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Secretary of Labor Thomas E. Perez
Proposed Amendment to Prohibited Transaction Exemption (PTE) 97-34 Involving Bear, Stearns & Co. Inc., Prudential Securities Incorporated, et al., (D-10829); Notice [Notices] [08/23/2000]

EBSA (Formerly PWBA) Federal Register Notice

Proposed Amendment to Prohibited Transaction Exemption (PTE) 97-34 Involving Bear, Stearns & Co. Inc., Prudential Securities Incorporated, et al., (D-10829); Notice [08/23/2000]

[PDF Version]

Volume 65, Number 164, Page 51453-51494



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Part III





Department of Labor





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Pension and Welfare Benefits Administration



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Proposed Amendment to Prohibited Transaction Exemption (PTE) 97-34 
Involving Bear, Stearns & Co. Inc., Prudential Securities Incorporated, 
et al., (D-10829); Notice


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DEPARTMENT OF LABOR

Pension and Welfare Benefits Administration

 
Proposed Amendment to Prohibited Transaction Exemption (PTE) 97-
34 Involving Bear, Stearns & Co. Inc., Prudential Securities 
Incorporated, et al., (D-10829)

AGENCY: Pension and Welfare Benefits Administration, Department of 
Labor.

ACTION: Notice of a proposed amendment to the Underwriter 
Exemptions.\1\

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    \1\ The term ``Underwriter Exemptions'' refers to the following 
individual Prohibited Transaction Exemptions (PTEs): PTE 89-88, 54 
FR 42582 (October 17, 1989); PTE 89-89, 54 FR 42569 (October 17, 
1989); PTE 89-90, 54 FR 42597 (October 17, 1989); PTE 90-22, 55 FR 
20542 (May 17, 1990); PTE 90-23, 55 FR 20545 (May 17, 1990); PTE 90-
24, 55 FR 20548 (May 17, 1990); PTE 90-28, 55 FR 21456 (May 24, 
1990); PTE 90-29, 55 FR 21459 (May 24, 1990); PTE 90-30, 55 FR 21461 
(May 24, 1990); PTE 90-31, 55 FR 23144 (June 6, 1990); PTE 90-32, 55 
FR 23147 (June 6, 1990); PTE 90-33, 55 FR 23151 (June 6, 1990); PTE 
90-36, 55 FR 25903 (June 25, 1990); PTE 90-39, 55 FR 27713 (July 5, 
1990); PTE 90-59, 55 FR 36724 (September 6, 1990); PTE 90-83, 55 FR 
50250 (December 5, 1990); PTE 90-84, 55 FR 50252 (December 5, 1990); 
PTE 90-88, 55 FR 52899 (December 24, 1990); PTE 91-14, 55 FR 48178 
(February 22, 1991); PTE 91-22, 56 FR 03277 (April 18, 1991); PTE 
91-23, 56 FR 15936 (April 18, 1991); PTE 91-30, 56 FR 22452 (May 15, 
1991); PTE 91-62, 56 FR 51406 (October 11, 1991); PTE 93-31, 58 FR 
28620 (May 5, 1993); PTE 93-32, 58 FR 28623 (May 14, 1993); PTE 94-
29, 59 FR 14675 (March 29, 1994); PTE 94-64, 59 FR 42312 (August 17, 
1994); PTE 94-70, 59 FR 50014 (September 30, 1994); PTE 94-73, 59 FR 
51213 (October 7, 1994); PTE 94-84, 59 FR 65400 (December 19, 1994); 
PTE 95-26, 60 FR 17586 (April 6, 1995); PTE 95-59, 60 FR 35938 (July 
12, 1995); PTE 95-89, 60 FR 49011 (September 21, 1995); PTE 96-22, 
61 FR 14828 (April 3, 1996); PTE 96-84, 61 FR 58234 (November 13, 
1996); PTE 96-92, 61 FR 66334 (December 17, 1996); PTE 96-94, 61 FR 
68787 (December 30, 1996); PTE 97-05, 62 FR 1926 (January 14, 1997); 
PTE 97-28, 62 FR 28515 (May 23, 1997); PTE 97-34, 62 FR 39021 (July 
21, 1997); PTE 98-08, 63 FR 8498 (February 19, 1998); PTE 99-11, 64 
FR 11046 (March 8, 1999); PTE 2000-19, 65 FR 25950 (May 4, 2000); 
PTE 2000-33, 65 FR 37171 (June 13, 2000); and PTE 2000-41, First 
Tennessee National Corporation (August, 2000).
    In addition, the Department notes that it is also proposing 
individual exemptive relief for: Deutsche Bank AG, New York Branch 
and Deutsche Morgan Grenfell/C.J. Lawrence Inc., Final Authorization 
Number (FAN) 97-03E (December 9, 1996); Credit Lyonnais Securities 
(USA) Inc., FAN 97-21E (September 10, 1997); ABN AMRO Inc., FAN 98-
08E (April 27, 1998); and Ironwood Capital Partners Ltd., FAN 99-31E 
(December 20, 1999), which received the approval of the Department 
to engage in transactions substantially similar to the transactions 
described in the Underwriter Exemptions pursuant to PTE 96-62. 
Finally, the Department notes that it is proposing relief for 
Countrywide Securities Corporation (Application No. D-10863).
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SUMMARY: This document contains a notice of pendency before the 
Department of Labor (the Department) of a proposed amendment to the 
Underwriter Exemptions. The Underwriter Exemptions are individual 
exemptions that provide relief for the origination and operation of 
certain asset pool investment trusts and the acquisition, holding and 
disposition of certain asset-backed pass-through certificates 
representing undivided interests in those investment trusts. The 
proposed amendment, if granted, would: (1) Permit, for certain 
categories of transactions, the offering of ``investment grade'' 
mortgage-backed securities and asset-backed securities which are either 
senior or subordinated; (2) permit the use of eligible interest rate 
swaps (both ratings dependent and non-ratings dependent) under 
circumstances described in this proposal; (3) permit the use of yield 
supplement agreements which involve notional principal amounts; and (4) 
make certain changes to the Underwriter Exemptions that would reflect 
the Department's current interpretation of the Underwriter Exemptions.
    Finally, the proposed amendment, if granted, would provide 
exemptive relief for transactions involving: (1) an Issuer of mortgage-
backed securities or asset-backed securities which is a trust 
(including a grantor or owner trust), REMIC, FASIT, special purpose 
corporation, limited liability company or partnership and (2) mortgage-
backed securities or asset-backed securities issued which are either 
debt or equity investments.

DATES: Written comments and/or requests for a public hearing should be 
received by October 10, 2000.
    Effective Date: If granted, the proposed amendment to the 
Underwriter Exemptions would be effective for transactions occurring on 
or after the date of publication of this notice in the Federal 
Register, except as otherwise provided in sections I.C., II.A.(4)(b), 
and III.JJ. of the proposed amendment to the Underwriter Exemptions.

ADDRESSES: All written comments and requests for a hearing (preferably 
at least three copies) should be sent to: Office of Exemption 
Determinations, Pension and Welfare Benefits Administration, Room N-
5649, Department of Labor, 200 Constitution Avenue, N.W., Washington, 
D.C. 20210, Attn: Proposed Amendment to the Underwriter Exemptions. The 
application pertaining to the amendment proposed herein and the 
comments received will be available for public inspection in the Public 
Documents Room of the Pension and Welfare Administration, U.S. 
Department of Labor, Room N-5638, 200 Constitution Avenue, N.W., 
Washington, D.C. 20210.

FOR FURTHER INFORMATION CONTACT: Wendy McColough of the Department, 
telephone (202) 219-8971. (This is not a toll-free number).

SUPPLEMENTARY INFORMATION: Notice is hereby given of the pendency 
before the Department of a proposed exemption to amend PTE 97-34, 62 FR 
39021 (July 21, 1997) (the 1997 Amendment). PTE 97-34 amended over 
forty individual Underwriter Exemptions. The Underwriter Exemptions 
provide substantially identical relief for the operation of certain 
asset pool investment trusts and the acquisition and holding by plans 
of certain asset-backed pass-through certificates representing 
interests in those trusts. These exemptions provide relief from certain 
of the restrictions of sections 406(a), 406(b) and 407(a) of the Act 
and from the taxes imposed by section 4975(a) and (b) of the Code, by 
reason of certain provisions of section 4975(c)(1) of the Code.

I. Introduction

    The proposed amendment was requested by application dated October 
22, 1999, and as restated in later submissions on behalf of Morgan 
Stanley & Co. Incorporated.\2\ (the Applicant). In preparing the 
application, the Applicant received input from members of The Bond 
Market Association (TBMA).
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    \2\ PTE 90-24, 55 FR 20548 (May 17, 1990). Morgan Stanley & Co. 
Incorporated (Morgan Stanley) is an international securities firm 
providing through its affiliates a wide range of financial and 
securities services on a global basis to a large and diversified 
group of clients and customers, including corporations, governments, 
financial institutions and individuals. The businesses of Morgan 
Stanley and its affiliates include securities underwriting, 
distribution and trading; merger, acquisition, restructuring, real 
estate, project finance and other corporate finance advisory 
activities; asset management; private equity and other principal 
investment activities; brokerage and research services; and the 
trading of foreign exchange and commodities as well as derivatives 
on a broad range of asset categories, rates and indices. Affiliates 
of Morgan Stanley also provide credit and transaction services, 
including the operation of the Discover/Novus (trademark symbol) 
Network, a proprietary network of merchant and cash access 
locations, and the issuance of proprietary general purpose credit 
cards.
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    The Department is proposing the amendment to this individual 
exemption pursuant to section 408(a) of the Act and section 4975(c)(2) 
of the Code, and in accordance with the procedures set forth in 29 CFR 
Part 2570 (Subpart B) 55 FR 32836, 32847(August 10, 1990).\3\ In 
addition, the Department

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is proposing to provide the same relief on its own motion pursuant to 
the authority described above for many of the other Underwriter 
Exemptions which have substantially similar terms and conditions.\4\ 
The Department notes that it is also proposing individual exemptive 
relief for: Deutsche Bank AG, New York Branch and Deutsche Morgan 
Grenfell/C.J. Lawrence Inc., FAN 97-03E (December 9, 1996); Credit 
Lyonnais Securities (USA) Inc., FAN 97-21E (September 10, 1997); ABN 
AMRO Inc., FAN 98-08E (April 27, 1998); and Ironwood Capital Partners 
Ltd., FAN 99-31E (December 20, 1999), which received the approval of 
the Department to engage in transactions substantially similar to the 
transactions described in the Underwriter Exemptions pursuant to PTE 
96-62. Finally, the Department notes that it is proposing relief for 
Countrywide Securities Corporation (Application No. D-10863).
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    \3\ Section 102 of Reorganization Plan No. 4 of 1978 (43 FR 
47713, October 17, 1978, 5 U.S.C. App. 1 [1995]) generally 
transferred the authority of the Secretary of the Treasury to issue 
exemptions under section 4975(c)(2) of the Code to the Secretary of 
Labor. In the discussion of the exemption, references to sections 
406 and 408 of the Act should be read to refer as well to the 
corresponding provisions of section 4975 of the Code.
    \4\ In this regard, the entities who received the other 
Underwriter Exemptions were contacted concerning their participation 
in this amendment process.
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A. The Underwriter Exemptions

    The original Underwriter Exemptions permit plans to invest in pass-
through certificates representing undivided interests in the following 
categories of trusts: \5\ (1) Single and multi-family residential or 
commercial mortgage investment trusts; \6\ (2) motor vehicle 
receivables investment trusts; (3) consumer or commercial receivables 
investment trusts; and (4) guaranteed governmental mortgage pool 
certificate investment trusts.\7\ Residential and commercial mortgage 
investment trusts may include mortgages on ground leases of real 
property. The terms of the ground leases pledged to secure leasehold 
mortgages will in all cases be at least ten years longer than the terms 
of such mortgages.\8\
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    \5\ The Department stated in the 1997 Proposed Amendment to the 
Underwriter Exemptions, 62 FR 28502 (May 23, 1997), that a given 
trust may include receivables of the type described in one or more 
of the categories under the definition of Trust.
    \6\ The Department noted that PTE 83-1, 48 FR 895 (January 7, 
1983), a class exemption for mortgage pool investment trusts, would 
generally apply to trusts containing single-family residential 
mortgages, provided that the applicable conditions of PTE 83-1 are 
met. The Underwriter Exemptions provide relief for single-family 
residential mortgages because the applicants preferred one exemption 
for all trusts of similar structure. However, the applicants have 
stated that they may still avail themselves of the exemptive relief 
provided by PTE 83-1.
    \7\ Guaranteed governmental mortgage pool certificates are 
mortgage-backed securities with respect to which interest and 
principal payable is guaranteed by the Government National Mortgage 
Association (GNMA), the Federal Home Loan Mortgage Corporation 
(FHLMC), or the Federal National Mortgage Association (FNMA). The 
Department's regulation relating to the definition of plan assets 
(29 CFR 2510.3-101(i)) provides that where a plan acquires a 
guaranteed governmental mortgage pool certificate, the plan's assets 
include the certificate and all of its rights with respect to such 
certificate under applicable law, but do not, solely by reason of 
the plan's holding of such certificate, include any of the mortgages 
underlying such certificate. Exemptive relief for trusts containing 
guaranteed governmental mortgage pool certificates was provided 
previously because the certificates in the trusts may be plan 
assets.
    \8\ The Department previously noted that Trust assets may also 
include obligations that are secured by leasehold interests on 
residential real property. See PTE 90-32 (involving Prudential-Bache 
Securities, Inc.) 55 FR 23147, at 23150 (June 6, 1990).
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    Each trust is established under a pooling and servicing agreement 
or an equivalent agreement among a sponsor, a servicer, and a trustee. 
Prior to the closing date under the pooling and servicing agreement, 
the sponsor and/or the servicer selects receivables from the classes of 
assets described in section III.B.(1)(a)-(f) of the original 
Underwriter Exemptions to be included in a trust, establishes the trust 
and designates an independent entity as trustee for the trust. 
Typically, on or prior to the closing date, the sponsor acquires legal 
title to all assets selected for the trust. In some cases, legal title 
to some or all of such assets continues to be held by the originator of 
the receivables until the closing date. On the closing date, the 
sponsor and/or the originator conveys to the trust legal title to the 
assets, and the trustee issued certificates representing fractional 
undivided interests in the trust assets.
    Since the receivables to be held in the trust were all transferred 
as of the Closing Date, no exemptive relief was requested under the 
Underwriter Exemptions for the trust to hold any cash, or temporary 
investments made therewith, other than cash representing undistributed 
proceeds from payments of principal and interest by obligors under the 
receivables. However, over time, the transactions relating to the 
funding of the trust changed. The 1997 Amendment to the Underwriter 
Exemptions: (1) Modified the definition of ``Trust'' to include a 
``pre-funding account'' (PFA) and a ``capitalized interest account'' 
(CIA) as part of the corpus of the trust; (2) provided retroactive 
relief for transactions involving asset pool investment trusts 
containing PFAs which have occurred on or after January 1, 1992; (3) 
included in the definition of ``Certificate'' a debt instrument that 
represents an interest in a Financial Asset Securitization Investment 
Trust (FASIT); and (4) made certain changes to the Underwriter 
Exemptions that reflected the Department's current interpretation of 
the Underwriter Exemptions.
    Under the Underwriter Exemptions as amended in 1997: (1) The rights 
and interests evidenced by certificates acquired by plans may not be 
subordinated to the rights and interests evidenced by other 
certificates of the same trust; (2) the certificates acquired by the 
plan must have received a rating from a Rating Agency at the time of 
such acquisition that is in one of the three highest generic rating 
categories; (3) the assets held by the trust must consist solely of 
receivables, obligations or credit instruments which are ``secured,'' 
(4) no interest rate swaps and no yield supplement agreements or 
similar yield maintenance agreements involving swap agreements or other 
notional principal contracts may be held by the trust and (5) the 
certificates must represent a beneficial ownership interest in the 
assets of a trust or a debt instrument issued by a REMIC or a FASIT 
which is a trust.

B. Proposed Amendment to the Exemptions

    The proposed amendment to the Underwriter Exemptions (the Proposed 
Amendment) is requested in order to permit plans to invest in 
investment-grade \9\ mortgage-backed securities (MBS) and asset-backed 
securities (ABS) (collectively, Securities) involving categories of 
transactions which are either senior or subordinated, and/or in certain 
cases, permit the entity issuing such Securities (Issuer) to hold 
receivables with loan-to-value property ratios (HLTV ratios) in excess 
of 100%. Specifically, the requested amendment would exempt 
transactions involving senior or subordinated Securities rated ``AAA,'' 
``AA,'' ``A'' or ``BBB'' issued by Issuers whose assets are comprised 
of the following categories of receivables: (1) Automobile and other 
motor vehicle loans, (2) residential and home equity loans which may 
have HLTV ratios in excess of 100%, (3) manufactured housing loans and 
(4) commercial

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mortgages (the Designated Transactions).
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    \9\ The term ``investment grade'' refers to Securities which are 
rated at the time of issuance in one of the four highest generic 
rating categories by at least one Rating Agency. The designations 
``AAA,'' ``AA,'' ``A'' and ``BBB'' are used herein to refer to the 
generic rating categories used by Standard & Poor's Ratings 
Services, a division of The McGraw-Hill Companies Inc., Fitch ICBA, 
Inc., and Duff & Phelps Credit Rating Co. and are deemed to include 
the equivalent generic category rating designations ``Aaa'' ``Aa,'' 
``A'' and ``Baa'' used by Moody's Investors Service, Inc.
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    The Applicant requests that the relief the Department granted to 
MBNA America Bank National Association (MBNA) in Prohibited Transaction 
Exemption 98-13, 63 FR 4038 (April 7, 1998) (PTE 98-13) and to Citibank 
South Dakota, N.A., Citibank (Nevada), N.A. and affiliates (Citibank) 
in Prohibited Transaction Exemption 98-14, 63 FR 4052 (April 7, 1998) 
(PTE 98-14) with respect to the use of Eligible Swaps (both Ratings 
Dependent and Non-Ratings Dependent) be extended to all securitizations 
which otherwise meet the conditions of the Underwriter Exemptions, 
provided that the swap transaction meets the requirements set forth in 
the requested amendment. As a corollary to such request, the Applicant 
also requests that yield supplement agreements which involve notional 
principal amounts be permitted.
    Finally, the Applicant is requesting that exemptive relief also be 
extended to all securitization transactions which otherwise meet the 
conditions of the Underwriter Exemptions notwithstanding that: (1) The 
Issuer of the Securities is a trust (including a grantor or owner 
trust), REMIC, FASIT, special purpose corporation, limited liability 
company or partnership or that (2) the Securities issued are either 
debt or equity investments.\10\
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    \10\ The Department notes that this exemption request will not 
preclude the Applicant (or any other parties which have previously, 
or may in the future, request an Underwriter Exemption) from 
requesting additional exemptive relief from the Department in future 
applications with respect to other issues relating to the 
Underwriter Exemptions.
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    The proposed amendment to the Underwriter Exemptions specifically 
will modify the relief previously provided in the following respects:

    (i) The rights and interests evidenced by securities acquired by 
plans in the Designated Transactions (i.e., motor vehicle, 
residential/home equity, manufactured housing and commercial 
mortgage ABS/MBS transactions) described in this application may be 
subordinated to the rights and interests evidenced by other 
securities of the same Issuer.
    (ii) Securities acquired by a plan in a Designated Transaction 
may receive a rating from a Rating Agency at the time of such 
acquisition that is in one of the four highest generic rating 
categories.
    (iii) The corpus of the Issuer in residential and home equity 
Designated Transactions may include mortgage loans with HLTV ratios 
in excess of 100%.
    (iv) Eligible interest rate swaps (both ratings dependent and 
non-ratings dependent) and yield supplement arrangements with 
notional principal amounts may be included.
    (v) The securitization vehicle can also be an owner trust, 
special purpose corporation, limited partnership or limited 
liability company.
    (vi) The security may be either an equity or debt interest 
issued by any permissible type of Issuer.

    The Applicant represents that the transactions associated with 
subordinated and/or ``BBB'' rated debt and equity ABS/MBS, issued by a 
variety of special purpose vehicles which may be funded with collateral 
with HLTV ratios in excess of 100% and may use interest rate swaps or 
yield supplement agreements with notional principal amounts, have been 
customary in the financial marketplace for many years, and all of these 
features and security types are taken into consideration by the Rating 
Agencies when they rate the securities issued by such entities. If 
these securities can not be sold to plans, investing plans will lose an 
opportunity to achieve a current market return through investment in 
securities that have received a rating from a Rating Agency which is as 
high or higher than that of comparable instruments in which such plans 
are clearly permitted to invest. In addition, thesetransactions are 
backed by diverse varieties of individual assets that a plan would be 
reluctant to purchase on its own, if for no other reason than the 
necessity to perform its own asset-by-asset credit analysis and 
servicing functions.
    The Applicant notes that the requested relief is administratively 
feasible since it substantially incorporates the provisions of the 
Underwriter Exemptions which have already proven in practice to be 
administratively feasible. To the extent that the requested amendment 
permits additional types of securitization vehicles and the use of 
yield supplement arrangements with notional principal balances and 
interest rate swaps, the additional safeguards the Department has 
required can be accommodated by market practices and do not require any 
further action by the Department. The Applicant states that all of the 
features included in the amendment request are also acceptable to the 
Rating Agencies. The Applicant believes that the amendment is in the 
interest of plan participants and beneficiaries because it provides 
greater opportunities for plans to invest in a more diverse range of 
liquid, extremely creditworthy securities. Lastly, the Applicant notes 
that the requested amendment is protective of the rights of 
participants and beneficiaries of affected plans because securities 
with the features proposed in the request for amended relief have 
experienced almost no defaults in their entire market history.

II. Request for Additional Types of Issuers

A. The Applicant's Request

    The Applicant is requesting that the Underwriter Exemptions be 
amended to expand the permissible types of securitization vehicles that 
may be used to offer securities to include special purpose 
corporations, limited partnerships and limited liability companies and 
owner trusts, in addition to grantor trusts, REMICs and FASITs. It is 
also requesting that the securities eligible for relief include those 
issued by all such entities whether they are debt or equity.
    When the original Underwriter Exemptions were granted, relief was 
only requested for ABS/MBS issued by grantor trusts and REMICs since, 
at that time, these were the principal securitization vehicles used for 
asset-backed transactions. FASITs were included under PTE 97-34 in 
response to legislation that had been enacted during the time period 
when the relief requested under PTE 97-34 was being considered by the 
Department. Currently, ABS/MBS securitizations are structured with a 
variety of types of special purpose vehicles which issue both debt and 
equity securities. The permissible types of Issuers used to offer 
Securities include trusts (including grantor and owner trusts), special 
purpose corporations, limited partnerships and limited liability 
companies and may also be REMICs or FASITs. The Applicant asserts that 
each of these different types of securitization entities provides 
virtually the same legal protections to investors. At the request of 
the Department, the Applicant provided the following discussion that 
describes the legal structure, bankruptcy status and taxation of each 
securitization vehicle. It also explains why debt is issued in certain 
transactions instead of equity and the relative rights of both types of 
securities.
    The principal factors in the choice of securitization vehicle and 
whether equity or debt securities are issued by the securitization 
vehicle are not economic but involve a combination of tax, accounting 
and ERISA considerations. In this regard, the Applicant notes that 
where the Issuer is not a Trust, equity will not be sold to plans 
pursuant to this exemption, if granted. In the final analysis, the 
choice of securitization entity or type of security does not 
significantly affect plan investors either from a legal rights,

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credit risk or tax perspective, but it significantly affects ERISA 
eligibility. Accordingly, transactions are restructured solely because 
of ERISA considerations which have no relationship to the safety of the 
securities for plan investors.
    Securitizations transactions are structured with a variety of types 
of Issuers which are special purpose vehicles which issue both debt 
\11\ and equity Securities. Each of the different types of 
securitization entities provides virtually the same legal protections 
to investors.
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    \ 11\ The Department notes that PTE 84-14, 49 FR 9494 (March 13, 
1984) (as corrected at 50 FR 41430 (Oct. 10, 1985), relating to 
transactions determined by independent qualified professional asset 
managers; PTE 90-1, 55 FR 2891 (Jan. 29, 1990), relating to certain 
transactions involving insurance company pooled separate accounts; 
PTE 91-38, 56 FR 31966 (July 12, 1991) (as corrected at 56 FR 59299 
(Nov. 25, 1991), relating to certain transactions involving bank 
collective trust funds; PTE 95-60, 60 FR 35925 (July 12, 1995), 
relating to certain transactions involving insurance company general 
accounts and PTE 96-23, 61 FR 15975 (Apr. 10, 1996), relating to 
transactions determined by in-house asset managers collectively 
(Investor-Based Exemptions), may apply to the acquisition or 
disposition of debt securities by plans. The Applicant requests 
relief for transactions meeting the conditions of the Underwriter 
Exemptions because it would prefer one Exemption for all Issuers of 
similar structures. However, the Applicant has stated that Issuers 
may still issue debt securities pursuant to the Investor-Based 
Exemptions.
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B. Legal Protections and Structure of Issuers

    A goal in every structured finance transaction is to remove the 
assets being securitized from the estate of the Sponsor so that in the 
event of a bankruptcy or insolvency of such Sponsor, its creditors (or 
regulators in the case of entities such as banks that are not eligible 
to be debtors under the Bankruptcy Code (11 U.S.C.)) will be unable to 
claim those assets or delay payments therefrom. This allows potential 
buyers of Securities to base their purchasing decisions solely on the 
creditworthiness of the assets and not the Sponsor. This transfer of 
assets is referred to as a ``true sale.''
    The Applicant asserts that if the transfer of assets by the Sponsor 
is not treated as a ``true sale,'' the transaction would be deemed a 
borrowing by the Sponsor, with the assets serving as collateral for the 
financing. In a typical financing transaction, if the Sponsor were to 
become the subject of a proceeding under the Bankruptcy Code (or 
comparable regulatory provisions for entities that are not eligible to 
be debtors under the Bankruptcy Code), the assets may be deemed 
property of the Sponsor's estate. Although a secured creditor should 
eventually realize the benefits of its pledged collateral, several 
provisions of the Bankruptcy Code or comparable regulatory provisions 
may operate to delay payments, and such creditor may in some cases 
receive less than the full value of the pledged collateral. First, 
immediately upon filing of a bankruptcy petition, Section 362(a) of the 
Bankruptcy Code imposes an automatic stay on the ability of all secured 
creditors to exercise their rights against pledged collateral. Other 
sections of the Bankruptcy Code allow a bankruptcy court to permit the 
use of pledged collateral to aid in the debtor's reorganization 
(Section 363), to provide ``super priority'' liens on such assets 
(Section 364), or to require a secured creditor in possession of the 
collateral to return it to the debtor (Section 542). Thus, in a loan 
financing transaction, the creditworthiness of the Sponsor is a prime 
factor in determining whether to extend credit, as well as the value of 
the collateral.
    Accordingly, the goal in a structured finance transaction is to 
insulate the collateral from the Sponsor. The usual mechanism to 
accomplish this goal is through the creation and use of a bankruptcy 
remote Issuer which issues the Securities. The assets to be securitized 
are transferred to the Issuer in a ``true sale'' transaction. The 
Issuer either issues Securities backed by those assets or transfers the 
Securities (in a second transaction) to a second Issuer, which then 
issues the Securities backed by those assets. These are known as ``one-
tier'' or ``two-tier'' transactions, respectively.
    An Issuer can be formed as a corporation, limited partnership, 
limited liability corporation or trust. Regardless of legal structure, 
many restrictions are placed on the Issuer's operations, including its 
ability to file for bankruptcy protection (either voluntarily or 
involuntarily). Examples of such prohibitions are severe restrictions 
on the Issuer's ability to borrow money or issue debt, as well as 
prohibitions on the Issuer's merging with another entity, reorganizing, 
liquidating or selling assets (outside of the permitted securitization 
transactions). In this regard, the Issuer can only borrow money or 
issue debt in connection with the securitization.
    The documents which create the Issuer (articles/certificates of 
incorporation for corporations, deeds of partnership/partnership 
agreements for limited partnerships, articles of organization for 
limited liability corporations or deeds of trust/trust agreements for 
trusts) contain restrictive clauses significantly limiting the 
activities of the Issuer (usually to just activities relating to the 
securitization transactions). They also provide for the election of one 
or more independent directors/partners/members whose affirmative 
consent is required before a voluntary bankruptcy petition can be filed 
by the Issuer. Independent directors are generally individuals not 
having significant interests in, or other relationships with, the 
related Sponsor or any of its affiliates. The legal documentation 
evidencing the securitization often contains covenants prohibiting all 
parties thereto from filing an involuntary bankruptcy petition against 
the Issuer or initiating any other form of insolvency proceeding. In 
this way, the Issuer, Sponsor, Servicer, trustees and others are 
contractually prohibited from seeking such actions against the Issuer.
    Once the Issuer is formed, the Sponsor will transfer the assets to 
the Issuer, typically in exchange for the cash (and possibly some 
Securities) received from the securitization transaction. This 
transaction will be evidenced by appropriate legal documentation. Also, 
a ``true sale'' opinion from counsel is obtained for Issuers subject to 
the Bankruptcy Code. For those Issuers not subject to the Bankruptcy 
Code, an opinion is obtained from counsel to the effect that in the 
event of insolvency or receivership of the Sponsor, the assets 
transferred to the Issuer will not be part of the estate of the 
Sponsor.
    The Applicant explains that the above procedures are generally 
perceived as effective in removing the assets from the Sponsor's 
bankruptcy estate. However, if the Sponsor were to file for bankruptcy 
protection, a bankruptcy court, under the provisions of Section 105 of 
the Bankruptcy Code, could still gain jurisdiction over the securitized 
assets if the Issuer could be ``substantively consolidated'' with the 
Sponsor. Substantive consolidation permits the bankruptcy court to 
treat separate but related legal entities as one and merge the assets 
and liabilities of two or more entities as if they belonged to one 
debtor. If a court determines that the Issuer has not acted as a 
separate legal entity but merely exists as an ``alter-ego'' of another 
entity, then the court may utilize the principles of ``piercing the 
corporate veil'' or substantive consolidation to gain control of the 
underlying assets even if a ``true sale'' of such assets from the 
Issuer to the Sponsor exists.
    To prevent a court from ordering a substantive consolidation, the 
applicable Rating Agencies require that the organizing documents of the 
Issuer

[[Page 51458]]

contain a variety of ``separateness'' covenants. These include, among 
other things, requirements that the Issuer: Maintain fully separate 
books and records, not commingle assets with any other entity, maintain 
separate accounts, conduct business in its own name, prepare separate 
financial statements, engage only in arm's-length transactions with 
affiliates, pay its liabilities only from its own funds, observe all 
trust, corporate or partnership formalities (as applicable), not 
guarantee the debts or pledge its assets in support of another entity, 
hold itself out to be a separate legal entity and maintain adequate 
capital for its business operations. In certain transactions, legal 
opinions are delivered to the effect that adherence to these covenants 
would be sufficient to prevent a court from ordering the substantive 
consolidation of the Issuer into a debtor-parent or affiliate. The 
Applicant has suggested similar restrictions relating to the activities 
of the Issuer and the parties to an ABS/MBS transaction that would 
serve as conditions of the exemptive relief requested with respect to 
non-Trust Issuers (see section II.A.(8) of the Proposed Amendment).
    The Applicant states that whether an Issuer is structured as a 
corporation, limited partnership, limited liability corporation or 
trust will have little impact on the relevant bankruptcy or insolvency 
protection features. They are merely different legal entities with 
differing structures but will produce, in the aggregate, similar types 
of protections for investors. A corporation will have shareholders (who 
benefit from limited liability protections) and debt holders (who enjoy 
a superior claim on assets to that of shareholders and are taxed 
differently). A limited partnership will have general partners (who 
operate the entity and are ultimately responsible for its debts) and 
limited partners (who will receive investment earnings but are only 
liable to the extent of their actual investment in the event of 
losses). In a limited liability corporation, ``members'' (also the 
holders of equity Securities) are given the limited liability 
protections of a corporation's equity holders (much like limited 
partners but with a greater degree of permitted active management 
abilities). In an owner trust (which is also referred to as a business 
trust), the trust itself is a separately existing entity that is under 
the day-to-day control of its trustee but whose profits are 
distributable to the beneficial owners. According to the Applicant, an 
owner trust is essentially a Delaware business trust or similar entity 
as organized under other local law. An owner trust may also issue debt 
instruments. It can also declare bankruptcy (unlike a common law trust 
which does not exist as a legal entity distinct and separate from its 
creator). As previously indicated, the specific entity chosen for a 
structured finance transaction is often motivated by tax considerations 
and less so by any legal advantage of one structural form over another.

