-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, D6HkpmwjE5WdZomLQEpnt6JaScsuMtfGPBdbOsgs2TpCvEjEAB1KAuivBMWuZ9Cx v9uiOtOYw36vdSqnokDUzg== 0000950116-03-003984.txt : 20030929 0000950116-03-003984.hdr.sgml : 20030929 20030929170625 ACCESSION NUMBER: 0000950116-03-003984 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 17 CONFORMED PERIOD OF REPORT: 20030630 FILED AS OF DATE: 20030929 FILER: COMPANY DATA: COMPANY CONFORMED NAME: AMERICAN BUSINESS FINANCIAL SERVICES INC /DE/ CENTRAL INDEX KEY: 0000772349 STANDARD INDUSTRIAL CLASSIFICATION: MORTGAGE BANKERS & LOAN CORRESPONDENTS [6162] IRS NUMBER: 870418807 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-14268 FILM NUMBER: 03915581 BUSINESS ADDRESS: STREET 1: THE WANAMAKER BLDG STREET 2: 100 PENN SQUARE EAST CITY: PHILADELPHIA STATE: PA ZIP: 19107 BUSINESS PHONE: 2159404000 MAIL ADDRESS: STREET 1: THE WANAMAKER BLDG STREET 2: 100 PENN SQUARE EAST CITY: PHILADELPHIA STATE: PA ZIP: 19107 FORMER COMPANY: FORMER CONFORMED NAME: GERIACO INTERNATIONAL INC /DE/ DATE OF NAME CHANGE: 19930308 FORMER COMPANY: FORMER CONFORMED NAME: KINGSWAY ENTERPRISES INC DATE OF NAME CHANGE: 19860327 10-K 1 tenk.txt TENK.TXT UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-K (Mark One) [ X ] Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended June 30, 2003 [ ] Transition report under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from _______________ to ________________ Commission File No. 000-22474 AMERICAN BUSINESS FINANCIAL SERVICES, INC. - -------------------------------------------------------------------------------- (Name of registrant as specified in its charter) Delaware 87-0418807 ------------------------------- ----------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 100 Penn Square East, Philadelphia, PA 19107 --------------------------------------------------- (Address of principal executive offices) (zip code) (215) 940-4000 ---------------------------------------------------- (Registrant's telephone number, including area code) 111 Presidential Boulevard, Bala Cynwyd, PA 19004 ------------------------------------------------------------- (Former name or former address, if changed since last report) Securities registered under Section 12(b) of the Exchange Act: None Securities registered under Section 12(g) of the Exchange Act: Common Stock, par value $.001 per share ---------------- (Title of Class) Indicate by check mark whether the Registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] YES [ ] NO Indicate by check mark if disclosure of delinquent filers in response to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or amendment to this Form 10-K. [ X ] Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). [X] YES [ ] NO The aggregate market value of the Registrant's common stock, $.001 par value per share, held by non-affiliates of the Registrant based on the price at which the common stock last sold as of June 30, 2003 was $8.4 million. The number of shares outstanding of the Registrant's sole class of common stock as of September 23, 2003 was 2,946,892 shares. DOCUMENTS INCORPORATED BY REFERENCE: Part III - Proxy Statement for 2003 Annual Meeting of Stockholders PART I Item 1. Business Forward Looking Statements Some of the information in this Annual Report on Form 10-K may contain forward-looking statements. You can identify these statements by words or phrases such as "will likely result," "may," "are expected to," "will continue to," "is anticipated," "estimate," "believe," "projected," "intends to" or other similar words. These forward-looking statements regarding our business and prospects are based upon numerous assumptions about future conditions, which may ultimately prove to be inaccurate. Actual events and results may materially differ from anticipated results described in those statements. Forward-looking statements involve risks and uncertainties described under "Risk Factors" as well as other portions of this Annual Report on Form 10-K, which could cause our actual results to differ materially from historical earnings and those presently anticipated. When considering forward-looking statements, you should keep these risk factors in mind as well as the other cautionary statements in this Form 10-K. You should not place undue reliance on any forward-looking statement. General We are a diversified financial services organization operating predominantly in the eastern and central portions of the United States. Through our principal direct and indirect subsidiaries, we originate, sell and service fixed interest rate: o mortgage loans, secured by first and second mortgages on one-to-four family residences, which may not satisfy the eligibility requirements of Fannie Mae, Freddie Mac or similar buyers and which we refer to in this document as home equity loans; and o loans to businesses, secured by real estate and other business assets, which we refer to in this document as business purpose loans. We also process and purchase home equity loans through our Bank Alliance Services program. Through this program, we purchase home equity loans from financial institutions and hold them as available for sale until they are sold in connection with a future securitization or whole loan sale. See "Lending Activities -- Home Equity Loans." Our customers are primarily credit-impaired borrowers who are generally unable to obtain financing from banks or savings and loan associations and who are attracted to our products and services. We originate loans through a combination of channels including a national processing center located at our centralized operating office in Philadelphia, Pennsylvania and a regional processing center in Roseland, New Jersey. Our centralized operating office was located in Bala Cynwyd, Pennsylvania prior to July 7, 2003. Prior to June 30, 2003 we also originated home equity loans through several retail branch offices. 1 Effective June 30, 2003, we no longer originate loans through retail branch offices. Our loan servicing and collection activities are performed at our Bala Cynwyd, Pennsylvania office, but are expected to relocate to our Philadelphia, Pennsylvania office. We sell substantially all of the loans we originate on a quarterly basis through a combination of securitizations and the sale of loans with servicing released, which we refer to as whole loan sales. When we securitize loans, we retain interests in the securitized loans in the form of interest-only strips and servicing rights, which we refer to as our securitization assets. In addition, we offer subordinated debt securities to the public, the proceeds of which are used for repayment of existing debt, loan originations, our operations (including repurchases of delinquent assets from securitization trusts), investments in systems and technology and for general corporate purposes. Recent Developments Fiscal 2003 Loss of $29.9 Million. In fiscal 2003, we recorded a net loss of $29.9 million. The loss was primarily due to our inability to complete our typical quarterly securitization of loans during the fourth quarter of our fiscal year and to $45.2 million of pre-tax charges for net valuation adjustments on our securitization assets charged to the income statement, compared to $22.1 million of net valuation adjustments in fiscal 2002. Our business strategy requires the sale of substantially all of the loans we originate at least on a quarterly basis through a combination of securitizations and whole loan sales. From 1995 until the fourth quarter of fiscal 2003, we had elected to utilize securitization transactions extensively due to the favorable conditions we had experienced in the securitization markets and the higher gains recorded on securitizations through the application of gain-on-sale accounting versus the gain realized on whole loan sales. During fiscal 2003, we charged to the income statement total pre-tax valuation adjustments on our interest-only strips and servicing rights, which we refer to as securitization assets, of $63.1 million, which primarily reflect the impact of higher than anticipated prepayments on securitized loans experienced in fiscal 2003 due to the low interest rate environment experienced during fiscal 2003. The pre-tax valuation adjustments charged to the income statement were partially offset by $17.9 million due to the impact of a decrease in the discount rates used to value our securitization assets, resulting in the $45.2 million of pre-tax charges for net valuation adjustments charged to the income statement. We reduced the discount rates on our interest-only strips and our servicing rights primarily to reflect the impact of the sustained decline in market interest rates. The discount rate on the projected residual cash flows from our interest-only strips was reduced from 13% to 11% at June 30, 2003. The discount rate used to determine the fair value of the overcollateralization portion of the cash flows from our interest-only strips was minimally impacted by the decline in interest rates and remained at 7% on average. As a result, the blended rate used to value our interest-only strips, including the overcollateralization cash flows, was 9% at June 30, 2003. The discount rate on our servicing rights was reduced from 11% to 9% at June 30, 2003. Our inability to complete our typical publicly underwritten securitization during the fourth quarter of fiscal 2003 was the result of our investment bankers' decision in late June not to underwrite the contemplated June 2003 securitization transaction. Management believes that a number of factors contributed to this decision, including a highly-publicized lawsuit finding liability of an underwriter in connection with the securitization of loans for another unaffiliated subprime lender, an inquiry by the U.S. Attorney's Office in Philadelphia regarding our forbearance practices, an anonymous letter regarding the Company received by our investment bankers, the SEC's recent enforcement action against another unaffiliated subprime lender related to its loan restructuring practices and related disclosure, a federal regulatory agency investigation of practices by another subprime servicer and our investment bankers' prior experience with securitization transactions with non-affiliated originators. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Short-Term Liquidity and Remedial Steps Taken. Because we have historically experienced negative cash flows from operations, our business requires continual access to short and long-term sources of debt to generate the cash required to fund our operations. Our short term liquidity was negatively impacted by several recent events. Our inability to complete our typical publicly underwritten securitization during the fourth quarter of fiscal 2003 contributed to our loss for fiscal 2003 and adversely impacted our short-term liquidity position. In addition, further advances under a non-committed portion of one of our credit facilities were subject to the discretion of the lender and subsequent to June 30, 2003, there were no new advances under the non-committed portion. Additionally, on August 20, 2003, this credit facility was amended and, among other changes, the non-committed portion was eliminated. We also had a 2 $300.0 million mortgage conduit facility with a financial institution that enabled us to sell our loans into an off-balance sheet facility, which expired pursuant to its terms on July 5, 2003. At June 30, 2003, of the $516.1 million in revolving credit and conduit facilities available to us, $453.4 million was drawn upon. At September 19, 2003, of the $117.0 million in revolving credit facilities available to us, $102.3 million was drawn upon. Our revolving credit facilities and mortgage conduit facility had $62.7 million of unused capacity available at June 30, 2003 (and $14.7 million of unused capacity at September 19, 2003), which significantly reduced our ability to fund future loan originations until we sell existing loans, extend or expand existing credit facilities, or add new credit facilities. In addition, we have temporarily discontinued sales of new subordinated debt, which further impaired our liquidity. As a result of these liquidity issues, since June 30, 2003, we substantially reduced our loan origination volume. From July 1, 2003 through August 31, 2003, we originated $85.7 million of loans which represents a significant reduction as compared to originations of $245.8 million of loans for the same period in fiscal 2003. Our inability to originate loans at previous levels may adversely impact the relationships our subsidiaries have or are developing with their brokers and our ability to retain employees. As a result of the decrease in loan originations and liquidity issues described above, we anticipate incurring a loss for the first quarter of fiscal 2004. The amount of the loss will depend, in part, upon our ability to complete a securitization prior to September 30, 2003 and, if completed, the size and terms of the securitization. Further, we can provide no assurances that we will be able to sell our loans, extend existing facilities or expand or add new credit facilities. If we are unable to obtain additional financing, we may not be able to restructure our business to permit profitable operations or repay our subordinated debt when due. Even if we are able to obtain adequate financing, our inability to securitize our loans could hinder our ability to operate profitably in the future and repay our subordinated debt when due. We undertook specific remedial actions to address short-term liquidity concerns including entering into an agreement on June 30, 2003 with an investment bank to sell up to $700.0 million of mortgage loans, subject to the satisfactory completion of the purchaser's due diligence review and other conditions, and soliciting bids and commitments from other participants in the whole loan sale market. In total, from June 30, 2003 through September 17, 2003, we sold approximately $482.9 million (which includes $221.9 million of loans sold by the expired mortgage conduit facility) of loans through whole loan sales. We are continuing the process of selling our loans. We also suspended paying quarterly cash dividends on our common stock. On September 22, 2003, we entered into definitive agreements with a financial institution for a new $200.0 million credit facility for the purpose of funding our loan originations. Pursuant to the terms of this facility, we are required to, among other things: (i) obtain a written commitment for another credit facility of at least $200.0 million and close that additional facility by October 3, 2003 (which condition would be satisfied by the closing of the $225.0 million facility described below); (ii) have a net worth of at least $28.0 million by September 30, 2003; with quarterly increases of $2.0 million thereafter; (iii) apply 60% of our net cash flow from operations each quarter to reduce the outstanding amount of subordinated debt commencing with the quarter ending March 31, 2004, and (iv) provide a parent company guaranty of 10% of the outstanding principal amount of loans under the facility. Prior to the closing of the second facility, our borrowing capacity on this $200.0 million credit facility is limited to $80.0 million. This facility has a term of 12 months expiring in September 2004 and is secured by the mortgage loans which are funded by advances under the facility with interest equal to LIBOR plus a margin. This facility is subject to representations and warranties and covenants, which are customary for a facility of this type, as well as amortization events and events of default related to our financial condition. These provisions require, among other things, our maintenance of a delinquency ratio for the managed portfolio (which represents the portfolio of securitized loans and leases we service for others) at the end of each fiscal quarter of less than 12.0%, our subordinated debt not to exceed $705.0 million at any time, our ownership of an amount of repurchased loans not to exceed 1.5% of the managed portfolio and our registration statement registering $295.0 million of subordinated debt be declared effective by the SEC no later than October 31, 2003. 3 On September 22, 2003, we executed a commitment letter for a mortgage warehouse credit facility with a warehouse lender, which consists of a senior secured revolving credit facility of up to $225.0 million and a secured last out revolver facility up to $25.0 million to fund loan originations. The commitment letter is subject to certain conditions, including, among other things: (i) entering into definitive agreements, except as provided in the commitment letter; (ii) the absence of a material adverse change in the business, operations, property, condition (financial or otherwise) or prospects of us or our affiliates; and (iii) our receipt of another credit facility in an amount not less than $200.0 million, subject to terms and conditions acceptable to this lender (which condition is satisfied by the new $200.0 million facility described above). The commitment letter provides that these facilities will have a term of three years with an interest rate on amounts outstanding under the $225.0 million portion of the credit facility equal to the greater of one-month LIBOR plus a margin or the difference between the yield maintenance fee (as defined in the commitment letter) and the one-month LIBOR plus a margin. Advances under this facility would be collateralized by substantially all of our present and future assets including pledged loans and a security interest in substantially all of our interest-only strips and residual interests which will be contributed to a special purpose entity organized by us to facilitate this transaction. We also agreed to pay fees of approximately $14.6 million annually plus a nonusage fee based on the difference between the average daily outstanding balance for the current month and the maximum credit amount under the facility and the lender's out-of-pocket expenses. We anticipate that these facilities will be subject to representations and warranties, events of default and covenants which are customary for facilities of this type, as well as our agreement to: (i) maintain sales or renewals of our subordinated debt securities of $10.0 million per month; (ii) restrict total principal and interest outstanding on our subordinated debt to $750.0 million or less; (iii) make quarterly reductions commencing in April 2004 of an amount of subordinated debt outstanding to be determined; (iv) maintain maximum interest rates payable on subordinated debt securities not to exceed 10 percentage points above comparable rates for FDIC insured products; and (v) the lender's receipt of our audited financial statements for the period ended June 30, 2003. The definitive agreements will grant the lender an option at any time after the first anniversary of entering into definitive agreements to increase the credit amount on the $250.0 million facility to $400.0 million with additional fees payable by us plus additional interest as may be required by the institutions or investors providing the lender with these additional funds. The commitment letter requires that we enter into definitive agreements not later than October 17, 2003. While we anticipate that we will close this transaction prior to such date, we cannot assure you that these negotiations will result in definitive agreements or that such agreements, as negotiated, will be on terms and conditions acceptable to us. In the event we are unable to close these facilities or another facility within the time frame provided under the new $200.0 million credit facility described above, the lender on that facility would be under no obligation to make further advances under the terms of that facility and outstanding advances would have to be repaid over a period of time. During the first quarter of fiscal 2004, we explored a number of strategic alternatives to address these liquidity issues in the event we are unable to borrow under the new $200.0 million credit facility, close the $250.0 million credit facilities or obtain alternative financing. In the event we were unable to obtain the additional credit facilities necessary to operate our business, we developed a contingent business plan (described more fully under "Business Strategy Adjustments") which contemplates, among other things, the sale of $100 million principal amount of additional subordinated debt through March 2004 and the renewal of approximately 50% of outstanding subordinated debt upon maturity. We believe that this contingent business plan addresses our liquidity issues and may permit us to restructure our operations, if necessary, without the receipt of an expanded or additional credit facility. There can be no assurance that our contingent business plan will be successful or that it will enable us to repay our subordinated debt when due. 4 To the extent that we are not successful in maintaining, replacing or obtaining alternative financing sources on acceptable terms, we may have to limit our loan originations, sell loans earlier than intended and further restructure our operations. Limiting our originations or earlier than intended sales of our loans could reduce our profitability or result in losses and restrict our ability to repay our subordinated debt upon maturity. While we currently believe that we would be able to restructure our operations, if necessary, we cannot assure you that such restructuring will enable us to attain profitable operations or repay the subordinated debt when due. See "Risk Factors - -- We depend upon the availability of financing to fund our continuing operations. Any failure to obtain adequate funding could hurt our ability to operate profitably and restrict our ability to repay our subordinated debt and negatively impact the value of our common stock," and "-- If we are unable to obtain additional financing, we may be not able to restructure our business to permit profitable operations or repay our subordinated debt when due, which would negatively impact the value of our common stock." Credit Facilities and Waivers Related to Financial Covenants. We borrow against various warehouse credit facilities as the primary funding source for our loan originations. The sale of our loans through a securitization or whole loan sale generates the cash proceeds necessary to repay the borrowings under the warehouse facilities. In addition, we have the availability of revolving credit facilities, which we may use to fund our operations. Each credit agreement requires that we comply with specific financial covenants and has multiple individualized financial covenant thresholds and ratio limits that we must meet as a condition to drawing on that particular facility. Pursuant to the terms of these credit facilities, the failure to comply with the financial covenants constitutes an event of default and the lender may, at its option, take certain actions including: terminate commitments to make future advances to us, declare all or a portion of the loan due and payable, foreclose on the collateral securing the loan, require servicing payments be made to the lender, or other third party, or assume the servicing of the loans securing the credit facility. An event of default under these credit facilities could result in defaults pursuant to cross-default provisions of our other agreements, including our other loan agreements and lease agreements. The failure to comply with the terms of these credit facilities or to obtain the necessary waivers from the lenders related to any default would have a material adverse effect on our liquidity and capital resources, could result in us not having sufficient cash to repay our indebtedness, require us to restructure our operations and may force us to sell assets on less than optimal terms and conditions. As a result of the loss experienced during fiscal 2003, we were not in compliance with the terms of certain of the financial covenants under two of our principal credit facilities (one for $50.0 million and the other for $200.0 million, of which $100.0 million was non-committed) and we requested and obtained waivers of these requirements from our lenders. The lender under the $50.0 million warehouse credit facility has granted us a waiver for our non-compliance with a financial covenant in that credit facility through September 30, 2003. This facility was amended to reduce the available credit to $8.0 million and the financial covenants were replaced with new covenants with which we are currently in compliance. We also entered into an amendment to the $200.0 million credit facility which provides for the waiver of our non-compliance with the financial covenants in that facility, the reduction of the committed portion of this facility from $100.0 million to $50.0 million, the elimination of the $100.0 million non-committed portion of this credit facility and the acceleration of the termination date of this facility from November 2003 to September 30, 2003. Our ability to repay this facility upon termination is dependent on our ability to refinance the loans in one of our new facilities or our sale of loans currently warehoused in the terminating facility by September 30, 2003. In addition, if the anticipated loss for the first quarter of fiscal 2004 described above results in our non-compliance with any financial covenants, we intend to seek the appropriate waivers. There can be no assurances that we will obtain any of these waivers. 5 Business Strategy Adjustments. Our business strategy requires the sale of substantially all of the loans we originate at least on a quarterly basis through a combination of securitizations and the sale of loans with servicing released, which we refer to as whole loan sales. Our determination as to whether to dispose of loans through securitizations or whole loan sales depends on a variety of factors including market conditions, profitability and cash flow considerations. From 1995 until the fourth quarter of fiscal 2003, we had elected to utilize securitization transactions extensively due to the favorable conditions we had experienced in the securitization markets. During fiscal 2003, 2002, and 2001, we securitized $1.42 billion, $1.35 billion, and $1.1 billion of loans, respectively. During the same periods, we sold $28.3 million, $57.7 million, and $76.3 million of loans, respectively, through whole loan sales. Under generally accepted accounting principles, we are permitted to record the gain on the sale of these securitized loans utilizing an accounting method referred to as "gain-on-sale" accounting. This accounting method permits us to record a non-cash gain based upon the estimated value of securitization assets generated in connection with the securitization of our loans even though only a small portion of the gain is received in cash during the period the gain is recorded. We are then required to reevaluate these assets quarterly and make adjustments based upon changes in the fair value of these assets. After we recognized our inability to securitize our assets in the fourth quarter of fiscal 2003, we adjusted our business strategy to emphasize more whole loan sales. We intend to continue to evaluate both public and privately placed securitization transactions, subject to market conditions. We generally realized higher gain on sale in our securitization transactions than on whole loan sales for cash. Although the gain on whole loan sales is generally significantly lower than gains realized in securitization transactions, we receive the gain in cash immediately and generally receive more cash immediately in a whole loan sale transaction than from securitizations of an equal principal amount of loans. As a result of the emphasis on whole loan sales in late June and July 2003, at July 31, 2003, our cash position was consistent with our projected cash position, which assumed the completion of a fourth quarter securitization. The use of whole loan sales will enable us to immediately generate cash flow, protect against volatility in the securitization markets and reduce risks inherent in retaining securitization assets. However, unlike securitizations, where we retain the right to service the loans for a fee, which we refer to as servicing rights, and receive securitization assets in the form of interest-only strips which generate future cash flows, whole loan sales are typically structured as a sale with servicing rights released and do not result in our receipt of securitization assets. As a result, using whole loan sales more extensively in the future will reduce our income from servicing activities and limit the amount of securitization assets created. We believe that our adjustments to our business strategy focus on a more diversified strategy of selling our loans, while protecting revenues, controlling costs and improving liquidity. However, if we are unable to generate sufficient liquidity through the sales of our loans, the sale of our subordinated debt, the receipt of new credit facilities or a combination of the foregoing, we will be required to restrict loan originations and make additional changes to our business strategy, including restricting or restructuring our operations which could reduce our profitability or result in losses and impair our ability to repay the subordinated debt. We have historically experienced negative cash flow from operations. To the extent we are unable to successfully implement our adjusted business strategy, which requires access to capital to originate loans and our ability to profitably sell these loans, we would continue to experience negative cash flows from operations which would impair our ability to repay our subordinated debt. See "Risk Factors -- If we are unable to successfully implement our adjusted business strategy which focuses on whole loan sales, we may be unable to attain profitable operations which could impair our ability to repay our subordinated debt and negatively impact the value of our common stock." 6 In the event we are unable to maintain the new $200.0 million credit facility described above, close the $250.0 million credit facilities described above within the required timeframes or obtain other credit facilities, we have developed a contingent business plan which management believes will enable us to repay the subordinated debt when due and continue operations, although with a materially reduced amount of loan originations as compared to historical levels. The major assumptions of our contingent business plan include, but are not limited to, the following: (i) the sale of $100.0 million of subordinated debt over a five month period ending in March 2004; (ii) the renewal of approximately 50% of our outstanding subordinated debt upon maturity; (iii) the securitization of approximately $40.0 million of business purpose loans which are less attractive to purchasers in the secondary loan market; (iv) the sale of substantially all of the home equity loans we originate in whole loan sales in the secondary market with servicing released; and (v) substantial cost reductions in our operations. If we utilize the contingent business plan, we currently anticipate incurring losses through the second quarter of fiscal 2004. Although management believes that the contingent business plan is feasible, there can be no assurance that we will be able to successfully implement it. Civil Subpoena from the U.S. Attorney's Office. We received a civil subpoena, dated May 14, 2003, from the Civil Division of the U.S. Attorney for the Eastern District of Pennsylvania. The subpoena requests that we provide certain documents and information with respect to us and our lending subsidiaries for the period from May 1, 2000 to May 1, 2003: (i) all loan files in which we entered into a forbearance agreement with a borrower who is in default; (ii) the servicing, processing, foreclosing, and handling of delinquent loans and non-performing loans, the carrying, processing and sale of real estate owned, and forbearance agreements; and (iii) agreements to sell or otherwise transfer mortgage loans (including, but not limited to, any pooling or securitization agreements) or to obtain funds to finance the underwriting, origination or provision of mortgage loans, any transaction in which mortgage loans were sold or transferred, any instance in which we were not to service or not to act as custodian for a mortgage loan, representations and warranties made in connection with mortgage loans, secondary market loan sale schedules, and credit loss, delinquency, default, and foreclosure rates of mortgage loans. We have directed our attorneys to cooperate fully with this inquiry. Currently, this inquiry appears to be focused on our practices relating to obtaining forbearance agreements from delinquent borrowers who would otherwise be subject to foreclosure. Because the inquiry is at a preliminary stage, we cannot reach any conclusions about the ultimate scope of the inquiry or the potential liability or financial consequences to us at this time. To the extent management is unsuccessful in resolving this matter, the ongoing review by the U.S. Attorney's Office could limit our ability to engage in publicly underwritten securitization transactions or otherwise sell or service our loans. In addition, the U.S. Attorney's inquiry could reduce sales of subordinated debt upon which we rely to fund our operations and limit our ability to obtain additional credit facilities, which are necessary for the implementation of our business strategy. Furthermore, the U.S. Attorney could impose sanctions or otherwise restrict our ability to restructure loans, which could negatively impact our profitability and our ability to repay the subordinated debt. See "-- Regulation." Delinquencies; Forbearance and Deferment Arrangements. During fiscal 2003, we experienced an increase in the total delinquencies in our total managed portfolio to $229.1 million at June 30, 2003 from $170.8 million and $107.0 million at June 30, 2002 and 2001, respectively. Total delinquencies (loans and leases, excluding real estate owned, with payments past due for more than 30 days) as a percentage of the total managed portfolio were 6.27% at June 30, 2003 compared to 5.57% and 4.13% at June 30, 2002 and 2001, respectively. As the managed portfolio continues to season and if our economy continues to lag or worsen, the delinquency rate may continue to increase, which could negatively impact our ability to sell or securitize loans and reduce our profitability and the funds available to repay our subordinated debt. Continuing low market interest rates could continue to encourage borrowers to refinance their loans and increase the levels of loan prepayments we experience which would negatively impact our delinquency rate. 7 Delinquencies in our total managed portfolio do not include $197.7 million of previously delinquent loans at June 30, 2003, which are subject to deferment and forbearance arrangements. Generally, a loan remains current after we enter into a deferment or forbearance arrangement with the borrower only if the borrower makes the principal and interest payments as required under the terms of the original note (exclusive of the delinquent payments advanced or fees paid by us on the borrower's behalf as part of the deferment or forbearance arrangement) and we do not reflect it as a delinquent loan in our delinquency statistics. However, if the borrower fails to make principal and interest payments, the account will generally be declared in default and collection actions resumed. During the final six months of fiscal 2003, we experienced a pronounced increase in the number of borrowers under deferment arrangements than in prior periods. At June 30, 2003, there was approximately $197.7 million of cumulative unpaid principal balance under deferment and forbearance arrangements as compared to approximately $138.7 million of cumulative unpaid principal balance at June 30, 2002. Total cumulative unpaid principal balances under deferment or forbearance arrangements as a percentage of the total managed portfolio were 5.41% at June 30, 2003 compared to 4.52% at June 30, 2002. Additionally, there are loans under deferment and forbearance arrangements which have returned to delinquent status. At June 30, 2003 there was $28.7 million of cumulative unpaid principal balance under deferment arrangements and $51.5 million of cumulative unpaid principal balance under forbearance arrangements that are now reported as delinquent 31 days or more. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Managed Portfolio Quality -- Deferment and Forbearance Arrangements." 8 Business Strategy The business strategy that we are emphasizing beginning in fiscal 2004 focuses on a shift from gain-on-sale accounting and the use of securitization transactions as our primary method of selling loans to a more diversified strategy which utilizes a combination of whole loan sales and securitizations, while protecting revenues, controlling costs and improving liquidity. Our business strategy includes the following: o Selling substantially all of the loans we originate on a quarterly basis through a combination of securitizations and whole loan sales. Whole loan sales may be completed on a more frequent basis. o Shifting from a predominantly publicly underwritten securitization strategy and gain-on-sale business model to a strategy focused on a combination of whole loan sales and smaller securitization transactions. Quarterly loan securitization levels will be reduced significantly from previous levels. Securitizations for the foreseeable future are expected to be executed as private placements to institutional investors or publicly underwritten securitizations, subject to market conditions. Historically, the market for whole loan sales has provided reliable liquidity for numerous originators as an alternative to securitization. Whole loan sales provide immediate cash premiums to us, while securitizations generate cash over time but generally result in higher gains at the time of sale. We intend to rely less on gain-on-sale accounting and loan servicing activities for our revenue and earnings and will rely more on cash premiums earned on whole loan sales. This strategy is expected to result in relatively lower earnings levels at current loan origination volumes, but will increase cash flow, accelerate the timeframe for becoming cash flow positive and improve our liquidity position. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources" for more detail on cash flow. 9 o Broadening our mortgage loan product line and increasing loan originations. We currently originate primarily fixed-rate loans. Under our business strategy, we plan to originate adjustable-rate and alt-A mortgage loans as well as a wide array of fixed-rate mortgage loans in order to appeal to a broader base of prospective customers and increase loan originations. o Offering competitive interest rates charged to borrowers on new products. By offering competitive interest rates charged on new products, we expect to originate loans with higher credit quality. In addition, by reducing interest rates we expect to appeal to a wider customer base and substantially reduce our marketing costs, make more efficient use of marketing leads and increase loan origination volume. o Reducing origination of the types of loans that are not well received in the whole loan sale and securitization markets. We intend to reduce the level of business purpose loans that we will originate, but we will continue to originate business purpose loans to meet demand in the whole loan sale and securitization markets. o Reducing the cost of loan originations. We have implemented plans to: - Eliminate our high cost origination branches. - Reduce the cost to originate in Upland Mortgage by among other things: a) broadening the product line and offering competitive interest rates in order to increase origination volume, b) reducing marketing costs, and c) developing broker relationships. - Reduce the cost to originate in American Business Mortgage Services by increasing volume through a broadening of the mortgage loan product line. - Reduce the cost to originate in the Bank Alliance Services program by broadening our product line and increasing the amount of fees we charge to participating financial institutions. o Reducing the amount of outstanding subordinated debt. The increase in cash flow expected under our business strategy is expected to accelerate a reduction in our reliance on issuing subordinated debt to meet our liquidity needs and allow us to begin to pay down existing subordinated debt. o Reducing operating costs. Since June 30, 2003, we reduced our workforce by 170 employees. With our shift in focus to whole loan sales with servicing released and offering a broader mortgage product line that we expect will appeal to a wider array of customers, we currently require a smaller employee base with fewer sales, servicing and support positions. These workforce reductions represent more than a 15% decrease in staffing levels. Our business strategy is expected to leverage our demonstrated strengths which include: o A strong credit culture which consistently originates quality performing loans. Our delinquency rates are among the lowest in the subprime industry. 10 o Long-term broker relationships at American Business Mortgage Services. o Upland Mortgage brand identity. o Relationships with participating financial institutions in the Bank Alliance Services program. o Institutional investors' interest in the bonds issued in our securitizations. Our business strategy is dependent on our ability to emphasize lending related activities that provide us with the most economic value. The implementation of this strategy will depend in large part on a variety of factors outside of our control, including, but not limited to, our ability to obtain adequate financing on favorable terms and to profitably securitize or sell our loans on a regular basis. Our failure with respect to any of these factors could impair our ability to successfully implement our strategy, which could adversely affect our results of operations and financial condition. See "Risk Factors -- If we are unable to continue to successfully implement our adjusted business strategy, which focuses on whole loan sales, we may be unable to attain profitable operations which could impair our ability to repay our subordinated debt and negatively impact the value of our common stock." The Company We were incorporated in Delaware in 1985 and began operations as a finance company in 1988, initially offering business purpose loans to customers whose borrowing needs we believed were not being adequately serviced by commercial banks. Since our inception, we have significantly expanded our product line and geographic scope and currently have licenses, or are in the process of becoming licensed, to offer our home equity loan products in 44 states. Our principal corporate office in Delaware is located at 103 Springer Building, 3411 Silverside Road, Wilmington, Delaware 19810. The telephone number at that address is (302) 478-6160. Our principal operating office is located at 100 Penn Square East, Philadelphia, Pennsylvania 19107. The telephone number at our principal operating office is (215) 940-4000. We maintain a site on the World Wide Web at www.abfsonline.com as well as web sites for most of our primary subsidiary companies. We file annual, quarterly and current reports, proxy statements and other information with the SEC. You may read and copy our reports or other filings made with the SEC at the SEC's Public Reference Room, located at 450 Fifth Street, N.W., Washington, DC 20549. You can obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. You can also access these reports and other filings electronically on the SEC's web site, www.sec.gov. We also make these reports and other filings available free of charge on our web site, www.abfsonline.com, as soon as reasonably practicable after filing with the SEC. We will provide, at no cost, paper or electronic copies of our reports and other filings made with the SEC. Requests should be directed to: 11 Stephen M. Giroux, Esquire American Business Financial Services, Inc. 100 Penn Square East Philadelphia, PA 19107 (215) 940-4000 The information on the web sites listed above, is not and should not be considered part of this Annual Report on Form 10-K and is not incorporated by reference in this document. These web sites are and are only intended to be inactive textual references. Subsidiaries As a holding company, our activities have been limited to: (1) holding the shares of our subsidiaries, and (2) raising capital for use in the subsidiaries' lending and loan servicing operations. We are the parent holding company of American Business Credit, Inc. and its primary subsidiaries, HomeAmerican Credit, Inc. (doing business as Upland Mortgage), American Business Mortgage Services, Inc., and Tiger Relocation Company. American Business Credit, Inc., a Pennsylvania corporation incorporated in 1988 and acquired by us in 1993, originates, sells and services business purpose loans and services home equity loans. HomeAmerican Credit, Inc., a Pennsylvania corporation incorporated in 1991, originates, purchases and sells home equity loans. HomeAmerican Credit acquired Upland Mortgage Corp in 1996 and since that time has conducted business as "Upland Mortgage." HomeAmerican Credit also administers the Bank Alliance Services program. American Business Mortgage Services, Inc., a New Jersey corporation organized in 1938 and acquired by us in October 1997, is currently engaged in the origination and sale of home equity loans. 12 Tiger Relocation Company, a Pennsylvania corporation, was incorporated in 1992 to hold, maintain and sell real estate properties acquired due to the default of a borrower under the terms of our loan documents. We also have numerous special purpose subsidiaries that were incorporated solely to facilitate our securitizations and off-balance sheet mortgage conduit facility. None of these corporations engage in any business activity other than holding the subordinated certificate, if any, and the interest-only strips created in connection with completed securitizations. See "-- Securitizations" and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Securitizations." We also utilize special purpose subsidiaries in connection with our financing activities, including credit facilities. We also have several additional subsidiaries that are inactive or not significant to our operations. 13 The following chart sets forth our basic organizational structure and our primary subsidiaries.(a) ------------------------------------ AMERICAN BUSINESS FINANCIAL SERVICES, INC. ------------------------------------ Holding company Issues subordinated debt securities ----------------|------------------- | | ----------------|------------------- AMERICAN BUSINESS CREDIT, INC. ------------------------------------ Originates, sells and services business purpose loans and services home equity loans ----------------|------------------- | |-----------------------------|------------------------| | | | - --------|------------ -------------|------------- -------|-------- AMERICAN HOMEAMERICAN TIGER BUSINESS CREDIT, INC. RELOCATION MORTGAGE D/B/A COMPANY SERVICES, INC. UPLAND MORTGAGE - --------------------- --------------------------- --------------- Originates, Originates, Holds purchases, sells purchases, sells and foreclosed real and services services home estate home equity equity loans and loans administers the Bank Alliance Services program - --------------------- --------------------------- --------------- _____________________ (a) In addition to the corporations pictured in this chart, we organized at least one special purpose corporation for each securitization and have several other subsidiaries that are inactive or not significant to our operations. 14 Lending Activities General. The following table sets forth information concerning our loan origination, purchase and sale activities for the periods indicated.
Year Ended June 30, ------------------------------------- 2003 2002 2001 ------------------------------------- (dollars in thousands) Loans Originated/Purchased Business purpose loans........................... $ 122,790 $ 133,352 $ 120,537 Home equity loans................................ $1,543,730 $1,246,505 $1,096,440 Number of Loans Originated/Purchased Business purpose loans........................... 1,340 1,372 1,318 Home equity loans................................ 17,003 14,015 13,443 Average Loan Size Business purpose loans........................... $ 92 $ 97 $ 91 Home equity loans................................ $ 91 $ 89 $ 82 Weighted-Average Interest Rate on Loans Originated/Purchased Business purpose loans........................... 15.76% 15.75% 15.99% Home equity loans................................ 9.99% 10.91% 11.46% Combined......................................... 10.42% 11.38% 11.91% Weighted-Average Term (in months) Business purpose loans........................... 160 161 163 Home equity loans................................ 272 260 259 Loans Securitized or Sold Business purpose loans........................... $ 112,025 $ 129,074 $ 109,892 Home equity loans................................ $1,339,752 $1,279,740 $1,068,507 Number of Loans Securitized or Sold Business purpose loans........................... 1,195 1,331 1,208 Home equity loans................................ 14,952 14,379 13,031
The following table sets forth information regarding the average loan-to-value ratios for loans we originated and purchased during the periods indicated. Year Ended June 30, --------------------------------------- Loan Type 2003 2002 2001 - -------------------------------------------------------------------------------- Business purpose loans................. 62.2% 62.6% 62.2% Home equity loans...................... 78.2 77.8 78.4 15 The following table shows the geographic distribution of our loan originations and purchases during the periods indicated.
Year Ended June 30, ------------------------------------------------------------------- 2003 2002 2001 ------------------- ------------------- ------------------- Amount % Amount % Amount % ---------- ----- --------- ----- ---------- ----- (dollars in thousands) New York $ 376,425 22.59% $ 341,205 24.73% $ 337,218 27.71% New Jersey 212,035 12.72 159,117 11.53 161,087 13.24 Florida 135,164 8.11 97,686 7.08 89,169 7.33 Massachusetts 134,342 8.06 101,383 7.35 75,958 6.24 Pennsylvania 118,915 7.14 103,865 7.53 102,789 8.44 Michigan 92,009 5.52 89,224 6.47 40,477 3.33 Illinois 90,111 5.41 73,152 5.30 51,904 4.26 Ohio 70,957 4.26 65,884 4.77 66,877 5.50 North Carolina 47,806 2.87 38,060 2.76 34,065 2.80 Virginia 46,508 2.79 33,169 2.40 33,739 2.77 Connecticut 42,525 2.55 30,461 2.21 18,741 1.54 Maryland 36,542 2.19 25,307 1.83 26,632 2.19 Indiana 33,671 2.02 27,833 2.02 21,489 1.76 Other(a) 229,510 13.77 193,511 14.02 156,832 12.89 ---------- ------ ---------- ------ ----------- ------ Total $1,666,520 100.00% $1,379,857 100.00% $ 1,216,977 100.00% ========== ====== ========== ====== =========== ======
____________________________ (a) No individual state included in "Other" constitutes more than 2% of total loan originations for fiscal 2003. Customers. Our loan customers are primarily credit-impaired borrowers who are generally unable to obtain financing from banks or savings and loan associations and who are attracted to our products and services. These institutions have historically provided loans only to individuals with the most favorable credit characteristics. These borrowers generally have impaired or unsubstantiated credit histories and/or unverifiable income. Our experience has indicated that these borrowers are attracted to our loan products as a result of our marketing efforts, the personalized service provided by our staff of highly trained lending officers and our timely response to loan requests. Historically, our customers have been willing to pay our origination fees and interest rates even though they are generally higher than those charged by traditional lending sources. See "-- Business Strategy." Home Equity Loans. We originate home equity loans through Upland Mortgage and American Business Mortgage Services. We also process and purchase loans through the Bank Alliance Services program. We originate home equity loans primarily to credit-impaired borrowers through various channels of retail marketing which include direct mail and our subsidiaries' interactive web sites, and have included radio and television advertisements. We entered the home equity loan market in 1991. Currently, we are licensed or otherwise qualified to originate home equity loans in 44 states and originate home equity loans predominantly in the eastern and central portions of the United States. We generally securitize or sell on a whole loan basis with servicing released, the home equity loans originated and funded by our subsidiaries. The business strategy that we are emphasizing beginning in fiscal 2004 will impact our origination of home equity loans. Our business strategy includes broadening our mortgage loan product line to include adjustable rate and alt-A mortgage loans and competitive interest rates in order to appeal to a broader prospective customer base and increase the amount of loan originations, and 16 reducing our cost to originate loans by expanding our broker network and reducing marketing costs. Our business strategy also focuses on shifting from a predominantly publicly underwritten securitization strategy and gain-on-sale business model to a strategy focused on a combination of whole loan sales and smaller securitization transactions. For a discussion of our business strategy and its potential impact on our home equity loan business see "-- Business Strategy." Home equity loan applications are obtained from potential borrowers over the phone, in writing, in person or through our Internet web site. The loan request is then evaluated for possible loan approval. The loan processing staff generally provides its home equity applicants who qualify for loans with a conditional loan approval within 24 hours and closes its home equity loans within approximately fifteen to twenty days of obtaining a conditional loan approval. Home equity loans generally ranged from $5,000 to $580,000 and had an average loan size of approximately $91,000 for the loans originated during fiscal 2003 and $89,000 during fiscal 2002. We originated $1.5 billion of home equity loans during the fiscal year ended June 30, 2003 and $1.2 billion during the fiscal year ended June 30, 2002. Home equity loans are generally made at fixed rates of interest and for terms ranging from five to thirty years, generally, with average origination fees of approximately 1.5% of the aggregate loan amount. The weighted-average interest rate received on home equity loans during fiscal 2003 was 9.99% and during fiscal 2002 was 10.91%. The average loan-to-value ratio for the loans originated by us during fiscal 2003 was 78.2% and was 77.8% for the loans originated during fiscal 2002. We attempt to maintain our interest and other charges on home equity loans to be competitive with the lending rates of other non-conforming mortgage finance companies. Interest on home equity loans originated subsequent to January 2001 is generally computed based on the scheduled interest method. Prior to January 2001, most of the home equity loans we originated computed interest on the simple interest method. To the extent permitted by law, borrowers are given an option to choose between a loan without a prepayment fee at a higher interest rate, or a loan with a prepayment fee at a lower interest rate. We may waive the collection of a prepayment fee, if any, in the event the borrower refinances a home equity loan with us. We have exclusive business arrangements with several financial institutions which provide for our purchase of home equity loans that meet our underwriting criteria, but do not meet the guidelines of the selling institution for loans to be held in its portfolio. This program is called the Bank Alliance Services program. The Bank Alliance Services program is designed to provide an additional source of home equity loans. This program targets traditional financial institutions, such as banks, which because of their strict underwriting and credit guidelines for loans held in their portfolio have generally provided mortgage financing only to the most credit-worthy borrowers. This program allows these financial institutions to originate loans to credit-impaired borrowers in order to achieve community reinvestment goals and to generate fee income and subsequently sell such loans to one of our subsidiaries. Under the Bank Alliance Services program, we enter into business arrangements with financial institutions which provide for the purchase by our lending subsidiaries of home equity loans which do not meet the underwriting criteria of the financial institutions for home equity loans to be held in the financial institutions' portfolios. Pursuant to the program, a financial institution adopts our underwriting criteria for home equity loans not intended to be held in its portfolio. If an applicant meets our underwriting criteria, as adopted by the program, we process the application materials and underwrite the loan for final approval by the financial institution. If the financial institution approves the loan, we close the loan for the financial institution in its name with funding provided by the financial institution. We purchase the loan from the financial institution shortly after the closing. Following our purchase of the loans through this program, we hold these loans as available for sale until they are sold in connection with a future securitization or whole loan sale. 17 During fiscal 2003 we received referrals from approximately 20 financial institutions participating in this program. These financial institutions provide us with the opportunity to process and purchase loans generated by the branch networks of such institutions, which consist of over 1,700 branches located in various states throughout the country. Pursuant to this program, our subsidiaries purchased approximately $201.9 million of loans during the fiscal year ended June 30, 2003 and $145.9 million during fiscal 2002. In fiscal 2003, our top three financial institutions under the Bank Alliance Services program accounted for approximately 96.1% of our loan volume from this program. We intend to continue to expand the Bank Alliance Services program with financial institutions across the United States. See " -- Business Strategy." During fiscal 1999, we launched an Internet loan distribution channel through Upland Mortgage's web site. Through this interactive web site, borrowers can examine available loan options and calculate monthly principal and interest payments. The Upland Mortgage Internet platform provides borrowers with convenient access to the mortgage loan information 7 days a week, 24 hours a day. Throughout the loan processing period, borrowers who submit applications are supported by our staff of highly trained loan officers. Currently, in addition to the ability to utilize an automated rapid pre-approval process, which we believe reduces time and manual effort required for loan approval, the site features our proprietary software, Easy Loan Advisor, which provides personalized services and solutions to retail customers through interactive web dialog. We have applied to the U.S. Patent and Trademark Office to patent this product. Business Purpose Loans. Through our subsidiary, American Business Credit, we originate business purpose loans predominantly in the eastern and central portions of the United States through a network of salespeople, loan brokers and through our business loan web site. We focus our marketing efforts on small businesses that do not meet all of the credit criteria of commercial banks and small businesses that our research indicates may be predisposed to using our products and services. We originate business purpose loans to corporations, partnerships, sole proprietors and other business entities for various business purposes including, but not limited to, working capital, business expansion, equipment acquisition, tax payments and debt-consolidation. We do not target any particular industries or trade groups and, in fact, take precautions against a concentration of loans in any one industry group. All business purpose loans generally are collateralized by a first or second mortgage lien on a principal residence of the borrower or a guarantor of the borrower or some other parcel of real property, such as office and apartment buildings and mixed use buildings, owned by the borrower, a principal of the borrower, or a guarantor of the borrower. In most cases, these loans are further collateralized by personal guarantees, pledges of securities, assignments of contract rights, life insurance and lease payments and liens on business equipment and other business assets. Prior to the fourth quarter of fiscal 2003, we generally securitized business purpose loans subsequent to their origination. Under our business strategy, we intend to reduce the level of business purpose loans that we will originate, but we will continue to originate business purpose loans to meet demand in the whole loan sale and securitization markets. See "-- Business Strategy." Our business purpose loans generally ranged from $14,000 to $685,000 and had an average loan size of approximately $92,000 for the loans originated 18 during the fiscal year ended June 30, 2003 and $97,000 in fiscal 2002. Generally, our business purpose loans are made at fixed interest rates and for terms ranging from five to fifteen years. We generally charge origination fees for these loans of 4.75% to 5.75% of the original principal balance. The weighted-average interest rate charged on the business purpose loans originated by us was 15.76% for the fiscal year ended June 30, 2003 and 15.75% for fiscal 2002. Business purpose loans we originated during fiscal 2003 had a loan-to-value ratio of 62.2%, based solely upon the real estate collateral securing the loans. Business purpose loans we originated during fiscal 2002 had a loan-to-value ratio, based solely upon the real estate collateral securing the loans, of 62.6%. We originated $122.8 million of business purpose loans during fiscal 2003 and $133.4 million of business purpose loans during fiscal 2002. Generally, we compute interest due on our outstanding business purpose loans using the simple interest method. We generally impose a prepayment fee. Although prepayment fees imposed vary based upon applicable state law, the prepayment fees on our business purpose loan documents can be a significant portion of the outstanding loan balance. Whether a prepayment fee is imposed and the amount of such fee, if any, is negotiated between the individual borrower and American Business Credit prior to closing of the loan. We may waive the collection of a prepayment fee, if any, in the event the borrower refinances a business loan with us. Prepayment Fees. At origination, approximately 80% to 85% of our home equity loans had prepayment fees and approximately 90% to 95% of our business purpose loans had prepayment fees. Home equity loans comprise approximately 93% of all loans we originate and the remaining 7% are business purpose loans. On home equity loans where the borrower has elected the prepayment fee option, the prepayment fee is generally a certain percentage of the outstanding principal balance of the loan. Our typical prepayment fee structure provides for a fee of 5% or less of the outstanding principal loan balance and will not extend beyond the first three years after a loan's origination. Prepayment fees on our existing home equity loans range from 1% to 5% of the outstanding principal balance and remain in effect for one to five years. The prepayment fee on business purpose loans is generally 8% to 12% of the outstanding principal balance, provided that no prepayment option is available until after the 24th scheduled payment is made and no prepayment fee is due after the 60th scheduled payment is made. From time to time, a different prepayment fee arrangement may be negotiated or we may waive prepayment fees for borrowers who refinance their loans with us. At June 30, 2003, approximately 60% to 65% of securitized home equity loans in our managed portfolio had prepayment fees and approximately 50% to 55% of securitized business purpose loans in our managed portfolio had prepayment fees. State law sometimes restricts our ability to charge a prepayment fee for both home equity and business purpose loans. We have used the Parity Act to preempt these state laws for home equity loans which meet the definition of alternative mortgage transactions under the Parity Act. However, the Office of Thrift Supervision has adopted a rule effective in July 2003, which precludes us and other non-bank, non-thrift creditors from using the Parity Act to preempt state prepayment penalty and late fee laws on new loan originations. Under the provisions of this rule, we are required to modify or eliminate the practice of charging prepayment and other fees in some of the states where we originate loans. We are continuing to evaluate the impact of the adoption of the new rule by the Office of Thrift Supervision on our future lending activities and results of operations. We currently expect that the percentage of home equity loans containing prepayment fees that we will originate in the future will decrease to approximately 65% to 70%, from 80% to 85% prior to this rule becoming effective. 19 Additionally, in a recent decision, the Appellate Division of the Superior Court of New Jersey determined that the Parity Act's preemption of state law was invalid and that the state laws precluding some lenders from imposing prepayment fees are applicable to loans made in New Jersey, including alternative mortgage transactions. Although this New Jersey decision is subject to appeal and may not be final, we are currently evaluating its impact on our future lending activities and results of operations. In states which have overridden the Parity Act and in the case of some fully amortizing home equity loans, state laws may restrict prepayment fees either by the amount of the prepayment fee or the time period during which it can be imposed. Federal law restrictions in connection with certain high interest rate and fee loans may also preclude the imposition of prepayment fees on these loans. Similarly, in the case of business purpose loans, some states prohibit or limit prepayment fees when the loan is below a specific dollar threshold or is secured by residential property. Marketing Strategy Historically, we concentrated our marketing efforts for home equity loans primarily on credit-impaired borrowers who are generally unable to obtain financing from banks or savings and loan associations and who are attracted to our products and services. Although we still intend to lend to credit-impaired borrowers under our business strategy, we intend to broaden our mortgage loan product line to include adjustable rate and alt-A mortgage loans and to offer competitive interest rates in order to appeal to a wider range of customers. See "-- Business Strategy" and "Risk Factors -- Lending to credit-impaired borrowers may result in higher delinquencies in our managed portfolio, which could hinder our ability to operate profitably, impair our ability to repay our subordinated debt and negatively impact the value of our common stock." We market home equity loans through direct mail campaigns and our interactive web sites, and have in the past used telemarketing, radio and television advertising. We believe that our targeted direct mail strategy delivers more leads at a lower cost than broadcast marketing channels. Our integrated approach to media advertising that utilizes a combination of direct mail and Internet advertising is intended to maximize the effect of our advertising campaigns. We expect the implementation of our business strategy to improve our response and conversion rates, which will reduce our overall marketing costs. We also use a network of loan brokers along with the Bank Alliance Services program as additional sources of loans. We intend to expand our network of loan brokers as part of our focus on whole loan sales in order to increase the amount of loans originated and reduce origination costs. Our marketing efforts for home equity loans are focused on the eastern and central portions of the United States with plans to expand to the western portion of the United States. We previously utilized branch offices in various states to market our loans. Effective June 30, 2003, we no longer originate loans through retail branch offices. Loan processing and underwriting procedures are performed at our centralized operating office located in Philadelphia, Pennsylvania and a regional processing center in Roseland, New Jersey. Our centralized operating office relocated from Bala Cynwyd, Pennsylvania on July 7, 2003. Our marketing efforts for business purpose loans focus on our niche market of selected small businesses located in our market area, which generally includes the eastern and central portions of the United States. 20 We target businesses, which might qualify for loans from traditional lending sources, but would elect to use our products and services. Our experience has indicated that these borrowers are attracted to us as a result of our marketing efforts, the personalized service provided by our staff of highly trained lending officers and our timely response to loan applications. Historically, such customers have been willing to pay our origination fees and interest rates, which are generally higher than those charged by traditional lending sources. We market business purpose loans through various forms of advertising, including large direct mail campaigns, our business loan web site and a direct sales force and loan brokers, and have in the past used newspaper and radio advertising. Our commissioned sales staff, which consists of full-time salespersons, is responsible for converting advertising leads into loan applications. We use a proprietary training program involving extensive and on-going training of our lending officers. Our sales staff uses significant person-to-person contact to convert advertising leads into loan applications and maintains contact with the borrower throughout the application process. While we intend to reduce the level of business purpose loans that we will originate under our business strategy, we will continue to originate business purpose loans to meet demand in the whole loan sale and securitization markets. See "-- Business Strategy" and "-- Lending Activities -- Business Purpose Loans." Underwriting Procedures and Practices Summarized below are some of the policies and practices which are followed in connection with the origination of business purpose loans and home equity loans. These policies and practices may be altered, amended and supplemented, from time to time, as conditions warrant. We reserve the right to make changes in our day-to-day practices and policies at any time. Our loan underwriting standards are applied to evaluate prospective borrowers' credit standing and repayment ability as well as the value and adequacy of the mortgaged property as collateral. Initially, the prospective borrower is required to provide pertinent credit information in order to complete a detailed loan application. As part of the description of the prospective borrower's financial condition, the borrower is required to provide information concerning assets, liabilities, income, credit, employment history and other demographic and personal information. If the application demonstrates the prospective borrower's ability to repay the debt as well as sufficient income and equity, loan processing personnel generally obtain and review an independent credit bureau report on the credit history of the borrower and verification of the borrower's income. Once all applicable employment, credit and property information is obtained, a determination is made as to whether sufficient unencumbered equity in the property exists and whether the prospective borrower has sufficient monthly income available to meet the prospective borrower's monthly obligations. 21 The following table outlines the key parameters of the major credit grades of our current home equity loan underwriting guidelines. Home equity loans represent approximately 90% of the loans we originate.
- ---------------------------------- ------------------------------- -------------------------------- "A" Credit Grade "B" Credit Grade - ---------------------------------- ------------------------------- -------------------------------- General Repayment Has good credit but might have Pays the majority of accounts some minor delinquency. on time but has some 30 and/or 60 day delinquency. - ---------------------------------- ------------------------------- -------------------------------- Existing Mortgage Loans Current at application time Current at application time and a maximum of two 30 day and a maximum of four 30 day delinquencies in the past 12 delinquencies in the past 12 months. months. - ---------------------------------- ------------------------------- -------------------------------- Non-Mortgage Credit Major credit and installment Major credit and installment debt should be current but debt can exhibit some minor 30 may exhibit some minor 30 day and/or 60 day delinquency. delinquency. Minor credit Minor credit may exhibit up to may exhibit some minor 90 day delinquency. delinquency. - ---------------------------------- ------------------------------- -------------------------------- Bankruptcy Filings Discharged more than 2 years Discharged more than 2 years with reestablished credit. with reestablished credit. - ---------------------------------- ------------------------------- -------------------------------- Debt Service-to-Income Generally not to exceed 50%. Generally not to exceed 50%. - ---------------------------------- ------------------------------- -------------------------------- Owner Occupied: Generally 80% to 90% for a Generally 80% to 85% for a 1-4 Loan-to-value ratio 1-4 family dwelling family dwelling residence; 80% residence; 80% for a for a condominium. condominium. - ---------------------------------- ------------------------------- -------------------------------- Non-Owner Occupied: Generally 80% for a 1-4 Generally 70% for a 1-4 family Loan-to-value ratio family dwelling or dwelling or condominium. condominium. - ---------------------------------- ------------------------------- --------------------------------
(a) Purchasers in the whole loan sale market generally do not accept "D" credit grade loans. As a result, we will also originate "C-" credit grade loans, which are substantially similar to "D" credit grade loans except that the acceptable mortgage delinquency is limited to 90 days at time of loan closing. 22 The following table outlines the key parameters of the major credit grades of our current home equity loan underwriting guidelines. Home equity loans represent approximately 90% of the loans we originate.
- ---------------------------------- --------------------------------- --------------------------------- "C" Credit Grade "D" Credit Grade (a) - ---------------------------------- --------------------------------- --------------------------------- Marginal credit history which is Designed to provide a borrower General Repayment offset by other positive with poor credit history an attributes. opportunity to correct past credit problems through lower monthly payments. - ---------------------------------- --------------------------------- --------------------------------- Existing Mortgage Loans Cannot exceed four 30 day Must be paid in full from loan delinquencies and/or two 60 day proceeds and no more than 120 delinquencies in the past 12 days delinquent. months. - ---------------------------------- --------------------------------- --------------------------------- Non-Mortgage Credit Major credit and installment Major and minor credit debt can exhibit some minor 30 delinquency is acceptable, but and/or 90 day delinquency. must demonstrate some payment Minor credit may exhibit more regularity. serious delinquency. - ---------------------------------- --------------------------------- --------------------------------- Bankruptcy Filings Discharged more than 1 year Discharged prior to closing or with reestablished credit. payoff of bankruptcy debts with proceeds. - ---------------------------------- --------------------------------- --------------------------------- Debt Service-to-Income Generally not to exceed 55%. Generally not to exceed 55%. - ---------------------------------- --------------------------------- --------------------------------- Owner Occupied: Generally 70% to 80% for a 1-4 Generally 60% to 65% for a 1-4 Loan-to-value ratio family dwelling residence; 70% family dwelling residence. for a condominium. - ---------------------------------- --------------------------------- --------------------------------- Non-Owner Occupied: Generally 60% for a 1-4 family N/A Loan-to-value ratio dwelling or condominium. - ---------------------------------- --------------------------------- ---------------------------------
(a) Purchasers in the whole loan sale market generally do not accept "D" credit grade loans. As a result, we will also originate "C-" credit grade loans, which are substantially similar to "D" credit grade loans except that the acceptable mortgage delinquency is limited to 90 days at time of loan closing. 23 In addition to the home equity loans we originate under the standard home equity loan underwriting guidelines outlined in the preceding table, we also originate a limited number of second mortgages that have loan-to-value ratios ranging from 90% to 100%. We consider these loans to be high loan-to-value home equity loans and we underwrite these loans with a more restrictive approach to evaluating the borrowers' qualifications and we require a stronger credit history than our standard guidelines. The borrowers' existing mortgage and installment debt payments must generally be paid as agreed, with no more than one 30-day delinquency on a mortgage within the last 12 months. No bankruptcy or foreclosure is permitted in the last 36 months. Pursuant to our business strategy, a greater number of loans that we originate will be offered to the secondary market through whole loan sales. These loans will be underwritten, allocated and sold to specific third party purchasers based on agreed upon products and underwriting guidelines. The purchaser products and guidelines currently being utilized generally conform to key parameters outlined in the preceding table. See "-- Business Strategy." Generally, business purpose loans are secured by residential real estate and at times commercial real estate. Loan amounts generally range from $14,000 to $685,000. The loan-to-value ratio (based solely on the appraised fair market value of the real estate collateral securing the loan) on the properties collateralizing the loans generally have a maximum range of 50% to 75%. The actual maximum loan-to-value ratio varies depending on a variety of factors including, the credit grade of the borrower, whether the collateral is a one to four family residence, a condominium or a commercial property and whether the property is owner occupied or non-owner occupied. The credit grade of a business purpose loan borrower will vary depending on the payment history of their existing mortgages, major lines of credit and minor lines of credit, allowing for delinquency but generally requiring major credit to be current at closing. The underwriting of the business purpose loan includes confirmation of income or cash flow through tax returns, bank statements and other forms of proof of income and business cash flow. Generally, we make loans to businesses whose bankruptcy was discharged at least two years prior to closing, but we may make exceptions to allow for the bankruptcy to be discharged just prior to or at closing. In addition, we generally receive additional collateral in the form of, among other things, personal guarantees, pledges of securities, assignments of contract rights, assignments of life insurance and lease payments and liens on business equipment and other business assets, as available. Based solely on the value of the real estate collateral securing our business purpose loans, the average loan-to-value ratio of business purpose loans we originated during the fiscal year ended June 30, 2003 was 62.2% and during fiscal 2002 was 62.6%. Generally, the maximum acceptable loan-to-value ratio for home equity loans to be securitized is 100%. The average loan-to-value ratio of home equity loans we originated during fiscal 2003 was 78.2% and during fiscal 2002 was 77.8%. We generally obtain title insurance in connection with our loans. In determining whether the mortgaged property is adequate as collateral, we have an appraisal performed for each property considered for financing. The appraisal is completed by a licensed qualified appraiser on a Fannie Mae form and generally includes pictures of comparable properties and pictures of the property securing the loan. 24 Any material decline in real estate values reduces the ability of borrowers to use home equity to support borrowings and increases the loan-to-value ratios of loans previously made by us, thereby weakening collateral coverage and increasing the possibility of a loss in the event of borrower default. Further, delinquencies, foreclosures and losses generally increase during economic slowdowns or recessions. As a result, we cannot assure that the market value of the real estate underlying the loans will at any time be equal to or in excess of the outstanding principal amount of those loans. Although we have expanded the geographic area in which we originate loans, a downturn in the economy generally or in a specific region of the country may have an effect on our originations. See "Risk Factors -- A decline in value of the collateral securing our loans could result in an increase in losses on foreclosure, which could hinder our ability to attain profitable operations, limit our ability to repay our subordinated debt and negatively impact the value of our common stock." Loan Servicing and Administrative Procedures We service the loans we hold as available for sale or that we securitize, in accordance with our established servicing procedures. Our servicing procedures include practices regarding processing of mortgage payments, processing of disbursements for tax and insurance payments, maintenance of mortgage loan records, performance of collection efforts, including disposition of delinquent loans, foreclosure activities and disposition of real estate owned and performance of investor accounting and reporting processes, which in general conform to the mortgage servicing practices of prudent mortgage lending institutions. We generally receive contractual servicing fees for our servicing responsibilities for securitized loans, calculated as a percentage of the outstanding principal amount of the loans serviced. In addition, we receive other ancillary fees related to the loans serviced. Our servicing and collections activities are principally located at our operating office in Bala Cynwyd, Pennsylvania, but we expect to relocate these activities to our Philadelphia, Pennsylvania office. At June 30, 2003, the total managed portfolio consisted of 44,538 loans with an aggregate outstanding balance of $3.6 billion. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Reconciliation of Non-GAAP Financial Measures" for a reconciliation of total managed portfolio to our balance sheet. In servicing loans, we send an invoice to borrowers on a monthly basis advising them of the required payment and its scheduled due date. We begin the collection process promptly after a borrower fails to make a scheduled monthly payment. When a loan becomes 45 to 60 days delinquent for a home equity loan or 90 days delinquent for a business purpose loan, it is transferred to a senior collector in the collections department. The senior collector tries to resolve the delinquency by reinstating a delinquent loan, seeking a payoff, or entering into a deferment or forbearance arrangement with the borrower to avoid foreclosure. All proposed arrangements are evaluated on a case-by-case basis, based on, among other things, the borrower's past credit history, current financial status, cooperativeness, future prospects and the reasons for the delinquency. If a mortgage loan becomes 45 days delinquent and we do not reach a satisfactory arrangement with the borrower, our legal department will mail a notice of default to the borrower. If the delinquency is not cured within the time period provided for in the loan documents, we generally start a foreclosure action. The collection department maintains normal collection efforts during the cure periods following a notice of default and the initiation of foreclosure action. If a borrower declares bankruptcy, our in-house attorneys and paralegals promptly act to protect our interests. We may initiate legal action earlier than 45 days following a delinquency if we determine that the circumstances warrant such action. 25 We employ a staff of experienced mortgage collectors and managers working in shifts seven days a week to manage delinquent loans. In addition, a staff of in-house attorneys and paralegals works closely with the collections staff to optimize collection efforts. The primary goal of our labor-intensive collections program is to emphasize delinquency and loss prevention. From time to time, borrowers are confronted with events, usually involving hardship circumstances or temporary financial setbacks that adversely affect their ability to continue payments on their loan. To assist borrowers, we may agree to enter into a deferment or forbearance arrangement. Prevailing economic conditions, which affect the borrower's ability to make their regular payments, may also have an impact on the value of the real estate or other collateral securing the loans, resulting in a change to the loan-to-value ratios. We may take these conditions into account when we evaluate a borrower's request for assistance for a relief from their financial hardship. Our policies and practices regarding deferment and forbearance arrangements, like all of our collections policies and practices, are designed to manage customer relationships, maximize collections and avoid foreclosure (or repossession of other collateral, as applicable) if reasonably possible. We review and regularly revise these policies and procedures in order to enhance their effectiveness in achieving these goals. We permit exceptions to the policies and practices from time to time based on individual borrowers' situations. In a deferment arrangement, we make advances to a securitization trust on behalf of the borrower in amounts equal to the delinquent loan payments, which include principal and interest. Additionally, we may pay taxes, insurance and other fees on behalf of the borrower. Based on our review of the borrower's current financial circumstances, the borrower must repay the advances and other payments and fees we make on borrower's behalf either at the termination of the loan or on a monthly payment plan. Borrowers must provide a written explanation of their hardship, which generally requests relief from their loan payments. We review the borrower's current financial situation and based upon this review, we may create a payment plan for the borrower which allows the borrower to pay past due amounts over a period from 12 to 42 months, but not beyond the maturity date of the loan, in addition to making regular monthly loan payments. Each deferment arrangement must be approved by two of our managers. Deferment arrangements which defer two or more past due payments must also be approved by a senior vice president. Principal guidelines currently applicable to the deferment process are: (i) the borrower may have up to six payments deferred during the life of the loan; (ii) no more than three payments may be deferred during a twelve-month period; and (iii) the borrower must have made a minimum of six payments on the loan and twelve months must have passed since the last deferment in order to qualify for a new deferment arrangement. Any deferment arrangement which includes an exception to our guidelines must be approved by the senior vice president of collections and an executive vice president. If the deferment arrangement is approved, a collector contacts the borrower regarding the approval and the revised payment terms. For borrowers who are two or more payments delinquent, we will consider using a forbearance arrangement if permitted under applicable state law. In a forbearance arrangement, we make advances to a securitization trust on behalf of the borrower in amounts equal to the delinquent loan payments, which include principal and interest. Additionally, we may pay taxes, insurance and other fees on behalf of the borrower. We assess the borrower's current financial situation and based upon this assessment, we may create a payment plan for the borrower which generally allows the borrower to pay past due amounts over a longer period than a typical deferment arrangement, but not beyond the maturity date of the loan. We typically structure a forbearance arrangement to require the borrower to make payments of principal and interest equivalent to the original loan terms plus additional monthly payments, which in the aggregate represent the amount that we advanced to the securitization trust and other fees we paid on behalf of the borrower. We currently require the borrower to provide a written explanation of their financial hardship, and we offer these arrangements to borrowers who we believe have the ability to remit post-forbearance principal and interest payments in addition to the amounts advanced or paid by us. As part of the written forbearance agreement, the borrower must execute a deed in lieu of foreclosure. If the borrower subsequently defaults before repaying the amount due under the forbearance agreement in full and becomes 60 days delinquent on principal and interest payments, we may elect to record the deed after providing proper notification to the borrower and a reasonable period of time to cure. Recording the deed in lieu of foreclosure gives us immediate legal title to the property without the need for further legal action. 26 Principal guidelines currently applicable to the forbearance process are: (i) the subject loan should be at least six months old; (ii) the loan should be a minimum of three payments delinquent; and (iii) each forbearance arrangement must be approved by a manager, the senior vice president of collections and the senior vice president of asset allocation. Forbearance arrangements which defer ten or more past due payments, involve advances or other payments of more than $25,000 or include an exception to our guidelines must also be approved by an executive vice president. For delinquent borrowers with business purpose loans, we may enter into written forbearance agreements pursuant to which we do not obtain a deed in lieu of foreclosure. These arrangements typically allow the borrower to pay past due amounts over a period of 12-36 months, but not beyond the maturity date of the loan and generally require the borrower to make a payment at the time of entering into a forbearance agreement. We do not enter into a deferment or forbearance arrangement based solely on the fact that a loan meets the criteria for one of the arrangements. Our use of any of these arrangements depends upon one or more of the following factors: our assessment of the individual borrower's current financial situation and reasons for the delinquency, a valuation of the real estate securing the loan and our view of prevailing economic conditions. Because deferment and forbearance arrangements are account management tools which help us to manage customer relationships, maximize collection opportunities and increase the value of our account relationships, the application of these tools generally is subject to constantly shifting complexities and variations in the marketplace. We attempt to tailor the type and terms of the arrangement we use to the borrower's circumstances, and we prefer to use deferment over forbearance arrangements, if possible. As a result of these arrangements, we reset the contractual status of a loan in our managed portfolio from delinquent to current based upon the borrower's resumption of making their loan payments. Generally, a loan remains current after a deferment or forbearance arrangement with the borrower only if the borrower makes the principal and interest payments as required under the terms of the original note (exclusive of delinquent payments advanced or fees paid by us on the borrower's behalf as part of the deferment or forbearance arrangement), and we do not reflect it as a delinquent loan in our delinquency statistics. However, if the borrower fails to make principal and interest payments, the account will generally be declared in default and collection actions resumed. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Managed Portfolio Quality -- Deferment and Forbearance Arrangements" for information regarding the impact of these arrangements on our operations. See also "Regulation -- Equal Credit Opportunity Fair Credit Reporting and Other Laws" and "Risk Factors -- The inquiry regarding our forbearance practices by the U.S. Attorney could result in concerns regarding our loan servicing and limit our ability to sell or service our loans, sell subordinated debt, or obtain additional credit facilities, which would hinder our ability to operate profitably and repay our subordinated debt, which could negatively impact the value of our common stock." We believe we are among a small number of non-conforming mortgage lenders that have an in-house legal staff dedicated to the collection of delinquent loans and the handling of bankruptcy cases. As a result, we believe our delinquent loans are reviewed from a legal perspective earlier in the collection process than is the case with loans made by traditional lenders so that troublesome legal issues can be noted and, if possible, resolved earlier. Our in-house legal staff also attempts to find solutions for delinquent loans, other than foreclosure. Real estate acquired as a result of foreclosure or by deed in lieu of foreclosure is classified as real estate owned until it is sold. When property is acquired by foreclosure or deed in lieu of foreclosure, we record it at the lower of cost or estimated fair value. After acquisition, all costs incurred in maintaining the property are accounted for as expenses. 27 Most foreclosures are handled by outside counsel who are managed by our in-house legal staff to ensure that the time period for handling foreclosures meets or exceeds established industry standards. Frequent contact between in-house and outside counsel ensures that the process moves quickly and efficiently in an attempt to achieve a timely and economical resolution to contested matters. Our ability to foreclose on some properties may be affected by state and federal environmental laws. The costs of investigation, remediation or removal of hazardous substances may be substantial and can easily exceed the value of the property. The presence of hazardous substances, or the failure to properly eliminate the substances from the property, can hurt the owner's ability to sell or rent the property and prevent the owner from using the property as collateral for another loan. Even parties who arrange for the disposal or treatment of hazardous or toxic substances may be liable for the costs of removal and remediation, whether or not the facility is owned or operated by the party who arranged for the disposal or treatment. See "Risk Factors -- Environmental laws and regulations and other environmental considerations may restrict our ability to foreclose on loans secured by real estate or increase costs associated with those loans which could hinder our ability to operate profitably and the funds available to repay our subordinated debt and negatively impact the value of our common stock." The technical nature of some laws and regulations, such as the Truth in Lending Act, can also contribute to difficulties in foreclosing on real estate and other assets, as even immaterial errors can trigger foreclosure delays or other difficulties. As the servicer of securitized loans, we are obligated to advance funds for scheduled interest payments that have not been received from the borrower unless we determine that our advances will not be recoverable from subsequent collections of the related loan payments. See "-- Securitizations" and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Off-Balance Sheet Arrangements." We are also required to compensate investors (without a right to reimbursement) for interest shortfall resulting from loan prepayments up to the amount of our servicing fee. See "Risk Factors -- Our securitization agreements impose obligations on us to make cash outlays which could impair our ability to operate profitably and our ability to repay the subordinated debt and negatively impact the value of our common stock." Securitizations We were unable to complete our typical quarterly securitization during the fourth quarter of fiscal 2003. Our inability to complete our typical publicly underwritten securitization during the fourth quarter of fiscal 2003 was the result of our investment bankers' decision in late June 2003 not to underwrite the contemplated June 2003 securitization transaction. Management believes that a number of factors contributed to this decision, including a highly-publicized lawsuit finding liability of an underwriter in connection with the securitization of loans for another unaffiliated subprime lender, an inquiry by the U.S. Attorney's Office in Philadelphia regarding our forbearance practices, an anonymous letter regarding the Company received by one of our investment bankers, the SEC's recent enforcement action against another unaffiliated subprime lender related to its loan restructuring practices and related disclosure, a federal regulatory agency investigation of practices by another subprime servicer and our investment bankers' prior experience with securitization transactions with non-affiliated originators. 28 During fiscal 2003, we securitized $112.0 million of business purpose loans and $1.3 billion of home equity loans. During fiscal 2002, we securitized $129.1 million of business purpose loans and $1.2 billion of home equity loans. During fiscal 2001, we securitized $109.9 million of business purpose loans and $992.2 million of home equity loans. The securitization of loans generated gains on sale of loans of $171.0 million during fiscal 2003, $185.6 million during fiscal 2002 and $129.0 million during fiscal 2001. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Off-Balance Sheet Arrangements -- Securitizations" for additional information regarding our securitizations. Securitization is a financing technique often used by originators of financial assets to raise capital. A securitization involves the sale of a pool of financial assets, in our case loans, to a trust in exchange for cash and a retained interest in the securitized loans which is called an interest-only strip. The trust issues multi-class securities which derive their cash flows from a pool of securitized loans. These securities, which are senior to our retained interest-only strips in the trust, are sold to public or private investors. We also retain servicing on securitized loans. See "-- Loan Servicing and Administrative Procedures" As the holder of the interest-only strips received in a securitization, we are entitled to receive excess (or residual) cash flows. These cash flows are the difference between the payments made by the borrowers on securitized loans and the sum of the scheduled and prepaid principal and pass-through interest paid to trust investors, servicing fees, trustee fees and, if applicable, surety fees. Surety fees are paid to an unrelated insurance entity to provide protection for the trust investors. These cash flows also include cash flows from overcollateralization. Overcollateralization is the excess of the aggregate principal balances of loans in a securitized pool over investor interests. Overcollateralization requirements are established to provide credit enhancement for the trust investors. We may be required either to repurchase or to substitute loans which do not conform to the representations and warranties we made in the agreements entered into when the loans are sold through a securitization. As of June 30, 2003, we have been required to substitute only one such loan from the securitization trusts for this reason. When borrowers are delinquent in making scheduled payments on loans included in a securitization trust, we are obligated to advance interest payments with respect to such delinquent loans if we deem that these advances will ultimately be recoverable. These advances can first be made out of funds available in the trust's collection account. If the funds available from the collection account are insufficient to make the required interest advances, then we are required to make the advances from our operating cash. The advances made from a trust's collection account, if not recovered from the borrower or proceeds from the liquidation of the loan, require reimbursement from us. These advances may require funding from our capital resources and may create greater demands on our cash flow than either selling loans with servicing released or maintaining a portfolio of loans on our balance sheet. However, any advances we make from our operating cash can be recovered from the subsequent mortgage loan payments to the applicable trust prior to any distributions to the certificate holders. See "Risk Factors -- Our securitization agreements impose obligations on us to make cash outlays which could impair our ability to operate profitably and our ability to repay the subordinated debt and negatively impact the value of our common stock." 29 At times we elect to repurchase some delinquent loans from the securitization trusts, some of which may be in foreclosure. Repurchasing loans benefits us by allowing us to limit the level of delinquencies and losses in the securitization trusts and as a result, we can avoid exceeding specified limits on delinquencies and losses that trigger a temporary reduction or discontinuation of residual or stepdown overcollateralization cash flows from our interest-only strips until the delinquencies or losses no longer exceed the triggers. We have the right, but are not obligated, to repurchase a limited amount of delinquent loans from securitization trusts. The purchase price of a delinquent loan is at the loan's outstanding contractual balance plus accrued and unpaid interest and unreimbursed servicing advances, however unpaid interest and unreimbursed servicing advances are returned to us by the trust. A foreclosed loan is one where we, as servicer, have initiated formal foreclosure proceedings against the borrower and a delinquent loan is one that is 31 days or more past due. The foreclosed and delinquent loans we typically elect to repurchase are usually 90 days or more delinquent and the subject of foreclosure proceedings, or where a completed foreclosure is imminent. In addition, we elect to repurchase loans in situations requiring more flexibility for the administration and collection of these loans in order to maximize their economic recovery. See "Risk Factors -- Our securitization agreements impose obligations on us to make cash outlays which could impair our ability to operate profitably and our ability to repay the subordinated debt and negatively impact the value of our common stock." See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Off-Balance Sheet Arrangements -- Trigger Management" for a description of the impact of these repurchases on our business. Our securitizations can include a prefunding option where a portion of the cash received from investors is withheld until additional loans are transferred to the trust. The loans to be transferred to the trust to satisfy the prefund option must be substantially similar in terms of collateral, size, term, interest rate, geographic distribution and loan-to-value ratio as the loans initially transferred to the trust. We had no prefund obligations at June 30, 2003. Whole Loan Sales Our determination to engage in whole loan sales depends upon a variety of factors, including market conditions in the securitization markets and the secondary loan markets, profitability and cash flow considerations. In recent years, we experienced a decrease in our whole loan sales as a result of our decision to emphasize the securitization of additional loans, due to the favorable conditions we experienced in the securitization markets during those years and, to a lesser extent, our decision to de-emphasize conventional first mortgage loans which we primarily sold on a whole loan basis. Due to our inability to complete our typical quarterly securitization during the fourth quarter of fiscal 2003, we adjusted our business strategy from a predominantly publicly underwritten securitization strategy to a strategy focused on a combination of whole loan sales and securitizations. See "-- Business Strategy." In whole loan sale transactions, the gain on sale is generally significantly lower than the gains realized in securitization transactions, but we receive the gain in cash. Whole loan sales enable us to immediately generate cash flow, protect against the potential volatility of the securitization market and reduce the risks inherent in retaining securitization assets. However, unlike securitizations, where we retain the servicing rights and receive securitization assets in the form of interest-only strips which generate future cash flows, whole loan sales are typically structured as a sale with servicing rights released and do not result in our receipt of securitization assets. As a result, using whole loan sales more extensively in the future will reduce our income from servicing activities and limit the amount of securitization assets created. 30 Competition We have significant competition for home equity loans. We concentrate our marketing efforts for home equity loans on credit-impaired borrowers. Through Upland Mortgage and American Business Mortgage Services, Inc., we compete with banks, thrift institutions, mortgage bankers and other finance companies, which may have greater resources and name recognition. We attempt to mitigate these factors through a highly trained staff of professionals, rapid response to prospective borrowers' requests and by maintaining a relatively short average loan processing time. See "-- Business Strategy" for discussion of our emphasis on broadening our mortgage loan product line and offering competitive interest rates. In addition, we implemented our Bank Alliance Services program in order to generate additional loan volume. See "Risk Factors - -- Competition from other lenders could adversely affect our ability to attain profitable operations and our ability to repay our subordinated debt and negatively impact the value of our common stock." We compete for business purpose loans against many other finance companies and financial institutions. Although many other entities originate business purpose loans, we have focused our lending efforts on our niche market of businesses which may qualify for loans from traditional lending sources but who we believe are attracted to our products as a result of our marketing efforts, responsive customer service and rapid processing and closing periods. Regulation General. Our business is regulated by federal, state and, in certain cases, local laws. All home equity loans must meet the requirements of, among other statutes and regulations, the Truth in Lending Act, the Real Estate Settlement Procedures Act, the Equal Credit Opportunity Act of 1974, and their associated Regulations Z, X and B, respectively. Truth in Lending. The Truth in Lending Act and Regulation Z contain disclosure requirements designed to provide consumers with uniform, understandable information about the terms and conditions of loans and credit transactions so that consumers may compare credit terms. The Truth in Lending Act also guarantees consumers a three-day right to cancel certain transactions described in the act and imposes specific loan feature restrictions on some loans, including some of the same types of loans originated by us. If we were found not to be in compliance with the Truth in Lending Act, some aggrieved borrowers could, depending on the nature of the non-compliance, have the right to recover actual damages, statutory damages, penalties, rescind their loans and/or to demand, among other things, the return of finance charges and fees paid to us and third parties. Other fines and penalties can also be imposed under the Truth in Lending Act and Regulation Z. Equal Credit Opportunity, Fair Credit Reporting Act and Other Laws. We are also required to comply with the Equal Credit Opportunity Act and Regulation B, which prohibit creditors from discriminating against applicants on the basis of race, color, religion, national origin, sex, age or marital status. Regulation B also restricts creditors from obtaining certain types of information from loan applicants. Among other things, it also requires lenders to advise applicants of the reasons for any credit denial. Equal Credit Opportunity Act violations can also result in fines, penalties and other remedies. 31 In instances where the applicant is denied credit or the rate of interest for a loan increases as a result of information obtained from a consumer credit reporting agency, the Fair Credit Reporting Act of 1970, as amended, requires lenders to supply the applicant with the name and address of the reporting agency whose credit report was used in making such determinations. It also requires that lenders provide other information and disclosures about the loan application rejection. In addition, we are subject to the Fair Housing Act and regulations under the Fair Housing Act, which broadly prohibit discriminatory practices in connection with our home equity and other lending businesses. Pursuant to the Home Mortgage Disclosure Act and Regulation C, we are also required to report information on loan applicants and certain other borrowers to the Department of Housing and Urban Development, which is among numerous federal and state agencies which monitor compliance with fair lending laws. We are also subject to the Real Estate Settlement Procedures Act and Regulation X. This law and this regulation, which are administered by the Department of Housing and Urban Development, imposes limits on the amount of funds a borrower can be required to deposit with us in any escrow account for the payment of taxes, insurance premiums or other charges; limits the fees which may be paid to third parties; and imposes various disclosure and other requirements. We are subject to various other federal, state and local laws, rules and regulations governing the licensing of mortgage lenders and servicers. We must comply with procedures mandated for mortgage lenders and servicers, and must provide disclosures to consumer applicants and borrowers. Failure to comply with these laws, as well as with the laws described above, may result in civil and criminal liability. Several of our subsidiaries are licensed and regulated by the departments of banking or similar entities in the various states in which they are conducting business. The rules and regulations of the various states impose licensing and other restrictions on lending activities, such as prohibiting discrimination and regulating collection, foreclosure procedures and claims handling, disclosure obligations, payment feature restrictions and, in some cases, these laws fix maximum interest rates and fees. Failure to comply with these requirements can lead to termination or suspension of licenses, rights of rescission for mortgage loans, individual and class action lawsuits and/or administrative enforcement actions. Our in-house compliance staff, which includes attorneys, and our outside counsel review and monitor the lending policies of our subsidiaries for compliance with the various federal and state laws. The previously described laws and regulations are subject to legislative, administrative and judicial interpretation. Some of these laws and regulations have recently been enacted or amended. Some of these laws and regulations are rarely challenged in, or interpreted by, the courts. Infrequent interpretations, an insignificant number of interpretations and/or conflicting interpretations of these enacted or amended laws and regulations can make it difficult for us to always know what is permitted conduct under these laws and regulations. 32 Any ambiguity or vagueness under the laws and regulations to which we are subject may lead to regulatory investigations or enforcement actions and private causes of action, such as class action lawsuits, with respect to our compliance with the applicable laws and regulations. See "Risk Factors -- Our residential lending business is subject to government regulation and licensing requirements, as well as private litigation, which may hinder our ability to operate profitably and repay our subordinated debt which would negatively impact the value of our common stock." The Gramm-Leach-Bliley Act, which was signed into law at the end of 1999, contains comprehensive consumer financial privacy restrictions. Various federal enforcement agencies, including the Federal Trade Commission, have issued final regulations to implement this act. These restrictions fall into two basic categories. First, a financial institution must provide various notices to consumers about such institution's privacy policies and practices. Second, this act imposes restrictions on a financial institution and gives consumers the right to prevent a financial institution from disclosing non-public personal information about the consumer to non-affiliated third parties, with exceptions. We have prepared the appropriate consumer disclosures and internal procedures to address these requirements. In addition, we are subject to review by state attorneys general and the U.S. Department of Justice. We received a civil subpoena, dated May 14, 2003, from the Civil Division of the U.S. Attorney for the Eastern District of Pennsylvania requesting that we provide certain documents and information with respect to us and our lending subsidiaries for the period from May 1, 2000 to May 1, 2003: (i) all loan files in which we entered into a forbearance agreement with a borrower who is in default; (ii) the servicing, processing, foreclosing, and handling of delinquent loans and non-performing loans, the carrying, processing and sale of real estate owned, and forbearance agreements; and (iii) agreements to sell or otherwise transfer mortgage loans (including but not limited to, any pooling or securitization agreements) or to obtain funds to finance the underwriting, origination or provision of mortgage loans, any transaction in which mortgage loans were sold or transferred, any instance in which we were not to service or not to act as custodian for a mortgage loan, representations and warranties made in connection with mortgage loans, secondary market loan sale schedules, and credit loss, delinquency, default, and foreclosure rates of mortgage loans. We have directed our attorneys to cooperate fully with this inquiry. Currently, this inquiry appears to be focused on our practices relating to obtaining forbearance agreements from delinquent borrowers who would otherwise be subject to foreclosure. Because the inquiry is at a preliminary stage, we cannot reach any conclusions at this time as to the ultimate scope of the inquiry or the potential liability or financial consequences for us. Predatory Lending Regulations. State and federal banking regulatory agencies, state attorneys general offices, the Federal Trade Commission, the U.S. Department of Justice, the U.S. Department of Housing and Urban Development and state and local governmental authorities have increased their focus on lending practices by some companies in the subprime lending industry, more commonly referred to as "predatory lending" practices. State, local and federal governmental agencies have imposed sanctions for practices including, but not limited to, charging borrowers excessive fees, imposing higher interest rates 33 than the borrower's credit risk warrants and failing to adequately disclose the material terms of loans to the borrowers. For example, the Pennsylvania Attorney General reviewed fees our subsidiary, Home American Credit, Inc., charged Pennsylvania customers. Although we believe that these fees were fair and in compliance with applicable federal and state laws, in April 2002 we agreed to reimburse borrowers approximately $221,000 with respect to a particular fee paid by borrowers from January 1, 1999 to mid-February 2001 and to reimburse the Commonwealth of Pennsylvania $50,000 for its costs of investigation and for future public protection purposes. We discontinued charging this particular fee in mid-February 2001. As a result of these initiatives, we are unable to predict whether state, local or federal authorities will require changes in our lending practices in the future, including reimbursement of fees charged to borrowers, or will impose fines on us. These changes, if required, could impact our profitability. These laws and regulations may limit our ability to securitize loans originated in certain states or localities due to rating agency, investor or market restrictions. As a result, we have limited the types of loans we offer in some states and may discontinue originating loans in other states or localities. See "Risk Factors -- Our residential lending business is subject to government regulation and licensing requirements, as well as private litigation, which may hinder our ability to operate profitably and repay our subordinated debt, which would negatively impact the value of our common stock." Additionally, the United States Congress is currently considering a number of proposed bills or proposed amendments to existing laws, such as the "Ney - Lucas Responsible Lending Act of 2003" introduced on February 11, 2003 into the U.S. House of Representatives, which could affect our lending activities and make our business less profitable. These bills and amendments, if adopted as proposed, could reduce our profitability by limiting the fees we are permitted to charge, including prepayment fees, restricting the terms we are permitted to include in our loan agreements and increasing the amount of disclosure we are required to give to potential borrowers. While we cannot predict whether or in what form Congress may enact legislation, we are currently evaluating the potential impact of these legislative initiatives, if adopted, on our lending practices and results of operations. In addition to new regulatory initiatives with respect to so-called "predatory lending" practices, current laws or regulations in some states restrict our ability to charge prepayment penalties and late fees. We have used the Federal Alternative Mortgage Transactions Parity Act of 1982, which we refer to as the Parity Act, to preempt these state laws for home equity loans which meet the definition of alternative mortgage transactions under the Parity Act. However, the Office of Thrift Supervision has adopted a rule effective in July 2003, which precludes us and other non-bank, non-thrift creditors from using the Parity Act to preempt state prepayment penalty and late fee laws on new loan originations. Under the provisions of this rule, we are required to modify or eliminate the practice of charging prepayment and other fees in some of the states where we originate loans. We are continuing to evaluate the impact of the adoption of the new rule by the Office of Thrift Supervision on our future lending activities and results of operations. We currently expect that the percentage of home equity loans containing prepayment fees that we will originate in the future will decrease to approximately 65% to 70%, from 80% to 85% prior to this rule becoming effective. Additionally, in a recent decision, the Appellate Division of the Superior Court of New Jersey determined that the Parity Act's preemption of state law was invalid and that the state laws precluding some lenders from imposing prepayment fees are applicable to loans made in New Jersey, including alternative mortgage transactions. Although this New Jersey decision is subject to appeal and may not be final, we are currently evaluating its impact on our future lending activities in the State of New Jersey and results of operations. See " -- Lending Activities -- Prepayment Fees." Soldiers' and Sailors' Civil Relief Act of 1940. Under the Soldiers' and Sailors' Civil Relief Act of 1940, members of all branches of the military on active duty, including draftees and reservists in military service and state national guard called to federal duty: o are entitled to have interest rates reduced and capped at 6% per annum, on obligations (including mortgage loans) incurred prior to the commencement of military service for the duration of military service; o may be entitled to a stay of proceeding on any kind of foreclosure or repossession action in the case of defaults on obligations entered into prior to military service for the duration of military service; and o may have the maturity of obligations incurred prior to military service extended, the payments lowered and the payment schedule readjusted for a period of time after the completion of military service. If a borrower's obligation to repay amounts otherwise due on a mortgage loan included in a trust is relieved pursuant to the Relief Act, none of the trust, the servicer, the back-up servicer, the seller, the depositor, the originators or the trustee will be required to advance these amounts, and any resulting loss may reduce the amounts available to be paid to the holders of the certificates. Any shortfalls in interest collections on mortgage loans included in the trust resulting from application of the Relief Act will be allocated to the certificates in reduction of the amounts payable to such certificates on the related distribution date. As a result of the current military actions in Iraq and Afghanistan, President Bush authorized the placement of tens of thousands of military reservists and members of the National Guard on active duty status. To the extent that any such person is a borrower under a loan, the interest rate limitations and other provisions of the Relief Act would apply to the loan during the period of active duty. The number of reservists and members of the National Guard placed on active duty status in the near future may increase. In addition, other borrowers who enter military service after the origination of their loans (including borrowers who are members of the National Guard at the time of the origination of their loans and are later called to active duty) would be covered by the terms of the Relief Act. See "Risk Factors -- If many of our borrowers become subject to the Soldiers' and Sailors' Civil Relief Act of 1940, our cash flows, interest income and profitability may be adversely affected which would negatively impact our ability to repay our subordinated debt." We have procedures and controls to monitor compliance with numerous federal, state and local laws and regulations. However, because these laws and regulations are complex and often subject to interpretation, or as a result of inadvertent errors, we may, from time to time, inadvertently violate these laws and regulations. If more restrictive laws, rules and regulations are enacted or more restrictive judicial and administrative interpretations of those laws are issued, compliance with the laws could become more expensive or difficult. 34 Risk Factors Investors in our common stock or subordinated debt should carefully consider these risk factors together with all of the information contained in this Form 10-K and incorporated by reference in this Form 10-K which could impact the value of our common stock. If we are unable to obtain additional financing, we may not be able to restructure our business to permit profitable operations or repay our subordinated debt when due, which would negatively impact the value of our common stock. Our inability to complete our typical publicly underwritten securitization during the fourth quarter of fiscal 2003 and our loss for fiscal 2003 adversely impacted our short-term liquidity position and resulted in our inability to comply with financial covenants contained in our credit facilities. The expiration of our $300.0 million mortgage conduit facility and the temporary discontinuation of the sale of new subordinated debentures also adversely impacted our short-term liquidity position. Although we have obtained one new $200.0 million credit facility, this new $200.0 million credit facility could terminate as early as October 3, 2003 if we cannot close by that date another credit facility for at least an additional $200.0 million. We have also received a written commitment letter for a $250.0 million credit facility and, although we are currently negotiating the definitive terms of this $250.0 million new credit facility, we cannot assure you that these negotiations will be successful. Our ability to obtain alternative sources of financing may be limited to the extent we have agreed to pledge our interest-only strips, which represent a significant amount of our assets, to secure the $250.0 million credit facility. To the extent that we are not successful in maintaining, replacing or obtaining alternative financing sources on acceptable terms, we may have to limit our loan originations, sell loans earlier than intended and restructure our operations under our contingent business plan. Limiting our originations or earlier sales of our loans could prevent us from operating profitably and restrict our ability to repay our subordinated debt. Likewise, there can be no assurance that we can successfully implement our contingent business plan, if necessary, or that the assumptions underlying the contingent business plan can be achieved. Our failure to successfully implement our contingent business plan, if necessary, would impair our ability to operate profitably and repay the subordinated debt. Even if we are able to obtain adequate financing, our inability to securitize our loans could hinder our ability to operate profitably in the future and repay our subordinated debt when due, which would negatively impact the value of our common stock. Since 1995, we have relied on the quarterly securitization of our loans to generate cash for the repayment of our credit facilities and the origination of additional loans. Our inability to complete our typical publicly underwritten quarterly securitization during the fourth quarter of 2003 and the $45.2 million pre-tax valuation adjustments to our securitization assets resulted in a loss of $29.9 million for fiscal 2003 and caused our shift in focus to less profitable whole loan sales. The loss resulted in our inability to comply with certain financial covenants contained in our credit facilities. The loss and the expiration of our mortgage conduit facility adversely impacted our short-term liquidity position. The temporary discontinuation of subordinated debt sales further impaired our liquidity. Our continued inability to complete securitization transactions could result in losses during the next several quarters causing us to fail to comply with the financial covenants in our credit facilities, increase our reliance on less profitable whole loan sales which will require us to originate more loans to reach the same level of profitability as we experienced in securitization transactions, and increase our need for additional financing to fund our loan originations. Our continued inability to securitize our loans could result in us reaching our capacity under our existing credit facilities or require us to sell our loans when market conditions are less favorable and could cause us to incur a loss on the sale transaction. See "-- An interruption or reduction in the securitization or whole loan sale markets would hinder our ability to operate profitably and repay our subordinated debt when due, which could negatively impact the value of our common stock." Because we have historically experienced negative cash flows from operations and expect to do so in the foreseeable future, our ability to repay our subordinated debt could be impaired, which would negatively impact the value of our common stock. We have historically experienced negative cash flow from operations since 1996 primarily because our strategy of selling loans through securitization requires us to build an inventory of loans over time. During the period we are building this inventory of loans, we incur costs and expenses. We do not recognize a gain on the sale of loans until we complete a securitization, which may not occur until a subsequent period. In addition, our gain on a securitization results from a combination of cash proceeds received and our retained interests in the securitized loans, consisting primarily of interest-only strips which do not generate cash flow immediately. We expect this negative cash flow from operations to continue in the foreseeable future. Should we continue to experience negative cash flows from operations, it could impair our ability to make principal and interest payments due under the terms of our subordinated debt. At June 30, 2003, there was $343.6 million of subordinated debt and accrued interest, which will mature through June 30, 2004. 35 We obtain the funds to repay our subordinated debt at their maturities by securitizing our loans, selling whole loans, collecting cash from our securitization assets and selling additional notes. We may in the future generate cash flows by securitizing or selling interest-only strips and selling servicing rights generated in past securitizations. If we are unable in the future to securitize our loans, to sell whole loans, or to realize cash flows from interest-only strips and servicing rights generated in past securitizations, our ability to repay our subordinated debt would be impaired, which would negatively impact the value of our common stock. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Our estimates of the value of interest-only strips and servicing rights we retain when we securitize loans could be inaccurate and could limit our ability to operate profitably and impair our ability to repay our subordinated debt, which would negatively impact the value of our common stock. We generally retain interest-only strips and servicing rights in the securitization transactions we complete. We estimate the fair value of the interest-only strips and servicing rights based upon discount rates, prepayment and credit loss rate assumptions established by the management of our company. The value of our interest-only strips totaled $598.3 million and the value of our servicing rights totaled $119.3 million at June 30, 2003. Together, these two assets represent 61.9% of our total assets at June 30, 2003. Although we believe that these amounts represent the fair value of these assets, the amounts were estimated based on discounting the expected cash flows to be received in connection with our securitizations using discount rate, prepayment rate and credit loss rate assumptions established by us. Changes in market interest rates may impact our discount rate assumptions and our actual prepayment and default experience may vary materially from these estimates. Even a small unfavorable change in these assumptions could have a significant adverse impact on the value of these assets. In the event of an unfavorable change in these assumptions, the fair value of these assets would be overstated, requiring an accounting adjustment, consisting of a corresponding reduction in pre-tax income or stockholders' equity or both in the period of adjustment. Adjustments to income could impair our ability to repay our subordinated debt. During fiscal 2003, we recorded a write down of $63.3 million on our interest-only strips and servicing rights, which we collectively refer to in this document as our securitization assets. The write down consisted of a $45.2 million reduction of pre-tax income and an $18.1 million pre-tax reduction of stockholders' equity. The write down was mainly due to actual prepayment experience that was higher than our assumptions, but was reduced by the favorable valuation impact of reducing the discount rates used to value our securitization assets at June 30, 2003. During fiscal 2002, we recorded a write down of $44.1 million on our securitization assets, consisting of a $22.1 million reduction of pre-tax income and a $22.0 million pre-tax reduction of stockholders' equity due to actual prepayment experience that was higher than anticipated. We cannot predict with certainty what our future prepayment experience will be. Any unfavorable difference between the assumptions used to value our securitization assets and our actual experience may have a significant adverse impact on the value of these assets. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Application of Critical Accounting Policies -- Impact of Changes in Critical Accounting Estimates in Prior Fiscal Years" and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Off-Balance Sheet Arrangements -- Securitizations" for information on the sensitivities of interest-only strips and servicing rights to changes in assumptions. In addition, our servicing rights (and the related fees) can be terminated under certain circumstances, such as failure to make required servicer payments, defined changes in control and reaching certain loss and delinquency levels on the underlying pool. 36 We depend upon the availability of financing to fund our continuing operations. Any failure to obtain adequate funding could hurt our ability to operate profitably and restrict our ability to repay our subordinated debt, and negatively impact the value of our common stock. For our ongoing operations, we depend upon frequent financings, including the sale of our unsecured subordinated debt and warehouse credit facilities or lines of credit. If we are unable to maintain, renew or obtain adequate funding under a warehouse credit facility, or other borrowings, including the sale of our subordinated debt, the lack of adequate funds would hinder our ability to operate profitably and restrict our ability to repay our subordinated debt upon maturity. During volatile times in the capital markets, access to financing has been severely constricted. On July 5, 2003, our $300.0 million mortgage conduit facility expired pursuant to its terms and was not renewed. In addition, further advances under a non-committed portion of one of our credit facilities were subject to the discretion of the lender and subsequent to June 30, 2003 there were no new advances under the non-committed portion. On August 20, 2003 this credit facility was amended to reduce the committed portion to $50.0 million (from $100.0 million), eliminate the non-committed portion and accelerate its expiration date from November 2003 to no later than September 30, 2003. Our ability to repay this facility upon termination is dependent on our ability to refinance the loans in one of our new facilities or our sale of loans currently warehoused in the terminating facility by September 30, 2003. On September 22, 2003, we entered into definitive agreements with a financial institution for a new $200.0 million credit facility, which requires, among other things that we obtain a written commitment for another credit facility of at least $200.0 million and close that additional facility by October 3, 2003. On September 22, 2003, we also executed a commitment letter, which includes a senior secured credit facility in the aggregate of up to $250.0 million. The commitment letter requires that we enter into a definitive agreement no later than October 17, 2003. While we anticipate that we will close this transaction by such date, we cannot assure you that these negotiations will result in a definitive agreement or that such agreement, as negotiated, will be on terms and conditions acceptable to us. In the event we are unable to close this facility or another facility within the time frame provided under the new $200.0 million credit facility described above, the lender on that facility would be under no obligation to make further advances under the terms of that facility and outstanding advances would be repaid over a period of time. Additionally, our ability to obtain alternative financing sources may be limited to the extent we have agreed to pledge our interest-only strips, which represent a significant amount of our assets, to secure the $250.0 million credit facility. See "--Recent Developments" for further discussion of these facilities. We cannot assure you that we will be successful in maintaining, replacing or obtaining alternative financing sources necessary to fund our operations, and to the extent that we are not successful, we may have to limit our loan originations or sell loans earlier than intended and restructure our operations. As a result of these liquidity issues, since June 30, 2003, we substantially reduced our loan origination volume. Limiting our originations or earlier sales of loans could hinder our ability to operate profitably or result in losses and restrict our ability to repay our subordinated debt upon maturity. Our ability to repay our subordinated debt at maturity may depend, in part, on our ability to raise new funds through the sale of additional subordinated debt. As the servicer of securitized loans, we could also incur certain additional cash requirements with respect to the securitization trusts which could increase our dependence on borrowed funds to the extent funds from non-credit sources were unavailable. If this additional cash requirement were to arise at a time when our access to borrowed funds was restricted, our ability to repay some or all of the subordinated debt as it came due could be impaired. See "-- Our securitization agreements impose obligations on us to make cash outlays which could impair our ability to operate profitably and our ability to repay the subordinated debt and negatively impact the value of our common stock" and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." 37 Because our business operations are generally not subject to regulation and examination by federal banking regulators, these protections are not available to protect investors in our subordinated debt or our stockholders. Currently, our operations are not regulated or subject to examination in the same manner as commercial banks, savings banks and thrift institutions. Our operations are not subject to the stringent regulatory requirements imposed upon the operations of those entities and are not subject to periodic compliance examinations by federal banking regulators designed to protect investors. See "Business -- Regulation" Our residential lending business is subject to government regulation and licensing requirements, as well as private litigation, which may hinder our ability to operate profitably and repay our subordinated debt, which would negatively impact the value of our common stock. Our residential lending business is subject to extensive regulation, supervision and licensing by various state departments of banking and other state, local and federal agencies. Our lending business is also subject to various laws and judicial and administrative decisions imposing requirements and restrictions on all or part of our home equity lending activities. We are also subject to examinations by state departments of banking or similar agencies in the 44 states where we are licensed or otherwise qualified with respect to originating, processing, underwriting, selling and servicing home equity loans. We are also subject to Federal Reserve Board, Federal Trade Commission, Department of Housing and Urban Development and other federal and state agency regulations related to residential mortgage lending, servicing and reporting. Failure to comply with these requirements can lead to, among other remedies, termination or suspension of licenses, rights of rescission for mortgage loans, class action lawsuits and administrative enforcement actions. In addition, we are subject to review by state attorneys general and the U.S. Department of Justice and recently received a civil subpoena from the Civil Division of the U.S. Attorney for the Eastern District of Pennsylvania. See "-- The inquiry regarding our forbearance practices by the U.S. Attorney could result in concerns regarding our loan servicing and limit our ability to sell or service our loans, sell subordinated debt, or obtain additional credit facilities, which would hinder our ability to operate profitably and repay our subordinated debt, which would negatively impact the value of our common stock." State and federal banking regulatory agencies, state attorneys general offices, the Federal Trade Commission, the U.S. Department of Justice, the U.S. Department of Housing and Urban Development and state and local governmental authorities have increased their focus on lending practices by some companies in the subprime lending industry, more commonly referred to as "predatory lending" practices. State, local and federal governmental agencies have imposed sanctions for practices, including, but not limited to, charging borrowers excessive fees, imposing higher interest rates than the borrower's credit risk warrants and failing to adequately disclose the material terms of loans to the borrowers. For example, the Pennsylvania Attorney General reviewed fees our subsidiary, HomeAmerican Credit, Inc., charged Pennsylvania customers. Although we believe that these fees were fair and in compliance with applicable federal and state 38 laws, in April 2002, we agreed to reimburse borrowers approximately $221,000 with respect to a particular fee paid by borrowers from January 1, 1999 to mid-February 2001 and to reimburse the Commonwealth of Pennsylvania $50,000 for its costs of investigation and for future public protection purposes. We discontinued charging this particular fee in mid-February 2001. As a result of these initiatives, we are unable to predict whether state, local or federal authorities will require changes in our lending practices in the future, including reimbursement of fees charged to borrowers, or will impose fines on us. These changes, if required, could impact our profitability. These laws and regulations may limit our ability to securitize loans originated in some states or localities due to rating agency, investor or market restrictions. As a result, we have limited the types of loans we offer in some states and may discontinue originating loans in other states or localities. Additionally, the United States Congress is currently considering a number of proposed bills or proposed amendments to existing laws, such as the "Ney - Lucas Responsible Lending Act of 2003" introduced on February 11, 2003 into the U.S. House of Representatives, which could affect our lending activities and make our business less profitable. These bills and amendments, if adopted as proposed, could reduce our profitability by limiting the fees we are permitted to charge, including prepayment fees, restricting the terms we are permitted to include in our loan agreements and increasing the amount of disclosure we are required to give to potential borrowers. See "Business -- Lending Activities" and "Business -- Regulation" In addition to new regulatory initiatives with respect to so-called "predatory lending" practices, current laws or regulations in some states restrict our ability to charge prepayment penalties and late fees. We have used the Federal Alternative Mortgage Transactions Parity Act of 1982, which we refer to as the Parity Act, to preempt these state laws for home equity loans which meet the definition of alternative mortgage transactions under the Parity Act. However, the Office of Thrift Supervision has adopted a rule, effective in July 2003, which precludes us and other non-bank, non-thrift creditors from using the Parity Act to preempt state prepayment penalty and late fee laws on new loan originations. Under the provisions of this rule, we are required to modify or eliminate the practice of charging prepayment and other fees in some of the states where we originate loans. We are continuing to evaluate the impact of the adoption of the new rule by the Office of Thrift Supervision on our future lending activities and results of operations. We currently expect that the percentage of home equity loans containing prepayment fees that we will originate in the future will decrease to approximately 65% to 70%, from 80% to 85% prior to this rule becoming effective. Additionally, in a recent decision, the Appellate Division of the Superior Court of New Jersey determined that the Parity Act's preemption of state law was invalid and that the state laws precluding some lenders from imposing prepayment fees are applicable to loans made in New Jersey, including alternative mortgage transactions. Although this New Jersey decision is subject to appeal and may not be final, we are currently evaluating its impact on our future lending activities in the State of New Jersey and results of operations. We are also subject, from time to time, to private litigation, including actual and purported class action suits, resulting from alleged "predatory lending" practices. Our lending subsidiaries, including HomeAmerican Credit, Inc., which does business as Upland Mortgage, are involved in class action lawsuits, other litigation, claims, investigations by governmental 39 authorities, and legal proceedings arising out of their lending and servicing activities. For example, the purported class action entitled, Calvin Hale v. HomeAmerican Credit, Inc., d/b/a Upland Mortgage, was filed on behalf of borrowers in several states alleging that the charging of, and failure to properly disclose the nature of, a document preparation fee were improper under applicable state law and ultimately settled. Due to the inherent uncertainty in litigation and because the ultimate resolution of these proceedings are influenced by factors outside of our control, our estimated liability under these proceedings may change or actual results may differ from our estimates. We expect, that as a result of the publicity surrounding "predatory lending" practices, we may be subject to other class action suits in the future. See "Business -- Legal Proceedings." We have procedures and controls to monitor compliance with numerous federal, state and local laws and regulations. However, because these laws and regulations are complex and often subject to interpretation, or as a result of inadvertent errors, we may, from time to time, inadvertently violate these laws and regulations. More restrictive laws, rules and regulations may be adopted in the future that could make compliance more difficult or expensive or we may be subject to additional litigation or governmental reviews of our lending practices which could hinder our ability to operate profitably and repay our subordinated debt, which could negatively impact the value of our common stock. See "Business -- Regulation." The inquiry regarding our forbearance practices by the U.S. Attorney could result in concerns regarding our loan servicing and limit our ability to sell or service our loans, sell subordinated debt, or obtain additional credit facilities, which would hinder our ability to operate profitably and repay our subordinated debt, which would negatively impact the value of our common stock. We received a civil subpoena, dated May 14, 2003, from the Civil Division of the United States Attorney for the Eastern District of Pennsylvania, requesting that we provide certain documents and information with respect to us and our lending subsidiaries for the period from May 1, 2000 to May 1, 2003: (i) all loan files in which we entered into a forbearance agreement with a borrower who is in default; (ii) the servicing, processing, foreclosing, and handling of delinquent loans, and non-performing loans, the carrying, processing and sale of real estate owned, and forbearance agreements; and (iii) agreements to sell or otherwise transfer mortgage loans (including but not limited to, any pooling or securitization agreements) or to obtain funds to finance the underwriting, origination or provision of mortgage loans, any transaction in which mortgage loans were sold or transferred, any instance in which we were not to service or not to act as custodian for a mortgage loan, representations and warranties made in connection with mortgage loans, secondary market loan sale schedules, and credit loss, delinquency, default, and foreclosure rates of mortgage loans. We have directed our attorneys to cooperate fully with this inquiry. Currently, this inquiry appears to be focused on our practices relating to obtaining forbearance agreements from delinquent borrowers who would otherwise be subject to foreclosure. Because the inquiry is at a preliminary stage, we cannot reach any conclusions at this time as to the ultimate scope of the inquiry or the potential liability or financial consequences for us. 40 Management believes the disclosure of the receipt of the civil subpoena, among other things, resulted in our investment bankers' decision not to underwrite our quarterly loan securitization. Our failure to complete this quarterly securitization contributed to our loss for the year ended June 30, 2003. To the extent management is unsuccessful in resolving this matter, the ongoing review by the U.S. Attorney's Office could limit our ability to engage in publicly underwritten securitization transactions or otherwise sell or service our loans. In addition, the U.S. Attorney's inquiry could reduce sales of subordinated debt upon which we rely to fund our operations and limit our ability to obtain additional credit facilities, which are necessary in connection with the implementation of our business strategy. Furthermore, the U.S. Attorney could impose sanctions or otherwise restrict our ability to restructure loans, which could negatively impact our profitability and our ability to repay the subordinated debt, which would negatively impact the value of our common stock. 41 Lending to credit-impaired borrowers may result in higher delinquencies in our managed portfolio, which could hinder our ability to operate profitably, impair our ability to repay our subordinated debt and negatively impact the value of our common stock. We market a significant portion of our loans to borrowers who are either unable or unwilling to obtain financing from traditional sources, such as commercial banks. This type of borrower is commonly referred to as a subprime borrower. Loans made to these borrowers may entail a higher risk of delinquency and loss than loans made to borrowers who use traditional financing sources. Historically, we have experienced higher rates of delinquency on loans made to these credit-impaired borrowers as compared to delinquency rates experienced by banks on loans to borrowers who are not credit-impaired. While we use underwriting standards and collection procedures designed to mitigate the higher credit risk associated with lending to these borrowers, our standards and procedures may not offer adequate protection against risks of default. Higher than anticipated delinquencies, foreclosures or losses in our managed portfolio could reduce the cash flow we receive from our securitization assets which would hinder our ability to operate profitably and could restrict our ability to repay our subordinated debt upon maturity, which would negatively impact the value of our common stock. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Managed Portfolio Quality" and "Business - -- Lending Activities." Delinquencies and prepayments in the pools of securitized loans could adversely affect the cash flow we receive from our interest-only strips, impair our ability to sell or securitize loans in the future and impair our ability to repay the subordinated debt and negatively impact the value of our common stock. Levels of delinquencies or losses in a particular securitized pool of loans, which exceed maximum percentage limits, or "triggers," set in the securitization agreement governing that pool, impact some or all of the cash that we would otherwise receive from our interest-only strips. If delinquencies or losses exceed maximum limits, the securitization trust withholds cash from our interest-only strips. The trust then uses the cash to repay outside investors, which reduces the proportionate interest of outside investors in the pool and results in additional overcollateralization. Additionally, for losses, the securitization trust utilizes cash from our interest-only strips to pay off investors. Our receipt of cash payments on the interest-only strip resumes when the additional overcollateralization created for outside investors meets specified targets or delinquency and loss rates for the pool of loans no longer exceed trigger levels. However, to adequately fund our ongoing operations during a period of suspended cash flow, we may need to borrow funds to replace the cash being withheld. The additional interest expense would hinder our ability to operate profitably and could impair our ability to repay subordinated debt as it matures and negatively impact the value of our common stock. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Off-Balance Sheet Arrangements -- Trigger Management." We have the ability to repurchase a limited number of delinquent loans from securitized pools. This ability to repurchase loans enables us to avoid disruptions in securitization cash flows by repurchasing delinquent loans before trigger limits are reached, or to restore suspended cash flows by repurchasing sufficient delinquent loans to lower delinquency and loss rates below trigger limits. However, the repurchase of loans for this purpose, called "trigger management," would require funding from the same sources we rely on for our other cash needs and could require us to borrow additional funds. If funds were not available to permit us to repurchase these loans, our cash flow from the interest-only strips would be reduced and our ability to repay the subordinated 42 debt could be impaired. Lack of liquidity in these circumstances could result in more pools reaching trigger levels, which, in turn, would further tighten liquidity. In addition, the additional interest expense resulting from additional outstanding debt would reduce our profitability and could impair our ability to repay subordinated debt as it matures. We depend upon the availability of financing to fund our continuing operations. Any failure to obtain adequate funding could hurt our profitability and restrict our ability to repay our subordinated debt, which could negatively impact the value of our common stock. See "-- We depend upon the availability of financing to fund our continuing operations. Any failure to obtain adequate funding could hurt our ability to operate profitably and restrict our ability to repay our subordinated debt which could negatively impact the value of our common stock." Prepayments by borrowers also make it more difficult for us to maintain delinquencies below trigger limits set in securitization agreements. By reducing current loans in a securitized pool, prepayments mathematically increase the percentage of delinquent loans remaining in the pool. The consequences resulting from either a suspension of cash flow or our repurchase of delinquent loans from the securitized pool could impair our ability to repay subordinated debt, which could negatively impact the value of our common stock. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Off-Balance Sheet Arrangements -- Securitizations -- Trigger Management," "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Managed Portfolio Quality" and "Business -- Lending Activities." For the fiscal year ended June 30, 2003, we repurchased delinquent loans with an aggregate unpaid principal balance of $55.0 million from securitization trusts primarily for trigger management. We received $37.6 million of proceeds from the liquidation of repurchased loans and real estate owned during fiscal year 2003. We had repurchased loans and real estate owned remaining on our balance sheet of $9.6 million at June 30, 2003. All loans and real estate owned were repurchased at the contractual outstanding balances at the time of repurchase and are carried at the lower of their cost basis or fair value. Because the contractual outstanding balance is typically greater than the fair value, we generally incur a loss on these repurchases. An interruption or reduction in the securitization or whole loan sale markets would hinder our ability to operate profitably and repay our subordinated debt when due, which could negatively impact the value of our common stock. A significant portion of our revenue and net income represents gain on the sale of loans. Our strategy is to sell substantially all of the loans we originate at least quarterly. Operating results for a given period can fluctuate significantly as a result of the timing and size of securitizations or whole loan sales. If we do not close securitizations or whole loan sales on a quarterly basis, we could experience a loss for that quarter. In addition, we rely on the quarterly sale of our loans to generate cash proceeds for the repayment of our warehouse credit facilities and origination of additional loans. Our ability to complete securitizations depends on several factors, including: o conditions in the securities markets generally, including market interest rates; o conditions in the asset-backed securities markets specifically; o general economic conditions, including conditions in the subprime industry; o the performance of our previously securitized loans; o the credit quality of our managed portfolio; and o changes in federal tax laws. 43 If we are not able to sell substantially all of the loans that we originate during the quarter in which the loans are made, we would likely not be profitable for the quarter. Any substantial impairment in the size or availability of the market for our loans could result in our inability to continue to originate loans and repay our subordinated debt upon maturity which would have a material adverse effect on our results of operations, financial condition and business prospects. If it is not possible or economical for us to complete a securitization or whole loan sale within favorable timeframes, we may exceed our capacity under our warehouse financing and lines of credit. We may be required to sell the accumulated loans at a time when market conditions for our loans are less favorable, and potentially to incur a loss on the sale transaction. If we cannot generate sufficient liquidity upon any such loan sale or through the sale of subordinated debt, we will be required to restrict or restructure our operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources" and "Business -- Securitizations." If we are unable to successfully implement our adjusted business strategy which focuses on whole loan sales, we may be unable to attain profitable operations which could impair our ability to repay our subordinated debt and negatively impact the value of our common stock. Our adjusted business strategy seeks to increase our loan volume by broadening our loan product line, offering competitive interest rates and through further development of existing markets while maintaining our origination fees, underwriting criteria and the interest rate spread between loan interest rates and the interest rates we pay for capital. Implementation of this strategy will depend in large part on our ability to: o Expand in markets with a sufficient concentration of borrowers who meet our underwriting criteria; o Obtain and maintain adequate financing on favorable terms to fund our operations; o Profitably sell and securitize our loans in the secondary market on a regular basis; o Hire, train and retain skilled employees; and o Successfully implement our marketing campaigns. Our inability to achieve any or all of these factors could impair our ability to successfully implement our business strategy and successfully leverage our fixed costs which could hinder our ability to operate profitably, result in continued losses and impair our ability to repay our subordinated debt, which would negatively impact the value of our common stock. Changes in interest rates could negatively impact our ability to operate profitably and impair our ability to repay the subordinated debt and negatively impact the value of our common stock. Rising interest rates could reduce our overall profitability in one or more of the following ways: o Reducing the demand for our loan products, which could reduce our profitability. o Causing investors in asset-backed securities to increase the interest rate spread requirements and overcollateralization requirements for our future securitizations, which could reduce the profitability of our securitizations. o Increasing interest rates required by purchasers of our loans in whole loan sales. o Reducing the spread between the interest rates we receive on loans we originate and the interest rates we pay to fund the originations, which among other effects, increases our carrying costs for these loans during the period they are being pooled for securitization. o Increasing the interest rates we must pay on our subordinated debt to attract investors at the levels we require to fund our operations. o Increasing our interest expense on all sources of borrowed funds, such as subordinated debt, credit facilities and lines of credit, and could restrict our access to the capital markets. o Negatively impacting the value and profitability of loans from the date of origination until the date we sell the loans. o Reducing the spread between the average interest rate on the loans in a securitization pool and the pass-through interest rate to investors issued in connection with the securitization. This reduction in the spread occurs because interest rates on loans in a securitization pool are typically set over the three months preceding a securitization while the pass-through rate on securities issued in the securitization is based on market rates at the time a securitization is priced. Therefore, if market interest rates 44 required by investors increase prior to securitization of the loans, the interest rate spread between the average interest rate on the loans and the pass-through interest rate to investors may be reduced or eliminated. This factor would reduce our profit on the sale of the loans. Any reduction in our profitability could impair our ability to repay our subordinated debt upon maturity. o Increasing the cost of floating rate certificates issued in certain securitizations without a corresponding increase in the interest income of the underlying fixed rate loan collateral. This situation would reduce the cash flow we receive from the interest-only strips related to those securitizations and reduce the fair value or expected future cash flow of that asset as well. At June 30, 2003, floating interest rate certificates represent 3.5% of total debt issued by loan securitization trusts. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-- Interest Rate Risk Management" for further discussion of the impact on our interest-only strips of interest rate changes in floating interest rate certificates issued by securitization trusts and outstanding debt issued by the securitization trusts. Declining interest rates could reduce our profitability in one or more of the following ways: o Subordinated debt with terms of one year or more which is not redeemable at our option represents an unfavorable source of borrowing in an environment where market rates fall below those paid on the subordinated debt. At June 30, 2003, $97.5 million in non-redeemable subordinated debt with maturities of greater than one year was outstanding. o A decline in market interest rates generally induces borrowers to refinance their loans, which are held in the securitization trusts, and could reduce our profitability. Prepayment levels in excess of our assumptions reduce the value of our securitization assets. A significant decline in market interest rates would increase the level of loan prepayments, which would decrease the size of the total managed loan portfolio and the related projected cash flows. Higher than anticipated rates of loan prepayments could require a write down of the fair value of the related interest-only strips and servicing rights, adversely impacting earnings during the period of adjustment which would result in a reduction in our profitability and could impair our ability to repay our subordinated debt. See "-- Our estimates of the value of interest-only strips and servicing rights we retain when we securitize loans could be inaccurate and could limit our ability to operate profitably and impair our ability to repay our subordinated debt, which could negatively impact the value of our common stock." Although both rising and falling interest rates negatively impact our business and profitability, the speed at which rates fluctuate, the duration of high or low interest rate environments and the nature and magnitude of any favorable interest rate consequences, as well as economic events and business conditions outside of our control, affect the overall manner in which interest rate changes impact our operations and the magnitude of such impact. In addition, because of the volatile and unpredictable manner in which these factors interact, we may experience interest rate risks in the future that we have not previously experienced or identified. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Interest Rate Risk Management." 45 Our securitization agreements impose obligations on us to make cash outlays which could impair our ability to operate profitably and our ability to repay the subordinated debt and negatively impact the value of our common stock. Our securitization agreements require us to replace or repurchase loans which do not conform to representations and warranties we made in the agreements. Additionally, as servicer, we are required to: o compensate investors for interest shortfalls on loan prepayments (up to the amount of the related servicing fee); and o advance interest payments for delinquent loans if we believe in good faith the advances will ultimately be recoverable by the securitization trust. These advances can first be made out of funds available in the trusts' collection accounts. If the funds available from the trusts' collection accounts are insufficient to make the required advances, then we are required to make the advances from our operating cash. The advances made from the trusts' collection accounts, if not recovered from the borrowers or proceeds from the liquidation of the loans, require reimbursement from us. These advances, if ultimately not recoverable by us, require funding from our capital resources and may create greater demands on our cash flow, which could limit our ability to repay subordinated debt as it comes due and negatively impact the value of our common stock. See "Business -- Securitizations." Our servicing rights may be terminated if we fail to satisfactorily perform our servicing obligations, or fail to meet minimum net worth requirements or financial covenants which could hinder our ability to operate profitably and impair our ability to repay our subordinated debt, which would negatively impact the value of our common stock. As part of the securitization of our loans, we generally retain the servicing rights, which is the right to service the loans for a fee. At June 30, 2003, 92.7% of the managed portfolio we serviced was owned by third parties. The value of servicing rights related to our managed portfolio is an asset on our balance sheet called servicing rights. We enter into agreements in connection with the securitizations that allow third parties to terminate us as the servicer if we breach our servicing obligations, fail to perform satisfactorily or fail to meet a minimum net worth requirement or other financial covenants. For example, our servicing rights may be terminated if losses on the pool of loans in a particular securitization exceed prescribed levels for specified periods of time. If we lose the right to service some or all of the loans in our managed portfolio, the servicing fees will no longer be paid to us and we would be required to write down or write off this asset, which would decrease our earnings and our net worth, impair our ability to repay the subordinated debt and negatively impact the value of our common stock. In addition, if we do not meet eligibility criteria to act as servicer in future securitizations, we would not receive income from these future servicing rights. If we are not able to sustain the levels of loan originations that we experienced in the past, we may be unable to attain profitable operations and our ability to repay our subordinated debt may be impaired, which would negatively impact the value of our common stock. During fiscal 2003 and 2002, we experienced record levels of loan originations. Our ability to sustain the levels of loan originations experienced in prior periods depends upon a variety of factors outside our control, including: o interest rates; o ability to obtain adequate financing on favorable terms; o conditions in the asset-backed securities markets; o economic conditions in our primary market area; o competition; and o regulatory restrictions. In addition, current economic conditions have had an adverse impact on smaller businesses and finding qualified borrowers has become more difficult. If we are unable to sustain our levels of loan originations, we may be unable to attain profitable operations and our ability to repay the subordinated debt upon maturity may be impaired. See " -- Changes in interest rates could negatively impact our ability to operate profitably and impair our ability to repay the subordinated debt and negatively impact the value of our common stock." and "Management's Discussion and Analysis of Financial Condition and Results of Operations." 46 A decline in real estate values could result in a reduction in originations, which could hinder our ability to attain profitable operations, impair our ability to repay our subordinated debt and negatively impact the value of our common stock. Our business may be adversely affected by declining real estate values. Any significant decline in real estate values reduces the ability of borrowers to use home equity as collateral for borrowings. This reduction in real estate values may reduce the number of loans we are able to make, which will reduce the gain on sale of loans and servicing and origination fees we will collect, which could hinder our ability to attain profitable operations and limit our ability to repay our subordinated debt upon maturity and negatively impact the value of our common stock. See "-- Lending Activities." A decline in value of the collateral securing our loans could result in an increase in losses on foreclosure, which could hinder our ability to attain profitable operations, limit our ability to repay our subordinated debt and negatively impact the value of our common stock. Declining real estate values will also increase the loan-to-value ratios of loans we previously made, which in turn, increases the probability of a loss in the event the borrower defaults and we have to sell the mortgaged property. In addition, delinquencies, foreclosures on loans and losses from delinquent and foreclosed loans generally increase during economic slowdowns or recessions, and the increase in delinquencies, foreclosures on loans and losses from delinquent and foreclosed loans we experience may be particularly pronounced because we lend to credit-impaired borrowers. As a result, the market value of the real estate or other collateral underlying our loans may not, at any given time, be sufficient to satisfy the outstanding principal amount of the loans which could hinder our ability to attain profitable operations and limit our ability to repay our subordinated debt. In addition, any sustained period of increased delinquencies, foreclosures or losses from delinquent and foreclosed loans could adversely affect our ability to sell loans, the prices we receive for our loans or the value of our interest-only strips which could have a material adverse effect on our results of operations, financial condition and business prospects. See "Business -- Lending Activities." 47 If we are unable to implement an effective hedging strategy, we may be unable to attain profitable operations, which would reduce the funds we have available to repay our subordinated debt and negatively impact the value of our common stock. In a declining interest rate environment, even an effective hedging strategy could result in losses in the current period. From time to time we use hedging strategies in an attempt to mitigate the effect of changes in interest rates on our fixed interest rate mortgage loans prior to securitization. These strategies may involve the use of, among other things, derivative financial instruments including futures, interest rate swaps and forward pricing of securitizations. An effective hedging strategy is complex and no strategy can completely insulate us from interest rate risk. In fact, poorly designed strategies or improperly executed transactions may increase rather than mitigate interest rate risk. Hedging involves transaction and other costs, and these costs could increase as the period covered by the hedging protection increases or in periods of rising and fluctuating interest rates. We recorded losses on the fair value of derivative financial instruments of $14.2 million during fiscal 2003, $9.4 million in fiscal 2002 and $4.3 million in fiscal 2001. The amount of losses settled in cash was $7.7 million in fiscal 2003, $9.4 million in fiscal 2002 and $4.3 million in fiscal 2001. In addition, an interest rate hedging strategy may not be effective against the risk that the interest rate spread needed to attract potential buyers of asset-backed securities may widen. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Interest Rate Risk Management." Competition from other lenders could adversely affect our ability to attain profitable operations and our ability to repay our subordinated debt and negatively impact the value of our common stock. The lending markets in which we compete are evolving. Some competitors have been acquired by companies with substantially greater resources, lower cost of funds, and a more established market presence than we have. Government sponsored entities are expanding their participation in our market. In addition, we have experienced increased competition over the Internet, where barriers to entry are relatively low. If these companies or entities increase their marketing efforts to include our market niche of borrowers, we may be forced to reduce the interest rates and fees we currently charge in order to maintain and expand our market share. Any reduction in our interest rates or fees could have an adverse impact on our profitability and our ability to repay our subordinated debt. As we expand our business further, we will face a significant number of new competitors, many of whom are well established in the markets we seek to penetrate. The profitability of other similar lenders may attract additional competitors into this market. The competition in the subprime lending industry has also led to rapid technological developments, evolving industry standards, and frequent releases of new products and enhancements. As loan products are offered more widely through alternative distribution channels, such as the Internet, we may be required to make significant changes to our current retail structure, broker structure and information systems to compete effectively. Our ability to adapt to other technological changes in the industry could have a material adverse effect on our business. 48 The need to maintain loan volume in this competitive environment creates a risk of price competition in the subprime lending industry. Competition in the industry can take many forms, including interest rates and costs of a loan, convenience in obtaining a loan, customer service, amount and term of a loan, marketing and distribution channels, and competition in attracting and retaining qualified employees. Price competition would lower the interest rates that we are able to charge borrowers, which would lower our interest income. Price-cutting or discounting reduces profits and will depress earnings if sustained for any length of time. Increased competition may also reduce the volume of our loan originations and result in a decrease in gain on sale from the securitization or sale of such loans which would decrease our income. As a result, any increase in these pricing pressures could have a material adverse effect on our business. See "Business -- Competition." An economic downturn or recession in the eastern half of the United States could hinder our ability to operate profitably, which would reduce the funds available to repay the subordinated debt and negatively impact the value of our common stock. We currently originate loans primarily in the eastern half of the United States. The concentration of loans in a specific geographic region subjects us to the risk that a downturn in the economy or recession in the eastern half of the country would more greatly affect us than if our lending business were more geographically diversified. As a result, an economic downturn or recession in this region could result in decreases in loan originations and increases in delinquencies and foreclosures in our managed portfolio which could negatively impact our ability to sell or securitize loans and hinder our ability to operate profitably and the funds available to repay our subordinated debt which could negatively impact the value of our common stock. See "-- Our securitization agreements impose obligations on us to make cash outlays which could impair our ability to operate profitably and our ability to repay the subordinated debt and negatively impact the value of our common stock." and "Business -- Lending Activities." 49 Claims by borrowers or investors in loans could hinder our ability to operate profitably, which would reduce the funds we have available to repay our subordinated debt and negatively impact the value of our common stock. In the ordinary course of our business, we are subject to claims made against us by borrowers and investors in loans arising from, among other things: o losses that are claimed to have been incurred as a result of alleged breaches of fiduciary obligations, misrepresentation, error and omission by our employees, officers and agents (including our appraisers); o incomplete documentation; and o failure to comply with various laws and regulations applicable to our business. If claims asserted, pending legal actions or judgments against us result in legal expenses or liability, these expenses could hinder our ability to operate profitably, which would reduce funds available to repay our subordinated debt. See "Business -- Legal Proceedings." If we are unable to realize cash proceeds from the sale of loans in excess of the cost to originate the loans, our financial position and our ability to repay the subordinated debt upon maturity could be adversely affected, which could negatively impact the value of our common stock. The net cash proceeds received from loan sales consist of the premiums we receive on sales of loans in excess of the outstanding principal balance, plus the cash proceeds we receive from securitizations, minus the discounts on loans that we have to sell for less than the outstanding principal balance. If we are unable to originate loans at a cost lower than the cash proceeds realized from loan sales, our results of operations, financial condition, business prospects and ability to repay the subordinated debt upon maturity could be adversely affected. The amount of our outstanding debt could impair our financial condition, our ability to fulfill our debt obligations and repay the subordinated debt, which would negatively impact the value of our common stock. As of June 30, 2003, we had total indebtedness of approximately $932.5 million, comprised of amounts outstanding under our credit facilities, warehouse lines, subordinated debt and capitalized lease obligations. At June 30, 2003, our ratio of total debt and liabilities to equity was approximately 26.5 to 1. At June 30, 2003, we also had availability to incur additional indebtedness of approximately $30.2 million under our revolving warehouse and credit facilities. The amount of our outstanding indebtedness could: o require us to dedicate a substantial portion of our cash flow to payment on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures and other general corporate requirements; o limit our flexibility in planning for, or reacting to, changes in operations and the subprime industry in which we operate; and o place us at a competitive disadvantage compared to our competitors that have proportionately less debt. If we are unable to meet our debt service obligations, we could be forced to restructure or refinance our indebtedness, seek additional equity capital or sell assets. Our ability to obtain additional financing could be limited to the extent that our interest-only strips, which represent a significant portion of our assets, are pledged to secure existing debt. Our inability to obtain financing or sell assets on satisfactory terms could impair our ability to operate profitably and our ability to repay the subordinated debt which would negatively impact the value of our common stock. 50 Restrictive covenants in the agreements governing our indebtedness may reduce our operating flexibility, limit our ability to operate profitably and our ability to repay our subordinated debt, which could negatively impact the value of our common stock. The agreements governing our credit facilities and warehouse lines of credit contain various covenants that may restrict our ability to: o incur other senior indebtedness; o engage in transactions with affiliates; o incur liens; o make certain restricted payments; o enter into certain business combinations and asset sale transactions; o engage in new lines of business; and o make certain investments. These restrictions may limit our ability to obtain future financings, make needed capital expenditures, withstand a future downturn in our business or the economy in general, conduct operations or otherwise take advantage of business opportunities that may arise. Our credit facilities and warehouse lines of credit also require us to maintain specified financial ratio covenants and satisfy other financial conditions. Our ability to meet those ratio covenants and conditions can be affected by events beyond our control, such as interest rates and general economic conditions. Pursuant to the terms of these credit facilities, the failure to comply with the financial covenants constitutes an event of default and at the option of the lender, entitles the lender to, among other things, terminate commitments to make future advances to us, declare all or a portion of the loan due and payable, foreclose on the collateral securing the loan, require servicing payments be made to the lender or other third party or assume the servicing of the loans securing the credit facility. As a result of the loss experienced during fiscal 2003, we were not in compliance with the terms of certain of the financial covenants under two of our principal credit facilities (one for $50.0 million and the other for $200.0 million, of which $100.0 million was non-committed) and we requested and obtained waivers of these requirements from our lenders. The lender under the $50.0 million warehouse credit facility has granted us a waiver for our non-compliance with a financial covenant in that credit facility through September 30, 2003. This facility was amended to reduce the available credit to $8.0 million and the financial covenants were replaced with new covenants with which we are currently in compliance. We also entered into an amendment to the $200.0 million credit facility which provides for the waiver of our non-compliance with the financial covenants in that facility, the reduction of the committed portion of this facility from $100.0 million to $50.0 million, the elimination of the $100.0 million non-committed portion of this credit facility and the acceleration of the termination date of this facility from November 2003 to September 30, 2003. Our ability to repay this facility upon termination is dependent on our ability to refinance the loans in one of our new facilities or our sale of loans currently warehoused in the terminating facility by September 30, 2003. In addition, if the anticipated loss for the first quarter of fiscal 2004 described above results in our non-compliance with any financial covenants, we intend to seek the appropriate waivers. There can be no assurances that we will obtain any of these waivers. We may also need to obtain additional waivers in future periods from our lenders but we cannot give you any assurances as to whether or in what form these waivers will be granted. Our breach of our financial covenants under our revolving credit facilities could result in a default under the terms of those facilities, which could cause that indebtedness and other senior indebtedness, by reason of cross-default provisions in such indebtedness, to become immediately due and payable. Our failure to repay those amounts could result in a bankruptcy proceeding or liquidation proceeding or our lenders could proceed against the collateral granted to them to secure that indebtedness. If the lenders under the credit facilities and warehouse lines of credit accelerate the repayment of borrowings, we may not have sufficient cash to repay our indebtedness and may be forced to sell assets on less than optimal terms and conditions which would negatively impact the value of our common stock. 51 We are dependent on financial institutions and brokers for 50.7% of our loan production and our failure to maintain these relationships could negatively impact the volume and pricing of our loans and adversely affect our results of operations and ability to repay subordinated debt, which could negatively impact the value of our common stock. We depend on financial institutions who enter into agreements with us under the Bank Alliance Services program and brokers for 50.7% of our loan originations. Moreover, our total loan purchases from Bank Alliance Services lenders, historically, have been highly concentrated. Our top three financial institutions under the Bank Alliance Services program accounted for approximately 96.1% of our loan volume from the Bank Alliance Services program and 11.6% of our total volume for fiscal 2003. Further, our competitors also have relationships with our brokers and other lenders, and actively compete with us in our efforts to expand our broker and Bank Alliance networks. Accordingly, we cannot assure you that we will be successful in maintaining our existing relationships or expanding our broker and Bank Alliance networks which could negatively impact the volume and pricing of our loans, which could have a material adverse effect on our results of operations. Some of our warehouse financing agreements include margin calls based on the lender's opinion of the value of our loan collateral. An unanticipated large margin call could adversely affect our liquidity and our ability to repay the subordinated debt upon maturity, which could negatively impact the value of our common stock. The amount of financing we receive under our warehouse agreements depends in large part on the lender's valuation of the mortgage loans that secure the financings. Each warehouse line provides the lender the right, under certain circumstances, to reevaluate the loan collateral that secures our outstanding borrowings at any time. In the event the lender determines that the value of the loan collateral has decreased, it has the right to initiate a margin call. A margin call would require us to provide the lender with additional collateral or to repay a portion of the outstanding borrowing. Any such margin call could have a material adverse effect on our results of operations, financial condition and business prospects and our ability to repay the subordinated debt upon maturity, which could negatively impact the value of our common stock. Environmental laws and regulations and other environmental considerations may restrict our ability to foreclose on loans secured by real estate or increase costs associated with those loans which could hinder our ability to operate profitably and limit the funds available to repay our subordinated debt and negatively impact the value of our common stock. Our ability to foreclose on the real estate collateralizing our loans may be limited by environmental laws which pertain primarily to commercial properties that require a current or previous owner or operator of real property to investigate and clean up hazardous or toxic substances or chemical releases on the property. In addition, the owner or operator may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and cleanup costs relating to the contaminated property. While we would not knowingly make a loan collateralized by real property that was contaminated, we may not discover the environmental contamination until after we had made the loan or after we had foreclosed on a loan. If we foreclosed upon a property and environmental liabilities subsequently arose, we could face significant liability. 52 Since the commencement of operations by the Company, there have been approximately eight instances where we have determined not to foreclose on the real estate collateralizing a delinquent loan because of environmental considerations. None are currently under administration. Any losses we sustained on these loans did not have a material adverse effect on our profitability. In addition to federal or state laws, owners or former owners of a contaminated site may be subject to common law claims, including tort claims, by third parties based on damages and costs resulting from environmental contamination migrating from the property. Other environmental considerations, such as pervasive mold infestation of real estate securing our loans, may also restrict our ability to foreclose on delinquent loans. See "Business -- Loan Servicing and Administrative Procedures." Terrorist attacks in the United States may cause disruption in our business and operations and other attacks or acts of war may adversely affect the markets in which our common stock trades, the markets in which we operate, our ability to operate profitably and our ability to repay our subordinated debt, which would negatively impact the value of our common stock. Terrorists' attacks in the United States in September 2001 caused major instability in the U.S. financial markets. These attacks or new events and responses on behalf of the U.S. government may lead to further armed hostilities or to further acts of terrorism in the U.S. which may cause a further decline in the financial market and may contribute to a further decline in economic conditions. These events may cause disruption in our business and operations including reductions in demand for our loan products and our subordinated debt, increases in delinquencies and credit losses in our managed loan portfolio, changes in historical prepayment patterns and declines in real estate collateral values. To the extent we experience an economic downturn, unusual economic patterns and unprecedented behaviors in financial markets, these developments may affect our ability to originate loans at profitable interest rates, to price future loan securitizations profitably, to effect whole loan sales and to effectively hedge our loan portfolio against market interest rate changes which could cause our stock price to decline. Should these disruptions and unusual activities occur, our ability to operate profitably and cash flow could be reduced and our ability to make principal and interest payments on our subordinated debt could be impaired which would negatively impact the value of our common stock. If many of our borrowers become subject to the Soldiers' and Sailors' Civil Relief Act of 1940, our cash flows and interest income may be adversely affected which would negatively impact our ability to repay our subordinated debt and negatively impact the value of our common stock. Under the Soldiers' and Sailors' Civil Relief Act of 1940, a borrower who enters military service after the origination of his or her loan generally may not be charged interest above an annual rate of six percent. Additionally, this Relief Act may restrict or delay our ability to foreclose on an affected loan during the borrower's active duty status. The Relief Act also applies to a borrower who was on reserve status and is called to active duty after origination of the loan. A significant mobilization by the U.S. Armed Forces could increase the number of our borrowers who are the subject of this Relief Act, thereby reducing our cash flow and the interest payments we collect from those borrowers, and in the event of default, delaying or preventing us from exercising the remedies for default that otherwise would be available to us. 53 We are subject to losses due to fraudulent and negligent acts on the part of loan applicants, mortgage brokers, other vendors and our employees which could hinder our ability to operate profitably, impair our ability to repay the subordinated debt and negatively impact the value of our common stock. When we originate mortgage loans, we rely heavily upon information supplied by third parties including the information contained in the loan application, property appraisal, title information and employment and income documentation. If any of this information is intentionally or negligently misrepresented and such misrepresentation is not detected prior to loan funding, the value of the loan may be significantly lower than expected. Whether a misrepresentation or fraudulent act is made by the loan applicant, the mortgage broker, another third party or one of our employees, we generally bear the risk of loss. A loan subject to a material misrepresentation or fraudulent act is typically unsaleable or subject to repurchase if it is sold prior to detection, such persons and entities are often difficult to locate and it is often difficult to collect any monetary losses we have suffered from them. We have controls and processes designed to help us identify misrepresented or fraudulent information in our loan origination operations. We cannot assure you, however, that we have detected or will detect all misrepresented or fraudulent information in our loan originations. Employees At June 30, 2003, we employed 1,095 people on a full-time basis and 24 employees on a part-time basis. None of our employees are covered by a collective bargaining agreement. We consider our employee relations to be good. Between June 30, 2003 and August 14, 2003, we reduced our workforce by 170 employees as part of adjustments made to our business strategy. See" -- Business Strategy." 54 Executive Officers Who Are Not Also Directors The following is a description of the business experience of our executive officers who are not also directors. Beverly Santilli, age 44, is First Executive Vice President, a position she has held since September 1998 and Secretary, a position she has held since our inception. Mrs. Santilli has held a variety of positions including Executive Vice President and Vice President. Mrs. Santilli is also the President of American Business Credit. Mrs. Santilli is responsible for all sales, marketing and the day-to-day operation of American Business Credit. Mrs. Santilli is also responsible for human resources of American Business Financial Services, Inc. and its subsidiaries. Prior to joining American Business Credit and from September 1984 to November 1987, Mrs. Santilli was affiliated with PSFS initially as an Account Executive and later as a Commercial Lending Officer with that bank's Private Banking Group. Mrs. Santilli is the wife of Anthony J. Santilli. Jeffrey M. Ruben, age 40, is Executive Vice President, a position he has held since September 1998. Mr. Ruben was general counsel from April 1992 to April 2001. He is also Executive Vice President of some of our subsidiaries, positions he has held since April 1992. Mr. Ruben is responsible for the loan servicing and collections departments, the asset allocation unit and the legal department. Mr. Ruben served as Vice President from April 1992 to 1995 and Senior Vice President from 1995 to 1998. From June 1990 until he joined us in April 1992, Mr. Ruben was an attorney with the law firm of Klehr, Harrison, Harvey, Branzburg & Ellers in Philadelphia, Pennsylvania. From December 1987 until June 1990, Mr. Ruben was employed as a credit analyst with the CIT Group Equipment Financing, Inc. Mr. Ruben is a member of the Pennsylvania and New Jersey Bar Associations. Mr. Ruben holds a New Jersey Mortgage Banker License and a New Jersey Secondary Mortgage Banker License. Albert W. Mandia, age 56, is Executive Vice President and Chief Financial Officer of American Business Financial Services, Inc., positions he has held since June 1998 and October 1998, respectively. Mr. Mandia is responsible for all financial, treasury, information systems, facilities and investor relations functions. Mr. Mandia also has responsibility for American Business Mortgage Services Broker Division. From 1974 to 1998, Mr. Mandia was associated with CoreStates Financial Corp. where he last held the position of Chief Financial Officer from February 1997 to April 1998. Milton Riseman, age 66, was formerly the Chairman of our Consumer Mortgage Group. Mr. Riseman held that position from the time he joined the Company in June 1999 until his resignation on July 2, 2003. Currently, Mr. Riseman serves as a consultant to us. As Chairman of the Consumer Mortgage Group, Mr. Riseman was responsible for the sales, marketing and day-to-day management of Upland Mortgage's retail operation and he held supervisory responsibility for the Bank Alliance Services program. From February 1994 until he joined the Company, Mr. Riseman served as President of Advanta Mortgage. Mr. Riseman joined Advanta in 1992 as Senior Vice President, Administration. From 1965 until 1992, Mr. Riseman served in various capacities at Citicorp, including serving as President of Citicorp Acceptance Corp. from 1986 to 1992. 55 Item 2. Properties Except for real estate acquired in foreclosure in the normal course of our business, we do not presently hold title to any real estate for operating purposes. The interests which we presently hold in real estate are in the form of mortgages against parcels of real estate owned by our borrowers or their affiliates and real estate acquired through foreclosure. We moved our corporate headquarters from Bala Cynwyd, Pennsylvania to Philadelphia, Pennsylvania on July 7, 2003. We lease office space for our corporate headquarters in Philadelphia, Pennsylvania. The current lease term expires in June 2014. The terms of the rental agreement require increased payments annually for the term of the lease with average minimum annual rental payments of $4.2 million. We have entered into contracts, or may engage parties in the future, related to the relocation of our corporate headquarters such as contracts for building improvements to the leased space, office furniture and equipment and moving services. The provisions of the lease and local and state grants will provide us with reimbursement of a substantial amount of our costs related to the relocation, subject to certain conditions and limitations. We do not believe our unreimbursed expenses or unreimbursed cash outlay related to the relocation will be material to our operations. The lease requires us to maintain a letter of credit in favor of the landlord to secure our obligations to the landlord throughout the term of the lease. The amount of the letter of credit is $8.0 million and declines over time to $4.0 million. The letter of credit is currently issued by JPMorgan Chase Bank under our $8.0 million facility with JPMorgan Chase Bank. We continue to lease some office space in Bala Cynwyd under a five-year lease expiring in November 2004 at an annual rental of approximately $0.7 million. We perform our loan servicing and collection activities at this office, but expect to relocate these activities to our Philadelphia office. In May 2003, we moved our regional processing center to a different location in Roseland, New Jersey. We lease the office space in Roseland, New Jersey and the nine-year lease expires in January 2012. The terms of the rental agreement require increased payments periodically for the term of the lease with average minimum annual rental payments of $0.8 million. The expenses and cash outlay related to the relocation were not material to our operations. Item 3. Legal Proceedings On February 26, 2002, a purported class action titled Calvin Hale v. HomeAmerican Credit, Inc., No. 02 C 1606, United States District Court for the Northern District of Illinois, was filed in the Circuit Court of Cook County, Illinois (subsequently removed by Upland Mortgage to the captioned federal court) against our subsidiary, HomeAmerican Credit, Inc., which does business as Upland Mortgage, on behalf of borrowers in Illinois, Indiana, Michigan and Wisconsin who paid a document preparation fee on loans originated since February 4, 1997. The case consisted of three purported class action counts and two individual counts. The plaintiff alleged that the charging of, and the failure to properly disclose the nature of, a document preparation fee were improper under applicable state law. In November 2002 the Illinois Federal District Court dismissed the three class action counts and an agreement in principle was reached in August 2003 to settle the matter. The terms of the settlement have been finalized and did not have a material effect on our consolidated financial position or results of operations. 56 Our lending subsidiaries, including HomeAmerican Credit, Inc. which does business as Upland Mortgage, are involved, from time to time, in class action lawsuits, other litigation, claims, investigations by governmental authorities, and legal proceedings arising out of their lending and servicing activities, including the purported class action entitled, Calvin Hale v. HomeAmerican Credit, Inc., d/b/a Upland Mortgage, described above. Due to our current expectation regarding the ultimate resolution of these actions, management believes that the liabilities resulting from these actions will not have a material adverse effect on our consolidated financial position or results of operations. However, due to the inherent uncertainty in litigation and because the ultimate resolution of these proceedings are influenced by factors outside of our control, our estimated liability under these proceedings may change or actual results may differ from our estimates. Additionally, court decisions in litigation to which we are not a party may also affect our lending activities and could subject us to litigation in the future. For example, in Glukowsky v. Equity One, Inc., (Docket No. A-3202 - 01T3), dated April 24, 2003, to which we are not a party, the Appellate Division of the Superior Court of New Jersey determined that the Parity Act's preemption of state law was invalid and that the state laws precluding some lenders from imposing prepayment fees are applicable to loans made in New Jersey. We expect that, as a result of the publicity surrounding predatory lending practices and this recent New Jersey court decision regarding the Parity Act, we may be subject to other class action suits in the future. In addition, from time to time, we are involved as plaintiff or defendant in various other legal proceedings arising in the normal course of our business. While we cannot predict the ultimate outcome of these various legal proceedings, management believes that the resolution of these legal actions should not have a material effect on our financial position, results of operations or liquidity. Item 4. Submission of Matters to a Vote of Security Holders No matter was submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the quarter ended June 30, 2003. 57 PART II Item 5. Market for Registrant's Common Stock and Related Stockholder Matters Our common stock is currently traded on the NASDAQ National Market System under the symbol "ABFI." Our common stock began trading on the NASDAQ National Market System on February 14, 1997. The following table sets forth the high and low sales prices of our common stock for the periods indicated. Quarter Ended High Low - --------------------------------------------------- ------ ------ September 30, 2001................................. $15.76 $10.68 December 31, 2001.................................. 21.98 14.65 March 31, 2002..................................... 17.49 8.16 June 30, 2002 ..................................... 14.36 8.74 September 30, 2002................................. 15.86 6.36 December 31, 2002.................................. 12.67 9.69 March 31, 2003..................................... 14.92 10.05 June 30, 2003...................................... 12.70 6.35 September 30, 2003 (through September 23, 2003).... 7.97 4.76 On September 23, 2003, the closing price of the common stock on the NASDAQ National Market System was $7.20. As of September 5, 2003, there were 216 record holders and approximately 1,681 beneficial holders of our common stock. During the first quarter of fiscal 2004, we suspended our practice of paying quarterly dividends. During the fiscal year ended June 30, 2003, we paid dividends of $0.32 per share on our common stock for an aggregate dividend payment of $0.9 million. During the fiscal year ended June 30, 2002, we paid dividends of $0.28 per share on our common stock for an aggregate dividend payment of $0.8 million. On August 21, 2002, the Board of Directors declared a 10% stock dividend which was paid September 13, 2002 to shareholders of record September 3, 2002. On October 1, 2001, the Board of Directors declared a 10% stock dividend which was paid November 5, 2001 to shareholders of record October 22, 2001. All cash dividends reported above have been adjusted to reflect all stock dividends. The payment of dividends in the future is at the sole discretion of our Board of Directors and will depend upon, among other things, our earnings, capital requirements and financial condition, as well as other relevant factors. As a Delaware corporation, we may not declare and pay dividends on capital stock if the amount paid exceeds an amount equal to the excess of our net assets over paid-in-capital or, if there is no excess, our net profits for the current and/or immediately preceding fiscal year. 58 The following table details information regarding our existing equity compensation plans as of June 30, 2003:
Number of Number of securities securities issued remaining available or to be under equity for future issuance issued upon Weighted-average compensation plans exercise of exercise price (excluding outstanding of outstanding securities reflected options (a) options in column (a)) ------------------- ---------------- ---------------------- Equity compensation plans approved by security holders Stock Option Plans...................... 732,637(1) $11.21 230,024 (2) Restricted Stock Plan................... -- -- 126,225 (3) Equity compensation plans not approved by security holders(4)................... 4,000(5) -- -- ------------------- ---------------------- Total....................................... 736,637 356,249 =================== ======================
- ------------------ (1) Includes options granted pursuant to the 1995 Stock Option Plan for Non-Employee Directors, the Amended and Restated 1993 Stock Option Plan, and the Amended and Restated 1999 Stock Option Plan. Does not include options granted pursuant to the 1997 Stock Option Plan for Non-Employee Directors because all options granted pursuant to this plan expired unexercised. (2) Includes shares of common stock issuable pursuant to the Amended and Restated 1999 Stock Option Plan and does not include shares of common stock authorized pursuant to our other stock option plans because we intend that all future option grants will be under the Amended and Restated 1999 Stock Option Plan. (3) Includes shares of common stock issuable pursuant to the 2002 Stock Incentive Plan. (4) Does not include shares of our common stock held by the ABFS 401(k) Plan for the benefit of the participants. As of the latest statement dated June 30, 2003, the ABFS 401(k) Plan held approximately 53,115 shares of our common stock. (5) Includes grants of 2,000 shares of common stock issued to each of Warren E. Palitz and Jeffrey S. Steinberg in consideration for their board service. On February 11, 2003, the Board of Directors issued 2,000 shares of common stock to each of Warren E. Palitz and Jeffrey S. Steinberg in consideration for their board service. On April 2, 2001, we issued 2,500 shares (3,025 shares after the effect of stock dividends) to our director, Richard Kaufman as a result of services rendered in connection with the stock buyback program. These issuances were exempt from registration under the Securities Act of 1933 pursuant to Section 4(2) of the Securities Act of 1933. 59 Item 6. Selected Financial Data You should consider our selected consolidated financial information set forth below together with the more detailed consolidated financial statements, including the related notes, and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this document. Also see "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Reconciliation of Non-GAAP Financial Measures" for a reconciliation of total managed portfolio and managed real estate owned, referred to as REO, to our balance sheet.
Year Ended June 30, --------------------------------------------------- 2003 2002 2001 2000 1999 -------- -------- -------- -------- ------- Statement of Income Data: (In thousands, except per share data) Revenues: Gain on sale of loans and leases: Securitizations............................ $170,950 $185,580 $128,978 $ 90,380 $64,490 Whole loan sales........................... 655 2,448 2,742 1,717 2,272 Interest and fees............................ 19,395 18,890 19,840 17,683 14,281 Interest accretion on interest-only strips 47,347 35,386 26,069 16,616 2,021 Other........................................ 3,059 5,597 5,707 4,250 3,360 -------- -------- -------- -------- ------- Total revenues................................. 241,406 247,901 183,336 130,646 86,424 Total expenses(a).............................. 290,426 234,351 170,151 120,284 64,573 -------- -------- -------- -------- ------- Operating income (loss) before income taxes (49,020) 13,550 13,185 10,362 21,851 Income tax expense (benefit)................... (19,118) 5,691 5,274 3,938 7,763 -------- -------- -------- -------- ------- Income (loss) before cumulative effect of a change in accounting principle...................... (29,902) 7,859 7,911 6,424 14,088 Cumulative effect of a change in accounting principle.................................... -- -- 174 -- -- -------- -------- -------- -------- ------- Net income (loss).............................. $(29,902) $ 7,859 $ 8,085 $ 6,424 $14,088 ======== ======== ======== ======== ======= Per Common Share Data: Income (loss) before cumulative effect of a change in accounting principle (b): Basic earnings (loss) per common share....... $ (10.25) $ 2.68 $ 2.08 $ 1.55 $ 3.16 Diluted earnings (loss) per common share..... (10.25) 2.49 2.04 1.51 3.07 Net income (loss): Basic earnings (loss) per common share....... $ (10.25) $ 2.68 $ 2.13 $ 1.55 $ 3.16 Diluted earnings (loss) per common share..... (10.25) 2.49 2.08 1.51 3.07 Cash dividends declared per common share....... 0.32 0.28 0.26 0.25 0.14
____________________________ (a) Includes securitization assets fair value adjustments of $45.2 million for the fiscal year ended June 30, 2003, $22.1 million in the year ended June 30, 2002 and $12.6 million in the year ended June 30, 2000. (b) Amounts for all periods have been retroactively adjusted to reflect the effect of a 10% stock dividend declared August 21, 2002 as if the additional shares had been outstanding for each period presented. Amounts for the years ended June 30, 2001 and prior have been similarly adjusted to reflect the effect of a 10% stock dividend declared October 1, 2001. 60
June 30, ------------------------------------------------------- 2003 2002 2001 2000 1999 ---------- -------- -------- -------- -------- (In thousands) Balance Sheet Data: Cash and cash equivalents............... $ 47,475 $108,599 $ 91,092 $ 69,751 $ 22,395 Loan and lease receivables, net Available for sale..................... 271,402 57,677 94,970 50,696 41,171 Interest and fees...................... 15,179 12,292 16,549 13,002 6,863 Other.................................. 23,761 9,028 2,428 -- -- Interest-only strips.................... 598,278 512,611 398,519 277,872 178,218 Servicing rights........................ 119,291 125,288 102,437 74,919 43,210 Receivable for sold loans and leases.... 26,734 -- -- 46,333 58,691 Total assets............................ 1,159,351 876,375 766,487 594,282 396,301 Subordinated debt....................... 719,540 655,720 537,950 390,676 211,652 Total liabilities....................... 1,117,282 806,997 699,625 532,167 338,055 Stockholders' equity.................... 42,069 69,378 66,862 62,115 58,246
Years Ended June 30, --------------------------------------------------------------- 2003 2002 2001 2000 1999 ---------- ---------- ---------- ---------- ---------- (Dollars in thousands) Other Data: Total managed loan and lease portfolio.......................... $3,651,074 $3,066,189 $2,589,395 $1,918,540 $1,176,918 Originations (a): Business purpose loans............ 122,790 133,352 120,537 106,187 64,818 Home equity loans................. 1,543,730 1,246,505 1,096,440 949,014 634,820 Average loan size of loans originated (a): Business purpose loans............ 92 97 91 89 80 Home equity loans................. 91 89 82 70 74 Weighted average interest rate of loans originated(a): Business purpose loans............ 15.76% 15.75% 15.99% 15.99% 15.91% Home equity loans................. 9.99 10.91 11.46 11.28 11.05 Combined.......................... 10.42 11.38 11.91 11.64 11.17 Loans and leases sold: Securitizations................... $1,423,764 $1,351,135 $1,102,066 $1,001,702 $ 777,598 Whole loan sales.................. 28,013 57,679 76,333 102,670 105,751
____________________________ (a) Conventional first mortgages and leases originated in fiscal 2000 and prior have been excluded because we no longer originate these types of loans and leases.
