0000950149-01-501592.txt : 20011101
0000950149-01-501592.hdr.sgml : 20011101
ACCESSION NUMBER: 0000950149-01-501592
CONFORMED SUBMISSION TYPE: 424B5
PUBLIC DOCUMENT COUNT: 1
FILED AS OF DATE: 20011031
FILER:
COMPANY DATA:
COMPANY CONFORMED NAME: SEQUOIA MORTGAGE FUNDING CORP
CENTRAL INDEX KEY: 0001033146
STANDARD INDUSTRIAL CLASSIFICATION: ASSET-BACKED SECURITIES [6189]
IRS NUMBER: 911771827
STATE OF INCORPORATION: MD
FISCAL YEAR END: 1231
FILING VALUES:
FORM TYPE: 424B5
SEC ACT: 1933 Act
SEC FILE NUMBER: 333-22681
FILM NUMBER: 1771077
BUSINESS ADDRESS:
STREET 1: 591 REDWOOD HWY
STREET 2: STE 3120
CITY: MILL VALLEY
STATE: CA
ZIP: 94941
BUSINESS PHONE: 4153811765
MAIL ADDRESS:
STREET 1: 591 REDWOOD HIGHWAY
STREET 2: STE 3120
CITY: MILL VALLEY
STATE: CA
ZIP: 94941
424B5
1
f76475e424b5.txt
PROSPECTUS & PROSPECTUS SUPPLEMENT
Filed Pursuant to Rule 424(b)(5)
Registration No. 333-22681
PROSPECTUS SUPPLEMENT
(TO PROSPECTUS DATED OCTOBER 29, 2001)
$510,047,100 (APPROXIMATE)
SEQUOIA MORTGAGE TRUST 5
BOND ISSUER
COLLATERALIZED MORTGAGE BONDS
Consider carefully the
risk factors beginning on
page S-7 of this
prospectus supplement.
The bonds are redeemable
only under the
circumstances described in
this prospectus
supplement.
The bonds represent
obligations of the bond
issuer only and do not
represent an interest in
or obligation of the owner
trustee, the bond trustee,
the depositor or any of
their respective
affiliates.
The bonds offered by this prospectus supplement will be purchased by Greenwich
Capital Markets, Inc. and Bear Stearns & Co. Inc., as underwriters, from the
bond issuer, and are being offered by the underwriters from time to time for
sale to the public in negotiated transactions or otherwise at varying prices to
be determined at the time of sale. The underwriters have the right to reject any
order. Proceeds to the bond issuer from the sale of these bonds will be
approximately 99.76% of their initial principal balance, before deducting
expenses.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED THE BONDS OR DETERMINED THIS PROSPECTUS
SUPPLEMENT OR THE ACCOMPANYING PROSPECTUS IS ACCURATE OR COMPLETE. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
On or about October 31, 2001, delivery of the bonds (other than the Class A-R
Bond which will be delivered in physical, fully registered form) offered by this
prospectus supplement will be made through the book-entry facilities of The
Depository Trust Company, Clearstream Banking, societe anonyme and the Euroclear
System.
GREENWICH CAPITAL MARKETS, INC. BEAR, STEARNS & CO. INC.
October 29, 2001
THE BOND ISSUER WILL ISSUE:
- Three classes of senior bonds; and
- Six classes of subordinate bonds.
This prospectus supplement and the accompanying
prospectus relate only to the offering of bonds
listed in the table on page S-1 under
"Summary -- Offered Bonds" and not to the other
classes of bonds that will be issued as
described in this prospectus supplement.
THE BONDS:
- Will be primarily collateralized by 25-year, adjustable rate, conventional
mortgage loans, which provide for payments of interest only for a period of
ten years following origination and are secured by first liens on one- to
four-family residential properties;
- Will have a payment date occurring on the 19th day of each month, or if such
day is not a business day, the next succeeding business day, commencing on
November 19, 2001. Payments on the bonds are described more fully under the
heading "Description of the Bonds" in this prospectus supplement; and
- Will be treated for federal income tax purposes as REMIC regular interests
(except the Class A-R Bond, which will represent the residual interest in each
of the upper-tier REMIC and lower-tier REMIC).
IMPORTANT NOTICE ABOUT THE INFORMATION PRESENTED IN THIS
PROSPECTUS SUPPLEMENT AND THE ACCOMPANYING PROSPECTUS
We tell you about the bonds in two separate documents that progressively
provide more detail: (1) the accompanying prospectus, which provides general
information, some of which may not apply to your series of bonds, and (2) this
prospectus supplement, which describes the specific terms of your series of
bonds and may be different from the information in the prospectus.
IF THE TERMS OF YOUR SERIES OF BONDS AND ANY OTHER INFORMATION CONTAINED
HEREIN VARY BETWEEN THIS PROSPECTUS SUPPLEMENT AND THE ACCOMPANYING PROSPECTUS,
YOU SHOULD RELY ON THE INFORMATION IN THIS PROSPECTUS SUPPLEMENT.
We include cross-references in this prospectus supplement and the
accompanying prospectus to captions in these materials where you can find
further related discussions. The table of contents for this prospectus
supplement and the table of contents included in the accompanying prospectus
provide the pages on which these captions are located.
You can find a listing of the pages where capitalized terms used in this
prospectus supplement are defined under "Index of Certain Definitions" beginning
on page S-64 in this prospectus supplement.
Dealers will deliver a prospectus supplement and prospectus when acting as
underwriters of the bonds and with respect to their unsold allotments and
subscriptions. In addition, all dealers selling the bonds will be required to
deliver a prospectus supplement and prospectus for ninety days following the
date of this prospectus supplement.
WHERE YOU CAN FIND MORE INFORMATION
Federal securities law requires the filing of certain information with the
Securities and Exchange Commission (the "SEC"), including annual, quarterly and
special reports, proxy statements and other information. You can read and copy
these documents at the public reference facility maintained by the SEC at
Judiciary Plaza, 450 Fifth Street, NW, Room 1024, Washington, DC 20549. You can
also copy and inspect such reports, proxy statements and other information at
the following regional offices of the SEC:
Woolworth Building Chicago Regional Office
233 Broadway Citicorp Center
New York, New York 10279 500 West Madison Street, Suite 1400
Chicago, Illinois 60661
Please call the SEC at 1-800-SEC-0330 for further information on the public
reference rooms. SEC filings are also available to the public on the SEC's web
site at http://www.sec.gov.
The SEC allows us to "incorporate by reference" the information we file
with it, which means that we can disclose important information to you by
referring you to those documents. The information that we incorporate by
reference is considered to be part of this prospectus supplement, and later
information that we file with the SEC will automatically update and supersede
this information.
This prospectus supplement and the accompanying prospectus are part of a
registration statement filed by the depositor with the SEC (Registration No.
333-22681). You may request a free copy of any of the above filings by writing
or calling:
SEQUOIA MORTGAGE FUNDING CORPORATION
591 REDWOOD HIGHWAY, SUITE 3120
MILL VALLEY, CA 94941
(415) 389-7373
You should rely only on the information provided in this prospectus
supplement or the accompanying prospectus or incorporated by reference herein.
We have not authorized anyone else to provide you with different information.
You should not assume that the information in this prospectus supplement or the
accompanying prospectus is accurate as of any date other than the date on the
cover page of this prospectus supplement or the accompanying prospectus or that
the information incorporated by reference herein is accurate as of any date
other than the date stated therein.
S-ii
TABLE OF CONTENTS
PROSPECTUS SUPPLEMENT
PAGE
----
SUMMARY............................... S-1
RISK FACTORS.......................... S-7
THE BOND ISSUER....................... S-12
DESCRIPTION OF THE BONDS.............. S-13
General............................. S-13
Book-Entry Bonds.................... S-14
Payments on Mortgage Loans;
Accounts......................... S-17
Available Payment Amount............ S-18
Payments of Interest................ S-19
Payments of Principal............... S-22
Priority of Payment................. S-26
Subordination of the Payment of the
Subordinate Bonds................ S-27
Allocation of Realized Losses....... S-27
Remedies Upon Default............... S-28
Reports to Bondholders.............. S-29
Stated Maturity..................... S-30
Optional Redemption of the Bonds.... S-30
Optional Clean-Up Redemption of the
Bonds............................ S-30
The Bond Trustee.................... S-31
Controlling Class Under the
Indenture........................ S-31
SECURITY FOR THE BONDS................ S-31
General............................. S-31
The Initial Mortgage Loans.......... S-31
The Additional Collateral Loans..... S-33
Tabular Characteristics of the
Initial Mortgage Loans........... S-34
The Indices; Conversion Options..... S-39
Assignment of the Mortgage Loans.... S-40
Conveyance of Subsequent Mortgage
Loans............................ S-42
Underwriting Standards.............. S-43
ORIGINATION OF THE MORTGAGE LOANS..... S-43
PAGE
----
MSDWCC Origination.................. S-43
MSDCC Underwriting Guidelines....... S-43
Cendant and Bishop's Gate
Underwriting Guidelines.......... S-44
THE SERVICERS......................... S-44
SERVICING OF THE MORTGAGE LOANS....... S-48
Servicing and Collection Procedures... S-48
Servicing Compensation and Payment of
Expenses............................ S-49
Adjustment to Servicing Fees in
Connection with Certain Prepaid
Mortgage Loans...................... S-49
Advances.............................. S-49
Evidence as to Compliance............. S-50
Resignation of Servicers; Merger...... S-50
YIELD, PREPAYMENT AND WEIGHTED AVERAGE
LIFE................................ S-50
General............................. S-50
Subordination of the Offered
Subordinate Bonds................ S-52
Weighted Average Life............... S-53
USE OF PROCEEDS....................... S-58
FEDERAL INCOME TAX CONSEQUENCES....... S-58
ERISA MATTERS......................... S-60
METHOD OF DISTRIBUTION................ S-62
LEGAL MATTERS......................... S-63
RATINGS............................... S-63
INDEX OF CERTAIN DEFINITIONS.......... S-64
ANNEX I GLOBAL CLEARANCE, SETTLEMENT
AND TAX DOCUMENTATION PROCEDURES.... I-1
S-iii
TABLE OF CONTENTS
PROSPECTUS
PAGE
----
SUMMARY............................... 3
RISK FACTORS.......................... 7
INTRODUCTION.......................... 10
THE ISSUER............................ 10
General............................. 10
The Company......................... 11
USE OF PROCEEDS....................... 11
MORTGAGE LOAN PROGRAM................. 12
Underwriting Standards.............. 12
Quality Control..................... 13
Representations by Sellers;
Repurchases...................... 13
DESCRIPTION OF THE BONDS.............. 14
General............................. 14
Payments of Interest................ 15
Payments of Principal............... 15
Special Redemption.................. 17
Optional Redemption................. 17
Call Protection and Guarantees...... 17
Weighted Average Life of the
Bonds............................ 17
Book-Entry Bonds.................... 19
SECURITY FOR THE BONDS................ 22
General............................. 22
The Pledged Mortgages............... 23
Agency Securities................... 26
Private Mortgage-Backed
Securities....................... 31
Substitution of Mortgage
Collateral....................... 32
Optional Purchase of Defaulted
Pledged Mortgages................ 32
Bond and Distribution Accounts...... 32
Pre-Funding Account................. 33
CREDIT ENHANCEMENT.................... 34
General............................. 34
Subordination....................... 35
Reserve Funds....................... 35
Mortgage Pool Insurance Policies.... 36
Special Hazard Insurance Policies... 37
Bankruptcy Bonds.................... 38
Bond Insurance Policies, Surety
Bonds and Guaranties............. 38
Letter of Credit.................... 39
Over-Collateralization.............. 39
PAGE
----
Cross-Collateralization............. 39
Minimum Principal Payment
Agreement........................ 39
Derivative Arrangements............. 40
SERVICING OF THE PLEDGED MORTGAGES.... 40
General............................. 40
Payments on Pledged Mortgages....... 41
Collection Procedures............... 42
Junior Mortgages.................... 43
Servicing and Other Compensation and
Payment of Expenses.............. 44
Prepayments......................... 44
Evidence as to Compliance........... 44
Advances and Other Amounts Payable
by Master Servicer............... 45
Resignation of Master Servicer...... 45
Stand-by Servicer................... 46
Special Servicing Agreement......... 46
Certain Matters Regarding the Master
Servicer and the Company......... 46
Servicing Defaults.................. 47
Rights Upon Servicing Default....... 47
Amendment of Master Servicing
Agreement........................ 47
THE INDENTURE......................... 47
General............................. 47
Modification of Indenture........... 48
Events of Default................... 48
Rights Upon Events of Default....... 49
Certain Covenants of the Issuer..... 49
Issuer's Annual Compliance
Statement........................ 50
Bond Trustee's Annual Report........ 50
Satisfaction and Discharge of
Indenture........................ 50
Report by Board Trustee to
Bondholders...................... 50
The Bond Trustee.................... 50
CERTAIN LEGAL ASPECTS OF PLEDGED
MORTGAGES........................... 50
General............................. 50
Junior Mortgages.................... 51
Foreclosure/Repossession............ 52
Rights of Redemption................ 54
S-iv
PAGE
----
Anti-Deficiency Legislation and
Other Limitations on Lenders..... 54
Environmental Risks................. 55
Due-on-Sale Clauses................. 56
Enforceability of Prepayment Charges
and Late Payment Fees............ 57
Applicability of Usury Laws......... 57
Soldiers' and Sailors' Civil Relief
Act.............................. 57
Subordinate Financing............... 58
FEDERAL INCOME TAX CONSEQUENCES....... 58
Overview............................ 58
Non-REMIC Bonds..................... 58
REMIC Bonds......................... 63
Withholding with Respect to Certain
Foreign Investors................ 69
Backup Withholding.................. 69
STATE TAX CONSIDERATIONS.............. 70
LEGAL INVESTMENT...................... 70
ERISA MATTERS......................... 71
General............................. 71
Prohibited Transactions............. 71
RATING................................ 72
PLAN OF DISTRIBUTION.................. 73
LEGAL MATTERS......................... 73
INDEX OF CERTAIN DEFINITIONS.......... 74
S-v
SUMMARY
This summary highlights selected information from this prospectus
supplement and does not contain all the information that you need to consider in
making your investment decision. Please read this entire prospectus supplement
and the accompanying prospectus carefully for additional information about the
offered bonds.
OFFERED BONDS
Sequoia Mortgage Trust 5 Collateralized Mortgage Bonds consist of the
classes of bonds listed in the table below, together with the Class B-4, Class
B-5, Class B-6 and Class X Bonds. Only the classes of bonds listed in the table
below are being offered by this prospectus supplement:
INITIAL CLASS
PRINCIPAL INTEREST CUSIP
CLASS AMOUNT(1) RATE DESIGNATION NUMBER
----- ------------- -------- ----------------- ----------
A............................... $496,667,000 (2) LIBOR/Senior 81743W AA9
A-R............................. 100 (3) Senior/Residual 81743W AB7
B-1............................. 5,918,000 (2) LIBOR/Subordinate 81743W AC5
B-2............................. 5,146,000 (2) LIBOR/Subordinate 81743W AD3
B-3............................. 2,316,000 (2) LIBOR/Subordinate 81743W AE1
---------------
(1) These balances are approximate and are subject to an increase or decrease of
up to 10%, as described in this prospectus supplement.
(2) Interest will accrue on the Class A, Class B-1, Class B-2 and Class B-3
Bonds based upon one-month LIBOR plus a specified margin, subject to
limitation, as described in this prospectus supplement.
(3) Interest will accrue on the Class A-R Bond based upon the net weighted
average of the interest rates on the mortgage loans securing the bonds.
The bonds offered by the prospectus supplement, except for the Class A-R
Bond, will be issued in book-entry form and in the minimum denominations (or
multiples thereof) set forth under "Description of the Bonds -- General" in this
prospectus supplement. The Class A-R Bond will be issued in fully registered
definitive form.
BOND ISSUER
The bond issuer, Sequoia Mortgage Trust 5, is a statutory business trust
established under the laws of the State of Delaware pursuant to a deposit trust
agreement between the depositor and the owner trustee for the sole purpose of
issuing the bonds and an investor certificate. The investor certificate, which
represents the sole equity interest in the trust, is not offered hereunder and
will initially be retained by the depositor. The bonds represent obligations of
the bond issuer only, and no other person or entity has guaranteed or is
otherwise obligated to pay the bonds.
SELLER
Redwood Trust, Inc. has previously acquired the initial mortgage loans (and
is expected to acquire subsequent mortgage loans) from the originators and will
sell all of its interest in the mortgage loans to the depositor.
DEPOSITOR
The settlor and owner of the investor certificate issued by the bond issuer
is Sequoia Mortgage Funding Corporation, a Delaware limited purpose finance
corporation and a wholly owned subsidiary of Redwood Trust, Inc. The depositor
will assign all its interest in the mortgage loans acquired from the seller to
the bond issuer.
OWNER TRUSTEE
Wilmington Trust Company, a banking corporation organized under the laws of
the state of Delaware.
S-1
BOND TRUSTEE
Bankers Trust Company of California, N.A., a national banking association,
will act as bond trustee under an indenture between the bond issuer and bond
trustee pursuant to which the bonds will be issued and the bond issuer will
pledge the mortgage loans and related collateral to secure payment of the bonds.
MANAGER
Redwood Trust, Inc., a Maryland corporation, will act as the manager of the
bond issuer pursuant to a management agreement, under which the manager will
perform certain administrative and ministerial duties for the bond issuer and
the owner trustee.
ORIGINATORS AND SERVICERS
Cendant Mortgage Corporation, Bishop's Gate Residential Mortgage Trust and
Morgan Stanley Dean Witter Credit Corporation originated or acquired the initial
mortgage loans. Cendant Mortgage Corporation and Morgan Stanley Dean Witter
Credit Corporation will continue to service the mortgage loans pursuant to
existing servicing agreements between each such servicer and Redwood Trust, Inc.
Redwood Trust, Inc. will assign its right under the servicing agreements to the
depositor who will, in turn, assign such rights to the bond issuer.
CUT-OFF DATE
October 1, 2001.
CLOSING DATE
On or about October 31, 2001.
PAYMENT DATE
The 19th day of each month or if such day is not a business day, the next
business day thereafter, commencing in November 2001. Payments on each payment
date will be made to bondholders of record as of the related record date, except
that the final payment on the bonds will be made only upon presentment and
surrender of the bonds at the corporate trust office of the bond trustee.
RECORD DATE
With respect to the Class A, Class B-1, Class B-2 and Class B-3 Bonds, the
last business day preceding a payment date (or the closing date, in the case of
the first payment date), unless such bonds are no longer book-entry bonds in
which case the record date is the last business day of the month preceding the
month of a payment date. With respect to the Class A-R Bond, the record date
will be last business day of the month preceding the month of a payment date (or
the closing date, in the case of the first payment date).
PRIORITY OF PAYMENTS
Payments will be made on each payment date from principal and interest
collections on the mortgage loans and other available funds in the following
order of priority:
1. To accrued and unpaid interest on the Class A-R, Class A and Class X
Bonds, pro rata; provided, however, that the amount of interest payable
on the Class X Bonds on any payment date, to the extent of the required
basis risk reserve fund deposit for such date, will be reduced by
amounts, if any, deposited in the basis risk reserve fund on such date;
2. To principal of the Class A-R, Class X and Class A Bonds, in that order;
3. To accrued and unpaid interest on and principal of the Class B-1 Bonds,
in that order;
4. To accrued and unpaid interest on and principal of the Class B-2 Bonds,
in that order;
5. To accrued and unpaid interest on and principal of the Class B-3 Bonds,
in that order;
6. From the basis risk reserve fund to the Class A, Class B-1, Class B-2
and Class B-3 Bonds, in that order, any basis risk shortfall or unpaid
basis risk shortfall, as described herein;
7. To accrued and unpaid interest on and principal of the Class B-4, Class
B-5 and Class B-6 Bonds, in that order; and
8. To the Class A-R Bond, any remaining amount.
S-2
We refer you to "Description of the Bonds -- Priority of Payments" and
"-- Allocation of Realized Losses" in this prospectus supplement for more
information.
PAYMENTS OF INTEREST
To the extent funds are available, each class of bonds will be entitled to
receive accrued and unpaid interest determined on the basis of the outstanding
class principal amount of such class immediately prior to such payment date (or
notional balance in the case of the Class X Bond), applicable bond interest rate
and accrual period, and, in the case of the Class A, Class B-1, Class B-2 and
Class B-3 Bonds, any interest shortfall attributable to basis risk, but solely
to the extent of funds available in the basis risk reserve fund.
The accrual period applicable to each class of bonds, other than the Class
X Bonds, will be the period commencing on the previous payment date (or in the
case of the first payment date, beginning on the closing date) and ending on the
date preceding the payment date. The accrual period applicable to the Class X
Bonds will be the calendar month preceding the month in which the payment date
occurs. Interest will be calculated and payable on the basis of a 360-day year
divided into twelve 30-day months. Interest payments will be made among
bondholders of a class of bonds on a pro rata basis.
We refer you to "Description of the Bonds -- Payments of Interest" in this
prospectus supplement for more information.
PAYMENTS OF PRINCIPAL
The amount of principal payable on the bonds on any payment date will be
determined by (1) formulas that allocate portions of principal payments received
on the mortgage loans among the different classes of bonds, and (2) the amount
of funds actually received on the mortgage loans to make payments on the bonds.
Funds actually received on the mortgage loans may consist of expected, scheduled
payments, and unexpected payments resulting from prepayments by borrowers,
liquidation of defaulted mortgage loans, or repurchases of mortgage loans under
the circumstances described in this prospectus supplement.
Principal payments for the Class A, Class A-R and Class X Bonds are
allocated from the Senior Principal Payment Amount. Principal payments for the
Class B-1, Class B-2, Class B-3 Bonds and other subordinate classes are
allocated from the Subordinate Principal Payment Amount.
We refer you to "Description of the Bonds -- Payments of Principal" in this
prospectus supplement and in the prospectus for more information.
STATED MATURITY
The stated maturity for each class of bonds is the payment date in October
2026, which is the payment date in the month immediately following the maturity
date of the latest maturing initial mortgage loan.
We refer you to "Description of the Bonds -- Stated Maturity" and
"-- Yield, Prepayment and Weighted Average Life" in this prospectus supplement
for more information.
OPTIONAL REDEMPTION OF THE BONDS
The bond issuer will have the option to redeem all, but not less than all,
the bonds on any payment date after which the aggregate outstanding principal
balance of the mortgage loans is equal to or less than 20% of the sum of the (i)
aggregate principal balance of the initial mortgage loans as of October 1, 2001
and (ii) pre-funding amount on the closing date, as described herein. The
optional redemption price must equal 100% of the unpaid principal balance of the
bonds plus accrued and unpaid interest thereon.
We refer you to "Description of the Bonds -- Optional Redemption of the
Bonds" in this prospectus supplement for more information.
OPTIONAL CLEAN-UP REDEMPTION
Commencing with the first payment date (the "clean-up call date") following
the payment date on which the aggregate outstanding principal balance of the
mortgage loans is equal to or less than 10% of the sum of the (i) aggregate
principal balance of the initial mortgage loans as of October 1, 2001 and (ii)
pre-funding amount on the closing date, as described herein, the bond issuer
will have the option to sell all of the mortgage loans and apply the proceeds to
redeem the bonds at a price equal to the
S-3
price described in "Optional Redemption of the Bonds" above.
If the bond issuer fails to exercise its optional right to sell the
mortgage loans on the first payment date on which it is entitled to do so (i.e.,
the clean-up call date), on such payment date and all succeeding payment dates
the related margin over LIBOR component of the interest rate of the Class A,
Class B-1, Class B-2 and Class B-3 Bonds will increase as described at
"Description of the Bonds -- Payments of Interest" and "-- Optional Clean-Up
Redemption of the Bonds" in this prospectus supplement.
We refer you to "Description of the Bonds -- Optional Clean-Up Redemption
of the Bonds" in this prospectus supplement for more information.
CREDIT ENHANCEMENT
Subordination. The subordinate classes of bonds will provide credit
enhancement for the senior bonds. In addition, the Class B-1 Bonds will have a
payment priority over the Class B-2, Class B-3, Class B-4, Class B-5 and Class
B-6 Bonds; the Class B-2 Bonds will have a payment priority over the Class B-3,
Class B-4, Class B-5 and Class B-6 Bonds; and the Class B-3 Bonds will have a
payment priority over the Class B-4, Class B-5 and Class B-6 Bonds.
If the mortgage loans experience losses (except for certain excess losses
as described in this prospectus supplement), then the principal amount of the
class of bonds that is lowest in seniority and still outstanding will be reduced
by the amount of those losses until the total outstanding principal balance of
such class equals zero.
If a loss has been allocated to reduce the principal amount of your class
of bonds, you will receive no payment in respect of that reduction. A reduction
in the principal amount of any of the subordinate classes of bonds attributable
to a loss allocation will not constitute an event of default under the indenture
that results in an acceleration of payment of the bonds.
We refer you to "Description of the Bonds -- Priority of Payments" and
"-- Allocation of Realized Losses" in this prospectus supplement and in the
prospectus for more information.
SECURITY FOR THE BONDS
The bonds will be secured by the collateral primarily consisting of the
following:
- mortgage loans (including any subsequent mortgage loans);
- principal and interest payments on the initial mortgage loans due after
October 1, 2001 (or the applicable subsequent cut-off date, in the case
of the subsequent mortgage loans);
- a security interest in the related underlying residential property (and
in certain hazard and primary mortgage insurance policies covering the
property); and
- amounts on deposit in certain accounts created under the indenture for
the benefit of the bondholders, as described in this prospectus
supplement.
We refer you to "Security for the Bonds -- The Initial Mortgage Loans",
"Description of the Bonds -- Payments on Mortgage Loans; Accounts" and
"Servicing of the Mortgage Loans" in this prospectus supplement for more detail.
THE INITIAL MORTGAGE LOANS
General. On the closing date, the assets of the bond issuer will consist of
approximately 1,021 initial mortgage loans with a total principal balance of
approximately $444,681,112. The mortgage loans (including the subsequent
mortgage loans) will be pledged under the indenture to the bond trustee to
secure payment of principal and interest on the bonds. The initial mortgage
loans will consist primarily of adjustable rate, conventional, fully amortizing,
first lien residential mortgage loans having an original term to stated maturity
of 25 years. All of the initial mortgage loans provide (and it is expected that
the subsequent mortgage loans will provide) for payments of interest at the
related mortgage interest rate, but no payment of principal, for a period of ten
years following origination of the mortgage loan. Following such ten-year
period, the monthly payment with respect to each of the mortgage loans will be
increased to an amount sufficient to amortize the principal balance of each
mortgage loan over the 15-year remaining term and to pay interest at the related
mortgage interest rate.
Approximately 5.04% and 94.96 % of the initial mortgage loans bear interest
rates which adjust
S-4
based upon one-month LIBOR and six-month LIBOR, respectively. Substantially all
such initial mortgage loans provide the related borrower the option to convert
the current mortgage interest rate index on the mortgage loan to a different
index (based on either the one-year Treasury rate or prime rate index) as
described in this prospectus supplement.
See "Security for the Bonds -- The Initial Mortgage Loans" in this
prospectus supplement for more detail.
Summary Statistical Data. The following table summarizes the
characteristics of the initial mortgage loans as of October 1, 2001. Such
information does not take into account amortization, account defaults,
delinquencies and prepayments that may have occurred with respect to the initial
mortgage loans since such date nor the potential acquisition of subsequent
mortgage loans subsequent to the closing date, as described below. As a result,
the statistical distribution of the characteristics of the pool of initial
mortgage loans as of the closing date will vary from the information set forth
herein, although such variance will not be material.
Outstanding Principal
Balance:..................... $444,681,112
Number of Initial Mortgage
Loans:....................... 1,021
Average Current Principal
Balance:..................... $ 435,535
Weighted Average Mortgage
Interest Rate................ 5.708%
Weighted Average Gross
Margin:...................... 1.760%
Weighted Average Original Term
to Maturity.................. 300 months
Weighted Average Remaining Term
to Maturity:................. 297 months
Additional Collateral Loans. Approximately 26.83% of the initial mortgage
loans with stated original loan-to-value ratios in excess of 80%, in addition to
being secured by real property, are secured by a security interest in a limited
amount of additional collateral owned by the borrower or a third-party
guarantor. Such additional collateral may no longer be required when the
principal balance of such additional collateral mortgage loan is reduced to a
predetermined amount set forth in the related pledge agreement or guaranty
agreement, as applicable, or when the loan-to-value ratio for such additional
collateral mortgage loan is reduced to the related servicer's applicable
loan-to-value ratio for such additional collateral mortgage loan by virtue of an
increase in the appraised value of the mortgaged property as determined by the
related servicer.
Pre-Funding Account and Capitalized Interest Account. On the closing date,
an aggregate cash deposit of up to $70,000,000 will be deposited to a
pre-funding account that will be used to fund the acquisition of subsequent
mortgage loans meeting the criteria described in this prospectus supplement;
such loans will be subsequently pledged to the bond trustee as security for the
bonds under the indenture. On the closing date, an amount will also be deposited
to a capitalized interest account to cover interest at the applicable bond
interest rate on the portion of the principal balance of the bonds secured by an
interest in the amounts on deposit in the pre-funding account. During the
pre-funding period (the period from the closing date to November 30, 2001),
amounts on deposit in the pre-funding account may be withdrawn from time to time
to fund subsequent mortgage loans. Any pre-funding amount remaining in the
pre-funding account at the end of the pre-funding period will be distributed as
principal on the bonds on the payment date occurring at or immediately following
the end of the pre-funding period.
We refer you to "Security for the Bonds -- The Initial Mortgage Loans and
"-- Conveyance of Subsequent Mortgage Loans" in this prospectus supplement for
more detail.
SERVICING OF THE MORTGAGE LOANS
The mortgage loans will be serviced by Cendant Mortgage Corporation and
Morgan Stanley Dean Witter Credit Corporation under existing servicing
agreements with Redwood Trust, Inc. Such servicing agreements (and the rights
thereunder enforceable against the servicers) will be assigned by Redwood Trust
Inc. to the depositor, and by the depositor to the bond issuer.
Under the servicing agreements, the servicers are generally obligated to
make monthly advances of cash (to the extent such advances are deemed
recoverable), which will be included with mortgage principal and interest
collections, in an amount equal to any delinquent monthly payments due on the
mortgage loans on the immediately preceding determination date. The servicers
will be entitled to reimburse themselves for any such advances from future
payments and collections (including insurance or liquidation proceeds) with
respect to the mortgage loans. However, if the servicers make advances which are
nonrecoverable from future payments and collections on the related mortgage
S-5
loan, the servicers will be entitled to reimbursement for such advances prior to
any payments to bondholders.
The servicers will also make interest payments to compensate in part for
any shortfall in interest payments on the bonds which results from a mortgagor
prepaying a mortgage loan in whole. However, the amount of such payments will
generally not exceed the servicing fees payable to the servicers for the related
due period.
We refer you to "Servicing of the Mortgage Loans" in this prospectus
supplement for more detail.
FEDERAL INCOME TAX CONSEQUENCES
Elections will be made to treat the assets of the trust estate pledged
under the indenture as comprising two REMICs for federal income tax purposes.
Each of the bonds, other than the Class A-R Bond, will represent ownership of
"regular interests in a REMIC and the Class A-R Bond will represent the sole
class of "residual interest" in each of the REMICs.
There are restrictions on certain types of investors to purchase the Class
A-R Bond.
We refer you to "Federal Income Tax Consequences" in this prospectus
supplement and in the prospectus for more information.
ERISA CONSIDERATIONS
Generally, all of the bonds offered by this prospectus supplement (except
the Class A-R Bond) may be purchased by employee benefit plans or individual
retirement accounts subject to the Employee Retirement Income Security Act of
1974 or Section 4975 of the Internal Revenue Code of 1986 or by persons
investing on behalf of or with plan assets of such plans.
We refer you to "ERISA Considerations" in this prospectus supplement and in
the prospectus for more information.
LEGAL INVESTMENT
Generally, following the termination of the pre-funding period, all of the
bonds offered by this prospectus supplement (except the Class A-R, Class B-2 and
Class B-3 Bonds) will constitute "mortgage related securities" for purposes of
the Secondary Mortgage Market Enhancement Act of 1984.
There are other restrictions on the ability of certain types of investors
to purchase the bonds that prospective investors should consider.
We refer you to "Legal Investment Considerations" in this prospectus
supplement and in the prospectus for more information.
BOND RATING
The bonds offered by this prospectus supplement will initially have the
following ratings from Moody's Investors Service, Inc., Standard and Poor's
Rating Services, a division of The McGraw-Hill Companies, Inc. and Fitch, Inc.
MOODY'S S&P FITCH
CLASS RATING RATING RATING
----- ------- ------ ------
A Aaa AAA AAA
A-R Aaa AAA AAA
B-1 Aa2 AA AA
B-2 A2 A A
B-3 Baa2 BBB BBB
- These ratings are not recommendations to buy, sell or hold these bonds. A
rating may be changed or withdrawn at any time by the assigning rating
agency.
- The ratings do not address the possibility that, as a result of principal
prepayments, the yield on your bonds may be lower than anticipated.
- The ratings do not address the likelihood that any basis risk shortfall
will be repaid to bondholders.
We refer you to "Ratings" in this prospectus supplement for a more complete
discussion of the bond ratings.
S-6
RISK FACTORS
INVESTORS SHOULD CONSIDER THE FOLLOWING FACTORS IN CONNECTION WITH THE
PURCHASE OF BONDS. YOU SHOULD ALSO CONSIDER THE RISK FACTORS DESCRIBED IN THE
ACCOMPANYING PROSPECTUS.
PREPAYMENTS ARE UNPREDICTABLE AND AFFECT YIELD
The rate of principal distributions and yield to maturity on the bonds will
be directly related to the rate of principal payments on the trust assets. For
example, the rate of principal payments on the mortgage loans will be affected
by the following:
- the amortization schedules of the mortgage loans;
- the rate of principal prepayments, including partial prepayments and full
prepayments resulting from refinancing, by borrowers;
- liquidations of defaulted loans by the related servicer; and
- repurchases of mortgage loans by the seller as a result of defective
documentation or breaches of representations and warranties.
The yield to maturity of the bonds will also be affected by the bond
issuer's exercise of its optional redemption rights.
The initial mortgage loans may be prepaid in whole or in part at any time
without payment of a prepayment penalty. The rate of principal payments on
mortgage loans is influenced by a wide variety of economic, geographic, social
and other factors including general economic conditions, the level of prevailing
interest rates, the availability of alternative financing and homeowner
maturity. For example, if interest rates for similar loans fall below the
interest rates on the mortgage loans, the rate of prepayment would generally be
expected to increase. Conversely, if interest rates on similar loans rise above
the interest rates on the mortgage loans, the rate of prepayment would generally
be expected to decrease. We cannot predict the rate at which borrowers will
repay their mortgage loans. Please consider the following:
- If you are purchasing a bond at a discount, your yield may be lower than
expected if principal payments on the mortgage loans occur at a slower
rate than you expected;
- If you are purchasing a bond at a premium, your yield may be lower than
expected if principal payments on the mortgage loans occur at a faster
rate than you expected, and you could lose your initial investment;
- If the rate of default and the amount of losses on the mortgage loans are
higher than you expect, then your yield may be lower than you expect;
- The earlier a payment of principal occurs, the greater the impact on your
yield. For example, if you purchase a bond at a premium, although the
average rate of principal payments is consistent with your expectations,
if the rate of principal payments occurs initially at a rate higher than
expected, which would adversely impact your yield, a subsequent reduction
in the rate of principal payments will not offset any adverse yield
effect; and
- The priorities governing payments of scheduled and unscheduled principal
will have the effect of accelerating the rate of principal payments to
holders of the classes of senior bonds relative to the classes of
subordinate bonds.
See "Yield, Prepayment and Weighted Average Life" and "Description of the
Bonds -- Payments of Principal" in this prospectus supplement for a description
of the factors that may influence the rate and timing of prepayments on the
mortgage loans.
S-7
THE EXERCISE BY BORROWERS OF THEIR CONVERSION OPTIONS MAY REDUCE AMOUNTS
OTHERWISE PAYABLE ON THE MORTGAGE LOANS
Borrowers under substantially all of the initial mortgage loans originated
by Cendant Mortgage Corporation and Bishop's Gate Residential Mortgage Trust may
elect to convert the index upon which the related mortgage rate is based from
six-month LIBOR to one-year Treasury or prime rate index; and borrowers under
all the initial mortgage loans originated by Morgan Stanley Dean Witter Credit
Corporation may elect to convert the index upon which the related mortgage rate
is based from (1) one-month LIBOR to one-year Treasury or prime rate index or
(2) from six-month LIBOR to one-year Treasury or prime rate index. The
conversion option is discussed in greater detail under "Security for the
Bonds -- the Indices; Conversion" in this prospectus supplement.
The exercise by borrowers of their conversion options may reduce amounts
payable on the mortgage loans. In the event borrowers elect to exercise their
conversion options, the index upon which their interest payments will be
calculated will change, along with the applicable margin (which may be lower
than the initial margin). It is likely that borrowers would exercise such an
election at times when such exercise would result in lower interest payments on
the mortgage loans, thus reducing the amount of interest that would otherwise be
available to pay the bonds. Such election by a substantial number of borrowers
could significantly alter interest payment characteristics of the mortgage
loans, since the new indices may respond to economic conditions in a different
manner than the initial indices.
No assurance can be given that borrowers will elect not to exercise their
conversion options. Prospective investors are urged to consider the potential
effect of such conversion rights on interest payment characteristics of the
mortgage loans in making their investment decision.
AMOUNTS IN THE PRE-FUNDING ACCOUNT MAY BE APPLIED TO PAY PRINCIPAL ON THE BONDS
If the aggregate principal balance of the subsequent mortgage loans sold to
the bond issuer and pledged under the indenture by the end of the pre-funding
period is less than the initial pre-funding amount, the amount of such
differential will be distributed to the bond holders in the same manner and
priority as the mortgage loan collections of principal. Any such distribution
will reduce the weighted average life of the bonds and may adversely affect the
yield of such bonds. The bondholders would bear the risk of being unable to
invest such early payment at a yield that is at least equal to the yield on the
bonds.
MORTGAGE LOANS WITH INTEREST-ONLY PAYMENTS
All of the initial mortgage loans provide (and it is expected that the
subsequent mortgage loans will provide) for payment of interest at the related
mortgage rate, but no payment of principal, for a period of ten years following
the origination of the related mortgage loan. Following the ten-year
interest-only period, the monthly payment with respect to the mortgage loans
will be increased to an amount sufficient to amortize the principal balance of
the mortgage loan over the 15-year remaining term and to pay interest at the
related mortgage interest rate.
Such interest-only mortgage loans will, absent other considerations, result
in longer weighted average lives of the bonds. If you purchase a bond at a
discount, you should consider that the extension of its weighted average life
could result in a lower yield than would be the case if such mortgage loans
provided for payment of principal and interest on every payment date. In
addition, a borrower may view the absence of any obligation to make a payment of
principal during the first ten years of the term of the mortgage loan as a
disincentive to prepayment.
If a recalculated monthly payment as described above is substantially
higher than a borrower's previous interest-only monthly payment, that loan may
also be subject to an increased risk of delinquency and loss.
See "Security For the Bonds -- The Initial Mortgage Loans" in this
prospectus supplement.
S-8
DEFAULT RISK ON HIGH BALANCE MORTGAGE LOANS
The principal balances of approximately 59 of the initial mortgage loans
(representing approximately 19.98% of the initial mortgage pool) were in excess
of $1,000,000 on the closing date. You should consider the risk that the loss
and delinquency experience on these high balance loans may have a
disproportionate effect on the performance of the pool as a whole.
YOUR YIELD MAY BE AFFECTED BY CHANGES IN INTEREST RATES
No prediction can be made as to future levels of one-month LIBOR (the
applicable index in determining the bond interest rate for the offered bonds
(other than the Class A-R Bond) and the mortgage interest rate for approximately
5.04% of the initial mortgage loans), six-month LIBOR (the applicable index in
determining the mortgage rate for approximately 94.96% of the initial mortgage
loans) or as to the timing of any changes therein, each of which will directly
affect the yields of the bonds. In addition, the mortgagors under substantially
all of the initial mortgage loans may elect to convert the index upon which the
related mortgage rate is based from (a) one-month LIBOR to the one-year Treasury
or the prime rate index (in each case adjustable monthly) or (b) from six-month
LIBOR to the one-year Treasury or the prime rate index (in each case adjustable
semi-annually); provided, however, that such conversion may only be made once.
In addition, for each such mortgage loan, such index conversion option is
exercisable either from the twelfth to the sixtieth change date of such mortgage
loan, in the case of the one-month LIBOR loans, or from the second to the tenth
change date, in the case of the six-month LIBOR loans, in each case within a
certain 21-day period commencing on the 45th day prior to each such change date.
No prediction can be made as to the likelihood of any such conversions, each of
which may affect the yield on the bonds. Following the index conversion of any
mortgage loan, such mortgage loan will remain in the trust estate, and the
related mortgage interest rate will be based on the new index. No party will
have any obligation to purchase or acquire such mortgage loan from the bond
issuer.
Except for any payments made from the basis risk reserve fund, as described
herein, the holders of the offered bonds (other than the Class A-R Bond) will
absorb the basis risk associated with a possible elimination or inversion of the
spread between (1) the related bond interest rate calculated on the basis of
one-month LIBOR plus the applicable margin and (2) the weighted average net
mortgage rate of the mortgage loans (based on the weighted average of the
mortgage rates of the mortgage loans as reduced by servicing fees and trustee
fees).
The holders of the Class A, Class B-1, Class B-2 and Class B-3 Bonds may
not always receive interest at a rate equal to one-month LIBOR plus the
applicable margin. If the weighted average net mortgage rate of the mortgage
loans is less than the one-month LIBOR plus the related margin, the interest
rate of those bonds will be reduced to that weighted average net mortgage rate.
Thus, the yield to investors in those bonds will be sensitive to fluctuations in
the level of one-month and six-month LIBOR and may be adversely affected by the
application of the weighted average net mortgage rate of the mortgage loans.
The prepayment of mortgage loans with relatively higher net mortgage rates
may result in a lower weighted average net mortgage rate. Consequently, if on
any payment date the application of the related weighted average net mortgage
rate results in an interest payment lower than one-month LIBOR plus the related
margin on the Class A, Class B-1, Class B-2 and Class B-3 Bonds during the
related interest accrual period, the value of those bonds may be temporarily or
permanently reduced.
Investors in the Class A, Class B-1, Class B-2 and Class B-3 Bonds should
be aware that the mortgage rates on 94.96% of the initial mortgage loans are
generally adjustable semi-annually based on the related six-month LIBOR index.
Consequently, the interest that becomes due on those mortgage loans during the
related due period may be less than interest that would accrue on such bonds at
the rate of one-month LIBOR plus the related margin. In a rising interest rate
environment, such bonds may receive interest at the weighted average net
mortgage rate of the mortgage loans for a protracted period of time.
To the extent that the related weighted average net mortgage rate of the
mortgage loans limits the amount of interest paid on a class of the offered
bonds, the difference between the related weighted average
S-9
net mortgage rate and the one-month LIBOR plus the related margin for such class
of bonds, will create a shortfall that will carry forward, with interest thereon
as described herein. However, any such resulting shortfall will only be paid
after any current interest for such payment date has been paid to the Class A,
Class B-1, Class B-2 and Class B-3 Bonds and only to the extent that there are
amounts on deposit in the basis risk reserve fund funded from interest accrued
on and otherwise distributable to the Class X Bond on the related payment date.
Accordingly, these shortfalls may remain unpaid on any optional redemption,
optional termination or final payment date.
See "Description of the Bonds -- Payments of Interest" in this prospectus
supplement.
POTENTIAL INADEQUACY OF CREDIT ENHANCEMENT
The bonds are NOT insured by any financial guaranty insurance policy. The
subordination and loss allocation features described in this prospectus
supplement are intended to enhance the likelihood that holders of more senior
classes of bonds will receive regular payments of interest and principal, but
are limited in nature and may be insufficient to cover all losses on the
mortgage loans.
The amount of any loss (other than certain "excess" losses described in
this prospectus supplement) experienced on a mortgage loan will be applied to
reduce the principal amount of the class of subordinate bonds with the highest
numerical class designation, until the principal balance of that class has been
reduced to zero. If subordination is insufficient to absorb losses, then holders
of more senior classes will incur losses and may never receive all of their
principal payments. You should consider the following:
- if you buy a Class B-3 Bond and losses on the mortgage loans exceed the
total principal amount of the Class B-4, Class B-5 and Class B-6 Bonds,
the principal amount of your bonds will be reduced proportionately with
the principal amount of the other Class B-3 Bonds by the amount of that
excess;
- if you buy a Class B-2 Bond and losses on the mortgage loans exceed the
total principal amount of the Class B-3, Class B-4, Class B-5 and Class
B-6 Bonds, the principal of your bond will be reduced proportionately
with the principal amount of the other Class B-2 Bonds by the amount of
that excess;
- if you buy a Class B-1 Bond and losses on the mortgage loans exceed the
total principal amount of the Class B-2, Class B-3, Class B-4, Class B-5
and Class B-6 Bonds, the principal amount of your bonds will be reduced
proportionately with the principal amount of the other Class B-1 Bonds by
the amount of that excess; and
- after the total class principal amount of the subordinate bonds has been
reduced to zero, losses on the mortgage loans will reduce the class
principal amounts of the senior bonds. See "Description of the
Bonds -- Priority of Payment" and "-- Allocation of Realized Losses" in
this prospectus supplement.
CASH FLOW CONSIDERATIONS AND RISKS
The mortgage loans, the related mortgaged property and additional
collateral and other assets of the trust are the sole source of payments on the
bonds. Even if the mortgaged properties provide adequate security for the
mortgage loans, you could encounter substantial delays in connection with the
liquidation of mortgage loans that are delinquent. This could result in
shortfalls in payments on the bonds if the credit enhancement provided by
subordination is insufficient. Further, liquidation expenses, such as legal
fees, real estate taxes and maintenance and preservation expenses, will reduce
the security for the related mortgage loans and could thereby reduce the
proceeds payable to bondholders. If any of the mortgaged properties and
additional collateral fail to provide adequate security for the related mortgage
loans, bondholders could experience a loss if the credit enhancement created by
the subordination has been exhausted.
YOU WILL HAVE LIMITED RECOURSE
The assets of the trust are the sole source of payments on the bonds. The
bonds represent obligations solely of the bond issuer and neither the bonds nor
the trust assets will be guaranteed by the depositor, the seller, the depositor,
the servicers, the owner trustee, the bond trustee or any of their respective
affiliates or
S-10
insured by any governmental agency. Consequently, if payments on the trust
assets are insufficient to make all payments required on the bonds, you may
incur a loss on your investment.
CONCENTRATION OF MORTGAGE LOANS COULD ADVERSELY AFFECT YOUR INVESTMENT
Approximately 18.98%, 15.08%, 12.64%, and 5.94% respectively, of the
initial mortgage loans (by principal balance as of the cut-off date) are secured
by mortgaged properties located in California, Florida, Georgia and New York,
respectively. Consequently, losses and prepayments on the mortgage loans and the
resultant payments on the bonds may be affected significantly by changes in the
housing markets and the regional economies in these areas and by the occurrence
of natural disasters, such as earthquakes, hurricanes, tornadoes, tidal waves,
mud slides, fires and floods, in these areas.
See "Security for the Bonds -- Tabular Characteristics of the Initial
Mortgage Loans" in this prospectus supplement.
ABILITY TO RESELL SECURITIES MAY BE LIMITED
There is currently no market for any of the bonds and the underwriters are
not required to assist investors in resales of the offered bonds, although they
may do so. We cannot assure you that a secondary market will develop, or if it
does develop, that it will continue to exist for the term of the bonds.
Consequently, you may not be able to sell your bonds readily or at prices that
will enable you to realize your desired yield. The market values of the bonds
are likely to fluctuate; these fluctuations may be significant and could result
in significant losses to you.
The secondary market for collateralized mortgage bonds have experienced
periods of illiquidity and can be expected to do so in the future. Illiquidity
can have a severe adverse effect on the prices of bonds that are especially
sensitive to prepayment, credit or interest rate risk, or that have been
structured to meet the investment requirements of limited categories of
investors.
CONSEQUENCES OF OWNING BOOK-ENTRY SECURITIES
LIMIT ON LIQUIDITY OF SECURITIES. Issuance of the bonds in book-entry form
may reduce their liquidity in the secondary trading market because investors may
be unwilling to purchase bonds for which they cannot obtain physical debt
instruments.
LIMIT ON ABILITY TO TRANSFER OR PLEDGE. Since transactions in the
book-entry bonds can be effected only though the DTC, participating
organizations, indirect participants and certain banks, your ability to transfer
or pledge a book-entry bond to persons or entities that do not participate in
the DTC system or otherwise to take actions in respect of such bonds, may be
limited due to lack of a physical debt instrument.
DELAYS IN PAYMENTS. You may experience some delay in the receipt of
payments on book-entry bonds because the payment will be forwarded by the bond
trustee to DTC for DTC to credit the accounts of its participants which will
thereafter credit them to your account either directly or indirectly through
indirect participants, as applicable.
DELINQUENCIES MAY ADVERSELY AFFECT INVESTMENT
The initial mortgage loans were (and it is expected that the subsequent
mortgage loans will be) either originated or acquired by Cendant Mortgage
Corporation, Bishop's Gate Residential Mortgage Trust or Morgan Stanley Dean
Witter Credit Corporation in accordance, generally, with the underwriting
guidelines described in this prospectus supplement. We cannot assure you that
the values of the mortgaged properties have remained or will remain at levels in
effect on the date of origination of the related mortgage loans.
YOU COULD BE ADVERSELY AFFECTED BY VIOLATIONS OF CONSUMER PROTECTION LAWS
Applicable state laws generally regulate interest rates and other charges
and require certain disclosures. In addition, state and federal consumer
protection laws, unfair and deceptive practices acts and debt collection
S-11
practices acts may apply to the origination or collection of the mortgage loans.
Depending on the provisions of the applicable law, violations of these laws may
limit the ability of the servicers to collect all or part of the principal of or
interest on the mortgage loans, may entitle the borrower to a refund of related
amounts previously paid and, in addition, could subject the related servicer to
damages and administrative enforcement. See "Certain Legal Aspects of Pledged
Mortgages" in the accompanying prospectus.
RECENT ATTACKS AND MILITARY ACTION
The effects that the recent attacks in the United States and related
military action may have on the performance of the mortgage loans cannot be
determined at this time. Investors should consider the possible effects on
delinquency, default and prepayment experience of the mortgage loans. Federal
agencies and non-government lenders may defer, reduce or forgive payments and
delay foreclosure proceedings in respect of loans to borrowers affected in some
way by recent and possible future events. In addition, activation of a
substantial number of U.S. military reservists or members of the National Guard
may significantly increase the proportion of mortgage loans whose mortgage rates
are reduced by application of the Soldiers' and Sailors' Civil Relief Act of
1940. The interest paid to the bondholders will be reduced by any Relief Act
Reduction (as defined herein) and the servicers will not be required to advance
for any interest shortfall caused by any such reduction.
BANKRUPTCY AND INSOLVENCY RISKS
It is believed that the transfer of the initial mortgage loans from the
seller to the depositor and the depositor to the bond issuer will each be
treated as a sale rather than a secured financing for purposes of state law.
Counsel for the seller will render an opinion on the closing date that in the
event of the bankruptcy of either the seller or the depositor, the mortgage
loans and other assets of the bond issuer would not be considered part of the
seller's or depositor's bankruptcy estates and, thus, would not be available to
their creditors. On the other hand, a bankruptcy trustee or one of the creditors
of the seller or the depositor might challenge this conclusion and argue that
the transfer of the pledge mortgage loans should be characterized as a pledge of
assets in a secured borrowing rather than as a sale. Such an attempt, even if
unsuccessful, might result in delays in payments on the bonds.
LIMITATION OF REMEDIES
In the event of a default under the indenture, Bondholders will have only
the limited remedies described in this prospectus supplement under "Description
of the Bonds -- Remedies Upon Default."
THE BOND ISSUER
Sequoia Mortgage Trust 5 (the "Bond Issuer" or the "Trust") is a statutory
business trust established under the laws of the State of Delaware pursuant to a
deposit trust agreement, dated as of October 1, 2001 (the "Deposit Trust
Agreement"), between Sequoia Mortgage Funding Corporation, as depositor (the
"Depositor"), and Wilmington Trust Company, as owner trustee (the "Owner
Trustee"). The Bond Issuer has been formed for the sole purpose of issuing its
Sequoia Mortgage Trust 5 Collateralized Mortgage Bonds (the "Bonds") in the
various classes described herein and an investor certificate (the "Investor
Certificate") which evidences the sole equity interest in the Trust.
The Depositor is the settlor of the Trust and will initially hold the
Investor Certificate issued by the Trust, as described below. The Depositor is a
limited purpose finance corporation the capital stock of which is wholly owned
by Redwood Trust, Inc., a Maryland corporation ("Redwood Trust"). Redwood Trust
is the seller (the "Seller") of the mortgage loans described herein and will
also act as the manager (the "Manager") of the Bond Issuer pursuant to a
management agreement, dated as of October 1, 2001 (the "Management Agreement")
entered into with the Bond Issuer. None of the Depositor, Redwood Trust, or any
of their respective affiliates has guaranteed or is otherwise obligated with
respect to payment of the Bonds and no person or entity other than the Bond
Issuer is obligated to pay the Bonds.
S-12
The Bond Issuer's assets will consist almost entirely of the Mortgage Loans
(as described at "Security for the Bonds" below) which will be pledged under an
indenture, dated as of October 1, 2001 (the "Indenture"), between the Bond
Issuer and Bankers Trust Company of California, N.A., as bond trustee (the "Bond
Trustee") to secure the Bonds. If the mortgage loans and other collateral
securing the Bonds are insufficient for payment of the Bonds, it is unlikely
that significant other assets of the Bond Issuer will be available for payment
of the Bonds.
The Indenture prohibits the Bond Issuer from incurring any indebtedness
other than the Bonds, or assuming or guaranteeing the indebtedness of any other
person.
DESCRIPTION OF THE BONDS
GENERAL
The Bonds will be issued pursuant to the Indenture. Set forth below are
summaries of the specific terms and provisions of the Indenture pursuant to
which the Bonds will be issued. The following summaries are subject to, and are
qualified in their entirety by reference to, the provisions of the Indenture.
When particular provisions or terms used in the Indenture are referred to, the
actual provisions (including definitions of terms) are incorporated by
reference.
The Bonds will consist of the Class A Bonds, the Class A-R Bond and the
Class X Bond (the "Senior Bonds"), the Class B-1, Class B-2, Class B-3, Class
B-4, Class B-5 and Class B-6 Bonds (the "Subordinate Bonds" or the "Subordinate
Classes"). The Senior Bonds (except the Class X Bond) and the Class B-1, Class
B-2 and Class B-3 Bonds are sometimes collectively referred to herein as the
"Offered Bonds." Only the Offered Bonds are offered under this prospectus
supplement. The Class B-4, Class B-5, Class B-6 and Class X Bonds are
collectively referred to as the "Privately-Offered Bonds." The Privately-Offered
Bonds are not offered under this prospectus supplement. Accordingly, the
description of the Privately-Offered Bonds provided in this prospectus
supplement is solely for informational purposes. The Class A, Class B-1, Class
B-2 and Class B-3 Bonds are sometimes collectively referred to herein as the
"LIBOR Bonds" for the purposes of describing interest payments with respect to
such classes.
The Offered Bonds will be issued in the initial Class Principal Amounts set
forth in the table or "Summary -- The Offered Bonds." The Class X, Class B-4,
Class B-5 and Class B-6 Bonds will be issued in the approximate initial Class
Principal Amounts of $100 (solely for purposes of payments of principal),
$1,545,000, $1,030,000, and $2,058,912, respectively. The initial Class
Principal Amounts and Class Notional Amount of each class may be increased or
decreased by up to 10% to the extent that the Stated Principal Balance of the
Initial Mortgage Loans is increased or decreased as described at "Security for
the Bonds -- The Initial Mortgage Loans".
The Offered Bonds will be issued in minimum denominations in principal
amount of $25,000 and integral multiples of $1 in excess thereof. The Class A-R
Bond will be issued as a single debt instrument in fully registered definitive
form, representing the entire principal amount of such Bond.
Payments on the Bonds will be made by the Bond Trustee on the 19th day of
each month, or if such day is not a Business Day, on the first Business Day
thereafter commencing in November 2001 (each, a "Payment Date"), to the persons
in whose names such Bonds are registered on the applicable Record Date. For this
purpose, a "Business Day" is any day other than (i) a Saturday or Sunday, or
(ii) a day on which banking institutions in the City of New York, New York, the
state of California or the city in which the Corporate Trust Office of the Bond
Trustee is located are authorized or obligated by law or Executive Order to be
closed. A "Record Date" with respect to the Book-Entry Bonds and any Payment
Date is the last Business Day preceding that Payment Date (or the closing date,
in the case of the first Payment Date) or, in the case of all other Bonds
(including Book-Entry Bonds that are subsequently reissued as Definitive Bonds
(as described below at "-- Book Entry Bonds")), the last Business Day of the
month preceding the month of that Payment Date.
S-13
Payments on each Payment Date will be made by check mailed to the address
of the holder of the bond (the "Bondholder") entitled thereto as it appears on
the applicable bond register or, in the case of a Bondholder who holds 100% of a
class of Bonds or who holds Bonds with an aggregate initial Class Principal
Balance of $1,000,000 or more and who has so notified the Bond Trustee in
writing in accordance with the Indenture, by wire transfer in immediately
available funds to the account of such Bondholder at a bank or other depository
institution having appropriate wire transfer facilities; provided, however, that
the final payment in retirement of the Bonds will be made only upon presentment
and surrender of such Bonds at the Corporate Trust Office of the Bond Trustee.
See "-- Book Entry Bonds" below for the method of payment to Beneficial Owners
of Book-Entry Bonds.
BOOK-ENTRY BONDS
GENERAL. The Offered Bonds (other than the Class A-R Bond) will be
book-entry bonds (each, a class of "Book-Entry Bonds") issued, maintained and
transferred on the book-entry records of The Depository Trust Company ("DTC")
and its Participants (as defined herein).
Each class of Book-Entry Bonds will be represented by one or more global
bonds which equal the initial principal balance of such class registered in the
name of the nominee of DTC. The Depositor has been informed by DTC that DTC's
nominee will be Cede & Co. No person acquiring an interest in a Book-Entry Bond
(each, a "Beneficial Owner") will be entitled to receive a physical bond
instrument evidencing such person's interest (a "Definitive Bonds"), except as
set forth below in the prospectus under "Description of the Bonds -- Book-Entry
Bonds." Unless and until Definitive Bonds are issued for the Book-Entry Bonds
under the limited circumstances described in the prospectus, all references to
actions by Bondholders with respect to the Book-Entry Bonds shall refer to
actions taken by DTC upon instructions from its Participants, and all references
herein to distributions, notices, reports and statements to Bondholders with
respect to the Book-Entry Bonds shall refer to distributions, notices, reports
and statements to DTC or Cede & Co., as the registered holder of the Book-Entry
Bonds, for distribution to Beneficial Owners by DTC in accordance with DTC
procedures. Beneficial Owners are only entitled to exercise their rights
indirectly through Participation in the DTC.
REGISTRATION. Beneficial Owners will hold their interests in their Offered
Bonds through DTC in the United States, or, upon request, through Clearstream
Banking, societe anonyme (formerly Cedelbank) (hereafter, "Clearstream
Luxembourg") or the Euroclear System ("Euroclear") in Europe if they are
participants of such systems, or indirectly through organizations which are
participants in such systems. Clearstream Luxembourg and Euroclear will hold
omnibus positions on behalf of their participants through customers' securities
accounts in Clearstream Luxembourg's and Euroclear's names on the books of their
respective depositaries which in turn will hold such positions in customers'
securities accounts in the depositaries' names on the books of DTC. Citibank
will act as depositary for Clearstream Luxembourg and The Chase Manhattan Bank
will act as depositary for Euroclear (in such capacities, individually the
"Relevant Depositary" and collectively, the "European Depositaries").
The Beneficial Owner's ownership interest in a Book-Entry Bond will be
recorded on the records of the brokerage firm, bank, thrift institution or other
financial intermediary (each, a "Financial Intermediary") that maintains the
Beneficial Owner's account for such purpose. In turn, the Financial
Intermediary's ownership of such Book-Entry Bond will be recorded on the records
of DTC (or of a participating firm (a "Participant") that acts as agent for the
Financial Intermediary, whose interest will in turn be recorded on the records
of DTC, if the Beneficial Owner's Financial Intermediary is not a DTC
participant and on the records of Clearstream Luxembourg or Euroclear, as
appropriate).
Beneficial Owners will receive all payments of principal of, and interest
on, the Offered Bonds from the Bonds Trustee through DTC and DTC participants.
While the Book-Entry Bonds are outstanding (except under the circumstances
described below), under the rules, regulations and procedures creating and
affecting DTC and its operations (the "Rules"), DTC is required to make
book-entry transfers among Participants on whose behalf it acts with respect to
the Book-Entry Bonds and is required to receive and transmit payments of
principal of, and interest on, the Book-Entry Bonds. Participants and indirect
participants with whom
S-14
Beneficial Owners have accounts with respect to Book-Entry Bonds are similarly
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 bonds, the Rules provide a
mechanism by which Beneficial Owners will receive payments and will be able to
transfer their interest.
Beneficial Owners will not receive or be entitled to receive Definitive
Bonds representing their respective interests in the Book-Entry Bonds, except
under the limited circumstances described below. Unless and until Definitive
Bonds are issued, Beneficial Owners who are not Participants may transfer
ownership of Book-Entry Bonds only through Participants and indirect
participants by instructing such Participants and indirect participants to
transfer their interest by book-entry transfer, through DTC for the account of
the purchasers of such Bonds, which account is maintained with their respective
Participants. Under the Rules and in accordance with DTC's normal procedures,
transfer of ownership of Book-Entry Bonds will be executed through DTC and the
accounts of the respective Participants at DTC will be debited and credited.
Similarly, the Participants and indirect participants will make debits or
credits, as the case may be, on their records on behalf of the selling and
purchasing Beneficial Owners.
Because of time zone differences, credits of securities received in
Clearstream Luxembourg or Euroclear as a result of a transaction with a
Participant will be made during subsequent securities settlement processing and
dated the business day following the DTC settlement date. Such credits or any
transactions in such securities settled during such processing will be reported
to the relevant Euroclear or Clearstream Luxembourg Participants on such
business day. Cash received in Clearstream Luxembourg or Euroclear as a result
of sales of securities by or through a Clearstream Luxembourg Participant (as
defined below) or Euroclear Participant (as defined below) to a DTC Participant
will be received with value on the DTC settlement date but will be available in
the relevant Clearstream Luxembourg or Euroclear cash account only as of the
business day following settlement in DTC. For information with respect to tax
documentation procedures relating to the Bonds, refer to "Federal Income Tax
Consequences -- Foreign Investors" and "-- Backup Withholding" in the Prospectus
and "Global Clearance, Settlement and Tax Documentation Procedures -- Certain
U.S. Federal Income Tax Documentation Requirements" in Annex I hereto.
Transfers between Participants will occur in accordance with DTC rules.
Transfers between Clearstream Luxembourg 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 Clearstream
Luxembourg Participants or Euroclear Participants, on the other, will be
effected in DTC in accordance with the DTC rules on behalf of the relevant
European international clearing system by the Relevant Depositary; however, such
cross market transactions will require delivery of instructions to the relevant
European international clearing system by the counterparty in such system in
accordance with its rules and procedures and within its established deadlines
(European time). The relevant European international clearing system will, if
the transaction meets its settlement requirements, deliver instructions to the
Relevant Depositary to take action to effect final settlement on its behalf by
delivering or receiving securities in DTC, and making or receiving payment in
accordance with normal procedures for same day funds settlement applicable to
DTC. Clearstream Luxembourg Participants and Euroclear Participants may not
deliver instructions directly to the European Depositaries.
DTC, which is a New York-chartered limited purpose trust company, performs
services for its participants, some of which (and/or their representatives) own
DTC. In accordance with its normal procedures, DTC is expected to record the
positions held by each DTC participant in the Book-Entry Bonds, whether held for
its own account or as a nominee for another person. In general, beneficial
ownership of Book-Entry Bonds will be subject to the rules, regulations and
procedures governing DTC and DTC participants as in effect from time to time.
Clearstream Luxembourg is incorporated under the laws of Luxembourg as a
professional depository. Clearstream Luxembourg holds securities for its
participating organizations ("Clearstream Luxembourg Participants") and
facilitates the clearance and settlement of securities transactions between
Clearstream Luxembourg Participants through electronic book-entry changes in
accounts of Clearstream Luxembourg
S-15
Participants, thereby eliminating the need for physical movement of bonds.
Transactions may be settled in Clearstream Luxembourg in any of various
currencies, including United States dollars. Clearstream Luxembourg provides to
its Clearstream Luxembourg Participants, among other things, services for
safekeeping, administration, clearance and settlement of internationally-traded
securities and securities lending and borrowing. Clearstream Luxembourg
interfaces with domestic markets in several countries. As a professional
depository, Clearstream Luxembourg is subject to regulation by the Luxembourg
Monetary Institute. Clearstream Luxembourg participants are recognized financial
institutions around the world, including underwriters, securities brokers and
dealers, banks, trust companies, clearing corporations and certain other
organizations. Indirect access to Clearstream Luxembourg is also available to
others, such as banks, brokers, dealers and trust companies that clear through
or maintain a custodial relationship with a Clearstream Luxembourg Participant,
either directly or indirectly.