C. Rights of Equity and Debt Holders

    Equity holders have an undivided beneficial ownership interest in 
the issuer's assets. Debt holders do not beneficially own such assets 
but have a security interest in such assets which has preference over 
the rights of the equity holders to such collateral. The Applicant 
believes that, since the Underwriter Exemptions currently allow equity 
investments by plans, it is entirely appropriate for the Department to 
also provide relief for debt instruments which give their holders 
preferential rights to the collateral.
    The equity holders, limited partners or other beneficial owners of 
all types of Issuers are liable on the obligations of the entity only 
to the extent of such holders' investment and are not personally liable 
on any obligations in excess thereof. In general, each type of Issuer 
may issue debt, and while debt holders (or note holders) of any of 
these entities do not own an ownership interest in the assets of the 
Issuer, they are entitled to preferential treatment over equity holders 
(e.g., certificateholders) or limited partners with respect to rights 
to collateral. To protect equity and debt holders further, the pooled 
assets of any specific transaction will be placed under the control of 
a trustee who is independent from the Sponsor and the Servicers. This 
can be accomplished in different ways depending on the type of Issuer. 
If the Issuer is a trust and only equity Securities are issued, then 
the trustee of the trust would have control over the pooled assets. If 
instead, debt Securities are issued by any type of Issuer (trust or 
non-trust), then the Indenture Trustee would have control of the pooled 
assets. Accordingly, any requirements under the Proposed Exemption 
applying to the ``trustee'' will apply to both the trustee of any 
Issuer which is a trust and to any Indenture Trustee (each a 
``Trustee'' and any Issuer which is a trust, a ``Trust''). In any 
transaction where debt Securities are issued, possession of the assets 
by the Trustee or filing a security interest would serve to perfect the 
debt holders' security interest in the pooled assets. In transactions 
involving debt Securities, the Rating Agencies require perfected 
security interest opinions. The Applicant agrees to make perfected 
security interest opinions a condition of exemptive relief for those 
securities issued which are debt instruments.

D. Choice of Issuer and Choice of Debt Versus Equity Securities

    The principal determining factors for the choice of securitization 
vehicle and whether equity or debt Securities are issued are tax and 
accounting considerations which have no affect on plan investors as 
they are tax exempt.\12\
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    \12\ Although plans are subject to tax on their unrelated 
business taxable income under sections 511-514 of the Internal 
Revenue Code of 1986, as amended (UBTI), the kind of income produced 
in securitization transactions does not generally trigger UBTI if 
the plan investor holds a Security which is treated as a debt 
instrument for tax purposes.
---------------------------------------------------------------------------

    Although the decision as to whether debt or equity Securities are 
issued does not significantly affect the interests of the 
securityholders, it does affect the Sponsor of an Issuer. A Sponsor may 
want to be able to recognize the gain from the sale of the receivables 
to the Issuer for accounting purposes but not have the sale trigger 
gain for tax purposes. Under Statement of Financial Accounting 
Standards No. 125 (FASB 125) issued by the Financial Accounting 
Standards Board, generally a transfer of assets to an Issuer which 
results in the Sponsor surrendering control of the transferred assets 
will allow the Sponsor to book the gain for accounting purposes. 
However, the tax treatment to a Sponsor can be greatly affected by 
whether the Issuer issues debt or equity Securities. For example, if an 
Issuer other than a REMIC or a FASIT issues debt, the Sponsor is 
generally not taxed on the sale of the assets into the Trust (which is 
treated instead as a financing) but will be taxed on the same 
percentage of the economic gain on such sale as the proportion of 
equity interest in the Issuer which is sold by the Sponsor. By way of 
illustration, if an Issuer issues $100 of Securities, $6 of which are 
equity and $94 are debt, and the Sponsor keeps 100% of the equity and 
sells all of the debt, it will not be taxed on the gain from selling 
the assets to the Trust. However, if the Sponsor issues $100 of equity 
Securities and sells 94% of them, it will recognize gain of $94 on the 
sale of the Securities. Accordingly, if a transaction does not qualify 
under the REMIC or FASIT rules, the transaction may be structured to 
issue debt instruments.

E. Effect of Tax Rules on Choice of Issuer and Securities

    The Applicant notes that the choice of Issuer and whether the 
Securities

[[Page 51459]]

offered are debt or equity is also greatly affected by the tax rules 
governing each type of Issuer. The tax characterization of Issuers is 
not necessarily the same as their characterization under local law. For 
example, a Trust can be taxed as a trust, a partnership, a corporation 
or be completely ignored for tax purposes. Conversely, any form of 
Issuer can be treated as a REMIC or FASIT for tax purposes if it meets 
the applicable requirements and so elects. However, regardless of the 
tax characterizations, the transaction will be structured to avoid 
double taxation; i.e., taxation at both the Issuer level and the 
investor level (for investors who are tax-paying entities). The tax 
treatment of each type of Issuer with respect to which exemptive relief 
is requested is as follows.
1. Grantor Trust
    Under the Federal tax rules which govern grantor trusts as set 
forth in Treas. Reg. section 301.7701-4(c), a grantor Trust is 
disregarded for tax purposes and the securityholders are generally 
taxed on their ratable share of the income of the Trust. There is no 
specific prohibition on a grantor Trust's ability to issue debt under 
the tax rules. However, this is usually not done because if the debt 
securities were ever recharacterized as equity for tax purposes, the 
trust could be viewed as violating Treas. Reg. section 301.7701-4(c) 
which generally prohibits multiple classes of equity from being issued. 
Although a grantor Trust is not permitted to issue multiple classes of 
equity with disproportionate payments or fast-pay/slow-pay structures, 
it may issue a senior class and a subordinated class, provided that 
they each receive normal distributions pro rata. Because a grantor 
Trust may not issue Securities with different maturity dates, real 
estate related securitization transactions which are intended to have 
these features are often structured as REMICs.
2. REMICs
    REMICs can be formed as any type of Issuer; i.e., Trust, 
corporation, partnership, limited liability company or even a 
segregated pool of assets. A REMIC is permitted to issue both equity 
and debt Securities but usually is set up as a Trust which issues 
equity Securities. The REMIC itself does not pay tax, but the residual 
equity holder instead is taxed on the REMIC's taxable income. REMIC 
``regular'' interests are treated as debt instruments for tax purposes. 
One of the principal advantages to using a REMIC structure is that the 
transaction can use a fast-pay/slow-pay structure.
3. FASITs
    FASITs can also be formed as any type of Issuer and can be a 
segregated pool of assets. FASITs are a type of statutory entity 
created by the Small Business Job Protection Act of 1996 (SBA) through 
amendments to the Code effective on September 1, 1997.\13\ FASITs are 
designed to facilitate the securitization \14\ of debt obligations, 
such as credit card receivables, home equity loans and auto loans, and 
thus allows certain features such as revolving pools of assets, Issuers 
containing unsecured receivables and certain hedging types of 
investments. A FASIT is permitted to issue both equity and debt 
Securities. A FASIT is not a taxable entity and debt instruments issued 
by such Issuers, which might otherwise be recharacterized as equity, 
will be treated as debt in the hands of the holder for tax purposes. 
The holder of the ownership interest (which may not be a pension plan) 
is taxed on the FASIT income. FASIT ``regular interests'' are treated 
as debt instruments.
---------------------------------------------------------------------------

    \13\ Section 1621 of the SBA added sections 860H, 860I, 860J, 
860K and 860L to the Internal Revenue Code of 1986, as amended.
    \14\ Securitization is the process of converting one type of 
asset into another and generally involves the use of an entity 
separate from the underlying assets. In the case of securitization 
of debt instruments, the instruments created in the securitization 
typically have different maturities and characteristics than the 
debt instruments that are securitized.
---------------------------------------------------------------------------

    Although FASITs are permitted to have revolving pools of permitted 
assets, exemptive relief is only currently available for FASITs that 
are, in fact, passive in nature which would preclude (in the absence of 
other exemptive relief) revolving asset pools. Thus, only FASITs with 
assets which were comprised of secured debt and which did not allow 
revolving pools of assets or hedging investments not otherwise 
specifically authorized by the Underwriter Exemptions would be 
permissible.
4. Owner Trusts
    There are many situations where a securitization transaction wishes 
to use a Trust as the Issuer but cannot qualify as a REMIC or a grantor 
Trust. These include transactions that do not qualify as REMICs because 
they either do not involve real estate assets (e.g., motor vehicle 
transactions) or are real estate transactions where the REMIC rules are 
not satisfied (e.g., the LTV ratios exceed the REMIC limits or the Pre-
Funding Period exceeds three months). If the parties wish to use the 
type of tranching which uses a fast-pay/slow-pay structure, they also 
cannot qualify as a grantor Trust. In such cases, the Issuer will be 
set up as an owner Trust which is a business Trust. State statutory and 
common law governs the formation and operation of owner trusts. An 
owner Trust with more than one equity holder is treated as a 
partnership with the same tax effects as the other types of Issuers 
described above. The ``partnership'' is not taxed; its income is taxed 
to its equity holders and any debt holders are taxed on the interest 
income they receive. If the owner Trust is wholly owned, it is 
disregarded for tax purposes.\15\ Whoever holds the equity in the owner 
Trust is the beneficial owner of the trust assets. Therefore, if the 
equity is sold to more than one entity it could have multiple 
beneficial owners. The debt holder(s) would have a security interest in 
the owner Trust assets.
---------------------------------------------------------------------------

    \15\ Whether an entity is wholly owned or owned by more than one 
equity holder is determined under the tax rules.
---------------------------------------------------------------------------

5. Limited Liability Companies, Partnerships and Special Purpose 
Corporations
    Entities which are limited liability companies with more than one 
equity holder or are partnerships under local law are taxed as 
partnerships. If the limited liability company is wholly owned, it is 
also disregarded for tax purposes.\16\ A special purpose corporation is 
taxed on its income, but it receives a deduction for interest paid to 
debt holders, so the tax result is similar to that of a partnership.
---------------------------------------------------------------------------

    \16\ Id.
---------------------------------------------------------------------------

    While the permissible types of Issuers under the requested 
exemption include Issuers which are not required under the tax rules to 
be passive entities,\17\ in order for a transaction to qualify for 
exemptive relief, each of the applicable requirements of the 
Underwriter Exemptions as modified must be met. This would mean, for 
example, that only transactions involving Issuers holding assets which 
are comprised of secured debt (unless the assets are residential and 
home equity loans in a Designated Transaction) and which do not allow 
revolving pools of assets or hedging investments (unless specifically 
authorized) are permissible under the requested relief. Specifically, 
the Issuer must be maintained as an essentially passive entity, and, 
therefore, both the Sponsor's discretion and the Servicer's discretion 
with respect to assets included in an Issuer must be severely limited 
both as to those assets transferred on the Closing Date and

[[Page 51460]]

those acquired during any Pre-Funding Period. Pooling and Servicing 
Agreements provide for the substitution of Issuer receivables by the 
Sponsor only in the event of breaches of representations and warranties 
or defects in documentation discovered within a short time after the 
issuance of Securities (within 120 days, except in the case of 
obligations having an original term of 30 years, in which case the 
period will not exceed two years). Any receivable so substituted is 
required to have characteristics substantially similar to the replaced 
receivable and will be at least as creditworthy as the replaced 
receivable. In some cases, the affected receivable would be 
repurchased, with the purchase price applied as a payment on the 
affected receivable and passed through to securityholders.
---------------------------------------------------------------------------

    \17\ Grantor trusts and REMICs are required under the tax rules 
to be passive entities with limited asset substitution rights, but 
other types of Issuers are not so restricted.
---------------------------------------------------------------------------

F. The Applicant's Arguments for Exemptive Relief for Different Types 
of Issuers and Securities

    Although, as previously noted, the choice of Issuer does not 
significantly affect the rights of securityholders or the safety of the 
investments, ERISA's prohibited transaction rules affect whether plan 
investors can purchase these different forms of ABS/MBS. The plan asset 
regulation set forth at 29 CFR Sec. 2510-3.101 (the Plan Asset 
Regulation) was intended to prevent an employee benefit plan subject to 
ERISA from retaining an asset manager indirectly through an equity 
investment by the plan in an investment fund in order to avoid the 
fiduciary responsibility and prohibited transaction provisions of 
ERISA. The Department made a determination that debt instruments should 
not be subject to the Plan Asset Regulations as they were not likely to 
be vehicles for the indirect provision of investment management 
services.\18\ As a consequence of this regulation, the treatment of 
debt and the treatment of equity is very different under ERISA. Equity 
investments in ABS/MBS not only can result in the purchase and sale of 
the securities triggering prohibited transactions, but if the 
underlying assets of the Trust are deemed to include plan assets, the 
operation of the Trust and the servicing of its assets can also trigger 
prohibited transactions.
---------------------------------------------------------------------------

    \18\ See the preamble to the final Plan Asset Regulation, 51 FR 
41280 (Nov. 13, 1986).
---------------------------------------------------------------------------

    In contrast, investments in ABS/MBS which are debt securities avoid 
any plan asset issues with respect to the operation of the Trust. 
However, they can still result in one or more prohibited transactions. 
This is because the acquisition or disposition of the debt security 
itself may be a sale or exchange of property between a plan and a party 
in interest and also an extension of credit between such entities. The 
acquisition or disposition of the debt securities may be covered under 
PTE 75-1. However, in many ABS/MBS transactions, the conditions of PTE 
75-1 may not be met, i.e., where a broker-dealer is not selling the 
securities but is instead acting as the placement agent for securities 
which are being offered pursuant to a private placement exempt from 
registration under the Securities Act of 1933. Similarly, if a plan 
sold the ABS/MBS to a party in interest in the secondary market, Part V 
of PTE 75-1 would not apply since it is limited to extensions of credit 
to a plan in connection with the purchase or sale of securities (e.g., 
extensions of credits during the three-day settlement period).
    When a plan purchases an ABS/MBS which is a debt security, it is 
effectively viewed as an extension of credit to the Issuer for ERISA 
purposes. While the Issuer, as a newly formed, special purpose entity, 
would not be a party in interest with respect to such plan, if the 
Issuer is deemed to be an affiliate of an existing party in interest, 
this could create a prohibited extension of credit. Whenever ABS/MBS 
are issued as debt, some other entity will own the equity of the 
Issuer, either as a residual equity interest held by the Sponsor or all 
or part of the equity could be sold to the public. If any equity holder 
which owns a 50% or more interest in the Issuer is a party in interest 
with respect to a plan holding the debt security, the Issuer will be 
deemed a party in interest under 3(14)(G) of ERISA. This problem is 
compounded by the fact that most publicly-offered securities are held 
by the Depository Trust Company and Clearing Corporation so that the 
identity of the public equity holders may not be known either at the 
initial issuance of the securities or when a security is sold in the 
secondary market. Accordingly, there is a need for the Underwriter 
Exemptions to cover the acquisition, disposition and holding of debt 
securities which is not met by PTE 75-1.
    As debt securities generally are not eligible for relief under the 
Underwriter Exemptions, an ABS/MBS which is a debt security may not be 
purchased by a plan investor from a party in interest unless another 
exemption is available. This is an anomalous result since the rights of 
debt holders in ABS/MBS transactions are senior to those of 
Certificateholders, and the decision to issue debt or equity ABS/MBS is 
not dictated by the relative rights of the investor but is made based 
on tax and accounting considerations which are not relevant to plan 
investors. In fact, purchasers make the decision to invest in ABS/MBS 
based on the projected return on the securities and the quality and 
sufficiency of the underlying obligations in the pool without regard to 
the characterization as debt or equity. According to the Applicant, 
either type of security issued in an ABS/MBS transaction is viewed by 
plan investment managers as a fixed income alternative to corporate 
bonds. The fact that ABS/MBS pass-through Certificates are equity 
interests under local law is completely disregarded by plan investors 
except to the extent that the equity characterization negatively 
impacts ERISA eligibility of those securities in the absence of an 
exemption. Thus, the Applicant asserts that allowing debt securities 
issued in ABS/MBS transactions to be eligible securities under the 
Underwriter Exemptions is beneficial to such investors in their efforts 
to diversify plan assets.
    In this regard, the Applicant has submitted letters from the Rating 
Agencies which state that the legal form of the issuer does not affect 
the ratings given to comparable securities and that the Rating 
Agencies' analysis takes into account the legal and structural risks of 
each type of Issuer. Accordingly, the Applicant believes that, if a 
particular transaction has sufficient substantive safeguards to protect 
the interests of plan investors, the choice of Issuer or whether the 
particular security is debt or equity should not be determinative of 
whether they are eligible investments for ERISA plans.
    Although the Applicant is requesting that the definition of 
securitization vehicle be expanded to include special purpose 
corporations, partnerships and limited liability companies, none of 
which is a Trust, the Applicant believes that any and all requirements 
under the Underwriter Exemptions which currently are applicable to the 
``Trustee'' will continue to be applicable and are appropriate no 
matter what type of Issuer is used. This is because, even in 
transactions where the Issuer is not a Trust, ABS/MBS which are debt 
securities will be issued pursuant to a Trust indenture, and there will 
be an Indenture Trustee representing the interests of debt holders 
which will be independent of the Sponsor and other members of the 
Restricted Group. The Indenture Trustee is the trustee appointed 
pursuant to an indenture which provides for the pledge of collateral to 
secure the debt securities issued by the issuer pursuant to the

[[Page 51461]]

indenture and sets forth the rights of the debt holders. Accordingly, 
the fact that an Issuer which is not a Trust does not have a Trustee 
will not affect the existing requirement under the Underwriter 
Exemptions relating to an independent Trustee that is not an affiliate 
of any other member of the Restricted Group (see section III.M. of the 
Proposed Amendment). Thus, there will always be an Independent Trustee 
in transactions entered into pursuant to the requested exemption. The 
Applicant notes that where the Issuer is not a Trust, equity will not 
be sold to plans.

G. Classes of Securities

    The Applicant notes that some of the Securities will be multi-class 
Securities. The Applicant requests exemptive relief for two types of 
multi-class Securities: ``strip'' Securities and ``fast-pay/slow-pay'' 
Securities. Strip Securities are a type of Security in which the stream 
of interest payments on receivables is split from the flow of principal 
payments and separate classes of Securities are established, each 
representing rights to disproportionate payments of principal and 
interest.\19\
---------------------------------------------------------------------------

    \ 19\ It is the Department's understanding that where a plan 
invests in REMIC ``residual'' interest Certificates to which this 
Exemption applies, some of the income received by the plan as a 
result of such investment may be considered unrelated business 
taxable income to the plan, which is subject to income tax under the 
Code. The Department emphasizes that the prudence requirement of 
section 404(a)(1)(B) of the Act would require plan fiduciaries to 
carefully consider this and other tax consequences prior to causing 
plan assets to be invested in Certificates pursuant to this Proposed 
Exemption.
---------------------------------------------------------------------------

    ``Fast-pay/slow-pay'' Securities involve the issuance of classes of 
Securities having different stated maturities or the same maturities 
with different payment schedules. Interest and/or principal payments 
received on the underlying Issuer's assets are distributed first to the 
class of Securities having the earliest stated maturity of principal 
and/or earlier payment schedule, and only when that class of Securities 
has been paid in full (or has received a specified amount) will 
distributions be made with respect to the second class of Securities. 
Distributions on Securities having later stated maturities will proceed 
in like manner until all the securityholders have been paid in full. 
The only difference between this multi-class arrangement and a single-
class arrangement is the order in which distributions are made to 
securityholders. In each case, securityholders will have a beneficial 
ownership interest in the underlying Issuer's assets or a security 
interest in the collateral securing such assets. Except as permitted in 
a Designated Transaction, the rights of a plan purchasing Securities 
will not be subordinated to the rights of another securityholder in the 
event of default on any of the underlying obligations. In particular, 
unless the Securities are issued in a Designated Transaction, if the 
amount available for distribution to securityholders is less than the 
amount required to be so distributed, all senior securityholders will 
share in the amount distributed on a pro rata basis.\20\
---------------------------------------------------------------------------

    \ 20\ If an Issuer issues subordinated Securities, holders of 
such subordinated Securities may not share in the amount distributed 
on a pro rata basis. The Department notes that the Proposed 
Exemption does not provide relief for plan investment in such 
subordinated Securities, unless the Securities are issued in a 
Designated Transaction.
---------------------------------------------------------------------------

III. Requested Modifications for Interest Rate Swap Agreements

A. Interest Rate Swaps

    PTE 98-13 and PTE 98-14 provide exemptive relief for 
securitizations featuring revolving pools of secured and unsecured 
credit card receivables held in Trusts sponsored by MBNA and Citibank, 
respectively, which Trusts may also hold simple interest rate swaps as 
an asset. The granting of these exemptions involved extensive 
discussions between the Department and representatives of MBNA and 
Citibank as to the structure and operation of credit card 
securitizations, including the use of interest rate swaps, and the 
approach used by the Rating Agencies in rating these types of 
securities where the rating given by the Rating Agency is dependent 
upon the existence of an interest rate swap agreement.
    Interest rate swaps are used in non-credit card securitization 
transactions in the same manner that they are used in credit card 
transactions; i.e., where the index used to calculate interest payments 
on the receivables is different than the index used to calculate 
interest payments on the securities issued by the Trust. For example, 
many securities bear interest based upon the London Interbank Offered 
Rate for dollar deposits of a specified maturity (LIBOR). However, the 
assets being securitized often bear interest at fixed rates or rates 
based upon U.S. Treasury securities, the prime rate or other indices 
that may not move in tandem with LIBOR. The swap helps assure that the 
Trust will have sufficient funds to make full payments of interest on 
the securities.
    The Applicant states that a class of Securities in a non-credit 
card securitization may have the benefit of an interest rate swap 
agreement entered into between the Issuer and a bank or other financial 
institution acting as a swap counterparty. Pursuant to the swap 
agreement, the swap counterparty would pay a certain rate of interest 
to the Issuer in return for a payment of a rate of interest by the 
Issuer, from collections allocable to the relevant class of Securities, 
to the swap counterparty. The Applicant represents that the credit 
rating provided to a particular class of Securities by the relevant 
Rating Agency may or may not be dependent upon the existence of a swap 
agreement. Thus, in some instances, the terms and conditions of the 
swap agreements will not affect the credit rating of the class of 
Securities to which the swap relates (i.e., a Non-Ratings Dependent 
Swap).
    The Applicant requests that the same exemptive relief which has 
been provided to MBNA and Citibank with respect to interest rate swaps 
be extended to all securitization transactions, otherwise meeting the 
conditions of the requested amendment. Thus, the Applicant is 
requesting relief for both ratings dependent and non-ratings dependent 
swaps as described in PTE 98-13 and PTE 98-14 (the Credit Card 
Exemptions), subject to the same terms and conditions regarding 
interest rate swaps contained in those exemptions. Consistent with the 
conditions of the Credit Card Exemptions, the Applicant has included 
the swap counterparty as a member of the Restricted Group. However, two 
revisions regarding interest rate swaps are necessary in order to make 
the swap provisions compatible with fixed asset pool transactions.
    First, the Credit Card Exemptions require that a ratings dependent 
swap include as an early payout event the withdrawal or reduction by a 
Rating Agency of the swap counterparty's credit rating where the 
Servicer has failed to meet its obligations under the Pooling and 
Servicing Agreement relating to obtaining a replacement swap agreement 
or causing the swap counterparty to post collateral. The early payout 
causes principal to be paid out for the benefit of securityholders 
instead of being used to purchase additional credit card receivables. 
In contrast, all principal and interest payments received by the Issuer 
in non-revolving pool transactions are used to make payments to either 
the securityholders, the swap counterparty or to pay servicing fees or 
other expenses; none are used to purchase additional obligations for 
deposit into the Issuer. Accordingly, the concept of an early payout 
event is not relevant for

[[Page 51462]]

the non-revolving pools of assets which are covered under the 
Underwriter Exemptions. Instead, the Applicant is proposing that if the 
swap counterparty's rating is downgraded, and the Servicer fails to 
obtain an acceptable replacement swap or to cause the swap counterparty 
to post collateral or make other arrangements satisfactory to the 
Rating Agency, the plan certificateholders would be notified in the 
immediately following Trustee's periodic report and would have sixty 
days thereafter to dispose of the Certificates before the exemptive 
relief under section I.C. of the Underwriter Exemptions with respect to 
the servicing, management and operation of the Issuer would 
prospectively cease to be available. The party responsible for such 
notification may be the Sponsor, the Trustee, a third-party 
administrator or any other party designated in the pooling and 
servicing agreement and/or servicing agreement to give periodic reports 
to the securityholders.
    Second, the Credit Card Exemptions use the term ``Excess Finance 
Charge Collections'' which is not relevant to non-credit card ABS/MBS 
transactions. Accordingly, the Applicant has substituted the term 
``Excess Spread'' which is the functionally equivalent term and best 
suited to the types of transactions covered by the Underwriter 
Exemptions. The term ``excess spread'' applies to both ratings 
dependent and non-ratings dependent swaps and is defined as the amount, 
as of any given day funds are distributed from the issuer, by which the 
interest allocated to the securities exceeds the amount necessary to 
pay interest to the securityholders, servicing fees and issuer 
expenses. This term is defined in section III.II. of the Proposed 
Amendment.
    The Applicant believes that allowing the use of interest rate swaps 
is beneficial to plan investors as it helps to protect them from the 
risk of interest rate fluctuations. The conditions the Department has 
imposed in PTE 98-13 and PTE 98-14, which will be met with respect to 
any interest rate swap used in transactions covered by the requested 
exemption, will further protect the interest of plans. Accordingly, the 
Applicant represents that whether or not the credit rating of a 
particular class of Securities is dependent upon the terms and 
conditions of one or more interest rate swap agreements entered into by 
the Issuer (i.e., a ``Ratings Dependent Swap'' or a ``Non-Ratings 
Dependent Swap''), each particular swap transaction will be an 
``Eligible Swap'' as defined in the Proposed Amendment.

B. Conditions

    In this regard, an Eligible Swap will be a swap transaction:
    1. Which is denominated in U.S. Dollars;
    2. Pursuant to which the Issuer pays or receives, on or immediately 
prior to the respective payment or distribution date for the applicable 
class of Securities, a fixed rate of interest or a floating rate of 
interest based on a publicly available index (e.g. LIBOR or the U.S. 
Federal Reserve's Cost of Funds Index (COFI)), with the Issuer 
receiving such payments on at least a quarterly basis and being 
obligated to make separate payments no more frequently than the 
counterparty, with all simultaneous payments being netted;
    3. Which has a notional amount that does not exceed either: (i) The 
principal balance of the class of Securities to which the swap relates, 
or (ii) the portion of the principal balance of such class represented 
solely by those types of corpus or assets of the Issuer referred to in 
subsections III.B. (1), (2) and (3) of the Proposed Amendment;
    4. Which is not leveraged (i.e., payments are based on the 
applicable notional amount, the day count fractions, the fixed or 
floating rates designated in item (b) above and the difference between 
the products thereof, calculated on a one-to-one ratio and not on a 
multiplier of such difference);
    5. Which has a final termination date that is the earlier of the 
date on which the Issuer terminates or the related class of Securities 
is fully repaid; and
    6. Which does not incorporate any provision which could cause a 
unilateral alteration in any provision described in items (1) through 
(5) above without the consent of the Trustee.
    In addition, any Eligible Swap entered into by the Issuer will be 
with an ``Eligible Swap Counterparty,'' which will be a bank or other 
financial institution with a rating at the date of issuance of the 
Securities by the Issuer which is in one of the three highest long-term 
credit rating categories, or one of the two highest short-term credit 
rating categories, utilized by at least one of the Rating Agencies 
rating the Securities; provided that, if a swap counterparty is relying 
on its short-term rating to establish its eligibility, such 
counterparty must either have a long-term rating in one of the three 
highest long-term rating categories or not have a long-term rating from 
the applicable Rating Agency, and provided further that if the class of 
Securities with which the swap is associated has a final maturity date 
of more than one year from the date of issuance of the Securities, and 
such swap is a Ratings Dependent Swap, the swap counterparty is 
required by the terms of the swap agreement to establish any 
collateralization or other arrangement satisfactory to the Rating 
Agencies in the event of a ratings downgrade of the swap counterparty.
    Under any termination of a swap, the Issuer will not be required to 
make any termination payments to the swap counterparty (other than a 
currently scheduled payment under the swap agreement) except from 
Excess Spread or other amounts that would otherwise be payable to the 
Servicer or the Sponsor.
    With respect to a Rating Dependent Swap, the Servicer shall either 
cause the Eligible Counterparty to establish certain collateralization 
or other arrangements satisfactory to the Rating Agencies in the event 
of a rating downgrade of such swap counterparty below a level specified 
by the Rating Agency (which will be no lower than the level which would 
make such counterparty an Eligible Counterparty), or the Servicer shall 
obtain a replacement swap with an Eligible Swap Counterparty acceptable 
to the Rating Agencies with substantially similar terms. If the 
Servicer fails to do so, the plan securityholders will be notified in 
the immediately following Trustee's periodic report to securityholders 
and will have a 60-day period thereafter to dispose of the Securities, 
at the end of which period the exemptive relief provided under section 
I.C. of the Underwriter Exemption (relating to the servicing, 
management and operation of the Issuer) would prospectively cease to be 
available. With respect to Non-Ratings Dependent Swaps, each Rating 
Agency rating the Securities must confirm, as of the date of issuance 
of the Securities by the Issuer, that entering into the swap 
transactions with the Eligible Counterparty will not affect the rating 
of the Securities, even if such counterparty is no longer an Eligible 
Counterparty and the swap is terminated.\21\
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    \21\ In the course of considering applications for exemptive 
relief under PTE 98-13 and PTE 98-14, the Department received 
representations from the Rating Agencies that certain classes of 
Securities issued by an Issuer holding receivables will have 
Securities ratings that are not dependent on the existence of a swap 
transaction entered into by the Issuer. Therefore, a downgrade in 
the swap counterparty's credit rating would not cause a downgrade in 
the rating established by the Rating Agency for the Securities. 
These Rating Agency representations stated that in such instances, 
there will be more credit enhancements (e.g., ``excess spread,'' 
letters of credit, cash collateral accounts) for the class to 
protect the securityholders than there would be in a comparable 
class where the Issuer enters into a so-called Ratings Dependent 
Swap. Non-Ratings Dependent Swaps are generally used as a 
convenience to enable the Issuer to pay certain fixed interest rates 
on a class of Securities. However, the receipt of such fixed rates 
by the Issuer from the counterparty is not a necessity for the 
Issuer to be able to make its fixed rate payments to the 
securityholders.

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[[Page 51463]]

    Any class of Securities to which one or more swap agreements 
entered into by the Issuer applies will be acquired or held only by 
Qualified Plan Investors. Qualified Plan Investors will be plan 
investors represented by an appropriate independent fiduciary that is 
qualified to analyze and understand the terms and conditions of any 
swap transaction relating to the class of Securities to be purchased 
and the effect such swap would have upon the credit rating of the 
Securities to which the swap relates.
    For purposes of the Underwriter Exemptions, such a qualified 
independent fiduciary will be either:
    (a) A ``qualified professional asset manager'' (i.e., QPAM), as 
defined under Part V(a) of PTE 84-14;
    (b) An ``in-house asset manager'' (i.e., INHAM), as defined under 
Part IV(a) of PTE 96-23; or
    (c) A plan fiduciary with total assets under management of at least 
$100 million at the time of the acquisition of such Securities.