Year Ended June 30, ------------------------------------------------ 2003 2002 2001 2000 1999 ------ ----- ----- ----- ----- Financial Ratios: Return on average assets................................. (3.07)% 0.94% 1.22% 1.31% 4.56% Return on average equity................................. (44.20) 11.75 12.22 10.29 28.10 Total delinquencies as a percentage of total managed portfolio at end of period (a)........................ 6.27 5.57 4.13 2.91 3.19 Real estate owned as a percentage of total managed portfolio at end of period............................ 0.77 1.11 1.10 0.68 0.85 Loan and lease losses as a percentage of the average total managed portfolio during the period (b) 0.90 0.60 0.53 0.31 0.12 Pre-tax income (loss) as a percentage of total revenues (20.00) 5.47 7.19 7.93 25.28 Ratio of earnings to fixed charges (c)................... 0.31x 1.19x 1.23x 1.26x 1.92x
____________________________ (a) Includes loans delinquent 31 days or more and excludes REO and previously delinquent loans subject to deferment and forbearance agreements if the borrower with this arrangement is current on principal and interest payments as required under the terms of the orginal note (exclusive of delinquent payments advanced or fees paid by us on the borrower's behalf as part of the deferment or forbearance arrangement). (b) Percentage based on annualized losses and average managed portfolio. (c) Earnings (loss) before income taxes and fixed charges were insufficient to cover fixed charges by $49.0 million for the year ended June 30, 2003. 61 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The following financial review and analysis of the financial condition and results of operations for the fiscal years ended June 30, 2003, 2002 and 2001 should be read in conjunction with the consolidated financial statements and the accompanying notes to the consolidated financial statements, and other detailed information appearing in this document. General We are a diversified financial services organization operating predominantly in the eastern and central portions of the United States. Through our principal direct and indirect subsidiaries, we originate, sell and service home equity and business purpose loans. We also process and purchase home equity loans through our Bank Alliance Services program. Our loans primarily consist of fixed interest rate loans secured by first or second mortgages on one-to-four family residences. Our customers are primarily credit-impaired borrowers who are generally unable to obtain financing from banks or savings and loan associations and who are attracted to our products and services. We originate loans through a combination of channels including a national processing center located at our centralized operating office in Philadelphia, Pennsylvania and a regional processing center in Roseland, New Jersey. Our centralized operating office was located in Bala Cynwyd, Pennsylvania prior to July 7, 2003. Prior to June 30, 2003 we also originated home equity loans through several retail branch offices. Effective June 30, 2003, we no longer originate loans through retail branch offices. Our loan servicing and collection activities are performed at our Bala Cynwyd, Pennsylvania office, but we expect to relocate these activities to our Philadelphia office. In addition, we offer subordinated debt securities to the public, the proceeds of which are used for repayment of existing debt, loan originations, our operations (including repurchases of delinquent assets from securitization trusts), investments in systems and technology and for general corporate purposes. 62 Recent Development Fiscal 2003 Loss of $29.9 Million. In fiscal 2003, we recorded a net loss of $29.9 million. The loss was primarily due to our inability to complete our typical quarterly securitization of loans during the fourth quarter of our fiscal year and to $45.2 million of pre-tax charges for net valuation adjustments on our securitization assets charged to the income statement, compared to $22.1 million of net valuation adjustments in fiscal 2002. Our business strategy requires the sale of substantially all of the loans we originate at least on a quarterly basis through a combination of securitizations and whole loan sales. From 1995 until the fourth quarter of fiscal 2003, we had elected to utilize securitization transactions extensively due to the favorable conditions we had experienced in the securitization markets and the higher gains recorded on securitizations through the application of gain-on-sale accounting versus the gain realized on whole loan sales. During fiscal 2003, we charged to the income statement total pre-tax valuation adjustments on our interest-only strips and servicing rights, which we refer to as securitization assets, of $63.1 million, which primarily reflect the impact of higher than anticipated prepayments on securitized loans experienced in fiscal 2003 due to the low interest rate environment experienced during fiscal 2003. The pre-tax valuation adjustments charged to the income statement were partially offset by $17.9 million due to the impact of a decrease in the discount rates used to value our securitization assets, resulting in the $45.2 million of pre-tax charges for net valuation adjustments charged to the income statement. We reduced the discount rates on our interest-only strips and our servicing rights primarily to reflect the impact of the sustained decline in market interest rates. The discount rate on the projected residual cash flows from our interest-only strips was reduced from 13% to 11% at June 30, 2003. The discount rate used to determine the fair value of the overcollateralization portion of the cash flows from our interest-only strips was minimally impacted by the decline in interest rates and remained at 7% on average. As a result, the blended rate used to value our interest-only strips, including the overcollateralization cash flows, was 9% at June 30, 2003. The discount rate on our servicing rights was reduced from 11% to 9% at June 30, 2003. Our inability to complete our typical publicly underwritten securitization during the fourth quarter of fiscal 2003 was the result of our investment bankers' decision in late June not to underwrite the contemplated June 2003 securitization transaction. Management believes that a number of factors contributed to this decision, including a highly-publicized lawsuit finding liability of an underwriter in connection with the securitization of loans for another unaffiliated subprime lender, an inquiry by the U.S. Attorney's Office in Philadelphia regarding our forbearance practices, an anonymous letter regarding the Company received by our investment bankers, the SEC's recent enforcement action against another unaffiliated subprime lender related to its loan restructuring practices and related disclosure, a federal regulatory agency investigation of practices by another subprime servicer and our investment bankers' prior experience with securitization transactions with non-affiliated originators. Short-Term Liquidity and Remedial Steps Taken. Because we have historically experienced negative cash flows from operations, our business requires continual access to short and long-term sources of debt to generate the cash required to fund our operations. Our short term liquidity was negatively impacted by several recent events. Our inability to complete our typical publicly underwritten securitization during the fourth quarter of fiscal 2003 contributed to our loss for fiscal 2003 and adversely impacted our short-term liquidity position. In addition, further advances under a non-committed portion of one of our credit facilities were subject to the discretion of the lender and subsequent to June 30, 2003, there were no new advances under the non-committed portion. Additionally, on August 20, 2003, this credit facility was amended and, among other changes, the non-committed portion was eliminated. We also had a 63 $300.0 million mortgage conduit facility with a financial institution that enabled us to sell our loans into an off-balance sheet facility, which expired pursuant to its terms on July 5, 2003. At June 30, 2003, of the $516.1 million in revolving credit and conduit facilities available to us, $453.4 million was drawn upon. At September 19, 2003, of the $117.0 million in revolving credit facilities available to us, $102.3 million was drawn upon. Our revolving credit facilities and mortgage conduit facility had $62.7 million of unused capacity available at June 30, 2003 (and $14.7 million of unused capacity at September 19, 2003), which significantly reduced our ability to fund future loan originations until we sell existing loans, extend or expand existing credit facilities, or add new credit facilities. In addition, we have temporarily discontinued sales of new subordinated debt, which further impaired our liquidity. As a result of these liquidity issues, since June 30, 2003, we substantially reduced our loan origination volume. From July 1, 2003 through August 31, 2003, we originated $85.7 million of loans which represents a significant reduction as compared to originations of $245.8 million of loans for the same period in fiscal 2003. Our inability to originate loans at previous levels may adversely impact the relationships our subsidiaries have or are developing with their brokers and our ability to retain employees. As a result of the decrease in loan originations and liquidity issues described above, we anticipate incurring a loss for the first quarter of fiscal 2004. The amount of the loss will depend, in part, upon our ability to complete a securitization prior to September 30, 2003 and, if completed, the size and terms of the securitization. Further, we can provide no assurances that we will be able to sell our loans, extend existing facilities or expand or add new credit facilities. If we are unable to obtain additional financing, we may not be able to restructure our business to permit profitable operations or repay our subordinated debt when due. Even if we are able to obtain adequate financing, our inability to securitize our loans could hinder our ability to operate profitably in the future and repay our subordinated debt when due. We undertook specific remedial actions to address short-term liquidity concerns including entering into an agreement on June 30, 2003 with an investment bank to sell up to $700.0 million of mortgage loans, subject to the satisfactory completion of the purchaser's due diligence review and other conditions, and soliciting bids and commitments from other participants in the whole loan sale market. In total, from June 30, 2003 through September 17, 2003, we sold approximately $482.9 million (which includes $221.9 million of loans sold by the expired mortgage conduit facility) of loans through whole loan sales. We are continuing the process of selling our loans. We also suspended paying quarterly cash dividends on our common stock. On September 22, 2003, we entered into definitive agreements with a financial institution for a new $200.0 million credit facility for the purpose of funding our loan originations. Pursuant to the terms of this facility, we are required to, among other things: (i) obtain a written commitment for another credit facility of at least $200.0 million and close that additional facility by October 3, 2003 (which condition would be satisfied by the closing of the $225.0 million facility described below); (ii) have a net worth of at least $28.0 million by September 30, 2003; with quarterly increases of $2.0 million thereafter; (iii) apply 60% of our net cash flow from operations each quarter to reduce the outstanding amount of subordinated debt commencing with the quarter ending March 31, 2004, and (iv) provide a parent company guaranty of 10% of the outstanding principal amount of loans under the facility. Prior to the closing of the second facility, our borrowing capacity on this $200.0 million credit facility is limited to $80.0 million. This facility has a term of 12 months expiring in September 2004 and is secured by the mortgage loans which are funded by advances under the facility with interest equal to LIBOR plus a margin. This facility is subject to representations and warranties and covenants, which are customary for a facility of this type, as well as amortization events and events of default related to our financial condition. These provisions require, among other things, our maintenance of a delinquency ratio for the managed portfolio at the end of each fiscal quarter of less than 12.0%, our subordinated debt not to exceed $705.0 million at any time, our ownership of an amount of repurchased loans not to exceed 1.5% of the managed portfolio and our registration statement registering $295.0 million of subordinated debt be declared effective by the SEC no later than October 31, 2003. 64 On September 22, 2003, we executed a commitment letter for a mortgage warehouse credit facility with a warehouse lender, which consists of a senior secured revolving credit facility of up to $225.0 million and a secured last out revolver facility up to $25.0 million to fund loan originations. The commitment letter is subject to certain conditions, including, among other things: (i) entering into definitive agreements, except as provided in the commitment letter; (ii) the absence of a material adverse change in the business, operations, property, condition (financial or otherwise) or prospects of us or our affiliates; and (iii) our receipt of another credit facility in an amount not less than $200.0 million, subject to terms and conditions acceptable to this lender (which condition is satisfied by the new $200.0 million facility described above). The commitment letter provides that these facilities will have a term of three years with an interest rate on amounts outstanding under the $225.0 million portion of the credit facility equal to the greater of one-month LIBOR plus a margin or the difference between the yield maintenance fee (as defined in the commitment letter) and the one month LIBOR plus a margin. Advances under this facility would be collateralized by substantially all of our present and future assets including pledged loans and a security interest in substantially all of our interest-only strips and residual interests which will be contributed to a special purpose entity organized by us to facilitate this transaction. We also agreed to pay fees of approximately $14.6 million annually plus a nonusage fee based on the difference between the average daily outstanding balance for the current month and the maximum credit amount under the facility and the lender's out-of-pocket expenses. We anticipate that these facilities will be subject to representations and warranties, events of default and covenants which are customary for facilities of this type, as well as our agreement to: (i) maintain sales or renewals of our subordinated debt securities of $10.0 million per month; (ii) restrict total principal and interest outstanding on our subordinated debt to $750.0 million or less; (iii) make quarterly reductions commencing in April 2004 of an amount of subordinated debt outstanding to be determined; (iv) maintain maximum interest rates payable on subordinated debt securities not to exceed 10 percentage points above comparable rates for FDIC insured products; and (v) the lender's receipt of our audited financial statements for the period ended June 30, 2003. The definitive agreements will grant the lender an option at any time after the first anniversary of entering into definitive agreements to increase the credit amount on the $250.0 million facility to $400.0 million with additional fees payable by us plus additional interest as may be required by the institutions or investors providing the lender with these additional funds. The commitment letter requires that we enter into definitive agreements not later than October 17, 2003. While we anticipate that we will close this transaction prior to such date, we cannot assure you that these negotiations will result in definitive agreements or that such agreements, as negotiated, will be on terms and conditions acceptable to us. In the event we are unable to close these facilities or another facility within the time frame provided under the new $200.0 million credit facility described above, the lender on that facility would be under no obligation to make further advances under the terms of that facility and outstanding advances would have to be repaid over a period of time. During the first quarter of fiscal 2004, we explored a number of strategic alternatives to address these liquidity issues in the event we are unable to borrow under the new $200.0 million credit facility, close the $250.0 million credit facilities or obtain alternative financing. In the event we were unable to obtain the additional credit facilities necessary to operate our business, we developed a contingent business plan (described more fully under "Business Strategy Adjustments") which contemplates, among other things, the sale of $100 million principal amount of additional subordinated debt through March 2004 and the renewal of approximately 50% of outstanding subordinated debt upon maturity. We believe that this contingent business plan addresses our liquidity issues and may permit us to restructure our operations, if necessary, without the receipt of an expanded or additional credit facility. There can be no assurance that our contingent business plan will be successful or that it will enable us to repay our subordinated debt when due. 65 To the extent that we are not successful in maintaining, replacing or obtaining alternative financing sources on acceptable terms, we may have to limit our loan originations, sell loans earlier than intended and further restructure our operations. Limiting our originations or earlier than intended sales of our loans could reduce our profitability or result in losses and restrict our ability to repay our subordinated debt upon maturity. While we currently believe that we would be able to restructure our operations, if necessary, we cannot assure you that such restructuring will enable us to attain profitable operations or repay the subordinated debt when due. See "Risk Factors - -- We depend upon the availability of financing to fund our continuing operations. Any failure to obtain adequate funding could hurt our ability to operate profitably and restrict our ability to repay our subordinated debt and negatively impact the value of our common stock." and "Risk Factors -- If we are unable to obtain additional financing, we may be not able to restructure our business to permit profitable operations or repay our subordinated debt when due, which would negatively impact the value of our common stock." Credit Facilities and Waivers Related to Financial Covenants. We borrow against various warehouse credit facilities as the primary funding source for our loan originations. The sale of our loans through a securitization or whole loan sale generates the cash proceeds necessary to repay the borrowings under the warehouse facilities. In addition, we have the availability of revolving credit facilities, which we may use to fund our operations. Each credit agreement requires that we comply with specific financial covenants and has multiple individualized financial covenant thresholds and ratio limits that we must meet as a condition to drawing on that particular facility. Pursuant to the terms of these credit facilities, the failure to comply with the financial covenants constitutes an event of default and the lender may, at its option, take certain actions including: terminate commitments to make future advances to us, declare all or a portion of the loan due and payable, foreclose on the collateral securing the loan, require servicing payments be made to the lender, or other third party, or assume the servicing of the loans securing the credit facility. An event of default under these credit facilities could result in defaults pursuant to cross-default provisions of our other agreements, including our other loan agreements and lease agreements. The failure to comply with the terms of these credit facilities or to obtain the necessary waivers from the lenders related to any default would have a material adverse effect on our liquidity and capital resources, could result in us not having sufficient cash to repay our indebtedness, require us to restructure our operations and may force us to sell assets on less than optimal terms and conditions. As a result of the loss experienced during fiscal 2003, we were not in compliance with the terms of certain of the financial covenants under two of our principal credit facilities (one for $50.0 million and the other for $200.0 million, of which $100.0 million was non-committed) and we requested and obtained waivers of these requirements from our lenders. The lender under the $50.0 million warehouse credit facility has granted us a waiver for our non-compliance with a financial covenant in that credit facility through September 30, 2003. This facility was amended to reduce the available credit to $8.0 million and the financial covenants were replaced with new covenants with which we are currently in compliance. We also entered into an amendment to the $200.0 million credit facility which provides for the waiver of our non-compliance with the financial covenants in that facility, the reduction of the committed portion of this facility from $100.0 million to $50.0 million, the elimination of the $100.0 million non-committed portion of this credit facility and the acceleration of the termination date of this facility from November 2003 to September 30, 2003. Our ability to repay this facility upon termination is dependent on our ability to refinance the loans in one of our new facilities or our sale of loans currently warehoused in the terminating facility by September 30, 2003. In addition, if the anticipated loss for the first quarter of fiscal 2004 described above results in our non-compliance with any financial covenants, we intend to seek the appropriate waivers. There can be no assurances that we will obtain any of these waivers. 66 Business Strategy Adjustments. Our business strategy requires the sale of substantially all of the loans we originate at least on a quarterly basis through a combination of securitizations and whole loan sales. Our determination as to whether to dispose of loans through securitizations or whole loan sales depends on a variety of factors including market conditions, profitability and cash flow considerations. From 1995 until the fourth quarter of fiscal 2003, we had elected to utilize securitization transactions extensively due to the favorable conditions we had experienced in the securitization markets. During fiscal 2003, 2002, and 2001, we securitized $1.42 billion, $1.35 billion, and $1.1 billion of loans, respectively. During the same periods, we sold $28.3 million, $57.7 million, and $76.3 million of loans, respectively, through whole loan sales. Under generally accepted accounting principles, we are permitted to record the gain on the sale of these securitized loans utilizing an accounting method referred to as "gain-on-sale" accounting. This accounting method permits us to record a non-cash gain based upon the estimated value of securitization assets generated in connection with the securitization of our loans even though only a small portion of the gain is received in cash during the period the gain is recorded. We are then required to reevaluate these assets quarterly and make adjustments based upon changes in the fair value of these assets. After we recognized our inability to securitize our assets in the fourth quarter of fiscal 2003, we adjusted our business strategy to emphasize more whole loan sales. We intend to continue to evaluate both public and privately placed securitization transactions, subject to market conditions. We generally realized higher gain on sale in our securitization transactions than on whole loan sales for cash. Although the gain on whole loan sales is generally significantly lower than gains realized in securitization transactions, we receive the gain in cash immediately and generally receive more cash immediately in a whole loan sale transaction than from securitizations of an equal principal amount of loans. As a result of the emphasis on whole loan sales in late June and July 2003, at July 31, 2003, our cash position was consistent with our projected cash position, which assumed the completion of a fourth quarter securitization. The use of whole loan sales will enable us to immediately generate cash flow, protect against volatility in the securitization markets and reduce risks inherent in retaining securitization assets. However, unlike securitizations, where we retain servicing rights, and receive interest-only strips, which generate future cash flows, whole loan sales are typically structured as a sale with servicing rights released and do not result in our receipt of interest-only strips. As a result, using whole loan sales more extensively in the future will reduce our income from servicing activities and limit the amount of securitization assets created. We believe that our adjustments to our business strategy focus on a more diversified strategy of selling our loans, while protecting revenues, controlling costs and improving liquidity. However, if we are unable to generate sufficient liquidity through the sales of our loans, the sale of our subordinated debt, the receipt of new credit facilities or a combination of the foregoing, we will be required to restrict loan originations and make additional changes to our business strategy, including restricting or restructuring our operations which could reduce our profitability or result in losses and impair our ability to repay the subordinated debt. We have historically experienced negative cash flow from operations. To the extent we are unable to successfully implement our adjusted business strategy, which requires access to capital to originate loans and our ability to profitably sell these loans, we would continue to experience negative cash flows from operations which would impair our ability to repay our subordinated debt. See "Risk Factors -- If we are unable to successfully implement our adjusted business strategy which focuses on whole loan sales, we may be unable to attain profitable operations which could impair our ability to repay our subordinated debt and negatively impact the value of our common stock." 67 In the event we are unable to maintain the new $200.0 million credit facility described above, close the $250.0 million credit facilities described above within the required timeframes or obtain other credit facilities, we have developed a contingent business plan which management believes will enable us to repay the subordinated debt when due and continue operations, although with a materially reduced amount of loan originations as compared to historical levels. The major assumptions of our contingent business plan include, but are not limited to, the following: (i) the sale of $100.0 million of subordinated debt over a five month period ending in March 2004; (ii) the renewal of approximately 50% of our outstanding subordinated debt upon maturity; (iii) the securitization of approximately $40.0 million of business purpose loans which are less attractive to purchasers in the secondary loan market; (iv) the sale of substantially all of the home equity loans we originate in whole loan sales in the secondary market with servicing released; and (v) substantial cost reductions in our operations. If we utilize the contingent business plan, we currently anticipate incurring losses through the second quarter of fiscal 2004. Although management believes that the contingent business plan is feasible, there can be no assurance that we will be able to successfully implement it. Civil Subpoena from the U.S. Attorney's Office. We received a civil subpoena, dated May 14, 2003, from the Civil Division of the U.S. Attorney for the Eastern District of Pennsylvania. The subpoena requests that we provide certain documents and information with respect to us and our lending subsidiaries for the period from May 1, 2000 to May 1, 2003: (i) all loan files in which we entered into a forbearance agreement with a borrower who is in default; (ii) the servicing, processing, foreclosing, and handling of delinquent loans and non-performing loans, the carrying, processing and sale of real estate owned, and forbearance agreements; and (iii) agreements to sell or otherwise transfer mortgage loans (including, but not limited to, any pooling or securitization agreements) or to obtain funds to finance the underwriting, origination or provision of mortgage loans, any transaction in which mortgage loans were sold or transferred, any instance in which we were not to service or not to act as custodian for a mortgage loan, representations and warranties made in connection with mortgage loans, secondary market loan sale schedules, and credit loss, delinquency, default, and foreclosure rates of mortgage loans. We have directed our attorneys to cooperate fully with this inquiry. Currently, this inquiry appears to be focused on our practices relating to obtaining forbearance agreements from delinquent borrowers who would otherwise be subject to foreclosure. Because the inquiry is at a preliminary stage, we cannot reach any conclusions about the ultimate scope of the inquiry or the potential liability or financial consequences to us at this time. To the extent management is unsuccessful in resolving this matter, the ongoing review by the U.S. Attorney's Office could limit our ability to engage in publicly underwritten securitization transactions or otherwise sell or service our loans. In addition, the U.S. Attorney's inquiry could reduce sales of subordinated debt upon which we rely to fund our operations and limit our ability to obtain additional credit facilities, which are necessary for the implementation of our business strategy. Furthermore, the U.S. Attorney could impose sanctions or otherwise restrict our ability to restructure loans, which could negatively impact our profitability and our ability to repay the subordinated debt. Delinquencies; Forbearance and Deferment Arrangements. During fiscal 2003, we experienced an increase in the total delinquencies in our total managed portfolio to $229.1 million at June 30, 2003 from $170.8 million and $107.0 million at June 30, 2002 and 2001, respectively. Total delinquencies (loans and leases, excluding real estate owned, with payments past due for more than 30 days) as a percentage of the total managed portfolio were 6.27% at June 30, 2003 compared to 5.57% and 4.13% at June 30, 2002 and 2001, respectively. As the managed portfolio continues to season and if our economy continues to lag or worsen, the delinquency rate may continue to increase, which could negatively impact our ability to sell or securitize loans and reduce our profitability and the funds available to repay our subordinated debt. Continuing low market interest rates could continue to encourage borrowers to refinance their loans and increase the levels of loan prepayments we experience which would negatively impact our delinquency rate. 68 Delinquencies in our total managed portfolio do not include $197.7 million of previously delinquent loans at June 30, 2003, which are subject to deferment and forbearance arrangements. Generally, a loan remains current after we enter into a deferment or forbearance arrangement with the borrower only if the borrower makes the principal and interest payments as required under the terms of the original note (exclusive of the delinquent payments advanced or fees paid by us on the borrower's behalf as part of the deferment or forbearance arrangement) and we do not reflect it as a delinquent loan in our delinquency statistics. However, if the borrower fails to make principal and interest payments, the account will generally be declared in default and collection actions resumed. During the final six months of fiscal 2003, we experienced a pronounced increase in the number of borrowers under deferment arrangements than in prior periods. At June 30, 2003, there was approximately $197.7 million of cumulative unpaid principal balance under deferment and forbearance arrangements as compared to approximately $138.7 million of cumulative unpaid principal balance at June 30, 2002. Total cumulative unpaid principal balances under deferment or forbearance arrangements as a percentage of the total managed portfolio were 5.41% at June 30, 2003 compared to 4.52% at June 30, 2002. Additionally, there are loans under deferment and forbearance arrangements which have returned to delinquent status. At June 30, 2003 there was $28.7 million of cumulative unpaid principal balance under deferment arrangements and $51.5 million of cumulative unpaid principal balance under forbearance arrangements that are now reported as delinquent 31 days or more. Business Strategy The business strategy that we are emphasizing beginning in fiscal 2004 focuses on a shift from gain-on-sale accounting and the use of securitization transactions as our primary method of selling loans to a more diversified loan sale strategy which utilizes a combination of whole loan sales and securitizations, while protecting revenues,controlling costs and improving liquidity. Our business strategy includes the following: o Selling substantially all of the loans we originate on at least a quarterly basis through a combination of securitizations and whole loan sales. Whole loan sales may be completed on a more frequent basis. o Shifting from a predominantly publicly underwritten securitization strategy and gain-on-sale business model to a strategy focused on a combination of whole loan sales and smaller securitization transactions. Quarterly loan securitization levels will be reduced significantly from previous levels. Securitizations for the foreseeable future are expected to be executed as private placements to institutional investors or publicly underwritten securitizations, subject to market conditions. Historically, the market for whole loan sales has provided reliable liquidity for numerous originators as an alternative to securitization. Whole loan sales provide immediate cash premiums to us, while securitizations generate cash over time but generally result in higher gains at the time of sale. We intend to rely less on gain-on-sale accounting and loan servicing activities for our revenue and earnings and will rely more on cash premiums earned on whole loan sales. This strategy is expected to result in relatively lower earnings levels at current loan origination volumes, but will increase cash flow, accelerate the timeframe for becoming cash flow positive and improve our liquidity position. See "--Liquidity and Capital Resources" for more detail on cash flow. 69 o Broadening our mortgage loan product line and increasing loan originations. We currently originate primarily fixed-rate loans. Under our business strategy, we plan to originate adjustable-rate and alt-A mortgage loans as well as a wide array of fixed-rate mortgage loans in order to appeal to a broader base of prospective customers and increase loan originations. o Offering competitive interest rates charged to borrowers on new products. By offering competitive interest rates charged on new products, we expect to originate loans with higher credit quality. In addition, by offering competitive interest rates we expect to appeal to a wider customer base and substantially reduce our marketing costs, make more efficient use of marketing leads and increase loan origination volume. o Reducing origination of the types of loans that are not well received in the whole loan sale and securitization markets. We intend to reduce the level of business purpose loans that we will originate, but we will continue to originate business purpose loans to meet demand in the whole loan sale and securitization markets. o Reducing the cost of loan originations. We have implemented plans to: - Eliminate our high cost origination branches. - Reduce the cost to originate in Upland Mortgage by: a) broadening the product line and offering competitive interest rates in order to increase origination volume, b) reducing marketing costs, and c) developing broker relationships. - Reduce the cost to originate in American Business Mortgage Services by increasing volume through a broadening of the mortgage loan product line. - Reduce the cost to originate in the Bank Alliance Services program by broadening our product line and increasing the amount of fees we charge to participating financial institutions. o Reducing the amount of outstanding subordinated debt. The increase in cash flow expected under our business strategy is expected to accelerate a reduction in our reliance on issuing subordinated debt to meet our liquidity needs and allow us to begin to pay down existing subordinated debt. 70 o Reducing operating costs. Since June 30, 2003, we reduced our workforce by 170 employees. With our shift in focus to whole loan sales, with servicing released, and offering a broader mortgage product line that we expect will appeal to a wider array of customers, we currently require a smaller employee base with fewer sales, servicing and support positions. These workforce reductions represent more than a 15% decrease in staffing levels. Our business strategy is expected to leverage our demonstrated strengths which include: o A strong credit culture which consistently originates quality performing loans. Our delinquency rates are among the lowest in the subprime industry. o Long-term broker relationships at American Business Mortgage Services. o Upland Mortgage brand identity. o Relationships with participating financial institutions in the Bank Alliance Services program. o Institutional investors' interest in the bonds issued in our securitizations. Our business strategy is dependent on our ability to emphasize lending related activities that provide us with the most economic value. The implementation of this strategy will depend in large part on a variety of factors outside of our control, including, but not limited to, our ability to obtain adequate financing on favorable terms and to profitably securitize or sell our loans on a regular basis. Our failure with respect to any of these factors could impair our ability to successfully implement our strategy, which could adversely affect our results of operations and financial condition. See "Risk Factors -- If we are unable to continue to successfully implement our adjusted business strategy, which focuses on whole loan sales, we may be unable to attain profitable operations, which could impair our ability to repay our subordinated debt and negatively impact the value of our common stock." Legal and Regulatory Considerations Local, state and federal legislatures, state and federal banking regulatory agencies, state attorneys general offices, the Federal Trade Commission, the U.S. Department of Justice, the U.S. Department of Housing and Urban Development and state and local governmental authorities have increased their focus on lending practices by companies in the subprime lending industry, more commonly referred to as "predatory lending" practices. State, local and federal governmental agencies have imposed sanctions for practices including, but not limited to, charging borrowers excessive fees, imposing higher interest rates than the borrower's credit risk warrants, failing to adequately disclose the material terms of loans to the borrowers and abusive servicing and collections practices. As a result of initiatives such as these, we are unable to predict whether state, local or federal authorities will require changes in our lending practices in the future, including reimbursement of fees charged to borrowers, or will impose fines on us. These changes, if required, could impact our profitability. These laws and regulations may limit our ability to securitize loans originated in some states or localities due to rating agency, investor or market restrictions. As a result, we have limited the types of loans we offer in some states and may discontinue originating loans in other states or localities. 71 We received a civil subpoena, dated May 14, 2003, from the Civil Division of the U.S. Attorney for the Eastern District of Pennsylvania. See "-- Recent Developments" and "Risk Factors -- The inquiry regarding our forbearance practices by the U.S. Attorney could result in concerns regarding our loan servicing and limit our ability to sell or service our loans, sell subordinated debt, or obtain additional credit facilities, which would hinder our ability to operate profitably and repay our subordinated debt, which would negatively impact the value of our common stock." Additionally, the United States Congress is currently considering a number of proposed bills or proposed amendments to existing laws, such as the "Ney - Lucas Responsible Lending Act of 2003" introduced on February 11, 2003 into the U.S. House of Representatives, which could affect our lending activities and make our business less profitable. These bills and amendments, if adopted as proposed, could reduce our profitability by limiting the fees we are permitted to charge, including prepayment fees, restricting the terms we are permitted to include in our loan agreements and increasing the amount of disclosure we are required to give to potential borrowers. While we cannot predict whether or in what form Congress may enact legislation, we are currently evaluating the potential impact of these legislative initiatives, if adopted, on our lending practices and results of operations. In addition to new regulatory initiatives with respect to so-called "predatory lending" practices, current laws or regulations in some states restrict our ability to charge prepayment penalties and late fees. We have used the Federal Alternative Mortgage Transactions Parity Act of 1982, which we refer to as the Parity Act, to preempt these state laws for loans which meet the definition of alternative mortgage transactions under the Parity Act. However, the Office of Thrift Supervision has adopted a rule effective in July 2003, which precludes us and other non-bank, non-thrift creditors from using the Parity Act to preempt state prepayment penalty and late fee laws on new loan originations. Under the provisions of this rule, we are required to modify or eliminate the practice of charging prepayment and other fees in some of the states where we originate loans. We are continuing to evaluate the impact of the adoption of the new rule by the Office of Thrift Supervision on our future lending activities and results of operations. We currently expect that the percentage of home equity loans containing prepayment fees that we will originate in the future will decrease to approximately 65% to 70%, from 80% to 85% prior to this rule becoming effective. Additionally, in a recent decision, the Appellate Division of the Superior Court of New Jersey determined that the Parity Act's preemption of state law was invalid and that the state laws precluding some lenders from imposing prepayment fees are applicable to loans made in New Jersey, including alternative mortgage transactions. Although this New Jersey decision is subject to appeal and may not be final, we are currently evaluating its impact on our future lending activities in the State of New Jersey and results of operations. 72 We are also subject, from time to time, to private litigation, including actual and purported class action suits. We expect that, as a result of the publicity surrounding predatory lending practices and the recent New Jersey court decision regarding the Parity Act, we may be subject to other class action suits in the future. See "Risk Factors -- Our residential lending business is subject to government regulation and licensing requirements, as well as private litigation, which may hinder our ability to operate profitably and repay our subordinated debt, which would negatively impact the value of our common stock." Although we are licensed or otherwise qualified to originate loans in 44 states, our loan originations are concentrated in the eastern half of the United States. The concentration of loans in a specific geographic region subjects us to the risk that a downturn in the economy or recession in the eastern half of the country would more greatly affect us than if our lending business were more geographically diversified. As a result, an economic downturn or recession in this region could result in reduced profitability. See "Risk Factors -- An economic downturn or recession in the eastern half of the United States could hinder our ability to operate profitably, which would reduce the funds available to repay the subordinated debt and negatively impact the value of our common stock." Application of Critical Accounting Policies Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America, referred to as GAAP. The accounting policies discussed below are considered by management to be critical to understanding our financial condition and results of operations. The application of these accounting policies requires significant judgment and assumptions by management, which are based upon historical experience and future expectations. The nature of our business and our accounting methods make our financial condition, changes in financial condition and results of operations highly dependent on management's estimates. The line items on our income statement and balance sheet impacted by management's estimates are described below. Revenue Recognition. Revenue recognition is highly dependent on the application of Statement of Financial Accounting Standards, referred to as SFAS in this document, No. 140 "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" and "gain-on-sale" accounting to our quarterly loan securitizations. Gains on sales of loans through securitizations for the fiscal year ended June 30, 2003 were 70.8% of total revenues. Securitization gains represent the difference between the net proceeds to us, including retained interests in the securitization, and the allocated cost of loans securitized. The allocated cost of loans securitized is determined by allocating their net carrying value between the loans, the interest-only strips and the servicing rights we retain based upon their relative fair values. Estimates of the fair values of the interest-only strips and the servicing rights we retain are discussed below. We believe the accounting estimates related to gain on sale are critical accounting estimates because more than 80% in fiscal 2003 and 2002 of the securitization gains were based on estimates of the fair value of retained interests. The amount recognized as gain on sale for the retained interests we receive as proceeds in a securitization, in accordance with accounting principles generally accepted in the United States of America, is highly dependent on management's estimates. 73 Interest-Only Strips. Interest-only strips, which represent the right to receive future cash flows from securitized loans, represented 51.6% of our total assets at June 30, 2003 and are carried at their fair values. Fair value is based on a discounted cash flow analysis which estimates the present value of the future expected residual cash flows and overcollateralization cash flows utilizing assumptions made by management at the time the loans are sold. These assumptions include the rates used to calculate the present value of expected future residual cash flows and overcollateralization cash flows, referred to as the discount rates, and expected prepayment and credit loss rates on pools of loans sold through securitizations. We believe the accounting estimates used in determining the fair value of interest-only strips are critical accounting estimates because estimates of prepayment and credit loss rates are made based on management's expectation of future experience, which is based in part, on historical experience, current and expected economic conditions and in the case of prepayment rate assumptions, consideration of the impact of changes in market interest rates. The actual loan prepayment rate may be affected by a variety of economic and other factors, including prevailing interest rates, the availability of alternative financing to borrowers and the type of loan. We re-evaluate expected future cash flows from our interest-only strips on a quarterly basis. We monitor the current assumptions for prepayment and credit loss rates against actual experience and other economic and market conditions and we adjust assumptions if deemed appropriate. Even a small unfavorable change in our assumptions made as a result of unfavorable actual experience or other considerations could have a significant adverse impact on our estimate of residual cash flows and on the value of these assets. In the event of an unfavorable change in these assumptions, the fair value of these assets would be overstated, requiring an accounting adjustment. In accordance with the provisions of Emerging Issues Task Force guidance on issue 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets", referred to as EITF 99-20 in this document, changes in the fair value of interest-only strips that are deemed to be temporary changes are recorded through other comprehensive income, a component of stockholders' equity. Other than temporary adjustments to decrease the fair value of interest-only strips are recorded through the income statement which would adversely affect our income in the period of adjustment. During fiscal 2003, we recorded total pre-tax valuation adjustments on our interest only-strips of $58.0 million, of which, in accordance with EITF 99-20, $39.9 million was charged to the income statement and $18.1 million was charged to other comprehensive income. The valuation adjustment reflects the impact of higher than anticipated prepayments on securitized loans experienced in fiscal 2003 due to the low interest rate environment experienced during fiscal 2003, which has impacted the entire mortgage industry. The valuation adjustment on interest-only strips for fiscal 2003 was reduced by a $20.9 million favorable valuation impact as a result of reducing the discount rates applied in valuing the interest-only strips at June 30, 2003. The amount of the valuation adjustment charged to the income statement was reduced by a $10.8 million favorable valuation impact as a result of reducing the discount rates and the charge to other comprehensive income was reduced by $10.1 million for the favorable impact of reducing discount rates. The discount rates were reduced at June 30, 2003 primarily to reflect the impact of the sustained decline in market interest rates. The discount rate on the projected residual cash flows from our interest-only strips was reduced from 13% to 11% at June 30, 2003. The discount rate used to determine the fair value of the overcollateralization portion of the cash flows from our interest-only strips was minimally impacted by the decline in interest rates and remained at 7% on average. As a result, the blended rate used to value our interest-only strips, including the overcollateralization cash flows, was 9% at June 30, 2003. See "-- Securitizations -- Discount rates" for more detail. See "-- Off-Balance Sheet Arrangements -- Securitizations" for more detail on the estimation of the fair value of interest-only strips and the sensitivities of these balances to changes in assumptions and the impact on our financial statements of changes in assumptions. See "Risk Factors -- Our estimates of the value of interest-only strips and servicing rights we retain when we securitize loans could be inaccurate and could limit our ability to operate profitably and impair our ability to repay our subordinated debt, which would negatively impact the value of our common stock." 74 Interest accretion income represents the yield component of cash flows received on interest-only strips. We use a prospective approach to estimate interest accretion. As previously discussed, we update estimates of residual cash flow from our securitizations on a quarterly basis. Under the prospective approach, when it is probable that there is a favorable or unfavorable change in estimated residual cash flow from the cash flow previously projected, we recognize a larger or smaller percentage of the cash flow as interest accretion. Any change in value of the underlying interest-only strip could impact our current estimate of residual cash flow earned from the securitizations. For example, a significant change in market interest rates could increase or decrease the level of prepayments, thereby changing the size of the total managed loan portfolio and related projected cash flows. The managed portfolio includes loans held as available for sale on our balance sheet and loans serviced for others. Servicing Rights. Servicing rights, which represent the rights to receive contractual servicing fees from securitization trusts and ancillary fees from borrowers, net of adequate compensation that would be required by a substitute servicer, represented 10.3% of our total assets at June 30, 2003. Servicing rights are carried at the lower of cost or fair value. The fair value of servicing rights is determined by computing the benefits of servicing in excess of adequate compensation, which would be required by a substitute servicer. The benefits of servicing are the present value of projected net cash flows from contractual servicing fees and ancillary servicing fees. We believe the accounting estimates used in determining the fair value of servicing rights are critical accounting estimates because the projected cash flows from servicing fees incorporate assumptions made by management, including prepayment rates, credit loss rates and discount rates. These assumptions are similar to those used to value the interest-only strips retained in a securitization. We monitor the current assumptions for prepayment and credit loss rates against actual experience and other economic and market conditions and we adjust assumptions if deemed appropriate. Even a small unfavorable change in our assumptions, made as a result of unfavorable actual experience or other considerations could have a significant adverse impact on the value of these assets. In the event of an unfavorable change in these assumptions, the fair value of these assets would be overstated, requiring an adjustment, which would adversely affect our income in the period of adjustment. During fiscal 2003, we recorded total pre-tax valuation adjustments on our servicing rights of $5.3 million, which was charged to the income statement. The valuation adjustment reflects the impact of higher than anticipated prepayments on securitized loans experienced in fiscal 2003 due to the low interest rate environment experienced during fiscal 2003. The valuation adjustment on servicing rights for fiscal 2003 was reduced by a $7.1 million favorable valuation impact as a result of reducing the discount rate applied in valuing the servicing rights at June 30, 2003. The discount rate was reduced at June 30, 2003 primarily to reflect the impact of the sustained decline in market interest rates. The discount rate on our servicing rights was reduced from 11% to 9% at June 30, 2003. See "-- Securitizations -- Servicing rights" for more detail. See "-- Off-Balance Sheet Arrangements -- Securitizations" for more detail on the estimation of the fair value of servicing rights and the sensitivities of these balances to changes in assumptions and the impact on our financial statements of changes in assumptions. 75 Amortization of the servicing rights asset for securitized loans is calculated individually for each securitized loan pool and is recognized in proportion to, and over the period of, estimated future servicing income on that particular pool of loans. A review for impairment is performed on a quarterly basis by stratifying the serviced loans by loan type, which is considered to be the predominant risk characteristic. If our analysis indicates the carrying value of servicing rights is not recoverable through future cash flows from contractual servicing and other ancillary fees, a valuation allowance or write down would be required. During fiscal 2003, our valuation analysis indicated that valuation adjustments of $5.3 million were required for impairment of servicing rights due to higher than expected prepayment experience. The write downs were recorded in the income statement. Impairment is measured as the excess of carrying value over fair value. Allowance for Loan and Lease Losses. The allowance for loan and lease losses is maintained primarily to account for loans and leases that are delinquent and are expected to be ineligible for sale into a future securitization and for delinquent loans that have been repurchased from securitization trusts. The allowance is calculated based upon management's estimate of our ability to collect on outstanding loans and leases based upon a variety of factors, including, periodic analysis of the available for sale loans and leases, economic conditions and trends, historical credit loss experience, borrowers' ability to repay, and collateral considerations. Additions to the allowance arise from the provision for credit losses charged to operations or from the recovery of amounts previously charged-off. Loan and lease charge-offs reduce the allowance. If the actual collection of outstanding loans and leases is less than we anticipate, further write downs would be required which would reduce our net income in the period the write down was required. Development of Critical Accounting Estimates. On a quarterly basis, senior management reviews the estimates used in our critical accounting policies. As a group, senior management discusses the development and selection of the assumptions used to perform its estimates described above. Management has discussed the development and selection of the estimates used in our critical accounting policies as of June 30, 2003 with the Audit Committee of our Board of Directors. In addition, management has reviewed its disclosure of the estimates discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations" with the Audit Committee. Impact of Changes in Critical Accounting Estimates. For a description of the impact of changes in critical accounting estimates in the fiscal year ended June 30, 2003, see "-- Off-Balance Sheet Arrangements -- Securitizations." 76 Initial Adoption of Accounting Policies. In conjunction with the relocation of our corporate headquarters to new leased office space, we have entered into a lease agreement and are in the process of finalizing certain governmental grant agreements that will provide us with reimbursement for certain expenditures related to our office relocation. The reimbursable expenditures include both capitalizable items for leasehold improvements, furniture and equipment and expense items such as legal costs, moving costs and employee communication programs. Amounts reimbursed to us in accordance with our lease agreement will be initially recorded as a liability on our balance sheet and will be amortized in the income statement on a straight-line basis over the term of the lease as a reduction of rent expense. Amounts received from government grants will be initially recorded as a liability. Grant funds received to offset expenditures for capitalizable items will be reclassified as a reduction of the related fixed asset and amortized to income over the depreciation period of the related asset as an offset to depreciation expense. Amounts received to offset expense items will be recognized in the income statement as an offset to the expense item. In fiscal 2002 we entered into a derivative financial instrument contract, which we have not designated as an accounting hedge and therefore is accounted for as a trading asset or liability. This contract was designed to reduce our exposure to changes in the fair value of certain interest-only strips due to changes in the one-month London Inter-Bank Offered Rate, referred to in this document as LIBOR. The structure of certain securitization trusts includes a floating interest rate tranche based on one-month LIBOR plus an interest rate spread. Floating interest rate tranches in a securitization expose us to gains or losses due to changes in the fair value of the interest-only strip from changes in the floating interest rate paid to the certificate holders. In order to manage this exposure we have entered into an interest rate swap agreement. The swap agreement requires a net cash settlement on a monthly basis of the difference between the fixed interest rate on the swap and the LIBOR paid on the certificates. The fair value of this swap agreement is based on estimated market values for the sale of the contract provided by a third party. As of June 30, 2003, the unrealized loss in the fair value of this derivative financial instrument was $0.3 million and an additional $1.0 million in net cash settlements were paid on the contract during fiscal 2003. Our interest-only strips are held as available for sale securities and therefore changes in the fair value of the interest-only strips are recorded as a component of equity unless the fair value of the interest-only strip falls below its cost basis, which would require a write down through current period income. See "-- Interest Rate Risk Management -- Strategies for Use of Derivative Financial Instruments" for further details of this interest rate swap agreement. Impact of Changes in Critical Accounting Estimates in Prior Fiscal Years. Discount rates. During fiscal 2000, a write down of $12.6 million was recorded on our interest-only strips, of which $11.2 million was due to a change in the discount rate used to value our interest-only strips. At June 30, 2000, we increased the discount rate applicable to the residual portion of our interest-only strips from 11% to 13%. No changes were made in the discount rate used to determine the fair value of the overcollateralization portion of the cash flows from our interest-only strips. The change in the discount rate was considered to be an other than temporary fair value adjustment and was recorded as expense in fiscal 2000. The factors that led to this other than temporary decline in fair value of our interest-only strips included: 77 o Sustained increase in market interest rates through the fourth quarter of fiscal 2000; o Increases in the all-in cost of our mortgage loan trust investor certificates from September 1998 through June 2000; o Increases in the cost of funding our interest-only strips, particularly the interest rate paid on subordinated debt; and o Events and conditions in the mortgage lending industry and the actions by others in that industry. Prepayment rates. During the nine-month period ended October 1998, the percentage of home equity loans that we originated containing prepayment fees increased from less than 50% of loans originated to over 85%, a percentage which has been maintained since that time. Due to this increase in the volume of loans originated with prepayment fees, we had reduced the initial annual prepayment rate assumption on business loans and lengthened the initial assumptions used for the prepayment ramp period on home equity loans from 12 to 18 months beginning with the 1999-1 mortgage loan securitization through the 2000-1 mortgage loan securitization and to 24 months beginning with the 2000-2 mortgage loan securitization. Our experience indicated that when a loan has a prepayment fee provision, fewer borrowers will prepay, and those prepaying will do so more slowly. Our actual cumulative prepayment experience through March 31, 2000 demonstrated that only 25% of home equity loans having prepayment fees were actually prepaid by the borrowers, while 47% of home equity loans without prepayment fees were prepaid. This cumulative historical performance demonstrates that it was nearly twice as likely that a loan without a prepayment fee would be prepaid. The effect of these changes in prepayment rate assumptions increased the gains on securitizations for fiscal 2000. In the third quarter of fiscal 2001, we evaluated our accumulated experience with pools of loans that had a high percentage of loans with prepayment fees. We had begun using a static pool analysis of prepayments, whereby we analyzed historical prepayments by period, to determine average prepayments expected by period. For business purpose loans, we found that prepayments for the first year are generally lower than we had anticipated, peak at a higher rate than previously anticipated by month 24 and decline by month 40. Home equity loan prepayments generally ramped faster in the first year than we had anticipated but leveled more slowly over 30 months and to a lower final rate than we had been using previously. We utilized this information to modify our loan prepayment rates and ramp periods to better reflect the amount and timing of expected prepayments. The effect of these changes implemented in the third quarter of fiscal 2001 was a net reduction in the value of our interest-only strips of $3.1 million or less than 1% and an insignificant net impact on securitization gains for fiscal 2001. The effect on the interest-only strips of this change in assumptions was recorded through an adjustment to comprehensive income in accordance with SFAS No. 115 "Accounting for Certain Investments in Debt and Equity Securities." Credit loss rates. In fiscal 2000, the initial credit loss assumptions beginning with the 1999-4 mortgage loan securitization were increased as a result of an increase in the percentage of second mortgage loans originated and our concerns regarding high levels of real estate values. The average percentage of first mortgage loans securitized had declined approximately 10% from the fiscal 1999 securitizations to the fiscal 2000 securitizations. High real estate values also affected our loss assumptions because in the event of an economic downturn, the loan-to-value ratios of the loans could be understated. Both of these factors increased the potential that the underlying real estate collateral would not be sufficient to satisfy the loan if a foreclosure were required. Although our percentage of first mortgages has subsequently increased, we believe real estate values may limit our ability to maintain the credit loss experience realized in prior securitizations. The effect of these changes in credit loss assumptions reduced the gains on securitizations in fiscal 2000 by approximately $1.7 million. 78 Off-Balance Sheet Arrangements We use off-balance sheet arrangements extensively in our business activities. The types of off-balance sheet arrangements we use include special purpose entities for the securitization of loans, obligations we incur as the servicer of securitized loans and other contractual obligations such as operating leases for corporate office space. See "-- Liquidity and Capital Resources" for additional information regarding our off-balance sheet contractual obligations. Special purpose entities and off-balance sheet facilities are used in our mortgage loan securitizations. Asset securitizations are one of the most common off-balance sheet arrangements in which a company transfers assets off of its balance sheet by selling them to a special purpose entity. We sell our loans into off-balance sheet facilities to generate the cash to pay off revolving credit facilities and to generate revenue through securitization gains. The special purpose entities described below meet our objectives for mortgage loan securitization structures and comply with accounting principles generally accepted in the United States of America. Our securitizations involve a two-step transfer that qualifies for sale accounting under SFAS No. 140. First, we sell the loans to a special purpose entity, which has been established for the limited purpose of buying and reselling the loans and establishing a true sale under legal standards. Next, the special purpose entity sells the loans to a qualified special purpose entity, which we refer to as the trust. The trust is a distinct legal entity, independent from us. By transferring title of the loans to the trust, we isolate those assets from our assets. Finally, the trust issues certificates to investors to raise the cash purchase price for the loans we have sold. Cash from the sale of certificates to third party investors is returned to us in exchange for our loan receivables and we use this cash, in part, to repay any borrowings under warehouse and credit facilities. The off-balance sheet trusts' activities are restricted to holding title to the loan collateral, issuing certificates to investors and distributing loan payments to the investors and us in accordance with the relevant agreement. In each securitization, we also retain the right to service the loans. We have no additional obligations to the off-balance sheet facilities other than those required as servicer of the loans and for breach of covenants or warranty obligations. We are not required to make any additional investments in the trusts. Under current accounting rules, the trusts do not qualify for consolidation in our financial statements. The trusts carry the loan collateral as assets and the certificates issued to investors as liabilities. Residual cash from the loans after required principal and interest payments are made to the investors and after payment of certain fees and expenses provides us with cash flows from our interest-only strips. We expect that future cash flows from our interest-only strips and servicing rights will generate more of the cash flows required to meet maturities of our subordinated debt and our operating cash needs. 79 We retain the rights to service the loans we sell through securitizations. As the servicer of securitized loans, we are obligated to advance interest payments for delinquent loans if we deem that the advances will ultimately be recoverable. These advances can first be made out of funds available in a trust's collection account. If the funds available from the collection account are insufficient to make the required interest advances, then we are required to make the advance from our operating cash. The advances made from a trust's collection account, if not recovered from the borrower or proceeds from the liquidation of the loan, require reimbursement from us. These advances may require funding from our capital resources and may create greater demands on our cash flow than either selling loans with servicing released or maintaining a portfolio of loans on our balance sheet. However, any advances we make on a mortgage loan from our operating cash can be recovered from the subsequent mortgage loan payments to the applicable trust prior to any distributions to the certificate holders. At June 30, 2003 and June 30, 2002, the mortgage securitization trusts held loans with an aggregate principal balance due of $3.4 billion and $2.9 billion as assets and owed $3.2 billion and $2.8 billion to third party investors, respectively. Revenues from the sale of loans to securitization trusts were $171.0 million, or 70.8% of total revenues for the fiscal year ended June 30, 2003 and $185.6 million, or 74.9% of total revenues for the fiscal year ended June 30, 2002. These amounts are net of $5.1 million in fiscal 2003 and $5.7 million in fiscal 2002 of expenses for underwriting fees, legal fees and other expenses associated with securitization transactions during the periods. We have interest-only strips and servicing rights with fair values of $598.3 million and $119.3 million, respectively at June 30, 2003, which represent 61.9% of our total assets. Cash flows received from interest-only strips and servicing rights were $132.1 million for the fiscal year ended June 30, 2003 and $88.7 million for the fiscal year ended June 30, 2002. These amounts are included in our operating cash flows. We also used special purpose entities in our sales of loans to a $300.0 million off-balance sheet mortgage conduit facility. Sales into the off-balance sheet facility involved a two-step transfer that qualified for sale accounting under SFAS No. 140, similar to the process described above. This facility had a revolving feature and could be directed by the third party sponsor to dispose of the loans. Typically, the loans were disposed of by securitizing the loans in a term securitization. The third party note purchaser also has the right to have the loans sold in whole loan sale transactions. Under this off-balance sheet facility arrangement, the loans have been isolated from us and our subsidiaries and as a result, transfers to the facility were treated as sales for financial reporting purposes. When loans were sold to this facility, we assessed the likelihood that the sponsor would transfer the loans into a term securitization. As the sponsor had typically transferred the loans to a term securitization prior to the fourth quarter of fiscal 2003, the amount of gain on sale we had recognized for loans sold to this facility was estimated based on the terms we would obtain in a term securitization rather than the terms of this facility. For the fourth quarter of fiscal 2003, the likelihood that the facility sponsor would ultimately transfer the underlying loans to a term securitization was significantly reduced and the amount of gain recognized for loans sold to this facility was based on terms expected in a whole loan sale transaction. Our ability to sell loans into this facility expired pursuant to its terms on July 5, 2003. At June 30, 2003, the off-balance sheet mortgage conduit facility held loans with principal balances due of $275.6 million as assets and owed $267.5 million to third parties. Through September 17, 2003, $221.9 million of the loans in the facility at June 30, 2003 were sold in whole loan sales as directed by the facility sponsor. 80 Securitizations In our mortgage loan securitizations, pools of mortgage loans are sold to a trust. The trust then issues certificates or notes, which we refer to as certificates in this document, to third-party investors, representing the right to receive a pass-through interest rate and principal collected on the mortgage loans each month. These certificates, which are senior in right to our interest-only strips in the trusts, are sold in public or private offerings. The difference between the weighted-average interest rate that is charged to borrowers on the fixed interest rate pools of mortgage loans and the weighted-average pass-through interest rate paid to investors is referred to as the interest rate spread. The interest rate spread after payment of certain fees and expenses and subject to certain conditions is distributed from the trust to us and is the basis of the value of our interest-only strips. In addition, when we securitize our loans we retain the right to service the loans for a fee, which is the basis for our servicing rights. Servicing includes processing of mortgage payments, processing of disbursements for tax and insurance payments, maintenance of mortgage loan records, performance of collection efforts, including disposition of delinquent loans, foreclosure activities and disposition of real estate owned, referred to as REO, and performance of investor accounting and reporting processes. Declines in securitization pass-through interest rates resulted in interest rate spreads improving by approximately 235 basis points from the fourth quarter of fiscal 2000 securitization, to our most recent securitization in the third quarter of fiscal 2003. Increased interest rate spreads resulted in increases in the residual cash flow we expect to receive on securitized loans, the amount we received at the closing of a securitization from the sale of notional bonds or premiums on investor certificates and corresponding increases in the gains we recognized on the sale of loans in a securitization. No assurances can be made that market interest rates will remain at current levels or that we can complete securitizations in the future. However, in a rising interest rate environment and under our business strategy we would expect our ability to originate loans at interest rates that will maintain our most recent level of securitization gain profitability to become more difficult than during a stable or falling interest rate environment. We would seek to address the challenge presented by a rising interest rate environment by carefully monitoring our product pricing, the actions of our competition, market trends and the use of hedging strategies in order to continue to originate loans in as profitable a manner as possible. See "-- Strategies for Use of Derivative Financial Instruments" for a discussion of our hedging strategies. A rising interest rate environment could unfavorably impact our liquidity and capital resources. Rising interest rates could impact our short-term liquidity by limiting our ability to sell loans at favorable premiums in whole loan sales, widening investor interest rate spread requirements in pricing future securitizations, increasing the levels of overcollateralization in future securitizations, limiting our access to borrowings in the capital markets and limiting our ability to sell our subordinated debt securities at favorable interest rates. In a rising interest rate environment, short-term and long-term liquidity could also be impacted by increased interest costs on all sources of borrowed funds, including the subordinated debt, and by reducing interest rate spreads on our securitized loans, which would reduce our cash flows. See "-- Liquidity and Capital Resources" for a discussion of both long and short-term liquidity. These effects may be offset to some degree by the positive effect of a decline in prepayment activity that we would expect in a rising interest rate environment. See "-- Liquidity and Capital Resources" for a discussion of both long and short-term liquidity. 81 Conversely, a declining interest rate environment could unfavorably impact the valuation of our interest-only strips. In a declining interest rate environment the level of mortgage refinancing activity tends to increase, which could result in an increase in loan prepayment experience and may require increases in assumptions for prepayments for future periods. After a two-year period during which management's estimates required no valuation adjustments to our interest-only strips and servicing rights, declining interest rates and high prepayment rates over the last seven quarters have required revisions to management's estimates of the value of these retained interests. Beginning in the second quarter of fiscal 2002 and on a quarterly basis thereafter, we increased the prepayment rate assumptions used to value our securitization assets, thereby decreasing the fair value of these assets. However, because our prepayment rates as well as those throughout the mortgage industry continued to remain at higher than expected levels due to continuous declines in interest rates during this period to 40-year lows, our prepayment experience exceeded even our revised assumptions. As a result, over the last seven quarters we have recorded cumulative pre-tax write downs to our interest-only strips in the aggregate amount of $102.0 million and pre-tax adjustments to the value of servicing rights of $5.3 million, for total adjustments of $107.3 million, mainly due to our higher than expected prepayment experience. Of this amount, $67.2 million was expensed through the income statement and $40.1 million resulted in a write down through other comprehensive income, a component of stockholders' equity. During fiscal 2003, we recorded total pre-tax valuation adjustments on our securitization assets of $63.3 million, of which $45.2 million was charged to the income statement and $18.1 million was charged to other comprehensive income. The breakout of the total adjustments in fiscal 2003 between interest-only strips and servicing rights was a follows: o We recorded total pre-tax valuation adjustments on our interest only-strips of $58.0 million, of which, in accordance with EITF 99-20, $39.9 million was charged to the income statement and $18.1 million was charged to other comprehensive income. The valuation adjustment reflects the impact of higher than anticipated prepayments on securitized loans experienced in fiscal 2003 due to the low interest rate environment experienced during fiscal 2003, which has impacted the entire mortgage industry. The valuation adjustment on interest-only strips for fiscal 2003 was reduced by a $20.9 million favorable valuation impact as a result of reducing the discount rates applied in valuing the interest-only strips at June 30, 2003. The amount of the valuation adjustment charged to the income statement was reduced by a $10.8 million favorable valuation impact as a result of reducing the discount rates and the charge to other comprehensive income was reduced by $10.1 million for the favorable impact of reducing discount rates. The discount rates were reduced at June 30, 2003 primarily to reflect the impact of the sustained decline in market interest rates. The discount rate on the projected residual cash flows from our interest-only strips was reduced from 13% to 11% at June 30, 2003. The discount rate used to determine the fair value of the overcollateralization portion of the cash flows from our interest-only strips was minimally impacted by the decline in interest rates and remained at 7% on average. As a result, the blended rate used to value our interest-only strips, including the overcollateralization cash flows, was 9% at June 30, 2003. o We recorded total pre-tax valuation adjustments on our servicing rights of $5.3 million, which was charged to the income statement. The valuation adjustment reflects the impact of higher than anticipated prepayments on securitized loans experienced in fiscal 2003 due to the low interest rate environment experienced during fiscal 2003. The valuation adjustment on servicing rights for fiscal 2003 was reduced by a $7.1 million favorable valuation impact as a result of reducing the discount rate applied in valuing the servicing rights at June 30, 2003. The discount rate was reduced at June 30, 2003 primarily to reflect the impact of the sustained decline in market interest rates. The discount rate on our servicing rights was reduced from 11% to 9% at June 30, 2003. 82 The long duration of historically low interest rates has given borrowers an extended opportunity to engage in mortgage refinancing activities which resulted in elevated prepayment experience. The persistence of historically low interest rate levels, unprecedented in the last 40 years, has made the forecasting of prepayment levels in future fiscal periods difficult. We had assumed that the decline in interest rates had stopped and a rise in interest rates would occur in the near term. Consistent with this view, we had utilized derivative financial instruments to manage interest rate risk exposure on our loan production and loan pipeline to protect the fair value of these fixed rate items against potential increases in market interest rates. Based on current economic conditions and published mortgage industry surveys including the Mortgage Bankers Association's Refinance Indexes available at the time of our quarterly revaluation of our interest-only strips and servicing rights, and our own prepayment experience, we believe prepayments will continue to remain at higher than normal levels for the near term before returning to average historical levels. The Mortgage Bankers Association of America has forecast as of June 13, 2003 that mortgage refinancings as a percentage share of total mortgage originations will decline from 71% in the first quarter of calendar 2003 to 50% in the first quarter of calendar 2004 and to 34% in the second quarter of calendar 2004. The Mortgage Bankers Association of America has also projected in its June 2003 economic forecast that the 10-year treasury rate (which generally affects mortgage rates) will increase over the next three quarters. As a result of our analysis of these factors, we have increased our prepayment rate assumptions for home equity loans for the near term, but at a declining rate, before returning to our historical levels. However, we cannot predict with certainty what our prepayment experience will be in the future. Any unfavorable difference between the assumptions used to value our securitization assets and our actual experience may have a significant adverse impact on the value of these assets. The following tables detail the pre-tax write downs of the securitization assets by quarter and details the impact to the income statement and to other comprehensive income in accordance with the provisions of SFAS No. 115 "Accounting for Certain Investments in Debt and Equity Securities" and EITF 99-20 as they relate to interest-only strips and SFAS No. 140 "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities" as it relates to servicing rights (in thousands): Fiscal Year 2003:
Income Other Total Statement Comprehensive Quarter Ended Write down Impact Income Impact - ----------------------------------------- ---------- --------- ------------- September 30, 2002....................... $ 16,739 $ 12,078 $ 4,661 December 31, 2002........................ 16,346 10,568 5,778 March 31, 2003........................... 16,877 10,657 6,220 June 30, 2003............................ 13,293 11,879 1,414 -------- -------- -------- Total Fiscal 2003........................ $ 63,255 $ 45,182 $ 18,073 ======== ======== ========
83 Fiscal Year 2002:
Income Other Total Statement Comprehensive Quarter Ended Write down Impact Income Impact - ----------------------------------------- ---------- --------- ------------- December 31, 2001........................ $ 11,322 $ 4,462 $ 6,860 March 31, 2002........................... 15,513 8,691 6,822 June 30, 2002............................ 17,244 8,900 8,344 -------- -------- -------- Total Fiscal 2002........................ $ 44,079 $ 22,053 $ 22,026 ======== ======== ========
Note: The impacts of prepayments on our securitization assets in the quarter ended September 30, 2001 were not significant. The following table summarizes the volume of loan securitizations and whole loan sales for the fiscal years ended June 30, 2003, 2002 and 2001 (dollars in thousands): Year Ended June 30, ------------------------------------ Securitizations: 2003 2002 2001 ---------- ---------- -------- Business loans......................... $ 112,025 $ 129,074 $ 109,892 Home equity loans...................... 1,311,739 1,222,061 992,174 ---------- ---------- ---------- Total.................................. $1,423,764 $1,351,135 $1,102,066 ========== ========== ========== Gain on sale of loans through securitization....................... $ 170,950 $ 185,580 $ 128,978 Securitization gains as a percentage of total revenue..................... 70.8% 74.9% 70.4% Whole loan sales....................... $ 28,013 $ 57,679 $ 76,333 Gains on whole loan sales.............. $ 655 $ 2,448 $ 2,742 As demonstrated in the fourth quarter of fiscal 2003, our quarterly revenues and net income may fluctuate in the future principally as a result of the timing, size and profitability of our securitizations. The business strategy of selling loans through securitizations and whole loan sales requires building an inventory of loans over time, during which time we incur costs and expenses. Since a gain on sale is not recognized until a securitization is closed or whole loan sale is settled, which may not occur until a subsequent quarter, operating results for a given quarter can fluctuate significantly. If securitizations or whole loan sales do not close when expected, we could experience a material adverse effect on our results of operations for a quarter. See "-- Liquidity and Capital Resources" for a discussion of the impact of securitizations and whole loan sales on our cash flow. Several factors affect our ability to complete securitizations on a profitable basis. These factors include conditions in the securities markets, such as fluctuations in interest rates described below, conditions in the asset-backed securities markets relating to the loans we originate, credit quality of the managed portfolio of loans or potential changes to the legal and accounting principles underlying securitization transactions. 84 Interest-Only Strips. As the holder of the interest-only strips, we are entitled to receive excess (or residual) cash flows and cash flows from overcollateralization. These cash flows are the difference between the payments made by the borrowers on securitized loans and the sum of the scheduled and prepaid principal and pass-through interest paid to trust investors, servicing fees, trustee fees and, if applicable, surety fees. In most of our securitizations, surety fees are paid to an unrelated insurance entity to provide credit enhancement for the trust investors. Generally, all residual cash flows are initially retained by the trust to establish required overcollateralization levels in the trust. Overcollateralization is the excess of the aggregate principal balances of loans in a securitized pool over the aggregate principal balance of investor interests. Overcollateralization requirements are established to provide credit enhancement for the trust investors. The overcollateralization requirements for a mortgage loan securitization are different for each securitization and include: (1) The initial requirement, if any, which is a percentage of the original unpaid principal balance of loans securitized and is paid in cash at the time of sale; (2) The final target, which is a percentage of the original unpaid principal balance of loans securitized and is funded from the monthly excess cash flow. Specific securitizations contain provisions requiring an increase above the final target overcollateralization levels during periods in which delinquencies exceed specified limits. The overcollateralization levels return to the target levels when delinquencies fall below the specified limits; and (3) The stepdown requirement, which is a percentage of the remaining unpaid principal balance of securitized loans. During the stepdown period, the overcollateralization amount is gradually reduced through cash payments to us until the overcollateralization balance declines to a specific floor. The stepdown period generally begins at the later of 30 to 36 months after the initial securitization of the loans or when the remaining balance of securitized loans is less than 50% of the original balance of securitized loans. The fair value of our interest-only strips is a combination of the fair values of our residual cash flows and our overcollateralization cash flows. At June 30, 2003, investments in interest-only strips totaled $598.3 million, including the fair value of overcollateralization related cash flows of $279.2 million. Trigger Management. Repurchasing delinquent loans from securitization trusts benefits us by allowing us to limit the level of delinquencies and losses in the securitization trusts and as a result, we can avoid exceeding specified limits on delinquencies and losses that trigger a temporary reduction or discontinuation of cash flow from our interest-only strips until the delinquency or loss triggers are no longer exceeded. We have the right, but are not obligated, to repurchase a limited amount of delinquent loans from securitization trusts. In addition, we elect to repurchase loans in situations requiring more flexibility for the administration and collection of these loans. The purchase price of a delinquent loan is at the loan's outstanding contractual balance. A foreclosed loan is one where we, as servicer, have initiated formal foreclosure proceedings against the borrower and a delinquent loan is one that is 31 days or more past due. The foreclosed and delinquent loans we typically elect to repurchase are usually 90 days or more delinquent and the subject of foreclosure proceedings, or where a completed foreclosure is imminent. The related allowance for loan losses on these repurchased loans is included in our provision for credit losses in the period of repurchase. Our ability to repurchase these loans does not disqualify us for sale accounting under SFAS No. 140, which was adopted on a prospective basis in the fourth quarter of fiscal 2001, or other relevant accounting literature because we are not required to repurchase any loan and our ability to repurchase a loan is limited by contract. 85 At June 30, 2003, none of our 25 mortgage securitization trusts were under a triggering event, an improvement from three trusts at March 31, 2003. For the fiscal year ended June 30, 2003, we repurchased delinquent loans with an aggregate unpaid principal balance of $55.0 million from securitization trusts primarily for trigger management. If delinquencies increase and we cannot cure the delinquency or liquidate the loans in the mortgage securitization trusts without exceeding loss triggers, the levels of repurchases required to manage triggers may increase. Our ability to continue to manage triggers in our securitization trusts in the future is affected by our availability of cash from operations or through the sale of subordinated debt to fund these repurchases. See "Risk Factors -- Delinquencies and prepayments in the pools of securitized loans could adversely affect the cash flow we receive from our interest-only strips, impair our ability to sell or securitize loans in the future and impair our ability to repay the subordinated debt and negatively impact the value of our common stock." Additionally, our repurchase activity increases prepayments which may result in unfavorable prepayment experience. See "-- Securitizations" for more detail of the effect prepayments have on our financial statements. Also see "Managed Portfolio Quality -- Delinquent Loans and Leases" for further discussion of the impact of delinquencies. The following table summarizes the principal balances of loans and REO we have repurchased from the mortgage loan securitization trusts for fiscal years 2003, 2002 and 2001. We received $37.6 million, $19.2 million and $10.9 million of proceeds from the liquidation of repurchased loans and REO for fiscal years 2003, 2002 and 2001, respectively. We had repurchased loans and REO remaining on our balance sheet in the amounts of $9.6 million, $9.4 million and $4.8 million at June 30, 2003, 2002 and 2001, respectively. All loans and REO were repurchased at the contractual outstanding balances at the time of repurchase and are carried at the lower of their cost basis or fair value. Because the contractual outstanding balance is typically greater than the fair value, we generally incur a loss on these repurchases. Mortgage loan securitization trusts are listed only if repurchases have occurred. 86 Summary of Loans and REO Repurchased from Mortgage Loan Securitization Trusts (dollars in thousands)
2001-3 2001-1 2000-4 2000-3 2000-2 2000-1 1999-4 1999-3 1999-2 1999-1 ------ ------ ------ ------ ------ ------ ------ ----- ------ ------ Year ended June 30, 2003: Business loans ................... $ 349 $ 543 $ 223 $ 144 $ 2,065 $ 1,573 $ 2,719 $ 2,138 $ 1,977 $ 1,199 Home equity loans ................ 853 4,522 520 839 4,322 4,783 5,175 3,697 3,140 4,432 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Total .......................... $ 1,202 $ 5,065 $ 743 $ 983 $ 6,387 $ 6,356 $ 7,894 $ 5,835 $ 5,117 $ 5,631 ======= ======= ======= ======= ======= ======= ======= ======= ======= ======= % of Original Balance of Loans Securitized ...................... 0.40% 1.84% 0.27% 0.66% 2.11% 2.68% 3.56% 2.63% 2.33% 3.04% Number of loans repurchased ...... 11 51 9 11 59 65 97 83 59 60 Year ended June 30, 2002: Business loans ................... $ -- $ -- $ -- $ -- $ -- $ -- $ 194 $ 1,006 $ 341 $ 438 Home equity loans ................ -- -- -- -- -- 84 944 3,249 2,688 2,419 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Total .......................... $ -- -- $ -- $ -- $ -- $ 84 $ 1,138 $ 4,255 $ 3,029 $ 2,857 ======= ======= ======= ======= ======= ======= ======= ======= ======= ======= % of Original Balance of Loans Securitized ...................... -- -- -- -- -- 0.04% 0.51% 1.92% 1.38% 1.54% Number of loans repurchased ...... -- -- -- -- -- 2 18 47 31 33 Year ended June 30, 2001: Business loans ................... $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ -- Home equity loans ................ -- -- -- 88 330 -- -- -- -- -- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Total .......................... $ -- $ -- $ -- $ 88 $ 330 $ -- $ -- $ -- $ -- $ -- ======= ======= ======= ======= ======= ======= ======= ======= ======= ======= % of Original Balance of Loans Securitized ...................... -- -- -- 0.06% 0.11% -- -- -- -- -- Number of loans repurchased ...... -- -- -- 1 2 -- -- -- -- -- (Continued) 1998-4 1998-3 1998-2 1998-1 1997-2 1997-1 1996-2 1996-1 Total ------ ------ ------ ------ ------ ------ ------ ------ ----- Year ended June 30, 2003: Business loans ................... $ 72 $ 1,455 $ 205 $ 395 $ 30 $ 714 $ 313 $ 138 $16,252 Home equity loans ................ 549 3,211 1,386 610 224 157 355 -- 38,775 ------- ------- ------- ------- ------- ------- ------- ------- ------- Total .......................... $ 621 $ 4,666 $ 1,591 $ 1,005 $ 254 $ 871 $ 668 $ 138 $55,027 ======= ======= ======= ======= ======= ======= ======= ======= ======= % of Original Balance of Loans Securitized ...................... 0.78% 2.33% 1.33% 0.96% 0.34% 0.87% 3.04% 0.35% Number of loans repurchased ...... 7 60 23 13 4 12 12 1 637 Year ended June 30, 2002: Business loans ................... $ 632 $ 260 $ 516 $ 1,266 $ 1,729 $ 183 $ -- $ 104 $ 6,669 Home equity loans ................ 4,649 5,575 1,548 1,770 223 239 60 123 23,571 ------- ------- ------- ------- ------- ------- ------- ------- ------- Total .......................... $ 5,281 $ 5,835 $ 2,064 $ 3,036 $ 1,952 $ 422 $ 60 $ 227 $30,240 ======= ======= ======= ======= ======= ======= ======= ======= ======= % of Original Balance of Loans Securitized ...................... 6.60% 2.92% 1.72% 2.89% 1.95% 0.56% 0.15% 1.03% Number of loans repurchased ...... 58 61 24 37 18 8 1 3 341 Year ended June 30, 2001: Business loans ................... $ 173 $ 803 $ 215 $ 428 $ 2,252 $ -- $ 380 $ 250 $ 4,501 Home equity loans ................ 1,310 3,886 1,284 1,686 1,764 -- 92 109 10,549 ------- ------- ------- ------- ------- ------- ------- ------- ------- Total .......................... $ 1,483 $ 4,689 $ 1,499 $ 2,114 $ 4,016 $ -- $ 472 $ 359 $15,050 ======= ======= ======= ======= ======= ======= ======= ======= ======= % of Original Balance of Loans Securitized ...................... 1.85% 2.34% 1.25% 2.01% 4.02% -- 1.18% 1.63% Number of loans repurchased ...... 10 48 13 31 37 -- 8 4 154
87 SFAS No. 140 was effective on a prospective basis for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. SFAS No. 140 requires that we record an obligation to repurchase loans from securitization trusts at the time we have the contractual right to repurchase the loans, whether or not we actually repurchase them. For securitization trusts 2001-2 and forward, to which this rule applies, we have the contractual right to repurchase a limited amount of loans greater than 180 days past due. In accordance with the provisions of SFAS No. 140, we have recorded on our June 30, 2003 balance sheet a liability of $27.9 million for the repurchase of loans subject to these removal of accounts provisions. A corresponding asset for the loans, at the lower of their cost basis or fair value, has also been recorded. 88 Mortgage Loan Securitization Trust Information. The following tables provide information regarding the nature and principal balances of mortgage loans securitized in each trust, the securities issued by each trust, and the overcollateralization requirements of each trust. Summary of Selected Mortgage Loan Securitization Trust Information Current Balances as of June 30, 2003 (dollars in millions)
2003-1 2002-4 2002-3 2002-2 2002-1 2001-4 2001-3 2001-2 2001-1 2000-4 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Original balance of loans securitized: Business loans ................... $ 33 $ 30 $ 34 $ 34 $ 32 $ 29 $ 31 $ 35 $ 29 $ 27 Home equity loans ................ 417 350 336 346 288 287 269 320 246 248 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Total ............................ $ 450 $ 380 $ 370 $ 380 $ 320 $ 316 $ 300 $ 355 $ 275 $ 275 ======= ======= ======= ======= ======= ======= ======= ======= ======= ======= Current balance of loans securitized: Business loans ................... $ 32 $ 28 $ 30 $ 30 $ 26 $ 23 $ 22 $ 26 $ 19 $ 15 Home equity loans ................ 410 324 283 259 190 163 139 146 103 93 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Total ............................ $ 442 $ 352 $ 313 $ 289 $ 216 $ 186 $ 161 $ 172 $ 122 $ 108 ======= ======= ======= ======= ======= ======= ======= ======= ======= ======= Weighted-average interest rate on loans securitized: Business loans ................... 15.89% 16.00% 15.94% 16.01% 15.76% 15.80% 15.95% 15.95% 16.05% 16.11% Home equity loans ................ 9.77% 10.53% 10.85% 10.91% 10.84% 10.70% 11.10% 11.22% 11.43% 11.61% Total ............................ 10.21% 10.96% 11.34% 11.44% 11.43% 11.32% 11.76% 11.94% 12.16% 12.26% Percentage of first mortgage loans . 86% 86% 87% 86% 90% 90% 89% 90% 89% 85% Weighted-average loan-to-value ... 77% 76% 77% 77% 76% 77% 76% 76% 75% 76% Weighted-average remaining term (months) on loans securitized .... 267 260 253 240 234 232 223 220 216 206 Original balance of Trust Certificates ..................... $ 450 $ 376 $ 370 $ 380 $ 320 $ 322 $ 306 $ 355 $ 275 $ 275 Current balance of Trust Certificates ..................... $ 437 $ 339 $ 302 $ 276 $ 201 $ 172 $ 149 $ 157 $ 111 $ 95 Weighted-average pass-through interest rate to Trust Certificate holders(a) ........... 5.03% 5.87% 6.87% 7.48% 6.84% 5.35% 5.73% 8.11% 7.73% 7.05% Highest Trust Certificate pass-through interest rate ....... 3.78% 8.61% 6.86% 7.39% 6.51% 5.35% 6.14% 6.99% 6.28% 7.05% Overcollateralization requirements: Required percentages: Initial .......................... -- 1.00% -- -- -- -- -- -- -- -- Final target ..................... 5.50% 5.75% 3.50% 3.50% 4.50% 4.25% 4.00% 4.40% 4.10% 4.50% Stepdown overcollateralization ... 11.00% 11.50% 7.00% 7.00% 9.00% 8.50% 8.00% 8.80% 8.20% 9.00% Required dollar amounts: Initial .......................... -- $ 4 -- -- -- -- -- -- -- -- Final target ..................... $ 25 $ 22 $ 13 $ 13 $ 14 $ 13 $ 12 $ 16 $ 11 $ 12 Current status: Overcollateralization amount ..... $ 5 $ 13 $ 11 $ 13 $ 15 $ 14 $ 12 $ 15 $ 11 $ 13 Final target reached or anticipated date to reach ...... 10/2004 3/2004 9/2003 7/2003 7/2003 7/2003 Yes Yes Yes Yes Stepdown reached or anticipated date to reach .................. 9/2006 3/2006 10/2006 7/2005 10/2004 7/2004 4/2004 1/2004 10/2003 1/2004 Annual surety wrap fee ............. 0.20% (b) (b) (b) 0.21% 0.20% 0.20% 0.20% 0.20% 0.21% Servicing rights: Original balance ................. $ 16 $ 14 $ 13 $ 15 $ 13 $ 13 $ 12 $ 15 $ 11 $ 14 Current balance .................. $ 16 $ 13 $ 11 $ 11 $ 9 $ 7 $ 7 $ 7 $ 5 $ 5
- ------------- (a) Rates for securitizations 2001-1 and forward include rates on notional bonds, or the impact of premiums to loan collateral received on trust certificates, included in securitization structure. The sale of notional bonds allows us to receive more cash at the closing of a securitization. See "-- Year Ended June 30, 2003 Compared to Year Ended June 30, 2002 -- Gain on Sale of Loans -- Securitizations" for further description of the notional bonds. (b) Credit enhancement was provided through a senior / subordinate certificate structure. 89 Summary of Selected Mortgage Loan Securitization Trust Information (Continued) Current Balances as of June 30, 2003 (dollars in millions)
2000-3 2000-2 2000-1 1999-4 1999-3 1999-2 1999-1 1998(a) 1997(a) 1996(a) ------ ------ ------ ------ ------ ------ ------ ------- ------- ------- Original balance of loans securitized: Business loans ................... $ 16 $ 28 $ 25 $ 25 $ 28 $ 30 $ 16 $ 57 $ 45 $ 29 Home equity loans ................ 134 275 212 197 194 190 169 448 130 33 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Total ............................ $ 150 $ 303 $ 237 $ 222 $ 222 $ 220 $ 185 $ 505 $ 175 $ 62 ======= ======= ======= ======= ======= ======= ======= ======= ======= ======= Current balance of loans securitized: Business loans ................... $ 8 $ 14 $ 12 $ 11 $ 11 $ 11 $ 6 $ 14 $ 10 $ 5 Home equity loans ................ 50 97 69 71 66 71 54 111 21 5 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Total ............................ $ 58 $ 111 $ 81 $ 82 $ 77 $ 82 $ 60 $ 125 $ 31 $ 10 ======= ======= ======= ======= ======= ======= ======= ======= ======= ======= Weighted-average interest rate on loans securitized: Business loans ................... 16.06% 16.04% 16.03% 16.09% 15.78% 15.71% 15.96% 15.93% 15.91% 15.89% Home equity loans ................ 11.42% 11.43% 11.35% 11.05% 10.85% 10.46% 10.66% 10.80% 11.55% 11.00% Total ............................ 12.09% 12.03% 12.03% 11.73% 11.54% 11.20% 11.17% 11.37% 12.93% 13.73% Percentage of first mortgage loans . 88% 83% 80% 85% 87% 89% 93% 90% 77% 75% Weighted-average loan-to-value ..... 77% 77% 77% 76% 77% 76% 77% 77% 74% 66% Weighted-average remaining term (months) on loans securitized .... 205 214 203 200 204 213 209 191 149 110 Original balance of Trust Certificates ..................... $ 150 $ 300 $ 235 $ 220 $ 219 $ 219 $ 184 $ 498 $ 171 $ 61 Current balance of Trust Certificates ..................... $ 51 $ 98 $ 72 $ 73 $ 69 $ 74 $ 54 $ 112 $ 27 $ 7 Weighted-average pass-through interest rate to Trust Certificate holders .............. 7.61% 7.06% 7.06% 6.87% 6.79% 6.64% 6.56% 6.30% 7.19% 7.67% Highest Trust Certificate pass-through interest rate ....... 7.61% 8.04% 7.93% 7.68% 7.49% 7.13% 6.58% 6.86% 7.53% 7.95% Overcollateralization requirements: Required percentages: Initial .......................... -- 0.90% 0.75% 1.00% 1.00% 0.50% 0.50% 1.50% 2.43% 1.94% Final target ..................... 4.75% 5.95% 5.95% 5.50% 5.00% 5.00% 5.00% 5.10% 7.43% 8.94% Stepdown overcollateralization ... 9.50% 11.90% 11.90% 11.00% 10.00% 10.00% 10.00% 10.21% 14.86% 12.90% Required dollar amounts: Initial .......................... -- $ 3 $ 2 $ 2 $ 2 $ 1 $ 1 $ 7 $ 4 $ 1 Final target ..................... $ 7 $ 18 $ 14 $ 12 $ 11 $ 11 $ 9 $ 26 $ 13 $ 6 Current status: Overcollateralization amount ..... $ 7 $ 13 $ 9 $ 9 $ 8 $ 8 $ 6 $ 13 $ 4 $ 3 Final target reached or anticipated date to reach ...... Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Stepdown reached or anticipated date to reach .................. 10/2003 7/2003 Yes Yes Yes Yes Yes Yes Yes Yes Annual surety wrap fee ............. 0.21% 0.21% 0.19% 0.21% 0.21% 0.19% 0.19% 0.22% 0.26% 0.18% Servicing rights: Original balance ................. $ 7 $ 14 $ 10 $ 10 $ 10 $ 10 $ 8 $ 18 $ 7 $ 4 Current balance .................. $ 3 $ 5 $ 3 $ 3 $ 3 $ 3 $ 2 $ 3 $ 1 $ 1
- ------------------ (a) Amounts represent combined balances and weighted-average percentages for four 1998 securitization pools, two 1997 securitization pools and two 1996 securitization pools. Discounted Cash Flow Analysis. The estimation of the fair value of interest-only strips is based upon a discounted cash flow analysis which estimates the present value of the future expected residual cash flows and overcollateralization cash flows utilizing assumptions made by management at the time loans are sold. These assumptions include the rates used to calculate the present value of expected future residual cash flows and overcollateralization cash flows, referred to as the discount rates, prepayment rates and credit loss rates on the pool of loans. These assumptions are monitored against actual experience and other economic and market conditions and are changed if deemed appropriate. Our methodology for determining the discount rates, prepayment rates and credit loss rates used to calculate the fair value of our interest-only strips is described below. 90 Discount rates. We use discount rates, which we believe are commensurate with the risks involved in our securitization assets. While quoted market prices on comparable interest-only strips are not available, we have performed comparisons of our valuation assumptions and performance experience to others in the non-conforming mortgage industry. We quantify the risks in our securitization assets by comparing the asset quality and performance experience of the underlying securitized mortgage pools to comparable industry performance. In determining the discount rate that we apply to residual cash flows, we follow what we believe to be the practice of other companies in the non-conforming mortgage industry. That is, to determine the discount rate by adding an interest rate spread to the all-in cost of securitizations to account for the risks involved in securitization assets. The all-in cost of the securitization trusts' investor certificates includes the highest trust certificate pass-through interest rate in each mortgage securitization, trustee fees, and surety fees. Trustee fees and surety fees, where applicable, generally range from 19 to 22 basis points combined. From industry experience comparisons and our evaluation of the risks inherent in our securitization assets, we have determined an interest rate spread, which is added to the all-in cost of our mortgage loan securitization trusts' investor certificates. From June 30, 2000 through March 31, 2003, we had applied a discount rate of 13% to residual cash flows. On June 30, 2003, we reduced that discount rate to 11% based on the following factors: o We have experienced a period of sustained decreases in market interest rates. Interest rates on three and five-year term US Treasury securities have been on the decline since mid-2000. Three-year rates have declined approximately 475 basis points and five-year rates have declined approximately 375 basis points. o The interest rates on the bonds issued in our securitizations over this same timeframe also have experienced a sustained period of decline. The highest trust certificate pass-through interest rate has declined 426 basis points, from 8.04% in the 2000-2 securitization to 3.78% in the 2003-1 securitization. o The weighted average interest rate on loans securitized has declined from a high of 12.01% in the 2000-3 securitization to 10.23% in the 2003-1 securitization. o Market factors and the economy favor the continuation of low interest rates for the foreseeable future. o Economic analysis of interest rates and data currently being released support declining mortgage refinancings even though predicting the continuation of low interest rates for the foreseeable future. o The interest rates paid on recently issued subordinated debt, which is used to fund our interest-only strips, has declined from a high of 11.85% in February 2001 to a current rate of 7.49% in June 2003. However, because the discount rate is applied to projected cash flows, which consider expected prepayments and losses, the discount rate assumption was not evaluated in isolation. These risks involved in our securitization assets were considered in establishing a discount rate. The impact of this reduction in discount rate from 13% to 11% was to increase the valuation of our interest-only strips by $17.6 million at June 30, 2003. The 11% discount rate that we apply to our residual cash flow portion of our interest-only strips compared to rates used by others in the industry reflects our historically higher asset quality and performance of our securitized assets compared to industry asset quality and performance and the other characteristics of our securitized loans described below: 91 o Underlying loan collateral with fixed interest rates, which are higher than others in the non-conforming mortgage industry. Average interest rate of securitized loans exceeds the industry average by 100 basis points or more. All of the securitized loans have fixed interest rates, which are more predictable than adjustable rate loans. o At origination, approximately 90% to 95% of securitized business purpose loans have prepayment fees and approximately 80% to 85% of securitized home equity loans have prepayment fees. Currently in our managed portfolio, approximately 50% to 55% of securitized business purpose loans have prepayment fees and approximately 60% to 65% of securitized home equity loans have prepayment fees. Our historical experience indicates that prepayment fees lengthen the prepayment ramp periods and slow annual prepayment speeds, which have the effect of increasing the life of the securitized loans. o A portfolio mix of first and second mortgage loans of 80-85% and 15-20%, respectively. Historically, the high proportion of first mortgages has resulted in lower delinquencies and losses. o A portfolio credit grade mix comprised of 60% A credits, 23% B credits, 14% C credits, and 3% D credits. In addition, our historical loss experience is below what is experienced by others in the non-conforming mortgage industry. We apply a second discount rate to projected cash flows from the overcollateralization portion of our interest-only strips. The discount rate applied to projected overcollateralization cash flows in each mortgage securitization is based on the highest trust certificate pass-through interest rate in the mortgage securitization. In fiscal 2001, we instituted the use of a minimum discount rate of 6.5% on overcollateralization cash flows. At June 30, 2003 we reduced the minimum discount rate to 5.0% to reflect the sustained decline in interest rates. This reduction in the minimum discount rate impacted the valuation of three securitizations and increased the June 30, 2003 valuation of our interest-only strips by $3.3 million. At June 30, 2003, the average discount rate applied to projected overcollateralization cash flows was 7%. This discount rate is lower than the discount rate applied to residual cash flows because the risk characteristics of the projected overcollateralization cash flows do not include prepayment risk and have minimal credit risk. For example, if the entire unpaid principal balance in a securitized pool of loans was prepaid by borrowers, we would fully recover the overcollateralization portion of the interest-only strips. In addition, historically, these overcollateralization balances have not been impacted by credit losses as the residual cash flow portion of our interest-only strips has always been sufficient to absorb credit losses and stepdowns of overcollateralization have generally occurred as scheduled. Overcollateralization represents our investment in the excess of the aggregate principal balance of loans in a securitized pool over the aggregate principal balance of trust certificates. The blended discount rate used to value the interest-only strips, including the overcollateralization cash flows, was 9% at June 30, 2003. 92 Prepayment rates. The assumptions we use to estimate future prepayment rates are regularly compared to actual prepayment experience of the individual securitization pools of mortgage loans and an average of the actual experience of other similar pools of mortgage loans at the same number of months after their inception. It is our practice to use an average historical prepayment rate of similar pools for the expected constant prepayment rate assumption while a pool of mortgage loans is less than a year old even though actual experience may be different. During this period, before a pool of mortgage loans reaches its expected constant prepayment rate, actual experience both quantitatively and qualitatively is generally not sufficient to conclude that final actual experience for an individual pool of mortgage loans would be materially different from the average. For pools of mortgage loans greater than one year old, prepayment experience trends for an individual pool is considered to be more significant. For these pools, adjustments to prepayment assumptions may be made to more closely conform the assumptions to actual experience if the variance from average experience is significant and is expected to continue. Current economic conditions, current interest rates and other factors are also considered in our analysis. As was previously discussed, for the past seven quarters, our actual prepayment experience was generally higher, most significantly on home equity loans, than our historical averages for prepayments. See "-- Off-Balance Sheet Arrangements -- Securitizations" for further detail of our recent prepayment experience. In addition to the use of prepayment fees on our loans, we have implemented programs and strategies in an attempt to reduce loan prepayments in the future. These programs and strategies may include providing information to a borrower regarding costs and benefits of refinancing, which at times may demonstrate a refinancing option is not in the best economic interest of the borrower. Other strategies include offering second mortgages to existing qualified borrowers or offering financial incentives to qualified borrowers to deter prepayment of their loan. We cannot predict with certainty what the impact these efforts will have on our future prepayment experience. Credit loss rates. Credit loss rates are analyzed in a similar manner to prepayment rates. Credit loss assumptions are compared to actual loss experience averages for similar mortgage loan pools and for individual mortgage loan pools. Delinquency trends and economic conditions are also considered. If our analysis indicates that loss experience may be different from our assumptions, we would adjust our assumptions as necessary. Floating interest rate certificates. Some of the securitization trusts have issued floating interest rate certificates supported by fixed interest rate mortgages. The fair value of the excess cash flow we will receive may be affected by any changes in the interest rates paid on the floating interest rate certificates. The interest rates paid on the floating interest rate certificates are based on one-month LIBOR. The assumption used to estimate the fair value of the excess cash flows received from these securitization trusts is based on a forward yield curve. See "--Interest Rate Risk Management -- Strategies for Use of Derivative Financial Instruments" for further detail of our management of the risk of changes in interest rates paid on floating interest rate certificates. 93 Sensitivity analysis. The table below outlines the sensitivity of the current fair value of our interest-only strips and servicing rights to 10% and 20% adverse changes in the key assumptions used in determining the fair value of those assets. Our base prepayment, loss and discount rates are described in the table "Summary of Material Mortgage Loan Securitization Valuation Assumptions and Actual Experience." (dollars in thousands): Securitized collateral balance.....................................$ 3,354,071 Balance sheet carrying value of retained interests (a).............$ 717,569 Weighted-average collateral life (in years)........................ 3.9 - ------------------------- (a) Amount includes interest-only strips and servicing rights. Sensitivity of assumptions used to determine the fair value of retained interests (dollars in thousands): Impact of Adverse Change --------------------------- 10% Change 20% Change ---------- ---------- Prepayment speed.......................... $ 29,916 $ 56,656 Credit loss rate.......................... 5,247 10,495 Floating interest rate certificates (a)... 829 1,614 Discount rate............................. 20,022 38,988 - ------------------------- (a) The floating interest rate certificates are indexed to one-month LIBOR plus a trust specific interest rate spread. The base one-month LIBOR assumption used in this sensitivity analysis was derived from a forward yield curve incorporating the effect of rate caps where applicable to the individual deals. The sensitivity analysis in the table above is hypothetical and should be used with caution. As the figures indicate, changes in fair value based on a 10% or 20% variation in management's assumptions generally cannot easily be extrapolated because the relationship of the change in the assumptions to the change in fair value may not be linear. Also, in this table, the effect that a change in a particular assumption may have on the fair value is calculated without changing any other assumption. Changes in one assumption may result in changes in other assumptions, which might magnify or counteract the impact of the intended change. These sensitivities reflect the approximate amount of the fair values that our interest-only strips and servicing rights would be reduced for the indicated adverse changes. These reductions would result in a charge to expense in the income statement in the period incurred and a resulting reduction of stockholders' equity, net of income taxes. The effect on our liquidity of changes in the fair values of our interest-only strips and servicing rights are discussed in "-- Liquidity and Capital Resources." 94 The following tables provide information regarding the initial and current assumptions applied in determining the fair values of mortgage loan related interest-only strips and servicing rights for each securitization trust. Summary of Material Mortgage Loan Securitization Valuation Assumptions and Actual Experience at June 30, 2003
2003-1 2002-4 2002-3 2002-2 2002-1 2001-4 2001-3 2001-2 2001-1 2000-4 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Interest-only strip residual discount rate: Initial valuation......................... 13% 13% 13% 13% 13% 13% 13% 13% 13% 13% Current valuation......................... 11% 11% 11% 11% 11% 11% 11% 11% 11% 11% Interest-only strip overcollateralization discount rate: Initial valuation......................... 7% 9% 7% 7% 7% 7% 7% 7% 6% 7% Current valuation........................ 5% 9% 7% 7% 7% 5% 6% 7% 6% 7% Servicing rights discount rate: Initial valuation......................... 11% 11% 11% 11% 11% 11% 11% 11% 11% 11% Current valuation......................... 9% 9% 9% 9% 9% 9% 9% 9% 9% 9% Prepayment rates: Initial assumption (a): Expected Constant Prepayment Rate (CPR): Business loans.......................... 11% 11% 11% 11% 11% 11% 11% 11% 11% 10% Home equity loans....................... 22% 22% 22% 22% 22% 22% 22% 22% 22% 24% Ramp period (months): Business loans.......................... 27 27 27 27 27 27 24 24 24 24 Home equity loans....................... 30 30 30 30 30 30 30 30 30 24 Current assumptions (b): Expected Constant Prepayment Rate (CPR): Business loans ......................... 11% 11% 11% 11% 11% 11% 11% 11% 11% 11% Home equity loans ...................... 22% 22% 22% 22% 22% 22% 22% 22% 22% 22% Ramp period (months): Business loans.......................... 27 27 27 27 27 27 27 27 27 27 Home equity loans....................... 30 30 30 30 30 30 30 30 30 30 CPR adjusted to reflect ramp: Business loans.......................... 5% 8% 10% 12% 15% 17% 20% 22% 22% 19% Home equity loans....................... 15% 32% 40% 51% 42% 46% 40% 40% 37% 41% Current prepayment experience (c): Business loans.......................... 8% 5% 13% 12% 15% 23% 19% 9% 21% 23% Home equity loans....................... 5% 9% 20% 28% 39% 42% 40% 37% 36% 37% Annual credit loss rates: Initial assumption........................ 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% Current assumption........................ 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.50% 0.40% Actual experience......................... -- -- 0.03% 0.03% 0.03% 0.12% 0.24% 0.17% 0.43% 0.36% Servicing fees: Contractual fees.......................... 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.70% Ancillary fees............................ 1.25% 1.25% 1.25% 1.25% 1.25% 1.25% 1.25% 1.25% 1.25% 1.25%
- ----------------- (a) The prepayment ramp is the length of time before a pool of mortgage loans reaches its expected Constant Prepayment Rate. The business loan prepayment ramp begins at 3% in month one ramps to an expected peak rate over 27 months then declines to the final expected CPR by month 40. The home equity loan prepayment ramp begins at 2% in month one and ramps to an expected rate over 30 months. (b) Current assumptions for business loans are the estimated expected weighted-average prepayment rates over the securitization's estimated remaining life. The majority of the home equity loan prepayment rate ramps have been increased for the next 6 months to provide for the expected near term continuation of higher than average prepayment. Generally, trusts for both business and home equity loans that are out of the ramping period are based on historical averages. (c) Current experience is a six-month historical average. 95 Summary of Material Mortgage Loan Securitization Valuation Assumptions and Actual Experience at June 30, 2003 (Continued)
2000-3 2000-2 2000-1 1999-4 1999-3 1999-2 1999-1 1998(d) 1997(d) 1996(d) ------ ------ ------ ------ ------ ------ ------ ------- ------- ------- Interest-only strip residual discount rate: Initial valuation........................ 13% 13% 11% 11% 11% 11% 11% 11% 11% 11% Current valuation........................ 11% 11% 11% 11% 11% 11% 11% 11% 11% 11% Interest-only strip overcollateralization discount rate: Initial valuation......................... 8% 8% 8% 8% 7% 7% 7% 7% 7% 8% Current valuation......................... 8% 8% 8% 8% 7% 7% 7% 7% 7% 8% Servicing rights discount rate: Initial valuation........................ 11% 11% 11% 11% 11% 11% 11% 11% 11% 11% Current valuation........................ 9% 9% 9% 9% 9% 9% 9% 9% 9% 9% Prepayment rates: Initial assumption (a): Expected Constant Prepayment Rate (CPR): Business loans ........................ 10% 10% 10% 10% 10% 10% 10% 13% 13% 13% Home equity loans...................... 24% 24% 24% 24% 24% 24% 24% 24% 24% 24% Ramp period (months): Business loans......................... 24 24 24 24 24 24 24 24 24 24 Home equity loans...................... 24 24 18 18 18 18 18 12 12 12 Current assumptions (b): Expected Constant Prepayment Rate (CPR): Business loans ........................ 11% 11% 11% 11% 10% 10% 10% 10% 22% 14% Home equity loans...................... 22% 22% 22% 22% 22% 22% 22% 23% 25% 25% Ramp period (months): Business loans......................... 27 Na Na Na Na Na Na Na Na Na Home equity loans...................... 30 30 Na Na Na Na Na Na Na Na CPR adjusted to reflect ramp: Business loans......................... 16% 13% 23% 35% 29% 27% 30% 20% 20% 10% Home equity loans...................... 32% 31% 37% 33% 32% 29% 26% 33% 22% 13% Current prepayment experience (c): Business loans......................... 23% 15% 23% 35% 29% 26% 30% 18% 19% 3% Home equity loans...................... 32% 31% 37% 32% 32% 29% 25% 33% 21% 13% Annual credit loss rates: Initial assumption....................... 0.40% 0.40% 0.40% 0.30% 0.25% 0.25% 0.25% 0.25% 0.25% 0.25% Current assumption....................... 0.45% 0.45% 0.65% 0.65% 0.60% 0.35% 0.55% 0.60% 0.40% 0.45% Actual experience........................ 0.41% 0.41% 0.65% 0.63% 0.58% 0.35% 0.49% 0.57% 0.36% 0.42% Servicing fees: Contractual fees......................... 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% Ancillary fees........................... 1.25% 1.25% 1.25% 1.25% 1.25% 1.25% 1.25% 0.75% 0.75% 0.75%
- -------------------------- (a) The prepayment ramp is the length of time before a pool of mortgage loans reaches its expected Constant Prepayment Rate. The business loan prepayment ramp begins at 3% in month one ramps to an expected peak rate over 27 months then declines to the final expected CPR by month 40. The home equity loan prepayment ramp begins at 2% in month one and ramps to an expected rate over 30 months. (b) Current assumptions for business loans are the estimated expected weighted-average prepayment rates over the securitization's estimated remaining life. Generally, trusts for both business and home equity loans that are out of the ramping period are based on historical averages. (c) Current experience is a six-month historical average. (d) Amounts represent weighted-average percentages for four 1998 securitization pools, two 1997 securitization pools and two 1996 securitization pools. Na = not applicable 96 Servicing Rights. As the holder of servicing rights on securitized loans, we are entitled to receive annual contractual servicing fees of 50 basis points (70 basis points in the case of the 2000-4 securitization) on the aggregate outstanding loan balance. These fees are paid out of accumulated mortgage loan payments before payments of principal and interest are made to trust certificate holders. In addition, ancillary fees such as prepayment fees, late charges, nonsufficient fund fees and other fees are retained directly by us, as servicer, as payments are collected from the borrowers. We also retain the interest paid on funds held in a trust's collection account until these funds are distributed from a trust. The fair value of servicing rights is determined by computing the benefits of servicing in excess of adequate compensation, which would be required by a substitute servicer. The benefits of servicing are the present value of projected net cash flows from contractual servicing fees and ancillary servicing fees. These projections incorporate assumptions, including prepayment rates, credit loss rates and discount rates. These assumptions are similar to those used to value the interest-only strips retained in a securitization. On a quarterly basis, we evaluate capitalized servicing rights for impairment, which is measured as the excess of unamortized cost over fair value. See "--Securitizations" for a discussion of the $5.3 million write down of servicing rights recorded in fiscal 2003. From June 2000 to March 2003, the discount rate applied in determining the fair value of servicing rights was 11% which is 200 basis points lower than the 13% discount rate applied to value residual cash flows from interest-only strips during that period. On June 30, 2003, we reduced the discount rate on servicing rights cash flows to 9%. In determining the discount rate applied to calculate the present value of cash flows from servicing rights, management has subtracted a factor from the discount rate used to value residual cash flows from interest-only strips to provide for the lower risks inherent in servicing assets. Unlike the interest-only strips, the servicing asset is not exposed to credit losses. Additionally, the distribution of the contractual servicing fee cash flow from the securitization trusts is senior to both the trusts' investor certificates and our interest-only strips. This priority of cash flow reduces the risks associated with servicing rights and thereby supports a lower discount rate than the rate applied to residual cash flows from interest-only strips. Cash flows related to ancillary servicing fees, such as prepayment fees, late fees, and non-sufficient fund fees are retained directly by us. The impact of this reduction in discount rate from 11% to 9% was to increase the valuation of our servicing rights by $7.1 million at June 30, 2003. This favorable impact was offset by a decrease of $12.4 million mainly due to prepayment experience in fiscal 2003. Servicing rights can be terminated under certain circumstances, such as our failure to make required servicer payments, defined changes of control and reaching specified loss levels on underlying mortgage pools. The origination of a high percentage of loans with prepayment fees impacts our servicing rights and income in two ways. Prepayment fees reduce the likelihood of a borrower prepaying their loan. This results in prolonging the length of time a loan is outstanding, which increases the contractual servicing fees to be collected over the life of the loan. Additionally, the terms of our servicing agreements with the securitization trusts allow us to retain prepayment fees collected from borrowers as part of our compensation for servicing loans. 97 In addition, although prepayments increased in recent periods compared to our historical averages, we have generally found that the non-conforming mortgage market is less sensitive to prepayments due to changes in interest rates than the conforming mortgage market where borrowers have more favorable credit history for the following reasons. First, there are relatively few lenders willing to supply credit to non-conforming borrowers which limits those borrowers' opportunities to refinance. Second, interest rates available to non-conforming borrowers tend to adjust much slower than conforming mortgage interest rates which reduces the non-conforming borrowers' opportunity to capture economic value from refinancing. As a result of the use of prepayment fees and the reduced sensitivity to interest rate changes in the non-conforming mortgage market, we believe the prepayment experience on our managed portfolio is more stable than the mortgage market in general. We believe this stability has favorably impacted our ability to value the future cash flows from our servicing rights and interest-only strips because it increased the predictability of future cash flows. However, for the past six quarters, our prepayment experience has exceeded our expectations for prepayments on our managed portfolio and as a result we have written down the value of our securitization assets. See "-- Off-Balance Sheet Arrangements -- Securitizations" for further detail of the effects prepayments that were above our expectations have had on the value of our securitization assets. Whole Loan Sales We also sell loans with servicing released, which we refer to as whole loan sales. Gains on whole loan sales equal the difference between the net proceeds from such sales and the net carrying value of the loans. The net carrying value of a loan is equal to its principal balance plus its unamortized origination costs and fees. See "-- Off-Balance Sheet Arrangements -- Securitizations" for information on the volume of whole loan sales and premiums recorded for fiscal years ended June 30, 2003, 2002 and 2001. Loans reported as sold on a whole loan basis were generally loans that we originated specifically for a whole loan sale and exclude impaired loans, which may be liquidated by selling the loan with servicing released. However, see "-- Business Strategy" for detail on our adjustment in business strategy from originating loans predominantly for publicly underwritten securitizations, to originating loans for a combination of whole loan sales and smaller securitizations. Also, see "Business -- Whole Loan Sales." 98 Results of Operations Summary Financial Results (dollars in thousands, except per share data) Year Ended June 30, Percentage Change --------------------------------- ----------------- 2003 2002 2001 '03/'02 '02/'01 ------ ------ ------ ------- ------- Total revenues............ $ 241,406 $ 247,901 $ 183,336 (2.6)% 35.2% Total expenses............ $ 290,426 $ 234,351 $ 170,151 23.9% 37.7% Net income (loss)......... $ (29,902) $ 7,859 $ 8,085 (480.5)% (2.8)% Return on average assets.. (3.07)% 0.94% 1.22% Return on average equity.. (44.20)% 11.75% 12.22% Earnings (loss) per share: Basic............. $ (10.25) $ 2.68 $ 2.13 (482.5)% 25.8% Diluted........... $ (10.25) $ 2.49 $ 2.08 (511.6)% 19.7% Dividends declared per share................... $ 0.32 $ 0.28 $ 0.26 14.3% 7.7% Overview Fiscal Year Ended June 30, 2003. For fiscal 2003, a net loss of $29.9 million was recorded as compared to $7.9 million net income for fiscal 2002. The loss was primarily due to our inability to complete our typical quarterly securitization of loans during the fourth quarter of our fiscal year as well as $45.2 million of pre-tax charges for valuation adjustments recorded on our securitization assets during the 2003 fiscal year, compared to $22.1 million of pre-tax charges for valuation adjustments in fiscal 2002. During fiscal 2003, we charged to the income statement total pre-tax valuation adjustments on our interest-only strips and servicing rights of $63.1 million, which primarily reflect the impact of higher than anticipated prepayments on securitized loans experienced in fiscal 2003 due to the low interest rate environment experienced during fiscal 2003. The pre-tax valuation adjustments charged to the income statement were partially offset by $17.9 million due to the impact of a decrease in the discount rates used to value our securitization assets, resulting in the $45.2 million of pre-tax charges for net valuation adjustments charged to the income statement. We reduced the discount rates on our interest-only strips and our servicing rights primarily to reflect the impact of the sustained decline in market interest rates. The discount rate on the projected residual cash flows from our interest-only strips was reduced from 13% to 11% at June 30, 2003. The discount rate used to determine the fair value of the overcollateralization portion of the cash flows from our interest-only strips was minimally impacted by the decline in interest rates and remained at 7% on average. As a result, the blended rate used to value our interest-only strips, including the overcollateralization cash flows, was 9% at June 30, 2003. The discount rate on our servicing rights was reduced from 11% to 9% at June 30, 2003. See "-- Off-Balance Sheet Arrangements -- Securitizations," "-- Off-Balance Sheet Arrangements -- Securitizations -- Discount rates" and "-- Off-Balance Sheet Arrangements -- Securitizations -- Servicing rights" for more detail. The diluted loss per common share for fiscal 2003 was $10.25 per share on average common shares of 2,918,000 compared to diluted net income per share of $2.49 per share on average common shares of 3,155,000 for fiscal 2002. Dividends of $0.32 and $0.28 per share were paid for the fiscal years ended June 30, 2003 and 2002, respectively. The common dividend payout ratio based on diluted earnings per share was 11.2% for fiscal 2002. In fiscal 1999, the Board of Directors initiated a stock repurchase program in view of the price level of our common stock, which at the time traded and has continued to trade at below book value. In addition, our consistent earnings growth at that time did not result in a corresponding increase in the market value of our common stock. The repurchase program was extended in fiscal 2000, 2001 and 2002. The total number of shares repurchased under the stock repurchase program was: 117,000 shares in fiscal 1999; 327,000 shares in fiscal 2000; 627,000 shares in fiscal 2001; and 352,000 shares in fiscal 2002. The cumulative effect of the stock repurchase program was an increase in diluted net earnings per share of $0.41 and $0.32 for the years ended 2002 and 2001, respectively. We currently have no plans to continue to repurchase additional shares or extend the repurchase program. 99 On August 21, 2002, the Board of Directors declared a 10% stock dividend, which was paid on September 13, 2002 to shareholders of record on September 3, 2002. As a result of the stock dividend, all outstanding stock options and related exercise prices were adjusted. Accordingly, we adjusted all outstanding common shares, earnings per common share, average common share and stock option amounts presented in this document to reflect the effect of this stock dividend. Amounts presented for fiscal 2001 and 2000 have been similarly adjusted for the effect of a 10% stock dividend declared on October 1, 2001 which was paid on November 5, 2001 to shareholders of record on October 22, 2001. In December 2002, the Company's shareholders approved an increase in the number of shares of authorized preferred stock from 1.0 million shares to 3.0 million shares. The preferred shares may be used to raise equity capital, redeem outstanding debt or acquire other companies, although no such acquisitions are currently contemplated. The Board of Directors has discretion with respect to designating and establishing the terms of each series of preferred stock prior to issuance. The following schedule details our loan originations during the fiscal years ended June 30, 2003, 2002 and 2001 (in thousands): Year Ended June 30, -------------------------------------- 2003 2002 2001 ---------- ---------- ---------- Business purpose loans....... $ 122,790 $ 133,352 $ 120,537 Home equity loans............ 1,543,730 1,246,505 1,096,440 ---------- ---------- ---------- $1,666,520 $1,379,857 $1,216,977 ========== ========== ========== Loan originations for our subsidiary, American Business Credit, Inc., which offers business purpose loans secured by real estate, decreased $10.6 million, or 7.9%, for the year ended June 30, 2003, to $122.8 million from $133.4 million for the year ended June 30, 2002. Current economic conditions have had an adverse impact on smaller businesses and our ability to find qualified borrowers has become more difficult. Due to less favorable response for our business purpose loans in the whole loan sale market, pursuant to our business strategy, we plan to continue to originate business purpose loans, but at lower volumes to meet demand in the whole loan sale and securitization markets. Home equity loans originated by our subsidiaries, HomeAmerican Credit, doing business as Upland Mortgage and American Business Mortgage Services, Inc., and purchased through the Bank Alliance Services program, increased $297.2 million, or 23.8%, for the year ended June 30, 2003, to $1.5 billion from $1.2 billion for the year ended June 30, 2002. Our home equity loan origination subsidiaries continue to focus on increasing efficiencies and productivity gains by refining marketing techniques and integrating technological improvements into the loan origination process. In addition, American Business Mortgage Services, Inc. is focusing on its broker relationships, a lower cost source of originations, in executing our new business strategy in the future. As a result of these efforts, as well as the favorable environment for originating home equity loans due to low interest rates, American Business Mortgage Services, Inc. home equity loan originations for the fiscal year ended June 30, 2003 increased by $157.4 million, or 32.4%, over the prior year period. In addition, the historically low interest rate environment and productivity gains in our Upland Mortgage branch operations have resulted in an increase in loan originations of $33.1 million, or 26.0%, over the prior year period. The Bank Alliance Services program's loan originations for the fiscal year ended June 30, 2003 increased $56.0 million, or 38.4%, over the comparable prior year period. Based on our business strategy, which emphasizes whole loan sales and smaller securitizations and reducing costs, effective June 30, 2003 we no longer originate loans through our retail branches, which were a high cost origination channel, and plan to increase our focus on broker and Bank Alliance Services' origination sources. 100 Year Ended June 30, 2003 Compared to Year Ended June 30, 2002 Total Revenues. For fiscal 2003, total revenues decreased $6.5 million, or 2.6%, to $241.4 million from $247.9 million for fiscal 2002. Our inability to complete our typical quarterly securitization of loans during the fourth quarter of our fiscal year accounted for this decrease in total revenues. Gain on Sale of Loans - Securitizations. For the year ended June 30, 2003, gains of $171.0 million were recorded on the securitization of $1.4 billion of loans. This was a decrease of $14.6 million, or 7.9% over gains of $185.6 million recorded on securitizations of $1.4 billion of loans for the year ended June 30, 2002. The decrease in gains recorded was a direct result of our inability to complete a quarterly securitization during the fourth quarter of our fiscal year. See "-- Recent Developments." During the year ended June 30, 2003, securitization gains as a percentage of loans securitized on our term securitization deals increased to 14.6% on loans securitized from 13.9% on loans securitized for the year ended June 30, 2002. Securitization gains as a percentage of loans securitized through our off-balance sheet facility, however, decreased to 5.5% for the year ended June 30, 2003 from 12.9% for the year ended June 30, 2002. At June 30, 2003, the likelihood that the facility sponsor would ultimately transfer the underlying mortgage loans to a term securitization was significantly reduced and the amount of gain recognized for loans sold to this facility in the fourth quarter of fiscal 2003 was based on terms expected in a whole loan sale transaction. Our ability to sell loans into this facility expired pursuant to its terms on July 5, 2003. See "-- Off-Balance Sheet Arrangements -- Securitizations" for further discussion of this facility. During fiscal 2003, we saw increases in interest rate spreads on our three permanent securitizations that increased residual cash flows to us and the amount of cash we received at the closing of a securitization from notional bonds or premiums on the sale of trust certificates. Increases in the cash received at the closing of a securitization and residual cash flows resulted in increases in the gains we recognized on the sale of loans into securitizations as compared to the year ended June 30, 2002. See "-- Off-Balance Sheet Arrangements -- Securitizations" for further detail of how securitization gains are calculated. The increase in interest rate spread realized in term securitization transactions during the year ended June 30, 2003 compared to the year ended June 30, 2002 resulted from decreases in pass-through interest rates on investor certificates issued by securitization trusts. For loans securitized during the year ended June 30, 2003, the weighted average loan interest rate was 10.82%, a 58 basis point decrease from the weighted average interest rate of 11.40% on loans securitized during the year ended June 30, 2002. However, the weighted average interest rate on trust certificates issued in mortgage loan securitizations during the year ended June 30, 2003 was 4.47%, a 104 basis point decrease from 5.51% during the year ended June 30, 2002. The resulting net improvement in interest rate spread was approximately 46 basis points. 101 The improvement in the interest rate spread through fiscal 2002 to the third quarter of fiscal 2003 enabled us to enter into securitization transactions structured to provide cash at the closing of our term securitizations through the sale of notional bonds, sometimes referred to as interest-only bonds, or the sale of trust certificates at a premium to total loan collateral. During the year ended June 30, 2003 we received additional cash at the closing of our three securitizations, due to these modified structures, of $30.2 million compared to $32.9 million received for four securitizations for fiscal 2002. Securitization gains and cash received at the closing of securitizations were partially offset by initial overcollateralization requirements of $10.6 million in fiscal 2003. There was no initial overcollateralization requirement in fiscal 2002. The Office of Thrift Supervision has adopted a rule effective in July 2003, which precludes us and other non-bank, non-thrift creditors from using the Parity Act to preempt state prepayment penalty and late fee laws and regulations on new loan originations. Under the provisions of this rule we are required to modify or eliminate the practice of charging a prepayment fee and other fees in some of the states where we originate loans. This new rule will potentially reduce the gain on sale recorded in new securitizations in two ways. First, because the percentage of loans with prepayment fees will be reduced, the prepayment rates on securitized loan pools may increase and therefore the value of our interest-only strips will decrease due to the shorter average life of the securitized loan pool. Second, the value of our servicing rights retained in a securitization may decrease due to a reduction in our ability to charge certain fees. We are continuing to evaluate the impact of the adoption of this rule on our future lending activities and results of operations. Gain on Sale of Loans - Whole Loan Sales. Gains on whole loan sales decreased $1.7 million, to $0.7 million for the year ended June 30, 2003 from $2.4 million for the year ended June 30, 2002. The volume of whole loan sales decreased 51.4%, to $28.0 million for the year ended June 30, 2003 from $57.7 million for the year ended June 30, 2002. The decrease in the volume of whole loan sales for the year ended June 30, 2003 resulted from management's decision to securitize additional loans as the securitization market's experience during the past year was more favorable than the whole loan sale market. However, our inability to complete a securitization in the fourth quarter of fiscal 2003 created a need for short-term liquidity which resulted in management utilizing whole loan sales to sell our fourth quarter of fiscal 2003 loan originations. See "-- Recent Developments " and "-- Liquidity and Capital Resources" for further detail. Interest and Fees. For the year ended June 30, 2003, interest and fee income increased $0.5 million, or 2.7%, to $19.4 million compared to $18.9 million in the same period of fiscal 2002. Interest and fee income consists primarily of interest income earned on loans available for sale, interest income on invested cash and other ancillary fees collected in connection with loan and lease originations. 102 During the year ended June 30, 2003, total interest income increased $1.0 million, or 10.5%, to $10.5 million from $9.5 million for the year ended June 30, 2002. Loan interest income increased $2.1 million from June 30, 2002 as a result of our carrying a higher average loan balance during fiscal 2003 as compared to fiscal 2002. This increase was offset by a decrease of $1.1 million of investment interest income due to lower interest rates earned on invested cash balances caused by general decreases in market interest rates. Other fees decreased $0.5 million for fiscal 2003 compared to the same periods in fiscal 2002. The decrease was mainly due to a decrease in leasing income, which resulted from our decision in fiscal 2000 to discontinue the origination of new leases. Our ability to collect certain fees on loans we originate in the future may be impacted by proposed laws and regulations by various authorities. Interest Accretion on Interest-Only Strips. Interest accretion of $47.3 million was earned in the year ended June 30, 2003 compared to $35.4 million in the year ended June 30, 2002. The increase reflects the growth in the balance of our interest-only strips of $85.7 million, or 16.7%, to $598.3 million at June 30, 2003 from $512.6 million at June 30, 2002. In addition, cash flows from interest-only strips for the year ended June 30, 2003 totaled $87.2 million, an increase of $26.9 million, or 50.4%, from the year ended June 30, 2002 due to the larger size of our more recent securitizations and additional securitizations reaching final target overcollateralization levels and stepdown overcollateralization levels. Servicing Income. Servicing income is comprised of contractual and ancillary fees collected on securitized loans serviced for others, less amortization of the servicing rights assets that are recorded at the time loans are securitized. Ancillary fees include prepayment fees, late fees and other servicing fee compensation. For the year ended June 30, 2003, servicing income decreased $2.4 million, or 44.4%, to $3.1 million from $5.5 million for the year ended June 30, 2002. Because loan prepayment levels in fiscal 2003 increased from fiscal 2002, the amortization of servicing rights has also increased. Amortization is recognized in proportion to contractual and ancillary fees collected. Therefore the collection of additional prepayment fees in fiscal 2003 has resulted in higher levels of amortization. The following table summarizes the components of servicing income for the years ended June 30, 2003, 2002 and 2001 (in thousands):
Year Ended June 30, ------------------------------------------- 2003 2002 2001 -------- -------- -------- Contractual and ancillary fees.......... $ 44,935 $ 35,314 $ 25,651 Amortization of servicing rights........ (41,886) (29,831) (19,951) -------- -------- -------- $ 3,049 $ 5,483 $ 5,700 ======== ======== ========
Total Expenses. Total expenses increased $56.0 million, or 23.9%, to $290.4 million for the year ended June 30, 2003 compared to $234.4 million for the year ended June 30, 2002. As described in more detail below, this increase was mainly a result of increases in securitization asset valuation adjustments recorded during the year ended June 30, 2003, increases in employee related costs and increases in general and administrative expenses. 103 Interest Expense. During fiscal 2003, interest expense decreased $0.6 million, or 0.9%, to $68.1 million compared to $68.7 million for fiscal 2002. Average subordinated debt outstanding during the year ended June 30, 2003 was $690.7 million compared to $615.2 million during the year ended June 30, 2002. Average interest rates paid on subordinated debt outstanding decreased to 9.27% during the year ended June 30, 2003 from 10.64% during the year ended June 30, 2002. Rates offered on subordinated debt were reduced beginning in the fourth quarter of fiscal 2001 and have continued downward through the fourth quarter of fiscal 2003 in response to decreases in market interest rates as well as declining cash needs during that period. The average interest rate of subordinated debt issued at its peak rate, which was the month of February 2001, was 11.85% compared to the average interest rate of subordinated debt issued in the month of June 2003 of 7.49%. We expect the average interest rate paid on subordinated debt to remain near current levels provided that market rates do not significantly increase. The average outstanding balances under warehouse lines of credit were $51.1 million during the year ended June 30, 2003, compared to $29.5 million during the year ended June 30, 2002. The increase in the average balance on warehouse lines was due to a higher volume of loans originated and lower average cash balances available for loan funding during the period. Interest rates paid on warehouse lines are generally based on one-month LIBOR plus an interest rate spread ranging from 0.95% to 1.75%. One-month LIBOR has decreased from approximately 1.8% at June 30, 2002 to 1.12% at June 30, 2003. Provision for Credit Losses. The provision for credit losses on loans and leases available for sale increased $0.1 million, or 1.5%, to $6.6 million for the year ended June 30, 2003 from $6.5 million for the year ended June 30, 2002. A related allowance for loan losses on repurchased loans is included in our provision for credit losses in the period of repurchase. See "-- Off-Balance Sheet Arrangements -- Securitizations" and "-- Off-Balance Sheet Arrangements -- Trigger Management" for further discussion of repurchases from securitization trusts. Non-accrual loans were $5.4 million at June 30, 2003, compared to $7.0 million at June 30, 2002. See "-- Managed Portfolio Quality" for further detail. The allowance for credit losses was $2.8 million, or 1.0% of loans and leases available for sale at June 30, 2003 compared to $3.7 million, or 6.0% of loans and leases available for sale at June 30, 2002. The allowance for credit losses as a percentage of gross receivables decreased from June 30, 2002 due to the decrease of the non-accrual loan balance being carried on our balance sheet at June 30, 2003 as well as an increase in the balance of loans available for sale. Although we maintain an allowance for credit losses at the level we consider adequate to provide for potential losses, there can be no assurances that actual losses will not exceed the estimated amounts or that an additional provision will not be required, particularly if economic conditions deteriorate. 104 The following table summarizes changes in the allowance for credit losses for the years ended June 30, 2003, 2002 and 2001 (in thousands):
Year Ended June 30, ----------------------------------------- 2003 2002 2001 --------- -------- -------- Balance at beginning of period .............. $ 3,705 $ 2,480 $ 1,289 Provision for credit losses ................. 6,553 6,457 5,190 (Charge-offs) recoveries, net ............... (7,410) (5,232) (3,999) --------- -------- -------- Balance at end of period .................... $ 2,848 $ 3,705 $ 2,480 ========= ======== ========
The following table summarizes the changes in the allowance for credit losses by loan and lease type for the fiscal year ended June 30, 2003 (in thousands):
Business Home Purpose Equity Equipment Year Ended June 30, 2003: Loans Loans Leases Total - ------------------------------- --------- -------- --------- -------- Balance at beginning of period .............. $ 1,388 $ 1,998 $ 319 $ 3,705 Provision for credit losses ................. 1,189 5,000 364 6,553 (Charge-offs) recoveries, net ............... (1,984) (4,913) (513) (7,410) -------- -------- ------ -------- Balance at end of period .................... $ 593 $ 2,085 $ 170 $ 2,848 ======== ======== ====== ========
The following table summarizes net charge-off experience by loan type for the fiscal years ended June 30, 2003, 2002 and 2001 (in thousands):
Year Ended June 30, ----------------------------------------- 2003 2002 2001 --------- -------- -------- Business purpose loans ...................... $ 1,984 $ 924 $ 1,374 Home equity loans ........................... 4,913 2,892 1,634 Equipment leases ............................ 513 1,416 991 --------- -------- -------- Total ....................................... $ 7,410 $ 5,232 $ 3,999 ========= ======== ========
Employee Related Costs. For the year ended June 30, 2003, employee related costs increased $5.3 million, or 14.6%, to $41.6 million from $36.3 million in the prior year. The increase in employee related costs for the year ended June 30, 2003 was primarily attributable to additions of personnel to originate, service and collect loans. Total employees at June 30, 2003 were 1,119 compared to 1,019 at June 30, 2002. Since June 30, 2003, we reduced our workforce by 170 employees. With our business strategy's focus on whole loan sales and offering a broader mortgage product line that we expect will appeal to a wider array of customers, we currently require a smaller employee base with fewer sales, servicing and support positions. These workforce reductions represent more than a 15% decrease in staffing levels. Increases in payroll and benefits expenses for the increased number of employees were offset by reductions of management bonus accruals due to the overall financial performance of the Company in fiscal 2003. The remaining increase was attributable to annual salary increases as well as increases in the costs of providing insurance benefits to employees during fiscal 2003. Sales and Marketing Expenses. For the year ended June 30, 2003, sales and marketing expenses increased $1.8 million, or 7.0%, to $27.8 million from $26.0 million for the year ended June 30, 2002. The increase was primarily due to increases in expenses for direct mail advertising and broker commissions for home equity and business loan originations partially offset by decreases in newspaper advertisements for subordinated debt. We expect to be able to streamline our sales and marketing costs in the future by offering a wider array of loan products and targeting segments that we believe will enable us to increase our loan origination conversion rates. By increasing our conversion rates, we expect to be able to lower our overall sales and marketing costs per dollar originated. See "-- Business Strategy" for further discussion. 105 General and Administrative Expenses. For the year ended June 30, 2003, general and administrative expenses increased $26.3 million, or 35.2%, to $101.2 million from $74.9 million for the year ended June 30, 2002. This increase was primarily attributable to increases of approximately $16.9 million in costs associated with servicing and collecting our larger total managed portfolio including expenses associated with REO and delinquent loans, $8.0 million increase in costs associated with customer retention incentives and an increase of $3.9 million in net losses on interest rate swaps. Securitization Assets Valuation Adjustment. During fiscal 2003, write downs through the Statement of Income of $45.2 million were recorded compared to $22.1 million for fiscal 2002. Of these adjustments, $39.9 million and $22.1 million were write downs of our interest-only strips in fiscal 2003 and 2002, respectively. The remaining $5.3 million in fiscal 2003 was a write down of our servicing rights. These adjustments primarily reflect the impact of higher prepayment experience on home equity loans than anticipated during the periods. The valuation adjustment recorded on securitization assets in fiscal 2003 was reduced by a $17.9 million favorable valuation impact to the income statement as a result of reducing the discount rates applied in valuing the securitization assets at June 30, 2003. The discount rates were reduced at June 30, 2003 primarily to reflect the impact of the sustained decline in market interest rates. The discount rate on the projected residual cash flows from our interest-only strips was reduced from 13% to 11% at June 30, 2003. The discount rate used to determine the fair value of the overcollateralization portion of the cash flows from our interest-only strips was minimally impacted by the decline in interest rates and remained at 7% on average. As a result, the blended rate used to value our interest-only strips, including the overcollateralization cash flows, was 9% at June 30, 2003. The discount rate on our servicing rights was reduced from 11% to 9% at June 30, 2003. The adjustments were considered to be other than temporary and were therefore recorded as an adjustment to earnings in the current period in accordance with SFAS No. 115 and EITF 99-20 as they relate to interest-only strips and SFAS No. 140 as it relates to servicing rights. See "-- Off-Balance Sheet Arrangements -- Securitizations" for further detail of these adjustments. Provision for Income Tax Expense (Benefit). For fiscal 2003, the provision for income taxes decreased $24.8 million as a result of a $62.6 million decline in pre-tax income and a reduction in our effective tax rate from 42% to 39%. The change in the effective tax rate was made due to an anticipated decrease in our overall tax liabilities. The utilization of net operating loss carryforwards is not dependent on future taxable income from operations, but on the reversal of timing differences principally related to existing securitization assets. These timing differences are expected to absorb the available net operating loss carryforwards during the carryforward period. Year Ended June 30, 2002 Compared to Year Ended June 30, 2001 Total Revenues. For fiscal 2002, total revenues increased $64.6 million, or 35.2%, to $247.9 million from $183.3 million for fiscal 2001. Growth in total revenue was mainly the result of increases in gains on the securitization of mortgage loans and increases in interest accretion earned on our interest-only strips. Gain on Sale of Loans - Securitizations. For the year ended June 30, 2002, gains of $185.6 million were recorded on the securitization of $1.4 billion of loans. This represents an increase of $56.6 million, or 43.9%, over gains of $129.0 million recorded on securitizations of $1.1 billion of loans for the year ended June 30, 2001. 106 The increase in securitization gains for the year ended June 30, 2002 was due to both an increase in interest rate spreads earned in our securitizations and an increase in the volume of loans securitized. The securitization gain as a percentage of loans securitized increased to 13.7% for the year ended June 30, 2002 from 11.7% on loans securitized for the year ended June 30, 2001. Increases in interest rate spreads increase expected residual cash flows to us and result in increases in the gains we recognize on the sale of loans into securitizations. See "-- Off-Balance Sheet Arrangements -- Securitizations" for further detail of how securitization gains are calculated. The increase in interest rate spread for the year ended June 30, 2002 compared to the year ended June 30, 2001 resulted from decreases in pass-through interest rates on investor certificates issued by securitization trusts. For loans securitized during the year ended June 30, 2002, the average loan interest rate was 11.40%, a 0.50% decrease from 11.90% on loans securitized during the year ended June 30, 2001. However, the average interest rate on trust certificates issued in mortgage loan securitizations during the year ended June 30, 2002 was 5.51%, a 1.54% decrease from 7.05% during the year ended June 30, 2001. The resulting net improvement in interest rate spread was approximately 104 basis points. Also contributing to the increase in the securitization gain percentages for the year ended June 30, 2002, was the increase in the amount of cash received at the closing of our securitizations. The improvement in the interest rate spread this fiscal year enabled us to enter into securitization transactions structured to provide additional cash at the closing of the securitization through the sale of trust certificates to investors at a premium, or through the sale of notional bonds, sometimes referred to as interest-only bonds. During the year ended June 30, 2002 we received additional cash at the closing of our securitizations, due to these modified structures, of $32.9 million compared to $10.1 million in fiscal 2001. Securitization gains and cash received at the closing of securitizations were reduced by hedging losses of $9.4 million in fiscal 2002, compared to losses of $4.3 million in fiscal 2001. Gain on Sale of Loans - Whole Loan Sales. Gains on whole loan sales decreased $0.3 million, to $2.4 million for the year ended June 30, 2002 from $2.7 million for the year ended June 30, 2001. The volume of whole loan sales decreased 24.3%, to $57.7 million for the year ended June 30, 2002 from $76.3 million for the year ended June 30, 2001. The decrease in the volume of whole loan sales for the year ended June 30, 2002 resulted from management's decision to securitize additional loans in the favorable securitization market experienced during the year. Interest and Fees. For the year ended June 30, 2002, interest and fee income decreased $0.9 million, or 4.8%, to $18.9 million compared to $19.8 million for the year ended June 30, 2001. Interest and fee income consists primarily of interest income earned on available for sale loans and other ancillary fees collected in connection with loans and leases. During the year ended June 30, 2002, interest income decreased $0.7 million, or 7.1%, to $9.5 million from $10.2 million for the year ended June 30, 2001. This decrease was due to a lower weighted-average interest rate on loans available for sale from the prior fiscal year and lower interest rates earned on invested cash balances due to general decreases in market interest rates. This decrease was partially offset by the effect of a modification of the terms of our securitizations beginning in the second quarter of fiscal 2001, which allowed us to retain interest income we had accrued up until the point of the sale. Prior to the second quarter of fiscal 2001, all accrued interest income was retained by the securitization trust when collected. 107 Other fees decreased $0.2 million for the year ended June 30, 2002 from the prior year mainly due to the decrease in fees collected in connection with our leasing portfolio. Our leasing portfolio has decreased due to our decision in fiscal 2000 to discontinue the origination of new leases. The ability to collect certain fees on loans we originate in the future may be impacted by proposed laws and regulations by various authorities. See "Business-- Regulation" for more information regarding how our practices related to fees could be affected. Interest Accretion on Interest-Only Strips. Interest accretion of $35.4 million was earned in the year ended June 30, 2002 compared to $26.1 million in the year ended June 30, 2001. The increase reflects the growth in the balance of our interest-only strips of $114.1 million, or 28.6%, to $512.6 million at June 30, 2002 from $398.5 million at June 30, 2001. In addition, cash flows from interest-only strips for the year ended June 30, 2002 totaled $100.7 million, an increase of $17.8 million, or 21.5%, from fiscal 2001 due to the larger size of our more recent securitizations and additional securitizations reaching final target overcollateralization levels and step-down overcollateralization levels. Servicing Income. For the year ended June 30, 2002, servicing income decreased $0.2 million, or 3.8%, to $5.5 million from $5.7 million for the year ended June 30, 2001. This decrease was attributable to an increase in prepayment fee collections resulting from higher prepayment rates, which caused an increase in servicing rights amortization. Total Expenses. Total expenses increased $64.2 million, or 37.7%, to $234.4 million for the year ended June 30, 2002 compared to $170.2 million for the year ended June 30, 2001. As described in more detail below, this increase was mainly a result of a $22.1 million interest-only strips valuation adjustment recorded during the year ended June 30, 2002, increased interest expense attributable to the issuance of additional subordinated debt, increases in employee related costs and increases in general and administrative expenses. Interest Expense. During fiscal 2002 interest expense increased $12.1 million, or 21.5%, to $68.7 million from $56.5 million for fiscal 2001. The increase in interest expense was primarily due to an increase in the level of subordinated debt outstanding. Average subordinated debt outstanding during the year ended June 30, 2002 was $615.2 million compared to $448.5 million during the year ended June 30, 2001. The effect of the increase in outstanding debt was partially offset by a decrease in the average interest rates paid on subordinated debt. Average interest rates paid on subordinated debt outstanding decreased to 10.64% during the year ended June 30, 2002 from 11.04% during the year ended June 30, 2001. Rates offered on subordinated debt were reduced beginning in the fourth quarter of fiscal 2001 and continued downward in fiscal 2002 in response to decreases in market interest rates as well as our lower cash needs. The average issuance rate of subordinated debt at its peak, which was the month of February 2001, was 11.85% compared to the average rate of subordinated debt issued in the month of June 2002 of 8.39%. 108 The increase in interest expense for the year ended June 30, 2002 related to subordinated debt was partially offset by the impact of a decrease in the average outstanding balances under warehouse lines of credit and decreased interest rates paid on warehouse lines. The average outstanding balances under warehouse lines of credit were $29.5 million during the year ended June 30, 2002, compared to $52.5 million during the year ended June 30, 2001. This decrease was due to the increased utilization of our available cash balances and proceeds from the sale of subordinated debt to fund loan originations and greater utilization of an off-balance sheet mortgage conduit facility for the sale of loans. Interest rates paid on warehouse lines are generally based on one-month LIBOR plus an interest rate spread ranging from 1.25% to 2.5%. One-month LIBOR decreased from approximately 3.9% at June 30, 2001 to 1.8% at June 30, 2002. Provision for Credit Losses. The provision for credit losses on loans and leases available for sale for the year ended June 30, 2002 increased $1.3 million, or 24.4%, to $6.5 million, compared to $5.2 million for the year ended June 30, 2001. The increase in the provision for credit losses was primarily due to increases in loans in non-accrual status, which were generally repurchased from securitization trusts. See "-- Off Balance Sheet Arrangements - -- Trigger Management" for further discussion of repurchases from securitization trusts. Non-accrual loans were $7.0 million and $4.5 million at June 30, 2002 and 2001, respectively. The allowance for credit losses was $3.7 million, or 6.0% of loans and leases available for sale at June 30, 2002 compared to $2.5 million, or 2.5% of loans and leases available for sale at June 30, 2001. This increase was due to an additional provision for delinquent and non-accrual loans. Although we maintain an allowance for credit losses at the level we consider adequate to provide for potential losses, there can be no assurances that actual losses will not exceed the estimated amounts or that an additional provision will not be required. The following table summarizes the changes in the allowance for credit losses by loan and lease type for the fiscal year ended June 30, 2002 (in thousands):
Business Home Purpose Equity Equipment Loans Loans Leases Total --------- -------- ---------- ------- Balance at beginning of period........... $ 591 $ 1,473 $ 416 $ 2,480 Provision for credit losses.............. 1,721 3,417 1,319 6,457 (Charge-offs) recoveries, net............ (924) (2,892) (1,416) (5,232) -------- --------- --------- -------- Balance at end of period................. $ 1,388 $ 1,998 $ 319 $ 3,705 ======== ========= ========= ========
Employee Related Costs. For the year ended June 30, 2002, employee related costs increased $7.4 million, or 25.7%, to $36.3 million from $28.9 million in the prior year. The increase was primarily attributable to additions of personnel primarily in the loan servicing and collections areas to service the larger managed portfolio. Total employees at June 30, 2002 were 1,019 compared to 884 at June 30, 2001. The remaining increase was attributable to annual salary increases as well as increases in the costs of providing insurance benefits to employees. Sales and Marketing Expenses. For the year ended June 30, 2002, sales and marketing expenses increased $1.0 million, or 4.1%, to $26.0 million from $24.9 million for the year ended June 30, 2001. Expenses for direct mail advertising for loan originations and subordinated debt increased $3.8 million and $0.7 million, respectively, for the year ended June 30, 2002, compared to the prior fiscal year. This increase was partially offset by a decrease of $2.7 million in newspaper advertising. 109 General and Administrative Expenses. For the year ended June 30, 2002, general and administrative expenses increased $20.3 million, or 37.2%, to $74.9 million from $54.6 million for the year ended June 30, 2001. This increase was primarily attributable to increases of approximately $14.3 million in costs associated with servicing and collection of our larger total managed portfolio including expenses associated with REO and delinquent loans, in addition to increases of $1.1 million in costs related to the issuance of our subordinated debt, $0.6 million in depreciation expense and $0.4 million in business insurance expense. Securitization Assets Valuation Adjustment. During fiscal 2002, a write down through the Statement of Income of $22.1 million was recorded on our interest-only strips. This adjustment reflects the impact of higher prepayment experience on home equity loans than anticipated during the period. This portion of the impact of increased prepayments was considered to be other than temporary and was therefore recorded as an adjustment to earnings in the current period in accordance with SFAS No. 115 and EITF 99-20. See "-- Off-Balance Sheet Arrangements -- Securitizations" for further detail of this adjustment. 110 Balance Sheet Information See "-- Reconciliation of Non-GAAP Financial Measures" for a reconciliation of the below four ratios to the most directly comparable financial measure prepared in accordance with GAAP. (Dollars in thousands, except per share data) Balance Sheet Data June 30, ---------------------------------- 2003 2002 2001 ------ ------ ------ Cash and cash equivalents .................. $ 47,475 $ 108,599 $ 91,092 Loan and lease receivables, net: Available for sale ....................... 271,402 57,677 94,970 Interest and fees ........................ 15,179 12,292 16,549 Other .................................... 23,761 9,028 2,428 Interest-only strips ....................... 598,278 512,611 398,519 Servicing rights ........................... 119,291 125,288 102,437 Receivable for sold loans .................. 26,734 -- -- Total assets ............................... 1,159,351 876,375 766,487 Subordinated debt .......................... 719,540 655,720 537,950 Warehouse lines and other notes payable .... 212,916 8,486 51,064 Accrued interest payable ................... 45,448 43,069 32,699 Deferred income taxes ...................... 17,036 35,124 30,954 Total liabilities .......................... 1,117,282 806,997 699,625 Total stockholders' equity ................. 42,069 69,378 66,862 Book value per common share ................ $ 14.28 $ 24.40 $ 20.47 Ratios: Total liabilities to tangible equity(c) .... 41.5x 14.9x 13.5x Adjusted debt to tangible equity (a)(c) .... 30.5x 12.2x 10.2x Subordinated debt to tangible equity(c) .... 26.7x 12.1x 10.4x Interest-only strips to adjusted tangible equity (b)(c) ................... 7.3x 4.3x 3.5x - ----------------- (a) Total liabilities less cash and secured borrowings to tangible equity. (b) Interest-only strips less overcollateralization interests to tangible equity plus subordinated debt with a remaining maturity greater than five years. (c) Tangible equity is calculated as total stockholders' equity less goodwill. June 30, 2003 Compared to June 30, 2002 Total assets increased $283.0 million, or 32.3%, to $1.2 billion at June 30, 2003 from $876.4 million at June 30, 2002 primarily due to increases in loan and lease receivables, interest-only strips and receivable for sold loans, offset by a decrease in cash and cash equivalents. Cash and cash equivalents decreased mainly due to higher levels of loan receivables funded with cash, a reduction in the amount of subordinated debt issued during fiscal year 2003 and also due to our inability to complete our typical quarterly securitization in the fourth quarter of fiscal year 2003. Loan and lease receivables - Available for sale increased $213.7 million due to our inability to complete our typical quarterly securitization in the fourth quarter of fiscal 2003. 111 Loan and lease receivables - Other increased $14.7 million or 163.2% due to increases in the amount of delinquent loans eligible for repurchase from securitization trusts. See Note 2 of the Consolidated Financial Statements and "-- Off-Balance Sheet Arrangements -- Securitizations -- Trigger Management" for an explanation of these receivables. Activity of our interest-only strips for the fiscal years ended June 30, 2003, 2002 and 2001 were as follows (in thousands):
June 30, --------------------------------------- 2003 2002 2001 ------ ------ ------ Balance at beginning of period ............................. $ 512,611 $ 398,519 $ 277,872 Initial recognition of interest-only strips, including initial overcollateralization of $10,641, $0 and $611 ... 160,116 153,463 125,408 Cash flow from interest-only strips ........................ (160,417) (100,692) (82,905) Required purchases of additional overcollateralization ..... 73,253 47,271 43,945 Interest accretion ......................................... 47,347 35,386 26,069 Termination of lease securitization (a) .................... (1,890) -- -- Net temporary adjustments to fair value (b) ................ 7,158 717 8,130 Other than temporary adjustments to fair value (b) ......... (39,900) (22,053) -- ---------- ---------- --------- Balance at end of period ................................... $ 598,278 $ 512,611 $ 398,519 ========== ========== =========
(a) Reflects release of lease collateral from two lease securitization trusts which were terminated in accordance with the trust documents after the full payout of trust note certificates. Net lease receivables of $1.7 million were recorded on our balance sheet as a result of these terminations. (b) Net temporary adjustments to fair value are recorded through other comprehensive income, which is a component of equity. Other than temporary adjustments to decrease the fair value of interest-only strips are recorded through the income statement. The following table summarizes our purchases of overcollateralization by securitization trust for the fiscal years ended June 30, 2003, 2002 and 2001. Purchases of overcollaterization represent amounts of residual cash flows from interest-only strips retained by the securitization trusts to establish required overcollateralization levels in the trust. Overcollateralization represents our investment in the excess of the aggregate principal balance of loans in a securitized pool over the aggregate principal balance of trust certificates. See "-- Off-Balance Sheet Arrangements -- Securitizations" for a discussion of overcollateralization requirements. 112
Summary of Mortgage Loan Securitization Overcollateralization Purchases (in thousands) 2003-1 2002-4 2002-3 2002-2 2002-1 2001-4 2001-3 2001-2 Other Total ------ ------ ------ ------ ------ ------ ------ ------ ----- ----- Year Ended June 30, 2003: Initial overcollateralization ..... $ -- $ 3,800 $ -- $ -- $ -- $ -- $ -- $ -- $ 6,841 $10,641 Required purchases of additional overcollateralization ..... 4,807 8,728 10,972 13,300 10,586 12,522 7,645 3,007 1,686 73,253 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Total ..................... $ 4,807 $12,528 $10,972 $13,300 $10,586 $12,522 $ 7,645 $ 3,007 $ 8,527 $83,894 ======= ======= ======= ======= ======= ======= ======= ======= ======= ======= 2002-1 2001-4 2001-3 2001-2 2001-1 2000-4 2000-3 2000-2 2000-1 Other Total ------ ------ ------ ------ ------ ------ ------ ------ ------ ----- ----- Year Ended June 30, 2002: Required purchases of additional overcollateralization ..... $ 3,814 $ 908 $ 4,354 $11,654 $ 8,700 $ 6,326 $ 3,074 $ 4,978 $ 2,490 $ 973 $47,271 ======= ======= ======= ======= ======= ======= ======= ======= ======= ======= ======= 2001-2 2001-1 2000-4 2000-3 2000-2 2000-1 1999-4 1999-3 1999-2 Other Total ------ ------ ------ ------ ------ ------ ------ ------ ------ ----- ----- Year Ended June 30, 2001: Initial overcollateralization ..... $ -- $ -- $ -- $ -- $ 611 $ -- $ -- $ -- $ -- $ -- $ 611 Required purchases of additional overcollateralization ..... 959 2,574 6,049 4,051 10,160 7,519 5,960 3,719 2,316 638 43,945 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Total ..................... $ 959 $ 2,574 $ 6,049 $ 4,051 $10,771 $ 7,519 $ 5,960 $ 3,719 $ 2,316 $ 638 $44,556 ======= ======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Servicing rights decreased $6.0 million, or 4.8%, to $119.3 million at June 30, 2003 from $125.3 million at June 30, 2002, primarily due to our inability to complete a securitization in the fourth quarter of fiscal 2003 and a $5.3 million write down of the servicing asset mainly due to the impact of higher than expected prepayment experience. The receivable for sold loans of $26.7 million at June 30, 2003 resulted from a whole loan sale transaction which closed on June 30, 2003, but settled in cash on July 1, 2003. Total liabilities increased $310.3 million, or 38.4%, to $1.1 billion from $807.0 million at June 30, 2002 primarily due to increases in warehouse lines and other notes payable, subordinated debt outstanding, accounts payable and accrued expenses and other liabilities. The increase in warehouse lines and other notes payable was due to not completing a securitization in the fourth quarter of fiscal 2003. A fourth quarter securitization would have provided the cash to pay down the warehouse lines. Accounts payable and accrued expenses increased $16.7 million, or 121.7%, primarily due to accruals for costs associated with customer retention incentives to help mitigate loan prepayments and liabilities to our securitization trust collection accounts for periodic interest advances. Other liabilities increased $41.1 million, or 80.7%, to 92.0 million from $50.9 due to a $17.3 million increase in the obligation for the repurchase of loans subject to removal of accounts provisions, recording an unearned rent incentive of $9.5 million related to our corporate headquarters lease and a $6.3 million recorded liability for unsettled interest rate swaps. 113 During fiscal 2003, subordinated debt increased $63.8 million, or 9.7%, to $719.5 million due to sales of subordinated debt used to repay existing debt, to fund loan originations and our operations and for general corporate purposes. Approximately $33.7 million of the increase in subordinated debt was due to the reinvestment of accrued interest on the subordinated debt at maturity. Subordinated debt was 26.7 times tangible equity at June 30, 2003, compared to 12.1 times at June 30, 2002. See "-- Liquidity and Capital Resources" for further information regarding outstanding debt. Deferred income taxes decreased $18.1 million, or 51.5%, to $17.0 million at June 30, 2003 from $35.1 million at June 30, 2002. This decrease is primarily due to a $4.4 million net increase in expected benefits from net operating loss carryforwards, less a valuation allowance, and an $8.2 million increase in other deferred tax debits. The increase in other deferred tax debits primarily resulted from recognizing the benefit of governmental grants and lease incentives associated with the relocation of our corporate headquarters earlier for tax purposes than for financial reporting purposes. In addition, deferred tax payables on our interest-only strips decreased by $5.6 million due to loan prepayment experience. June 30, 2002 Compared to June 30, 2001 Total assets increased $109.9 million, or 14.3%, to $876.4 million at June 30, 2002 from $766.5 million at June 30, 2001 primarily due to increases in cash and cash equivalents, interest-only strips and servicing rights which were partially offset by decreases in loan and lease receivables available for sale and receivables for sold loans. Cash and cash equivalents increased $17.5 million, or 19.2%, due to receipts from sales of subordinated debt, cash receipts on the sale of loans in securitizations and cash receipts from our interest-only strips. Servicing rights increased $22.9 million, or 22.3%, to $125.3 million at June 30, 2002 from $102.4 at June 30, 2001, due to the securitization of $1.4 billion of loans during the year ended June 30, 2002, partially offset by amortization of the servicing asset for fees collected during the same period. Loan and lease receivables - Available for sale decreased $37.3 million or 39.3% due to the securitization of more loans than were originated during the period. Total liabilities increased $107.4 million, or 15.3%, to $807.0 million from $699.6 million at June 30, 2001 primarily due to increases in subordinated debt outstanding, accrued interest payable and other liabilities partially offset by a decrease in warehouse lines and other notes payable. During fiscal 2002 subordinated debt increased $117.8 million, or 21.9%, to $655.7 million due to sales of subordinated debt used to repay existing debt, to fund loan originations and our operations and for general corporate purposes including, but not limited to, repurchases of our outstanding common stock. Approximately $31.7 million of the increase in subordinated debt was due to the reinvestment of accrued interest on the subordinated debt. Subordinated debt was 12.1 times tangible equity at June 30, 2002, compared to 10.4 times as of June 30, 2001. See "-- Liquidity and Capital Resources" for further information regarding outstanding debt. Warehouse lines and other notes payable decreased $42.6 million due to the lower balance of loan receivables held at June 30, 2002, and greater use of available cash to fund loans. Accrued interest payable increased $10.4 million, or 31.7%, to $43.1 million from $32.7 million at June 30, 2001 due to an increase in the level of subordinated debt outstanding partially offset by a decrease in average interest rates paid on debt. 114 Deferred income taxes increased $4.2 million, or 13.5%, to $35.1 million from $31.0 million. This increase was mainly due to higher levels of debt for tax securitization structures in the first and second quarters of fiscal 2002. As debt for tax transactions, the tax liability on securitization gains is deferred and becomes payable in future periods as cash is received from securitization trusts. These structures created additional deferred tax credits of $22.1 million which were partially offset by an increase in our federal tax loss carryforward receivable of $11.9 million to a cumulative $31.3 million. In addition, miscellaneous deferred tax assets increased by $4.3 million and miscellaneous deferred tax credits decreased by $1.7 million resulting in a net increase of $6.0 million. The net operating loss carryforward will be utilized in future periods by structuring more securitization transactions as taxable transactions. 115 Managed Portfolio Quality The following table provides data concerning delinquency experience, real estate owned and loss experience for the managed loan and lease portfolio. See "-- Reconciliation of Non-GAAP Financial Measures" for a reconciliation of total managed portfolio and managed REO measures to our balance sheet. See "-- Deferment and Forbearance Arrangements" for the amounts of previously delinquent loans subject to these deferment and forbearance arrangements which are not included in this table if borrowers are current on principal and interest payments as required under the terms of the original note (exclusive of delinquent payments advanced or fees paid by us on the borrower's behalf as part of a deferment or forbearance arrangement (dollars in thousands):
June 30, -------------------------------------------------------------------- 2003 2002 2001 ----------------- ----------------- ----------------- Delinquency by Type Amount % Amount % Amount % - ------------------- ---------- ----- ---------- ----- ---------- ----- Business Purpose Loans Total managed portfolio ............ $ 393,098 $ 361,638 $ 300,192 ========== ========== ========== Period of delinquency: 31-60 days ....................... $ 4,849 1.23% $ 2,449 0.68% $ 3,460 1.15% 61-90 days ....................... 4,623 1.18 1,648 0.46 1,837 0.61 Over 90 days ..................... 38,466 9.79 32,699 9.03 22,687 7.56 ---------- ----- ---------- ----- ---------- ---- Total delinquencies .............. $ 47,938 12.20% $ 36,796 10.17% $ 27,984 9.32% ========== ===== ========== ===== ========== ==== REO ................................ $ 5,744 $ 6,220 $ 4,530 ========== ========== ========== Home Equity Loans Total managed portfolio ............ $3,249,501 $2,675,559 $2,223,429 ========== ========== ========== Period of delinquency: 31-60 days ....................... $ 48,332 1.49% $ 37,213 1.39% $ 16,227 0.73% 61-90 days ....................... 24,158 0.74 22,919 0.86 14,329 0.64 Over 90 days ..................... 108,243 3.33 72,918 2.72 47,325 2.13 ---------- ----- ---------- ----- ---------- ---- Total delinquencies .............. $ 180,733 5.56% $ 133,050 4.97% $ 77,881 3.50% ========== ==== ========== ==== ========== ==== REO ................................ $ 22,256 $ 27,825 $ 23,902 ========== ========== ========== Equipment Leases Total managed portfolio ............ $ 8,475 $ 28,992 $ 65,774 ========== ========== ========== Period of delinquency: 31-60 days ....................... $ 162 1.91% $ 411 1.42% $ 595 0.90% 61-90 days ....................... 83 0.98 93 0.32 206 0.31 Over 90 days ..................... 154 1.82 423 1.46 347 0.53 ---------- ----- ---------- ----- ---------- ---- Total delinquencies .............. $ 399 4.71% $ 927 3.20% $ 1,148 1.74% ========== ==== ========== ==== ========== ==== Combined Total managed portfolio ............ $3,651,074 $3,066,189 $2,589,395 ========== ========== ========== Period of delinquency: 31-60 days ....................... $ 53,343 1.46% $ 40,073 1.31% $ 20,282 0.78% 61-90 days ....................... 28,864 0.79 24,660 0.80 16,372 0.63 Over 90 days ..................... 146,863 4.02 106,040 3.46 70,359 2.72 ---------- ----- ---------- ----- ---------- ---- Total delinquencies .............. $ 229,070 6.27% $ 170,773 5.57% $ 107,013 4.13% ========== ==== ========== ==== ========== ==== REO ................................ $ 28,000 0.77% $ 34,045 1.11% $ 28,432 1.10% ========== ==== ========== ==== ========== ==== Losses experienced during the period(a)(b): Loans ............................ $ 29,507 0.89% $ 15,478 0.56% $ 10,886 0.50% ==== ==== ==== Leases ........................... 497 2.82% 1,415 3.20% 1,003 1.20% ---------- ==== ---------- ==== ---------- ==== Total managed portfolio .......... $ 30,004 0.90% $ 16,893 0.60% $ 11,889 0.53% ========== ==== ========== ==== ========== ====
(a) Percentage based on annualized losses and average managed portfolio. (b) Losses recorded on our books were $16.8 million ($6.8 million from charge-offs through the provision for credit losses and $10.0 million for write downs of real estate owned) for the year ended June 30, 2003. Losses absorbed by loan securitization trusts were $13.2 million for fiscal 2003. Losses recorded on our books were $9.0 million ($4.4 million from charge-offs through the provision for loan losses and $4.6 million for write downs of real estate owned) and losses absorbed by loan securitization trusts were $7.9 million for fiscal 2002. Losses recorded on our books were $7.1 million ($4.0 million from charge-offs through the provision for loan losses and $3.1 million for write downs of real estate owned) and losses absorbed by loan securitization trusts were $4.8 million for fiscal 2001. Losses recorded on our books include losses for loans we hold as available for sale or real estate owned and loans repurchased from securitization trusts. 116 The following table summarizes key delinquency statistics related to loans, leases and REO recorded on our balance sheet and their related percentage of our available for sale portfolio (dollars in thousands):
June 30, -------------------------------------- 2003 2002 2001 ------- ------- ------- Delinquent loans and leases on balance sheet (a) $ 5,412 $ 5,918 $ 3,382 % of on balance sheet loan and lease receivables 2.04% 10.5% 3.9% Loans and leases in non-accrual status on balance sheet (b).......................... $ 5,358 $ 6,991 $ 4,514 % of on balance sheet loan and lease receivables 2.02% 12.3% 5.1% Allowance for losses on available for sale loans and leases........................... $ 2,848 $ 3,705 $ 2,480 % of available for sale loans and leases....... 1.0% 6.0% 2.5% Real estate owned on balance sheet............. $ 4,776 $ 3,784 $ 2,322
- ---------- (a) Delinquent loans and leases are included in total delinquencies in the previously presented "Managed Portfolio Quality" table. Included in total delinquencies are loans in non-accrual status of $5.0 million, $5.6 million, and $3.2 million at June 30, 2003, 2002 and 2001, respectively. (b) It is our policy to suspend the accrual of interest income when a loan is contractually delinquent for 90 days or more. Non-accrual loans and leases are included in total delinquencies in the previously presented "Managed Portfolio Quality" table. Deferment and Forbearance Arrangements. From time to time, borrowers are confronted with events, usually involving hardship circumstances or temporary financial setbacks that adversely affect their ability to continue payments on their loan. To assist borrowers, we may agree to enter into a deferment or forbearance arrangement. Prevailing economic conditions, which affect the borrower's ability to make their regular payments, may also have an impact on the value of the real estate or other collateral securing the loans, resulting in a change to the loan-to-value ratios. We may take these conditions into account when we evaluate a borrower's request for assistance for relief from their financial hardship. Our policies and practices regarding deferment and forbearance arrangements, like all of our collections policies and practices, are designed to manage customer relationships, maximize collections and avoid foreclosure (or repossession of other collateral, as applicable) if reasonably possible. We review and regularly revise these policies and procedures in order to enhance their effectiveness in achieving these goals. We permit exceptions to the policies and practices from time to time based on individual borrowers' situations. In a deferment arrangement, we make advances to a securitization trust on behalf of the borrower in amounts equal to the delinquent loan payments, which include principal and interest. Additionally, we may pay taxes, insurance and other fees on behalf of the borrower. Based on our review of the borrower's current financial circumstances, the borrower must repay the advances and other payments and fees we make on the borrower's behalf either at the termination of the loan or on a monthly payment plan. Borrowers must provide a written explanation of their hardship, which generally requests relief from their loan payments. We review the borrower's current financial situation and based upon this review, we may create a payment plan for the borrower which allows the borrower to pay past due amounts over a period from 12 to 42 months, but not beyond the maturity date of the loan, in addition to making regular monthly loan payments. Each deferment arrangement must be approved by two of our managers. Deferment arrangements which defer two or more past due payments must also be approved by a senior vice president. Principal guidelines currently applicable to the deferment process are: (i) the borrower may have up to six payments deferred during the life of the loan; (ii) no more than three payments may be deferred during a twelve-month period; and (iii) the borrower must have made a minimum of six payments on the loan and twelve months must have passed since the last deferment in order to qualify for a new deferment arrangement. Any deferment arrangement which includes an exception to our guidelines must be approved by the senior vice president of collections and an executive vice president. If the deferment arrangement is approved, a collector contacts the borrower regarding the approval and the revised payment terms. 117 For borrowers who are two or more payments delinquent, we will consider using a forbearance arrangement if permitted under applicable state law. In a forbearance arrangement, we make advances to a securitization trust on behalf of the borrower in amounts equal to the delinquent loan payments, which include principal and interest. Additionally, we may pay taxes, insurance and other fees on behalf of the borrower. We assess the borrower's current financial situation and based upon this assessment, we may create a payment plan for the borrower which generally allows the borrower to pay past due amounts over a longer period than a typical deferment arrangement, but not beyond the maturity date of the loan. We typically structure a forbearance arrangement to require the borrower to make payments of principal and interest equivalent to the original loan terms plus additional monthly payments, which in the aggregate represent the amount that we advanced to the securitization trust and other fees paid by us on behalf of the borrower. We currently require the borrower to provide written documentation outlining their financial hardship, and we offer these arrangements to borrowers who we believe have the ability to remit post-forbearance principal and interest payments in addition to the amounts advanced or paid by us. As part of the written forbearance agreement, the borrower must execute a deed in lieu of foreclosure. We retain the unrecorded deed until such time as the entire amount due under the forbearance agreement is repaid. If the borrower subsequently defaults before repaying the amount due under the forbearance agreement in full and becomes 60 days delinquent on principal and interest payments, we may elect to record the deed after providing proper notification to the borrower and a reasonable period of time to cure. Recording the deed in lieu of foreclosure gives us immediate legal title to the property without the need for further legal action. Principal guidelines currently applicable to the forbearance process are: (i) the subject loan should be at least six months old; (ii) the loan should be a minimum of three payments delinquent; and (iii) each forbearance arrangement must be approved by a manager, the senior vice president of collections and the senior vice president of asset allocation. Forbearance arrangements which defer ten or more past due payments, involve advances or other payments of more than $25,000 or include an exception to our guidelines must also be approved by an executive vice president. For delinquent borrowers with business purpose loans, we may enter into written forbearance agreements pursuant to which we do not obtain a deed in lieu of foreclosure. These arrangements typically allow the borrower to pay past due amounts over a period of 12-36 months, but not beyond the maturity date of the loan, and generally require the borrower to make a payment at the time of entering into the forbearance agreement. We do not enter into a deferment or forbearance arrangement based solely on the fact that a loan meets the criteria for one of the arrangements. Our use of any of these arrangements depends upon one or more of the following factors: our assessment of the individual borrower's current financial situation and reasons for the delinquency, a valuation of the real estate securing the loan and our view of prevailing economic conditions. Because deferment and forbearance arrangements are account management tools which help us to manage customer relationships, maximize collection opportunities and increase the value of our account relationships, the application of these tools generally is subject to constantly shifting complexities and variations in the marketplace. We attempt to tailor the type and terms of the arrangement we use to the borrower's circumstances, and we prefer to use deferment over forbearance arrangements, if possible. As a result of these arrangements, we reset the contractual status of a loan in our managed portfolio from delinquent to current based upon the borrower's resumption of making their loan payments. Generally, a loan remains current after a deferment or forbearance arrangement with the borrower only if the borrower makes the principal and interest as required under the terms of the original note (exclusive of delinquent payments advanced or fees paid by us on the borrower's behalf as part of the deferment or forbearance arrangement), and we do not reflect it as a delinquent loan in our delinquency statistics. However, if the borrower fails to make principal and interest payments, the account will generally be declared in default and collection actions resumed. See "Regulation -- Equal Credit Opportunity Fair Credit Reporting and Other Laws" and " Risk Factors -- The inquiry regarding our forbearance practices by the U.S. Attorney could result in concerns regarding our loan servicing and limit our ability to sell or service our loans, sell subordinated debt, or obtain additional credit facilities, which would hinder our ability to operate profitably and repay our subordinated debt, which could negatively impact the value of our common stock." The following table presents, as of the end of our last five quarters, information regarding loans under deferment and forbearance arrangements, which are reported as current loans if borrowers are current on principal and interest payments (exclusive of delinquent payments advanced or fees paid by us on the borrower's behalf as part of the deferment or forbearance arrangement) and thus not included in delinquencies in the delinquency table. (dollars in thousands):
Cumulative Unpaid Principal Balance ---------------------------------------------- % of Under Under Managed Deferment Forbearance Total(a) Portfolio ---------- ----------- ------- --------- June 30, 2002................. $64,958 $73,705 $138,663 4.52% September 30, 2002............ 67,282 76,649 143,931 4.50 December 31, 2002............. 70,028 81,585 151,613 4.55 March 31, 2003................ 85,205 84,751 169,956 4.89 June 30, 2003................. 110,487 87,199 197,686 5.41
118 - ------------------------ (a)Included in cumulative unpaid principal balance are loans with arrangements that were entered into longer than twelve months ago. At June 30, 2003, there was $64.6 million of cumulative unpaid principal balance under deferment arrangements and $47.4 million of cumulative unpaid principal balance under forbearance arrangements that were entered into prior to July 2002. Additionally, there are loans under deferment and forbearance arrangements which have returned to delinquent status. At June 30, 2003 there was $28.7 million of cumulative unpaid principal balance under deferment arrangements and $51.5 million of cumulative unpaid principal balance under forbearance arrangements that are now reported as delinquent 31 days or more. During the final six months of fiscal 2003, we experienced a pronounced increase in the number of borrowers under deferment arrangements and in light of the weakened economic environment we made use of deferment arrangements to a greater degree than in prior periods. We currently expect this condition to be temporary and will attempt to actively manage the loan accounts under deferment arrangements to maximize our chances for full recovery of the borrowed amount while still accommodating borrower needs during their period of hardship. The following table presents the amount of unpaid principal balance of loans that entered into a deferment or forbearance arrangement in each quarter of fiscal 2003 (dollars in thousands):
Unpaid Principal Balance Impacted by Arrangements ------------------------------------------------ % of Under Under Managed Quarter Ended: Deferment Forbearance Total Portfolio -------------- -------------- ------------ ----------- September 30, 2002............ $11,619 $23,564 $35,183 1.10% December 31, 2002............. 17,015 27,004 44,019 1.32 March 31, 2003................ 37,117 28,051 65,168 1.87 June 30, 2003................. 44,840 18,064 62,904 1.72
Delinquent loans and leases. Total delinquencies (loans and leases with payments past due greater than 30 days, excluding REO) in the total managed portfolio were $229.1 million at June 30, 2003 compared to $170.8 million and $107.0 million at June 30, 2002 and 2001, respectively. Total delinquencies as a percentage of the total managed portfolio were 6.27% at June 30, 2003 compared to 5.57% and 4.13% at June 30, 2002 and 2001, respectively. The increase in delinquencies and delinquency percentages in fiscal 2003 and 2002 were mainly due to the impact on our borrowers of continued uncertain economic conditions, which may include the reduction in other sources of credit to our borrowers and the seasoning of the managed portfolio. These factors have resulted in a significant increase in the usage of deferment and forbearance activities. In addition, the delinquency percentage has increased due to increased prepayment rates resulting from refinancing activities. Refinancing is not typically available to delinquent borrowers, and therefore the remaining portfolio is experiencing a higher delinquency rate. A decrease in the growth rate for the origination of new loans also contributed to the increase in the delinquency percentage in fiscal 2003 and 2002 from 2001. As the managed portfolio continues to season, and if our economy continues to lag or worsen, the delinquency rate may continue to increase. Delinquent loans and leases held as available for sale on our balance sheet decreased from $5.9 million at June 30, 2002 to $5.4 million at June 30, 2003. Real estate owned. Total REO, comprising foreclosed properties and deeds acquired in lieu of foreclosure, decreased to $28.0 million, or 0.77% of the total managed portfolio at June 30, 2003 compared to $34.0 million, or 1.11% at June 30, 2002 and $28.4 million, or 1.10% at June 30, 2001. The decrease in the volume of REO was mainly due to a concerted effort by management to reduce the time a loan remains in seriously delinquent status until the sale of an REO property. The acceleration of the foreclosure process had caused a substantial increase in the balance of properties classified as REO during fiscal 2001 and fiscal 2002. We have implemented processes to decrease the cycle time in the disposition of REO properties. Part of this strategy includes bulk sales of REO properties as evidenced by the leveling of REO as a percentage of the managed portfolio. Reducing the time properties are carried reduces carrying costs for interest on funding the cost of the property, legal fees, taxes, insurance and maintenance related to these properties. As our portfolio seasons and if our economy continues to lag or worsen, the REO balance may increase. REO held by us on our balance sheet increased from $3.8 million at June 30, 2002 to $4.8 million at June 30, 2003 primarily due to repurchases of foreclosed loans from our mortgage securitization trusts. Loss experience. During the year ended June 30, 2003, we experienced net loan and lease charge-offs in the total managed portfolio of $30.0 million or 0.90% on an annualized basis. During the year ended June 30, 2002, we experienced net loan and lease charge-offs in the total managed portfolio of $16.9 million, or 0.60% of the total managed portfolio. During fiscal 2001, we experienced net loan and lease charge-offs in the total managed portfolio of $11.9 million, or 0.53% of the average total managed portfolio. Principal loss severity experience on delinquent loans generally has ranged from 10% to 30% of principal and loss severity experience on REO generally has ranged from 25% to 40% of principal. The increase in net charge-offs from the prior periods were due to a larger volume of loans that became delinquent, and or, were liquidated during the period as well as economic conditions and the seasoning of the managed portfolio. As noted above, we have attempted to reduce the time a loan remains in seriously delinquent status until the sale of an REO property in order to reduce carrying costs on the property. The increase in the charge-off percentage was partially offset by reductions in our carrying costs due to the acceleration of the timing of the disposition of REO. See "-- Summary of Loans 119 and REO Repurchased from Mortgage Loan Securitization Trusts" for further detail of loan repurchase activity. See "-- Off-Balance Sheet Arrangements -- Securitizations" for more detail on credit loss assumptions used to estimate the fair value of our interest-only strips and servicing rights compared to actual loss experience. Real estate values have generally experienced an increase in recent periods and their increases have exceeded the rate of increase of many other types of investments in the current economy. If in the future this trend reverses and real estate values begin to decline our loss severity could increase. See "Risk Factors -- A decline in value of the collateral securing our loans could result in an increase in losses on foreclosure, which could hinder our ability to attain profitable operations, limit our ability to repay our subordinated debt and negatively impact the value of our common stock" for further detail of the effect that declining real estate values could have on our business. Interest Rate Risk Management A primary market risk exposure that we face is interest rate risk. Profitability and financial performance is sensitive to changes in interest rate swap yields, one-month LIBOR yields and the interest rate spread between the effective rate of interest received on loans available for sale or securitized (all fixed interest rates) and the interest rates paid pursuant to credit facilities or the pass-through interest rate to investors for interests issued in connection with securitizations. Profitability and financial performance is also sensitive to the impact of changes in interest rates on the fair value of loans which are expected to be sold in whole loan sales. A substantial and sustained increase in market interest rates could adversely affect our ability to originate and purchase loans and maintain our profitability. The overall objective of our interest rate risk management strategy is to mitigate the effects of changing interest rates on profitability and the fair value of interest rate sensitive balances (primarily loans available for sale, interest-only strips, servicing rights and subordinated debt). We would address this challenge by carefully monitoring our product pricing, the actions of our competition and market trends and the use of hedging strategies in order to continue to originate loans in as profitable a manner as possible. A component of our interest rate risk exposure relates to changes in the fair value of certain interest-only strips due to changes in one-month LIBOR. The structure of certain securitization trusts includes a floating interest rate certificate, which pays interest based on one-month LIBOR plus an interest rate spread. Floating interest rate certificates in a securitization expose us to gains or losses due to changes in the fair value of the interest-only strip from changes in the floating interest rate paid to the certificate holders. A rising interest rate environment could unfavorably impact our liquidity and capital resources. Rising interest rates could impact our short-term liquidity by limiting our ability to sell loans at favorable premiums in whole loan sales, widening investor interest rate spread requirements in pricing future securitizations, increasing the levels of overcollateralization in future securitizations, limiting our access to borrowings in the capital markets and limiting our ability to sell our subordinated debt securities at favorable interest rates. In a rising interest rate environment, short-term and long-term liquidity could also be impacted by increased interest costs on all sources of borrowed funds, including the subordinated debt, and by reducing interest rate spreads on our securitized loans, which would reduce our cash flows. See "-- Liquidity and Capital Resources" for a discussion of both long-term and short-term liquidity. 120 Interest Rate Sensitivity. The following table provides information about financial instruments that are sensitive to changes in interest rates. For interest-only strips and servicing rights, the table presents projected principal cash flows utilizing assumptions including prepayment and credit loss rates. See "-- Off-Balance Sheet Arrangements -- Securitizations" for more information on these assumptions. For debt obligations, the table presents principal cash flows and related average interest rates by expected maturity dates (dollars in thousands):
Amount Maturing After June 30, 2003 ------------------------------------------------------------------------------------- Months Months Months Months Months There- Fair 1 to 12 13 to 24 25 to 36 37 to 48 49 to 60 after Total Value -------- --------- --------- -------- -------- -------- -------- --------- Rate Sensitive Assets: Loans and leases available for sale (a) ... $265,770 $ 75 $ 84 $ 94 $ 105 $ 5,274 $271,402 $272,991 Interest-only strips ...................... 146,273 119,532 113,746 96,530 76,825 272,298 825,204 598,278 Servicing rights .......................... 37,295 28,997 22,773 17,832 13,964 44,929 165,790 119,291 Investments held to maturity .............. 156 137 296 292 -- -- 881 946 Rate Sensitive Liabilities: Fixed interest rate borrowings ............ $321,961 $170,627 $157,813 $27,668 $14,998 $ 26,473 $719,540 $718,387 Average interest rate ..................... 8.01% 9.07% 9.17% 9.68% 9.72% 11.26% 9.49% Variable interest rate borrowings ......... $186,757 $ -- $ -- $ -- $ -- $ -- $186,757 $186,757 Average interest rate ..................... 2.23% -- -- -- -- -- 2.23%
- ---------- (a) For purposes of this table, all loans and leases which qualify for securitization or whole loan sale are reflected as maturing within twelve months, since loans and leases available for sale are generally held for less than three months prior to securitization or whole loan sale. Loans Available for Sale. Gain on sale of loans may be unfavorably impacted to the extent we hold loans with fixed interest rates prior to their sale. See "-- Business Strategy" for a discussion of our intent to add adjustable rate mortgage loans to our loan product line. A significant variable affecting the gain on sale of loans in a securitization is the interest rate spread between the average interest rate on fixed interest rate loans and the weighted-average pass-through interest rate to investors for interests issued in connection with the securitization. Although the average loan interest rate is fixed at the time the loan is originated, the pass-through interest rate to investors is not fixed until the pricing of the securitization which occurs just prior to the sale of the loans. Generally, the period between loan origination and pricing of the pass-through interest rate is less than three months. If market interest rates required by investors increase prior to securitization of the loans, the interest rate spread between the average interest rate on the loans and the pass-through interest rate to investors may be reduced or eliminated. This factor could have a material adverse effect on our future results of operations and financial condition. We estimate that each 0.1% reduction in the interest rate spread reduces the gain on sale of loans as a percentage of loans securitized by approximately 0.22%. See "-- Strategies for Use of Derivative Financial Instruments" for further detail of our interest rate risk management for available for sale loans. A significant variable affecting the gain on sale of fixed interest rate loans sold in whole loan sale transactions is the change in market interest rates between the date the loan was originated at a fixed rate of interest and the date the loan was sold in a whole loan sale. If market interest rates required by investors increase prior to sale of the loans, the premium expected 121 on sale of the loans would be reduced. This factor could have a material adverse effect on our future results of operations and financial condition. Interest-Only Strips and Servicing Rights. A portion of the certificates issued to investors by certain securitization trusts are floating interest rate certificates based on one-month LIBOR plus an interest rate spread. The fair value of the excess cash flow we will receive from these trusts would be affected by any changes in interest rates paid on the floating interest rate certificates. At June 30, 2003, $115.1 million of debt issued by loan securitization trusts was floating interest rate certificates based on one-month LIBOR, representing 3.5% of total debt issued by loan securitization trusts. In accordance with accounting principles generally accepted in the United States of America, the changes in fair value are generally recognized as part of net adjustments to other comprehensive income, which is a component of retained earnings. As of June 30, 2003, the interest rate sensitivity for $44.5 million of floating interest rate certificates issued by securitization trusts is managed with an interest rate swap contract effectively fixing our cost for this debt. See "-- Strategies for Use of Derivative Financial Instruments" for further detail. In addition, the interest rate sensitivity for $63.0 million of floating interest rate certificates issued from the 2003-1 Trust is managed by an interest rate cap which was entered into by the Trust at the inception of the securitization. This interest rate cap limits the one-month LIBOR to a maximum rate of 4.0% and was structured to automatically unwind as the floating interest rate certificates pay down. A significant change in market interest rates could increase or decrease the level of loan prepayments, thereby changing the size of the total managed loan portfolio and the related projected cash flows. We attempt to minimize prepayment risk on interest-only strips and servicing rights by requiring prepayment fees on business loans and home equity loans, where permitted by law. When originally recorded, approximately 90-95% of business loans and 80-85% of home equity loans in the total managed portfolio were subject to prepayment fees. Currently, approximately 50-55% of business loans and 60-65% of home equity loans in the total managed portfolio are subject to prepayment fees. However, higher than anticipated rates of loan prepayments could result in a write down of the fair value of related interest-only strips and servicing rights, adversely impacting earnings during the period of adjustment. We perform revaluations of our interest-only strips and servicing rights on a quarterly basis. As part of the revaluation process, we monitor the assumptions used for prepayment rates against actual experience, economic conditions and other factors and we adjust the assumptions, if warranted. See "-- Off-Balance Sheet Arrangements -- Securitizations" for further information regarding these assumptions and the impact of prepayments during this period. Subordinated Debt. We also experience interest rate risk to the extent that as of June 30, 2003 approximately $397.6 million of our liabilities were comprised of fixed interest rate subordinated debt with scheduled maturities of greater than one year. To the extent that market interest rates demanded on subordinated debt increase in the future, the interest rates paid on replacement debt could exceed interest rates currently paid thereby increasing interest expense and reducing net income. Strategies for Use of Derivative Financial Instruments. All derivative financial instruments are recorded on the balance sheet at fair value with realized and unrealized gains and losses included in the statement of income in the period incurred. 122 In June 1998, the FASB issued SFAS No. 133 "Accounting for Derivative Financial Instruments and Hedging Activities." SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. If certain criteria are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment (fair value hedge), (b) a hedge of the exposure to variable cash flows of a forecasted transaction (cash flow hedge), or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation. If a derivative is a hedge, depending on the nature of the hedge designation, changes in the fair value of a derivative are either offset against the change in the fair value of assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be recognized in earnings immediately. SFAS No. 133 was effective on a prospective basis for all fiscal quarters of fiscal years beginning after June 15, 2000. The adoption of SFAS No. 133 on July 1, 2000 resulted in the cumulative effect of a change in accounting principle of $15 thousand pre-tax being recognized as expense in the Consolidated Statement of Income for the year ended June 30, 2001. Due to the immateriality of the cumulative effect of adopting SFAS No. 133, the $15 thousand pre-tax expense is included in general and administrative expense in the Consolidated Statement of Income. The tax effects and earnings per share amounts related to the cumulative effect of adopting SFAS No. 133 are not material. Hedging activity From time to time, we utilize derivative financial instruments in an attempt to mitigate the effect of changes in interest rates between the date loans are originated at fixed interest rates and the date the fixed interest rate pass-through certificates to be issued by a securitization trust are priced or the date the terms and pricing for a whole loan sale are fixed. Generally, the period between loan origination and pricing of the pass-through interest rate or whole loan sale is less than three months. Derivative financial instruments we use for hedging changes in fair value due to interest rate changes may include interest rate swaps, futures and forward contracts. The nature and quantity of hedging transactions are determined based on various factors, including market conditions and the expected volume of mortgage loan originations and purchases. The unrealized gain or loss derived from these derivative financial instruments, which are designated as fair value hedges, is reported in earnings as it occurs with an offsetting adjustment to the fair value of the item hedged. The fair value of derivative financial instruments is based on quoted market prices. The fair value of the items hedged is based on current pricing of these assets in a securitization or whole loan sale. Cash flow related to hedging activities is reported as it occurs. The effectiveness of our hedge relationships is continuously monitored. If highly effective correlation did not exist, the related gain or loss on the hedged item would no longer be recognized as an adjustment to income. Related to Loans Expected to Be Sold Through Securitizations. At the time the derivative contracts are executed, they are specifically designated as hedges of mortgage loans or our residual interests in mortgage 123 loans in our mortgage conduit facility, which we would expect to be included in a term securitization at a future date. The mortgage loans and mortgage loans underlying residual interests in mortgage pools consist of essentially similar pools of fixed interest rate loans, collateralized by real estate (primarily residential real estate) with similar maturities and similar credit characteristics. Fixed interest rate pass-through certificates issued by securitization trusts are generally priced to yield an interest rate spread above interest rate swap yield curves with maturities matching the maturities of the pass-through certificates. We may hedge potential interest rate changes in interest rate swap yield curves with forward starting interest rate swaps, Eurodollar futures, forward treasury sales or derivative contracts of similar underlying securities. This practice has provided strong correlation between our hedge contracts and the ultimate pricing we will receive on the subsequent securitization. Related to Loans Expected to Be Sold Through Whole Loan Sale Transactions. We may also utilize derivative financial instruments in an attempt to mitigate the effect of changes in market interest rates between the date loans are originated at fixed interest rates and the date that the loans will be sold in a whole loan sale. At the time the derivative contracts are executed, they are specifically designated as hedges of mortgage loans or our residual interests in mortgage loans in our mortgage conduit facility, which we would expect to be included in a whole loan sale transaction at a future date. We may hedge the effect of changes in market interest rates with forward sale commitments, forward starting interest rate swaps, Eurodollar futures, forward treasury sales or derivative contracts of similar underlying securities. On June 30, 2003, we entered into a forward sale agreement providing for the sale of $275.0 million of home equity mortgage loans at a price of 105.0%. Disqualified Hedging Relationship. The securitization market was not available to us in the fourth quarter of fiscal 2003. As a result, we realized that the expected high correlation between the changes in the fair values of the derivative contracts and the mortgage loans would not be achieved and discontinued hedge accounting. During the fourth quarter of fiscal 2003, $4.0 million of losses on $170.0 million notional amount of forward starting interest rate swaps previously designated as a hedge of mortgage loans expected to be securitized was charged to earnings. An offsetting increase of $3.7 million in the value of the hedged mortgage loans was recorded in earnings, representing the changes in value of the loans until the date that we learned that the securitization market was not available. 124 We recorded the following gains and losses on the fair value of derivative financial instruments accounted for as hedging transactions or on disqualified hedging relationships for the years ended June 30, 2003, 2002 and 2001. Ineffectiveness related to qualified hedging relationships during the period was immaterial. Ineffectiveness is a measure of the difference in the change in fair value of the derivative financial instrument as compared to the change in the fair value of the item hedged (in thousands): Year Ended June 30, ---------------------------------- 2003 2002 2001 ---------- ---------- ---------- Offset by gains and losses recorded on securitizations: Losses on derivative financial instruments......................... $ (3,806) $ (9,401) $ (4,343) Offset by gains and losses recorded on the fair value of hedged items: Losses on derivative financial instruments......................... $ (7,037) $ -- $ -- Amount settled in cash - paid............ $ (5,041) $ (9,401) $ (4,343) At June 30, 2003, forward sale agreements and outstanding forward starting interest rate swap contracts accounted for as hedges and unrealized losses recorded as liabilities on the balance sheet were as follows (in thousands): Notional Unrealized Amount Loss --------------- --------------- Forward sale agreement.............. $ 275,000 $ -- Forward starting interest rate swaps............................ $ -- $ (6,776)(a) (a) Represents the liability carried on the balance sheet at June 30, 2003 for previously recorded losses not yet settled in cash. There were no outstanding derivatives contracts accounted for as hedges at June 30, 2002 or 2001. Trading activity Generally, we do not enter into derivative financial instrument contracts for trading purposes. However, we have entered into derivative financial instrument contracts which we have not designated as hedges in accordance with SFAS No. 133 and were therefore accounted for as trading assets or liabilities. Related to Loans Expected to Be Sold Through Securitizations. During fiscal 2003, we used interest rate swap contracts to protect the future securitization spreads on loans in our pipeline. Loans in the pipeline represent loan applications for which we are in the process of obtaining all the documentation required for a loan approval or approved loans, which have not been accepted by the borrower and are not considered to be firm commitments. We believed there was a greater chance that market interest rates we would obtain on the subsequent securitization of these loans would increase rather than decline, and chose to protect the spread we could earn in the event of rising rates. 125 However due to a decline in market interest rates during the period the derivative contracts were used to manage interest rate risk on loans in our pipeline, we recorded losses on forward starting interest rate swap contracts during the fiscal year ended June 30, 2003. The losses are summarized in the table below. Related to Loans Expected to Be Sold Through Whole Loan Sale Transactions. The $170.0 million notional amount of forward starting interest rate swap contracts carrying over from the disqualified hedging relationship discussed above are currently being utilized to manage the effect of changes in market interest rates on the fair value of fixed-rate mortgage loans that were previously expected to be sold in a fourth quarter securitization, but are now expected to be sold in whole loan sale transactions. We have elected not to designate these derivative contracts as an accounting hedge. We recorded the following gains and losses on the fair value of derivative financial instruments classified as trading for the year ended June 30, 2003. There were no derivative contracts classified as trading for the years ended June 30, 2002 and 2001 except those noted below to manage the exposure to changes in the fair value of certain interest-only strips due to changes in one-month LIBOR. (in thousands): Trading gains(losses) on forward starting interest rate swaps: Related to loan pipeline........... $ (3,796) Related to whole loan sales........ $ 441 Amount settled in cash - paid...... $ (2,671) At June 30, 2003, outstanding forward starting interest rate swap contracts used to manage interest rate risk on loans expected to be sold in whole loan sale transactions and the associated unrealized gains recorded as assets on the balance sheet are summarized in the table below. There were no open derivative contracts classified as trading for the years ended June 30, 2002 and 2001 except those noted below to manage the exposure to changes in the fair value of certain interest-only strips due to changes in one-month LIBOR. (in thousands): Notional Unrealized Amount Gain --------------- --------------- Forward starting interest rate swaps.......................... $170,000 $441 The sensitivity of the forward starting interest rate swap contracts held as trading as of June 30, 2003 to a 0.1% change in market interest rates is $0.1 million. Related to Interest-only Strips. For fiscal years ended June 30, 2003 and 2002, respectively, we recorded net losses of $0.9 million and $0.7 million on an interest rate swap contract which is not designated as an accounting hedge. This contract was designed to reduce the exposure to changes in the fair value of certain interest-only strips due to changes in one-month LIBOR. The loss on the swap contract was due to decreases in the interest rate swap yield curve 126 during the periods the contract was in place. Included in the $0.9 million net loss recorded in the fiscal year ended June 30, 2003, were unrealized gains of $0.1 million representing the net change in the fair value of the contract during the fiscal year and $1.0 million of cash losses paid during the fiscal year. Included in the $0.7 million net loss recorded in the fiscal year ended June 30, 2002, were unrealized losses of $0.5 million representing the net change in the fair value of the contract during the fiscal year and $0.2 million of cash losses paid during the fiscal year. The cumulative net unrealized loss of $0.3 million is included as a trading liability in Other liabilities. Terms of the interest rate swap contract at June 30, 2003 were as follows (dollars in thousands): Notional amount................................. $ 44,535 Rate received - Floating (a).................... 1.18% Rate paid - Fixed............................... 2.89% Maturity date................................... April.2004 Unrealized loss................................. $ 334 Sensitivity to 0.1% change in interest rates.... $ 17 ____________________________ (a) Rate represents the spot rate for one-month LIBOR paid on the securitized floating interest rate certificate at the end of the period. Derivative transactions are measured in terms of a notional amount, but this notional amount is not carried on the balance sheet. The notional amount is not exchanged between counterparties to the derivative financial instrument, but is only used as a basis to determine fair value, which is recorded on the balance sheet and to determine interest and other payments between the counterparties. Our exposure to credit risk in a derivative transaction is represented by the fair value of those derivative financial instruments in a gain position. We attempt to manage this exposure by limiting our derivative financial instruments to those traded on major exchanges and where our counterparties are major financial institutions. At June 30, 2003, we held no derivative financial instruments in a cumulative gain position. In the future, we may expand the types of derivative financial instruments we use to hedge interest rate risk to include other types of derivative contracts. However, an effective interest rate risk management strategy is complex and no such strategy can completely insulate us from interest rate changes. Poorly designed strategies or improperly executed transactions may increase rather than mitigate risk. Hedging involves transaction and other costs that could increase as the period covered by the hedging protection increases. Although it is expected that such costs would be offset by income realized from securitizations in that period or in future periods, we may be prevented from effectively hedging fixed interest rate loans held for sale without reducing income in current or future periods. In addition, while Eurodollar rates, interest rate swap yield curves and the pass-through interest rate of securitizations are generally strongly correlated, this correlation has not held in periods of financial market disruptions (e.g., the so-called Russian Crisis in the later part of 1998). Liquidity and Capital Resources Liquidity and capital resource management is a process focused on providing the funding to meet our short and long-term cash needs. We have used a substantial portion of our funding sources to build our managed portfolio and investments in securitization residual assets with the expectation that they will generate sufficient cash flows in the future to cover our operating requirements, including repayment of maturing subordinated debt. Our cash needs change as the mix of loan sales through securitization shifts to whole loan sales, as the managed portfolio grows, as our interest-only strips grow and release more cash, as subordinated debt matures, as operating expenses change and as revenues increase. Because we have historically experienced negative cash 127 flows from operations, our business requires continual access to short and long-term sources of debt to generate the cash required to fund our operations. Our cash requirements include funding loan originations and capital expenditures, repaying existing subordinated debt, paying interest expense and operating expenses, and in connection with our securitizations, funding overcollateralization requirements and servicer obligations. At times, we have used cash to repurchase our common stock and could in the future use cash for unspecified acquisitions of related businesses or assets (although no acquisitions are currently contemplated). Initially, we finance our loans under several secured and partially committed credit facilities. These credit facilities are generally revolving lines of credit, which we have with several financial institutions that enable us to borrow on a short-term basis against our loans. We then securitize or sell our loans to unrelated third parties on a whole loan basis to generate the cash to pay off these revolving credit facilities. In fiscal 2003, we recorded a net loss of $29.9 million. The loss was due in part to our inability to complete our typical quarterly securitization of loans during the fourth quarter of our fiscal year. Also contributing to the loss was $45.2 million of net pre-tax charges for valuation adjustments (compared to $22.1 million of valuation adjustments in fiscal 2002) recorded on our securitization assets during the 2003 fiscal year. See "-- Off-Balance Sheet Arrangements -- Securitizations" for more detail on the valuation adjustments. Our short term liquidity was negatively impacted by several recent events. Our inability to complete our typical publicly underwritten securitization during the fourth quarter of fiscal 2003 contributed to our loss for fiscal 2003 and adversely impacted our short-term liquidity position. In addition, further advances under a non-committed portion of one of our credit facilities were subject to the discretion of the lender and subsequent to June 30, 2003, there were no new advances under the non-committed portion. Additionally, on August 20, 2003, this credit facility was amended and, among other changes, the non-committed portion was eliminated. We also had a $300.0 million mortgage conduit facility with a financial institution that enabled us to sell our loans into an off-balance sheet facility, which expired pursuant to its terms on July 5, 2003. At June 30, 2003, of the $516.1 million in revolving credit and conduit facilities available to us, $453.4 million was drawn upon. At September 19, 2003, of the $117.0 million in revolving credit facilities available to us, $102.3 million was drawn upon. Our revolving credit facilities and mortgage conduit facility had $62.7 million of unused capacity available at June 30, 2003 (and $14.7 million of unused capacity at September 19, 2003), which significantly reduced our ability to fund future loan originations until we sell existing loans, extend or expand existing credit facilities, or add new credit facilities. In addition, we have temporarily discontinued sales of new subordinated debt, which further impaired our liquidity. As a result of these liquidity issues, since June 30, 2003, we substantially reduced our loan origination volume. From July 1, 2003 through August 31, 2003, we originated $85.7 million of loans, which represents a significant reduction as compared to originations of $245.8 million of loans for the same period in fiscal 2003. Our inability to originate loans at previous levels may adversely impact the relationships our subsidiaries have or are developing with their brokers and our ability to retain employees. As a result of the decrease in loan originations and liquidity issues described above, we anticipate incurring a loss for the first quarter of fiscal 2004. The amount of the loss will depend, in part, upon our ability to complete a securitization prior to September 30, 2003 and, if completed, the size and terms of the securitization. Further, we can provide no assurances that we will be able to sell our loans, extend existing facilities or expand or add new credit facilities. If we are unable to obtain additional financing, we may not be able to restructure our business to permit profitable operations or repay our subordinated debt when due. Even if we are able to obtain adequate financing, our inability to securitize our loans could hinder our ability to operate profitably in the future and repay our subordinated debt when due. 128 We undertook specific remedial actions to address short-term liquidity concerns including entering into an agreement on June 30, 2003 with an investment bank to sell up to $700.0 million of mortgage loans, subject to the satisfactory completion of the purchaser's due diligence review and other conditions, and soliciting bids and commitments from other participants in the whole loan sale market. In total, from June 30, 2003 through September 17, 2003, we sold approximately $482.9 million (which includes $221.9 million of loans sold by the expired mortgage conduit facility) of loans through whole loan sales. We are continuing the process of selling our loans. We also suspended paying quarterly cash dividends on our common stock. As a result of the loss experienced during fiscal 2003, we were not in compliance with the terms of certain of the financial covenants under two of our principal credit facilities (one for $50.0 million and the other for $200.0 million, of which $100.0 million was non-committed) and we requested and obtained waivers of these requirements from our lenders. See "-- Credit Facilities." The lender under the $50.0 million warehouse credit facility has granted us a waiver for our non-compliance with a financial covenant in that credit facility through September 30, 2003. This facility was amended to reduce the available credit to $8.0 million and the financial covenants were replaced with new covenants with which we are currently in compliance. We also entered into an amendment to the $200.0 million credit facility which provides for the waiver of our non-compliance with the financial covenants in that facility, the reduction of the committed portion of this facility from $100.0 million to $50.0 million, the elimination of the $100.0 million non-committed portion of this credit facility and the acceleration of the termination date of this facility from November 2003 to September 30, 2003. Our ability to repay this facility upon termination is dependent on our ability to refinance the loans in one of our new facilities or our sale of loans currently warehoused in the terminating facility by September 30, 2003. In addition, if the anticipated loss for the first quarter of fiscal 2004 described above results in our non-compliance with any financial covenants, we intend to seek the appropriate waivers. There can be no assurances that we will obtain any of these waivers. On September 22, 2003, we entered into definitive agreements with a financial institution for a new $200.0 million credit facility for the purpose of funding our loan originations. Pursuant to the terms of this facility, we are required to, among other things: (i) obtain a written commitment for another credit facility of at least $200.0 million and close that additional facility by October 3, 2003 (which condition would be satisfied by the closing of the $225.0 million facility described below); (ii) have a net worth of at least $28.0 million by September 30, 2003; with quarterly increases of $2.0 million thereafter; (iii) apply 60% of our net cash flow from operations each quarter to reduce the outstanding amount of subordinated debt commencing with the quarter ending March 31, 2004; and (iv) provide a parent company guaranty of 10% of the outstanding principal amount of loans under the facility. Prior to the closing of the second facility, our borrowing capacity on this $200.0 million credit facility is limited to $80.0 million. This facility has a term of 12 months expiring in September 2004 and is secured by the mortgage loans which are funded by advances under the facility with interest equal to LIBOR plus a margin. This facility is subject to representations and warranties and covenants, which are customary for a facility of this type, as well as amortization events and events of default related to our financial condition. These provisions require, among other things, our maintenance of a delinquency ratio for the managed portfolio at the end of each fiscal quarter of less than 12.0%, our subordinated debt not to exceed $705.0 million at any time, our ownership of an amount of repurchased loans not to exceed 1.5% of the managed portfolio and our registration statement registering $295.0 million of subordinated debt be declared effective by the SEC no later than October 31, 2003. 129 On September 22, 2003, we executed a commitment letter for a mortgage warehouse credit facility with a warehouse lender, which consists of a senior secured revolving credit facility of up to $225.0 million to fund loan originations and a secured last out revolver facility up to $25.0 million. The commitment letter is subject to certain conditions, including, among other things: (i) entering into definitive agreements, except as provided in the commitment letter; (ii) the absence of a material adverse change in the business, operations, property, condition (financial or otherwise) or prospects of us or our affiliates; and (iii) our receipt of another credit facility in an amount not less that $200.0 million, subject to terms and conditions acceptable to this lender (which condition is satisfied by the new $200.0 million facility described above). The commitment letter provides that these facilities will have a term of three years with an interest rate on amounts outstanding under the $225.0 million portion of the credit facility equal to the greater of one-month LIBOR plus a margin or the difference between the yield maintenance fee (as defined in the commitment letter) and the one-month LIBOR plus a margin. Advances under this facility would be collateralized by substantially all of our present and future assets including pledged loans and a security interest in substantially all of our interest-only strips and residual interests which will be contributed to a special purpose entity organized by us to facilitate this transaction. We also agreed to pay fees of approximately $14.6 million annually plus a nonusage fee based on the difference between the average daily outstanding balance for the current month and the maximum credit amount under the facility and the lender's out-of-pocket expenses. We anticipate that these facilities will be subject to representations and warranties, events of default and covenants which are customary for facilities of this type, as well as our agreement to: (i) maintain sales or renewals of our subordinated debt securities of $10.0 million per month; (ii) restrict total principal and interest outstanding on our subordinated debt to $750.0 million or less; (iii) make quarterly reductions commencing in April 2004 of an amount of subordinated debt outstanding to be determined; (iv) maintain maximum interest rates payable on subordinated debt securities not to exceed 10 percentage points above comparable rates for FDIC insured products; and (v) the lender's receipt of our audited financial statements for the period ended June 30, 2003. The definitive agreements will grant the lender an option at any time after the first anniversary of entering into the definitive agreements to increase the credit amount on the $250.0 million facility to $400.0 million with additional fees payable by us plus additional interest as may be required by the institutions or investors providing the lender with these additional funds. The commitment letter requires that we enter into definitive agreements not later than October 17, 2003. While we anticipate that we will close this transaction prior to such date, we cannot assure you that these negotiations will result in definitive agreements or that such agreements, as negotiated, will be on terms and conditions acceptable to us. In the event we are unable to close these facilities or another facility within the time frame provided under the new $200.0 million credit facility described above, the lender on that facility would be under no obligation to make further advances under the terms of that facility and outstanding advances would have to be repaid over a period of time. During the first quarter of fiscal 2004, we explored a number of strategic alternatives to address these liquidity issues in the event we are unable to borrow under the new $200.0 million credit facility, close the $250.0 million credit facilities or obtain alternative financing. In the event we were unable to obtain the additional credit facilities necessary to operate our business, we developed a contingent business plan (described more fully under "-- Recent Developments -- Business Strategy Adjustments") which contemplates, among other things, the sale of $100 million principal amount of additional subordinated debt through March 2004 and the renewal of approximately 50% of outstanding subordinated debt upon maturity. We believe that this contingent business plan addresses our liquidity issues and may permit us to restructure our operations, if necessary, without the receipt of an expanded or additional credit facility. There can be no assurance that our contingent business plan will be successful or that it will enable us to repay our subordinated debt when due. 130 The following discussion of liquidity and capital resources should be read in conjunction with the discussion contained in "-- Application of Critical Accounting Policies." When loans are sold through a securitization, we retain the rights to service the loans. Servicing loans obligates us to advance interest payments for delinquent loans under certain circumstances and allows us to repurchase a limited amount of delinquent loans from securitization trusts. See "-- Off-Balance Sheet Arrangements," "-- Off-Balance Sheet Arrangements -- Securitizations" and "-- Off-Balance Sheet Arrangements -- Trigger Management" for more information on how the servicing of securitized loans affects requirements on our capital resources and cash flow. Cash flow from operations, the issuance of subordinated debt and lines of credit fund our operating cash needs. We expect these sources of funds to be sufficient to meet our cash needs. Loan originations are funded through borrowings against warehouse credit facilities and sales into an off-balance sheet facility. Each funding source is described in more detail below. Cash flow from operations. One of our corporate goals is to achieve positive cash flow from operations. However, we cannot be certain that we will achieve our projections regarding declining negative cash flow or positive cash flow from operations. The achievement of this goal is dependent on our ability to successfully implement our business strategy and on the following items: o Manage the mixture of whole loan sales and securitization transactions to maximize cash flow and economic value; o Manage levels of securitizations to maximize cash flows received at closing and subsequently from interest-only strips and servicing rights; o Maintain a portfolio of mortgage loans which will generate income and cash flows through our servicing activities and the residual interests we hold in the securitized loans; 131 o Build on our established approaches to underwriting loans, servicing and collecting loans and managing credit risks in order to control delinquency and losses; o Continue to identify and invest in technology and other efficiencies to reduce per unit costs in our loan origination and servicing process; and o Control overall expense levels. Historically, our cash flow from operations has been negatively impacted by a number of factors. The growth of our loan originations negatively impacts our cash flow from operations because we incur the cash expenses of the origination, but generally do not recover the cash outflow from these origination expenses until we securitize or sell the underlying loans. With respect to loans securitized, we may be required to wait more than one year to begin recovering the cash outflow from loan origination expenses through cash inflows from our residual assets retained in securitization. A second factor, which could negatively impact our cash flow, is an increase in market interest rates. If market interest rates increase, the premiums we would be paid on whole loan sales could be reduced and the interest rates that investors will demand on the certificates issued in future securitizations will increase. The increase in interest rates paid to investors reduces the cash we will receive from interest-only strips created in future securitizations. Although we may have the ability in a rising interest rate market to charge higher loan interest rates to our borrowers, competition, laws and regulations and other factors may limit or delay our ability to do so. Cash flow from operations for the year ended June 30, 2003 was a negative $285.4 million compared to negative $13.3 million for fiscal 2002. Negative cash flow from operations increased $272.1 million for the year ended June 30, 2003 mainly due to our inability to complete a securitization in the fourth quarter of fiscal 2003. At June 30, 2003 we carried $271.4 million of loans available for sale, compared to $57.7 million at June 30, 2002. We also carried a receivable of $26.7 million for the proceeds on loans sold in a whole loan sale transaction, which closed on June 30, 2003, but settled in cash on July 1, 2003. Also contributing to the increase in negative cash flow for fiscal 2003 was an increase in the amount of delinquent loans repurchased from securitization trusts in order to avoid delinquency and loss triggers and the funding of $3.8 million in initial overcollateralization from the proceeds of our December 2002 securitization and $6.8 million on our fourth quarter of fiscal 2003 sales to a mortgage conduit facility. Increases in the cash flow from interest-only strips in fiscal 2003 were offset by increases in operating expenses, mainly general and administrative expenses to service and collect the larger managed portfolio. The amount of cash we receive and the amount of overcollateralization we are required to fund at the closing of our securitizations and the amount of cash we receive as gains on whole loan sales are dependent upon a number of factors including market factors over which we have no control. Although we expect negative cash flow from operations to continue and fluctuate in the foreseeable future, our goal is to reduce our negative cash flow from operations from historical levels. We believe that if our projections based on our business strategy prove accurate, our cash flow from operations will become positive. However, negative cash flow from operations in fiscal 2004 may continue due to the nature of our operations and the timing to implement our business strategy. We generally expect the level of cash flow from operations to fluctuate. 132 As was previously discussed, during the seven quarters ended June 30, 2003, our actual prepayment experience on our managed portfolio was generally higher than our average historical levels for prepayments. Prepayments result in decreases in the size of our managed portfolio and decreases in the expected future cash flows to us from our interest-only strips and servicing rights. However, due to the favorable interest rate spreads, favorable initial overcollateralization requirements and levels of cash received at closing on our more recent securitizations we do not believe our recent increase in prepayment experience will have a significant impact on our aggregate expected cash flows from operations in the future. Other factors could negatively affect our cash flow and liquidity such as increases in mortgage interest rates, legislation or other economic conditions which may make our ability to originate loans more difficult. As a result, our costs to originate loans could increase or our volume of loan originations could decrease. Contractual obligations. Following is a summary of future payments required on our contractual obligations as of June 30, 2003 (in thousands):
Payments Due by Period --------------------------------------------------------------- Less than 1 to 3 4 to 5 More than Contractual Obligations Total 1 year years years 5 years - -------------------------------- ---------- --------- -------- ------- --------- Subordinated debt.............. $ 719,540 $ 321,960 $328,440 $42,666 $26,474 Accrued interest - subordinated debt (a) ................... 45,283 21,635 17,657 2,360 3,631 Warehouse and operating lines of credit................... 212,109 212,109 -- -- -- Capitalized lease (b).......... 807 319 488 -- -- Operating leases (c)........... 56,123 1,420 10,415 10,755 33,533 Services and equipment (d)..... 7,331 7,331 -- -- -- ---------- --------- -------- ------- ------- Total obligations.............. $1,041,193 $ 564,774 $357,000 $55,781 $63,638 ========== ========= ======== ======= =======
(a) This table reflects interest payment terms elected by subordinated debt holders as of June 30, 2003. In accordance with the terms of the subordinated debt offering, subordinated debt holders have the right to change the timing of the interest payment on their notes once during the term of their investment. (b) Amounts include principal and interest. (c) Amounts include lease for office space. (d) Amounts related to the relocation of our corporate headquarters. The provisions of the lease, local and state grants will provide us with reimbursement of a substantial amount of these payments. Credit facilities. Borrowings against warehouse credit facilities represent cash advanced to us for a limited duration, generally no more than 270 days, and are secured by the loans we pledge to the lender. These credit facilities provide the primary funding source for loan originations. The ultimate sale of the loans through securitization or whole loan sale generates the cash proceeds necessary to repay the borrowings under the warehouse facilities. In addition, we have the availability of revolving credit facilities, which may be used to fund our operations. These credit facilities are generally extended for a one-year term before the renewal of the facility must be re-approved by the lender. We periodically review our expected future credit needs and negotiate credit commitments for those needs as well as excess capacity in order to allow us flexibility in the timing of the securitization of our loans. 133 The following is a description of the warehouse and operating lines of credit and mortgage conduit facilities, which were available to us at June 30, 2003 (in thousands):
Amount Amount Facility Utilized On- Utilized Off- Amount Balance Sheet Balance Sheet -------- ------------- ------------- Revolving credit and conduit facilities: Mortgage conduit facility, expiring July 2003 (a) $300,000 $ Na $267,488 Warehouse revolving line of credit, expiring November 2003 (b) 200,000 136,098 Na Warehouse and operating revolving line of credit, expiring December 2003 (c) 50,000 30,182 Na Warehouse revolving line of credit, expiring October 2003 (d) 25,000 19,671 Na Operating revolving line of credit, expiring January 2004 (e) 5,000 -- Na -------- -------- -------- Total revolving credit facilities 580,000 185,951 267,488 Other facilities: Capitalized leases, maturing January 2006 (f) 807 807 Na -------- -------- -------- Total credit facilities $580,807 $186,758 $267,488 ======== ======== ========
- ------------------------------------- Na - not applicable for facility (a) $300.0 million mortgage conduit facility. The facility provided for the sale of loans into an off-balance sheet facility with UBS Principal Finance, LLC, an affiliate of UBS Warburg. This facility expired pursuant to its terms on July 5, 2003. See "-- Application of Critical Accounting Policies" for further discussion of the off-balance sheet features of this facility. (b) $200.0 million warehouse line of credit with Credit Suisse First Boston Mortgage Capital, LLC. $100.0 million of this facility was continuously committed for the term of the facility while the remaining $100.0 million of the facility was available at Credit Suisse's discretion. Subsequent to June 30, 2003, there were no new advances under the non-committed portion. On August 20, 2003, this credit facility was amended to reduce the committed portion to $50.0 million (from $100.0 million), eliminate the non-committed portion and accelerate its expiration date from November 2003 to no later than September 30, 2003. The interest rate on the facility is based on one-month LIBOR plus a margin. Advances under this facility are collateralized by pledged loans. (c) $50.0 million warehouse and operating credit facility with JPMorgan Chase Bank which includes a sublimit for a letter of credit to secure lease obligations for corporate office space. Interest rates on the advances under this facility are based upon one-month LIBOR plus a margin. The amount of the letter of credit was $8.0 million at June 30, 2003 and will vary over the term of the lease. Obligations under the facility are collateralized by pledged loans, REO, and advances to securitization trusts. Advances on this line for general operating purposes are limited to $5.0 million and are collateralized by our Class R Certificates of the ABFS Mortgage Loan Trusts 1997-2, 1998-1 and 1998-3. (d) $25.0 million warehouse line of credit facility from Residential Funding Corporation. Under this warehouse facility, advances may be obtained, subject to specific conditions described in the agreements. Interest rates on the advances are based on one-month LIBOR plus a margin. The obligations under this agreement are collateralized by pledged loans. (e) $5.0 million revolving line of credit facility from Firstrust Savings Bank. The obligations under this facility are collateralized by the cash flows from our investments in the ABFS 99-A lease securitization trust and Class R and X certificates of the ABFS Mortgage Loan Trust 2001-2. The interest rate on the advances from this facility is one-month LIBOR plus a margin. (f) Capitalized leases, imputed interest rate of 8.0%, collateralized by computer equipment. 134 On September 22, 2003, we entered into definitive agreements with a financial institution for a new $200.0 million credit facility for the purpose of funding our loan originations. Pursuant to the terms of this facility, we are required to, among other things: (i) obtain a written commitment for another credit facility of at least $200.0 million and close that additional facility by October 3, 2003 (which condition would be satisfied by the closing of the $225.0 million facility described below); (ii) have a net worth of at least $28.0 million by September 30, 2003; with quarterly increases of $2.0 million thereafter; (iii) apply 60% of our net cash flow from operations each quarter to reduce the outstanding amount of subordinated debt commencing with the quarter ending March 31, 2004; and (iv) provide a parent company guaranty of 10% of the outstanding principal amount of loans under the facility. Prior to the closing of the second facility, our borrowing capacity on this $200.0 million credit facility is limited to $80.0 million. This facility has a term of 12 months expiring in September 2004 and is secured by the mortgage loans which are funded by advances under the facility with interest equal to LIBOR plus a margin. This facility is subject to representations and warranties and covenants, which are customary for a facility of this type, as well as amortization events and events of default related to our financial condition. These provisions require, among other things, our maintenance of a delinquency ratio for the managed portfolio at the end of each fiscal quarter of less than 12.0%, our subordinated debt not to exceed $705.0 million at any time, our ownership of an amount of repurchased loans not to exceed 1.5% of the managed portfolio and our registration statement registering $295.0 million of subordinated debt be declared effective by the SEC no later than October 31, 2003. On September 22, 2003, we executed a commitment letter for a mortgage warehouse credit facility with a warehouse lender, which consists of a senior secured revolving credit facility of up to $225.0 million to fund loan originations and a secured last out revolver facility up to $25.0 million. The commitment letter is subject to certain conditions, including, among other things: (i) entering into definitive agreements, except as provided in the commitment letter; (ii) the absence of a material adverse change in the business, operations, property, condition (financial or otherwise) or prospects of us or our affiliates; and (iii) our receipt of another credit facility in an amount not less that $200.0 million, subject to terms and conditions acceptable to this lender (which condition is satisifed by the new $200.0 million facility described above). The commitment letter provides that these facilities will have a term of three years with an interest rate on amounts outstanding under the $225.0 million portion of the credit facility equal to the greater of one-month LIBOR plus a margin or the difference between the yield maintenance fee (as defined in the commitment letter) and the one-month LIBOR plus a margin. Advances under this facility would be collateralized by substantially all of our present and future assets including pledged loans and a security interest in substantially all of our interest-only strips and residual interests which will be contributed to a special purpose entity organized by us to facilitate this transaction. We also agreed to pay fees of approximately $14.6 million annually plus a nonusage fee based on the difference between the average daily outstanding balance for the current month and the maximum credit amount under the facility and the lender's out-of-pocket expenses. We anticipate that these facilities will be subject to representations and warranties, events of default and covenants which are customary for facilities of this type, as well as our agreement to: (i) maintain sales or renewals of our subordinated debt securities of $10.0 million per month; (ii) restrict total principal and interest outstanding on our subordinated debt to $750.0 million or less; (iii) make quarterly reductions commencing in April 2004 of an amount of subordinated debt outstanding to be determined; (iv) maintain maximum interest rates payable on subordinated debt securities not to exceed 10 percentage points above comparable rates for FDIC insured products; and (v) the lender's receipt of our audited financial statements for the period ended June 30, 2003. The definitive agreements will grant the lender an option at any time after the first anniversary of entering into the definitive agreements to increase the credit amount on the $250.0 million facility to $400.0 million with additional fees payable by us plus additional interest as may be required by the institutions or investors providing the lender with these additional funds. The commitment letter requires that we enter into the definitive agreements not later than October 17, 2003. While we anticipate that we will close this transaction prior to such date, we cannot assure you that these negotiations will result in definitive agreements or that such agreements, as negotiated, will be on terms and conditions acceptable to us. In the event we are unable to close these facilities or another facility within the time frame provided under the new $200.0 million credit facility described above, the lender on that facility would be under no obligation to make further advances under the terms of that facility and outstanding advances would have to be repaid over a period of time. 135 The warehouse credit agreements require that we maintain specific financial covenants regarding net worth, leverage, net income, liquidity, total debt and other standards. Each agreement has multiple individualized financial covenant thresholds and ratio of limits that we must meet as a condition to drawing on a particular line of credit. As a result of the loss experienced during fiscal 2003, we were not in compliance with the terms of certain of the financial covenants related to net worth, consolidated stockholders' equity and the ratio of total liabilities to consolidated stockholders' equity under two of our principal credit facilities (one for $50.0 million and the other for $200.0 million, of which $100.0 million was non-committed). Pursuant to the terms of these credit facilities, the failure to comply with the financial covenants constitutes an event of default and at the option of the lender, entitles the lender to, among other things, terminate commitments to make future advances to us, declare all or a portion of the loan due and payable, foreclose on the collateral securing the loan, require servicing payments be made to the lender or other third party or assume the servicing of the loans securing the credit facility. An event of default under these credit facilities would result in defaults pursuant to cross-default provisions of our other agreements, including but not limited to, other loan agreements, lease agreements and other agreements. The failure to comply with the terms of these credit facilities or to obtain the necessary waivers would have a material adverse effect on our liquidity and capital resources. We have requested and obtained waivers from these covenant provisions from both lenders. The lender under the $50.0 million warehouse credit facility has granted us a waiver for our non-compliance with a financial covenant in that credit facility through September 30, 2003. This facility was amended to reduce the available credit to $8.0 million and the financial covenants were replaced with new covenants. We also entered into an amendment to the $200.0 million credit facility which provides for the waiver of our non-compliance with the financial covenants in that facility, the reduction of the committed portion of this facility from $100.0 million to $50.0 million, the elimination of the $100.0 million non-committed portion of this credit facility and the acceleration of the termination date of this facility from November 2003 to September 30, 2003. Our ability to repay this facility upon termination is dependent on our ability to refinance the loans in one of our new facilities or our sale of loans currently warehoused in the terminating facility by September 30, 2003. In addition, if the anticipated loss for the first quarter of fiscal 2004 described above results in our non-compliance with any financial covenants, we intend to seek the appropriate waivers. There can be no assurances that we will obtain any of these waivers. Some of our financial covenants in other credit facilities have minimal flexibility and we cannot say with certainty that we will continue to comply with the terms of all debt covenants. There can be no assurance as to whether or in what form a waiver or modification of these agreements would be granted us. Subordinated debt securities. The issuance of subordinated debt funds the majority of our remaining operating cash requirements. We rely significantly on our ability to issue subordinated debt since our cash flow from operations is not sufficient to meet these requirements. In order to expand our businesses we have issued subordinated debt to partially fund growth and to partially fund maturities of subordinated debt. In addition, at times we may elect to utilize proceeds from the issuance of subordinated debt to fund loans instead of using our warehouse credit facilities, depending on our determination of liquidity needs. During fiscal 2003, subordinated debt increased by $63.8 million, net of redemptions compared to an increase of $117.8 million in fiscal 2002. The reduction in the level of subordinated debt sold was a result of our focus on becoming cash flow positive and reducing our reliance on subordinated debt. We registered $315.0 million of subordinated debt under a registration statement, which was declared effective by the SEC on October 3, 2002. Of the $315.0 million, $121.3 million of this debt was unsold as of June 30, 2003. In June 2003, we filed a new registration statement with the SEC to register an additional $295.0 million of subordinated debt. 136 We intend to meet our obligation to repay such debt and interest as it matures with cash flow from operations, cash flows from interest-only strips and cash generated from additional debt financing. The utilization of funds for the repayment of such obligations should not adversely affect operations. Our unrestricted cash balances are sufficient to cover approximately 8.9% of the $343.6 million of subordinated debt and accrued interest maturities due within one year. Unrestricted cash balances were $30.5 million at June 30, 2003, compared to $99.6 million at June 30, 2002. The current low interest rate environment has provided an opportunity to reduce the interest rates offered on our subordinated debt. The weighted-average interest rate of our subordinated debt issued in the month of June 2003 was 7.49%, compared to debt issued in June 2002, which had a weighted-average interest rate of 8.39%. Debt issued at our peak rate, which was in February 2001, was at a rate of 11.85%. Our ability to further decrease the rates offered on subordinated debt, or maintain the current rates, depends on market interest rates and competitive factors among other circumstances. The weighted average remaining maturity of our subordinated debt at June 2003 was 19.5 months compared to 17.2 months at June 2002. Sales into special purpose entities and off-balance sheet facilities. We rely significantly on access to the asset-backed securities market through securitizations to provide permanent funding of our loan production. We also retain the right to service the loans. Residual cash from the loans after required principal and interest payments are made to the investors provides us with cash flows from our interest-only strips. It is our expectation that future cash flows from our interest-only strips and servicing rights will generate more of the cash flows required to meet maturities of our subordinated debt and our operating cash needs. See "-- Off-Balance Sheet Arrangements" for further detail of our securitization activity and effect of securitizations on our liquidity and capital resources. Other liquidity considerations. In December 2002, our shareholders approved an amendment to our Certificate of Incorporation to increase the number of shares of authorized preferred stock from 1.0 million shares to 3.0 million shares. The preferred shares may be used to raise equity capital, redeem outstanding debt or acquire other companies, although no such acquisitions are currently contemplated. The Board of Directors has discretion with respect to designating and establishing the terms of each series of preferred stock prior to issuance. A further decline in economic conditions, continued instability in financial markets or further acts of terrorism in the United States may cause disruption in our business and operations including reductions in demand for our loan products and our subordinated debt securities, increases in delinquencies and credit losses in our managed loan portfolio, changes in historical prepayment patterns and declines in real estate collateral values. To the extent the United States experiences an economic downturn, unusual economic patterns and unprecedented behaviors in financial markets, these developments may affect our ability to originate loans at profitable interest rates, to price future loan securitizations profitably and to hedge our loan portfolio effectively against market interest rate changes which could cause reduced profitability. Should these disruptions and unusual activities occur, our profitability and cash flow could be reduced and our ability to make principal and interest payments on our subordinated debt could be impaired. Additionally, under the Soldiers' and Sailors' Civil Relief Act of 1940, members of all branches of the military on active duty, including draftees and reservists in military service and state national guard called to federal duty are entitled to have interest rates reduced and capped at 6% per annum, on obligations (including mortgage 137 loans) incurred prior to the commencement of military service for the duration of military service and may be entitled to other forms of relief from mortgage obligations. To date, compliance with the Act has not had a material effect on our business. Related Party Transactions We have a loan receivable from our Chairman and Chief Executive Officer, Anthony J. Santilli, for $0.6 million, which was an advance for the exercise of stock options to purchase 247,513 shares of our common stock in 1995. The loan is due in September 2005 (earlier if the stock is disposed of). Interest at 6.46% is payable annually. The loan is secured by 247,513 shares of our common stock, and is shown as a reduction of stockholders' equity in our financial statements. On April 2, 2001, we awarded 2,500 shares (3,025 shares after the effect of stock dividends) of our common stock to Richard Kaufman, our director, as a result of services rendered in connection with our stock repurchases. In February 2003, we awarded 2,000 shares of our common stock to each of Warren E. Palitz and Jeffrey S. Steinberg, as newly appointed members of our Board of Directors. We employ members of the immediate family of two of our directors and executive officers in various executive and other positions. We believe that the salaries we pay these individuals are competitive with salaries paid to other employees in similar positions in our organization and in our industry. In fiscal 2003, Lanard & Axilbund, Inc., a real estate brokerage and management firm in which our Director, Mr. Sussman, was a partner and is now Chairman Emeritus, acted as our agent in connection with the lease of our new corporate office space. As a result of this transaction, Lanard & Axilbund, Inc. has received commissions from the landlord of the new corporate office space. We believe the amount of this commission is consistent with market and industry standards. Additionally, as part of our agreement with Lanard & Axilbund, Inc., they have reimbursed us for some of our costs related to finding new office space including some of our expenses related to legal services, feasibility studies and space design. Additionally, we have business relationships with other related parties, including family members of two of our directors and executive officers, through which we have, from time to time, purchased appraisal services, office equipment and real estate advisory services. None of our related party transactions, individually or collectively, are material to our results of operations. Reconciliation of Non-GAAP Financial Measures This document contains non-GAAP financial measures. For purposes of the SEC's Regulation G, a non-GAAP financial measure is a numerical measure of a registrant's historical or future financial performance, financial position or cash flow that excludes amounts, or is subject to adjustments that have the effect of excluding amounts, that are included in the most directly comparable measure calculated and presented in accordance with GAAP in our statement of 138 income, balance sheet or statement of cash flows (or equivalent statement); or includes amounts, or is subject to adjustments that have the effect of including amounts, that are excluded from the most directly comparable measure so calculated and presented. In this regard, GAAP refers to accounting principles generally accepted in the United States of America. Pursuant to the requirements of Regulation G, following is a reconciliation of the non-GAAP financial measures to the most directly comparable GAAP financial measure. We present certain financial ratios to measure balance sheet leverage relationships that include or exclude items from GAAP based financial ratios consistent with common industry practices. Additionally, some ratios are adjusted in order to isolate secured items such as secured debt or overcollateralization, which is secured by loan principal in securitization trusts, from unsecured items. Management believes these measures enhance the users' overall understanding of our current financial performance and prospects for the future and that these measures help in understanding the risk characteristics of certain significant balance sheet amounts and how their proportions to equity change over time. The following tables reconcile the ratios presented in "Balance Sheet Information -- Balance Sheet Data" to GAAP basis measures (dollars in thousands): June 30, Total liabilities to tangible ---------------------------------------- equity: 2003 2002 2001 ---------- ---------- ---------- Total liabilities .............. $1,117,282 $806,997 $699,625 Equity ......................... 42,069 69,378 66,862 Less: Goodwill ................. (15,121) (15,121) (15,121) ---------- -------- -------- Tangible equity ........... $ 26,948 $ 54,257 $ 51,741 ========== ======== ======== Total liabilities to tangible equity ...................... 41.5 x 14.9 x 13.5 x ========== ======== ======== Liabilities/equity ............. 26.6 x 11.6 x 10.5 x ========== ======== ======== Adjusted debt to tangible equity: Total liabilities .............. $1,117,282 $806,997 $699,625 Less: Cash ..................... (47,475) (108,599) (91,092) Less: Warehouse lines .......... (212,916) (8,486) (51,064) Less: Loans in process ......... (35,187) (29,866) (29,130) ---------- -------- -------- 821,704 660,046 528,339 Equity ......................... 42,069 69,378 66,862 Less: Goodwill ................. (15,121) (15,121) (15,121) ---------- -------- -------- Tangible equity ........... $ 26,948 $ 54,257 $ 51,741 ========== ======== ======== Adjusted debt to tangible equity ...................... 30.5 x 12.2 x 10.2 x ========== ======== ======== Liabilities/equity ............. 26.6 x 11.6 x 10.5 x ========== ======== ======== 139 Subordinated debt to tangible June 30, equity: --------------------------------------- 2003 2002 2001 ---------- ---------- ---------- Subordinated debt .............. $719,540 $655,720 $537,950 Equity ......................... 42,069 69,378 66,862 Less: Goodwill ................. (15,121) (15,121) (15,121) -------- -------- -------- Tangible equity ............. $ 26,948 $ 54,257 $ 51,741 ======== ======== ======== Subordinated debt to tangible equity ...................... 26.7 x 12.1 x 10.4 x ======== ======== ======== Liabilities/equity ............. 26.6 x 11.6 x 10.5 x ======== ======== ======== Interest-only strips to adjusted tangible equity: Interest-only strips ........... $598,278 $512,611 $398,519 Less: Overcollateralization .... (210,719) (160,079) (119,000) 387,559 352,532 279,519 Equity ......................... 42,069 69,378 66,862 Less: Goodwill ................. (15,121) (15,121) (15,121) -------- -------- -------- Tangible equity ........... 26,948 54,257 51,741 Plus: Subordinated debt with remaining maturity >5 years .................... 26,474 27,629 28,637 -------- -------- -------- $ 53,422 $ 81,886 $ 80,378 ======== ======== ======== Interest-only strips to adjusted tangible equity ........... 7.3 x 4.3 x 3.5 x ======== ======== ======== Interest-only strips/equity .... 14.2 x 7.4 x 6.0 x ======== ======== ======== We present managed portfolio and managed real estate owned, referred to as REO, information. Management believes these measures enhance the users' overall understanding of our current financial performance and prospects for the future because the volume and credit characteristics of off-balance sheet securitized loan and lease receivables have a significant effect on our financial performance as a result of our retained interests in the securitized loans. Retained interests include interest-only strips and servicing rights. In addition, because the servicing and collection of our off-balance sheet securitized loan and lease receivables are performed in the same manner and according to the same standards as the servicing and collection of our on-balance sheet loan and lease receivables, certain of our resources, such as personnel and technology, are allocated based on their pro rata relationship to the total managed portfolio and total managed REO. The following tables reconcile the managed portfolio measures presented in "-- Managed Portfolio Quality" and "Selected Financial Information." (dollars in thousands): 140 June 30, 2003: Delinquencies - ----------------------------------------------------------------------- Amount % -------- ---- On-balance sheet loan and lease receivables.................. $ 265,764 $ 5,412 2.04% Securitized loan and lease receivables..................... 3,385,310 223,658 6.61% ---------- -------- Total Managed Portfolio........... $3,651,074 $229,070 6.27% ========== ======== On-balance sheet REO.............. $ 4,776 Securitized REO................... 23,224 ---------- Total Managed REO................. $ 28,000 ========== June 30, 2002: Delinquencies - ------------------------------------------------------------------------ Amount % -------- ----- On-balance sheet loan and lease receivables............... $ 56,625 $ 5,918 10.45% Securitized loan and lease receivables..................... 3,009,564 164,855 5.48% ---------- -------- Total Managed Portfolio........... $3,066,189 $170,773 5.57% ========== ======== On-balance sheet REO.............. $ 3,784 Securitized REO................... 30,261 ---------- Total Managed REO................. $ 34,045 ========== June 30, 2001: Delinquencies - ----------------------------------------------------------------------- Amount % -------- ---- On-balance sheet loan and lease receivables............... $ 87,899 $ 3,382 3.85% Securitized loan and lease receivables..................... 2,501,496 103,631 4.14% ---------- -------- Total Managed Portfolio........... $2,589,395 $107,013 4.13% ========== ======== On-balance sheet REO.............. $ 2,323 Securitized REO................... 26,109 ---------- Total Managed REO................. $ 28,432 ========== Office Facilities We presently lease office space for our corporate headquarters in Philadelphia, Pennsylvania. Our corporate headquarters was located in Bala Cynwyd, Pennsylvania prior to July 7, 2003. The lease for the Bala Cynwyd facility has expired. The current lease term for the Philadelphia facility expires in June 2014. The terms of the rental agreement require increased payments annually for the term of the lease with average minimum annual rental payments of $4.2 million. We have entered into contracts, or may engage parties in the future, related to the relocation of our corporate headquarters such as contracts for building improvements to the leased space, office furniture and equipment and moving services. The provisions of the lease and local and state grants will provide us with reimbursement of a substantial amount of our costs related to the relocation, subject to certain conditions and limitations. We do not believe our unreimbursed expenses or unreimbursed cash outlay related to the relocation will be material to our operations. 141 The lease requires us to maintain a letter of credit in favor of the landlord to secure our obligations to the landlord throughout the term of the lease. The amount of the letter of credit is $8.0 million and declines over time to $4.0 million. The letter of credit is currently issued by JPMorgan Chase Bank under our $8.0 million facility with JPMorgan Chase Bank. We continue to lease some office space in Bala Cynwyd under a five-year lease expiring in November 2004 at an annual rental of approximately $0.7 million. We perform our loan servicing and collection activities at this office, but expect to relocate these activities to our Philadelphia office. In May 2003, we moved our regional processing center to a different location in Roseland, New Jersey. We also lease the office space in Roseland, New Jersey and the nine-year lease expires in January 2012. The terms of the rental agreement require increased payments periodically for the term of the lease with average minimum annual rental payments of $0.8 million. The expenses and cash outlay related to the relocation were not material to our operations. Recent Accounting Pronouncements The following description should be read in conjunction with the significant accounting policies, which have been adopted and are set forth in Note 1 of the June 30, 2003 Consolidated Financial Statements. In November 2002, the Financial Accounting Standards Board ("FASB") issued Financial Interpretation No. ("FIN") 45 "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." FIN 45 standardizes practices related to the recognition of a liability for the fair value of a guarantor's obligation. The rule requires companies to record a liability for the fair value of its guarantee to provide or stand ready to provide services, cash or other assets. The rule applies to contracts that require a guarantor to make payments based on an underlying factor such as change in market value of an asset, collection of the scheduled contractual cash flows from individual financial assets held by a special purpose entity, non-performance of a third party, for indemnification agreements, or for guarantees of the indebtedness of others among other things. The provisions of FIN 45 are effective on a prospective basis for guarantees that are issued or modified after December 31, 2002. The disclosure requirements were effective for statements of annual or interim periods ending after December 15, 2002. Based on the requirements of this guidance for the year ended June 30, 2003, we have recorded a $0.7 million liability in conjunction with the sale of mortgage loans to the ABFS 2003-1 securitization trust which occurred in March 2003. This liability represents the fair value of periodic interest advances that we, as servicer of the securitized loans, are obligated to pay on behalf of delinquent loans in the trust. The recording of this liability reduces the gain on sale recorded for the securitization. We would expect to record a similar liability for any subsequent securitization as it occurs. The amount of the liability that will be recorded is dependent mainly on the volume of loans we securitize, the expected performance of those loans and the interest rate of the loans. In the year ended June 30, 2003, the adoption of FIN 45 reduced net income by approximately $0.4 million and diluted earnings per share by $0.14. See Note 14 of the Consolidated Financial Statements for further detail of this obligation. In December 2002, the FASB issued Statement of Financial Accounting Standard ("SFAS") No. 148 "Accounting for Stock-Based Compensation - Transition and Disclosure." SFAS No. 148 amends SFAS No. 123 "Accounting for Stock-Based Compensation." SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based compensation and requires pro forma disclosures of the effect on net income and earnings per share had the fair value method been used to be included in annual and interim reports and disclosure of the effect of the transition method used if the accounting method was changed, among other things. SFAS No. 148 is effective for annual reports of fiscal years beginning after December 15, 2002 142 and interim reports for periods beginning after December 15, 2002. We plan to continue using the intrinsic value method of accounting for stock-based compensation and therefore the new rule will have no effect on our financial condition or results of operations. We have adopted the new standard related to disclosure in the interim period beginning January 1, 2003. See Notes 1 and 12 of the Consolidated Financial Statements for further detail of the adoption of this rule. In April 2003, the FASB began reconsidering the current alternatives available for accounting for stock-based compensation. Currently, the FASB is continuing its deliberations on this matter. We cannot predict whether the guidance will change our current accounting for stock-based compensation, or what effect, if any, changes may have on our current financial condition or results of operations. In January 2003, the FASB issued FIN 46 "Consolidation of Variable Interest Entities." FIN 46 provides guidance on the identification of variable interest entities that are subject to consolidation requirements by a business enterprise. A variable interest entity subject to consolidation requirements is an entity that does not have sufficient equity at risk to finance its operations without additional support from third parties and the equity investors in the entity lack certain characteristics of a controlling financial interest as defined in the guidance. SPEs are one type of entity, which under certain circumstances may qualify as a variable interest entity. Although we use unconsolidated SPEs extensively in our loan securitization activities, the guidance will not affect our current consolidation policies for SPEs as the guidance does not change the guidance incorporated in SFAS No. 140 "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities" which precludes consolidation of a qualifying SPE by a transferor of assets to that SPE. FIN 46 will therefore have no effect on our financial condition or results of operations and would not be expected to affect it in the future. In March 2003, the FASB announced that it is reconsidering the permitted activities of a qualifying SPE. We cannot predict whether the guidance will change or what effect, if any, changes may have on our current consolidation policies for SPEs. In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" to clarify the financial accounting and reporting for derivative instruments and hedging activities. SFAS No. 149 is intended to improve financial reporting by requiring comparable accounting methods for similar contracts. SFAS No. 149 is effective for contracts entered into or modified subsequent to June 30, 2003. The requirements of SFAS No. 149 do not affect our current accounting for derivative instruments or hedging activities, therefore, it will have no effect on our financial condition or results of operations. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No.150 requires an issuer to classify certain financial instruments having characteristics of both liabilities and equity, such as mandatorily redeemable shares and obligations to repurchase the issuer's equity shares, as liabilities. The guidance is effective for financial instruments entered into or modified subsequent to May 31, 2003, and otherwise is effective at the beginning of the first interim period after June 15, 2003. We do not have any instruments with such characteristics and do not expect SFAS No. 150 to have a material impact on our financial condition or results of operations. 143 Item 7A. Quantitative and Qualitative Disclosures About Market Risk The information required to be included in this Item 7A regarding Quantitative and Qualitative Disclosures About Market Risk is incorporated by reference from "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Interest Rate Risk Management." 144 Item 8. Financial Statements Index to Consolidated Financial Statements Page ---- Report of Independent Certified Public Accountants..................... 131 Consolidated Balance Sheets as of June 30, 2003 and 2002............... 132 Consolidated Statements of Income for the years ended June 30, 2003, 2002 and 2001...................................... 133 Consolidated Statements of Stockholders' Equity for the years ended June 30, 2003, 2002 and 2001...................................... 134 Consolidated Statements of Cash Flow for the years ended June 30, 2003, 2002 and 2001...................................... 135 Notes to Consolidated Financial Statements............................. 137 145 Report of Independent Certified Public Accountants American Business Financial Services, Inc. Philadelphia, Pennsylvania We have audited the accompanying consolidated balance sheets of American Business Financial Services, Inc. and subsidiaries as of June 30, 2003 and 2002, and the related consolidated statements of income, stockholders' equity, and cash flow for each of the three years in the period ended June 30, 2003. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of American Business Financial Services, Inc. and subsidiaries as of June 30, 2003 and 2002, and the consolidated results of their operations and their cash flow for each of the three years in the period ended June 30, 2003 in conformity with accounting principles generally accepted in the United States of America. /s/ BDO Seidman LLP BDO Seidman LLP Philadelphia, Pennsylvania August 29, 2003, except for Note 1, Business Conditions, and Note 9, which are as of September 22, 2003 146 American Business Financial Services, Inc. and Subsidiaries Consolidated Balance Sheets
June 30, 2003 2002 ----------------------------- (dollar amounts in thousands) Assets Cash and cash equivalents $ 47,475 $108,599 Loan and lease receivables, net Available for sale 271,402 57,677 Interest and fees 15,179 12,292 Other 23,761 9,028 Interest-only strips (includes the fair value of overcollateralization related cash flows of $279,245 and $236,629 at June 30, 2003 and 2002) 598,278 512,611 Servicing rights 119,291 125,288 Receivable for sold loans 26,734 - Prepaid expenses 3,477 3,640 Property and equipment, net 23,302 18,446 Other assets 30,452 28,794 ---------- -------- Total assets $1,159,351 $876,375 ========== ======== Liabilities Subordinated debt $ 719,540 $655,720 Warehouse lines and other notes payable 212,916 8,486 Accrued interest payable 45,448 43,069 Accounts payable and accrued expenses 30,352 13,690 Deferred income taxes 17,036 35,124 Other liabilities 91,990 50,908 ---------- -------- Total liabilities 1,117,282 806,997 ---------- -------- Stockholders' equity Preferred stock, par value $.001, authorized, 3,000,000 shares at June 30, 2003 and 1,000,000 shares at June 30, 2002; Issued and outstanding, none - - Common stock, par value $.001, authorized, 9,000,000 shares; Issued: 3,653,165 shares in 2003 and 3,645,192 shares in 2002 (including Treasury shares of 706,273 in 2003 and 801,823 in 2002) 4 4 Additional paid-in capital 23,985 23,985 Accumulated other comprehensive income 14,540 11,479 Retained earnings 13,104 47,968 Treasury stock, at cost (8,964) (13,458) ---------- -------- 42,669 69,978 Note receivable (600) (600) ---------- -------- Total stockholders' equity 42,069 69,378 ---------- -------- Total liabilities and stockholders' equity $1,159,351 $876,375 ========== ========
See accompanying notes to financial statements. 147 American Business Financial Services, Inc. and Subsidiaries Consolidated Statements of Income
Year ended June 30, 2003 2002 2001 ---------------------------------------------- (dollar amounts in thousands except per share data) Revenues Gain on sale of loans: Securitizations $170,950 $185,580 $128,978 Whole loan sales 655 2,448 2,742 Interest and fees 19,395 18,890 19,840 Interest accretion on interest-only strips 47,347 35,386 26,069 Servicing income 3,049 5,483 5,700 Other income 10 114 7 -------- -------- -------- Total revenues 241,406 247,901 183,336 -------- -------- -------- Expenses Interest 68,098 68,683 56,547 Provision for credit losses 6,553 6,457 5,190 Employee related costs 41,601 36,313 28,897 Sales and marketing 27,773 25,958 24,947 General and administrative 101,219 74,887 54,570 Securitization assets valuation adjustment 45,182 22,053 - -------- -------- -------- Total expenses 290,426 234,351 170,151 -------- -------- -------- Income (loss) before provision for income taxes (49,020) 13,550 13,185 Provision for income tax expense (benefit) (19,118) 5,691 5,274 -------- -------- -------- Income (loss) before cumulative effect of a change in accounting principle (29,902) 7,859 7,911 Cumulative effect of a change in accounting principle - - 174 -------- -------- -------- Net income (loss) $(29,902) $ 7,859 $ 8,085 ======== ======== ======== Earnings (loss) per common share Income (loss) before cumulative effect of a change in accounting principle: Basic $ (10.25) $ 2.68 $ 2.08 Diluted $ (10.25) $ 2.49 $ 2.04 Net income (loss): Basic $ (10.25) $ 2.68 $ 2.13 Diluted $ (10.25) $ 2.49 $ 2.08 Average common shares (in thousands): Basic 2,918 2,934 3,797 Diluted 2,918 3,155 3,885
See accompanying notes to financial statements. 148 American Business Financial Services, Inc. and Subsidiaries Consolidated Statements of Stockholders' Equity
Common Stock -------------------- Accumulated Number of Additional Other Total Shares Paid-In Comprehensive Retained Treasury Note Stockholders' (amounts in thousands) Outstanding Amount Capital Income Earnings Stock Receivable Equity ----------- ------ ---------- ------------- -------- -------- ---------- ------------- Balance, June 30, 2000 4,022 $4 $24,291 $ 5,458 $36,850 $(3,888) $(600) $62,115 Comprehensive income: Net income - - - - 8,085 - - 8,085 Unrealized gains on interest-only strips - - - 4,879 - - - 4,879 ----- -- ------- ------- ------- ------- ----- ------- Total comprehensive income - - - 4,879 8,085 - - 12,964 Issuance of non-employee stock options - - (333) - - - - (333) Cash dividends ($0.26 per share) - - - - (1,013) - - (1,013) Repurchase of treasury shares (759) - - - - (6,897) - (6,897) Shares issued to directors 3 - 26 - - - - 26 ----- -- ------- ------- ------- ------- ----- ------- Balance, June 30, 2001 3,266 4 23,984 10,337 43,922 (10,785) (600) 66,862 Comprehensive income: Net income - - - - 7,859 - - 7,859 Unrealized gains on interest-only strips - - - 1,142 - - - 1,142 ------ -- ------- ------- ------- ------- ----- ------- Total comprehensive income - - - 1,142 7,859 - - 9,001 Stock dividend (10% of outstanding shares) - - - (2,979) 2,979 - - Cash dividends ($0.28 per share) - - - - (834) - - (834) Repurchase of treasury shares (423) - - - - (5,652) - (5,652) Exercise of stock options 1 - 1 - - - - 1 ------ -- ------- ------- ------- ------- ----- ------- Balance, June 30, 2002 2,844 4 23,985 11,479 47,968 (13,458) (600) 69,378 Comprehensive income (loss): Net loss - - - - (29,902) - - (29,902) Unrealized gains on interest-only strips - - - 3,061 - - - 3,061 ----- -- ------- ------- ------- ------- ----- ------- Total comprehensive income (loss) - - - 3,061 (29,902) - - (26,841) Exercise of non employee stock options 57 - - - (569) 619 - 50 Exercise of employee stock options 4 - - - (31) 51 - 20 Shares issued to employees 38 - - - (119) 492 - 373 Shares issued to directors 4 - - - (28) 51 - 23 Stock dividend (10% of outstanding shares) - - - - (3,281) 3,281 - - Cash dividends ($0.32 per share) - - - - (934) - - (934) ----- -- ------- ------- ------- ------- ----- ------- Balance, June 30, 2003 2,947 $4 $23,985 $14,540 $13,104 $(8,964) $(600) $42,069 ===== == ======= ======= ======= ======= ===== =======
See accompanying notes to financial statements. 149 American Business Financial Services, Inc. and Subsidiaries Consolidated Statements of Cash Flow
Year ended June 30, 2003 2002 2001 ----------------------------------------------------- (dollar amounts in thousands) Cash flows from operating activities Net income (loss) $ (29,902) $ 7,859 $ 8,085 Adjustments to reconcile net income (loss) to net cash used in operating activities: Gain on sales of loans - Securitizations (170,950) (185,580) (128,978) Depreciation and amortization 53,614 40,615 30,434 Interest accretion on interest-only strips (47,347) (35,386) (26,069) Interest-only strips fair value adjustment 45,182 22,053 - Provision for credit losses 6,553 6,457 5,190 Loans and leases originated for sale (1,732,346) (1,434,176) (1,256,090) Proceeds from sale of loans and leases 1,458,302 1,443,898 1,218,370 Principal payments on loans and leases 19,136 12,654 7,658 (Increase) decrease in accrued interest and fees on loan and lease receivables (2,887) 4,257 (3,547) Purchase of initial overcollateralization on securitized loans (10,641) - - Required purchase of additional overcollateralization on securitized loans (73,253) (47,271) (43,945) Cash flow from interest-only strips 160,417 100,692 82,905 Increase (decrease) in prepaid expenses 163 (183) (1,248) Increase in accrued interest payable 2,379 10,370 14,779 Increase (decrease) in accounts payable and accrued expenses 17,037 5,366 (5,252) Accrued interest payable reinvested in subordinated debt 38,325 31,706 16,026 (Decrease) increase in deferred income taxes (22,185) 4,595 4,930 Increase (decrease) in loans in process 5,321 736 (4,012) Other, net (2,293) (1,969) (8,841) ----------------------------------------------------- Net cash used in operating activities (285,375) (13,307) (89,605) ----------------------------------------------------- Cash flows from investing activities Purchase of property and equipment, net (12,450) (4,472) (9,210) Principal receipts and maturity of investments 36 28 751 ----------------------------------------------------- Net cash used in investing activities (12,414) (4,444) (8,459) -----------------------------------------------------
150 American Business Financial Services, Inc. and Subsidiaries Consolidated Statements of Cash Flow (Continued)
Year ended June 30, 2003 2002 2001 ----------------------------------------------------- (dollar amounts in thousands) Cash flows from financing activities Proceeds from issuance of subordinated debt $ 181,500 $ 224,062 $ 217,694 Redemptions of subordinated debt (156,005) (137,998) (86,446) Net borrowings (repayments) on revolving lines of credit 179,594 (34,077) 8,095 Principal payments on lease funding facility (2,129) (3,345) (3,866) Principal payments under capital lease obligations (213) - - Repayments of repurchase agreement - - (3,605) Net borrowings (repayments) of other notes payable 26,158 (5,156) (402) Financing costs incurred (841) (1,743) (4,155) Exercise of employee stock options 20 1 - Exercise of non-employee stock options 50 - - Lease incentive receipts 9,465 - - Cash dividends paid (934) (834) (1,013) Repurchase of treasury stock - (5,652) (6,897) ----------------------------------------------------- Net cash provided by financing activities 236,665 35,258 119,405 ----------------------------------------------------- Net (decrease) increase in cash and cash equivalents (61,124) 17,507 21,341 Cash and cash equivalents at beginning of year 108,599 91,092 69,751 ----------------------------------------------------- Cash and cash equivalents at end of year $ 47,475 $ 108,599 $ 91,092 ===================================================== Supplemental disclosures: Cash paid during the year for: Interest $ 27,394 $ 26,729 $ 25,620 Income taxes $ 787 $ 1,511 $ 662 Noncash transaction recorded for capitalized lease agreement: Increase in property and equipment $ (1,020) $ - $ - Increase in warehouse lines and other notes payable $ 1,020 $ - $ - See accompanying notes to financial statements.
