that require no monthly payments and non-amortizing Mortgage
Loans that require only small principal payments in proportion to the
principal balance of such Mortgage Loan, the amount of principal distributions
on the Certificates generally will be less than the amount that would
otherwise be distributable on a similar pool of conventional loans.
On the day specified in the related Prospectus Supplement as the
determination date (the "DETERMINATION DATE"), the Master Servicer will
determine the amounts of principal and interest which will be passed through
to Certificateholders on the succeeding Distribution Date. Prior to the close
of business on the business day succeeding each Determination Date, the Master
Servicer will furnish a statement to the Trustee (the information in such
statement to be made available to Certificateholders by the Master Servicer on
request) setting forth, among other things, the amount to be distributed on
the next succeeding Distribution Date.
ADVANCES ON CLOSED-END LOANS
Unless otherwise specified in the related Prospectus Supplement, in
connection with Closed-End Loans, the Master Servicer will agree to advance
(either out of its own funds, funds advanced to it by Subservicers or funds
being held in the Custodial Account for future distribution), for the benefit
of the Certificateholders, on or before each Distribution Date, an amount
equal to the aggregate of all scheduled payments of principal (except with
respect to Simple Interest Mortgage Loans and other than any Balloon Amount in
the case of a Balloon Loan) and interest at the applicable Pass-Through Rate
or Net Mortgage Rate, as the case may be (an "ADVANCE"), which were delinquent
as of the close of business on the business day preceding the Determination
Date on the Mortgage Loans in the related Mortgage Pool, but only to the
extent that such Advances would, in the judgment of the Master Servicer, be
recoverable out of late payments by the Mortgagors, Liquidation Proceeds,
Insurance Proceeds or otherwise. Advances will not be made in connection with
Revolving Credit Loans, except as otherwise provided in the related Prospectus
Supplement. As specified in the related Prospectus Supplement with respect to
any series of Certificates as to which the Trust Fund includes Mortgage
Securities, the Master Servicer's advancing obligations will be pursuant to
the terms of such Mortgage Securities, as may be supplemented by the terms of
the applicable Pooling and Servicing Agreement, and may differ from the
provisions relating to Advances described herein. Unless specified in the
related Prospectus Supplement, the Master Servicer will not make any advance
with respect to principal on any Simple Interest Mortgage Loan.
Advances are intended to maintain a regular flow of scheduled interest and
principal payments to related Certificateholders. Such advances do not
represent an obligation of the Master Servicer to guarantee or insure against
losses. If Advances have been made by the Master Servicer from cash being held
for future distribution to Certificateholders, such funds will be required to
be replaced on or before any future Distribution Date to the extent that funds
in the Certificate Account on such Distribution Date would be less than
payments required to be made to Certificateholders. Any Advance will be
reimbursable to the Master Servicer out of recoveries on the related Mortgage
Loans for which such amounts were advanced (e.g., late payments made by the
related Mortgagor, any related Liquidation Proceeds and Insurance Proceeds,
proceeds of any applicable form of credit enhancement or proceeds of any
Mortgage Loan purchased by the Company, Residential Funding, a Subservicer or
a Seller under the circumstances described above). Such Advances will also be
reimbursable from cash otherwise distributable to Certificateholders
(including the holders of Senior Certificates, if applicable) to the extent
that the Master Servicer shall determine that any such Advances previously
made are not ultimately recoverable as described above. With respect to any
Senior/Subordinate Series, so long as the related Subordinate Certificates
remain outstanding and subject to certain limitations with respect to Special
Hazard Losses, Fraud Losses, Bankruptcy Losses and Extraordinary Losses, such
Advances may also be reimbursable out of amounts otherwise distributable to
holders of the Subordinate Certificates, if any. The Master Servicer generally
will also be obligated to make Servicing Advances, to the extent recoverable
out of Liquidation Proceeds or otherwise, in
38
<PAGE>
respect of certain taxes and insurance premiums not paid by Mortgagors on a
timely basis. Funds so advanced will be reimbursable to the Master Servicer to
the extent permitted by the Pooling and Servicing Agreement. The Master
Servicer's obligation to make Advances may be supported by another entity, the
Trustee, a Financial Guaranty Insurance Policy, a letter of credit or other
method as may be described in the related Pooling and Servicing Agreement. In
the event that the short-term or long-term obligations of the provider of such
support are downgraded by a Rating Agency rating the related Certificates or
if any collateral supporting such obligation is not performing or is removed
pursuant to the terms of any agreement described in the related Prospectus
Supplement, the Certificates may also be downgraded.
FUNDING ACCOUNT
If so specified in the related Prospectus Supplement, a Pooling and
Servicing Agreement or other agreement may provide for the transfer by the
Sellers of additional Mortgage Loans to the related Trust after the Closing
Date for the related Certificates. Such additional Mortgage Loans will be
required to conform to the requirements set forth in the related Pooling and
Servicing Agreement or other agreement providing for such transfer. As
specified in the related Prospectus Supplement, such transfer may be funded by
the establishment of a Funding Account (a "FUNDING ACCOUNT"). If a Funding
Account is established, all or a portion of the proceeds of the sale of one or
more Classes of Certificates of the related Series or a portion of collections
on the Mortgage Loans in respect of principal will be deposited in such
account to be released as additional Mortgage Loans are transferred. Unless
otherwise specified in the related Prospectus Supplement, a Funding Account
will be required to be maintained as an Eligible Account, all amounts therein
will be required to be invested in Permitted Investments and the amount held
therein shall at no time exceed 25% of the aggregate outstanding principal
balance of the Certificates. Unless otherwise specified in the related
Prospectus Supplement, the related Pooling and Servicing Agreement or other
agreement providing for the transfer of additional Mortgage Loans will provide
that all such transfers must be made within 9 months (as to amounts
representing proceeds of the sale of the Certificates) or 12 months (as to
amounts representing principal collections on the Mortgage Loans) after the
Closing Date, and that amounts set aside to fund such transfers (whether in a
Funding Account or otherwise) and not so applied within the required period of
time will be deemed to be principal prepayments and applied in the manner set
forth in such Prospectus Supplement.
REPORTS TO CERTIFICATEHOLDERS
On each Distribution Date, the Master Servicer will forward or cause to be
forwarded to each Certificateholder of record a statement or statements with
respect to the related Trust Fund setting forth the information described in
the related Pooling and Servicing Agreement. Except as otherwise provided in
the related Pooling and Servicing Agreement, such information generally will
include the following, as applicable:
(i) the amount, if any, of such distribution allocable to principal;
(ii) the amount, if any, of such distribution allocable to interest, and
the amount, if any, of any shortfall in the amount of interest and
principal;
(iii) the aggregate unpaid principal balance of the Mortgage Loans or, if
applicable, the Trust Balances thereof after giving effect to the
distribution of principal on such Distribution Date;
(iv) the outstanding principal balance or notional amount of each class
of Certificates after giving effect to the distribution of principal on
such Distribution Date;
(v) based on the most recent reports furnished by Subservicers, the
number of Mortgage Loans in the related Mortgage Pool that are delinquent
(a) one month, (b) two months and (c) three months, and that are in
foreclosure and the aggregate principal balances of such Mortgage Loans or,
if applicable, the Trust Balances thereof;
(vi) the book value of any property acquired by such Trust Fund through
foreclosure or grant of a deed in lieu of foreclosure;
(vii) the balance of the Reserve Fund, if any, at the close of business
on such Distribution Date;
39
<PAGE>
(viii) the percentage of the outstanding principal balance of the Senior
Certificates, if applicable, after giving effect to the distributions on
such Distribution Date;
(ix) the amount of coverage under any Letter of Credit or other form of
credit enhancement covering default risk as of the close of business on the
applicable Determination Date and a description of any credit enhancement
substituted therefor;
(x) if applicable, the Special Hazard Amount, Fraud Loss Amount and
Bankruptcy Amount as of the close of business on the applicable
Distribution Date and a description of any change in the calculation of
such amounts;
(xi) in the case of Certificates benefiting from alternative credit
enhancement arrangements described in a Prospectus Supplement, the amount
of coverage under such alternative arrangements as of the close of business
on the applicable Determination Date; and
(xii) with respect to any series of Certificates as to which the Trust
Fund includes Mortgage Securities, certain additional information as
required under the related Pooling and Servicing Agreement.
Each amount set forth pursuant to clause (i) or (ii) above will be expressed
as a dollar amount per Single Certificate. As to a particular class of
Certificates, a "SINGLE CERTIFICATE" generally will evidence a Percentage
Interest obtained by dividing $1,000 by the initial principal balance or
notional balance of all the Certificates of such class, except as otherwise
provided in the related Pooling and Servicing Agreement. In addition to the
information described above, reports to Certificateholders will contain such
other information as is set forth in the applicable Pooling and Servicing
Agreement, which may include, without limitation, information as to Advances,
reimbursements to Subservicers and the Master Servicer and losses borne by the
related Trust Fund.
In addition, to the extent described in the Pooling and Servicing Agreement,
within a reasonable period of time after the end of each calendar year, the
Master Servicer will furnish a report to each person that was a holder of
record of any class of Certificates at any time during such calendar year.
Such report will include information as to the aggregate of amounts reported
pursuant to clauses (i) and (ii) above for such calendar year or, in the event
such person was a holder of record of a class of Certificates during a portion
of such calendar year, for the applicable portion of such year.
COLLECTION AND OTHER SERVICING PROCEDURES
The Master Servicer, directly or through Subservicers, as the case may be,
will make reasonable efforts to collect all payments called for under the
Mortgage Loans and will, consistent with the related Pooling and Servicing
Agreement and any applicable insurance policy or other credit enhancement,
follow such collection procedures which shall be normal and usual in its
general mortgage servicing activities with respect to mortgage loans
comparable to the Mortgage Loans. Consistent with the foregoing, the Master
Servicer may in its discretion waive any prepayment charge in connection with
the prepayment of a Mortgage Loan or extend the Due Dates for payments due on
a Mortgage Note, provided that the insurance coverage for such Mortgage Loan
or any coverage provided by any alternative credit enhancement will not be
adversely affected thereby. With respect to any series of Certificates as to
which the Trust Fund includes Mortgage Securities, the Master Servicer's
servicing and administration obligations will be pursuant to the terms of such
Mortgage Securities.
Under its Subservicing Agreement, a Subservicer is granted certain
discretion to extend relief to Mortgagors whose payments become delinquent. A
Subservicer may grant a period of temporary indulgence (generally up to three
months) to a Mortgagor or may enter into a liquidating plan providing for
repayment by the Mortgagor of delinquent amounts within six months from the
date of execution of the plan, in each case without the prior approval of the
Master Servicer. Other types of forbearance generally require Master Servicer
approval. Neither indulgence nor forbearance with respect to a Mortgage Loan
will affect the Pass-Through Rate or Rates used in calculating distributions
to Certificateholders. See "--Distributions."
In certain instances in which a Mortgage Loan is in default (or if default
is reasonably foreseeable), and if determined by the Master Servicer to be in
the best interests of the related Certificateholders, the Master Servicer
40
<PAGE>
may permit certain modifications of the Mortgage Loan or make forbearances on
the Mortgage Loan rather than proceeding with foreclosure. In making such
determination, the estimated Realized Loss that might result if such Mortgage
Loan were liquidated would be taken into account. Such modifications may have
the effect of reducing the Mortgage Rate or extending the final maturity date
of the Mortgage Loan. Any such modified Mortgage Loan may remain in the
related Trust Fund, and the reduction in collections resulting from such
modification may result in reduced distributions of interest (or other
amounts) on, or may extend the final maturity of, one or more classes of the
related Certificates.
In connection with any significant partial prepayment of a Mortgage Loan,
the Master Servicer, to the extent not inconsistent with the terms of the
Mortgage Note and local law and practice, may permit the Mortgage Loan to be
re-amortized such that the monthly payment is recalculated as an amount that
will fully amortize the remaining principal amount thereof by the original
maturity date based on the original Mortgage Rate, provided that such re-
amortization shall not be permitted if it would constitute a modification of
the Mortgage Loan for federal income tax purposes.
In any case in which property subject to a Mortgage Loan (other than an ARM
Loan described below) is being conveyed by the Mortgagor, the Master Servicer,
directly or through a Subservicer, shall in general 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, but only if the exercise of such rights is permitted by
applicable law and only to the extent it would not adversely affect or
jeopardize coverage under any applicable credit enhancement arrangements. If
the Master Servicer or Subservicer is prevented from enforcing such due-on-
sale clause under applicable law or if the Master Servicer or Subservicer
determines that it is reasonably likely that a legal action would be
instituted by the related Mortgagor to avoid enforcement of such due-on-sale
clause, the Master Servicer or Subservicer will enter into an assumption and
modification agreement with the person to whom such property has been or is
about to be conveyed, pursuant to which such person becomes liable under the
Mortgage Note subject to certain specified conditions. The original Mortgagor
may be released from liability on a Mortgage Loan if the Master Servicer or
Subservicer shall have determined in good faith that such release will not
adversely affect the collectability of the Mortgage Loan. An ARM Loan may be
assumed if such ARM Loan is by its terms assumable and if, in the reasonable
judgment of the Master Servicer or the Subservicer, the proposed transferee of
the related Mortgaged Property establishes its ability to repay the loan and
the security for such ARM Loan would not be impaired by the assumption. If a
Mortgagor transfers the Mortgaged Property subject to an ARM Loan without
consent, such ARM Loan may be declared due and payable. Any fee collected by
the Master Servicer or Subservicer for entering into an assumption or
substitution of liability agreement will be retained by the Master Servicer or
Subservicer as additional servicing compensation unless otherwise set forth in
the related Prospectus Supplement. See "Certain Legal Aspects of Mortgage
Loans and Related Matters-Enforceability of Certain Provisions" herein. In
connection with any such assumption, the Mortgage Rate borne by the related
Mortgage Note may not be altered. Mortgagors may, from time to time, request
partial releases of the Mortgaged Properties, easements, consents to
alteration or demolition and other similar matters. The Master Servicer or the
related Subservicer may approve such a request if it has determined,
exercising its good faith business judgment in the same manner as it would if
it were the owner of the related Mortgage Loan, that such approval will not
adversely affect the security for, and the timely and full collectability of,
the related Mortgage Loan. Any fee collected by the Master Servicer or the
Subservicer for processing such request will be retained by the Master
Servicer or Subservicer as additional servicing compensation.
REALIZATION UPON DEFAULTED MORTGAGE LOANS
With respect to a Mortgage Loan in default, the Master Servicer or the
related Subservicer will decide whether to foreclose upon the Mortgaged
Property or write off the principal balance of the Mortgage Loan, or the Trust
Balance thereof, as a bad debt. In connection with such decision, the Master
Servicer or the related Subservicer will, following usual practices in
connection with senior and junior mortgage servicing activities, estimate the
proceeds expected to be received and the expenses expected to be incurred in
connection with such
41
<PAGE>
foreclosure to determine whether a foreclosure proceeding is appropriate. To
the extent that a Mortgage Loan is a junior Mortgage Loan, following any
default thereon, unless foreclosure proceeds for such Mortgage Loan are
expected to at least satisfy the related senior mortgage loan in full and to
pay foreclosure costs, it is likely that such Mortgage Loan will be written
off as bad debt with no foreclosure proceeding. See "Risk Factors--Special
Features of the Mortgage Loans" herein. In the event that title to any
Mortgaged Property is acquired in foreclosure or by deed in lieu of
foreclosure, the deed or certificate of sale will be issued to the Trustee or
to its nominee on behalf of Certificateholders and, if applicable, the holders
of any Excluded Balances. Notwithstanding any such acquisition of title and
cancellation of the related Mortgage Loan, such Mortgage Loan (an "REO
MORTGAGE LOAN") will be considered for most purposes to be an outstanding
Mortgage Loan or an outstanding Trust Balance of the related Revolving Credit
Loan, held in the Trust Fund until such time as the Mortgaged Property is sold
and all recoverable Liquidation Proceeds and Insurance Proceeds have been
received with respect to such defaulted Mortgage Loan (a "LIQUIDATED MORTGAGE
LOAN"). For purposes of calculations of amounts distributable to
Certificateholders in respect of an REO Mortgage Loan, the amortization
schedule in effect at the time of any such acquisition of title (before any
adjustment thereto by reason of any bankruptcy or any similar proceeding or
any moratorium or similar waiver or grace period) will be deemed to have
continued in effect (and, in the case of an ARM Loan, such amortization
schedule will be deemed to have adjusted in accordance with any interest rate
changes occurring on any adjustment date therefor) so long as such REO
Mortgage Loan is considered to remain in the Trust Fund. If a REMIC election
has been made, any Mortgaged Property so acquired by the Trust Fund must be
disposed of in accordance with applicable federal income tax regulations and
consistent with the status of the Trust Fund as a REMIC. To the extent
provided in the related Pooling and Servicing Agreement, any income (net of
expenses and other than gains described below) received by the Subservicer or
the Master Servicer on such Mortgaged Property prior to its disposition will
be deposited in the Custodial Account upon receipt and will be available at
such time to the extent provided in the related Pooling and Servicing
Agreement, for making payments to Certificateholders.
With respect to a Mortgage Loan in default, the Master Servicer may pursue
foreclosure (or similar remedies) subject to any senior lien positions and
certain other restrictions pertaining to junior liens as described under
"Certain Legal Aspects of Mortgage Loans and Related Matters--Foreclosure on
Mortgage Loans" concurrently with pursuing any remedy for a breach of a
representation and warranty. However, the Master Servicer is not required to
continue to pursue both such remedies if it determines that one such remedy is
more likely to result in a greater recovery. Upon the first to occur of final
liquidation and a repurchase or substitution pursuant to a breach of a
representation and warranty, such Mortgage Loan will be removed from the
related Trust Fund. The Master Servicer may elect to treat a defaulted
Mortgage Loan as having been finally liquidated if substantially all amounts
expected to be received in connection therewith have been received. Any
additional liquidation expenses relating to such Mortgage Loan thereafter
incurred will be reimbursable to the Master Servicer (or any Subservicer) from
any amounts otherwise distributable to the related Certificateholders, or may
be offset by any subsequent recovery related to such Mortgage Loan.
Alternatively, for purposes of determining the amount of related Liquidation
Proceeds to be distributed to Certificateholders, the amount of any Realized
Loss or the amount required to be drawn under any applicable form of credit
enhancement, the Master Servicer may take into account minimal amounts of
additional receipts expected to be received, as well as estimated additional
liquidation expenses expected to be incurred in connection with such defaulted
Mortgage Loan. Upon foreclosure of a Revolving Credit Loan, the related
Liquidation Proceeds will be allocated among the Trust Balances and Excluded
Balances as described in the Prospectus Supplement.
With respect to certain series of Certificates, if so provided in the
related Prospectus Supplement, the applicable form of credit enhancement may
provide, to the extent of coverage thereunder, that a defaulted Mortgage Loan
or REO Mortgage Loan will be removed from the Trust Fund prior to the final
liquidation thereof in which case any estimated loss may be covered by any
applicable form of credit enhancement or other insurance or the
Certificateholders may bear such loss. If a defaulted Mortgage Loan or REO
Mortgage Loan is not so removed from the Trust Fund, then, upon the final
liquidation thereof, if a loss is realized which is not covered by any
applicable form of credit enhancement or other insurance, the
Certificateholders will bear such loss. However, if a gain results from the
final liquidation of an REO Mortgage Loan which is not required by
42
<PAGE>
law to be remitted to the related Mortgagor, the Master Servicer will be
entitled to retain such gain as additional servicing compensation unless the
related Prospectus Supplement provides otherwise. For a description of the
Master Servicer's obligations to maintain and make claims under applicable
forms of credit enhancement and insurance relating to the Mortgage Loans, see
"Description of Credit Enhancement" and "Description of the Certificates--
Hazard Insurance; Claims Thereunder."
The Master Servicer is required to maintain a fidelity bond and errors and
omissions policy with respect to its officers and employees and other persons
acting on behalf of the Master Servicer in connection with its activities
under the Pooling and Servicing Agreement. The Master Servicer may be subject
to certain restrictions under the Pooling and Servicing Agreement with respect
to the refinancing of a lien senior to a Mortgage Loan on the related
Mortgaged Property.
HAZARD INSURANCE; CLAIMS THEREUNDER
Each Mortgage Loan (other than a Cooperative Loan) will be required to be
covered by a hazard insurance policy (as described below). The following
summary, as well as other pertinent information included elsewhere in this
Prospectus, do not describe all terms of a hazard insurance policy but will
reflect all material terms thereof relevant to an investment in the
Certificates. Such insurance is subject to underwriting and approval of
individual Mortgage Loans by the respective insurers. The descriptions of any
insurance policies described in this Prospectus or any Prospectus Supplement
and the coverage thereunder do not purport to be complete and are qualified in
their entirety by reference to such forms of policies.
The Pooling and Servicing Agreement will require the Master Servicer to
cause to be maintained for each Mortgaged Property a hazard insurance policy
providing for no less than the coverage of the standard form of fire insurance
policy with extended coverage customary in the state in which the property is
located. Such coverage generally will be in an amount equal to the lesser of
(i) 100% of the insurable value of the improvements (guaranteed replacement)
or (ii) the sum of the outstanding balance of such Mortgage Loan plus the
outstanding balance on any mortgage loan senior to such Mortgage Loan. The
ability of the Master Servicer to ensure that hazard insurance proceeds are
appropriately applied may be dependent on its being named as an additional
insured under any hazard insurance policy or upon the extent to which
information in this regard is furnished to the Master Servicer by Mortgagors
or Subservicers.
As set forth above, all amounts collected by 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 Mortgagor in accordance with the
Master Servicer's normal servicing procedures) will be deposited initially in
the Custodial Account and ultimately in the Certificate Account. The Pooling
and Servicing Agreement provides that the Master Servicer may satisfy its
obligation to cause hazard policies to be maintained by maintaining a blanket
policy insuring against losses on the Mortgage Loans. If such blanket policy
contains a deductible clause, the Master Servicer will deposit in the
Custodial Account or the applicable Certificate Account all amounts which
would have been deposited therein but for such clause.
Unless otherwise specified in the related Prospectus Supplement, the Master
Servicer shall also cause to be maintained on property acquired upon
foreclosure, or deed in lieu of foreclosure, of any Mortgage Loan, fire
insurance with extended coverage in an amount which is at least equal to the
amount necessary to avoid the application of any co-insurance clause contained
in the related hazard insurance policy.
Since the amount of hazard insurance that Mortgagors are required to
maintain on the improvements securing the Mortgage Loans may decline as the
principal balances owing thereon decrease, and since residential properties
have historically appreciated in value over time, hazard insurance proceeds
could be insufficient to restore fully the damaged property in the event of a
partial loss. See "Description of Credit Enhancement--Special Hazard Insurance
Policies" for a description of the limited protection afforded by any
43
<PAGE>
Special Hazard Insurance Policy against losses occasioned by hazards which are
otherwise uninsured against (including losses caused by the application of the
co-insurance clause described in the preceding paragraph).
DESCRIPTION OF CREDIT ENHANCEMENT
Credit support with respect to each series of Certificates may be comprised
of one or more of the components described below. Each component may have a
dollar limit and will generally provide coverage with respect to Realized
Losses that are (i) attributable to the Mortgagor's failure to make any
payment of principal or interest as required under the Mortgage Note, but not
including Special Hazard Losses, Extraordinary Losses or other losses
resulting from damage to a Mortgaged Property, Bankruptcy Losses or Fraud
Losses (any such loss, a "DEFAULTED MORTGAGE LOSS"); (ii) of a type generally
covered by a Special Hazard Insurance Policy (any such loss, a "SPECIAL HAZARD
LOSS"); (iii) attributable to certain actions which may be taken by a
bankruptcy court in connection with a Mortgage Loan, including a reduction by
a bankruptcy court of the principal balance of or the Mortgage Rate on a
Mortgage Loan or an extension of its maturity (any such loss, a "BANKRUPTCY
LOSS"); and (iv) incurred on defaulted Mortgage Loans as to which there was
fraud in the origination of such Mortgage Loans (any such loss, a "FRAUD
LOSS").
Unless otherwise specified in the related Prospectus Supplement, credit
support will not provide protection against all risks of loss and will not
guarantee repayment of the entire outstanding principal balance of the
Certificates and interest thereon. If losses occur which exceed the amount
covered by credit support or which are not covered by the credit support,
Certificateholders will bear their allocable share of deficiencies. In
particular, Defaulted Mortgage Losses, Special Hazard Losses, Bankruptcy
Losses and Fraud Losses in excess of the amount of coverage provided therefor
and losses occasioned by war, civil insurrection, certain governmental
actions, nuclear reaction and certain other risks ("EXTRAORDINARY LOSSES")
will not be covered. To the extent that the credit enhancement for any series
of Certificates is exhausted, the Certificateholders will bear all further
risks of loss not otherwise insured against.
As set forth below and in the related Prospectus Supplement, (i) coverage
with respect to Defaulted Mortgage Losses may be provided by one or more
Letters of Credit, (ii) coverage with respect to Special Hazard Losses may be
provided by one or more Letters of Credit or a Special Hazard Insurance
Policies (any instrument, to the extent providing such coverage, a "SPECIAL
HAZARD INSTRUMENT"), (iii) coverage with respect to Bankruptcy Losses may be
provided by one or more Letters of Credit or a Bankruptcy Bonds and (iv)
coverage with respect to Fraud Losses may be provided by one or more Letters
of Credit or mortgage repurchase bonds. In addition, if so specified in the
applicable Prospectus Supplement, in lieu of or in addition to any or all of
the foregoing arrangements, credit enhancement may be in the form of (i) a
Reserve Fund to cover such losses, (ii) subordination of one or more classes
of Subordinate Certificates to provide credit support to one or more classes
of Senior Certificates or (iii) Overcollateralization, Letters of Credit,
surety bonds, Financial Guaranty Insurance Policies or other types of
insurance policies, certain other secured or unsecured corporate guarantees or
in such other form as may be described in the related Prospectus Supplement,
or in the form of a combination of two or more of the foregoing. The credit
support may be provided by an assignment of the right to receive certain cash
amounts, a deposit of cash into a Reserve Fund or other pledged assets, or by
banks, insurance companies, guarantees or any combination thereof identified
in the related Prospectus Supplement.
With respect to any defaulted Mortgage Loan that is finally liquidated, the
amount of loss realized, if any (as described in the related Pooling and
Servicing Agreement, a "REALIZED LOSS"), will equal the portion of the Stated
Principal Balance remaining after application of all amounts recovered (net of
amounts reimbursable to the Master Servicer for related Advances, if
applicable, and expenses allocable to the Trust Fund) towards interest and
principal owing on the Mortgage Loan. With respect to a Mortgage Loan the
principal balance of which has been reduced in connection with bankruptcy
proceedings, the amount of such reduction will be treated as a Realized Loss.
The "STATED PRINCIPAL BALANCE" of any Mortgage Loan as of any date of
determination is equal to the principal balance thereof as of the Cut-off
Date, after application of all scheduled principal payments due on or before
the Cut-off Date whether received or not, reduced by all amounts allocable to
principal that are
44
<PAGE>
distributed to Certificateholders on or before the date of determination, and
as further reduced to the extent that any Realized Loss thereon has been
allocated to any Certificates on or before such date.
For any series of Certificates backed by Trust Balances of Revolving Credit
Loans, the credit enhancement provided with respect to such Certificates will
cover any portion of any Realized Losses allocated to such Trust Balances,
subject to any limitations described herein and in the related Prospectus
Supplement. See "Allocation of Revolving Credit Loan Balances" herein.
Each Prospectus Supplement will include a description of (a) the amount
payable under the credit enhancement arrangement, if any, provided with
respect to a series, (b) any conditions to payment thereunder not otherwise
described herein, (c) the conditions under which the amount payable under such
credit support may be reduced and under which such credit support may be
terminated or replaced and (d) the material provisions of any agreement
relating to such credit support. Additionally, each such Prospectus Supplement
will set forth certain information with respect to the Issuer of any third-
party credit enhancement (the "CREDIT ENHANCER"). The Pooling and Servicing
Agreement or other documents may provide for reimbursement rights, control
rights or other provisions that may be required by the Credit Enhancer.