C. Yield Supplement Agreements

    A yield supplement agreement is a contract under which the issuer 
makes a single cash payment to the contract provider in return for the 
contract provider promising to make certain payments to the issuer in 
the event of market fluctuations in interest rates. For example, if a 
class of securities promises an interest rate which is the greater of 
7% or LIBOR and LIBOR increases significantly, the yield supplement 
agreement might obligate the contract provider pay to the issuer the 
excess of LIBOR over 7%. In some circumstances, the contract provider's 
obligation may be capped at a certain aggregate maximum dollar 
liability under the contract. Alternatively, a cap could be placed on 
the supplemental interest that would be paid to a securityholder from 
monies paid under the yield supplement agreement. For example, the 
yield supplement agreement would provide the difference between LIBOR 
and 7% but only to the extent that the securityholder would be paid a 
total of 9%. The interest to be paid by the contract provider to the 
issuer under the yield supplement agreement is usually calculated based 
on a notional principal balance which may mirror the principal balances 
of those classes of securities to which the yield supplement agreement 
relates or some other fixed amount. This notional amount will not 
exceed either: (i) The principal balance of the class of Securities to 
which such agreement or arrangement relates, or (ii) the portion of the 
principal balance of such class represented solely by those types of 
corpus or assets of the Issuer referred to in subsections III.B. (1), 
(2) and (3) of the Proposed Amendment. In all cases, the issuer makes 
no payments other than the fixed purchase price for the yield 
supplement agreement and may, therefore, be distinguished from an 
interest rate swap agreement, notwithstanding that both types of 
agreements may use an ISDA form of contract. The 1997 Amendment 
includes within the definition of ``Trust'' cash or investments made 
therewith which are credited to an account to provide payments to 
certificateholders pursuant to any yield supplement agreement or 
similar yield maintenance arrangement provided that such arrangements 
do not involve swap agreements or other notional principal contracts. 
However, the Applicant notes that the Credit Card Exemptions (PTE 98-13 
and PTE 98-14) permit interest rate swaps which clearly feature 
notional principal amounts. In addition to requesting exemptive relief 
for ``plain vanilla'' interest rate swaps, the Applicant also requests 
relief for yield supplement arrangements that do not involve interest 
rate payments by the Trustee, even if they have a notional principal 
amount.
    Accordingly, the Applicant is requesting that yield supplement 
agreements with notional principal amounts be permitted retroactively 
to April 7, 1998, which is the date that PTE 98-13 and PTE 98-14 were 
issued as final exemptions. The Applicant's request for relief covers 
only the type of interest rate cap agreements which are currently 
covered under the Underwriter Exemptions. The only change being 
requested is to clarify that agreements which have a notional principal 
balance and/or are set forth on International Swaps and Derivatives 
Association, Inc. (``ISDA'') forms will be permitted.
    The Applicant notes that no ``plan assets'' within the meaning of 
the Plan Asset Regulation (under 29 CFR 2510-3-101) are utilized in the 
purchase of the cap agreement, as the Sponsor or some other third party 
funds such arrangement with an up-front single-sum payment. The 
Issuer's only obligation is to receive payments from the counterparty 
if interest rate fluctuations require them under the terms of the 
contract and to pass them through to securityholders. The Rating 
Agencies examine the creditworthiness of the counterparty in a ratings 
dependent yield supplement agreement. The Applicant suggests that the 
relief for yield supplement agreements should be subject to the same 
conditions as for interest rate swaps found in the Credit Card 
Exemptions ( PTE 98-13 and PTE 98-14), to the extent relevant. These 
conditions would include that the yield supplement agreement must be 
denominated in U.S. dollars, the agreement must not be leveraged, any 
changes in these conditions must be subject to the consent of the 
Trustee, and the counterparty must be subject to the same eligibility 
requirements as an interest rate swap counterparty.

IV. Other Features of Securitizations

A. Formation of the Issuer

    Each Issuer is established under a Pooling and Servicing Agreement 
or equivalent agreement between a Sponsor, a Servicer and a Trustee. 
Prior to the Closing Date under the Pooling and Servicing Agreement, 
the Sponsor and/or Servicer selects receivables from the classes of 
assets described in section III.B.(1)(a)-(f) of the Underwriter 
Exemptions to be included in the Issuer, establishes the Issuer and 
designates an independent entity as Trustee. Typically, on or prior to 
the Closing Date, the Sponsor acquires legal title to all assets 
selected for the Issuer. In some cases, legal title to some or all of 
such assets continue to be held by the originator until the Closing 
Date. On the Closing Date, the Sponsor and/or the originator conveys to 
the Issuer legal title to the assets, and the Issuer issues Securities 
representing fractional undivided interests in the Issuer's assets and/
or debt obligations of the Issuer.

B. Pre-Funding Accounts

    While in many cases all of the receivables to be held in the Issuer 
are transferred to the Issuer on or prior to the Closing Date,\22\ it 
is also common for other transactions to be structured using a Pre-
Funding Account and/or a Capitalized Interest Account as described 
below. If pre-funding is used, some portion of the receivables will be 
transferred after the Closing Date during an interim Pre-Funding 
Period. The Pre-Funding Period for any Issuer will be

[[Page 51464]]

defined as the period beginning on the Closing Date and ending on the 
earliest to occur of: (i) The date on which the amount on deposit in 
the Pre-Funding Account is less than a specified dollar amount, (ii) 
the date on which an event of default occurs under the related Pooling 
and Servicing Agreement \23\ or (iii) the date which is the later of 
three months or ninety days after the Closing Date. If pre-funding is 
used, cash sufficient to purchase the receivables to be transferred 
after the Closing Date will be transferred to the Issuer by the Sponsor 
or originator on the Closing Date. During the Pre-Funding Period, such 
cash and temporary investments, if any, made therewith will be held in 
a Pre-Funding Account and used to purchase the additional receivables, 
the characteristics of which will be substantially similar to the 
characteristics of the receivables transferred to the Issuer on the 
Closing Date. Certain specificity and monitoring requirements described 
below will be met which will be disclosed in the Pooling and Servicing 
Agreement and/or the prospectus \24\ or private placement memorandum.
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    \22\ The Department is of the view that the term ``Issuer'' 
under the Underwriter Exemptions would include an Issuer: (a) The 
assets of which, although all specifically identified by the Sponsor 
or originator as of the Closing Date, are not all transferred to the 
Issuer on the Closing Date for administrative or other reasons but 
will be transferred to the Issuer shortly after the Closing Date, or 
(b) with respect to which Securities are not purchased by plans 
until after the end of the Pre-Funding Period at which time all 
receivables are contained in the Issuer.
    \23\ The minimum dollar amount is generally the dollar amount 
below which it becomes too uneconomical to administer the Pre-
Funding Account. An event of default under the Pooling and Servicing 
Agreement generally occurs when: (i) A breach of a covenant or a 
breach of a representation and warranty concerning the Sponsor, the 
Servicer or certain other parties occurs which is not cured, (ii) 
there occurs a failure to make required payments to securityholders 
or (iii) the Servicer becomes insolvent.
    \24\ References to the term ``prospectus'' herein shall include 
any related prospectus supplement thereto, pursuant to which 
Securities are offered to investors.
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    For a transaction involving an Issuer using pre-funding, on the 
Closing Date, a portion of the offering proceeds will be allocated to 
the Pre-Funding Account generally in an amount equal to the excess of: 
(i) The principal amount of Securities being issued over (ii) the 
principal balance of the receivables being transferred to the Issuer on 
such Closing Date. In certain transactions, the aggregate principal 
balance of the receivables intended to be transferred to the Issuer may 
be larger than the total principal balance of the Securities being 
issued. In these cases, the cash deposited in the Pre-Funding Account 
will equal the excess of the principal balance of the total receivables 
intended to be transferred to the Issuer over the principal balance of 
the receivables being transferred on the Closing Date.
    On the Closing Date, the Sponsor transfers the receivables to the 
Issuer in exchange for the Securities. The Securities are then sold to 
an Underwriter for cash or to the securityholders directly if the 
Securities are sold through a placement agent. The cash received by the 
Sponsor from the securityholders (or the Underwriter) from the sale of 
the Securities issued by the Issuer in excess of the purchase price for 
the receivables and certain other Issuer expenses, such as underwriting 
or placement agent fees and legal and accounting fees, constitutes the 
cash to be deposited in the Pre-Funding Account. Such funds are either 
held in the Issuer and accounted for separately, or are held in a sub-
account or sub-trust. In either event, these funds are not part of 
assets of the Sponsor.
    Generally, the receivables are transferred at par value, unless the 
interest rate payable on the receivables is not sufficient to service 
both the interest rates to be paid on the Securities and the 
transaction fees (i.e., servicing fees, Trustee fees and fees to credit 
support providers). In such cases, the receivables are sold to the 
Issuer at a discount, based on an objective, written, mechanical 
formula which is set forth in the Pooling and Servicing Agreement and 
agreed upon in advance between the Sponsor, the Rating Agency and any 
credit support provider or other Insurer. The proceeds payable to the 
Sponsor from the sale of the receivables transferred to the Issuer may 
also be reduced to the extent they are used to pay transaction costs. 
In addition, in certain cases, the Sponsor may be required by the 
Rating Agencies or credit support providers to set up Issuer reserve 
accounts to protect the securityholders against credit losses.
    The exemptive relief provided under the 1997 Amendment for pre-
funding is limited so that the percentage or ratio of the amount 
allocated to the Pre-Funding Account, as compared to the total 
principal amount of the Securities being offered (the Pre-Funding 
Limit), does not exceed 25% effective for transactions occurring on or 
after May 23, 1997 and did not exceed 40% effective for transactions 
occurring on or after January 1, 1992, but prior to May 23, 1997. The 
Pre-Funding Limit (which may be expressed as a ratio or as a stated 
percentage or as a combination thereof) will be specified in the 
prospectus or the private placement memorandum.
    Any amounts paid out of the Pre-Funding Account are used solely to 
purchase receivables and to support the interest rate payable on the 
Securities (as explained below). Amounts used to support the interest 
rate are payable only from investment earnings and are not payable from 
principal. However, in the event that, after all of the requisite 
receivables have been transferred into the Issuer, any funds remain in 
the Pre-Funding Account, such funds will be paid to the securityholders 
as principal prepayments. Upon termination of the Issuer, if no 
receivables remain in the Issuer and all amounts payable to the 
securityholders have been distributed, any amounts remaining in the 
Issuer would be returned to the Sponsor.
    A dramatic change in interest rates on the receivables held in an 
Issuer using a Pre-Funding Account would be handled as follows. If the 
receivables (other than those with adjustable or variable rates) had 
already been originated prior to the Closing Date, no action would be 
required as the fluctuations in market interest rates would not affect 
the receivables transferred to the Issuer after the Closing Date. In 
contrast, if interest rates fall after the Closing Date, receivables 
originated after the Closing Date will tend to be originated at lower 
rates, with the possible result that the receivables will not support 
the interest rate payable on the Securities. In such situations, the 
Sponsor could sell the receivables into the Issuer at a discount and 
more receivables will be used to fund the Issuer in order to support 
the interest rate. In a situation where interest rates drop 
dramatically and the Sponsor is unable to provide sufficient loans at 
the requisite interest rates, the pool of receivables would be closed. 
In this latter event, under the terms of the Pooling and Servicing 
Agreement, the securityholders would receive a repayment of principal 
from the unused cash held in the Pre-Funding Account. In transactions 
where the interest rates payable on the Securities are variable or 
adjustable, the effects of market interest rate fluctuations are 
mitigated. In no event will fluctuations in interest rates payable on 
the receivables affect the interest rate payable on fixed rate 
Securities.
    The cash deposited into the Issuer and allocated to the Pre-Funding 
Account is invested in certain permitted investments (see below), which 
may be commingled with other accounts of the Issuer. The allocation of 
investment earnings to each Issuer account is made periodically as 
earned in proportion to each account's allocable share of the 
investment returns. As Pre-Funding Account investment earnings are 
required to be used to support (to the extent authorized in the 
particular transaction) the amounts of interest payable to the 
securityholders with respect to a periodic distribution date, the 
Trustee is necessarily required to make periodic, separate allocations 
of

[[Page 51465]]

the Issuer's earnings to each Issuer account, thus ensuring that all 
allocable commingled investment earnings are properly credited to the 
Pre-Funding Account on a timely basis.

C. The Capitalized Interest Account

    In certain transactions where a Pre-Funding Account is used, the 
Sponsor and/or originator may also transfer to the Issuer additional 
cash on the Closing Date, which is deposited in a Capitalized Interest 
Account and used during the Pre-Funding Period to compensate the 
securityholders for any shortfall between the investment earnings on 
the Pre-Funding Account and the interest rate payable on the 
Securities.
    The Capitalized Interest Account is needed in certain transactions 
since the Securities are supported by the receivables and the earnings 
on the Pre-Funding Account, and it is unlikely that the investment 
earnings on the Pre-Funding Account will equal the interest rates 
payable on the Securities (although such investment earnings will be 
available to pay interest on the Securities). The Capitalized Interest 
Account funds are paid out periodically to the securityholders as 
needed on distribution dates to support the interest rate. In addition, 
a portion of such funds may be returned to the Sponsor from time to 
time as the receivables are transferred into the Issuer and the need 
for the Capitalized Interest Account diminishes. Any amounts held in 
the Capitalized Interest Account generally will be returned to the 
Sponsor and/or originator either at the end of the Pre-Funding Period 
or periodically as receivables are transferred and the proportionate 
amount of funds in the Capitalized Interest Account can be reduced. 
Generally, the Capitalized Interest Account terminates no later than 
the end of the Pre-Funding Period. However, there may be some cases 
where the Capitalized Interest Account remains open until the first 
date distributions are made to securityholders following the end of the 
Pre-Funding Period.
    In other transactions, a Capitalized Interest Account is not 
necessary because the interest paid on the receivables exceeds the 
interest payable on the Securities at the applicable interest rate and 
the fees payable by the Issuer. Such excess is sufficient to make up 
any shortfall resulting from the Pre-Funding Account earning less than 
the interest rate payable on the Securities. In certain of these 
transactions, this occurs because the aggregate principal amount of 
receivables exceeds the aggregate principal amount of Securities.

D. Pre-Funding Account and Capitalized Interest Account Payments and 
Investments

    Pending the acquisition of additional receivables during the Pre-
Funding Period, it is expected that amounts in the Pre-Funding Account 
and the Capitalized Interest Account will be invested in certain 
permitted investments or will be held uninvested. Pursuant to the 
Pooling and Servicing Agreement, all permitted investments must mature 
prior to the date the actual funds are needed. The permitted types of 
investments in the Pre-Funding Account and Capitalized Interest Account 
are investments which are either: (i) Direct obligations of, or 
obligations fully guaranteed as to timely payment of principal and 
interest by, the United States or any agency or instrumentality 
thereof, provided that such obligations are backed by the full faith 
and credit of the United States or (ii) have been rated (or the Obligor 
on the investment has been rated) in one of the three highest generic 
rating categories by Standard & Poor's Ratings Services, a division of 
The McGraw-Hill Companies Inc., (S&P's), Moody's Investors Service, 
Inc. (Moody's), Duff & Phelps Credit Rating Co. (D&P), Fitch ICBA, Inc. 
(Fitch) or any successors thereto (each a Rating Agency or 
collectively, the Rating Agencies) as set forth in the Pooling and 
Servicing Agreement and as required by the Rating Agencies. The credit 
grade quality of the permitted investments is generally no lower than 
that of the Securities. The types of permitted investments will be 
described in the Pooling and Servicing Agreement.
    The ordering of interest payments to be made from the Pre-Funding 
Account and Capitalized Interest Accounts is pre-established and set 
forth in the Pooling and Servicing Agreement. The only principal 
payments which will be made from the Pre-Funding Account are those made 
to acquire the receivables during the Pre-Funding Period and those 
distributed to the securityholders in the event that the entire amount 
in the Pre-Funding Account is not used to acquire receivables. The only 
principal payments which will be made from the Capitalized Interest 
Account are those made to securityholders if necessary to support the 
Security interest rate or those made to the Sponsor either periodically 
as they are no longer needed or at the end of the Pre-Funding Period 
when the Capitalized Interest Account is no longer necessary.

E. The Characteristics of the Receivables Transferred During the Pre-
Funding Period

    In order to ensure that there is sufficient specificity as to the 
representations and warranties of the Sponsor regarding the 
characteristics of the receivables to be transferred after the Closing 
Date during the Pre-Funding Period:
    1. All such receivables will meet the same terms and conditions for 
eligibility as those of the original receivables used to create the 
Issuer (as described in the prospectus or private placement memorandum 
and/or Pooling and Servicing Agreement for such Securities), which 
terms and conditions have been approved by a Rating Agency. However, 
the terms and conditions for determining the eligibility of a 
receivable may be changed if such changes receive prior approval either 
by a majority vote of the outstanding securityholders or by a Rating 
Agency; \25\
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    \25\ In some transactions, the Insurer and/or credit support 
provider may have the right to veto the inclusion of receivables, 
even if such receivables otherwise satisfy the underwriting 
criteria. This right usually takes the form of a requirement that 
the Sponsor obtain the consent of these parties before the 
receivables can be included in the Issuer. The Insurer and/or credit 
support provider may, therefore, reject certain receivables or 
require that the Sponsor establish certain Issuer reserve accounts 
as a condition of including these receivables. Virtually all Issuers 
which have Insurers or other credit support providers are structured 
to give such veto rights to these parties. The percentage of Issuers 
that have Insurers and/or credit support providers, and accordingly 
feature such veto rights, varies.
---------------------------------------------------------------------------

    2. The transfer of the receivables acquired during the Pre-Funding 
Period will not result in the Securities receiving a lower credit 
rating from the Rating Agency upon termination of the Pre-Funding 
Period than the rating that was obtained at the time of the initial 
issuance of the Securities by the Issuer;
    3. The weighted average annual percentage interest rate (the 
average interest rate) for all of the receivables in the Issuer at the 
end of the Pre-Funding Period will not be more than 100 basis points 
(``bps'') lower than the average interest rate for the receivables 
which were transferred to the Issuer on the Closing Date;
    4. The Trustee of the Trust (or any agent with which the Trustee 
contracts to provide trust services) will be a substantial financial 
institution or trust company experienced in Issuer activities and 
familiar with its duties, responsibilities and liabilities as a 
fiduciary under the Act. The Trustee, as the legal owner of the 
receivables in the Issuer or the holder of a security interest in the 
receivables, will enforce all the

[[Page 51466]]

rights created in favor of securityholders of the Issuer, including 
employee benefit plans subject to the Act.
    In order to ensure that the characteristics of the receivables 
actually acquired during the Pre-Funding Period are substantially 
similar to receivables that were acquired as of the Closing Date, the 
Applicant represents that for transactions occurring on or after May 
23, 1997,\26\ the characteristics of the subsequently acquired 
receivables will either be monitored by a credit support provider or 
other insurance provider which is independent of the Sponsor or an 
independent accountant retained by the Sponsor will provide the Sponsor 
with a letter (with copies provided to the Rating Agencies, the 
Underwriter and the Trustee) stating whether or not the characteristics 
of the additional receivables acquired after the Closing Date conform 
to the characteristics of the receivables described in the prospectus, 
private placement memorandum and/or Pooling and Servicing Agreement. In 
preparing such letter, the independent accountant will use the same 
type of procedures as were applicable to the receivables which were 
transferred as of the Closing Date.
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    \26\ May 23, 1997, was the date the proposed 1997 Amendment to 
the Underwriter Exemption was published in the Federal Register.
---------------------------------------------------------------------------

    Each prospectus, private placement memorandum and/or Pooling and 
Servicing Agreement will set forth the terms and conditions for 
eligibility of the receivables to be held by the Issuer as of the 
related Closing Date, as well as those to be acquired during the Pre-
Funding Period, which terms and conditions will have been agreed to by 
the Rating Agencies which are rating the applicable Securities as of 
the Closing Date. Also included among these conditions is the 
requirement that the Trustee be given prior notice of the receivables 
to be transferred, along with such information concerning those 
receivables as may be requested. Each prospectus or private placement 
memorandum will describe the amount to be deposited in, and the 
mechanics of, the Pre-Funding Account and will describe the Pre-Funding 
Period for the Issuer.

F. Parties to Transactions

    The originator of a receivable is the entity that initially lends 
money to a borrower (Obligor), such as a homeowner or automobile 
purchaser, or leases property to a lessee. The originator may either 
retain a receivable in its portfolio or sell it to a purchaser, such as 
a Sponsor.
    Originators of receivables held by the Issuer will be entities that 
originate receivables in the ordinary course of their business 
including finance companies for whom such origination constitutes the 
bulk of their operations, financial institutions for whom such 
origination constitutes a substantial part of their operations, and any 
kind of manufacturer, merchant, or service enterprise for whom such 
origination is an incidental part of its operations. Each Issuer may 
hold assets of one or more originators. The originator of the 
receivables may also function as the Sponsor or Servicer.
    The Sponsor will be one of three entities: (i) A special-purpose or 
other corporation unaffiliated with the Servicer, (ii) a special-
purpose or other corporation affiliated with the Servicer, or (iii) the 
Servicer itself. Where the Sponsor is not also the Servicer, the 
Sponsor's role will generally be limited to acquiring the receivables 
to be held by the Issuer, establishing the Issuer, designating the 
Trustee, and assigning the receivables to the Issuer.
    The Trustee of a Trust (or the Issuer, if it is not a Trust) is the 
legal owner of the obligations held by the Issuer and would hold a 
security interest in the collateral securing such obligations. The 
Trustee is also a party to or beneficiary of all the documents and 
instruments transferred to the Issuer, and as such, has both the 
authority to, and the responsibility for, enforcing all the rights 
created thereby in favor of securityholders, including those rights 
arising in the event of default by the servicer.
    The Trustee will be an independent entity, and therefore will be 
unrelated to the Underwriter, the Sponsor or the Servicer or any other 
member of the Restricted Group. The Applicant represents that the 
Trustee will be a substantial financial institution or trust company 
experienced in trust activities. The Trustee receives a fee for its 
services, which will be paid by the Servicer, Sponsor or out of the 
Issuer's assets. The method of compensating the Trustee will be 
specified in the Pooling and Servicing Agreement and disclosed in the 
prospectus or private placement memorandum relating to the offering of 
the Securities.
    The rights and obligations of the Indenture Trustee are no 
different than those of the Trustee of an Issuer which is a Trust. The 
Indenture Trustee is obligated to oversee and administer the activities 
of all of the ongoing parties to the transaction and possesses the 
authority to replace those entities, sue them, liquidate the collateral 
and perform all necessary acts to protect the interests of the debt 
holders. If debt is issued in a transaction, there may not be a pooling 
and servicing agreement. Instead, there is a sales agreement and 
servicing agreement (or these two agreements are sometimes combined 
into a single agreement). The agreement(s) set(s) forth, among other 
things, the duties and responsibilities of the parties to the 
transaction relating to the administration of the Issuer. The Indenture 
Trustee is often a party to these agreements. At a minimum, the 
Indenture Trustee acknowledges its rights and responsibilities in these 
agreements or they are contractually set forth in the indenture 
agreement pursuant to which the Indenture Trustee is appointed.
    The Servicer of an Issuer administers the receivables on behalf of 
the securityholders. The Servicer's functions typically involve, among 
other things, notifying borrowers of amounts due on receivables, 
maintaining records of payments received on receivables and instituting 
foreclosure or similar proceedings in the event of default. In cases 
where a pool of receivables has been purchased from a number of 
different originators and transferred to an Issuer, it is common for 
the receivables to be ``subserviced'' by their respective originators 
and for a single entity to ``master service'' the pool of receivables 
on behalf of the owners of the related series of Securities. Where this 
arrangement is adopted, a receivable continues to be serviced from the 
perspective of the borrower by the local Subservicer, while the 
investor's perspective is that the entire pool of receivables is 
serviced by a single, central Master Servicer who collects payments 
from the local Subservicers and pays them to securityholders.
    A Servicer's default is treated in the same manner whether or not 
the Issuer is a Trust. The original Servicer is replaced. The entity 
replacing the Servicer varies from transaction to transaction. In 
certain cases, it may be the Trustee (or Indenture Trustee if the 
Issuer is not a Trust) or may be a third party satisfactory to the 
Rating Agencies. In addition, there are transactions where the Trustee 
or Indenture Trustee will assume the Servicer's responsibilities on a 
temporary basis until the permanent replacement takes over. In all 
cases, the replacement entity must be capable of satisfying all of the 
duties and responsibilities of the original Servicer and must be an 
entity that is satisfactory to the Rating Agencies.
    As noted above, the Underwriter Exemptions currently require that 
the Trustee not be an Affiliate of any

[[Page 51467]]

member of the Restricted Group. Thus, if a Servicer of receivables held 
by an Issuer which has issued Securities in reliance upon the 
Underwriter Exemptions (or an Affiliate thereof) merges with or is 
acquired by (or acquires) the Trustee of such Trust (or an Affiliate 
thereof), exemptive relief would cease to be available under the 
Underwriter Exemptions. The Applicant states that, as the result of 
legal constraints applicable to such merger and acquisition 
transactions (e.g., confidentiality requirements), the entities 
involved in the transaction are unable before the transaction is 
consummated to cross check all relationships between the often numerous 
Affiliates of the entities involved in the transaction in order to 
determine whether or not any of the new affiliations resulting from the 
transaction will violate this non-affiliation condition of the 
Underwriter Exemptions. In response to this issue, the Department 
proposes to revise subsection II.A.(4) of the Underwriter Exemptions to 
provide that this condition will not be considered to be violated for 
transactions occurring on or after January 1, 1998, merely by reason of 
a Servicer becoming an Affiliate of the Trustee as the result of a 
merger or acquisition between or among the Trustee, such Servicer and/
or their Affiliates which occurs after the initial issuance of the 
Securities, provided that: (i) Such Servicer ceases to be an Affiliate 
of the Trustee no later than six months after the later of August 23, 
2000, or the date such Servicer became an Affiliate of the Trustee; and 
(ii) such Servicer did not breach any of its obligations under the 
Pooling and Servicing Agreement, unless such breach was immaterial and 
timely cured in accordance with the terms of such agreement, during the 
period from the closing date of such merger or acquisition transaction 
through the date the Servicer ceased to be an Affiliate of the Trustee. 
The Department proposes to make this revision retroactive to January 1, 
1998 in response to the Applicant's representations that recent merger 
and acquisition transactions occurring within the financial services 
industry have resulted in an unknown but potentially significant number 
of inadvertent violations of this condition.
    The Underwriter will be a registered broker-dealer that acts as 
Underwriter or placement agent with respect to the sale of Securities. 
Public offerings of Securities are generally made on a firm commitment 
or agency basis. Private placement of Securities may be made on a firm 
commitment or agency basis. It is anticipated that the lead or co-
managing Underwriters will make a market in Securities offered to the 
public.
    In some cases, the originator and Servicer of receivables to be 
held by an Issuer and the Sponsor of the Issuer (though they themselves 
may be related) will be unrelated to the Underwriter. In other cases 
however, Affiliates of the Underwriter may originate or service 
receivables held by an Issuer or may sponsor an Issuer.

G. Security Price, Interest Rate and Fees

    In some cases, the Sponsor will obtain the receivables from various 
originators or other secondary market participants pursuant to existing 
contracts with such originators or other secondary market participants 
under which the Sponsor continually buys receivables. In other cases, 
the Sponsor will purchase the receivables at fair market value from the 
originator or a third party pursuant to a purchase and sale agreement 
related to the specific offering of Securities. In other cases, the 
Sponsor will originate the receivables itself.
    As compensation for the receivables transferred to the Issuer, the 
Sponsor receives Securities representing the entire beneficial interest 
in the Issuer and/or debt Securities representing the Issuer's 
obligations to debt securityholders, or the cash proceeds of the sale 
of such Securities. If the Sponsor receives Securities from the Issuer, 
the Sponsor sells some or all of these Securities for cash to investors 
or securities underwriters.
    The price of the Securities, both in the initial offering and in 
the secondary market, is affected by market forces including investor 
demand, the interest rate payable on the Securities in relation to the 
rate payable on investments of similar types and quality, expectations 
as to the effect on yield resulting from prepayment of the underlying 
receivables, and expectations as to the likelihood of timely payment.
    The interest rate payable on the Securities is equal to the 
interest rate on receivables included in the Issuer minus a specified 
servicing fee.\27\ This rate is generally determined by the same market 
forces that determine the price of a Security. The price of a Security 
and its interest, or coupon, rate, together determine the yield to 
investors. If an investor purchases a Security at less than par, that 
discount augments the stated interest rate; conversely, a Security 
purchased at a premium yields less than the stated coupon.
---------------------------------------------------------------------------

    \ 27\ The interest rate payable on Securities representing 
interests in Issuers holding leases is determined by breaking down 
lease payments into ``principal'' and ``interest'' components based 
on an implicit interest rate.
---------------------------------------------------------------------------

    As compensation for performing its servicing duties, the Servicer 
(who may also be the Sponsor or an Affiliate thereof, and receive fees 
for acting as Sponsor) will retain the difference between payments 
received on the receivables held by the Issuer and payments (payable at 
the interest rate) to securityholders, except that in some cases a 
portion of the payments on the receivables may be paid to a third 
party, such as a fee paid to a provider of credit support. The Servicer 
may receive additional compensation by having the use of the amounts 
paid on the receivables between the time they are received by the 
Servicer and the time they are due to the Issuer (which time is set 
forth in the Pooling and Servicing Agreement). The Servicer typically 
will be required to pay the administrative expenses of servicing the 
Issuer, including in some cases the Trustee's fee, out of its servicing 
compensation.
    The Servicer is also compensated to the extent it may provide 
credit enhancement to the Issuer or otherwise arrange to obtain credit 
support from another party. This ``credit support fee'' may be 
aggregated with other servicing fees, and is either paid out of the 
income received on the receivables in the Issuer in excess of the 
interest rate or paid in a lump sum at the time the Issuer is 
established.
    The Servicer may be entitled to retain certain administrative fees 
paid by a third party, usually the Obligor. These administrative fees 
fall into three categories: (a) Prepayment fees; (b) late payment and 
payment extension fees; and (c) expenses, fees and charges associated 
with foreclosure or repossession, or other conversion of a secured 
position into cash proceeds, upon default of an obligation.
    Compensation payable to the Servicer will be set forth or referred 
to in the Pooling and Servicing Agreement and described in reasonable 
detail in the prospectus or private placement memorandum relating to 
the Securities.
    Payments on receivables held by the Issuer may be made by Obligors 
to the Servicer at various times during the period preceding any date 
on which interest payments to the Issuer are due. In some cases, the 
Pooling and Servicing Agreement may permit the Servicer to place these 
payments in non-interest bearing accounts in itself or to commingle 
such payments with its own funds prior to the distribution dates. In 
these cases, the Servicer would be entitled to the benefit derived from 
the use of the funds between the date of payment on a receivable and 
the

[[Page 51468]]

payment date on the Securities. Commingled payments may not be 
protected from the creditors of the Servicer in the event of the 
Servicer's bankruptcy or receivership. In those instances when payments 
from receivables are held in non-interest bearing accounts or are 
commingled with the Servicer's own funds, the Servicer is required to 
deposit these payments by a date specified in the Pooling and Servicing 
Agreement into an account from which the Issuer makes payments to 
securityholders.
    The Underwriter will receive a fee in connection with the 
underwriting or private placement of Securities. In a firm commitment 
underwriting, this fee would normally consist of the difference between 
what the Underwriter receives for the Securities that it distributes 
and what it pays the Sponsor for those Securities. In a private 
placement, the fee normally takes the form of an agency commission paid 
by the Sponsor. In a best efforts underwriting in which the Underwriter 
would sell Securities in a public offering on an agency basis, the 
Underwriter would receive an agency commission rather than a fee based 
on the difference between the price at which the Securities are sold to 
the public and what it pays the Sponsor. In some private placements, 
the Underwriter may buy Securities as principal, in which case its 
compensation would be the difference between what the Underwriter 
receives for the Securities and what it pays the Sponsor for these 
Securities.

