UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM 10-Q X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE - ----- SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2002 ----------------------------------------------- OR - ----- TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to --------------------- ---------------------- Commission file number: 1-7184 B. F. SAUL REAL ESTATE INVESTMENT TRUST - ------------------------------------------------------------------------------- (Exact name of registrant as specified in the charter) Maryland 52-6053341 - ------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 7501 Wisconsin Avenue, Bethesda, Maryland 20814 - ------------------------------------------------------------------------------- (Address of principal executive office) (Zip Code) (301) 986-6000 - ------------------------------------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirement for the past 90 days. Yes X No --- --- The number of Common Shares of Beneficial Interest, $1 Par Value, outstanding as of May 14, 2002, was 4,826,910. TABLE OF CONTENTS PART I. FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited): (a) Consolidated Balance Sheets at March 31, 2002 and September 30, 2001 (b) Consolidated Statements of Operations for the three-month and six-month periods ended March 31, 2002 and 2001 (c) Consolidated Statements of Comprehensive Income and Changes in Shareholders' Equity (Deficit) for the three-month and six-month periods ended March 31, 2002 and 2001 (d) Consolidated Statements of Cash Flows for the six-month periods ended March 31, 2002 and 2001 (e) Notes to Consolidated Financial Statements Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations: (a) Financial Condition Real Estate Banking (b) Liquidity and Capital Resources Real Estate Banking (c) Results of Operations Three months ended March 31, 2002 compared to three months ended March 31, 2001 Six months ended March 31, 2002 compared to six months ended March 31, 2001 Item 3. Quantitative and Qualitative Disclosures About Market Risk PART II. OTHER INFORMATION Item 6. Exhibits and Reports On Form 8-K Consolidated Balance Sheets B. F. SAUL REAL ESTATE INVESTMENT TRUST (Unaudited) ============================================================================================================================ March 31 September 30 ---------------------------- (In thousands) 2002 2001 - ---------------------------------------------------------------------------------------------------------------------------- ASSETS Real Estate Income-producing properties Hotel $ 254,143 $ 254,165 Office and industrial 163,767 157,653 Other 2,803 2,825 ------------- ------------- 420,713 414,643 Accumulated depreciation (140,863) (131,659) ------------- ------------- 279,850 282,984 Land parcels 41,014 40,835 Construction in progress 13,076 15,681 Cash and cash equivalents 16,493 13,860 Note receivable and accrued interest -- related party 7,787 7,787 Other assets 82,122 86,983 ------------- ------------- Total real estate assets 440,342 448,130 - ---------------------------------------------------------------------------------------------------------------------------- Banking Cash and other deposits 460,108 409,995 Loans held for securitization and/or sale 752,728 528,083 Investment securities (market value $46,002 and $46,181, respectively) 46,427 45,794 Trading securities 7,412 6,690 Mortgage-backed securities (market value $1,211,094 and $1,489,835, respectively) 1,219,439 1,474,495 Loans and leases receivable (net of allowance for losses of $69,018 and $63,018, respectively) 7,403,036 8,018,495 Federal Home Loan Bank stock 84,843 113,030 Real estate held for investment or sale (net of allowance for losses of $85,468 and $85,354, respectively) 25,009 31,704 Property and equipment, net 453,937 437,795 Goodwill and other intangible assets, net 25,904 27,058 Interest only strips, net 63,231 47,146 Other assets 228,273 248,181 ------------- ------------- Total banking assets 10,770,347 11,388,466 - ---------------------------------------------------------------------------------------------------------------------------- TOTAL ASSETS $ 11,210,689 $ 11,836,596 - ---------------------------------------------------------------------------------------------------------------------------- LIABILITIES Real Estate Mortgage notes payable $ 322,948 $ 325,750 Notes payable - secured 200,000 202,500 Notes payable - unsecured 54,904 50,717 Deferred gains - real estate 113,045 113,045 Accrued dividends payable - preferred shares of beneficial interest 16,012 19,303 Other liabilities and accrued expenses 34,249 36,874 ------------- ------------- Total real estate liabilities 741,158 748,189 - ---------------------------------------------------------------------------------------------------------------------------- Banking Deposit accounts 7,560,384 7,562,470 Borrowings 211,578 282,350 Federal Home Loan Bank advances 1,676,858 2,240,598 Other liabilities 402,407 403,190 Capital notes -- subordinated 250,000 250,000 ------------- ------------- Total banking liabilities 10,101,227 10,738,608 - ---------------------------------------------------------------------------------------------------------------------------- Commitments and contingencies Minority interest held by affiliates 90,163 86,310 Minority interest -- other 218,307 218,307 - ---------------------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES 11,150,855 11,791,414 - ---------------------------------------------------------------------------------------------------------------------------- SHAREHOLDERS' EQUITY Preferred shares of beneficial interest, $10.50 cumulative, $1 par value, 90 million shares authorized, 516,000 shares issued and outstanding, liquidation value $51.6 million 516 516 Common shares of beneficial interest, $1 par value, 10 million shares authorized, 6,641,598 shares issued 6,642 6,642 Paid-in surplus 92,943 92,943 Retained earnings (deficit) 800 (11,401) Accumulated other comprehensive income (loss) 781 (1,670) ------------- ------------- 101,682 87,030 Less cost of 1,814,688 common shares of beneficial interest in treasury (41,848) (41,848) ------------- ------------- TOTAL SHAREHOLDERS' EQUITY 59,834 45,182 - ---------------------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 11,210,689 $ 11,836,596 - ---------------------------------------------------------------------------------------------------------------------------- The Notes to Consolidated Financial Statements are an integral part of these statements. Consolidated Statements of Operations B. F. SAUL REAL ESTATE INVESTMENT TRUST (Unaudited) ============================================================================================================================ For the Three Months For the Six Months Ended March 31 Ended March 31 ------------------------------- ---------------------------- (In thousands, except per share amounts) 2002 2001 2002 2001 - ---------------------------------------------------------------------------------------------------------------------------- REAL ESTATE Income Hotels $ 20,350 $ 25,509 $ 40,211 $ 48,846 Office and industrial (including $830, $812, $1,646 and $1,637 of rental income from banking segment, respectively) 9,633 10,463 19,307 20,434 Other 370 489 793 1,220 ---------------- ------------- ------------- ------------- Total income 30,353 36,461 60,311 70,500 - ---------------------------------------------------------------------------------------------------------------------------- Expenses Direct operating expenses: Hotels 14,028 15,945 27,769 31,053 Office and industrial properties 2,731 2,744 5,349 5,297 Land parcels and other 234 276 549 643 Interest expense 12,493 12,731 25,115 25,037 Capitalized interest (117) (101) (287) (421) Amortization of debt expense 196 225 416 416 Depreciation 4,614 4,165 9,203 8,063 Advisory, management and leasing fees - related parties 3,021 2,991 6,022 5,824 General and administrative 501 403 1,221 1,104 ---------------- ------------- ------------- ------------- Total expenses 37,701 39,379 75,357 77,016 - ---------------------------------------------------------------------------------------------------------------------------- Equity in earnings of unconsolidated entities 3,140 2,114 5,742 3,998 Gain on sale of property -- -- -- 2,545 - ---------------------------------------------------------------------------------------------------------------------------- REAL ESTATE OPERATING INCOME (LOSS) $ (4,208) $ (804) $ (9,304) $ 27 - ---------------------------------------------------------------------------------------------------------------------------- BANKING Interest income Loans and leases 132,777 $ 181,001 $ 280,963 $ 358,031 Mortgage-backed securities 19,010 14,944 40,729 31,498 Trading securities 1,037 372 1,852 661 Investment securities 384 683 869 1,378 Other 1,950 4,031 4,528 8,045 ---------------- ------------- ------------- ------------- Total interest income 155,158 201,031 328,941 399,613 - ---------------------------------------------------------------------------------------------------------------------------- Interest expense Deposit accounts 38,086 64,742 84,338 132,367 Borrowings 31,383 45,057 65,753 90,450 ---------------- ------------- ------------- ------------- Total interest expense 69,469 109,799 150,091 222,817 ---------------- ------------- ------------- ------------- Net interest income 85,689 91,232 178,850 176,796 Provision for loan and lease losses (14,976) (18,016) (32,896) (33,939) - ---------------------------------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 70,713 73,216 145,954 142,857 - ---------------------------------------------------------------------------------------------------------------------------- Other income Servicing and securitization income 25,529 26,004 38,951 40,503 Deposit servicing fees 27,365 24,130 55,610 49,108 Gain (loss) on sales of trading securities, net 3,825 17 8,891 (119) Loss on real estate held for investment or sale, net (50) (729) (963) (1,609) Gain (loss) on sales of loans, net (655) 1,353 928 2,935 Gain on other investment -- 9,444 -- 9,444 Other 9,117 7,915 19,129 14,588 ---------------- ------------- ------------- ------------- Total other income 65,131 68,134 122,546 114,850 - ---------------------------------------------------------------------------------------------------------------------------- Continued on following page. Consolidated Statements of Operations (Continued) B. F. SAUL REAL ESTATE INVESTMENT TRUST (Unaudited) ============================================================================================================================ For the Three Months For the Six Months Ended March 31 Ended March 31 ------------------------------- ---------------------------- (In thousands, except per share amounts) 2002 2001 2002 2001 - ---------------------------------------------------------------------------------------------------------------------------- BANKING (Continued) Operating expenses Salaries and employee benefits $ 50,459 $ 48,616 $ 98,799 $ 99,433 Loan 9,102 15,531 18,741 22,020 Property and equipment (including $830, $812, $1,646 and $1,637 of rental expense paid to real estate segment, respectively) 11,410 8,781 23,913 17,207 Marketing 1,171 2,066 4,029 5,689 Data processing 8,484 6,835 16,714 13,079 Depreciation and amortization 8,952 8,450 17,753 16,856 Deposit insurance premiums 346 363 680 709 Amortization of goodwill and other intangible assets 554 575 1,155 1,173 Other 13,703 13,361 27,618 26,116 ---------------- ------------- ------------- ------------- Total operating expenses 104,181 104,578 209,402 202,282 - ---------------------------------------------------------------------------------------------------------------------------- BANKING OPERATING INCOME $ 31,663 $ 36,772 $ 59,098 $ 55,425 - ---------------------------------------------------------------------------------------------------------------------------- TOTAL COMPANY Operating income $ 27,455 $ 35,968 $ 49,794 $ 55,452 Income tax provision 9,524 12,162 16,988 16,853 ---------------- ------------- ------------- ------------- Income before minority interest 17,931 23,806 32,806 38,599 Minority interest held by affiliates (2,858) (3,736) (5,240) (5,190) Minority interest -- other (6,327) (6,327) (12,656) (12,656) - ---------------------------------------------------------------------------------------------------------------------------- TOTAL COMPANY NET INCOME $ 8,746 $ 13,743 $ 14,910 $ 20,753 - ---------------------------------------------------------------------------------------------------------------------------- NET INCOME AVAILABLE TO COMMON SHAREHOLDERS $ 7,391 $ 12,389 $ 12,201 $ 18,045 NET INCOME PER COMMON SHARE Income before minority interest $ 3.43 $ 4.65 $ 6.24 $ 7.44 Minority interest held by affiliates (0.59) (0.77) (1.09) (1.08) Minority interest -- other (1.31) (1.31) (2.62) (2.62) - ---------------------------------------------------------------------------------------------------------------------------- NET INCOME PER COMMON SHARE $ 1.53 $ 2.57 $ 2.53 $ 3.74 - ---------------------------------------------------------------------------------------------------------------------------- The Notes to Consolidated Financial Statements are an integral part of these statements.Consolidated Statements of Comprehensive Income and Changes in Shareholders' Equity B. F. SAUL REAL ESTATE INVESTMENT TRUST (Unaudited) ============================================================================================================================ For