The descriptions of any insurance policies, bonds or other instruments
described in this Prospectus or any Prospectus Supplement and the coverage
thereunder do not describe all terms thereof but will reflect all relevant
terms thereof material to an investment in the Certificates. Copies of such
instruments will be included as exhibits to the Form 8-K to be filed with the
Commission in connection with the issuance of the related series of
Certificates.
FINANCIAL GUARANTY INSURANCE POLICY
If so specified in the related Prospectus Supplement, a financial guaranty
insurance policy or surety bond (a "FINANCIAL GUARANTY INSURANCE POLICY") may
be obtained and maintained for a Class or Series of Certificates. The issuer
of the Financial Guaranty Insurance Policy (the "INSURER") will be described
in the related Prospectus Supplement and a copy of the form of Financial
Guaranty Insurance Policy will be filed with the related Current Report on
Form 8-K.
Unless otherwise specified in the related Prospectus Supplement, a Financial
Guaranty Insurance Policy will be unconditional and irrevocable and will
guarantee to holders of the applicable Certificates that an amount equal to
the full amount of distributions due to such holders will be received by the
Trustee or its agent on behalf of such holders for distribution on each
Distribution Date. The specific terms of any Financial Guaranty Insurance
Policy will be set forth in the related Prospectus Supplement. A Financial
Guaranty Insurance Policy may have limitations and generally will not insure
the obligation of the Sellers or the Master Servicer to purchase or substitute
for a defective Mortgage Loan and will not guarantee any specific rate of
principal prepayments. Unless otherwise specified in the related Prospectus
Supplement, the Insurer will be subrogated to the rights of each holder to the
extent the Insurer makes payments under the Financial Guaranty Insurance
Policy.
LETTER OF CREDIT
If any component of credit enhancement as to any series of Certificates is
to be provided by a letter of credit (the "LETTER OF CREDIT"), a bank (the
"LETTER OF CREDIT BANK") will deliver to the Trustee an irrevocable Letter of
Credit. The Letter of Credit may provide direct coverage with respect to the
Mortgage Loans. The Letter of Credit Bank, the amount available under the
Letter of Credit with respect to each component of credit enhancement, the
expiration date of the Letter of Credit, and a more detailed description of
the Letter of Credit will be specified in the related Prospectus Supplement.
On or before each Distribution Date, the Letter of Credit Bank will be
required to make certain payments after notification from the Trustee, to be
deposited in the related Certificate Account with respect to the coverage
provided thereby. The Letter of Credit may also provide for the payment of
Advances.
45
<PAGE>
SPECIAL HAZARD INSURANCE POLICIES
Any insurance policy covering Special Hazard Losses (a "SPECIAL HAZARD
INSURANCE POLICY") obtained by the Company for a Trust Fund will be issued by
the insurer named in the related Prospectus Supplement. Each Special Hazard
Insurance Policy generally will, subject to limitations described in the
related Prospectus Supplement, if any, will protect the related
Certificateholders from Special Hazard Losses which are (i) losses due to
direct physical damage to a Mortgaged Property other than any loss of a type
covered by a hazard insurance policy or a flood insurance policy, if
applicable, and (ii) losses from partial damage caused by reason of the
application of the co-insurance clauses contained in hazard insurance
policies. See "Description of the Certificates--Hazard Insurance; Claims
Thereunder." A Special Hazard Insurance Policy will not cover losses
occasioned by war, civil insurrection, certain governmental actions, errors in
design, faulty workmanship or materials (except under certain circumstances),
nuclear reaction, chemical contamination or waste by the Mortgagor. Aggregate
claims under a Special Hazard Insurance Policy will be limited to the amount
set forth in the related Pooling and Servicing Agreement and will be subject
to reduction as set forth in such related Pooling and Servicing Agreement. A
Special Hazard Insurance Policy will provide that no claim may be paid unless
hazard and, if applicable, flood insurance on the property securing the
Mortgage Loan has been kept in force and other protection and preservation
expenses have been paid by the Master Servicer.
To the extent set forth in the related Prospectus Supplement, coverage in
respect of Special Hazard Losses for a series of Certificates may be provided,
in whole or in part, by a type of special hazard coverage other than a Special
Hazard Insurance Policy or by means of a representation of the Company or
Residential Funding.
BANKRUPTCY BONDS
In the event of a personal bankruptcy of a Mortgagor, a bankruptcy court may
establish the value of the Mortgaged Property of such Mortgagor at an amount
less than the then outstanding principal balance of the first and junior loans
secured by such Mortgaged Property (such difference, a "DEFICIENT VALUATION").
The amount of the secured debt could then be reduced to such value, and, thus,
the holder of such first and junior loans would become unsecured creditors to
the extent the outstanding principal balance of such loans exceeds the value
assigned to the Mortgaged Property by the bankruptcy court. In addition,
certain other modifications of the terms of a Mortgage Loan can result from a
bankruptcy proceeding, including a reduction in the amount of the Monthly
Payment on the related Mortgage Loan (a "DEBT SERVICE REDUCTION;" Debt Service
Reductions and Deficient Valuations, collectively referred to herein as
"BANKRUPTCY LOSSES"). See "Certain Legal Aspects of Mortgage Loans and Related
Matters--Anti-Deficiency Legislation and Other Limitations on Lenders." Any
Bankruptcy Bond to provide coverage for Bankruptcy Losses resulting from
proceedings under the federal Bankruptcy Code obtained by the Company for a
Trust Fund will be issued by an insurer named in the related Prospectus
Supplement. The level of coverage under each Bankruptcy Bond will be set forth
in the related Prospectus Supplement.
SUBORDINATION
A Senior/Subordinate Series of Certificates will consist of one or more
classes of Senior Certificates and one or more classes of Subordinate
Certificates, as set forth in the related Prospectus Supplement. With respect
to any Senior/Subordinate Series, the total amount available for distribution
on each Distribution Date, as well as the method for allocating such amount
among the various classes of Certificates included in such series, will be
described in the related Prospectus Supplement. Generally, with respect to any
such series the amount available for distribution will be allocated first to
interest on the Senior Certificates of such series, and then to principal of
the Senior Certificates up to the amounts described in the related Prospectus
Supplement, prior to allocation of any amounts to the Subordinate Certificates
of such series.
Realized Losses will be allocated to the Subordinate Certificates of the
related series in the order specified in the related Prospectus Supplement
until the outstanding principal balance of such Class has been reduced to
zero. Additional Realized Losses, if any, will be allocated to the Senior
Certificates. If such series includes more than one class of Senior
Certificates, such additional Realized Losses will be allocated either on a
pro rata basis
46
<PAGE>
among all of the Senior Certificates in proportion to their respective
outstanding principal balances or as otherwise provided in the related
Prospectus Supplement. The respective amounts of specified types of losses
(including certain Special Hazard Losses, Fraud Losses and Bankruptcy Losses)
that may be borne solely by the Subordinate Certificates may be limited to an
amount described in the related Prospectus Supplement, in which case such
losses would be allocated on a pro rata basis among all outstanding classes of
Certificates. Generally, any allocation of a Realized Loss to a Certificate
will be made by reducing the outstanding principal balance thereof as of the
Distribution Date following the calendar month in which such Realized Loss was
incurred. At any given time, the percentage of the outstanding principal
balances of all of the Certificates evidenced by the Senior Certificates is
the "SENIOR PERCENTAGE," determined in the manner set forth in the related
Prospectus Supplement.
As set forth above, the rights of holders of the various classes of
Certificates of any series to receive distributions of principal and interest
is determined by the aggregate outstanding principal balance of each such
class (or, if applicable, the related notional amount). The outstanding
principal balance of any Certificate will be reduced by all amounts previously
distributed on such Certificate in respect of principal and by any Realized
Losses allocated thereto. If there are no Realized Losses or prepayments of
principal on any of the Mortgage Loans, the respective rights of the holders
of Certificates of any series to future distributions generally would not
change. However, to the extent set forth in the related Prospectus Supplement,
holders of Senior Certificates may be entitled to receive a disproportionately
larger amount of prepayments received during certain specified periods, which
will have the effect (absent offsetting losses) of accelerating the
amortization of the Senior Certificates and increasing the respective
percentage ownership interest evidenced by the Subordinate Certificates in the
related Trust Fund (with a corresponding decrease in the Senior Percentage),
thereby preserving the availability of the subordination provided by the
Subordinate Certificates. In addition, as set forth above, certain Realized
Losses generally will be allocated first to Subordinate Certificates by
reduction of the outstanding principal balance thereof, which will have the
effect of increasing the respective ownership interest evidenced by the Senior
Certificates in the related Trust Fund.
If so provided in the Pooling and Servicing Agreement, the Master Servicer
may be permitted, under certain circumstances, to purchase any Mortgage Loan
(or the Trust Balance thereof, if applicable) that is three or more months
delinquent in payments of principal and interest, at the Purchase Price. Such
Purchase Price will be advanced by the Master Servicer to the Trust Fund,
subject to the right of the Master Servicer to reimbursement from the Trust
Fund for any Realized Losses subsequently incurred. Any Realized Loss so
incurred in connection with any such Mortgage Loan (or the Trust Balance
thereof, if applicable) will be allocated among the then outstanding
Certificateholders of the related series in the same manner as Realized Losses
on Mortgage Loans that have not been so purchased.
To the extent provided in the related Prospectus Supplement, certain amounts
otherwise payable on any Distribution Date to holders of Subordinate
Certificates may be deposited into a Reserve Fund. Amounts held in any Reserve
Fund may be applied as described under "Description of Credit Enhancement--
Reserve Funds" in the related Prospectus Supplement.
With respect to any Senior/Subordinate Series, the terms and provisions of
the subordination may vary from those described above. Any such variation and
any additional credit enhancement will be described in the related Prospectus
Supplement.
OVERCOLLATERALIZATION
If so specified in the related Prospectus Supplement, interest collections
on the Mortgage Loans, or the Trust Balances of the related Revolving Credit
Loans, as applicable, may exceed interest distributions on the Certificates
for the related Distribution Date (such excess referred to as "EXCESS
INTEREST"). Such Excess Interest may be deposited into a Reserve Fund or
applied as a distribution of principal on the Certificates. To the extent
Excess Interest is applied as principal distributions on the Certificates, the
effect will be to reduce the principal balance of the Certificates relative to
the outstanding balance of the Mortgage Loans, thereby creating
47
<PAGE>
"Overcollateralization" and additional protection to the Certificateholders,
as specified in the related Prospectus Supplement.
RESERVE FUNDS
If so specified in the related Prospectus Supplement, the Company will
deposit or cause to be deposited in an account (a "RESERVE FUND") any
combination of cash or Permitted Investments in specified amounts, or any
other instrument satisfactory to the Rating Agency or Agencies, which will be
applied and maintained in the manner and under the conditions specified in the
related Pooling and Servicing Agreement. In the alternative or in addition to
such deposit, to the extent described in the related Prospectus Supplement, a
Reserve Fund may be funded through application of all or a portion of amounts
otherwise payable on any related Certificates, from the Excess Spread,
Excluded Spread or otherwise. A Reserve Fund for a series of Certificates
which is funded over time by depositing therein a portion of the interest
payment on each Mortgage Loan may be referred to as a "SPREAD ACCOUNT" in the
related Prospectus Supplement and Pooling and Servicing Agreement. To the
extent that the funding of the Reserve Fund is dependent on amounts otherwise
payable on related Certificates, Excess Spread, Excluded Spread or other cash
flows attributable to the related Mortgage Loans or on reinvestment income,
the Reserve Fund may provide less coverage than initially expected if the cash
flows or reinvestment income on which such funding is dependent are lower than
anticipated. With respect to any series of Certificates as to which credit
enhancement includes a Letter of Credit, if so specified in the related
Prospectus Supplement, under certain circumstances the remaining amount of the
Letter of Credit may be drawn by the Trustee and deposited in a Reserve Fund.
Amounts in a Reserve Fund may be distributed to Certificateholders, or
applied to reimburse the Master Servicer for outstanding advances, or may be
used for other purposes, in the manner and to the extent specified in the
related Prospectus Supplement. Unless otherwise provided in the related
Prospectus Supplement, any such Reserve Fund will not be deemed to be part of
the related Trust Fund. A Reserve Fund may provide coverage to more than one
series of Certificates if set forth in the related Prospectus Supplement. If
so specified in the related Prospectus Supplement, Reserve Funds may be
established to provide limited protection against only certain types of losses
and shortfalls. Following each Distribution Date amounts in a Reserve Fund in
excess of any amount required to be maintained therein may be released from
the Reserve Fund under the conditions and to the extent specified in the
related Prospectus Supplement and will not be available for further
application to the Certificates.
Unless otherwise specified in the related Prospectus Supplement, the Trustee
will have a perfected security interest for the benefit of the
Certificateholders in the assets in the Reserve Fund. However, to the extent
that the Company, any affiliate thereof or any other entity has an interest in
any Reserve Fund, in the event of the bankruptcy, receivership or insolvency
of such entity, there could be delays in withdrawals from the Reserve Fund and
the corresponding payments to the Certificateholders. Such delays could
adversely affect the yield to investors on the related Certificates.
Amounts deposited in any Reserve Fund for a series will be invested in
Permitted Investments by, or at the direction of, and for the benefit of the
Master Servicer or any other person named in the related Prospectus
Supplement. Unless otherwise specified in the related Prospectus Supplement,
any reinvestment income or other gain from such investments will be credited
to the related Reserve Fund for such series, and any loss resulting from such
investments will be charged to such Reserve Fund. However, such income may be
payable to the Master Servicer or another service provider as additional
compensation.
MAINTENANCE OF CREDIT ENHANCEMENT
If credit enhancement has been obtained for a series of Certificates, the
Master Servicer will be obligated to exercise its best reasonable efforts to
keep or cause to be kept such credit enhancement in full force and effect
throughout the term of the applicable Pooling and Servicing Agreement, unless
coverage thereunder has been exhausted through payment of claims or otherwise,
or substitution therefor is made as described below under
48
<PAGE>
"--Reduction or Substitution of Credit Enhancement." The Master Servicer, on
behalf of itself, the Trustee and Certificateholders, will provide the Trustee
information required for the Trustee to draw any applicable credit
enhancement.
Unless otherwise specified in the related Prospectus Supplement, the Master
Servicer will agree to pay the premiums for each Financial Guaranty Insurance
Policy, Special Hazard Insurance Policy or Bankruptcy Bond, as applicable, on
a timely basis. In the event the related insurer ceases to be a "QUALIFIED
INSURER" because it ceases to be qualified under applicable law to transact
such insurance business or coverage is terminated for any reason other than
exhaustion of such coverage, the Master Servicer will use its best reasonable
efforts to obtain from another Qualified Insurer a comparable replacement
insurance policy or bond with a total coverage equal to the then outstanding
coverage of such policy or bond. If the cost of the replacement policy is
greater than the cost of such policy or bond, the coverage of the replacement
policy or bond will, unless otherwise agreed to by the Company, be reduced to
a level such that its premium rate does not exceed the premium rate on the
original insurance policy. Any losses in market value of the Certificates
associated with any reduction or withdrawal in rating by an applicable Rating
Agency shall be borne by the Certificateholders.
If any property securing a defaulted Mortgage Loan is damaged and proceeds,
if any, from the related hazard insurance policy or any applicable Special
Hazard Insurance Policy are insufficient to restore the damaged property to a
condition sufficient to permit recovery under any Letter of Credit, the Master
Servicer is not required to expend its own funds to restore the damaged
property unless it determines (i) that such restoration will increase the
proceeds to one or more classes of Certificateholders on liquidation of the
Mortgage Loan after reimbursement of the Master Servicer for its expenses and
(ii) that such expenses will be recoverable by it through Liquidation Proceeds
or Insurance Proceeds. If recovery under any Letter of Credit or other credit
enhancement is not available because the Master Servicer has been unable to
make the above determinations, has made such determinations incorrectly or
recovery is not available for any other reason, the Master Servicer is
nevertheless obligated to follow such normal practices and procedures (subject
to the preceding sentence) as it deems necessary or advisable to realize upon
the defaulted Mortgage Loan and in the event such determination has been
incorrectly made, is entitled to reimbursement of its expenses in connection
with such restoration.
REDUCTION OR SUBSTITUTION OF CREDIT ENHANCEMENT
The amount of credit support provided with respect to any series of
Certificates and relating to various types of losses incurred may be reduced
under certain specified circumstances. In most cases, the amount available as
credit support will be subject to periodic reduction on a non-discretionary
basis in accordance with a schedule or formula set forth in the related
Pooling and Servicing Agreement. Additionally, in most cases, such credit
support may be replaced, reduced or terminated, and the formula used in
calculating the amount of coverage with respect to Bankruptcy Losses, Special
Hazard Losses or Fraud Losses may be changed, without the consent of the
Certificateholders, upon the written assurance from each applicable Rating
Agency that the then-current rating of the related series of Certificates will
not be adversely affected thereby. Furthermore, in the event that the credit
rating of any obligor under any applicable credit enhancement is downgraded,
the credit rating of each class of the related Certificates may be downgraded
to a corresponding level, and, unless otherwise specified in the related
Prospectus Supplement, neither the Master Servicer nor the Company will be
obligated to obtain replacement credit support in order to restore the rating
of the Certificates. The Master Servicer will also be permitted to replace
such credit support with other credit enhancement instruments issued by
obligors whose credit ratings are equivalent to such downgraded level and in
lower amounts which would satisfy such downgraded level, provided that the
then-current rating of each class of the related series of Certificates is
maintained. Where the credit support is in the form of a Reserve Fund, a
permitted reduction in the amount of credit enhancement will result in a
release of all or a portion of the assets in the Reserve Fund to the Company,
the Master Servicer or such other person that is entitled thereto. Any assets
so released and any amount by which the credit enhancement is reduced will not
be available for distributions in future periods.
49
<PAGE>
THE COMPANY
The Company is an indirect wholly-owned subsidiary of GMAC Mortgage, which
is a wholly-owned subsidiary of General Motors Acceptance Corporation. The
Company was incorporated in the State of Delaware on May 5, 1995. The Company
was organized for the purpose of acquiring first or junior lien home equity
mortgage loans and mortgage securities and issuing securities backed by such
mortgage loans and mortgage securities. The Company anticipates that it will
in many cases have acquired Mortgage Loans indirectly through Residential
Funding, which is also an indirect wholly-owned subsidiary of GMAC Mortgage.
The Company does not have, nor is it expected in the future to have, any
significant assets.
The Certificates do not represent an interest in or an obligation of the
Company. The Company's only obligations with respect to a series of
Certificates will be pursuant to certain limited representations and
warranties made by the Company or as otherwise provided in the related
Prospectus Supplement.
The Company maintains its principal office at 8400 Normandale Lake
Boulevard, Suite 700, Minneapolis, Minnesota 55437. Its telephone number is
(612) 832-7000.
RESIDENTIAL FUNDING CORPORATION
If so specified in the related Prospectus Supplement, Residential Funding,
an affiliate of the Company, will act as the Master Servicer or Manager for a
series of Certificates.
Residential Funding buys mortgage loans under several loan purchase programs
from mortgage loan originators or sellers nationwide, including affiliates,
that meet its seller/servicer eligibility requirements and services mortgage
loans for its own account and for others. Residential Funding's principal
executive offices are located at 8400 Normandale Lake Boulevard, Suite 700,
Minneapolis, Minnesota 55437. Its telephone number is (612) 832-7000.
Residential Funding conducts operations from its headquarters in Minneapolis
and from offices located in California, Colorado, Connecticut, Florida,
Georgia, Maryland, New York, North Carolina, Rhode Island and Texas. At June
30, 1996, Residential Funding was master servicing a first lien loan portfolio
of approximately $30.8 billion and a second lien portfolio of approximately
$1.1 billion.
THE POOLING AND SERVICING AGREEMENT
As described above under "Description of the Certificates--General," each
series of Certificates will be issued pursuant to a Pooling and Servicing
Agreement. The following summaries describe certain additional provisions
common to each Pooling and Servicing Agreement and are qualified entirely by
reference to the actual terms of the Pooling and Servicing Agreement for a
series of Certificates.
SERVICING AND ADMINISTRATION
The principal servicing compensation to be paid to the Master Servicer in
respect of its master servicing activities for each series of Certificates
will be equal to the percentage per annum described in the related Prospectus
Supplement (which may vary under certain circumstances). As compensation for
its servicing duties, a Subservicer or, if there is no Subservicer, the Master
Servicer will be entitled to a monthly servicing fee as described in the
related Prospectus Supplement, which may vary under certain circumstances from
the amounts described in the Prospectus Supplement. Certain Subservicers may
also receive additional compensation in the amount of all or a portion of the
interest due and payable on the applicable Mortgage Loan which is over and
above the interest rate specified at the time the Company or Residential
Funding, as the case may be, committed to purchase the Mortgage Loan. See
"Mortgage Loan Program--Subservicing." Subservicers will be required to pay to
the Master Servicer an amount equal to one month's interest (net of its
servicing or other compensation) on the amount of any partial Principal
Prepayment. Unless otherwise specified in the related Prospectus Supplement,
the Master Servicer will retain such amounts to the extent collected from
Subservicers. In addition,
50
<PAGE>
the Master Servicer or a Subservicer will retain all prepayment charges,
assumption fees and late payment charges, to the extent collected from
Mortgagors, and any benefit which may accrue as a result of the investment of
funds in the Custodial Account or the applicable Certificate Account (unless
otherwise specified in the related Prospectus Supplement) or in a Subservicing
Account, as the case may be. In addition, certain reasonable duties of the
Master Servicer may be performed by an affiliate of the Master Servicer who
will be entitled to reasonable compensation therefor from the Trust Fund.
The Master Servicer (or, if specified in the related Pooling and Servicing
Agreement, the Trustee on behalf of the applicable Trust Fund) will pay or
cause to be paid certain ongoing expenses associated with each Trust Fund and
incurred by it in connection with its responsibilities under the Pooling and
Servicing Agreement, including, without limitation, payment of any fee or
other amount payable in respect of certain credit enhancement arrangements,
payment of the fees and disbursements of the Trustee, any custodian appointed
by the Trustee, the Certificate Registrar and any Paying Agent, and payment of
expenses incurred in enforcing the obligations of Subservicers and Designated
Sellers. The Master Servicer will be entitled to reimbursement of expenses
incurred in enforcing the obligations of Subservicers and Designated Sellers
under certain limited circumstances. In addition, as indicated in the
preceding section, the Master Servicer will be entitled to reimbursements for
certain expenses incurred by it in connection with Liquidated 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 Liquidation Proceeds (including Insurance Proceeds).
EVIDENCE AS TO COMPLIANCE
Each Pooling and Servicing Agreement will provide for delivery (on or before
a specified date in each year) to the Trustee of an annual statement signed by
an officer of the Master Servicer to the effect that the Master Servicer has
fulfilled in all material respects the minimum servicing standards set forth
in the audit guide for audits of non-supervised mortgagees approved by the
Department of Housing and Urban Development for use by independent public
accountants, the Uniform Single Attestation Program for Mortgage Bankers or
the Audit Program for Mortgages serviced for Federal Home Mortgage Corporation
(each, an "AUDIT GUIDE") throughout the preceding year or, if there has been a
material default in the fulfillment of any such obligation, such statement
shall specify each such known default and the nature and status thereof. Such
statement may be provided as a single form making the required statements as
to more than one Pooling and Servicing Agreement.
Each Pooling and Servicing Agreement will also provide that on or before a
specified date in each year, beginning the first such date that is at least a
specified number of months after the Cut-off Date, a firm of independent
public accountants will furnish a statement to the Company and the Trustee to
the effect that, on the basis of an examination by such firm conducted
substantially in compliance with the standards established by the American
Institute of Certified Public Accountants, the servicing of mortgage loans
under agreements (including the related Pooling and Servicing Agreement) was
conducted substantially in compliance with the minimum servicing standards set
forth in the related Audit Guide (to the extent that procedures in such Audit
Guide are applicable to the servicing obligations set forth in such
agreements) except for such significant exceptions or errors in records that
shall be reported in such statement. In rendering its statement such firm may
rely, as to the matters relating to the direct servicing of mortgage loans by
Subservicers, upon comparable statements for examinations conducted
substantially in compliance with the related Audit Guide described above
(rendered within one year of such statement) of firms of independent public
accountants with respect to those Subservicers which also have been the
subject of such an examination.
Copies of the annual statement of an officer of the Master Servicer may be
obtained by Certificateholders without charge upon written request to the
Master Servicer, at the address indicated in the monthly statement to
Certificateholders.
CERTAIN MATTERS REGARDING THE MASTER SERVICER AND THE COMPANY
The Pooling and Servicing Agreement for each series of Certificates will
provide that the Master Servicer may not resign from its obligations and
duties thereunder except upon a determination that performance of such
51
<PAGE>
duties is no longer permissible under applicable law or except in connection
with a permitted transfer of servicing. No such resignation will become
effective until the Trustee or a successor servicer has assumed the Master
Servicer's obligations and duties under the Pooling and Servicing Agreement.
Each Pooling and Servicing Agreement will also provide that, except as set
forth below, neither the Master Servicer, the Company, nor any director,
officer, employee or agent of the Master Servicer or the Company will be under
any liability to the Trust Fund or the Certificateholders for any action taken
or for refraining from the taking of any action in good faith pursuant to the
Pooling and Servicing Agreement, or for errors in judgment; provided, however,
that neither the Master Servicer, the Company, nor any such person will be
protected against any liability which would otherwise be imposed by reason of
willful misfeasance, bad faith or gross negligence in the performance of
duties or by reason of reckless disregard of obligations and duties
thereunder. Each Pooling and Servicing Agreement will further provide that the
Master Servicer, the Company, and any director, officer, employee or agent of
the Master Servicer or the Company is entitled to indemnification by the Trust
Fund and will be held harmless against any loss, liability or expense incurred
in connection with any legal action relating to the Pooling and Servicing
Agreement or the related series of Certificates, other than 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, each
Pooling and Servicing Agreement will provide that the Master Servicer and the
Company will not be under any obligation to appear in, prosecute or defend any
legal or administrative action that is not incidental to its respective duties
under the Pooling and Servicing Agreement and which in its opinion may involve
it in any expense or liability. The Master Servicer or the Company may,
however, in its discretion undertake any such action which it may deem
necessary or desirable with respect to the Pooling and Servicing 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 will be expenses, costs and
liabilities of the Trust Fund and the Master Servicer or the Company, as the
case may be, will be entitled to be reimbursed therefor out of funds otherwise
distributable to Certificateholders.
Any person into which the Master Servicer may be merged or consolidated, any
person resulting from any merger or consolidation to which the Master Servicer
is a party or any person succeeding to the business of the Master Servicer
will be the successor of the Master Servicer under the Pooling and Servicing
Agreement, provided that such person meets the requirements set forth in the
Pooling and Servicing Agreement. In addition, notwithstanding the prohibition
on its resignation, the Master Servicer may assign its rights and delegate its
duties and obligations under a Pooling and Servicing Agreement to any person
reasonably satisfactory to the Company and the Trustee and meeting the
requirements set forth in the related Pooling and Servicing Agreement. In the
case of any such assignment, the Master Servicer will be released from its
obligations under such Pooling and Servicing Agreement, exclusive of
liabilities and obligations incurred by it prior to the time of such
assignment.