H. Purchase of Receivables by the Servicer

    The Applicant represents that as the principal amount of the 
receivables held by an Issuer is reduced by payments, the cost of 
administering the Issuer generally increases, making the servicing of 
the receivables prohibitively expensive at some point. Consequently, 
the Pooling and Servicing Agreement generally provides that the 
Servicer may purchase the receivables remaining in the Issuer when the 
aggregate unpaid balance payable on the receivables is reduced to a 
specified percentage (usually between 5 and 10 percent) of the initial 
aggregate unpaid balance.
    The purchase price of a receivable is specified in the Pooling and 
Servicing Agreement and will be at least equal to either: (1) The 
unpaid principal balance on the receivable plus accrued interest, less 
any unreimbursed advances of principal made by the Servicer, or (2) the 
greater of the amount in (1) or (b) the fair market value of such 
obligations in the case of a REMIC, or the fair market value of the 
receivables in the case of an Issuer which is not a REMIC.

V. Requested Modifications for Motor Vehicles, Residential/Home 
Equity, Manufactured Housing and Commercial Mortgage-Backed 
Securities Transactions

A. The Applicant's Request

    The Applicant requests an amendment to the 1997 Amendment to 
provide relief for the offering of investment-grade mortgage-backed 
securities (MBS) and asset-backed securities (ABS) which are either 
senior or subordinated, and/or in certain cases, permit the Issuer to 
hold receivables with loan-to-value property ratios (LTV ratios) in 
excess of 100%. Specifically, this request relates to Securities issued 
by Issuers for a limited number of asset categories: (1) Automobile and 
other motor vehicle ABS which are senior or subordinated securities 
rated ``AAA,'' ``AA,'' ``A'' or ``BBB''; (2) residential and home 
equity ABS/MBS with senior or subordinated securities rated either 
``AAA,'' ``AA,'' ``A'' or ``BBB,'' which are issued by Issuers whose 
assets may include mortgage loans with LTV ratios in excess of 100%; 
(3) manufactured housing ABS/MBS with senior or subordinated securities 
rated either ``AAA,'' ``AA,'' ``A'' or ``BBB'' and (4) commercial 
mortgage-backed securities (CMBS) which are senior or subordinated 
securities rated ``AAA,'' ``AA,'' ``A'' or ``BBB.''
    The Applicant requests that the Department include high LTV loans 
as acceptable assets of the Issuer only in residential and/or home 
equity transactions, as long as such loans are secured by collateral 
whose fair market value on the Closing Date of the securitization 
transaction is at least equal to 80% of the sum of the outstanding 
principal balance due under the loan which is held as an asset of the 
Issuer and that of other loans if any, of higher priority (whether or 
not held by the Issuer) which are secured by the same collateral. This 
modification would also address the situation where a residential or 
home equity pool of assets contains a de minimis number of 
undercollateralized loans. According to TBMA, a pool could have, for 
example, 400 loans, 399 of which are fully secured and one of which is 
99% secured, but the transaction would not qualify for the Underwriter 
Exemptions. The situation cannot always be cured by removing even a 
small number of loans from the pool because replacement loans may not 
be available by closing, and pre-funding may not be feasible. The 
Applicant has suggested as additional safeguards, that: (i) the rights 
and interests evidenced by the Securities issued in such Designated 
Transactions involving residential and/or home equity transactions with 
high LTV loans are not subordinated to the rights and interests 
evidenced by Securities of the same Issuer, and (ii) such Securities 
acquired by the plan have received a rating from a Rating Agency at the 
time of such acquisition that is in one of the two highest generic 
rating categories.
    The Applicant believes that it is appropriate for the Department to 
provide relief for Designated Transactions for three principal reasons.
    First, such ABS/MBS have proven to be extremely safe investments 
with superior credit performance and investment return. Defaults on 
investment-grade ABS/MBS have occurred in only isolated instances, 
despite significant down-market cycles experienced during the financial 
history of such securities. In addition, comparably rated corporate 
bonds have historically experienced more downgrades and a much greater 
number of defaults. Even during extreme credit market conditions, such 
as those of the late summer and early fall of 1998 which put severe 
cash flow stress on securitization Sponsors, ABS/MBS securitization 
structures maintained their integrity and continued to perform in 
accordance with their terms.
    Second, allowing a broader range of ABS/MBS to be purchased by plan 
investors as an alternative to corporate bonds is beneficial to plan 
participants and their beneficiaries because it allows greater 
diversification of investments by plans without sacrificing the safety 
and credit quality of those investments. It also gives plan investors 
the flexibility of being able to structure a portfolio of fixed income 
securities with varying maturities and cash flow characteristics that 
can be tailored to the unique requirements of each plan.
    Third, most ABS/MBS, unlike corporate bonds whose performance is 
dependent on the financial condition of one Obligor, constitute 
interests in a discrete pool of financial assets which can be evaluated 
by plan fiduciaries who have available to them a large body of 
historical data as to the performance of various types of ABS/MBS 
issued by many different issuers. Fiduciaries are also able to monitor 
the performance of the pool of assets supporting payments on the ABS/
MBS on a contemporaneous basis, as investors are given monthly reports 
on collections, account balances, credit support levels and the status 
of the receivables. All of these points are discussed in greater detail 
below.

[[Page 51469]]

B. Reliance on Ratings

1. Background
    The Applicant notes that when the Underwriter Exemptions originally 
were applied for in the mid-1980s, public and private offerings of ABS 
and MBS by private sector originators had only recently been introduced 
in the United States capital markets. The Applicant states that the 
Department, in granting exemptive relief under the original Underwriter 
Exemptions, was cognitive of the relative infancy of private sector 
ABS/MBS transactions when it originally considered the extent to which 
reliance should be placed on the determinations of the Rating Agencies 
in establishing the boundaries of exemptive relief. For example, in the 
Notice of Proposed Exemption relating to Application D-6555 made by 
First Boston Corporation, 53 FR 52851 at 52857 (December 29, 1988) the 
Department stated:

    After consideration of the representations of the applicant and 
the information provided by S&P's, Moody's and D&P, the Department 
has decided to condition exemptive relief upon the certificates in 
which a plan invests having attained a rating in one of the three 
highest generic rating categories from S&P's, Moody's or, in the 
case of certificates representing interests in trust containing 
multi-family residential mortgages or commercial mortgages, D&P.
    The Department believes that the rating condition will permit 
the applicant flexibility in structuring trusts containing a variety 
of mortgages and other receivables, while ensuring that the 
interests of plans holding certificates are adequately protected. In 
particular, in rating certificates, S&P's, Moody's and D&P take into 
account such factors as commingling of funds and conflicts of 
interest of the trust sponsor and servicer.
    However, the Department is not prepared to rely solely on 
determinations made by these rating agencies in providing exemptive 
relief. In this regard, the applicant originally requested that 
exemptive relief apply to trusts containing any type of receivable--
secured or unsecured--provided that the rating condition is met.
    The Department is not prepared at this time to grant such broad 
exemptive relief. The Department believes that the rating agencies 
currently have more expertise in rating certificates representing 
interests in secured, as opposed to unsecured, receivable trusts. 
Consequently, the Department believes that the ratings are more 
indicative of the relative safety of the investment when applied to 
trusts containing secured receivables.
    Moreover, First Boston has represented that trusts containing 
different types of receivables are continuously being developed and 
rated. While the Department would generally prefer to be more 
specific as to the types of assets contained in the trusts, the 
Department recognizes the applicant's need for flexibility. At the 
same time, the Department believes that it is appropriate to ensure 
that the rating agencies have developed expertise in rating a 
particular type of asset-backed security and that such security has 
been tested in the marketplace prior to plan investment pursuant to 
this exemption. Consequently, the Department has further conditioned 
the proposed exemptive relief upon each particular type of asset-
backed security having been rated in one of the three highest rating 
categories for at least one year and having been sold to investors 
other than plans for at least one year.

2. Rating Agency Expertise
    The Applicant asserts that since the time of the First Boston 
Corporation application, the Rating Agencies have developed an enormous 
depth of experience in rating ABS/MBS due to the extensive growth of 
these markets. Since that time, investment-grade ratings have been 
assigned to a broad range of asset classes and transaction structures 
in the ABS/MBS markets. The Applicant notes that those ratings, and the 
credit quality of underlying collateral, have been the subject of 
continuing surveillance and active scrutiny by the Rating Agencies and 
that the historical performance record of these offerings clearly 
demonstrates that the Rating Agencies have developed the expertise 
necessary for the Department to conclude that ratings are extremely 
reliable indicators of the relative safety of the securities and the 
transactions with respect to which exemptive relief is requested.
3. Growth in the ABS/MBS Markets
    According to the Applicant, ABS/MBS now constitute a major segment 
of the fixed-income marketplace. This growth, which is manifested in a 
rapid increase in issuance levels and the continuing entry and 
acceptance of new issuers, asset types and transaction structures into 
the market, has generated an accompanying growth in market depth, 
liquidity and efficiency.
    The first pass-through security was issued in 1970, with a 
guarantee by Ginnie Mae. Soon, Freddie Mac and Fannie Mae began issuing 
mortgage securities as well. The development of the collateralized 
mortgage obligation (CMO) in 1983 expanded the market for mortgage 
securities by establishing a product appealing to a broad range of 
investors with various investment time frames and cash-flow needs. As a 
result of tremendous growth in the primary housing credit market and an 
increasing level of investor interest and comfort in these investments, 
the mortgage securities market is now one of the largest financial 
markets in the world. Total volume of outstanding agency mortgage 
securities exceeded $2.0 trillion at the end of 1998, as compared to 
the $372.1 billion outstanding level at year-end 1985. New issuance of 
agency pass-throughs totaled $726.9 billion in 1998, while agency CMO 
issuance reached $225.1 billion for the year. This compares to the 
$111.1 billion in agency pass-throughs issued in 1985. Private label 
CMO issuance was $135 billion in 1998. In contrast, total issuance in 
the corporate bond market was $678 billion in 1998.
    Asset-backed securities constitute a relatively newer but fast-
growing segment of the debt markets. The first ABS were issued in 1985, 
with the new issue dollar volume reaching $1.2 billion in that year. In 
comparison, $197.6 billion in ABS were issued in 1998, while the 
outstanding level of ABS was an estimated $630 billion at the end of 
the year. The ABS market has grown dramatically since its inception in 
the mid-1980s and has become a basic financing mechanism in the debt 
capital markets, with rapid domestic and international growth. Strong 
investor demand and the diversity of securities available have helped 
to fuel the growth in the ABS market.
    The home equity, credit card and auto loan sectors are the 
mainstays of the ABS market. However, the strength in home equity-
backed issuance has been the driving force behind the growth in ABS 
issuance in the past few years. This sector maintained its dominance in 
1998, with volume representing 41.9% of total issuance in the period. 
Issuance in the home equity sector totaled $82.8 billion in 1998, a 
28.7% increase over the $64.4 billion sold in 1997. Issuance in the 
credit card sector was relatively flat in 1998, with volume totaling 
$37.1 billion, essentially unchanged from 1997's $37.5 billion. Auto 
loan ABS issuance rose by 6.0% in 1998, totaling $35.1 billion, as 
compared to the $33.1 billion issued in 1997.
    Commercial mortgage-backed securities (CMBS) issuance has grown 
sharply in recent years. Approximately 20% of all real estate debt is 
now securitized and held in the hands of investors in the form of CMBS. 
Standardization of loan structures, growing investor acceptance and the 
changing regulatory environment have all contributed to the market's 
growth. Issuance in the CMBS market increased by more than tenfold over 
the past eight years. CMBS issuance jumped sharply in 1998 with volume 
increasing to a record $78.3 billion in 1998, a 78.0% increase over the 
$44.3 billion reported in 1997 and 162.8% greater than the $29.8 
billion issued in 1996. In

[[Page 51470]]

comparison, CMBS issuance totaled just $6.0 billion in 1990.
4. Congressional and Agency Reliance on Ratings
    The Applicant states that Congress and governmental regulatory 
agencies rely on the efficacy of the rating process for many purposes. 
The United States Securities and Exchange Commission (the ``SEC'') has 
relied frequently on ratings assigned by a ``nationally recognized 
statistical rating organization'' (NRSRO). Two prime reasons that the 
ABS/MBS market has grown dramatically over the past five years are the 
ability to offer investment-grade asset-backed securities to the public 
on a shelf registration statement and changes to the Investment Company 
Act of 1940. With a shelf registration, the SEC review and comment 
period occurs prior to effectiveness of the registration statement. 
Thereafter, an issuer can sell securities on an expedited basis. No 
additional SEC review is necessary. However, each security offered on a 
shelf must be rated by at least one NRSRO in one of its four highest 
generic rating categories. The Investment Company Act of 1940 was a 
major impediment in developing the ABS/MBS markets. Absent an 
exemption, substantially all of the Trusts and other vehicles issuing 
ABS would be required to register as an ``investment company'' under 
this Act. Congress and the SEC realized that the securitization markets 
could not function as regulated investment companies. As a result, Rule 
3a-7 under the Investment Company Act was enacted in 1992. If the 
conditions of this rule are satisfied, an issuer of ABS/MBS is not 
deemed to be an investment company. One requirement of the rule is that 
any security sold to investors (other than accredited investors or 
qualified institutional buyers) be rated, at the time of sale, in one 
of the four highest generic categories by at least one NRSRO.
5. Securities Ratings
    The Securities in transactions which are not Designated 
Transactions (as described below) will have received one of the three 
highest generic ratings available from a Rating Agency. Insurance or 
other credit support (such as surety bonds, letters of credit, 
guarantees or overcollateralization) will be obtained by the Sponsor to 
the extent necessary for the Securities to attain the desired rating. 
The amount of this credit support is set by the Rating Agencies at a 
level that is typically a multiple of the worst historical net credit 
loss experience for the types of obligations included in the Issuer.
6. The Rating Process
    Ratings on a class of Securities are an evaluation by the Rating 
Agency of the credit, structural and legal risks of a transaction, 
which is made to help predict the probability of an investor receiving 
timely payment of interest and payment of principal by the maturity 
date of the Securities. Ratings generally do not address risks arising 
from interest rate fluctuations or prepayments of the underlying 
obligations by borrowers. In order to make their assessment of a class 
of Securities, the Rating Agencies perform sophisticated analyses of 
the predicted frequency and severity of losses on the pool of 
obligations by conducting extensive investigative due diligence reviews 
of both the originator and assets to be securitized, sampling the asset 
pool or performing a review of the entire asset pool, comparing the 
expected performance of that particular pool against historical 
performance of pools containing similar assets (either from the same 
originator or based upon industry standards) and making determinations 
of the adequate levels of credit enhancement required to support each 
rating level. For all investment-grade ratings, including ``BBB,'' the 
credit support levels are set to require the transaction to withstand 
not just expected losses on the pool of assets but a multiple of such 
projected losses (or, in some cases, a more severe economic default 
model). Regression analysis is continually performed whereby the Rating 
Agencies determine how factors such as LTV ratios, geographic 
diversity, strength of borrower's credit history, type of loan and 
other factors correlate positively or negatively with both loss 
frequency and severity in order to predict how a pool will perform. The 
particular asset type is of primary importance in determining the 
nature and scope of the diligence review. Also, the type of asset will 
determine the type of legal and structural safeguards that must be 
implemented to safeguard the interests of the related securityholders 
and permit the issuance of the applicable rating.
    The Rating Agencies differ slightly in what they consider their 
ratings to represent. Specifically, Moody's ratings express an opinion 
of the amount by which the internal rate of return in a diversified 
portfolio of similarly rated Securities would be reduced as a result of 
defaults on the Securities. For example, ``Aaa'' rated Securities held 
to maturity without any changes in rating are expected to suffer a 
reduction in realized yield over a ten-year period of less than one 
basis point (i.e., 1/100th of a percent); 1-3 bps for an ``Aa'' rating; 
5-13 bps for an ``A'' rating; 20-50 bps for a ``Baa'' rating; 75-150 
bps for a ``Ba'' rating and 175-325 bps for a ``B'' rating. 
Accordingly, the expected reduction in yield for all investment-grade 
Securities, whether or not subordinated, is 0.5% or less, and as 
indicated below, for Securities has turned out to be virtually zero. 
The ratings of the three other Rating Agencies express an opinion on 
the probability that no losses will be experienced on the Securities in 
different rating categories. However, any slight differences in the 
technical meaning of a rating are not considered to be of any material 
significance in the capital markets.
    The rating process generally rates to the ``weakest link'' in that 
if credit support is provided for by a third party, the rating given to 
the Securities cannot exceed that of the credit support provider. In 
addition, the Rating Agencies may also require minimum credit ratings 
of other parties to the transactions such as the Servicer, back-up 
Servicers and pool Insurers and, at a minimum, the credit strength of 
such parties is factored into the analysis of the pool when projecting 
losses.
7. Reasons to Extend Relief to Subordinated ABS/MBS and High LTV 
Receivables
    As support for the requested modifications, the Applicant notes 
that the Department already has permitted securities with ratings of 
``A'' or better to be eligible for relief under the Underwriter 
Exemptions, although, in particular transactions, the credit quality of 
the borrowers who are obligated on the loans held as Trust assets may 
be less than A.\28\ Many securities issued in securitization 
transactions receive ``AAA'' ratings even if the borrowers on the loans 
have B and C credit. This risk is addressed by requiring greater credit 
support using conservative stress tests.
---------------------------------------------------------------------------

    \28\ The applicant notes that borrowers are frequently 
categorized by originators as being of A, B, C or D credit quality, 
although other designations may be used.
---------------------------------------------------------------------------

    The Applicant asserts that subordinated securities and higher LTV 
ratio collateral for transactions in those rating and asset categories 
already approved by the Department would be equally as protective of 
plan investors as those transactions currently permitted with non-
subordinated and lower LTV ratios. Granting this relief would also 
address the anomaly which now exists

[[Page 51471]]

where an ``A'' rated senior security is currently eligible for 
exemptive relief, but an ``AAA'' rated subordinated security or a 
senior security issued by a Trust with less than fully secured loans is 
not. While this anomaly developed because of the Department's concerns 
as to whether the Rating Agencies had the requisite experience to rate 
certain types of ABS/MBS, the market has developed to a point where 
this distinction is no longer necessary to protect plan investors. The 
ratings quantify the credit risk of a transaction at various rating 
levels, and any deficiencies in the credit quality of the assets, the 
credit of the borrowers, the strength of the parties to the transaction 
or the structure are factored into the credit support requirements, 
with the result that every rating of the same letter designation 
represents the same credit quality of a security without regard to the 
particular features of any single transaction. In this regard, at the 
request of the Department, the Applicant has provided letters from the 
Rating Agencies confirming their view to this effect.
    The Applicant states that the need for flexibility is nowhere 
better exemplified than in the inclusion of subordinated securities in 
the type of securities eligible for exemptive relief. Transactions in 
the 1980s typically did not feature investment-grade subordinated 
securities. In contrast, the market has now evolved to the point where 
ABS/MBS offerings typically include multiple tranches of senior and 
subordinated investment-grade securities. In common market terminology, 
in transactions where there are two or more subordinated classes of 
securities, ``AAA'' rated ABS/MBS classes are described as ``senior'' 
classes, ``AA'' through ``BBB'' subordinated classes are described as 
``mezzanine'' classes, and sub-investment-grade classes are described 
as ``subordinated'' classes. In other transactions, the ``AAA'' and 
``AA'' classes may be referred to as senior, and the ``BBB'' class or 
classes may be referred to as either mezzanine or subordinated, 
depending on the number of classes and the structure. In contrast, 
under the current Underwriter Exemptions, all classes of ABS/MBS below 
the most senior ``AAA'' class are regarded as subordinated.
    The Applicant believes that Rating Agencies can rate subordinated 
classes of securities with a high level of expertise, thereby ensuring 
the safety of these investments for plans through the use of other 
credit support (including increased levels of non-investment-grade 
securities). The subordination of a security, while factored into the 
evaluation made by the Rating Agencies in their assessment of credit 
risk, is not indicative of whether a security is more or less safe for 
investors. In fact, there are ``AAA'' rated subordinated 
securities.\29\ Subordination is simply another form of credit support. 
The Rating Agencies, after determining the level of credit support 
required to achieve a given rating level, are essentially indifferent 
as to how these credit support requirements are implemented--whether 
through subordination or other means. If subordination is used, 
however, the subordinated class will have no greater credit risks or 
fewer legal protections in comparison with other credit-supported 
classes that possesses the same rating.
---------------------------------------------------------------------------

    \29\ For example, a transaction may have two classes of ``AAA'' 
rated securities and one is subordinated to the other. The 
subordinated class would be required to have more credit support to 
qualify for the ``AAA'' rating than the more senior ``AAA'' rated 
class.
---------------------------------------------------------------------------

    According to the Applicant, there is much benefit to plan investors 
in having subordinated securities eligible for exemptive relief. First, 
credit support provided through third-party credit providers is more 
expensive than an equal amount of credit support provided through 
subordination. As a result, the ability to use subordinated tranches to 
provide credit support for the more senior classes (which may or may 
not themselves be subordinated) creates economic savings for all the 
parties to the transaction which, in turn, can allow greater returns to 
investors. In addition, if the credit rating of a third-party credit 
support provider is downgraded, the rating of the securities is also 
downgraded. Second, the yields available on subordinated securities are 
often higher than those paid on comparably rated non-subordinated 
securities because investors expect to receive higher returns for 
subordinated securities. Third, subordinated securities are usually 
paid after other more senior securities, which results in their having 
longer terms to maturity. This is appealing to many investors who are 
looking for medium-term fixed income investments to diversify their 
portfolios. The combination of these factors benefits investors by 
making available securities which can provide higher yields for longer 
periods. It should be noted that as the rating of a security generally 
addresses the probability of all interest being timely paid and all 
principal being paid by maturity under various stress scenarios, the 
Rating Agencies are particularly concerned with the ability of the pool 
to generate sufficient cash flow to pay all amounts due on subordinated 
tranches, and several features of the credit support mechanisms 
discussed below are designed to protect subordinated classes of 
securities.
8. Performance of Investment-Grade ABS/MBS
    The Applicant asserts that the arguments articulated for the safety 
of subordinated securities or securities issued by entities holding 
loans with high LTV ratios are supported by the statistics. Ratings 
have proven to be a remarkably accurate prognosticator of the 
probability of default on ABS/MBS and also support the appropriateness 
of extending exemptive relief to ``BBB'' rated securities. Accompanying 
the tremendous growth of the asset-backed and mortgage-backed markets 
has been a stellar record of repayment of principal and interest. After 
extensive investigative efforts and interviews with Rating Agencies, 
bond insurance companies and the TBMA dealer membership, the Applicant 
has concluded that, to the best of its knowledge, there have been only 
isolated instances of defaults on any investment-grade ABS/MBS.
    During the three-year period from 1995-1997, 139 corporate issues 
representing $22 billion in corporate bonds defaulted. Yet, corporate 
bonds may be purchased by benefit plan investors without triggering 
prohibited transactions pursuant to a number of prohibited transaction 
class exemptions based on the identity of the plan investor or the 
fiduciary making the investment decision on behalf of the plan 
(``Investor-Based Exemptions'').\30\ Equity investments in any type of 
corporate stocks (which can be highly speculative and have certainly 
experienced significant losses) are also not restricted by the 
prohibited transaction rules because of the operating company exception 
under the Plan Asset Regulation, set forth at 29 CFR Sec. 2510-
3.101(c). Similarly, plans can invest in a commercial mortgage loan, 
yet may not be able to invest in any investment-grade collateralized 
MBS which carries far less credit risk. In addition, while there have 
been rating downgrades of ABS/MBS, the ABS/MBS downgrade statistics are 
vastly superior to the comparable statistics for corporate debt 
instruments.

[[Page 51472]]

The Applicant states that the purpose in drawing these comparisons is 
not to suggest that corporate bonds, commercial mortgage loans or any 
other instruments are unsafe plan investments. Rather, the point is 
that investment-grade ABS/MBS are equally as safe, if not safer, 
investments than other alternatives presently available to plans under 
various existing exemptions.
---------------------------------------------------------------------------

    \30\ These exemptions include (a) PTE 84-14, regarding 
transactions negotiated by qualified professional asset managers; 
(b) PTE 90-1, regarding investments by insurance company pooled 
separate accounts; (c) PTE 91-38, regarding investments by bank 
collective investment funds; (d) PTE 95-60, regarding investments by 
insurance company general accounts; and (e) PTE 96-23, regarding 
investments determined by in-house asset managers.
---------------------------------------------------------------------------

    The Applicant believes that investment-grade ABS/MBS are an 
attractive investment alternative to plan fiduciaries. This is because 
in most ABS/MBS transactions, credit risk is spread across many 
Obligors instead of just one corporate borrower as would be the case 
with the issuance of a corporate bond. At least one reason for this is 
that if the Obligor on a corporate bond defaults, the bond holder will 
not be paid in full, whereas in a securitization, even if a number of 
the underlying obligations go into default, the holder of an 
investment-grade security is still likely to receive payment because of 
the size of the asset pool and/or credit support features of the 
transaction. In addition, the returns on ABS/MBS are generally higher 
than those paid on corporate debt instruments in comparable rating 
categories in order to compensate investors for prepayment risk (i.e., 
the risk that an investor may receive a return of the principal it 
invested earlier than anticipated).
    The Applicant believes that allowing a greater proportion of ABS/
MBS to be eligible for relief under the Underwriter Exemptions is of 
considerable benefit to plan participants and their beneficiaries 
because it increases the access plans have to fixed income investments 
with high credit quality as an alternative to corporate bonds and other 
forms of investments. Plan fiduciaries have available to them a 
significant amount of statistical data as to the historical performance 
of ABS/MBS by asset type, investment rating and originator which can 
assist them in evaluating the pool of assets being securitized. Plan 
investors are also able to contemporaneously monitor the performance of 
ABS/MBS because they are provided periodic reports in which they 
receive, in general, the following information: the amount of principal 
and source of principal (e.g., from regular loan principal payments, 
prepayments or reserve accounts), the amount of interest, the status of 
the payments on the underlying mortgages (e.g., are any 30, 60 or 90 
days in arrears) and the status of the credit support (e.g., 
overcollateralization levels and reserve account balances).

C. Description of Rating Agencies' Due Diligence With Respect to 
Parties Involved in Transactions

    The Applicant states that the due diligence performed by the Rating 
Agencies with respect to the parties to the transaction, such as the 
Sponsor, Servicer, Trustee and Insurer, and their requirements 
regarding these parties which are described below, are generally common 
to all securitizations.
1. The Sponsor
    The Rating Agencies do not have minimum credit rating requirements 
for the Sponsor if it is not also acting as a Servicer because its 
assets are not subject to the claims of the Issuer. However, the Rating 
Agencies do apply a factor to the expected loss estimate for a pool of 
mortgages or other assets based upon the quality of the Sponsor, and 
they evaluate the Sponsor's underwriting standards and operations in 
order to determine the general financial stability of the Sponsor. Such 
an evaluation provides an indication of the credit quality of the 
assets being securitized. An on-site investigation may be made, 
including meetings with management. This will generally include a 
review of the operations, policies and procedures of the Sponsor, 
including the quality and completeness of loan documentation. For 
example, the historic and current lending criteria of the Sponsor, 
including the Sponsor's policies regarding allowing extensions of 
payment schedules, renegotiating contracts, granting grace or cure 
periods and loan liquidation procedures, will be reviewed. Its manner 
of competing in the market for borrowers is also examined (e.g., to see 
whether borrowers are sought without conducting adequate review of 
their finances and whether the Sponsor has adequate capital to support 
a growing loan portfolio and its access to bank financing or other 
sources of liquidity). Historic delinquency rates with respect to the 
Sponsor's receivables will generally also be examined, as will the 
underwriting standards of the Sponsor (i.e., evaluating the credit of 
potential borrowers within stated lending guidelines and the use of 
credit checks). If such guidelines are applied consistently, the 
Sponsor's historical record may be helpful in predicting future 
performance of the loan portfolios. The information presented by the 
Sponsor will also be evaluated in order to determine the overall 
stability of the Sponsor, including its historic and expected financial 
performance, its organizational strengths and weaknesses and its 
competitive position. The importance of the financial stability of the 
Sponsor in determining the overall rating of the securitization 
transaction will depend on determination of the correlation between the 
performance of the receivables and any fundamental risks inherent in 
the Sponsor's business operations. The process by which the receivables 
are chosen for a transaction is also reviewed in order to ensure that 
the pool represents either a random sampling or quality-oriented 
sampling of the Sponsor's receivables and not predominately lower-
quality receivables.
2. The Servicer
    (a) Review of Servicer's Operations--The Servicer is required to 
service the receivables held by an Issuer. The Rating Agencies, 
therefore, perform a thorough evaluation of the Servicer as part of 
their evaluation of the general credit risk of a particular 
transaction. A complete review of the Servicer is conducted beginning 
with its formation. If it has been in business for less than three to 
five years or has shown weak portfolio performance, bond insurance for 
the Securities offered may be required providing full coverage against 
borrower defaults. The management of the Servicer is reviewed to assess 
the experience, character and integrity of management. The Rating 
Agencies will also conduct a review of the Servicer's operations and 
capabilities, such as the degree to which the recordkeeping and 
collection process is automated, the internal audit and review systems, 
capacity constraints, fraud prevention procedures and collection 
methods. The evaluation of the Servicer usually involves an on-site 
visit, including a meeting with management to discuss procedures, 
methodology, past history and future financial outlook. High-quality 
servicing provides investor protection which is required in order for a 
high rating of the Securities and, conversely, low-quality servicing 
could lower a rating.
    (b) Collection and Handling of Funds--The Servicer will usually be 
in the asset servicing business and may, therefore, have responsibility 
for the assets of many securitization transactions. Often operating 
efficiencies require that payments be made to one source and then be 
allocated to the individual Issuers. This central collection feature 
causes short-term commingling of assets. Accordingly, unless the 
Servicer is highly rated, the Rating Agencies will require the servicer 
to transfer all collections it receives in the course of its acting as 
a servicer for different issuers to segregated accounts for each

[[Page 51473]]

issuer which are held at highly rated banks within two to three days of 
receipt. The Rating Agencies also examine the effect that bankruptcy or 
other insolvency would have on the Servicer's ability to service the 
loans or advance funds to pay securityholders or pay other required 
fees.
    (c) Payment Support Features--As part of its servicing 
responsibilities, the Servicer may also be required to provide two 
payment support features to the securityholders. The first is a 
liquidity facility or monthly advance requirement, and the second is a 
``compensating interest'' feature. The overall credit quality of the 
Servicer affects the Servicer's ability to perform these functions. 
Accordingly, if a Servicer provides financial support, the Rating 
Agencies prefer that such Servicer have a rating which is not lower 
than the rating to be assigned to the Securities. If the Servicer's 
rating is lower, additional protections may be required, such as 
requiring the Servicer to obtain a surety bond, letter of credit or 
other rated credit support for its financial support.
    (i) Servicer Advances--Where advancing is required, the Servicer is 
generally required to advance funds to the Issuer in an amount equal to 
delinquent payments of interest and, in some transactions principal, to 
the extent that the Servicer believes that these amounts may be 
recovered from subsequent payments and collections. If an Obligor is 
late in making payments, the Servicer will advance the funds to the 
Issuer. The Servicer is entitled to a return of these funds from future 
collections. The Servicer is essentially making an interest-free loan 
to the Issuer, but it is the Issuer that bears the ultimate risk of 
loss. An alternative to Servicer advancing is an advance claims payment 
provision. An advance claims payment provision is an insurance policy 
that guarantees timeliness of payments to the securityholders. In 
addition, the Rating Agencies require errors and omissions insurance in 
at least the amount of the maximum cash balance anticipated to be in 
the Issuer's accounts held by the Servicer, Issuer, paying agent or 
other agent covering potential losses arising from errors and omissions 
of officers, directors and employees of such transaction participants 
to the extent they have access to Issuer funds.
    (ii) Servicer Compensating Interest--When an Obligor on a mortgage 
loan or other prepayable asset makes a prepayment (either full or 
partial) on the obligation, interest is only required to be paid that 
month up until the date of the prepayment, but the securityholder is 
entitled to a full month's interest on that loan. The Servicer may be 
required to fund the difference between a full month's interest on such 
prepaid loan and the interest actually received from the Obligor. The 
Servicer is generally only required to make such compensating interest 
payments in amounts that will not exceed its servicing compensation for 
that month.
    (d) Successor Servicers and Subservicers--Transaction documents 
will provide for the appointment of a successor Servicer if the 
original Servicer is deemed unable to perform its required duties. 
Typically, a Trustee with an acceptable rating may act as a back-up 
Servicer by assuming an obligation to perform the servicing function in 
the event of a default by the Servicer. However, a Servicer is not 
permitted to resign voluntarily until a replacement is appointed. 
Servicing compensation is also set at a level so that a successor 
Servicer will be adequately compensated for assuming such servicing 
responsibilities. Transaction documentation may also allow the Servicer 
to subcontract some or all of its servicing obligations to qualified 
Subservicers. While these Subservicers may perform the actual servicing 
work on a selected portion of the pool of assets, the Servicer remains 
responsible for the ultimate performance of the servicing activities 
and is liable for any failure to adequately perform the required 
servicing duties.
    Prior to the transfer of servicing responsibilities to a successor 
Servicer and prior to a merger or consolidation affecting the Servicer, 
the parties to the transaction must obtain the Rating Agency's written 
confirmation that the rating of the rated Securities in effect 
immediately prior to the transfer of servicing responsibilities will 
not be qualified, downgraded or withdrawn as a result of such 
resignation, merger or other transfer. Typically, a Servicer may 
voluntarily resign only upon a determination that the performance of 
its servicing duties under the servicing agreement is no longer 
permissible under applicable law and appointment by the Trustee or 
securityholders of, and acceptance by, a successor Servicer. A Servicer 
may be forced to resign by the Trustee or securityholders if the 
continuation of the Servicer's servicing responsibilities would result 
in the qualification, downgrade or withdrawal of the rating assigned to 
the Securities or in the event of a default of the Servicer's 
obligations under the Pooling and Servicing Agreement.
    (e) Reports to Investors--The Servicer will be responsible for 
preparing periodic reports on the performance of the pool of assets 
containing such information as: beginning principal balance, ending 
principal balance, the allocation of payments received between interest 
and principal, scheduled principal payments, prepayments received, 
delinquencies and status of various categories of delinquent accounts 
(e.g., number of accounts 30-59 days, 60-89 days and 90 or more days 
delinquent), defaults, foreclosures, if any, and other relevant 
information for the related Trustee. The Trustee will utilize this data 
in preparing the reports to securityholders.
3. The Trustee
    The Trustee is also examined by the Rating Agencies to ensure that 
credit problems of the Trustee do not affect the Issuer. Monies 
received by the Issuer from the Servicer must be immediately deposited 
into segregated accounts earmarked for the Issuer so that no 
commingling occurs in the hands of the Trustee. If these funds are to 
be invested, they only may be invested in instruments that have been 
rated at a level specified by the Rating Agency as acceptable for the 
rating given to such Securities (a ``Rating Condition''). Transaction 
documentation will specify a list of permitted investments acceptable 
to the applicable Rating Agencies. Typical examples of permitted 
investments include the following: (a) Direct obligations or 
obligations guaranteed by the United States or an agency or 
instrumentality thereof; (b) demand or time deposits, federal funds or 
bankers' acceptances issued by banks or trust companies that are 
subject to federal and/or state banking authorities (subject to the 
Rating Condition or FDIC insurance); (c) repurchase obligations with 
respect to (a) and (b) above; (d) discount or interest-bearing 
Securities issued by United States corporations that meet the 
applicable Rating Condition; (e) commercial paper meeting the 
applicable Rating Condition; and (f) money market funds or common trust 
funds that meet the applicable Rating Condition.
    The Trustee must be capable of performing the duties of the 
Servicer in case the Servicer cannot perform its duties and a successor 
has not been appointed. Transaction documentation will usually specify 
minimum capital and surplus requirements for a Trustee and any 
successor. As with the Servicer, adequate compensation for the services 
performed by the Trustee will be provided for in the governing 
documents. The Trustee is examined for its ability to administer 
transactions; its

[[Page 51474]]

ability to assume successor Servicer responsibilities (or hire another 
entity to do so); its plan to assume successor servicing, if necessary, 
and whether its computer systems are compatible with the Servicer's 
systems.
4. The Insurer
    In transactions using third-party credit support, the rating of 
Securities normally can be no higher than that of the claims-paying 
ratings of the credit support provider. For this reason, selection of 
an insurance company to provide advance claims payment insurance, 
Security or bond insurance, pool insurance, mortgage insurance or 
special hazard insurance is an important element in the structuring of 
a securitization transaction. In assessing the credit of mortgage 
insurance companies, the Rating Agencies make a number of 
determinations as part of their review. The review includes a 
determination of standing with the applicable state insurance 
commission, adequacy of surplus and contingency reserves, historic 
underwriting performance and operating profitability, quality of 
investment portfolio, quality in management and internal control and 
secondary support, such as reinsurance policies. Similar factors are 
considered in the assessment of the claims-paying ability of Security 
or bond insurance providers.