151 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 1. Summary of Significant Accounting Policies Business American Business Financial Services, Inc. ("ABFS"), together with its subsidiaries (the "Company"), is a diversified financial services organization operating predominantly in the eastern and central portions of the United States. The Company originates, sells and services business purpose loans and home equity loans through its principal direct and indirect subsidiaries. The Company also processes and purchases home equity loans from other financial institutions through the Bank Alliance Services program. The Company's loans primarily consist of fixed interest rate loans secured by first or second mortgages on one-to-four family residences. The Company's customers are primarily credit-impaired borrowers who are generally unable to obtain financing from banks or savings and loan associations and who are attracted to our products and services. The Company originates loans through a combination of channels including a national processing center located at its centralized operating office in Philadelphia, Pennsylvania and a regional processing center in Roseland, New Jersey. The Company's centralized operating office was located in Bala Cynwyd, Pennsylvania prior to July 7, 2003. Prior to June 30, 2003 the Company also originated home equity loans through several retail branch offices. Effective June 30, 2003, the Company no longer originates home equity loans through retail branch offices. In addition, the Company offers subordinated debt securities to the public, the proceeds of which are used for repayment of existing debt, loan originations, operations (including repurchases of delinquent assets from securitization trusts), investments in systems and technology and for general corporate purposes. Effective December 31, 1999, the Company de-emphasized and subsequent to that date, discontinued the equipment leasing origination business but continues to service the remaining portfolio of leases. Business Conditions For its ongoing operations, the Company depends upon frequent financings, including the sale of unsecured subordinated debt securities, borrowings under warehouse credit facilities or lines of credit and the sale of loans through publicly underwritten securitizations. If the Company is unable to renew or obtain adequate funding on acceptable terms through its sale of subordinated debt securities or under a warehouse credit facility, or other borrowings, the lack of adequate funds would adversely impact liquidity and reduce profitability or result in losses. If the Company is unable to securitize or otherwise sell its loans, its liquidity would be reduced and it may incur losses. To the extent that the Company is not successful in maintaining or replacing existing subordinated debt securities upon maturity, or 152 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 1. Summary of Significant Accounting Policies (continued) Business Conditions (continued) maintaining adequate warehouse credit facilities or lines of credit, or securitizing and selling its loans, it may have to limit future loan originations and further restructure its operations. Limiting loan originations or restructuring operations could impair the Company's ability to repay subordinated debt at maturity and may result in losses. The Company has historically experienced negative cash flow from operations since 1996 primarily because in general, its business strategy of selling loans through securitization has not generated cash flow immediately. For the fiscal year ended June 30, 2003, the Company experienced negative cash flow from operations of $285.4 million. In fiscal 2003, the Company recorded a net loss of $29.9 million. The loss was primarily due to the Company's inability to complete its typical quarterly securitization of loans during the fourth quarter of the fiscal year ended June 30, 2003 and to $45.2 million of pre-tax charges for valuation adjustments (compared to $22.1 million of valuation adjustments in the fiscal year ended June 30, 2002) recorded on the Company's securitization assets during the fiscal year ended June 30, 2003. The valuation adjustments reflect the impact of higher than anticipated prepayments on securitized loans experienced in fiscal 2003 due to the low interest rate environment experienced during most of 2003, which has impacted the entire mortgage industry. The valuation adjustment recorded on securitization assets in fiscal 2003 was reduced by a $17.9 million favorable valuation impact to the income statement as a result of reducing the discount rates applied in valuing the securitization assets at June 30, 2003. The discount rates were reduced at June 30, 2003 primarily to reflect the impact of the sustained decline in market interest rates. The discount rate on the projected residual cash flows from the Company's interest-only strips was reduced from 13% to 11% at June 30, 2003. The discount rate used to determine the fair value of the overcollateralization portion of the cash flows from interest-only strips was minimally impacted by the decline in interest rates and remained at 7% on average. As a result, the blended rate used to value interest-only strips, including the overcollateralization cash flows, was 9% at June 30, 2003. See Note 4 for more details on the valuation adjustments. The Company's inability to complete its typical publicly underwritten securitization during the fourth quarter of fiscal 2003 also adversely impacted the Company's short-term liquidity position. In addition, further advances under a non-committed portion of one of the Company's credit facilities were subject to the discretion of the lender and from June 30, 2003 to August 20, 2003, there were no new advances under the non-committed portion. On August 20, 2003, this credit facility was amended to reduce the committed portion to $50.0 million (from $100.0 million), eliminate the non-committed portion and accelerate its expiration date from November 2003 to no later than September 30, 2003. The Company also had a $300.0 million mortgage conduit facility with a financial institution that enabled the Company to sell its loans into an off-balance sheet facility, which expired pursuant to its terms on July 5, 2003. At June 30, 2003, of the $516.1 million in revolving credit and conduit facilities available to the Company, $453.4 million was drawn upon. The Company's revolving credit facilities and mortgage conduit facility had $62.7 million of unused capacity available at June 30, 2003, which significantly reduced its ability to fund future loan originations until it sells existing loans, extends or expands existing credit facilities or adds new credit facilities. The Company can provide no assurances that it will be able to sell all of its loans, extend or expand existing facilities or add new credit facilities. The Company undertook specific remedial actions to address short-term liquidity concerns including entering into an agreement on June 30, 2003 with an investment bank 153 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 1. Summary of Significant Accounting Policies (continued) Business Conditions (continued) to sell up to $700.0 million of mortgage loans, subject to the satisfactory completion of the purchaser's due diligence review and other conditions, and soliciting bids and commitments from other participants in the whole loan sale market. In total, through August 29, 2003, the Company sold approximately $453.2 million of loans in whole loan sales. The process of selling loans is continuing. The Company also suspended paying quarterly dividends on its common stock. On September 22, 2003, the Company entered into definitive agreements with a financial institution for a new $200.0 million credit facility for the purpose of funding our loan originations. Pursuant to the terms of this facility, the Company is required to, among other things: (i) obtain a written commitment for another credit facility of at least $200.0 million and close that additional facility by October 3, 2003 (which condition would be satisfied by the closing of the $225.0 million facility described below), (ii) have a net worth of at least $28.0 million by September 30, 2003, with quarterly increases of $2.0 million thereafter; (iii) apply 60% of net cash flow from operations each quarter to reduce the outstanding amount of subordinated debt commencing with the quarter ending March 31, 2004; and (iv) provide a parent company guaranty of 10% of the outstanding principal amount of loans under the facility. Prior to the closing of the second facility, borrowing capacity on this $200.0 million credit facility is limited to $80.0 million. This facility has a term of 12 months expiring in September 2004 and is secured by the mortgage loans, which are funded by advances under the facility with interest equal to LIBOR plus a margin. This facility is subject to representations and warranties and covenants, which are customary for a facility of this type, as well as amortization events and events of default related to the Company's financial condition. These provisions require, among other things, maintenance of a delinquency ratio for the managed portfolio (which represents the portfolio of securitized loans and leases serviced for others) at the end of each fiscal quarter of less than 12.0%, the Company's subordinated debt not to exceed $705.0 million at any time, its ownership of an amount of repurchased loans not to exceed 1.5% of the managed portfolio and its registration statement registering $295.0 million of subordinated debt be declared effective by the SEC no later than October 31, 2003. On September 22, 2003, the Company executed a commitment letter for a mortgage warehouse credit facility with a warehouse lender, which consists of a senior secured revolving credit facility of up to $225.0 million to fund loan originations and a secured last out revolver facility up to $25.0 million. The commitment letter is subject to certain conditions, including, among other things: (i) entering into definitive agreements, except as provided in the commitment letter; (ii) the absence of a material adverse change in the Company's business, operations, property, condition (financial or otherwise) or prospects of it or its affiliates; and (iii) the receipt of another credit facility in an amount not less than $200.0 million, subject to terms and conditions acceptable to this lender (which condition is satisfied by the new $200.0 million facility described above). The commitment letter provides that these facilities will have a term of three years with an interest rate on amounts outstanding under the $225.0 million portion of the credit facility equal to the greater of one-month LIBOR plus a margin or the difference between the yield maintenance fee (as defined in the commitment letter) and the one month LIBOR plus a margin. Advances under this facility would be collateralized by substantially all of the Company's present and future assets including pledged loans and a security interest in substantially all of its interest-only strips and residual interests which will be contributed to a special purpose entity organized by the Company to facilitate this transaction. The Company also agreed to pay fees of approximately $14.6 million annually plus a nonusage fee based on the difference between the average daily outstanding balance for the current month and the maximum credit amount under the facility and the lender's out-of-pocket expenses. 154 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 1. Summary of Significant Accounting Policies (continued) Business Conditions (continued) The Company anticipates that these facilities will be subject to representations and warranties, events of default and covenants which are customary for facilities of this type, as well as its agreement to: (i) maintain sales or renewals of our subordinated debt securities of $10.0 million per month; (ii) restrict total principal and interest outstanding on its subordinated debt to $750.0 million or less; (iii) make quarterly reductions commencing in April 2004 of an amount of subordinated debt outstanding to be determined; (iv) maintain maximum interest rates payable on subordinated debt securities not to exceed 10 percentage points above comparable rates for FDIC insured products; and (v) the lender's receipt of the Company's audited financial statements for the period ended June 30, 2003. The definitive agreements will grant the lender an option at any time after the first anniversary of entering into the definitive agreements to increase the credit amount on the $250.0 million facility to $400.0 million with additional fees payable by the Company plus additional interest as may be required by the institutions or investors providing the lender with these additional funds. The commitment letter requires that the Company enter into definitive agreements not later than October 17, 2003. While the Company anticipates that it will close this transaction prior to such date, it cannot provide assurance that these negotiations will result in definitive agreements or that such agreements, as negotiated, will be on terms and conditions acceptable to the Company. In the event the Company is unable to close these facilities or another facility within the time frame provided under the new $200.0 million credit facility described above, the lender on that facility would be under no obligation to make further advances under the terms of that facility and outstanding advances would have to be repaid over a period of time. After the Company recognized its inability to securitize its loans in the fourth quarter of fiscal 2003, it adjusted its business strategy to emphasize, among other things, more whole loan sales. The Company intends to continue to evaluate both public and privately placed securitization transactions, subject to market conditions. At June 30, 2003 there were approximately $322.0 million of subordinated debentures maturing through June 30, 2004. The Company obtains the funds to repay the subordinated debentures at their maturities by securitizing loans, selling whole loans and selling additional subordinated debentures. Cash flow from operations, the issuance of subordinated debentures and lines of credit fund the Company's cash needs. The Company expects these sources of funds to be sufficient to meet its cash needs. The Company could, in the future, generate cash flows by securitizing, selling, or borrowing against its interest-only strips and selling servicing rights generated in past securitizations. In the event the Company was for any reason prohibited from offering additional subordinated debentures, the Company has developed a contingent financial restructuring plan including cash flow projections for the next twelve-month period. Based on the Company's current cash flow projections, the Company anticipates being able to make all scheduled subordinated debenture maturities and vendor payments. The contingent financial restructuring plan is based on actions that the Company would take, in addition to those indicated in its adjusted business strategy, to 155 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 1. Summary of Significant Accounting Policies (continued) Business Conditions (continued) reduce its operating expenses and conserve cash. These actions would include reducing capital expenditures, selling all loans originated on a whole loan basis, eliminating or downsizing various lending, overhead and support groups, and scaling back less profitable businesses. Basis of Financial Statement Presentation The consolidated financial statements include the accounts of ABFS and its subsidiaries (all of which are wholly owned). The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. All significant intercompany balances and transactions have been eliminated. In preparing the consolidated financial statements, management is required to make estimates and assumptions which affect the reported amounts of assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. These estimates include, among other things, estimated prepayment, credit loss and discount rates on interest-only strips and servicing rights, estimated servicing revenues and costs, valuation of real estate owned, the net recoverable value of interest and fee receivables and determination of the allowance for credit losses. Certain prior period financial statement balances have been reclassified to conform to current period presentation. All outstanding shares, average common shares, earnings per common share and stock option amounts have been retroactively adjusted to reflect the effect of a 10% stock dividend declared August 21, 2002 and amounts reported for June 30, 2001 and 2000 have been retroactively adjusted to reflect the effect of a 10% stock dividend declared October 1, 2001. See Note 10 for further description. Cash and Cash Equivalents Cash equivalents consist of short-term investments with an initial maturity of three months or less. The Company held restricted cash balances of $11.0 million and $9.0 million related to borrower escrow accounts at June 30, 2003 and June 30, 2002, respectively, and $6.0 million at June 30, 2003 related to deposits for future settlement of interest rate swap contracts. There was no restricted cash related to interest rate swap contracts at June 30, 2002. 156 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 1. Summary of Significant Accounting Policies (continued) Loan and Lease Receivables Loan and lease receivables - Available for sale are loans and leases the Company plans to sell or securitize and are carried at the lower of aggregate cost (principal balance, including unamortized origination costs and fees) or fair value. Fair value is determined by quality of credit risk, types of loans originated, current interest rates, economic conditions, and other relevant factors. Loan and lease receivables - Interest and fees are comprised mainly of accrued interest and fees on loans and leases that are less than 90 days delinquent. Fee receivables include, among other types of fees, forbearance and deferment advances. Under deferment and forbearance arrangements, the Company makes advances to a securitization trust on behalf of a borrower in amounts equal to the delinquent loan payments and may pay taxes, insurance and other fees on behalf of the borrower. As a result of these arrangements the Company resets the contractual status of a loan in its managed portfolio from delinquent to current based upon the borrower's resumption of making their loan payments. These amounts are carried at their estimated net recoverable value. Loan and lease receivables - Other is comprised of receivables for securitized loans. In accordance with the Company's securitization agreements, the Company has the right, but not the obligation, to repurchase a limited amount of delinquent loans from securitization trusts. In accordance with the provisions of SFAS No. 140, the Company has recorded an obligation for the repurchase of loans subject to these removal of accounts provisions, whether or not the Company plans to repurchase the loans. The obligation for the loans' purchase price is recorded in Other liabilities. A corresponding receivable is recorded at the lower of the loans' cost basis or fair value. Allowance for Credit Losses The Company's allowance for credit losses on available for sale loans and leases is maintained to account for loans and leases that are delinquent and are expected to be ineligible for sale into a securitization, delinquent loans that have been repurchased from securitization trusts and to account for estimates for credit losses on loans and leases that are current. The allowance is calculated based upon management's estimate of its ability to collect on outstanding loans and leases based upon a variety of factors, including, but not limited to, periodic analysis of the available for sale loans and leases, economic conditions and trends, historical credit loss experience, borrowers' ability to repay and collateral considerations. Additions to the allowance arise from the provision for credit losses charged to operations or from the recovery of amounts previously charged-off. Loan and lease charge-offs reduce the allowance. Delinquent loans are charged off when deemed fully uncollectable or when liquidated in a payoff. 157 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 1. Summary of Significant Accounting Policies (continued) Loan and Lease Origination Costs and Fees Direct loan and lease origination costs and loan fees such as points and other closing fees are recorded as an adjustment to the cost basis of the related loan and lease receivable. This asset is recognized in the Consolidated Statement of Income, in the case of loans, as an adjustment to the gain on sale recorded at the time the loans are securitized, or in the case of leases, as amortization expense over the term of the leases. Interest-Only Strips The Company sells a majority of its originated loans through securitizations. In connection with these securitizations, the Company receives cash and an interest-only strip, which represents the Company's retained interest in the securitized loans. As a holder of the interest-only strips, the Company is entitled to receive certain excess (or residual) cash flows and overcollateralization cash flows, which are derived from payments made to a trust from the securitized loans after deducting payments to investors in the securitization trust and other miscellaneous fees. These retained interests are carried at their fair value. Fair value is based on a discounted cash flow analysis which estimates the present value of the future expected residual cash flows and overcollateralization cash flows utilizing assumptions made by management at the time the loans are sold. These assumptions include the rates used to calculate the present value of expected future residual cash flows and overcollateralization cash flows, referred to as the discount rates, and expected prepayment and credit loss rates on the pools of loans sold through securitizations. Cash flows are discounted from the date the cash is expected to be available to the Company (the "cash-out method"). Estimates of prepayment and credit loss rates are made based on management's expectation of future experience, which is based in part on historical experience, current and expected economic conditions and in the case of prepayment rate assumptions, consideration of the impact of changes in market interest rates. Excess cash flows are retained by the trust until certain overcollateralization levels are established. The overcollateralization is the excess of the aggregate principal balances of loans in a securitized pool over investor interests. The overcollateralization serves as credit enhancement for the investors. The expected future cash flows from interest-only strips are periodically re-evaluated. The current assumptions for prepayment and credit loss rates are monitored against actual experience and other economic conditions and are changed if deemed necessary. The securitization trusts and their investors have no recourse to other assets of the Company for failure of the securitized loans to pay when due. 158 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 1. Summary of Significant Accounting Policies (continued) Servicing Rights When loans are sold through a securitization, the servicing of the loans is retained and the Company capitalizes the benefit associated with the rights to service securitized loans. Servicing rights represent the rights to receive contractual servicing fees from securitization trusts and ancillary fees from borrowers net of adequate compensation that would be required by a substitute servicer. Servicing rights are carried at the lower of cost or fair value. Fair value represents the present value of projected net cash flows from servicing. The projected cash flows from servicing fees incorporate assumptions made by management, including prepayment rates, credit loss rates and discount rates. These assumptions are similar to those used to value the interest-only strips retained in a securitization. Amortization of the servicing rights asset for securitized loans is calculated individually for each securitized loan pool and is recognized in proportion to servicing income on that particular pool of loans. The expected future cash flows from servicing rights are periodically re-evaluated. The current assumptions for prepayment and credit loss rates are monitored against actual experience and other economic conditions and are changed if deemed necessary. If the Company's analysis indicates the carrying value of servicing rights are not recoverable through future cash flows from contractual servicing and other ancillary fees, a valuation allowance would be required. Receivable for Sold Loans Receivable for sold loans represents a receivable held by the Company for loans sold on a whole loan basis which have closed but not yet settled in cash. 159 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 1. Summary of Significant Accounting Policies (continued) Prepaid Assets Prepaid assets are comprised mainly of amounts paid for insurance coverage and printed marketing materials and customer lists, which have not yet been utilized. Costs for printed materials and customer lists are expensed as they are utilized. Other marketing and advertising costs are expensed as incurred. Property and Equipment Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization is computed using the straight-line method over the estimated useful life of the assets ranging from 3 to 15 years. Financing Costs and Amortization Financing costs incurred in connection with public offerings of subordinated debt securities are recorded in other assets and are amortized over the term of the related debt. Investments Held to Maturity Investments classified as held to maturity recorded in other assets consist of asset-backed securities that the Company has the positive intent and ability to hold to maturity. These investments are stated at amortized cost. Real Estate Owned Property acquired by foreclosure or in settlement of loan receivables is recorded in other assets, and is carried at the lower of the cost basis in the loan or fair value of the property less estimated costs to sell. Goodwill Goodwill is recorded in other assets and represents the excess of cost over the fair value of the net assets acquired from the Company's 1997 acquisition of New Jersey Mortgage and Investment Corp. (now American Business Mortgage Services, Inc.). The Company adopted SFAS No. 142 "Goodwill and Other Intangible Assets" in July 2001. In accordance with SFAS No. 142, the amortization of goodwill was discontinued. The Company performs periodic reviews for events or changes in circumstances that may indicate that the carrying amount of goodwill might exceed the fair value, which would require an adjustment to the goodwill balance for the amount of impairment. At June 30, 160 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 1. Summary of Significant Accounting Policies (continued) Goodwill (continued) 2003, no goodwill impairment existed. For segment reporting purposes, the goodwill balance is allocated to the loan origination segment. See Note 20 for segment reporting. Revenue Recognition The Company derives its revenue principally from gains on sales of loans, interest accretion on interest-only strips, interest and fee income on loans and leases, and servicing income. Gains on sales of loans through securitizations represent the difference between the net proceeds to the Company, including retained interests in the securitization and the allocated cost of loans or leases securitized. The allocated cost of loans securitized is determined by allocating their net carrying value between the loans, the interest-only strips and the servicing rights retained by the Company based upon their relative fair values. Gains on loans sold with servicing released, referred to as whole loan sales, are the difference between the net proceeds from the sale and the loans' net carrying value. The net carrying value of loans is equal to their principal balance plus unamortized origination costs and fees. Interest accretion income represents the yield component of cash flows received on interest-only strips. The Company uses a prospective approach to estimate interest accretion. As previously discussed, the Company updates estimates of residual cash flow from the securitizations. Under the prospective approach, when it is probable that there is a favorable or unfavorable change in estimated residual cash flow from the cash flow previously projected, the Company recognizes a larger or smaller percentage of the cash flow as interest accretion. Any change in value of the underlying interest-only strip could impact the current estimate of residual cash flow earned from the securitizations. For example, a significant change in market interest rates could increase or decrease the level of prepayments, thereby changing the size of the total managed loan portfolio and related projected cash flows. Interest and fee income consists of interest earned on loans and leases while held in the Company's managed portfolio, and other ancillary fees collected in connection with loan origination. Interest income is recognized based on the simple interest or scheduled interest method depending on the original structure of the loan. Accrual of interest income is suspended when the receivable is contractually delinquent for 90 days or more. The accrual is resumed when the receivable becomes contractually current, and past-due interest income is recognized at that time. In addition, a detailed review will cause earlier suspension if collection is doubtful. Servicing income is recognized as contractual fees and other fees for servicing loans and leases are incurred, net of amortization of servicing rights assets. 161 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 1. Summary of Significant Accounting Policies (continued) Derivative Financial Instruments A primary market risk exposure that the Company faces is interest rate risk. Interest rate risk occurs due to potential changes in interest rates between the date fixed rate loans are originated and the date a securitization is priced or the date the terms and pricing for a whole loan sale is fixed. From time to time, derivative financial instruments are utilized in an attempt to mitigate the effect of changes in interest rates between the date loans are originated at fixed interest rates and the date the fixed interest rate pass-through certificates to be issued by a securitization trust are priced or the date the terms and pricing for a whole loan sale are fixed. Generally, the period between loan origination and pricing of the pass-through interest rate or whole loan sale is less than three months. The types of derivative financial instruments used to hedge the effects of changes in fair value due to interest rate changes may include interest rate swaps, futures and forward contracts. The nature and quantity of hedging transactions are determined based on various factors, including market conditions and the expected volume of mortgage loan originations and purchases. At the time the derivative contracts are executed, they are specifically designated as hedges of mortgage loans or the Company's residual interests in mortgage loans in its mortgage conduit facility, which the Company would expect to be included in a term securitization or sold in whole loan sale transactions at a future date. The mortgage loans and mortgage loans underlying the residual interests in mortgage pools consist of essentially similar pools of fixed interest rate loans, collateralized by real estate (primarily residential real estate) with similar maturities and similar credit characteristics. Fixed interest rate pass-through certificates issued by securitization trusts are generally priced to yield an interest rate spread above interest rate swap yield curves with maturities to match the maturities of the interest rate pass-through certificates. The Company may hedge potential interest rate changes in interest rate swap yield curves with forward starting interest rate swaps, Eurodollar futures, forward treasury sales or derivative contracts of similar underlying securities. This practice has provided strong correlation between the Company's hedge contracts and the ultimate pricing the Company will receive on the subsequent securitization. The unrealized gain or loss derived from these derivative financial instruments, which are designated as fair value hedges, is reported in earnings as it occurs with an offsetting adjustment to the fair value of the item hedged. The fair value of derivative financial instruments is based on quoted market prices. The fair value of the items hedged is based on current pricing of these assets in a securitization or whole loan sale. Cash flow related to hedging activities is reported as it occurs. The effectiveness of the Company's hedges is continuously monitored. If correlation did not exist, the related gain or loss on the 162 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 1. Summary of Significant Accounting Policies (continued) Derivative Financial Instruments (continued) hedged item would no longer be recognized as an adjustment to income. Generally, the Company does not enter into derivative financial instrument contracts for trading purposes. However, the Company has entered into derivative financial instrument contracts which are not designated as accounting hedges and are therefore accounted for as trading assets or liabilities. These contracts have been used to protect the future securitization spreads on loans in the Company's pipeline and to reduce the exposure to changes in the fair value of certain interest-only strips due to changes in one-month LIBOR. Loans in the pipeline represent loan applications for which the Company is in the process of obtaining all the documentation required for a loan approval or approved loans, which have not been accepted by the borrower and are not considered to be firm commitments. The structure of certain securitization trusts includes a floating interest rate tranche based on one-month LIBOR plus an interest rate spread. Floating interest rate tranches in a securitization expose the Company to gains or losses due to changes in the fair value of the interest-only strip from changes in the floating interest rate paid to the certificate holders. In order to manage this exposure, the Company has entered into an interest rate swap agreement to lock in a fixed interest rate on the Company's third quarter fiscal 2002 securitization's variable rate tranche. The swap agreement requires a net cash settlement on a monthly basis of the difference between the fixed interest rate on the swap and the LIBOR paid on the certificates. The fair value of this swap agreement is based on estimated market values for the sale of the contract provided by a third party. The fair value of the contract is recorded in other assets or other liabilities as appropriate. Net changes in the fair value during a period are included in administrative expenses in the Statement of Income. The interest-only strips are held as available for sale securities and therefore changes in the fair value of the interest-only strips are recorded as a component of equity unless the fair value of the interest-only strip falls below its cost basis, which would require a write down through current period income. The interest rate sensitivity for $63.0 million of floating interest rate certificates issued from the 2003-1 securitization trust is managed by an interest rate cap which was entered into by the trust at the inception of the securitization. This interest rate cap limits the one-month LIBOR to a maximum rate of 4.0% and was structured to automatically unwind as the floating interest rate certificates pay down. See Note 18 for further discussion of the Company's use of derivative financial instruments. 163 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 1. Summary of Significant Accounting Policies (continued) Income Taxes The Company and its subsidiaries file a consolidated federal income tax return. Under the asset and liability method used by the Company to provide for income taxes, deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial statement and tax basis carrying amounts of existing assets and liabilities. Stock Options The Company has stock option plans that provide for the periodic granting of options to key employees and non-employee directors. The Company accounts for stock options issued under these plans using the intrinsic value method of APB Opinion No. 25 "Accounting for Stock Issued to Employees", and accordingly, no expense is recognized where the exercise price equals or exceeds the fair value of the common stock at the date of grant. Had the Company accounted for stock options granted under these plans using the fair value method of SFAS No. 123 and SFAS No. 148, pro forma net income and earnings per share would have been as follows (in thousands, except per share amounts):
Year Ended June 30, 2003 2002 2001 ---------------------------------------------------- Net income (loss), as reported $ (29,902) $ 7,859 $ 8,085 Stock based compensation costs, net of tax effects included in reported net income - - (174) Stock based compensation costs, net of tax effects determined under fair value method for all awards (130) (170) 83 ---------------------------------------------------- Pro forma $ (30,032) $ 7,689 $ 7,994 ==================================================== Earnings (loss) per share - basic As reported $ (10.25) $ 2.68 $ 2.13 Pro forma (10.29) 2.62 2.15 Earnings (loss) per share - diluted As reported $ (10.25) $ 2.49 $ 2.08 Pro forma (10.29) 2.44 2.10
Recent Accounting Pronouncements In November 2002, the Financial Accounting Standards Board ("FASB") issued Financial Interpretation No. ("FIN") 45 "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." FIN 45 standardizes practices related to the recognition of a liability for the fair value of a 164 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 1. Summary of Significant Accounting Policies (continued) Recent Accounting Pronouncements (continued) guarantor's obligation. The rule requires companies to record a liability for the fair value of its guarantee to provide or stand ready to provide services, cash or other assets. The rule applies to contracts that require a guarantor to make payments based on an underlying factor such as change in market value of an asset, collection of the scheduled contractual cash flows from individual financial assets held by a special purpose entity ("SPE"), non-performance of a third party, for indemnification agreements, or for guarantees of the indebtedness of others among other things. The provisions of FIN 45 are effective on a prospective basis for guarantees that are issued or modified after December 31, 2002. The disclosure requirements were effective for statements of annual or interim periods ending after December 15, 2002. Based on the requirements of this guidance for the year ended June 30, 2003, the Company has recorded a $0.7 million liability in conjunction with the sale of mortgage loans to the ABFS 2003-1 securitization trust which occurred in March 2003. This liability represents the fair value of periodic interest advances that the Company, as servicer of the securitized loans, is obligated to pay on behalf of delinquent loans in the trust. The recording of this liability reduces the gain on sale recorded for the securitization. The Company would expect to record a similar liability for any subsequent securitization as it occurs. The amount of the liability that will be recorded is dependent mainly on the volume of loans the Company securitizes, the expected performance of those loans and the interest rates of the loans. In the year ended June 30, 2003, the adoption of FIN 45 reduced net income by approximately $0.4 million and diluted earnings per share by $0.14. See Note 14 for further detail of this obligation. In December 2002, the FASB issued Statement of Financial Accounting Standard ("SFAS") No. 148 "Accounting for Stock-Based Compensation - Transition and Disclosure." SFAS No. 148 amends SFAS No. 123 "Accounting for Stock-Based Compensation." SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based compensation and requires pro forma disclosures of the effect on net income and earnings per share had the fair value method been included in annual and interim reports and disclosure of the effect of the transition method used if the accounting method was changed. SFAS No. 148 is effective for annual reports of fiscal years beginning after December 15, 2002 and interim reports for periods beginning after December 15, 2002. The Company plans to continue using the intrinsic value method of accounting for stock-based compensation and therefore the new rule will have no effect on the Company's financial condition or results of operations. The Company has adopted the new standard related to disclosure in the interim period beginning January 1, 2003. See Note 12 for further detail. 165 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 1. Summary of Significant Accounting Policies (continued) Recent Accounting Pronouncements (continued) In April 2003, the FASB began reconsidering the current alternatives available for accounting for stock-based compensation. Currently, the FASB is continuing its deliberations on this matter. The Company cannot predict whether the guidance will change the Company's current accounting for stock-based compensation, or what effect, if any, changes may have on the Company's current financial condition or results of operations. In January 2003, the FASB issued FIN 46 "Consolidation of Variable Interest Entities." FIN 46 provides guidance on the identification of variable interest entities that are subject to consolidation requirements by a business enterprise. A variable interest entity subject to consolidation requirements is an entity that does not have sufficient equity at risk to finance its operations without additional support from third parties and the equity investors in the entity lack certain characteristics of a controlling financial interest as defined in the guidance. SPEs are one type of entity, which under certain circumstances may qualify as a variable interest entity. Although the Company uses unconsolidated SPEs extensively in its loan securitization activities, the guidance will not affect the Company's current consolidation policies for SPEs as the guidance does not change the guidance incorporated in SFAS No. 140 "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities" which precludes consolidation of a qualifying SPE by a transferor of assets to that SPE. FIN 46 will therefore have no effect on the Company's financial condition or results of operations and would not be expected to affect it in the future. In March 2003, the FASB announced that it is reconsidering the permitted activities of a qualifying SPE. The Company cannot predict whether the guidance will change or what effect, if any, changes may have on the Company's current consolidation policies for SPEs. In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" to clarify the financial accounting and reporting for derivative instruments and hedging activities. SFAS No. 149 is intended to improve financial reporting by requiring comparable accounting methods for similar contracts. SFAS No. 149 is effective for contracts entered into or modified subsequent to June 30, 2003. The requirements of SFAS No. 149 do not affect the Company's current accounting for derivative instruments or hedging activities and therefore will have no effect on the Company's financial condition or results of operations. 166 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 1. Summary of Significant Accounting Policies (continued) Recent Accounting Pronouncements (continued) In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 requires an issuer to classify certain financial instruments, such as mandatorily redeemable shares and obligations to repurchase the issuer's equity shares, as liabilities. The guidance is effective for financial instruments entered into or modified subsequent to May 31, 2003, and otherwise is effective at the beginning of the first interim period after June 15, 2003. The Company does not have any instruments with such characteristics and does not expect SFAS No. 150 to have a material impact on the financial condition or results of operations. 2. Loan and Lease Receivables Loan and lease receivables - Available for sale were comprised of the following (in thousands): June 30, 2003 2002 -------- -------- Real estate secured loans (a) $270,096 $ 53,171 Leases, net of unearned income of $550 and $668 (b) 4,154 8,211 -------- -------- 274,250 61,382 Less: allowance for credit losses on loan and lease receivables available for sale 2,848 3,705 -------- -------- $271,402 $ 57,677 ======== ======== (a) Includes deferred direct loan origination costs of $6.8 million and $1.4 million at June 30, 2003 and June 30, 2002, respectively. (b) Includes deferred direct lease origination costs of $28 thousand and $0.4 million at June 30, 2003 and June 30, 2002, respectively. Real estate secured loans have contractual maturities of up to 30 years. At June 30, 2003 and June 30, 2002, the accrual of interest income was suspended on real estate secured loans of $5.4 million and $7.0 million, respectively. The allowance for loan losses includes reserves established for expected losses on these loans in the amount of $1.4 million and $2.9 million at June 30, 2003 and June 30, 2002, respectively. Average balances of non-accrual loans during the years ended June 30, 2003 and 2002 were $8.6 million and $6.7 million, respectively. Substantially all leases are direct finance-type leases whereby the lessee has the right to purchase the leased equipment at the lease expiration for a nominal amount. 167 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 2. Loan and Lease Receivables (continued) Loan and lease receivables - Interest and fees are comprised mainly of accrued interest and fees on loans and leases that are less than 90 days delinquent. Fee receivables include, among other types of fees, forbearance and deferment advances. Under deferment and forbearance arrangements, the Company makes advances to a securitization trust on behalf of a borrower in amounts equal to the delinquent principal and interest and may pay taxes, insurance and other fee on behalf of the borrower. As a result of these arrangements the Company resets the contractual status of a loan in its managed portfolio from delinquent to current based upon the borrower's resumption of making their loan payments. These amounts are carried at their estimated net recoverable value. Loan and lease receivables - Other is comprised of receivables for securitized loans. In accordance with the Company's securitization agreements, the Company has the right, but not the obligation, to repurchase a limited amount of delinquent loans from securitization trusts. Repurchasing delinquent loans from securitization trusts benefits the Company by allowing it to limit the level of delinquencies and losses in the securitization trusts and as a result, the Company can avoid exceeding specified limits on delinquencies and losses that trigger a temporary reduction or discontinuation of cash flow from its interest-only strips until the delinquency or loss triggers are no longer exceeded. See Note 3 for more detail on loan repurchases. The Company's ability to repurchase these loans does not disqualify it for sale accounting under SFAS No. 140, which was adopted on a prospective basis in the fourth quarter of fiscal 2001, or other relevant accounting literature because the Company is not required to repurchase any loan and its ability to repurchase a loan is limited by contract. In accordance with the provisions of SFAS No. 140, the Company has recorded an obligation for the repurchase of loans subject to these removal of accounts provisions, whether or not the Company plans to repurchase the loans. The obligation for the loans' purchase price is recorded in other liabilities. A corresponding receivable is recorded at the lower of the loans' cost basis or fair value. 168 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 3. Allowance for Credit Losses The activity for the allowance of credit losses is summarized as follows (in thousands): Year ended June 30, 2003 2002 2001 -------------------------------- Balance at beginning of year $ 3,705 $ 2,480 $ 1,289 Provision for credit losses: Business purpose loans 1,189 1,721 1,503 Home equity loans 5,000 3,417 2,600 Equipment leases 364 1,319 1,087 -------------------------------- Total provision 6,553 6,457 5,190 -------------------------------- Charge-offs, net of recoveries: Business purpose loans (1,984) (924) (1,374) Home equity loans (4,913) (2,892) (1,634) Equipment leases (513) (1,416) (991) -------------------------------- Total charge-offs, net (7,410) (5,232) (3,999) -------------------------------- Balance at end of year $ 2,848 $ 3,705 $ 2,480 ================================ Ratio of losses in the portfolio during the period to the average managed portfolio (a) 0.90% 0.60 % 0.53 % Ratio of allowance to loans and leases 1.04% 6.04 % 2.49 % available for sale (a) The average managed portfolio includes loans and leases held as available for sale and securitized loans and leases serviced for others. See Note 6 for detail of the total managed portfolio. Recoveries of loans and leases previously charged-off were $402 thousand, $302 thousand and $434 thousand during the years ended June 30, 2003, 2002 and 2001, respectively. While the Company is under no obligation to do so, at times it elects to repurchase delinquent loans from the securitization trusts, some of which may be in foreclosure. The Company elects to repurchase loans in situations requiring more flexibility for the administration and collection of these loans in order to maximize their economic recovery and to avoid temporary discontinuations of residual or stepdown overcollateralization cash flow from securitization trusts. The purchase price of a delinquent loan is at the loan's outstanding contractual balance. A foreclosed loan is one where the Company, as servicer, has initiated formal foreclosure proceedings against the borrower and a delinquent loan is one that is 31 days or more past due. 169 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 3. Allowance for Credit Losses (continued) The foreclosed and delinquent loans the Company typically elects to repurchase are usually 90 days or more delinquent and the subject of completed foreclosure proceedings or where a completed foreclosure is imminent. The related charge-offs on these repurchased loans are included in the provision for credit losses in the period of charge-off. The following table summarizes the principal balances of loans and real estate owned (REO) repurchased from securitization trusts (dollars in thousands): Year ended June 30, 2003 2002 2001 ------------------------------- Business purpose loans $16,252 $ 6,669 $ 4,501 Home equity loans 38,775 23,571 10,549 ------------------------------- Total $55,027 $30,240 $15,050 =============================== Number of loans repurchased 637 341 154 =============================== The Company received $37.6 million, $19.2 million and $10.9 million of proceeds from the liquidation of repurchased loans and REO for the years ended June 30, 2003, 2002 and 2001, respectively. The Company had repurchased loans remaining on the balance sheet in the amounts of $5.1 million, $7.3 million and $2.8 million at June 30, 2003, 2002 and 2001, respectively and REO of $4.5 million, $2.1 million and $2.0 million at June 30, 2003, 2002 and 2001, respectively. 170 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 4. Securitizations The following schedule details loan and lease securitizations (dollars in millions):
Year ended June 30, 2003 2002 2001 ------------------------------------------- Loans and leases securitized: Business purpose loans $ 112.0 $ 129.1 $ 109.9 Home equity loans 1,311.7 1,222.0 992.2 ------------------------------------------- $ 1,423.7 $ 1,351.1 $ 1,102.1 =========================================== Number of term securitizations: Business purpose and home equity loans 3 4 4 Cash proceeds: Business purpose and home equity loans $ 1,445.0 $ 1,374.6 $ 1,113.8 Gains: Business purpose and home equity loans $ 171.0 $ 185.6 $ 129.0
The table below summarizes certain cash flows received from and paid to securitization trusts (in millions):
Year ended June 30, 2003 2002 -------------- --------------- Proceeds from new securitizations $ 1,445.0 $ 1,374.6 Contractual servicing fees received 44.9 35.3 Other cash flows received on retained interests (a) 87.2 53.4 Purchases of delinquent or foreclosed assets (55.0) (30.2) Servicing advances (11.6) (7.5) Reimbursement of servicing advances 10.2 7.2
(a) Amount is net of required purchases of additional overcollateralization. The Company's securitizations involve a two-step transfer that qualified for sale accounting under SFAS No. 125 and also qualify under SFAS No. 140. First, the Company sells the loans to an SPE, which has been established for the limited purpose of buying and reselling the loans and establishing a true sale under legal standards. Next, the SPE sells the loans to a qualified SPE, which is a trust transferring title of the loans and isolating those assets from the Company's assets. Finally, the trust issues certificates to investors to raise the cash purchase price for the loans being sold, collects proceeds on 171 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 4. Securitizations (continued) behalf of the certificate holders, distributes proceeds and is a distinct legal entity, independent from the Company. The Company also used SPEs in the sales of loans to a $300.0 million off-balance sheet mortgage conduit facility. Sales into the off-balance sheet facility involved a two-step transfer that qualified for sale accounting under SFAS No. 140, similar to the process described above. This facility had a revolving feature and could be directed by the sponsor to dispose of the loans. Typically, the loans were disposed of by securitizing the loans in a term securitization. The third party note purchaser also has the right to have the loans sold in whole loan sale transactions. Under this off-balance sheet facility arrangement, the loans had been isolated from the Company and its subsidiaries and as a result, transfers to the facility were treated as sales for financial reporting purposes. When loans were sold to this facility, the Company assessed the likelihood that the sponsor would transfer the loans into a term securitization. As the sponsor had typically transferred the loans to a term securitization prior to the fourth quarter of fiscal 2003, the amount of gain on sale recognized for loans sold to this facility was estimated based on the terms the Company would obtain in a term securitization rather than the terms of this facility. For the fourth quarter of fiscal 2003, the likelihood that the facility sponsor would ultimately transfer the underlying loans to a term securitization was significantly reduced and the amount of gain recognized for loans sold to this facility was based on terms expected in a whole loan sale transaction. The Company's ability to sell loans into this facility expired pursuant to its terms on July 5, 2003. At June 30, 2003, the off-balance sheet mortgage conduit facility held loans with principal balance due of $275.6 million as assets and owed $267.5 million to third parties. Through August 29, 2003, $214.7 million of the loans in the facility at June 30, 2003 were sold in whole loan sales as directed by the facility sponsor. Prior to March 2001, the Company had an arrangement with a warehouse lender, which included an off-balance sheet facility. The sale into this off-balance sheet conduit facility involved a two step transfer that also qualified for sale accounting under SFAS No. 125. The Company terminated this facility in March 2001. During the year ended June 30, 2003, the Company recorded total pre-tax valuation adjustments on our securitization assets of $63.3 million, of which $45.2 million was charged to the income statement and $18.1 million was charged to other comprehensive income. The breakout of the total adjustments in fiscal 2003 between interest-only strips and servicing rights was as follows: o The Company recorded total pre-tax valuation adjustments on our interest only-strips of $58.0 million, of which, in accordance with the provisions of SFAS No. 115 "Accounting for Certain Investments in Debt and Equity Securities" and Emerging Issues Task Force guidance on issue 99- 172 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 4. Securitizations (continued) 20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets", referred to as EITF 99-20 in this document, $39.9 million was charged to the income statement and $18.1 million was charged to other comprehensive income. The valuation adjustment reflects the impact of higher than anticipated prepayments on securitized loans experienced in fiscal 2003 due to the low interest rate environment experienced during fiscal 2003. The valuation adjustment on interest-only strips for fiscal 2003 was reduced by a $20.9 million favorable valuation impact as a result of reducing the discount rates applied in valuing the interest-only strips at June 30, 2003. The amount of the valuation adjustment charged to the income statement was reduced by a $10.8 million favorable valuation impact as a result of reducing the discount rates and the charge to other comprehensive income was reduced by $10.1 million for the favorable impact of reducing discount rates. The discount rates were reduced at June 30, 2003 primarily to reflect the impact of the sustained decline in market interest rates. The discount rate on the projected residual cash flows from the Company's interest-only strips was reduced from 13% to 11% at June 30, 2003. The discount rate used to determine the fair value of the overcollateralization portion of the cash flows from interest-only strips was minimally impacted by the decline in interest rates and remained at 7% on average. As a result, the blended rate used to value interest-only strips, including the overcollateralization cash flows, was 9% at June 30, 2003. o The Company recorded total pre-tax valuation adjustments on our servicing rights of $5.3 million, which was charged to the income statement. The valuation adjustment reflects the impact of higher than anticipated prepayments on securitized loans experienced in fiscal 2003 due to the low interest rate environment experienced during fiscal 2003. The valuation adjustment on servicing rights for fiscal 2003 was reduced by a $7.1 million favorable valuation impact as a result of reducing the discount rate applied in valuing the servicing rights at June 30, 2003. The discount rate was reduced at June 30, 2003 primarily to reflect the impact of the sustained decline in market interest rates. The discount rate on the Company's servicing rights was reduced from 11% to 9% at June 30, 2003. The write down reduced net income by $27.6 million and increased the diluted loss per share by $9.45 in fiscal 2003. Although beginning in the second quarter of fiscal 2002 the Company increased its prepayment rate assumptions used to value the interest-only strips, prepayment rates throughout the mortgage industry continued to increase and the Company's prepayment experience continued to exceed even its revised assumptions. Based on current economic conditions, published mortgage industry surveys and the Company's prepayment experience, the Company believes prepayments will continue to remain at higher than normal levels for the near term before returning to average historical levels. Therefore the Company has 173 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 4. Securitizations (continued) increased the prepayment rate assumptions for home equity loans for the near term, but at a declining rate, before returning to historical levels. However, the Company cannot predict with certainty what its prepayment experience will be in the future. Any unfavorable difference between the assumptions used to value interest-only strips and actual experience may have a significant adverse impact on the value of these assets. The following tables provide information regarding the initial and current assumptions applied in determining the fair values of mortgage loan related interest-only strips and servicing rights for each securitization trust. Summary of Material Mortgage Loan Securitization Valuation Assumptions and Actual Experience at June 30, 2003
2003-1 2002-4 2002-3 2002-2 2002-1 2001-4 2001-3 2001-2 2001-1 2000-4 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Interest-only strip residual discount rate: Initial valuation......................... 13% 13% 13% 13% 13% 13% 13% 13% 13% 13% Current valuation......................... 11% 11% 11% 11% 11% 11% 11% 11% 11% 11% Interest-only strip overcollateralization discount rate: Initial valuation........................ 7% 9% 7% 7% 7% 7% 7% 7% 6% 7% Current valuation........................ 5% 9% 7% 7% 7% 5% 6% 7% 6% 7% Servicing rights discount rate: Initial valuation......................... 11% 11% 11% 11% 11% 11% 11% 11% 11% 11% Current valuation......................... 9% 9% 9% 9% 9% 9% 9% 9% 9% 9% Prepayment rates: Initial assumption (a): Expected Constant Prepayment Rate (CPR): Business loans.......................... 11% 11% 11% 11% 11% 11% 11% 11% 11% 10% Home equity loans....................... 22% 22% 22% 22% 22% 22% 22% 22% 22% 24% Ramp period (months): Business loans.......................... 27 27 27 27 27 27 24 24 24 24 Home equity loans....................... 30 30 30 30 30 30 30 30 30 24 Current assumptions (b): Expected Constant Prepayment Rate (CPR): Business loans ......................... 11% 11% 11% 11% 11% 11% 11% 11% 11% 11% Home equity loans ...................... 22% 22% 22% 22% 22% 22% 22% 22% 22% 22% Ramp period (months): Business loans.......................... 27 27 27 27 27 27 27 27 27 27 Home equity loans....................... 30 30 30 30 30 30 30 30 30 30 CPR adjusted to reflect ramp: Business loans.......................... 5% 8% 10% 12% 15% 17% 20% 22% 22% 19% Home equity loans....................... 15% 32% 40% 51% 42% 46% 40% 40% 37% 41% Current prepayment experience (c): Business loans.......................... 8% 5% 13% 12% 15% 23% 19% 9% 21% 23% Home equity loans....................... 5% 9% 20% 28% 39% 42% 40% 37% 36% 37% Annual credit loss rates: Initial assumption........................ 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% Current assumption........................ 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.50% 0.40% Actual experience......................... -- -- 0.03% 0.03% 0.03% 0.12% 0.24% 0.17% 0.43% 0.36% Servicing fees: Contractual fees.......................... 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.70% Ancillary fees............................ 1.25% 1.25% 1.25% 1.25% 1.25% 1.25% 1.25% 1.25% 1.25% 1.25%
- ----------------- (a) The prepayment ramp is the length of time before a pool of mortgage loans reaches its expected Constant Prepayment Rate. The business loan prepayment ramp begins at 3% in month one ramps to an expected peak rate over 27 months then declines to the final expected CPR by month 40. The home equity loan prepayment ramp begins at 2% in month one and ramps to an expected rate over 30 months. (b) Current assumptions for business loans are the estimated expected weighted-average prepayment rates over the securitization's estimated remaining life. The majority of the home equity loan prepayment rate ramps have been increased for the next 6 months to provide for the expected near term continuation of higher than average prepayment. Generally, trusts for both business and home equity loans that are out of the ramping period are based on historical averages. (c) Current experience is a six-month historical average. 174 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 4. Securitizations (continued) Summary of Material Mortgage Loan Securitization Valuation Assumptions and Actual Experience at June 30, 2003 (Continued)
2000-3 2000-2 2000-1 1999-4 1999-3 1999-2 1999-1 1998(d) 1997(d) 1996(d) ------ ------ ------ ------ ------ ------ ------ ------- ------- ------- Interest-only strip residual discount rate: Initial valuation........................ 13% 13% 11% 11% 11% 11% 11% 11% 11% 11% Current valuation........................ 11% 11% 11% 11% 11% 11% 11% 11% 11% 11% Interest-only strip overcollateralization discount rate: Initial valuation........................ 8% 8% 8% 8% 7% 7% 7% 7% 7% 8% Current valuation........................ 8% 8% 8% 8% 7% 7% 7% 7% 7% 8% Servicing rights discount rate: Initial valuation........................ 11% 11% 11% 11% 11% 11% 11% 11% 11% 11% Current valuation........................ 9% 9% 9% 9% 9% 9% 9% 9% 9% 9% Prepayment rates: Initial assumption (a): Expected Constant Prepayment Rate (CPR): Business loans ........................ 10% 10% 10% 10% 10% 10% 10% 13% 13% 13% Home equity loans...................... 24% 24% 24% 24% 24% 24% 24% 24% 24% 24% Ramp period (months): Business loans......................... 24 24 24 24 24 24 24 24 24 24 Home equity loans...................... 24 24 18 18 18 18 18 12 12 12 Current assumptions (b): Expected Constant Prepayment Rate (CPR): Business loans ........................ 11% 11% 11% 11% 10% 10% 10% 10% 22% 14% Home equity loans...................... 22% 22% 22% 22% 22% 22% 22% 23% 25% 25% Ramp period (months): Business loans......................... 27 Na Na Na Na Na Na Na Na Na Home equity loans...................... 30 30 Na Na Na Na Na Na Na Na CPR adjusted to reflect ramp: Business loans......................... 16% 13% 23% 35% 29% 27% 30% 20% 20% 10% Home equity loans...................... 32% 31% 37% 33% 32% 29% 26% 33% 22% 13% Current prepayment experience (c): Business loans......................... 23% 15% 23% 35% 29% 26% 30% 18% 19% 3% Home equity loans...................... 32% 31% 37% 32% 32% 29% 25% 33% 21% 13% Annual credit loss rates: Initial assumption....................... 0.40% 0.40% 0.40% 0.30% 0.25% 0.25% 0.25% 0.25% 0.25% 0.25% Current assumption....................... 0.45% 0.45% 0.65% 0.65% 0.60% 0.35% 0.55% 0.60% 0.40% 0.45% Actual experience........................ 0.41% 0.41% 0.65% 0.63% 0.58% 0.35% 0.49% 0.57% 0.36% 0.42% Servicing fees: Contractual fees......................... 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% Ancillary fees........................... 1.25% 1.25% 1.25% 1.25% 1.25% 1.25% 1.25% 0.75% 0.75% 0.75%
- -------------------------- (a) The prepayment ramp is the length of time before a pool of mortgage loans reaches its expected Constant Prepayment Rate. The business loan prepayment ramp begins at 3% in month one ramps to an expected peak rate over 27 months then declines to the final expected CPR by month 40. The home equity loan prepayment ramp begins at 2% in month one and ramps to an expected rate over 30 months. (b) Current assumptions for business loans are the estimated expected weighted-average prepayment rates over the securitization's estimated remaining life. Generally, trusts for both business and home equity loans that are out of the ramping period are based on historical averages. (c) Current experience is a six-month historical average. (d) Amounts represent weighted-average percentages for four 1998 securitization pools, two 1997 securitization pools and two 1996 securitization pools. Na = not applicable 175 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 4. Securitizations (continued) Sensitivity analysis. The table below outlines the sensitivity of the current fair value of the Company's interest-only strips and servicing rights to 10% and 20% adverse changes in the key assumptions used in determining the fair value of those assets. The Company's base prepayment, loss and discount rates are described in the table "Summary of Material Mortgage Loan Securitization Valuation Assumptions and Actual Experience." (dollars in thousands): Securitized collateral balance.....................................$ 3,354,071 Balance sheet carrying value of retained interests (a).............$ 717,569 Weighted-average collateral life (in years)........................ 3.9 - ------------------------- (a) Amount includes interest-only strips and servicing rights. Sensitivity of assumptions used to determine the fair value of retained interests (dollars in thousands): Impact of Adverse Change ---------------------------- 10% Change 20% Change ---------- ---------- Prepayment speed.......................... $ 29,916 $ 56,656 Credit loss rate.......................... 5,247 10,495 Floating interest rate certificates (a)... 829 1,614 Discount rate............................. 20,022 38,988 - ------------------------- (a) The floating interest rate certificates are indexed to one-month LIBOR plus a trust specific interest rate spread. The base one-month LIBOR assumption used in this sensitivity analysis was derived from a forward yield curve incorporating the effect of rate caps where applicable to the individual deals. The sensitivity analysis in the table above is hypothetical and should be used with caution. As the figures indicate, changes in fair value based on a 10% or 20% variation in management's assumptions generally cannot easily be extrapolated because the relationship of the change in the assumptions to the change in fair value may not be linear. Also, in this table, the effect that a change in a particular assumption may have on the fair value is calculated without changing any other assumption. Changes in one assumption may result in changes in other assumptions, which might magnify or counteract the impact of the intended change. These sensitivities reflect the approximate amount of the fair values that the Company's interest-only strips and servicing rights would be reduced for the indicated adverse changes. These reductions would result in a charge to expense in the income statement in the period incurred and a resulting reduction of stockholders' equity, net of income taxes. 5. Interest-Only Strips Interest-only strips were comprised of the following (in thousands): June 30, 2003 2002 -------------------------------- Interest-only strips Available for sale $ 597,166 $ 510,770 Trading assets 1,112 1,841 -------------------------------- $ 598,278 $ 512,611 ================================ Interest-only strips include overcollateralization balances that represent undivided interests in securitizations maintained to provide credit enhancement to investors in securitization trusts. At June 30, 2003 and 2002, the fair value of overcollateralization related cash flows were $279.2 million and $236.6 million, respectively. 176 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 5. Interest-Only Strips (continued) The activity for interest-only strip receivables is summarized as follows (in thousands):
June 30, 2003 2002 --------------------------------- Balance at beginning of period $ 512,611 $ 398,519 Initial recognition of interest-only strips, including initial overcollateralization of $10.6 million and $0 160,116 153,463 Cash flow from interest-only strips (160,417) (100,692) Required purchases of additional overcollateralization 73,253 47,271 Interest accretion 47,347 35,386 Termination of lease securitization (a) (1,890) - Net temporary adjustments to fair value (b) 7,158 717 Other than temporary fair value adjustment (b) (39,900) (22,053) --------------------------------- Balance at end of period $ 598,278 $ 512,611 =================================
(a) Reflects release of lease collateral from two lease securitization trusts which were terminated in accordance with the trust documents after the full payout of trust note certificates. Net lease receivables of $1.7 million were recorded on the balance sheet as a result of these terminations. (b) Net temporary adjustments to fair value are recorded through other comprehensive income, which is a component of equity. Other than temporary adjustments to decrease the fair value of interest-only strips are recorded through the income statement. See Note 4 for a further description of the write downs recognized in fiscal 2003. 6. Servicing Rights The total managed loan and lease portfolio, which includes loans and leases held by the Company as available for sale, and securitized loans and leases serviced for others, is as follows (in thousands): June 30, 2003 2002 ----------------------------------- Home equity loans $ 3,249,501 $ 2,675,559 Business purpose loans 393,098 361,638 Equipment leases 8,475 28,992 ---------------------------------- $ 3,651,074 $ 3,066,189 ================================== 177 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 6. Servicing Rights (continued) The activity for the loan and lease servicing rights asset is summarized as follows (in thousands): Year ended June 30, 2003 2002 ---------------------------------- Balance at beginning of year $ 125,288 $ 102,437 Initial recognition of servicing rights 41,171 52,682 Amortization (41,886) (29,831) Write down (5,282) - ---------------------------------- Balance at end of year $ 119,291 $ 125,288 ================================== Servicing rights are valued quarterly by the Company based on the current estimated fair value of the servicing asset. A review for impairment is performed by stratifying the serviced loans and leases based on loan type, which is considered to be the predominant risk characteristic due to their different prepayment characteristics and fee structures. During fiscal 2003, we recorded total pre-tax valuation adjustments on our servicing rights of $5.3 million, which was charged to the income statement. See Note 4 for more detail. Key assumptions used in the periodic valuation of the servicing rights are described in Note 4. Information regarding the sensitivity of the current fair value of interest-only strips and servicing rights to adverse changes in the key assumptions used to value these assets is detailed in Note 4. 178 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 7. Property and Equipment Property and equipment is comprised of the following (in thousands): June 30, 2003 2002 ----------------------------- Computer software $ 20,282 $ 18,789 Computer hardware 3,816 4,845 Office furniture and equipment 4,680 8,038 Leasehold improvements 8,585 2,481 ----------------------------- 37,363 34,153 Less accumulated depreciation and amortization 14,061 15,707 ----------------------------- $ 23,302 $ 18,446 ============================= Depreciation and amortization expense was $8.6 million, $6.8 million and $6.2 million for the years ended June 30, 2003, 2002 and 2001, respectively. 8. Other Assets and Other Liabilities Other assets were comprised of the following (in thousands): June 30, 2003 2002 ------------ ----------- Goodwill $ 15,121 $ 15,121 Real estate owned 4,776 3,784 Financing costs, debt offerings 3,984 5,849 Due from securitization trusts for servicing related activities - 1,616 Investments held to maturity 881 917 Other 5,690 1,507 ------------ ---------- $ 30,452 $ 28,794 ============ ========== 179 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 8. Other Assets and Other Liabilities (continued) Other liabilities were comprised of the following (in thousands): June 30, 2003 2002 ------------ ----------- Commitments to fund closed loans $ 35,187 $ 29,866 Obligation for repurchase of securitized loans 27,954 10,621 Escrow deposits held 10,988 9,011 Hedging liabilities, at fair value 6,335 - Unearned lease incentives 9,465 - Periodic advance guarantee 650 - Trading liabilities, at fair value 334 461 Other 1,077 949 ------------ ----------- $ 91,990 $ 50,908 ============ =========== See Note 2 for an explanation of the obligation for the repurchase of securitized loans and Note 18 for an explanation of the Company's hedging and trading activities. Unearned lease incentives represent reimbursements received in conjunction with the lease agreement for the Company's new corporate office space in Philadelphia, Pennsylvania. These funds represent reimbursement from the landlord for leasehold improvements and furniture and equipment in the rented space and will be recognized as an offset to rent expense over the term of the lease or the life of the asset, whichever is shorter. 9. Subordinated Debt and Warehouse Lines and Other Notes Payable Subordinated debt was comprised of the following (in thousands): June 30, 2003 2002 ------------ ----------- Subordinated debt (a) $ 702,423 $ 640,411 Subordinated debt - money market notes (b) 17,117 15,309 ------------ ----------- Total subordinated debt $ 719,540 $ 655,720 ============ =========== 180 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 9. Subordinated Debt and Warehouse Lines and Other Notes Payable (continued) Warehouse lines and other notes payable were comprised of the following (in thousands):
June 30, 2003 2002 ---------------- ------------- Warehouse and operating revolving line of credit (c) $ 30,182 $ 6,171 Warehouse revolving line of credit (d) 136,098 - Warehouse revolving line of credit (e) 19,671 187 Bank overdraft (f) 26,158 - Lease funding facility (g) - 2,128 Capitalized leases (h) 807 - ---------------- ------------- Total warehouse lines and other notes payable $ 212,916 $ 8,486 ================ =============
(a) Subordinated debt due July 2003 through June 2013, interest rates ranging from 3.50% to 13.00%; average rate at June 30, 2003 was 8.86%, average remaining maturity was 19.5 months, subordinated to all of the Company's senior indebtedness. The average rate on subordinated debt including money market notes was 8.74% at June 30, 2003. (b) Subordinated debt - money market notes due upon demand, interest rate at 4.0%; subordinated to all of the Company's senior indebtedness. (c) $50.0 million warehouse and operating revolving line of credit expiring December 2003, which includes a sublimit for a letter of credit that expires in December 2003 to secure lease obligations for corporate office space, collateralized by certain pledged loans, advances to securitization trusts, real estate owned and certain interest-only strips. The amount of the letter of credit was $8.0 million at June 30, 2003 and will vary over the term of the office lease. (d) $200.0 million warehouse revolving line of credit expiring November 2003, collateralized by certain pledged loans. $100.0 million of this facility was continuously committed for the term of the facility while the remaining $100.0 million of the facility was available at the lender's discretion. From June 30, 2003 to August 20, 2003, there were no new advances under the non-committed portion. On August 20, 2003, this credit facility was amended to reduce the committed portion to $50.0 million (from $100.0 million), eliminate the non-committed portion and accelerate its expiration date from November 2003 to no later than September 30, 2003. (e) $25.0 million warehouse revolving line of credit expiring October 2003, collateralized by certain pledged loans. (f) Overdraft amount on bank accounts paid on the following business day. (g) Lease funding facility matured in May 2003, collateralized by certain lease receivables. The Company does not intend to renew this facility. (h) Capitalized leases, maturing through January 2006, imputed interest rate of 8.0%, collateralized by computer equipment. Principal payments on subordinated debt, warehouse lines and other notes payable for the next five years are as follows (in thousands): year ending June 30, 2004 - - $534,388; 2005 - $170,976; 2006 - $157,952; 2007 - $27,668; and, 2008 - $14,998. 181 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 9. Subordinated Debt and Warehouse Lines and Other Notes Payable (continued) At June 30, 2003, warehouse lines and other notes payable were collateralized by $190.2 million of loan and lease receivables and $1.0 million of computer equipment. In addition to the above, the Company had available to it the following credit facilities: o $5.0 million operating line of credit expiring January 2004, fundings to be collateralized by investments in the 99-A lease securitization trust and Class R and X certificates of Mortgage Loan Trust 2001-2. This line was unused at June 30, 2003. o $300.0 million facility, which provided for the sale of mortgage loans into an off-balance sheet funding facility. This facility expired pursuant to its terms on July 5, 2003. See Note 4 for further discussion of the off-balance sheet features of this facility. At June 30, 2003, $267.5 million of this facility was utilized. Interest rates paid on the revolving credit facilities range from London Inter-Bank Offered Rate ("LIBOR") plus 0.95% to LIBOR plus 1.75%. The weighted-average interest rate paid on the revolving credit facilities was 2.24% and 3.35% at June 30, 2003 and June 30, 2002, respectively. The warehouse credit agreements require that the Company maintain specific financial covenants regarding net worth, leverage, net income, liquidity, total debt and other standards. Each agreement has multiple individualized financial covenant thresholds and ratio limits that it must meet as a condition to drawing on that particular line of credit. Pursuant to the terms of these credit facilities, the failure to comply with the financial covenants constitutes an event of default and the lender may, at its option, take certain actions including: terminate commitments to make future advances to the Company, declare all or a portion of the loan due and payable, foreclose on the collateral securing the loan, require servicing payments be made to the lender, or other third party, or assume the servicing of the loans securing the credit facility. An event of default under these credit facilities could result in defaults pursuant to cross-default provisions of the Company's other agreements, including its other loan agreements and lease agreements. The failure to comply with the terms of these credit facilities or to obtain the necessary waivers from the lenders related to any default would have a material adverse effect on the Company's liquidity and capital resources, could result in the Company not having sufficient cash to repay its indebtedness, require the Company to restructure its operations and may force the Company to sell assets on less than optimal terms and conditions. As a result of the loss experienced during fiscal 2003, the Company was not in compliance with the terms of certain of the financial covenants related to net worth, consolidated stockholders' equity and the ratio of total liabilities to consolidated stockholders' equity under two of its principal credit facilities (one for $50.0 million and the other for $200.0 million, of which $100.0 million was non-committed) and the Company requested and obtained waivers of these covenant provisions from both lenders. The lender under the $50.0 million warehouse credit facility has granted a waiver for the Company's non-compliance with a financial covenant in that credit facility through September 30, 2003. This facility was amended to reduce the available credit to $8.0 million and the financial covenants were replaced with new covenants. The Company also entered into an amendment to the $200.0 million credit facility which provides for the waiver of its non-compliance with the financial covenants in that facility, the reduction of the committed portion of this facility from $100.0 million to $50.0 million, the elimination of the $100.0 million non-committed portion of this credit facility and the acceleration of the termination date of this facility from November 2003 to September 30, 2003. The Company's ability to repay this facility upon termination is dependent on its ability to refinance the loans in one of its new facilities or the sale of loans currently warehoused in the terminating facility by September 30, 2003. 182 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 9. Subordinated Debt and Warehouse Lines and Other Notes Payable (continued) Some of the Company's financial covenants in other credit facilities have minimal flexibility and it cannot say with certainty that it will continue to comply with the terms of all debt covenants. There can be no assurance as to whether or in what form a waiver or modification of terms of these agreements would be granted the Company. On September 22, 2003, the Company entered into definitive agreements with a financial institution for a new $200.0 million credit facility for the purpose of funding its loan originations. Pursuant to the terms of this facility, the Company is required to, among other things: (i) obtain a written commitment for another credit facility of at least $200.0 million and close that additional facility by October 3, 2003 (which condition would be satisfied by the closing of the $225.0 million facility described below); (ii) have a net worth of at least $28.0 million by September 30, 2003; with quarterly increases of $2.0 million thereafter; (iii) apply 60% of its net cash flow from operations each quarter to reduce the outstanding amount of subordinated debt commencing with the quarter ending March 31, 2004; and (iv) provide a parent company guaranty of 10% of the outstanding principal amount of loans under the facility. This facility has a term of 12 months expiring in September 2004 and is secured by the mortgage loans which are funded by advances under the facility with interest equal to LIBOR plus a margin. This facility is subject to representations and warranties and covenants, which are customary for a facility of this type, as well as amortization events and events of default related to the Company's financial condition. These provisions require, among other things, the Company's maintenance of a delinquency ratio for the managed portfolio (which represents the portfolio of securitized loans and leases we service for others) at the end of each fiscal quarter of less than 12.0%, its subordinated debt not to exceed $705.0 million at any time, its ownership of an amount of repurchased loans not to exceed 1.5% of the managed portfolio and its registration statement registering $295.0 million of subordinated debt be declared effective by the SEC no later than October 31, 2003. On September 22, 2003, the Company executed a commitment letter for a mortgage warehouse credit facility with a warehouse lender, which consists of a senior secured revolving credit facility of up to $225.0 million and a secured last out revolver facility up to $25.0 million to fund loan originations. The commitment letter is subject to certain conditions, including, among other things: (i) entering into definitive agreements, except as provided in the commitment letter; (ii) the absence of a material adverse change in the business, operations, property, condition (financial or otherwise) or prospects of the Company or its affiliates; and (iii) its receipt of another credit facility in an amount not less than $200.0 million, subject to terms and conditions acceptable to this lender (which condition is satisfied by the new $200.0 million facility described above). The commitment letter provides that these facilities will have a term of three years with an interest rate on amounts outstanding under the $225.0 million portion of the credit facility equal to the greater of one-month LIBOR plus a margin or the difference between the yield maintenance fee (as defined in the commitment letter) and the one-month LIBOR plus a margin. Advances under this facility would be collateralized by substantially all of the Company's present and future assets including pledged loans and a security interest in substantially all of its interest-only strips and residual interests which will be contributed to a special purpose entity organized by the Company to facilitate this transaction. The Company also agreed to pay fees of approximately $14.6 million annually plus a nonusage fee based on the difference between the average daily outstanding balance for the current month and the maximum credit amount under the facility and the lender's out-of-pocket expenses. 183 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 9. Subordinated Debt and Warehouse Lines and Other Notes Payable (continued) The Company anticipates that these facilities will be subject to representations and warranties, events of default and covenants which are customary for facilities of this type, as well as its agreement to: (i) maintain sales or renewals of our subordinated debt securities of $10.0 million per month; (ii) restrict total principal and interest outstanding on its subordinated debt to $750.0 million or less; (iii) make quarterly reductions commencing in April 2004 of an amount of subordinated debt outstanding to be determined; (iv) maintain maximum interest rates payable on subordinated debt securities not to exceed 10 percentage points above comparable rates for FDIC insured products; and (v) the lender's receipt of the Company's audited financial statements for the period ended June 30, 2003. The definitive agreements will grant the lender an option at any time after the first anniversary of entering into the definitive agreements to increase the credit amount on the $250.0 million facility to $400.0 million with additional fees payable by the Company plus additional interest as may be required by the institutions or investors providing the lender with these additional funds. The commitment letter requires that the Company enter into definitive agreements not later than October 17, 2003. While the Company anticipates that it will close this transaction prior to such date, it cannot provide assurance that these negotiations will result in definitive agreements or that such agreements, as negotiated, will be on terms and conditions acceptable to the Company. In the event the Company is unable to close these facilities or another facility within the time frame provided under the new $200.0 million credit facility described above, the lender on that facility would be under no obligation to make further advances under the terms of that facility and outstanding advances would have to be repaid over a period of time. Under a registration statement declared effective by the SEC on October 3, 2002, the Company registered $315.0 million of subordinated debt. Of the $315.0 million, $121.3 million of debt from this registration statement was available for future issuance as of June 30, 2003. In June 2003, the Company filed a new registration statement with the SEC to register an additional $295.0 million of subordinated debt. The Company's subordinated debt securities are subordinated in right of payment to, or subordinate to, the payment in full of all senior debt as defined in the indentures related to such debt, whether outstanding on the date of the applicable indenture or incurred following the date of the indenture. The Company's assets, including the stock it holds in its subsidiaries, are available to repay the subordinated debt in the event of default following payment to holders of the senior debt. In the event of the Company's default and liquidation of its subsidiaries to repay the debt holders, creditors of the subsidiaries must be paid or provision made for their payment from the assets of the subsidiaries before the remaining assets of the subsidiaries can be used to repay the holders of the subordinated debt securities. 184 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 9. Subordinated Debt and Warehouse Lines and Other Notes Payable (continued) In September 2002, the Company entered into a series of leases for computer equipment which qualify as capital leases. The total principal amount of debt to be recorded under these leases is $1.0 million. The leases have an imputed interest rate of 8.0% and mature through January 2006. The Company paid commitment fees and non-usage fees on warehouse lines and operating lines of credit of $0.4 million, $0.7 million and $0.4 million in the years ended June 30, 2003, 2002 and 2001, respectively. 10. Stockholders' Equity In fiscal 1999, the Board of Directors initiated a stock repurchase program in view of the price level of the Company's common stock, which at the time traded and has continued to trade at below book value. In addition, the Company's consistent earnings growth over the past several years through fiscal 2002 did not result in a corresponding increase in the market value of its common stock. The repurchase program was extended in fiscal 2000, 2001 and 2002. The fiscal 2002 extension authorized the purchase of up to 10% of the then outstanding shares, which totaled approximately 2,661,000 shares on the date of the extension. The Company repurchased 43,000 shares under the most current repurchase program, which terminated in November 2002. The Company did not extend the repurchase program beyond this date and currently has no plans to repurchase additional shares. The total number of shares repurchased under the stock repurchase program was: 117,000 in fiscal 1999; 327,000 in fiscal 2000; 627,000 in fiscal 2001; and 352,000 in fiscal 2002. The cumulative effect of the stock repurchase program was an increase in diluted earnings per share of $0.41 and $0.32 for the years ended June 30, 2002 and 2001, respectively. On August 21, 2002, the Board of Directors declared a 10% stock dividend payable September 13, 2002 to shareholders of record on September 3, 2002. In conjunction with the Board's resolution, all outstanding stock options and related exercise prices were adjusted. Accordingly, all outstanding common shares, earnings per common share, average common share and stock option amounts presented have been adjusted to reflect the effect of this stock dividend. Amounts presented for fiscal 2001 have been similarly adjusted for the effect of a 10% stock dividend declared October 1, 2001, which was paid on November 5, 2001 to shareholders of record on October 22, 2001. The Company increased its quarterly cash dividend to $0.08 per share in fiscal 2003. Cash dividends of $0.32, $0.28 and $0.26 were paid in the years ended June 30, 2003, 2002 and 2001, respectively. 185 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 10. Stockholders' Equity (continued) In May 2002 the Company registered 440,000 shares of its common stock for use in a dividend reinvestment plan. The dividend reinvestment plan is intended to allow shareholders to purchase the Company's common stock with dividend payments from their existing common stock holdings. This option continues to be offered to the shareholders. As of June 30, 2003, 431,566 shares are available for use in the plan. In December 2002, the Company's shareholders approved an increase in the number of shares of authorized preferred stock from 1.0 million shares to 3.0 million shares. The preferred shares may be used to raise equity capital, redeem outstanding debt or acquire other companies, although no such acquisitions are currently contemplated. The Board of Directors has discretion with respect to designating and establishing the terms of each series of preferred stock prior to issuance. 11. Employee Benefit Plan The Company has a 401(k) defined contribution plan, which was established in 1995, available to all employees who have been with the Company for one month and have reached the age of 21. Employees may generally contribute up to 15% of their earnings each year, subject to IRS imposed limitations. For participants with one or more years of service, the Company, at its discretion, may match up to 25% of the first 5% of earnings contributed by the employee, and may match an additional 25% of the first 5% of earnings contributed by the employee in Company stock. The Company's contribution was $417 thousand, $350 thousand and $307 thousand for the years ended June 30, 2003, 2002 and 2001, respectively. 186 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 12. Stock Option and Stock Incentive Plans The Company has stock option plans that provide for the periodic granting of options to key employees and non-employee directors. These plans have been approved by the Company's shareholders. Options are generally granted to key employees at the market price of the Company's stock on the date of grant and expire five to ten years from date of grant. Options either fully vest when granted or over periods of up to five years. At June 30, 2003, 230,024 shares were available for future grant under the Company's stock option plans. A summary of key employee stock option activity for the years ended June 30, 2003, 2002 and 2001 follows. Stock option activity has been retroactively adjusted for the effect of the stock dividends described in Note 10.
Weighted-Average Number of Shares Exercise Price -------------------------------------------------- Options outstanding, June 30, 2000 563,981 $ 13.23 Options granted 81,675 5.32 Options canceled (91,052) 15.82 -------------------------------------------------- Options outstanding, June 30, 2001 554,604 11.64 Options granted 110,311 12.81 Options exercised (121) 10.75 Options canceled (61,336) 7.32 -------------------------------------------------- Options outstanding, June 30, 2002 603,458 11.95 Options granted 6,000 13.50 Options exercised (4,000) 5.06 Options canceled (41,466) 14.41 -------------------------------------------------- Options outstanding, June 30, 2003 563,992 $ 11.79 ==================================================
The Company also issues stock options to non-employee directors. Options generally are granted to non-employee directors at or above the market price of the stock on the date of grant, fully vest when granted and expire three to ten years after the date of grant. A summary of non-employee director stock option activity for the three years ended June 30, 2003, 2002 and 2001 follows. Stock option activity has been retroactively adjusted for the effect of the stock dividends described in Note 10. 187 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 12. Stock Option and Stock Incentive Plans (continued)
Weighted-Average Number of Shares Exercise Price -------------------------------------------------- Options outstanding, June 30, 2000 211,750 $ 9.45 Options granted 48,400 5.27 Options canceled (25,410) 18.30 -------------------------------------------------- Options outstanding, June 30, 2001 234,740 7.63 Options granted 59,400 13.97 Options canceled (25,410) 11.81 -------------------------------------------------- Options outstanding, June 30, 2002 268,730 8.64 Options exercised (87,985) 7.37 Options canceled (12,100) 10.74 -------------------------------------------------- Options outstanding, June 30, 2003 168,645 $ 9.25 ==================================================
The Company accounts for stock options issued under these plans using the intrinsic value method. See Note 1 for more detail. The weighted-average fair value of options granted during the fiscal years ended June 30, 2003, 2002 and 2001 were $7.00, $5.85 and $2.15, respectively. The fair value of options granted was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:
June 30, 2003 2002 2001 ------------------------------------------------------------ Expected volatility 65% 50% 40% Expected life 8 yrs. 8 yrs. 8 yrs. Risk-free interest rate 3.3% - 3.8% 3.4% - 5.3% 5.0% - 5.9%
188 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 12. Stock Option and Stock Incentive Plans (continued) The following tables summarize information about stock options outstanding under these plans at June 30, 2003:
Options Outstanding - ------------------------------------------------------------------------------------------ Weighted Remaining Weighted- Range of Exercise Number of Contractual Life Average Prices of Options Shares in Years Exercise Price - ------------------------------------------------------------------------------------------ $ 3.94 to 5.63 174,971 3.7 $ 4.62 10.74 to 12.59 312,549 6.7 11.27 13.49 to 15.74 186,671 3.0 14.94 17.22 to 20.46 58,446 4.6 18.70 --------------------------------------------------------------- 732,637 4.9 $ 11.21 =============================================================== Options Exercisable - ------------------------------------------------------------------------------------------ Weighted Remaining Weighted- Range of Exercise Number of Contractual Life Average Prices of Options Shares in Years Exercise Price - ------------------------------------------------------------------------------------------ $ 3.94 to 5.63 144,701 2.9 $ 4.52 10.74 to 12.59 161,019 5.9 11.02 13.49 to 15.74 139,531 3.1 15.14 17.22 to 20.46 58,446 4.6 18.70 --------------------------------------------------------------- 503,697 4.1 $ 11.18 ===============================================================
The FASB released interpretation No. 44 "Accounting for Certain Transactions Involving Stock Compensation" allows options granted to directors to be accounted for consistently with those granted to employees if certain conditions are met, and therefore, no expense is recognized where the exercise price equals or exceeds the fair value of the shares at the date of grant. In accordance with the guidance, in fiscal 2001, the Company recorded $174 thousand as a cumulative effect of a change in accounting principle, which represents the cumulative amount of expense recognized in prior years for stock options issued to non-employee directors. In fiscal 2002 the Board of Directors adopted, and the shareholders approved, a stock incentive plan. The stock incentive plan provides for awards to officers and other employees of the Company in the form of the Company's common stock. Awards made pursuant to this plan are under the direction of the Compensation Committee of the Board of Directors and are dependent on the Company, and individuals receiving the grant, achieving certain goals developed by the Compensation Committee. The vesting schedule for awards under this plan, if any, 189 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 12. Stock Option and Stock Incentive Plans (continued) are set by the Compensation Committee at time of grant. The total number of shares authorized to be granted under the Stock Incentive Plan are 165,000 shares. The number of shares issuable can be adjusted, however, in the event of a reorganization, recapitalization, stock split, stock dividend, merger, consolidation or other change in the corporate structure of the Company. On October 15, 2002, 27,899 shares were granted at a price of $10.05 per share and 10,876 shares were granted on October 17, 2002 at $10.43 per share to officers and employees under this plan. 13. Income Taxes The provision for income taxes consists of the following (in thousands):
Year ended June 30, 2003 2002 2001 ----------------------------------------------------- Current Federal $ 9 $ 1,455 $ 383 State 400 250 76 ----------------------------------------------------- 409 1,705 459 ----------------------------------------------------- Deferred Federal (19,377) 3,986 4,641 State (150) - 174 ----------------------------------------------------- (19,527) 3,986 4,815 ----------------------------------------------------- Total provision for income taxes $ (19,118) $ 5,691 $ 5,274 =====================================================
There were $4.1 million in federal tax benefits from the utilization of net operating loss carryforwards in the year ended June 30, 2003 while there were no tax benefits from the utilization of net operating loss carryforwards in the year ended June 30, 2002. 190 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 13. Income Taxes (continued) The cumulative temporary differences resulted in net deferred income tax assets or liabilities consisting primarily of the following (in thousands): Year ended June 30, 2003 2002 --------------------------------------- Deferred income tax assets: Allowance for credit losses $ 997 $ 1,297 Net operating loss carryforwards 72,581 60,720 Other 14,544 6,303 --------------------------------------- 88,122 68,320 Less valuation allowance 36,830 29,326 --------------------------------------- 51,292 38,994 --------------------------------------- Deferred income tax liabilities: Interest-only strips and other receivables 68,328 74,118 --------------------------------------- 68,328 74,118 --------------------------------------- Net deferred income tax liability $ 17,036 $ 35,124 ======================================= The valuation allowance represents the income tax effect of state net operating loss carryforwards of the Company, which are not presently expected to be utilized. The utilization of net operating loss carryforwards for federal tax purposes is not dependent on future taxable income from operations, but on the reversal of timing differences principally related to existing securitization assets. These timing differences are expected to absorb the available net operating loss carryforwards during the carryforward period. A reconciliation of income taxes at federal statutory rates to the Company's tax provision is as follows (in thousands): Year ended June 30, 2003 2002 2001 ------------------------------------- Federal income tax at statutory rates $ (17,157) $ 4,742 $ 4,615 Nondeductible items 85 65 534 Other, net (2,046) 884 125 ------------------------------------- $ (19,118) $ 5,691 $ 5,274 ===================================== For income tax reporting, the Company has net operating loss carryforwards aggregating approximately $460.4 million available to reduce future state income taxes for various states as of June 30, 2003. If not used, substantially all of the carryforwards will expire at various dates from June 30, 2003 to June 30, 2005. The $2.0 million benefit in the other, net category is the result of the reversal of state and federal reserves which are no longer deemed necessary. 191 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 14. Commitments and Contingencies Operating Leases As of June 30, 2003, the Company leases property under noncancelable operating leases requiring minimum annual rentals as follows (in thousands): Year ending June 30, 2004 $ 1,422 2005 5,283 2006 5,131 2007 5,312 2008 5,442 Thereafter 33,533 ------------- $ 56,123 ============= Rent expense for leased property was $5.1 million, $4.9 million and $5.2 million, respectively, for the years ended June 30, 2003, 2002, and 2001. Employment Agreements In January 1997, the Company entered into employment agreements, as amended, with three executives under which they are entitled to an initial annual base compensation of $625 thousand, collectively, automatically adjusted for increases in the Consumer Price Index and may be adjusted for merit increases. The agreements with two of the executives also provide for bonus payments up to 225% of the executive's annual salary under a cash bonus plan established by the Company's Board of Directors. The third executive is entitled to a bonus payment of up to 50% of the executive's annual salary. The agreements terminate upon the earlier of: (a) the executive's death, permanent disability, termination of employment for cause, voluntary resignation or 70th birthday; (b) the later of five years from any anniversary date of the agreements for two executives and three years for one executive; or (c) five years from the date of notice to the executive of the Company's intention to terminate the agreement for two executives and three years for one executive. In addition, two of the executives are entitled to a cash payment equal to 299% of the last five years average annual compensation in the event of a "change in control," as defined in the agreement. The remaining executive is entitled to a similar payment but only if he is terminated in connection with a change in control. The Company has also entered into an employment agreement with another executive under which the executive is entitled to receive an initial annual base compensation of $335 thousand which shall be reviewed annually and may be adjusted for merit increases. The executive is eligible for a cash bonus payment 192 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 14. Commitments and Contingencies (continued) Employment Agreements (continued) of up to 50% of the executive's annual base compensation based upon the Company achieving specific goals and objectives. This agreement terminates upon: (a) the earlier of the executive's death, permanent disability, termination of employment for cause, voluntary resignation or 70th birthday; or (b) upon notice to the executive of the Company's intention to terminate the agreement without cause in which case the executive will receive a cash payment equal to his annual base salary. This agreement is binding upon any successor of the Company by merger, consolidation, purchase or otherwise. In the event of a change in control, this executive will receive his highest annual salary for the twelve-month period preceding the termination of his employment and his highest annual bonus paid in any of the three fiscal years preceding termination. In addition, this executive is eligible for a cash bonus payment of up to 50% of the executive's annual base compensation at the time of award based upon the executive achieving specific goals and objectives. The Company has also entered into an employment arrangement with another executive under which the executive is entitled to receive an initial annual base compensation of $275 thousand. In addition, this executive is eligible for a cash bonus payment of up to 50% of the executive's annual base compensation based upon the Company achieving specific goals and objectives. This executive is entitled to receive one year's base salary if terminated for any reason, except for cause as defined in the agreement. This executive is also entitled to a severance payment equal to two times the executive's highest annual base salary and bonus earned within a specified period if terminated due to a change in control of the Company or within twenty-four months of a change in control of the Company the executive resigns due to circumstances specified in the agreement. Periodic Advance Guarantees As the servicer of securitized loans, the Company is obligated to advance interest payments for delinquent loans if we deem that the advances will ultimately be recoverable. These advances can first be made out of funds available in a trust's collection account. If the funds available from the trust's collection account are insufficient to make the required interest advances, then the Company is required to make the advance from its operating cash. The advances made from a trust's collection account, if not recovered from the borrower or proceeds from the liquidation of the loan, require reimbursement from the Company. However, the Company can recover any advances the Company makes from its operating cash from the subsequent month's mortgage loan payments to the applicable trust prior to any distributions to the certificate holders. 193 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 14. Commitments and Contingencies (continued) Periodic Advance Guarantees (continued) The Company adopted FIN 45 on a prospective basis for guarantees that are issued or modified after December 31, 2002. Based on the requirements of this guidance for the fiscal year ended June 30, 2003, the Company has recorded a $0.7 million liability in conjunction with the sale of mortgage loans to the ABFS 2003-1 securitization trust which occurred in March 2003. This liability represents its estimate of the fair value of periodic interest advances that the Company as servicer of the securitized loans, is obligated to pay to the trust on behalf of delinquent loans. The fair value of the liability was estimated based on an analysis of historical periodic interest advances and recoveries from securitization trusts. Other State and federal banking regulatory agencies, state attorneys general offices, the Federal Trade Commission, the U.S. Department of Justice, the U.S. Department of Housing and Urban Development and state and local governmental authorities have increased their focus on lending practices by some companies in the subprime industry, more commonly referred to as "predatory lending" practices. State, local and federal governmental agencies have imposed sanctions for practices including, but not limited to, charging borrowers excessive fees, imposing higher interest rates than the borrower's credit risk warrants and failing to adequately disclose the material terms of loans to the borrowers. As a result of these initiatives, the Company is unable to predict whether state, local or federal authorities will require changes in the Company's lending practices in the future, including the reimbursement of borrowers as a result of fees charged or the imposition of fines, or the impact of those changes on the Company's profitability. The Pennsylvania Attorney General reviewed certain fees charged to Pennsylvania customers by the Company's subsidiary, HomeAmerican Credit, Inc., which does business as Upland Mortgage. Although the Company believes that these fees were fair and in compliance with applicable federal and state laws, in April 2002 the Company agreed to reimburse borrowers approximately $221,000 with respect to a particular fee paid by borrowers from January 1, 1999 to mid-February 2001 and to reimburse the Commonwealth of Pennsylvania $50,000 for their costs of investigation and for future public protection purposes. The Company discontinued charging this particular fee in mid-February 2001. The Company has satisfied the monetary commitments and obligations to the Pennsylvania Attorney General. The reserve, which the Company previously established, was adequate to cover the resolution of this matter. 15. Legal Proceedings On February 26, 2002, a purported class action titled Calvin Hale v. HomeAmerican Credit, Inc., No. 02 C 1606, United States District Court for the Northern District of Illinois, was filed in the Circuit Court of Cook County, Illinois (subsequently removed by Upland Mortgage to the captioned federal 194 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 15. Legal Proceedings (continued) court) against the Company's subsidiary, HomeAmerican Credit, Inc., which does business as Upland Mortgage, on behalf of borrowers in Illinois, Indiana, Michigan and Wisconsin who paid a document preparation fee on loans originated since February 4, 1997. The case consisted of three purported class action counts and two individual counts. The plaintiff alleged that the charging of, and the failure to properly disclose the nature of, a document preparation fee were improper under applicable state law. In November 2002, the Illinois Federal District Court dismissed the three class action counts and an agreement in principle was reached in August 2003 to settle the matter. The terms of the settlement have been finalized and did not have a material effect on the Company's consolidated financial position or results of operations. The Company's lending subsidiaries, including HomeAmerican Credit, Inc. which does business as Upland Mortgage, are involved, from time to time, in class action lawsuits, other litigation, claims, investigations by governmental authorities, and legal proceedings arising out of their lending and servicing activities, including the purported class action entitled, Calvin Hale v. HomeAmerican Credit, Inc., d/b/a Upland Mortgage, described above. Due to the Company's current expectation regarding the ultimate resolution of these actions, management believes that the liabilities resulting from these actions will not have a material adverse effect on its consolidated financial position or results of operations. However, due to the inherent uncertainty in litigation and because the ultimate resolution of these proceedings are influenced by factors outside of the Company's control, the Company's estimated liability under these proceedings may change or actual results may differ from its estimates. Additionally, court decisions in litigation to which the Company is not a party may also affect its lending activities and could subject it to litigation in the future. For example, in Glukowsky v. Equity One, Inc., (Docket No. A-3202 - 01T3), dated April 24, 2003, to which the Company is not a party, the Appellate Division of the Superior Court of New Jersey determined that the Parity Act's preemption of state law was invalid and that the state laws precluding some lenders from imposing prepayment fees are applicable to loans made in New Jersey. The Company expects that, as a result of the publicity surrounding predatory lending practices and this recent New Jersey court decision regarding the Parity Act, it may be subject to other class action suits in the future. In addition, from time to time, the Company is involved as plaintiff or defendant in various other legal proceedings arising in the normal course of its business. While the Company cannot predict the ultimate outcome of these various legal proceedings, management believes that the resolution of these legal actions should not have a material effect on the Company's financial position, results of operations or liquidity. 195 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 16. Related Party Transactions The Company has a loan receivable from an officer of the Company for $600 thousand, which was an advance for the exercise of stock options to purchase 247,513 shares of the Company's common stock in 1995. The loan is due in September 2005 (earlier if the stock is disposed of). Interest at 6.46% is payable annually. The loan is secured by 247,513 shares of the Company's stock, and is shown as a reduction of stockholders' equity on the accompanying balance sheet. On April 2, 2001, the Company awarded 2,500 shares (3,025 shares after the effect of stock dividends) of its common stock to a director of the Company as a result of services rendered in connection with its stock repurchases. In February 2003, the Company awarded 2,000 shares of its common stock to each of two newly appointed members of its Board of Directors. The Company employs members of the immediate family of one of its directors and one of its non-director executive officers in various executive and other positions. The Company believes that the salaries paid to these individuals are competitive with salaries paid to other employees in similar positions within the Company and in its industry. Additionally, the Company has business relationships with other related parties including family members of one of its directors and one of its non-director executive officers through which the Company has, from time to time, purchased appraisal services, office equipment and real estate advisory services. None of these related party transactions, individually or collectively, are material to the Company's results of operations. 196 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 17. Fair Value of Financial Instruments No active market exists for certain of the Company's assets and liabilities. Therefore, fair value estimates are based on judgments regarding credit risk, investor expectation of future economic conditions, normal cost of administration and other risk characteristics, including interest rates and prepayment risk. These estimates are subjective in nature and involve uncertainties and matters of judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates. The following table summarizes the carrying amounts and fair value estimates of financial instruments recorded on the Company's financial statements at June 30, 2003 and 2002 (in thousands):
June 30, 2003 June 30, 2002 ------------------------ ------------------------- Carrying Carrying Value Fair Value Value Fair Value --------- ---------- ---------- ---------- Assets Cash and cash equivalents $ 47,475 $ 47,475 $ 108,599 $ 108,599 Loans and leases available for sale 271,402 272,991 57,677 67,145 Interest-only strips 598,278 598,278 512,611 512,611 Servicing rights 119,291 119,291 125,288 125,951 Investments held to maturity 881 946 917 989 Liabilities Subordinated debt and warehouse lines and notes payable $ 932,456 $ 931,302 $ 664,206 $ 663,212
The methodology and assumptions utilized to estimate the fair value of the Company's financial instruments are as follows: Cash and cash equivalents - For these short-term instruments, the carrying amount approximates fair value. Loans and leases available for sale - Fair value is determined by recent sales and securitizations. Interest-only strips - Fair value is determined using estimated discounted future cash flows taking into consideration anticipated prepayment rates and credit loss rates of the underlying loans and leases. Servicing rights - Fair value is determined using estimated discounted future cash flows taking into consideration anticipated prepayment rates and credit loss rates of the underlying loans and leases. Investments held to maturity - Represent mortgage loan backed securities retained in securitizations. Fair value is determined using estimated 197 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 17. Fair Value of Financial Instruments (continued) discounted future cash flows taking into consideration anticipated prepayment rates and credit loss rates of the underlying loans and pass through investment certificate interest rates of current securitizations. Subordinated debt and notes payable - The fair value of fixed debt is estimated using the rates currently available to the Company for debt of similar terms. The carrying value of mortgage backed securities retained in securitizations, which were held-to-maturity investment securities were as follows (in thousands): Gross Gross Amortized Unrealized Unrealized Cost Gains Losses Fair Value ------------------------------------------------------ June 30, 2003 $ 881 $ 65 $ -- $ 946 June 30, 2002 $ 917 $ 72 $ -- $ 989 Mortgage backed securities mature through November 2005. 18. Derivative Financial Instruments SFAS No. 133 was effective on a prospective basis for all fiscal quarters of fiscal years beginning after June 15, 2000. The adoption of SFAS No. 133 on July 1, 2000 resulted in the cumulative effect of a change in accounting principle of $15 thousand pre-tax being recognized as expense in the Consolidated Statement of Income for the year ended June 30, 2001. Due to the immateriality of the cumulative effect of adopting SFAS No. 133, the $15 thousand pre-tax expense is included in general and administrative expense in the Consolidated Statement of Income. The tax effects and earnings per share amounts related to the cumulative effect of adopting SFAS No. 133 are not material. Hedging activity Related to Loans Expected to Be Sold Through Securitizations. At the time the derivative contracts are executed, they are specifically designated as hedges of mortgage loans or the Company's residual interests in mortgage loans in its mortgage conduit facility, which the Company would expect to be included in a term securitization at a future date. The mortgage loans and mortgage loans underlying residual interests in mortgage pools consist of essentially similar pools of fixed interest rate loans, collateralized by real estate (primarily residential real estate) with similar maturities and similar credit characteristics. Fixed interest rate pass-through certificates issued by 198 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 18. Derivative Financial Instruments (continued) Hedging activity (continued) securitization trusts are generally priced to yield an interest rate spread above interest rate swap yield curves with maturities to match the maturities of the interest rate pass-through certificates. The Company may hedge potential interest rate changes in interest rate swap yield curves with forward starting interest rate swaps, Eurodollar futures, forward treasury sales or derivative contracts of similar underlying securities. This practice has provided strong correlation between the hedge contracts and the ultimate pricing that the Company will receive on the subsequent securitization. Related to Loans Expected to Be Sold Through Whole Loan Sale Transactions. The Company may also utilize derivative financial instruments in an attempt to mitigate the effect of changes in market interest rates between the date loans are originated at fixed interest rates and the date that the loans will be sold in a whole loan sale. At the time the derivative contracts are executed, they are specifically designated as hedges of mortgage loans or the Company's residual interests in mortgage loans in its mortgage conduit facility, which the Company would expect to be included in a whole loan sale transaction at a future date. The Company may hedge the effect of changes in market interest rates with forward sale commitments, forward starting interest rate swaps, Eurodollar futures, forward treasury sales or derivative contracts of similar underlying securities. On June 30, 2003, the Company entered into a forward sale agreement providing for the sale of $275 million of home equity mortgage loans at a price of 105.0%. Disqualified Hedging Relationship. The securitization market was not available to the Company in the fourth quarter of fiscal 2003. As a result, the Company realized that the expected high correlation between the changes in the fair values of the derivatives and the mortgage loans would not be achieved and discontinued hedge accounting. During the quarter ending June 30, 2003, $4.0 million of losses on $170.0 million of forward starting interest rate swaps previously designated as a hedge of mortgage loans expected to be securitized was charged to earnings. An offsetting increase of $3.7 million in the value of the hedged mortgage loans was recorded in earnings, representing the changes in value of the loans until the date that the Company learned that the securitization market was not available. The Company recorded the following gains and losses on the fair value of derivative financial instruments accounted for as hedging transactions or on disqualified hedging relationships for the years ended June 30, 2003, 2002 and 2001. Ineffectiveness related to qualified hedging relationships during the period was immaterial. Ineffectiveness is a measure of the difference in the change in fair value of the derivative financial instrument as compared to the change in the fair value of the item hedged (in thousands): 199 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 18. Derivative Financial Instruments (continued) Hedging activity (continued) Year Ended June 30, --------------------------------------- 2003 2002 2001 ------------- ----------- ----------- Offset by gains and losses recorded on securitizations: Losses on derivative financial instruments $ (3,806) $ (9,401) $ (4,343) Offset by gains and losses recorded on the fair value of hedged items: Losses on derivative financial instruments $ (7,037) $ -- $ -- Amount settled in cash - paid $ (5,041) $ (9,401) $ (4,343) At June 30, 2003, forward sale agreements and outstanding forward starting interest rate swap contracts accounted for as hedges and unrealized losses recorded as liabilities on the balance sheet were as follows (in thousands): Notional Unrealized Amount Loss --------- ------------ Forward sale agreement $ 275,000 $ -- Forward starting interest rate swaps $ -- $ (6,776)(a) (a) Represents the liability carried on the balance sheet at June 30, 2003 for previously recorded losses not yet settled in cash. There were no outstanding derivatives contracts accounted for as hedges at June 30, 2002 or 2001. Trading activity Generally, the Company does not enter into derivative financial instrument contracts for trading purposes. However, the Company has entered into derivative financial instrument contracts which have not been designated as hedges in accordance with SFAS No. 133 and were therefore accounted for as trading assets or liabilities. Related to Loans Expected to Be Sold Through Securitizations. During fiscal 2003, the Company used interest rate swap contracts to protect the future securitization spreads on loans in its pipeline. Loans in the pipeline represent loan applications for which the Company is in the process of obtaining all the documentation required for a loan approval or approved loans, which have not been accepted by the borrower and are not considered to be firm commitments. The 200 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 18. Derivative Financial Instruments (continued) Trading activity (continued) Company believed there was a greater chance that market interest rates that would be obtained on the subsequent securitization of these loans would increase rather than decline, and chose to protect the spread that could be earned in the event of rising rates. However due to a decline in market interest rates during the period the derivative contracts were used to manage interest rate risk on loans in the pipeline, the Company recorded losses on forward starting interest rate swap contracts during the fiscal year ended June 30, 2003. The losses are summarized in the table below. Related to Loans Expected to Be Sold Through Whole Loan Sale Transactions. The $170.0 million notional amount of forward starting interest rate swap contracts carrying over from the disqualified hedging relationship discussed above are currently being utilized to manage the effect of changes in market interest rates on the fair value of fixed-rate mortgage loans that were previously expected to be sold in a fourth quarter of fiscal 2003 securitization, but are now expected to be sold in whole loan sale transactions. The Company has elected not to designate these derivative contracts as an accounting hedge. The following gains and losses were recorded on the fair value of derivative financial instruments classified as trading for the year ended June 30, 2003. There were no derivative contracts classified as trading for the years ended June 30, 2002 and 2001 except those noted below to manage the exposure to changes in the fair value of certain interest-only strips due to changes in one-month LIBOR. (in thousands): Trading gains(losses) on forward starting interest rate swaps: Related to loan pipeline $ (3,796) Related to whole loan sales $ 441 Amount settled in cash - paid $ (2,671) At June 30, 2003, outstanding forward starting interest rate swap contracts used to manage interest rate risk on loans expected to be sold in whole loan sale transactions and the associated unrealized gains recorded as assets on the balance sheet are summarized in the table below. There were no open derivative contracts classified as trading for the years ended June 30, 2002 and 2001 except those noted below to manage the exposure to changes in the fair value of certain interest-only strips due to changes in one-month LIBOR. (in thousands): 201 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 18. Derivative Financial Instruments (continued) Trading activity (continued) Notional Unrealized Amount Gain --------- ----------- Forward starting interest rate $170,000 $ 441 swaps The sensitivity of the forward starting interest rate swap contracts held as trading as of June 30, 2003 to a 0.1% change in market interest rates is $0.1 million. Related to Interest-only Strips. For fiscal years ended June 30, 2003 and 2002, respectively, the Company recorded net losses of $0.9 million and $0.7 million on an interest rate swap contract which was not designated as an accounting hedge. This contract was designed to reduce the exposure to changes in the fair value of certain interest-only strips due to changes in one-month LIBOR. The loss on the swap contract was due to decreases in the interest rate swap yield curve during the periods the contract was in place. Included in the $0.9 million net loss recorded in the fiscal year ended June 30, 2003, were unrealized gains of $0.1 million representing the net change in the fair value of the contract during the fiscal year and $1.0 million of cash losses paid during the fiscal year. Included in the $0.7 million net loss recorded in the fiscal year ended June 30, 2002, were unrealized losses of $0.5 million representing the net change in the fair value of the contract during the fiscal year and $0.2 million of cash losses paid during the fiscal year. The cumulative net unrealized loss of $0.3 million is included as a trading liability in Other liabilities. Terms of the interest rate swap contract at June 30, 2003 were as follows (dollars in thousands): Notional amount $ 44,535 Rate received - Floating (a) 1.18% Rate paid - Fixed 2.89% Maturity date April 2004 Unrealized loss $ 334 Sensitivity to 0.1% change in interest rates $ 17 - ---------- (a) Rate represents the spot rate for one-month LIBOR paid on the securitized floating interest rate certificate at the end of the period. 202 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 19. Reconciliation of Basic and Diluted Earnings Per Common Share
Year ended June 30, 2003 2002 2001 ----------------------------------------------------- (in thousands except per share data) (Numerator) Income (loss) before cumulative effect of a change in accounting principle $ (29,902) $ 7,859 $ 7,911 Cumulative effect of a change in accounting principle - - 174 ----------------------------------------------------- Net income (loss) $ (29,902) $ 7,859 $ 8,085 ===================================================== (Denominator) Average Common Shares: Average common shares outstanding 2,918 2,934 3,797 Average potentially dilutive shares (a) 221 88 ----------------------------------------------------- Average common and potentially dilutive shares 2,918 3,155 3,885 ===================================================== Earnings (loss) per common share: Basic: Income (loss) before cumulative effect of a change in accounting principle $ (10.25) $ 2.68 $ 2.08 Cumulative effect of a change in accounting principle - - 0.05 ----------------------------------------------------- Net income (loss) $ (10.25) $ 2.68 $ 2.13 ===================================================== Diluted: Income (loss) before cumulative effect of a change in accounting principle $ (10.25) $ 2.49 $ 2.04 Cumulative effect of a change in accounting principle - - 0.04 ----------------------------------------------------- Net income (loss) $ (10.25) $ 2.49 $ 2.08 =====================================================
- ---------- (a) Anti-dilutive in fiscal year 2003. 203 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 20. Segment Information The Company has three operating segments: Loan Origination, Servicing and Treasury and Funding. The Loan Origination segment originates business purpose loans secured by real estate and other business assets, home equity loans typically to credit-impaired borrowers and loans secured by one to four family residential real estate. The Servicing segment services the loans originated by the Company both while held as available for sale by the Company and subsequent to securitization. Servicing activities include billing and collecting payments from borrowers, transmitting payments to securitization trust investors, accounting for principal and interest, collections and foreclosure activities and disposing of real estate owned. The Treasury and Funding segment offers the Company's subordinated debt securities pursuant to a registered public offering and obtains other sources of funding for the Company's general operating and lending activities. The All Other caption on the following tables mainly represents segments that do not meet the SFAS No. 131 "Disclosures about Segments of an Enterprise and Related Information" defined thresholds for determining reportable segments, financial assets not related to operating segments and is mainly comprised of interest-only strips, unallocated overhead and other expenses of the Company unrelated to the reportable segments identified. The reporting segments follow the same accounting policies used for the Company's consolidated financial statements as described in the summary of significant accounting policies. Management evaluates a segment's performance based upon profit or loss from operations before income taxes. Reconciling items represent elimination of inter-segment income and expense items, and are included to reconcile segment data to the consolidated financial statements. 204 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 20. Segment Information (continued)
Year ended June 30, 2003 ------------------------------------------------------------------------------------ Loan Treasury and Reconciling Origination Funding Servicing All Other Items Consolidated ------------------------------------------------------------------------------------ (in thousands) External revenues: Gain on sale of loans: Securitizations $ 170,950 $ - $ - $ - $ - $ 170,950 Whole loan sales 655 - - - - 655 Interest income 9,311 422 762 47,347 - 57,842 Non-interest income 8,295 4 45,480 - (41,820) 11,959 Inter-segment revenues - 75,422 - 74,752 (150,174) - Operating expenses: Interest expense 20,970 66,526 2,467 53,557 (75,422) 68,098 Non-interest expense 52,471 9,079 42,542 64,406 - 168,498 Depreciation and amortization 3,236 108 1,168 4,136 - 8,648 Interest-only strips valuation adjustment - - - 45,182 - 45,182 Inter-segment expense 116,572 - - - (116,572) - Income tax expense (benefit) (1,575) 53 25 (17,621) - (19,118) ------------------------------------------------------------------------------------ Net income (loss) $ (2,463) $ 82 $ 40 $ (27,561) $ - $ (29,902) ==================================================================================== Segment assets $ 349,207 $ 156,082 $ 111,254 $ 639,377 $ (96,569) $ 1,159,351 ====================================================================================
205 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 20. Segment Information (continued)
Year ended June 30, 2002 ------------------------------------------------------------------------------------ Loan Treasury and Reconciling Origination Funding Servicing All Other Items Consolidated ------------------------------------------------------------------------------------ (in thousands) External revenues: Gain on sale of loans and leases Securitizations $ 185,580 $ - $ - $ - $ - $ 185,580 Whole loan sales 2,448 - - - - 2,448 Interest income 7,199 998 1,309 35,386 - 44,892 Non-interest income 9,198 1 35,387 102 (29,707) 14,981 Inter-segment revenues - 70,586 - 68,335 (138,921) - Operating expenses: Interest expense 22,387 67,256 298 49,328 (70,586) 68,683 Non-interest expense 41,547 11,613 31,375 52,163 - 136,698 Depreciation and amortization 3,348 142 1,095 2,332 - 6,917 Interest-only strips valuation adjustment - - - 22,053 - 22,053 Inter-segment expense 98,042 - - - (98,042) - Income tax expense (benefit) 16,423 (3,119) 1,650 (9,263) - 5,691 ------------------------------------------------------------------------------------ Net income (loss) $ 22,678 $ (4,307) $ 2,278 $ (12,790) $ - $ 7,859 ==================================================================================== Segment assets $ 95,017 $ 202,621 $ 124,914 $ 541,950 $ (88,127) $ 876,375 ====================================================================================
206 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 21. Quarterly Data Statement (unaudited) The interim financial statements below contain all adjustments (consisting of normal recurring accruals and the elimination of intercompany balances) necessary in management's opinion for a fair presentation of financial position and results of operations. The following tables summarize financial data by quarters (in thousands, except per share amounts):
Fiscal 2003 Quarters Ended ------------------------------------------------------------------------------ June 30, March 31, December 31, September 30, ------------------------------------------------------------------------------ Revenues Gain on sale of loans and leases Securitizations $ 556 $ 54,504 $ 57,879 $ 58,011 Whole sale loans 626 (4) (2) 35 Interest and fees 6,002 4,665 4,595 4,133 Interest accretion on interest-only strips 12,986 12,114 11,500 10,747 Servicing income 382 486 644 1,537 Other income 3 1 2 4 ------------------------------------------------------------------------------ Total revenues 20,555 71,766 74,618 74,467 Total expenses (a) 76,383 71,737 70,979 71,327 ------------------------------------------------------------------------------ Income (loss) before provision for income tax expense (55,828) 29 3,639 3,140 Provision for income tax expense (benefit) (21,773) (192) 1,528 1,319 ------------------------------------------------------------------------------ Net income (loss) $ (34,055) $ 221 $ 2,111 $ 1,821 ============================================================================== Earnings (loss) per common share: Basic $ (11.68) $ 0.07 $ 0.72 $ 0.64 Diluted $ (11.68) $ 0.06 $ 0.69 $ 0.61
(a) Includes pre-tax adjustments to the fair value of securitization assets of $11.8 million, $10.7 million, $10.6 and $12.1 million for the quarters ended June 30, March 31, December 31 and September 30, respectively. 207 American Business Financial Services, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued) June 30, 2003 21. Quarterly Data Statement (unaudited) (continued)
Fiscal 2002 Quarters Ended ----------------------------------------------------------------------------- June 30, March 31, December 31, September 30, ----------------------------------------------------------------------------- Revenues Gain on sale of loans and leases Securitizations $ 56,441 $ 49,220 $ 44,563 $ 35,356 Whole sale loans 74 540 641 1,193 Interest and fees 4,505 4,752 4,885 4,748 Interest accretion on interest-only strips 9,466 9,538 8,646 7,736 Servicing income 1,267 1,282 1,298 1,636 Other income 7 103 1 3 ----------------------------------------------------------------------------- Total revenues 71,760 65,435 60,034 50,672 Total expenses (a) 67,818 62,399 55,810 48,324 ----------------------------------------------------------------------------- Income before provision for income tax expense 3,942 3,036 4,224 2,348 Provision for income tax expense 1,656 1,275 1,774 986 ----------------------------------------------------------------------------- Net Income $ 2,286 $ 1,761 $ 2,450 $ 1,362 ============================================================================= Earnings per common share: Basic $ 0.80 $ 0.58 $ 0.87 $ 0.43 Diluted $ 0.75 $ 0.55 $ 0.79 $ 0.40
(a) Includes pre-tax adjustments to the fair value of securitization assets of $8.9 million, $8.7 million and $4.5 million for the quarters ended June 30, March 31 and December 31, respectively. 208 Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure --------------------------------------------------------------- On August 2, 2001, Ernst & Young LLP resigned as our independent accountants. Ernst & Young LLP had been engaged as our auditor on May 17, 2001, replacing BDO Seidman, LLP. During the period of engagement through August 2, 2001, Ernst & Young LLP did not issue any reports on our financial statements. During fiscal 2001 and the subsequent interim period through August 2, 2001, we did not have any disagreements with Ernst & Young LLP, on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of Ernst & Young LLP, would have caused it to make a reference to the subject matter of the disagreements in connection with its report. During fiscal 2001 and the subsequent interim period through August 2, 2001, none of the events described in Regulation S-K Item 304 (a)(1)(v) occurred. Our Board of Directors approved the reengagement of BDO Seidman, LLP as the Company's independent accountants effective August 8, 2001. BDO Seidman, LLP acted as our independent accountants during the two-year period ended June 30, 2000 through May 17, 2001. During the two years ended June 30, 2000 and the subsequent interim period through May 17, 2001, we consulted with BDO Seidman, LLP regarding the application of accounting principles in the normal course of BDO Seidman, LLP's engagement as our independent auditors. BDO Seidman, LLP issued reports on our financial statements during the two-year period ended June 30, 2000. The reports of BDO Seidman, LLP on our financial statements during the two-year period ended June 30, 2000 did not contain an adverse opinion, or a disclaimer of opinion, and were not qualified or modified as to uncertainty, audit scope or accounting principles. During the two-year period ended June 30, 2000, and interim period from July 1, 2000 through May 17, 2001, we did not have any disagreements with BDO Seidman, LLP, on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of BDO Seidman, LLP, would have caused it to make a reference to the subject matter of the disagreements in connection with its report. Item 9A. Controls and Procedures ----------------------- The Company, under the supervision and with the participation of its management, including its principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of its disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation, the principal executive officer and principal financial officer concluded that the Company's disclosure controls and procedures are effective in reaching a reasonable level of assurance that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time period specified in the Securities and Exchange Commission's rules and forms. 209 The principal executive officer and principal financial officer also conducted an evaluation of internal control over financial reporting ("Internal Control") to determine whether any changes in Internal Controls occurred during the quarter that have materially affected or which are reasonably likely to materially affect Internal Controls. Based on that evaluation, there has been no such change during the quarter covered by this report. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. The Company conducts periodic evaluations to enhance, where necessary its procedures and controls. 210 PART III Item 10. Directors and Executive Officers of the Registrant -------------------------------------------------- The information required to be included in Item 10 of Part III of this Form 10-K incorporates by reference certain information from our definitive proxy statement for our 2003 Annual Meeting of Stockholders to be filed with the SEC not later than 120 days after the end of our fiscal year covered by this report. For information regarding our executive officers, See "Item 1. Business - -- Executive Officers Who Are Not Also Directors." Section 16(a) Beneficial Ownership Reporting Compliance Section 16(a) of the Exchange Act ("Section 16(a)") requires our directors, executive officers, and persons who own more than 10% of a registered class of our equity securities, to file with the SEC initial reports of ownership and reports of changes in ownership of our common stock and other equity securities. Officers, directors and greater than 10% stockholders are required by SEC regulation to furnish us with copies of all Section 16(a) forms they file. To our knowledge, based solely on a review of the copies of such reports furnished to us and written representations that no other reports were required, during the fiscal year ended June 30, 2003, our officers, directors and greater than 10% beneficial owners have complied with all Section 16(a) filing requirements. Item 11. Executive Compensation ----------------------- The information required to be included in Item 11 of Part III of this Form 10-K incorporates by reference certain information from our definitive proxy statement, for our 2003 Annual Meeting of Stockholders to be filed with the SEC not later than 120 days after the end of our fiscal year covered by this report. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters ------------------------------------------------------------------- The information required to be included in Item 12 of Part III of this Form 10-K incorporates by reference certain information from our definitive proxy statement, for our 2003 Annual Meeting of Stockholders to be filed with the SEC not later than 120 days after the end of our fiscal year covered by this report. For information, including a tabular presentation, regarding our securities authorized for issuance under equity compensation plans, see "Item 5. Market for Registrant's Common Stock and Related Stockholder Matters." 211 Item 13. Certain Relationships and Related Transactions ---------------------------------------------- The information required to be included in Item 13 of Part III of this Form 10-K incorporates by reference certain information from our definitive proxy statement for our 2003 Annual Meeting of Stockholders to be filed with the SEC not later than 120 days after the end of our fiscal year covered by this report. Item 14. Principal Accounting Fees and Services -------------------------------------- The information required to be included in Item 14 of Part III of this Form 10-K incorporates by reference certain information from our definitive proxy statement for our 2003 Annual Meeting of Stockholders to be filed with the SEC not later than 120 days after the end of our fiscal year covered by this report. PART IV Item 15. Exhibits and Reports on Form 8-K --------------------------------
Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 3.1 Amended and Restated Certificate of Incorporation (Incorporated by reference from Exhibit 3.1 to the Quarterly Report on Form 10-Q filed February 14, 2003). 3.2 Amended and Restated Bylaws (Incorporated by reference from Exhibit 3.2 to the Quarterly Report on Form 10-Q filed February 14, 2003). 4.1 Form of Unsecured Investment Note (Incorporated by reference from Exhibit 4.1 of Amendment No. 1 to the Registration Statement on Form SB-2 filed April 29, 1994, Registration Number 33-76390). 4.2 Form of Unsecured Investment Note issued pursuant to Indenture with First Trust, National Association, a national banking association (Incorporated by reference from Exhibit 4.5 of Amendment No. One to the Registration Statement on Form SB-2 filed on December 14, 1995, Registration Number 33-98636 (the "1995 Form SB-2")). 4.3 Form of Indenture by and between ABFS and First Trust, National Association, a national banking association (Incorporated by reference from Exhibit 4.6 of the Registration Statement on Form SB-2 filed on October 26, 1995, Registration Number 33-98636). 4.4 Form of Indenture by and between ABFS and First Trust, National Association, a national banking association (Incorporated by reference from Exhibit 4.4 of the Registration Statement on Form SB-2 filed March 28, 1997, Registration Number 333-24115 (the "1997 Form SB-2")). 4.5 Form of Unsecured Investment Note (Incorporated by reference from Exhibit 4.5 of the 1997 Form SB-2). 4.6 Form of Indenture by and between ABFS and First Trust, National Association, a national banking association (Incorporated by reference from Exhibit 4.4 of the Registration Statement on Form SB-2 filed May 23, 1997, Registration Number 333-24115). 4.7 Form of Unsecured Investment Note (Incorporated by reference from Exhibit 4.5 of the Registration Statement on Form SB-2 filed May 23, 1997, Registration Number 333-24115).
212
Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 4.8 Form of Indenture by and between ABFS and U.S. Bank Trust, National Association, a national banking association (Incorporated by reference from Exhibit 4.8 of Registrant's Registration Statement on Form S-2, No. 333-63859, filed September 21, 1998). 4.9 Form of Unsecured Investment Note (Incorporated by reference from Exhibit 4.9 of Registrant's Registration Statement on Form S-2, No. 333-63859, filed September 21, 1998). 4.10 Form of Indenture by and between ABFS and U.S. Bank Trust National Association (Incorporated by reference from Exhibit 4.10 of Registrant's Registration Statement on Form S-2, No. 333-87333, filed September 17, 1999). 4.11 Form of Indenture by and between ABFS and U.S. Bank Trust National Association. (Incorporated by reference from Exhibit 4.11 of Registrant's Registration Statement on Form S-2, No. 333-40248, filed June 27, 2000). 4.12 Form of Investment Note. (Incorporated by reference from Exhibit 4.12 of Registrant's Registration Statement on Form S-2, No. 333-40248, filed June 27, 2000). 4.13 Form of Indenture by and between ABFS and U.S. Bank Trust National Association. (Incorporated by reference from Exhibit 4.13 of Registrant's Registration Statement on Form S-2, No. 333-63014, filed on June 14, 2001). 4.14 Form of Investment Note. (Incorporated by reference from Exhibit 4.14 of Registrant's Registration Statement on Form S-2, No. 333-63014, filed on June 14, 2001). 4.15 Form of Indenture by and between ABFS and U.S. Bank National Association. (Incorporated by reference from Exhibit 4.15 of Registrant's Registration Statement on Form S-2, No. 333-90366, filed on June 12, 2002). 4.16 Form of Investment Note. (Incorporated by reference from Exhibit 4.16 of Registrant's Registration Statement on Form S-2, No. 333-90366, filed on June 12, 2002). 4.17 Form of Indenture by and between ABFS and U.S. Bank National Association (Incorporated by reference from Exhibit 4.17 of Registrant's Registration Statement on Form S-2, No. 333-106476, filed on June 25, 2003). 4.18 Form of Investment Note (Incorporated by reference from Exhibit 4.18 of Registrant's Registration Statement on Form S-2, No. 333-106476, filed on June 25, 2003).
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Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 10.1 Amended and Restated Stock Option Plan (Incorporated by reference from Exhibit 10.2 of ABFS' Quarterly Report on Form 10-QSB from the quarter ended September 30, 1997, File No. 0-22474).** 10.2 Stock Option Award Agreement (Incorporated by reference from Exhibit 10.1 of the Registration Statement on Form S-11 filed on February 26, 1993, Registration No. 33-59042 (the "Form S-11")).** 10.3 1995 Stock Option Plan for Non-Employee Directors (Incorporated by reference from Exhibit 10.6 of the Amendment No. 1 to the 1996 Form SB-2 filed on February 4, 1996 Registration No. 333-18919 (the "Amendment No. 1 to the 1996 Form SB-2")).** 10.4 Form of Option Award Agreement for Non-Employee Directors Plan for Formula Awards (Incorporated by reference from Exhibit 10.13 of the 1996 Form 10-KSB).** 10.5 1997 Non-Employee Director Stock Option Plan (including form of Option Agreement) (Incorporated by reference from Exhibit 10.1 of the September 30, 1997 Form 10-QSB).** 10.6 Lease dated January 7, 1994 by and between TCW Realty Fund IV Pennsylvania Trust and ABFS (Incorporated by reference from Exhibit 10.9 of the Registration Statement on Form SB-2 filed March 15, 1994, File No. 33-76390). 10.7 First Amendment to Agreement of Lease by and between TCW Realty Fund IV Pennsylvania Trust and ABFS dated October 24, 1994. (Incorporated by reference from Exhibit 10.9 of ABFS' Annual Report on Form 10-KSB for the fiscal year ended June 30, 1995 (the "1995 Form 10-KSB")). 10.8 Second Amendment to Agreement of Lease by and between TCW Realty Fund IV Pennsylvania Trust and ABFS dated December 23, 1994 (Incorporated by reference from Exhibit 10.10 of the 1995 Form 10-KSB). 10.9 Third Amendment to Lease between TCW Realty Fund IV Pennsylvania Trust and ABFS dated July 25, 1995 (Incorporated by reference from Exhibit 10.11 of the 1995 Form 10-KSB). 10.10 Promissory Note of Anthony J. Santilli and Stock Pledge Agreement dated September 29, 1995 (Incorporated by reference from Exhibit 10.14 of the 1995 Form SB-2). 10.11 Form of Employment Agreement with Anthony J. Santilli, Beverly Santilli and Jeffrey M. Ruben (Incorporated by reference from Exhibit 10.15 of the Amendment No. 1 to the 1996 Form SB-2).**
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Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 10.12 Amendment One to Anthony J. Santilli's Employment Agreement (Incorporated by reference from Exhibit 10.3 of the September 30, 1997 Form 10-QSB).** 10.13 Amendment One to Beverly Santilli's Employment Agreement (Incorporated by reference from Exhibit 10.4 of the September 30, 1997 Form 10-QSB).** 10.14 Management Incentive Plan (Incorporated by reference from Exhibit 10.16 of the 1996 Form SB-2).** 10.15 Form of Option Award Agreement for Non-Employee Directors Plan for Non-Formula Awards (Incorporated by reference from Exhibit 10.18 of the Amendment No. 1 to the 1996 Form SB-2).** 10.16 Form of Pooling and Servicing Agreement related to the Company's loan securitizations dated May 1, 1996, August 31, 1996, February 28, 1997, September 1, 1997, February 1, 1998, June 1, 1998, and September 1, 1998 (Incorporated by reference from Exhibit 4.1 of ABFS' Quarterly Report on Form 10-QSB for the quarter ended March 31, 1995 (the "March 31, 1995 Form 10-QSB")). 10.17 Form of Sales and Contribution Agreement related to the Company's loan securitizations dated May 1, 1996 and September 27, 1996 (Incorporated by reference from Exhibit 4.1 of the March 31, 1995 Form 10-QSB). 10.18 Form of Indenture related to the Company's loan securitizations dated December 1, 1998, March 1, 1999, June 1, 1999, September 1, 1999, December 1, 1999, March 1, 2000, June 1, 2000, September 1, 2000, December 1, 2000, September 1, 2001 and December 1, 2001. (Incorporated by reference from Exhibit 10.18 to the Registration Statement on Form S-2 filed June 14, 2001, Registration No. 333-63014 (the "2001 Form S-2")). 10.19 Form of Unaffiliated Seller's Agreement related to the Company's loan securitizations dated December 1, 1998, March 1, 1999, June 1, 1999, September 1, 1999, December 1, 1999, March 1, 2000, June 1, 2000, September 1, 2000, December 1, 2000, September 1, 2001 and December 1, 2001. (Incorporated by reference from Exhibit 10.19 to the 2001 Form S-2). 10.20 Fourth Amendment to Lease between TCW Realty Fund IV Pennsylvania Trust and ABFS dated April 9, 1996 (Incorporated by reference from Exhibit 10.22 to the Amendment No. 1 to the 1997 SB-2). 10.21 Fifth Amendment to Lease between TCW Realty Fund IV Pennsylvania Trust and ABFS dated October 8, 1996 (Incorporated by reference from Exhibit 10.23 to the Amendment No. 1 to the 1997 SB-2).
215
Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 10.22 Sixth Amendment to Lease between TCW Realty Fund IV Pennsylvania Trust and ABFS dated March 31, 1997 (Incorporated by reference from Exhibit 10.24 to the Amendment No. 1 to the 1997 SB-2). 10.23 Agreement for Purchase and Sale of Stock between Stanley L. Furst, Joel E. Furst and ABFS dated October 27, 1997 (Incorporated by reference from ABFS' Current Report on Form 8-K dated October 27, 1997, File No. 0-22747). 10.24 Standard Form of Office Lease and Rider to Lease dated April 2, 1993 by and between 5 Becker Farm Associates and NJMIC (Incorporated by reference from Exhibit 10.29 of Post-Effective Amendment No. 1 to the Registration Statement on Form SB-2 filed on January 22, 1998, Registration No. 333-2445). 10.25 First Amendment of Lease by and between 5 Becker Farm Associates and NJMIC dated July 27, 1994 (Incorporated by reference from Exhibit 10.30 of Post-Effective Amendment No. 1 to the Registration Statement on Form SB-2 filed on January 22, 1998, Registration No. 333-2445). 10.26 Form of Debenture Note related to NJMIC's subordinated debt (Incorporated by reference from Exhibit 10.31 of Post-Effective Amendment No. 1 to the Registration Statement on Form SB-2 filed on January 22, 1998, Registration No. 333-2445). 10.27 Form of Standard Terms and Conditions of Servicing Agreement related to NJMIC's lease securitizations dated May 1, 1995 and March 1, 1996. (Incorporated by reference from Exhibit 10.33 of Post-Effective Amendment No. 1 to the Registration Statement on Form SB-2 filed on January 22, 1998, Registration No. 333-2445). 10.28 Form of Standard Terms and Conditions of Lease Acquisition Agreement related to NJMIC's lease securitizations dated May 1, 1995 and March 1, 1996 (Incorporated by reference from Exhibit 10.34 of Post-Effective Amendment No. 1 to the Registration Statement on Form SB-2 filed on January 22, 1998, Registration No. 333-2445). 10.29 Amended and Restated Specific Terms and Conditions of Servicing Agreement related to NJMIC's lease securitization dated May 1, 1995 (Incorporated by reference from Exhibit 10.35 of Post-Effective Amendment No. 1 to the Registration Statement on Form SB-2 filed on January 22, 1998, Registration No. 333-2445).
216
Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 10.30 Amended and Restated Specific Terms and Conditions of Lease Acquisition Agreement related to NJMIC's lease securitization dated May 1, 1995 (Incorporated by reference from Exhibit 10.36 of Post-Effective Amendment No. 1 to the Registration Statement on Form SB-2 filed on January 22, 1998, Registration No. 333-2445). 10.31 Specific Terms and Conditions of Servicing Agreement related to NJMIC's lease securitization dated March 1, 1996 (Incorporated by reference from Exhibit 10.37 of Post-Effective Amendment No. 1 to the Registration Statement on Form SB-2 filed on January 22, 1998, Registration No. 333-2445). 10.32 Specific Terms and Conditions of Lease Acquisition Agreement related to NJMIC's lease securitization dated March 1, 1996 (Incorporated by reference from Exhibit 10.38 of Post-Effective Amendment No. 1 to the Registration Statement on Form SB-2 filed on January 22, 1998, Registration No. 333-2445). 10.33 Form of Indenture related to the lease-backed securitizations among ABFS Equipment Contract Trust 1998-A, American Business Leasing, Inc. and The Chase Manhattan Bank dated June 1, 1998 and among ABFS Equipment Contract Trust 1999-A, American Business Leasing, Inc. and The Chase Manhattan Bank dated June 1, 1999. (Incorporated by reference from Exhibit 10.39 of Registrant's Registration Statement on Form S-2, No. 333-63859, filed September 21, 1998). 10.34 Form of Receivables Sale Agreement related to the lease-backed securitizations ABFS Equipment Contract Trust 1998-A, dated June 1, 1998, and ABFS Equipment Contract Trust 1999-A, dated June 1, 1999. (Incorporated by reference from Exhibit 10.34 of the 2001 Form S-2). 10.35 Form of Unaffiliated Seller's Agreement related to the Company's home equity loan securitizations dated March 27, 1997, September 29, 1997, February 1, 1998, June 1, 1998, and September 1, 1998 (Incorporated by reference from Exhibit 10.40 of Registrant's Registration Statement on Form S-2, No. 333-63859, filed September 21, 1998). 10.36 $100.0 Million Receivables Purchase Agreement, dated September 30, 1998 among American Business Lease Funding Corporation, American Business Leasing, Inc. and a syndicate of financial institutions led by First Union Capital Markets and First Union National Bank, as liquidity agent. (Incorporated by reference from Exhibit 10.1 of the Registrant's September 30, 1998 Form 10-Q). 10.37 Lease Agreement dated August 30, 1999 related to One Presidential Boulevard, Bala Cynwyd, Pennsylvania (Incorporated by reference to Exhibit 10.1 of the Registrant's September 30, 1999 Form 10-Q).
217
Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 10.38 Employment Agreement between American Business Financial Services, Inc. and Albert Mandia (Incorporated by reference to Exhibit 10.2 of the Registrant's September 30, 1999 Form 10-Q).** 10.39 Change in Control Agreement between American Business Financial Services, Inc. and Albert Mandia (Incorporated by reference to Exhibit 10.3 of the Registrant's September 30, 1999 Form 10-Q).** 10.40 American Business Financial Services, Inc. Amended and Restated 1999 Stock Option Plan (Incorporated by reference from Exhibit 10.4 of the Registrant's Quarterly Report on Form 10-Q from the quarter ended September 30, 2001 filed on November 14, 2001).** 10.41 Amendment No. 3 to Receivables Purchase Agreement, dated as of October 13, 1999 among American Business Lease Funding Corporation, American Business Leasing, Inc. and a syndicate of financial institutions led by First Union Securities, Inc. as Deal Agent (Incorporated by reference from Exhibit 10.3 of the Registrant's December 31, 1999 Form 10-Q). 10.42 Amendment No. 4, dated as of November 12, 1999, to the Receivables Purchase Agreement, dated as of September 30, 1998, among American Business Lease Funding Corporation, American Business Leasing, Inc. and a syndicate of financial institutions led by First Union Securities, Inc. as Deal Agent (Incorporated by reference from Exhibit 10.4 of the Registrant's December 31, 1999 Form 10-Q). 10.43 Amendment No. 5, dated as of November 29, 1999, to the Receivables Purchase Agreement, dated as of September 30, 1998, among American Business Lease Funding Corporation, American Business Leasing, Inc. and a syndicate of financial institutions led by First Union Securities, Inc. as Deal Agent (Incorporated by reference from Exhibit 10.5 of the Registrant's December 31, 1999 Form 10-Q). 10.44 Amendment No. 6, dated as of December 14, 1999, to the Receivables Purchase Agreement, dated as of September 30, 1998, among American Business Lease Funding Corporation, American Business Leasing, Inc. and a syndicate of financial institutions led by First Union Securities, Inc. as Deal Agent (Incorporated by reference from Exhibit 10.6 of the Registrant's December 31, 1999 Form 10-Q). 10.45 Seventh Amendment, dated as of December 31, 1999, to the Receivables Purchase Agreement, dated as of September 30, 1998, among American Business Lease Funding Corporation, American Business Leasing, Inc. and a syndicate of financial institutions led by First Union Securities, Inc. as Deal Agent (Incorporated by reference from Exhibit 10.7 of the Registrant's December 31, 1999 Form 10-Q).
218
Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 10.46 Eight Amendment, dated as of January 10, 2000, to the Receivables Purchase Agreement, dated as of September 30, 1998, among American Business Lease Funding Corporation, American Business Leasing, Inc. and a syndicate of financial institutions led by First Union Securities, Inc. as Deal Agent (Incorporated by reference from Exhibit 10.8 of the Registrant's December 31, 1999 Form 10-Q). 10.47 Sale and Servicing Agreement, dated as of March 1, 2000, by and among Prudential Securities Secured Financing Corporation, ABFS Mortgage Loan Trust 2000-1, Chase Bank of Texas, N.A., as collateral agent, The Chase Manhattan Bank, as indenture trustee and American Business Credit, Inc., as Servicer (Incorporated by reference from Exhibit 10.1 of the Registrant's March 31, 2000 Form 10-Q). 10.48 Warehousing Credit and Security Agreement dated as of May 5, 2000 between New Jersey Mortgage and Investment Corp., American Business Credit, Inc., HomeAmerican Credit, Inc. d/b/a Upland Mortgage and Residential Funding Corporation. (Incorporated by reference from Exhibit 10.63 of Registrant's Registration Statement on Form S-2, No. 333-40248, filed June 27, 2000). 10.49 Sale and Servicing Agreement dated as of July 6, 2000 by and among ABFS Greenmont, Inc., as Depositor, HomeAmerican Credit, Inc., d/b/a Upland Mortgage, and New Jersey Mortgage and Investment Corp., as Originators and Subservicers, ABFS Mortgage Loan Warehouse Trust 2000-2, as Trust, American Business Credit, Inc., as an Originator and Servicer, American Business Financial Services, Inc., as Sponsor, and The Chase Manhattan Bank, as Indenture Trustee and Collateral Agent (Incorporated by reference from Exhibit 10.64 of the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 2000 (the "2000 Form 10-K")). 10.50 Indenture dated as of July 6, 2000 between ABFS Mortgage Loan Warehouse Trust 2000-2 and The Chase Manhattan Bank. (Incorporated by reference from Exhibit 10.65 of the 2000 Form 10-K). 10.51 Employment Agreement by and between American Business Financial Services, Inc. and Milton Riseman (Incorporated by reference from Exhibit 10.66 of the 2000 Form 10-K).** 10.52 Letter Employment Agreement by and between American Business Financial Services, Inc. and Ralph Hall (Incorporated by reference from Exhibit 10.67 of the 2000 Form 10-K).**
219
Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 10.53 Master Loan and Security Agreement, dated as of January 22, 2001, between American Business Credit, Inc., HomeAmerican Credit, Inc., d/b/a Upland Mortgage, and American Business Mortgage Services, Inc., f/k/a New Jersey Mortgage and Investment Corp., as Borrowers, American Business Financial Services, Inc., as Guarantor, and Morgan Stanley Dean Witter Mortgage Capital Inc., as Lender (Incorporated by reference from Exhibit 10.1 of Registrant's December 31, 2000 Form 10-Q). 10.54 Senior Secured Credit Agreement, among: American Business Credit, Inc. ("ABC"), a Pennsylvania corporation, HomeAmerican Credit, Inc. ("HAC"), a Pennsylvania corporation doing business under the assumed or fictitious name Upland Mortgage, and New Jersey Mortgage and Investment Corp., a New Jersey corporation whose name will be changed in January 2001 to American Business Mortgage, American Business Financial Services, Inc. (the "Parent"), and The Chase Manhattan Bank (Incorporated by reference from Exhibit 10.2 of Registrant's December 31, 2000 Form 10-Q). 10.55 Sale and Servicing Agreement, dated as of March 1, 2001, by and among ABFS OSO, Inc., a Delaware corporation, as the Depositor, American Business Credit, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc., d/b/a Upland Mortgage, a Pennsylvania corporation, and American Business Mortgage Services, Inc., a New Jersey corporation, as the Originators, American Business Financial Services Inc., a Delaware corporation, as the Guarantor, ABFS Mortgage Loan Warehouse Trust 2001-1, a Delaware business trust, as the Trust, American Business Credit, Inc., a Pennsylvania corporation, as the Servicer, EMC Mortgage Corporation, a Delaware corporation, as the Back-up Servicer, and The Chase Manhattan Bank, a New York banking corporation, as the Indenture Trustee and the Collateral Agent. (Incorporated by reference from Exhibit 10.72 of Registrant's Post-Effective Amendment No. One to the Registration Statement on Form S-2, No. 333-40248, filed April 5, 2001). 10.56 Indenture, dated as of March 1, 2001, by and among Triple-A One Funding Corporation, a Delaware corporation, as the Initial Purchaser, ABFS Mortgage Loan Warehouse Trust 2001-1, a Delaware statutory business trust, and its successors and assigns, as the Trust or the Issuer, The Chase Manhattan Bank, a New York banking corporation, and its successors, as the Indenture Trustee, and American Business Financial Services, Inc., as the Guarantor. (Incorporated by reference from Exhibit 10.73 of Registrant's Post-Effective Amendment No. One to the Registration Statement on Form S-2, No. 333-40248, filed April 5, 2001). 10.57 Insurance and Reimbursement Agreement, dated as of March 28, 2001, among MBIA Insurance Corporation, a New York stock insurance company, ABFS Mortgage Loan Warehouse Trust 2001-1, a Delaware business trust, as the Trust, ABFS OSO, Inc., a Delaware corporation, as the Depositor, American Business Credit, Inc., a Pennsylvania corporation, as the Originator and the Servicer, HomeAmerican Credit, Inc., a Pennsylvania corporation, d/b/a Upland Mortgage, as the Originator, American Business Mortgage Services, Inc., a New Jersey corporation, as the Originator, American Business Financial Services, Inc., a Delaware corporation, as the Guarantor, The Chase Manhattan Bank, as the Indenture Trustee, and Triple-A One Funding Corporation, a Delaware corporation, as the Initial Purchaser. (Incorporated by reference from Exhibit 10.74 of Registrant's Post-Effective Amendment No. One to the Registration Statement on Form S-2, No. 333-40248, filed April 5, 2001).
220
Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 10.58 Pooling and Servicing Agreement, relating to ABFS Mortgage Loan Trust 2001-1, dated as of March 1, 2001, by and among Morgan Stanley ABS Capital I Inc., a Delaware corporation, as the Depositor, American Business Credit, Inc., a Pennsylvania corporation, as the Servicer, and The Chase Manhattan Bank, a New York banking corporation, as the Trustee. (Incorporated by reference from Exhibit 10.75 of Registrant's Post-Effective Amendment No. One to the Registration Statement on Form S-2, No. 333-40248, filed April 5, 2001). 10.59 Unaffiliated Seller's Agreement, dated as of March 1, 2001, by and among Morgan Stanley ABS Capital I, Inc., a Delaware corporation, and its successors and assigns, as the Depositor, ABFS 2001-1, Inc., a Delaware corporation, and its successors, as the Unaffiliated Seller, American Business Credit, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc., d/b/a Upland Mortgage, a Pennsylvania corporation, and American Business Mortgage Services Inc., a New Jersey corporation, as the Originators. (Incorporated by reference from Exhibit 10.76 of Registrant's Post-Effective Amendment No. One to the Registration Statement on Form S-2, No. 333-40248, filed April 5, 2001). 10.60 Amended and Restated Sale and Servicing Agreement dated as of June 28, 2001 by and among ABFS Greenmont, Inc., as Depositor, HomeAmerican Credit, Inc. d/b/a Upland Mortgage and American Business Mortgage Services, Inc. f/k/a New Jersey Mortgage and Investment Corp., as Originators and Subservicers, ABFS Mortgage Loan Warehouse Trust 2000-2, as Trust, American Business Credit, Inc., as an Originator and Servicer, American Business Financial Services, Inc., as Sponsor and The Chase Manhattan Bank, as Indenture Trustee and Collateral Agent. (Incorporated by reference from Exhibit 10.60 to the Form 10-K for the fiscal year ended June 30, 2001 filed on September 28, 2001). 10.61 Letter Agreement dated July 1, 2000 between ABFS and Albert W. Mandia. (Incorporated by reference to Exhibit 10.61 of Amendment No. 1 to the 2001 Form S-2 filed on October 5, 2001).** 10.62 American Business Financial Services, Inc. 2001 Stock Incentive Plan. (Incorporated by reference from Exhibit 10.1 to the Form 10-Q for the quarter ended September 30, 2001 filed on November 14, 2001 (the "September 2001 Form 10-Q")).**
221
Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 10.63 American Business Financial Services, Inc. 2001 Stock Incentive Plan Restricted Stock Agreement. (Incorporated by reference from Exhibit 10.2 of the September 2001 Form 10-Q).** 10.64 American Business Financial Services, Inc. 2001 Executive Management Incentive Plan. (Incorporated by reference from Exhibit 10.3 of the September 2001 Form 10-Q).** 10.65 December 2001 Amendment to Senior Secured Credit Agreement dated December 2001, among American Business Financial Services, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc., a Pennsylvania corporation doing business under the assumed or fictitious name Upland Mortgage, and American Business Mortgage Services, Inc. and JPMorgan Chase Bank. (Incorporated by reference from Exhibit 10.1 to Registrant's Quarterly Report on Form 10-Q for the quarter ended December 31, 2001 filed on February 14, 2002 (the "December 2001 Form 10-Q")). 10.66 Master Repurchase Agreement between Credit Suisse First Boston Mortgage Capital LLC and ABFS Repo 2001, Inc. (Incorporated by reference to Exhibit 10.2 from the December 2001 Form 10-Q). 10.67 Master Contribution Agreement, dated as of November 16, 2001 by and between American Business Financial Services, Inc. and ABFS Repo 2001, Inc. (Incorporated by reference from Exhibit 10.3 to the December 2001 Form 10-Q). 10.68 Custodial Agreement dated as of November 16, 2001, by and among ABFS Repo 2001, Inc., a Delaware corporation; American Business Credit, Inc., a Pennsylvania corporation; JPMorgan Chase Bank, a New York banking corporation; and Credit Suisse First Boston Mortgage Capital LLC. (Incorporated by reference from Exhibit 10.4 to the December 2001 Form 10-Q). 10.69 Guaranty, dated as of November 16, 2001, by and among American Business Financial Services, Inc., American Business Credit, Inc., HomeAmerican Credit, Inc. d/b/a Upland Mortgage, American Business Mortgage Services, Inc. and Credit Suisse First Boston Mortgage Capital LLC. (Incorporated by reference from Exhibit 10.5 to the December 2001 Form 10-Q). 10.70 Amendment No. 1 to the Indenture dated March 1, 2001 among Triple-A One Funding Corporation, ABFS Mortgage Loan Warehouse Trust 2001-1 and JPMorgan Chase Bank. (Incorporated by reference from Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2002 filed on May 15, 2002 (the "March 2002 Form 10-Q").
222
Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 10.71 Amendment No. 2 to the Sale and Servicing Agreement dated as of March 1, 2001 by and among ABFS OSO Inc., a Delaware corporation, as Depositor, ABFS Mortgage Loan Warehouse Trust 2001-1, a Delaware business trust, as the Trust, American Business Financial Services, Inc., a Delaware corporation, as Guarantor, American Business Credit, Inc., a Pennsylvania corporation, as Servicer, JPMorgan Chase Bank f/k/a The Chase Manhattan Bank, a New York banking corporation, as Indenture Trustee and as Collateral Agent and MBIA Insurance Corporation, a New York stock insurance company, as Note Insurer. (Incorporated by reference from Exhibit 10.2 to the March 2002 Form 10-Q). 10.72 3/02 Amended and Restated Senior Secured Credit Agreement dated as of March 15, 2002 among: American Business Credit, Inc. and certain affiliates and JPMorgan Chase Bank, as Agent and as a Lender. (Incorporated by reference from Exhibit 10.3 to the March 2002 Form 10-Q). 10.73 $1.2 million Committed Line of Credit Note between American Business Financial Services, Inc. and Firstrust Savings Bank dated January 18, 2002. (Incorporated by reference from Exhibit 10.4 to the March 2002 Form 10-Q). 10.74 American Business Financial Services, Inc. Dividend Reinvestment and Stock Purchase Plan. (Incorporated by reference from Exhibit 10.1 of the Registrant's Registration Statement on Form S-3, No. 333-87574, filed on May 3, 2002). 10.75 Pooling and Servicing Agreement, relating to ABFS Mortgage Loan Trust 2001-2, dated as of June 1, 2001, by and among Bear Stearns Asset Backed Securities, Inc., a Delaware corporation, American Business Credit, Inc., a Pennsylvania corporation, and The Chase Manhattan Bank, a New York banking corporation. (Incorporated by reference from Exhibit 10.75 of Registrant's Registration Statement on Form S-2, No. 33-90366, filed on June 12, 2002 (the "2002 Form S-2). 10.76 Unaffiliated Seller's Agreement, dated June 1, 2001 by and among Bear Stearns Asset Backed Securities, Inc., a Delaware corporation, ABFS 2001-2, Inc., a Delaware corporation, American Business Credit, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc., d/b/a Upland Mortgage, a Pennsylvania corporation, and American Business Mortgage Services, Inc., a New Jersey corporation. (Incorporated by reference from Exhibit 10.76 of the 2002 Form S-2). 10.77 Pooling and Servicing Agreement, relating to ABFS Mortgage Loan Trust 2002-1, dated as of March 1, 2002, by and among Bear Stearns Asset Backed Securities, Inc., a Delaware corporation, American Business Credit, Inc., a Pennsylvania corporation and JPMorgan Chase Bank, a New York banking corporation. (Incorporated by reference from Exhibit 10.77 of the 2002 Form S-2).
223
Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 10.78 Unaffiliated Seller's Agreement, dated as of March 1, 2002 by and among Bear Stearns Asset Backed Securities, Inc., a Delaware corporation, ABFS 2002-1, Inc., a Delaware corporation, American Business Credit, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc. d/b/a Upland Mortgage, a Pennsylvania corporation and American Business Mortgage Services, Inc., a New Jersey corporation. (Incorporated by reference from Exhibit 10.78 of the 2002 Form S-2). 10.79 Pooling and Services Agreement relating to ABFS Mortgage Loan Trust 2002-2, dated as of June 1, 2002, by and among Credit Suisse First Boston Mortgage Securities Corp., a Delaware corporation, American Business Credit, Inc., a Pennsylvania corporation, and JP Morgan Chase Bank, a New York corporation. (Incorporated by reference from Exhibit 10.79 to Registrant's Annual Report on Form 10-K for the year ended June 30, 2002 filed on September 20, 2002 (the "2002 Form 10-K")). 10.80 Unaffiliated Seller's Agreement, dated as of June 1, 2002, by and among Credit Suisse First Boston Mortgage Securities Corp., a Delaware corporation, ABFS 2002-2, Inc., a Delaware corporation, American Business Credit, Inc., a Pennsylvania corporation, and HomeAmerican Credit Inc., d/b/a Upland Mortgage, a Pennsylvania corporation, and American Business Mortgage Services, Inc., a New Jersey corporation. (Incorporated by reference from Exhibit 10.80 to 2002 Form 10-K). 10.81 Indemnification Agreement dated June 21, 2002, by ABFS 2002-2, Inc., American Business Credit, Inc., HomeAmerican Credit, Inc. and American Business Mortgage Services, Inc. in favor of Credit Suisse First Boston Mortgage Securities Corp. and Credit Suisse First Boston Corp. (Incorporated by reference from Exhibit 10.81 to 2002 Form 10-K). 10.82 First Amended and Restated Warehousing Credit and Security Agreement between American Business Credit, Inc., a Pennsylvania corporation, American Business Mortgage Services, Inc., a New Jersey corporation, HomeAmerican Credit, Inc., a Pennsylvania corporation, and Residential Funding Corporation, a Delaware corporation dated as of July 1, 2002. (Incorporated by reference from Exhibit 10.82 to 2002 Form 10-K). 10.83 Promissory Note between American Business Credit, Inc., a Pennsylvania corporation, American Business Mortgage Services, Inc., a New Jersey corporation, HomeAmerican Credit, Inc., a Pennsylvania corporation, and Residential Funding Corporation, a Delaware corporation dated July 1, 2002. (Incorporated by reference from Exhibit 10.83 to 2002 Form 10-K). 10.84 Guaranty dated July 1, 2002 given by American Business Financial Services, Inc., a Delaware corporation, to Residential Funding Corporation, a Delaware corporation. (Incorporated by reference from Exhibit 10.84 to 2002 Form 10-K).
224
Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 10.85 Office Lease Agreement, dated November 27, 2002 and Addendum to Office Lease, dated November 27, 2002 between the Registrant and Wanamaker, LLC. (Incorporated by reference to Exhibit 10.1 to the Registrant's Report on Form 8-K, dated December 9, 2002 and filed December 27, 2002). 10.86 Letter Agreement dated May 20, 2002 between the Registrant and the Commonwealth of Pennsylvania. (Incorporated by reference to Exhibit 10.2 to the Registrant's Current Report on Form 8-K, dated December 9, 2002 and filed December 27, 2002). 10.87 Letter of Intent with PIDC Local Development Corporation dated December 3, 2002. (Incorporated by reference to Exhibit 10.3 to the Registrant's Report on Form 8-K, dated December 9, 2002 and filed December 27, 2002). 10.88 Letter of Credit from JPMorgan Chase Bank for $6,000,000 provided as security for a lease for office space. (Incorporated by reference to Exhibit 10.4 to the Registrant's Quarterly Report on Form 10-Q for the period ended December 31, 2002). 10.89 12/02 Amendment to Senior Secured Credit Agreement for $50.0 million warehouse line, operating line and letter of credit with JPMorgan Chase. (Incorporated by reference to Exhibit 10.5 to the Registrant's Quarterly Report on Form 10-Q for the period ended December 31, 2002). 10.90 Lease between CWLT Roseland Exchange L.L.C., and American Business Financial Services, Inc. for 105 Eisenhower Parkway, Roseland, N.J. (the "Roseland Lease") (Incorporated by reference to Exhibit 10.2 to the Registrant's Quarterly Report on Form 10-Q for the period ended March 31, 2003 (the "March 31, 2003 Form 10-Q")). 10.91 Amendment No. 3 to Letter of Credit Agreement with JP Morgan Chase (Incorporated by reference to Exhibit 10.1 to the March 31, 2003 Form 10-Q). 10.92 First Amendment to the Roseland Lease (Incorporated by reference to Exhibit 10.3 of the March 31, 2003 Form 10-Q). 10.93 Pooling and Servicing Agreement relating to ABFS Mortgage Loan Trust 2002-3, dated as of September 1, 2002, by and among Credit Suisse First Boston Mortgage Securities Corp., a Delaware corporation, American Business Credit, Inc., a Pennsylvania corporation, and JPMorgan Chase Bank, a New York banking corporation (Incorporated by reference from Exhibit 10.93 of Registrant's Registration Statement on Form S-2, No. 333-106476, filed on June 25, 2003).
225
Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 10.94 Unaffiliated Seller's Agreement, dated as of September 1, 2002, by and among Credit Suisse First Boston Mortgage Securities Corp., a Delaware corporation, ABFS 2002-3, Inc., a Delaware corporation, American Business Credit, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc. d/b/a Upland Mortgage, a Pennsylvania corporation, and American Business Mortgage Services, Inc., a New Jersey corporation (Incorporated by reference from Exhibit 10.94 of Registrant's Registration Statement on Form S-2, No. 333-106476, filed on June 25, 2003). 10.95 Indemnification Agreement, dated September 23, 2002, by ABFS 2002-3, Inc., American Business Credit, Inc., HomeAmerican Credit, Inc. d/b/a Upland Mortgage and American Business Mortgage Services, Inc. in favor of Credit Suisse First Boston Mortgage Securities Corp. and Credit Suisse First Boston Corporation (Incorporated by reference from Exhibit 10.95 of Registrant's Registration Statement on Form S-2, No. 333-106476, filed on June 25, 2003). 10.96 Unaffiliated Seller's Agreement, dated as of December 1, 2002, by and among Credit Suisse First Boston Mortgage Securities Corp., a Delaware corporation, ABFS 2002-4, Inc., a Delaware corporation, American Business Credit, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc. d/b/a Upland Mortgage, a Pennsylvania corporation, and American Business Mortgage Services, Inc., a New Jersey corporation (Incorporated by reference from Exhibit 10.96 of Registrant's Registration Statement on Form S-2, No. 333-106476, filed on June 25, 2003). 10.97 Pooling and Servicing Agreement relating to ABFS Mortgage Loan Trust 2002-4, dated as of December 1, 2002, by and among Credit Suisse First Boston Mortgage Securities Corp., a Delaware corporation, American Business Credit, Inc., a Pennsylvania corporation, and JPMorgan Chase Bank, a New York banking corporation (Incorporated by reference from Exhibit 10.97 of Registrant's Registration Statement on Form S-2, No. 333-106476, filed on June 25, 2003). 10.98 Indemnification Agreement, dated December 18, 2002, by ABFS 2002-4, Inc., American Business Credit, Inc., HomeAmerican Credit, Inc. d/b/a Upland Mortgage and American Business Mortgage Services, Inc. in favor of Credit Suisse First Boston Mortgage Securities Corp. and Credit Suisse First Boston Corporation (Incorporated by reference from Exhibit 10.98 of Registrant's Registration Statement on Form S-2, No. 333-106476, filed on June 25, 2003). 10.99 Unaffiliated Seller's Agreement, dated as of March 1, 2003, by and among Bear Stearns Asset Backed Securities, Inc., a Delaware corporation, ABFS 2003-1, Inc., a Delaware corporation, American Business Credit, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc. d/b/a Upland Mortgage, a Pennsylvania corporation, and American Business Mortgage Services, Inc., a New Jersey corporation.
226
Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 10.100 Pooling and Servicing Agreement relating to ABFS Mortgage Loan Trust 2003-1, dated as of March 1, 2003, by and among Bear Stearns Asset Backed Securities, Inc., a Delaware corporation, American Business Credit, Inc., a Pennsylvania corporation, and JPMorgan Chase Bank, a New York banking corporation. 10.101 Insurance and Indemnity Agreement, dated March 31, 2003, by Radian Asset Assurance Inc., a New York stock insurance company, American Business Credit, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc. d/b/a Upland Mortgage, American Business Mortgage Services, Inc., ABFS 2003-1, Inc., Bear Stearns Asset Backed Securities, Inc. and JPMorgan Chase Bank. 10.102 Amended and Restated Committed Line of Credit Note, dated June 2, 2003, between American Business Financial Services, Inc. and Firstrust Savings Bank. 10.103 Amendment Number One to the Master Repurchase Agreement, dated November 13, 2002, between Credit Suisse First Boston Mortgage Capital LLC and ABFS REPO 2001, Inc. 10.104 3/31/03 Amendment to Senior Secured Credit Agreement, dated March 31, 2003, among American Business Credit, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc., a Pennsylvania corporation, American Business Mortgage Services, Inc., a New Jersey corporation, ABFS Residual 2002, Inc., American Business Financial Services, Inc., a Delaware corporation, and JPMorgan Chase Bank and certain other lenders. 10.105 12/02 Amendment to 3/02 Security Agreement - Residual Interest Certificates, dated December 18, 2002, made by ABFS Residual 2002, Inc., a Delaware corporation in favor of JPMorgan Chase Bank. 10.106 Letter, dated August 21, 2003 from JPMorgan Chase Bank to American Business Credit, Inc., HomeAmerican Credit, Inc., American Business Mortgage Services, Tiger Relocation Company, ABFS Residual 2002, Inc. and American Business Financial Services, Inc. regarding waiver of financial covenant in 3/02 Senior Secured Credit Agreement dated as of March 15, 2002. (Incorporated by reference to Exhibit 10.1 of the Registrant's Current Report on Form 8-K, File No. 0-22474, filed on September 25, 2003 (the "9/25/03 8-K")). 10.107 Mortgage Loan Purchase and Interim Servicing Agreement, dated July 22, 2003, among DLJ Mortgage Capital, Inc., American Business Credit, Inc., Homeamerican Credit, Inc. d/b/a Upland Mortgage and American Business Mortgage Services, Inc. 10.108 Mortgage Loan Purchase and Interim Servicing Agreement, dated as of June 30, 2003, among EMC Mortgage Corporation, American Business Credit, Inc., Homeamerican Credit, Inc. d/b/a Upland Mortgage, and American Business Mortgage Services, Inc. 10.109 Waiver and Amendment Number Two to the Master Repurchase Agreement between Credit Suisse First Boston Mortgage Capital LLC and ABFS Repo 2001, Inc. dated August 20, 2003 and Letter dated as of August 20, 2003 from Credit Suisse First Boston Mortgage Capital LLC to ABFS Repo 2001, Inc. (Incorporated by reference to Exhibit 10.2 of the Registrant's 9/25/03 8-K). 10.110 Sale and Servicing Agreement, dated September 22, 2003, among ABFS Balapointe, Inc., HomeAmerican Credit, Inc., ABFS Mortgage Loan Warehouse Trust 2003-1, American Business Credit, Inc., American Business Financial Services, Inc. and JPMorgan Chase Bank. (Incorporated by reference to Exhibit 10.3 of the 9/25/03 8-K). 10.111 Indenture, dated September 22, 2003 between ABFS Mortgage Loan Warehouse Trust 2003-1 and JPMorgan Chase Bank, as Indenture Trustee, with Appendix I, Defined Terms. (Incorporated by reference to Exhibit 10.4 of the Registrant's 9/25/03 8-K). 10.112 Trust Agreement, dated as of September 22, 2003, by and between ABFS Bala Pointe, Inc., as Depositor and Wilmington Trust Company, as Owner Trustee. (Incorporated by reference to Exhibit 10.5 of the Registrant's 9/25/03 8-K). 10.113 ABFS Mortgage Loan Warehouse Trust 2003-1 Secured Notes Series 2003-1 Purchase Agreement. (Incorporated by reference to Exhibit 10.6 of the Registrant's 9/25/03 8-K). 10.114 Commitment letter dated September 22, 2003 addressed to American Business Financial Services Inc. from Chrysalis Warehouse Funding, LLC. (Incorporated by reference to Exhibit 10.7 of the Registrant's 9/25/03 8-K). 10.115 Fee letter dated September 22, 2003 addressed to American Business Financial Services, Inc. and Chrysalis Warehouse Funding, LLC from Clearwing Capital, LLC. (Incorporated by reference to Exhibit 10.8 of the Registrant's 9/25/03 8-K). 10.116 Amendment to Senior Secured Credit Agreement dated as of September 22,2003 among American Business Credit, Inc. and certain affiliates and JPMorgan Chase Bank and other parties thereto. (Incorporated by reference to Exhibit 10.9 of the Registrant's 9/25/03 8-K)
227
Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 11.1 Statement of Computation of Per Share Earnings (Included in Note 19 of the Notes to June 30, 2003 Consolidated Financial Statements). 12.1 Computation of Ratio of Earnings to Fixed Charges. 16.1 Letter regarding change in certifying accountants. (Incorporated by reference from Exhibit 16.1 of the Registrant's Current Report on Form 8-K dated May 17, 2001.) 16.2 Letter regarding change in certifying accountants. (Incorporated by reference from Exhibit 16.2 of the Registrant's Current Report on Form 8-K dated August 2, 2001.) 21.1 Subsidiaries of the Registrant. 23.1 Consent of BDO Seidman, LLP. 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes Oxley Act of 2002. 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes Oxley Act of 2002. 32.1 Certification pursuant to Section 906 of the Sarbanes Oxley Act of 2002.
- ---------------------- ** Indicates management contract or compensatory plan or arrangement. Reports on Form 8-K: May 8, 2003 - (Items 7, 9 and 12) related to the press release dated May 1, 2003 regarding results of operations for the quarter ended March 31, 2003. June 13, 2003 - (Item 5) related to receipt of a civil subpoena from the U.S. Department of Justice. 228 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act of 1934, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. AMERICAN BUSINESS FINANCIAL SERVICES, INC. Date: September 29, 2003 By: /s/ Anthony J. Santilli --------------------------------------- Name: Anthony J. Santilli Title: Chairman, President, Chief Executive Officer, Chief Operating Officer and Director (Duly Authorized Officer) In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature Capacity Date - ---------------------------------- ------------------------------------- ---------------- /s/ Anthony J. Santilli Chairman, President, Chief Executive September 29, 2003 - ---------------------------------- Officer, Chief Operating Officer and Anthony J. Santilli Director (Principal Executive and Operating Officer) /s/ Albert W. Mandia Executive Vice President and Chief September 29, 2003 - ---------------------------------- Financial Officer (Principal Financial Albert W. Mandia and Accounting Officer) /s/ Leonard Becker Director September 29, 2003 - ---------------------------------- Leonard Becker /s/ Michael DeLuca Director September 29, 2003 - ---------------------------------- Michael DeLuca /s/ Richard Kaufman Director September 29, 2003 - ---------------------------------- Richard Kaufman /s/ Jerome Miller Director September 29, 2003 - ---------------------------------- Jerome Miller /s/ Warren Palitz Director September 29, 2003 - ---------------------------------- Warren Palitz Director September 29, 2003 - ---------------------------------- Jeffrey Steinberg /s/ Harold Sussman Director September 29, 2003 - ---------------------------------- Harold Sussman
229 EXHIBIT INDEX
Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 3.1 Amended and Restated Certificate of Incorporation (Incorporated by reference from Exhibit 3.1 to the Quarterly Report on Form 10-Q filed February 14, 2003). 3.2 Amended and Restated Bylaws (Incorporated by reference from Exhibit 3.2 to the Quarterly Report on Form 10-Q filed February 14, 2003). 4.1 Form of Unsecured Investment Note (Incorporated by reference from Exhibit 4.1 of Amendment No. 1 to the Registration Statement on Form SB-2 filed April 29, 1994, Registration Number 33-76390). 4.2 Form of Unsecured Investment Note issued pursuant to Indenture with First Trust, National Association, a national banking association (Incorporated by reference from Exhibit 4.5 of Amendment No. One to the Registration Statement on Form SB-2 filed on December 14, 1995, Registration Number 33-98636 (the "1995 Form SB-2")). 4.3 Form of Indenture by and between ABFS and First Trust, National Association, a national banking association (Incorporated by reference from Exhibit 4.6 of the Registration Statement on Form SB-2 filed on October 26, 1995, Registration Number 33-98636). 4.4 Form of Indenture by and between ABFS and First Trust, National Association, a national banking association (Incorporated by reference from Exhibit 4.4 of the Registration Statement on Form SB-2 filed March 28, 1997, Registration Number 333-24115 (the "1997 Form SB-2")). 4.5 Form of Unsecured Investment Note (Incorporated by reference from Exhibit 4.5 of the 1997 Form SB-2). 4.6 Form of Indenture by and between ABFS and First Trust, National Association, a national banking association (Incorporated by reference from Exhibit 4.4 of the Registration Statement on Form SB-2 filed May 23, 1997, Registration Number 333-24115). 4.7 Form of Unsecured Investment Note (Incorporated by reference from Exhibit 4.5 of the Registration Statement on Form SB-2 filed May 23, 1997, Registration Number 333-24115).
230
Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 4.8 Form of Indenture by and between ABFS and U.S. Bank Trust, National Association, a national banking association (Incorporated by reference from Exhibit 4.8 of Registrant's Registration Statement on Form S-2, No. 333-63859, filed September 21, 1998). 4.9 Form of Unsecured Investment Note (Incorporated by reference from Exhibit 4.9 of Registrant's Registration Statement on Form S-2, No. 333-63859, filed September 21, 1998). 4.10 Form of Indenture by and between ABFS and U.S. Bank Trust National Association (Incorporated by reference from Exhibit 4.10 of Registrant's Registration Statement on Form S-2, No. 333-87333, filed September 17, 1999). 4.11 Form of Indenture by and between ABFS and U.S. Bank Trust National Association. (Incorporated by reference from Exhibit 4.11 of Registrant's Registration Statement on Form S-2, No. 333-40248, filed June 27, 2000). 4.12 Form of Investment Note. (Incorporated by reference from Exhibit 4.12 of Registrant's Registration Statement on Form S-2, No. 333-40248, filed June 27, 2000). 4.13 Form of Indenture by and between ABFS and U.S. Bank Trust National Association. (Incorporated by reference from Exhibit 4.13 of Registrant's Registration Statement on Form S-2, No. 333-63014, filed on June 14, 2001). 4.14 Form of Investment Note. (Incorporated by reference from Exhibit 4.14 of Registrant's Registration Statement on Form S-2, No. 333-63014, filed on June 14, 2001). 4.15 Form of Indenture by and between ABFS and U.S. Bank National Association. (Incorporated by reference from Exhibit 4.15 of Registrant's Registration Statement on Form S-2, No. 333-90366, filed on June 12, 2002). 4.16 Form of Investment Note. (Incorporated by reference from Exhibit 4.16 of Registrant's Registration Statement on Form S-2, No. 333-90366, filed on June 12, 2002). 4.17 Form of Indenture by and between ABFS and U.S. Bank National Association (Incorporated by reference from Exhibit 4.17 of Registrant's Registration Statement on Form S-2, No. 333-106476, filed on June 25, 2003). 4.18 Form of Investment Note (Incorporated by reference from Exhibit 4.18 of Registrant's Registration Statement on Form S-2, No. 333-106476, filed on June 25, 2003).
231
Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 10.1 Amended and Restated Stock Option Plan (Incorporated by reference from Exhibit 10.2 of ABFS' Quarterly Report on Form 10-QSB from the quarter ended September 30, 1997, File No. 0-22474).** 10.2 Stock Option Award Agreement (Incorporated by reference from Exhibit 10.1 of the Registration Statement on Form S-11 filed on February 26, 1993, Registration No. 33-59042 (the "Form S-11")).** 10.3 1995 Stock Option Plan for Non-Employee Directors (Incorporated by reference from Exhibit 10.6 of the Amendment No. 1 to the 1996 Form SB-2 filed on February 4, 1996 Registration No. 333-18919 (the "Amendment No. 1 to the 1996 Form SB-2")).** 10.4 Form of Option Award Agreement for Non-Employee Directors Plan for Formula Awards (Incorporated by reference from Exhibit 10.13 of the 1996 Form 10-KSB).** 10.5 1997 Non-Employee Director Stock Option Plan (including form of Option Agreement) (Incorporated by reference from Exhibit 10.1 of the September 30, 1997 Form 10-QSB).** 10.6 Lease dated January 7, 1994 by and between TCW Realty Fund IV Pennsylvania Trust and ABFS (Incorporated by reference from Exhibit 10.9 of the Registration Statement on Form SB-2 filed March 15, 1994, File No. 33-76390). 10.7 First Amendment to Agreement of Lease by and between TCW Realty Fund IV Pennsylvania Trust and ABFS dated October 24, 1994. (Incorporated by reference from Exhibit 10.9 of ABFS' Annual Report on Form 10-KSB for the fiscal year ended June 30, 1995 (the "1995 Form 10-KSB")). 10.8 Second Amendment to Agreement of Lease by and between TCW Realty Fund IV Pennsylvania Trust and ABFS dated December 23, 1994 (Incorporated by reference from Exhibit 10.10 of the 1995 Form 10-KSB). 10.9 Third Amendment to Lease between TCW Realty Fund IV Pennsylvania Trust and ABFS dated July 25, 1995 (Incorporated by reference from Exhibit 10.11 of the 1995 Form 10-KSB). 10.10 Promissory Note of Anthony J. Santilli and Stock Pledge Agreement dated September 29, 1995 (Incorporated by reference from Exhibit 10.14 of the 1995 Form SB-2). 10.11 Form of Employment Agreement with Anthony J. Santilli, Beverly Santilli and Jeffrey M. Ruben (Incorporated by reference from Exhibit 10.15 of the Amendment No. 1 to the 1996 Form SB-2).**
232
Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 10.12 Amendment One to Anthony J. Santilli's Employment Agreement (Incorporated by reference from Exhibit 10.3 of the September 30, 1997 Form 10-QSB).** 10.13 Amendment One to Beverly Santilli's Employment Agreement (Incorporated by reference from Exhibit 10.4 of the September 30, 1997 Form 10-QSB).** 10.14 Management Incentive Plan (Incorporated by reference from Exhibit 10.16 of the 1996 Form SB-2).** 10.15 Form of Option Award Agreement for Non-Employee Directors Plan for Non-Formula Awards (Incorporated by reference from Exhibit 10.18 of the Amendment No. 1 to the 1996 Form SB-2).** 10.16 Form of Pooling and Servicing Agreement related to the Company's loan securitizations dated May 1, 1996, August 31, 1996, February 28, 1997, September 1, 1997, February 1, 1998, June 1, 1998, and September 1, 1998 (Incorporated by reference from Exhibit 4.1 of ABFS' Quarterly Report on Form 10-QSB for the quarter ended March 31, 1995 (the "March 31, 1995 Form 10-QSB")). 10.17 Form of Sales and Contribution Agreement related to the Company's loan securitizations dated May 1, 1996 and September 27, 1996 (Incorporated by reference from Exhibit 4.1 of the March 31, 1995 Form 10-QSB). 10.18 Form of Indenture related to the Company's loan securitizations dated December 1, 1998, March 1, 1999, June 1, 1999, September 1, 1999, December 1, 1999, March 1, 2000, June 1, 2000, September 1, 2000, December 1, 2000, September 1, 2001 and December 1, 2001. (Incorporated by reference from Exhibit 10.18 to the Registration Statement on Form S-2 filed June 14, 2001, Registration No. 333-63014 (the "2001 Form S-2")). 10.19 Form of Unaffiliated Seller's Agreement related to the Company's loan securitizations dated December 1, 1998, March 1, 1999, June 1, 1999, September 1, 1999, December 1, 1999, March 1, 2000, June 1, 2000, September 1, 2000, December 1, 2000, September 1, 2001 and December 1, 2001. (Incorporated by reference from Exhibit 10.19 to the 2001 Form S-2). 10.20 Fourth Amendment to Lease between TCW Realty Fund IV Pennsylvania Trust and ABFS dated April 9, 1996 (Incorporated by reference from Exhibit 10.22 to the Amendment No. 1 to the 1997 SB-2). 10.21 Fifth Amendment to Lease between TCW Realty Fund IV Pennsylvania Trust and ABFS dated October 8, 1996 (Incorporated by reference from Exhibit 10.23 to the Amendment No. 1 to the 1997 SB-2).
233
Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 10.22 Sixth Amendment to Lease between TCW Realty Fund IV Pennsylvania Trust and ABFS dated March 31, 1997 (Incorporated by reference from Exhibit 10.24 to the Amendment No. 1 to the 1997 SB-2). 10.23 Agreement for Purchase and Sale of Stock between Stanley L. Furst, Joel E. Furst and ABFS dated October 27, 1997 (Incorporated by reference from ABFS' Current Report on Form 8-K dated October 27, 1997, File No. 0-22747). 10.24 Standard Form of Office Lease and Rider to Lease dated April 2, 1993 by and between 5 Becker Farm Associates and NJMIC (Incorporated by reference from Exhibit 10.29 of Post-Effective Amendment No. 1 to the Registration Statement on Form SB-2 filed on January 22, 1998, Registration No. 333-2445). 10.25 First Amendment of Lease by and between 5 Becker Farm Associates and NJMIC dated July 27, 1994 (Incorporated by reference from Exhibit 10.30 of Post-Effective Amendment No. 1 to the Registration Statement on Form SB-2 filed on January 22, 1998, Registration No. 333-2445). 10.26 Form of Debenture Note related to NJMIC's subordinated debt (Incorporated by reference from Exhibit 10.31 of Post-Effective Amendment No. 1 to the Registration Statement on Form SB-2 filed on January 22, 1998, Registration No. 333-2445). 10.27 Form of Standard Terms and Conditions of Servicing Agreement related to NJMIC's lease securitizations dated May 1, 1995 and March 1, 1996. (Incorporated by reference from Exhibit 10.33 of Post-Effective Amendment No. 1 to the Registration Statement on Form SB-2 filed on January 22, 1998, Registration No. 333-2445). 10.28 Form of Standard Terms and Conditions of Lease Acquisition Agreement related to NJMIC's lease securitizations dated May 1, 1995 and March 1, 1996 (Incorporated by reference from Exhibit 10.34 of Post-Effective Amendment No. 1 to the Registration Statement on Form SB-2 filed on January 22, 1998, Registration No. 333-2445). 10.29 Amended and Restated Specific Terms and Conditions of Servicing Agreement related to NJMIC's lease securitization dated May 1, 1995 (Incorporated by reference from Exhibit 10.35 of Post-Effective Amendment No. 1 to the Registration Statement on Form SB-2 filed on January 22, 1998, Registration No. 333-2445).
234
Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 10.30 Amended and Restated Specific Terms and Conditions of Lease Acquisition Agreement related to NJMIC's lease securitization dated May 1, 1995 (Incorporated by reference from Exhibit 10.36 of Post-Effective Amendment No. 1 to the Registration Statement on Form SB-2 filed on January 22, 1998, Registration No. 333-2445). 10.31 Specific Terms and Conditions of Servicing Agreement related to NJMIC's lease securitization dated March 1, 1996 (Incorporated by reference from Exhibit 10.37 of Post-Effective Amendment No. 1 to the Registration Statement on Form SB-2 filed on January 22, 1998, Registration No. 333-2445). 10.32 Specific Terms and Conditions of Lease Acquisition Agreement related to NJMIC's lease securitization dated March 1, 1996 (Incorporated by reference from Exhibit 10.38 of Post-Effective Amendment No. 1 to the Registration Statement on Form SB-2 filed on January 22, 1998, Registration No. 333-2445). 10.33 Form of Indenture related to the lease-backed securitizations among ABFS Equipment Contract Trust 1998-A, American Business Leasing, Inc. and The Chase Manhattan Bank dated June 1, 1998 and among ABFS Equipment Contract Trust 1999-A, American Business Leasing, Inc. and The Chase Manhattan Bank dated June 1, 1999. (Incorporated by reference from Exhibit 10.39 of Registrant's Registration Statement on Form S-2, No. 333-63859, filed September 21, 1998). 10.34 Form of Receivables Sale Agreement related to the lease-backed securitizations ABFS Equipment Contract Trust 1998-A, dated June 1, 1998, and ABFS Equipment Contract Trust 1999-A, dated June 1, 1999. (Incorporated by reference from Exhibit 10.34 of the 2001 Form S-2). 10.35 Form of Unaffiliated Seller's Agreement related to the Company's home equity loan securitizations dated March 27, 1997, September 29, 1997, February 1, 1998, June 1, 1998, and September 1, 1998 (Incorporated by reference from Exhibit 10.40 of Registrant's Registration Statement on Form S-2, No. 333-63859, filed September 21, 1998). 10.36 $100.0 Million Receivables Purchase Agreement, dated September 30, 1998 among American Business Lease Funding Corporation, American Business Leasing, Inc. and a syndicate of financial institutions led by First Union Capital Markets and First Union National Bank, as liquidity agent. (Incorporated by reference from Exhibit 10.1 of the Registrant's September 30, 1998 Form 10-Q). 10.37 Lease Agreement dated August 30, 1999 related to One Presidential Boulevard, Bala Cynwyd, Pennsylvania (Incorporated by reference to Exhibit 10.1 of the Registrant's September 30, 1999 Form 10-Q).
235
Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 10.38 Employment Agreement between American Business Financial Services, Inc. and Albert Mandia (Incorporated by reference to Exhibit 10.2 of the Registrant's September 30, 1999 Form 10-Q).** 10.39 Change in Control Agreement between American Business Financial Services, Inc. and Albert Mandia (Incorporated by reference to Exhibit 10.3 of the Registrant's September 30, 1999 Form 10-Q).** 10.40 American Business Financial Services, Inc. Amended and Restated 1999 Stock Option Plan (Incorporated by reference from Exhibit 10.4 of the Registrant's Quarterly Report on Form 10-Q from the quarter ended September 30, 2001 filed on November 14, 2001).** 10.41 Amendment No. 3 to Receivables Purchase Agreement, dated as of October 13, 1999 among American Business Lease Funding Corporation, American Business Leasing, Inc. and a syndicate of financial institutions led by First Union Securities, Inc. as Deal Agent (Incorporated by reference from Exhibit 10.3 of the Registrant's December 31, 1999 Form 10-Q). 10.42 Amendment No. 4, dated as of November 12, 1999, to the Receivables Purchase Agreement, dated as of September 30, 1998, among American Business Lease Funding Corporation, American Business Leasing, Inc. and a syndicate of financial institutions led by First Union Securities, Inc. as Deal Agent (Incorporated by reference from Exhibit 10.4 of the Registrant's December 31, 1999 Form 10-Q). 10.43 Amendment No. 5, dated as of November 29, 1999, to the Receivables Purchase Agreement, dated as of September 30, 1998, among American Business Lease Funding Corporation, American Business Leasing, Inc. and a syndicate of financial institutions led by First Union Securities, Inc. as Deal Agent (Incorporated by reference from Exhibit 10.5 of the Registrant's December 31, 1999 Form 10-Q). 10.44 Amendment No. 6, dated as of December 14, 1999, to the Receivables Purchase Agreement, dated as of September 30, 1998, among American Business Lease Funding Corporation, American Business Leasing, Inc. and a syndicate of financial institutions led by First Union Securities, Inc. as Deal Agent (Incorporated by reference from Exhibit 10.6 of the Registrant's December 31, 1999 Form 10-Q). 10.45 Seventh Amendment, dated as of December 31, 1999, to the Receivables Purchase Agreement, dated as of September 30, 1998, among American Business Lease Funding Corporation, American Business Leasing, Inc. and a syndicate of financial institutions led by First Union Securities, Inc. as Deal Agent (Incorporated by reference from Exhibit 10.7 of the Registrant's December 31, 1999 Form 10-Q).
236
Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 10.46 Eight Amendment, dated as of January 10, 2000, to the Receivables Purchase Agreement, dated as of September 30, 1998, among American Business Lease Funding Corporation, American Business Leasing, Inc. and a syndicate of financial institutions led by First Union Securities, Inc. as Deal Agent (Incorporated by reference from Exhibit 10.8 of the Registrant's December 31, 1999 Form 10-Q). 10.47 Sale and Servicing Agreement, dated as of March 1, 2000, by and among Prudential Securities Secured Financing Corporation, ABFS Mortgage Loan Trust 2000-1, Chase Bank of Texas, N.A., as collateral agent, The Chase Manhattan Bank, as indenture trustee and American Business Credit, Inc., as Servicer (Incorporated by reference from Exhibit 10.1 of the Registrant's March 31, 2000 Form 10-Q). 10.48 Warehousing Credit and Security Agreement dated as of May 5, 2000 between New Jersey Mortgage and Investment Corp., American Business Credit, Inc., HomeAmerican Credit, Inc. d/b/a Upland Mortgage and Residential Funding Corporation. (Incorporated by reference from Exhibit 10.63 of Registrant's Registration Statement on Form S-2, No. 333-40248, filed June 27, 2000). 10.49 Sale and Servicing Agreement dated as of July 6, 2000 by and among ABFS Greenmont, Inc., as Depositor, HomeAmerican Credit, Inc., d/b/a Upland Mortgage, and New Jersey Mortgage and Investment Corp., as Originators and Subservicers, ABFS Mortgage Loan Warehouse Trust 2000-2, as Trust, American Business Credit, Inc., as an Originator and Servicer, American Business Financial Services, Inc., as Sponsor, and The Chase Manhattan Bank, as Indenture Trustee and Collateral Agent (Incorporated by reference from Exhibit 10.64 of the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 2000 (the "2000 Form 10-K")). 10.50 Indenture dated as of July 6, 2000 between ABFS Mortgage Loan Warehouse Trust 2000-2 and The Chase Manhattan Bank. (Incorporated by reference from Exhibit 10.65 of the 2000 Form 10-K). 10.51 Employment Agreement by and between American Business Financial Services, Inc. and Milton Riseman (Incorporated by reference from Exhibit 10.66 of the 2000 Form 10-K).** 10.52 Letter Employment Agreement by and between American Business Financial Services, Inc. and Ralph Hall (Incorporated by reference from Exhibit 10.67 of the 2000 Form 10-K).**
237
Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 10.53 Master Loan and Security Agreement, dated as of January 22, 2001, between American Business Credit, Inc., HomeAmerican Credit, Inc., d/b/a Upland Mortgage, and American Business Mortgage Services, Inc., f/k/a New Jersey Mortgage and Investment Corp., as Borrowers, American Business Financial Services, Inc., as Guarantor, and Morgan Stanley Dean Witter Mortgage Capital Inc., as Lender (Incorporated by reference from Exhibit 10.1 of Registrant's December 31, 2000 Form 10-Q). 10.54 Senior Secured Credit Agreement, among: American Business Credit, Inc. ("ABC"), a Pennsylvania corporation, HomeAmerican Credit, Inc. ("HAC"), a Pennsylvania corporation doing business under the assumed or fictitious name Upland Mortgage, and New Jersey Mortgage and Investment Corp., a New Jersey corporation whose name will be changed in January 2001 to American Business Mortgage, American Business Financial Services, Inc. (the "Parent"), and The Chase Manhattan Bank (Incorporated by reference from Exhibit 10.2 of Registrant's December 31, 2000 Form 10-Q). 10.55 Sale and Servicing Agreement, dated as of March 1, 2001, by and among ABFS OSO, Inc., a Delaware corporation, as the Depositor, American Business Credit, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc., d/b/a Upland Mortgage, a Pennsylvania corporation, and American Business Mortgage Services, Inc., a New Jersey corporation, as the Originators, American Business Financial Services Inc., a Delaware corporation, as the Guarantor, ABFS Mortgage Loan Warehouse Trust 2001-1, a Delaware business trust, as the Trust, American Business Credit, Inc., a Pennsylvania corporation, as the Servicer, EMC Mortgage Corporation, a Delaware corporation, as the Back-up Servicer, and The Chase Manhattan Bank, a New York banking corporation, as the Indenture Trustee and the Collateral Agent. (Incorporated by reference from Exhibit 10.72 of Registrant's Post-Effective Amendment No. One to the Registration Statement on Form S-2, No. 333-40248, filed April 5, 2001). 10.56 Indenture, dated as of March 1, 2001, by and among Triple-A One Funding Corporation, a Delaware corporation, as the Initial Purchaser, ABFS Mortgage Loan Warehouse Trust 2001-1, a Delaware statutory business trust, and its successors and assigns, as the Trust or the Issuer, The Chase Manhattan Bank, a New York banking corporation, and its successors, as the Indenture Trustee, and American Business Financial Services, Inc., as the Guarantor. (Incorporated by reference from Exhibit 10.73 of Registrant's Post-Effective Amendment No. One to the Registration Statement on Form S-2, No. 333-40248, filed April 5, 2001). 10.57 Insurance and Reimbursement Agreement, dated as of March 28, 2001, among MBIA Insurance Corporation, a New York stock insurance company, ABFS Mortgage Loan Warehouse Trust 2001-1, a Delaware business trust, as the Trust, ABFS OSO, Inc., a Delaware corporation, as the Depositor, American Business Credit, Inc., a Pennsylvania corporation, as the Originator and the Servicer, HomeAmerican Credit, Inc., a Pennsylvania corporation, d/b/a Upland Mortgage, as the Originator, American Business Mortgage Services, Inc., a New Jersey corporation, as the Originator, American Business Financial Services, Inc., a Delaware corporation, as the Guarantor, The Chase Manhattan Bank, as the Indenture Trustee, and Triple-A One Funding Corporation, a Delaware corporation, as the Initial Purchaser. (Incorporated by reference from Exhibit 10.74 of Registrant's Post-Effective Amendment No. One to the Registration Statement on Form S-2, No. 333-40248, filed April 5, 2001).
238
Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 10.58 Pooling and Servicing Agreement, relating to ABFS Mortgage Loan Trust 2001-1, dated as of March 1, 2001, by and among Morgan Stanley ABS Capital I Inc., a Delaware corporation, as the Depositor, American Business Credit, Inc., a Pennsylvania corporation, as the Servicer, and The Chase Manhattan Bank, a New York banking corporation, as the Trustee. (Incorporated by reference from Exhibit 10.75 of Registrant's Post-Effective Amendment No. One to the Registration Statement on Form S-2, No. 333-40248, filed April 5, 2001). 10.59 Unaffiliated Seller's Agreement, dated as of March 1, 2001, by and among Morgan Stanley ABS Capital I, Inc., a Delaware corporation, and its successors and assigns, as the Depositor, ABFS 2001-1, Inc., a Delaware corporation, and its successors, as the Unaffiliated Seller, American Business Credit, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc., d/b/a Upland Mortgage, a Pennsylvania corporation, and American Business Mortgage Services Inc., a New Jersey corporation, as the Originators. (Incorporated by reference from Exhibit 10.76 of Registrant's Post-Effective Amendment No. One to the Registration Statement on Form S-2, No. 333-40248, filed April 5, 2001). 10.60 Amended and Restated Sale and Servicing Agreement dated as of June 28, 2001 by and among ABFS Greenmont, Inc., as Depositor, HomeAmerican Credit, Inc. d/b/a Upland Mortgage and American Business Mortgage Services, Inc. f/k/a New Jersey Mortgage and Investment Corp., as Originators and Subservicers, ABFS Mortgage Loan Warehouse Trust 2000-2, as Trust, American Business Credit, Inc., as an Originator and Servicer, American Business Financial Services, Inc., as Sponsor and The Chase Manhattan Bank, as Indenture Trustee and Collateral Agent. (Incorporated by reference from Exhibit 10.60 to the Form 10-K for the fiscal year ended June 30, 2001 filed on September 28, 2001). 10.61 Letter Agreement dated July 1, 2000 between ABFS and Albert W. Mandia. (Incorporated by reference to Exhibit 10.61 of Amendment No. 1 to the 2001 Form S-2 filed on October 5, 2001).** 10.62 American Business Financial Services, Inc. 2001 Stock Incentive Plan. (Incorporated by reference from Exhibit 10.1 to the Form 10-Q for the quarter ended September 30, 2001 filed on November 14, 2001 (the "September 2001 Form 10-Q")).**
239
Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 10.63 American Business Financial Services, Inc. 2001 Stock Incentive Plan Restricted Stock Agreement. (Incorporated by reference from Exhibit 10.2 of the September 2001 Form 10-Q).** 10.64 American Business Financial Services, Inc. 2001 Executive Management Incentive Plan. (Incorporated by reference from Exhibit 10.3 of the September 2001 Form 10-Q).** 10.65 December 2001 Amendment to Senior Secured Credit Agreement dated December 2001, among American Business Financial Services, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc., a Pennsylvania corporation doing business under the assumed or fictitious name Upland Mortgage, and American Business Mortgage Services, Inc. and JPMorgan Chase Bank. (Incorporated by reference from Exhibit 10.1 to Registrant's Quarterly Report on Form 10-Q for the quarter ended December 31, 2001 filed on February 14, 2002 (the "December 2001 Form 10-Q")). 10.66 Master Repurchase Agreement between Credit Suisse First Boston Mortgage Capital LLC and ABFS Repo 2001, Inc. (Incorporated by reference to Exhibit 10.2 from the December 2001 Form 10-Q). 10.67 Master Contribution Agreement, dated as of November 16, 2001 by and between American Business Financial Services, Inc. and ABFS Repo 2001, Inc. (Incorporated by reference from Exhibit 10.3 to the December 2001 Form 10-Q). 10.68 Custodial Agreement dated as of November 16, 2001, by and among ABFS Repo 2001, Inc., a Delaware corporation; American Business Credit, Inc., a Pennsylvania corporation; JPMorgan Chase Bank, a New York banking corporation; and Credit Suisse First Boston Mortgage Capital LLC. (Incorporated by reference from Exhibit 10.4 to the December 2001 Form 10-Q). 10.69 Guaranty, dated as of November 16, 2001, by and among American Business Financial Services, Inc., American Business Credit, Inc., HomeAmerican Credit, Inc. d/b/a Upland Mortgage, American Business Mortgage Services, Inc. and Credit Suisse First Boston Mortgage Capital LLC. (Incorporated by reference from Exhibit 10.5 to the December 2001 Form 10-Q). 10.70 Amendment No. 1 to the Indenture dated March 1, 2001 among Triple-A One Funding Corporation, ABFS Mortgage Loan Warehouse Trust 2001-1 and JPMorgan Chase Bank. (Incorporated by reference from Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2002 filed on May 15, 2002 (the "March 2002 Form 10-Q").
240
Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 10.71 Amendment No. 2 to the Sale and Servicing Agreement dated as of March 1, 2001 by and among ABFS OSO Inc., a Delaware corporation, as Depositor, ABFS Mortgage Loan Warehouse Trust 2001-1, a Delaware business trust, as the Trust, American Business Financial Services, Inc., a Delaware corporation, as Guarantor, American Business Credit, Inc., a Pennsylvania corporation, as Servicer, JPMorgan Chase Bank f/k/a The Chase Manhattan Bank, a New York banking corporation, as Indenture Trustee and as Collateral Agent and MBIA Insurance Corporation, a New York stock insurance company, as Note Insurer. (Incorporated by reference from Exhibit 10.2 to the March 2002 Form 10-Q). 10.72 3/02 Amended and Restated Senior Secured Credit Agreement dated as of March 15, 2002 among: American Business Credit, Inc. and certain affiliates and JPMorgan Chase Bank, as Agent and as a Lender. (Incorporated by reference from Exhibit 10.3 to the March 2002 Form 10-Q). 10.73 $1.2 million Committed Line of Credit Note between American Business Financial Services, Inc. and Firstrust Savings Bank dated January 18, 2002. (Incorporated by reference from Exhibit 10.4 to the March 2002 Form 10-Q). 10.74 American Business Financial Services, Inc. Dividend Reinvestment and Stock Purchase Plan. (Incorporated by reference from Exhibit 10.1 of the Registrant's Registration Statement on Form S-3, No. 333-87574, filed on May 3, 2002). 10.75 Pooling and Servicing Agreement, relating to ABFS Mortgage Loan Trust 2001-2, dated as of June 1, 2001, by and among Bear Stearns Asset Backed Securities, Inc., a Delaware corporation, American Business Credit, Inc., a Pennsylvania corporation, and The Chase Manhattan Bank, a New York banking corporation. (Incorporated by reference from Exhibit 10.75 of Registrant's Registration Statement on Form S-2, No. 33-90366, filed on June 12, 2002 (the "2002 Form S-2). 10.76 Unaffiliated Seller's Agreement, dated June 1, 2001 by and among Bear Stearns Asset Backed Securities, Inc., a Delaware corporation, ABFS 2001-2, Inc., a Delaware corporation, American Business Credit, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc., d/b/a Upland Mortgage, a Pennsylvania corporation, and American Business Mortgage Services, Inc., a New Jersey corporation. (Incorporated by reference from Exhibit 10.76 of the 2002 Form S-2). 10.77 Pooling and Servicing Agreement, relating to ABFS Mortgage Loan Trust 2002-1, dated as of March 1, 2002, by and among Bear Stearns Asset Backed Securities, Inc., a Delaware corporation, American Business Credit, Inc., a Pennsylvania corporation and JPMorgan Chase Bank, a New York banking corporation. (Incorporated by reference from Exhibit 10.77 of the 2002 Form S-2).
241
Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 10.78 Unaffiliated Seller's Agreement, dated as of March 1, 2002 by and among Bear Stearns Asset Backed Securities, Inc., a Delaware corporation, ABFS 2002-1, Inc., a Delaware corporation, American Business Credit, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc. d/b/a Upland Mortgage, a Pennsylvania corporation and American Business Mortgage Services, Inc., a New Jersey corporation. (Incorporated by reference from Exhibit 10.78 of the 2002 Form S-2). 10.79 Pooling and Services Agreement relating to ABFS Mortgage Loan Trust 2002-2, dated as of June 1, 2002, by and among Credit Suisse First Boston Mortgage Securities Corp., a Delaware corporation, American Business Credit, Inc., a Pennsylvania corporation, and JP Morgan Chase Bank, a New York corporation. (Incorporated by reference from Exhibit 10.79 to Registrant's Annual Report on Form 10-K for the year ended June 30, 2002 filed on September 20, 2002 (the "2002 Form 10-K")). 10.80 Unaffiliated Seller's Agreement, dated as of June 1, 2002, by and among Credit Suisse First Boston Mortgage Securities Corp., a Delaware corporation, ABFS 2002-2, Inc., a Delaware corporation, American Business Credit, Inc., a Pennsylvania corporation, and HomeAmerican Credit Inc., d/b/a Upland Mortgage, a Pennsylvania corporation, and American Business Mortgage Services, Inc., a New Jersey corporation. (Incorporated by reference from Exhibit 10.80 to 2002 Form 10-K). 10.81 Indemnification Agreement dated June 21, 2002, by ABFS 2002-2, Inc., American Business Credit, Inc., HomeAmerican Credit, Inc. and American Business Mortgage Services, Inc. in favor of Credit Suisse First Boston Mortgage Securities Corp. and Credit Suisse First Boston Corp. (Incorporated by reference from Exhibit 10.81 to 2002 Form 10-K). 10.82 First Amended and Restated Warehousing Credit and Security Agreement between American Business Credit, Inc., a Pennsylvania corporation, American Business Mortgage Services, Inc., a New Jersey corporation, HomeAmerican Credit, Inc., a Pennsylvania corporation, and Residential Funding Corporation, a Delaware corporation dated as of July 1, 2002. (Incorporated by reference from Exhibit 10.82 to 2002 Form 10-K). 10.83 Promissory Note between American Business Credit, Inc., a Pennsylvania corporation, American Business Mortgage Services, Inc., a New Jersey corporation, HomeAmerican Credit, Inc., a Pennsylvania corporation, and Residential Funding Corporation, a Delaware corporation dated July 1, 2002. (Incorporated by reference from Exhibit 10.83 to 2002 Form 10-K). 10.84 Guaranty dated July 1, 2002 given by American Business Financial Services, Inc., a Delaware corporation, to Residential Funding Corporation, a Delaware corporation. (Incorporated by reference from Exhibit 10.84 to 2002 Form 10-K).
242
Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 10.85 Office Lease Agreement, dated November 27, 2002 and Addendum to Office Lease, dated November 27, 2002 between the Registrant and Wanamaker, LLC. (Incorporated by reference to Exhibit 10.1 to the Registrant's Report on Form 8-K, dated December 9, 2002 and filed December 27, 2002). 10.86 Letter Agreement dated May 20, 2002 between the Registrant and the Commonwealth of Pennsylvania. (Incorporated by reference to Exhibit 10.2 to the Registrant's Current Report on Form 8-K, dated December 9, 2002 and filed December 27, 2002). 10.87 Letter of Intent with PIDC Local Development Corporation dated December 3, 2002. (Incorporated by reference to Exhibit 10.3 to the Registrant's Report on Form 8-K, dated December 9, 2002 and filed December 27, 2002). 10.88 Letter of Credit from JPMorgan Chase Bank for $6,000,000 provided as security for a lease for office space. (Incorporated by reference to Exhibit 10.4 to the Registrant's Quarterly Report on Form 10-Q for the period ended December 31, 2002). 10.89 12/02 Amendment to Senior Secured Credit Agreement for $50.0 million warehouse line, operating line and letter of credit with JPMorgan Chase. (Incorporated by reference to Exhibit 10.5 to the Registrant's Quarterly Report on Form 10-Q for the period ended December 31, 2002). 10.90 Lease between CWLT Roseland Exchange L.L.C., and American Business Financial Services, Inc. for 105 Eisenhower Parkway, Roseland, N.J. (the "Roseland Lease") (Incorporated by reference to Exhibit 10.2 to the Registrant's Quarterly Report on Form 10-Q for the period ended March 31, 2003 (the "March 31, 2003 Form 10-Q")). 10.91 Amendment No. 3 to Letter of Credit Agreement with JP Morgan Chase (Incorporated by reference to Exhibit 10.1 to the March 31, 2003 Form 10-Q). 10.92 First Amendment to the Roseland Lease (Incorporated by reference to Exhibit 10.3 of the March 31, 2003 Form 10-Q). 10.93 Pooling and Servicing Agreement relating to ABFS Mortgage Loan Trust 2002-3, dated as of September 1, 2002, by and among Credit Suisse First Boston Mortgage Securities Corp., a Delaware corporation, American Business Credit, Inc., a Pennsylvania corporation, and JPMorgan Chase Bank, a New York banking corporation (Incorporated by reference from Exhibit 10.93 of Registrant's Registration Statement on Form S-2, No. 333-106476, filed on June 25, 2003).
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Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 10.94 Unaffiliated Seller's Agreement, dated as of September 1, 2002, by and among Credit Suisse First Boston Mortgage Securities Corp., a Delaware corporation, ABFS 2002-3, Inc., a Delaware corporation, American Business Credit, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc. d/b/a Upland Mortgage, a Pennsylvania corporation, and American Business Mortgage Services, Inc., a New Jersey corporation (Incorporated by reference from Exhibit 10.94 of Registrant's Registration Statement on Form S-2, No. 333-106476, filed on June 25, 2003). 10.95 Indemnification Agreement, dated September 23, 2002, by ABFS 2002-3, Inc., American Business Credit, Inc., HomeAmerican Credit, Inc. d/b/a Upland Mortgage and American Business Mortgage Services, Inc. in favor of Credit Suisse First Boston Mortgage Securities Corp. and Credit Suisse First Boston Corporation (Incorporated by reference from Exhibit 10.95 of Registrant's Registration Statement on Form S-2, No. 333-106476, filed on June 25, 2003). 10.96 Unaffiliated Seller's Agreement, dated as of December 1, 2002, by and among Credit Suisse First Boston Mortgage Securities Corp., a Delaware corporation, ABFS 2002-4, Inc., a Delaware corporation, American Business Credit, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc. d/b/a Upland Mortgage, a Pennsylvania corporation, and American Business Mortgage Services, Inc., a New Jersey corporation (Incorporated by reference from Exhibit 10.96 of Registrant's Registration Statement on Form S-2, No. 333-106476, filed on June 25, 2003). 10.97 Pooling and Servicing Agreement relating to ABFS Mortgage Loan Trust 2002-4, dated as of December 1, 2002, by and among Credit Suisse First Boston Mortgage Securities Corp., a Delaware corporation, American Business Credit, Inc., a Pennsylvania corporation, and JPMorgan Chase Bank, a New York banking corporation (Incorporated by reference from Exhibit 10.97 of Registrant's Registration Statement on Form S-2, No. 333-106476, filed on June 25, 2003). 10.98 Indemnification Agreement, dated December 18, 2002, by ABFS 2002-4, Inc., American Business Credit, Inc., HomeAmerican Credit, Inc. d/b/a Upland Mortgage and American Business Mortgage Services, Inc. in favor of Credit Suisse First Boston Mortgage Securities Corp. and Credit Suisse First Boston Corporation (Incorporated by reference from Exhibit 10.98 of Registrant's Registration Statement on Form S-2, No. 333-106476, filed on June 25, 2003). 10.99 Unaffiliated Seller's Agreement, dated as of March 1, 2003, by and among Bear Stearns Asset Backed Securities, Inc., a Delaware corporation, ABFS 2003-1, Inc., a Delaware corporation, American Business Credit, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc. d/b/a Upland Mortgage, a Pennsylvania corporation, and American Business Mortgage Services, Inc., a New Jersey corporation.
244
Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 10.100 Pooling and Servicing Agreement relating to ABFS Mortgage Loan Trust 2003-1, dated as of March 1, 2003, by and among Bear Stearns Asset Backed Securities, Inc., a Delaware corporation, American Business Credit, Inc., a Pennsylvania corporation, and JPMorgan Chase Bank, a New York banking corporation. 10.101 Insurance and Indemnity Agreement, dated March 31, 2003, by Radian Asset Assurance Inc., a New York stock insurance company, American Business Credit, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc. d/b/a Upland Mortgage, American Business Mortgage Services, Inc., ABFS 2003-1, Inc., Bear Stearns Asset Backed Securities, Inc. and JPMorgan Chase Bank. 10.102 Amended and Restated Committed Line of Credit Note, dated June 2, 2003, between American Business Financial Services, Inc. and Firstrust Savings Bank. 10.103 Amendment Number One to the Master Repurchase Agreement, dated November 13, 2002, between Credit Suisse First Boston Mortgage Capital LLC and ABFS REPO 2001, Inc. 10.104 3/31/03 Amendment to Senior Secured Credit Agreement, dated March 31, 2003, among American Business Credit, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc., a Pennsylvania corporation, American Business Mortgage Services, Inc., a New Jersey corporation, ABFS Residual 2002, Inc., American Business Financial Services, Inc., a Delaware corporation, and JPMorgan Chase Bank and certain other lenders. 10.105 12/02 Amendment to 3/02 Security Agreement - Residual Interest Certificates, dated December 18, 2002, made by ABFS Residual 2002, Inc., a Delaware corporation in favor of JPMorgan Chase Bank. 10.106 Letter, dated August 21, 2003 from JPMorgan Chase Bank to American Business Credit, Inc., HomeAmerican Credit, Inc., American Business Mortgage Services, Tiger Relocation Company, ABFS Residual 2002, Inc. and American Business Financial Services, Inc. regarding waiver of financial covenant in 3/02 Senior Secured Credit Agreement dated as of March 15, 2002. (Incorporated by reference to Exhibit 10.1 of the Registrant's Current Report on Form 8-K, File No. 0-22474, filed on September 25, 2003 (the "9/25/03 8-K")). 10.107 Mortgage Loan Purchase and Interim Servicing Agreement, dated July 22, 2003, among DLJ Mortgage Capital, Inc., American Business Credit, Inc., Homeamerican Credit, Inc. d/b/a Upland Mortgage and American Business Mortgage Services, Inc. 10.108 Mortgage Loan Purchase and Interim Servicing Agreement, dated as of June 30, 2003, among EMC Mortgage Corporation, American Business Credit, Inc., Homeamerican Credit, Inc. d/b/a Upland Mortgage, and American Business Mortgage Services, Inc. 10.109 Waiver and Amendment Number Two to the Master Repurchase Agreement between Credit Suisse First Boston Mortgage Capital LLC and ABFS Repo 2001, Inc. dated August 20, 2003 and Letter dated as of August 20, 2003 from Credit Suisse First Boston Mortgage Capital LLC to ABFS Repo 2001, Inc. (Incorporated by reference to Exhibit 10.2 of the Registrant's 9/25/03 8-K). 10.110 Sale and Servicing Agreement, dated September 22, 2003, among ABFS Balapointe, Inc., HomeAmerican Credit, Inc., ABFS Mortgage Loan Warehouse Trust 2003-1, American Business Credit, Inc., American Business Financial Services, Inc. and JPMorgan Chase Bank. (Incorporated by reference to Exhibit 10.3 of the 9/25/03 8-K). 10.111 Indenture, dated September 22, 2003 between ABFS Mortgage Loan Warehouse Trust 2003-1 and JPMorgan Chase Bank, as Indenture Trustee, with Appendix I, Defined Terms. (Incorporated by reference to Exhibit 10.4 of the Registrant's 9/25/03 8-K). 10.112 Trust Agreement, dated as of September 22, 2003, by and between ABFS Bala Pointe, Inc., as Depositor and Wilmington Trust Company, as Owner Trustee. (Incorporated by reference to Exhibit 10.5 of the Registrant's 9/25/03 8-K). 10.113 ABFS Mortgage Loan Warehouse Trust 2003-1 Secured Notes Series 2003-1 Purchase Agreement. (Incorporated by reference to Exhibit 10.6 of the Registrant's 9/25/03 8-K). 10.114 Commitment letter dated September 22, 2003 addressed to American Business Financial Services Inc. from Chrysalis Warehouse Funding, LLC. (Incorporated by reference to Exhibit 10.7 of the Registrant's 9/25/03 8-K). 10.115 Fee letter dated September 22, 2003 addressed to American Business Financial Services, Inc. and Chrysalis Warehouse Funding, LLC from Clearwing Capital, LLC. (Incorporated by reference to Exhibit 10.8 of the Registrant's 9/25/03 8-K). 10.116 Amendment to Senior Secured Credit Agreement dated as of September 22, 2003 among American Business Credit, Inc. and certain affiliates and JPMorgan Chase Bank and other parties thereto. (Incorporated by reference to Exhibit 10.9 of the Registrant's 9/25/03 8-K).
245
Exhibit Number Description - ------ -------------------------------------------------------------------------------------------------------- 11.1 Statement of Computation of Per Share Earnings (Included in Note 19 of the Notes to June 30, 2003 Consolidated Financial Statements). 12.1 Computation of Ratio of Earnings to Fixed Charges. 16.1 Letter regarding change in certifying accountants. (Incorporated by reference from Exhibit 16.1 of the Registrant's Current Report on Form 8-K dated May 17, 2001.) 16.2 Letter regarding change in certifying accountants. (Incorporated by reference from Exhibit 16.2 of the Registrant's Current Report on Form 8-K dated August 2, 2001.) 21.1 Subsidiaries of the Registrant. 23.1 Consent of BDO Seidman, LLP. 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes Oxley Act of 2002. 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes Oxley Act of 2002. 32.1 Certification pursuant to Section 906 of the Sarbanes Oxley Act of 2002.