Euroclear was created in 1968 to hold securities for its participants
("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 bonds and
any risk from lack of simultaneous transfers of securities and cash.
Transactions may be settled in any of various currencies, including United
States dollars. Euroclear includes various other services, including securities
lending and borrowing, and interfaces with domestic markets in several countries
generally similar to the arrangements for cross-market transfers with DTC
described above. Euroclear is operated by the Brussels, Belgium office of Morgan
Guaranty Trust Company of New York (the "Euroclear Operator"), under contract
with Euroclear Clearance Systems S.C., a Belgian cooperative corporation (the
"Cooperative"). All operations are conducted by the Euroclear Operator, and all
Euroclear securities clearance accounts and Euroclear cash accounts are accounts
with the Euroclear Operator, not the Cooperative. The Cooperative establishes
policy for Euroclear on behalf of Euroclear Participants. Euroclear Participants
include banks (including central banks), securities brokers and dealers and
other professional financial intermediaries. Indirect access to Euroclear is
also available to other firms that clear through or maintain a custodial
relationship with a Euroclear Participant, either directly or indirectly.
The Euroclear Operator is the Belgian branch of a New York banking
corporation which is a member bank of the Federal Reserve System. As such, it is
regulated and examined by the Board of Governors of the Federal Reserve System
and the New York State Banking Department, as well as the Belgian Banking
Commission.
Securities clearance accounts and cash accounts with the Euroclear Operator
are governed by the Terms and Conditions Governing Use of Euroclear and the
related Operating Procedures of the Euroclear System and applicable Belgian law
(collectively, the "Terms and Conditions"). The Terms and Conditions govern
transfers of securities and cash within Euroclear, withdrawals of securities and
cash from Euroclear, and receipts of payments with respect to securities in
Euroclear. All securities in Euroclear are held on a fungible basis without
attribution of specific bonds to specific securities clearance accounts. The
Euroclear Operator acts under the Terms and Conditions only on behalf of
Euroclear Participants, and has no record of or relationship with persons
holding through Euroclear Participants.
Payments on the Book-Entry Bonds will be made on each Payment Date by the
Bond Trustee to DTC. DTC will be responsible for crediting the amount of such
payments to the accounts of the applicable DTC participants in accordance with
DTC's normal procedures. Each DTC participant will be responsible for disbursing
such payment to the Beneficial Owners of the Book-Entry Bonds that it represents
and to each Financial Intermediary for which it acts as agent. Each such
Financial Intermediary will be responsible for disbursing funds to the
beneficial owners of the Book-Entry Bonds that it represents.
Under a book-entry format, Beneficial Owners of the Book-Entry Bonds may
experience some delay in their receipt of payments, since such payments will be
forwarded by the Bond Trustee to Cede & Co. Payments with respect to Bonds held
through Clearstream Luxembourg or Euroclear will be credited to the cash
accounts of Clearstream Luxembourg Participants or Euroclear Participants in
accordance with the relevant system's rules and procedures, to the extent
received by the Relevant Depositary. Such payments will be subject to tax
reporting in accordance with relevant United States tax laws and regulations.
See "Federal
S-16
Income Tax Consequences -- Withholding with Respect to Certain Foreign
Investors" and "-- Backup Withholding Bonds" in the Prospectus.
Because DTC can only act on behalf of Financial Intermediaries, the ability
of a Beneficial Owner to pledge Book-Entry Bonds to persons or entities that do
not participate in the Depository system, or otherwise take actions in respect
of such Book-Entry Bonds, may be limited due to the lack of physical bonds for
such Book-Entry Bonds. In addition, issuance of the Book-Entry Bonds in
book-entry form may reduce the liquidity of such Bonds in the secondary market
since certain potential investors may be unwilling to purchase Bonds for which
they cannot obtain physical bonds.
Monthly and annual reports will be provided to Cede & Co., as nominee of
DTC, and may be made available by Cede & Co. to Beneficial Owners upon request,
in accordance with the rules, regulations and procedures creating and affecting
the Depository, and to the Financial Intermediaries to whose DTC accounts the
Book-Entry Bonds of such Beneficial Owners are credited.
DTC has advised the Bond Trustee that, unless and until Definitive Bonds
are issued, DTC will take any action permitted to be taken by the holders of the
Book-Entry Bonds under the Agreement only at the direction of one or more
Financial Intermediaries to whose DTC accounts the Book-Entry Bonds are
credited, to the extent that such actions are taken on behalf of Financial
Intermediaries whose holdings include such Book-Entry Bonds. Clearstream
Luxembourg or the Euroclear Operator, as the case may be, will take any other
action permitted to be taken by a Bondholder under the Indenture on behalf of a
Clearstream Luxembourg Participant or Euroclear Participant only in accordance
with its relevant rules and procedures and subject to the ability of the
Relevant Depositary to effect such actions on its behalf through DTC. DTC may
take actions, at the direction of the related Participants, with respect to some
Book-Entry Bonds which conflict with actions taken with respect to other Bonds.
Although DTC, Clearstream Luxembourg and Euroclear have agreed to the
foregoing procedures in order to facilitate transfers of Book-Entry Bonds among
participants of DTC, Clearstream Luxembourg and Euroclear, they are under no
obligation to perform or continue to perform such procedures and such procedures
may be discontinued at any time.
None of the Seller, the Depositor, the Servicers, the Manager, the Bond
Issuer or the Bond Trustee will have any responsibility for any aspect of the
records relating to or payments made on account of beneficial ownership
interests of the Book-Entry Bonds held by Cede & Co., as nominee of DTC, or for
maintaining, supervising or reviewing any records relating to such beneficial
ownership interests.
Definitive Bonds 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
Bonds -- Book-Entry Bonds." Upon the occurrence of an event described in the
fourth to last paragraph thereunder, the Bond Trustee is required to direct DTC
to notify Participants that have ownership of Book-Entry Bonds as indicated on
the records of DTC of the availability of Definitive Bonds for the Book-Entry
Bonds. Upon surrender by DTC of the Definitive Bonds representing the Book-Entry
Bonds, and upon receipt of instruction from DTC for re-registration, the Bond
Trustee will re-issue the Book-Entry Bonds as Definitive Bonds in the respective
principal balances owned by the individual Beneficial Owner and thereafter the
Bond Trustee will recognize the holders of such Definitive Bonds as bondholders
under the Indenture.
For a description of the procedures generally applicable to the Book-Entry
Bonds, see "Description of the Bonds -- Book-Entry Bonds" in the Prospectus.
PAYMENTS ON MORTGAGE LOANS; ACCOUNTS
On or prior to the closing date, each Servicer will establish and maintain
or cause to be established and maintained an account or accounts for the
collection of payments on the Mortgage Loans which will be separate from such
Servicer's other assets (each, a "Custodial Account"). On or prior to the
closing date, the Bond Trustee will establish an account (the "Distribution
Account"), which will be maintained with the Bond Trustee in trust for the
benefit of the Bondholders. On or prior to the Business Day immediately
preceding each Payment Date, each Servicer will remit amounts on deposit in the
related Custodial Account to the
S-17
Distribution Account. On each Payment Date, to the extent of the Available
Payment Amount on deposit in the Distribution Account, the Bond Trustee will
withdraw the Bond Payment Amount to pay the Bondholders. The "Bond Payment
Amount" for any Payment Date will equal the sum of the (i) respective Interest
Payment Amounts with respect to each class of Bonds, (ii) the Senior Principal
Payment Amount and (iii) the Subordinate Principal Payment Amount (as each such
term is defined herein).
Funds credited to the Custodial Account established by each Servicer may be
invested at the discretion of such Servicer for its own benefit in Permitted
Investments (as defined in the related Servicing Agreement).
On the closing date, the Bond Issuer will deposit up to $70,000,000 of the
net proceeds from the sale of the Bonds into an account (the "Pre-Funding
Account") to be established and maintained by the Bond Trustee to be used to
fund the transfer and pledge of Subsequent Mortgage Loans. An additional amount
will also be deposited in an account (the "Capitalized Interest Account") to
cover interest at the applicable Bond Interest Rate on that portion of the Class
Principal Amounts of each class of the Bonds that is secured by an interest in
the amounts on deposit in the Pre-Funding Account. Neither of these accounts
will be an asset of the Upper-Tier REMIC or the Lower Tier REMIC. See "Security
for the Bonds -- Conveyance of Subsequent Mortgage Loans".
Any amounts remaining on deposit at the end of the Pre-Funding Period shall
be paid to the Depositor.
AVAILABLE PAYMENT AMOUNT
Payments of interest and principal on the Bonds will be made on each
Payment Date from the "Available Payment Amount" in the order of priority set
forth below at "-- Priority of Payment" below. The "Available Payment Amount"
with respect to any Payment Date, as more fully described in the Indenture, will
generally equal the following amounts:
(1) all scheduled installments of interest (net of Servicing Fees and
other reimbursable expenses) and principal collected on the Mortgage Loans
and due during the Due Period in which such Payment Date occurs, together
with any Monthly Advances in respect thereof;
(2) all proceeds of any primary mortgage guaranty insurance policies
or any other insurance policies with respect to the Mortgage Loans, to the
extent such proceeds are not applied to the restoration or repair of the
related mortgaged property or released to the related mortgagor in
accordance with the Servicer's normal servicing procedures (collectively,
"Insurance Proceeds");
(3) all other amounts received and retained in connection with the
liquidation of defaulted Mortgage Loans, by foreclosure or otherwise
("Liquidation Proceeds") preceding the month of such Payment Date;
(4) all partial or full prepayments of principal, together with any
accrued interest thereon, identified as having been received on the
Mortgage Loans during the calendar month immediately preceding the Payment
Date (the "Prepayment Period"), plus any amounts received form the
Servicers in respect of Prepayment Interest Shortfalls (as defined at
"-- Payments of Interest"); and
(5) amounts received with respect to such Payment Date as the purchase
price or a price adjustment in respect of a defective Mortgage Loan
purchased or replaced by the Seller as of such Payment Date as a result of
a breach of a representation or warranty or a document defect; minus
(a) in the case of paragraph (1) above, all fees, charges and other
penalty amounts payable to the Servicers under the Servicing Agreements;
(b) in the case of paragraphs (3) and (4) above, any unreimbursed
expenses incurred in connection with a liquidation or foreclosure and
any unreimbursed Monthly Advances or servicing advances due to the
Servicers;
(c) in the case of paragraph (5) above, any unreimbursed Monthly
Advances or servicing advances due to the Servicers;
S-18
(d) in the case of paragraphs (1) through (4) above, any amounts
collected which are determined to be attributable to a subsequent Due
Period or Prepayment Period; and
(e) fees payable to the Indenture Trustee.
During the period from the closing date to November 30, 2001 (the
"Pre-Funding Period"), the Available Payment Amount will be supplemented by
amounts on deposit in the Capitalized Interest Account, to the extent needed to
pay interest payments on that portion of the Class Principal Amount of each
class of the Bonds secured by an interest in amounts on deposit in the
Pre-Funding Account. See "Security for the Bonds -- Conveyance of Subsequent
Mortgage Loans".
PAYMENTS OF INTEREST
General. The "Interest Payment Amount" on each Payment Date with respect to
each class of Bonds will equal the Current Interest for that class on that
Payment Date as reduced by such class's share of (1) Net Prepayment Interest
Shortfalls; (2) the interest portion of any related Excess Losses (as defined at
"-- Allocation of Realized Losses") and (3) with respect to any Mortgage Loan as
to which there has been a reduction in the amount of interest collectible as a
result of application of the Soldiers' and Sailors' Civil Relief Act of 1940, as
amended (the "Relief Act," and any such reduction, a "Relief Act Reduction"),
the amount of such reduction. See "Certain Legal Aspects of Pledged
Mortgages -- Soldiers' and Sailors' Civil Relief Act" in the accompanying
prospectus.
- "Current Interest" for each class of Bonds on any Payment Date will equal
the amount of interest accrued during the related Accrual Period on the
related Class Principal Amount immediately prior to that Payment Date
(or, in the case of the Class X Bond, the related Class Notional Amount
for that Payment Date) at the applicable Bond Interest Rate. For purposes
of the calculation of "Current Interest" on the Class X Bond, the Class X
Bond will not accrue interest on its Class Principal Amount of $100, but
rather on a notional amount (the "Class Notional Amount") that will at
all times equal the aggregate of the outstanding Class Principal Amounts
of the LIBOR Bonds.
- "Net Prepayment Interest Shortfalls" with respect to a Mortgage Loan and
any Payment Date is the amount by which a Prepayment Interest Shortfall
for the related Due Period exceeds the amount that each Servicer is
obligated to remit pursuant to the applicable Servicing Agreement, to
cover such shortfall for such Due Period.
- A "Prepayment Interest Shortfall" with respect to a Mortgage Loan and any
Payment Date is the amount by which one month's interest at the
applicable Mortgage Rate on a Mortgage Loan as to which a voluntary
prepayment has been made exceeds the amount of interest actually received
in connection with such prepayment.
- The "Accrual Period" applicable to each class of Bonds (other than the
Class X Bonds), will be the period commencing on the previous Payment
Date (or in the case of the first Payment Date, beginning on the closing
date of this transaction) and ending on the date preceding the Payment
Date. The "Accrual Period" applicable to the Class X Bonds will be the
calendar month immediately preceding the month in which the related
Payment Date occurs. Interest will accrue on all the classes of Bonds on
the basis of a 360-day year consisting of twelve 30-day months.
- The "Class Principal Amount" of each class of Bonds will be equal to the
aggregate Bond Principal Amounts of the Bonds of that class. The "Bond
Principal Amount" of any Bond will equal its Bond Principal Amount as of
the closing date of this transaction as reduced by all amounts previously
distributed on that Bond in respect of principal and the principal
portion of any Realized Losses (as defined at "-- Allocation of Realized
Losses") previously allocated to that Bond. The Bond Principal Amount of
a Class of Subordinate Bonds may be additionally reduced by allocation of
any Subordinate Bond Writedown Amount (as defined at "-- Allocation of
Realized Losses").
For purposes of determining the Interest Payment Amount for a Payment Date,
any Net Prepayment Interest Shortfall, and the interest portion of any Excess
Loss and Relief Act Reduction will be allocated
S-19
among the Senior Bonds and the Subordinate Bonds proportionately based on the
Interest Payment Amount otherwise distributable on such Bonds.
Any Current Interest not paid on a Payment Date related to the Accrual
Period in which it accrued, other than any Net Prepayment Interest Shortfalls,
the interest portion of any Excess Losses, Basis Risk Shortfalls and Relief Act
Reductions, will be an "Interest Shortfall". For purposes of payments of
interest on the Bonds, interest will not accrue on Interest Shortfalls.
Bond Interest Rates. The Bond Interest Rate for each Accrual Period for
each class of Bonds is as follows:
(A) BOND INTEREST RATES FOR LIBOR BONDS. The "Bond Interest Rate" for
each class of LIBOR Bonds will be the applicable annual rate described
below:
- Class A Bonds: the least of (i) LIBOR plus 0.350% (the "A Margin"),
(ii) the Net WAC or (iii) 11.000%;
- Class B-1 Bonds: the least of (i) LIBOR plus 0.800% (the "B-1
Margin"), (ii) the Net WAC, or (iii) 11.000%;
- Class B-2 Bonds: the least of (i) LIBOR plus 0.800% (the "B-2
Margin"), (ii) the Net WAC; or (iii) 11.000%;
- Class B-3 Bonds: the least of (i) LIBOR plus 0.800% (the "B-3
Margin"), (ii) the Net WAC or (iii) 11.000%;
As described at "-- Optional Clean-Up Redemption of the Bonds", if the
option to sell the Mortgage Loans and redeem the Bonds is not exercised by the
Depositor on the first Payment Date the Depositor is entitled to exercise such
option, then on such Payment Date, and all succeeding Payment Dates, the A
Margin will be increased to 0.700%; the B-1 Margin will be increased to 1.200%;
the B-2 Margin will be increased to 1.200%; and the B-3 Margin will be increased
to 1.200%.
(B) BOND INTEREST RATE FOR THE CLASS X BOND. The "Bond Interest Rate"
applicable to the Class X Bond will be a rate equal to the excess of (i)
the Net WAC on the Mortgage Loans over (ii) the weighted average of the
Bond Interest Rates for the LIBOR Bonds (weighted on the basis of their
outstanding Class Principal Amounts); provided, however, that on each
Payment Date, the Interest Payment Amount that would otherwise be payable
to the Class X Bondholder, based on the Bond Interest Rate described above,
may be reduced by the amount, if any, that is necessary to fund payment of
any Basis Risk Shortfalls or unpaid Basis Risk Shortfalls to holders of the
LIBOR Bonds (see "Basis Risk Reserve Fund" below).
(C) BOND INTEREST RATES FOR THE CLASS B-4, B-5 AND B-6 BONDS. The Bond
Interest Rate applicable to each of the Class B-4, Class B-5 and Class B-6
Bonds with respect to each Accrual Period will equal the Net WAC of the
Mortgage Loans.
(D) BOND INTEREST RATE FOR THE CLASS A-R BOND. The Bond Interest Rate
applicable to the Class A-R Bond with respect to each Accrual Period will
equal the Net WAC of the Mortgage Loans.
- The "Net WAC" of the Mortgage Loans for each Payment Date will be the
weighted average of the Net Mortgage Rates of the Mortgage Loans at
the beginning of the applicable Accrual Period, weighted on the basis
of their Stated Principal Balances.
- The "Net Mortgage Rate" as to any Mortgage Loan and any Payment Date
will equal the Mortgage Rate (i.e., the annual rate of interest borne
by the related mortgage note from time to time) as of the Due Date
(i.e., the first day of each calendar month) in the month preceding
the month of such Payment Date reduced by the related Expense Rate.
- The "Expense Rate" as to each Mortgage Loan is equal to the sum of the
applicable Servicing Fee Rate and the Bond Trustee Fee Rate.
S-20
- The "Stated Principal Balance" of a Mortgage Loan at any Due Date is
equal to the unpaid principal balance of such Mortgage Loan as of such
Due Date as specified in the amortization schedule at the time
relating thereto (before any adjustment to such amortization schedule
by reason of any moratorium or similar waiver or grace period) after
giving effect to any previous principal prepayments and Liquidation
Proceeds allocable to principal and to the payment of principal due on
such Due Date and irrespective of any delinquency in payment by the
related mortgagor.
Basis Risk Reserve Fund. The Indenture also establishes an account (the
"Basis Risk Reserve Fund"), which is held in trust by the Bond Trustee on behalf
of the holders of the LIBOR Bonds. The Basis Risk Reserve Fund will not be an
asset of either the Upper-Tier REMIC or Lower-Tier REMIC. On any Payment Date on
which the Bond Interest Rate applicable to any class of LIBOR Bonds is based
upon the Net WAC, the holders of the LIBOR Bonds will be entitled to receive
payments from the Basis Risk Reserve Fund in an amount (the "Basis Risk
Shortfall") equal to the excess of:
(1) the amount of interest that the applicable class of LIBOR Bonds
would have been entitled to receive on such Payment Date had the Bond
Interest Rate applicable to such class been determined without regard to
clause (ii) in the definition thereof, over
(2) the amount of interest that the LIBOR Bonds received on such
Payment Date based on the Net WAC,
together with any unpaid Basis Risk Shortfall from prior Payment Dates, plus
interest thereon (to the extent legally permitted) at the then applicable Bond
Interest Rate determined without regard to clause (ii) in the definition thereof
to the extent not previously reimbursed from amounts withdrawn from the Basis
Risk Reserve Fund.
The amount (the "Basis Risk Reserve Fund Deposit") required to be deposited
in the Basis Risk Reserve Fund on any Payment Date will equal the greater of:
(1) any Basis Risk Shortfall for such Payment Date and any unpaid
Basis Risk Shortfalls from prior Payment Dates, and
(2) the amount, if any, necessary to be deposited so that the amount
on deposit in the Basis Risk Reserve Fund is at least $10,000 (after taking
into account any other amount already deposit therein);
provided that the Basis Risk Reserve Fund Deposit for such Payment Date shall
not exceed an amount equal to the Current Interest due on the Class X Bonds on
such Payment Date.
On each Payment Date and with respect to any class of LIBOR Bonds for which
a Basis Risk Shortfall exists, or for which there are unpaid Basis Risk
Shortfalls from prior Payment Dates, the Bond Trustee shall withdraw amounts
from the Basis Risk Reserve Fund and pay such amounts to those classes of LIBOR
Bonds in the order and priority described herein under "-- Priority of Payment."
Any investment earnings on amounts on deposit in the Basis Risk Reserve Fund
will be paid to (and held for the benefit of) the holders of the Class X Bonds
and will not be available to pay any Basis Risk Shortfall.
Determination of One-Month LIBOR. On the second LIBOR Business Day (as
defined below) preceding the commencement of each Accrual Period (each such
date, a "LIBOR Determination Date"), the Bond Trustee will determine LIBOR based
on the "Interest Settlement Rate" for U.S. dollar deposits of one-month maturity
set by the British Bankers' Association (the "BBA") as of 11:00 a.m. (London
time) on the LIBOR Determination Date ("LIBOR").
The BBA's Interest Settlement Rates are currently displayed on the Dow
Jones Telerate Service page 3750 (such page, or such other page as may replace
page 3750 on that service or such other service as may be nominated by the BBA
as the information vendor for the purpose of displaying the BBA's Interest
Settlement Rates for deposits in U.S. dollars, the "Designated Telerate Page").
Such Interest Settlement Rates are also currently available on Reuters Monitor
Money Rates Service page "LIBOR01" and Bloomberg L.P. page "BBAM." The BBA's
Interest Settlement Rates currently are rounded to five decimal places.
S-21
A "LIBOR Business Day" is any day on which banks in London and New York are
open for conducting transactions in foreign currency and exchange.
With respect to any LIBOR Determination Date, if the BBA's Interest
Settlement Rate does not appear on the Designated Telerate Page as of 11:00 a.m.
(London time) on such date, or if the Designated Telerate Page is not available
on such date, the Bond Trustee will obtain such rate from the Reuters or
Bloomberg page. If such rate is not published for such LIBOR Determination Date,
LIBOR for such date will be the most recently published Interest Settlement
Rate. In the event that the BBA no longer sets an Interest Settlement Rate, the
Bond Trustee will designate an alternative index that has performed, or that the
Bond Trustee expects to perform, in a manner substantially similar to the BBA's
Interest Settlement Rate. The Bond Trustee will select a particular index as the
alternative index only if it receives an opinion of counsel (furnished at the
Bond Issuer's expense) that the selection of such index will not cause any of
the REMICs to lose their classification as REMICs for federal income tax
purposes.
The establishment of LIBOR on each LIBOR Determination Date by the Bond
Trustee and the Bond Trustee's calculation of the Bond Interest Rate applicable
to each class of LIBOR Bonds for the related Accrual Period will (in the absence
of manifest error) be final and binding.
PAYMENTS OF PRINCIPAL
General. All payments and other amounts received in respect of principal of
the Mortgage Loans will be allocated between the Senior Bonds and the
Subordinate Bonds as follows:
Senior Principal Payment Amount. On each Payment Date, the Available
Payment Amount remaining after the payment of the applicable Interest Payment
Amounts on the Senior Bonds, up to the amount of the Senior Principal Payment
Amount, will be distributed as principal on the Senior Bonds.
- The "Senior Principal Payment Amount" for each Payment Date is equal to
the sum of:
(1) the product of (a) the Senior Percentage and (b) the principal
portion of each Scheduled Payment (without giving effect to any Debt
Service Reduction occurring prior to the Bankruptcy Coverage Termination
Date (see -- "Allocation of Losses" below)) on each Mortgage Loan due
during the related Due Period;
(2) the product of (a) the Senior Prepayment Percentage and (b) each
of the following amounts: (i) the principal portion of each full and
partial principal prepayment made by a borrower on a Mortgage Loan during
the related Prepayment Period; (ii) each other unscheduled collection,
including Insurance Proceeds and net Liquidation Proceeds (other than with
respect to any Mortgage Loan that was finally liquidated during the related
Prepayment Period) representing or allocable to recoveries of principal of
the related Mortgage Loans received during the related Prepayment Period
and (iii) the principal portion of the purchase price of each Mortgage Loan
that was purchased by the Seller or any other person pursuant to the
Mortgage Loan Purchase Agreement (as defined at "Security for the
Bonds -- The Initial Mortgage Loans") or, in the case of a permitted
substitution of a defective Mortgage Loan, the amount representing any
principal adjustment in connection with any replaced Mortgage Loan with
respect to such Payment Date;
(3) with respect to unscheduled recoveries allocable to principal of
any Mortgage Loan that was fully liquidated during the related Prepayment
Period, the lesser of (a) the net Liquidation Proceeds allocable to
principal and (b) the product of (i) the Senior Prepayment Percentage for
that date and (ii) the remaining Stated Principal Balance of the related
Mortgage Loan at the time of liquidation; and
(4) any amounts described in clauses (1) through (3) above that remain
unpaid from prior Payment Dates.
- A "Scheduled Payment" with respect to a Mortgage Loan means the scheduled
monthly payment on a Mortgage Loan on any Due Date allocable to principal
or interest which, unless otherwise specified in the related Servicing
Agreement, shall give effect to any related Debt Service Reduction and
any
S-22
Deficient Valuation (as each such term is defined at "--Allocation of
Realized Losses") that has the effect of reducing the monthly payment due
on such Mortgage Loan.
- Except as provided below, the "Senior Percentage" for any Payment Date
occurring prior to the Payment Date in November 2011 is 100%. For any
Payment Date (i) occurring before the Payment Date in November 2011 but
in or after October 2004 on which the "Two Times Test" is satisfied or
(ii) in or after November 2011, the Senior Percentage will be the "Pro
Rata Senior Percentage". For any Payment Date occurring prior to October
2004 on which the Two Times Test is satisfied, the Senior Percentage will
be equal to the Pro Rata Senior Percentage plus 50% of an amount equal to
100% minus the Pro Rata Senior Percentage. With respect to any Payment
Date on or after the date on which the aggregate Class Principal Amount
of the Senior Bonds is equal to zero, the Senior Percentage will be 0%.
- The "Two Times Test" will be satisfied on any Payment Date if all the
following conditions are met:
- the Aggregate Subordinated Percentage is at least two times the
Aggregate Subordinated Percentage as of the closing date;
- the condition described in clause first of the definition of "Step-Down
Test" (described below) is satisfied, and
- cumulative Realized Losses with respect to the Mortgage Loans do not
exceed 30% of the aggregate Class Principal Amount of the Subordinate
Bonds as of the closing date.
- The "Aggregate Subordinated Percentage" for any Payment Date is the
percentage equivalent of a fraction the numerator of which is the
aggregate Class Principal Amount of the Subordinate Bonds immediately
prior to that date and the denominator of which is the sum of the Pool
Balance and the amount on deposit in the Pre-Funding Account for that
date.
- The "Pool Balance" for any Payment Date will equal the aggregate of the
principal balances of the Mortgage Loans outstanding on the Due Date of
the month preceding the month of that Payment Date.
- The "Pro Rata Senior Percentage" for each Payment Date will equal the
percentage equivalent of a fraction the numerator of which is the
aggregate Class Principal Amount of all classes of Senior Bonds
immediately prior to that Date and the denominator of which is the sum of
the Pool Balance and the amount on deposit in the Pre-Funding Account for
that date.
- The "Senior Prepayment Percentage" for any Payment Date occurring before
the Payment Date in November 2011 is 100%. Thereafter, the Senior
Prepayment Percentage will be subject to gradual reduction as described
in the following paragraphs. This disproportionate allocation of
unscheduled payments of principal to the Senior Bonds will have the
effect of accelerating the amortization of the Senior Bonds while, in the
absence of Realized Losses, increasing the interest in the principal
balance of the Mortgage Loans evidenced by the Subordinate Bonds.
Increasing the interest of the Subordinate Bonds relative to that of the
Senior Bonds is intended to preserve the availability of the
subordination provided by the Subordinate Bonds.
- For any Payment Date occurring on or after November 2011, the Senior
Prepayment Percentage of each class of Senior Bonds will be as follows:
- for any Payment Date occurring in or after November 2011 but before
November 2012, the Senior Percentage plus 70% of the Subordinate
Percentage for that date;
- for any Payment Date occurring in or after November 2012 but before
November 2013, the Senior Percentage plus 60% of the Subordinate
Percentage for that date;
- for any Payment Date occurring in or after November 2013 but before
November 2014, the Senior Percentage plus 40% of the Subordinate
Percentage for that date;
S-23
- for any Payment Date occurring in or after November 2014 but before
November 2015, the Senior Percentage plus 20% of the Subordinate
Percentage for that date; and
- for any Payment Date occurring in November 2015 or thereafter, the
Senior Percentage for that date.
Notwithstanding the preceding paragraphs, no decrease in the Senior
Prepayment Percentage will occur unless the Step-Down Test is satisfied on such
Payment Date.
- As to any Payment Date, the "Step-Down Test" will be satisfied if both of
the following conditions are met:
first, the outstanding principal balance of all Mortgage Loans
delinquent 60 days or more (including Mortgage Loans in foreclosure and REO
property), averaged over the preceding six-month period, as a percentage of
the aggregate Class Principal Amounts on such Payment Date (without giving
effect to any payments on such Payment Date) of the Subordinate Bonds, does
not equal or exceed 50%, and
second, cumulative Realized Losses on the Mortgage Loans do not
exceed:
- for each Payment Date occurring in the period from November 2011 to
October 2012, 30% of the aggregate Class Principal Amounts of the
Subordinate Bonds as of the closing date,
- for each Payment Date occurring in the period from November 2012 to
October 2013, 35% of the aggregate Class Principal Amounts of the
Subordinate Bonds as of the closing date,
- for each Payment Date occurring in the period from November 2013 to
October 2014, 40% of the aggregate Class Principal Amounts of the
Subordinate Bonds as of the closing date,
- for each Payment Date occurring in the period from November 2014 to
October 2015, 45% of the aggregate Class Principal Amounts of the
Subordinate Bonds as of the closing date; and
- for the Payment Date in November 2015 and thereafter, 50% of the
aggregate Class Principal Amounts of the Subordinate Bonds as of the
closing date.
Notwithstanding the preceding paragraphs, if on any Payment Date, the Two
Times Test is satisfied, the Senior Prepayment Percentage will equal the Senior
Percentage.
However, if, on any Payment Date occurring on or after the Payment Date in
November 2011, the Pro Rata Senior Percentage exceeds the Pro Rata Senior
Percentage on the closing date, the Senior Prepayment Percentage for that date
will once again equal 100%.
If on any Payment Date the allocation to the Senior Bonds then entitled to
distributions of principal of full and partial principal prepayments and other
amounts in the percentage required above would reduce the sum of the Class
Principal Amounts of those Bonds below zero, the related Senior Prepayment
Percentage for such Payment Date will be limited to the percentage necessary to
reduce that Class Principal Amount to zero.
Subordinate Principal Payment Amount: Except as provided in the next
paragraph, from the Available Payment Amount remaining after the payment of
interest and principal to the Senior Bondholders and any Subordinate Bond
ranking in higher priority as described at "-- Priority of Payment", each class
of Subordinate Bonds will be entitled to receive on each Payment Date its pro
rata share of the Subordinate Principal Payment Amount. Distributions of
principal of the Subordinate Bonds will be made on each Payment Date
sequentially to the classes of Subordinate Bonds in order of their numerical
class designations, beginning with the Class B-1 Bonds, until each such class
has received its pro rata share for that Payment Date. Distributions to each
such class's share of the Subordinate Principal Payment Amount will made only
after payment of interest and principal to each class ranking senior to such
class has been paid. See "-- Priority of Payment."
With respect to each class of Subordinate Bonds, if on any Payment Date the
sum of the Class Subordination Percentage of that class and the aggregate Class
Subordination Percentage of all classes of Subordinate Bonds which have higher
numerical class designations than that class is less than the Applicable Credit
S-24
Support Percentage for that class on the date of issuance of the Bonds, no
distribution of principal prepayments will be made to any such classes and the
amount otherwise distributable to those classes in respect of principal
prepayments will be allocated among the remaining classes of Subordinate Bonds,
pro rata, based upon their respective Class Principal Amounts, and distributed
in the order described above.
The approximate original Applicable Credit Support Percentages for the
Subordinate Classes of Bonds on the date of issuance of the such Bonds are
expected to be as follows:
Class B-1............................................. 3.50%
Class B-2............................................. 2.35%
Class B-3............................................. 1.35%
Class B-4............................................. 0.90%
Class B-5............................................. 0.60%
Class B-6............................................. 0.40%
- The "Subordinate Principal Payment Amount" for each Payment Date is equal
to the sum of:
(1) the product of (a) the Subordinate Percentage and (b) the
principal portion of each Scheduled Payment (without giving effect to any
Debt Service Reduction occurring prior to the Bankruptcy Coverage
Termination Date) on each Mortgage Loan due during the related Due Period;
(2) the product of (a) the Subordinate Prepayment Percentage and (b)
each of the following amounts: (i) the principal portion of each full and
partial principal prepayment made by a borrower on a Mortgage Loan during
the related Prepayment Period, (ii) each other unscheduled collection,
including Insurance Proceeds and net Liquidation Proceeds (other than with
respect to any related Mortgage Loan that was finally liquidated during the
related Prepayment Period), representing or allocable to recoveries of
principal of related Mortgage Loans received during the related Prepayment
Period, and (iii) the principal portion of the purchase price of each
Mortgage Loan that was purchased by the Seller or any other person pursuant
to the Mortgage Loan Purchase Agreement or, in the case of a permitted
substitution of a defective Mortgage Loan, the amount representing any
principal adjustment in connection with any replaced Mortgage Loan with
respect to such Payment Date;
(3) with respect to unscheduled recoveries allocable to principal of
any Mortgage Loan that was finally liquidated during the related Prepayment
Period, the related net Liquidation Proceeds allocable to principal, to the
extent not distributed pursuant to clause (3) of the definition of Senior
Principal Payment Amount); and
(4) any amounts described in clauses (1) through (3) for any previous
Payment Date that remain unpaid.
- The "Subordinate Class Percentage" for each class of Subordinate Bonds
for each Payment Date is equal to the percentage obtained by dividing the
Class Principal Amount of such class immediately prior to such Payment
Date by the aggregate Class Principal Amount of all classes of
Subordinate Bonds immediately prior to such date.
- The "Subordinate Prepayment Percentage" for any Payment Date is the
difference between 100% and the Senior Prepayment Percentage for such
Payment Date.
- The "Subordinate Percentage" for any Payment Date is the difference
between 100% and the Senior Percentage for such Payment Date.
- The "Applicable Credit Support Percentage" for each class of Subordinate
Bonds and any Payment Date will equal the sum of the Class Subordination
Percentage of that class and the aggregate Class Subordination Percentage
of all other classes of Subordinate Bonds having higher numerical class
designations than that class.
- The "Class Subordination Percentage" for any Payment Date and each class
of Subordinate Bonds will equal a fraction (expressed as a percentage)
the numerator of which is the Class Principal Amount of
S-25
that class immediately before that Payment Date and the denominator of
which is the aggregate Class Principal Amount of all classes of Bonds
immediately before that Payment Date.
PRIORITY OF PAYMENT
On each Payment Date, the Available Payment Amount from the Mortgage Loans
(as supplemented by drawings from the Capitalized Interest Account during the
Pre-Funding Period) will be allocated among the classes of Senior Bonds and
Subordinate Bonds in the following order of priority:
(1) Concurrently, to the payment of the Interest Payment Amount and
any accrued but unpaid Interest Shortfalls on each class of Senior Bonds;
provided, however, that on each Payment Date, to the extent of the Basis
Risk Reserve Fund Deposit for such date, the Interest Payment Amount that
would otherwise be payable to the Class X Bondholder will be deposited in
the Basis Risk Reserve Fund;
(2) Sequentially, to the Class A-R Bond, Class X Bonds and Class A
Bonds, in that order, the Senior Principal Payment Amount until their
respective Class Principal Amounts have been reduced to zero;
(3) To the Class B-1 Bonds, the payment of its applicable Interest
Payment Amount and any outstanding Interest Shortfalls;
(4) To the Class B-1 Bonds, such class's Subordinate Class Percentage
of the Subordinate Principal Payment Amount, until its Class Principal
Amount has been reduced to zero;
(5) To the Class B-2 Bonds, the payment of its applicable Interest
Payment Amount and any outstanding Interest Shortfalls;
(6) To the Class B-2 Bonds, such class's Subordinate Class Percentage
of the Subordinate Principal Payment Amount, until its Class Principal
Amount has been reduced to zero;
(7) To the Class B-3 Bonds, the payment of its applicable Interest
Payment Amount and any outstanding Interest Shortfalls;
(8) To the Class B-3 Bonds, such class's Subordinate Class Percentage
of the Subordinate Principal Payment Amount, until its Class Principal
Amount has been reduced to zero;
(9) From the Basis Risk Reserve Fund for payment to the Class A, Class
B-1, Class B-2 and Class B-3 Bonds, sequentially in that order, any Basis
Risk Shortfall or unpaid Basis Risk Shortfall;
(10) To the Class B-4 Bonds, the payment of its applicable Interest
Payment Amount and any outstanding Interest Shortfalls;
(11) To the Class B-4 Bonds, such class's Subordinate Class Percentage
of the Subordinate Principal Payment Amount, until its Class Principal
Amount has been reduced to zero;
(12) To the Class B-5 Bonds, the payment of its applicable Interest
Payment Amount and any outstanding Interest Shortfalls;
(13) To the Class B-5 Bonds, such class's Subordinate Class Percentage
of the Subordinate Principal Payment Amount, until its Class Principal
Amount has been reduced to zero;
(14) To the Class B-6 Bonds, the payment of its applicable Interest
Payment Amount and any outstanding Interest Shortfalls;
(15) To the Class B-6 Bonds, such class's Subordinate Class Percentage
of the Subordinate Principal Payment Amount, until its Class Principal
Amount has been reduced to zero; and
(16) To the Class A-R Bond, any remaining amount of the Available
Payment Amount.
S-26
SUBORDINATION OF THE PAYMENT OF THE SUBORDINATE BONDS
The rights of the holders of the Subordinate Bonds to receive payments with
respect to the Mortgage Loans will be subordinated to the rights of the holders
of the Senior Bonds and the rights of the holders of each class of Subordinate
Bonds (other than the Class B-1 Bonds) to receive such payments will be further
subordinated to the rights of the class or classes of Subordinate Bonds with
lower numerical class designations, in each case only to the extent described in
this prospectus supplement. The subordination of the Subordinate Bonds to the
Senior Bonds and the further subordination among the Subordinate Bonds is
intended to provide the Bondholders having higher relative payment priority with
protection against Realized Losses other than Excess Losses. In addition, the
Subordinate Bonds will provide limited protection against Special Hazard Losses,
Fraud Losses and Bankruptcy Losses as discussed at "-- Allocation of Realized
Losses" below.
ALLOCATION OF REALIZED LOSSES
If a Realized Loss occurs on the Mortgage Loans, then, on each Payment Date
the principal portion of that Realized Loss other than an Excess Loss will be
allocated first, to reduce the Class Principal Amount of each class of
Subordinate Bonds, in inverse order of priority, until the Class Principal
Amount thereof has been reduced to zero (that is, such Realized Losses will be
allocated to the Class B-6 Bonds while those Bonds are outstanding, then to the
Class B-5 Bonds, and so forth) and second, to the Senior Bonds, on the basis of
their respective Bond Principal Amounts.
The principal portion of any Excess Loss (other than a Debt Service
Reduction) on a Mortgage Loan for any Payment Date will be allocated
proportionately to the Senior Bonds and the Subordinate Bonds.
The Class Principal Amount of the lowest ranking class of Subordinate Bonds
then outstanding will also be reduced by the amount, if any, by which the total
Bond Principal Amount of all the Bonds on any Payment Date (after giving effect
to distributions of principal and allocation of Realized Losses on that date)
exceeds the total Stated Principal Balance of the Mortgage Loans for the related
Payment Date (a "Subordinate Bond Writedown Amount").
- In general, a "Realized Loss" means (a) with respect to a Liquidated
Mortgage Loan, the amount by which the remaining unpaid principal balance
of that Mortgage Loan plus all accrued and unpaid interest thereon and
any related expenses exceeds the amount of Liquidation Proceeds applied
to the principal balance of that Mortgage Loan, or (b) the amount by
which, in the event of bankruptcy of a borrower, a bankruptcy court
reduces the secured debt to the value of the related Mortgaged Property
(a "Deficient Valuation"). In determination whether a Realized Loss is a
loss of principal or of interest, Liquidation Proceeds and other
recoveries on a Mortgage Loan will be applied first to outstanding
expenses incurred with respect to such Mortgage Loan, then to accrued,
unpaid interest, and finally to principal.
- "Bankruptcy Losses" are losses that are incurred as a result of Deficient
Valuations and any reduction, in a bankruptcy proceeding, of the amount
of the Scheduled Payment on a Mortgage Loan other than as a result of a
Deficient Valuation (a "Debt Service Reduction"). The principal portion
of Debt Service Reductions will not be allocated in reduction of the Bond
Principal Amounts of any Bonds.
- "Special Hazard Losses" are, in general terms, Realized Losses arising
out of certain direct physical loss or damage to Mortgaged Properties
that are not covered by a standard hazard insurance policy, but
excluding, among other things, faulty design or workmanship and normal
wear and tear.
- "Fraud Losses" are losses sustained on a Liquidated Mortgage Loan by
reason of a default arising from fraud, dishonesty or misrepresentation.
- A "Liquidated Mortgage Loan" generally is a defaulted Mortgage Loan as to
which the Mortgage Loan or related REO Property has been disposed of and
all amounts expected to be recovered in respect of that Mortgage Loan
have been received by the related Servicer.
The principal portion of Special Hazard Losses, Bankruptcy Losses (other
than Debt Service Reductions) and Fraud Losses on the Mortgage Loans that exceed
the "Special Hazard Loss Limit," "Bankruptcy
S-27
Loss Limit," and "Fraud Loss Limit," respectively ("Excess Losses"), will be
allocated as described above. The "Special Hazard Loss Limit," will initially be
approximately $5,502,000; the "Bankruptcy Loss Limit" will initially be
approximately $148,271; and the "Fraud Loss Limit" will initially be
approximately $10,293,622.
The Special Hazard Loss Limit will be reduced, from time to time, to an
amount equal on any Payment Date to the lesser of (a) the greatest of (1) 1% of
the aggregate of the Stated Principal Balances of the Mortgage Loans, (2) twice
the Stated Principal Balance of the Initial Mortgage Loan having the highest
Stated Principal Balance and (3) the aggregate Stated Principal Balance of the
Initial Mortgage Loans secured by Mortgaged Properties located in the single
California postal zip code area having the highest aggregate Stated Principal
Balance of any such zip code area and (b) the Special Hazard Loss Limit as of
the closing date less the amount, if any, of the Special Hazard Losses incurred
since the closing date.
The Bankruptcy Loss Limit will be reduced, from time to time, by the amount
of Bankruptcy Loses allocated to the Bonds. The date on which the Bankruptcy
Loss Limit has been reduced to zero is the "Bankruptcy Coverage Termination
Date."
As of the Cut-off Date, the Fraud Loss Limit will equal 2.00% of the sum of
the aggregate principal balance of the Initial Mortgage Loans and the amount on
deposit in the Pre-Funding Account on the closing date. The Fraud Loss Limit
will be reduced, from time to time, by the amount of Fraud Losses allocated to
the Bonds. In addition, on each anniversary of the Cut-off Date, the Fraud Loss
Limit will be reduced:
- on the first, second, third and fourth anniversaries of the Cut-off Date,
to the lesser of
(a) 1.00% of the aggregate principal balance of the Mortgage Loans as
of the Due Date in the preceding month, and
(b) the excess of the Fraud Loss Limit as of the Cut-off Date over the
cumulative amount of Fraud Losses allocated to the Bonds since the Cut-off
Date,
- on the fifth anniversary of the Cut-off Date, to zero.
In the event that any amount is recovered in respect of principal of a
Liquidated Mortgage Loan after any related Realized Loss has been allocated as
described herein, such amount will be distributed to the Bonds still
outstanding, proportionately, on the basis of any Realized Losses previously
allocated thereto. It is generally not anticipated that any such amounts will be
recovered.
REMEDIES UPON DEFAULT
Under the Indenture, an Event of Default will not occur solely due to the
occurrence of Realized Losses allocated to the Subordinated Bonds until all the
Senior Bonds have been paid in full and then only if shortfalls on the
Subordinated Bonds have not been paid. In addition, an Event of Default by
reason of any Realized Losses that are allocated to the Senior Bonds will occur
on any Payment Date only when the Pool Balance is less than the principal amount
of the Senior Bonds outstanding after application of all available amounts on
deposit in the Distribution Account on such Payment Date. Nevertheless, at any
time following an Event of Default arising from a shortfall affecting the Senior
Bonds, the holders of outstanding Bonds, representing more than 50% in principal
amount of all Bonds then outstanding, may declare the Bonds due and payable or
take any other action pursuant to the terms of the Indenture. Until the Bonds
have been declared due and payable following an Event of Default, the holders of
the Subordinate Bonds generally may not request the Bond Trustee to take any
action, and may not otherwise cause any action to be taken to enforce the
obligation of the Bond Issuer to pay principal and interest on the Subordinate
Bonds. Additionally, prior to the Bonds being declared due and payable following
an Event of Default, the Senior Bonds will not accrue interest in any form on
the interest component of any shortfall attributable to the Senior Bonds. Should
an Event of Default occur, payments will be allocated on each Payment Date in
accordance with the priorities described herein under "Priority of Payment",
which would otherwise be applicable on such Payment Date had an Event of Default
not occurred. See "-- Controlling Class Under the Indenture."
S-28
REPORTS TO BONDHOLDERS
On each Payment Date, the Bond Trustee will make available to each
Bondholder and will forward to the rating agencies a statement (based on
information received from each servicer) generally setting forth, among other
things:
- the amount of the payments, separately identified, with respect to each
class of Bonds;
- the amount of the payments set forth in the first clause above allocable
to principal, separately identifying the aggregate amount of any
principal prepayments or other unscheduled recoveries of principal
included in that amount;
- the amount of the distributions set forth in the first clause above
allocable to interest and how it was calculated;
- the amount of any unpaid Interest Shortfall, Basis Risk Shortfall or
unpaid Basis Risk Shortfall (if applicable) and the related accrued
interest thereon, with respect to each class of Bonds;
- the Class Principal Amount of each class of Bonds after giving effect to
the distribution of principal on that Payment Date;
- the Pool Balance and the Net WAC of the Mortgage Loans at the end of the
related Prepayment Period;
- the aggregate principal balance of the Mortgage Loans whose Mortgage
Rates adjust on the basis of the One-Month LIBOR index, the Six-Month
LIBOR index (or the One-Year Treasury Index or Prime Rate Index, if the
Mortgage Rate has been converted by the borrower) at the end of the
related Prepayment Period;
- the Pro Rata Senior Percentage, Senior Percentage and the Subordinate
Percentage for the following Payment Date;
- the Senior Prepayment Percentage and Subordinate Prepayment Percentage
for the following Payment Date;
- the amount of the Servicing Fee paid to or retained by each Servicer;
- the amount of Monthly Advances for the related Due Period;
- the number and aggregate principal balance of the Mortgage Loans that
were (A) delinquent (exclusive of Mortgage Loans in foreclosure) (1) 30
to 59 days, (2) 60 to 89 days and (3) 90 or more days, (B) in foreclosure
and delinquent (1) 30 to 59 days, (2) 60 to 89 days and (3) 90 or more
days and (C) in bankruptcy as of the close of business on the last day of
the calendar month preceding that Payment Date;
- for any Mortgage Loan as to which the related mortgaged property was an
REO property during the preceding calendar month, the loan number, the
principal balance of that Mortgage Loan as of the close of business on
the last day of the related Due Period and the date of acquisition of the
REO property;
- the total number and principal balance of any REO properties as of the
close of business on the last day of the preceding Due Period;
- the aggregate amount of Realized Losses incurred during the preceding
calendar month;
- the cumulative amount of Realized Losses incurred since the closing date;
- the aggregate amount of Special Hazard Losses, Bankruptcy Losses and
Fraud Losses incurred during the preceding calendar month;
- the cumulative amount of Special Hazard Losses, Bankruptcy Losses and
Fraud Losses incurred since the closing date;
S-29
- the Special Hazard Limit, the Fraud Loss Limit and the Bankruptcy Loss
Coverage Amount, in each case as of the related determination date;
- the Realized Losses and Excess Losses, if any, allocated to each class of
Bonds on that Payment Date; and
- the Bond Interest Rate for each class of Bonds for that Payment Date.
In addition, within a reasonable period of time after the end of each
calendar year, the Bond Trustee will prepare and deliver to each holder of a
Bond of record during the previous calendar year a statement containing
information necessary to enable holders of the Bonds to prepare their tax
returns. These statements will not have been examined and reported upon by an
independent public accountant.
STATED MATURITY
The Stated Maturity for each class of Bonds is the Payment Date in October
2026 which is the Payment Date in the month immediately following the last
scheduled Due Date for the Mortgage Loan having the latest stated maturity date.
It is expected that the actual last Payment Date of the Bonds will occur
significantly earlier than such Stated Maturity Date. See "Yield, Prepayment and
Weighted Average Life".
OPTIONAL REDEMPTION OF THE BONDS
The Bond Issuer has the option to redeem the Bonds, in whole but not in
part, on any Payment Date after which the then aggregate outstanding principal
balance of the Mortgage Loans is equal to or less than 20% of the sum of (i) the
aggregate principal balance of the Initial Mortgage Loans of the Cut-off Date
and (ii) the initial amount on deposit in the Pre-Funding Account.
If the Bond Issuer elects to redeem the Bonds it shall deliver notice of
such election to the Bond Trustee together with an undertaking to deposit the
Redemption Price into the Distribution Account on or prior to the redemption
date. In addition, the Bond Issuer must cause each REMIC to adopt a qualified
plan of liquidation for tax purposes. The Redemption Price must equal 100% of
the then aggregate outstanding Class Principal Amount of all the Bonds, plus
accrued interest thereon through the end of the Accrual Period immediately
preceding the related Payment Date. THERE WILL BE NO PREPAYMENT PREMIUM IN
CONNECTION WITH SUCH A REDEMPTION.
At the option of the Bond Issuer, such optional redemption of the Bonds can
be effected without retiring the Bonds, so that the Bond Issuer has the ability
to own or resell the Bonds and make new REMIC elections, if any. Upon a
redemption with retirement of the Bonds, the collateral securing the Bonds will
be released from the lien of the Indenture. The payment on the final Payment
Date in connection with the redemption of the Bonds shall be in lieu of the
payment otherwise required to be made on such Payment Date in respect of the
Bonds.
OPTIONAL CLEAN-UP REDEMPTION OF THE BONDS
Commencing with the Payment Date following the Payment Date on which the
aggregate outstanding principal balance of the Mortgage Loans is equal to or
less than 10% of the sum of the (i) aggregate principal balance of the Mortgage
Loans as of the Cut-off Date and (ii) the initial amount on deposit in the Pre-
Funding Account, the Bond Issuer will have the option to sell the Mortgage Loans
and apply the proceeds to redeem the bonds at a price equal to the amount
described under "-- Optional Redemption of the Bonds" above. Upon such
redemption of the bonds, any funds or property remaining as collateral will be
released from the lien of the Indenture.
If the Bond Issuer does not exercise its optional clean-up redemption right
on the first Payment Date on which it is entitled to do so and redeem the Bonds,
then on such Payment Date and all succeeding payment dates the applicable margin
specified in clause (i) of the definition of Bond Interest Rate for the Class A,
Class B-1, Class B-2 and Class B-3 Bonds will increase as described at
"Description of the Bonds--Payment of Interest".
S-30
THE BOND TRUSTEE
Bankers Trust Company of California, N.A., a national banking association,
will be the Bond Trustee under the Indenture. The Indenture will provide that
the Bond Trustee is entitled to a fee payable monthly on each Payment Date,
calculated as one-twelfth of 0.0045% (the "Bond Trustee Fee Rate") of the
aggregate Stated Principal Balance of the Mortgage Loans as of the first day of
the related Due Period, and reimbursement of certain expenses. The Bond Trustee
will also perform the functions of calculation agent and paying agent and will,
in addition, provide Bondholders with a monthly payment report on its website
located at http.\\www.apps.gis.deutsche-bank.com\invr, based upon information
provided by the Servicers and the necessary information to prepare federal and
state tax returns with respect to the Bonds. The Bond Trustee's Corporate Trust
Office is located at 1761 East St. Andrew Place, Santa Ana, California 92705,
Attention: Trustee Sequoia 5 Collateralized Mortgage Bonds -- SQ0101.
CONTROLLING CLASS UNDER THE INDENTURE
For the purposes described in the Prospectus under the headings "The
Indenture -- Modification of Indenture," "-- Events of Default" and "Rights Upon
Event of Default," the "Controlling Class" shall be the Class A Bondholders or,
if the Class A Bonds are no longer outstanding, the holders of the most senior
class of Subordinated Bonds then outstanding.
SECURITY FOR THE BONDS
GENERAL
The Bonds will be secured by assignments to the Bond Trustee of collateral
consisting of (i) the Initial Mortgage Loans, (ii) the pledge agreements or
guaranty agreements, as applicable, in respect of the Additional Collateral
Loans, (iii) funds on deposit in the Distribution Account, the Pre-Funding
Account, the Capitalized Interest Account and the Basis Risk Reserve Fund, (iv)
the Bond Issuer's rights under the Servicing Agreements and each transfer
agreement pursuant to which the Originators assigned the Initial Mortgage Loans
to Redwood Trust, (v) the Bond Issuer's rights under the Mortgage Loan Purchase
Agreement, as described under "--Assignment of the Mortgage Loans" below and
(vi) the proceeds of all of the foregoing. In addition, rights under the Limited
Purpose Surety Bonds with respect to the Additional Collateral Loans will be
assigned to the Bond Trustee for the benefit of the Bondholders. The Basis Risk
Reserve Fund will not be part of any REMIC.
THE FOLLOWING STATISTICAL INFORMATION PRESENTED IN THIS PROSPECTUS
SUPPLEMENT CONCERNING THE MORTGAGE LOANS DESCRIBES THE INITIAL MORTGAGE LOANS
AND DOES NOT INCLUDE ADDITIONAL MORTGAGE LOANS (THE "SUBSEQUENT MORTGAGE LOANS")
WHICH MAY BE INCLUDED IN THE PLEDGED MORTGAGE POOL AFTER THE CLOSING DATE. SEE
"SECURITY FOR THE BONDS -- CONVEYANCE OF SUBSEQUENT MORTGAGE LOANS" AND
"DESCRIPTION OF THE BONDS -- PAYMENTS ON MORTGAGE LOANS; ACCOUNTS."
THE INITIAL MORTGAGE LOANS
At the closing date, the Bonds will be secured by a pool (the "Pledged
Mortgage Pool") of approximately 1,021 conventional, adjustable rate mortgage
loans (the "Initial Mortgage Loans," and together with the "Subsequent Mortgage
Loans, the "Mortgage Loans") with original terms to maturity of twenty-five
years. All of the Initial Mortgage Loans provide for payment of interest at the
related Mortgage Rate, but no payment of principal, for a period of ten years
following the origination of the related Initial Mortgage Loan. Following the
ten-year interest-only period, the Scheduled Payment with respect to the Initial
Mortgage Loans will be increased to an amount sufficient to amortize the
principal balance of the mortgage loan over the 15-year remaining term and to
pay interest at the related Mortgage Rate.
The Initial Mortgage Loans have an aggregate Stated Principal Balance as of
the Cut-off Date of approximately $444,681,112 (the "Cut-off Date Pool Principal
Balance") and are secured by first liens on one- to four-family residential
properties (each, a "Mortgaged Property"). None of the Mortgage Loans will
S-31
be guaranteed by any governmental agency. All of the Mortgage Loans will have
been deposited with the Bond Issuer by the Depositor, which, in turn, will have
acquired them from Redwood Trust pursuant to an agreement (the "Mortgage Loan
Purchase Agreement") between the Depositor and Redwood Trust. All of the
Mortgage Loans have been acquired by Redwood Trust in the ordinary course of its
business from Cendant Mortgage Corporation ("Cendant"), Bishop's Gate
Residential Mortgage Trust ("Bishop's Gate") and Morgan Stanley Dean Witter
Credit Corporation ("MSDWCC" and collectively with Cendant and Bishop's Gate,
the "Originators") and substantially in accordance with the underwriting
criteria specified herein. Cendant and MSDWCC will continue to service the
Initial Mortgage Loans pursuant to existing Servicing Agreements with Redwood
Trust which have been assigned to the Bond Issuer.
Certain information with respect to the Initial Mortgage Loans is set forth
below. Prior to the closing date, Initial Mortgage Loans may be removed from the
collateral and other Initial Mortgage Loans may be substituted therefor. The
Bond Issuer believes that the information set forth herein with respect to the
Initial Mortgage Loans as presently constituted is representative of the
characteristics of the Initial Mortgage Loans as they will be constituted at the
closing date, although certain characteristics of the Initial Mortgage Loans may
vary. Unless otherwise indicated, information presented below expressed as a
percentage (other than rates of interest) are approximate percentages based on
the Stated Principal Balances of the Initial Mortgage Loans as of the Cut-off
Date.
All of the Initial Mortgage Loans provide for payments due on the first day
of each month (the "Due Date"). Scheduled monthly payments made by the borrowers
on the Initial Mortgage Loans ("Scheduled Payments") either earlier or later
than the scheduled Due Dates thereof will not affect the amortization schedule
or the relative application of such payments to principal and interest. Each
Initial Mortgage Loans provides for monthly payments of interest at the Mortgage
Rate, but no payments of principal for the first ten years after origination of
such Initial Mortgage Loan. Following such ten-year period, the monthly payment
on each such Initial Mortgage Loan will be increased to an amount sufficient to
fully amortize the outstanding principal balance of such Initial Mortgage Loan
over its fifteen year remaining term and pay interest at the related Mortgage
Rate.
The Initial Mortgage Loans were originated from April 1999 through August
2001. No more than approximately 1.13% of the Initial Mortgage Loans are secured
by Mortgaged Properties located in any one zip code area. At origination, all of
the Initial Mortgage Loans had terms to stated maturity of 25 years. The latest
stated maturity date of any Initial Mortgage Loan is September 2026.
As of the Cut-off Date, none of the Initial Mortgage Loans was more than 30
days delinquent.
No Initial Mortgage Loan had a Loan-to-Value Ratio at origination of more
than 100.00%. Approximately 1.69% of the Initial Mortgage Loans had an Effective
Loan-to-Value Ratio at origination of greater than 80%, and such Initial
Mortgage Loans are covered by a primary mortgage insurance policy. All of the
Initial Mortgage Loans having Loan-to-Value Ratios greater than 80% at
origination were originated by MSDWCC under its FlexSource(TM) Loans program or
Merrill Lynch Credit Corporation ("MLCC") under its Mortgage 100(SM) or Parent
Power(R) programs, which in addition to being secured by real property, are
secured by a security interest in a limited amount of additional collateral
owned by the borrower or are supported by a third-party guarantee as described
as "Additional Collateral Loans" below. This portfolio of MLCC mortgage loans
was subsequently acquired by Cendant and Bishop's Gate.
The "Loan-to-Value Ratio" of a Mortgage Loan at any given time is a
fraction, expressed as a percentage, the numerator of which is the principal
balance of the related Mortgage Loan at the date of determination and the
denominator of which is (a) in the case of a purchase, the lesser of the selling
price of the Mortgaged Property and its appraised value determined in an
appraisal obtained by the originator at origination of such Mortgage Loan, or
(b) in the case of a refinance, the appraised value of the Mortgaged Property at
the time of such refinance. No assurance can be given that the value of any
Mortgaged Property has remained or will remain at the level that existed on the
appraisal or sales date. If residential real estate values generally or in a
particular geographic area decline, the Loan-to-Value Ratios might not be a
reliable indicator of the rates of delinquencies, foreclosures and losses that
could occur with respect to such Mortgage Loans.
S-32
The "Effective Loan-to-Value Ratio" means a fraction, expressed as a
percentage, the numerator of which is the original Stated Principal Balance of
the related Initial Mortgage Loan, less the amount secured by the Additional
Collateral required at the time of origination, if any, and the denominator of
which is the appraised value of the related Mortgaged Property at such time, or
in the case of a Mortgage Loan financing the acquisition of the Mortgaged
Property, the sales price of the Mortgaged Property if such sales price is less
than such appraised value.
As set forth in the "Credit Scores" table below, credit scores have been
supplied with respect to the mortgagors. Credit scores are obtained by many
mortgage lenders in connection with mortgage loan applications to help assess a
borrower's credit-worthiness. Credit scores are generated by models developed by
a third party which analyzed data on consumers in order to establish patterns
which are believed to be indicative of the borrower's probability of default.
The credit score is based on a borrower's historical credit data, including,
among other things, payment history, delinquencies on accounts, levels of
outstanding indebtedness, length of credit history, types of credit, and
bankruptcy experience. Credit scores range from approximately 250 to
approximately 900, with higher scores indicating an individual with a more
favorable credit history compared to an individual with a lower score. However,
a credit score purports only to be a measurement of the relative degree of risk
a borrower represents to a lender, i.e., that a borrower with a higher score is
statistically expected to be less likely to default in payment than a borrower
with a lower score. In addition, it should be noted that credit scores were
developed to indicate a level of default probability over a two-year period
which does not correspond to the life of a mortgage loan. Furthermore, credit
scores were not developed specifically for use in connection with mortgage
loans, but for consumer loans in general. Therefore, a credit score does not
take into consideration the effect of mortgage loan characteristics (which may
differ from consumer loan characteristics) on the probability of repayment by
the borrower. There can be no assurance that a credit score will be an accurate
predictor of the likely risk or quality of the related mortgage loan.
THE ADDITIONAL COLLATERAL LOANS
Those Initial Mortgage Loans with Loan-to-Value Ratios at origination in
excess of 80% originated under the MSDWCC FlexSource(TM) Loans program or under
MLCC's Mortgage 100(SM) or Parent Power(R) programs are, in general, also either
(i) secured by a security interest in additional collateral (generally
securities) owned by the borrower (referred to as Mortgage 100(SM) Loans in the
MLCC program) or (ii) supported by a third party guarantee (usually a parent of
the borrower), which in turn was secured by a security interest in collateral
(normally securities) or by a lien on residential real estate of the guarantor
(and/or supported by the right to draw on a home equity line of credit extended
by MLCC to the guarantor), such loans in clause (ii) being referred to as
"Parent Power(R) Loans" in the case of the MLCC program and such loans in
clauses (i) and (ii) being referred to as "FlexSource(TM) Loans" in the case of
the MSDWCC program. Such Initial Mortgage Loans in clauses (i) and (ii) are also
collectively referred to as "Additional Collateral Loans" and the collateral
referred to in clauses (i) and (ii) is referred to herein as "Additional
Collateral." The amount of Additional Collateral generally does not exceed 30%
of the loan amount, although the amount of Additional Collateral may exceed 30%
of the loan amount if the original principal amount of the loan exceeds
$1,000,000. In limited cases, either MSDWCC or MLCC may require Additional
Collateral in excess of 30% of the loan amount as part of the underwriting
decision. The requirement to maintain Additional Collateral generally terminates
when the principal balance of an Additional Collateral Loan is reduced to a
predetermined amount set forth in the related pledge agreement or guaranty
agreement, as applicable, or when the Loan-to-Value Ratio is reduced to the
originator's applicable Loan-to-Value Ratio limit for that loan by virtue of an
increase in the appraised value of the related mortgaged property as determined
by the applicable originator. The pledge agreement and the guaranty agreement,
as applicable, and the security interest in the Additional Collateral, if any,
provided in the case of an Additional Collateral Loan will be assigned to the
Bond Trustee as part of the Trust Estate. To the extent Initial Mortgage Loans
include any Additional Collateral Loans that are supported by a guarantee that
is secured by a lien or residential real estate, the lien will not be
transferred to the Bond Issuer or the Bond Trustee; however, MLCC and MSDWCC
will be obligated to make all reasonable efforts to realize on any such security
interest if the related Initial Mortgage Loan defaults and is
S-33
accelerated or is liquidated upon default as permitted by the related pledge
agreement and applicable state law.
On or prior to the closing date, the Depositor will have assigned to the
Bond Issuer its rights under limited purpose surety bonds issued to MLCC and
MSDWWC, respectively, by AMBAC Assurance Corporation (the "Limited Purpose
Surety Bonds"), each of which is intended to guarantee the receipt by the Bond
Issuer of certain shortfalls in the net proceeds realized from the liquidation
of any required Additional Collateral (such amount not to exceed 30% of the
original principal amount of the related Additional Collateral Loan) to the
extent that any such shortfall results in a loss of principal as an Additional
Collateral Loan that becomes a Liquidated Mortgage Loan, as more particularly
described in, and as limited by, the terms and provisions of the applicable
Limited Purpose Surety Bond. The Limited Purpose Surety Bonds will not cover any
payments on the Bonds that are recoverable or sought to be recovered as a
voidable preference under applicable law.
No assurance can be given as to the amount of proceeds, if any, that might
be realized from Additional Collateral. Proceeds from the liquidation of any
Additional Collateral will be included in net proceeds only when permitted by
applicable state law and by the terms of the related pledge or guaranty
agreement, as applicable.