D. Types of Credit Support

    Credit support consists of two general varieties: external credit 
support and internal credit support. The Applicant notes that the 
choice of the type of credit support depends on many factors. Internal 
credit support which is generated by the operation of the Issuer is 
preferred because it is less expensive than external credit support 
which must be purchased from outside third parties. In addition, there 
is a limited number of appropriately rated third-party credit support 
providers available. Further, certain types of credit support are not 
relevant to certain asset types. For example, there is generally little 
or no excess spread available in residential or CMBS transactions 
because the interest rates on the obligations being securitized are 
relatively low. Third, the Ratings Agencies may require certain types 
of credit support in a particular transaction. In this regard, the 
selection of the types and amounts of the various kinds of credit 
support for any given transaction are usually a product of negotiations 
between the Underwriter of the securities and the Ratings Agencies. For 
example, the Underwriter might propose using excess spread and 
subordination as the types of credit support for a particular 
transaction and the Rating Agency might require cash reserve accounts 
funded up front by the Sponsor, excess spread and a smaller sized 
subordinated tranche than that proposed by the Underwriter. In 
addition, market forces can affect the types of credit support. For 
example, there may not be a market for subordinated tranches because 
the transaction cannot generate sufficient cash flow to pay a high 
enough interest rate to compensate investors for the subordination 
feature, or the market may demand an insurance wrap on a class of 
securities before it will purchase certain classes of securities. All 
of these considerations interact to dictate which particular 
combination of credit support will be used in a particular transaction.
1. External Credit Support
    In the case of external credit support, credit enhancement for 
principal and interest repayments is provided by a third party so that 
if required collections on the pooled receivables fall short due to 
greater than anticipated delinquencies or losses, the credit 
enhancement provider will pay the securityholders the shortfall. 
Examples of such external credit support features include: insurance 
policies from ``AAA'' rated monoline \31\ insurance companies (referred 
to as ``wrapped'' transactions), corporate guarantees, letters of 
credit and cash collateral accounts. In the case of wrapped or other 
credit supported transactions, the Insurer or other credit provider 
will usually take a lead role in negotiating with the Sponsor 
concerning levels of overcollateralization and selection of receivables 
for inclusion into the pool as it is the Insurer or credit provider 
that will bear the ultimate risk of loss. As mentioned above, one 
disadvantage of insurance, corporate guarantees and letters of credit 
is that they are relatively expensive in comparison with other types of 
credit support. Also, if the credit rating of the insurance company or 
other credit provider is downgraded, the rating of the Securities is 
correspondingly downgraded because the Rating Agencies will only rate 
the Securities as highly as the credit rating of the credit support 
provider. In any event, credit support providers require that each 
class of Securities they insure be ``shadow rated'' no lower than 
``BBB.'' A shadow rating is the rating that the Securities would have 
received from the Rating Agency if the class of Securities had not been 
wrapped, and the Rating Agency will provide a letter addressed solely 
to the credit support provider verifying such rating. However, there 
are only a handful of ``AAA'' monoline insurance providers, and 
investors do not want to have too high a concentration of Securities 
which are backed by such Insurers. There are also few providers of 
letters of credit or corporate guarantees that have sufficiently high 
long-term debt credit ratings. These disadvantages are some of the 
reasons why subordination is often used as an alternative form of 
credit support. Cash collateral accounts include reserve accounts which 
are funded, usually by the Sponsor, on the Closing Date and are 
available to cover principal and/or interest shortfalls as provided in 
the documents.
---------------------------------------------------------------------------

    \31\ The term ``monoline'' is used to describe such insurance 
companies because writing these types of insurance policies is their 
sole business activity.
---------------------------------------------------------------------------

2. Internal Credit Support
    Internal credit support relies upon some combination of utilization 
of excess interest generated by the receivables, specified levels of 
overcollateralization and/or subordination of junior classes of 
Securities. Transactions that look almost exclusively to the underlying 
pooled assets for cash payments (or ``senior/subordinated'' 
transactions) will contain multiple classes of Securities, some of 
which bear losses prior to others and, therefore, support more senior 
Securities. A subordinate Security will absorb realized losses from the 
asset pool, and have its principal amount ``written down'' to zero, 
before any losses will be allocated to the more senior classes. In this 
way, the more senior classes will receive higher rating classifications 
than the more subordinate classes. However, the Rating Agencies require 
cash flow modeling of all senior/subordinated structures. These cash 
flows must be sufficient so that all rated classes, including the 
subordinated classes, will receive timely payment of interest and 
ultimate repayment of principal by the maturity date. The cash flow 
models are tested assuming a variety of stressed prepayment speeds, 
declining weighted average interest payments and loss assumptions. 
Other structural mechanisms to assure payment to subordinated classes 
are to allow collections held in the reserve account for the next 
payment date to be used if necessary to pay current interest to the 
subordinated class or to create a separate interest liquidity reserve. 
The collections held in the reserve account are from principal and 
interest paid on the underlying mortgages or other receivables held in 
the Issuer and are not from the securities issued by the

[[Page 51475]]

Issuer.\32\ Also, some structures allow both principal and interest to 
be applied to all payments to securityholders, and in others, principal 
can be used to pay interest to the subordinate tranches.
---------------------------------------------------------------------------

    \32\ A collections reserve account is established for almost all 
transactions to hold interest and principal payments on the 
mortgages or receivables as they are collected until the necessary 
amounts are paid to securityholders on the next periodic 
distribution date. In some transactions, the Rating Agencies or 
other interested parties may require, in order to protect the 
interests of the securityholders, that excess interest in amount(s) 
equal to a specified number of future period anticipated collections 
be retained in the collection account. This protects both senior and 
subordinated securityholders in situations where there are 
shortfalls in collections on the underlying obligations because it 
provides an additional source of funds from which these 
securityholders can be paid their current distributions before the 
holders of the residual or more subordinated securities receive 
their periodic distributions, if any. Accordingly, any reference to 
``collections'' from principal and interest paid on the mortgages is 
intended to describe such excess interest or principal not required 
to cover current payments to the senior and subordinated class 
eligible to be purchased by plans. Thus, this mechanism is not 
harmful to the interests of senior securityholders.
---------------------------------------------------------------------------

    Interest which is received but is not required to make monthly 
payments to securityholders (or to pay servicing or other 
administrative fees or expenses) can be used as credit support. This 
excess interest is known as ``excess spread'' or ``excess servicing'' 
(``Excess Spread'') and may be paid out to holders of certain 
Securities, returned to the Sponsor or used to build up 
overcollateralization or a loss reserve. The credit given to Excess 
Spread is conservatively evaluated to ensure sufficient cash flow at 
any one point in time to cover losses. The Rating Agencies reduce the 
credit given to Excess Spread as credit support to take into account 
the risk of higher coupon loans prepaying first, higher than expected 
total prepayments, timing mismatching of losses with Excess Spread 
collections and the amounts allowed to be returned to the Sponsor once 
minimum overcollateralization targets are met (thereby reducing the 
amounts available for credit support).
    ``Overcollateralization'' is the difference between the outstanding 
principal balance of the pool of assets and the outstanding principal 
balance of the Securities backed by such pool of assets. This results 
in a larger principal balance of underlying assets than the amount 
needed to make all required payments of principal to investors. In all 
senior/subordinated transactions, the requisite level of 
overcollateralization and the amount of principal that may be paid to 
holders of the more subordinated Securities before the more senior 
Securities are retired (since once such amounts are paid, they are 
unavailable to absorb future losses) is determined by the Rating 
Agencies and varies from transaction to transaction, depending on the 
type of assets, quality of the assets, the term of the Securities and 
other factors.
    The senior/subordinated structure often combines the use of 
subordinated tranches with overcollateralization that builds over time 
from the application of excess interest to pay principal on more senior 
classes. This is often referred to as a ``turbo'' structure. The credit 
enhancement for each more senior class is provided by the aggregate 
dollar amount of the respective subordinated classes, plus 
overcollateralization that results from the payment of principal to the 
more senior classes using excess spread prior to payment of any 
principal to the more subordinated classes. As overcollateralization 
grows, the pool of loans can withstand a larger dollar amount of losses 
without resulting in losses on the senior Securities. This also has the 
effect of increasing the amount of funds available to pay the more 
subordinated classes as an ever-decreasing portion of the principal 
cash flow is needed to pay the more senior classes. Excess interest is 
used to pay down the more senior Security balances until a specific 
dollar amount of overcollateralization is achieved. This is referred to 
as the overcollateralization target amount required by the Rating 
Agencies. Typically, the targeted amount is set to ensure that even in 
a worst-case loss scenario commensurate with the assigned rating level, 
all securityholders, including holders of subordinated classes, will 
receive timely payment of interest and ultimate payment of principal by 
the applicable maturity date. In these transactions, the targeted 
amount is usually set as a percentage of the original pool balance. It 
may be reduced after a fixed number of years after the Closing Date, 
subject to the satisfaction of certain loss and delinquency triggers. 
These triggers ensure that overcollateralization continues to be 
available if pool performance begins to deteriorate. In a senior/
subordinated structure, every investment-grade class (whether or not 
subordinated) is protected by either a lower rated subordinated class 
or classes or other credit support.

E. Provision of Credit Support Through Servicer Advancing

    In some cases, the Master Servicer, or an Affiliate of the 
Servicer, may provide credit support to the Issuer (i.e., act as an 
Insurer). In these cases, the Servicer will first advance funds to the 
full extent that it determines that such advances will be recoverable 
(a) out of late payments by the Obligors, (b) from the credit support 
provider (which may be the Master Servicer or an Affiliate Servicer) 
or, (c) in the case of an Issuer that issues subordinated Securities, 
from amounts otherwise distributable to holders of subordinated 
Securities, and the Master Servicer will advance such funds in a timely 
manner. When the Servicer is a provider of the credit support and 
provides its own funds to cover defaulted payments, it will do so 
either on the initiative of the Trustee, or on its own initiative on 
behalf of the Trustee, but in either event it will provide such funds 
to cover payments to the full extent of its obligations under the 
credit support mechanism. In some cases, however, the Servicer may not 
be obligated to advance funds but instead would be called upon to 
provide funds to cover defaulted payments to the full extent of its 
obligations as Insurer. Moreover, a Master Servicer typically can 
recover advances either from the provider of credit support or from the 
future payments on the affected receivables.
    If the Master Servicer fails to advance funds, fails to call upon 
the credit support mechanism to provide funds to cover delinquent 
payments, or otherwise fails in its duties, the Trustee would be 
required and would be able to enforce the securityholders' rights as 
both a party to the Pooling and Servicing Agreement and the owner of 
the Trust estate where the Issuer is a Trust (or as the holder of the 
security interest in the receivables), including rights under the 
credit support mechanism. Therefore, the Trustee, who is independent of 
the Servicer, will have the ultimate right to enforce the credit 
support arrangement.
    When a Master Servicer advances funds, the amount so advanced is 
recoverable by the Master Servicer out of future payments on 
receivables held by the Issuer to the extent not covered by credit 
support. However, where the Master Servicer provides credit support to 
the Issuer, there are protections, including those described below, in 
place to guard against a delay in calling upon the credit support to 
take advantage of the fact that the credit support declines 
proportionally with the decrease in the principal amount of the 
obligations held by the Issuer as payments on receivables are passed 
through to investors. These protective safeguards include:
    1. There is often a disincentive to postponing credit losses 
because the sooner repossession or foreclosure activities are 
commenced, the more value that can be realized on the security for the 
obligation;

[[Page 51476]]

    2. The Master Servicer has servicing guidelines which include a 
general policy as to the allowable delinquency period after which an 
obligation ordinarily will be deemed uncollectible. The Pooling and 
Servicing Agreement will require the Master Servicer to follow its 
normal servicing guidelines and will set forth the Master Servicer's 
general policy as to the period of time after which delinquent 
obligations ordinarily will be considered uncollectible;
    3. As frequently as payments are due on the receivables held by the 
Issuer, as set forth in the Pooling and Servicing Agreement (typically 
monthly, quarterly or semi-annually), the Master Servicer is required 
to report to the independent Trustee the amount of all payments which 
are past due more than a specified number of days and the amount of all 
Servicer advances, along with other current information as to 
collections on the assets and draws upon the credit support. Further, 
the Master Servicer is required to deliver to the Trustee annually a 
certificate of an executive officer of the Master Servicer stating that 
a review of the servicing activities has been made under such officer's 
supervision, and either stating that the Servicer has fulfilled all of 
its obligations under the Pooling and Servicing Agreement or, if the 
Master Servicer has defaulted under any of its obligations, specifying 
any such default. The Master Servicer's reports are reviewed at least 
annually by independent accountants to ensure that the Master Servicer 
is following its normal servicing standards and that the Master 
Servicer's reports conform to the Master Servicer's internal accounting 
records. The results of the independent accountant's review are 
delivered to the Trustee; and
    4. The credit support has a ``floor'' dollar amount that protects 
investors against the possibility that a large number of credit losses 
might occur towards the end of the life of the Issuer, whether due to 
Servicer advances or any other cause. Once the floor amount has been 
reached, the Servicer lacks an incentive to postpone the recognition of 
credit losses because the credit support amount becomes a fixed-dollar 
amount, subject to reduction only for actual draws. From the time that 
the floor amount is effective until the end of the life of the Issuer, 
there are no proportionate reductions in the credit support amount 
caused by reductions in the pool principal balance. Indeed, since the 
floor is a fixed-dollar amount, the amount of credit support ordinarily 
increases as a percentage of the pool principal balance during the 
period that the floor is in effect.

F. Description of Designated Transactions

    The Applicant requests relief for senior and/or subordinated 
investment-grade securities issued by Issuers with respect to a limited 
number of asset categories: Motor vehicles, residential/home equity, 
manufactured housing and CMBS. Accordingly, the Applicant has provided 
the Department with detailed, separate profiles of a typical 
transaction for each asset category. Each profile describes 
specifically how each type of transaction generally is structured, the 
due diligence that the Rating Agencies conduct before assigning a 
rating to a particular class of such securities, the calculations that 
are performed to determine projected cash flows, loss frequency and 
loss severity and the manner in which credit support requirements are 
determined for each rating class. The motor vehicle, residential/home 
equity, manufactured housing and commercial ABS/MBS transactions, as 
described in this section will collectively be referred to as 
``Designated Transactions.'' \33\
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    \33\ The modifications requested with respect to the type of 
securitization vehicle (i.e., both Trust and non-Trust) and type of 
security (both debt and equity securities) or the use of interest 
rate swaps or yield supplement agreements with notional principal 
amounts would be applicable to both Designated Transactions and all 
other types of asset categories currently permitted under the 
Underwriter Exemptions.
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    Each of the four types of Designated Transactions is already 
encompassed within the existing asset categories. Specifically:
    (i). Automobile and other motor vehicle ABS would principally fall 
within category III.B.(1)(d) obligations that are secured by motor 
vehicles or equipment but could also be covered under category 
III.B.(1)(a) secured consumer receivables or III.B.(1)(b) secured 
credit investments between business entities, depending on the factual 
situation.
    (ii). Home equity and residential ABS/MBS would fall within 
categories III.B.(1)(a) which specifically refers to home equity loans 
and III.B.(1)(c) which specifically refers to single-family residential 
real property.
    (iii). Manufactured housing would fall within category III.B.(1)(a) 
if the manufactured housing is considered to be personal property under 
local law, or within category III.B.(1)(c) if the manufactured housing 
is considered real property under local law.
    (iv). CMBS would fall within category III.B.(1)(c) which 
specifically refers to multi-family residential and commercial real 
property.
1. Motor Vehicle Loan Transactions
    The Applicant asserts that many motor vehicle loan securitizations 
are currently ineligible for exemptive relief under the Underwriter 
Exemptions if such transactions have subordinated tranches, 
notwithstanding being rated ``A'' or better. The Applicant notes that 
in a typical motor vehicle transaction, ``AAA'' rated senior Securities 
are issued that might represent approximately 90% or more of the 
principal balances of the Securities, with ``A'' rated subordinated 
Securities issued that might represent the remaining 10% or less of the 
principal balance of the Securities. The total level of credit 
enhancement from all sources, including Excess Spread, typically 
averages approximately 7% of the initial principal balance of 
Securities issued by prime issuers and 14% for subprime Issuers in 
order to obtain an ``AAA'' rated Security. Credit support equaling 3% 
for prime Issuers is usually required in order to obtain an ``A'' or 
better rating on the subordinated Securities. Typical types of credit 
support used in auto transactions are subordination, reserve accounts, 
Excess Spread and financial guarantees from ``AAA'' rated monoline 
insurance companies. Transactions with subprime Sponsors generally use 
surety bonds as credit enhancement, so there is no subordinated class.
    The Applicant states that as 70% of the motor vehicle 
securitization market is attributable to automobile loans, the 
following discussion principally relates to automobiles. (The term 
``automobile'' as used herein also is intended to include light 
trucks.) Other types of motor vehicles include boat loans, agricultural 
equipment, construction equipment and recreation vehicles (RVs). The 
Applicant is not requesting additional exemptive relief at this time 
for motor vehicle leasing transactions or dealer floor plan financing.
    The Applicant provided the following description of the analysis 
performed by the Rating Agencies in their consideration of automobile 
securitizations and their determination of appropriate credit support 
requirements:
    (a) Motor Vehicles--General Considerations--The credit rating of 
the borrower in auto loan securitizations is much more important than 
in real estate mortgage loan securitizations, where the value of the 
collateral is one of the principal considerations. LTV ratios in auto 
transactions increase over time due to the depreciation in value of the 
automobiles over the term of the loan.

[[Page 51477]]

This makes it much more likely that borrowers will default if they fall 
behind in their payments because they cannot pay off the loan with the 
proceeds realized from selling the automobile. Accordingly, a 
particularly intensive review of the underwriting policies and 
procedures of the loan originators and the loss histories of each 
originator is conducted in order to evaluate the predicted strength of 
the borrowers. In addition, in order to insure timely payment to the 
securityholders, the financial strength of the Sponsor/Servicer and its 
operations and procedures, particularly with respect to how diligently 
and timely it acts to monitor and correct late monthly payments and/or 
to declare a default on the loan and repossess the collateral, are 
closely scrutinized.
    (b) Motor Vehicles--Due Diligence--The particular aspects of the 
Rating Agencies' due diligence that are specific to motor vehicle 
transactions are as follows. The originator's dealer network is 
examined to determine the presence of any significant dealer 
concentration, the composition of business across manufacturer 
franchised new and used car dealerships, the selection process for new 
dealerships, management tools to track performance by dealers, how 
business is solicited and the methods used to prevent and detect dealer 
fraud. Because the automobile sales market is extremely competitive, 
companies are under pressure to meet certain growth targets. Therefore, 
the Rating Agencies conduct an extensive review of the originator's 
underwriting (loan approval) standards and monitoring controls. Both 
the originator's underwriting criteria and the nature and frequency of 
updates are examined. Factors included in this review are: how many 
years of the borrower's credit history are considered; stability of the 
borrower in job and residence; income levels; payment-to-income and 
debt-to-income ratios; approval rates of origination; presence of 
first-time buyers and whether and what type of credit scoring of 
borrowers is performed.
    (c) Motor Vehicles--Determination of Expected Losses--In order to 
determine the correct amount of credit support which will be required 
to support a particular rating for a class of auto loan Securities, a 
base-case securitized pool loss assumption is calculated using the 
following factors. Static pool data, if available, is compiled by 
taking a discrete period of originations of the originator, such as a 
financial quarter, and that pool's performance is tracked on a monthly 
basis as the loans amortize, particularly focusing on loans which have 
been outstanding (seasoned) 18-24 months and have been substantially 
paid down. This allows a determination of the shape of the loss curve 
and project timing of losses to be made. The cumulative net loss on the 
less seasoned pools can then be extrapolated from the older pools. 
Static pool data is preferred over active pool data, which can mask 
losses during periods when the originator's pool of loans is rapidly 
growing.
    In creating the base-case expected loss amount, a detailed 
breakdown of originations, delinquencies, repossessions, gross and net 
losses and recoveries are examined. Any understatement of portfolio 
losses are isolated and all originators are placed on a comparable 
basis by dividing net annual losses by the outstanding principal 
balance of a prior period, which creates a growth adjustment factor. 
Once expected losses are estimated, the expected cumulative losses are 
derived by multiplying these expected losses by the weighted average 
life of the collateral, using conservative assumptions regarding losses 
and prepayments.
    The pool of loans selected for the securitization is examined in 
order to assure that it is representative of the base-line loss 
assumption for that originator and has not been selected from lesser-
quality receivables. The selection process used by the originator is 
monitored by checking the annual percentage rate on the loans, the 
principal amount of the loan, the LTV ratios, original maturity date of 
the loans and remaining maturity, the new and used mix, the model year 
and mileage of the vehicles, the amortization methods and geographic 
concentrations. The characteristics of the borrowers are also examined 
to monitor representative creditworthiness and stability by looking at 
gross income, monthly debt service, debt-to-gross income ratio, down 
payment-to-value ratio, years of credit history, credit scores, length 
of time at the borrower's residence, employment term and past credit 
problems to make sure that these criteria are representative of the 
originator's broader portfolio. Credit scoring is a relatively new 
method used by lending facilities to assess a borrower's likelihood of 
repaying a loan. The Rating Agencies monitor the correlation between 
such scores and actual losses to refine the appropriate weighting to be 
given to credit scores.
    Delinquency data is broken out over 30-day, 60-day and 90-day 
groups, and delinquencies are examined based on the loan contract 
terms. In order to make sure that default data is not misleading, the 
Rating Agencies examine whether all loans that are not performing and 
are not charged off (even if the debtor is in bankruptcy or where the 
automobile has been repossessed) are considered to be in default. The 
originator's charge-off policy and accounting method used to calculate 
losses are examined, as the timing of the charge-off is important 
because it affects loss statistics, and delays in charge-offs put 
stress on liquidity.
    (d) Special Factors Applicable to Motor Vehicles other than 
Automobile--(i) Recreational Vehicles--The methodology used in 
evaluating the credit quality of a pool of RV loans is very similar to 
that used to assess auto loan pools but takes into account the fact 
that the average RV Obligor is of higher credit quality than the 
average auto loan Obligor. However, as RVs are generally regarded as 
luxury items, buyers tend to default on them before debt obligations on 
necessities. The characteristics of the RV Obligor base can vary widely 
across pools, depending on such factors as the specific types of 
vehicles in the pools and whether they are new or used, and therefore 
must be evaluated on a case-by-case basis.
    (ii) Boat Loans--Boat loan pools are similar in many ways to RV 
loan pools as the underlying assets are luxury goods purchased by 
persons who are generally more affluent than the average consumer. 
However, there are some significant differences. There is an extremely 
wide range of boats that can be purchased with costs ranging from a few 
thousand dollars to more than $1 million. Consequently, the 
characteristics of the obligations also span a wide range. Boat buyers, 
especially those of small boats, tend to be younger than the typical RV 
purchaser and are slightly higher credit risks. The resale value of 
boats is highly seasonal, causing the recovery values on defaulted 
loans to be highly variable. Finally, boats are produced by a large 
number of generally small manufacturers. Accordingly, if a manufacturer 
goes out of business, the resale value of its boats can decline sharply 
since parts may be hard to replace; this increases the expected pool 
losses and the variability of those losses. Second, there is an 
increased risk of pool losses resulting from the bankruptcy of a 
manufacturer; if the manufacturer has received the purchase price and 
becomes bankrupt before delivery of the boat, the buyer may default on 
the loan.
    (iii) Agricultural Equipment--Special factors which are taken into 
account in agricultural equipment (tractors and combines) (``AG'') 
securitizations include the following. These loan

[[Page 51478]]

portfolios are particularly affected by commodity prices, weather, 
financial stability of the borrower's business operations and 
governmental price supports. Extensions granted for late payments are 
also common in cases of floods, crop failures, etc., and for this 
reason, geographic diversity in AG pools is especially desirable 
because of varying weather patterns across the United States. Expected 
losses are lower than those experienced in automobile transactions 
because changes in the general economy do not affect frequency of AG 
losses as much, and the equipment has a relatively stable value over 
the life of the loans. However, the loss curve for AG securitizations 
peaks much earlier than for auto loans, with 70% of defaults occurring 
by 18 months, which is a significant factor in analyzing cash flows. 
The size of the average AG loan is significantly higher than for other 
motor vehicles, and the terms are longer (five to seven years). It is 
not unusual for loan payments to be made only once per year to coincide 
with income from annual harvests so the Rating Agencies are concerned 
with an inability of Servicers to ascertain whether a borrower is in 
financial difficulty as quickly. Because the condition of the equipment 
is crucial to generating farm income, the strength of the dealer's 
service department is also considered. On the other hand, companies 
providing financing for AG dealers require such dealers to maintain 
significant cash reserves against potential losses.
    (iv) Construction Equipment Loans--The particular factors which 
relate to construction equipment (``CE'') are as follows. CE includes 
heavy equipment used in highway construction, forestry and mining and 
includes, for example, back-hoes, bulldozers, excavators, truck loaders 
and asphalt pavers. Unlike farm equipment, the health of the general 
economy (and specifically housing starts, interest rates and public and 
private project financing) impacts construction starts which directly 
affects the Obligor's cash flow and thus loss frequency. In addition, 
CE depreciates in value during the loan terms, and the amounts borrowed 
are relatively large, which increases loss severity. Like AG equipment 
loans, the equipment is needed to produce revenue so the Obligor has a 
strong incentive to repay the loan. The cash flow of Obligors is often 
seasonal, and although these loans pay monthly, losses can be sudden. 
On the other hand, loans typically are structured to suspend payments 
during winter months which lessens the frequency of defaults. Most 
loans are serviced by rural businesses which negatively impacts on the 
efficiency of the collection process. The loss curve for CE is also 
early, with 70% of defaults occurring in the first 18 months. The terms 
of a CE may not require any payments in the first six months of the 
loan, depending on the time of year the loan was initiated, so 
seasoning statistics need to be adjusted for this factor.
    (e) Motor Vehicles--Determining Required Credit Support--The total 
credit support required by the Rating Agencies for the desired ratings 
of each class of Securities being offered must be sufficient to cover 
certain pre-established loss multiples which are applied to a base-case 
loss model. For example, a Rating Agency might require sufficient 
credit support from all sources to be able to withstand five times the 
base-case losses for an `AAA' rating and to cover three times the base-
case losses for an `A' rating (whether or not the Security is 
subordinated).
    Cash flow modeling is performed so that the minimum credit support 
levels required on the Closing Date which, when combined with 
structural features that trap Excess Spread, are sufficient to cover 
losses at various levels. The cash flow modeling also allows the 
liquidity of a proposed structure to be tested, using worst-case 
scenarios regarding repossession, recovery periods and amounts, 
prepayments and reinvestment rates for investment and cash on deposit. 
The amount of scheduled principal payments available to retire these 
Securities under various stress scenarios; e.g., higher than expected 
prepayments, delinquencies and losses or less than expected Excess 
Spread is also considered. In addition, the sufficiency of liquidity 
(funds on deposit in reserve accounts) to pay the principal balances by 
the legal final maturity date is examined.
    A loss curve showing the timing of losses is then determined in 
order to decide which types of credit support are necessary. For 
example, auto loan loss curves are significantly front-loaded with peak 
losses occurring between 6 to 18 months for most five-year collateral 
pools. Credit is given to Excess Spread on a discounted, conservative 
basis. The presence of triggers (see below), which raise the level of 
the reserve account as a percentage of current outstanding Securities 
or collateral if performance begins to deteriorate, is also given 
credit. A conservative estimate of investment return on any cash held 
pending distribution in reserve/spread accounts is made; e.g., 2.5%, 
unless a guaranteed investment contract issued by an entity with a 
rating at least equal to the desired transaction rating is used.
    Greater credit support is required if there is insufficient 
geographic loan distribution or disproportionate amounts in states 
which are not economically diverse or which have onerous repossession 
requirements. Greater credit support may also be required to address 
liquidity risks as the rating addresses the likelihood of timely 
payment of interest. The common liquidity risks addressed in motor 
vehicle loan transactions include the following: early maturity, 
differences in how borrowers are credited with having made interest and 
principal payments under the terms of the loan and how interest and 
principal are paid to securityholders. Interest rate risk where the 
motor vehicle loans are fixed rate but the Securities have a variable 
interest rate is also considered.
    In auto transactions which feature declining credit support 
requirements over the life of the transaction, credit support floor 
coverage, which provides a minimum percentage of credit support at the 
end of a securitization, may be required. This is because even though 
most losses occur between 6-18 months and borrowers are less likely to 
default once they have built up equity, losses may increase as a 
transaction enters its final stages. In general, for an ``AAA'' rated 
auto transaction, a reserve account floor is required when the pool has 
amortized down to 20% of its original total balance. Auto loan 
securitizations may use overcollateralization and subordination as 
credit support.
    Excess spread in automobile transactions usually ranges between 2%-
3% for prime issues and 7%-14% for subprime issues and can be used to 
absorb credit losses and/or to build up reserve/spread accounts or to 
create overcollateralization. Spread and reserve accounts protect 
against disruptions in cash flows for delinquencies and payment 
disruptions (e.g., bankruptcy of the Sponsor/Servicer). The amount of 
cash available in these accounts is a very important rating 
consideration. However, a reserve or spread account which is funded on 
the Closing Date is more favorably regarded than Excess Spread. This is 
because if the amounts are set aside on the Closing Date, they are 
immediately available; whereas, if they are to be funded over time from 
projected Excess Spread, their availability is less certain. 
Accordingly, if losses are projected such that credit support equaling 
8% of the transaction were to be required, the entire 8% could not be 
provided solely through Excess Spread.