EVENTS OF DEFAULT
Events of Default under the Pooling and Servicing Agreement in respect of a
series of Certificates, unless otherwise specified in the Prospectus
Supplement, generally will include: (i) any failure by the Master Servicer to
make a required deposit to the Custodial Account or the Certificate Account
or, if the Master Servicer is the Paying Agent, to distribute to the holders
of any class of Certificates of such series any required payment which
continues unremedied for five business days after the giving of written notice
of such failure to the Master Servicer by the Trustee or the Company, or to
the Master Servicer, the Company and the Trustee by the holders of
Certificates of such class evidencing not less than 25% of the aggregate
Percentage Interests constituting such class; (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 Pooling and Servicing Agreement with respect to
such series of Certificates which continues unremedied for 30 days (15 days in
the case of a failure to pay the premium for any insurance policy which is
required to be maintained under the Pooling and Servicing Agreement) after the
giving of written notice of such failure to the Master Servicer by the Trustee
or the Company, or to the Master Servicer, the Company and the Trustee by the
holders of any class of Certificates of such series evidencing not less than
25% of the aggregate Percentage Interests constituting such class; (iii)
certain events of insolvency, readjustment of debt, marshalling of assets and
liabilities or similar proceedings regarding the Master Servicer and certain
actions by
52
<PAGE>
the Master Servicer indicating its insolvency or inability to pay its
obligations and (iv) any other Event of Default as set forth in the Pooling
and Servicing Agreement. A default pursuant to the terms of any Mortgage
Securities included in any Trust Fund will not constitute an Event of Default
under the related Pooling and Servicing Agreement.
RIGHTS UPON EVENT OF DEFAULT
So long as an Event of Default remains unremedied, either the Company or the
Trustee may (except as otherwise provided for in the related Pooling and
Servicing Agreement with respect to the Credit Enhancer, if applicable), and,
at the direction of the holders of Certificates evidencing not less than 51%
of the aggregate voting rights in the related Trust Fund, the Trustee shall
(except as otherwise provided for in the related Pooling and Servicing
Agreement with respect to the Credit Enhancer), by written notification to the
Master Servicer and to the Company or the Trustee, as applicable, terminate
all of the rights and obligations of the Master Servicer under the Pooling and
Servicing Agreement (other than any right of the Master Servicer as
Certificateholder and other than the right to receive servicing compensation,
expenses for servicing the Mortgage Loans during any period prior to the date
of such termination and such other reimbursements and amounts entitled to be
withdrawn from Custodial Account) covering such Trust Fund and in and to the
Mortgage Loans and the proceeds thereof, whereupon the Trustee will succeed to
all responsibilities, duties and liabilities of the Master Servicer under such
Pooling and Servicing Agreement (other than the obligation to purchase
Mortgage Loans under certain circumstances) 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 so to act, it may appoint (or if
it is unable so to act, it shall appoint) or petition a court of competent
jurisdiction for the appointment of an approved mortgage servicing institution
with a net worth of at least $10,000,000 to act as successor to the Master
Servicer under the Pooling and Servicing Agreement (unless otherwise set forth
in the Pooling and Servicing Agreement). Pending such appointment, the Trustee
is obligated to act in such capacity. The Trustee and such successor may agree
upon the servicing compensation to be paid, which in no event may be greater
than the compensation to the initial Master Servicer under the Pooling and
Servicing Agreement.
No Certificateholder will have any right under a Pooling and Servicing
Agreement to institute any proceeding with respect to such Pooling and
Servicing Agreement unless (a) such holder previously has given to the Trustee
written notice of default and the continuance thereof, (b) the holders of
Certificates of any class evidencing not less than 25% of the aggregate
Percentage Interests constituting such class (i) have made written request
upon the Trustee to institute such proceeding in its own name as Trustee
thereunder and (ii) have offered to the Trustee reasonable indemnity and (c)
the Trustee has neglected or refused to institute any such proceeding for 60
days after receipt of such request and indemnity (except as otherwise provided
for in the related Pooling and Servicing Agreement with respect to the Credit
Enhancer). However, the Trustee will be under no obligation to exercise any of
the trusts or powers vested in it by the Pooling and Servicing Agreement or to
institute, conduct or defend any litigation thereunder or in relation thereto
at the request, order or direction of any of the holders of Certificates
covered by such Pooling and Servicing 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.
AMENDMENT
Each Pooling and Servicing Agreement may be amended by the Company, the
Master Servicer and the Trustee, without the consent of the related
Certificateholders, (i) to cure any ambiguity; (ii) to correct or supplement
any provision therein which may be inconsistent with any other provision
therein or to correct any error; (iii) to change the timing and/or nature of
deposits in the Custodial Account or the Certificate Account or to change the
name in which the Custodial Account is maintained (except that (a) deposits to
the Certificate Account may not occur later than the related Distribution
Date, (b) such change may not adversely affect in any material respect the
interests of any Certificateholder, as evidenced by an opinion of counsel, and
(c) such change may not adversely affect the then-current rating of any rated
classes of Certificates, as evidenced by a letter from each applicable Rating
Agency) as specified in the related Prospectus Supplement; (iv) if a REMIC
election has
53
<PAGE>
been made with respect to the related Trust Fund, to modify, eliminate or add
to any of its provisions (a) to the extent necessary to maintain the
qualification of the Trust Fund as a REMIC or to avoid or minimize the risk of
imposition of any tax on the related Trust Fund, provided that the Trustee has
received an opinion of counsel to the effect that (1) such action is necessary
or desirable to maintain such qualification or to avoid or minimize such risk,
and (2) such action will not adversely affect in any material respect the
interests of any related Certificateholder or (b) to restrict the transfer of
the REMIC Residual Certificates, provided that the Company has determined that
such change would not adversely affect the applicable ratings of any classes
of the Certificates, as evidenced by a letter from each applicable Rating
Agency as specified in the related Prospectus Supplement, and that any such
amendment will not give rise to any tax with respect to the transfer of the
REMIC Residual Certificates to a non-permitted transferee; or (v) to make any
other provisions with respect to matters or questions arising under such
Pooling and Servicing Agreement which are not materially inconsistent with the
provisions thereof, so long as such action will not adversely affect in any
material respect the interests of any Certificateholder.
The Pooling and Servicing Agreement may also be amended by the Company, the
Master Servicer and the Trustee (except as otherwise provided for in the
related Pooling and Servicing Agreement with respect to the Credit Enhancer)
with the consent of the holders of Certificates of each class affected thereby
evidencing, in each case, not less than 66% of the aggregate Percentage
Interests constituting such class for the purpose of adding any provisions to
or changing in any manner or eliminating any of the provisions of such Pooling
and Servicing Agreement or of modifying in any manner the rights of the
related Certificateholders, except that no such amendment may (i) reduce in
any manner the amount of, or delay the timing of, payments received on
Mortgage Loans which are required to be distributed on a Certificate of any
class without the consent of the holder of such Certificate, (ii) impair the
right of any Certificateholder to institute suit for the enforcement of the
provisions of the Pooling and Servicing Agreement or (iii) reduce the
percentage of Certificates of any class the holders of which are required to
consent to any such amendment unless the holders of all Certificates of such
class have consented to the change in such percentage.
Notwithstanding the foregoing, if a REMIC election has been made with
respect to the related Trust Fund, the Trustee will not be entitled to consent
to any amendment to a Pooling and Servicing Agreement without having first
received an opinion of counsel to the effect that such amendment or the
exercise of any power granted to the Master Servicer, the Company or the
Trustee in accordance with such amendment will not result in the imposition of
a tax on the related Trust Fund or cause such Trust Fund to fail to qualify as
a REMIC.
TERMINATION; RETIREMENT OF CERTIFICATES
The obligations created by the Pooling and Servicing Agreement for each
series of Certificates (other than certain limited payment and notice
obligations of the Trustee and the Company, respectively) will terminate upon
the payment to the related Certificateholders of all amounts held in the
Certificate Account or by the Master Servicer and required to be paid to such
Certificateholders following the earlier of (i) the final payment or other
liquidation or disposition (or any advance with respect thereto) of the last
Mortgage Loan subject thereto and all property acquired upon foreclosure or
deed in lieu of foreclosure of any Mortgage Loan and (ii) the purchase by the
Master Servicer or the Company or, if specified in the related Prospectus
Supplement, by the holder of the REMIC Residual Certificates (see "Certain
Federal Income Tax Consequences" below) from the Trust Fund for such series of
all remaining Mortgage Loans and all property acquired in respect of such
Mortgage Loans. In addition to the foregoing, the Master Servicer or the
Company may have the option to purchase, in whole but not in part, the
Certificates specified in the related Prospectus Supplement in the manner set
forth in the related Prospectus Supplement. Upon the purchase of such
Certificates or at any time thereafter, at the option of the Master Servicer
or the Company, the Mortgage Loans may be sold, thereby effecting a retirement
of the Certificates and the termination of the Trust Fund, or the Certificates
so purchased may be held or resold by the Master Servicer or the Company.
Written notice of termination of the Pooling and Servicing 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.
If the Certificateholders are permitted to terminate the trust under the
applicable Pooling and
54
<PAGE>
Servicing Agreement, a penalty may be imposed upon the Certificateholders
based upon the fee that would be foregone by the Master Servicer because of
such termination.
Any such purchase of Mortgage Loans and property acquired in respect of
Mortgage Loans evidenced by a series of Certificates shall be made at the
option of the Master Servicer, the Company or, if applicable, the holder of
the REMIC Residual Certificates at the price specified in the related
Prospectus Supplement. The exercise of such right will effect early retirement
of the Certificates of that series, but the right of any such entity to
purchase the Mortgage Loans and related property will be subject to the
criteria, and will be at the price set forth in the related Prospectus
Supplement. Such early termination may adversely affect the yield to holders
of certain classes of such Certificates. If a REMIC election has been made,
the termination of the related Trust Fund will be effected in a manner
consistent with applicable federal income tax regulations and its status as a
REMIC.
THE TRUSTEE
The Trustee under each Pooling and Servicing Agreement will be named in the
related Prospectus Supplement. The commercial bank or trust company serving as
Trustee may have normal banking relationships with the Company and/or its
affiliates, including Residential Funding.
The Trustee may resign at any time, in which event the Company will be
obligated to appoint a successor trustee. The Company may also remove the
Trustee if the Trustee ceases to be eligible to continue as such under the
Pooling and Servicing Agreement or if the Trustee becomes insolvent. Upon
becoming aware of such circumstances, the Company will be obligated to appoint
a successor Trustee. The Trustee may also be removed at any time by the
holders of Certificates evidencing not less than 51% of the aggregate voting
rights in the related Trust Fund. 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.
YIELD AND PREPAYMENT CONSIDERATIONS
The yield to maturity of a Certificate will depend on the price paid by the
holder for such Certificate, the Pass-Through Rate on any such Certificate
entitled to payments of interest (which Pass-Through Rate may vary if so
specified in the related Prospectus Supplement) and the rate and timing of
principal payments (including payments in excess of required installments,
prepayments or terminations, liquidations and repurchases) on the Mortgage
Loans and the rate and timing of Draws in the case of Revolving Credit Loans
and the allocation thereof to reduce the principal balance of such Certificate
(or notional amount thereof, if applicable).
The amount of interest payments on a Mortgage Loan distributed (or accrued
in the case of Deferred Interest or Accrual Certificates) monthly to holders
of a class of Certificates entitled to payments of interest will be calculated
on the basis of such class's specified percentage of each such payment of
interest (or accrual in the case of Accrual Certificates) and will be
expressed as a fixed, adjustable or variable Pass-Through Rate payable on the
outstanding principal balance or notional amount of such Certificate, or any
combination of such Pass-Through Rates, calculated as described herein and in
the related Prospectus Supplement. See "Description of the Certificates--
Distributions." Holders of Strip Certificates or a class of Certificates
having a Pass-Through Rate that varies based on the weighted average Mortgage
Rate of the underlying Mortgage Loans will be affected by disproportionate
prepayments and repurchases of Mortgage Loans having higher Net Mortgage Rates
or rates applicable to the Strip Certificates, as applicable.
The effective yield to maturity to each holder of Certificates entitled to
payments of interest will be below that otherwise produced by the applicable
Pass-Through Rate and purchase price of such Certificate to the extent that
interest accrues on each Mortgage Loan during the calendar month or a period
preceding a Distribution Date instead of through the day immediately preceding
such Distribution Date.
A class of Certificates may be entitled to payments of interest at a
variable or adjustable Pass-Through Rate, or any combination of such Pass-
Through Rates, as specified in the related Prospectus Supplement. A variable
55
<PAGE>
Pass-Through Rate may be calculated based on the weighted average of the
Mortgage Rates (net of Servicing Fees and any Excess Spread or Excluded
Spread) of the related Mortgage Loans (the "NET MORTGAGE RATE") or certain
balances thereof for the month preceding the Distribution Date, by reference
to an index or otherwise. The aggregate payments of interest on a class of
Certificates, and the yield to maturity thereon, will be affected by the rate
of payment of principal on the Certificates (or the rate of reduction in the
notional amount of Certificates entitled to payments of interest only) and, in
the case of Certificates evidencing interests in ARM Loans, by changes in the
Net Mortgage Rates on the ARM Loans. The yield on the Certificates will also
be affected by liquidations of Mortgage Loans following Mortgagor defaults and
by purchases of Mortgage Loans in the event of certain breaches of
representations made in respect of such Mortgage Loans, or conversions of ARM
Loans to a fixed interest rate. See "Mortgage Loan Program--Representations
Relating to Mortgage Loans" and "Description of the Certificates--Assignment
of Trust Fund Assets" above. In addition, if the index used to determine the
Pass-Through Rate for the Certificates is different than the Index applicable
to the Mortgage Rates, the yield on the Certificates will be sensitive to
changes in the index related to the Pass-Through Rate and the yield on the
Certificates may be reduced by application of a cap on the Pass-Through Rate
based on the weighted average of the Net Mortgage Rates or such other formulas
as may be set forth in the related Prospectus Supplement.
In general, if a Certificate is purchased at a premium over its face amount
and distributions of principal on such Certificate occur at a rate faster than
anticipated at the time of purchase, the purchaser's actual yield to maturity
will be lower than that assumed at the time of purchase. Conversely, if a
Certificate is purchased at a discount from its face amount and distributions
of principal on such Certificate occur at a rate slower than that assumed at
the time of purchase, the purchaser's actual yield to maturity will be lower
than that originally anticipated. If Strip Certificates are issued evidencing
a right to payments of interest only or disproportionate payments of interest,
a faster than expected rate of principal payments on the Mortgage Loans (net
of Draws if applicable) will negatively affect the total return to investors
in any such Certificates. The yield on a class of Strip Certificates that is
entitled to receive payments of interest only will nevertheless be affected by
any losses on the related Mortgage Loans because of the effect on the timing
and amount of payments. In certain circumstances, rapid principal payments on
the Mortgage Loans (net of Draws if applicable) may result in the failure of
such holders to recoup their original investment. If Strip Certificates are
issued evidencing a right to payments of principal only or disproportionate
payments of principal, a slower than expected rate of principal payments on
the Mortgage Loans (net of Draws if applicable) could negatively affect the
anticipated yield on such Strip Certificates. In addition, the total return to
investors of Certificates evidencing a right to distributions of interest at a
rate that is based on the weighted average Net Mortgage Rate of the Mortgage
Loans from time to time will be adversely affected by principal payments on
Mortgage Loans with Mortgage Rates higher than the weighted average Mortgage
Rate on the Mortgage Collateral. In general, mortgage loans with higher
Mortgage Rates or Gross Margins are likely to prepay at a faster rate than
mortgage loans with lower Mortgage Rates or Gross Margins. In addition, the
yield to maturity on certain other types of classes of Certificates, including
Accrual Certificates, Certificates with a Pass-Through Rate that fluctuates
inversely with or at a multiple of an index or certain other classes in a
series including more than one class of Certificates, may be relatively more
sensitive to the rate of principal payments on the related Mortgage Loans (net
of Draws if applicable) than other classes of Certificates.
The timing of changes in the rate of principal distributions on a
Certificate may significantly affect an investor's actual yield to maturity,
even if the average rate of principal distributions experienced over time is
consistent with an investor's expectation. In general, the earlier a
distribution of principal on a Certificate, the greater will be the effect on
an investor's yield to maturity. As a result, the effect on an investor's
yield of principal distributions occurring at a rate higher (or lower) than
the rate anticipated by the investor during the period immediately following
the issuance of a series of Certificates would not be fully offset by a
subsequent like reduction (or increase) in the rate of principal
distributions.
Unless otherwise specified in the related Prospectus Supplement, prepayments
in full or final liquidations of Closed-End Loans will reduce the amount of
interest distributed in the following month to holders of Certificates
entitled to distribution of interest because the resulting Prepayment Interest
Shortfall will not be covered by
56
<PAGE>
Compensating Interest. See "Description of the Certificates--Principal and
Interest on the Certificates." Unless otherwise specified in the related
Prospectus Supplement, a partial prepayment of principal of a Closed-End Loan
is applied so as to reduce the outstanding principal balance thereof as of the
first day of the month in which such partial prepayment is received. As a
result, the effect of a partial prepayment on a Closed-End Loan generally will
be to reduce the amount of interest distributed to holders of Certificates in
the month following the receipt of such partial prepayment by an amount equal
to one month's interest at the applicable Pass-Through Rate or Net Mortgage
Rate, as the case may be, on the prepaid amount. See "Description of the
Certificates--Payment on Mortgage Loans; Deposits to Certificate Account."
Neither full nor partial principal prepayments on Closed-End Loans will be
distributed until the Distribution Date in the month following receipt.
The rate and timing of defaults on the Mortgage Loans will also affect the
rate and timing of principal payments on the Mortgage Loans and thus the yield
on the related Certificates. For a general discussion of the risk of defaults
on the Mortgage Loans, see "Risk Factors--Special Features of the Mortgage
Loans" herein. There can be no assurance as to the rate of losses or
delinquencies on any of the Mortgage Loans, however, such losses and
delinquencies may be expected to be higher than those of traditional first
lien mortgage loans. To the extent that any losses are incurred on any of the
Mortgage Loans that are not covered by the applicable credit enhancement,
holders of Certificates of the series evidencing interests in the related
Mortgage Pool (or certain classes thereof) will bear all risk of such losses
resulting from default by Mortgagors. See "Risk Factors--Limitations,
Reduction and Substitution of Credit Enhancement" herein. Even where the
applicable credit enhancement covers all losses incurred on the Mortgage
Loans, the effect of losses may be to increase prepayment experience on the
Mortgage Loans, thus reducing average weighted life and affecting yield to
maturity.
With respect to certain Mortgage Loans (including ARM Loans and Revolving
Credit Loans), the Mortgage Rate at origination may be below the rate that
would result from the sum of the then-applicable Index and Gross Margin. Under
the applicable underwriting standards, Mortgagors under Closed-End Loans
generally will be qualified on the basis of the Mortgage Rate in effect at
origination, and Mortgagors under Revolving Credit Loans are generally
qualified based on an assumed payment which reflects a rate significantly
lower than the maximum rate. The repayment of any such Mortgage Loan may thus
be dependent on the ability of the mortgagor to make larger interest payments
following the adjustment of the Mortgage Rate.
With respect to certain Closed-End Loans that permit negative amortization,
during a period of rising interest rates as well as immediately after
origination, that portion of the interest currently accruing thereon but not
currently payable will become Deferred Interest which will be added to the
principal balance thereof and will bear interest at the applicable Mortgage
Rate. The addition of any such Deferred Interest to the principal balance of
any related class of Certificates will lengthen the weighted average life
thereof and may adversely affect yield to holders thereof. Unless otherwise
specified in the related Prospectus Supplement, Revolving Credit Loans will
not be subject to negative amortization.
With respect to Revolving Credit Loans, except for certain programs under
which the Draw Period is less than the full term thereof, required minimum
monthly payments are generally equal to or not significantly larger than the
amount of interest currently accruing thereon, and therefore are not expected
to significantly amortize the outstanding principal amounts of such Mortgage
Loans prior to maturity, which amounts may include substantial Draws recently
made. As a result, a borrower will generally be required to pay a substantial
principal amount at the maturity of a Revolving Credit Loan. Alternatively, a
pool of Closed-End Loans may include Balloon Loans which require a single
payment at maturity. Such Mortgage Loans pose a greater risk of default than
fully-amortizing Mortgage Loans, because the Mortgagor's ability to make such
a substantial payment at maturity will generally depend on the Mortgagor's
ability to obtain refinancing of such Mortgage Loans or to sell the Mortgaged
Property prior to the maturity of the Balloon Loan. The ability to obtain
refinancing will depend on a number of factors prevailing at the time
refinancing or sale is required, including, without limitation, the
Mortgagor's personal economic circumstances, the Mortgagor's equity in the
related Mortgaged Property, real estate values, prevailing market interest
rates, tax laws and national and regional economic conditions. For a general
discussion of factors that may affect a Mortgagor's personal economic
circumstances, see "Risk Factors
57
<PAGE>
- --Special Features of the Mortgage Loans--Mortgagor Credit" herein. Unless
otherwise specified in the related Prospectus Supplement, neither the Company,
Residential Funding, GMAC Mortgage nor any of their affiliates will be
obligated to refinance or repurchase any Mortgage Loan or to sell any
Mortgaged Property.
For any Mortgage Loans secured by junior mortgages, any inability of the
Mortgagor to pay off the balance thereof may also affect the ability of the
Mortgagor to obtain refinancing at any time of any related senior mortgage
loan, thereby preventing a potential improvement in the Mortgagor's
circumstances. Furthermore, if so specified in the related Prospectus
Supplement, under the applicable Pooling and Servicing Agreement the Master
Servicer may be restricted or prohibited from consenting to any refinancing of
any related senior mortgage loan, which in turn could adversely affect the
Mortgagor's circumstances or result in a prepayment or default under the
corresponding junior Mortgage Loan.
In addition to the Mortgagor's personal economic circumstances, a number of
factors, including homeowner mobility, job transfers, changes in the
Mortgagor's housing needs, the Mortgagor's net equity in the Mortgaged
Property, changes in the value of the Mortgaged Property, national and
regional economic conditions, enforceability of due-on-sale clauses,
prevailing market interest rates, servicing decisions, solicitations and the
availability of mortgage funds, seasonal purchasing and payment habits of
borrowers or changes in the deductibility for federal income tax purposes of
interest payments on home equity loans, may affect the rate and timing of
principal payments (or Draws if applicable) on the Mortgage Loans. For a
discussion of certain factors that may affect national and regional economic
conditions, see "Risk Factors--Special Features of the Mortgage Loans--
Mortgagor Credit" herein. There can be no assurance as to the rate of
principal payments on the Mortgage Loans, and there can be no assurance of the
rate of Draws on Revolving Credit Loans. The rate of principal payments and
the rate of Draws (if applicable) may fluctuate substantially from time to
time. Generally, home equity loans are not viewed by mortgagors as permanent
financing. Accordingly, Closed-End Loans may experience a higher rate of
prepayment than typical first lien mortgage loans. On the other hand, for
Revolving Credit Loans, due to the unpredictable nature of both principal
payments and Draws, the rates of principal payments net of Draws for such
loans may be much more volatile than for typical first lien mortgage loans.
The yield to maturity of the Certificates of any series, or the rate and
timing of principal payments (or Draws if applicable) on the related Mortgage
Loans, may also be affected by a wide variety of specific terms and conditions
applicable to the respective programs under which the Mortgage Loans were
originated. For example, Revolving Credit Loans may provide for future Draws
to be made only in specified minimum amounts, or alternatively may permit
Draws to be made by check or through a credit card in any amount. A pool of
Revolving Credit Loans subject to the latter provisions may be likely to
remain outstanding longer with a higher aggregate principal balance than a
pool of Revolving Credit Loans with the former provisions, because of the
relative ease of making new Draws. Furthermore, Revolving Credit Loans may
provide for interest rate changes on a daily or monthly basis, or may have
Gross Margins that may vary under certain circumstances over the term of the
loan. In extremely high market interest rate scenarios, Certificates backed by
Revolving Credit Loans with adjustable rates subject to substantially higher
maximum rates than typically apply to adjustable rate first mortgage loans may
experience rates of default and liquidation substantially higher than those
that have been experienced on other adjustable rate mortgage loan pools.
The yield to maturity of the Certificates of any series, or the rate and
timing of principal payments (or Draws if applicable) on the related Mortgage
Loans and corresponding distributions on the Certificates, will also be
affected by the specific terms and conditions applicable to the Certificates.
For example, if the index used to determine the Pass-Through Rates for a
series of Certificates is different from the Index applicable to the Mortgage
Rates of the underlying Mortgage Loans, the yield on the Certificates may be
reduced by application of a cap on the Pass-Through Rates based on the
weighted average of the Mortgage Rates. Depending on applicable cash flow
allocation provisions, changes in the relationship between the two indexes may
also affect the timing of certain principal distributions on the Certificates,
or may affect the amount of any Overcollateralization (or the amount on
deposit in any Reserve Fund) which could in turn accelerate the distribution
of principal on the Certificates if so provided in the Prospectus Supplement.
For any series of Certificates backed by Revolving Credit Loans, provisions
governing whether future Draws on the Revolving
58
<PAGE>
Credit Loans will be included in the Trust Fund will have a significant effect
on the rate and timing of principal distributions on the Certificates. For a
series of Certificates backed by the Trust Balances of Revolving Credit Loans,
the specific provisions applicable to the allocation of payments, Draws and
losses on the Revolving Credit Loans between the Trust Balances and the
Excluded Balances thereof will also have a significant effect on the rate and
timing of principal distributions on the Certificates. See "Allocation of
Revolving Credit Loan Balances" herein.
For a series of Certificates backed by Revolving Credit Loans, as a result
of the payment terms of the Mortgage Loans or of the Certificate provisions
relating to future Draws, there may be no principal distributions on such
Certificates in any given month. In addition, it is possible that the
aggregate Draws on Revolving Credit Loans included in a Mortgage Pool may
exceed the aggregate payments with respect to principal on such Revolving
Credit Loans for the related period.
Unless otherwise specified in the related Prospectus Supplement, all
Revolving Credit Loans and all Closed-End Loans (other than ARM Loans) will
contain due-on-sale provisions permitting the mortgagee to accelerate the
maturity of the Mortgage Loan upon sale or certain transfers by the Mortgagor
of the underlying Mortgaged Property. Unless the related Prospectus Supplement
indicates otherwise, the Master Servicer will generally enforce any due-on-
sale clause to the extent it has knowledge of the conveyance or proposed
conveyance of the underlying Mortgaged Property and it is entitled to do so
under applicable law, provided, however, that the Master Servicer will not
take any action in relation to the enforcement of any due-on-sale provision
which would adversely affect or jeopardize coverage under any applicable
insurance policy. An ARM Loan is generally assumable under certain conditions
if the proposed transferee of the related Mortgaged Property establishes its
ability to repay the Mortgage Loan and, in the reasonable judgment of the
Master Servicer or the related Subservicer, the security for the ARM Loan
would not be impaired by the assumption. The extent to which ARM Loans are
assumed by purchasers of the Mortgaged Properties rather than prepaid by the
related Mortgagors in connection with the sales of the Mortgaged Properties
will affect the weighted average life of the related series of Certificates.
See "Description of the Certificates--Collection and Other Servicing
Procedures" and "Certain Legal Aspects of the Mortgage Loans and Related
Matters--Enforceability of Certain Provisions" for a description of certain
provisions of the Pooling and Servicing Agreement and certain legal
developments that may affect the prepayment experience on the Mortgage Loans.
In addition, certain Mortgage Securities included in a Mortgage Pool may be
backed by underlying Mortgage Loans having differing interest rates.
Accordingly, the rate at which principal payments are received on the related
Certificates will, to a certain extent, depend on the interest rates on such
underlying Mortgage Loans.