the Three Months For the Six Months Ended March 31 Ended March 31 ------------------------------- ---------------------------- (Dollars in thousands) 2002 2001 2002 2001 - ---------------------------------------------------------------------------------------------------------------------------- COMPREHENSIVE INCOME Net income $ 8,746 $ 13,743 $ 14,910 $ 20,753 Other comprehensive income: Net unrealized holding gains (losses) (1,508) (1,198) 2,451 (1,615) - ---------------------------------------------------------------------------------------------------------------------------- TOTAL COMPREHENSIVE INCOME $ 7,238 $ 12,545 $ 17,361 $ 19,138 - ---------------------------------------------------------------------------------------------------------------------------- CHANGES IN SHAREHOLDERS' EQUITY PREFERRED SHARES OF BENEFICIAL INTEREST Beginning and end of period (516,000 shares) $ 516 $ 516 $ 516 $ 516 ---------------- ------------- ------------- ------------- COMMON SHARES OF BENEFICIAL INTEREST Beginning and end of period (6,641,598 shares) 6,642 6,642 6,642 6,642 ---------------- ------------- ------------- ------------- PAID-IN SURPLUS Beginning and end of period 92,943 92,943 92,943 92,943 ---------------- ------------- ------------- ------------- RETAINED EARNINGS (DEFICIT) Beginning of period (6,591) (43,986) (11,401) (49,642) Net income 8,746 13,743 14,910 20,753 Dividends: Real Estate Trust preferred shares of beneficial interest: Distributions payable (1,355) (1,354) (2,709) (2,708) ---------------- ------------- ------------- ------------- End of period 800 (31,597) 800 (31,597) ---------------- ------------- ------------- ------------- ACCUMULATED OTHER COMPREHENSIVE INCOME Beginning of period 2,289 (417) (1,670) -- Net unrealized holding gains (losses) (1,508) (1,198) 2,451 (1,615) ---------------- ------------- ------------- ------------- End of period 781 (1,615) 781 (1,615) ---------------- ------------- ------------- ------------- TREASURY SHARES Beginning and end of period (1,814,688 shares) (41,848) (41,848) (41,848) (41,848) - ---------------------------------------------------------------------------------------------------------------------------- TOTAL SHAREHOLDERS' EQUITY $ 59,834 $ 25,041 $ 59,834 $ 25,041 - ---------------------------------------------------------------------------------------------------------------------------- The Notes to Consolidated Financial Statements are an integral part of these statements. Consolidated Statements of Cash Flows B. F. SAUL REAL ESTATE INVESTMENT TRUST (Unaudited) ============================================================================================================================ For the Six Months Ended March 31 ---------------------------- (In thousands) 2002 2001 - ---------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Real Estate Net loss $ (6,048) $ (7) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation 9,203 8,063 Gain on sale of property -- (2,545) Increase in accounts receivable and accrued income (366) (670) Increase in deferred tax asset (3,256) (4) Decrease in accounts payable and accrued expenses (1,600) (5,938) Amortization of debt expense 920 890 Equity in earnings of unconsolidated entities (5,742) (3,998) Dividends and tax sharing payments 12,900 6,400 Other (3,512) (1,456) ------------- ------------- 2,499 735 ------------- ------------- Banking Net income 20,958 20,760 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Amortization of premiums, discounts and net deferred loan fees 8,804 2,241 Depreciation and amortization 17,753 16,856 Loss on retirement of fixed assets 2,034 -- Provision for loan and lease losses 32,896 33,939 Capitalized interest on real estate under development -- (1,683) Proceeds from sales of trading securities 733,206 182,482 Net fundings of loans held for sale and/or securitization (1,099,220) (546,546) Proceeds from sales of loans held for sale and/or securitization 1,108,716 637,976 Loss on sales of real estate held for sale 1,013 248 Provision for losses on real estate held for investment or sale 2,100 2,100 (Gain) loss on sales of trading securities, net (8,891) 119 Increase in interest-only strips (16,085) (18,137) (Increase) decrease in servicing assets (20,053) 10,218 Amortization of goodwill and other intangible assets 1,159 1,178 Decrease in other assets 43,081 3,506 Increase (decrease) in other liabilities (24,403) 26,187 Minority interest held by affiliates 5,240 5,190 Minority interest - other 4,875 4,875 Other 46,677 39,641 ------------- ------------- 859,860 421,150 ------------- ------------- Net cash provided by operating activities 862,359 421,885 - ---------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Real Estate Capital expenditures - properties (3,666) (17,067) Property acquisitions -- (15,159) Property sales 22 7,287 Note receivable and accrued interest -- related party Repayments -- 2,000 Equity investment in unconsolidated entities 1,469 1,467 Net proceeds from settlement escrow 9,628 -- Other -- 2 ------------- ------------- 7,453 (21,470) ------------- ------------- Banking Net proceeds from redemption (purchases) of Federal Home Loan Bank stock 28,187 (8,087) Net proceeds from sales of real estate 13,283 9,758 Net principal collected (fundings) of loans and leases receivable 889,990 (143,072) Principal collected on mortgage-backed securities 264,514 165,779 Purchases of investment securities (11,730) (31) Purchases of loans receivable (1,327,025) (564,327) Purchases of property and equipment (35,989) (48,533) Disbursements for real estate held for investment or sale (5,199) -- Increase in goodwill -- (4,178) Other 2,076 (4,634) ------------- ------------- (181,893) (597,325) ------------- ------------- Net cash provided by (used in) investing activities (174,440) (618,795) - ---------------------------------------------------------------------------------------------------------------------------- Continued on following page. Consolidated Statements of Cash Flows (Continued) B. F. SAUL REAL ESTATE INVESTMENT TRUST (Unaudited) ============================================================================================================================ For the Six Months Ended March 31 ---------------------------- (In thousands) 2002 2001 - ---------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Real Estate Proceeds from mortgage financing $ 1,386 $ 14,160 Principal curtailments and repayments of mortgages (4,188) (5,557) Proceeds from secured note financings -- 13,000 Repayments of secured note financings (2,500) (5,500) Proceeds from sales of unsecured notes 7,969 5,385 Repayments of unsecured notes (3,782) (2,758) Costs of obtaining financings (204) (254) Dividends paid - preferred shares of beneficial interest (6,000) (6,000) ------------- ------------- (7,319) 12,476 ------------- ------------- Banking Proceeds from customer deposits and sales of certificates of deposit 24,120,079 20,919,769 Customer withdrawals of deposits and payments for maturing certificates of deposit (24,122,165) (20,739,955) Net increase in securities sold under repurchase agreements (63,623) (138,464) Advances from the Federal Home Loan Bank 3,815,317 3,800,748 Repayments of advances from the Federal Home Loan Bank (4,379,057) (3,652,447) Net increase (decrease) in other borrowings (7,189) (4,842) Cash dividends paid on preferred stock (4,875) (4,875) Cash dividends paid on common stock (10,000) (8,000) Other 23,659 61,968 ------------- ------------- (627,854) 233,902 ------------- ------------- Net cash provided by (used in) financing activities (635,173) 246,378 - ---------------------------------------------------------------------------------------------------------------------------- Net increase in cash and cash equivalents 52,746 49,468 Cash and cash equivalents at beginning of period 423,855 446,362 ------------- ------------- Cash and cash equivalents at end of period $ 476,601 $ 495,830 - ---------------------------------------------------------------------------------------------------------------------------- Components of cash and cash equivalents at end of period as presented in the consolidated balance sheets: Real Estate Cash and cash equivalents $ 16,493 $ 9,870 Banking Cash and other deposits 460,108 352,960 Federal funds sold and securities purchased under agreements to resell -- 133,000 ------------- ------------- Cash and cash equivalents at end of period $ 476,601 $ 495,830 - ---------------------------------------------------------------------------------------------------------------------------- Supplemental disclosures of cash flow information: Cash paid during the year for: Interest (net of amount capitalized) $ 173,262 $ 241,567 Income taxes paid 12,712 109 Shares of Saul Centers, Inc. common stock 4,201 3,852 Cash received during the year from: Dividends on shares of Saul Centers, Inc. common stock 2,406 2,055 Distributions from Saul Holdings Limited Partnership 3,263 3,263 Supplemental disclosures of noncash activities: Rollovers of notes payable - unsecured 2,620 2,079 Loans held for sale exchanged for trading securities 725,037 192,045 Loans receivable transferred to loans held for securitization and sale 924,085 396,529 Loans receivable transferred to real estate acquired in settlement of loans 1,882 376 Loans held for sale transferred to loans receivable 11,406 -- - ---------------------------------------------------------------------------------------------------------------------------- The Notes to Consolidated Financial Statements are an integral part of these statements. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. In the opinion of management, the consolidated financial statements reflect all adjustments necessary for a fair presentation of the Trust's financial position and results of operations. All such adjustments are of a normal recurring nature. These financial statements and the accompanying notes should be read in conjunction with the Trust's audited consolidated financial statements included in its Form 10-K for the fiscal year ended September 30, 2001. The results of operations for interim periods are not necessarily indicative of results to be expected for the year. 2. The accompanying financial statements include the accounts of B.F. Saul Real Estate Investment Trust and its wholly owned subsidiaries (the "Real Estate Trust"), which are involved in the ownership and development of income-producing properties. The accounts of the Trust's 80%-owned banking subsidiary, Chevy Chase Bank, F.S.B., and its subsidiaries ("Chevy Chase" or the "Bank") have also been consolidated. Accordingly, the accompanying financial statements reflect the assets, liabilities, operating results, and cash flows for two business segments: Real Estate and Banking. All significant intercompany transactions, except as disclosed elsewhere on the financial statements, have been eliminated in consolidation. Tax sharing and dividend payments between the Real Estate Trust and the bank are presented gross in the Consolidated Statements of Cash Flows. 3. The Trust voluntarily terminated its qualification as a real estate investment trust under the Internal Revenue Code during fiscal 1978. As a result of the Trust's acquisition of an additional 20% equity interest in the bank in June 1990, the bank became a member of the Trust's affiliated group filing consolidated federal income tax returns. The current effect of the Trust's consolidation of the bank's operations into its federal income tax return results in the use of the Trust's net operating losses and net operating loss carryforwards to reduce the federal income taxes the bank would otherwise owe. 4. BANKING: LOANS HELD FOR SECURITIZATION AND/OR SALE: Loans held for securitization and/or sale is composed of the following: March 31, September 30, 2002 2001 ------------------ ------------------ Single-family residential loans $ 712,670 $ 233,359 Automobile loans 39,562 282,000 Home improvement and related loans 496 12,724 ------------------ ------------------ Total $ 752,728 $ 528,083 ================== ================== LOANS AND LEASES RECEIVABLE: Loans and leases receivable is composed of the following: March 31, September 30, 2002 2001 -------------------- -------------------- Single-family residential $ 3,792,957 $ 4,555,814 Home equity 485,269 372,095 Real estate construction and ground 450,674 472,489 Commercial real estate and multifamily 27,842 30,703 Commercial 1,397,223 1,376,582 Automobile 530,492 361,930 Subprime automobile 317,774 420,658 Automobile leases 1,135,450 1,124,106 Home improvement and related loans 110,380 100,494 Overdraft lines of credit and other consumer 36,961 36,356 -------------------- -------------------- 8,285,022 8,851,227 -------------------- -------------------- Less: Undisbursed portion of loans 860,595 812,325 Unearned discounts and net deferred loan origination costs (47,627) (42,611) Allowance for losses on loans and leases 69,018 63,018 -------------------- -------------------- 881,986 832,732 -------------------- -------------------- Total $ 7,403,036 $ 8,018,495 ==================== ==================== REAL ESTATE HELD FOR INVESTMENT OR SALE: The bank's real estate held for investment is carried at the lower of aggregate cost or net realizable value. The bank's real estate acquired in settlement of loans or real estate owned ("REO") is considered to be held for sale and is carried at the lower of cost or fair value (less estimated selling costs). Real estate held for investment or sale is composed of the following: March 31, September 30, 2002 2001 ------------------- ------------------- Real estate held for investment (net of allowance for losses of $202 for both periods) $ 925 $ 925 Real estate held for sale (net of allowance for losses of $85,266 and $85,152, respectively) 24,084 30,779 ------------------- ------------------- Total real estate held for investment or sale $ 25,009 $ 31,704 =================== =================== ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Trust has prepared its financial statements and other disclosures on a fully consolidated basis. The term "Trust" used in the text and the financial statements included herein refers to the combined entity, which includes B.F. Saul Real Estate Investment Trust and its subsidiaries, including Chevy Chase and Chevy Chase's subsidiaries. "Real Estate Trust" refers to B.F. Saul Real Estate Investment Trust and its subsidiaries, excluding Chevy Chase and Chevy Chase's subsidiaries. The operations conducted by the Real Estate Trust are designated as "Real Estate," while the business conducted by the bank and its subsidiaries is identified by the term "Banking." Recent Developments Regarding Arthur Andersen LLP. On March 14, 2002, our independent public accountant, Arthur Andersen LLP, was indicted on federal obstruction of justice charges arising from the government's investigation of Enron. In light of this and other recent, highly publicized developments concerning Arthur Andersen, the Audit Committee and the Board of Trustees has been monitoring, and will continue to monitor, the engagement of Arthur Andersen and other developments relating to that firm. In addition, it is becoming increasingly likely that in the near future, based on circumstances existing at that time, the Company will elect to appoint an accounting firm other than Arthur Andersen to serve as our independent public accountant for the fiscal year ending September 30, 2002. FINANCIAL CONDITION REAL ESTATE The Real Estate Trust's investment portfolio at March 31, 2002, consisted primarily of hotels, office projects and land parcels. At March 31, 2002 the hotel portfolio included 18 properties containing 3,578 available rooms and the office portfolio consisted of 12 properties containing 1,878,000 square feet of gross leasable area. An additional office property containing 100,000 square feet of gross leasable area was placed in service in April 2002. The Real Estate Trust was directly affected by the terrorist attacks of September 11 because of its concentration of hotels in the Washington, DC metropolitan area, one of the sites of the attacks. Eleven of the Real Estate Trust's eighteen hotels are located in the Washington, DC metropolitan area. In addition, five of these eleven hotels are within minutes from either Washington Reagan National Airport or Dulles International Airport and were more directly affected by the sharp decline in air travel. The two hotels located near Reagan National were especially affected by Reagan National's prolonged closure and limited flight schedule during the first half of fiscal 2002. Consequently, the hotel portfolio experienced an average occupancy rate of 55% and an average room rate of $86.05 during the six-month period ended March 31, 2002, compared to an average occupancy of 64% and an average room rate of $96.14 during the same period in the prior year. For the sixteen hotels owned throughout both periods, the average occupancies were 55% and 65%, and the average rates were $82.72 and $94.41. REVPAR (revenue per available room) for the sixteen hotels was $45.81 for the six-month period ended March 31, 2002, a 25% decrease from REVPAR for the six-month period ended March 31, 2001 of $61.27. The Real Estate Trust has developed strategies to manage its hotel operations through this downturn. The Real Estate Trust has focused on reducing its direct operating expenses related to the hotels and has reduced its hotel capital expenditure budget for 2002. Office space in the Real Estate Trust's office property portfolio was 87% leased at March 31, 2002, compared to leasing rates of 92% and 96% at September 30, 2001 and at March 31, 2001. The decline in leasing rates was primarily due to the Trust placing into service, during December 2001, an 81,000 square foot building that remains unleased. At March 31, 2002, the Real Estate Trust's office property portfolio consisted of 12 properties and had a total gross leasable area of 1.9 million square feet, of which 80,000 square feet (4.3%) and 205,000 square feet (11.0%) are subject to leases whose terms expire in the balance of fiscal 2002 and in fiscal 2003. BANKING General. The bank's assets at the end of the current quarter were $10.8 billion, a decrease of $529.9 million from the last quarter. Total loans and leases decreased $370.6 million during the quarter to $8.2 billion at March 31, 2002. This decrease was primarily due to the securitization and/or sale of $687.4 million of single-family residential loans, which was partially offset by increases in automobile leases, commercial loans and home equity loans. The bank recorded operating income of $31.7 million during the quarter ended March 31, 2002, compared to operating income of $36.8 million in the prior corresponding quarter. Contributing to the decreased income for the current quarter were decreases in net interest income and other (non-interest) income which was partially offset by a decrease in the provision for loan and lease losses. At March 31, 2002, the bank's tangible, core, tier 1 risk-based and total risk-based regulatory capital ratios were 5.91%, 5.91%, 7.28% and 11.14%, respectively. The bank's regulatory capital ratios exceeded the requirements under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 ("FIRREA") as well as the standards established for "well-capitalized" institutions under the prompt corrective action regulations issued pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"). See "Capital." During the quarter ended March 31, 2002, the bank declared and paid out of retained earnings a cash dividend on its Common Stock in the amount of $500 per share. Asset Quality. Non-Performing Assets. The following table sets forth information concerning the bank's non-performing assets. The figures shown are after charge-offs and, in the case of REO, after all valuation allowances. Non-Performing Assets (Dollars in thousands) March 31, December 31, September 30, 2002 2001 2001 ----------------- ------------------ ------------------ Non-performing assets: Non-accrual loans: Residential $ 12,101 $ 11,338 $ 7,314 Real estate construction and ground 527 - - Subprime automobile 9,983 14,816 13,379 Other consumer 5,126 6,882 7,028 ----------------- ------------------ ------------------ Total non-accrual loans (1) 27,737 33,036 27,721 ----------------- ------------------ ------------------ Real estate owned 109,350 115,672 115,931 Allowance for losses on real estate owned (85,266) (86,302) (85,152) ----------------- ------------------ ------------------ Real estate owned, net 24,084 29,370 30,779 ----------------- ------------------ ------------------ Total non-performing assets $ 51,821 $ 62,406 $ 58,500 ================= ================== ================== Allowance for losses on loans and leases $ 69,018 $ 66,018 $ 63,018 Allowance for losses on real estate held for investment 202 202 202 Allowance for losses on real estate owned 85,266 86,302 85,152 ----------------- ------------------ ------------------ Total allowances for losses $ 154,486 $ 152,522 $ 148,372 ================= ================== ================== Ratios: Total non-performing assets to total assets (2) 0.48% 0.55% 0.51% Total allowance for losses to total non-performing assets (1) 112.69% 102.56% 103.29% Allowance for losses on real estate loans to non-accrual real estate loans (1) 61.97% 70.96% 70.86% Allowance for losses on consumer loans and leases to non-accrual consumer loans (1)(3) 290.89% 207.58% 230.55% Allowance for losses on loans and leases to non-accrual loans (1) 248.83% 199.84% 227.33% Allowance for losses on loans and leases to total loans and leases receivable (4) 0.84% 0.77% 0.73% (1) Before deduction of allowances for losses. (2) Total non-performing assets are presented after allowances for losses on real estate held for sale. (3) Includes subprime automobile loans. (4) Includes loans and leases receivable and loans held for sale and/or securitization, before deduction of allowance for losses. Non-performing assets totaled $51.8 million, after valuation allowances on REO of $85.3 million, at March 31, 2002, compared to $62.4 million, after valuation allowances on REO of $86.3 million, at December 31, 2001. In addition to the valuation allowances on REO, the bank maintained $69.0 million and $66.0 million of valuation allowances on its loan and lease portfolio at March 31, 2002 and December 31, 2001, respectively. The $10.6 million decrease in non-performing assets for the current quarter was attributable to a decrease in non-accrual loans of $5.3 million and a net decrease in REO of $5.3 million. See "Non-accrual Loans" and "REO." Non-accrual Loans. The bank's non-accrual loans totaled $27.7 million at March 31, 2002, as compared to $33.0 million at December 31, 2001. At March 31, 2002, non-accrual loans consisted of $12.6 million of non-accrual real estate loans and $15.1 million of non-accrual consumer and other loans, compared to non-accrual real estate loans of $11.3 million and non-accrual consumer and other loans of $21.7 million at December 31, 2001. Total non-accrual consumer loans decreased primarily as a result of decreases of delinquent discontinued subprime automobile loans. REO. At March 31, 2002, the bank's REO totaled $24.1 million, after valuation allowances on those assets of $85.3 million as set forth in the following table. The principal component of REO consists of four planned unit developments (the "Communities"), all of which are under active development. Only commercial ground properties remain in two of the four Communities. Number Balance Before Balance After Percent of Gross Charge- Valuation Valuation Valuation of (Dollars in thousands) Properties Balance Offs Allowances Allowances Allowances Total ------------------------------------------------------------------------------------------- Communities 4 $ 130,295 $ 29,767 $ 100,528 $ 81,535 $ 18,993 78.9% Residential ground 1 100 - 100 100 - - Commercial ground 1 9,754 2,732 7,022 3,631 3,391 14.1% Single-family residential properties 8 1,875 175 1,700 - 1,700 7.0% ------------------------------------------------------------------------------------------- Total REO 14 $ 142,024 $ 32,674 $ 109,350 $ 85,266 $ 24,084 100.0% =========================================================================================== During the three months ended March 31, 2002, REO decreased $5.3 million primarily as a result of sales of $7.4 million and increased provision for losses of $1.1 million. The decrease was partially offset by $2.6 million in lot finishing and infrastructure costs in one of the communities and $0.6 million in other additions to REO. During the three months ended March 31, 2002, the bank received revenues of $8.4 million from the disposition of 30 residential lots or units in the Communities ($1.2 million), approximately 22 acres of commercial land in two of the Communities ($4.2 million), one residential ground property ($2.5 million) and one single-family residential property ($0.5 million). Delinquent Loans. At March 31, 2002, delinquent loans totaled $81.7 million, or 1.0% of loans, compared to $117.5 million, or 1.4% of loans, at December 31, 2001. The following table sets forth information regarding the bank's delinquent loans at March 31, 2002. Principal Balance (Dollars in Thousands) ------------------------------------------------------------------------------ Real Subprime Other Total as a Estate Automobile Consumer Percentage Loans Loans Commercial Loans Total of Loans (1) ----------- ------------- -------------- ------------ ----------- ------------- Loans delinquent for: 30-59 days... $ 7,736 $ 37,855 $ 5,850 $ 11,792 $63,233 0.8% 60-89 days.... 4,132 11,000 - 3,290 18,422 0.2% ------------- ------------- ------------- -------------- ------------ ----------- Total........... $ 11,868 $ 48,855 $ 5,850 $ 15,082 $81,655 1.0% ============= ============= ============== ============ =========== ============= - -------------------------- (1) Includes loans held for sale and/or securitization, before deduction of valuation allowances, unearned premiums and discounts and deferred loan origination fees (costs). Real estate loans classified as delinquent 30-89 days consists entirely of single-family residential mortgage loans and home equity loans. Total delinquent real estate loans decreased to $11.9 million at March 31, 2002, from $18.8 million at December 31, 2001, when delinquencies are at their traditional season high. Delinquent subprime automobile loans decreased to $48.9 million at March 31, 2002, from $76.8 million at December 31, 2001, primarily because delinquencies are at their traditional season high in the December quarter and the bank's portfolio of these discontinued loans continues to decline as a result of the bank's prior decision to discontinue origination of these loans. Commercial loans classified as delinquent 30-89 days consisted of 20 loans totaling $5.9 million at March 31, 2002. There were no delinquent commercial loans at December 31, 2001. The increase in delinquencies reflect general economic conditions. Other consumer loans delinquent 30-89 days decreased to $15.1 million at March 31, 