UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
- --- ACT OF 1934
For the fiscal year ended September 30, 2002
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- --- EXCHANGE ACT OF 1934
For the transition period from to
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Commission File number 1-7184
B. F. SAUL REAL ESTATE INVESTMENT TRUST
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(Exact name of registrant as specified in its charter)
Maryland 52-6053341
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
7501 Wisconsin Avenue, Bethesda, Maryland 20814
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (301) 986-6000
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Securities registered pursuant to Section 12(b) of Act:
Title of each class Name of each exchange on which registered
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N/A N/A
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Securities registered pursuant to Section 12(g) of the Act:
N/A
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(Title of class)
Indicate by check mark whether 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
requires to file such reports), and (2) has been subject to such filing
requirement for the past 90 days. Yes X No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendments to
this Form 10-K. /x/
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12-b-2). Yes No X
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There were no Common Shares of Beneficial Interest held by non-affiliates of the
registrant as of December 15, 2002.
The number of Common Shares of Beneficial Interest, $1 Par Value, outstanding as
of December 15, 2002 was 4,826,910.
TABLE OF CONTENTS
PART I
ITEM 1. BUSINESS
Overview ..........................................................
Real Estate .......................................................
Banking ...........................................................
Federal Taxation ..................................................
ITEM 2. PROPERTIES ...................................................
Real Estate .......................................................
Banking ...........................................................
ITEM 3. LEGAL PROCEEDINGS ............................................
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ..........
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS .................................
ITEM 6. SELECTED FINANCIAL DATA ......................................
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS ...............
Financial Condition ...............................................
Real Estate ..................................................
Banking ......................................................
Liquidity and Capital Resources ...................................
Real Estate ..................................................
Banking ......................................................
Results of Operations .............................................
Fiscal 2002 Compared to Fiscal 2001 ..........................
Real Estate .............................................
Banking .................................................
Fiscal 2001 Compared to Fiscal 2000 ..........................
Real Estate .............................................
Banking .................................................
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK....
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ..................
Management's Statement on Responsibility ..........................
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE .........................
PART III
ITEM 10. TRUSTEES AND EXECUTIVES OFFICERS OF THE TRUST ................
Executive Officers of the Trust Who Are Not Directors ............
Committees of the Board of Trustees ..............................
ITEM 11. EXECUTIVE COMPENSATION .......................................
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT .......................................
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ...............
Real Estate .............................................
Banking .................................................
ITEM 14. CONTROLS AND PROCEDURES ......................................
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
AND REPORTS ON FORM 8-K .....................................
PART I
ITEM 1. BUSINESS
Overview
B.F. Saul Real Estate Investment Trust operates as a Maryland real estate
investment trust. The Trust began its operations in 1964 as an unincorporated
business trust organized under a Declaration of Trust governed by District of
Columbia law. The Trust terminated its status as a qualified real estate
investment trust for federal income tax purposes in 1978 and is now taxable as a
corporation. On October 24, 1988, the Trust amended its Declaration of Trust to
qualify the Trust as a statutory real estate investment trust under Maryland
law.
The principal business activities of the Trust are the ownership of 80% of the
outstanding common stock of Chevy Chase Bank, F.S.B. ("Chevy Chase"), whose
assets accounted for 96% of the Trust's consolidated assets at September 30,
2002, and the ownership and development of income-producing properties. By
virtue of its ownership of a majority interest in Chevy Chase, the Trust is a
savings and loan holding company and subject to regulation, examination and
supervision by the Office of Thrift Supervision, also know as "OTS." See
"Banking -- Holding Company Regulation."
The Trust recorded net income of $27.4 million in the fiscal year ended
September 30, 2002, compared to a net income of $34.6 million in the fiscal year
ended September 30, 2001.
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. The term "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 Chevy
Chase and its subsidiaries is identified as "Banking."
On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002,
which contains sweeping provisions intended to restore public confidence in the
honesty and integrity of the public securities markets. The Trust is currently
evaluating the Act and intends to comply with those provisions applicable to the
Trust.
Real Estate
The Real Estate Trust's long-term objectives are to increase cash flow from
operations and to maximize capital appreciation of its real estate. The
properties owned by the Real Estate Trust are located predominantly in the
mid-Atlantic and southeastern regions of the United States and consist
principally of hotels, office projects, and undeveloped land parcels.