At the request of the Mortgagor, the Master Servicer or a Subservicer may
allow the refinancing of a Mortgage Loan in any Trust Fund by accepting
prepayments thereon and permitting a new loan secured by a mortgage on the
same property. In the event of such a refinancing, the new loan would not be
included in the related Trust Fund and, therefore, such refinancing would have
the same effect as a prepayment in full of the related Mortgage Loan. A
Subservicer or the Master Servicer may, from time to time, implement programs
designed to encourage refinancing. Such programs may include, without
limitation, modifications of existing loans, general or targeted
solicitations, the offering of pre-approved applications, reduced origination
fees or closing costs, or other financial incentives. In addition, the Master
Servicer or any Subservicers may encourage the refinancing of Mortgage Loans,
including defaulted Mortgage Loans, that would permit creditworthy borrowers
to assume the outstanding indebtedness of such Mortgage Loans.
If the Pooling and Servicing Agreement for a Series of Certificates provides
for a Funding Account or other means of funding the transfer of additional
Mortgage Loans to the related Trust, as described under "Description of the
Certificates; Funding Account" herein, and the Trust is unable to acquire such
additional Mortgage Loans within any applicable time limit, the amounts set
aside for such purpose may be applied as principal distributions on one or
more Classes of Certificates of such Series.
59
<PAGE>
Although the Mortgage Rates on Revolving Credit Loans and ARM Loans will be
subject to periodic adjustments, such adjustments generally (i) as to ARM
Loans will not increase or decrease such Mortgage Rates by more than a fixed
percentage amount on each adjustment date, (ii) will not increase such
Mortgage Rates over a fixed maximum rate during the life of any Revolving
Credit Loan or ARM Loan and (iii) will be based on an Index (which may not
rise and fall consistently with prevailing market interest rates) plus the
related Gross Margin (which may vary under certain circumstances, and which
may be different from margins being used at the time for newly originated
adjustable rate mortgage loans). As a result, the Mortgage Rates on the
Revolving Credit Loans or ARM Loans in any Mortgage Pool at any time may not
equal the prevailing rates for similar, newly originated adjustable rate home
equity mortgage loans or lines of credit, and accordingly the rate of
principal payments (and Draws if applicable) may be lower or higher that would
otherwise be anticipated. In certain rate environments, the prevailing rates
on fixed-rate mortgage loans may be sufficiently low in relation to the then-
current Mortgage Rates on Revolving Credit Loans or ARM Loans that the rate of
prepayment may increase as a result of refinancings. There can be no certainty
as to the rate of principal payments (or Draws if applicable) on the Mortgage
Loans during any period or over the life of any series of Certificates.
With respect to any index used in determining the Pass-Through Rates for a
series of Certificates or Mortgage Rates of the underlying Mortgage Loans, a
number of factors affect the performance of such index and may cause such
index to move in a manner different from other indices. To the extent that
such index may reflect changes in the general level of interest rates less
quickly than other indices, in a period of rising interest rates, increases in
the yield to Certificateholders due to such rising interest rates may occur
later than that which would be produced by other indices, and in a period of
declining rates, such index may remain higher than other market interest rates
which may result in a higher level prepayments of the Mortgage Loans, which
adjust in accordance with such index, than of mortgage loans which adjust in
accordance with other indices.
Under certain circumstances, the Master Servicer, the Company or, if
specified in the related Prospectus Supplement, the holders of the REMIC
Residual Certificates may have the option to purchase the Mortgage Loans in a
Trust Fund, thus resulting in the early retirement of the related
Certificates. See "The Pooling and Servicing Agreement--Termination;
Retirement of Certificates."
CERTAIN LEGAL ASPECTS OF MORTGAGE LOANS AND RELATED MATTERS
The following discussion contains summaries of certain legal aspects of
mortgage loans that are general in nature. Because such legal aspects are
governed in part by state law (which laws may differ from state to state), the
summaries do not purport to be complete, to reflect the laws of any particular
state or to encompass the laws of all states in which the Mortgaged Properties
may be situated. The summaries are qualified in their entirety by reference to
the applicable federal and state laws governing the Mortgage Loans.
GENERAL
The Mortgage Loans (other than Cooperative Loans) will be secured by either
deeds of trust, mortgages or deeds to secure debt, depending upon the
prevailing practice in the state in which the related Mortgaged Property is
located, and may have first, second or third priority. Mortgages and deeds to
secure debt are herein referred to as "mortgages". In some states, a mortgage
or deed of trust creates a lien upon the real property encumbered by the
mortgage or deed of trust. However, in other states, the mortgage or deed of
trust conveys legal title to the property respectively, to the mortgagee or to
a trustee for the benefit of the mortgagee subject to a condition subsequent
(i.e., the payment of the indebtedness secured thereby). The lien created by
the mortgage or deed of trust is not prior to the lien for real estate taxes
and assessments and other charges imposed under governmental police powers.
Priority between mortgages depends on their terms or on the terms of separate
subordination or inter-creditor agreements, the knowledge of the parties in
some cases and generally on the order of recordation of the mortgage in the
appropriate recording office. There are two parties to a mortgage, the
mortgagor, who is the borrower and homeowner, and the mortgagee, who is the
lender. Under the mortgage instrument, the mortgagor delivers to the mortgagee
a note or bond and the mortgage. In the case of a land trust, there are three
60
<PAGE>
parties because title to the property is held by a land trustee under a land
trust agreement of which the borrower is the beneficiary; at origination of a
mortgage loan, the borrower executes a separate undertaking to make payments
on the mortgage note. Although a deed of trust is similar to a mortgage, a
deed of trust has three parties: the trustor who is the borrower-homeowner;
the beneficiary who is the lender; and a third-party grantee called the
trustee. Under a deed of trust, the borrower grants the property, irrevocably
until the debt is paid, in trust, generally with a power of sale, to the
trustee to secure payment of the obligation. The trustee's authority under a
deed of trust, the grantee's authority under a deed to secure debt and the
mortgagee's authority under a mortgage are governed by the law of the state in
which the real property is located, the express provisions of the deed of
trust or mortgage, and, in certain deed of trust transactions, the directions
of the beneficiary.
COOPERATIVE LOANS
If specified in the Prospectus Supplement relating to a series of
Certificates, the Mortgage Loans may include Cooperative Loans. Each debt
instrument (a "COOPERATIVE NOTE") evidencing a Cooperative Loan will be
secured by a security interest in shares issued by the related corporation (a
"COOPERATIVE") that owns the related apartment building, which is a
corporation entitled to be treated as a housing cooperative under federal tax
law, and in the related proprietary lease or occupancy agreement granting
exclusive rights to occupy a specific dwelling unit in the Cooperative's
building. The security agreement will create a lien upon the shares of the
Cooperative, the priority of which will depend on, among other things, the
terms of the particular security agreement as well as the order of recordation
and/or filing of the agreement (or financing statements related thereto) in
the appropriate recording office.
Unless otherwise specified in the related Prospectus Supplement, all
Cooperative buildings relating to the Cooperative Loans are located in the
State of New York. Generally, each Cooperative owns in fee or has a leasehold
interest in all the real property and owns in fee or leases the building and
all separate dwelling units therein. The Cooperative is directly responsible
for property management and, in most cases, payment of real estate taxes,
other governmental impositions and hazard and liability insurance. If there is
an underlying mortgage (or mortgages) on the Cooperative's building or
underlying land, as is generally the case, or an underlying lease of the land,
as is the case in some instances, the Cooperative, as mortgagor or lessor, as
the case may be, is also responsible for fulfilling such mortgage or rental
obligations. An underlying mortgage loan is ordinarily obtained by the
Cooperative in connection with either the construction or purchase of the
Cooperative's building or the obtaining of capital by the Cooperative. The
interest of the occupant under proprietary leases or occupancy agreements as
to which that Cooperative is the landlord is generally subordinate to the
interest of the holder of an underlying mortgage and to the interest of the
holder of a land lease. If the Cooperative is unable to meet the payment
obligations (i) arising under an underlying mortgage, the mortgagee holding an
underlying mortgage could foreclose on that mortgage and terminate all
subordinate proprietary leases and occupancy agreements or (ii) arising under
its land lease, the holder of the landlord's interest under the land lease
could terminate it and all subordinate proprietary leases and occupancy
agreements. In addition, an underlying mortgage on a Cooperative may provide
financing in the form of a mortgage that does not fully amortize, with a
significant portion of principal being due in one final payment at maturity.
The inability of the Cooperative to refinance a mortgage and its consequent
inability to make such final payment could lead to foreclosure by the
mortgagee. Similarly, a land lease has an expiration date and the inability of
the Cooperative to extend its term or, in the alternative, to purchase the
land, could lead to termination of the Cooperative's interest in the property
and termination of all proprietary leases and occupancy agreements. In either
event, a foreclosure by the holder of an underlying mortgage or the
termination of the underlying lease could eliminate or significantly diminish
the value of any collateral held by the mortgagee who financed the purchase by
an individual tenant-stockholder of shares of the Cooperative or, in the case
of the Mortgage Loans, the collateral securing the Cooperative Loans.
Each Cooperative is owned by shareholders (referred to as tenant-
stockholders) who, through ownership of stock or shares in the Cooperative,
receive proprietary leases or occupancy agreements which confer exclusive
rights to occupy specific dwellings. Generally, a tenant-stockholder of a
Cooperative must make a monthly payment to the Cooperative pursuant to the
proprietary lease, which payment represents such tenant-
61
<PAGE>
stockholder's pro rata share of the Cooperative's payments for its underlying
mortgage, real property taxes, maintenance expenses and other capital or
ordinary expenses. An ownership interest in a Cooperative and accompanying
occupancy rights may be financed through a Cooperative Loan evidenced by a
Cooperative Note and secured by an assignment of and a security interest in
the occupancy agreement or proprietary lease and a security interest in the
related shares of the related Cooperative. The mortgagee generally takes
possession of the share certificate and a counterpart of the proprietary lease
or occupancy agreement and a financing statement covering the proprietary
lease or occupancy agreement and the Cooperative shares is filed in the
appropriate state and local offices to perfect the mortgagee's interest in its
collateral. Subject to the limitations discussed below, upon default of the
tenant-stockholder, the lender may sue for judgment on the Cooperative Note,
dispose of the collateral at a public or private sale or otherwise proceed
against the collateral or tenant-stockholder as an individual as provided in
the security agreement covering the assignment of the proprietary lease or
occupancy agreement and the pledge of Cooperative shares. See "--Foreclosure
on Shares of Cooperatives" below.
TAX ASPECTS OF COOPERATIVE OWNERSHIP
In general, a "tenant-stockholder" (as defined in Section 216(b)(2) of the
Internal Revenue Code (the "CODE")) of a corporation that qualifies as a
"cooperative housing corporation" within the meaning of Section 216(b)(1) of
the Code is allowed a deduction for amounts paid or accrued within his taxable
year to the corporation representing his proportionate share of certain
interest expenses and certain real estate taxes allowable as a deduction under
Section 216(a) of the Code to the corporation under Sections 163 and 164 of
the Code. In order for a corporation to qualify under Section 216(b)(1) of the
Code for its taxable year in which such items are allowable as a deduction to
the corporation, such section requires, among other things, that at least 80%
of the gross income of the corporation be derived from its tenant-
stockholders. By virtue of this requirement, the status of a corporation for
purposes of Section 216(b)(1) of the Code must be determined on a year-to-year
basis. Consequently, there can be no assurance that Cooperatives relating to
the Cooperative Loans will qualify under such section for any particular year.
In the event that such a Cooperative fails to qualify for one or more years,
the value of the collateral securing any related Cooperative Loans could be
significantly impaired because no deduction would be allowable to tenant-
stockholders under Section 216(a) of the Code with respect to those years. In
view of the significance of the tax benefits accorded tenant-stockholders of a
corporation that qualifies under Section 216(b)(1) of the Code, the likelihood
that such a failure would be permitted to continue over a period of years
appears remote.
FORECLOSURE ON MORTGAGE LOANS
Although a deed of trust may also be foreclosed by judicial action,
foreclosure of a deed of trust is generally accomplished by a non-judicial
trustee's sale under a specific provision in the deed of trust which
authorizes the trustee to sell the property upon any default by the borrower
under the terms of the note or deed of trust. In addition to any notice
requirements contained in a deed of trust, in some states, prior to a sale the
trustee must record a notice of default and send a copy to the
borrower/trustor and to any person who has recorded a request for a copy of
notice of default and notice of sale. In addition, in some states, prior to
such sale, the trustee must provide notice to any other individual having an
interest of record in the real property, including any junior lienholders. If
the deed of trust is not reinstated within a specified period, a notice of
sale must be posted in a public place and, in most states, published for a
specific period of time in one or more newspapers in a specified manner prior
to the date of trustee's sale. In addition, some states' laws require that a
copy of the notice of sale be posted on the property and sent to all parties
having an interest of record in the real property.
In some states, the borrower-trustor has the right to reinstate the loan at
any time following default until shortly before the trustee's sale. In
general, in such states, the borrower, or any other person having a junior
encumbrance on the real estate, may, during a reinstatement period, cure the
default by paying the entire amount in arrears plus the costs and expenses
incurred in enforcing the obligation.
Foreclosure of a mortgage generally is accomplished by judicial action.
Generally, the action is initiated by the service of legal pleadings upon all
parties having an interest of record in the real property. Delays in
62
<PAGE>
completion of the foreclosure may occasionally result from difficulties in
locating necessary parties. If the mortgagee's right to foreclose is
contested, the legal proceedings necessary to resolve the issue can be time-
consuming.
In the case of foreclosure under either a mortgage or a deed of trust, the
sale by the referee or other designated officer or by the trustee is generally
a public sale. However, because of the difficulty a potential third-party
buyer at the sale might have in determining the exact status of title, and
because the physical condition of the property may have deteriorated during
the foreclosure proceedings, it is uncommon for a third party to purchase the
property at a foreclosure sale. Rather, it is common for the lender to
purchase the property from the trustee or referee for a credit bid less than
or equal to the unpaid principal amount of note plus the accrued and unpaid
interest and the expense of foreclosure, in which case the mortgagor's debt
will be extinguished unless the lender purchases the property for a lesser
amount in order to preserve its right against a borrower to seek a deficiency
judgment and such remedy is available under state law and the loan documents.
In the same states, there is a statutory minimum purchase price which the
lender may offer for the property and generally, state law controls the amount
of foreclosure costs and expenses, including attorneys' fees, which may be
recovered by a lender. Thereafter, subject to the right of the borrower in
some states to remain in possession during the redemption period, the lender
will assume the burdens of ownership, including obtaining hazard insurance,
paying taxes and making such repairs at its own expense as are necessary to
render the property suitable for sale. Generally, the lender will obtain the
services of a real estate broker and pay the broker's commission in connection
with the sale of the property. Depending upon market conditions, the ultimate
proceeds of the sale of the property may not equal the lender's investment in
the property and, in some states, the lender may be entitled to a deficiency
judgment. Any loss may be reduced by the receipt of any mortgage insurance
proceeds or other forms of credit enhancement for a series of Certificates.
See "Description of Credit Enhancement."
A junior mortgagee may not foreclose on the property securing a junior
mortgage unless it forecloses subject to the senior mortgages, in which case
it must either pay the entire amount due on the senior mortgages to the senior
mortgagees prior to or at the time of the foreclosure sale or undertake the
obligation to make payments on the senior mortgages in the event the mortgagor
is in default thereunder, in either event adding the amounts expended to the
balance due on the junior loan, and may be subrogated to the rights of the
senior mortgagees. In addition, in the event that the foreclosure by a junior
mortgagee triggers the enforcement of a "due-on-sale" clause in a senior
mortgage, the junior mortgagee may be required to pay the full amount of the
senior mortgages to the senior mortgagees to avoid foreclosure. Accordingly,
with respect to those Mortgage Loans which are junior mortgage loans, if the
lender purchases the property, the lender's title will be subject to all
senior liens and claims and certain governmental liens. The proceeds received
by the referee or trustee from the sale are applied first to the costs, fees
and expenses of sale and then in satisfaction of the indebtedness secured by
the mortgage or deed of trust under which the sale was conducted. Any
remaining proceeds are generally payable to the holders of junior mortgages or
deeds of trust and other liens and claims in order of their priority, whether
or not the borrower is in default. Any additional proceeds are generally
payable to the mortgagor or trustor. The payment of the proceeds to the
holders of junior mortgages may occur in the foreclosure action of the senior
mortgagee or may require the institution of separate legal proceedings. See
"Risk Factors--Special Features of the Mortgage Loans" and "Description of the
Certificates--Realization Upon Defaulted Mortgage Loans" herein.
FORECLOSURE ON SHARES OF COOPERATIVES
The Cooperative shares owned by the tenant-stockholder, together with the
rights of the tenant-stockholder under the proprietary lease or occupancy
agreement, are pledged to the lender and are, in almost all cases, subject to
restrictions on transfer as set forth in the Cooperative's certificate of
incorporation and by-laws, as well as in the proprietary lease or occupancy
agreement. The proprietary lease or occupancy agreement, even while pledged,
may be cancelled by the Cooperative for failure by the tenant-stockholder to
pay its obligations or charges owed by such tenant-stockholder, including
mechanics' liens against the Cooperative's building incurred by such tenant-
stockholder. Generally, obligations and charges arising under a proprietary
lease or occupancy agreement which are owed to the Cooperative are made liens
upon the shares to which the proprietary lease or occupancy agreement relates.
In addition, the proprietary lease or occupancy agreement generally permits
the
63
<PAGE>
Cooperative to terminate such lease or agreement in the event the borrower
defaults in the performance of covenants thereunder. Typically, the lender and
the Cooperative enter into a recognition agreement which, together with any
lender protection provisions contained in the proprietary lease or occupancy
agreement, establishes the rights and obligations of both parties in the event
of a default by the tenant-stockholder on its obligations under the
proprietary lease or occupancy agreement. A default by the tenant-stockholder
under the proprietary lease or occupancy agreement will usually constitute a
default under the security agreement between the lender and the tenant-
stockholder.
The recognition agreement generally provides that, in the event that the
tenant-stockholder has defaulted under the proprietary lease or occupancy
agreement, the Cooperative will take no action to terminate such lease or
agreement until the lender has been provided with notice of and an opportunity
to cure the default. The recognition agreement typically provides that if the
proprietary lease or occupancy agreement is terminated, the Cooperative will
recognize the lender's lien against proceeds from a sale of the shares and the
proprietary lease or occupancy agreement allocated to the dwelling, subject,
however, to the Cooperative's right to sums due under such proprietary lease
or occupancy agreement or which have become liens on the shares relating to
the proprietary lease or occupancy agreement. The total amount owed to the
Cooperative by the tenant-stockholder, which the lender generally cannot
restrict and does not monitor, could reduce the amount realized upon a sale of
the collateral below the outstanding principal balance of the Cooperative Loan
and accrued and unpaid interest thereon.
Recognition agreements also generally provide that in the event the lender
succeeds to the tenant-shareholder's shares and proprietary lease or occupancy
agreement as the result of realizing upon its collateral for a Cooperative
Loan, the lender must obtain the approval or consent of the board of directors
of the Cooperative as required by the proprietary lease before transferring
the Cooperative shares or assigning the proprietary lease. Such approval or
consent is usually based on the prospective purchaser's income and net worth,
among other factors, and may significantly reduce the number of potential
purchasers, which could limit the ability of the lender to sell and realize
upon the value of the collateral. Generally, the lender is not limited in any
rights it may have to dispossess the tenant-stockholder.
Because of the nature of Cooperative Loans, lenders do not require the
tenant-stockholder (i.e., the borrower) to obtain title insurance of any type.
Consequently, the existence of any prior liens or other imperfections of title
affecting the Cooperative's building or real estate also may adversely affect
the marketability of the shares allocated to the dwelling unit in the event of
foreclosure.
In New York, foreclosure on the Cooperative shares is accomplished by public
sale in accordance with the provisions of Article 9 of the New York Uniform
Commercial Code (the "UCC") and the security agreement relating to those
shares. Article 9 of the UCC requires that a sale be conducted in a
"commercially reasonable" manner. Whether a sale has been conducted in a
"commercially reasonable" manner will depend on the facts in each case. In
determining commercial reasonableness, a court will look to the notice given
the debtor and the method, manner, time, place and terms of the sale and the
sale price. Generally, a sale conducted according to the usual practice of
banks selling similar collateral in the same area will be considered
reasonably conducted.
Article 9 of the UCC provides that the proceeds of the sale will be applied
first to pay the costs and expenses of the sale and then to satisfy the
indebtedness secured by the lender's security interest. The recognition
agreement, however, generally provides that the lender's right to
reimbursement is subject to the right of the Cooperative corporation to
receive sums due under the proprietary lease or occupancy agreement. If there
are proceeds remaining, the lender must account to the tenant-stockholder for
the surplus. Conversely, if a portion of the indebtedness remains unpaid, the
tenant-stockholder is generally responsible for the deficiency. See "--Anti-
Deficiency Legislation and Other Limitations on Lenders" below.
RIGHTS OF REDEMPTION
In some states, after sale pursuant to a deed of trust or foreclosure of a
mortgage, the borrower and foreclosed junior lienors or other parties are
given a statutory period (generally ranging from six months to two
64
<PAGE>
years) 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 interest and expenses of foreclosure. In other states,
redemption may be authorized if the former borrower pays only a portion of the
sums due. In some states, the right to redeem is an equitable right. The
equity of redemption, which is a non-statutory right that must be exercised
prior to a foreclosure sale, should be distinguished from statutory rights of
redemption. The effect of a statutory right of redemption is to diminish the
ability of the lender to sell the foreclosed property. The rights of
redemption would defeat the title of any purchaser subsequent to foreclosure
or sale under a deed of trust. Consequently, the practical effect of the
redemption right is to force the lender to maintain the property and pay the
expenses of ownership until the redemption period has expired.
ANTI-DEFICIENCY LEGISLATION AND OTHER LIMITATIONS ON LENDERS
Certain states have imposed statutory prohibitions which limit the remedies
of a beneficiary under a deed of trust or a mortgagee under a mortgage. In
some states (including California), statutes limit the right of the
beneficiary or mortgagee to obtain a deficiency judgment against the borrower
following foreclosure. A deficiency judgment is a personal judgment against
the former borrower equal in most cases to the difference between the net
amount realized upon the public sale of the real property and the amount due
to the lender. In the case of a Mortgage Loan secured by a property owned by a
trust where the Mortgage Note is executed on behalf of the trust, a deficiency
judgment against the trust following foreclosure or sale under a deed of
trust, even if obtainable under applicable law, may be of little value to the
mortgagee or beneficiary if there are no trust assets against which such
deficiency judgment may be executed. Some state statutes require the
beneficiary or mortgagee to exhaust the security afforded under a deed of
trust or mortgage by foreclosure in an attempt to satisfy the full debt before
bringing a personal action against the borrower. In certain other states, the
lender has the option of bringing a personal action against the borrower on
the debt without first exhausting such security; however, in some of these
states, the lender, following judgment on such personal action, may be deemed
to have elected a remedy and may be precluded from exercising remedies with
respect to the security. Consequently, the practical effect of the election
requirement, in those states permitting such election, is that lenders will
usually proceed against the security first rather than bringing a personal
action against the borrower.
Finally, in certain other states, statutory provisions limit any deficiency
judgment against the borrower following a foreclosure to the excess of the
outstanding debt over the fair market value of the property at the time of the
public sale. The purpose of these statutes is generally to prevent a
beneficiary or mortgagee from obtaining a large deficiency judgment against
the former borrower as a result of low or no bids at the judicial sale.
Generally, Article 9 of the UCC governs foreclosure on Cooperative Shares
and the related proprietary lease or occupancy agreement. Some courts have
interpreted Article 9 to prohibit or limit a deficiency award in certain
circumstances, including circumstances where the disposition of the collateral
(which, in the case of a Cooperative Loan, would be the shares of the
Cooperative and the related proprietary lease or occupancy agreement) was not
conducted in a commercially reasonable manner.
In addition to laws limiting or prohibiting deficiency judgments, numerous
other federal and state statutory provisions, including the federal bankruptcy
laws and state laws affording relief to debtors, may interfere with or affect
the ability of the secured mortgage lender to realize upon its collateral
and/or enforce a deficiency judgment. For example, under the federal
bankruptcy law, all actions against the debtor, the debtor's property and any
co-debtor are automatically stayed upon the filing of a bankruptcy petition.
Moreover, a court having federal bankruptcy jurisdiction may permit a debtor
through its Chapter 11 or Chapter 13 rehabilitative plan to cure a monetary
default in respect of a mortgage loan on such debtor's residence by paying
arrearages within a reasonable time period and reinstating the original
mortgage loan payment schedule, even though the lender accelerated the
mortgage loan and final judgment of foreclosure had been entered in state
court (provided no sale of the residence had yet occurred) prior to the filing
of the debtor's petition. Some courts with federal bankruptcy jurisdiction
have approved plans, based on the particular facts of the reorganization case,
that effected the curing of a mortgage loan default by permitting the borrower
to pay over a number of years.
65
<PAGE>
Courts with federal bankruptcy jurisdiction have also indicated that the
terms of a mortgage loan secured by property which is not the principal
residence of the debtor may be modified. These courts have allowed
modifications that include reducing the amount of each monthly payment,
changing the rate of interest, altering the repayment schedule, forgiving all
or a portion of the debt and reducing the lender's security interest to the
value of the residence, thus leaving the lender a general unsecured creditor
for the difference between the value of the residence and the outstanding
balance of the loan. Generally, however, the terms of a mortgage loan secured
only by a mortgage on real property that is the debtor's principal residence
may not be modified pursuant to a plan confirmed pursuant to Chapter 13 except
with respect to mortgage payment arrearages, which may be cured within a
reasonable time period. Courts with federal bankruptcy jurisdiction similarly
may be able to modify the terms of a Cooperative Loan.
Certain tax liens arising under the Code may, in certain circumstances, have
priority over the lien of a mortgage or deed of trust. This may have the
effect of delaying or interfering with the enforcement of rights with respect
to a defaulted Mortgage Loan. In addition, substantive requirements are
imposed upon mortgage lenders in connection with the origination and the
servicing of mortgage loans by numerous federal and some state consumer
protection laws. These laws include the federal Truth-in-Lending Act, Real
Estate Settlement Procedures Act, Equal Credit Opportunity Act, Fair Credit
Billing Act, Fair Credit Reporting Act and related statutes. These federal
laws impose specific statutory liabilities upon lenders who originate mortgage
loans and who fail to comply with the provisions of the law. In some cases,
this liability may affect assignees of the mortgage loans.
Certain of the Mortgage Loans may be subject to special rules, disclosure
requirements and other provisions that were added to the federal Truth-in-
Lending Act by the Homeownership and Equity Protection Act of 1994 (such
Mortgage Loans, "HIGH COST LOANS"), if such Mortgage Loans were originated on
or after October 1, 1995, are not mortgage loans made to finance the purchase
of the mortgaged property and have interest rates or origination costs in
excess of certain prescribed levels. Purchasers or assignees of any High Cost
Loan, including any Trust Fund, could be liable for all claims and subject to
all defenses arising under such provisions that the borrower could assert
against the originator thereof. Remedies available to the borrower include
monetary penalties, as well as recision rights if the appropriate disclosures
were not given as required.
ENVIRONMENTAL LEGISLATION
Under the federal Comprehensive Environmental Response, Compensation and
Liability Act, as amended ("CERCLA"), and under state law in certain states, a
secured party which takes a deed-in-lieu of foreclosure, purchases a mortgaged
property at a foreclosure sale, or operates a mortgaged property may become
liable in certain circumstances for the costs of cleaning up hazardous
substances regardless of whether they have contaminated the property. CERCLA
imposes strict, as well as joint and several, liability on several classes of
potentially responsible parties, including current owners and operators of the
property who did not cause or contribute to the contamination. Furthermore,
liability under CERCLA is not limited to the original or unamortized principal
balance of a loan or to the value of the property securing a loan. Lenders may
be held liable under CERCLA as owners or operators unless they qualify for the
secured creditor exemption to CERCLA. This exemption exempts from the
definition of owners and operators those who, without participating in the
management of a facility, hold indicia of ownership primarily to protect a
security interest in the facility. What constitutes sufficient participation
in the management of a property securing a loan or the business of a borrower
to render the exemption unavailable to a lender has been a matter of
interpretation by the courts. CERCLA has been interpreted to impose liability
on a secured party, even absent foreclosure, where the party participated in
the financial management of the borrower's business to a degree indicating a
capacity to influence waste disposal decisions. However, court interpretations
of the secured creditor exemption have been inconsistent. In addition, when
lenders foreclose and thereupon become owners of collateral property, courts
are inconsistent as to whether such ownership renders the secured creditor
exemption unavailable. Other federal and state laws in certain circumstances
may impose liability on a secured party which takes a deed-in-lieu of
foreclosure, purchases a mortgaged property at a foreclosure sale, or operates
a mortgaged property on which contaminants other than CERCLA hazardous
substances are present, including petroleum, agricultural chemicals, hazardous
wastes,
66
<PAGE>
asbestos, radon, and lead-based paint. Such cleanup costs may be substantial.