TABULAR CHARACTERISTICS OF THE INITIAL MORTGAGE LOANS
The following information sets forth in tabular format certain information,
as of the Cut-off Date, as to the Initial Mortgage Loans. Other than with
respect to rates of interest, percentages (approximate) are stated by Stated
Principal Balance of the Initial Mortgage Loans as of the Cut-off Date and have
been rounded in order to total 100%.
CUT-OFF DATE STATED PRINCIPAL BALANCE(1)
PERCENT OF
NUMBER OF AGGREGATE AGGREGATE
INITIAL PRINCIPAL PRINCIPAL
MORTGAGE BALANCE BALANCE
CUT-OFF DATE STATED PRINCIPAL BALANCES($) LOANS OUTSTANDING OUTSTANDING
----------------------------------------- --------- --------------- -----------
44,250.00 - 50,000.00........................... 5 $ 235,978.84 0.05%
50,000.01 - 75,000.00........................... 15 995,708.92 0.22
75,000.01 - 100,000.00............................ 26 2,366,669.60 0.53
100,000.01 - 200,000.00............................. 206 32,312,388.19 7.27
200,000.01 - 300,000.00............................. 220 55,729,122.62 12.53
300,000.01 - 400,000.00............................. 165 57,916,570.40 13.02
400,000.01 - 500,000.00............................. 107 48,084,635.54 10.81
500,000.01 - 600,000.00............................. 62 34,071,673.78 7.66
600,000.01 - 700,000.00............................. 54 35,422,335.69 7.97
700,000.01 - 800,000.00............................. 39 29,524,161.95 6.64
800,000.01 - 900,000.00............................. 20 17,184,962.27 3.86
900,000.01 - 1,000,000.00............................ 43 42,004,299.74 9.45
1,000,000.01 - 1,500,000.00........................... 34 41,997,527.30 9.44
1,500,000.01 - 2,000,000.00........................... 22 39,554,077.00 8.89
2,000,000.01 - 2,500,000.00........................... 2 4,530,000.00 1.02
2,500,000.01 - 2,751,000.00........................... 1 2,751,000.00 0.62
----- --------------- ------
Total....................................... 1,021 $444,681,111.84 100.00%
===== =============== ======
---------------
(1) As of the Cut-off Date, the average Stated Principal Balance of the Initial
Mortgage Loans is expected to be approximately $435,535.
S-34
CURRENT MORTGAGE RATES(1)
PERCENT OF
NUMBER OF AGGREGATE AGGREGATE
INITIAL PRINCIPAL PRINCIPAL
MORTGAGE BALANCE BALANCE
CURRENT MORTGAGE RATES(%) LOANS OUTSTANDING OUTSTANDING
------------------------- --------- --------------- -----------
4.750 - 4.999......................................... 5 $ 2,067,001.04 0.46%
5.000 - 5.249......................................... 39 17,110,362.31 3.85
5.250 - 5.499......................................... 219 97,705,168.25 21.97
5.500 - 5.749......................................... 272 118,018,693.10 26.54
5.750 - 5.999......................................... 225 104,527,870.95 23.51
6.000 - 6.249......................................... 120 48,878,518.00 10.99
6.250 - 6.499......................................... 87 34,885,913.14 7.85
6.500 - 6.749......................................... 31 12,708,575.95 2.86
6.750 - 6.999......................................... 20 7,852,159.10 1.77
7.000 - 7.249......................................... 2 556,850.00 0.13
7.250 - 7.250......................................... 1 370,000.00 0.08
----- --------------- ------
Total....................................... 1,021 $444,681,111.84 100.00%
===== =============== ======
---------------
(1) As of the Cut-off Date, the weighted average Mortgage Rate of the Initial
Mortgage Loans is expected to be approximately 5.708% per annum.
REMAINING TERM(1)
PERCENT OF
NUMBER OF AGGREGATE AGGREGATE
INITIAL PRINCIPAL PRINCIPAL
MORTGAGE BALANCE BALANCE
REMAINING TERM (MONTHS) LOANS OUTSTANDING OUTSTANDING
----------------------- --------- --------------- -----------
294................................................... 9 $ 3,853,603.45 0.87%
295................................................... 68 28,786,734.47 6.47
296................................................... 229 97,390,340.82 21.90
297................................................... 329 140,118,579.89 31.51
298................................................... 284 123,758,709.53 27.83
299................................................... 102 50,773,143.68 11.42
----- --------------- ------
Total....................................... 1,021 $444,681,111.84 100.00%
===== =============== ======
---------------
(1) As of the Cut-off Date, the weighted average "Remaining Term" of the Initial
Mortgage Loans is expected to be approximately 297 months.
S-35
ORIGINAL LOAN-TO-VALUE RATIOS(1)
PERCENT OF
NUMBER OF AGGREGATE AGGREGATE
INITIAL PRINCIPAL PRINCIPAL
MORTGAGE BALANCE BALANCE
ORIGINAL LOAN-TO-VALUE RATIOS(%) LOANS OUTSTANDING OUTSTANDING
-------------------------------- --------- --------------- -----------
13.00 - 20.00........................................ 4 $ 2,544,500.00 0.57%
20.01 - 30.00........................................ 15 5,617,899.57 1.26
30.01 - 40.00........................................ 34 18,729,715.52 4.21
40.01 - 50.00........................................ 56 23,701,003.79 5.33
50.01 - 60.00........................................ 66 34,266,254.39 7.71
60.01 - 70.00........................................ 110 49,333,575.09 11.09
70.01 - 80.00........................................ 459 183,634,474.99 41.30
80.01 - 90.00........................................ 29 17,243,765.13 3.88
90.01 - 100.00........................................ 248 109,609,923.36 24.65
----- --------------- ------
Total....................................... 1,021 $444,681,111.84 100.00%
===== =============== ======
---------------
(1) The weighted average "Original Loan-to-Value Ratio" of the Initial Mortgage
Loans is expected to be approximately 75.50%.
EFFECTIVE LOAN-TO-VALUE RATIOS(1)
PERCENT OF
NUMBER OF AGGREGATE AGGREGATE
INITIAL PRINCIPAL PRINCIPAL
MORTGAGE BALANCE BALANCE
EFFECTIVE LOAN-TO-VALUE RATIOS(%) LOANS OUTSTANDING OUTSTANDING
--------------------------------- --------- --------------- -----------
3.66 - 10.00......................................... 1 $ 150,000.00 0.03%
10.01 - 20.00......................................... 5 3,094,500.00 0.70
20.01 - 30.00......................................... 15 5,617,899.57 1.26
30.01 - 40.00......................................... 33 18,579,715.52 4.18
40.01 - 50.00......................................... 81 33,937,526.46 7.63
50.01 - 60.00......................................... 79 40,952,055.39 9.21
60.01 - 70.00......................................... 330 161,813,155.22 36.39
70.01 - 80.00......................................... 448 173,008,974.99 38.91
80.01 - 90.00......................................... 9 2,744,400.00 0.62
90.01 - 95.00......................................... 20 4,782,884.69 1.08
----- --------------- ------
Total....................................... 1,021 $444,681,111.84 100.00%
===== =============== ======
---------------
(1) The weighted average Effective Loan-to-Value Ratio of the Initial Mortgage
Loans is expected to be approximately 67.11%. See "Security for the
Bonds -- The Initial Mortgage Loans" herein.
S-36
CREDIT SCORE(1)
PERCENT OF
AGGREGATE AGGREGATE
NUMBER OF PRINCIPAL PRINCIPAL
INITIAL MORTGAGE BALANCE BALANCE
CREDIT SCORE LOANS OUTSTANDING OUTSTANDING
------------ ---------------- --------------- ----------------
540 - 559.................................... 1 $ 304,500.00 0.07%
560 - 579.................................... 4 1,730,096.00 0.39
580 - 599.................................... 8 3,642,600.00 0.82
600 - 619.................................... 21 11,851,521.69 2.67
620 - 639.................................... 28 11,267,354.07 2.53
640 - 659.................................... 39 17,359,417.28 3.90
660 - 679.................................... 62 31,276,183.47 7.03
680 - 699.................................... 83 38,266,007.08 8.61
700 - 719.................................... 98 40,731,364.74 9.16
720 - 739.................................... 123 54,511,759.61 12.26
740 - 759.................................... 145 67,420,874.05 15.16
760 - 779.................................... 186 83,800,033.77 18.84
780 - 799.................................... 152 56,146,812.16 12.63
800 - 838.................................... 68 25,713,412.94 5.78
N/A.......................................... 3 659,174.98 0.15
----- --------------- ------
Total.............................. 1,021 $444,681,111.84 100.00%
===== =============== ======
---------------
(1) The weighted average "Credit Score" of the Initial Mortgage Loans is
approximately 732. See discussion above under "-- General."
GEOGRAPHIC DISTRIBUTION OF MORTGAGED PROPERTIES(1)
PERCENT OF
AGGREGATE AGGREGATE
NUMBER OF PRINCIPAL PRINCIPAL
INITIAL MORTGAGE BALANCE BALANCE
STATE LOANS OUTSTANDING OUTSTANDING
----- ---------------- --------------- ----------------
California................................... 140 $ 84,413,375.65 18.98%
Florida...................................... 170 67,066,883.67 15.08
Georgia...................................... 172 56,198,944.78 12.64
New York..................................... 46 26,431,657.44 5.94
Other(1)..................................... 493 210,570,250.30 47.35
----- --------------- ------
Total.............................. 1,021 $444,681,111.84 100.00%
===== =============== ======
---------------
(1) Other includes 45 other states, and the District of Columbia, with under 5%
concentrations individually. No more than approximately 1.13% of the Initial
Mortgage Loans will be secured by Mortgaged Properties located in any one
postal zip code area.
OCCUPANCY TYPE(1)
PERCENT OF
AGGREGATE AGGREGATE
NUMBER OF PRINCIPAL PRINCIPAL
INITIAL MORTGAGE BALANCE BALANCE
OCCUPANCY TYPE LOANS OUTSTANDING OUTSTANDING
-------------- ---------------- --------------- ----------------
Primary...................................... 881 $377,622,730.28 84.92%
Second Home.................................. 108 59,074,947.43 13.28
Investor..................................... 32 7,983,434.13 1.80
----- --------------- ------
Total.............................. 1,021 $444,681,111.84 100.00%
===== =============== ======
---------------
(1) Based upon representations of the related borrowers at the time of
origination.
S-37
PROPERTY TYPE
PERCENT OF
AGGREGATE AGGREGATE
NUMBER OF PRINCIPAL PRINCIPAL
INITIAL MORTGAGE BALANCE BALANCE
PROPERTY TYPE LOANS OUTSTANDING OUTSTANDING
------------- ---------------- --------------- ----------------
Single Family................................ 593 $268,071,790.16 60.28%
PUD.......................................... 290 127,917,858.90 28.77
Condominium.................................. 121 40,495,301.90 9.11
Cooperative.................................. 10 6,295,160.88 1.42
Two - Four Family............................ 7 1,901,000.00 0.43
----- --------------- ------
Total.............................. 1,021 $444,681,111.84 100.00%
===== =============== ======
LOAN PURPOSE
PERCENT OF
AGGREGATE AGGREGATE
NUMBER OF PRINCIPAL PRINCIPAL
INITIAL MORTGAGE BALANCE BALANCE
LOAN PURPOSE LOANS OUTSTANDING OUTSTANDING
------------ ---------------- --------------- ----------------
Purchase..................................... 529 $232,454,484.00 52.27%
Refinance (Cash-out)......................... 314 136,893,978.53 30.78
Refinance (Rate or Term)..................... 178 75,332,649.31 16.94
----- --------------- ------
Total.............................. 1,021 $444,681,111.84 100.00%
===== =============== ======
MARGIN(1)
PERCENT OF
AGGREGATE AGGREGATE
NUMBER OF PRINCIPAL PRINCIPAL
INITIAL MORTGAGE BALANCE BALANCE
MARGIN(%) LOANS OUTSTANDING OUTSTANDING
--------- ---------------- --------------- ----------------
1.000........................................ 5 $ 2,067,001.04 0.46%
1.125........................................ 3 1,699,939.01 0.38
1.375........................................ 16 7,273,978.63 1.64
1.500........................................ 39 18,803,210.21 4.23
1.625........................................ 552 241,376,266.53 54.28
1.750........................................ 24 7,400,236.83 1.66
1.875........................................ 94 36,645,445.84 8.24
2.000........................................ 187 85,519,187.89 19.23
2.125........................................ 78 33,842,434.52 7.61
2.250........................................ 22 7,553,411.34 1.70
2.625........................................ 1 2,500,000.00 0.56
----- --------------- ------
Total.............................. 1,021 $444,681,111.84 100.00%
===== =============== ======
---------------
(1) As of the Cut-off Date, the weighted average "Margin" of the Initial
Mortgage Loans is expected to be approximately 1.760%.
S-38
MAXIMUM MORTGAGE RATE(1)
PERCENT OF
AGGREGATE AGGREGATE
NUMBER OF PRINCIPAL PRINCIPAL
INITIAL MORTGAGE BALANCE BALANCE
MAXIMUM MORTGAGE RATE(%) LOANS OUTSTANDING OUTSTANDING
------------------------ ---------------- --------------- ----------------
12.000....................................... 781 $364,697,080.81 82.01%
13.000....................................... 240 79,984,031.03 17.99
----- --------------- ------
Total.............................. 1,021 $444,681,111.84 100.00%
===== =============== ======
---------------
(1) As of the Cut-off Date, the weighted average "Maximum Mortgage Rate" of the
Initial Mortgage Loans is expected to be approximately 12.180% per annum.
NEXT NOTE RATE ADJUSTMENT DATE(1)
PERCENT OF
AGGREGATE AGGREGATE
NUMBER OF PRINCIPAL PRINCIPAL
INITIAL MORTGAGE BALANCE BALANCE
NEXT NOTE RATE ADJUSTMENT DATE LOANS OUTSTANDING OUTSTANDING
------------------------------ ---------------- --------------- ----------------
November 2001................................ 106 $ 48,432,120.74 10.89%
December 2001................................ 228 96,740,340.82 21.75
January 2002................................. 321 135,301,230.93 30.43
February 2002................................ 273 119,250,456.41 26.82
March 2002................................... 84 41,103,359.49 9.24
April 2002................................... 9 3,853,603.45 0.87
----- --------------- ------
Total.............................. 1,021 $444,681,111.84 100.00%
===== =============== ======
---------------
(1) As of the Cut-off Date, the weighted average months to the "Next Note Rate
Adjustment Date" of the Initial Mortgage Loans was approximately 3 months.
THE INDICES; CONVERSION OPTIONS
The Mortgage Rate for all of the Initial Mortgage Loans will be adjusted
monthly or semi-annually on the related adjustment date. The index for the
Mortgage Rate borne by these Initial Mortgage Loans may be calculated as follows
(in each case, rounded to the nearest one-eighth of one percent):
ONE-MONTH LIBOR. The Mortgage Rate borne by approximately 5.04% of
the Initial Mortgage Loans (by Stated Principal Balance as of the Cut-off
Date) is adjusted every month to equal the London interbank offered rate
for one-month U.S. dollar deposits as listed under "Money Rates" in The
Wall Street Journal most recently available as of the first day of the
month prior to the month in which the related interest adjustment date
occurs ("One-Month LIBOR") plus a margin ranging from 1.000% to 2.000%.
SIX-MONTH LIBOR. The Mortgage Rate borne by approximately 94.96% of
the Initial Mortgage Loans (by Stated Principal Balance as of the Cut-off
Date) is adjusted every six months to equal the London interbank offered
rate for six-month U.S. dollar deposits as listed under "Money Rates" in
The Wall Street Journal most recently available as of 45 days prior to the
related adjustment date ("Six-Month LIBOR") plus a margin ranging from
1.000% to 2.625%.
In addition, the borrowers under substantially all of the Initial Mortgage
Loans originated by Cendant and Bishop's Gate may elect to convert the index
upon which the related Mortgage Rate is based from Six-Month LIBOR to One-Year
Treasury or Prime Rate (in each case adjustable semi-annually); and the
borrowers under all of the Initial Mortgage Loans originated by MSDWCC may elect
to convert the index upon which the related Mortgage Rate is based from (a)
One-Month LIBOR to One-Year Treasury or Prime Rate (in each case adjustable
monthly) or (b) from Six-Month LIBOR to One-Year Treasury or Prime Rate
S-39
(in each case adjustable semi-annually); provided, however, in each case that
such conversion may only be made once and is generally exercisable either from
the twelfth to the sixtieth adjustment date of such Mortgage Loan, in the case
of Mortgage Loans with Mortgage Rates based on One-Month LIBOR, or from the
second to the tenth adjustment date, in the case of Mortgage Loans with Mortgage
Rates based on Six-Month LIBOR, in each case, within a certain 21-day period
commencing on the 45th day prior to each such adjustment date and is generally
permitted with respect to an Initial Mortgage Loan only if: (1) the borrower
must still be the owner of the subject property; (2) the borrower has not been
more than 30 days late on any of the scheduled monthly payments; (3) the
borrower has not been late on any of the 12 scheduled monthly payments
immediately preceding the month in which the borrower requests conversion; (4)
the borrower must give the lender notice that it wants to exercise the index
conversion option; (5) the borrower must not be in default under the note or the
security instrument; and (6) the borrower may be required to pay an index
conversion fee.
- "Prime Rate" means the highest prime rate listed under "Money Rates" in
The Wall Street Journal most recently available as of 45 days, in the
case of Initial Mortgage Loans with original Mortgage Rates based on
Six-Month LIBOR, or 25 days, in the case of Initial Mortgage Loans with
original Mortgage Rates based on One-Month LIBOR, prior to the related
adjustment date.
- "One-Year Treasury" means the weekly average yield on United States
Treasury Securities adjusted to a constant maturity of one year, as made
available by the Federal Reserve board in Statistical Release H.15 most
as of 45 days, in the case of Initial Mortgage Loans with original
Mortgage Rates based on Six-Month LIBOR, or 25 days, in the case of
Initial Mortgage Loans with original Mortgage Rates based on One-Month
LIBOR, prior to the related adjustment date.
The margin for any index to which a borrower elects to convert will be
different from the margin on the original index. When a borrower elects to
convert the index of a Mortgage Loan, the borrower may not change the frequency
with which the Mortgage Rate adjusts or add a periodic cap to a Mortgage Loan
that did not carry such a periodic cap upon origination. Upon conversion of the
index, the margin generally applicable to the indices to which a Mortgage Loan
may be converted will be as specified below for the applicable Originator:
CENDANT/BISHOP'S GATE-ORIGINATED MORTGAGE LOANS
OLD INDEX OLD MARGIN NEW INDEX NEW MARGIN
--------- ---------- ----------------- ----------
Six-Month LIBOR............................... +1.6250% Prime Rate -0.1250%
Six-Month LIBOR............................... +1.6250% One-Year Treasury +3.2500%
MSDWCC-ORIGINATED MORTGAGE LOANS
OLD INDEX OLD MARGIN NEW INDEX NEW MARGIN
--------- ---------- ----------------- ----------
One-Month LIBOR................................. +1.5000% Prime Rate -0.5000%
One-Month LIBOR................................. +1.5000% One-Year Treasury +2.0000%
Six-Month LIBOR................................. +1.6250% Prime Rate -0.2500%
Six-Month LIBOR................................. +1.6250% One-Year Treasury +2.2500%
The margins set forth above may be higher for borrowers who elect not to
pay origination fees and may be lower for borrowers who elect to pay additional
points to buy down their margin.
ASSIGNMENT OF THE MORTGAGE LOANS
Under the Mortgage Loan Purchase Agreement, Redwood Trust will sell the
Mortgage Loans to the Depositor and will make certain representations,
warranties and covenants to the Depositor relating to, among other things,
certain characteristics of the Mortgage Loans, and subject to the limitations
described below, will be obligated as described herein to purchase or substitute
a similar mortgage loan for any Mortgage Loan as to which there exists deficient
documentation or as to which there has been an uncured breach of any such
S-40
representation or warranty relating to the characteristics of the Mortgage Loan
that materially and adversely affects the value of such Mortgage Loans or the
interests of the Bondholders in such Mortgage Loan (a "Defective Mortgage
Loan"). See "Mortgage Loan Program -- Representations by Sellers; Repurchases"
in the accompanying prospectus.
Pursuant to the Mortgage Loan Purchase Agreement, on the closing date the
Depositor will sell, transfer, assign, set over and otherwise convey without
recourse to the Bond Issuer all of its rights to the Mortgage Loans and its
rights under the Mortgage Loan Purchase Agreement. Under the Indenture, the Bond
Issuer will pledge all its right, title and interest in and to the Mortgage
Loans and such rights (including the right to enforce Redwood Trust's purchase
obligation) to the Bond Trustee for the benefit of the Bondholders. The Bond
Issuer will make no representations or warranties with respect to the Mortgage
Loans and will have no obligation to repurchase or substitute for Defective
Mortgage Loans. The obligations of Redwood Trust with respect to the Bonds are
limited to Redwood Trust's obligation to purchase or substitute for Defective
Mortgage Loans.
Pursuant to the Indenture, on the closing date, the Bond Issuer will
pledge, transfer, assign, set over and otherwise convey without recourse to the
Bond Trustee in trust for the benefit of the Bondholders all right, title and
interest of the Bond Issuer in and to each Initial Mortgage Loan, and all right,
title and interest in and to all other assets included in the Collateral,
including all principal and interest received on or with respect to, the Initial
Mortgage Loans, exclusive of principal and interest due on or prior to the
Cut-off Date.
In connection with such transfer and assignment of the Initial Mortgage
Loans, the Bond Issuer will deliver or cause to be delivered to the Bond
Trustee, among other things, the original promissory note (the "Mortgage Note")
(and any modification or amendment thereto) endorsed in blank without recourse,
the original instrument creating a first lien on the related Mortgaged Property
(the "Mortgage") with evidence of recording indicated thereon, an assignment in
recordable form of the Mortgage, the title policy with respect to the related
Mortgaged Property and, if applicable, all recorded intervening assignments of
the Mortgage and any riders or modifications to such Mortgage Note and Mortgage
(except for any such document other than Mortgage Notes not available on the
closing date, which will be delivered to the Bond Trustee as soon as the same is
available to the Bond Issuer) (collectively, the "Mortgage File"). Assignments
of the Mortgage Loans to the Bond Trustee (or its nominee) will be recorded in
the appropriate public office for real property records, except in states where,
in the opinion of counsel, such recording is not required to protect the Bond
Trustee's interest in the Mortgage Loans against the claim of any subsequent
transferee or any successor to or creditor of the Bond Issuer.
The Bond Trustee will review, or cause to be reviewed, each Mortgage File
within 270 days of the closing date (or promptly after the Bond Trustee's
receipt of any document permitted to be delivered after the closing date) and
will hold such Mortgage Files in trust for the benefit of the Bondholders. If at
the end of such 270-day period, any document in a Mortgage File is found to be
missing or defective in a material respect and Redwood Trust cannot or does not
cure such omission or defect within 180 days after its receipt of notice from
the Bond Trustee, Redwood Trust is obligated to purchase the related Defective
Mortgage Loan from the Bond Issuer at a price equal to the sum of (a) 100% of
the Stated Principal Balance thereof, (b) unpaid accrued interest thereon from
the Due Date to which interest was last paid by the mortgagor to the Due Date
immediately preceding the repurchase and (c) any unreimbursed servicing advances
not included in clauses (a) and (b) above. Rather than purchase the Defective
Mortgage Loan as provided above, Redwood Trust may remove such Mortgage Loan (a
"Deleted Mortgage Loan") from the Pledged Mortgage Pool and substitute in its
place one or more mortgage loans of like kind (such loan a "Replacement Mortgage
Loan"); provided, however, that such substitution is permitted only within two
years after the closing date and may not be made unless an opinion of counsel is
provided to the effect that such substitution would not disqualify the REMIC
elections or result in a prohibited transaction tax under the Code.
Any Replacement Mortgage Loan generally will, on the date of substitution,
among other characteristics set forth in the Mortgage Loan Purchase Agreement,
(i) have an outstanding principal balance, after deduction of all Scheduled
Payments due in the month of substitution, not in excess (and not less than 90%)
of the Stated Principal Balance of the Deleted Mortgage Loan (the amount of any
shortfall to be deposited in
S-41
the Distribution Account by Redwood Trust not later than the succeeding
Determination Date and held for distribution to the Bondholders on the related
Payment Date), (ii) have a maximum Mortgage Rate not less than (and not more
than two percentage points greater than) the maximum mortgage rate of the
Deleted Mortgage Loan, (iii) have a gross margin not less than that of the
Deleted Mortgage Loan and, if Mortgage Loans equal to 1% or more of the Cut-off
Date Pool Balance have become Deleted Mortgage Loans, not more than two
percentage points more than that of the Deleted Mortgage Loan, (iv) have an
Effective Loan-to-Value Ratio not higher than that of the Deleted Mortgage Loan,
(v) have a remaining term to maturity not greater than (and not more than one
year less than) that of the Deleted Mortgage Loan, (vi) not permit conversion of
the related Mortgage Rate to a permanent fixed Mortgage Rate, (vii) have the
same or higher credit score, (viii) have an initial interest adjustment date no
earlier than five months before (and no later than five months after) the
initial interest adjustment date of the Deleted Mortgage Loan, (ix) be a
"qualified replacement mortgage" within the meaning of Section 860G(a)(4) of the
Code and (x) comply with all of the representations and warranties set forth in
the Mortgage Loan Purchase Agreement. This cure, repurchase or substitution
obligation constitutes the sole remedy available to the Bondholders or the Bond
Trustee for omission of, or a material defect in, a Mortgage File.
CONVEYANCE OF SUBSEQUENT MORTGAGE LOANS
On the closing date, the excess of the aggregate Class Principal Amount of
each class of Bonds over the Cut-off Date Pool Principal Balance (which excess
is not expected to exceed $70,000,000) will be deposited in the Pre-Funding
Account established and maintained by the Bond Trustee on behalf of the
Bondholders. During the Pre-Funding Period, the Depositor is expected to
purchase Subsequent Mortgage Loans from Redwood Trust and to sell those
Subsequent Mortgage Loans to the Bond Issuer as described above. The Bond Issuer
will in turn pledge the Subsequent Mortgage Loans to the Bond Trustee in
exchange for payment of a funding amount for each Subsequent Mortgage Loan equal
to the Stated Principal Balance of such Subsequent Mortgage Loan as of the date
of origination of such Subsequent Mortgage Loan (reduced by principal payments
due or paid on or prior to the related subsequent cut-off date, if any) and will
be paid from the Pre-Funding Account. Accordingly, the funding of Subsequent
Mortgage Loans will decrease the amount on deposit in the Pre-Funding Account
and increase the aggregate Stated Principal Balance of the Mortgage Loans.
Pursuant to the Indenture, the pledge of Subsequent Mortgage Loans may be
made on any Business Day during the Pre-Funding Period, subject to certain
conditions in the Indenture being satisfied, including that:
- the Subsequent Mortgage Loans pledged on the subsequent transfer date
satisfy the same representations and warranties applicable to the Initial
Mortgage Loans;
- the Subsequent Mortgage Loans pledged on the subsequent transfer date
were selected in a manner reasonably believed not to be adverse to the
interests of the Bondholders;
- the Bond Trustee receives an opinion of counsel with respect to the
validity of the pledge of Subsequent Mortgage Loans pledged on the
subsequent transfer date and the absence of any adverse effect on any
REMIC election, or cause any REMIC created pursuant to the Indenture to
incur any tax;
- the pledge of the Subsequent Mortgage Loans on the subsequent transfer
date will not result in a reduction or withdrawal of any ratings assigned
to the Offered Bonds;
- no Subsequent Mortgage Loan pledged on the subsequent transfer date was
more than two payments delinquent in payment;
- each Subsequent Mortgage Loan pledged on the subsequent transfer date is
secured by a first lien on the related Mortgaged Property; and
- following the pledge of the Subsequent Mortgage Loans on the subsequent
transfer date, the characteristics of the Mortgage Loans will remain
substantially similar to the characteristics of the Initial Mortgage
Loans as of the Cut-off Date.
S-42
UNDERWRITING STANDARDS
Approximately 65.38% of the Initial Mortgage Loans, respectively, have been
purchased by Redwood Trust directly from Cendant and Bishop's Gate, and
approximately 34.62% of the Initial Mortgage Loans have been purchased by
Redwood Trust directly from MSDWCC, in the ordinary course of business. Redwood
Trust approved each Originator as an eligible originator after an evaluation of
certain criteria, including the Originator's mortgage origination and servicing
experience and financial stability. It is expected that the Subsequent Mortgage
Loans will also be originated by the Originators. Each Originator will represent
and warrant that all Initial Mortgage Loans originated and/or sold by it will
have been underwritten in accordance with standards consistent with those
utilized by mortgage lenders generally during the period of origination.
ORIGINATION OF THE MORTGAGE LOANS
The following is a general summary of the Underwriting Guidelines believed
by Redwood Trust to be applied by each Originator with respect to the Mortgage
Loans originated by it. This summary does not purport to be a complete
description of the Underwriting Guidelines of any Originator.
MSDWCC ORIGINATION
MSDWCC is an indirect wholly-owned subsidiary of Morgan Stanley Dean Witter
& Co. MSDWCC is a retail residential mortgage lender that originates and
services loans for borrowers who are clients of Morgan Stanley Dean Witter & Co.
Clients are introduced to MSDWCC typically through Morgan Stanley Dean Witter &
Co. brokerage account relationships, and through Discover Card cardmember
relationships. MSDWCC utilizes each of these companies' sales forces to
reinforce brand identity and customer relationships, in addition to marketing to
these consumers directly through the mail or via inserts in existing account
statements.
MSDWCC is structured to operate nationally on a remote basis and through
the World Wide Web. Clients are provided toll-free telephone number access to
loan officers who will discuss alternative products to meet specific needs. Loan
officers take mortgage loan applications, and lead customers through the entire
mortgage loan origination process. MSDWCC's loan origination, servicing and
collection systems are fully integrated, providing a more flexible,
user-friendly technology foundation and enhanced customer service. In order to
provide convenient customer service for all U.S. properties, MSDWCC maintains
corporate licensing/authorization to conduct business in all 50 states. MSDWCC's
loans are serviced and supported by its servicing center in Sioux Falls, South
Dakota.
MSDWCC UNDERWRITING GUIDELINES
Generally, a potential borrower may submit written or telephone
applications which provide pertinent information about the applicant's ability
to repay the proposed loan. Information supporting the potential borrower's
assets, liabilities, income and expenses is required. Such information typically
includes verification of income, deposits and mortgage payment history.
Additionally, MSDWCC obtains and reviews a property appraisal, title policy,
credit bureau reporting credit history, analysis of income supporting repayment
ability and proof of insurance coverage.
A potential borrower's ability to make the proposed loan payments is
measured by the applicant's income ratio, credit, residence stability and
assets. One test to determine this ability is the debt-to-income ratio, which is
the borrower's total monthly debt service divided by total monthly gross income.
MSDWCC typically allows for debt-to-income of 40% when the borrower's annual
income is less than or equal to $75,000 or 45% when the borrower's annual income
is greater than $75,000. Debt-to-income exceptions must be approved by the
appropriate level underwriter, and supported by compensating factors.
The adequacy of mortgaged property as security for the proposed mortgage
loan will generally be determined by an appraisal acceptable to MSDWCC.
Appraisals are conducted by independent appraisers acceptable to MSDWCC.
Appraisals over 180 days old will not be sufficient if conducted by an
independent
S-43
appraiser engaged by the potential borrower. If the proposed loan amount exceeds
$1,000,000, a second appraisal will be required.
CENDANT AND BISHOP'S GATE UNDERWRITING GUIDELINES
The Initial Mortgage Loans purchased by Redwood Trust from Cendant and
Bishop's Gate were originated by Cendant on behalf of MLCC, in accordance with
the parameters established for the MLCC program. The underwriting standards of
Cendant generally allow various Loan-to-Value Ratios at origination up to
maximum levels based upon the size of the original principal balance of the
related Mortgage Loans, among other factors. Any mortgage loans originated with
an Effective Loan-to-Value Ratio at origination in excess of 80% are required to
have a primary mortgage insurance policy. In determining whether a prospective
borrower has sufficient monthly income available (i) to meet the borrower's
monthly obligation on the proposed mortgage loan and (ii) to meet monthly
housing expenses and other financial obligations including the borrower's
monthly obligations on the proposed mortgage loan, Cendant generally applies
ratios of up to 33% and 38%, respectively, of the proposed borrower's acceptable
stable monthly gross income. From time to time, Cendant makes loans where these
ratios are exceeded. In those instances, Cendant's underwriters typically look
at mitigating factors such as the liquidity of the borrower, the stability of
the real estate market where the property is located, and local economic
conditions. In addition, with respect to mortgage loans secured by
owner-occupied condominium units, Cendant generally will fund up to the lesser
of 10 units or 50% of the total units in a project.
Cendant also originates mortgage loans pursuant to alternative sets of
underwriting criteria under its reduced documentation and no income, no asset
programs. Both of these programs are designed to facilitate the loan approval
process. Under both of these programs, certain documentation concerning income/
employment and asset verification is reduced or excluded. Loans underwritten
under both of these programs are limited to borrowers who have demonstrated an
established ability and willingness to repay the mortgage loans in a timely
fashion. Permitted maximum loan-to-value ratios under both programs are more
restrictive than those under the standard underwriting criteria of Cendant.
From time to time, exceptions to Cendant's underwriting policies may be
made. Such exceptions may be made only on a loan-by-loan basis at the discretion
of Cendant's underwriter. Exceptions may be made only after careful
consideration of certain mitigating factors such as borrower capacity,
liquidity, employment and residential stability and local economic conditions.
Cendant's executive offices are located at 3000 Leadenhall Road, Mt.
Laurel, New Jersey 08054, and its telephone number is (856) 439-6000.
THE SERVICERS
Cendant and MSDWCC, as servicers (in such capacity, the "Servicers") will
initially have primary responsibility for servicing the Mortgage Loans,
including, but not limited to, all collection, advancing and loan-level
reporting obligations, maintenance of escrow accounts, maintenance of insurance
and enforcement of foreclosure proceedings with respect to the Mortgage Loans
and related Mortgage Properties. Cendant will service approximately 65.38% of
the Initial Mortgage Loans, and MSDWCC will service approximately 34.62% of the
Initial Mortgage Loans. It is expected that Cendant and MSDWCC also will be the
servicers for the Subsequent Mortgage Loans.
The delinquency, foreclosure and loss experience set forth below for each
Servicer has been provided by such Servicer and solely represents the historical
experience of the Servicer's servicing portfolio for its First Mortgage Program,
in the case of MSDWCC, and for its entire portfolio of one-to four-family
residential mortgage loans, in the case of Cendant, for the periods indicated
and no representation is made by the Servicer that the delinquency and/or loss
experience of the Mortgage Loans will be similar to that of the servicing
portfolio, nor is any representation made by either Servicer as to the rate at
which losses may be experienced on liquidation of defaulted Mortgage Loans.
S-44
MORGAN STANLEY DEAN WITTER CREDIT CORPORATION
DELINQUENCY AND LOSS HISTORY
(DOLLARS IN THOUSANDS)
NOVEMBER 30, 1996 NOVEMBER 30, 1997 NOVEMBER 30, 1998 NOVEMBER 30, 1999
Fiscal Year ended: ----------------- ------------------ ----------------- -------------------
$ # $ # $ # $ #
-------- ----- -------- ------ -------- ----- ---------- -----
First Mortgage Loans
Outstanding.................. $177,371 1,011 $347,419 2,095 $747,776 4,507 $1,322,472 6,880
Delinquency Period:(1)
30 - 59 Days................... $ 617 4 $ 760 6 $ 182 2 $ 1,126 6
60 - 89 Days................... $ 1,931 3 $ -- $ -- $ -- -- $ -- --
90 Days or More................ $ 1,449 3 $ 318 2 $ 800 5 $ 218 3
-------- ----- -------- ------ -------- ----- ---------- -----
Total Delinquency.............. $ 3,997 10 $ 1,078 8 $ 982 7 $ 1,345 9
Percent of Loan Portfolio...... 2.25% 0.99% 0.31% 0.38% 0.13% 0.16% 0.10% 0.13%
Foreclosures:
Outstanding.................... 2,511 4 318 2 800 5 264 3
Percent of Loan Portfolio...... 1.42% 0.40% 0.09% 0.10% 0.11% 0.11% 0.02% 0.04%
Average Portfolio Balance(2)... $141,620 780 $248,051 1,467 $527,914 3,231 $1,019,303 5,770
Gross Losses................... $ (1) $ 400 $ (13) $ 41
Recoveries..................... $ -- $ (5) $ -- $ (6)
Net Losses..................... $ (1) $ 395 $ (13) $ 35
Percent of Average Portfolio
Balance...................... 0.00% 0.16% 0.00% 0.00%
PERIOD ENDED
NOVEMBER 30, 2000 SEPTEMBER 30, 2001
Fiscal Year ended: ------------------- ----------------------
$ # $ #
---------- ----- ---------- --------
First Mortgage Loans
Outstanding.................. $1,988,245 9,029 $2,539,283 11,264
Delinquency Period:(1)
30 - 59 Days................... $ 2,022 15 $ 2,813 14
60 - 89 Days................... $ 2,559 3 $ 313 3
90 Days or More................ $ 429 3 $ 2,906 6
---------- ----- ---------- --------
Total Delinquency.............. $ 5,010 21 $ 6,031 23
Percent of Loan Portfolio...... 0.25% 0.23% 0.24% 0.20%
Foreclosures:
Outstanding.................... 314 2 1,548 7
Percent of Loan Portfolio...... 0.02% 0.02% 0.05% 0.06%
Average Portfolio Balance(2)... $1,644,072 7,939 $2,222,100 9,977
Gross Losses................... $ 98 $ --
Recoveries..................... $ (0) $ --
Net Losses..................... $ 98 $ --
Percent of Average Portfolio
Balance...................... 0.01% 0.00%(3)
---------------
(1) Delinquency is based on the number of days payments are contractually past
due. Any loans in foreclosure status are included in the respective aging
category in the chart.
(2) Average portfolio balance is the sum of the prior fiscal year-end balance
plus the sum of each month-end balance for the year indicated divided by
thirteen periods (or 11 periods in the case of September 30, 2001).
(3) Annualized.
S-45
DELINQUENCY AND FORECLOSURE EXPERIENCE IN CENDANT'S PORTFOLIO
OF ONE-TO FOUR-FAMILY, RESIDENTIAL MORTGAGE LOANS(1)
AS OF AS OF AS OF
DECEMBER 31, 1999 DECEMBER 31, 2000* SEPTEMBER 30, 2001
--------------------- --------------------- ---------------------
NUMBER PRINCIPAL NUMBER PRINCIPAL NUMBER PRINCIPAL
OF LOANS BALANCE OF LOANS BALANCE OF LOANS BALANCE
-------- --------- -------- --------- -------- ---------
Total Portfolio................ 443,427 $52,163 623,196 $82,187 701,898 $94,088
======= ======= ======= ======= ======= =======
Period of Delinquency(2)(3)
30 to 59 days................ 9,465 $ 959 16,708 $ 1,917 20,104 $ 2,350
Percent Delinquent........... 2.1% 1.8% 2.7% 2.3% 2.9% 2.5%
60 to 89 days................ 1,756 $ 164 3,753 $ 374 4,307 $ 452
Percent Delinquent........... 0.4% 0.3% 0.6% 0.5% 0.6% 0.5%
90 day or more............... 1,498 $ 136 4,294 $ 396 4,366 $ 405
Percent Delinquent........... 0.3% 0.3% 0.7% 0.5% 0.6% 0.4%
------- ------- ------- ------- ------- -------
Total Delinquencies(4)......... 12,719 $ 1,259 24,755 $ 2,687 28,777 $ 3,208
======= ======= ======= ======= ======= =======
Total Delinquencies by Percent
of Total Portfolio........... 2.9% 2.4% 4.0% 3.3% 4.1% 3.4%
Foreclosures, Bankruptcies or
Real Estate Owned............ 3,470 $ 321 4,561 $ 403 6,507 $ 580
Percent of Total Portfolio in
Foreclosure, Bankruptcy or
Real Estate Owned............ 0.8% 0.6% 0.7% 0.5% 0.9% 0.6%
---------------
(1) The table shows mortgage loans which were delinquent or for which
foreclosure proceedings had been instituted as of the date indicated. All
dollar amounts are in millions and have been rounded to the nearest whole
number.
(2) No mortgage loan is included in this table as delinquent until it is 30 days
past due.
(3) Bankruptcies are included in the delinquency calculations and also in the
"Foreclosure, Bankruptcies or Real Estate Owned" category. The Foreclosures
and Real Estate Owned categories are excluded from the delinquency
calculations.
(4) Entries may not add up to total due to rounding.
(5) Percentages stated are of the total servicing portfolio.
* Includes approximately 46,982 MLCC mortgage loans subserviced by Cendant.
While the above foreclosure and delinquency experience is typical of
Cendant's recent experience, there can be no assurance that experience on the
Mortgage Loans will be similar. As a result of the rapid growth experienced by
Cendant, including its purchase of MLCC's first lien mortgage servicing
portfolio, its servicing portfolio is relatively unseasoned. Accordingly, the
above statistical data should not be considered to reflect the credit quality of
the Mortgage Loans, or be used as a basis for assessing the likelihood, amount
or severity of losses on the Mortgage Loans. The statistical data in the table
is based on all of the loans in Cendant's servicing portfolio. The Mortgage
Loans may be more recently originated than, and also have other characteristics
which distinguish them from, the majority of the loans in Cendant's servicing
portfolio.
Recent Developments. On April 30, 1997, Cendant Mortgage Corporation's
parent PHH Corporation announced that it had merged with HFS Incorporated
("HFS") pursuant to which PHH Corporation became a subsidiary of HFS. On
December 18, 1997, HFS announced it had merged with CUC International,
Inc.("CUC"). The new company name is Cendant Corporation. Cendant Corporation's
primary business segments include travel related services businesses that
facilitate vacation timeshare exchanges, franchise car rentals and hotel
businesses; real estate related services businesses that franchise real estate
brokerage businesses, provide home buyers with mortgages and assist in employee
relocations; and alliance marketing related services businesses that provide an
array of value driven products and services.
S-46
On April 15, 1998, Cendant Corporation announced that in the course of
transferring responsibility for Cendant Corporation's accounting functions from
the former CUC personnel to former HFS accounting personnel and preparing for
the reporting of first quarter 1998 financial results, it had discovered
accounting irregularities in certain CUC business units. Upon discovering such
accounting irregularities in certain former CUC business units, the Audit
Committee of Cendant Corporation's Board of Directors and its counsel, assisted
by auditors, began an intensive investigation that resulted, in part, in Cendant
Corporation restating its previously reported financial results for 1997, 1996
and 1995.
As a result of these accounting irregularities, more than 70 lawsuits
claiming to be class action lawsuits, two lawsuits claiming to be brought
derivatively on Cendant Corporation's behalf and several individual lawsuits
have been filed in various courts against Cendant Corporation and other
defendants, asserting various claims under the federal securities laws and
certain state statutory and common laws, including claims that Cendant
Corporation allegedly knew or should have known that they caused the price of
Cendant Corporation's securities to be artificially inflated. In addition, the
staff of the Securities and Exchange Commission (the "SEC") and the United
States Attorney for the District of New Jersey have conducted investigations
relating to the accounting issues. Please see Cendant Corporation's Annual
Report on Form 10-K/A for the fiscal year ending December 31, 1998. As it
concerned Cendant Corporation, the SEC investigation was resolved on June 14,
2000 via the issuance of an administrative order ("Order") by the SEC. Without
admitting or denying the finding contained therein, Cendant Corporation
consented to the issuance of the Order, which ordered Cendant Corporation to
cease and desist from future violations of the federal securities laws. In
fashioning its Order, the SEC recognized remedial acts promptly undertaken by
Cendant Corporation and cooperation afforded the SEC. The Order can be viewed on
the SEC's website which is located at http://www.sec.gov.
On December 7, 1999, Cendant Corporation announced that it reached a
preliminary agreement to settle the principal securities class action pending
against it in the U.S. District Court in Newark, New Jersey relating to the
aforementioned class action lawsuits. Under the agreement, Cendant Corporation
would pay the class members $2.85 billion in cash. The settlement was approved
by the U.S. District Court on August 15, 2000. Certain parties in the class
action appealed the District Court's orders approving the plan of allocation of
the settlement fund and awarding of attorneys' fees and expenses to counsel for
the lead plaintiffs. No appeals challenging the fairness of the $2.85 billion
settlement amount were filed. As a result of the appeals, Cendant Corporation
was not required to immediately fund the settlement amount of $2.85 billion.
However, the settlement agreement required Cendant Corporation to post
collateral in the form of credit facilities and/or surety bonds by November 13,
2000. Accordingly, on November 13, 2000, Cendant Corporation posted a surety
bond in the amount of $790 million and letters of credit aggregating $1.71
billion. Cendant Corporation also had the option of forming a trust established
for the benefit of the plaintiffs in lieu of posting collateral. On November 13,
2000, Cendant Corporation funded such trust with a cash deposit of approximately
$350 million. Cendant Corporation is also required to make additional minimum
deposits of $600 million, $800 million and $800 million during 2001, 2002 and
2003, respectively. Such deposits will serve to reduce the amount of collateral
required to be posted under the settlement agreement. Please see Cendant
Corporation's Form 8-K, dated December 27, 1999, for a description of the
agreement to settle the common stock class action litigation.
On August 28, 2001, the United States Court of Appeals for the Third
Circuit (the "Third Circuit") issued two decisions resolving all appeals from
the August 15, 2000 orders of the United States District Court for the District
of New Jersey (the "District Court") that, INTER ALIA, (1) approved Cendant
Corporation's proposed $2.85 billion settlement of the principal securities
class action pending against it styled IN RE CENDANT CORPORATION LITIGATION, No.
98-cv-1664 (D.N.J.) (the "CalPERS Action"), (2) overruled all objections to the
settlement of the CalPERS Action, (3) approved the plan of allocation for the
settlement proceeds, and (4) awarded attorneys' fees and expenses to counsel for
the lead plaintiffs and the class in the CalPERS Action. In one decision, the
Third Circuit affirmed the District Court's decision overruling the objections
to the settlement made by the plaintiff in a derivative action pending against
Cendant Corporation. In the second, the Third Circuit affirmed the District
Court's finding that the settlement of the CalPERS Action is fair, reasonable
and adequate, and affirmed the District Court's decision overruling the
S-47
objections to the settlement and the plan of allocation made by a number of
class members. Also in the second decision, the Third Circuit vacated the
District Court's award of attorneys' fees and expenses to counsel for the lead
plaintiffs and the class, and remanded the action to the District Court for
additional proceedings on this issue. The vacatur and remand of the attorneys'
fees and expenses issue is not expected to have any effect on the finality of
the settlement. As a result of the Third Circuit's decisions, unless the Third
Circuit's findings are appealed to the Supreme Court of the United States within
three months, Cendant Corporation will be required to fund the settlement no
earlier than the end of March 2002. As of August 30, 2001, Cendant Corporation's
unfunded settlement obligation was approximately $2.1 billion. As Cendant
Corporation continues to make quarterly payments of $250 million to reduce its
outstanding obligation, the unfunded obligation is projected to be approximately
$1.41 billion in March 2002, consisting of a $1.25 billion principal obligation
and $160 in million accrued interest. In anticipation of the final settlement
payment, Cendant Corporation established a $1.75 billion committed revolving
credit facility maturing in August 2003. In addition, as of August 30, 2001,
Cendant Corporation had approximately $2.8 billion of cash on hand. Accordingly,
Cendant Corporation anticipates that it will use a combination of available
cash, operating cash flow and revolving credit facility borrowings to fund the
settlement obligation when due.
The accounting irregularities described above did not include PHH
Corporation or any of its subsidiaries, including Cendant Mortgage Corporation.
SERVICING OF THE MORTGAGE LOANS
SERVICING AND COLLECTION PROCEDURES
Servicing functions to be performed by each Servicer under the related
Servicing Agreement include collection and remittance of principal and interest
payments, administration of mortgage escrow accounts, collection of certain
insurance claims and, if necessary, foreclosure. Each Servicer may contract with
subservicers to perform some or all of such Servicer's servicing duties, but the
Servicer will not thereby be released from its obligations under the related
Servicing Agreement. When used herein with respect to servicing obligations, the
term Servicer includes a subservicer. The Mortgage Loans will not be master
serviced by a "Master Servicer" and no "Bond Account" will be established with
respect to the Mortgage Loans (as such terms are defined in the accompanying
prospectus).
Each Servicer will make reasonable efforts to collect all payments called
for under the Mortgage Loans and will, consistent with the related Servicing
Agreement and any primary mortgage insurance policy, follow such collection
procedures as are customary with respect to mortgage loans that are comparable
to the Mortgage Loans. Consistent with the above, each Servicer may, in its
discretion, (i) waive any assumption fee, late payment or other charge in
connection with a Mortgage Loan and (ii) to the extent not consistent with the
coverage of such Mortgage Loan by a primary mortgage insurance policy, arrange
with a mortgagor a schedule for the liquidation of delinquencies. So long as no
Event of Default has occurred and is continuing under the Indenture, the Bond
Issuer's prior approval or consent will be required for certain servicing
activities such as modification of the terms of any Mortgage Loan and the sale
of any defaulted Mortgage Loan or REO Property.
Pursuant to each Servicing Agreement, the Servicer will deposit collections
on the Mortgage Loans into the Custodial Account established by it. Each
Custodial Account is required to be kept segregated from operating accounts of
the related Servicer and to meet the eligibility criteria set forth in the
related Servicing Agreement. Under each Servicing Agreement, amounts on deposit
in the Custodial Account may be invested in certain permitted investments
described therein. Any losses resulting from such investments are required to be
reimbursed to the Custodial Account by the related Servicer out of its own
funds.
On or before the closing date, the Bond Trustee will establish the
Distribution Account into which each Servicer will remit all amounts required to
be deposited therein pursuant to the related Servicing Agreement (net of such
Servicer's servicing compensation) on the 18th day of each month (or, if the
18th is not a Business Day, on the first Business Day thereafter). Not later
than the 15th day of each month (a
S-48
"Determination Date"), each Servicer will furnish to the Bond Trustee
information with respect to loan level remittance data for such month's
remittance.
In the event of a default by a Servicer under its Servicing Agreement, the
Bond Trustee will have the right to remove the Servicer and will exercise that
right if it considers such removal to be in the best interest of the
Bondholders. In the event that the Bond Trustee removes a Servicer, the Bond
Trustee will act as successor servicer under the related Servicing Agreement or
will appoint a successor servicer acceptable to the Bond Issuer. In connection
with the removal of a Servicer, the Bond Trustee will be entitled to be
reimbursed from the assets of the Bond Issuer for all of its reasonable costs
associated with the transfer of servicing to a successor servicer.
SERVICING COMPENSATION AND PAYMENT OF EXPENSES
Each Servicer shall be entitled to receive, from interest actually
collected on each Mortgage Loan serviced by it, a servicing fee (the "Servicing
Fee") calculated as 0.375% per annum with respect to approximately 98.22% of the
Initial Mortgage Loans and with respect to the remaining Initial Mortgage Loans,
as either 0.438% or 0.938% per annum (each a "Servicing Fee Rate"), in each
case, as a percentage of the aggregate Stated Principal Balance of the Initial
Mortgage Loans serviced by such Servicer. The Servicers are also entitled to
receive, as additional servicing compensation, all late payment fees, assumption
fees and other similar charges and all reinvestment income earned on amounts on
deposit in the Custodial Accounts.
The amount of each Servicer's Servicing Fee is subject to adjustment with
respect to prepaid Mortgage Loans, as described below under "-- Adjustment to
Servicing Fees in Connection with Certain Prepaid Mortgage Loans."
ADJUSTMENT TO SERVICING FEES IN CONNECTION WITH CERTAIN PREPAID MORTGAGE LOANS
When a borrower prepays a Mortgage Loan between Due Dates, the borrower is
required to pay interest on the amount prepaid only to the date of prepayment
and not thereafter. Principal prepayments by borrowers received by a Servicer
during the Due Period for a Payment Date will be distributed to Bondholders on
the related Payment Date. Thus, less than one month's interest may have been
collected on Mortgage Loans that have been prepaid with respect to any Payment
Date. A "Prepayment Interest Shortfall" is the amount by which interest paid by
a borrower in connection with a prepayment of principal on a Mortgage Loan is
less than one month's interest at the related Mortgage Rate on the Stated
Principal Balance of such Mortgage Loan. Pursuant to each Servicing Agreement,
the related Servicing Fee for any month may be reduced, generally not below
zero, by the amount of any Prepayment Interest Shortfall, resulting from
prepayments in full occurring during such month with respect to the Mortgage
Loans serviced by the Servicer. The amount of interest available to be paid to
Bondholders will be reduced by any uncompensated Prepayment Interest Shortfalls.
ADVANCES
Subject to the limitations described in the following paragraph, each
Servicer will be required to advance prior to each Payment Date, from its own
funds, or funds in its Custodial Account that are not otherwise required to be
remitted to the Distribution Account for such Payment Date, an amount equal to
the scheduled payment of interest at the related Mortgage Rate (less the
applicable Servicing Fee Rate) and scheduled principal payment on each Mortgage
Loan which were due on the related Due Date and which were not received prior to
the Payment Date (any such advance, a "Monthly Advance").
Monthly Advances are intended to maintain a regular flow of scheduled
interest and principal payments on the Bonds rather than to guarantee or insure
against losses. Each Servicer is obligated to make Monthly Advances with respect
to delinquent payments of interest and principal on each Mortgage Loans serviced
by it, to the extent that such Monthly Advances are, in its reasonable judgment,
recoverable from future payments and collections or insurance payments or
proceeds of liquidation of the related Mortgage Loans. If a Servicer determines
on any Determination Date to make a Monthly Advance, such Monthly Advance will
be included with the payment to Bondholders on the related Payment Date.
S-49
EVIDENCE AS TO COMPLIANCE
Each Servicing Agreement provides that on or before a specified date in
each year, a firm of independent public accountants will furnish a statement to
the Bond Issuer and the Bond Trustee to the effect that, on the basis of the
examination by such firm conducted substantially in compliance with the Uniform
Single Attestation Program for Mortgage Bankers, the servicing by or on behalf
of the Servicer was conducted in compliance with its Servicing Agreement, except
for any significant exceptions or errors in records that, in the opinion of the
firm, the Uniform Single Attestation Program for Mortgage Bankers requires it to
report.
Each Servicing Agreement also provides for delivery to the Bond Issuer and
the Bond Trustee, on or before a specified date in each, of an annual statement
signed by two officers of the Servicer to the effect that the Servicer has
fulfilled its obligations under its Servicing Agreement throughout the preceding
year.
RESIGNATION OF SERVICERS; MERGER
A Servicer may not resign from its obligations and duties under its
Servicing Agreement or assign or transfer such duties or obligations except (i)
upon a determination that its duties thereunder are no longer permissible under
applicable law, (ii) upon the sale of substantially all of its assets or (iii)
upon a sale of its servicing rights with respect to the Mortgage Loans with the
prior written consents of the Bond Trustee and the Bond Issuer, which consents
may not be unreasonably withheld. No such resignation will become effective
until the Bond Trustee or a successor servicer appointed by it has assumed the
Servicer's obligations and duties under such Servicing Agreement.
Any person into which a Servicer may be merged or consolidated, or any
person resulting from any merger or consolidation which a Servicer is a party,
or any person succeeding to the business of a Servicer, will be the successor of
such Servicer under the related Servicing Agreement, provided that, in the case
of Cendant, such person is qualified to sell mortgage loans to, and service
mortgage loans on behalf of, Fannie Mae or Freddie Mac.
YIELD, PREPAYMENT AND WEIGHTED AVERAGE LIFE
GENERAL
The yields to maturity (or to early termination) of the Offered Bonds will
be affected by the rate of principal payments (including prepayments, which may
include amounts received by virtue of purchase, condemnation, insurance or
foreclosure) on the Mortgage Loans. Yields will also be affected by the extent
to which Mortgage Loans bearing higher Mortgage Rates prepay at a more rapid
rate than Mortgage Loans with lower Mortgage Rates, the amount and timing of
borrower delinquencies and defaults resulting in Realized Losses, the purchase
price for the Offered Bonds and other factors.
Principal prepayments may be influenced by a variety of economic,
geographic, demographic, social, tax, legal and other factors. The Mortgage
Loans do not provide for the payment of any penalty or premium in connection
with any voluntary prepayment in full or in part. In general, if prevailing
interest rates fall below the interest rates on the Mortgage Loans, the Mortgage
Loans are likely to be subject to higher prepayments than if prevailing rates
remain at or above the interest rates on the Mortgage Loans. Conversely, if
prevailing interest rates rise above the interest rates on the Mortgage Loans,
the rate of prepayment would be expected to decrease. Other factors affecting
prepayment of the Mortgage Loans include such factors as changes in borrowers'
housing needs, job transfers, unemployment, borrowers' net equity in the
mortgaged properties, changes in the value of the mortgaged properties, mortgage
market interest rates and servicing decisions. The Mortgage Loans generally have
due-on-sale clauses.
In the event that at the end of the Pre-Funding Period, not all of the
amount on deposit in the Pre-Funding Account has been used to acquire Subsequent
Mortgage Loans for inclusion in the Pledged Mortgage Pool, then Bondholders will
receive a partial prepayment on the Payment Date in December 2001, equal to the
amount remaining in the Pre-Funding Amount. Although no assurance can be given,
the Redwood Trust expects that the principal amount of Subsequent Mortgage Loans
sold to the Bond Issuer for inclusion in the
S-50
Pledged Mortgage Pool, will require the application of substantially all the
amount on deposit in the Pre-Funding Account and that there should be no
material principal prepaid to the Bondholders. See "Risk Factors -- Amounts in
the Pre-Funding Account May be Applied to Pay Principal on the Bonds."
Approximately 94.96% of the Initial Mortgage Loans have Mortgage Rates that
adjust on a semi-annual basis, and approximately 5.04% of the Initial Mortgage
Loans have Mortgage Rates that adjust on a monthly basis. Increases and
decreases in the Mortgage Rate on a Mortgage Loan will be limited (except in the
case of the first rate adjustment) by the maximum Mortgage Rate and the minimum
Mortgage Rate, if any, and will be based on the applicable index in effect on
the applicable date prior to the related interest rate adjustment date plus the
applicable gross margin. The applicable index may not rise and fall consistently
with Mortgage Rates. As a result, the Mortgage Rates on the Mortgage Loans at
any time may not equal the prevailing mortgage interest rates for similar
adjustable rate loans, and accordingly the prepayment rate may be lower or
higher than would otherwise be anticipated. Moreover, some borrowers who prefer
the certainty provided by fixed rate mortgage loans may nevertheless obtain
adjustable rate mortgage loans at a time when they regard the mortgage interest
rates (and, therefore, the payments) on fixed rate mortgage loans as
unacceptably high. These borrowers may be induced to refinance adjustable rate
loans when the mortgage interest rates and monthly payments on comparable fixed
rate mortgage loans decline to levels which these borrowers regard as
acceptable, even though such mortgage interest rates and monthly payments may be
significantly higher than the current mortgage interest rates and monthly
payments on the borrowers' adjustable rate mortgage loans. The ability to
refinance a Mortgage Loan will depend on a number of factors prevailing at the
time refinancing is desired, including, without limitation, real estate values,
the borrower's financial situation, prevailing mortgage interest rates, the
borrower's equity in the related mortgaged property, tax laws and prevailing
general economic conditions.
The rate of principal payments on the Mortgage Loans will also be affected
by the amortization schedules of the Mortgage Loans, the rate and timing of
prepayments thereon, liquidations of defaulted Mortgage Loans and repurchases of
Mortgage Loans due to certain breaches of representations and warranties or
defective documentation. The timing of changes in the rate of prepayments,
liquidations and repurchases of the related 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. Because 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 accompanying prospectus under "Weighted
Average Life Of The Bonds"), no assurance can be given as to such rate or the
timing of principal payments on the Offered Bonds. In general, the earlier a
prepayment of principal of the related Mortgage Loans, the greater the effect on
an investor's yield. The effect on an investor's yield of principal payments
occurring at a rate higher (or lower) than the rate anticipated by the investor
during the period immediately following the issuance of the Bonds may not be
offset by a subsequent like decrease (or increase) in the rate of principal
payments.
From time to time, areas of the United States may be affected by flooding,
severe storms, landslides, wildfires, earthquakes or other natural disasters.
Under the Mortgage Loan Purchase Agreement, Redwood Trust will represent and
warrant that as of the closing date each Mortgaged Property was free of material
damage. In the event of an uncured breach of this representation and warranty
that materially and adversely affects the interests of Bondholders, Redwood
Trust will be required to repurchase the affected Mortgage Loan or substitute
another mortgage loan therefor. If any damage caused by flooding, storms,
wildfires, landslides or earthquakes (or other cause) occurs after the closing
date, Redwood Trust will not have any repurchase obligation. In addition, the
standard hazard policies covering the Mortgaged Properties generally do not
cover damage caused by earthquakes, flooding and landslides, and earthquake,
flood or landslide insurance may not have been obtained with respect to such
Mortgaged Properties. As a consequence, Realized Losses could result. To the
extent that the insurance proceeds received with respect to any damaged Mortgage
Properties are not applied to the restoration thereof, the proceeds will be used
to prepay the related Mortgage Loans in whole or in part. Any repurchases or
repayments of the Mortgage Loans may reduce the weighted average lives of the
Offered Bonds and will reduce the yields on the Offered Bonds to the extent they
are purchased at a premium.
S-51
Prepayments, liquidations and repurchases of the Mortgage Loans will result
in distributions to Bondholders of principal amounts that would otherwise be
distributed over the remaining terms of such Mortgage Loans. 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.
As described herein, none of the Mortgage Loans provide for monthly
payments of principal for the first ten years following origination. Instead,
only monthly payments of interest are due during such period. Other
considerations aside, due to such characteristics, borrowers may be disinclined
to prepay the Mortgage Loans during such ten-year period. In addition, because
no principal is due on the Mortgage Loans for their initial ten year period, the
Bonds will amortize at a slower rate during such period than would otherwise be
the case. Thereafter, when the monthly payments on the Mortgage Loans are
recalculated on the basis of a fifteen year, level payment amortization schedule
as described herein, principal payments on the Bonds are expected to increase
correspondingly, and, in any case, at a faster rate than if payments on the
Mortgage Loans were calculated on the basis of a twenty-five year amortization
schedule. Notwithstanding the foregoing, no assurance can be given as to any
prepayment rate on the Mortgage Loans.
As described under "Description of the Bonds -- Payments of Principal"
herein, scheduled and unscheduled principal payments on the Mortgage Loans will
generally be allocated disproportionately to the Senior Bonds during the first
ten years following the closing date (except as described herein) or if certain
conditions are met. Such allocation will initially accelerate the amortization
of the Senior Bonds.
The yields on the Offered Bonds may also be adversely affected by Net
Prepayment Interest Shortfalls. The Bond Interest Rates, and the yields on the
Class A, Class B-1, Class B-2 and Class B-3 Bonds will be affected by the level
of LIBOR from time to time, and the yield on each class of Offered Bonds will be
affected by the Mortgage Rates of the Mortgage Loans from time to time, as
described under "Risk Factors -- Your Yield May Be Affected by Changes in
Interest Rates." No prediction can be made as to future levels of One-Month
LIBOR, Six-Month LIBOR (or One-Year Treasury or the Prime Rate, if the
conversion option is exercised) or as to the timing of any changes therein or as
to the rate or timing of any index conversion.
The yields to investors in the Offered Bonds will be affected by the
exercise of the Bond Issuer's option to redeem the Bonds, as described herein.
See "Description of the Bonds -- Optional Redemption of the Bonds" and
"-- Optional Clean-Up Redemption of the Bonds."
If the purchaser of a Bond offered at a discount from its initial principal
amount calculates its anticipated yield to maturity (or early termination) based
on an assumed rate of payment of principal that is faster than that actually
experienced on the related Mortgage Loans, the actual yield may be lower than
that so calculated. Conversely, if the purchaser of a Bond offered at a premium,
calculates its anticipated yield based on an assumed rate of payment of
principal that is slower than that actually experienced on the related Mortgage
Loans, the actual yield may be lower than that so calculated.
The effective yield to holders of the Offered Bonds will be lower than the
yield otherwise produced by the applicable Bond Interest Rate and the related
purchase price because monthly distributions will not be payable to such holders
until the 19th day of the month (or the immediately following Business Day if
such day is not a Business Day) following the month in which interest accrues on
the Mortgage Loans (without any additional distribution of interest or earnings
thereon in respect of such delay).
SUBORDINATION OF THE OFFERED SUBORDINATE BONDS
On each Payment Date, the holders of classes of Bonds having a relatively
higher priority of distribution will have a preferential right to receive
amounts of interest and principal due them on such Payment Date before any
distributions are made on any class of Bonds subordinate to such higher ranking
class. As a result, the yields to maturity and the aggregate amount of
distributions on the Class B-1, Class B-2 and Class B-3 Bonds will be more
sensitive than the yields of higher ranking Bonds to the rate of delinquencies
and defaults on the Mortgage Loans.
S-52
As more fully described herein, the principal portion of Realized Losses
(other than excess losses) on the Mortgage Loans will be allocated first to the
lower ranking class of Subordinate Bonds, then to the higher ranking class of
Subordinate Bonds, in inverse order of priority, until the Class Principal
Amount of each such class has been reduced to zero, before any such Realized
Losses will be allocated to the Senior Bonds. The interest portion of Realized
Losses on the Mortgage Loans (other than excess losses) will reduce the amount
available for distribution on the related Payment Date to the lowest ranking
related class outstanding on such date.
