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

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.

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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).

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.

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(the Applicant). In preparing the application, the Applicant received input from members of The Bond Market Association (TBMA).

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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.

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).

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In addition, the Department

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.

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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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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.

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In this regard, the entities who received the other Underwriter Exemptions were contacted concerning their participation in this amendment process.

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:

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(1) Single and multi-family residential or commercial mortgage investment trusts;

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(2) motor vehicle receivables investment trusts; (3) consumer or commercial receivables investment trusts; and (4) guaranteed governmental mortgage pool certificate investment trusts.

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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.

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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.

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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.

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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.

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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).

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

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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

mortgages (the Designated Transactions).

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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.

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.

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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.

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,

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

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and equity Securities. Each of the different types of securitization entities provides virtually the same legal protections to investors.

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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.

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

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.

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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

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.

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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.

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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.

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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.

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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,

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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

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.

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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 § 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.

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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.

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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

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.

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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.

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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

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.

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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.

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,

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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

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

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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

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or private placement memorandum.

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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.

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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.

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References to the term “prospectus” herein shall include any related prospectus supplement thereto, pursuant to which Securities are offered to investors.

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

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;

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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

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,

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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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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

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.

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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.

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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

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.

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

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.

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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

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.

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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”).

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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 § 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.

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.

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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

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

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

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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 l

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