It is possible that such cleanup costs could become a liability of a Trust
Fund and reduce the amounts otherwise distributable to the holders of the
related Series of Certificates. Moreover, certain federal statutes and certain
states by statute impose a lien for any cleanup costs incurred by such state
on the property that is the subject of such cleanup costs (an "environmental
lien"). All subsequent liens on such property generally are subordinated to
such an environmental lien and, in some states, even prior recorded liens are
subordinated to environmental liens. In the latter states, the security
interest of the Trustee in a related parcel of real property that is subject
to such an environmental lien could be adversely affected.
Traditionally, many residential mortgage lenders have not taken steps to
evaluate whether contaminants are present with respect to any mortgaged
property prior to the origination of the mortgage loan or prior to foreclosure
or accepting a deed-in-lieu of foreclosure. Accordingly, the Company has not
made and will not make such evaluations prior to the origination of the
Secured Contracts. Neither the Company nor any replacement Servicer will be
required by any Agreement to undertake any such evaluations prior to
foreclosure or accepting a deed-in-lieu of foreclosure. The Company does not
make any representations or warranties or assume any liability with respect to
the absence or effect of contaminants on any related real property or any
casualty resulting from the presence or effect of contaminants. However, the
Company will not be obligated to foreclose on related real property or accept
a deed-in-lieu of foreclosure if it knows or reasonably believes that there
are material contaminated conditions on such property. A failure so to
foreclose may reduce the amounts otherwise available to Certificateholders of
the related Series.
ENFORCEABILITY OF CERTAIN PROVISIONS
The Mortgage Loans generally contain due-on-sale clauses. These clauses
permit the mortgagee to accelerate the maturity of the loan if the borrower
sells, transfers or conveys the property without the prior consent of the
mortgagee. 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 has been limited or denied. However, the Garn-St Germain
Depository Institutions Act of 1982 (the "GARN-ST GERMAIN ACT"), subject to
certain exceptions, preempts state law that prohibits the enforcement of due-
on-sale clauses and permits lenders to enforce these clauses in accordance
with their terms. The Garn-St Germain Act does "encourage" lenders to permit
assumption of loans at the original rate of interest or at some other rate
less than the average of the original rate and the market rate.
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 intra-family transfers, certain transfers by operation
of law, leases of fewer than three years and the creation of a junior
encumbrance. Regulations promulgated under the Garn-St Germain Act also
prohibit the imposition of a prepayment penalty upon the acceleration of a
loan pursuant to a due-on-sale clause.
The inability to enforce a due-on-sale clause may result in a mortgage 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.
Forms of notes and mortgages used by lenders may contain provisions
obligating the borrower to pay a late charge if payments are not timely made,
and in some circumstances may provide for prepayment fees or penalties if the
obligation is paid prior to maturity. In certain states, there are or may be
specific limitations upon the late charges which a lender may collect from a
borrower for delinquent payments. Certain states also limit the amounts that a
lender may collect from a borrower as an additional charge if the loan is
prepaid.
In foreclosure actions, 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.
67
<PAGE>
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 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.
APPLICABILITY OF USURY LAWS
Title V of the Depository Institutions Deregulation and Monetary Control Act
of 1980 ("TITLE V"), provides that state usury limitations shall not apply to
certain types of residential first mortgage loans, including cooperative loans
originated by certain lenders after March 31, 1980. A similar federal statute
was in effect with respect to mortgage loans made during the first three
months of 1980. The Office of Thrift Supervision is authorized to issue rules
and regulations and to publish interpretations governing implementation of
Title V. The statute authorized any state to impose 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
or to limit discount points or other charges.
Usury limits apply to junior mortgage loans in many states. Any applicable
usury limits in effect at origination will be reflected in the maximum
Mortgage Rates for Revolving Credit Loans and ARM Loans, as set forth in the
related Prospectus Supplement.
Unless otherwise set forth in the related Prospectus Supplement, each Seller
of a Mortgage Loan will have represented that such Mortgage Loan was
originated in compliance with then applicable state laws, including usury
laws, in all material respects. However, the Mortgage Rates on the Mortgage
Loans will be subject to applicable usury laws as in effect from time to time.
ALTERNATIVE MORTGAGE INSTRUMENTS
Alternative mortgage instruments, including adjustable rate mortgage loans
and adjustable rate cooperative loans, and early ownership mortgage loans,
originated by non-federally chartered lenders have historically been subjected
to a variety of restrictions. Such restrictions differed from state to state,
resulting in difficulties in determining whether a particular alternative
mortgage instrument originated by a state-chartered lender was in compliance
with applicable law. These difficulties were alleviated substantially as a
result of the enactment of Title VIII of the Garn-St Germain Act ("TITLE
VIII"). Title VIII provides that, notwithstanding any state law to the
contrary, (i) state-chartered banks may originate alternative mortgage
instruments in accordance with regulations promulgated by the Comptroller of
the Currency with respect to the origination of alternative mortgage
instruments by national banks, (ii) state-chartered credit unions may
originate alternative mortgage instruments in accordance with regulations
promulgated by the National Credit Union Administration with respect to
origination of alternative mortgage instruments by federal credit unions and
(iii) all other non-federally chartered housing creditors, including state-
chartered savings and loan associations, state-chartered savings banks and
mutual savings banks and mortgage banking companies, may originate alternative
mortgage instruments in accordance with the regulations promulgated by the
Federal Home Loan Bank Board, predecessor to the Office of Thrift Supervision,
with respect to origination of alternative mortgage instruments by federal
savings and loan associations. Title VIII also provides that any state may
reject applicability of the provisions of Title VIII by
68
<PAGE>
adopting, prior to October 15, 1985, a law or constitutional provision
expressly rejecting the applicability of such provisions. Certain states have
taken such action.
SOLDIERS' AND SAILORS' CIVIL RELIEF ACT OF 1940
Under the terms of the Soldiers' and Sailors' Civil Relief Act of 1940, as
amended (the "RELIEF ACT"), a Mortgagor who enters military service after the
origination of such Mortgagor's Mortgage Loan (including a Mortgagor who was
in reserve status and is called to active duty after origination of the
Mortgage Loan), may not be charged interest (including fees and charges) above
an annual rate of 6% during the period of such Mortgagor's active duty status,
unless a court orders otherwise upon application of the lender. The Relief Act
applies to Mortgagors who are members of the Air Force, Army, Marines, Navy,
National Guard, Reserves, Coast Guard, and officers of the U.S. Public Health
Service assigned to duty with the military. Because the Relief Act applies to
Mortgagors who enter military service (including reservists who are called to
active duty) after origination of the related Mortgage Loan, no information
can be provided as to the number of loans that may be affected by the Relief
Act. Application of the Relief Act would adversely affect, for an
indeterminate period of time, the ability of the Master Servicer to collect
full amounts of interest on certain of the Mortgage Loans. Any shortfall in
interest collections resulting from the application of the Relief Act or
similar legislation or regulations, which would not be recoverable from the
related Mortgage Loans, would result in a reduction of the amounts
distributable to the holders of the related Certificates, and would not be
covered by Advances and may not be covered by the applicable form of credit
enhancement provided in connection with the related series of Certificates. In
addition, the Relief Act imposes limitations that would impair the ability of
the Master Servicer to foreclose on an affected Mortgage Loan during the
Mortgagor's period of active duty status, and, under certain circumstances,
during an additional three month period thereafter. Thus, in the event that
the Relief Act or similar legislation or regulations applies to any Mortgage
Loan which goes into default, there may be delays in payment and losses on the
related Certificates in connection therewith. Any other interest shortfalls,
deferrals or forgiveness of payments on the Mortgage Loans resulting from
similar legislation or regulations may result in delays in payments or losses
to Certificateholders of the related series.
FORFEITURES IN DRUG AND RICO PROCEEDINGS
Federal law provides that property owned by persons convicted of drug-
related crimes or of criminal violations of the Racketeer Influenced and
Corrupt Organizations ("RICO") statute can be seized by the government if the
property was used in, or purchased with the proceeds of, such crimes. Under
procedures contained in the Comprehensive Crime Control Act of 1984 (the
"CRIME CONTROL ACT"), the government may seize the property even before
conviction. The government must publish notice of the forfeiture proceeding
and may give notice to all parties "known to have an alleged interest in the
property", including the holders of mortgage loans.
A lender may avoid forfeiture of its interest in the property if it
establishes that: (i) its mortgage was executed and recorded before commission
of the crime upon which the forfeiture is based, or (ii) the lender was, at
the time of execution of the mortgage, "reasonably without cause to believe"
that the property was used in, or purchased with the proceeds of, illegal drug
or RICO activities.
JUNIOR MORTGAGES; RIGHTS OF SENIOR MORTGAGEES
The Mortgage Loans or Mortgage Securities included in the Trust Fund for a
Series will be secured by mortgages or deeds of trust which are Revolving
Credit Loans or Closed-End Loans which generally will be junior to other
mortgages or deeds of trust held by other lenders or institutional investors.
The rights of the Trust Fund (and therefore the Certificateholders), as
mortgagee under a junior mortgage, are subordinate to those of the mortgagee
under the senior mortgage, including the prior rights of the senior mortgagee
to receive hazard insurance and condemnation proceeds and to cause the
property securing the Mortgage Loan to be sold upon default of the mortgagor,
which may extinguish the junior mortgagee's lien unless the junior mortgagee
asserts its subordinate interest in the property in foreclosure litigation
and, in certain cases, either reinitiates or satisfies
69
<PAGE>
the defaulted senior loan or loans. A junior mortgagee may satisfy a defaulted
senior loan in full or, in some states, may cure such default and bring the
senior loan current thereby reinstating the senior loan, in either event
usually adding the amounts expended to the balance due on the junior loan. In
most states, absent a provision in the mortgage or deed of trust, no notice of
default is required to be given to a junior mortgagee. Where applicable law or
the terms of the senior mortgage or deed of trust do not require notice of
default to the junior mortgagee, the lack of any such notice may prevent the
junior mortgagee from exercising any right to reinstate the loan which
applicable law may provide.
The standard form of the mortgage or deed of trust used by most
institutional lenders confers on the mortgagee the right both to receive all
proceeds collected under any hazard insurance policy and all awards made in
connection with 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 may determine. Thus, in the event improvements on the
property are damaged or destroyed by fire or other casualty, or in the event
the property is taken by condemnation, the mortgagee or beneficiary under
underlying senior mortgages will have the prior right to collect any insurance
proceeds payable under a hazard insurance policy and any award of damages in
connection with the condemnation and to apply the same to the indebtedness
secured by the senior mortgages. Proceeds in excess of the amount of senior
mortgage indebtedness, in most cases, may be applied to the indebtedness of
junior mortgages in the order of their priority.
Another provision sometimes found in the form of the mortgage or deed of
trust used by institutional lenders obligates the mortgagor to pay before
delinquency all taxes and assessments on the property and, when due, all
encumbrances, charges and liens on the property which are prior to the
mortgage or deed of trust, to provide and maintain fire insurance on the
property, to maintain and repair the property and not to commit or permit any
waste thereof, and to appear in and defend any action or proceeding purporting
to affect the property or the rights of the mortgagee under the mortgage. Upon
a failure of the mortgagor to perform any of these obligations, the mortgagee
or beneficiary is given the right under certain mortgages or deeds of trust to
perform the obligation itself, at its election, with the mortgagor agreeing to
reimburse the mortgagee for any sums expended by the mortgagee on behalf of
the mortgagor. All sums so expended by a senior mortgagee become part of the
indebtedness secured by the senior mortgage.
The form of credit line trust deed or mortgage used by most institutional
lenders which make Revolving Credit Loans typically contains a "future
advance" clause, which provides, in essence, that additional amounts advanced
to or on behalf of the borrower by the beneficiary or lender are to be secured
by the deed of trust or mortgage. The priority of the lien securing any
advance made under the clause may depend in most states on whether the deed of
trust or mortgage is designated as a credit line deed of trust or mortgage. If
the beneficiary or lender advances additional amounts, the advance is entitled
to receive the same priority as amounts initially advanced under the trust
deed or mortgage, notwithstanding the fact that there may be junior trust
deeds or mortgages and other liens which intervene between the date of
recording of the trust deed or mortgage and the date of the future advance,
and notwithstanding that the beneficiary or lender had actual knowledge of
such intervening junior trust deeds or mortgages and other liens at the time
of the advance. In most states, the trust deed or mortgage lien securing
mortgage loans of the type which includes Revolving Credit Loans applies
retroactively to the date of the original recording of the trust deed or
mortgage, provided that the total amount of advances under the Credit Limit
does not exceed the maximum specified principal amount of the recorded trust
deed or mortgage, except as to advances made after receipt by the lender of a
written notice of lien from a judgment lien creditor of the trustor.
70
<PAGE>
CERTAIN FEDERAL INCOME TAX CONSEQUENCES
GENERAL
The following is a general discussion of certain anticipated material
federal income tax consequences of the purchase, ownership and disposition of
the Certificates offered hereunder. This discussion has been prepared with the
advice of Thacher Proffitt & Wood and Orrick, Herrington & Sutcliffe LLP,
counsel to the Company. This discussion is directed solely to
Certificateholders that hold the Certificates as capital assets within the
meaning of Section 1221 of the Code and does not purport to discuss all
federal income tax consequences that may be applicable to particular
categories of investors, some of which (such as banks, insurance companies and
foreign investors) may be subject to special rules. Further, the authorities
on which this discussion, and the opinion referred to below, are based are
subject to change or differing interpretations, which could apply
retroactively. Taxpayers and preparers of tax returns (including those filed
by any REMIC or other issuer) should be aware that under applicable Treasury
regulations a provider of advice on specific issues of law is not considered
an income tax return preparer unless the advice (i) is given with respect to
events that have occurred at the time the advice is rendered and is not given
with respect to the consequences of contemplated actions, and (ii) is directly
relevant to the determination of an entry on a tax return. Accordingly,
taxpayers should consult their tax advisors and tax return preparers regarding
the preparation of any item on a tax return, even where the anticipated tax
treatment has been discussed herein. In addition to the federal income tax
consequences described herein, potential investors should consider the state
and local tax consequences, if any, of the purchase, ownership and disposition
of the Certificates. See "State and Other Tax Consequences."
Certificateholders are advised to consult their tax advisors concerning the
federal, state, local or other tax consequences to them of the purchase,
ownership and disposition of the Certificates offered hereunder.
Unless otherwise specified in the related Prospectus Supplement, as to each
series of Certificates, the Master Servicer will cause an election to be made
to have the related Trust Fund treated as a REMIC under Sections 860A through
860G (the "REMIC PROVISIONS") of the Code. If a REMIC election (or elections)
will be made for the related Trust Fund, the related Prospectus Supplement for
each series of Certificates will identify all "regular interests" and
"residual interests" in the REMIC. If a REMIC election will not be made for a
Trust Fund, the federal income consequences of the purchase, ownership and
disposition of the related Certificates will be set forth in the related
Prospectus Supplement. For purposes of this tax discussion, references to a
"Certificateholder" or a "holder" are to the beneficial owner of a
Certificate.
The following discussion is based in part upon the rules governing original
issue discount that are set forth in Sections 1271-1273 and 1275 of the Code
and in the Treasury regulations issued thereunder (the "OID REGULATIONS"), and
in part upon the REMIC Provisions and the Treasury regulations issued
thereunder (the "REMIC REGULATIONS"). The OID Regulations, which are effective
with respect to debt instruments issued on or after April 4, 1994, do not
adequately address certain issues relevant to, and in some instances provide
that they are not applicable to, securities such as the Certificates.
REMICS
CLASSIFICATION OF REMICS
Upon the issuance of each series of REMIC Certificates, either Thacher
Proffitt & Wood or Orrick, Herrington & Sutcliffe LLP, counsel to the Company,
will deliver its opinion generally to the effect that, assuming compliance
with all provisions of the related Pooling and Servicing Agreement, the
related Trust Fund (or each applicable portion thereof) will qualify as a
REMIC and the REMIC Certificates offered with respect thereto will be
considered to evidence ownership of "regular interests" ("REMIC REGULAR
CERTIFICATES") or
71
<PAGE>
"residual interests" ("REMIC RESIDUAL CERTIFICATES") in that REMIC within the
meaning of the REMIC Provisions.
If an entity electing to be treated as a REMIC fails to comply with one or
more of the ongoing requirements of the Code for such status during any
taxable year, the Code provides that the entity will not be treated as a REMIC
for such year and thereafter. In that event, such entity may be taxable as a
separate corporation under Treasury regulations, and the related REMIC
Certificates may not be accorded the status or given the tax treatment
described below. Although the Code authorizes the Treasury Department to issue
regulations providing relief in the event of an inadvertent termination of
REMIC status, no such regulations have been issued. Any such relief, moreover,
may be accompanied by sanctions, such as the imposition of a corporate tax on
all or a portion of the Trust Fund's income for the period in which the
requirements for such status are not satisfied. The Pooling and Servicing
Agreement with respect to each REMIC will include provisions designed to
maintain the Trust Fund's status as a REMIC under the REMIC Provisions. It is
not anticipated that the status of any Trust Fund as a REMIC will be
terminated.
CHARACTERIZATION OF INVESTMENTS IN REMIC CERTIFICATES
In general, the REMIC Certificates will be "real estate assets" within the
meaning of Section 856(c)(5)(A) of the Code and assets described in Section
7701(a)(19)(C) of the Code in the same proportion that the assets of the REMIC
underlying such Certificates would be so treated. Moreover, if 95% or more of
the assets of the REMIC qualify for any of the foregoing treatments at all
times during a calendar year, the REMIC Certificates will qualify for the
corresponding status in their entirety for that calendar year. Interest
(including original issue discount) on the REMIC Regular Certificates and
income allocated to the class of REMIC Residual Certificates will be interest
described in Section 856(c)(3)(B) of the Code to the extent that such
Certificates are treated as "real estate assets" within the meaning of Section
856(c)(5)(A) of the Code. In addition, the REMIC Regular Certificates will be
"qualified mortgages" within the meaning of Section 860G(a)(3) of the Code if
transferred to another REMIC on its startup day in exchange for regular or
residual interests therein. The determination as to the percentage of the
REMIC's assets that constitute assets described in the foregoing sections of
the Code will be made with respect to each calendar quarter based on the
average adjusted basis of each category of the assets held by the REMIC during
such calendar quarter. The Master Servicer will report those determinations to
Certificateholders in the manner and at the times required by applicable
Treasury regulations.
The assets of the REMIC will include, in addition to Mortgage Loans,
payments on Mortgage Loans held pending distribution on the REMIC Certificates
and property acquired by foreclosure held pending sale, and may include
amounts in reserve accounts. It is unclear whether property acquired by
foreclosure held pending sale and amounts in reserve accounts would be
considered to be part of the Mortgage Loans, or whether such assets (to the
extent not invested in assets described in the foregoing sections) otherwise
would receive the same treatment as the Mortgage Loans for purposes of all of
the foregoing sections. In addition, in some instances Mortgage Loans may not
be treated entirely as assets described in the foregoing sections. The REMIC
Regulations do provide, however, that payments on Mortgage Loans held pending
distribution are considered part of the Mortgage Loans for purposes of Section
856(c)(5)(A) of the Code. Furthermore, foreclosure property will qualify as
"real estate assets" under Section 856(c)(5)(A) of the Code.
TIERED REMIC STRUCTURES
For certain series of REMIC Certificates, two or more separate elections may
be made to treat designated portions of the related Trust Fund as REMICs
("TIERED REMICS") for federal income tax purposes. Upon the issuance of any
such series of REMIC Certificates, Thacher Proffitt & Wood or Orrick,
Herrington & Sutcliffe LLP, counsel to the Company, will deliver their opinion
generally to the effect that, assuming compliance with all provisions of the
related Pooling and Servicing Agreement, the Tiered REMICs will each qualify
as a REMIC and the REMIC Certificates issued by the Tiered REMICs,
respectively, will be considered to evidence ownership of REMIC Regular
Certificates or REMIC Residual Certificates in the related REMIC within the
meaning of the REMIC Provisions.
72
<PAGE>
Solely for purposes of determining whether the REMIC Certificates will be
"real estate assets" within the meaning of Section 856(c)(5)(A) of the Code,
and "loans secured by an interest in real property" under Section
7701(a)(19)(C) of the Code, and whether the income on such Certificates is
interest described in Section 856(c)(3)(B) of the Code, the Tiered REMICs will
be treated as one REMIC.
TAXATION OF OWNERS OF REMIC REGULAR CERTIFICATES
General
Except as otherwise stated in this discussion, REMIC Regular Certificates
will be treated for federal income tax purposes as debt instruments issued by
the REMIC and not as ownership interests in the REMIC or its assets. Moreover,
holders of REMIC Regular Certificates that otherwise report income under a
cash method of accounting will be required to report income with respect to
REMIC Regular Certificates under an accrual method.
Original Issue Discount
Certain REMIC Regular Certificates may be issued with "original issue
discount" within the meaning of Section 1273(a) of the Code. Any holders of
REMIC Regular Certificates issued with original issue discount generally will
be required to include original issue discount in income as it accrues, in
accordance with the method described below, in advance of the receipt of the
cash attributable to such income. In addition, Section 1272(a)(6) of the Code
provides special rules applicable to REMIC Regular Certificates and certain
other debt instruments issued with original issue discount. Regulations have
not been issued under that section.
The Code requires that a prepayment assumption be used with respect to
Mortgage Loans held by a REMIC in computing the accrual of original issue
discount on REMIC Regular Certificates issued by that REMIC, and that
adjustments be made in the amount and rate of accrual of such discount to
reflect differences between the actual prepayment rate and the prepayment
assumption. The prepayment assumption is to be determined in a manner
prescribed in Treasury regulations; as noted above, those regulations have not
been issued. The Conference Committee Report (the "COMMITTEE REPORT")
accompanying the Tax Reform Act of 1986, indicates that the regulations will
provide that the prepayment assumption used with respect to a REMIC Regular
Certificate must be the same as that used in pricing the initial offering of
such REMIC Regular Certificate. The prepayment assumption used by the Master
Servicer in reporting original issue discount for each series of REMIC Regular
Certificates (the "PREPAYMENT ASSUMPTION") will be consistent with this
standard and will be disclosed in the related Prospectus Supplement. However,
neither the Company nor the Master Servicer will make any representation that
the Mortgage Loans will in fact prepay at a rate conforming to the Prepayment
Assumption or at any other rate.
The original issue discount, if any, on a REMIC Regular Certificate will be
the excess of its stated redemption price at maturity over its issue price.
The issue price of a particular class of REMIC Regular Certificates will be
the first cash price at which a substantial amount of REMIC Regular
Certificates of that class is sold (excluding sales to bond houses, brokers
and underwriters). If less than a substantial amount of a particular class of
REMIC Regular Certificates is sold for cash on or prior to the date of their
initial issuance (the "CLOSING DATE"), the issue price for such class will be
treated as the fair market value of such class on the Closing Date. Under the
OID Regulations, the stated redemption price of a REMIC Regular Certificate is
equal to the total of all payments to be made on such Certificate other than
"qualified stated interest." "Qualified stated interest" includes interest
that is unconditionally payable at least annually at a single fixed rate, or
in the case of a variable rate debt instrument, at a "qualified floating
rate," an "objective rate," a combination of a single fixed rate and one or
more "qualified floating rates" or one "qualified inverse floating rate," or a
combination of "qualified floating rates" that generally does not operate in a
manner that accelerates or defers interest payments on such REMIC Regular
Certificate. It is possible that the Internal Revenue Service (the "IRS") will
take the position that no portion of interest on a subordinated Certificate
(or, perhaps, any Certificate) is qualified stated interest on the grounds
that such interest is not unconditionally payable.
73
<PAGE>
In the case of REMIC Regular Certificates bearing adjustable interest rates,
the determination of the total amount of original issue discount and the
timing of the inclusion thereof will vary according to the characteristics of
such REMIC Regular Certificates. In general terms, original issue discount is
accrued by treating the interest rate of the Certificates as fixed and making
adjustments to reflect actual interest rate adjustments.
Certain classes of the REMIC Regular Certificates may provide for the first
interest payment with respect to such Certificates to be made more than one
month after the date of issuance, a period which is longer than the subsequent
monthly intervals between interest payments. Assuming the "accrual period" (as
defined below) for original issue discount is each monthly period that ends on
a Distribution Date, in some cases, as a consequence of this "long first
accrual period," some or all interest payments may be required to be included
in the stated redemption price of the REMIC Regular Certificate and accounted
for as original issue discount. Because interest on REMIC Regular Certificates
must in any event be accounted for under an accrual method, applying this
analysis would result in only a slight difference in the timing of the
inclusion in income of the yield on the REMIC Regular Certificates.
In addition, if the accrued interest to be paid on the first Distribution
Date is computed with respect to a period that begins prior to the Closing
Date, a portion of the purchase price paid for a REMIC Regular Certificate
will reflect such accrued interest. In such cases, information returns to the
Certificateholders and the IRS will be based on the position that the portion
of the purchase price paid for the interest accrued with respect to periods
prior to the Closing Date is treated as part of the overall purchase price of
such REMIC Regular Certificate (and not as a separate asset the purchase price
of which is recovered entirely out of interest received on the next
Distribution Date) and that portion of the interest paid on the first
Distribution Date in excess of interest accrued for a number of days
corresponding to the number of days from the Closing Date to the first
Distribution Date should be included in the stated redemption price of such
REMIC Regular Certificate. However, the OID Regulations state that all or some
portion of such accrued interest may be treated as a separate asset the cost
of which is recovered entirely out of interest paid on the first Distribution
Date. It is unclear how an election to do so would be made under the OID
Regulations and whether such an election could be made unilaterally by a
Certificateholder.
Notwithstanding the general definition of original issue discount, original
issue discount on a REMIC Regular Certificate will be considered to be de
minimis if it is less than 0.25% of the stated redemption price of the REMIC
Regular Certificate multiplied by its weighted average maturity. For this
purpose, the weighted average maturity of the REMIC Regular Certificate is
computed as the sum of the amounts determined, as to each payment included in
the stated redemption price of such REMIC Regular Certificate, by multiplying
(i) the number of complete years (rounding down for partial years) from the
issue date until such payment is expected to be made (presumably taking into
account the Prepayment Assumption) by (ii) a fraction, the numerator of which
is the amount of the payment, and the denominator of which is the stated
redemption price at maturity of such REMIC Regular Certificate. Under the OID
Regulations, original issue discount of only a de minimis amount (other than
de minimis original issue discount attributable to a so-called "teaser"
interest rate or an initial interest holiday) will be included in income as
each payment of stated principal is made, based on the product of the total
amount of such de minimis original issue discount and a fraction, the
numerator of which is the amount of such principal payment and the denominator
of which is the outstanding stated principal amount of the REMIC Regular
Certificate. The OID Regulations also would permit a Certificateholder to
elect to accrue de minimis original issue discount into income currently based
on a constant yield method. See "Taxation of Owners of REMIC Regular
Certificates--Market Discount" for a description of such election under the
OID Regulations.