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 net reduction of principal of such
security (assuming no losses). The weighted average lives of the Offered Bonds
will be influenced by, among other things, the rate at which principal of the
related Mortgage Loans is paid, which may be in the form of scheduled
amortization, prepayments or liquidations.
For a discussion of the factors which may influence the rate of payments
(including prepayments) of the Mortgage Loans, see "Risk Factors -- Prepayments
Are Unpredictable and Affect Yield" herein and "Risk Factors -- Prepayment and
Yield Considerations; Reinvestment Risk" in the accompanying prospectus.
Prepayments of mortgage loans are commonly measured relative to a
prepayment standard or model. The model used in this prospectus supplement for
the Mortgage Loans is a Constant Prepayment Rate ("CPR"). CPR represents an
assumed constant rate of prepayment each month, relative to the then outstanding
principal balance of a pool of mortgage loans, for the life of such Mortgage
Loans.
CPR DOES NOT PURPORT TO BE EITHER AN HISTORICAL DESCRIPTION OF THE
PREPAYMENT EXPERIENCE OF ANY POOL OF MORTGAGE LOANS OR A PREDICTION OF THE
ANTICIPATED RATE OF PREPAYMENT OF ANY POOL OF MORTGAGE LOANS, INCLUDING THE
MORTGAGE LOANS.
The tables beginning on page S-56 of this prospectus supplement were
prepared on the basis of the following assumptions (collectively, the
"Structuring Assumptions"): (i) payments in respect of the Bonds are received in
cash on the 19th day of each month commencing in November 2001, (ii) the
Mortgage Loans prepay at the indicated percentages of CPR, (iii) no defaults or
delinquencies occur in the payment by borrowers of principal and interest on the
Mortgage Loans, and no shortfalls are incurred due to the application of the
Relief Act, (iv) Redwood Trust is not required to purchase or substitute for any
Mortgage Loan, (v) scheduled monthly payments on the Mortgage Loans are received
on the first day of each month commencing in November 2001 (December 2001 for
the Subsequent Mortgage Loans) and are computed prior to giving effect to any
prepayments received in the prior month, (vi) prepayments are allocated as
described herein without giving effect to loss and delinquency tests, (vii)
prepayments represent prepayments in full of individual Mortgage Loans and are
received on the last day of each month, commencing in October 2001 (November
2001 for the Subsequent Mortgage Loans) and include 30 days' interest, (viii)
the scheduled monthly payment for each Mortgage Loan has been calculated based
on the assumed mortgage loan characteristics described in item (xiv) below such
that each such Mortgage Loan will amortize in amounts sufficient to repay the
principal balance of such assumed mortgage loan by its remaining term to
maturity (taking into account any interest-only period), (ix) interest accrues
on each class of Bonds at the applicable Bond Interest Rate described under
"Description of the Bonds -- Payments of Interest" in this prospectus
supplement, (x) the initial Class Principal Amount of each class of Bonds is as
described in this prospectus supplement, (xi) Six-Month LIBOR is 2.3525% and
One-Month LIBOR is 2.4625% at all times, (xii) there is no conversion of the
index on which any Mortgage Rate is based, (xiii) no optional redemption of the
Bonds or exercise of any optional clean-up redemption, will occur, except that
this assumption does not apply to the calculation of weighted average lives to
the optional clean-up redemption, (xiv) the closing date of the sale of the
Offered Bonds is October 31, 2001, and (xv) the Mortgage Loans are aggregated
into assumed Mortgage Loans having the following characteristics:
S-53
ASSUMED MORTGAGE LOAN CHARACTERISTICS
REMAINING INTEREST-
CURRENT NET TERM TO ONLY GROSS
PRINCIPAL MORTGAGE MORTGAGE MATURITY REMAINING MARGIN
LOAN TYPE(1) BALANCE($) RATE(%) RATE(%) (MONTHS) (MONTHS) (%)
------------ -------------- -------- -------- --------- --------- -------
One-Month LIBOR
Initial Mortgage Loan..................... 22,396,386.27 5.31228 4.93278 298 118 1.57135
Six-Month LIBOR
Initial Mortgage Loan..................... 37,692,385.24 5.91162 5.53212 297 117 1.94485
Six-Month LIBOR
Initial Mortgage Loan..................... 253,052,212.42 5.78450 5.40500 297 117 1.78003
Six-Month LIBOR
Initial Mortgage Loan..................... 131,540,127.91 5.56934 5.17659 298 118 1.70029
One-Month LIBOR
Subsequent Mortgage Loan(2)............... 3,525,553.47 5.31228 4.93278 300 120 1.57135
Six-Month LIBOR
Subsequent Mortgage Loan(2)............... 5,933,391.13 5.91162 5.53212 300 120 1.94485
Six-Month LIBOR
Subsequent Mortgage Loan(2)............... 39,834,511.51 5.78450 5.40500 300 120 1.78003
Six-Month LIBOR
Subsequent Mortgage Loan(2)............... 20,706,543.88 5.56934 5.17659 300 120 1.70029
MAXIMUM MINIMUM NEXT RATE
MORTGAGE MORTGAGE ADJUSTMENT
LOAN TYPE(1) RATE(%) RATE(%) (MONTHS)
------------ -------- -------- ----------
One-Month LIBOR
Initial Mortgage Loan..................... 12.00000 1.57135 1
Six-Month LIBOR
Initial Mortgage Loan..................... 12.81100 1.94485 3
Six-Month LIBOR
Initial Mortgage Loan..................... 12.19528 1.78003 3
Six-Month LIBOR
Initial Mortgage Loan..................... 12.00000 1.70029 4
One-Month LIBOR
Subsequent Mortgage Loan(2)............... 12.00000 1.57135 1
Six-Month LIBOR
Subsequent Mortgage Loan(2)............... 12.81100 1.94485 6
Six-Month LIBOR
Subsequent Mortgage Loan(2)............... 12.19528 1.78003 6
Six-Month LIBOR
Subsequent Mortgage Loan(2)............... 12.00000 1.70029 6
---------------
(1) Each assumed Mortgage Loan has a weighted average original term of 25 years.
(2) Each assumed Subsequent Mortgage Loan is assumed to be delivered to the Bond
Issuer on November 1, 2001. The characteristics set forth above are
applicable for the Mortgage Loan payment due on December 1, 2001.
S-54
The actual characteristics and the performance of the Mortgage Loans will
differ from the assumptions used in constructing the tables set forth below,
which are hypothetical in nature and are provided only to give a general sense
of how the principal cash flows might behave under varying prepayment scenarios.
For example, it is not expected that the Mortgage Loans will prepay at a
constant rate until maturity, that all of the Mortgage Loans will prepay at the
same rate or that there will be no defaults or delinquencies on the Mortgage
Loans. Moreover, the diverse remaining terms to maturity of the Mortgage Loans
could produce slower or faster principal distributions than indicated in the
tables at the various percentages of CPR 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 cause the
percentages of initial Class Principal Amounts outstanding over time and the
weighted average lives of the Offered Bonds to differ (which difference could be
material) from the corresponding information in the tables for each indicated
percentage of CPR.
Subject to the foregoing discussion and assumptions, the following tables
indicate the weighted average lives of the Offered Bonds and set forth the
percentages of the initial Class Principal Amounts of the Offered Bonds that
would be outstanding after each of the Payment Dates shown at various
percentages of CPR.
The weighted average life of an Offered Bond is determined by (1)
multiplying the net reduction, if any, of the applicable Class Principal Amount
by the number of years from the date of issuance of the Offered Bond to the
related Payment Date, (2) adding the results and (3) dividing the sum by the
aggregate of the net reductions of Class Principal Amount described in (1)
above.
S-55
PERCENTAGE OF INITIAL CLASS PRINCIPAL AMOUNT OF THE OFFERED BONDS
OUTSTANDING AT THE FOLLOWING PERCENTAGES OF CPR
CLASS A BONDS
----------------------------------------------
PAYMENT DATE 10% 15% 20% 25% 30% 35% 40%
------------ ---- ---- ---- ---- ---- ---- ----
Initial Percentage............................. 100% 100% 100% 100% 100% 100% 100%
October 2002................................... 90 85 79 74 69 64 59
October 2003................................... 80 71 63 55 47 41 34
October 2004................................... 72 60 50 41 33 26 20
October 2005................................... 64 51 40 30 23 17 12
October 2006................................... 58 43 32 23 16 11 7
October 2007................................... 52 36 25 17 11 7 4
October 2008................................... 46 31 20 13 8 5 3
October 2009................................... 42 26 16 10 5 3 2
October 2010................................... 37 22 13 7 4 2 1
October 2011................................... 33 19 10 5 3 1 1
October 2012................................... 28 15 8 4 2 1 0
October 2013................................... 24 12 6 3 1 0 0
October 2014................................... 20 10 4 2 1 0 0
October 2015................................... 17 8 3 1 1 0 0
October 2016................................... 14 6 2 1 0 0 0
October 2017................................... 12 5 2 1 0 0 0
October 2018................................... 10 4 1 0 0 0 0
October 2019................................... 8 3 1 0 0 0 0
October 2020................................... 6 2 1 0 0 0 0
October 2021................................... 5 1 0 0 0 0 0
October 2022................................... 3 1 0 0 0 0 0
October 2023................................... 2 1 0 0 0 0 0
October 2024................................... 1 0 0 0 0 0 0
October 2025................................... 1 0 0 0 0 0 0
October 2026................................... 0 0 0 0 0 0 0
October 2027................................... 0 0 0 0 0 0 0
October 2028................................... 0 0 0 0 0 0 0
October 2029................................... 0 0 0 0 0 0 0
October 2030................................... 0 0 0 0 0 0 0
October 2031................................... 0 0 0 0 0 0 0
Weighted Average Life in Years
to maturity.................................. 7.76 5.62 4.27 3.36 2.73 2.26 1.91
to optional clean-up redemption of the
Bonds..................................... 7.46 5.28 3.95 3.08 2.48 2.06 1.73
S-56
PERCENTAGE OF INITIAL CLASS PRINCIPAL AMOUNT OF THE OFFERED BONDS
OUTSTANDING AT THE FOLLOWING PERCENTAGES OF CPR
CLASS B-1, B-2 AND B-3 BONDS
-----------------------------------------------------
PAYMENT DATE 10% 15% 20% 25% 30% 35% 40%
------------ ----- ---- ---- ---- ---- ---- ----
Initial Percentage...................... 100% 100% 100% 100% 100% 100% 100%
October 2002............................ 100 100 100 100 100 100 100
October 2003............................ 100 100 100 100 100 93 86
October 2004............................ 100 100 100 92 83 74 66
October 2005............................ 100 100 83 69 58 48 39
October 2006............................ 100 90 66 52 40 31 24
October 2007............................ 100 76 53 39 28 20 14
October 2008............................ 97 65 43 29 20 13 9
October 2009............................ 87 55 34 22 14 9 5
October 2010............................ 78 47 27 16 10 6 3
October 2011............................ 70 39 22 12 7 4 2
October 2012............................ 60 32 16 9 4 2 1
October 2013............................ 51 26 12 6 3 1 1
October 2014............................ 43 20 9 4 2 1 0
October 2015............................ 36 16 7 3 1 1 0
October 2016............................ 30 13 5 2 1 0 0
October 2017............................ 25 10 4 1 1 0 0
October 2018............................ 20 8 3 1 0 0 0
October 2019............................ 16 6 2 1 0 0 0
October 2020............................ 13 4 1 0 0 0 0
October 2021............................ 10 3 1 0 0 0 0
October 2022............................ 7 2 1 0 0 0 0
October 2023............................ 5 1 0 0 0 0 0
October 2024............................ 3 1 0 0 0 0 0
October 2025............................ 1 0 0 0 0 0 0
October 2026............................ 0 0 0 0 0 0 0
October 2027............................ 0 0 0 0 0 0 0
October 2028............................ 0 0 0 0 0 0 0
October 2029............................ 0 0 0 0 0 0 0
October 2030............................ 0 0 0 0 0 0 0
October 2031............................ 0 0 0 0 0 0 0
Weighted Average Life in Years
to maturity........................... 13.01 9.66 7.41 6.11 5.21 4.54 4.01
to optional clean-up redemption of the
Bonds.............................. 12.38 8.94 6.74 5.46 4.59 3.96 3.46
S-57
USE OF PROCEEDS
The Bond Issuer intends to distribute all of the net proceeds of the
issuance of the Offered Bonds (other than those proceeds not necessary to
establish the Pre-Funding Account) to the Depositor which will use such proceeds
to pay for the acquisition of the Initial Mortgage Loans from Redwood Trust. See
"USE OF PROCEEDS" in the accompanying prospectus and "Method of Distribution" in
this prospectus supplement.
FEDERAL INCOME TAX CONSEQUENCES
For federal income tax purposes, the Trust Estate will be deemed to include
two segregated asset pools referred to as the Upper-Tier REMIC and the
Lower-Tier REMIC. The Lower Tier REMIC will hold as its assets the assets
included in the Trust Estate other than the Additional Collateral, the
Pre-Funding Account, the Capitalized Interest Account and the Basis Risk Reserve
Fund. The Upper Tier REMIC will hold as assets the several uncertificated
regular interests in the Lower-Tier REMIC. Elections will be made to treat each
pool as a separate REMIC for federal income tax purposes. The Bonds, other than
the Class A-R Bond, will represent ownership of regular interests in the
Upper-Tier REMIC, and the Class A-R Bond will represent ownership of the
residual interest in each of the Upper-Tier REMIC and the Lower-Tier REMIC.
Accordingly, prospective investors should review the section entitled "REMIC
Bonds" under "Federal Income Tax Consequences" in the accompanying prospectus.
In addition, each Offered Bond will represent a beneficial interest in the
right to receive payments from the Basis Risk Reserve Fund pursuant to the
provisions of the Indenture. For information reporting purposes, the Bond
Trustee will treat the entitlement to such payments as an interest in an
interest rate cap contract written by the Class X Bondholder in favor of the
holders of the Offered Bonds (the "Interest Rate Cap Agreement"), and, under the
terms of the Indenture, each holder of an Offered Bond and the Class X
Bondholder will agree, by virtue of their purchase of such Bonds, to adopt a tax
reporting position consistent with that characterization. Alternative
characterizations of such rights are, however, possible. For instance, the right
to receive such payments could be classified for federal income tax purposes as
an interest in a partnership formed among the holders of the Offered Bonds and
the Class X Bondholder to share cash flows from the Class X Bond. Such an
alternative characterization would result in tax treatment of payments of Basis
Risk Shortfalls that would differ from that which is described below.
Prospective investors in the Offered Bonds should consult their tax advisors
regarding the tax treatment of the rights of the holders of such Bonds to
receive payments in respect of Basis Risk Shortfalls.
A holder of an Offered Bond must allocate its purchase price for such Bond
between its two components -- the regular interest component and the Interest
Rate Cap Agreement component. For information reporting purposes, the Bond
Trustee will assume that, with respect to any Offered Bond, the Interest Rate
Cap Agreement component will have only nominal value relative to the value of
the regular interest component. The IRS could argue, however, that the Interest
Rate Cap Agreement component has significant value, and if that argument were to
be sustained, the regular interest component could be viewed as having been
issued with an additional amount of original issue discount ("OID") (which could
cause the total amount of discount to exceed a statutorily defined de minimis
amount). See "Material Federal Income Tax Consequences -- Taxation of Regular
Interest Bonds" in the accompanying prospectus.
Upon the sale, exchange, or other disposition of an Offered Bond, the
holder must allocate the amount realized between the two components of such Bond
based on the relative fair market values of those components at the time of
sale. Assuming that an Offered Bond is held as a capital asset within the
meaning of Section 1221 of the Code, gain or loss on the disposition of an
interest in the Interest Rate Cap Agreement component should be capital gain or
loss, and, gain or loss on the disposition of the regular interest component
should, subject to the limitation described below, be capital gain or loss.
Except for any amounts of accrued but unrecognized market discount, and except
as provided in this paragraph, any gain or loss on the sale or exchange of the
regular interest component of an Offered Bond realized by an investor who holds
such Bond as a capital asset will be capital gain or loss and will be long-term
or short-term depending on whether the Bond has been held for the long-term
capital gain holding period (currently more than one year). Such gain will be
treated as ordinary income (i) if the Bond is held as part of a conversion
transaction, as described in Code
S-58
Section 1258(c), up to the amount of interest that would have accrued on the
holder's net investment in the conversion transaction at 120% of the appropriate
applicable Federal rate under Code Section 1274(d) in effect at the time the
holder entered into the transaction minus any amount previously treated as
ordinary income with respect to any prior disposition of property that was held
as a part of such transaction, (ii) in the case of a non-corporate taxpayer, to
the extent such taxpayer has made an election under Code Section 163(d)(4) to
have net capital gains taxed as investment income at ordinary income rates, or
(iii) to the extent that such gain does not exceed the excess, if any, of (a)
the amount that would have been includable in the gross income of the holder if
its yield on such Bond were 110% of the applicable Federal rate as of the date
of purchase, over (b) the amount of income actually includable in the gross
income of such holder with respect to such Bond. In addition, gain or loss
recognized from the sale of an Offered Bond by certain banks or thrift
institutions will be treated as ordinary income or loss pursuant to Code Section
582(c). Long-term capital gains of certain non-corporate taxpayers are subject
to a lower minimum tax rate than ordinary income of such taxpayers for property
held for more than one year. The maximum tax rate for corporations is the same
with respect to both ordinary income and capital gains.
As indicated above, a portion of the purchase price paid by a holder to
acquire an Offered Bond will be attributable to the Interest Rate Cap Agreement
component of such Bond. The portion of the overall purchase price attributable
to the Interest Rate Cap Agreement component must be amortized over the life of
such Offered Bond, taking into account the declining balance of the related
regular interest component. Treasury regulations concerning notional principal
contracts provide alternative methods for amortizing the purchase price of an
interest rate cap contract. Under one method -- the level yield constant
interest method -- the price paid for an interest rate cap agreement is
amortized over the life of the cap as though it were the principal amount of a
loan bearing interest at a reasonable rate. Bondholders are urged to consult
their tax advisors concerning the methods that can be employed to amortize the
portion of the purchase price paid for the Interest Rate Cap Agreement component
of an Offered Bond.
Any payments made to a holder of an Offered Bond from the Basis Risk
Reserve Fund will be treated as periodic payments on an interest rate cap
agreement. To the extent the sum of such periodic payments for any year exceed
that year's amortized cost of the Interest Rate Cap Agreement component, such
excess is ordinary income. If for any year the amount of that year's amortized
cost exceeds the sum of the periodic payments, such excess is allowable as an
ordinary deduction.
The regular interest component of each Offered Bond will be treated as (i)
assets described in Section 7701(a)(19)(C) of the Internal Revenue Code of 1986,
as amended (the "Code") and (ii) "real estate assets" under Section 856(c)(4)(A)
of the Code, in the same proportion that the assets of the Trust Estate,
exclusive of the Basis Risk Reserve Fund, would be so treated. The Interest Rate
Cap Agreement component of the Offered Bonds will not be treated as assets
described in Section 7701(a)(19)(C) of the Code or "real estate assets" under
Section 856(c)(4)(A) of the Code.
The Offered Bonds may be treated as having been issued with original issue
discount. The prepayment assumption that will be used for purposes of computing
original issue discount, if any, for federal income tax purposes is a CPR of
25%. No representation is made that the Mortgage Loans will, in fact, prepay at
this or any other rate.
Under federal income tax law, a Bondholder, beneficial owner, financial
intermediary or other recipient of a payment on behalf of a beneficial owner may
be subject backup withholding. For payments made after August 6, 2001, backup
withholding is made at a rate generally equal to the fourth lowest rate of
income tax then in effect. See "Federal Income Tax Consequences -- Backup
Withholding" in the accompanying prospectus for a general discussion of the
mechanics of backup withholding.
All investors are urged to review the section entitled "Federal Income Tax
Consequences" in the accompanying prospectus.
S-59
ERISA MATTERS
The Employee Retirement Income Security Act of 1974, as amended ("ERISA")
and the Code impose requirements on certain employee benefit plans -- and on
certain other retirement plans and arrangements, including individual retirement
accounts and annuities, Keogh plans and collective investment funds and separate
accounts in which plans, accounts or arrangements are invested -- and on persons
who are fiduciaries with respect to these types of plans and arrangements
(together, "Plans").
ERISA prohibits "parties in interest" with respect to a Plan from engaging
in certain transactions involving the Plan and its assets unless a statutory,
regulatory or administrative exemption applies to the transaction. Section 4975
of the Code imposes certain excise taxes on prohibited transactions involving
plans described under that section; ERISA authorizes the imposition of civil
penalties for prohibited transactions involving plans not covered under Section
4975 of the Code. Any Plan fiduciary which proposes to cause a Plan to acquire
any of the Offered Bonds should consult with its counsel with respect to the
potential consequences under ERISA and the Code of the Plan's acquisition and
ownership of such Bonds. See "ERISA MATTERS" in the accompanying prospectus.
Certain employee benefit plans, including governmental plans and certain
church plans, are not subject to ERISA's requirements. Accordingly, assets of
those plans may be invested in the Offered Bonds without regard to the ERISA
considerations described in this prospectus supplement and in the accompanying
prospectus, subject to the provisions of other applicable federal and state law.
Any such plan which is qualified and exempt from taxation under Sections 401(a)
and 501(a) of the Code may nonetheless be subject to the prohibited transaction
rules set forth in Section 503 of the Code.
Investments by Plans that are subject to ERISA are subject to ERISA's
general fiduciary requirements, including the requirement of investment prudence
and diversification and the requirement that a Plan's investments be made in
accordance with the documents governing the Plan. A fiduciary which decides to
invest the assets of a Plan in the Offered Bonds should consider, among other
factors, the extreme sensitivity of the investments to the rate of principal
payments (including prepayments) on the Mortgage Loans.
The U.S. Department of Labor has granted to Greenwich Capital Markets, Inc.
Prohibited Transaction Exemption (PTE) 90-59 (Exemption Application No. D-8374),
as amended by PTE 97-34 (Exemption Application No. D-10245 and D-10246) and by
PTE 2000-58 (Exemption Application No. D-10829), which exempts from the
application of the prohibited transaction rules transactions relating to:
- the acquisition, holding and sale by Plans of certain securities
representing debt instruments issued by a trust with respect to which
Greenwich Capital Markets, Inc. or any of its affiliates is the sole
underwriter or the manager or co-manager of the underwriting syndicate,
and
- the servicing, operation and management of such trusts,
provided that the general conditions and certain other requirements set forth in
the exemption are satisfied.
Each of the conditions listed below must be satisfied for the exemption to
apply:
- The acquisition of the Offered Bonds by a Plan is on terms (including the
price for the Bonds) that are at least as favorable to the Plan as they
would be in an arm's length transaction with an unrelated party.
- The Offered Bonds acquired by the Plan have received a rating at the time
of such acquisition that is one of the four highest generic rating
categories from a rating agency identified in the exemption, such as S&P,
Fitch or Moody's.
- The Bond Trustee must not be an affiliate of any other member of the
"restricted group" (defined below in the second following paragraph).
- The sum of all payments made to and retained by the Underwriters in
connection with the distribution of the Offered Bonds represents not more
than reasonable compensation for Underwriting the Offered Bonds; the sum
of all payments made to and retained by Redwood Trust and the Depositor
pursuant to the assignment of the trust assets to the Bond Issuer
represents not more than the fair market value of
S-60
such assets; the sum of all payments made to and retained by any Servicer
represents not more than reasonable compensation for the Servicer's
services under the related Servicing Agreement and reimbursements of such
person's reasonable expenses in connection therewith.
- The Plan investing in the Offered Bonds is an "accredited investor" as
defined in Rule 501(a)(1) of Regulation D of the SEC under the Securities
Act of 1933.
The Bond Issuer must also meet each of the requirements listed below:
- The Pledged Mortgage Pool must consist solely of assets of the type that
have been included in other investment pools.
- Bonds representing indebtedness backed by such other investment pools
must have been rated in one of the three highest generic rating
categories (four, if the investment pool contains certain types of
assets) by a rating agency for at least one year prior to the Plan's
acquisition of Offered Bonds.
- Bonds evidencing indebtedness backed by such other investment pools must
have been purchased by investors other than Plans for at least one year
prior to any Plan's acquisition of Offered Bonds.
Moreover, the exemption provides relief from certain self-dealing/conflict
of interest prohibited transactions that may occur when the Plan fiduciary
causes a Plan to acquire indebtedness of a trust holding receivables as to which
the fiduciary (or its affiliate) is an obligor provided, among other
requirements, that:
- in the case of an acquisition in connection with the initial issuance of
Bonds, at least 50% of each class of Bonds in which Plans have invested
and at least 50% of the aggregate interests in the trust is acquired by
persons independent of the restricted group;
- such fiduciary (or its affiliate) is an obligor with respect to not more
than 5% of the fair market value of the obligations contained in the
trust;
- the Plan's investment in Offered Bonds of any class does not exceed 25%
of all of the Bonds of that class outstanding at the time of the
acquisition; and
- immediately after the acquisition, no more than 25% of the assets of any
Plan with respect to which such person is a fiduciary are invested in
securities representing indebtedness of one or more issuers containing
assets sold or serviced by the same entity.
This relief does not apply to Plans sponsored by members of the "restricted
group" consisting of the Depositor, any Servicer, the Bond Trustee, any
indemnitor or any obligor with respect to Mortgage Loans included in the assets
of the Bond Issuer constituting more than 5% of the aggregate unamortized
principal balance of the assets of the Bond Issuer, or any affiliate of these
parties.
It is expected that the exemption will apply to the acquisition and holding
by Plans of the Offered Bonds and that all conditions of the exemption other
than those within the control of the investors will be met.
The rating of a class of Offered Bonds may change. If a class of Offered
Bonds no longer has a rating of at least "BBB-", Bonds of that class will no
longer be eligible for relief under the exemption, and consequently may not be
purchased by or sold to a Plan (although a Plan that had purchased the Bond when
it had an investment-grade rating would not be required by the exemption to
dispose of it).
BECAUSE THE CHARACTERISTICS OF THE CLASS A-R BOND MAY NOT MEET THE
REQUIREMENTS OF THE EXEMPTION DISCUSSED ABOVE OR ANY OTHER ISSUED EXEMPTION
UNDER ERISA INCLUDING PROHIBITED TRANSACTION CLASS EXEMPTION (PTCE) 83-1, THE
PURCHASE AND HOLDING OF THE CLASS A-R BOND BY A PLAN OR BY INDIVIDUAL RETIREMENT
ACCOUNTS OR OTHER PLANS SUBJECT TO SECTION 4975 OF THE CODE MAY RESULT IN
PROHIBITED TRANSACTIONS OR THE IMPOSITION OF EXCISE TAXES OR CIVIL PENALTIES.
CONSEQUENTLY, THE INITIAL ACQUISITION AND
S-61
TRANSFER OF THE CLASS A-R BOND WILL NOT BE REGISTERED BY THE BOND TRUSTEE UNLESS
THE BOND TRUSTEE RECEIVES:
- a representation from the acquiror or transferee of the Class A-R Bond to
the effect that the transferee is not an employee benefit plan subject to
section 406 of ERISA or a plan or arrangement subject to section 4975 of
the Code, nor a person acting on behalf of any such plan or arrangement
nor using the assets of any such plan or arrangement to effect such
transfer, or
- if the purchaser is an insurance company, a representation that the
purchaser is an insurance company which is purchasing the Class A-R Bond
with funds contained in an "insurance company general account" (as such
term is defined in Section V(e) of PTCE 95-60) and that the purchase and
holding of the Class A-R Bond are covered under Section I and III of PTCE
95-60.
Prospective Plan investors should consult with their legal advisors
concerning the impact of ERISA and the Code, the applicability of the exemption
described above and PTCE 83-1 described in the prospectus, and the potential
consequences in their specific circumstances prior to making an investment in
the Offered Bonds. Moreover, each Plan fiduciary should determine whether under
the general fiduciary standards of investment prudence and diversification, an
investment in the Offered Bonds is appropriate for the Plan, taking into account
the overall investment policy of the Plan and the composition of the Plan's
investment portfolio.
METHOD OF DISTRIBUTION
Subject to the terms and conditions set forth in the Underwriting Agreement
among the Depositor, Redwood Trust and Greenwich Capital Markets, Inc. and Bear,
Stearns & Co. Inc. (together, the "Underwriters"), the Depositor has agreed to
cause the Bond Issuer to sell to the Underwriters, and the Underwriters have
agreed to purchase from the Bond Issuer, the initial Class Principal Amount of
each class of Offered Bonds as set forth below.
Distribution of the Offered Bonds will be made by the Underwriters from
time to time in negotiated transactions or otherwise at varying prices to be
determined at the time of sale. In connection with the sale of the Offered
Bonds, the Underwriters may be deemed to have received compensation from the
Bond Issuer in the form of underwriting discounts.
GREENWICH CAPITAL
CLASS MARKETS, INC. BEAR, STEARNS & CO. INC.
----- ----------------- ------------------------
A............................................... $372,500,250 $124,166,750
B-1............................................. 5,918,000 0
B-2............................................. 5,146,000 0
B-3............................................. 2,316,000 0
The Underwriters intend to make a secondary market in the Offered Bonds,
but have no obligation to do so. There can be no assurance that a secondary
market for the Offered Bonds will develop or, if it does develop, that it will
continue or that it will provide Bondholders with a sufficient level of
liquidity of investment. The Offered Bonds will not be listed on any national
securities exchange.
Immediately prior to the sale of the Initial Mortgage Loans to the
Depositor, the Initial Mortgage Loans were subject to financing provided by an
affiliate of Greenwich Capital Markets, Inc. A portion of the proceeds from the
sale of the Initial Mortgage Loans to the Depositor will be applied to repay the
financing.
The Depositor and Redwood Trust have agreed to indemnify the Underwriters
against, or make contributions to the Underwriters with respect to, certain
liabilities, including liabilities under the Securities Act of 1933, as amended.
Expenses incurred by the Depositor in connection with this offering are
expected to be approximately $700,000.
S-62
LEGAL MATTERS
The validity of the Bonds will be passed upon for the Bond Issuer by Tobin
& Tobin, a professional corporation, San Francisco, California. Certain tax
matters will be passed upon by for the Bond Issuer by GnazzoThill, A
Professional Corporation, San Francisco, California. McKee Nelson LLP,
Washington, D.C. will act as counsel for the Underwriters.
RATINGS
It is a condition of the issuance of the Senior Bonds that they be rated
"AAA" by each of Fitch, Inc. ("Fitch") and Standard and Poor's Rating Services,
a division of The McGraw-Hill Companies, Inc. ("S&P") and "Aaa" by Moody's
Investors Service, Inc. ("Moody's" and collectively with Fitch and S&P, the
"Rating Agencies"). It is a condition to the issuance of the Class B-1 Bonds
that they be rated "AA" by each of Fitch and S&P and "Aa2" by Moody's. It is a
condition to the issuance of the Class B-2 Bonds that they be rated "A" by each
of Fitch and S&P and "A2" by Moody's. It is a condition to the issuance of the
Class B-3 Bonds that they be rated "BBB" by each of Fitch and S&P and "Baa2" by
Moody's.
The ratings assigned to collateralized mortgage obligations address the
likelihood of the receipt of all payments on the mortgage loans by the related
bondholders under the agreements pursuant to which such bonds are issued. Such
ratings take into consideration the credit quality of the related mortgage pool,
including any credit support providers, structural and legal aspects associated
with such bonds, and the extent to which the payment stream on the mortgage pool
is adequate to make the payments required by such bonds. Ratings on such bonds
do not, however, constitute a statement regarding frequency of prepayments of
the mortgage loans.
The ratings do not address the likelihood that any Basis Risk Shortfalls or
unpaid Basis Risk Shortfalls will be repaid to holders of the Offered Bonds.
The ratings assigned to the Offered Bonds should be evaluated independently
from similar ratings on other types of securities. A rating is not a
recommendation to buy, sell or hold securities and may be subject to revision or
withdrawal at any time by the Rating Agencies.
The Bond Issuer has not requested a rating of the Offered Bonds by any
rating agency other than the Rating Agencies; there can be no assurance,
however, as to whether any other rating agency will rate the Offered Bonds or,
if it does, what rating would be assigned by such other rating agency. The
rating assigned by such other rating agency to the Offered Bonds could be lower
than the respective ratings assigned by the Rating Agencies.
S-63
INDEX OF CERTAIN DEFINITIONS
PAGE
----
A Margin.............................. S-20
Accrual Period........................ S-19
Additional Collateral................. S-33
Additional Collateral Loans........... S-33
Aggregate Subordinated Percentage..... S-23
Applicable Credit Support
Percentage.......................... S-25
Available Payment Amount.............. S-18
B-1 Margin............................ S-20
B-2 Margin............................ S-20
B-3 Margin............................ S-20
Bankruptcy Coverage Termination
Date................................ S-28
Bankruptcy Loss Limit................. S-27
Bankruptcy Losses..................... S-27
Basis Risk Reserve Fund............... S-21
Basis Risk Reserve Fund Deposit....... S-21
Basis Risk Shortfall.................. S-21
BBA................................... S-21
BBAM.................................. S-21
Beneficial Owner...................... S-14
Bishop's Gate......................... S-32
Bond Interest Rate.................... S-20
Bond Issuer........................... S-12
Bond Payment Amount................... S-18
Bond Principal Amount................. S-19
Bond Trustee.......................... S-13
Bond Trustee Fee Rate................. S-31
Bondholder............................ S-14
Bonds................................. S-12
Book-Entry Bonds...................... S-14
Business Day.......................... S-13
CalPERS Action........................ S-47
Capitalized Interest Account.......... S-18
Cendant............................... S-32
Class Notional Amount................. S-19
Class Principal Amount................ S-19
Class Subordination Percentage........ S-25
Clearstream Luxembourg................ S-14
Clearstream Luxembourg Participants... S-15
Code.................................. S-59
Controlling Class..................... S-31
Cooperative........................... S-16
CPR................................... S-53
Credit Scores......................... S-33
CUC................................... S-46
PAGE
----
Current Interest...................... S-19
Custodial Account..................... S-17
Cut-off Date Pool Principal Balance... S-31
Debt Service Reduction................ S-27
Defective Mortgage Loan............... S-41
Deficient Valuation................... S-27
Definitive Bonds...................... S-14
Deleted Mortgage Loan................. S-41
Deposit Trust Agreement............... S-12
Depositor............................. S-12
Designated Telerate Page.............. S-21
Determination Date.................... S-49
Distribution Account.................. S-17
District Court........................ S-47
DTC................................... S-14
Due Date.............................. S-32
Effective Loan-to-Value Ratio......... S-33
ERISA................................. S-60
Euroclear............................. S-14
Euroclear Operator.................... S-16
Euroclear Participants................ S-16
European Depositaries................. S-14
Excess Losses......................... S-28
Expense Rate.......................... S-20
Financial Intermediary................ S-14
Fitch................................. S-63
FlexSource(TM) Loans.................. S-33
Fraud Loss Limit...................... S-28
Fraud Losses.......................... S-27
HFS................................... S-46
Indenture............................. S-13
Initial Mortgage Loans................ S-31
Insurance Proceeds.................... S-18
Interest Payment Amount............... S-19
Interest Rate Cap Agreement........... S-58
Interest Settlement Rate.............. S-21
Interest Shortfall.................... S-20
Investor Certificate.................. S-12
LIBOR................................. S-21
LIBOR Bonds........................... S-13
LIBOR Business Day.................... S-22
LIBOR Determination Date.............. S-21
Limited Purpose Surety Bonds.......... S-34
Liquidated Mortgage Loan.............. S-27
S-64
PAGE
----
Liquidation Proceeds.................. S-18
Loan-to-Value Ratio................... S-32
Management Agreement.................. S-12
Manager............................... S-12
MLCC.................................. S-32
Monthly Advance....................... S-49
Moody's............................... S-63
Mortgage.............................. S-41
Mortgage File......................... S-41
Mortgage Loan Purchase Agreement...... S-32
Mortgage Loans........................ S-31
Mortgage Note......................... S-41
Mortgaged Property.................... S-31
MSDWCC................................ S-32
Net Mortgage Rate..................... S-20
Net Prepayment Interest Shortfalls.... S-19
Net WAC............................... S-20
Offered Bonds......................... S-13
OID................................... S-58
One-Month LIBOR....................... S-39
One-Year Treasury..................... S-40
Order................................. S-47
Originators........................... S-32
Owner Trustee......................... S-12
Parent Power(R) Loans................. S-33
Participant........................... S-14
Payment Date.......................... S-13
Plans................................. S-60
Pledged Mortgage Pool................. S-31
Pool Balance.......................... S-23
Pre-Funding Account................... S-18
Pre-Funding Period.................... S-19
Prepayment Interest Shortfall......... S-19
Prepayment Period..................... S-18
Prime Rate............................ S-40
Privately-Offered Bonds............... S-13
Pro Rata Senior Percentage............ S-23
Rating Agencies....................... S-63
Realized Loss......................... S-27
PAGE
----
Record Date........................... S-13
Redwood Trust......................... S-12
Relevant Depositary................... S-14
Relief Act............................ S-19
Relief Act Reduction.................. S-19
Replacement Mortgage Loan............. S-41
Rules................................. S-14
S&P................................... S-63
Scheduled Payment..................... S-22
Scheduled Payments.................... S-32
SEC................................... S-47
Seller................................ S-12
Senior Bonds.......................... S-13
Senior Percentage..................... S-23
Senior Prepayment Percentage.......... S-23
Senior Principal Payment Amount....... S-22
Servicers............................. S-44
Servicing Fee......................... S-49
Servicing Fee Rate.................... S-49
Six-Month LIBOR....................... S-39
Special Hazard Loss Limit............. S-27
Special Hazard Losses................. S-27
Stated Principal Balance.............. S-21
Step-Down Test........................ S-24
Structuring Assumptions............... S-53
Subordinate Bond Writedown Amount..... S-27
Subordinate Bonds..................... S-13
Subordinate Class Percentage.......... S-25
Subordinate Classes................... S-13
Subordinate Percentage................ S-25
Subordinate Prepayment Percentage..... S-25
Subordinate Principal Payment
Amount.............................. S-25
Subsequent Mortgage Loans............. S-31
Terms and Conditions.................. S-16
Third Circuit......................... S-47
Trust................................. S-12
Two-Times Test........................ S-23
Underwriters.......................... S-62
S-65
ANNEX I
GLOBAL CLEARANCE, SETTLEMENT AND TAX DOCUMENTATION PROCEDURES
Except in certain limited circumstances, the globally offered Sequoia
Mortgage Trust 5 Collateralized Mortgage Bonds (the "Global Bonds") will be
available only in book-entry form. Investors in the Global Bonds may hold such
Global Bonds through any of DTC, Clearstream Luxembourg or Euroclear. The Global
Bonds will be tradeable as home market instruments in both the European and U.S.
domestic markets. Initial settlement and all secondary trades will settle in
same-day funds.
Secondary market trading between investors holding Global Bonds through
Clearstream Luxembourg and Euroclear will be conducted in the ordinary way in
accordance with their normal rules and operating procedures and in accordance
with conventional eurobond practice (i.e., seven calendar day settlement).
Secondary market trading between investors holding Global Bonds through DTC
will be conducted according to the rules and procedures applicable to U.S.
corporate debt obligations and prior collateralized mortgage bond issues.
Secondary cross-market trading between Clearstream Luxembourg or Euroclear
and DTC Participants holding Bonds will be effected on a
delivery-against-payment basis through the respective Depositaries of
Clearstream Luxembourg and Euroclear (in such capacity) and as DTC Participants.
A holder that is not a United States person (as described below) of Global
Bonds will be subject to U.S. withholding taxes unless such holders meet certain
requirements and deliver appropriate U.S. tax documents to the securities
clearing organizations or their participants.
INITIAL SETTLEMENT
All Global Bonds will be held in book-entry form by DTC in the name of Cede
& Co. as nominee of DTC. Investors' interests in the Global Bonds will be
represented through financial institutions acting on their behalf as direct and
indirect Participants in DTC. As a result, Clearstream Luxembourg and Euroclear
will hold positions on behalf of their participants through their respective
Relevant Depositaries, which in turn will hold such positions in accounts as DTC
Participants.
Investors electing to hold their Global Bonds through DTC will follow the
settlement practices applicable to prior collateralized mortgage bond issues.
Investor securities custody accounts will be credited with their holdings
against payment in same-day funds on the settlement date.
Investors electing to hold their Global Bonds through Clearstream
Luxembourg or Euroclear accounts will follow the settlement procedures
applicable to conventional eurobonds, except that there will be no temporary
global bond and no "lock-up" or restricted period. Global Bonds will be credited
to the securities custody accounts on the settlement date against payment in
same-day funds.
SECONDARY MARKET TRADING
Since the purchaser determines the place of delivery, it is important to
establish at the time of the trade where both the purchaser's and seller's
accounts are located to ensure that settlement can be made on the desired value
date.
TRADING BETWEEN DTC PARTICIPANTS. Secondary market trading between DTC
Participants will be settled using the procedures applicable to prior
collateralized mortgage bond issues in same-day funds.
TRADING BETWEEN CLEARSTREAM LUXEMBOURG AND/OR EUROCLEAR
PARTICIPANTS. Secondary market trading between Clearstream Luxembourg
Participants or Euroclear Participants will be settled using the procedures
applicable to conventional eurobonds in same-day funds.
TRADING BETWEEN DTC SELLER AND CLEARSTREAM LUXEMBOURG OR EUROCLEAR
PURCHASER. When Global Bonds are to be transferred from the account of a DTC
Participant to the account of a Clearstream Luxembourg Participant or a
Euroclear Participant, the purchaser will send instructions to Clearstream
I-1
Luxembourg or Euroclear through a Clearstream Luxembourg Participant or
Euroclear Participant at least one business day prior to settlement. Clearstream
Luxembourg or Euroclear will instruct the respective Relevant Depositary, as the
case may be, to receive the Global Bonds against payment. Payment will include
interest accrued on the Global Bonds from and including the last coupon payment
date to and excluding the settlement date, on the basis of either the actual
number of days in such accrual period and a year assumed to consist of 360 days
or a 360-day year of twelve 30-day months as applicable to the related class of
Global Bonds. For transactions settling on the 31st of the month, payment will
include interest accrued to and excluding the first day of the following month.
Payment will then be made by the respective Relevant Depositary of the DTC
Participant's account against delivery of the Global Bonds. After settlement has
been completed, the Global Bonds will be credited to the respective clearing
system and by the clearing system, in accordance with its usual procedures, to
the Clearstream Luxembourg Participant's or Euroclear Participant's account. The
securities credit will appear the next day (European time) and the cash debt
will be back-valued to, and the interest on the Global Bonds will accrue from,
the value date (which would be the preceding day when settlement occurred in New
York). If settlement is not completed on the intended value date (i.e., the
trade fails), the Clearstream Luxembourg or Euroclear cash debt will be valued
instead as of the actual settlement date.
Clearstream Luxembourg Participants and Euroclear Participants will need to
make available to the respective clearing systems the funds necessary to process
same-day funds settlement. The most direct means of doing so is to preposition
funds for settlement, either from cash on hand or existing lines of credit, as
they would for any settlement occurring within Clearstream Luxembourg or
Euroclear. Under this approach, they may take on credit exposure to Clearstream
Luxembourg or Euroclear until the Global Bonds are credited to their accounts
one day later.
As an alternative, if Clearstream Luxembourg or Euroclear has extended a
line of credit to them, Clearstream Luxembourg Participants or Euroclear
Participants can elect not to preposition funds and allow that credit line to be
drawn upon the finance settlement. Under this procedure, Clearstream Luxembourg
Participants or Euroclear Participants purchasing Global Bonds would incur
overdraft charges for one day, assuming they cleared the overdraft when the
Global Bonds were credited to their accounts. However, interest on the Global
Bonds would accrue from the value date. Therefore, in many cases the investment
income on the Global Bonds earned during that one-day period may substantially
reduce or offset the amount of such overdraft charges, although this result will
depend on each Clearstream Luxembourg Participant's or Euroclear Participant's
particular cost of funds.
Since the settlement is taking place during New York business hours, DTC
Participants can employ their usual procedures for sending Global Bonds to the
respective European Depositary for the benefit of Clearstream Luxembourg
Participants or Euroclear Participants. The sale proceeds will be available to
the DTC seller on the settlement date. Thus, to the DTC Participants a
cross-market transaction will settle no differently than a trade between two DTC
Participants.
TRADING BETWEEN CLEARSTREAM LUXEMBOURG OR EUROCLEAR SELLER AND DTC
PURCHASER. Due to time zone differences in their favor, Clearstream Luxembourg
Participants and Euroclear Participants may employ their customary procedures
for transactions in which Global Bonds are to be transferred by the respective
clearing system, through the respective Relevant Depositary, to a DTC
Participant. The seller will send instructions to Clearstream Luxembourg or
Euroclear through a Clearstream Luxembourg Participant or Euroclear Participant
at least one business day prior to settlement. In these cases Clearstream
Luxembourg or Euroclear will instruct the respective Relevant Depositary, as
appropriate, to deliver the Global Bonds to the DTC Participant's account
against payment. Payment will include interest accrued on the Global Bonds from
and including the last coupon payment to and excluding the settlement date on
the basis of either the actual number of days in such accrual period and a year
assumed to consist of 360 days or a 360-day year of twelve 30-day months as
applicable to the related class of Global Bonds. For transactions settling on
the 31st of the month, payment will include interest accrued to and excluding
the first day of the following month. The payment will then be reflected in the
account of the Clearstream Luxembourg Participant or Euroclear Participant the
following day, and receipt of the cash proceeds in the Clearstream Luxembourg
Participant's or Euroclear Participant's account would be back-valued to the
value date (which would be the preceding day,
I-2
when settlement occurred in New York). Should the Clearstream Luxembourg
Participant or Euroclear Participant have a line of credit with its respective
clearing system and elect to be in debt in anticipation of receipt of the sale
proceeds in its account, the back-valuation will extinguish any overdraft
incurred over that one day period. If settlement is not completed on the
intended value date (i.e., the trade fails), receipt of the cash proceeds in the
Clearstream Luxembourg Participant's or Euroclear Participant's account would
instead be valued as of the actual settlement date.
Finally, day traders that use Clearstream Luxembourg or Euroclear and that
purchase Global Bonds from DTC Participants for delivery to Clearstream
Luxembourg Participants or Euroclear Participants should note that these trades
would automatically fail on the sale side unless affirmative action were taken.
At least three techniques should be readily available to eliminate this
potential problem:
(a) borrowing through Clearstream Luxembourg or Euroclear for one day
(until the purchase side of the day trade is reflected in their Clearstream
Luxembourg or Euroclear accounts) in accordance with the clearing system's
customary procedures;
(b) borrowing the Global Bonds in the U.S. from a DTC Participant no
later than one day prior to the settlement, which would give the Global
Bonds sufficient time to be reflected in their Clearstream Luxembourg or
Euroclear account in order to settle the sale side of the trade; or
(c) staggering the value dates for the buy and sell sides of the trade
so that the value date for the purchase from the DTC Participant is at
least one day prior to the value date for the sale to the Clearstream
Luxembourg or Euroclear Participant.
CERTAIN U.S. FEDERAL INCOME TAX DOCUMENTATION REQUIREMENTS
A holder that is not a "United States person" within the meaning of Section
7701(a)(30) of the Internal Revenue Code of 1986 holding a book-entry bond
through Clearstream, Euroclear or DTC may be subject to U.S. withholding tax at
a rate of 30% unless such holder provides certain documentation to the Bond
Trustee or to the U.S. entity required to withhold tax (the "U.S. withholding
agent") establishing an exemption from withholding. A holder that is not a
United States person may be subject to 30% withholding unless:
I. the Bond Trustee or the U.S. withholding agent receives a
statement --
(a) from the holder on Internal Revenue Service ("IRS") Form W-8BEN
(or any successor form) that --
(i) is signed by the bondholder under penalty of perjury,
(ii) certifies that such owner is not a United States person,
and
(iii) provides the name and address of the bondholder, or
(b) from a securities clearing organization, a bank or other
financial institution that holds customers' securities in the ordinary
course of its trade or business that --
(i) is signed under penalties of perjury by an authorized
representative of the financial institution,
(ii) states that the financial institution has received an IRS
Form W-8BEN (or any successor form) from the bondholder or that
another financial institution acting on behalf of the bondholder has
received such IRS Form W-8BEN (or any successor form),
(iii) provides the name and address of the bondholder, and
(iv) attaches the IRS Form W-8BEN (or any successor form)
provided by the bondholder;
II. the holder claims an exemption or reduced rate based on a treaty
and provides a properly executed IRS Form W-8BEN (or any successor form) to
the Bond Trustee or the U.S. withholding agent;
I-3
III. the holder claims an exemption stating that the income is
effectively connected to a U.S. trade or business and provides a properly
executed IRS Form W-8ECI (or any successor form) to the Bond Trustee or the
U.S. withholding agent; or
IV. the holder is a "nonwithholding partnership" and provides a
properly executed IRS Form W-8IMY (or any successor form) with all
necessary attachments to the Bond Trustee or the U.S. withholding agent.
Certain pass-through entities that have entered into agreements with the
Internal Revenue Service (for example "qualified intermediaries") may be
subject to different documentation requirements; it is recommended that
such holders consult with their tax advisors when purchasing the Bonds.
A holder holding book-entry bonds through Clearstream or Euroclear provides
the forms and statements referred to above by submitting them to the person
through which he holds an interest in the book-entry bonds, which is the
clearing agency, in the case of persons holding directly on the books of the
clearing agency. Under certain circumstances a Form W-8BEN, if furnished with a
taxpayer identification number, ("TIN"), will remain in effect until the status
of the beneficial owner changes, or a change in circumstances makes any
information on the form incorrect. A Form W-8BEN, if furnished without a TIN,
and a Form W-8ECI will remain in effect for a period starting on the date the
form is signed and ending on the last day of the third succeeding calendar year,
unless a change in circumstances makes any information on the form incorrect.
In addition, all holders holding book-entry bonds through Clearstream,
Euroclear or DTC may be subject to backup withholding unless the holder:
I. provides a properly executed IRS Form W-8BEN, Form W-8ECI or Form
W-8IMY(or any successor forms) if that person is not a United States
person;
II. provides a properly executed IRS Form W-9 (or any substitute form)
if that person is a United States person; or
III. is a corporation, within the meaning of Section 7701(a) of the
Internal Revenue Code of 1986, or otherwise establishes that it is a
recipient exempt from United States backup withholding.
This summary does not deal with all aspects of federal income tax
withholding or backup withholding that may be relevant to investors that are not
"United States persons" within the meaning of Section 7701(a)(30) of the
Internal Revenue Code. Such investors are advised to consult their own tax
advisors for specific tax advice concerning their holding and disposing of the
book-entry bonds.
The term "United States person" means (1) a citizen or resident of the
United States, (2) a corporation or partnership organized in or under the laws
of the United States or any state or the District of Columbia (other than a
partnership that is not treated as a United States person under any applicable
Treasury regulations), (3) an estate the income of which is includible in gross
income for United States tax purposes, regardless of its source, or (4) 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 persons have
authority to control all substantial decisions of the trust. Notwithstanding the
preceding sentence, to the extent provided in regulations, certain trusts in
existence on August 20, 1996 and treated as United States persons prior to such
date that elect to continue to be so treated also shall be considered United
States persons.
This summary does not deal with all aspects of U.S. Federal income tax
withholding that may be relevant to foreign holders of the Global Bonds.
Investors are advised to consult their own tax advisors for specific tax advice
concerning their holding and disposing of the Global Bonds.
I-4
PROSPECTUS
OCTOBER 29, 2001
SEQUOIA MORTGAGE FUNDING CORPORATION
DEPOSITOR
$3,000,000,000
(AGGREGATE AMOUNT)
COLLATERALIZED MORTGAGE BONDS
(ISSUABLE IN SERIES)
Consider carefully the
risk factors beginning on
page 7 of this prospectus
which include:
- Yield, Prepayment and
Maturity Risks;
- Cash Flow
Considerations;
- Limited Recourse;
- Bankruptcy and
Insolvency Risks;
- Risks associated with
Book-Entry Bonds; and
- Limited Liquidity of
Investments.
The Bonds are redeemable
only under circumstances
described herein and in
the related prospectus
supplement.
Each series of bonds will
be issued by a separate
trust, will represent
obligations solely of such
trust and will not be
insured or guaranteed by
GNMA, FNMA or FHLMC or any
other governmental agency
or instrumentality, any
affiliate of the
Depositor, or, unless
otherwise specified in the
related prospectus
supplement, any other
person or entity.
Bonds of each series will be characterized for federal income tax purposes as
debt instruments or interests in a REMIC.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS SUPPLEMENT IS ACCURATE OR COMPLETE. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
THIS PROSPECTUS RELATES TO:
- The establishment of one or more trusts to issue and sell one or more series
of collateralized mortgage bonds.
THE BONDS:
- Will be collateralized by one or more of the following:
- Fixed-rate, first or junior lien mortgage loans secured by one- to four-
family residential properties;
- Floating-rate, first or junior lien mortgage loans secured by one- to
four-family residential properties;
- Mortgage pass-through securities issued or guaranteed by GNMA, FNMA, or FHLMC;
- Private mortgage-backed securities; or
- Any combination thereof; and
- Will receive principal payments in the manner specified in the related
prospectus supplement.
EACH SERIES OF BONDS:
- May include one or more classes of bonds entitled to principal distributions,
with disproportionate, nominal or no interest distributions or interest
distributions, with disproportionate or nominal principal distributions;
- May include one or more classes of bonds entitled to receive principal
distributions prior to other classes.
- May include one or more classes of bonds that are senior in right of payment
to one or more other classes of bonds of such series; and
- Will have credit enhancement as specified in the related prospectus
supplement.
IMPORTANT NOTICE ABOUT THE INFORMATION PRESENTED
IN THIS PROSPECTUS AND THE ACCOMPANYING PROSPECTUS SUPPLEMENT
We tell you about the bonds in two separate documents that progressively
provide more detail: (1) this prospectus, which provides general information,
some of which may not apply to your series of bonds, and (2) the accompanying
prospectus supplement, which describes the specific terms of your series of
bonds and may be different from the information in this prospectus.
IF THE TERMS OF YOUR SERIES OF BONDS AND ANY OTHER INFORMATION CONTAINED
HEREIN VARY BETWEEN THIS PROSPECTUS AND THE ACCOMPANYING PROSPECTUS SUPPLEMENT,
YOU SHOULD RELY ON THE INFORMATION IN THE ACCOMPANYING PROSPECTUS SUPPLEMENT.
We include cross-references in this prospectus and the accompanying
prospectus supplement to captions in these materials where you can find further
related discussions. The following table of contents and the table of contents
included in the accompanying prospectus supplement provide the pages on which
these captions are located.
You can find a listing of the pages where capitalized terms used in this
prospectus are defined under "Index of Defined Terms" beginning on page 74 in
this prospectus.
The underwriter may engage in transactions that stabilize, maintain, or in
some way affect the price of the bonds. These types of transactions may include
stabilizing the purchase of bonds to cover syndicate short positions and the
imposition of penalty bids. For a description of these activities, please read
the section entitled "Plan of Distribution" in this prospectus.
WHERE YOU CAN FIND MORE INFORMATION
Federal securities law requires the filing of certain information with the
Securities and Exchange Commission (the "SEC" OR "COMMISSION"), including
annual, quarterly and special reports, proxy statements and other information.
You can read and copy these documents at the public reference facility
maintained by the SEC at Judiciary Plaza, 450 Fifth Street, NW, Room 1024,
Washington, DC 20549. You can also copy and inspect such reports, proxy
statements and other information at the following regional offices of the SEC:
Woolworth Building Chicago Regional Office
233 Broadway Citicorp Center
New York, New York 10279 500 West Madison Street, Suite 1400
Chicago, Illinois 60661
Please call the SEC at 1-800-SEC-0330 for further information on the public
reference rooms. SEC filings are also available to the public on the SEC's web
site at http://www.sec.gov.
The SEC allows us to "incorporate by reference" the information we file
with it, which means that we can disclose important information to you by
referring you to those documents. The information that we incorporate by
reference is considered to be part of the accompanying prospectus supplement,
and later information that we file with the SEC will automatically update and
supersede this information.
This prospectus and the accompanying prospectus supplement are part of a
registration statement filed by the Depositor with the SEC (Registration No.
333-22681). You may request a free copy of any of the above filings by writing
or calling:
SEQUOIA MORTGAGE FUNDING CORPORATION
591 REDWOOD HIGHWAY, SUITE 3120
MILL VALLEY, CA 94941
(415) 389-7373
You should rely only on the information provided in this prospectus or the
accompanying prospectus supplement or incorporated by reference herein. We have
not authorized anyone else to provide you with different information. You should
not assume that the information in this prospectus or the accompanying
prospectus supplement is accurate as of any date other than the date on the
cover page of this prospectus or the accompanying prospectus supplement or that
the information incorporated by reference herein is accurate as of any date
other than the date stated therein.
2
SUMMARY
This summary highlights selected information from this prospectus and does
not contain all the information that you need to consider in making your
investment decision. Please read this entire prospectus carefully for additional
information about the offered bonds.
OFFERED BONDS
Each trust will issue collateralized mortgage bonds, in such designations
and classes as set forth in the prospectus supplement.
We refer you to "Description of the Bonds" in this prospectus and in the
related prospectus supplement for more information.
DESIGNATIONS
Senior bonds -- such classes of bonds as
are supported by one or
more subordinated
classes of bonds, as set
forth in the prospectus
supplement
Subordinated bonds -- such classes of bonds as
are subordinated to
senior classes of bonds,
as set forth in the
prospectus supplement
Offered bonds -- those classes of bonds
as set forth in the
prospectus supplement
We refer you to "Description of the Bonds" in this prospectus and in the
related prospectus supplement for more information.
BOND ISSUER
The bond issuer with respect to each series of bonds will be a statutory
business trust under the laws of the State of Delaware and will be established
by Sequoia Mortgage Funding Corporation by the deposit trust agreement, as
defined in this prospectus, for the sole purpose of issuing the bonds and the
investor certificate. Sequoia Mortgage Funding Corporation is a wholly owned
limited purpose finance subsidiary of Redwood Trust, Inc., a Maryland
corporation. Redwood Trust will be the manager of the issuer pursuant to a
management agreement entered into with the issuer. None of Redwood Trust,
Sequoia Mortgage Funding Corporation nor any of their respective affiliates, has
guaranteed or is otherwise obligated with respect to payment of the bonds, and
no other person or entity other than the issuer is obligated to pay the bonds.
We refer you to "The Issuer" in this prospectus and in the related
prospectus supplement for more information.
BOND TRUSTEE
The bonds will be issued pursuant to the indenture between the issuer and a
financial institution qualified to act as the indenture trustee, such trustee to
be named in the prospectus supplement.
OWNER TRUSTEE
The owner trustee will be a financial institution qualified to act as owner
trustee of a statutory business trust under the laws of the State of Delaware,
such owner trustee to be named in the prospectus supplement.
MASTER SERVICER
The entity or entities, if any, named as master servicer in the related
prospectus supplement will act as master servicer with respect to all of the
pledged mortgages securing a series of bonds pursuant to an agreement among the
master servicer, the related issuer and the related bond trustee.
Except as otherwise provided in the related prospectus supplement, the
mortgages pledged as collateral will be serviced pursuant to a master servicing
agreement among the issuer, the bond trustee and the master servicer.
We refer you to "Servicing of the Pledged Mortgages" in this prospectus and
in the related prospectus supplement for more information.
SPECIAL SERVICER
If specified in the related prospectus supplement, Sequoia Mortgage Funding
Corporation may appoint a special servicer for the related series of bonds.
We refer you to "Servicing of the Pledged Mortgages--Special Servicing
Agreement" in this prospectus and in the related prospectus supplement for more
information.
3
PRIORITY OF PAYMENTS
Payment of principal and interest on bonds of a series will be allocated
among the classes of bonds of such series on the payment dates and in the manner
specified in the related prospectus supplement. One or more classes of bonds of
a series may be subordinated in the right to receive payments of principal and
interest to one or more other classes of bonds of such series.
We refer you to "Description of the Bonds--General" in this prospectus and
in the related prospectus supplement for more information.
PAYMENTS OF INTEREST
Each class of bonds of a series will bear interest at the rate, or
determined in the manner, set forth for such class in the related prospectus
supplement. Interest on a series of bonds or on a class of bonds within a series
may accrue at a fixed rate, a variable rate or a combination thereof, as
specified in the related prospectus supplement.
We refer you to "Description of the Bonds -- Interest" in this prospectus
and in the related prospectus supplement for more information.
PAYMENTS OF PRINCIPAL
Each class of bonds of a series will receive principal payments on each
payment date, in the manner set forth for such class in the related prospectus
supplement. One or more classes of bonds of a series may be subordinated in the
right to receive payments of principal to one ore more other classes of bonds of
such series, as specified in the related prospectus supplement. All payments of
principal on bonds of a particular class will be applied on a pro rata basis
among all bonds of such class, unless otherwise specified in the related
prospectus supplement.
We refer you to "Description of the Bonds -- Principal" in this prospectus
and in the related prospectus supplement for more information.
STATED MATURITY
The stated maturities for the classes of bonds comprising a series are the
dates determined by Sequoia Mortgage Funding Corporation to fall within a
specified period after the dates on which the bonds of each such class will be
fully paid assuming:
- Timely receipt of payments, with no prepayments, on the mortgage
collateral securing the bonds;
- If applicable, such scheduled payments are, upon deposit in the bond
account, reinvested at a rate specified in the related prospectus
supplement;
- No mortgage collateral is substituted by the issuer or the seller for any
of the mortgage collateral initially pledged to secure the bonds of a
series; and
- If applicable, no portion of the spread is applied to the payment of the
bonds, unless the related prospectus supplement provides otherwise, in
which event such stated maturities will be based on assumption specified
in the related prospectus supplement.
Holders of one or more classes of bonds of a series may have the right, at
their option, to receive full payment in respect of such bonds prior to the
stated maturity, if so provided in the related prospectus supplement.
We refer you to "Description of the Bonds--Stated Maturity" in this
prospectus and in the related prospectus supplement for more information.
REDEMPTION OF THE BONDS
- SPECIAL REDEMPTION OF BONDS
The bonds of each series may be subject to special redemption as specified
in the related prospectus supplement. Pursuant to a special redemption, the
issuer will be required to redeem, on the dates specified in the related
prospectus supplement, at 100% of their unpaid original amount, plus accrued
interest, outstanding bonds of a series or class at the determination of the
bond trustee.
We refer you to "Description of the Bonds--Special Redemption" in this
prospectus and in the related prospectus supplement for more information.
- OPTIONAL REDEMPTION OF THE BONDS
The bonds of each series may be subject to redemption at the option of the
issuer if so provided in the related prospectus supplement.
4
We refer you to "Description of the Bonds--Optional Redemption" in this
prospectus and in the related prospectus supplement for more information.
SECURITY FOR THE BONDS
The security for a series of bonds may consist of:
- pledged mortgages;
- a pool of conventional, loans secured by first or junior mortgages or
deeds of trust on one-to four-family residential properties. The pledged
mortgages may include cooperative apartment loans secured by security
interests in shares issued by private, nonprofit, cooperative housing
corporations and in the related proprietary leases or occupancy
agreements granting exclusive rights to occupy specific units in such
cooperatives' buildings;
- securities issued and guaranteed by governmental agencies such as GNMA,
FNMA and FHLMC;
- private mortgage-backed securities; and
- any combination of the above.
We refer you to "Security for the Bonds" in this prospectus and in the
related prospectus supplement for more information.
BOND AND DISTRIBUTION ACCOUNTS
All scheduled monthly principal and interest payments and all prepayments
received with respect to the mortgage collateral for a series of bonds, other
than amounts not required to be remitted to the bond trustee, such as amounts
retained by the master servicer, any servicer or any subservicer of the pledged
mortgages as servicing compensation, to pay insurance premiums or to reimburse
the master servicer or any servicer for advances it has made, will be remitted
to an account to be established as an eligible account on the closing date for
the sale of such series of bonds.
On or prior to the closing date, the bond trustee will establish a
distribution account which shall be an eligible account maintained with the bond
trustee for the benefit of the bondholders of the related series. On or prior to
a date specified in the related prospectus supplement and preceding each related
payment date, the master servicer will withdraw from the bond account the amount
to be distributed to bondholders on such payment date, to the extent of funds
available, and will deposit such amount in the distribution account.
We refer you to "Security for the Bonds--Bond and Distribution Accounts" in
this prospectus and in the related prospectus supplement for more information.
PRE-FUNDING ACCOUNTS
If so specified in the related prospectus supplement, the assets of the
issuer will include the funds on deposit in an account, which will be used to
purchase additional mortgage collateral during a period specified in such
prospectus supplement.
We refer you to "Security for the Bonds--Pre-Funding Accounts" in this
prospectus and in the related prospectus supplement for more information.
CREDIT ENHANCEMENT
The mortgage collateral securing a series of bonds or the bonds of one or
more classes in the related series may have the benefit of one or more types of
credit enhancement, as specified in the related prospectus supplement. In
addition, one or more classes of bonds of a series may be guaranteed as to
payment of principal and interest by a third party insurer or guarantor. Credit
enhancement could consist of any one or more of the following:
- subordination of one or more classes of bonds to one or more classes of
Senior bonds;
- reserve funds;
- mortgage pool insurance policy;
- special hazard insurance policy;
- bankruptcy bond;
- bond insurance polices, surety bonds and guarantees;
- letter of credit;
- over-collateralization;
- cross-collateralization;
- minimum principal payment agreement;
5
- derivative arrangements; and
- any combination of the above.