- ---------------------- ** Indicates management contract or compensatory plan or arrangement. 246 EX-10.99 3 ex10-99.txt EXHIBIT 19.99 BEAR STEARNS ASSET BACKED SECURITIES, INC., Depositor, ABFS 2003-1, INC., Unaffiliated Seller and AMERICAN BUSINESS CREDIT, INC. HOMEAMERICAN CREDIT, INC., D/B/A UPLAND MORTGAGE, and AMERICAN BUSINESS MORTGAGE SERVICES, INC., Originators ___________________________ UNAFFILIATED SELLER'S AGREEMENT Dated as of March 1, 2003 TABLE OF CONTENTS Page ARTICLE I DEFINITIONS Section 1.01. Definitions.....................................................1 ARTICLE II PURCHASE, SALE AND CONVEYANCE OF MORTGAGE LOANS Section 2.01. Agreement to Purchase the Initial Mortgage Loans................2 Section 2.02. Agreement to Purchase any Subsequent Mortgage Loans.............3 Section 2.03. Purchase Price..................................................3 Section 2.04. Conveyance of Mortgage Loans; Possession of Mortgage Files......4 Section 2.05. Delivery of Mortgage Loan Documents.............................5 Section 2.06. Acceptance of Mortgage Loans....................................6 Section 2.07. Sale of Mortgage Loans; Assignment of Agreement.................7 Section 2.08. Examination of Mortgage Files...................................8 Section 2.09. Books and Records...............................................8 Section 2.10. Cost of Delivery and Recordation of Documents...................8 ARTICLE III REPRESENTATIONS AND WARRANTIES Section 3.01. Representations and Warranties as to the Originators............8 Section 3.02. Representations and Warranties as to the Unaffiliated Seller...10 Section 3.03. Representations and Warranties Relating to the Mortgage Loans..12 Section 3.04. Representations and Warranties of the Depositor................21 Section 3.05. Repurchase Obligation for Defective Documentation and for Breach of a Representation or Warranty.......................21 Section 3.06. Limited Purpose and Corporate Separateness of the Unaffiliated Seller..........................................24 ARTICLE IV THE UNAFFILIATED SELLER Section 4.01. Covenants of the Originators and the Unaffiliated Seller.......26 Section 4.02. Merger or Consolidation........................................26 Section 4.03. Costs..........................................................27 Section 4.04. Indemnification................................................27 i ARTICLE V CONDITIONS OF CLOSING Section 5.01. Conditions of Depositor's Obligations..........................29 Section 5.02. Conditions of Unaffiliated Seller's Obligations................31 Section 5.03. Termination of Depositor's Obligations.........................32 ARTICLE VI MISCELLANEOUS Section 6.01. Notices........................................................32 Section 6.02. Severability of Provisions.....................................32 Section 6.03. Agreement of Unaffiliated Seller...............................33 Section 6.04. Survival.......................................................33 Section 6.05. Effect of Headings and Table of Contents.......................33 Section 6.06. Successors and Assigns.........................................33 Section 6.07. Confirmation of Intent; Grant of Security Interest.............33 Section 6.08. Miscellaneous..................................................34 Section 6.09. Amendments.....................................................34 Section 6.10. Third-Party Beneficiaries......................................34 Section 6.11. GOVERNING LAW; CONSENT TO JURISDICTION; WAIVER OF JURY TRIAL...35 Section 6.12. Execution in Counterparts......................................35 Exhibit A - Mortgage Loan Schedule ii THIS UNAFFILIATED SELLER'S AGREEMENT, dated as of March 1, 2003, by and among BEAR STEARNS ASSET BACKED SECURITIES, INC., a Delaware corporation, its successors and assigns (the "Depositor"), ABFS 2003-1, INC., a Delaware corporation and its successors (the "Unaffiliated Seller"), AMERICAN BUSINESS CREDIT, INC., a Pennsylvania corporation ("ABC"), HOMEAMERICAN CREDIT, INC. D/B/A UPLAND MORTGAGE, a Pennsylvania corporation ("Upland"), and AMERICAN BUSINESS MORTGAGE SERVICES, INC., a New Jersey corporation ("ABMS", and together with ABC and Upland, the "Originators"). WHEREAS, Exhibit A attached hereto and made a part hereof lists certain fixed rate business purpose and consumer purpose first and second lien mortgage loans (the "Mortgage Loans") owned by the Originators that the Originators desire to sell to the Unaffiliated Seller and the Unaffiliated Seller desires to sell to the Depositor and that the Depositor desires to purchase; and WHEREAS, it is the intention of the Originators, the Unaffiliated Seller and the Depositor that, simultaneously with the Originators' conveyance of the Mortgage Loans to the Unaffiliated Seller and the Unaffiliated Seller's conveyance of the Mortgage Loans to the Depositor on the Closing Date, (a) the Depositor shall sell the Mortgage Loans to the ABFS Mortgage Loan Trust 2003-1 (the "Trust"), pursuant to a Pooling and Servicing Agreement to be dated as of March 1, 2003 (the "Pooling and Servicing Agreement"), to be entered into by and among the Depositor, as depositor, American Business Credit, Inc., as servicer (in such capacity, the "Servicer") and JPMorgan Chase Bank, as trustee, collateral agent and back-up servicer (in each such capacity, as applicable, the "Trustee", the "Collateral Agent" and the "Back-up Servicer") and (b) the Trust shall issue certificates (the "Certificates") evidencing beneficial ownership interests in the property of the trust fund formed by the Pooling and Servicing Agreement to the Depositor. NOW, THEREFORE, in consideration of the premises and the mutual agreements hereinafter set forth, the parties hereto agree as follows: ARTICLE I DEFINITIONS Section 1.01. Definitions. Whenever used herein, the following words and phrases, unless the context otherwise requires, shall have the meanings specified in this Article I: "Agreement" means this Unaffiliated Seller's Agreement, as amended or supplemented in accordance with the provisions hereof. "Prospectus" means the Prospectus dated February 25, 2003 relating to the offering by the Depositor from time to time of its Mortgage-Backed/Asset-Backed Securities (Issuable in Series) in the form in which it was or will be filed with the Commission pursuant to Rule 424(b) under the Securities Act with respect to the offer and sale of the Certificates. "Prospectus Supplement" means the Prospectus Supplement dated March 26, 2003, relating to the offering of the Certificates in the form in which it was or will be filed with the Commission pursuant to Rule 424(b) under the Securities Act with respect to the offer and sale of the Certificates. "Registration Statement" means that certain registration statement on Form S-3, as amended (Registration No. 333-91344), relating to the offering by the Depositor from time to time of its Mortgage-Backed/Asset-Backed Securities (Issuable in Series) as heretofore declared effective by the Commission. "Securities Act" means the Securities Act of 1933, as amended. "Termination Event" means the existence of any one or more of the following conditions: (a) a stop order suspending the effectiveness of the Registration Statement shall have been issued or a proceeding for that purpose shall have been initiated or threatened by the Commission; or (b) subsequent to the execution and delivery of this Agreement, a downgrading, or public notification of a possible change, without indication of direction, shall have occurred in the rating afforded any of the debt securities or claims paying ability of any person providing any form of credit enhancement for any of the Certificates, by any "nationally recognized statistical rating organization," as that term is defined by the Commission for purposes of Rule 436(g)(2) under the Securities Act; or (c) subsequent to the execution and delivery of this Agreement, there shall have occurred an adverse change in the condition, financial or otherwise, earnings, affairs, regulatory situation or business prospects of the Certificate Insurer or the Unaffiliated Seller reasonably determined by the Depositor to be material; or (d) subsequent to the date of this Agreement there shall have occurred any of the following: (i) a suspension or material limitation in trading in securities substantially similar to the Certificates; (ii) a general moratorium on commercial banking activities in the State of New York declared by either Federal or New York State authorities; or (iii) the engagement by the United States in hostilities, or the escalation of such hostilities, or any calamity or crisis, if the effect of any such event specified in this clause (iii) in the judgment of the Depositor makes it impracticable or inadvisable to proceed with the public offering or the delivery of the Certificates on the terms and in the manner contemplated in the Prospectus Supplement. "Unaffiliated Seller" means ABFS 2003-1, Inc., in its capacity as Unaffiliated Seller of the Mortgage Loans under this Agreement. Capitalized terms used herein that are not otherwise defined shall have the respective meanings ascribed thereto in the Pooling and Servicing Agreement. 2 ARTICLE II PURCHASE, SALE AND CONVEYANCE OF MORTGAGE LOANS Section 2.01. Agreement to Purchase the Initial Mortgage Loans. (a) Subject to the terms and conditions of this Agreement, the Originators agree to sell, and the Unaffiliated Seller agrees to purchase on the Closing Date and, immediately subsequent thereto, the Unaffiliated Seller agrees to sell, and the Depositor agrees to purchase, the Mortgage Loans having the Cut-Off Date Aggregate Principal Balance or, in accordance with Section 2.08 hereof, such other balance as is evidenced by the actual Original Aggregate Principal Balance of the Mortgage Loans accepted by the Depositor on the Closing Date and listed in the Mortgage Loan Schedule. (b) Subject to Section 2.08 hereof, the Depositor and the Unaffiliated Seller have agreed upon which of the Unaffiliated Seller's Mortgage Loans are to be purchased by the Depositor on the Closing Date pursuant to this Agreement, and the Unaffiliated Seller has prepared a schedule describing the Mortgage Loans (the "Mortgage Loan Schedule") setting forth all of the Mortgage Loans to be purchased under this Agreement, which schedule is attached hereto as Exhibit A. The Mortgage Loan Schedule shall conform to the requirements of the Depositor and to the definition of "Mortgage Loan Schedule" in the Pooling and Servicing Agreement. (c) The closing for the purchase and sale of the Mortgage Loans shall take place at the offices of Dewey Ballantine LLP, New York, New York, at 10:00 a.m., New York time, on March 31, 2003 or such other place and time as the parties shall agree (such time being herein referred to as the "Closing Date"). Section 2.02. Agreement to Purchase any Subsequent Mortgage Loans. Subject to the satisfaction of the conditions set forth in Section 2.03 of the Pooling and Servicing Agreement and provided that the Original Pre-Funded Amount is greater than zero, (i) in consideration of the Unaffiliated Seller's delivery on the related Subsequent Transfer Dates to or upon the order of the Originators of all or a portion of the balance of funds on deposit in the Pre-Funding Account, the Originators shall on any Subsequent Transfer Date sell, transfer, assign, set over and convey to the Unaffiliated Seller, without recourse, but subject to the terms and provisions of this Agreement, all of the right, title and interest of the Originators in and to the Subsequent Mortgage Loans, including all principal of, and all interest due on, such Subsequent Mortgage Loans, and all other assets included or to be included in the Trust Fund, and (ii) in consideration of the Depositor's delivery on the related Subsequent Transfer Dates to or upon the order of the Unaffiliated Seller of all or a portion of the balance of funds on deposit in the Pre-Funding Account, the Unaffiliated Seller shall on any Subsequent Transfer Date sell, transfer, assign, set over and convey to the Depositor, without recourse, but subject to the terms and provisions of this Agreement, all of the right, title and interest of the Unaffiliated Seller in and to the Subsequent Mortgage Loans, including all principal of, and all interest due on, such Subsequent Mortgage Loans, and all other assets included or to be included in the Trust Fund. The amount released from the Pre-Funding Account with respect to a transfer of Subsequent Mortgage Loans to the Mortgage Loan Pool shall be one hundred percent (100%) of the Aggregate Principal Balance of such Subsequent Mortgage Loans so transferred, as of the related Subsequent Cut-Off Date. 3 The obligation of the Depositor to purchase a Subsequent Mortgage Loan on any Subsequent Transfer Date is subject to the satisfaction of the requirements set forth in Section 2.03 of the Pooling and Servicing Agreement. Section 2.03. Purchase Price. (a) On the Closing Date, as consideration for the Originators' sale of the Initial Mortgage Loans to the Unaffiliated Seller, the Unaffiliated Seller will deliver to the Originators an amount in cash equal to the sum of (i) with respect to each Class of Offered Certificates, the product of (x) the Original Certificate Principal Balance of such Class of Offered Certificates and (y) the purchase percentage for such Class set forth in the table below, plus (ii) with respect to the Class A and Class A-IO Certificates only, accrued interest on each such Original Certificate Principal Balance at the Pass-Through Rate for such Class set forth in the table below from (and including) March 1, 2003 to (but not including) the Closing Date, minus (iv) the Original Pre-Funded Amount, if any. On the Closing Date, as consideration for the Unaffiliated Seller's sale of the Initial Mortgage Loans to the Depositor, the Depositor will deliver to the Unaffiliated Seller (i) an amount in cash equal to the sum of (A) with respect to each Class of Offered Certificates, the product of (x) the Original Certificate Principal Balance of such Class of Offered Certificates and (y) the purchase percentage for such Class set forth in the table below, plus (B) with respect to the Class A and Class A-IO Certificates only, accrued interest on each such Original Certificate Principal Balance at the Pass-Through Rate for such Class set forth in the table below, from (and including) March 1, 2003 to (but not including) the Closing Date, minus (D) the Original Pre-Funded Amount, if any, and (ii) the Class X, Class I and Class R Certificates to be issued pursuant to the Pooling and Servicing Agreement, if any. Class Purchase Percentage Pass-Through Rate ----- ------------------- ----------------- A 99.927390% 3.78% A-IO 7.091795% 4.00% M 100.000000% LIBOR plus 1.50% (b) On any Subsequent Transfer Date, as full consideration for the Originators' sale of the Subsequent Mortgage Loans to the Unaffiliated Seller and the Unaffiliated Seller's sale of the Subsequent Mortgage Loans to the Depositor, the Depositor will deliver to the Unaffiliated Seller and the Unaffiliated Seller will deliver to the Originators an amount in cash equal to the sum of 100.00000% of the Aggregate Principal Balance of the Subsequent Mortgage Loans as of the related Subsequent Cut-Off Date. (c) The consideration described in this Section 2.03 collectively represents (i) full consideration for the Originators' sale of the Initial Mortgage Loans to the Unaffiliated Seller and (ii) full consideration for the Unaffiliated Seller's sale of the Initial Mortgage Loans to the Depositor. The consideration received by the Originators will be allocated among them in proportion to the outstanding principal balance of the Initial Mortgage Loans sold by each. 4 Section 2.04. Conveyance of Mortgage Loans; Possession of Mortgage Files. (a) On the Closing Date and on any Subsequent Transfer Date, the Originators shall sell, transfer, assign, set over and convey, or cause to be assigned, set over or conveyed, to the Unaffiliated Seller, without recourse but subject to the terms of this Agreement, all right, title and interest in and to the applicable Mortgage Loans, including all principal outstanding as of, and all interest due and accruing after, the related Cut-Off Date, the Insurance Policies relating to each such Mortgage Loan and all right, title and interest in and to the proceeds of such Insurance Policies from and after the Initial Cut-Off Date or the Subsequent Cut-Off Date, as applicable, and the Unaffiliated Seller shall sell, transfer, assign, set over and convey or cause to be assigned, set over or conveyed, to the Depositor, without recourse but subject to the terms of this Agreement, all right, title and interest in and to the applicable Mortgage Loans, including all principal outstanding as of, and all interest due after, the related Cut-Off Date, the Insurance Policies relating to each such Mortgage Loan, all right, title and interest in and to the proceeds of such Insurance Policies and all of its rights under this Agreement with respect to the Mortgage Loans from and after the Initial Cut-Off Date or the Subsequent Cut-Off Date, as applicable. Upon payment of the purchase price for such Mortgage Loans as provided in Section 2.03 of this Agreement, the Originators and the Unaffiliated Seller shall have hereby, and shall be deemed to have, or caused to have sold, transferred, assigned, set over and conveyed such Mortgage Loans, the Insurance Policies relating to each such Mortgage Loan, all right, title and interest in and to the proceeds of such Insurance Policies and all of their rights under this Agreement with respect to the Mortgage Loans from and after the Initial Cut-Off Date or the Subsequent Cut-Off Date, as applicable. (b) Upon the sale of such Mortgage Loans, the ownership of each related Mortgage Note, each related Mortgage and the contents of the related Mortgage File shall immediately vest in the Depositor and the ownership of all related records and documents with respect to each Mortgage Loan prepared by or which come into the possession of the Originators or the Unaffiliated Seller shall immediately vest in the Depositor. The contents of any Mortgage File in the possession of the Originators or the Unaffiliated Seller at any time after such sale, and any principal collected and interest due on the Mortgage Loans after the related Cut-Off Date and received by the Originators or the Unaffiliated Seller, shall be held in trust by the Originators or the Unaffiliated Seller for the benefit of the Depositor as the owner thereof, and shall be promptly delivered by the Originators or the Unaffiliated Seller to or upon the order of the Depositor. (c) Pursuant to the Pooling and Servicing Agreement, the Depositor shall, on the Closing Date, assign all of its right, title and interest in and to the Initial Mortgage Loans, the related Insurance Policies and any proceeds thereof and all of its rights under this Agreement to the Trustee for the benefit of the Certificateholders and the Certificate Insurer. Section 2.05. Delivery of Mortgage Loan Documents. (a) On or prior to the Closing Date or any Subsequent Transfer Date, as applicable, the related Originator shall deliver or cause to be delivered to the Unaffiliated Seller, and the Unaffiliated Seller shall deliver to the Collateral Agent, on behalf of the Trustee (as assignee of the Depositor 5 pursuant to the Pooling and Servicing Agreement), each of the documents described in clauses (i) through (vi) of Section 2.05(a) of the Pooling and Servicing Agreement for each applicable Mortgage Loan in accordance with the provisions of Section 2.05 of the Pooling and Servicing Agreement. (b) Pursuant to the Pooling and Servicing Agreement, the Unaffiliated Seller shall within sixty (60) days of the Closing Date be required to promptly submit, or cause to be submitted by the related Originator, for recording in the appropriate public office for real property records, each assignment referred to in Section 2.05(a) of the Pooling and Servicing Agreement. The Collateral Agent, on behalf of the Trustee, shall be required to retain a copy of each assignment submitted for recording. In the event that any such assignment is lost or returned unrecorded because of a defect therein, the Unaffiliated Seller or such Originator shall promptly prepare a substitute assignment or cure such defect, as the case may be, and thereafter the Unaffiliated Seller or such Originator shall be required to submit each such assignment for recording. (c) The Unaffiliated Seller or the related Originator shall, within five (5) Business Days after the receipt thereof, deliver or cause to be delivered to the Collateral Agent, on behalf of the Trustee (pursuant to the Pooling and Servicing Agreement): (i) the original recorded Mortgage and related power of attorney, if any, in those instances where a copy thereof certified by the related Originator was delivered to the Collateral Agent, on behalf of the Trustee (pursuant to the Pooling and Servicing Agreement); (ii) the original recorded assignment of Mortgage from the related Originator to the Trustee (pursuant to the Pooling and Servicing Agreement), which, together with any intervening assignments of Mortgage, evidences a complete chain of assignment from the originator of the Mortgage Loan to the Trustee in those instances where copies of such assignments certified by the related Originator were delivered to the Collateral Agent, on behalf of the Trustee (pursuant to Section 2.05 of the Pooling and Servicing Agreement); and (iii) the title insurance policy or title opinion required in Section 2.05(a)(vi) of the Pooling and Servicing Agreement. Notwithstanding anything to the contrary contained in this Section 2.05, in those instances where the public recording office retains the original Mortgage, power of attorney, if any, assignment or assignment of Mortgage after it has been recorded or such original has been lost, the Unaffiliated Seller or the related Originator shall be deemed to have satisfied its obligations hereunder upon delivery to the Collateral Agent, on behalf of the Trustee (pursuant to the Pooling and Servicing Agreement), of a copy of such Mortgage, power of attorney, if any, assignment or assignment of Mortgage certified by the public recording office to be a true copy of the recorded original thereof. From time to time the Unaffiliated Seller or the related Originator may forward or cause to be forwarded to the Collateral Agent, on behalf of the Trustee (pursuant to the Pooling and Servicing Agreement), additional original documents evidencing an assumption or modification of a Mortgage Loan. (d) All original documents relating to the Mortgage Loans that are not delivered to the Collateral Agent, on behalf of the Trustee (pursuant to the Pooling and Servicing Agreement), as permitted by Section 2.05(a) hereof are and shall be held by the Servicer, the Unaffiliated Seller or the related Originator 6 in trust for the benefit of the Trustee on behalf of the Certificateholders and the Certificate Insurer. In the event that any such original document is required pursuant to the terms of this Section 2.05 to be a part of a Trustee Mortgage File, such document shall be delivered promptly to the Collateral Agent, on behalf of the Trustee (as assignee of the Depositor pursuant to the Pooling and Servicing Agreement). From and after the sale of the Mortgage Loans to the Depositor pursuant hereto, to the extent that the Unaffiliated Seller or the related Originator retains legal title of record to any Mortgage Loans prior to the vesting of legal title in the Trustee (as assignee of the Depositor pursuant to the Pooling and Servicing Agreement), such title shall be retained in trust for the Trustee on behalf of the Trust as the owner of the Mortgage Loans and as the Depositor's assignee. Section 2.06. Acceptance of Mortgage Loans. (a) To evidence the transfer of the Mortgage Loans and related Mortgage Files to the Collateral Agent, on behalf of the Trustee, the Collateral Agent shall deliver the acknowledgement of receipt, the Initial Certification and the Final Certification required to be delivered pursuant to Section 2.06(a) and (b) of the Pooling and Servicing Agreement. (b) Pursuant to the Pooling and Servicing Agreement, the Collateral Agent, on behalf of the Trustee, has agreed to execute and deliver on or prior to the Closing Date an acknowledgment of receipt, in the form attached as Exhibit R to the Pooling and Servicing Agreement, of the original Mortgage Note with respect to each Mortgage Loan (with any exceptions noted), and declares that it will hold, or cause the Collateral Agent to hold, on its behalf, such documents and any amendments, replacements or supplements thereto, as well as any other assets included in the definition of Trust Fund in the Pooling and Servicing Agreement and delivered to the Trustee or the Collateral Agent, on its behalf, in trust upon and subject to the conditions set forth in the Pooling and Servicing Agreement for the benefit of the Certificateholders and the Certificate Insurer. Pursuant to the Pooling and Servicing Agreement, the Collateral Agent, on behalf of the Trustee, has agreed, for the benefit of the Certificateholders and the Certificate Insurer, to review (or cause to be reviewed) each Trustee's Mortgage File within thirty (30) days after the Closing Date (with respect to the Initial Mortgage Loans) or within thirty (30) days of any Subsequent Transfer Date (with respect to the Subsequent Mortgage Loans), as applicable (or, with respect to any Qualified Substitute Mortgage Loan, within thirty (30) days after the receipt by the Collateral Agent, on behalf of the Trustee thereof), and to deliver to the Unaffiliated Seller, the Certificate Insurer, the Back-up Servicer and the Servicer a certification in the form attached to, the Pooling and Servicing Agreement as Exhibit I to the effect that, as to each Mortgage Loan listed in the Mortgage Loan Schedule (other than any Mortgage Loan paid in full or any Mortgage Loan specifically identified in such certification as not covered by such certification), (i) all documents required to be delivered to it pursuant to the Pooling and Servicing Agreement are in its possession, (ii) each such document has been reviewed by it and has not been mutilated, damaged, torn or otherwise physically altered (handwritten additions, changes or corrections shall not constitute physical alteration if initiated by the Mortgagor), appears regular on its face and relates to such Mortgage Loan, and (iii) based on its examination and only as to the foregoing documents, the information set forth on the Mortgage Loan Schedule accurately reflects the information set forth in the Trustee's Mortgage File delivered on such date. Pursuant to the Pooling and Servicing Agreement, the Collateral Agent, on behalf of the Trustee, shall be under no duty or obligation to inspect, review or examine any such documents, instruments, certificates or 7 other papers to determine that they are genuine, enforceable, or appropriate for the represented purpose or that they are other than what they purport to be on their face. Pursuant to the Pooling and Servicing Agreement, within ninety (90) days of the Closing Date (with respect to the Initial Mortgage Loans) or within ninety (90) days of any Subsequent Transfer Date (with respect to the Subsequent Mortgage Loans), as applicable, the Collateral Agent, on behalf of the Trustee, shall be required to deliver (or cause to be delivered) to the Certificate Insurer, the Servicer, the Back-up Servicer and the Unaffiliated Seller a final certification in the form attached to the Pooling and Servicing Agreement as Exhibit J to the effect that, as to each Mortgage Loan listed in the Mortgage Loan Schedule (other than any Mortgage Loan paid in full or any Mortgage Loan specifically identified in such certification as not covered by such certification), (i) all documents required to be delivered to it pursuant to the Pooling and Servicing Agreement are in its possession, (ii) each such document has been reviewed by it and has not been mutilated, damaged, torn or otherwise physically altered (handwritten additions, changes or corrections shall not constitute physical alteration if initialed by the Mortgagor), appears regular on its face and relates to such Mortgage Loan, and (iii) based on its examination and only as to the foregoing documents, the information set forth on the Mortgage Loan Schedule accurately reflects the information set forth in the Trustee's Mortgage File delivered on such date. (c) The Pooling and Servicing Agreement provides that, if the Collateral Agent during the process of reviewing the Trustee's Mortgage Files finds any document required to be delivered to it and constituting a part of a Trustee's Mortgage File which is not executed, has not been received, is unrelated to the Mortgage Loan identified in the Mortgage Loan Schedule, or does not conform to the requirements of Section 2.05 or the description thereof as set forth in the Mortgage Loan Schedule, the Collateral Agent shall promptly so notify the Certificate Insurer, the Servicer, the Back-up Servicer, the Trustee, the Unaffiliated Seller and the related Originator. The Unaffiliated Seller agrees that in performing any such review, the Collateral Agent may conclusively rely on the Unaffiliated Seller as to the purported genuineness of any such document and any signature thereon. Each of the Originators and the Unaffiliated Seller agrees to use reasonable efforts to remedy a material defect in a document constituting part of the Trustee's Mortgage File when notified of such defect in reasonable detail. If, however, within sixty (60) days after such notice neither the Unaffiliated Seller nor any Originator has remedied the defect and the defect materially and adversely affects the interest of the Certificateholders in the related Mortgage Loan or the interests of the Certificate Insurer, then the Unaffiliated Seller and the Originators shall be obligated to either substitute in lieu of such Mortgage Loan a Qualified Substitute Mortgage Loan or purchase such Mortgage Loan in the manner and subject to the conditions set forth in Section 3.05 hereof. (d) The failure of the Certificate Insurer, the Collateral Agent or the Trustee to give any notice contemplated herein within the time periods specified above shall not affect or relieve the Unaffiliated Seller's or the Originators' obligation to repurchase for any Mortgage Loan pursuant to this Section 2.06 or Section 3.05 of this Agreement. Section 2.07. Sale of Mortgage Loans; Assignment of Agreement. The Originators and the Unaffiliated Seller each hereby acknowledges and agrees that the Depositor may sell, assign and convey its interest under this Agreement to the Trustee for the benefit of the Trust as may be required to effect the purposes of the Pooling and Servicing Agreement, without further notice to, or 8 consent of, the Unaffiliated Seller or the Originators, and the Trustee shall succeed to such of the rights and obligations of the Depositor hereunder as shall be so assigned. The Depositor shall, pursuant to the Pooling and Servicing Agreement, assign all of its right, title and interest in and to the Mortgage Loans and its right to exercise the remedies created by this Agreement, including, without limitation, its rights to exercise remedies created by Sections 2.06 and 3.05 hereof for breaches of the representations, warranties, agreements and covenants of the Unaffiliated Seller or the Originators contained in Sections 2.05, 2.06, 3.01, 3.02 and 3.03 hereof to the Trustee for the benefit of the Certificateholders and the Certificate Insurer. Each of the Originators and the Unaffiliated Seller agrees that, upon such assignment to the Trustee, such representations, warranties, agreements and covenants will run to and be for the benefit of the Trustee and the Certificate Insurer and the Trustee may enforce, without joinder of the Depositor, the repurchase and indemnification obligations of the Unaffiliated Seller and the Originators set forth herein with respect to breaches of such representations, warranties, agreements and covenants. Section 2.08. Examination of Mortgage Files. Prior to the Closing Date and any Subsequent Transfer Date, as applicable, the Unaffiliated Seller shall make the Mortgage Files available to the Depositor or its designee for examination at the Unaffiliated Seller's offices or at such other place as the Unaffiliated Seller shall reasonably specify. Such examination may be made by the Depositor or its designee at any time on or before the Closing Date or any Subsequent Transfer Date, as the case may be. If the Depositor or its designee makes such examination prior to the Closing Date or any Subsequent Transfer Date, as the case may be, and identifies any Mortgage Loans that do not conform to the requirements of the Depositor as described in this Agreement, such Mortgage Loans shall be deleted from the Mortgage Loan Schedule and may be replaced, prior to the Closing Date or any Subsequent Transfer Date, as the case may be, by substitute Mortgage Loans acceptable to the Depositor. The Depositor may, at its option and without notice to the Unaffiliated Seller, purchase all or part of the Mortgage Loans without conducting any partial or complete examination. The fact that the Depositor, the Collateral Agent or the Trustee has conducted or has failed to conduct any partial or complete examination of the Mortgage Files shall not affect the rights of the Depositor or the Trustee to demand repurchase or other relief as provided in this Agreement. Section 2.09. Books and Records. The sale of each Mortgage Loan shall be reflected on each of the Originators' and the Unaffiliated Seller's accounting and other records, balance sheet and other financial statements as a sale of assets by the Originators to the Unaffiliated Seller and by the Unaffiliated Seller to the Depositor. Each of the Originators and the Unaffiliated Seller shall be responsible for maintaining, and shall maintain, a complete set of books and records for each Mortgage Loan which shall be clearly marked to reflect the ownership of each Mortgage Loan by the Trustee for the benefit of the Certificateholders and the Certificate Insurer. Section 2.10. Cost of Delivery and Recordation of Documents. The costs relating to the delivery and recordation of the documents specified in this Article II in connection with the Mortgage Loans shall be borne by the Unaffiliated Seller or the Originators. 9 ARTICLE III REPRESENTATIONS AND WARRANTIES Section 3.01. Representations and Warranties as to the Originators. Each of the Originators hereby represents and warrants to the Unaffiliated Seller and the Depositor, as of the Closing Date, that: (a) The Originator is a corporation duly organized, validly existing and in good standing under the laws of (i) with respect to ABC and Upland, the Commonwealth of Pennsylvania or (ii) with respect to ABMS, the State of New Jersey, and has all licenses necessary to carry on its business as now being conducted and is licensed, qualified and in good standing in each state where a Mortgaged Property is located if the laws of such state require licensing or qualification in order to conduct business of the type conducted by the Originator and to perform its obligations as the Originator hereunder, and in any event the Originator is in compliance with the laws of any such state to the extent necessary to ensure the enforceability of the related Mortgage Loan; the Originator has the full power and authority, corporate and otherwise, to execute and deliver this Agreement and to perform in accordance herewith; the execution, delivery and performance of this Agreement (including all instruments of transfer to be delivered pursuant to this Agreement) by the Originator or the consummation of the transactions contemplated hereby have been duly and validly authorized; this Agreement evidences the valid, binding and enforceable obligation of the Originator; and all requisite corporate action has been taken by the Originator to make this Agreement valid and binding upon the Originator in accordance with its terms; (b) No consent, approval, authorization or order of any court or governmental agency or body is required for the execution, delivery and performance by the Originator of, or compliance by the Originator with, this Agreement or the sale of the Mortgage Loans pursuant to the terms of this Agreement or the consummation of the transactions contemplated by this Agreement, or if required, such approval has been obtained prior to the Closing Date; (c) Neither the execution and delivery of this Agreement, the acquisition nor origination of the Mortgage Loans by the Originator or the transactions contemplated hereby, nor the fulfillment of or compliance with the terms and conditions of this Agreement, has or will conflict with or result in a breach of any of the terms, conditions or provisions of the Originator's charter or by-laws or any legal restriction or any agreement or instrument to which the Originator is now a party or by which it is bound or to which its property is subject, or constitute a default or result in an acceleration under any of the foregoing, or result in the violation of any law, rule, regulation, order, judgment or decree to which the Originator or its property is subject, or impair the ability of the Trustee (or the Servicer as the agent of the Trustee) to realize on the Mortgage Loans, or impair the value of the Mortgage Loans; (d) Neither this Agreement nor the information contained in the Prospectus Supplement (other than the information under the caption "Underwriting") nor any statement, report or other document prepared by the Originator and furnished or to be furnished pursuant to this Agreement or in connection with the transactions contemplated hereby contains any untrue 10 statement or alleged untrue statement of any material fact or omits to state a material fact necessary to make the statements contained herein or therein, in light of the circumstances under which they were made, not misleading; (e) There is no action, suit, proceeding or investigation pending or, to the knowledge of the Originator, threatened before a court, administrative agency or government tribunal against the Originator which, either in any one instance or in the aggregate, may result in any material adverse change in the business, operations, financial condition, properties or assets of the Originator, or in any material impairment of the right or ability of the Originator to carry on its business substantially as now conducted, or in any material liability on the part of the Originator, or which would draw into question the validity of this Agreement, the Mortgage Loans, or of any action taken or to be taken in connection with the obligations of the Originator contemplated herein, or which would impair materially the ability of the Originator to perform under the terms of this Agreement or that will prohibit its entering into this Agreement or the consummation of any of the transactions contemplated hereby; (f) The Originator is not in violation of or in default with respect to, and the execution and delivery of this Agreement by the Originator and its performance of and compliance with the terms hereof will not constitute a violation or default with respect to, any order or decree of any court or any order, regulation or demand of any federal, state, municipal or governmental agency, which violation or default might have consequences that would materially and adversely affect the condition (financial or other) or operations of the Originator or its properties or might have consequences that would materially and adversely affect its performance hereunder or under any subservicing agreement; (g) Upon the receipt of each Trustee's Mortgage File by the Depositor (or its assignee) under this Agreement, the Depositor (or its assignee) will have good title on behalf of the Trust Fund to each related Mortgage Loan and such other items comprising the corpus of the Trust Fund free and clear of any lien created by the Originator (other than liens which will be simultaneously released); (h) The consummation of the transactions contemplated by this Agreement are in the ordinary course of business of the Originator, and the transfer, assignment and conveyance of the Mortgage Notes and the Mortgages by the Originator pursuant to this Agreement are not subject to the bulk transfer or any similar statutory provisions in effect in any applicable jurisdiction; (i) With respect to any Mortgage Loan purchased by the Originator, the Originator acquired title to the Mortgage Loan in good faith, without notice of any adverse claim; (j) The Originator does not believe, nor does it have any reason or cause to believe, that it cannot perform each and every covenant contained in this Agreement. The Originator is solvent and the sale of the Mortgage Loans by the Originator pursuant to the terms of this Agreement will not cause the Originator to become insolvent. The sale of the Mortgage Loans by the Originator pursuant to the terms of this Agreement was not undertaken with the intent to hinder, delay or defraud any of the Originator's creditors; 11 (k) The Mortgage Loans are not intentionally selected in a manner so as to affect adversely the interests of the Depositor or of any transferee of the Depositor (including the Trustee); (l) The Originator has determined that it will treat the disposition of the Mortgage Loans pursuant to this Agreement as a sale for accounting and tax purposes; (m) The Originator has not dealt with any broker or agent or anyone else that may be entitled to any commission or compensation in connection with the sale of the Mortgage Loans to the Depositor other than to the Depositor or an affiliate thereof; and (n) The consideration received by the Originator upon the sale of the Mortgage Loans under this Agreement constitutes fair consideration and reasonably equivalent value for the Mortgage Loans. Section 3.02. Representations and Warranties as to the Unaffiliated Seller. The Unaffiliated Seller hereby represents and warrants to the Depositor, as of the Closing Date, that: (a) The Unaffiliated Seller is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware and has all licenses necessary to carry on its business as now being conducted and is licensed, qualified and in good standing in each state where a Mortgaged Property is located if the laws of such state require licensing or qualification in order to conduct business of the type conducted by the Unaffiliated Seller and to perform its obligations as the Unaffiliated Seller hereunder, and in any event the Unaffiliated Seller is in compliance with the laws of any such state to the extent necessary to ensure the enforceability of the related Mortgage Loan; the Unaffiliated Seller has the full power and authority, corporate and otherwise, to execute and deliver this Agreement and to perform in accordance herewith; the execution, delivery and performance of this Agreement (including all instruments of transfer to be delivered pursuant to this Agreement) by the Unaffiliated Seller and the consummation of the transactions contemplated hereby have been duly and validly authorized; this Agreement evidences the valid, binding and enforceable obligation of the Unaffiliated Seller; and all requisite corporate action has been taken by the Unaffiliated Seller to make this Agreement valid and binding upon the Unaffiliated Seller in accordance with its terms; (b) No consent, approval, authorization or order of any court or governmental agency or body is required for the execution, delivery and performance by the Unaffiliated Seller of or compliance by the Unaffiliated Seller with this Agreement or the sale of the Mortgage Loans pursuant to the terms of this Agreement or the consummation of the transactions contemplated by this Agreement, or if required, such approval has been obtained prior to the Closing Date; (c) Neither the execution and delivery of this Agreement, the acquisition nor origination of the Mortgage Loans by the Unaffiliated Seller nor the transactions contemplated hereby, nor the fulfillment of or compliance with the terms and conditions of this Agreement, has or will conflict with or result in a breach of any of the terms, conditions or provisions of the Unaffiliated Seller's charter or by-laws or any legal restriction or any agreement or instrument to which the Unaffiliated Seller is now a party or by which it is bound or to which its property is subject, or constitute a default or result in 12 an acceleration under any of the foregoing, or result in the violation of any law, rule, regulation, order, judgment or decree to which the Unaffiliated Seller or its property is subject, or impair the ability of the Trustee (or the Servicer as the agent of the Trustee) to realize on the Mortgage Loans, or impair the value of the Mortgage Loans; (d) Neither this Agreement nor the information contained in the Prospectus Supplement (other than the information under the caption "Underwriting") nor any statement, report or other document prepared by the Unaffiliated Seller and furnished or to be furnished pursuant to this Agreement or in connection with the transactions contemplated hereby contains any untrue statement or alleged untrue statement of any material fact or omits to state a material fact necessary to make the statements contained herein or therein, in light of the circumstances under which they were made, not misleading; (e) There is no action, suit, proceeding or investigation pending nor, to the knowledge of the Unaffiliated Seller, threatened before a court, administrative agency or government tribunal against the Unaffiliated Seller which, either in any one instance or in the aggregate, may result in any material adverse change in the business, operations, financial condition, properties or assets of the Unaffiliated Seller, or in any material impairment of the right or ability of the Unaffiliated Seller to carry on its business substantially as now conducted, or in any material liability on the part of the Unaffiliated Seller, or which would draw into question the validity of this Agreement, the Mortgage Loans, or of any action taken or to be taken in connection with the obligations of the Unaffiliated Seller contemplated herein, or which would impair materially the ability of the Unaffiliated Seller to perform under the terms of this Agreement or that will prohibit its entering into this Agreement or the consummation of any of the transactions contemplated hereby or under any subservicing agreements; (f) The Unaffiliated Seller is not in violation of or in default with respect to, and the execution and delivery of this Agreement by the Unaffiliated Seller and its performance of and compliance with the terms hereof will not constitute a violation or default with respect to, any order or decree of any court or any order, regulation or demand of any federal, state, municipal or governmental agency, which violation or default might have consequences that would materially and adversely affect the condition (financial or other) or operations of the Unaffiliated Seller or its properties or might have consequences that would materially and adversely affect its performance hereunder or under any subservicing agreement; (g) Upon the receipt of each Trustee's Mortgage File by the Depositor (or its assignee) under this Agreement, the Depositor (or its assignee) will have good title on behalf of the Trust Fund to each related Mortgage Loan and such other items comprising the corpus of the Trust Fund free and clear of any lien created by the Unaffiliated Seller (other than liens which will be simultaneously released); (h) The consummation of the transactions contemplated by this Agreement are in the ordinary course of business of the Unaffiliated Seller, and the transfer, assignment and conveyance of the Mortgage Notes and the Mortgages by the Unaffiliated Seller pursuant to this Agreement are not subject to the bulk transfer or any similar statutory provisions in effect in any applicable jurisdiction; 13 (i) With respect to any Mortgage Loan purchased by the Unaffiliated Seller, the Unaffiliated Seller acquired title to the Mortgage Loan in good faith, without notice of any adverse claim; (j) The Unaffiliated Seller does not believe, nor does it have any reason or cause to believe, that it cannot perform each and every covenant contained in this Agreement. The Unaffiliated Seller is solvent and the sale of the Mortgage Loans by the Unaffiliated Seller pursuant to the terms of this Agreement will not cause the Unaffiliated Seller to become insolvent. The sale of the Mortgage Loans by the Unaffiliated Seller pursuant to the terms of this Agreement was not undertaken with the intent to hinder, delay or defraud any of the Unaffiliated Seller's creditors; (k) The Mortgage Loans are not intentionally selected in a manner so as to affect adversely the interests of the Depositor or of any transferee of the Depositor (including the Trustee); (l) The Unaffiliated Seller has determined that it will treat the disposition of the Mortgage Loans pursuant to this Agreement as a sale for accounting and tax purposes; (m) The Unaffiliated Seller has not dealt with any broker or agent or anyone else that may be entitled to any commission or compensation in connection with the sale of the Mortgage Loans to the Depositor other than to the Depositor or an affiliate thereof; and (n) The consideration received by the Unaffiliated Seller upon the sale of the Mortgage Loans under this Agreement constitutes fair consideration and reasonably equivalent value for the Mortgage Loans. Section 3.03. Representations and Warranties Relating to the Mortgage Loans. The Originators represent and warrant to the Unaffiliated Seller and the Depositor and the Unaffiliated Seller represents and warrants to the Depositor that, as of the Closing Date, as to each Initial Mortgage Loan, and as of the Subsequent Transfer Date, as to each Subsequent Mortgage Loan, immediately prior to the sale and transfer of such Mortgage Loan by the Unaffiliated Seller to the Depositor: (a) The information set forth in the Mortgage Loan Schedule is complete, true and correct; (b) The information provided by the Originators or any Affiliate to the Depositor, the Trust, the Certificate Insurer, the Collateral Agent and the Trustee in connection with a Mortgage Loan will be true and correct in all material respects on the date or dates when such information is furnished; (c) Each Mortgage is a valid first or second lien on a fee simple (or its equivalent under applicable state law) estate in the real property securing the amount owed by the Mortgagor under the Mortgage Note subject only to (i) the lien of current real property taxes and assessments which are not delinquent, (ii) with respect to any Mortgage Loan identified on the Mortgage Loan Schedule as secured by a second lien, the related first mortgage loan, (iii) covenants, conditions and restrictions, rights of way, easements and other matters of 14 public record as of the date of recording of such Mortgage, such exceptions appearing of record being acceptable to mortgage lending institutions generally in the area wherein the property subject to the Mortgage is located or specifically reflected in the appraisal obtained in connection with the origination of the related Mortgage Loan obtained by the Unaffiliated Seller, and (iv) other matters to which like properties are commonly subject which do not materially interfere with the benefits of the security intended to be provided by such Mortgage; (d) Immediately prior to the sale, transfer and assignment by the related Originator to the Unaffiliated Seller and by the Unaffiliated Seller to the Depositor, the Unaffiliated Seller or such Originator, as applicable, had good title to, and was the sole owner of each Mortgage Loan, free of any interest of any other Person, and the Unaffiliated Seller or such Originator has transferred all right, title and interest in each Mortgage Loan to the Depositor or the Unaffiliated Seller, as applicable; (e) As of the Cut-Off Date, no payment of principal or interest on or in respect of any Mortgage Loan remains unpaid for thirty (30) or more days past the date the same was due in accordance with the related Mortgage Note without regard to applicable grace periods and without giving effect to any Periodic Advances by the applicable Originator or any Affiliate thereof; (f) As of the Initial Cut-Off Date, no Mortgage Loan has a Mortgage Interest Rate less than 6.25% per annum and the weighted average Mortgage Interest Rate of the Mortgage Loans is 10.23%; (g) At origination, no Mortgage Loan had an original term to maturity of greater than 360 months; (h) As of the Initial Cut-Off Date, the weighted average remaining term to maturity of the Mortgage Loans is 270 months; (i) To the best knowledge of the Unaffiliated Seller and each of the Originators, there is no mechanics' lien or claim for work, labor or material (and no rights are outstanding that under law could give rise to such lien) affecting the premises subject to any Mortgage which is or may be a lien prior to, or equal or coordinate with, the lien of such Mortgage, except those which are insured against by the title insurance policy referred to in (ff) below; (j) To the best knowledge of the Unaffiliated Seller and each of the Originators, there is no delinquent tax or assessment lien against any Mortgaged Property; (k) Such Mortgage Loan, the Mortgage, and the Mortgage Note, including, without limitation, the obligation of the Mortgagor to pay the unpaid principal of and interest on the Mortgage Note, are each not subject to any right of rescission (or any such rescission right has expired in accordance with applicable law), set-off, counterclaim, or defense, including the defense of usury, nor will the operation of any of the terms of the Mortgage Note or the Mortgage, or the exercise of any right thereunder, render either the Mortgage Note or the Mortgage unenforceable, in whole or in part, or subject to any right 15 of rescission, set-off, counterclaim, or defense, including the defense of usury, and no such right of rescission, set-off, counterclaim, or defense has been asserted with respect thereto; (l) To the best knowledge of the Unaffiliated Seller and each of the Originators, the Mortgaged Property is free of material damage and is in good repair, and there is no pending or threatened proceeding for the total or partial condemnation of the Mortgaged Property; (m) Neither the Originators nor the Unaffiliated Seller has received a notice of default of any first mortgage loan secured by the Mortgaged Property which has not been cured by a party other than the Unaffiliated Seller; (n) Each Mortgage Note and Mortgage are in substantially the forms previously provided to the Trustee on behalf of the Unaffiliated Seller; (o) No Mortgage Loan had, at the date of origination, a Combined Loan-to-Value Ratio in excess of 100.00%, and the weighted average Combined Loan-to-Value Ratio of all Mortgage Loans as of the Initial Cut-Off Date is approximately 76.80%; (p) The Mortgage Loan was not originated in a program in which the amount of documentation in the underwriting process was limited in comparison to an Originator's normal documentation requirements; (q) No more than the following percentages of the Mortgage Loans by Principal Balance as of the Initial Cut-Off Date are secured by Mortgaged Properties located in the following states: Mortgage Loan Pool ----------------------------------------------------- Percent of State Principal Balance -------------------------------- ------------------ Connecticut 2.87% Florida 8.23% Illinois 5.00% Maryland 2.82% Massachusetts 8.88% Michigan 5.59% New Jersey 12.65% New York 22.54% North Carolina 2.90% Ohio 4.23% Pennsylvania 7.23% Rhode Island 2.03% Virginia 3.26% Other 12.17% ====== Total 100.00% 16 (r) The Mortgage Loans were (i) originated by an Originator in the normal course of its business, (ii) not selected by the Unaffiliated Seller or the Originators for sale hereunder or inclusion in the Trust Fund on any basis adverse to the Trust Fund relative to the portfolio of similar mortgage loans of the Unaffiliated Seller or the Originators and (iii) prior to the Closing Date, serviced by the Originator or an Affiliate thereof in accordance with Accepted Servicing Practices; (s) No more than 5% (by Principal Balance) of the Mortgage Loans constitutes a lien on leasehold interests, and with respect to such Mortgage Loan the cost of the leasehold expense has been factored into the debt-to-income calculations with respect to the related Mortgagor and the maturity date of the ground lease is later than the maturity date of the Mortgage Loan; (t) Each Mortgage and related Mortgage Note contains customary and enforceable provisions which render the rights and remedies of the holder thereof adequate for the realization against the related Mortgaged Property of the benefits of the security including (A) in the case of a Mortgage designated as a deed of trust, by trustee's sale and (B) otherwise by judicial foreclosure. To the best of the Unaffiliated Seller's and the Originators' knowledge, there is no homestead or other exemption available to the related Mortgagor which would materially interfere with the right to sell the related Mortgaged Property at a trustee's sale or the right to foreclose the related Mortgage. The Mortgage contains customary and enforceable provisions for the acceleration of the payment of the Principal Balance of such Mortgage Loan in the event all or any part of the related Mortgaged Property is sold or otherwise transferred without the prior written consent of the holder thereof; (u) The proceeds of such Mortgage Loan have been fully disbursed, including reserves set aside by the Unaffiliated Seller or the Originators, there is no requirement for, and neither the Unaffiliated Seller nor the Originators shall make any, future advances thereunder. Any future advances made prior to the applicable Cut-Off Date have been consolidated with the principal balance secured by the Mortgage, and such principal balance, as consolidated, bears a single interest rate and single repayment term reflected on the applicable Mortgage Loan Schedule. The Principal Balance as of the applicable Cut-Off Date does not exceed the original principal amount of such Mortgage Loan. Except with respect to no more than $200,000 of escrow funds in the aggregate with respect to all Mortgage Loans, any and all requirements as to completion of any on-site or off-site improvements and as to disbursements of any escrow funds therefor have been complied with. All costs, fees and expenses incurred in making or recording such Mortgage Loan have been paid; (v) All Mortgage Loans were originated in compliance with the Originators' Underwriting Guidelines; (w) The terms of the Mortgage and the Mortgage Note have not been impaired, waived, altered, or modified in any respect, except by a written instrument which has been recorded, if necessary, to protect the interest of the Trustee and which has been delivered to the Collateral Agent, on behalf of the Trustee. The substance of any such alteration or modification will be reflected on the applicable Mortgage Loan Schedule and, to the extent necessary, has been or will be approved by (i) the insurer under the applicable mortgage title 17 insurance policy, and (ii) the insurer under any other insurance policy required hereunder for such Mortgage Loan where such insurance policy requires approval and the failure to procure approval would impair coverage under such policy; (x) No instrument of release, waiver, alteration or modification has been executed in connection with such Mortgage Loan, and no Mortgagor has been released, in whole or in part, except in connection with an assumption agreement which has been approved by the insurer under any insurance policy required hereunder for such Mortgage Loan where such policy requires approval and the failure to procure approval would impair coverage under such policy, and which is part of the Mortgage File and has been delivered to the Collateral Agent, on behalf of the Trustee, and the terms of which are reflected in the applicable Mortgage Loan Schedule; (y) There is no default, breach, violation or event of acceleration existing under the Mortgage or the Mortgage Note and no event which, with the passage of time or with notice and the expiration of any grace or cure period, would constitute such a default, breach, violation or event of acceleration, and neither the Originators nor the Unaffiliated Seller has waived any such default, breach, violation or event of acceleration. All taxes, governmental assessments (including assessments payable in future installments), insurance premiums, water, sewer, and municipal charges, leaseholder payments or ground rents which previously became due and owing in respect of or affecting the related Mortgaged Property have been paid. Neither the Originators nor the Unaffiliated Seller has advanced funds or induced, solicited or knowingly received any advance of funds by a party other than the Mortgagor, directly or indirectly, for the payment of any amount required by the Mortgage or the Mortgage Note; (z) All of the improvements which were included for the purposes of determining the Appraised Value of the Mortgaged Property were completed at the time that such Mortgage Loan was originated and lie wholly within the boundaries and building restriction lines of such Mortgaged Property. Except for de minimis encroachments, no improvements on adjoining properties encroach upon the Mortgaged Property. To the best of the Unaffiliated Seller's and the Originators' knowledge, no improvement located on or being part of the Mortgaged Property is in violation of any applicable zoning law or regulation. All inspections, licenses and certificates required to be made or issued with respect to all occupied portions of the Mortgaged Property (including all such improvements which were included for the purpose of determining such Appraised Value) and, with respect to the use and occupancy of the same, including, but not limited, to certificates of occupancy and fire underwriter's certificates, have been made or obtained from the appropriate authorities and the Mortgaged Property is lawfully occupied under applicable law; (aa) To the best of the Unaffiliated Seller's and the Originators' knowledge, there do not exist any circumstances or conditions with respect to the Mortgage, the Mortgaged Property, the Mortgagor or the Mortgagor's credit standing that can be reasonably expected to cause such Mortgage Loan to become delinquent or adversely affect the value or marketability of such Mortgage Loan, other than any such circumstances or conditions permitted under the Originator's Underwriting Guidelines; 18 (bb) All parties which have had any interest in the Mortgage, whether as mortgagee, assignee, pledgee or otherwise, are (or, during the period in which they held and disposed of such interest, were) (i) in compliance with any and all applicable licensing requirements of the laws of the state wherein the Mortgaged Property is located, and (ii) (A) organized under the laws of such state, (B) qualified to do business in such state, (C) federal savings and loan associations or national banks having principal offices in such state, (D) not doing business in such state, or (E) not required to qualify to do business in such state; (cc) The Mortgage Note and the Mortgage are genuine, and each is the legal, valid and binding obligation of the maker thereof, enforceable in accordance with its terms, except as such enforcement may be limited by bankruptcy, insolvency, reorganization, moratorium or other similar laws affecting the enforcement of creditors' rights generally and except that the equitable remedy of specific performance and other equitable remedies are subject to the discretion of the courts. All parties to the Mortgage Note and the Mortgage had legal capacity to execute the Mortgage Note and the Mortgage and convey the estate therein purported to be conveyed, and the Mortgage Note and the Mortgage have been duly and properly executed by such parties or pursuant to a valid power-of-attorney that has been recorded with the Mortgage; (dd) The sale, transfer and conveyance of the Mortgage Note and the Mortgage as and in the manner contemplated by Section 2.05 of this Agreement is sufficient (i) fully to transfer to the Depositor all right, title and interest of the Unaffiliated Seller and the Originators thereto as note holder and mortgagee, and (ii) to the extent an Originator or the Unaffiliated Seller retains an interest in such Mortgage Note or Mortgage despite such sale, transfer and conveyance, to grant to the Depositor the security interest referred to in Section 6.07 hereof and thereafter (x) to transfer the right, title and interest of the Depositor to the Trust, and (y) to pledge the interest of the Trust to the Trustee for the benefit of the Certificateholders and the Certificate Insurer. The Mortgage has been duly assigned by the Originators to the Unaffiliated Seller and by the Unaffiliated Seller to the Depositor and by the Depositor to the Trust and the Mortgage Note has been duly endorsed. The Assignment of Mortgage delivered to the Collateral Agent, on behalf of the Trustee, pursuant to Section 2.05(a)(iv) of the Pooling and Servicing Agreement, is in recordable form and is acceptable for recording under the laws of the applicable jurisdiction. The endorsement of the Mortgage Note, the delivery to the Collateral Agent, on behalf of the Trustee, of the endorsed Mortgage Note, and such Assignment of Mortgage, and the delivery of such Assignment of Mortgage to the Collateral Agent, on behalf of the Trustee, for recording are sufficient to permit the Trustee to avail itself of all protection available under applicable law against the claims of any present or future creditors of the Depositor, the Unaffiliated Seller or any of the Originators, and are sufficient to prevent any other sale, transfer, assignment, pledge or hypothecation of the Mortgage Note and Mortgage by the Depositor, the Unaffiliated Seller or any of the Originators from being enforceable, even if the Servicer does not record such Assignment of Mortgage in the applicable recording office. After the transfer pursuant to Section 2.05 hereof, the Trustee shall have a first priority perfected security interest in the Mortgage Loans; (ee) Any and all requirements of any federal, state, or local law including, without limitation, usury, truth-in-lending, real estate settlement procedures, consumer credit protection, equal credit opportunity, or disclosure 19 laws applicable to such Mortgage Loan have been complied with, and the Servicer shall maintain in its possession, available for the Trustee's inspection, and shall deliver to the Trustee or its designee upon demand, evidence of compliance with all such requirements. The consummation of the transactions contemplated by this Agreement will not cause the violation of any such laws; (ff) Such Mortgage Loan is covered by an ALTA mortgage title insurance policy or such other generally used and acceptable form of policy, issued by and the valid and binding obligation of a title insurer qualified to do business in the jurisdiction where the Mortgaged Property is located, insuring the Unaffiliated Seller, and its successors and assigns, as to the first or second priority lien, as applicable, of the Mortgage in the original principal amount of such Mortgage Loan. The assignment to the Trustee of the Unaffiliated Seller's interest in such mortgage title insurance policy does not require the consent of or notification to the insurer. Such mortgage title insurance policy is in full force and effect and will be in full force and effect and inure to the benefit of the Trustee upon the consummation of the transactions contemplated by this Agreement. No claims have been made under such mortgage title insurance policy and none of the Unaffiliated Seller, the Originators nor any prior holder of the Mortgage has done, by act or omission, anything which would impair the coverage of such mortgage title insurance policy; (gg) All improvements upon the Mortgaged Property are insured against loss by fire, hazards of extended coverage, and such other hazards as are customary in the area where the Mortgaged Property is located pursuant to insurance policies conforming to the requirements of Section 3.05 hereof. If the Mortgaged Property at origination was located in an area identified on a flood hazard boundary map or flood insurance rate map issued by the Federal Emergency Management Agency as having special flood hazards (and such flood insurance has been made available), such Mortgaged Property was covered by flood insurance at origination. Each individual insurance policy is the valid and binding obligation of the insurer, is in full force and effect, and will be in full force and effect and inure to the benefit of the Trustee upon the consummation of the transactions contemplated by this Agreement, and contain a standard mortgage clause naming the originator of such Mortgage Loan, and its successors and assigns, as mortgagee and loss payee. All premiums thereon have been paid. The Mortgage obligates the Mortgagor to maintain all such insurance at the Mortgagor's cost and expense, and upon the Mortgagor's failure to do so, authorizes the holder of the Mortgage to obtain and maintain such insurance at the Mortgagor's cost and expense and to seek reimbursement therefor from the Mortgagor, and none of the Unaffiliated Seller, the related Originator or any prior holder of the Mortgage has acted or failed to act so as to impair the coverage of any such insurance policy or the validity, binding effect, and enforceability thereof; (hh) If the Mortgage constitutes a deed of trust, a trustee, duly qualified under applicable law to serve as such, has been properly designated and currently so serves and is named in such Mortgage, and no fees or expenses are or will become payable by the Trust or the Trustee or the Certificateholders or the Certificate Insurer to any trustee under the deed of trust, except in connection with a trustee's sale after default by the Mortgagor; (ii) The Mortgaged Property consists of one or more parcels of real property separately assessed for tax purposes. To the extent there is erected thereon a detached or an attached one-family residence or a detached 20 two-to-six-family dwelling, or an individual condominium unit in a low-rise condominium, or an individual unit in a planned unit development, or a commercial property, a manufactured home, or a mixed use or multiple purpose property, such residence, dwelling or unit is not (i) a unit in a cooperative apartment, (ii) a property constituting part of a syndication, (iii) a time share unit, (iv) a property held in trust, (v) a mobile home, (vi) a log-constructed home, or (vii) a recreational vehicle; (jj) There exist no material deficiencies with respect to escrow deposits and payments, if such are required, for which customary arrangements for repayment thereof have not been made or which the Unaffiliated Seller or the related Originator expects not to be cured, and no escrow deposits or payments of other charges or payments due the Unaffiliated Seller have been capitalized under the Mortgage or the Mortgage Note; (kk) Such Mortgage Loan was not originated at a below market interest rate. Such Mortgage Loan does not have a shared appreciation feature, or other contingent interest feature; (ll) The origination and collection practices used by the Unaffiliated Seller, the Originators or the Servicer with respect to such Mortgage Loan have been in all respects legal, proper, prudent, and customary in the mortgage origination and servicing business; (mm) The Mortgagor has, to the extent required by applicable law, executed a statement to the effect that the Mortgagor has received all disclosure materials, if any, required by applicable law with respect to the making of fixed-rate mortgage loans. The Servicer shall maintain or cause to be maintained such statement in the Mortgage File; (nn) All amounts received by the Unaffiliated Seller or the Originators with respect to such Mortgage Loan after the applicable Cut-Off Date and required to be deposited in the Distribution Account have been so deposited in the Distribution Account and are, as of the Closing Date, or will be as of the Subsequent Transfer Date, as applicable, in the Distribution Account; (oo) The appraisal report with respect to the Mortgaged Property contained in the Mortgage File was signed prior to the approval of the application for such Mortgage Loan by a qualified appraiser, duly appointed by the originator of such Mortgage Loan, who had no interest, direct or indirect, in the Mortgaged Property or in any loan made on the security thereof and whose compensation is not affected by the approval or disapproval of such application; (pp) When measured by the Cut-Off Date Aggregate Principal Balances of all Mortgage Loans as of the Initial Cut-Off Date, the Mortgagors with respect to at least 92.23% of the Mortgage Loans represented at the time of origination that the Mortgagor would occupy the Mortgaged Property as the Mortgagor's primary residence; (qq) Each of the Originators and the Unaffiliated Seller has no knowledge with respect to the Mortgaged Property of any governmental or regulatory action or third party claim made, instituted or threatened in writing relating to a violation of any applicable federal, state or local environmental law, statute, ordinance, regulation, order, decree or standard; 21 (rr) Each Mortgage Loan is a "qualified mortgage" within the meaning of Section 860G(a)(3) of the Code; (ss) With respect to second lien Mortgage Loans: (i) neither the Unaffiliated Seller nor the Originators have any knowledge that the Mortgagor has received notice from the holder of the prior mortgage that such prior mortgage is in default; (ii) no consent from the holder of the prior mortgage is needed for the creation of the second lien Mortgage or, if required, has been obtained and is in the related Mortgage File; (iii) if the prior mortgage has a negative amortization, the Combined Loan-to-Value Ratio was determined using the maximum loan amount of such prior mortgage; (iv) the related first mortgage loan encumbering the related Mortgaged Property does not have a mandatory future advance provision; (v) the Mortgage Loans conform in all material respects to the description thereof in the Prospectus Supplement; and (vi) No more than 14.16% (by Principal Balance) of the Mortgage Loans are secured by Mortgages that are second liens. (tt) Each of the Originators and the Unaffiliated Seller further represents and warrants to the Certificate Insurer, the Trustee and the Certificateholders that as of the Subsequent Cut-Off Date all representations and warranties set forth in clauses (a) through (ss) above and (uu) through (jjj) below will be correct in all material respects as to any Subsequent Mortgage Loan; (uu) To the best of the Unaffiliated Seller's and the Originators' knowledge, no error, omission, misrepresentation, negligence, fraud or similar occurrence with respect to a Mortgage Loan has taken place on the part of any person, including, without limitation, the Mortgagor, any appraiser, any builder or developer, or any other party involved in the origination of the Mortgage Loan or in the application of any insurance in relation to such Mortgage Loan; (vv) Each Mortgaged Property is in compliance with all environmental laws, ordinances, rules, regulations and orders of federal, state or governmental authorities relating thereto. No hazardous material has been or is incorporated in, stored on or under (other than properly stored materials used for reasonable residential purposes), released from, treated on, transported to or from, or disposed of on or from, any Mortgaged Property such that, under applicable law (A) any such hazardous material would be required to be eliminated before the Mortgaged Property could be altered, renovated, demolished or transferred, or (B) the owner of the Mortgaged Property, or the holder of a security interest therein, could be subjected to liability for the removal of such hazardous material or the elimination of the hazard created thereby. Neither the Unaffiliated Seller nor any Mortgagor has received notification from 22 any federal, state or other governmental authority relating to any hazardous materials on or affecting the Mortgaged Property or to any potential or known liability under any environmental law arising from the ownership or operation of the Mortgaged Property. For the purposes of this subsection, the term "hazardous materials" shall include, without limitation, gasoline, petroleum products, explosives, radioactive materials, polychlorinated biphenyls or related or similar materials, asbestos or any material containing asbestos, lead, lead-based paint and any other substance or material as may be defined as a hazardous or toxic substance by any federal, state or local environmental law, ordinance, rule, regulation or order, including, without limitation, CERCLA, the Clean Air Act, the Clean Water Act, the Resource Conservation and Recovery Act, the Toxic Substances Control Act and any regulations promulgated pursuant thereto; (ww) With respect to any business purpose loan, the related Mortgage Note contains an acceleration clause, accelerating the maturity date under the Mortgage Note to the date the individual guarantying such loan, if any, becomes subject to any bankruptcy, insolvency, reorganization, moratorium, or other similar laws affecting the enforcement of creditors' rights generally; (xx) To the best of the Originators' and the Unaffiliated Seller's knowledge, no Mortgage Loan is covered by the Home Ownership and Equity Protection Act, no Mortgage Loan is in violation of any comparable state or local law and no Mortgage Loan is a "high-cost" loan or a loan having similar characteristics under the laws of the States of Georgia, New York, Massachusetts, Illinois or North Carolina or any comparable state or local laws; (yy) Except for 2.65% (by Principal Balance) of the Mortgage Loans, which may have an initial CLTV ratio range of up to 100.00%, no Mortgage Loans have initial CLTV ratios greater than 90.00%; (zz) No more than 7.39% (by Principal Balance) of the Mortgage Loans are loans the proceeds of which are to be used for business purposes; (aaa) At least 92.23% (by Principal Balance) of the Mortgage Loans are secured exclusively by Owner Occupied Mortgaged Property; (bbb) To the extent that a credit score was obtained, the weighted average FICO or similar scoring result score (by Principal Balance) for the Mortgage Loans is at least 570, not more than 1.85% (by Principal Balance) of the Mortgage Loans have FICO or similar scoring result scores that are less than 500 and at least 99.68% (by Principal Balance) of the Mortgage Loans have FICO or similar scoring result scores; (ccc) The Mortgage Loans have a weighted average CLTV (by Principal Balance) of not more than 76.80% and no more than 2.65% (by Principal Balance) of the Mortgage Loans have a CLTV greater than 90.00%; (ddd) No more than 11.43% (by Principal Balance) of the Mortgage Loans are made to limited or no documentation borrowers; (eee) The Mortgage Interest Rate for each Mortgage Loan is fixed; 23 (fff) No more than 38.65% (by Principal Balance ) of the Mortgage Loans consist of balloon Mortgage Loans that mature within 10 years of the date of origination; (ggg) No Mortgage Loan has a Principal Balance greater than $550,000.00; (hhh) At least 78.20% (by Principal Balance) of the Mortgage Loans are secured by a single-family detached home, an individual unit in a planned unit development or a townhouse; (iii) No more than 0.39% (by Principal Balance) of the Mortgage Loans are secured by manufactured homes; (jjj) None of the consumer Mortgage Loans have prepayment penalties that apply for more than five years from the date of origination; and (kkk) No proceeds from any Mortgage Loan was used to finance single-premium credit life insurance. Section 3.04. Representations and Warranties of the Depositor. The Depositor hereby represents, warrants and covenants to the Unaffiliated Seller, as of the date of execution of this Agreement and the Closing Date, that: (a) The Depositor is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware; (b) The Depositor has the corporate power and authority to purchase each Mortgage Loan and to execute, deliver and perform, and to enter into and consummate all the transactions contemplated by this Agreement; (c) This Agreement has been duly and validly authorized, executed and delivered by the Depositor, and, assuming the due authorization, execution and delivery hereof by the Unaffiliated Seller and the Originators, constitutes the legal, valid and binding agreement of the Depositor, enforceable against the Depositor in accordance with its terms, except as such enforcement may be limited by bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to or affecting the rights of creditors generally, and by general equity principles (regardless of whether such enforcement is considered in a proceeding in equity or at law); (d) No consent, approval, authorization or order of or registration or filing with, or notice to, any governmental authority or court is required for the execution, delivery and performance of or compliance by the Depositor with this Agreement or the consummation by the Depositor of any of the transactions contemplated hereby, except such as have been made on or prior to the Closing Date; (e) The Depositor has filed or will file the Prospectus and Prospectus Supplement with the Commission in accordance with Rule 424(b) under the Securities Act; and 24 (f) None of the execution and delivery of this Agreement, the purchase of the Mortgage Loans from the Unaffiliated Seller, the consummation of the other transactions contemplated hereby, or the fulfillment of or compliance with the terms and conditions of this Agreement, (i) conflicts or will conflict with the charter or bylaws of the Depositor or conflicts or will conflict with or results or will result in a breach of, or constitutes or will constitute a default or results or will result in an acceleration under, any term, condition or provision of any indenture, deed of trust, contract or other agreement or other instrument to which the Depositor is a party or by which it is bound and which is material to the Depositor, or (ii) results or will result in a violation of any law, rule, regulation, order, judgment or decree of any court or governmental authority having jurisdiction over the Depositor. Section 3.05. Repurchase Obligation for Defective Documentation and for Breach of a Representation or Warranty. (a) Each of the representations and warranties contained in Sections 3.01, 3.02 and 3.03 shall survive the purchase by the Depositor of the Mortgage Loans and the subsequent transfer thereof by the Depositor to the Trustee, for the benefit of the Certificateholders and the Certificate Insurer, and shall continue in full force and effect, notwithstanding any restrictive or qualified endorsement on the Mortgage Notes and notwithstanding subsequent termination of this Agreement or the Pooling and Servicing Agreement. (b) With respect to any representation or warranty contained in Sections 3.01 or 3.03 hereof that is made to the best of the Originators' knowledge or contained in Sections 3.02 or 3.03 hereof that is made to the best of the Unaffiliated Seller's knowledge, if it is discovered by the Certificate Insurer, the Servicer, the Back-up Servicer, the Collateral Agent, any Subservicer, the Trustee or any Certificateholder that the substance of such representation and warranty was inaccurate as of the Closing Date or the Subsequent Transfer Date, as applicable, and such inaccuracy materially and adversely affects the value of the related Mortgage Loan, then notwithstanding the Originators' or the Unaffiliated Seller's lack of knowledge with respect to the inaccuracy at the time the representation or warranty was made, such inaccuracy shall be deemed a breach of the applicable representation or warranty. Upon discovery by the Originators, the Certificate Insurer, the Unaffiliated Seller, the Collateral Agent, the Servicer, the Back-up Servicer, any Subservicer, the Trustee or any Certificateholder of a breach of any of such representations and warranties which materially and adversely affects the value of Mortgage Loans or the interest of the Certificate Insurer or the Certificateholders, or which materially and adversely affects the interests of the Certificateholders in the related Mortgage Loan in the case of a representation and warranty relating to a particular Mortgage Loan (notwithstanding that such representation and warranty was made to the Originators' or the Unaffiliated Seller's best knowledge), the party discovering such breach shall promptly give pursuant to this Section 3.05(b) and pursuant to Section 4.02 of the Pooling and Servicing Agreement (and in any event, within five (5) Business Days of the discovery) written notice to the others. Subject to the last paragraph of this Section 3.05(b), within sixty (60) days of the earlier of its discovery or its receipt of notice of any breach of a representation or warranty, the Unaffiliated Seller and the Originators shall (a) promptly cure such breach in all material respects, or (b) purchase such Mortgage Loan at the Loan Repurchase Price, or (c) remove such Mortgage Loan 25 from the Trust Fund (in which case it shall become a Deleted Mortgage Loan) and substitute one or more Qualified Substitute Mortgage Loans; provided, that, such substitution is effected not later than the date which is 2 years after the Startup Day or at such later date, if the Trustee and the Certificate Insurer receive an Opinion of Counsel to the effect set forth below in this Section. Any such substitution shall be accompanied by payment by the Unaffiliated Seller of the Substitution Adjustment, if any, to be deposited in the Collection Account pursuant to the Pooling and Servicing Agreement. The Originators shall cooperate with the Unaffiliated Seller to cure any breach and shall reimburse the Unaffiliated Seller for the costs and expenses related to any cure, substitution (including any Substitution Adjustment) or repurchase incurred by the Unaffiliated Seller pursuant to this Section 3.05. (c) As to any Deleted Mortgage Loan for which the Unaffiliated Seller or an Originator substitutes a Qualified Substitute Mortgage Loan or Loans, the Unaffiliated Seller or such Originator shall effect such substitution by delivering to the Trustee and the Certificate Insurer a certification in the form attached to the Pooling and Servicing Agreement as Exhibit K, executed by a Servicing Officer and the documents described in Section 2.06(d) for such Qualified Substitute Mortgage Loan or Loans. Pursuant to the Pooling and Servicing Agreement, upon receipt by the Trustee and the Collateral Agent of a certification of a Servicing Officer of such substitution or purchase and, in the case of a substitution, upon receipt by the Collateral Agent, on behalf of the Trustee, of the related Trustee's Mortgage File, and the deposit of certain amounts in the Distribution Account pursuant to Section 2.07(b) of the Pooling and Servicing Agreement (which certification shall be in the form of Exhibit K to the Pooling and Servicing Agreement), the Collateral Agent, on behalf of the Trustee shall be required to release to the Servicer for release to the Unaffiliated Seller the related Trustee's Mortgage File and shall be required to execute, without recourse, and deliver such instruments of transfer furnished by the Unaffiliated Seller as may be necessary to transfer such Mortgage Loan to the Unaffiliated Seller or such Originator. (d) Pursuant to the Pooling and Servicing Agreement, the Servicer shall deposit in the Collection Account all payments received in connection with such Qualified Substitute Mortgage Loan or Loans after the date of such substitution. Monthly Payments received with respect to Qualified Substitute Mortgage Loans on or before the date of substitution will be retained by the Unaffiliated Seller. The Trust Fund will own all payments received on the Deleted Mortgage Loan on or before the date of substitution, and the Unaffiliated Seller or the Originator, as applicable, shall thereafter be entitled to retain all amounts subsequently received in respect of such Deleted Mortgage Loan. Pursuant to the Pooling and Servicing Agreement, the Servicer shall be required to give written notice to the Certificate Insurer, the Trustee and the Collateral Agent that such substitution has taken place and shall amend the Mortgage Loan Schedule to reflect the removal of such Deleted Mortgage Loan from the terms of the Pooling and Servicing Agreement and the substitution of the Qualified Substitute Mortgage Loan. The parties hereto agree to amend the Mortgage Loan Schedule accordingly. Upon such substitution, such Qualified Substitute Mortgage Loan or Loans shall be subject to the terms of the Pooling and Servicing Agreement and this Agreement in all respects, and the Unaffiliated Seller shall be deemed to have made with respect to such Qualified Substitute Mortgage Loan or Loans, as of the date of substitution, the representations and warranties set forth in Sections 3.02 and 3.03 herein. On the date of such 26 substitution, the Unaffiliated Seller will remit to the Servicer and pursuant to the Pooling and Servicing Agreement the Servicer will deposit into the Distribution Account an amount equal to the Substitution Adjustment, if any. (e) With respect to any Mortgage Loan that has been converted to an REO Mortgage Loan, all references in this Section 3.05 or Section 2.06 to "Mortgage Loan" shall be deemed to refer to such REO Mortgage Loan. With respect to any Mortgage Loan that the Originator or Unaffiliated Seller is required to repurchase that is or becomes a Liquidated Mortgage Loan, in lieu of repurchasing such Mortgage Loan, the Originator or Unaffiliated Seller shall deposit into the Distribution Account, pursuant to Section 6.01 of the Pooling and Servicing Agreement an amount equal to the amount of the Liquidated Loan Loss, if any, incurred in connection with the liquidation of such Mortgage Loan within the same time period in which the Originator or Unaffiliated Seller would have otherwise been required to repurchase such Mortgage Loan. (f) Subject to Section 3.05(l), it is understood and agreed that the obligations of the Unaffiliated Seller and the Originator set forth in Section 2.06 and this Section 3.05 to cure, purchase or substitute for a defective Mortgage Loan as provided in Section 2.06 and this Section 3.05 constitute the sole remedies of the Depositor, the Trustee, the Certificate Insurer and the Certificateholders respecting a breach of the foregoing representations and warranties. (g) Any cause of action against the Unaffiliated Seller or an Originator relating to or arising out of the breach of any representations and warranties or covenants made in Sections 2.06, 3.02 or 3.03 shall accrue as to any Mortgage Loan upon (i) discovery of such breach by any party and notice thereof to the Unaffiliated Seller or such Originator, (ii) failure by the Unaffiliated Seller or such Originator to cure such breach or purchase or substitute such Mortgage Loan as specified above, and (iii) demand upon the Unaffiliated Seller or such Originator by the Trustee for all amounts payable in respect of such Mortgage Loan. (h) Notwithstanding any contrary provision of this Agreement, with respect to any Mortgage Loan which is not in default or as to which no default is imminent, no purchase, or substitution pursuant to Section 2.06(b) or this Section 3.05 shall be made unless the Unaffiliated Seller provides to the Trustee and the Certificate Insurer an Opinion of Counsel to the effect that such purchase or substitution would not (i) result in the imposition of taxes on "prohibited transactions" of the REMIC Trust, as defined in Section 860F of the Code or a tax on contributions to the REMIC Trust under the REMIC Provisions, or (ii) cause any REMIC created under the Pooling and Servicing Agreement to fail to qualify as a REMIC at any time that any Certificates are outstanding. Any Mortgage Loan as to which purchase or substitution was delayed pursuant to this paragraph shall be purchased or substituted (subject to compliance with Section 2.06 and this Section 3.05) upon the earlier of (a) the occurrence of a default or imminent default with respect to such loan and (b) receipt by the Trustee and the Certificate Insurer of an Opinion of Counsel to the effect that such purchase or substitution will not result in the events described in clauses (i) and (ii) of the preceding sentence. (i) Pursuant to the Pooling and Servicing Agreement, upon discovery by the Unaffiliated Seller, the Servicer, the Back-up Servicer, the Trustee and the Certificate Insurer or any Certificateholder that any Mortgage Loan does not satisfy the requirements of Sections 3.02 and 3.03 hereof, the party discovering 27 such fact shall promptly (and in any event, within 5 Business Days of the discovery) give written notice thereof to the other parties. In connection therewith, the Unaffiliated Seller or the related Originator shall repurchase or substitute a Qualified Substitute Mortgage Loan for the affected Mortgage Loan within ninety (90) days of the earlier of such discovery by any of the foregoing parties, or the Trustee's or the Unaffiliated Seller's receipt of notice, in the same manner as it would a Mortgage Loan for a breach of representation or warranty contained in Sections 3.01, 3.02 or 3.03. Pursuant to the Pooling and Servicing Agreement the Trustee shall reconvey to the Unaffiliated Seller or the related Originator the Mortgage Loan to be released pursuant hereto in the same manner, and on the same terms and conditions, as it would a Mortgage Loan repurchased for breach of a representation or warranty contained in Sections 3.01, 3.02 or 3.03. (j) Notwithstanding anything in this Agreement or the Pooling and Servicing Agreement to the contrary, the Unaffiliated Seller's repurchase obligations hereunder shall not include failure of the Trustee to record assignments of the Mortgage Loans referenced in clause (a)(iii) in Section 2.05 of the Pooling and Servicing Agreement. All parties hereto acknowledge and agree that the Trustee has the responsibility to record all such assignments of the Mortgage Loans to the Trustee. (k) Each of the Originators and the Unaffiliated Seller shall be jointly and severally responsible for any repurchase, cure or substitution obligation of any of the Originators or the Unaffiliated Seller under this Agreement and the Pooling and Servicing Agreement. (l) The Unaffiliated Seller and the Originators hereby agree, jointly and severally, to indemnify the Trustee, the Depositor, the Certificate Insurer and the Certificateholders and their successors, assigns, agents and servants (collectively, the "Indemnified Parties") from and against, any and all liabilities, obligations, losses, damages, taxes, claims, actions and suits, and any and all reasonable out of pocket costs, expenses and disbursements (including reasonable legal fees and expenses) of any kind and nature whatsoever (collectively, "Expenses") which may at any time be imposed on, incurred by, or asserted against any Indemnified Party in any way relating to or arising out of a breach by the Unaffiliated Seller or the related Originator of the representations or warranties in Article III hereof. The indemnities contained in this Section 3.05 shall survive the resignation or termination of the Trustee or the termination of this Agreement. Section 3.06. Limited Purpose and Corporate Separateness of the Unaffiliated Seller. (a) The Unaffiliated Seller covenants to the Trustee, the Depositor, the Servicer the Back-up Servicer, the Certificate Insurer and the Certificateholders as follows: (i) The Unaffiliated Seller shall not engage in any business or activity of any kind or enter into any transaction or indenture, mortgage, instrument, agreement contract, lease or other undertaking other than the transactions contemplated and authorized by this Agreement. Without limiting the generality of the foregoing, the Unaffiliated Seller shall not create, incur, guarantee, assume or suffer to exist any indebtedness or other liabilities, whether direct or contingent, other than (i) as a result of the endorsement of negotiable instruments for deposit or collection or similar transactions in the ordinary course of business, (ii) the 28 incurrence of obligations under this Agreement and the Insurance and Indemnity Agreement and (iii) the incurrence of operating expenses in the ordinary course of business permitted under this Agreement; (ii) The Unaffiliated Seller shall not amend its certificate of incorporation or by-laws in any respect without the prior written consent of the Certificate Insurer (absent a Certificate Insurer Default); (iii) The Unaffiliated Seller has been formed for, and shall limit its activities to, the following purposes: (i) to purchase the Mortgage Loans from the Originators and to sell such Mortgage Loans to the Depositor, in each case pursuant to this Agreement; (ii) in the event of the occurrence of a breach of certain representations and warranties, to cause the substitution or repurchase of the related Mortgage Loans by the Originators; (iii) to enter into and perform its obligations under this Agreement and the Insurance and Indemnity Agreement and (iv) to engage in those activities that are necessary, suitable or convenient to accomplish the foregoing or are incidental thereto or connected therewith; (iv) The Unaffiliated Seller shall not incur, assume or guarantee any indebtedness or other liabilities except under the provisions of this Agreement and the Insurance and Indemnity Agreement; (v) The Unaffiliated Seller shall maintain separate corporate records and books of account from those of the Originators or any of their Affiliates; (vi) The Unaffiliated Seller shall not become involved in the day to day management of any other Person, and it shall operate so as not to be substantively consolidated with any other Person; (vii) The Unaffiliated Seller shall maintain its assets separate from those of the Originators or any of their Affiliates; (viii) The Unaffiliated Seller shall conduct correspondence in its own name on its own stationery; (ix) The Unaffiliated Seller shall not act as an agent of any other entity or Person except pursuant to contractual documents indicating such capacity; (x) The Unaffiliated Seller shall take all other actions necessary on its part in order to ensure that all of the facts and assumptions set forth in the opinion issued by Dewey Ballantine LLP in connection with the closing or initial purchase under this Agreement and relating to true sale and substantive consolidation issues, and in the certificates accompanying such opinion, remain true and correct at all times; and (xi) The Unaffiliated Seller shall not undertake any activity which is not a permitted activity for a qualified special purpose entity under current accounting literature. 29 (b) The Originators will operate in such a manner that the Unaffiliated Seller would not be substantively consolidated in the trust estate of the Originators, ABFS or any of their respective Affiliates (each an "ABFS Company") and the separate existence of Unaffiliated Seller would not be disregarded in the event of a bankruptcy or insolvency of any ABFS Company. Without limiting the generality of the foregoing and in addition to the other covenants set forth herein, each Originator shall take, and shall cause each of their Affiliates to take, all actions required on its part to ensure that: (i) the Unaffiliated Seller shall conduct its business solely in its own name and make all written and oral communications solely in its name; (ii) the Unaffiliated Seller shall provide for its expenses and liabilities from its own funds; (iii) the Unaffiliated Seller shall not be contractually liable for the payment of any liability of any ABFS Company nor generally hold its assets nor creditworthiness as being available for the payment of any liability of any ABFS Company; (iv) the Unaffiliated Seller shall maintain an arm's-length relationship with each other ABFS Company; (v) the Unaffiliated Seller shall not transfer any assets between itself and any other ABFS Company without fair consideration or with the intent to hinder, delay or defraud the creditors of any other ABFS Company; and (vi) any consolidated financial statements of any ABFS Company that include the Unaffiliated Seller have notes clearly stating that the Unaffiliated Seller is a corporation separate and distinct from each of the other ABFS Companies and that the assets of the Unaffiliated Seller will be available first and foremost to satisfy the claims of the creditors of the Unaffiliated Seller. ARTICLE IV THE UNAFFILIATED SELLER Section 4.01. Covenants of the Originators and the Unaffiliated Seller. Each of the Originators and the Unaffiliated Seller covenants to the Depositor as follows: (a) The Originators and the Unaffiliated Seller shall cooperate with the Depositor and the firm of independent certified public accountants retained with respect to the issuance of the Certificates in making available all information and taking all steps reasonably necessary to permit the accountants' letters required hereunder to be delivered within the times set for delivery herein. (b) The Unaffiliated Seller agrees to satisfy or cause to be satisfied on or prior to the Closing Date, all of the conditions to the Depositor's obligations set forth in Section 5.01 hereof that are within the Unaffiliated Seller's (or its agents') control. 30 (c) The Originators and the Unaffiliated Seller hereby agree to do all acts, transactions, and things and to execute and deliver all agreements, documents, instruments, and papers by and on behalf of the Originators or the Unaffiliated Seller as the Depositor or its counsel may reasonably request in order to consummate the transfer of the Mortgage Loans to the Depositor and the subsequent transfer thereof to the Trustee, and the rating, issuance and sale of the Certificates. Section 4.02. Merger or Consolidation. Each of the Originators and the Unaffiliated Seller will keep in full effect its existence, rights and franchises as a corporation and will obtain and preserve its qualification to do business as a foreign corporation, in each jurisdiction necessary to protect the validity and enforceability of this Agreement or any of the Mortgage Loans and to perform its duties under this Agreement. Any Person into which any of the Originators or the Unaffiliated Seller may be merged or consolidated, or any corporation resulting from any merger, conversion or consolidation to which the Originators or the Unaffiliated Seller shall be a party, or any Person succeeding to the business of the Originators or the Unaffiliated Seller, shall be approved by the Certificate Insurer (which approval shall not be unreasonably withheld). The successor shall be an established mortgage loan servicing institution that is a permitted transferee and in all events shall be the successor of the Originators and the Unaffiliated Seller without the execution or filing of any paper or any further act on the part of any of the parties hereto, anything herein to the contrary notwithstanding. The Originators and the Unaffiliated Seller shall send notice of any such merger or consolidation to the Trustee and the Certificate Insurer. Section 4.03. Costs. In connection with the transactions contemplated under this Agreement and the Pooling and Servicing Agreement, the Unaffiliated Seller shall promptly pay (or shall promptly reimburse the Depositor to the extent that the Depositor shall have paid or otherwise incurred): (a) the fees and disbursements of the Depositor's (100% of fees in excess of $30,000 but not to exceed $65,000), the Unaffiliated Seller's and the Originators' counsel; (b) the fees of S&P, Moody's and Fitch; (c) any of the fees and expenses of the Trustee, the Collateral Agent and the Back-Up Servicer and the fees and disbursements of the Trustee's, the Collateral Agent's and the Back-Up Servicer's counsel; (d) expenses incurred in connection with printing the Prospectus, the Prospectus Supplement, any amendment or supplement thereto, any preliminary prospectus and the Certificates; (e) fees and expenses relating to the filing of documents with the Securities and Exchange Commission (including, without limitation, periodic reports under the Exchange Act); (f) the shelf registration amortization fee of 0.0094% of the Certificate Principal Balance of the Offered Certificates on the Closing Date, paid in connection with the issuance of Certificates; (g) the fees and disbursements for the accountants for the Originators; and (h) all of the initial expenses of the Certificate Insurer including, without limitation, legal fees and expenses, accountant fees and expenses and expenses in connection with due diligence conducted on the Mortgage Files but not including the initial premium paid to the Certificate Insurer. For the avoidance of doubt, the parties hereto acknowledge that it is the intention of the parties that the Depositor shall not pay any of the Trustee's fees and expenses in connection with the transactions contemplated by the Pooling and Servicing Agreement. All other costs and expenses in connection with the transactions contemplated hereunder shall be borne by the party incurring such expenses. 31 Section 4.04. Indemnification. (a) The Originators, the Servicer and the Unaffiliated Seller, jointly and severally, agree (i) to indemnify and hold harmless the Depositor, each of its directors, each of its officers who have signed the Registration Statement, and each of its directors and each person or entity who controls the Depositor or any such person, within the meaning of Section 15 of the Securities Act, against any and all losses, claims, damages or liabilities, joint and several, to which the Depositor or any such person or entity may become subject, under the Securities Act or otherwise, and will reimburse the Depositor and each such controlling person for any legal or other expenses incurred by the Depositor or such controlling person in connection with investigating or defending any such loss, claim, damage, liability or action, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of any material fact contained in the Prospectus Supplement or any amendment or supplement to the Prospectus Supplement or the omission or the alleged omission to state therein a material fact required to be stated therein or necessary to make the statements in the Prospectus Supplement or any amendment or supplement to the Prospectus Supplement approved in writing by the Originators or the Unaffiliated Seller, in light of the circumstances under which they were made, not misleading, but only to the extent that such untrue statement or alleged untrue statement or omission or alleged omission relates to the information contained in the Prospectus Supplement referred to in Section 3.01(d); provided, however, that in no event will the Unaffiliated Seller be liable in excess of the net proceeds of its sale hereunder. This indemnity agreement will be in addition to any liability which the Originators and the Unaffiliated Seller may otherwise have; and (ii) to indemnify and to hold the Depositor harmless against any and all claims, losses, penalties, fines, forfeitures, legal fees and related costs, judgments, and any other costs, fees and expenses that the Depositor may sustain in any way related to the failure of any of the Originators or the Unaffiliated Seller to perform its duties in compliance with the terms of this Agreement. The Originators or the Unaffiliated Seller shall immediately notify the Depositor if a claim is made by a third party with respect to this Agreement, and the Servicer shall assume the defense of any such claim and pay all expenses in connection therewith, including reasonable counsel fees, and promptly pay, discharge and satisfy any judgment or decree which may be entered against the Depositor in respect of such claim. Pursuant to the Pooling and Servicing Agreement, the Trustee shall reimburse the Servicer in accordance with Section 5.19(b) of the Pooling and Servicing Agreement for all amounts advanced by the Servicer pursuant to the preceding sentence except when the claim relates directly to the failure of the Unaffiliated Seller to perform its duties in compliance with the terms of this Agreement. (b) The Depositor agrees to indemnify and hold harmless each of the Originators and the Unaffiliated Seller, each of their respective directors and each person or entity who controls the Originators or the Unaffiliated Seller or any such person, within the meaning of Section 15 of the Securities Act, against any and all losses, claims, damages or liabilities, joint and several, to which the Originators or the Unaffiliated Seller or any such person or entity may 32 become subject, under the Securities Act or otherwise, and will reimburse the Originators and the Unaffiliated Seller and any such director or controlling person for any legal or other expenses incurred by such party or any such director or controlling person in connection with investigating or defending any such loss, claim, damage, liability or action, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of any material fact contained in the Registration Statement, the Prospectus, the Prospectus Supplement, any amendment or supplement to the Prospectus or the Prospectus Supplement or the omission or the alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading, but only to the extent that such untrue statement or alleged untrue statement or omission or alleged omission is other than a statement or omission relating to the information set forth in subsection (a)(i) of this Section 4.04; provided, however, that in no event shall the Depositor be liable to the Unaffiliated Seller under this paragraph (b) in an amount in excess of the Depositor's resale profit or the underwriting fee on the sale of the Certificates. This indemnity agreement will be in addition to any liability which the Depositor may otherwise have. (c) Promptly after receipt by an indemnified party under this Section 4.04 of notice of the commencement of any action, such indemnified party will, if a claim in respect thereof is to be made against the indemnifying party under this Section 4.04, notify the indemnifying party in writing of the commencement thereof, but the omission to so notify the indemnifying party will not relieve the indemnifying party from any liability which the indemnifying party may have to any indemnified party hereunder except to the extent such indemnifying party has been prejudiced thereby. In case any such action is brought against any indemnified party, and it notifies the indemnifying party of the commencement thereof, the indemnifying party will be entitled to participate therein and, to the extent that it may elect by written notice delivered to the indemnified party promptly after receiving the aforesaid notice from such indemnified party, to assume the defense thereof with counsel reasonably satisfactory to such indemnified party. After notice from the indemnifying party to such indemnified party of its election to assume the defense thereof, the indemnifying party will not be liable to such indemnified party under this Section 4.04 for any legal or other expenses subsequently incurred by such indemnified party in connection with the defense thereof other than reasonable costs of investigation; provided, however, if the defendants in any such action include both the indemnified party and the indemnifying party and the indemnified party shall have reasonably concluded that there may be legal defenses available to it that are different from or additional to those available to the indemnifying party, the indemnified party or parties shall have the right to select separate counsel to assert such legal defenses and to otherwise participate in the defense of such action on behalf of such indemnified party or parties. The indemnifying party shall not be liable for the expenses of more than one separate counsel. (d) In order to provide for just and equitable contribution in circumstances in which the indemnity agreement provided for in the preceding parts of this Section 4.04 is for any reason held to be unavailable to or insufficient to hold harmless an indemnified party under subsection (a) or subsection (b) of this Section 4.04 in respect of any losses, claims, damages or liabilities (or actions in respect thereof) referred to therein, the indemnifying party shall contribute to the amount paid or payable by the indemnified party as a result of such losses, claims, damages or liabilities (or actions in respect thereof) subject to the limits set forth in subsection (a) and subsection (b) of this Section 4.04; provided, however, that no person 33 guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to a contribution from any person who was not guilty of such fraudulent misrepresentation. In determining the amount of contribution to which the respective parties are entitled, there shall be considered the relative benefits received by the Originators and the Unaffiliated Seller on the one hand, and the Depositor on the other, the Originators', the Unaffiliated Seller's and the Depositor's relative knowledge and access to information concerning the matter with respect to which the claim was asserted, the opportunity to correct and prevent any statement or omission, and any other equitable considerations appropriate in the circumstances. The Originators, the Unaffiliated Seller and the Depositor agree that it would not be equitable if the amount of such contribution were determined by pro rata or per capita allocation. For purposes of this Section 4.04, each director of the Depositor, each officer of the Depositor who signed the Registration Statement, and each person, if any who controls the Depositor within the meaning of Section 15 of the Securities Act, shall have the same rights to contribution as the Depositor, and each director of the Originators or the Unaffiliated Seller, and each person, if any who controls the Originators or the Unaffiliated Seller within the meaning of Section 15 of the Securities Act, shall have the same rights to contribution as the Originators and the Unaffiliated Seller. ARTICLE V CONDITIONS OF CLOSING Section 5.01. Conditions of Depositor's Obligations. The obligations of the Depositor to purchase the Mortgage Loans will be subject to the satisfaction on the Closing Date of the following conditions. Upon payment of the purchase price for the Mortgage Loans, such conditions shall be deemed satisfied or waived. (a) Each of the obligations of the Unaffiliated Seller required to be performed by it on or prior to the Closing Date pursuant to the terms of this Agreement shall have been duly performed and complied with and all of the representations and warranties of the Unaffiliated Seller and the Originators under this Agreement shall be true and correct as of the Closing Date and no event shall have occurred which, with notice or the passage of time, would constitute a default under this Agreement, and the Depositor shall have received a certificate to the effect of the foregoing signed by an authorized officer of the Unaffiliated Seller and the Originators. (b) The Depositor shall have received (i) a letter dated the date of this Agreement, in form and substance acceptable to the Depositor and its counsel, prepared by Deloitte & Touche LLP, independent certified public accountants, regarding the numerical information contained in the Prospectus Supplement, including, but not limited to, the information under the captions "Prepayment and Yield Considerations" and "The Mortgage Loan Pool" regarding any numerical information in any marketing materials relating to the Certificates and regarding any other information as reasonably requested by the Depositor and (ii) a letter dated the date of this Agreement, in form and substance acceptable to the Depositor and its counsel, prepared by BDO Seidman LLP, independent certified public accountants, regarding the numerical information contained in the Prospectus Supplement under the caption "The Originators, the Seller and the Servicer -- Delinquency and Loan Loss Experience." 34 (c) The Mortgage Loans will be acceptable to the Depositor, in its sole reasonable discretion. (d) The Depositor shall have received the following additional closing documents, in form and substance reasonably satisfactory to the Depositor and its counsel: (i) the Mortgage Loan Schedule; (ii) this Agreement, the Pooling and Servicing Agreement, dated as of March 1, 2003, and the Underwriting Agreement dated as of March 27, 2003 and between the Depositor and the Representative, and all documents required thereunder, duly executed and delivered by each of the parties thereto other than the Depositor; (iii) officer's certificates of an officer of each of the Originators and the Unaffiliated Seller, dated as of the Closing Date, and attached thereto resolutions of the board of directors and a copy of the charter and by-laws; (iv) copy of each of the Originators and the Unaffiliated Seller's charter and all amendments, revisions, and supplements thereof, certified by a secretary of each entity; (v) an opinion of the counsel for the Originators and the Unaffiliated Seller as to various corporate matters in a form acceptable to the Depositor, its counsel, the Certificate Insurer, S&P, Moody's and Fitch (it being agreed that the opinion shall expressly provide that the Trustee shall be entitled to rely on the opinion); (vi) opinions of counsel for the Unaffiliated Seller, in forms acceptable to the Depositor, its counsel, the Certificate Insurer, S&P, Moody's and Fitch as to such matters as shall be required for the assignment of a rating to the Offered Certificates described in clauses (vii), (viii) and (ix) below (it being agreed that such opinions shall expressly provide that the Trustee shall be entitled to rely on such opinions); (vii) a letter from Moody's to the effect that it has assigned a rating of "Aaa" to the Class A and Class A-IO Certificates; (viii) a letter from S&P to the effect that it has assigned a rating of "AAA" to the Class A and Class A-IO Certificates and "AA" to the Class M Certificates; (ix) a letter from Fitch to the effect that it has assigned a rating of "AAA" to the Class A and Class A-IO Certificates and "AA" to the Class M Certificates; (x) an opinion of counsel for the Trustee in form and substance acceptable to the Depositor, its counsel, the Certificate Insurer, Moody's, S&P and Fitch (it being agreed that the opinion shall expressly provide that the Unaffiliated Seller shall be entitled to rely on the opinion); (xi) an opinion or opinions of counsel for the Servicer, in form and substance acceptable to the Depositor, its counsel, the Certificate 35 Insurer, Moody's, S&P and Fitch (it being agreed that the opinion shall expressly provide that the Unaffiliated Seller shall be entitled to rely on the opinion); (xii) an opinion or opinions of the counsel for the Originators and the Unaffiliated Seller as to corporate securities, true sale and 10b-5 matters; (xiii) an opinion of the counsel for the Depositor and the Underwriters as to tax and 10b-5 matters; (xiv) an opinion or opinions of counsel for the Certificate Insurer, in each case in form and substance acceptable to the Depositor, its counsel, Moody's, S&P and Fitch (it being agreed that the opinion shall expressly provide that the Unaffiliated Seller shall be entitled to rely on the opinion); and (xv) the Interest Rate Hedge Agreement. (e) The Certificate Insurance Policy shall have been duly executed, delivered and issued with respect to the Class M Certificates. (f) All proceedings in connection with the transactions contemplated by this Agreement and all documents incident hereto shall be satisfactory in form and substance to the Depositor and its counsel. (g) The Unaffiliated Seller shall have furnished the Depositor with such other certificates of its officers or others and such other documents or opinions as the Depositor or its counsel may reasonably request. (h) All other terms and conditions of this Agreement and the Pooling and Servicing Agreement shall be complied with. Section 5.02. Conditions of Unaffiliated Seller's Obligations. The obligations of the Unaffiliated Seller under this Agreement shall be subject to the satisfaction, on the Closing Date, of the following conditions: (a) Each of the obligations of the Depositor required to be performed by it at or prior to the Closing Date pursuant to the terms of this Agreement shall have been duly performed and complied with and all of the representations and warranties of the Depositor contained in this Agreement shall be true and correct as of the Closing Date and the Unaffiliated Seller shall have received a certificate to that effect signed by an authorized officer of the Depositor. (b) The Unaffiliated Seller shall have received the following additional documents: (i) this Agreement and the Pooling and Servicing Agreement, and all documents required thereunder, in each case executed by the Depositor as applicable; 36 (ii) a letter from Moody's to the effect that it has assigned a rating of "Aaa" to the Class A and Class A-IO Certificates; (iii) a letter from S&P to the effect that it has assigned a rating of "AAA" to the Class A and Class A-IO Certificates and "AA" to the Class M Certificates; (iv) a letter from Fitch to the effect that it has assigned a rating of "AAA" to the Class A and Class A-IO Certificates and "AA" to the Class M Certificates; (v) an opinion or opinions of the counsel for the Originators and the Unaffiliated Seller as to corporate securities, true sale and 10b-5 matters; (vi) an opinion of counsel for the Trustee in form and substance acceptable to the Unaffiliated Seller and its counsel; (vii) an opinion of counsel for the Certificate Insurer, in form and substance acceptable to the Unaffiliated Seller, its counsel, Moody's, S&P and Fitch; and (viii) an opinion of counsel for the Depositor, in form and substance acceptable to the Unaffiliated Seller, its counsel, Moody's, S&P and Fitch. (c) The Depositor shall have furnished the Unaffiliated Seller with such other certificates of its officers or others and such other documents to evidence fulfillment of the conditions set forth in this Agreement as the Unaffiliated Seller may reasonably request. Section 5.03. Termination of Depositor's Obligations. The Depositor may terminate its obligations hereunder by notice to the Unaffiliated Seller at any time before delivery of and payment of the purchase price for the Mortgage Loans if: (a) any of the conditions set forth in Section 5.01 are not satisfied when and as provided therein; (b) there shall have been the entry of a decree or order by a court or agency or supervisory authority having jurisdiction in the premises for the appointment of a conservator, receiver or liquidator in any insolvency, readjustment of debt, marshalling of assets and liabilities or similar proceedings of or relating to the Unaffiliated Seller, or for the winding up or liquidation of the affairs of the Unaffiliated Seller; (c) there shall have been the consent by the Unaffiliated Seller to the appointment of a conservator or receiver or liquidator in any insolvency, readjustment of debt, marshalling of assets and liabilities or similar proceedings of or relating to the Unaffiliated Seller or of or relating to substantially all of the property of the Unaffiliated Seller; (d) any purchase and assumption agreement with respect to the Unaffiliated Seller or the assets and properties of the Unaffiliated Seller shall have been entered into; or (e) a Termination Event shall have occurred. The termination of the Depositor's obligations hereunder shall not terminate the Depositor's rights hereunder or its right to exercise any remedy available to it at law or in equity. ARTICLE VI MISCELLANEOUS Section 6.01. Notices. All demands, notices and communications hereunder shall be in writing and shall be deemed to have been duly given if 37 personally delivered to or mailed by registered mail, postage prepaid, or transmitted by telex or telegraph and confirmed by a similar mailed writing, if to the Depositor, addressed to the Depositor at Bear Stearns Asset Backed Securities, Inc., 383 Madison Avenue, 10th Floor, New York, New York 10179, Attention: Chief Counsel, or to such other address as the Depositor may designate in writing to the Unaffiliated Seller and if to the Unaffiliated Seller, addressed to the Unaffiliated Seller at ABFS 2003-1, Inc., Balapointe Office Centre, 111 Presidential Boulevard, Suite 127, Bala Cynwyd, Pennsylvania 19004, Attention: Mr. Jeffrey M. Ruben, or to such other address as the Unaffiliated Seller may designate in writing to the Depositor. Section 6.02. Severability of Provisions. Any part, provision, representation, warranty or covenant of this Agreement which is prohibited or which is held to be void or unenforceable shall be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof. Any part, provision, representation, warranty or covenant of this Agreement which is prohibited or unenforceable or is held to be void or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof, and any such prohibition or unenforceability in any jurisdiction as to any Mortgage Loan shall not invalidate or render unenforceable such provision in any other jurisdiction. To the extent permitted by applicable law, the parties hereto waive any provision of law which prohibits or renders void or unenforceable any provision hereof. Section 6.03. Agreement of Unaffiliated Seller. The Unaffiliated Seller agrees to execute and deliver such instruments and take such actions as the Depositor may, from time to time, reasonably request in order to effectuate the purpose and to carry out the terms of this Agreement. Section 6.04. Survival. The parties to this Agreement agree that the representations, warranties and agreements made by each of them herein and in any certificate or other instrument delivered pursuant hereto shall be deemed to be relied upon by the other party hereto, notwithstanding any investigation heretofore or hereafter made by such other party or on such other party's behalf, and that the representations, warranties and agreements made by the parties hereto in this Agreement or in any such certificate or other instrument shall survive the delivery of and payment for the Mortgage Loans. Section 6.05. Effect of Headings and Table of Contents. The Article and Section headings herein and the Table of Contents are for convenience only and shall not affect the construction hereof. Section 6.06. Successors and Assigns. This Agreement shall inure to the benefit of and be binding upon the parties hereto and their respective successors and permitted assigns. Except as expressly permitted by the terms hereof, this Agreement may not be assigned, pledged or hypothecated by any party hereto to a third party without the written consent of the other parties to this Agreement and the Certificate Insurer; provided, however, that the Depositor may assign its rights hereunder without the consent of the Unaffiliated Seller. Section 6.07. Confirmation of Intent; Grant of Security Interest. It is the express intent of the parties hereto that the conveyance of the Mortgage Loans by the Originators to the Unaffiliated Seller and by the Unaffiliated 38 Seller to the Depositor as contemplated by this Unaffiliated Seller's Agreement be, and be treated for all purposes as, a sale of the Mortgage Loans and that the conveyance of the Mortgage Loans by the Unaffiliated Seller to the Depositor as contemplated by this Unaffiliated Seller's Agreement be, and be treated for accounting purposes as, a sale of the Mortgage Loans. It is, further, not the intention of the parties that such conveyance be deemed a pledge of the Mortgage Loans by the Originators to the Unaffiliated Seller or by the Unaffiliated Seller to the Depositor to secure a debt or other obligation of the Originators or the Unaffiliated Seller, as the case may be. However, in the event that, notwithstanding the intent of the parties, the Mortgage Loans are held to continue to be property of the Originators or the Unaffiliated Seller then (a) this Unaffiliated Seller's Agreement shall also be deemed to be a security agreement within the meaning of Articles 8 and 9 of the Uniform Commercial Code; (b) the transfer of the Mortgage Loans provided for herein shall be deemed to be a grant by the Originators to the Unaffiliated Seller and by the Unaffiliated Seller to the Depositor of a security interest in all of such parties' right, title and interest in and to the Mortgage Loans and all amounts payable on the Mortgage Loans in accordance with the terms thereof and all proceeds of the conversion, voluntary or involuntary, of the foregoing into cash, instruments, securities or other property; (c) the possession by the Depositor of Mortgage Notes and such other items of property as constitute instruments, money, negotiable documents or tangible chattel paper shall be deemed to be "taking possession of the collateral" for purposes of perfecting the security interest pursuant to Section 9-312 of the Uniform Commercial Code; and (d) notifications to persons holding such property, and acknowledgments, receipts or confirmations from persons holding such property, shall be deemed notifications to, or acknowledgments, receipts or confirmations from, financial intermediaries, bailees or agents (as applicable) of the Depositor for the purpose of perfecting such security interest under applicable law. Any assignment of the interest of the Depositor pursuant to any provision hereof shall also be deemed to be an assignment of any security interest created hereby. The Originators, the Unaffiliated Seller and the Depositor shall, to the extent consistent with this Unaffiliated Seller's Agreement, take such actions as may be necessary to ensure that, if this Unaffiliated Seller's Agreement were deemed to create a security interest in the Mortgage Loans, such security interest would be deemed to be a perfected security interest of first priority under applicable law and will be maintained as such throughout the term of this Agreement. Section 6.08. Miscellaneous. This Agreement supersedes all prior agreements and understandings relating to the subject matter hereof. Section 6.09. Amendments. (a) This Agreement may be amended from time to time by the Originators, the Unaffiliated Seller and the Depositor by written agreement, with the prior written consent of the Certificate Insurer (absent a Certificate Insurer Default), without notice to or consent of the Certificateholders to cure any ambiguity, to correct or supplement any provisions herein, to comply with any changes in the Code, or to make any other provisions with respect to matters or questions arising under this Agreement which shall not be inconsistent with the provisions of this Agreement; provided, however, that such action shall not, as evidenced by (i) an Opinion of Counsel, at the expense of the party requesting the change, delivered to the Trustee and the Certificate Insurer or (ii) a letter from each Rating Agency confirming that such amendment will not 39 result in the reduction, qualification or withdrawal of the current rating of the Offered Certificates, adversely affect in any material respect the interests of any Certificateholder; and provided, further, that no such amendment shall (x) reduce in any manner the amount of, or delay the timing of, payments received on Mortgage Loans which are required to be distributed on any Certificate without the consent of the Holder of such Certificate, or (y) change the rights or obligations of any other party hereto without the consent of such party, or (z) cause the Unaffiliated Seller to conduct any activity not permitted for qualified special purpose entities under the current accounting literature. (b) This Agreement may be amended from time to time by the Originators, the Unaffiliated Seller and the Depositor, with the consent of the Certificate Insurer, or, following the occurrence of a Certificate Insurer Default, the Majority Certificateholders and the Holders of the majority of the Percentage Interest in the Class R Certificates, for the purpose of adding any provisions to or changing in any manner or eliminating any of the provisions of this Agreement or of modifying in any manner the rights of the Holders; provided, however, that no such amendment shall be made unless the Trustee and the Certificate Insurer receives an Opinion of Counsel, at the expense of the party requesting the change, that such change will not adversely affect the status of any REMIC created under the Pooling and Servicing Agreement as a REMIC or cause a tax to be imposed on any such REMIC, and provided further, that no such amendment shall reduce in any manner the amount of, or delay the timing of, payments received on Mortgage Loans which are required to be distributed on any Certificate without the consent of the Holder of such Certificate or reduce the percentage for each Class the Holders of which are required to consent to any such amendment without the consent of the Holders of 100% of each Class of Certificates affected thereby. (c) It shall not be necessary for the consent of Holders under this Section to approve the particular form of any proposed amendment, but it shall be sufficient if such consent shall approve the substance thereof. Section 6.10. Third-Party Beneficiaries. The parties agree that each of the Certificate Insurer, the Collateral Agent and the Trustee is an intended third-party beneficiary of this Agreement to the extent necessary to enforce the rights and to obtain the benefit of the remedies under this Agreement which are assigned to the Trustee for the benefit of the Certificateholders and the Certificate Insurer pursuant to the Pooling and Servicing Agreement, and to the extent necessary to obtain the benefit of the enforcement of the obligations and covenants of the Unaffiliated Seller and the Originators. Section 6.11. GOVERNING LAW; CONSENT TO JURISDICTION; WAIVER OF JURY TRIAL. (a) THIS AGREEMENT SHALL BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH, THE INTERNAL LAWS (AS OPPOSED TO CONFLICT OF LAWS PROVISIONS) OF THE STATE OF NEW YORK. (b) THE ORIGINATORS, THE DEPOSITOR AND THE UNAFFILIATED SELLER EACH HEREBY SUBMIT TO THE NON-EXCLUSIVE JURISDICTION OF THE COURTS OF THE STATE OF NEW YORK AND THE UNITED STATES DISTRICT COURT LOCATED IN THE BOROUGH OF MANHATTAN IN NEW YORK CITY, AND EACH WAIVES PERSONAL SERVICE OF ANY AND ALL 40 PROCESS UPON IT AND CONSENTS THAT ALL SUCH SERVICE OF PROCESS BE MADE BY REGISTERED MAIL DIRECTED TO THE ADDRESS SET FORTH IN SECTION 6.01 OF THIS AGREEMENT AND SERVICE SO MADE SHALL BE DEEMED TO BE COMPLETED FIVE DAYS AFTER THE SAME SHALL HAVE BEEN DEPOSITED IN THE U.S. MAIL, POSTAGE PREPAID. THE ORIGINATORS, THE DEPOSITOR AND THE UNAFFILIATED SELLER EACH HEREBY WAIVES ANY OBJECTION BASED ON FORUM NON CONVENIENS, AND ANY OBJECTION TO VENUE OF ANY ACTION INSTITUTED HEREUNDER AND CONSENTS TO THE GRANTING OF SUCH LEGAL OR EQUITABLE RELIEF AS IS DEEMED APPROPRIATE BY THE COURT. NOTHING IN THIS SECTION SHALL AFFECT THE RIGHT OF THE ORIGINATORS, THE DEPOSITOR AND THE UNAFFILIATED SELLER TO SERVE LEGAL PROCESS IN ANY OTHER MANNER PERMITTED BY LAW OR AFFECT ANY SUCH PARTIES' RIGHT TO BRING ANY ACTION OR PROCEEDING IN THE COURTS OF ANY OTHER JURISDICTION. (c) THE ORIGINATORS, THE DEPOSITOR AND THE UNAFFILIATED SELLER EACH HEREBY WAIVE ANY RIGHT TO HAVE A JURY PARTICIPATE IN RESOLVING ANY DISPUTE, WHETHER SOUNDING IN CONTRACT, TORT, OR OTHERWISE ARISING OUT OF, CONNECTED WITH, RELATED TO, OR IN CONNECTION WITH THIS AGREEMENT. INSTEAD, ANY DISPUTE RESOLVED IN COURT WILL BE RESOLVED IN A BENCH TRIAL WITHOUT A JURY. Section 6.12. Execution in Counterparts. This Agreement may be executed in any number of counterparts, each of which so executed shall be deemed to be an original, but all such counterparts shall together constitute but one and the same instrument. [Remainder of Page Intentionally Left Blank] 41 IN WITNESS WHEREOF, the parties, to this Unaffiliated Seller's Agreement have caused their names to be signed by their respective officers thereunto duly authorized as of the date first above written. BEAR STEARNS ASSET BACKED SECURITIES, INC. By: Jonathan Lieberman ------------------------------------- Name: Jonathan Lieberman Title: Senior Managing Director ABFS 2003-1, INC. By: Jeffrey M. Ruben ------------------------------------- Name: Jeffrey M. Ruben Title: Executive Vice President AMERICAN BUSINESS CREDIT, INC. By: Jeffrey M. Ruben ------------------------------------- Name: Jeffrey M. Ruben Title: Executive Vice President HOMEAMERICAN CREDIT, INC., D/B/A UPLAND MORTGAGE By: Jeffrey M. Ruben ------------------------------------- Name: Jeffrey M. Ruben Title: Executive Vice President AMERICAN BUSINESS MORTGAGE SERVICES, INC. By: Jeffrey M. Ruben ------------------------------------- Name: Jeffrey M. Ruben Title: Executive Vice President [Signature Page to the Unaffiliated Seller's Agreement] EX-10.100 4 ex10-100.txt EXHIBIT 10.100 POOLING AND SERVICING AGREEMENT dated as of March 1, 2003 by and among BEAR STEARNS ASSET BACKED SECURITIES, INC. (Depositor) AMERICAN BUSINESS CREDIT, INC. (Servicer) and JPMORGAN CHASE BANK (Trustee, Collateral Agent and Back-up Servicer) ABFS MORTGAGE LOAN TRUST 2003-1 Mortgage Pass-Through Certificates, Series 2003-1, Class A, Class A-IO, Class M, Class X, Class I and Class R TABLE OF CONTENTS
Page ---- ARTICLE I DEFINITIONS Section 1.01 Certain Defined Terms.......................................................................1 Section 1.02 Provisions of General Application..........................................................39 Section 1.03 Business Day Certificate...................................................................39 ARTICLE II ESTABLISHMENT OF THE TRUST SALE AND CONVEYANCE OF THE TRUST FUND Section 2.01 Establishment of the Trust.................................................................40 Section 2.02 Purchase and Sale of Initial Mortgage Loans................................................40 Section 2.03 Purchase and Sale of Subsequent Mortgage Loans.............................................40 Section 2.04 Possession of Mortgage Files; Access to Mortgage Files.....................................42 Section 2.05 Delivery of Mortgage Loan Documents........................................................43 Section 2.06 Acceptance by Trustee of the Trust Fund; Certain Substitutions; Certification by Collateral Agent...........................................................................46 Section 2.07 Designations under REMIC Provisions; Designation of Startup Day............................48 Section 2.08 Execution of Certificates..................................................................54 Section 2.09 Application of Principal and Interest......................................................54 Section 2.10 Grant of Security Interest.................................................................55 Section 2.11 Further Action Evidencing Assignments......................................................55 ARTICLE III REPRESENTATIONS, WARRANTIES AND COVENANTS Section 3.01 Representations of the Servicer and the Unaffiliated Seller................................55 Section 3.02 Representations, Warranties and Covenants of the Depositor.................................58 Section 3.03 Purchase and Substitution..................................................................60 Section 3.04 Representations, Warranties and Covenants of the Trustee, the Collateral Agent and the Back-up Servicer.......................................................................62 Section 3.05 Negative Covenants of the Trustee and the Servicer.........................................63 ARTICLE IV THE CERTIFICATES Section 4.01 The Certificates...........................................................................63 Section 4.02 Registration of Transfer and Exchange of Certificates......................................64 Section 4.03 Mutilated, Destroyed, Lost or Stolen Certificates..........................................70 Section 4.04 Persons Deemed Owners......................................................................70
ARTICLE V ADMINISTRATION AND SERVICING OF THE MORTGAGE LOANS Section 5.01 REMIC Matters; The Servicer................................................................71 Section 5.02 Collection of Certain Mortgage Loan Payments; Collection Account...........................73 Section 5.03 Permitted Withdrawals from the Collection Account..........................................74 Section 5.04 Hazard Insurance Policies; Property Protection Expenses....................................75 Section 5.05 Assumption and Modification Agreements.....................................................76 Section 5.06 Realization Upon Defaulted Mortgage Loans..................................................76 Section 5.07 Trustee to Cooperate.......................................................................78 Section 5.08 Servicing Compensation; Payment of Certain Expenses by Servicer............................79 Section 5.09 Annual Statement as to Compliance..........................................................79 Section 5.10 Annual Independent Public Accountants' Servicing Report....................................79 Section 5.11 Access to Certain Documentation............................................................79 Section 5.12 Maintenance of Fidelity Bond...............................................................80 Section 5.13 The Subservicers...........................................................................80 Section 5.14 Reports to the Trustee; Collection Account Statements......................................80 Section 5.15 Optional Purchase of Defaulted Mortgage Loans..............................................80 Section 5.16 Reports to be Provided by the Servicer.....................................................81 Section 5.17 Adjustment of Servicing Compensation in Respect of Prepaid Mortgage Loans..................82 Section 5.18 Periodic Advances; Special Advance.........................................................82 Section 5.19 Indemnification; Third Party Claims........................................................83 Section 5.20 Maintenance of Corporate Existence and Licenses; Merger or Consolidation of the Servicer...................................................................................83 Section 5.21 Assignment of Agreement by Servicer; Servicer Not to Resign................................84 Section 5.22 Periodic Filings with the Securities and Exchange Commission; Additional Information................................................................................84 ARTICLE VI DISTRIBUTIONS AND PAYMENTS Section 6.01 Establishment of Accounts; Withdrawals from Accounts; Deposits to the Distribution Account....................................................................................85 Section 6.02 Permitted Withdrawals From the Distribution Account........................................87 Section 6.03 Collection of Money........................................................................87 Section 6.04 The Certificate Insurance Policy...........................................................87 Section 6.05 Distributions..............................................................................89 Section 6.06 Investment of Accounts.....................................................................91 Section 6.07 Reports....................................................................................92 Section 6.08 Additional Reports by Trustee..............................................................95 Section 6.09 Compensating Interest......................................................................95 Section 6.10 Supplemental Interest Trust; Net WAC Cap Carryover Fund; Interest Rate Hedge Payment Fund...............................................................................95 Section 6.11 Effect of Payments by the Certificate Insurer; Subrogation.................................97 Section 6.12 Additional Rights of Certificate Insurer...................................................97 Section 6.13 Special Reserve Account....................................................................99
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ARTICLE VII DEFAULT Section 7.01 Events of Default..........................................................................99 Section 7.02 Back-up Servicer to Act; Appointment of Successor.........................................101 Section 7.03 Waiver of Defaults........................................................................103 Section 7.04 Rights of the Certificate Insurer to Exercise Rights of Certificateholders................103 Section 7.05 Trustee To Act Solely with Consent of the Certificate Insurer.............................104 Section 7.06 Mortgage Loans, Trust Fund and Accounts Held for Benefit of the Certificate Insurer.......104 Section 7.07 Certificate Insurer Default...............................................................105 ARTICLE VIII TERMINATION Section 8.01 Termination...............................................................................106 Section 8.02 Additional Termination Requirements.......................................................107 Section 8.03 Accounting Upon Termination of Servicer...................................................108 ARTICLE IX THE TRUSTEE Section 9.01 Duties of Trustee.........................................................................109 Section 9.02 Certain Matters Affecting the Trustee.....................................................111 Section 9.03 Trustee Not Liable for Certificates or Mortgage Loans.....................................112 Section 9.04 Trustee May Own Certificates..............................................................112 Section 9.05 Trustee's Fees and Expenses; Indemnity....................................................113 Section 9.06 Eligibility Requirements for Trustee......................................................113 Section 9.07 Resignation and Removal of the Trustee....................................................114 Section 9.08 Successor Trustee.........................................................................115 Section 9.09 Merger or Consolidation of Trustee........................................................115 Section 9.10 Appointment of Co-Trustee or Separate Trustee.............................................115 Section 9.11 Tax Returns...............................................................................116 Section 9.12 Retirement of Certificates................................................................116 Section 9.13 Trustee May Enforce Claims Without Possession of Certificates.............................117 Section 9.14 Suits for Enforcement.....................................................................117
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ARTICLE X THE COLLATERAL AGENT Section 10.01 Duties of the Collateral Agent............................................................117 Section 10.02 Certain Matters Affecting the Collateral Agent............................................119 Section 10.03 Collateral Agent Not Liable for Certificates or Mortgage Loans............................120 Section 10.04 Collateral Agent May Own Certificates.....................................................120 Section 10.05 Collateral Agent's Fees and Expenses; Indemnity...........................................120 Section 10.06 Eligibility Requirements for Collateral Agent.............................................120 Section 10.07 Resignation and Removal of the Collateral Agent...........................................121 Section 10.08 Successor Collateral Agent................................................................121 Section 10.09 Merger or Consolidation of Collateral Agent...............................................122 ARTICLE XI MISCELLANEOUS PROVISIONS Section 11.01 Limitation on Liability of the Depositor, the Back-up Servicer and the Servicer...........122 Section 11.02 Acts of Certificateholders................................................................123 Section 11.03 Amendment.................................................................................123 Section 11.04 Recordation of Agreement..................................................................124 Section 11.05 Duration of Agreement.....................................................................124 Section 11.06 Notices...................................................................................124 Section 11.07 Severability of Provisions................................................................125 Section 11.08 No Partnership............................................................................125 Section 11.09 Counterparts..............................................................................125 Section 11.10 Successors and Assigns....................................................................125 Section 11.11 Headings..................................................................................125 Section 11.12 Third Party Beneficiary...................................................................125 Section 11.13 Appointment of Tax Matters Person; Certain Taxes..........................................125 Section 11.14 GOVERNING LAW; CONSENT TO JURISDICTION; WAIVER OF JURY TRIAL..............................129 EXHIBITS EXHIBIT A Class A Certificate EXHIBIT B Class A-IO Certificate EXHIBIT C Class M Certificate EXHIBIT D Class R Certificate EXHIBIT E Class X Certificate EXHIBIT F Class I Certificate EXHIBIT G Contents of the Mortgage File EXHIBIT H Certificate Re: Prepaid Loans EXHIBIT I Initial Certification of Collateral Agent EXHIBIT J Final Certification of Collateral Agent EXHIBIT K Request for Release of Documents EXHIBIT L Transfer Affidavit and Agreement EXHIBIT M Transferor's Certificate EXHIBIT N ERISA Investment Representation Letter EXHIBIT O Resale Certification EXHIBIT P Assignment EXHIBIT Q Wiring Instruction Form EXHIBIT R Trustee's Acknowledgement of Receipt EXHIBIT S Collateral Agent's Acknowledgment of Receipt EXHIBIT T Form of Subsequent Transfer Agreement SCHEDULES SCHEDULE I Mortgage Loan Schedule
iv POOLING AND SERVICING AGREEMENT, relating to ABFS MORTGAGE LOAN TRUST 2003-1, dated as of March 1, 2003 (this "Agreement"), by and among BEAR STEARNS ASSET BACKED SECURITIES, INC., a Delaware corporation, in its capacity as depositor (the "Depositor"), AMERICAN BUSINESS CREDIT, INC., a Pennsylvania corporation, in its capacity as servicer (the "Servicer"), and JPMORGAN CHASE BANK, a New York banking corporation, in its capacity as trustee, collateral agent and back-up servicer (the "Trustee", the "Collateral Agent" and the "Back-up Servicer", respectively). WHEREAS, the Depositor wishes to establish a trust which provides for the allocation and sale of the beneficial interests therein and the maintenance and distribution of the trust estate; WHEREAS, the Servicer has agreed to service the Mortgage Loans, which constitute the principal assets of the trust estate; WHEREAS, JPMorgan Chase Bank is willing to serve in the capacities of Trustee, Collateral Agent and Back-up Servicer hereunder; and WHEREAS, Radian Asset Assurance Inc. (the "Certificate Insurer") is intended to be a third-party beneficiary of this Agreement and is hereby recognized by the parties hereto to be a third-party beneficiary of this Agreement. NOW, THEREFORE, in consideration of the premises and the mutual agreements herein contained, the Depositor, the Servicer, the Trustee, the Collateral Agent and the Back-up Servicer hereby agree as follows: ARTICLE I DEFINITIONS Section 1.01 Certain Defined Terms. Whenever used herein, the following words and phrases, unless the context otherwise requires, shall have the following meanings: ABFS: American Business Financial Services, Inc. ACCEPTED SERVICING PRACTICES: The Servicer's normal servicing practices including practices regarding reconciliation of bank accounts, processing of mortgage payments, processing of disbursements for tax and insurance payments, maintenance of mortgage loan records, performance of collection efforts including disposition of delinquent loans, foreclosure activities and disposition of real estate owned and performance of investor accounting and reporting processes. Such practices will conform to the mortgage servicing practices of prudent mortgage lending institutions which service, for their own account, mortgage loans of the same type as the Mortgage Loans in the jurisdiction in which the related Mortgaged Properties are located, which may change from time to time; provided, that such practices shall at all times conform to the Credit and Servicing Policy Manuals. ACCOUNT: Any of the Collection Account, the Distribution Account, the Interest Reserve Account, the Capitalized Interest Account, if any, the Pre-Funding Account, if any, the Certificate Insurance Payment Account, the Net WAC Cap Carryover Fund, the Interest Rate Hedge Payment Fund or the Special Reserve Account. ACCRUAL PERIOD: With respect to (x) the Class A and Class A-IO Certificates and any Distribution Date, the prior calendar month, and (y) the Class M Certificates, the period from and including the prior Distribution Date (or the Closing Date in the case of the first Distribution Date) to but excluding the applicable Distribution Date. ADDITION NOTICE: A written notice from the Unaffiliated Seller to the Trustee, the Rating Agencies and the Certificate Insurer that the Unaffiliated Seller desires to make a Subsequent Transfer. ADJUSTED PASS-THROUGH RATE: With respect to any Distribution Date, the weighted average (weighted by Certificate Principal Balance or Class A-IO Notional Balance, as applicable) of (a) the Class A Pass-through Rate, (b) the Class A-IO Pass-through Rate and (c) the percentage equal to the sum of (i) the Class M Pass-through Rate, plus (ii) the Premium Percentage. AFFILIATE: With respect to any Person, any other Person directly or indirectly controlling, controlled by, or under direct or indirect common control with such specified Person. For the purposes of this definition, "control" when used with respect to any specified Person means the power to direct the management and policies of such Person, directly or indirectly, whether through the ownership of voting securities, by contract or otherwise; and the terms "controlling" and "controlled" have meanings correlative to the foregoing. AGGREGATE PRINCIPAL BALANCE: With respect to the Mortgage Loans and any date of determination, the aggregate Principal Balance of the Mortgage Loans as of such date of determination. AGREEMENT: This Pooling and Servicing Agreement, including the Exhibits hereto, and all amendments hereof and supplements hereto. APPLIED REALIZED LOSS AMOUNT: With respect to any Distribution Date, the amount, if any, by which the aggregate Certificate Principal Balance of the Offered Certificates after distributions of principal on such Distribution Date exceeds the Current Pool Principal Balance for that Distribution Date. APPRAISED VALUE: As to any Mortgaged Property and time referred to herein, the appraised value of the Mortgaged Property based upon the appraisal made by or on behalf of the related Originator at the time referred to herein or, in the case of a Mortgage Loan that is a purchase money mortgage loan, the sales price of the Mortgaged Property, if such sales price is less than such appraised value. ASSIGNMENT OF MORTGAGE: With respect to each Mortgage Loan, an assignment of the Mortgage, notice of transfer or equivalent instrument sufficient under the laws of the jurisdiction wherein the related Mortgaged Property is located to reflect of record the sale of the Mortgage to the Trustee for the benefit of the Certificateholders and the Certificate Insurer. 2 AUTHORIZED DENOMINATIONS: Each of the Offered Certificates is issuable only in the minimum Percentage Interest corresponding to a minimum denomination of $1,000 or integral multiples of $1,000 in excess thereof, in each case of Certificate Principal Balance; provided, however, that one Certificate of each Class is issuable in a denomination equal to any such multiple plus an additional amount such that the aggregate denomination of each Class of Offered Certificates shall be equal to the applicable Original Certificate Principal Balance or the Class A-IO Notional Balance, as applicable. AVAILABLE AMOUNT: For any Distribution Date, the amount on deposit in the Distribution Account, exclusive of the amount of any Class M Insured Payment, on that Distribution Date. BACK-UP SERVICER: JPMorgan Chase Bank, a New York banking corporation, its successors and assigns. BACK-UP SERVICING FEE: As to any Distribution Date, the fee payable to the Back-up Servicer in respect of its services as Back-up Servicer that accrues at a monthly rate equal to one-twelfth of 0.01125% on the Principal Balance of each Mortgage Loan as of the immediately preceding Due Date. BANKRUPTCY CODE: The Bankruptcy Reform Act of 1978 (Title 11 of the United States Code), as amended. BASIC DOCUMENTS: This Agreement, the Unaffiliated Seller's Agreement, the Insurance and Indemnity Agreement and the Underwriting Agreement. BUSINESS DAY: Any day other than (a) a Saturday or Sunday, or (b) a day on which banking institutions in the States of Pennsylvania, New York, Delaware or New Jersey are authorized or obligated by law or executive order to be closed. BUSINESS PURPOSE PROPERTY: Any mixed-use property, commercial property, or four or more unit multifamily property. CAPITALIZED INTEREST ACCOUNT: The Capitalized Interest Account, if any, established in accordance with Section 6.01(a) hereof and maintained by the Trustee. CAPITALIZED INTEREST REQUIREMENT: With respect to the Pre-Funding Distribution Dates, if any, an amount equal to (A) the product of (i) one twelfth of the Adjusted Pass-Through Rate as calculated as of such Distribution Date and (ii) the Pre-Funding Amount as of the first day of the related Due Period, minus (B) 30 days' interest, at the related Mortgage Interest Rate, on the Subsequent Mortgage Loans transferred to the Trust during the related Due Period which had a Due Date after the related Subsequent Cut-Off Date during the related Due Period, minus (C) the amount of any Pre-Funding Earnings earned from the last Distribution Date (or the Closing Date with respect to the first Distribution Date). In no event will the Capitalized Interest Requirement be less than zero. 3 CAPPED CERTIFICATES: The Class A and Class M Certificates. CERCLA: The Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended. CERTIFICATE: Any Class A, Class A-IO, Class M, Class X, Class I or Class R Certificate executed by the Trustee on behalf of the Trust Fund and authenticated by the Trustee. CERTIFICATEHOLDER or HOLDER: Each Person in whose name a Certificate is registered in the Certificate Register, except that, solely for the purposes of giving any consent, waiver, request or demand pursuant to this Agreement, any Certificate registered in the name of the Servicer or any Subservicer or the Unaffiliated Seller, or any Affiliate of any of them, shall be deemed not to be outstanding and the undivided Percentage Interest evidenced thereby shall not be taken into account in determining whether the requisite percentage of Certificates necessary to effect any such consent, waiver, request or demand has been obtained. For purposes of any consent, waiver, request or demand of Certificateholders pursuant to this Agreement, upon the Trustee's request, the Servicer and the Unaffiliated Seller shall provide to the Trustee a notice identifying any of their respective Affiliates or the Affiliates of any Subservicer that is a Certificateholder as of the date(s) specified by the Trustee in such request. Any Certificates on which payments are made under the Certificate Insurance Policy shall be deemed to be outstanding and held by the Certificate Insurer to the extent of such payment. CERTIFICATE INSURANCE PAYMENT ACCOUNT: The Certificate Insurance Payment Account established in accordance with Section 6.04(c) hereof and maintained by the Trustee. CERTIFICATE INSURANCE POLICY: The Financial Guaranty Insurance Policy No. FANI-0509-03090-NY issued by the Certificate Insurer, and all endorsements thereto dated the Closing Date, issued by the Certificate Insurer for the benefit of the Class M Certificateholders. CERTIFICATE INSURER: Radian Asset Assurance Inc., a New York stock insurance company, its successors and assigns. CERTIFICATE INSURER DEFAULT: The existence and continuance of any of the following: (a) the Certificate Insurer shall have failed to make a required payment when due under the Certificate Insurance Policy; (b) the Certificate Insurer shall have (i) filed a petition or commenced any case or proceeding under any provision or chapter of the United States Bankruptcy Code, the New York State Insurance Law, the New York Department of Insurance or any other similar federal or state law relating to insolvency, bankruptcy, rehabilitation, liquidation, or reorganization, (ii) made a general assignment for the benefit of its creditors or (iii) had an order for relief entered against it under the United States Bankruptcy Code, the New York State Insurance Law or any other similar federal or state law relating to insolvency, bankruptcy, rehabilitation, liquidation, or reorganization that is final and nonappealable; or 4 (c) a court of competent jurisdiction, the New York Department of Insurance or any other competent regulatory authority shall have entered a final and nonappealable order, judgment or decree (i) appointing a custodian, trustee, agent, or receiver for the Certificate Insurer or for all of any material portion of its property or (ii) authorizing the taking of possession by a custodian, trustee, agent, or receiver of the Certificate Insurer or of all or any material portion of its property. CERTIFICATE PRINCIPAL BALANCE: With respect to any Class of Certificates, other than the Class A-IO, Class X, Class I or Class R Certificates, as of any date of determination, the maximum dollar amount of principal to which the Holders thereof are then entitled hereunder, such amount being equal to the Original Certificate Principal Balance of such Class minus (i) the amount of all distributions of principal previously made with respect thereto and (ii) in the case of any Subordinate Certificates, reduced by any Applied Realized Loss Amounts applicable to such Class of Subordinate Certificates. The Class A-IO, Class X, Class I and Class R Certificates do not have a "Certificate Principal Balance". CERTIFICATE REGISTER: As defined in Section 4.02(a). CERTIFICATE REGISTRAR: As defined in Section 4.02(a). CHANGE OF CONTROL: Any of the following: (a) ABFS shall cease to own, beneficially and of record, 100% of the issued and outstanding Stock of the Servicer; (b) the consummation of a merger or consolidation of ABFS with or into another entity or any other corporate reorganization, if more that 50% of the combined voting power of the continuing or surviving entity's Stock outstanding immediately after such merger, consolidation or such other reorganization is owned by persons who were not stockholders of ABFS immediately prior to such merger, consolidation or other reorganization; or (c) the sale, transfer, or other disposition of all or substantially all of ABFS's assets. For purposes of the foregoing, "Stock" means all shares, options, warrants, interests, participation or other equivalents (regardless of how designated) of or in a corporation or equivalent entity, whether voting or nonvoting, including common stock, preferred stock, convertible debentures and all agreements, instruments and documents convertible, in whole or in part, into any one or more or all of the foregoing. CIVIL RELIEF ACT: The Soldiers' and Sailors' Civil Relief Act of 1940, as amended or similar state statutes. CIVIL RELIEF ACT INTEREST SHORTFALL: With respect to any Distribution Date, for any Mortgage Loan as to which there has been a reduction in the amount of interest collectible thereon for the most recently ended Due Period as a result of the application of the Civil Relief Act, the amount, if any, by which (a) interest collectible on such Mortgage Loan during the most recently ended calendar month is less than (b) the sum of one month's interest on the Principal Balance of such Mortgage Loan, calculated at a rate equal to the Mortgage Interest Rate. 5 CLASS: Each class of Certificates designated as the Class A, Class A-IO, Class M, Class X, Class I or Class R Certificates and, for the purposes of Section 2.07, any class of interests referenced in Section 2.07. CLASS A CERTIFICATE: Any Certificate designated as a "Class A Certificate" on the face thereof, in the form of Exhibit A hereto. The Class A Certificates shall be issued with an initial aggregate Certificate Principal Balance equal to the Original Certificate Principal Balance therefor. CLASS A PASS-THROUGH RATE: With respect to any Distribution Date, the lesser of (1) for any Distribution Date which occurs on or prior to the Clean-Up Call Date, the per annum rate equal to 3.78%, and for any Distribution Date thereafter, the per annum rate equal to 4.28% and (2) the Net WAC Cap for such Distribution Date. CLASS A PRINCIPAL DISTRIBUTION AMOUNT: With respect to any Distribution Date (a) prior to the Stepdown Date and on any Distribution Date thereafter on which a Trigger Event is in effect, the lesser of (i) 100% of the Principal Distribution Amount and (ii) the Certificate Principal Balance of the Class A Certificates immediately prior to the related Distribution Date and (b) on or after the related Stepdown Date, to the extent a Trigger Event is not in effect, the least of: (i) the Principal Distribution Amount; (ii) the excess of (1) the Certificate Principal Balance of the Class A Certificates immediately prior to the related Distribution Date over (2) the lesser of (a) 61.00% of the Current Pool Principal Balance for that Distribution Date and (b) the Current Pool Principal Balance for that Distribution Date minus the OC Floor (but not less than zero); and (iii) the Certificate Principal Balance of the Class A Certificates immediately prior to the related Distribution Date. CLASS A-IO CERTIFICATE: Any Certificate designated as a "Class A-IO Certificate" on the face thereof, in the form of Exhibit B hereto. CLASS A-IO NOTIONAL BALANCE: With respect to any Distribution Date (i) prior to the Distribution Date occurring in October 2005, an amount equal to the lesser of (x) the Class A-IO Scheduled Notional Balance and (y) the Aggregate Principal Balance of the Mortgage Loans as of the first day of the related Due Period and (ii) on and after the Distribution Date occurring in October 2005, an amount equal to $0. CLASS A-IO PASS-THROUGH RATE: With respect to any Distribution Date, a per annum rate equal to 4.00%. 6 CLASS A-IO SCHEDULED NOTIONAL BALANCE: With respect to any Distribution Date, the applicable amount set forth in the following schedule:
Class A-IO Class A-IO Scheduled Scheduled Distribution Date Notional Balance Distribution Date Notional Balance - ------------------------- ---------------- --------------------------- ---------------- April 2003 $118,125,000 August 2004 $92,362,500 May 2003 $118,125,000 September 2004 $92,362,500 June 2003 $118,125,000 October 2004 $91,350,000 July 2003 $117,562,500 November 2004 $91,350,000 August 2003 $117,562,500 December 2004 $91,350,000 September 2003 $117,562,500 January 2005 $72,337,500 October 2003 $112,106,250 February 2005 $72,337,500 November 2003 $112,106,250 March 2005 $72,337,500 December 2003 $112,106,250 April 2005 $57,375,000 January 2004 $105,975,000 May 2005 $57,375,000 February 2004 $105,975,000 June 2005 $57,375,000 March 2004 $105,975,000 July 2005 $48,937,500 April 2004 $98,718,750 August 2005 $48,937,500 May 2004 $98,718,750 September 2005 $48,937,500 June 2004 $98,718,750 October 2005 July 2004 $92,362,500 and thereafter $0
CLASS I CERTIFICATE: Any Certificate designated as a "Class I Certificate" on the face thereof, in the form of Exhibit F hereto. CLASS I CERTIFICATEHOLDER: A Holder of a Class I Certificate. CLASS I DISTRIBUTION AMOUNT: With respect to each Distribution Date from the initial Distribution Date through the Distribution Date in September, 2005, $125,517.00, and with respect to each Distribution Date thereafter, $0. CLASS INTEREST CARRYOVER SHORTFALL: With respect to any Class of Offered Certificates and any Distribution Date, an amount equal to the sum of (a) the excess, if any, of (i) the Class Monthly Interest for such Class (the amount to which the Class is entitled in the absence of any shortfall but after giving effect to the Net WAC Cap, if applicable) for the preceding Distribution Date plus any outstanding Class Interest Carryover Shortfall with respect to that Class from any preceding Distribution Dates over (ii) the amount in respect of interest that is actually distributed to the Holders of that Class on the preceding Distribution Date, plus (b) one-month's interest on the amount described in clause (a), to the extent permitted by law, at the related Pass-Through Rate. CLASS M CERTIFICATE: Any Certificate designated as a "Class M Certificate" on the face thereof, in the form of Exhibit C hereto. The Class M Certificates shall be comprised of the Class M Components and shall be issued with an initial aggregate Certificate Principal Balance equal to the Original Certificate Principal Balance therefor. Following the occurrence of a Separation Event, references herein to the Class M Certificates shall be deemed to be references to the Class M-1, Class M-2 and Class M-3 Certificates, as applicable. 7 CLASS M COLLATERALIZATION DEFICIT: With respect to any Distribution Date immediately prior to which the Class M Certificates are outstanding, the lesser of (i) the amount, if any, by which (A) the aggregate Certificate Principal Balance of the Class A and Class M Certificates (after giving effect to all distributions to be made thereon on such Distribution Date other than any portion thereof consisting of a Class M Insured Principal Payment in respect of a Class M Collateralization Deficit) exceeds (B) the Aggregate Principal Balance of the Mortgage Loans on the last day of the immediately preceding Due Period (after giving effect to scheduled payments of principal due during the related Due Period, to the extent received or advanced, and unscheduled collections of principal received during the preceding calendar month), and (ii) the Certificate Principal Balance of the Class M Certificates (after giving effect to all distributions to be made thereon on such Distribution Date other than any portion thereof consisting of a Class M Insured Principal Payment in respect of a Class M Collateralization Deficit). CLASS M COMPONENT: The Class M-1 Component, the Class M-2 Component and the Class M-3 Component, as applicable. CLASS M DEFICIENCY AMOUNT: For any Distribution Date and the Class M Certificates, the sum of (i) any Class M Insured Interest Payment for such Distribution Date and (ii) any Class M Insured Principal Payment for such Distribution Date. CLASS M INSURED AMOUNTS: With respect to any Distribution Date, any Class M Deficiency Amount for such Distribution Date plus any Class M Preference Amount for such Distribution Date. A Class M Insured Amount will not include any Prepayment Interest Shortfalls, any Civil Relief Act Interest Shortfalls or any Net WAC Cap Carryover Amounts. CLASS M INSURED INTEREST PAYMENT: With respect to any Distribution Date and the Class M Certificates, the excess, if any, of (i) the sum of the Class Monthly Interest and any Class Interest Carryover Shortfall for the Class M Certificates for such Distribution Date over (ii) the Net Available Amount remaining on deposit in the Distribution Account following the payment of the Class Monthly Interest and any Class Interest Carryover Shortfall on the Class A and Class A-IO Certificates on that Distribution Date. CLASS M INSURED PAYMENTS: With respect to any Distribution Date, the aggregate amount actually paid by the Certificate Insurer pursuant to the Certificate Insurance Policy in respect of Class M Insured Amounts for such Distribution Date. CLASS M INSURED PRINCIPAL PAYMENT: With respect to (x) any Distribution Date other than the Final Insured Distribution Date and the Class M Certificates, the lesser of (i) the Class M Collateralization Deficit, if any, for such Distribution Date and (ii) the Applied Realized Loss Amount applied in reduction of the Certificate Principal Balance of the Class M Certificates on such Distribution Date (after taking into account any funds in the Interest Rate Hedge Payment Fund which are applied on such Distribution Date towards the payment of such Applied Realized Loss Amount pursuant to Section 6.10(d) of this Agreement), and (y) the Final Insured Distribution Date and the Class M Certificates, the aggregate Certificate Principal Balance of the Class M Certificates (after giving effect to all distributions of principal to be made thereon on such Distribution Date other than any portion thereof consisting of a Class M Insured Principal Payment). 8 CLASS M PASS-THROUGH RATE: With respect to any Distribution Date, the lesser of (1) for any Distribution Date which occurs on or prior to the Clean-Up Call Date, the per annum rate equal to LIBOR plus 1.50%, and for any Distribution Date thereafter, the per annum rate equal to LIBOR plus 2.25% and (2) the Net WAC Cap for such Distribution Date. CLASS M PREFERENCE AMOUNT: Any amount previously paid in respect of the Class M Certificates that is recoverable and sought to be recovered as a voidable preference by a trustee in bankruptcy pursuant to the United States Bankruptcy Code (11 U.S.C. ss.ss.101 et seq.), as amended from time to time in accordance with a final, nonappealable order of a court having competent jurisdiction. CLASS M PREFERENCE CLAIM: As defined in Section 6.04(f). CLASS M PRINCIPAL DISTRIBUTION AMOUNT: With respect to any Distribution Date, sum of the Class M-1 Principal Distribution Amount, the Class M-2 Principal Distribution Amount and the Class M-3 Principal Distribution Amount for such Distribution Date. CLASS M-1 COMPONENT: The component portion of the Class M Certificates designated as the "Class M-1 Component" and having an initial Component Principal Balance equal to $25,875,000. The Class M-1 Component will not be transferable separately from the other Class M Components except upon the occurrence of a Separation Event, at which time the Class M-1 Component will be issued as a Class M-1 Certificate. CLASS M-1 CERTIFICATE: Any Certificate designated as a "Class M-1 Certificate" on the face thereof, in the form of Exhibit C hereto. The Class M-1 Certificates will be issued upon the occurrence of a Separation Event with an initial aggregate Certificate Principal Balance equal to the Component Principal Balance of the Class M-1 Component on the date of the Separation Event. The CUSIP number for the Class M-1 Certificates is 000759 OH0. CLASS M-1 PRINCIPAL DISTRIBUTION AMOUNT: With respect to any Distribution Date: (a) prior to the Stepdown Date and on any Distribution Date thereafter on which a Trigger Event is in effect: (i) if any Class A Certificates remain outstanding, zero ($0); or (ii) if the Certificate Principal Balance of the Class A Certificates has been reduced to zero ($0), the lesser of (A) the Certificate Principal Balance of the Class M-1 Component immediately prior to that Distribution Date and (B) 100% of the Principal Distribution Amount; and 9 (b) on an after the Stepdown Date, to the extent a Trigger Event is not in effect, the least of: (i) the Principal Distribution Amount remaining after distribution of the Class A Principal Distribution Amount on the related Distribution Date; (ii) the excess of (A) the sum of (1) the Certificate Principal Balance of the Class A Certificates after distribution of the Class A Principal Distribution Amount on the related Distribution Date and (2) the Certificate Principal Balance of the Class M-1 Component immediately prior to the related Distribution Date over (B) the lesser of (1) 72.50% of the Current Pool Principal Balance for that Distribution Date and (2) the Current Pool Principal Balance for that Distribution Date minus the OC Floor (but not less than zero); and (iii) the Certificate Principal Balance of the Class M-1 Component immediately prior to the related Distribution Date. CLASS M-2 COMPONENT: The component portion of the Class M Certificates designated as the "Class M-2 Component" and having an initial Component Principal Balance equal to $23,625,000. The Class M-2 Component will not be transferable separately from the other Class M Components except upon the occurrence of a Separation Event, at which time the Class M-2 Component will be issued as a Class M-2 Certificate. CLASS M-2 CERTIFICATE: Any Certificate designated as a "Class M-2 Certificate" on the face thereof, in the form of Exhibit C hereto. The Class M-2 Certificates will be issued upon the occurrence of a Separation Event with an initial aggregate Certificate Principal Balance equal to the Component Principal Balance of the Class M-2 Component on the date of the Separation Event. The CUSIP number for the Class M-2 Certificates is 000759 DJ6. CLASS M-2 PRINCIPAL DISTRIBUTION AMOUNT: With respect to any Distribution Date: (a) prior to the Stepdown Date and on any Distribution Date thereafter on which a Trigger Event is in effect: (i) if any Class A Certificates or Class M-1 Component remain outstanding, zero ($0); or (ii) if the Certificate Principal Balance of the Class A Certificates and Class M-1 Component have been reduced to zero ($0), the lesser of (A) the Certificate Principal Balance of the Class M-2 Component immediately prior to that Distribution Date and (B) 100% of the Principal Distribution Amount; and 10 (b) on an after the Stepdown Date, to the extent a Trigger Event is not in effect, the least of: (i) the Principal Distribution Amount remaining after distribution of the Class A and Class M-1 Principal Distribution Amounts on the related Distribution Date; (ii) the excess of (A) the sum of (1) the aggregate Certificate Principal Balance of the Class A Certificates and the Class M-1 Component after distribution of the Class A and Class M-1 Principal Distribution Amounts on the related Distribution Date and (2) the Certificate Principal Balance of the Class M-2 Component immediately prior to the related Distribution Date over (B) the lesser of (1) 83.00% of the Current Pool Principal Balance for that Distribution Date and (2) the Current Pool Principal Balance for that Distribution Date minus the OC Floor (but not less than zero); and (iii) the Certificate Principal Balance of the Class M-1 Component immediately prior to the related Distribution Date. CLASS M-3 COMPONENT: The component portion of the Class M Certificates designated as the "Class M-3 Component" and having an initial Component Principal Balance equal to $13,500,000. The Class M-3 Component will not be transferable separately from the other Class M Components except upon the occurrence of a Separation Event, at which time the Class M-3 Component will be issued as a Class M-3 Certificate. CLASS M-3 CERTIFICATE: Any Certificate designated as a "Class M-3 Certificate" on the face thereof, in the form of Exhibit C hereto. The Class M-3 Certificates will be issued upon the occurrence of a Separation Event with an initial aggregate Certificate Principal Balance equal to the Component Principal Balance of the Class M-3 Component on the date of the Separation Event. The CUSIP number for the Class M-3 Certificates is 000759 DK3. CLASS M-3 PRINCIPAL DISTRIBUTION AMOUNT: With respect to any Distribution Date: (a) prior to the Stepdown Date and on any Distribution Date thereafter on which a Trigger Event is in effect: (i) if any Class A Certificates or Class M-1 or Class M-2 Component remain outstanding, zero ($0); or (ii) if the Certificate Principal Balance of the Class A Certificates and Class M-1 and Class M-2 Component have been reduced to zero ($0), the lesser of (A) the Certificate Principal Balance of the Class M-3 Component immediately prior to that Distribution Date and (B) 100% of the Principal Distribution Amount; and 11 (b) on an after the Stepdown Date, to the extent a Trigger Event is not in effect, the least of: (i) the Principal Distribution Amount remaining after distribution of the Class A, Class M-1 and Class M-2 Principal Distribution Amounts on the related Distribution Date; (ii) the excess of (A) the sum of (1) the aggregate Certificate Principal Balance of the Class A Certificates and the Class M-1 and Class M-2 Component after distribution of the Class A, Class M-1 and Class M-2 Principal Distribution Amounts on the related Distribution Date and (2) the Certificate Principal Balance of the Class M-3 Component immediately prior to the related Distribution Date over (B) the lesser of (1) 89.00% of the Current Pool Principal Balance for that Distribution Date and (2) the Current Pool Principal Balance for that Distribution Date minus the OC Floor (but not less than zero); and (iii) the Certificate Principal Balance of the Class M-3 Component immediately prior to the related Distribution Date. CLASS MONTHLY INTEREST: With respect to any Class of Offered Certificates and any Distribution Date, the amount of interest accrued during the related Accrual Period on the Certificate Principal Balance of such Class (or the Class A-IO Notional Balance in the case of the Class A-IO Certificates) immediately prior to such Distribution Date at the related Pass-Through Rate, as reduced by that Class's pro rata share of Mortgage Loan Interest Shortfalls for such Distribution Date allocated to such Class pursuant to Section 6.05(c) of this Agreement and, with respect to the Class M Certificates only, as further reduced by the amount of any distribution to the Holder of the Class M Certificates in respect of Class Monthly Interest on such Distribution Date pursuant to Section 6.10(d) hereof. CLASS R CERTIFICATE: Any Certificate designated as a "Class R Certificate" on the face thereof, in the form of Exhibit D hereto. CLASS R CERTIFICATEHOLDER: A Holder of a Class R Certificate. CLASS X CERTIFICATE: Any Certificate designated as a "Class X Certificate" on the face thereof, in the form of Exhibit E hereto. CLASS X CERTIFICATEHOLDER: A Holder of a Class X Certificate. CLASS X DISTRIBUTION AMOUNT: With respect to any Distribution Date, the sum of (i) the Overcollateralization Reduction Amount and (ii) the product of the notional principal balance of the Class X Certificate and the Pass-Through Rate of the Class X Certificate each as described in footnotes (5) and (6), respectively, of Section 2.07(b) hereof for the current and for all prior Distribution Dates less amounts distributed to the Class X Certificates on prior Distribution Dates pursuant to Sections 6.05(a)(ix) and (xiii) hereof. CLEAN-UP CALL DATE: As defined in Section 8.01(b). 12 CLOSING DATE: March 31, 2003. CODE: The Internal Revenue Code of 1986, as amended. COLLATERAL AGENT: JPMorgan Chase Bank, a New York banking corporation, its successors and assigns. COLLECTION ACCOUNT: The Eligible Account established and maintained by the Servicer pursuant to Section 5.02(b). COMBINED LOAN-TO-VALUE RATIO or CLTV: As to any Mortgage Loan at any time, the fraction, expressed as a percentage, the numerator of which is the sum of (i) the Principal Balance thereof at such time and (ii) if such Mortgage Loan is subject to a second mortgage, the unpaid principal balance of any related first mortgage loan or loans, if any, as of such time, and the denominator of which is the Appraised Value of any related Mortgaged Property or Properties as of the date of the appraisal used by or on behalf of the Unaffiliated Seller to underwrite such Mortgage Loan. COMMISSION: The Securities and Exchange Commission. COMPENSATING INTEREST: As defined in Section 6.09 hereof. COMPONENT PRINCIPAL BALANCE: With respect to any Class M Component and any Distribution Date, the initial component principal balance of such Class M Component, reduced by the aggregate amount of principal payments on the Class M Certificates prior to such Distribution Date which were allocable to such Class M Component. CORRESPONDING CLASS: Means the Class of Master REMIC Regular Interests as used in the Table in Section 2.07. CREDIT AND SERVICING POLICY MANUALS: With respect to an Originator, its written policies and procedures regarding underwriting, origination and servicing of mortgage loans, as delivered to the Certificate Insurer on or prior to the Closing Date, with such changes notified to the Certificate Insurer (a) that do not have a material adverse effect on such policies and procedures, or (b) that are approved by the Certificate Insurer, such approval not to be unreasonably withheld, conditional or delayed, or (c) that the Servicer does not apply to the Mortgage Loans. CUMULATIVE LOSS PERCENTAGE: As of any date of determination thereof, the percentage obtained by dividing (x) the aggregate of all Liquidated Loan Losses incurred since the Closing Date through the last day of the related Due Period by (y) the Maximum Pool Principal Balance. 13 CUMULATIVE LOSS TRIGGER EVENT: With respect to any Distribution Date, the event that occurs if the Cumulative Loss Percentage for such Distribution Date exceeds the following percentages with respect to the applicable Distribution Date specified below:
Distribution Date Loss Percentage ---------------------------- -------------------------------------------------- January 2006 - December 2006 2.75% for the first month, plus an additional 1/12 of 1.75% for each month thereafter January 2007 - December 2007 4.50% for the first month, plus an additional 1/12 of 1.50% for each month thereafter January 2008 - December 2008 6.00% for the first month, plus an additional 1/12 of 1.00% for each month thereafter January 2009 - December 2009 7.00% for the first month, plus an additional 1/12 of 0.25% for each month thereafter January 2010 and thereafter 7.25%
CURRENT POOL PRINCIPAL BALANCE: With respect to any Distribution Date, the sum of (i) the Aggregate Principal Balance of the Mortgage Loans on the last day of the related Due Period, and (ii) the Pre-Funding Amount (net of Pre-Funding Earnings), if any, immediately prior to the Distribution Date. CUT-OFF DATE: With respect to Initial Mortgage Loans, the Initial Cut-Off Date, and, with respect to Subsequent Mortgage Loans, if any, the Subsequent Cut-Off Date. DEBT SERVICE REDUCTION: With respect to any Mortgage Loan, a reduction by a court of competent jurisdiction of the Monthly Payment due on such Mortgage Loan in a proceeding under the United States Bankruptcy Code, except such a reduction that constitutes a Deficient Valuation or a permanent forgiveness of principal. DEFICIENT VALUATION: With respect to any Mortgage Loan, a valuation of the related Mortgaged Property by a court of competent jurisdiction in an amount less than the then outstanding principal balance of the Mortgage Loan, which valuation results from a proceeding initiated under the United States Bankruptcy Code. DELETED MORTGAGE LOAN: A Mortgage Loan replaced by or to be replaced by a Qualified Substitute Mortgage Loan. DELINQUENCY RATIO: With respect to any Distribution Date, the percentage equivalent of a fraction (a) the numerator of which equals the aggregate Principal Balances of all Mortgage Loans that are 60 or more days Delinquent, in foreclosure, converted to REO Property or in bankruptcy and are 60 or more days Delinquent, as of the last day of the related Due Period and (b) the denominator of which is the Current Pool Principal Balance for that Distribution Date. 14 DELINQUENCY TRIGGER EVENT: The event that occurs when the Rolling Three Month Delinquency Rate exceeds 45% of the Senior Enhancement Percentage. DELINQUENT: A Mortgage Loan is "delinquent" if any payment due thereon is not made by the close of business on the day such payment is scheduled to be due. A Mortgage Loan is "30 days delinquent" if such payment has not been received by the close of business on the corresponding day of the month immediately succeeding the month in which such payment was due, or, if there is no such corresponding day (e.g., as when a 30-day month follows a 31-day month in which a payment was due on the 31st day of such month) then on the last day of such immediately succeeding month. Similarly for "60 days delinquent," "90 days delinquent" and so on. DEPOSITOR: Bear Stearns Asset Backed Securities, Inc., a Delaware corporation, and any successor thereto. DEPOSITORY: The Depository Trust Company, 55 Water Street, New York, New York 10041 and any successor Depository hereafter named. DIRECT PARTICIPANT: Any broker-dealer, bank or other financial institution for which the Depository holds Offered Certificates from time to time as a securities depository. DISTRIBUTION ACCOUNT: The Distribution Account established in accordance with Section 6.01(a) hereof and maintained by the Trustee. DISTRIBUTION DATE: The 15th day of any month or if such 15th day is not a Business Day, the first Business Day immediately following, commencing on April 15, 2003. DUE DATE: With respect to each Mortgage Loan and any Distribution Date, the day of the calendar month preceding the calendar month in which such Distribution Date occurs on which the Monthly Payment for such Mortgage Loan was due. DUE PERIOD: With respect to each Distribution Date, the calendar month preceding the related Distribution Date. ELIGIBLE ACCOUNT: Either (A) an account or accounts maintained with an institution (which may include the Trustee, provided such institution otherwise meets these requirements) whose deposits are insured by the FDIC, the unsecured and uncollateralized debt obligations of which institution shall be rated "AA" or better by S&P and "Aa2" or better by Moody's and in the highest short term rating category by S&P and Moody's, and which is (i) a federal savings and loan association duly organized, validly existing and in good standing under the federal banking laws, (ii) an institution (including the Trustee) duly organized, validly existing and in good standing under the applicable banking laws of any state, (iii) a national banking association duly organized, validly existing and in good standing under the federal banking laws, (iv) a principal subsidiary of a bank holding company, or (v) approved in writing by the Certificate Insurer and the Rating Agencies or (B) a trust account or accounts maintained with the trust department of a federal or state chartered depository institution or trust company (which may include the Trustee, provided that the Trustee otherwise meets these requirements), having capital and surplus of not less than $50,000,000, acting in its fiduciary capacity. 15 ERISA: As defined in Section 4.02(n) hereof. EVENT OF DEFAULT: As described in Section 7.01. EXCESS INTEREST: For any Distribution Date is equal to the excess of (a) the Net Available Amount for such Distribution Date over (b) the sum of: (i) the Interest Distribution Amount for such Distribution Date; (ii) the Principal Distribution Amount for such Distribution Date (calculated for this purpose without regard to any Overcollateralization Increase Amount or portion thereof included therein); and (iii) any Reimbursement Amount or other amount owed to the Certificate Insurer on such Distribution Date. EXCESS OVERCOLLATERALIZED AMOUNT: With respect to any Distribution Date, the excess, if any, of (a) the Overcollateralized Amount that would apply on such Distribution Date after taking into account all distributions that would be made on such Distribution Date (other than the Overcollateralization Reduction Amount) over (b) the Specified Overcollateralization Amount. FDIC: The Federal Deposit Insurance Corporation, and any successor thereto. FHLMC: The Federal Home Loan Mortgage Corporation, and any successor thereto. FINAL CERTIFICATION: As defined in Section 2.06(b) hereof. FINAL INSURED DISTRIBUTION DATE: The earlier of (i) the Distribution Date on August 15, 2033 or (ii) the final Distribution Date that occurs in connection with any earlier termination of the Trust pursuant to Section 8.01 of this Pooling and Servicing Agreement. FINAL SCHEDULED MATURITY DATE: With respect to any Class of Offered Certificates (other than the Class A-IO Certificates), the Distribution Date occurring in the month specified below: Final Scheduled Class Maturity Date ------------- --------------------- A August 2033 M August 2033 FITCH: Fitch Ratings, a corporation organized and existing under Delaware law, or any successor thereto and if such corporation no longer for any reason performs the services of a securities rating agency, "Fitch" shall be deemed to refer to any other nationally recognized rating agency designated by the Certificate Insurer. 16 FNMA: The Federal National Mortgage Association, and any successor thereto. FORECLOSURE PROFITS: As to any Servicer Remittance Date, the excess, if any, of (i) Net Liquidation Proceeds in respect of each Mortgage Loan that became a Liquidated Mortgage Loan during the related Due Period over (ii) the sum of the unpaid Principal Balance of each such Liquidated Mortgage Loan plus accrued and unpaid interest at the applicable Mortgage Interest Rate on the unpaid Principal Balance thereof from the Due Date to which interest was last paid by the Mortgagor (or, in the case of a Liquidated Mortgage Loan that had been an REO Mortgage Loan, from the Due Date to which interest was last deemed to have been paid pursuant to Section 5.06 to the first day of the month following the month in which such Mortgage Loan became a Liquidated Mortgage Loan). GAAP: Generally accepted accounting principles, consistently applied, as of the date of such application. HEDGE COUNTERPARTY: Bear Stearns Financial Products Inc., a Delaware corporation, its successors and assigns. HEDGE PAYMENTS: With respect to any Distribution Date, any amounts paid by the Hedge Counterparty under the Interest Rate Hedge Agreement to the Trustee for deposit into the Interest Rate Hedge Payment Fund, other than any Hedge Termination Payments. HEDGE PREMIUM: With respect to any Distribution Date, the Fixed Amount (as defined in the Interest Rate Hedge Agreement) owing to the Hedge Counterparty pursuant to the Interest Rate Hedge Agreement on such Distribution Date. HEDGE TERMINATION PAYMENTS: Any termination payments paid by the Hedge Counterparty under the Interest Rate Hedge Agreement to the Trustee for deposit into the Interest Rate Hedge Payment Fund, including any termination payments in respect of a Additional Termination Event (as defined in the Interest Rate Hedge Agreement). INDIRECT PARTICIPANT: Any financial institution for whom any Direct Participant holds an interest in an Offered Certificate. INITIAL CERTIFICATION: As defined in Section 2.06(a) hereof. INITIAL CUT-OFF DATE: With respect to any Initial Mortgage Loan, the close of business on February 28, 2003, or, if such Initial Mortgage Loan was originated or otherwise acquired by an Originator after February 28, 2003, the date of origination or acquisition of such Initial Mortgage Loan. INITIAL MORTGAGE LOANS: The Mortgage Loans delivered by the Depositor on the Closing Date. INSURANCE AND INDEMNITY AGREEMENT: The Insurance and Indemnity Agreement, dated as of March 31, 2003, among the Certificate Insurer, the Depositor, the Trustee, the Collateral Agent, the Back up Servicer, the Servicer, the Unaffiliated Seller and the Originators, as such agreement may be amended or supplemented in accordance with the provisions thereof. 17 INSURANCE POLICIES: All insurance policies insuring any Mortgage Loan or Mortgaged Property to the extent the Trust or the Trustee has any interest therein. INSURANCE PROCEEDS: Proceeds paid by any insurer pursuant to any insurance policy covering a Mortgage Loan to the extent such proceeds are not applied to the restoration of the related Mortgaged Property or released to the related Mortgagor in accordance with Accepted Servicing Practices. "Insurance Proceeds" do not include "Class M Insured Payments". INTEREST DISTRIBUTION AMOUNT: With respect to any Distribution Date, an amount equal to the sum of the Class Monthly Interest and any Class Interest Carryover Shortfall for the Class A, Class A-IO and Class M Certificates, in each case, as of such Distribution Date. INTEREST RATE HEDGE AGREEMENT: The Interest Rate Hedge Agreement, dated as of March 31, 2003, between the Hedge Counterparty and the Trustee, on behalf of the Supplemental Interest Trust. INTEREST RATE HEDGE PAYMENT FUND: The Eligible Account established and maintained in accordance with Section 6.10(a). INTEREST RATE HEDGE PAYMENT RIGHT: The right of the Holders of the Class M Certificates to receive Hedge Payments in accordance with Section 6.10(d). INTEREST REMITTANCE AMOUNT: With respect to any Distribution Date, the sum, without duplication, of: (i) all scheduled installments of interest due (or advanced by the Servicer) on the Mortgage Loans during the related Due Period; plus (ii) Compensating Interest paid by the Servicer on the related Servicer Remittance Date; plus (iii) the interest component of all related Substitution Adjustments and Loan Repurchase Prices; plus (iv) the interest component, if any, of all Insurance Proceeds and Liquidation Proceeds received by the Servicer during the related Due Period (in each case, net (but not to be reduced below zero) of unreimbursed expenses incurred in connection with a liquidation or foreclosure and unreimbursed Periodic Advances and Servicing Advances, if any); plus (v) the interest component of the proceeds of any termination of the Trust Fund; plus 18 (vi) any Special Advance amounts transferred to the Distribution Account pursuant to Section 5.18(b) hereof; plus (vii) on the Pre-Funding Distribution Dates, if any, the Capitalized Interest Requirement for such Distribution Date, if any; plus (viii) on the Pre-Funding Distribution Dates, if any, the Pre-Funding Earnings, if any; minus (xi) to the extent previously retained by the Servicer, the Servicing Fee for the related Due Period, together with amounts in reimbursement for Periodic Advances or Servicing Advances previously made with respect to the Mortgage Loans and other amounts as to which the Servicer is entitled to be reimbursed pursuant to this Agreement. INTEREST RESERVE ACCOUNT: The Eligible Account established in accordance with Section 6.01(a) hereof and maintained by the Trustee. LATE PAYMENT RATE: Has the meaning given in the Insurance and Indemnity Agreement. LIBOR: With respect to any Accrual Period for the Class M Certificates, the rate determined by the Trustee on the related LIBOR Determination Date on the basis of the offered rates of the Reference Banks for one-month U.S. dollar deposits, as such rates appear on Telerate Page 3750, as of 11:00 a.m. (London time) on such LIBOR Determination Date. On each LIBOR Determination Date, LIBOR for the related Accrual Period will be established by the Trustee as follows: (a) if on such LIBOR Determination Date two or more Reference Banks provide such offered quotations, LIBOR for the related Accrual Period for the Class M Certificates shall be the arithmetic mean of such offered quotations (rounded upwards if necessary to the nearest whole multiple of 1/16%); or (b) if on such LIBOR Determination Date fewer than two Reference Banks provide such offered quotations, LIBOR for the related Accrual Period for the Class M Certificates shall be the higher of (i) LIBOR as determined on the previous LIBOR Determination Date and (ii) the Reserve Interest Rate. LIBOR Determination Date: With respect to any Accrual Period for the Class M Certificates, the second London Business Day preceding the first day of such Accrual Period. LIQUIDATED LOAN LOSS: With respect to any Servicer Remittance Date as of the related Due Date, an amount equal to the excess of (i) the unpaid principal balance of a Liquidated Mortgage Loan, plus accrued interest thereon in accordance with the amortization schedule at the time applicable thereto at the applicable Mortgage Interest Rate from the Due Date as to which interest was last paid with respect thereto through the last day of the month in which such Mortgage Loan became a Liquidated Mortgage Loan, over (ii) Net Liquidation Proceeds with respect to such Liquidated Mortgage Loan. 19 LIQUIDATED MORTGAGE LOAN: A Mortgage Loan with respect to which the related Mortgaged Property has been acquired, liquidated or foreclosed in connection with (i) the taking of all or a part of Mortgaged Property by exercise of the power of eminent domain or condemnation, (ii) the liquidation of a defaulted Mortgage Loan through a trustee's sale, foreclosure sale, REO Disposition or otherwise and with respect to which the Servicer determines that all Liquidation Proceeds which it expects to recover have been recovered. LIQUIDATION EXPENSES: Without limitation, expenses incurred by the Servicer in connection with the liquidation of any Liquidated Mortgage Loan or property acquired in respect thereof (including, without limitation, legal fees and expenses, committee or referee fees, and, if applicable, brokerage commissions and conveyance taxes), any unreimbursed amount expended by the Servicer pursuant to Sections 5.04 and 5.06 hereof in respect of the related Mortgage Loan and any unreimbursed expenditures for real property taxes or for property restoration or preservation of the related Mortgaged Property. Liquidation Expenses shall not include any previously incurred expenses in respect of an REO Mortgage Loan which have been netted against related REO Proceeds. In no event may Liquidation Expenses with respect to a Liquidated Mortgage Loan exceed the related Liquidation Proceeds. LIQUIDATION PROCEEDS: The amount (other than Insurance Proceeds) received by the Servicer in connection with (i) the taking of all or a part of Mortgaged Property by exercise of the power of eminent domain or condemnation, (ii) the liquidation of a defaulted Mortgage Loan through a trustee's sale, foreclosure sale, REO Disposition or otherwise or (iii) the liquidation of any other security for such Mortgage Loan, including, without limitation, pledged equipment, inventory and working capital and assignments of rights and interests made by the related mortgagor. LOAN REPURCHASE PRICE: As defined in Section 2.06(c). LONDON BUSINESS DAY: A day on which banks are open for dealing in foreign currency and exchange in London and New York City. MAJORITY CERTIFICATEHOLDERS: For so long as any of the Offered Certificates are outstanding, the Holder or Holders of Offered Certificates evidencing Percentage Interests in excess of 51% in the aggregate, and thereafter, the Holder or Holders of Class R Certificates evidencing Percentage Interests in excess of 51% in the aggregate. MASTER REMIC: As defined in Section 2.07. MASTER REMIC REGULAR INTERESTS: As defined in Section 2.07. MAXIMUM POOL PRINCIPAL BALANCE: The sum of (i) the Aggregate Principal Balance of the Initial Mortgage Loans as of their respective Initial Cut-Off Dates and (ii) the Original Pre-Funded Amount, if any. MONTHLY PAYMENT: As to any Mortgage Loan (including any REO Mortgage Loan) and any Due Date, the payment of principal and interest due thereon as specified for such Due Date in the related amortization schedule at the time applicable thereto (after adjustment for any Deficient Valuations occurring prior to such Due Date but before any adjustment to such amortization schedule by reason of any bankruptcy, other than Deficient Valuations or similar proceeding or any moratorium or similar waiver or grace period). 20 MONTHLY SERVICING FEE: As defined in Section 5.08 hereof. MOODY'S: Moody's Investors Service, Inc., a corporation organized and existing under Delaware law, or any successor thereto and if such corporation no longer for any reason performs the services of a securities rating agency, "Moody's" shall be deemed to refer to any other nationally recognized rating agency designated by the Certificate Insurer. MORTGAGE: The mortgage, deed of trust or other instrument creating a first or second lien on the Mortgaged Property. MORTGAGED PROPERTY: The underlying property or properties securing a Mortgage Loan, consisting of a fee simple estate in such real property. MORTGAGE FILE: As described in Exhibit G. MORTGAGE INTEREST RATE: As to any Mortgage Loan, the per annum fixed rate at which interest accrues on the unpaid principal balance thereof as set forth on the related Mortgage Note. MORTGAGE LOAN INTEREST SHORTFALL: With respect to any Distribution Date, as to any Mortgage Loan, the sum of (a) any Prepayment Interest Shortfall for which no payment of Compensating Interest is paid and (b) any Civil Relief Act Interest Shortfall in respect of such Mortgage Loan for such Distribution Date. MORTGAGE LOAN POOL: Those Initial Mortgage Loans listed on the initial Mortgage Loan Schedule together with any Subsequent Mortgage Loans listed on any subsequent Mortgage Loan Schedules. MORTGAGE LOANS: The Initial Mortgage Loans and the Subsequent Mortgage Loans, if any, together with any Qualified Substitute Mortgage Loans submitted therefor in accordance with this Agreement, as from time to time are held as a part of the Trust Fund. When used in respect of any Distribution Date, the term Mortgage Loans shall mean all Mortgage Loans (including those in respect of which the Trustee has acquired the related Mortgaged Property) which have not been repaid in full prior to the related Due Period, did not become Liquidated Mortgage Loans prior to such related Due Period or were not repurchased or replaced by the Unaffiliated Seller prior to such related Due Period. MORTGAGE LOAN SCHEDULE: The initial schedule of Initial Mortgage Loans as of the Initial Cut-Off Date as attached hereto as Schedule I, which will be deemed to be modified automatically upon any replacement, sale, substitution, liquidation, transfer or addition of any Mortgage Loan, including the addition of a Subsequent Mortgage Loan, pursuant to the terms hereof. The initial Mortgage Loan Schedule sets forth as to each Initial Mortgage Loan, and any subsequent Mortgage Loan Schedule provided in connection with the Subsequent Mortgage Loans will set forth as to each Subsequent Mortgage Loan: (i) its identifying number and the name of the related Mortgagor; (ii) the billing address for the related Mortgaged Property including the state and zip code; (iii) its date of origination; (iv) the original number of months to stated maturity; (v) the original stated maturity; (vi) the original Principal Balance; (vii) the Principal Balance as of its Cut-Off Date; (viii) the Mortgage Interest Rate; and (ix) the scheduled monthly payment of principal and interest. 21 MORTGAGE NOTE: The original, executed note or other evidence of indebtedness evidencing the indebtedness of a Mortgagor under a Mortgage Loan. MORTGAGED PROPERTY: The underlying property or properties securing a Mortgage Loan, consisting of a fee simple interest in such real property. MORTGAGOR: The obligor on a Mortgage Note. NET AVAILABLE AMOUNT: With respect to any Distribution Date, the Available Amount, less the sum of the Servicing Fee, the Back-up Servicing Fee, the Trustee Fee, the Class I Distribution Amount and the Premium Amount due on such Distribution Date and any applicable expenses due on such Distribution Date. NET FORECLOSURE PROFITS: As to any Servicer Remittance Date, the excess, if any, of (i) the aggregate Foreclosure Profits with respect to such Servicer Remittance Date over (ii) Liquidated Loan Losses with respect to such Servicer Remittance Date. NET LIQUIDATION PROCEEDS: As to any Liquidated Mortgage Loan, Liquidation Proceeds net of Liquidation Expenses and net of any unreimbursed Periodic Advances made by the Servicer out of its own funds. For all purposes of this Agreement, Net Liquidation Proceeds shall be allocated first to accrued and unpaid interest on the related Mortgage Loan and then to the unpaid principal balance thereof. NET REO PROCEEDS: As to any REO Mortgage Loan, REO Proceeds net of any related expenses of the Servicer. NET WAC CAP: As of any Distribution Date, a per annum rate equal to: (a) in the case of the Class A Certificates, (i) the Net Weighted Average Mortgage Interest Rate less (ii) a per annum rate equal to the product of (A) 4.00% per annum and (B) a per annum rate equal to a fraction, the numerator of which is the Class A-IO Notional Balance for that Distribution Date and the denominator of which is the sum of (x) the Aggregate Principal Balance of the Mortgage Loans as of the beginning of the related Due Period and (y) the Pre-Funding Amount, if any, immediately prior to such Distribution Date (net of the Pre-Funding Earnings); and (b) in the case of the Class M Certificates, (i) the sum of (A) the Net Weighted Average Mortgage Interest Rate and (B) any Hedge Payment and any Hedge Termination Payment for such Distribution Date (converted to a per annum rate based upon the Certificate Principal Balance of the Class M Certificates) less (ii) a per annum rate equal to the sum of (1) the Premium Percentage, (2) the Class I Distribution Amount (converted to a per annum rate based upon the Certificate Principal Balance of the Class M Certificates) and (3) the product of (A) 4.00% per annum and (B) a per annum rate equal to a fraction, the numerator of which is the Class A-IO Notional Balance for that Distribution Date and the denominator of which is the sum of (x) the Aggregate Principal Balance of the Mortgage Loans as of the beginning of the related Due Period and (y) the Pre-Funding Amount, if any, immediately prior to such Distribution Date (net of the Pre-Funding Earnings). 22 NET WAC CAP CARRYOVER AMOUNT: With respect to each Class of the Capped Certificates and any Distribution Date, the sum of (a) the excess, if any, of the Class Monthly Interest for such Class, calculated at the applicable Pass-Through Rate without regard to the Net WAC Cap, over the Class Monthly Interest for such Class for the applicable Distribution Date, (b) any Net WAC Cap Carryover Amount remaining unpaid from prior Distribution Dates, and (c) one month's interest on the amount in clause (b) calculated at the applicable Pass-Through Rate without regard to the Net WAC Cap. NET WAC CAP CARRYOVER FUND: The Eligible Account established and maintained in accordance with Section 6.10(a). NET WAC CAP CARRYOVER RIGHT: The right of the Holders of the Capped Certificates to receive Net WAC Cap Carryover Amounts in accordance with Section 6.10(b). NET WEIGHTED AVERAGE MORTGAGE INTEREST RATE: With respect to any Due Period, the weighted average Mortgage Interest Rates (weighted by Principal Balances) of the Mortgage Loans, calculated at the opening of business on the first day of such Due Period, less the rate at which the Servicing Fee is then calculated, less the rate at which the Back-up Servicing Fee is then calculated, less the rate at which the Trustee Fee is then calculated. NONRECOVERABLE ADVANCES: With respect to any Mortgage Loan, (a) any Periodic Advance previously made and not reimbursed from late collections pursuant to Section 5.03, or (b) a Periodic Advance proposed to be made in respect of a Mortgage Loan or REO Property either of which, in the good faith business judgment of the Servicer, as evidenced by an Officer's Certificate delivered to the Certificate Insurer and the Trustee no later than the Business Day following such determination, would not ultimately be recoverable pursuant to Sections 5.03. OC FLOOR: 0.50% of the Maximum Pool Principal Balance. OFFERED CERTIFICATES: The Senior Certificates and the Subordinate Certificates. OFFICER'S CERTIFICATE: A certificate signed by the Chairman of the Board, the President or a Vice President, the Treasurer, the Secretary or one of the Assistant Treasurers or Assistant Secretaries of the Unaffiliated Seller and/or the Servicer, or the Depositor, as required by this Agreement. OPINION OF COUNSEL: A written opinion of counsel, who may, without limitation, be counsel for the Unaffiliated Seller, the Servicer, the Trustee, a Certificateholder or a Certificateholder's prospective transferee or the Certificate Insurer (including except as otherwise provided herein, in-house counsel) reasonably acceptable to each addressee of such opinion and experienced in matters relating to the subject of such opinion; except that any opinion of counsel relating to (a) the qualification of any of the REMICs described in Section 2.07 hereof as a REMIC or (b) compliance with the REMIC Provisions must be an opinion of counsel who (i) is in fact independent of the Unaffiliated Seller, the Servicer and the Trustee, (ii) does not have any direct financial interest or any material indirect financial interest in the Unaffiliated Seller or the Servicer or the Trustee or in an Affiliate thereof, (iii) is not connected with the Unaffiliated Seller or the Servicer or the Trustee as an officer, employee, director or person performing similar functions and (iv) is reasonably acceptable to the Certificate Insurer. 23 ORIGINAL AGGREGATE PRINCIPAL BALANCE: The Aggregate Principal Balance of the Mortgage Loan Pool on the Closing Date, calculated as of the Initial Cut-Off Date, which amount is equal to $450,000,068.12. ORIGINAL CERTIFICATE PRINCIPAL BALANCE: As of the Startup Day and with respect to each Class of Certificates, the amount set forth below: Original Certificate Class Principal Balance ------------- --------------------------- A $387,000,000 M $63,000,000 The Class A-IO, Class X, Class I and Class R Certificates do not have an Original Certificate Principal Balance. ORIGINAL PRE-FUNDED AMOUNT: $0. ORIGINATORS: American Business Credit, Inc., HomeAmerican Credit, Inc., d/b/a Upland Mortgage and American Business Mortgage Services, Inc. Overcollateralization Deficit: With respect to any Distribution Date, the amount, if any, by which (i) the aggregate Certificate Principal Balance of the Offered Certificates as of such Distribution Date (after taking into account the distribution of the Principal Distribution Amount on such Distribution Date, except for any portion thereof in respect of the Overcollateralization Deficit) exceeds (ii) the Current Pool Principal Balance for such Distribution Date. OVERCOLLATERALIZATION INCREASE AMOUNT: With respect to any Distribution Date, the lesser of (x) the Excess Interest for such Distribution Date and (y) the Specified Overcollateralization Amount for such Distribution Date, minus the Overcollateralized Amount immediately prior to such Distribution Date. OVERCOLLATERALIZATION REDUCTION AMOUNT: With respect to any Distribution Date, an amount equal to the lesser of (a) the Excess Overcollateralized Amount for such Distribution Date and (b) the Principal Distribution Amount for such Distribution Date (without regard to clause (b)(10) of the definition of Principal Distribution Amount). 24 OVERCOLLATERALIZED AMOUNT: With respect to any Distribution Date, the excess, if any, of (a) the Current Pool Principal Balance for that Distribution Date, over (b) the aggregate Certificate Principal Balance of the Offered Certificates as of such Distribution Date (after taking into account the distribution of the Principal Distribution Amount on such Distribution Date, except for any portion thereof related to any Overcollateralization Increase Amount). OVERFUNDED INTEREST AMOUNT: With respect to each Subsequent Transfer Date, if any, occurring in the first calendar month of the Pre-Funding Period, if any, the excess, if any, of (i) the amount on deposit in the Capitalized Interest Account, over (ii) three-months' interest calculated at the Adjusted Pass-Through Rate on the Pre-Funding Amount (net of any Pre-Funding Earnings) immediately following such Subsequent Transfer Date (disregarding any amount applied from the Pre-Funding Account to a Subsequent Mortgage Loan that does not have a Due Date in such month). With respect to each Subsequent Transfer Date, if any, occurring in the second calendar month of the Pre-Funding Period, if any, the excess of (i) the amount on deposit in the Capitalized Interest Account, over (ii) two-month's interest calculated at the Adjusted Pass-Through Rate on the Pre-Funding Amount (net of any Pre-Funding Earnings) immediately following such Subsequent Transfer Date (disregarding any amount applied from the Pre-Funding Account to a Subsequent Mortgage Loan that does not have a Due Date in such month). With respect to each Subsequent Transfer Date, if any, occurring in the third calendar month of the Pre-Funding Period, if any, the excess of (i) the amount on deposit in the Capitalized Interest Account, over (ii) one-month's interest calculated at the Adjusted Pass-Through Rate on the Pre-Funding Amount (net of any Pre-Funding Earnings) immediately following such Subsequent Transfer Date (disregarding any amount applied from the Pre-Funding Account to a Subsequent Mortgage Loan that does not have a Due Date in such month). OWNER-OCCUPIED MORTGAGED PROPERTY: A Residential Dwelling as to which (a) the related Mortgagor represented an intent to occupy as such Mortgagor's primary, secondary or vacation residence at the origination of the Mortgage Loan, and (b) the Unaffiliated Seller has no actual knowledge that such Residential Dwelling is not so occupied. OWNERSHIP INTEREST: As to any Certificate, any ownership or security interest in such Certificate, including any interest in such Certificate as the Holder thereof and any other interest therein, whether direct or indirect, legal or beneficial, as owner or as pledgee. PASS-THROUGH RATE: The Class A, Class A-IO and Class M Pass-Through Rate and, for the purposes of Section 2.07, the pass-through rate for any class of interests referenced in Section 2.07. PAYING AGENT: As defined in Section 6.05(a) hereof. PERCENTAGE INTEREST: With respect to any Offered Certificate, other than a Class A-IO Certificate, the portion evidenced by such Certificate, expressed as a percentage rounded to four decimal places, equal to a fraction the numerator of which is the denomination represented by such Certificate and the denominator of which is the Original Certificate Principal Balance of such Class. With respect to a Class A-IO, Class X, Class I or Class R Certificate, the portion evidenced thereby as stated on the face of such Certificate. 25 PERIODIC ADVANCE: The aggregate of the advances required to be made by the Servicer on any Servicer Remittance Date pursuant to Section 5.18 hereof, the amount of any such advances being equal to the sum of: (a) with respect to each Mortgage Loan that was Delinquent as of the close of business on the last day of the Due Period preceding the related Servicer Remittance Date, the product of (i) the Principal Balance of such Mortgage Loan and (ii) one-twelfth of the Mortgage Interest Rate for such Mortgage Loan net of the Servicing Fee; and (b) with respect to each REO Property which was acquired during or prior to the related Due Period and as to which an REO Disposition did not occur during the related Due Period, an amount equal to the excess, if any, of (i) interest on the Principal Balance of such REO Mortgage Loan at the Mortgage Interest Rate for such REO Mortgage Loan net of the Servicing Fee, for the most recently ended Due Period over (ii) the net income from the REO Property transferred to the Distribution Account for such Distribution Date; provided, however, that in each such case such advance has not been determined by the Servicer to be a Nonrecoverable Advance. PERMITTED INVESTMENTS: As used herein, Permitted Investments shall include the following: (i) obligations of, or guaranteed as to principal and interest by, the United States or any agency or instrumentality thereof when such obligations are backed by the full faith and credit of the United States; (ii) repurchase agreements on obligations specified in clause (i) maturing not more than three months from the date of acquisition thereof, provided that the unsecured obligations of the party agreeing to repurchase such obligations are at the time rated in one of the two highest rating categories by the Rating Agencies; (iii) certificates of deposit, time deposits and bankers' acceptances (which, in the case of bankers' acceptances, shall in no event have an original maturity of more than 365 days) of any U.S. depository institution or trust company, incorporated under the laws of the United States or any state; provided, that the debt obligations of such depository institution or trust company at the date of acquisition thereof have been rated in one of the two highest rating categories by the Rating Agencies; (iv) commercial paper (having original maturities of not more than 270 days) of any corporation incorporated under the laws of the United States or any state thereof which on the date of acquisition has been rated in the highest short-term rating category by the Rating Agencies; 26 (v) the JPMorgan Funds U.S. Government Money Market Fund, the JPMorgan Prime Money Market Fund and the JPMorgan Treasury Plus Fund, so long as any such fund is rated in the highest rating category by Moody's or S&P; provided, that each such Permitted Investment shall be a "permitted investment" within the meaning of Section 860G(a)(5) of the Code and that no instrument described hereunder shall evidence either the right to receive (x) only interest with respect to the obligations underlying such instrument or (y) both principal and interest payments derived from obligations underlying such instrument and the interest and principal payments with respect to such instrument provided a yield to maturity at par greater than 120% of the yield to maturity at par of the underlying obligations; provided, further, that no instrument described hereunder may: (x) be purchased at a price greater than par if such instrument may be prepaid or called at a price less than its purchase price prior to stated maturity; or (y) provide any voting right or substantially equivalent interest in the producer of such investment, whether directly or indirectly, through conversion or any other manner or method. or be disposed of prior to its maturity. PERMITTED TRANSFEREE: Any Person other than (a) the United States, any State or political subdivision thereof, or any agency or instrumentality of any of the foregoing, (b) a foreign government, international organization or any agency or instrumentality of either of the foregoing, (c) an organization (except certain farmers' cooperatives described in Section 521 of the Code) which is exempt from tax imposed by Chapter 1 of the Code (including the tax imposed by Section 511 of the Code on unrelated business taxable income) on any excess inclusions (as defined in Section 860E(c)(1) of the Code) with respect to any Class R Certificate, (d) rural electric and telephone cooperatives described in Section 1381(a)(2)(C) of the Code, (e) an "electing large partnership" within the meaning Section 775 of the Code and (f) any other Person so designated by the Trustee based upon an Opinion of Counsel to the Trustee and the Certificate Insurer that the transfer of an Ownership Interest in a Class R Certificate to such Person may cause either (i) any of the REMICs described in Section 2.07 hereof to fail to qualify as a REMIC at any time that the Offered Certificates or Class X Certificates are outstanding or (ii) the Trust Fund or any Person having an Ownership Interest in any Class of Certificates, other than such Person, to incur a liability for any federal tax imposed under the Code that would not otherwise be imposed but for the Transfer of an Ownership Interest in a Class R Certificate to such Person. The terms "United States," "State" and "international organization" shall have the meanings set forth in Section 7701 of the Code or successor provisions. A corporation will not be treated as an instrumentality of the United States or of any State or political subdivision thereof for these purposes if all of its activities are subject to tax and, with the exception of FHLMC, a majority of its board of directors is not selected by such governmental unit. PERSON: Any individual, corporation, partnership, joint venture, association, joint-stock company, trust, national banking association, unincorporated organization or government or any agency or political subdivision thereof. PLAN: As defined in Section 4.02(n). PRE-FUNDING ACCOUNT: The Pre-Funding Account, if any, established in accordance with Section 6.01 hereof and maintained by the Trustee. 27 PRE-FUNDING AMOUNT: With respect to any date, the amount, if any, on deposit in the Pre-Funding Account. PRE-FUNDING DISTRIBUTION DATES: Each Distribution Date occurring during the Pre-Funding Period, if any, and the Distribution Date immediately following the end of the Pre-Funding Period, if any. PRE-FUNDING EARNINGS: The actual investment earnings realized on amounts deposited in the Pre-Funding Account, if any. PRE-FUNDING PERIOD: If the Original Pre-Funded Amount is greater than zero, the period commencing on the Startup Day and ending on the earliest to occur of (i) the date on which the Pre-Funding Amount (net of any Pre-Funding Earnings) is less than $100,000, (ii) the date on which any Event of Default occurs and (iii) the close of business on May 31, 2003. PREMIUM AMOUNT: The product of the Premium Percentage and the Certificate Principal Balance of the Class M Certificates for the related Distribution Date. PREMIUM PERCENTAGE: Has the meaning given in the Insurance and Indemnity Agreement. PREPAYMENT ASSUMPTION: A constant prepayment rate of 23% HEP for the Offered Certificates and Class X Certificates used solely for determining the accrual of original issue discount and market discount on the Certificates for federal income tax purposes. PREPAYMENT INTEREST SHORTFALL: With respect to any Distribution Date, for each Mortgage Loan that was the subject during the related Due Period of a Principal Prepayment in full, an amount equal to the excess, if any, of (a) 30 days' interest on the Principal Balance, prior to giving effect to a principal distribution for the related Due Period, of such Mortgage Loan at a per annum rate equal to (i) the Mortgage Interest Rate (or at such lower rate as may be in effect for such Mortgage Loan pursuant to application of the Civil Relief Act, any Deficient Valuation and/or any Debt Service Reduction) minus (ii) the rate at which the Servicing Fee is calculated over (b) the amount of interest actually remitted by the Mortgagor in connection with such Principal Prepayment less the Servicing Fee for such Mortgage Loan in such month. PRINCIPAL BALANCE: As to any Mortgage Loan and any date of determination, the outstanding principal balance of such Mortgage Loan as of such date of determination after giving effect to Principal Prepayments received prior to the end of the related Due Period and Deficient Valuations incurred prior to the related Due Date. The Principal Balance of a Mortgage Loan which becomes a Liquidated Mortgage Loan on or prior to the related Due Date shall be zero (except for purposes of calculating the Loan Repurchase Price of such Mortgage Loan). 28 PRINCIPAL DISTRIBUTION AMOUNT: With respect to any Distribution Date, will be the lesser of: (a) the excess of (x) the sum, as of such Distribution Date, of (1) the Net Available Amount and (2) any Class M Insured Payment (to be applied to the Class M Principal Distribution Amount only) over (y) the Interest Distribution Amount for such Distribution Date; and (b) the sum, without duplication, of: (1) all principal in respect of the Mortgage Loans actually collected during the related Due Period; (2) the Principal Balance of each Mortgage Loan that either was repurchased by the Unaffiliated Seller or purchased by the Servicer on the related Servicer Remittance Date, to the extent such Principal Balance is actually received by the Trustee; (3) any Substitution Adjustments delivered by the Unaffiliated Seller on the related Servicer Remittance Date in connection with a substitution of a Mortgage Loan, to the extent such Substitution Adjustments are actually received by the Trustee; (4) the Net Liquidation Proceeds actually collected by the Servicer on all Mortgage Loans during the related Due Period (to the extent such Net Liquidation Proceeds relate to principal); (5) on the Pre-Funding Distribution Dates, if any, moneys released from the Pre-Funding Account pursuant to Section 6.01(g); (6) the proceeds received by the Trustee upon the exercise by the Servicer of its option to repurchase the Mortgage Loans on or after the Clean-up Call Date (to the extent that such proceeds relate to principal); (7) the amount of any Overcollateralization Deficit for such Distribution Date; (8) the proceeds received by the Trustee on any termination of the Trust (to the extent such proceeds relate to principal); (9) the amount of any Overcollateralization Increase Amount for such Distribution Date, to the extent of any Excess Interest available for such purpose; and (10) if the Certificate Insurer so elects in its sole discretion, an amount of principal (including Liquidated Loan Losses) that would have been distributed pursuant to clauses (1) through (9) above if sufficient funds were available therefore; minus 29 (11) the amount of any Overcollateralization Reduction Amount for such Distribution Date. PRINCIPAL PREPAYMENT: Any payment of principal made by the Mortgagor on a Mortgage Loan which is received in advance of its scheduled Due Date. PROSPECTUS SUPPLEMENT: The Prospectus Supplement dated March 26, 2003 relating to the Offered Certificates filed with the Commission in connection with the Registration Statement heretofore filed or to be filed with the Commission pursuant to Rule 424(b)(2) or 424(b)(5). QUALIFIED APPRAISER: An appraiser, duly appointed by the Unaffiliated Seller, who had no interest, direct or indirect, in the Mortgaged Property or in any loan made on the security thereof, and whose compensation is not affected by the approval or disapproval of the Mortgage Loan, and such appraiser and the appraisal made by such appraiser both satisfy the requirements of Title XI of the Federal Institutions Reform, Recovery and Enforcement Act of 1989 and the regulations promulgated thereunder, all as in effect on the date the Mortgage Loan was originated. QUALIFIED MORTGAGE: "Qualified Mortgage" shall have the meaning set forth from time to time in the definition thereof at Section 860G(a)(3) of the Code (or any successor statute thereto). QUALIFIED SUBSTITUTE MORTGAGE LOAN: A mortgage loan or mortgage loans substituted for a Deleted Mortgage Loan pursuant to Section 2.06(c) or 3.03 hereof, which (a) has or have an interest rate at least equal to that applicable to the Deleted Mortgage Loan, (b) relates or relate to a detached one-family residence or to the same type of Residential Dwelling or Business Purpose Property, or any combination thereof, as the Deleted Mortgage Loan and in each case has or have the same or a better lien priority as the Deleted Mortgage Loan and has the same occupancy status or is an Owner Occupied Mortgaged Property, (c) matures or mature no later than (and not more than one year earlier than) the Deleted Mortgage Loan, (d) has or have a Loan-to-Value Ratio at the time of such substitution no higher than the Loan-to-Value Ratio of the Deleted Mortgage Loan, (e) has or have a Combined Loan-to-Value Ratio or Combined Loan-to-Value Ratios at the time of such substitution no higher than the Combined Loan-to-Value Ratio of the Deleted Mortgage Loan, (f) has or have a Principal Balance or Principal Balances (after application of all payments received on or prior to the date of substitution) not substantially less and not more than the Principal Balance of the Deleted Mortgage Loan as of such date, (g) satisfies or satisfy the criteria set forth from time to time in the definition of "qualified replacement mortgage" at Section 860G(a)(4) of the Code (or any successor statute thereto), and (h) complies or comply as of the date of substitution with each representation and warranty set forth in Sections 3.01, 3.02 and 3.03 of the Unaffiliated Seller's Agreement. RATING AGENCY: S&P, Moody's or Fitch. 30 RATING AGENCY CONDITION: With respect to any action, written confirmation from the Rating Agencies that such action will not result in the withdrawal, downgrade or qualification of the then-current rating (including, in the case of the Class M Certificates, the rating of such Certificates without giving effect to the Certificate Insurance Policy) of any of the Offered Certificates. RECORD DATE: With respect to (i) the first Distribution Date, for all of the Offered Certificates, the Closing Date and (ii) thereafter, with respect to (x) the Class A Certificates and Class A-IO Certificates, the last Business Day of the calendar month immediately preceding the month in which a Distribution Date occurs and (y) the Class M Certificates, the Business Day preceding the applicable Distribution Date. REFERENCE BANKS: Citibank, Barclay's Bank PLC, The Bank of Tokyo-Mitsubishi and National Westminster Bank PLC; provided, that if any of the foregoing banks are not suitable to serve as a Reference Bank, then any leading banks which are engaged in transactions in Eurodollar deposits in the international Eurocurrency market whose quotations appear on the Telerate Page 3750 on the relevant LIBOR Determination Date. REGULAR INTEREST: As defined in Section 2.07 herein. REIMBURSEMENT AMOUNT: As of any Distribution Date, the sum of (a)(i) all Class M Insured Payments paid by the Certificate Insurer pursuant to the Certificate Insurance Policy but for which the Certificate Insurer has not been reimbursed prior to such Distribution Date pursuant to Sections 6.05(a) hereof plus (ii) interest accrued thereon, calculated at the Late Payment Rate from the date the Trustee (or other party entitled thereto, in case of a Class M Preference Amount) received the related Class M Insured Payments or the date such Class M Insured Payments were made and (b)(i) any other amounts then due and owing to the Certificate Insurer hereunder and under the Insurance and Indemnity Agreement but for which the Certificate Insurer has not been reimbursed prior to such Distribution Date, as certified to the Trustee by the Certificate Insurer plus (ii) interest on such amounts at the Late Payment Rate. The Certificate Insurer shall notify the Trustee, the Servicer and the Depositor of the amount of any Reimbursement Amount. REMIC: A "real estate mortgage investment conduit" within the meaning of Section 860D of the Code. REMIC I: As described in Section 2.07 herein. REMIC I REGULAR INTERESTS: As described in Section 2.07 herein. REMIC II: As described in Section 2.07 herein. REMIC II NET WAC CAP: As described in Section 2.07 herein. REMIC II REGULAR INTERESTS: As described in Section 2.07 herein. REMIC III: As described in Section 2.07 herein. 31 REMIC III NET WAC CAP: As described in Section 2.07 herein. REMIC III REGULAR INTERESTS: As described in Section 2.07 herein. REMIC PROVISIONS: Provisions of the federal income tax law relating to real estate mortgage investment conduits, which appear at Sections 860A through 860G of Subchapter M of Chapter 1 of the Code, and related provisions, and temporary and final regulations promulgated thereunder and published rulings, notices and announcements, as the foregoing may be in effect from time to time. REMIC TRUST: The segregated pool of assets consisting of the Trust Fund; provided, however, that the Pre-Funding Account, if any, the Capitalized Interest Account, if any, the Net WAC Cap Carryover Fund and the Interest Rate Hedge Payment Fund shall not be part of the REMIC Trust. REO DISPOSITION: The final sale by the Servicer of a Mortgaged Property acquired by the Servicer in foreclosure or by deed-in-lieu of foreclosure. REO MORTGAGE LOAN: Any Mortgage Loan which is not a Liquidated Mortgage Loan and as to which the indebtedness evidenced by the related Mortgage Note is discharged and the related Mortgaged Property is held as part of the Trust Fund. REO PROCEEDS: Proceeds received in respect of any REO Mortgage Loan (including, without limitation, proceeds from the rental of the related Mortgaged Property). REO PROPERTY: A Mortgaged Property acquired by the Servicer in the name of the Trustee on behalf of the Certificateholders through foreclosure or deed-in-lieu of foreclosure following a default on the related Mortgage Loan. REPRESENTATION LETTER: Letters to, or agreements with, the Depository to effectuate a book entry system with respect to the Offered Certificates registered in the Certificate Register under the nominee name of the Depository. REPRESENTATIVE: Bear Stearns & Co. Inc., as the representative underwriter for the Underwriters listed on Schedule A to the Underwriting Agreement. REQUEST FOR RELEASE: A request for release in substantially the form attached as Exhibit K hereto. REQUIRED INFORMATION: With respect to each Mortgage Loan and any date of determination: (a) the name and address of the obligor; (b) the aggregate Principal Balance of the Mortgage Loan as of the end of the immediately preceding Due Period; (c) the maturity date; and (d) the Mortgage Interest Rate as of the end of the immediately preceding Due Period; provided, that the Servicer's obligation to furnish any portion of the Required Information to any Person shall not require the Servicer to fail to observe any applicable law prohibiting disclosure of information regarding the obligors. 32 RESERVE INTEREST RATE: The rate per annum that the Trustee determines to be either: (a) the arithmetic mean (rounded upwards if necessary to the nearest whole multiple of 1/16%) of the one-month U.S. dollar lending rates which New York City banks selected by the Trustee are quoting on the relevant LIBOR Determination Date to the principal London offices of leading banks in the London interbank market; or (b) in the event that the Trustee can determine no such arithmetic mean as described in clause (a), the lowest one-month U.S. dollar lending rate which New York City banks selected by the Trustee are quoting on such LIBOR Determination Date to leading European banks. RESIDENTIAL DWELLING: A one- to four-family dwelling, a unit in a planned unit development, a unit in a condominium development, a townhouse or a manufactured housing unit which is non-mobile. RESPONSIBLE OFFICER: When used with respect to the Trustee, the Collateral Agent and the Back-up Servicer, any officer assigned to the Corporate Trust Division (or any successor thereto), including any Vice President, Assistant Vice President, Trust Officer, any Assistant Secretary or any other officer of the Trustee customarily performing functions similar to those performed by any of the above designated officers and to whom, with respect to a particular matter, such matter is referred because of such officer's knowledge of and familiarity with the particular subject in each case having direct responsibility for the administration of this Agreement. When used with respect to the Unaffiliated Seller or the Servicer, the President or any Vice President, Assistant Vice President, or any Secretary or Assistant Secretary. RETAINED INTEREST: An interest in a pool of promissory notes, mortgage loans, or other financial assets which entitles the holder to receive excess cash flows derived from such assets after payments to senior holders of direct or indirect beneficial or other interests in such assets as well as expenses and other payments accorded priority in right or payment to such residual interest. ROLLING THREE MONTH DELINQUENCY RATE: For any Distribution Date, the percentage, equal to the average of the Delinquency Ratio for each of the three (1 or 2 in the case of the first three Distribution Dates, as the case may be) immediately preceding Due Periods. S&P: Standard & Poor's, a division of The McGraw-Hill Companies, Inc. or any successor thereto and if such corporation no longer for any reason performs the services of a securities rating agency, "S&P" shall be deemed to refer to any other nationally recognized statistical rating organization designated by the Certificate Insurer. SENIOR CERTIFICATES: The Class A and Class A-IO Certificates. SENIOR ENHANCEMENT PERCENTAGE: With respect to any Distribution Date, the percentage obtained by dividing (x) the sum of (i) the aggregate Certificate Principal Balance of the Subordinate Certificates and (ii) the Overcollateralized Amount (in each case after taking into account the distributions of the Principal Distribution Amount) by (y) the Current Pool Principal Balance for that Distribution Date. 33 SEPARATION EVENT: The occurrence of a Certificate Insurer Default. SERVICER: American Business Credit, Inc., a Pennsylvania corporation, or any successor appointed as herein provided. SERVICER REMITTANCE AMOUNT: With respect to any Servicer Remittance Date, an amount equal to the sum of (i) all collections of principal and interest on the Mortgage Loans (including Principal Prepayments, Net REO Proceeds and Net Liquidation Proceeds, if any) collected by the Servicer during the related Due Period, (ii) all Periodic Advances made by the Servicer with respect to interest payments due to be received on the Mortgage Loans on the related Due Date and (iii) any other amounts required to be placed in the Collection Account by the Servicer pursuant to this Agreement (including Insurance Proceeds), but excluding the following: (a) amounts received on particular Mortgage Loans as late payments of interest and respecting which the Servicer has previously made an unreimbursed Periodic Advance out of its own funds; (b) those portions of each payment of interest on a particular Mortgage Loan which represent the Servicing Fee; (c) that portion of Liquidation Proceeds and REO Proceeds to the extent of any unpaid Servicing Fee; (d) all income from Permitted Investments that is held in the Collection Account for the account of the Servicer; (e) all amounts in respect of late fees, assumption fees, prepayment fees and similar fees; (f) certain other amounts which are reimbursable to the Servicer, as provided in this Pooling and Servicing Agreement; and (g) Net Foreclosure Profits. SERVICER REMITTANCE DATE: With respect to any Distribution Date, the 10th day of the month in which such Distribution Date occurs, or if such 10th day is not a Business Day, the Business Day preceding such 10th day. SERVICER REMITTANCE REPORT: As defined in Section 6.07 hereof. 34 SERVICER TERMINATION LOSS TRIGGER EVENT: With respect to any Distribution Date, the event that occurs if the Cumulative Loss Percentage for such Distribution Date exceeds the following percentages with respect to the applicable Distribution Date specified below:
Distribution Date Loss Percentage - ---------------------------- -------------------------------------------------- January 2006 - December 2006 4.00% for the first month, plus an additional 1/12 of 1.75% for each month thereafter January 2007 - December 2007 5.75% for the first month, plus an additional 1/12 of 1.50% for each month thereafter January 2008 - December 2008 7.25% for the first month, plus an additional 1/12 of 1.00% for each month thereafter January 2009 - December 2009 8.25% for the first month, plus an additional 1/12 of 0.25% for each month thereafter January 2010 and thereafter 8.50%