If original issue discount on a REMIC Regular Certificate is in excess of a
de minimis amount, the holder of such Certificate must include in ordinary
gross income the sum of the "daily portions" of original issue discount for
each day during its taxable year on which it held such REMIC Regular
Certificate, including the purchase date but excluding the disposition date.
In the case of an original holder of a REMIC Regular Certificate, the daily
portions of original issue discount will be determined as follows.
74
<PAGE>
As to each "accrual period," that is, unless otherwise stated in the related
Prospectus Supplement, each period that ends on a date that corresponds to a
Distribution Date and begins on the first day following the immediately
preceding accrual period (or in the case of the first such period, begins on
the Closing Date), a calculation will be made of the portion of the original
issue discount that accrued during such accrual period. The portion of
original issue discount that accrues in any accrual period will equal the
excess, if any, of (i) the sum of (A) the present value, as of the end of the
accrual period, of all of the distributions remaining to be made on the REMIC
Regular Certificate, if any, in future periods and (B) the distributions made
on such REMIC Regular Certificate during the accrual period of amounts
included in the stated redemption price, over (ii) the adjusted issue price of
such REMIC Regular Certificate at the beginning of the accrual period. The
present value of the remaining distributions referred to in the preceding
sentence will be calculated (i) assuming that distributions on the REMIC
Regular Certificate will be received in future periods based on the Mortgage
Loans being prepaid at a rate equal to the Prepayment Assumption and (ii)
using a discount rate equal to the original yield to maturity of the
Certificate. For these purposes, the original yield to maturity of the
Certificate will be calculated based on its issue price and assuming that
distributions on the Certificate will be made in all accrual periods based on
the Mortgage Loans being prepaid at a rate equal to the Prepayment Assumption.
The adjusted issue price of a REMIC Regular Certificate at the beginning of
any accrual period will equal the issue price of such Certificate, increased
by the aggregate amount of original issue discount that accrued with respect
to such Certificate in prior accrual periods, and reduced by the amount of any
distributions made on such REMIC Regular Certificate in prior accrual periods
of amounts included in its stated redemption price. The original issue
discount accruing during any accrual period, computed as described above, will
be allocated ratably to each day during the accrual period to determine the
daily portion of original issue discount for such day.
A subsequent purchaser of a REMIC Regular Certificate that purchases such
Certificate at a price (excluding any portion of such price attributable to
accrued qualified stated interest) less than its remaining stated redemption
price will also be required to include in gross income the daily portions of
any original issue discount with respect to such Certificate. However, each
such daily portion will be reduced, if such cost is in excess of its "adjusted
issue price," in proportion to the ratio such excess bears to the aggregate
original issue discount remaining to be accrued on such REMIC Regular
Certificate. The adjusted issue price of a REMIC Regular Certificate on any
given day equals the sum of (i) the adjusted issue price (or, in the case of
the first accrual period, the issue price) of such Certificate at the
beginning of the accrual period which includes such day and (ii) the daily
portions of original issue discount for all days during such accrual period
prior to such day.
Market Discount
A Certificateholder that purchases a REMIC Regular Certificate at a market
discount, that is, in the case of a REMIC Regular Certificate issued without
original issue discount, at a purchase price less than its remaining stated
principal amount, or in the case of a REMIC Regular Certificate issued with
original issue discount, at a purchase price less than its adjusted issue
price will recognize income upon receipt of each distribution representing
stated redemption price. In particular, under Section 1276 of the Code such a
Certificateholder generally will be required to allocate the portion of each
such distribution representing stated redemption price first to accrued market
discount not previously included in income, and to recognize ordinary income
to that extent. A Certificateholder may elect to include market discount in
income currently as it accrues rather than including it on a deferred basis in
accordance with the foregoing. If made, such election will apply to all market
discount bonds acquired by such Certificateholder on or after the first day of
the first taxable year to which such election applies. In addition, the OID
Regulations permit a Certificateholder to elect to accrue all interest,
discount (including de minimis market or original issue discount) and premium
in income as interest, based on a constant yield method. If such an election
were made with respect to a REMIC Regular Certificate with market discount,
the Certificateholder would be deemed to have made an election to include
market discount in income currently with respect to all other debt instruments
having market discount that such Certificateholder acquires during the taxable
year of the election or thereafter, and possibly previously acquired
instruments. Similarly, a Certificateholder that made this election for a
Certificate that is acquired at a premium would be deemed to have made an
election to amortize bond premium with respect to all debt instruments having
amortizable bond
75
<PAGE>
premium that such Certificateholder owns or acquires. See "Taxation of Owners
of REMIC Regular Certificates--Premium." Each of these elections to accrue
interest, discount and premium with respect to a Certificate on a constant
yield method or as interest would be irrevocable.
However, market discount with respect to a REMIC Regular Certificate will be
considered to be de minimis for purposes of Section 1276 of the Code if such
market discount is less than 0.25% of the remaining stated redemption price of
such REMIC Regular Certificate multiplied by the number of complete years to
maturity remaining after the date of its purchase. In interpreting a similar
rule with respect to original issue discount on obligations payable in
installments, the OID Regulations refer to the weighted average maturity of
obligations, and it is likely that the same rule will be applied with respect
to market discount, presumably taking into account the Prepayment Assumption.
If market discount is treated as de minimis under this rule, it appears that
the actual discount would be treated in a manner similar to original issue
discount of a de minimis amount. See "Taxation of Owners of REMIC Regular
Certificates--Original Issue Discount." Such treatment would result in
discount being included in income at a slower rate than discount would be
required to be included in income using the method described above.
Section 1276(b)(3) of the Code specifically authorizes the Treasury
Department to issue regulations providing for the method for accruing market
discount on debt instruments, the principal of which is payable in more than
one installment. Until regulations are issued by the Treasury Department,
certain rules described in the Committee Report apply. The Committee Report
indicates that in each accrual period market discount on REMIC Regular
Certificates should accrue, at the Certificateholder's option: (i) on the
basis of a constant yield method, (ii) in the case of a REMIC Regular
Certificate issued without original issue discount, in an amount that bears
the same ratio to the total remaining market discount as the stated interest
paid in the accrual period bears to the total amount of stated interest
remaining to be paid on the REMIC Regular Certificate as of the beginning of
the accrual period, or (iii) in the case of a REMIC Regular Certificate issued
with original issue discount, in an amount that bears the same ratio to the
total remaining market discount as the original issue discount accrued in the
accrual period bears to the total original issue discount remaining on the
REMIC Regular Certificate at the beginning of the accrual period. Moreover,
the Prepayment Assumption used in calculating the accrual of original issue
discount is to be used in calculating the accrual of market discount. Because
the regulations referred to in this paragraph have not been issued, it is not
possible to predict what effect such regulations might have on the tax
treatment of a REMIC Regular Certificate purchased at a discount in the
secondary market.
To the extent that REMIC Regular Certificates provide for monthly or other
periodic distributions throughout their term, the effect of these rules may be
to require market discount to be includible in income at a rate that is not
significantly slower than the rate at which such discount would accrue if it
were original issue discount. Moreover, in any event a holder of a REMIC
Regular Certificate generally will be required to treat a portion of any gain
on the sale or exchange of such Certificate as ordinary income to the extent
of the market discount accrued to the date of disposition under one of the
foregoing methods, less any accrued market discount previously reported as
ordinary income.
Further, under Section 1277 of the Code a holder of a REMIC Regular
Certificate may be required to defer a portion of its interest deductions for
the taxable year attributable to any indebtedness incurred or continued to
purchase or carry a REMIC Regular Certificate purchased with market discount.
For these purposes, the de minimis rule referred to above applies. Any such
deferred interest expense would not exceed the market discount that accrues
during such taxable year and is, in general, allowed as a deduction not later
than the year in which such market discount is includible in income. If such
holder elects to include market discount in income currently as it accrues on
all market discount instruments acquired by such holder in that taxable year
or thereafter, the interest deferral rule described above will not apply.
Premium
A REMIC Regular Certificate purchased at a cost (excluding any portion of
such cost attributable to accrued qualified stated interest) greater than its
remaining stated redemption price will be considered to be purchased at
76
<PAGE>
a premium. The holder of such a REMIC Regular Certificate may elect under
Section 171 of the Code to amortize such premium under the constant yield
method over the life of the Certificate. If made, such an election will apply
to all debt instruments having amortizable bond premium that the holder owns
or subsequently acquires. Amortizable premium will be treated as an offset to
interest income on the related REMIC Regular Certificate, rather than as a
separate interest deduction. The OID Regulations also permit
Certificateholders to elect to include all interest, discount and premium in
income based on a constant yield method, further treating the
Certificateholder as having made the election to amortize premium generally.
See "Taxation of Owners of REMIC Regular Certificates--Market Discount." The
Committee Report states that the same rules that apply to accrual of market
discount (which rules will require use of a Prepayment Assumption in accruing
market discount with respect to REMIC Regular Certificates without regard to
whether such Certificates have original issue discount) will also apply in
amortizing bond premium under Section 171 of the Code.
Realized Losses
Under Section 166 of the Code, both corporate holders of the REMIC Regular
Certificates and noncorporate holders of the REMIC Regular Certificates that
acquire such Certificates in connection with a trade or business should be
allowed to deduct, as ordinary losses, any losses sustained during a taxable
year in which their Certificates become wholly or partially worthless as the
result of one or more realized losses on the Mortgage Loans. However, it
appears that a noncorporate holder that does not acquire a REMIC Regular
Certificate in connection with a trade or business will not be entitled to
deduct a loss under Section 166 of the Code until such holder's Certificate
becomes wholly worthless (i.e., until its outstanding principal balance has
been reduced to zero) and that the loss will be characterized as a short-term
capital loss.
Each holder of a REMIC Regular Certificate will be required to accrue
interest and original issue discount with respect to such Certificate, without
giving effect to any reductions in distributions attributable to defaults or
delinquencies on the Mortgage Loans or the Underlying Certificates until it
can be established that any such reduction ultimately will not be recoverable.
As a result, the amount of taxable income reported in any period by the holder
of a REMIC Regular Certificate could exceed the amount of economic income
actually realized by the holder in such period. Although the holder of a REMIC
Regular Certificate eventually will recognize a loss or reduction in income
attributable to previously accrued and included income that, as the result of
a realized loss, ultimately will not be realized, the law is unclear with
respect to the timing and character of such loss or reduction in income.
TAXATION OF OWNERS OF REMIC RESIDUAL CERTIFICATES
General
As residual interests, the REMIC Residual Certificates will be subject to
tax rules that differ significantly from those that would apply if the REMIC
Residual Certificates were treated for federal income tax purposes as direct
ownership interests in the Mortgage Loans or as debt instruments issued by the
REMIC.
A holder of a REMIC Residual Certificate generally will be required to
report its daily portion of the taxable income or, subject to the limitations
noted in this discussion, the net loss of the REMIC for each day during a
calendar quarter that such holder owned such REMIC Residual Certificate. For
this purpose, the taxable income or net loss of the REMIC will be allocated to
each day in the calendar quarter ratably using a "30 days per month/90 days
per quarter/360 days per year" convention unless otherwise disclosed in the
related Prospectus Supplement. The daily amounts will then be allocated among
the REMIC Residual Certificateholders in proportion to their respective
ownership interests on such day. Any amount included in the gross income or
allowed as a loss of any REMIC Residual Certificateholder by virtue of this
allocation will be treated as ordinary income or loss. The taxable income of
the REMIC will be determined under the rules described below in "Taxable
Income of the REMIC" and will be taxable to the REMIC Residual
Certificateholders without regard to the timing or amount of cash
distributions by the REMIC. Ordinary income derived from REMIC Residual
Certificates will be "portfolio income" for purposes of the taxation of
taxpayers subject to limitations under Section 469 of the Code on the
deductibility of "passive losses."
77
<PAGE>
A holder of a REMIC Residual Certificate that purchased such Certificate
from a prior holder of such Certificate also will be required to report on its
federal income tax return amounts representing its daily portion of the
taxable income (or net loss) of the REMIC for each day that it holds such
REMIC Residual Certificate. These daily portions generally will equal the
amounts of taxable income or net loss determined as described above. The
Committee Report indicates that certain modifications of the general rules may
be made, by regulations, legislation or otherwise, to reduce (or increase) the
income or loss of a holder of a REMIC Residual Certificateholder that
purchased such REMIC Residual Certificate from a prior holder of such
Certificate at a price greater than (or less than) the adjusted basis (as
defined below) such REMIC Residual Certificate would have had in the hands of
an original holder of such Certificate. The REMIC Regulations, however, do not
provide for any such modifications.
Any payments received by a holder of a REMIC Residual Certificate in
connection with the acquisition of such REMIC Residual Certificate will be
taken into account in determining the income of such holder for federal income
tax purposes. Although it appears likely that any such payment would be
includible in income immediately upon its receipt, the IRS might assert that
such payment should be included in income over time according to an
amortization schedule or according to some other method. Because of the
uncertainty concerning the treatment of such payments, holders of REMIC
Residual Certificates should consult their tax advisors concerning the
treatment of such payments for income tax purposes.
The amount of income REMIC Residual Certificateholders will be required to
report (or the tax liability associated with such income) may exceed the
amount of cash distributions received from the REMIC for the corresponding
period. Consequently, REMIC Residual Certificateholders should have other
sources of funds sufficient to pay any federal income taxes due as a result of
their ownership of REMIC Residual Certificates or unrelated deductions against
which income may be offset, subject to the rules relating to "excess
inclusions," residual interests without "significant value" and "noneconomic"
residual interests discussed below. The fact that the tax liability associated
with the income allocated to REMIC Residual Certificateholders may exceed the
cash distributions received by such REMIC Residual Certificateholders for the
corresponding period may significantly adversely affect such REMIC Residual
Certificateholders' after-tax rate of return.
Taxable Income of the REMIC
The taxable income of the REMIC will equal the income from the Mortgage
Loans and other assets of the REMIC plus any cancellation of indebtedness
income due to the allocation of realized losses to REMIC Regular Certificates,
less the deductions allowed to the REMIC for interest (including original
issue discount and reduced by the amortization of any premium received on
issuance) on the REMIC Regular Certificates (and any other class of REMIC
Certificates constituting "regular interests" in the REMIC not offered
hereby), amortization of any premium on the Mortgage Loans, bad debt
deductions with respect to the Mortgage Loans and, except as described below,
for servicing, administrative and other expenses.
For purposes of determining its taxable income, the REMIC will have an
initial aggregate basis in its assets equal to their fair market value
immediately after their transfer to the REMIC. For this purpose, the Master
Servicer intends to treat the fair market value of the Mortgage Loans as being
equal to the aggregate issue prices of the REMIC Regular Certificates and
REMIC Residual Certificates. Such aggregate basis will be allocated among the
Mortgage Loans collectively and the other assets of the REMIC in proportion to
their respective fair market values. The issue price of any REMIC Certificates
offered hereby will be determined in the manner described above under "--
Taxation of Owners of REMIC Regular Certificates--Original Issue Discount."
Accordingly, if one or more classes of REMIC Certificates are retained
initially rather than sold, the Master Servicer may be required to estimate
the fair market value of such interests in order to determine the basis of the
REMIC in the Mortgage Loans and other property held by the REMIC.
Subject to the possible application of the de minimis rules, the method of
accrual by the REMIC of original issue discount income and market discount
income with respect to Mortgage Loans that it holds will be equivalent to the
method of accruing original issue discount income for REMIC Regular
Certificateholders (that
78
<PAGE>
is, under the constant yield method taking into account the Prepayment
Assumption). However, a REMIC that acquires loans at a market discount must
include such discount in income currently, as it accrues, on a constant
interest basis. See "--Taxation of Owners of REMIC Regular Certificates"
above, which describes a method of accruing discount income that is analogous
to that required to be used by a REMIC as to Mortgage Loans with market
discount that it holds.
A Mortgage Loan will be deemed to have been acquired with discount (or
premium) to the extent that the REMIC's basis therein, determined as described
in the preceding paragraph, is less than (or greater than) its stated
redemption price. Any such discount will be includible in the income of the
REMIC as it accrues, in advance of receipt of the cash attributable to such
income, under a method similar to the method described above for accruing
original issue discount on the REMIC Regular Certificates. It is anticipated
that each REMIC will elect under Section 171 of the Code to amortize any
premium on the Mortgage Loans. Premium on any Mortgage Loan to which such
election applies may be amortized under a constant yield method, presumably
taking into account a Prepayment Assumption.
The REMIC will be allowed deductions for interest (including original issue
discount) on the REMIC Regular Certificates (including any other class of
REMIC Certificates constituting "regular interests" in the REMIC not offered
hereby) equal to the deductions that would be allowed if the REMIC Regular
Certificates (including any other class of REMIC Certificates constituting
"regular interests" in the REMIC not offered hereby) were indebtedness of the
REMIC. Original issue discount will be considered to accrue for this purpose
as described above under "--Taxation of Owners of REMIC Regular Certificates--
Original Issue Discount," except that the de minimis rule and the adjustments
for subsequent holders of REMIC Regular Certificates (including any other
class of Certificates constituting "regular interests" in the REMIC not
offered hereby) described therein will not apply.
If a class of REMIC Regular Certificates is issued at a price in excess of
the stated redemption price of such class (such excess, "ISSUE PREMIUM"), the
REMIC will have an additional item of income in an amount equal to the portion
of the Issue Premium that is considered to be amortized or repaid in that
year. Although the matter is not entirely certain, it is likely that Issue
Premium would be amortized under a constant yield method in a manner analogous
to the method of accruing original issue discount described above under "--
Taxation of Owners of REMIC Regular Certificates--Original Issue Discount."
As a general rule, the taxable income of the REMIC is required to be
determined in the same manner as if the REMIC were an individual having the
calendar year as its taxable year and using the accrual method of accounting.
However, no item of income, gain, loss or deduction allocable to a prohibited
transaction will be taken into account. See "--Prohibited Transactions and
Other Possible REMIC Taxes" below. Further, the limitation on miscellaneous
itemized deductions imposed on individuals by Section 67 of the Code (which
allows such deductions only to the extent they exceed in the aggregate two
percent of the taxpayer's adjusted gross income) will not be applied at the
REMIC level so that the REMIC will be allowed deductions for servicing,
administrative and other non-interest expenses in determining its taxable
income. All such expenses will be allocated as a separate item to the holders
of REMIC Certificates, subject to the limitation of Section 67 of the Code and
the rules relating to the alternative minimum tax. See "--Possible Pass-
Through of Miscellaneous Itemized Deductions." If the deductions allowed to
the REMIC exceed its gross income for a calendar quarter, such excess will be
the net loss for the REMIC for that calendar quarter.
Basis Rules, Net Losses and Distributions
The adjusted basis of a REMIC Residual Certificate will be equal to the
amount paid for such REMIC Residual Certificate, increased by amounts included
in the income of the REMIC Residual Certificateholder and decreased (but not
below zero) by distributions made, and by net losses allocated, to such REMIC
Residual Certificateholder.
A REMIC Residual Certificateholder is not allowed to take into account any
net loss for any calendar quarter to the extent such net loss exceeds such
REMIC Residual Certificateholder's adjusted basis in its REMIC
79
<PAGE>
Residual Certificate as of the close of such calendar quarter (determined
without regard to such net loss). Any loss that is not currently deductible by
reason of this limitation may be carried forward indefinitely to future
calendar quarters and, subject to the same limitation, may be used only to
offset income from the REMIC Residual Certificate. The ability of REMIC
Residual Certificateholders to deduct net losses may be subject to additional
limitations under the Code, as to which REMIC Residual Certificateholders
should consult their tax advisors.
Any distribution on a REMIC Residual Certificate will be treated as a non-
taxable return of capital to the extent it does not exceed the holder's
adjusted basis in such REMIC Residual Certificate. To the extent a
distribution on a REMIC Residual Certificate exceeds such adjusted basis, it
will be treated as gain from the sale of such REMIC Residual Certificate.
Holders of certain REMIC Residual Certificates may be entitled to
distributions early in the term of the related REMIC under circumstances in
which their bases in such REMIC Residual Certificates will not be sufficiently
large that such distributions will be treated as nontaxable returns of
capital. Their bases in such REMIC Residual Certificates will initially equal
the amount paid for such REMIC Residual Certificates and will be increased by
their allocable shares of taxable income of the Trust Fund. However, such
basis increases may not occur until the end of the calendar quarter, or
perhaps the end of the calendar year, with respect to which such REMIC taxable
income is allocated to the REMIC Residual Certificateholders. To the extent
such REMIC Residual Certificateholders' initial bases are less than the
distributions to such REMIC Residual Certificateholders, and increases in such
initial bases either occur after such distributions or (together with their
initial bases) are less than the amount of such distributions, gain will be
recognized to such REMIC Residual Certificateholders on such distributions and
will be treated as gain from the sale of their REMIC Residual Certificates.
The effect of these rules is that a Residual Certificateholder may not
amortize its basis in a REMIC Residual Certificate, but may only recover its
basis through distributions, through the deduction of its share of any net
losses of the REMIC or upon the sale of its REMIC Residual Certificate. See
"--Sales of REMIC Certificates." For a discussion of possible modifications of
these rules that may require adjustments to income of a holder of a REMIC
Residual Certificate other than an original holder in order to reflect any
difference between the cost of such REMIC Residual Certificate to such holder
and the adjusted basis such REMIC Residual Certificate would have had in the
hands of the original holder, see "--Taxation of Owners of REMIC Residual
Certificates--General."
Excess Inclusions
Any "excess inclusions" with respect to a REMIC Residual Certificate will be
subject to federal income tax in all events.
In general, the "excess inclusions" with respect to a REMIC Residual
Certificate for any calendar quarter will be the excess, if any, of (i) the
sum of the daily portions of REMIC taxable income allocable to such REMIC
Residual Certificate over (ii) the sum of the "daily accruals" (as defined
below) for each day during such quarter that such REMIC Residual Certificate
was held by such REMIC Residual Certificateholder. The daily accruals of a
REMIC Residual Certificateholder will be determined by allocating to each day
during a calendar quarter its ratable portion of the product of the "adjusted
issue price" of the REMIC Residual Certificate at the beginning of the
calendar quarter and 120% of the "long-term Federal rate" in effect on the
Closing Date. For this purpose, the adjusted issue price of a REMIC Residual
Certificate as of the beginning of any calendar quarter will be equal to the
issue price of the REMIC Residual Certificate, increased by the sum of the
daily accruals for all prior quarters and decreased (but not below zero) by
any distributions made with respect to such REMIC Residual Certificate before
the beginning of such quarter. The issue price of a REMIC Residual Certificate
is the initial offering price to the public (excluding bond houses and
brokers) at which a substantial amount of the REMIC Residual Certificates were
sold. The "long-term Federal rate" is an average of current yields on Treasury
securities with a remaining term of greater than nine years, computed and
published monthly by the IRS. Although it has not done so, the Treasury has
authority to issue regulations that would treat the entire
80
<PAGE>
amount of income accruing on a REMIC Residual Certificate as an excess
inclusion if the REMIC Residual Certificates are considered not to have
"significant value."
For REMIC Residual Certificateholders, an excess inclusion (i) will not be
permitted to be offset by deductions, losses or loss carryovers from other
activities, (ii) will be treated as "unrelated business taxable income" to an
otherwise tax-exempt organization and (iii) will not be eligible for any rate
reduction or exemption under any applicable tax treaty with respect to the 30%
United States withholding tax imposed on distributions to REMIC Residual
Certificateholders that are foreign investors. See, however, "--Foreign
Investors in REMIC Certificates," below. Furthermore, for purposes of the
alternative minimum tax, (i) excess inclusions will not be permitted to be
offset by the alternative tax net operating loss deduction and (ii)
alternative minimum taxable income may not be less than the taxpayer's excess
inclusions. The latter rule has the effect of preventing nonrefundable tax
credits from reducing the taxpayer's income tax to an amount lower than the
tentative minimum tax on excess inclusions.
In the case of any REMIC Residual Certificates held by a real estate
investment trust, the aggregate excess inclusions with respect to such REMIC
Residual Certificates, reduced (but not below zero) by the real estate
investment trust taxable income (within the meaning of Section 857(b)(2) of
the Code, excluding any net capital gain), will be allocated among the
shareholders of such trust in proportion to the dividends received by such
shareholders from such trust, and any amount so allocated will be treated as
an excess inclusion with respect to a REMIC Residual Certificate as if held
directly by such shareholder. Treasury regulations yet to be issued could
apply a similar rule to regulated investment companies, common trust funds and
certain cooperatives; the REMIC Regulations currently do not address this
subject.
Noneconomic REMIC Residual Certificates
Under the REMIC Regulations, transfers of "noneconomic" REMIC Residual
Certificates will be disregarded for all federal income tax purposes if "a
significant purpose of the transfer was to enable the transferor to impede the
assessment or collection of tax." If such transfer is disregarded, the
purported transferor will continue to remain liable for any taxes due with
respect to the income on such "noneconomic" REMIC Residual Certificate. The
REMIC Regulations provide that a REMIC Residual Certificate is noneconomic
unless, based on the Prepayment Assumption and on any required or permitted
clean up calls, or required qualified liquidation provided for in the REMIC's
organizational documents, (1) the present value of the expected future
distributions (discounted using the "applicable Federal rate" for obligations
whose term ends on the close of the last quarter in which excess inclusions
are expected to accrue with respect to the REMIC Residual Certificate, which
rate is computed and published monthly by the IRS) on the REMIC Residual
Certificate equals at least the present value of the expected tax on the
anticipated excess inclusions, and (2) the transferor reasonably expects that
the transferee will receive distributions with respect to the REMIC Residual
Certificate at or after the time the taxes accrue on the anticipated excess
inclusions in an amount sufficient to satisfy the accrued taxes. Accordingly,
all transfers of REMIC Residual Certificates that may constitute noneconomic
residual interests will be subject to certain restrictions under the terms of
the related Pooling and Servicing Agreement that are intended to reduce the
possibility of any such transfer being disregarded. Such restrictions will
require each party to a transfer to provide an affidavit that no purpose of
such transfer is to impede the assessment or collection of tax, including
certain representations as to the financial condition of the prospective
transferee, as to which the transferor also is required to make a reasonable
investigation to determine such transferee's historic payment of its debts and
ability to continue to pay its debts as they come due in the future. Prior to
purchasing a REMIC Residual Certificate, prospective purchasers should
consider the possibility that a purported transfer of such REMIC Residual
Certificate by such a purchaser to another purchaser at some future date may
be disregarded in accordance with the above-described rules which would result
in the retention of tax liability by such purchaser.
The related Prospectus Supplement will disclose whether offered REMIC
Residual Certificates may be considered "noneconomic" residual interests under
the REMIC Regulations; provided, however, that any disclosure that a REMIC
Residual Certificate will not be considered "noneconomic" will be based upon
certain assumptions, and the Company will make no representation that a REMIC
Residual Certificate will not be
81
<PAGE>
considered "noneconomic" for purposes of the above-described rules. See "--
Foreign Investors in REMIC Certificates--REMIC Residual Certificates" below
for additional restrictions applicable to transfers of certain REMIC Residual
Certificates to foreign persons.
Mark-to-Market Rules
On December 28, 1993, the IRS released temporary regulations (the "MARK-TO-
MARKET REGULATIONS") relating to the requirement that a securities dealer mark
to market securities held for sale to customers. This mark-to-market
requirement applies to all securities owned by a dealer, except to the extent
that the dealer has specifically identified a security as held for investment.
The Mark-to-Market Regulations provide that for purposes of this mark-to-
market requirement, a "negative value" REMIC Residual Certificate is not
treated as a security and thus generally may not be marked to market. This
exclusion from the mark-to-market requirement is expanded to include all REMIC
Residual Certificates under proposed Treasury regulations published January 4,
1995 which provide that any REMIC Residual Certificate issued after January 4,
1995 will not be treated as a security and therefore generally may not be
marked to market.