We refer you to "Credit Enhancement" in this prospectus and in the related
prospectus supplement for more information.
ADVANCES
The master servicer and each servicer may be obligated to make advances of
cash which will be included with mortgage collections, in an amount equal to the
delinquent monthly payments due on the immediately preceding monthly payment
date. The master servicer's and each servicer's obligation may be subject to
limitations as specified in the related prospectus supplement. In the event the
master servicer or servicer fails to make a required advance, the bond trustee
may be obligated to advance such amounts otherwise required to be advanced by
the master servicer or servicer.
We refer you to "Servicing of Mortgage Loans -- Advances" in this
prospectus and in the related prospectus supplement for more information.
BOND RATING
It will be a condition to the issuance of the securities offered hereby
that they be rated in one of the four highest rating categories by at least one
rating agency as identified in the prospectus supplement. The ratings of the
securities will be based on, among other things, the adequacy of the value of
the trust assets and any credit enhancement. A security rating does not address
the frequency of prepayments on the mortgage loans or the corresponding effect
on yield to investors. The rating should not be deemed a recommendation to
purchase, hold or sell the securities, particularly since the ratings do not
address market price or suitability for an investor. There is no assurance that
the ratings will remain in effect over the life of the security, and the ratings
may be lowered or withdrawn.
We refer you to "Summary of Terms -- Ratings" in this prospectus and in the
related prospectus supplement for more information.
FEDERAL INCOME TAX CONSEQUENCES
A series of bonds may be treated as debt for federal income tax purposes,
and interest, including original issue discount with respect to any class of
such bonds issued with original issue discount, will be taxable to nonexempt
bondholders.
Alternatively, the depositor may elect to have a series of bonds issued in
a REMIC structure, with one or more classes of regular and residual interests.
We refer you to "Federal Income Tax Consequences" in this prospectus and in
the related prospectus supplement for more information.
LEGAL INVESTMENT
So long as any class of bonds is rated in one of the two highest ratings
categories by at least one nationally recognized statistical rating agency, such
class of bonds will constitute "mortgage related securities" under the Secondary
Mortgage Market Enhancement Act of 1984.
We refer you to "Legal Investment" in this prospectus and in the related
prospectus supplement for more information.
ERISA CONSIDERATIONS
A fiduciary of any employee benefit plan subject to the Employee Retirement
Income Security Act of 1974, as amended, or section 4975 of the Internal Revenue
Code of 1986, as amended, should carefully review with its legal advisors
whether the purchase or holding of bonds could give rise to a transaction
prohibited or not otherwise permissible under applicable law.
We refer you to "ERISA Considerations" in this prospectus and in the
related prospectus supplement for more information.
6
RISK FACTORS
INVESTORS SHOULD CONSIDER THE FOLLOWING FACTORS IN CONNECTION WITH THE
PURCHASE OF BONDS. YOU SHOULD ALSO CONSIDER THE RISK FACTORS DESCRIBED IN THE
ACCOMPANYING PROSPECTUS SUPPLEMENTS.
A DECLINE IN THE VALUE OF MORTGAGED PROPERTIES RELATIVE TO THE OUTSTANDING
BALANCE OF THE RELATED PLEDGED MORTGAGES COULD RESULT IN LOSSES ON YOUR
INVESTMENT.
If the value of mortgaged properties declines such that the outstanding
balance of the related pledged mortgages equals or exceeds the value of the
mortgaged properties, investors will bear the losses on such pledged mortgages
that are not otherwise covered by credit enhancement. Factors that could
adversely affect the value of mortgaged properties are:
- an overall decline in the residential real estate market in the areas in
which the mortgaged properties are located;
- a decline in the general condition of the mortgaged properties as a
result of the borrower's failure to maintain adequately the mortgaged
property; and
- natural disasters that are not necessarily covered by insurance, such as
earthquakes and floods.
DELAYS DUE TO LIQUIDATION COULD RESULT IN DELAYED PAYMENT OF PROCEEDS TO
INVESTORS.
There could be substantial delays in connection with the liquidation of
defaulted pledged mortgages. An action to foreclose on a mortgaged property
securing a pledged mortgage is regulated by state statutes and rules and is
subject to many of the delays and expenses of other lawsuits and could take
several years to complete. Furthermore, in some states an action to obtain a
deficiency judgment is not permitted following a nonjudicial sale of a mortgaged
property. If a borrower defaults, these restrictions may impede the ability of
the master servicer or the related servicer to foreclose on or sell the
mortgaged property or to obtain liquidation proceeds sufficient to repay all
amounts due on the related pledged mortgage. Also, the master servicer or the
related servicer will be entitled to deduct from related liquidation proceeds
all expenses reasonably incurred in attempting to recover amounts due on
defaulted pledged mortgages, including legal fees, cost of legal action, real
estate taxes and maintenance and preservation expenses.
PLEDGED MORTGAGES THAT ARE SECURED BY JUNIOR LIENS COULD RESULT IN PAYMENT
DELAYS AND LOSSES ON YOUR INVESTMENT.
Mortgages and deeds of trust that are junior in priority receive proceeds
from liquidation, insurance or condemnation proceedings for the related property
only after the senior liens and related foreclosure costs have been paid. If the
remaining proceeds are insufficient to satisfy the junior liens, then:
- there will be a delay in payments to you while a deficiency judgment
against the borrower is sought; and
- you may incur a loss if a deficiency judgment cannot be obtained or is
not realized upon.
PREPAYMENTS ARE UNPREDICTABLE AND AFFECT YIELD.
The rate of principal distributions and yield to maturity on the bonds will
be directly related to the rate of principal payments on the trust assets. For
example, the rate of principal payments on the loans will be affected by the
following:
- the amortization schedules of the loans;
- the rate of principal prepayments, including partial prepayments and
prepayments resulting from refinancing, by borrowers;
- liquidations of defaulted loans by the master servicer or the related
servicer;
7
- repurchases of loans by the seller as a result of defective documentation
or breaches of representations and warranties; and
- the optional purchase by the master servicer or the related servicer of
all of the loans in connection with the termination of the trust.
The rate of principal payments on loans is influenced by a variety of
economic, geographic, social and other factors. For example, if interest rates
for similar loans fall below the interest rates on the loans, the rate of
prepayment would generally be expected to increase. Conversely, if interest
rates on similar loans rise above the interest rates on the loans, the rate of
prepayment would generally be expected to decrease. We cannot predict the rate
at which borrowers will repay their loans. Please consider the following:
- If you are purchasing a bond at a discount, in particular, a
principal-only bond, your yield may be lower than expected if principal
payments on the loans occur at a slower rate than you expected;
- If you are purchasing a bond at a premium, in particular, an
interest-only bond, your yield may be lower than expected if principal
payments on the loans occur at a faster rate than you expected and you
could lose your initial investment; and
- The earlier a payment of principal occurs, the greater the impact on your
yield. For example, if you purchase a bond at a premium, although the
average rate of principal payments is consistent with your expectations,
if the rate of principal payments occurs initially at a rate higher than
expected, which would adversely impact your yield, a subsequent reduction
in the rate of principal payments will not offset any adverse yield
effect.
We refer you to "Security for the Bonds -- the Pledged Mortgages" in this
prospectus for more detail.
ENVIRONMENTAL CONTAMINATION OF MORTGAGED PROPERTY COULD RESULT IN LOSSES OF
PROCEEDS TO INVESTORS.
Under the laws of some states, contamination of a property may give rise to
a lien on the property that has priority over the lien of an existing mortgage
against such property. In addition, under the laws of some states and under the
federal Comprehensive Environmental Response Compensation and Liability Act of
1980, a lender may be liable as an "owner" or "operator" for costs of addressing
releases or threatened releases of hazardous substances that require remedy at a
property, regardless of whether the environmental damage or threat was caused by
a prior owner. A lender also risks liability on foreclosure of the related
mortgaged property. Any lien of costs attached to a contaminated mortgaged
property could result in a loss to investors.
YOU WILL HAVE LIMITED RECOURSE
The assets of the trust are the sole source of distributions for the bonds.
The bonds represent obligations solely of the issuer and neither the bonds nor
the trust assets will be guaranteed by or insured by any governmental agency or
instrumentality, the depositor, the seller, the master servicer, the servicer,
the trustee or any of their affiliates, unless otherwise specified.
Consequently, if payments on the trust assets are insufficient to make all
payments required on the bonds you may incur a loss on your investment.
CONCENTRATION OF PLEDGED MORTGAGES COULD ADVERSELY AFFECT YOUR INVESTMENT
The pledged mortgages may be secured by mortgaged properties that are
concentrated in particular geographic areas, as specified in the prospectus
supplement. Consequently, losses and prepayments on the pledged mortgages and
the resultant payments on the bonds may be affected significantly by changes in
the housing markets and the regional economies in these areas and by the
occurrence of natural disasters, such as earthquakes, hurricanes, tornadoes,
tidal waves, mud slides, fires and floods, in these areas.
ABILITY TO RESELL SECURITIES MAY BE LIMITED
We cannot assure you that a secondary market for any of the bonds will
develop, or if it does develop, that it will continue to exist for the term of
the bonds. Consequently, you may not be able to sell your bonds readily
8
or at prices that will enable you to realize your desired yield. The market
values of the bonds are likely to fluctuate; these fluctuations may be
significant and could result in significant losses to you.
The secondary market for mortgage backed bonds has experienced periods of
illiquidity and can be expected to do so in the future. Illiquidity can have a
severely adverse effect on the prices of bonds that are especially sensitive to
prepayment, credit, or interest rate risk, or that have been structured to meet
the investment requirements of limited categories of investors.
YOUR PAYMENTS AND RIGHTS MAY BE ADVERSELY AFFECTED BY INSOLVENCY OF SELLER
The seller, the depositor and the issuer will treat the transfer of the
loans from the seller to the depositor and from the depositor to the issuer as a
sale. If these characterizations are correct, then if the seller were to become
bankrupt, the loans would not be part of the seller's bankruptcy estate and
would not be available to the seller's creditors. On the other hand, if the
seller becomes bankrupt, its bankruptcy trustee or one of its creditors may
argue that the transfer of the loans is a pledge of the loans as bond for a
borrowing rather than a sale. Such an attempt, even if unsuccessful, could
result in delays in payments to you.
In the event of a bankruptcy of the master servicer, the bankruptcy trustee
or receiver may have the power to prevent the trustee or the bondholders from
appointing a successor master servicer, which could result in a delay in
payments to you. In addition, federal and state statutory provisions, including
the federal bankruptcy laws and state laws affording relief to debtors, may
interfere with or affect the ability of the master servicer to liquidate the
property, which could result in a delay in payments to you.
CONSEQUENCES OF OWNING BOOK-ENTRY SECURITIES
LIMIT ON LIQUIDITY OF SECURITIES. Issuance of the bonds in book-entry form
may reduce their liquidity in the secondary trading market because investors may
be unwilling to purchase bonds for which they cannot obtain physical bonds.
LIMIT ON ABILITY TO TRANSFER OR PLEDGE. Since transactions in the
book-entry bonds can be effected only through the DTC System, by dealing with a
participating organization, indirect participant or a qualified bank, your
ability to transfer or pledge a book-entry bond to persons or entities that do
not participate in the DTC system or otherwise act with respect of such bonds,
may be limited due to the lack of a physical bond.
DELAYS IN DISTRIBUTIONS. You may experience some delay in the receipt of
distributions on book-entry bonds because the distributions will be forwarded by
the trustee to DTC for DTC to credit the accounts of its participants which will
thereafter credit them to your account either directly or indirectly through
indirect participants, as applicable.
We refer you to "Description of the Bonds" in this prospectus for more
detail.
RATING OF THE SECURITIES DOES NOT ASSURE PAYMENT
It will be a condition to the issuance of the bonds offered hereby that
they be rated in one of the four highest rating categories by the rating agency
identified in this supplement. The ratings of the bonds will depend primarily on
an assessment by the rating agency and the claims paying ability of the insurer,
if any. The ratings of the bonds will be based on, among other things, the
adequacy of the value of the trust assets and any credit enhancement. The
ratings should not be deemed a recommendation to purchase, hold or sell the
bonds, particularly since the ratings do not address market price or suitability
for an investor. There is no assurance that the ratings will remain in effect
over the life of the bond, and may be lowered or withdrawn.
We refer you to "Rating" in this prospectus for more detail.
PRE-FUNDING ACCOUNTS MAY RESULT IN RE-INVESTMENT RISK TO INVESTORS.
Amounts remaining in any pre-funded account at the end of the related
funding period will be distributed as prepayment of principal to investors on
the distribution date immediately following the end of the funding
9
period in the manner specified in the related prospectus supplement. Investors
will bear any reinvestment risk resulting from such prepayment.
THE ADDITION OF SUBSEQUENT MORTGAGE COLLATERAL FUNDED FROM PRE-FUNDING ACCOUNTS
DURING THE FUNDING PERIOD MAY ADVERSELY AFFECT THE PERFORMANCE OF THE BONDS.
Although subsequent mortgage collateral must satisfy the characteristics
described in the related prospectus supplement, such subsequent mortgage
collateral may have different characteristics, including, without limitation, a
more recent origination date than the initial mortgage collateral. As a result,
the addition of such subsequent mortgage collateral funded from a pre-funding
account may adversely affect the performance of the related bonds.
OWNERS OF ORIGINAL ISSUE DISCOUNT BONDS SHOULD CONSIDER FEDERAL INCOME TAX
CONSEQUENCES.
An investor owning a bond issued with original issue discount will be
required to include original issue discount in ordinary gross income for federal
income tax purposes as it accrues, in advance of receipt of the cash
attributable to such income. Accrued but unpaid interest on bonds with deferred
interest will be treated as original issue discount for this federal income tax
purpose.
INTRODUCTION
Sequoia Mortgage Funding Corporation, a Delaware corporation (the
"Company"), proposes to establish one or more trusts to issue and sell Bonds
from time to time under this Prospectus and related Prospectus Supplements. The
Company is a limited purpose finance corporation whose capital stock is wholly
owned by Redwood Trust, Inc. ("Redwood Trust"). Redwood Trust, a Maryland
corporation, has elected to be treated as a real estate investment trust under
the Internal Revenue Code of 1986, as amended (the "Code"). The Company was
formed for the sole purpose of acting as the depositor of one or more trusts to
be formed for the purpose of issuing the Bonds offered hereby and by the related
Prospectus Supplements. Each trust that is formed to act as an Issuer will be
created pursuant to an agreement between the Company acting as depositor (in
such capacity, the "Depositor"), and a bank, trust company or other fiduciary,
acting as owner trustee (the "Owner Trustee"). Each trust will be established
solely for the purpose of issuing one Series of Bonds and engaging in
transactions relating thereto. Each Series of Bonds will be separately secured
by the collateral described in the Prospectus Supplement relating to such
Series, which collateral will constitute the only significant assets available
to make payments on the Bonds of such Series. Accordingly, the investment
characteristics of a Series of Bonds will be determined by the collateral
pledged to secure such Series and will not be affected by the identity of the
obligor with respect to such Series of Bonds. The term "Issuer," as used herein,
with respect to a Series of Bonds refers to the trust established by the Company
for the sole purpose of issuing such Series of Bonds.
Each Series of Bonds will be issued pursuant to a separate Indenture (the
"Indenture") between the Issuer of such Series and a bank or trust company
acting as trustee for the holders of such Bonds (the "Bond Trustee"). A form of
the Indenture has been filed as an exhibit to the Registration Statement of
which this Prospectus forms a part. The Indenture relating to each Series of
Bonds will be filed with the Securities and Exchange Commission as soon as
practicable following the issuance of such Series of Bonds.
THE ISSUER
GENERAL
Any trust established to act as Issuer of a Series of Bonds will be created
pursuant to a deposit trust agreement between the Company and a bank, trust
company or other fiduciary acting as Owner Trustee. Under the terms of each
deposit trust agreement, the Company initially will retain the entire beneficial
interest in the trust created thereunder unless otherwise specified in the
related Prospectus Supplement. The Company may thereafter sell or assign all or
a portion of such beneficial ownership to another entity or entities unless
10
prohibited from doing so by the related deposit trust agreement. The beneficial
owners of each Issuer will have no liability for the obligations of the Issuer
under the Bonds issued by it. Unless otherwise specified in the related
Prospectus Supplement, each Issuer will be managed by Redwood Trust.
The Mortgage Collateral for each Series of Bonds will have been deposited
with the Issuer of such Series by the Company which, in turn, will have either
(i) received such collateral from Redwood Trust (or an affiliate) as a
contribution to the Company's capital or (ii) acquired such collateral from
Redwood Trust (or an affiliate) or another entity or entities (in such capacity,
each a "Seller"), as provided in the related Prospectus Supplement, in exchange
for the net proceeds from the issuance of such Series plus the beneficial
interest in the Issuer issuing such Series. (References herein to Redwood Trust
in its capacity as Seller shall be deemed to include any affiliate of Redwood
Trust acting in such capacity.) Redwood Trust acquires mortgage loans in the
normal course of its business from persons who have originated or otherwise
acquired such loans.
Upon the issuance of each Series of Bonds, the related Mortgage Collateral
will be deposited by the Company with the Issuer of such Series and pledged by
such Issuer to the Bond Trustee under the related Indenture to secure such
Series of Bonds. The Indenture with respect to each Series of Bonds will
prohibit the incurrence of further indebtedness by the Issuer of such Series of
Bonds. The Bond Trustee will hold the Mortgage Collateral for a Series of Bonds
as security pledged only for that Series, and holders of the Bonds of that
Series will be entitled to the equal and proportionate benefits of such
security.
Each deposit trust agreement will provide that the related trust may not
conduct any activities other than those related to the issuance and sale of the
Bonds of the particular Series issued by it and such other limited activities as
may be required in connection with reports and distributions to holders of
beneficial interests in the trust. No deposit trust agreement will be subject to
amendment without the prior written consent of the Bond Trustee for the related
Series, which consent may not be unreasonably withheld if such amendment would
not adversely affect the interests of the holders of the Bonds of each such
Series (the "Bondholders"). The holders of the beneficial interest in each
Issuer will not be liable for payment of principal and interest on the Bonds,
and holders of Bonds of each Series will be deemed to have released the holders
of beneficial interest from any claim, liability or obligation on or with
respect to the Bonds of such Series.
THE COMPANY
The Company was incorporated in the State of Delaware on January 31, 1997
and is a limited purpose finance subsidiary of Redwood Trust. The Company is a
qualified real estate investment trust subsidiary. Redwood Trust is a publicly
owned real estate investment trust. The Company's principal executive offices
are located at 591 Redwood Highway, Suite 3120, Mill Valley, California 94941.
The Company's telephone number is 415-381-1765.
Redwood Trust has agreed with the Company that Redwood Trust will not file
or cause to be filed any voluntary petition in bankruptcy against the Company or
any trust created by it until at least one year after the date on which the
Bonds have been paid in full, if at all.
USE OF PROCEEDS
The net proceeds to be received from the sale of the Bonds of each Series
will be applied by the Company to the purchase or acquisition of the related
Mortgage Collateral or the payment of expenses incurred in connection with the
issuance of Bonds and otherwise incurred in connection with the conduct of the
Company's operations. The Mortgage Collateral pledged to secure a Series of
Bonds will either be contributed to the Company's capital by Redwood Trust (or
an affiliate) or acquired by the Company from Redwood Trust (or an affiliate) or
another Seller and deposited with the Issuer of such Series by the Company.
11
MORTGAGE LOAN PROGRAM
The Pledged Mortgages will have been purchased by the Depositor, either
directly or through affiliates, from Sellers. The Pledged Mortgages so acquired
by the Depositor will have been originated substantially in accordance with the
underwriting criteria specified below under "Underwriting Standards."
UNDERWRITING STANDARDS
Unless otherwise specified in the related Prospectus Supplement, each
Seller will represent and warrant that all Pledged Mortgages originated and/or
sold by it to the Depositor or one of its affiliates will have been underwritten
in accordance with standards consistent with those utilized by mortgage lenders
generally during the period of origination. The related Prospectus Supplement
will include detailed information with respect to the underwriting standards
employed by the applicable originators of the Pledged Mortgages, to the extent
such information is reasonably available to the Depositor. Such information may
include, as applicable, underwriting guidelines with respect to required
borrower income, debt to income ratios, credit histories, loan-to-value ratios
and documentation and verification requirements.
Underwriting standards are applied by or on behalf of a lender to evaluate
the borrower's credit standing and repayment ability, and the value and adequacy
of the related Mortgaged Property as collateral. In general, a prospective
borrower applying for a loan is required to fill out a detailed application
designed to provide to the underwriting officer pertinent credit information. As
part of the description of the borrower's financial conditions, the borrower
generally is required to provide a current list of assets and liabilities and 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 local
merchants and lenders and any record of bankruptcy. In most cases, an employment
verification is obtained from an independent source (typically the borrower's
employer) which verification reports, among other things, the length of
employment with that organization, the current salary, and 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 demand
or savings accounts.
In determining the adequacy of the Mortgaged Property as collateral, an
appraisal is made of each property considered for financing. The appraiser is
required to inspect the property and verify that it is in good condition and
that construction, if new, has been completed. The appraisal is based on the
market value of comparable homes, the estimated rental income (if considered
applicable by the appraiser) and the cost of replacing the home. The value of
the property being financed, as indicated by the appraisal, must be such that it
currently supports, and is anticipated to support in the future, the outstanding
loan balance. The maximum Loan-to-Value Ratio is generally not expected to
exceed 95%. Most loans with Loan-to-Value Ratios in excess of 80% at origination
must be covered by private mortgage insurance insuring the balance thereof down
to a 75% Loan-to-Value Ratio. The method of calculating the "Loan-to-Value
Ratio" of a Pledged Mortgage will be described in the Prospectus Supplement for
a Series of Bonds secured by Pledged Mortgages.
Once all applicable employment, credit and property information is
received, a determination generally is made as to whether the prospective
borrower has sufficient monthly income available (i) to meet the borrower's
monthly obligations on the proposed mortgage loan (determined on the basis of
the monthly payments due in the year of origination) and other expenses related
to the Mortgaged Property (such as property taxes and hazard insurance) and (ii)
to meet monthly housing expenses and other financial obligations and monthly
living expenses. The maximum housing expense to income ratio referred to in (i)
is generally not expected to exceed 40% and the maximum debt to income ratio
described in (ii) is generally not expected to exceed 55%. The underwriting
standards applied by Sellers may be varied in appropriate cases where factors
such as low Loan-to-Value Ratios or other favorable credit issues exist.
The Depositor expects that a substantial portion of the Pledged Mortgages
it purchases will be "jumbo" loans, i.e., loans that exceed the maximum balance
for purchase by the Federal National Mortgage Association ("FNMA") or the
Federal Home Loan Mortgage Corporation ("FHLMC"). Under current regulations, the
maximum principal balance allowed on loans eligible for purchase by FNMA or
FHLMC
12
ranges from $252,700 ($379,050 for mortgage loans secured by mortgaged
properties located in either Alaska or Hawaii) for one-unit to $485,800
($728,700 for mortgage loans secured by mortgaged properties located in either
Alaska or Hawaii) for four-unit residential loans. The maximum loan amount is
generally not expected to exceed $1,500,000 in the case of any of the foregoing
types of loans.
A lender may originate mortgage loans under a reduced documentation
program. A reduced documentation program is designed to facilitate the loan
approval process and thereby improve the lender's competitive position among
other loan originators. Under a reduced documentation program, relatively more
emphasis is placed on property underwriting than on credit underwriting and
certain underwriting documentation concerning income and employment verification
is waived.
In the case of a loan secured by a leasehold interest in a real property,
the title to which is held by a third party lessor, generally, the Seller will
be required to represent and warrant, among other things, that the remaining
term of the lease and any sublease is at least five years longer than the
remaining term of the mortgage loan.
Certain of the types of loans which may be included in the Mortgage
Collateral are recently developed and may involve additional uncertainties not
present in traditional types of loans. For example, certain of such Pledged
Mortgages may provide for escalating or variable payments by the mortgagor or
obligor. These types of Pledged Mortgages are underwritten on the basis of a
judgment that mortgagors or obligors will have the ability to make monthly
payments required initially. In some instances, however, a mortgagor's or
obligor's income may not be sufficient to permit continued loan payments as such
payments increase. These types of loans may also be underwritten primarily upon
the basis of Loan-to-Value Ratios or other favorable credit factors.
QUALITY CONTROL
The Depositor's parent, Redwood Trust, has developed a quality control
program to monitor the quality of loan underwriting at the time of acquisition
and on an ongoing basis. All loans purchased by the Depositor will be subject to
this quality control program. A legal document review of each loan acquired will
be conducted to verify the accuracy and completeness of the information
contained in the mortgage notes, security instruments and other pertinent
documents in the file. A sample of loans to be acquired, selected by focusing on
those loans with higher risk characteristics, will normally be submitted to a
third party nationally recognized underwriting review firm for a compliance
check of underwriting and review of income, asset and appraisal information.
REPRESENTATIONS BY SELLERS; REPURCHASES
Each Seller will have made representations and warranties in respect of the
mortgage loans sold by such Seller and included in the Pledged Mortgages
securing a Series of Bonds. Such representations and warranties generally
include, among other things: (i) that title insurance (or in the case of
Mortgaged Properties located in areas where such policies are generally not
available, an attorney's certificate of title) and any required hazard insurance
policy and Primary Mortgage Insurance Policy (as defined herein) were effective
at the origination of each mortgage loan other than Cooperative Loans, and that
each policy (or certificate of title as applicable) remained in effect on the
date of purchase of the mortgage loan from the Seller by or on behalf of the
Company; (ii) that the Seller had good title to each such mortgage loan and such
mortgage loan was subject to no offsets, defenses, counterclaims or rights of
rescission except to the extent that any buydown agreement described herein may
forgive certain indebtedness of the obligors on such Pledged Mortgages (each, a
"Mortgagor"); (iii) that each mortgage loan constituted a valid first or junior
lien, as the case may be, on the Mortgaged Property (subject only to permissible
title insurance exceptions, if applicable, and certain other exceptions typical
in the residential mortgage lending industry) and that the Mortgaged Property
was free from damage and was in good repair; (iv) that there were no delinquent
tax or assessment liens against the Mortgaged Property; (v) that no required
payment on a mortgage loan was 60 or more days delinquent at any time during the
twelve months prior to the date it is pledged to secure the related Series of
13
Bonds; and (vi) that each mortgage loan was made in compliance with, and is
enforceable under, all applicable local, state and federal laws and regulations
in all material respects.
If the Seller cannot cure a breach of any representation or warranty made
by it in respect of a Pledged Mortgage that materially and adversely affects the
interests of the Bondholders in such Pledged Mortgage within 90 days after
notice of such breach, then such Seller will be obligated to either (i)
substitute a similar mortgage loan for such Pledged Mortgage under the
conditions specified in the related Prospectus Supplement or (ii) repurchase
such Pledged Mortgage from the Issuer at a price (the "Purchase Price") equal to
100% of the outstanding principal balance thereof as of the date of the
repurchase plus accrued interest thereon to the first day of the month following
the month in which such Pledged Mortgage is repurchased at the Mortgage Rate
(less any unreimbursed advances or amount payable as related master servicing
compensation if the Seller is the Master Servicer with respect to such Pledged
Mortgage). The Master Servicer will be required under the applicable Master
Servicing Agreement and Indenture to enforce this obligation for the benefit of
the Bond Trustee and the Bondholders, following the practices it would employ in
its good faith business judgment were it the owner of such Pledged Mortgage.
These substitution or repurchase obligations will constitute the sole remedies
available to Bondholders or the Bond Trustee for a breach of representation by a
Seller.
DESCRIPTION OF THE BONDS
GENERAL
Each Series of bonds (the "Bonds") offered hereby and by the related
Prospectus Supplement will be issued pursuant to a separate Indenture between
the Issuer of such Series and the Bond Trustee for such Series. The following
summaries describe certain provisions common to each Series of Bonds. The
summaries are subject to, and are qualified in their entirety by reference to,
the Prospectus Supplement and the provisions of the Indenture relating to each
Series of Bonds. Summaries of particular provisions or terms used in the
Indenture incorporate by reference the actual provisions (including definitions
of terms) as part of such summaries, and are qualified in their entirety by
reference to the actual provisions of the Indenture.
The Bonds are issuable in Series. Each Series may include one or more
Classes of Bonds ("Deferred Interest Bonds") upon which interest will accrue but
will not be payable, except in certain circumstances upon the optional
redemption thereof or as otherwise provided in the related Prospectus
Supplement. Prior to such time, the amount of interest so accrued will be added
to the principal of such Class of Deferred Interest Bonds on each Payment Date.
(Indenture, Section 2.03) A Series of Bonds may include one or more Classes that
are senior in right of payment to one or more other Classes of Bonds of such
Series. A Series of Bonds may also include one or more Classes of zero coupon
bonds. The Bonds of each Series will be issued in either fully registered or
book-entry form in the authorized denominations specified in the related
Prospectus Supplement. (Indenture, Section 2.04) The transfer of the Bonds will
be registered and the Bonds may be exchanged without the payment of any service
charge other than any tax or governmental charge payable in connection with such
registration of transfer or exchange. (Indenture, Section 2.07)
Payments of principal of, and interest on, each Series of Bonds will be
made on the dates specified in the related Prospectus Supplement (the "Payment
Date") relating to such Series by check mailed to Bondholders of such Series
registered as such at the close of business on each of the dates specified in
such Prospectus Supplement (each, a "Record Date") preceding such Payment Date
at their addresses appearing on the Bond Register, except that final payments of
principal in retirement of each Bond will be made only upon presentation and
surrender of such Bond at the office or agency of the Issuer maintained for that
purpose. (Indenture, Section 2.09(a) and (b)) Notice will be mailed before the
Payment Date on which the final principal payment on any Bond is expected to be
made by the Bond Trustee to the holder of such Bond. (Indenture, Section
2.09(b)) Payments in respect of interest and principal on the Bonds will be made
by the Bond Trustee, or such other bank, trust company or other fiduciary
identified in the related Prospectus Supplement, as the paying agent of the
Issuer. (Indenture, Section 3.03)
14
The Bond Trustee will include with each payment on a Bond which includes
principal and interest a statement showing the allocation of such payment to
principal and interest and the remaining unpaid principal amount of such Bond.
Payments on Bonds which include only interest will be accompanied by a statement
showing the aggregate unpaid principal amount of the Bonds of each Class of the
same Series. On each Payment Date before payments of principal are first made on
a particular Class of Deferred Interest Bonds of a Series, the Bond Trustee for
such Series will furnish to each holder of a Bond of such Class a statement
showing the aggregate unpaid principal amount of such Class of Bonds and the new
principal balance of such holder's Deferred Interest Bond.
PAYMENTS OF INTEREST
The Bonds of each Class will bear interest on their unpaid principal
amounts from the date and at the rates per annum specified or determined in the
manner set forth in the related Prospectus Supplement (calculated on the basis
of a 360-day year of twelve 30-day months unless otherwise specified in the
related Prospectus Supplement) until the principal amount of the Bonds of such
Class is paid in full. Interest on a Series of Bonds or on a Class of Bonds
within a Series may accrue at a fixed rate, a variable rate or a combination
thereof, as determined or reset in the manner specified in the related
Prospectus Supplement. Interest on the Bonds other than Deferred Interest Bonds
will be due and payable on the Payment Dates specified in the related Prospectus
Supplement. Payments of interest on each Class of Deferred Interest Bonds will
commence as specified in the related Prospectus Supplement. Prior to such time,
interest on such Class of Deferred Interest Bonds will accrue and the amount of
interest so accrued will be added to the principal thereof on each Payment Date.
Such Class of Deferred Interest Bonds will thereafter accrue interest on the
outstanding principal amount thereof as so adjusted. Each such payment or
accrual of interest will include all interest accrued either to, but not
including, the related Payment Date or through a date prior to such Payment Date
as specified in the related Prospectus Supplement. In the latter case, the
effective yield to the Bondholders will be reduced to a level below the yield
that would apply if interest were accrued to, but not including, the respective
Payment Date.
A Series of Bonds or one or more Classes of Bonds within a Series may bear
interest at a variable rate (the "Floating Rate Bonds") which may have an
interest rate cap or an interest rate floor, or both, as specified in the
related Prospectus Supplement. The interest payment dates on Floating Rate Bonds
will be set forth in the related Prospectus Supplement and may not be the same
as the interest payment dates for the other Bonds of such Series, but may be
either more or less frequent. The variable interest rate formula for any Series
or Class of Floating Rate Bonds will generally be based off a financial index
recognized in the national or international financial markets. The Prospectus
Supplement for any Series or Class within a Series of Floating Rate Bonds will
set forth the initial interest rate, the index upon which adjustments thereto
will be computed, the formula for such computation, the intervals at which such
computations will be made, the maximum and minimum interest rates, if any, and
other characteristics common to such Bonds.
PAYMENTS OF PRINCIPAL
Principal payments on each Series of Bonds will be made on each Payment
Date in an amount equal to the sum of (a) if specified in the related Prospectus
Supplement, the amount of interest, if any, accrued but not then payable on the
Deferred Interest Bonds of such Series from the prior Payment Date or, if
specified in the related Prospectus Supplement, from a date prior to such prior
Payment Date and (b) either (i) the percentage or percentages specified in the
related Prospectus Supplement of the funds available for such purpose
("Available Funds") for such Payment Date or (ii) the sum of (x) an amount
determined by reference to the aggregate decline in the bond values (the "Bond
Value" or "Bond Values") of the Mortgage Collateral securing such Series of
Bonds in the period (each a "Due Period") ending prior to such Payment Date
(collectively, the "Basic Principal Payment") and (y) the amount, if any, of the
spread (the "Spread") specified in such Prospectus Supplement. The Prospectus
Supplement for each Series of Bonds will specify the manner in which the
Available Funds or the Bond Values, as applicable, will be determined. The
aggregate amount of principal payments required to be made on a Series of Bonds
on any Payment Date will be reduced by the principal amount of the Bonds of such
Series redeemed pursuant to any special redemption
15
and certain optional redemptions occurring subsequent to the preceding Payment
Date. See "DESCRIPTION OF THE BONDS -- Special Redemption" and " -- Optional
Redemption" herein.
The Bond Value of Mortgage Collateral securing the Bonds of a Series
represents the principal amount of Bonds of such Series that, based on certain
assumptions and irrespective of prepayments on such Mortgage Collateral, can be
supported by scheduled distributions on such Mortgage Collateral, together with
(depending on the method used to determine the Bond Value of the Mortgage
Collateral) the reinvestment earnings thereon at the rate described in the
related Prospectus Supplement (the "Assumed Reinvestment Rate") and, if
applicable, the cash available to be withdrawn from a related Reserve Fund, if
any. For convenience of calculation with respect to each Series of Bonds,
Certificates securing a Series of Bonds that are backed by a pool of mortgage
loans sharing similar payment characteristics, or Pledged Mortgages which secure
a Series of Bonds and share similar payment characteristics, may be aggregated
into one or more groups (each, a "Collateral Group") each of which will be
assigned an aggregate Bond Value.
If so specified in the related Prospectus Supplement, the aggregate Bond
Value of a Collateral Group consisting of Pledged Mortgages or Certificates
sharing similar payment characteristics will be calculated as if such Pledged
Mortgages or the mortgage loans underlying such Certificates constituted a
single mortgage loan having such of the payment characteristics of such Pledged
Mortgages or of the mortgage loans underlying the Certificates included in such
Collateral Group as would result in the lowest Bond Value being assigned to the
Pledged Mortgages or Certificates included in such Collateral Group. There are a
number of alternative means of determining the Bond Value of a mortgage loan or
of collateral backed by mortgage loans, including determinations based on the
discounted present value of the remaining scheduled distributions on such
mortgage loans and determinations based on the relationship of the interest rate
borne by such mortgage loans and by the related Bonds. If applicable, the
Prospectus Supplement for a Series of Bonds will specify the method or methods
used to determine the Bond Values of the Collateral Groups securing such Series
of Bonds. The aggregate of the Bond Values on any Payment Date of all such
Collateral Groups will be at least equal to the outstanding principal amount of
the Bonds of such Series.
If applicable, the Assumed Reinvestment Rate for a Series of Bonds will be
described in the related Prospectus Supplement and may be any rate permitted by
each applicable Rating Agency or a rate provided under a guaranteed investment
contract, surety bond or similar arrangement satisfactory to each applicable
Rating Agency. If the Assumed Reinvestment Rate is so provided, the related
Prospectus Supplement will describe the terms of such arrangement.
Unless the related Prospectus Supplement provides otherwise, the Spread, if
applicable, for each Series of Bonds as of any Payment Date will be the excess,
if any, of the sum of (i) all distributions received with respect to the
Mortgage Collateral securing such Series of Bonds in the related Due Period,
(ii) the reinvestment income thereon and (iii) amounts which are required or are
permitted to be withdrawn from a Reserve Fund, if any, less the sum of (i) all
interest payable on the Bonds of such Series on such Payment Date, (ii) the
Basic Principal Payment required to be made on such Series of Bonds on such
Payment Date and (iii) an amount reflecting the redemption price of any Bonds of
such Series redeemed during the related Due Period and the expenses accrued by
the Issuer during the related Due Period relating to the administration of such
Series of Bonds.
Payments of principal will be allocated among the Classes of Bonds
comprising a Series in the manner specified in the related Prospectus Supplement
and, with respect to a particular Class of Bonds, will be applied on a pro rata
basis, unless otherwise specified in the related Prospectus Supplement. Each
Class of Bonds will be scheduled to be fully paid no later than the Stated
Maturity for such Class of Bonds specified in the related Prospectus Supplement.
If so specified in the related Prospectus Supplement, holders of one or more
Classes of Bonds of a Series may have the right, at their option, to receive
full payment in respect of such Bonds prior to Stated Maturity, in each case to
the extent and under the circumstances specified in their related Prospectus
Supplement.
16
SPECIAL REDEMPTION
If so specified in the related Prospectus Supplement, the Bonds of each
Series or Class may be subject to special redemption, in whole or in part, under
the circumstances and in the manner described below or in the related Prospectus
Supplement. If applicable, the Issuer will be required to redeem, on the day of
any month specified in the related Prospectus Supplement, outstanding Bonds of a
Series in the amount described below if, as a result of substantial payments of
principal on the Pledged Mortgages or the mortgage loans underlying the
Certificates pledged as security for such Series of Bonds or low reinvestment
yields, or both, the Bond Trustee determines, based on the procedures and
assumptions specified in the Indenture, that, in the absence of such special
redemption, the amount of cash to be on deposit in the related Bond Account on
the next Payment Date for such Series of Bonds would be insufficient to make
required payments on the Bonds of such Series on such Payment Date. (Indenture,
Section 10.01) The amount of Bonds required to be so redeemed will not exceed
the distributions on the Mortgage Collateral securing such Series of Bonds
received during the Due Period that would otherwise be required to be applied to
the payment of principal of such Series of Bonds on the following Payment Date.
All payments of principal pursuant to any special redemption will be made
in the priority and manner specified in the related Prospectus Supplement. Bonds
of the same Class will be redeemed in the manner specified in the related
Prospectus Supplement. Notice of any such redemption must be mailed by the
Issuer or the Bond Trustee at least five days prior to the special redemption
date. (Indenture, Section 10.02) The redemption price required to be paid for
any Bond to be so redeemed will be equal to 100% of the principal amount thereof
together with accrued interest. (Indenture, Section 10.01)
OPTIONAL REDEMPTION
If so provided in the related Prospectus Supplement, the Bonds of any Class
of a Series may be subject to redemption at the option of the Issuer. Unless
otherwise provided in the related Prospectus Supplement, notice of any such
redemption must be given by the Issuer to the Bond Trustee not less than 30 days
prior to the redemption date and must be mailed by the Issuer or the Bond
Trustee to affected Bondholders at least five days prior to the redemption date.
(Indenture, Sections 10.01 and 10.02) The Prospectus Supplement for each Series
will specify the circumstances, if any, under which the Bonds of such Series may
be so redeemed, the manner of effecting such redemption, the conditions to which
such redemption are subject and the redemption prices for each Class of Bonds to
be redeemed.
CALL PROTECTION AND GUARANTEES
The Issuer also may, at its option, obtain for any Series of Bonds one or
more guarantees from a company or companies acceptable to each applicable Rating
Agency, which guarantees may provide for (i) call protection (which may include
yield maintenance) for any Class of Bonds of such Series or (ii) a guarantee of
a certain prepayment rate with respect to some or all of the Pledged Mortgages
or mortgage loans underlying the Certificates pledged as collateral for such
Series. Any call protection or guarantees may affect the weighted average life
of the Bonds of such Series.
WEIGHTED AVERAGE LIFE OF THE BONDS
All of the Pledged Mortgages securing a Series of Bonds will consist of
mortgage loans which are neither insured nor guaranteed by any governmental
agency ("Conventional Loans"). See "SECURITY FOR THE BONDS -- The Pledged
Mortgages" herein. The mortgage loans underlying the Private Mortgage-Backed
Securities, FHLMC Certificates and FNMA Certificates securing a Series of Bonds
will consist of either Conventional Loans, FHA Loans (as defined herein) or VA
Loans (as defined herein), or any combination thereof. The mortgage loans
underlying the GNMA Certificates securing a Series of Bonds will consist of FHA
Loans or VA Loans. Each Pledged Mortgage and each Certificate will provide by
its terms for monthly payments (or, in the case of Private Mortgage-Backed
Securities, such other period as may be specified in the related Prospectus
Supplement) of principal and interest in the amounts described in "SECURITY FOR
17
THE BONDS -- The Pledged Mortgages," "-- Agency Securities," and "-- Private
Mortgage-Backed Securities" herein.
Since the aggregate amount of the principal payment required to be made on
a Series of Bonds on a Payment Date will depend on the amount of the principal
payments (including for this purpose prepayments resulting from refinancing or
liquidations due to defaults, casualties, condemnations and repurchases by the
Seller, the Issuer or Redwood Trust or purchases by the Master Servicer or the
Company) received on the related Pledged Mortgages or Certificates, as the case
may be, in the related Due Period, the prepayment experience on the underlying
mortgage loans (with respect to a Series of Bonds secured by Certificates) or on
the Pledged Mortgages (with respect to a Series of Bonds secured by Pledged
Mortgages) will affect (i) the weighted average life of each Class of Bonds and
(ii) the extent to which such Class is paid prior to its Stated Maturity. The
prepayment experience on the Pledged Mortgages which secure a Series of Bonds
may be affected by recoveries on foreclosures or other liquidations of Pledged
Mortgages and by losses from defaults and delinquencies on Pledged Mortgages.
See "SERVICING OF THE PLEDGED MORTGAGES" herein. The weighted average life of
each outstanding Class of Bonds also may be affected by the actual reinvestment
income earned on the payments on the Mortgage Collateral, if applicable, if a
portion of the Spread is paid as a principal payment on such Bonds and by the
exercise by the Issuer of its right to substitute other Mortgage Collateral for
the Mortgage Collateral originally pledged as security for such Bonds. Although
any substitute Mortgage Collateral will have payment terms anticipated to result
in a cash flow substantially similar to, but in no event less than, the
anticipated cash flow of the Mortgage Collateral it replaces, such substitutions
may, individually or in the aggregate, affect the weighted average life of such
Bonds. See "SECURITY FOR THE BONDS -- Substitution of Mortgage Collateral"
herein. Further, the weighted average life of each Class of a Series of Bonds
secured by FNMA Certificates may be affected by the exercise by FNMA of its
right to repurchase the mortgage loans backing such FNMA Certificates, as
described under "SECURITY FOR THE BONDS -- Agency Securities" herein. Any
Private Mortgage-Backed Securities may also be redeemed or otherwise subject to
early prepayment in accordance with their terms. The Stated Maturity for each
Class of Bonds is the date determined by the Company to fall a specified period
after the date on which the principal thereof will be fully paid, assuming (i)
timely receipt of scheduled payments (with no prepayments) on the Mortgage
Collateral, (ii) if applicable, such scheduled payments are reinvested at the
Assumed Reinvestment Rate for such Series, (iii) no Mortgage Collateral is
substituted by the Issuer or the Seller in place of the Mortgage Collateral
initially pledged to secure such Bonds and (iv) if applicable, no portion of the
Spread is applied to the payment of the Bonds, unless the related Prospectus
Supplement provides otherwise, in which event such Stated Maturities will be
based on the assumptions specified in such Prospectus Supplement. If so provided
in the related Prospectus Supplement, holders of one or more Classes of Bonds of
a Series may have the right, at their option, to receive full payment in respect
of such Bonds prior to Stated Maturity, in each case to the extent and subject
to the conditions specified in such Prospectus Supplement.
The rate of principal prepayments on pools of mortgage loans is influenced
by a variety of economic, geographic, social and other factors including,
without limitation, homeowner mobility, economic conditions, the presence and
enforceability of "due-on-sale" clauses, mortgage market interest rates and the
availability of mortgage funds, and no assurance can be given as to the actual
prepayment experience of the Mortgage Collateral. In general, however, if
interest rates vary significantly from those prevailing when the Pledged
Mortgages or the mortgage loans underlying the Certificates pledged as security
for a Series of Bonds were originated, such Pledged Mortgages and mortgage loans
are likely to be subject to higher or lower principal prepayments than if
interest rates remain at or near those prevailing when such Pledged Mortgages
and mortgage loans were originated. It should be noted that certain Certificates
pledged as security for a Series of Bonds may be backed by mortgage loans with
different interest rates, and, similarly, that not all of the Pledged Mortgages
securing a Series of Bonds are likely to bear the same interest rate.
Accordingly, the prepayment experience of these Certificates and Pledged
Mortgages will to some extent be a function of the mix of interest rates of the
underlying mortgage loans and of the Pledged Mortgages. Furthermore, the stated
certificate rate on certain Certificates may be less than the weighted average
interest rate of the underlying mortgage loans. See "SECURITY FOR THE BONDS"
herein.
18
BOOK-ENTRY BONDS
As described in the related Prospectus Supplement, if not issued in fully
registered form, one or more Classes of Bonds of any Series (each, a Class of
"Book-Entry Bonds") will be registered as book-entry certificates. Persons
acquiring beneficial ownership interests in the Bonds ("Bond Owners") will hold
their Bonds through the Depository Trust Company ("DTC") in the United States,
or CEDEL or Euroclear (in Europe) if they are participants of such systems, or
indirectly through organizations which are participants in such systems. The
Book-Entry Bonds will be issued in one or more certificates which equal the
aggregate principal balance of the Bonds and will initially be registered in the
name of Cede & Co., the nominee of DTC. CEDEL and Euroclear will hold omnibus
positions on behalf of their participants through customers' securities accounts
in CEDEL's and Euroclear's names on the books of their respective depositaries
which in turn will hold such positions in customers' securities accounts in the
depositaries' names on the books of DTC. Citibank, N.A., will act as depositary
for CEDEL and The Chase Manhattan Bank will act as depositary for Euroclear (in
such capacities, individually the "Relevant Depositary" and collectively the
"European Depositaries"). Except as described below, no person acquiring a
Book-Entry Bond (each, a "Beneficial Owner") will be entitled to receive a
physical certificate representing such Bond (a "Definitive Bond"). Unless and
until Definitive Bonds are issued, it is anticipated that the only "Bondholders"
of the Bonds will be Cede & Co., as nominee of DTC. Bond Owners are only
permitted to exercise their rights indirectly through Participants and DTC.
The beneficial owner's ownership of a Book-Entry Bond will be recorded on
the records of the brokerage firm, bank, thrift institution or other financial
intermediary (each, a "Financial Intermediary") that maintains the beneficial
owner's account for such purpose. In turn, the Financial Intermediary's
ownership of such Book-Entry Bond will be recorded on the records of DTC (or of
a participating firm that acts as agent for the Financial Intermediary, whose
interest will in turn be recorded on the records of DTC, if the beneficial
owner's Financial Intermediary is not a DTC participant, and on the records of
CEDEL or Euroclear, as appropriate).
Bond Owners will receive all distributions of principal of, and interest
on, the Bonds from the Bond Trustee through DTC and DTC participants. While the
Bonds are outstanding (except under the circumstances described below), under
the rules, regulations and procedures creating and affecting DTC and its
operations (the "Rules"), DTC is required to make book-entry transfers among
Participants on whose behalf it acts with respect to the Bonds and is required
to receive and transmit distributions of principal of, and interest on, the
Bonds. Participants and indirect participants with whom Bond Owners have
accounts with respect to Bonds are similarly required to make book-entry
transfers and receive and transmit such distributions on behalf of their
respective Bond Owners. Accordingly, although Bond Owners will not possess
certificates, the Rules provide a mechanism by which Bond Owners will receive
distributions and will be able to transfer their interest.
Bond Owners will not receive or be entitled to receive certificates
representing their respective interests in the Bonds, except under the limited
circumstances described below. Unless and until Definitive Bonds are issued,
Bond Owners who are not Participants may transfer ownership of Bonds only
through Participants and indirect participants by instructing such Participants
and indirect participants to transfer Bonds, by book-entry transfer, through DTC
for the account of the purchasers of such Bonds, which account is maintained
with their respective Participants. Under the Rules and in accordance with DTC's
normal procedures, transfers of ownership of Bonds will be executed through DTC
and the accounts of the respective Participants at DTC will be debited and
credited. Similarly, the Participants and indirect participants will make debits
or credits, as the case may be, on their records on behalf of the selling and
purchasing Bond Owners.
Because of time zone differences, credits of securities received in CEDEL
or Euroclear as a result of a transaction with a Participant will be made during
subsequent securities settlement processing and dated the business day following
the DTC settlement date. Such credits or any transactions in such securities
settled during such processing will be reported to the relevant Euroclear or
CEDEL Participants on such business day. Cash received in CEDEL or Euroclear as
a result of sales of securities by or through a CEDEL Participant (as defined
herein) or Euroclear Participant (as defined herein) to a DTC Participant will
be
19
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 Depositary; however, such cross-market
transactions will require delivery of instructions to the relevant European
international clearing system by the counterparty in such system in accordance
with its rules and procedures and within its established deadlines (European
time). The relevant European international clearing system will, if the
transaction meets its settlement requirements, deliver instructions to the
Relevant Depositary to take action to effect final settlement on its behalf by
delivering or receiving securities in DTC, and making or receiving payment in
accordance with normal procedures for same day fund settlement applicable to
DTC. CEDEL Participants and Euroclear Participants may not deliver instructions
directly to the European Depositaries.
CEDEL is incorporated under the laws of Luxembourg as a professional
depository. CEDEL holds securities for its participating organizations ("CEDEL
Participants") and facilitates the clearance and settlement of securities
transactions between CEDEL Participants through electronic book-entry changes in
accounts of CEDEL Participants, thereby eliminating the need for physical
movement of certificates. Transactions may be settled in CEDEL in any of 28
currencies, including United States dollars. CEDEL provides to its CEDEL
Participants, among other things, services for safekeeping, administration,
clearance and settlement of internationally traded securities and securities
lending and borrowing. CEDEL interfaces with domestic markets in several
countries. As a professional depository, CEDEL is subject to regulation by the
Luxembourg Monetary Institute. CEDEL participants are recognized financial
institutions around the world, including underwriters, securities brokers and
dealers, banks, trust companies, clearing corporations and certain other
organizations. Indirect access to CEDEL is also available to others, such as
banks, brokers, dealers and trust companies that clear through or maintain a
custodial relationship with a CEDEL Participant, either directly or indirectly.
Euroclear was created in 1968 to hold securities for its participants
("Euroclear Participants") and to clear and settle transactions between
Euroclear Participants through simultaneous electronic book-entry delivery
against payment, thereby eliminating the need for physical movement of
certificates and any risk from lack of simultaneous transfers of securities and
cash. Transactions may be settled in any of 32 currencies, including United
States dollars. Euroclear includes various other services, including securities
lending and borrowing and interfaces with domestic markets in several countries
generally similar to the arrangements for cross-market transfers with DTC
described above. Euroclear is operated by the Brussels, Belgium office of Morgan
Guaranty Trust Company of New York ("Morgan" and in such capacity, the
"Euroclear Operator"), under contract with Euroclear Clearance Systems S.C., a
Belgian cooperative corporation (the "Belgian Cooperative"). All operations are
conducted by Morgan, and all Euroclear securities clearance accounts and
Euroclear cash accounts are accounts with the Euroclear Operator, not the
Belgian Cooperative. The Belgian Cooperative establishes policy for Euroclear on
behalf of Euroclear Participants. Euroclear Participants include banks
(including central banks), securities brokers and dealers and other professional
financial intermediaries. Indirect access to Euroclear is also available to
other firms that clear through or maintain a custodial relationship with a
Euroclear Participant, either directly or indirectly.
Morgan is the Belgian branch of a New York banking corporation which is a
member bank of the Federal Reserve System. As such, it is regulated and examined
by the Board of Governors of the Federal Reserve System and the New York State
Banking Department, as well as the Belgian Banking Commission.
Securities clearance accounts and cash accounts with Morgan are governed by
the Terms and Conditions Governing Use of Euroclear and the related Operating
Procedures of the Euroclear System and applicable Belgian law (collectively, the
"Terms and Conditions"). The Terms and Conditions govern transfers of
20
securities and cash within Euroclear, withdrawals of securities and cash from
Euroclear, and receipts of payments with respect to securities in Euroclear. All
securities in Euroclear are held on a fungible basis without attribution of
specific certificates to specific securities clearance accounts. The Euroclear
Operator acts under the Terms and Conditions only on behalf of Euroclear
Participants, and has no record of or relationship with persons holding through
Euroclear Participants.
Under a book-entry format, beneficial owners of the Book-Entry Bonds may
experience some delay in their receipt of payments, since such payments will be
forwarded by the Bond Trustee to Cede & Co., as nominee of DTC. Distributions
with respect to Bonds held through CEDEL or Euroclear will be credited to the
cash accounts of CEDEL Participants or Euroclear Participants in accordance with
the relevant system's rules and procedures, to the extent received by the
Relevant Depositary. Such distributions will be subject to tax reporting in
accordance with relevant United States tax laws and regulations. See "FEDERAL
INCOME TAX CONSEQUENCES -- Withholding with Respect to Certain Foreign
Investors" and " -- Backup Withholding" herein. Because DTC can only act on
behalf of Financial Intermediaries, the ability of a beneficial owner to pledge
Book-Entry Bonds to persons or entities that do not participate in the
depository system may be limited due to the lack of physical certificates for
such Book-Entry Bonds. In addition, issuance of the Book-Entry Bonds in
book-entry form may reduce the liquidity of such Bonds in the secondary market
since certain potential investors may be unwilling to purchase Bonds for which
they cannot obtain physical certificates.
Monthly and annual reports on the Issuer will be provided to Cede & Co., as
nominee of DTC, and may be made available by Cede & Co. to beneficial owners
upon request, in accordance with the rules, regulations and procedures creating
and affecting DTC, and to the Financial Intermediaries to whose DTC accounts the
Book-Entry Bonds or such beneficial owners are credited.
DTC has advised the Bond Trustee that, unless and until Definitive Bonds
are issued, DTC will take any action permitted to be taken by the holders of the
Book-Entry Bonds under the Indenture only at the direction of one or more
Financial Intermediaries to whose DTC accounts the Book-Entry Bonds are
credited, to the extent that such actions are taken on behalf of Financial
Intermediaries whose holdings include such Book-Entry Bonds. CEDEL or the
Euroclear Operator, as the case may be, will take any other action permitted to
be taken by a Bondholder under the Indenture on behalf of a CEDEL Participant or
Euroclear Participant only in accordance with its relevant rules and procedures
and subject to the ability of the Relevant Depositary to effect such actions on
its behalf through DTC. DTC may take actions with respect to some Bonds, at the
direction of the related Participants, which conflict with actions taken with
respect to other Bonds.
Upon the occurrence of any of the events described in the immediately
preceding paragraph, the Bond Trustee will be required to notify all beneficial
owners of the occurrence of such event and the availability through DTC of the
Definitive Bonds. Upon surrender by DTC of the global certificate or
certificates representing the Book-Entry Bonds and instructions for
re-registration, the Bond Trustee will issue Definitive Bonds, and thereafter
the Bond Trustee will recognize the holders of such Definitive Bonds as
Bondholders under the Indenture.
Although DTC, CEDEL and Euroclear have agreed to the foregoing procedures
in order to facilitate transfers of Bonds among participants of DTC, CEDEL and
Euroclear, they are under no obligation to perform or continue to perform such
procedures and such procedures may be discontinued at any time.
None of the Master Servicer, the Depositor, the Issuer or the Bond Trustee
will have any responsibility for any aspect of the records relating to or
payments made on account of beneficial ownership interests of the Book-Entry
Bonds held by Cede & Co., as nominee of DTC, or for maintaining, supervising or
reviewing any records relating to such beneficial ownership interests.
21
SECURITY FOR THE BONDS
GENERAL
Each Series of Bonds will be secured by assignments to the Bond Trustee of
collateral (the "Collateral") consisting of (i) the Mortgage Collateral pledged
as security for such Series of Bonds, (ii) funds on deposit in the Bond Account
and the Distribution Account under the Indenture for such Series of Bonds
representing payments and prepayments on Mortgage Collateral, including, to the
extent applicable, all payments which may become due under any applicable
hazard, mortgage guaranty, mortgagor bankruptcy, title insurance and bond
insurance policies (collectively, the "Insurance Proceeds") and the proceeds
(the "Liquidation Proceeds") of foreclosure or settlement of defaulted Pledged
Mortgages each as required to be remitted to the Bond Trustee, (iii) cash,
certificates of deposit, letters of credit, surety bonds, reinvestment income,
guaranteed investment contracts or any combination thereof in the aggregate
amount, if any, specified in the related Prospectus Supplement to be deposited
by the Issuer in a related Reserve Fund, (iv) the amount of cash, if any,
specified in the related Prospectus Supplement, to be initially deposited by the
Issuer in the related Bond Account, (v) certain cash accounts, insurance
policies, surety bonds, reinvestment income, guarantees, letters of credit,
cross-collateralization or derivative arrangements, as specified herein and in
the related Prospectus Supplement, (vi) to the extent applicable, the
reinvestment income on all of the foregoing, (vii) the Issuer's rights under the
Master Servicing Agreement with respect to the Series of Bonds, (viii) the
Issuer's rights under the Mortgage Loan Purchase Agreement with respect to the
Series of Bonds, (ix) amounts (excluding any reinvestment income thereon)
deposited in the related early remittance account, if any, under the Indenture
for such Series of Bonds and (x) the Issuer's rights under certain of the
Mortgage Pool Insurance Policies and/or Bond Insurance Policies obtained for
such Series of Bonds. Scheduled payments on the Mortgage Collateral securing a
Series of Bonds and amounts, if any, initially deposited in the related Bond
Account, together with, to the extent applicable, the earnings thereon at the
Assumed Reinvestment Rate for such Series specified in the related Prospectus
Supplement and, if applicable, amounts available to be withdrawn from any
related Reserve Fund, will be sufficient to make timely payments of interest on
the Bonds of such Series and to retire each Class of Bonds comprising such
Series not later than the Stated Maturity of such Class of Bonds specified in
the related Prospectus Supplement.
Each Prospectus Supplement relating to a Series of Bonds will include
information as to (i) the approximate aggregate principal amount of the Mortgage
Collateral securing such Series and whether the Mortgage Collateral consists of
Pledged Mortgages, GNMA Certificates, FNMA Certificates, FHLMC Certificates,
other pass-through certificates or collateralized mortgage obligations (the
"Private Mortgage -- Backed Securities") or some combination of Pledged
Mortgages and Certificates and (ii) the approximate weighted average terms to
maturity of such Mortgage Collateral.
The Collateral securing each Series of Bonds will secure each Class of the
Bonds of such Series as described in the related Prospectus Supplement, and the
Collateral securing such Series will serve as collateral only for that Series of
Bonds, except to the extent that any Mortgage Pool Insurance Policies, Special
Hazard Insurance Policies, Bankruptcy Bonds or other form of credit enhancement
specified herein may, if specified in the related Prospectus Supplement, be
pledged to secure more than one Series of Bonds. See "CREDIT ENHANCEMENT"
herein.
The following is a brief description of the mortgage collateral (the
"Mortgage Collateral") expected to secure a Series of Bonds. If specific
information respecting the Mortgage Collateral is not known at the time the
related Series of Bonds initially is offered, more general information of the
nature described below will be provided in the related Prospectus Supplement,
and specific information will be set forth in a report on Form 8-K to be filed
with the Securities and Exchange Commission within fifteen days after the
initial issuance of such Bonds (the "Detailed Description"). A schedule of the
Mortgage Collateral relating to such Series of Bonds will be attached to the
Indenture delivered to the Bond Trustee upon delivery of the Bonds.
22
THE PLEDGED MORTGAGES
General. All of the fixed-rate, first or junior lien mortgage loans secured
by one-to four- family residential properties (the "Fixed Rate Pledged
Mortgages") and by floating-rate, first or junior lien mortgage loans secured by
one-to four family residential properties (the "Floating Rate Pledged Mortgages"
and together with the Fixed Rate Pledged Mortgages the "Pledged Mortgages") will
be contributed to the Company's capital by Redwood Trust (or an affiliate) or
acquired by the Company from Redwood Trust (or an affiliate) or another Seller
and will be master serviced by the Master Servicer to the extent specified in
the related Prospectus Supplement. For any Series of Bonds, the Pledged
Mortgages may be alternatively referred to in the related Prospectus Supplement
as "Mortgage Loans." See "SERVICING OF THE PLEDGED MORTGAGES" herein. Pledged
Mortgages contributed to or acquired by the Company will have been originated in
accordance with the underwriting criteria specified under "MORTGAGE LOAN
PROGRAM -- Underwriting Standards" herein and in the related Prospectus
Supplement. The Pledged Mortgages securing a Series of Bonds will consist solely
of conventional loans secured by first or junior liens on one-to four-family
residential properties. See "CERTAIN LEGAL ASPECTS OF PLEDGED
MORTGAGES -- General" herein. The real property constituting security for
repayment of a Pledged Mortgages (each, a "Mortgaged Property") may be located
in any one of the fifty states, the District of Columbia, Guam, Puerto Rico, any
other territory of the United States or such other location as may be specified
in the related Prospectus Supplement. Pledged Mortgages with certain
Loan-to-Value Ratios and/or certain principal balances may be covered wholly or
partially by primary mortgage insurance policies (each, a "Primary Mortgage
Insurance Policy") issued by mortgage loan insurers (the "Mortgage Insurer").
The existence, extent and duration of any such coverage will be described in the
applicable Prospectus Supplement.
Unless otherwise specified in the related Prospectus Supplement, all of the
Pledged Mortgages securing a Series of Bonds will have monthly payments due on
the first day of each month. Such monthly installments on each such Pledged
Mortgage, net of (i) applicable servicing compensation or master servicing
compensation, (ii) amounts retained by the Master Servicer or Servicer (as
defined herein) to be applied to the payment of premiums for certain Mortgage
Pool Insurance Policies and, if applicable, bond insurance policies and (iii)
amounts retained to reimburse the Master Servicer or Servicer for certain
advances it has made, will be payable to the Bond Trustee by the Master Servicer
on or before the monthly remittance date specified in the Prospectus Supplement
relating to the Series of Bonds secured by such Pledged Mortgages (each, a
"Remittance Date"). See "SERVICING OF THE PLEDGED MORTGAGES -- Payments on
Pledged Mortgages" and "-- Advances and Other Amounts Payable by Master
Servicer" herein. The payment terms of the Pledged Mortgages securing a Series
of Bonds will be described in the related Prospectus Supplement and may include
any of the following features or combination thereof or other features described
in the related Prospectus Supplement:
(a) Interest may be payable at a fixed rate, a rate adjustable from
time to time in relation to an index (which will be specified in the
related Prospectus Supplement), a rate that is fixed for a period of time
or under certain circumstances and is followed by an adjustable rate, a
rate that otherwise varies from time to time, or a rate that is convertible
from an adjustable rate to a fixed rate. Changes to an adjustable rate may
be subject to periodic limitations, maximum rates, minimum rates or a
combination of such limitations as set forth in the related loan agreement
or promissory note (the "Mortgage Note"). Accrued interest may be deferred
and added to the principal of a loan for such periods and under such
circumstances as may be specified in the related Prospectus Supplement. A
Mortgage Note may provide for the payment of interest at a rate lower than
the interest rate (the "Mortgage Rate") specified in such Mortgage Note for
a period of time or for the life of the loan and the amount of any
difference may be contributed from funds supplied by the seller of the
Mortgaged Property or another source.
(b) Principal may be payable on a level debt service basis to fully
amortize the Pledged Mortgage over its term, may be calculated on the basis
of an assumed amortization schedule that is significantly longer than the
original term to maturity or on an interest rate that is different from the
Mortgage Rate or may not be amortized during all or a portion of the
original term. Payment of all or a substantial portion of the principal may
be due on maturity ("Balloon Payments"). Principal may include interest
that has been deferred and added to the principal balance of the Pledged
Mortgage.
23
(c) Monthly payments of principal and interest may be fixed for the
life of the Pledged Mortgage, may increase over a specified period of time
or may change from period to period. The terms of a Pledged Mortgage may
include limits on periodic increases or decreases in the amount of monthly
payments and may include maximum or minimum amounts of monthly payments.