2002, from $21.9 million at December 31, 2001, when the delinquencies are at their traditional seasonal high. Troubled Debt Restructurings. At March 31, 2002 and December 31, 2001, the bank had no troubled debt restructurings. Real Estate Held for Investment. At March 31, 2002 and December 31, 2001, real estate held for investment consisted of one property with book value of $1.1 million, before valuation allowances of $0.2 million. Allowances for Losses. The following tables show loss experience by asset type and the components of the allowance for losses on loans and leases and the allowance for losses on real estate held for investment or sale. These tables reflect charge-offs taken against assets during the periods indicated and may include charge-offs taken against assets, which the bank disposed of during such periods. Analysis of Allowance for and Chargeoffs of Loans and Leases (Dollars in thousands) Six Months Ended Three Months March 31, Ended --------------------------------- March 31, 2002 2001 2002 --------------- ---------------- --------------- Balance at beginning of period $ 63,018 $ 54,018 $ 66,018 --------------- ---------------- --------------- Provision for loan and lease losses 32,896 33,939 14,976 --------------- ---------------- --------------- Chargeoffs: Single-family residential and home equity (484) (381) (276) Subprime automobile (22,527) (26,555) (10,078) Other (10,107) (8,191) (4,898) --------------- ---------------- --------------- Total chargeoffs (33,118) (35,127) (15,252) --------------- ---------------- --------------- Recoveries: Single-family residential and home equity 44 38 9 Subprime automobile 4,896 3,127 2,545 Other 1,282 1,023 722 --------------- ---------------- --------------- Total recoveries 6,222 4,188 3,276 --------------- ---------------- --------------- Chargeoffs, net of recoveries (26,896) (30,939) (11,976) --------------- ---------------- --------------- Balance at end of period $ 69,018 $ 57,018 $ 69,018 =============== ================ =============== Provision for loan and lease losses to average loans and leases (1) (2) 0.78% 0.79% 0.72% Net loan and lease chargeoffs to average loans and leases (1) (2) 0.64% 0.72% 0.57% Ending allowance for losses on loans and leases to total loans and leases (2) (3) 0.84% 0.65% 0.84% (1) Annualized. (2) Includes loans held for sale and/or securitization. (3) Before deduction of allowance for losses. Components of Allowance for Losses on Loans and Leases by Type (Dollars in thousands) March 31, ---------------------------------------------------------- September 30, 2002 2001 2001 ---------------------------- --------------------------- ---------------------------- Percent of Percent of Percent of Loans to Loans to Loans to Amount Total Loans Amount Total Loans Amount Total Loans ------------- ------------- ------------- ------------- ------------- ------------- Balance at end of period allocated to: Single-family residential $ 2,485 55.1 % $ 2,686 60.7 % $ 2,686 55.9 % Home equity 539 5.9 447 3.5 448 4.4 Commercial real estate and multifamily 160 0.3 1,394 0.4 197 0.4 Real estate construction and ground 4,641 3.0 4,141 4.9 1,852 3.1 Commercial 10,516 9.1 9,021 6.2 9,135 9.0 Automobile 3,780 7.0 9,034 8.2 7,034 7.5 Automobile leases 5,866 13.9 2,500 8.4 6,000 13.1 Subprime automobile 32,000 3.9 25,782 6.2 32,000 4.9 Home improvement and related loans 1,694 1.4 1,523 1.1 1,523 1.3 Overdraft lines of credit and other consumer 610 0.4 490 0.4 491 0.4 Unallocated 6,727 - - - 1,652 - ------------- ------------- ------------- Total $ 69,018 $ 57,018 $ 63,018 ============= ============= ============= Real Estate Held for Investment or Sale (Dollars in thousands) Activity in Allowance for Losses Six Months Ended Three Months March 31, Ended ---------------------------------- March 31, 2002 2001 2002 --------------- ---------------- ------------------- Balance at beginning of period: Real estate held for investment $ 202 $ 202 $ 202 Real estate held for sale 85,152 80,752 86,302 --------------- ---------------- ------------------- Total 85,354 80,954 86,504 --------------- ---------------- ------------------- Provision for real estate losses: Real estate held for sale 2,100 2,100 1,050 --------------- ---------------- ------------------- Total 2,100 2,100 1,050 --------------- ---------------- ------------------- Chargeoffs, net of recoveries: Real estate held for sale: Communities (1,986) (41) (2,086) --------------- ---------------- ------------------- Total net chargeoffs (1,986) (41) (2,086) --------------- ---------------- ------------------- Balance at end of period: Real estate held for investment 202 202 202 Real estate held for sale 85,266 82,811 85,266 --------------- ---------------- ------------------- Total $ 85,468 $ 83,013 $ 85,468 =============== ================ =================== Components of Allowance for Losses March 31, December 31, September 30, 2002 2001 2001 --------------- ---------------- ------------------- Allowance for losses on real estate held for investment $ 202 $ 202 $ 202 --------------- ---------------- ------------------- Allowance for losses on real estate held for sale: Residential ground 100 1,689 1,689 Commercial ground 3,631 3,631 3,631 Communities 81,535 80,982 79,832 --------------- ---------------- ------------------- Total 85,266 86,302 85,152 --------------- ---------------- ------------------- Total allowance for losses on real estate held for investment or sale $ 85,468 $ 86,504 $ 85,354 =============== ================ =================== At March 31, 2002, the bank's total valuation allowances for losses on loans and leases and real estate held for investment or sale was $154.5 million, an increase of $2.0 million from December 31, 2001. Management reviews the adequacy of the valuation allowances on loans and leases and real estate using a variety of measures and tools including historical loss performance, delinquency status, internal risk ratings, current economic conditions and current underwriting policies and procedures. Using this analysis, management determines a range of acceptable valuation allowances. Management believes that the overall level of the allowance is appropriate. The allowance for losses on loans secured by real estate and real estate held for investment or sale totaled $93.3 million at March 31, 2002, which constituted 76.5% of total non-performing real estate assets, before valuation allowances. During the three months ended March 31, 2002, the bank recorded net charge-offs of $2.4 million on these assets. The allowance for losses on real estate held for sale at March 31, 2002 is in addition to approximately $32.7 million of cumulative charge-offs previously taken against assets remaining in the bank's portfolio at March 31, 2002. At March 31, 2002 and December 31, 2001, the combined allowance for losses on consumer loans and leases, including automobile, subprime automobile, home improvement and related loans, overdraft lines of credit and other consumer loans was $44.0 million and $45.0 million, respectively. The decline in the allowance for losses on consumer loans and leases is primarily attributable to declining loan balances following recent automobile securitizations and sales. Net chargeoffs of consumer and other loans totaled $11.7 million for the three months ended March 31, 2002, compared to $14.7 million for the three months ended December 31, 2001. The decline in net chargeoffs is attributable to declining subprime automobile loan balances coupled with decreased delinquencies following December's traditional seasonal high. Asset and Liability Management. The following table presents the interest rate sensitivity of the bank's interest-earning assets and interest-bearing liabilities at March 31, 2002, which reflects loan amortization and management's estimate of loan prepayments. Variable rate loans are assumed to mature in the period in which their interest rates are next scheduled to adjust. Prepayment rates for the bank's loans are based on recent actual and market experience. Statement savings accounts with balances under $20,000 are classified based upon management's assumed attrition rate of 17.5%, and those with balances of $20,000 or more, as well as all NOW accounts, are assumed to be subject to repricing within six months or less. Interest Rate Sensitivity Table (Gap) (Dollars in thousands) More than More than More than Six Months One Year Three Years Six Months through through through More than or Less One Year Three Years Five Years Five Years Total --------------- -------------- ---------------- --------------- -------------- ------------ As of March 31, 2002 Real estate loans: Adjustable-rate $ 1,964,808 $ 265,386 $ 423,070 $ 182,418 $ 142,303 $ 2,977,985 Fixed-rate 94,577 72,836 237,099 171,534 479,393 1,055,439 Home equity credit lines and second mortgages 502,170 3,143 11,032 8,840 38,963 564,148 Commercial 581,530 21,700 68,688 46,084 25,943 743,945 Consumer and other 411,077 349,602 1,018,778 267,285 83,795 2,130,537 Loans held for sale 252,728 - - - - 252,728 Loans held for securitization and sale 500,000 - - - - 500,000 Mortgage-backed securities 208,889 144,573 232,252 168,021 465,704 1,219,439 Trading securities 7,412 - - - - 7,412 Other investments 293,989 - 46,427 - - 340,416 --------------- -------------- ---------------- --------------- -------------- ------------ Total interest-earning assets 4,817,180 857,240 2,037,346 844,182 1,236,101 9,792,049 Total non-interest earning assets - - - - 978,298 978,298 --------------- -------------- ---------------- --------------- -------------- ------------ Total assets $ 4,817,180 $ 857,240 $ 2,037,346 $ 844,182 $ 2,214,399 $ 10,770,347 =============== ============== ================ =============== ============== ============ Deposits: Fixed maturity deposits $ 1,654,381 $ 467,977 $ 181,304 $ 57,618 $ - $ 2,361,280 NOW and statement accounts 2,099,843 46,399 154,538 105,183 224,157 2,630,120 Money market deposit accounts 1,858,174 - - - - 1,858,174 Borrowings: Capital notes - subordinated - - - 150,000 100,000 250,000 Other 287,986 1,299 1,478,851 22,412 98,081 1,888,629 --------------- -------------- ---------------- --------------- -------------- ------------ Total interest-bearing liabilities 5,900,384 515,675 1,814,693 335,213 422,238 8,988,203 Minority interest - - - - 144,000 144,000 Total non-interest bearing liabilities - - - - 1,095,155 1,095,155 Stockholders' equity - - - - 542,989 542,989 --------------- -------------- ---------------- --------------- -------------- ------------ Total liabilities and stockholders' equity $ 5,900,384 $ 515,675 $ 1,814,693 $ 335,213 $ 2,204,382 $ 10,770,347 =============== ============== ================ =============== ============== ============ Gap $ (1,083,204) $ 341,565 $ 222,653 $ 508,969 $ 813,863 Cumulative gap $ (1,083,204) $ (741,639) $ (518,986) $ (10,017) $ 803,846 Adjusted cumulative gap as a percentage of total assets (10.1)% (6.9)% (4.8)% (0.1)% 7.5 % The interest sensitivity "gap" shown in the table represents the sum of all interest-earning assets minus all interest-bearing liabilities subject to repricing within the same period. The one-year gap, as a percentage of total assets, was a negative 6.9% at March 31, 2002, compared to a negative 9.4% at December 31, 2001. The improvement in the bank's one year gap during this period results from various initiatives undertaken by management in light of the current interest rate environment, including increased origination of short-term adjustable rate mortgage loans. The bank continues to consider a variety of strategies to manage its interest rate risk position. Capital. At March 31, 2002, the bank was in compliance with all of its regulatory capital requirements under FIRREA, and its capital ratios exceeded the ratios established for "well-capitalized" institutions under OTS prompt corrective action regulations. The following table shows the bank's regulatory capital levels at March 31, 2002, in relation to the regulatory requirements in effect at that date. The information below is based upon the bank's understanding of the regulations and interpretations currently in effect and may be subject to change. Regulatory Capital (Dollars in thousands) Minimum Excess Actual Capital Requirement Capital --------------------------- --------------------------- -------------------------- As a % As a % As a % Amount of Assets Amount of Assets Amount of Assets -------------- ---------- --------------- ---------- --------------- --------- Stockholders' equity per financial statements $ 542,989 Minority interest in REIT Subsidiary (1) 144,000 Accumulated other comprehensive income (2) (977) -------------- 686,012 Adjustments for tangible and core capital: Intangible assets (46,038) Non-includable subsidiaries (3) (1,411) Non-qualifying purchased/originated loan servicing rights (4,625) -------------- Total tangible capital 633,938 5.91% $ 161,034 1.50% $ 472,904 4.41% -------------- ========== =============== ========== =============== ========= Total core capital (4) 633,938 5.91% $ 429,424 4.00% $ 204,514 1.91% -------------- ========== =============== ========== =============== ========= Tier 1 risk-based capital (4) 633,938 7.28% $ 316,969 4.00% $ 316,969 3.28% -------------- ========== =============== ========== =============== ========= Adjustments for total risk-based capital: Subordinated capital debentures 250,000 Allowance for general loan and lease losses 69,018 -------------- Total supplementary capital 319,018 -------------- Total risk-based capital (4) $ 952,956 11.14% $ 696,613 8.00% $ 256,343 