The Real Estate Trust has significant relationships with B.F. Saul Company (the
"Saul Company") and two of its wholly owned subsidiaries, B.F. Saul Advisory
Company L.L.C., formerly known as B.F. Saul Advisory Company, referred to in
this report as the "Advisor," and B. F. Saul Property Company, ("Saul Property
Co.") formerly known as Franklin Property Company. Saul Company, founded in
1892, specializes in commercial property management and leasing, hotel
management, development and construction management, acquisitions, sales and
financing of real estate property and insurance. Certain officers and trustees
of the Trust are also officers and/or directors of Saul Company, the Advisor and
Saul Property Co. Other than uncompensated officers, the Trust has no employees.
See "Item 13. Certain Relationships and Related Transactions - Management
Personnel."
The Advisor acts as the Real Estate Trust's investment advisor and manages the
day-to-day financial, accounting, legal and administrative affairs of the Real
Estate Trust. Saul Property Co. acts as leasing and management agent for the
income-producing properties owned by the Real Estate Trust, and plans and
oversees the development of new properties and the expansion and renovation of
existing properties.
Banking
Chevy Chase Bank, F.S.B., referred to in this document as "Chevy Chase" or the
"bank," is a federally chartered and federally insured stock savings bank which
at September 30, 2002 was conducting business from 197 full-service branch
offices, including 53 grocery store banking centers, and 771 automated teller
machines in Maryland, Delaware, Virginia and the District of Columbia. The bank
has its home office in McLean, Virginia and its executive offices in Bethesda,
Maryland, both suburban communities of Washington, DC. The bank either directly
or through a wholly owned subsidiary also maintains a commercial loan production
office located in Baltimore, Maryland, seven mortgage loan production offices in
the mid-Atlantic region and five automobile loan production offices. In
addition, the bank maintains a network of third party originators in order to
supplement its direct origination of loans. At September 30, 2002, the bank had
total assets of $11.3 billion aand total deposits of $7.4 billion. Based on
total assets at September 30, 2002, Chevy Chase is the largest full-service bank
headquartered in the Washington, DC metropolitan area.
Chevy Chase is a consumer oriented, full service banking institution principally
engaged in the business of attracting deposits from the public and using such
deposits, together with borrowings and other funds, to make loans secured by
real estate, primarily residential mortgage loans, and other consumer loans. The
bank also has an active commercial lending program. The bank's principal deposit
and lending markets are located in the Washington, DC metropolitan area. As a
complement to its basic deposit and lending activities, the bank provides
related financial services to its customers, including securities brokerage and
insurance products offered through its subsidiaries. In addition, the bank
offers a variety of investment products and provides fiduciary services to a
primarily institutional customer base through its subsidiary, ASB Capital
Management, Inc., and to a primarily high net worth customer base through
another subsidiary, Chevy Chase Trust Company.
The bank seeks to capitalize on its status as the largest locally headquartered
full-service bank in the Washington, DC metropolitan area by expanding its
community banking objectives. Accordingly, the bank continues to build its
branch and alternative delivery systems, to maintain and expand its mortgage
banking operations, and to offer a broad range of consumer products, including
home equity loans and lines of credit and automobile loans and leases. In
addition, the bank continues to expand its business banking program, with an
emphasis on businesses operating in the Washington, DC metropolitan area. The
bank also continues to develop further the fee-based services it provides to
customers, including securities brokerage, trust, asset management and insurance
products offered through its subsidiaries.
Chevy Chase recorded operating income of $106.7 million for the year ended
September 30, 2002, compared to operating income of $97.1 million for the year
ended September 30, 2001. At September 30, 2002, the bank's tangible, core, tier
1 risk-based and total risk-based regulatory capital ratios were 5.63%, 5.63%,
7.08% and 10.86%, respectively. The bank's regulatory capital ratios exceeded
the requirements under the Financial Institutions Reform, Recovery, and
Enforcement Act of 1989, also known as "FIRREA," as well as the standards
established for "well-capitalized" institutions under the prompt corrective
action regulations established pursuant to the Federal Deposit Insurance
Corporation Improvement Act of 1991, also known as "FDICIA".
Chevy Chase is subject to comprehensive regulation, examination and supervision
by the Office of Thrift Supervision (the "OTS") and, to a lesser extent, by the
Federal Deposit Insurance Corporation (the "FDIC"). The bank's deposit accounts
are fully insured up to $100,000 per insured depositor by the Savings
Association Insurance Fund, (the "SAIF"), which is administered by the FDIC.