[[Page 51479]]

    Automobile securitizations often feature credit support triggers, 
which allow initial credit enhancement levels to be maintained until 
certain levels of pool loan delinquencies or losses occur, at which 
point higher credit enhancement levels are ``triggered.'' If the 
performance of the securitized pool of loans deteriorates beyond the 
specified levels, the cash flow mechanics of the transaction will 
divert the flow of funds (typically Excess Spread is captured to 
enhance the spread account to a particular level) to provide additional 
protection for the Securities. Conversely, because the quality of an 
auto loan pool increases over time, credit support levels are generally 
permitted to decline proportionately as a tranche amortizes, provided 
that losses and delinquencies are within expectations. However, once 
delinquency and loss triggers are reached, the dollar amount of credit 
support either stops declining or increases to a higher specified 
level, in both cases by retaining some or all Excess Spread. The 
effectiveness of the triggers and the incremental amount of Excess 
Spread that must be retained as performance deteriorates are 
considered, as is the timing of the trigger being reached.
2. Residential/Home Equity Mortgage Transactions
    The Applicant provided the following information on typical 
transactions. In a typical residential mortgage transaction, ``AAA'' 
rated senior Securities might be issued which represent approximately 
95% of the principal balances of the Securities; ``AA'' rated 
subordinated Securities might comprise 2%; ``A'' rated subordinated 1%; 
``BBB'' rated subordinated 1% and junior subordinated Securities might 
constitute 1%. The total level of credit enhancement from all sources 
averages about 4% in order to obtain ``AAA'' rated Securities, 2% for 
an ``AA'' rating, 1.5% for an ``A'' rating and 1% for a ``BBB'' rating. 
Subordination is the predominant type of credit support used in 
traditional residential mortgage transactions.
    In a typical ``B&C home/equity loan'' transaction (see description 
below), ``AAA'' rated senior Securities might be issued which represent 
80% of the principal balances of the Securities; ``AA'' rated 
subordinated Securities might comprise 11%; ``A'' rated subordinated 
6%; ``BBB'' or lower rated subordinated Securities might constitute 3%. 
The total level of credit enhancement from all sources averages about 
13% in order to obtain ``AAA'' rated Securities, 10% for an ``AA'' 
rating, 7% for an ``A'' rating and 3% for a ``BBB'' rating.
    In a typical high LTV ratio (i.e., above 100%) second-lien loan 
transaction, ``AAA'' rated senior Securities might be issued which 
represent approximately 76% of the principal balances of the 
Securities; ``AA'' rated subordinated Securities might comprise 10%; 
``A'' rated subordinated 3%; ``BBB'' rated subordinated 4% and junior 
subordinated Securities might constitute 7%. The total level of credit 
enhancement from all sources averages about 24% in order to obtain 
``AAA'' rated Securities, 14% for an ``AA'' rating, 10% for an ``A'' 
rating and 7% for a ``BBB'' rating.
    Typical types of credit support used in home equity transactions 
are subordination, reserve accounts, Excess Spread, 
overcollateralization and in transactions which do not use 
subordination, financial guarantees from ``AAA'' rated monoline 
insurance companies or highly rated Sponsors. The Applicant provided 
the following description of the analysis performed by the Rating 
Agencies in their consideration of residential/home equity 
securitizations and their determination of appropriate credit support 
requirements.
    (a) Residential/Home Equity--General Considerations--The non-
commercial mortgage securitization market can generally be divided into 
two basic types of assets: ``residential mortgages,'' the majority of 
whose Obligors have ``prime'' credit ratings, and all other 
securitizations of residential real estate which are collectively 
referred to as ``sub-prime'' or ``home equity'' loans (manufactured 
housing is treated as a separate type of asset and is discussed below). 
The term ``home equity'' loan includes second mortgages taken out to 
finance home improvements as well as first and second-lien loans where 
the purpose of the loan is either for refinancing an existing loan, a 
source of credit in lieu of using credit cards or for debt 
consolidation. In addition, it includes first-lien and second-lien 
loans used to purchase a residence where the borrower does not have an 
A credit rating.
    The dollar volume of home equity loan Securities is now the largest 
segment of the securitization market, surpassing credit cards. The 
primary reason for this is that borrowers are increasingly turning to 
first and second-lien home equity loans instead of other forms of 
consumer borrowing (i.e., credit cards), as the interest rates on the 
loans are lower, and the interest payments may be tax deductible. These 
types of loans have a higher credit risk than traditional first-lien 
mortgages. However, the Rating Agencies adjust for the additional risk 
by requiring additional credit support for each tranche of Securities 
in order to achieve the same rating as would be given to a comparably 
rated tranche in a residential mortgage securitization.
    Another significant feature of home equity loans is that they may 
have higher LTV ratios than residential mortgages, often higher than 
100%. In transactions where LTV ratios are in excess of 100%, little or 
no credit is given to the collateral in determining necessary credit 
support, which instead must be supplied from other sources. In the 
traditional rating analysis for residential mortgage securitizations, 
the single most significant factor historically was the loan-to-value 
ratios of the mortgages in the pool. However, statistical information 
has clearly shown that LTV's on both residential and home equity 
mortgages are much less important as a predictor of risk than the 
quality of the borrowers and their capacity to make loan payments. This 
is due to a borrower's reluctance to default on his residence, without 
regard to the amount of equity that is built up. There is an increased 
ability to assess borrower credit risk through the use of credit/
mortgage scoring systems. In order for an originator's credit scoring 
system to be incorporated into the rating process, however, the system 
is tested against a blind pool of loans with known default rates to 
verify the validity of the scoring system to predict losses. Capacity 
to pay is indicated by the borrower's monthly debt-to-income ratio. The 
Rating Agencies test the predictability of such scoring systems before 
relying upon them in their credit analysis.
    Home equity loans can be subdivided into different categories. The 
first category, known as ``B & C home equity loans,'' are made 
primarily to B & C quality borrowers for consolidating credit card and 
other consumer debt or refinancing existing mortgage loans. The second 
category, known as ``home equity lines'' of credit,\34\ are usually 
made to A quality buyers for large specific purchases, such as a car or 
their children's college education expenses. The third category, known 
as home improvement loans, include loans which are guaranteed by 
governmental

[[Page 51480]]

agencies such as the U.S. Department of Housing and Urban Development 
(``HUD'') but have borrowers with poor credit quality (below B & C) or 
are non-guaranteed home improvement loans with B & C credit borrowers. 
The fourth category refers to high LTV ratio loans with borrowers of 
mixed credit quality but on average above B & C quality.
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    \ 34\ While this group of transactions may include pools where 
some portion of the mortgages may be substituted throughout the life 
of the transaction to provide additional credit support, 
substitution is currently permitted under the Underwriter Exemptions 
only for defects in documentation. The Underwriter is not requesting 
relief for transactions with this feature.
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    In transactions where the credit quality of the borrower is lower 
and LTV ratios are higher, the interest rates charged on the loans are 
significantly greater than those on traditional residential loans. This 
results in Excess Spread of typically 450-550 bps which can be used as 
credit support. The home equity market has had a sufficient track 
record to provide the Rating Agencies with a depth of expertise and 
statistical information to rate these Securities with a high degree of 
reliability. The Securities have been well received by investors as 
they have tended to offer higher returns than comparably rated 
residential mortgage Securities in all rating categories other than 
`AAA.' In addition, although the prepayment rates are higher for home/
equity Securities than for traditional residential Securities, these 
prepayment rates are more constant and thus more predictable.
    (b) Residential/Home Equity--Determination of Expected Losses and 
Amount of Credit Support--The basic approach used by all of the Rating 
Agencies to determine the level of credit support necessary for each 
tranche of a residential/home equity securitization is similar. 
Historical data is used to predict loss frequency and severity of loss 
in arriving at the necessary amount of credit support for each rating 
level. Essentially, the process may be described as follows.
    The appropriate credit enhancement for a residential/home equity 
Security is determined by evaluating the individual characteristics of 
the mortgages supporting the Security, the aggregate characteristics of 
the mortgages considered as a pool and the structure of the Securities 
offered. The model identifies the characteristics of the mortgage that 
contribute to the likelihood of default and loss (i.e., loss frequency) 
and the size of the mortgage loss in the event of default (i.e., the 
loss severity). Among the characteristics examined are the LTV ratio of 
the mortgage, the type and term of the mortgage, the type of mortgaged 
property, the guidelines used in approving the mortgage and the quality 
of the borrower. The credit enhancement required for a mortgage is 
calculated by multiplying the loss frequency for the mortgage by its 
loss severity. In assessing potential severity, the calculated severity 
is compared to a minimum loss percentage, using the larger of the two 
figures to calculate the credit enhancement for the mortgage.
    The sum of the credit enhancements for the individual mortgages 
represents the initial credit enhancement requirement for the mortgage 
pool. This figure is then adjusted for mortgage pool characteristics 
and for originator and Servicer quality. Pool characteristics, 
including the number of mortgages and the geographic concentration of 
the mortgaged properties, are important because they impact the 
statistical independence of the mortgage level credit enhancement 
calculations. The originator adjustment reflects an assessment of the 
originator's ability to generate mortgages that perform better or worse 
than otherwise similar mortgages. The Servicer adjustment reflects an 
assessment of the Servicer's ability to keep mortgagors paying and to 
mitigate losses in the event of default. The credit enhancement 
requirement established after these adjustments reflects a full 
assessment of the credit risk of the entire mortgage pool. Additional 
adjustments may be necessary in response to structural aspects of the 
transaction. Among the transaction characteristics that can have a 
significant impact on credit enhancement levels are the sequence of 
payments among different classes of Securities, the allocation of 
mortgage principal prepayments, the form of credit enhancement and its 
provider and the relative size of the classes offered. An analysis of 
the cash flow necessary to make timely payments of principal and 
interest is performed, and the last step in determining the amount of 
credit support necessary for each rated Securities tranche is to test 
the ability of a pool of mortgages to withstand certain stress tests 
and still be able to generate timely payments of interest and pay 
principal on or before maturity.
    In developing a stress model, conservative assumptions are made as 
to real estate market conditions, economic factors and expenses 
associated with events of loss, applying a worst-case scenario 
incorporating high unemployment, deflation and sharply falling real 
estate values. The worst-case model considered by S&P to be appropriate 
for its highest rating categories incorporates the foreclosure 
frequencies and loss severity experienced during the Great Depression 
of the 1930s, whereas other Rating Agencies use those experienced in 
the Houston, Texas disastrous housing market in the mid-1980s. The 
choice of economic model is selected based on the severity of the 
stress to be applied. Generally, ``AAA'' and ``AA'' rated Securities 
have to withstand so-called national depression models based on the 
Great Depression/Houston, Texas models. For ``A'' and ``BBB'' rating 
categories, other geographic severe depression models, such as Boston 
in the 1980s or New York and Los Angeles in the early 1990s, might be 
used as the basis for the stress model. Alternatively, a system of 
local forecasting models or some other statistically derived stress 
models may be created for these purposes. ``BB'' rated Securities or 
lower would have to withstand less severe recession models.
    The initial frequency and severity of loss analysis on each 
mortgage in the pool may be described as follows. A computer model is 
used to analyze the expected losses on a mortgage pool backing 
Securities. The model examines (i) characteristics of each underlying 
mortgage to determine the probability of it defaulting and (ii) the 
default performance of several million mortgages originated or serviced 
by established originators. A housing price index may be used which 
combines housing price and other economic data and refines the analysis 
to the smallest geographic unit for which reliable information can be 
found (usually a metropolitan statistical area). This approach enables 
the Rating Agencies to analyze variations in losses arising from 
differences in real estate markets with separate housing price 
histories, regional economic conditions and foreclosure experience. 
Through an analysis of adverse economic conditions for discrete 
geographic areas, the localized impact of regional business cycles and 
economic restructuring can be factored into the process.
    Mortgages in a pool must have certain preferred characteristics to 
qualify as prime mortgages. In the absence of other mitigating factors, 
additional loss coverage will be required for pools failing to meet 
prime pool criteria. The following are the basic criteria for mortgages 
in a prime pool: first liens on single-family detached properties 
located in the United States; fixed-rate loans; level payment, fully 
amortizing loans on the mortgagor's primary residence; mortgages not in 
excess of a dollar-ceiling amount; a loan-to-value ratio of 80% or 
less; mortgage documentation and underwriting consistent with Fannie 
Mae/Freddie Mac guidelines, including minimum underwriting criteria of 
a fixed percent ratio of borrower's monthly housing expense (e.g., 28%) 
to gross monthly income and a fixed ratio of borrower's

[[Page 51481]]

total monthly debt obligations to gross monthly income (e.g., 36%); 
whether properties securing mortgages in the pool are well dispersed 
throughout an area having a strong and diversified economic base and 
whether there is a minimum number of loans in the pool (e.g., 300). 
Because most mortgage loan pools do not meet prime pool criteria in 
each category, rating a portfolio involves assessing the additional 
credit enhancement required owing to the deviation from prime pool 
criteria.
    Other factors may have a bearing on default rates and could 
counterbalance negative characteristics of a pool. Thus, a portfolio of 
well-seasoned mortgage loans would be expected to experience a lower 
default rate than newly originated loans due to both the history of the 
creditworthiness of the borrowers and the lower loan-to-value ratio 
associated with seasoned loans. (For example, default rates are highest 
in the 3-8 year period of a loan.) The marketability of the underlying 
mortgages is also an important factor in determining required loss 
coverage because collateral underlying a defaulted loan needs to be 
liquidated as quickly as possible. Another significant factor is the 
availability and type of insurance in connection with the pooled 
mortgages and their underlying properties. Mortgage insurance, hazard 
insurance, special hazard insurance, pool insurance on the underlying 
properties and bankruptcy insurance covering mortgagor bankruptcy and 
insolvency all may be relevant to the rating of the Security. Primary 
mortgage insurance (PMI) also can reduce the loss coverage required on 
a mortgage pool. The credit of the PMI issuer and the quality of its 
underwriting standards are considered by the Rating Agencies. However, 
the full benefit of a reduced loss coverage requirement will be 
available only if the PMI issuer meets Rating Agency standards.
    The rating of a residential mortgage loan pool will also vary 
depending upon the purpose for which the mortgage loans have been made. 
The most desirable loan is a purchase money mortgage loan for the 
financing of the mortgagor's single-family detached primary residence. 
In contrast, home equity loans and apartments, condos, coops, non-owner 
occupied or vacation homes are projected to have higher losses. The 
type of loan is also considered. For example, adjustable rate, balloon 
payment and negative amortization of principal features are all 
negative factors. The loss severity analysis assumes that the potential 
for loss upon foreclosure of a second mortgage is greater than for loss 
upon foreclosure of a comparable first mortgage. The foreclosure 
frequency analysis for second mortgage loans focuses on the increased 
credit risk generally associated with second mortgage loans, which 
frequently are not subject to standard underwriting criteria based upon 
Fannie Mae and Freddie Mac standards and generally have lower combined 
LTV ratios than is the case for first mortgages. Geographic 
diversification of the properties securing mortgages in the pool is 
important to spread the risk of loss, and higher loss coverage is 
required for pools of fewer than 300 loans.
    As many insurable risks as possible are reduced or eliminated, 
which is generally accomplished by requiring various types of insurance 
or bonding expressly covering such risks. Because costs of insurance 
premiums are in some cases prohibitive, Issuers over the years have 
devised alternative forms of credit enhancement to avoid the purchase 
of third-party insurance. Frequent substitutes include lines of credit 
from large commercial banks, self insurance (available only to Issuers 
with high credit ratings) and overcollateralization. Hazard insurance 
must be in place with respect to all properties securing the mortgages 
that constitute the pool.
    (c) Residential/Home Equity--Selecting the Type of Credit Support--
The most prevalent forms of credit support for residential/home equity 
Securities are the senior/subordinated tranched structure, 
overcollateralization, Excess Spread, reserve funds and surety bonds. 
In addition, as described above, pool insurance may be obtained for 
credit losses on the mortgages.
3. Manufactured Housing Transactions
    The Applicant states that, in a typical manufactured housing 
transaction, ``AAA'' rated senior Securities might be issued which 
represent approximately 80% of the principal balances of the 
Securities; ``AA'' rated subordinated Securities might comprise 6%; 
``A'' rated subordinated 5%; ``BBB'' rated subordinated 5% and junior 
subordinated Securities might constitute 4%. The total level of credit 
enhancement from all sources including Excess Spread averages about 
15%-16% in order to obtain ``AAA'' rated Securities, 10%-11% for an 
``AA'' rating, 7.5%-8.5% for an ``A'' rating and 3.5%-9% for a ``BBB'' 
rating. Typical types of credit support used in manufactured housing 
transactions are subordination, reserve accounts, Excess Spread, 
overcollateralization and financial guarantees from ``AAA'' rated 
monoline insurance companies or highly rated Sponsors. The Applicant 
provided the following description of the analysis performed by the 
Rating Agencies in their consideration of manufactured housing 
securitizations and their determination of appropriate credit support 
requirements.
    (a) Manufactured Housing--General Considerations--There has been a 
general growth in the sale of manufactured housing and an improvement 
in the construction of the units. Transactions with a greater 
percentage of multi-wide units, customized units and units financed 
with land privately purchased (as opposed to being placed in trailer 
park rental spaces) are being securitized which results in less loss 
severity, as such units have greater resale value, and these types of 
units are increasingly being purchased by owners with better credit 
histories. There has also been an increased public market for 
manufactured housing-backed Securities since the 1980s due to a trend 
toward lower repossessions and lower losses on such mortgages as a 
result of improved underwriting and servicing throughout the industry, 
strong investor interest in medium-term structured investments with 
loan terms typically between 15-20 years (versus 5 for autos and 30 for 
residential mortgages) and the inclusion of manufactured housing 
contracts as qualifying assets for REMICs, which facilitates the 
issuance of multi-class Securities.
    (b) Manufactured Housing--Determination of Expected Losses--LTV 
ratios are not considered as significant a factor in predicting loss 
frequency in manufactured housing securitizations as they are for 
conventional home mortgages because the loan amounts are lower and 
significant equity is not built up. Instead, the Rating Agencies assign 
a frequency of default and loss severity factor to the pool of loans 
(in some cases, on a loan-by-loan basis) to project losses.
    An analysis of the credit quality of the underlying pool of 
manufactured housing contracts in a particular securitization 
transaction is performed by developing static pool data based on the 
historical performance of the specific originator of the contracts. 
This information (which is continuously updated) is then used to 
predict expected cumulative net losses for the particular pool which 
takes into account both foreclosure frequency and loss severity. The 
historical data is adjusted depending on the Servicer's capacity to 
service the loans, the type of collateral being financed, LTV ratios, 
loan seasoning, underwriting of loan

[[Page 51482]]

standards, experience of management and the quality and quantity of the 
historical information provided by the originator. As a result, the 
expected cumulative losses will vary from originator to originator.
    An analysis of the actual pool is also performed to predict loss 
frequency based on collateral characteristics such as type of unit 
(single versus multi-wide) and real property type (trailer park, 
private rental or private owned) and loan attributes such as whether 
the LTV ratios, loan interest rates, loan terms and monthly payments 
are high (which is a negative factor) and how long the loan has been 
outstanding (as the risk of default is higher in the earlier years of 
the loan). Also considered are borrower demographics. The elements 
regarding borrower demographics which have the greatest impact on 
default frequency are the originator's borrowing credit scoring 
methodology, debt-to-income ratios, purchase versus refinance status, 
employment period, employment status, borrower's age, existing versus 
first-time home buyer and presence of a co-signer. The specific impact 
of geographic distribution is forecasted using a mortgage default model 
which divides the United States in a myriad of counties, standard 
metropolitan statistical loan areas and state and multi-state regions. 
This model is used to forecast foreclosure rates and home price trends 
by projecting economic conditions over a fixed number of years.
    Loss severity is determined by predicting the expected recovery 
rate in case of loan default (i.e., the percentage of the outstanding 
balance realized upon liquidation of the unit). For example, recovery 
rates are high (typically 70%) during the first two years after 
origination and thereafter drop to a lower constant level. The most 
significant factors affecting loss severity are the age of the unit and 
the delay time in repossessing and recovering on the unit. Here LTV 
ratios are a significant indicator of loss severity as repossession 
costs are usually fixed and, therefore, the lower the net equity the 
lower the percentage recovery. Also, whether the originator/Servicer 
has good access to retail distribution for repossessed units 
significantly affects recoveries. Dealer/manufacturer recourse is also 
a very important factor in determining both frequency and severity of 
loss expectancies. Some originators have recourse programs under which 
dealers or manufacturers will repurchase a defaulted contract at the 
time of default or cover any loss associated with liquidation of the 
repossessed unit. The recourse obligation can vary from six months to 
five years. The amount of credit given to dealer recourse is affected 
by whether the dealers have historically honored their recourse 
commitments. The use of dealer recourse is also scrutinized to 
determine whether a repossession is treated as a default, and if dealer 
recourse is applicable, to make sure that the originator is not 
understating its default rates.
    (c) Manufactured Housing--Determining Required Amount of Credit 
Support--In order to determine how much credit support is required, a 
determination is made as to how much principal liquidation losses can 
be covered by Excess Spread collection, as opposed to other credit 
support. Through various cash flow tests, an amount of credit support 
is calculated that, when combined with Excess Spread, is sufficient to 
cover all losses under the various rating stress scenarios, while still 
paying timely interest and principal by the final maturity date for all 
tranches of Securities issued. Various cash flow runs are reviewed 
assuming multiples of expected repossession, losses and prepayments to 
value the amount of Excess Spread that would be generated over the life 
of the transaction. In a typical manufactured housing securitization, 
the cumulative net losses on the pool of loans are expected to 
represent approximately 6%-8% of the original pool balance. Various 
minimum standards for cash flows at each rating category level are then 
fixed. For example, in order to merit an ``AAA'' rating, the Rating 
Agency might require the cash flows sufficient to pay all interest and 
principal while withstanding a 44% cumulative default frequency, a 
recovery of 37% (assuming a recovery time lag of six months) and 28% in 
cumulative net losses. For a ``BBB'' rated tranche, cash flows might be 
required to withstand a 28% cumulative default frequency, a recovery 
upon default of 50% and 44% in cumulative losses. The originator's 
expected loss curve, i.e., how soon defaults occur in the life of the 
securitization are factored into the cash flow runs, which are then 
subjected to additional stress (e.g., if the originator's expected loss 
curve is such that 65% of all anticipated defaults will occur by year 
five after origination, the Rating Agency will assume 75% will occur in 
this time period). Finally, if such information is available, 
prepayments are presumed to occur first on the highest coupon-bearing 
loans, which maximizes the stress put on the cash flow runs. The final 
credit support is determined by setting the final loss coverage level 
required which represents some multiple of the cumulative credit losses 
expected over the life of the transaction.
    At the time the original Underwriter Exemptions were requested, 
manufactured housing securitizations were structured to offer only 
``AAA'' rated senior Securities using third-party letters of credit 
(LOC) as security, with spread accounts and Issuer recourse protecting 
the LOC. However, since that time, such transactions are typically 
structured using a senior/subordinated structure. All subordinated 
Securities which receive ``A'' or ``BBB'' ratings themselves have other 
forms of credit support. A typical transaction would have a large 
percentage of subordinated classes, representing 20% of the principal 
balances of the Securities, and such subordinated classes could range 
from ``AA'' to ``B'' rated tranches. These subordinated Securities have 
longer lives than the single tranche senior-only securitization 
transactions structured with credit support solely from third-party LOC 
and spread accounts.
    Overcollateralization is also used as credit support for the 
subordinated Securities once the seniors have been paid. Because the 
coupon rate on manufactured housing loans is substantially higher than 
that charged on traditional residential mortgages, there is a large 
amount of Excess Spread (typically more than 300 bps) that can be used 
for credit support of both senior and subordinated tranches. In other 
structures, the Excess Spread is trapped into a reserve fund which 
provides the credit support for the subordinated tranches. In still 
other cases, credit support is provided to an investment-grade 
subordinated tranche through a junior subordinated tranche which 
receives principal only after the more senior subordinated tranches are 
paid. Sponsor guarantees are also used as credit support.
4. Commercial Mortgage-Backed Securities (CMBS)
    The Applicant states that in a typical CMBS transaction, two 
classes of ``AAA'' rated Securities might be issued which represent 
approximately 78% of the principal balances of the Securities (one such 
``AAA'' class will be issued with a shorter, and the other ``AAA'' 
class with a longer, expected maturity); ``AA'' rated subordinated 
Securities might represent 5%; ``A'' rated subordinated 5%; ``BBB'' 
rated subordinated 5% and junior subordinated Securities 7%. The total 
level of credit enhancement from all sources averages about 23% in 
order to

[[Page 51483]]

obtain ``AAA'' rated Securities, 18% for an ``AA'' rating, 13% for an 
``A'' rating and 7% for a ``BBB'' rating. Subordination is generally 
the only type of credit support used in CMBS transactions. The 
Applicant provided the following description of the analysis performed 
by the Rating Agencies in their consideration of CMBS securitizations 
and their determination of appropriate credit support requirements.
    (a) CMBS--General Considerations--CMBS transactions securitize 
pools of commercial mortgage loans which generally represent a mix of 
asset types, principally retail, multi-family, office, hotel/motel and 
industrial. While most CMBS transactions have pools with multiple 
Obligors on the loans, the term also includes securitizations which are 
``property specific'' and represent either a single or small number of 
high-quality properties with respect to which there is one Obligor. 
While property specific CMBS securitizations do not represent a pool of 
mortgages with different Obligors, the LTV ratios are much lower, and 
the credit quality of the single Obligor is much higher, than would be 
the case in a CMBS securitization of a pool of assets. In property 
specific CMBS transactions, Securities are generally not issued with a 
rating lower than ``BBB'' which is an indication of the superior credit 
quality of the Obligors. Another category of CMBS transactions is the 
credit (or net) lease transaction where a loan is made to the ground 
lessor of the real estate and the securitization rating is based on the 
credit quality of the underlying lessee instead of the lessor/Obligor 
on the note. In a net lease transaction, the obligor on the note which 
is being securitized is the lessor of the property, and the lessee of 
the property is the party actually involved in the management of the 
property.\35\ Accordingly, the true source of payment on the note is 
the cash flow generated by the lease payments. As a result, the ratings 
agencies look to the credit quality of the lessee and not that of the 
lessor/note obligor. However, the rating process for all three types of 
CMBS transactions is generally similar.
    (b) CMBS--Due Diligence--Due diligence for CMBS is performed by 
multiple parties, at multiple levels. Every CMBS pool is sampled and 
analyzed by the originator, the Rating Agencies, the Underwriter and 
the purchasers of subordinated classes. Every mortgage pool is sampled 
for underwriting and site inspection due diligence. A representative 
sample of the collateral by loan size, geographic location, property 
type, originator and other common features is reviewed in conjunction 
with the assets that pose the largest risks to the transaction, such as 
loans with the largest balance or related borrowers. The asset 
summaries and files are reviewed to assure that the sample selection is 
representative of the pool. If the initial sample is insufficient, 
further sampling will be required until the Rating Agency is 
comfortable extrapolating the findings to the remainder of the pool. In 
property specific transactions, due diligence is performed for each 
property. Site inspections and file reviews are performed to determine 
the quality of the real estate and the integrity of the asset files. A 
quality grade may be assigned to each visited property. The quality 
grade will reflect the property location, condition, tenancy, 
management, amenities, competitive market position and other relevant 
information that may affect the underwriting of the asset. Asset 
summaries and loan files are reviewed to obtain more detailed 
information about pool assets and the quality of the underwriting.
---------------------------------------------------------------------------

    \35\ In the case where the landlord owns the land and retains 
ownership of the building, the lessor would be both the ground 
lessor and the building lessor. In other cases, where the tenant 
owns the building, the landlord would be only the ground lessor. The 
obligation held by the Issuer would be secured by either the ground 
lease or the real estate.
---------------------------------------------------------------------------

    The originator's mortgage loan systems are examined, as well as 
their actual execution through meetings with management and extensive 
file reviews. The number of years of the originator's real estate 
experience, whether it escrows taxes and insurance, whether it is able 
to provide several years of operating statements verified by source 
documents and whether there is recourse to a third party in case of 
fraud are considered. Audit checks and legal searches may also be 
performed on the originators.
    The Servicer function in a CMBS transaction is particularly 
important because not only does the Servicer or Servicers fulfill the 
normal functions of collecting and remitting loan payments from 
borrowers to securityholders and advancing funds for such purposes, but 
the Servicer may also become responsible for activities relating to 
defaulted or potentially defaulting loans (which are more likely to be 
restructured than in non-commercial transactions where the loans are 
usually liquidated). If a Servicer advances funds, its credit rating 
cannot be more than one rating category below the highest rated tranche 
in the securitization and no less than ``BBB'' unless it has a 
qualifying back-up advancer. All entities servicing CMBS transactions 
must be approved by the Rating Agencies.
    An additional responsibility of the Servicer is ensuring that 
insurance is maintained by each borrower covering each mortgaged 
property in accordance with the applicable mortgage documents. 
Insurance coverage typically includes, at a minimum, fire and casualty, 
general liability and rental interruption insurance but may include 
flood and earthquake coverage depending on the location of a particular 
mortgaged property. If a borrower fails to maintain the required 
insurance coverage or the mortgaged property defaults and becomes an 
asset of the Issuer, the Servicer is obligated to obtain insurance 
which, in pool transactions, may be provided by a blanket policy 
covering all pool properties. Generally, the blanket policy must be 
provided by an insurance provider with a rating of at least ``BBB.''
    Each Servicer, special Servicer and Subservicer is required to 
maintain a fidelity bond and a policy of insurance covering loss 
occasioned by the errors and omissions of its officers and employees in 
connection with its servicing obligations unless the Rating Agency 
allows self-insurance. All fidelity bonds and policies of errors and 
omissions insurance must be issued in favor of the Trustee or the 
Issuer by insurance carriers which are rated by the Rating Agency with 
a claims-paying ability rating no lower than two categories below the 
highest rated Securities in the transaction but no less than ``BBB.'' 
Subservicers may not make important servicing decisions (such as 
modifications of the mortgage loans or the decision to foreclose) 
without the involvement of the Master Servicer or special Servicer, and 
the Trustee or any successor Servicer may be permitted to terminate the 
subservicing agreement without cause and without cost or further 
obligation to the Issuer or the holders of the rated Securities.
    Loans secured by credit tenant leases require special analysis. 
Credit enhancement for credit tenant loans is based on an analysis of 
the probability that the lessee will file bankruptcy, and the 
likelihood that the lessee will disaffirm the lease and loan structures 
that may present a risk other than that of the lessee filing 
bankruptcy.
    (c) CMBS--Determination of Expected Losses and Required Credit 
Support--The approach to rating CMBS transactions is not that different 
from other asset types, as it is based on the concept of estimating 
default frequency and loss severity for the loans being securitized, 
applying adjustments for