3.14% ============== ========== =============== ========== =============== ========= (1) Eligible for inclusion in core capital in an amount up to 25% of the Bank's core capital pursuant to authorization from the OTS. (2) Under OTS policy, accumulated other comprehensive income is excluded from regulatory capital. (3) Reflects an aggregate offset of $0.2 million representing the allowance for general loan losses maintained against the Bank's equity investments and non-includable subsidiaries which, pursuant to OTS guidelines, is available as a "credit" against the deductions from capital otherwise required for such investments. (4) Under the OTS "prompt corrective action" regulations, the standards for classification as "well capitalized" are a leverage (or "core capital") ratio of at least 5.0%, a tier 1 risk-based capital ratio of at least 6.0% and a total risk-based capital ratio of at least 10.0%. OTS capital regulations provide a five-year holding period (or such longer period as may be approved by the OTS) for REO to qualify for an exception from treatment as an equity investment. If an REO property is considered an equity investment, its then-current book value is deducted from total risk-based capital. The following table sets forth the bank's REO at March 31, 2002, after valuation allowances of $85.3 million, by the fiscal year in which the property was acquired through foreclosure. Fiscal Year (In thousands) ----------- ------------------ 1990 $ 160 (1) 1991 18,833 (1) 1992 - 1993 - 1994 - 1995 3,391 (1) 1996 - 1997 - 1998 - 1999 - 2000 - 2001 504 2002 1,196 ----------------- Total REO $ 24,084 ================= - ----------------------- (1) Includes REO, with an aggregate net book value of $22.4 million, for which the bank received an extension of the holding periods through December 19, 2002. Although the bank stopped originating subprime automobile loans in November 2000, the bank's subprime automobile loan portfolio at March 31, 2002 exceeded 25% of its Tier 1 capital. As a result, the bank remains potentially subject to the OTS guidance for subprime lending, including increased capital requirements of 1 1/2 to 3 times the amount required for non-subprime assets of the same type. LIQUIDITY AND CAPITAL RESOURCES REAL ESTATE The Real Estate Trust's cash flows from operating activities have been historically insufficient to meet all of its cash flow requirements. The Real Estate Trust's internal sources of funds, primarily cash flow generated by its income-producing properties, generally have been sufficient to meet its cash needs other than the repayment of principal on outstanding debt, including outstanding unsecured notes sold to the public, the payment of interest on its indebtedness, and the payment of capital improvement costs. In the past, the Real Estate Trust funded such shortfalls through a combination of external funding sources, primarily new financings, the sale of unsecured notes, refinancing of maturing mortgage debt, proceeds from asset sales, and dividends and tax sharing payments from the bank. For the foreseeable future, the Real Estate Trust's ability to generate positive cash flow from operating activities and to meet its liquidity needs, including debt service payments, repayment of debt principal and capital expenditures, will continue to depend on these available external sources. Dividends received from the bank are a component of funding sources available to the Real Estate Trust. The availability and amount of dividends in future periods is dependent upon, among other things, the bank's operating performance and income, and regulatory restrictions on such payments. The Real Estate Trust believes that the financial condition and operating results of the bank in recent periods should enhance prospects for the Real Estate Trust to receive tax sharing payments and dividends from the bank. During the six-month period ended March 31, 2002, the bank made tax sharing payments totaling $4.9 million and dividend payments totaling $8.0 million to the Real Estate Trust. Tax sharing and dividend payments received by the Real Estate Trust are presented as cash flows from operating activities in the Consolidated Statements of Cash Flows. In recent years, the operations of the trust have generated net operating losses while the bank has reported net income. It is anticipated that the Trust's consolidation of the bank's operations into the Trust's federal income tax return will result in the use of the Trust's net operating losses to reduce the federal income taxes the bank would otherwise owe. If in any future year, the bank has taxable losses or unused credits, the Trust would be obligated to reimburse the bank for the greater of (i) the tax benefit to the group using such tax losses or unused tax credits in the group's consolidated federal income tax returns or (ii) the amount of the refund which the bank would otherwise have been able to claim if it were not being included in the consolidated federal income tax return of the group. During the six-month period ended March 31, 2002, the Trust purchased through dividend reinvestment 216,000 shares of common stock of Saul Centers and as of March 31, 2002, owned approximately 3,245,000 shares representing 22.1% of such company's outstanding common stock. As of March 31, 2002, the market value of these shares was approximately $72.0 million. Substantially all these shares have been pledged as collateral with the Real Estate Trust's credit line bank. As the owner, directly and through two wholly-owned subsidiaries, of a limited partnership interest in Saul Holdings Limited Partnership ("Saul Holdings Partnership") the Real Estate Trust shares in cash distributions from operations and from capital transactions involving the sales of properties. The partnership agreement of Saul Holdings Partnership provides for quarterly cash distributions to the partners out of net cash flow. During the six-month period ended March 31, 2002, the Real Estate Trust received total cash distributions of $3.3 million from Saul Holdings Partnership. Substantially all of the Real Estate Trust's ownership interest in Saul Holdings Partnership has been pledged as collateral with the Real Estate Trust's lines of credit banks. In March 1998, the Real Estate Trust issued $200.0 million aggregate principal amount of 9 3/4% Senior Secured Notes due 2008 (the "1998 Notes"). After providing for the retirement of $175.0 million aggregate principal amount of 11 5/8% Senior Secured Notes issued in 1994 (the "1994 Notes"), including a prepayment premium of $10.0 million and debt issuance costs of approximately $5.9 million, the Real Estate Trust realized approximately $9.1 million in new funds. In addition, the Real Estate Trust received about $13.2 million in cash which had been held as additional collateral by the indenture agent under the 1994 Notes. The 1998 Notes are secured by a first priority perfected security interest in 8,000 shares or 80% of the issued and outstanding common stock of the bank, which constitute all of the bank common stock held by the Real Estate Trust. The 1998 Notes are nonrecourse obligations of the Real Estate Trust. The Real Estate Trust is currently selling unsecured notes, with a maturity ranging from one to ten years, primarily to provide funds to repay maturing unsecured notes. To the degree that the Real Estate Trust does not sell new unsecured notes in an amount sufficient to finance completely the scheduled repayment of outstanding unsecured notes as they mature, it will finance such repayments from other sources of funds. In fiscal 1995, the Real Estate Trust established a $15.0 million secured revolving credit line with an unrelated bank. This facility was for an initial two-year period subject to extension for one or more additional one-year terms. In fiscal 1997, the facility was increased to $20.0 million and was renewed for an additional two-year period. In September 1999, this facility was increased to $50.0 million and its term was set at three years with provisions for extending the term annually. The current maturity date is September 29, 2002. This facility is secured by a portion of the Real Estate Trust's ownership in Saul Holdings Partnership and Saul Centers. Interest is computed by reference to a floating rate index. At March 31, 2002, the Real Estate Trust had no outstanding borrowings under the facility and unrestricted availability was $50.0 million. In fiscal 1996, the Real Estate Trust established an $8.0 million revolving credit line with an unrelated bank, secured by a portion of the Real Estate Trust's ownership interest in Saul Holdings Partnership. This facility was initially for a one-year term, after which any outstanding loan amount would amortize over a two-year period. During fiscal 1997, the line of credit was increased to $10.0 million and was extended for a year. During fiscal 1998, the credit was increased to $20.0 million and was extended for an additional year. In July 2000, the line of credit was further increased to $25.0 million. The current maturity date for this line is July 31, 2002. Interest is computed by reference to a floating rate index. At March 31,2002, the Real Estate Trust had no outstanding borrowings under this facility and unrestricted availability was $25.0 million. The maturity schedule for the Real Estate Trust's outstanding debt at March 31, 2002 for the balance of fiscal 2002 and subsequent years is set forth in the following table: Debt Maturity Schedule (In thousands) - ------------------------------------------------------------------- Fiscal Mortgage Notes Payable- Notes Payable- Year Notes Secured Unsecured Total - ------------------------------------------------------------------- 2002(1) $29,309 $ --- $ 4,260 $ 33,569 2003 27,940 --- 11,919 39,859 2004 9,009 --- 11,617 20,626 2005 13,651 --- 9,659 23,310 2006 94,406 --- 5,714 100,120 Thereafter 148,633 200,000 11,735 360,368 - ------------------------------------------------------------------- Total $322,948 $200,000 $ 54,904 $577,852 =================================================================== (1) April 1,2002 - September 30,2002 Of the $323.0 million of mortgage debt outstanding at March 31, 2002, $294.2 million was nonrecourse to the Real Estate Trust. DEVELOPMENT AND CAPITAL EXPENDITURES On June 29, 2000, the Real Estate Trust purchased a 6.17 acre site in the Loudoun Tech Center, a 246-acre business park located in Loudoun County, Virginia, for $1.1 million. The site was purchased for the purpose of developing an 81,000 square foot office/flex building to be known as Loudoun Tech Phase I. The cost of development was $8.4 million and was financed by a $7.4 million construction loan, which has a five-year term, a floating interest rate and one two-year renewal option. Construction of the base building was completed in December 2000, and the building was placed in service during December 2001. No leases have been signed as yet for space in the building. During the quarter ended September 30, 2000, the Real Estate Trust began the development of a 100,000 square foot office/flex building located on an 8.3 acre site in Dulles North Corporate Park near other Real Estate Trust projects. The new building is known as Dulles North Building Four. Development costs are projected to be $10.8 million and are being financed with the proceeds of a $9.5 million construction loan, which has a three-year term, a floating interest rate and two one-year renewal options. Construction of the base building is completed and the building was placed in service in April 2002. The Real Estate Trust has negotiated a lease with a tenant for the entire building and occupancy is expected during the third quarter of fiscal 2002. The Real Estate Trust believes that the capital improvement costs for its income-producing properties will be in the range of $8.0 to $13.0 million per year for the next several years. BANKING Liquidity. The bank's average liquidity ratio for the quarter ended March 31, 2002, was 8.4%, compared to 9.1% for the quarter ended December 31, 2001. As part of its mortgage banking activities, the bank sold $687.4 million of single-family residential loans during the current quarter. As part of its operating strategy, the bank continues to explore opportunities to sell assets and to securitize and sell various loan receivables to meet liquidity and other balance sheet objectives. The bank is obligated under various recourse provisions (primarily related to credit losses) related to the securitization and sale of loan receivables. As a result of these recourse provisions, the bank maintained restricted cash accounts and overcollateralization of receivables amounting to $21.4 million and $28.0 million, respectively, at March 31, 2002, and $26.0 million and $29.6 million, respectively, at December 31, 2001, both of which are included in other assets in the Consolidated Balance Sheets. The bank also is obligated under various recourse provisions related to the swap of single family residential loans for mortgage-backed securities issued by the bank. At March 31, 2002, recourse to the bank under these arrangements was $6.1 million, consisting of restricted cash accounts of $3.7 million and overcollateralization of receivables of $2.4 million. The bank also is obligated under a recourse provision related to the servicing of certain of its residential mortgage loans. At March 31, 2002 and December 31, 2001, recourse to the bank under this arrangement totaled $3.4 million. There were no material commitments for capital expenditures at March 31, 2002. The