REAL ESTATE
Real Estate Investments
The Real Estate Trust's investment portfolio consists principally of seasoned
operating properties. The Real Estate Trust expects to hold its properties as
long-term investments and has no maximum period for retention of any investment.
It may acquire additional income-producing properties, expand and improve its
properties, or sell such properties, as and when circumstances warrant. The Real
Estate Trust also may participate with other entities in property ownership,
through joint ventures or other types of co-ownership.
The following tables set forth, at and for the periods indicated, certain
information regarding the properties in the Real Estate Trust's investment
portfolio at September 30, 2002.
HOTELS
Average Occupancy (2) Average Room Rate
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Year Ended
September 30, Year Ended September 30,
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Location Name Rooms (1) 2002 2001 2000 2002 2001 2000
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COLORADO
Pueblo Pueblo Holiday Inn 191 51% 52% 63% $57.39 $58.47 $51.59
FLORIDA
Boca Raton Boca Raton SpringHill Suites 146 59% 64% 60% $71.72 $83.91 $82.94
Boca Raton Boca Raton TownePlace Suites 91 74% 78% 73% $69.43 $71.79 $75.57
Ft. Lauderdale Ft. Lauderdale TownePlace Suites (3) 95 75% 81% 64% $64.23 $64.00 $68.45
MARYLAND
Gaithersburg Gaithersburg Holiday Inn 300 57% 67% 68% $88.94 $88.99 $80.28
Gaithersburg Gaithersburg TownePlace Suites 91 76% 75% 75% $69.44 $78.04 $70.90
MICHIGAN
Auburn Hills Auburn Hills Holiday Inn Select 190 65% 64% 76% $101.24 $111.20 $117.67
NEW YORK
Rochester Rochester Airport Holiday Inn 280 59% 61% 65% $67.80 $72.22 $72.97
OHIO
Cincinnati Cincinnati Holiday Inn 275 55% 55% 63% $67.66 $70.28 $72.08
VIRGINIA
Arlington National Airport Crowne Plaza 308 62% 72% 68% $116.20 $105.55 $107.49
Arlington National Airport Holiday Inn 280 57% 71% 74% $91.78 $101.99 $89.12
Herndon Herndon Holiday Inn Express 115 55% 69% 79% $84.70 $101.48 $91.64
McLean Tysons Corner Courtyard (4) 229 64% 61% NA $132.69 $136.35 NA
McLean Tysons Corner Holiday Inn 316 63% 68% 73% $95.66 $112.94 $112.71
Sterling Dulles Airport Hampton Inn 127 54% 72% 81% $81.71 $95.04 $91.62
Sterling Dulles Airport Holiday Inn 297 60% 66% 81% $82.60 $106.14 $99.74
Sterling Dulles Airport TownePlace Suites 95 74% 71% 83% $71.36 $93.73 $85.57
Sterling Dulles Town Center Hampton Inn(5) 152 62% 57% NA $80.36 $98.80 NA
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3,578 61% 66% 71% $86.82 $94.32 $89.16
(1) Available rooms as of September 30, 2002.
(2) Average occupancy is calculated by dividing the rooms occupied by the rooms available.
(3) Opened October 25, 1999.
(4) Opened December 15, 2000.
(5) Opened November 27, 2000.
OFFICE AND INDUSTRIAL
Leasing Percentages Expiring Leases (1)
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Gross September 30, Year Ending September 30,
Leasable --------------------- ----------------------------
Location Name Area (1) 2002 2001 2000 2003 2004
----------------------- --------------------------------- ---------- ----- ---- ---- ---- ------
FLORIDA
Fort Lauderdale Commerce Center - Phase II 61,149 92% 90% 90% 14,643 16,305
GEORGIA
Atlanta 900 Circle 75 Parkway 345,502 82% 87% 98% 49,642 60,484
Atlanta 1000 Circle 75 Parkway 89,412 97% 100% 98% 2,069 21,622
Atlanta 1100 Circle 75 Parkway 269,049 95% 93% 99% 44,653 11,804
MARYLAND
Laurel Sweitzer Lane (2) 150,020 100% 100% NA NA NA
VIRGINIA
McLean 8201 Greensboro Drive 360,854 81% 86% 95% 103,150 2,992
McLean Tysons Park Place (3) 247,581 86% 87% 100% 10,561 31,699
Sterling Dulles North 59,886 100% 100% 99% 16,943 34,373
Sterling Dulles North Two 79,210 100% 100% 100% NA 80
Sterling Dulles North Four (4) 100,207 100% NA NA NA NA
Sterling Dulles North Five (5) 80,391 100% 100% 100% NA NA
Sterling Dulles North Six (6) 53,517 100% 100% 100% NA NA
Sterling Loudoun Tech I (7) 81,238 0% NA NA NA NA
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Totals 1,978,016 86% 92% 98% 241,661(8) 179,359 (8)
(1) Square feet
(2) Acquired November 15, 2000.