SERVICING ADVANCES: All reasonable and customary "out-of-pocket" costs and expenses (including legal fees) incurred in the performance by the Servicer of its servicing obligations, including, but not limited to, the cost and expenses relating to (a) the preservation, restoration, inspection and protection of the Mortgaged Property, (b) any enforcement or judicial proceedings, including foreclosures, (c) the management and liquidation of the REO Property, including reasonable fees paid to any independent contractor in connection therewith, (d) compliance with the obligations under Section 5.22, all of which reasonable and customary out-of-pocket costs and expenses are reimbursable to the Servicer to the extent provided in Sections 5.03 and 5.22. SERVICING COMPENSATION: The Servicing Fee and other amounts to which the Servicer is entitled pursuant to Section 5.08. SERVICING FEE: As to each Mortgage Loan, the annual fee payable to the Servicer, which is calculated as an amount equal to the product of (a) 0.50% per annum, and (b) the Principal Balance thereof (or, in the case of any successor Servicer, such other amount as the Certificate Insurer and such successor may agree upon in writing; provided, however, that if the Back-up Servicer is acting as successor Servicer in no event shall the Servicing Fee be less than the amount paid to the initial Servicer hereunder). Such fee shall be calculated and payable monthly only from the amounts received in respect of interest on such Mortgage Loan and shall be computed on the basis of the same principal amount and for the period respecting which any related interest payment on a Mortgage Loan is computed. The Servicing Fee includes any servicing fees owed or payable to any Subservicer. SERVICING OFFICER: Any officer of the Servicer involved in, or responsible for, the administration and servicing of the Mortgage Loans whose name and specimen signature appear on a list of servicing officers furnished to the Trustee and the Certificateholders by the Servicer on the Closing Date, as such list may from time to time be amended. 35 SPECIAL ADVANCE: As defined in Section 5.18(b) hereof. SPECIAL RESERVE ACCOUNT: The Eligible Account established in accordance with Section 6.13 hereof and maintained by the Trustee. SPECIFIED OVERCOLLATERALIZATION AMOUNT: With respect to any Distribution Date, (i) prior to the Stepdown Date 5.50% of the Maximum Pool Principal Balance or (ii) on or after the Stepdown Date 11.00% of the Current Pool Principal Balance for that Distribution Date; provided, that the Specified Overcollateralization Amount shall never be less than the OC Floor; provided, further, that on any Distribution Date on which a Trigger Event is in effect, the Specified Overcollateralization Amount shall be equal to 100.00% of the Current Pool Principal Balance for such Distribution Date. STARTUP DAY: The day designated as such pursuant to Section 2.07(g) hereof. STEPDOWN DATE: The earlier to occur of (i) the Distribution Date on which the aggregate Certificate Principal Balance of the Class A Certificates has been reduced to zero and (ii) the later to occur of (a) the Distribution Date in April 2006 and (b) the first Distribution Date on which the Current Pool Principal Balance (after giving effect to distributions on that Distribution Date) has been reduced to less than 50% of the Maximum Pool Principal Balance. SUBORDINATE CERTIFICATES: The Class M Certificates. SUBSERVICERS: HomeAmerican Credit, Inc., d/b/a Upland Mortgage, a Pennsylvania corporation, or its successor in interest and American Business Mortgage Services, Inc., a New Jersey corporation, or its successor in interest. SUBSEQUENT CUT-OFF DATE: With respect to any Subsequent Mortgage Loan, the date specified in the Addition Notice delivered in connection therewith, which date shall be the close of business on the last day of the month immediately preceding the month in which such Subsequent Mortgage Loan will be conveyed to the Trust or, if such Subsequent Mortgage Loan was originated, or otherwise required by an Originator after such day, the date of origination or acquisition of such Mortgage Loan. SUBSEQUENT MORTGAGE LOANS: The Mortgage Loans, if any, transferred and assigned to the Trust pursuant to Section 2.03 hereof. SUBSEQUENT TRANSFER: The transfer and assignment by the Depositor to the Trust of any Subsequent Mortgage Loans pursuant to the terms hereof. SUBSEQUENT TRANSFER DATE: The Business Day, if any, on which a Subsequent Transfer occurs. SUBSERVICING AGREEMENT: The agreement between the Servicer and the Subservicers relating to subservicing and/or administration of certain Mortgage Loans as provided in Section 5.13, a copy of which shall be delivered, along with any modifications thereto, to the Trustee and the Certificate Insurer. 36 SUBSTITUTION ADJUSTMENT: As to any date on which a substitution occurs pursuant to Sections 2.06 or 3.03 hereof, the amount (if any) by which the aggregate unpaid principal balance (after application of principal payments received on or before the date of substitution) of any Qualified Substitute Mortgage Loans as of the date of substitution, are less than the aggregate of the Principal Balances of the related Deleted Mortgage Loans together with 30 days' interest thereon at the Mortgage Interest Rate. SUPPLEMENTAL INTEREST TRUST: The trust established in accordance with Section 6.10(a) to hold (x) the Net WAC Cap Carryover Fund and the Interest Rate Hedge Payment Fund and (y) the Interest Rate Hedge Agreement. The Supplemental Interest Trust will not be an asset of any REMIC. TAX MATTERS PERSON: The Person or Persons appointed pursuant to Section 11.13 from time to time to act as the "tax matters person" (within the meaning of the REMIC Provisions) for each of the REMICs created hereunder. TAX RETURN: The federal income tax return on Internal Revenue Service Form 1066, "U.S. Real Estate Mortgage Investment Conduit (REMIC) Income Tax Return," including Schedule Q thereto, Quarterly Notice to Residual Interest Holders of REMIC Taxable Income or Net Loss Allocation, or any successor forms, to be filed on behalf of each REMIC created hereunder due to its classification as a REMIC under the REMIC Provisions, together with any and all other information reports or returns that may be required to be furnished to the Certificateholders or filed with the Internal Revenue Service or any other governmental taxing authority under any applicable provision of federal, state or local tax laws. Telerate Page 3750: The display designated as page 3750 on the Telerate Service (or such other page as may replace the page 3750 on that service for the purpose of displaying London interbank offered rates of major banks). TRANSFER: Any direct or indirect transfer, sale, pledge, hypothecation or other form of assignment of any Ownership Interest in a Certificate. TRANSFER AFFIDAVIT AND AGREEMENT: As defined in Section 4.02(l)(ii). TRANSFEREE: Any Person who is acquiring by Transfer any Ownership Interest in a Certificate. TRANSFEROR: Any Person who is disposing by Transfer any Ownership Interest in a Certificate. TRIGGER EVENT: Either a Delinquency Trigger Event or Cumulative Loss Trigger Event. 37 TRUST: ABFS Mortgage Loan Trust 2003-1, the express trust created hereunder in Section 2.01(a). TRUST FUND: The segregated pool of assets subject hereto, constituting the trust created hereby and to be administered hereunder, consisting of: (i) such Mortgage Loans as from time to time are subject to this Agreement, together with the Mortgage Files relating thereto, and together with all principal collected and interest due and accruing thereon after the related Cut-Off Date, and any proceeds thereof; (ii) any REO Property, together with all collections thereon and proceeds thereof; (iii) the Trustee's rights with respect to the Mortgage Loans under all insurance policies required to be maintained pursuant to this Agreement and any proceeds thereof; any other security for such Mortgage Loan, including, without limitation, pledged equipment, inventory and working capital and assignments of rights and interests made by the related mortgagor; (v) the rights and remedies of the Trustee against any Person making any representation or warranty to the Trustee hereunder, to the extent provided herein; (vi) all rights of the Depositor under the Unaffiliated Seller's Agreement; (vii) each Account and such assets that are deposited therein from time to time and any investments thereof, together with any and all income, proceeds and payments with respect thereto; and (viii) all proceeds of the foregoing. TRUSTEE: JPMorgan Chase Bank, a New York banking corporation, or its successor-in-interest, or any successor trustee appointed as herein provided. TRUSTEE FEE: As to any Distribution Date, the fee payable to the Trustee in respect of its services as Trustee that accrues at a monthly rate equal to one-twelfth of 0.00625% on the Principal Balance of each Mortgage Loan as of the immediately preceding Due Date. TRUSTEE'S MORTGAGE FILE: The documents delivered to the Trustee or its designated agent pursuant to Section 2.05. TRUSTEE'S REMITTANCE REPORT: As defined in Section 6.07. UNAFFILIATED SELLER: ABFS 2003-1, Inc. UNAFFILIATED SELLER'S AGREEMENT: The Unaffiliated Seller's Agreement, dated as of the date hereof, among the Unaffiliated Seller, the Originators and the Depositor relating to the sale of the Mortgage Loans from the Originators to the Unaffiliated Seller and from the Unaffiliated Seller to the Depositor. UNDERWRITERS: The Representative and Credit Suisse First Boston LLC. UNDERWRITING AGREEMENT: The Underwriting Agreement, dated as of March 27, 2003 between the Depositor and the Representative. UNITED STATES PERSON: A citizen or resident of the United States, a corporation, partnership or other entity created or organized in, or under the laws of, the United States, any state thereof or the District of Columbia, an estate whose income from sources without the United States is includible in gross income for United States federal income tax purposes regardless of its connection with the conduct of a trade or business within the United States or a trust if a court within the United States can exercise primary jurisdiction over its administration and at least one United States fiduciary has the authority to control all substantial decisions of the trust. 38 WAC EXCESS: The sum of the Net WAC Cap Carryover Amounts allocable to each of the Capped Certificates. Section 1.02 Provisions of General Application. (a) All accounting terms not specifically defined herein shall be construed in accordance with GAAP. (b) The terms defined in this Article include the plural as well as the singular. (c) The words "herein," "hereof" and "hereunder" and other words of similar import refer to this Agreement as a whole. All references to Articles and Sections shall be deemed to refer to Articles and Sections of this Agreement. (d) Any reference to statutes are to be construed as including all statutory provisions consolidating, amending or replacing the statute to which reference is made and all regulations promulgated pursuant to such statutes. (e) All calculations of interest (other than with respect to the Mortgage Loans and the Class M Certificates) provided for herein shall be made on the basis of a 360-day year consisting of twelve 30-day months. All calculations of interest with respect to the Class M Certificates shall be made on the basis of a 360-day year consisting of the actual number of days elapsed in the applicable Accrual Period. All calculations of interest with respect to any Mortgage Loan provided for herein shall be made in accordance with the terms of the related Mortgage Note and Mortgage or, if such documents do not specify the basis upon which interest accrues thereon, on the basis of a 360-day year consisting of twelve 30-day months, to the extent permitted by applicable law. (f) Any Mortgage Loan payment is deemed to be received on the date such payment is actually received by the Servicer; provided, however, that for purposes of calculating distributions on the Certificates prepayments with respect to any Mortgage Loan are deemed to be received on the date they are applied in accordance with Accepted Servicing Practices consistent with the terms of the related Mortgage Note and Mortgage to reduce the outstanding principal balance of such Mortgage Loan on which interest accrues. Section 1.03 Business Day Certificate. On the Closing Date (with respect to the calendar year 2003) and thereafter, within 15 days prior to the end of each calendar year while this Agreement remains in effect (with respect to the succeeding calendar years), the Servicer shall provide to the Trustee, the Depositor and the Certificate Insurer a certificate of a Servicing Officer specifying the days on which banking institutions in the State of Pennsylvania are authorized or obligated by law, executive order or governmental decree to be closed. 39 ARTICLE II ESTABLISHMENT OF THE TRUST SALE AND CONVEYANCE OF THE TRUST FUND Section 2.01 Establishment of the Trust(a). (a) The Depositor does hereby establish, pursuant to the further provisions of this Agreement and the laws of the State of New York, an express trust to be known, for convenience, as "ABFS Mortgage Loan Trust 2003-1" and does hereby appoint JPMorgan Chase Bank as Trustee in accordance with the provisions of this Agreement. (b) The Trust may perform the following permitted activities: (i) hold receivables transferred from the Unaffiliated Seller and other passive assets of the Trust, which assets cannot be contrary to the status of the Trust as a qualified special purpose entity under existing accounting literature, including passive derivative financial instruments that pertain to beneficial interests issued or sold to parties other than the Unaffiliated Seller, its affiliates or agents; (ii) issue the Certificates and other interests in the Trust; (iii) receive collections and make payments on such Certificates and interests in accordance with the terms of this Agreement; and (iv) engage in other activities that are necessary or incidental to accomplish these limited purposes, which activities cannot be contrary to the status of the Trust as a qualified special purpose entity under existing accounting literature. Section 2.02 Purchase and Sale of Initial Mortgage Loans. The Depositor does hereby sell, transfer, assign, set over and convey to the Trustee, on behalf of the Trust, without recourse but subject to the terms and provisions of this Agreement, all of the right, title and interest of the Depositor in and to the Initial Mortgage Loans, including the outstanding principal as of and interest due and accruing after the Initial Cut-Off Date on such Mortgage Loans, and all other assets included or to be included in the Trust Fund for the benefit of the Certificateholders and the Certificate Insurer. In connection with such transfer and assignment, and pursuant to Section 2.07 of the Unaffiliated Seller's Agreement, the Depositor does hereby also irrevocably transfer, assign, set over and otherwise convey to the Trustee, on behalf of the Trust, all of its rights under the Unaffiliated Seller's Agreement, including, without limitation, its right to exercise the remedies created by Sections 2.06 and 3.05 of the Unaffiliated Seller's Agreement for defective documentation and for breaches of representations and warranties, agreements and covenants of the Unaffiliated Seller and the Originators contained in Sections 3.01, 3.02 and 3.03 of the Unaffiliated Seller's Agreement. Section 2.03 Purchase and Sale of Subsequent Mortgage Loans. (a) Subject to the satisfaction of the conditions set forth in paragraph (b) below and provided that the Original Pre-Funded Amount is greater than zero, in consideration of the Trustee's delivery on the related Subsequent Transfer Dates, if any, upon the order of the Depositor of all or a portion of the balance of funds in the Pre-Funding Account (net of the Pre-Funding Earnings), if any, the Depositor shall on any Subsequent Transfer Date sell, transfer, assign, set over and convey to the Trustee without recourse but subject to terms and provisions of this Agreement, all of the right, title and interest of the Depositor in and to the Subsequent Mortgage Loans, including the outstanding principal of and interest due on such Subsequent Mortgage Loans, and all other assets included or to be included in the Trust Fund for the benefit of the Certificateholders and the Certificate Insurer. In connection with such transfer and assignment, and pursuant to Section 2.07 of the Unaffiliated Seller's Agreement, the Depositor does hereby also irrevocably transfer, assign, set over and otherwise convey to the Trustee, for the benefit of the Certificateholders and the Certificate Insurer, all of its rights under the Unaffiliated Seller's Agreement, including, without limitation, its right to exercise the remedies arising under Sections 2.06 and 3.05 of the Unaffiliated Seller's Agreement for defective documentation and for breaches of representations and warranties, agreements and covenants of the Unaffiliated Seller contained in Sections 3.01, 3.02 and 3.03 of the Unaffiliated Seller's Agreement. 40 The amount released from the Pre-Funding Account with respect to a transfer of Subsequent Mortgage Loans shall be one-hundred percent (100%) of the aggregate Principal Balance of the Subsequent Mortgage Loans so transferred as of the related Subsequent Cut-Off Date. (b) The Subsequent Mortgage Loans, if any, and the other property and rights related thereto described in paragraph (a) above shall be transferred by the Depositor to the Trust only upon the satisfaction of each of the following conditions on or prior to the related Subsequent Transfer Date: (i) the Unaffiliated Seller shall have provided the Trustee, the Rating Agencies and the Certificate Insurer with a timely Addition Notice, which shall include a Mortgage Loan Schedule, listing the Subsequent Mortgage Loans and shall provide any other information reasonably requested by any of the foregoing with respect to the Subsequent Mortgage Loans or required by this Agreement; (ii) the Unaffiliated Seller shall have deposited in the Collection Account all collections of (x) principal in respect of the Subsequent Mortgage Loans received after the related Subsequent Cut-Off Date and (y) interest due on the Subsequent Mortgage Loans after the related Subsequent Cut-Off Date; (iii) as of each Subsequent Transfer Date, the Depositor was not insolvent nor will be made insolvent by such transfer nor is the Depositor aware of any pending insolvency; (iv) such addition will not result in a material adverse tax consequence to the Trust or the Holders of the Certificates; (v) the Pre-Funding Period shall not have terminated; (vi) the Unaffiliated Seller shall have delivered to the Trustee and the Certificate Insurer an Officer's Certificate confirming the satisfaction of each condition precedent specified in this paragraph (b) and that the Subsequent Mortgage Loans comply with the provisions of this Section 2.03 and the terms of the Unaffiliated Seller's Agreement, including each of the representations and warranties made with respect thereto; 41 (vii) there shall have been delivered to the Certificate Insurer, the Rating Agencies and the Trustee, Independent Opinions of Counsel with respect to the transfer of the Subsequent Mortgage Loans substantially in the form of the Opinions of Counsel delivered to the Certificate Insurer and the Trustee on the Startup Day (bankruptcy, corporate and tax opinions); and (viii) the Originators, the Certificate Insurer, the Unaffiliated Seller and the Depositor shall have delivered to the Trustee an executed copy of a Subsequent Transfer Agreement, substantially in the form of Exhibit T hereto. (c) The obligation of the Trust to purchase the Subsequent Mortgage Loans on a Subsequent Transfer Date is subject to the requirements in Section 2.02 of the Unaffiliated Seller's Agreement. (d) In connection with the transfer and assignment of any Subsequent Mortgage Loans, the Depositor shall satisfy the document delivery requirements set forth in Section 2.05. (e) On each Subsequent Transfer Date, if any, upon written instruction from the Unaffiliated Seller, the Trustee shall withdraw from the Capitalized Interest Account and pay to the Unaffiliated Seller on such Subsequent Transfer Date the Overfunded Interest Amount for such Subsequent Transfer Date, as calculated by the Servicer with the cooperation of the Unaffiliated Seller and subject to the approval of the Certificate Insurer. (f) For any Subsequent Mortgage Loan that has a first Due Date that occurs later than the last day of the Due Period in which the Subsequent Mortgage Loan was sold to the Trust, on the Servicer Remittance Date following such Subsequent Transfer Date, the Servicer will deposit into the Distribution Account a Special Advance in the amount of 30 days' interest at the Mortgage Interest Rate, net of the Servicing Fee, for the month in which the Subsequent Transfer Date occurs and any month thereafter until, but not including, the month in which the first Due Date occurs. Section 2.04 Possession of Mortgage Files; Access to Mortgage Files. (a) Upon the issuance of the Certificates, the ownership of each Mortgage Note, the Mortgage and the contents of the related Mortgage File related to each Initial Mortgage Loan is vested, and on each Subsequent Transfer Date, if any, the ownership of each Mortgage Note, the Mortgage and the contents of the related Mortgage File related to each Subsequent Mortgage Loan will be vested in the Trustee for the benefit of the Certificateholders and the Certificate Insurer. (b) Pursuant to Section 2.05 of the Unaffiliated Seller's Agreement, the Depositor has delivered or caused to be delivered the Trustee's Mortgage File related to each Mortgage Loan to the Trustee. (c) The Collateral Agent, on behalf of the Trustee, will be the custodian or may, with the consent of the Certificate Insurer, enter into a custodial agreement pursuant to which the Trustee will appoint a custodian to hold the Mortgage Files in trust for the benefit of all present and future Certificateholders and the Certificate Insurer; provided, however, that the custodian so appointed shall satisfy the eligibility requirements for the Collateral Agent as described in Section 10.06 hereof, shall in no event be the Depositor or the Servicer or any Person known to a Responsible Officer of the Trustee to be an Affiliate of the Depositor or the Servicer and shall be approved by the Certificate Insurer. 42 (d) The Collateral Agent shall afford the Depositor, the Certificate Insurer, the Servicer and the Back-up Servicer reasonable access to all records and documentation regarding the Mortgage Loans relating to this Agreement, such access being afforded upon reasonable request and during normal business hours at the offices of the Collateral Agent at customary charges. Section 2.05 Delivery of Mortgage Loan Documents(a). (a) In connection with the transfer and assignment of the Mortgage Loans, the Depositor does hereby with respect to the Initial Mortgage Loans, and will, on or before each Subsequent Transfer Date, if any, with respect to Subsequent Mortgage Loans, deliver or cause to be delivered to the Collateral Agent, on behalf of the Trustee the following documents or instruments with respect to each Mortgage Loan so transferred or assigned: (i) the original Mortgage Note, endorsed without recourse in blank by the related Originator, including all intervening endorsements showing a complete chain of endorsement; (ii) the related original Mortgage with evidence of recording indicated thereon and the original recorded power of attorney or a copy thereof certified by the applicable recording office; (iii) the original recorded Assignment of Mortgage, or copy thereof certified by the applicable recording office, if any, showing a complete chain of assignment from the original mortgagee/secured party of the related Mortgage Loan to the related Originator (which assignment may, at such Originator's option, be combined with the assignment referred to in subpart (iv) hereof); (iv) an Assignment of Mortgage in recordable form (which, if acceptable for recording in the relevant jurisdiction, may be included in a blanket assignment or assignments) of each Mortgage from the related Originator to the Trustee; (v) originals of all assumption, modification and substitution agreements in those instances where the terms or provisions of a Mortgage or Mortgage Note have been modified or such Mortgage or Mortgage Note has been assumed; and (vi) an original title insurance policy (or (A) a copy of the title insurance policy, or (B) a binder thereof or copy of such binder together with a certificate from the related Originator that the original Mortgage has been delivered to the title insurance company that issued such binder for recordation). In instances where the original recorded Mortgage and any original recorded Assignment of Mortgage thereof pursuant to clause (iii) above cannot be delivered by the Depositor to the Collateral Agent on behalf of the Trustee prior to or concurrently with the execution and delivery of this Agreement (or, with respect to any Subsequent Mortgage Loans, prior to or on the Subsequent Transfer Date), due to a delay in connection with recording, the Depositor may: 43 (x) in lieu of delivering such original recorded Mortgage, deliver to the Collateral Agent on behalf of the Trustee a copy thereof provided that the related Originator certifies that the original Mortgage has been delivered to a title insurance company for recordation after receipt of its policy of title insurance or binder therefor; and (y) in lieu of delivering the original recorded Assignment of Mortgage, deliver to the Collateral Agent on behalf of the Trustee a copy of the Assignment of Mortgage certified by the related Originator. The Trustee shall promptly upon receipt thereof, with respect to each Mortgage Note described in (i) above and each Assignment of Mortgage described in (iv) above, endorse such Mortgage Note and Assignment of Mortgage as follows: "JPMorgan Chase Bank, as Trustee under the Pooling and Servicing Agreement dated as of March 1, 2003, ABFS Mortgage Loan Trust 2003-1." As promptly as practicable, but in any event within thirty (30) days from the Closing Date, or any Subsequent Transfer Date, as applicable, the related Originator shall cause to be recorded, at the related Originator's expense, in the appropriate public office for real property records, the Assignments of Mortgages to the Trustee. All original documents relating to the Mortgage Loans which are not delivered to the Trustee, as permitted by Section 2.05(a) of the Unaffiliated Seller's Agreement and this Section 2.05(a), are and shall be held by the related Originator, the Unaffiliated Seller or the Servicer in trust for the benefit of the Trustee on behalf of the Certificateholders and the Certificate Insurer. (b) Within thirty (30) days following delivery of the Mortgage Files to the Collateral Agent on behalf of the Trustee, the Collateral Agent will review each Mortgage File to ascertain that all required documents set forth in Section 2.05(a) (other than clause (v) thereof) have been executed and received, and that such documents relate to the Mortgage Loans identified on the Mortgage Loan Schedule, and in so doing the Trustee may rely on the purported due execution and genuineness of any signature thereon. If within such 30-day period (or, with respect to any Qualified Substitute Mortgage Loan, within thirty (30) days after the assignment thereof) the Collateral Agent on behalf of the Trustee finds any document constituting a part of a Mortgage File not to have been executed or received or to be unrelated to the Mortgage Loans identified in the Mortgage Loan Schedule, the Collateral Agent shall promptly notify the Certificate Insurer, the Servicer, the Back-up Servicer and the Trustee, and the Servicer shall have a period of sixty (60) days after such notice within which to correct or cure any such defect. Each original recorded Assignment of Mortgage shall be delivered to the Trustee within ten (10) days following the date on which it is returned to the Servicer by the office with which such Assignment of Mortgage was filed for recording and within ten (10) days following receipt by the Trustee, the Trustee shall review such Assignment of Mortgage to confirm the information specified above with respect to the documents constituting the Mortgage File. Upon receipt by the Trustee of the recorded assignment such recorded assignment shall become part of the Mortgage File. The Trustee shall notify the Servicer of any defect in such assignment based on such review. The Servicer shall have a period of 60 days following such notice to correct or cure such defect. In the event that the Servicer fails to record an Assignment of Mortgage as herein provided the Trustee shall, at the Servicer's expense, use reasonable efforts to prepare and, if required hereunder, file such assignments for recordation in the appropriate real property or other records and the Servicer hereby appoints the Collateral Agent, on behalf of the Trustee as its attorney-in-fact with full power and authority acting in its stead for the purpose of such preparation, execution and filing. 44 (c) It is intended that the conveyance of the Mortgage Loans and other property by the Depositor to the Trustee as provided in this Section 2.05 and Section 2.02 be, and be construed as, a sale of the Mortgage Loans and such other property by the Depositor to the Trustee for the benefit of the Certificateholders and the Certificate Insurer. It is, further, not intended that such conveyance be deemed a pledge of the Mortgage Loans or such other property by the Depositor to the Trustee to secure a debt or other obligation of the Depositor. However, in the event that the Mortgage Loans or any of such other property are held to be property of the Depositor, or if for any reason this Agreement is held or deemed to create a security interest in the Mortgage Loans or any of such other property, then it is intended that: (i) this Agreement shall also be deemed to be a security agreement within the meaning of the Uniform Commercial Code; (ii) the conveyance provided for in this Section shall be deemed to be a grant by the Depositor to the Trustee of a security interest in all of the Depositor's right, title and interest in and to the Mortgage Loans, the Trust Fund and such other property and all amounts payable to the holders of the Mortgage Loans in accordance with the terms thereof and all proceeds of the conversion, voluntary or involuntary, of the foregoing into cash, instruments, securities or other property, including, without limitation, all amounts from time to time held or invested in the Distribution Account, whether in the form of cash, instruments, securities or other property; (iii) the possession by the Trustee or its agent of the Mortgage Notes and such other items of property as constitute instruments, money, negotiable documents or chattel paper shall be deemed to be "possession by the secured party" for purposes of perfecting the security interest pursuant to the Uniform Commercial Code; and (iv) notifications to persons holding such property, and acknowledgments, receipts or confirmations from persons holding such property, shall be deemed notifications to, or acknowledgments, receipts or confirmations from financial intermediaries, bailees or agents (as applicable) of the Trustee for the purpose of perfecting such security interest under applicable law. The Depositor and the Trustee shall, to the extent consistent with this Agreement, take such actions as may be necessary to ensure that, if this Agreement were deemed to create a security interest in the Mortgage Loans, the Trust Fund or any of such other property, such security interest would be deemed to be a perfected security interest of first priority under applicable law and will be maintained as such throughout the term of this Agreement. (d) Without diminution of the requirements of Sections 2.04(c) and this Section 2.05, all original documents relating to the Mortgage Loans that are not delivered to the Trustee, are and shall be held by the Servicer in trust for the benefit of the Trustee on behalf of the Certificateholders and the Certificate Insurer. In the event that any such original document is required pursuant to the terms of this Section 2.05 to be a part of a Mortgage File, such document shall be delivered promptly to the Trustee pursuant to the Unaffiliated Seller's Agreement. In acting as custodian of any such original document, the Servicer agrees further that it does not and will not have or assert any beneficial ownership interest in the Mortgage Loans or the Mortgage Files. Promptly upon the Depositor's and the Trust's acquisition thereof and the Servicer's receipt thereof, the Servicer on behalf of the Trust shall mark conspicuously each original document not delivered to the Trustee, and the Unaffiliated Seller's master data processing records evidencing each Mortgage Loan with a legend, acceptable to the Trustee, evidencing that the Trust has purchased the Mortgage Loans and all right and title thereto and interest therein pursuant to the Unaffiliated Seller's Agreement and this Agreement. 45 (e) In connection with the execution of this Agreement, the Depositor shall deliver to the Trustee an executed copy of the Unaffiliated Seller's Agreement. Section 2.06 Acceptance by Trustee of the Trust Fund; Certain Substitutions; Certification by Collateral Agent. (a) The Trustee agrees to execute and deliver to the Depositor, the Back-up Servicer, the Servicer, the Certificate Insurer and the Unaffiliated Seller on or prior to the Closing Date an acknowledgement of receipt of the Certificate Insurance Policy, in the form attached as Exhibit R hereto, and the Collateral Agent agrees to execute and deliver to the Depositor, the Back-up Servicer, the Servicer, the Certificate Insurer and the Unaffiliated Seller, on or prior to the Closing Date or any Subsequent Transfer Date an acknowledgement of receipt of, with respect to each Mortgage Loan transferred on such date, the original Mortgage Note (with any exceptions noted), and the Trustee declares that it will hold or cause the Collateral Agent, on its behalf to hold such documents and any amendments, replacements or supplements thereto, as well as any other assets included in the definition of Trust Fund and delivered to the Trustee or the Collateral Agent on its behalf, as Trustee in trust upon and subject to the conditions set forth herein for the benefit of the Certificateholders and the Certificate Insurer. The Collateral Agent agrees, for the benefit of the Certificateholders and the Certificate Insurer, to review (or cause to be reviewed) each Trustee's Mortgage File within thirty (30) days after the Closing Date (with respect to the Initial Mortgage Loans), within thirty (30) days after receipt by the Collateral Agent, on behalf of the Trustee, thereof (with respect to Qualified Substitute Mortgage Loans) or any Subsequent Transfer Date (with respect to the Subsequent Mortgage Loans), as applicable, and to deliver to the Unaffiliated Seller, the Servicer, the Back-up Servicer, the Certificate Insurer and the Depositor a certification in the form attached hereto as Exhibit I (the "Initial Certification") certifying that, as to each Mortgage Loan listed in the related Mortgage Loan Schedule (other than any Mortgage Loan paid in full or any Mortgage Loan specifically identified in such certification as not covered by such certification), and unless otherwise noted, (i) all documents required to be delivered to it pursuant to Section 2.05 hereof (other than the items listed in clause (a)(v) thereof) are in its possession, (ii) each such document has been reviewed by it and has not been mutilated, damaged, torn or otherwise physically altered (handwritten additions, changes or corrections shall not constitute physical alteration if initialed by the Mortgagor), appears regular on its face and relates to such Mortgage Loan, and (iii) based on its examination and only as to the foregoing documents, the information set forth on the Mortgage Loan Schedule as to the information set forth in (i), (ii), (v) and (vi) of the definition of "Mortgage Loan Schedule" set forth herein accurately reflects the information set forth in the Trustee's Mortgage File delivered on such date. The Collateral Agent, on behalf of the Trustee shall be under no duty or obligation to inspect, review or examine any such documents, instruments, certificates or other papers to determine that they are genuine, enforceable, or appropriate for the represented purpose or that they are other than what they purport to be on their face. 46 (b) Within ninety (90) days of the Closing Date, with respect to the Initial Mortgage Loans, and within ninety (90) days of any Subsequent Transfer Date, with respect to the Subsequent Mortgage Loans transferred on such date, the Collateral Agent shall deliver (or cause to be delivered) to the Servicer, the Back-up Servicer, the Unaffiliated Seller, the Depositor, the Rating Agencies and the Certificate Insurer a final certification in the form attached hereto as Exhibit J (the "Final Certification") certifying that, as to each Mortgage Loan listed in the related Mortgage Loan Schedule (other than any Mortgage Loan paid in full or any Mortgage Loan specifically identified in such certification as not covered by such certification), and unless otherwise noted, (i) all documents required to be delivered to it pursuant to Section 2.05 (other than the items listed in clause (a)(v) thereof) are in its possession, (ii) each such document has been reviewed by it and has not been mutilated, damaged, torn or otherwise physically altered (handwritten additions, changes or corrections shall not constitute physical alteration if initialed by the Mortgagor), appears regular on its face and relates to such Mortgage Loan, and (iii) based on its examination and only as to the foregoing documents, the information set forth in (i), (ii), (v) and (vi) of the definition of "Mortgage Loan Schedule" set forth herein accurately reflects the information set forth in the Trustee's Mortgage File delivered on such date. (c) If the Collateral Agent on behalf of the Trustee during the process of reviewing the Trustee's Mortgage Files finds any document constituting a part of a Trustee's Mortgage File which is not executed, has not been received, is unrelated to the Mortgage Loan identified in the related Mortgage Loan Schedule, or does not conform to the requirements of Section 2.05 or the description thereof as set forth in the related Mortgage Loan Schedule, the Trustee or the Collateral Agent, as applicable, shall promptly so notify the Servicer, the Back-up Servicer, the Certificate Insurer and the Unaffiliated Seller. In performing any such review, the Collateral Agent on behalf of the Trustee may conclusively rely on the Unaffiliated Seller as to the purported genuineness of any such document and any signature thereon. It is understood that the scope of the Collateral Agent or the Trustee's review of the Mortgage Files is limited solely to confirming that the documents listed in Section 2.05 (other than those listed in clause (v) thereof) have been executed and received and relate to the Mortgage Files identified in the related Mortgage Loan Schedule. The Collateral Agent on behalf of the Trustee shall have no responsibility for determining whether any document is valid and binding, whether the text of any assignment or endorsement is in proper or recordable form, whether any document has been recorded in accordance with the requirements of any applicable jurisdiction, or whether a blanket assignment is permitted in any applicable jurisdiction. Pursuant to the Unaffiliated Seller's Agreement, the Unaffiliated Seller and the Originators have agreed to use reasonable efforts to cause to be remedied a material defect in a document constituting part of a Mortgage File of which it is so notified by the Collateral Agent or the Trustee. If, however, within sixty (60) days after the Collateral Agent or the Trustee's notice to it respecting such defect the Unaffiliated Seller has not caused to be remedied the defect and the defect materially and adversely affects the value of, or the interest of the Certificateholders in the related Mortgage Loan or the interest of the Certificate Insurer, the Unaffiliated Seller and the Originators will be obligated, pursuant to the Unaffiliated Seller's Agreement, to either (i) substitute in lieu of such Mortgage Loan a Qualified Substitute Mortgage Loan in the manner and subject to the conditions set forth in Section 3.03 or (ii) purchase such Mortgage Loan at a purchase price equal to the Principal Balance of such Mortgage Loan as of the date of purchase, plus all accrued and unpaid interest on such Principal Balance computed at the Mortgage Interest Rate, net of the Servicing Fee if the Unaffiliated Seller or an Originator, as applicable, is the Servicer, plus the amount of any unreimbursed Servicing Advances made by the Servicer with respect to such Mortgage Loan, which purchase price shall be deposited in the Collection Account on the next succeeding Servicer Remittance Date, after deducting therefrom any amounts received in respect of such repurchased Mortgage Loan or Loans and being held in the Collection Account for future distribution to the extent such amounts have not yet been applied to principal or interest on such Mortgage Loan (the "Loan Repurchase Price"). For purposes of calculating the Interest Remittance Amount and the Principal Remittance Amount, any Loan Repurchase Price or Substitution Adjustment that is paid shall be deemed deposited in the Distribution Account in the Due Period preceding such Servicer Remittance Date. 47 (d) Upon receipt by the Trustee of a certification of a Servicing Officer of such substitution or purchase and, in the case of a substitution, upon receipt of the related Trustee's Mortgage File, and the deposit of the amounts described above in the Collection Account (which certification shall be in the form of Exhibit M hereto), the Trustee shall release to the Servicer for release or cause the Collateral Agent to release to the Unaffiliated Seller the related Trustee's Mortgage File and shall execute, without recourse, and deliver such instruments of transfer furnished by the Unaffiliated Seller as may be necessary to transfer such Mortgage Loan to the Unaffiliated Seller. The Trustee shall notify the Certificate Insurer if the Unaffiliated Seller fails to repurchase or substitute for a Mortgage Loan in accordance with the foregoing. Section 2.07 Designations under REMIC Provisions; Designation of Startup Day. (a) REMIC I will consist of all of the assets of the Trust Fund (other than the Pre-Funding Account, if any, the Capitalized Interest Account, if any, the Net WAC Cap Carryover Fund, the Special Reserve Account and the Interest Rate Hedge Payment Fund) and will be evidenced by the Class I-1 Interest and the Class Q-1 Interest (collectively, the "REMIC I Regular Interests") which will be uncertificated and will represent the "regular interests" in REMIC I. REMIC II will consist of the REMIC I Regular Interests and will be evidenced by the Class I-2 Interest, the Class AIO-2i, AIO-2ii, AIO-2iii, AIO-2iv, AIO-2v, AIO-2vi, AIO-2vii, AIO-2viii, AIO-2ix and AIO-2x Interests (collectively, the Class AIO-2 Interests) and the Class Q-2 Interest (collectively, the "REMIC II Regular Interests") which will be uncertificated and will represent the "regular interests" in REMIC II. REMIC III will consist of the REMIC II Regular Interests and will be evidenced by the Class I-3 Interest, the Class A-3 Interest, the Class AIO-3 Interest, the Class M1-3 Interest, the Class M2-3 Interest, the Class M3-3 Interest and the Class Q-3 Interest (collectively, the "REMIC III Regular Interests") which will be uncertificated and will represent the "regular interests" in REMIC III. The Class R-1 Interest, the Class R-2 Interest and the Class R-3 Interest will represent the sole class of "residual interest" in each of REMIC I, REMIC II and REMIC III, respectively. The Trustee will hold the REMIC I Regular Interests, the REMIC II Regular Interests and the REMIC III Regular Interests. The Master REMIC will consist of the REMIC III Regular Interests and will be evidenced by Class A (other than the Net WAC Cap Carryover Right of the Class A Certificates), Class A-IO, Class I, Class M-1, Class M-2, Class M-3 (for each of Class M-1, M-2 and M-3, other than the Net WAC Cap Carryover Right and the Interest Rate Hedge Payment Right of the Class M Certificates) and Class X Certificates (collectively, the "Master REMIC Regular Interests") which will represent the "regular interests" in the Master REMIC (also known as REMIC IV). The Class R-4 Interest will represent the sole class of "residual interest" in the Master REMIC. The Class R Certificates will represent the beneficial ownership of the Class R-1, R-2, R-3 and R-4 Interests. The Final Scheduled Maturity Date for each of the REMIC I Regular Interests, the REMIC II Regular Interests (other than Class I-2), the REMIC III Regular Interests (other than Class AIO-3 and Class I-3) and the Master REMIC Regular Interests (other than the Class A-IO Certificate and the Class I Certificate) shall be the Distribution Date in August, 2033. The Final Scheduled Maturity Date for the Class I, Class I-2 and Class I-3 Interests shall be the Distribution Date in September, 2005 and the Final Scheduled Maturity Date for the Class A-IO Certificate and Class AIO-3 Interest shall be the Distribution Date in September, 2005. 48 (b) The Master REMIC Regular Interests and the Class R-4 Interest shall have the initial principal balances and Pass-Through Rates set forth in the following table: Class Initial Principal Balance Pass-Through Rate - ---------------------- ------------------------- ----------------- Class A (1) $387,000,000 (4) Class A-IO (3) (9) Class M-1 (2) 25,875,000 (5) Class M-2 (2) 23,625,000 (5) Class M-3 (2) 13,500,000 (5) Class X $0(6) (7) Class I (3) (9) Class R/R-4 (8) (8) (1) The Class A Certificates represent two separate investments: (i) a regular interest in a REMIC (a "Regular Interest") represented by the Class A Certificates, without the Net WAC Cap Carryover Rights and (ii) the Net WAC Cap Carryover Rights. Only the Regular Interests will be treated as regular interests in the Master REMIC. (2) The Class M Certificates represent five separate investments: (i) three Regular Interests represented by the Class M-1, Class M-2 and Class M-3 Components, without the Net WAC Cap Carryover Rights or Interest Rate Hedge Payment Rights, (ii) the Net WAC Cap Carryover Rights and (iii) the Interest Rate Hedge Payment Rights. In the event that separate Class M-1, Class M-2 and Class M-3 Certificates are issued, each such Class will represent three separate investments: (i) a Regular Interest represented by such Class, without the Net WAC Cap Carryover Rights or Interest Rate Hedge Payment Rights, (ii) the Net WAC Cap Carryover Rights and (iii) the Interest Rate Hedge Payment Rights. In each case, only the Regular Interests will be treated as regular interests in the Master REMIC. (3) On the first Distribution Date through the Distribution Date in September, 2005, the Class A-IO Certificates will have a notional balance equal to the notional balance of Class AIO-3, and for each Distribution Date thereafter, $0. On the first Distribution Date through the Distribution Date in September, 2005, the Class I Certificates will have a notional balance equal to the notational balance of Class I-3, and for each Distribution Date thereafter, $0. 49 (4) With respect to any Distribution Date prior to the Clean-up Call Date, the lesser of (1) 3.78% per annum and (2) the REMIC III Net WAC Cap for such Distribution Date. With respect to any Distribution Date after the Clean-up Call Date, the lesser of (1) 4.28% per annum and (2) the REMIC III Net WAC Cap for such Distribution Date. (5) With respect to any Distribution Date prior to the Clean-up Call Date, the lesser of (1) LIBOR plus 1.50 per annum, (2) the REMIC III Net WAC Cap for such Distribution Date and (3) prior to the termination of the Interest Rate Hedge Agreement, 5.50%. With respect to any Distribution Date after the Clean-up Call Date, the lesser of (1) LIBOR plus 2.25% per annum, (2) the REMIC III Net WAC Cap for such Distribution Date and (3) prior to the termination of the Interest Rate Hedge Agreement, 6.25%. (6) The Class X has an initial principal balance of $68, but will not earn interest on its principal balance. Any principal on the Class X Certificates will be paid after all other regular interests have been paid in full. The Class X Certificates have a notional balance, on which the Class X Certificates will earn interest, equal to the Aggregate Principal Balance of the Mortgage Loans. (7) The Pass-Through Rate of the Class X Certificates will be the excess of: (i) the REMIC III Net WAC Cap over (ii) the product of: (A) 10,000 and (B) the weighted average of the Pass-Through Rates on the REMIC III Regular Interests (other than the Class AIO-3 and I-3), where the Class Q-3 is subject to a cap equal to zero and the Class A-3, Class M1-3, Class M2-3 and Class M3-3 are each subject to a cap equal to the Pass-Through Rate on its Corresponding Class. With respect to any Distribution Date, interest that so accrues on the notional principal balance of the Class X Certificates shall be deferred in an amount equal to the Overcollateralization Increase Amount on such Distribution Date. Such deferred interest shall not itself bear interest. (8) The Class R Certificates will represent the beneficial ownership of the Class R-1, R-2, R-3 and R-4 Interests. The Class R-4 Interest does not have a principal balance or a Pass-Through Rate but is entitled to any remaining distributions of principal and interest after the Master REMIC Regular Interests have been paid in full. (9) On each Distribution Date up to and including the Distribution Date in September, 2005, a per annum rate equal to 4.00% and (ii) thereafter, a Pass-Through Rate equal to 0%. 50 (c) The REMIC III Regular Interests and the Class R-3 Interest shall have the initial principal balances, Pass-Through Rates and Corresponding Classes of Certificates set forth in the following table:
Corresponding REMIC Initial Principal Class of Master Interests Balance Pass-Through Rate REMIC Interest ----------- ------------------------ ------------------- ------------------ Q-3 $449,955,068 (1) N/A A-3 $38,700 (1) A AIO-3 (2) (3) A-IO M1-3 $2,587.50 (1) M1 M2-3 $2,362.50 (1) M2 M3-3 $1,350 (1) M3 I-3 $37,655,100 notional (5) (3) I R-3 (4) (4) N/A
(1) On any Distribution Date, a Pass-Through Rate equal to the REMIC III Net WAC Cap. (2) The Class AIO-3 will have a notional balance equal to (a) on the first Distribution Date through the Distribution Date in June 2003, the sum of the principal balances of Class AIO-2i, AIO-2ii, AIO-2iii, AIO-2iv, AIO-2v, AIO-2vi, AIO-2vii, AIO-2viii, AIO-2ix and AIO-2x; (b) from the Distribution Date in July 2003 through the Distribution Date in September 2003, the sum of the principal balances of AIO-2ii, AIO-2iii, AIO-2iv, AIO-2v, AIO-2vi, AIO-2vii, AIO-2viii, AIO-2ix and AIO-2x; (c) from the Distribution Date in October 2003 through the Distribution Date in December 2003, the sum of the principal balances of AIO-2iii, AIO-2iv, AIO-2v, AIO-2vi, AIO-2vii, AIO-2viii, AIO-2ix and AIO-2x; (d) from the Distribution Date in January 2004 through the Distribution Date in March 2004, the sum of the principal balances of AIO-2iv, AIO-2v, AIO-2vi, AIO-2vii, AIO-2viii, AIO-2ix and AIO-2x; (e) from the Distribution Date in April 2004 through the Distribution Date in June 2004, the sum of the principal balances of Class AIO-2v, AIO-2vi, AIO-2vii, AIO-2viii, AIO-2ix and AIO-2x; (f) from the Distribution Date in July 2004 through the Distribution Date in September 2004, the sum of the principal balances of AIO-2vi, AIO-2vii, AIO-2viii, AIO-2ix and AIO-2x; (g) from the Distribution Date in October 2004 through the Distribution Date in December 2004, the sum of the principal balances of AIO-2vii, AIO-2viii, AIO-2ix and AIO-2x; (h) from the Distribution Date in January 2005 through the Distribution Date in March 2005, the sum of the principal balances of AIO-2viii, AIO-2ix and AIO-2x; (i) from the Distribution Date in April 2005 through the Distribution Date in June 2005, the sum of the principal balances of AIO-2ix and AIO-2x; (j) from the Distribution Date in July 2005 through the Distribution Date in September 2005, the principal balance of Class AIO-2x; and (k) on each Distribution Date thereafter, $0. 51 (3) On each Distribution Date up to and including the Distribution Date in September 2005, a per annum rate equal to 4.0% and (ii) thereafter, a Pass Through Rate equal to 0%. (4) The Class R-3 Interest does not have a principal balance or a Pass-Through Rate but is entitled to any remaining distributions of principal and interest after the REMIC II Regular Interests have been paid in full. (5) The Class I-3 notional balance is equal to the notional balance of Class I-2. On each Distribution Date, 0.01% of the increase in the Overcollateralized Amount will be payable as a reduction of the principal balances of Class A-3, Class M1-3, Class M2-3 and Class M3-3 (in the order and amount of such reduction to the principal balance of each classes' Corresponding Class) and will be accrued and added to the principal balance of the Class Q-3. The remaining 99.99% increase in the Overcollateralized Amount will be allocable to Class Q-3. On each Distribution Date, the Principal Remittance Amount shall be allocated 99.99% to Class Q-3 and 0.01% to Class A-3, Class M1-3, Class M2-3 and Class M3-3 (in the order and amount of reductions to the principal balances of each classes' Corresponding Class) until paid in full. Notwithstanding the above, payments allocated to the Class X Certificates that result in the reduction of the Overcollateralized Amount shall be allocated to the Class Q-3 Interest (until paid in full). Liquidated Loan Losses shall be applied so that after all distributions have been made on each Distribution Date the principal balances of the Class A-3, Class M1-3, M2-3 and M3-3 Interests are each equal to 0.01% of the principal balance of its Corresponding Class and the remainder shall be allocated to Class Q-3. (d) The REMIC II Regular Interests and the Class R-2 Interest shall have the initial principal balances, Pass-Through Rates and Corresponding Classes of Certificates set forth in the following table: 52
Corresponding REMIC Initial Principal Pass-Through Class of Master Interests Balance Rate REMIC Interest -------------- -------------------------- ------------------ ------------------------ Q-2 $331,875,068 (1) N/A AIO-2i $562,500 (1) A-IO AIO-2ii $5,456,250 (1) A-IO AIO-2iii $6,131,250 (1) A-IO AIO-2iv $7,256,250 (1) A-IO AIO-2v $6,356,250 (1) A-IO AIO-2vi $1,012,500 (1) A-IO AIO-2vii $19,012,500 (1) A-IO AIO-2viii $14,962,500 (1) A-IO AIO-2ix $8,437,500 (1) A-IO AIO-2x $48,937,500 (1) A-IO I-2 $37,655,100 notional (4) (3) I R-2 (2) (2) N/A
(1) On any Distribution Date, a Pass-Through Rate equal to the REMIC II Net WAC Cap. (2) The Class R-2 Interest does not have a principal balance or a Pass-Through Rate but is entitled to any remaining distributions of principal and interest after the REMIC II Regular Interests have been paid in full. (3) On each Distribution Date up to and including the Distribution Date in September, 2005, a per annum rate equal to 4.00% and (ii) thereafter, a Pass-Through Rate equal to 0%. (4) The Class I-2 notional amount is equal to the Class I-1 principal balance. On each Distribution Date, the Principal Remittance Amount and losses will be allocated to Class Q-2 until the Class Q-2 is paid in full or eliminated by such losses; and thereafter, such amounts will be allocated to the Class AIO-2i, AIO-2ii, AIO-2iii, AIO-2iv, AIO-2v, AIO-2vi, AIO-2vii, AIO-2viii, AIO-2ix and AIO-2x in such order until each is paid in full or eliminated. (e) The REMIC I Regular Interests and the Class R-1 Interest shall have the Initial Principal Balances and Pass-Through Rates set forth in the following table: 53 REMIC Initial Principal Pass-Through Interests Balance Rate - ------------ ------------------- ---------------- I-1 $ 37,655,100 (1) Q-1 $412,344,968 (1) R-1 (2) (2) (1) On any Distribution Date, a Pass-Through Rate equal to the Net Weighted Average Mortgage Interest Rate. (2) The Class R-1 Interest does not have a principal balance or a Pass-Through Rate but is entitled to any remaining distributions of principal and interest after the REMIC I Regular Interests have been paid in full. (f) The REMIC II Net WAC Cap equals the weighted average of Q-1 and I-1, where I-1 is first reduced by 4% through the Distribution Date in September, 2005. The REMIC III Net WAC Cap is the weighted average of the Q-2 and AIO-2 Interests where each of the AIO-2 Interests is reduced by 4% for the following periods: REMIC Interests Period ----------------- -------------------------- AIO-2x through September, 2005 AIO-2ix through June, 2005 AIO-2viii through March, 2005 AIO-2vii through December, 2004 AIO-2vi through September, 2004 AIO-2v through June, 2004 AIO-2iv through March, 2004 AIO-2iii through December, 2003 AIO-2ii through September, 2003 AIO-2i through June, 2003 (g) The Closing Date will be the "startup day" of each REMIC created hereunder within the meaning of Section 860G(a)(9) of the Code. Section 2.08 Execution of Certificates. The Trustee acknowledges the assignment to it of the Mortgage Loans and the delivery of the Trustee's Mortgage Files relating thereto to it and, concurrently with such delivery, has executed, authenticated and delivered to or upon the order of the Depositor, in exchange for the Mortgage Loans, the Trustee's Mortgage Files and the other assets included in the definition of Trust Fund, Certificates duly authenticated by the Trustee in Authorized Denominations evidencing the entire ownership of the Trust Fund. Section 2.09 Application of Principal and Interest. In the event that Net Liquidation Proceeds on a Liquidated Mortgage Loan are less than the Principal Balance of the related Mortgage Loan plus accrued interest thereon, or any Mortgagor makes a partial payment of any Monthly Payment due on a Mortgage Loan, such Net Liquidation Proceeds or partial payment shall be applied as provided in the related Mortgage Note, and if not so provided, first to interest accrued at the Mortgage Interest Rate and then to principal. 54 Section 2.10 Grant of Security Interest. (a) Except with respect to the REMIC Provisions, it is the intention of the parties hereto that the conveyance by the Depositor of the Trust Fund to the Trustee on behalf of the Trust shall constitute a purchase and sale of such Trust Fund and not a loan. In the event, however, that a court of competent jurisdiction were to hold that the transaction evidenced hereby constitutes a loan and not a purchase and sale, it is the intention of the parties hereto that this Agreement shall constitute a security agreement under applicable law, and that the Depositor shall be deemed to have granted to the Trustee, on behalf of the Trust, a first priority perfected security interest in all of the Depositor's right, title and interest in, to and under the Trust Fund. The conveyance by the Depositor of the Trust Fund to the Trustee on behalf of the Trust shall not constitute and is not intended to result in an assumption by the Trustee or any Certificateholder of any obligation of the Unaffiliated Seller or any other Person in connection with the Trust Fund. (b) The Depositor and the Servicer shall take no action inconsistent with the Trust's ownership of the Trust Fund and each shall indicate or shall cause to be indicated in its records and records held on its behalf that ownership of each Mortgage Loan and the assets in the Trust Fund are held by the Trustee on behalf of the Trust. In addition, the Depositor and the Servicer shall respond to any inquiries from third parties with respect to ownership of a Mortgage Loan or any other asset in the Trust Fund by stating that it is not the owner of such asset and that ownership of such Mortgage Loan or other Trust Fund asset is held by the Trustee on behalf of the Trust. Section 2.11 Further Action Evidencing Assignments. (a) The Servicer agrees that, from time to time, at its expense, it shall cause the Unaffiliated Seller (and the Depositor on behalf of itself also agrees that it shall), promptly to execute and deliver all further instruments and documents, and take all further action, that may be necessary or appropriate, or that the Servicer, the Certificate Insurer, the Collateral Agent or the Trustee may reasonably request, in order to perfect, protect or more fully evidence the transfer of ownership of the Trust Fund or to enable the Trustee to exercise or enforce any of its rights hereunder. Without limiting the generality of the foregoing, the Servicer and the Depositor will, upon the request of the Servicer, the Certificate Insurer, the Collateral Agent or the Trustee, execute and file (or cause to be executed and filed) such real estate filings, financing or continuation statements, or amendments thereto or assignments thereof, and such other instruments or notices, as may be necessary or appropriate. (b) The Depositor hereby grants to the Servicer and the Trustee powers of attorney to execute all documents on its behalf under this Agreement and the Unaffiliated Seller's Agreement as may be necessary or desirable to effectuate the foregoing. ARTICLE III REPRESENTATIONS, WARRANTIES AND COVENANTS Section 3.01 Representations of the Servicer and the Unaffiliated Seller. The Servicer and the Unaffiliated Seller hereby represent and warrant to the Collateral Agent, the Trustee, the Depositor, the Back-up Servicer, the Certificate Insurer and the Certificateholders as of the Closing Date and during the term of this Agreement that: 55 (a) Each of the Unaffiliated Seller, the Servicer and the Subservicers is a corporation duly organized, validly existing and in good standing under the laws of their respective states of incorporation and has the corporate power to own its assets and to transact the business in which it is currently engaged. Each of the Unaffiliated Seller, the Servicer and the Subservicers is duly qualified to do business as a foreign corporation and is in good standing in each jurisdiction in which the character of the business transacted by it or properties owned or leased by it or the performance of its obligations hereunder requires such qualification and in which the failure so to qualify could reasonably be expected to have a material adverse effect on the business, properties, assets, or condition (financial or other) of the Unaffiliated Seller, the Servicer or the Subservicers or the performance of their respective obligations hereunder or under the Unaffiliated Seller's Agreement; (b) The Unaffiliated Seller and the Servicer each has the power and authority to make, execute, deliver and perform this Agreement and all of the transactions contemplated under this Agreement, and has taken all necessary corporate action to authorize the execution, delivery and performance of this Agreement. When executed and delivered, this Agreement will constitute the legal, valid and binding obligation of the Unaffiliated Seller and the Servicer, enforceable in accordance with its terms, except as enforcement of such terms may be limited by bankruptcy, insolvency, reorganization, moratorium or similar laws relating to or affecting the rights of creditors generally and by general equity principles (regardless of whether such enforcement is considered in a proceeding in equity or at law); (c) Neither the Unaffiliated Seller nor the Servicer is required to obtain the consent of any other party or any consent, license, approval or authorization from, or registration or declaration with, any governmental authority, bureau or agency which consent already has not been obtained in connection with the execution, delivery, performance, validity or enforceability of this Agreement, except such as have been obtained prior to the Closing Date; (d) The execution, delivery and performance of this Agreement by the Unaffiliated Seller and the Servicer will not violate any provision of any existing law or regulation or any order or decree of any court or the Articles of Incorporation or Bylaws of the Unaffiliated Seller or the Servicer, respectively, or constitute a breach of any mortgage, indenture, contract or other agreement to which the Unaffiliated Seller or the Servicer, respectively, is a party or by which it may be bound; (e) There is no action, suit, proceeding or investigation pending or threatened against the Servicer, the Unaffiliated Seller or the Subservicers which, either in any one instance or in the aggregate, is, likely to result in any material adverse change in the business, operations, financial condition, properties, or assets of the Servicer, the Unaffiliated Seller or the Subservicers, or in any material impairment of the right or ability of any of them to carry on its business substantially as now conducted, or in any material liability on the part of any of them, or which would draw into question the validity of this Agreement, the Certificates, or the Mortgage Loans or of any action taken or to be taken in connection with the obligations of the Unaffiliated Seller or the Servicer contemplated herein or therein, or which would be likely to impair materially the ability of the Unaffiliated Seller or the Servicer to perform its obligations hereunder; 56 (f) Neither this Agreement nor any statement, report, or other document furnished or to be furnished by the Servicer, the Unaffiliated Seller or the Subservicer pursuant to this Agreement or the Insurance and Indemnity Agreement or in connection with the transactions contemplated hereby, including, without limitation, the sale or placement of the Certificates, contains any untrue statement of fact provided by or on behalf of the Unaffiliated Seller or the Servicer or omits to state a fact necessary to make the statements provided by or on behalf of the Unaffiliated Seller or the Servicer contained herein or therein not misleading; (g) Neither the Unaffiliated Seller nor the Servicer believes, nor does either have any reason or cause to believe, that it cannot perform each and every covenant contained in this Agreement; (h) The transfer, assignment, and conveyance of the Mortgage Loans by the Unaffiliated Seller pursuant to the Unaffiliated Seller's Agreement is not subject to the bulk transfer or any similar statutory provisions in effect in any applicable jurisdiction; (i) The Unaffiliated Seller is solvent and will not as a result of this Agreement and the undertakings of the Unaffiliated Seller hereunder be rendered insolvent; (j) None of the Unaffiliated Seller, the Servicer or the Subservicers is an "investment company" or a company "controlled by an investment company," within the meaning of the Investment Company Act of 1940, as amended; (k) Immediately prior to the transfer and assignment by the Depositor to the Trustee, the Depositor had good title to, and was the sole owner of each Mortgage Loan, free of any interest of any other Person, and the Depositor has transferred all right, title and interest in each Mortgage Loan to the Trustee. The transfer of the Mortgage Note and the Mortgage as and in the manner contemplated by this Agreement is sufficient either (i) fully to transfer to the Trustee, for the benefit of the Certificateholders and the Certificate Insurer, all right, title, and interest of the Depositor thereto as note holder and mortgagee or (ii) to grant to the Trustee, for the benefit of the Certificateholders and the Certificate Insurer, the security interest referred to in Section 2.10 hereof. The Mortgage has been duly assigned and the Mortgage Note has been duly endorsed. The Assignment of Mortgage delivered to the Trustee pursuant to Section 2.05(a)(iv) is in recordable form and is acceptable for recording under the laws of the applicable jurisdiction. The endorsement of the Mortgage Note, the delivery to the Trustee of the endorsed Mortgage Note, and such Assignment of Mortgage, and the delivery of such Assignment of Mortgage for recording to, and the due recording of such Assignment of Mortgage in, the appropriate public recording office in the jurisdiction in which the Mortgaged Property is located are sufficient to permit the Trustee to avail itself of all protection available under applicable law against the claims of any present or future creditors of the Depositor, and are sufficient to prevent any other sale, transfer, assignment, pledge, or hypothecation of the Mortgage Note and Mortgage by the Depositor from being enforceable; 57 (l) Neither this Agreement nor any information, certificate of an officer, statement furnished in writing or report delivered to the Trustee by the Servicer in connection with the transactions contemplated hereby contains any untrue statement of a material fact; and (m) The Servicer covenants that its computer and other systems used in servicing the Mortgage Loans operate in a manner such that the Servicer can service the Mortgage Loans in accordance with the terms of this Agreement. It is understood and agreed that the representations, warranties and covenants set forth in this Section 3.01 shall survive the delivery of the respective Mortgage Files to the Collateral Agent on behalf of the Trustee or to a custodian, as the case may be, and inure to the benefit of the Trustee and the Certificate Insurer. Upon discovery by the Unaffiliated Seller, the Depositor, the Servicer, the Back-up Servicer, any Subservicer, the Certificate Insurer or the Trustee of a breach of any of the representations and warranties contained in this Section which materially and adversely affects the value of the Mortgage Loans or the interest of the Trustee, the Certificate Insurer or the Certificateholders, the party discovering such breach shall promptly (and in any event within five (5) Business Days of the discovery) give written notice to the others. Section 3.02 Representations, Warranties and Covenants of the Depositor. The Depositor hereby represents, warrants and covenants to the Collateral Agent, the Servicer, the Back-up Servicer, the Trustee, the Unaffiliated Seller, the Certificate Insurer and the Certificateholders that as of the date of this Agreement or as of such date specifically provided herein: (a) The Depositor is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware; (b) The Depositor has the corporate power and authority to convey the Mortgage Loans and to execute, deliver and perform, and to enter into and consummate the transactions contemplated by, this Agreement; (c) This Agreement has been duly and validly authorized, executed and delivered by the Depositor, all requisite corporate action having been taken, and, upon the due authorization, execution and delivery hereof by the other parties hereto, will constitute the legal, valid and binding agreement of the Depositor, enforceable against the Depositor in accordance with its terms, except as such enforcement may be limited by bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to or affecting the rights of creditors generally, and by general equity principles (regardless of whether such enforcement is considered in a proceeding in equity or at law); 58 (d) No consent, approval, authorization or order of or registration or filing with, or notice to, any governmental authority or court is required for the execution, delivery and performance of or compliance by the Depositor with this Agreement or the consummation by the Depositor of any of the transactions contemplated hereby, except as have been made on or prior to the Closing Date; (e) None of the execution and delivery of this Agreement, the consummation of the transactions contemplated hereby or thereby, or the fulfillment of or compliance with the terms and conditions of this Agreement, (i) conflicts or will conflict with or results or will result in a breach of, or constitutes or will constitute a default or results or will result in an acceleration under (A) the charter or bylaws of the Depositor, or (B) of any term, condition or provision of any material indenture, deed of trust, contract or other agreement or instrument to which the Depositor or any of its subsidiaries is a party or by which it or any of its subsidiaries is bound; (ii) results or will result in a violation of any law, rule, regulation, order, judgment or decree applicable to the Depositor of any court or governmental authority having jurisdiction over the Depositor or its subsidiaries; or (iii) results in the creation or imposition of any lien, charge or encumbrance which would have a material adverse effect upon the Mortgage Loans or any documents or instruments evidencing or securing the Mortgage Loans; (f) There are no actions, suits or proceedings before or against or investigations of, the Depositor pending, or to the knowledge of the Depositor, threatened, before any court, administrative agency or other tribunal, and no notice of any such action, which, in the Depositor's reasonable judgment, might materially and adversely affect the performance by the Depositor of its obligations under this Agreement, or the validity or enforceability of this Agreement; (g) The Depositor is not in default with respect to any order or decree of any court or any order, regulation or demand of any federal, state, municipal or governmental agency that may materially and adversely affect its performance hereunder; (h) The transfer, assignment, and conveyance of the Mortgage Loans by the Depositor pursuant to this Agreement is not subject to the bulk transfer or any similar statutory provisions in effect in any applicable jurisdiction; and (i) Immediately prior to the transfer and assignment by the Depositor to the Trustee, the Depositor had good title to, and was the sole owner of each Mortgage Loan, free of any interest of any other Person, and the Depositor has transferred all right, title and interest in each Mortgage Loan to the Trustee. The transfer of the Mortgage Note and the Mortgage as and in the manner contemplated by this Agreement is sufficient either (i) fully to transfer to the Trustee, for the benefit of the Certificateholders and the Certificate Insurer, all right, title, and interest of the Depositor thereto as note holder and mortgagee or (ii) to grant to the Trustee, for the benefit of the Certificateholders and the Certificate Insurer, the security interest referred to in Section 2.10 hereof. The Mortgage has been duly assigned and the Mortgage Note has been duly endorsed. The Assignment of Mortgage delivered to the Collateral Agent on behalf of the Trustee pursuant to Section 2.05(a)(iv) is in recordable form and is acceptable for recording under the laws of the applicable jurisdiction. The endorsement of the Mortgage Note, the delivery to the Collateral Agent on behalf of the Trustee of the endorsed Mortgage Note, and such Assignment of Mortgage, and the delivery of such Assignment of Mortgage for recording to, and the due recording of such Assignment of Mortgage in, the appropriate public recording office in the jurisdiction in which the Mortgaged Property is located are sufficient to permit the Trustee to avail itself of all protection available under applicable law against the claims of any present or future creditors of the Depositor, and are sufficient to prevent any other sale, transfer, assignment, pledge, or hypothecation of the Mortgage Note and Mortgage by the Depositor from being enforceable. The Depositor has not transferred the Mortgage Loans to the Trustee, for the benefit of the Certificateholders and the Certificate Insurer, with any intent to hinder, delay or defraud any of its creditors. 59 It is understood and agreed that the representations, warranties and covenants set forth in this Section 3.02 shall survive delivery of the respective Mortgage Files to the Collateral Agent on behalf of the Trustee or to a custodian, as the case may be, and shall inure to the benefit of the Trustee and the Certificate Insurer. Upon discovery by the Unaffiliated Seller, the Depositor, the Servicer, the Back-up Servicer, any Subservicer, the Certificate Insurer or the Trustee of a breach of any of the representations and warranties contained in this Section which materially and adversely affects the value of the Mortgage Loans or the interest of the Trustee, the Certificate Insurer or the Certificateholders, the party discovering such breach shall promptly (and in any event within five (5) Business Days of the discovery) give written notice to the others. Section 3.03 Purchase and Substitution. (a) It is understood and agreed that the representations and warranties set forth in Sections 3.01, 3.02 and 3.03 of the Unaffiliated Seller's Agreement shall survive delivery of the Certificates to the Certificateholders. Pursuant to the Unaffiliated Seller's Agreement, with respect to any representation or warranty contained in Sections 3.01, 3.02 or 3.03 of the Unaffiliated Seller's Agreement that is made to the best of the Unaffiliated Seller's knowledge, the Unaffiliated Seller shall be deemed to have knowledge of all facts and circumstances in existence as of such date and, if it is discovered by the Servicer, the Back-up Servicer, any Subservicer, the Trustee, the Certificate Insurer or any Certificateholder that the substance of such representation and warranty was inaccurate as of the Closing Date and such inaccuracy materially and adversely affects the value of the related Mortgage Loan or the interests of the Trustee or the Certificate Insurer with respect thereto, then notwithstanding the Unaffiliated Seller's lack of knowledge with respect to the inaccuracy at the time the representation or warranty was made, such inaccuracy shall be deemed a breach of the applicable representation or warranty. Upon discovery by the Unaffiliated Seller, the Servicer, the Back-up Servicer, any Subservicer, the Certificate Insurer or the Trustee of a breach of any of such representations and warranties which materially and adversely affects the value of the Mortgage Loans or the interest of the Trustee, the Certificate Insurer or the Certificateholders, or which materially and adversely affects the interests of the Trustee, the Certificate Insurer or the Certificateholders in the related Mortgage Loan in the case of a representation and warranty relating to a particular Mortgage Loan (notwithstanding that such representation and warranty was made to the Unaffiliated Seller's best knowledge), the party discovering such breach shall promptly (and in any event within five (5) Business Days of the discovery) give written notice to the others. Subject to the last paragraph of this Section 3.03, within sixty (60) days of the earlier of its discovery or its receipt of notice of any breach of a representation or warranty, pursuant to the Unaffiliated Seller's Agreement, the Servicer shall, or shall cause the Unaffiliated Seller or an Originator to (a) promptly cure such breach in all material respects, or (b) purchase such Mortgage Loan on the next succeeding Servicer Remittance Date, by depositing an amount equal to the Loan Repurchase Price into the Collection Account, or (c) remove such Mortgage Loan from the 60 Trust Fund (in which case it shall become a Deleted Mortgage Loan) and substitute one or more Qualified Substitute Mortgage Loans; provided, that such substitution is effected not later than the date which is two years after the Startup Day or at such later date, if the Trustee and the Certificate Insurer receive an Opinion of Counsel, by and at the cost of the Servicer, to the effect that such substitution will not cause (a) any federal tax to be imposed on the Trust Fund, including without limitation, any federal tax imposed on "prohibited transactions" under Section 860F(a)(1) of the Code or on "contributions after the startup date" under Section 860G(d)(1) of the code or (b) any REMIC to fail to qualify as a REMIC at any time that any Certificate is outstanding. If such Opinion of Counsel can not be delivered, then such substitution may only be effected at such time as the required Opinion of Counsel can be given. In addition, pursuant to the Unaffiliated Seller's Agreement, the Unaffiliated Seller and the related Originator shall be obligated to indemnify the Trustee, the Certificate Insurer and the Certificateholders for any third party claims arising out of a breach by the Unaffiliated Seller of representations or warranties regarding the Mortgage Loans. Pursuant to the Unaffiliated Seller's Agreement any such substitution shall be accompanied by payment by the Unaffiliated Seller of the Substitution Adjustment, if any, to be deposited in the Collection Account. (b) As to any Deleted Mortgage Loan for which the Unaffiliated Seller substitutes a Qualified Substitute Mortgage Loan or Loans, the Servicer shall cause the Unaffiliated Seller or an Originator, as applicable, to effect such substitution by delivering to the Collateral Agent on behalf of the Trustee a certification in the form attached hereto as Exhibit M, executed by a Servicing Officer and shall cause the Unaffiliated Seller or an Originator, as applicable, to deliver the documents described in Sections 2.05(a)(i) through (vi) for such Qualified Substitute Mortgage Loan or Loans to the Collateral Agent on behalf of the Trustee. (c) The Servicer shall deposit in the Collection Account all payments received in connection with such Qualified Substitute Mortgage Loan or Loans after the date of such substitution. Monthly Payments received with respect to a Qualified Substitute Mortgage Loan or Loans on or before the date of substitution will be retained by the Unaffiliated Seller. The Trust Fund will own all payments received on the Deleted Mortgage Loan on or before the date of substitution, and the Unaffiliated Seller shall thereafter be entitled to retain all amounts subsequently received in respect of such Deleted Mortgage Loan. The Servicer shall give written notice to the Trustee, the Certificate Insurer and the Back-up Servicer that such substitution has taken place and shall amend the Mortgage Loan Schedule to reflect the removal of such Deleted Mortgage Loan from the terms of this Agreement and the substitution of the Qualified Substitute Mortgage Loan or Loans. Upon such substitution, such Qualified Substitute Mortgage Loan or Loans shall be subject to the terms of this Agreement in all respects. (d) It is understood and agreed that the obligations of the Unaffiliated Seller and the related Originator set forth in Sections 2.06 and 3.05 of the Unaffiliated Seller's Agreement to, and the Servicer's obligation to cause the Unaffiliated Seller and the Originator to cure, purchase or substitute for a defective Mortgage Loan, or to indemnify as described in clause (a) above, constitute the sole remedies of the Trustee, the Certificate Insurer and the Certificateholders respecting a breach of the representations and warranties of the Unaffiliated Seller and the Originators set forth in Sections 3.01, 3.02 and 3.03 of the Unaffiliated Seller's Agreement. The Trustee shall give prompt written notice to the Certificate Insurer and the Rating Agencies of any repurchase or substitution made pursuant to this Section 3.03 or Section 2.06(b). 61 (e) Upon discovery by the Servicer, the Back-up Servicer, the Trustee, the Certificate Insurer or any Certificateholder that any Mortgage Loan does not constitute a Qualified Mortgage, the party discovering such fact shall promptly (and in any event within five (5) Business Days of the discovery) give written notice thereof to the other parties. In connection therewith, pursuant to the Unaffiliated Seller's Agreement, the Unaffiliated Seller shall be required to repurchase or substitute a Qualified Substitute Mortgage Loan for the affected Mortgage Loan within sixty (60) days of the earlier of such discovery by any of the foregoing parties, or the Trustee's or the Unaffiliated Seller's receipt of notice, in the same manner as it would a Mortgage Loan for a breach of representation or warranty contained in Sections 3.01, 3.02 or 3.03 of the Unaffiliated Seller's Agreement. The Trustee shall reconvey to the Unaffiliated Seller the Mortgage Loan to be released pursuant hereto in the same manner, and on the same terms and conditions, as it would a Mortgage Loan repurchased for breach of a representation or warranty contained in Sections 3.01, 3.02 or 3.03 of the Unaffiliated Seller's Agreement. (f) Pursuant to Section 3.05(k) of the Unaffiliated Seller's Agreement, the Unaffiliated Seller and each of the Originators shall be jointly and severally responsible for any repurchase, cure or substitution obligation of the Unaffiliated Seller or any of the Originators under this Agreement or the Unaffiliated Seller's Agreement. Section 3.04 Representations, Warranties and Covenants of the Trustee, the Collateral Agent and the Back-up Servicer. Each of the Trustee, the Collateral Agent and the Back-up Servicer hereby represents, warrants and covenants to the Servicer, the Certificate Insurer, the Certificateholders, the Unaffiliated Seller and the Depositor that as of the date of this Agreement or as of such date specifically provided herein: (a) It is a banking corporation duly organized, validly existing and in good standing under the laws of the State of New York; (b) It has the corporate power and authority to execute, deliver and perform, and to enter into and consummate transactions contemplated by this Agreement; and (c) This Agreement has been duly and validly authorized, executed and delivered by it, all requisite corporate action having been taken, and, assuming the due authorization, execution and delivery hereof by the other parties hereto, constitutes or will constitute the legal, valid and binding agreement of it, enforceable against it in accordance with its terms, except as such enforcement may be limited by bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to or affecting the rights of creditors generally, and by general equity principles (regardless of whether such enforcement is considered in a proceeding in equity or at law). 62 It is understood and agreed that the representations, warranties and covenants set forth in this Section 3.04 shall survive delivery of the respective Trustee's Mortgage Files to the Collateral Agent, on behalf of the Trustee or to another custodian, as the case may be, and shall inure to the benefit of the Certificateholders and the Certificate Insurer. Upon discovery by the Unaffiliated Seller, the Depositor, the Servicer, the Back-up Servicer, any Subservicer, the Certificate Insurer or the Trustee of a breach of any of the representations and warranties contained in this Section which materially and adversely affects the value of the Mortgage Loans or the interest of the Trustee, the Certificate Insurer or the Certificateholders, the party discovering such breach shall promptly (and in any event within five (5) Business Days of the discovery) give written notice to the others. Section 3.05 Negative Covenants of the Trustee and the Servicer. Except as otherwise expressly permitted by this Agreement, neither the Trustee nor the Servicer shall cause the Trust to: (i) sell, transfer, exchange or otherwise dispose of any of the assets of the Trust Fund; (ii) dissolve or liquidate the Trust Fund in whole or in part; (iii) engage, directly or indirectly, in any business other than that arising out of the issue of the Certificates, and the actions contemplated or required to be performed under this Agreement; (iv) incur, create or assume any indebtedness for borrowed money; (v) voluntarily file a petition for bankruptcy, reorganization, assignment for the benefit of creditors or similar proceeding; or (vi) merge, convert or consolidate with any other Person. ARTICLE IV THE CERTIFICATES Section 4.01 The Certificates. (a) The Class A Certificates shall be substantially in the form annexed hereto of Exhibit A, the Class A-IO Certificates shall be substantially in the form annexed hereto as Exhibit B, the Class M Certificates (including any Class M-1, Class M-2 or Class M-3 Certificates) shall be substantially in the form annexed hereto of Exhibit C and the Class R, Class X and Class I Certificates shall be substantially in the forms annexed hereto as Exhibits D, E and F, respectively. All Certificates shall be executed by manual or facsimile signature on behalf of the Trustee by an authorized officer and authenticated by the manual or facsimile signature of an authorized officer. Certificates bearing the signatures of individuals who were at the time of the execution of the Certificates the authorized officers of the Trustee shall bind the Trustee, notwithstanding that such individuals or any of them have ceased to hold such offices prior to the delivery of such Certificates or did not hold such offices at the date of such Certificates. All Certificates issued hereunder shall be dated the date of their authentication. 63 (b) Solely for purposes of calculating distributions and allocating losses, the Class M Certificates will be made up of the Class M-1, Class M-2 and Class M-3 Components. The Pass-Through Rate on each of the components will be the same as the Pass-Through Rate on the Class M Certificates. The Component Principal Balance with respect to any component as of any Distribution Date is the initial Component Principal Balance thereof on the Closing Date, reduced by all amounts applied, and losses allocated in reduction of, the Component Principal Balance of such component on previous Distribution Dates. The Certificate Principal Balance of the Class M Certificates will be equal to the aggregate of the Component Principal Balances of the Class M-1, Class M-2 and Class M-3 Components. Until the occurrence of a Separation Event, the components comprising the Class M Certificates will not be separately transferable. With respect to each Distribution Date, the Servicer Remittance Report will include an accounting of the Certificate Principal Balance of the Class M Certificates and the Component Principal Balance of each of the components after giving effect to the distribution of the Class M Principal Distribution Amount on such Distribution Date. Upon the occurrence of a Separation Event, the Trustee will notify the holders of the Class M Certificates of the separation of their Class M Certificates into its component parts. Following the separation, the Class M Certificates will no longer be outstanding, and each holder of a Class M Certificate prior to separation will become the holder of Class M-1, Class M-2 and Class M-3 Certificates (which will be separately transferable and fully registered securities) in Percentage Interests equal to such holder's Percentage Interest in the Class M Certificates immediately prior to the separation. The Trustee may require payment from the holders of the Class M Certificates of a sum sufficient to cover any tax or other governmental charge payable in connection with such separation. The costs, if any, associated with the separation of the Class M Certificates will be borne by the holders thereof in proportion to their Percentage Interests. The Class M-1, Class M-2 and Class M-3 Certificates shall continue to be registered in the same manner as the Class M Certificates so as to participate a global book-entry system with the Depository as provided in Section 4.02(e). Section 4.02 Registration of Transfer and Exchange of Certificates. (a) The Trustee, as registrar, shall cause to be kept a register (the "Certificate Register") in which, subject to such reasonable regulations as it may prescribe, the Trustee shall provide for the registration of Certificates and the registration of transfer of Certificates. The Trustee is hereby appointed registrar (the "Certificate Registrar") for the purpose of registering Certificates and transfers of Certificates as herein provided. The Certificate Insurer shall be entitled to inspect and copy the Certificate Register and the records of the Trustee relating to the Certificates during normal business hours upon reasonable notice. (b) All Certificates issued upon any registration of transfer or exchange of Certificates shall be valid evidence of the same ownership interests in the Trust and entitled to the same benefits under this Agreement as the Certificates surrendered upon such registration of transfer or exchange. 64 (c) Every Certificate presented or surrendered for registration of transfer or exchange shall be duly endorsed, or be accompanied by a written instrument of transfer in form satisfactory to the Trustee duly executed by the Holder thereof or his attorney duly authorized in writing. (d) No service charge shall be made to a Holder for any registration of transfer or exchange of Certificates, but the Trustee may require payment of a sum sufficient to cover any tax or other governmental charge that may be imposed in connection with any registration of transfer or exchange of Certificates; any other expenses in connection with such transfer or exchange shall be an expense of the Trust. (e) It is intended that the Offered Certificates be registered so as to participate in a global book-entry system with the Depository, as set forth herein. The Offered Certificates shall, except as otherwise provided in the next paragraph, be initially issued in the form of a single fully registered Certificate with a denomination equal to the Original Certificate Principal Balance or Class A-IO Notional Balance, respectively. Upon initial issuance, the ownership of each such Offered Certificate shall be registered in the Certificate Register in the name of Cede & Co., or any successor thereto, as nominee for the Depository. The Depositor and the Trustee are hereby authorized to execute and deliver the Representation Letter with the Depository. With respect to the Offered Certificates registered in the Certificate Register in the name of Cede & Co., as nominee of the Depository, the Depositor, the Unaffiliated Seller, the Servicer, the Back-up Servicer, the Certificate Insurer and the Trustee shall have no responsibility or obligation to Direct or Indirect Participants or beneficial owners for which the Depository holds Offered Certificates from time to time as a Depository. Without limiting the immediately preceding sentence, the Depositor, the Unaffiliated Seller, the Servicer, the Back-up Servicer, the Certificate Insurer and the Trustee shall have no responsibility or obligation with respect to (i) the accuracy of the records of the Depository, Cede & Co., or any Direct or Indirect Participant with respect to any Ownership Interest, (ii) the delivery to any Direct or Indirect Participant or any other Person, other than a Certificateholder, of any notice with respect to the Offered Certificates or (iii) the payment to any Direct or Indirect Participant or any other Person, other than a Certificateholder, of any amount with respect to any distribution of principal or interest on the Offered Certificates. No Person other than a Certificateholder shall receive a certificate evidencing such Offered Certificate. Upon delivery by the Depository to the Trustee of written notice to the effect that the Depository has determined to substitute a new nominee in place of Cede & Co., and subject to the provisions hereof with respect to the payment of interest by the mailing of checks or drafts to the Certificateholders appearing as Certificateholders at the close of business on a Record Date, the name "Cede & Co." in this Agreement shall refer to such new nominee of the Depository. (f) In the event that (i) the Depository or the Servicer advises the Trustee in writing that the Depository is no longer willing or able to discharge properly its responsibilities as nominee and depository with respect to the Offered Certificates and the Servicer or the Depository is unable to locate a qualified successor or (ii) the Trustee at its sole option elects to terminate the book-entry system through the Depository, the Offered Certificates shall no longer be restricted to being registered in the Certificate Register in the name of Cede & Co. (or a successor nominee) as nominee of the Depository. At that time, the Servicer may determine that the Offered Certificates shall be registered in the name of and deposited with a successor depository operating a global book-entry system, as may be acceptable to the Servicer, or such depository's agent or designee but, if the Servicer does not select such alternative global book-entry system, then the Offered Certificates may be registered in whatever name or names Certificateholders transferring Offered Certificates shall designate, in accordance with the provisions hereof; provided, however, that any such reregistration shall be at the expense of the Servicer. 65 (g) Notwithstanding any other provision of this Agreement to the contrary, so long as any Offered Certificate is registered in the name of Cede & Co., as nominee of the Depository, all distributions of principal or interest on such Offered Certificates, as the case may be, and all notices with respect to such Offered Certificates, as the case may be, shall be made and given, respectively, in the manner provided in the Representation Letter. (h) No transfer, sale, pledge or other disposition of any Class R, Class I or Class X Certificate shall be made unless such disposition is made pursuant to an effective registration statement under the Securities Act of 1933, as amended (the "1933 Act") and effective registration or qualification under applicable state securities laws or "Blue Sky" laws, or is made in a transaction that does not require such registration or qualification. In the event that a transfer of a Certificate is to be made in reliance upon an exemption from the 1933 Act, the Trustee or the Certificate Registrar shall require, in order to assure compliance with the 1933 Act, that the Certificateholder desiring to effect such disposition and such Certificateholder's prospective transferee each certify to the Trustee or the Certificate Registrar in writing the facts surrounding such disposition substantially in the form of Exhibit L hereto (with respect to a transfer made pursuant to Rule 144A promulgated under the 1933 Act) and may, unless such transfer occurs more than three years after the Closing Date or is made pursuant to Rule 144A promulgated under the 1933 Act, require an Opinion of Counsel satisfactory to the Trustee or Certificate Registrar as the case may be, that such transfer may be made pursuant to an exemption from the 1933 Act, which Opinion of Counsel shall be at the expense of the Certificateholder. None of the Servicer, the Back-up Servicer, the Depositor, the Unaffiliated Seller or the Trustee is obligated under this Agreement to register Certificates under the 1933 Act, as amended or any other securities law or to take any action not otherwise required under this Agreement to permit the transfer of the Class R, Class I or Class X Certificates without such registration or qualification. Every Certificate presented or surrendered for registration of transfer or exchange shall be accompanied by a written instrument of transfer substantially in the form of Exhibit M hereto, or such other endorsement or written instrument of transfer as is satisfactory to the Trustee, duly executed by the Holder thereof or his attorney duly authorized in writing, together with wiring instructions, if applicable, in the form of Exhibit Q. (i) Any such Certificateholder desiring to effect such transfer shall, and does hereby agree to, indemnify the Trustee, the Depositor, the Unaffiliated Seller, the Certificate Insurer, the Back-up Servicer and the Servicer against any liability that may result if the transfer is not exempt or is not made in accordance with such applicable federal and state laws. Promptly after receipt by an indemnified party under this paragraph of notice of the commencement of any action, such indemnified party will, if a claim in respect thereof is to be made against the indemnifying party under this paragraph, notify the indemnifying party in writing of the commencement thereof; but the omission so to notify the indemnifying party will not relieve it from any liability which it may have to any indemnified party otherwise than under this paragraph. In case any such action is brought against any indemnified party, and it notifies the indemnifying party of the commencement thereof, the indemnifying party will be entitled to appoint counsel reasonably satisfactory to such indemnified party to represent the indemnified party in such action; provided, however, that if the defendants in any such action include both the indemnified party and the indemnifying party and the indemnified party shall have reasonably concluded that there may be legal defenses available to it and/or other indemnified parties which are different from or additional to those available to 66 the indemnifying party, the indemnified party or parties shall have the right to select separate counsel to defend such action on behalf of such indemnified party or parties. Upon receipt of notice from the indemnifying party to such indemnified party of its election so to appoint counsel to defend such action and approval by the indemnified party of such counsel, the indemnifying party will not be liable to such indemnified party under this paragraph for any legal or other expenses subsequently incurred by such indemnified party in connection with the defense thereof unless (i) the indemnified party shall have employed separate counsel in accordance with the proviso of the next preceding sentence (it being understood, however, that the indemnifying party shall not be liable for the expenses of more than one separate counsel for any indemnified party), (ii) the indemnifying party shall not have employed counsel satisfactory to the indemnified party to represent the indemnified party within a reasonable time after notice of commencement of the action or (iii) the indemnifying party has authorized the employment of counsel for the indemnified party at the expense of the indemnifying party. Under no circumstances shall the indemnified party enter into a settlement agreement with respect to any lawsuit, claim or other proceeding without the prior written consent of the indemnifying party. (j) Subject to the restrictions set forth in this Agreement, upon surrender for registration of transfer of any Certificate at the office or agency of the Trustee located in New York, New York, the Trustee shall execute, authenticate and deliver in the name of the designated transferee or transferees, a new Certificate of the same Class and Percentage Interest and dated the date of authentication by the Trustee. At the option of the Certificateholders, Certificates may be exchanged for other Certificates of Authorized Denominations of a like aggregate Percentage Interest, upon surrender of the Certificates to be exchanged at such office. Whenever any Certificates are so surrendered for exchange, the Trustee shall execute, authenticate and deliver the Certificates which the Certificateholder making the exchange is entitled to receive. No service charge shall be made for any transfer or exchange of Certificates, but the Trustee may require payment of a sum sufficient to cover any tax or governmental charge that may be imposed in connection with any transfer or exchange of Certificates. All Certificates surrendered for transfer and exchange shall be cancelled and destroyed by the Trustee in accordance with the Trustee's standard procedures. (k) No transfer of an Offered Certificate shall be made to the Unaffiliated Seller or, to the actual knowledge of a Responsible Officer of the Trustee, to any of the Unaffiliated Seller's Affiliates, successors or assigns. (l) Each Person who has or who acquires any Ownership Interest in a Class R Certificate shall be deemed by the acceptance or acquisition of such Ownership Interest to have agreed to be bound by the following provisions and to have irrevocably appointed the Servicer or its designee as its attorney-in-fact to negotiate the terms of any mandatory sale under clause (viii) below and to execute all instruments of transfer and to do all other things necessary in connection with any such sale, and the rights of each Person acquiring any Ownership Interest in a Class R Certificate are expressly subject to the following provisions: 67 (i) Each Person holding or acquiring any Ownership Interest in a Class R Certificate shall be a Permitted Transferee and a United States Person and shall promptly notify the Trustee of any change or impending change in its status as either a United States Person or a Permitted Transferee. (ii) In connection with any proposed Transfer of any Ownership Interest in a Class R Certificate, the Trustee shall require delivery to it of, and shall not register the Transfer of any Class R Certificate until its receipt of, an affidavit and agreement (a "Transfer Affidavit and Agreement") attached hereto as Exhibit L from the proposed Transferee, in form and substance satisfactory to the Trustee. (iii) The Trustee will register the Transfer of any Class R Certificate only if it shall have received the Transfer Affidavit and Agreement and all of such other documents as shall have been reasonably required by the Trustee as a condition to such registration. In addition, no Transfer of a Class R Certificate shall be made unless the Trustee shall have received a representation letter from the Transferee of such Certificate to the effect that such Transferee is a United States Person and is not a "disqualified organization" (as defined in Section 860E(e)(5) of the Code). (iv) Notwithstanding the delivery of a Transfer Affidavit and Agreement by a proposed Transferee under clause (ii) above, if a Responsible Officer of the Trustee has actual knowledge that the proposed Transferee is not a Permitted Transferee, no Transfer of an Ownership Interest in a Class R Certificate to such proposed Transferee shall be effected. (v) Each Person holding or acquiring any Ownership Interest in a Class R Certificate shall agree (A) to require a Transfer Affidavit and Agreement from any other Person to whom such Person attempts to transfer its Ownership Interest in a Class R Certificate (B) to require a Transfer Affidavit and Agreement from any Person for whom such Person is acting as nominee, trustee or agent in connection with any transfer of its Ownership Interest in a Class R Certificate, (C) not to transfer any Ownership Interest in a Class R Certificate to any other Person (1) if it has actual knowledge that such Person is not a Permitted Transferee or that such Transfer Affidavit and Agreement is false, (2) if such transfer is for the purpose of impeding the assessment or collection of tax, (3) if it has actual knowledge or reason to know that the proposed transferee would be unwilling or unable to pay taxes attributed to the Class R Certificate, or (4) if it has actual knowledge or reason to know that the proposed transferee will not honor the restrictions on subsequent transfers of the Class R Certificate set forth in this section 4.02(l) and in the Transfer Affidavit and Agreement, (D) to conduct a reasonable investigation of the financial condition of the proposed transferee and transfer its Ownership Interest in the Class R Certificate only if, as a result of such investigation, it concludes that the proposed transferee has historically paid its debts as they came due and will continue to pay its debts as they come due in the future, and (E) to provide a certificate attached hereto as Exhibit M to the Trustee in connection with any transfer of its Ownership Interest in a Class R Certificate. 68 (vi) Each Person holding or acquiring an Ownership Interest in a Class R Certificate, by purchasing an Ownership Interest in such Certificate, agrees to give the Trustee written notice that it is a "pass-through interest holder" within the meaning of temporary Treasury regulation Section 1.67-3T(a)(2)(i)(A) immediately upon acquiring an Ownership Interest in a Class R Certificate, if it is, or is holding an Ownership Interest in a Class R Certificate on behalf of, a "pass-through interest holder". (vii) Any attempted or purported transfer of any Ownership Interest in a Class R Certificate in violation of the provisions of this Section 4.02 shall be absolutely null and void and shall vest no rights in the purported transferee. If any purported transferee shall become a Holder of a Class R Certificate in violation of the provisions of this Section 4.02, then the last preceding Permitted Transferee shall be restored to all rights as Holder thereof retroactive to the date of registration of transfer of such Class R Certificate. The Trustee shall notify the Servicer upon receipt of written notice or discovery by a Responsible Officer that the registration of transfer of a Class R Certificate was not in fact permitted by this Section 4.02. Knowledge shall not be imputed to the Trustee with respect to an impermissible transfer in the absence of such a written notice or discovery by a Responsible Officer. The Trustee shall be under no liability to any Person for any registration of transfer of a Class R Certificate that is in fact not permitted by this Section 4.02 or for making any payments due on such Certificate to the Holder thereof or taking any other action with respect to such Holder under the provisions of this Agreement so long as the transfer was registered after receipt of the related Transfer Affidavit and Agreement. The Trustee shall be entitled, but not obligated to, recover from any Holder of a Class R Certificate that was in fact not a Permitted Transferee at the time it became a Holder or, at such subsequent time as it became other than a Permitted Transferee, all payments made on such Class R Certificate at and after either such time and any and all costs incurred by the Trustee in reversing the non-permitted transfer. Any such payments so recovered by the Trustee shall be paid and delivered by the Trustee to the last preceding Holder of such Certificate. (viii) If any purported transferee shall become a Holder of a Class R Certificate in violation of the restrictions in this Section 4.02, then the Servicer or its designee shall have the right, without notice to the Holder or any prior Holder of such Class R Certificate, to sell such Class R Certificate to a purchaser selected by the Servicer or its designee on such reasonable terms as the Servicer or its designee may choose. Such purchaser may be the Servicer itself or any Affiliate of the Servicer. The proceeds of such sale, net of commissions, expenses and taxes due, if any, will be remitted by the Servicer to the last preceding purported transferee of such Class R Certificate, except that in the event that the Servicer determines that the Holder or any prior Holder of such Class R Certificate may be liable for any amount due under this Section 4.02 or any other provision of this Agreement, the Servicer may withhold a corresponding amount from such remittance as security for such claim. The terms and conditions of any sale under this clause (viii) shall be determined in the sole discretion of the Servicer or its designee, and it shall not be liable to any Person having an Ownership Interest in a Class R Certificate as a result of its exercise of such discretion. 69 (m) The provisions of Section 4.02(l) may be modified, added to or eliminated, provided that there shall have been delivered to the Trustee and the Certificate Insurer an Opinion of Counsel to the effect that such modification of, addition to or elimination of such provisions will not cause the transfer to be disregarded under Treasury Regulation ss.1.860E-1(c), will not cause any of the REMICs included in the Trust Fund to cease to qualify as a REMIC and will not cause (x) any of the REMICs included in the Trust Fund to be subject to an entity-level tax caused by the Transfer of any Ownership Interest in a Class R Certificate to a Person that is not a Permitted Transferee or (y) a Person other than the prospective transferee to be subject to a REMIC-related tax caused by the Transfer of an Ownership Interest in a Class R Certificate to a Person that is not a Permitted Transferee. (n) The Trustee and the Servicer shall require the prospective transferee of any Class R, Class I or Class X Certificate to certify (in the form of Exhibit N hereto) that it is not a pension or benefit plan or individual retirement arrangement that is subject to the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), or to Section 4975 of the Code (a "Plan") or an entity whose underlying assets are deemed to be assets of a Plan by reason of such plan's or arrangement's investment in the entity, as determined under U.S. Department of Labor Regulations 29 C.F.R. ss. 2510.3-101 or otherwise. Section 4.03 Mutilated, Destroyed, Lost or Stolen Certificates. If (a) any mutilated Certificate is surrendered to the Trustee, or the Trustee receives evidence to its satisfaction of the destruction, loss or theft of any Certificate, and (b) there is delivered to the Servicer, the Certificate Insurer and the Trustee such security or indemnity as may reasonably be required by each of them to save each of them harmless, then, in the absence of notice to the Servicer and the Trustee that such Certificate has been acquired by a bona fide purchaser, the Trustee shall execute, authenticate and deliver, in exchange for or in lieu of any such mutilated, destroyed, lost or stolen Certificate, a new Certificate of like tenor and Percentage Interest, but bearing a number not contemporaneously outstanding. Upon the issuance of any new Certificate under this Section 4.03, the Servicer and the Trustee may require the payment of a sum sufficient to cover any tax or other governmental charge that may be imposed in relation thereto and their fees and expenses connected therewith. Any duplicate Certificate issued pursuant to this Section 4.03 shall constitute complete and indefeasible evidence of ownership in the Trust Fund, as if originally issued, whether or not the mutilated, destroyed, lost or stolen Certificate shall be found at any time. Section 4.04 Persons Deemed Owners. Prior to due presentation of a Certificate for registration of transfer and subject to the provisions of Section 4.02 and Article X, the Servicer, the Back-up Servicer, the Depositor, the Unaffiliated Seller, the Certificate Insurer and the Trustee may treat the Person in whose name any Certificate is registered as the owner of such Certificate for the purpose of receiving remittances pursuant to Section 6.05 and for all other purposes whatsoever, and the Servicer, the Back-up Servicer, the Depositor, the Unaffiliated Seller, the Certificate Insurer and the Trustee shall not be affected by notice to the contrary. 70 ARTICLE V ADMINISTRATION AND SERVICING OF THE MORTGAGE LOANS Section 5.01 REMIC Matters; The Servicer. (a) The parties intend that the Trust Fund formed hereunder shall, except for the Pre-Funding Account, if any, the Capitalized Interest Account, if any, the Net WAC Cap Carryover Fund, the Special Reserve Account, the Interest Rate Hedge Agreement and the Interest Rate Hedge Payment Fund, constitute, and that the affairs of the Trust Fund shall be conducted and this Agreement shall be construed so as to qualify the Trust Fund as, four separate "real estate mortgage investment conduits" as defined in and in accordance with the REMIC Provisions. In furtherance of such intention, the Servicer covenants and agrees that it shall, to the extent permitted by applicable law, act as agent (and the Servicer is hereby appointed to act as agent) on behalf of the Trust Fund and that in such capacity it shall: (a) prepare and file, or cause to be prepared and filed, all required federal, state and local tax returns for each REMIC using a calendar year as the taxable year for the Trust Fund when and as required by the REMIC Provisions and other applicable federal, state and local income tax laws; (b) maintain or cause the maintenance of the books of each REMIC on the accrual method of accounting; (c) make elections, on behalf of each REMIC, to be treated as a REMIC on the federal tax return of the Trust Fund for its first taxable year, in accordance with the REMIC Provisions; provided, however, that such election shall not be made with respect to the Pre-Funding Account, if any, the Capitalized Interest Account, if any, the Net WAC Cap Carryover Fund, the Special Reserve Account, the Interest Rate Hedge Payment Fund and the Interest Rate Hedge Agreement and shall specifically exclude the Pre-Funding Account, if any, the Capitalized Interest Account, if any, the Net WAC Cap Carryover Fund, the Special Reserve Account, the Interest Rate Hedge Payment Fund and the Interest Rate Hedge Payment Agreement from the assets for which a REMIC election is made; (d) prepare and forward, or cause to be prepared and forwarded, to the Certificateholders all information reports as and when required to be provided to them in accordance with the REMIC Provisions; (e) conduct the affairs of each REMIC at all times that any Certificates are outstanding so as to maintain the status thereof as a REMIC under the REMIC Provisions; and (f) not knowingly or intentionally take any action or omit to take any action that would cause the termination of the REMIC status of any REMIC created hereunder. (b) The Capitalized Interest Account, if any, the Net WAC Cap Carryover Fund and the Interest Rate Hedge Payment Fund are each an "outside reserve" fund within the meaning of Treasury Regulations Section 1.860G-2(h) and is not an asset of any REMIC created hereunder. The Unaffiliated Seller is the owner of the Capitalized Interest Account, if any, the Holder of the Class X Certificates is the owner of the Net WAC Cap Carryover Fund and the Holder of the Class I Certificates is the owner of the Interest Rate Hedge Payment Fund for purposes of Treasury Regulations Section 1.860G-2(h). For all federal income tax purposes, amounts transferred by the Capitalized Interest Account, if any, to REMIC III, if any, will be treated as amounts contributed by the Unaffiliated Seller to REMIC III. (c) In the event that any income tax (including any tax with regard to "prohibited transactions" of any REMIC created hereunder as defined in Section 860F of the Code) is imposed on the Trust Fund, such tax shall be charged against amounts otherwise distributable to the Holders of the Class R or Class X Certificates on a pro rata basis to the extent hereinafter provided. In the event that any such tax shall be due and owing at a time when amounts otherwise distributable to the Holders of the Class R or Class X Certificates are not available, the Servicer shall pay such tax from its own funds. In such event, and upon receipt of written instruction from the Servicer, signed by a Responsible Officer, the Trustee is hereby authorized to retain from amounts otherwise distributable to the Holders of the Class R and Class X Certificates on any Distribution Date sufficient funds to reimburse the Servicer for the payment of such tax (but such obligation shall not prevent the Trustee or any other appropriate Person from contesting any such tax in appropriate proceedings and shall prevent the Trustee from withholding payment of such tax, if permitted by law, pending the outcome of such proceedings). 71 (d) The Servicer shall service and administer the Mortgage Loans in the best interests of and for the benefit of the Certificateholders in accordance with the Accepted Servicing Practices and shall have full power and authority to do any and all things not inconsistent therewith in connection with such servicing and administration which it may deem necessary or desirable in order to maximize collections on the Mortgage Loans, subject to the limitations set forth in this Agreement. The Trustee shall furnish the Servicer with any powers of attorney and other documents necessary or appropriate to enable the Servicer to carry out its servicing and administrative duties hereunder. Without limiting the generality of the foregoing, the Servicer shall continue, and is hereby authorized and empowered by the Trustee, to execute and deliver, on behalf of itself, the Certificateholders, the Certificate Insurer and the Trustee or any of them, any and all instruments of satisfaction or cancellation, or of partial or full release or discharge and all other comparable instruments, and to effect such modifications, waivers, indulgences and other like matters as are in its judgment necessary or desirable, with respect to the Mortgage Loans and the Mortgaged Properties and the servicing and administration thereof in order to maximize collections on the Mortgage Loans subject to the limitations set forth in this Agreement. The Servicer shall notify the Trustee of any such waiver, release, discharge, modification, indulgence or other such matter by delivering to the Trustee an Officer's Certificate certifying that such agreement is in compliance with this Section 5.01(d) together with the original copy of any written agreement or other document executed in connection therewith, all of which written agreements or documents shall, for all purposes, be considered a part of the related Mortgage File to the same extent as all other documents and instruments constituting a part thereof. Notwithstanding anything in this Agreement to the contrary, the Servicer shall not (i) permit any modification with respect to any Mortgage Loan that would change the Mortgage Interest Rate, reduce or increase the principal balance, change the lien priority, the original CLTV or change the final maturity date on or of such Mortgage Loan unless (A) the Mortgagor is in default with respect to the Mortgage Loan or such default is, in the judgment of the Servicer, imminent and (B) the Certificate Insurer consents to such modifications in writing; provided, however, that the Servicer shall be permitted to extend the final maturity date of any Mortgage Loan by 180 days or less without the consent of the Certificate Insurer, so long as such final maturity date (as so extended) is not later than the latest Final Scheduled Maturity Date for any outstanding Class of Offered Certificates or (ii) permit any modification, waiver or amendment of any term of any Mortgage Loan that would both (A) effect an exchange or reissuance of such Mortgage Loan under Section 1001 of the Code (or Treasury regulations promulgated thereunder) and (B) cause any REMIC created hereunder to fail to qualify as a REMIC under the Code or the imposition of any tax on "prohibited transactions" or "contributions after the startup date" under the REMIC Provisions. 72 (e) The relationship of the Servicer (and of any successor to the Servicer as servicer under this Agreement) to the Trustee under this Agreement is intended by the parties to be that of an independent contractor and not that of a joint venturer, partner or agent. Section 5.02 Collection of Certain Mortgage Loan Payments; Collection Account. (a) The Servicer shall make reasonable efforts to collect all payments called for under the terms and provisions of the Mortgage Loans, and shall, to the extent such procedures shall be consistent with this Agreement, follow the Accepted Servicing Practices. Consistent with the foregoing, the Servicer may in its discretion waive any assumption fees or other fees which may be collected in the ordinary course of servicing such Mortgage Loans. (b) The Servicer shall establish and maintain in the name of the Trustee the Collection Account, in trust for the benefit of the Certificateholders and the Certificate Insurer. The Collection Account shall be established and maintained as an Eligible Account. (c) The Servicer shall deposit in the Collection Account any amounts representing Monthly Payments on the Mortgage Loans due and accrued or to be applied as of a date after the respective Cut-Off Date, and thereafter, on each Business Day (except as otherwise permitted herein), the following payments and collections received or made by it (other than in respect of principal collected and interest due and accrued on the Mortgage Loans on or before the respective Cut-Off Date): (i) Payments of interest on the Mortgage Loans; (ii) Payments of principal of the Mortgage Loans; (iii) The Loan Repurchase Price of Mortgage Loans repurchased pursuant to Sections 2.06, 3.03, 5.05, 5.15 or otherwise hereunder; (iv) The Substitution Adjustment received in connection with Mortgage Loans for which Qualified Substitute Mortgage Loans are received pursuant to Sections 2.06 and 3.03; (v) All Liquidation Proceeds; and (vi) All Insurance Proceeds (including, for this purpose, any amounts required to be deposited by the Servicer pursuant to the last sentence of Section 5.04). It is understood that the Servicer need not deposit amounts representing fees, prepayment premiums, late payment charges or extension or other administrative charges payable by Mortgagors, or amounts received by the Servicer for the account of Mortgagors for application towards the payment of taxes, insurance premiums, assessments and similar items. (d) The Trustee shall invest any funds in the Collection Account in Permitted Investments as directed in writing by the Servicer, which shall mature not later than the Business Day next preceding the Servicer Remittance Date next following the date of such investment (except that any investment held by the Trustee may mature on such Servicer Remittance Date) and shall not be sold or disposed of prior to its maturity. All net income and gain realized from any such investment shall be for the benefit of the Servicer and shall be subject to its withdrawal or order on a Distribution Date. The Servicer shall deposit from its own funds the amount of any loss, to the extent not offset by investment income or earnings, in the Collection Account upon the realization of such loss. In the event that the Servicer fails to provide written investment instructions, the Trustee shall invest such funds pursuant to clause (v) of the definition of Permitted Investments. 73 Section 5.03 Permitted Withdrawals from the Collection Account. The Trustee shall make withdrawals from the Collection Account, on any Distribution Date, for the following purposes: (a) to reimburse the Servicer for Liquidation Expenses theretofore incurred in respect of any Mortgage Loan in an amount not to exceed the amount of the sum of the related Insurance Proceeds and Liquidation Proceeds deposited in the Collection Account pursuant to Section 5.02(c)(v)-(vi); (b) to reimburse the Servicer for amounts expended by it pursuant to Section 5.04 in good faith in connection with the restoration of damaged property, in an amount not to exceed the amount of the related Insurance Proceeds and Liquidation Proceeds (net of withdrawals pursuant to clause (a) above) and amounts representing proceeds of other insurance policies covering the property subject to the related Mortgage deposited in the Collection Account pursuant to Section 5.02(c)(v)-(vi); (c) to pay to the Unaffiliated Seller amounts received in respect of any Deleted Mortgage Loan purchased or substituted for by the Unaffiliated Seller to the extent that the distribution to the Certificateholders of any such amounts on the Distribution Date upon which the proceeds of such purchase are distributed to the Certificateholders would make the total amount distributed in respect of any such Mortgage Loan on such Distribution Date greater than the Loan Repurchase Price or the Substitution Adjustment therefor; (d) to reimburse the Servicer for unreimbursed Servicing Advances, without interest, with respect to the Mortgage Loans for which it has made a Servicing Advance, from subsequent collections with respect to interest on such Mortgage Loans and from Liquidation Proceeds, Insurance Proceeds and/or the Loan Repurchase Price or Substitution Adjustment of or relating to such Mortgage Loans; (e) to reimburse the Servicer for any Periodic Advances, such reimbursement to be made from any collections in respect of the related Mortgage Loan with respect to which such Periodic Advance was made; (f) to withdraw any amount received from a Mortgagor that is recoverable and sought to be recovered as a voidable preference by a trustee in bankruptcy pursuant to the United States Bankruptcy Code in accordance with a final, nonappealable order of a court having competent jurisdiction; (g) to withdraw any funds deposited in the Collection Account that were not required to be deposited therein; 74 (h) to pay the Servicer Servicing Compensation pursuant to Section 5.08 hereof to the extent not retained or paid; and (i) to remit funds to the Distribution Account pursuant to Section 6.01(c) hereof. The Servicer shall keep and maintain a separate accounting for each Mortgage Loan for the purpose of accounting for withdrawals from the Collection Account pursuant to subclause (a). Section 5.04 Hazard Insurance Policies; Property Protection Expenses. (a) The Servicer shall cause to be maintained for each Mortgage Loan a hazard insurance policy with extended coverage which contains a standard mortgagee's clause with an appropriate endorsement in an amount equal to the lesser of (a) the maximum insurable value of the related Mortgaged Property or (b) the sum of the Principal Balance of such Mortgage Loan plus the outstanding balance of any mortgage loan senior to such Mortgage Loan, but in no event shall such amount be less than is necessary to prevent the Mortgagor from becoming a coinsurer thereunder. The Servicer shall also maintain on property acquired upon foreclosure, or by deed in lieu of foreclosure, hazard insurance with extended coverage in an amount which is at least equal to the lesser of (i) the maximum insurable value from time to time of the improvements which are a part of such property or (ii) the combined Principal Balance of such Mortgage Loan and the principal balance of any mortgage loan senior to such Mortgage Loan at the time of such foreclosure plus accrued interest and the good-faith estimate of the Servicer of related Liquidation Expenses to be incurred in connection therewith. Amounts collected by the Servicer under any such policies shall be deposited in the Collection Account to the extent that they constitute Liquidation Proceeds or Insurance Proceeds. Each hazard insurance policy shall contain a standard mortgage clause naming the Originator, its successors and assigns, as mortgagee. Subject to Section 5.04(c), the Servicer shall be under no obligation to require that any Mortgagor maintain earthquake or flood or other additional insurance and shall be under no obligation itself to maintain any such additional insurance on property acquired in respect of a Mortgage Loan, other than pursuant to such applicable laws and regulations as shall at any time be in force and as shall require such additional insurance. (b) If the Servicer shall obtain and maintain a blanket policy issued by an insurer acceptable to the Rating Agencies and the Certificate Insurer insuring against hazard losses on all of the Mortgage Loans, it shall conclusively be deemed to have satisfied its obligations as set forth in Section 5.04(a), it being understood and agreed that such policy may contain a deductible clause, in which case the Servicer shall, in the event that there shall not have been maintained on the related Mortgaged Property a policy complying with Section 5.04(a), and there shall have been a loss which would have been covered by such policy, deposit in the Collection Account the amount not otherwise payable under the blanket policy because of such deductible clause. (c) If the Mortgaged Property or REO Property is located at the time of origination of the Mortgage Loan in a federally designated special flood hazard area (and if the flood insurance policy referenced herein has been made available), the Servicer will cause to be maintained flood insurance in respect thereof. Such flood insurance shall be in an amount equal to the lesser of (i) the Principal Balance of the related Mortgage Loan and the balance of the related first lien, if any, (ii) the maximum insurable value of the related Mortgaged Property, and (iii) the maximum amount of such insurance available for the related Mortgaged Property under the national flood insurance program (assuming that the area in which such Mortgaged Property is located is participating in such program). Upon the written request of the Trustee or the Certificate Insurer, the Servicer shall provide copies of such policies to the Trustee or the Certificate Insurer, as applicable. 75 Section 5.05 Assumption and Modification Agreements. In any case in which a Mortgaged Property has been or is about to be conveyed by the Mortgagor, the Servicer shall exercise its right to accelerate the maturity of the related Mortgage Loan and require that the Principal Balance thereof be paid in full on or prior to such conveyance by the Mortgagor under any "due-on-sale" clause applicable thereto. If such "due-on-sale" clause, by its terms, is not operable or the Servicer is prevented, as provided in the last paragraph of this Section 5.05, from enforcing any such clause, the Servicer is authorized, subject to the consent of the Certificate Insurer, to take or enter into an assumption and modification agreement from or with the Person to whom such property has been or is about to be conveyed, pursuant to which such Person becomes liable under the Mortgage Note and the Mortgagor remains liable thereon or, if the Servicer in its reasonable judgment finds it appropriate, is released from liability thereon. The Servicer shall notify the Trustee, the Certificate Insurer and the Collateral Agent that any assumption and modification agreement has been completed by delivering to the Trustee and the Certificate Insurer an Officer's Certificate certifying that such agreement is in compliance with this Section 5.05 together with the original copy of such assumption and modification agreement. Any such assumption and modification agreement shall, for all purposes, be considered a part of the related Mortgage File to the same extent as all other documents and instruments constituting a part thereof. In connection with any such agreement, the then current Mortgage Interest Rate thereon shall not be increased or decreased. Any fee collected by the Servicer for entering into any such agreement will be retained by the Servicer as additional servicing compensation. At its sole election, the Servicer may purchase from the Trust Fund any Mortgage Loan that has been assumed in accordance with this Section 5.05 within one month after the date of such assumption at a price equal to the greater of (i) the fair market value of such Mortgage Loan (as determined by the Servicer in its good faith judgment) and (ii) the Loan Repurchase Price. Such amount, if any, shall be deposited into the Collection Account in the Due Period in which such repurchase is made. Notwithstanding the foregoing paragraph of this Section 5.05 or any other provision of this Agreement, the Servicer shall not be deemed to be in default, breach or any other violation of its obligations hereunder by reason of any assumption of a Mortgage Loan, or transfer of any Mortgaged Property without the assumption thereof, by operation of law or any assumption or transfer which the Servicer reasonably believes it may be restricted by law from preventing for any reason whatsoever. 76 Section 5.06 Realization Upon Defaulted Mortgage Loans. (a) The Servicer shall foreclose upon or otherwise comparably convert to ownership Mortgaged Properties securing such of the Mortgage Loans as come into and continue in default and as to which no satisfactory arrangements can be made for collection of delinquent payments pursuant to Section 5.02(a). Prior to conducting any sale in a foreclosure proceeding or recording a deed-in-lieu of foreclosure with respect to any Mortgaged Property, the Servicer shall cause an environmental review to be performed, in accordance with Accepted Servicing Practices on the Mortgaged Property by a company such as Equifax, Inc. or Toxicheck. In connection with such foreclosure or other conversion, the Servicer shall follow such practices (including, in the case of any default on a related senior mortgage loan, the advancing of funds to correct such default) and procedures which are consistent with Accepted Servicing Practices as it shall deem necessary or advisable and as shall be normal and usual in its general first and second mortgage loan servicing activities. If the Servicer determines, as described above, that it is in the best economic interest of the Trust Fund to take such actions as are necessary to bring any such Mortgaged Property into compliance with applicable environmental laws, or to take such action with respect to the containment, clean-up or remediation of hazardous substances, hazardous materials, hazardous wastes or petroleum-based materials affecting any such Mortgaged Property, then the Servicer shall take such action as it deems to be in the best economic interest of the Trust Fund. The foregoing is subject to the proviso that the Servicer shall not be required to expend its own funds in connection with any foreclosure or towards the correction of any default on a related senior mortgage loan or restoration of any property unless, in the reasonable judgment of the Servicer, such expenses will be recoverable from Liquidation Proceeds. Notwithstanding the foregoing, if such environmental audit reveals, or if the Servicer has actual knowledge or notice, that such Mortgaged Property contains such wastes or substances, the Servicer shall not foreclose or accept a deed in lieu of foreclosure without the prior written consent of the Certificate Insurer. (b) In the event that title to any Mortgaged Property is acquired in foreclosure or by deed in lieu of foreclosure, the deed or certificate of sale shall be issued to the Trustee, or to its nominee on behalf of Certificateholders and the Certificate Insurer. With respect to any REO Property, the Servicer either itself or through an agent selected by the Servicer shall manage, conserve, protect and operate such REO Property in the same manner and to such extent as is customary in the locality where such REO Property is located. Any net income generated from the REO Property and the proceeds from a sale of any REO Property shall be deposited in the Collection Account. Any expenses incurred by the Servicer pursuant to its obligations with respect to any REO Property shall constitute Servicing Advances. In the event that the Trust Fund acquires any Mortgaged Property as aforesaid or otherwise in connection with a default or imminent default on a Mortgage Loan, the Servicer shall (i) with respect to any REO Property held for a period of one year or more, the Servicer, at the written direction of the Certificate Insurer, will write-off the balance of the related Mortgage Loan and treat it as a Liquidated Mortgage Loan and (ii) either (x) dispose of such Mortgaged Property prior to the end of the third taxable year after its acquisition by the Trust Fund or (y) in its capacity as Tax Matters Person, request more than 60 days prior to the date on which such 3 year period would otherwise expire, an extension of the 3 year period; provided, however, that in the event the Servicer shall have furnished the Trustee and the Certificate Insurer with an Opinion of Counsel to the effect that the holding by the Trust Fund of such Mortgaged Property subsequent to the third taxable year after its acquisition will not result in the imposition of taxes on "prohibited transactions" of the Trust Fund as defined in Section 860F of the Code or cause the Trust Fund to fail to qualify as a REMIC at any time that any Certificates are outstanding, such disposition or extension shall not be required. 77 (c) Any Insurance Proceeds or Liquidation Proceeds received with respect to a Mortgage Loan or REO Property (other than received in connection with a purchase by the Servicer of all the Mortgage Loans and REO Properties in the Trust Fund pursuant to Section 8.01(b)) will be applied in the following order of priority, in each case to the extent of available funds: first, to pay the Servicer any accrued and unpaid Servicing Fees relating to such Mortgage Loan; second, to reimburse the Servicer or any Subservicer for any related unreimbursed Servicing Advances, and any related unreimbursed Periodic Advances theretofore funded by the Servicer or any Subservicer from its own funds, in each case, with respect to the related Mortgage Loan; third, to accrued and unpaid interest on the Mortgage Loan, at the Mortgage Interest Rate (or at such lesser rate as may be in effect for such Mortgage Loan pursuant to application of the Civil Relief Act) on the Principal Balance of such Mortgage Loan, to the date such Mortgage Loan is determined to be a Liquidated Mortgage Loan if it is a Liquidated Mortgage Loan, or to the Due Date in the Due Period prior to the Distribution Date on which such amounts are to be distributed if such determination has not yet been made, minus any unpaid Servicing Fees with respect to such Mortgage Loan; fourth, to the extent of the Principal Balance of the Mortgage Loan outstanding immediately prior to the receipt of such proceeds, as a recovery of principal of the related Mortgage Loan; and fifth, to any prepayment or late payment charges or penalty interest payable in connection with the receipt of such proceeds and to all other fees and charges due and payable with respect to such Mortgage Loan. The amount of any gross Insurance Proceeds and Liquidation Proceeds received with respect to any Mortgage Loan or REO Property minus the amount of any unreimbursed Servicing Advances, unreimbursed Periodic Advances or unpaid Servicing Fees, in each case, with respect to the related Mortgage Loan, are the "Net Recovery Proceeds" with respect to such Mortgage Loan or REO Property. (d) The Servicer shall manage, conserve, protect and operate each REO Property for the Certificateholders solely for the purpose of its prompt disposition and sale in a manner which does not cause such REO Property to fail to qualify as "foreclosure property" within the meaning of Section 860G(a)(8) of the Code or result in the receipt by any of the REMICs created hereunder of any "income from non-permitted assets" within the meaning of Section 860F(a)(2)(B) of the Code, or any "net income from foreclosure property" which is subject to taxation under the REMIC Provisions. Section 5.07 Trustee to Cooperate. Upon the payment in full of the Principal Balance of any Mortgage Loan, the Servicer will notify the Trustee by a certification (which certification shall include a statement to the effect that all amounts received in connection with such payment which are required to be deposited in the Collection Account pursuant to Section 5.02 have been so deposited) of a Servicing Officer. Upon any such payment in full, the Servicer is authorized to execute, pursuant to the authorization contained in Section 5.01, an instrument of satisfaction regarding the related Mortgage, which instrument of satisfaction shall be recorded by the Servicer if required by applicable law and be delivered to the Person entitled thereto, it being understood and agreed that no expenses incurred in connection with such instrument of satisfaction shall be reimbursed from the Collection Account. From time to time and as appropriate for the servicing or foreclosure of any Mortgage Loan, the Collateral Agent on behalf of the Trustee shall, upon request of the Servicer and delivery to the Trustee of a trust receipt signed by a Servicing Officer, release the related Mortgage File to the Servicer and shall execute such documents as shall be necessary for the prosecution of any such proceedings. Such trust receipt shall obligate the Servicer to return the Mortgage File to the Collateral Agent on behalf of the Trustee when the need therefor by the Servicer no longer exists unless the Mortgage Loan shall be liquidated, in which case, upon receipt of a certificate of a Servicing Officer similar to that hereinabove specified, the trust receipt shall be released by the Collateral Agent on behalf of the Trustee to the Servicer. 78 Section 5.08 Servicing Compensation; Payment of Certain Expenses by Servicer. On each Distribution Date, the Servicer shall be entitled to receive, and the Trustee shall pay in the event such servicing compensation is not retained by the Servicer, out of collections on the Mortgage Loans for the Due Period, as servicing compensation for such Due Period, an amount (the "Monthly Servicing Fee") equal to the product of one-twelfth of the Servicing Fee. Additional servicing compensation in the form of assumption fees, late payment charges or extension and other administrative charges shall be retained by the Servicer. The Servicer shall be required to pay all expenses incurred by it in connection with its activities hereunder (including payment of all fees and expenses of the Subservicer and payment of the Trustee Fee to the extent that monies in the Collection Account are insufficient therefor, as provided in Section 9.05 hereof, and all other fees and expenses not expressly stated hereunder to be payable by or from another source) and shall not be entitled to reimbursement therefor except as specifically provided herein. Section 5.09 Annual Statement as to Compliance. The Servicer will deliver to the Depositor, the Trustee, the Rating Agencies, the Certificate Insurer and each Certificateholder, on or before April 30 of each year, beginning April 30, 2004, an Officer's Certificate of the Servicer stating that (a) a review of the activities of the Servicer during the preceding calendar year and of its performance under this Agreement has been made under such Responsible Officer's supervision and (b) to the best of such officer's knowledge, based on such review, the Servicer has fulfilled all its material obligations under this Agreement throughout such year, or, if there has been a default in the fulfillment of any such obligation, specifying each such default known to such officer and the nature and status thereof. Section 5.10 Annual Independent Public Accountants' Servicing Report. On or before April 30 of each year, beginning April 30, 2004, the Servicer at its expense shall cause a firm of independent public accountants that is a member of the American Institute of Certified Public Accountants (who may also render other services to the Servicer) to furnish a report to the Depositor, the Trustee, the Rating Agencies, the Certificate Insurer and each Certificateholder to the effect that such firm has examined certain documents and records relating to the servicing of mortgage loans under pooling and servicing agreements (including this Agreement) substantially similar to this Agreement, and that such examination, which has been conducted substantially in compliance with the Uniform Single Attestation Program for Mortgage Bankers (to the extent that the procedures in such audit guide are applicable to the servicing obligations set forth in such agreements), has disclosed no items of noncompliance with the provisions of this Agreement which, in the opinion of such firm, are material, except for such items of noncompliance as shall be set forth in such report. Section 5.11 Access to Certain Documentation. Each of the Servicer, the Depositor and the Unaffiliated Seller shall permit the designated agents or representatives of each Certificateholder, the Certificate Insurer and the Trustee (i) to examine and make copies of and abstracts from all books, records and documents (including computer tapes and disks) in the possession or under the control of the Servicer, the Depositor or the Unaffiliated Seller relating to the Mortgage Loans and (ii) to visit the offices and properties of the Servicer and of the Unaffiliated Seller for the purpose of examining such materials and to discuss matters relating to the Mortgage Loans and the Servicer's, the Depositor's and the Unaffiliated Seller's performance under this Agreement with any of the officers or employees of the Servicer, the Depositor and the Unaffiliated Seller having knowledge thereof and with the independent public accountants of the Servicer (and by this provision the Servicer and the Unaffiliated Seller each authorize their respective accountants to discuss their respective finances and affairs), all at such reasonable times, as often as may be reasonably requested and without charge to such Certificateholder or the Trustee. 79 Section 5.12 Maintenance of Fidelity Bond. The Servicer shall during the term of its service as servicer maintain in force a fidelity bond and errors and omissions insurance in respect of its officers, employees or agents. Such bond and insurance shall comply with the requirements from time to time of the FNMA for Persons performing servicing for mortgage loans purchased by such association. Section 5.13 The Subservicers. The parties acknowledge that the Servicer intends to appoint the Subservicers as the Servicer's agents for the purpose of servicing on the Servicer's behalf such of the Mortgage Loans as were originated by such subservicer. The Servicer agrees to cause the Subservicers to service such Mortgage Loans in a manner consistent with the Accepted Servicing Practices set forth in this Agreement, and agrees that receipt by the Subservicers of any and all amounts which by the terms hereof are required to be deposited in the Collection Account shall constitute receipt thereof by the Servicer for all purposes hereof as of the date so received by the Subservicers. Notwithstanding such designation of the Subservicers, the Servicer agrees that it is, and it shall remain, fully obligated under the terms hereof as Servicer with respect to all such Mortgage Loans, and nothing herein shall relieve or release the Servicer from its obligations to the other parties hereto to service such Mortgage Loans in the manner provided in this Agreement. Section 5.14 Reports to the Trustee; Collection Account Statements. Not later than fifteen (15) days after each Distribution Date, the Servicer shall provide to the Trustee and the Certificate Insurer a statement, certified by a Servicing Officer, setting forth the status of the Collection Account as of the close of business on the related Distribution Date, stating that all distributions required by this Agreement to be made by the Servicer on behalf of the Trustee have been made (or if any required distribution has not been made by the Servicer, specifying the nature and status thereof) and showing, for the period covered by such statement, the aggregate of deposits into and withdrawals from the Collection Account for each category of deposit specified in Section 5.02 and each category of withdrawal specified in Section 5.03 and the aggregate of deposits into the Collection Account as specified in Section 6.01(c). Such statement shall also state the aggregate unpaid principal balance of all the Mortgage Loans as of the close of business on the last day of the month preceding the month in which such Distribution Date occurs. Copies of such statement shall be provided by the Trustee to any Certificateholder upon request. 80 Section 5.15 Optional Purchase of Defaulted Mortgage Loans. (a) The Unaffiliated Seller, in its sole discretion, shall have the right, after the aggregate Principal Balance of defaulted Mortgage Loans exceeds 1.50% of the Maximum Pool Principal Balance, to elect (by written notice sent to the Trustee and the Certificate Insurer), but shall not be obligated, to purchase for its own account from the Trust Fund any Mortgage Loan which is one hundred and eighty (180) days or more Delinquent in the manner and at the price specified in Section 2.06(c). The purchase price for any Mortgage Loan purchased hereunder shall be deposited in the Collection Account and the Trustee, upon receipt of such deposit, shall release or cause to be released to the Unaffiliated Seller the related Trustee's Mortgage File and shall execute and deliver such instruments of transfer or assignment prepared by the Unaffiliated Seller, in each case without recourse, as shall be necessary to vest in the Unaffiliated Seller any Mortgage Loan released pursuant hereto and the Unaffiliated Seller shall succeed to all the Trustee's right, title and interest in and to such Mortgage Loan and all security and documents related thereto. Such assignment shall be an assignment outright and not for security. The Unaffiliated Seller shall thereupon own such Mortgage Loan, and all security and documents, free of any further obligation to the Trustee, the Certificate Insurer or the Certificateholders with respect thereto. (b) If the Unaffiliated Seller shall have repurchased Mortgage Loans under this Section 5.15 in an aggregate Principal Balance equal to 2.00% of the Maximum Pool Principal Balance, the Unaffiliated Seller may not thereafter exercise its right under this Section 5.15 to purchase any Mortgage Loan without the prior written consent of the Certificate Insurer. Any request by the Unaffiliated Seller to the Certificate Insurer for consent to repurchase Mortgage Loans that are not the most Delinquent shall be accompanied by a description of the Mortgage Loans that have been Delinquent longer than the Mortgage Loan or Mortgage Loans the Unaffiliated Seller proposes to repurchase. If the Certificate Insurer fails to respond to such request within ten (10) Business Days after receipt thereof, the Unaffiliated Seller shall be deemed to have been granted consent to repurchase the Mortgage Loan or Mortgage Loans proposed to be repurchased. Notice to the Certificate Insurer shall be delivered in accordance with the terms of the Insurance and Indemnity Agreement. Notwithstanding the foregoing, the Unaffiliated Seller shall in no event repurchase Mortgage Loans pursuant to this Section 5.15 in an aggregate Principal Balance in excess of 10.00% of the Maximum Pool Principal Balance. Section 5.16 Reports to be Provided by the Servicer(a). (a) In connection with the transfer of the Certificates, the Trustee on behalf of any Certificateholder may request that the Servicer make available to any prospective Certificateholder annual financial statements of the Servicer for one or more of the most recently completed five fiscal years for which such statements are available, which request shall not be unreasonably denied or unreasonably delayed. Such annual financial statements also shall be made available to the Certificate Insurer upon request. (b) The Servicer also agrees to make available on a reasonable basis to the Certificate Insurer or any prospective Certificateholder a knowledgeable financial or accounting officer for the purpose of answering reasonable questions respecting recent developments affecting the Servicer or the financial statements of the Servicer and to permit the Certificate Insurer or such prospective Certificateholder to inspect the Servicer's servicing facilities during normal business hours for the purpose of satisfying such prospective Certificateholder that the Servicer has the ability to service the Mortgage Loans in accordance with this Agreement. 81 Section 5.17 Adjustment of Servicing Compensation in Respect of Prepaid Mortgage Loans. The Monthly Servicing Fee that the Servicer shall be entitled to receive with respect to all of the Mortgage Loans and each Distribution Date shall be offset on such Distribution Date by an amount equal to the aggregate Prepayment Interest Shortfall with respect to all Mortgage Loans which were subjects of Principal Prepayments during the month preceding the month of such Distribution Date. The amount of any offset against the Monthly Servicing Fee with respect to any Distribution Date under this Section 5.17 shall be limited to the Monthly Servicing Fee otherwise payable to the Servicer (without adjustment on account of Prepayment Interest Shortfalls) with respect to such Distribution Date, and the rights of the Certificateholders to the offset of the aggregate Prepayment Interest Shortfalls shall not be cumulative. Section 5.18 Periodic Advances; Special Advance. (a) If, on any Servicer Remittance Date, the Servicer determines that any Monthly Payments due on the Due Date immediately preceding such Servicer Remittance Date have not been received as of the close of business on the Business Day preceding such Servicer Remittance Date, the Servicer shall determine the amount of any Periodic Advance required to be made with respect to the related Distribution Date. The Servicer shall include in the amount to be deposited in the Collection Account on such Servicer Remittance Date an amount equal to the Periodic Advance, if any, which deposit may be made in whole or in part from funds in the Collection Account being held for future distribution or withdrawal on or in connection with Distribution Dates in subsequent months. Any funds being held for future distribution to Certificateholders and so used shall be replaced by the Servicer from its own funds by deposit in the Collection Account on or before the Business Day preceding the next Servicer Remittance Date on which the funds in the Collection Account shall be less than the amount necessary to pay in full the distributions required to be made on such date; provided, that if such funds are not sufficient the Servicer will use its own funds to the extent necessary to fulfill its replacement or advance obligation. The Servicer shall designate on its records the specific Mortgage Loans and related installments (or portions thereof) as to which such Periodic Advance shall be deemed to have been made, such determination being conclusive for purposes of withdrawals from the Collection Account pursuant to Section 5.03. (b) In addition to the Periodic Advances the Servicer shall make a special advance (the "Special Advance") on the Closing Date as set forth in Section 6.01, with respect to interest on Mortgage Loans not having their first payment due until after March 2003. The Special Advance will be deposited into the Interest Reserve Account and, on the immediately succeeding Distribution Date, an amount equal to the lesser of (1) the difference of (i) the aggregate Class Monthly Interest for each Class of Offered Certificates for such Distribution Date over (ii) the sum of (x) the amount of interest collected for the first Due Period and (y) the amount on deposit in the Interest Reserve Account immediately prior to such Special Advance and (2) an amount equal to the amount of interest that would have accrued on all such Mortgage Loans from the applicable Cut-Off Date to its corresponding scheduled payment date, assuming it had a payment date in March 2003, will be transferred by the Trustee from the Interest Reserve Account to the Distribution Account and treated as a portion of the Interest Remittance Amount. Any funds remaining in the Interest Reserve Account after the immediately succeeding Distribution Date shall be remitted to the Servicer on such Distribution Date. The Servicer shall also make the Special Advance required by Section 2.03(f) in respect of each Subsequent Transfer Date. The Special Advance shall be made without regard to recoverability, and shall not be reimbursable, except as set forth in the preceding sentences. In no event shall the Trustee, as successor Servicer, be liable for the payment of the Special Advance except to the extent of the amount on deposit in the Interest Reserve Account. 82 Section 5.19 Indemnification; Third Party Claims. (a) The Servicer agrees to indemnify and to hold each of the Depositor, the Trustee, the Back-up Servicer, the Collateral Agent, the Unaffiliated Seller, the Certificate Insurer and each Certificateholder harmless against any and all claims, losses, penalties, fines, forfeitures, legal fees and related costs, judgments, and any other costs, fees and expenses that the Depositor, the Trustee, the Back-up Servicer, the Collateral Agent, the Unaffiliated Seller, the Certificate Insurer and any Certificateholder may sustain in any way related to the failure of the Servicer to perform its duties and service the Mortgage Loans in compliance with the terms of this Agreement. Each indemnified party and the Servicer shall immediately notify the other indemnified parties if a claim is made by a third party with respect to this Agreement, and the Servicer shall assume the defense of any such claim and pay all expenses in connection therewith, including reasonable counsel fees, and promptly pay, discharge and satisfy any judgment or decree which may be entered against the Depositor, the Servicer, the Back-up Servicer, the Trustee, the Unaffiliated Seller, the Certificate Insurer and/or a Certificateholder in respect of such claim. The obligations of the Servicer under this Section 5.19 arising prior to any resignation or termination of the Servicer hereunder shall survive the resignation or termination of the Servicer. (b) Upon receipt of written instruction from the Servicer, signed by a Servicing Officer, the Trustee may, if necessary, reimburse the Servicer from amounts otherwise distributable on the Class X and R Certificates for all amounts advanced by it pursuant to Section 4.04 of the Unaffiliated Seller's Agreement, except when the claim relates directly to the failure of the Servicer, if it is, or is an Affiliate of, the Unaffiliated Seller, to perform its obligations to service and administer the Mortgages in compliance with the terms of the Unaffiliated Seller's Agreement, or the failure of the Unaffiliated Seller to perform its duties in compliance with the terms of this Agreement. (c) Upon receipt of written instruction from the Servicer, signed by a Servicing Officer, the Trustee shall reimburse the Unaffiliated Seller from amounts otherwise distributable on the Class X and R Certificates for all amounts advanced by the Unaffiliated Seller pursuant to the second sentence of Section 4.04(a) of the Unaffiliated Seller's Agreement except when the relevant claim relates directly to the failure of the Unaffiliated Seller to perform its duties in compliance with the terms of the Unaffiliated Seller's Agreement. Section 5.20 Maintenance of Corporate Existence and Licenses; Merger or Consolidation of the Servicer. (a) The Servicer will keep in full effect its existence, rights and franchises as a corporation, will obtain and preserve its qualification to do business as a foreign corporation in each jurisdiction necessary to protect the validity and enforceability of this Agreement or any of the Mortgage Loans and to perform its duties under this Agreement and will otherwise operate its business so as to cause the representations and warranties under Section 3.01 to be true and correct at all times under this Agreement. 83 (b) Any Person into which the Servicer may be merged or consolidated, or any corporation resulting from any merger, conversion or consolidation to which the Servicer shall be a party, or any Person succeeding to the business of the Servicer, shall be an established mortgage loan servicing institution that has a net worth of at least $15,000,000 and is a Permitted Transferee, and in all events shall be the successor of the Servicer without the execution or filing of any paper or any further act on the part of any of the parties hereto, anything herein to the contrary notwithstanding. The Servicer shall send notice of any such merger or consolidation to the Trustee and the Certificate Insurer. Section 5.21 Assignment of Agreement by Servicer; Servicer Not to Resign. The Servicer shall not assign this Agreement nor resign from the obligations and duties hereby imposed on it except by mutual consent of the Servicer, the Back-up Servicer, the Unaffiliated Seller, the Certificate Insurer and the Trustee; provided, however, that in the event the Servicer is terminated pursuant to Section 7.01 hereof, the consent of the Unaffiliated Seller shall no longer be required, or upon the determination that the Servicer's duties hereunder are no longer permissible under applicable law and that such incapacity cannot be cured by the Servicer without incurring, in the reasonable judgment of the Certificate Insurer, unreasonable expense. Any such determination that the Servicer's duties hereunder are no longer permissible under applicable law permitting the resignation of the Servicer shall be evidenced by a written Opinion of Counsel (who may be outside counsel for the Servicer) to such effect delivered to the Trustee, the Back-up Servicer, the Unaffiliated Seller, the Depositor and the Certificate Insurer. No such resignation shall become effective until the Trustee or a successor appointed in accordance with the terms of this Agreement has assumed the Servicer's responsibilities and obligations hereunder in accordance with Section 7.02. The Servicer shall provide the Trustee, the Back-up Servicer, the Certificate Insurer and the Rating Agencies with 30 days prior written notice of its intention to resign pursuant to this Section 5.21. Section 5.22 Periodic Filings with the Securities and Exchange Commission; Additional Information. The Trustee shall prepare or cause to be prepared, and shall execute as trustee on behalf of the Trust (other than any Form 10-K, which shall be executed by the Servicer, on behalf of the Trust), for filing with the Commission (other than the initial Current Report on Form 8-K to be filed by the Depositor in connection with the issuance of the Certificates) any and all reports, statements and information respecting the Trust and/or the Certificates required to be filed, and shall solicit any and all proxies of the Certificateholders whenever such proxies are required to be solicited, pursuant to the Securities Exchange Act of 1934, as amended. Unless otherwise advised by the Servicer (with the consent of the Depositor), the reports to be filed shall consist only of the following: 8-K reports attaching the related Servicer Remittance Report, to be filed in April of 2003 through December of 2003, a Form 10-K to be filed no later than March 31 of 2004, including any accountant's report referred to in Section 5.10, and a Form 15 to be filed in January 2004 and to be executed by the Servicer. The Servicer shall prepare, execute and deliver to the Trustee for filing with the Commission no later than March 15 of each year in which a Form 10-K is filed with the Commission the certification required under Section 302(a) of the Sarbanes-Oxley Act of 2002 (as such may be amended from time to time) and any rules or regulations promulgated with respect thereto (which certification shall be executed by the Servicer). Fees and expenses incurred by the Trustee in connection with the foregoing shall be reimbursed pursuant to Section 9.05 and shall not be paid by the Trust. 84 The Servicer agrees to promptly furnish to the Trustee, from time to time upon request, such further information, reports and financial statements as the Trustee deems appropriate to prepare and file all necessary reports with the Securities and Exchange Commission. ARTICLE VI DISTRIBUTIONS AND PAYMENTS Section 6.01 Establishment of Accounts; Withdrawals from Accounts; Deposits to the Distribution Account. (a) The Trustee shall establish and maintain a Distribution Account which shall be titled "Distribution Account, JPMorgan Chase Bank, as trustee for the registered holders of ABFS Mortgage Loan Trust 2003-1, Mortgage Pass-Through Certificates, Series 2003-1", which account shall be an Eligible Account held by the Trustee on behalf of the Certificateholders and the Certificate Insurer. The Trustee shall establish and maintain on behalf of the Certificateholders and the Certificate Insurer the Interest Reserve Account which shall be titled "Interest Reserve Account, JPMorgan Chase Bank, as trustee for the registered holders of ABFS Mortgage Loan Trust 2003-1, Mortgage Pass-Through Certificates, Series 2003-1" which account shall be an Eligible Account. If the Original Pre-Funded Amount is greater than zero, the Trustee shall establish and maintain on behalf of the Certificateholders and the Certificate Insurer the Pre-Funding Account which shall be titled "Pre-Funding Account, JPMorgan Chase Bank, as trustee for the registered holders of ABFS Mortgage Loan Trust 2003-1, Mortgage Pass-Through Certificates, Series 2003-1", which account shall be an Eligible Account, and the Capitalized Interest Account which shall be titled "Capitalized Interest Account, JPMorgan Chase Bank, as trustee for the registered holders of ABFS Mortgage Loan Trust 2003-1, Mortgage Pass-Through Certificates, Series 2003-1", which account shall be an Eligible Account. Upon receipt of the proceeds of the sale of the Certificates, on the Closing Date, the Trustee shall, upon the Unaffiliated Seller's direction, from the proceeds of the sale of the Certificates, deposit, on behalf of the Certificateholders and the Certificate Insurer in the Interest Reserve Account, an amount equal to $1,585,444.20. If the Original Pre-Funded Amount is greater than zero, upon receipt of the proceeds of the sale of the Certificates, on the Closing Date, the Trustee shall, upon the Unaffiliated Seller's direction, from the proceeds of the sale of the Certificates, deposit, on behalf of the Certificateholders and the Certificate Insurer (i) in the Pre-Funding Account, the Original Pre-Funded Amount, and (ii) in the Capitalized Interest Account, an amount equal to three months' interest calculated at the Adjusted Pass-Through Rate on the Pre-Funding Amount (net of any Pre-Funding Earnings). Amounts on deposit in the Interest Reserve Account shall be invested by the Trustee, at the direction of the Servicer in Permitted Investments. In the event that the Servicer fails to provide written investment instructions, the Trustee shall invest such funds pursuant to clause (v) of the definition of Permitted Investments. Any such Permitted Investment shall mature no later than the Servicer Remittance Date. All income realized from any such Permitted Investment shall be for the benefit of the Servicer as additional servicing compensation. The amount of any losses incurred in respect of any such Permitted Investment shall be deposited in the Interest Reserve Account by the Servicer out if its own funds immediately as realized. 85 (b) The Servicer shall direct the Trustee in writing to invest the funds in the Distribution Account only in Permitted Investments. Any such Permitted Investment shall mature no later than one Business Day prior to the Distribution Date. No Permitted Investment shall be sold or disposed of prior to maturity. All income realized from any such Permitted Investment shall be for the benefit of the Servicer as additional servicing compensation. The amount of any losses incurred in respect of any such investments shall be deposited in the Distribution Account by the Servicer out of its own funds immediately as realized. (c) On each Servicer Remittance Date, the Servicer shall cause to be deposited in the Distribution Account, from funds on deposit in the Collection Account, (a) an amount equal to the Servicer Remittance Amount and (b) Net Foreclosure Profits, if any with respect to the related Distribution Date, minus any portion thereof payable to the Servicer pursuant to Section 5.03. On each Servicer Remittance Date, the Servicer shall also deposit into the Distribution Account any Periodic Advances with respect to the related Distribution Date calculated in accordance with Section 5.18 and any amounts required to be deposited in connection with a Subsequent Mortgage Loan pursuant to Section 2.03(f); on the Servicer Remittance Dates relating to the Pre-Funding Distribution Dates, if any, the Servicer also will deposit the Special Advance, if any. (d) On the Pre-Funding Distribution Dates, if any, the Trustee shall transfer from the Capitalized Interest Account to the Distribution Account the Capitalized Interest Requirement, if any, for such Distribution Date. (e) On the Distribution Date following either the final Subsequent Transfer Date or the Final Pre-Funding Distribution Date, whichever date is earlier, any amounts remaining in the Capitalized Interest Account, if any, after taking into account the transfers in respect of the Distribution Date described in clause (d) above, shall be paid to the Unaffiliated Seller, and the Capitalized Interest Account shall be terminated. (f) On any Subsequent Transfer Date, the Unaffiliated Seller shall instruct the Trustee in writing to withdraw from the Pre-Funding Account an amount equal to 100% of the aggregate Principal Balances as of the related Subsequent Cut-Off Date of the Subsequent Mortgage Loans sold to the Trust on such Subsequent Transfer Date and pay such amount to or upon the order of the Unaffiliated Seller upon satisfaction of the conditions set forth in Section 2.03(b) and (c) hereof with respect to such transfer. The Trustee may conclusively rely on such written instructions from the Unaffiliated Seller. (g) If the Pre-Funding Amount (exclusive of Pre-Funding Earnings), if any, has been reduced to $100,000 or less by the last day of any calendar month during the Pre-Funding Period, then, on the related Pre-Funding Distribution Date, after giving effect to any reductions in the Pre-Funding Amount on such date, the Trustee shall withdraw from the Pre-Funding Account on such date and deposit in the Distribution Account the amount on deposit in the Pre-Funding Account other than any Pre-Funding Earnings and distribute such amount to the Holders of the Certificates in respect of the Principal Distribution Amount. 86 (h) On the Pre-Funding Distribution Dates, if any, the Trustee shall transfer from the Pre-Funding Account to the Distribution Account the Pre-Funding Earnings, if any, applicable as of each such Distribution Date. Section 6.02 Permitted Withdrawals From the Distribution Account. The Trustee shall withdraw or cause to be withdrawn funds from the Distribution Account for the following purposes: (a) to effect the distributions described in Section 6.05; (b) to pay to the Unaffiliated Seller with respect to each Mortgage Loan or property acquired in respect thereof that has been repurchased or replaced pursuant to Section 2.05 or 3.03 or to pay to the Servicer with respect to each Mortgage Loan or property acquired in respect thereof that has been purchased, all amounts received thereon and not required to be distributed as of the date on which the related repurchase or purchase price or Principal Balance was determined; (c) to pay the Servicer any interest earned on or investment income earned with respect to funds in the Distribution Account; (d) to return to the Collection Account any amount deposited in the Distribution Account that was not required to be deposited therein; and (e) to clear and terminate the Distribution Account upon termination of the Trust Fund pursuant to Article VIII. The Trustee shall keep and maintain a separate accounting for withdrawals from the Distribution Account pursuant to each of subclauses (a) through (e) listed above. Section 6.03 Collection of Money. Except as otherwise expressly provided herein, the Trustee may demand payment or delivery of all money and other property payable to or receivable by the Trustee pursuant to this Agreement, including (a) all payments due on the Mortgage Loans in accordance with the respective terms and conditions of such Mortgage Loans and required to be paid over to the Trustee by the Servicer or by any Sub-Servicer and (b) Class M Insured Payments. The Trustee shall hold all such money and property received by it, as part of the Trust Fund and shall apply it as provided in this Agreement. Section 6.04 The Certificate Insurance Policy. (a) Within two (2) days of each Servicer Remittance Date and based solely on the Servicer's Remittance Report delivered to the Trustee, the Trustee shall determine with respect to the immediately following Distribution Date, the Net Available Amount. (b) If on any Distribution Date there is a Class M Deficiency Amount, the Trustee shall complete a notice and certificate in the form of Exhibit A to the Certificate Insurance Policy and submit such notice to the Certificate Insurer no later than 10:00 a.m. New York, New York City time on the second Business Day preceding such Distribution Date as a claim for an Class M Insured Payment in an amount equal to such Class M Deficiency Amount. 87 (c) The Trustee shall establish a separate Eligible Account for the benefit of Holders of the Certificates and the Certificate Insurer referred to herein as the "Certificate Insurance Payment Account" over which the Trustee shall have exclusive control and sole right of withdrawal. The Trustee shall deposit upon receipt any amount paid under the Certificate Insurance Policy in the Certificate Insurance Payment Account and distribute such amount only for purposes of payment to the Class M Certificateholders of the Class M Insured Payment for which a claim was made and such amount may not be applied to satisfy any costs, expenses or liabilities of the Servicer, the Trustee or the Trust Fund. Amounts paid under the Certificate Insurance Policy, to the extent needed to pay the Class M Deficiency Amount shall be transferred to the Distribution Account on the related Distribution Date and disbursed by the Trustee to the Class M Certificateholders in accordance with Section 6.05. It shall not be necessary for such payments to be made by checks or wire transfers separate from the checks or wire transfers used to pay the Class M Deficiency Amount with other funds available to make such payment. However, the amount of any payment of principal or of interest on the Class M Certificates to be paid from funds transferred from the Certificate Insurance Payment Account shall be noted as provided in paragraph (d) below in the Certificate Register and in the statement to be furnished to Holders of the Class M Certificates pursuant to Section 6.07. Funds held in the Certificate Insurance Payment Account shall not be invested. Any funds remaining in the Certificate Insurance Payment Account on the first Business Day following a Distribution Date shall be returned to the Certificate Insurer pursuant to the written instructions of the Certificate Insurer by the end of such Business Day. (d) The Trustee shall keep a complete and accurate record of the amount of interest and principal paid in respect of any Class M Certificate from moneys received under the Certificate Insurance Policy. The Certificate Insurer shall have the right to inspect such records at reasonable times during normal business hours upon one Business Day's prior notice to the Trustee. (e) In the event that the Trustee has received a certified copy of an order of the appropriate court that any Class M Insured Payment has been voided in whole or in part as a preference payment under applicable bankruptcy law, the Trustee shall so notify the Certificate Insurer, shall comply with the provisions of the Certificate Insurance Policy to obtain payment by the Certificate Insurer of such voided Class M Insured Payment, and shall, at the time it provides notice to the Certificate Insurer, notify, by mail to the Certificateholders of the affected Class M Certificates that, in the event any Certificateholder's Class M Insured Payment is so voided, such Certificateholder will be entitled to payment pursuant to the Certificate Insurance Policy, a copy of which shall be made available through the Trustee, the Certificate Insurer or the Certificate Insurer's fiscal agent, if any, and the Trustee shall furnish to the Certificate Insurer or its fiscal agent, if any, its records evidencing the payments which have been made by the Trustee and subsequently recovered from the Certificateholders, and dates on which such payments were made. (f) The Trustee shall promptly notify the Certificate Insurer of any proceeding or the institution of any action, of which a Responsible Officer of the Trustee has actual knowledge, seeking the avoidance as a preferential transfer under applicable bankruptcy, insolvency, receivership or similar law (a "Class M Preference Claim") of any distribution made with respect to the Class M Certificates. Each Class M Certificateholder, by its purchase of a Class M Certificate, the Servicer and the Trustee agree that, the Certificate Insurer may at any time during the continuation of any proceeding relating to a Class M Preference Claim direct all matters relating to such Class M Preference Claim, including, without limitation, (i) the direction of any appeal of any order relating to such Class M Preference Claim and (ii) the posting of any surety, supersedeas or performance bond pending any such appeal. In addition and without limitation of the foregoing, the Certificate Insurer shall be subrogated to, and each Class M Certificateholder, the Servicer and the Trustee hereby delegate and assign to the Certificate Insurer, to the fullest extent permitted by law, the rights of the Servicer, the Trustee and each Class M Certificateholder in the conduct of any such Class M Preference Claim, including, without limitation, all rights of any party to any adversary proceeding or action with respect to any court order issued in connection with any such Class M Preference Claim. 88 (g) The Trustee shall, upon retirement of the Class M Certificates, furnish to the Certificate Insurer a notice of such retirement, and, upon retirement of the Class M Certificates and the expiration of the term of the Certificate Insurance Policy, surrender the Certificate Insurance Policy to the Certificate Insurer for cancellation. Section 6.05 Distributions. No later than 12:00 noon, New York, New York time on the Servicer Remittance Date, the Servicer shall deliver to the Trustee and the Back-up Servicer a report in computer-readable form containing such information as to enable the Trustee to make the distributions pursuant to clauses (a) through (d) below, and such other information as the Trustee shall reasonably require. With respect to amounts held in the Distribution Account, on each Distribution Date, the Trustee shall make the following allocations, disbursements and transfers in the following order of priority, and each such allocation, transfer and disbursement shall be treated as having occurred only after all preceding allocations, transfers and disbursements have occurred: (a) Allocations of Available Amount. On each Distribution Date, the Trustee, as paying agent, or any other paying agent appointed by the Trustee (the "Paying Agent"), based solely on the information received from the Servicer in the Servicer Remittance Report prior to such Distribution Date shall make the following disbursements and transfers from the Available Amount then on deposit in the Distribution Account and, with respect to the Class M Certificate only, any Class M Insured Payment for such Distribution Date, in the following order of priority until such amounts have been fully distributed: (i) first, to the Servicer, the Servicing Fee, to the extent such amounts were not retained by the Servicer from collections; (ii) second, to the Trustee, the Trustee Fee; (iii) third, to the Back-up Servicer, the Back-up Servicing Fee and any amounts owing to the Back-up Servicer in connection with the transfer of servicing after the resignation or removal of the Servicer, in an amount not to exceed $200,000 in the aggregate for any servicing transfer that has been effected; 89 (iv) fourth, concurrently, (i) to the Certificate Insurer, the Premium Amount then due to it, and (ii) to the Interest Rate Hedge Payment Fund (as a distribution to the Holders of the Class I Certificates), the Class I Distribution Amount; (v) fifth, concurrently, to the Class A and Class A-IO Certificates and then to the Class M Certificates, in that order, the Class Monthly Interest and any Class Interest Carryover Shortfall for each such Class (or, following a Separation Event, concurrently, to the Class A and Class A-IO Certificates, and then to the Class M-1, Class M-2 and Class M-3 Certificates, in that order); (vi) sixth, to the Class A Certificates, the Class A Principal Distribution Amount; (vii) seventh, to the Certificate Insurer, the Reimbursement Amount, if any; (viii) eighth, to the Class M Certificates, the Class M Principal Distribution Amount (or, following a Separation Event, to the Class M-1, Class M-2 and Class M-3 Certificates, the Class M-1, Class M-2 and Class M-3 Principal Distribution Amounts, respectively, in that order); (ix) ninth, to the Net WAC Cap Carryover Fund (as a distribution to the Holders of the Class X Certificates), the lesser of (x) the Class X Distribution Amount and (y) the WAC Excess; (x) tenth, to the Trustee, to the extent not previously paid, an amount equal to the sum of all reimbursable expenses incurred in connection with its duties and obligations under this Agreement and for any indemnity amounts payable to the Trustee under this Agreement; (xi) eleventh, to the Back-up Servicer, to the extent not paid pursuant to clause (iii) above, any amounts owing to the Back-up Servicer in connection with the transfer of servicing after the resignation or removal of the Servicer; (xii) twelfth, to the Servicer to the extent of any unreimbursed Periodic Advances and Servicing Advances; (xiii) thirteenth, subject to the provisions of Section 6.13, to the Class X Certificates, the Class X Distribution Amount less any amounts thereof applied pursuant to clauses (ix) through (xii); and (xiv) fourteenth, to the Class R Certificates, any remaining amount. (b) Allocation of Pre-Funding Amounts. In addition to the foregoing, if any Pre-Funding Amount remains on deposit in the Pre-Funding Account, if any, at the end of the Pre-Funding Period, such remaining amount will be included in the Principal Distribution Amount and applied to the mandatory payment of the Class A and Class M Certificates, in accordance with paragraph (a) above, on the first Distribution Date following the end of the Pre-Funding Period. 90 (c) Allocation of Mortgage Loan Interest Shortfalls. On any Distribution Date, any Mortgage Loan Interest Shortfalls for such Distribution Date will be allocated as a reduction of the following amounts in the following order of priority: (i) to the amount payable to or in respect of the Class X Certificates; and (ii) pro rata, as a reduction of the Class Monthly Interest for the Class A, Class A-IO and Class M Certificates, based on the amount of interest to which such Classes would otherwise be entitled. (d) Allocation of Applied Realized Loss Amounts. If, on any Distribution Date, after giving effect to all distributions of principal as described above (excluding any Class M Insured Principal Payment for such Distribution Date), the aggregate Certificate Principal Balance of the Offered Certificates exceeds the Current Pool Principal Balance for that Distribution Date, the Certificate Principal Balance of the Class M Certificates will be reduced by an amount equal to that excess, until the Certificate Principal Balance of the Class M Certificates is reduced to zero. Any Applied Realized Loss Amounts allocated to the Class M Certificates shall be allocated to the Class M-3 Component, the Class M-2 Component and the Class M-1 Component, in that order, until the Component Principal Balance of each component is reduced to zero. The Certificate Insurer will be obligated to pay to the Holders of the Class M Certificates pursuant to the Certificate Insurance Policy an amount equal to the Applied Realized Loss Amount for such Distribution Date (after taking into account any funds in the Interest Rate Hedge Payment Fund to be applied on such Distribution Date towards the payment of such Applied Realized Loss Amount pursuant to Section 6.10(d)), but in no event will such payment by the Certificate Insurer be more than the Class M Collateralization Deficit. Section 6.06 Investment of Accounts. (a) So long as no Event of Default shall have occurred and be continuing, and consistent with any requirements of the Code, all or a portion of any Account (other than the Certificate Insurance Payment Account) held by the Trustee shall be invested and reinvested by the Trustee, as directed in writing by the Servicer, in one or more Permitted Investments bearing interest or sold at a discount. If an Event of Default shall have occurred and be continuing or if the Servicer does not provide investment directions, the Trustee shall invest all Accounts in Permitted Investments described in paragraph (v) of the definition of Permitted Investments. No such investment in any Account shall mature later than the Business Day immediately preceding the next Distribution Date. (b) Subject to Section 6.01(b), if any amounts are needed for disbursement from any Account held by the Trustee and sufficient uninvested funds are not available to make such disbursement, the Trustee shall cause to be sold or otherwise converted to cash a sufficient amount of the investments in such Account. The Trustee shall not be, and the Servicer shall be, liable for any investment loss or other charge resulting therefrom unless the Trustee's failure to perform in accordance with this Section 6.06 is the cause of such loss or charge. (c) Subject to Section 9.01 hereof, the Trustee shall not in any way be held liable by reason of any insufficiency in any Account held by the Trustee resulting from any investment loss on any Permitted Investment included therein (except to the extent that the Trustee is the obligor and has defaulted thereon or as provided in subsection (b) of this Section 6.06). 91 (d) So long as no Event of Default shall have occurred and be continuing, all net income and gain realized from investment of, and all earnings on, funds deposited in any Account (other than the Certificate Insurance Payment Account) shall be for the benefit of the Servicer as servicing compensation (in addition to the Servicing Fee). The Servicer shall deposit in the related Account the amount of any loss incurred in respect of any Permitted Investment held therein which is in excess of the income and gain thereon immediately upon realization of such loss, without any right to reimbursement therefor from its own funds. Section 6.07 Reports. (a) On each Distribution Date the Trustee shall forward to each Holder, the Underwriters, the Depositor, the Back-up Servicer, the Certificate Insurer and the Rating Agencies the report provided by the Servicer pursuant to Section 6.05 (the "Servicer Remittance Report"), setting forth information including, without limitation, the following: (i) the amount of the distribution with respect to each Class of Certificates; (ii) the amount of such distributions allocable to principal, separately identifying the aggregate amount of any Principal Prepayments or other unscheduled recoveries of principal included therein and separately identifying any Overcollateralization Increase Amounts; (iii) the amount of such distributions allocable to interest and the calculation thereof; (iv) the Certificate Principal Balance of each Class of Offered Certificates, other than the Class A-IO Certificates, as of such Distribution Date, together with the principal amount of each such Class (based on a Certificate in an original principal amount of $1,000) then outstanding, in each case after giving effect to any payment of principal on such Distribution Date; (v) the Class A-IO Notional Balance then outstanding as of such Distribution Date, after giving effect to any payment of interest on such Distribution Date; (vi) the amount of any Class M Insured Payment included in the amounts distributed to the Class M Certificateholders on such Distribution Date; (vii) the total of any Substitution Adjustments and any Loan Repurchase Price amounts included in such distribution; and (viii) the amounts, if any, of any Liquidated Loan Losses for consumer purpose loans and for business purpose loans for the related Due Period and cumulative Liquidated Loan Losses since the Startup Day for consumer purpose loans and for business purpose loans. Items (i), (ii) and (iii) above shall, with respect to the Offered Certificates (other than the Class A-IO Certificates), be presented on the basis of a Certificate having a $1,000 denomination. In addition, by January 31 of each calendar year following any year during which the Certificates are outstanding, the Trustee shall furnish a report to each Holder of record if so requested in writing at any time during each calendar year as to the aggregate of amounts reported pursuant to (i), (ii) and (iii) with respect to the Certificates for such calendar year. 92 (b) All distributions made to the Certificateholders of each Class as a Class on each Distribution Date will be made on a pro rata basis among the Certificateholders of each Class on the next preceding Record Date based on the Percentage Interest represented by their respective Certificates, and shall be made by wire transfer of immediately available funds to the account of such Certificateholder at a bank or other entity having appropriate facilities therefor, if, in the case of a Holder of an Offered Certificate, such Certificateholder shall own of record Certificates of the same Class which have denominations aggregating at least $5,000,000 appearing in the Certificate Register and shall have provided complete wiring instructions at least five Business Days prior to the Record Date, and otherwise by check mailed to the address of such Certificateholder appearing in the Certificate Register. (c) In addition, the Servicer Remittance Report described in subsection (a) above forwarded by the Trustee to each Holder, to the Underwriters, to the Servicer, to the Back-up Servicer, to the Depositor, to the Certificate Insurer and to the Rating Agencies on each Distribution Date, shall include the following information with respect to all Mortgage Loans as well as a break out as to (x) consumer purpose and (y) business purpose Mortgage Loans as of the close of business on the last Business Day of the prior calendar month (except as otherwise provided in clause (v) below), which is hereby required to be prepared by the Servicer and furnished to the Trustee for such purpose and to the Certificate Insurer on or prior to the related Servicer Remittance Date: (i) for the related Due Period, the total number of Mortgage Loans and the aggregate Principal Balances thereof, together with the number, aggregate principal balances of such Mortgage Loans and the percentage (based on the aggregate Principal Balances of the Mortgage Loans) of the aggregate Principal Balances of such Mortgage Loans to the aggregate Principal Balance of all Mortgage Loans (A) 31-60 days Delinquent, (B) 61-90 days Delinquent and (C) 91 or more days Delinquent; (ii) for the related Due Period, the number, aggregate Principal Balances of all Mortgage Loans and percentage (based on the aggregate Principal Balances of the Mortgage Loans) of the aggregate Principal Balances of such Mortgage Loans to the aggregate Principal Balance of all Mortgage Loans in foreclosure proceedings and the number, aggregate Principal Balances of all Mortgage Loans and percentage (based on the aggregate Principal Balances of the Mortgage Loans) of any such Mortgage Loans also included in any of the statistics described in the foregoing clause (i); (iii) for the related Due Period, the number, aggregate Principal Balances of all Mortgage Loans and percentage (based on the aggregate Principal Balances of the Mortgage Loans) of the aggregate Principal Balances of such Mortgage Loans to the aggregate Principal Balance of all Mortgage Loans relating to Mortgagors in bankruptcy proceedings and the number, aggregate Principal Balances of all Mortgage Loans and percentage (based on the aggregate Principal Balances of the Mortgage Loans) of any such Mortgage Loans also included in any of the statistics described in the foregoing clause (i); 93 (iv) for the related Due Period, the number, aggregate Principal Balances of all Mortgage Loans and percentage (based on the aggregate Principal Balances of the Mortgage Loans) of the aggregate Principal Balances of such Mortgage Loans to the aggregate Principal Balance of all Mortgage Loans relating to REO Properties and the number, aggregate Principal Balances of all Mortgage Loans and percentage (based on the aggregate Principal Balances of the Mortgage Loans) of any such Mortgage Loans also included in any of the statistics described in the foregoing clause (i); (v) the weighted average Mortgage Interest Rate as of the Due Date occurring in the Due Period related to such Distribution Date; (vi) the weighted average remaining term to stated maturity of all Mortgage Loans; (vii) the book value of any REO Property; (viii) the Cumulative Loss Percentage for the related Due Period and the aggregate Cumulative Loss Percentage since the Closing Date; (ix) the Delinquency Ratio and the Rolling Three Month Delinquency Rate; (x) the aggregate Principal Balance of the three largest Mortgage Loans; and (xi) the total number of Mortgage Loans and the Aggregate Principal Balance. (d) No later than 12:00 noon, New York, New York time on the Servicer Remittance Date, the Servicer shall deliver to the Back-up Servicer an electronic transmission acceptable to the Back-up Servicer containing the Servicer Remittance Report and the Required Information with respect to such Servicer Remittance Date. No later than three (3) Business Days after each Servicer Remittance Date, the Back-up Servicer shall use such electronic transmission acceptable to the Back-up Servicer to (i) confirm that such electronic transmission is in readable form and (ii) compare the following information contained in the Servicer Remittance Report with that contained in the Required Information: (A) the total number of Mortgage Loans, (B) the aggregate Principal Balance of the Mortgage Loans and (C) the weighted average Mortgage Interest Rate. The Back-up Servicer shall report any inconsistencies to the Servicer and the Trustee (unless the Back-up Servicer and the Trustee are the same party). The Back-up Servicer shall only review the information provided by the Servicer in the Servicer Remittance Report and in the Required Information and its obligation to report any inconsistencies shall be limited to those apparent from the Back-up Servicer's review thereof and those relating to the total number of Mortgage Loans, the aggregate Principal Balance of the Mortgage Loans or the weighted average Mortgage Interest Rate. In the event that the Back-up Servicer reports any discrepancies, the Servicer and the Back-up Servicer shall attempt to reconcile such discrepancies prior to the next succeeding Distribution Date, but in the absence of a reconciliation, the Servicer's Remittance Report shall control for the purpose of calculations and distributions with respect to the next succeeding Distribution Date. In the event that the Back-up Servicer and the Servicer are unable to reconcile discrepancies with respect to a Servicer's Remittance Report by the next succeeding Distribution Date, the Servicer shall cause a firm of independent certified public accountants, at the Servicer's expense, to audit the Servicer's Remittance Report and, prior to the last day of the month after the month in which such Servicer's Remittance Report was delivered, reconcile the discrepancies. The effect, if any, of such reconciliation shall be reflected in the Servicer's Remittance Report for the next succeeding Distribution Date. Other than the duties specifically set forth in this Agreement, the Back-up Servicer shall have no obligations hereunder, including, without limitation, to supervise, verify, monitor or administer the performance of the Servicer. The Back-up Servicer shall have no liability for any actions taken or omitted by the Servicer. 94 Section 6.08 Additional Reports by Trustee. (a) The Trustee shall report to the Depositor, the Certificate Insurer and the Servicer with respect to the amount then held in each Account (including investment earnings accrued or scheduled to accrue) held by the Trustee and the identity of the investments included therein, as the Depositor, the Certificate Insurer or the Servicer may from time to time request in writing. (b) From time to time, at the request of the Certificate Insurer, the Trustee shall report to the Certificate Insurer with respect to its actual knowledge, without independent investigation, of any breach of any of the representations or warranties relating to individual Mortgage Loans set forth in any Unaffiliated Seller's Agreement or in Section 3.01 or 3.02 hereof. The Trustee shall also provide the Certificate Insurer such other information as may be reasonably requested by them. Section 6.09 Compensating Interest. Not later than the Servicer Remittance Date, the Servicer shall remit to the Trustee (without right of reimbursement therefor) for deposit into the Distribution Account an amount equal to the lesser of (a) the aggregate of the Prepayment Interest Shortfalls for the related Distribution Date resulting from Principal Prepayments during the related Due Period and (b) its aggregate Monthly Servicing Fees received in the related Due Period and shall not have the right to reimbursement therefor (the "Compensating Interest"); provided, however, that Compensating Interest with respect to any Mortgage Loan and any Distribution Date shall not exceed the Servicing Fees due in respect of such Mortgage Loan on such Distribution Date. Section 6.10 Supplemental Interest Trust; Net WAC Cap Carryover Fund; Interest Rate Hedge Payment Fund. (a) The parties hereto do hereby create and establish a trust, the "ABFS Mortgage Loan Supplemental Interest Trust 2003-1" (the "Supplemental Interest Trust"). The Supplemental Interest Trust shall hold (i) a trust account at the corporate trust office of the Trustee (the "Net WAC Cap Carryover Fund"), to be held by the Trustee in its name on behalf of the Supplemental Interest Trust, (ii) a trust account at the corporate trust office of the Trustee (the "Interest Rate Hedge Payment Fund"), to be held by the Trustee in its name on behalf of the Supplemental Interest Trust and (iii) the Interest Rate Hedge Agreement. None of the assets of the Supplemental Interest Trust shall be considered assets of the REMIC Trust, and (x) any amounts transferred from the REMIC Trust to the Net WAC Cap Carryover Fund shall be treated as distributions with respect to the Class X Certificates and (y) any amounts transferred from the REMIC Trust to the Interest Rate Hedge Payment Fund shall be treated as distributions with respect to the Class I Certificates. The Trustee shall deposit all Hedge Payments and Hedge Termination Payments received from the Hedge Counterparty under the Interest Payment Hedge Agreement into the Interest Rate Hedge Payment Fund. 95 (b) On each Distribution Date, the Paying Agent shall, based on the distribution information provided by the Servicer, withdraw all amounts on deposit in the Net WAC Cap Carryover Fund on such Distribution Date and pay to the applicable owners of each Net WAC Cap Carryover Right (which owners shall, in the absence of contrary instructions received by the Trustee from the applicable Holders of the Capped Certificates, be the Holders of the related Capped Certificates) or the owners of the Class X Certificates, as applicable, the following amounts in the following priority: (i) to the Class A Certificates, the Net WAC Cap Carryover Amount for such Class; (ii) to the Class M Certificates (or, following a Separation Event, to the Class M-1, Class M-2 and Class M-3 Certificates, in that order), the Net WAC Cap Carryover Amount; and (iii) to the owners of the Class X Certificates pro rata in accordance with their Percentage Interests, any remaining amounts. (c) On each Distribution Date, the Paying Agent shall, based on the distribution information provided by the Servicer, withdraw all amounts on deposit in the Interest Rate Hedge Payment Fund representing the Class I Distribution Amount for such Distribution Date, and distribute such amount, first, to the to Hedge Counterparty, an amount equal to the Hedge Premium for such Distribution Date and, second, for distribution in accordance with Section 6.10(d) below, any remaining amounts. (d) On each Distribution Date, the Paying Agent shall, based on the distribution information provided by the Servicer, withdraw all amounts on deposit in the Interest Rate Hedge Payment Fund representing Hedge Payments and any Hedge Termination Payments for such Distribution Date and any Retained Hedge Amounts (as defined below) from any previous Distribution Dates and distribute such amounts to the applicable owners of each Interest Rate Hedge Payment Right, pro rata (which owners shall, in the absence of contrary instructions received by the Trustee from the applicable Holders of the Class M Certificates, be the Holders of the related Class M Certificates), in an amount not greater than the sum of the Class Monthly Interest, any Class Interest Carryover Shortfall and any Applied Realized Loss Amounts, in each case, for the Class M Certificates for such Distribution Date. If, on any Distribution Date, the sum of the Hedge Payments and any Hedge Termination Payments for such Distribution Date are greater than the sum of the Class Monthly Interest, any Class Interest Shortfall and any Applied Realized Loss Amounts for the Class M Certificates for such Distribution Date, 50% of such excess amount shall be distributed by the Paying Agent to the Holders of the Class I Certificates and the remaining 50% of such excess amount shall be retained in the Interest Rate Hedge Payment Fund for distribution on future Distribution Dates (such retained amount being the "Retained Hedge Amount"). On each Distribution Date on or after the Stepdown Date, if the aggregate Retained Hedge Amount remaining on deposit in the Interest Rate Hedge Payment Fund following distributions to the Holders of the Class M Certificates on such Distribution Date is greater than 0.50% of the Certificate Principal Balance of the Class M Certificates on such Distribution Date (after all distributions pursuant to Section 6.05 and this Section 6.10), such excess amount shall be distributed by the Paying Agent to the Holders of the Class I Certificates. 96 (e) The Paying Agent, on behalf of the Supplemental Interest Trust, shall comply with all requirements of the Code and applicable state and local law with respect to the withholding from any distributions made by it to any Person entitled thereto of any applicable withholding taxes imposed thereon and with respect to any applicable reporting requirements in connection therewith. (f) Notwithstanding any other provision of this Section 6.10, the Net WAC Cap Carryover Rights shall be separately transferable from the related Capped Certificates, and the Interest Rate Hedge Payment Rights shall be separately transferable from the related Class M Certificates, in each case, subject to the restrictions on transfer set forth in Article IV hereof. Section 6.11 Effect of Payments by the Certificate Insurer; Subrogation. Anything herein to the contrary notwithstanding, any payment with respect to principal of or interest on the Class M Certificates which is made with moneys received pursuant to the terms of the Certificate Insurance Policy shall not be considered payment of the Class M Certificates from the Trust Fund. The Depositor, the Servicer and the Trustee acknowledge, and each Holder by its acceptance of a Class M Certificate agrees, that without the need for any further action on the part of the Certificate Insurer, the Depositor, the Servicer, the Trustee or the Certificate Registrar (a) to the extent the Certificate Insurer makes payments, directly or indirectly, on account of principal of or interest on the Class M Certificates to the Holders of such Class M Certificates, the Certificate Insurer will be fully subrogated to, and each Class M Certificateholder, the Servicer and the Trustee hereby delegate and assign to the Certificate Insurer, to the fullest extent permitted by law, the rights of such Holders to receive such principal and interest from the Trust Fund, including, without limitation, any amounts due to the Class M Certificateholders in respect of securities law violations arising from the offer and sale of the Class M Certificates, and (b) the Certificate Insurer shall be paid such amounts from the sources and in the manner provided herein for the payment of such amounts and as provided in the Insurance and Indemnity Agreement. The Trustee and the Servicer shall cooperate in all respects with any reasonable request by the Certificate Insurer for action to preserve or enforce the Certificate Insurer's rights or interests under this Agreement without limiting the rights or affecting the interests of the Holders as otherwise set forth herein. Section 6.12 Additional Rights of Certificate Insurer. (a) The Trustee, the Depositor and the Servicer shall cooperate in all respects with any reasonable request by the Certificate Insurer for action to preserve or enforce the Certificate Insurer's rights or interests hereunder without limiting the rights or affecting the interests of the Certificateholders as otherwise set forth herein. 97 (b) The Certificate Insurer will have the right to exercise all rights, including voting rights, which the Holders of the Class M Certificates are entitled to exercise under this Agreement, under the Unaffiliated Seller Agreement or any other instrument, document or agreement relating to the foregoing. In addition, the Certificate Insurer shall have the right to participate in, to direct the enforcement or defense of, and, at the Certificate Insurer's sole option, to institute or assume the defense of, any action, proceeding or investigation for any remedy available to the Trustee with respect to any matter that could adversely affect the Trust, the Trust Fund or the rights or obligations of the Certificate Insurer hereunder, under the Unaffiliated Seller Agreement, under the Insurance and Indemnity Agreement or under the Certificate Insurance Policy or any other instrument, document or agreement relating to the foregoing (collectively, the "Transaction Documents") or under the other Transaction Documents, including (without limitation) any insolvency or bankruptcy proceeding in respect of any Originator, the Unaffiliated Seller, the Servicer, the Depositor or any Affiliate thereof provided, that such participation or direction shall not be in conflict with any rule of law or with the terms of this Agreement. Following written notice to the Trustee, the Certificate Insurer shall have exclusive right to determine, in its sole discretion, the actions necessary to preserve and protect the Trust and the Trust Fund. The Certificate Insurer shall be entitled to reimbursement from the Distribution Account as provided for in Section 6.05 for all out-of-pocket costs and expenses of the Certificate Insurer in connection with such action, proceeding or investigation, including (without limitation) reasonable attorneys' fees and any judgment or settlement entered into affecting the Certificate Insurer or the Certificate Insurer's interests, all of which shall be included in the Reimbursement Amount. (c) In connection with any such action, proceeding or investigation for any remedy available to the Trustee with respect to any matter that could adversely affect the Trust, the Trust Fund or the rights or obligations of the Certificate Insurer hereunder or under the Certificate Insurance Policy or the Transaction Documents, including (without limitation) any insolvency or bankruptcy proceeding in respect of any Originator, the Unaffiliated Seller, the Servicer, the Depositor, the Trust or any Affiliate thereof, the Trustee hereby agrees to cooperate with, and to take such action as reasonably directed in writing by, the Certificate Insurer, including (without limitation) entering into such agreements and settlements as the Certificate Insurer shall direct, in its sole discretion, without the consent of any Certificateholder. Notwithstanding any other provision herein or in any of the other Transaction Documents, the Trustee shall not be liable to the Certificate Insurer or any Certificateholder for any such action that conforms to the direction of the Certificate Insurer. (d) Any judgment or settlement entered against or affecting the Trust or the Trust Fund in connection with any action, proceeding or investigation shall be paid by the Trustee from the Trust Fund out of funds that would otherwise be distributed to the Holders of the Class X or R Certificates. (e) The Trustee hereby agrees to provide to the Certificate Insurer prompt written notice of any action, proceeding or investigation that names the Trust or the Trustee as a party or that could adversely affect the Trust, the Trust Fund or the rights or obligations of the Certificate Insurer hereunder or under the Certificate Insurance Policy or the Transaction Documents, including (without limitation) any insolvency or bankruptcy proceeding in respect of any Originator, the Unaffiliated Seller, the Servicer, the Depositor, the Trust or any Affiliate thereof. (f) Notwithstanding anything contained herein or in any of the other Transaction Documents to the contrary, the Trustee shall not, without the Certificate Insurer's prior written consent or unless directed in writing by the Certificate Insurer, undertake or join any litigation or agree to any settlement of any action, proceeding or investigation affecting the Trust, the Trust Fund or the rights or obligations of the Certificate Insurer hereunder or under the Certificate Insurance Policy or the Transaction Documents. 98 (g) Each Holder of a Certificate, by acceptance of its Certificate, and the Trustee agree that Certificate Insurer shall have such rights as set forth in this Section, which are in addition to any rights of the Certificate Insurer pursuant to the other provisions of the Transaction Documents, that the rights set forth in this Section may be exercised by the Certificate Insurer, in its sole discretion, without the need for the consent or approval of any Certificateholder or the Trustee, notwithstanding any other provision contained herein or in any of the other Transaction Documents, and that nothing contained in this Section shall be deemed to be an obligation of the Certificate Insurer to exercise any of the rights provided for herein. (h) The Trustee shall, upon reasonable prior written request, permit any representative of the Certificate Insurer, during the Trustee's normal business hours, to examine all books of accounts, records, reports and other information of the Trustee relating to the Certificates and the Trust Fund (including, without limitation, the Mortgage Files), to make copies and extracts therefrom and to discuss the Trustee's performance of its duties with respect to the Transaction Documents with the Responsible Officers of the Trustee. Section 6.13 Special Reserve Account. On or prior to the Distribution Date occurring in October 2005, the Trustee shall establish and maintain a Special Reserve Account which shall be titled "Special Reserve Account, JPMorgan Chase Bank, as trustee for the registered holders of the ABFS Mortgage Loan Trust 2003-1, Mortgage Pass-Through Certificates, Series 2003-1, Class M", which account shall be an Eligible Account held by the Trustee on behalf of the Class M Certificateholders and the Certificate Insurer. If, on any Distribution Date occurring from October 2005 through March 2006, the Current Pool Principal Balance (after giving effect to distributions on such Distribution Date) has been reduced to less than 50.0% of the Maximum Pool Principal Balance, the Paying Agent shall deposit into the Special Reserve Account, from the amount otherwise distributable to the Holders of the Class X Certificates pursuant to Section 6.05(a)(xiii) hereof on such Distribution Date, an amount equal to 28% of the Principal Distribution Amount for such Distribution Date, or such lesser amount as would have been distributable to the Holders of the Class X Certificates. Any amounts on deposit in the Special Reserve Account on any Distribution Date shall be available for the payment of, and deposited by the Paying Agent into the Distribution Account in satisfaction of, any Class M Insured Payment that would otherwise be required to be made by the Certificate Insurer on such Distribution Date. Provided that no Trigger Event is then in effect, all amounts on deposit in the Special Reserve Account on the April 2006 Distribution Date (after giving effect to distributions on such Distribution Date) will be distributed by the Paying Agent to the Holders of the Class X Certificates. In the event that any amounts remain on deposit in the Special Reserve Account on the date of termination of this Agreement pursuant to Article VIII (after the making of all payments to the Certificateholders, the Trustee and the Certificate Insurer), any remaining amounts on deposit in the Special Reserve Account shall be distributed to the Holders of the Class X Certificates. 99 ARTICLE VII DEFAULT Section 7.01 Events of Default. (a) In case one or more of the following events (each an "Event of Default") shall occur and be continuing: (i) any failure by the Servicer to remit to the Trustee any payment required to be made by the Servicer under the terms of this Agreement, other than Servicing Advances covered by clause (ii) below, which continues unremedied for one (1) Business Day after the date upon which written notice of such failure, requiring the same to be remedied, shall have been given to the Servicer and the Certificate Insurer by the Trustee or to the Servicer and the Trustee by the Certificate Insurer or the Certificateholders of Offered Certificates evidencing Percentage Interests of at least 25%; (ii) the failure by the Servicer to make any required Servicing Advance which failure continues unremedied for a period of thirty (30) days after the date on which written notice of such failure, requiring the same to be remedied, shall have been given to the Servicer by the Trustee or to the Servicer and the Trustee by any Certificateholder or the Certificate Insurer; (iii) any failure on the part of the Servicer duly to observe or perform in any material respect any other of the covenants or agreements on the part of the Servicer contained in this Agreement, or the failure of any representation and warranty made pursuant to Section 3.01 to be true and correct which continues unremedied for a period of thirty (30) days after the date on which written notice of such failure, requiring the same to be remedied, shall have been given to the Servicer, as the case may be, by the Depositor or the Trustee or to the Servicer and the Trustee by any Certificateholder or the Certificate Insurer; (iv) a decree or order of a court or agency or supervisory authority having jurisdiction in an involuntary case under any present or future federal or state bankruptcy, insolvency or similar law or for the appointment of a conservator or receiver or liquidator in any insolvency, readjustment of debt, marshalling of assets and liabilities or similar proceedings, or for the winding-up or liquidation of its affairs, shall have been entered against the Servicer and such decree or order shall have remained in force, undischarged or unstayed for a period of forty-five (45) days; (v) the Servicer shall consent to the appointment of a conservator or receiver or liquidator in any insolvency, readjustment of debt, marshalling of assets and liabilities or similar proceedings of or relating to the Servicer or of or relating to all or substantially all of the Servicer's property; (vi) the Servicer shall admit in writing its inability to pay its debts as they become due, file a petition to take advantage of any applicable insolvency or reorganization statute, make an assignment for the benefit of its creditors, or voluntarily suspend payment of its obligations; 100 (vii) if on any Distribution Date a Servicer Termination Loss Trigger Event occurs; (viii) the Certificate Insurer shall notify the Trustee and the Servicer in writing of any "event of default" on the part of the Servicer under the Insurance and Indemnity Agreement; or (ix) any Change of Control shall occur; then, and in each and every such case, so long as such Event of Default shall not have been remedied: (x) with respect solely to clause (i) above, if such payment is in respect of Periodic Advances or Compensating Interest owing by the Servicer and such payment is not made by 12:00 Noon, New York time on the fourth Business Day prior to the applicable Distribution Date, the Trustee, upon receipt of written notice or discovery by a Responsible Officer of such failure, shall give immediate telephonic notice of such failure to a Servicing Officer of the Servicer and to the Certificate Insurer and the Trustee may, at the written direction of the Majority Certificateholders, with the written consent of the Certificate Insurer, and shall, at the written direction of the Certificate Insurer, terminate all of the rights and obligations of the Servicer under this Agreement and the Back-up Servicer, or a successor servicer appointed in accordance with Section 7.02, shall immediately make such Periodic Advance or payment of Compensating Interest and assume, pursuant to Section 7.02 hereof, the duties of a successor Servicer; (y) with respect to clause (ix) above, such Event of Default shall be waived in the event the Servicer receives the written consent of the Certificate Insurer, such consent not to be unreasonably withheld; and (z) with respect to any other Event of Default, the Trustee may, at the written direction of the Majority Certificateholders, with the written consent of the Certificate Insurer, and shall, at the written direction of the Certificate Insurer, by notice in writing to the Servicer and a Responsible Officer of the Trustee, terminate all the rights and obligations of the Servicer under this Agreement and in and to the Mortgage Loans and the proceeds thereof, as servicer. Upon receipt by the Servicer of such written notice, all authority and power of the Servicer under this Agreement, whether with respect to the Mortgage Loans or otherwise, shall, subject to Section 7.02, pass to and be vested in the Back-up Servicer or such other Person as may be specified by the Certificate Insurer and the Back-up Servicer is hereby authorized and empowered to execute and deliver, on behalf of the Servicer, as attorney-in-fact or otherwise, at the expense of the Servicer, any and all documents and other instruments and do or cause to be done all other acts or things necessary or appropriate to effect the purposes of such notice of termination, including, but not limited to, the transfer and endorsement or assignment of the Mortgage Loans and related documents. The Servicer agrees to cooperate (and pay any related costs and expenses) with the Trustee and the Back-up Servicer in effecting the termination of the Servicer's responsibilities and rights hereunder and the transfer of such responsibilities and rights to a successor Servicer, including, without limitation, the transfer to the Back-up Servicer or its designee for administration by it of all amounts which shall at the time be credited by the Servicer to the Collection Account or thereafter received with respect to the Mortgage Loans. The Trustee shall promptly notify the Certificate Insurer and the Rating Agencies of the occurrence of an Event of Default. 101 Section 7.02 Back-up Servicer to Act; Appointment of Successor. (a) On and after the time the Servicer receives a notice of termination pursuant to Section 7.01, or the Trustee receives the resignation of the Servicer evidenced by an Opinion of Counsel pursuant to Section 5.21, the Trustee shall promptly notify the Rating Agencies and the Certificate Insurer and, except as otherwise provided in Section 7.01, the Back-up Servicer or such other Person as may be specified by the Certificate Insurer shall be the successor in all respects to the Servicer in its capacity as servicer under this Agreement and the transactions set forth or provided for herein and shall be subject to all the responsibilities, duties and liabilities relating thereto placed on the Servicer by the terms and provisions hereof arising on or after the date of succession; provided, however, that the Back-up Servicer shall not be liable for any actions or the representations and warranties of any servicer prior to it and including, without limitation, the obligations of the Servicer set forth in Sections 2.06 and 3.03. The Back-up Servicer, as successor servicer, shall be obligated to pay Compensating Interest pursuant to Section 6.09 in any event and to make advances pursuant to Section 5.18 unless, and only to the extent the Back-up Servicer determines reasonably and in good faith that such advances would not be recoverable pursuant to Section 5.04, such determination to be evidenced by a certification of a Responsible Officer of the Back-up Servicer delivered to the Certificate Insurer. (b) Notwithstanding the above, the Trustee may, if the Back-up Servicer shall be unwilling to so act, or shall, if the Back-up Servicer is unable to so act or if the Certificate Insurer so requests in writing to the Trustee, appoint, pursuant to such direction of the Certificate Insurer, or if no such direction is provided to the Trustee, pursuant to the provisions set forth in paragraph (c) below, or petition a court of competent jurisdiction to appoint, any established mortgage loan servicing institution acceptable to the Certificate Insurer that has a net worth of not less than $15,000,000 as the successor to the Servicer hereunder in the assumption of all or any part of the responsibilities, duties or liabilities of the Servicer hereunder. (c) In the event the Back-up Servicer is the successor servicer, it shall be entitled to the same Servicing Compensation (including the Servicing Fee as adjusted pursuant to the definition thereof) and other funds pursuant to Section 5.08 hereof as the Servicer if the Servicer had continued to act as servicer hereunder; it being understood that, in such event, the Back-up Servicer would no longer be entitled to the Back-up Servicing Fee. In the event the Back-up Servicer is unable or unwilling to act as successor servicer, the Trustee shall solicit, by public announcement, bids from housing and home finance institutions, banks and mortgage servicing institutions meeting the qualifications set forth above. Such public announcement shall specify that the successor servicer shall be entitled to the full amount of the aggregate Servicing Fees hereunder as servicing compensation, together with the other Servicing Compensation. Within thirty days after any such public announcement, the Trustee shall negotiate and effect the sale, transfer and assignment of the servicing rights and responsibilities hereunder to the qualified party submitting the highest qualifying bid. The Trustee shall deduct from any sum received by the Trustee from the successor to the Servicer in respect of such sale, transfer and assignment all costs and expenses of any public announcement and of any sale, transfer and assignment of the servicing rights and responsibilities hereunder and the amount of any unreimbursed Servicing Advances and Periodic Advances owed to the Back-up Servicer. After such deductions, the remainder of such sum shall be paid by the Trustee to the Servicer at the time of such sale, transfer and assignment to the Servicer's successor. 102 (d) The Trustee and such successor servicer (including, without limitation, the Back-up Servicer) shall take such action, consistent with this Agreement, as shall be necessary to effectuate any such succession. The Servicer agrees to cooperate with the Trustee and any successor servicer in effecting the termination of the Servicer's servicing responsibilities and rights hereunder and shall promptly provide the Trustee or such successor servicer, as applicable, at the Servicer's cost and expense, all documents and records reasonably requested by it to enable it to assume the Servicer's functions hereunder and shall promptly also transfer to the Trustee or such successor servicer, as applicable, all amounts that then have been or should have been deposited in the Collection Account by the Servicer or that are thereafter received with respect to the Mortgage Loans. Any collections received by the Servicer after such removal or resignation shall be endorsed by it to the Trustee and remitted directly to the Trustee or, at the direction of the Trustee, to the successor servicer. In connection with any failure by the Servicer to make any remittance required to be made by the Servicer to the Collection Account pursuant to this Section 7.01 on the day and by the time such remittance is required to be made under the terms of this Section 7.01 (without giving effect to any grace or cure period), the Servicer shall pay to the Trustee for the account of the Trustee interest at the Late Payment Rate on any amount not timely remitted from and including the day such remittance was required to be made to, but not including, the day on which such remittance was actually made. Neither the Trustee nor any successor servicer shall be held liable by reason of any failure to make, or any delay in making, any distribution hereunder or any portion thereof caused by (i) the failure of the Servicer to deliver, or any delay in delivering, cash, documents or records to it, or (ii) restrictions imposed by any regulatory authority having jurisdiction over the Servicer hereunder. Notwithstanding anything to the contrary herein, no appointment of a successor to the Servicer under this Agreement shall be effective until the Certificate Insurer shall have consented in writing thereto, and written notice of such proposed appointment shall have been provided by the Trustee to each Certificateholder and to the Certificate Insurer. The Back-up Servicer shall not resign as servicer until a successor servicer has been appointed or until a successor servicer reasonably acceptable to the Certificate Insurer has been appointed in accordance with paragraph (c) above. The Certificate Insurer shall have the right to remove the Back-up Servicer (or any successor Servicer) as successor Servicer under this Section 7.02 without cause, and the Trustee shall appoint such other successor Servicer as directed in writing by the Certificate Insurer. (e) Pending appointment of a successor to the Servicer hereunder, the Back-up Servicer shall act in such capacity as hereinabove provided. In connection with such appointment and assumption, the Trustee may make such arrangements for the compensation of such successor out of payments on Mortgage Loans as the Certificate Insurer and such successor shall agree; provided, however, that unless otherwise agreed by the Certificate Insurer, no such compensation shall be in excess of that permitted the Servicer pursuant to Section 5.08, together with other Servicing Compensation. The Servicer, the Back-up Servicer, the Trustee and such successor shall take such action, consistent with this Agreement, as shall be necessary to effectuate any such succession. Section 7.03 Waiver of Defaults. The Majority Certificateholders may, on behalf of all Certificateholders, and subject to the written consent of the Certificate Insurer, waive any events permitting removal of the Servicer as servicer pursuant to this Article VII; provided, however, that the Majority Certificateholders may not waive a default in making a required distribution on a Certificate without the consent of the holder of such Certificate. Upon any waiver of a past default, such default shall cease to exist, and any Event of Default arising therefrom shall be deemed to have been remedied for every purpose of this Agreement. No such waiver shall extend to any subsequent or other default or impair any right consequent thereto except to the extent expressly so waived. Notice of any such waiver shall be given by the Trustee to the Rating Agencies and the Certificate Insurer. 103 Section 7.04 Rights of the Certificate Insurer to Exercise Rights of Certificateholders. By accepting its Certificate, each Certificateholder agrees that the Certificate Insurer shall be deemed to be the Certificateholders for all purposes (other than with respect to the receipt of payment on the Certificates) and shall have the right to exercise all rights of the Certificateholders under this Agreement and under the Certificates without any further consent of the Certificateholders, including, without limitation: (a) the right to require the Unaffiliated Seller to repurchase Mortgage Loans pursuant to Section 2.06 or 3.03 hereof to the extent set forth in such Sections; (b) the right to give notices of breach or to terminate the rights and obligations of the Servicer as servicer pursuant to Section 7.01 hereof and to consent to or direct in writing waivers of Servicer defaults pursuant to Section 7.03 hereof; (c) the right to direct in writing the actions of the Trustee during the continuance of an Event of Default pursuant to Sections 7.01 and 7.02 hereof; (d) the right to institute proceedings against the Servicer pursuant to Section 7.01 hereof; (e) the right to direct in writing the Trustee to investigate certain matters pursuant to Section 9.02(a)(v) hereof; (f) the right to direct in writing the removal of the Trustee pursuant to Section 9.07 hereof; (g) the right to direct foreclosures upon the failure of the Servicer to do so in accordance with the provisions of Section 5.06 of this Agreement; and (h) any rights or remedies expressly given the Majority Certificateholders. In addition, each Certificateholder agrees that, subject to Section 10.02, the rights specifically enumerated above may only be exercised by the Certificateholders with the prior written consent of the Certificate Insurer. Section 7.05 Trustee To Act Solely with Consent of the Certificate Insurer. The Trustee shall not, without the Certificate Insurer's written consent or unless directed in writing by the Certificate Insurer: (a) terminate the rights and obligations of the Servicer as Servicer pursuant to Section 7.01 hereof; (b) agree to any amendment pursuant to Section 10.03 hereof; or 104 (c) undertake any litigation. The Certificate Insurer may, in writing and in its sole discretion renounce all or any of its rights under Sections 7.04, 7.05 or 7.06 or any requirement for the Certificate Insurer's consent for any period of time. Section 7.06 Mortgage Loans, Trust Fund and Accounts Held for Benefit of the Certificate Insurer. (a) The Trustee shall hold the Trust Fund and shall cause the Collateral Agent on its behalf to hold the Mortgage Files for the benefit of the Certificateholders and the Certificate Insurer and all references in this Agreement and in the Certificates to the benefit of Holders of the Certificates shall be deemed to include the Certificate Insurer. The Trustee shall cooperate in all reasonable respects with any reasonable request by the Certificate Insurer for action to preserve or enforce the Certificate Insurer's rights or interests under this Agreement and the Certificates unless, as stated in an Opinion of Counsel addressed to the Trustee and the Certificate Insurer, such action is adverse to the interests of the Certificateholders or diminishes the rights of the Certificateholders or imposes additional burdens or restrictions on the Certificateholders. (b) The Servicer hereby acknowledges and agrees that it shall service the Mortgage Loans for the benefit of the Certificateholders and for the benefit of the Certificate Insurer, and all references in this Agreement to the benefit of or actions on behalf of the Certificateholders shall be deemed to include the Certificate Insurer. Section 7.07 Certificate Insurer Default. (a) Except as specifically set forth in Section 7.07(b) and notwithstanding anything elsewhere in this Agreement or in the Certificates to the contrary, if a Certificate Insurer Default exists and is continuing, or if and to the extent the Certificate Insurer has delivered its written renunciation of all of its rights under this Agreement, the provisions of this Article VII and all other provisions of this Agreement which (a) permit the Certificate Insurer to exercise rights of the Certificateholders, (b) restrict the ability of the Certificateholders, the Servicer or the Trustee to act without the consent or approval of the Certificate Insurer, (c) provide that a particular act or thing must be acceptable to the Certificate Insurer, (d) permit the Certificate Insurer to direct (or otherwise to require) the actions of the Trustee, the Servicer or the Certificateholders, (e) provide that any action or omission taken with the consent, approval or authorization of the Certificate Insurer shall be authorized hereunder or shall not subject the party taking or omitting to take such action to any liability hereunder or (f) which have a similar effect, shall be suspended and shall be of no further force and effect and the Trustee shall administer the Trust Fund and perform its obligations hereunder solely for the benefit of the Holders of the Certificates. Nothing in the foregoing sentence, nor any action taken pursuant thereto or in compliance therewith, shall be deemed to have released the Certificate Insurer from any obligation or liability it may have to any party or to the Certificateholders hereunder, under any other agreement, instrument or document (including, without limitation, the Certificate Insurance Policy) or under applicable law. Notwithstanding anything elsewhere in this Agreement to the contrary, at such time as the Class M Certificates are no longer outstanding hereunder, the Certificate Insurance Policy has terminated in accordance with its terms and no amounts owed to the Certificate Insurer hereunder and under the Insurance and Indemnity Agreement and no Reimbursement Amounts remain unpaid, the Certificate Insurer's rights hereunder shall terminate. 105 (b) Notwithstanding anything elsewhere in this Agreement to the contrary, none of the following rights of the Certificate Insurer shall be suspended even if a Certificate Insurer Default shall have occurred and be continuing: (i) the right to receive any Premium Amount, any Reimbursement Amounts and any and all other amounts due under this Agreement and the Insurance and Indemnity Agreement; (ii) any subrogation right with respect to payments made by the Certificate Insurer under the Certificate Insurance Policy; (iii) the right to receive notices, reports, opinions and certifications; (iv) the right to give notice of any Event of Default under this Agreement and any "event of default" under the Insurance and Indemnity Agreement; (v) the right to consent to any amendment pursuant to Section 11.03; and (vi) the right to consent to termination of this Agreement under Section 8.01(a) if such termination would result in a draw under the Certificate Insurance Policy or failure to pay all amounts owed to the Certificate Insurer under this Agreement and the Insurance and Indemnity Agreement. ARTICLE VIII TERMINATION Section 8.01 Termination. (a) Subject to Section 8.02, this Agreement shall terminate upon notice to the Trustee of the later of the distribution to Certificateholders of the final payment with respect to the Certificates and the full and final payment of all Reimbursement Amounts, Premium Amounts, Trustee Fees and other amounts due and payable to the Certificate Insurer and Trustee, or the disposition of all funds with respect to the last Mortgage Loan and the remittance of all funds due hereunder; provided, however, that in no event shall the Trust established by this Agreement terminate later than: (i) twenty-one years after the death of the last surviving lineal descendant of Joseph P. Kennedy, late Ambassador of the United States to the Court of St. James, alive as of the date hereof or (ii) the Distribution Date in December 2034. (b) In addition, subject to Section 8.02, Servicer may, at its option and at its sole cost and expense, elect to cause this Agreement to be terminated and all the Offered Certificates to be redeemed in whole, but not in part, on the first Distribution Date after any Distribution Date on which the Aggregate Principal Balance is equal to or less than 10% of the Maximum Pool Principal Balance (the "Clean-Up Call Date") by purchasing, on such succeeding Distribution Date, all of the outstanding Mortgage Loans and REO Properties at a price equal to the sum of (i) 100% of the aggregate Principal Balance of each outstanding Mortgage Loan and each REO Property, (ii) the greater of (1) the aggregate amount of accrued and unpaid interest on the Mortgage Loans through the related Due Period and (2) 30 days' accrued interest thereon computed at a rate equal to the related Mortgage Interest Rate, in each case net of the Servicing Fee, (iii) any Back-up Servicer Fees or other amounts due to the Back-up Servicer hereunder, (iv) any and all Reimbursement Amounts and Premium Amounts and any other amounts due to the Certificate Insurer under this Agreement and the Insurance and Indemnity Agreement and (v) any Trustee Fees or other amounts due to the Trustee hereunder (the "Termination Price"); provided, that in no event will the Termination Price be less than the sum of the aggregate Certificate Principal Balance of the Offered Certificates, plus all accrued and unpaid Premium Amounts, Reimbursement Amounts and all accrued and unpaid interest on the Offered Certificates plus all amounts due the Trustee and the Back-up Servicer hereunder plus all unreimbursed Periodic Advances and Servicing Advances. Any such purchase shall be accomplished by deposit of the Termination Price into the Distribution Account. No such termination is permitted without the prior written consent of the Certificate Insurer if it would result in a draw on the Certificate Insurance Policy or the failure to pay any and all amounts owed to the Certificate Insurer under this Agreement or the Insurance and Indemnity Agreement. 106 (c) If on any Distribution Date, the Servicer determines that there are no outstanding Mortgage Loans and no other funds or assets in the Trust Fund other than funds in the Distribution Account, the Servicer shall send a final distribution notice promptly to each such Certificateholder and the Certificate Insurer in accordance with paragraph (d) below. (d) Notice of any termination, specifying the Distribution Date upon which the Trust Fund will terminate and the Certificateholders shall surrender their Certificates to the Trustee for payment of the final distribution and cancellation, shall be given promptly by the Servicer by letter to the Certificateholders and the Certificate Insurer mailed during the month of such final distribution before the Servicer Remittance Date in such month, specifying (i) the Distribution Date upon which final payment of the Certificates will be made upon presentation and surrender of Certificates at the office of the Trustee therein designated, (ii) the amount of any such final payment and (iii) that the Record Date otherwise applicable to such Distribution Date is not applicable, payments being made only upon presentation and surrender of the Certificates at the office of the Trustee therein specified. The Servicer shall give such notice to the Trustee therein specified. The Servicer shall give such notice to the Trustee at the time such notice is given to Certificateholders. The obligations of the Certificate Insurer hereunder shall terminate upon the deposit by the Servicer with the Trustee of a sum sufficient to purchase all of the Mortgage Loans and REO Properties as set forth above or when the Certificate Principal Balance of the Class M Certificates falls to zero. (e) In the event that all of the Certificateholders shall not surrender their Certificates for cancellation within six months after the time specified in the above-mentioned written notice, the Servicer shall give a second written notice to the remaining Certificateholders to surrender their Certificates for cancellation and receive the final distribution with respect thereto. If within six months after the second notice, all of the Certificates shall not have been surrendered for cancellation, the Trustee may take appropriate steps, or may appoint an agent to take appropriate steps, to contact the remaining Certificateholders concerning surrender of their Certificates and the cost thereof shall be paid out of the funds and other assets which remain subject hereto. If within nine months after the second notice all the Certificates shall not have been surrendered for cancellation, the Class R Certificateholders shall be entitled to all unclaimed funds and other assets which remain subject hereto and the Trustee upon transfer of such funds shall be discharged of any responsibility for such funds and the Certificateholders shall look only to the Class R Certificateholders for payment and not to the Certificate Insurer or the Trustee. Such funds shall remain uninvested. 107 Section 8.02 Additional Termination Requirements. (a) In the event that the Servicer exercises its purchase option as provided in Section 8.01, the Trust Fund shall be terminated in accordance with the following additional requirements, unless the Trustee and the Certificate Insurer have been furnished with an Opinion of Counsel to the effect that the failure of the Trust Fund to comply with the requirements of this Section 8.02 will not (i) result in the imposition of taxes on "prohibited transactions" of any REMIC created hereunder as defined in Section 860F of the Code or (ii) cause any REMIC created hereunder to fail to qualify as a REMIC at any time that any Offered Certificates or Class X or Class I Certificates are outstanding: (i) Within 90 days prior to the final Distribution Date the Servicer shall adopt and the Trustee shall sign, a plan of complete liquidation of each REMIC created hereunder meeting the requirements of a "Qualified Liquidation" under Section 860F of the Code and any regulations thereunder; (ii) At or after the time of adoption of such a plan of complete liquidation and at or prior to the final Distribution Date, the Trustee shall sell all of the assets of the REMIC I to the Servicer for cash; and (iii) At the time of the making of the final payment on the Certificates, the Trustee shall distribute or credit, or cause to be distributed or credited (A) to the Class A Certificateholders, the Class A Certificate Principal Balance, plus one month's interest thereon at the Class A Pass-Through Rate, (B) to the Class A-IO Certificateholders, one month's interest on the Class A-IO Notional Amount, if any, at the Class A-IO Pass-Through Rate, (C) to the Class M Certificateholders, the Class M Certificate Principal Balance, plus one month's interest thereon at the Class M Pass-Through Rate, (D) to the Certificate Insurer any and all amounts due the Certificate Insurer under this Agreement or the Insurance and Indemnity Agreement and unpaid, including all Reimbursement Amounts, (E) to the Class X Certificateholders, all cash on hand after such payment to the Class A, Class A-IO and Class M Certificateholders and to the Certificate Insurer (but in no event in excess of the Class X Distribution Amount), and (F) to the Class R Certificates in respect of the Class R-I Interest, any remaining amounts (other than cash retained to meet claims) and the Trust Fund shall terminate at such time; provided, however, that any such payment will be made after all outstanding fees, costs and expenses of the Trustee have been paid in full. (b) By their acceptance of the Certificates, the Holders thereof hereby agree to appoint the Servicer as their attorney in fact to: (i) adopt such a plan of complete liquidation (and the Certificateholders hereby appoint the Trustee as their attorney in fact to sign such plan) as appropriate or upon the written request of the Certificate Insurer and (ii) to take such other action in connection therewith as may be reasonably required to carry out such plan of complete liquidation all in accordance with the terms hereof. 108 Section 8.03 Accounting Upon Termination of Servicer. Upon termination of the Servicer, the Servicer shall, at its expense: (a) deliver to its successor or, if none shall yet have been appointed, to the Trustee, the funds in any Account; (b) deliver to its successor or, if none shall yet have been appointed, to the Collateral Agent on behalf of the Trustee all Mortgage Files and related documents and statements held by it hereunder and a Mortgage Loan portfolio computer tape; (c) deliver to its successor or, if none shall yet have been appointed, to the Trustee and, upon request, to the Certificateholders a full accounting of all funds, including a statement showing the Monthly Payments collected by it and a statement of monies held in trust by it for the payments or charges with respect to the Mortgage Loans; and (d) execute and deliver such instruments and perform all acts reasonably requested in order to effect the orderly and efficient transfer of servicing of the Mortgage Loans to its successor and to more fully and definitively vest in such successor all rights, powers, duties, responsibilities, obligations and liabilities of the "Servicer" under this Agreement. ARTICLE IX THE TRUSTEE Section 9.01 Duties of Trustee. (a) The Trustee, prior to the occurrence of an Event of Default of which a Responsible Officer of the Trustee shall have actual knowledge and after the curing of all Events of Default which may have occurred, undertakes to perform such duties and only such duties as are specifically set forth in this Agreement. If an Event of Default of which a Responsible Officer of the Trustee shall have actual knowledge has occurred and has not been cured or waived, the Trustee shall exercise such of the rights and powers vested in it by this Agreement, and use the same degree of care and skill in its exercise as a prudent person would exercise or use under the circumstances in the conduct of such person's own affairs. (b) The Trustee, upon receipt of all resolutions, certificates, statements, opinions, reports, documents, orders or other instruments furnished to the Trustee which are specifically required to be furnished pursuant to any provision of this Agreement, shall examine them to determine whether they conform on their face to the requirements of this Agreement; provided, however, that the Trustee shall not be responsible for the accuracy or content of any resolution, certificate, statement, opinion, report, document, order or other instrument furnished by the Servicer, the Back-up Servicer (if not the Trustee) or the Unaffiliated Seller hereunder. If any such instrument is found not to conform on its face to the requirements of this Agreement, the Trustee will, at the expense of the Servicer, notify the Certificate Insurer of such instrument in the event the Trustee, after so requesting, does not receive a satisfactorily corrected instrument. 