bank's liquidity requirements in fiscal 2002, and for years subsequent to fiscal 2002, will continue to be affected both by the asset size of the bank, the growth of which will be constrained by capital requirements, and the composition of the asset portfolio. Management believes that the bank's primary sources of funds will be sufficient to meet the bank's foreseeable long-term liquidity needs. The mix of funding sources utilized from time to time will be determined by a number of factors, including capital planning objectives, lending and investment strategies and market conditions. RESULTS OF OPERATIONS THREE MONTHS ENDED MARCH 31, 2002 (the "2002 quarter") COMPARED TO THREE MONTHS ENDED MARCH 31, 2001 (the "2001 quarter") REAL ESTATE The Real Estate Trust recorded income before depreciation and amortization of $602,000 and an operating loss of $4.2 million in the 2002 quarter compared to income before depreciation and amortization of $3.6 million and an operating loss of $804,000 in the 2001 quarter. The increase in the operating loss was largely attributable to declining results from operations of income-producing properties. Income after direct operating expenses from hotel properties decreased $3,242,000 (33.9%)in the 2002 quarter over the level achieved in the 2001 quarter. This decrease was attributable to a decrease of $366,000 from two acquisition properties while results from sixteen properties owned throughout both quarters decreased by $2,875,000 (35.7%). The decrease in total revenue of $5,159,000 (20.2%) was partially offset by the decrease of $1,917,000 (12.0%) in direct operating expenses. For the sixteen hotels owned throughout both periods, the decrease in total revenue was $4,774,000 (21%) and the decrease in direct operating expenses was $1,899,000 (12.9%). Income after direct operating expenses from office and industrial properties decreased $807,000 (10.5%) in the 2002 quarter compared to such income in the 2001 quarter. $534,000 (7.6%) of this decrease reflected lower results from the ten properties owned throughout both quarters and $272,000 reflected lower results caused by a property no longer in the portfolio and two acquisition properties. The decrease in total revenue of $830,000 (7.9%) with an increase was offset slightly by the decrease of $24,000 (0.9%) in direct operating expenses. For the ten properties owned throughout both periods, the decrease in total revenue was $464,000 (4.9%) with an increase in direct operating expenses of $69,000 (2.7%). Additionally the 2001 quarter reflected $369,000 in total revenue and $158,000 in direct expenses from a property which was sold in the latter part of fiscal 2001. Other income decreased $118,000 (24.2%) during the 2002 quarter due principally to lower interest income. Land parcels and other expense decreased $34,000 (12.6%) during the 2002 quarter. Interest expense decreased $176,000 (1.4%) in the 2002 quarter, primarily because of lower mortgage interest and lower interest on bank lines of credit. The average balance of the Real Estate Trust's outstanding borrowings increased to $578.1 million for the 2002 quarter from $562.5 million for the 2001 quarter. The increase in average borrowings was the result of mortgage loan refinancings and unsecured note sales. The weighted average cost of borrowings was 8.9% in the 2002 quarter compared to 9.4% in the 2001 quarter. Capitalized interest increased $79,000 (78.0%) during the 2002 quarter due to greater level of development activity in the current period. Amortization of debt expense decreased $29,000 (12.8%) in the 2001 quarter. Depreciation increased $450,000 (10.8%) in the 2002 quarter as a result of the addition new properties and new assets placed in service in the past year. Advisory, management and leasing fees paid to related parties increased $30,000 (1.0%) in the 2002 quarter from their expense level in the 2001 quarter. The monthly advisory fee in the 2002 quarter was $475,000 compared to $363,000 in the 2001 quarter, which resulted in an aggregate increase of $337,000. Management fees decreased $307,000 (16.1%) in the current quarter, reflecting both lower hotel sales and office rents on which the fees are based. General and administrative expense increased $97,000 (24.0%) in the 2002 quarter, principally as a result of higher legal expense in the current period. Equity on earnings of unconsolidated entities reflected earnings of $3,140,000 in the 2002 quarter, an increase of $1,026,000 (48.5%) over the amount recorded in the 2001 quarter. The improvement was due to increased period-to-period earnings of Saul Centers, Inc. BANKING Overview. The bank recorded operating income of $31.7 million for the 2002 quarter compared to operating income of $36.8 million for the 2001 quarter. Net interest income and other (non-interest) income decreased in the 2002 quarter, but the decrease was partially offset by a decrease in the provision for loan and lease losses. Net Interest Income. Net interest income, before the provision for loan and lease losses, decreased $5.5 million (or 6.1%) in the 2002 quarter compared to the 2001 quarter. There was no interest income recorded during the 2002 quarter on non-accrual assets and restructured loans. The bank would have recorded interest income of $0.9 million for the 2002 quarter if non-accrual assets and restructured loans had been current in accordance with their original terms. The bank's net interest income in future periods will continue to be adversely affected by the bank's non-performing assets. See "Financial Condition - Asset Quality - Non-Performing Assets." The following table sets forth, for the periods indicated, information regarding the total amount of income from interest-earning assets and the resulting yields, the interest expense associated with interest-bearing liabilities, expressed in dollars and rates, and the net interest spread and net yield on interest-earning assets. Net Interest Margin Analysis (Dollars in thousands) Three Months Ended March 31, -------------------------------------------------------------------------------------- 2002 2001 ------------------------------------------ ------------------------------------------ Average Yield/ Average Yield/ Balances Interest Rate Balances Interest Rate ------------- ----------- ----------- -------------- ----------- ----------- Assets: Interest-earning assets: Loans and leases receivable, net (1) $ 8,358,056 $ 132,777 6.35 % $ 8,781,294 $ 181,001 8.24 % Mortgage-backed securities 1,261,895 19,010 6.03 925,616 14,944 6.46 Federal funds sold and securities purchased under agreements to resell 63,992 283 1.77 56,360 774 5.49 Trading securities 58,852 1,037 7.05 21,050 372 7.07 Investment securities 46,319 384 3.32 45,678 683 5.98 Other interest-earning assets 207,114 1,667 3.22 193,440 3,257 6.73 ------------- ----------- -------------- ----------- Total 9,996,228 155,158 6.21 10,023,438 201,031 8.02 ----------- ----------- ----------- ----------- Noninterest-earning assets: Cash 210,336 260,092 Real estate held for investment or sale 30,371 48,963 Property and equipment, net 454,917 383,291 Goodwill and other intangible assets, net 26,271 25,972 Other assets 309,605 298,144 ------------- -------------- Total assets $ 11,027,728 $ 11,039,900 ============= ============== Liabilities and stockholders' equity: Interest-bearing liabilities: Deposit accounts: Demand deposits $ 1,500,238 1,109 0.30 $ 1,284,814 2,116 0.66 Savings deposits 946,598 2,289 0.97 871,662 3,563 1.64 Time deposits 2,489,490 26,974 4.33 2,981,473 45,955 6.17 Money market deposits 1,784,169 7,714 1.73 1,337,221 13,108 3.92 ------------- --------- -------------- --------- Total deposits 6,720,495 38,086 2.27 6,475,170 64,742 4.00 Borrowings 2,623,237 31,383 4.79 3,057,580 45,057 5.89 ------------- ----------- -------------- ----------- Total liabilities 9,343,732 69,469 2.97 9,532,750 109,799 4.61 ----------- ----------- ----------- ----------- Noninterest-bearing items: Noninterest-bearing deposits 821,223 654,798 Other liabilities 200,647 231,955 Minority interest 144,000 144,000 Stockholders' equity 518,126 476,397 ------------- -------------- Total liabilities and stockholders' equity $ 11,027,728 $ 11,039,900 ============= ============== Net interest income $ 85,689 $ 91,232 =========== =========== Net interest spread (2) 3.23 % 3.42 % =========== =========== Net yield on interest-earning assets (3) 3.43 % 3.64 % =========== =========== Interest-earning assets to interest-bearing liabilities 106.98 % 105.15 % =========== =========== - --------------------------------------------------------------------------------------------------------------------------------- (1) Includes loans held for sale and/or securitization. Interest on non-accruing loans has been included only to the extent reflected in the Consolidated Statements of Operations; however, the loan balance is included in the average amount outstanding until transferred to real estate acquired in settlement of loans. (2) Equals weighted average yield on total interest-earning assets less weighted average rate on total interest-bearing liabilities. (3) Equals annualized net interest income divided by the average balances of total interest-earning assets. The following table presents certain information regarding changes in interest income and interest expense of the bank during the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to changes in volume (change in volume multiplied by old rate); changes in rate (change in rate multiplied by old volume); and changes in rate and volume. Volume and Rate Changes in Net Interest Income (Dollars in thousands) Three Months Ended March 31, 2002 Compared to Three Months Ended March 31, 2001 Increase (Decrease) Due to Change in (1) ------------------------------------------------------ Total Volume Rate Change --------------- --------------- --------------- Interest income: Loans (2) $ (8,374) $ (39,850) $ (48,224) Mortgage-backed securities 10,164 (6,098) 4,066 Federal funds sold and securities purchased under agreements to resell 617 (1,108) (491) Trading securities 672 (7) 665 Investment securities 65 (364) (299) Other interest-earning assets 1,431 (3,021) (1,590) --------------- --------------- --------------- Total interest income 4,575 (50,448) (45,873) --------------- --------------- --------------- Interest expense: Deposit accounts 15,898 (42,554) (26,656) Borrowings (5,907) (7,767) (13,674) --------------- --------------- --------------- Total interest expense 9,991 (50,321) (40,330) --------------- --------------- --------------- Increase in net interest income $ (5,416) $ (127) $ (5,543) =============== =============== =============== - ---------------------------------------------------------------------------------------------------------------- (1) The net change attributable to the combined impact of volume and rate has been allocated in proportion to the absolute value of the change due to volume and the change due to rate. (2) Includes loans held for sale and/or securitization. Interest income in the 2002 quarter decreased $45.9 million (22.8%) from the level in the 2001 quarter as a result of lower average yields, particularly on loans and leases, coupled with a $423.2 million decline in average balances of loans and leases. A $336.3 million increase in the average balance of mortgage-backed securities partially offset the decrease in interest income. The bank's net interest spread decreased to 3.23% in the 2002 quarter, from 3.42% in the 2001 quarter, primarily because the average yield of the bank's interest-earning assets decreased more than the average cost of its interest-bearing liabilities. Average interest-earning assets as a percentage of average interest bearing liabilities increased to 107.0% for the 2002 quarter, compared to 105.2% for the 2001 quarter. Interest income on loans and leases, the largest category of interest-earning assets, decreased $48.2 million from the 2001 quarter primarily because of lower average yields. The average yield on the loan and lease portfolio decreased 189 basis points (from 8.24% to 6.35%) from the 2001 quarter. Interest income declined by $24.7 million (or 27.0%) on single-family residential loans, and by $15.2 million (or 25.8%) on automobile loans, primarily because of lower average yields on those loans. In addition, lower average yields on commercial loans and home equity loans contributed to decreases in terest income of $3.7 million (or 29.1%) and $1.9 million (or 27.2%), respectively, from those loans. Partially offsetting the decrease in interest income were increases in the average balances of home equity loans, commercial loans and home improvement loans. Interest income on mortgage-backed securities increased $4.1 million (or 27.2%) primarily because of higher average balances. The effect of the $336.3 million increase in average balances was partially offset by a decrease in the average interest rates on those securities from 6.46% to 6.03%. Interest expense on deposits decreased $26.7 million (or 41.2%) during the 2002 quarter, due to a decrease in average rates. The 173 basis point decrease in the average rate on deposits (from 4.00% to 2.27%) resulted from a general decline in market interest rates. The bank also reduced its use of higher cost brokered deposits in the 2002 quarter compared to the 2001 quarter. Interest expense on borrowings decreased $13.7 million (or 30.3%) in the 2002 quarter from the 2001 quarter. The bank used funds from deposit growth to repay borrowings. Average balances of Federal Home Loan Bank advances decreased by $391.1 