(3) Acquired December 13, 1999.
(4) Operational April 1, 2002.
(5) Operational March 1, 2000.
(6) Operational October 1, 2000.
(7) Operational December 14, 2001.
(8) Represents 12.2% and 9.1%, respectively, of the Real Estate Trust's
office and industrial portfolio in terms of square footage as of September
30, 2002.
LAND PARCELS
Location Name Acres Zoning
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FLORIDA
Boca Raton Arvida Park of Commerce 6.5 Mixed Use
Fort Lauderdale Commerce Center 1.6 Office and Warehouse
GEORGIA
Atlanta Circle 75 124.9 Office and Industrial
KANSAS
Overland Park Overland Park 161.9 Residential, Office and Retail
MARYLAND
Rockville Flagship Centre 7.7 Commercial
MICHIGAN
Auburn Hills Auburn Hills Holiday Inn 0.5 Commercial
NEW YORK
Rochester Rochester Airport Holiday Inn 2.9 Commercial
VIRGINIA
Sterling Cedar Green 10.7 Commercial
Sterling Church Road 39.9 Office and Industrial
Sterling Sterling Boulevard 31.9 Industrial
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Total 388.5
OTHER REAL ESTATE INVESTMENTS
PURCHASE-LEASEBACK PROPERTIES (1)
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APARTMENTS
Location Name Number of Units
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LOUISIANA
Metairie Chateau Dijon 336
TENNESSEE
Knoxville Country Club 232
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Total 568
SHOPPING CENTERS
Location Name Gross Leasable Area (2)
- ----------------- -------------- ------------------------
GEORGIA
Atlanta Old National 160,000
Warner Robbins Houston Mall 264,000
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Total 424,000
(1) The Real Estate Trust owns the ground under certain income-producing
properties and receives fixed ground rent, which is subject to periodic
escalation, from the owners of the improvements. In certain instances, the Real
Estate Trust also receives percentage rent based upon the income generated by
the properties.
(2) Square feet.
Investment in Saul Holdings Limited Partnership
On August 26, 1993, the Real Estate Trust consummated a series of transactions
in which it transferred 22 shopping center properties and one of its office
properties together with the debt associated with such properties, to a newly
organized limited partnership, Saul Holdings Limited Partnership ("Saul Holdings
Partnership"), and one of two newly organized subsidiary limited partnerships of
Saul Holdings Partnership.
In exchange for the transferred properties, the Real Estate Trust received
securities representing a 21.5% limited partnership interest in Saul Holdings
Partnership. Entities under common control with the Trust received limited
partnership interests collectively representing a 5.5% partnership interest in
Saul Holdings Partnership in exchange for the transfer of property management
functions and certain other properties to Saul Holdings Partnership and its
subsidiaries. Saul Centers, Inc., a newly organized, publicly held real estate
investment trust ("Saul Centers"), received a 73.0% general partnership interest
in Saul Holdings Partnership in exchange for the contribution of approximately
$220.7 million to Saul Holdings Partnership.
Affiliates of the Trust received certain cash distributions from Saul Holdings
Partnership and purchased 4.0% of the common stock of Saul Centers in a private
offering consummated concurrently with the initial public offering of such
common stock. Certain officers and trustees of the Trust are also officers
and/or directors of Saul Centers. See "Item 13. Certain Relationships and
Related Transactions -- Management Personnel."
The Real Estate Trust and affiliates of the Trust own rights enabling them to
convert their limited partnership interests in Saul Holdings Partnership into
shares of Saul Center's common stock on the basis of one share of Saul Centers'
common stock for each partnership unit provided, subject to Saul Centers'
articles of incorporation and subsequent board resolution issued in March 2000,
that they do not own rights to the extent that they collectively would be
treated as owning, directly or indirectly, more than 29.9% of the value of the
outstanding equity securities of Saul Centers.