109 (c) No provision of this Agreement shall be construed to relieve the Trustee from liability for its own negligent action, its own negligent failure to act or its own willful misconduct; provided, however, that: (i) prior to the occurrence of an Event of Default of which a Responsible Officer of the Trustee shall have actual knowledge, and after the curing of all such Events of Default which may have occurred, the duties and obligations of the Trustee shall be determined solely by the express provisions of this Agreement, the Trustee shall not be liable except for the performance of such duties and obligations as are specifically set forth in this Agreement, no implied covenants or obligations shall be read into this Agreement against the Trustee and, in the absence of bad faith on the part of the Trustee, the Trustee may conclusively rely, as to the truth of the statements and the correctness of the opinions expressed therein, upon any certificates or opinions furnished to the Trustee and conforming to the requirements of this Agreement; (ii) the Trustee shall not be personally liable for an error of judgment made in good faith by a Responsible Officer or other officers of the Trustee, unless it shall be proved that the Trustee was negligent in ascertaining the pertinent facts; (iii) the Trustee shall not be personally liable with respect to any action taken, suffered or omitted to be taken by it in good faith in accordance with this Agreement or at the written direction of the Certificate Insurer or, with the written consent of the Certificate Insurer, at the written direction of the Majority Certificateholders, relating to the time, method and place of conducting any proceeding for any remedy available to the Trustee, or exercising any trust or power conferred upon the Trustee, under this Agreement; (iv) the Trustee shall not be required to take notice or be deemed to have notice or knowledge of any default, Event of Default (except an Event of Default with respect to the nonpayment of any amount described in Section 7.01(a)) or Certificate Insurer Default, unless a Responsible Officer of the Trustee shall have received written notice thereof. In the absence of receipt of such notice, the Trustee may conclusively assume that there is no default, Event of Default or Certificate Insurer Default; (v) the Trustee shall not be required to expend or risk its own funds or otherwise incur financial liability for the performance of any of its duties hereunder or the exercise of any of its rights or powers if there is reasonable ground for believing that the repayment of such funds or adequate indemnity against such risk or liability is not reasonably assured to it and none of the provisions contained in this Agreement shall in any event require the Trustee to perform, or be responsible for the manner of performance of, any of the obligations of the Servicer under this Agreement except during such time, if any, as the Trustee shall be the successor to, and be vested with the rights, duties, powers and privileges of, the Servicer in accordance with the terms of this Agreement; and 110 (vi) subject to the other provisions of this Agreement (and except in its capacity as successor Servicer) and without limiting the generality of this Section, the Trustee shall have no duty (A) to see to any recording, filing, or depositing of this Agreement or any agreement referred to herein or any financing statement or continuation statement evidencing a security interest, or to see to the maintenance of any such recording or filing or depositing or to any rerecording, refiling or redepositing of any thereof, (B) to see to any insurance, (C) to see to the payment or discharge of any tax, assessment, or other governmental charge or any lien or encumbrance of any kind owing with respect to, assessed or levied against, any part of the Trust, the Trust Fund, the Certificateholders or the Mortgage Loans, (D) to confirm or verify the contents of any reports or certificates of the Servicer delivered to the Trustee pursuant to this Agreement believed by the Trustee to be genuine and to have been signed or presented by the proper party or parties or (E) execute the certification required by the Sarbanes Oxley Act of 2002. Section 9.02 Certain Matters Affecting the Trustee. (a) Except as otherwise provided in Section 9.01: (i) the Trustee may rely and shall be protected in acting or refraining from acting upon any resolution, Officer's Certificate, Opinion of Counsel, advice of counsel, certificate of auditors or any other certificate, statement, instrument, opinion, report, notice, request, consent, order, appraisal, bond or other paper or document believed by it to be genuine and to have been signed or presented by the proper party or parties; (ii) the Trustee may consult with counsel and any Opinion of Counsel or written advice of counsel shall be full and complete authorization and protection in respect of any action taken or suffered or omitted by it hereunder in good faith and in accordance with such Opinion of Counsel or advice of counsel; (iii) the Trustee shall be under no obligation to exercise any of the trusts or powers vested in it by this Agreement or to institute, conduct or defend by litigation hereunder or in relation hereto at the request, order or direction of the Certificate Insurer or any of the Certificateholders, pursuant to the provisions of this Agreement, unless such Certificateholders or the Certificate Insurer, as applicable, shall have offered to the Trustee reasonable security or indemnity reasonably satisfactory to it against the costs, expenses and liabilities which may be incurred therein by the Trustee or thereby; nothing contained herein shall, however, relieve the Trustee of the obligation, upon the occurrence of an Event of Default of which a Responsible Officer of the Trustee shall have actual knowledge (which has not been cured), to exercise such of the rights and powers vested in it by this Agreement, and to use the same degree of care and skill in its exercise as a prudent person would exercise or use under the circumstances in the conduct of such person's own affairs; (iv) the Trustee shall not be personally liable for any action taken, suffered or omitted by it in good faith and believed by it to be authorized or within the discretion or rights or powers conferred upon it by this Agreement; 111 (v) the Trustee shall not be bound to make any investigation into the facts or matters stated in any resolution, certificate, statement, instrument, opinion, report, notice, request, consent, order, approval, bond or other paper or document, unless requested in writing to do so by the Certificate Insurer or the Majority Certificateholders; provided, however, that if the payment within a reasonable time to the Trustee of the costs, expenses or liabilities likely to be incurred by it in the making of such investigation is, in the opinion of the Trustee, not reasonably assured to the Trustee by the security afforded to it by the terms of this Agreement, the Trustee may require reasonable indemnity satisfactory to the Trustee against such cost, expense or liability as a condition to taking any such action. The reasonable expense of every such examination shall be paid by the Servicer or, if paid by the Trustee, shall be repaid by the Servicer upon demand from the Servicer's own funds; (vi) the right of the Trustee to perform any discretionary act enumerated in this Agreement shall not be construed as a duty, and the Trustee shall not be answerable for other than its negligence or willful misconduct in the performance of such act; (vii) the Trustee shall not be required to give any bond or surety in respect of the execution of the Trust created hereby or the powers granted hereunder; and (viii) the Trustee may execute any of the trusts or powers hereunder or perform any duties hereunder either directly or by or through agents, attorneys or custodians and the Trustee shall not be responsible for any misconduct or negligence on the part of any such agent, attorney or custodian appointed by the Trustee with due care. (b) Following the Startup Day, the Trustee shall not knowingly accept any contribution of assets to the Trust Fund, unless the Trustee and the Certificate Insurer shall have received an Opinion of Counsel (at the expense of the Servicer) to the effect that the inclusion of such assets in the Trust Fund will not cause any REMIC created hereunder to fail to qualify as a REMIC at any time that any Certificates are outstanding or subject any REMIC created hereunder to any tax under the REMIC Provisions or other applicable provisions of federal, state and local law or ordinances. The Trustee agrees to indemnify the Trust Fund, the Certificate Insurer and the Servicer for any taxes and costs, including any attorney's fees, imposed or incurred by the Trust Fund or the Servicer as a result of the breach of the Trustee's covenants set forth within this subsection (b). Section 9.03 Trustee Not Liable for Certificates or Mortgage Loans. The recitals, representations, warranties and covenants contained herein or in the Certificates (other than the certificate of authentication on the Certificates) shall be taken as the statements, representations, warranties and covenants of the Unaffiliated Seller or the Servicer as the case may be, and the Trustee assumes no responsibility for their correctness. The Trustee makes no representations as to the validity or sufficiency of this Agreement or of any Mortgage Loan or related document. The Trustee shall not be accountable for the use or application by the Depositor of any of the Certificates or the proceeds of the Certificates, or for the use or application of any funds paid to the Servicer in respect of the Mortgage Loans or deposited in or withdrawn from the Collection Account by the Servicer. The Trustee shall not be responsible for the legality or validity of the Agreement or the validity, priority, perfection or sufficiency of the security for the Certificates issued or intended to be issued hereunder. The Trustee shall have no responsibility for filing any financing or continuation statement in any public office at any time or to otherwise perfect or maintain the perfection of any security interest or lien granted to it hereunder or to record this Agreement. 112 Section 9.04 Trustee May Own Certificates. The Trustee in its individual or any other capacity may become the owner or pledgor of Certificates with the same rights it would have if it were not Trustee, and may otherwise deal with the parties hereto. Section 9.05 Trustee's Fees and Expenses; Indemnity. (a) The Trustee acknowledges that in consideration of the services rendered by the Trustee in the execution of the trust hereby created and in the exercise and performance of any of the powers and duties hereunder it is entitled to receive the Trustee's Fee in accordance with the provision of Section 6.05(a) (which shall not be limited by any provision of law in regard to the compensation of a trustee of any express trust). Additionally, the Trustee hereby covenants, for the benefit of the Depositor and the Certificate Insurer, that the Trustee has arranged separately with the Servicer for the payment or reimbursement to the Trustee of all of the Trustee's expenses in connection with this Agreement, including, without limitation, all reasonable out of pocket expenses, disbursements and advances incurred or made by the Trustee in accordance with any of the provisions of this Agreement (including the reasonable compensation and the expenses and disbursements of its counsel and of all persons not regularly in its employ). Notwithstanding any other provision of this Agreement to the contrary, the Servicer covenants and agrees to indemnify the Trustee and its officers, directors, employees and agents from, and hold it harmless against, any and all losses, liabilities, damages, claims or expenses incurred in connection with any legal action relating to this Agreement, the Certificates or incurred in connection with the administration of the Trust, other than any loss, liability or expense incurred by reason of willful misfeasance, bad faith or negligence of the Trustee in the performance of its duties hereunder or by reason of the Trustee's reckless disregard of obligations and duties hereunder. For the avoidance of doubt, the parties hereto acknowledge that it is the intent of the parties that the Depositor and the Certificate Insurer shall not pay any of the Trustee's fees and expenses in connection with this transaction. (b) The Trust Fund, the Trustee and any director, officer, employee or agent of the Trustee shall be indemnified by the Servicer and held harmless against any loss, liability, claim, damage or expense arising out of, or imposed upon the Trust or the Trustee through the Servicer's acts or omissions in violation of this Agreement, other than any loss, liability or expense incurred by reason of willful misfeasance, bad faith or negligence of the Trustee in the performance of its duties hereunder or by reason of the Trustee's reckless disregard of obligations and duties hereunder. The Servicer shall immediately notify the Trustee, the Back-up Servicer, the Custodian, the Depositor, the Certificate Insurer and all Certificateholders if a claim is made by a third party with respect to this Agreement, and the Servicer shall assume (with the consent of the Certificate Insurer) the defense of any such claim and advance all expenses in connection therewith, including reasonable counsel fees, and promptly advance funds to pay, discharge and satisfy any judgment or decree which may be entered against the Servicer, the Back-up Servicer, the Custodian, the Depositor, the Trustee, the Certificate Insurer and/or any Certificateholder in respect of such claim. The obligations of the Servicer under this Section 9.05 arising prior to any resignation or termination of the Servicer hereunder shall survive the resignation or removal of the Trustee, termination of the Servicer and payment of the Certificates, and shall extend to any co-trustee or separate trustee appointed pursuant to this Article IX. Anything in this Agreement to the contrary notwithstanding, in no event shall the Trustee be liable for special, indirect or consequential loss or damage of any kind whatsoever (including but not limited to lost profits), even if the Trustee has been advised of the likelihood of such loss or damage and regardless of the form of action. 113 Section 9.06 Eligibility Requirements for Trustee. The Trustee hereunder shall at all times be a banking entity (a) organized and doing business under the laws of any state or the United States of America subject to supervision or examination by federal or state authority, (b) authorized under such laws to exercise corporate trust powers, including taking title to the Trust Fund assets on behalf of the Certificateholders, (c) be a wholly-owned subsidiary of a bank holding company having a combined capital and surplus of at least $50,000,000, (d) whose long-term deposits, if any, shall be rated at least BBB- by S&P and Baa3 by Moody's (except as provided herein) or such lower long-term deposit rating as may be approved in writing by the Certificate Insurer, and (e) reasonably acceptable to the Certificate Insurer as evidenced in writing. If such banking entity publishes reports of condition at least annually, pursuant to law or to the requirements of the aforesaid supervising or examining authority, then for the purposes of determining an entity's combined capital and surplus for clause (c) of this Section, the amount set forth in its most recent report of condition so published shall be deemed to be its combined capital and surplus. In case at any time the Trustee shall cease to be eligible in accordance with the provisions of this Section, the Trustee shall resign immediately in the manner and with the effect specified in Section 9.07. Section 9.07 Resignation and Removal of the Trustee. (a) The Trustee may at any time resign and be discharged from the trusts hereby created by giving written notice thereof to the Servicer, the Back-up Servicer, the Rating Agencies, the Certificate Insurer and the Depositor. Upon receiving such notice of resignation, the Depositor shall, with the consent of the Certificate Insurer, promptly appoint a successor trustee by written instrument, in duplicate, which instrument shall be delivered to the resigning Trustee and to the successor trustee. A copy of such instrument shall be delivered to the Depositor, the Back-up Servicer, the Certificateholders, the Certificate Insurer and the Unaffiliated Seller by the Servicer. Unless a successor trustee shall have been so appointed and shall have accepted appointment within 30 days after the giving of such notice of resignation, the resigning Trustee may petition any court of competent jurisdiction for the appointment of a successor trustee. (b) If at any time the Trustee shall cease to be eligible in accordance with the provisions of Section 9.06 and shall fail to resign after written request therefor by the Servicer or the Certificate Insurer, or if at any time the Trustee shall become incapable of acting, or shall be adjudged bankrupt or insolvent, or a receiver of the Trustee or of its property shall be appointed, or any public officer shall take charge or control of the Trustee or of its property or affairs for the purpose of rehabilitation, conservation or liquidation, or the Trustee shall breach any of its obligations hereunder in any material respect, then the Servicer (with the consent of the Certificate Insurer) or the Certificate Insurer may remove the Trustee and the Servicer shall, at the direction of the Certificate Insurer, within thirty (30) days after such removal, appoint a successor trustee by written instrument, in duplicate, which instrument shall be delivered to the Trustee so removed and to the successor trustee. A copy of such instrument shall be delivered to the Depositor, the Back-up Servicer, the Certificateholders, the Certificate Insurer and the Unaffiliated Seller by the Servicer. 114 (c) If the Trustee fails to perform in accordance with the terms of this Agreement, the Majority Certificateholders (with the consent of the Certificate Insurer) or the Certificate Insurer may remove the Trustee and the Depositor shall appoint a successor trustee acceptable to the Certificate Insurer, by written instrument or instruments, in triplicate, signed by such Holders or their attorneys-in-fact duly authorized, one complete set of which instruments shall be delivered to the Servicer, one complete set to the Trustee so removed and one complete set to the successor Trustee so appointed. (d) Any resignation or removal of the Trustee and appointment of a successor trustee pursuant to any of the provisions of this Section shall not become effective until acceptance of appointment by the successor trustee as provided in Section 9.08 and the satisfaction of the Rating Agency Condition. Section 9.08 Successor Trustee. Any successor trustee appointed as provided in Section 9.07 shall execute, acknowledge and deliver to the Depositor, the Certificate Insurer, the Unaffiliated Seller, the Servicer, the Back-up Servicer and to its predecessor trustee an instrument accepting such appointment hereunder, and thereupon the resignation or removal of the predecessor trustee shall become effective and such successor trustee, without any further act, deed or conveyance, shall become fully vested with all the rights, powers, duties and obligations of its predecessor hereunder, with the like effect as if originally named as trustee herein. The predecessor trustee shall deliver to the successor trustee all Mortgage Files and related documents and statements held by it hereunder, and the Servicer and the predecessor trustee shall execute and deliver such instruments and do such other things as may reasonably be required for more fully and certainly vesting and confirming in the successor trustee all such rights, powers, duties and obligations. No successor trustee shall accept appointment as provided in this Section unless at the time of such acceptance such successor trustee shall be eligible under the provisions of Section 9.06. Upon acceptance of appointment by a successor trustee as provided in this Section, the Servicer shall mail notice of the succession of such trustee hereunder to all Holders of Certificates at their addresses as shown in the Certificate Register and to the Rating Agencies. If the Servicer fails to mail such notice within 10 days after acceptance of appointment by the successor trustee, the successor trustee shall cause such notice to be mailed at the expense of the Servicer. Section 9.09 Merger or Consolidation of Trustee. Any Person into which the Trustee may be merged or converted or with which it may be consolidated or any corporation or national banking association resulting from any merger, conversion or consolidation to which the Trustee shall be a party, or any corporation or national banking association succeeding to the business of the trustee, shall be the successor of the Trustee hereunder, provided such corporation or national banking association shall be eligible under the provisions of Section 9.06, without the execution or filing of any paper or any further act on the part of any of the parties hereto, anything herein to the contrary notwithstanding. 115 Section 9.10 Appointment of Co-Trustee or Separate Trustee. (a) Notwithstanding any other provisions hereof, at any time, for the purpose of meeting any legal requirements of any jurisdiction in which any part of the Trust Fund or property securing the same may at the time be located, the Servicer and the Trustee acting jointly, with the consent of the Certificate Insurer, shall have the power and shall execute and deliver all instruments to appoint one or more Persons approved by the Trustee to act as co-trustee or co-trustees, jointly with the Trustee, or separate trustee or separate trustees, of all or any part of the Trust Fund, and to vest in such Person or Persons, in such capacity, such title to the Trust Fund, or any part thereof, and, subject to the other provisions of this Section 9.10 and the consent of the Certificate Insurer, such powers, duties, obligations, rights and trusts as the Servicer and the Trustee may consider necessary or desirable. If the Servicer shall not have joined in such appointment within 15 days after the receipt by it of a request so to do, or in case an Event of Default shall have occurred and be continuing, the Trustee alone, with the consent of the Certificate Insurer, shall have the power to make such appointment. No co-trustee or separate trustee hereunder shall be required to meet the terms of eligibility as a successor trustee under Section 9.06 hereunder and no notice to Holders of Certificates of the appointment of co-trustee(s) or separate trustee(s) shall be required under Section 9.08 hereof. (b) In the case of any appointment of a co-trustee or separate trustee pursuant to this Section 9.10, all rights, powers, duties and obligations conferred or imposed upon the Trustee shall be conferred or imposed upon and exercised or performed by the Trustee and such separate trustee or co-trustee jointly, except to the extent that under any law of any jurisdiction in which any particular act or acts are to be performed (whether as Trustee hereunder or as successor to the Servicer hereunder), the Trustee shall be incompetent or unqualified to perform such act or acts, in which event such rights, powers, duties and obligations (including the holding of title to the Trust Fund or any portion thereof in any such jurisdiction) shall be exercised and performed by such separate trustee or co-trustee at the direction of the Trustee. (c) Any notice, request or other writing given to the Trustee shall be deemed to have been given to each of the then separate trustees and co-trustees, as effectively as if given to each of them. Every instrument appointing any separate trustee or co-trustee shall refer to this Agreement and the conditions of this Article IX. Each separate trustee and co-trustee, upon its acceptance of the trusts conferred, shall be vested with the estates or property specified in its instrument of appointment, either jointly with the Trustee or separately, as may be provided therein, subject to all the provisions of this Agreement, specifically including every provision of this Agreement relating to the conduct of, affecting the liability of, or affording protection to, the Trustee. Every such instrument shall be filed with the Trustee. (d) Any separate trustee or co-trustee may, at any time, constitute the Trustee, its agent or attorney-in-fact, with full power and authority, to the extent not prohibited by law, to do any lawful act under or in respect of this Agreement on its behalf and in its name. The Trustee shall not be responsible for any action or inaction of any such separate trustee or co-trustee, provided that the Trustee appointed such separate trustee or co-trustee with due care. If any separate trustee or co-trustee shall die, become incapable of acting, resign or be removed, all of its estates, properties, rights, remedies and trusts shall vest in and be exercised by the Trustee, to the extent permitted by law, without the appointment of a new or successor trustee. Section 9.11 Tax Returns. The Tax Matters Person will prepare, sign and file all Tax Returns required to be filed by the Trust Fund in accordance with Section 11.13(a)(i). The Servicer, upon request, will promptly furnish the Trustee with all such information as may be reasonably required by the Trustee for the purpose of the Trustee responding to reasonable requests for information made by Certificateholders in connection with tax matters. 116 Section 9.12 Retirement of Certificates. The Trustee shall, upon the retirement of the Certificates pursuant hereto or otherwise, furnish to the Depositor, the Back-up Servicer, the Servicer and the Certificate Insurer a notice of such retirement, and, upon retirement of the Certificates and the expiration of the term of the Certificate Insurance Policy, shall surrender the Certificate Insurance Policy to the Certificate Insurer for cancellation. Section 9.13 Trustee May Enforce Claims Without Possession of Certificates. All rights of action and claims under this Agreement or the Certificates may be prosecuted and enforced by the Trustee without the possession of any of the Certificates or the production thereof in any proceeding relating thereto, any such proceeding instituted by the Trustee shall be brought in its own name or in its capacity as Trustee. Any recovery of judgment shall, after provision for the payment of the reasonable compensation, expenses, disbursements and advances of the Trustee, its agents and counsel, be for the ratable benefit of the Certificateholders in respect of which such judgment has been recovered. Section 9.14 Suits for Enforcement. In case an Event of Default or other default by the Servicer hereunder shall occur and be continuing, the Trustee shall, at the direction of the Certificate Insurer, or may, in its discretion, but subject to Section 9.01 and Section 7.01, as applicable, proceed to protect and enforce its rights and the rights of the Certificateholders and the Certificate Insurer under this Agreement by a suit, action or proceeding in equity or at law or otherwise, whether for the specific performance of any covenant or agreement contained in this Agreement or in aid of the execution of any power granted in this Agreement or for the enforcement of any other legal, equitable or other remedy, as the Trustee, being advised by counsel, shall deem most effectual to protect and enforce any of the rights of the Trustee or the Certificateholders. ARTICLE X THE COLLATERAL AGENT Section 10.01 Duties of the Collateral Agent. (a) The Collateral Agent, prior to the occurrence of an Event of Default of which a Responsible Officer shall have actual knowledge and after the curing of all Events of Default which may have occurred, undertakes to perform such duties and only such duties as are specifically set forth in this Agreement. If an Event of Default of which a Responsible Officer shall have actual knowledge has occurred and has not been cured or waived, the Collateral Agent shall exercise such of the rights and powers vested in it by this Agreement, and use the same degree of care and skill in its exercise as a prudent person would exercise or use under the circumstances in the conduct of such person's own affairs. (b) The Collateral Agent, upon receipt of all resolutions, certificates, statements, opinions, reports, documents, orders or other instruments furnished to the Collateral Agent which are specifically required to be furnished pursuant to any provision of this Agreement, shall examine them to determine whether they conform on their face to the requirements of this Agreement; provided, however, that the Collateral Agent shall not be responsible for the accuracy or content of any resolution, certificate, statement, opinion, report, document, order or other instrument furnished by any Person hereunder. If any such instrument is found not to conform on its face to the requirements of this Agreement, the Collateral Agent shall note it as such on the applicable certification delivered pursuant to Section 2.06. 117 (c) No provision of this Agreement shall be construed to relieve the Collateral Agent from liability for its own negligent action, its own negligent failure to act or its own willful misconduct; provided, however, that: (i) prior to the occurrence of an Event of Default of which a Responsible Officer shall have actual knowledge, and after the curing of all such Events of Default which may have occurred, the duties and obligations of the Collateral Agent shall be determined solely by the express provisions of this Agreement, the Collateral Agent shall not be liable except for the performance of such duties and obligations as are specifically set forth in this Agreement, no implied covenants or obligations shall be read into this Agreement against the Collateral Agent and, in the absence of bad faith on the part of the Collateral Agent, the Collateral Agent may conclusively rely, as to the truth of the statements and the correctness of the opinions expressed therein, upon any certificates or opinions furnished to the Collateral Agent and conforming to the requirements of this Agreement; (ii) the Collateral Agent shall not be personally liable for an error of judgment made in good faith by a Responsible Officer or other officers of the Collateral Agent, unless it shall be proved that the Collateral Agent was negligent in ascertaining the pertinent facts; (iii) the Collateral Agent shall not be personally liable with respect to any action taken, suffered or omitted to be taken by it in good faith in accordance with this Agreement or at the direction of the Certificate Insurer or the Trustee or with the consent of the Certificate Insurer or the Trustee; (iv) the Collateral Agent shall not be required to expend or risk its own funds or otherwise incur financial liability for the performance of any of its duties hereunder or the exercise of any of its rights or powers if there is reasonable ground for believing that the repayment of such funds or adequate indemnity against such risk or liability is not reasonably assured to it and none of the provisions contained in this Agreement shall in any event require the Collateral Agent to perform, or be responsible for the manner of performance of, any of the obligations of the Servicer or the Trustee under this Agreement; and (v) subject to the other provisions of this Agreement and without limiting the generality of this Section 10.01, the Collateral Agent shall have no duty (A) to see to any recording, filing, or depositing of this Agreement or any agreement referred to herein or any financing statement or continuation statement evidencing a security interest, or to see to the maintenance of any such recording or filing or depositing or to any rerecording, refiling or redepositing of any thereof, (B) to see to any insurance, (C) to see to the payment or discharge of any tax, assessment, or other governmental charge or any lien or encumbrance of any kind owing with respect to, assessed or levied against, any part of the Trust, the Trust Fund, the Certificateholders or the Mortgage Loans, (D) to confirm or verify the contents of any reports or certificates of any Person delivered to the Collateral Agent pursuant to this Agreement believed by the Collateral Agent to be genuine and to have been signed or presented by the proper party or parties. 118 Section 10.02 Certain Matters Affecting the Collateral Agent. Except as otherwise provided in Section 10.01 hereof: (a) the Collateral Agent may rely and shall be protected in acting or refraining from acting upon any resolution, Officer's Certificate, Opinion of Counsel, certificate of auditors or any other certificate, statement, instrument, opinion, report, notice, request, consent, order, appraisal, bond or other paper or document believed by it to be genuine and to have been signed or presented by the proper party or parties; (b) the Collateral Agent may consult with counsel and any Opinion of Counsel or written advice of such counsel shall be full and complete authorization and protection in respect of any action taken or suffered or omitted by it hereunder in good faith and in accordance with such Opinion of Counsel or advice of such counsel; (c) the Collateral Agent shall be under no obligation to exercise any of the powers vested in it by this Agreement or to institute, conduct or defend by litigation hereunder or in relation hereto at the request, order or direction of the Certificate Insurer or any of the Certificateholders, pursuant to the provisions of this Agreement, unless such Certificateholders or the Certificate Insurer, as applicable, shall have offered to the Trustee reasonable security or indemnity reasonably satisfactory to it against the costs, expenses and liabilities which may be incurred therein by the Collateral Agent or thereby; nothing contained herein shall, however, relieve the Collateral Agent of the obligation, upon the occurrence of an Event of Default of which a Responsible Officer shall have actual knowledge (which has not been cured), to exercise such of the rights and powers vested in it by this Agreement, and to use the same degree of care and skill in its exercise as a prudent person would exercise or use under the circumstances in the conduct of such person's own affairs; (d) the Collateral Agent shall not be personally liable for any action taken, suffered or omitted by it in good faith and believed by it to be authorized or within the discretion or rights or powers conferred upon it by this Agreement; (e) the Collateral Agent shall not be bound to make any investigation into the facts or matters stated in any resolution, certificate, statement, instrument, opinion, report, notice, request, consent, order, approval, bond or other paper or document, unless requested in writing to do so by the Certificate Insurer or the Majority Certificateholders; provided, however, that if the payment within a reasonable time to the Collateral Agent of the costs, expenses or liabilities likely to be incurred by it in the making of such investigation is, in the opinion of the Collateral Agent, not reasonably assured to the Collateral Agent by the security afforded to it by the terms of this Agreement, the Collateral Agent may require reasonable indemnity reasonably satisfactory to the Collateral Agent against such cost, expense or liability as a condition to taking any such action. The reasonable expense of every such examination shall be paid by the Servicer or, if paid by the Collateral Agent, shall be repaid by the Servicer upon demand from the Servicer's own funds; 119 (f) the right of the Collateral Agent to perform any discretionary act enumerated in this Agreement shall not be construed as a duty, and the Collateral Agent shall not be answerable for anything other than its negligence or willful misconduct in the performance of such act; and (g) the Collateral Agent may execute any of the powers hereunder or perform any duties hereunder either directly or by or through agents or attorneys. Section 10.03 Collateral Agent Not Liable for Certificates or Mortgage Loans. The recitals contained herein shall be taken as the statements of the Trust and the Servicer, as the case may be, and the Collateral Agent assumes no responsibility for their correctness. The Collateral Agent makes no representations as to the validity or sufficiency of this Agreement or of any Mortgage Loan or related document. The Collateral Agent shall not be accountable for the use or application of any funds paid to the Servicer in respect of the Mortgage Loans or deposited in or withdrawn from the Collection Account by the Servicer. The Collateral Agent shall not be responsible for the legality or validity of the Agreement or the validity, priority, perfection or sufficiency of the security for the Certificates issued or intended to be issued under this Agreement. Section 10.04 Collateral Agent May Own Certificates. The Collateral Agent in its individual or any other capacity may become the owner or pledgor of Certificates with the same rights it would have if it were not Collateral Agent, and may otherwise deal with the parties hereto. Section 10.05 Collateral Agent's Fees and Expenses; Indemnity. (a) The Collateral Agent acknowledges that in consideration of the performance of its duties hereunder it is entitled to receive its fees and expenses from the Servicer, as separately agreed between the Servicer and the Collateral Agent. The Depositor, the Certificate Insurer and the Trustee shall not pay any of the Collateral Agent fees and expenses in connection with this transaction. The Collateral Agent shall not be entitled to compensation for any expense, disbursement or advance as may arise from its negligence or bad faith. (b) The Collateral Agent and any director, officer, employee or agent of the Collateral Agent shall be indemnified by the Servicer and held harmless against any loss, liability, claim, damage or reasonable expense incurred in connection with this Agreement other than any loss, liability or expense incurred by reason of willful misfeasance, bad faith or negligence of the Collateral Agent in the performance of its duties hereunder or by reason of the Collateral Agent's reckless disregard of obligations and duties hereunder. The obligations of the Servicer under this Section 10.05 arising prior to any resignation or termination of the Servicer hereunder shall survive termination of the Servicer and payment of the Certificates. 120 Section 10.06 Eligibility Requirements for Collateral Agent. The Collateral Agent hereunder shall at all times be a banking entity (a) organized and doing business under the laws of any state or the United States of America subject to supervision or examination by federal or state authority, (b) authorized under such laws to exercise corporate trust powers, including taking title to the Trust Fund on behalf of the Trustee, for the benefit of the Certificateholders and the Certificate Insurer, (c) be a wholly owned subsidiary of a bank holding company having a combined capital and surplus of at least $50,000,000, (d) whose long-term deposits, if any, shall be rated at least BBB- by S&P and Baa3 by Moody's (except as provided herein) or such lower long-term deposit rating as may be approved in writing by the Certificate Insurer, and (e) reasonably acceptable to the Certificate Insurer as evidenced in writing. If such banking entity publishes reports of condition at least annually, pursuant to law or to the requirements of the aforesaid supervising or examining authority, then for the purposes of determining an entity's combined capital and surplus for clause (c) of this Section 10.06, the amount set forth in its most recent report of condition so published shall be deemed to be its combined capital and surplus. In case at any time the Collateral Agent shall cease to be eligible in accordance with the provisions of this Section 10.06, the Collateral Agent shall resign immediately in the manner and with the effect specified in Section 10.07. Section 10.07 Resignation and Removal of the Collateral Agent. (a) The Collateral Agent may at any time resign and be discharged from the trusts hereby created by giving thirty (30) days' written notice thereof to the Trustee, the Certificate Insurer and the Servicer. (b) If at any time the Collateral Agent shall cease to be eligible in accordance with the provisions of Section 10.06 and shall fail to resign after written request therefor by the Trustee, the Certificate Insurer or the Servicer, or if at any time the Collateral Agent shall become incapable of acting, or shall be adjudged bankrupt or insolvent, or a receiver of the Collateral Agent or of its property shall be appointed, or any public officer shall take charge or control of the Collateral Agent or of its property or affairs for the purpose of rehabilitation, conservation or liquidation, then the Trustee or the Servicer, with the consent of the Certificate Insurer, may remove the Collateral Agent. (c) If the Collateral Agent fails to perform in accordance with the terms of this Agreement, the Trustee, the Servicer or the or the Majority Certificateholders, with the consent of the Certificate Insurer, or the Certificate Insurer may remove the Collateral Agent. (d) Upon removal or receipt of notice of resignation of the Collateral Agent, the Trustee shall either (i) take possession of the Trustee's Mortgage Files and assume the duties of the Collateral Agent hereunder or (ii) appoint a successor Collateral Agent pursuant to Section 9.08. If the Trustee shall assume the duties of the Collateral Agent hereunder, it shall notify the Trust, the Depositor, the Servicer and Certificate Insurer in writing. 121 Section 10.08 Successor Collateral Agent. Upon the resignation or removal of the Collateral Agent, the Trustee may appoint a successor Collateral Agent, with the written approval of the Certificate Insurer; provided, however, that the successor Collateral Agent so appointed shall satisfy the eligibility criteria set forth in Section 10.06 hereof, shall in no event be the Unaffiliated Seller, the Depositor or the Servicer or any Person known to a Responsible Officer of the Trustee to be an Affiliate of the Unaffiliated Seller, the Depositor or the Servicer and shall be approved by the Certificate Insurer. The Trustee or such custodian, as the case may be, shall assume the duties of the Collateral Agent hereunder. Any successor Collateral Agent appointed as provided in this Section 10.08 shall execute, acknowledge and deliver to the Trust, the Depositor, the Servicer, the Back-up Servicer, the Trustee, the Certificate Insurer and to its predecessor Collateral Agent an instrument accepting such appointment hereunder, and thereupon the resignation or removal of the predecessor Collateral Agent shall become effective and such successor Collateral Agent, without any further act, deed or conveyance, shall become fully vested with all the rights, powers, duties and obligations of its predecessor hereunder, with the like effect as if originally named as Collateral Agent herein. The predecessor Collateral Agent shall deliver to the successor Collateral Agent all of the Trustee's Mortgage Files and related documents and statements held by it hereunder, and the Servicer and the predecessor Collateral Agent shall execute and deliver such instruments and do such other things as may reasonably be required for more fully and certainly vesting and confirming in the successor Collateral Agent all such rights, powers, duties and obligations. The cost of any such transfer to the successor Collateral Agent shall be for the account of the Collateral Agent in the event of the resignation of the Collateral Agent, and shall be for the account of the Servicer in the event of the removal of the Collateral Agent. No successor Collateral Agent shall accept appointment as provided in this Section 10.08 unless at the time of such acceptance such successor Collateral Agent shall be eligible under the provisions of Section 10.06. Upon acceptance of appointment by a successor Collateral Agent as provided in this Section 10.08, the Servicer shall mail notice of the succession of such Collateral Agent hereunder to all Certificateholders at their addresses as shown in the Certificate Register and to the Rating Agencies. If the Servicer fails to mail such notice within ten (10) days after acceptance of appointment by the successor Collateral Agent, the successor Collateral Agent shall cause such notice to be mailed at the expense of the Servicer. Section 10.09 Merger or Consolidation of Collateral Agent. Any Person into which the Collateral Agent may be merged or converted or with which it may be consolidated or any corporation or national banking association resulting from any merger, conversion or consolidation to which the Collateral Agent shall be a party, or any corporation or national banking association succeeding to the business of the Collateral Agent, shall be the successor of the Collateral Agent hereunder; provided, that, such corporation or national banking association shall be eligible under the provisions of Section 10.06, without the execution or filing of any paper or any further act on the part of any of the parties hereto, anything herein to the contrary notwithstanding. ARTICLE XI MISCELLANEOUS PROVISIONS Section 11.01 Limitation on Liability of the Depositor, the Back-up Servicer and the Servicer. None of the Depositor, the Servicer, the Back-up Servicer or any of the directors, officers, employees or agents of the Depositor, the Servicer or the Back-up Servicer shall be under any liability to the Trust, the Certificateholders or the Certificate Insurer for any action taken, or for refraining from the taking of any action, in good faith pursuant to this Agreement, or for errors in judgment; provided, however, that this provision shall not protect the Depositor, the Back-up Servicer or the Servicer or any such Person against any breach of warranties, representations, covenants or agreements made herein, or against any specific liability imposed on each such party pursuant to this Agreement or against any liability which would otherwise be imposed by reason of willful misfeasance, bad faith or gross negligence in the performance of duties or by reason of reckless disregard of obligations or duties hereunder. The Depositor, the Back-up Servicer or the Servicer and any director, officer, employee or agent of the Depositor, the Back-up Servicer or the Servicer may rely in good faith on any document of any kind which, prima facie, is properly executed and submitted by any appropriate Person respecting any matters arising hereunder. 122 Section 11.02 Acts of Certificateholders. (a) Except as otherwise specifically provided herein, whenever Certificateholder action, consent or approval is required under this Agreement, such action, consent or approval shall be deemed to have been taken or given on behalf of, and shall be binding upon, all Certificateholders if the Majority Certificateholders or the Certificate Insurer agrees to take such action or give such consent or approval. (b) The death or incapacity of any Certificateholder shall not operate to terminate this Agreement or the Trust Fund, nor entitle such Certificateholder's legal representatives or heirs to claim an accounting or to take any action or proceeding in any court for a partition or winding up of the Trust Fund, nor otherwise affect the rights, obligations and liabilities of the parties hereto or any of them. (c) No Certificateholder shall have any right to vote (except as expressly provided for herein) or in any manner otherwise control the operation and management of the Trust Fund, or the obligations of the parties hereto, nor shall anything herein set forth, or contained in the terms of the Certificates, be construed so as to constitute the Certificateholders from time to time as partners or members of an association; nor shall any Certificateholder be under any liability to any third person by reason of any action taken by the parties to this Agreement pursuant to any provision hereof. (d) Prior to the execution of any amendment to this Agreement, the Trustee shall be entitled to receive and rely upon an Opinion of Counsel (which shall be an expense of the Trust) stating that the execution of such amendment is authorized and permitted by this Agreement. The Trustee may, but shall not be obligated to, enter into any such amendment which affects the Trustee's own rights, duties or immunities under this Agreement. Section 11.03 Amendment. (a) This Agreement may be amended from time to time by the Servicer, the Depositor and the Trustee, by written agreement, upon the prior written consent of the Certificate Insurer (which consent shall not be unreasonably withheld, delayed or conditioned if a Certificate Insurer Default shall have occurred and be continuing), without notice to or consent of the Certificateholders to cure any ambiguity, to correct or supplement any provisions herein, to comply with any changes in the Code, or to make any other provisions with respect to matters or questions arising under this Agreement which shall not be inconsistent with the provisions of this Agreement or effect a significant change in the permitted activities of the Trust; provided, however, that such change, as evidenced by an Opinion of Counsel, at the expense of the party requesting the change, delivered to the Trustee and the Certificate Insurer, (i) will not adversely affect in any material respect the interests of any Certificateholder and (ii) (x) will not adversely affect the status of any REMIC created hereunder as a REMIC, (y) will not cause a tax to be imposed on any REMIC created hereunder and (z) such change will not effect a significant change in the permitted activities of the Trust; provided, further, that no such amendment shall (x) reduce in any manner the amount of, or delay the timing of, payments received on Mortgage Loans which are required to be distributed on any Certificate without the consent of the Holder of such Certificate, or change the rights or obligations of any other party hereto without the consent of such party, or (y) amend or alter Section 2.01(b) hereof. The Trustee shall give prompt written notice to the Rating Agencies of any amendment made pursuant to this Section 11.03 or pursuant to Section 6.09 of the Unaffiliated Seller's Agreement. 123 (b) This Agreement may be amended from time to time by the Servicer, the Depositor and the Trustee, with the consent of the Certificate Insurer and the Majority Certificateholders, for the purpose of adding any provisions to or changing in any manner or eliminating any of the provisions of this Agreement or of modifying in any manner the rights of the Holders; provided, however, that no such amendment shall be made unless the Trustee and the Certificate Insurer receive an Opinion of Counsel, at the expense of the party requesting the change, that such change (x) will not adversely affect the status of any REMIC created hereunder as a REMIC, (y) will not cause a tax to be imposed on any REMIC created hereunder and (z) such change will not effect a significant change in the permitted activities of the Trust; provided, further, that no such amendment shall reduce in any manner the amount of, or delay the timing of, payments received on Mortgage Loans which are required to be distributed on any Class of Certificates without the consent of the Holders of such Class of Certificates or reduce the percentage for the Holders of which are required to consent to any such amendment without the consent of the Holders of 100% of such Class of Certificates affected thereby. (c) It shall not be necessary for the consent of Holders under this Section to approve the particular form of any proposed amendment, but it shall be sufficient if such consent shall approve the substance thereof. Section 11.04 Recordation of Agreement. To the extent permitted by applicable law, this Agreement, or a memorandum thereof if permitted under applicable law, is subject to recordation in all appropriate public offices for real property records in all of the counties or other comparable jurisdictions in which any or all of the properties subject to the Mortgages are situated, and in any other appropriate public recording office or elsewhere, such recordation to be effected by the Servicer at the direction of the Majority Certificateholders or the Certificate Insurer. Section 11.05 Duration of Agreement. This Agreement shall continue in existence and effect until terminated as herein provided. Section 11.06 Notices. All demands, notices and communications hereunder shall be in writing and shall be deemed to have been duly given when delivered to (i) in the case of the Servicer, American Business Credit, Inc., Balapointe Office Centre, 111 Presidential Boulevard, Suite 127, Bala Cynwyd, Pennsylvania 19004, Attention: Mr. Jeffrey M. Ruben, (ii) in the case of the Unaffiliated Seller, ABFS 2003-1, Inc., Balapointe Office Centre, 111 Presidential Boulevard, Suite 127, Bala Cynwyd, Pennsylvania 19004, Attention: Mr. Jeffrey M. Ruben, (iii) in the case of the Trustee, the Collateral Agent and the Back-up Servicer, JPMorgan Chase Bank, Institutional Trust Services, 4 New York Plaza, 6th Floor, New York, New York 10004-2413, Attention: Structured Finance Services, ABFS 2003-1, (iv) in the case of the Certificateholders, as set forth in the Certificate Register, (v) in the case of Moody's Investors Service, Inc., 99 Church Street, New York, New York 10007, Attention: Home Equity Monitoring Group, (vi) in the case of Standard & Poor's, 55 Water Street, New York, New York 10041-0003, Attention: Residential Mortgage Surveillance Group, (vii) in the case of Fitch Ratings, One State Street Plaza, New York, New York 10004, Attention: Mortgage Surveillance Group, (viii) in the case of the Depositor or the Underwriter, Bear Stearns Asset Backed Securities, Inc. or Bear Stearns & Co. Inc., 383 Madison Avenue, 10th Floor, New York, New York 10179, Attention: Chief Counsel, or (ix) in the case of the Certificate Insurer, Radian Asset Assurance Inc., 335 Madison Avenue, New York, New York 10017, Attention: Chief Risk Officer and Chief Legal Officer, Re: ABFS Mortgage Loan Trust, Series 2003-1, Class M. Any such notices shall be deemed to be effective with respect to any party hereto upon the receipt of such notice by such party, except that notices to the Certificateholders shall be effective upon mailing or personal delivery. 124 Section 11.07 Severability of Provisions. If any one or more of the covenants, agreements, provisions or terms of this Agreement shall be held invalid for any reason whatsoever, then such covenants, agreements, provisions or terms shall be deemed severable from the remaining covenants, agreements, provisions or terms of this Agreement and shall in no way affect the validity or enforceability of the other covenants, agreements, provisions or terms of this Agreement. Section 11.08 No Partnership. Nothing herein contained shall be deemed or construed to create a co-partnership or joint venture between the parties hereto and the services of the Servicer shall be rendered as an independent contractor and not as agent for the Certificateholders. Section 11.09 Counterparts. This Agreement may be executed in one or more counterparts and by the different parties hereto on separate counterparts, each of which, when so executed, shall be deemed to be an original; such counterparts, together, shall constitute one and the same agreement. Section 11.10 Successors and Assigns. This Agreement shall inure to the benefit of and be binding upon the Servicer, the Back-up Servicer, the Depositor, the Trustee, the Collateral Agent and the Certificateholders and their respective successors and permitted assigns. Section 11.11 Headings. The headings of the various sections of this Agreement have been inserted for convenience of reference only and shall not be deemed to be part of this Agreement. Section 11.12 Third Party Beneficiary. The parties agree that each of the Unaffiliated Seller and the Certificate Insurer is intended and shall have all rights of a third-party beneficiary of this Agreement to the same extent as if it were a party hereto, and shall have the right to enforce the provisions of this Agreement. Section 11.13 Appointment of Tax Matters Person; Certain Taxes(a). (a) The Holders of the Class R Certificates as the Tax Matters Person hereby appoint the Servicer to act, as their agent in such capacity, for each REMIC created hereunder for all purposes of the Code. The Tax Matters Person will perform, or cause to be performed, such duties and take, or cause to be taken, such actions as are required to be performed or taken by the Tax Matters Person under the code. The Holders of the Class R Certificates may hereafter appoint a different entity as their agent, or may appoint one of the Class R Certificateholders to be the Tax Matters Person. The Tax Matters Person shall: 125 (i) prepare, sign and file, or cause to be prepared and filed, in a timely manner, a U.S. Real Estate Mortgage Investment Conduit (REMIC) Income Tax Return (Form 1066) and any other Tax Return required to be filed by each REMIC created hereunder, using a calendar year as the taxable year for each REMIC created hereunder; (ii) make, or cause to be made, an election, on behalf of each REMIC created hereunder, to be treated as a REMIC on the federal tax return of each REMIC created hereunder for its first taxable year; (iii) prepare and forward, or cause to be prepared and forwarded, to the Trustee, the Certificateholders and to the Internal Revenue Service and any other relevant governmental taxing authority all information returns or reports as and when required to be provided to them in accordance with the REMIC Provisions; (iv) to the extent that the affairs of the Trust Fund are within its control, conduct such affairs of the Trust Fund at all times that any Certificates are outstanding so as to maintain the status of each REMIC created hereunder as a REMIC under the REMIC Provisions and any other applicable federal, state and local laws, including, without limitation, information reports relating to "original issue discount," as defined in the Code, based upon the Prepayment Assumption and calculated by using the issue price of the Certificates; (v) not knowingly or intentionally take any action or omit to take any action that would cause the termination of the REMIC status of any REMIC created hereunder; (vi) pay the amount of any and all federal, state, and local taxes collected from the parties provided for in Section 11.13(b), including, without limitation, upon the Trustee or the Certificateholders in connection with the Trust, the Trust Fund or the Mortgage Loans, prohibited transaction taxes as defined in Section 860F of the Code, other than any amount due as a result of a transfer or attempted or purported transfer in violation of Section 4.02, imposed on any REMIC created hereunder when and as the same shall be due and payable (but such obligation shall not prevent the Unaffiliated Seller or any other appropriate Person from contesting any such tax in appropriate proceedings and shall not prevent the Unaffiliated Seller from withholding payment of such tax, if permitted by law, pending the outcome of such proceedings); (vii) ensure that any such returns or reports filed on behalf of any REMIC created hereunder by the Trustee are properly executed by the appropriate person and submitted in a timely manner; 126 (viii) represent any REMIC created hereunder in any administrative or judicial proceedings relating to an examination or audit by any governmental taxing authority, request an administrative adjustment as to any taxable year of any REMIC created hereunder, enter into settlement agreements with any governmental taxing agency, extend any statute of limitations relating to any item of any REMIC created hereunder and otherwise act on behalf of each REMIC created hereunder in relation to any tax matter involving any REMIC created hereunder; (ix) as provided in Section 5.11 hereof, make available information necessary for the computation of any tax imposed (1) on transferors of residual interests to transferees that are not Permitted Transferees or (2) on pass-through entities, any interest in which is held by an entity which is not a Permitted Transferee. The Trustee covenants and agrees that it will cooperate with the Servicer in the foregoing matters and that it will sign, as Trustee, any and all Tax Returns required to be filed by each REMIC created hereunder. Notwithstanding the foregoing, at such time as the Trustee becomes the successor Servicer, the holder of the largest percentage of the Class R Certificates shall serve as Tax Matters Person until such time as an entity is appointed to succeed the Trustee as Servicer; (x) make available to the Internal Revenue Service and those Persons specified by the REMIC Provisions all information necessary to compute any tax imposed (A) as a result of the Transfer of an Ownership Interest in a Class R Certificate to any Person who is not a Permitted Transferee, including the information described in Treasury regulations sections 1.860D-1(b)(5) and 1.860E-2(a)(5) with respect to the "excess inclusions" of such Class R Certificate and (B) as a result of any regulated investment company, real estate investment trust, common trust fund, partnership, trust, estate or organization described in Section 1381 of the Code that holds an Ownership Interest in a Class R Certificate having as among its record holders at any time any Person that is not a Permitted Transferee; (xi) pay out of its own funds, without any right of reimbursement, any and all tax related expenses of each REMIC created hereunder (including, but not limited to, tax return preparation and filing expenses and any professional fees or expenses related to audits or any administrative or judicial proceedings with respect to each REMIC created hereunder that involve the Internal Revenue Service or state tax authorities), other than the expense of obtaining any Opinion of Counsel required pursuant to Sections 3.03, 5.06(b), 5.10, 8.02, 9.02(b) and 11.03 and other than taxes except as specified herein; (xii) upon filing with the Internal Revenue Service, the Tax Matters Person shall furnish to the Holders of the Class R Certificates the Form 1066 and each Form 1066Q and the Unaffiliated Seller shall respond promptly to written requests made not more frequently than quarterly by any Holder of Class R Certificates with respect to the following matters: (A) the original projected principal and interest cash flows on the Closing Date on the regular and residual interests created hereunder and on the Mortgage Loans, based on the Prepayment Assumption; 127 (B) the projected remaining principal and interest cash flows as of the end of any calendar quarter with respect to the regular and residual interests created hereunder and the Mortgage Loans, based on the Prepayment Assumption; (C) the Prepayment Assumption and any interest rate assumptions used in determining the projected principal and interest cash flows described above; (D) the original issue discount (or, in the case of the Mortgage Loans, market discount) or premium accrued or amortized through the end of such calendar quarter with respect to the regular or residual interests created hereunder and with respect to the Mortgage Loans, together with each constant yield to maturity used in computing the same; (E) the treatment of losses realized with respect to the Mortgage Loans or the regular interests created hereunder, including the timing and amount of any cancellation of indebtedness income of any REMIC created hereunder with respect to such regular interests or bad debt deductions claimed with respect to the Mortgage Loans; (F) the amount and timing of any non-interest expenses of any REMIC created hereunder; and (G) any taxes (including penalties and interest) imposed on any REMIC created hereunder, including, without limitation, taxes on "prohibited transactions," "contributions" or "net income from foreclosure property" or state or local income or franchise taxes; and (xiii) make any other required reports in respect of interest payments in respect of the Mortgage Loans and acquisitions and abandonments of Mortgaged Property to the Internal Revenue Service and/or the borrowers, as applicable. (b) In the event that any tax is imposed on "prohibited transactions" of any REMIC created hereunder as defined in Section 860F(a)(2) of the Code, on the "net income from foreclosure property" of any REMIC created hereunder as defined in Section 860G(c) of the Code, on any contribution to any REMIC created hereunder after the Startup Day pursuant to Section 860G(d) of the Code, or any other tax is imposed, such tax shall be paid by (i) the Trustee, if such tax arises out of or results from a breach by the Trustee of any of its obligations under this Agreement, (ii) the Servicer, if such tax arises out of or results from a breach by the Servicer of any of its obligations under this Agreement, or otherwise (iii) the holders of the Class R Certificates in proportion to their Percentage Interests. To the extent such tax is chargeable against the holders of the Class R Certificates, notwithstanding anything to the contrary contained herein, the Trustee is hereby authorized to retain from amounts otherwise distributable to the Holders of the Class R Certificates on any Distribution Date sufficient funds for the payment of such tax. 128 Section 11.14 GOVERNING LAW; CONSENT TO JURISDICTION; WAIVER OF JURY TRIAL. (a) THIS AGREEMENT SHALL BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH, THE INTERNAL LAWS (AS OPPOSED TO CONFLICT OF LAWS PROVISIONS) OF THE STATE OF NEW YORK. (b) THE DEPOSITOR, THE SERVICER, THE BACK-UP SERVICER, THE COLLATERAL AGENT AND THE TRUSTEE HEREBY SUBMIT TO THE NON-EXCLUSIVE JURISDICTION OF THE COURTS OF THE STATE OF NEW YORK AND THE UNITED STATES DISTRICT COURT LOCATED IN THE BOROUGH OF MANHATTAN IN NEW YORK CITY, AND EACH WAIVES PERSONAL SERVICE OF ANY AND ALL PROCESS UPON IT AND CONSENTS THAT ALL SUCH SERVICE OF PROCESS BE MADE BY REGISTERED MAIL DIRECTED TO THE ADDRESS SET FORTH IN SECTION 10.06 HEREOF AND SERVICE SO MADE SHALL BE DEEMED TO BE COMPLETED FIVE DAYS AFTER THE SAME SHALL HAVE BEEN DEPOSITED IN THE U.S. MAILS, POSTAGE PREPAID. THE DEPOSITOR, THE SERVICER, THE BACK-UP SERVICER, THE COLLATERAL AGENT AND THE TRUSTEE EACH HEREBY WAIVE ANY OBJECTION BASED ON FORUM NON CONVENIENS, AND ANY OBJECTION TO VENUE OF ANY ACTION INSTITUTED HEREUNDER AND CONSENTS TO THE GRANTING OF SUCH LEGAL OR EQUITABLE RELIEF AS IS DEEMED APPROPRIATE BY THE COURT. NOTHING IN THIS SECTION SHALL AFFECT THE RIGHT OF THE DEPOSITOR, THE SERVICER, THE BACK-UP SERVICER THE COLLATERAL AGENT OR THE TRUSTEE TO SERVE LEGAL PROCESS IN ANY OTHER MANNER PERMITTED BY LAW OR AFFECT ANY OF THEIR RIGHTS TO BRING ANY ACTION OR PROCEEDING IN THE COURTS OF ANY OTHER JURISDICTION. (c) THE DEPOSITOR, THE SERVICER, THE BACK-UP SERVICER, THE COLLATERAL AGENT AND THE TRUSTEE EACH HEREBY WAIVES ANY RIGHT TO HAVE A JURY PARTICIPATE IN RESOLVING ANY DISPUTE, WHETHER SOUNDING IN CONTRACT, TORT, OR OTHERWISE ARISING OUT OF, CONNECTED WITH, RELATED TO, OR IN CONNECTION WITH THIS AGREEMENT. INSTEAD, ANY DISPUTE WILL BE RESOLVED IN A BENCH TRIAL WITHOUT A JURY. [Remainder of Page Intentionally Left Blank] 129 IN WITNESS WHEREOF, the Depositor, the Servicer, the Trustee, the Collateral Agent and the Back-up Servicer have caused their names to be signed hereto by their respective officers thereunto duly authorized as of the day and year first above written. BEAR STEARNS ASSET BACK SECURITIES, INC., as Depositor By: Jonathan Lieberman --------------------------------- Name: Jonathan Lieberman Title: Senior Managing Director AMERICAN BUSINESS CREDIT, INC., as Servicer By: Beverly Santilli --------------------------------- Name: Beverly Santilli Title: President JPMORGAN CHASE BANK, as Trustee, Collateral Agent and Back-up Servicer By: Joseph M. Constantino --------------------------------- Name: Joseph M. Constantino Title: Trust Officer EX-10.101 5 ex10-101.txt EXHIBIT 10.101 Exhibit 10.101 RADIAN ASSET ASSURANCE INC., as Certificate Insurer, HOMEAMERICAN CREDIT, INC. D/B/A UPLAND MORTGAGE, as an Original Mortgage Loan Seller, AMERICAN BUSINESS MORTGAGE SERVICES, INC., as an Original Mortgage Loan Seller, AMERICAN BUSINESS CREDIT, INC., as an Original Mortgage Loan Seller and as Servicer, ABFS 2003-1, INC., as Secondary Mortgage Loan Seller, BEAR STEARNS ASSET BACKED SECURITIES, INC., as Depositor, and JPMORGAN CHASE BANK, as Trustee, as Back-up Servicer and as Collateral Agent INSURANCE AND INDEMNITY AGREEMENT ABFS MORTGAGE LOAN TRUST 2003-1, MORTGAGE PASS-THROUGH CERTIFICATES, SERIES 2003-1, CLASS M Dated as of March 31, 2003 TABLE OF CONTENTS (This Table of Contents is for convenience of reference only and shall not be deemed to be part of this Agreement. All capitalized terms used in this Agreement and not otherwise defined shall have the meanings set forth in Article I of this Agreement.) Page ---- ARTICLE I DEFINITIONS.......................................................2 Section 1.01 Defined Terms...............................................2 Section 1.02. Other Definitional Provisions...............................6 ARTICLE II REPRESENTATIONS, WARRANTIES AND COVENANTS........................6 Section 2.01. Representations and Warranties..............................6 Section 2.02. Affirmative Covenants......................................11 Section 2.03. Negative Covenants.........................................17 Section 2.04. Representations, Warranties and Covenants of the Certificate Insurer..................................18 ARTICLE III THE POLICY; REIMBURSEMENT......................................20 Section 3.01. Issuance of the Policy.....................................20 Section 3.02. Payment of Fees and Premium................................22 Section 3.03. Reimbursement Obligation...................................23 Section 3.04. Indemnification............................................25 Section 3.05. Payment Procedure..........................................28 Section 3.06. Subrogation................................................28 Section 3.07. Assignment and Other Rights................................29 ARTICLE IV FURTHER AGREEMENTS..............................................29 Section 4.01. Effective Date; Term of the Insurance Agreement............29 Section 4.02. Further Assurances and Corrective Instruments..............29 Section 4.03. Obligations Absolute.......................................30 Section 4.04. Assignments; Reinsurance; Third-Party Rights...............32 Section 4.05. Liability of the Certificate Insurer.......................32 Section 4.06. Annual Servicing Audit and Certification...................33 ARTICLE V DEFAULTS AND REMEDIES............................................33 Section 5.01. Defaults...................................................33 Section 5.02. Remedies; No Remedy Exclusive..............................34 Section 5.03. Waivers....................................................35 ARTICLE VI MISCELLANEOUS...................................................36 Section 6.01. Amendments, Etc............................................36 Section 6.02. Notices....................................................36 Section 6.03. Severability...............................................36 Section 6.04. GOVERNING LAW..............................................37 Section 6.05. Payments...................................................37 i Section 6.06. Consent to Jurisdiction....................................37 Section 6.07. Consent of the Certificate Insurer.........................38 Section 6.08. Counterparts...............................................38 Section 6.09. Headings...................................................38 Section 6.10. Trial by Jury Waived.......................................38 Section 6.11. Limited Liability..........................................38 Section 6.12. Entire Agreement...........................................39 Section 6.13. Joint and Several Liability................................39 ii INSURANCE AND INDEMNITY AGREEMENT (as may be amended, modified or supplemented from time to time, this "Insurance Agreement"), dated as of March 31, 2003, by and among RADIAN ASSET ASSURANCE INC., a New York stock insurance company, regulated by the Insurance Department of the State of New York, as Certificate Insurer, AMERICAN BUSINESS CREDIT, INC., a Pennsylvania corporation ("ABC Inc."), in its capacity as an Original Mortgage Loan Seller and as Servicer, HOMEAMERICAN CREDIT, INC. d/b/a UPLAND MORTGAGE, as an Original Mortgage Loan Seller, AMERICAN BUSINESS MORTGAGE SERVICES, INC., as an Original Mortgage Loan Seller, ABFS 2003-1, INC., as Secondary Mortgage Loan Seller, BEAR STEARNS ASSET BACKED SECURITIES, INC., a Delaware corporation, in its capacity as depositor (the "Depositor"), and JPMORGAN CHASE BANK, a New York banking corporation, as Trustee, Back-up Servicer and Collateral Agent (the "Trustee"). W I T N E S S E T H: WHEREAS, (i) the Original Mortgage Loan Sellers have sold and assigned their entire interest to the Secondary Mortgage Loan Seller and (ii) the Secondary Mortgage Loan Seller has sold and assigned its entire interest to the Depositor, and the Depositor has accepted from the Secondary Mortgage Loan Seller the sale and assignment of such interest, in the Mortgage Loans pursuant to an Unaffiliated Seller's Agreement, dated as of March 1, 2003, by and among the Original Mortgage Loan Sellers, the Secondary Mortgage Loan Seller and the Depositor (the "Purchase Agreement"); WHEREAS, each of the Original Mortgage Loan Sellers and the Secondary Mortgage Loan Seller has made certain representations and warranties with respect to the related Mortgage Loans subject to the Purchase Agreement; WHEREAS, a Pooling and Servicing Agreement, dated as of March 1, 2003, by and among the Depositor, the Servicer, the Back-up Servicer, the Collateral Agent and the Trustee (as may be amended, modified or supplemented from time to time as set forth therein, the "P&S Agreement") provides for, among other things, the assignment of the Mortgage Loans by the Depositor to the Trustee for the benefit of the Certificateholders and the Certificate Insurer, the issuance of the ABFS Mortgage Loan Trust 2003-1 Mortgage Pass-Through Certificates, Series 2003-1 evidencing the entire beneficial ownership interest in the Trust Fund and the servicing of the Mortgage Loans; WHEREAS, the Certificate Insurer intends to issue the Policy, pursuant to which it will agree to pay in favor of the Trustee for the benefit of the Holders of the Class M Certificates, amounts in respect of certain payments on the Class M Certificates; WHEREAS, the Certificate Insurer shall be paid a Premium as set forth herein; and WHEREAS, each of the Sellers and the Depositor has undertaken certain obligations under the Purchase Agreement and the P&S Agreement for the benefit of the Certificate Insurer and in consideration for the Certificate Insurer's issuance of its Policy. NOW, THEREFORE, in consideration of the premises and the mutual agreements herein contained, the parties hereto agree as follows: ARTICLE I DEFINITIONS Section 1.01. Defined Terms. Unless the context clearly requires otherwise, capitalized terms used and not defined herein shall have the respective meanings given to them in the P&S Agreement or, if not defined therein, the Policy specified below. References herein to the Servicer shall also be deemed to refer to ABC Inc. in its capacity as Servicer under the P&S Agreement. For purposes of this Insurance Agreement, the terms set forth below shall have the following meanings: "ABC Inc." means American Business Credit, Inc., a Pennsylvania corporation, as seller and/or originator under the Purchase Agreement and as Servicer under the P&S Agreement. "ABFS" means American Business Financial Services, Inc., a Delaware corporation. "Affiliate" means, as to any specified Person, any other Person controlling or controlled by or under common control with such specified Person. For the purposes of this definition, "control" when used with respect to any specified Person means the power to direct the management and policies of such Person, directly or indirectly, whether through the ownership of voting securities, by contract or otherwise; and the terms "controlling" or "controlled" have meanings correlative to the foregoing. "Benefit Plan" means any "employee benefit plan," as defined in Section 3(3) of ERISA, and any other employee benefit arrangement or payroll practice, including, without limitation, any bonus plan, consulting, employment or other compensation agreement, incentive, equity or equity-based compensation, or deferred compensation arrangement, stock purchase, severance pay, sick leave, vacation pay, salary continuation for disability, hospitalization, medical insurance, life insurance, scholarship program. "Certificate Insurer" means Radian Asset Assurance Inc., or any successor thereto, as issuer of the Policy. "Certificates" means the ABFS Mortgage Loan Trust 2003-1 Mortgage Pass-Through Certificates, Series 2003-1, issued pursuant to the P&S Agreement. "Class M Certificates" means those of the Certificates designated as belonging to Class M pursuant to the P&S Agreement. "Closing Date" means the date hereof. "Code" means the Internal Revenue Code of 1986, as amended. "Commonly Controlled Entity" means, with respect to any Person, each entity, whether or not incorporated, which is affiliated with such Person pursuant to Section 414(b), (c), (m) or (o) of the Code. "Default" means any event which results, or which with the giving of notice or the lapse of time or both would result, in an Event of Default. 2 "Depositor" means Bear Stearns Asset Backed Securities, Inc., a Delaware corporation, or any successor thereto as Depositor under the P&S Agreement. "Documents" has the meaning given to such term in Section 2.01(k) herein. "ERISA" means the Employee Retirement Income Security Act of 1974, including the rules and regulations thereunder, as amended from time to time. "ERISA Affiliate" means any entity or trade or business (whether or not incorporated) which, together with the subject Person, would be treated as a single employer or under common control under Section 414 of the Code or Section 4001 of ERISA and any general partnership of which any such entity is or has been a general partner. "Event of Default" means any event of default specified in Section 5.01 of this Insurance Agreement. "Financial Statements" means, with respect to each of the Sellers, the consolidated statements of financial condition of ABFS as of June 30, 2002 and June 30, 2001, and the statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended June 30, 2001 and for the interim period ended December 31, 2002. "Fitch" means Fitch Ratings, and any successor thereto. "Indemnification Agreement" means the Indemnification Agreement dated the Closing Date among the Certificate Insurer and Bear, Stearns & Co. Inc., as representative of the Underwriters. "Insurance Agreement" has the meaning given to such term in the initial paragraph hereof. "Insurer Information" means the information with respect to the Certificate Insurer set forth in the Offering Document under the caption "THE CERTIFICATE INSURER." "Investment Company Act" means the Investment Company Act of 1940, including, unless the context otherwise requires, the rules and regulations thereunder, as in effect from time to time. "Late Payment Rate" means the lesser of (A) the greater of (1) the "prime rate" of interest, which is published in the "Money Rates" section of The Wall Street Journal (any change in such rate of interest to be effective on the date such change is so announced), plus 3%, and (2) the then applicable highest rate of interest on the Class M Certificates and (B) the maximum rate permissible under applicable usury or similar laws limiting interest rates. Interest at the Late Payment Rate shall be computed on the basis of a 360-day year and the actual number of days elapsed in the related accrual period. "Material Adverse Change" means, in respect of any Person, a material adverse change in (i) the ability of such Person to perform its obligations under any of the Operative Documents or (ii) the business, financial condition, 3 results of operations or properties of such Person. References to a "Material Adverse Change" herein which do not refer to a particular Person mean a Material Adverse Change with regard to the Sellers, the Depositor or the Trust Fund. "Mortgage Loan Information" means the information in the Offering Document regarding the Mortgage Loans set forth under the heading "THE MORTGAGE LOAN POOL" and the related Sellers' underwriting standards set forth under the headings "THE ORIGINATORS, THE SELLER AND THE SERVICER--Origination of Mortgage Loans" and "--Underwriting Procedures and Practices" and "RISK FACTORS" (to the extent of information concerning the Mortgage Loans thereunder). "Multiemployer Plan" means a multiemployer plan (within the meaning of Section 400(1)(a)(3) of ERISA) in respect of which a Commonly Controlled Entity makes contributions, is obligated to contribute or has liability. "Offering Document" means the Prospectus Supplement, dated March 26, 2003 in respect of the Class A, Class A-IO and Class M Certificates and any amendment or supplement thereto. "Operative Documents" means this Insurance Agreement, the Policy, the Indemnification Agreement, the Certificates, the Optional Termination Side Letter, the Support Agreement, the Interest Rate Hedge Agreement, the Underwriting Agreement, the P&S Agreement and the Purchase Agreement. "Optional Termination Side Letter" means the optional termination side letter dated as of the date hereof from the Servicer to the Certificate Insurer and the Trustee. "Original Mortgage Loan Seller" means each of ABC Inc., HomeAmerican Credit, Inc. d/b/a Upland Mortgage and American Business Mortgage Services, Inc. or any successor thereto, as originator/purchaser of the Mortgage Loans and seller thereof to the Secondary Mortgage Loan Seller. "P&S Agreement" has the meaning given to such term in the recitals. "PBGC" means the Pension Benefit Guaranty Corporation or any successor agency, corporation or instrumentality of the United States to which the duties and powers of the Pension Benefit Guaranty Corporation are transferred. "Person" means an individual, joint stock company, trust, unincorporated association, joint venture, corporation, business or other trust, limited liability company, partnership or other organization or entity (whether governmental or private). "Plan" means any Benefit Plan (other than a Multiemployer Plan) covered by Title IV of ERISA, which is maintained by a Commonly Controlled Entity or in respect of which a Commonly Controlled Entity has liability. "Policy" means the Financial Guaranty Insurance Policy, designated as policy number FANI-0509-03090-NY, together with all endorsements thereto, issued 4 by the Certificate Insurer in favor of the Trustee and for the benefit of the Class M Certificateholders in respect of certain payments on the Class M Certificates. "Premium" means the non-refundable premium payable in respect of the Policy, which shall be payable (a) on the Closing Date in an amount equal to $75,000.00 and (b) on each Distribution Date in an amount equal to the product of (i) the Premium Percentage, (ii) the aggregate Certificate Principal Balance of the Class A Certificates and the Class M Certificates that are Outstanding on the immediately preceding Distribution Date (or on the Closing Date, in the case of the first Distribution Date), after giving effect to any payments of principal made on such immediately preceding Distribution Date other than any such payment related to an unreimbursed Insured Payment and (iii) 1/12 (or, on the first Distribution Date, a fraction, the numerator of which is the actual number of days from and including the Closing Date to but excluding the first Distribution Date, and the denominator of which is 360). "Premium Percentage" shall mean 0.20%. "Purchase Agreement" has the meaning given to such term in the recitals. "S&P" means Standard & Poor's Ratings Services, a division of The McGraw-Hill Companies, Inc., and any successor thereto. "Securities Act" means the Securities Act of 1933, including, unless the context otherwise requires, the rules and regulations thereunder, as amended from time to time. "Securities Exchange Act" means the Securities Exchange Act of 1934, including, unless the context otherwise requires, the rules and regulations thereunder, as amended from time to time. "Secondary Mortgage Loan Seller" means ABFS 2003-1, Inc. or any successor thereto, as seller of the Mortgage Loans to the Depositor. "Seller" means each of the Original Mortgage Loan Sellers and the Secondary Mortgage Loan Seller. "Servicing Information" means the information in the Offering Document regarding the Servicer and certain of its servicing practices and set forth under the heading "THE ORIGINATORS, THE SELLER AND THE SERVICER--The Servicer" and "SERVICING OF THE MORTGAGE LOANS" (to the extent of information concerning the Servicer) therein. "Transaction" means the transactions contemplated by the Operative Documents, including the transactions described in the Offering Document. "Trustee" means JPMorgan Chase Bank, as the Trustee under the P&S Agreement, and any successor thereto under the P&S Agreement. "Underwriter Information" has the meaning provided in section 3(c) of the Indemnification Agreement. 5 "Underwriters" means Bear Stearns & Co. Inc. and Credit Suisse First Boston LLC. "Underwriting Agreement" means the Underwriting Agreement between Bear, Stearns & Co. Inc., as representative of the Underwriters and the Depositor, dated March 26, 2003, with respect to the offer and sale of certain of the Certificates, as such may be amended, modified or supplemented from time to time. Section 1.02. Other Definitional Provisions. The words "hereof," "herein" and "hereunder" and words of similar import when used in this Insurance Agreement shall refer to this Insurance Agreement as a whole and not to any particular provision of this Insurance Agreement, and Section, subsection, Schedule and Exhibit references are to this Insurance Agreement unless otherwise specified. The meanings given to terms defined herein shall be equally applicable to both the singular and plural forms of such terms. The words "include" and "including" and words of similar import shall be deemed to be followed by the phrase "without limitation." ARTICLE II REPRESENTATIONS, WARRANTIES AND COVENANTS Section 2.01. Representations and Warranties. Each of the Sellers, the Depositor and the Servicer represents and warrants with respect to itself (subject to Section 6.13), in each case, as of the Closing Date and as of the date of each transfer of the Mortgage Loans (other than any Qualified Substitute Mortgage Loan) to the Trust pursuant to the P&S Agreement, as follows: (a) Due Organization and Qualification. It is a corporation, duly organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation or formation. It is duly qualified to do business, is in good standing and has obtained all necessary licenses, permits, charters, registrations and approvals (together, "approvals") necessary for the conduct of its business as currently conducted and as described in the Offering Document and the performance of its obligations under the Operative Documents to which it is a party in each jurisdiction in which the failure to be so qualified or to obtain such approvals would render any Operative Document unenforceable in any material respect or would have a material adverse effect upon the Transaction. (b) Power and Authority. It has all necessary power and authority to conduct its business as currently conducted and as described in the Offering Document, to execute and deliver, and to perform its obligations under, the Operative Documents to which it is a party and to consummate the Transaction. (c) Due Authorization. The execution, delivery and performance by it of the Operative Documents to which it is a party have been duly authorized by all necessary action on its part and does not require any additional approvals or consents from, or other action by or any notice to or filing with, any Person, including any governmental entity or any of its stockholders, members or other owners which have not previously been obtained or given by it. 6 (d) Noncontravention. The execution and delivery by it of the Operative Documents to which it is a party, the consummation of the Transaction and the satisfaction of the terms and conditions of the Operative Documents do not and will not: (i) conflict with or result in any breach or violation of any provision of its organizational documents or any law, rule, regulation, order, writ, judgment, injunction, decree, determination or award currently in effect having applicability to it or any of their respective material properties, including regulations issued by any administrative agency or other governmental authority having supervisory powers over it; (ii) constitute a default by it or result in the acceleration of any obligation under, or breach any provision of, any loan agreement, mortgage, indenture or other agreement or instrument to which it is a party or by which any of their respective properties is or may be bound or affected; or (iii) result in or require the creation of any lien upon or in respect of any of its assets, except as otherwise contemplated by the Operative Documents. (e) Legal Proceedings. There is no action, proceeding or investigation by or before any court, governmental or administrative agency or arbitrator against or affecting it or any of its respective subsidiaries, any of its properties or rights or any of its subsidiaries or any of the Mortgage Loans, pending or, to its knowledge after reasonable inquiry, threatened, which, in any case, could result in a Material Adverse Change. (f) Valid and Binding Obligations. The Operative Documents (other than the Certificates) to which it is a party have been duly executed and delivered by such party and constitute its legal, valid and binding obligations, as applicable, enforceable against it in accordance with their respective terms, except as such enforceability may be limited by bankruptcy, insolvency, reorganization, moratorium or other similar laws affecting creditors' rights generally and general equitable principles and public policy considerations as to rights of indemnification for violations of federal securities laws. Without attributing the representations and warranties in this sentence to the Servicer or the Sellers, the Certificates when executed, authenticated and delivered by the Trustee in accordance with the P&S Agreement, will be validly issued and outstanding and entitled to the benefits of the P&S Agreement. It will not at any time in the future deny that the Operative Documents to which it is a party constitute its legal, valid and binding obligations. (g) Financial Statements. Without attributing the representations and warranties in this Section 2.01(g) to the Depositor, such of ABFS's Financial Statements as have been furnished to the Certificate Insurer, (i) are, as of the dates and for the periods referred to therein, complete and correct in all material respects, (ii) present fairly its financial condition and results of operations as of the dates and for the periods indicated and (iii) have been prepared in accordance with generally accepted accounting principles consistently applied, except as certified therein (subject as to interim statements to normal year-end adjustments). Since the respective dates of the most recent of such Financial Statements, there has been no Material Adverse Change with respect to it. Except as disclosed in the Financial Statements, it 7 is not subject to any contingent liabilities or commitments that, individually or in the aggregate, have a material possibility of causing a Material Adverse Change. (h) ERISA. (i) No accumulated funding deficiency (as defined in Section 302 of ERISA or Section 412 of the Code), whether or not waived, has occurred with respect to any Plan. No Plan has been terminated, and no Commonly Controlled Entity has withdrawn from any Multiemployer Plan under circumstances that could result in a Commonly Controlled Entity incurring liability under ERISA that has not been satisfied. No Commonly Controlled Entity has withdrawn from a Plan that is or was subject to Section 4063 of ERISA during a plan year in which such Commonly Controlled Entity was a substantial employer (as defined in Section 4001(a)(2) of ERISA) and no Commonly Controlled Entity has had a cessation of operations that could be treated as a withdrawal under Section 4062(e) of ERISA in either case which could result in material liability to it. No reportable event (as defined in Section 4043 of ERISA) or other event or condition has occurred which could result in the termination of any Plan by the PBGC. As of the last day of the Plan's most recently ended plan year, no Plan has liabilities (determined using the actuarial and interest factors used by such Plan for purposes of the actuarial report used for such plan year, the interest and actuarial factors being reasonable at the time used,) that exceed the Plan's assets by more than $100,000. As of the last day of the Plan's most recently ended plan year, the aggregate liabilities for all Plans (determined using the actuarial and interest factors used by such Plan for purposes of the actuarial report used for such plan year, the interest and actuarial factors being reasonable at the time used,) do not exceed the aggregate assets of the Plans by more than $100,000. The liability to which the Commonly Controlled Entities would become subject under ERISA if they withdrew completely from all Multiemployer Plans (determined as of the most recent valuation date for each Multiemployer Plan) does not exceed $100,000. No Multiemployer Plan is in reorganization (as defined in Section 4241 of ERISA) or insolvent (as defined in Section 4245 of ERISA). (ii) Each Commonly Controlled Entity is in compliance in all material respects with ERISA and has not incurred and does not reasonably expect to incur any liabilities to the PBGC under ERISA in connection with any Plan or Multiemployer Plan in any capacity other than as a Commonly Controlled Entity with respect to it, or to contribute now or in the future in respect of any Plan or Multiemployer Plan. (i) Compliance With Law, Etc. No practice, procedure or policy employed, or proposed to be employed, by it in the conduct of its business violates any law, regulation, judgment, agreement, order or decree applicable to either of them that, if enforced, could reasonably be expected to result in a Material Adverse Change with respect to it. (j) Taxes. It has filed or has participated in the filing of a consolidated filing with its parent company or companies prior to the date hereof all United States federal, state and local tax returns that are required to be filed and paid all taxes, including any assessments received by it or its parent company or companies that are not being contested in good faith, to the extent that such taxes have become due. Any taxes, fees and other governmental charges payable by it or any of its respective parent companies in connection with the Transaction, the execution and delivery of the Operative Documents to which it is a party and the issuance of the Certificates have been paid or shall 8 have been paid at or prior to the Closing Date if such taxes, fees or other governmental changes were due on or prior to the Closing Date. (k) Accuracy of Information. (i) Without attributing the representations and warranties in this Section 2.01(k)(i) to the Servicer or the Sellers, neither the Operative Documents nor any other information furnished by it to the Certificate Insurer and relating to the Operative Documents, the Mortgage Loans, the Trust Fund, the Certificates, or the operations or financial condition of the Trustee, any Seller, the Depositor, or the Servicer (as amended, supplemented or superseded, collectively, the "Documents") contain any statement of a material fact which was untrue or misleading in any material respect when made. (ii) Without attributing the representations and warranties in this Section 2.01(k)(ii) other than to the Servicer and the Sellers, no information furnished by it to the Certificate Insurer and relating to the Operative Documents, the Mortgage Loans, the Trust Fund or its operations or financial condition (as amended, supplement or superseded, collectively, the "Limited Documents") contain any statement of a material fact which was untrue or misleading in any material respect when made. (iii) It does not have any knowledge of any circumstances that could reasonably be expected to cause a Material Adverse Change or, to the extent that the representations and warranties in this sentence are attributable to the Servicer or the Sellers, a Material Adverse Change with respect to it or the Trust Fund. (iv) Since the furnishing by it of such Documents or, in the case of the Servicer and the Sellers, such Limited Documents, there has been no change, nor any development or event involving a prospective change known to it, that would render any of such Documents or, in the case of the Servicer and the Sellers, such Limited Documents untrue or misleading in any material respect. (l) Compliance With Securities Laws. (i) Without attributing the representations and warranties in this Section 2.01(l)(i) to the Servicer or the Sellers, the offer and sale of the Certificates comply in all material respects with all requirements of law, including all registration requirements of applicable federal securities laws and the representations and warranties made in the Underwriting Agreement are true and correct as of the date of the Offering Document and the date of this Insurance Agreement. Without limiting the foregoing, the Offering Document does not contain any untrue statement of a material fact and does not omit to state a material fact necessary to make the statements made therein, in light of the circumstances under which they were made, not misleading; provided, however, that no representation is made with respect to the Insurer Information, the Servicing Information or the Mortgage Loan Information. The offer and sale of the Certificates have not been and will not be in violation of the Securities Act, any other federal, state or local securities laws. The P&S Agreement is not required to be qualified under the Trust Indenture Act, and none of the Trustee, the Depositor or the Trust Fund is required to be registered as an "investment company" under the Investment Company Act. Each of the Trust Fund and the 9 Depositor will satisfy in all material respects any of the information reporting requirements of the Securities Exchange Act arising out of the Transaction to which it or the Depositor is subject. (ii) Without attributing the representations and warranties in this Section 2.01 (l)(ii) other than to the Servicer, the Servicing Information does not contain any untrue statement of a material fact and does not omit to state a material fact necessary to make the statements made therein, in light of the circumstances under which they were made, not misleading. The Servicer has not participated in the offer and sale of the Certificates. (iii) Without attributing the representations and warranties in this Section 2.01(l)(iii) other than to the Sellers, the Mortgage Loan Information does not contain any untrue statement of a material fact and does not omit to state a material fact necessary to make the statements made therein, in light of the circumstances under which they were made, not misleading. None of the Sellers have participated in the offer and sale of the Certificates. (m) Operative Documents. Each of the representations and warranties made by it in the Operative Documents (other than this Insurance Agreement) to which it is a party is true and correct in all material respects and it hereby makes each such representation and warranty to, and for the benefit of, the Certificate Insurer as if the same were set forth in full herein; provided, however, that, except as provided in Section 3.04 and subject to Article V hereto, the remedies for a breach of any such representation or warranty shall be limited to the remedies therefor provided in the related Operative Document. (n) No Consents. No consent, license, approval or authorization from, or registration, filing or declaration with, any regulatory body, administrative agency, or other governmental instrumentality, nor any consent, approval, waiver or notification of any creditor, lessor or other nongovernmental person, is required in connection with the execution, delivery and performance by it of this Insurance Agreement or of any other Operative Document to which such Person is a party, except (in each case) as have been obtained and are in full force and effect. (o) Solvency; Fraudulent Conveyance. It is solvent and will not be rendered insolvent by the Transaction and, after giving effect to the Transaction, it will not be left with an unreasonably small amount of capital with which to engage in its business, and it does not intend to incur, nor does it believe that it has incurred debts beyond its ability to pay as they mature. None of the Sellers, the Servicer, the Depositor or the Trustee contemplates the commencement of insolvency, bankruptcy, liquidation or consolidation proceedings or the appointment of a receiver, liquidator, conservator, trustee or similar official in respect of the Sellers, the Servicer, the Depositor or the Trustee, or any of their respective assets. The amount of consideration being received by the Original Mortgage Loan Sellers upon the sale of Mortgage Loans to the Secondary Mortgage Loan Seller and by the Secondary Mortgage Loan Seller upon the sale of the Mortgage Loans to the Depositor constitutes reasonably equivalent value and fair consideration therefor. The amount of consideration being received by the Depositor upon the sale of the Certificates to the Underwriters constitutes reasonably equivalent value and fair consideration for the Certificates. None of the Original Mortgage Loan Sellers are transferring the Mortgage Loans to the Secondary Mortgage Loan Seller and the Secondary 10 Mortgage Loan Seller is not transferring the Mortgage Loans to the Depositor and the Depositor is not transferring Mortgage Loans to the Trust Fund, nor is the Depositor transferring the Certificates to the Underwriters, with any intent to hinder, delay or defraud any of the Sellers or the Depositor, or any of their respective creditors. (p) Good Title; Absence of Liens. Without attributing the representations. and warranties in this subsection 2.01(p) to the Servicer or the Sellers, immediately prior to the conveyance of the Mortgage Loans to the Trust Fund pursuant to the P&S Agreement, the Depositor had good title to, and was the sole owner of each Mortgage Loan, free of any interest of any other Person. (q) Rating Agency. The information supplied by each of the Sellers, the Servicer and the Depositor to S&P and Fitch in connection with obtaining a rating for the Class M Certificates did not contain any untrue statement of a material fact or omit to state any material fact required to be stated in order to make such information not misleading. (r) No Violation of Securities Exchange Act or Regulations T, U or X. Without attributing the representations and warranties in this subsection 2.01(r) to the Servicer or the Sellers, none of the transactions contemplated in the Operative Documents (including the use of the proceeds from the sale of any Class of Certificates) will result in a violation of Section 7 of the Securities Exchange Act, or any regulations issued pursuant thereto, or will result in a violation of any of Regulations T, U or X of the Board of Governors of the Federal Reserve System. Section 2.02. Affirmative Covenants. Each of the Sellers, the Depositor and the Servicer hereby agrees, with respect to itself (subject to Section 6.13), in each case, that during the term of this Insurance Agreement, unless the Certificate Insurer shall otherwise expressly consent in writing: (a) Compliance With Agreements and Applicable Laws. It shall comply in all material respects with the terms and conditions of, and shall perform its obligations under, and shall not be in default under, any of the Operative Documents to which it is a party, and shall comply with all material requirements of any law, rule or regulation applicable to it. (b) Existence. It and its successors and permitted assigns shall maintain its existence and shall at all times continue to be duly organized under the laws of its jurisdiction of incorporation or formation and duly qualified and duly authorized (as described in subsections 2.01(a), (b) and (c) hereof) and shall conduct its business in accordance with the terms of its organizational documents. (c) Financial Statements; Accountants' Reports; Other information. It shall keep or cause to be kept in reasonable detail books and records of account of its assets and business, including books and records relating to the Transaction. Each of the Sellers, the Depositor and the Servicer shall furnish or cause to be furnished to the Certificate Insurer in respect of itself: 11 (i) Annual Financial Statements. As soon as available, and in any event within 90 days after the close of ABFS's fiscal year, ABC Inc. shall furnish the audited consolidated statement of financial condition of ABFS and its subsidiaries as of the end of such fiscal year and the related audited consolidated statements of operations, stockholders' equity and cash flows for such fiscal year, all in reasonable detail and stating in comparative form the respective figures for the corresponding date and period in the preceding fiscal year, prepared in accordance with generally accepted accounting principles, consistently applied, and accompanied by the audit opinion of its independent accountants (which shall be a nationally recognized independent public accounting firm or otherwise acceptable to the Certificate Insurer) and by the certificate specified in Section 2.02(d). (ii) Quarterly Financial Statements. As soon as available and in any event within 45 days after the close of each of the first three quarters of each fiscal year, ABC Inc. shall furnish the unaudited consolidated statement of financial condition of ABFS and its subsidiaries as of the end of such quarter and the related unaudited consolidated statements of operations, stockholders' equity and cash flows for the portion of the fiscal year then ended, all in reasonable detail and stating in comparative form the respective figures for the corresponding date and period in the preceding fiscal year, prepared in accordance with generally accepted accounting principles consistently applied (subject to normal year-end adjustments) and accompanied by the certificate specified in Section 2.02(d). (iii) Initial Report. On or before the Closing Date, the Depositor shall furnish or cause to be furnished to the Certificate Insurer a copy of a magnetic tape setting forth, as to each Mortgage Loan to be included in the Trust on the Closing Date, the information required under the definition of "Mortgage Loan Schedule" in the P&S Agreement. (iv) Certain Information. Upon the written request of the Certificate Insurer, copies of any proxy statements, financial statements, reports and other documents that it or any of its affiliates files with the United States Securities and Exchange Commission or any national securities exchange. (v) Other Information. (A) Promptly upon receipt or delivery thereof, copies of all schedules, financial statements or other similar reports delivered to or by it pursuant to the terms of any of the Operative Documents, including all reports and other information provided by or to the Trustee or any holder of Certificates pursuant to the P&S and (B) promptly upon the written request of the Certificate Insurer, such other information as the Certificate Insurer may reasonably request. (d) Compliance Certificate. ABC Inc. shall, with respect to itself and the Original Mortgage Loan Sellers, deliver or cause to be delivered to the Certificate Insurer, concurrently with the delivery of the financial statements required pursuant to subsection 2.02(c)(i) and (ii) hereof, one or more certificates signed by an officer authorized to execute such certificates on its behalf stating that: (i) a review of its performance under the Operative Documents to which it is a party during such period has been made under such officer's supervision; 12 (ii) to the best of such individual's knowledge and belief following reasonable inquiry, no Default or Event of Default has occurred, or if a Default or Event of Default has occurred, specifying the nature thereof and, if there is a right to cure such Default or Event of Default, stating in reasonable detail (including, if applicable, any supporting calculations) the steps, if any, being taken by it to cure such Default or Event of Default or to otherwise comply with the terms of the agreement to which such Default or Event of Default relates; (iii) the financial statements submitted in accordance with subsection 2.02(c)(i) or (ii) hereof are complete and correct in all material respects and present fairly the financial condition and the results of its, operations or the operations of its parent company and consolidated subsidiaries as of the dates and for the periods indicated, in accordance with generally accepted accounting principles consistently applied; and (iv) the Servicer has in full force and effect a blanket fidelity bond (or direct surety bond) and an errors and omissions insurance policy in accordance with the terms and requirements of the P&S Agreement. (e) Access to Records; Discussions with Officers and Accountants. Upon the prior written request of the Certificate Insurer, each of the Sellers, the Servicer and the Depositor shall permit, at the Certificate Insurer's sole expense, the Certificate Insurer or its authorized agents: (i) to inspect the books and records as they may relate to the Certificates, the Mortgage Loans, the obligations of any such Person under the Operative Documents to which it is a party, and the Transaction; (ii) to discuss the affairs, finances and accounts of such Person (with respect to the Servicer or the Sellers, to the extent relating to its capacity to perform its obligations under the Operative Documents to which it is a party) with its chief operating officer and chief financial officer; and (iii) with its consent, which shall not be unreasonably withheld, to discuss the affairs, finances and accounts of such Person (with respect to the Servicer or the Sellers, to the extent relating to its capacity to perform its obligations under the Operative Documents to which it is a party) with its independent accountants; provided, however, that its officers shall have the right to be present during such discussions. Such inspections and discussions shall be conducted during normal business hours and shall not unreasonably disrupt the business of the Sellers, the Servicer or the Depositor. The books and records of each of the Sellers, the Servicer and the Depositor shall be maintained at its address as designated herein for receipt of notices, unless it shall otherwise advise the parties hereto in writing. (f) Notice of Material Events. It shall be obligated promptly to inform the Certificate Insurer in writing of the occurrence of any of the following: 13 (i) the submission of any claim or the initiation or threat of any legal process, litigation or administrative or judicial investigation, or rule making or disciplinary proceeding by or against it that (A) would be required to be disclosed to its shareholders or to the United States Securities and Exchange Commission if any Class of Certificates were publicly registered or (B) could result in a Material Adverse Change, or the initiation of any proceeding or the promulgation of any proposed or final rule which would likely result in a Material Adverse Change; (ii) any change in the location of its principal office or any change in the location of its books and records, other than the date of the relocation by the Sellers and the Servicer to 100 East Penn Square, Philadelphia, PA 19103 in July 2003; provided, that, if such relocation does not occur in July 2003, it shall so inform the Certificate Insurer; (iii) the occurrence of any Default or Event of Default or any Material Adverse Change; (iv) the commencement of any proceedings by or against it under any applicable bankruptcy, reorganization, liquidation, rehabilitation, insolvency or other similar law now or hereafter in effect or of any proceeding in which a receiver, liquidator, conservator, trustee or similar official shall have been, or may be, appointed or requested for it or any of its assets, or any actual, proposed or anticipated assignment for the benefit of its creditors; (v) the receipt of notice that (A) it is being placed under regulatory supervision, (B) any license, permit, charter, registration or approval materially necessary for the conduct of its business is to be, or may be, suspended or revoked or (C) it is to cease and desist any practice, procedure or policy employed by it in the conduct of its business, and such suspension, revocation or cessation may result in a Material Adverse Change; or (vi) the imposition of any tax, assessment or other government charge upon the Trust Fund other than any such charge payable out of collections on the Mortgage Loans pursuant to the P&S Agreement. (g) Further Assurances. It agrees to cooperate with S&P and Fitch in connection with any review of the Transaction that may be undertaken by S&P or Fitch after the date hereof. (h) Maintenance of Licenses. It has and shall maintain all licenses, permits, charters and registrations which are material to the conduct of its business. (i) Retirement of Class M Certificates. Without attributing the covenants in this sentence to the Servicer or the Sellers, it shall instruct the Trustee upon a retirement or other payment of all of the Class M Certificates to surrender the Policy to the Certificate Insurer for cancellation. (j) Third-Party Beneficiary. It agrees that the Certificate Insurer shall have all rights of a third-party beneficiary in respect of the Operative Documents (other than this Insurance Agreement, the Underwriting Agreement, the Certificates and any other Operative Document to which the Certificate Insurer is a party) and hereby incorporates and restates its representations, 14 warranties, covenants and agreements as set forth therein or in any certificate or other document delivered in connection with the Transaction for the benefit of the Certificate Insurer. (k) Transaction Documents. It shall comply with each of the covenants and other agreements made by it in any of the Operative Documents. (l) [Reserved] (m) Closing Documents. The Depositor shall provide or cause to be provided to the Certificate Insurer (i) a photostatic or facsimile copy of each of the Operative Documents and any other documents executed and/or delivered in connection with the Transaction as requested by the Certificate Insurer concurrently with the closing on the Closing Date, and (ii) an executed original copy of each document executed in connection with the Transaction within 60 days after the Closing Date. (n) Due Diligence. The Certificate Insurer shall have the right, so long as any Class M Certificates remain outstanding, to conduct reviews of the Servicer's practices through reviews of the Mortgage Loans and the servicing practices of the Servicer and through reappraisals of Mortgaged Properties. Such due diligence shall be conducted in a reasonable manner convenient to both the Servicer and the Certificate Insurer and at the Certificate Insurer's sole expense. (o) Disclosure Document. Each Offering Document delivered with respect to the Class M Certificates shall clearly disclose that the Policy is not covered by the property/casualty insurance security fund specified in Article 76 of the New York Insurance Law. In addition, each Offering Document delivered with respect to the Class M Certificates which includes financial information of the Certificate Insurer prepared in accordance with GAAP shall include the following statement immediately preceding such financial information: The New York State Insurance Department recognizes only statutory accounting practices for determining and reporting the financial condition and results of operations of an insurance company, for determining its solvency under the New York Insurance Law, and for determining where its financial condition warrants the payment of a dividend to its stockholders. No consideration is given by the New York State Insurance Department to financial statements prepared in accordance with generally accepted accounting principles in making any such determinations. (p) Special Purpose Entities. (i) Each of the Depositor and the Secondary Mortgage Loan Seller shall conduct its business solely in its own name through its duly authorized officers or agents so as not to mislead others as to the identity of the entity with which those others are concerned. (ii) Each of the Depositor and the Secondary Mortgage Loan Seller shall keep its assets and liabilities wholly separate from those of all other entities. Neither the Depositor nor the Secondary Mortgage Loan Seller shall commingle its funds or other assets with those of any of its Affiliates (other than in respect of items of payment or funds which may be commingled until 15 deposit into the Collection Account in accordance with the P&S Agreement) and shall not hold its assets in any manner that would create an appearance that such assets belong to any such Affiliate, not maintain bank accounts or other depository accounts to which any such Affiliate is an account party, into which such Affiliate makes deposits or from which any such Affiliate has the power to make withdrawals and not act as an agent or representative of any of its Affiliates in any capacity. (iii) Neither the Depositor nor the Secondary Mortgage Loan Seller shall guarantee any obligation of any of its Affiliates, or otherwise hold itself out as responsible for the debts of any Affiliate. (iv) Each of the Depositor and the Secondary Mortgage Loan Seller shall pay its own incidental administrative costs and expenses from its own funds and allocate all other shared overhead expenses (including, without limitation, telephone and other utility charges, the services of shared employees, consultants and agent, and reasonable legal auditing expenses), and other items of cost and expense shared between the Depositor or the Secondary Mortgage Loan Seller and any respective Affiliate thereof, on the basis of actual use to the extent practicable. (v) The financial statements, of the Secondary Mortgage Loan Seller and the Depositor and their respective affiliates shall disclose the effects of the Transactions in accordance with GAAP and shall disclose that the assets of the Depositor are not available to pay creditors of the Sellers or their respective Affiliates. (vi) The resolutions, agreements and other instruments of each of the Depositor and the Secondary Mortgage Loan Seller underlying the transactions described in this Insurance Agreement and in the other Documents shall, be continuously maintained by it as its official records, separately identified and held apart from the records of their respective Affiliates. (vii) Each of the Depositor and the Secondary Mortgage Loan Seller shall take such actions as are necessary on its part to ensure that the facts and assumptions set forth in the opinions delivered by its counsel remain true and correct at all times. (q) Benefit Plan. (i) It shall comply in all material respects with the provisions of ERISA, the Code and all other applicable laws, and the Plan and Multi-Employer Plan regulations and interpretations thereunder to the extent applicable, with respect to each Benefit Plan. Without limiting the foregoing, it shall not, and shall cause each ERISA Affiliate not to: (A) permit to exist any material accumulated funding deficiency as defined in Section 302 of ERISA or Section 412 of the Code with respect to any Plan or amend any Plan if, as a result of such amendment, it or an ERISA Affiliate would be required to provide material security under Section 401 or 412 of the Code or Section 306 or 307 of ERISA; or 16 (B) terminate any Benefit Plan of either it or any ERISA Affiliate if such termination would result in any material liability to it or an ERISA Affiliate or withdraw from any Multiemployer Plan if such withdrawal would result in any material liability to it or an ERISA Affiliate. (ii) It and its subsidiaries shall not engage in any non-exempt prohibited transaction (within the meaning of Code Section 4975 or ERISA Section 406) with respect to any Benefit Plan which would result in a material liability to it or any such subsidiary. Section 2.03. Negative Covenants. Each of the Sellers, the Servicer, the Depositor and the Trustee hereby agrees, with respect to itself (subject to Section 6.13), that during the term of this Insurance Agreement, unless the Certificate Insurer shall otherwise expressly consent in writing: (a) Impairment of Rights. It shall not take any action, or fail to take any action, if such action or failure to take action may result in a Material Adverse Change (within the meaning of the second sentence of the definition of such term, for the avoidance of doubt), nor shall it interfere (or, with respect to the Trustee, intentionally interfere or fail to remove or otherwise withdraw any unintentional interference by it brought to the attention of a Responsible Officer, as defined in the P&S Agreement) with the enforcement of any rights of the Certificate Insurer under or with respect to any of the Operative Documents or with respect to the Trust Fund. It shall give the Certificate Insurer written notice of any such event, action or failure to act on the earlier of: (i) the date upon which any publicly available filing or release is made with respect to such event, action or failure to act and (ii) promptly prior to the date of occurrence of such event, action or failure to act. It shall furnish to the Certificate Insurer all information reasonably requested by it that is necessary to determine compliance with this paragraph. (b) Waiver, Amendments, Etc. It shall not modify, waive or amend, or consent to any modification, waiver or amendment of, any of the terms, provisions or conditions of the Operative Documents to which it is a party without the prior written consent of the Certificate Insurer except as permitted by the P&S Agreement. (c) Clean-up Calls. The Servicer shall not exercise its right to terminate the Trust Fund by purchasing the Mortgage Loans and other assets at the applicable Termination Price, or otherwise, without the consent of the Certificate Insurer unless, as a result of the termination, all interest, principal and other amounts due or otherwise owed in respect of the Class M Certificates would be or otherwise are paid in full and, following such termination, all amounts reimbursable or otherwise payable to the Certificate Insurer under any Operative Document would be or otherwise are reimbursed or otherwise paid in full of the applicable Termination Price or other consideration payable in respect thereof. None of the Servicer, the Depositor or the Trustee shall appoint, consent to or otherwise suffer the appointment of any successor to the Servicer under the P&S Agreement without the consent of the Certificate Insurer unless such successor shall have agreed to be bound by the provisions of this Insurance Agreement and the Optional Termination Side Letter, and upon becoming the successor to the Servicer under the P&S Agreement, the Trustee shall be so bound. 17 (d) Creation of Indebtedness; Guarantees. Except as contemplated by the Documents, the Depositor shall not create, incur, assume or suffer to exist any indebtedness other than indebtedness guaranteed or approved in writing by the Certificate Insurer except debt for which there is no recourse to the Depositor excluding recourse to the assets pledged to secure such indebtedness. The Depositor shall not assume, guarantee, endorse or otherwise be or become directly or contingently liable for the obligations of any Person by, among other things, agreeing to purchase any obligation of another Person, agreeing to advance funds to such Person or causing or assisting such Person to maintain any amount of capital. (e) Retirement of Certificates. The Trustee shall, upon retirement of the Class M Certificates, furnish to the Certificate Insurer a notice of such retirement and, upon such retirement, shall surrender the Policy to the Certificate Insurer for cancellation. (f) No Change in Name, Etc. The Depositor shall not change its name (including using any trade names, fictitious names, assumed names or "doing business as" names), identity or organizational structure in any manner that would, could or might make any financing statement or continuation statement filed in connection with the closing of the Transactions, or otherwise in accordance herewith, seriously misleading unless it shall have given the Certificate Insurer at least 60 days' prior written notice thereof and shall have filed before the date of such change appropriate amendments to all such previously filed financing statements or continuation statements. (g) Limitation on Mergers, Etc. The Depositor shall not consolidate with or merge with or into any Person or transfer all or substantially all of its assets to any Person or liquidate or dissolve except as provided in the Operative Documents to which it is a party or as permitted hereby. The Depositor shall furnish to the Certificate Insurer all information requested by the Certificate Insurer that is reasonably necessary to determine compliance with this paragraph. (h) Successors. No successor Servicer, Paying Agent, Collateral Agent or Trustee shall be terminated or designated without the prior written approval of the Certificate Insurer, which consent shall not be unreasonably withheld or delayed. Section 2.04. Representations, Warranties and Covenants of the Certificate Insurer. The Certificate Insurer represents and warrants to and covenants with the other parties hereto as follows: (a) Organization and Licensing. The Certificate Insurer is duly authorized and validly existing stock insurance company organized under the Insurance Laws of the State of New York, duly qualified and licensed to issue financial guaranty insurance policies under the laws of the State of New York and is in good standing under the laws of that State. (b) Corporate Power. The Certificate Insurer has the corporate power and authority to issue the Policy and execute and deliver this Insurance Agreement and to perform all of its obligations hereunder and thereunder. 18 (c) Authorization; Approvals. Proceedings legally required for the issuance and execution of the Policy and the execution, delivery and performance of this Insurance Agreement have been taken and licenses, orders, consents or other authorizations or approvals of any governmental boards or bodies legally required for the enforceability of the Policy and the conduct by the Certificate Insurer of the business and activities contemplated by the Transaction have been obtained; any proceedings not taken and any licenses, authorizations or approvals not obtained are not material to the enforceability of the Policy. (d) Enforceability. The Policy, when issued, and this Insurance Agreement will each constitute a legal, valid and binding obligation of the Certificate Insurer, enforceable against the Certificate Insurer in accordance with its terms, subject to bankruptcy, insolvency, reorganization, moratorium, receivership and other similar laws affecting creditors' rights generally and to general principles of equity and subject to principles of public policy limiting the right to enforce the indemnification provisions contained therein and herein, insofar as such provisions relate to indemnification for liabilities arising under federal securities laws. (e) Insurer Information. The Insurer Information is limited. With due regard for the limitations of the Insurer Information, however, as of the date of the Offering Document and as of the date hereof, the Insurer Information does not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements contained therein, in the light of the circumstances under which they were made, not misleading. Copies of the Certificate Insurer's quarterly and annual statutory financial statements prepared on the basis of statutory accounting principles as filed with the New York State Insurance Department and annual financial statements prepared in accordance with generally accepted accounting principles are available upon written request to the Certificate Insurer. (f) No Litigation. There are no actions, suits, proceedings or investigations pending or, to the best of the Certificate Insurer's knowledge, threatened against it at law or in equity or before or by any court, governmental agency, board or commission or any arbitrator which, if decided adversely, would materially and adversely affect its ability to perform its obligations under the Policy or this Insurance Agreement. (g) The execution by the Certificate Insurer of this Insurance Agreement will not, and the satisfaction of the terms hereof will not, conflict with or result in a breach of any of the terms, conditions or provisions of the organizational documents of the Certificate Insurer, or any restriction contained in any contract, agreement or instrument to which the Certificate Insurer is a party or by which it is bound or constitute a default under any of the foregoing. (h) Confidential Information. The Certificate Insurer agrees that it and its shareholders, directors, agents, accountants and attorneys shall keep confidential any information or matter of which it becomes aware (i) as a result of financial statements, reports or other information furnished pursuant to Section 2.02(c) or (ii) during the inspections conducted or discussions had pursuant to Section 2.02(e), unless such information is readily available from public sources or is disclosed to the Certificate Insurer on a non-confidential basis from any Person or source, which Person or source is not actually known to the Certificate Insurer to be subject to a confidentiality obligation to the Sellers, the Servicer or the Depositor, or except as may be otherwise required by regulation, law or court order or requested by appropriate governmental 19 authorities or as necessary or expedient to preserve its rights or security under or to enforce any of the Operative Documents or any other agreement executed in connection with the transactions related to the Operative Documents to which the Certificate Insurer is a party or of which the Certificate Insurer is a third party beneficiary, or in connection with the defense of any legal proceeding in which the Certificate Insurer is a party; provided, however, that the foregoing shall not limit the right of the Certificate Insurer to make such information available to its regulators, rating agencies, reinsurers, participants, credit and liquidity providers, any government sponsored entities, counsel and accountants. If the Certificate Insurer is requested or required (by oral questions, interrogatories, requests for information or documents subpoena, civil investigative demand or similar process) to disclose any information of which it becomes aware through such inspections or discussions, the Certificate Insurer will promptly notify the Sellers, the Servicer and the Depositor of such request(s) so that the Sellers, the Servicer and the Depositor may seek an appropriate protective order and/or waive the Certificate Insurer's compliance with the provisions of this Insurance Agreement, unless the Certificate Insurer, in the opinion of its counsel, is prohibited from providing such notice by any tribunal, court or governmental agency or other governmental or quasi-governmental authority. If, in the absence of a protective order or the receipt of a waiver hereunder, the Certificate Insurer is, nonetheless, in the opinion of its counsel, compelled to disclose such information to any tribunal or else suffer a penalty or liability, the Certificate Insurer may disclose such information to such tribunal that the Certificate Insurer is compelled to disclose; provided, however, that a copy of all information disclosed is provided to the Sellers, the Servicer and the Depositor promptly upon such disclosure; provided, further, however, that no such copy must be delivered or supplied if the Certificate Insurer, in the opinion of its counsel, is prohibited from providing such a copy by any tribunal, court or governmental agency or other governmental or quasi-governmental authority. (i) Compliance with Law, Etc. No practice, procedure or policy employed, or proposed to be employed, by the Certificate Insurer in the conduct of its business violates any law, regulation, judgment, agreement, order or decree applicable to the Certificate Insurer that, if enforced, could result in a Material Adverse Change with respect to the Certificate Insurer. (j) Rating. The Certificate Insurer is not aware of any facts with regard to itself which, if disclosed to S&P or Fitch, would be reasonably expected to result in a downgrade of the rating of the claims paying ability of the Certificate Insurer by S&P or Fitch. (k) Securities Act Registration. To the extent that the Policy constitutes a security within the meaning of Section 2(1) of the Securities Act, the Policy is a security that is exempt from registration under the Securities Act pursuant to the exemption provided by Section 3(a)(8) thereof. ARTICLE III THE POLICY; REIMBURSEMENT Section 3.01. Issuance of the Policy. The Certificate Insurer agrees to issue the Policy on the Closing Date subject to satisfaction of the conditions precedent set forth below on or prior to the Closing Date: 20 (a) Payment of Fees, Premium and Expenses. The Certificate Insurer shall have been paid or reimbursed for, or payment shall have been made on behalf of the Certificate Insurer of, that portion of the Premium and those fees and expenses that are payable on the Closing Date; (b) Operative Documents. The Certificate Insurer shall have received a copy of each of the Operative Documents, in form and substance reasonably satisfactory to the Certificate Insurer, duly authorized, executed and delivered by each party thereto (other than the Certificate Insurer); (c) Certified Documents and Resolutions. The Certificate Insurer shall have received copies of (i) the organizational documents for each of the Sellers, the Servicer, the Depositor and the other parties to the Operative Documents and (ii) the resolutions of the Board of Directors of each such Person authorizing the issuance of the Certificates and the execution, delivery and performance by such Person of the Operative Documents to which it is a party and the transactions contemplated thereby, certified by the Secretary or an Assistant Secretary of such Person (which certificate shall state that such organizational documents are in full force and effect without modification on the Closing Date); (d) Incumbency Certificate. The Certificate Insurer shall have received a certificate of the Secretary or an Assistant Secretary of each of the Sellers, the Servicer, the Depositor and the other parties to the Operative Documents certifying the names and signatures of the officers of each such Person authorized to execute and deliver the Operative Documents to which such Person is a party and that shareholder consent to the execution and delivery of such documents is not necessary or has been obtained; (e) Representations and Warranties. The representations and warranties of the Sellers, the Servicer, and the Depositor set forth or incorporated by reference in this Insurance Agreement shall be true and correct on and as of the Closing Date as if made on the Closing Date and the Certificate Insurer shall have received a certificate of appropriate officers of each such Person to that effect; (f) Opinions of Counsel. The Certificate Insurer shall have received opinions of counsel addressed to the Certificate Insurer in respect of the Sellers, the Servicer and the Depositor, and the other parties to the Operative Documents and the Transaction, in form and substance satisfactory to the Certificate Insurer and addressing such matters as the Certificate Insurer may reasonably request; (g) Approvals, Etc. The Certificate Insurer shall have received true and correct copies of all approvals and consents, if any (including any required approval of the shareholders or other owners of equity interests in each of the Sellers, the Servicer and the Depositor), required in connection with the Transaction; (h) No Litigation, Etc. No suit, action or other proceeding, investigation or injunction, or final judgment relating thereto, shall be pending or threatened before any court, governmental or administrative agency or 21 arbitrator in which it is sought to restrain or prohibit or to obtain damages or other relief in connection with any of the Operative Documents or the consummation of the Transaction; (i) Legality. No statute, rule, regulation or order shall have been enacted, entered or deemed applicable by any government or governmental or administrative agency or court that would make the Transaction illegal or otherwise prevent the consummation thereof; (j) Satisfaction of Conditions of the Underwriting Agreement. All conditions in the Underwriting Agreement relating to the Underwriters' obligation to purchase the Certificates shall have been satisfied. The Certificate Insurer shall have received copies of each of the documents, and shall be entitled to rely on each of the documents (other than the opinion of counsel to the Underwriter), required to be delivered to the Underwriter pursuant to the Underwriting Agreement; (k) Issuance of Ratings. The Certificate Insurer shall have received confirmation that the Class M Certificates insured by the Policy are rated at least "BBB" by S&P and Fitch, without regard to the Policy, and that the Class M Certificates, when issued, will be rated at least "AA" by S&P and Fitch; (l) No Default. No Default or Event of Default shall have occurred; (m) Additional Items. The Certificate Insurer shall have received such other documents, instruments, approvals or opinions reasonably requested by the Certificate Insurer, including evidence satisfactory to the Certificate Insurer that the conditions precedent, if any, in the other Operative Documents have been satisfied; and (n) Satisfactory Documentation. The Certificate Insurer and its counsel shall have reasonably determined that all agreements, instruments, certificates, opinions and other documents to be delivered in connection with the issuance of the Class M Certificates conform to the terms of the Operative Documents and the Offering Document. Section 3.02. Payment of Fees and Premium. (a) Legal, Accounting and Due Diligence Fees. ABC Inc. shall pay or cause to be paid to the Certificate Insurer, on the Closing Date, the legal, accounting and due diligence fees of the Certificate Insurer, as well as disbursements of counsel to the Certificate Insurer. (b) Rating Agency Fees. ABC Inc. will promptly pay or cause to be paid the initial fees of S&P and Fitch with respect to the Class M Certificates and the transactions contemplated hereby following, receipt of a statement with respect thereto. All periodic and subsequent fees of S&P or Fitch with respect to, and directly allocable to, the Class M Certificates shall be for the account of, and shall be billed to, ABC Inc.. The fees for any other rating agency shall be paid by the party requesting such other agency's rating, unless such other agency is a substitute for S&P or Fitch in the event that S&P or Fitch is no longer rating the Class M Certificates, in which case the fees for such agency shall be paid by ABC Inc. 22 (c) Premium. In consideration of the issuance by the Certificate Insurer of the Policy, the Certificate Insurer shall be entitled to receive pursuant to this Insurance Agreement and the P&S Agreement, in the State of New York, the Premium as and when due in accordance with the terms of this Insurance Agreement (i) in the case of the Premium due on the Closing Date, directly from the net proceeds of the issuance of the Class M Certificates or from ABC Inc. to the extent that such proceeds are insufficient to pay such Premium, and (ii) on each Distribution Date, pursuant to Section 6.05 of the P&S Agreement until the Class M Certificates have been indefeasibly paid in full. The Premium paid under this Insurance Agreement or under the P&S Agreement shall be nonrefundable and the right of the Certificate Insurer to receive any Premium payable hereunder or thereunder shall be absolute and unconditional, in each case without regard to whether the Certificate Insurer makes any payment under the Policy or any other circumstances relating to the Class M Certificates or the Policy (including any provision being made for payment of the Class' M Certificates prior to maturity). All payments of the Premium shall be made to the Certificate Insurer by wire transfer to an account designated by the Certificate Insurer in a written notice to ABC Inc. and the Trustee. Section 3.03. Reimbursement Obligation. (a) As and when due in accordance with and from the funds specified in Section 6.05 of the P&S Agreement, the Certificate Insurer shall be entitled to reimbursement for any payment made by the Certificate Insurer under the Policy and any other amount reimbursable or otherwise payable to the Certificate Insurer under this Agreement, to the extent not previously reimbursed or otherwise paid. Such right of reimbursement shall be absolute and unconditional, in each case without regard to whether the Certificate Insurer makes any payment under the Policy or any other circumstances relating to the Class M Certificates or the Policy (including any provision) being made for payment of the Class M Certificates prior to maturity). Reimbursement shall be due and payable on the date that any such amount is paid, in an amount equal to the amount so paid and all such amounts previously paid that remain unreimbursed, together with interest on any and all such amounts remaining unreimbursed (to the extent permitted by law, if in respect of any unreimbursed amounts representing interest) from the date such amounts became due until paid in full (after as well as before judgment), at a rate of interest equal to the Late Payment Rate. (b) Each of the Depositor, the Sellers and the Servicer agrees to pay, anything herein or in any of the other Operative Documents to the contrary notwithstanding, and the Certificate Insurer shall be entitled to full reimbursement from it for: (i) in the case of the Servicer, (A) any payment made under the Policy' arising as a result of any failure by the Servicer to repurchase, substitute for or otherwise deposit any amount required to be deposited in respect of any Mortgage Loan as mandated by any Operative Document (whether because defective or otherwise), together with interest on any and all such amounts remaining unreimbursed (to the extent permitted by law, if in respect of any such unreimbursed amounts representing interest) from the date such amounts became due until paid in full (after as well as before judgment), at a rate of interest equal to the Late Payment Rate, and (B) any payment made under the Policy arising as a result of the failure by the Servicer to otherwise pay or deposit any amount required to be paid or deposited pursuant to the Operative Documents (other than the Certificates), together with interest on any and all 23 such amounts remaining unreimbursed (to the extent permitted by law, if in respect of any such unreimbursed amounts representing interest) from the date such amounts became due until paid in full (after as well as before judgment), at a rate of interest equal to the Late Payment Rate; (ii) in case of the Sellers, (A) any payment made under the Policy arising as a result of its failure to repurchase, substitute for or otherwise deposit any amount required to be deposited in respect of any Mortgage Loan as mandated by the Purchase Agreement (whether because defective or otherwise), together with interest on any and alt such amounts remaining unreimbursed (to the extent permitted by law, if in respect of any such unreimbursed amounts representing interest) from the date such amounts became due until paid in full (after as well as before judgment), at a rate of interest equal to the Late Payment Rate; and (iii) in the case of the Depositor, any payment made under the Policy arising as a result of a breach by the Depositor of any of its representations, warranties, covenants or agreements in any of the Operative Documents (including any failure to make any payment, remittance or deposit required to be made by it pursuant to the Operative Documents (other than the Certificates)), together with interest on any and all such amounts remaining unreimbursed (to the extent permitted by law, if in respect of any such unreimbursed amounts representing interest) from the date such amounts became due until paid in full (after as well as before judgment), at a rate of interest equal to the Late Payment Rate. (c) Each of the Sellers, the Depositor and the Servicer agrees to pay to the Certificate Insurer any and all reasonable charges, fees, costs and expenses that the Certificate Insurer may reasonably pay or incur, including reasonable attorneys' and accountants' fees and expenses, in connection with: (i) in the case of the Depositor, the enforcement, defense or preservation of any rights in respect of any of the Operative Documents as against or otherwise relating to it, including defending, monitoring or participating in any litigation or proceeding (including any bankruptcy or other insolvency proceeding in respect of any Transaction participant or any affiliate thereof) relating to any of the Operative Documents or any party to any of the Operative Documents (in its capacity as such a party) or the Transaction; and (ii) in the case of the Sellers and the Servicer, (i) any accounts established to facilitate payments under the Policy to the extent that the Certificate Insurer has not been immediately reimbursed on the date that any amount is paid by the Certificate Insurer under the Policy, (ii) the enforcement, defense or preservation of any rights in respect of any of the Operative Documents as against or otherwise relating to it, including defending, monitoring or participating in any litigation or proceeding (including any bankruptcy or other insolvency proceeding in respect of any Transaction participant or any affiliate thereof) relating to any of the Operative Documents, any party to any of the Operative Documents (in its capacity as such a party) or the Transaction or (iii) any amendment, waiver, consent or other action with respect to, or related to, any Operative Document, whether or not executed or completed. 24 Costs and expenses shall include a reasonable allocation of compensation and overhead (up to a limit of $30,000 in the aggregate) attributable to the time of employees of the Certificate Insurer spent in connection with the actions described above (other than surveillance and monitoring), and the Certificate Insurer reserves the right to charge a reasonable fee as a condition to executing any waiver or consent proposed in respect of any of the Operative Documents. Payments under this subsection 3.03(c) shall be made as the related charges, fees, costs or expenses are paid or incurred by the Certificate Insurer. All amounts payable under this Section 3.03 are to be immediately due and payable without demand, in full, without any requirement on the part of the Certificate Insurer or any other Person to seek reimbursement of such amounts from any source of reimbursement or indemnity, or to allocate such amounts to any other transaction that may have benefited from the expenditure of such amounts. (d) Each of the Sellers, the Servicer and the Depositor agrees to pay to the Certificate Insurer interest on any and all amounts specified in subsection 3.03(b) or 3.03(c) from the date payable until payment thereof in full and to pay to the Certificate Insurer interest on any and all amounts specified in Section 3.02 or 3.04 from the date such amounts become due or, in the case of Section 3.04, are incurred or paid by the Certificate Insurer until payment thereof in full (after as well as before judgment), in each case at the Late Payment Rate. Section 3.04. Indemnification. (a) In addition to any and all of the Certificate Insurer's rights of reimbursement, indemnification, subrogation and to any other rights of the Certificate Insurer pursuant hereto or under law or in equity, each of the Depositor, the Sellers and the Servicer agrees to pay, and to protect, indemnify and save harmless, the Certificate Insurer and its officers, directors, shareholders, employees, agents and each Person, if any, who controls the Certificate Insurer within the meaning of either Section 15 of the Securities Act or Section 20 of the Securities Exchange Act from and against, any and all claims, losses, liabilities (including penalties), actions, suits, judgments, demands, damages, costs or expenses (including reasonable fees and expenses of attorneys, consultants and auditors and reasonable costs of investigations actually incurred) of any nature (including payments made under the Policy): (i) in the case of the Depositor and the Servicer (subject to the proviso that, to the extent not required to be paid by the Certificate Insurer to any other Person, the Servicer shall not be required to pay to the Certificate Insurer or to protect, indemnify or hold the Certificate Insurer harmless against punitive or other exemplary damages or loss of profits), arising out of or relating to the breach by the Depositor or, with respect to the Servicer, its breach of any of the representations, warranties or covenants contained herein or arising out of or relating to the transactions contemplated by the Operative Documents by reason of: (A) with, respect to the Depositor only, any omission or action in connection with the offering, sale, issuance or delivery of the Certificates by the Depositor, other than those covered by subparagraph (F) below; (B) the misfeasance or malfeasance of, or gross negligence or theft committed by, the Depositor or, with respect to the Servicer, itself, or any director, officer, employee, agent, independent contractor or other 25 representative of any such Person, in connection with the Transaction or arising from or relating to any Operative Document; (C) the violation by the Depositor or, with respect to the Servicer, itself of (a) any United States federal, state or local law, rule or regulation or (b) any judgment, order or decree that is applicable to any such Person; (D) the breach by the Depositor or, with respect to the Servicer, itself of any representation, warranty, or covenant under any of the other Operative Documents or the occurrence, in respect of any such Person under any of the other Operative Documents, of any "incipient default" or "event of default"; (E) shortfalls, if any (but in the case of the Servicer, only to the extent caused by it), attributable to the (A) liability of any Person for taxes payable in respect of the Certificates or any interest or interests represented thereby, (B) failure to qualify or loss of status by, or termination of, any REMIC as such or (C) imposition of income or other taxes on or with respect to the Trust or the Trust Fund; or (F) subject to the proviso that the Servicer shall be liable under this subparagraph (F) only in respect of the Servicing Information and that the Depositor shall not have liability in respect of the Servicing Information, any untrue statement or alleged untrue statement of a material fact contained in the Offering Document (or any preliminary version thereof or information provided in addition thereto, to the extent not corrected in the Offering Document as delivered or any subsequently provided additional information consistent therewith), or any omission or alleged omission to state in the Offering Document (or any preliminary version thereof or information provided in addition thereto, to the extent not corrected in the Offering Document as delivered or any subsequently provided additional information consistent therewith) a material fact required to be stated in the Offering Document (or any preliminary version thereof or information provided in addition thereto, to the extent not corrected in the Offering Document as delivered or any subsequently provided additional information consistent therewith) or necessary to make the statements in the Offering Document (or any preliminary version thereof or information provided in addition thereto, to the extent not corrected in the Offering Document as delivered or any subsequently provided additional information consistent therewith), in the light of the circumstances under which they were made, not misleading; and provided, further, that this subparagraph (F) does not cover the Insurer Information, the Underwriters Information and the Mortgage Loan Information; and (ii) in the case of each of the Sellers, arising out of or relating to its breach of any of the representations, warranties or covenants contained herein or arising out of or relating to the transactions contemplated by the Operative Documents by reason of: (A) the misfeasance or malfeasance of, or gross negligence or theft committed by, it or any of its directors, officers, employees, agents, independent contractors or other representatives in connection with the Transaction or arising from or relating to any Operative Document; 26 (B) the occurrence under any of the other Operative Documents, of any "incipient default" or "event of default"; or (C) any (1) untrue statement or alleged untrue statement of any material fact contained in the Mortgage Loan Information, or the omission or the alleged omission to state therein a material fact required to be stated therein or necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading or (2) representation, warranty or covenant made by any of the Sellers in the Purchase Agreement, the P&S Agreement or any of the other Operative Documents, being or alleged to be untrue or incorrect. (b) The Certificate Insurer agrees to pay, and to protect, indemnify and save harmless, the Sellers, the Servicer, the Trustee and the Depositor, and their respective officers, directors, shareholders, employees, agents and each Person, if any, who controls any of them, within the meaning of either Section 15 of the Securities Act or Section 20 of the Securities Exchange Act from and against, any and all claims, losses, liabilities (including penalties), actions, suits, judgments, demands, damages, costs or expenses (including reasonable fees and expenses of attorneys, consultants and auditors and reasonable costs of investigations) of any nature arising out of or by reason of (i) any untrue statement or alleged untrue statement of a material fact contained in the Insurer Information or any omission or. alleged omission to state in the Insurer Information a material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading, (ii) any failure of the Certificate Insurer to make a payment required to be made under the Policy or (iii) a breach of any of the representations and warranties of the Certificate Insurer contained in Section 2.04. (c) If any action or proceeding (including any governmental investigation) shall be brought or asserted against any Person (individually, an "Indemnified Party" and, collectively, the "Indemnified Parties") in respect of which the indemnity provided, in Section 3.04(a) or (b) may be sought from any party under Section 3.04(a), on the one hand, or the Certificate Insurer, on the other (each, an "Indemnifying Party") hereunder, each such Indemnified Party shall promptly notify the Indemnifying Party in writing, and the Indemnifying Party shall assume the defense thereof, including the employment of counsel reasonably satisfactory to the Indemnified Party and the payment of all expenses thereof. The omission so to notify the Indemnifying Party will not relieve it from any liability which it may have to any Indemnified Party except to the extent the Indemnifying Party is prejudiced thereby. The Indemnified Party shall have the right to employ separate counsel in any such action and to participate in the defense thereof at the expense of the Indemnified Party, but the fees and expenses of such separate counsel shall be at the expense of the Indemnifying Party if (i) the Indemnifying Party has agreed in writing to pay such fees and expenses, (ii) the Indemnifying Party shall have failed within a reasonable period of time to assume, the defense of such action or proceeding and employ counsel reasonably satisfactory to the Indemnified Party in any such action or proceeding or (iii) the named parties to any such action or proceeding (including any impleaded parties) include both the Indemnified Party and the Indemnifying Party, and the Indemnified Party shall have been advised by counsel that there may be one or more legal defenses available to it which are different from or additional to those available to the Indemnifying Party (in which case, if the Indemnified Party notifies the Indemnifying Party in writing that it 27 elects to employ separate counsel at the expense of the Indemnifying Party, the Indemnifying Party shall not have the right to assume the defense of such action or proceeding on behalf of such Indemnified Party, it being understood, however, that the Indemnifying Party shall not, in connection with any one such action or proceeding or separate but substantially similar or related actions or proceedings in the same jurisdiction arising out of the same general allegations or circumstances, be liable at any time for the reasonable fees and expenses of more than one separate firm of attorneys acting as general counsel and one separate firm of attorneys acting as local counsel for the Indemnified Parties, which firm or firms shall be designated in writing by the Indemnified Party and shall be reasonably satisfactory to the Indemnifying Party). The Indemnifying Party shall not be liable for any settlement of any such action or proceeding effected without its written consent, which consent shall not be unreasonably withheld, conditioned or delayed, but, if settled with its written consent, or if there is a final judgment for the plaintiff in any such action or proceeding with respect to which ,the Indemnifying Party shall have received notice in accordance with this subsection (c), the Indemnifying Party agrees to indemnify and hold the Indemnified Parties harmless from and against any loss or liability by reason of such settlement or judgment. Notwithstanding anything in this paragraph to the contrary, the consent of such Indemnified Party shall not be required if such settlement fully discharges, with prejudice against the plaintiff, the claim or action against such Indemnified Party. (d) To provide for just and equitable contribution if the indemnification provided by the Indemnifying Party is determined to be unavailable or insufficient to hold harmless any Indemnified Party (other than due to application of this Section), each Indemnifying Party shall contribute to the losses incurred by the Indemnified Parties on the basis of the relative fault of the Indemnifying Party, on the one hand, and the Indemnified Parties, on the other hand. Section 3.05. Payment Procedure. In the event of any payment by the Certificate Insurer, each other party hereto agrees to accept the voucher or other evidence of payment as prima facie evidence of the propriety thereof and the liability, if any, described in Section 3.03 therefor to the Certificate Insurer. All payments to be made to the Certificate Insurer under this Insurance Agreement shall be made to the Certificate Insurer in lawful currency of the United States of America in immediately available funds at the notice address for the Certificate Insurer as specified herein on the date when due or as the Certificate Insurer shall otherwise direct by written notice to the other parties hereto. In the event that the date of any payment to the Certificate Insurer or the expiration of any time period hereunder occurs on a day that is not a Business Day, then such payment or expiration of time period shall be made or occur on the next succeeding Business Day with the same force and effect as if such payment was made or time period expired on the scheduled date of payment or expiration date except as provided in Section 6.05. Payments to be made to the Certificate Insurer hereunder shall bear interest at the Late Payment Rate from and including the date when payable to but excluding the date when paid. Section 3.06. Subrogation. (a) The parties hereto acknowledge that, to the extent of any payment made by the Certificate Insurer pursuant to the Policy, the Certificate Insurer 28 shall be subrogated to the rights of each Class M Certificateholder to receive payments in respect of the Class M Certificates, all in accordance with the P&S Agreement and in accordance with the priorities set forth therein for reimbursement of the Certificate Insurer as provided herein and therein. The Depositor agrees to take, or cause to be taken, all actions deemed desirable by the Certificate Insurer to preserve, enforce, perfect or maintain the perfection in the Certificate Insurer's favor of such rights and of all equitable rights of subrogation. (b) Each of the parties hereto agrees to promptly and duly take, execute, acknowledge and deliver such further acts, documents, instruments and assurances as the Certificate Insurer may from time to time reasonably request to more effectively evidence any rights to assignment or subrogation under this Article III, and to protect and perfect all of the Certificate Insurer's other rights. Section 3.07. Assignment and Other Rights. (a) In consideration of the issuance of the Policy by the Certificate Insurer, in the case of any payment made by or on behalf of the Certificate Insurer under the Policy, in addition to and not by way of limitation of any of the rights and remedies of the Certificate Insurer hereunder, under the Policy or under the P&S Agreement with respect to such payment, each of the Depositor, the Sellers and the Servicer hereby acknowledges and consents to the assignment by the Trustee, on behalf of the Class M Certificateholders, to the Certificate Insurer in accordance with the terms of the relevant notice and certificate (in the case of any payment made by or on behalf of the Certificate Insurer under the Policy) the rights of the Class M Certificateholders with respect to the Class M Certificates to the extent of any such payment made on the Class M Certificates under the Policy. (b) The rights and remedies of the Certificate Insurer described in clause (a) above are in addition to, and not in limitation of, the rights of subrogation and other rights and remedies otherwise available to the Certificate Insurer in respect of payments under the Policy made by the Certificate Insurer. The Trustee shall take such action and deliver such instruments as may be reasonably requested or required by the Certificate Insurer to effectuate the purpose or provisions of this Section 3.07. ARTICLE IV FURTHER AGREEMENTS Section 4.01. Effective Date; Term of the Insurance Agreement. This Insurance Agreement shall take effect on the Closing Date and shall remain in effect until the later of such time as (a) the Certificate Insurer is no longer subject to a claim under the Policy and the Policy shall have been surrendered to the Certificate Insurer for cancellation and (b) all amounts payable to the Certificate Insurer by any party hereunder or from any other source hereunder or under any or the other Operative Documents, and all amounts payable under the Class M Certificates, have been indefeasibly paid in full; provided, that the provisions of Sections 3.02, 3.03 and 3.04 hereof shall survive any termination of this Insurance Agreement. Section 4.02. Further Assurances and Corrective Instruments. 29 (a) Except at such times as a default in payment under the Policy shall exist or shall have occurred, none of the parties hereto shall grant any waiver of rights under any of the Operative Documents to which it is a party without the prior written consent of the Certificate Insurer, which shall not be unreasonably withheld, conditioned or delayed and any such waiver without prior written consent of the Certificate Insurer shall be null and void and of no force or effect. (b) To the extent permitted by law, each party hereto agrees that it will promptly and from time to time execute, acknowledge and deliver, or cause to be executed, acknowledged and delivered, such supplements hereto and such further instruments as the Certificate Insurer may reasonably request and as may be required in the Certificate Insurer's judgment to effectuate the intention of or facilitate the performance of this Insurance Agreement. Section 4.03. Obligations Absolute. (a) The obligations of the parties hereto shall be absolute and unconditional and shall be paid or performed strictly in accordance with this Insurance Agreement under all circumstances irrespective of: (i) any lack of validity or enforceability of any of the Operative Documents or any amendment or other modification of, or waiver with respect to, any of the Operative Documents; (ii) any exchange or release of any other obligations hereunder or under any other Operative Document, or of any guarantee of or security for any obligations hereunder or thereunder; (iii) the existence of any claim, counterclaim, setoff, defense, reduction, abatement or other right that any Person may have at any time against the Certificate Insurer or any other Person, including with respect to the liability of any other Person for the payment of any such obligation; (iv) any document presented in connection with the Policy proving to be forged, fraudulent, invalid or insufficient in any respect or any statement therein being untrue or inaccurate in any respect; (v) any payment by the Certificate Insurer under the Policy against presentation of a certificate or other document that does not strictly comply with terms of the Policy; (vi) any failure of the Depositor or ABC Inc. to receive the proceeds from the sale of the Certificates; and (vii) the inaccuracy or alleged inaccuracy of any Servicer Remittance Report or any notice and certificate upon which any drawing under the Policy is based; (viii) the bankruptcy or insolvency of the Certificate Insurer or any other party or any default or alleged default of the Certificate Insurer under the Policy; 30 (ix) any nonapplication or misapplication of the proceeds of any drawing upon the Policy; and (x) any other circumstances, other than payment in full, that might otherwise constitute a defense available to, or discharge of, any party to any Operative Document. (b) The Sellers, the Servicer and the Depositor and any and all others who are now or may become liable for all or part of their respective obligations under this Insurance Agreement, agree to be bound by this Insurance Agreement or any other Operative Document and, to the extent permitted by applicable law, waive and renounce the right to assert as a defense to the performance of their respective obligations each of the following: (i) any and all redemption and exemption rights and the benefit of all valuation and appraisement privileges against the indebtedness and obligations evidenced by any Operative Document or by any extension or renewal thereof; (ii) diligence, presentment and demand for payment, notices of nonpayment and of dishonor, protest of dishonor and notice of protest; (iii) all notices in connection with the delivery and acceptance hereof and all other notices in connection with the performance, default or enforcement of any payment hereunder, except as required by the Operative Documents; (iv) all rights of abatement, diminution, postponement or deduction, and to any defense other than payment, and to any right of setoff or recoupment arising out of any breach under any of the Operative Documents, by any party thereto or any beneficiary thereof, or out of any obligation at any time owing to any of them; and (v) any requirement that any Person exhaust any right, power or remedy or proceed against any other Person under this Insurance Agreement or any other Operative document, or against any other Person or any collateral under any other obligation to pay, guarantee or security arrangement. (c) The Sellers, the Servicer, the Depositor and any and all others who are now or may become liable for all or part of their respective obligations under this Insurance Agreement, to the extent permitted by law, agree to be bound by this Insurance Agreement and (i) agree that its liabilities hereunder shall, except as otherwise expressly provided herein, be absolute and unconditional and without regard to any setoff or counterclaim or the liability of any other Person for the payment thereof; (ii) agree that any consent, waiver or forbearance hereunder with respect to an event shall operate only for such event and not for any subsequent event; (iii) consent to any and all extensions of time that may be granted by the Certificate Insurer with respect to any payment hereunder or other provisions hereof and to the release of any security at any time given for any payment hereunder, or any part thereof, with or without substitution, and to the release of any Person or entity liable for any such payment; and (iv) consent to the addition of any and all other makers, endorsers, guarantors and other obligors for any payment hereunder, and to the acceptance of any and all other security for any payment hereunder, and agree that the addition of any such obligors or security shall not affect the liability of the parties hereto for any payment hereunder. (d) The obligations of ABC Inc. under Sections 3.03 and 3.04 shall be automatically restored and reinstated if and to the extent that for any reason any payment by or on behalf of any Seller is rescinded or must be otherwise restored by any Person, whether as a result of any proceedings in bankruptcy or reorganization or otherwise, and ABC Inc. agrees to indemnify each such Person on demand for all reasonable costs and expenses (including fees and 31 disbursements of counsel) incurred by such Person in connection with such rescission or restoration. (e) The obligations of ABC Inc. under Sections 3.03 and 3.04 are continuing obligations and shall apply to all related amounts and other obligations whenever arising. (f) Except as otherwise provided in this Insurance Agreement, nothing herein shall be construed as prohibiting any party hereto from pursuing any rights or remedies it may have against any Person in a separate legal proceeding. Section 4.04. Assignments; Reinsurance; Third-Party Rights. (a) This Insurance Agreement shall be a continuing obligation of the parties hereto and shall be binding upon and inure to the benefit of the parties hereto and their respective successors and permitted assigns. None of the Sellers, the Servicer, the Depositor or the Trustee may assign any of their respective rights under this Insurance Agreement or any other Operative Document, or delegate any of their respective duties hereunder or thereunder, without the prior written consent of the Certificate Insurer. Any assignments made in violation of this Insurance Agreement shall be null and void. (b) The Certificate Insurer shall have the right to give participations in its rights under this Insurance Agreement and to enter into contracts of reinsurance with respect to the Policy upon such terms and conditions as the Certificate Insurer may in its discretion determine; provided, however, that no such participation or reinsurance agreement or arrangement shall relieve the Certificate Insurer of any of its obligations hereunder or under the Policy. The Certificate Insurer shall be entitled to assign or pledge to any bank or other investor providing liquidity or credit with respect to the Transaction or the obligations of the Certificate Insurer in connection therewith any rights of the Certificate Insurer under the Operative Documents or with respect to any real or personal property or other interests pledged to the Certificate Insurer, or in which the Certificate Insurer has a security interest, in connection with the Transaction. (c) Except as provided herein with respect to participants and reinsurers, nothing in this Insurance Agreement shall confer any right, remedy or claim, express or implied, upon any Person, including, particularly, any Certificateholder or Certificate Owner, other than the Certificate Insurer against the Sellers, the Servicer or the Depositor, and all the terms, covenants, conditions, promises and agreements contained herein shall be for the sole and exclusive benefit of the parties hereto and their successors and permitted assigns. None of the Trustee or any Certificateholder or Certificate Owner shall have any right to payment from any Premiums paid or payable under the P&S Agreement pursuant hereto or from any amounts paid pursuant to Sections 3.02, 3.03 or 3.04. Section 4.05. Liability of the Certificate Insurer. Neither the Certificate Insurer nor any of its officers, directors or employees shall be liable or responsible for: (a) the use that may be made of the Policy by the Trustee or for any acts or omissions of the Trustee in connection therewith; or (b) the validity, sufficiency, accuracy or genuineness of documents delivered to 32 the Certificate Insurer in connection with any claim under the Policy, or of any signatures thereon, even if such documents or signatures should in fact prove to be in any or all respects invalid, insufficient, fraudulent or forged (unless the Certificate Insurer shall have actual knowledge thereof). In furtherance and not in limitation of the foregoing, the Certificate Insurer may accept documents that appear on their face to be in order, without responsibility for further investigation. Section 4.06. Annual Servicing Audit and Certification. The annual servicing audit required pursuant to Section 5.10 of the P&S Agreement shall be performed by an independent third party reasonably acceptable to the Certificate Insurer. Any one of the five major nationally recognized firms of independent public accountants is deemed to be acceptable. ARTICLE V DEFAULTS AND REMEDIES Section 5.01. Defaults. The occurrence of any of the following shall constitute an Event of Default hereunder: (a) Any representation or warranty made by any party hereto (other than the Certificate Insurer) under this Insurance Agreement or any such party, a counterparty under the Interest Rate Hedge Agreement, or any other Person under any other Operative Document, or in any certificate furnished hereunder or thereunder by any such party or Person, shall prove to be untrue or incorrect in any material respect; provided, however, that if such party effectively cures any such defects in any representation or warranty with respect to the Mortgage Loans under any Operative Document or certificate or report furnished under any Operative Document, within the time period specified in the related document as the cure period thereof, such defect shall not in and of itself constitute an Event of Default; (b) (i) Any party hereto (other than the Certificate Insurer), a counterparty under any Interest Rate Hedge Agreement, or any other Person shall fail to pay when due any amount payable by it hereunder or under any other Operative Document or (ii) a legislative body has enacted any law that declares or a court of competent jurisdiction shall find or rule, or any Seller, the Servicer or the Depositor shall assert, that this Insurance Agreement or any other Operative Document is not valid and binding on any party hereto or thereto; (c) The occurrence and continuance of an "event of default," "Event of Default," or "Servicer Event of Default," or any similar occurrence, in each case under any Operative Document, or any termination of or loss of status or failure to qualify by any REMIC as such; (d) Any failure on the part of any party hereto (other than the Certificate Insurer), a counterparty under any Interest Rate Hedge Agreements, or any other Person to duly observe or perform in any material respect any other of the covenants or agreements on its part contained in this Insurance Agreement or in any other Operative Document which continues unremedied, with respect to this Insurance Agreement, for a period of 30 days after the date on which written notice of such failure requiring the same to be remedied shall have been given to it by the Certificate Insurer (with a copy to the Trustee) or, with respect to any other Operative Document, beyond any cure period provided therein 33 commencing on the date at which written notice of such failure requiring the same to be remedied shall have been given to it by the Certificate Insurer (with a copy to the Trustee); (e) A decree or order of a court or agency or supervisory authority having jurisdiction in the premises in an involuntary case under any present or future federal or state bankruptcy, insolvency or similar law or the appointment of a conservator or receiver or liquidator or other similar official in any bankruptcy, insolvency, readjustment of debt, marshaling of assets and liabilities or similar proceedings, or for the winding-up or liquidation of its affairs, shall have been entered against any Seller, the Servicer or the Depositor, a counterparty under any Interest Rate Hedge Agreements and such decree or order shall have remained in force undischarged or unstayed for a period of 60 consecutive days; (f) Any Seller, the Servicer or the Depositor, the counterparty under the Interest Rate Hedge Agreements shall consent to the appointment of a trustee, conservator or receiver or liquidator or other similar official in any bankruptcy, insolvency, readjustment of debt, marshaling of assets and liabilities or similar proceedings of or relating to it or of or relating to all or substantially all of its property; (g) Any Seller, the Servicer or the Depositor, a counterparty under any Interest Rate Hedge Agreement shall admit in writing its inability to pay its debts generally as they become due, file a petition to take advantage of or otherwise voluntarily commence a case or proceeding under any applicable bankruptcy, insolvency, reorganization or other similar statute, make an assignment for the benefit of its creditors or voluntarily suspend payment of its obligations; or (h) The Trust Fund or the Depositor shall become subject to registration as an investment company under the Investment Company Act, or for United States federal, state or local income and tax purposes, (i) the Trust Fund shall not qualify as one or more separate REMICs or (ii) the Class A Certificates, the Class M Certificates or the Class A-IO Certificates shall not be treated as one or more regular interests in a REMIC. Section 5.02. Remedies; No Remedy Exclusive. (a) Upon the occurrence of an Event of Default, the Certificate Insurer may exercise any one or more of the rights and remedies set forth below: (i) declare all indebtedness under this Insurance Agreement of every type or description then owed by any Seller, the Servicer or the Depositor to be immediately due and payable, and the same shall thereupon be immediately due and payable; (ii) exercise any rights and remedies under this Insurance Agreement or any other Operative Document in accordance with the terms hereof or thereof or direct the Trustee, the Depositor or the Servicer to exercise its rights and remedies in accordance with any Operative Document to which it is a party; 34 (iii) exercise any rights and remedies under the Purchase Agreement in accordance with the terms thereof or direct the Depositor to exercise such rights and remedies in accordance with the terms of the Purchase Agreement; or (iv) take whatever action at law or in equity as may appear necessary or desirable in its judgment to collect the amounts, if any, then due under this Insurance Agreement or any other Operative Document or to enforce performance and observance of any obligation, agreement or covenant on the part of any party (other than the Certificate Insurer) under this Insurance Agreement or under any other Operative Document. (b) Unless otherwise expressly provided, no remedy herein conferred or reserved is intended to be exclusive of any other available remedy, but each remedy shall be cumulative and shall be in addition to other remedies given under this Insurance Agreement or any other Operative Document or existing at law or in equity. No delay or omission to exercise any right or power accruing under this Insurance Agreement or any other Operative Document upon the happening of any event set forth in Section 5.01 shall impair any such right or power or shall be construed to be a waiver thereof, but any such right and power may be exercised from time to time and as often as may be deemed expedient. In order to entitle the Certificate Insurer to exercise any remedy reserved to the Certificate Insurer in this Article, it shall not be necessary to give any notice, other than such notice as may be required by this Article. Section 5.03. Waivers. (a) No failure by the Certificate Insurer to exercise, and no delay by the Certificate Insurer in exercising, any right hereunder shall operate as a waiver thereof. The exercise by the Certificate Insurer of any right hereunder shall not preclude the exercise of any other right, and the remedies provided herein to the Certificate Insurer are declared in every case to be cumulative and not exclusive of any remedies provided by law or equity. Any waiver, consent or forbearance hereunder with respect to an event or other occurrence shall operate only with respect to such event or occurrence and not with respect to any subsequent or other event or occurrence, whether or not similar. (b) The Certificate Insurer shall have the right, to be exercised in its complete discretion, to waive any Event of Default hereunder, by a writing setting forth the terms, conditions and extent of such waiver signed by the Certificate Insurer and delivered to the Depositor (with a copy to the Trustee). Unless such writing expressly provides to the contrary, any waiver so granted shall extend only to the specific event or occurrence which gave rise to the Event of Default so waived and not to any other similar event or occurrence which occurs subsequent to the date of such waiver. (c) If any proceeding has been commenced to enforce any right or remedy under this Insurance Agreement and such proceeding has been discontinued or abandoned for any reason, or has been determined adversely to the Certificate Insurer, then and in every such case the parties hereto shall, subject to any determination in such proceeding, be restored to their respective former positions hereunder and, thereafter, all rights and remedies of the Certificate Insurer shall continue as though no such proceeding had been instituted. 35 ARTICLE VI MISCELLANEOUS Section 6.01. Amendments, Etc. This Insurance Agreement may be amended, modified, supplemented or terminated only by written instrument or written instruments signed by the parties hereto. The Depositor agrees to provide a copy of any amendment to this Insurance Agreement promptly to the rating agencies maintaining a rating on the Certificates. No act or course of dealing shall be deemed to constitute an amendment, modification, supplement or termination hereof. Section 6.02. Notices. All demands, notices and other communications to be given hereunder shall be in writing (except as otherwise specifically provided herein) and shall be mailed by registered mail, reliable overnight courier or personally delivered and telecopied to the recipient as follows: (a) To the Certificate Insurer: Radian Asset Assurance Inc. 335 Madison Avenue New York, New York 10017 Attention: Chief Risk Officer and Chief Legal Officer Re: ABFS Mortgage Loan Trust, Series 2003-1, Class M Facsimile: (212) 682-5377 Confirmation: (212) 983-5859 (in each case in which notice or other communication to the Certificate Insurer refers to an Event of Default, a claim on the Policy or with respect to which failure on the part of the Certificate Insurer to respond shall be deemed to constitute consent or acceptance, then a copy of such notice or other communication should also be sent to the attention of the general counsel of the Certificate Insurer and shall be marked to indicate "URGENT MATERIAL ENCLOSED.") (b) To any other party hereto, at the address for such party provided in the Operative Documents (other than this Insurance Agreement) to which it is a party. A party may specify an additional or different address or addresses by writing mailed or delivered to the other parties as aforesaid. All such notices and other communications shall be effective upon receipt. Section 6.03. Severability. In the event that any provision of this Insurance Agreement shall be held invalid or unenforceable by any court of competent jurisdiction, the parties hereto agree that such holding shall not invalidate or render unenforceable any other provision hereof. The parties hereto further agree that the holding by any court of competent jurisdiction that any remedy pursued by any party hereto is unavailable or unenforceable shall not affect in any way the ability of such party to pursue any other remedy available to it. 36 Section 6.04. GOVERNING LAW. THIS INSURANCE AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK (WITHOUT GIVING EFFECT TO THE CONFLICT OF LAWS PROVISIONS THEREOF). Section 6.05. Payments. (a) All payments to the Certificate Insurer hereunder shall be made in lawful currency of the United States and in immediately available funds, shall be made prior to 12:00 p.m. noon (New York City time) on the date such payment is due by wire transfer pursuant to wire transfer instructions and bank account information provided by the Certificate Insurer, or to such other office or account as the Certificate Insurer may direct. Payments received by the Certificate Insurer after 12:00 p.m. noon (New York City time) shall be deemed to have been received on the next succeeding Business Day, and such extension of time shall be included in computing interest, commissions or fees, if any, in connection with such payment. (b) Whenever any payment under this Insurance Agreement stated to be due on a day which is not a Business Day is to be made on the next succeeding Business Day pursuant to Section 3.05, such extension of time shall in such cases be included in computing interest, commissions or fees, if any, in connection with such payment. (c) To the extent permitted by law, the Certificate Insurer shall be entitled to interest on all amounts owed to the Certificate Insurer under this Agreement in respect of interest from the date such amounts become due until paid in full (after as well as before judgment), at a rate of interest equal to the Late Payment Rate. Section 6.06. Consent to Jurisdiction. (a) The parties hereto hereby irrevocably submit to the non-exclusive jurisdiction of the United States District Court for the Southern District of New York and any court in the State of New York located in the Borough of Manhattan, and any appellate court from any thereof, in any action, suit or proceeding brought against it and to or in connection with this Insurance Agreement, the Policy or any of the other Operative Documents or the Transaction or for recognition or enforcement of any judgment, and the parties hereto hereby irrevocably and unconditionally agree that all claims in respect of any such action or proceeding may be heard or determined in such New York court or, to the extent permitted by law, in such federal court. The parties hereto agree that a final unappealable judgment in any such action, suit or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner provided by law. To the extent permitted by applicable law, the parties hereto hereby waive and agree not to assert by way of motion, as a defense or otherwise in any such suit, action or proceeding, any claim that it is not personally subject to the jurisdiction of such courts, that the suit, action or proceeding is brought in an inconvenient forum, that the venue of the suit, action or proceeding is improper or that the related documents or the subject matter thereof may not be litigated in or by such courts. 37 (b) To the extent permitted by applicable law, the parties hereto shall not seek and hereby waive the right to any review of the judgment of any such court by any court of any other nation or jurisdiction which may be called upon to grant an enforcement of such judgment. (c) Service on the Depositor may be made by mailing or delivering copies of the summons and complaint and other process which may be served in any suit, action or proceeding to the Depositor addressed as follows: Bear Stearns Asset Backed Securities, Inc., 383 Madison Avenue, New York, New York 10179, Attention: General Counsel. Such address may be changed by the applicable party or parties by written notice to the other parties hereto. The provision of notice to change the address set forth in Section 6.02 shall constitute notice for purposes of the preceding sentence, unless such notice shall expressly state to the contrary. (d) Nothing contained in this Insurance Agreement shall limit or affect any party's right to serve process in any other manner permitted by law or to start legal proceedings relating to this Insurance Agreement, the Policy or any of the other Operative Documents against any other party or its properties in the courts of any jurisdiction. Section 6.07. Consent of the Certificate Insurer. In the event that the consent of the Certificate Insurer is required under this Insurance Agreement, the Policy or any of the other Operative Documents, the determination whether to grant or withhold such consent shall be made by the Certificate Insurer in its sole discretion without any implied duty towards any other Person, except as otherwise expressly provided therein, and such consent shall be effective only when and if given by the Certificate Insurer in writing. Section 6.08. Counterparts. This Insurance Agreement may be executed in counterparts by the parties hereto, and all such counterparts shall constitute one and the same instrument. Section 6.09. Headings. The headings of Articles and Sections and the Table of Contents contained in this Insurance Agreement are provided for convenience only. They form no part of this Insurance Agreement and shall not affect its construction or interpretation. Unless otherwise indicated, all references to Articles and Sections in this Insurance Agreement refer to the corresponding Articles and Sections of this Insurance Agreement. Section 6.10. Trial by Jury Waived. Each party hereby waives, to the fullest extent permitted by law, any right to a trial by jury in respect of any litigation arising directly or indirectly out of, under or in connection with this Insurance Agreement, the Policy or any of the other Operative Documents or any of the transactions contemplated thereunder. Each party hereto (A) certifies that no representative, agent or attorney of any party hereto has represented, expressly or otherwise, that it would not, in the event of litigation, seek to enforce the foregoing waiver and (B) acknowledges that it has been induced to enter into this Insurance Agreement, the Policy (in the case of the Certificate Insurer) and the other Operative Documents to which it is a party by, among other things, this waiver. Section 6.11. Limited Liability. No recourse under this Insurance Agreement, the Policy or any other Operative Document shall be had against, and no personal liability shall attach to, any officer, employee, director, 38 affiliate or shareholder of any party hereto, as such, by the enforcement of any assessment or by any legal or equitable proceeding, by virtue of any statute or otherwise in respect of any of the Operative Documents, it being expressly agreed and understood that this Insurance Agreement and each other Operative Document is solely a corporate obligation of each party thereto and hereto, and that any and all personal liability, either at common law or in equity, or by statute or constitution, of every such officer, employee, director, affiliate or shareholder for breaches of any party hereto of any obligations under any Operative Document is hereby expressly waived as a condition of and in consideration for the execution and delivery of this Insurance Agreement and the issuance of the Policy hereunder. Section 6.12. Entire Agreement. This Insurance Agreement, the Policy and the other Operative Documents set forth the entire agreement between the parties with respect to the subject matter hereof and thereof and supersede and replace any agreement or understanding that may have existed between the parties prior to the date hereof in respect of such subject matter. Section 6.13. Joint and Several Liability. Each of the representations, warranties, covenants and other agreements made by any of the Sellers in this Insurance Agreement are made by such party for it and on its own behalf. However, such agreements and all other obligations and other duties of HomeAmerican Credit, Inc. d/b/a Upland Mortgage, American Business Mortgage Services, Inc. and ABFS 2003-1, Inc. (collectively, the "ABFS Entities"), separately or together with ABC Inc., under this Insurance Agreement shall be joint and several obligations and duties of the ABFS Entities and ABC Inc., irrespective of any allocation of proceeds, rights or obligations between them and of any other matter. Without limiting the generality of the foregoing, each representation, warranty, covenant or other agreement designated in this Insurance Agreement as a representation, warranty, covenant or other agreement of the ABFS Entities, separately or together with ABC Inc., shall be a representation, warranty, covenant or other agreement of ABC Inc., jointly and severally with the ABFS Entities. ABC Inc. shall not exercise any right of subrogation as against the ABFS Entities until one year and one day after the Class M Certificates are no longer Outstanding, the Class M Certificateholders and the Certificate Insurer have indefeasibly been paid in full all amounts owing to them under the Class M Certificates, this Insurance Agreement and all other Operative Documents, have been fully satisfied, discharged and otherwise terminated and the security interest Granted under the P&S Agreement with respect to the collateral in the Trust Fund has been released in accordance therewith. If, prior to such time, any amount is paid by the ABFS Entities to ABC Inc., or is otherwise received by ABC Inc. on account of any such right of subrogation, such amount shall be held by it in trust for and shall be promptly be paid by it to the Trustee. 39 IN WITNESS WHEREOF, the parties hereto have executed this Agreement, all as of the day and year first above mentioned. RADIAN ASSET ASSURANCE INC., as Certificate Insurer By: Myer R. Strauss --------------------------------- Name: Myer R. Strauss Title: Vice President HOMEAMERICAN CREDIT, INC., d/b/a UPLAND MORTGAGE, as an Original Mortgage, as an Original Mortgage Loan Seller By: Jeffrey M. Ruben --------------------------------- Name: Jeffrey M. Ruben Title: EVP AMERICAN BUSINESS MORTGAGE SERVICES, INC., as an Original Mortgage Loan By: Jeffrey M. Ruben --------------------------------- Name: Jeffrey M. Ruben Title: EVP AMERICAN BUSINESS CREDIT, INC., as an Original Mortgage Loan Seller and as Servicer By: Beverly Santilli --------------------------------- Name: Beverly Santilli Title: President ABFS 2003-1, as Secondary Mortgage Loan Seller By: Jeffrey M. Ruben --------------------------------- Name: Jeffrey M. Ruben Title: EVP 40 BEAR STEARNS ASSET BACKED SECURITIES, INC., as Depositor By: Jonathan Lieberman --------------------------------- Name: Jonathan Lieberman Title: Senior Managing Director JPMORGAN CHASE BANK, not in its individual capacity but solely as Trustee, as Back-up Servicer and as Collateral Agent By: Joseph M. Costantino --------------------------------- Name: Joseph M. Costantino Title: Trust Officer 41 EX-10.102 6 ex10-102.txt EXHIBIT 10.102 AMENDED AND RESTATED COMMITTED LINE OF CREDIT NOTE $5,000,000 June 2, 2003 FOR VALUE RECEIVED, AMERICAN BUSINESS FINANCIAL SERVICES, INC. (the "Borrower"), with an address at 111 Presidential Boulevard, Bala Cynwyd, PA 19004, promises to pay to the order of FIRSTRUST SAVINGS BANK (the "Bank"), in lawful money of the United States of America in immediately available funds at its offices located at 4612 Street Road, Trevose, PA 19053, or at such other location as the Bank may designate from time to time, the principal sum of FIVE MILLION DOLLARS ($5,000,000) or such lesser amount as may be advanced to or for the benefit of the Borrower hereunder, together with interest accruing on the outstanding principal balance from the date hereof, as provided below: 1. Rate of Interest. Amounts outstanding under this Note will accrue interest at a per annum rate (the "Note Rate") equal to the LIBOR Rate (as hereinafter defined) plus the Applicable Margin, calculated on the basis of a year of 360 days for the actual number of days elapsed. As used herein: (i) "Applicable Margin" means: (A) 3.25 percentage points with respect to loan advances supported by the X Note and the R Note, and (B) 2.50 percentage points with respect to loan advances supported by the B Note, as each of those terms are defined in the Amendment No. 2 referred to in Section 7 hereof, provided that the interest rate hereon shall in no event be less than (A) 5.25% with respect to loan advances supported by the X Note and the R Note and (B) 4.50% with respect to loan advances supported by the B Note. (ii) "LIBOR Rate" means, for each calendar month on and after the date hereof and with respect to the principal outstanding hereunder during such calendar month, the interest rate per annum determined by the Bank by dividing (the resulting quotient rounded upwards, if necessary, to the nearest 1/100th of 1%) (a) the rate of interest determined by the Bank in accordance with its usual procedures (which determination shall be conclusive absent manifest error) to be the average of the one (1) month London inter-bank offered rates for U.S. Dollars quoted by the British Bankers' Association, or appropriate successor, as set forth on Dow Jones Markets Service (formerly known as Telerate) display page 3750 (or such other display page on the Dow Jones Markets Service system as may replace display page 3750), or if British Bankers' Association or its successor ceases to provide such quote, a comparable replacement rate determined by the Bank (which determination shall be conclusive absent manifest error), on the first day of such month by (b) a number equal to 1.00 minus the LIBOR Reserve Percentage; (iii) "Business Day" means a day on which commercial banks settle payments in U.S. dollars in New York City and London other than a Saturday or Sunday or a legal holiday on which commercial banks are authorized or required to be closed for business in New York, New York; and (iv) "LIBOR Reserve Percentage" shall mean the maximum effective percentage in effect on any day as prescribed by the Board of Governors of the Federal Reserve System (or any successor) for determining the reserve requirements (including, without limitation, supplemental, marginal and emergency reserve requirements) with respect to eurocurrency funding (currently referred to as "Eurocurrency liabilities"). Upon maturity, whether by acceleration, demand or otherwise, and at the Bank's option upon the occurrence of any Event of Default (as hereinafter defined) and during the continuance thereof, this Note shall bear interest at a rate per which shall be 2.5 percentage points in excess of the interest rate in effect from time to time under this Note but not more than the maximum rate allowed by law (the "Default Rate"). The Default Rate shall continue to apply whether or not judgment shall be entered on this Note. The Default Rate is imposed as liquidated damages for the purpose of defraying the Bank's expenses incident to the handling of delinquent payments, but is in addition to, and not in lieu of, the Bank's exercise of any rights and remedies hereunder, under other loan documents or under applicable law, and any fees and expenses of any agents or attorneys which the Bank may employ. In addition, the Default Rate reflects the increased credit risk to the Bank of carrying a loan that is in default. The Borrower agrees that the Default Rate is a reasonable forecast of just compensation for anticipated and actual harm incurred by the Bank, and that the actual harm incurred by the Bank cannot be estimated with certainty and without difficulty. If the Bank determines (which determination shall be final and conclusive) that, by reason of circumstances affecting the eurodollar market generally, deposits in dollars (in the applicable amounts) are not being offered to banks in the eurodollar market for the selected term, or adequate means do not exist for ascertaining LIBOR, then the Bank shall give notice thereof to the Borrower. Thereafter, until the Bank notifies the Borrower that the circumstances giving rise to such suspension no longer exist, (a) the availability of LIBOR shall be suspended, and (b) the interest rate for all amounts outstanding under this Note shall be immediately converted to a rate of interest per annum equal to the Bank's variable prime rate ("Prime Rate") as in effect from time to time at Bank as its prime rate, which rate is not necessarily the best or lowest rate which Bank makes available to its commercial customers. In addition, if, after the date of this Note, the Bank shall determine (which determination shall be final and conclusive) that any enactment, promulgation or adoption of or any change in any applicable law, rule or regulation, or any change in the interpretation or administration thereof by a governmental authority, central bank or comparable agency charged with the interpretation or administration thereof, or compliance by the Bank with any guideline, request or directive (whether or not having the force of law) of any such authority, central bank or comparable agency shall make it unlawful or impossible for the Bank to make or maintain or fund loans bearing interest based on LIBOR, the Bank shall notify the Borrower in writing. Ten Business Days after receipt of such notice, until the Bank notifies the Borrower that the circumstances giving rise to such determination no longer apply, (a) the availability of LIBOR shall be suspended, and (b) the interest rate on all amounts outstanding under this Note shall be converted to the Prime Rate either (i) as of the first day of the immediately preceding month if the Bank may lawfully continue to maintain amounts outstanding hereunder to such day at a rate of interest based on LIBOR, or (ii) immediately if the Bank may not lawfully continue to maintain amounts outstanding hereunder at a rate of interest based on LIBOR. -2- 2. Advances. The Borrower may borrow, repay and reborrow hereunder until the Expiration Date, subject to the terms and conditions of this Note and the Loan Documents (as defined herein). The "Expiration Date" shall mean January 14, 2004, or such later date as may be designated by the Bank by written notice from the Bank to the Borrower. The Borrower acknowledges and agrees that in no event will the Bank be under any obligation to extend or renew the Facility or this Note beyond the Expiration Date. In no event shall the aggregate unpaid principal amount of advances under this Note exceed the Facility Limit as set forth in the Loan Agreement referred to in Section 7 hereof. 3. Advance Procedures. A request for advance made by telephone or electronically must be promptly confirmed in writing by such method as the Bank may reasonably require. The Borrower authorizes the Bank to accept telephonic requests for advances, and the Bank shall be entitled to rely upon the authority of any person providing such instructions. The Borrower hereby indemnifies and holds the Bank harmless from and against any and all damages, losses, liabilities, costs and expenses (including reasonable attorneys' fees and expenses) which may arise or be created by the acceptance of such telephone requests or making such advances. The Bank will enter on its books and records, which entry when made will be presumed correct, the date and amount of each advance, as well as the date and amount of each payment made by the Borrower. 4. Payment Terms. Accrued interest will be due and payable on the first day of each month, beginning with the payment due on June 1, 2003. The outstanding principal balance and any accrued but unpaid interest shall be due and payable on the Expiration Date. If any payment under this Note shall become due on a Saturday, Sunday or public holiday under the laws of the State where the Bank's office indicated above is located, such payment shall be made on the next succeeding business day and such extension of time shall be included in computing interest in connection with such payment. Payments received will be applied to charges, fees and expenses (including reasonable attorneys' fees), accrued interest and principal in any order the Bank may choose, in its sole discretion. 5. Late Payments. If the Borrower fails to make any payment of principal, interest or other amount coming due pursuant to the provisions of this Note within 15 calendar days of the date due and payable, the Borrower also shall pay to the Bank a late charge equal to the lesser of two percent (2%) of the amount of such payment or $100.00 (the "Late Charge"). Such 15 day period shall not be construed in any way to extend the due date of any such payment. 6. Prepayment. The indebtedness evidenced by this Note may be prepaid in whole or in part at any time without penalty or notice. 7. Other Loan Documents. This Note is issued in connection with a loan agreement between the Borrower and the Bank dated January 18, 2002 (as amended from time to time, including by Amendment No. 2 of even date herewith, being herein called the "Loan Agreement"), and the other agreements and documents executed in connection therewith or referred to therein, the terms of which are incorporated herein by reference (as amended, modified or renewed from time to time, collectively the "Loan Documents"), and is secured by the property described in the Loan Documents (if any) and by such other collateral as previously may have been or may in the future be granted to the Bank to secure this Note. -3- 8. Events of Default. The occurrence of any of the following events will be deemed to be an "Event of Default" under this Note: (i) the nonpayment of any principal, interest or other indebtedness under this Note within two (2) Business Days when due; (ii) the occurrence of any event of default or default and the lapse of any notice or cure period under any Loan Document or any other debt, liability or obligation to the Bank of any Obligor; (iii) the filing by or against any Obligor of any proceeding in bankruptcy, receivership, insolvency, reorganization, liquidation, conservatorship or similar proceeding (and, in the case of any such proceeding instituted against any Obligor, such proceeding is not dismissed or stayed within 60 days of the commencement thereof, provided that the Bank shall not be obligated to advance additional funds during such period); (iv) any assignment by any Obligor for the benefit of creditors, or any levy, garnishment, attachment or similar proceeding is instituted against any property of any Obligor held by or deposited with the Bank; (v) a default with respect to any other indebtedness of any Obligor for borrowed money in excess of $1,000,000 in the aggregate, if the effect of such default is to cause or permit the acceleration of such debt; (vi) the commencement of any foreclosure or forfeiture proceeding, execution or attachment against any collateral securing the obligations of any Obligor to the Bank; (vii) the entry of a final judgment or judgements in excess of $1,000,000 in the aggregate against any Obligor and the failure of such Obligor to discharge the judgment within ten days of the entry thereof; (viii) [intentionally omitted]; (ix) any material adverse change in any Obligor's business, assets, operations, financial condition or results of operations; (x) any Obligor ceases doing business as a going concern; (xi) the revocation or attempted revocation, in whole or in part, of any guarantee by any Guarantor; (xii) the death, incarceration, indictment or legal incompetency of any individual Obligor or, if any Obligor is a partnership or limited liability company, the death, incarceration, indictment or legal incompetency of any individual general partner or member; (xiii) any representation or warranty made by any Obligor to the Bank in any Loan Document, or any other documents now or in the future evidencing or securing the obligations of any Obligor to the Bank, is false, erroneous or misleading in any material respect; or (xiv) any Obligor's failure to observe or perform any covenant or other agreement with the Bank contained in any Loan Document or any other documents now or in the future evidencing or securing the obligations of any Obligor to the Bank. As used herein, the term "Obligor" means any Borrower and any Guarantor, and the term "Guarantor" means any guarantor of the Borrower's obligations to the Bank existing on the date of this Note or arising in the future. Upon the occurrence of an Event of Default: (a) the Bank shall be under no further obligation to make advances hereunder; (b) if an Event of Default specified in clause (iii) or (iv) above shall occur, the outstanding principal balance and accrued interest hereunder together with any additional amounts payable hereunder shall be immediately due and payable without demand or notice of any kind; (c) if any other Event of Default shall occur, the outstanding principal balance and accrued interest hereunder together with any additional amounts payable hereunder, at the Bank's option and without demand or notice of any kind, may be accelerated and become immediately due and payable; (d) at the Bank's option, this Note will bear interest at the Default Rate from the date of the occurrence of the Event of Default; and (e) the Bank may exercise from time to time any of the rights and remedies available under the Loan Documents or under applicable law. -4- 9. Right of Setoff. In addition to all liens upon and rights of setoff against the Borrower's money, securities or other property given to the Bank by law, the Bank shall have, with respect to the Borrower's obligations to the Bank under this Note and to the extent permitted by law, a contractual possessory security interest in and a contractual right of setoff against, and the Borrower hereby assigns, conveys, delivers, pledges and transfers to the Bank all of the Borrower's right, title and interest in and to, all of the Borrower's deposits, moneys, securities and other property now or hereafter in the possession of or on deposit with, or in transit to, the Bank, whether held in a general or special account or deposit, whether held jointly with someone else, or whether held for safekeeping or otherwise, excluding, however, all IRA, Keogh, and trust accounts. Every such security interest and right of setoff may be exercised without demand upon or notice to the Borrower. Every such right of setoff shall be deemed to have been exercised immediately upon the occurrence of an Event of Default hereunder without any action of the Bank, although the Bank may enter such setoff on its books and records at a later time. 10. Miscellaneous. All notices, demands, requests, consents, approvals and other communications required or permitted hereunder must be in writing (except as may be agreed otherwise above with respect to borrowing requests) and will be effective upon receipt. Such notices and other communications may be hand-delivered, sent by facsimile transmission with confirmation of delivery and a copy sent by first-class mail, or sent by nationally recognized overnight courier service, to the addresses for the Bank and the Borrower set forth above or to such other address as either may give to the other in writing for such purpose. No delay or omission on the Bank's part to exercise any right or power arising hereunder will impair any such right or power or be considered a waiver of any such right or power, nor will the Bank's action or inaction impair any such right or power. No modification, amendment or waiver of any provision of this Note nor consent to any departure by the Borrower therefrom will be effective unless made in a writing signed by the Bank. The Borrower agrees to pay on demand, to the extent permitted by law, all costs and expenses incurred by the Bank in the enforcement of its rights in this Note and in any security therefor, including without limitation reasonable fees and expenses of the Bank's counsel. If any provision of this Note is found to be invalid by a court, all the other provisions of this Note will remain in full force and effect. The Borrower and all other Borrowers and indorsers of this Note hereby forever waive presentment, protest, notice of dishonor and notice of non-payment. The Borrower also waives all defenses based on suretyship or impairment of collateral. If this Note is executed by more than one Borrower, the obligations of such persons or entities hereunder will be joint and several. This Note shall bind the Borrower and its heirs, executors, administrators, successors and assigns, and the benefits hereof shall inure to the benefit of the Bank and its successors and assigns; provided, however, that the Borrower may not assign this Note in whole or in part without the Bank's written consent and the Bank at any time may assign this Note in whole or in part except that Bank may not assign it to any entity or person which it knows or reasonably should know is a competitor or Borrower. -5- This Note has been delivered to and accepted by the Bank and will be deemed to be made in the State where the Bank's office indicated above is located. THIS NOTE WILL BE INTERPRETED AND THE RIGHTS AND LIABILITIES OF THE BANK AND THE BORROWER DETERMINED IN ACCORDANCE WITH THE LAWS OF THE STATE WHERE THE BANK'S OFFICE INDICATED ABOVE IS LOCATED, EXCLUDING ITS CONFLICT OF LAWS RULES. The Borrower hereby irrevocably consents to the exclusive jurisdiction of any state or federal court in the county or judicial district where the Bank's office indicated above is located; provided that nothing contained in this Note will prevent the Bank from bringing any action, enforcing any award or judgment or exercising any rights against the Borrower individually, against any security or against any property of the Borrower within any other county, state or other foreign or domestic jurisdiction. The Borrower acknowledges and agrees that the venue provided above is the most convenient forum for both the Bank and the Borrower. The Borrower waives any objection to venue and any objection based on a more convenient forum in any action instituted under this Note. 11. WAIVER OF JURY TRIAL. THE BORROWER IRREVOCABLY WAIVES ANY AND ALL RIGHTS THE BORROWER MAY HAVE TO A TRIAL BY JURY IN ANY ACTION, PROCEEDING OR CLAIM OF ANY NATURE RELATING TO THIS NOTE, ANY DOCUMENTS EXECUTED IN CONNECTION WITH THIS NOTE OR ANY TRANSACTION CONTEMPLATED IN ANY OF SUCH DOCUMENTS. THE BORROWER ACKNOWLEDGES THAT THE FOREGOING WAIVER IS KNOWING AND VOLUNTARY. The Borrower acknowledges that it has read and understood all the provisions of this Note, including the waiver of jury trial, and has been advised by counsel as necessary or appropriate. WITNESS the due execution hereof as a document under seal, as of the date first written above, with the intent to be legally bound hereby. WITNESS / ATTEST: AMERICAN BUSINESS FINANCIAL SERVICES, INC. ____________________________________ By:_________________________________ (SEAL) Print Name:___________________________ Print Name:_________________________ Title:________________________________ Title:______________________________ -6- EX-10 7 ex10-103.txt EXHIBIT 10.103 Exhibit 10.103 AMENDMENT NUMBER ONE TO THE MASTER REPURCHASE AGREEMENT Dated as of November 13, 2002 Reference is made to the Master Repurchase Agreement dated as of November 16, 2001 (the "Master Repurchase Agreement") between Credit Suisse First Boston Mortgage Capital LLC (the "Buyer") and ABFS REPO 2001, Inc. (the "Seller"). Capitalized terms used herein but not defined herein shall have the meanings ascribed thereto in the Master Repurchase Agreement. Section 1. Amendment of the Master Repurchase Agreement. As of November 13, 2002, the Master Repurchase Agreement is hereby amended as follows: (a) Section 18(q) is hereby deleted in its entirety and replaced with the following: As of the end of any fiscal quarter, ABFS on a consolidated basis fails to maintain at all times a minimum Consolidated Stockholders' Equity in excess of the sum of (1) $50,000,000, plus (2) the aggregate amount equal to 50% of the aggregate net cash proceeds received by ABFS or any of its subsidiaries from the issuance of capital stock after June 30, 2002, plus (3) for each fiscal quarter ending after June 30, 2002, the aggregate amount equal to 60% of positive consolidated Net Income for such fiscal quarters, provided that if ABFS should incur a net loss for any fiscal quarter, the Consolidated Stockholders' Equity requirement hereunder will not be reduced from the amount required at the previous fiscal quarter end; and (b) Section 18(r) is hereby deleted in its entirety and replaced with the following: The ratio of ABFS's Total Liabilities to Consolidated Stockholders' Equity is greater than 16:1 as of the end of any fiscal quarter. ABFS shall fail to maintain at the end of any fiscal quarter at least $225,000,000 in Subordinated Debt with maturities of at least one year or greater and at least $350,000,000 of total Subordinated Debt. (c) Section 27 is hereby amended by deleting the reference to "November 14, 2002" and replacing it with "November 13, 2003". Section 2. Reference to and Effect on the Master Repurchase Agreement. 2.1 Upon the effectiveness of this Amendment Number One, each reference in the Master Repurchase Agreement to "this Agreement," "hereunder," "hereof," "herein," "hereby" or words of like import shall mean and be a reference to the Master Repurchase Agreement as amended hereby, and each reference to the Master Repurchase Agreement in other document, instrument and agreement executed and/or delivered in connection with Master Repurchase Agreement shall mean and be a reference to the Master Agreement as amended hereby. 2.2 Except as specifically amended hereby, the Master Repurchase Agreement and all other documents, instruments and agreements executed and/or delivered in connection therewith shall remain in full force and effect and are hereby ratified and confirmed. 2.3 The execution, delivery and effectiveness of this Amendment Number One shall not operate as a waiver of any right, power or remedy of any of the parties to the Master Repurchase Agreement or any other document, instrument, or agreement executed in connection therewith, nor constitute a waiver of any provision contained therein. 2.4 By execution of this Amendment Number One, both of the parties hereto hereby acknowledges that it has been notified of this Amendment Number One and consent to the execution thereof. Section 3. Representations. In order to induce the Buyer to execute and deliver this Amendment, the Seller hereby represents to the Buyer that as of the date hereof, after giving effect to this Amendment, the Seller is in full compliance with all of the terms and conditions of the Master Repurchase Agreement. Section 4. Governing Law. THIS AMENDMENT NUMBER ONE SHALL BE GOVERNED AND CONSTRUED IN ACCORDANCE WITH THE INTERNAL LAWS (AS OPPOSED TO THE CONFLICT OF LAW PROVISIONS) AND DECISIONS OF THE STATE OF NEW YORK. Section 5. Execution in Counterparts, This Amendment Number One may be executed in any number of Counterparts and by different parties hereto in separate counterparts, each of which when so executed and delivered shall be deemed to be an original and all of which taken together shall constitute but one and the same instrument. Section 6. Headings. Section headings in this Amendment Number One are included herein for convenience of reference only and shall not constitute apart of this Amendment Number One for any other purpose. [Remainder of Page Intentionally Left Blank] 2 IN WITNESS WHEREOF, the parties have executed this Amendment Number One as of the date first above written. ABFS REPO 2001, INC., as Seller By: /s/ Jeffrey M. Ruben --------------------------------- Name: Jeffrey M. Ruben Title: Executive Vice President CREDIT SUISSE FIRST BOSTON MORTGAGE CAPITAL LLC, as Buyer By: /s/ Anthony Giordano -------------------------------- Name: Anthony Giordano Title: Director Acknowledged and Agreed: AMERICAN BUSINESS CREDIT, INC. AMERICAN BUSINESS MORTGAGE as Guarantor SERVICES, INC., as Guarantor By: /s/ Beverly Santilli By: /s/ Jeffrey M. Ruben -------------------------- ------------------------------ Name: Beverly Santilli Name: Jeffrey M. Ruben Title: President Title: Executive Vice President HOMEAMERICAN CREDIT, INC., d/b/a AMERICAN BUSINESS FINANCIAL UPLAND MORTGAGE, as Guarantor SERVICES, INC., as Guarantor By: /s/ Jeffrey M. Ruben By: /s/ Beverly Santilli ------------------------- ------------------------------ Name: Jeffrey M. Ruben Name: Beverly Santilli Title: Executive Vice President Title: First Executive Vice President [Signature Page to the Amendment Number One] 3 EX-10 8 ex10-104.txt EXHIBIT 10.104 Exhibit 10.104 - -------------------------------------------------------------------------------- 3/31/03 AMENDMENT TO SENIOR SECURED CREDIT AGREEMENT dated as of March 31, 2003 by and among AMERICAN BUSINESS CREDIT, INC. and certain affiliates and JPMORGAN CHASE BANK, as Agent and as a Lender, and the other Lender(s) parties hereto amending (for the third time) the 3/02 Senior Secured Credit Agreement dated as of March 15, 2002, as supplemented by the 10/02 Letter of Credit Supplement to Senior Secured Credit Agreement, and as previously amended by the 12/02 Amendment and the 3/03 Amendment, all among such parties - -------------------------------------------------------------------------------- TABLE OF CONTENTS 1. DEFINITIONS...............................................................2 7. COLLATERAL................................................................3 8. CONDITIONS PRECEDENT......................................................3 9. REPRESENTATIONS...........................................................3 10. AFFIRMATIVE COVENANTS.....................................................3 11. NEGATIVE COVENANTS........................................................4 12. DEFAULTS AND REMEDIES.....................................................5 16. MISCELLANEOUS.............................................................6 i INDEX OF DEFINED TERMS 3/02 Credit Agreement..........................................................1 3/31/03 Amendment..............................................................1 3/31/03 Amendment Effective Date...............................................2 ABC............................................................................1 ABFRS2002......................................................................1 ABMS...........................................................................1 Acceleration Date..............................................................3 Agent..........................................................................1 Agreement......................................................................1 Amended Credit Agreement.......................................................1 Chase..........................................................................1 Companies......................................................................1 Company........................................................................1 Current Credit Agreement.......................................................1 HAC............................................................................1 Lease..........................................................................2 Maturity Date..................................................................3 Parent.........................................................................1 Serviced Leases................................................................2 Servicing Agreement............................................................2 Total Delinquency Rate.........................................................2 TRC............................................................................1 ii 3/31/03 AMENDMENT TO SENIOR SECURED CREDIT AGREEMENT Preamble This 3/31/03 Amendment to the Senior Secured Credit Agreement dated as of March 31, 2003 (the "3/31/03 Amendment") amending the 3/02 Amended and Restated Senior Secured Credit Agreement dated March 15, 2002 (the "3/02 Credit Agreement", as supplemented by the 10/02 Supplement, as amended by the 12/02 Amendment and the 3/03 Amendment, as amended hereby and as it may be further supplemented, further amended or restated from time to time, the "Current Credit Agreement" or, within itself, this "Agreement"), among: AMERICAN BUSINESS CREDIT, INC. ("ABC"), a Pennsylvania corporation, HOMEAMERICAN CREDIT, INC. ("HAC"), a Pennsylvania corporation doing business under the assumed or fictitious name Upland Mortgage, and AMERICAN BUSINESS MORTGAGE SERVICES ("ABMS"), a New Jersey corporation formerly named New Jersey Mortgage & Investment Corp., Inc., TIGER RELOCATION COMPANY ("TRC"), a Pennsylvania corporation formerly named ABC Holdings Corporation, and ABFS Residual 2002, Inc. ("ABFSR2002"), each with its principal office at BalaPointe Office Centre, 111 Presidential Boulevard, Suite 215, Bala Cynwyd, Pennsylvania 19004 (ABC, HAC, ABMS, TRC, and ABFSR2002 are herein collectively the "Companies" and are sometimes individually referred to as a "Company"); AMERICAN BUSINESS FINANCIAL SERVICES, INC. (the "Parent"), a Delaware corporation and owner of all of the capital stock of ABFSR2002, and all of the capital stock of ABC which owns all of the capital stock of each of the other Companies; JPMORGAN CHASE BANK ("Chase"), a New York banking corporation, acting herein as a Lender and as agent and representative of the Lenders and Eligible Assignees (in that capacity, Chase is called the "Agent"); and such other Lender(s) as may from time to time be party to the Current Credit Agreement; recites and provides as follows: Recitals The parties wish to amend the 3/02 Credit Agreement, as supplemented by the 10/02 Supplement and amended by the 12/02 Amendment and the 3/03 Amendment (as so supplemented and amended, the "Amended Credit Agreement") to extend the maturity of the facility to December 22, 2003 and to revise and expand its covenants and its defaults and remedies provisions. 1 All capitalized terms defined in the Amended Credit Agreement and used but not defined differently in this Amendment have the same meanings here as there. The Sections of this 3/31/03 Amendment are numbered to correspond with the numbers of the Sections of the 3/02 Credit Agreement and are consequently nonsequential. Agreements In consideration of the premises, the mutual agreements stated below and other good and valuable consideration paid by each party to each other party to this Agreement, the receipt and sufficiency of which each party hereby acknowledges, the parties hereby agree as follows: 1. DEFINITIONS 1.2 Definitions of General Application. This Section is hereby amended as follows: A. The following definitions are hereby added to Section 1.2, in alphabetical order: "3/31/03 Amendment" means the 3/31/03 Amendment to Senior Secured Credit Agreement dated as of March 31, 2003. "3/31/03 Amendment Effective Date" is defined in the 3/31/03 Amendment (to mean March 31, 2003.) "Lease" means an equipment lease agreement between a lessor and a lessee for a commercial purpose only, whether or not a true lease. "Serviced Leases" means all Leases serviced or required to be serviced by a Company under any Servicing Agreement, irrespective of whether the actual servicing is done by another Person (a subservicer) retained by the Company for that purpose. "Total Delinquency Rate" means (x) the total delinquencies (Mortgage Loans and Leases with at least one payment past due for thirty (30) days or more, excluding REO) in the Companies' total (managed and owned) portfolio of Serviced Loans and Serviced Leases, expressed as a percentage of (y) the aggregate amount of such total portfolio. B. The definition of "Servicing Agreement set forth in Section 1.2 is hereby amended in its entirety to henceforth read as follows: "Servicing Agreement" means, with respect to any Person, the arrangement--whether or not in writing--pursuant to which that Person acts as servicer of Mortgage Loans or Leases, whether owned by that Person or by others. 2 C. The definition of "Maturity Date" set forth in Section 1.2 (as amended) is hereby reamended in its entirety to henceforth read as follows: "Maturity Date" means December 22, 2003, or the earlier date (the "Acceleration Date"), if any, to which maturity of the Senior Credit Notes is accelerated pursuant to this Agreement, by order of any Governmental Authority or by operation of law. 7. COLLATERAL 7.1 Grant of Security Interest. The provisions of Section 7 of the 3/02 Credit Agreement are not amended hereby. Cumulative of such existing provisions, as security for the payment of the Loan and for the payment and performance of all of the Obligations, each Companies hereby GRANTS to the Agent, as agent and representative of the Lenders, a first priority security interest in all of such Company's present and future estate, right, title and interest in and to the Collateral, in addition to and cumulative of the security interest in the Collateral granted in the 3/02 Credit Agreement, the 12/02 Amendment and the 3/03 Amendment, and the security interest in the Collateral granted in the Security Agreement-Class R Certificate, as amended, and the parties hereby declare and confirm that all such security interests were and are granted to and held by the Agent as agent and representative of the Lenders, including Chase. 8. CONDITIONS PRECEDENT Section 8 of the 3/02 Credit Agreement is hereby amended by adding the following new Section 8.6: 8.6 Each Advance on or after the 3/31/03 Amendment Effective Date. The obligations of the Lenders to fund their respective Funding Shares of each Advance requested on or after the 3/31/03 Amendment Effective Date are also subject to the condition precedent that the Agent shall have received the following, all of which must be satisfactory in form and content to the Agent in its sole discretion: (a) The 3/31/03 Amendment duly executed by all parties; and (b) such other documents, if any, as shall be specified by the Agent. 9. REPRESENTATIONS The Companies and the Parent hereby republish all of their representations and warranties made in the 3/02 Credit Agreement. 10. AFFIRMATIVE COVENANTS Section 10.2(b) of the 3/02 Credit Agreement is hereby amended to read as follows: (b)As soon as available and in any event within sixty (60) days after the close of each of the first three (3) fiscal quarters in each of its fiscal years, statements of income, statements of cash flow, and 3 statements of changes in its stockholders' equity and cash flows of the Parent and its Subsidiaries on a consolidating and consolidated basis for the period from the beginning of such fiscal year to the end of such fiscal quarter, and the related balance sheet as at the end of such fiscal quarter, all in reasonable detail, with all notes and certified by its chief financial officer that, to the best of his or her knowledge, such financial statements were prepared in accordance with GAAP and present fairly the financial condition and the results of operations and cash flows for the period covered, subject, however, to year-end audit adjustments and the omission of footnotes. New Sections 10.4(l) and 10.4(m) reading, respectively, as follows are hereby added to the end of Section 10.4: (l) Monthly, a repurchase activity report detailing activity related to Repurchased Defaulted Mortgage Loans, in a form acceptable to the Agent. (m) Monthly, a residual interest summary report listing, by securitization trust, the cash flows from the Companies' residual interests in Mortgage Loan pools that have been securitized, in a form acceptable to the Agent. 11. NEGATIVE COVENANTS Sections 11.4, 11.5, 11.7, 11.8, and 11.10 of the 3/02 Credit Agreement are hereby amended to read as follows: 11.4. The Parent's Debt to Adjusted Net Worth Ratio. The Parent will not permit the ratio of Debt (excluding nonrecourse Debt whether under repurchase agreements or otherwise) to the sum of (x) GAAP Net Worth plus (y) that portion of Subordinated Debt not due before the Maturity Date, of the Parent and its Subsidiaries, on a consolidated basis, to exceed 4.00:1.00 as at the end of any of the Company's fiscal quarters or fiscal years. 11.5. The Parent's Minimum Liquidity. The Parent will at all times maintain at least Thirty-five Million Dollars ($35,000,000) in (x) unrestricted cash and Cash Equivalents that is owned and held free and clear of Liens other than bankers' liens or setoff rights against cash on deposit with the Agent or another depositary institution and the Agent's or another warehouse lender's Lien and (y) Eligible Single-family Collateral owned by the Parent or one of the Companies and that is either unpledged or, if Pledged to the Agent or pledged to another warehouse lender (or that has been delivered to a warehousing repurchase agreement counterparty) against which no borrowing is outstanding (or that has not been purchased by such repurchase agreement counterparty). 11.7. The Parent's Minimum Adjusted Tangible Net Worth. As of the end of any fiscal quarter, permit the Adjusted Tangible Net Worth of the Parent (on a consolidated basis with its Subsidiaries) to be less than Three Hundred Million Dollars ($300,000,000). 4 11.8. The Parent's Minimum Subordinated Debt and Limit on Current Subordinated Debt. The Parent will maintain Subordinated Debt of at least Five Hundred Million Dollars ($500,000,000) at all times, but the Parent will not on any day permit Subordinated Debt principal that will become due (whether as scheduled installment payments, calls, mandatory prepayments, as a result of acceleration or by any other means or for any other reason) within one (1) year of that day to exceed sixty-five percent (65%) of the aggregate principal amount of all of the Parent's Subordinated Debt on that day. 11.10. The Parent's Minimum GAAP Net Worth. As of the end of any fiscal quarter, permit the GAAP Net Worth of the Parent (on a consolidated basis with its Subsidiaries) to be less than Sixty-five Million Dollars ($65,000,000). Section 11.12, as added by the 12/02 Amendment (the numbering of the new Section added to Section 11 by the 12/02 Amendment is hereby corrected to be 11.12 instead of 11.11 as stated in the 12/02 Amendment) is hereby amended to read as follows: 11 .12. Repurchased Mortgage Loans Limitation. The Companies will not own on any day Repurchased Defaulted Mortgage Loans (including both those Pledged to the Agent and those not Pledged to the Agent) having aggregate outstanding principal balances of more than one and one-half percent (1.5%) of the sum of the aggregate outstanding principal balances of the Companies' managed and owned portfolio of Serviced Loans and Serviced Leases. New Sections 11.13 and 11.14 reading, respectively, as follows are hereby added to the end of Section 11: 11.13. Total Delinquency Rate Limitation. The Companies will not permit the Total Delinquency Rate as of the end of any calendar quarter to exceed nine and three-fourths percent (9.75%). 11.14. Minimum Cash Flows from Securitization Trusts. The Parent and the Companies will not permit the actual aggregate cash flows received in any calendar quarter from all of the Parent's and the Companies' residual interests in Mortgage Loan pools that have been securitized (described in the Parent's SEC Form 10-K as the excess or residual cash flows and cash flows from overcollateralization received by the Companies as holders of interest-only strips) to be less than the sum of (x) the average of the cash flows from all such residual interests for the immediately preceding four (4) quarters plus (y) $1. 12. DEFAULTS AND REMEDIES Section 12 of the 3/02 Credit Agreement is hereby amended by adding the following new Section 1.1(p) to the end of such Section: 5 (p) Any occurrence or event (a "trigger event") occurs under the relevant Pooling and Servicing Agreement after which the cash flow to the Parent or any Company (whichever is the owner of such residual interest) from any residual interest in Mortgage Loan pools that have been securitized is interrupted, and such trigger event remains uncured for ninety (90) days. 16. MISCELLANEOUS The parties hereby ratify and confirm the Current Credit Agreement (being the 3/02 Credit Agreement, as supplemented by the 10/02 Supplement, as amended by the 12/02 Amendment and the 3/03 Amendment and as amended hereby). The Parent hereby ratifies the Guaranty and confirms that (i) the Guaranty is and remains in full force and effect and (ii) the Parent, as primary obligor and not as a surety, unconditionally guarantees to the Lenders and the Agent the full, prompt and punctual payment of the Loan when due (whether at its stated maturity, by acceleration or otherwise) in accordance with the terms and provisions of the Current Credit Agreement, the Notes and the other Credit Papers, and that such guaranty obligation is not and shall not be impaired, diminished or otherwise affected in any way adverse to the Agent or the Lenders by this Amendment or any act or transaction contemplated hereby, and the Parent hereby irrevocably consents to this Amendment. 16.10 Notice Pursuant to Tex. Bus. & Comm. Codess.26.02. This Section is hereby amended to read as follows: THE 3/02 CREDIT AGREEMENT, AS SUPPLEMENTED BY THE 10/02 SUPPLEMENT, AS AMENDED BY THE 12/02 AMENDMENT AND THE 3/03 AMENDMENT AND AS AMENDED HEREBY, AND THE OTHER FACILITIES PAPERS TOGETHER CONSTITUTE A WRITTEN LOAN AGREEMENT WHICH REPRESENTS THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES. (The remainder of this page is blank; unnumbered counterpart signature pages follow.) 6 EXECUTED as of March 31, 2003. By the Companies: AMERICAN BUSINESS CREDIT, INC. By: Beverly Santilli -------------------------------------- Name: Beverly Santilli Title: President HOMEAMERICAN CREDIT, INC., doing business as UPLAND MORTGAGE By: Jeffrey M. Ruben -------------------------------------- Name: Jeffrey M. Ruben Title: EVP AMERICAN BUSINESS MORTGAGE SERVICES, INC. By: Jeffrey M. Ruben -------------------------------------- Name: Jeffrey M. Ruben Title: EVP TIGER RELOCATION COMPANY By: Jeffrey M. Ruben -------------------------------------- Name: Jeffrey R. Ruben Title: EVP ABFS RESIDUAL 2002, INC. By: Jeffrey M. Ruben -------------------------------------- Name: Jeffrey M. Ruben Title: EVP By the Parent/Guarantor: AMERICAN BUSINESS FINANCIAL SERVICES, INC. By: Jeffrey M. Ruben -------------------------------------- Name: Jeffrey M. Ruben Title: EVP By the Agent and a Lender: JPMORGAN CHASE BANK, as the Agent and as a Lender By: Michael W. Nicholson -------------------------------------- Name: Michael W. Nicholson Title: Senior Vice President Unnumbered counterpart signature page to 3/31/03 Amendment to Senior Secured Credit Agreement among American Business Credit Inc. and certain affiliates and JPMorgan Chase Bank, as Agent and as a Lender. EX-10 9 ex10-105.txt EXHIBIT 10.105 Exhibit 10.105 12/02 AMENDMENT TO 3/02 SECURITY AGREEMENT - RESIDUAL INTEREST CERTIFICATES This 12/02 Amendment to the Security Agreement dated as of December 18, 2002 (the "12/02 Security Agreement Amendment") amending the 3/02 Security Agreement - Residual Interest Certificates ("3/02 Security Agreement") dated March 15, 2002, as amended hereby and as it may be further amended, supplemented or restated from time to time, the "Current Security Agreement", or within itself this "Agreement"), made by ABFS RESIDUAL 2002, INC. ("ABFSR2002" or "Debtor"), a Delaware corporation, in favor of JPMORGAN CHASE BANK ("Chase" or "Secured Party"), as secured party, recites and provides as follows. Recitals ABFSR2002, AMERICAN BUSINESS CREDIT, INC. ("ABC"), a Pennsylvania corporation, HOMEAMERICAN CREDIT, INC. ("HAC"), a Pennsylvania corporation doing business as UPLAND MORTGAGE, AMERICAN BUSINESS MORTGAGE SERVICES, INC., a New Jersey corporation, and TIGER RELOCATION COMPANY ("TRC"), a Pennsylvania corporation ("TRC" and collectively with ABFSR2002, ABC, HAC and ABMS, "Borrowers") wish to amend the 3/02 Security Agreement and as it may be supplemented, amended or restated from time to time, to provide for an additional Class R Certificate to be Pledged to the Agent as collateral. It is a condition precedent to the obligation of the Lenders to extend credit to the Borrowers under the Current Credit Agreement that Debtor shall have entered into this Agreement. All capitalized terms defined in the 3/02 Security Agreement and used but not defined differently in this 12/02 Security Agreement Amendment have the same meanings here as there. The Sections of this 12/02 Security Agreement Amendment are numbered to correspond with the numbers of the Sections of the 3/02 Security Agreement and are consequently nonsequential. Agreements In consideration of the premises, the mutual agreements stated below and other good and valuable consideration paid by each party to each other party to this Agreement, the receipt and sufficiency of which each party hereby acknowledges, the parties hereby agree as follows, Section 3. Grant of Security interest Section 3(a) of the 3/02 Security Agreement is hereby amended to read as follows: (a) The ABFS Mortgage Loan Trust 1997-2 Mortgage Pass-Through Certificate dated September 29, 1997, Certificate No. R-1 (the "1997-2 Residual Interest Certificate"), issued in respect of the Pooling and Servicing Agreement dated as of September 1, 1997 by and among American Business Credit, Inc., as servicer, Prudential Securities Secured Financing Corporation, a Delaware corporation, as depositor, and Chase (which was then named The Chase Manhattan Bank), as trustee, issued by such trustee to ABFS 1997-2, Inc., representing a one hundred percent (100%) Percentage Interest (as defined in such Pooling and Servicing Agreement) of the related interest in ABFS Mortgage Loan Trust 1997-2 existing under the laws of the State of New York and created pursuant to said Pooling and Servicing Agreement, and (ii) the ABFS Mortgage Loan Trust 1998-3 Mortgage Pass-Through Certificate dated September 29, 1998, Certificate No. R-1 (the "1998-3 Residual Interest Certificate") issued in respect of the Pooling and Servicing Agreement dated as of September 1, 1998 by and among American Business Credit, Inc., as servicer, Prudential Securities Secured Financing Corporation, a Delaware corporation, as depositor, and Chase (which was then named The Chase Manhattan Bank), as trustee, issued by such trustee to ABFS 1998-3, Inc., representing a one hundred percent (100%) Percentage Interest (as defined in such Pooling and Servicing Agreement) of the related interest in ABFS Mortgage Loan Trust 1998-3 existing under the laws of the State of New York and created pursuant to said Pooling and Servicing Agreement, and (iii) the ABFS Mortgage Loan Trust 1998-1 Mortgage Pass-Through Certificate dated March 12, 1998, Certificate No. R-1 (the "1998-1 Residual Interest Certificate" and, collectively with the 1997-2 Residual interest Certificate and the 1998-3 Residual Interest Certificate, the "Residual Interest Certificates"), issued in respect of the Pooling and Servicing Agreement dated February 1, 1998 by and among American Business Credit, Inc., as servicer, Prudential Securities Secured Financing Corporation, a Delaware corporation, as depositor, and The Chase Manhattan Bank (Chase's merger predecessor), as trustee, issued by such trustee to ABFS 1998-1, Inc., representing a one hundred percent (100%) Percentage Interest (as defined in such Pooling and Servicing Agreement) of the related interest in ABFS Mortgage Loan Trust 1998-1 existing under the laws of the State of New York and created pursuant to said Pooling and Servicing Agreement, a copy of such certificates being attached as Exhibit A to this Security Agreement and hereby incorporated herein, and all existing and future ownership interests evidenced thereby or described therein in first and second lien closed-end mortgage loans (the "Mortgage Loans") serviced by American Business Credit, Inc. in its capacity as servicer (the "Servicer") under such Pooling and Servicing Agreements dated as of September 1, 1997, February 1, 1998, and September 1, 1998 (the "Pooling and Servicing Agreements"), whether such ownership interests (1) are now or hereafter in the form of, or represented by, one of the Residual Interest Certificates or other securities (whether definitive certificated securities, certificated securities traded in book-entry form or book-entry securities), (2) are now or hereafter in another form of investment property (as defined In Section 9.102(a)(49) of the UCC) or (3) simply constitute an account, a payment intangible, a general intangible or a contract right, and including, without limitation, all securities, investment property, accounts, payment intangibles, general intangibles and contract rights that (x) from time to time have, been or are delivered or intended to be delivered or negotiated to Secured Party or to a bailee, financial intermediary of securities intermediary for Secured Party by or on behalf of a Debtor, or over which Secured Party from time to time obtains control, whether or not the item is described, designated or referred to in a written notice from a Debtor to Secured Party identifying it as part of the Collateral of this Security Agreement and (y) comprise all or part 2 of the equity class or tranche of Mortgage Securities created in whole or in part from a pool or pools of mortgage loans, however the same may be designated (i.e., whether as a "Class R Certificate" or otherwise), and all interest on, all rights to receive distributions of or in respect of, renewals and extensions of, all substitutions for and all general intangibles arising in respect of such securities, other types of investment securities, general intangibles or contract rights, irrespective of whether they are in uncertificated or certificated form; Section 5. Representations and Warranties The Companies hereby republish all of their representations and warranties made in the 3/02 Security Agreement. The remainder of this page is intentionally blank; unnumbered counterpart signature pages follow. 