million, or 17.6%, and the average interest rate on such advances decreased (from 5.59% to 5.12%), resulting in a reduction of $7.6 million in interest expense. Also contributing to the decrease in interest expense on borrowings was a decrease in the average cost of securities sold under repurchase agreements (from 5.94% to 1.82%) and a decrease in the average balance of those agreements of $51.2 million (or 12.1%), which, combined, resulted in a $4.6 million decrease in interest expense. Provision for Loan and Lease Losses. The bank's provision for loan and lease losses decreased to $15.0 million in the 2002 quarter from $18.0 million in the 2001 quarter. The $3.0 million decrease is largely attributable to decreased charge-offs due to the declining balance of the subprime automobile loan portfolio. See "Financial Condition - Asset Quality - Allowances for Losses." Other Income. Other non-interest income decreased to $65.1 million in the 2002 quarter from $68.1 million in the 2001 quarter. The $3.0 million (or 4.4%) decrease was primarily attributable to a nonrecurring gain on other investment in the 2001 quarter, which was partially offset by increases in the net gain on trading securities and deposit servicing fees. The bank recognized a pre-tax gain of $9.4 million on the sale of its interest in Star Systems, Inc. to Concord EFS, Inc. during the 2001 quarter. The gain is included in Gain on Other Investment in the Consolidated Statements of Operations. The $3.8 million increase in the gain on trading securities was primarily due to gains on sales of mortgage-backed securities related to mortgage banking activities. Deposit servicing fees increased $3.2 million (or 13.4%) during the 2002 quarter primarily due to fees generated from the continued expansion of the bank's branch and ATM network. Operating Expenses. Operating expenses for the 2002 quarter increased $0.4 million (or 0.4%) from the 2001 quarter. Loan expenses decreased $6.4 million, primarily due to a writedown, in the 2001 quarter, of the bank's mortgage servicing assets as a result of increased prepayments. Property and equipment expenses increased by $2.6 million due primarily to increased rent expense and related property taxes associated with the bank's new headquarters. SIX MONTHS ENDED MARCH 31, 2002 (the "2002 period") COMPARED TO SIX MONTHS ENDED MARCH 31, 2001(the "2001 period") REAL ESTATE The Real Estate Trust recorded income before depreciation and amortization of $315,000 and an operating loss of $9.3 million in the 2002 period compared to income before depreciation and amortization of $8.5 million and operating income of $27,000 in the 2001 period. The changes reflect declining results in operations of hotels and office and industrial properties. Additionally, in the 2001 period the Trust recognized approximately $2.5 million in gains from the sale of two properties. Income after direct operating expenses from hotels decreased $5,351,000 (30.1%) in the 2002 period over the level achieved in the 2001 period. The decrease is a result of $6,133,000 (37.9%) lower results from sixteen hotels owned throughout both periods offset by $782,000 improved results from two acquisition properties. The decrease in total revenue of $8,635,000 (17.7%) was offset by decrease of $3,284,000 (10.6%) in direct operating expenses. For the sixteen hotels owned throughout both periods, the decrease in total revenue was $10,528,000 (23.0%) and the decrease in direct operating expenses was $4,395,000 (14.8%). The revenue decrease was attributable to declining market conditions resulting from the effects of the September 11, 2001 terrorist attacks and the slowing economy. Income after direct operating expenses from office and industrial properties decreased $1,179,000 (7.8%) in the 2002 period compared to such income in the 2001 period. $981,000 (7.0%) of this decrease reflected lower results from the ten properties owned throughout both periods; the balance of the decrease was caused by a property that was sold late in fiscal 2001, partially reduced by improved results from two acquisition properties. The decrease in total revenue of $1,127,000 (5.5%) coupled with the increase of $52,000 (1.0%) in direct operating expenses resulted in lower income during the 2002 period. For the ten properties owned throughout both periods, the decrease in total revenue was $745,000 (3.9%) and the increase in direct operating expenses was $236,000 (4.7%). Other income decreased $426,000 (34.9%) during the 2002 period primarily due to lower interest income and less apartment income due to the sale of an apartment property. Land parcels and other expense decreased $206,000(27.3%) during the 2002 period largely due to the sale of an apartment property. Interest expense increased $78,000 (0.3%) in the 2002 period, primarily because of higher mortgage borrowings. Average balances of the Real Estate Trust's outstanding borrowings increased to $578.9 million for the 2002 period from $548.0 million for the 2001 period. The increase in average borrowings occurred as a result of mortgage loan refinancings and unsecured note sales. The weighted average cost of borrowings was 8.96% in the 2002 period compared to 9.45% in the 2001 period. Capitalized interest decreased $134,000(31.9%) during the 2002 period due to the lower level of development activity in the current period. Amortization of debt expense remained at the same level in the 2002 period as it was in the 2001 period. Depreciation increased $1,141,000 (14.1%) in the 2002 period as a result of the additions of new properties and new assets placed in service in the past year. Advisory, management and leasing fees paid to related parties increased $198,000 (34%) in the 2002 period from their expense level in the 2001 period. The monthly advisory fee in the 2002 period was $475,000 compared to $363,000 in the prior period, which resulted in an aggregate increase of $673,000. Management and leasing fees decreased $475,000 (13.0%) in the current period, reflecting both lower hotel sales and office rents on which fees are based. General and administrative expense increased $117,000 (10.6%) in the 2002 period, principally because of increased legal fees. Equity in earnings of unconsolidated entities reflected earnings of $5,742,000 for the 2002 period and earnings of $3,998,000 for the 2001 period, an increase of $1,744,000 (43.6%). The improvement was due to increased period-to-period earnings of Saul Centers, Inc. BANKING Overview. The bank recorded operating income of $59.1 million for the 2002 period, compared to operating income of $55.4 million for the 2001 period. Increased net interest income and other (non-interest) income were partially offset by increases in operating expense. Net Interest Income. Net interest income, before the provision for loan and lease losses, increased $2.1 million (or 1.2%) in the 2002 period compared to the 2001 period. There was no interest income recorded during the 2002 period on non-accrual assets and restructured loans. The bank would have recorded interest income of $2.0 million for the 2002 period if non-accrual assets and restructured loans had been current in accordance with their original terms. The bank's net interest income in future periods will continue to be adversely affected by the bank's non-performing assets. See "Financial Condition - Asset Quality - Non-Performing Assets." The following table sets forth, for the periods indicated, information regarding the total amount of income from interest-earning assets and the resulting yields, the interest expense associated with interest-bearing liabilities, expressed in dollars and rates, and the net interest spread and net yield on interest-earning assets. Net Interest Margin Analysis (Dollars in thousands) Six Months Ended March 31, --------------------------------------------------------------------------------- 2002 2001 --------------------------------------- ---------------------------------------- Average Yield/ Average Yield/ Balances Interest Rate Balances Interest Rate ------------- ----------- ---------- -------------- ----------- ----------- Assets: Interest-earning assets: Loans and leases receivable, net (1) $ 8,438,281 $ 280,963 6.66 % $ 8,615,603 $ 358,031 8.31 % Mortgage-backed securities 1,340,923 40,729 6.07 968,204 31,498 6.51 Federal funds sold and securities purchased under agreements to resell 40,121 363 1.81 51,778 1,557 6.01 Trading securities 59,407 1,852 6.23 18,324 661 7.21 Investment securities 45,949 869 3.78 45,667 1,378 6.03 Other interest-earning assets 218,505 4,165 3.81 187,514 6,488 6.92 ------------- ----------- -------------- ----------- Total 10,143,186 328,941 6.49 9,887,090 399,613 8.08 ----------- ---------- ----------- ----------- Noninterest-earning assets: Cash 230,961 276,234 Real estate held for investment or sale 31,092 52,147 Property and equipment, net 449,328 376,533 Goodwill and other intangible assets, net 26,558 25,514 Other assets 291,097 285,103 ------------- -------------- Total assets $ 11,172,222 $ 10,902,621 ============= ============== Liabilities and stockholders' equity: Interest-bearing liabilities: Deposit accounts: Demand deposits $ 1,452,062 2,285 0.31 $ 1,262,406 4,721 0.75 Savings deposits 926,917 4,610 0.99 873,619 7,515 1.72 Time deposits 2,635,920 61,154 4.64 3,026,989 94,650 6.25 Money market deposits 1,714,990 16,289 1.90 1,267,032 25,481 4.02 Total deposits 6,729,889 84,338 2.51 6,430,046 132,367 4.12 Borrowings 2,755,016 65,753 4.77 2,983,480 90,450 6.06 ------------- ----------- -------------- ----------- Total liabilities 9,484,905 150,091 3.16 9,413,526 222,817 4.73 ----------- ---------- ----------- ----------- Noninterest-bearing items: Noninterest-bearing deposits 814,322 635,623 Other liabilities 215,020 236,166 Minority interest 144,000 144,000 Stockholders' equity 513,975 473,306 ------------- -------------- Total liabilities and stockholders' equity $ 11,172,222 $ 10,902,621 ============= ============== Net interest income $ 178,850 $ 176,796 =========== =========== Net interest spread (2) 3.32 % 3.35 % ========== =========== Net yield on interest-earning assets (3) 3.53 % 3.58 % ========== =========== Interest-earning assets to interest-bearing liabilities 106.94 % 105.03 % ========== =========== - ---------------------------------------------------------------------------------------------------------------------------- (1) Includes loans held for sale and/or securitization. Interest on non-accruing loans has been included only to the extent reflected in the Consolidated Statements of Operations; however, the loan balance is included in the average amount outstanding until transferred to real estate acquired in settlement of loans. (2) Equals weighted average yield on total interest-earning assets less weighted average rate on total interest-bearing liabilities. (3) Equals annualized net interest income divided by the average balances of total interest-earning assets. The following table presents certain information regarding changes in interest income and interest expense of the bank during the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to changes in volume (change in volume multiplied by old rate); changes in rate (change in rate multiplied by old volume); and changes in rate and volume. Volume and Rate Changes in Net Interest Income (Dollars in thousands) Six Months Ended March 31, 2002 Compared to Six Months Ended March 31, 2001 Increase (Decrease) Due to Change in (1) ------------------------------------------------------ Total Volume Rate Change --------------- --------------- --------------- Interest income: Loans (2) $ (7,238) $ (69,830) $ (77,068) Mortgage-backed securities 15,100 (5,869) 9,231 Federal funds sold and securities purchased under agreements to resell (73) (225) (298) Trading securities 617 (322) 295 Investment securities 25 (534) (509) Other interest-earning assets 2,511 (4,834) (2,323) --------------- --------------- --------------- Total interest income 10,942 (81,614) (70,672) --------------- --------------- --------------- Interest expense: Deposit accounts 16,953 (64,982) (48,029) Borrowings (6,534) (18,163) (24,697) --------------- --------------- --------------- Total interest expense 10,419 (83,145) (72,726) --------------- --------------- --------------- Increase in net interest income $ 523 $ 1,531 $ 2,054 =============== =============== =============== - ---------------------------------------------------------------------------------------------------------------- (1) The net change attributable to the combined impact of volume and rate has been allocated in proportion to the absolute value of the change due to volume and the change due to rate. (2) Includes loans held for sale and/or securitization. Interest income in the 2002 period decreased $70.7 million (17.7%) from the level in the 2001 period as a result of lower average yields, coupled with lower average balances of $177.3 million, on loans and leases. A $372.7 million increase in the average balances of mortgage-backed securities partially offset the decrease in interest income. The bank's net interest spread decreased slightly to 3.32% in the 2002 period from 3.35% in the 2001 period primarily because the average yield of the bank's interest-earning assets decreased more than the average cost of its interest bearing liabilities. Average interest-earning assets as a percentage of average interest bearing liabilities increased to 106.9% for the 2002 period compared to 105.0% for the 2001 period. Interest income on loans and leases, the largest category of interest-earning