(d) The Pledged Mortgages may be prepaid (i) at any time without the
payment of any prepayment fee or (ii) subject to a prepayment fee, which
may be fixed for the life of any such Pledged Mortgage or may decline over
time, and may be prohibited for the life of such Pledged Mortgage or for
certain periods ("Lockout Periods"). Certain Pledged Mortgages may permit
prepayments after expiration of the applicable lockout period and may
require the payment of a prepayment fee in connection with any such
subsequent prepayment. Other Pledged Mortgages may permit prepayments
without payment of a fee unless the prepayment occurs during specified time
periods. The loans may include "due-on-sale" clauses that permit the
mortgagee to demand payment of the entire Pledged Mortgage in connection
with the sale or certain transfers of the related Mortgaged Property. Other
Pledged Mortgages may be assumable by persons meeting the then applicable
underwriting standards. See "MORTGAGE LOAN PROGRAM -- Underwriting
Standards" herein.
The Mortgage Collateral securing a Series of Bonds may include certain
Pledged Mortgages ("Buydown Loans") that include provisions whereby a third
party partially subsidizes the monthly payments of the Mortgagors during the
early years of such Pledged Mortgages, the difference to be made up from a fund
(a "Buydown Fund") contributed by such third party at the time of origination of
the Pledged Mortgage. A Buydown Fund will be in an amount equal either to the
discounted value or full aggregate amount of future payment subsidies. The
underlying assumption of buydown plans is that the income of the Mortgagor will
increase during the buydown period as a result of normal increases in
compensation and inflation, so that the Mortgagor will be able to meet the full
mortgage payments at the end of the buydown period. To the extent that this
assumption as to increased income is not fulfilled, the possibility of defaults
on Buydown Loans is increased. The related Prospectus Supplement will contain
information with respect to any Buydown Loan concerning limitations on the
interest rate paid by the Mortgagor initially, on annual increases in the
interest rate and on the length of the buydown period.
Each Prospectus Supplement will contain information, as of the date of such
Prospectus Supplement and to the extent then specifically known to the Company,
with respect to the Pledged Mortgages securing the related Series of Bonds,
including (i) the aggregate outstanding principal balance and the average
outstanding principal balance of the Pledged Mortgages as of the date pledged to
secure the related Series of Bonds, (ii) the types of property securing the
Pledged Mortgages, including any collateral in addition to the Mortgage
Properties, (iii) the original terms to maturity of the Pledged Mortgages, (iv)
the earliest origination date and latest maturity date of any of the Pledged
Mortgages, (v) the maximum and minimum per annum Mortgage Rates and (vi) the
geographical distribution of the Pledged Mortgages.
No assurance can be given that values of the Mortgaged Properties have
remained or will remain at their levels on the dates of origination of the
related Pledged Mortgages. If the residential real estate market should
experience an overall decline in property values such that the outstanding
principal balances of the Pledged Mortgages, and any secondary financing on the
Mortgaged Properties, securing a Series of Bonds become equal to or greater than
the value of the Mortgaged Properties, the actual rates of delinquencies,
foreclosures and losses could be higher than those now generally experienced in
the mortgage lending industry. In addition, adverse economic conditions and
other factors (which may or may not affect real property values) may affect the
timely payment by Mortgagors of scheduled payments of principal and interest on
the Pledged Mortgages and, accordingly, the actual rates of delinquencies,
foreclosures and losses with respect to any Mortgage Collateral. To the extent
that such losses are not covered by subordination provisions, any other credit
enhancement or alternative arrangements described herein and in the related
Prospectus Supplement, such losses will be borne, at least in part, by the
holders of the Bonds of the related Series.
The Issuer will cause the Pledged Mortgages securing each Series of Bonds
to be pledged to the Bond Trustee named in the related Prospectus Supplement for
the benefit of the Bondholders of such Series. The Master Servicer will service
the Pledged Mortgages, either directly or through other mortgage servicing
24
institutions ("Servicers"), pursuant to a Master Servicing Agreement (as defined
herein), and will receive a fee for such services. See "MORTGAGE LOAN PROGRAM"
and "SERVICING OF THE PLEDGED MORTGAGES" herein. With respect to Pledged
Mortgages serviced by the Master Servicer through a Servicer, the Master
Servicer will remain liable for its servicing obligations under the related
Master Servicing Agreement as if the Master Servicer alone were servicing such
Pledged Mortgages.
The obligations of the Master Servicer with respect to the Pledged
Mortgages will consist principally of its contractual master servicing
obligations under the related Master Servicing Agreement (including its
obligation to enforce the obligations of the Servicers) as more fully described
herein under "MORTGAGE LOAN PROGRAM -- Representations by Sellers; Repurchases"
and its obligation to make certain cash advances in the event of delinquencies
in payments on or with respect to the Pledged Mortgages in the amounts described
herein under "SERVICING OF THE PLEDGED MORTGAGES -- Advances and Other Amounts
Payable by Master Servicer" herein. The obligations of the Master Servicer to
make advances may be subject to limitations, to the extent provided herein and
in the related Prospectus Supplement.
Pledged Mortgages will consist of mortgage loans or deeds of trust secured
by first or junior liens on one-to four-family residential properties. If
provided in the related Prospectus Supplement, certain of the Pledged Mortgages
may be secured by junior liens where the related senior liens ("Senior Liens")
are not to be included as part of the Mortgage Collateral. Holders of such
Pledged Mortgages secured by junior liens are subject to the risk that adequate
funds will not be received in connection with a foreclosure of the related
Senior Liens to satisfy fully both the Senior Liens and the Pledged Mortgages.
In the event that a holder of a Senior Lien forecloses on a Mortgaged Property,
the proceeds of the foreclosure or similar sale will be applied first to the
payment of court costs and fees in connection with the foreclosure, second to
real estate taxes, third in satisfaction of all principal, interest, prepayment
or acceleration penalties, if any, and any other sums due and owing to the
holder of the Senior Liens. The claims of the holders of the Senior Liens will
be satisfied in full out of proceeds of the liquidation of the related Mortgaged
Property, if such proceeds are sufficient, before the Issuer as holder of the
junior lien receives any payments in respect of the Pledged Mortgage. If the
Master Servicer or a Servicer were to foreclose on any such Pledged Mortgage, it
would do so subject to any related Senior Liens. In order for the debt related
to the Pledged Mortgage to be paid in full at such sale, a bidder at the
foreclosure sale of such Pledged Mortgage would have to bid an amount sufficient
to pay off all sums due under the Pledged Mortgage and the Senior Liens or
purchase the Mortgaged Property subject to the Senior Liens. 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 Pledged Mortgage
in the aggregate, the Issuer, as the holder of the junior liens, and,
accordingly, holders of one or more classes of the Bonds of the related Series,
bear (i) the risk of delay in distributions while a deficiency judgment against
the borrower is obtained and (ii) the risk of loss if the deficiency judgment is
not realized upon. Moreover, deficiency judgments may not be available in
certain jurisdictions or the Pledged Mortgage may be nonrecourse. In addition, a
junior mortgagee may not foreclose on the property securing a junior mortgage
unless it forecloses subject to the senior mortgages.
If so specified in the related Prospectus Supplement, the Pledged Mortgages
may include cooperative apartment loans ("Cooperative Loans") secured by
security interests in shares issued by private, non-profit, cooperative housing
corporations ("Cooperatives") and in the related proprietary leases or occupancy
agreements granting exclusive rights to occupy specific dwelling units in such
Cooperatives' buildings.
The Mortgaged Properties relating to Pledged Mortgages will consist of
detached or semi-detached one-family dwelling units, two- to four-family
dwelling units, townhouses, rowhouses, individual condominium units, individual
units in planned unit developments and certain other dwelling units. Such
Mortgaged Properties may include vacation and second homes, investment
properties and leasehold interests. In the case of leasehold interests, the term
of the leasehold will exceed the scheduled maturity of the Pledged Mortgages by
at least five years, or such other period specified in the related Prospectus
Supplement.
ASSIGNMENT OF PLEDGED MORTGAGES TO BOND TRUSTEE. Assignments of the
mortgages or deeds of trust in recordable form, naming the Bond Trustee as
assignee, will be executed and, subject to release for recording purposes,
delivered to the Bond Trustee along with certain other original documents
evidencing the Pledged Mortgages, including the related Mortgage Notes. The
original mortgage documents will be held by the Bond
25
Trustee or its custodian, except to the extent released to the Master Servicer
or any Servicer from time to time in connection with its respective servicing
activities. Except as otherwise specified in the related Prospectus Supplement,
the Issuer will promptly cause the assignments of the related Pledged Mortgages
to be recorded in the appropriate public office for real property records,
except in states in which, in the opinion of counsel, such recording is not
required to protect the Bond Trustee's interest in such Pledged Mortgages
against the claim of any subsequent transferee or any successor to or creditor
of the Issuer or the originator of such Pledged Mortgage. In the event an
assignment of a Pledged Mortgage to the Bond Trustee is not recorded or the
opinion referred to above is not delivered to the Bond Trustee within the period
specified in the related Prospectus Supplement, Redwood Trust, may, if required
by the Bond Trustee in accordance with the terms of the Indenture, be obligated
to (i) purchase such Pledged Mortgage at a price equal to the outstanding
principal balance thereof on the date of such purchase plus accrued and unpaid
interest thereon to the first day of the month following the month in which such
Pledged Mortgage is purchased and deposit such amount in the Bond Account for
such Series of Bonds or (ii) if permitted by the applicable provisions of the
Indenture and the Mortgage Loan Purchase Agreement with respect to such Series
of Bonds, replace such Pledged Mortgage with an eligible substitute mortgage
loan (an "Eligible Substitute Pledged Mortgage"). See " -- Substitution of
Mortgage Collateral" herein.
AGENCY SECURITIES
GENERAL. The agency securities ("Agency Securities") securing a Series of
Bonds will consist of (i) fully modified pass-through mortgage-backed
certificates guaranteed as to timely payment of principal and interest by the
Government National Mortgage Association ("GNMA", and such certificates, the
"GNMA Certificates"), (ii) certificates ("Guaranteed Mortgage Pass-Through
Certificates") issued and guaranteed as to timely payment of principal and
interest by the Federal National Mortgage Association ("FNMA Certificates"),
(iii) mortgage participation certificates issued and guaranteed as to timely
payment of interest and, unless otherwise specified in the related Prospectus
Supplement, ultimate payment of principal by the Federal Home Loan Mortgage
Corporation ("FHLMC Certificates"), (iv) stripped mortgage-backed securities
representing an undivided interest in all or a part of either the principal
distributions (but not the interest distributions) or the interest distributions
(but not the principal distributions) or in some specified portion of the
principal and interest distributions (but not all of such distributions) on
certain GNMA, FNMA or FHLMC Certificates and, unless otherwise specified in the
related Prospectus Supplement, guaranteed to the same extent as the underlying
securities, (v) another type of pass-through certificate issued or guaranteed by
GNMA, FNMA or FHLMC and described in the related Prospectus Supplement or (vi) a
combination of such Agency Securities (collectively, the "Certificates").
GNMA CERTIFICATES. GNMA is a wholly-owned corporate instrumentality of the
United States with the Department of Housing and Urban Development. Section
306(g) of Title III of the National Housing Act of 1934, as amended (the
"Housing Act"), authorizes GNMA to guarantee the timely payment of the principal
of, and interest on, GNMA Certificates that represent an interest in a pool of
mortgage loans insured by the FHA under the Housing Act or Title V of the
Housing Act of 1949 ("FHA Loans"), or partially guaranteed by the VA under the
Servicemen's Readjustment Act of 1944, as amended, or Chapter 37 of Title 38,
United States Code ("VA Loans").
Section 306(g) of the Housing Act provides that "the full faith and credit
of the United States is pledged to the payment of all amounts which may be
required to be paid under any guaranty under this subsection." In order to meet
its obligations under such guaranty, GNMA may, under Section 306(d) of the
Housing Act, borrow from the United States Treasury in an unlimited amount which
is at any time sufficient to enable GNMA to perform its obligations under its
guaranty.
Each GNMA Certificate pledged to secure a Series of Bonds (which may be
issued under either the GNMA I program (each such certificate, a "GNMA I
Certificate") or the GNMA II program (each such certificate, a "GNMA II
Certificate")) will be a "fully modified pass-through" mortgage-backed
certificate issued and serviced by a mortgage banking company or other financial
concern ("GNMA Issuer") approved by GNMA or by FNMA as a seller-servicer of FHA
Loans and/or VA Loans. The mortgage loans underlying the GNMA Certificates will
consist of FHA Loans and/or VA Loans. Each such mortgage loan is secured by
26
a one- to four-family or multifamily residential property. GNMA will approve the
issuance of each such GNMA Certificate in accordance with a guaranty agreement
(a "Guaranty Agreement") between GNMA and the GNMA Issuer. Pursuant to its
Guaranty Agreement, a GNMA Issuer will be required to advance its own funds in
order to make timely payments of all amounts due on each such GNMA Certificate
if the payments received by the GNMA Issuer on the FHA Loans or VA Loans
underlying each such GNMA Certificate are less than the amounts due on each such
GNMA Certificate.
The full and timely payment of principal of and interest on each GNMA
Certificate will be guaranteed by GNMA, which obligation is backed by the full
faith and credit of the United States. Each such GNMA Certificate will have an
original maturity of not more than 30 years (but may have original maturities of
substantially less than 30 years). Each such GNMA Certificate will be based on
and backed by a pool of FHA Loans or VA Loans secured by one- to four-family
residential properties and will provide for the payment by or on behalf of the
GNMA Issuer to the registered holder of such GNMA Certificate of scheduled
monthly payments of principal and interest equal to the registered holder's
proportionate interest in the aggregate amount of the monthly principal and
interest payment on each FHA Loan or VA Loan underlying such GNMA Certificate,
less the applicable servicing and guaranty fee, which together equal the
difference between the interest on the FHA Loan or VA Loan and the pass-through
rate on the GNMA Certificate. In addition, each payment will include
proportionate pass-through payments of any prepayments of principal on the FHA
Loans or VA Loans underlying such GNMA Certificate and liquidation proceeds in
the event of a foreclosure or other disposition of any such FHA Loans or VA
Loans.
If a GNMA Issuer is unable to make the payments on a GNMA Certificate as it
becomes due, it must promptly notify GNMA and request GNMA to make such payment.
Upon notification and request, GNMA will make such payments directly to the
registered holder of such GNMA Certificate. In the event no payment is made by a
GNMA Issuer and the GNMA Issuer fails to notify and request GNMA to make such
payment, the holder of such GNMA Certificate will have recourse only against
GNMA to obtain such payment. The Bond Trustee or its nominee, as registered
holder of the GNMA Certificates securing a Series of Bonds will have the right
to proceed directly against GNMA under the terms of the Guaranty Agreements
relating to such GNMA Certificates for any amounts that are not paid when due.
All mortgage loans underlying a particular GNMA I Certificate must have the
same interest rate (except for pools of mortgage loans secured by manufactured
homes) over the term of the loan. The interest rate on such GNMA I Certificate
will equal the interest rate on the mortgage loans included in the pool of
mortgage loans underlying such GNMA I Certificate, less one-half percentage
point per annum of the unpaid principal balance of the mortgage loans.
Mortgage loans underlying a particular GNMA II Certificate may have per
annum interest rates that vary from each other by up to one percentage point.
The interest rate on each GNMA II Certificate will be between one-half
percentage point and one and one-half percentage points lower than the highest
interest rate on the mortgage loans included in the pool of mortgage loans
underlying such GNMA II Certificate (except for pools of mortgage loans secured
by manufactured homes).
Regular monthly installment payments on each GNMA Certificate securing a
Series of Bonds will be comprised of interest due as specified on such GNMA
Certificate plus the scheduled principal payments on the FHA Loans or VA Loans
underlying such GNMA Certificate due on the first day of the month in which the
scheduled monthly installments on such GNMA Certificate are due. Such regular
monthly installments on each such GNMA Certificate are required to be paid to
the registered holder by the 15th day of each month in the case of a GNMA I
Certificate and are required to be mailed to the registered holder by the 20th
day of each month in the case of a GNMA II Certificate. Any principal
prepayments on any FHA Loans or VA Loans underlying a GNMA Certificate securing
a Series of Bonds or any other early recovery of principal on such loans will be
passed through to the registered holder of such GNMA Certificate.
GNMA Certificates may be backed by graduated payment mortgage loans or by
Buydown Loans for which funds will have been provided (and deposited into escrow
accounts) for application to the payment of a portion of the borrowers' monthly
payments during the early years of such mortgage loan. Payments due the
registered holders of GNMA Certificates backed by pools containing Buydown Loans
will be computed in the
27
same manner as payments derived from other GNMA Certificates and will include
amounts to be collected from both the borrower and the related escrow account.
The graduated payment mortgage loans will provide for graduated interest
payments that, during the early years of such mortgage loans, will be less than
the amount of stated interest on such mortgage loans. The interest not so paid
will be added to the principal of such graduated payment mortgage loans and,
together with interest thereon, will be paid in subsequent years. The
obligations of GNMA and of a GNMA Issuer will be the same irrespective of
whether the GNMA Certificates are backed by graduated payment mortgage loans or
Buydown Loans. No statistics comparable to the FHA's prepayment experience on
level payment, non-"buydown" mortgage loans are available in respect of
graduated payment or Buydown Loans. GNMA Certificates related to a Series of
Bonds may he held in book-entry form.
The GNMA Certificates securing a Series of Bonds, and the related
underlying mortgage loans, may have characteristics and terms different from
those described above. Any such different characteristics and terms will be
described in the related Prospectus Supplement.
FNMA CERTIFICATES. FNMA is a federally chartered and privately owned
corporation organized and existing under the Federal National Mortgage
Association Charter Act, as amended. FNMA originally was established in 1938 as
a United States government agency to provide supplemental liquidity to the
mortgage market and was transformed into a stockholder-owned and
privately-managed corporation by legislation enacted in 1968.
FNMA provides funds to the mortgage market primarily by purchasing mortgage
loans from lenders, thereby replenishing their funds for additional lending.
FNMA acquires funds to purchase mortgage loans from many capital market
investors that may not ordinarily invest in mortgages, thereby expanding the
total amount of funds available for housing. Operating nationwide, FNMA helps to
redistribute mortgage funds from capital-surplus to capital-short areas.
FNMA Certificates are Guaranteed Mortgage Pass-Through Certificates
representing fractional undivided interests in a pool of mortgage loans formed
by FNMA. Each mortgage loan generally must meet the applicable standards of the
FNMA purchase program. Mortgage loans comprising a pool are either provided by
FNMA from its own portfolio or purchased pursuant to the criteria of the FNMA
purchase program.
Mortgage loans underlying FNMA Certificates securing a Series of Bonds will
consist of conventional loans, FHA Loans or VA Loans. Original maturities of
substantially all of the conventional, level payment mortgage loans underlying a
FNMA Certificate are expected to be between either 8 to 15 years or 20 to 40
years. The original maturities of substantially all of the fixed rate, level
payment FHA Loans or VA Loans are expected to be 30 years.
Mortgage loans underlying a FNMA Certificate may have annual interest rates
that vary by as much as two percentage points from each other. The rate of
interest payable on a FNMA Certificate is equal to the lowest interest rate of
any mortgage loan in the related pools, less a specified minimum annual
percentage representing servicing compensation and FNMA's guaranty fee. Under a
regular servicing option (pursuant to which the mortgagee or each other servicer
assumes the entire risk of foreclosure losses), the annual interest rates on the
mortgage loans underlying a FNMA Certificate will be between 50 basis points and
250 basis points greater than is its annual pass-through rate and under a
special servicing option (pursuant to which FNMA assumes the entire risk for
foreclosure losses), the annual interest rates on the mortgage loans underlying
a FNMA Certificate will generally be between 55 basis points and 255 basis
points greater than the annual FNMA Certificate pass-through rate. One "basis
point" is equal to one-hundredth of a percentage point (0.01%). If specified in
the related Prospectus Supplement, FNMA Certificates may be backed by adjustable
rate mortgages.
FNMA guarantees to each registered holder of a FNMA Certificate that it
will distribute amounts representing such holder's proportionate share of
scheduled principal and interest payments at the applicable pass-through rate
provided for by such FNMA Certificate on the underlying mortgage loans, whether
or not received, and such holder's proportionate share of the full principal
amount of any foreclosed or other finally liquidated mortgage loan, whether or
not such principal amount is actually recovered. The obligations of
28
FNMA under its guaranties are obligations solely of FNMA and are not backed by,
or entitled to, the full faith and credit of the United States. Although the
Secretary of the Treasury of the United States has discretionary authority to
lend FNMA up to $2.25 billion outstanding at any time, neither the United States
nor any agency thereof is obligated to finance FNMA's operations or to assist
FNMA in any other manner. If FNMA were unable to satisfy its obligations,
distributions to holders of FNMA Certificates would consist solely of payments
and other recoveries on the underlying mortgage loans and accordingly, monthly
distributions to holders of FNMA Certificates would be affected by delinquent
payments and defaults on such mortgage loans.
FNMA Certificates evidencing interests in pools of mortgage loans formed on
or after May 1, 1985 (other than FNMA Certificates backed by pools containing
graduated payment mortgage loans or mortgage loans secured by multifamily
projects) are available in book-entry form only. Distributions of principal and
interest on each FNMA Certificate will be made by FNMA on the 25th day of each
month to the persons in whose name the FNMA Certificate is entered in the books
of the Federal Reserve Banks (or registered on the FNMA Certificate register in
the case of fully registered FNMA Certificates) as of the close of business on
the last day of the preceding month. With respect to FNMA Certificates issued in
book-entry form, distributions thereon will be made by wire, and with respect to
fully registered FNMA Certificates, distributions thereon will be made by check.
The FNMA Certificates securing a Series of Bonds, and the related
underlying mortgage loans, may have characteristics and terms different from
those described above. Any such different characteristics and terms will be
described in the related Prospectus Supplement.
FHLMC CERTIFICATES. FHLMC is a corporate instrumentality of the United
States created pursuant to Title III of the Emergency Home Finance Act of 1970,
as amended (the "FHLMC Act"). The common stock of FHLMC is owned by the Federal
Home Loan Banks and its preferred stock is owned by stockholders of the Federal
Home Loan Banks. FHLMC was established primarily for the purpose of increasing
the availability of mortgage credit for the financing of urgently needed
housing. It seeks to provide an enhanced degree of liquidity for residential
mortgage investments primarily by assisting in the development of secondary
markets for conventional mortgages. The principal activity of FHLMC currently
consists of the purchase of first lien, conventional mortgage loans or
participation interests in such mortgage loans and the sale of the mortgage
loans or participations so purchased in the form of guaranteed mortgage
securities, primarily FHLMC Certificates. FHLMC is confined to purchasing, so
far as practicable, mortgage loans that it deems to be of such quality, type and
class as to meet generally the purchase standards imposed by private
institutional mortgage investors.
Each FHLMC Certificate represents an undivided interest in a pool of
mortgage loans that may consist of first lien Conventional Loans, FHA Loans or
VA Loans. FHLMC Certificates are sold under the terms of a Mortgage
Participation Certificate Agreement. A FHLMC Certificate may be issued under
either FHLMC's Cash Program or Guarantor Program.
Mortgage loans underlying the FHLMC Certificates securing a Series of Bonds
will generally consist of mortgage loans with original terms to maturity of
between 10 and 40 years. Each such mortgage loan must meet the applicable
standards set forth in the FHLMC Act. A FHLMC Certificate group may include
whole loans, participation interests in whole loans and undivided interests in
whole loans and/or participations comprising another FHLMC Certificate group.
Under the Guarantor Program, any such FHLMC Certificate group may include only
whole loans or participation interests in whole loans.
FHLMC guarantees to each registered holder of a FHLMC Certificate the
timely payment of interest on the underlying mortgage loans to the extent of the
applicable certificate interest rate on the registered holder's pro rata share
of the unpaid principal balance outstanding on the underlying mortgage loans in
the FHLMC Certificate group represented by such FHLMC Certificate, whether or
not received. FHLMC also guarantees to each registered holder of a FHLMC
Certificate collection by such holder of all principal on the underlying
mortgage loans, without any offset or deduction, to the extent of such holder's
pro rata share thereof, but does not, except if and to the extent specified in
the related Prospectus Supplement for a Series of Bonds, guarantee the timely
payment of scheduled principal. Under FHLMC's Gold PC Program, FHLMC guarantees
the timely payment of principal based on the difference between the pool factor
published in the month preceding
29
the month of distribution and the pool factor published in such month of
distribution. Pursuant to its guaranties, FHLMC indemnifies holders of FHLMC
Certificates against any diminution in principal by reason of charges for
property repairs, maintenance and foreclosure. FHLMC may remit the amount due on
account of its guaranty of collection of principal at any time after default on
an underlying mortgage loan, but not later than (i) 30 days following
foreclosure sale, (ii) 30 days following payment of the claim by any mortgage
insurer or (iii) 30 days following the expiration of any right of redemption,
whichever occurs later, but in any event no later than one year after demand has
been made upon the mortgagor for accelerated payment of principal. In taking
actions regarding the collection of principal after default on the mortgage
loans underlying FHLMC Certificates, including the timing of any demand for
acceleration, FHLMC reserves the right to exercise its judgment with respect to
the mortgage loans in the same manner as for mortgage loans that it has
purchased but not sold. The length of time necessary for FHLMC to determine that
a mortgage loan should be accelerated varies with the particular circumstances
of each mortgagor and FHLMC has not adopted standards which require that the
demand be made within any specified period.
FHLMC Certificates are not guaranteed by the United States or by any
Federal Home Loan Bank and do not constitute debts or obligations of the United
States or any Federal Home Loan Bank. The obligations of FHLMC under its
guaranty are obligations solely of FHLMC and are not backed by, or entitled to,
the full faith and credit of the United States. If FHLMC were unable to satisfy
such obligations, distributions to holders of FHLMC Certificates would consist
solely of payments and other recoveries on the underlying mortgage loans and,
accordingly, monthly distributions to holders of FHLMC Certificates would be
affected by delinquent payments and defaults on such mortgage loans.
Registered holders of FHLMC Certificates are entitled to receive their
monthly pro rata share of all principal payments on the underlying mortgage
loans received by FHLMC, including any scheduled principal payments, full and
partial prepayments of principal and principal received by FHLMC by virtue of
condemnation, insurance, liquidation or foreclosure and repurchases of the
mortgage loans by FHLMC or the seller thereof. FHLMC is required to remit each
registered FHLMC certificateholder's pro rata share of principal payments on the
underlying mortgage loans, interest at the FHLMC pass-through rate and any other
sums such as prepayment fees, within 60 days of the date on which such payments
are deemed to have been received by FHLMC.
Under FHLMC's Cash Program, there is no limitation on the amount by which
interest rates on the mortgage loans underlying a FHLMC Certificate may exceed
the pass-through rate on the FHLMC Certificate. Under such program, FHLMC
purchases groups of whole mortgage loans from sellers at specified percentages
of their unpaid principal balances, adjusted for accrued or prepaid interest,
which when applied to the interest rate of the mortgage loans and participations
purchased results in the yield (expressed as a percentage) required by FHLMC.
The required yield, which includes a minimum servicing fee retained by the
servicer, is calculated using the outstanding principal balance. The range of
interest rates on the mortgage loans and participations in a FHLMC Certificate
group under the Cash Program will vary since mortgage loans and participations
are purchased and assigned to a FHLMC Certificate group based upon their yield
to FHLMC rather than on the interest rate on the underlying mortgage loans.
Under FHLMC's Guarantor Program, the pass-through rate on a FHLMC Certificate is
established based upon the lowest interest rate on the underlying mortgage
loans, minus a minimum servicing fee and the amount of FHLMC's management and
guaranty income as agreed upon between the seller and FHLMC.
FHLMC Certificates duly presented for registration of ownership on or
before the last business day of a month are registered effective as of the first
day of the month. The first remittance to a registered holder of a FHLMC
Certificate will be distributed so as to be received normally by the 15th day of
the second month following the month in which the purchaser became a registered
holder of such FHLMC Certificate. Thereafter, such remittance will be
distributed monthly to the registered holder so as to be received normally by
the 15th day of each month. The Federal Reserve Bank of New York maintains
book-entry accounts with respect to FHLMC Certificates sold by FHLMC on or after
January 2, 1985, and makes payments of principal and interest each month to the
registered holders thereof in accordance with such holders' instructions.
30
PRIVATE MORTGAGE-BACKED SECURITIES
Private Mortgage-Backed Securities may consist of (a) mortgage pass-through
certificates evidencing an undivided interest in a pool of mortgage loans or (b)
collateralized mortgage obligations secured by mortgage loans. Private
Mortgage-Backed Securities may include stripped mortgage-backed securities
representing an undivided interest in all or part of either the principal
distributions (but not the interest distributions) or the interest distributions
(but not the principal distributions) or in some specified portion of the
principal and interest distributions (but not all of such distributions) on
certain mortgage loans. Private Mortgage-Backed Securities will have been issued
pursuant to a pooling and servicing agreement, an indenture or similar agreement
(a "PMBS Agreement"). Unless otherwise specified in the related Prospectus
Supplement, the seller/servicer of the underlying mortgage loans will have
entered into the PMBS Agreement with the trustee under such PMBS Agreement (the
"PMBS Trustee"). The PMBS Trustee or its agent, or a custodian will possess the
mortgage loans underlying such Private Mortgage-Backed Security. Mortgage loans
underlying a Private Mortgage-Backed Security will be serviced by a servicer
(the "PMBS Servicer") directly or by one or more subservicers who may be subject
to the supervision of the PMBS Servicer. Private Mortgage-Backed Securities must
(i) either (a) have been previously registered under the Securities Act of 1933,
as amended (the "Securities Act") or (b) if not so registered, held for at least
the holding period required by Rule 144(k) under the Securities Act and (ii) be
acquired in bona fide secondary market transactions.
The issuer of the Private Mortgage-Backed Securities (the "PMBS Issuer")
will be a financial institution or other entity engaged generally in the
business of mortgage lending, a public agency or instrumentality of a state,
local or federal government, or a limited purpose corporation organized for the
purpose of, among other things, establishing trusts and acquiring and selling
housing loans to such trusts and selling beneficial interests in such trusts. If
so specified in the related Prospectus Supplement, the PMBS Issuer may be an
affiliate of the Depositor. The obligations of the PMBS Issuer will generally be
limited to certain representations and warranties with respect to the assets
conveyed by it to the related trust. Unless otherwise specified in the related
Prospectus Supplement, the PMBS Issuer will not have guaranteed any of the
assets conveyed to the related trust or any of the Private Mortgage-Backed
Securities issued under the PMBS Agreement. Additionally, although the mortgage
loans underlying the Private Mortgage-Backed Securities may be guaranteed by an
agency or instrumentality of the United States, the Private Mortgage-Backed
Securities themselves will not be so guaranteed.
Distributions of principal and interest will be made on the Private
Mortgage-Backed Securities on the dates specified in the related Prospectus
Supplement. The Private Mortgage-Backed Securities may be entitled to receive
nominal or no principal distributions or nominal or no interest distributions.
Principal and interest distributions will be made on the Private Mortgage-Backed
Securities by the PMBS Trustee or the PMBS Servicer. The PMBS Issuer or the PMBS
Servicer may have the right to repurchase assets underlying the Private
Mortgage-Backed Securities after a certain date or under the circumstances
specified in the related Prospectus Supplement.
The mortgage loans underlying the Private Mortgage-Backed Securities may
consist of fixed rate, level payment, fully amortizing loans or graduated
payment mortgage loans, Buydown Loans, adjustable mortgage loans or loans having
balloon or other special payment features. Such mortgage loans may be secured by
single (one- to four-) family property or multifamily property or by an
assignment of the proprietary lease or occupancy agreement relating to a
specific dwelling within a Cooperative and the related shares issued by such
Cooperative.
The Prospectus Supplement for a Series of Bonds for which the Mortgage
Collateral includes Private Mortgage-Backed Securities will specify the
aggregate approximate principal amount and type of the Private Mortgage-Backed
Securities to be included in the Mortgage Collateral and, as to any such Private
Mortgage-Backed Securities comprising a significant part of the Mortgage
Collateral, to the extent such information is known to the Issuer, will in
general include the following: (i) certain characteristics of the mortgage loans
that comprise the underlying assets for the Private Mortgage-Backed Securities
including (A) the payment features of such mortgage loans, (B) the approximate
aggregate principal balance of underlying mortgage loans insured or guaranteed
by a governmental entity, (C) the servicing fee or range of servicing fees with
31
respect to the mortgage loans and (D) the minimum and maximum stated maturities
of the underlying mortgage loans at origination; (ii) the maximum original term
to stated maturity of the Private Mortgage-Backed Securities; (iii) the weighted
average term to stated maturity of the Private Mortgage-Backed Securities; (iv)
the pass-through or interest rate of the Private Mortgage-Backed Securities; (v)
the weighted average pass-through or interest rate of the Private
Mortgage-Backed Securities; (vi) the PMBS Issuer, the PMBS Servicer (if other
than the PMBS Issuer) and the PMBS Trustee for such Private Mortgage-Backed
Securities; (vii) certain characteristics of credit support, if any, such as
reserve funds, insurance policies, surety bonds, letters of credit or guaranties
relating to the mortgage loans underlying the Private Mortgage-Backed Securities
or to such Private Mortgage-Backed Securities themselves; (viii) the terms on
which the underlying mortgage loans for such Private Mortgage-Backed Securities
may, or are required to, be purchased prior to their stated maturity or the
stated maturity of the Private Mortgage-Backed Securities and the terms of any
redemption or other call feature; and (ix) the terms on which mortgage loans may
be substituted for those originally underlying the Private Mortgage-Backed
Securities.
SUBSTITUTION OF MORTGAGE COLLATERAL
Substitution of Mortgage Collateral (the "Substitute Collateral") will be
permitted in the event of breaches of representations and warranties with
respect to any original Mortgage Collateral or in the event the documentation
with respect to any Mortgage Collateral is determined by the Bond Trustee to be
incomplete. The period during which such substitution will be permitted
generally will be indicated in the Prospectus Supplement for a Series of Bonds.
The Prospectus Supplement for a Series of Bonds will describe the conditions
upon which Mortgage Collateral may be substituted for Mortgage Collateral
initially securing such Series.
OPTIONAL PURCHASE OF DEFAULTED PLEDGED MORTGAGES
If so provided in the related Prospectus Supplement, the Master Servicer,
the Company, the Bond Insurer and/or other entities specified in the Prospectus
Supplement may, at its option, purchase from the Issuer any Pledged Mortgage
which is delinquent in payment by more than the number of days specified in such
Prospectus Supplement, at a price specified in such Prospectus Supplement.
BOND AND DISTRIBUTION ACCOUNTS
Unless otherwise provided in the related Prospectus Supplement, a separate
Bond Account will be established with the Bond Trustee for each Series of Bonds
for receipt of (i) all interest and principal payments (including, to the extent
applicable, any required advances by the Master Servicer and any Servicers) and
all prepayments on the Mortgage Collateral securing such Series required to be
remitted to the Bond Trustee (including, to the extent applicable, Insurance
Proceeds required to be remitted to the Bond Trustee and Liquidation Proceeds);
(ii) the amount of cash, if any, withdrawn from any related Reserve Fund; and
(iii) if so specified in the related Prospectus Supplement, the reinvestment
income on all of the foregoing. On or prior to the date specified in the related
Prospectus Supplement (each, a "Distribution Account Deposit Date"), the Master
Servicer shall withdraw from the Bond Account the Bond Distribution Amount for
such Payment Date, to the extent of funds available for such purpose on deposit
therein, and will deposit such amount in the distribution account (the
"Distribution Account").
The Bond Trustee will invest the funds in the Bond Account and the
Distribution Account in Permitted Investments maturing no later than the next
Payment Date for the related Series of Bonds. (Indenture, Section 8.02(b))
"Permitted Investments" may include (i) obligations of the United States or any
agency thereof, provided such obligations are backed by the full faith and
credit of the United States; (ii) general obligations of or obligations
guaranteed by any state of the United States or the District of Columbia
receiving the highest long-term debt rating of each applicable Rating Agency, or
such lower rating which will not result in a change in the rating then assigned
to each related Series of Bonds by each applicable Rating Agency, (iii)
commercial paper or finance company paper which is then receiving the highest
commercial or finance company paper rating of each applicable Rating Agency, or
such lower rating as will not result in a change in the rating then assigned to
each related Series of Bonds by each applicable Rating Agency; (iv) certificates
of deposit, demand or time deposits, or bankers' acceptances issued by any
depository institution or trust
32
company incorporated under the laws of the United States or of any state thereof
and subject to supervision and examination by federal and/or state banking
authorities, provided that the commercial paper and/or long term unsecured debt
obligations of such depository institution or trust company (or in the case of
the principal depository institution in a holding company system, the commercial
paper or long-term unsecured debt obligations of such holding company, but only
if Moody's Investors Service, Inc. ("Moody's") is not an applicable Rating
Agency) are then rated one of the two highest long-term and the highest
short-term ratings of each such Rating Agency for such securities, or such lower
ratings as will not result in a change in the rating then assigned to each
related Series of Bonds by each Rating Agency; (v) demand or time deposits or
certificates of deposit issued by any bank or trust company or savings
institution to the extent such deposits are fully insured by the FDIC; (vi)
guaranteed reinvestment agreements issued by any bank, insurance company or
other corporation containing, at the time of the issuance of such agreements,
such terms and conditions as will not result in a change in the rating then
assigned to each related Series of Bonds by each applicable Rating Agency; (vii)
repurchase obligations with respect to any security described in clauses (i) and
(ii) above, in either case entered into with a depository institution or trust
company (acting as principal) described in clause (iv) above; (viii) securities
(other than stripped bonds, stripped coupons or instruments sold at a purchase
price in excess of 115% of the face amount thereof) bearing interest or sold at
a discount issued by any corporation incorporated under the laws of the United
States or any state thereof which, at the time of such investment, have one of
the two highest ratings of each applicable Rating Agency (except if the Rating
Agency is Moody's, such rating shall be the highest commercial paper rating of
Moody's for any such securities), or such lower rating as will not result in a
change in the rating then assigned to each related Series of Bonds by each
applicable Rating Agency, as evidenced by a signed writing delivered by each
such Rating Agency; (ix) interests in any money market fund which at the date of
acquisition of the interests in such fund and throughout the time such interests
are held in such fund has the highest applicable rating by each applicable
Rating Agency or such lower rating as will not result in a change in the rating
then assigned to each related Series of Bonds by each such Rating Agency; and
(x) short term investment funds sponsored by any trust company or national
banking association incorporated under the laws of the United States or any
state thereof which on the date of acquisition has been rated by each applicable
Rating Agency in their respective highest applicable rating category or such
lower rating as will not result in a change in the rating then assigned to each
related Series of Bonds by each such Rating Agency; provided that no such
instrument shall be a Permitted Investment if such instrument evidences the
right to receive interest only payments with respect to the obligations
underlying such instrument; and provided, further, that no investment specified
in clause (ix) or clause (x) above shall be a Permitted Investment for any
Pre-Funding Account or any related Capitalized Interest Account (as defined
herein). If a letter of credit is deposited with the Bond Trustee, such letter
of credit will be irrevocable, will name the Bond Trustee, in its capacity as
trustee for the Bondholders, as the sole beneficiary and will be issued by a
bank acceptable to each applicable Rating Agency. (Indenture, Section 1.01)
Unless an Event of Default or an event which if not timely cured will
constitute an Event of Default with respect to a Series of Bonds has occurred
and is continuing, funds remaining in the related Bond Account following a
Payment Date for such Bonds (other than certain amounts not constituting
Available Funds if so specified in the related Prospectus Supplement or any
funds required to be deposited in a related Reserve Fund) will be subject to
withdrawal upon the order of the Issuer free from the lien of the Indenture.
PRE-FUNDING ACCOUNT
If so specified in the related Prospectus Supplement, the Master Servicer
will establish and maintain an account (the "Pre-Funding Account"), in the name
of the related Bond Trustee on behalf of the related Bondholders, into which the
Depositor will deposit cash in an amount (the "Pre-Funded Amount") specified in
such Prospectus Supplement on the related closing date for the sale of such
Series of Bonds (the "Closing Date"). The Pre-Funding Account will be maintained
with the Bond Trustee for the related Series of Bonds and is designed solely to
hold funds to be applied by such Bond Trustee during a period specified in such
Prospectus Supplement (such period, the "Funding Period") to pay the Depositor
for the pledge of additional Pledged Mortgages and/or Certificates ("Subsequent
Mortgage Collateral"). Prior to inclusion in the Collateral securing a Series of
Bonds, in accordance with the provisions of the related Indenture, the
33
Subsequent Mortgage Collateral will be subject to review by the same parties as
reviewed the initial Mortgage Collateral. Specifically, the Bond Trustee will be
required to perform a document review and an independent firm will certify the
fair value of the Subsequent Mortgage Collateral. In addition, the Issuer will
be required to deliver to the Bond Trustee a legal opinion to the effect that
all Indenture requirements have been met for including the Subsequent Mortgage
Collateral in the Collateral.
Monies on deposit in the Pre-Funding Account will not be available to cover
losses on or in respect of the related Mortgage Collateral. The Pre-Funded
Amount will not exceed 50% of the initial aggregate principal amount of the
Bonds of the related Series. The Pre-Funded Amount will be used by the related
Bond Trustee to fund the pledge of Subsequent Mortgage Collateral from the
Depositor from time to time during the Funding Period. The Funding Period, if
any, for a Series of Bonds will begin on the related Closing Date and will end
on the date specified in the related Prospectus Supplement, which in no event
will be later than the date that is one year after the related Closing Date.
Monies on deposit in the Pre-Funding Account may be invested in Permitted
Investments (as such term is defined above under "-- Bond and Distribution
Accounts") under the circumstances and in the manner described in the related
Agreement. Earnings on investment of funds in the Pre-Funding Account will be
deposited into the related Bond Account or such other trust account as is
specified in the related Prospectus Supplement and losses will be charged
against the funds on deposit in the Pre-Funding Account. Any amounts remaining
in the Pre-Funding Account at the end of the Funding Period will be paid to the
related Bondholders in the manner and priority specified in the related
Prospectus Supplement, as a prepayment of principal of the related Bonds.
Certain information with respect to the Subsequent Mortgage Collateral will be
filed with the Commission on Form 8-K within fifteen days after the date such
Subsequent Mortgage Collateral is conveyed to the related Trust.
In addition, if so specified in the related Prospectus Supplement, on the
related Closing Date the Depositor will deposit in an account (the "Capitalized
Interest Account") cash in such amount as is necessary to cover shortfalls in
interest on the related Series of Bonds that may arise as a result of
utilization of the Pre-Funding Account as described above. The Capitalized
Interest Account shall be maintained with the Bond Trustee for the related
Series of Bonds and is designed solely to cover the above-mentioned interest
shortfalls. Monies on deposit in the Capitalized Interest Account will not be
available to cover losses on or in respect of the related Mortgage Collateral.
To the extent that the entire amount on deposit in the Capitalized Interest
Account has not been applied to cover shortfalls in interest on the related
Series of Bonds by the end of the Funding Period, any amounts remaining in the
Capitalized Interest Account will be paid to the Depositor.
CREDIT ENHANCEMENT
GENERAL
Credit enhancement may be provided with respect to one or more Classes of a
Series of Bonds or with respect to the related Mortgage Collateral for the
purpose of (i) maintaining timely payments or providing additional protection
against losses on the Collateral securing such Series of Bonds, (ii) paying
administrative expenses or (iii) establishing a minimum reinvestment rate on the
payments made in respect of such Collateral or principal payment rate on such
Collateral. Credit enhancement may be in the form of the subordination of one or
more Classes of such Series, the establishment of one or more Reserve Funds, use
of a Mortgage Pool Insurance Policy, a Special Hazard Insurance Policy,
Bankruptcy Bond, cash account, insurance policy, surety bond, guaranteed
investment contract, cross-collateralization, reinvestment income, guaranty,
letter of credit or derivative arrangement as described herein and in the
related Prospectus Supplement, or any combination of the foregoing. Unless
otherwise specified in the related Prospectus Supplement, no credit enhancement
will provide protection against all risks of loss or guarantee repayment of the
entire principal balance of the Bonds and interest thereon. If losses occur
which exceed the amount covered by credit enhancement or which are not covered
by the credit enhancement, Bondholders will bear their allocable share of any
deficiencies.
34
SUBORDINATION
If so specified in the related Prospectus Supplement, a Series of Bonds may
consist of one or more Classes of senior bonds ("Senior Bonds") and one or more
Classes of subordinated bonds ("Subordinated Bonds"). The rights of the holders
of the Subordinated Bonds of a Series (the "Subordinated Bondholders") to
receive payments of principal and/or interest (or any combination thereof) will
be subordinated to such rights of the holders of the Senior Bonds of the same
Series (the "Senior Bondholders") to the extent described in the related
Prospectus Supplement. This subordination is intended to enhance the likelihood
of regular receipt by the Senior Bondholders of the full amount of their
scheduled payments of principal and/or interest. The protection afforded to the
Senior Bondholders of a Series by means of the subordination feature will be
accomplished by (i) the preferential right of such holders to receive, prior to
any payment being made on the related Subordinated Bonds, the amounts of
principal and/or interest due them on each Payment Date out of the funds
available for payment on such date in the related Distribution Account and, to
the extent described in the related Prospectus Supplement, by the right of such
holders to receive future payments that would otherwise have been payable to the
Subordinated Bondholders; or (ii) as otherwise described in the related
Prospectus Supplement. If so specified in the related Prospectus Supplement,
subordination may apply only in the event of certain types of losses not covered
by other forms of credit support, such as hazard losses not covered by standard
hazard insurance policies or losses due to the bankruptcy or fraud of the
borrower. The related Prospectus Supplement will set forth information
concerning, among other things, the amount of subordination of a Class or
Classes of Subordinated Bonds in a Series, the circumstances in which such
subordination will be applicable and the manner, if any, in which the amount of
subordination will decrease over time.
If so specified in the related Prospectus Supplement, delays in receipt of
scheduled payments on the Mortgage Collateral and losses with respect to the
Mortgage Collateral will be borne first by the various Classes of Subordinated
Bonds and thereafter by the various Classes of Senior Bonds, in each case under
the circumstances and subject to the limitations specified in such Prospectus
Supplement. The aggregate payments in respect of delinquent payments on the
Mortgage Collateral over the lives of the Bonds or at any time, the aggregate
losses in respect of Mortgage Collateral which must be borne by the Subordinated
Bonds by virtue of subordination and the amount of payments otherwise
distributable to the Subordinated Bondholders that will be distributable to
Senior Bondholders on any Payment Date may be limited as specified in the
related Prospectus Supplement. If aggregate payments in respect of delinquent
payments on the Mortgage Collateral or aggregate losses in respect of such
Mortgage Collateral were to exceed the amount specified in the related
Prospectus Supplement, Senior Bondholders would experience losses on the Bonds.
If so specified in the related Prospectus Supplement, various Classes of
Senior Bonds and Subordinated Bonds may themselves be subordinate in their right
to receive certain payments to other Classes of Senior and Subordinated Bonds,
respectively.
As between Classes of Senior Bonds and as between Classes of Subordinated
Bonds, payments may be allocated among such Classes (i) in accordance with a
schedule or formula, (ii) in relation to the occurrence of events or (iii)
otherwise, in each case as specified in the related Prospectus Supplement. As
between Classes of Subordinated Bonds, payments to Senior Bondholders on account
of delinquencies or losses and payments to the Reserve Fund will be allocated as
specified in the related Prospectus Supplement.
RESERVE FUNDS
If so specified in the related Prospectus Supplement, the Issuer will
deposit in one or more accounts to be established with the Bond Trustee (each, a
"Reserve Fund") cash, certificates of deposit, letters of credit, surety bonds,
guaranteed investment contracts or any combination thereof, which may be used by
the Bond Trustee to make payments on such Series of Bonds to the extent funds
are not otherwise available. Reserve Funds will be established if they are
deemed by the Issuer to be required to assure timely payment of principal of,
and interest on, its Series of Bonds or are otherwise required as a condition to
the rating of such Bonds by any Rating Agency, or if the Issuer chooses to
reduce the likelihood of a special redemption of such Bonds. The Bond Trustee
will invest any cash in any Reserve Fund in Permitted Investments maturing no
later than
35
the dates specified in the related Prospectus Supplement. If a letter of credit
is deposited with the Bond Trustee, such letter of credit will be irrevocable,
will name the Bond Trustee, in its capacity as trustee for the Bondholders, as
the sole beneficiary and will be issued by a bank acceptable to each Rating
Agency. If a surety bond is deposited with the Bond Trustee, such surety bond
will represent an obligation of an insurance company or other corporation whose
credit standing is acceptable to each Rating Agency and will provide that the
Bond Trustee may exercise all of the rights of the Issuer under such surety bond
without the necessity of the taking of any action by the Issuer. Following each
Payment Date for such Series of Bonds, amounts may be withdrawn from the related
Reserve Funds and remitted to the Issuer free from the lien of the Indenture
under the conditions and to the extent specified in the related Prospectus
Supplement. Additional information concerning any Reserve Fund securing a Series
of Bonds, including without limitation the manner in which such Reserve Fund
shall be funded and the conditions under which the amounts on deposit therein
will be used to make payments to holders of Bonds of a particular Class of the
related Series will be set forth in the related Prospectus Supplement.
MORTGAGE POOL INSURANCE POLICIES
If so specified in the related Prospectus Supplement, a separate mortgage
pool insurance policy or policies ("Mortgage Pool Insurance Policy") may be
obtained for a Series of Bonds secured by Pledged Mortgages and issued by the
insurer (the "Pool Insurer") named in such Prospectus Supplement. Each Mortgage
Pool Insurance Policy will, subject to the limitations described below, cover
loss by reason of default in payment on the related Pledged Mortgages in an
amount equal to a percentage specified in such Prospectus Supplement of the
aggregate principal balance of such Pledged Mortgages as of the first day of the
month of issuance of the related Series of Bonds or such other date as is
specified in the related Prospectus Supplement (the "Cut-Off Date") which are
not covered as to their entire outstanding principal balances by Primary
Mortgage Insurance Policies. As more fully described below, the Master Servicer
will present claims thereunder to the Pool Insurer on behalf of itself, the Bond
Trustee and the Bondholders. The Mortgage Pool Insurance Policies, however, are
not blanket policies against loss, since claims thereunder may be made only
respecting particular defaulted Pledged Mortgages and only upon satisfaction of
certain conditions precedent described below. Unless otherwise specified in the
related Prospectus Supplement, the Mortgage Pool Insurance Policies will not
cover losses due to a failure to pay or denial of a claim under a Primary
Mortgage Insurance Policy.
Unless otherwise specified in the related Prospectus Supplement, each
Mortgage Pool Insurance Policy will provide that no claims may be validly
presented unless (i) any required Primary Mortgage Insurance Policy is in effect
for the defaulted Pledged Mortgage and a claim thereunder has been submitted and
settled; (ii) hazard insurance on the related Mortgaged Property has been kept
in force and real estate taxes and other protection and preservation expenses
have been paid; (iii) if there has been physical loss or damage to the Mortgaged
Property, it has been restored to its physical condition (reasonable wear and
tear excepted) at the time of issuance of the policy; and (iv) the insured has
acquired good and merchantable title to the Mortgaged Property free and clear of
liens except certain permitted encumbrances. Upon satisfaction of these
conditions, the Pool Insurer will have the option either (a) to purchase the
Mortgaged Property at a price equal to the principal balance of the related
Pledged Mortgage plus accrued and unpaid interest at the Mortgage Rate to the
date of such purchase and certain expenses incurred by the Master Servicer on
behalf of the Bond Trustee and Bondholders or (b) to pay the amount by which the
sum of the principal balance of the defaulted Pledged Mortgage plus accrued and
unpaid interest at the Mortgage Rate to the date of payment of the claim and the
aforementioned expenses exceeds the proceeds received from an approved sale of
the Mortgaged Property, in either case net of certain amounts paid or assumed to
have been paid under the related Primary Mortgage Insurance Policy. If any
Mortgaged Property is damaged, and proceeds, if any, from the related standard
hazard insurance policy or the applicable Special Hazard Insurance Policy are
insufficient to restore the damaged property to a condition sufficient to permit
recovery under the Mortgage Pool Insurance Policy, the Master Servicer will not
be required to expend its own funds to restore the damaged property unless it
determines that (i) such restoration will increase the proceeds to Bondholders
on liquidation of the Pledged Mortgage after reimbursement of the Master
Servicer for its expenses and (ii) such expenses will be recoverable by it
through proceeds of the sale of the Mortgaged Property or proceeds of the
related Mortgage Pool Insurance Policy or any related Primary Mortgage Insurance
Policy.
36
Unless otherwise specified in the related Prospectus Supplement, no
Mortgage Pool Insurance Policy will insure (and many Primary Mortgage Insurance
Policies do not insure) against loss sustained by reason of a default arising
from, among other things, (i) fraud or negligence in the origination or
servicing of a Pledged Mortgage, including misrepresentation by the Mortgagor,
the originator or persons involved in the origination thereof, or (ii) failure
to construct a Mortgaged Property in accordance with plans and specifications. A
failure of coverage attributable to one of the foregoing events might result in
a breach of the related Seller's representations described above and, in such
event, might give rise to an obligation on the part of such Seller to repurchase
the defaulted Pledged Mortgage if the breach cannot be cured by such Seller. No
Mortgage Pool Insurance Policy will cover (and many Primary Mortgage Insurance
Policies do not cover) a claim in respect of a defaulted Pledged Mortgage
occurring when the servicer of such Pledged Mortgage, at the time of default or
thereafter, was not approved by the applicable insurer.
Unless otherwise specified in the related Prospectus Supplement, the
original amount of coverage under each Mortgage Pool Insurance Policy will be
reduced over the life of the related Bonds by the aggregate dollar amount of
claims paid less the aggregate of the net amounts realized by the Pool Insurer
upon disposition of all foreclosed properties. The amount of claims paid will
include certain expenses incurred by the Master Servicer as well as accrued
interest on delinquent Pledged Mortgages to the date of payment of the claim,
unless otherwise specified in the related Prospectus Supplement. Accordingly, if
aggregate net claims paid under any Mortgage Pool Insurance Policy reach the
original policy limit, coverage under that Mortgage Pool Insurance Policy will
be exhausted and any further losses will be borne by the Bondholders.
SPECIAL HAZARD INSURANCE POLICIES
If so specified in the related Prospectus Supplement, a separate special
hazard insurance policy or policies (the "Special Hazard Insurance Policy") may
be obtained for a Series of Bonds secured by Pledged Mortgages and will be
issued by the insurer (the "Special Hazard Insurer") named in such Prospectus
Supplement. Each Special Hazard Insurance Policy will, subject to limitations
described below, protect holders of the related Bonds from (i) loss by reason of
damage to Mortgaged Properties caused by certain hazards (including earthquakes
and, to a limited extent, tidal waves and related water damage or as otherwise
specified in the related Prospectus Supplement) not insured against under the
standard form of hazard insurance policy for the respective states in which the
Mortgaged Properties are located or under a flood insurance policy (unless the
Mortgaged Property is located in a federally designated flood area) and (ii)
loss caused by reason of the application of the coinsurance clause contained in
standard hazard insurance policies. No Special Hazard Insurance Policy will
cover losses occasioned by fraud or conversion by the Bond Trustee or Master
Servicer, war, insurrection, civil war, certain governmental action, errors in
design, faulty workmanship or materials (except under certain circumstances),
nuclear or chemical reaction, flood (if the Mortgaged Property is located in a
federally designated flood area), nuclear or chemical contamination and certain
other risks. The amount of coverage under any Special Hazard Insurance Policy
will be specified in the related Prospectus Supplement. Each Special Hazard
Insurance Policy will provide that no claim may be paid unless hazard and, if
applicable, flood insurance on the property securing the Pledged Mortgage have
been kept in force and other protection and preservation expenses have been
paid.
Subject to the foregoing limitations, and unless otherwise specified in the
related Prospectus Supplement, each Special Hazard Insurance Policy will provide
that where there has been damage to property securing a foreclosed Pledged
Mortgage (title to which has been acquired by the insured) and to the extent
such damage is not covered by the standard hazard insurance policy or flood
insurance policy, if any, maintained by the mortgagor or the Master Servicer,
the Special Hazard Insurer will pay the lesser of (i) the cost of repair or
replacement of such property or (ii) upon transfer of the property to the
Special Hazard Insurer, the unpaid principal balance of such Pledged Mortgage at
the time of acquisition of such property by foreclosure or deed in lieu of
foreclosure, plus accrued interest to the date of claim settlement and certain
expenses incurred by the Master Servicer with respect to such property. If the
unpaid principal balance of a Pledged Mortgage plus accrued interest and certain
expenses is paid by the Special Hazard Insurer, the amount of further coverage
under the related Special Hazard Insurance Policy will be reduced by such amount
less any net proceeds from the sale of the property. Any amount paid as the cost
of repair of such property will further reduce coverage by
37
such amount. So long as a Mortgage Pool Insurance Policy remains in effect, the
payment by the Special Hazard Insurer of the cost of repair or of the unpaid
principal balance of the related Pledged Mortgage plus accrued interest and
certain expenses will not affect the total insurance proceeds paid to
Bondholders, but will affect the relative amounts of coverage remaining under
the related Special Hazard Insurance Policy and Mortgage Pool Insurance Policy.
To the extent specified in the related Prospectus Supplement, the Master
Servicer may deposit cash, an irrevocable letter of credit or a guaranteed
investment contract in a special trust account to provide protection in lieu of
or in addition to that provided by a Special Hazard Insurance Policy. The amount
of any Special Hazard Insurance Policy or of the deposit to the special trust
account in lieu thereof relating to such Bonds may be reduced so long as any
such reduction will not result in a downgrading of the rating of such Bonds by
any applicable Rating Agency.
BANKRUPTCY BONDS
If so specified in the related Prospectus Supplement, a bankruptcy bond or
bonds (the "Bankruptcy Bond") may be obtained for a Series of Bonds secured by
Pledged Mortgages to cover losses resulting from proceedings under the federal
Bankruptcy Code with respect to a Pledged Mortgage will be issued by an insurer
named in such Prospectus Supplement. Each Bankruptcy Bond will cover, to the
extent specified in the related Prospectus Supplement, certain losses resulting
from a reduction by a bankruptcy court of scheduled payments of principal and
interest on a Pledged Mortgage or a reduction by such court of the principal
amount of a Pledged Mortgage and will cover certain unpaid interest on the
amount of such a principal reduction from the date of the filing of a bankruptcy
petition. The required amount of coverage under each Bankruptcy Bond will be set
forth in the related Prospectus Supplement. Coverage under a Bankruptcy Bond may
be cancelled or reduced by the Master Servicer if such cancellation or reduction
would not adversely affect the then current rating or ratings of the related
Bonds. See "CERTAIN LEGAL ASPECTS OF THE PLEDGED MORTGAGES -- Anti-Deficiency
Legislation and Other Limitations on Lenders" herein.
To the extent specified in the related Prospectus Supplement, the Master
Servicer may deposit cash, an irrevocable letter of credit or a guaranteed
investment contract in a special trust account to provide protection in lieu of
or in addition to that provided by a Bankruptcy Bond. The amount of any
Bankruptcy Bond or of the deposit to the special trust account in lieu thereof
relating to such Bonds may be reduced so long as any such reduction will not
result in a downgrading of the then current rating of such Bonds by any such
Rating Agency.
BOND INSURANCE POLICIES, SURETY BONDS AND GUARANTIES
If specified in the related Prospectus Supplement, deficiencies in amounts
otherwise payable on Bonds of a Series or certain Classes thereof will be
covered by insurance policies and/or surety bonds (the "Bond Insurance Policy")
provided by one or more insurance companies or sureties (the "Bond Insurer").
Such instruments may cover, with respect to one or more Classes of Bonds of the
related Series, timely payments of interest and/or full payments of principal on
the basis of a schedule of principal payments set forth in or determined in the
manner specified in the related Prospectus Supplement. In addition, if specified
in the related Prospectus Supplement, a Series of Bonds may also be covered by
insurance or guaranties for the purpose of (i) maintaining timely payments or
providing additional protection against losses on the Mortgage Collateral
pledged to secure such Series, (ii) paying administrative expenses or (iii)
establishing a minimum reinvestment rate on the payments made in respect of such
Mortgage Collateral or principal payment rate on such Mortgage Collateral. Such
arrangements may include agreements under which Bondholders are entitled to
receive amounts deposited in various accounts held by the Bond Trustee upon the
terms specified in such Prospectus Supplement. A copy of any such instrument for
a Series will be filed with the Commission as an exhibit to a Current Report on
Form 8-K to be filed within 15 days of issuance of the Bonds of the related
Series.
38
LETTER OF CREDIT
If so specified in the related Prospectus Supplement, credit enhancement
may be provided by a letter of credit. The letter of credit, if any, with
respect to a Series of Bonds will be issued by the bank or financial institution
specified in the related Prospectus Supplement (the "L/C Bank"). Under the
letter of credit, the L/C Bank will be obligated to honor drawings thereunder in
an aggregate fixed dollar amount, net of unreimbursed payments thereunder, equal
to the percentage specified in the related Prospectus Supplement of the
aggregate principal balance of the Mortgage Collateral pledged to secure the
related Series of Bonds on the related Cut-off Date or of one or more Classes of
Bonds (the "L/C Percentage"). If so specified in the related Prospectus
Supplement, the letter of credit may permit drawings in the event of losses not
covered by insurance policies or other credit support, such as losses arising
from damage not covered by standard hazard insurance policies, losses resulting
from the bankruptcy of a borrower and the application of certain provisions of
the federal Bankruptcy Code, or losses resulting from denial of insurance
coverage due to misrepresentations in connection with the origination of a
Pledged Mortgage. The amount available under the letter of credit will, in all
cases, be reduced to the extent of the unreimbursed payments thereunder. The
obligations of the L/C Bank under the letter of credit for each Series of Bonds
will expire at the date specified in the related Prospectus Supplement. A copy
of the letter of credit for a Series, if any, will be filed with the Commission
as an exhibit to a Current Report on Form 8-K to be filed within 15 days of
issuance of the Securities of the related Series.
OVER-COLLATERALIZATION
If so specified in the related Prospectus Supplement, credit enhancement
may consist of over-collateralization whereby the aggregate principal balance of
the related Mortgage Collateral exceeds the aggregate principal balance of the
Bonds of the related Series. Such over-collateralization may exist on the
related Closing Date or develop thereafter as a result of the application of a
portion of the principal and interest payments on each Pledged Mortgage or
Certificate, as the case may be, as an additional payment in respect of
principal to reduce the principal balance of a certain Class or Classes of Bonds
and, thus, accelerate the rate of payment of principal on such Class or Classes
of Bonds.
CROSS-COLLATERALIZATION
If so specified in the related Prospectus Supplement, separate groups of
Mortgage Collateral may be pledged to secure separate Classes of the related
Series of Bonds. In such case, credit support may be provided by a
cross-collateralization feature which requires that payments be made with
respect to Bonds secured by one or more groups of Mortgage Collateral prior to
distributions to Subordinated Bonds secured by one or more other groups of
Mortgage Collateral. Cross-collateralization may be provided by (i) the
allocation of certain excess amounts generated by one or more groups of Mortgage
Collateral to one or more other groups of Mortgage Collateral or (ii) the
allocation of losses with respect to one or more groups of Mortgage Collateral,
to one or more other groups of Mortgage Collateral. Such excess amounts will be
applied and/or such losses will be allocated to the Class or Classes of
Subordinated Bonds of the related Series then outstanding having the lowest
rating assigned by any applicable Rating Agency or the lowest payment priority,
in each case to the extent and in the manner more specifically described in the
related Prospectus Supplement. The Prospectus Supplement for a Series which
includes a cross-collateralization feature will describe the manner and
conditions for applying such cross-collateralization feature.
If so specified in the related Prospectus Supplement, the coverage provided
by one or more of the forms of credit enhancement described in this Prospectus
may apply concurrently to two or more separate Series of Bonds. If applicable,
the related Prospectus Supplement will identify the Series of Bonds to which
such credit enhancement relates and the manner of determining the amount of
coverage provided to such Series of Bonds thereby and of the application of such
coverage to the identified Series of Bonds.
MINIMUM PRINCIPAL PAYMENT AGREEMENT
If so specified in the related Prospectus Supplement, an Issuer may enter
into an agreement with an institution pursuant to which such institution will
provide such funds as may be necessary to enable such
39
Issuer to make principal payments on the Bonds of the related Series at a
minimum rate set forth in such Prospectus Supplement.
DERIVATIVE ARRANGEMENTS
If so specified in the related Prospectus Supplement, credit enhancement
may be provided with respect to one or more Classes of Bonds of a Series or with
respect to the Mortgage Collateral securing a Series of Bonds in the form of one
or more derivative arrangements. A derivative arrangement is a contract or
agreement, the price of which is directly dependent upon (i.e., "derived from")
the value of one or more underlying assets, including securities, equity
indices, debt instruments, commodities, other derivative instruments, or any
agreed upon pricing index or arrangement (e.g., the movement over time of the
Consumer Price Index or interest rates). Derivatives involve rights or
obligations based on the underlying asset, but do not necessarily result in a
transfer of the underlying asset. Derivative arrangements include swap
agreements, interest rate swaps, interest rate caps, interest rate floors,
interest rate collars and currency swap agreements. A "swap agreement" is a
contractual agreement providing for a series of exchanges of principal and/or
interest in the same or different currencies. At a more general level, the term
"swap agreement" includes the exchange of fixed-for-floating payments on a given
quantity of a specified commodity, security or other asset. An "interest rate
swap" is a swap agreement between two parties to engage in a series of exchanges
of interest payments on the same notional principal amount denominated in the
same currency based, respectively, on variable or fixed rates of interest. An
"interest rate cap" is an agreement providing for multi-period cash settled
options on interest rates. The cap purchaser receives a cash payment whenever
the reference rate exceeds the ceiling rate on a fixing date. An "interest rate
floor" is an agreement providing for a multi-period interest rate option that
provides a cash payment to the holder of the option whenever the reference rate
is below the floor on a fixing date. An "interest rate collar" is an agreement
providing for a combination of an interest rate cap and an interest rate floor
such that a cap is purchased and a floor is sold or vice versa. The effect of an
interest rate collar is to place upper and lower bounds on the cost of funds. A
"currency swap agreement" is a swap agreement between two parties for the
exchange of a future series of interest and principal payments in which one
party pays in one currency and the other party pays in a different currency. The
exchange rate is fixed over the life of the currency swap agreement.