The shares of Saul Centers' common stock are listed on the New York Stock
Exchange under trading symbol "BFS."
Saul Centers operates as a real estate investment trust for federal income tax
purposes under Sections 856 through 860 of the Internal Revenue Code. Under the
Internal Revenue Code, REITs are subject to numerous organizational and
operational requirements. If Saul Centers continues to qualify as a REIT, it
generally will not be subject to federal income tax, provided it makes certain
distributions to its stockholders and meets certain organizational and other
requirements. Saul Centers has made and has announced that it intends to
continue to make regular quarterly dividend distributions to its stockholders.
Allocations and Distributions of Saul Holdings Partnership. The net income or
net loss of Saul Holdings Partnership for tax purposes generally will be
allocated to Saul Centers and the limited partners in accordance with their
percentage interests, subject to compliance with the applicable provisions of
the Internal Revenue Code and the regulations promulgated thereunder. Net cash
flow after reserves of Saul Holdings Partnership and after reimbursement of
specified expenses will be distributed quarterly to the partners in proportion
to their respective partnership interests.
Competition
As an owner of, or investor in, commercial real estate properties, the Real
Estate Trust is subject to competition from a variety of other owners of similar
properties in connection with their sale, lease or other disposition and use.
Management believes that success in such competition is dependent upon the
geographic location of the property, the performance of property managers, the
amount of new construction in the area and the maintenance and appearance of the
property. Additional competitive factors with respect to commercial and
industrial properties are the ease of access to the property, the adequacy of
related facilities such as parking, and the ability to provide rent concessions
and additional tenant improvements without increasing rent. Management believes
that general economic circumstances and trends and new properties in the
vicinity of each of the Real Estate Trust's properties also will be competitive
factors.
Environmental Matters
The Real Estate Trust's properties are subject to various laws and regulations
relating to environmental and pollution controls. The Real Estate Trust requires
an environmental study to be performed with respect to a property that may be
subject to possible environmental hazards prior to its acquisition to ascertain
that there are no material environmental hazards associated with such property.
Although the effect upon the Real Estate Trust of the application of
environmental and pollution laws and regulations cannot be predicted with
certainty, management believes that their application either prospectively or
retrospectively will not have a material adverse effect on the Real Estate
Trust's property operations.
Holding Company Regulation
The Trust, the Saul Company, Chevy Chase Property Company, referred to in this
report as "CCPC," and CCPC's wholly-owned subsidiary, Westminster Investing
Corporation, collectively referred to in this report as the "Holding Companies,"
are registered as "savings and loan holding companies" because of their direct
or indirect ownership interests in the bank, and are subject to regulation,
examination and supervision by the OTS. The bank is prohibited from making or
guaranteeing loans or advances to or for the benefit of the Holding Companies or
other affiliates engaged in activities beyond those permissible for bank holding
companies and from investing in the securities of the Holding Companies or other
affiliates. Transactions between the bank and the Holding Companies must be on
terms substantially the same, or at least as favorable to the bank, as those
that would be available to non-affiliates.
On April 16, 2002, the OTS published a revised Regulatory Handbook for Holding
Companies. The revised handbook mostly reorganizes and expands upon aspects of
the earlier edition, but also suggests a more active role for the OTS in the
direct regulation of thrift holding companies such as the Holding Companies. The
revised handbook places a greater emphasis on reviewing the adequacy of the
Holding Companies' capital, their level of debt, and their ability to fund
outstanding debt obligations, and suggests that particular scrutiny will be
given to holding companies that, like the Holding Companies, are engaged in real
estate activities.
The Holding Companies must obtain OTS approval before acquiring any federally
insured savings institution or any savings and loan holding company. The status
of the Holding Companies as "unitary thrift holding companies" and the
activities in which the Holding Companies may engage have been grandfathered
under the Gramm-Leach-Bliley Act of 1999 (the "GLB Act"). As grandfathered
unitary thrift holding companies, the Holding Companies are virtually
unrestricted in the types of business activities in which they may engage
provided the bank continues to meet the QTL test. See "Banking - Qualified
Thrift Lender ("QTL") Test." The GLB Act prohibits the sale of grandfathered
unitary thrift holding companies such as the Holding Companies (together with
their thrift subsidiaries) or their thrift subsidiaries alone to commercial
companies. Corporate reorganizations are expressly permitted.