Possible Pass-Through of Miscellaneous Itemized Deductions
Fees and expenses of a REMIC generally will be allocated to the holders of
the related REMIC Residual Certificates. The applicable Treasury regulations
indicate, however, that in the case of a REMIC that is similar to a single
class grantor trust, all or a portion of such fees and expenses should be
allocated to the holders of the related REMIC Regular Certificates. Unless
otherwise stated in the related Prospectus Supplement, such fees and expenses
will be allocated to holders of the related REMIC Residual Certificates in
their entirety and not to the holders of the related REMIC Regular
Certificates.
With respect to REMIC Residual Certificates or REMIC Regular Certificates
the holders of which receive an allocation of fees and expenses in accordance
with the preceding discussion, if any holder thereof is an individual, estate
or trust, or a "pass-through entity" beneficially owned by one or more
individuals, estates or trusts, (i) an amount equal to such individual's,
estate's or trust's share of such fees and expenses will be added to the gross
income of such holder and (ii) such individual's, estate's or trust's share of
such fees and expenses will be treated as a miscellaneous itemized deduction
allowable subject to the limitation of Section 67 of the Code, which permits
such deductions only to the extent they exceed in the aggregate two percent of
a taxpayer's adjusted gross income. In addition, Section 68 of the Code
provides that the amount of itemized deductions otherwise allowable for an
individual whose adjusted gross income exceeds a specified amount will be
reduced by the lesser of (i) 3% of the excess of the individual's adjusted
gross income over such amount or (ii) 80% of the amount of itemized deductions
otherwise allowable for the taxable year. The amount of additional taxable
income reportable by REMIC Certificateholders that are subject to the
limitations of either Section 67 or Section 68 of the Code may be substantial.
Furthermore, in determining the alternative minimum taxable income of such a
holder of a REMIC Certificate that is an individual, estate or trust, or a
"pass-through entity" beneficially owned by one or more individuals, estates
or trusts, no deduction will be allowed for such holder's allocable portion of
servicing fees and other miscellaneous itemized deductions of the REMIC, even
though an amount equal to the amount of such fees and other deductions will be
included in such holder's gross income. Accordingly, such REMIC Certificates
may not be appropriate investments for individuals, estates, or trusts, or
pass-through entities beneficially owned by one or more individuals, estates
or trusts. Such prospective investors should consult with their tax advisors
prior to making an investment in such Certificates.
SALES OF REMIC CERTIFICATES
If a REMIC Certificate is sold, the selling Certificateholder will recognize
gain or loss equal to the difference between the amount realized on the sale
and its adjusted basis in the REMIC Certificate. The adjusted basis of a REMIC
Regular Certificate generally will equal the cost of such REMIC Regular
Certificate to such Certificateholder, increased by income reported by such
Certificateholder with respect to such REMIC Regular Certificate (including
original issue discount and market discount income) and reduced (but not below
zero) by
82
<PAGE>
distributions on such REMIC Regular Certificate received by such
Certificateholder and by any amortized premium. The adjusted basis of a REMIC
Residual Certificate will be determined as described under "--Taxation of
Owners of REMIC Residual Certificates--Basis Rules, Net Losses and
Distributions." Except as described below, any such gain or loss generally
will be capital gain or loss. The Code as of the date of this Prospectus
provides for a top marginal tax rate of 39.6% for individuals and a maximum
marginal rate for long-term capital gains of individuals of 28%. No such rate
differential exists for corporations. In addition, the distinction between a
capital gain or loss and ordinary income or loss remains relevant for other
purposes.
Gain from the sale of a REMIC Regular Certificate that might otherwise be
capital gain will be treated as ordinary income to the extent such gain does
not exceed the excess, if any, of (i) the amount that would have been
includible in the seller's income with respect to such REMIC Regular
Certificate had income accrued thereon at a rate equal to 110% of the
"applicable Federal rate" (generally, a rate based on an average of current
yields on Treasury securities having a maturity comparable to that of the
Certificate, which rate is computed and published monthly by the IRS),
determined as of the date of purchase of such REMIC Regular Certificate, over
(ii) the amount of ordinary income actually includible in the seller's income
prior to such sale. In addition, gain recognized on the sale of a REMIC
Regular Certificate by a seller who purchased such REMIC Regular Certificate
at a market discount will be taxable as ordinary income to the extent of any
accrued and previously unrecognized market discount that accrued during the
period the Certificate was held. See "--Taxation of Owners of REMIC Regular
Certificates--Market Discount."
REMIC Certificates will be "evidences of indebtedness" within the meaning of
Section 582(c)(1) of the Code, so that gain or loss recognized from the sale
of a REMIC Certificate by a bank or thrift institution to which such section
applies will be ordinary income or loss.
A portion of any gain from the sale of a REMIC Regular Certificate that
might otherwise be capital gain may be treated as ordinary income to the
extent that such Certificate is held as part of a "conversion transaction"
within the meaning of Section 1258 of the Code. A conversion transaction
generally is one in which the taxpayer has taken two or more positions in
Certificates or similar property that reduce or eliminate market risk, if
substantially all of the taxpayer's return is attributable to the time value
of the taxpayer's net investment in such transaction. The amount of gain so
realized in a conversion transaction that is recharacterized as ordinary
income generally will not exceed the amount of interest that would have
accrued on the taxpayer's net investment at 120% of the appropriate
"applicable Federal rate" (which rate is computed and published monthly by the
IRS) at the time the taxpayer enters into the conversion transaction, subject
to appropriate reduction for prior inclusion of interest and other ordinary
income items from the transaction.
Finally, a taxpayer may elect to have net capital gain taxed at ordinary
income rates rather than capital gains rates in order to include such net
capital gain in total net investment income for the taxable year, for purposes
of the limitation on the deduction of interest on indebtedness incurred to
purchase or carry property held for investment to a taxpayer's net investment
income.
Except as may be provided in Treasury regulations yet to be issued, if the
seller of a REMIC Residual Certificate reacquires the Certificate, any other
residual interest in a REMIC or any similar interest in a "taxable mortgage
pool" (as defined in Section 7701(i) of the Code) within six months of the
date of such sale, the sale will be subject to the "wash sale" rules of
Section 1091 of the Code. In that event, any loss realized by the REMIC
Residual Certificateholder on the sale will not be deductible, but instead
will be added to such REMIC Residual Certificateholder's adjusted basis in the
newly-acquired asset.
PROHIBITED TRANSACTIONS AND OTHER POSSIBLE REMIC TAXES
The Code imposes a tax on REMICs equal to 100% of the net income derived
from "prohibited transactions" (a "PROHIBITED TRANSACTIONS TAX"). In general,
subject to certain specified exceptions a prohibited transaction means the
disposition of a Mortgage Loan, the receipt of income from a source other than
a Mortgage Loan or certain other permitted investments, the receipt of
compensation for services, or gain from
83
<PAGE>
the disposition of an asset purchased with the payments on the Mortgage Loans
for temporary investment pending distribution on the REMIC Certificates. It is
not anticipated that any REMIC will engage in any prohibited transactions in
which it would recognize a material amount of net income.
In addition, certain contributions to a REMIC made after the day on which
the REMIC issues all of its interests could result in the imposition of a tax
on the REMIC equal to 100% of the value of the contributed property (a
"CONTRIBUTIONS TAX"). Each Pooling and Servicing Agreement will include
provisions designed to prevent the acceptance of any contributions that would
be subject to such tax.
REMICs also are subject to federal income tax at the highest corporate rate
on "net income from foreclosure property," determined by reference to the
rules applicable to real estate investment trusts. "Net income from
foreclosure property" generally means gain from the sale of a foreclosure
property that is inventory property and gross income from foreclosure property
other than qualifying rents and other qualifying income for a real estate
investment trust. Unless otherwise disclosed in the related Prospectus
Supplement, it is not anticipated that any REMIC will recognize "net income
from foreclosure property" subject to federal income tax.
Unless otherwise disclosed in the related Prospectus Supplement, it is not
anticipated that any material state or local income or franchise tax will be
imposed on any REMIC.
Unless otherwise stated in the related Prospectus Supplement, and to the
extent permitted by then applicable laws, any Prohibited Transactions Tax,
Contributions Tax, tax on "net income from foreclosure property" or state or
local income or franchise tax that may be imposed on the REMIC will be borne
by the related Master Servicer or Trustee in either case out of its own funds,
provided that the Master Servicer or the Trustee, as the case may be, has
sufficient assets to do so, and provided further that such tax arises out of a
breach of the Master Servicer's or the Trustee's obligations, as the case may
be, under the related Pooling and Servicing Agreement and in respect of
compliance with applicable laws and regulations. Any such tax not borne by the
Master Servicer or the Trustee will be payable out of the related Trust Fund
resulting in a reduction in amounts payable to holders of the related REMIC
Certificates.
TAX AND RESTRICTIONS ON TRANSFERS OF REMIC RESIDUAL CERTIFICATES TO CERTAIN
ORGANIZATIONS
If a REMIC Residual Certificate is transferred to a "disqualified
organization" (as defined below), a tax would be imposed in an amount
(determined under the REMIC Regulations) equal to the product of (i) the
present value (discounted using the "applicable Federal rate" for obligations
whose term ends on the close of the last quarter in which excess inclusions
are expected to accrue with respect to the Certificate, which rate is computed
and published monthly by the IRS) of the total anticipated excess inclusions
with respect to such REMIC Residual Certificate for periods after the transfer
and (ii) the highest marginal federal income tax rate applicable to
corporations. The anticipated excess inclusions must be determined as of the
date that the REMIC Residual Certificate is transferred and must be based on
events that have occurred up to the time of such transfer, the Prepayment
Assumption and any required or permitted clean up calls or required
liquidation provided for in the REMIC's organizational documents. Such a tax
generally would be imposed on the transferor of the REMIC Residual
Certificate, except that where such transfer is through an agent for a
disqualified organization, the tax would instead be imposed on such agent.
However, a transferor of a REMIC Residual Certificate would in no event be
liable for such tax with respect to a transfer if the transferee furnishes to
the transferor an affidavit that the transferee is not a disqualified
organization and, as of the time of the transfer, the transferor does not have
actual knowledge that such affidavit is false. Moreover, an entity will not
qualify as a REMIC unless there are reasonable arrangements designed to ensure
that (i) residual interests in such entity are not held by disqualified
organizations and (ii) information necessary for the application of the tax
described herein will be made available. Restrictions on the transfer of REMIC
Residual Certificates and certain other provisions that are intended to meet
this requirement will be included in the Pooling and Servicing Agreement, and
will be discussed more fully in any Prospectus Supplement relating to the
offering of any REMIC Residual Certificate.
84
<PAGE>
In addition, if a "pass-through entity" (as defined below) includes in
income excess inclusions with respect to a REMIC Residual Certificate, and a
disqualified organization is the record holder of an interest in such entity,
then a tax will be imposed on such entity equal to the product of (i) the
amount of excess inclusions on the REMIC Residual Certificate that are
allocable to the interest in the pass-through entity held by such disqualified
organization and (ii) the highest marginal federal income tax rate imposed on
corporations. A pass-through entity will not be subject to this tax for any
period, however, if each record holder of an interest in such pass-through
entity furnishes to such pass-through entity (i) such holder's social security
number and a statement under penalties of perjury that such social security
number is that of the record holder or (ii) a statement under penalties of
perjury that such record holder is not a disqualified organization.
For these purposes, a "disqualified organization" means (i) the United
States, any State or political subdivision thereof, any foreign government,
any international organization, or any agency or instrumentality of the
foregoing (but would not include instrumentalities described in Section
168(h)(2)(D) of the Code or the Federal Home Loan Mortgage Corporation), (ii)
any organization (other than a cooperative described in Section 521 of the
Code) that is exempt from federal income tax, unless it is subject to the tax
imposed by Section 511 of the Code or (iii) any organization described in
Section 1381(a)(2)(C) of the Code. For these purposes, a "pass-through entity"
means any regulated investment company, real estate investment trust, trust,
partnership or certain other entities described in Section 860E(e)(6) of the
Code. In addition, a person holding an interest in a pass-through entity as a
nominee for another person will, with respect to such interest, be treated as
a pass-through entity.
TERMINATION
A REMIC will terminate immediately after the Distribution Date following
receipt by the REMIC of the final payment in respect of the Mortgage Loans or
upon a sale of the REMIC's assets following the adoption by the REMIC of a
plan of complete liquidation. The last distribution on a REMIC Regular
Certificate will be treated as a payment in retirement of a debt instrument.
In the case of a REMIC Residual Certificate, if the last distribution on such
REMIC Residual Certificate is less than the REMIC Residual Certificateholder's
adjusted basis in such Certificate, such REMIC Residual Certificateholder
should be treated as realizing a loss equal to the amount of such difference.
Such loss may be subject to the "wash sale" rules of Section 1091 of the Code.
See "--Sales of REMIC Certificates." The character of any such loss as
ordinary or capital is uncertain.
REPORTING AND OTHER ADMINISTRATIVE MATTERS
Solely for purposes of the administrative provisions of the Code, the REMIC
will be treated as a partnership and Residual Certificateholders will be
treated as partners. Unless otherwise stated in the related Prospectus
Supplement, the Master Servicer will file REMIC federal income tax returns on
behalf of the related REMIC, will be designated as and will act as the "tax
matters person" with respect to the REMIC in all respects, and generally will
hold at least a nominal amount of REMIC Residual Certificates.
As the tax matters person, the Master Servicer will, subject to certain
notice requirements and various restrictions and limitations, generally have
the authority to act on behalf of the REMIC and the REMIC Residual
Certificateholders in connection with the administrative and judicial review
of items of income, deduction, gain or loss of the REMIC, as well as the
REMIC's classification. REMIC Residual Certificateholders will generally be
required to report such REMIC items consistently with their treatment on the
related REMIC's tax return and may in some circumstances be bound by a
settlement agreement between the Master Servicer, as tax matters person, and
the IRS concerning any such REMIC item. Adjustments made to the REMIC tax
return may require a REMIC Residual Certificateholder to make corresponding
adjustments on its return, and an audit of the REMIC's tax return, or the
adjustments resulting from such an audit, could result in an audit of a REMIC
Residual Certificateholder's return. No REMIC will be registered as a tax
shelter pursuant to Section 6111 of the Code because it is not anticipated
that any REMIC will have a net loss for any of the first five taxable years of
its existence. Any person that holds a REMIC Residual Certificate as a nominee
for another person may be
85
<PAGE>
required to furnish to the related REMIC, in a manner to be provided in
Treasury regulations, the name and address of such person and other
information.
Reporting of interest income, including any original issue discount, with
respect to REMIC Regular Certificates is required annually, and may be
required more frequently under Treasury regulations. These information reports
generally are required to be sent to individual holders of REMIC Regular
Interests and the IRS; holders of REMIC Regular Certificates that are
corporations, trusts, securities dealers and certain other non-individuals
will be provided interest and original issue discount income information and
the information set forth in the following paragraph upon request in
accordance with the requirements of the applicable regulations. The
information must be provided by the later of 30 days after the end of the
quarter for which the information was requested, or two weeks after the
receipt of the request. The REMIC must also comply with rules requiring a
REMIC Regular Certificate issued with original issue discount to disclose on
its face certain information including the amount of original issue discount
and the issue date, and requiring such information to be reported to the IRS.
Reporting with respect to the REMIC Residual Certificates, including income,
excess inclusions, investment expenses and relevant information regarding
qualification of the REMIC's assets will be made as required under the
Treasury regulations, generally on a quarterly basis.
As applicable, the REMIC Regular Certificate information reports will
include a statement of the adjusted issue price of the REMIC Regular
Certificate at the beginning of each accrual period. In addition, the reports
will include information required by regulations with respect to computing the
accrual of any market discount. Because exact computation of the accrual of
market discount on a constant yield method requires information relating to
the holder's purchase price that the Master Servicer will not have, such
regulations only require that information pertaining to the appropriate
proportionate method of accruing market discount be provided. See "Taxation of
Owners of REMIC Regular Certificates--Market Discount."
The responsibility for complying with the foregoing reporting rules will be
borne by the Master Servicer. Certificateholders may request any information
with respect to the returns described in Section 1.6049-7(e)(2) of the
Treasury regulations. Such request should be directed to the Master Servicer
at Residential Funding Corporation, 8400 Normandale Lake Boulevard, Suite 600,
Minneapolis, Minnesota 55437.
BACKUP WITHHOLDING WITH RESPECT TO REMIC CERTIFICATES
Payments of interest and principal, as well as payments of proceeds from the
sale of REMIC Certificates, may be subject to the "backup withholding tax"
under Section 3406 of the Code at a rate of 31% if recipients of such payments
fail to furnish to the payor certain information, including their taxpayer
identification numbers, or otherwise fail to establish an exemption from such
tax. Any amounts deducted and withheld from a distribution to a recipient
would be allowed as a credit against such recipient's federal income tax.
Furthermore, certain penalties may be imposed by the IRS on a recipient of
payments that is required to supply information but that does not do so in the
proper manner.
FOREIGN INVESTORS IN REMIC CERTIFICATES
A REMIC Regular Certificateholder that is not a "United States person" (as
defined below) and is not subject to federal income tax as a result of any
direct or indirect connection to the United States in addition to its
ownership of a REMIC Regular Certificate will not be subject to United States
federal income or withholding tax in respect of a distribution on a REMIC
Regular Certificate, provided that the holder complies to the extent necessary
with certain identification requirements (including delivery of a statement,
signed by the Certificateholder under penalties of perjury, certifying that
such Certificateholder is not a United States person and providing the name
and address of such Certificateholder). For these purposes, "United States
person" means a citizen or resident of the United States, a corporation,
partnership or other entity created or organized in, or under the laws of, the
United States or any political subdivision thereof, or an estate whose income
is subject to United States federal income tax regardless of its source, or a
trust if a court within the United States is able to exercise primary
supervision over the administration of the trust and one or more United States
86
<PAGE>
fiduciaries have the authority to control all substantial decisions of the
trust. It is possible that the IRS may assert that the foregoing tax exemption
should not apply with respect to a REMIC Regular Certificate held by a REMIC
Residual Certificateholder that owns directly or indirectly a 10% or greater
interest in the REMIC Residual Certificates. If the holder does not qualify
for exemption, distributions of interest, including distributions in respect
of accrued original issue discount, to such holder may be subject to a tax
rate of 30%, subject to reduction under any applicable tax treaty.
In addition, the foregoing rules will not apply to exempt a United States
shareholder of a controlled foreign corporation from taxation on such United
States shareholder's allocable portion of the interest income received by such
controlled foreign corporation.
Further, it appears that a REMIC Regular Certificate would not be included
in the estate of a non-resident alien individual and would not be subject to
United States estate taxes. However, Certificateholders who are non-resident
alien individuals should consult their tax advisors concerning this question.
Unless otherwise stated in the related Prospectus Supplement, transfers of
REMIC Residual Certificates to investors that are not United States Persons
will be prohibited under the related Pooling and Servicing Agreement.
STATE AND OTHER TAX CONSEQUENCES
In addition to the federal income tax consequences described in "Certain
Federal Income Tax Consequences," potential investors should consider the
state and local tax consequences of the acquisition, ownership, and
disposition of the Certificates offered hereunder. State tax law may differ
substantially from the corresponding federal tax law, and the discussion above
does not purport to describe any aspect of the tax laws of any state or other
jurisdiction. Therefore, prospective investors should consult their tax
advisors with respect to the various tax consequences of investments in the
certificates offered hereunder.
ERISA CONSIDERATIONS
ERISA imposes certain fiduciary and prohibited transaction restrictions on
employee pension and welfare benefit plans subject to ERISA ("ERISA PLANS").
Section 4975 of the Code imposes similar prohibited transaction restrictions
on tax-qualified retirement plans described in Section 401(a) of the Code
("QUALIFIED RETIREMENT PLANS") and on individual retirement accounts and
annuities ("IRAS") described in Section 408 of the Code (collectively, "TAX-
FAVORED PLANS").
Certain employee benefit plans, such as governmental plans (as defined in
Section 3(32) of ERISA), and, if no election has been made under Section
410(d) of the Code, church plans (as defined in Section 3(33) of ERISA), are
not subject to the ERISA requirements discussed herein. Accordingly, assets of
such plans may be invested in Certificates without regard to the ERISA
considerations described below, subject to the provisions of applicable
federal and state law. Any such plan that is a Qualified Retirement Plan and
exempt from taxation under Sections 401(a) and 501(a) of the Code, however, is
subject to the prohibited transaction rules set forth in Section 503 of the
Code.
In addition to imposing general fiduciary requirements, including those of
investment prudence and diversification and the requirement that a Plan's
investment be made in accordance with the documents governing the Plan,
Section 406 of ERISA and Section 4975 of the Code prohibit a broad range of
transactions involving assets of ERISA Plans and Tax-Favored Plans
(collectively, "PLANS") and persons ("PARTIES IN INTEREST" under ERISA or
"DISQUALIFIED PERSONS" under the Code) who have certain specified
relationships to the Plans, unless a statutory or administrative exemption is
available. Certain Parties in Interest (or Disqualified Persons) that
87
<PAGE>
participate in a prohibited transaction may be subject to a penalty (or an
excise tax) imposed pursuant to Section 502(i) of ERISA or Section 4975 of the
Code, unless a statutory or administrative exemption is available.
PLAN ASSET REGULATIONS
An investment of the assets of a Plan in Certificates may cause the
underlying Mortgage Loans and Mortgage Securities (if any) included in a Trust
Fund to be deemed plan assets ("PLAN ASSETS" as defined below) of such Plan.
The U.S. Department of Labor (the "DOL") has promulgated regulations at 29
C.F.R. (S)2510.3-101 (the "DOL REGULATIONS") concerning whether or not a
Plan's assets would be deemed to include an interest in the underlying assets
of an entity (such as a Trust Fund) for purposes of applying the general
fiduciary responsibility provisions of ERISA and the prohibited transaction
provisions of ERISA and the Code, when a Plan acquires an "equity interest"
(such as a Certificate) in such entity. Exceptions contained in the DOL
Regulations provide that a Plan's assets will not include an undivided
interest in each asset of an entity in which it makes an equity investment if:
(1) the entity is an operating company; or (2) the equity investment made by
the Plan is either a "publicly-offered security" that is "widely held," both
as defined in the DOL Regulations, or a security issued by an investment
company registered under the Investment Company Act of 1940, as amended; or
(3) Benefit Plan Investors do not own 25% or more in value of any class of
equity securities issued by the entity. For this purpose, "Benefit Plan
Investors" include Plans, as well as any employee benefit plan (as defined in
Section 3(3) or ERISA) which is not subject to Title I of ERISA, such as
foreign plans, governmental plans (as defined in Section 3(32) of ERISA) and
church plans (as defined in Section 3(33) of ERISA) which have not made an
election under Section 410(d) of the Code, and any entity whose underlying
assets include Plan Assets by reason of a Plan's investment in the entity.
Depending upon whether or not an exception applies under the DOL Regulations,
Plan Assets either may be deemed to include an interest in the assets of an
entity (such as a Trust Fund) or may be deemed merely to include its interest
in the instrument evidencing such equity interest (such as a Certificate).
Therefore, because of the factual nature of certain of the rules governing the
applicability of those exceptions neither Plans nor such entities should
acquire or hold Certificates in reliance upon the availability of any
exception under the DOL Regulations. For purposes of this section "ERISA
Considerations," the term Plan Assets or "assets of a Plan" has the meaning
specified in the DOL Regulations and includes an undivided interest in the
underlying assets of certain entities in which a Plan invests.
The prohibited transaction provisions of Section 406 of ERISA and Section
4975 of the Code may apply to a Trust Fund and cause the Company, the Master
Servicer, any Subservicer, the Trustee, the obligor under any credit
enhancement mechanism or certain affiliates thereof to be considered or become
Parties in Interest (or Disqualified Persons) with respect to an investing
Plan (or of a Plan holding an interest in such an entity). If so, the
acquisition or holding of Certificates by or on behalf of any such investing
Plan could also give rise to a prohibited transaction under ERISA and the
Code, unless some statutory or administrative exemption is available.
Certificates acquired by a Plan would be assets of that Plan. Under the DOL
Regulations, the Trust Fund, including the Mortgage Loans or Mortgage
Securities and the other assets held in the Trust Fund, may also be deemed to
be assets of each Plan that acquires Certificates. Special caution should be
exercised before Plan Assets are used to acquire a Certificate in such
circumstances, especially if, with respect to such assets, the Company, the
Master Servicer, any Subservicer, the Trustee, the obligor under any credit
enhancement mechanism or an affiliate thereof either (i) has investment
discretion with respect to the investment of Plan Assets; or (ii) has
authority or responsibility to give (or regularly gives) investment advice
with respect to Plan Assets for a fee pursuant to an agreement or
understanding that such advice will serve as a primary basis for investment
decisions with respect to such Plan Assets.
Any person who has discretionary authority or control with respect to the
management or disposition of Plan Assets and any person who provides
investment advice with respect to such Plan Assets for a fee (in the manner
described above) is a fiduciary of the investing Plan. If the Mortgage Loans
or Mortgage Securities were to constitute Plan Assets, then any party
exercising management or discretionary control regarding those Plan Assets may
be deemed to be a Plan "fiduciary," and thus subject to the fiduciary
requirements of ERISA and the prohibited transaction provisions of ERISA and
Section 4975 of the Code with respect to any investing Plan. In addition, if
the Mortgage Loans or Mortgage Securities were to constitute Plan Assets, then
the acquisition or
88
<PAGE>
holding of Certificates by or on behalf of a Plan or with Plan Assets, as well
as the operation of the Trust Fund, may constitute or involve a prohibited
transaction under ERISA and the Code.
PROHIBITED TRANSACTION EXEMPTIONS
On March 29, 1994, the DOL issued (with an effective date of June 9, 1992)
an individual exemption (Prohibited Transaction Exemption 94-29, 59 Fed. Reg.
14,674 (March 29, 1994)) (the "EXEMPTION"), to Residential Funding and certain
of its affiliates, which generally exempts from the application of certain of
the prohibited transaction provisions of Section 406 of ERISA, and the excise
taxes imposed on such prohibited transactions pursuant to Section 4975(a) and
(b) of the Code, certain transactions, among others, relating to the servicing
and operation of mortgage pools and the purchase, sale and holding of pass-
through certificates issued by such a trust as to which (i) the Company or any
of its affiliates is the sponsor, and any entity which has received from the
DOL an individual prohibited transaction exemption which is similar to the
Exemption is the sole underwriter, or manager or co-manager of the
underwriting syndicate or a seller or placement agent, or (ii) the Company or
an affiliate is the underwriter, provided that certain conditions set forth in
the Exemption are satisfied. For purposes of this section, the term
"Underwriter" shall include (a) the Company and certain of its affiliates, (b)
any person directly or indirectly, through one or more intermediaries,
controlling, controlled by or under common control with the Company and
certain of its affiliates, (c) any member of the underwriting syndicate or
selling group of which a person described in (a) or (b) is a manager or co-
manager with respect to a class of Certificates, or (d) any entity which has
received an exemption from the DOL relating to Certificates which is similar
to the Exemption.
The Exemption sets forth six general conditions which must be satisfied for
a transaction involving the purchase, sale and holding of Certificates to be
eligible for exemptive relief thereunder. First, the acquisition of
Certificates by a Plan or with Plan Assets must be on terms that are at least
as favorable to the Plan as they would be in an arm's-length transaction with
an unrelated party. Second, the Exemption only applies to Certificates
evidencing rights and interests that are not subordinated to the rights and
interests evidenced by the other Certificates of the same trust. Third, the
Certificates at the time of acquisition by a Plan or with Plan Assets must be
rated in one of the three highest generic rating categories by Standard &
Poor's Ratings Services, Moody's Investors Service, Inc., Duff & Phelps, Inc.
or Fitch Investors Service, L.P. (collectively, the "EXEMPTION RATING
AGENCIES"). Fourth, the Trustee cannot be an affiliate of any member of the
"Restricted Group" which consists of any Underwriter, the Company, the Master
Servicer, any Subservicer and any mortgagor with respect to assets of a Trust
Fund constituting more than 5% of the aggregate unamortized principal balance
of the assets in the related Trust Fund as of the date of initial issuance of
the Certificates. Fifth, the sum of all payments made to and retained by the
Underwriters must represent not more than reasonable compensation for
underwriting the Certificates; the sum of all payments made to and retained by
the Company pursuant to the assignment of the assets to the related Trust Fund
must represent not more than the fair market value of such obligations; and
the sum of all payments made to and retained by the Master Servicer and any
Subservicer must represent not more than reasonable compensation for such
person's services under the related Pooling and Servicing Agreement and
reimbursement of such person's reasonable expenses in connection therewith.