[[Page 51484]]

various factors relating to the pool as a whole and stressing the pool 
projected performance at various levels to determine the credit support 
necessary for particular rating categories. However, the methodology 
differs from that used for other asset types because the payments on 
the loans are being made from the cash flow from the property's 
operations and not a borrower's personal funds. Accordingly, the focus 
of the rating process is on the ability of each property in the pool to 
generate sufficient net operating income to comfortably carry the debt 
service on a loan and to project the value of the business operation 
based on capitalization of such projected income. This allows the 
Rating Agencies to predict both default frequency and loss severity in 
case of a borrower defaulting on a loan and is accomplished by an in-
depth evaluation of the properties that are being sampled in order to 
essentially ``reunderwrite'' the loans in the pool. An analysis is done 
to determine the ``debt service coverage ratio'' (DSCR) for each loan 
which is similar in concept to the due diligence performed by the 
original lender on the loan in deciding whether to make the loan and in 
what amount. However, the estimates given by the borrower are not used 
other than for informational purposes. Instead, the numbers are 
reconfigured by increasing projected expenses and decreasing projected 
income to take into account various contingencies using a worst-case 
scenario. The Rating Agencies differ somewhat in how they perform these 
calculations, but the analysis is intended to predict loss frequency 
and loss severity in order to make informed decisions about the credit 
support they will require at the different rating levels.
    For example, the basic approach used by S&P to rate CMBS is to 
analyze the cash flow generated by each loan, the loan's DSCR based on 
stabilized net cash flow and its LTV ratio based on estimated property 
values, which value is determined by capitalization of the net cash 
flow generated by the property. These analyses are then used to 
determine whether that loan is likely to default under various stress 
scenarios, and if so, what the loss of principal might be. Further 
adjustments are made for a presumed percentage decline in the value of 
the property upon default and a lag time with an accompanying loss of 
income before the defaulted loan is actually liquidated. Each stress 
scenario is related to a particular rating category, so the aggregate 
estimated losses of all loans in the pool under a given scenario 
determine the amount of credit support required at each rating 
category. A matrix model is used to generate estimated losses under a 
variety of default scenarios which assume that the mortgage loans have 
a 100% probability of defaulting at specific DSCR and LTV thresholds 
and that the thresholds vary by property type and rating category. For 
example, in an ``AAA'' rating category, all multi-family loans with a 
DSCR below 1.65 and LTV ratios above 50% are presumed to default, and 
for a ``BBB'' rating, all such loans with DSCR below 1.30 and LTV 
ratios above 70% will default.
    Fitch has a somewhat different approach to rating CMBS 
transactions. The Fitch performing loan model is based on research 
indicating that DSCR is the best indicator of loan default and that a 
loan with a high DSCR is less likely to default than a loan with a DSCR 
below 1.00. The modeling analysis is performed by calculating each DSCR 
assuming an ``A'' stress environment. After reunderwriting asset cash 
flows and stressing debt service, the DSCR is calculated. Based on the 
stressed DSCR, a default probability and loss severity is assigned. The 
expected loss on each loan is its percentage of the pool times its 
default probability times its loss severity. The default probability 
and loss severity assumptions based on the DSCR for each loan are then 
adjusted based on certain property and loan features to determine the 
necessary credit enhancement based on the individual loan 
characteristics. Next, the composition of the pool is analyzed to 
identify any concentration risks. Finally, the transaction structure is 
evaluated and incorporated into the ratings. The results are further 
adjusted to reflect various stresses from ``AAA'' to ``B.'' The final 
credit enhancement levels for a transaction equal the sum of the loan-
by-loan expected losses based on the DSCR analysis plus or minus 
adjustments for particular asset characteristics, pool concentration 
issues and structural requirements.
    Factors that are considered in determining cash flows are extensive 
and may differ among Rating Agencies but could include the following 
items. Management's budget for the property for the next year is 
reviewed taking into consideration economic and demographic information 
about the market in which a property is located. Trends in population 
growth, household formation and composition, employment, income, 
existing competition, the vacancy rate, trends in building permits and 
proposed construction are examined. In arriving at a stabilized income 
figure for all types of commercial properties, rents are adjusted to 
reflect market rates, and any seasonal changes in the income stream are 
factored into the analysis. Gross potential rental income and income 
from other sources are reduced by vacancy and collection losses. 
Assumptions based on property type of combined vacancy and credit 
losses are made, even if the historical vacancy and credit loss has 
been lower. All normal expenses for the property are accounted for 
whether currently incurred or not. If the property is subject to a 
ground lease, ground rent must also be included in expenses. If the 
ground rent payments increase significantly over time, the amount of 
the payment is stabilized by taking an average or calculating a level 
annual equivalent at an appropriate yield. Revenue is marked to the 
lower of market or actual rent and occupancy. Consideration is given 
for future conditions, such as new construction, that could affect 
rents and/or occupancy. Reserves are taken for normalized tenant 
improvement, leasing commissions and capital repair and maintenance. 
Care is taken to incorporate all material facts with respect to the 
property, such as lease rollover risk, credit tenants, ground lease 
payments, recent capital improvements, market conditions and collateral 
quality.
    Debt service analysis estimates debt service payments required in 
the event a loan must be refinanced under a stress environment. A 
specific interest rate and amortization terms based on property types 
is assumed to determine a hypothetical constant payment rate. The 
refinance rate is not based on the prevailing interest rate or the 
highest historical rate but, rather, on rates generally available over 
a fixed period of years using a designated environment. For fixed-rate 
loans, the interest rate is reduced by a specified number of basis 
points if the loan is fully amortizing over its term, and the actual 
interest rate (the greater of pay or accrual rate) is used if it is 
higher than the assumed interest rate. Because floating-rate loans may 
be affected by rising interest rates, the lesser of the ceiling rate, 
if any, and a stress rate is used for floating-rate loans. In a pool 
transaction, each borrower may or may not be required to fund a 
replacement reserve for capital expenditures, depending on the practice 
of the loan originator. Regardless of whether replacement reserves are 
required, it is assumed that each borrower in a pool will find it 
necessary to make some amount of capital expenditures each year to 
preserve the value of its investment. Third-party appraisals of the 
underlying real estate assets are

[[Page 51485]]

considered, but they generally use such reports only for the 
information that they contain regarding conditions in local markets 
rather than for their specific property value conclusions.
    Estimates of loss frequency and loss severity are further adjusted 
for the following types of qualitative factors: certain types of 
property will tend to lose tenants in economic stress periods (e.g., 
hotels and restaurants) and will have more volatile cash flows (e.g., 
seasonal industries); environmental risks, such as asbestos; climate 
risks (e.g., earthquakes and floods) and economic trends (e.g., some 
states are slow in paying nursing home reimbursements). Extensive 
default regression analysis has also been performed to isolate which 
asset types have higher default rates and higher loss severity 
percentages. The more geographically diversified the loans are, the 
lower the loss frequency. Loan size does not clearly correlate to loss 
frequency so is it minimized as a factor, but loan size can affect 
severity as the larger the loan the more severe its effect can be on 
the pool as a whole. Fixed interest rate loans have lower default and 
severity rates than floating, and the lower the interest rate, the 
lower the default rate. Balloon mortgage loans have a higher rate of 
default than amortizing loans. Loans with subordinated liens, loans 
underwritten by lenders with non-typical underwriting standards and 
loans characterized by prior defaults or workouts all require greater 
credit support.
    Environmental reports for each property are generally required. A 
reserve is usually required for any reported remediation costs, and any 
actions covenanted must be completed within a specified period. Risks 
that cannot be quantified or that have not been mitigated through 
either remediation or reserves are assumed to pose a risk to the Trust 
and are reflected in the credit enhancement requirements. Properties 
with certain types of asbestos problems, or those that are assumed to 
have such problems given their date of construction, are assumed to 
have higher losses due to the clean-up costs and increased difficulty 
or cost in leasing or selling the asset. Seasoned or acquired pools 
that may not have current reports for each property are also assumed to 
have higher environmental losses.
    (d) CMBS--Selecting the Type of Credit Support--In general, 
although there are other types of credit support available, 
subordination is the only type of credit support used in CMBS. However, 
protection is also provided to subordinated classes through the concept 
of a ``directing class'' which has evolved to give those holders of 
rated subordinated Securities in the first loss position some control 
over the servicing and realization on defaulted mortgage loans. In a 
typical transaction, the Servicer might be required to obtain the 
consent of the directing class before proceeding with any of the 
following: any modification, consent or forgiveness of principal or 
interest with respect to a defaulted mortgage loan; any proposed 
foreclosure or acquisition of a mortgaged property by deed-in-lieu of 
foreclosure; any proposed sale of a defaulted mortgage loan and any 
decision to conduct environmental clean up or remediation. The 
directing class might also have the right to remove a Servicer, with or 
without cause, subject to the Rating Agency's confirmation that 
appointment of the successor Servicer would not result in a 
qualification, withdrawal or downgrade of the then-applicable rating 
assigned to the rated Securities, compliance with the terms and 
conditions of the Pooling and Servicing Agreement and payment by the 
directing class of any and all termination or other fees relating to 
such removal. Holders of CMBS enjoy additional protection, in that the 
Master Servicer or Servicer occupies a first-loss position and usually 
holds an equity stake in the offering, which gives it an incentive to 
maximize recoveries on defaulted loans. The Master Servicer and 
Servicer are in a first loss position because they hold the most 
subordinated equity position interest(s) in the Issuer. Accordingly, 
they absorb losses before any other classes of securityholders.
    Additional cash flow stability is created through call protection 
features on the commercial mortgages held in the Issuer. Call 
protection prevents the borrowers from prepaying the mortgage loans 
during a fixed ``lock-out period.'' In certain transactions, under the 
terms of the mortgage agreement, the borrower is only allowed to prepay 
the loan at the end of the lock-out period if it provides ``yield 
maintenance'' \36\ whereby it is required to contribute a cash payment 
derived from a formula which is calculated based on current interest 
rates and is intended to offset the borrower's refinancing incentive. 
This amount also effectively compensates the Issuer for the loss of 
interest payable on the mortgage loan.
---------------------------------------------------------------------------

    \ 36\ The Applicant represents that the yield maintenance 
provision in the mortgage agreement would meet the definition of a 
``yield supplement agreement'' currently permitted under section 
III.B.(3)(b) of the Underwriter Exemptions.
---------------------------------------------------------------------------

    Another mechanism, referred to as ``defeasance'', assures stability 
of cash flow and operates as follows. If a borrower wishes to have the 
mortgage lien released on the property (for example, where it is being 
sold), the original obligation either remains an asset of the Issuer 
and is assumed by a third party, or a new obligation with the same 
outstanding principal balance, interest rate, periodic payment dates, 
maturity date and default provisions is entered into with such third 
party. The new obligation replicates the cash flows over the remaining 
term of the original obligor's obligation. In either case, the property 
or assets originally collateralizing the obligation are replaced by 
collateral consisting of United States Treasury securities or any other 
security guaranteed as to principal and interest by the United States, 
or by a person controlled or supervised by and acting as an 
instrumentality of the Government of the United States; for any of the 
foregoing (Government Securities). Defeasance generally operates so 
that, pursuant to an assumption and release or similar arrangement 
valid under applicable state law, the original obligor is replaced with 
a new obligor.
    The new obligor is generally a bankruptcy-remote special purpose 
entity (SPE), the assets of which consist of Government Securities. In 
the defeasance of a mortgage loan held in a CMBS pool, a new entity 
must be created (the SPE) which becomes the obligor on the mortgage 
loan and holds the Government Securities being substituted for the 
original collateral securing the mortgage loan. This newly formed 
entity is required by the Rating Agencies to be an SPE in order to 
assure that the owner of the securities to be pledged has no 
liabilities or creditors other than the CMBS pool trustee, has no 
assets or business other than the ownership of the Government 
Securities and is not susceptible to substantive consolidation with the 
original mortgage borrower in the event of the original mortgage 
borrower's bankruptcy. Such an SPE is purely passive and does not 
engage in any activities other than the ownership of securities. 
Although there is no prescribed market requirement as to ownership of 
the SPE, the securitization sponsor (e.g., the original mortgage 
lender) is usually its owner, except that in certain circumstances the 
original mortgage borrower may own the SPE for a variety of reasons; 
e.g., to be entitled to any excess value of securities pledged as 
collateral at maturity of the new defeasance note over the amount due 
at such time. As a condition to

[[Page 51486]]

defeasance, all fees and expenses are paid at the substitution of the 
Government Securities for the mortgage lien. Mechanically, the 
Government Securities are transferred to a custodian which holds then 
as collateral for the securitization trust. The payments on the 
Government Securities are actually made directly to the Issuer so that 
the SPE does not receive any payments or make any payments.
    Whether the original mortgage obligation is replaced with a new 
securitized obligation or the original obligation remains an asset of 
the Issuer, is usually dictated by how the transaction is treated for 
mortgage recording tax purposes under state law. Both call protection 
and defeasance are intended to protect investors from the risk of 
prepayments of the loans.
5. Corollary Effects of Requesting Relief for Subordinated and 
Investment Grade-Securities.
    The Applicant wishes to note that the extension of exemptive relief 
to the Designated Transactions described in this Section V. has a 
corollary effect on other provisions of the Underwriter Exemptions 
which will be discussed here.
    First, the current ``seasoning requirement'' contained in the last 
paragraph of section III.B. of the text of the current Underwriter 
Exemptions provides that Certificates which have been issued in other 
pools containing the same asset types must have been rated in one of 
the three highest generic rating categories for at least one year prior 
to the plan's acquisition of securities pursuant to the Underwriter 
Exemptions. The Applicant believes that it is consistent with the 
extension of exemptive relief to Designated Transactions to have this 
seasoning requirement expanded to cover securities issued in Designated 
Transactions which have been rated in one of the highest four generic 
rating categories.
    Second, the current Underwriter Exemptions provide in footnote 9 
that the term ``Trust'' includes a two-tier structure, provided that 
the securities held by the second Trust are not subordinated to the 
rights and interests evidenced by the first Trust. This restriction was 
based on the premise that the Underwriter Exemptions did not afford 
relief for any subordinated securities. The Applicant believes that it 
would be appropriate and consistent with the relief requested in 
Section I. of this application for this non-subordination restriction 
to be removed where the securities of the first Trust are issued in 
Designated Transactions, even if they are subordinated to other classes 
of securities issued by the first Trust.

VI. Remaining Provisions

A. Disclosure

    In connection with the original issuance of Securities, the 
prospectus or private placement memorandum will be furnished to 
investing plans. The prospectus or private placement memorandum will 
contain information material to a fiduciary's decision to invest in the 
Securities, including:
    1. Information concerning the payment terms of the Securities, the 
rating of the Securities, any material risk factors with respect to the 
Securities and the fact that principal amounts left in the Pre-Funding 
Account at the end of the Pre-Funding Period will be paid to 
securityholders as a repayment of principal.
    2. A description of the Issuer as a legal entity and a description 
of how the Issuer was formed by the seller/Servicer or other Sponsor of 
the transaction;
    3. Identification of the independent Trustee;
    4. A description of the receivables contained in the Issuer, 
including the types of receivables, the diversification of the 
receivables, their principal terms and their material legal aspects, 
and a description of any Pre-Funding Account used or Capitalized 
Interest Account used in connection with a Pre-Funding Account;
    5. A description of the Sponsor and Servicer;
    6. A description of the Pooling and Servicing Agreement, including 
a description of the Sponsor's principal representations and warranties 
as to the Issuer's assets, including the terms and conditions for 
eligibility of any receivables transferred during the Pre-Funding 
Period and the Trustee's remedy for any breach thereof; a description 
of the procedures for collection of payments on receivables and for 
making distributions to investors, and a description of the accounts 
into which such payments are deposited and from which such 
distributions are made; a description of permitted investments for any 
Pre-Funding Account or Capitalized Interest Account; identification of 
the servicing compensation and a description of any fees for credit 
enhancement that are deducted from payments on receivables before 
distributions are made to investors; a description of periodic 
statements provided to the Trustee, and provided or made available to 
investors by the Issuer; and a description of the events that 
constitute events of default under the pooling and servicing contract 
and a description of the Trustee's and the investors' remedies incident 
thereto;
    7. A description of the credit support;
    8. A general discussion of the principal federal income tax 
consequences of the purchase, ownership and disposition of the 
Securities by a typical investor;
    9. A description of the Underwriter's plan for distributing the 
Securities to investors;
    10. Information about the scope and nature of the secondary market, 
if any, for the Securities; and
    11. A statement as to the duration of any Pre-Funding Period and 
the Pre-Funding Limit for the Issuer.
    Reports indicating the amount of payments of principal and interest 
are provided to securityholders at least as frequently as distributions 
are made to securityholders. Securityholders will also be provided with 
periodic information statements setting forth material information 
concerning the underlying assets, including, where applicable, 
information as to the amount and number of delinquent and defaulted 
loans or receivables.
    In the case of an Issuer that offers and sells Securities in a 
registered public offering, the Issuer, the Servicer or the Sponsor 
will file such periodic reports as may be required to be filed under 
the Securities Exchange Act of 1934. Although some Issuers that offer 
Securities in a public offering will file quarterly reports on Form 10-
Q and Annual Reports on Form 10-K, many Issuers obtain, by application 
to the Securities and Exchange Commission, relief from the requirement 
to file quarterly reports on Form 10-Q and a modification of the 
disclosure requirements for annual reports on Form 10-K. If such relief 
is obtained, these Issuers normally would continue to have the 
obligation to file current reports on Form 8-K to report material 
developments concerning the Issuer and the Securities and copies of the 
statements sent to securityholders. While the Securities and Exchange 
Commission's interpretation of the periodic reporting requirements is 
subject to change, periodic reports concerning an Issuer will be filed 
to the extent required under the Securities Exchange Act of 1934.
    At or about the time distributions are made to securityholders, a 
report will be delivered to the Trustee as to the status of the Issuer 
and its assets, including underlying obligations. Such report will 
typically contain information regarding the Issuer's assets (including 
those purchased by the Issuer from any Pre-Funding Account), payments 
received or collected by the Servicer, the amount

[[Page 51487]]

of prepayments, delinquencies, Servicer advances, defaults and 
foreclosures, the amount of any payments made pursuant to any credit 
support, and the amount of compensation payable to the Servicer. Such 
report also will be delivered to or made available to the Rating Agency 
or Agencies that have rated the Securities.
    In addition, promptly after each distribution date, securityholders 
will receive a statement prepared by the Servicer, paying agent or 
Trustee summarizing information regarding the Issuer and its assets. 
Such statement will include information regarding the Issuer and its 
assets, including underlying receivables. Such statement will typically 
contain information regarding payments and prepayments, delinquencies, 
the remaining amount of the guaranty or other credit support and a 
breakdown of payments between principal and interest.

B. Secondary Market Transactions

    It is the Applicant's normal policy to attempt to make a market for 
Securities for which it is lead or co-managing Underwriter, and it is 
the Applicant's intention to make a market for any Securities for which 
the Applicant is a lead or co-managing Underwriter. At times the 
Applicant will facilitate sales by investors who purchase Securities if 
the Applicant has acted as agent or principal in the original private 
placement of the Securities and if such investors request the 
Applicant's assistance.

VII. Summary

    In summary, the Applicant represents that the transactions for 
which exemptive relief is requested satisfy the statutory criteria of 
section 408(a) of the Act due to the following:
    A. The Issuers contain ``fixed pools'' of assets. There is little 
discretion on the part of the Sponsor to substitute receivables 
contained in the Issuer once the Issuer has been formed;
    B. In the case where a Pre-Funding Account is used, the 
characteristics of the receivables to be transferred to the Issuer 
during the Pre-Funding Period must be substantially similar to the 
characteristics of those transferred to the Issuer on the Closing Date 
thereby giving the Sponsor and/or originator little discretion over the 
selection process, and compliance with this requirement will be assured 
by the specificity of the characteristics and the monitoring mechanisms 
contemplated under the amended exemptive relief proposed. In addition, 
certain cash accounts will be established to support the Security 
interest rate and such cash accounts will be invested in short-term, 
conservative investments; the Pre-Funding Period will be of a 
reasonably short duration; a pre-funding limit will be imposed; and any 
Internal Revenue Service requirements with respect to pre-funding 
intended to preserve the passive income character of the Issuer will be 
met. The fiduciary of the plans making the decision to invest in 
Securities is thus fully apprised of the nature of the receivables 
which will be held in the Issuer and has sufficient information to make 
a prudent investment decision;
    C. Securities in which plans invest will have been rated in one of 
the three highest generic rating categories (or four in the case of 
Designated Transactions) by a Rating Agency. The Rating Agency, in 
assigning a rating to such Securities, will take into account the fact 
that Issuers may hold interest rate swaps or yield supplement 
agreements with notional principal amounts or, in Designated 
Transactions, Securities may be issued by Issuers holding residential 
and home equity loans with LTV ratios in excess of 100%. Credit support 
will be obtained to the extent necessary to attain the desired rating;
    D. Securities will be issued by Issuers whose assets will be 
protected from the claims of the Sponsor's creditors in the event of 
bankruptcy or other insolvency of the Sponsor, and both equity and debt 
securityholders will have a beneficial or security interest in the 
receivables held by the Issuer. In addition, an independent Trustee 
will represent the securityholders' interests in dealing with other 
parties to the transaction;
    E. All transactions for which the Underwriter seeks exemptive 
relief will be governed by the Pooling and Servicing Agreement, the 
principal provisions of which are described in the prospectus or 
private placement memorandum and which is made available to plan 
fiduciaries for their review prior to the plan's investment in 
Securities;
    F. Exemptive relief from sections 406(b) and 407 for sales to plans 
is substantially limited; and
    G. The Underwriter has made, and anticipates that it will continue 
to make, a secondary market in Securities.

Notice to Interested Persons

    The applicant represents that because those potentially interested 
participants and beneficiaries cannot all be identified, the only 
practical means of notifying such participants and beneficiaries of 
this proposed exemption is by the publication of this notice in the 
Federal Register. Comments and requests for a hearing must be received 
by the Department not later than 45 days from the date of publication 
of this notice of proposed exemption in the Federal Register.

General Information

    The attention of interested persons is directed to the following:
    1. The fact that a transaction is the subject of an exemption under 
section 408(a) of the Act and section 4975(c)(2) of the Code does not 
relieve a fiduciary or other party in interest or disqualified person 
from certain other provisions of the Act and the Code, including any 
prohibited transaction provisions to which the exemption does not apply 
and the general fiduciary responsibility provisions of section 404 of 
the Act, which require, among other things, a fiduciary to discharge 
his or her duties respecting the plan solely in the interest of the 
participants and beneficiaries of the plan and in a prudent fashion in 
accordance with section 404(a)(1)(B) of the Act; nor does it affect the 
requirements of section 401(a) of the Code that the plan operate for 
the exclusive benefit of the employees of the employer maintaining the 
plan and their beneficiaries;
    2. Before an exemption can be granted under section 408(a) of the 
Act and section 4975(c)(2) of the Code, the Department must find that 
the exemption is administratively feasible, in the interest of the 
plans and of their participants and beneficiaries and protective of the 
rights of participants and beneficiaries of the plans;
    3. The proposed amendment, if granted, will be supplemental to, and 
not in derogation of, any other provisions of the Act and/or the Code, 
including statutory or administrative exemptions and transitional 
rules. Furthermore, the fact that a transaction is subject to an 
administrative or statutory exemption is not dispositive of whether the 
transaction is in fact a prohibited transaction; and
    4. The proposed amendment, if granted, will be subject to the 
express condition that the material facts and representations contained 
in each application are true and complete and accurately describe all 
material terms of the transaction which is the subject of the 
exemption.

Written Comments and Hearing Requests

    All interested persons are invited to submit written comments or 
requests for a hearing on the proposed amendment to the address above, 
within the time period set forth above. All comments will be made a 
part of the record. Comments and requests for a hearing

[[Page 51488]]

should state the reasons for the writer's interest in the proposed 
amendment. Comments received will be available for public inspection 
with the referenced applications at the address set forth above.

Proposed Exemption

    Under section 408(a) of ERISA and section 4975(c)(2) of the Code 
and in accordance with the procedures set forth in 29 CFR Part 2570, 
subpart B (55 FR 32836, August 10, 1990), the Department proposes to 
amend the following individual Prohibited Transaction Exemptions 
(PTEs): PTE 89-88, 54 FR 42582 (October 17, 1989); PTE 89-89, 54 FR 
42569 (October 17, 1989); PTE 89-90, 54 FR 42597 (October 17, 1989); 
PTE 90-22, 55 FR 20542 (May 17, 1990); PTE 90-23, 55 FR 20545 (May 17, 
1990); PTE 90-24, 55 FR 20548 (May 17, 1990); PTE 90-28, 55 FR 21456 
(May 24, 1990); PTE 90-29, 55 FR 21459 (May 24, 1990); PTE 90-30, 55 FR 
21461 (May 24, 1990); PTE 90-31, 55 FR 23144 (June 6, 1990); PTE 90-32, 
55 FR 23147 (June 6, 1990); PTE 90-33, 55 FR 23151 (June 6, 1990); PTE 
90-36, 55 FR 25903 (June 25, 1990); PTE 90-39, 55 FR 27713 (July 5, 
1990); PTE 90-59, 55 FR 36724 (September 6, 1990); PTE 90-83, 55 FR 
50250 (December 5, 1990); PTE 90-84, 55 FR 50252 (December 5, 1990); 
PTE 90-88, 55 FR 52899 (December 24, 1990); PTE 91-14, 55 FR 48178 
(February 22, 1991); PTE 91-22, 56 FR 03277 (April 18, 1991); PTE 91-
23, 56 FR 15936 (April 18, 1991); PTE 91-30, 56 FR 22452 (May 15, 
1991); PTE 91-62, 56 FR 51406 (October 11, 1991); PTE 93-31, 58 FR 
28620 (May 5, 1993); PTE 93-32, 58 FR 28623 (May 14, 1993); PTE 94-29, 
59 FR 14675 (March 29, 1994); PTE 94-64, 59 FR 42312 (August 17, 1994); 
PTE 94-70, 59 FR 50014 (September 30, 1994); PTE 94-73, 59 FR 51213 
(October 7, 1994); PTE 94-84, 59 FR 65400 (December 19, 1994); PTE 95-
26, 60 FR 17586 (April 6, 1995); PTE 95-59, 60 FR 35938 (July 12, 
1995); PTE 95-89, 60 FR 49011 (September 21, 1995); PTE 96-22, 61 FR 
14828 (April 3, 1996); PTE 96-84, 61 FR 58234 (November 13, 1996); PTE 
96-92, 61 FR 66334 (December 17, 1996); PTE 96-94, 61 FR 68787 
(December 30, 1996); PTE 97-05, 62 FR 1926 (January 14, 1997); PTE 97-
28, 62 FR 28515 (May 23, 1997); PTE 97-34, 62 FR 39021 (July 21, 1997); 
PTE 98-08, 63 FR 8498 (February 19, 1998); PTE 99-11, 64 FR 11046 
(March 8, 1999); PTE 2000-19, 65 FR 25950 (May 4, 2000); PTE 2000-33, 
65 FR 37171 (June 13, 2000); and PTE 2000-41, First Tennessee National 
Corporation (August, 2000).
    In addition, the Department notes that it is also proposing 
individual exemptive relief for: Deutsche Bank AG, New York Branch and 
Deutsche Morgan Grenfell/C.J. Lawrence Inc., FAN 97-03E (December 9, 
1996); Credit Lyonnais Securities (USA) Inc., FAN 97-21E (September 10, 
1997); ABN AMRO Inc., FAN 98-08E (April 27, 1998); and Ironwood Capital 
Partners Ltd., FAN 99-31E (December 20, 1999). They have received the 
approval of the Department to engage in transactions substantially 
similar to the transactions described in the Underwriter Exemptions 
pursuant to PTE 96-62. Finally, the Department notes that it is 
proposing relief for Countrywide Securities Corporation (Application 
No. D-10863).

I. Transactions

    A. Effective for transactions occurring on or after the date of 
publication of this notice in the Federal Register, the restrictions of 
sections 406(a) and 407(a) of the Act, and the taxes imposed by 
sections 4975(a) and (b) of the Code, by reason of section 
4975(c)(1)(A) through (D) of the Code shall not apply to the following 
transactions involving Issuers and Securities evidencing interests 
therein:
    (1) The direct or indirect sale, exchange or transfer of Securities 
in the initial issuance of Securities between the Sponsor or 
Underwriter and an employee benefit plan when the Sponsor, Servicer, 
Trustee or Insurer of an Issuer, the Underwriter of the Securities 
representing an interest in the Issuer, or an Obligor is a party in 
interest with respect to such plan;
    (2) The direct or indirect acquisition or disposition of Securities 
by a plan in the secondary market for such Securities; and
    (3) The continued holding of Securities acquired by a plan pursuant 
to subsection I.A.(1) or (2).
    Notwithstanding the foregoing, section I.A. does not provide an 
exemption from the restrictions of sections 406(a)(1)(E), 406(a)(2) and 
407 of the Act for the acquisition or holding of a Security on behalf 
of an Excluded Plan by any person who has discretionary authority or 
renders investment advice with respect to the assets of that Excluded 
Plan.\37\
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    \37\ Section I.A. provides no relief from sections 406(a)(1)(E), 
406(a)(2) and 407 of the Act for any person rendering investment 
advice to an Excluded Plan within the meaning of section 
3(21)(A)(ii) of the Act, and regulation 29 CFR 2510.3-21(c).
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    B. Effective for transactions occurring on or after the date of 
publication of this notice in the Federal Register, the restrictions of 
sections 406(b)(1) and 406(b)(2) of the Act and the taxes imposed by 
sections 4975(a) and (b) of the Code, by reason of section 
4975(c)(1)(E) of the Code, shall not apply to:
    (1) The direct or indirect sale, exchange or transfer of Securities 
in the initial issuance of Securities between the Sponsor or 
Underwriter and a plan when the person who has discretionary authority 
or renders investment advice with respect to the investment of plan 
assets in the Securities is (a) an Obligor with respect to 5 percent or 
less of the fair market value of obligations or receivables contained 
in the Issuer, or (b) an Affiliate of a person described in (a); if:
    (i) The plan is not an Excluded Plan;
    (ii) Solely in the case of an acquisition of Securities in 
connection with the initial issuance of the Securities, at least 50 
percent of each class of Securities in which plans have invested is 
acquired by persons independent of the members of the Restricted Group 
and at least 50 percent of the aggregate interest in the Issuer is 
acquired by persons independent of the Restricted Group;
    (iii) A plan's investment in each class of Securities does not 
exceed 25 percent of all of the Securities of that class outstanding at 
the time of the acquisition; and
    (iv) Immediately after the acquisition of the Securities, no more 
than 25 percent of the assets of a plan with respect to which the 
person has discretionary authority or renders investment advice are 
invested in Securities representing an interest in an Issuer containing 
assets sold or serviced by the same entity.\38\ For purposes of this 
paragraph (iv) only, an entity will not be considered to service assets 
contained in a Issuer if it is merely a Subservicer of that Issuer;
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    \38\ For purposes of this Underwriter Exemption, each plan 
participating in a commingled fund (such as a bank collective trust 
fund or insurance company pooled separate account) shall be 
considered to own the same proportionate undivided interest in each 
asset of the commingled fund as its proportionate interest in the 
total assets of the commingled fund as calculated on the most recent 
preceding valuation date of the fund.
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    (2) The direct or indirect acquisition or disposition of Securities 
by a plan in the secondary market for such Securities, provided that 
the conditions set forth in paragraphs (i), (iii) and (iv) of 
subsection I.B.(1) are met; and
    (3) The continued holding of Securities acquired by a plan pursuant 
to subsection I.B.(1) or (2).
    C. Effective for transaction occurring on or after the date of 
publication of this notice in the Federal Register, the restrictions of 
sections 406(a), 406(b) and 407(a) of the Act, and the taxes imposed by 
section 4975(a) and (b) of

[[Page 51489]]

the Code by reason of section 4975(c) of the Code, shall not apply to 
transactions in connection with the servicing, management and operation 
of an Issuer, including the use of any Eligible Swap Transaction; or, 
effective January 1, 1999, the defeasance of a mortgage obligation held 
as an asset of the Issuer through the substitution of a new mortgage 
obligation in a commercial mortgage-backed Designated Transaction, 
provided:
    (1) Such transactions are carried out in accordance with the terms 
of a binding Pooling and Servicing Agreement;
    (2) The Pooling and Servicing Agreement is provided to, or 
described in all material respects in the prospectus or private 
placement memorandum provided to, investing plans before they purchase 
Securities issued by the Issuer; \39\ and
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    \39\ In the case of a private placement memorandum, such 
memorandum must contain substantially the same information that 
would be disclosed in a prospectus if the offering of the securities 
were made in a registered public offering under the Securities Act 
of 1933. In the Department's view, the private placement memorandum 
must contain sufficient information to permit plan fiduciaries to 
make informed investment decisions. For purposes of this exemption, 
references to ``prospectus'' include any related prospectus 
supplement thereto, pursuant to which Securities are offered to 
investors.
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    (3) The defeasance of a mortgage obligation and the substitution of 
a new mortgage obligation in a commercial mortgage-backed Designated 
Transaction meet the terms and conditions for such defeasance and 
substitution as are described in the prospectus or private placement 
memorandum for such Securities, which terms and conditions have been 
approved by a Rating Agency and does not result in the Securities 
receiving a lower credit rating from the Rating Agency than the current 
rating of the Securities.
    Notwithstanding the foregoing, section I.C. does not provide an 
exemption from the restrictions of section 406(b) of the Act or from 
the taxes imposed by reason of section 4975(c) of the Code for the 
receipt of a fee by a Servicer of the Issuer from a person other than 
the Trustee or Sponsor, unless such fee constitutes a Qualified 
Administrative Fee.
    D. Effective for transactions occurring on or after the date of 
publication of this notice in the Federal Register, the restrictions of 
sections 406(a) and 407(a) of the Act, and the taxes imposed by section 
4975(a) and (b) of the Code by reason of section 4975(c)(1)(A) through 
(D) of the Code, shall not apply to any transactions to which those 
restrictions or taxes would otherwise apply merely because a person is 
deemed to be a party in interest or disqualified person (including a 
fiduciary) with respect to a plan by virtue of providing services to 
the plan (or by virtue of having a relationship to such service 
provider described in section 3(14)(F), (G), (H) or (I) of the Act or 
section 4975(e)(2)(F), (G), (H) or (I) of the Code), solely because of 
the plan's ownership of Securities.