The derivative arrangements described above will support the payments on
the Bonds to the extent and under the conditions specified in the related
Prospectus Supplement. Unless otherwise specified in the related Prospectus
Supplement, no credit enhancement will provide protection against all risks of
loss or guarantee repayment of the entire principal balance of the Bonds and
interest thereon. If losses occur which exceed the amount covered by credit
enhancement or which are not covered by the credit enhancement, Bondholders will
bear their allocable share of any deficiencies.
SERVICING OF THE PLEDGED MORTGAGES
GENERAL
If so specified in the related Prospectus Supplement, the master servicer
(the "Master Servicer") of the Pledged Mortgages, if any, securing a Series of
Bonds will be responsible for servicing such Pledged Mortgages in accordance
with the terms set forth in a master servicing agreement (the "Master Servicing
Agreement") among the Issuer, the Master Servicer and the Bond Trustee. The
Master Servicer with respect to a Series of Bonds will be identified in the
related Prospectus Supplement. The Master Servicer will perform certain of its
servicing obligations under the Master Servicing Agreement through one or more
servicers (each, a "Servicer") pursuant to one or more mortgage servicing
agreements (each, a "Servicing Agreement"). Notwithstanding any such servicing
arrangements, unless otherwise provided in the related Prospectus Supplement,
the Master Servicer will remain liable for its servicing duties and obligations
under the Master Servicing Agreement.
No Servicing Agreement will contain any terms inconsistent with the related
Master Servicing Agreement. While each Servicing Agreement will typically be a
contract solely between Redwood Trust and
40
the Servicer, Redwood Trust will assign all of its rights under each Servicing
Agreement to the Depositor under the related Mortgage Loan Purchase Agreement
and such rights will be assigned to the Bond Trustee pursuant to the Indenture.
The Master Servicing Agreement relating to a Series of Bonds will provide that
the Master Servicer and, if for any reason such Master Servicer is no longer the
Master Servicer of the related Pledged Mortgages, the Bond Trustee or any
successor Master Servicer must recognize the Servicer's rights and obligations
under such Servicing Agreement. As an independent contractor, each Servicer will
perform servicing functions for the Pledged Mortgages including collection and
remittance of principal and interest payments, administration of mortgage escrow
accounts, collection of certain insurance claims and, if necessary, foreclosure.
The Master Servicer may permit Servicers to contract with subservicers to
perform some or all of the Servicer's servicing duties, but the Servicer will
not thereby be released from its obligations under the related Servicing
Agreement. The Master Servicer also may enter into servicing contracts directly
with an affiliate of a Servicer or permit a Servicer to transfer its servicing
rights and obligations to a third party. In such instances, the affiliate or
third party, as the case may be, will perform servicing functions comparable to
those normally performed by the Servicer as described above, and the Servicer
will not be obligated to perform such servicing functions. When used herein with
respect to servicing obligations, the term Servicer includes any such affiliate
or third party. The Master Servicer may perform certain supervisory functions
with respect to servicing by the Servicers directly or through an agent or
independent contractor.
On or before the related Closing Date, the Master Servicer or each Servicer
will establish one or more accounts (each, a "Custodial Account") into which
each Servicer will remit collections on the Pledged Mortgages serviced by it
(net of its related servicing compensation, amounts retained to pay certain
insurance premiums and amounts retained by such Servicer as reimbursement for
certain advances it has made). For purposes of the Master Servicing Agreement,
the Master Servicer will be deemed to have received any amounts with respect to
the Pledged Mortgages that are received by a Servicer regardless of whether such
amounts are remitted by the Servicer to the Master Servicer. The Master Servicer
will have the right under the Master Servicing Agreement to remove the Servicer
servicing any Pledged Mortgages in the event such Servicer defaults under its
Servicing Agreement and will exercise that right if the Master Servicer
considers such removal to be in the best interest of the Bondholders. In the
event that the Master Servicer removes a Servicer, the Master Servicer will
continue to be responsible for servicing the related Pledged Mortgages.
Notwithstanding any description of the Master Servicer or Master Servicing
Agreement contained in this Prospectus, a Series of Bonds may be secured by
Pledged Mortgages serviced by Servicers under one or more Servicing Agreements
without a Master Servicer. The Prospectus Supplement for any such Series of
Bonds will identify the Servicers and summarize certain provisions of the
Servicing Agreements.
A form of Master Servicing Agreement has been filed as an exhibit to the
Registration Statement of which this Prospectus forms a part. The Master
Servicing Agreement with respect to a Series of Bonds secured by Pledged
Mortgages will be assigned to the Bond Trustee as security for such Series. The
following summaries describe certain provisions of the form of Master Servicing
Agreement. The summaries are qualified in their entirety by reference to the
form of Master Servicing Agreement. Where particular provisions or terms used in
the form of Master Servicing Agreement are referred to, the actual provisions
(including definitions of terms) are incorporated by reference as part of such
summaries.
PAYMENTS ON PLEDGED MORTGAGES
Pursuant to the Master Servicing Agreement with respect to a Series of
Bonds, unless otherwise provided in the related Prospectus Supplement the Master
Servicer will be required to establish and maintain a separate Eligible Account
or Eligible Accounts (collectively, the "Bond Account") into which it will
deposit or cause to be deposited on a daily basis, or such other basis as may be
specified in the related Prospectus Supplement, payments of principal and
interest (net of servicing compensation, amounts retained to pay certain
insurance premiums and amounts retained by the Master Servicer or any Servicer
as reimbursement for certain advances it has made) received with respect to the
related Pledged Mortgages. Such amounts will include principal prepayments,
certain Insurance Proceeds and Liquidation Proceeds and amounts paid by the
41
Servicer or the Company in connection with any optional purchase by the Servicer
or the Company of any defaulted Pledged Mortgages.
An "Eligible Account" is an account either (i) maintained with a depository
institution the short-term debt obligations of which (or in the case of a
depository institution that is the principal subsidiary of a holding company,
the short-term debt obligations of which, but only if Moody's is not an
applicable Rating Agency) are rated in the highest short-term rating category by
each applicable Rating Agency, (ii) an account or accounts the deposits in which
are fully insured by either the BIF or SAIF, (iii) an account or accounts the
deposits in which are insured by the BIF or SAIF to the limits established by
the FDIC, and the uninsured deposits in which are otherwise secured such that,
as evidenced by an opinion of counsel, the Bondholders have a claim with respect
to the funds in the Bond Account or a perfected first priority security interest
against any collateral securing such funds that is superior to the claims of any
other depositors or general creditors of the depository institution with which
the Bond Account is maintained, (iv) a trust account or accounts maintained with
the trust department of a federal or a state chartered depository institution or
trust company, acting in a fiduciary capacity or (v) an account or accounts
otherwise acceptable to each applicable Rating Agency. The collateral eligible
to secure amounts in the Bond Account is limited to Permitted Investments. A
Bond Account may be maintained as an interest bearing account or the funds held
therein may be invested pending each succeeding Payment Date in Permitted
Investments. If so specified in the related Prospectus Supplement, the Master
Servicer or its designee will be entitled to receive any such interest or other
income earned on funds in the Bond Account as additional compensation and will
be obligated to deposit in the Bond Account the amount of any loss immediately
as realized.
Pursuant to the Master Servicing Agreement, the Master Servicer will be
required to remit to the Bond Trustee (to the extent not previously remitted),
on or before each Distribution Account Deposit Date, the Bond Distribution
Amount for the related Payment Date for deposit in the Distribution Account for
such Series of Bonds maintained with the Bond Trustee.
Any amounts received by the Master Servicer as Insurance Proceeds or as
Liquidation Proceeds, net of any expenses and other amounts reimbursable to the
Master Servicer pursuant to the Master Servicing Agreement, will (unless applied
to the repair or restoration of a Mortgaged Property) be deemed to be payments
received with respect to the Pledged Mortgages securing the related Series of
Bonds and will be deposited in the related Bond Account.
Prior to each Payment Date for a Series of Bonds, the Master Servicer will
furnish to the Bond Trustee a statement setting forth certain information with
respect to payments received with respect to the Pledged Mortgages.
COLLECTION PROCEDURES
The Master Servicer, directly or through one or more Servicers, will make
reasonable efforts to collect all payments called for under the Pledged
Mortgages and will, consistent with each Master Servicing Agreement and any
Mortgage Pool Insurance Policy, Primary Mortgage Insurance Policy and Bankruptcy
Bond or alternative arrangements, follow such collection procedures as are
customary with respect to mortgage loans that are comparable to the Pledged
Mortgages. Consistent with the above, the Master Servicer or applicable Servicer
may, in its discretion, (i) waive any assumption fee, late payment or other
charge in connection with a Pledged Mortgage and (ii) to the extent not
inconsistent with the coverage of such Pledged Mortgage by a Mortgage Pool
Insurance Pool Policy, Primary Mortgage Insurance Policy or Bankruptcy Bond or
alternative arrangements, if applicable, arrange with a Mortgagor a schedule for
the liquidation of delinquencies running for no more than 180 days (unless a
longer period is specified in the related Prospectus Supplement) after the
applicable due date for each payment. To the extent the Master Servicer is
obligated to make or to cause to be made advances, such obligation will remain
during any period of such an arrangement.
Unless otherwise specified in the related Prospectus Supplement, in any
case in which property securing a Pledged Mortgage has been, or is about to be,
conveyed by the Mortgagor, the Master Servicer will, to the extent it has
knowledge of such conveyance or proposed conveyance, exercise or cause to be
exercised its rights to accelerate the maturity of such Pledged Mortgage under
any due-on-sale clause applicable thereto,
42
but only if the exercise of such rights is permitted by applicable law and will
not impair or threaten to impair any recovery under any related Primary Mortgage
Insurance Policy. If these conditions are not met or if the Master Servicer
reasonably believes it is unable under applicable law to enforce such
due-on-sale clause, the Master Servicer will enter into or cause to be entered
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 for repayment of the Pledged Mortgage and, to the extent
permitted by applicable law, the Mortgagor also remains liable thereon. If a
Mortgaged Property is sold or transferred, the Master Servicer will be required
promptly to notify the Bond Trustee and the respective issuers of any hazard
insurance policies, mortgagor bankruptcy insurance and mortgage insurance
policies to assure that all required endorsements to each insurance policy are
obtained and that coverage under each such policy will remain in effect after
the occurrence of such sale or transfer. Any fee collected by or on behalf of
the Master Servicer for entering into an assumption agreement will be retained
by or on behalf of the Master Servicer as additional servicing compensation. See
"CERTAIN LEGAL ASPECTS OF PLEDGED MORTGAGES -- 'Due-on-Sale' Clauses" herein. In
connection with any such assumption, the terms of the related Pledged Mortgage
may not be changed.
With respect to Cooperative Loans, any prospective purchaser will generally
have to obtain the approval of the board of directors of the relevant
Cooperative before purchasing the shares and acquiring rights under the related
proprietary lease or occupancy agreement. See "CERTAIN LEGAL ASPECTS OF PLEDGED
MORTGAGES" herein. This approval is usually based on the purchaser's income and
net worth and numerous other factors. Although the Cooperative's approval is
unlikely to be unreasonably withheld or delayed, the necessity of acquiring such
approval could limit the number of potential purchasers for those shares and
otherwise limit the ability to sell and realize the value of those shares.
In general, a "tenant-stockholder" (as defined in Code Section 216(b)(2))
of a corporation that qualifies as a "cooperative housing corporation" within
the meaning of Code Section 216(b)(1) 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 Code Section 216(a) to the corporation under Code
Sections 163 and 164. In order for a corporation to qualify under Code Section
216(b)(1) 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
(as defined in Code Section 216(b)(2)). By virtue of this requirement, the
status of a corporation for purposes of Code Section 216(b)(1) 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 Code Section 216(a) with respect to those
years. In view of the significance of the tax benefits accorded
tenant-stockholders of a corporation that qualifies under Code Section
216(b)(1), the likelihood that such a failure would be permitted to continue
over a period of years appears remote.
JUNIOR MORTGAGES
In the case of single family loans secured by junior liens on the related
Mortgaged Properties, the Master Servicer will be required to file (or cause to
be filed) of record a request for notice of any action by a superior lienholder
under the Senior Lien for the protection of the related Bond Trustee's interest,
where permitted by local law and whenever applicable state law does not require
that a junior lienholder be named as a party defendant in foreclosure
proceedings in order to foreclose such junior lienholder's equity of redemption.
The Master Servicer also will be required to notify any superior lienholder in
writing of the existence of the Pledged Mortgage and request notification of any
action (as described below) to be taken against the Mortgagor or the Mortgaged
Property by the superior lienholder. If the Master Servicer is notified that any
superior lienholder has accelerated or intends to accelerate the obligations
secured by the related Senior Lien, or has declared or intends to declare a
default under the mortgage or the promissory note secured thereby, or has filed
or intends to file an election to have the related Mortgaged Property sold or
foreclosed, then the
43
Master Servicer will be required to take, on behalf of the related Issuer,
whatever actions are necessary to protect the interests of the related
Bondholders, and/or to preserve the security of the related Pledged Mortgage.
The Master Servicer will generally be required to advance the necessary funds to
cure the default or reinstate the superior lien, if such advance is in the best
interests of the related Bondholders and the Master Servicer determines such
advances are recoverable out of payments on or proceeds of the related Pledged
Mortgage.
SERVICING AND OTHER COMPENSATION AND PAYMENT OF EXPENSES
The principal servicing compensation to be paid to the Master Servicer in
respect of its master servicing activities for each Series of Bonds will be
equal to the percentage per annum described in the related Prospectus Supplement
(which may vary under certain circumstances) of the outstanding principal
balance of each Pledged Mortgage securing such Series of Bonds and such
compensation will be retained by it from collections of interest on such Pledged
Mortgage (the "Master Servicing Fee"). As compensation for its servicing duties,
any Servicer or subservicer will generally be entitled to a monthly servicing
fee as described in the related Prospectus Supplement. In addition, the Master
Servicer, any Servicer or any subservicer will retain as additional compensation
all prepayment charges, assumption fees and late payment charges, to the extent
collected from Mortgagors, and any benefit that may accrue as a result of the
investment of funds in the applicable Bond Account (unless otherwise specified
in the related Prospectus Supplement).
The Master Servicer will pay or cause to be paid certain ongoing expenses
associated with each Series of Bonds and incurred by it in connection with its
responsibilities under the related Master Servicing Agreement, including,
without limitation, payment of any fee or other amount payable in respect of any
credit enhancement arrangements, payment of the fees and disbursements of the
Bond Trustee, any custodian appointed by the Bond Trustee, the certificate
registrar and any paying agent, and payment of expenses incurred in enforcing
the obligations of Servicers and Sellers. The Master Servicer will be entitled
to reimbursement of expenses incurred in enforcing the obligations of Servicers
under certain limited circumstances. In addition, as indicated in the preceding
section, the Master Servicer will be entitled to reimbursement of expenses
incurred by it in connection with any defaulted Pledged Mortgage as to which it
has determined that all recoverable Liquidation Proceeds and Insurance Proceeds
have been received (a "Liquidated Mortgage"), and in connection with the
restoration of Mortgaged Properties, such right of reimbursement being prior to
the rights of Bondholders to receive any related Liquidation Proceeds (including
Insurance Proceeds).
PREPAYMENTS
In general, when a borrower prepays a mortgage loan between due dates, the
borrower is required to pay interest on the amount prepaid only to the date of
prepayment and not thereafter. In the event such prepayments, together with
other prepayments (including for this purpose prepayments resulting from
refinancing or liquidations of the Pledged Mortgages or the mortgage loans
underlying the Certificates, as the case may be, due to defaults, casualties,
condemnations, repurchases by the Seller, the Issuer or Redwood Trust or
purchases thereof by the Master Servicer or the Company), result in a shortfall
in the amount of interest available on a Payment Date for the Bonds of a Series,
the Master Servicer may be required to cover the shortfall, but only if and to
the extent specified in the related Prospectus Supplement.
EVIDENCE AS TO COMPLIANCE
Each Master Servicing Agreement and Indenture will provide that on or
before a specified date in each year, a firm of independent public accountants
will furnish a statement to the Issuer and the Bond Trustee to the effect that,
on the basis of the examination by such firm conducted substantially in
compliance with the Uniform Single Attestation Program for Mortgage Bankers, the
Audit Program for Mortgages serviced for FHLMC or such other procedures as may
be specified in the related Prospectus Supplement, the servicing by or on behalf
of the Master Servicer of Pledged Mortgages under agreements substantially
similar to each other (including the related Master Servicing Agreement) was
conducted in compliance with such agreements except for any significant
exceptions or errors in records that, in the opinion of the firm, the Audit
Program for
44
Mortgages serviced for FHLMC, the Uniform Single Attestation Program for
Mortgage Bankers or such other procedure, requires it to report. In rendering
its statement such firm may rely, as to matters relating to the direct servicing
of Pledged Mortgages by Servicers, upon comparable statements for examinations
conducted substantially in compliance with the Uniform Single Attestation
Program for Mortgage Bankers, the Audit Program for Mortgages serviced for FHLMC
or such other procedure, (rendered within one year of such statement) of firms
of independent public accountants with respect to the related Servicer.
Each Master Servicing Agreement and Indenture will also provide for
delivery to the Issuer and the Bond Trustee, on or before a specified date in
each year, of an annual statement signed by two officers of the Master Servicer
to the effect that the Master Servicer has fulfilled its obligations under the
Master Servicing Agreement throughout the preceding year.
Copies of the annual accountants' statement and the statement of officers
of the Master Servicer may be obtained by Bondholders of the related Series
without charge upon written request to the Issuer at its principal executive
offices.
ADVANCES AND OTHER AMOUNTS PAYABLE BY MASTER SERVICER
Subject to any limitations set forth in the related Prospectus Supplement,
each Master Servicing Agreement will require the Master Servicer to advance on
or before each Payment Date (from its own funds, funds advanced by Servicers or
funds held in the Bond Account for future distribution to Bondholders), an
amount equal to the aggregate of payments of principal and interest that were
delinquent on the related Determination Date ("Advances"), subject to the Master
Servicer's determination that such advances will be recoverable out of late
payments by obligors on the Mortgage Collateral, Liquidation Proceeds, Insurance
Proceeds or otherwise. In the case of Cooperative Loans, the Master Servicer
also will be required to advance any unpaid maintenance fees and other charges
under the related proprietary leases as specified in the related Prospectus
Supplement.
In making Advances, the Master Servicer will endeavor to maintain a regular
flow of scheduled interest and principal payments to Bondholders, rather than to
guarantee or insure against losses. If Advances are made by the Master Servicer
from cash being held for future distribution to Bondholders, the Master Servicer
will replace such funds on or before any future Payment Date to the extent that
funds in the applicable Bond Account on such Payment Date would be less than the
amount required to be available for distributions to Bondholders on such date.
Any Advances will be reimbursable to the Master Servicer out of recoveries on
the specific Mortgage Collateral with respect to which such Advances were made
(e.g., late payments made by the related obligors, any related Insurance
Proceeds, Liquidation Proceeds or proceeds of any Pledged Mortgage repurchased
pursuant to the related Master Servicing Agreement). In addition, Advances by
the Master Servicer (and any advances by a Servicer) also will be reimbursable
to the Master Servicer (or Servicer) from cash otherwise distributable to
Bondholders to the extent that the Master Servicer determines that any such
Advances previously made are not ultimately recoverable as described in the
immediately preceding sentence. The Master Servicer also will be obligated to
make Advances, to the extent recoverable out of Insurance Proceeds, Liquidation
Proceeds or otherwise, in respect of certain taxes and insurance premiums not
paid by Mortgagors on a timely basis. Funds so advanced are reimbursable to the
Master Servicer to the extent permitted by the Master Servicing Agreement. If
specified in the related Prospectus Supplement, the obligations of the Master
Servicer to make Advances may be supported by a cash advance reserve fund, a
surety bond or a letter of credit, in each case as described in such Prospectus
Supplement.
RESIGNATION OF MASTER SERVICER
A Master Servicer may not resign from its obligations and duties under a
Master Servicing Agreement or assign or transfer such duties or obligations
except (i) upon a determination that its duties thereunder are no longer
permissible under applicable law or (ii) upon a sale of its servicing rights
with respect to the Pledged Mortgages with the prior written consents of the
Bond Trustee, the Issuer and any applicable Bond Insurer. No such resignation
will become effective until the Bond Trustee, as Stand-by Master Servicer, or a
Successor
45
Master Servicer (as such terms are defined below) has assumed the Master
Servicer's obligations and duties under such Master Servicing Agreement.
Each Master Servicing Agreement will provide that such a successor master
servicer (the "Successor Master Servicer") must be satisfactory to the Issuer,
the Bond Trustee and any applicable Bond Insurer, in the exercise of their
reasonable discretion and must be approved to act as a mortgage servicer for
FHLMC or FNMA.
STAND-BY SERVICER
If so specified in the related Prospectus Supplement, the Bond Trustee will
act as stand-by Master Servicer (the "Stand-by Master Servicer") with respect to
each Series of Bonds secured by Pledged Mortgages. As Stand-by Master Servicer,
the Bond Trustee will succeed to the rights and obligations of the Master
Servicer with respect to the Pledged Mortgages securing such Series upon a
default by the Master Servicer or upon resignation by the Master Servicer until
the appointment of a Successor Master Servicer.
SPECIAL SERVICING AGREEMENT
The Company may appoint a special servicer (the "Special Servicer") to
undertake certain responsibilities with respect to certain defaulted Pledged
Mortgages securing a Series. The Special Servicer may engage various independent
contractors to perform certain of its responsibilities, provided, however, the
Special Servicer remains fully responsible and liable for all its requirements
under the special servicing agreement (the "Special Servicing Agreement"). As
may be further specified in the related Prospectus Supplement, the Special
Servicer, if any, may be entitled to various fees, including, but not limited
to, (i) a monthly engagement fee applicable to each Pledged Mortgage, (ii) a
special servicing fee, or (iii) a performance fee applicable to each liquidated
Pledged Mortgage, in each case calculated as set forth in the related Prospectus
Supplement.
CERTAIN MATTERS REGARDING THE MASTER SERVICER AND THE COMPANY
Each Master Servicing Agreement will provide that neither the Master
Servicer, the Company, the Owner Trustee nor any director, officer, employee or
agent of the Master Servicer, the Company or the Owner Trustee will be under any
liability to the related Bondholders for any action taken or for refraining from
the taking of any action in good faith pursuant to the Master Servicing
Agreement, or for errors in judgment; provided, however, that neither the Master
Servicer, the Company, the Owner Trustee nor any such person will be protected
against any liability that would otherwise be imposed by reason of willful
misfeasance, bad faith or negligence in the performance of duties thereunder or
by reason of reckless disregard of obligations and duties thereunder. Each
Master Servicing Agreement will further provide that the Master Servicer, the
Company, the Owner Trustee and any director, officer, employee or agent of the
Master Servicer, the Company or the Owner Trustee will be entitled to
indemnification by the related Issuer and will be held harmless against any
loss, liability or expense incurred in connection with any legal action relating
to the Master Servicing Agreement or the Bonds, other than any loss, liability
or expense related to any specific Mortgage Collateral (except any such loss,
liability or expense otherwise reimbursable pursuant to the Master Servicing
Agreement) and any loss, liability or expense incurred by reason of willful
misfeasance, bad faith or negligence in the performance of duties thereunder or
by reason of reckless disregard of obligations and duties thereunder. In
addition, each Master Servicing Agreement will provide that neither the Master
Servicer, the Company nor the Owner Trustee will be under any obligation to
appear in, prosecute or defend any legal action which is not incidental to its
respective responsibilities under the Master Servicing Agreement and which in
its opinion may involve it in any expense or liability. The Master Servicer, the
Company or the Owner Trustee may, however, in its discretion undertake any such
action which it may deem necessary or desirable with respect to the Master
Servicing Agreement and the rights and duties of the parties thereto and the
interests of the Bondholders thereunder. In such event, the legal expenses and
costs of such action and any liability resulting therefrom will be expenses,
costs and liabilities of the related Issuer, and the Master Servicer, the
Company or the Owner Trustee, as the case may be, will be entitled to be
reimbursed therefor out of funds otherwise available for distribution to
Bondholders.
46
Any person into which the Master Servicer may be merged or consolidated, or
any person resulting from any merger or consolidation to which the Master
Servicer is a party, or any person succeeding to the business of the Master
Servicer, will be the successor of the Master Servicer under each Master
Servicing Agreement, provided that such person is qualified to sell mortgage
loans to, and service mortgage loans on behalf of, FNMA or FHLMC and further
provided that such merger, consolidation or succession does not adversely affect
the then current rating or ratings of the Bonds of such Series.
SERVICING DEFAULTS
Events of default under the Master Servicing Agreement (each, a "Servicing
Default") for a Series of Bonds will include (i) any failure of the Master
Servicer to deposit in the Bond Account or remit to the Bond Trustee any
required payment (other than an Advance) which continues unremedied for one
business day after the giving of written notice of such failure to the Master
Servicer by the Bond Trustee or the Issuer; (ii) any failure by the Master
Servicer to make an Advance as required under the Master Servicing Agreement,
unless cured as specified therein; (iii) any failure by the Master Servicer duly
to observe or perform in any material respect any of its other covenants or
agreements in the Master Servicing Agreement which continues unremedied for
thirty days after the giving of written notice of such failure to the Master
Servicer by the Bond Trustee or the Issuer; and (iv) certain events of
insolvency, readjustment of debt, marshalling of assets and liabilities or
similar proceeding and certain actions by or on behalf of the Master Servicer
indicating its insolvency, reorganization or inability to pay its obligations.
RIGHTS UPON SERVICING DEFAULT
If a Servicing Default under a Master Servicing Agreement shall have
occurred and be continuing, the Bond Trustee (with the consent of the Bond
Insurer, if any) may terminate all of the rights and obligations of the Master
Servicer under such Master Servicing Agreement, including the Master Servicer's
rights to receive any Master Servicing Fees. Upon such termination, the Bond
Trustee, as Stand-by Master Servicer, or any Successor Master Servicer duly
appointed by the Bond Trustee will succeed to all the responsibilities, duties
and liabilities of the Master Servicer under such Master Servicing Agreement and
will be entitled to similar compensation arrangements. Neither the Issuer nor
the Bond Trustee shall have any right to waive any Servicing Default, except
under certain circumstances specified in the Master Servicing Agreement.
AMENDMENT OF MASTER SERVICING AGREEMENT
A Master Servicing Agreement with respect to any Series of Bonds secured by
Pledged Mortgages may not be amended, changed, modified, terminated or
discharged, except by an instrument in writing signed by all parties thereto,
and with prior written notice to any applicable Bond Insurer.
THE INDENTURE
The following is a general summary of certain provisions of the Indenture
for each Series of Bonds not described elsewhere in this Prospectus. The
summaries are qualified in their entirety by reference to the provisions of the
Indenture. Where particular provisions or terms used in the Indenture are
referred to, the actual provisions (including definitions of terms) are
incorporated by reference as part of such summaries. The Indenture relating to
each Series of Bonds will be filed with the Securities and Exchange Commission
within fifteen days of the closing of the sale of such Series of Bonds.
GENERAL
Unless otherwise specified in the related Prospectus Supplement, the
Indenture will limit the amount of Bonds that can be issued thereunder and will
provide that Bonds may be issued only up to the aggregate principal amount
authorized by the Issuer.
47
MODIFICATION OF INDENTURE
With the consent of the holders of not less than 66 2/3% of the then
outstanding principal amount of the Class of Bonds of the related Series
specified in the related Prospectus Supplement to be the "Controlling Class",
the Bond Trustee and the Issuer may execute a supplemental indenture to add
provisions to, or change in any manner or eliminate any provisions of, the
Indenture with respect to the Bonds of such Series or modify (except as provided
below) in any manner the rights of the Bondholders.
Without the consent of the holder of each outstanding Bond affected,
however, no supplemental indenture shall (a) change the Stated Maturity of the
principal of, or any installment of interest on, any Bond or reduce the
principal amount thereof, the interest rate specified thereon or the redemption
price with respect thereto, or change the earliest date on which any Bond may be
redeemed at the option of the Issuer, or any place of payment where, or the coin
or currency in which, any affected Bond or any interest thereon is payable, or
impair the right to institute suit for the enforcement of the provisions of the
Indenture regarding payment, (b) reduce the percentage of the aggregate amount
of the outstanding Bonds, the consent of the holders of which is required for
any such supplemental indenture, or the consent of the holders of which is
required for any waiver of compliance with certain provisions of the Indenture
or certain defaults thereunder and their consequences provided for in the
Indenture, (c) modify the provisions of the Indenture specifying the
circumstances under which such a supplemental indenture may not change the
provisions of the Indenture without the consent of each outstanding Bond
affected thereby, or the provisions of the Indenture with respect to certain
remedies available in an Event of Default (as defined herein), except to
increase any percentage specified therein or to provide that certain other
provisions of the Indenture cannot be modified or waived without the consent of
the holder of each outstanding Bond affected thereby, (d) modify or alter the
provisions of the Indenture defining when Bonds are outstanding, (e) permit the
creation of any lien (other than certain permitted liens) ranking prior to or on
a parity with the lien of the Indenture with respect to any part of the property
subject to lien under the Indenture, or terminate the lien of the Indenture on
any property at any time subject thereto or deprive the holder of any Bond of
the security afforded by the lien of the Indenture (other than in connection
with a permitted substitution of Mortgage Collateral) or (f) modify any of the
provisions of the Indenture in such manner as to affect the calculation of the
debt service requirement for any Bond or the rights of the Bondholders to the
benefits of any provisions for the mandatory redemption of Bonds contained
therein. (Indenture, Section 9.02)
The Issuer and the Bond Trustee may also enter into supplemental
indentures, without obtaining the consent of Bondholders, to cure ambiguities or
make minor corrections, and to do such other things as would not adversely
affect the interests of Bondholders. (Indenture, Section 9.01)
Each Bondholder agrees that unless a Bond Insurer default exists, the Bond
Insurer, if any, shall have the right to exercise the voting rights of the
Bondholders to the extent set forth in the Indenture.
EVENTS OF DEFAULT
Unless otherwise specified in the related Prospectus Supplement, an event
of default (an "Event of Default") with respect to any Series of Bonds is
defined in the Indenture as being: (a) the failure (i) to pay any principal of,
or interest on, any Bond of such Series then due, (ii) if applicable, to call
for special redemption any Bonds that are required to be so redeemed or (iii) to
pay the redemption price of any Bonds called for redemption; (b) a default in
the observance of certain negative covenants in the Indenture; (c) a material
default in the observance of any other covenant of the Issuer, and the
continuation of any such default for a period of 30 days after notice thereof is
given to the Issuer by the Bond Trustee or by the holders of more than 50% in
outstanding principal amount of the Controlling Class of Bonds of such Series;
(d) any representation or warranty made by the Issuer in the Indenture or in any
certificate delivered pursuant thereto being incorrect in a material respect as
of the time made, and the circumstances in respect of which such representation
or warranty is incorrect are not cured within 30 days after notice thereof is
given to the Issuer by the Bond Trustee or by the holders of more than 50% in
outstanding principal amount of the Controlling Class of Bonds of such Series;
or (e) certain events of bankruptcy, insolvency, receivership or reorganization
of the Issuer. (Indenture, Section 5.01)
48
RIGHTS UPON EVENTS OF DEFAULT
In case an Event of Default shall occur and be continuing with respect to a
Series of Bonds, the Bond Trustee or holders of more than 50% in outstanding
principal amount of the Controlling Class of Bonds of such Series may declare
the principal of such Series of Bonds to be due and payable. Such declaration
may under certain circumstances be rescinded by the holders of a majority in
principal amount of the outstanding Bonds of such Series. (Indenture, Section
5.02)
Upon an Event of Default the Bond Trustee may, in its discretion, sell the
Collateral for such Series, in which event the Bonds of such Series will be
payable pro rata, without regard to their Stated Maturities, or in such other
manner as is specified in the related Prospectus Supplement, out of the
collections on, or the proceeds from the sale of, such Collateral and will, to
the extent permitted by applicable law, bear interest at the interest rate
specified in the Indenture. (Indenture, Section 5.08) If so specified in the
related Prospectus Supplement, following an Event of Default, if a Series of
Bonds has been declared to be due and payable, the Bond Trustee may, in its
discretion, refrain from selling the Collateral, including the Mortgage
Collateral, for such Series and continue to apply all amounts received on the
Collateral to payments due on the Bonds of such Series in accordance with their
terms, notwithstanding the acceleration of the maturity of such Bonds.
(Indenture, Section 5.05)
In case an Event of Default shall occur and be continuing, the Bond Trustee
shall be under no obligation to expend or risk its own funds or otherwise incur
any financial liability in the performance of its duties under the Indenture if
it has reasonable grounds for believing that it has not been assured of adequate
security or indemnity. (Indenture, Section 6.01(e)) Subject to such provisions
for indemnification and certain limitations contained in the Indenture, the
holders of a majority in principal amount outstanding of the Controlling Class
of outstanding Bonds of a Series shall have the right to direct the time, method
and place of conducting any proceeding for any remedy available to the Bond
Trustee or exercising any trust or power conferred on the Bond Trustee with
respect to the Bonds of such Series; and the holders of a majority in principal
amount of the Controlling Class of Bonds of a Series then outstanding may, in
certain cases, waive any default with respect thereto, except a default in
payment of principal or interest or a default in respect of a covenant or
provision of the Indenture that cannot be modified without the consent of each
holder of Bonds affected. (Indenture, Sections 5.14 and 5.15)
No holder of Bonds will have the right to institute any proceeding with
respect to the Indenture, unless (a) such holder previously has given to the
Bond Trustee written notice of an Event of Default, (b) the holders of more than
50% in outstanding principal amount of the Controlling Class of Class of Bonds
of the Series have made written request upon the Bond Trustee to institute such
proceedings in its own name as Bond Trustee and have offered the Bond Trustee
indemnity in full, (c) the Bond Trustee has for 60 days neglected or refused to
institute any such proceeding and (d) no direction inconsistent with such
written request has been given to the Bond Trustee during such 60-day period by
the holders of a majority in principal amount of the outstanding Bonds of such
Series. (Indenture, Section 5.09)
CERTAIN COVENANTS OF THE ISSUER
The Issuer covenants in the Indenture, among other matters, that it will
not (a) sell, exchange or otherwise dispose of any portion of the Collateral for
a Series of Bonds except as expressly permitted by the Indenture or the Master
Servicing Agreement, (b) amend Sections 2.03 or 11.01 of the Issuer's Deposit
Trust Agreement without the consent of the holders of 66 2/3% in outstanding
principal amount of each Class of Bonds affected thereby or (c) incur, assume or
guarantee any indebtedness other than in connection with the issuance of the
Bonds. (Indenture, Section 3.09) Section 2.03 of the Issuer's Deposit Trust
Agreement provides that the trust shall not have the power to perform any act or
engage in any business whatsoever except to issue and administer the Bonds of a
Series, to receive and own the Collateral, to maintain and administer the
Collateral, to pledge the Collateral to support such Bonds pursuant to the
Indenture and to take certain other actions incidental thereto. Section 11.01 of
the Issuer's Deposit Trust Agreement prohibits the amendment of the Deposit
Trust Agreement if the Owner Trustee determines that such amendment will
adversely affect any right, duty or liability of, or immunity or indemnity in
favor of, the Owner Trustee under
49
the Issuer's Deposit Trust Agreement, or will cause or result in any conflict
with or breach of any terms of, or default under, the charter documents or
bylaws of the Owner Trustee or any document to which the Owner Trustee is a
party.
ISSUER'S ANNUAL COMPLIANCE STATEMENT
The Issuer will be required to file annually with the Bond Trustee a
written statement as to fulfillment of its obligations under the Indenture.
(Indenture, Section 3.10)
BOND TRUSTEE'S ANNUAL REPORT
The Bond Trustee will be required to mail each year to all Bondholders a
brief report relating to its eligibility and qualifications to continue as the
Bond Trustee under the Indenture, any amounts advanced by it under the
Indenture, the amount, interest rate and maturity date of certain indebtedness
owing by the Issuer to the Bond Trustee in its individual capacity, the property
and funds physically held by the Bond Trustee as such, and any action taken by
it which materially affects the Bonds and which has not been previously
reported. (Indenture, Section 7.03)
SATISFACTION AND DISCHARGE OF INDENTURE
The Indenture will be discharged with respect to the Collateral securing
the Bonds of a Series upon the delivery to the Bond Trustee for cancellation of
all of the Bonds of such Series or, with certain limitations, upon deposit with
the Bond Trustee of funds sufficient for the payment in full of all of the Bonds
of such Series. (Indenture, Section 4.01)
REPORT BY BOND TRUSTEE TO BONDHOLDERS
On each Payment Date, the Bond Trustee will send a report to each
Bondholder setting forth the amount of such payment representing interest, the
amount thereof, if any, representing principal, the amount of any related
Advance and the outstanding principal amount of Bonds of each Class (the
aggregate principal amount of the Bonds of each Class in the case of holders of
Bonds on which payments of interest only are then being made) after giving
effect to the payments made on such Payment Date. (Indenture, Section 8.06)
THE BOND TRUSTEE
The Bond Trustee under each Indenture will be identified in the related
Prospectus Supplement.
CERTAIN LEGAL ASPECTS OF PLEDGED MORTGAGES
The following discussion contains general summaries of certain legal
aspects of mortgage loans. Because such legal aspects are governed primarily by
applicable state law (which laws may differ substantially from state to state),
the summaries do not purport to be complete nor to reflect the laws of any
particular state, nor to encompass the laws of all states in which Mortgaged
Properties may be located. The summaries are qualified in their entirety by
reference to the applicable federal and state laws governing the Pledged
Mortgages.
GENERAL
The Pledged Mortgages will consist of notes and either mortgages, deeds of
trust, security deeds or deeds to secure debts, depending upon the prevailing
practice in the state in which the underlying Mortgaged Property is located.
Deeds of trust are used almost exclusively in California instead of mortgages. A
mortgage creates a lien upon the real property encumbered by the mortgage, which
lien is generally not prior to the lien for real estate taxes and assessments.
Priority between mortgages depends on their terms and generally on the order of
recording with a state or county office. There are two parties to a mortgage:
the mortgagor, who is the borrower and owner of the mortgaged property; and the
mortgagee, who is the lender. Under a mortgage instrument, the mortgagor
delivers to the mortgagee (i) a note or bond evidencing the loan and (ii) the
50
mortgage. Although a deed of trust is similar to a mortgage, a deed of trust has
three parties: the borrower-property owner, called the trustor (similar to a
mortgagor); a lender (similar to a mortgagee) called the beneficiary; 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. A
security deed and a deed to secure debt are special types of deeds which
indicate on their face that they are granted to secure an underlying debt. By
executing a security deed or deed to secure debt, the grantor conveys title to,
as opposed to merely creating a lien upon, the subject property to the grantee
until such time as the underlying debt is repaid. The trustee's authority under
a deed of trust, the mortgagee's authority under a mortgage and the grantee's
authority under a security deed or deed to secure a debt are governed by law,
and, with respect to some deeds of trust, the directions of the beneficiary.
COOPERATIVES. Certain of the Pledged Mortgages may be Cooperative Loans.
The Cooperative owns all the real property that comprises the project, including
the land, separate dwelling units and all common areas. The Cooperative is
directly responsible for project management and, in most cases, payment of real
estate taxes and hazard and liability insurance. If there is a blanket mortgage
on the Cooperative and/or underlying land, as is generally the case, the
Cooperative, as project mortgagor, is also responsible for meeting these
mortgage obligations. A blanket mortgage is ordinarily incurred by the
Cooperative in connection with the construction or purchase of the Cooperative's
apartment building. The interest of the occupant under proprietary leases or
occupancy agreements to which that Cooperative is a party are generally
subordinate to the interest of the holder of the blanket mortgage in that
building. If the Cooperative is unable to meet the payment obligations arising
under its blanket mortgage, the mortgagee holding the blanket mortgage could
foreclose on that mortgage and terminate all subordinate proprietary leases and
occupancy agreements. In addition, the blanket mortgage on a Cooperative may
provide financing in the form of a mortgage that does not fully amortize with a
significant portion of principal being due in one lump sum at final maturity.
The inability of the Cooperative to refinance this mortgage and its consequent
inability to make such final payment could lead to foreclosure by the mortgagee
providing the financing. A foreclosure in either event by the holder of the
blanket mortgage could eliminate or significantly diminish the value of any
collateral held by the lender who financed the purchase by an individual
tenant-stockholder of Cooperative shares or, in the case of any Mortgage
Collateral securing a Series of Bonds that includes Cooperative Loans, the
collateral securing the Cooperative Loans.
The Cooperative is owned by tenant-stockholders who, through ownership of
stock, shares or membership certificates in the corporation, receive proprietary
leases or occupancy agreements which confer exclusive rights to occupy specific
units. Generally, a tenant-stockholder of a Cooperative must make a monthly
payment to the Cooperative representing such tenant-stockholder's pro rata share
of the Cooperative's payments for its blanket mortgage, real property taxes,
maintenance expenses and other capital or ordinary expenses. An ownership
interest in a Cooperative and accompanying rights is financed through a
Cooperative share loan evidenced by a promissory note and secured by a security
interest in the occupancy agreement or proprietary lease and in the related
Cooperative shares. The lender 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 if filed in the appropriate state and local offices to
perfect the lender's interest in its collateral. Subject to the limitations
discussed below, upon default of the tenant-stockholder, the lender may sue for
judgment on the promissory note, dispose of the collateral at a public or
private sale or otherwise proceed against the collateral or tenant-stockholder
as an individual as provided in the security agreement covering the assignment
of the proprietary lease or occupancy agreement and the pledge of Cooperative
shares.
JUNIOR MORTGAGES
Certain of the Pledged Mortgages may be secured by junior mortgages or
deeds of trust, which are junior to senior mortgages or deeds of trust which are
not part of the Mortgage Collateral. The rights of the Bondholders as the
holders of a junior deed of trust or a junior mortgage are subordinate in lien
priority and in payment priority to those of the holder of the senior mortgage
or deed of trust, including the prior rights of the senior mortgagee or
beneficiary to receive and apply hazard insurance and condemnation proceeds and,
upon
51
default of the mortgagor, to cause a foreclosure on the property. Upon
completion of the foreclosure proceedings by the holder of the senior mortgage
or the sale pursuant to the deed of trust, the junior mortgagee's or junior
beneficiary's lien will be extinguished unless the junior lienholder satisfies
the defaulted senior loan or asserts its subordinate interest in a property in
foreclosure proceedings. See " -- Foreclosure/Repossession" below.
Furthermore, the terms of the junior mortgage or deed of trust are
subordinate to the terms of the senior mortgage or deed of trust. In the event
of a conflict between the terms of the senior mortgage or deed of trust and the
junior mortgage or deed of trust, the terms of the senior mortgage or deed of
trust will govern generally. Upon a failure of the mortgagor or trustor to
perform any of its obligations, the senior mortgagee or beneficiary, subject to
the terms of the senior mortgage or deed of trust, may have the rights to
perform the obligation itself. Generally, all sums so expended by the mortgagee
or beneficiary become part of the indebtedness secured by the mortgage or deed
of trust. To the extent a senior mortgagee expends such sums, such sums will
generally have priority over all sums due under the junior mortgage.
FORECLOSURE/REPOSSESSION
DEED OF TRUST. Foreclosure of a deed of trust is generally accomplished by
a non-judicial sale under a specific provision in the deed of trust which
authorizes the trustee to sell the property at public auction upon any default
by the borrower under the terms of the note or deed of trust. In certain states,
such foreclosure also may be accomplished by judicial action in the manner
provided for foreclosure of mortgages. In addition to any notice requirements
contained in a deed of trust, in some states, such as California, 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 any notice of default and
notice of sale, to any successor in interest to the borrower-trustor, to the
beneficiary of any junior deed of trust and to certain other persons. In some
states, including California, the borrower-trustor has the right to reinstate
the loan at any time following default until shortly before the trustee's sale.
In general, the borrower, or any other person having a junior encumbrance on the
real estate, may, during a statutorily prescribed reinstatement period, cure a
monetary default by paying the entire amount in arrears plus other designated
costs and expenses incurred in enforcing the obligation. Generally, state law
controls the amount of foreclosure expenses and costs, including attorney's
fees, which may be recovered by a lender. After the reinstatement period has
expired without the default having been cured, the borrower or junior lienholder
no longer has the right to reinstate the loan and must pay the loan in full to
prevent the scheduled foreclosure sale. If the deed of trust is not reinstated
within any applicable cure period, a notice of sale must be posted in a public
place and, in most states, including California, published for a specific period
of time in one or more newspapers. In addition, some state 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 California, the entire
process from recording a notice of default to a non-judicial sale usually takes
four to five months.
MORTGAGES. Foreclosure of a mortgage is generally accomplished by judicial
action. The action is initiated by the service of legal pleadings upon all
parties having an interest in the real property. Delays in completion of the
foreclosure may occasionally result from difficulties in locating necessary
parties. Judicial foreclosure proceedings are often not contested by any of the
parties. When the mortgagee's right to foreclosure is contested, the legal
proceedings necessary to resolve the issue can be time consuming. After the
completion of a judicial foreclosure proceeding, the court generally issues a
judgment of foreclosure and appoints a referee or other court officer to conduct
the sale of the property. In some states, mortgages may also be foreclosed by
advertisement, pursuant to a power of sale provided in the mortgage.
Although foreclosure sales are typically public sales, frequently no third
party purchaser bids in excess of the lender's lien because of the difficulty of
determining the exact status of title to the property, the possible
deterioration of the property during the foreclosure proceedings and a
requirement that the purchaser pay for the property in cash or by cashier's
check. Thus the foreclosing lender often purchases the property from the trustee
or referee for an amount equal to the principal amount outstanding under the
loan, accrued and unpaid interest and the expenses of foreclosure in which event
the mortgagor's debt will be extinguished, or the lender may purchase for a
lesser amount in order to preserve its right against a borrower to seek a
deficiency judgment in states where such judgment is available. Thereafter,
subject to the right of the borrower in some
52
states to remain in possession during the redemption period, the lender will
assume the burden of ownership, including obtaining hazard insurance and making
such repairs at its own expense as are necessary to render the property suitable
for sale. The lender will commonly obtain the services of a real estate broker
and pay the broker's commission in connection with the sale of the property.
Depending upon market conditions, the ultimate proceeds of the sale of the
property may not equal the lender's investment in the property. See "SECURITY
FOR THE BONDS" herein.
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 of a junior
mortgage triggers the enforcement of a "due-on-sale" clause, the junior
mortgagee may be required to pay the full amount of the senior mortgages to the
senior mortgagees. 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 proceeds.
Courts have imposed general equitable principles upon foreclosure, which
are generally designed to mitigate the legal consequences to the borrower of the
borrower's defaults under the loan documents. Some courts have been faced with
the issue of whether federal or state constitutional provisions reflecting due
process concerns for fair notice require that borrowers under deeds of trust
receive notice longer than that prescribed by statute. 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 does not involve sufficient state
action to afford constitutional protection to the borrower.
COOPERATIVE LOANS. The Cooperative shares owned by the tenant-stockholder
and pledged to the lender are, in almost all cases, subject to restrictions on
transfer as set forth in the Cooperative's certificate of incorporation and
bylaws, as well as the proprietary lease or occupancy agreement, and may be
cancelled by the Cooperative for failure by the tenant-stockholder to pay rent
or other obligations or charges owed by such tenant-stockholder, including
mechanics' liens against the cooperative apartment building incurred by such
tenant-stockholder. The proprietary lease or occupancy agreement generally
permits the Cooperative to terminate such lease or agreement in the event an
obligor fails to make payments or defaults in the performance of covenants
required thereunder. Typically, the lender and the Cooperative enter into a
recognition agreement which establishes the rights and obligations of both
parties in the event of a default by the tenant-stockholder 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 an opportunity to cure the
default. The recognition agreement typically provides that if the proprietary
lease or occupancy agreement is terminated, the Cooperative will recognize the
lender's lien against proceeds from the sale of the Cooperative apartment,
subject, however, to the Cooperative's right to sums due under such proprietary
lease or occupancy agreement. The total amount owed to the Cooperative by the
tenant-stockholder, which the lender generally cannot restrict and does not
monitor, could reduce the value of the collateral below the outstanding
principal balance of the Cooperative Loan and accrued and unpaid interest
thereon.
53
Recognition agreements also provide that in the event of a foreclosure on a
Cooperative Loan, the lender must obtain the approval or consent of the
Cooperative as required by the proprietary lease before transferring the
Cooperative shares or assigning the proprietary lease. Generally, the lender is
not limited in any rights it may have to dispossess the tenant-stockholders.
In some states, foreclosure on the Cooperative shares is accomplished by a
sale in accordance with the provisions of Article 9 of the 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 foreclosure sale has been conducted in a "commercially
reasonable" manner will depend on the facts in each case. In determining
commercial reasonableness, a court will look to the notice given the debtor and
the method, manner, time, place and terms of the foreclosure. Generally, a sale
conducted according to the usual practice of banks selling similar collateral
will be considered reasonably conducted.
Article 9 of the UCC provides that the proceeds of the sale will be applied
first to pay the costs and expenses of the sale and then to satisfy the
indebtedness secured by the lender's security interest. The recognition
agreement, however, generally provides that the lender's right to reimbursement
is subject to the right of the Cooperative 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.
In the case of foreclosure on a building which was converted from a rental
building to a building owned by a Cooperative under a non-eviction plan, some
states require that a purchaser at a foreclosure sale take the property subject
to rent control and rent stabilization laws which apply to certain tenants who
elected to remain in the building but who did not purchase shares in the
Cooperative when the building was so converted.
RIGHTS OF REDEMPTION
In some states, after sale pursuant to a deed of trust or foreclosure of a
mortgage, the borrower and certain foreclosed junior lienholders are given a
statutory period in which to redeem the property from the foreclosure sale. In
certain other states, including California, this right of redemption applies
only to sales following judicial foreclosure, and not to sales pursuant to a
non-judicial power of sale. In most states where the right of redemption is
available, statutory redemption may occur upon a payment of the foreclosure
purchase price, accrued interest and taxes. In some states, the right to redeem
is an equitable right. The effect of a right of redemption is to diminish the
ability of the lender to sell the foreclosed property. The exercise of a right
of redemption would defeat the title of any purchaser at a foreclosure sale, or
of any purchaser from the lender subsequent to judicial foreclosure or sale
under a deed of trust. Consequently, the practical effect of the redemption
right is to force the lender to retain the property and pay the expenses of
ownership until the redemption period has run.
ANTI-DEFICIENCY LEGISLATION AND OTHER LIMITATIONS ON LENDERS
Certain states have imposed statutory restrictions that 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 or sale under a deed of trust. A deficiency judgment is a personal
judgment against the former borrower equal in most cases to the difference
between the amount due to the lender and the current fair market value of the
property at the time of the foreclosure sale. As a result of these prohibitions,
it is anticipated that in most instances the Master Servicer will utilize the
non-judicial foreclosure remedy and will not seek deficiency judgments against
defaulting mortgagors.
Some state statutes may 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
54
from exercising remedies with respect to the security. Consequently, the
practical effect of the election requirement, when applicable, is that lenders
will usually proceed first against the security rather than bringing a personal
action against the borrower.
In some states, exceptions to the anti-deficiency statutes are provided for
in certain instances where the value of the lender's security has been impaired
by acts or omissions of the borrower, for example, in the event of waste of the
property. Finally, other statutory provisions limit any deficiency judgment
against the former borrower following a foreclosure sale to the excess of the
outstanding debt over the fair market value of the property at the time of the
public sale. The purpose of these statutes is generally to prevent a beneficiary
or a mortgagee from obtaining a large deficiency judgment against the former
borrower as a result of low or no bids at the foreclosure sale.
In addition to anti-deficiency and related legislation, numerous other
federal and state statutory provisions, including the federal bankruptcy laws,
the federal Soldiers' and Sailors' Civil Relief Act of 1940 and state laws
affording relief to debtors, may interfere with or affect the ability of the
secured mortgage lender to realize upon its security. For example, in a
proceeding under the federal Bankruptcy Code, a lender may not foreclose on a
mortgaged property without the permission of the bankruptcy court. In certain
instances, a rehabilitation plan proposed by the debtor may reduce the secured
indebtedness to the value of the mortgaged property as of the date of the
commencement of the bankruptcy, rendering the lender a general unsecured
creditor for the difference, and also may reduce the monthly payments due under
such mortgage loan, change the rate of interest and alter the mortgage loan
repayment schedule. The effect of any such proceedings under the federal
Bankruptcy Code, including but not limited to any automatic stay, could result
in delays in receiving payments on the Pledged Mortgages securing a Series of
Bonds and possible reductions in the aggregate amount of such payments.
The federal tax laws provide priority to certain tax liens over the lien of
a mortgage or secured party. Numerous federal and state consumer protection laws
impose substantive requirements upon mortgage lenders in connection with the
origination, servicing and enforcement of mortgage loans. 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 and regulations. These federal and state laws impose specific
statutory liabilities upon lenders who fail to comply with the provisions of the
law. In some cases, this liability may affect assignees of the loans.
Generally, Article 9 of the UCC governs foreclosure on Cooperative shares
and the related proprietary lease or occupancy agreement. Some courts have
interpreted section 9-504 of the UCC to prohibit a deficiency award unless the
creditor establishes that the sale of the collateral (which, in the case of a
Cooperative Loan, would be the shares of the Cooperative and the related
proprietary lease or occupancy agreement) was conducted in a commercially
reasonable manner.
ENVIRONMENTAL RISKS
Real property pledged as security to a lender may be subject to unforeseen
environmental risks. Under the laws of certain states, contamination of a
property may give rise to a lien on the property to assure the payment of the
costs of clean-up. In several states, such a lien has priority over the lien of
an existing mortgage against such property. In addition, under the federal
Comprehensive Environmental Response, Compensation and Liability Act of 1980
("CERCLA"), the United States Environmental Protection Agency ("EPA") may impose
a lien on property where the EPA has incurred cleanup costs. However, a CERCLA
lien is subordinate to pre-existing, perfected security interests.
Under the laws of some states, and under CERCLA, it is conceivable that a
secured lender may be held liable as an "owner or operator" for the costs of
addressing releases or threatened releases of hazardous substances at a
Mortgaged Property even though the environmental damage or threat was caused by
a prior or current owner or operator or a third-party. CERCLA imposes liability
for such costs on any and all "responsible parties," including "owners or
operators." However, CERCLA excludes from the definition of "owner or operator"
a secured creditor "who without participating in the management of the
facility," holds indicia of ownership primarily to protect its security interest
(the "secured creditor exclusion"). Thus, if a
55
lender's activities begin to encroach on the actual management of a contaminated
facility or property, the lender may incur liability as an "owner or operator"
under CERCLA. Similarly, if a lender forecloses and takes title to a
contaminated facility or property, the lender may incur CERCLA liability in
various circumstances, including, but not limited to, when it holds the facility
or property as an investment (including leasing the facility or property to a
third party), or fails to market the property in a timely fashion.
Whether actions taken by a lender would constitute participation in the
management of a mortgaged property, or the business of a borrower, so as to
render the secured creditor exemption unavailable to a lender has been a matter
of judicial interpretation of the statutory language, and court decisions have
been inconsistent. In 1990, the Court of Appeals for the Eleventh Circuit
suggested that the mere capacity of the lender to influence a borrower's
decisions regarding disposal of hazardous substances was sufficient
participation in the management of the borrower's business to deny the
protection of the secured creditor exemption to the lender.
This ambiguity appears to have been resolved by the enactment of the Asset
Conservation, Lender Liability and Deposit Insurance Protection Act of 1996,
which was signed into law by President Clinton on September 30, 1996. The new
legislation provides that in order to be deemed to have participated in the
management of a mortgaged property, a lender must actually participate in the
operational affairs of the property or the borrower. The legislation also
provides that participation in the management of the property does not include
"merely having the capacity to influence, or unexercised right to control"
operations. Rather, a lender will lose the protection of the secured creditor
exemption only if it exercises decision-making control over the day-to-day
management of all operational functions of the mortgaged property.
If a lender is or becomes liable, it can bring an action for contribution
against any other "responsible parties," including a previous owner or operator,
who created the environmental hazard, but those persons or entities may be
bankrupt or otherwise judgment proof. The costs associated with environmental
cleanup may be substantial. It is conceivable that such costs arising from the
circumstances set forth above would become a liability of the Issuer and
occasion a loss to Bondholders.
CERCLA does not apply to petroleum products, and the secured creditor
exclusion does not govern liability for cleanup costs under federal laws other
than CERCLA, in particular Subtitle I of the federal Resource Conservation and
Recovery Act ("RCRA"), which regulates underground petroleum storage tanks
(except heating oil tanks). The EPA has adopted a lender liability rule for
underground storage tanks under Subtitle I of RCRA. Under such rule, a holder of
a security interest in an underground storage tank or real property containing
an underground storage tank is not considered an operator of the underground
storage tank as long as petroleum is not added to, stored in or dispensed from
the tank. In addition, under the Asset Conservation, Lender Liability and
Deposit Insurance Protection Act of 1996, the protections accorded to lenders
under CERCLA are also accorded to the holders of security interests in
underground storage tanks. It should be noted, however, that liability for
cleanup of petroleum contamination may be governed by state law, which may not
provide for any specific protection for secured creditors.
Except as otherwise specified in the applicable Prospectus Supplement, at
the time the Pledged Mortgages or the mortgage loans underlying the
Certificates, as the case may be, were originated, no environmental assessment
or a very limited environmental assessment of the Mortgage Properties or the
real property constituting security for such mortgage loans, respectively, was
conducted.
DUE-ON-SALE CLAUSES
Unless otherwise provided in the related Prospectus Supplement, each
Pledged Mortgage will contain a due-on-sale clause which will generally provide
that if the mortgagor or obligor sells, transfers or conveys the Mortgaged
Property, the loan may be accelerated by the mortgagee. In recent years, court
decisions and legislative actions have placed substantial restriction on the
right of lenders to enforce such clauses in many states. For instance, the
California Supreme Court in August 1978 held that due-on-sale clauses were
generally unenforceable. However, the Garn-St Germain Depository Institutions
Act of 1982 (the "Garn-St Germain Act"), subject to certain exceptions, preempts
state constitutional, statutory and case law prohibiting the enforcement of
due-on-sale clauses. As a result, due-on-sale clauses have become generally
56
enforceable except in those states whose legislatures exercised their authority
to regulate the enforceability of such clauses with respect to mortgage loans
that were (i) originated or assumed during the "window period" under the Garn-St
Germain Act which ended in all cases not later than October 15, 1982, and (ii)
originated by lenders other than national banks, federal savings institutions
and federal credit unions. FHLMC has taken the position in its published
mortgage servicing standards that, out of a total of eleven "window period
states," five states (Arizona, Michigan, Minnesota, New Mexico and Utah) have
enacted statutes extending, for various terms and for varying periods, the
prohibition on enforcement of due-on-sale clauses with respect to certain
categories of window period loans. Also, the Garn-St Germain Act does
"encourage" lenders to permit assumption of loans at the original rate of
interest or at some other rate less than the average of the original rate and
the market rate.
As to loans secured by an owner-occupied residence, the Garn-St Germain Act
sets forth nine specific instances in which a mortgagee covered by the Garn-St
Germain Act may not exercise its rights under a due-on-sale clause,
notwithstanding the fact that a transfer of the property may have occurred. The
inability to enforce a due-on-sale clause may result in transfer of the related
Mortgaged Property to an uncreditworthy person, which could increase the
likelihood of default or may result in a mortgage bearing an interest rate below
the current market rate being assumed by a new home buyer, which may affect the
average life of the Pledged Mortgages and the number of Pledged Mortgages which
may extend to maturity.
ENFORCEABILITY OF PREPAYMENT CHARGES AND LATE PAYMENT FEES
Forms of notes, mortgages and deeds of trust used by lenders may contain
provisions obligating the borrower to pay a late charge if payments are not
timely made, and in some circumstances may provide for prepayment fees or
penalties if the obligation is paid prior to maturity. In certain states, there
are or may be specific limitations upon the late charges which a lender may
collect from a borrower for delinquent payments. Certain states also limit the
amounts that a lender may collect from a borrower as an additional charge if the
loan is prepaid.
Under certain state laws, prepayment charges may not be imposed after a
certain period of time following the origination of mortgage loans with respect
to prepayments on loans secured by liens encumbering owner-occupied residential
properties. Since many of the Mortgaged Properties will be owner-occupied, it is
anticipated that prepayment charges may not be imposed with respect to many of
the Pledged Mortgages. The absence of such a restraint on prepayment,
particularly with respect to Fixed Rate Pledged Mortgages having higher interest
rates, may increase the likelihood of refinancing or other early retirement of
such loans or contracts. Late charges and prepayment fees are typically retained
by servicers as additional servicing compensation.
APPLICABILITY OF USURY LAWS
Title V of the Depository Institutions Deregulation and Monetary Control
Act of 1980, enacted in March 1980 ("Title V"), provides that state usury
limitations shall not apply to certain types of residential first mortgage loans
originated by certain lenders after March 31, 1980. The Office of Thrift
Supervision, as successor to the Federal Home Loan Bank Board, is authorized to
issue rules and regulations and to publish interpretations governing
implementation of Title V. The statute authorized the states to reimpose
interest rate limits by adopting, before April 1, 1983, a law or constitutional
provision which expressly rejects an application of the federal law. In
addition, even where Title V is not so rejected, any state is authorized by the
law to adopt a provision limiting discount points or other charges on mortgage
loans covered by Title V. Certain states have taken action to reimpose interest
rate limits and/or to limit discount points or other charges.
SOLDIERS' AND SAILORS' CIVIL RELIEF ACT
Generally, under the terms of the Soldiers' and Sailors' Civil Relief Act
of 1940, as amended (the "Relief Act"), a borrower who enters military service
after the origination of such borrower's mortgage loan (including a borrower who
is a member of the National Guard or is in reserve status at the time of the
origination of the mortgage loan and is later called to active duty) may not be
charged interest above an
57
annual rate of 6% during the period of such borrower's active duty status,
unless a court orders otherwise upon application of the lender. It is possible
that such interest rate limitation could have an effect, for an indeterminate
period of time, on the ability of the applicable Servicer to collect full
amounts of interest on certain of the Pledged Mortgages. Any shortfall in
interest collections resulting from the application of the Relief Act could
result in losses to the holders of the Bonds. In addition, the Relief Act
imposes limitations which would impair the ability of the applicable Servicer to
foreclose on an affected Pledged Mortgage during the borrower's period of active
duty status. Thus, in the event that such a Pledged Mortgage goes into default,
there may be delays and losses occasion by the inability to realize upon the
Mortgaged Property in a timely fashion.
SUBORDINATE FINANCING
When the mortgagor encumbers mortgaged property with one or more junior
liens, the senior lender is subjected to additional risk. First, the mortgagor
may have difficulty servicing and repaying multiple loans. In addition, if the
junior loan permits recourse to the mortgagor (as junior loans often do) and the
senior loan does not, a mortgagor may be more likely to repay sums due on the
junior loan than those on the senior loan. Second, acts of the senior lender
that prejudice the junior lender or impair the junior lender's security may
create a superior equity in favor of the junior lender. For example, if the
mortgagor and the senior lender agree to an increase in the principal amount of
or the interest rate payable on the senior loan, the senior lender may lose its
priority to the extent an existing junior lender is harmed or the mortgagor is
additionally burdened. Third, if the mortgagor defaults on the senior loan
and/or any junior loan or loans, the existence of junior loans and actions taken
by junior lenders can impair the security available to the senior lender and can
interfere with or delay the taking of action by the senior lender. Moreover, the
bankruptcy of a junior lender may operate to stay foreclosure or similar
proceeds by the senior lender.
FEDERAL INCOME TAX CONSEQUENCES
The following discussion summarizes the anticipated material federal income
tax consequences of the purchase, ownership and disposition of the Bonds, as
based on the advice of Giancarlo & Gnazzo, A Professional Corporation, special
tax counsel to the Issuer. This summary is based on the Internal Revenue Code of
1986, as amended (the "CODE"), regulations, rulings and decisions in effect as
of the date of this Prospectus, all of which are subject to change. This summary
does not address federal income tax consequences applicable to all categories of
investors, some of which (such as banks and insurance companies) may be subject
to special rules. In addition, the summary is limited to investors who will hold
the Bonds as "capital assets" (generally, property held for investment) as
defined in Section 1221 of the Code. Investors should consult their own tax
advisors in determining the federal, state, local and any other tax consequences
to them of the purchase, ownership and disposition of the Bonds. As applied to
any particular Class or Series of Bonds, the summary is subject to further
discussion or change as provided in the related Prospectus Supplement.