3 IN WITNESS WHEREOF, Debtor and Secured Party have caused this Agreement to be executed by their duly authorized offices on the date first set forth above. ABFS RESIDUAL 2002, INC. By: Jeffrey M. Ruben ----------------------------------- Name: Jeffrey M. Ruben --------------------------------- Title: Executive Vice President -------------------------------- ABC joins in execution hereof to make the agreement set forth in Section 6(k) of the 3/02 Security Agreement. AMERICAN BUSINESS CREDIT, INC. By: Jeffrey M. Ruben ----------------------------------- Name: Jeffrey M. Ruben --------------------------------- Title: Executive Vice President -------------------------------- Unnumbered counterpart signature page to 12/02 Security Agreement Amendment dated December 19, 2002 from ABFS Residual 2002, Inc. to JPMorgan Chase Bank, as agent and representative of certain lenders EX-10 10 ex10-106.txt EXHIBIT 10.106 Exhibit 10.106 JPMORGAN CHASE BANK 707 Travis, 6th Floor North Houston, Texas 11002 August 14, 2003 American Business Financial Services, Inc. The Wanamaker Building 100 Penn Square East Philadelphia, PA 19107 Attention: Mr. Jeffrey Ruben Gentlemen and Ladies: This Commitment Letter is intended to set forth the results of discussions between JPMorgan Chase Bank ("JPM") and American Business Financial Services, Inc. ("ABFS") relating to the proposed secured mortgage warehouse facility (the "Facility") provided by JPM. Subject to the satisfaction of the conditions set forth in this Commitment Letter, JPM commits to make the loan (the "Loan") and provide the Facility contemplated hereby to ABFS and ABFS, commits to have a bankruptcy remote business trust, wholly owned by ABFS, borrow such Loan. Capitalized terms used herein and not otherwise defined herein have the meaning assigned to them in the "Summary of Terms and Conditions" attached hereto. 1. Principal Terms and Standard Conditions. The principal terms of the Facility are set forth in the Summary of Terms and Conditions. The Summary of Terms and Conditions are incorporated by reference herein for all purposes and deemed part of this Commitment Letter. 2. General Understanding. ABFS and JPM each covenants to act in good faith to do all things reasonably required to consummate the closing of the Facility. ABFS will cooperate and use best efforts to promptly supply JPM with all due diligence materials requested by JPM and prepare or cause to be prepared documents relating to the Facility. ABFS acknowledges that JPM has set forth in this Commitment Letter the terms and conditions upon which it is willing to provide the Facility based upon ABFS oral or written representations regarding itself and the Eligible Collateral and prior to its own due diligence investigation. If, as a result of JPM's own due diligence investigation, JPM's findings are inconsistent with ABFS's oral or written representations, JPM may terminate its obligations under this Commitment Letter. On the closing date, (a) the value and condition of the Eligible Collateral, the financial statements of ABFS and all other features of the transaction shall be as represented in the documents and communications presented to JPM in order to induce JPM to enter into the Commitment Letter; (b) the condition of the Eligible Collateral, the economy and the capital markets shall be without material adverse change, in all cases, JPM shall have no obligation to close the Facility under this Commitment Letter. 1 3. Expiration Date. If the Facility does not close on or prior to September 15, 2003 (as such date may be extended, the "Commitment Expiration Date"), this Commitment Letter will be deemed terminated and JPM shall have no further obligations hereunder unless JPM otherwise elects in writing to extend the Commitment Expiration Date. 4. Confidentiality. Except to the extent required by law, ABFS agrees not to disclose, and to cause its officers, directors, employees and agents not to disclose, this Commitment Letter, any of the terms, conditions, or other facts relating to the Facility, including the status thereof, or the fact that discussions or negotiations are taking place concerning the Facility, to any person other than its attorneys and other advisors who need to know such information for the purpose of causing the consummation of the Facility. Notwithstanding anything to the contrary contained herein or in the Summary of Terms and Conditions, all persons may disclose to any and all persons, without limitation of any kind, the federal income tax treatment of the Facility, any fact relevant to understanding the federal tax treatment of the Facility, and all materials of any kind (including opinions or other tax analyses) relating to such federal income tax treatment; provided, that no person may disclose the name of or identifying information with respect to any party identified herein or in the Summary of Terms and Conditions or any pricing terms or other nonpublic business or financial information (including Wet Sublimits and Financial Covenants) that is unrelated to the purported or claimed federal income tax treatment of the transaction without the prior consent of JPM. The terms set forth herein are proprietary to JPM and are made available to ABFS solely for the evaluation of the Facility. Oral or written disclosure of this Commitment Letter to any competitor of JPM shall be detrimental to JPM and shall be an explicit violation of this paragraph. The obligations of ABFS under this paragraph shall survive the Commitment Expiration Date. 5. Expenses. ABFS hereby agrees to pay or to reimburse JPM, upon demand, whether or not the Facility is consummated, the out-of-pocket expenses (collectively, the "Expenses") incurred by JPM in connection with the preparation of the Facility, as more particularly described in the Summary of Terms and Conditions. 6. Indemnification. ABFS agrees to indemnify and hold harmless JPM and each director, officer, employee, affiliate and agent thereof (each, an "indemnified person") against, and to reimburse each indemnified person, upon its demand, for, any losses, claims, damages, liabilities or other expenses ("Losses") to which such indemnified person may become subject insofar as such Losses arise out of or in any way relate to or result from this Commitment Letter or the Facility contemplated hereby, including, without limitation, Losses consisting of legal or other expenses incurred in connection with investigating, defending or participating in any legal proceeding relating to any of the foregoing (whether or not such indemnified person is a party thereto); provided that the foregoing will not apply to any Losses to the extent they result are found by a final decision of a court of competent jurisdiction to have resulted from the gross negligence or willful misconduct of such indemnified person. ABFS's obligations under this paragraph shall remain effective whether or not definitive facility documentation is executed and notwithstanding any termination of this Commitment Letter. Neither JPM nor any other indemnified personal shall be responsible or liable to any other person for consequential damages, which may be alleged as a result of this Commitment Letter or the Facility contemplated hereby. 2 7. Miscellaneous. (a) By ABFS's execution and delivery below, ABFS hereby represents, warrants, covenants and agrees that: (i) it has the power and authority to enter into this Commitment Letter; (ii) no other party has a right of refusal or other option which could cause the Facility not to be consummated; and (iii) neither ABFS nor any of their affiliates or principals have been a party to any bankruptcy, insolvency or similar proceedings. (b) ABFS will have no right to assign this Commitment Letter or any of its rights or obligations hereunder. (c) This Commitment Letter shall be governed by and construed and interpreted in accordance with the internal laws of the State of New York. Each party hereto hereby submits to the exclusive jurisdiction of the courts of the State of New York for any legal action or proceeding resulting from the transaction contemplated herein. (d) EACH PARTY HERETO HEREBY WAIVES ITS RIGHT TO A TRIAL BY JURY. (e) This Commitment Letter is intended for the benefit of the parties hereto and their respective affiliates and not for the benefit of any third parties. (f) No amendment or modification to this Commitment Letter will be effective unless evidenced by a writing executed by all the parties hereto. (g) This Commitment Letter contains the entire agreement of the parties hereto in respect of the transactions contemplated hereby and all prior agreements, understandings and negotiations among or between such parties, whether oral or written, are superseded by the terms of this Commitment Letter. [SIGNATURES COMMENCE ON FOLLOWING PAGE] 3 Please indicate your agreement to the above by executing a copy of this Commitment Letter in the place provided below and returning a fully executed copy to the undersigned. This Commitment Letter shall not be effective unless executed by both JPM and ABFS on or prior to September 15, 2003 unless extended in writing by JPM in its sole discretion. Very truly yours, JP MORGAN CHASE BANK By: /s/ Michael W. Nicholson ----------------------------------------- Name: Michael W. Nicholson Title Senior Vice President Agreed and Accepted as of this 14th day of August, 2003: AMERICAN BUSINESS FINANCIAL SERVICES, INC. By: /s/ Stephen Giroux - ------------------------------------------------ Name: Stephen Giroux Title: Vice President and General Counsel 4 Confidential [a Delaware business trust to be determined]. - -------------------------------------------------------------------------------- SUMMARY OF TERMS AND CONDITIONS ------------------------------- This is a summary of indicative terms and conditions (the "Term Sheet") solely for discussion purposes. The Term Sheet is not a commitment by JPM to provide the Facility (as defined below). Any commitment will be in the form of a commitment letter, which may contain further or different terms from those set forth below, depending on the outcome of due diligence, the credit review process and negotiations with Borrower and Guarantor (as defined below). Borrower and Guarantor are advised to make an independent review and reach their own conclusions regarding the legal, tax and accounting aspects of the terms outlined herein. Subject to, among other things, satisfactory due diligence, credit approval, documents, filings and opinions acceptable to counsel, JPM would be prepared to consider providing the Facility on the indicative terms set forth herein. BORROWER: A bankruptcy-remote Delaware business trust wholly owned by ABFS SERVICER: American Business Financial Services ("ABFS"). The Servicer is subject to renewal every 60 days by the Agent with a minimum of 30 days notice of termination. PARTIAL GUARANTOR: American Business Financial Services ("ABFS"). The Guarantor shall unconditionally guarantee 10% of the aggregate outstanding amount due under the Facility. LENDER: JPMorgan Chase Bank COLLATERAL AGENT: JPMorgan Chase Bank ("JPM") or ("Agent") FACILITY: $200,000,000 Secured, Mortgage Warehouse Facility (the "Facility" or "Total Facility Amount"). MATURITY: 364 days from closing. PURPOSE: To warehouse conforming and nonconforming first and second lien mortgage loans secured primarily by residential mortgages, for which the Collateral Agent has received documents until they are sold into the secondary market (whether through securitization or through direct cash sales to Investors). The amount available for Wet Sublimit is available to finance those mortgage loans which have closed and funded at or by title companies and whose documents are in transit to the Collateral Agent. Loan documents are to be delivered to the Collateral Agent within five business days. Once the loans have been received by the Collateral Agent, they will be moved from the Wet Sublimit to the regular warehouse line. ELIGIBLE COLLATERAL: GENERAL COLLATERAL RESTRICTIONS o No mortgage loan that is delinquent 60 days or more at any time will be included o No mortgage loan that is delinquent 30 days or more, at the Original Pledge Date under this Facility, shall be included o Each first lien mortgage loan has been pledged for 90 days or less from the Original Pledge Date, except for an aggregate amount not to exceed 10% of the Facility for up to 120 days from the Original Pledge Date o Each second lien mortgage loan has been pledged for 60 days or less from the Original Pledge Date o Each mortgage loan is covered by a forward loan purchase agreement. o Notes or other material documents sent out for correction have been returned to the custody of the Collateral Agent within 10 Calendar days - -------------------------------------------------------------------------------- [LOGO] JPMORGAN 1 Confidential [a Delaware business trust to be determined]. - -------------------------------------------------------------------------------- o The Wet Sublimit will be limited to no more than 20% of the Facility Amount, with documents to be delivered to the Agent within five business days o Total second lien mortgage loans will be limited to no more than 10% of the Facility o Mobile Home loans shall be excluded o Residential mortgage loans to affiliates, or to corporations, partnerships or any entity (other than natural persons) are not permitted o No Mortgage Loan (a) is subject to Section 226.32 of Regulation Z or any similar state or local law (relating to high interest rate credit/lending transactions), or (b) contains any term or condition, or involves any loan origination practice, that has been defined as "predatory", "covered" or "threshold" under applicable federal, state or local law, or which has been expressly categorized as an "unfair" or "deceptive" term, condition, or practice in any applicable federal, state or local law (or the regulations promulgated thereunder). o No mortgage loan will have a CLTV greater than 90%, except for an amount up to 5% of the Facility with a CLTV up to 95% o CLTV for B credit grade loans cannot exceed 85% o CLTV for C credit grade loans cannot exceed 80% o Loans with a credit grade of less than C shall not be considered eligible collateral o Loans with a FICO score of less than 525 shall not be considered eligible collateral SPECIFIC COLLATERAL RESTRICTIONS Residential mortgage loans, subject to the following: o The minimum weighted average FICO score of 610 must be maintained o The maximum weighted average LTV is 83% for fixed rate mortgages and 85% for adjustable rate mortgages Maximum Utilization % --------------------- o Mortgage Loans delinquent in payment more than 30 days and less than 60 days are limited to 5% o Manufactured Housing loans (Agency eligible) up to $150,000 in principal 3% o C grade mortgage loans 15% o Jumbo mortgage loans (>$300,000 but not More than $500,000 principal balance) 15% o Super Jumbo mortgage loans (>$500,000 but not more than $1.5 million principal balance) 5% o Jumbo mortgage loans and Super Jumbo mortgage loans together in aggregate 15% o Mortgage loans with LTV >80% 50% ADVANCE RATE: For all Fixed-Rate Eligible Assets other than second lien mortgage loans, 90% of the lesser of: (1) the net cash amount paid for the asset, (2) the unpaid principal amount of the underlying loan, or (3) market value. - -------------------------------------------------------------------------------- [LOGO] JPMORGAN 2 Confidential [a Delaware business trust to be determined]. - -------------------------------------------------------------------------------- For all Adjustable-Rate Eligible Assets other than second lien mortgage loans, 88% of the lesser of: (1) the net cash amount paid for the asset, (2) the unpaid principal amount of the underlying loan, or (3) market value. For all second lien mortgage loans, 75% of the lesser of: (1) the net cash amount paid for the loan, (2) the unpaid principal amount of the underlying loan, or (3) market value. FACILITY FEE: 0.75% per annum on the amount of the Commitment, payable in two equal installments (at closing and six months thereafter). INTEREST RATES: The pricing rate with respect to each transaction will be 30-day reserve-adjusted LIBOR, floating daily, plus 2.00%; SECURITY: Perfected first lien on all residential mortgage loans funded under the facility (including "Wet" loans), all rights and takeout commitments (including hedge instruments related to collateral securing this Facility), all sale proceeds related thereto, including an assignment of takeout commitments as well as a priority lien on all second lien loans, and all receivables related to servicing advances. Collateral may be released to an investor by the Agent (in its capacity as documents custodian) on a bailee letter or pursuant to a bailee agreement. All loans will be shipped directly to the permanent investors by the custodian. Collateral released on a bailee letter or pursuant to a bailee agreement shall not be outstanding beyond 45 days. All payments from investors must come directly to the Agent. Borrower will provide the Agent with a list of Investors for approval. CASH COLLATERAL ACCOUNT: All principal & interest received by ABFS as servicer will be segregated and kept in a separate account at JPMorgan Chase Bank. DOCUMENTATION: For each mortgage loan purchased: o ABFS will deliver to the Collateral Agent a Banking Package comprised of: - The original executed note; - Recorded original (or if in the process of recordation a certified copy of the) Deed of Trust; - Originally executed and notarized assignment in blank, in recordable form, plus originals or recording-officer certified copies of any intervening assignments, if applicable; - Title Policy Commitment (or Title Insurance policy, if issued); - Power of Attorney, if applicable. o ABFS will hold, in trust for JPM: - Original casualty insurance policy; - Original appraisal; - Original assumption agreement, if any; - Buy-Down Agreement, if any; and - All other original documents. MANDATORY PREPAYMENTS: Mandatory repurchases or the conveyance of additional appropriate Eligible Assets will be required in the amounts by which the amount outstanding under this facility exceeds 90% of the Market Value. Market value shall mean the value, determined in good faith by JPM in its sole good faith discretion, taking into account customary factors, such as market conditions and potential default of the Borrower or Guarantor. The Borrower or Guarantor will repurchase eligible Assets that become ineligible for any reason upon request by the Purchaser or Agent. Representations and warranties from ABFS and Subsidiaries customary to the sale of mortgage loans will be assigned to Purchaser. - -------------------------------------------------------------------------------- [LOGO] JPMORGAN 3 Confidential [a Delaware business trust to be determined]. - -------------------------------------------------------------------------------- CONDITIONS PRECEDENT TO INITIAL BORROWING: Usual for facilities and transactions of this nature, including but not limited to: 1) Execution and delivery of all documentation satisfactory to JPM and its counsel; 2) Absence of Default; 3) Accuracy of Representations and Warranties; 4) Legal opinion from counsel for ABFS satisfactory to JPM and its counsel; 5) Guarantor will have received additional warehouse line commitments of at least $200,000,000 for a 364 day period or more. CONDITIONS PRECEDENT TO ALL BORROWINGS: Customary, including, but not limited to: 1) All Representations and Warranties are true on and as of the date of the borrowing as though made on and as of such date; 2) No Event of Default, or event which with the giving of notice or lapse of time or both would be an Event of Default, has occurred and is continuing, or would result from such borrowing 3) A true sale opinion with respect to the sale of the Mortgage Loans by the Guarantor to the Borrower and a non-consolidation opinion with respect to the Guarantor on the one hand and the Borrower on the other hand, each in form and substance acceptable to JPM; 4) A favorable opinion of counsel from ABFS's counsel; and 5) This facility will not contravene any applicable law. REPRESENTATIONS AND WARRANTIES: ABFS will make the customary Representations and Warranties at closing, including with respect to financial statements and other information furnished, no material adverse changes, litigation, compliance with laws (including ERISA and government agencies), insurance, taxes, properties and licenses. EVENTS OF DEFAULT: The credit agreement will contain customary default provisions appropriate in the context of the proposed transaction, including but not limited to the following: o Failure to pay principal, interest or fees when due; o Failure to comply with any covenant of the credit agreement, the security agreement or any other loan document (subject to permitted grace period); o Material breach of any Representation or Warranty in the credit agreement or any other loan document delivered to the Agent or any Lender; o Bankruptcy or insolvency of the Borrower or Guarantor; o Material change in the executive management of the Guarantor; o Failure of the Borrower or Guarantor to pay any debt when due, or upon the acceleration of such indebtedness, or upon a default under or in respect of such indebtedness which would, with or without the giving of notice or lapse of time or both, permit its acceleration; o Guarantor shall have closed the credit facilities described as a Condition Precedent To Initial Borrowing within 60 days from the closing of this Facility. - -------------------------------------------------------------------------------- [LOGO] JPMORGAN 4 COVENANTS APPLICABLE TO THE SERVICER AND PARTIAL GUARANTOR: General: -------- o Provision of Financial Statements, including monthly company prepared financial statements and an annual audited consolidated statement on ABFS and subsidiaries. This provision will include monthly, quarterly, and annual financial statements on the Borrower, [Delaware business trust to be named]. Annual audited consolidated statements will include an unaudited consolidating balance sheet and income statement audited by an independent public accounting firm. o Provision of supplementary financial disclosures acceptable to JPMorgan, including a quarterly company prepared cash flow statement, monthly detailed repurchase activity report, and a monthly residual interest summary report. o Provision of residual evaluation information quarterly in a format acceptable to the Agent; o No mergers or acquisitions in which the corporate structure of the Borrower or Guarantor or Servicer does not remain intact or the Borrower is not the surviving entity; o No additional debt except as permitted by the Credit Agreement. Financial: (As measured on a consolidated basis) ------------------------------------------------ 1) ABFS will maintain a Minimum GAAP Net Worth of $36MM. GAAP Net Worth will be defined as Total Assets minus Total Liabilities. 2) ABFS will maintain a Minimum Adjusted Tangible Net Worth of $300MM. Adjusted Tangible Net Worth will be defined as GAAP Net Worth minus advances to affiliates and intangibles, plus Subordinated Debt with a maturity greater than one year and (plus or minus) net unrealized holding losses or gains, if any, on available-for-sale debt securities as required by FASB 115. 3) Total Liabilities to GAAP Net Worth plus subordinated debt with a maturity date beyond the maturity of this Facility will not exceed 4.0 to 1.0. 4) ABFS will maintain, at all times, minimum liquidity of $25MM in the form of unrestricted cash or cash equivalents; 5) ABFS will maintain a minimum subordinated debt level of $500MM and at no time will the amount of subordinated debt maturing within one year exceed 65% of the total outstanding subordinated debt amount; 6) The book value of repurchased assets shall not exceed 1.5% of ABFS' owned and managed servicing portfolio at any time. 7) ABFS must maintain a Total Delinquency Rate of less than 9.75% of the Company's owned and managed portfolio. 8) Any trigger event that ABFS elects not to cure that interrupts cash flow from any securitization trust and that continues for 90 days shall constitute an event of default. 9) Aggregate cash flow from all securitization trusts shall be greater than the average of the actual cash flow from the immediately preceding four quarters. - -------------------------------------------------------------------------------- [LOGO] JPMORGAN 5 10) Dividends will be permitted to the extent that no event of default exists or the payment of the dividend will not create an event of default. INDEMNIFICATION: ABFS will indemnify JPM against all losses, liabilities, claims, damages or expenses relating to their loans, the commitments and the credit agreement due to willful misconduct or gross negligence by ABFS or subsidiaries. All payments to be free of all deductions, set-offs, counterclaims and withholding taxes. LEGAL EXPENSES: ABFS shall be responsible for any and all legal fees, due diligence and other out-of pocket costs incurred by JPM in setting up and administering the Facility (whether or not the Facility is consummated). GOVERNING LAW: State of New York - -------------------------------------------------------------------------------- [LOGO] JPMORGAN 6 EX-10 11 ex10-107.txt EXHIBIT 10.107 EXECUTION COPY MORTGAGE LOAN PURCHASE AND INTERIM SERVICING AGREEMENT DLJ MORTGAGE CAPITAL, INC. Initial Purchaser AMERICAN BUSINESS CREDIT, INC. Seller and Servicer HOMEAMERICAN CREDIT, INC. D/B/A UPLAND MORTGAGE Seller AMERICAN BUSINESS MORTGAGE SERVICES, INC. Seller Dated as of July 22, 2003 Fixed Rate Mortgage Loans MORTGAGE LOAN PURCHASE AND INTERIM SERVICING AGREEMENT This is a MORTGAGE LOAN PURCHASE AND INTERIM SERVICING AGREEMENT (the "Agreement"), dated as of July 22, 2003, by and among DLJ Mortgage Capital, Inc., as initial purchaser (in such capacity, the "Initial Purchaser," and the Initial Purchaser or the Person, if any, to which the Initial Purchaser assigns its rights and obligations hereunder as Purchaser with respect to a Mortgage Loan, and each of their respective successors and assigns, the "Purchaser"), American Business Credit, Inc. ("ABC"), as a seller (in such capacity, a "Seller") and as servicer (in such capacity, the "Servicer"), HomeAmerican Credit, Inc., doing business as Upland Mortgage ("Upland"), as a seller (in such capacity, a "Seller") and American Business Mortgage Services, Inc. ("ABMS"), as a seller (in such capacity, a "Seller" and, together with ABC and Upland, the "Sellers"). W I T N E S S E T H : WHEREAS, the Sellers desire to sell to the Purchaser, and the Purchaser desires to purchase from the Sellers, certain fixed rate residential first lien and second lien mortgage loans (the "Mortgage Loans"), including the right to any Prepayment Charges payable by the related mortgagors in connection with any principal prepayments on the Mortgage Loans, which are serviced by the Servicer as described herein on a servicing-released basis, and which shall be delivered as whole loans as provided herein (with respect to the Mortgage Loans purchased on any such date, the related "Closing Date"); WHEREAS, each Mortgage Loan is secured by a mortgage, deed of trust or other security instrument creating a first or second lien on a residential dwelling located in the jurisdiction indicated on the Mortgage Loan Schedule, which is to be annexed hereto on the related Closing Date as Schedule I; WHEREAS, the Purchaser, the Sellers and the Servicer wish to prescribe the manner of the conveyance, servicing and control of the Mortgage Loans; and WHEREAS, following its purchase of the Mortgage Loans from the Sellers, the Purchaser desires to sell some or all of the Mortgage Loans to one or more purchasers in one or more whole loan transfers or in one or more public or private mortgage-backed securities transactions; NOW, THEREFORE, in consideration of the premises and mutual agreements set forth herein, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the Purchaser, the Sellers and the Servicer agree as follows: 1. Definitions. For purposes of this Agreement the following capitalized terms shall have the respective meanings set forth below. Accepted Servicing Practices: As defined in the Servicing Addendum. Agreement: This Mortgage Loan Purchase and Interim Servicing Agreement including all exhibits, schedules, amendments and supplements hereto. Ancillary Income: All income derived from the Mortgage Loans, other than interest, principal, and Prepayment Charges collected, including but not limited to, fees received with respect to late charges, checks or bank drafts returned by the related bank for non-sufficient funds, assumption fees (subject to Subsection 11.19 hereof), and all other incidental fees and charges. The Servicer shall retain all Ancillary Income. Appraised Value: With respect to any Mortgaged Property, the lesser of (i) the lesser of (a) the value thereof as determined by an appraisal made for the originator of the Mortgage Loan at the time of origination of the Mortgage Loan by a licensed appraiser and (b) the value thereof as determined by a review appraisal conducted by the Servicer in the event any such review appraisal determines an appraised value ten percent or more lower than the value thereof as determined by the appraisal referred to in clause (i)(a) above, and (ii) the purchase price paid for the related Mortgaged Property by the Mortgagor with the proceeds of the Mortgage Loan, provided, however, (1) in the case of a Refinanced Mortgage Loan, such value of the Mortgaged Property is based solely upon the lesser of (i) the value determined by an appraisal made for the originator of such Refinanced Mortgage Loan at the time of origination of such Refinanced Mortgage Loan by a licensed appraiser and (ii) the value thereof as determined by a review appraisal conducted by the Servicer in the event any such review appraisal determines an appraised value ten percent or more lower than the value thereof as determined by the appraisal referred to in clause (ii)(a)(i) above and (2) in the case of a Mortgage Loan originated in connection with a "lease-option purchase," such value of the Mortgaged Property is based on the lower of the value determined by an appraisal made for the originator of such Mortgage Loan at the time of origination or the sale price of such Mortgaged Property if the "lease option purchase price" was set less than 12 months prior to origination, and is based on the value determined by an appraisal made for the originator of such Mortgage Loan at the time of origination if the "lease option purchase price" was set 12 months or more prior to origination. Assignment of Mortgage: An individual assignment of the Mortgage, notice of transfer or equivalent instrument in recordable form, sufficient under the laws of the jurisdiction wherein the related Mortgaged Property is located to give record notice of the sale of the Mortgage to the Purchaser. Bankruptcy Act: The Bankruptcy Reform Act of 1978, as amended (Title 11 of the United States Code). BIF: The Bank Insurance Fund, or any successor thereto. Business Day: Any day other than a Saturday or Sunday, or a day on which banking and savings and loan institutions in the State of California or the State of New York are authorized or obligated by law or executive order to be closed. Cash-Out Refinancing: A Refinanced Mortgage Loan, the proceeds of which were more than $1,000 in excess of the principal balance of an existing first mortgage on the related Mortgaged Property, the principal balance of any existing subordinate mortgages on the related Mortgaged Property and related closing costs, and were used to satisfy such existing first mortgage, any such subordinate mortgages, to pay related closing costs and to provide to the mortgagor more than $1,000 in addition thereto. 2 Certificate Insurer: The certificate insurer as shall be designated by the Purchaser in connection with any Reconstitution Agreement. Certificates: The certificates issued in connection with any Reconstitution Agreement on the related Reconstitution Date as provided in Section 12 hereof. Closing Date: With respect to each Mortgage Loan, the date on which the Purchaser shall purchase and the related Seller shall sell to the Purchaser such Mortgage Loan together with such other Mortgage Loans as shall be listed on the related Mortgage Loan Schedule. The Closing Date for any Mortgage Loan shall in no event be later than August 10, 2003. Closing Documents: The documents required pursuant to Section 9. Code: The Internal Revenue Code of 1986, or any successor statute thereto. Combined Loan-to-Value Ratio or CLTV: As of any date and Mortgage Loan which is secured by a Mortgaged Property which also secures the repayment of a subordinated second mortgage loan, the fraction, expressed as a percentage, the numerator of which is the sum of (a) the original principal balance of the Mortgage Loan, plus (b) the unpaid principal balance of any second mortgage loan secured by the Mortgaged Property as of such date, and the denominator of which is the Appraised Value of the related Mortgaged Property; as of any date and Mortgage Loan which is secured by a Mortgaged Property which does not also secure the repayment of a subordinated second mortgage loan, the Loan-to-Value Ratio. Commitment Letter: With respect to each Mortgage Loan, the related letter agreement dated July 1, 2003 between the Purchaser and the Sellers (including any exhibits, schedules and attachments thereto) and attached hereto as Exhibit 9. Condemnation Proceeds: All awards, compensation and settlements in respect of a taking of all or part of a Mortgaged Property by exercise of the power of condemnation or the right of eminent domain. Custodial Account: The separate account or accounts, each of which shall be an Eligible Account, created and maintained pursuant to this Agreement, which shall be entitled "American Business Credit, Inc., as custodian for the Purchaser, First and Second Lien Fixed Rate Mortgage Loans" or such other title as shall be acceptable to the Purchaser. Custodial Agreement: The custodial agreement dated as of July 1, 2003 among the Initial Purchaser, the Sellers and the Custodian, governing the retention of the originals of each Mortgage Note, Mortgage, Assignment of Mortgage and other Mortgage Loan Documents, a form of which agreement is annexed hereto as Exhibit 6 or any other custodial agreement among a custodian, the Sellers and the Initial Purchaser pursuant to which such custodian is to hold any of the documents or instruments referred to above as agent for the Initial Purchaser. Custodian: A custodian that is appointed pursuant to a Custodial Agreement or its successor in interest or assigns, any successor to the Custodian under the Custodial Agreement, as therein provided. The initial Custodian shall be JPMorgan Chase Bank. 3 Cut-off Date: With respect to each Mortgage Loan (other than a Qualified Substitute Mortgage Loan), the later of (i) the last day of the month immediately preceding the month in which the related Closing Date with respect to such Mortgage Loan occurs and (ii) the origination date of the related Mortgage Loan, and with respect to each Qualified Substitute Mortgage Loan, its date of substitution. Deleted Mortgage Loan: A Mortgage Loan rejected by the Purchaser or a Mortgage Loan replaced or to be replaced by a Qualified Substitute Mortgage Loan. Determination Date: With respect to each Distribution Date, the tenth (10th) day of the calendar month in which such Distribution Date occurs or, if such tenth (10th) day is not a Business Day, the Business Day immediately preceding such tenth (10th) day. Distribution Date: The fifteenth (15th) day of each month, commencing on the fifteenth (15th) day of the month next following the month in which the related Cut-off Date occurs, or if such fifteenth (15th) day is not a Business Day, the first Business Day immediately following such fifteenth (15th) day. Due Date: With respect to each Mortgage Loan and any Distribution Date, the date on which Monthly Payments on such Mortgage Loan are due which is either the first day of the month of such Distribution Date, or if Monthly Payments on such Mortgage Loan are due on a day other than the first day of the month, the date in the calendar month immediately preceding the Distribution Date on which such Monthly Payments are due, exclusive of any days of grace. Due Period: With respect to each Distribution Date, the period commencing on the first day of the month preceding the month of the Distribution Date and ending on the last day of the month of the preceding the month of the Distribution Date. Eligible Account: Either (i) an account or accounts maintained with a federal or state chartered depository institution or trust company the short-term unsecured debt obligations of which (or, in the case of a depository institution or trust company that is the principal subsidiary of a holding company, the short-term unsecured debt obligations of such holding company) are rated A-1 by S&P or Prime-1 by Moody's (or a comparable rating if another rating agency is specified by the Initial Purchaser by written notice to each Seller) at the time any amounts are held on deposit therein, (ii) an account or accounts the deposits in which are fully insured by the FDIC to the full extent permitted or (iii) a trust account or accounts maintained with a federal or state chartered depository institution or trust company acting in its fiduciary capacity. Eligible Accounts may bear interest. Escrow Account: The separate trust account or accounts created and maintained pursuant to this Agreement which shall be entitled "American Business Credit, Inc., as Servicer, in trust for the Purchaser and various Mortgagors, Fixed Rate Mortgage Loans" or such other title as shall be acceptable to the Purchaser. Escrow Payments: The amounts constituting ground rents, taxes, assessments, water charges, sewer rents, Primary Insurance Policy premiums (if any), fire and hazard insurance premiums and other payments required to be escrowed by the Mortgagor with the Mortgagee pursuant to the terms of any Mortgage Note or Mortgage. 4 Event of Default: Any one of the events enumerated in Subsection 14.01. Fair Credit Reporting Act: 15 U.S.C.ss.ss.1681 et seq. Fannie Mae: Fannie Mae, formerly known as Federal National Mortgage Association ("FNMA") or any successor thereto. FDIC: The Federal Deposit Insurance Corporation or any successor thereto. Final Recovery Determination: With respect to any defaulted Mortgage Loan or any REO Property (other than a Mortgage Loan or REO Property purchased by the Servicer), a determination made by the Servicer that all Condemnation Proceeds, Insurance Proceeds, Liquidation Proceeds and other payments or recoveries which the Servicer, in its reasonable good faith judgment, expects to be finally recoverable in respect thereof have been so recovered. The Servicer shall maintain records, prepared by a servicing officer of the Servicer, of each Final Recovery Determination. First Lien: With respect to any second lien Mortgage Loan, the mortgage loan relating to the corresponding Mortgaged Property having a first priority lien. First Payment Default Loan: Any Mortgage Loan for which the related Mortgagor does not make the contractual first payment within 30 days of its due date or the related Mortgagor does not make the first contractual payment after such Mortgage Loan is owned by the Initial Purchaser within 30 days of its due date. For example, if a Mortgagor of a Mortgage Loan fails to make the June 2003 payment, July 2003 payment or the August 2003 payment within 30 days of its due date, that Mortgage Loan qualifies as a First Payment Default Loan. Fitch: Fitch Ratings, or its successor in interest. Fixed Rate Mortgage Loan: A Mortgage Loan with respect to which the Mortgage Interest Rate is fixed for the life of such Mortgage Loan. Freddie Mac: Freddie Mac, formerly known as Federal Home Loan Mortgage Corporation ("FHLMC") or any successor thereto. Holdback Amount: The amount due to be paid by the Purchaser to the related Seller pursuant to the Commitment Letter upon delivery to the Seller or its Custodian Assignments of Mortgage in blank in recordable form for each of the Mortgage Loans sold by such Seller to the Purchaser. HUD: The United States Department of Housing and Urban Development or any successor thereto. Initial Purchaser: DLJ Mortgage Capital, Inc., or its successor thereto. Insurance Proceeds: With respect to each Mortgage Loan, proceeds of insurance policies insuring the Mortgage Loan or the related Mortgaged Property to the extent such proceeds are not applied to the restoration of the related Mortgaged Property or released to the related Mortgagor. 5 Interim Servicing Period: With respect to any Mortgage Loan, the period commencing on the related Closing Date and ending not later than the close of business on October 1, 2003, or such other date, earlier or later, as specified in a written notice from the Purchaser to each Seller and the Servicer. Liquidation Event: With respect to any Mortgage Loan or REO Property, any of the following events: (i) a Final Recovery Determination is made as to such Mortgage Loan or REO Property; (ii) such Mortgage Loan or REO Property is removed from this Agreement by reason of its being repurchased, sold or replaced pursuant to or as contemplated by any provision of this Agreement; or (iii) such Mortgage Loan is paid in full. Liquidation Proceeds: Amounts, other than Insurance Proceeds and Condemnation Proceeds, received in connection with the liquidation of a defaulted Mortgage Loan through trustee's sale, foreclosure sale or otherwise, other than amounts received following the acquisition of REO Property. Loan-to-Value Ratio or LTV: With respect to any Mortgage Loan as of any date of determination, the ratio on such date of the outstanding principal amount of such Mortgage Loan, to the Appraised Value of the related Mortgaged Property. Monthly Payment: With respect to any Mortgage Loan, the scheduled combined payment of principal and interest payable by a Mortgagor under the related Mortgage Note on each Due Date. Moody's: Moody's Investors Service, Inc. or its successor in interest. Mortgage: The mortgage, deed of trust or other instrument creating a first or second lien on Mortgaged Property securing the Mortgage Note. Mortgage File: The items pertaining to a particular Mortgage Loan referred to in Exhibit 5 annexed hereto, and any additional documents required to be added to the Mortgage File pursuant to this Agreement or the Commitment Letter. Mortgage Interest Rate: The annual rate of interest borne on a Mortgage Note with respect to each Mortgage Loan as set forth in the related Mortgage Loan and the Mortgage Loan Schedule. Mortgage Loan: Each Mortgage Loan sold, assigned and transferred to the Purchaser pursuant to this Agreement and the Commitment Letter and identified on the Mortgage Loan Schedule annexed to this Agreement on the related Closing Date, which Mortgage Loan includes without limitation the related Mortgage File, the Monthly Payments, Principal Prepayments, Prepayment Charges, Liquidation Proceeds, Condemnation Proceeds, Insurance Proceeds, REO Disposition proceeds, and all other rights, benefits, proceeds and obligations arising from or in connection with such Mortgage Loan. 6 Mortgage Loan Documents: The documents listed in Section 2 of the Custodial Agreement pertaining to the related Mortgage Loan. Mortgage Loan Remittance Rate: With respect to each Mortgage Loan, the annual rate of interest remitted to the Purchaser, which shall be equal to the related Mortgage Interest Rate. Mortgage Loan Schedule: The schedule of Mortgage Loans to be annexed hereto as Schedule I on the related Closing Date for the Mortgage Loans delivered on that Closing Date, in both hard copy and "read only" electronic format, such schedule setting forth the following information with respect to each such Mortgage Loan: (1) the related Seller's Mortgage Loan identifying number; (2) the Mortgagor's name; (3) the street address of the Mortgaged Property including the state and zip code; (4) a code indicating whether the Mortgaged Property is owner-occupied; (5) the type of Residential Dwelling constituting the Mortgaged Property; (6) the Loan-to-Value Ratio or Combined Loan-to-Value Ratio, as applicable, at origination; (7) the Mortgage Interest Rate in effect as of the related Cut-off Date; (8) the stated maturity date of the Mortgage Loan and, if such Mortgage Loan is a second lien Mortgage Loan, the stated maturity date of the related First Lien; (9) the amount of the Monthly Payment at origination; (10) the amount of the Monthly Payment as of the related Cut-off Date; (11) the last Due Date on which a Monthly Payment was actually applied to the unpaid stated principal balance; (12) the original principal balance of the Mortgage Loan and, if such Mortgage Loan is a second lien Mortgage Loan, the original principal balance of the related First Lien, as of the date of origination; (13) the Stated Principal Balance of the Mortgage Loan and, if such Mortgage Loan is a second lien Mortgage Loan, the Stated Principal Balance of the related First Lien, as of the close of business on the related origination date; (14) a code indicating the purpose of the loan (i.e., purchase financing, Rate/Term Refinancing, Cash-Out Refinancing); (15) the Mortgage Interest Rate at origination; (16) a code indicating the documentation style (i.e., full, limited or stated); (17) the related Seller's risk grade; (18) the Appraised Value of the Mortgaged Property; (19) the sale price of the Mortgaged Property, if applicable; (20) on the Mortgage Loan Schedule in "read only" electronic format, the actual unpaid principal balance of the Mortgage Loan as of the related Cut-off Date; (21) the actual paid to date; (22) the number of years any prepayment penalty is in effect; (23) the loan type (e.g., fixed); (24) a code indicating whether the Mortgage Loan is a second lien Mortgage Loan. With respect to the Mortgage Loans in the aggregate, the Mortgage Loan Schedule shall set forth the following information, as of the related Cut-off Date: (1) the number of Mortgage Loans; (2) the Stated Principal Balance of the Mortgage Loans; (3) the weighted average Mortgage Interest Rate of the Mortgage Loans; and (4) the weighted average maturity of the Mortgage Loans. Mortgage Note: The original executed note or other evidence of the Mortgage Loan indebtedness of a Mortgagor. Mortgaged Property: The Mortgagor's real property securing repayment of a related Mortgage Note, consisting of a fee simple interest in a single parcel of real property improved by a Residential Dwelling. Mortgagee: The mortgagee or beneficiary named in the Mortgage and the successors and assigns of such mortgagee or beneficiary. 7 Mortgagor: The obligor on a Mortgage Note, the owner of the Mortgaged Property and the grantor or mortgagor named in the related Mortgage and such grantor's or mortgagor's successors in title to the Mortgaged Property. Nonrecoverable Servicing Advance: Any Servicing Advance previously made or proposed to be made in respect of a Mortgage Loan or REO Property that, in the good faith business judgment of the Servicer, will not, or, in the case of a proposed Servicing Advance, would not, be ultimately recoverable from related late payments, Condemnation Proceeds, Insurance Proceeds or Liquidation Proceeds on such Mortgage Loan or REO Property as provided herein. Officer's Certificate: A certificate signed by the Chairman of the Board or the Vice Chairman of the Board or a President or a Vice President and by the Treasurer or the Secretary or one of the Assistant Treasurers or Assistant Secretaries of the Person on behalf of whom such certificate is being delivered. Pass-Through Transfer: The sale or transfer of some or all of the Mortgage Loans by the Purchaser to a trust to be formed as part of a publicly issued or privately placed mortgage-backed securities transaction. Person: An individual, corporation, partnership, limited liability company, joint venture, association, joint stock company, trust, unincorporated organization or government or any agency or political subdivision thereof. Prepayment Charge: With respect to each Mortgage Loan, any prepayment penalty payable in connection with a Principal Prepayment on such Mortgage Loan made on or after the related Cut-off Date, transferred and assigned to the Purchaser pursuant to the terms of this Agreement and identified in the Mortgage Loan Schedule. Principal Prepayment: Any payment or other recovery of principal on a Mortgage Loan received in advance of its scheduled Due Date, including any prepayment penalty or premium thereon, which is not accompanied by an amount of interest representing scheduled interest due on any date or dates in any month or months subsequent to the month of prepayment. Prospectus and Prospectus Supplement: The prospectus and the prospectus supplement relating to the Certificates, if any. Purchase Price: The price paid on the related Closing Date by the Purchaser to the related Seller pursuant to the Commitment Letter in exchange for the Mortgage Loans purchased on such Closing Date as calculated as provided in Section 4. Qualified Substitute Mortgage Loan: A mortgage loan eligible to be substituted by a Seller for a Deleted Mortgage Loan, which must have the following qualities on the date of substitution: (i) have an outstanding principal balance, after deduction of all scheduled payments due in the month of substitution, not in excess of the outstanding principal balance of the Deleted Mortgage Loan (the amount of any shortfall shall be deposited in the Custodial Account by the related Seller out of its own funds without right of reimbursement as provided in Subsection 7.04 herein), (ii) have a current Mortgage Interest Rate not less than and not more than 1% greater than the current Mortgage Interest Rate of the Deleted Mortgage Loan, (iii) have a remaining term to maturity not greater than, and not more than three (3) months less than, that of the Deleted Mortgage Loan, (iv) be of the same type as the Deleted Mortgage Loan (i.e., if the Deleted Mortgage Loan is a Fixed Rate Mortgage Loan, the substituted loan shall be a Fixed Rate Mortgage Loan), (v) comply with each representation and warranty respecting individual Mortgage Loans set forth in Subsection 7.03 herein, provided, that for purposes of applying such representations and warranties to each such Qualified Substitute Mortgage Loan, references in such Subsection to the related Closing Date shall be deemed to be references to the date of substitution of such Qualified Substitute Mortgage Loan and (vi) be contractually current as of the date of substitution. If one or more Mortgage Loans are substituted for one or more Deleted Mortgage Loans pursuant to Subsection 7.04 herein, the amounts described in clause (i) hereof shall be determined on the basis of the aggregate principal balances; the Mortgage Interest Rate and the term to maturity described in clauses (ii) and (iii) hereof shall be determined on the basis of weighted average Mortgage Interest Rates and original terms to maturity respectively. 8 Rate/Term Refinancing: A Refinanced Mortgage Loan, the proceeds of which were not more than $1,000 in excess of the principal balance of an existing first mortgage on the related Mortgaged Property, the principal balance of any existing subordinate mortgages on the related Mortgaged Property and related closing costs, and were used to satisfy such existing first mortgage or any such subordinate mortgages, to pay related closing costs and to provide to the Mortgagor not more than $1,000 in addition thereto. Rating Agency: Each of S&P, Moody's and Fitch. Reconstitution: Either a Pass-Through Transfer or Whole Loan Transfer. Reconstitution Agreement: In connection with a Reconstitution, an agreement pursuant to which each Seller makes representations and warranties with respect to the Mortgage Loans subject to the Reconstitution as of the date of the Reconstitution and undertakes certain other obligations, as set forth in such Reconstitution Agreement. Reconstitution Date: As to any Mortgage Loan, the date on which this Agreement, as it relates to such Mortgage Loan, is reconstituted as part of a transaction described in Section 12 hereof. Reconstitution Period: With respect to any Mortgage Loan, the period beginning from the related Closing Date to no later than September 30, 2003. Record Date: With respect to each Distribution Date, the last Business Day of the month immediately preceding the month in which such Distribution Date occurs. Refinanced Mortgage Loan: A Mortgage Loan the proceeds of which were not used to purchase the related Mortgaged Property. REMIC: A "real estate mortgage investment conduit" within the meaning of Section 860D of the Code. REO Disposition: The final sale by the Servicer of any REO Property. 9 REO Property: A Mortgaged Property acquired as a result of the liquidation of a Mortgage Loan. Repurchase Price: The Repurchase Price for any Mortgage Loan as to which a First Payment Default has occurred or such Mortgage Loan is to be repurchased pursuant to Subsection 7.04 shall be equal to the sum of (i) the product of the Purchase Price Percentage (as stated in the Commitment Letter) and the Stated Principal Balance of such Mortgage Loan as of the date of repurchase, plus accrued interest thereon until the date in which such repurchase occurs and (ii) any costs and damages incurred by the Purchaser in connection with a breach of the representation made in Subsection 7.03(h). All amounts owed to the Purchaser shall be delivered via wire transfer of immediately available funds within two Business Days of such event. Residential Dwelling: Any one of the following: (i) an attached or detached one-family dwelling, (ii) an attached or detached two- to four-family dwelling, (iii) an attached or detached one-family dwelling unit in a condominium project, (iv) an attached or detached one-family dwelling in a planned unit development, none of which is a cooperative, or mobile home (as defined in 42 United States Code, Section 5402(6)) or (v) a manufactured home. SAIF: The Savings Association Insurance Fund or any successor thereto. Sellers: American Business Credit, Inc., HomeAmerican Credit, Inc. doing business as Upland Mortgage and American Business Mortgage Services, Inc. or any of their respective successor in interest thereto. Servicer: American Business Credit, Inc., or its successor in interest thereto. Servicing Addendum: The terms and conditions attached hereto as Exhibit 11 which will govern the servicing of the Mortgage Loans by the Servicer during the Interim Servicing Period. Servicing Advances: All customary, reasonable and necessary "out-of-pocket" costs and expenses incurred by the Servicer in the performance of its servicing obligations, including, but not limited to, the cost of (i) preservation, restoration and repair of a Mortgaged Property, (ii) any enforcement or judicial proceedings with respect to a Mortgage Loan, including foreclosure actions and (iii) the management and liquidation of REO Property. Servicing Fee: With respect to each Mortgage Loan, the amount of the fee the Purchaser shall pay to the Servicer, which shall, for each month, be equal to 0.50% per annum per Mortgage Loan, payable monthly, in arrears. If the Interim Servicing Period includes any partial month, the Servicing Fee for such month shall be pro rated at a per diem rate based upon a 30-day month. Servicing File: With respect to each Mortgage Loan, the file retained by the Servicer consisting of originals of all documents in the Mortgage File that are not delivered to the Purchaser or the Custodian and copies of the Mortgage Loan Documents set forth in Section 2 of the Custodial Agreement. 10 Servicing Rights: All of the Purchaser's right, title and interest in and to the servicing of the Mortgage Loans, together with all Custodial Accounts, Escrow Accounts, contract rights, incidental income and benefits, and exclusive rights to possession and use of servicing files and records directly or indirectly related thereto, including, without limitation, borrower lists, insurance policies and tax service agreements. Servicing Transfer Date: With respect to a Mortgage Loan, the date on which the physical servicing of such Mortgage Loan and the related Servicing Rights and servicer responsibilities are transferred to the Purchaser or its designee, pursuant to Subsection 13.05 herein, which date shall not be later than the end of the Interim Servicing Period, or such other date as may be mutually agreed to in writing by the Sellers and Initial Purchaser; provided, however, if the Purchaser exercises its option to terminate the Servicer pursuant to this Agreement, the Servicing Transfer Date will be deemed to have occurred upon such termination. S&P: Standard & Poor's Ratings Services, a division of The McGraw-Hill Companies, Inc. or its successor in interest thereto. Stated Principal Balance: As to each Mortgage Loan as of any date of determination, (i) the unpaid principal balance of the Mortgage Loan as of the related Cut-off Date, minus (ii) all amounts previously distributed to the Purchaser with respect to such Mortgage Loan representing payments or recoveries of principal. Whole Loan Transfer: Any sale or transfer of some or all of the Mortgage Loans by the Purchaser to a third party, which sale or transfer is not a Pass-Through Transfer. 2. Agreement to Purchase. On the related Closing Date, the Sellers agree to sell, and the Purchaser agrees to purchase, without recourse but subject to the representations, warranties, terms and provisions of this Agreement, Mortgage Loans having an aggregate principal balance on the related Cut-off Date in an amount as set forth in the Commitment Letter, or in such other amount as agreed by the Purchaser and the Sellers as evidenced by the actual aggregate principal balance of the Mortgage Loans accepted by the Purchaser on such Closing Date. 3. Mortgage Loan Schedule. The Sellers shall deliver a Mortgage Loan Schedule for the Mortgage Loans, or each Seller shall deliver a Mortgage Loan Schedule for the related Mortgage Loans, to be purchased on the related Closing Date to the Purchaser at least two (2) Business Days prior to such Closing Date. 4. Purchase Price. The Purchase Price for each Mortgage Loan listed on the related Mortgage Loan Schedule shall be the amount determined pursuant to the terms of the Commitment Letter (subject to adjustment as provided therein). If so provided in the Commitment Letter, portions of the Mortgage Loans shall be priced separately. The Purchase Price shall be remitted by the Initial Purchaser to the related Seller on the related Closing Date by wire transfer of immediately available funds to the bank account designated by such Seller. At such time as the Sellers deliver to the Purchaser or its Custodian Assignments of Mortgage in blank in recordable form for each Mortgage Loan purchased by the Purchaser on a Closing Date, the Purchaser shall pay the applicable Holdback Amount to the related Seller; provided, that, no Seller shall be entitled to payment of the Holdback Amount if the Assignments of Mortgage relating to all the purchased Mortgage Loans are not delivered to the Purchaser or its Custodian on or prior to August 11, 2003. 11 In addition to the Purchase Price as described above, the Initial Purchaser shall pay to related Seller, on the related Closing Date, accrued interest on the Stated Principal Balance of each Mortgage Loan at its Mortgage Interest Rate from the last interest paid-through date to but not including related Closing Date. The Purchaser shall own and be entitled to receive with respect to each Mortgage Loan purchased, (1) all scheduled principal received after the related Cut-off Date, (2) all other recoveries of principal collected after the related Cut-off Date, (3) all payments of interest on the Mortgage Loans at the Mortgage Interest Rate from the last interest paid-through date and (4) all Prepayment Charges on the Mortgage Loans collected on or after the related Cut-off Date. The Stated Principal Balance of each Mortgage Loan as of the related Cut-off Date is determined after application to the reduction of principal of payments of principal received on or before the related Cut-off Date. All payments of principal and interest, less the applicable Servicing Fee, received on a Due Date following the related Cut-off Date shall belong to the Purchaser. 5. Examination of Mortgage Files. In addition to the rights granted to the Initial Purchaser under the Commitment Letter to underwrite the Mortgage Loans and review the Mortgage Files, the Sellers, at least two (2) days prior to the related Closing Date, shall (a) deliver to the Custodian in escrow, for examination with respect to each Mortgage Loan to be purchased on such Closing Date, the related Mortgage File, including the Assignment of Mortgage, pertaining to each Mortgage Loan, or (b) at the option of the Initial Purchaser, make the related Mortgage File available to the Initial Purchaser for examination at the related Seller's offices or such other location as shall otherwise be agreed upon by the Purchaser and such Seller. Such examination may be made by the Purchaser or its designee at any reasonable time before or after the related Closing Date. If the Initial Purchaser identifies any Mortgage Loans that do not conform to the terms of the Commitment Letter or this Agreement, such Mortgage Loans may, at the Initial Purchaser's option, be rejected for purchase by the Initial Purchaser prior to the related Closing Date. If not purchased by the Initial Purchaser, such Mortgage Loans shall be deleted from the Mortgage Loan Schedule. The Initial Purchaser may, at its option and without notice to any Seller, purchase all or less than all of the Mortgage Loans without conducting any partial or complete examination. The fact that the Purchaser has conducted or has determined not to conduct any partial or complete examination of the Mortgage Files shall not affect the Purchaser's (or any of its successors') rights to demand repurchase or other relief or remedy provided for in this Agreement. 6. Conveyance from the Sellers to the Initial Purchaser. 6.01. Conveyance of Mortgage Loans; Possession of Servicing Files. The Sellers, simultaneously with the payment of the Purchase Price, shall execute and deliver to the Initial Purchaser an Assignment and Conveyance with respect to the related Mortgage Loans in the form attached hereto as Exhibit 4. The Servicing File retained by the Servicer with respect to each Mortgage Loan pursuant to this Agreement shall be appropriately identified in the Servicer's computer system to reflect clearly the sale of such related Mortgage Loan to the Purchaser. The Servicer shall release from its custody the contents of any Servicing File retained by it only in accordance with this Agreement, except when such release is (i) required in connection with a repurchase of any such Mortgage Loan pursuant to Subsection 7.04 or 7.06 or (ii) to a document imaging or reproduction contractor engaged by the Servicer at its own expense and identified to the Purchaser. 12 6.02. Books and Records. Upon the purchase of the Mortgage Loans hereunder, record title to each Mortgage and the related Mortgage Note as of the related Closing Date shall be in the name of the related Seller, the related Seller's predecessor in interest, the Purchaser, the Custodian or one or more designees of the Purchaser, as the Purchaser shall designate. Notwithstanding the foregoing, beneficial ownership of each Mortgage and the related Mortgage Note shall be vested solely in the Purchaser or the appropriate designee of the Purchaser, as the case may be. Upon the purchase of the Mortgage Loans hereunder, all rights arising out of the Mortgage Loans including, but not limited to, all funds received by the Sellers or the Servicer after the related Cut-off Date on or in connection with a Mortgage Loan as provided in and subject to Section 4 shall be vested in the Purchaser or one or more designees of the Purchaser; provided, however, that all such funds received on or in connection with a Mortgage Loan as provided in and subject to Section 4 shall be received and held by the Servicer as custodian for the benefit of the Purchaser or the assignee of the Purchaser, as the case may be, as the owner of the Mortgage Loans pursuant to the terms of this Agreement. It is the express intention of the parties that the transactions contemplated by this Agreement be, and be construed as, a sale of the Mortgage Loans by the Sellers and not a pledge of the Mortgage Loans by any Seller to the Purchaser to secure a debt or other obligation of such Seller. Consequently, the sale of each Mortgage Loan shall be reflected as a sale on the related Seller's business records, tax returns and financial statements. 6.03. Delivery of Mortgage Loan Documents. Pursuant to the Custodial Agreement to be executed among and delivered by the Initial Purchaser, the Custodian, the Servicer and the Sellers prior to the related Closing Date, each Seller shall in connection with such Closing Date, at least two (2) Business Days prior to such Closing Date, deliver and release to the Custodian those Mortgage Loan Documents as required by the Custodial Agreement with respect to each Mortgage Loan to be purchased and sold on the such Closing Date and set forth on the Mortgage Loan Schedule delivered with such Mortgage Loan Documents. The Custodian shall certify its receipt of all such Mortgage Loan Documents required to be delivered pursuant to the Custodial Agreement for the related Closing Date, as evidenced by the Trust Receipt and Initial Certification of the Custodian in the form annexed to the Custodial Agreement. The Sellers shall be responsible for maintaining in effect the Custodial Agreement during the Interim Servicing Period. The fees and expenses of the Custodian during such period and thereafter shall be paid by the Sellers. Each Seller shall forward to the Custodian original documents evidencing an assumption, modification, consolidation or extension of any Mortgage Loan entered into in accordance with this Agreement within two weeks of their execution, provided, however, that each Seller shall provide the Custodian with a certified true copy of any such document submitted for recordation within two weeks of its execution, and shall provide the original of any document submitted for recordation or a copy of such document certified by the appropriate public recording office (unless the recording office does not routinely return originals or provide certifications) to be a true and complete copy of the original within five days after its return from the recording office. 13 7. Representations, Warranties and Covenants of each Seller and the Servicer: Remedies for Breach. 7.01. Representations and Warranties Respecting each Seller. Each Seller represents, warrants and covenants to the Purchaser as of the date hereof, the related Closing Date and the Reconstitution Date, or as of such other date specifically provided herein or in the applicable Assignment and Conveyance: (a) Each Seller is duly organized, validly existing and in good standing as a corporation under the laws of its state of incorporation and is and will remain in compliance with the laws of each state in which any Mortgaged Property is located to the extent necessary to ensure the enforceability of each Mortgage Loan in accordance with the terms of this Agreement; (b) Each Seller has the full power and authority to hold each Mortgage Loan, to sell each Mortgage Loan, and to execute, deliver and perform, and to enter into and consummate, all transactions contemplated by this Agreement. Each Seller has duly authorized the execution, delivery and performance of this Agreement, has duly executed and delivered this Agreement, and this Agreement, assuming due authorization, execution and delivery by the Initial Purchaser and the Servicer, constitutes a legal, valid and binding obligation of each Seller, enforceable against it in accordance with its terms except as the enforceability thereof may be limited by bankruptcy, insolvency or reorganization; (c) The execution and delivery of this Agreement by each Seller and the performance of and compliance with the terms of this Agreement will not violate such Seller's articles of incorporation or by-laws or constitute a default under or result in a breach or acceleration of, any material contract, agreement or other instrument to which such Seller is a party or which may be applicable to such Seller or its assets; (d) Each Seller is not in violation of, and the execution and delivery of this Agreement by each Seller and its performance and compliance with the terms of this Agreement will not constitute a violation with respect to, any order or decree of any court or any order or regulation of any federal, state, municipal or governmental agency having jurisdiction over such Seller or its assets, which violation might have consequences that would materially and adversely affect the condition (financial or otherwise) or the operation of such Seller or its assets or might have consequences that would materially and adversely affect the performance of its obligations and duties hereunder; (e) Each Seller does not believe, nor does it have any reason or cause to believe, that it cannot perform each and every covenant contained in this Agreement; (f) Immediately prior to the payment of the Purchase Price for a Mortgage Loan, the related Seller was the sole owner of the related Mortgage and the indebtedness evidenced by the related Mortgage Note and upon the payment of the Purchase Price by the Purchaser, the Purchaser will own such Mortgage Loan free and clear of any lien. In the event that the related Seller retains record title, such Seller shall retain such record title to each Mortgage, each related Mortgage Note and the related Mortgage Files with respect thereto for the sole benefit of the Purchaser as the owner thereof; 14 (g) There are no actions or proceedings against, investigations known to it of, a Seller before any court, administrative or other tribunal (A) that might prohibit its entering into this Agreement, (B) seeking to prevent the sale of the Mortgage Loans or the consummation of the transactions contemplated by this Agreement or (C) that might prohibit or materially and adversely affect the performance by such Seller of its obligations under, or validity or enforceability of, this Agreement or the Mortgage Loans; (h) No consent, approval, authorization or order of any court or governmental agency or body is required for the execution, delivery and performance by a Seller of, or compliance by such Seller with, this Agreement or the consummation of the transactions contemplated by this Agreement, except for such consents, approvals, authorizations or orders, if any, that have been obtained; (i) The consummation of the transactions contemplated by this Agreement are in the ordinary course of business of each Seller, and the transfer, assignment and conveyance of the Mortgage Notes and the Mortgages by each Seller pursuant to this Agreement are not subject to the bulk transfer or any similar statutory provisions; (j) With respect to each Mortgage Loan, each Seller is in possession of a complete Mortgage File in compliance with Exhibit 5, except for such documents as have been delivered to the Custodian; and (k) Neither this Agreement nor any written statement report or other document prepared and furnished or to be prepared and furnished by each Seller pursuant to this Agreement or in connection with the transaction contemplated hereby contains any untrue statement of material fact or omits to state a material fact necessary to make the statements contained herein or therein not misleading in light of the circumstances in which they were made. 7.02. Representations and Warranties Respecting the Servicer. The Servicer represents warrants and covenants to the Purchaser as of the related Closing Date and as of each Reconstitution Date, or as of such other date specifically provided herein: (a) The Servicer is duly organized, validly existing and in good standing as a corporation under the laws of the Commonwealth of Pennsylvania and is and will remain duly licensed and in compliance with the laws of each state in which any Mortgaged Property is located to the extent necessary to ensure the enforceability of each Mortgage Loan in accordance with the terms of this Agreement; (b) The Servicer has the full power and authority to (1) on behalf of the Purchaser, (i) hold each Mortgage Loan and (ii) sell each Mortgage Loan, and (2) execute, deliver and perform, and to enter into and consummate, all transactions contemplated by this Agreement. The Servicer has duly authorized the execution, delivery and performance of this Agreement, has duly executed and delivered this Agreement, and this Agreement, assuming due authorization, execution and delivery by the Purchaser and the Seller, constitutes a legal, valid and binding obligation of the Servicer, enforceable against it in accordance with its terms except as the enforceability thereof may be limited by bankruptcy, insolvency or reorganization; 15 (c) The execution and delivery of this Agreement by the Servicer and the performance of and compliance with the terms of this Agreement will not violate the Servicer's articles of incorporation or by-laws or constitute a default under or result in a breach or acceleration of, any material contract, agreement or other instrument to which the Servicer is a party or which may be applicable to the Servicer or its assets; (d) The Servicer is not in violation of, and the execution and delivery of this Agreement by the Servicer and its performance and compliance with the terms of this Agreement will not constitute a violation with respect to, any order or decree of any court or any order or regulation of any federal, state, municipal or governmental agency having jurisdiction over the Seller or its assets, which violation might have consequences that would materially and adversely affect the condition (financial or otherwise) or the operation of the Servicer or its assets or might have consequences that would materially and adversely affect the performance of its obligations and duties hereunder; (e) The Servicer does not believe, nor does it have any reason or cause to believe, that it cannot perform each and every covenant contained in this Agreement; (f) There are no actions or proceedings against, investigations known to it of, the Servicer before any court, administrative or other tribunal (i) that might prohibit its entering into this Agreement, (ii) seeking to prevent the sale of the Mortgage Loans or the consummation of the transactions contemplated by this Agreement or (iii) other than the subpoena from the United States Attorney for the Eastern District of Pennsylvania dated May 14, 2003, that might prohibit or materially and adversely affect the performance by the Servicer of its obligations under, or validity or enforceability of, this Agreement or to the Mortgage Loans; (g) No consent, approval, authorization or order of any court or governmental agency or body is required for the execution, delivery and performance by the Servicer of, or compliance by the Servicer with, this Agreement or the consummation of the transactions contemplated by this Agreement, except for such consents, approvals, authorizations or orders, if any, that have been obtained; (h) The consummation of the transactions contemplated by this Agreement are in the ordinary course of business of the Servicer; (i) The information delivered by the Servicer to the Purchaser with respect to the Servicer's loan loss, foreclosure and delinquency experience on mortgage loans underwritten to the same standards as the Mortgage Loans and covering mortgaged properties similar to the Mortgaged Properties, is true and correct in all material respects and includes adjustments for payments which are timely received but which are not honored, due to insufficient funds or for any other reason; and (j) The Servicer will not waive any Prepayment Charge unless it is waived in accordance with Accepted Servicing Practices or the Servicing Addendum. 16 7.03. Representations and Warranties Regarding Individual Mortgage Loans. The Sellers and the Servicer hereby represent and warrant to the Purchaser that, as to each Mortgage Loan, as of the related Closing Date and as of each Reconstitution Date, or as of such date specifically provided herein; provided that the application and interpretation of the following representation and warranties with respect to second lien Mortgage Loans shall be deemed to be modified only to the extent that a specific requirement or guideline addressed in the related Seller's underwriting guidelines for the origination of second lien mortgage loans differs from the comparable requirement or guideline addressed in such Seller's underwriting guidelines for the origination of first lien mortgage loans: (a) The information set forth in the Mortgage Loan Schedule is complete, true and correct as of the related Cut-off Date; (b) The Mortgage Loan is in compliance with all requirements set forth in the Commitment Letter; (c) No Seller has advanced funds, or induced, solicited or knowingly received any advance of funds from a party other than the owner of the related Mortgaged Property, directly or indirectly, for the payment of any amount required by the Mortgage Note or Mortgage, and no Mortgage Loan has been delinquent for more than 30 days (as of any month end) in the prior 12 months as of the related Closing Date; (d) There are no delinquent taxes, ground rents, water charges, sewer rents, assessments, insurance premiums, leasehold payments, including assessments payable in future installments or other outstanding charges affecting the related Mortgaged Property; (e) The terms of the Mortgage Note and the Mortgage have not been impaired, waived, altered or modified in any respect, except by written instruments, recorded in the applicable public recording office if necessary to maintain the lien priority of the Mortgage, and which have been delivered to the Custodian; the substance of any such waiver, alteration or modification has been approved by the title insurer, to the extent required by the related policy, and is reflected on the Mortgage Loan Schedule. No instrument of waiver, alteration or modification has been executed, and no Mortgagor has been released, in whole or in part, except in connection with an assumption agreement approved by the title insurer, to the extent required by the policy, and which assumption agreement has been delivered to the Custodian and the terms of which are reflected in the Mortgage Loan Schedule; (f) The Mortgage Note and the Mortgage are not subject to any right of rescission, set-off, counterclaim or defense, including the defense of usury, nor will the operation of any of the terms of the Mortgage Note and the Mortgage, or the exercise of any right thereunder, render the Mortgage unenforceable, in whole or in part, or subject to any right of rescission, set-off, counterclaim or defense, including the defense of usury and no such right of rescission, set-off, counterclaim or defense has been asserted with respect thereto; 17 (g) All buildings upon the Mortgaged Property are insured by a generally acceptable insurer against loss by fire, hazards of extended coverage and such other hazards as are customary in the area where the Mortgaged Property is located, pursuant to insurance policies conforming to the requirements of the Servicing Addendum. All such insurance policies contain a standard mortgagee clause naming the Servicer, its successors and assigns as mortgagee and all premiums thereon have been paid. If upon origination of the Mortgage Loan, the Mortgaged Property was in an area identified on a Flood Hazard Map or Flood Insurance Rate Map issued by the Federal Emergency Management Agency as having special flood hazards (and such flood insurance has been made available) a flood insurance policy meeting the requirements of the current guidelines of the Federal Insurance Administration is in effect. The Mortgage obligates the Mortgagor thereunder to maintain all such insurance at the Mortgagor's cost and expense, and on the Mortgagor's failure to do so, authorizes the holder of the Mortgage to maintain such insurance at Mortgagor's cost and expense and to seek reimbursement therefor from the Mortgagor; (h) Each Mortgage Loan at the time it was made complied in all material respects with all applicable local, state and federal laws, including, without limitation, usury, equal credit opportunity, disclosure, recording and all applicable predatory and abusive lending laws; (i) The Mortgage has not been satisfied, canceled, subordinated or rescinded, in whole or in part, and the Mortgaged Property has not been released from the lien of the Mortgage, in whole or in part, nor has any instrument been executed that would effect any such satisfaction, cancellation, subordination, rescission or release; (j) With respect to a first lien Mortgage Loan, the Mortgage creates a first lien or a first priority ownership interest in the related Mortgaged Property. With respect to a second lien Mortgage Loan, the Mortgage creates a second lien or a second priority ownership interest in the related Mortgaged Property; (k) With respect to any first lien Mortgage Loan, the related Mortgage is a valid, existing and enforceable first lien on the related Mortgaged Property and, with respect to any second lien Mortgage Loan, the related Mortgage is a valid, existing and enforceable second lien on the related Mortgaged Property, including all improvements on the related Mortgaged Property subject only to (i) with respect to any second lien Mortgage Loan, the related First Lien, (ii) the lien of current real property taxes and assessments not yet due and payable, (iii) covenants, conditions and restrictions, rights of way, easements, mineral right reservations and other matters of the public record as of the date of recording of such Mortgage being acceptable to mortgage lending institutions generally and specifically referred to in the lender's title insurance policy delivered to the originator of the related Mortgage Loan and which do not adversely affect the Appraised Value of the related Mortgaged Property and (iv) other matters to which like properties are commonly subject which do not materially interfere with the benefits of the security intended to be provided by the related Mortgage or the use, enjoyment, value (as determined by Appraised Value) or marketability of the related Mortgaged Property. Any security agreement, chattel mortgage or equivalent document related to and delivered in connection with the Mortgage Loan establishes and creates (1) with respect to any first lien Mortgage Loan, a valid, subsisting, enforceable and perfected first lien and first priority security interest and (2) with respect to any second lien Mortgage Loan, a valid, subsisting, enforceable and perfected second lien and second priority security interest, in each case, on the property described therein, and the Seller has the full right to sell and assign the same to the Purchaser; 18 (l) The Mortgage Note and the related Mortgage are genuine and each is the legal, valid and binding obligation of the maker thereof, enforceable in accordance with its terms; (m) All parties to the Mortgage Note and the Mortgage had legal capacity to enter into the Mortgage Loan and to execute and deliver the Mortgage Note and the Mortgage, and the Mortgage Note and the Mortgage have been duly and properly executed by such parties. The Mortgagor is a natural person who is a party to the Mortgage Note and the Mortgage is in an individual capacity or family trust that is guaranteed by a natural person; (n) The proceeds of the Mortgage Loan have been fully disbursed to or for the account of the Mortgagor and there is no obligation for the Mortgagee to advance additional funds thereunder and any and all requirements as to completion of any on-site or off-site improvement and as to disbursements of any escrow funds therefor have been complied with. All costs, fees and expenses incurred in making or closing the Mortgage Loan and the recording of the Mortgage have been paid, and the Mortgagor is not entitled to any refund of any amounts paid or due to the Mortgagee pursuant to the Mortgage Note or Mortgage; (o) As of the related Closing Date and immediately prior to the sale of the Mortgage Loan hereunder, each Seller is the sole legal, beneficial and equitable owner of the related Mortgage Note and the related Mortgage and has full right to transfer and sell the Mortgage Loan to the Purchaser free and clear of any encumbrance, equity, lien, pledge, charge, claim or security interest; (p) All parties which have had any interest in the Mortgage Loan, whether as mortgagee, assignee, pledgee or otherwise, are (or, during the period in which they held and disposed of such interest, were) in compliance with any and all applicable "doing business" and licensing requirements of the laws of the state wherein the Mortgaged Property is located; (q) The Mortgage Loan is covered by an ALTA lender's title insurance policy issued by a title insurer indicated in the Mortgage File and qualified to do business in the jurisdiction where the Mortgaged Property is located, insuring (subject to the exceptions contained in (j)(ii) and (iii) above) the related Seller or Servicer, its successors and assigns as to the first or second, as applicable, priority lien of the Mortgage in the original principal amount of the Mortgage Loan. Additionally, such lender's title insurance policy affirmatively insures ingress and egress to and from the Mortgaged Property, and against encroachments by or upon the Mortgaged Property or any interest therein. The related Seller or Servicer is the sole insured of such lender's title insurance policy, and such lender's title insurance policy is in full force and effect and will be in full force and effect upon the consummation of the transactions contemplated by this Agreement. Such lender's title insurance policy has been duly and validly endorsed to the Purchaser or the assignment to the Purchaser of the Servicer's interest therein does not require the consent of or notification to the related insurer. No claims have been made under such lender's title insurance policy, and no prior holder of the related Mortgage, including the related Seller, has done, by act or omission, anything which would impair the coverage of such lender's title insurance policy; 19 (r) As of the related Closing Date, there is no default, breach, violation or event of acceleration existing under the Mortgage or the Mortgage Note and no event which, with the passage of time or with notice and the expiration of any grace or cure period, would constitute a default, breach, violation or event of acceleration; and as of the related Closing Date and Reconstitution Date, the Sellers or the Servicer has not waived any default, breach, violation or event of acceleration. With respect to each second lien Mortgage Loan, (i) the First Lien is in full force and effect, (ii) to the related Seller's knowledge, there is no default, breach, violation or event of acceleration existing under such prior mortgage or the related mortgage note, (iii) no event which, with the passage of time or with notice and the expiration of any grace or cure period, has occurred that would constitute a default, breach, violation or event of acceleration thereunder, and (iv) either (A) the prior mortgage contains a provision which allows or (B) applicable law requires, the mortgagee under the second lien Mortgage Loan to receive notice of, and affords such mortgagee an opportunity to cure any default by payment in full or otherwise under the prior mortgage. For purposes of the foregoing, a delinquent payment of less than 30 days on a Mortgage Loan in and of itself does not constitute a default, breach, violation or event of acceleration with respect to such Mortgage Loan. (s) There are no mechanics' or similar liens or claims which have been filed for work, labor or material (and no rights are outstanding that under law could give rise to such lien) affecting the related Mortgaged Property which are or may be liens prior to, or equal or coordinate with, the lien of the related Mortgage; (t) All improvements which were considered in determining the Appraised Value of the related Mortgaged Property lay wholly within the boundaries and building restriction lines of the Mortgaged Property, and no improvements on adjoining properties encroach upon the Mortgaged Property. Each appraisal has been performed in accordance with the provisions of the Financial Institutions Reform, Recovery and Enforcement Act of 1989; (u) The Mortgage Loan was (i) originated by a Seller or by a savings and loan association, a savings bank, a commercial bank or similar banking institution which is supervised and examined by a federal or state authority, or by a mortgagee approved as such by the Secretary of HUD or (ii) acquired by a Seller directly through loan brokers or correspondents such that (a) the Mortgage Loan was originated in conformity with such Seller's underwriting guidelines, (b) such Seller approved the Mortgage Loan prior to funding and (c) such Seller provided, or caused one of its lenders to provide, the funds used to originate the Mortgage Loan and acquired the Mortgage Loan on the date of origination thereof; (v) Principal payments on the Mortgage Loan are scheduled to commence no more than sixty days after the proceeds of the Mortgage Loan are disbursed. The Mortgage Loan bears interest at the Mortgage Interest Rate. Interest on the Mortgage Loan is calculated on the basis of a 360-day year consisting of twelve 30-day months. The Mortgage Note does not permit negative amortization; (w) The origination and collection practices used by the Sellers and the Servicer, as applicable, with respect to each Mortgage Note and Mortgage have been in all respects legal, proper, prudent and customary in the mortgage origination and servicing industry. The Mortgage Loan has been serviced by the Servicer and any predecessor servicer in accordance with the terms of the Mortgage Note and applicable law. With respect to escrow deposits and Escrow Payments, if any, all such payments are in the possession of, or under the control with, the Servicer, and there exist no deficiencies in connection therewith for which customary arrangements for repayment thereof have not been made. No escrow deposits or Escrow Payments or other charges or payments due the Servicer have been capitalized under any Mortgage or the related Mortgage Note; 20 (x) The Mortgaged Property is free of damage and waste and there is no proceeding pending for the total or partial condemnation thereof; (y) The Mortgage and related Mortgage Note contain customary and enforceable provisions such as to render the rights and remedies of the holder thereof adequate for the realization against the Mortgaged Property of the benefits of the security provided thereby, including, (i) in the case of a Mortgage designated as a deed of trust, by trustee's sale, and (ii) otherwise by judicial foreclosure. Since the date of origination of the Mortgage Loan, the Mortgaged Property has not been subject to any bankruptcy proceeding or foreclosure proceeding and the Mortgagor has not filed for protection under applicable bankruptcy laws. There is no homestead or other exemption available to the Mortgagor, which would interfere with the right to sell the Mortgaged Property at a trustee's sale or the right to foreclose the Mortgage. The Mortgagor has not notified the Servicer or any Seller and neither the Sellers nor the Servicer has any knowledge of any relief requested or allowed to the Mortgagor under the Soldiers and Sailors Civil Relief Act of 1940; (z) The related Mortgaged Property is not a leasehold estate or, if such Mortgaged Property is a leasehold estate, the remaining term of such lease is at least ten (10) years greater than the remaining term of the related Mortgage Note; (aa) The Mortgage Note is not and has not been secured by any collateral except the lien of the corresponding Mortgage on the Mortgaged Property, any commercial mortgage granted for a business purpose and the security interest of any applicable security agreement or chattel mortgage referred to above; (bb) The Mortgage File contains an appraisal of the related Mortgaged Property made and signed, prior to the approval of the Mortgage Loan application, by a qualified appraiser who had no interest, direct or indirect in the Mortgaged Property or in any loan made on the security thereof, whose compensation is not affected by the approval or disapproval of the Mortgage Loan; (cc) In the event the Mortgage constitutes a deed of trust, a trustee, duly qualified under applicable law to serve as such, has been properly designated and currently so serves and is named in the Mortgage, and no fees or expenses are or will become payable by the Purchaser to the trustee under the deed of trust, except in connection with a trustee's sale after default by the Mortgagor; (dd) No Mortgage Loan contains provisions pursuant to which Monthly Payments are (i) paid or partially paid with funds deposited in any separate account established by the related Seller, the Mortgagor, or anyone on behalf of the Mortgagor, (ii) paid by any source other than the Mortgagor or (ii) contains any other similar provisions which may constitute a "buydown" provision. The Mortgage Loan is not a graduated payment mortgage loan and the Mortgage Loan does not have a shared appreciation or other contingent interest feature; 21 (ee) The Mortgagor has executed a statement to the effect that the Mortgagor has received the specified disclosure materials required by applicable law with respect to the making of a Refinanced Mortgage Loan, and evidence of such receipt is and will remain in the Mortgage File; (ff) The Mortgage Note, the Mortgage, the Assignment of Mortgage and any other documents required to be delivered with respect to each Mortgage Loan pursuant to the Custodial Agreement, have been delivered to the Custodian all in compliance with the specific requirements of the Custodial Agreement; (gg) The Mortgaged Property is lawfully occupied under applicable law; all inspections, licenses and certificates required to be made or issued with respect to all occupied portions of the Mortgaged Property and, with respect to the use and occupancy of the same, including but not limited to certificates of occupancy, have been made or obtained from the appropriate authorities; (hh) No error, omission, misrepresentation, negligence, fraud or similar occurrence with respect to a Mortgage Loan has taken place on the part of any person, including, without limitation, the Mortgagor, any appraiser, any builder or developer, or any other party involved in the origination of the Mortgage Loan or in the application of any insurance in relation to such Mortgage Loan; (ii) The Assignment of Mortgage, is in recordable form and (other than with respect to the blank assignee) is acceptable for recording under the laws of the jurisdiction in which the Mortgaged Property is located. When endorsed as provided for in this Agreement, the Mortgage Notes will be duly endorsed under applicable law; (jj) Any principal advances made to the Mortgagor prior to the related Cut-off Date have been consolidated with the outstanding principal amount secured by the Mortgage, and the secured principal amount, as consolidated, bears a single interest rate and single repayment term. The lien of the Mortgage securing the consolidated principal amount is expressly insured as having first lien priority by a title insurance policy, an endorsement to the policy insuring the mortgagee's consolidated interest or by other title evidence. The consolidated principal amount does not exceed the original principal amount of the Mortgage Loan; (kk) Reserved; (ll) No statement, report or other document constituting a part of the Mortgage File contains any material untrue statement of fact or omits to state a fact necessary to make the statements contained therein not misleading which would, either individually or in the aggregate, have a material adverse effect on the value of the Mortgage Loans; no error or omission, misrepresentations, negligence, fraud or similar occurrence with respect to any Mortgage Loan has taken place on the part of any person, including without limitation, the Mortgagor, any appraiser, any builder or developer, or any other party involved in the origination of the Mortgage Loan or in the application for any insurance in relation to the Mortgage Loan; 22 (mm) Assuming a REMIC election were made with respect to a trust of which the Mortgage Loans are a part, each Mortgage Loan constitutes a "qualified mortgage" within the meaning of Section 860G(a)(3) of the Code; (nn) No Mortgage Loan has an LTV or CLTV, as applicable, of more than 100%; (oo) With respect to any second lien Mortgage Loan, either (a) no consent for the second lien Mortgage Loan is required by the holder of the related First Lien or (b) such consent has been obtained and is contained in the Mortgage File; (pp) With respect to any second lien Mortgage Loan, neither the Sellers nor the Servicer has received notice of (1) any proceeding for the total or partial condemnation of any Mortgaged Property or (2) any default under any mortgage, lien or other encumbrance senior to the related Mortgage; (qq) With respect to any second lien Mortgage Loan, where required by law in the jurisdiction in which the Mortgaged Property is located, the original lender has filed for record a request for notice of any action by the senior lienholder under the related First Lien, and the original lender has notified any senior lienholder in writing of the existence of the second lien Mortgage Loan and requested notification of any action to be taken against the Mortgagor by the senior lienholder; (rr) No second lien Mortgage Loan is a "home equity line of credit"; (ss) As of the related Closing Date and with respect to any second lien Mortgage Loan, neither the Seller nor the Servicer has received a notice of default of a First Lien that has not been cured. For purposes of the foregoing, a delinquent payment of less than 30 days on a Mortgage Loan in and of itself does not constitute a default, breach, violation or event of acceleration with respect to such Mortgage Loan; (tt) No Mortgage Loan is a "high cost" mortgage loan, as defined in the applicable predatory and abusive lending laws, including, but not limited to, the Georgia Fair Lending Act and Section 6-L of the New York State Banking Law; and (uu) No Mortgage Loan is subject to the Home Ownership and Equity Protection Act of 1994 ("HOEPA") or in violation of any comparable federal, state or local law; (vv) No Mortgage Loan originated on or after October 1, 2002 and before March 7, 2003 is secured by a Mortgaged Property located in the State of Georgia; (ww) No proceeds from any Mortgage Loan were used to finance single-premium credit insurance policies; 23 (xx) No Mortgage Loan will impose a Prepayment Charge for a term in excess of five years; (yy) The Servicer has fully furnished, in accordance with the Fair Credit Reporting Act and its implementing regulations, accurate and complete information (i.e., favorable and unfavorable) on its borrower credit files to Equifax, Experian and Trans Union Credit Information Seller, on a monthly basis; (zz) With respect to any Mortgage Loan secured by a manufactured home, each such contract is secured by a "single family residence" within the meaning of Section 25(e)(10) of the Internal Revenue Code of 1986, as amended (the "Code"). The fair market value of the manufactured home securing each such contract was at least equal to 80% of the adjusted issue price of the contract at either (i) the time the contract was originated (determined pursuant to REMIC Provisions) or (ii) the time the contract is transferred to the Initial Purchaser. Assuming a REMIC election were made with respect to a trust of which the Mortgage Loans secured by a manufactured home are a part, each such contract is a "qualified mortgage" under Section 860(a)(3) of the Code. (aaa) With respect to each Mortgage Loan subject to a Prepayment Charge, such Prepayment Charge, at the time of the origination of the related Mortgage Loan, is enforceable and in compliance with all applicable local, state and federal law. 7.04. Remedies for Breach of Representations and Warranties. It is understood and agreed that the representations and warranties set forth in Subsections 7.01, 7.02 and 7.03 shall survive the sale of the Mortgage Loans to the Purchaser and shall inure to the benefit of the Purchaser, notwithstanding any restrictive or qualified endorsement on any Mortgage Note or Assignment of Mortgage or the examination or lack of examination of any Mortgage File. Upon discovery by the Purchaser of a breach of any of the foregoing representations and warranties which materially and adversely affects the value of the Mortgage Loans or the interest of the Purchaser (or which materially and adversely affects the interests of the Purchaser in the related Mortgage Loan in the case of a representation and warranty relating to a particular Mortgage Loan), the party discovering such breach shall give prompt written notice to the others. Any breach of the representations and warranties set forth in Subsections 7.03(uu) through 7.03(aaa) shall be deemed to materially and adversely affect the value of the related Mortgage Loan. With respect to any representation and warranties described in this Subsections 7.01, 7.02 and 7.03 which are made to a Seller's knowledge if it is discovered that the substance of such representation and warranty is inaccurate and such inaccuracy materially and adversely affects the value of the related Mortgage Loan or the interests of the Purchaser therein, notwithstanding such Seller's lack of knowledge with respect to the substance of such representation or warranty, such inaccuracy shall be deemed a breach of the applicable representation or warranty. With respect to the representation and warranty described in Subsection 7.02(f)(iii), if it is discovered that the substance of such representation and warranty is inaccurate and such inaccuracy materially and adversely affects the value of the Mortgage Loans or the interests of the Purchaser therein, notwithstanding the disclosure of the existence of the subpoena by the Sellers, such inaccuracy shall be deemed a breach of that representation and warranty. 24 Within 60 days of the earlier of either discovery by or notice to a Seller of any breach of a representation or warranty which materially and adversely affects the value of a Mortgage Loan or the Mortgage Loans, such Seller shall use its best efforts promptly to cure such breach in all material respects and, if such breach cannot be cured, such Seller shall, at the Purchaser's option, repurchase such Mortgage Loan at the Repurchase Price. In the event that a breach shall involve any representation or warranty set forth in Subsection 7.01 which materially and adversely affects the value of the Mortgage Loans and such breach cannot be cured within 60 days of the earlier of either discovery by or notice to such Seller of such breach, all of the Mortgage Loans shall, at the Purchaser's option, be repurchased by the Sellers at the Repurchase Price. Any repurchase of a Mortgage Loan(s) pursuant to the foregoing provisions of this Subsection 7.04 shall occur on a date designated by the Purchaser and shall be accomplished (i) during the Interim Servicing Period by deposit in the Custodial Account of the amount of the Repurchase Price for distribution to the Purchaser on the next scheduled Distribution Date and (ii) following the Interim Servicing Period, by wire transfer of immediately available funds on the repurchase date to an account designated by the Purchaser. Notwithstanding the foregoing, if a Seller discovers or receives notice of any such breach or defect, such Seller may remove any such Deleted Mortgage Loan, rather than repurchase any such Mortgage Loan as provided above, and substitute in its place a Qualified Substitute Mortgage Loan(s). For each Qualified Substitute Mortgage Loan(s) substituted for a Deleted Mortgage Loan, the related Seller shall deliver to the Custodian the documents specified in Subsection 6.03, with the Mortgage Note endorsed as required by Subsection 6.03 and, where applicable, original documents having evidence of recording thereon. Such Seller shall also take such actions with respect to the documents pertaining to each such Qualified Substitute Mortgage Loan as are required to be taken pursuant to Subsection 6.03 with respect to the Mortgage Loans originally subject to this Agreement. For purposes of applying the requirements of Subsection 6.03 to any Qualified Substitute Mortgage Loan, references in such Subsection to the related Closing Date shall be deemed to be references to the applicable date of substitution of such Qualified Substitute Mortgage Loan. Each Seller shall deposit in the Custodial Account the Monthly Payment due on each Qualified Substitute Mortgage Loan in the month following the date of such substitution (with the interest portion thereof adjusted to the applicable Mortgage Loan Remittance Rate), and the Monthly Payment due with respect to such Qualified Substitute Mortgage Loan in the month of substitution shall be retained by such Seller. For the month of substitution, distributions to the Purchaser shall include the Monthly Payment due on such Deleted Mortgage Loan in the month of substitution, including all interest due up to, but not including, the date of substitution, and each Seller shall thereafter be entitled to retain all amounts subsequently received by such Seller in respect of such Deleted Mortgage Loan. Each Seller shall amend the related Mortgage Loan Schedule to reflect the removal of such Deleted Mortgage Loan from the terms of this Agreement and the substitution of the Qualified Substitute Mortgage Loan(s) and shall give written notice to the Purchaser that such substitution has taken place, which notice shall have attached thereto a copy of such amended Mortgage Loan Schedule in hard copy or "read-only" electronic format (as reasonably acceptable to the Sellers and the Purchaser). Upon such substitution, each such Qualified Substitute Mortgage Loan shall be subject to the terms of this Agreement in all respects, and each Seller shall make and shall be deemed to have made, with respect to such Qualified Substitute Mortgage Loan(s), as of the date of substitution or of any reconstitution, the representations and warranties set forth in Subsections 7.01 and 7.03 (and, for purposes of applying such representations and warranties to each such Qualified Substitute Mortgage Loan, references in such Subsections to the related Closing Date shall be deemed to be references to such date of substitution of such Qualified Substitute Mortgage Loan). 25 For any month in which a Seller substitutes one or more Qualified Substitute Mortgage Loans for one or more Deleted Mortgage Loans, the Servicer shall determine and notify such Seller and the Purchaser of the amount, if any, by which the aggregate Stated Principal Balance of all such Qualified Substitute Mortgage Loans as of the date of substitution is less than the aggregate Stated Principal Balance of all such Deleted Mortgage Loans (after application of scheduled principal payments due in the month of substitution). Each Seller shall deposit from its own funds (and without any right of reimbursement therefor) into the Custodial Account an amount equal to the amount of such shortfall. Prior to the repurchase or substitution of any deficient Mortgage Loan, the Purchaser and each Seller shall arrange for (1) the reassignment of the repurchased Mortgage Loan or Deleted Mortgage Loan to each Seller, without recourse, and (2) the delivery to such Seller of any documents held by the Custodian relating to the repurchased Mortgage Loan or Deleted Mortgage Loan. In the event the Repurchase Price is deposited in the Custodial Account, each Seller shall, simultaneously with such deposit, give written notice to the Purchaser that such deposit has taken place. Upon such repurchase, the Mortgage Loan Schedule shall be amended to reflect the withdrawal of the repurchased Mortgage Loan from this Agreement. Payments of principal received by the Purchaser with respect to a repurchased Mortgage Loan shall belong to the respective Seller (to the extent not deducted in the Stated Principal Balance on the related repurchase date) and the Purchaser shall forward such payments of principal to the respective Seller within five (5) Business Days. Each Seller shall also be required to promptly repurchase at the Repurchase Price or substitute any Mortgage Loan that is a First Payment Default Loan; provided, however, that such repurchase request must be made within 90 days of such default. In addition to such cure, repurchase and substitution obligation, the Sellers or the Servicer, as applicable, shall indemnify the Purchaser and hold it harmless against any losses, damages, penalties, fines, forfeitures, reasonable and necessary legal fees and related costs including those incurred in an action between the parties, judgments, and other costs and expenses resulting from any claim, demand, defense or assertion based on or grounded upon, or resulting from, a breach of a Seller's or Servicer's representations and warranties, as applicable, contained in Section 7 (including the representation and warranty described in Subsection 7.02(f)(iii) notwithstanding the disclosure to the Purchaser of the existence of the subpoena referred to therein). It is understood and agreed that the obligations of the Sellers set forth in this Section 7 to cure, repurchase or substitute a defective Mortgage Loan and to indemnify the Purchaser constitute the sole remedies of the Purchaser respecting a breach of a Seller's representations and warranties contained in Section 7. 26 Any cause of action against the Sellers or the Servicer, as applicable, relating to or arising out of the breach of any representations and warranties made in Subsections 7.01, 7.02 or 7.03, as applicable, shall accrue as to any Mortgage Loan upon (i) discovery of such breach by the Purchaser or notice thereof by a Seller or the Servicer, as applicable, to the Purchaser, (ii) failure by the Sellers or the Servicer, as applicable, to cure such breach or repurchase such Mortgage Loan as specified above, and (iii) demand upon a Seller or the Servicer, as applicable, by the Purchaser for compliance with the relevant provisions of this Agreement. 7.05. Prepayments and Partial Prepayments. (a) In the event that any full Principal Prepayments are made on any Mortgage Loans on or before ninety (90) days after the related Closing Date and such Mortgage Loans do not entail a Prepayment Charge, the Seller shall pay to the Purchaser an amount equal to the sum of (a) the product of (i) the aggregate amount of such full Principal Prepayment multiplied by (ii) the excess, if any, of the Purchase Price percentage as stated in the Commitment Letter over 100%. (b) Any Prepayment Charges received on the Mortgage Loans shall be distributed to the Purchaser. In the event the Servicer waives the obligation of a Mortgagor to make a Prepayment Charge in connection with any full or partial Principal Prepayment, the Servicer shall distribute or cause to be distributed the amount of the Prepayment Charge otherwise payable to the Purchaser. The Servicer shall be required to enforce the obligation of any Mortgagor to pay a Prepayment Charge. (c) The Purchaser agrees not to directly solicit the Mortgagors for a refinance during the ninety day period referred to in Section 7.05(a). 7.06. First Payment Default Loans. With respect to each First Payment Default Loan, the related Seller shall (i) repurchase such First Payment Default Loan at the Purchase Price, plus accrued interest on the Stated Principal Balance at the Mortgage Loan Remittance Rate from the date on which interest has last been paid and distributed to the Purchaser to date of repurchase, less amounts received or advanced in respect of such First Payment Default Loan which are being held in the Custodial Account for distribution in the month of repurchase, plus all actual costs and expenses (excluding Purchaser's internal or overhead costs), including reasonable attorney fees, incurred by the Purchaser to effect such repurchases, within thirty (30) days of demand thereof, (ii) recalculate the purchase price of such First Payment Default Loan as agreed to by the parties and remit any monies owed to the Purchaser as a result of such recalculation within thirty (30) days of demand thereof, or (iii) substitute a Qualified Substitute Mortgage Loan for such First Payment Default Mortgage Loan; provided, however, that any such request to repurchase or substitute a Mortgage Loan must be made within 90 days of such default. 8. Closing. The closing shall take place on the related Closing Date. At the Purchaser's option, the closing shall be either: by telephone, confirmed by letter or wire as the parties shall agree, or conducted in person, at such place as the parties shall agree. The closing for the Mortgage Loans to be purchased on the related Closing Date shall be subject to each of the following conditions: 27 (a) all of the representations and warranties of the Sellers and the Servicer under this Agreement shall be true and correct as of the related Closing Date and no event shall have occurred which, with notice or the passage of time, would constitute a default under this Agreement; (b) the Initial Purchaser shall have received, or the Initial Purchaser's attorneys shall have received in escrow, all Closing Documents and other documents specified in Section 9 of this Agreement in such forms as are agreed upon and acceptable to the Purchaser, duly executed by all signatories other than the Purchaser as required pursuant to the terms hereof; (c) the Sellers shall have delivered and released to the Custodian all documents required pursuant to the Custodial Agreement; and (d) all other terms and conditions of this Agreement shall have been complied with. Subject to the foregoing conditions, the Initial Purchaser shall pay to the related Seller on the related Closing Date the Purchase Price, plus accrued interest pursuant to Section 4, by wire transfer of immediately available funds to the account designated by such Seller. 9. Closing Documents. (a) On or before the related Closing Date, the related Seller or the Servicer, as applicable, shall submit to the Initial Purchaser fully executed originals of the following documents: 1. this Agreement, in counterparts; 2. the Custodial Agreement, in counterparts, in the form attached as Exhibit 6 hereto; 3. a Custodial Account Letter Agreement in the form attached as Exhibit 7 hereto; 4. an Escrow Account Letter Agreement in the form attached as Exhibit 8 hereto; 5. Officer's Certificates of each Seller, in the form of Exhibit 1A hereto, including all attachments thereto; 6. an Officer's Certificate of the Servicer, in the form of Exhibit 1B hereto, including all attachments thereto; 7. Opinion(s) of Counsel to Sellers and the Servicer, in the form of Exhibit 2 hereto, including any attachments thereto; 28 8. an Assignment and Conveyance in the form of Exhibit 4 hereto; and 9. the related Commitment Letter. (b) The Closing Documents for the Mortgage Loans to be purchased on the related Closing Date shall consist of fully executed originals of the following documents: 1. the related Mortgage Loan Schedule, one copy to be attached hereto and one copy to be attached to the Custodian's counterpart to the Custodial Agreement, as the Mortgage Loan Schedule thereto; 2. a Custodian's Trust Receipt and Certification, as required under the Custodial Agreement, in the form attached to the Custodial Agreement; 3. Officer's Certificates of the Sellers, in the form of Exhibit 1A hereto, including all attachments thereto; 4. an Officer's Certificate of the Servicer, in the form of Exhibit 1B hereto, including all attachments thereto; 5. Opinion(s) of Counsel to the Sellers and the Servicer, in the form of Exhibit 2 hereto, including any attachments thereto; 6. a Security Release Certification, in the form of Exhibit 3 hereto executed by any Person, as requested by the Initial Purchaser, if any of the Mortgage Loans has at any time been subject to any security interest, pledge or hypothecation for the benefit of such Person; 7. an Assignment and Conveyance in the form of Exhibit 4 hereto; and 8. the related Commitment Letter, if such Commitment Letter was not delivered pursuant to Section 9(a) above. 10. Costs. The Sellers shall pay all costs and expenses incurred in connection with the transfer and delivery of the Mortgage Loans at the Initial Purchaser's sole discretion and direction, including without limitation recording fees, fees for title policy endorsements and continuations, fees for recording Assignments of Mortgage, (including any fees to complete Assignments of Mortgages) and the fees and expenses of the Sellers' accountants and attorneys. The Initial Purchaser shall pay any commissions due its salesmen, and the costs and expenses of printing (or otherwise reproducing) and delivering a prospectus, prospectus supplement, any private placement memorandum, a Reconstitution Agreement and related documents including the costs of printing any mortgage pass-through certificates, the fees, costs and expenses of any trustee under a Reconstitution Agreement, the fees and expenses of the Purchaser's counsel in connection with the preparation of any Reconstitution Agreements, any filing fees charged by the Securities and Exchange Commission for registration of certificates related to a Reconstitution Agreement and the fees charged by any rating agency to rate certificates related to a Reconstitution Agreement. 29 11. Servicer's Servicing Obligations. The Servicer, as independent contract servicer, shall service and administer the Mortgage Loans during the Interim Servicing Period in accordance with the Servicing Addendum. 12. Reconstitution. The Sellers, the Servicer and the Initial Purchaser agree that with respect to some or all of the Mortgage Loans, the Initial Purchaser may effect one or more Whole Loan Transfers or one or more Pass-Through Transfers within the Reconstitution Period for such Mortgage Loan; however, the Initial Purchaser shall not be entitled to effect more than two Reconstitutions during the Reconstitution Period. With respect to any Reconstitution, the Sellers and the Servicer agree to the following: (a) to cooperate fully with the Initial Purchaser and any prospective purchaser with respect to all reasonable requests and due diligence procedures including participating in meetings with rating agencies, bond insurers and such other parties as the Initial Purchaser shall designate and participating in meetings with prospective purchasers of the Mortgage Loans or interests therein and providing information reasonably requested by such purchasers; (b) to execute all Reconstitution Agreements provided that each of the Sellers, the Servicer and the Initial Purchaser is given an opportunity to review and reasonably negotiate in good faith the content of such documents not specifically referenced or provided for herein; provided, however, no Reconstitution Agreement shall contain any additional provisions which would be deemed to be onerous by the parties unless such provisions are standard industry practice for similar transactions; (c) with respect to any Whole Loan Transfer or Pass-Through Transfer, the Sellers and the Servicer shall make the representations and warranties contained in this Agreement regarding the Sellers or the Servicer, as applicable, and the Mortgage Loans and such other reasonable representations, warranties and covenants which in form and substance conform to the representations and warranties in this Agreement and to secondary market standards for securities backed by mortgage loans similar to the Mortgage Loans and other covenants as required by the Initial Purchaser and one or more nationally recognized rating agencies for "AAA" rated mortgage pass-through transactions; provided that the Sellers and the Servicer shall only be required to make such representations and warranties with respect to the period during which the Servicer serviced the related Mortgage Loans; 30 (d) to deliver to the Initial Purchaser for inclusion in any prospectus or other offering material such publicly available information regarding the Servicer, its financial condition and its mortgage loan delinquency, foreclosure and loss experience and any additional information reasonably requested by the Initial Purchaser, and to deliver to the Initial Purchaser any similar non-public, unaudited financial information (which the Initial Purchaser may, at its option and cost, have audited by certified public accountants) and such other information as is reasonably requested by the Initial Purchaser and which the Servicer is capable of providing without unreasonable effort or expense. The Servicer and each Seller agrees to indemnify and hold harmless the Purchaser and each person, if any, who controls the Purchaser within the meaning of Section 15 of the 1933 Act (collectively, the "Indemnified Party") against any and all losses, claims, expenses, damages or liabilities to which the Indemnified Party may become subject, under the Securities Act of 1933, as amended (the "1933 Act") or otherwise, insofar as such losses, claims, expenses, damages or liabilities (or actions in respect thereof) arise out of or are based upon (a) any untrue statement or alleged untrue statement of any material fact contained in the Prospectus Supplement or the related Prospectus (or in any related private placement memorandum) or the omission or the alleged omission to state therein a material fact necessary in order to make the statements therein not misleading, in each case to the extent, that such untrue statement or alleged untrue statement or omission or alleged omission was made in reliance upon and in conformity with information furnished in writing to the Purchaser by a Seller or the Servicer, as applicable, specifically for use therein or (b) any representation, warranty or covenant made by a Seller or the Servicer, as applicable, in this Agreement or in any Reconstitution Agreement, on which the Purchaser has relied, being, or alleged to be, untrue or incorrect; provided, however, that to the extent that any such losses, claims, expenses, damages or liabilities to which the Indemnified Party may become subject arise out of or are based upon both (1) statements, omissions, representations, warranties or covenants of a Seller or the Servicer, as applicable, described in clause (a) or (b) above and (2) any other factual basis, the Sellers or the Servicer, as applicable, shall indemnify and hold harmless the Indemnified Party only to the extent that the losses, claims, expenses, damages or liabilities of the person or persons asserting the claim are determined to arise from or be based upon matters set forth above. This indemnity agreement will be in addition to any liability that each Seller or the Servicer, as applicable, may otherwise have. Notwithstanding the foregoing, each Seller and the Servicer shall have the right to review and comment on the Prospectus Supplement prior to the finalization of such document; (e) to deliver to the Initial Purchaser and to any Person designated by the Initial Purchaser, at the Seller's expense, such statements and audit letters of reputable, certified public accountants pertaining to information provided by the Seller pursuant to clause (d) above as shall be reasonably requested by the Initial Purchaser; (f) to deliver to the Initial Purchaser, and to any Person designated by the Initial Purchaser, such legal documents, Opinions of Counsel and in-house Opinions of Counsel as are customarily delivered by originators or servicers, as the case may be, and reasonably determined by the Initial Purchaser to be necessary in connection with Whole Loan Transfers or Pass-Through Transfers, as the case may be, such Opinions of Counsel and in-house Opinions of Counsel for a Pass-Through Transfer to be in a form reasonably acceptable to the Initial Purchaser, it being understood that the cost of any opinions of outside special counsel that may be required for a Whole Loan Transfer or Pass-Through Transfer, as the case may be, shall be the responsibility of the Initial Purchaser; (g) to cooperate fully with the Initial Purchaser and any prospective purchaser with respect to the delivery of Mortgage Loan Documents and other related documents, with respect to servicing requirements reasonably requested by the rating agencies and credit enhancers; 31 (h) to negotiate in good faith and execute one or more subservicing agreements between the Servicer and any master servicer which is generally considered to be a prudent master servicer in the secondary mortgage market, designated by the Initial Purchaser in its sole discretion after consultation with the Servicer and/or one or more custodial and servicing agreements among the Initial Purchaser or an Affiliate, the Servicer, the Sellers and a third party custodian/trustee which is generally considered to be a prudent custodian/trustee in the secondary mortgage market and designated by the Initial Purchaser in its sole discretion after consultation with the Servicer, in either case at a market rate subservicing fee and for the purpose of pooling the Mortgage Loans with other Mortgage Loans for resale or securitization; and (i) in connection with any securitization of any Mortgage Loans, to execute a pooling and servicing agreement, which pooling and servicing agreement may, at the Initial Purchaser's direction, contain mortgage loan representations and warranties which in form and substance conform to the representations and warranties in this Agreement and to secondary market standards for securities backed by mortgage loans similar to the Mortgage Loans and other covenants as are required by the Initial Purchaser and one or more nationally recognized rating agencies for "AAA" rated mortgage pass-through transactions, unless otherwise mutually agreed. If the Initial Purchaser deems it advisable at any time to pool the Mortgage Loans with other mortgage loans for the purpose of resale or securitization, the Servicer agrees to execute one or more subservicing agreements between itself (as master servicer) and a sub-servicer designated by the Initial Purchaser at its sole discretion, and/or one or more servicing agreements among the Servicer (as servicer), the Initial Purchaser or an Affiliate and a trustee designated by the Initial Purchaser at its sole discretion, such agreements in each case incorporating terms and provisions, such as a market rate subservicing fee, substantially identical to those described in the immediately preceding paragraph. All Mortgage Loans not sold or transferred pursuant to a Whole Loan Transfer or Pass-Through Transfer shall be subject to this Agreement and shall continue to be serviced for the remainder of the Interim Servicing Period in accordance with the terms of this Agreement and with respect thereto this Agreement shall remain in full force and effect. 13. The Servicer. 13.01. Additional Indemnification by the Servicer. In addition to the indemnification provided in Subsection 7.04, the Servicer shall indemnify the Purchaser and hold the Purchaser harmless against any and all claims, losses, damages, penalties, fines, forfeitures, reasonable and necessary legal fees and related costs, judgments, and any other costs, fees and expenses that the Purchaser may sustain in any way related to the failure of the Servicer to perform its obligations under this Agreement including but not limited to the Servicer's obligation to service and administer the Mortgage Loans in strict compliance with the terms of this Agreement or any Reconstitution Agreement entered into pursuant to Section 12. 13.02. Merger or Consolidation of the Servicer. The Servicer shall keep in full force and effect its existence, rights and franchises as a corporation under the laws of the state of its incorporation except as permitted herein, and shall obtain and preserve its qualification to do business as a foreign corporation in each jurisdiction in which such qualification is or shall be necessary to protect the validity and enforceability of this Agreement or any of the Mortgage Loans, and to enable the Servicer to perform its duties under this Agreement. 32 Any Person into which the Servicer may be merged or consolidated, or any corporation resulting from any merger, conversion or consolidation to which the Servicer shall be a party, or any Person succeeding to the business of the Servicer, shall be the successor of the Servicer hereunder, as applicable, without the execution or filing of any paper or any further act on the part of any of the parties hereto, anything herein to the contrary notwithstanding; provided, however, that the successor or surviving Person with respect to the Servicer shall be an institution whose deposits are insured by FDIC or a company whose business is the origination and servicing of mortgage loans, shall be a Fannie Mae or Freddie Mac approved seller/servicer and shall satisfy any requirements of Section 16 with respect to the qualifications of a successor to the Servicer. 13.03. Limitation on Liability of the Sellers, the Servicer and Others. Neither the Servicer, nor any of the officers, employees or agents of the Servicer shall be under any liability to the Purchaser for any action taken or for refraining from the taking of any action in good faith in connection with the servicing of the Mortgage Loans pursuant to this Agreement, or for errors in judgment; provided, however, that this provision shall not protect the Sellers or the Servicer or any such person against any breach of warranties or representations made herein, or failure to perform its obligations in strict compliance with any standard of care set forth in this Agreement, or any liability which would otherwise be imposed by reason of any breach of the terms and conditions of this Agreement. The Sellers or the Servicer or any officer, employee or agent of the Sellers or Servicer may rely in good faith on any document of any kind prima facie properly executed and submitted by any Person respecting any matters arising hereunder. Neither the Sellers nor the Servicer shall be under any obligation to appear in, prosecute or defend any legal action which is not incidental to its obligation to sell or duty to service the Mortgage Loans in accordance with this Agreement and which in its opinion may involve it in any expenses or liability; provided, however, that the Servicer may, with the consent of the Purchaser, undertake any such action which it may deem necessary or desirable in respect to this Agreement and the rights and duties of the parties hereto. In such event, the legal expenses and costs of such action and any liability resulting therefrom shall be expenses, costs and liabilities for which the Purchaser shall be liable, the Servicer or shall be entitled to reimbursement therefor from the Purchaser upon written demand except when such expenses, costs and liabilities are subject to the Servicer's indemnification under Subsections 7.04 or 13.01. 13.04. Servicer Not to Resign. The Servicer shall not assign this Agreement or any rights or obligations hereunder or resign from the obligations and duties hereby imposed on it except by mutual consent of the parties hereto, or with respect to the Servicer, upon the determination that its servicing duties hereunder are no longer permissible under applicable law and such incapacity cannot be cured by the Servicer in which event the Servicer may resign as Servicer. Any such determination permitting the resignation of the Servicer as servicer shall be evidenced by an Opinion of Counsel to such effect delivered to the Purchaser which Opinion of Counsel shall be in form and substance acceptable to the Purchaser. No such resignation shall become effective until a successor shall have assumed the Servicer's responsibilities and obligations hereunder in the manner provided in Section 16. 13.05. Transfer of Servicing. The Servicer acknowledges that the Purchaser has acted in reliance upon the adequacy of the Servicer's servicing facilities, personnel, records and procedures, its integrity, reputation and financial standing and the continuance thereof. Without in any way limiting the generality of this Section and except with respect to the transfer of servicing described below, the Servicer shall neither assign this Agreement nor the servicing hereunder nor delegate its rights or duties hereunder or any portion thereof, nor sell or otherwise dispose of all or substantially all of its property or assets, without the prior written approval of the Purchaser, which consent will not be unreasonably withheld. 33 On the applicable Servicing Transfer Date, the Purchaser, or its designee, shall assume all servicing responsibilities related to, and the Sellers shall cause the Servicer to cease all servicing responsibilities related to, the related Mortgage Loans subject to such Servicing Transfer Date. On or prior to the applicable Servicing Transfer Date, the Sellers shall, at its sole cost and expense, take such steps as may be necessary or appropriate to effectuate and evidence the transfer of the servicing of the related Mortgage Loans to the Purchaser, or its designee, including but not limited to the following: (a) The Sellers shall cause the Servicer to mail to the Mortgagor of each related Mortgage Loan a letter advising such Mortgagor of the transfer of the servicing of the related Mortgage Loan to the Purchaser, or its designee, in accordance with the Cranston Gonzales National Affordable Housing Act of 1990; provided, however, the content and format of the letter shall have the prior approval of the Purchaser. The Sellers shall cause the Servicer to provide the Purchaser with copies of all such related notices no later than the Servicing Transfer Date. (b) The Sellers shall cause the Servicer to transmit to the applicable taxing authorities and insurance companies (including primary mortgage insurance policy insurers, if applicable) and/or agents, notification of the transfer of the servicing to the Purchaser, or its designee, and instructions to deliver all notices, tax bills and insurance statements, as the case may be, to the Purchaser from and after the Servicing Transfer Date. The Sellers shall cause the Servicer to provide the Purchaser with copies of all such notices no later than the Servicing Transfer Date. (c) The Sellers shall cause the Servicer to forward to the Purchaser, or its designee, all servicing records and the Servicing File in the Servicer's possession relating to each related Mortgage Loan. (d) The Sellers shall cause the Servicer to provide the Purchaser, or its designee, with immediately available funds by wire transfer in the amount of the net Escrow Payments and suspense balances and all loss draft balances associated with the related Mortgage Loans. The Sellers shall cause the Servicer to provide the Purchaser with an accounting statement, in electronic format acceptable to the Purchaser in its sole discretion, of Escrow Payments and suspense balances and loss draft balances sufficient to enable the Purchaser to reconcile the amount of such payment with the accounts of the Mortgage Loans. Additionally, the Sellers shall cause the Servicer to wire transfer to the Purchaser the amount of any agency, trustee or prepaid Mortgage Loan payments and all other similar amounts held by the Servicer. (e) The Sellers shall cause the Servicer to provide to the Purchaser, or its designee, copies of all assumption and payoff statements generated by the Servicer on the related Mortgage Loans from the related Cut-off Date to the Servicing Transfer Date. 34 (f) Prior to the Servicing Transfer Date all payments received by the Servicer or the Sellers on each related Mortgage Loan shall be properly applied by the Sellers to the account of the particular Mortgagor. (g) The amount of any related Monthly Payments received by the Seller after the Servicing Transfer Date shall be forwarded to the Purchaser by overnight mail on the date of receipt. Each Seller shall notify the Purchaser of the particulars of the payment, which notification requirement shall be satisfied if such Seller forwards with its payment sufficient information to permit appropriate processing of the payment by the Purchaser. Such Seller shall assume full responsibility for the necessary and appropriate legal application of such Monthly Payments received by such Seller after the Servicing Transfer Date with respect to related Mortgage Loans then in foreclosure or bankruptcy; provided, for purposes of this Agreement, necessary and appropriate legal application of such Monthly Payments shall include, but not be limited to, endorsement of a Monthly Payment to the Purchaser with the particulars of the payment such as the account number, dollar amount, date received and any special Mortgagor application instructions and such Seller shall cause the Servicer to comply with the foregoing requirements with respect to all Monthly Payments received by the Servicer after the Servicing Transfer Date. (h) Misapplied payments shall be processed as follows: (1) All parties shall cooperate in correcting misapplication errors; (2) The party receiving notice of a misapplied payment occurring prior to the applicable Servicing Transfer Date and discovered after the Servicing Transfer Date shall immediately notify the other party; (3) If a misapplied payment which occurred prior to the Servicing Transfer Date cannot be identified and said misapplied payment has resulted in a shortage in a Custodial Account or Escrow Account, the Sellers shall be liable for the amount of such shortage. The Sellers shall reimburse the Purchaser for the amount of such shortage within thirty (30) days after receipt of written demand therefor from the Purchaser; (4) If a misapplied payment which occurred prior to the Servicing Transfer Date has created an improper Purchase Price as the result of an inaccurate outstanding principal balance, a check shall be issued to the party shorted by the improper payment application within five (5) Business Days after notice thereof by the other party; and (5) Any check issued under the provisions of this Section shall be accompanied by a statement indicating the corresponding Seller and/or the Purchaser Mortgage Loan identification number and an explanation of the allocation of any such payments. 35 (i) On the Servicing Transfer Date, the books, records and accounts of the Sellers with respect to the related Mortgage Loans shall be in accordance with all applicable Purchaser requirements. (j) The Sellers shall, on or before the Servicing Transfer Date, reconcile principal balances and make any monetary adjustments required by the Purchaser. Any such monetary adjustments will be transferred between the Sellers and the Purchaser as appropriate. (k) The Sellers shall or shall cause the Servicer to file all IRS forms 1099, 1099A, 1098 or 1041 and K-1 which are required to be filed on or before the Servicing Transfer Date in relation to the servicing and ownership of the related Mortgage Loans. The Sellers shall provide copies of such forms to the Purchaser upon request and shall reimburse the Purchaser for any costs or penalties incurred by the Purchaser due to the Sellers' failure to comply with this paragraph. (l) The Purchaser agrees to indemnify the Servicer and Sellers against any and all claims, losses, penalties, fines, forfeitures, reasonable legal fees and related costs, judgments, and any other costs, fees and expenses that the Servicer or a Seller may sustain in any way related to the gross negligence of any subsequent servicer of the Mortgage Loans in the performance of its duties in connection with the servicing of the Mortgage Loans; provided that the Purchaser shall have liability under this clause (l) only to the extent that the Purchaser has received indemnification for such claims, losses, penalties, fines, forfeitures, reasonable legal fees and related costs, judgments, and any other costs, fees and expenses from such subsequent servicer. 14. Default. 14.01. Events of Default. In case one or more of the following Events of Default by the Servicer shall occur and be continuing, that is to say: (i) any failure by the Servicer to remit to the Purchaser any payment required to be made under the terms of this Agreement which continues unremedied for a period of three Business Days after the date due; or (ii) failure on the part of the Servicer duly to observe or perform in any material respect any other of the covenants or agreements on the part of the Servicer set forth in this Agreement which continues unremedied for a period of thirty days (except that such number of days shall be fifteen in the case of a failure to pay any premium for any insurance policy required to be maintained under this Agreement) after the date on which written notice of such failure, requiring the same to be remedied, shall have been given to the Servicer by the Purchaser; or (iii) a decree or order of a court or agency or supervisory authority having jurisdiction for the appointment of a conservator or receiver or liquidator in any insolvency, bankruptcy, readjustment of debt, marshalling of assets and liabilities or similar proceedings, or for the winding-up or liquidation of its affairs, shall have been entered against the Servicer and such decree or order shall have remained in force undischarged or unstayed for a period of sixty days; or 36 (iv) the Servicer shall consent to the appointment of a conservator or receiver or liquidator in any insolvency, bankruptcy, readjustment of debt, marshalling of assets and liabilities or similar proceedings of or relating to the servicer or of or relating to all or substantially all of its property; or (v) the Servicer shall admit in writing its inability to pay its debts generally as they become due, file a petition to take advantage of any applicable insolvency or reorganization statute, make an assignment for the benefit of its creditors, or voluntarily suspend payment of its obligations; or (vi) failure by the Servicer to be in compliance with the "doing business" or licensing laws of any jurisdiction where a Mortgaged Property is located which continues unremedied for a period of thirty (30) days after knowledge of such failure by the Servicer; or (vii) other than as provided in Subsection 13.05, the Servicer attempts to assign its right to servicing compensation hereunder or the Servicer attempts, without the consent of the Purchaser, to sell or otherwise dispose of all or substantially all of its property or assets or to assign this Agreement or the servicing responsibilities hereunder or to delegate its duties hereunder or any portion thereof; then, and in each and every such case, so long as an Event of Default shall not have been remedied, the Purchaser, by notice in writing to the Servicer may, in addition to whatever rights the Purchaser may have at law or equity to damages, including injunctive relief and specific performance, terminate all the rights and obligations of the Servicer as servicer under this Agreement. On or after the receipt by the Servicer of such written notice, all authority and power of the Servicer to service the Mortgage Loans under this Agreement shall on the date set forth in such notice pass to and be vested in the successor appointed pursuant to Section 16 herein. 14.02. Waiver of Defaults. The Purchaser may waive any default by the Servicer in the performance of its obligations hereunder and its consequences. Upon any such waiver of a past default, such default shall cease to exist, and any Event of Default arising therefrom shall be deemed to have been remedied for every purpose of this Agreement. No such waiver shall extend to any subsequent or other default or impair any right consequent thereon except to the extent expressly so waived. 15. Termination. The obligations and responsibilities of the Servicer as servicer, shall terminate at the expiration of the Interim Servicing Period unless terminated with respect to all or a portion of the Mortgage Loans on an earlier date at the option of the Purchaser pursuant to this Section 15 or pursuant to Section 14. Upon written request from the Purchaser in connection with any such termination, the Servicer shall prepare, execute and deliver, any and all documents and other instruments, place in the Purchaser's possession all Mortgage Files, and do or accomplish all other acts or things necessary or appropriate to effect the purposes of such notice of termination, whether to complete the transfer and endorsement or assignment of the Mortgage Loans and related documents, or otherwise, at the Servicer's sole expense. The Servicer agrees to cooperate with the Purchaser and such successor in effecting the termination of the Servicer's responsibilities and rights hereunder as servicer, including, without limitation, the transfer to such successor for administration by it of all cash amounts which shall at the time be credited by the Servicer to the Custodial Account or Escrow Account or thereafter received with respect to the Mortgage Loans. 37 16. Successor to the Servicer. Prior to the termination of Servicer's responsibilities and duties under this Agreement pursuant to Section 14 or 15, the Purchaser shall (i) succeed to and assume all of the Servicer's responsibilities, rights, duties and obligations under this Agreement, or (ii) appoint a successor which shall succeed to all rights and assume all of the responsibilities, duties and obligations of the Servicer under this Agreement; provided that the Purchaser or such successor will not assume any liabilities of the Servicer arising from acts or omissions prior to the effective date of termination, for which the Servicer shall remain liable. In connection with such appointment and assumption, the Purchaser may make such arrangements for the compensation of such successor out of payments on Mortgage Loans as it and such successor shall agree. In the event that the Servicer's duties, responsibilities and liabilities as servicer under this Agreement should be terminated pursuant to the aforementioned Sections, the Servicer shall discharge such duties and obligations during the period from the date it acquires knowledge of such termination until the effective date thereof with the same degree of diligence and prudence which it is obligated to exercise under this Agreement, and shall take no action whatsoever that might impair or prejudice the rights or financial condition of the Purchaser or such successor. The termination of the Servicer as servicer pursuant to the aforementioned Sections shall not become effective until a successor shall be appointed pursuant to this Section 16 and shall in no event relieve the Servicer of the representations and warranties made pursuant to Subsections 7.02 and 7.03 and the remedies available to the Purchaser under Subsection 7.04 or 13.01, it being understood and agreed that the provisions of such Subsections 7.01, 7.02, 7.03 and 13.01 shall be applicable to the Servicer and the Sellers, as applicable, notwithstanding any such resignation or termination of the Servicer, or the termination of this Agreement. Any successor appointed as provided herein shall execute, acknowledge and deliver to the Servicer and to the Purchaser an instrument accepting such appointment, whereupon such successor shall become fully vested with all the rights, powers, duties, responsibilities and obligations of the Servicer, with like effect as if originally named as a party to this Agreement and the Custodial Agreement provided, however, that such successor shall not assume, and the Servicer shall indemnify such successor for, any and all liabilities arising out of the Servicer's acts as servicer. Any termination of the Servicer as servicer pursuant to Section 12, 14 or 15 shall not affect any claims that the Purchaser may have against the Servicer arising prior to any such termination or resignation or remedies with respect to such claims. The Servicer shall timely deliver to the successor the funds in the Custodial Account and the Escrow Account and the Mortgage Files and related documents and statements held by it hereunder and the Servicer shall account for all funds. The Servicer shall execute and deliver such instruments and do such other things all as may reasonably be required to more fully and definitely vest and confirm in the successor all such rights, powers, duties, responsibilities, obligations and liabilities of the Servicer as servicer. The successor shall make arrangements as it may deem appropriate to reimburse the Servicer for amounts the Servicer actually expended as servicer pursuant to this Agreement which the successor is entitled to retain hereunder and which would otherwise have been recovered by the Servicer pursuant to this Agreement but for the appointment of the successor servicer. 38 17. Financial Statements. The Servicer understands that in connection with the Purchaser's marketing of the Mortgage Loans, the Purchaser shall make available to prospective purchasers the Servicer's, or the Servicer's parent's, publicly available financial statements for the most recently completed three fiscal years. The Servicer also shall make available any comparable interim statements to the extent any such statements have been prepared by such parties (and are available upon request to members or stockholders of such parties or the public at large). The Servicer, if it has not already done so, agrees to furnish promptly to the Purchaser copies of the statements specified above. Each such party also shall make available information on its servicing performance with respect to mortgage loans serviced for others, including delinquency ratios. The Servicer also agrees to allow access to knowledgeable financial, accounting, origination and servicing officers of such parties for the purpose of answering questions asked by any prospective purchaser regarding recent developments affecting such parties, their loan origination or servicing practices or the financial statements of such parties. 18. Mandatory Delivery: Grant of Security Interest. The sale and delivery of all of the Mortgage Loans on the related Closing Date is mandatory from and after the date of the execution of the Commitment Letter, it being specifically understood and agreed that each Mortgage Loan is unique and identifiable on the date hereof and that an award of money damages would be insufficient to compensate the Initial Purchaser for the losses and damages incurred by the Initial Purchaser (including damages to prospective purchasers of the Mortgage Loans) in the event of a Seller's failure to deliver each of the Mortgage Loans or one or more Mortgage Loans otherwise acceptable to the Purchaser on or before the related Closing Date. The Seller hereby grants to the Initial Purchaser a lien on and a continuing security interest in each Mortgage Loan and each document and instrument evidencing each such Mortgage Loan to secure the performance by the Seller of its obligation hereunder, and the Seller agrees that it holds such Mortgage Loans in custody for the Initial Purchaser subject to the Initial Purchaser's (i) right to reject any Mortgage Loan under the terms of this Agreement and the Commitment Letter, and (ii) obligation to pay the Purchase Price for the Mortgage Loans. All rights and remedies of the Purchaser under this Agreement are distinct from, and cumulative with, any other rights or remedies under this Agreement or afforded by law or equity and all such rights and remedies may be exercised concurrently, independently or successively. 19. Notices. All demands, notices and communications hereunder shall be in writing and shall be deemed to have been duly given if mailed, by registered or certified mail, return receipt requested, or, if by other means, when received by the other party at the address as follows: (i) if to ABC, Upland or ABMS: American Business Credit, Inc. The Wanamaker Building 100 Penn Square East Philadelphia, Pennsylvania 19107 Attention: Stephen Giroux, General Counsel 39 (ii) with a copy to: Blank Rom LLP One Logan Square Philadelphia, Pennsylvania 19103-6998 Attention: Lawrence F. Flick II (iii) if to the Purchaser: DLJ Mortgage Capital, Inc. Eleven Madison Avenue, 4th Floor New York, New York 10010 Attention: General Counsel Attention: Joe Little or such other address as may hereafter be furnished to the other party by like notice. Any such demand, notice or communication hereunder shall be deemed to have been received on the date delivered to or received at the premises of the addressee (as evidenced, in the case of registered or certified mail, by the date noted on the return receipt). 20. Severability Clause. Any part, provision, representation or warranty of this Agreement that is prohibited or which is held to be void or unenforceable shall be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof. Any part, provision, representation or warranty of this Agreement which is prohibited or unenforceable or is held to be void or unenforceable in any jurisdiction shall be ineffective, as to such jurisdiction, to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof, and any such prohibition or unenforceability in any jurisdiction as to any Mortgage Loan shall not invalidate or render unenforceable such provision in any other jurisdiction. To the extent permitted by applicable law, the parties hereto waive any provision of law that prohibits or renders void or unenforceable any provision hereof. If the invalidity of any part, provision, representation or warranty of this Agreement shall deprive any party of the economic benefit intended to be conferred by this Agreement, the parties shall negotiate, in good-faith, to develop a structure the economic effect of which is nearly as possible the same as the economic effect of this Agreement without regard to such invalidity. 21. Counterparts. This Agreement may be executed simultaneously in any number of counterparts. Each counterpart shall be deemed to be an original, and all such counterparts shall constitute one and the same instrument. 22. Governing Law. The Agreement shall be construed in accordance with the laws of the State of New York and the obligations, rights and remedies of the parties hereunder shall be determined in accordance with the laws of the State of New York without regard to the conflicts of laws provisions therein, except to the extent preempted by Federal law. 23. Intention of the Parties. It is the intention of the parties that the Initial Purchaser is purchasing, and the Sellers are selling, the Mortgage Loans and not a debt instrument of the Sellers or another security. Accordingly, the parties hereto each intend to treat the transaction for Federal income tax purposes as a sale by the Sellers, and a purchase by the Purchaser, of the Mortgage Loans. The Initial Purchaser shall have the right to review the Mortgage Loans and the related Mortgage Loan Files to determine the characteristics of the Mortgage Loans which shall affect the Federal income tax consequences of owning the Mortgage Loans and the Sellers shall cooperate with all reasonable requests made by the Initial Purchaser in the course of such review. 40 24. Successors and Assigns. This Agreement shall bind and inure to the benefit of and be enforceable by the Sellers, the Servicer and the Purchaser and the respective successors and assigns of the Sellers, the Servicer and the Purchaser. The Purchaser may assign this Agreement to any Person to whom any Mortgage Loan is transferred whether pursuant to a sale or financing and to any Person to whom the servicing or master servicing of any Mortgage Loan is sold or transferred. Upon any such assignment and written notice thereof to the Sellers and the Servicer, the Person to whom such assignment is made shall succeed to all rights and obligations of the Purchaser under this Agreement to the extent of the related Mortgage Loan or Mortgage Loans and this Agreement, to the extent of the related Mortgage Loan or Loans, shall be deemed to be a separate and distinct Agreement among the Sellers and such Purchaser, and a separate and distinct Agreement among the Sellers, the Servicer and each other Purchaser to the extent of the other related Mortgage Loan or Loans. This Agreement shall not be assigned, pledged or hypothecated by the Sellers or the Servicer to a third party without the consent of the Purchaser. 25. Waivers. No term or provision of this Agreement may be waived or modified unless such waiver or modification is in writing and signed by the party against whom such waiver or modification is sought to be enforced. 26. Exhibits. The exhibits to this Agreement are hereby incorporated and made a part hereof and are an integral part of this Agreement. 27. General Interpretive Principles. For purposes of this Agreement, except as otherwise expressly provided or unless the context otherwise requires: (a) the terms defined in this Agreement have the meanings assigned to them in this Agreement and include the plural as well as the singular, and the use of any gender herein shall be deemed to include the other gender; (b) accounting terms not otherwise defined herein have the meanings assigned to them in accordance with generally accepted accounting principles; (c) references herein to "Articles," "Sections," "Subsections," "Paragraphs," and other Subdivisions without reference to a document are to designated Articles, Sections, Subsections, Paragraphs and other subdivisions of this Agreement; (d) reference to a Subsection without further reference to a Section is a reference to such Subsection as contained in the same Section in which the reference appears, and this rule shall also apply to Paragraphs and other subdivisions; (e) the words "herein," "hereof," "hereunder" and other words of similar import refer to this Agreement as a whole and not to any particular provision; and 41 (f) the term "include" or "including" shall mean without limitation by reason of enumeration. 28. Reproduction of Documents. This Agreement and all documents relating thereto, including, without limitation, (a) consents, waivers and modifications which may hereafter be executed, (b) documents received by any party at the closing, and (c) financial statements, certificates and other information previously or hereafter furnished, may be reproduced by any photographic, photostatic, microfilm, micro-card, miniature photographic or other similar process. The parties agree that any such reproduction shall be admissible in evidence as the original itself in any judicial or administrative proceeding, whether or not the original is in existence and whether or not such reproduction was made by a party in the regular course of business, and that any enlargement, facsimile or further reproduction of such reproduction shall likewise be admissible in evidence. 29. Further Agreements. The Sellers, the Servicer and the Purchaser each agree to execute and deliver to the other such reasonable and appropriate additional documents, instruments or agreements as may be necessary or appropriate to effectuate the purposes of this Agreement. Without limiting the generality of the foregoing, the Sellers and the Servicer shall reasonably cooperate with the Purchaser in connection with any Whole Loan Transfer or Pass-Through Transfer contemplated by the Purchaser pursuant to Section 12 hereof. In such connection, the Sellers and the Servicer shall provide to the Initial Purchaser or any prospective purchaser: (i) any and all information and appropriate verification of information, whether through letters of its auditors and counsel or otherwise, as the Initial Purchaser shall request in its sole discretion; and (ii) such representations, warranties, covenants, opinions of counsel, letters from auditors, and certificates of public officials or officers of the Sellers and the Servicer as are reasonably believed necessary by the Initial Purchaser, in its sole discretion, in connection with such transactions. 30. Tax Service Contracts. To the extent the Sellers have not already obtained and paid for a fully assignable life of loan tax service contract issued by a tax service contract provider for each Mortgage Loan, the Sellers shall obtain such a contract at its expense on or before the Servicing Transfer Date; provided that such fees and expenses do not exceed $75.00 per tax service contract. 31. Access to Files. The Purchaser or its designee agrees to permit, or cause its designee to permit, for so long as the Purchaser is the owner of the related Mortgage Loan, the Sellers and their representatives reasonable access to the Mortgage Files after the Closing Date, to the extent the Sellers or representatives do not have access to similar documentation, at the Sellers' expense, in the event such access is required to defend any third party claim or potential claim (including any regulatory or government proceedings that may occur) against any of the Sellers or their respective affiliates in relation to the Mortgage Loans or if reasonably necessary in order to permit the Sellers to comply with applicable law, to demonstrate such compliance or to respond to a regulatory or governmental inquiry with respect to the Mortgage Loans or the Sellers. 42 IN WITNESS WHEREOF, the Initial Purchaser, the Sellers and the Servicer have caused their names to be signed hereto by their respective officers thereunto duly authorized as of the date first above written. DLJ MORTGAGE CAPITAL, INC. (Initial Purchaser) By: /s/ Joseph C. Little ---------------------------------------- Name: Joseph C. Little Title: Vice President AMERICAN BUSINESS CREDIT, INC. (Seller and Servicer) By: /s/ Beverly Santilli ---------------------------------------- Name: Beverly Santilli Title: President HOMEAMERICAN CREDIT, INC., D/B/A UPLAND MORTGAGE (Seller) By: /s/ Anthony Santilli ---------------------------------------- Name: Anthony Santilli Title: Chief Executive Officer AMERICAN BUSINESS MORTGAGE SERVICES, INC. (Seller) By: /s/ Jeffrey M. Ruben ---------------------------------------- Name: Jeffrey M. Ruben Title: Executive Vice President 43 EXHIBIT 1A FORM OF COMPANY'S OFFICER'S CERTIFICATE I, ________________________, hereby certify that I am a duly elected ______________ of [Seller Name], a [Incorporation State] corporation (the "Seller"), and further certify, on behalf of the Seller as follows: 1. Attached hereto as Attachment I are a true and correct copy of the Articles of Incorporation and by-laws of the Seller as are in full force and effect on the date hereof. No event has occurred since ___________________, which has affected the good standing of the Seller under the laws of the State of [Incorporation State]. 2. No proceedings looking toward merger, liquidation, dissolution or bankruptcy of the Seller are pending or contemplated. 3. Each person who, as an officer or attorney-in-fact of the Seller, signed (a) the Mortgage Loan Purchase and Interim Servicing Agreement (the "Purchase Agreement"), dated as of July 22, 2003 by and among each Seller, the Initial Purchaser and the Servicer (the "Servicer"), (b) the Commitment Letter, dated July 1, 2003, among each Seller, the Initial Purchaser and the Servicer (the "Commitment Letter"), and (c) any other document delivered prior hereto or on the date hereof in connection with the sale and servicing of the Mortgage Loans in accordance with the Purchase Agreement and the Commitment Letter was, at the respective times of such signing and delivery, and is as of the date hereof, duly elected or appointed, qualified and acting as such officer or attorney-in-fact, and the signatures of such persons appearing on such documents are their genuine signatures. 4. Attached hereto as Attachment II is a true and correct copy of the resolutions duly adopted by the board of directors of the Seller on _______________, (the "Resolutions") with respect to the authorization and approval of the sale and servicing of the Mortgage Loans; said Resolutions have not been amended, modified, annulled or revoked and are in full force and effect on the date hereof. 5. Attached hereto as Attachment III is a Certificate of Good Standing of the Seller dated ____________________. 6. All of the representations and warranties of the Seller contained in Subsections 7.01 and 7.03 of the Purchase Agreement were true and correct in all material respects as of the date of the Purchase Agreement and are true and correct in all material respects as of the date hereof. 7. The Seller has performed all of its duties and has satisfied all the material conditions on its part to be performed or satisfied prior to the related Closing Date pursuant to the Purchase Agreement and the Commitment Letter. All capitalized terms used herein and not otherwise defined shall have the meaning assigned to them in the Purchase Agreement. 1A-1 IN WITNESS WHEREOF, I have hereunto signed my name and affixed the seal of the Seller. Dated: _______________ [Seal] [COMPANY] By: __________________________________ Name: Title: I, ___________________, a ____________ of [Seller], hereby certify that ______________________ is a duly elected, qualified and acting __________ of the Seller and that the signature appearing above is his/her genuine signature. IN WITNESS WHEREOF, I have hereunto signed my name. Dated: _______________ [Seal] [COMPANY] By: __________________________________ Name: Title: 1A-2 EXHIBIT 1B FORM OF SERVICER'S OFFICER'S CERTIFICATE I, ________________________, hereby certify that I am a duly elected ______________ of [Servicer], a [Incorporation State] corporation (the "Servicer"), and further certify, on behalf of the Servicer as follows: 1. Attached hereto as Attachment I are a true and correct copy of the Articles of Incorporation and by-laws of the Servicer as are in full force and effect on the date hereof. No event has occurred since ___________________, which has affected the good standing of the Servicer under the laws of the State of [Incorporation State]. 2. No proceedings looking toward merger, liquidation, dissolution or bankruptcy of the Servicer are pending or contemplated. 3. Each person who, as an officer or attorney-in-fact of the Servicer, signed (a) the Mortgage Loan Purchase and Interim Servicing Agreement (the "Purchase Agreement"), dated as of July 22, 2003 by and among each Seller, the Initial Purchaser and the Servicer, (b) the Commitment Letter, July 1, 2003, among each Seller, the Initial Purchaser and the Servicer (the "Commitment Letter"), and (c) any other document delivered prior hereto or on the date hereof in connection with the sale and servicing of the Mortgage Loans in accordance with the Purchase Agreement was, at the respective times of such signing and delivery, and is as of the date hereof, duly elected or appointed, qualified and acting as such officer or attorney-in-fact, and the signatures of such persons appearing on such documents are their genuine signatures. 4. Attached hereto as Attachment II is a true and correct copy of the resolutions duly adopted by the board of directors of the Servicer on _______________, (the "Resolutions") with respect to the authorization and approval of the servicing of the Mortgage Loans; said Resolutions have not been amended, modified, annulled or revoked and are in full force and effect on the date hereof. 5. Attached hereto as Attachment III is a Certificate of Good Standing of the Servicer dated ____________________. 6. All of the representations and warranties of the Servicer contained in Subsections 7.02 and 7.03 of the Purchase Agreement were true and correct in all material respects as of the date of the Purchase Agreement and are true and correct in all material respects as of the date hereof. 7. The Servicer has performed all of its duties and has satisfied all the material conditions on its part to be performed or satisfied prior to the related Closing Date pursuant to the Purchase Agreement. 1B-1 All capitalized terms used herein and not otherwise defined shall have the meaning assigned to them in the Purchase Agreement. IN WITNESS WHEREOF, I have hereunto signed my name and affixed the seal of the Servicer. Dated: _______________ [Seal] [SERVICER] By: __________________________________ Name: Title: I, ___________________, a ____________ of [Servicer], hereby certify that ______________________ is a duly elected, qualified and acting __________ of the Seller and that the signature appearing above is his/her genuine signature. IN WITNESS WHEREOF, I have hereunto signed my name. Dated: _______________ [Seal] [SERVICER] By: __________________________________ Name: Title: 1B-2 EXHIBIT 2 [FORM OF OPINION OF COUNSEL TO THE SELLERS AND THE [_____], 200[_] DLJ Mortgage Capital, Inc. Eleven Madison Avenue, 4th Floor New York, New York 10010 Re: Mortgage Loan Purchase and Interim Servicing Agreement, dated as of July 22, 2003 Ladies and Gentlemen: I am the general counsel of American Business Credit, Inc. ("ABC"), HomeAmerican Credit, Inc. d/b/a Upland Mortgage ("HAC") and American Business Mortgage Services, Inc. ("ABMS," and, collectively, with HAC and ABC, the "Sellers"). You have requested my opinion with respect to certain matters in connection with the sale by the Sellers of certain mortgage loans (the "Mortgage Loans"), pursuant to the Mortgage Loan Purchase and Interim Servicing Agreement dated as of July 22, 2003 (the "MLPISA"), and the related Commitment Letter dated July 1, 2003, (the "Commitment Letter" and together with the MLPISA, the "Purchase Agreement"), between the Sellers and DLJ Mortgage Capital, Inc. as purchaser (the "Purchaser"). Capitalized terms not otherwise defined herein have the meanings set forth in the Purchase Agreement. I have examined the following documents: 1. the MLPISA; 2. the Commitment Letter; 3. good standing affidavits or certificates, for each of the Sellers dated within two weeks of the date of this opinion letter; 4. a sample Assignment of Mortgage; 5. a sample endorsement of the Mortgage Note; 6. the certificate or articles of incorporation and bylaws for each of the Sellers; and 7. the minutes and resolutions of each of the Sellers' Board of Directors. Based upon the foregoing, and subject to the qualifications and assumptions contained elsewhere in this letter, it is my opinion that: 2-1 1. ABC and HAC are duly organized, validly existing and in good standing under the laws of the Commonwealth of Pennsylvania and ABMS is duly organized, validly existing and in good standing under the laws of the State of New Jersey. Each Seller has the corporate power and authority to sell and, in the case of ABMS, service the Mortgage Loans and to execute, deliver and perform its obligations under the Agreements. 2. The Purchase Agreement has been duly authorized, executed and delivered by each of the Sellers and ABMS in the capacity of servicer and is a legal, valid and binding agreement enforceable against each Seller and ABMS in the capacity of servicer in accordance with its terms, subject to bankruptcy laws and other similar laws of general application affecting rights of creditors and subject to the application of the rules of equity, including those respecting the availability of specific performance, none of which will materially interfere with the realization of the benefits provided thereunder or with the Purchaser's ownership of the Mortgage Loans. 3. Either (i) no consent, approval, authorization or order of any court or governmental agency or body is required for the execution, delivery and performance by the Sellers of or compliance by the Sellers with the Purchase Agreement, or the consummation of the transactions contemplated by the Purchase Agreement or (ii) any required consent, approval, authorization or order has been obtained by the Sellers. 4. Neither the consummation of the transactions contemplated by, nor the fulfillment of the terms of, the Purchase Agreement conflicts or will conflict with or results or will result in a breach of or constitutes or will constitute a default under the charter or by-laws of any of the Sellers, the terms of any indenture or other agreement or instrument to which any of the Sellers is a party or by which it is bound or to which it is subject, or any statute or order, rule, regulations, writ, injunction or decree of any court, governmental authority or regulatory body to which any of the Sellers is subject or by which any of them are bound. 5. To my knowledge, no proceedings looking toward merger, liquidation, dissolution or bankruptcy of the Sellers are pending or contemplated. 6. To my knowledge, except as has been separately disclosed to Purchaser, there is no action, suit, proceeding or investigation pending or threatened against the Sellers which, in my judgment, either in any one instance or in the aggregate, may result in any material adverse change in the business, operations, financial condition, properties or assets of the Sellers or in any material impairment of the right or ability of the Sellers to carry on its business substantially as now conducted or in any material liability on the part of the Sellers or which would draw into question the validity of the Purchase Agreement or of any action taken or to be taken in connection with the transactions contemplated hereby, or which would be likely to impair materially the ability of the Sellers to perform under the terms of the Purchase Agreement. 2-2 7. Assuming Purchaser and/or its agent has received or obtained custody of executed Assignments of Mortgage with respect to each Mortgage, in for the form provided to me as a representative sample, and a Mortgage Note duly endorsed in the form provided to me as a representative sample, each Assignment of Mortgage is in recordable form and each Mortgage Note will be duly endorsed under applicable law. The endorsement and delivery of each Mortgage Note, and the preparation, delivery and recording of an Assignment of Mortgage with respect to each Mortgage is sufficient fully to transfer to Purchaser all right, title and interest of the Sellers in the Mortgage Note and Mortgage, as noteholder and mortgagee or assignee thereof. ________________ My opinions set forth in this letter are qualified and limited in the following respects and are subject to the following exclusions, qualifications and limitations, in addition to those assumptions, exceptions, qualifications, limitations and exclusions set forth above: a. This opinion is limited to the laws of the Commonwealth of Pennsylvania and the State of New Jersey. Furthermore, recognizing that the parties to the Purchase Agreement have selected the law of the State of New York to govern the Purchase Agreement, with your permission I have assumed, notwithstanding such provision, the application of the law of the Commonwealth of Pennsylvania to matters described in opinion paragraph 2 above. I have also assumed application of the law of the Commonwealth of Pennsylvania to the matters described in opinion paragraph 7, notwithstanding that the laws of the several states in which the Mortgaged Properties are located may govern such issues. In rendering this opinion, I have assumed compliance with all other laws, including, without limitation, all federal and state securities laws. b. As to matters of both fact and mixed fact and law, I have assumed and relied upon the truth and completeness of the good standing certificates or affidavits for each of the Sellers which I have obtained, the representations, warranties, covenants and agreements of the Sellers and the Purchaser given pursuant to or in connection with the Purchase Agreement and the representations set forth in the officer's certificates delivered to Purchaser on the Closing Date. I have not made any independent investigation in rendering this opinion other than the document examination described above. My opinion is therefore qualified in all respects by the scope of that document examination. I make no representation as to the sufficiency of my investigation for your purposes. c. I have also assumed that the Purchase Agreement is valid and legally binding upon and enforceable in accordance with its terms against the Purchaser. Whenever my opinions in this opinion letter, with respect to the existence or absence of facts, is intended to be based on my knowledge or attention, it is intended to signify that during the course of executing my duties as General Counsel, no information came to my attention which gave me actual knowledge of the existence or absence of those facts. d. Notwithstanding anything in this opinion to the contrary, I express no opinion whatsoever regarding the following: (1) the validity or enforceability of any indemnity to the extent it would protect an indemnitee from the negligence, willful misconduct or other wrong doing of such indemnitee, its predecessor in interest or its agent; or 2-3 (2) (a) the availability of equitable remedies, including, without limitation, specific performance, appointment of a receiver and injunctive relief, or (b) the effect of applicable laws and court decisions which may hereafter be enacted, promulgated or made and which may limit or render unenforceable certain rights and remedies under the Agreements (including, without limitation, remedies involving self-help or acceleration of indebtedness). e. I express no opinion herein concerning any statutes, ordinances, administrative decisions, rules or regulations of any county, town, municipality or special political subdivision (whether created or enabled through legislative action at the federal, state or regional level). f. I express no opinion whatsoever regarding the validity, enforceability or effectiveness of provisions: (i) that purport to establish evidentiary standards or render ineffective any waiver or modification not in writing; (ii) related to the waiver of rights or remedies (or the delay or omission of enforcement thereof) (including, without limitation, waivers of notices and hearing, waivers of defenses, waivers of jury trials, waivers of rights of marshalling, waivers of exemptions and stays of execution, waivers of statutes of limitations); (iii) that provide for the release or waiver of liability, or exculpation or nonliability for negligence, misconduct, bad faith or similar conduct; (iv) that purport to waive or discharge defenses; (v) providing for liquidated damages; (vi) allowing the institution of judicial or non-judicial proceedings or the exercise of any other rights without notice to the person or entity against whom enforcement is sought; (vii) implying that a person or entity may act in a commercially unreasonable manner or where absolute discretion is reserved; (viii) relating to court costs, attorneys' fees and expenses which may be chargeable or recoverable in any judicial proceedings; and (ix) other remedies or provisions which may be limited by the application of constitutional or public policy principles or standards of unconscionability, or requirements of commercial reasonableness and good faith. g. This opinion is strictly limited to the matters stated herein and no other or more extensive opinion is intended, implied or to be inferred beyond the matters expressly stated herein. This opinion is not a guarantee and should not be construed or relied on as such. h. This opinion is given as of the date hereof. I assume no obligation to update or supplement this opinion to reflect any facts or circumstances which may hereafter come to my attention or any changes in laws which may hereafter occur. ________________ This opinion is given to you for your sole benefit, and no other person or entity is entitled to rely hereon except that purchasers to which you initially and directly resell the Mortgage Loans may rely on this opinion as if it were addressed to them as of its date. Very truly yours, 2-4 EXHIBIT 3 SECURITY RELEASE CERTIFICATION I. Release of Security Interest ___________________________, hereby relinquishes any and all right, title and interest it may have in and to the Mortgage Loans described in Exhibit A attached hereto upon purchase thereof by DLJ Mortgage Capital, Inc. from the Seller named below pursuant to that certain Mortgage Loan Purchase and Interim Servicing Agreement, dated as of July 22, 2003, as of the date and time of receipt by ______________________________ of $__________ for such Mortgage Loans (the "Date and Time of Sale"), and certifies that all notes, mortgages, assignments and other documents in its possession relating to such Mortgage Loans have been delivered and released to the Seller named below or its designees as of the Date and Time of Sale. Name and Address of Financial Institution __________________________________ (Name) __________________________________ (Address) By: ______________________________ 3-1 II. Certification of Release The Seller named below hereby certifies to DLJ Mortgage Capital, Inc. that, as of the Date and Time of Sale of the above mentioned Mortgage Loans to DLJ Mortgage Capital, Inc., the security interests in the Mortgage Loans released by the above named corporation comprise all security interests relating to or affecting any and all such Mortgage Loans. The Seller warrants that, as of such time, there are and will be no other security interests affecting any or all of such Mortgage Loans. [COMPANY] By: __________________________________ Name: Title: 3-2 EXHIBIT 4 ASSIGNMENT AND CONVEYANCE On this __ day of _______________, (each a "Seller" and collectively, the "Sellers") as the Sellers under that certain Mortgage Loan Purchase and Interim Servicing Agreement dated as of July 22, 2003 (the "Agreement") among the Sellers, [SERVICER] (the "Servicer") and DLJ Mortgage Capital, Inc. (the "Initial Purchaser") does hereby sell, transfer, assign, set over and convey to DLJ Mortgage Capital, Inc. as Initial Purchaser under the Agreement, without recourse, but subject to the terms of the Agreement, all rights, title and interest of the Sellers in and to the Mortgage Loans listed on the Mortgage Loan Schedule attached hereto together with the related Mortgage Files and all rights and obligations arising under the documents contained therein, including the right to any prepayment penalties or other charges payable by the related Mortgagors in connection with any principal prepayments on the Mortgage Loans. Pursuant to Subsection 6.03 of the Agreement, each Seller has delivered to the Custodian the documents for each Mortgage Loan to be purchased as set forth in the Custodial Agreement. The contents of each related Servicing File required to be delivered to the Servicer to service the Mortgage Loans pursuant to the Agreement and thus not delivered to the Initial Purchaser are and shall be held in trust for the benefit of the Initial Purchaser as the owner thereof. The Servicer's possession of any portion of each such Servicing File is at the will of the Initial Purchaser for the sole purpose of facilitating servicing of the related Mortgage Loan pursuant to the Agreement, and such retention and possession by the Servicer shall be in a custodial capacity only. The ownership of each Mortgage Note, Mortgage, and the contents of the Mortgage File and Servicing File is vested in the Initial Purchaser and the ownership of all records and documents with respect to the related Mortgage Loan prepared by or which come into the possession of each Seller or the Servicer shall immediately vest in the Initial Purchaser and shall be retained and maintained, in trust, by each Seller or the Servicer at the will of the Purchaser in such custodial capacity only. The Sellers and the Servicer confirm to the Purchaser that the representations and warranties set forth in Subsection 7.01, 7.02 and 7.03, as applicable, of the Agreement are true and correct as of the date hereof, and that all statements made in the related Officer's Certificate and all attachments thereto remain complete, true and correct in all respects as of the date hereof, and confirm that all statements made in the Commitment Letter are true and correct as of the date hereof. 4-1 Capitalized terms used herein and not otherwise defined shall have the meanings set forth in the Agreement. AMERICAN BUSINESS CREDIT, INC. (Seller and Servicer) By:_________________________________ Name: Title: HOMEAMERICAN CREDIT, INC., D/B/A UPLAND MORTGAGE (Seller) By:_________________________________ Name: Title: AMERICAN BUSINESS MORTGAGE SERVICES, INC. (Seller) By:_________________________________ Name: Title: 4-2 EXHIBIT 5 CONTENTS OF EACH MORTGAGE FILE With respect to each Mortgage Loan, the Mortgage File shall include each of the following items, which shall be available for inspection by the Purchaser and which shall be retained by the Seller or delivered to the Custodian: 1. Mortgage Loan Documents. 2. Residential loan application. 3. Mortgage Loan closing statement. 4. Verification of employment and income. 5. Verification of acceptable evidence of source and amount of down payment. 6. Credit report on Mortgagor. 7. Residential appraisal report. 8. Photograph of the Mortgaged Property, if available. 9. Survey of the Mortgaged Property, if available. 10. Copy of each instrument necessary to complete identification of any exception set forth in the exception schedule in the title policy, i.e., map or plat, restrictions, easements, sewer agreements, home association declarations, etc. 11. All required disclosure statements and statement of Mortgagor confirming receipt thereof. 12. If available, termite report, structural engineer's report, water potability and septic certification. 13. Sales Contract. 14. Hazard insurance policy. 15. Tax receipts, insurance premium receipts, ledger sheets, payment history from date of origination, insurance claim files, correspondence, current and historical computerized data files, and all other processing, underwriting and closing papers and records which are customarily contained in a mortgage loan file and which are required to document the Mortgage Loan or to service the Mortgage Loan. 16. Amortization schedule, if available. 5-1 17. Payment history for Mortgage Loans that have been closed for more than 90 days. 18. The original policy of primary mortgage guaranty insurance or, if such insurance is provided by a master policy, the original certificate of insurance and a copy of such master policy, if available. 5-2 EXHIBIT 6 CUSTODIAL AGREEMENT [ON FILE] 6-1 EXHIBIT 7 FORM OF CUSTODIAL ACCOUNT LETTER AGREEMENT _______________ To: (the "Depository") As Servicer under the Mortgage Loan Purchase and Interim Servicing Agreement (Fixed Rate Mortgage Loans), dated as of July 22, 2003, we hereby authorize and request you to establish an account, as a Custodial Account, to be designated as "[SERVICER], as servicer, in trust for the Purchaser (Fixed Rate Mortgage Loans)." All deposits in the account shall be subject to withdrawal therefrom by order signed by the Servicer. You may refuse any deposit that would result in violation of the requirement that the account be fully insured as described below. This letter is submitted to you in duplicate. Please execute and return one original to us. [SERVICER] By: __________________________________ Name: Title: Date: The undersigned, as Depository, hereby certifies that the above-described account has been established under Account Number ___________ at the office of the Depository indicated above, and agrees to honor withdrawals on such account as provided above. The Federal Deposit Insurance Corporation ("FDIC"), through the Bank Insurance Fund ("BIF") or the Savings Association Insurance Fund ("SAIF"), will insure the full amount deposited at any time in the account, provided that such amount does not exceed the limits on insured deposits set by the FDIC. [Depository] By: ___________________________ Name: Title: Date: 7-1 EXHIBIT 8 FORM OF ESCROW ACCOUNT LETTER AGREEMENT _______________ To: (the "Depository") As Servicer under the Mortgage Loan Purchase and Interim Servicing Agreement (Fixed Rate Mortgage Loans), dated as of July 22, 2003, we hereby authorize and request you to establish an account, as an Escrow Account, to be designated as "[SERVICER], as servicer, in trust for the Purchaser and various Mortgagors (Fixed Rate Mortgage Loans)." All deposits in the account shall be subject to withdrawal therefrom by order signed by the Servicer. You may refuse any deposit which would result in violation of the requirement that the account be fully insured as described below. This letter is submitted to you in duplicate. Please execute and return one original to us. [SERVICER] By: __________________________________ Name: Title: Date: The undersigned, as Depository, hereby certifies that the above-described account has been established under Account Number ___________ at the office of the Depository indicated above, and agrees to honor withdrawals on such account as provided above. The Federal Deposit Insurance Corporation ("FDIC"), through the Bank Insurance Fund ("BIF") or the Savings Association Insurance Fund ("SAIF"), will insure the full amount deposited at any time in the account, provided that such amount does not exceed the limits on insured deposits set by the FDIC. [Depository] By: ____________________________ Name: Title: Date: 8-1 EXHIBIT 9 COMMITMENT LETTER [ON FILE] 9-1 EXHIBIT 10 [RESERVED] 10-1 EXHIBIT 11 SERVICING ADDENDUM Section 11.01 Servicer to Act as Servicer. The Servicer, as independent contract servicer, shall service and administer the Mortgage Loans in accordance with this Agreement and shall have full power and authority, acting alone, to do or cause to be done any and all things in connection with such servicing and administration which the Servicer may deem necessary or desirable and consistent with the terms of this Agreement. The Servicer shall administer the Mortgage Loans on behalf of the Purchaser (as determined by the Servicer in its reasonable judgment) in accordance with the terms of this Agreement and the respective Mortgage Loans and, to the extent consistent with such terms, in the same manner in which it administers similar mortgage loans for its own portfolio, giving due consideration to customary and usual standards of practice of prudent mortgage lenders and loan servicers administering similar mortgage loans but without regard to: (i) any relationship that the Servicer or any Affiliate of the Servicer may have with the related Mortgagor and (ii) the Servicer's right to receive compensation for its services hereunder. To the extent consistent with the foregoing, the Servicer (a) shall seek to maximize the timely and complete recovery of principal and interest on the Mortgage Notes and (b) shall waive (or permit a subservicer to waive) a Prepayment Charge only under the following circumstances: (i) such waiver is standard and customary in servicing similar Mortgage Loans or required to comply with applicable law and (ii) either (A) such waiver would, in the reasonable judgment of the Servicer, maximize recovery of total proceeds taking into account the value of such Prepayment Charge and the related Mortgage Loan and, if such waiver is made in connection with a refinancing of the related Mortgage Loan, such refinancing is related to a default or a reasonably foreseeable default or (B) such waiver is made in connection with a refinancing of the related Mortgage Loan unrelated to a default or a reasonably foreseeable default where (x) the related mortgagor has stated to the Servicer or an applicable subservicer an intention to refinance the related Mortgage Loan and (y) the Servicer has concluded in its reasonable judgment that the waiver of such Prepayment Charge would induce such mortgagor to refinance with the Servicer. If a Prepayment Charge is waived as permitted by meeting the standards described in clauses (i) and (ii)(B) above, then the Servicer is required to pay the amount of such waived Prepayment Charge by depositing such amount into the Collection Account together with and at the time that the amount prepaid on the related Mortgage Loan is required to be deposited into the Custodial Account; provided however, that if such Prepayment Charge is waived within the first ninety days after the Closing Date, the Servicer is required to pay only the greater of the amount required in the preceding sentence and the amount required under Section 7.05 of the Mortgage Loan Purchase and Interim Servicing Agreement. 11-1 Consistent with the terms of this Agreement, the Servicer may waive, modify or vary any term of any Mortgage Loan or consent to the postponement of strict compliance with any such term or in any manner grant indulgence to any Mortgagor if in the Servicer's reasonable and prudent determination such waiver, modification, postponement or indulgence is not materially adverse to the Purchaser; provided, however, that the Servicer shall not permit any modification with respect to any Mortgage Loan that would change the Mortgage Interest Rate, defer or forgive the payment thereof or of any principal or interest payments, reduce the outstanding principal amount (except for actual payments of principal), make additional advances of additional principal or extend the final maturity date on such Mortgage Loan, in each case unless the Purchaser consents in writing. Without limiting the generality of the foregoing, the Servicer shall continue, and is hereby authorized and empowered, to execute and deliver on behalf of itself, and the Purchaser, all instruments of satisfaction or cancellation, or of partial or full release, discharge and all other comparable instruments, with respect to the Mortgage Loans and with respect to the Mortgaged Property. If reasonably required by the Servicer, the Purchaser shall furnish the Servicer with any powers of attorney and other documents necessary or appropriate to enable the Servicer to carry out its servicing and administrative duties under this Agreement. In servicing and administering the Mortgage Loans, the Servicer shall employ procedures including collection procedures and exercise the same care that it customarily employs and exercises in servicing and administering mortgage loans for its own account giving due consideration to accepted mortgage servicing practices of prudent lending institutions and the Purchaser's reliance on the Servicer ("Accepted Servicing Practices"). The Servicer may enter into subservicing arrangements with other sellers or any subservicers acceptable to the Purchaser, pursuant to subservicing agreements which are acceptable to the Purchaser, provided the Servicer shall be responsible for any costs or expenses payable to such subservicers, such subservicing agreements shall not be inconsistent with this Agreement, and any such subservicing agreements shall be immediately terminable upon the direction of the Purchaser. The Servicer shall remain obligated and liable to the Purchaser for the servicing and administering of the Mortgage Loans without diminution of such obligation or liability by virtue of such subservicing agreements or arrangements or by virtue of indemnification from the subservicer for any acts or omissions and to the same extent and under the same terms and conditions as if the Servicer alone were servicing and administering the Mortgage Loans and any other transactions or services relating to the Mortgage Loans involving the subservicer shall be deemed to be between the subservicer and the Servicer alone and the Purchaser shall have no obligations, duties or liabilities with respect to the subservicer including no obligation, duty or liability of the Purchaser to pay the subservicer's fees and expenses or the obligation to pay any termination fees and expenses of the subservicer. The Servicer shall pay all fees and expenses of the subservicer from its own funds or other amounts permitted to be retained by or reimbursed to the Servicer hereunder. Section 11.02 Collection of Mortgage Loan Payments. Continuously from the date hereof until the principal and interest on all Mortgage Loans are paid in full, the Servicer shall proceed diligently to collect all payments due under each Mortgage Loan when the same shall become due and payable and shall, to the extent such procedures shall be consistent with this Agreement and the terms and provisions of any related Primary Insurance Policy, follow such collection procedures as it follows with respect to mortgage loans comparable to the Mortgage Loans and held for its own account. Further, the Servicer shall take special care in ascertaining and estimating Escrow Payments and all other charges that will become due and payable to the end that the installments payable by the Mortgagors will be sufficient to pay such charges as and when they become due and payable. 11-2 Section 11.03 Realization Upon Defaulted Mortgage Loans. (a) The Servicer shall use its best efforts, consistent with Accepted Servicing Practices to foreclose upon or otherwise comparably convert the ownership of such Mortgaged Properties as come into and continue in default and as to which no satisfactory arrangements can be made for collection of delinquent payments pursuant to Subsection 11.01. The Servicer shall use its best efforts to realize upon defaulted Mortgage Loans in such a manner as will maximize the receipt of principal and interest by the Purchaser, taking into account, among other things, the timing of foreclosure proceedings. The foregoing is subject to the provisions that, in any case in which Mortgaged Property shall have suffered damage, the Servicer shall not be required to expend its own funds toward the restoration of such property in excess of $2,000 unless it shall determine in its discretion (i) that such restoration will increase the proceeds of liquidation of the related Mortgage Loan to the Purchaser after reimbursement to itself for such expenses, and (ii) that such expenses will be recoverable by the Servicer through Insurance Proceeds or Liquidation Proceeds from the related Mortgaged Property, as contemplated in Subsection 11.05. In the event that any payment due under any Mortgage Loan is not paid when the same becomes due and payable, or in the event the Mortgagor fails to perform any other covenant or obligation under the Mortgage Loan and such failure continues beyond any applicable grace period, the Servicer shall take such action as it shall deem to be in the best interest of the Purchaser. In the event that any payment due under any Mortgage Loan remains delinquent for a period of 90 days or more, the Servicer shall commence foreclosure proceedings, provided that prior to commencing foreclosure proceedings by delivering notice of default to Mortgagor and initiating the filing of a complaint, the Servicer shall notify the Purchaser in writing of the Servicer's intention to do so, and the Servicer shall not commence foreclosure proceedings if the Purchaser objects to such action within ten (10) Business Days of receiving such notice. The Servicer shall notify the Purchaser in writing of the commencement of foreclosure proceedings. In such connection, the Servicer shall be responsible for all costs and expenses incurred by it in any such proceedings; provided, however, that it shall be entitled to reimbursement thereof from the related Mortgaged Property, as contemplated in Subsection 11.05. (b) Notwithstanding the foregoing provisions of this Subsection 11.03, with respect to any Mortgage Loan as to which the Servicer has received actual notice of, or has actual knowledge of, the presence of any toxic or hazardous substance on the related Mortgaged Property, the Servicer shall not either (i) obtain title to such Mortgaged Property as a result of or in lieu of foreclosure or otherwise, or (ii) otherwise acquire possession of, or take any other action, with respect to, such Mortgaged Property if, as a result of any such action, the Purchaser would be considered to hold title to, to be a mortgagee-in-possession of, or to be an owner or operator of such Mortgaged Property within the meaning of the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended from time to time, or any comparable law, unless the Servicer has also previously determined, based on his reasonable judgment and a prudent report prepared by a Person who regularly conducts environmental audits using customary industry standards, that: 11-3 (1) such Mortgaged Property is in compliance with applicable environmental laws or, if not, that it would be in the best economic interest of the Purchaser to take such actions as are necessary to bring the Mortgaged Property into compliance therewith; and (2) there are no circumstances present at such Mortgaged Property relating to the use, management or disposal of any hazardous substances, hazardous materials, hazardous wastes, or petroleum-based materials for which investigation, testing, monitoring, containment, clean-up or remediation could be required under any federal, state or local law or regulation, or that if any such materials are present for which such action could be required, that it would be in the best economic interest of the Purchaser to take such actions with respect to the affected Mortgaged Property. The cost of the environmental audit report contemplated by this Subsection 11.03 shall be advanced by the Servicer, subject to the Servicer's right to be reimbursed therefor from the Custodial Account as provided in Subsection 11.05(vi). If the Servicer determines, as described above, that it is in the best economic interest of the Purchaser to take such actions as are necessary to bring any such Mortgaged Property into compliance with applicable environmental laws, or to take such action with respect to the containment, clean-up or remediation of hazardous substances, hazardous materials, hazardous wastes, or petroleum-based materials affecting any such Mortgaged Property, then the Servicer shall take such action as it deems to be in the best economic interest of the Purchaser. The cost of any such compliance, containment, cleanup or remediation shall be advanced by the Servicer, subject to the Servicer's right to be reimbursed therefor from the Custodial Account as provided in Subsection 11.05(vi). (c) Proceeds received in connection with any Final Recovery Determination, as well as any recovery resulting from a partial collection of Insurance Proceeds or Liquidation Proceeds in respect of any Mortgage Loan, will be applied in the following order of priority: first, to reimburse the Servicer for any related unreimbursed Servicing Advances, pursuant to Subsection 11.05(iii); second, to accrued and unpaid interest on the Mortgage Loan, to the date of the Final Recovery Determination, or to the Due Date prior to the Distribution Date on which such amounts are to be distributed if not in connection with a Final Recovery Determination; and third, as a recovery of principal of the Mortgage Loan. If the amount of the recovery so allocated to interest is less than the full amount of accrued and unpaid interest due on such Mortgage Loan, the amount of such recovery will be allocated by the Servicer as follows: first, to unpaid Servicing Fees; and second, to the balance of the interest then due and owing. The portion of the recovery so allocated to unpaid Servicing Fees shall be reimbursed to the Servicer pursuant to Subsection 11.05(iii). The portion of the recovery allocated to interest (net of unpaid Servicing Fees) and the portion of the recovery allocated to principal of the Mortgage Loan shall be applied as part of the amounts to be distributed to the Purchaser in accordance with Subsection 11.14. 11-4 Section 11.04 Establishment of Custodial Accounts; Deposits in Custodial Accounts. The Servicer shall segregate and hold all funds collected and received pursuant to each Mortgage Loan separate and apart from any of its own funds and general assets and shall establish and maintain one or more Custodial Accounts, in the form of time deposit, demand accounts or other Eligible Accounts. The creation of any Custodial Account shall be evidenced by a Custodial Account Letter Agreement in the form of Exhibit 7. The Servicer shall deposit in the Custodial Account on a daily basis, and retain therein the following payments and collections received by it subsequent to the Cut-off Date: (i) all payments on account of principal on the Mortgage Loans; (ii) all payments on account of interest on the Mortgage Loans; (iii) all Liquidation Proceeds and income from REO Property; (iv) all Insurance Proceeds including amounts required to be deposited pursuant to Subsections 11.10 and 11.11, other than proceeds to be held in the Escrow Account and applied to the restoration or repair of the Mortgaged Property or released to the Mortgagor in accordance with the Servicer's normal servicing procedures, the loan documents or applicable law; (v) all Condemnation Proceeds affecting any Mortgaged Property which are not released to the Mortgagor in accordance with the Servicer's normal servicing procedures, the loan documents or applicable law; (vi) reserved; (vii) all proceeds of any Mortgage Loan repurchased in accordance with Subsections 7.03 and 7.04 and all amounts required to be deposited by the Servicer in connection with shortfalls in principal amount of Qualified Substitute Mortgage Loans pursuant to Subsection 7.03; (viii) any amounts required to be deposited by the Servicer pursuant to Subsection 11.11 in connection with the deductible clause in any blanket hazard insurance policy. Such deposit shall be made from the Servicer's own funds, without reimbursement therefor; (ix) any amounts required to be deposited by the Servicer in connection with any REO Property pursuant to Subsection 11.13; (x) any amounts required to be deposited in the Custodial Account pursuant to Subsection 11.20, and (xi) any amounts relating to Prepayment Charges as described in Subsection 7.05. 11-5 The foregoing requirements for deposit in the Custodial Account shall be exclusive, it being understood and agreed that, without limiting the generality of the foregoing, payments in the nature of Servicing Fees and Ancillary Income, to the extent permitted by Subsection 11.01, need not be deposited by the Servicer in the Custodial Account. Such Custodial Account shall be an Eligible Account. Any interest or earnings on funds deposited in the Custodial Account by the depository institution shall accrue to the benefit of the Servicer and the Servicer shall be entitled to retain and withdraw such interest from the Custodial Account pursuant to Subsection 11.05(iii). The Servicer shall give notice to the Purchaser of the location of the Custodial Account when established and prior to any change thereof. If the balance on deposit in the Custodial Account exceeds $75,000 as of the commencement of business on any Business Day and the Custodial Account constitutes an Eligible Account solely pursuant to clause (ii) of the definition of Eligible Account, the Servicer shall, on or before twelve o'clock noon Eastern time on such Business Day, withdraw from the Custodial Account any and all amounts payable to the Purchaser and remit such amounts to the Purchaser by wire transfer of immediately available funds. Section 11.05 Permitted Withdrawals From the Custodial Account. The Servicer may, from time to time, withdraw from the Custodial Account for the following purposes: (i) to make distributions to the Purchaser in the amounts and in the manner provided for in Subsection 11.14; (ii) reserved; (iii) to reimburse itself for unreimbursed Servicing Advances, the Servicer's right to reimburse itself pursuant to this subclause (iii) with respect to any Mortgage Loan being limited to related Liquidation Proceeds, Condemnation Proceeds, Insurance Proceeds and such other amounts as may be collected by the Servicer from the Mortgagor or otherwise relating to the Mortgage Loan, it being understood that, in the case of such reimbursement, the Servicer's right thereto shall be prior to the rights of the Purchaser, except that, where the Seller is required to repurchase a Mortgage Loan, pursuant to Subsection 7.04, the Servicer's right to such reimbursement shall be subsequent to the payment to the Purchaser of the repurchase price pursuant to Subsection 7.04 and all other amounts required to be paid to the Purchaser with respect to such Mortgage Loans; (iv) to pay to itself pursuant to Subsection 11.22 as servicing compensation (a) any interest earned on funds in the Custodial Account (all such interest to be withdrawn monthly not later than each Distribution Date), (b) the Servicing Fee from that portion of any payment or recovery as to interest on a particular Mortgage Loan and (c) Ancillary Income to the extent not previously retained; (v) reserved; (vi) reserved; (vii) to pay, or to reimburse the Servicer for advances in respect of, expenses incurred in connection with any Mortgage Loan pursuant to Subsection 11.03(b), but only to the extent of amounts received in respect of the Mortgage Loans to which such expense is attributable; 11-6 (vii) to clear and terminate the Custodial Account on the termination of this Agreement; and (viii) to withdraw funds deposited in error. The Servicer shall keep and maintain separate accounting, on a Mortgage Loan by Mortgage Loan basis, for the purpose of justifying any withdrawal from the Custodial Account pursuant to such subclauses (ii), (iii), (v), (vi) and (vii) above. The Servicer shall provide written notification in the form of an Officers' Certificate to the Purchaser, on or prior to the next succeeding Distribution Date, upon making any withdrawals from the Custodial Account pursuant to subclause (iv) above. Section 11.06 Establishment of Escrow Accounts; Deposits in Escrow Accounts. The Servicer shall segregate and hold all funds collected and received pursuant to each Mortgage Loan which constitute Escrow Payments separate and apart from any of its own funds and general assets and shall establish and maintain one or more Escrow Accounts, in the form of time deposit, demand accounts or the Eligible Accounts. The creation of any Escrow Account shall be evidenced by Escrow Account Letter Agreement in the form of Exhibit 8. The Servicer shall deposit in the Escrow Account or Accounts on a daily basis, and retain therein, (i) all Escrow Payments collected on account of the Mortgage Loans, for the purpose of effecting timely payment of any such items as required under the terms of this Agreement, and (ii) all Insurance Proceeds which are to be applied to the restoration or repair of any Mortgaged Property. The Servicer shall make withdrawals therefrom only to effect such payments as are required under this Agreement, and for such other purposes as shall be as set forth or in accordance with Subsection 11.08. The Servicer shall be entitled to retain any interest paid on funds deposited in the Escrow Account by the depository institution other than interest on escrowed funds required by law to be paid to the Mortgagor and, to the extent required by law, the Servicer shall pay interest on escrowed funds to the Mortgagor notwithstanding that the Escrow Account is non interest bearing or that interest paid thereon is insufficient for such purposes. Section 11.07 Permitted Withdrawals From Escrow Account. Withdrawals from the Escrow Account may be made by the Servicer (i) to effect timely payments of ground rents, taxes, assessments, water rates, hazard insurance premiums, Primary Insurance Policy premiums, if applicable, and comparable items, (ii) to reimburse the Servicer for any Servicing Advance made by the Servicer with respect to a related Mortgage Loan but only from amounts received on the related Mortgage Loan which represent late payments or collections of Escrow Payments thereunder, (iii) to refund to the Mortgagor any funds as may be determined to be overages, (iv) for transfer to the Custodial Account in accordance with the terms of this Agreement, (v) for application to restoration or repair of the Mortgaged Property, (vi) to pay to the Servicer, or to the Mortgagor to the extent required by law, any interest paid on the funds deposited in the Escrow Account, or (vii) to clear and terminate the Escrow Account on the termination of this Agreement. 11-7 Section 11.08 Payment of Taxes, Insurance and Other Charges; Collections Thereunder. With respect to each Mortgage Loan, the Servicer shall maintain (itself or through third party services customarily used by similar servicers) accurate records reflecting the status of ground rents, taxes, assessments, water rates and other charges which are or may become a lien upon the Mortgaged Property and the status of fire and hazard insurance coverage and shall obtain, from time to time, all bills for the payment of such charges, including insurance renewal premiums and shall effect payment thereof prior to the applicable penalty or termination date and at a time appropriate for securing maximum discounts allowable, employing for such purpose deposits of the Mortgagor in the Escrow Account which shall have been estimated and accumulated by the Servicer in amounts sufficient for such purposes, as allowed under the terms of the Mortgage and applicable law. To the extent that any such Mortgage does not provide for Escrow Payments, the Servicer shall determine that any such payments are made by the Mortgagor at the time they first become due. The Servicer assumes full responsibility for the timely payment of all such bills and shall effect timely payments of all such bills irrespective of the Mortgagor's faithful performance in the payment of same or the making of the Escrow Payments and shall make advances from its own funds to effect such payments. Section 11.09 Transfer of Accounts. The Servicer may transfer the Custodial Account or the Escrow Account to a different depository institution from time to time. Such transfer shall be made only upon obtaining the consent of the Purchaser, which consent shall not be unreasonably withheld. In any case, the Custodial Account and Escrow Account shall be Eligible Accounts. Section 11.10 Maintenance of Hazard Insurance. The Servicer shall cause to be maintained for each Mortgage Loan fire and hazard insurance with extended coverage as is customary in the area where the Mortgaged Property is located in an amount which is at least equal to the lesser of (i) the amount necessary to fully compensate for any damage or loss to the improvements which are a part of such property on a replacement cost basis or (ii) the outstanding principal balance of the Mortgage Loan, in each case in an amount not less than such amount as is necessary to prevent the Mortgagor and/or the Mortgagee from becoming a co-insurer. In the case of second liens, the Servicer may request the first lienholder to address any insurance discrepancies prior to taking corrective action itself. If the Mortgaged Property is in an area identified on a Flood Hazard Boundary Map or Flood Insurance Rate Map issued by the Flood Emergency Management Agency as having special flood hazards and flood insurance has been made available, the Servicer will cause to be maintained a flood insurance policy meeting the requirements of the current guidelines of the Federal Insurance Administration with a generally acceptable insurance carrier, in an amount representing coverage not less than the lesser of (i) the outstanding principal balance of the Mortgage Loan or (ii) the maximum amount of insurance which is available under the National Flood Insurance Act of 1968 and the Flood Disaster Protection Act of 1973, as amended. The Servicer also shall maintain on any REO Property, fire and hazard insurance with extended coverage in an amount which is at least equal to the lesser of (i) the maximum insurable value of the improvements which are a part of such property and (ii) the outstanding principal balance of the related Mortgage Loan at the time it became an REO Property plus accrued interest at the Mortgage 11-8 Interest Rate and related Servicing Advances, liability insurance and, to the extent required and available under the National Flood Insurance Act of 1968 and the Flood Disaster Protection Act of 1973, as amended, flood insurance in an amount as provided above. Pursuant to Subsection 11.04, any amounts collected by the Servicer under any such policies other than amounts to be deposited in the Escrow Account and applied to the restoration or repair of the Mortgaged Property or REO Property, or released to the Mortgagor in accordance with the Servicer's normal servicing procedures, shall be deposited in the Custodial Account, subject to withdrawal pursuant to Subsection 11.05. Any cost incurred by the Servicer in maintaining any such insurance shall not, for the purpose of calculating distributions to the Purchaser, be added to the unpaid principal balance of the related Mortgage Loan, notwithstanding that the terms of such Mortgage Loan so permit. It is understood and agreed that no earthquake or other additional insurance need be required by the Servicer of the Mortgagor or maintained on property acquired in respect of the Mortgage Loan, other than pursuant to such applicable laws and regulations as shall at any time be in force and as shall require such additional insurance. All such policies shall be endorsed with standard mortgagee clauses with loss payable to the Servicer, or upon request to the Purchaser, and shall provide for at least thirty days prior written notice of any cancellation, reduction in the amount of, or material change in, coverage to the Servicer. The Servicer shall not interfere with the Mortgagor's freedom of choice in selecting either his insurance carrier or agent, provided, however, that the Servicer shall not accept any such insurance policies from insurance companies unless such companies currently reflect a General Policy Rating of A:X or better in Best's Key Rating Guide and are licensed to do business in the state wherein the property subject to the policy is located. Section 11.11 Maintenance of Mortgage Impairment Insurance Policy. In the event that the Servicer shall obtain and maintain a mortgage impairment or blanket policy issued by an issuer that has a Best rating of A:VI insuring against hazard losses on all of Mortgaged Properties securing the Mortgage Loans, then, to the extent such policy provides coverage in an amount equal to the amount required pursuant to Subsection 11.10 and otherwise complies with all other requirements of Subsection 11.10, the Servicer shall conclusively be deemed to have satisfied its obligations as set forth in Subsection 11.10, it being understood and agreed that such policy may contain a deductible clause, in which case the Servicer shall, in the event that there shall not have been maintained on the related Mortgaged Property or REO Property a policy complying with Subsection 11.10, and there shall have been one or more losses which would have been covered by such policy, deposit in the Custodial Account the amount not otherwise payable under the blanket policy because of such deductible clause. In connection with its activities as servicer of the Mortgage Loans, the Servicer agrees to prepare and present, on behalf of the Purchaser, claims under any such blanket policy in a timely fashion in accordance with the terms of such policy. Upon request of the Purchaser, the Servicer shall cause to be delivered to the Purchaser a certified true copy of such policy and a statement from the insurer thereunder that such policy shall in no event be terminated or materially modified without thirty days prior written notice to the Purchaser. 11-9 Section 11.12 Fidelity Bond, Errors and Omissions Insurance. The Servicer shall maintain, at its own expense, a blanket fidelity bond and an errors and omissions insurance policy, with broad coverage with responsible companies that meet the requirements of Fannie Mae or Freddie Mac on all officers, employees or other persons acting in any capacity with regard to the Mortgage Loan to handle funds, money, documents and papers relating to the Mortgage Loan. The fidelity bond and errors and omissions insurance shall be in the form of the Mortgage Banker's Blanket Bond and shall protect and insure the Servicer against losses, including forgery, theft, embezzlement, fraud, errors and omissions and negligent acts of such persons. Such fidelity bond shall also protect and insure the Servicer against losses in connection with the failure to maintain any insurance policies required pursuant to this Agreement and the release or satisfaction of a Mortgage Loan without having obtained payment in full of the indebtedness secured thereby. No provision of this Subsection 11.12 requiring the fidelity bond and errors and omissions insurance shall diminish or relieve the Servicer from its duties and obligations as set forth in this Agreement. The minimum coverage under any such bond and insurance policy shall be at least equal to the corresponding amounts required by Fannie Mae in the Fannie Mae Servicing Guide or by Freddie Mac in the Freddie Mac Servicers' and Servicers' Guide. Upon request of the Purchaser, the Servicer shall cause to be delivered to the Purchaser a certified true copy of the fidelity bond and insurance policy and a statement from the surety and the insurer that such fidelity bond or insurance policy shall in no event be terminated or materially modified without thirty days' prior written notice to the Purchaser. Section 11.13 Title, Management and Disposition of REO Property. In the event that title to the Mortgaged Property is acquired in foreclosure or by deed in lieu of foreclosure, the deed or certificate of sale shall be taken in the name of the person designated by the Purchaser, or in the event such person is not authorized or permitted to hold title to real property in the state where the REO Property is located, or would be adversely affected under the "doing business" or tax laws of such state by so holding title, the deed or certificate of sale shall be taken in the name of such Person or Persons as shall be consistent with an opinion of counsel obtained by the Servicer from an attorney duly licensed to practice law in the state where the REO Property is located. Any Person or Persons holding such title other than the Purchaser shall acknowledge in writing that such title is being held as nominee for the benefit of the Purchaser. The Servicer shall either itself or through an agent selected by the Servicer, manage, conserve, protect and operate each REO Property (and may temporarily rent the same) in the same manner that it manages, conserves, protects and operates other foreclosed property for its own account, and in the same manner that similar property in the same locality as the REO Property is managed. If a REMIC election is or is to be made with respect to the arrangement under which the Mortgage Loans and any REO property are held, the Servicer shall manage, conserve, protect and operate each REO Property in a manner which does not cause such REO Property to fail to qualify as "foreclosure property" within the meaning of Section 860G(a)(8) of the Code or result in the receipt by such REMIC of any "income from non permitted assets" within the meaning of Section 860F(a)(2)(B) of the Code or any "net income from foreclosure property" within the meaning of Section 860G(c)(2) of the Code. The Servicer shall cause each REO Property to be inspected promptly upon the acquisition of title thereto and shall cause each REO Property to be inspected at least annually thereafter. The Servicer shall make or cause to be made a written report of each such inspection. Such reports shall be retained in the Mortgage File and copies thereof shall be forwarded by the Servicer to the Purchaser. The Servicer shall use its best efforts to dispose of the REO Property as soon as possible and shall sell such REO Property in any event within two years, or such other period as may be permitted under Section 860(G)(a)(8) of the Code, after title has been taken to such REO Property, unless the Servicer determines, and gives appropriate notice to the Purchaser, that a longer period is necessary for the orderly liquidation of such REO Property. 11-10 With respect to each REO Property, the Servicer shall segregate and hold all funds collected and received in connection with the operation of the REO Property separate and apart from its own funds or general assets and shall deposit such amounts in the Collection Account subject to withdrawal as provided in this Agreement. The Servicer shall deposit or cause to be deposited, on a daily basis in the Collection Account all revenues received with respect to the REO Property and shall withdraw therefrom funds necessary for the proper operation, management and maintenance of the REO Property, including the cost of maintaining any hazard insurance pursuant to Subsection 11.10 hereof and the fees of any managing agent acting on behalf of the Servicer. The Servicer shall furnish to the Purchaser on each Distribution Date, an operating statement for each REO Property covering the operation of each REO Property for the previous month. Such operating statement shall be accompanied by such other information as the Purchaser shall reasonably request. Each REO Disposition shall be carried out by the Servicer at such price and upon such terms and conditions as the Servicer deems to be in the best interest of the Purchaser only with the prior written consent of the Purchaser. If as of the date title to any REO Property was acquired by the Servicer there were outstanding unreimbursed Servicing Advances with respect to the REO Property, the Servicer, upon an REO Disposition of such REO Property, shall be entitled to reimbursement for any related unreimbursed Servicing Advances from proceeds received in connection with such REO Disposition. The proceeds from the REO Disposition, net of any payment to the Servicer as provided above, and prior to the Reconstitution Date, up to the outstanding principal balance of the Mortgage Loan, shall be deposited in the Custodial Account on the Determination Date in the month following receipt thereof for distribution on the succeeding Distribution Date in accordance with Section 4. Section 11.14 Distributions. On each Distribution Date, the Servicer shall distribute to the Purchaser all amounts credited to the Custodial Account as of the close of business on the preceding Determination Date, net of charges against or withdrawals from the Custodial Account pursuant to Subsection 11.05. All distributions made to the Purchaser on each Distribution Date will be made to the Purchaser of record on the preceding Record Date, and shall be based on the Mortgage Loans owned and held by the Purchaser, and shall be made by wire transfer of immediately available funds to the account of the Purchaser at a bank or other entity having appropriate facilities therefor, if the Purchaser shall have so notified the Servicer or by check mailed to the address of the Purchaser. 11-11 With respect to any remittance received by the Purchaser on or after the second Business Day following the Business Day on which such payment was due, the Servicer shall pay to the Purchaser interest on any such late payment at an annual rate equal to the rate of interest as is publicly announced from time to time at its principal office by Chase Manhattan Bank, N.A., New York, New York, as its prime lending rate, adjusted as of the date of each change, plus three percentage points, but in no event greater than the maximum amount permitted by applicable law. Such interest shall be paid by the Servicer to the Purchaser on the date such late payment is made and shall cover the period commencing with the day following such second Business Day and ending with the Business Day on which such payment is made, both inclusive. Such interest shall be remitted along with such late payment. The payment by the Servicer of any such interest shall not be deemed an extension of time for payment or a waiver of any Event of Default by the Servicer. Section 11.15 Remittance Reports. No later than the fifth Business Day of each month, the Servicer shall furnish to the Purchaser or its designee a computer tape containing, and a hard copy of, the monthly data, as further described and set forth in Exhibit 9-1. On the Business Day following each Determination Date, the Servicer shall deliver to the Purchaser or its designee by telecopy (or by such other means as the Servicer and the Purchaser may agree from time to time) a computer tape containing, and a hard copy of, the determination data with respect to the related Distribution Date, all as further described and set forth in Exhibit 9-1 hereto, together with such other information with respect to the Mortgage Loans as the Purchaser may reasonably require to allocate distributions made pursuant to this Agreement and provide appropriate statements with respect to such distributions. On the same date, the Servicer shall forward to the Purchaser by overnight mail a computer readable magnetic tape containing the information set forth in the Remittance Report with respect to the related Distribution Date. Section 11.16 Statements to the Purchaser. Not later than fifteen days after each Distribution Date, the Servicer shall forward to the Purchaser or its designee a statement prepared by the Servicer setting forth the status of the Custodial Account as of the close of business on such Distribution Date and showing, for the period covered by such statement, the aggregate amount of deposits into and withdrawals from the Custodial Account of each category of deposit specified in Subsection 11.04 and each category of withdrawal specified in Subsection 11.05. The Servicer shall provide the Purchaser with such information concerning the Mortgage Loans for the period during which it is servicing the Mortgage Loans for the Purchaser as is necessary for the Purchaser to prepare its federal income tax return as any Purchaser may reasonably request from time to time. Section 11.17 Real Estate Owned Reports. Together with the statement furnished pursuant to Subsection 11.02, with respect to any REO Property, the Servicer shall furnish to the Purchaser a statement covering the Servicer's efforts in connection with the sale of such REO Property and any rental of such REO Property incidental to the sale thereof for the previous month, together with the operating statement. Such statement shall be accompanied by such other information as the Purchaser shall reasonably request. 11-12 Section 11.18 Liquidation Reports. Upon the foreclosure sale of any Mortgaged Property or the acquisition thereof by the Purchaser pursuant to a deed in lieu of foreclosure, the Servicer shall submit to the Purchaser a liquidation report with respect to such Mortgaged Property. Section 11.19 Assumption Agreements. The Servicer shall, to the extent it has knowledge of any conveyance or prospective conveyance by any Mortgagor of the Mortgaged Property (whether by absolute conveyance or by contract of sale, and whether or not the Mortgagor remains or is to remain liable under the Mortgage Note and/or the Mortgage), exercise its rights to accelerate the maturity of such Mortgage Loan under any "due on sale" clause applicable thereto; provided, however, that the Servicer shall not exercise any such rights if prohibited by law from doing so or if the exercise of such rights would impair or threaten to impair any recovery under the related Primary Insurance Policy, if any. If the Servicer reasonably believes it is unable under applicable law to enforce such "due on sale" clause, the Servicer shall enter into an assumption agreement with the person to whom the Mortgaged Property has been conveyed or is proposed to be conveyed, pursuant to which such person becomes liable under the Mortgage Note and, to the extent permitted by applicable state law, the Mortgagor remains liable thereon. Where an assumption is allowed pursuant to this Subsection 11.01, the Servicer is authorized to enter into a substitution of liability agreement with the person to whom the Mortgaged Property has been conveyed or is proposed to be conveyed pursuant to which the original Mortgagor is released from liability and such Person is substituted as Mortgagor and becomes liable under the related Mortgage Note. Any such substitution of liability agreement shall be in lieu of an assumption agreement. In connection with any such assumption or substitution of liability, the Servicer shall follow the underwriting practices and procedures of prudent mortgage lenders in the state in which the related Mortgaged Property is located. With respect to an assumption or substitution of liability, Mortgage Interest Rate, the amount of the Monthly Payment, and the final maturity date of such Mortgage Note may not be changed. The Servicer shall notify the Purchaser that any such substitution of liability or assumption agreement has been completed by forwarding to the Purchaser the original of any such substitution of liability or assumption agreement, which document shall be added to the related Mortgage File and shall, for all purposes, be considered a part of such Mortgage File to the same extent as all other documents and instruments constituting a part thereof. Any fee collected by the Servicer for entering into an assumption or substitution of liability agreement in excess of 1% of the outstanding principal balance of the Mortgage Loan shall be deposited in the Custodial Account pursuant to Subsection 11.04. Notwithstanding the foregoing paragraphs of this Subsection or any other provision of this Agreement, the Servicer shall not be deemed to be in default, breach or any other violation of its obligations hereunder by reason of any assumption of a Mortgage Loan by operation of law or any assumption which the Servicer may be restricted by law from preventing, for any reason whatsoever. For purposes of this Subsection 11.19, the term "assumption" is deemed to also include a sale of the Mortgaged Property subject to the Mortgage that is not accompanied by an assumption or substitution of liability agreement. 11-13 Section 11.20 Satisfaction of Mortgages and Release of Mortgage Files. Upon the payment in full of any Mortgage Loan, or the receipt by the Servicer of a notification that payment in full will be escrowed in a manner customary for such purposes, the Servicer will immediately notify the Purchaser by a certification of a servicing officer, which certification shall include a statement to the effect that all amounts received or to be received in connection with such payment which are required to be deposited in the Custodial Account pursuant to Subsection 11.04 have been or will be so deposited, and shall request execution of any document necessary to satisfy the Mortgage Loan and delivery to it of the portion of the Mortgage File held by the Purchaser or the Purchaser's designee. Upon receipt of such certification and request, the Purchaser, shall promptly release the related mortgage documents to the Servicer and the Servicer shall prepare and process any satisfaction or release. No expense incurred in connection with any instrument of satisfaction or deed of reconveyance shall be chargeable to the Custodial Account or the Purchaser. In the event the Servicer satisfies or releases a Mortgage without having obtained payment in full of the indebtedness secured by the Mortgage or should it otherwise prejudice any right the Purchaser may have under the mortgage instruments, the Servicer, upon written demand, shall remit to the Purchaser the then outstanding principal balance of the related Mortgage Loan by deposit thereof in the Custodial Account. The Servicer shall maintain the fidelity bond insuring the Servicer against any loss it may sustain with respect to any Mortgage Loan not satisfied in accordance with the procedures set forth herein. From time to time and as appropriate for the service or foreclosure of the Mortgage Loan, including for this purpose collection under any Primary Insurance Policy, the Purchaser shall, upon request of the Servicer and delivery to the Purchaser of a servicing receipt signed by a Servicing Officer, release the requested portion of the Mortgage File held by the Purchaser to the Servicer. Such servicing receipt shall obligate the Servicer to return the related Mortgage documents to the Purchaser when the need therefor by the Servicer no longer exists, unless the Mortgage Loan has been liquidated and the Liquidation Proceeds relating to the Mortgage Loan have been deposited in the Custodial Account or the Mortgage File or such document has been delivered to an attorney, or to a public trustee or other public official as required by law, for purposes of initiating or pursuing legal action or other proceedings for the foreclosure of the Mortgaged Property either judicially or non judicially, and the Servicer has delivered to the Purchaser a certificate of a servicing officer certifying as to the name and address of the Person to which such Mortgage File or such document was delivered and the purpose or purposes of such delivery. Upon receipt of a certificate of a servicing officer stating that such Mortgage Loan was liquidated, the servicing receipt shall be released by the Purchaser to the Servicer. Section 11.21 Reserved. Section 11.22 Servicing Compensation. As compensation for its services hereunder, the Servicer shall, subject to Subsection 11.04(x), be entitled to withdraw from the Custodial Account or to retain from interest payments on the Mortgage Loans the amounts provided for as the Servicer's Servicing Fee. Additional servicing compensation in the form of Ancillary Income shall be retained by the Servicer to the extent not required to be deposited in the Custodial Account. The Servicer shall be required to pay all expenses incurred by it in connection with its servicing activities hereunder and shall not be entitled to reimbursement therefor except as specifically provided for. 11-14 Section 11.23 Statement as to Compliance. The Servicer will deliver to the Purchaser and the Servicer not later than March 31, 2004, an Officers' Certificate stating, as to each signatory thereof, that (i) a review of the activities of the Servicer during the interim servicing period and of performance under this Agreement has been made under such officers' supervision and (ii) to the best of such officers' knowledge, based on such review, the Servicer has fulfilled all of its obligations under this Agreement throughout such period, or, if there has been a default in the fulfillment of any such obligation, specifying each such default known to such officer and the nature and status thereof. Copies of such statement shall be provided by the Purchaser to any Person identified as a prospective purchaser of the Mortgage Loans. Section 11.24 Independent Public Accountants' Servicing Report. Not later than March 31, 2004, the Servicer at its expense shall cause a firm of independent public accountants (which may also render other services to the Servicer) which is a member of the American Institute of Certified Public Accountants to furnish a statement to the Purchaser or its designee and the Servicer to the effect that such firm has examined certain documents and records relating to the servicing of the Mortgage Loans under this Agreement or of mortgage loans under pooling and servicing agreements (including the Mortgage Loans and this Agreement) substantially similar one to another (such statement to have attached thereto a schedule setting forth the pooling and servicing agreements covered thereby) and that, on the basis of such examination conducted substantially in compliance with the Uniform Single Attestation Program for Mortgage Bankers or the Audit Program for Mortgages serviced for Freddie Mac, such firm confirms that such servicing has been conducted in compliance with such pooling and servicing agreements except for such significant exceptions or errors in records that, in the opinion of such firm, the Uniform Single Attestation Program for Mortgage Bankers or the Audit Program for Mortgages serviced for Freddie Mac requires it to report. Copies of such statement shall be provided by the Purchaser to any Person identified as a prospective purchaser of the Mortgage Loans. Section 11.25 Access to Certain Documentation. The Servicer shall provide to the Office of Thrift Supervision, the FDIC and any other federal or state banking or insurance regulatory authority that may exercise authority over the Purchaser access to the documentation regarding the Mortgage Loans serviced by the Servicer required by applicable laws and regulations. Such access shall be afforded without charge, but only upon reasonable request and during normal business hours at the offices of the Servicer. In addition, access to the documentation will be provided to the Purchaser and any Person identified to the Servicer by the Purchaser without charge, upon reasonable request during normal business hours at the offices of the Servicer. 11-15 Section 11.26 Recovery of Servicing Advances. Prior to the transfer of servicing on any Servicing Transfer Date, the Servicer shall be entitled to reimbursement from either (i) the Custodial Account, if funds are available therefore, or (ii) from the successor servicer or Purchaser for any unreimbursed Servicing Advances made by the Servicer during the period from the related Closing Date through the Servicing Transfer Date, in an amount not to exceed $50,000 in the aggregate; provided that the Servicer has complied with its reporting obligations described in the following sentence. The Servicer shall deliver promptly written notification to the Purchaser if the amount of Servicing Advances made by the Servicer equals an aggregate of $50,000, which notification shall set forth the amount and purpose of such Servicing Advances and the related Mortgage Loans. 11-16 SCHEDULE I MORTGAGE LOAN SCHEDULE [ON FILE] I-1 EX-10 12 ex10-108.txt EXHIBIT 10.108 EXECUTION COPY MORTGAGE LOAN PURCHASE AND INTERIM SERVICING AGREEMENT EMC MORTGAGE CORPORATION Purchaser and AMERICAN BUSINESS CREDIT, INC. HOMEAMERICAN CREDIT, INC., D/B/A UPLAND MORTGAGE, AND AMERICAN BUSINESS MORTGAGE SERVICES, INC. Originators Dated as of June 30, 2003 MORTGAGE LOAN PURCHASE AND INTERIM SERVICING AGREEMENT This is a MORTGAGE LOAN PURCHASE AND INTERIM SERVICING AGREEMENT (the "Agreement"), dated as of June 30, 2003, by and among EMC Mortgage Corporation (the "Purchaser"), American Business Credit, Inc., a Pennsylvania corporation ("ABC"), Homeamerican Credit, Inc. d/b/a Upland Mortgage, a Pennsylvania corporation ("Upland"), and American Business Mortgage Services, Inc., a New Jersey corporation ("ABMS", and together with ABC and Upland, the "Originators"). W I T N E S S E T H : WHEREAS, the Originators desire to sell to the Purchaser, and the Purchaser desires to purchase from the Originators, from time to time, certain fixed-rate residential first or second lien mortgage loans as described herein, including all Servicing Rights (as defined below) related thereto (the "Mortgage Loans") and which shall be delivered as whole loans; WHEREAS, each Mortgage Loan is secured by a mortgage, deed of trust or other security instrument creating a first or second lien on a residential dwelling located in the jurisdiction indicated on the related Mortgage Loan Schedule, which is annexed to the related Term Sheet; WHEREAS, the Purchaser and the Originators wish to prescribe the manner of the conveyance, interim servicing and control of the Mortgage Loans. NOW, THEREFORE, in consideration of the premises and mutual agreements set forth herein, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the Purchaser and the Originators agree as follows: SECTION 1. Definitions: For purposes of this Agreement the following capitalized terms shall have the respective meanings set forth below. Accepted Servicing Practices: With respect to any Mortgage Loan, the Originators' normal servicing practices including practices regarding reconciliation of bank accounts, processing of mortgage payments, processing of disbursements for tax and insurance payments, maintenance of mortgage loan records, performance of collection efforts including disposition of delinquent loans, foreclosure activities and disposition of real estate owned and performance of investor accounting and reporting processes. Such practices will conform to the mortgage servicing practices of prudent mortgage lending institutions which service, for their own account, mortgage loans of the same type as the Mortgage Loans in the jurisdiction in which the related Mortgaged Properties are located, which may change from time to time; provided, that such practices shall at all times conform to the Credit and Servicing Policy Manuals. Agreement: This Mortgage Loan Purchase and Interim Servicing Agreement including all exhibits, schedules, amendments and supplements hereto. Appraised Value: With respect to any Mortgaged Property, the lesser of (i) the value thereof as determined by an appraisal made for the originator of the Mortgage Loan at the time of origination of the Mortgage Loan by a Qualified Appraiser, and (ii) the purchase price paid for the related Mortgaged Property by the Mortgagor with the proceeds of the Mortgage Loan, provided, however, in the case of a Refinanced Mortgage Loan, such value of the Mortgaged Property is based solely upon the value determined by an appraisal made for the originator of such Refinanced Mortgage Loan at the time of origination of such Refinanced Mortgage Loan by a Qualified Appraiser. 1 Assignment of Mortgage: An individual assignment of Mortgage, notice of transfer or equivalent instrument in recordable form, sufficient under the laws of the jurisdiction wherein the related Mortgaged Property is located to give record notice of the sale of the Mortgage to the Purchaser. None of the assignments of Mortgage will be "blanket" assignments of Mortgage. Business Day: Any day other than a Saturday or Sunday, or a day on which banking and savings and loan institutions in the State of New York or other states where the Purchaser is located or in the State of Pennsylvania are authorized or obligated by law or executive order to be closed. Cash-Out Refinancing: A Refinanced Mortgage Loan the proceeds of which were in excess of the principal balance of any existing first mortgage on the related Mortgaged Property and related closing costs, and were used to pay any such existing first mortgage, related closing costs and subordinate mortgages on the related Mortgaged Property. Closing Date: With respect to any Mortgage Loan, the date set forth in Section 4.01 or stated on the related Term Sheet. Closing Documents: The documents required pursuant to Section 9. Combined Loan-to-Value Ratio or CLTV: With respect to any Mortgage Loan, the sum of the original principal balance of such Mortgage Loan as of the date of origination of the Mortgage Loan, divided by the lesser of the Appraised Value of the Mortgage Property as of the origination date or the purchase price of the Mortgaged Property. Condemnation Proceeds: All awards, compensation and settlements in respect of a taking of all or part of a Mortgaged Property by exercise of the power of condemnation or the right of eminent domain. Credit and Servicing Policy Manuals: With respect to an Originator, its written policies and procedures regarding underwriting, origination and servicing of mortgage loans, as delivered to the Purchaser on or prior to the initial Closing Date, with such changes notified to the Purchaser (a) that do not have a material adverse effect on such policies and procedures, or (b) that are approved by the Purchaser, such approval not to be unreasonably withheld, conditional or delayed, or (c) that the Servicer does not apply to the Mortgage Loans. Confirmation: In the case of any purchase of Mortgage Loans by the Purchaser from the Originators other than the initial purchase, the trade confirmation letter between the Purchaser and the Originators which relates to the Mortgage Loans. 