II. General Conditions

    A. The relief provided under section I. is available only if the 
following conditions are met:
    (1) The acquisition of Securities by a plan is on terms (including 
the Security price) that are at least as favorable to the plan as they 
would be in an arm's-length transaction with an unrelated party;
    (2) The rights and interests evidenced by the Securities are not 
subordinated to the rights and interests evidenced by other Securities 
of the same Issuer, unless the Securities are issued in a Designated 
Transaction;
    (3) The Securities acquired by the plan have received a rating from 
a Rating Agency at the time of such acquisition that is in one of the 
three (or in the case of Designated Transactions, four) highest generic 
rating categories;
    (4) The Trustee is not an Affiliate of any member of the Restricted 
Group. For purposes of this requirement:
    (a) The Trustee shall not be considered to be an Affiliate of a 
Servicer solely because the Trustee has succeeded to the rights and 
responsibilities of the Servicer pursuant to the terms of a Pooling and 
Servicing Agreement providing for such succession upon the occurrence 
of one or more events of default by the Servicer; and
    (b) Effective for transactions occurring on or after January 1, 
1998, subsection II.A.(4) will be deemed satisfied notwithstanding a 
Servicer becoming an Affiliate of the Trustee as the result of a merger 
or acquisition involving the Trustee, such Servicer and/or their 
Affiliates which occurs after the initial issuance of the Securities, 
provided that:
    (i) such Servicer ceases to be an Affiliate of the Trustee no later 
than six months after the later of August 23, 2000, or the date such 
Servicer became an Affiliate of the Trustee; and
    (ii) such Servicer did not breach any of its obligations under the 
Pooling and Servicing Agreement, unless such breach was immaterial and 
timely cured in accordance with the terms of such agreement, during the 
period from the closing date of such merger or acquisition transaction 
through the date the Servicer ceased to be an Affiliate of the Trustee;
    (5) The sum of all payments made to and retained by the 
Underwriters in connection with the distribution or placement of 
Securities represents not more than Reasonable Compensation for 
underwriting or placing the Securities; the sum of all payments made to 
and retained by the Sponsor pursuant to the assignment of obligations 
(or interests therein) to the Issuer represents not more than the fair 
market value of such obligations (or interests); and the sum of all 
payments made to and retained by the Servicer represents not more than 
Reasonable Compensation for the Servicer's services under the Pooling 
and Servicing Agreement and reimbursement of the Servicer's reasonable 
expenses in connection therewith;
    (6) The plan investing in such Securities is an ``accredited 
investor'' as defined in Rule 501(a)(1) of Regulation D of the 
Securities and Exchange Commission under the Securities Act of 1933; 
and
    (7) In the event that the obligations used to fund a Issuer have 
not all been transferred to the Issuer on the Closing Date, additional 
obligations of the types specified in subsection III.B.(1) may be 
transferred to the Issuer during the Pre-Funding Period in exchange for 
amounts credited to the Pre-Funding Account, provided that:
    (a) The Pre-Funding Limit is not exceeded;
    (b) All such additional obligations meet the same terms and 
conditions for determining the eligibility of the original obligations 
used to create the Issuer (as described in the prospectus or private 
placement memorandum and/or Pooling and Servicing Agreement for such 
Securities), which terms and conditions have been approved by a Rating 
Agency. Notwithstanding the foregoing, the terms and conditions for 
determining the eligibility of an obligation may be changed if such 
changes receive prior approval either by a majority vote of the 
outstanding securityholders or by a Rating Agency;
    (c) The transfer of such additional obligations to the Issuer 
during the Pre-Funding Period does not result in the Securities 
receiving a lower credit rating from a Rating Agency upon termination 
of the Pre-Funding Period than the rating that was obtained at the time 
of the initial issuance of the Securities by the Issuer;
    (d) The weighted average annual percentage interest rate (the 
average interest rate) for all of the obligations

[[Page 51490]]

held by the Issuer at the end of the Pre-Funding Period will not be 
more than 100 basis points lower than the average interest rate for the 
obligations which were transferred to the Issuer on the Closing Date;
    (e) In order to ensure that the characteristics of the receivables 
actually acquired during the Pre-Funding Period are substantially 
similar to those which were acquired as of the Closing Date, the 
characteristics of the additional obligations will either be monitored 
by a credit support provider or other insurance provider which is 
independent of the Sponsor or an independent accountant retained by the 
Sponsor will provide the Sponsor with a letter (with copies provided to 
the Rating Agency, the Underwriter and the Trustee) stating whether or 
not the characteristics of the additional obligations conform to the 
characteristics of such obligations described in the prospectus, 
private placement memorandum and/or Pooling and Servicing Agreement. In 
preparing such letter, the independent accountant will use the same 
type of procedures as were applicable to the obligations which were 
transferred as of the Closing Date;
    (f) The Pre-Funding Period shall be described in the prospectus or 
private placement memorandum provided to investing plans; and
    (g) The Trustee of the Trust (or any agent with which the Trustee 
contracts to provide Trust services) will be a substantial financial 
institution or trust company experienced in trust activities and 
familiar with its duties, responsibilities and liabilities as a 
fiduciary under the Act. The Trustee, as the legal owner of the 
obligations in the Trust or the holder of a security interest in the 
obligations held by the Issuer, will enforce all the rights created in 
favor of securityholders of the Issuer, including employee benefit 
plans subject to the Act;
    (8) In order to insure that the assets of the Issuer may not be 
reached by creditors of the Sponsor in the event of bankruptcy or other 
insolvency of the Sponsor:
    (a) The legal documents establishing the Issuer will contain:
    (i) Restrictions on the Issuer's ability to borrow money or issue 
debt other than in connection with the securitization;
    (ii) Restrictions on the Issuer merging with another entity, 
reorganizing, liquidating or selling assets (other than in connection 
with the securitization);
    (iii) Restrictions limiting the authorized activities of the Issuer 
to activities relating to the securitization;
    (iv) If the Issuer is not a Trust, provisions for the election of 
at least one independent director/partner/member whose affirmative 
consent is required before a voluntary bankruptcy petition can be filed 
by the Issuer; and
    (v) If the Issuer is not a Trust, requirements that each 
independent director/partner/member must be an individual that does not 
have a significant interest in, or other relationships with, the 
Sponsor or any of its Affiliates; and
    (b) The Pooling and Servicing Agreement and/or other agreements 
establishing the contractual relationships between the parties to the 
securitization transaction will contain covenants prohibiting all 
parties thereto from filing an involuntary bankruptcy petition against 
the Issuer or initiating any other form of insolvency proceeding until 
after the Securities have been paid; and
    (c) Prior to the issuance by the Issuer of any Securities, a legal 
opinion is received which states that either:
    (i) A ``true sale'' of the assets being transferred to the Issuer 
by the Sponsor has occurred and that such transfer is not being made 
pursuant to a financing of the assets by the Sponsor; or
    (ii) In the event of insolvency or receivership of the Sponsor, the 
assets transferred to the Issuer will not be part of the estate of the 
Sponsor;
    (9) If a particular class of Securities held by any plan involves a 
Ratings Dependent or Non-Ratings Dependent Swap entered into by the 
Issuer, then each particular swap transaction relating to such 
Securities:
    (a) Shall be an Eligible Swap;
    (b) Shall be with an Eligible Swap Counterparty;
    (c) In the case of a Ratings Dependent Swap, shall provide that if 
the credit rating of the counterparty is withdrawn or reduced by any 
Rating Agency below a level specified by the Rating Agency, the 
Servicer (as agent for the Trustee) shall, within the period specified 
under the Pooling and Servicing Agreement:
    (i) Obtain a replacement swap agreement with an Eligible Swap 
Counterparty which is acceptable to the Rating Agency and the terms of 
which are substantially the same as the current swap agreement (at 
which time the earlier swap agreement shall terminate); or
    (ii) Cause the swap counterparty to establish any collateralization 
or other arrangement satisfactory to the Rating Agency such that the 
then current rating by the Rating Agency of the particular class of 
Securities will not be withdrawn or reduced.
    In the event that the Servicer fails to meet its obligations under 
this subsection II.A.(9)(c), plan securityholders will be notified in 
the immediately following Trustee's periodic report which is provided 
to securityholders, and sixty days after the receipt of such report, 
the exemptive relief provided under section I.C. will prospectively 
cease to be applicable to any class of Securities held by a plan which 
involves such Ratings Dependent Swap; provided that in no event will 
such plan securityholders be notified any later than the end of the 
second month that begins after the date on which such failure occurs.
    (d) In the case of a Non-Ratings Dependent Swap, shall provide 
that, if the credit rating of the counterparty is withdrawn or reduced 
below the lowest level specified in section III.GG., the Servicer (as 
agent for the Trustee) shall within a specified period after such 
rating withdrawal or reduction:
    (i) Obtain a replacement swap agreement with an Eligible Swap 
Counterparty, the terms of which are substantially the same as the 
current swap agreement (at which time the earlier swap agreement shall 
terminate); or
    (ii) Cause the swap counterparty to post collateral with the 
Trustee in an amount equal to all payments owed by the counterparty if 
the swap transaction were terminated; or
    (iii) Terminate the swap agreement in accordance with its terms; 
and
    (e) Shall not require the Issuer to make any termination payments 
to the counterparty (other than a currently scheduled payment under the 
swap agreement) except from Excess Spread or other amounts that would 
otherwise be payable to the Servicer or the Sponsor;
    (10) Any class of Securities, to which one or more swap agreements 
entered into by the Issuer applies, may be acquired or held in reliance 
upon this Underwriter Exemption only by Qualified Plan Investors; and
    (11) Prior to the issuance of any debt securities, a legal opinion 
is received which states that the debt holders have a perfected 
security interest in the Issuer's assets.
    B. Neither any Underwriter, Sponsor, Trustee, Servicer, Insurer or 
any Obligor, unless it or any of its Affiliates has discretionary 
authority or renders investment advice with respect to the plan assets 
used by a plan to acquire Securities, shall be denied the relief 
provided under section I., if the provision of subsection II.A.(6) is 
not satisfied with respect to acquisition or holding by a plan of such 
Securities,

[[Page 51491]]

provided that (1) such condition is disclosed in the prospectus or 
private placement memorandum; and (2) in the case of a private 
placement of Securities, the Trustee obtains a representation from each 
initial purchaser which is a plan that it is in compliance with such 
condition, and obtains a covenant from each initial purchaser to the 
effect that, so long as such initial purchaser (or any transferee of 
such initial purchaser's Securities) is required to obtain from its 
transferee a representation regarding compliance with the Securities 
Act of 1933, any such transferees will be required to make a written 
representation regarding compliance with the condition set forth in 
subsection II.A.(6).

III. Definitions

    For purposes of this exemption:
    A. ``Security'' means:
    (1) A pass-through certificate or trust certificate that represents 
a beneficial ownership interest in the assets of an Issuer which is a 
Trust and which entitles the holder to payments of principal, interest 
and/or other payments made with respect to the assets of such Trust; or
    (2) A security which is denominated as a debt instrument that is 
issued by, and is an obligation of, an Issuer; with respect to which 
the Underwriter is either (i) the sole underwriter or the manager or 
co-manager of the underwriting syndicate, or (ii) a selling or 
placement agent.
    B. ``Issuer'' means an investment pool, the corpus or assets of 
which are held in trust (including a grantor or owner Trust) or whose 
assets are held by a partnership, special purpose corporation or 
limited liability company (which Issuer may be a Real Estate Mortgage 
Investment Conduit (REMIC) or a Financial Asset Securitization 
Investment Trust (FASIT) within the meaning of section 860D(a) or 
section 860L, respectively, of the Code); and the corpus or assets of 
which consist solely of:
    (1)(a) Secured consumer receivables that bear interest or are 
purchased at a discount (including, but not limited to, home equity 
loans and obligations secured by shares issued by a cooperative housing 
association); and/or
    (b) Secured credit instruments that bear interest or are purchased 
at a discount in transactions by or between business entities 
(including, but not limited to, Qualified Equipment Notes Secured by 
Leases); and/or
    (c) Obligations that bear interest or are purchased at a discount 
and which are secured by single-family residential, multi-family 
residential and/or commercial real property (including obligations 
secured by leasehold interests on residential or commercial real 
property); and/or
    (d) Obligations that bear interest or are purchased at a discount 
and which are secured by motor vehicles or equipment, or Qualified 
Motor Vehicle Leases; and/or
    (e) Guaranteed governmental mortgage pool certificates, as defined 
in 29 CFR 2510.3-101(i)(2); \40\ and/or
---------------------------------------------------------------------------

    \40\ In Advisory Opinion 99-05A (Feb. 22, 1999), the Department 
expressed its view that mortgage pool certificates guaranteed and 
issued by the Federal Agricultural Mortgage Corporation (``Farmer 
Mac'') meet the definition of a guaranteed governmental mortgage 
pool certificate as defined in 29 CFR 2510.3-101(i)(2).
---------------------------------------------------------------------------

    (f) Fractional undivided interests in any of the obligations 
described in clauses (a)-(e) of this subsection B.(1).\41\
---------------------------------------------------------------------------

    \41\ The Department wishes to take the opportunity to clarify 
its view that the definition of Issuer contained in subsection 
III.B. includes a two-tier structure under which Securities issued 
by the first Issuer, which contains a pool of receivables described 
above, are transferred to a second Issuer which issues Securities 
that are sold to plans. However, the Department is of the further 
view that, since the Underwriter Exemption generally provides relief 
only for the direct or indirect acquisition or disposition of 
Securities that are not subordinated, no relief would be available 
if the Securities held by the second Issuer were subordinated to the 
rights and interests evidenced by other Securities issued by the 
first Issuer, unless such Securities were issued in a Designated 
Transaction.
---------------------------------------------------------------------------

    Notwithstanding the foregoing, residential and home equity loan 
receivables issued in Designated Transactions may be less than fully 
secured, provided that: (i) the rights and interests evidenced by the 
Securities issued in such Designated Transactions (as defined in 
section III.DD.) are not subordinated to the rights and interests 
evidenced by Securities of the same Issuer; (ii) such Securities 
acquired by the plan have received a rating from a Rating Agency at the 
time of such acquisition that is in one of the two highest generic 
rating categories; and (iii) any obligation included in the corpus or 
assets of the Issuer must be secured by collateral whose fair market 
value on the Closing Date of the Designated Transaction is at least 
equal to 80% of the sum of: (I) the outstanding principal balance due 
under the obligation which is held by the Issuer and (II) the 
outstanding principal balance(s) of any other obligation(s) of higher 
priority (whether or not held by the Issuer) which are secured by the 
same collateral.
    (2) Property which had secured any of the obligations described in 
subsection III.B.(1);
    (3)(a) Undistributed cash or temporary investments made therewith 
maturing no later than the next date on which distributions are made to 
securityholders; and/or
    (b) Cash or investments made therewith which are credited to an 
account to provide payments to securityholders pursuant to any Eligible 
Swap Agreement meeting the conditions of subsection II.A.(9) or 
pursuant to any Eligible Yield Supplement Agreement; and/or
    (c) Cash transferred to the Issuer on the Closing Date and 
permitted investments made therewith which:
    (i) Are credited to a Pre-Funding Account established to purchase 
additional obligations with respect to which the conditions set forth 
in paragraphs (a)-(g) of subsection II.A.(7) are met; and/or
    (ii) Are credited to a Capitalized Interest Account; and
    (iii) Are held by the Issuer for a period ending no later than the 
first distribution date to securityholders occurring after the end of 
the Pre-Funding Period.
    For purposes of this paragraph (c) of subsection III.B.(3), the 
term ``permitted investments'' means investments which: (i) Are either: 
(x) direct obligations of, or obligations fully guaranteed as to timely 
payment of principal and interest by, the United States or any agency 
or instrumentality thereof, provided that such obligations are backed 
by the full faith and credit of the United States or (y) have been 
rated (or the Obligor has been rated) in one of the three highest 
generic rating categories by a Rating Agency; (ii) are described in the 
Pooling and Servicing Agreement; and (iii) are permitted by the Rating 
Agency.
    (4) Rights of the Trustee under the Pooling and Servicing 
Agreement, and rights under any insurance policies, third-party 
guarantees, contracts of suretyship, Eligible Yield Supplement 
Agreements, Eligible Swap Agreements meeting the conditions of 
subsection II.A.(9) or other credit support arrangements with respect 
to any obligations described in subsection III.B.(1).
    Notwithstanding the foregoing, the term ``Issuer'' does not include 
any investment pool unless: (i) The assets of the type described in 
paragraphs (a)-(f) of subsection III.B.(1) which are contained in the 
investment pool have been included in other investment pools, (ii) 
Securities evidencing interests in such other investment pools have 
been rated in one of the three (or in the case of Designated 
Transactions, four) highest generic rating categories by a Rating 
Agency for at least one year prior to the plan's acquisition of 
Securities pursuant to this Underwriter

[[Page 51492]]

Exemption, and (iii) Securities evidencing interests in such other 
investment pools have been purchased by investors other than plans for 
at least one year prior to the plan's acquisition of Securities 
pursuant to this Underwriter Exemption.
    C. ``Underwriter'' means:
    (1) An entity defined as an Underwriter in subsection III.C.(1) of 
each of the Underwriter Exemptions that are being amended by this 
proposed exemption. In addition, the term Underwriter includes Deutsche 
Bank AG, New York Branch and Deutsche Morgan Grenfell/C.J. Lawrence 
Inc, Credit Lyonnais Securities (USA) Inc., ABN AMRO Inc. and Ironwood 
Capital Partners Ltd. (which received the approval of the Department to 
engage in transactions substantially similar to the transactions 
described in the Underwriter Exemptions pursuant to PTE 96-62);
    (2) Any person directly or indirectly, through one or more 
intermediaries, controlling, controlled by or under common control with 
such entity; or
    (3) Any member of an underwriting syndicate or selling group of 
which a person described in subsections III.C.(1) or (2) is a manager 
or co-manager with respect to the Securities.
    D. ``Sponsor'' means the entity that organizes an Issuer by 
depositing obligations therein in exchange for Securities.
    E. ``Master Servicer'' means the entity that is a party to the 
Pooling and Servicing Agreement relating to assets of the Issuer and is 
fully responsible for servicing, directly or through Subservicers, the 
assets of the Issuer.
    F. ``Subservicer'' means an entity which, under the supervision of 
and on behalf of the Master Servicer, services loans contained in the 
Issuer, but is not a party to the Pooling and Servicing Agreement.
    G. ``Servicer'' means any entity which services loans contained in 
the Issuer, including the Master Servicer and any Subservicer.
    H. ``Trust'' means an Issuer which is a trust (including an owner 
trust, grantor trust or a REMIC or FASIT which is organized as a 
Trust).
    I. ``Trustee'' means the Trustee of any Trust which issues 
Securities and also includes an Indenture Trustee. ``Indenture 
Trustee'' means the Trustee appointed under the indenture pursuant to 
which the subject Securities are issued, the rights of holders of the 
Securities are set forth and a security interest in the Trust assets in 
favor of the holders of the Securities is created. The Trustee or the 
Indenture Trustee is also a party to or beneficiary of all the 
documents and instruments transferred to the Issuer, and as such, has 
both the authority to, and the responsibility for, enforcing all the 
rights created thereby in favor of holders of the Securities, including 
those rights arising in the event of default by the servicer.
    J. ``Insurer'' means the insurer or guarantor of, or provider of 
other credit support for, an Issuer. Notwithstanding the foregoing, a 
person is not an insurer solely because it holds Securities 
representing an interest in an Issuer which are of a class subordinated 
to Securities representing an interest in the same Issuer.
    K. ``Obligor'' means any person, other than the Insurer, that is 
obligated to make payments with respect to any obligation or receivable 
included in the Issuer. Where an Issuer contains Qualified Motor 
Vehicle Leases or Qualified Equipment Notes Secured by Leases, 
``Obligor'' shall also include any owner of property subject to any 
lease included in the Issuer, or subject to any lease securing an 
obligation included in the Issuer.
    L. ``Excluded Plan'' means any plan with respect to which any 
member of the Restricted Group is a ``plan sponsor'' within the meaning 
of section 3(16)(B) of the Act.
    M. ``Restricted Group'' with respect to a class of Securities 
means:
    (1) Each Underwriter;
    (2) Each Insurer;
    (3) The Sponsor;
    (4) The Trustee;
    (5) Each Servicer;
    (6) Any Obligor with respect to obligations or receivables included 
in the Issuer constituting more than 5 percent of the aggregate 
unamortized principal balance of the assets in the Issuer, determined 
on the date of the initial issuance of Securities by the Issuer;
    (7) Each counterparty in an Eligible Swap Agreement; or
    (8) Any Affiliate of a person described in subsections III.M.(1)-
(7).
    N. ``Affiliate'' of another person includes:
    (1) Any person directly or indirectly, through one or more 
intermediaries, controlling, controlled by, or under common control 
with such other person;
    (2) Any officer, director, partner, employee, relative (as defined 
in section 3(15) of the Act), a brother, a sister, or a spouse of a 
brother or sister of such other person; and
    (3) Any corporation or partnership of which such other person is an 
officer, director or partner.
    O. ``Control'' means the power to exercise a controlling influence 
over the management or policies of a person other than an individual.
    P. A person will be ``independent'' of another person only if:
    (1) Such person is not an Affiliate of that other person; and
    (2) The other person, or an Affiliate thereof, is not a fiduciary 
who has investment management authority or renders investment advice 
with respect to any assets of such person.
    Q. ``Sale'' includes the entrance into a Forward Delivery 
Commitment, provided:
    (1) The terms of the Forward Delivery Commitment (including any fee 
paid to the investing plan) are no less favorable to the plan than they 
would be in an arm's-length transaction with an unrelated party;
    (2) The prospectus or private placement memorandum is provided to 
an investing plan prior to the time the plan enters into the Forward 
Delivery Commitment; and
    (3) At the time of the delivery, all conditions of this Underwriter 
Exemption applicable to sales are met.
    R. ``Forward Delivery Commitment'' means a contract for the 
purchase or sale of one or more Securities to be delivered at an agreed 
future settlement date. The term includes both mandatory contracts 
(which contemplate obligatory delivery and acceptance of the 
Securities) and optional contracts (which give one party the right but 
not the obligation to deliver Securities to, or demand delivery of 
Securities from, the other party).
    S. ``Reasonable Compensation'' has the same meaning as that term is 
defined in 29 CFR 2550.408c-2.
    T. ``Qualified Administrative Fee'' means a fee which meets the 
following criteria:
    (1) The fee is triggered by an act or failure to act by the Obligor 
other than the normal timely payment of amounts owing in respect of the 
obligations;
    (2) The Servicer may not charge the fee absent the act or failure 
to act referred to in subsection III.T.(1);
    (3) The ability to charge the fee, the circumstances in which the 
fee may be charged, and an explanation of how the fee is calculated are 
set forth in the Pooling and Servicing Agreement; and
    (4) The amount paid to investors in the Issuer will not be reduced 
by the amount of any such fee waived by the Servicer.
    U. ``Qualified Equipment Note Secured By A Lease'' means an 
equipment note:
    (1) Which is secured by equipment which is leased;
    (2) Which is secured by the obligation of the lessee to pay rent 
under the equipment lease; and

[[Page 51493]]

    (3) With respect to which the Issuer's security interest in the 
equipment is at least as protective of the rights of the Issuer as the 
Issuer would have if the equipment note were secured only by the 
equipment and not the lease.
    V. ``Qualified Motor Vehicle Lease'' means a lease of a motor 
vehicle where:
    (1) The Issuer owns or holds a security interest in the lease;
    (2) The Issuer owns or holds a security interest in the leased 
motor vehicle; and
    (3) The Issuer's security interest in the leased motor vehicle is 
at least as protective of the Issuer's rights as the Issuer would 
receive under a motor vehicle installment loan contract.
    W. ``Pooling and Servicing Agreement'' means the agreement or 
agreements among a Sponsor, a Servicer and the Trustee establishing a 
Trust. ``Pooling and Servicing Agreement'' also includes the indenture 
entered into by the Issuer and the Indenture Trustee.
    X. ``Rating Agency'' means Standard & Poor's Ratings Services, a 
division of The McGraw-Hill Companies Inc., Moody's Investors Service, 
Inc., Duff & Phelps Credit Rating Co., Fitch ICBA, Inc. or any 
successors thereto.
    Y. ``Capitalized Interest Account'' means an Issuer account:
    (i) which is established to compensate securityholders for 
shortfalls, if any, between investment earnings on the Pre-Funding 
Account and the interest rate payable under the Securities; and (ii) 
which meets the requirements of paragraph (c) of subsection III.B.(3).
    Z. ``Closing Date'' means the date the Issuer is formed, the 
Securities are first issued and the Issuer's assets (other than those 
additional obligations which are to be funded from the Pre-Funding 
Account pursuant to subsection II.A.(7)) are transferred to the Issuer.
    AA. ``Pre-Funding Account'' means an Issuer account: (i) which is 
established to purchase additional obligations, which obligations meet 
the conditions set forth in paragraph (a)-(g) of subsection II.A.(7); 
and (ii) which meets the requirements of paragraph (c) of subsection 
III.B.(3).
    BB. ``Pre-Funding Limit'' means a percentage or ratio of the amount 
allocated to the Pre-Funding Account, as compared to the total 
principal amount of the Securities being offered, which is less than or 
equal to: (i) 40 percent, effective for transactions occurring on or 
after January 1, 1992, but prior to May 23, 1997; and (ii) 25 percent, 
for transactions occurring on or after May 23, 1997.
    CC. ``Pre-Funding Period'' means the period commencing on the 
Closing Date and ending no later than the earliest to occur of: (i) the 
date the amount on deposit in the Pre-Funding Account is less than the 
minimum dollar amount specified in the Pooling and Servicing Agreement; 
(ii) the date on which an event of default occurs under the Pooling and 
Servicing Agreement or (iii) the date which is the later of three 
months or ninety days after the Closing Date.
    DD. ``Designated Transaction'' means a securitization transaction 
in which the assets of the Issuer consist of secured consumer 
receivables, secured credit instruments or secured obligations that 
bear interest or are purchased at a discount and are: (i) Motor 
vehicle, home equity and/or manufactured housing consumer receivables; 
and/or (ii) motor vehicle credit instruments in transactions by or 
between business entities; and/or (iii) single-family residential, 
multi-family residential, home equity, manufactured housing and/or 
commercial mortgage obligations that are secured by single-family 
residential, multi-family residential, commercial real property or 
leasehold interests therein. For purposes of this section III.DD., the 
collateral securing motor vehicle consumer receivables or motor vehicle 
credit instruments may include motor vehicles and/or Qualified Motor 
Vehicle Leases.
    EE. ``Ratings Dependent Swap'' means an interest rate swap, or (if 
purchased by or on behalf of the Issuer) an interest rate cap contract, 
that is part of the structure of a class of Securities where the rating 
assigned by the Rating Agency to any class of Securities held by any 
plan is dependent on the terms and conditions of the swap and the 
rating of the counterparty, and if such Security rating is not 
dependent on the existence of the swap and rating of the counterparty, 
such swap or cap shall be referred to as a ``Non-Ratings Dependent 
Swap''. With respect to a Non-Ratings Dependent Swap, each Rating 
Agency rating the Securities must confirm, as of the date of issuance 
of the Securities by the Issuer, that entering into an Eligible Swap 
with such counterparty will not affect the rating of the Securities.
    FF. ``Eligible Swap'' means a Ratings Dependent or Non-Ratings 
Dependent Swap:
    (1) Which is denominated in U.S. dollars;
    (2) Pursuant to which the Issuer pays or receives, on or 
immediately prior to the respective payment or distribution date for 
the class of Securities to which the swap relates, a fixed rate of 
interest, or a floating rate of interest based on a publicly available 
index (e.g., LIBOR or the U.S. Federal Reserve's Cost of Funds Index 
(COFI)), with the Issuer receiving such payments on at least a 
quarterly basis and obligated to make separate payments no more 
frequently than the counterparty, with all simultaneous payments being 
netted;
    (3) Which has a notional amount that does not exceed either: (i) 
The principal balance of the class of Securities to which the swap 
relates, or (ii) the portion of the principal balance of such class 
represented solely by those types of corpus or assets of the Issuer 
referred to in subsections III.B.(1), (2) and (3);
    (4) Which is not leveraged (i.e., payments are based on the 
applicable notional amount, the day count fractions, the fixed or 
floating rates designated in subsection III.FF.(2), and the difference 
between the products thereof, calculated on a one to one ratio and not 
on a multiplier of such difference);
    (5) Which has a final termination date that is either the earlier 
of the date on which the Issuer terminates or the related class of 
securities is fully repaid; and
    (6) Which does not incorporate any provision which could cause a 
unilateral alteration in any provision described in subsections 
III.FF.(1) through (4) without the consent of the Trustee.
    GG. ``Eligible Swap Counterparty'' means a bank or other financial 
institution which has a rating, at the date of issuance of the 
Securities by the Issuer, which is in one of the three highest long