OVERVIEW
The federal income tax consequences applicable with respect to a specific
Series of Bonds will vary depending on whether an election is made to treat the
Trust Estate relating to such Series of Bonds as a real estate mortgage
investment conduit ("REMIC") under the Code. The Prospectus Supplement for each
Series of Bonds will specify whether a REMIC election will be made with respect
to such Series. Bonds of any Series that are not the subject of a REMIC election
("NON-REMIC BONDS") are intended to be classified as indebtedness of the Issuer
for federal income tax purposes.
NON-REMIC BONDS
General. If a REMIC election is not made, Giancarlo & Gnazzo, A
Professional Corporation, will deliver its opinion that, although no
regulations, published rulings or judicial decisions exist that discuss the
characterization for federal income tax purposes of securities with terms
substantially the same as the Non-
58
REMIC Bonds, in its opinion such Bonds will be treated for federal income tax
purposes as indebtedness of the Issuer and not as an ownership interest in the
Collateral, or an equity interest in the Issuer or in a separate association
taxable as a corporation.
Status as Real Property Loans. Because, in such counsel's opinion, the
Non-REMIC Bonds will be treated as indebtedness of the Issuer for federal income
tax purposes, (i) such Bonds held by a thrift institution taxed as a domestic
building and loan association will not constitute "loans . . . secured by an
interest in real property" within the meaning of Code Section 7701(a)(19)(C)(v),
(ii) interest on Non-REMIC Bonds held by a real estate investment trust will not
be treated as "interest on obligations secured by mortgages on real property or
on interests in real property" within the meaning of Code Section 856(c)(3)(B),
and Non-REMIC Bonds will not constitute "real estate assets" or "government
securities" within the meaning of Code Section 856(c)(4)(A), and (iii) Non-REMIC
Bonds held by a regulated investment company will not constitute "government
securities" within the meaning of Code Section 851(b)(4)(A)(i).
Interest on Non-REMIC Bonds. Except as described below with respect to
original issue discount, market discount or premium, interest paid or accrued on
Non-REMIC Bonds generally will be treated as ordinary income to the holder, and
will be includible in income in accordance with such holder's regular method of
accounting.
Original Issue Discount. All Deferred Interest Bonds will be, and some or
all of the other Bonds may be, issued with "original issue discount" within the
meaning of Code Section 1273(a). Holders of any Class of Bonds having original
issue discount must generally include original issue discount in ordinary gross
income for federal income tax purposes as it accrues, in accordance with the
constant yield method, in advance of receipt of the cash attributable to such
income. The Issuer will indicate on the face of each Bond issued by it
information concerning the application of the original issue discount rules to
such Bond and certain other information that may be required. The Issuer will
report annually to the Internal Revenue Service (the "IRS") and to holders of
record of such Bonds information with respect to the original issue discount
accruing on such Bonds during the reporting period.
Rules governing original issue discount are set forth in Code Sections 1271
through 1273, 1275 and 1281 through 1283 and in regulations issued thereunder
(the "OID REGULATIONS"). The Code or the OID Regulations either do not address,
or are subject to varying interpretations with respect to, several issues
relevant to obligations, such as the Bonds, that are subject to prepayment.
Therefore, there is some uncertainty as to the manner in which the original
issue discount rules of the Code will be applied to the Bonds.
Original Issue Discount Defined. In general, each Bond will be treated as a
single installment obligation for purposes of determining the original issue
discount includible in a Bondholder's income. The amount of original issue
discount on such a Bond is the excess of the stated redemption price at maturity
of the Bond over its issue price. The issue price of a Bond is the initial
offering price to the public at which a substantial amount of the Bonds of that
Class are first sold to the public (excluding bond houses, brokers, underwriters
or wholesalers), generally as set forth on the cover page of the Prospectus
Supplement for a Series of Bonds. (The portion of the initial offering price
which consists of interest accrued on the Bonds from the date of issuance to the
Closing Date may, at the option of the Bondholder, be subtracted from the issue
price of the Bonds and treated as an offset of interest received on the first
Payment Date.) The stated redemption price at maturity of a Bond is equal to the
total of all payments to be made on the Bond other than "qualified stated
interest payments." "Qualified stated interest payments" are payments on the
Bonds which are paid at least annually and are based on either a fixed rate or a
"qualified variable rate." Under the OID Regulations, interest is treated as
payable at a "qualified variable rate" and not as contingent interest if,
generally, (i) such interest is unconditionally payable at least annually, (ii)
the issue price of the Bond does not exceed the total noncontingent principal
payments and (iii) interest is based on a "qualified floating rate," an
"objective rate," or a combination of "qualified floating rates" that do not
operate in a manner that significantly accelerates or defers interest payments
on such Bond. Generally, the stated redemption price at maturity of a Bond
(other than a Deferred Interest Bond or a Payment Lag Bond, as defined below) is
its stated principal amount; the stated redemption price at maturity of a
Deferred Interest Bond is the sum of all payments (regardless of how
59
denominated) scheduled to be received on such Bond under the Tax Prepayment
Assumption (as defined below). Any payment of interest that is not a qualified
stated interest payment is a "contingent interest payment." The related
Prospectus Supplement will discuss whether the payments of interest on a Bond
are qualified stated interest payments and the treatment for federal income tax
purposes of any contingent interest payments.
De Minimis Original Issue Discount. Notwithstanding the general definition
of original issue discount above, any original issue discount with respect to a
Bond will be considered to be zero if such discount is less than 0.25% of the
stated redemption price at maturity of the Bond multiplied by its weighted
average life (a "de minimis" amount). The weighted average life of a Bond for
this purpose is the sum of the following amounts (computed for each payment
included in the stated redemption price at maturity of the Bond): (i) the number
of complete years (rounded down for partial years) from the Closing Date until
the date on which each such payment is scheduled to be made under the Tax
Prepayment Assumption, multiplied by (ii) a fraction, the numerator of which is
the amount of the payment, and the denominator of which is the Bond's stated
redemption price at maturity. Bondholders generally must report de minimis
original issue discount pro rata as principal payments are received, and such
income will be capital gain if the Bond is held as a capital asset. However,
accrual method holders may elect to accrue all interest on a Bond, including de
minimis original issue discount and market discount and as adjusted by any
premium, under a constant yield method.
Accrual of Original Issue Discount. The Code requires that the amount and
rate of accrual of original issue discount be calculated based on a reasonable
assumed prepayment rate for the Pledged Mortgages, the mortgage loans underlying
the Bonds and/or other Mortgage Collateral securing the Bonds (the "TAX
PREPAYMENT ASSUMPTION") and prescribes a method for adjusting the amount and
rate of accrual of such discount if actual prepayment rates exceed the Tax
Prepayment Assumption. However, if such mortgage loans prepay at a rate slower
than the Tax Prepayment Assumption, no deduction for original issue discount
previously accrued, based on the Tax Prepayment Assumption, is allowed. The Tax
Prepayment Assumption is required to be determined in the manner prescribed by
regulations that have not yet been issued. It is anticipated that the
regulations will require that the Tax Prepayment Assumption be the prepayment
assumption that is used in determining the initial offering price of such Bonds.
The related Prospectus Supplement for each Series of Bonds will specify the Tax
Prepayment Assumption determined by the Issuer for the purposes of determining
the amount and rate of accrual of original issue discount. No representation is
made that the Mortgage Collateral will prepay at the Tax Prepayment Assumption
or at any other rate.
Generally, a Bondholder must include in gross income the sum of the "daily
portions," as determined below, of the original issue discount that accrues on a
Bond for each day the Bondholder holds that Bond, including the purchase date
but excluding the disposition date. In the case of an original holder of a Bond,
a calculation will be made of the portion of the original issue discount that
accrues during each successive period (or shorter period from date of original
issue) (an "accrual period") that ends on the day in the calendar year
corresponding to each of the Payment Dates on the Bonds (or the date prior to
each such date). This will be done, in the case of each full accrual period, by
adding (A) the present value at the end of the accrual period of all remaining
payments to be received (based on (i) the yield to maturity of the Bond at the
issue date, (ii) events (including actual prepayments) that have occurred prior
to the end of the accrual period, and (iii) the Tax Prepayment Assumption) and
(B) any payments received during such accrual period, other than payments of
qualified stated interest, and subtracting from that total the "adjusted issue
price" of the Bonds at the beginning of such accrual period. The adjusted issue
price of a Bond at the beginning of the initial accrual period is its issue
price; the adjusted issue price of a Bond at the beginning of a subsequent
accrual period is the adjusted issue price at the beginning of the immediately
preceding accrual period plus the amount of original issue discount allocable to
the accrual period and reduced by the amount of any payment other than a payment
of qualified stated interest made at the end of or during that accrual period.
The original issue discount accrued during such accrual period will then be
divided by the number of days in the period to determine the daily portion of
original issue discount for each day in the period. With respect to an initial
accrual period shorter than a full accrual period, the daily portions of
original issue discount must be
60
determined according to any reasonable method, provided that such method is
consistent with the method used to determine yield on the Bonds.
With respect to any Bond that is a Variable Rate Debt Instrument, the sum
of the daily portions of original issue discount that is includible in the
holder's gross income is determined under the same principles described above,
with the following modifications: the yield to maturity on the Bonds should be
calculated as if the interest index remained at its value as of the issue date
of such Bonds. Because the proper method of adjusting accruals of OID on a
Variable Rate Debt Instrument as a result of prepayments is uncertain, holders
of such instruments should consult their own tax advisors regarding the
appropriate treatment of such Bonds for federal income tax purposes.
Purchasers of Bonds with the above key features for which the period
between the Closing Date and the first Payment Date does not exceed the Payment
Date Interval would nevertheless pay upon purchase of the Bonds an additional
amount of accrued interest as compared with the accrued interest that would be
paid if interest accrued from Payment Date to Payment Date. This accrued
interest (together with any accrued interest with respect to which the
Bondholder chooses not to treat as an offset to interest paid on the first
Payment Date, as described above) should be treated for federal income tax
purposes as part of the initial purchase price of the Bonds. Bonds described in
this paragraph issued or purchased at a discount would be treated as being
issued or purchased at a smaller discount or at a premium, and such Bonds issued
or purchased at a premium would be treated as being issued or purchased at a
larger premium.
Subsequent Purchasers of Bonds with OID. A subsequent purchaser of a
Deferred Interest Bond or any other Bond issued with original issue discount who
purchases the Bond at a cost less than the remaining stated redemption price at
maturity, will also be required to include in gross income for all days during
his or her taxable year on which such Bond is held, the sum of the daily
portions of original issue discount on the Bond. In computing the daily portions
of original issue discount with respect to a Bond for such a subsequent
purchaser, however, the daily portion for any day shall be reduced by the amount
that would be the daily portion for such day (computed in accordance with the
rules set forth above) multiplied by a fraction, the numerator of which is the
amount, if any, by which the price paid by such holder for the Bond exceeds its
adjusted issue price (the "acquisition premium"), and the denominator of which
is the amount by which the remaining stated redemption price at maturity exceeds
the adjusted issue price.
Premium. A holder who purchases a Bond at a cost greater than its stated
redemption price at maturity generally will be considered to have purchased the
Bond at a premium, which it may elect to amortize as an offset to interest
income on such Bond (and not as a separate deduction item) on a constant yield
method. Although no regulations addressing the computation of premium accrual on
securities similar to the Bonds have been issued, the legislative history of the
Tax Reform Act of 1986 indicates that premium is to be accrued in the same
manner as market discount. Accordingly, it appears that the accrual of premium
on a Class of Bonds of a Series will be calculated using the prepayment
assumption used in pricing such Class. If a holder makes an election to amortize
premium on a Bond, such election will apply to all taxable debt instruments
(including all REMIC regular interests and all pass-through certificates
representing ownership interests in a trust holding debt obligations) held by
the holder at the beginning of the taxable year in which the election is made,
and to all taxable debt instruments acquired thereafter by such holder, and will
be irrevocable without the consent of the Internal Revenue Service. Purchasers
who pay a premium for the Bonds should consult their tax advisers regarding the
election to amortize premium and the method to be employed.
Market Discount. The Bonds are subject to the market discount provisions of
Code Sections 1276 through 1278. These rules provide that if a subsequent holder
of a Bond purchases it at a market discount, some or all of any principal
payment or of any gain recognized upon the disposition of the Bond will be
taxable as ordinary interest income. Market discount on a Bond means the excess,
if any, of (1) the sum of its issue price and the aggregate amount of original
issue discount includible in the gross income of all holders of the Bond prior
to the acquisition by the subsequent holder (presumably adjusted to reflect
prior principal payments), over (2) the price paid by the holder for the Bond.
Market discount on a Bond will be considered to be zero if such discount is less
than .25% of the stated redemption price at maturity of such Bond multiplied by
its weighted average life, which presumably would be calculated in a manner
similar to weighted average
61
life (described above), taking into account distributions (including
prepayments) prior to the date of acquisition of such Bond by the subsequent
purchaser. If market discount on a Bond is treated as zero under this rule, the
actual amount of such discount must be allocated to the remaining principal
distributions on such Bond and when each such distribution is made, gain equal
to the discount allocated to such distribution will be recognized.
Any principal payment (whether a scheduled payment or a prepayment) or any
gain on the disposition of a market discount bond is to be treated as ordinary
income to the extent that it does not exceed the accrued market discount at the
time of such payment or disposition. The amount of accrued market discount for
purposes of determining the tax treatment of subsequent principal payments or
dispositions of the Bonds is to be reduced by the amount so treated as ordinary
income.
The Tax Reform Act of 1986 grants authority to the U.S. Treasury to issue
regulations providing for the computation of accrued market discount on debt
instruments, the principal of which is payable in more than one installment.
Until such time as regulations are issued by the U.S. Treasury, certain rules
described in the legislative history accompanying the Tax Reform Act of 1986
will apply. Under those rules, the holder of a market discount bond may elect to
accrue market discount either on the basis of a constant interest rate or using
one of the following methods. For bonds issued with original issue discount, the
amount of market discount that accrues during a period is equal to the product
of (i) the total remaining market discount, multiplied by (ii) a fraction, the
numerator of which is the original issue discount accruing during the period and
the denominator of which is the total remaining original issue discount at the
beginning of the period. For bonds issued without original issue discount, the
amount of market discount that accrues during a period is equal to the product
of (i) the total remaining market discount, multiplied by (ii) a fraction, the
numerator of which is the amount of stated interest paid during the accrual
period and the denominator of which is the total amount of stated interest
remaining to be paid at the beginning of the period. For purposes of calculating
market discount under any of the above methods in the case of instruments (such
as the Bonds) that provide for payments that may be accelerated by reason of
prepayments of other obligations securing such instruments, the same prepayment
assumption applicable to calculating the accrual of original issue discount
shall apply. Regulations are to provide similar rules for computing the accrual
of amortizable bond premium on instruments payable in more than one principal
installment. As an alternative to the inclusion of market discount in income on
the foregoing basis, the holder may elect to include such market discount in
income currently as it accrues on all market discount instruments acquired by
such holder in that taxable year or thereafter. In addition, accrual method
holders may elect to accrue all interest on a Bond, including de minimis
original issue discount and market discount and as adjusted by any premium,
under a constant yield method.
A subsequent holder of a Bond who acquired the Bond at a market discount
also may be required to defer, until the maturity date of the Bond or the
earlier disposition of the Bond in a taxable transaction, the deduction of a
portion of the amount of interest that the holder paid or accrued during the
taxable year on indebtedness incurred or maintained to purchase or carry the
Bond in excess of the aggregate amount of interest (including original issue
discount) includible in his or her gross income for the taxable year with
respect to such Bond. The amount of such net interest expense deferred in a
taxable year may not exceed the amount of market discount accrued on the Bond
for the days during the taxable year on which the subsequent holder held the
Bond, and the amount of such deferred deduction to be taken into account in the
taxable year in which the Bond is disposed of in a transaction in which gain or
loss is not recognized in whole or in part is limited to the amount of gain
recognized on the disposition. This deferral rule does not apply to a holder
that elects to include market discount in income currently as it accrues on all
market discount instruments acquired by such holder in that taxable year or
thereafter.
Because the regulations described above with respect to market discounts
and premiums have not been issued, it is impossible to predict what effect those
regulations might have on the tax treatment of a Bond purchased at a discount or
premium in the secondary market.
Election to Treat All Interest as Original Issue Discount. The OID
Regulations permit a holder of a Bond to elect to accrue all interest, discount
(including de minimis market or original issue discount) and
62
premium in income as interest, based on a constant yield method for Bonds
acquired on or after April 4, 1994. If such an election were to be made with
respect to a Bond with market discount, the holder of the Bond would be deemed
to have made an election to include in income currently market discount with
respect to all other debt instruments having market discount that such holder of
the Bonds acquires during the year of the election or thereafter. Similarly, a
holder of a Bond that makes this election for a Bond that is acquired at a
premium will be deemed to have made an election to amortize bond premium with
respect to all debt instruments having amortizable bond premium that such holder
owns or acquires. The election to accrue interest, discount and premium on a
constant yield method with respect to a Bond is irrevocable.
Sale or Redemption. If a Bond is sold, the seller will recognize gain or
loss equal to the difference between the amount realized on the sale and the
seller's adjusted basis in the Bond. Such adjusted basis generally will equal
the cost of the Bond to the seller, increased by any original issue discount and
market discount included in the seller's gross income with respect to the Bond
and reduced by payments, other than payments of qualified stated interest,
previously received by the seller and by any amortized premium. If a Bondholder
is a bank, thrift or similar institution described in Section 582(c) of the
Code, gain or loss realized on the sale or exchange of a Bond will be taxable as
ordinary income or loss. Any such gain or loss recognized by any other seller
will be capital gain or loss, provided that the Bond is held by the seller as a
"capital asset" (generally, property held for investment) within the meaning of
Code Section 1221.
REMIC BONDS
General. If a REMIC election is made with respect to a Series of Bonds,
Giancarlo & Gnazzo, A Professional Corporation will deliver an opinion generally
to the effect that, under existing law, assuming timely filing of a REMIC
election and ongoing compliance with all provisions of the related Indenture and
other contemporaneous agreements, all or a portion of the Trust Estate securing
such Series of Bonds will qualify as a REMIC for federal income tax purposes.
The Bonds in such Series will be designated either as one or more "regular
interests" in a REMIC, which generally are treated as debt for federal income
tax purposes, or as "residual interests" in a REMIC, which generally are not
treated as debt for such purposes but rather as representing rights and
responsibilities with respect to the taxable income or loss of the related
REMIC. The Prospectus Supplement for such Series will indicate which Bonds are
being designated as regular interest ("REGULAR INTEREST BONDS") and which are
being designated as residual interests ("RESIDUAL INTEREST BONDS"). The REMIC
residual interests may alternatively be evidenced, instead of by a Residual
Interest Bond, by residual certificates ("RESIDUAL INTEREST CERTIFICATES"), as
set forth in the related Prospectus Supplement. Neither the Residual Interest
Bonds nor the Residual Interest Certificates will be offered by the Prospectus.
Tiered REMIC Structures. For certain Series of Bonds, two or more separate
elections may be made to treat designated portions of the related Trust Estate
as REMICs (where two separate elections are made, one will be referred to as the
"UPPER TIER REMIC" and the other as the "LOWER TIER REMIC" respectively) for
federal income tax purposes. Upon the issuance of any such Series of Bonds,
Giancarlo & Gnazzo, A Professional Corporation, will deliver its opinion
generally to the effect that, under existing law, assuming timely filing of
applicable REMIC elections and ongoing compliance with all provisions of the
related Indenture and other contemporaneous agreements, the Upper Tier REMIC and
the Lower Tier REMIC will each qualify as a REMICs for federal income tax
purposes. In certain cases, a single Residual Interest Bond may represent the
residual interest in both the Upper Tier REMIC and the Lower Tier REMIC. In such
cases, the discussion of Residual Interest Bonds set forth below should be
interpreted as applying to each residual interest separately.
Status as Real Property Loans. Except to the extent otherwise provided in
the related Prospectus Supplement: (i) REMIC Bonds held by a "domestic building
and loan association" ("DB&LS") will constitute assets described in Code Section
7701(a)(19)(C)(xi); (ii) REMIC Bonds held by a "real estate investment trust"
("REIT") will constitute "real estate assets" within the meaning of Code section
856(c)(4)(A) and interest on such Bonds will be considered "interest on
obligations secured by mortgages on real property" within the meaning of Code
Section 856(c)(3)(B); and (iii) Regular Interest Bonds held by a
63
"financial assets securitization investment trust" ("FASIT") will qualify for
treatment as "permitted assets" within the meaning of Code Section 860L(c)(1)(G)
and as "qualified mortgages" within the meaning of Code Section 860G(a)(3) if
held by another REMIC. REMIC Bonds held by REITs or regulated investment
companies ("RIC") will not constitute "government securities" within the meaning
of Code Section 856(c)(5)(A) or 851(b)(4)(A)(ii), respectively. REMIC Bonds held
by certain financial institutions will constitute "evidences of indebtedness"
within the meaning of Code Section 582(c)(1).
In the case of items (i), (ii) and (iii) above, if less than 95% of the
REMIC's assets are assets qualifying under any of the foregoing Code Sections,
the REMIC Bonds will be qualifying assets only to the extent that the REMIC's
assets are qualifying assets. If a Series of Bonds employs a multi-tier REMIC
structure, both the Upper Tier REMIC and the Lower Tier REMIC will be treated as
a single REMIC for purposes of determining the extent to which the related REMIC
Bonds and the income thereon will be treated as such assets and income.
Taxation of Regular Interest Bonds.
General. Except as otherwise stated in this discussion, Regular Interest
Bonds 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. Holders
of Regular Interest Bonds that otherwise report income under a cash method of
accounting will be required to report income with respect to Regular Interest
Bonds under an accrual method.
Original Issue Discount. Certain classes of Regular Interest Bonds may be
issued with OID within the meaning of Section 1273(a) of the Code. The rules
governing OID with respect to a Regular Interest Bond are described above under
"Non-REMIC Bonds -- Original Issue Discount." Holders of Regular Interest Bonds
should be aware, however, that the OID Regulations do not adequately address
certain issues relevant to prepayable securities, such as the Regular Interest
Bonds. In view of the complexities and current uncertainties as to the manner of
inclusion in income of OID on Regular Interest Bonds, each investor should
consult his own tax advisor to determine the appropriate amount and method of
inclusion in income of OID on such Regular Interest Bonds for federal income tax
purposes.
Market Discount. A subsequent purchaser of a Regular Interest Bond may also
be subject to the market discount provisions of Code Sections 1276 through 1278.
These rules are described above under "Non-REMIC Bonds -- Market Discount."
Premium. The rules governing "premium" apply equally to Regular Interest
Bonds (see above "Non-REMIC Bonds -- Premium).
Sale or Exchange. If a Regular Interest Bond is sold, exchanged, redeemed
or retired the Holder will recognize gain or loss equal to the difference
between the amount realized on such disposition and the adjusted basis in the
Regular Interest Bond. Similarly, a Holder who receives a payment denominated as
principal with respect to a Regular Interest Bond will recognize gain equal to
the excess of the amount of such payment over his adjusted basis in the Regular
Interest Bond. A Holder that receives a final payment that is less than the
Holder's adjusted basis in a Regular Interest Bond will generally recognize a
loss. The adjusted basis of a Regular Interest Bond generally will equal the
cost of the Regular Interest Bond to the Holder, increased by any OID or market
discount previously included in the Holder's gross income with respect to the
Regular Interest Bond, and reduced by payments (other than payments of qualified
stated interest) previously received by the Holder on the Regular Interest Bond
and by any amortized premium. Except to the extent that the market discount
rules apply and except as provided below, any gain or loss on the sale or other
disposition of a Regular Interest Bond generally will be capital gain or loss.
Such gain or loss will be long-term gain or loss if the Regular Interest Bond is
held as a capital asset for more than one year. Long-term capital gains of
certain non-corporate taxpayers are subject to a lower minimum tax rate than
ordinary income of such taxpayers for property held for more than one year. The
maximum tax rate for corporations is the same with respect to both ordinary
income and capital gains.
If the Holder of a Regular Interest Bond is a bank, a mutual savings bank,
a thrift, or a similar institution described in Section 582 of the Code, any
gain or loss on the sale or exchange of the Regular Interest Bond
64
will be treated as ordinary income or loss. In the case of other types of
Holders, gain on the sale or exchange of the Regular Interest Bond will be
treated as ordinary income (i) if the Regular Interest Bond is held as part of a
"conversion transaction" as described in Code Section 1258(c), up to the amount
of interest that would have accrued on the holder's net investment in the
conversion transaction at 120% of the appropriate applicable Federal rate under
Code Section 1274(d) in effect at the time the holder entered into the
transaction minus any amount previously treated as ordinary income with respect
to any prior disposition of property that was held as a part of such
transaction, (ii) in the case of a non-corporate taxpayer, to the extent such
taxpayer has made an election under Code Section 163(d)(4) to have net capital
gains taxed as investment income at ordinary income rates, or (iii) to the
extent that such gain does not exceed the excess, if any, of (a) the amount that
would have been includable in the gross income of the holder if its yield on
such Regular Interest Bond were 110% of the applicable Federal rate as of the
date of purchase, over (b) the amount of income actually includable in the gross
income of such holder with respect to such Regular Interest Bond. Although the
relevant legislative history indicates that the portion of the gain from
disposition of a Regular Interest Bond that will be recharacterized as ordinary
income is limited to the amount of OID (if any) on the Regular Interest Bond
that was not previously includible in income, the applicable Code provision
contains no such limitation.
Taxation of Holders of Residual Interest Bonds.
The REMIC will not be subject to Federal income tax except with respect to
income from prohibited transactions and certain other transactions. Instead, the
holder of a Bond representing a residual interest (a "Residual Interest Bond")
will take into account the "daily portion" of the taxable income or net loss of
the REMIC for each day during the taxable year on which such holder held the
Residual Interest Bond. The daily portion is determined by allocating to each
day in any calendar quarter its ratable portion of the taxable income or net
loss of the REMIC for such quarter, and by allocating that amount among the
holders (on such day) of the Residual Interest Bonds in proportion to their
respective holdings on such day.
The holder of a Residual Interest Bond may be required to include taxable
income from the Residual Interest Bond in excess of the cash distributed. The
reporting of taxable income without corresponding distributions could occur, for
example, in certain REMIC issues in which the loans held by the REMIC were
issued or acquired at a discount, since mortgage prepayments cause recognition
of discount income, while the corresponding portion of the prepayment could be
used in whole or in part to make principal payments on REMIC Regular Interests
issued without any discount or at an insubstantial discount (if this occurs, it
is likely that cash distributions will exceed taxable income in later years).
Taxable income may also be greater in earlier years of certain REMIC issues as a
result of the fact that interest expense deductions, as a percentage of
outstanding principal on REMIC Regular Interest Bonds, will typically increase
over time as lower yielding Bonds are paid, whereas interest income with respect
to loans will generally remain constant over time as a percentage of loan
principal.
In any event, because the holder of a Residual Interest Bond is taxed on
the net income of the REMIC, the taxable income derived from a Residual Interest
Bond in a given taxable year will not be equal to the taxable income associated
with investment in a corporate bond or stripped instrument having similar cash
flow characteristics and pretax yield. Therefore, the after-tax yield on the
Residual Interest Bond may be less than that of such a bond or instrument.
Limitation on Losses. The amount of the REMIC's net loss that a holder may
take into account currently is limited to the holder's adjusted basis at the end
of the calendar quarter in which such loss arises. A holder's basis in a
Residual Interest Bond will initially equal such holder's purchase price, and
will subsequently be increased by the amount of the REMIC's taxable income
allocated to the holder, and decreased (but not below zero) by the amount of
distributions made and the amount of the REMIC's net loss allocated to the
holder. Any disallowed loss may be carried forward indefinitely, but may be used
only to offset income of the REMIC generated by the same REMIC. The ability of
holders of Residual Interest Bonds to deduct net losses may be subject to
additional limitations under the Code, as to which such holders should consult
their tax advisers.
65
Distributions. Distributions on a Residual Interest Bond (whether at their
scheduled times or as a result of prepayments) will generally not result in any
additional taxable income or loss to a holder of a Residual Interest Bond. If
the amount of such payment exceeds a holder's adjusted basis in the Residual
Interest Bond, however, the holder will recognize gain (treated as gain from the
sale of the Residual Interest Bond) to the extent of such excess.
Sale or Exchange. A holder of a Residual Interest Bond will recognize gain
or loss on the sale or exchange of a Residual Interest Bond equal to the
difference, if any, between the amount realized and such holder's adjusted basis
in the Residual Interest Bond at the time of such sale or exchange. In general,
any such gain or loss will be capital gain or loss provided the Residual
Interest Bond is held as a capital asset. Except to the extent provided in
regulations, which have not yet been issued, any loss upon disposition of a
Residual Interest Bond will be disallowed if the selling holder acquires any
residual interest in a REMIC or similar mortgage pool within six months before
or after such disposition. In that event, any loss will increase such Regular
Interest Bondholder's adjusted basis in the newly acquired interest.
Excess Inclusions. The excess inclusion portion of a REMIC's income is
generally equal to the excess, if any, of REMIC taxable income for the quarterly
period allocable to a Residual Interest Bond, over the daily accruals for such
quarterly period of (i) 120% of the long term applicable federal rate on the
Startup Day multiplied by (ii) the adjusted issue price of such Residual
Interest Bond at the beginning of such quarterly period. The adjusted issue
price of a residual interest at the beginning of each calendar quarter will
equal its issue price (calculated in a manner analogous to the determination of
the issue price of a Regular Interest), increased by the aggregate of the daily
accruals for prior calendar quarters, and decreased (but not below zero) by the
amount of loss allocated to a holder and the amount of distributions made on the
Residual Interest Bond before the beginning of the quarter. The long-term
federal rate, which is announced monthly by the Treasury Department, is an
interest rate that is based on the average market yield of outstanding
marketable obligations of the United States government having remaining
maturities in excess of nine years.
The portion of the REMIC taxable income of a holder of a Residual Interest
Bond consisting of "excess inclusion" income may not be offset by other
deductions or losses, including net operating losses, on such holder's federal
income tax return. Further, if the holder of a Residual Interest Bond is an
organization subject to the tax on unrelated business income imposed by Code
Section 511, such holder's excess inclusion income will be treated as unrelated
business taxable income of such holder. In addition, under Treasury regulations
yet to be issued, if a real estate investment trust, a regulated investment
company, a common trust fund, or certain cooperatives were to own a Residual
Interest Bond, a portion of dividends (or other distributions) paid by the real
estate investment trust (or other entity) would be treated as excess inclusion
income. If a Residual Bond is owned by a foreign person excess inclusion income
is subject to tax at a rate of 30% which may not be reduced by treaty, is not
eligible for treatment as "portfolio interest" and is subject to certain
additional limitations. See "Tax Treatment of Foreign Investors." The Small
Business Job Protection Act of 1996 has eliminated the special rule permitting
Section 593 institutions ("thrift institutions") to use net operating losses and
other allowable deductions to offset their excess inclusion income from REMIC
residual certificates that have "significant value" within the meaning of the
REMIC Regulations, effective for taxable years beginning after December 31,
1995, except with respect to residual certificates continuously held by a thrift
institution since November 1, 1995.
In addition, the Small Business Job Protection Act of 1996 provides three
rules for determining the effect of excess inclusions on the alternative minimum
taxable income of a residual holder. First, alternative minimum taxable income
for such residual holder is determined without regard to the special rule that
taxable income cannot be less than excess inclusions. Second, a residual
holder's alternative minimum taxable income for a tax year cannot be less than
excess inclusions for the year. Third, the amount of any alternative minimum tax
net operating loss deductions must be computed without regard to any excess
inclusions. These rules are effective for tax years beginning after December 31,
1986, unless a residual holder elects to have such rules apply only to tax years
beginning after August 20, 1996.
Restrictions on Ownership and Transfer of Residual Interest Bonds. As a
condition to qualification as a REMIC, reasonable arrangements must be made to
prevent the ownership of a Residual Interest Bond by any
66
"Disqualified Organization." Disqualified Organizations include the United
States, any State or political subdivision thereof, any foreign government, any
international organization, or any agency or instrumentality of any of the
foregoing, a rural electric or telephone cooperative described in Section
1381(a)(2)(C) of the Code, or any entity exempt from the tax imposed by Sections
1-1399 of the Code, if such entity is not subject to tax on its unrelated
business income. Accordingly, the applicable Pooling and Servicing Agreement
will prohibit Disqualified Organizations from owning a Residual Interest Bond.
In addition, no transfer of a Residual Interest Bond will be permitted unless
the proposed transferee shall have furnished to the Trustee an affidavit
representing and warranting that it is neither a Disqualified Organization nor
an agent or nominee acting on behalf of a Disqualified Organization.
If a Residual Interest Bond is transferred to a Disqualified Organization
(in violation of the restrictions set forth above), a substantial tax will be
imposed on the transferor of such Residual Interest Bond at the time of the
transfer. In addition, if a Disqualified Organization holds an interest in a
pass-through entity (including, among others, a partnership, trust, real estate
investment trust, regulated investment company, or any person holding as
nominee), that owns a Residual Interest Bond, the pass-through entity will be
required to pay an annual tax on its allocable share of the excess inclusion
income of the REMIC.
Under the REMIC Regulations, if a Residual Interest Bond is a "noneconomic
residual interest," as described below, a transfer of a Residual Interest Bond
to a United States person will be disregarded for all Federal tax purposes
unless no significant purpose of the transfer was to impede the assessment or
collection of tax. A Residual Interest Bond is a "noneconomic residual interest"
unless, at the time of the transfer (i) the present value of the expected future
distributions on the Residual Interest Bond at least equals the product of the
present value of the anticipated excess inclusions and the highest rate of tax
for the year in which the transfer occurs, and (ii) the transferor reasonably
expects that the transferee will receive distributions from the REMIC at or
after the time at which the taxes accrue on the anticipated excess inclusions in
an amount sufficient to satisfy the accrued taxes. A significant purpose to
impede the assessment or collection of tax exists if the transferor, at the time
of the transfer, either knew or should have known that the transferee would be
unwilling or unable to pay taxes due on its share of the taxable income of the
REMIC. A transferor is presumed not to have such knowledge if (i) the transferor
conducted a reasonable investigation of the transferee and (ii) the transferee
acknowledges to the transferor that the residual interest may generate tax
liabilities in excess of the cash flow and the transferee represents that it
intends to pay such taxes associated with the residual interest as they become
due. In addition, proposed Treasury regulations issued on February 4, 2000 would
also require the present value of the anticipated tax liabilities associated
with holding the residual interest does not exceed the present value of the sum
of (i) any consideration given to the transferee to acquire the interest, (ii)
the expected future distributions on the interest, and (iii) any anticipated tax
savings associated with holding the interest as the REMIC generates losses. If a
transfer of a "noneconomic residual certificate" is disregarded, the transferor
would continue to be treated as the owner of the Residual Interest Bond and
would continue to be subject to tax on its allocable portion of the net income
of the REMIC. A similar type of limitation exists with respect to certain
transfers of Residual Interest Bonds by foreign persons to United States
persons. See "-- Tax Treatment of Foreign Investors."
Mark to Market Rules. Prospective purchasers of a Residual Interest Bond
should be aware that a Residual Interest Bond acquired after January 3, 1995
cannot be marked-to-market.
Administrative Matters. The REMIC's books must be maintained on a calendar
year basis and the REMIC must file an annual federal income tax return. The
REMIC will also be subject to the procedural and administrative rules of the
Code applicable to partnerships, including the determination of any adjustments
to, among other things, items of REMIC income, gain, loss, deduction, or credit,
by the IRS in a unified administrative proceeding.
Taxation of the REMIC
General. Although a REMIC is a separate entity for federal income tax
purposes, a REMIC is not generally subject to entity-level tax. Rather, the
taxable income or net loss of a REMIC is taken into account
67
by the holders of residual interests. As described above, the regular interests
are generally taxable as debt of the REMIC.
Qualification as a REMIC. The Trust Estate or one or more designated pools
of the assets of the Trust Estate may elect to be treated under the Code as a
REMIC in which the Regular Interest Bonds and Residual Interest Bonds will
constitute the "regular interests" and "residual interests," respectively, if a
REMIC election is in effect and certain tests concerning (i) the composition of
the REMIC's assets and (ii) the nature of the Holders' interests in the REMIC
are met on a continuing basis. A loss of REMIC status could have a number of
consequences for Holders. If, as the result of REMIC disqualification, the Trust
Estate were treated as an association taxable as a corporation, distributions on
the Bond could be recharacterized in part as dividends from a non-includible
corporation and in part as returns of capital. Alternatively, distributions on a
Regular Interest Bond could continue to be treated as comprised of interest and
principal notwithstanding REMIC disqualification, in which case a cash-basis
Holder might not be required to continue to recognize interest and market
discount with respect to the Bond on a accrual basis. Under the first
alternative, a loss of REMIC status would, and under the second alternative, a
loss of REMIC status could cause the Bonds and the associated distributions not
to be qualified assets and income for the various purposes of DB&Ls, FASITs and
REITs described under "REMIC Bonds--Status as Real Property Loans" above,
although such a loss would not affect the status of the Securities as
"government securities" for REITs. The Bonds should continue to qualify as
"government securities" for RICs, regardless of whether REMIC status is lost.
Calculation of REMIC Income. The taxable income or net loss of a REMIC is
determined under an accrual method of accounting and in the same manner as in
the case of an individual, with certain adjustments. In general, the taxable
income or net loss will be the difference between (i) the gross income produced
by the REMIC's assets, including stated interest and any OID or market discount
on loans and other assets, and (ii) deductions, including stated interest and
OID accrued on Regular Interest Bonds, amortization of any premium with respect
to Loans, and servicing fees and other expenses of the REMIC. A holder of a
Residual Interest Bond that is an individual or a "pass-through interest holder"
(including certain pass-through entities, but not including real estate
investment trusts) will be unable to deduct servicing fees payable on the loans
or other administrative expenses of the REMIC for a given taxable year, to the
extent that such expenses, when aggregated with such holder's other
miscellaneous itemized deductions for that year, do not exceed two percent of
such holder's adjusted gross income.
For purposes of computing its taxable income or net loss, the REMIC should
have an initial aggregate tax basis in its assets equal to the aggregate fair
market value of the regular interests and the residual interests on the Startup
Day (generally, the day that the interests are issued). That aggregate basis
will be allocated among the assets of the REMIC in proportion to their
respective fair market values.
The OID provisions of the Code apply to loans of individuals originated on
or after March 2, 1984, and the market discount provisions apply to loans
originated after July 18, 1984. Subject to possible application of the de
minimis rules, the method of accrual by the REMIC of OID income on such loans
will be equivalent to the method under which holders of Pay-Through Bonds accrue
OID (i.e., under the constant yield method taking into account the Prepayment
Assumption). The REMIC will deduct OID on the Regular Interest Bonds in the same
manner that the holders of the Regular Interest Bonds include such discount in
income, but without regard to the de minimis rules. See "Taxation of Debt
Securities" above. However, a REMIC that acquires loans at a market discount
must include such market discount in income currently, as it accrues, on a
constant interest basis.
To the extent that the REMIC's basis allocable to loans that it holds
exceeds their principal amounts, the resulting premium, if attributable to
mortgages originated after September 27, 1985, will be amortized over the life
of the loans (taking into account the Prepayment Assumption) on a constant yield
method. Although the law is somewhat unclear regarding recovery of premium
attributable to loans originated on or before such date, it is possible that
such premium may be recovered in proportion to payments of loan principal.
Prohibited Transactions and Contributions Tax. The REMIC will be subject to
a 100% tax on any net income derived from a "prohibited transaction." For this
purpose, net income will be calculated without taking into account any losses
from prohibited transactions or any deductions attributable to any prohibited
68
transaction that resulted in a loss. In general, prohibited transactions
include: (i) subject to limited exceptions, the sale or other disposition of any
qualified mortgage transferred to the REMIC; (ii) subject to limited exceptions,
the sale or other disposition of a cash flow investment; (iii) the receipt of
any income from assets not permitted to be held by the REMIC pursuant to the
Code; or (iv) the receipt of any fees or other compensation for services
rendered by the REMIC. It is anticipated that a REMIC will not engage in any
prohibited transactions in which it would recognize a material amount of net
income. In addition, subject to a number of exceptions, a tax is imposed at the
rate of 100% on amounts contributed to a REMIC after the close of the
three-month period beginning on the Startup Day. The holders of Residual
Interest Bonds will generally be responsible for the payment of any such taxes
imposed on the REMIC. To the extent not paid by such holders or otherwise,
however, such taxes will be paid out of the Trust Fund and will be allocated pro
rata to all outstanding classes of Bonds of such REMIC.
WITHHOLDING WITH RESPECT TO CERTAIN FOREIGN INVESTORS
Interest, including OID, paid on a Bond to a nonresident alien individual,
foreign corporation or other non-United States person unrelated to the Issuer
("Non-U.S. Person") generally will be treated as "portfolio interest" and,
therefore, will not be subject to any United States withholding tax, provided
that (i) such interest is not effectively connected with a trade or business in
the United States of the Bondholder, and (ii) the person required to withhold
tax is provided with appropriate certification that the beneficial owner of the
Bond is a Non-U.S. Person ("Foreign Person Certification"). If Foreign Person
Certification is not provided, interest (including OID) paid on such a Bond may
be subject to either a 30 percent withholding tax or 31 percent backup
withholding. See "Backup Withholding."
Final regulations dealing with withholding tax on income paid to foreign
persons, backup withholding and related matters (the "New Withholding
Regulations") were issued by the Treasury Department on October 6, 1997. The New
Withholding Regulations generally attempt to unify certification requirements
and modify reliance standards. The New Withholding Regulations generally will be
effective for payments made after December 31, 2000, subject to certain
transition rules. Prospective investors are strongly urged to consult their own
tax advisors with respect to the New Withholding Regulations.
The 30% withholding tax imposed on a foreign person is subject to reduction
or elimination under applicable tax treaties. Non-U.S. Persons who hold a Bond
should consult their tax advisors regarding their qualification for reduced rate
of, or exemption from, withholding and the procedure for obtaining such a
reduction or exemption.
BACKUP WITHHOLDING
Under federal income tax law, a Bondholder, beneficial owner, financial
intermediary or other recipient of a payment on behalf of a beneficial owner may
be subject to "backup withholding" under certain circumstances. Backup
withholding may apply to such person who is a United States person if such
person, among other things, (i) fails to furnish his social security number or
other taxpayer identification number ("TIN"), (ii) furnishes an incorrect TIN,
(iii) fails to report properly interest and dividends, or (iv) under certain
circumstances, fails to provide a certified statement, signed under penalties of
perjury, that the TIN provided is correct and that such person is not subject to
backup withholding. Backup withholding may apply, under certain circumstances,
to a Bondholder who is a Non-U.S. Person if the Bondholder fails to provide
securities broker with a Foreign Person Certification. Backup withholding
applies to "reportable payments," which include interest payments and principal
payments to the extent of accrued OID, as well as distributions of proceeds from
the sale of Regular Interest Bonds or Residual Interest Bonds. The backup
withholding rate is 31%. Backup withholding, however, does not apply to payments
on a Bond made to certain exempt recipients, such as tax-exempt organizations,
and to certain Non-U.S. Person. Bondholders should consult their tax advisors
for additional information concerning the potential application of backup
withholding to payments received by them with respect to a Bond.
DUE TO THE COMPLEXITY OF THE FEDERAL INCOME TAX RULES APPLICABLE TO
BONDHOLDERS AND THE CONSIDERABLE UNCERTAINTY THAT EXISTS WITH RESPECT
69
TO MANY ASPECTS OF THOSE RULES, POTENTIAL INVESTORS SHOULD CONSULT THEIR OWN TAX
ADVISORS REGARDING THE TAX TREATMENT OF THE ACQUISITION, OWNERSHIP, AND
DISPOSITION OF THE BONDS.
STATE TAX CONSIDERATIONS
In addition to the federal income tax consequences described above under
"FEDERAL INCOME TAX CONSEQUENCES," potential investors should consider the state
income tax consequences of the acquisition, ownership, and disposition of the
Bonds. State income tax law may differ substantially from the corresponding
federal law, and this discussion does not purport to describe any aspect of the
income tax laws of any state. Therefore, potential investors should consult
their own tax advisors with respect to the various state tax consequences of an
investment in the Bonds.
LEGAL INVESTMENT
The Prospectus Supplement for each Series of Bonds will specify which, if
any, of the Classes of Bonds offered thereby will constitute "mortgage related
securities" for purposes of the Secondary Mortgage Market Enhancement Act of
1984 ("SMMEA"). Classes of Bonds that qualify as "mortgage related securities"
will be legal investments for persons, trusts, corporations, partnerships,
associations, business trusts and business entities (including depository
institutions, life insurance companies and pension funds) created pursuant to or
existing under the laws of the United States or any state (including the
District of Columbia and Puerto Rico) whose authorized investments are subject
to state regulation to the same extent as, under applicable law, obligations
issued by or guaranteed as to principal and interest by the United States or any
such entities. Under SMMEA, if a state enacts legislation prior to October 4,
1991 specifically limiting the legal investment authority of any of such
entities with respect to "mortgage related securities," the Bonds will
constitute legal investments for entities subject to such legislation only to
the extent provided therein. Approximately twenty-one states adopted such
legislation prior to the October 4, 1991 deadline. SMMEA provides, however, that
in no event will the enactment of any such legislation affect the validity of
any contractual commitment to purchase, hold or invest in Bonds, or require the
sale or other disposition of Bonds, so long as such contractual commitment was
made or such Bonds were acquired prior to the enactment of such legislation.
SMMEA also amended the legal investment authority of federally-chartered
depository institutions as follows: federal savings and loan associations and
federal savings banks may invest in, sell or otherwise deal in Bonds without
limitations as to the percentage of their assets represented thereby, federal
credit unions may invest in mortgage related securities, and national banks may
purchase Bonds for their own account without regard to the limitations generally
applicable to investment securities set forth in 12 U.S.C. 24 (Seventh), subject
in each case to such regulations as the applicable federal authority may
prescribe. In this connection, federal credit unions should review the National
Credit Union Administration ("NCUA") Letter to Credit Unions No. 96, as modified
by Letter to Credit Unions No. 108, which includes guidelines to assist federal
credit unions in making investment decisions for mortgage related securities,
and the NCUA's regulation "Investment and Deposit Activities" (12 C.F.R. Part
703) (whether or not the Class of Bonds under consideration for purchase
constitutes a "mortgage related security").
All depository institutions considering an investment in the Bonds (whether
or not the Class of Bonds under consideration for purchase constitutes a
"mortgage related security") should review the Federal Financial Institutions
Examination Council's Supervisory Policy Statement on Securities Activities (to
the extent adopted by their respective regulators) (the "Policy Statement"),
setting forth, in relevant part, certain securities trading and sales practices
deemed unsuitable for an institution's investment portfolio, and guidelines for
(and restrictions on) investing in mortgage derivative products, including
"mortgage related securities" that are "high-risk mortgage securities" as
defined in the Policy Statement. According to the Policy Statement, such
"high-risk mortgage securities" include securities such as Bonds not entitled to
distributions allocated to principal or interest, or Subordinated Bonds. Under
the Policy Statement, it is the responsibility of each depository institution to
determine, prior to purchase (and at stated intervals thereafter),
70
whether a particular mortgage derivative product is a "high-risk mortgage
security," and whether the purchase (or retention) of such a product would be
consistent with the Policy Statement.
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
that may restrict or prohibit investment in securities that are not "interest
bearing" or "income paying."
There may be other restrictions on the ability of certain investors,
including depository institutions, either to purchase Bonds or to purchase Bonds
representing more than a specified percentage of the investor's assets.
Investors should consult their own legal advisors in determining whether and to
what extent the Bonds constitute legal investments for such investors.
ERISA MATTERS
GENERAL
The Employee Retirement Income Security Act of 1974, as amended ("ERISA")
and section 4975 of the Code impose certain restrictions on employee benefit
plans subject to ERISA or plans or arrangements subject to Section 4975 of the
Code ("Plans") and on persons who are parties in interest or disqualified
persons ("parties in interest") with respect to such Plans. Certain employee
benefit plans, such as governmental plans and church plans (if no election has
been made under section 410(d) of the Code), are not subject to the restrictions
of ERISA, and assets of such plans may be invested in the Bonds without regard
to the ERISA considerations described below, subject to other applicable federal
and state law. However, any such governmental or church plan which is qualified
under section 401(a) of the Code and exempt from taxation under section 501(a)
of the Code is subject to the prohibited transaction rules set forth in section
503 of the Code. Any Plan fiduciary which proposes to cause a Plan to acquire
any of the Bonds should consult with its counsel with respect to the potential
consequences under ERISA, and the Code, of the Plan's acquisition and ownership
of the Bonds. Investments by Plans are also subject to ERISA's general fiduciary
requirements, including the requirement of investment prudence and
diversification and the requirement that a Plan's investments be made in
accordance with the documents governing the Plan.
PROHIBITED TRANSACTIONS
GENERAL. Section 406 of ERISA prohibits parties in interest with respect
to a Plan from engaging in certain transactions (including loans) involving a
Plan and its assets unless a statutory or administrative exemption applies to
the transaction. Section 4975 of the Code imposes certain excise taxes (or, in
some cases, a civil penalty may be assessed pursuant to section 502(i) of ERISA)
on parties in interest which engage in non-exempt prohibited transactions.
PLAN ASSET REGULATION. The United States Department of Labor ("Labor") has
issued final regulations concerning the definition of what constitutes the
assets of a Plan for purposes of ERISA and the prohibited transaction provisions
of the Code (the "Plan Asset Regulation"). The Plan Asset Regulation describes
the circumstances under which the assets of an entity in which a Plan invests
will be considered to be "plan assets" such that any person who exercises
control over such assets would be subject to ERISA's fiduciary standards. Under
the Plan Asset Regulation, generally when a Plan invests in another entity, the
Plan's assets do not include, solely by reason of such investment, any of the
underlying assets of the entity. However, the Plan Asset Regulation provides
that, if a Plan acquires an "equity interest" in an entity that is neither a
"publicly-offered security" (as defined therein) nor a security issued by an
investment company registered under the Investment Company Act of 1940, the
assets of the entity will be treated as assets of the Plan investor unless
certain exceptions apply. If the Bonds were deemed to be equity interests and no
statutory, regulatory or administrative exemption applies, the Issuer could be
considered to hold plan assets by reason of a Plan's investment in the Bonds.
Such plan assets would include an undivided interest in any assets held by the
Issuer. In such an event, the Bond Trustee and other persons, in providing
services with respect to the Issuer's assets, may be parties in interest with
respect to such Plans, subject to the fiduciary responsibility provisions of
Title I of ERISA, including the prohibited transaction provisions of section 406
of ERISA, and
71
section 4975 of the Code with respect to transactions involving the Issuer's
assets. Under the Plan Asset Regulation, the term "equity interest" is defined
as any interest in an entity other than an instrument that is treated as
indebtedness under "applicable local law" and which has no "substantial equity
features." Although the Plan Assets Regulation is silent with respect to the
question of which law constitutes "applicable local law" for this purpose, Labor
has stated that this determination should be made under the state law governing
interpretation of the instrument in question. In the preamble to the Plan Assets
Regulation, Labor declined to provide a precise definition of what features are
equity features or the circumstances under which such features would be
considered "substantial," noting that the question of whether a plan's interest
has substantial equity features is an inherently factual one, but that in making
a determination it would be appropriate to take into account whether the equity
features are such that a Plan's investment would be a practical vehicle for the
indirect provision of investment management services. If the Bonds are deemed to
be equity interests in the Issuer and no statutory, regulatory or administrative
exemption applies, the Issuer could be considered to hold plan assets by reason
of a Plan's investment in the Bonds. Those exemptions potentially include
Prohibited Transaction Class Exemption ("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," PTCE 95-60, regarding investments by
insurance company general accounts, or PTCE 96-23, regarding transactions
effected by an "in-house asset manager".
REVIEW BY PLAN FIDUCIARIES. Any Plan fiduciary considering whether to
purchase any Bonds on behalf of a Plan should consult with its counsel regarding
the applicability of the fiduciary responsibility and prohibited transaction
provisions of ERISA and the Code to such investment. Among other things, before
purchasing any Bonds, a fiduciary of a Plan should make its own determination as
to whether the Issuer, as obligor on the Bonds, is a party in interest with
respect to the Plan, the availability of the exemptive relief provided in the
Plan Asset Regulations and the availability of any other prohibited transaction
exemptions.
RATING
It is a condition to the issuance of the Bonds of each Series offered
hereby and by the Prospectus Supplement that they shall have been rated in one
of the four highest rating categories by the nationally recognized statistical
rating agency or agencies (each, a "Rating Agency") specified in the related
Prospectus Supplement.
Any such rating would be based on, among other things, the adequacy of the
value of the Mortgage Collateral securing a Series of Bonds and any credit
enhancement with respect to such Class and will reflect such Rating Agency's
assessment solely of the likelihood that holders of a Class of Bonds will
receive payments to which such Bondholders are entitled under the related Bond.
Such rating will not constitute an assessment of the likelihood that principal
prepayments on the related Mortgage Collateral will be made, the degree to which
the rate of such prepayments might differ from that originally anticipated or
the likelihood of early optional termination of the Series of Bonds. Such rating
should not be deemed a recommendation to purchase, hold or sell Bonds, inasmuch
as it does not address market price or suitability for a particular investor.
Each security rating should be evaluated independently of any other security
rating. Such rating will not address the possibility that prepayment at higher
or lower rates than anticipated by an investor may cause such investor to
experience a lower than anticipated yield or that an investor purchasing a
security at a significant premium might fail to recoup its initial investment
under certain prepayment scenarios.
There is also no assurance that any such rating will remain in effect for
any given period of time or that it may not be lowered or withdrawn entirely by
the applicable Rating Agency in the future if in its judgment circumstances in
the future so warrant. In addition to being lowered or withdrawn due to any
erosion in the adequacy of the value of the Mortgage Collateral securing a
Series of Bonds or any credit enhancement with respect to a Series of Bonds,
such rating might also be lowered or withdrawn among other reasons, because of
an adverse change in the financial or other condition of a credit enhancement
provider or a change in the rating of such credit enhancement provider's long
term debt.
The amount, type and nature of credit enhancement, if any, established with
respect to a Series of Bonds will be determined on the basis of criteria
established by each Rating Agency rating Classes of such Series of Bonds. Such
criteria are sometimes based upon an actuarial analysis of the behavior of
mortgage loans in a
72
larger group. Such analysis is often the basis upon which each Rating Agency
determines the amount of credit enhancement required with respect to each such
Class. There can be no assurance that the historical data supporting any such
actuarial analysis will accurately reflect future experience nor any assurance
that the data derived from a large actuarial analysis will accurately reflect
future experience nor any assurance that the data derived from a large pool of
mortgage loans accurately predicts the delinquency, foreclosure or loss
experience of any particular pool of Mortgage Collateral. No assurance can be
given that values of any Mortgaged Properties or mortgaged properties securing
the mortgage loans underlying any Certificates, as the case may be, have
remained or will remain at their levels on the respective dates of origination
of the related mortgage loans. If the residential real estate markets should
experience an overall decline in property values such that the outstanding
principal balances of the Mortgage Collateral securing a particular Series of
Bonds and any secondary financing on the related Mortgaged Properties become
equal to or greater than the value of the Mortgaged Properties or mortgaged
properties securing the mortgage loans underlying any Certificates, as the case
may be, the rates of delinquencies, foreclosures and losses could be higher than
those now generally experienced in the mortgage lending industry. In addition,
adverse economic conditions (which may or may not affect real property values)
may affect the timely payment by mortgagors of scheduled payments of principal
and interest on the Mortgage Collateral and, accordingly, the rates of
delinquencies, foreclosures and losses with respect to any Mortgage Collateral
securing a particular Series of Bonds. To the extent that such losses are not
covered by credit enhancement, such losses will be borne, at least in part, by
the holders of one or more Classes of Bonds.
PLAN OF DISTRIBUTION
The Issuer may sell the Bonds offered hereby either directly or through an
underwriter or underwriters or through underwriting syndicates managed by an
underwriter or underwriters. The Prospectus Supplement for each Series will set
forth the terms of the offering of such Series and of each Class within such
Series, including the name or names of the underwriters, the proceeds to and
their use by the Issuer, and either the initial public offering price, the
discounts and commissions to the underwriters and any discounts or concessions
allowed or reallowed to certain dealers or the method by which the price at
which the underwriters will sell the Bonds will be determined.
The Bonds of a Series may be acquired by underwriters for their own account
and may be resold from time to time in one or more transactions, including
negotiated transactions, at a fixed public offering price or at varying prices
determined at the time of sale. The obligations of any underwriters will be
subject to certain conditions precedent, and such underwriters will be severally
obligated to purchase all the Bonds of a Series described in the related
Prospectus Supplement, if any are purchased. If Bonds of a Series are offered
other than through underwriters, the related Prospectus Supplement will contain
information regarding the nature of such offering and any agreements to be
entered into between the Issuer and purchasers of Bonds of such Series.
Redwood Trust or other affiliate of the Issuer may purchase Bonds and
pledge them to secure indebtedness or, together with its pledgees, donees,
transferees or other successors in interest, sell the Bonds, from time to time,
either directly or through one or more underwriters, underwriting syndicates or
designated agents.
The place and time of delivery for the Bonds of a Series in respect of
which this Prospectus is delivered will be set forth in the related Prospectus
Supplement.
LEGAL MATTERS
The validity of the Bonds will be passed upon for the Issuer by Tobin &
Tobin, a professional corporation, San Francisco, California. Certain tax
matters will be passed upon by GnazzoThill, A Professional Corporation, San
Francisco, California. McKee Nelson, LLP, Washington, D.C. will act as counsel
for the underwriters, unless otherwise specified in the related Prospectus
Supplement.
73
INDEX OF CERTAIN DEFINITIONS
Set forth below is a list of certain terms used in this Prospectus,
together with the pages on which the terms are defined herein.
Advance..................................................... 45
Agency Securities........................................... 26
Assumed Reinvestment Rate................................... 16
Available Funds............................................. 15
Balloon payments............................................ 23
Bankruptcy Bond............................................. 38
Basic Principal Payment..................................... 15
Belgian Cooperative......................................... 20
Beneficial owner............................................ 19
Bond Account................................................ 41
Bond Distribution Amount.................................... 5
Bond Insurance Policy....................................... 38
Bond Insurer................................................ 38
Bond Owners................................................. 19
Bond Trustee................................................ 10
Bond Value.................................................. 15
Bond Values................................................. 15
Bondholders................................................. 11
Bonds....................................................... 14
Book-Entry Bonds............................................ 19
Buydown Fund................................................ 24
Buydown Loans............................................... 24
Capitalized Interest Account................................ 34
CEDEL Participants.......................................... 20
CERCLA...................................................... 55
Certificates................................................ 26
Closing Date................................................ 33
Code........................................................ 10
Collateral.................................................. 22
Collateral Group............................................ 16
Commission.................................................. 2
Company..................................................... 10
Controlling Class........................................... 47
Conventional Loans.......................................... 17
Cooperative Loans........................................... 25
Cooperatives................................................ 25
Custodial Account........................................... 41
Cut-off Date................................................ 36
DB&Ls....................................................... 63
Deferred Interest Bonds..................................... 14
Definitive Bond............................................. 19
Depositor................................................... 10
Detailed Description........................................ 22
Distribution Account........................................ 32
Distribution Account Deposit Date........................... 32
74
DTC......................................................... 19
Due Period.................................................. 15
Eligible Substitute Pledged Mortgage........................ 26
EPA......................................................... 55
ERISA....................................................... 71
Euroclear Operator.......................................... 20
Euroclear Participants...................................... 20
European Depositaries....................................... 19
Event of Default............................................ 48
FASIT....................................................... 64
FHA Loans................................................... 26
FHLMC....................................................... 12
FHLMC Act................................................... 29
FHLMC Certificates.......................................... 26
Financial Intermediary...................................... 19
Fixed Rate Pledged Mortgages................................ 23
Floating Rate Bonds......................................... 15
Floating Rate Pledged Mortgages............................. 23
FNMA........................................................ 12
FNMA Certificates........................................... 26
Foreign Person Certification................................ 69
Funding Period.............................................. 33
Garn-St Germain Act......................................... 56
GNMA........................................................ 26
GNMA Certificates........................................... 26
GNMA I Certificate.......................................... 26
GNMA II Certificate......................................... 26
GNMA Issuer................................................. 26
Guaranteed Mortgage Pass-Through Certificates............... 26
Guaranty Agreement.......................................... 27
Housing Act................................................. 26
Indenture................................................... 10
Insurance Proceeds.......................................... 22
IRS......................................................... 59
Issuer...................................................... 10
L/C Bank.................................................... 39
L/C Percentage.............................................. 39
Labor....................................................... 71
Liquidated Mortgage......................................... 44
Liquidation Proceeds........................................ 22
Lockout periods............................................. 24
Lower Tier Remic............................................ 63
Master Servicer............................................. 40
Master Servicing Agreement.................................. 40
Master Servicing Fee........................................ 44
Moody's..................................................... 33
Morgan...................................................... 20
Mortgage Collateral......................................... 22
Mortgage Insurer............................................ 23
75
Mortgage Loans.............................................. 23
Mortgage Note............................................... 23
Mortgage Pool Insurance Policy.............................. 36
Mortgage Rate............................................... 23
Mortgaged Property.......................................... 23
Mortgagor................................................... 13
NCUA........................................................ 70
New Withholding Regulations................................. 69
Non-Remic Bonds............................................. 58
Non-U.S. Person............................................. 69
Offered Bonds............................................... 3
OID Regulations............................................. 59
Owner Trustee............................................... 10
Parties in interest......................................... 71
Payment Date................................................ 14
Permitted Investments....................................... 32
Plan Asset Regulation....................................... 71
Plans....................................................... 71
Pledged Mortgages........................................... 23
PMBS Agreement.............................................. 31
PMBS Issuer................................................. 31
PMBS Servicer............................................... 31
PMBS Trustee................................................ 31
Policy Statement............................................ 70
Pool Insurer................................................ 36
Pre-Funded Amount........................................... 33
Pre-Funding Account......................................... 33
Primary Mortgage Insurance Policy........................... 23
Private Mortgage-Backed Securities.......................... 22
PTCE........................................................ 72
Purchase Price.............................................. 14
Rating Agency............................................... 72
RCRA........................................................ 56
Record Date................................................. 14
Redwood Trust............................................... 10
Regular Interest Bonds...................................... 63
REIT........................................................ 63
Relevant Depositary......................................... 19
Relief Act.................................................. 57
Remic....................................................... 58
Remittance Date............................................. 23
Reserve Fund................................................ 35
Residual Interest Bonds..................................... 63
Residual Interest Certificates.............................. 63
Rules....................................................... 19
SEC......................................................... 2
Securities Act.............................................. 30
Seller...................................................... 11
Senior Bondholders.......................................... 35
76
Senior Bonds................................................ 35
Senior Liens................................................ 24
Servicer.................................................... 40
Servicers................................................... 25
Servicing Agreement......................................... 40
Servicing Default........................................... 47
SMMEA....................................................... 70
Special Hazard Insurance Policy............................. 37
Special Hazard Insurer...................................... 37
Special Servicer............................................ 46
Special Servicing Agreement................................. 46
Spread...................................................... 15
Stand-by Master Servicer.................................... 46
Subordinated Bondholders.................................... 35
Subordinated Bonds.......................................... 35
Subsequent Mortgage Collateral.............................. 33
Substitute Collateral....................................... 32
Successor Master Servicer................................... 46
Tax Prepayment Assumption................................... 60
Terms and Conditions........................................ 20
TIN......................................................... 69
Title V..................................................... 57
UCC......................................................... 54
Upper Tier REMIC............................................ 63
VA Loans.................................................... 26
77
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
YOU SHOULD RELY ON THE INFORMATION CONTAINED OR INCORPORATED BY REFERENCE
IN THIS PROSPECTUS SUPPLEMENT AND THE ACCOMPANYING PROSPECTUS. WE HAVE NOT
AUTHORIZED ANYONE TO PROVIDE YOU WITH ANY OTHER INFORMATION OR TO MAKE ANY
REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS SUPPLEMENT AND THE PROSPECTUS.
THIS PROSPECTUS SUPPLEMENT AND THE PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO
SELL, OR A SOLICITATION OF AN OFFER TO BUY, THE SECURITIES OFFERED HEREBY BY
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. WE REPRESENT THE ACCURACY OF THE INFORMATION IN THIS
PROSPECTUS SUPPLEMENT AND THE ACCOMPANYING PROSPECTUS ONLY AS OF THE DATES ON
THEIR RESPECTIVE COVERS.
$510,047,100 (APPROXIMATE)
SEQUOIA MORTGAGE TRUST 5
COLLATERALIZED MORTGAGE BONDS
SEQUOIA MORTGAGE FUNDING CORPORATION
DEPOSITOR
REDWOOD TRUST, INC.
SELLER
-------------------------------------------
PROSPECTUS SUPPLEMENT
-------------------------------------------
GREENWICH CAPITAL MARKETS, INC. BEAR, STEARNS & CO. INC.
October 29, 2001
Dealers will be required to deliver a prospectus supplement and prospectus
when acting as underwriters of the bonds offered hereby and with respect to
their unsold allotments or subscriptions. In addition, all dealers selling the
bonds, whether or not participating in this offering, may be required to deliver
a prospectus supplement and prospectus until ninety days after the date of this
prospectus supplement.
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------