2 Current Appraised Value: With respect to any Mortgaged Property, the value thereof as determined by an appraisal made for the applicable Originator (by a Qualified Appraiser) at the request of a Mortgagor for the purpose of canceling a Primary Mortgage Insurance Policy in accordance with federal, state and local laws and regulations. Current LTV: The ratio of the Stated Principal Balance of a Mortgage Loan to the Current Appraised Value of the Mortgaged Property. Custodial Account: Each separate account or accounts, each of which shall be an Eligible Account, created and maintained pursuant to this Agreement, which shall be entitled "[Servicer], in trust for EMC Mortgage Corporation, Owner of Mortgage Loans, P&I Account," and shall be established in an Eligible Account, in the name of the Person that is the "Purchaser" with respect to the related Mortgage Loans. Custodian: JPMorgan Chase Bank, a New York banking corporation, its successors and assigns, as custodian for the Purchaser. Cut-off Date: With respect to any Mortgage Loan, the later of (i) the date set forth in Section 4.01 or stated on the related Term Sheet and (ii) the date of origination of such Mortgage Loan. Due Date: With respect to each Mortgage Loan, the day on which the Monthly Payment for such Mortgage Loan is due, exclusive of any days of grace. Due Period: With respect to each Distribution Date, the calendar month preceding the related Distribution Date. Eligible Account: An account established and maintained: (i) within FDIC insured accounts created, maintained and monitored by the Servicer so that all funds deposited therein are fully insured, or (ii) as a trust account with the corporate trust department of a depository institution or trust company organized under the laws of the United States of America or any one of the states thereof or the District of Columbia which is not affiliated with the Servicer (or any sub-servicer) or (iii) with an entity which is an institution whose deposits are insured by the FDIC, the unsecured and uncollateralized long-term debt obligations of which shall be rated "A2" or higher by Moody's Investor Services Inc. and "A" or higher by Standard and Poor's Corp. or one of the two highest short-term ratings by any applicable Rating Agency, and which is either (a) a federal savings association duly organized, validly existing and in good standing under the federal banking laws, (b) an institution duly organized, validly existing and in good standing under the applicable banking laws of any state, (c) a national banking association under the federal banking laws, or (d) a principal subsidiary of a bank holding company, or (iv) if ownership of the Mortgage Loans is evidenced by mortgaged-backed securities, the equivalent required ratings of each Rating Agency, and held such that the rights of the Purchaser and the owner of the Mortgage Loans shall be fully protected against the claims of any creditors of the Servicer (or any sub-servicer) and of any creditors or depositors of the institution in which such account is maintained. In the event that a Custodial Account is established pursuant to clause (iii) or (iv) of the preceding sentence, the Servicer shall provide the Purchaser with written notice on the Business Day following the date on which the applicable institution fails to meet the applicable ratings requirements. 3 Escrow Account: Each separate trust account or accounts created and maintained pursuant to this Agreement which shall be entitled "[Servicer], in trust for EMC Mortgage Corporation, the Owner of Mortgage Loans, and various Mortgagors, T&I Account," and shall be established in an Eligible Account, in the name of the Person that is the "Purchaser" with respect to the related Mortgage Loans. Escrow Payments: The amounts constituting ground rents, taxes, assessments, water charges, sewer rents, mortgage insurance premiums, fire and hazard insurance premiums and other payments as may be required to be escrowed by the Mortgagor with the Mortgagee pursuant to the terms of any Mortgage Note or Mortgage. Event of Default: Any one of the events enumerated in Subsection 13.01. Fannie Mae: Fannie Mae or any successor thereto. FDIC: The Federal Deposit Insurance Corporation or any successor thereto. Freddie Mac: Freddie Mac or any successor thereto. GAAP: Generally accepted accounting principles, consistently applied. HMDA: The Home Mortgage Disclosure Act, as amended. Insurance Proceeds: With respect to each Mortgage Loan, proceeds of any insurance policy insuring the Mortgage Loan or the related Mortgaged Property. Interest Paid to Date: With respect to a Mortgage Loan, the last date to which interest has been paid on such Mortgage Loan, as shown on the books and records of Servicer as of the related Cut-off Date. Interim Servicing Period: With respect to any Mortgage Loan, the period during which the Servicer shall service the Mortgage Loans in accordance with the provisions of this Agreement, commencing on the related Closing Date and ending on the related Servicing Transfer Date. Liquidation Proceeds: Amounts, other than Insurance Proceeds and Condemnation Proceeds, received in connection with the liquidation of a defaulted Mortgage Loan through trustee's sale, foreclosure sale or otherwise, other than amounts received following the acquisition of REO Property. Loan-to-Value Ratio or LTV: With respect to any Mortgage Loan as of origination, the ratio on such date of the outstanding principal amount of the Mortgage Loan to the lesser of the Appraised Value of the Mortgaged Property as of the Origination Date or the purchase price of the Mortgaged Property. Maximum Aggregate Purchase Amount: $700,000,000. MERS: Mortgage Electronic Registration Systems, Inc., a corporation organized and existing under the laws of the State of Delaware, or any successor thereto. 4 MERS Mortgage Loan: Any Mortgage Loan registered with MERS on the MERS(R)System. MERS(R) System: The system of recording transfers of mortgages electronically maintained by MERS. MIN: The Mortgage Identification Number for any MERS Mortgage Loan. MOM Loan: Any Mortgage Loan as to which MERS is acting as original mortgagee, solely as nominee for the originator of such Mortgage Loan and its successors and assigns. Monthly Payment: With respect to any Mortgage Loan, the scheduled combined payment of principal and interest payable by a Mortgagor under the related Mortgage Note on each Due Date. Mortgage: The mortgage, deed of trust or other instrument securing a Mortgage Note which creates a first or second lien on an unsubordinated estate in fee simple in real property securing the Mortgage Note. Mortgagee: The mortgagee or beneficiary named in the Mortgage and the successors and assigns of such mortgagee or beneficiary. Mortgage File: With respect to each Mortgage Loan, the file consisting of the Mortgage Loan Documents and originals of all other documents referred to in Exhibit 2 annexed hereto and any additional documents related to the origination of a particular Mortgage Loan and all documents, files and other information necessary to service the Mortgage Loans. Mortgage Interest Rate: With respect to each Mortgage Loan, the annual rate at which interest accrues on such Mortgage Loan from time to time in accordance with the provisions of the related Mortgage Note. Mortgage Loan: Each mortgage loan sold, assigned and transferred to the Purchaser pursuant to this Agreement and identified on the related Mortgage Loan Schedule attached to the related Term Sheet, which Mortgage Loan includes without limitation the Servicing Rights, the Mortgage File, the Monthly Payments, Principal Prepayments, Liquidation Proceeds, Condemnation Proceeds, Insurance Proceeds, REO Disposition proceeds, and all other rights, benefits, proceeds and obligations arising from or in connection with such mortgage loan. Mortgage Loan Documents: The documents listed in Subsection 6.03 pertaining to any Mortgage Loan. 5 Mortgage Loan Schedule: The schedule of Mortgage Loans annexed to the related Term Sheet (which shall also be provided in an electronic format acceptable to Purchaser), such schedule setting forth the following information with respect to each Mortgage Loan: (1) the Servicer's Mortgage Loan identifying number; (2) the Mortgagor's first and last name; (3) the street address of the Mortgaged Property including the city, state and zip code; (4) a code indicating whether the Mortgaged Property is owner-occupied, a second home or investor property; (5) the type of Residential Dwelling constituting the Mortgaged Property; (6) a code indicating the purpose of the loan (i.e., purchase financing, Rate/Term Refinancing, Cash-Out Refinancing); (7) the original principal amount of the Mortgage Loan; (8) the Mortgage Interest Rate; (9) the date on which the first Monthly Payment was due on the Mortgage Loan; (10) the stated maturity date; (11) the amount of the Monthly Payment; (12) the original months to maturity; (13) the Origination Date of the Mortgage Loan and the remaining months to maturity from the related Cut-off Date, based on the original amortization schedule; (14) the last Due Date on which a Monthly Payment was actually applied to the unpaid Stated Principal Balance; (15) the Stated Principal Balance of the Mortgage Loan as of the related Cut-off Date; (16) the amount of the Monthly Payment as of the related Cut-off Date;(17) the sales price of the Mortgaged Property, if applicable, the Appraised Value and the Loan-to-Value Ratio at origination; (18) the Current Appraised Value and Current LTV, if applicable; (19) a code indicating the documentation style; (20) credit score and/or mortgage score, each if applicable; (21) a code indicating whether or not the Mortgage Loan is the subject of Primary Mortgage Insurance Policy and the name of the related insurer and, if such loan has Primary Mortgage Insurance, the amount of such Primary Mortgage Insurance expressed as a percent of the Appraised Value; (22) loan type (i.e. fixed, etc.); (23) a code indicating whether or not each Mortgage Loan has a prepayment penalty and if so, the amount and duration of such penalty; (24) the debt-to-income ratio; (25) a code indicating whether the Mortgage Loan is a buydown loan; (26) a code indicating whether or not the Mortgage Loan has "balloon features"; (27) a code indicating whether or not the Mortgage Loan has a "lifetime" tax service contract in effect; (28) a code indicating whether the Mortgage Loan is a MERS Mortgage Loan; (29) the credit grade, if applicable, assigned to such loan at origination according to the Underwriting Guidelines of the applicable Originator; (30) the CLTV; (31) amortization term; (32) assumable (Y/N); (33) MERS #, if applicable; (34) co-borrower name (first and last); (35) borrower social security #; (36) co-borrower social security #; (37) borrower race if disclosed; (38) co-borrower race if disclosed; (39) borrower gender if disclosed; (40) co-borrower gender if disclosed; (41) monthly combined income-if applicable; (42) monthly debt; (43) the monthly Escrow Payment; and (44) the amount of the total monthly payment by the Mortgagor (e.g., the Monthly Payment plus the monthly Escrow Payment). With respect to the Mortgage Loans in the aggregate, the related Mortgage Loan Schedule attached to the related Term Sheet shall set forth the following information, as of the related Cut-off Date: (1) the number of Mortgage Loans; (2) the current principal balance of the Mortgage Loans; (3) the weighted average Mortgage Interest Rate of the Mortgage Loans; and (4) the weighted average maturity of the Mortgage Loans. Mortgage Note: The note or other evidence of the Mortgage Loan indebtedness of a Mortgagor. Mortgaged Property: The underlying real property securing repayment of a Mortgage Note, consisting of a single parcel of real estate considered to be real estate under the laws of the state in which such real property is located which may include condominium units and planned unit developments, improved by a residential dwelling. Mortgagor: The obligor on a Mortgage Note, the owner of the Mortgaged Property and the grantor or mortgagor named in the related Mortgage and such grantor's or mortgagor's successor(s) in title to the Mortgaged Property. Net Escrow Payments: Escrow Payment balances remaining after advances by the Servicer for taxes and insurance to the extent documented under a detailed statement provided to the Purchaser. 6 Officer's Certificate: A certificate signed by the Chairman of the Board or the Vice Chairman of the Board or a President or a Vice President and by the Treasurer or the Secretary or one of the Assistant Treasurers or Assistant Secretaries of the Person on behalf of whom such certificate is being delivered. Opinion of Counsel: A written opinion of counsel, who may be salaried counsel for the Person on behalf of whom the opinion is being given, reasonably acceptable to each Person to whom such opinion is addressed. Origination Date: The date on which a Mortgage Loan funded. Originators: American Business Credit, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc., d/b/a Upland Mortgage, a Pennsylvania corporation, and American Business Mortgage Services, Inc., a New Jersey corporation. Pass-Through Transfer: The sale of some or all of the Mortgage Loans to a trust as part of a publicly issued or privately placed, rated or unrated, mortgage pass-through transaction. Person: An individual, corporation, partnership, joint venture, association, joint-stock company, limited liability company, trust, unincorporated organization or government or any agency or political subdivision thereof. Primary Mortgage Insurance Policy or PMI Policy: Each primary policy of mortgage insurance issued by a Qualified Insurer and represented to be in effect pursuant to Section 7.02. Principal Prepayment: Any payment or other recovery of principal on a Mortgage Loan, full or partial, which is received in advance of its scheduled Due Date, which is not accompanied by an amount of interest representing scheduled interest due on any date or dates in any month or months subsequent to the month of prepayment. Purchase Price: The price paid by the Purchaser in exchange for the Mortgage Loans (including the Servicing Rights thereon) purchased on the related Closing Date, calculated as provided in Section 4. Purchase Price Percentage: That certain purchase price percentage specified herein or in the related Term Sheet with respect to the Mortgage Loans, as adjusted as provided for therein. Purchaser: EMC Mortgage Corporation, its successors in interest and assigns. Qualified Appraiser: An appraiser, duly appointed by the Servicer, who had no interest, direct or indirect, in the Mortgaged Property or in any loan made on the security thereof, and whose compensation is not affected by the approval or disapproval of the Mortgage Loan, and such appraiser and the appraisal made by such appraiser both satisfy the requirements of Title XI of the Federal Institutions Reform, Recovery and Enforcement Act of 1989 and the regulations promulgated thereunder, all as in effect on the date the Mortgage Loan was originated. 7 Qualified Insurer: An insurance company duly qualified as such under the laws of the states in which the Mortgaged Properties are located, duly authorized and licensed in such states to transact the applicable insurance business and to write the insurance provided, and whose claims paying ability is rated in the two highest rating categories by each applicable Rating Agency with respect to primary mortgage insurance and in the two highest rating categories in Best's Key Rating Guide with respect to hazard and flood insurance. Rate/Term Refinancing: A Refinanced Mortgage Loan, the proceeds of which are limited to the sum of the unpaid principal balance of the existing first mortgage, closing costs (including all prepaid items), points, the amount required to satisfy any subordinate mortgage liens that are more than one year old (if the borrower plans to satisfy them), and other funds for the borrower's use (as long as the amount does not exceed 2% of the principal amount of the new mortgage or $2,000). A property that has subordinate liens that have been in existence for one year or less also may be treated as a rate/term refinance transaction as long as the proceeds of the subordinate lien were used to make documented home improvements. Rating Agency: Moody's Investors Servicers, Inc., Standard & Poor's, a division of The McGraw-Hill Companies, Inc., and Fitch Ratings or, in the event that some or all of the ownership of the Mortgage Loans is evidenced by mortgage-backed securities, the nationally recognized rating agencies issuing ratings with respect to such securities, if any. Recording Fee: For any Mortgage Loan that is not a MERS Mortgage Loan, $25.00 per Mortgage Loan. Refinanced Mortgage Loan: A Mortgage Loan the proceeds of which were not used to purchase the related Mortgaged Property. REO Disposition: The final sale by the Servicer of any REO Property. REO Property: A Mortgaged Property acquired as a result of the liquidation of a Mortgage Loan. Repurchase Price: With respect to any Mortgage Loan, a price equal to (x) the product of the greater of 100% or the Purchase Price Percentage multiplied by the Stated Principal Balance of such Mortgage Loan on the repurchase date, plus (y) accrued interest on such Stated Principal Balance at the Mortgage Interest Rate from the last interest paid to date through which interest has been paid by or on behalf of the Mortgagor through the date prior to the date of repurchase, less (z) amounts received in respect of such repurchased Mortgage Loan which are being held in the Custodial Account for distribution in connection with such Mortgage Loan. Residential Dwelling: Any one of the following: (i) a detached single family dwelling, (ii) an attached single family dwelling (iii) a two-to-four family dwelling, (iv) a unit in a condominium project, or (v) a detached single family dwelling in a planned unit development. Mortgaged Properties that consist of the following property types are not eligible for sale to the Purchaser: (a) co-operative units, (b) log homes, (c) earthen homes, (d) underground homes, (e) mobile homes, (f) homes which are situated on more than ten acres of property and (g) homes which are secured by a leasehold estate. SAIF: The Savings Association Insurance Fund, or any successor thereto. Servicer: American Business Credit, Inc., a Pennsylvania corporation, or any successor appointed as herein provided. 8 Servicing Addendum: The terms and conditions attached hereto as Exhibit 5 which will govern the servicing of the Mortgage Loans by the Servicer during the Interim Servicing Period; provided, however, the Servicing Addendum shall not be applicable to the servicing of any Mortgage Loan subject to a Short Interim Servicing Period. Servicing Rights: With respect to each Mortgage Loan, any and all of the following: (a) all rights to service the Mortgage Loan; (b) all rights to receive servicing fees, additional servicing compensation (including without limitation any late fees, assumption fees, prepayment penalties or premiums due in connection with a Principal Prepayment (if any), other penalties, fees or similar payments with respect to the Mortgage Loan, and income on escrow accounts or other receipts on or with respect to the Mortgage Loan), reimbursements or indemnification for servicing the Mortgage Loan, and any payments received in respect of the foregoing and proceeds thereof; (c) the right to collect, hold and disburse Escrow Payments or other similar payments with respect to the Mortgage Loans, Escrow Accounts and any amounts actually collected with respect thereto and to receive interest income on such amounts to the extent permitted by applicable law; (d) all accounts and other rights to payment related to any of the property described in this paragraph; (e) possession and use of any and all Mortgage Files pertaining to the Mortgage Loans or pertaining to the past, present or prospective servicing of the Mortgage Loans; (f) all rights and benefits relating to the direct solicitation of the related Mortgagors for refinance or modification of the Mortgage Loans and attendant right, title and interest in and to the list of such Mortgagors and data relating to their respective Mortgage Loans; (g) all rights, powers and privileges incident to any of the foregoing; and (h) all agreements or documents creating, defining or evidencing any of the foregoing rights to the extent they relate to such rights and all rights of the Servicer thereunder including, but not limited to, any clean-up calls and termination options. Servicing Rights Owner: The Person to whom the Servicing Rights are transferred at any time, which Person may or may not be the Purchaser of the Mortgage Loans hereunder, and which Person will, on the related Closing Date, be the Purchaser. Servicing Transfer Date: As set forth herein or in the related Term Sheet. Short Interim Servicing Period: As defined in Section 11. Stated Principal Balance: As to each Mortgage Loan (i) the principal balance of such Mortgage Loan as of the related Cut-off Date, minus (ii) all amounts thereafter distributed to the Purchaser with respect to the related Mortgage Loan representing payments or recoveries of principal. Term Sheet: A supplemental agreement in the form attached hereto as Exhibit 1 which shall be executed and delivered by the Originators and the Purchaser to provide for the sale pursuant to the terms of this Agreement of the Mortgage Loans including all Servicing Rights related thereto listed on Schedule I attached thereto, which supplemental agreement shall contain certain specific information relating to such sale of such Mortgage Loans and may contain additional covenants relating to such sale of such Mortgage Loans. Underwriting Guidelines: The underwriting guidelines attached as, and the restrictions (if any) set forth in, Exhibit 9 hereto, as revised from time to time. 9 Value: With respect to any Mortgage Loan, the lower of the Appraised Value of the Mortgaged Property as of the origination date or the purchase price of the Mortgaged Property. Whole Loan Transfer: The sale or transfer of some or all of the ownership interest in the Mortgage Loans by the Purchaser to one or more third parties in whole loan or participation format. SECTION 2. Agreement to Purchase. The Originators agree to sell, and the Purchaser agrees to purchase, from time to time, without recourse, but subject to the terms of this Agreement, Mortgage Loans, together with the Servicing Rights, having an aggregate principal balance on the related Cut-off Date in an amount set forth in Section 4.01 or on the related Term Sheet or in such other amount as agreed by the Purchaser and the Originators as evidenced by the actual aggregate principal balance of the Mortgage Loans accepted by the Purchaser on the related Closing Date. As part of the foregoing agreement, on or before July 15, 2003 (or such later date up to and including July 31, 2003 as necessary due to any delays connected to the completion of the Purchaser's due diligence review of the Mortgage Loans, but not including delays caused by direct actions taken by the Purchaser) the Originators shall agree to sell, and in good faith the Purchaser shall agree to purchase, Mortgage Loans, together with the Servicing Rights, having a minimum aggregate principal balance of $275,000,000 as of the related Cut-off Dates. These Mortgage Loans are referred to as the "First Acquired Pool" and shall include the Mortgage Loans purchased on the initial Closing Date. The Purchase Price Percentage for each Mortgage Loan in the First Acquired Pool accepted for purchase by the Purchaser shall be 105.00%; provided, however, that such Purchase Price Percentage shall be adjusted to a lower percentage if (i) the initial weighted average Mortgage Interest Rate of all Mortgage Loans in the First Acquired Pool is less than 9.58% per annum or (ii) there is a material adverse change in the overall loan characteristics of all Mortgage Loans in the First Acquired Pool compared to the loan characteristics of the approximately $215,000,000 pool of mortgage loans (other than any mortgage loans secured by mortgaged properties located in New York City or mortgage loans originated for business purposes) set forth in the electronic data tape sent in June 2003 by the Originators to the Purchaser. Any adjustment of the Purchase Price Percentage for decreases in the weighted average Mortgage Interest Rate below 9.58% per annum shall be at a 2 to 1 multiple. Any or all of the adjustment in the Purchase Price Percentage for the Mortgage Loans in the First Acquired Pool by means of a refund or other form of settlement between the Originators and the Purchaser shall be completed at the time of the final purchase of Mortgage Loans in the First Acquired Pool or within one week of such date. Notwithstanding any other provision in this section to the contary, until such time as each Term Sheet is executed and delivered by the Originators and the Purchaser in connection with a purchase of Mortgage Loans and subject to the Purchaser's satisfactory completion, in the sole discretion, of its due diligence review of the Mortgage Loans to be purchased to insure that they meet the requirements set forth in this Agreement, except in the case of the initial purchase of Mortgage Loans at the time of the execution and delivery of this Agreement, the Originators shall not be obligated to sell, and the Purchaser shall not be obligated to purchase, any Mortgage Loans. 10 Notwithstanding any other provision in this Agreement, the maximum aggregate principal balance (as of the related Cut-off Date) of the Mortgage Loans purchased under this Agreement from time to time shall not exceed the Maximum Aggregate Purchase Amount. SECTION 3. Mortgage Loan Schedule. Except in the case of the purchase of Mortgage Loans on the initial Closing Date, the Originators shall deliver the related Mortgage Loan Schedule to the Purchaser at least two (2) Business Days prior to the related Closing Date. SECTION 4. Purchase Price; Near-term Principal Prepayments. Subsection 4.01 Purchase Price. In the case of the initial purchase of Mortgage Loans by the Purchaser at the time of the execution and delivery of this Agreement, the Originators shall deliver to the Purchaser a Mortgage Loan Schedule, pursuant to and in accordance with the terms and conditions set forth in this Agreement, and in lieu of a Term Sheet for the initial purchase, the following terms shall apply: Aggregate Principal Balance (as of the Cut-off Date): $102,721,833.42 Initial Closing Date: June 30, 2003 Cut-off Date: June 1, 2003 (or, for any Mortgage Loan originated after that date, the date of origination of such Mortgage Loan) Initial Weighted Average Mortgage Interest Rate: 9.68% Purchase Price Percentage: 105.00% Servicing Transfer Date: On or before August 31, 2003 Holdback 0.25% of the Purchase Price for the Mortgage Loans will be held back and paid to the Originators on the Servicing Transfer Date. Interest on the amount held back will accrue and be payable by the Purchaser on the Holdback Payment Date at a per annum rate equal to one-month LIBOR plus 0.25. Holdback Payment Date The date on which the requirements under this Agreement for the transfer of the Servicing Rights from the Servicer to the Purchaser have been completed to the reasonable satisfaction of the Purchaser. 11 Additional Closing Conditions Satisfactory completion, in the sole discretion of the Purchaser, of its due diligence review of the Mortgage Loans to insure that they meet the requirements set forth in this Agreement The Purchase Price for each Mortgage Loan (inclusive of the Servicing Rights associated with such Mortgage Loan) listed on the related Mortgage Loan Schedule shall be the Purchase Price Percentage, multiplied by the Stated Principal Balance of such Mortgage Loan as of the related Cut-off Date. In addition to the Purchase Price as described above, the Purchaser shall pay to the Originators, on the related Closing Date, accrued interest on each Mortgage Loan at the Mortgage Interest Rate from the related last Interest Paid to Date through the day prior to the related Closing Date, inclusive; provided, however, with respect to those Mortgage Loans for which interest has been paid through a date beyond the related Closing Date, such accrued interest owing to Originators shall be reduced by the amount of interest accruing on the Stated Principal Balance of each such Mortgage Loan at a rate equal to the Mortgage Interest Rate of such Mortgage Loan, from the related Closing Date to the day prior to the Interest Paid to Date for such Mortgage Loan, inclusive. The Purchase Price shall be reduced by the Recording Fee, multiplied by the number of Mortgage Loans that are not MERS Mortgage Loans. With respect to each Mortgage Loan purchased, the Purchaser shall own and be entitled to receive (except as otherwise described in this Agreement during the related Interim Servicing Period) the following items that are received or collected on or after the related Cut-off Date: (i) all payments and/or recoveries of principal, (ii) all payments of interest on the Mortgage Loans, (iii) all fees, prepayment penalties or premiums (subject to Section 4.02), and (iv) all other Ancillary Income. Subsection 4.02 Near-term Principal Prepayments. In the event any Principal Prepayment is made by a Mortgagor on or prior to three months after the related Closing Date, the Originators shall remit to the Purchaser an amount equal to the excess, if any, of the Purchase Price Percentage over par multiplied by the Stated Principal Balance of such Mortgage Loan as of the Cut-off Date (each such amounts the "Premium"), net of any prepayment fee or penalty collected in regard to such prepayment. Such remittance shall be made by the Originators to the Purchaser no later than the third Business Day following receipt of such Principal Prepayment. SECTION 5. Examination of Mortgage Files. With regard to the examination of the Mortgage Loans and Mortgage Files prior to the related Closing Date, Purchaser and Originators shall have such rights as are set forth in any related Confirmation. If Purchaser declines, in accordance with its rights under any related Confirmation, to purchase a Mortgage Loan, such Mortgage Loan shall be deleted from the related Mortgage Loan Schedule. The Purchaser may, at its option and without notice to the Originators, purchase all or a portion of the Mortgage Loans without conducting any partial or complete examination. The fact that the Purchaser has conducted or has determined not to conduct any partial or complete examination of the Mortgage Files shall not affect the Purchaser's (or any of its successors') rights to demand repurchase or any other relief or remedy provided for in this Agreement. 12 SECTION 6. Conveyance from Originators to Purchaser. Subsection 6.01 Conveyance of Mortgage Loans; Possession of Mortgage Files. On the related Closing Date, the Originators, simultaneously with the payment of the related Purchase Price, do hereby sell, transfer, assign, set over and convey to the Purchaser, without recourse, but subject to the terms of this Agreement, all rights, title and interest of the Originators in and to the Mortgage Loans (including the Servicing Rights thereon) listed on the related Mortgage Loan Schedule attached to the related Term Sheet, together with the related Mortgage Files and all rights and obligations arising under the documents contained therein. Pursuant to Subsection 6.03 of the Agreement, the Originators shall deliver to the Purchaser (or, upon Purchaser's request, its designee) the Mortgage Loan Documents. The contents of each related Mortgage File required to be retained by the Servicer to interim service the Mortgage Loans pursuant to the Agreement and the related Term Sheet and thus not delivered to the Purchaser prior to the related Closing Date are, and shall be, held in trust by the Servicer for the benefit of the Purchaser as the owner thereof. The Servicer's possession of any portion of each such Mortgage File is at the will of the Purchaser for the sole purpose of facilitating interim servicing of the related Mortgage Loan pursuant to the Agreement and the related Term Sheet, and such retention and possession by the Servicer shall be in a custodial capacity only. The ownership of each Mortgage Note, Mortgage, and the contents of the Mortgage File is vested in the Purchaser and the ownership of all records and documents with respect to the related Mortgage Loan and Servicing Rights prepared by or which come into the possession of the Servicer shall immediately vest in the Purchaser and shall be retained and maintained, in trust, by the Servicer at the will of the Purchaser in such custodial capacity only. The Mortgage File retained by the Servicer with respect to each Mortgage Loan pursuant to this Agreement and the related Term Sheet shall be appropriately identified in the Servicer's computer system to reflect clearly the sale of such related Mortgage Loan to the Purchaser. The Servicer shall release from its custody the contents of any Mortgage File retained by it only in accordance with this Agreement. Subsection 6.02 Books and Records. Record title to each Mortgage and the related Mortgage Note as of the related Closing Date shall be in the name of the applicable Originator in trust for the benefit of the Purchaser or one or more designees of the Purchaser, as the Purchaser shall designate, solely for the purpose of facilitating the interim servicing of the Mortgage Loans as described herein. Upon Purchaser's request, the Originators shall transfer, or cause to be transferred, record title to each Mortgage and the related Mortgage Note to the Purchaser. Notwithstanding the foregoing, beneficial ownership of each Mortgage, the related Mortgage Note and the related Servicing Rights shall be vested solely in the Purchaser or the appropriate designee of the Purchaser, as the case may be. All rights arising out of the Mortgage Loans including, but not limited to, all funds received by the Servicer to which Purchaser is entitled as provided in Section 4 shall be vested in the Purchaser or one or more designees of the Purchaser; provided, however, that all such funds shall be received and held by the Servicer in trust for the benefit of the Purchaser or the assignee of the Purchaser, as the case may be, as the owner of the Mortgage Loans pursuant to the terms of this Agreement. 13 It is the express intention of the parties that the transactions contemplated by this Agreement and the related Term Sheet be, and be construed as, a sale of the Mortgage Loans, and the Servicing Rights by the Servicer and not a pledge of the Mortgage Loans or the Servicing Rights by the Servicer to the Purchaser to secure a debt or other obligation of the Originators. Consequently, the sale of each Mortgage Loan and the Servicing Rights shall be reflected as a sale on the Originators' business records, tax returns and financial statements. Subsection 6.03 Delivery of Mortgage Loan Documents. No later than five Business Days prior to the related Closing Date (or (i) in the case of the initial purchase of Mortgage Loans and the related original Mortgage Notes only, on or before the initial Closing Date, and (ii) in all other cases, such lesser period as agreed to in writing by the Purchaser and the Originators), the Originators shall deliver to the Purchaser, or its Custodian, as agent, the following Mortgage Loan Documents with respect to each Mortgage Loan to be purchased and sold on the related Closing Date and set forth on the related Mortgage Loan Schedule delivered to the Purchaser or attached to the related Term Sheet: (a) The original Mortgage Note endorsed "Pay to the order of JPMorgan Chase Bank, as collateral agent for the holder of the related Mortgage Note from time to time, without recourse," and signed via original signature in the name of the applicable Originator by an authorized officer, with all intervening endorsements showing a complete chain of title, together with any applicable riders. In no event may an endorsement be a facsimile endorsement. If the Mortgage Loan was acquired by an Originator in a merger, the endorsement must be by "[Originator], successor by merger to the [name of predecessor]". If the Mortgage Loan was acquired or originated by an Originator while doing business under another name, the endorsement must be by "[Originator] formerly known as [previous name]". None of the Mortgage Notes may be in the form of a lost note affidavit; (b) In the case of each Mortgage Loan that is not a MERS Mortgage Loan, the original Assignment of Mortgage, from the applicable Originator to "JPMorgan Chase Bank, as collateral agent for the holder of the related Mortgage Note from time to time," or otherwise in accordance with Purchaser's instructions, which assignment of mortgage shall, but for any blanks requested by Purchaser, be in form and substance acceptable for recording. If the Mortgage Loan was acquired or originated by an Originator while doing business under another name, the Assignment must be by "[Originator] formerly known as [previous name]". If the Mortgage Loan was acquired by an Originator in a merger, the endorsement must be by "[Originator], successor by merger to the [name of predecessor]". None of the Assignments are blanket assignments of mortgage; (c) the original of any guarantee executed in connection with the Mortgage Note; (d) Except as provided below and for each Mortgage Loan that is not a MERS Mortgage Loan, the original Mortgage with evidence of recording thereon. If in connection with any Mortgage Loan that is not a MERS Mortgage Loan, the Originators cannot deliver or cause to be delivered the original Mortgage with evidence of recording thereon on or prior to the related Closing Date because of a delay caused by the public recording office where such Mortgage has been delivered for recordation or because such Mortgage has been lost or because such public recording office retains the original recorded Mortgage, the Servicer shall deliver or cause to be delivered to the Purchaser a photocopy of such Mortgage together with (i) in the case of a delay caused by the public recording office, an Officer's Certificate of the title insurer insuring the Mortgage stating that such Mortgage has been delivered to the appropriate public recording office for recordation and that the original recorded Mortgage or a copy of such Mortgage certified by such public recording office to be a true and complete copy of the original recorded Mortgage will be promptly delivered to the Purchaser upon receipt thereof by the Servicer; or (ii) in the case of a Mortgage where a public recording office retains the original recorded Mortgage or in the case where a Mortgage is lost after recordation in a public recording office, a copy of such Mortgage with the recording information thereon certified by such public recording office to be a true and complete copy of the original recorded Mortgage. With respect to each MERS Mortgage Loan, the original Mortgage, noting the presence of the MIN of the Mortgage Loans and either language indicating that the Mortgage Loan is a MOM Loan or if the Mortgage Loan was not a MOM Loan at origination, the original Mortgage and the assignment thereof to MERS, with evidence of recording indicated thereon, or a copy of the Mortgage certified by the public recording office in which such Mortgage has been recorded; 14 (e) originals, or copies thereof certified by the public recording office in which such documents have been recorded, of each assumption, extension, modification, written assurance or substitution agreements, if applicable, or if the original of such document has not been returned from the applicable public recording office, a true certified copy, certified by the Servicer; (f) In the case of each Mortgage Loan that is not a MERS Mortgage Loan, the originals of all intervening assignments of mortgage with evidence of recording thereon, or if any such intervening assignment of mortgage has not been returned from the applicable recording office or has been lost or if such public recording office retains the original recorded assignment of mortgage, the Servicer shall deliver or cause to be delivered to the Purchaser, a photocopy of such intervening assignment of mortgage together with (i) in the case of a delay caused by the public recording office, an Officer's Certificate of the title insurer insuring the Mortgage stating that such intervening assignment of mortgage has been delivered to the appropriate public recording office for recordation and that such original recorded intervening assignment of mortgage or a copy of such intervening assignment of mortgage certified by the appropriate public recording office to be a true and complete copy of the original recorded intervening assignment of mortgage will be promptly delivered to the Purchaser upon receipt thereof by the Servicer; or (ii) in the case of an intervening assignment of mortgage where a public recording office retains the original recorded intervening assignment of mortgage or in the case where an intervening assignment of mortgage is lost after recordation in a public recording office, a copy of such intervening assignment of mortgage with recording information thereon certified by such public recording office to be a true and complete copy of the original recorded intervening assignment of mortgage; (g) The original mortgagee policy of title insurance, including riders and endorsements thereto, or if the policy has not yet been issued, (a) a written commitment or interim binder for title issued by the title insurance or escrow company dated as of the date the Mortgage Loan was funded, with a statement by the title insurance company, or closing attorney that the priority of the lien of the related Mortgage during the period between the date of the funding of the related Mortgage Loan and the date of the related title policy (which title policy shall be dated the date of recording of the related Mortgage) is insured or (b) a preliminary title report issued by a title insurer in anticipation of issuing a title insurance policy which evidences existing liens and gives a preliminary opinion as to the absence of any encumbrance on title to the Mortgaged Property, except liens to be removed on or before purchase by the Mortgagor or which constitute customary exceptions acceptable to lenders generally; the original policy of title insurance shall be delivered promptly upon receipt thereof by the Servicer. 15 (h) the original of any security agreement, chattel mortgage or equivalent document executed in connection with the Mortgage; and (i) if the Mortgage Note or Mortgage or any other material document or instrument relating to the Mortgage Loan has been signed by a person on behalf of the Mortgagor, the original or copy of power of attorney or other instrument that authorized and empowered such person to sign bearing evidence that such instrument has been recorded, if so required in the appropriate jurisdiction where the Mortgaged Property is located, or a copy thereof certified by the public recording office in which such instrument has been recorded or, if the original instrument has not been returned from the applicable public recording office, a true certified copy, certified by the Servicer. (j) The original Primary Mortgage Insurance Policy, if applicable. If the Originators cannot deliver the original recorded Mortgage Loan Documents on the related Closing Date, the Originators shall, promptly upon receipt thereof and in any case not later than 120 days from the related Closing Date, deliver such original documents, including original recorded documents, to the Purchaser or, upon Purchaser's request, its designee (unless the Originators are delayed in making such delivery by reason of the fact that such documents shall not have been returned by the appropriate recording office). If delivery is not completed within 120 days of the related Closing Date, solely due to delays in making such delivery by reason of the fact that such documents shall not have been returned by the appropriate recording office, the Servicer shall deliver such document to Purchaser, or upon Purchaser's request, its designee, within such time period as specified in an Officer's Certificate of the Servicer. In the event that documents have not been received by the date specified in the Officer's Certificate of the Servicer, a subsequent Officer's Certificate of the Servicer shall be delivered by such date specified in the prior Officer's Certificate, stating a revised date for receipt of documentation. The procedure shall be repeated until the documents have been received and delivered. If delivery is not completed within 180 days of the related Closing Date, solely due to delays in making such delivery by reason of the fact that such documents shall not have been returned by the appropriate recording office, the Servicer shall continue to use its best efforts to effect delivery as soon as possible thereafter, provided that if such documents are not delivered by the 270th day from the date of execution of the related Term Sheet, the Originators shall repurchase the related Mortgage Loans at the Repurchase Price in accordance with Section 7.03 hereof. 16 The Servicer shall forward to the Purchaser original documents evidencing an assumption, modification, consolidation or extension of any Mortgage Loan entered into in accordance with this Agreement within two (2) weeks of their execution, provided, however, that the Servicer shall provide the Purchaser with a certified true copy of any such document submitted for recordation within two (2) weeks of its execution, and shall provide the original of any document submitted for recordation or a copy of such document certified by the appropriate public recording office to be a true and complete copy of the original within ninety (90) days of its submission for recordation. The Servicer shall provide an original or duplicate original of the title insurance policy to Purchaser or, upon Purchaser's request, its designee, within ninety (90) days of the receipt of the recorded documents (required for issuance of such policy) from the applicable recording office. If the Purchaser discovers any defect with respect to a Mortgage File, the Purchaser shall give prompt written specification of such defect to the Originators, and the Originators shall cure or repurchase such Mortgage Loan in accordance with Section 7.03. In addition, in connection with the assignment of any MERS Mortgage Loan, the Originators agree that they will cause, at their own expense, the MERS(R) System to indicate that such Mortgage Loans have been assigned by the Originators to the Purchaser in accordance with this Agreement by including (or deleting, in the case of Mortgage Loans which are repurchased in accordance with this Agreement) in such computer files the information required by the MERS(R) System to identify the Purchaser of such Mortgage Loans. The Originators further agree that they will not alter the information referenced in this paragraph with respect to any Mortgage Loan during the term of this Agreement unless and until such Mortgage Loan is repurchased in accordance with the terms of this Agreement. For any Mortgage Loan that is not a MERS Mortgage Loan, the Servicer shall prepare the Assignments of Mortgage and shall pay to the Purchaser a Recording Fee for each Mortgage Loan in connection with Purchaser's recordation of the Assignments of Mortgage. SECTION 7. Representations, Warranties and Covenants of the Originators; Remedies for Breach. Subsection 7.01 Representations and Warranties Respecting the Originators. The Originators hereby represent and warrant to the Purchaser and the Servicing Rights Owner as of the related Closing Date that: (i) Each of ABC and Upland is a corporation duly organized, validly existing and in good standing under the laws of the State of Pennsylvania, and ABMS is a corporation duly organized, validly existing and in good standing under the laws of the State of New Jersey. Each Originator is and will remain in compliance with the laws of each state in which any Mortgaged Property is located to the extent necessary to ensure the enforceability of each Mortgage Loan and the servicing of the Mortgage Loan in accordance with the terms of this Agreement. Each Originator has all licenses necessary to carry out its business as now being conducted, and is licensed and qualified to transact business in and is in good standing under the laws of each state in which any Mortgaged Property is located or is otherwise exempt under applicable law from such licensing or qualification or is otherwise not required under applicable law to effect such licensing or qualification and no demand for such licensing or qualification has been made upon such Originator by any such state, and in any event such Originator is in compliance with the laws of any such state to the extent necessary to ensure the enforceability of each Mortgage Loan and the sale of the Mortgage Loans and Servicing Rights in accordance with the terms of this Agreement and the related Term Sheet; 17 (ii) Each Originator has the full power and authority and legal right to hold, transfer and convey each Mortgage Loan (including the Servicing Rights), to sell each Mortgage Loan and the Servicing Rights, and to execute, deliver and perform, and to enter into and consummate, all transactions contemplated by this Agreement and the related Term Sheet and to conduct its business as presently conducted. Each Originator has duly authorized the execution, delivery and performance of this Agreement and any agreements contemplated hereby, has duly executed and delivered this Agreement, and any agreements contemplated hereby, and this Agreement and the related Term Sheet, assuming due authorization, execution and delivery by the Purchaser, and each Assignment of Mortgage and any agreements contemplated hereby, constitutes a legal, valid and binding obligation of such Originator, enforceable against it in accordance with its terms and all requisite corporate action has been taken by such Originator to make this Agreement and all agreements contemplated hereby valid and binding upon such Originator in accordance with their terms; (iii) Neither the execution and delivery of this Agreement or the related Term Sheet by each Originator, nor the origination or purchase of the Mortgage Loans by such Originator, the sale of the Mortgage Loans or the Servicing Rights to the Purchaser, the consummation of the transactions contemplated hereby, or the performance of or compliance with the terms and conditions of this Agreement or the related Term Sheet will conflict with any of the terms, conditions or provisions of such Originator's articles of incorporation or by-laws, or constitute a default under or result in a breach or acceleration of, any material contract, agreement or other instrument to which such Originator is a party or which may be applicable to such Originator or its assets, or result in the material violation of any law, rule, regulation, order, judgment or decree to which such Originator or its properties are subject, or impair the ability of the Purchaser to realize on the Mortgage Loans; (iv) Each Originator is not in violation of, and the execution and delivery of this Agreement or the related Term Sheet by such Originator and its performance and compliance with the terms of this Agreement will not constitute a violation with respect to, any order or decree of any court or any order or regulation of any federal, state, municipal or governmental agency having jurisdiction over such Originator or its assets, which violation might have consequences that would materially and adversely affect the condition (financial or otherwise) or the operation of such Originator or its assets or might have consequences that would materially and adversely affect the performance of its obligations and duties hereunder; 18 (v) Each Originator does not believe, nor does it have any reason or cause to believe, that it cannot perform each and every covenant contained in this Agreement or the related Term Sheet. Each Originator is solvent and the sale of the Mortgage Loans and the Servicing Rights will not cause such Originator to become insolvent. The sale of the Mortgage Loans and Servicing Rights is not undertaken with the intent to hinder, delay or defraud any of such Originator's creditors; (vi) Each Originator is properly qualified to service the Mortgage Loans and has been servicing the Mortgage Loans prior to the related Cut-off Date; (vii) Immediately prior to the payment of the related Purchase Price for each Mortgage Loan and the Servicing Rights thereto, the applicable Originator was the owner of the related Mortgage and the indebtedness evidenced by the related Mortgage Note and the related Servicing Rights and upon the payment of the related Purchase Price by the Purchaser, in the event that such Originator retains record title, such Originator shall retain such record title to each Mortgage, each related Mortgage Note and the related Mortgage Files with respect thereto in trust for the Purchaser as the owner thereof and only for the purpose of interim servicing and supervising the interim servicing of each Mortgage Loan; (viii) There are no actions or proceedings against, or investigations of, the Originators before any court, administrative or other tribunal (A) that might prohibit its entering into this Agreement or the related Term Sheet, (B) seeking to prevent the sale of the Mortgage Loans, the sale of the Servicing Rights or the consummation of the transactions contemplated by this Agreement (C) that might prohibit or materially and adversely affect the performance by the Originators of their obligations under, or the validity or enforceability of, this Agreement or (D) that is reasonably likely to have a material adverse effect on the financial condition of the Originators; (ix) No consent, approval, authorization or order of any court or governmental agency or body is required for the execution, delivery and performance by the Originators of, or compliance by the Originators with, this Agreement or the sale of the Mortgage Loans and Servicing Rights and delivery of the Mortgage Files to the Purchaser or the consummation of the transactions contemplated by this Agreement, except for such consents, approvals, authorizations or orders, if any, that have been obtained prior to the related Closing Date; (x) The consummation of the transactions contemplated by this Agreement and the related Term Sheet are in the ordinary course of business of the Originators, and the transfer, assignment and conveyance of the Mortgage Notes, the Mortgages and/or the Servicing Rights by the Originators pursuant to this Agreement are not subject to the bulk transfer or any similar statutory provisions in effect in any applicable jurisdiction; 19 (xi) As of the related Closing Date and as of the related Servicing Transfer Date, the origination, servicing and collection practices used by the Originators and any prior originator or servicer since origination with respect to each Mortgage Note and Mortgage (including, without limitation, the establishment, maintenance and servicing of the Escrow Accounts and Escrow Payments, if any), have been legal and in accordance with applicable laws and regulations and the Mortgage Loan Documents, and in all material respects in accordance with Accepted Servicing Practices. With respect to Escrow Accounts and Escrow payments that the Servicer, on behalf of the investor, is entitled to collect, all such payments are in the possession of, or under the control of, the Servicer, and there exist no deficiencies in connection therewith for which customary arrangements for repayment thereof have not been made. All Escrow Payments have been collected in full compliance with state and federal law, Accepted Servicing Practices and the provisions of the related Mortgage Note and Mortgage. As to any Mortgage Loan that is the subject of an escrow, escrow of funds is not prohibited by applicable law and has been established in an amount sufficient to pay for every escrowed item that remains unpaid and has been assessed but is not yet due and payable. Any Escrow Account interest required to be paid pursuant to state and local law has been properly paid and credited. No escrow deposits or other charges or payments due under the Mortgage Note have been capitalized under any Mortgage or the related Mortgage Note. Each Originator is duly qualified, licensed, registered and otherwise authorized under all applicable federal state and local laws, and regulations, and if applicable, meets the minimum capital requirements set forth by its regulators, and no event has occurred, including but not limited to, a change in insurance coverage, which would make such Originator unable to comply with eligibility requirements. At the time any Mortgage Loan is registered by the applicable Originator with MERS, such Originator will be a member of MERS in good standing, and will comply in all material respects with the rules and procedures of MERS in connection with the servicing of the MERS Mortgage Loans for as long as such Mortgage Loans are registered with MERS; (xii) In the opinion of the Originators, the consideration received by them upon the sale of the Mortgage Loans and the Servicing Rights to Purchaser under this Agreement and the related Term Sheet constitutes fair consideration for the Mortgage Loans and Servicing Rights under current market conditions. The Originators will treat the sale of the Mortgage Loans and the Servicing Rights to the Purchaser as a sale for reporting and accounting purposes and, to the extent appropriate, for federal income tax purposes; (xiii) The Originators have delivered to the Purchaser financial statements for its last two complete fiscal years. All such financial information fairly presents the pertinent results of operations and financial position for the period identified and has been prepared in accordance with GAAP consistently applied throughout the periods involved, except as set forth in the notes thereto. There has been no change in the business, operations, financial condition, properties or assets of the Originators since the date of the Originators' financial information that would have a material adverse effect on its ability to perform its obligations under this Agreement and the related Term Sheet. No statement, tape, diskette, form, report or other document furnished or to be furnished by an Originator pursuant to this Agreement or the related Term Sheet or in connection with the transactions contemplated hereby contains or will contain any statement that is or will be inaccurate or misleading in any material respect or omits to state a material fact required to be stated therein or necessary to make the information and statements therein not misleading; 20 (xiv) The Originators have not dealt with any broker, investment banker, agent or other person that may be entitled to any commission or compensation in connection with the sale of the Mortgage Loans or the Servicing Rights; and (xv) The Originators have the computer systems and the capability to effect the servicing transfer via a "tape-to-tape" method or via a reasonably acceptable electronic data processing method. Subsection 7.02 Representations and Warranties Regarding Individual Mortgage Loans. The Originators hereby represent and warrant to the Purchaser and the Servicing Rights Owner, with respect to each Mortgage Loan, as of the related Closing Date or such other date specified herein, except as otherwise specified on the related Mortgage Loan Schedule (other than the Mortgage Loan Schedule delivered in connection with the initial purchase of Mortgage Loans) to the extent that such Mortgage Loan Schedule is delivered to the Purchaser at least two (2) Business Days prior to the related Closing Date: (i) The information set forth in the related Mortgage Loan Schedule is complete, true and correct; (ii) As of the related Cut-off Date, all of the Mortgage Loans will have an actual Interest Paid to Date as stated in the related Mortgage Loan Schedule and will be due for the scheduled monthly payment as stated in the related Mortgage Loan Schedule, as evidenced by a posting to the Servicer's servicing collection system. No payment under any Mortgage Loan is delinquent as of the related Closing Date nor has any scheduled payment been delinquent more than 90 days at any time during the twelve month period prior to the related Cut-off Date. The Mortgage Loan has not been dishonored. There are no material defaults under the terms of the Mortgage Loan. For purposes of this paragraph, a Mortgage Loan will be deemed delinquent if any payment due thereunder was not paid by the Mortgagor within one month of its Due Date; (iii) There is no valid offset, right of rescission, defense or counterclaim of any obligor under any Mortgage Note or Mortgage, including the obligation of the Mortgagor to pay the unpaid principal of or interest on such Mortgage Note, and any applicable right of rescission has expired, nor will the operation of any of the terms of such Mortgage Note or Mortgage, or the exercise of any right thereunder, render either the Mortgage Note or the Mortgage unenforceable, in whole or in part, or subject to any right of rescission, set-off, recoupment, counterclaim or defense, including, without limitation, the defense of usury, and no such right of rescission, set-off, recoupment, counterclaim or defense has been asserted with respect thereto. No Mortgage Loan is subject to any pending bankruptcy, insolvency, reorganization or moratorium; 21 (iv) There are no mechanics' liens or similar liens or claims for work, labor or material affecting any Mortgaged Property which have been filed (and no rights are outstanding that under law could give rise to such liens), which are or may be a lien prior to, or equal with, the lien of such Mortgage, except those which are insured against by the title insurance policy referred to in clause (ix) below; (v) As of the date of origination of the Mortgage Loan and as of the related Closing Date, there was and there currently is no damage to any Mortgaged Property. At origination of the Mortgage Loan there was not, since origination of the Mortgage Loan there has been and there currently is, no proceeding pending or threatened for the total or partial condemnation of the Mortgaged Property. The Servicer has not received notification that any such proceedings are scheduled to commence at a future date; (vi) Each Mortgage is a valid, subsisting, enforceable and perfected first or second lien on the Mortgaged Property securing the related Mortgage Note, including all buildings on the Mortgaged Property and all installations and mechanical, electrical, plumbing, heating and air conditioning systems affixed to such buildings, and all additions, alterations and replacements made at any time with respect to the foregoing securing the Mortgage Note's original principal balance subject to principles of equity, bankruptcy, insolvency and other laws of general application affecting the rights of creditors. The Mortgage and the Mortgage Note do not contain any evidence of any security interest or other interest or right thereto. Each Mortgaged Property is owned by the Mortgagor in fee simple and is free and clear of all adverse claims, encumbrances and liens having priority over the first or second lien of the Mortgage, as applicable, subject only to (1) with respect to any Mortgage Loan identified on the Mortgage Loan Schedule as secured by a second lien, the related first mortgage loan, (2) the lien of nondelinquent current real property taxes and assessments not yet due and payable, (3) covenants, conditions and restrictions, rights of way, easements and other matters of public record as of the date of recording of such Mortgage, such exceptions appearing of record being acceptable to mortgage lending institutions generally and specifically reflected in the appraisal made in connection with the origination of the related Mortgage Loan or referred to in the lender's title insurance policy delivered to the originator of the related Mortgage Loan, and (4) other matters to which like properties are commonly subject which do not individually or in the aggregate materially interfere with the benefits of the security intended to be provided by such Mortgage or the use, enjoyment, value or marketability of the related Mortgaged Property. Any security agreement, chattel mortgage or equivalent document related to and delivered in connection with the Mortgage Loan establishes and creates a valid, subsisting enforceable, and perfected first or second lien and first or second priority, as applicable, security interest on the property described therein, and immediately prior to the sale of such Mortgage Loan to the Purchaser pursuant to this Agreement and the related Term Sheet, the Originators had full right to sell and assign the same to the Purchaser; As of the date of origination of the Mortgage Loan, the Mortgaged Property was not subject to a Mortgage, deed of trust, or other security instrument creating a lien subordinate to the lien of the Mortgage; 22 (vii) Each Mortgage Loan complies with, and the Originators have complied with, applicable local, state and federal laws, regulations and other requirements including, without limitation, usury, equal credit opportunity, real estate settlement procedures, the Federal Truth-In-Lending Act, predatory and abusive lending laws, and disclosure laws and consummation of the transactions contemplated hereby, including without limitation, the receipt of interest by the owner of such Mortgage Loan, will not involve the violation of any such laws, rules or regulations. None of the Mortgage Loans are covered (a) under 12 CFR Part 226.31, 12 CFR Part 226.32 or 226.34 of Regulation Z, the regulation implementing TILA, which implements the Home Ownership and Equity Protection Act of 1994, as amended or (b) as a "high cost", "threshold", "predatory" or "covered" loan under any other applicable state, federal or local law, including, but not limited to, the States of Georgia, North Carolina and New York, or the City of New York. Each Mortgage Loan is being (and has been) serviced in accordance with Accepted Servicing Practices and applicable state and federal laws, including, without limitation, the Federal Truth-In-Lending Act and other consumer protection laws, real estate settlement procedures, usury, equal credit opportunity and disclosure laws. The Originators shall maintain in their possession, available for the Purchaser's inspection, as appropriate, and shall deliver to the Purchaser or its designee upon demand, evidence of compliance with all such requirements; (viii) Neither any Originator nor any prior holder of any Mortgage Loan has impaired, waived, altered or modified the Mortgage or Mortgage Note (except that a Mortgage Loan may have been modified by a written instrument (a copy of which is in the Mortgage File and the terms of which are reflected on the Mortgage Loan Schedule) which has been recorded, if necessary to protect the interests of the owner of such Mortgage Loan; the substance of any such waiver, alteration or modification has been approved by the issuer of any related Primary Mortgage Insurance Policy and title insurance policy, to the extent required by the related policies); satisfied, canceled, rescinded or subordinated such Mortgage in whole or in part; released the applicable Mortgaged Property in whole or in part from the lien of such Mortgage; or executed any instrument of cancellation, rescission or satisfaction with respect thereto. No instrument of release or waiver has been executed in connection with any Mortgage Loan, and no Mortgagor has been released, in whole or in part from its obligations in connection with a Mortgage Loan; 23 (ix) Each Mortgage Loan is covered by an ALTA lender's title insurance policy or equivalent form of policy or insurance acceptable to Fannie Mae or Freddie Mac in a form acceptable to, and issued by a title insurer acceptable to, Fannie Mae or Freddie Mac, together with all applicable ALTA endorsements, including without limitation, if applicable, a condominium endorsement, a planned unit development endorsement, an extended coverage endorsement, and an 8.1 ALTA or equivalent environmental endorsement, insuring the applicable Originator, its successors and assigns, as to the first or second lien priority of the Mortgage (subject to the exceptions contained in (vi) (1), (2), and (3) above), in an amount at least equal to the original principal balance of each such Mortgage Loan and against any loss by reason of the invalidity or unenforceability of the lien resulting from the provisions of the Mortgage providing for adjustment in the Mortgage Interest Rate and Monthly Payment. Each title insurance policy affirmatively insures ingress and egress and insures against encroachments by or upon the Mortgaged Property and each such policy was issued on the date of the origination of each related Mortgage Loan by a title insurer qualified to do business in the jurisdiction where the Mortgaged Property is located. The applicable Originator, its successors and assigns, are the sole insured of such lender's title insurance policy, such title insurance policy has been duly and validly endorsed to the Purchaser or the assignment to the Purchaser of such Originator's interest therein does not require the consent of or notification to the insurer and such lender's title insurance policy is in full force and effect and will be in full force and effect upon the consummation of the transactions contemplated by this Agreement. Where required by law or regulation, the Mortgagor has been given the opportunity to choose the carrier of the required mortgage title insurance. No claims have been made under such lender's title insurance policy, and no prior holder of the related Mortgage, including the applicable Originator, nor any Mortgagor, has done, by act or omission, anything which would impair the coverage of such lender's title insurance policy; (x) All of the improvements which were included for the purpose of determining the Appraised Value of the Mortgaged Property lie wholly within the boundaries and building restriction lines of such property (and wholly within the project with respect to a condominium unit), and no improvements on adjoining properties encroach upon the Mortgaged Property; (xi) No improvement located on or being part of the Mortgaged Property is in violation of any applicable zoning law or regulation, subdivision law or ordinance. All inspections, licenses and certificates required to be made or issued with respect to all occupied portions of the Mortgaged Property and, with respect to the use and occupancy of the same, including but not limited to certificates of occupancy and fire underwriting certificates, have been made or obtained from the appropriate authorities, and the Mortgaged Property is lawfully occupied under applicable law; (xii) All parties that have had any interest in the Mortgage, whether as mortgagee, assignee, pledgee or otherwise, are (or, during the period in which they held and disposed of such interest, were) (A) in compliance with any and all applicable licensing requirements of the laws of the state wherein the Mortgaged Property is located, and (B) (1) organized under the laws of such state ,or (2) qualified to do business in such state, or (3) federal savings and loan associations or national banks having principal offices in such state, or (4) not doing business in such state; 24 (xiii) Each Mortgage Note and the applicable Mortgage are original and genuine, there are no other originals of the Mortgage Note or Mortgage, and each is the legal, valid and binding obligation of the maker thereof, enforceable in accordance with its terms, except as limited by bankruptcy, insolvency, reorganization, moratorium, receivership and other similar laws relating to creditors' rights generally or by equitable principles (regardless of whether such enforcement is considered in a proceeding in equity or at law) and the Originators have taken all action necessary to transfer such rights of enforceability to the Purchaser. All parties to the Mortgage Note and the Mortgage had legal capacity to execute the Mortgage Note and the Mortgage and each Mortgage Note and Mortgage has been duly and properly executed by such parties. Either the Mortgagor or the guarantor of a Mortgage Loan is a natural person; (xiv) The proceeds of the Mortgage Loan have been fully disbursed; there is no requirement for future advances thereunder and any and all requirements as to completion of any on-site or off-site improvements and as to disbursement of any escrow funds therefor have been complied with. All costs, fees and expenses incurred in making, closing or recording the Mortgage Loan were paid and the Mortgagor is not entitled to any refund of amounts paid or due under the Mortgage Note or Mortgage; (xv) Each Mortgage contains customary and enforceable provisions that render the rights and remedies of the holder thereof adequate for the realization against the Mortgaged Property of the benefits of the security, including (i) in the case of a Mortgage designated as a deed of trust, by trustee's sale, and (ii) otherwise by judicial foreclosure or if applicable, non-judicial foreclosure. Upon default by a Mortgagor on a Mortgage Loan and foreclosure on, or trustee's sale of, the Mortgaged Property pursuant to the proper procedures, the holder of the Mortgage Loan will be able to deliver good and merchantable title to the property. There is no homestead or other exemption available to the Mortgagor which would interfere with such right to foreclose; (xvi) With respect to each Mortgage constituting a deed of trust, either a trustee, duly qualified under applicable law to serve as such, has been properly designated and currently so serves and is named in such Mortgage or if no duly qualified trustee has been properly designated and so serves, the Mortgage contains satisfactory provisions for the appointment of such trustee by the holder of the Mortgage at no cost or expense to such holder, and no fees or expenses are or will become payable by the Purchaser to the trustee under the deed of trust, except in connection with a trustee's sale after default by the Mortgagor; (xvii) There are no defaults by the applicable Originator in complying with the terms of the Mortgage, and all taxes, governmental assessments, insurance premiums, water, sewer and municipal charges, leasehold payments or ground rents or other outstanding charges affecting the Mortgaged Property which previously became due and owing have been paid, or escrow funds have been established in an amount sufficient to pay for every such escrowed item which remains unpaid and which has been assessed but is not yet due and payable. There exist no deficiencies with respect to escrow deposits and payments, if such are required, for which customary arrangements for repayment thereof have not been made, and no escrow deficits or payments of other charges or payments due the applicable Originator have been capitalized under the Mortgage or the applicable Mortgage Note; 25 (xviii) The Mortgage Note is not and has not been secured by any collateral, pledged account or other security other than the lien of the corresponding Mortgage and the security interest of any applicable security agreement or chattel mortgage referred to above and such collateral does not serve as security for any other obligation and no Mortgage Loan is secured by more than one Mortgaged Property; (xix) The buildings and improvements upon each Mortgaged Property are insured against loss pursuant to a standard, valid and existing hazard insurance policy, which policy insures against loss by fire, hazards of extended coverage and such other hazards as are provided for in the Credit and Servicing Policy Manuals representing coverage in an amount not less than the lesser of (A) the maximum insurable value of the improvements securing such Mortgage Loan and (B) the outstanding principal balance of the related Mortgage Loan, but in no event an amount less than an amount that is required to prevent the Mortgagor from being deemed to be a co-insurer thereunder. If the Mortgaged Property is in an area identified in the Federal Register by the Federal Emergency Management Agency as having special flood hazards, a flood insurance policy in a form meeting the requirements of the current guidelines of the Flood Insurance Administration was in effect with respect to such Mortgaged Property at origination in an amount representing coverage not less than the least of (A) the outstanding Stated Principal Balance of the Mortgage Loan, (B) the maximum insurable value of the improvements securing such Mortgage Loan or (C) the maximum amount of insurance that is available under federal law. All individual insurance policies contain a standard mortgagee clause naming the applicable Originator or the original holder of the Mortgage, and its successors in interest, as loss payee, and all of the premiums due and payable thereon have been paid; the Mortgage obligates the Mortgagor thereunder to maintain all such insurance at the Mortgagor's cost and expense, and upon the Mortgagor's failure to do so, authorizes the holder of the Mortgage to obtain and maintain such insurance at the Mortgagor's cost and expense and to seek reimbursement therefor from the Mortgagor. Neither the Originators (nor any prior originator or servicer of any of the Mortgage Loans) nor any Mortgagor has engaged in any act or omission which has impaired or would impair the coverage of any such policy, the benefits of the endorsement provided for herein, or the validity and binding effect of either; All such insurance policies contain a standard mortgagee clause naming the applicable Originator, its successors and assigns as loss payee and contain a clause that the insurer will notify the named mortgagee at least ten (10) days prior to any reduction in coverage or cancellation of the policy; 26 (xx) There is no default, breach or event of acceleration existing under the Mortgage or the applicable Mortgage Note; and no event which, with the passage of time or with notice and the expiration of any grace or cure period, would constitute a default, breach, violation or event of acceleration, and none of (i) the Originators and any of their affiliates (ii) any servicer or subservicer and (iii) any prior mortgagee, of any Mortgage Loan has waived any default, breach or event of acceleration; no foreclosure action is threatened or has been commenced with respect to the Mortgage Loan; (xxi) The Mortgage Note and the Mortgage contain the entire agreement of the Mortgagor, and there is no obligation on the part of the Originators or any other party to make any payments with respect to the related Mortgage Loan in addition to the Monthly Payments required to be made by the applicable Mortgagor and the Mortgage Note with respect to any Mortgage Loan does not permit or obligate the Originators to make future advances to the Mortgagor at the option of the Mortgagor; (xxii) The applicable Originator has caused or will cause to be performed any and all acts required to preserve the rights and remedies of the Purchaser in any insurance policies applicable to the Mortgage Loans including, without limitation, any necessary notifications of insurers, assignments of policies or interests therein, and establishments of coinsured, joint loss payee and mortgagee rights in favor of the Purchaser; (xxiii) The applicable Originator has not advanced funds, or induced, solicited or knowingly received any advance of funds by a party other than the Mortgagor, directly or indirectly, for the payment of any amount required by the Mortgage Loan; (xxiv) The Mortgage File contains an appraisal of the Mortgaged Property signed prior to the final approval of the mortgage loan application by a Qualified Appraiser, approved by the applicable Originator, who had no interest, direct or indirect, in the Mortgaged Property or in any loan made on the security thereof, and whose compensation is not affected by the approval or disapproval of the Mortgage Loan. (xxv) Each of the Mortgaged Properties consists of a single parcel of real property with a detached single-family residence erected thereon, or a two- to four-family dwelling, or a townhouse, or an individual condominium unit in a condominium project, or an individual unit in a planned unit development. No Mortgaged Property consists of cooperative housing or stock in a cooperative housing corporation. No such residence is a manufactured dwelling or mobile home. None of the Mortgage Loans are considered agricultural loans. No Mortgaged Property consists of a log home, earthen home, underground home, a home which is situated on more than ten acres of property or a home which is secured by a leasehold estate. No Mortgaged Property (and no portion of a Mortgaged Property) is being used for commercial purposes; (xxvi) None of the Mortgage Loans provide for deferred interest or negative amortization. None of the Mortgage Loans are simple interest Mortgage Loans. No Mortgaged Property is a timeshare; 27 (xxvii) The Mortgage Loan does not contain provisions pursuant to which Monthly Payments are paid or partially paid with funds deposited in any separate account established by the applicable Originator, the Mortgagor or anyone on behalf of the Mortgagor, or paid by any source other than the Mortgagor nor does it contain any other similar provisions currently in effect which may constitute a "buydown" provision. The Mortgage Loan is not a graduated payment Mortgage Loan; (xxviii) The applicable Originator is the sole owner of record and is the holder of the Mortgage Loan and the indebtedness evidenced by the Mortgage Note and the related Servicing Rights thereto. Upon the sale of the Mortgage Loan to the Purchaser, and prior to the transfer of Servicing Rights to the Purchaser, such Originator will retain the Mortgage File or any part thereof with respect thereto not delivered to the Purchaser or the Purchaser's designee in trust only for the purpose of servicing and supervising the servicing of the Mortgage Loan. Immediately prior to the transfer and assignment to the Purchaser, the Mortgage Loan, including the Mortgage Note and the Mortgage, were not subject to an assignment sale or pledge to any person other than Purchaser and the applicable Originator had good and marketable title to and was the sole owner thereof and had full right to transfer and sell the Mortgage Loan to the Purchaser free and clear of any encumbrance, equity, lien, pledge, charge, claim or security interest and has the full right and authority subject to no interest or participation of, or agreement with, any other party, to sell and assign the Mortgage Loan pursuant to this Agreement and the related Term Sheet and following the sale of the Mortgage Loan, the Purchaser will own such Mortgage Loan free and clear of any encumbrance, equity, participation interest, lien, pledge, charge, claim or security interest. The applicable Originator intends to relinquish all rights to possess, control and monitor the Mortgage Loan, except for the purposes of interim servicing the Mortgage Loan as set forth in this Agreement. After the related Closing Date, the applicable Originator will not have any right to modify or alter the terms of the sale of the Mortgage Loan and such Originator will not have any obligation or right to repurchase the Mortgage Loan or substitute another Mortgage Loan, except as provided in this Agreement or the related Term Sheet, or as otherwise agreed to by the Originators and the Purchaser;. The Originators acquired any right, title and interest in and to the Mortgage Loans in good faith and without notice of any adverse claim; (xxix) All of the Mortgage Loans are fixed rate mortgage loans. Principal payments on the Mortgage Loan commenced no more than sixty (60) days after the funds were disbursed in connection with the Mortgage Loan. Monthly payments of interest are calculated on the basis of a year comprised of twelve 30-day months; (xxx) The Mortgage contains a provision for the acceleration of the payment of the unpaid principal balance of the Mortgage Loan in the event that the Mortgaged Property is sold or transferred without the prior written consent of the mortgagee thereunder, at the option of the mortgagee and such provision is enforceable; 28 (xxxi) Each of the Mortgage and the Assignment of Mortgage (for each Mortgage Loan that is not a MERS Mortgage Loan) is in recordable form and is acceptable for recording under the laws of the jurisdiction in which the Mortgaged Property is located; (xxxii) The Mortgagor has not notified the applicable Originator, and such Originator has no knowledge of any relief requested or allowed to the Mortgagor under the Soldiers' and Sailors' Civil Relief Act of 1940; (xxxiii) There exists no violation of any local, state, or federal environmental law, rule or regulation with respect to the Mortgaged Property which violation has or could have a material adverse effect on the market value of such Mortgaged Property. The applicable Originator has no knowledge of any pending action or proceeding directly involving the related Mortgaged Property in which compliance with any environmental law, rule or regulation is an issue; and nothing further remains to be done to satisfy in full all requirements of each such law, rule or regulation constituting a prerequisite to the use and enjoyment of such Mortgaged Property; (xxxiv) For each Mortgage Loan, the related Mortgage File is complete and contains a true, accurate and correct copy of each of the documents and instruments specified to be included therein; (xxxv) Each Mortgage Note, each Mortgage, each Assignment of Mortgage and any other documents required pursuant to this Agreement to be delivered by the Originators hereunder has been delivered to the Purchaser or its agent; (xxxvi) No Mortgage Loan was originated based on an appraisal of the related Mortgaged Property made prior to completion of construction of the improvements thereon. No Mortgage Loan was made in connection with the construction or rehabilitation of a Mortgaged Property or facilitating the trade-in or exchange of a Mortgaged Property; (xxxvii) The Originators used no selection procedures that identified the Mortgage Loans as being less desirable or valuable than other comparable mortgage loans in the Originators' portfolio; No statement, tape, diskette, form, report or other document furnished or to be furnished by the Originators pursuant to this Agreement or the related Term Sheet or in connection with the transactions contemplated hereby contains or will contain any statement that is or will be inaccurate or misleading in any material respect or omits to state a material fact required to be stated therein or necessary to make the information and statements therein not misleading; (xxxviii) To the best of the Originators' knowledge, no error, omission, misrepresentation, negligence, fraud or similar occurrence with respect to a Mortgage Loan has taken place on the part of any person, including, without limitation, the Mortgagor, any appraiser, any builder or developer, or any other party involved in the origination or servicing of the Mortgage Loan or in the application of any insurance in relation to such Mortgage Loan; 29 (xxxix) The Mortgagor has received and has executed, where applicable, prior to origination of the Mortgage Loan, all disclosure and rescission materials required by applicable law with respect to the making of the Mortgage Loan; (xl) No Mortgage Loan has a Loan-to-Value Ratio in excess of 95%. Any Mortgage Loan subject to a Primary Mortgage Insurance Policy obligates the Mortgagor thereunder to maintain the Primary Mortgage Insurance Policy and to pay all premiums and charges in connection therewith. The mortgage interest rate for the Mortgage Loan as set forth on the Mortgage Loan Schedule is net of any such insurance premium. None of the Mortgage Loans are covered by a "lender-paid" Primary Mortgage Insurance Policy; (xli) The Originators have no knowledge of any circumstances or condition with respect to the Mortgage, the Mortgaged Property, the Mortgagor or the Mortgagor's credit standing that could reasonably be expected to cause investors to regard the Mortgage Loan as an unacceptable investment, cause such Mortgage Loan to become delinquent or adversely affect the value or the marketability of the Mortgage Loan. The Originators did not select the Mortgage Loans sold to Purchaser based on any adverse selection of mortgage loans in its portfolio that met Purchaser's purchase parameters for this transaction (as such parameters are set forth in any related Confirmation), including without limitation, the location or condition of the Mortgaged Property, payment pattern of the borrower or any other factor that may adversely affect the expected cost of foreclosing, owning or holding the Mortgage Loans or related Mortgaged Property or collecting the insurance or guarantee proceeds related thereto; (xlii) Each Mortgage Loan was originated by or for the Originators pursuant to, and conforms with, the applicable Originator's Underwriting Guidelines, except for any exceptions to such guidelines for such Mortgage Loan that the applicable Originator has documented in the related credit file; (xliii) With respect to each Mortgage Loan that has a prepayment penalty feature, each such prepayment penalty is enforceable and will be enforced by the Servicer and each prepayment penalty is permitted pursuant to federal, state and local law. No Mortgage Loan will impose a prepayment penalty for a term in excess of five (5) years from the date such Mortgage Loan was originated. Except as otherwise set forth on the Mortgage Loan Schedule, with respect to each Mortgage Loan that contains a prepayment penalty, such prepayment penalty is at least equal to the lesser of (A) the maximum amount permitted under applicable law and (B) six months interest at the related Mortgage Interest Rate on the amount prepaid in excess of 20% of the original principal balance of such Mortgage Loan; (xliv) No Mortgage Loan originated after October 1, 2002 will impose a prepayment penalty for a term in excess of three (3) years from the date such Mortgage Loan was originated; 30 (xlv) Each Mortgage Loan is covered by a valid and transferable "lifetime" tax service contract, which shall be assigned to the Purchaser without the payment of any fee by the Purchaser; (xlvi) If any Mortgage Loan was originated by an entity other than an Originator, the Purchaser may enforce against such entity any representations or warranties made by such entity to the applicable Originator; (xlvii) No Mortgage Loan has a shared appreciation or other contingent interest feature; (xlviii) The sale, transfer, assignment and conveyance of Mortgage Loans by the Originators is not subject to and will not result in any tax, fee or governmental charge payable by the Originators, except those that have been paid; (xlix) The Mortgage Loans conform to the characteristics set forth in the Term Sheet, if any; (l) None of the Mortgage Loans had an original principal balance in excess of $750,000; (li) None of the Mortgage Loans has a debt-to-income ratio greater than 60%; (lii) None of the Mortgage Loan has a credit score less than 520; (liii) No proceeds from any Mortgage Loan was used to finance single-premium credit life insurance policies; (liv) No Mortgage Loan secured by property located in the State of Georgia and originated on or after October 1, 2002 is subject to the Georgia Fair Lending Act (Title 7 of the Official Code of Georgia); (lv) No Mortgage Loan secured by property located in the State of New York and originated on or after April 1, 2003 is subject to New York Banking Law ss. 6-1, as amended; (lvi) No Mortgage Loan secured by property located in the City of New York and originated on or after February 20, 2003 is subject to New York City Local Law No. 36 (2002); and (lvii) The Originators are not aware of any facts that could reasonably be expected to affect adversely the value or marketability of any Mortgage Property. 31 Subsection 7.03 Remedies for Breach of Representations and Warranties; Repurchase of Near-term Payment Defaults. It is understood and agreed that the covenants, representations and warranties of the Originators set forth in this Agreement and the related Term Sheet shall survive the sale of the Mortgage Loans and the Servicing Rights to the Purchaser and shall inure to the benefit of the Purchaser, notwithstanding any restrictive or qualified endorsement on any Mortgage Note or Assignment of Mortgage or the examination or lack of examination of any Mortgage File. Upon discovery by either any Originator or the Purchaser of a breach of any of the foregoing representations and warranties which materially and adversely affects the value of the Mortgage Loans (or the Servicing Rights) or the interest of the Purchaser therein (or which materially and adversely affects the value of a Mortgage Loan (or related Servicing Rights) or the interests of the Purchaser in the related Mortgage Loan (including the Servicing Rights thereon)) in the case of a representation and warranty relating to a particular Mortgage Loan), the party discovering such breach shall give prompt written notice to the other. Notwithstanding the foregoing, any breach of the representations and warranties in Section 7.02(vii), (xliv), (liii), (liv), (lv) or (lvi) shall be deemed to materially adversely affect the interests of the Purchaser therein (or the interests of the Purchaser in the related Mortgage Loan (including the Servicing Rights thereon)). With respect to any representation or warranty contained in Section 7.02 that is made to the best of the Originators' knowledge, if it is discovered by the Purchaser that the substance of such representation and warranty was inaccurate as of the related Closing Date, and such inaccuracy materially and adversely affects the value of the related Mortgage Loan, then notwithstanding the Originators' lack of knowledge with respect to the inaccuracy at the time the representation or warranty was made, such inaccuracy shall be deemed a breach of the applicable representation or warranty. Within sixty (60) days of the earlier of either discovery by or notice to the applicable Originator of any breach of a representation or warranty which materially and adversely affects the value of a Mortgage Loan or the Mortgage Loans, or the interest of the Purchaser therein, such Originator shall use its best efforts promptly to cure such breach in all material respects and, if such breach cannot be cured, such Originator shall, at the Purchaser's option, repurchase such Mortgage Loan (including the related Servicing Rights) at the Repurchase Price. In the event that a breach shall involve any representation or warranty set forth in Subsection 7.01 and such breach cannot be cured within sixty (60) days of the earlier of either discovery by or notice to the Originators of such breach, all of the affected Mortgage Loans (including the related Servicing Rights) shall, at the Purchaser's option, be repurchased by the Originators at the Repurchase Price. Any repurchase of a Mortgage Loan or Mortgage Loans (including the corresponding Servicing Rights) pursuant to the foregoing provisions of this Subsection 7.03 shall occur on a date designated by the Purchaser and shall be accomplished by wire transfer of immediately available funds on the repurchase date to an account designated by the Purchaser. In the event either of the first two (2) scheduled Monthly Payments which are due under any Mortgage Loan within sixty (60) days of the related Closing Date are delinquent for 30 days or more from the day such Monthly Payments were due, then not later than five (5) Business Days after notice to the Originators by Purchaser (and at Purchaser's sole option), the Originators shall repurchase such Mortgage Loan (including the Servicing Rights thereon) from the Purchaser and the Servicing Rights Owner pursuant to the repurchase provisions contained in this Subsection 7.03. If pursuant to the foregoing provisions an Originator repurchases a Mortgage Loan that is a MERS Mortgage Loan, such Originator shall either (a) cause MERS to execute and deliver an assignment of the Mortgage in recordable form to transfer the Mortgage from MERS to such Originator and shall cause such Mortgage to be removed from registration on the MERS(R) System in accordance with MERS' rules and regulations or (b) cause MERS to designate on the MERS(R) System such Originator as the beneficial holder of such Mortgage Loan. 32 At the time of repurchase, the Purchaser, the Servicing Rights Owner, as applicable, and the Originators shall arrange for the reassignment of the repurchased Mortgage Loan and/or the related Servicing Rights, as applicable, to the Originators and the delivery to the Originators of any documents held by the Purchaser and/or the Servicing Rights Owner and their respective designees relating to the repurchased Mortgage Loan or Servicing Rights, as applicable. Upon the repurchase of a Mortgage Loan, the Mortgage Loan Schedule shall be amended to reflect the withdrawal of the repurchased Mortgage Loan from this Agreement. In addition to such cure and repurchase obligation, the Originators shall indemnify the Purchaser and the Servicing Rights Owner and hold them harmless against any losses, damages, penalties, fines, forfeitures, reasonable and necessary legal fees and related costs, judgments, and other costs and expenses resulting from any claim, demand, defense or assertion based on or grounded upon, or resulting from any assertion based on, grounded upon or resulting from a breach or, in the case of the representations and warranties in Section 7.02(vii) only, alleged breach of any of the representations and warranties contained in this Section 7. In addition to the obligations of the Originators set forth in this Subsection 7.03, the Purchaser and Servicing Rights Owner may pursue any and all remedies otherwise available at law or in equity, including, but not limited to, the right to seek damages. Any cause of action against the Originators relating to or arising out of the breach of any representations and warranties made in Subsections 7.01 or 7.02 shall accrue as to any Mortgage Loan or Servicing Rights upon (i) discovery of such breach by the Purchaser or notice thereof by the Originators to the Purchaser and Servicing Rights Owner, (ii) failure by the Originators to cure such breach or repurchase such Mortgage Loan and/or Servicing Rights as specified above, and (iii) demand upon the the Originators by the Purchaser or Servicing Rights Owner for compliance with the relevant provisions of this Agreement. SECTION 8. Closing. The closing for the Mortgage Loans shall take place on the related Closing Date. At the Purchaser's option, the closing shall be either by telephone and facsimile, confirmed by letter or wire as the parties shall agree, or conducted in person, at such place as the parties shall agree. Subsection 8.01 Conditions to Purchaser's Obligations. The obligation of Purchaser to purchase the Mortgage Loans and the Servicing Rights on the related Closing Date is subject to the satisfaction at or prior to the related Closing Date of each of the following conditions (any or all of which may be waived by Purchaser): (a) Representations and Warranties Correct. Each of the representations and warranties of the Originators contained in this Agreement and the related Term Sheet shall be true and correct as of the related Closing Date. (b) Compliance with Covenants. The Originators shall have performed and be in compliance with, in all material respects, all of its respective covenants, acts, and obligations to be performed on or prior to the related Closing Date under this Agreement and the related Term Sheet. 33 (c) Closing Documents. The Originators shall have executed and delivered this Agreement and the related Term Sheet and all other Closing Documents and all other documents required to be delivered by the Originators hereunder. (d) Corporate Actions. All corporate, partnership and other acts necessary to authorize the execution, delivery, and performance of this Agreement and the related Term Sheet and the consummation of the transactions contemplated hereunder shall have been taken by the Originators. (e) Mortgage File. The Originators shall have delivered to the Purchaser all of the Mortgage Loan Documents in accordance with Section 6.03 and a complete Mortgage File with respect to each Mortgage Loan. Subsection 8.02 Conditions to Originators' Obligations. The obligation of the Originators to sell the Mortgage Loans and the Servicing Rights on the related Closing Date is subject to the satisfaction at or prior to the related Closing Date of each of the following conditions (any or all of which may be waived by the Originators): (a) Purchase Price. The related Purchase Price, plus accrued interest pursuant to Section 4, shall have been delivered to the Originators by wire transfer of immediately available funds pursuant to the Originators' reasonable instructions. (b) Compliance with Covenants. The Originators shall have performed and be in compliance with, in all material respects, all of its respective covenants, acts, and obligations to be performed under this Agreement and the related Term Sheet. (c) Closing Documents. The Originators shall have executed and delivered this Agreement and the related Term Sheet. (d) Corporate Actions. All corporate and other acts necessary to authorize the execution, delivery, and performance of this Agreement and the related Term Sheet and the consummation of the transactions contemplated hereunder shall have been taken by Purchaser. SECTION 9. Closing Documents. The Closing Documents for the Mortgage Loans and the Servicing Rights to be purchased on the related Closing Date shall consist of fully executed originals of the following documents: 1. this Agreement, in two (2) counterparts; 2. upon the request of Purchaser, a Custodial Account Letter Agreement in the form attached as Exhibit 3 hereto; 3. upon the request of Purchaser, an Escrow Account Letter Agreement in the form attached as Exhibit 4 hereto; 34 4. the related Mortgage Loan Schedule, one copy to be attached to the related Term Sheet in the case of any purchase of Mortgage Loans subsequent to the intial purchase; 5. the related Term Sheet in the case of any purchase of Mortgage Loans subsequent to the intial purchase; 6. an Officer's Certificate of the Originators in the form attached as Exhibit 11 hereto; 7. an Opinion of Counsel to the Originators, in a form acceptable to the Purchaser and which, in the case of the initial purchase of Mortgage Loans, may be delivered within three Business Days of the initial Closing Date; 8. a guaranty agreement from American Business Financial Services, Inc., relating to the payment and performance obligations of the Originators and the Servicer, in a form acceptable to the Purchaser, and which, in the case of the initial purchase of Mortgage Loans, may be delivered within three Business Days of the initial Closing Date; and 9. such other documents related to the purchase and sale of the Mortgage Loans and the Servicing Rights as the Purchaser may reasonably request. SECTION 10. Costs; Assignments. The Purchaser shall pay any commissions due its salesmen, the expenses of its accountants and attorneys and the expenses and fees of any broker retained by the Purchaser with respect to the transaction covered by this Agreement. All other costs and expenses (without duplication) incurred in connection with the transfer and delivery of the Mortgage Loans and related Servicing Rights including, without limitation, fees for the preparation and recording of intervening assignments of Mortgage and Assignments of Mortgage, any termination fees owed to the Originators' document custodian, any costs relating to transfer of the Mortgage File, and other Mortgage Loan records to Purchaser, the costs of delivering complete master file tape information and other electronically stored information to the Purchaser, Recording Fees (as provided for in Section 4.01), the costs of notifying the Mortgagors, hazard and flood insurance companies and other third parties as required, the costs of transferring "lifetime" tax service contracts (as described in Section 14.01) to the Purchaser, the costs of transferring "lifetime" flood certification contracts (as described in Section 14.02) to the Purchaser, and the legal fees and expenses of the Originators' attorneys shall be paid by the Originators. The Originators shall reimburse the Purchaser for the costs of transferring "lifetime" tax service contracts for the Mortgage Loans to the Purchaser in an amount not to exceed $78.00 for each Mortgage Loan. The Purchase Price shall be reduced by the sum of such fees and reimbursement amount. SECTION 11. Servicer's Interim Servicing Obligations. The Servicer, as independent contract servicer, shall service and administer the Mortgage Loans during the related Interim Servicing Period in accordance with the terms and provisions set forth in this Agreement, the related Term Sheet and in the Servicing Addendum attached hereto as Exhibit 5, which Servicing Addendum is incorporated herein by reference; provided, however, with respect to any Mortgage Loan, if the Servicing Transfer Date is fifteen (15) days or less after the Closing Date (a "Short Interim Servicing Period"), the Servicing Addendum shall not be applicable to the servicing of such Mortgage Loan. The Originators shall perform in accordance with Accepted Servicing Practices. 35 SECTION 12. The Originators and the Servicer. Subsection 12.01 Indemnification. The Originators and the Servicer, jointly and severally, agree to indemnify the Purchaser and the Servicing Rights Owner and hold them harmless from and against any and all claims, losses, damages, penalties, fines, forfeitures, legal fees and related costs, judgments, and any other costs, fees and expenses (including, without limitation, reasonable attorney's fees and expenses) that the Purchaser or the Servicing Rights Owner may sustain in any way related to (i) any act or omission on the part of the Originators or the Servicer in receiving, processing, funding or servicing any Mortgage Loan prior to the related Servicing Transfer Date or otherwise arising from the transfer of the Servicing Rights provide for in this Agreement; (ii) the Originators' or the Servicer's inability to effect or cause the transfer of the Servicing Rights to Purchaser unless such inability is the sole result of any act or omission of the Purchaser; (iii) the failure of the Servicer to perform in any way its duties and interim service the Mortgage Loans in strict compliance with the terms of this Agreement; and (iv) for breach of any covenant, representation or warranty of the Originators or the Servicer contained herein. In addition to the obligations of the Originators and the Servicer set forth in this Subsection 12.01, the Purchaser and Servicing Rights Owner may pursue any and all remedies otherwise available at law or in equity, including, but not limited to, the right to seek damages. The Originators and the Servicer shall immediately notify the Purchaser and Servicing Rights Owner if a claim is made by a third party with respect to this Agreement or the Mortgage Loans, assume (with the consent of the Purchaser and Servicing Rights Owner and with counsel reasonably satisfactory to the Purchaser and Servicing Rights Owner) the defense of any such claim and pay all expenses in connection therewith, including counsel fees, and promptly pay, discharge and satisfy any judgment or decree which may be entered against it or the Purchaser or Servicing Rights Owner in respect of such claim but failure to so notify the Purchaser and Servicing Rights Owner shall not limit its obligations hereunder. The Originators and the Servicer agree that they will not enter into any settlement of any such claim without the consent of the Purchaser and Servicing Rights Owner, as applicable. The provisions of this Section 12.01 shall survive termination of this Agreement. Subsection 12.02 Merger or Consolidation of the Originators. Each of ABC and Upland shall keep in full force and effect its existence, rights and franchises as a corporation under the laws of its formation in the State of Pennsylvania, and ABMS shall keep in full force and effect its existence, rights and franchises as a corporation under the laws of its formation in the State of New Jersey, except as permitted herein. Each of the Originators shall obtain and preserve its qualification to do business as a foreign corporation in each jurisdiction in which such qualification is or shall be necessary to protect the validity and enforceability of this Agreement or any of the Mortgage Loans, and to enable each Originator to perform its duties under this Agreement. Any Person into which any of the Originators may be merged or consolidated, or any corporation resulting from any merger, conversion or consolidation to which the Originators shall be a party, or any Person succeeding to the business of the Originators, shall be the successor of such Originator hereunder, without the execution or filing of any paper or any further act on the part of any of the parties hereto, anything herein to the contrary notwithstanding; provided, however, that the successor or surviving Person shall satisfy any requirements of Section 15 with respect to the qualifications of a successor to the Originators. 36 Subsection 12.03 Limitation on Liability of the Originators, the Servicer and Others. Neither any of the Originators, the Servicer nor any of the officers, employees or agents of the Originators or the Servicer shall be under any liability to the Purchaser for any action taken, or for refraining from the taking of any action, in good faith in connection with the interim servicing of the Mortgage Loans pursuant to this Agreement, or for errors in judgment; provided, however, that this provision shall not protect the Originators, the Servicer or any such person against any breach of warranties or representations made herein, or failure to perform its obligations in strict compliance with any standard of care set forth in this Agreement, or any liability which would otherwise be imposed by reason of any breach of the terms and conditions of this Agreement. The Originators, the Servicer and any officer, employee or agent of the Originators or the Servicer may rely in good faith on any document of any kind prima facie properly executed and submitted by any Person respecting any matters arising hereunder. The Originators and the Servicer shall not be under any obligation to appear in, prosecute or defend any legal action which is not incidental to its obligation to sell, or duty to interim service, the Mortgage Loans in accordance with this Agreement and which in its opinion may involve it in any expenses or liability; provided, however, that the Originators and the Servicer may, with the consent of the Purchaser, undertake any such action which they may deem necessary or desirable in respect to this Agreement and the rights and duties of the parties hereto. In such event, the legal expenses and costs of such action and any liability resulting therefrom shall be expenses, costs and liabilities for which the Purchaser shall be liable, the Originators and the Servicer shall each be entitled to reimbursement therefor from the Purchaser upon written demand except when such expenses, costs and liabilities are subject to the Originators' and the Servicer's indemnification under Subsections 7.03 or 12.01. Subsection 12.04 Servicer and Originators Not to Resign. Neither the Servicer nor the Originators shall not assign this Agreement or resign from the obligations and duties hereby imposed on it except by mutual consent of the Servicer, the Originators and the Purchaser or upon the determination that the Servicer's servicing duties hereunder are no longer permissible under applicable law and such incapacity cannot be cured by the Servicer in which event the Servicer may resign as interim servicer. Any such determination permitting the resignation of the Servicer as interim servicer shall be evidenced by an Opinion of Counsel to such effect delivered to the Purchaser which Opinion of Counsel shall be in form and substance acceptable to the Purchaser. No such resignation shall become effective until a successor shall have assumed the Servicer's responsibilities and obligations hereunder in the manner provided in Section 15. Subsection 12.05 No Transfer of Servicing. With respect to the retention of the Servicer to service the Mortgage Loans during the Interim Servicing Period, the Servicer acknowledges that the Purchaser has acted in reliance upon the Servicer's independent status, the adequacy of its servicing facilities, plant, personnel, records and procedures, its integrity, reputation and financial standing and the continuance thereof. Without in any way limiting the generality of this Section, during the Interim Servicing Period, the Servicer shall not either assign this Agreement or the servicing hereunder or delegate its rights or duties hereunder or any portion thereof, or sell or otherwise dispose of all or substantially all of its property or assets, without the prior written approval of the Purchaser, which consent will not be unreasonably withheld. 37 SECTION 13. Default. Subsection 13.01 Events of Default. In case one or more of the following Events of Default by the Originators or the Servicer shall occur and be continuing, that is to say: (i) any failure by the Servicer to remit to the Purchaser any payment required to be made under the terms of this Agreement which continues unremedied for a period of one (1) Business Day; or (ii) failure on the part of the Servicer or the Originators duly to observe or perform in any material respect any other of the covenants or agreements on the part of the Servicer or the Originators, respectively, set forth in this Agreement or the related Term Sheet which continues unremedied for a period of thirty (30) days (except that such number of days shall be fifteen (15) in the case of a failure to pay any premium for any insurance policy required to be maintained under this Agreement) after the date on which written notice of such failure, requiring the same to be remedied, shall have been given to the Servicer or the Originators, as applicable, by the Purchaser; or (iii) a decree or order of a court or agency or supervisory authority having jurisdiction for the appointment of a conservator or receiver or liquidator in any insolvency, bankruptcy, readjustment of debt, marshalling of assets and liabilities or similar proceedings, or for the winding-up or liquidation of its affairs, shall have been entered against the Originators or the Servicer and such decree or order shall have remained in force undischarged or unstayed for a period of sixty (60) days; or (iv) the Originators or the Servicer shall consent to the appointment of a conservator or receiver or liquidator in any insolvency, bankruptcy, readjustment of debt, marshalling of assets and liabilities or similar proceedings of, or relating to, the Originators or of, or relating to, all or substantially all of their property; or (v) any Originator or the Servicer shall admit in writing its inability to pay its debts generally as they become due, file a petition to take advantage of any applicable insolvency or reorganization statute, make an assignment for the benefit of its creditors, or voluntarily suspend payment of its obligations; or (vi) failure by the Servicer to be in compliance with the "doing business" or licensing laws of any jurisdiction where a Mortgaged Property is located; or (vii) the Servicer attempts to assign, sell, pledge or hypothecate its right to servicing compensation hereunder. 38 then, and in each and every such case, so long as an Event of Default shall not have been remedied, the Purchaser, by notice in writing to the Originators or the Servicer, as applicable, may, in addition to whatever rights the Purchaser may have at law or equity to damages, including injunctive relief and specific performance, terminate all the rights and obligations of the Servicer as interim servicer under this Agreement. On or after the receipt by the Originators and the Servicer of such written notice, all authority and power of the Servicer to interim service the Mortgage Loans under this Agreement shall on the date set forth in such notice pass to and be vested in the successor appointed pursuant to Section 15. If any of the Mortgage Loans are MERS Mortgage Loans, in connection with the termination or resignation (as described in Subsection 12.04) of the Servicer hereunder, either (i) the successor to the Servicer shall represent and warrant that it is a member of MERS in good standing and shall agree to comply in all material respects with the rules and procedures of MERS in connection with the servicing of the Mortgage Loans that are registered with MERS, or (ii) the predecessor Servicer shall cooperate with the successor either (x) in causing MERS to execute and deliver an assignment of Mortgage in recordable form to transfer the Mortgage from MERS to the Purchaser and to execute and deliver such other notices, documents and other instruments as may be necessary or desirable to effect a transfer of such Mortgage Loan or servicing of such Mortgage Loan on the MERS(R) System to the successor or (y) in causing MERS to designate on the MERS(R) System the successor as the servicer of such Mortgage Loan. Subsection 13.02 Waiver of Defaults. The Purchaser may waive any default by the Originators or the Servicer in the performance of their obligations hereunder and its consequences. Upon any such waiver of a past default, such default shall cease to exist, and any Event of Default arising therefrom shall be deemed to have been remedied for every purpose of this Agreement. No such waiver shall extend to any subsequent or other default or impair any right consequent thereon except to the extent expressly so waived. SECTION 14. Termination; Servicing Transfer. With respect to a Mortgage Loan, the respective obligations and responsibilities of the Servicer, as interim servicer, shall terminate at the expiration of the related Interim Servicing Period unless earlier terminated in accordance with the terms of this Agreement or the related Term Sheet, without the payment of any termination fee. Upon request from the Purchaser in connection with any such termination, the Servicer shall prepare, execute and deliver, any and all documents and other instruments, place in the Purchaser's possession all Mortgage Files, and do or accomplish all other acts or things necessary or appropriate to effect the purposes of such notice of termination, whether to complete the transfer and endorsement or assignment of the Mortgage Loans and related documents, to prepare notices to the mortgagors and related insurance companies, or otherwise, at the Servicer's sole expense. The Servicer agrees to cooperate with the Purchaser and such successor in effecting the termination of the Servicer's responsibilities and rights hereunder as interim servicer, including, without limitation, the transfer to such successor for administration by it of all cash amounts which shall at the time be credited by the Servicer to the Custodial Account or Escrow Account or thereafter received with respect to the Mortgage Loans. The Servicer shall follow the servicing transfer instructions of the Purchaser contained herein and attached hereto as Exhibit 7 with respect to servicing transfer procedures or as otherwise agreed upon in a reasonably acceptable manner by the Servicer and Purchaser. Servicer and Purchaser will each, at the request of the other, execute and deliver to each other all such documents that either may reasonably request in order to perfect the transfer, assignment and delivery to Purchaser of the Servicing Rights to be sold, transferred, assigned and delivered as of the consummation of this Agreement. The Servicer shall not be entitled to any transfer fee but shall be reimbursed on the related Servicing Transfer Date by the Purchaser or its successor servicer for any outstanding and unreimbursed Servicing Advances. 39 Subsection 14.01 Obligations of the Servicer Prior to the Servicing Transfer Date. The Servicer shall take, or cause to be taken, the following actions with respect to the Mortgage Loans prior to the related Servicing Transfer Date (or within such time as may otherwise be specified below) in order to effect the transfer of the Servicing Rights to the Purchaser on the related Servicing Transfer Date: (a) Preliminary Test Tape. On or prior to the related Closing Date, the Servicer shall forward to the Purchaser a preliminary test tape (including master file, escrow file, payee file, all HMDA data required by the Agencies, etc.) containing all of the Mortgage Loans as of the date mutually agreed upon by the Servicer and the Purchaser. The preliminary test tape shall include all field descriptions and record layouts; (b) Notice to Hazard Insurers. The Servicer shall inform by written notice all hazard insurance companies and/or their agents of the transfer and request a change in the loss payee mortgage endorsement clause to the Purchaser's name; provided, however, such written notice shall have occurred on or prior to the related Closing Date with respect to Mortgage Loans subject to a Short Interim Servicing Period. The Servicer shall provide the Purchaser with a copy of the notification letter and an officer's written certification that all hazard insurance companies have been notified by an identical letter; (c) Notice to Mortgage Insurance Companies. The Servicer shall inform by written notice all mortgage insurance companies providing any Primary Mortgage Insurance Policy of the change in insured's name on each such policy to the Purchaser's name; provided, however, such written notice shall have occurred on or prior to the related Closing Date with respect to Mortgage Loans subject to a Short Interim Servicing Period. The Servicer shall provide the Purchaser with a copy of one notification letter and an officer's written certification that all such mortgage insurance companies have been notified by an identical letter; (d) Tax Service Contracts. Either, on or prior to the related Closing Date with respect to Mortgage Loans subject to a Short Interim Servicing Period or, prior to the related Servicing Transfer Date with respect to all other Mortgage Loans, the Servicer shall have obtained a life of loan, transferable real estate tax service contract with LERETA Corp. on all of the Mortgage Loans and shall assign all such contracts to the Purchaser or, in the alternative, the Servicer shall notify the Purchaser as to any Mortgage Loans for which it has not procured the requisite contract by indicating such on the related Mortgage Loan Schedule and shall pay to the Purchaser the fee specified in Section 10 of this Agreement for each such Mortgage Loan; (e) Flood Certifications. Either, on or prior to the related Closing Date with respect to Mortgage Loans subject to a Short Interim Servicing Period or, prior to the related Servicing Transfer Date with respect to all other Mortgage Loans, the Servicer shall have obtained a life of loan, transferable flood certification contract for each Mortgage Loan and shall assign all such contracts to the Purchaser or, in the alternative, the Servicer shall notify the Purchaser as to any Mortgage Loans for which it has not procured the flood certification referenced above and shall pay to the Purchaser a fee for each such Mortgage Loan equal to the fee that is customarily charged for each such contract, as determined by the Purchaser in its reasonable discretion; 40 (f) Notice to Mortgagors. Either, on or prior to the related Closing Date with respect to Mortgage Loans subject to a Short Interim Servicing Period or, no later than fifteen (15) days prior to the related Servicing Transfer Date with respect to all other Mortgage Loans, the Servicer shall inform in writing all Mortgagors of the change in servicer from the Servicer to the Purchaser, all in accordance with applicable law. The Servicer shall obtain the Purchaser's approval of the form of such notifications prior to their mailing. The Servicer acknowledges that the Purchaser's review of this notice shall not be a review for statutory or regulatory compliance purposes, and that the Servicer shall have the sole responsibility for such compliance. The Servicer shall provide the Purchaser with a copy of one notification letter and an officer's written certification that all Mortgagors have been notified by an identical letter; (g) Payment of Real Estate Taxes. The Servicer shall make or cause to be made all payments of all real estate taxes on the Mortgage Loans which (i) will be delinquent on or prior to the related Servicing Transfer Date, (ii) are required to be paid within thirty (30) days after the related Servicing Transfer Date to receive a discount, or (iii) will be delinquent within thirty (30) days after the related Servicing Transfer Date. If tax bills have not been received by the Servicer by the related Servicing Transfer Date on any Mortgage Loans subject to this subsection, the Servicer shall obtain and pay all tax bills subsequent to the related Servicing Transfer Date and the Purchaser will promptly reimburse the Servicer upon receipt from the Servicer of documentation evidencing such payment. On non-impounded accounts, the Servicer shall ensure that all taxes which would otherwise be delinquent by the related Servicing Transfer Date, if not paid by such date, have been paid. With respect to each of the Mortgage Loans which do not have an impound or escrow account maintained for the payment of taxes and insurance, the Servicer shall hold harmless and indemnify the Purchaser against any and all costs, expenses, penalties, fines, damages and judgments of whatever kind arising from the Servicer's failure to pay, or cause to be paid, any delinquent taxes or tax penalties outstanding as of the related Servicing Transfer Date; (h) Payment of Insurance Premiums. The Servicer shall pay all hazard and flood insurance and Primary Mortgage Insurance Policy premiums required to be paid prior to the related Servicing Transfer Date or within thirty (30) days after the related Servicing Transfer Date on all impounded accounts relating to the Mortgage Loans and shall ensure that all premiums required to be paid prior to the related Servicing Transfer Date by the Mortgagors on non-impounded accounts have been paid. With respect to each of the Mortgage Loans which do not have an impound or escrow account maintained for the payment of taxes and insurance, the Servicer shall hold harmless and indemnify the Purchaser against any and all costs, expenses, penalties, fines, damages and judgments of whatever kind arising from the Servicer's failure to ensure that the related Mortgagor is maintaining adequate insurance coverage on the Mortgaged Property at all times prior to the related Servicing Transfer Date in accordance with the terms of the any document contained in the Mortgage File or any applicable law or regulation including, without limitation, adequate flood insurance coverage for all Mortgaged Properties located within an "A" or "V" flood hazard area; 41 (i) Notice to Sub-servicers. On or prior to the related Closing Date, the Servicer shall inform by written notice all sub-servicers who perform servicing obligations with respect to the Mortgage Loans of the sale of the Mortgage Loans to the Purchaser and of the transfer of the Servicing Rights to the Purchaser on the related Servicing Transfer Date. The Servicer shall provide the Purchaser with a copy of the notification letter and an officer's certification that all sub-servicers have been notified by an identical letter. (j) Mortgage Payments Received During a Short Interim Servicing Period. For the first thirty (30) days following the Closing Date, the Servicer shall forward to the Purchaser on a daily basis via overnight delivery service any payment received by it (endorsed to EMC Mortgage Corporation) with respect to any of the Mortgage Loans, whether such payment is in the form of principal, interest, taxes, insurance, loss drafts, insurance refunds, etc., in the original form received, unless such payment has been received in cash or by the Servicer's lock box facility, in which case the Servicer shall forward such payment in a form acceptable to the Purchaser. After the thirty (30) day period following the Closing Date, the Servicer shall forward to the Purchaser such funds on a weekly basis via overnight delivery service. In all cases, the Servicer shall notify the Purchaser of the particulars of the payment, which notification shall set forth sufficient information to permit timely and appropriate processing of the payment by the Purchaser. Continuously from the related Closing Date until the related Servicing Transfer Date, the Servicer shall proceed diligently to collect all payments due under each Mortgage Loan when the same shall become due any payable and shall follow such collection procedures as it follows with respect to mortgage loans comparable to the Mortgage Loans and held for its own account. Further, the Servicer shall take special care in ascertaining and estimating annual ground rents, taxes, assessments, water rates, fire and hazard insurance premiums, mortgage insurance premiums, and all other charges that, as provided in the Mortgage, will become due and payable to the end that the installments payable by the Mortgagors will be sufficient to pay such charges as and when they become due and payable. Subsection 14.02 Obligations of the Servicer after the Servicing Transfer Date. Without limiting the generality of Section 14., the Servicer shall take, or cause to be taken, the following actions with respect to the Mortgage Loans within three (3) Business Days following the related Servicing Transfer Date (or within such time as may otherwise be specified below): (a) Tape. The Servicer shall furnish to the Purchaser all available computer or like records requested by the Purchaser reflecting the status of payments, balances and other pertinent information with respect to the Mortgage Loans as of the related Servicing Transfer Date (including, without limitation, (i) master file, (ii) escrow file, (iii) payee file, which includes comprehensive tax and insurance information identifying payee, payee address, next payment due date, next amount payable and policy number/parcel number, and (iv) all HMDA data required by the Agencies). Such records shall include magnetic tapes reflecting all computer files maintained on the Mortgage Loans and shall include reports in electronic format as specifically requested by the Purchaser; 42 (b) Mortgage File. If the Servicer has not already done so, the Servicer shall have forwarded a complete Mortgage File with respect to each Mortgage Loan; (c) Accounting Reports. The Servicer shall furnish to the Purchaser copies of all accounting reports relating to the Mortgage Loans as of the related Closing Date with respect to Mortgage Loans subject to a Short Interim Servicing Period or, as of the related Servicing Transfer Date with respect to Mortgage Loans subject to an Interim Servicing Period, including, without limitation, a trial balance and reports of collections, delinquencies, prepaids, curtailments, escrow payments, escrow balances, partial payments, partial payment balances and other like information with respect to the Mortgage Loans; (d) Other Documentation. The Servicer shall provide the Purchaser any and all further documents reasonably required by the Purchaser in order to fully transfer to the Purchaser possession of all tangible evidence of the Servicing Rights and escrow, impound and trust funds transferred hereunder; (e) Transfer of Escrow Funds and Other Proceeds. The Servicer shall transfer to the Purchaser, by wire transfer to the account designated by the Purchaser, an amount equal to the sum of (i) the Net Escrow Payments, (ii) all undistributed insurance loss draft funds, (iii) all unapplied funds received by the Servicer, (iv) all unapplied interest on escrow balances accrued through the related Servicing Transfer Date, (v) all buydown funds held by the Servicer as of the related Closing Date with respect to Mortgage Loans subject to a Short Interim Servicing Period or, as of the related Servicing Transfer Date with respect to Mortgage Loans subject to an Interim Servicing Period, and (vi) all other amounts held by the Servicer with respect to the Mortgage Loans as of the related Servicing Transfer Date which the Servicer is not entitled to retain (collectively, the "Escrow Proceeds"). Within five (5) Business Days following the Purchaser's receipt of the Escrow Proceeds, the Servicer and the Purchaser shall resolve any discrepancies between the Servicer's accounting statement and the Purchaser's reconciliation with respect thereto. No later than ten (10) Business Days following the related Servicing Transfer Date, the Servicer or the Purchaser, as the case may be, shall transfer to the other, by wire transfer to the designated account, any amounts to which the other party is entitled; and (f) Mortgage Payments received after Servicing Transfer Date with respect to Mortgage Loans not serviced during a Short Interim Servicing Period. The Servicer shall forward to the Purchaser on a weekly basis via overnight delivery any payment received by it after the related Servicing Transfer Date with respect to any of the Mortgage Loans, whether such payment is in the form of principal, interest, taxes, insurance, loss drafts, insurance refunds, etc., in the original form received, unless such payment has been received in cash or by the Servicer's lock box facility, in which case the Servicer shall forward such payment in a form acceptable to the Purchaser. The Servicer shall notify the Purchaser of the particulars of the payment, which notification shall set forth sufficient information to permit timely and appropriate processing of the payment by the Purchaser. 43 (g) Tax Reporting. The Servicer shall prepare and file any and all tax returns, information statements or other filings required to be delivered to any governmental taxing authority or to any Purchaser pursuant to any applicable law with respect to the Mortgage Loans and the transactions contemplated hereby, including, but not limited to all Internal Revenue Service Form 1098 reporting (both to Internal Revenue Service and the Mortgagor) for all reportable funds received by the Servicer. In addition, the Servicer shall provide the Purchaser with such information concerning the Mortgage Loans as is necessary for the Purchaser to prepare its federal income tax return as any Purchaser may reasonably request from time to time. Subsection 14.03 Limited Power of Attorney. If requested by Purchaser, Servicer shall furnish to Purchaser a limited power of attorney in the form attached here as Exhibit 10 appointing Purchaser and any of its employees to act as Servicer's attorney in fact to execute documents pertaining to the discharge and satisfaction of Mortgages which were recorded in Servicer's name and to endorse checks received by the Purchaser from Mortgagor after the related Servicing Transfer Date in the Servicer's name. Subsection 14.04 Supplementary Information. From time to time prior to the related Servicing Transfer Date for the servicing of any given Mortgage Loan, Servicer shall furnish to Purchaser such information supplementary to the information contained in the documents and schedules delivered pursuant hereto and file such reports as purchaser may reasonably request. Subsection 14.05 Reasonable Access. Between the date of this Agreement and the related Servicing Transfer Date, Servicer shall give Purchaser its authorized representatives reasonable access to all documents, files, books, records, accounts, offices and other facilities of Servicer related to the Mortgage Loans and Servicing Rights transferred hereby, and permit Purchaser to make such inspections thereof as Purchaser may reasonably request during normal business hours, provided, however, that such investigation or inspection shall be conducted in such a manner as to not interfere unreasonably with Servicer's business operations. Subsection 14.06 Facilities. Servicer shall maintain and employ throughout the term hereof a sufficient number of qualified employees to perform the servicing activities to be carried out hereunder in an efficient and professional basis as carried out by Servicer when it was the owner of the Servicing Rights. If necessary to perform its duties hereunder, Servicer shall employ additional or more qualified personnel. Servicer shall maintain throughout the term hereof physical facilities from which the servicing activities can be performed in a manner consistent with the foregoing. Subsection 14.07 Referral of Refinance Inquiries. During the any Interim Servicing Period, Servicer will promptly refer to Purchaser any Mortgagor inquiries as to refinance of any Mortgage Loans. 44 SECTION 15. Successor to the Servicer. Prior to termination of the Servicer's responsibilities and duties as interim servicer under this Agreement pursuant to Section 13 or 14, the Purchaser shall (i) succeed to and assume all of the Servicer's responsibilities, rights, duties and obligations as interim servicer under this Agreement, or (ii) appoint a successor which shall succeed to all rights and assume all of the responsibilities, duties and liabilities of the Servicer as interim servicer under this Agreement. In connection with such appointment and assumption, the Purchaser may make such arrangements for the compensation of such successor out of payments on Mortgage Loans as it and such successor shall agree. In the event that the Servicer's duties, responsibilities and liabilities as interim servicer under this Agreement should be terminated pursuant to the aforementioned Sections, the Servicer shall discharge such duties and responsibilities during the period from the date it acquires knowledge of such termination until the effective date thereof with the same degree of diligence and prudence which it is obligated to exercise under this Agreement, and shall take no action whatsoever that might impair or prejudice the rights or financial condition of the Purchaser or such successor. The termination of the Servicer as interim servicer pursuant to the aforementioned Sections shall not become effective until a successor shall be appointed pursuant to this Section 15 and shall in no event relieve the Servicer of the representations and warranties made pursuant to Subsections 7.01 and 7.02 and the remedies available to the Purchaser under Subsection 7.03 or 12.01, it being understood and agreed that the provisions of such Subsections 7.01, 7.02, 7.03 or 12.01 shall be applicable to the Servicer notwithstanding any such resignation or termination of the Servicer, or the termination of this Agreement. SECTION 16. Notices. All demands, notices and communications hereunder shall be in writing and shall be deemed to have been duly given if mailed, by registered or certified mail, return receipt requested, or, if by other means, when received by the other party at the address as follows: (i) if to the Originators and the Servicer: American Business Financial Services, Inc. Balapointe Office Centre 111 Presidential Boulevard Suite 127 Bala Cynwyd, PA 19004 Attention: Mr. Jeffrey M. Ruben (ii) if to the Purchaser: EMC Mortgage Corporation Mac Arthur Ridge II 909 Hidden Ridge Drive Suite 200 Irving, Texas 75038 Attention: Ralene Ruyle With a copy to: Bear, Stearns & Co. Inc. 383 Madison Avenue New York, N.Y. 10179 Attention: Ms. Ginny Darrow 45 Bear, Stearns & Co. Inc. 383 Madison Avenue New York, N.Y. 10179 Attention: Mr. Jonathan Lieberman or such other address as may hereafter be furnished to the other party by like notice. Any such demand, notice or communication hereunder shall be deemed to have been received on the date delivered to or received at the premises of the addressee (as evidenced, in the case of registered or certified mail, by the date noted on the return receipt). SECTION 17. Modification of Obligations. Purchaser may, without any notice to Servicer, extend, compromise, renew, release, change, modify, adjust or alter, by operation of law or otherwise, any of the obligations of the Mortgagors or other persons obligated under a Mortgage Loan without releasing or otherwise affecting the obligations of Originators or the Servicer under this Agreement, or with respect to such Mortgage Loan, except to the extent Purchaser's extension, compromise, release, change, modification, adjustment, or alteration affects Servicer's ability to collect the Mortgage Loan or realize on the security of the Mortgage, but then only to the extent such action has such effect. SECTION 18. Severability Clause. Any part, provision, representation or warranty of this Agreement which is prohibited or which is held to be void or unenforceable shall be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof. Any part, provision, representation or warranty of this Agreement which is prohibited or unenforceable or is held to be void or unenforceable in any jurisdiction shall be ineffective, as to such jurisdiction, to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof, and any such prohibition or unenforceability in any jurisdiction as to any Mortgage Loan shall not invalidate or render unenforceable such provision in any other jurisdiction. To the extent permitted by applicable law, the parties hereto waive any provision of law which prohibits or renders void or unenforceable any provision hereof. If the invalidity of any part, provision, representation or warranty of this Agreement shall deprive any party of the economic benefit intended to be conferred by this Agreement, the parties shall negotiate, in good-faith, to develop a structure the economic effect of which is nearly as possible the same as the economic effect of this Agreement without regard to such invalidity. SECTION 19. Counterparts. This Agreement and a Term Sheet may be executed simultaneously in any number of counterparts. Each counterpart shall be deemed to be an original, and all such counterparts shall constitute one and the same instrument. SECTION 20. Governing Law. This Agreement shall be construed in accordance with the laws of the State of New York without regard to any conflicts of laws provisions. SECTION 21. Intention of the Parties. It is the intention of the parties that the Purchaser is purchasing, and the Originators are selling the Mortgage Loans and the Servicing Rights, and not a debt instrument of the Originators or another security. Accordingly, the parties hereto each intend to treat the transaction for federal income tax purposes as a sale by the Originators, and a purchase by the Purchaser, of the Mortgage Loans and the Servicing Rights. The Purchaser shall have the right to review the Mortgage Loans and the related Mortgage Loan Files to determine the characteristics of the Mortgage Loans which shall affect the federal income tax consequences of owning the Mortgage Loans and the Servicing Rights and the Originators shall cooperate with all reasonable requests made by the Purchaser in the course of such review. 46 SECTION 22. Successors and Assigns. This Agreement shall bind and inure to the benefit of and be enforceable by the Originators, the Servicer and the Purchaser and the respective successors and assigns of the Originators, the Servicer and the Purchaser. The Purchaser may assign this Agreement to any Person to whom any Mortgage Loan is transferred whether pursuant to a sale or financing and to any Person to whom the servicing or master servicing of any Mortgage Loan is sold or transferred. Upon any such assignment, the Person to whom such assignment is made shall succeed to all rights and obligations of the Purchaser under this Agreement. A form of such assignment is attached as Exhibit 8 hereto. This Agreement shall not be assigned, pledged or hypothecated by the Originators or the Servicer to a third party without the consent of the Purchaser. SECTION 23. Waivers. No term or provision of this Agreement and a Term Sheet may be waived or modified unless such waiver or modification is in writing and signed by the party against whom such waiver or modification is sought to be enforced. SECTION 24. Exhibits. The exhibits to this Agreement are hereby incorporated and made a part hereof and are an integral part of this Agreement. SECTION 25. General Interpretive Principles. For purposes of this Agreement, except as otherwise expressly provided or unless the context otherwise requires: (a) the terms defined in this Agreement have the meanings assigned to them in this Agreement and include the plural as well as the singular, and the use of any gender herein shall be deemed to include the other gender; (b) accounting terms not otherwise defined herein have the meanings assigned to them in accordance with GAAP; (c) references herein to "Articles," "Sections," "Subsections," "Paragraphs," and other subdivisions without reference to a document are to designated Articles, Sections, Subsections, Paragraphs and other subdivisions of this Agreement; (d) reference to a Subsection without further reference to a Section is a reference to such Subsection as contained in the same Section in which the reference appears, and this rule shall also apply to Paragraphs and other subdivisions; (e) the words "herein," "hereof," "hereunder" and other words of similar import refer to this Agreement as a whole and not to any particular provision; and (f) the term "include" or "including" shall mean without limitation by reason of enumeration. SECTION 26. Reproduction of Documents. This Agreement and all documents relating thereto, including, without limitation, (a) consents, waivers and modifications which may hereafter be executed, (b) documents received by any party at the closing, and (c) financial statements, certificates and other information previously or hereafter furnished, may be reproduced by any photographic, photostatic, microfilm, micro-card, miniature photographic or other similar process. The parties agree that any such reproduction shall be admissible in evidence as the original itself in any judicial or administrative proceeding, whether or not the original is in existence and whether or not such reproduction was made by a party in the regular course of business, and that any enlargement, facsimile or further reproduction of such reproduction shall likewise be admissible in evidence. 47 SECTION 27. Nonsolicitation. From and after the related Closing Date, the Servicer agrees that it will not take any action or cause any action to be taken by any of its employees, agents or affiliates, or by any independent contractors acting on the Servicer's behalf, to directly target the Mortgagors to prepay or refinance a Mortgage Loan; provided, however, that such prohibition shall not include general solicitations and advertising not targeted at the Mortgagors. It is understood and agreed by the Servicer and the Purchaser that all rights and benefits relating to the direct, targeted solicitation of any Mortgagors to refinance any Mortgage Loans shall be transferred to the Purchaser pursuant hereto on the related Closing Date and the Servicer shall take no action to undermine these rights and benefits. The Servicer shall (a) not sell the name of any Mortgagor, and (b) use its best efforts to prevent the sale of the name of any Mortgagor by the Servicer's wholly owned subsidiaries and affiliates, to any person or entity for the direct or indirect purpose of allowing such person or entity to solicit the refinancing of any Mortgage Loan. During the period ending three months after the related Closing Date, the Purchaser agrees that it will not take any action or cause any action to be taken by any of its employees, agents or affiliates, or by any independent contractors acting on the Purchaser's behalf, to directly target Mortgagors to prepay or refinance their Mortgage Loans; provided, however, that such prohibition shall not include general solicitations or advertising not targeted at such Mortgagors. SECTION 28. Survival. All covenants, agreements, representations and warranties made herein shall survive the execution and delivery of this Agreement. SECTION 29. Further Agreements and Assurances. The Purchaser and the Originators each agree to execute and deliver to the other such additional documents, instruments or agreements as may be necessary or appropriate to effectuate the purposes of this Agreement. The Originators and the Servicer acknowledge that with respect to some or all of the Mortgage Loans, the Purchaser intends to effect one or more Whole Loan Transfers and/or one or more Pass-Through Transfers. With respect to each Whole Loan Transfer or Pass-Through Transfer, as the case may be, entered into by the Purchaser, the Originators and the Servicer agree: (i) to cooperate fully with the Purchaser, any prospective purchaser, any rating agency or any party to any agreement executed in connection with such Whole Loan Transfer or Pass-Through Transfer, with respect to all reasonable requests and due diligence procedures and to use its best efforts to facilitate such Whole Loan Transfer or Pass-Through Transfer, as the case may be; and (ii) to execute all agreements executed in connection with such Whole Loan Transfer or Pass-Through Transfer that govern the servicing and administration of the Mortgage Loans (and any agreements and other documents incidental thereto) as the Purchaser shall request, which governing documents, in the case of a Pass-Through Transfer, shall contain provisions customarily included in publicly issued or privately placed rated secondary mortgage market transactions. 48 (iii) as of the closing date of the Whole Loan Transfer or Pass-Through Transfer, as the case may be, to restate, for the benefit of the owners of the Mortgage Loans, the representations and warranties contained in Sections 7.01 and 7.02. All Mortgage Loans not sold or transferred pursuant to a Whole Loan Transfer or Pass-Through Transfer shall continue to be serviced in accordance with the terms of this Agreement. SECTION 30. Mandatory Delivery; Grant of Security Interest. The sale and delivery of each Mortgage Loan on or before the applicable Closing Date is mandatory from and after the date of the execution of this Agreement and the related the Term Sheet, it being specifically understood and agreed that each Mortgage Loan is unique and identifiable on the date hereof and that an award of money damages would be insufficient to compensate the Purchaser for the losses and damages incurred by the Purchaser (including damages to prospective purchasers of the Mortgage Loans) in the event of the Originators' failure to deliver each of the related Mortgage Loans or one or more Mortgage Loans otherwise acceptable to the Purchaser on or before the applicable Closing Date. The Originators and the Purchaser intend that the transactions hereunder be sales to the Purchaser of the Mortgage Loans and not loans from the Purchaser to the Originators secured by the Mortgage Loans. However, in order to preserve the Purchaser's rights under this Agreement in the event that a court or other forum recharacterizes the transactions hereunder as loans and as security for the performance by the Originators and the Servicer of all of the Originators' and the Servicer's respective obligations to the Purchaser under this Agreement and the transactions entered into pursuant to this Agreement, the Originators hereby grants to the Purchaser a lien on and a continuing first priority security interest in each Mortgage Loan and each document and instrument evidencing each such Mortgage Loan to secure the performance by the Originators and the Servicer of its respective obligations hereunder, and the Servicer agrees that it holds such Mortgage Loans in custody for the Purchaser subject to the Purchaser's (i) right to reject any Mortgage Loan under the terms of this Agreement and the related Term Sheet, and (ii) obligation to pay the Purchase Price for the Mortgage Loans. All rights and remedies of the Purchaser under this Agreement are distinct from, and cumulative with, any other rights or remedies under this Agreement or afforded by law or equity and all such rights and remedies may be exercised concurrently, independently or successively. * * * 49 IN WITNESS WHEREOF, the Originators and the Purchaser have caused their names to be signed hereto by their respective officers thereunto duly authorized as of the date first above written. AMERICAN BUSINESS CREDIT, INC. By: ------------------------------- Name: Title: HOMEAMERICAN CREDIT, INC., D/B/A UPLAND MORTGAGE By: ------------------------------- Name: Title: AMERICAN BUSINESS MORTGAGE SERVICES, INC. By: ------------------------------- Name: Title: EMC MORTGAGE CORPORATION By: ------------------------------- Name: Title: 50 EXHIBIT 1 TERM SHEET 51 TERM SHEET This TERM SHEET (the "Term Sheet") dated [_____________], by and among EMC Mortgage Corporation, a Delaware corporation, located at Mac Arthur Ridge II, 909 Hidden Ridge Drive, Suite 200, Irving, Texas 75038, (the "Purchaser"), American Business Credit, Inc., a Pennsylvania corporation ("ABC"), Homeamerican Credit, Inc. d/b/a Upland Mortgage, a Pennsylvania corporation ("Upland"), and American Business Mortgage Services, Inc., a New Jersey corporation ("ABMS", and together with ABC and Upland, the "Originators"), is made pursuant to the terms and conditions of that certain Mortgage Loan Purchase and Interim Servicing Agreement (the "Agreement") dated as of June 30, 2003, among the Originators and the Purchaser, the provisions of which are incorporated herein as if set forth in full herein, as such terms and conditions may be modified or supplemented hereby. All initially capitalized terms used herein unless otherwise defined shall have the meanings ascribed thereto in the Agreement. The Purchaser hereby purchases from the Originators and the Originators hereby sell to the Purchaser, without recourse, all of the Originators' right, title and interest in and to the Mortgage Loans described on the Mortgage Loan Schedule annexed hereto as Schedule I, pursuant to and in accordance with the terms and conditions set forth in the Agreement, as same may be supplemented or modified hereby. Hereinafter, the Servicer shall service the Mortgage Loans for the benefit of the Purchaser and all subsequent transferees of the Mortgage Loans pursuant to and in accordance with the terms and conditions set forth in the Agreement. 1. Definitions For purposes of the Mortgage Loans to be sold pursuant to this Term Sheet, the following terms shall have the following meanings: Aggregate Principal Balance (as of the Cut-Off Date): [_________] Closing Date: [_________] Cut-off Date: [_________] Initial Weighted Average [_________] Mortgage Loan Remittance Rate: Mortgage Loan: [_________] Purchase Price Percentage: [_________] Servicing Transfer Date: [_________] Additional Closing Conditions: In addition to the conditions specified in the Agreement, the obligation of each of the Originators and the Purchaser is subject to the fulfillment, on or prior to the applicable Closing Date, of the following additional conditions: [None]. 52 Additional Loan Documents: In addition to the contents of the Mortgage File specified in the Agreement, the following documents shall be delivered with respect to the Mortgage Loans: [None] Additional [Modification of] Representations and Warranties: In addition to the representations and warranties set forth in the Agreement, as of the date hereof, the Originators make the following additional representations and warranties with respect to the Mortgage Loans: (a) As of the Closing Date, all of the Mortgage Loans will have an actual paid-to-date of [____________] 1, 2003 (or later) and will be due for the [_________] 1, 2003 scheduled monthly payment (or later). [Notwithstanding anything to the contrary set forth in the Agreement, with respect to each Mortgage Loan to be sold on the Closing Date, the representation and warranty set forth in Section ______ of the Agreement shall be modified to read as follows:] Except as modified herein, Section ______ of the Agreement shall remain in full force and effect as of the date hereof. Additional Repurchase Obligations; Principal Prepayments. (a) The Originators will repurchase any Mortgage Loan for which the Monthly Payment due in [________], 2003, [________] 2003, [________] 2003 or [________] 2003 becomes 30 days delinquent. Such repurchase will be made at the Purchase Price Percentage originally paid by the Purchaser multiplied by the unpaid principal balance of the Mortgage Loan plus accrued interest through the end of the month of repurchase. Such repurchase will occur within 5 days after notice by Purchaser to the applicable Originator of such delinquency. (b) For any Mortgage Loan purchased by the Purchaser that has prepaid on prior to [________], 2003 (each a "Prepaid Loan"), the Originators shall remit to the Purchaser the Premium (as defined below) with respect to such Prepaid Loan as provided in the Agreement. With respect to each Prepaid Loan, the Premium shall be an amount equal to the product of (x) the difference between the Purchase Price Percentage for such Prepaid Loan and 100.00%, and (y) the outstanding principal balance of such Prepaid Loan as of the Cut-off Date. * * * 53 IN WITNESS WHEREOF, the Originators and the Purchaser have caused their names to be signed hereto by their respective officers thereunto duly authorized as of the date first above written. AMERICAN BUSINESS CREDIT, INC. By: ------------------------------ Name: Title: HOMEAMERICAN CREDIT, INC., D/B/A UPLAND MORTGAGE By: ------------------------------ Name: Title: AMERICAN BUSINESS MORTGAGE SERVICES, INC. By: ------------------------------ Name: Title: EMC MORTGAGE CORPORATION By: ------------------------------ Name: Title: 54 SCHEDULE I MORTGAGE LOAN SCHEDULE (On file with EMC and ABFS) 55 EXHIBIT 2 CONTENTS OF EACH MORTGAGE FILE With respect to each Mortgage Loan, the Mortgage File shall include each of the following items, which shall be available for inspection by the Purchaser and which shall be delivered to the Purchaser or, upon Purchaser's request, its designee: 1. Mortgage Loan Documents. 2. Residential loan application. 3. Mortgage Loan closing statement. 4. Verification of employment and income, if applicable. 5. Verification of acceptable evidence of source and amount of down payment, if applicable. 6. Credit report on Mortgagor. 7. Residential appraisal report. 8. Photograph of the Mortgaged Property. 9. Survey of the Mortgaged Property. 10. Copy of each instrument necessary to complete identification of any exception set forth in the exception schedule in the title policy, i.e., map or plat, restrictions, easements, sewer agreements, home association declarations, etc. 11. All required disclosure statements and statement of Mortgagor confirming receipt thereof. 12. If available, termite report, structural engineer's report, water potability and septic certification. 13. Sales Contract, if applicable. 14. Hazard insurance policy. 15. Tax receipts, insurance premium receipts, ledger sheets, payment history from date of origination, insurance claim files, correspondence, current and historical computerized data files, and all other processing, underwriting and closing papers and records which are customarily contained in a mortgage loan file and which are required to document the Mortgage Loan or to service the Mortgage Loan. 16. Amortization schedule, if available. 17. Payment history for each of the Mortgage Loans. 56 EXHIBIT 3 FORM OF CUSTODIAL ACCOUNT LETTER AGREEMENT ________________________ __, 200[_] To: _____________________________ (the "Depository") As the Servicer under the Mortgage Loan Purchase and Interim Servicing Agreement, dated as of ___________________ 200[_], we hereby authorize and request you to establish an account, as a Custodial Account, to be designated as "__________, in trust for the Purchaser and various Mortgagors, Mortgage Loans, P&I Account." All deposits in the account shall be subject to withdrawal therefrom by order signed by the Servicer. You may refuse any deposit which would result in violation of the requirement that the account be fully insured as described below. This letter is submitted to you in duplicate. Please execute and return one original to us. ___________________________________ By: _______________________________ Name: _____________________________ Title: ______________________________ Date: ______________________________ The undersigned, as Depository, hereby certifies that the above-described account has been established under Account Number ___________ at the office of the Depository indicated above, and agrees to honor withdrawals on such account as provided above. The full amount deposited at any time in the account will be insured by the Federal Deposit Insurance Corporation through the Bank Insurance Fund ("BIF") or the Savings Association Insurance Fund ("SAIF"). Depository By: _______________________________ Name: _____________________________ Title: ______________________________ Date: ______________________________ 57 EXHIBIT 4 FORM OF ESCROW ACCOUNT LETTER AGREEMENT ________________________ __, 200[_] To: _____________________________ (the "Depository") As the Servicer under the Mortgage Loan Purchase and Interim Servicing Agreement, dated as of ______________, 200[_], we hereby authorize and request you to establish an account, as an Escrow Account, to be designated as "_____________, in trust for the Purchaser and various Mortgagors, Mortgage Loans, T&I Account." All deposits in the account shall be subject to withdrawal therefrom by order signed by the Servicer. You may refuse any deposit which would result in violation of the requirement that the account be fully insured as described below. This letter is submitted to you in duplicate. Please execute and return one original to us. ___________________________________ By: _______________________________ Name: _____________________________ Title: ______________________________ Date: ______________________________ The undersigned, as Depository, hereby certifies that the above-described account has been established under Account Number ___________ at the office of the Depository indicated above, and agrees to honor withdrawals on such account as provided above. The full amount deposited at any time in the account will be insured by the Federal Deposit Insurance Corporation through the Bank Insurance Fund ("BIF") or the Savings Association Insurance Fund ("SAIF"). Depository By: _______________________________ Name: _____________________________ Title: ______________________________ Date: ______________________________ 58 EXHIBIT 5 SERVICING ADDENDUM SECTION 11. Servicing. Subsection 11.01. Additional Definitions. Ancillary Income: Additional servicing compensation in the form of assumption fees, late payment charges and other miscellaneous fees. Prepayment penalties or premiums due in connection with a Principal Prepayment shall not constitute Ancillary Income and shall be deposited in the Custodial Account as set forth in Subsection 11.04. The Servicer's right to Ancillary Income shall terminate on the Servicing Transfer Date. BIF: The Bank Insurance Fund, or any successor thereto. Code: The Internal Revenue Code of 1986, or any successor statute thereto. Determination Date: With respect to each Distribution Date, the close of business of the last day of the month preceding the month in which such of Distribution Date occurs. Distribution Date: The fifteenth (15th) day of each month, commencing on the fifteenth (15th) day of the month next following the month in which the Cut-off Date occurs, or if such fifteenth (15th) day is not a Business Day, the first Business Day immediately following such fifteenth (15th) day. Final Recovery Determination: With respect to any defaulted Mortgage Loan or any REO Property (other than a Mortgage Loan or REO Property purchased by the Servicer pursuant to this Agreement), a determination made by the Servicer that all Insurance Proceeds, Liquidation Proceeds and other payments or recoveries which the Servicer, in its reasonable good faith judgment, expects to be finally recoverable in respect thereof have been so recovered. The Servicer shall maintain records, prepared by a servicing officer of the Servicer, of each Final Recovery Determination. Interim Servicing Fee: With respect to each Mortgage Loan, the amount of the servicing fee the Purchaser shall pay to the Servicer, which shall, for each month, be equal to $8.00 per Mortgage Loan per month. Such fee shall be payable monthly. If the Interim Servicing Period includes any partial calendar month, the Interim Servicing Fee for such month shall be pro rated at a per diem rate based upon a 30-day month. For each Mortgage Loan, such servicing fee will be payable solely from amounts representing interest actually received by the Servicer from the related Mortgagor. Permitted Investments: Any one or more of the following obligations or securities: (i) direct obligations of, and obligations fully guaranteed by the United States of America or any agency or instrumentality of the United States of America the obligations of which are backed by the full faith and credit of the United States of America; (ii) (a) demand or time deposits, federal funds or bankers' acceptances issued by any depository institution or trust company incorporated under the laws of the United States of America or any state thereof and subject to supervision and examination by federal and/or state banking authorities, provided that the commercial paper and/or the short-term deposit rating and/or the long-term unsecured debt obligations or deposits of such depository institution or trust company at the time of such investment or contractual commitment providing for such investment are rated in one of the two highest rating categories by each Rating Agency and (b) any other demand or time deposit or certificate of deposit that is fully insured by the FDIC; 59 (iii) repurchase obligations with a term not to exceed thirty (30) days and with respect to (a) any security described in clause (i) above and entered into with a depository institution or trust company (acting as principal) described in clause (ii)(a) above; (iv) securities bearing interest or sold at a discount issued by any corporation incorporated under the laws of the United States of America or any state thereof that are rated in one of the two highest rating categories by each Rating Agency at the time of such investment or contractual commitment providing for such investment; provided, however, that securities issued by any particular corporation will not be Permitted Investments to the extent that investments therein will cause the then outstanding principal amount of securities issued by such corporation and held as Permitted Investments to exceed 10% of the aggregate outstanding principal balances of all of the Mortgage Loans and Permitted Investments; (v) commercial paper (including both non-interest-bearing discount obligations and interest-bearing obligations payable on demand or on a specified date not more than one year after the date of issuance thereof) which are rated in one of the two highest rating categories by each Rating Agency at the time of such investment; (vi) any other demand, money market or time deposit, obligation, security or investment as may be acceptable to each Rating Agency as evidenced in writing by each Rating Agency; and (vii) any money market funds the collateral of which consists of obligations fully guaranteed by the United States of America or any agency or instrumentality of the United States of America the obligations of which are backed by the full faith and credit of the United States of America (which may include repurchase obligations secured by collateral described in clause (i)) and other securities and which money market funds are rated in one of the two highest rating categories by each Rating Agency. provided, however, that no instrument or security shall be a Permitted Investment if such instrument or security evidences a right to receive only interest payments with respect to the obligations underlying such instrument or if such security provides for payment of both principal and interest with a yield to maturity in excess of 120% of the yield to maturity at par or if such investment or security is purchased at a price greater than par. Prime Rate: The prime rate announced to be in effect from time to time as published as the average rate in the Wall Street Journal (Northeast Edition). Qualified Depository: A depository, the accounts of which are insured by the FDIC through the BIF or the SAIF and the short term debt ratings and the long term deposit ratings of which are rated in the highest rating category by each Rating Agency. 60 REMIC: A "real estate mortgage investment conduit" as such term is defined in the Code, as amended. REMIC Provisions: The provisions of the federal income tax law relating to REMICs, which appear at Sections 860A through 860G of the Code, and related provisions and regulations promulgated thereunder, as the foregoing may be in effect from time to time. Servicing Advances: All customary, reasonable and necessary "out of pocket" costs and expenses (including reasonable attorneys' fees and disbursements) incurred in the performance by the Servicer of its interim servicing obligations, including, but not limited to, the cost of (a) the preservation, restoration and protection of the Mortgaged Property, (b) any enforcement, administrative or judicial proceedings, or any legal work or advice specifically related to servicing the Mortgage Loans, including but not limited to, foreclosures, bankruptcies, condemnations, drug seizures, elections, foreclosures by subordinate or superior lienholders, and other legal actions incidental to the interim servicing of the Mortgage Loans (provided that such expenses are reasonable and that the Servicer specifies the Mortgage Loan(s) to which such expenses relate and, upon Purchaser's request, provides documentation supporting such expense (which documentation would be acceptable to Fannie Mae or Freddie Mac), and provided further that any such enforcement, administrative or judicial proceeding does not arise out of a breach of any representation, warranty or covenant of the Servicer hereunder), (c) the management and liquidation of the Mortgaged Property if the Mortgaged Property is acquired in full or partial satisfaction of the Mortgage, (d) taxes, assessments, water rates, sewer rates and other charges which are or may become a lien upon the Mortgaged Property, and Primary Mortgage Insurance Policy premiums and fire and hazard insurance coverage, (e) any expenses reasonably sustained by the Servicer with respect to the liquidation of the Mortgaged Property in accordance with the terms of this Agreement and (f) compliance with the obligations under this Agreement. Subsection 11.01 Servicer to Act as servicer. Servicer, as independent contract servicer, shall interim service and administer the Mortgage Loans in accordance with Accepted Servicing Practices and this Agreement and shall have full power and authority, acting alone, to do or cause to be done any and all things in connection with such servicing and administration which the Servicer may deem necessary or desirable and consistent with the terms of this Agreement. Without limiting the generality of the foregoing, the Servicer shall not take, or fail to take, any action which would result in the Purchaser's interest in the Mortgage Loans being adversely affected. Consistent with the terms of this Agreement and Accepted Servicing Practices, the Servicer may waive, modify or vary any term of any Mortgage Loan or consent to the postponement of strict compliance with any such term or in any manner grant indulgence to any Mortgagor if in the Servicer's reasonable and prudent determination such waiver, modification, postponement or indulgence is not materially adverse to the Purchaser; provided, however, that unless the Servicer has obtained the prior written consent of the Purchaser, the Servicer shall not permit any modification with respect to any Mortgage Loan that would change the Mortgage Interest Rate, defer or forgive the payment thereof or of any principal or interest payments, reduce the outstanding principal amount (except for actual payments of principal), make additional advances of additional principal or extend the final maturity date on such Mortgage Loan. Without limiting the generality of the foregoing, during the Interim Servicing Period the Servicer shall continue, and is hereby authorized and empowered, to execute and deliver on behalf of itself, and the Purchaser, all instruments of satisfaction or cancellation, or of partial or full release, discharge and all other comparable instruments, with respect to the Mortgage Loans and with respect to the Mortgaged Property. If required by the Servicer, the Purchaser shall furnish the Servicer with powers of attorney at the Purchaser's option and other documents necessary or appropriate to enable the Servicer to carry out its servicing and administrative duties under this Agreement. 61 In interim servicing and administering the Mortgage Loans, the Servicer shall employ procedures including collection procedures and exercise the same care that it customarily employs and exercises in servicing and administering mortgage loans for its own account giving due consideration to Accepted Servicing Practices. If Servicer elects to utilize a subservicer to perform any or all of Servicer's duties hereunder, Servicer shall remain liable as though such duties were performed directly by Servicer and Servicer shall be responsible for the payment of any and all fees of any such subservicer. Subsection 11.02 Collection of Mortgage Loan Payments. Continuously from the related Closing Date until the related Servicing Transfer Date, the Servicer shall proceed diligently to collect all payments due under each Mortgage Loan when the same shall become due and payable and shall, to the extent such procedures shall be consistent with this Agreement and the terms and provisions of any related Primary Mortgage Insurance Policy, follow such collection procedures as it follows with respect to mortgage loans comparable to the Mortgage Loans and held for its own account. Further, the Servicer shall take special care in ascertaining and estimating annual ground rents, taxes, assessments, water rates, fire and hazard insurance premiums, mortgage insurance premiums, and all other charges that, as provided in the Mortgage, will become due and payable to the end that the installments payable by the Mortgagors will be sufficient to pay such charges as and when they become due and payable. Subsection 11.03 Realization Upon Defaulted Mortgage Loans. (a) The Servicer shall use its best efforts, consistent with the procedures that the Servicer would use in servicing loans for its own account, to foreclose upon or otherwise comparably convert the ownership of such Mortgaged Properties as come into and continue in default and as to which no satisfactory arrangements can be made for collection of delinquent payments pursuant to Subsection 11.01. The Servicer shall use its best efforts to realize upon defaulted Mortgage Loans in such a manner as will maximize the receipt of principal and interest by the Purchaser, taking into account, among other things, the timing of foreclosure proceedings. The foregoing is subject to the provisions that, in any case in which Mortgaged Property shall have suffered damage, the Servicer shall not be required to expend its own funds toward the restoration of such property unless it shall determine in its discretion (i) that such restoration will increase the proceeds of liquidation of the related Mortgage Loan to the Purchaser after reimbursement to itself for such expenses, and (ii) that such expenses will be recoverable by the Servicer through Insurance Proceeds or Liquidation Proceeds from the related Mortgaged Property, as contemplated in Subsection 11.05. In the event that any payment due under any Mortgage Loan is not paid when the same becomes due and payable, or in the event the Mortgagor fails to perform any other covenant or obligation under the Mortgage Loan and such failure continues beyond any applicable grace period, the Servicer shall take such action as it shall deem to be in the best interest of the Purchaser. If a Mortgage Loan becomes sixty (60) or more days delinquent or subject to a foreclosure proceeding, then with respect to the Servicing Rights to such Mortgage Loan the related Servicing Transfer Date shall be the close of business on the next Business Day if so requested by the Purchaser. In the event that any payment due under any Mortgage Loan remains delinquent for a period of ninety (90) days or more, and the Purchaser has not exercised its right to accelerate the related Servicing Transfer Date as described in the previous sentence, the Servicer shall commence foreclosure proceedings, provided that prior to commencing foreclosure proceedings, the Servicer shall notify the Purchaser in writing of the Servicer's intention to do so, and the Servicer shall not commence foreclosure proceedings if the Purchaser objects to such action within ten (10) Business Days of receiving such notice. The Servicer shall notify the Purchaser in writing of the commencement of foreclosure proceedings. In such connection, the Servicer shall be responsible for all costs and expenses incurred by it in any such proceedings; provided, however, that it shall be entitled to reimbursement thereof from the related Mortgaged Property, as contemplated in Subsection 11.05. 62 (b) Notwithstanding the foregoing provisions of this Subsection 11.03, with respect to any Mortgage Loan as to which the Servicer has received actual notice of, or has actual knowledge of, the presence of any toxic or hazardous substance on the related Mortgaged Property, the Servicer shall not either (i) obtain title to such Mortgaged Property as a result of or in lieu of foreclosure or otherwise, or (ii) otherwise acquire possession of, or take any other action, with respect to, such Mortgaged Property if, as a result of any such action, the Purchaser would be considered to hold title to, to be a mortgagee-in-possession of, or to be an owner or operator of such Mortgaged Property within the meaning of the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended from time to time, or any comparable law, unless the Servicer has received approval from the Purchaser and has also previously determined, based on its reasonable judgment and a prudent report prepared by a Person who regularly conducts environmental audits using customary industry standards, that: (1) such Mortgaged Property is in compliance with applicable environmental laws or, if not, that it would be in the best economic interest of the Purchaser to take such actions as are necessary to bring the Mortgaged Property into compliance therewith; and (2) there are no circumstances present at such Mortgaged Property relating to the use, management or disposal of any hazardous substances, hazardous materials, hazardous wastes, or petroleum-based materials for which investigation, testing, monitoring, containment, clean-up or remediation could be required under any federal, state or local law or regulation, or that if any such materials are present for which such action could be required, that it would be in the best economic interest of the Purchaser to take such actions with respect to the affected Mortgaged Property. The cost of the environmental audit report contemplated by this Subsection 11.03 shall be advanced by the Servicer, subject to the Servicer's right to be reimbursed therefor from the Custodial Account as provided in Subsection 11.05(vii). If the Servicer determines, in consultation with the Purchaser, as described above, that it is in the best economic interest of the Purchaser to take such actions as are necessary to bring any such Mortgaged Property into compliance with applicable environmental laws, or to take such action with respect to the containment, clean-up or remediation of hazardous substances, hazardous materials, hazardous wastes, or petroleum-based materials affecting any such Mortgaged Property, then the Servicer shall take such action as it deems to be in the best economic interest of the Purchaser. The cost of any such compliance, containment, cleanup or remediation shall be advanced by the Servicer, subject to the Servicer's right to be reimbursed therefor from the Custodial Account as provided in Subsection 11.05(vii). 63 (c) The Servicer shall also promptly notify the Purchaser upon learning of any state insolvency or federal bankruptcy proceedings in which any Mortgagor is seeking relief or is the defendant debtor, or of the death or incapacity or any Mortgagor or guarantor. Subsection 11.04 Establishment of Custodial Accounts; Deposits in Custodial Accounts. The Servicer shall segregate and hold all funds collected and received pursuant to each Mortgage Loan separate and apart from any of its own funds and general assets and shall establish and maintain one or more Custodial Accounts, with a Qualified Depository, in the form of time deposit or demand accounts. Funds deposited in the Custodial Account shall at all times be insured by the FDIC up to the FDIC insurance limits, or must be invested in Permitted Investments for the benefit of the Purchaser. Upon the request of the Purchaser, the Servicer shall deliver to the Purchaser a Custodial Account Letter Agreement in the form of Exhibit 3. The Servicer shall deposit in the Custodial Account on a daily basis within two Business Days of receipt, and retain therein the following payments and collections received by it subsequent to the related Cut-off Date: (i) all payments on account of principal including Principal Prepayments (and prepayment penalty fees collected from Mortgagors for any Principal Prepayments) on the Mortgage Loans; (ii) all payments on account of interest on the Mortgage Loans; (iii) all Liquidation Proceeds; (iv) all Insurance Proceeds including amounts required to be deposited pursuant to Subsections 11.10 and 11.11, other than proceeds to be held in the Escrow Account and applied to the restoration or repair of the Mortgaged Property or released to the Mortgagor in accordance with Accepted Servicing Practices, the loan documents or applicable law; (v) all Condemnation Proceeds affecting any Mortgaged Property which are not released to the Mortgagor in accordance with Accepted Servicing Practices, the loan documents or applicable law; (vi) all proceeds of any Mortgage Loan repurchased in accordance with Subsection 7.03; (vii) any amounts required to be deposited by the Servicer pursuant to Subsection 11.11 in connection with the deductible clause in any blanket hazard insurance policy. Such deposit shall be made from the Servicer's own funds, without reimbursement therefor; 64 (viii) any amounts required to be deposited by the Servicer in connection with any REO Property pursuant to Subsection 11.13; and (ix) any amounts required to be deposited in the Custodial Account pursuant to Subsections 11.19 or 11.20. The foregoing requirements for deposit in the Custodial Account shall be exclusive, it being understood and agreed that, without limiting the generality of the foregoing, Ancillary Income need not be deposited by the Servicer in the Custodial Account. Such Custodial Account shall be an Eligible Account. Any interest or earnings on funds deposited in the Custodial Account by the depository institution shall accrue to the benefit of the Servicer and the Servicer shall be entitled to retain and withdraw such interest from the Custodial Account pursuant to Subsection 11.05(iv). The Servicer shall give notice to the Purchaser of the location of the Custodial Account when established and prior to any change thereof. Subsection 11.05 Permitted Withdrawals From the Custodial Account. The Servicer may, from time to time, withdraw from the Custodial Account for the following purposes: (i) to make distributions to the Purchaser in the amounts and in the manner provided for in Subsection 11.14; (ii) to reimburse itself for unreimbursed Servicing Advances, the Servicer's right to reimburse itself pursuant to this subclause (ii) with respect to any Mortgage Loan being limited to related Liquidation Proceeds, Condemnation Proceeds, Insurance Proceeds and such other amounts as may be collected by the Servicer from the Mortgagor or otherwise relating to the Mortgage Loan, it being understood that, in the case of such reimbursement, the Servicer's right thereto shall be prior to the rights of the Purchaser, except that, where the Servicer is required to repurchase a Mortgage Loan, pursuant to Subsection 7.03, the Servicer's right to such reimbursement shall be subsequent to the payment to the Purchaser of the Repurchase Price pursuant to Subsection 7.03 and all other amounts required to be paid to the Purchaser with respect to such Mortgage Loans; (iii) to pay to itself pursuant to Subsection 11.21 as servicing compensation (a) any interest earned on funds in the Custodial Account (all such interest to be withdrawn monthly not later than each Distribution Date), and (b) the Interim Servicing Fee; (iv) to pay to itself with respect to each Mortgage Loan that has been repurchased pursuant to Subsection 7.03, all amounts received thereon and not distributed as of the date on which the related Repurchase Price is determined; (v) to pay, or to reimburse the Servicer for advances in respect of, expenses incurred in connection with any Mortgage Loan pursuant to Subsection 11.03(b), but only to the extent of amounts received in respect of the Mortgage Loans to which such expense is attributable; 65 (vi) to reimburse itself for any expenses that are reimbursable pursuant to Subsection 11.03; and (vii) to clear and terminate the Custodial Account on the termination of this Agreement. (viii) The Servicer shall keep and maintain separate accounting, on a Mortgage Loan by Mortgage Loan basis, for the purpose of justifying any withdrawal from the Custodial Account pursuant to such subclauses (ii), (iv), (v), and (vi) above. The Servicer shall provide written notification in the form of an Officers' Certificate to the Purchaser, on or prior to the next succeeding Distribution Date, upon making any withdrawals from the Custodial Account pursuant to subclause (v) above. Subsection 11.06 Establishment of Escrow Accounts; Deposits in Escrow Accounts. The Servicer shall segregate and hold all funds collected and received pursuant to each Mortgage Loan which constitute Escrow Payments separate and apart from any of its own funds and general assets and shall establish and maintain one or more Escrow Accounts, with a Qualified Depository, in the form of time deposit or demand accounts. Upon the request of the Purchaser, the Servicer shall deliver to the Purchaser an Escrow Account Letter Agreement in the form of Exhibit 4. The Servicer shall deposit in the Escrow Account or Accounts on a daily basis within two Business Days of receipt, and retain therein, (i) all Escrow Payments collected on account of the Mortgage Loans, for the purpose of effecting timely payment of any such items as required under the terms of this Agreement, and (ii) all Insurance Proceeds which are to be applied to the restoration or repair of any Mortgaged Property. The Servicer shall make withdrawals therefrom only to effect such payments as are required under this Agreement, and for such other purposes as shall be as set forth or in accordance with Subsection 11.08. The Servicer shall be entitled to retain any interest paid on funds deposited in the Escrow Account by the depository institution other than interest on escrowed funds required by law to be paid to the Mortgagor and, to the extent required by law, the Servicer shall pay interest on escrowed funds to the Mortgagor notwithstanding that the Escrow Account is non-interest bearing or that interest paid thereon is insufficient for such purposes. Subsection 11.07 Permitted Withdrawals From Escrow Account. Withdrawals from the Escrow Account may be made by the Servicer (i) to effect timely payments of ground rents, taxes, assessments, water rates, hazard insurance premiums, Primary Mortgage Insurance Policy premiums, if applicable, and comparable items, (ii) to reimburse the Servicer for any Servicing Advance made by the Servicer with respect to a related Mortgage Loan but only from amounts received on the related Mortgage Loan which represent late payments or collections of Escrow Payments thereunder, (iii) to refund to the Mortgagor any funds as may be determined to be overages, (iv) for transfer to the Custodial Account in accordance with the terms of this Agreement, (v) for application to the restoration or repair of the Mortgaged Property, (vi) to pay to the Servicer, or to the Mortgagor to the extent required by law, any interest paid on the funds deposited in the Escrow Account, or (vii) to clear and terminate the Escrow Account on the termination of this Agreement. 66 Subsection 11.08 Payment of Taxes, Insurance and Other Charges. With respect to each Mortgage Loan, the Servicer shall maintain accurate records reflecting the status of ground rents, taxes, assessments, water rates and other charges which are or may become a lien upon the Mortgaged Property and the status of Primary Mortgage Insurance Policy premiums and fire and hazard insurance coverage and shall obtain, from time to time, all bills for the payment of such charges, including insurance renewal premiums and shall effect payment thereof prior to the applicable penalty or termination date and at a time appropriate for securing maximum discounts allowable, employing for such purpose deposits of the Mortgagor in the Escrow Account which shall have been estimated and accumulated by the Servicer in amounts sufficient for such purposes, as allowed under the terms of the Mortgage and applicable law. To the extent that the Mortgage does not provide for Escrow Payments, the Servicer shall determine that any such payments are made by the Mortgagor at the time they first become due. The Servicer assumes full responsibility for the timely payment of all such bills and shall effect timely payments of all such bills irrespective of the Mortgagor's faithful performance in the payment of same or the making of the Escrow Payments and shall make Servicing Advances from its own funds to effect such payments. Subsection 11.09 Transfer of Accounts. The Servicer may transfer the Custodial Account or the Escrow Account to a different Qualified Depository institution from time to time. Such transfer shall be made only upon obtaining the prior written consent of the Purchaser. In any case, the Custodial Account and Escrow Account shall be Eligible Accounts. Subsection 11.10 Maintenance of Hazard Insurance. The Servicer shall cause to be maintained for each Mortgage Loan fire, and hazard insurance with extended coverage as is customary in the area where the Mortgaged Property is located in an amount which is at least equal to the lesser of (i) the amount necessary to fully compensate for any damage or loss to the improvements which are a part of such property on a replacement cost basis or (ii) the outstanding principal balance of the Mortgage Loan, in each case in an amount not less than such amount as is necessary to prevent the Mortgagor and/or the Mortgagee from becoming a co-insurer. If the Mortgaged Property is in an area identified on a Flood Hazard Boundary Map or Flood Insurance Rate Map issued by the Flood Emergency Management Agency as having special flood hazards and such flood insurance has been made available, the Servicer will cause to be maintained a flood insurance policy meeting the requirements of the current guidelines of the Federal Insurance Administration with a generally acceptable insurance carrier, in an amount representing coverage not less than the lesser of (i) the outstanding principal balance of the Mortgage Loan or (ii) the maximum amount of insurance which is available under the National Flood Insurance Act of 1968 or the Flood Disaster Protection Act of 1973, as amended. The Servicer also shall maintain on any REO Property, fire and hazard insurance with extended coverage in an amount which is at least equal to the lesser of (i) the maximum insurable value of the improvements which are a part of such property and (ii) the outstanding principal balance of the related Mortgage Loan at the time it became an REO Property plus accrued interest at the Mortgage Interest Rate and related Servicing Advances, liability insurance and, to the extent required and available under the National Flood Insurance Act of 1968 or the Flood Disaster Protection Act of 1973, as amended, flood insurance in an amount as provided above. Pursuant to Subsection 11.04, any amounts collected by the Servicer under any such policies other than amounts to be deposited in the Escrow Account and applied to the restoration or repair of the Mortgaged Property or REO Property, or released to the Mortgagor in accordance with the Servicer's normal servicing procedures, shall be deposited in the Custodial 67 Account, subject to withdrawal pursuant to Subsection 11.05. Any cost incurred by the Servicer in maintaining any such insurance shall not, for the purpose of calculating distributions to the Purchaser, be added to the unpaid principal balance of the related Mortgage Loan, notwithstanding that the terms of such Mortgage Loan so permit. It is understood and agreed that no earthquake or other additional insurance need be required by the Servicer of the Mortgagor or maintained on property acquired in respect of the Mortgage Loan, other than pursuant to such applicable laws and regulations as shall at any time be in force and as shall require such additional insurance. All such policies shall be endorsed with standard mortgagee clauses with loss payable to the Servicer, or upon request to the Purchaser, and shall provide for at least thirty (30) days' prior written notice of any cancellation, reduction in the amount of, or material change in, coverage to the Servicer. The Servicer shall not interfere with the Mortgagor's freedom of choice in selecting either his insurance carrier or agent, provided, however, that the Servicer shall not accept any such insurance policies from insurance companies unless such companies currently reflect a General Policy Rating of A:VI or better in Best's Key Rating Guide and are licensed to do business in the state wherein the property subject to the policy is located. Subsection 11.11 Maintenance of Mortgage Impairment Insurance Policy. In the event that the Servicer shall obtain and maintain a mortgage impairment or blanket policy issued by an issuer that has an A.M. Best rating of A:VI or better insuring against hazard losses on all of Mortgaged Properties securing the Mortgage Loans, then, to the extent such policy provides coverage in an amount equal to the amount required pursuant to Subsection 11.10 and otherwise complies with all other requirements of Subsection 11.10, the Servicer shall conclusively be deemed to have satisfied its obligations as set forth in Subsection 11.10, it being understood and agreed that such policy may contain a deductible clause, in which case the Servicer shall, in the event that there shall not have been maintained on the related Mortgaged Property or REO Property a policy complying with Subsection 11.10, and there shall have been one or more losses which would have been covered by such policy, deposit in the Custodial Account the amount not otherwise payable under the blanket policy because of such deductible clause. In connection with its activities as servicer of the Mortgage Loans, the Servicer agrees to prepare and present, on behalf of the Purchaser, claims under any such blanket policy in a timely fashion in accordance with the terms of such policy. Upon request of the Purchaser, the Servicer shall cause to be delivered to the Purchaser a certified true copy of such policy and a statement from the insurer thereunder that such policy shall in no event be terminated or materially modified without thirty (30) days' prior written notice to the Purchaser. Subsection 11.12 Fidelity Bond, Errors and Omissions Insurance. The Servicer shall maintain, at its own expense, a blanket fidelity bond and an errors and omissions insurance policy, with broad coverage with responsible companies that would meet the requirements of Fannie Mae or Freddie Mac on all officers, employees or other persons acting in any capacity with regard to the Mortgage Loans to handle funds, money, documents and papers relating to the Mortgage Loans. The fidelity bond and errors and omissions insurance shall be in the form of the Mortgage Banker's Blanket Bond and shall protect and insure the Servicer against losses, including forgery, theft, embezzlement, fraud, errors and omissions and negligent acts of such persons. Such fidelity bond shall also protect and insure the Servicer against losses in connection with the failure to maintain any insurance policies required pursuant to this Agreement and the release or satisfaction of a Mortgage Loan without having obtained payment in full of the indebtedness secured thereby. No provision of this Subsection 11.12 requiring the fidelity bond and errors and omissions insurance shall diminish or relieve the Servicer from its duties and obligations as set forth in this Agreement. The minimum coverage under any such bond and insurance policy shall be at least equal to the corresponding amounts required by Fannie Mae or by Freddie Mac. Upon request of the Purchaser, the Servicer shall cause to be delivered to the Purchaser a certified true copy of the fidelity bond and insurance policy and a statement from the surety and the insurer that such fidelity bond or insurance policy shall in no event be terminated or materially modified without thirty (30) days' prior written notice to the Purchaser. 68 Subsection 11.13 Title, Management and Disposition of REO Property. In the event that title to the Mortgaged Property is acquired in foreclosure or by deed in lieu of foreclosure, the deed or certificate of sale shall be taken in the name of the Purchaser or its designee. Any Person or Persons holding such title other than the Purchaser shall acknowledge in writing that such title is being held as nominee for the benefit of the Purchaser. The Servicer shall either itself or through an agent selected by the Servicer, manage, conserve, protect and operate each REO Property (and may temporarily rent the same) in the same manner that it manages, conserves, protects and operates other foreclosed property for its own account, and in the same manner that similar property in the same locality as the REO Property is managed. If a REMIC election is or is to be made with respect to the arrangement under which the Mortgage Loans and any REO property are held, the Servicer shall manage, conserve, protect and operate each REO Property in a manner which does not cause such REO Property to fail to qualify as "foreclosure property" within the meaning of Section 860G(a)(8) of the Code or result in the receipt by such REMIC of any "income from non?permitted assets" within the meaning of Section 860F(a)(2)(B) of the Code or any "net income from foreclosure property" within the meaning of Section 860G(c)(2) of the Code. The Servicer shall cause each REO Property to be inspected promptly upon the acquisition of title thereto and shall cause each REO Property to be inspected at least annually thereafter. The Servicer shall make or cause to be made a written report of each such inspection. Such reports shall be retained in the Mortgage File and copies thereof shall be forwarded by the Servicer to the Purchaser. The Servicer shall use its best efforts to dispose of the REO Property as soon as possible and shall sell such REO Property in any event within three (3) years after title has been taken to such REO Property, unless the Servicer determines, and gives appropriate notice to the Purchaser, that a longer period is necessary for the orderly liquidation of such REO Property. If a period longer than three years is necessary to sell any REO property, (i) the Servicer shall report monthly to the Purchaser as to the progress being made in selling such REO Property and (ii) if, with the written consent of the Purchaser, a purchase money mortgage is taken in connection with such sale, such purchase money mortgage shall name the Servicer as mortgagee, and a separate servicing agreement among the Servicer and the Purchaser shall be entered into with respect to such purchase money mortgage. Notwithstanding the foregoing, if a REMIC election is made with respect to the arrangement under which the Mortgage Loans and the REO Property are held, such REO Property shall be disposed of within three (3) years or such other period as may be permitted under Section 860G(a)(8) of the Code. With respect to each REO Property, the Servicer shall segregate and hold all funds collected and received in connection with the operation of the REO Property separate and apart from its own funds or general assets and shall deposit or cause to be deposited in the Custodial Account, on a daily basis within two Business Days of receipt all revenues received with respect to the related REO Property and shall withdraw therefrom funds necessary for the proper operation, management and maintenance of the REO Property, including the cost of maintaining any hazard insurance pursuant to Subsection 11.10 hereof and the fees of any managing agent acting on behalf of the Servicer. 69 The Servicer shall furnish to the Purchaser on each Distribution Date, an operating statement for each REO Property covering the operation of each REO Property for the previous month. Such operating statement shall be accompanied by such other information as the Purchaser shall reasonably request. Each REO Disposition shall be carried out by the Servicer at such price and upon such terms as the Purchaser shall direct. If as of the date title to any REO Property was acquired by the Servicer there were outstanding unreimbursed Servicing Advances with respect to the REO Property, the Servicer, upon an REO Disposition of such REO Property, shall be entitled to reimbursement for any related unreimbursed Servicing Advances from proceeds received in connection with such REO Disposition. The proceeds from the REO Disposition, net of any payment to the Servicer as provided above, shall be deposited in the Custodial Account within two Business Days of receipt. Subsection 11.14 Distributions. On each Distribution Date, the Servicer shall distribute to the Purchaser all amounts credited to the Custodial Account as of the close of business on the preceding Determination Date, net of charges against or withdrawals from the Custodial Account pursuant to Subsection 11.05. All distributions made to the Purchaser on each Distribution Date shall be based on the Mortgage Loans owned and held by the Purchaser, and shall be made by wire transfer of immediately available funds to the account of the Purchaser at a bank or other entity having appropriate facilities therefor, if the Purchaser shall have so notified the Servicer or by check mailed to the address of the Purchaser. With respect to any remittance received by the Purchaser on or after the second Business Day following the Business Day on which such payment was due, the Servicer shall pay to the Purchaser interest on any such late payment at an annual rate equal to Prime Rate, adjusted as of the date of each change, plus three percentage points, but in no event greater than the maximum amount permitted by applicable law. Such interest shall be paid by the Servicer to the Purchaser on the date such late payment is made and shall cover the period commencing with the day following such second Business Day and ending with the Business Day on which such payment is made, both inclusive. Such interest shall be remitted along with such late payment. The payment by the Servicer of any such interest shall not be deemed an extension of time for payment or a waiver of any Event of Default by the Servicer. Subsection 11.15 Remittance Reports. No later than the Distribution Date, the Servicer shall furnish to the Purchaser or its designee a report in Excel (or compatible) electronic format (that can be downloaded into a Sybase database) with the fields and format as further described and set forth in Exhibit 6, together with such other information with respect to the Mortgage Loans as the Purchaser may reasonably require to allocate distributions made pursuant to this Agreement and provide appropriate statements with respect to such distributions. On the same date, the Servicer shall forward to the Purchaser by overnight mail a computer readable magnetic tape containing the information set forth in the remittance report with respect to the related Distribution Date. 70 With respect to any remittance report received by the Purchaser on or after the second Business Day following the Business Day on which such remittance report was due, the Servicer shall pay to the Purchaser a penalty in the amount of $100 dollars; provided, however, the penalty shall be $500 dollars after the first violation of the foregoing. Such penalty shall be paid by the Servicer to the Purchaser on the date such remittance report is sent. The payment by the Servicer of any such penalty shall not be deemed an extension of time for sending the remittance report or a waiver of any Event of Default by the Servicer. Subsection 11.16 Statements to the Purchaser. No later than the Distribution Date, the Servicer shall forward to the Purchaser or its designee a statement prepared by the Servicer setting forth the status of the Custodial Account as of the close of business on such Distribution Date and showing, for the period covered by such statement, the aggregate amount of deposits into and withdrawals from the Custodial Account of each category of deposit specified in Subsection 11.04 and each category of withdrawal specified in Subsection 11.05. In addition, not more than ninety (90) days after the end of each calendar year, the Servicer shall furnish to each Person who was the Purchaser at any time during such calendar year, (i) as to the aggregate of remittances for the applicable portion of such year, an annual statement in accordance with the requirements of applicable federal income tax law, and (ii) listing of the principal balances of the Mortgage Loans outstanding at the end of such calendar year. The Servicer shall prepare and file any and all tax returns, information statements or other filings required to be delivered to any governmental taxing authority or to any Purchaser pursuant to any applicable law with respect to the Mortgage Loans and the transactions contemplated hereby. In addition, the Servicer shall provide the Purchaser with such information concerning the Mortgage Loans as is necessary for the Purchaser to prepare its federal income tax return as any Purchaser may reasonably request from time to time. Subsection 11.17 Real Estate Owned Reports. Together with the statement furnished pursuant to Subsection 11.13, with respect to any REO Property, the Servicer shall furnish to the Purchaser a statement covering the Servicer's efforts in connection with the sale of such REO Property and any rental of such REO Property incidental to the sale thereof for the previous month, together with the operating statement. Such statement shall be accompanied by such other information as the Purchaser shall reasonably request. Subsection 11.18 Liquidation Reports. Upon the foreclosure sale of any Mortgaged Property or the acquisition thereof by the Purchaser pursuant to a deed-in-lieu of foreclosure, the Servicer shall deliver to the Purchaser within three Business Days after completion of the foreclosure sale a liquidation report with respect to such Mortgaged Property. 71 Subsection 11.19 Assumption Agreements. The Servicer shall, to the extent it has knowledge of any conveyance or prospective conveyance by any Mortgagor of the Mortgaged Property (whether by absolute conveyance or by contract of sale, and whether or not the Mortgagor remains or is to remain liable under the Mortgage Note and/or the Mortgage), exercise its rights to accelerate the maturity of such Mortgage Loan under any "due-on-sale" clause applicable thereto; provided, however, that the Servicer shall not exercise any such rights if prohibited by law from doing so or if the exercise of such rights would impair or threaten to impair any recovery under the related Primary Mortgage Insurance Policy, if any. If the Servicer reasonably believes it is unable under applicable law to enforce such "due-on-sale" clause, the Servicer, upon prior Purchaser consent, shall enter into an assumption agreement with the person to whom the Mortgaged Property has been conveyed or is proposed to be conveyed, pursuant to which such person becomes liable under the Mortgage Note and, to the extent permitted by applicable state law, the Mortgagor remains liable thereon. Where an assumption is allowed pursuant to this Subsection 11.19, the Servicer, with the prior written consent of the insurer under the Primary Mortgage Insurance Policy, if any, is authorized to enter into a substitution of liability agreement with the person to whom the Mortgaged Property has been conveyed or is proposed to be conveyed pursuant to which the original Mortgagor is released from liability and such Person is substituted as Mortgagor and becomes liable under the related Mortgage Note. Any such substitution of liability agreement shall be in lieu of an assumption agreement. In connection with any such assumption or substitution of liability, the Servicer shall follow the Servicer's Underwriting Guidelines. With respect to an assumption or substitution of liability, the Mortgage Interest Rate, the amount of the Monthly Payment, and the final maturity date of such Mortgage Note may not be changed. The Servicer shall notify the Purchaser that any such substitution of liability or assumption agreement has been completed by forwarding to the Purchaser the original of any such substitution of liability or assumption agreement, which document shall be added to the related Mortgage File and shall, for all purposes, be considered a part of such Mortgage File to the same extent as all other documents and instruments constituting a part thereof. Notwithstanding the foregoing paragraphs of this Subsection or any other provision of this Agreement, the Servicer shall not be deemed to be in default, breach or any other violation of its obligations hereunder by reason of any assumption of a Mortgage Loan by operation of law or any assumption which the Servicer may be restricted by law from preventing, for any reason whatsoever. For purposes of this Subsection 11.19, the term "assumption" is deemed to also include a sale of the Mortgaged Property subject to the Mortgage that is not accompanied by an assumption or substitution of liability agreement. Subsection 11.20 Satisfaction of Mortgages and Release of Mortgage Files. Upon the payment in full of any Mortgage Loan, or the receipt by the Servicer of a notification that payment in full will be escrowed in a manner customary for such purposes, the Servicer will immediately notify the Purchaser by a certification of a servicing officer of the Servicer (a "Servicing Officer"), which certification shall include a statement to the effect that all amounts received or to be received in connection with such payment which are required to be deposited in the Custodial Account pursuant to Subsection 11.04 have been or will be so deposited, and shall request execution of any document necessary to satisfy the Mortgage Loan and delivery to it of the portion of the Mortgage File held by the Purchaser or the Purchaser's designee. Upon receipt of such certification and request, the Purchaser, shall promptly release the related mortgage documents to the Servicer and the Servicer shall prepare and process any satisfaction or release. No expense incurred in connection with any instrument of satisfaction or deed of reconveyance shall be chargeable to the Custodial Account or the Purchaser. 72 In the event the Servicer satisfies or releases a Mortgage without having obtained payment in full of the indebtedness secured by the Mortgage or should it otherwise prejudice any right the Purchaser may have under the mortgage instruments, the Servicer, upon written demand, shall remit to the Purchaser the then outstanding principal balance of the related Mortgage Loan by deposit thereof in the Custodial Account. The Servicer shall maintain the fidelity bond insuring the Servicer against any loss it may sustain with respect to any Mortgage Loan not satisfied in accordance with the procedures set forth herein. From time to time and as appropriate for the interim servicing or foreclosure of any Mortgage Loan, including for this purpose collection under any Primary Mortgage Insurance Policy, the Purchaser shall, upon request of the Servicer and delivery to the Purchaser of a servicing receipt signed by a Servicing Officer, release the requested portion of the related Mortgage File held by the Purchaser to the Servicer. Such servicing receipt shall obligate the Servicer to return the related Mortgage documents to the Purchaser when the need therefor by the Servicer no longer exists, unless the Mortgage Loan has been liquidated and the Liquidation Proceeds relating to the Mortgage Loan have been deposited in the Custodial Account or the Mortgage File or such document has been delivered to an attorney, or to a public trustee or other public official as required by law, for purposes of initiating or pursuing legal action or other proceedings for the foreclosure of the Mortgaged Property either judicially or non?judicially, and the Servicer has delivered to the Purchaser a certificate of a Servicing Officer certifying as to the name and address of the Person to which such Mortgage File or such document was delivered and the purpose or purposes of such delivery. Upon receipt of a certificate of a Servicing Officer stating that such Mortgage Loan was liquidated, the servicing receipt shall be released by the Purchaser to the Servicer. Subsection 11.21 Servicing Compensation. As compensation for its services hereunder, the Servicer shall be entitled to receive on the Mortgage Loans the amounts provided for as the Servicer's Interim Servicing Fee and Ancillary Income. Ancillary Income shall be retained by the Servicer to the extent not required to be deposited in the Custodial Account. The Servicer shall be required to pay all expenses incurred by it in connection with its servicing activities hereunder and shall not be entitled to reimbursement therefor except as specifically provided for. Subsection 11.22 Access to Certain Documentation. The Servicer shall provide to any federal or state banking or insurance regulatory authority that may exercise authority over the Purchaser access to the documentation regarding the Mortgage Loans interim serviced by the Servicer required by applicable laws and regulations. Such access shall be afforded without charge, but only upon reasonable request and during normal business hours at the offices of the Servicer. Subsection 11.23 Reports and Returns to be Filed by the Servicer. The Servicer shall file information reports with respect to the receipt of mortgage interest received in a trade or business, reports of foreclosures and abandonments of any Mortgaged Property and information returns relating to cancellation of indebtedness income with respect to any Mortgaged Property as required by Sections 6050H, 6050J and 6050P of the Code. Such reports shall be in form and substance sufficient to meet the reporting requirements imposed by such Sections 6050H, 6050J and 6050P of the Code. 73 Subsection 11.24 Compliance with REMIC Provisions. If a REMIC election has been made with respect to the arrangement under which the Mortgage Loans and REO Property are held, the Servicer shall not take any action, cause the REMIC to take any action or fail to take (or fail to cause to be taken) any action that, under the REMIC Provisions, if taken or not taken, as the case may be, could (i) endanger the status of the REMIC as a REMIC or (ii) result in the imposition of a tax upon the REMIC (including but not limited to the tax on "prohibited transactions" as defined in Section 860F(a)(2) of the Code and the tax on "contributions" to a REMIC set forth in Section 860G(d) of the Code) unless the Servicer has received an Opinion of Counsel (at the expense of the party seeking to take such action) to the effect that the contemplated action will not endanger such REMIC status or result in the imposition of any such tax. Notwithstanding anything in this Agreement to the contrary, the Servicer (a) shall not permit any modification with respect to any Mortgage Loan that would change the Mortgage Interest Rate and (b) shall not (unless the Mortgagor is in default with respect to the Mortgage Loan or such default is, in the judgment of the Servicer, reasonably foreseeable) make or permit any modification, waiver or amendment of any term of any Mortgage Loan that would both (i) effect an exchange or reissuance of such Mortgage Loan under Section 1001 of the Code (or Treasury regulations promulgated thereunder) and (ii) cause any REMIC to fail to qualify as a REMIC under the Code or the imposition of any tax on "prohibited transactions" or "contributions" after the startup date under the REMIC Provisions. The Servicer shall not permit the creation of any "interests" (within the meaning of Section 860G of the Code) in any REMIC. The Servicer shall not enter into any arrangement by which a REMIC will receive a fee or other compensation for services nor permit a REMIC to receive any income from assets other than "qualified mortgages" as defined in Section 860G(a)(3) of the Code or "permitted investments" as defined in Section 860G(a)(5) of the Code. 74 EXHIBIT 6 FORM OF MONTHLY DATA 75 EXHIBIT 7 SERVICING TRANSFER INSTRUCTIONS 76 EXHIBIT 8 FORM OF ASSIGNMENT, ASSUMPTION AND RECOGNITION AGREEMENT This Assignment, Assumption and Recognition Agreement (the "Agreement") is made and entered into as of [___________], 200[_] (the "Closing Date"), among [___________________], a [__________] corporation, having an address at [___________________] (the "Assignor"), [_____________________________], a [___________________] corporation, having an address at [_________________________________] (the "Assignee"), and [__________________], a [___________] corporation, having an address at [_________________] (the "Servicer"). Any capitalized term used and not otherwise defined herein shall have the meaning assigned to such term in the Purchase Agreement (as defined below). In consideration of the mutual promises and agreements contained herein, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows: 1. Assignment and Assumption. Except as expressly provided for herein, the Assignor hereby grants, transfers and assigns to the Assignee (a) all of its right, title and interest as "Purchaser" in, to and under that certain Mortgage Loan Purchase and Interim Servicing Agreement dated as of June 30, 2003 and duly executed by American Business Credit, Inc., a Pennsylvania corporation ("ABC"), Homeamerican Credit, Inc. d/b/a Upland Mortgage, a Pennsylvania corporation ("Upland"), American Business Mortgage Services, Inc., a New Jersey corporation ("ABMS", and together with ABC and Upland, the "Originators"), and EMC Mortgage Corporation ("EMC") (the "Purchase Agreement") attached hereto as Exhibit A, only with respect to the Mortgage Loans, and (b) all of its right, title and interest in and to each of the mortgage loans identified in Exhibit B hereto (the "Mortgage Loans"). Notwithstanding anything to the contrary contained herein, the Assignor is not assigning to the Assignee any of its right, title and interest as "Purchaser" in, to and under the Purchase Agreement with respect to any other mortgage loan other than those set forth on Exhibit B and furthermore, the Assignor is not assigning to the Assignee, but instead is expressly reserving for the Servicing Rights Owner's exclusive right and benefit only, the following: (a) any of the Servicing Rights relating to the Mortgage Loans, as the term "Servicing Rights" is defined in the Purchase Agreement and further described herein; (b) all rights and benefits accorded the Servicing Rights Owner under the Purchase Agreement; Except as is otherwise expressly provided herein, the Assignor makes no representations, warranties or covenants to the Assignee and the Assignee acknowledges that the Assignor has no obligations to the Assignee under the terms of the Purchase Agreement, or otherwise relating to the transaction contemplated herein (including, but not limited to, any obligation to repurchase any of the Mortgage Loans or to indemnify the Assignee), and that all such obligations are assumed by the Servicer. The Assignor acknowledges and agrees that upon execution of this Agreement, [____________] shall become the "Purchaser" under the Purchase Agreement, and all representations, warranties and covenants by the "Seller" to the "Purchaser" under such Purchase Agreement including, but not limited to, the rights to require repurchase of any Mortgage Loan and to receive indemnification, shall accrue to Assignee by virtue of this Agreement. 77 2. Consideration. In consideration for the sale of the Mortgage Loans to the Assignee, the Assignee agrees to pay to the Assignor the amount referenced in that certain trade confirmation dated as of [____________], 200[__] (the "Confirmation"), and duly executed by the Assignor and the Assignee (the "Purchase Price"). The Assignee shall pay the Purchase Price to the Assignor by wire transfer of immediately available funds to the account designated by the Assignor on or before the Closing Date, as defined in this Confirmation. 3. Servicing of the Mortgage Loans. [From and after the related Servicing Transfer Date, the Servicing Rights Owner shall service the Mortgage Loans for the Assignee in accordance with that certain Servicing Agreement dated as of [________________], by and between the Servicing Rights Owner and the Assignee (the "Servicing Agreement").] Prior to the related Servicing Transfer Date, the Servicer shall service the Mortgage Loans on an interim basis on behalf of the Assignee and the Servicing Rights Owner in accordance with the Purchase Agreement. The address of the "Purchaser" set forth in Section 16 of the Purchase Agreement shall be changed to read as follows: [___________________] [___________________] [___________________] Attention: [___________] The wire transfer instructions for distributions to the Assignee on each Distribution Date shall be as follows: Bank: ABA Routing Number: For Credit to: Attn: 4. Status of Purchase Agreement. The Assignor represents and warrants that (a) the Purchase Agreement attached hereto as Exhibit A is a true, complete and accurate copy of the Purchase Agreement, (b) the Purchase Agreement with respect to each of the Mortgage Loans is in full force and effect as of the date hereof, (c) the Purchase Agreement has not been amended or modified in any respect, (d) there has been no waiver or modification or any agreement to waive or modify any provision, nor has any notice of termination been given, under the Purchase Agreement, (e) the Assignor is not in default, and has received no notice of default, under the Purchase Agreement, and, to the best of the Assignor's knowledge, the Servicer is not in default under the Purchase Agreement, and (f) to the best of the Assignor's knowledge, there are no offsets, claims or defenses available to the Servicer with respect to the Purchase Agreement or Mortgage Loans. 5. Covenants, Representations and Warranties of the Assignor. The Assignor represents and warrants to, and covenants with, the Assignee that: 78 a. Assignor is a corporation duly organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation, and has all requisite corporate power and authority to acquire, own and sell the Mortgage Loans; b. The Assignor has full corporate power and authority to execute, deliver and perform under this Agreement, and to consummate the transactions set forth herein. The execution, delivery and performance of the Assignor of this Agreement, and the consummation by it of the transactions contemplated hereby, have been duly authorized by all necessary corporate action of the Assignor. This Agreement has been fully executed and delivered by the Assignor and constitutes the valid and legally binding obligation of the Assignor enforceable against the Assignor in accordance with its respective terms, subject to the effect of bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to or affecting creditors' rights and to the application of equitable principles in any proceeding, whether at law or in equity; c. No material consent, approval, order or authorization of, or declaration, filing or registration with, any governmental entity is required to be obtained or made by the Assignor in connection with the execution, delivery or performance by the Assignor of this Agreement, or the consummation by it of the transactions contemplated hereby; d. There is no action, suit, proceeding, investigation or litigation pending or, to the Assignor's knowledge, threatened, which either in any instance or in the aggregate, if determined adversely to the Assignor, would adversely affect the sale of the Mortgage Loans to the Assignee, the execution, delivery or enforceability of this Agreement, or the Assignor's ability to perform its obligations under this Agreement; e. Immediately prior to payment of the Purchase Price for the Mortgage Loans, the Assignor is the lawful owner of the Mortgage Loans with the full right to transfer the Mortgage Loans free from any and all claims and encumbrances whatsoever. f. The Assignor shall use its reasonable commercial efforts to cause to be delivered to the Assignee all of the Mortgage Loan Documents in accordance with Section 6.03 of the Purchase Agreement. g. Each of the terms and conditions set forth in the Purchase Agreement which are required to be satisfied on or before the Closing Date by the Assignor in order for the Assignor to acquire title to the Mortgage Loans has been satisfied unless waived by the prejudiced party(ies). h. The Assignor shall deliver to the Assignee on or before the Closing Date the following documents: (1) a fully executed Agreement and Purchase Agreement; and (2) the Mortgage Loan Schedule; 79 6. Covenants, Representations and Warranties of the Servicer. The Servicer represents and warrants to, and covenants with, the Assignee that: a. The representations and warranties made by the Servicer under Subsection 7.01 and Subsection 7.02 of the Purchase Agreement are true and correct in all material respects as of the date hereof and no event has occurred which, with notice or the passage of time, would constitute a default under the Purchase Agreement. b. The Servicer acknowledges and agrees that upon execution of this Agreement, [___________] shall become the "Purchaser" under the Purchase Agreement but not the Servicing Rights Owner, and all representations, warranties and covenants by the Servicer as the "Seller" thereunder, including, but not limited to, the representations, warranties and covenants to repurchase any Mortgage Loan and to indemnify the "Purchaser", shall accrue to [__________] by virtue of this Agreement. 7. Covenants, Representations and Warranties of Assignee. The Assignee agrees to be bound, as "Purchaser", by all of the terms, covenants and conditions of the Agreement and the Mortgage Loans, and from and after the date hereof, the Assignee assumes for the benefit of each of the Servicer and the Assignor all of the Assignor's obligations as "Purchaser" thereunder, with respect to the Mortgage Loans (except for any obligations relating to the Servicing Rights); 8. Governing Law. This Agreement shall be construed in accordance with the laws of New York and the obligations, rights and remedies of the parties hereunder shall be determined in accordance with the laws of [________________], except to the extent preempted by federal law. 9. Conflict with Purchase Agreement. To the extent there is any conflict between the terms of the Purchase Agreement and this Agreement, the latter shall be controlling, notwithstanding anything to the contrary contained in the Purchase Agreement. 10. Capitalized Terms. All capitalized terms used herein and not otherwise defined herein shall have the meanings assigned to such terms in the Purchase Agreement. 11. Counterparts. This Agreement may be executed in any number of counterparts. Each counterpart shall be deemed to be an original and all such counterparts shall constitute one and the same instrument. 80 IN WITNESS WHEREOF, the parties hereto have executed this Agreement on the date first above written. [Assignor_______________________] [Assignee ______________________] the Assignor the Assignee BY:_____________________________ BY:_____________________________ ITS:______________________________ ITS:____________________________ [Servicer_______________________] the Servicer BY:_____________________________ ITS:_____________________________ 81 EXHIBIT 9 COMPANY'S UNDERWRITING GUIDELINES 82 EXHIBIT 10 FORM OF POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS: WHEREAS, pursuant to the terms of the Master Mortgage Loan Purchase and Interim Servicing Agreement dated as of _________, 2003 (the "Purchase Agreement"), among __________ ("______") and EMC Mortgage Corporation("EMC"), is selling certain mortgage loans (the "Mortgage Loans") to EMC; AND WHEREAS, ______ is providing this Limited Power of Attorney pursuant to the Purchase Agreement; NOW, THEREFORE, in consideration of the mutual promises, obligations and covenants contained herein and in the Purchase Agreement and for other good and valuable consideration the receipt and adequacy of which is hereby acknowledged, ______ does hereby make, constitute and appoint EMC, ______'s true and lawful agent and attorney-in-fact with respect to each Mortgage Loan in ______'s name, place and stead: (i) to complete (to the extent necessary) and to cause to be submitted for filing or recording in the appropriate public filing or recording offices, all assignments of mortgage, deeds of trust or similar documents, assignments or reassignments of rents, leases and profits, in each case in favor of EMC, and all Form UCC-2 or UCC-3 assignments of financing statements and all other comparable instruments or documents with respect to the Mortgage Loans which are customarily and reasonably necessary or appropriate to assign agreements, documents and instruments pertaining to the Mortgage Loans, and to evidence, provide notice of and perfect such assignments and conveyances in favor of EMC in the public records of the appropriate filing and recording offices; (ii) to file or record in the appropriate public filing or recording offices, all other Mortgage Loan documents to be recorded under the terms of the Purchase Agreement or any such Mortgage Loan which have not been submitted for filing or recordation by ______ on or before the date hereof or which have been so submitted but are subsequently lost or returned unrecorded or unfiled as a result of actual or purported defects therein, in order to evidence, provide notice of and perfect such documents in the public records of the appropriate filing and recording offices; and (iii) to do and perform all acts in connection with the servicing, administration and management of the Mortgage Loans, including but not limited to: (1) execute and deliver customary consents or waivers and other instruments and documents; (2) consent to transfers of any Mortgaged Property and assumptions of the Mortgage Notes and related Mortgages; (3) collect any Insurance Proceeds and other Liquidation Proceeds; (4) effectuate foreclosure or other conversion of the ownership of the Mortgaged Property securing any Mortgage Loan; (5) to sign any necessary Assignments of Mortgage to fully give the lienholder rights over from _________ to EMC; 83 (6) execute and deliver any and all instruments of satisfaction or cancellation or of partial or full release or discharge and all other comparable instruments, with respect to the Mortgage Loans, and with respect to the Mortgaged Properties; and (7) execute all documents customarily and reasonably necessary and appropriate for the transfer post-foreclosure of the previously Mortgaged Properties to third parties, and then to collect the sales proceeds from that transfer. This Limited Power of Attorney may be utilized fully to all intents and purposes as _________ might or could do if personally present, hereby ratifying and confirming all that EMC as said attorney in fact shall lawfully do or cause to be done by virtue hereof. ARTICLE I The enumeration of particular powers herein is not intended in any way to limit the grant to EMC as ______'s attorney-in-fact of full power and authority with respect to the Mortgage Loans to complete (to the extent necessary), file and record any documents, instruments or other writings referred to above as fully, to all intents and purposes, as ______ might or could do if personally present, hereby ratifying and confirming whatsoever such attorney-in-fact shall and may do by virtue hereof; and ______ agrees and represents to those dealing with such attorney-in-fact that they may rely upon this Limited Power of Attorney until termination thereof under the provisions of Article III below. Any and all third parties dealing with EMC as ______'s attorney-in-fact may rely completely, unconditionally and conclusively on the authority of EMC, as applicable, and need not make any inquiry about whether EMC is acting pursuant to the Purchase Agreement. Any purchaser, title insurance company or other third party may rely upon a written statement by EMC that any particular Mortgage Loan or related mortgaged real property in question is subject to and included under this Limited Power of Attorney and the Purchase Agreement. ARTICLE II Any act or thing lawfully done hereunder by EMC shall be binding on ______ and ______'s successors and assigns. ARTICLE III This Limited Power of Attorney shall continue in full force and effect until the earliest occurrence of any of the following events: (i) the transfer by EMCof its servicing obligations under the Purchase Agreement to another servicer; (ii) with respect to any Mortgage Loan, such Mortgage Loan is no longer a part of the Purchase Agreement; and (iii) the termination of the Purchase Agreement in accordance with its terms. Nothing herein shall be deemed to amend or modify the Purchase Agreement or the respective rights, duties or obligations of ______ under the Purchase Agreement, and nothing herein shall constitute a waiver of any rights or remedies thereunder. 84 ARTICLE IV Capitalized terms used but not defined herein have the respective meanings assigned thereto in the Purchase Agreement. IN WITNESS WHEREOF, ______ has caused this instrument to be executed and its corporate seal to be affixed hereto by its officer duly authorized as of _____ ___, 2003. By:_______________________________ Name:_____________________________ Title:____________________________ 85 ACKNOWLEDGEMENT STATE OF ) ) ss: COUNTY OF ) On this ___ day of __________, 3 before me appeared _______________________, to me personally known, who, being by me duly sworn did say that he/she is the _____________________ of _____________, and that the seal affixed to the foregoing instrument is the corporate seal of said corporation, and that said instrument was signed and sealed in behalf of said corporation by authority of its board of directors, and said ____________ acknowledged said instrument to be the free act and deed of said corporation. Name:_____________________________ Notary Public in and for said County and State My Commission Expires: 86 EXHIBIT 11 FORM OF OFFICER'S CERTIFICATE I, _____________, hereby certify that I am the duly elected [Vice] President of _________, a ______, (the "Servicer") and further as follows: 1. Attached hereto is a true and correct copy of the [Charter and By-laws/formation documents] of the Servicer which are in full force and effect as of the date hereof. 2. There are no actions, suits or proceedings pending (nor, to my knowledge, are any actions, suits or proceedings threatened), against or affecting the Servicer which if adversely determined, individually or in the aggregate, would adversely affect the Servicer's obligations under the Mortgage Loan Purchase and Interim Servicing Agreement, dated as of June 30, 2003, among American Business Credit, Inc. ("ABC"), Homeamerican Credit, Inc. d/b/a Upland Mortgage ("Upland"), American Business Mortgage Services, Inc. ("ABMS", and together with ABC and Upland, the "Originators") and EMC Mortgage Corporation ("EMC"), and the related Term Sheet, dated as of ________, between the Servicer and EMC (together, the "Agreements"). 3. Each person who, as an officer or representative of the Servicer, signed the Agreements and any other document delivered prior hereto or on the date hereof in connection with the sale of Mortgage Loans pursuant to the Agreements was, at the respective times of such signing and delivery, and is now duly elected or appointed, qualified and acting as such officer or representative, and the signatures of such persons appearing on such documents are their genuine signatures. 4. Attached hereto is a certified true copy of the resolution of the board of directors of the Servicer that authorizes the sale of the Mortgage Loans subject to the Agreements. 5. The Servicer has performed and complied with all agreements and conditions to in the Agreements which are required to be performed or complied with by the Servicer on or before the date hereof. IN WITNESS WHEREOF, I have hereunto signed my name and affixed the seal of the Servicer. Dated: [Closing Date] By:______________________________ Name:____________________________ I, _________________, a [Assistant] Secretary of the Servicer, hereby certify that _______________ is the duly elected, qualified and acting [Vice] President of the Servicer and that the signature appearing above is [her] [his] genuine signature. 87 IN WITNESS WHEREOF, I have hereunto signed my name. Dated: [Closing Date] By:______________________________ Name:____________________________ Title: [Vice] President 88 EX-12 13 ex12-1.txt EXHIBIT 12.1 EXHIBIT 12.1 Computation of Ratio of Earnings to Fixed Charges The following table sets forth the ratio of earnings to fixed charges of the Company for the five fiscal years ended June 30, 2003 computed by dividing net fixed charges (interest expense on all debt plus the interest element of operating leases) into earnings (income before income taxes and fixed charges). (Dollar amounts in thousands):
For Fiscal Years Ended June 30, ----------------------------------------------------------------- 2003 2002 2001 2000 1999 ----------------------------------------------------------------- Net income (loss) $(29,902) $ 7,859 $ 8,085 $ 6,424 $ 14,088 Income tax expense (benefit) (19,118) 5,691 5,274 3,938 7,763 Interest charges 68,098 68,683 56,547 38,122 22,427 Amortization of debt issuance costs 2,706 3,600 2,514 1,734 1,012 Interest portion of rental expense 326 350 440 534 232 -------- -------- -------- -------- -------- Earnings available to cover fixed charges $ 22,110 $ 86,183 $ 72,860 $ 50,752 $ 45,522 ======== ======== ======== ======== ======== Fixed charges: Interest charges $ 68,098 $ 68,683 $ 56,547 $ 38,122 $ 22,427 Amortization of debt issuance costs 2,706 3,600 2,514 1,734 1,012 Interest portion of rental expense 326 350 440 534 232 -------- -------- -------- -------- -------- Total fixed charges $ 71,130 $ 72,633 $ 59,501 $ 40,390 $ 23,671 ======== ======== ======== ======== ======== Ratio of earnings to fixed charges (a) 0.31 x 1.19 x 1.23 x 1.26 x 1.92 x ======== ======== ======== ======== ========
(a) Earnings (loss) before income taxes and fixed charges were insufficient to cover fixed charges by $49.0 million for the year ended June 30, 2003. EX-21 14 exh21-1.txt EXHIBIT 21.1 EXHIBIT 21.1 SUBSIDIARIES OF American Business Financial Services, Inc.
JURISDICTION PARENT SUBSIDIARY OF INCORPORATION - ------------------------------ -------------------------------------------- ----------------------------- American Business Financial American Business Credit, Inc. ("ABC") Pennsylvania Services, Inc. ("ABFS") ABC, HAC, ABMS ABFS Balapointe, Inc. Delaware ABFS ABFS Residual Holding II, Inc. Delaware ABFS ABFS 2003-1, Inc. Delaware ABFS ABFS 2002-1, Inc. Delaware ABFS ABFS 2002-2, Inc. Delaware ABFS ABFS 2002-3, Inc. Delaware ABFS ABFS 2002-4, Inc. Delaware ABFS ABFS 2001-1, Inc. Delaware ABFS ABFS 2001-2, Inc. Delaware ABFS ABFS 2001-3, Inc. Delaware ABFS ABFS 2001-4, Inc. Delaware ABFS ABFS 2000-1, Inc. Delaware ABFS ABFS 2000-2, Inc. Delaware ABFS ABFS 2000-3, Inc. Delaware ABFS ABFS 2000-4, Inc. Delaware ABFS ABFS OSO, Inc. Delaware ABC American Business Mortgage Services, Inc. New Jersey (formerly New Jersey Mortgage and Investment Corp.) ("ABMS") ABC Processing Service Center, Inc. Pennsylvania ABC HomeAmerican Credit, Inc. ("HAC")(1) Pennsylvania ABC HomeAmerican Consumer Discount Company Pennsylvania ABC American Business Leasing, Inc. ("ABL") Pennsylvania ABC Tiger Relocation Company Pennsylvania ABC Marion's Management Corp. Delaware ABC August Advertising Agency Inc. Pennsylvania
JURISDICTION PARENT SUBSIDIARY OF INCORPORATION - ------------------------------ -------------------------------------------- ----------------------------- ABFS ABFS 1996-1, Inc. Delaware ABFS ABFS 1996-2, Inc. Delaware ABFS ABFS 1997-1, Inc. Delaware ABFS ABFS 1997-2, Inc. Delaware ABFS ABFS 1998-1, Inc. Delaware ABFS ABFS 1998-2, Inc. Delaware ABFS ABFS 1998-3, Inc. Delaware ABFS ABFS 1998-4, Inc. Delaware ABFS ABFS 1999-1, Inc. Delaware ABFS ABFS 1999-2, Inc. Delaware ABFS ABFS 1999-3, Inc. Delaware ABFS ABFS 1999-4, Inc. Delaware ABFS ABFS 1998-A-1, Inc. Delaware ABFS ABFS 1998-A-2, Inc. Delaware ABFS ABFS Special Purpose Management, Inc. Delaware ABFS Upland Corporation Utah ABFS ABFS Millenium, Inc. Delaware ABFS ABFS Residual Holding, Inc. Delaware ABC, HAC & ABMS ABFS Greenmont, Inc. Delaware ABC, HAC & ABMS ABFS 1999-A-1, Inc. Delaware ABC, HAC & ABMS ABFS 1999-A-2, Inc. Delaware ABC NJLQ Holdings Inc. New Jersey ABMS Federal Leasing Corp. ("FLC") New Jersey ABL and FLC ABFS Finance LLC Delaware ABL and FLC ABFS Residual LLC Delaware ABL ABFS Finance LLC, 1999-A Delaware ABL ABFS Residual LLC, 1999-A Delaware
JURISDICTION PARENT SUBSIDIARY OF INCORPORATION - ------------------------------ -------------------------------------------- ----------------------------- ABL American Business Lease Funding Delaware Corporation FLC FLC Financial Corp. Delaware FLC FLC Financial Corp. II Delaware
_______________________________ (1) HomeAmerican Credit, Inc. is doing business as Upland Mortgage. EX-23 15 ex23-1.txt EXHIBIT 23.1 EXHIBIT 23.1 Consents of BDO Seidman LLP Consent of Independent Certified Public Accountants American Business Financial Services, Inc. Philadelphia, Pennsylvania We hereby consent to the incorporation by reference in the Form S-8 Registration Statement filed on September 29, 1998, File No. 333-64655, the Form S-8 Registrations Statement filed on July 1, 1999, File No. 333-82127, the Form S-8 Registration Statement filed May 26, 2000, File No. 333-37944 and the Form S-8 Registration Statement filed May 3, 2002 File No. 333-87598, of our report dated August 29, 2003, except for Note l, Business Conditions, and Note 9, which are as of September 22, 2003, relating to the consolidated financial statements and schedules of American Business Financial Services, Inc. appearing in the Company's Annual Report on Form 10-K for the year ended June 30, 2003. /s/ BDO Seidman, LLP ---------------------- BDO Seidman, LLP Philadelphia, Pennsylvania September 29, 2003 EX-31 16 ex31-1.txt EXHIBIT 31.1 Exhibit 31.1 I, Anthony J. Santilli, President, Chief Executive Officer and Chief Operating Officer of American Business Financial Services, Inc., certify that: 1. I have reviewed this Form 10-K of American Business Financial Services, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered in this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) [Intentionally omitted]; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and; d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors: a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and; b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: September 29, 2003 /s/ Anthony J. Santilli ------------------------------------------------ Anthony J. Santilli Chairman, President, Chief Executive Officer, Chief Operating Officer, and Director (principal executive officer) EX-31 17 ex31-2.txt EXHIBIT 31.2 Exhibit 31.2 I, Albert W. Mandia, Chief Financial Officer and Executive Vice President of American Business Financial Services, Inc., certify that: 1. I have reviewed this Form 10-K of American Business Financial Services, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered in this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) [Intentionally omitted]; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and; d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors: a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and; b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: September 29, 2003 /s/ Albert W. Mandia ----------------------------------------------- Albert W. Mandia Executive Vice President and Chief Financial Officer (principal financial officer) EX-32 18 ex32-1.txt EXHIBIT 32.1 Exhibit 32.1 AMERICAN BUSINESS FINANCIAL SERVICES, INC. CERTIFICATION PURSUANT TO 18 U.S.C. ss. 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Section 1350 of Chapter 63 of Title 18 of the United States Code), each of the undersigned officers of American Business Financial Services, Inc. (the "Company"), does hereby certify with respect to the Annual Report of the Company on Form 10-K for the period ended June 30, 2003 (the "Report") that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: September 29, 2003 /s/ Anthony J. Santilli ----------------------------- Anthony J. Santilli Chief Executive Officer Date: September 29, 2003 /s/ Albert W. Mandia ----------------------------- Albert W. Mandia Chief Financial Officer The foregoing certification is being furnished solely pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Section 1350 of Chapter 63 of Title 18 of the United States Code) and is not being filed as part of the Report or as a separate disclosure document. -----END PRIVACY-ENHANCED MESSAGE-----