Sixth, the Exemption states that the investing Plan or Plan-Asset Investor
must be an accredited investor as defined in Rule 501(a)(1) of Regulation D of
the Commission under the Securities Act of 1933, as amended.
The Exemption also requires that each Trust Fund meet the following
requirements: (i) the Trust Fund must consist solely of assets of the type
that have been included in other investment pools; (ii) certificates
evidencing interests in such other investment pools must have been rated in
one of the three highest categories of one of the Exemption Rating Agencies
for at least one year prior to the acquisition of Certificates by or on behalf
of a Plan or with Plan Assets; and (iii) certificates in such other investment
pools must have been purchased by investors other than Plans for at least one
year prior to any acquisition of Certificates by or on behalf of a Plan or
with Plan Assets.
89
<PAGE>
A Plan fiduciary or other investor of Plan Assets contemplating purchasing a
Certificate must make its own determination that the general conditions set
forth above will be satisfied with respect to such Certificate.
If the general conditions of the Exemption are satisfied, the Exemption may
provide an exemption from the restrictions imposed by Sections 406(a) and
407(a) of ERISA, and the excise taxes imposed by Sections 4975(a) and (b) of
the Code by reason of Sections 4975(c)(1)(A) through (D) of the Code, in
connection with the direct or indirect sale, exchange, transfer, holding or
the direct or indirect acquisition or disposition in the secondary market of
Certificates by a Plan or with Plan Assets. However, no exemption is provided
from the restrictions of Sections 406(a)(1)(E) and 406(a)(2) of ERISA for the
acquisition or holding of a Certificate by an Excluded Plan or with Plan
Assets of an Excluded Plan by any person who has discretionary authority or
renders investment advice with respect to Plan Assets of such Excluded Plan.
For purposes of the Certificates, an "EXCLUDED PLAN" is a Plan sponsored by
any member of the Restricted Group.
If certain specific conditions of the Exemption are also satisfied, the
Exemption may provide an exemption from the restrictions imposed by Sections
406(b)(1) and (b)(2) of ERISA, and the excise taxes imposed by Section 4975(a)
and (b) of the Code by reason of Section 4975(c)(1)(E) of the Code, in
connection with (1) the direct or indirect sale, exchange or transfer of
Certificates in the initial issuance of Certificates between the Company or an
Underwriter and a Plan when the person who has discretionary authority or
renders investment advice with respect to the investment of the relevant Plan
Assets in the Certificates is (a) a mortgagor with respect to 5% or less of
the fair market value of the assets of a Trust Fund or (b) an affiliate of
such a person (provided that, with respect to the acquisition of certificates
in connection with the initial issuance of the certificates, certain
quantitative restrictions set forth in the Exemption are met), (2) the direct
or indirect acquisition or disposition in the secondary market of Certificates
by a Plan or with Plan Assets and (3) the holding of Certificates by a Plan or
with Plan Assets.
Additionally, if certain specific conditions of the Exemption are satisfied,
the Exemption may provide an exemption from the restrictions imposed by
Sections 406(a), 406(b) and 407(a) of ERISA, and the excise taxes imposed by
Sections 4975(a) and (b) of the Code by reason of Section 4975(c) of the Code,
for transactions in connection with the servicing, management and operation of
the Mortgage Pools. Unless otherwise set forth in the related Prospectus
Supplement, the Company expects that the specific conditions of the Exemption
required for this purpose will be satisfied with respect to the Certificates
so that the Exemption would provide an exemption from the restrictions imposed
by Sections 406(a) and (b) of ERISA (as well as the excise taxes imposed by
Sections 4975(a) and (b) of the Code by reason of Section 4975(c) of the Code)
for transactions in connection with the servicing, management and operation of
the Mortgage Pools, provided that the general conditions of the Exemption are
satisfied.
The Exemption also may provide an exemption from the restrictions imposed by
Sections 406(a) and 407(a) of ERISA, and the excise taxes imposed by Section
4975(a) and (b) of the Code by reason of Sections 4975(c)(1)(A) through (D) of
the Code, if such restrictions are deemed to otherwise apply merely because a
person is deemed to be a Party in Interest (or a Disqualified Person) with
respect to an investing Plan (or the investing entity holding Plan Assets) by
virtue of providing services to the Plan or such Plan Assets (or by virtue of
having certain specified relationships to such a person) solely as a result of
the ownership of Certificates by a Plan or such Plan Assets investor.
In addition to the Exemption, a fiduciary or other Plan Asset investor
should consider the availability of certain class exemptions granted by the
DOL ("Class Exemptions"), which provide relief from certain of the prohibited
transaction provisions of ERISA and the related excise tax provisions of the
Code, including Prohibited Transaction Class Exemption ("PTCE") 83-1,
regarding transactions involving mortgage pool investment trusts; PTCE 95-60,
regarding transactions by insurance company general accounts, PTCE 90-1,
regarding investments by insurance company pooled separate accounts; PTCE 91-
38, regarding investments by bank collective investment funds; PTCE 84-14,
regarding transactions effected by a "qualified professional asset manager";
and PTCE 96-23, regarding transactions effected by an "in-house asset
manager." In particular, in
90
<PAGE>
connection with a contemplated purchase of Certificates representing a
beneficial ownership interest in a pool of single-family residential first or
second mortgage loans, such fiduciary or other Plan Asset investor should
consider the availability of the Exemption or PTCE 83-1. The Prospectus
Supplement with respect to a series of Certificates may contain additional
information regarding the application of the Exemption, PTCE 83-1, or any
other Class Exemption, with respect to the Certificates offered thereby.
However, PTCE 83-1 does not provide exemptive relief with respect to
Certificates evidencing interests in Trust Funds which include Mortgage Loans
secured by third or more junior liens, or Cooperative Loans.
INSURANCE COMPANY GENERAL ACCOUNTS
The Small Business Job Protection Act of 1996 added a new Section 401(c) to
ERISA, which provides an exemption from the restrictions imposed by Sections
406 and 407 of ERISA, and the excise taxes imposed by Sections 4975(a) and (b)
of the Code by reason of Sections 4975(c)(1)(A) through (D) of the Code, for
the purchase and holding of Certificates by an insurance company general
account. Pursuant to Section 401(c) of ERISA, the DOL is required to issue
final regulations ("401(c) Regulations") no later than December 31, 1997 which
provide guidance for purposes of determining, in cases where insurance
policies supported by an insurer's general account are issued on or before
December 31, 1998 to or for the benefit of a Plan, which general account
assets constitute Plan Assets for purposes of the fiduciary responsibility and
prohibited transaction provisions of ERISA and Section 4975 of the Code.
Section 401(c) of ERISA requires that the 401(c) Regulations, in connection
with any policy issued by an insurer to a Plan (to the extent that such policy
is not a guaranteed benefit policy within the meaning or Section 410(b)(2) of
ERISA), impose certain requirements regarding the purchase of such policies,
disclose certain obligations of the insurance company with respect to such
policies and impose certain fiduciary requirements on the insurer with respect
to those assets of the insurer which are assets of such insurer's general
account. Section 401(c) of ERISA provides that, until the date which is 18
months after the 401(c) Regulations become final, no liability under the
fiduciary responsibility and prohibited transactions provisions of ERISA and
Section 4975 of the Code may result on the basis of a claim that the assets of
an insurance company general account constitute Plan Assets, unless an action
is brought by the Secretary of Labor for a breach of fiduciary duty which
would also constitute a violation of federal or state criminal law.
Any assets of an insurance company general account which support insurance
policies issued to a Plan after December 31, 1998 or issued to Plans on or
before December 31, 1998 for which the insurance company does not comply with
the 401(c) Regulations may be treated as Plan Assets. In addition, because
Section 401(c) does not relate to insurance company separate accounts,
separate account assets are still treated as Plan Assets of any Plan invested
in such separate account. Insurance companies contemplating the investment of
general account assets in the Certificates should consult with their legal
advisors with respect to the applicability of Section 401(c) of ERISA,
including the general account's ability to continue to hold the Certificates
after the date which is 18 months after the date the 401(c) Regulations become
final.
Upon the purchase of Certificates by an insurance company with the assets of
its general account, such insurance company shall be deemed to have
represented and warranted that (i) it understands that the operation of the
general account after December 31, 1998 may adversely affect its ability to
continue to hold the Certificates after the date which is 18 months after the
401(c) Regulations become final, and (ii) unless exemptive relief under the
Exemption, a Class Exemption or an exception under Section 401(c) of ERISA is
then available for the continued holding of Certificates, if the assets of the
general account constitute Plan Assets, it will dispose of the Certificates
prior to the date which is 18 months after the 401(c) Regulations become
final.
REPRESENTATION FROM PLANS INVESTING IN CERTIFICATES BACKED BY REVOLVING CREDIT
LOANS OR SUBORDINATED CERTIFICATES
It is not clear whether Certificates backed by Revolving Credit Loans with
respect to which certain Trust Balances of Revolving Credit Loans are included
in the related Trust Fund would constitute "certificates" for purposes of the
Exemption. In promulgating the Exemption, the DOL did not have under
consideration interests in mortgage pools of the exact nature described in
this paragraph and accordingly, unless otherwise provided in the related
Prospectus Supplement, Certificates representing interests as described in
this paragraph should not
91
<PAGE>
be purchased by or on behalf of a Plan or with Plan Assets based solely upon
the Exemption. In addition, with respect to any Senior/Subordinate Series, any
class of Certificates which is subordinate to any other class of Certificates
in such Senior/Subordinate Series will not qualify for exemptive relief under
the Exemption.
To the extent Certificates are backed by Revolving Credit Loans or are
subordinate to any other class of Certificates, transfers of such Certificates
to a Plan, to a trustee or other person acting on behalf of any Plan, or to
any other person using the assets of any Plan to effect such acquisition will
not be registered by the Trustee unless the transferee provides the Company
and the Trustee with an opinion of counsel satisfactory to the Company and the
Trustee, which opinion will not be at the expense of the Company or the
Trustee, that the purchase of such Certificates by or on behalf of such Plan
is permissible under applicable law, will not constitute or result in a non-
exempt prohibited transaction under ERISA or Section 4975 of the Code and will
not subject the Company or the Trustee to any obligation in addition to those
undertaken in the Pooling and Servicing Agreement. In lieu of such opinion of
counsel, the transferee may provide a certification substantially to the
effect that the purchase of Certificates by or on behalf of such Plan is
permissible under applicable law, will not constitute or result in a non-
exempt prohibited transaction under ERISA or Section 4975 of the Code and will
not subject the Company or the Trustee to any obligation in addition to those
undertaken in the Pooling and Servicing Agreement, and the following
statements in at least one of (i), (ii), (iii), (iv), (v) or (vi) is accurate:
(i) the conditions set forth in PTCE 83-1 have been satisfied; (ii) the
transferee is an insurance company and (a) the source of funds used to
purchase such Certificates is an "insurance company general account" (as such
term is defined in PTCE 95-60), (b) the conditions set forth in PTCE 95-60
have been satisfied, and (c) there is no Plan with respect to which the amount
of such general account's reserves and liabilities for contracts held by or on
behalf of such Plan and all other Plans maintained by the same employer (or
any "affiliate" thereof, as defined in PTCE 95-60) or by the same employee
organization exceed 10% of the total of all reserves and liabilities of such
general account (as determined under PTCE 95-60) as of the date of acquisition
of such Certificates; (iii) the transferee is an insurance company and (a) the
source of funds used to purchase such Certificates is an "insurance company
pooled separate account" (as such term is defined in PTCE 90-1), (b) the
conditions set forth in PTCE 90-1 have been satisfied, and (c) there is no
Plan, together with all other Plans maintained by the same employer (or any
"affiliate" thereof, as defined in PTCE 90-1) or by the same employee
organization with assets which exceed 10% of the total of all assets in such
pooled separate account (as determined under PTCE 90-1) as of the date of
acquisition of such Certificates; (iv) the transferee is a bank and (a) the
source of funds used to purchase such Certificates is a "collective investment
fund" (as defined in PTCE 91-38), (b) the conditions set forth in PTCE 91-38
have been satisfied, and (c) there is no Plan, the interests of which together
with the interests of any other Plans maintained by the same employer or
employee organization in the collective investment fund do not exceed 10% of
the total of all assets in the collective investment fund (as determined under
PTCE 91-38) as of the date of acquisition of such Certificates; (v) the
transferee is a "qualified professional asset manager" described in PTCE 84-14
and the conditions set forth in PTCE 84-14 have been satisfied and will
continue to be satisfied; or (vi) the transferee is an "in-house asset
manager" described in PTCE 96-23 and the conditions set forth in PTCE 96-23
have been satisfied and will continue to be satisfied.
TAX EXEMPT INVESTORS
A Plan that is exempt from federal income taxation pursuant to Section 501
of the Code (a "TAX-EXEMPT INVESTOR") nonetheless will be subject to federal
income taxation to the extent that its income is "unrelated business taxable
income" ("UBTI") within the meaning of Section 512 of the Code. All "excess
inclusions" of a REMIC allocated to a REMIC Residual Certificate held by a
Tax-Exempt Investor will be considered UBTI and thus will be subject to
federal income tax. See "Certain Federal Income Tax Consequences--Taxation of
Owners of REMIC Residual Certificates--Excess Inclusions."
CONSULTATION WITH COUNSEL
There can be no assurance that any DOL exemption will apply with respect to
any particular Plan that acquires the Certificates or, even if all the
conditions specified therein were satisfied, that the exemption would
92
<PAGE>
apply to transactions involving the Trust Fund. Prospective Plan investors
should consult with their legal advisors concerning the impact of ERISA and
the Code and the potential consequences to their specific circumstances prior
to making an investment in the Certificates.
Before purchasing a Certificate, a fiduciary of a Plan should itself confirm
that (a) all the specific and general conditions set forth in the Exemption or
in one of the Class Exemptions would be satisfied and (b) in the case of a
Certificate purchased under the Exemption, the Certificate constitutes a
"certificate" for purposes of the Exemption. In addition to making its own
determination as to the availability of the exemptive relief provided in the
Exemption or in any of the Class Exemptions, the Plan fiduciary should
consider its general fiduciary obligations under ERISA in determining whether
to purchase a Certificate on behalf of a Plan.
LEGAL INVESTMENT MATTERS
Each class of Certificates offered hereby and by the related Prospectus
Supplement will be rated at the date of issuance in one of the four highest
rating categories by at least one Rating Agency. Unless otherwise specified in
the related Prospectus Supplement, each Class of Certificates will evidence an
interest in Mortgage Loans primarily secured by second or more junior liens,
and therefore will not constitute "mortgage related securities" for purposes
of SMMEA. Accordingly, investors whose investment authority is subject to
legal restrictions should consult their legal advisors to determine whether
and to what extent the Certificates constitute legal investments for them.
All depository institutions considering an investment in the Certificates
should review the Federal Financial Institutions Examination Council's
Supervisory Policy Statement on the Selection of Securities Dealers and
Unsuitable Investment Practices (to the extent adopted by their respective
regulators), setting forth, in relevant part, certain investment practices
deemed to be unsuitable for an institution's investment portfolio, as well as
guidelines for investing in certain types of mortgage related securities.
The foregoing does not take into consideration the applicability of
statutes, rules, regulations, orders, guidelines or agreements generally
governing investments made by a particular investor, including, but not
limited to, "prudent investor" provisions, percentage-of-assets limits and
provisions which may restrict or prohibit investment in securities which are
not "interest bearing" or "income paying."
There may be other restrictions on the ability of certain investors either
to purchase certain classes of Certificates or to purchase any class of
Certificates representing more than a specified percentage of the investors'
assets. The Company will make no representations as to the proper
characterization of any class of Certificates for legal investment or other
purposes, or as to the ability of particular investors to purchase any class
of Certificates under applicable legal investment restrictions. These
uncertainties may adversely affect the liquidity of any class of Certificates.
Accordingly, all investors whose investment activities are subject to legal
investment laws and regulations, regulatory capital requirements or review by
regulatory authorities should consult with their legal advisors in determining
whether and to what extent the Certificates of any class constitute legal
investments or are subject to investment, capital or other restrictions.
93
<PAGE>
USE OF PROCEEDS
Unless otherwise specified in the related Prospectus Supplement,
substantially all of the net proceeds to be received from the sale of
Certificates will be applied by the Company to finance the purchase of, or to
repay short-term loans incurred to finance the purchase of, the Mortgage Loans
or Mortgage Securities underlying the Certificates or will be used by the
Company for general corporate purposes. The Company expects that it will make
additional sales of securities similar to the Certificates from time to time,
but the timing and amount of any such additional offerings will be dependent
upon a number of factors, including the volume of mortgage loans purchased by
the Company, prevailing interest rates, availability of funds and general
market conditions.
METHODS OF DISTRIBUTION
The Certificates offered hereby and by the related Prospectus Supplements
will be offered in series through one or more of the methods described below.
The Prospectus Supplement prepared for each series will describe the method of
offering being utilized for that series and will state the net proceeds to the
Company from such sale.
The Company intends that Certificates will be offered through the following
methods from time to time and that offerings may be made concurrently through
more than one of these methods or that an offering of a particular series of
Certificates may be made through a combination of two or more of these
methods. Such methods are as follows:
1. by negotiated firm commitment or best efforts underwriting and
public re-offering by underwriters;
2. by placements by the Company with institutional investors through
dealers; and
3. by direct placements by the Company with institutional investors.
In addition, if specified in the related Prospectus Supplement, a series of
Certificates may be offered in whole or in part to the Seller of the related
Mortgage Loans (and other assets, if applicable) that would comprise the
Mortgage Pool in respect of such Certificates.
If underwriters are used in a sale of any Certificates (other than in
connection with an underwriting on a best efforts basis), such Certificates
will be acquired by the underwriters for their own account and may be resold
from time to time in one or more transactions, including negotiated
transactions, at fixed public offering prices or at varying prices to be
determined at the time of sale or at the time of commitment therefor. Such
underwriters may be broker-dealers affiliated with the Company whose
identities and relationships to the Company will be as set forth in the
related Prospectus Supplement. The managing underwriter or underwriters with
respect to the offer and sale of a particular series of Certificates will be
set forth on the cover of the Prospectus Supplement relating to such series
and the members of the underwriting syndicate, if any, will be named in such
Prospectus Supplement.
In connection with the sale of the Certificates, underwriters may receive
compensation from the Company or from purchasers of the Certificates in the
form of discounts, concessions or commissions. Underwriters and dealers
participating in the distribution of the Certificates may be deemed to be
underwriters in connection with such Certificates, and any discounts or
commissions received by them from the Company and any profit on the resale of
Certificates by them may be deemed to be underwriting discounts and
commissions under the Securities Act of 1933, as amended.
It is anticipated that the underwriting agreement pertaining to the sale of
any series of Certificates will provide that the obligations of the
underwriters will be subject to certain conditions precedent, that the
underwriters will be obligated to purchase all such Certificates if any are
purchased (other than in connection with an underwriting on a best efforts
basis) and that, in limited circumstances, the Company will indemnify the
several underwriters and the underwriters will indemnify the Company against
certain civil liabilities, including
94
<PAGE>
liabilities under the Securities Act of 1933, as amended, or will contribute
to payments required to be made in respect thereof.
The Prospectus Supplement with respect to any series offered by placements
through dealers will contain information regarding the nature of such offering
and any agreements to be entered into between the Company and purchasers of
Certificates of such series.
The Company anticipates that the Certificates offered hereby will be sold
primarily to institutional investors or sophisticated non-institutional
investors. Purchasers of Certificates, including dealers, may, depending on
the facts and circumstances of such purchases, be deemed to be "underwriters"
within the meaning of the Securities Act of 1933, as amended, in connection
with reoffers and sales by them of Certificates. Holders of Certificates
should consult with their legal advisors in this regard prior to any such
reoffer or sale.
LEGAL MATTERS
Certain legal matters, including certain federal income tax matters, will be
passed upon for the Company by Thacher Proffitt & Wood, New York, New York, or
by Orrick, Herrington & Sutcliffe LLP, New York, New York, as specified in the
Prospectus Supplement.
FINANCIAL INFORMATION
The Company has determined that its financial statements are not material to
the offering made hereby. The Certificates do not represent an interest in or
an obligation of the Company. The Company's only obligations with respect to a
series of Certificates will be to repurchase Mortgage Loans or Mortgage
Securities upon any breach of certain limited representations and warranties
made by the Company, or as otherwise provided in the applicable Prospectus
Supplement.
95
<PAGE>
INDEX OF PRINCIPAL DEFINITIONS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Account Balance........................................................... 20
Accrual Certificates...................................................... 5
Actuarial Mortgage Loan................................................... 18
Additional Balance........................................................ 19
Additional Charges........................................................ 20
Advance................................................................... 38
Affiliated Sellers........................................................ 15
ARM Loans................................................................. 17
Audit Guide............................................................... 51
Balloon Amount............................................................ 18
Balloon Loans............................................................. 18
Bankruptcy Loss........................................................... 44
Beneficial Owner.......................................................... 30
Book-Entry Certificates................................................... 30
CEDEL..................................................................... 30
CEDEL Participants........................................................ 31
CERCLA.................................................................... 66
Certificate Account....................................................... 35
Certificate Administrator................................................. 16
Certificateholder......................................................... 30
Certificate Registrar..................................................... 30
Certificates.............................................................. 1
Clearance Cooperative..................................................... 31
Closed-End Loans.......................................................... 1
Closing Date.............................................................. 73
CLTV...................................................................... 16
Code...................................................................... 9, 62
Combined Loan-to-Value Ratio.............................................. 16
Commission................................................................ 16
Committee Report.......................................................... 73
Company................................................................... 1
Contributions Tax......................................................... 84
Convertible Mortgage Loan................................................. 19
Cooperative............................................................... 61
Cooperative Loans......................................................... 15
Cooperative Note.......................................................... 61
Cooperative Notes......................................................... 15
Credit Enhancer........................................................... 45
Credit Line Agreements.................................................... 19
Credit Utilization Rate................................................... 16
Crime Control Act......................................................... 69
Custodial Account......................................................... 26
Custodian................................................................. 33
Debt Service Reduction.................................................... 46
Defaulted Mortgage Loss................................................... 44
Deferred Interest......................................................... 18
Deficient Valuation....................................................... 46
</TABLE>
96
<PAGE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Deleted Mortgage Loan..................................................... 26
Depositaries.............................................................. 30
Designated Seller......................................................... 15
Designated Seller Transaction............................................. 15
Determination Date........................................................ 38
Disqualified Persons...................................................... 87
Distribution Amount....................................................... 37
Distribution Date......................................................... 6
DOL....................................................................... 88
DOL Regulations........................................................... 88
Draw...................................................................... 19
Draw Period............................................................... 19
DTC....................................................................... 30
DTC Participants.......................................................... 30
Eligible Account.......................................................... 35
ERISA..................................................................... 9
ERISA Plans............................................................... 87
Euroclear................................................................. 30
Euroclear Operator........................................................ 31
Euroclear Participants.................................................... 31
Excess Interest........................................................... 47
Excess Spread............................................................. 34
Exchange Act.............................................................. 2
Excluded Balance.......................................................... 1
Excluded Plan............................................................. 90
Excluded Spread........................................................... 34
Exemption................................................................. 89
Exemption Rating Agencies................................................. 89
Extraordinary Losses...................................................... 44
FDIC...................................................................... 2
Finance Charge............................................................ 20
Financial Guaranty Insurance Policy....................................... 45
Fraud Loss................................................................ 44
Funding Account........................................................... 39
Garn-St Germain Act....................................................... 67
Gross Margin.............................................................. 17
Guide..................................................................... 21
High Cost Loans........................................................... 66
Home Equity Program....................................................... 21
Index..................................................................... 17
Indirect Participants..................................................... 30
Insurance Proceeds........................................................ 34
Insurer................................................................... 45
IRAs...................................................................... 87
IRS....................................................................... 73
Issue Premium............................................................. 79
Junior Ratio.............................................................. 16
Letter of Credit.......................................................... 45
Letter of Credit Bank..................................................... 45
</TABLE>
97
<PAGE>
<TABLE>
<CAPTION>
PAGE
------
<S> <C>
Liquidated Mortgage Loan................................................ 42
Liquidation Proceeds.................................................... 34
Manager................................................................. 16
Mark-to-Market Regulations.............................................. 82
Master Commitments...................................................... 22
Mezzanine Certificates.................................................. 5
Mortgage................................................................ 20
Mortgage Loans.......................................................... 1, 15
Mortgage Notes.......................................................... 14, 15
Mortgage Pool........................................................... 4
Mortgage Rate........................................................... 17
Mortgage Securities..................................................... 6
Mortgaged Properties.................................................... 5, 15
Mortgagor............................................................... 10
Net Mortgage Rate....................................................... 56
Nonrecoverable P&I Advance.............................................. 36
OID Regulations......................................................... 71
Overcollateralization................................................... 30
Participants............................................................ 30
Parties in Interest..................................................... 87
Pass-Through Rate....................................................... 4
Paying Agent............................................................ 37
Percentage Interest..................................................... 37
Permitted Investments................................................... 35
Plan Assets............................................................. 88
Plans................................................................... 87
Pooling and Servicing Agreement......................................... 1, 4
Prepayment Assumption................................................... 73
Prepayment Interest Shortfalls.......................................... 7
Prohibited Transactions Tax............................................. 83
PTCE.................................................................... 90
Purchase Price.......................................................... 26
Qualified Insurer....................................................... 49
Qualified Retirement Plans.............................................. 87
Qualified Substitute Mortgage Loan...................................... 26
Rating Agency........................................................... 9
Realized Loss........................................................... 44
Record Date............................................................. 37
Registration Statement.................................................. 2
Relief Act.............................................................. 69
REMIC................................................................... 1
REMIC Provisions........................................................ 71
REMIC Regular Certificates.............................................. 71
REMIC Regulations....................................................... 71
REMIC Residual Certificates............................................. 72
REO Mortgage Loan....................................................... 42
Reserve Fund............................................................ 48
Residential Funding..................................................... 4
Revolving Credit Loans.................................................. 1, 14
RICO.................................................................... 69
</TABLE>
98
<PAGE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Sellers................................................................... 15
Senior Certificates....................................................... 5
Senior Percentage......................................................... 47
Senior/Subordinate Series................................................. 29
Servicing Advances........................................................ 36
Simple Interest Mortgage Loan............................................. 18
Single Certificate........................................................ 40
SMMEA..................................................................... 9
Special Hazard Instrument................................................. 44
Special Hazard Insurance Policy........................................... 46
Special Hazard Loss....................................................... 44
Spread Account............................................................ 48
Stated Principal Balance.................................................. 44
Strip Certificates........................................................ 5
Subordinate Certificates.................................................. 5
Subservicers.............................................................. 16
Subservicing Account...................................................... 34
Subservicing Agreement.................................................... 27
Tax-Exempt Investor....................................................... 92
Tax-Favored Plans......................................................... 87
Terms and Conditions...................................................... 31
Tiered REMICs............................................................. 72
Title V................................................................... 68
Title VIII................................................................ 68
Trust Balance............................................................. 20
Trust Fund................................................................ 1
Trustee................................................................... 4
UBTI...................................................................... 92
UCC....................................................................... 64
Unaffiliated Sellers...................................................... 15
</TABLE>
99