assets, decreased $77.1 million from the 2001 period primarily because of lower average yields. The average yield on the loan and lease portfolio decreased 165 basis points (from 8.31% to 6.66%) from the 2001 period. Interest income declined by $39.7 million (or 21.8%) on the bank's single-family residential loans, by $21.7 million (or 19.0%) on automobile loans, and by $6.5 million (or 46.7%) on construction loans, primarily because of lower average yields on those loans. In addition, lower average yields resulted in a $6.5 million (or 25.4%) decrease in interest income on commercial loans and a $3.4 million (or 24.1%) decrease in interest income on home equity loans. Partially offsetting the decrease in interest income were increases in the average balances of home equity loans, commercial loans and home improvement loans. Interest income on mortgage-backed securities increased $9.2 million (or 29.3%) primarily because of higher average balances. The effect of the $372.7 million increase in average balances was partially offset by a decrease in the average interest rates on those securities from 6.51% to 6.07%. Interest expense on deposits decreased $48.0 million (or 36.3%) during the 2002 period, due to a decrease in average interest rates. The 161 basis point decrease in the average rate on deposits (from 4.12% to 2.51%) resulted from a general decline in market interest rates. The bank also reduced its use of higher cost brokered deposits in the 2002 period compared to the 2001 period. Interest expense on borrowings decreased $24.7 million (or 27.3%) in the 2002 period over the 2001 period. Average balances of Federal Home Loan Bank advances decreased by $235.2 million, or 11.0%, and the average interest rate on such advances decreased (from 5.70% to 5.12%), resulting in a reduction of $12.3 million in interest expense. Also contributing to the decrease in interest expense on borrowings were decreases in the average cost of securities sold under repurchase agreements (from 6.26% to 2.06%) and in other borrowings (from 5.36% to 1.26%), which contributed to $9.0 million and $3.4 million decrease in interest expense, respectively. Partially offsetting the decreased expense on borrowings was an increase in the average balances of $7.2 million in other borrowings. Provision for Loan and Lease Losses. The bank's provision for loan and lease losses decreased slightly to $32.9 million in the 2002 period from $33.9 million in the 2001 period. See "Financial Condition - Asset Quality - Allowances for Losses." Other Income. Other non-interest income increased to $122.5 million in the 2002 period from $114.9 million in the 2001 period. The $7.6 million (or 6.7%) increase resulted from increases in the net gain on trading securities and deposit servicing fees. A nonrecurring gain on other investment during the 2001 period partially offset this increase. The $9.0 million increase in the gain on trading securities reflected $7.0 million in gains on sales of mortgage-backed securities related to mortgage banking activities and a $2.0 million unrealized gain in market value of the bank's interest in other securities. Deposit servicing fees increased $6.5 million (or 13.2%) during the 2002 period primarily due to fees generated from the continued expansion of the bank's branch and ATM network. The bank recognized a pre-tax gain of $9.4 million on the sale of its interest in Star Systems, Inc. to Concord EFS, Inc. during the 2001 period. The gain is included in Gain on Other Investment in the Consolidated Statements of Operations. Operating Expenses. Operating expenses for the 2002 period increased $7.1 million (or 3.5%) from the 2001 period. Property and equipment expenses increased by $6.7 million due primarily to increased rent expense and related property taxes associated with the bank's new headquarters. Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Information required by this Item is included in Item 2 "Management's Discussion and Analysis of Financial Condition and Results of Operations." PART II Item 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits required by Item 601 of Regulation S-K are set forth below. EXHIBITS EXHIBITS DESCRIPTION ---------- ------------------------------------------------------------------ 3. ORGANIZATIONAL DOCUMENTS (a) Amended and Restated Declaration of Trust filed with the Maryland State Department of Assessments and Taxation on June 22, 1990 as filed as Exhibit 3(a) to Registration Statement No. 33-34930 is hereby incorporated by reference. (b) Amendment to Amended and Restated Declaration of Trust reflected in Secretary Certificate filed with the Maryland State Department of Assessments and Taxation on June 26, 1990 as filed as Exhibit 3(b) to Registration Statement No. 33-34930 is hereby incorporated by reference. (c) Amended and Restated By-Laws of the Trust dated as of February 28, 1991 as filed as Exhibit T3B to the Trust's Form T-3 Application for Qualification of Indentures under the Trust Indenture Act of 1939 (File No. 22-20838) is hereby incorporated by reference. 4. INSTRUMENTS DEFINING THE RIGHTS OF SECURITY HOLDERS, INCLUDING INDENTURES (a) Indenture dated as of March 25, 1998 between the Trust and Norwest Bank Minnesota, National Association, as Trustee, with respect to the Trust's 9 3/4% Series B Senior Secured Notes due 2008, as filed as Exhibit 4(a) to Registration Statement 333-49937 is hereby incorporated by reference. (b) Indenture with respect to the Trust's Senior Notes Due from One Year to Ten Years from Date of Issue as filed as Exhibit 4(a) to Registration No. 33-19909 is hereby incorporated by reference. (c) First Supplemental Indenture with respect to the Trust's Senior Notes due from One Year to Ten Years from Date of Issue as filed as Exhibit T-3C to the Trust's Form T-3 Application for Qualification of Indentures under the Trust Indenture Act of 1939 (File No. 22-20838) is hereby incorporated by reference. (d) Indenture with respect to the Trust's Senior Notes due from One Year to Ten Years from Date of Issue as filed as Exhibit 4(a) to Registration Statement No. 33-9336 is hereby incorporated by reference. (e) Fourth Supplemental Indenture with respect to the Trust's Senior Notes due from One Year to Ten Years from Date of Issue as filed as Exhibit 4(a) to Registration Statement No. 2-95506 is hereby incorporated by reference. (f) Third Supplemental Indenture with respect to the Trust's Senior Notes due from One Year to Ten Years from Date of Issue as filed as Exhibit 4(a) to Registration Statement No. 2-91126 is hereby incorporated by reference. (g) Second Supplemental Indenture with respect to the Trust's Senior Notes due from One Year to Ten Years from Date of Issue as filed as Exhibit 4(a) to Registration Statement No. 2-80831 is hereby incorporated by reference. (h) Supplemental Indenture with respect to the Trust's Senior Notes due from One Year to Ten Years from Date of Issue as filed as Exhibit 4(a) to Registration Statement No. 2-68652 is hereby incorporated by reference. (i) Indenture with respect to the Trust's Senior Notes due from One Year to Five Years from Date of Issue as filed as Exhibit T-3C to the Trust's Form T-3 Application for Qualification of Indentures under the Trust Indenture Act of 1939 (file No. 22-10206) is hereby incorporated by reference (j) Indenture dated as of September 1, 1992 with respect to the Trust's Notes due from One to Ten Years form Date of Issue filed as Exhibit 4(a) to Registration Statement No. 33-34930 is hereby incorporated by reference. (k) First Supplemental Indenture dated as of January 16, 1997 with respect to the Trust's Notes due from One to Ten years from Date of Issue filed as Exhibit 4(b) to Registration Statement No. 33-34930 is hereby incorporated by reference. (l) Second Supplemental Indenture dated as of January 13, 1999 with respect to the Trust's Notes due from One to Ten Years from Date of Issuance as filed as Exhibit 4(l) to Registration Statement No. 333-70753 is hereby incorporated by reference. 10. MATERIAL CONTRACTS (a) Amended and Restated Advisory Contract by and among the Trust, B.F. Saul Company and B.F. Saul Advisory Company effective October 1, 1992, as amended, as filed as Exhibit 10(a) to the Trust's Annual Report on Form 10-K (File No. 1-7184) for the fiscal year ended September 30, 2001 is hereby incorporated by reference. (b) Assignment and Guaranty Agreement effective May 1, 1972 by and among the Trust, B.F. Saul Company and B.F. Saul Advisory Company, as filed as Exhibit 10(b) to the Trust's Annual Report on Form 10-K (File No. 1-7184) for the fiscal year ended September 30, 2001 is hereby incorporated by reference. (c) Commercial Property Leasing and Management Agreement effective October 1, 1982 between the Trust and B.F. Saul Property Company filed as Exhibit 10(b) to Registration Statement No. 2-80831 is hereby incorporated by reference. (d) Amendments to Commercial Property Leasing and Management Agreement between the Trust and B.F. Saul Property Company dated as of December 31, 1992 (Amendment No. 5), July 1, 1989 (Amendment No. 4), October 1, 1986 (Amendment No. 3), January 1, 1985 (Amendment No. 2) and July 1, 1984 (Amendment No. 1) filed as Exhibit 10(o) to Registration Statement No. 33-34930 is hereby incorporated by reference. (e) Tax Sharing Agreement dated June 28, 1990 among the Trust, Chevy Chase Bank F.S.B. and certain of their subsidiaries filed as Exhibit 10(c) to Registration Statement No. 33-34930 is hereby incorporated by reference. (f) First Amendment to Tax Sharing Agreement effective May 16, 1995 among the Trust, Chevy Chase Bank F.S.B. and certain of their subsidiaries, as filed as Exhibit 10(f) to the Trust's Annual Report on Form 10-K (File No. 1-7184) for the fiscal year ended September 30, 2001 is hereby incorporated by reference. (g) Agreement dated June 28, 1990 among the Trust, B.F. Saul Company, Franklin Development Co., Inc., The Klingle Corporation and Westminster Investing Corporation relating to the transfer of certain shares of Chevy Chase Bank, F.S.B. and certain real property to the Trust in exchange for Preferred Shares of the Trust filed as Exhibit 10(d) to Registration Statement No. 33-34930 is hereby incorporated by reference. (h) Regulatory Capital Maintenance/Dividend Agreement dated May 17, 1988 among B.F. Saul Company, the Trust and the Federal Savings and Loan Insurance Corporation filed as Exhibit 10(e) to the Trust's Annual Report on Form 10-K (File No. 1-7184) for the fiscal year ended September 30, 1991 is hereby incorporated by reference. (i) Registration Rights and Lock-Up Agreement dated August 26, 1993 by and among Saul Centers, Inc. and the Trust, Westminster Investing Corporation, Van Ness Square Corporation, Dearborn, L.L.C., B.F. Saul Property Company and Avenel Executive Park Phase II, Inc. as filed as Exhibit 10.6 to Registration Statement No. 33-64562 is hereby incorporated by reference. (j) First Amendment to Registration Rights and Lock-Up Agreement dated September 29, 1999 by and among Saul Centers, Inc., the Trust, Westminster Investing Corporation, Van Ness Square Corporation, Dearborn Corporation, Franklin Property Company and Avenel Executive Park Phase II, Inc., as filed as Exhibit 10(b) to the Trust's Annual Report on Form 10-K (File No. 1-7184) for the fiscal year ended September 30, 2001 is hereby incorporated by reference. (k) Exclusivity and Right of First Refusal Agreement dated August 26, 1993 among Saul Centers, Inc., the Trust, B.F. Saul Company, Westminster Investing Corporation, B.F. Saul Property Company, Van Ness Square Corporation, and Chevy Chase Savings Bank, F.S.B. as filed as Exhibit 10.7 to Registration Statement No. 33-64562 hereby incorporated by reference. (l) Fourth Amended and Restated Reimbursement Agreement dated as of April 25, 2000 by and among Saul Centers, Inc., Saul Holdings Limited Partnership, Saul Subsidiary I Limited Partnership, Saul Subsidiary II Limited Partnership, Saul QRS, Inc., B.F. Saul Property Company, Westminster Investing Corporation, Van Ness Square Corporation, Dearborn, L.L.C., Avenel Executive Park Phase II, L.L.C., and the Trust, as filed as Exhibit 10(k) to the Trust's Quarterly Report on Form 10-Q (File No. 1-7184) for the fiscal quarter ended March 31, 2000 is hereby incorporated by reference. (m) Bank Stock Registration Rights Agreement dated as of March 25, 1998 between the Trust and Norwest Bank Minnesota, National Association, as Trustee, as filed as Exhibit 4(d) to Registration Statement No. 333-49937 is hereby incorporated by reference. (n) Note Administration Fee Agreement dated as of February 8, 2002, between the Trust and B.F. Saul Advisory Company L.L.C., as filed as Exhibit 10(n) to the Trust's Quarterly Report on Form 10-Q (File No. 1-7184) for the fiscal quarter ended December 31, 2001 is hereby incorporated by reference. - ------------------- (b) The Registrant did not file any reports on Form 8-K during the fiscal quarter covered by this report. SIGNATURES Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. B. F. SAUL REAL ESTATE INVESTMENT TRUST (Registrant) Date: May 15, 2002 Stephen R. Halpin, Jr. ----------------- --------------------------------------- Stephen R. Halpin, Jr. Vice President and Chief Financial Officer Date: May 15, 2002 Bill D. Tzamaras ----------------- --------------------------------------- Bill D. Tzamaras Vice President and Principal Accounting Officer
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10-Q Filing
Saul B F Real Estate Investment Trust Inactive 10-Q2002 Q2 Quarterly report
Filed: 15 May 02, 12:00am