If the Holding Companies were to acquire one or more federally insured
institutions and operate them as separate subsidiaries rather than merging them
into the bank, the Holding Companies would become "multiple" savings and loan
holding companies. As multiple savings and loan holding companies, the Holding
Companies would be subject to limitations on the types of business activities in
which they would be permitted to engage, unless the additional thrifts were
troubled institutions acquired pursuant to certain emergency acquisition
provisions and all subsidiary thrifts met the QTL test. The Holding Companies
may acquire and operate additional savings institution subsidiaries outside of
Maryland and Virginia only if the laws of the target institution's state
specifically permit such acquisitions or if the acquisitions are made pursuant
to emergency acquisition provisions.
The Trust and the Saul Company entered into an agreement with OTS's predecessor,
the Federal Savings and Loan Insurance Corporation, to maintain the bank's
regulatory capital at the required levels, and, if necessary, to infuse
additional capital to enable the bank to meet those requirements. Since the
execution of this agreement, the OTS has changed its policy and no longer
requires such agreements from companies acquiring thrift institutions. In
addition, the regulatory capital requirements applicable to the bank have
changed significantly as a result of FIRREA. The OTS has stated that capital
maintenance agreements entered into prior to the modification of OTS policy and
the enactment of FIRREA were not affected by those changes. The Trust and the
Saul Company have not sought to modify the existing agreement. To the extent the
bank is unable to meet regulatory capital requirements in the future, the OTS
could seek to enforce the obligations of the Trust and the Saul Company under
the agreement.
If the bank were to become "undercapitalized" under the prompt corrective action
regulations, it would be required to file a capital restoration plan with the
OTS setting forth, among other things, the steps the bank would take to become
"adequately capitalized." The OTS could not accept the plan unless the Holding
Companies guaranteed in writing the bank's compliance with that plan. The
aggregate liability of the Holding Companies under such a commitment would be
limited to the lesser of:
o an amount equal to 5.0% of the bank's total assets at the time the bank became
"undercapitalized," and
o the amount necessary to bring the bank into compliance with all applicable
capital standards as of the time the bank fails to comply with its capital plan.
If the Holding Companies refused to provide the guarantee, the bank would be
subject to the more restrictive supervisory actions applicable to "significantly
undercapitalized" institutions. See "Banking - Prompt Corrective Action."
BANKING
REGULATION
FEDERAL HOME LOAN BANK SYSTEM. The bank is a member of the Federal Home Loan
Bank (the "FHLB") of Atlanta, which is one of 12 FHLBs administered by the
Federal Housing Finance Board, an independent agency within the executive branch
of the federal government. The FHLBs serve as central credit facilities for
their members. Their primary credit mission is to facilitate residential
mortgage lending and support community and economic development activity in
rural and urban communities. From time to time, the bank obtains advances from
the FHLB of Atlanta. At September 30, 2002, the bank had outstanding advances of
$1.7 billion. See Note 26 to the Consolidated Financial Statements in this
report and "Deposits and Other Sources of Funds - Borrowings."
As a member of the FHLB of Atlanta, the bank is required to acquire and hold
shares of capital stock in that bank in an amount equal to the greater of:
o 1.0% of mortgage-related assets;
o $500; or
o 5.0% of outstanding advances.
The bank had an investment of $88.6 million in FHLB of Atlanta stock at
September 30, 2002. The bank earned dividends on that stock of $5.3 million and
$8.1 million during the years ended September 30, 2002 and 2001, respectively.
Since 1999, membership in the FHLB has been voluntary rather than mandatory for
federal thrifts like the bank. Because membership is required to obtain advances
from the FHLB and the bank continues to rely on FHLB advances as an important
source of funds, the bank currently intends to retain its voluntary membership
in the FHLB of Atlanta.
LIQUIDITY REQUIREMENTS. The bank is required to maintain sufficient liquidity to
ensure its safe and sound operation. Failure to meet this requirement could
subject the bank to monetary penalties imposed by the OTS. Management believes
that the bank's ratio of cash and cash equivalents and other liquid assets to
deposits and short-term borrowings of 8.02% at September 30, 2002 was sufficient
to ensure the bank's safe and sound operation.
DEPOSIT INSURANCE PREMIUMS. Under FDIC insurance regulations, the bank is
required to pay premiums to the SAIF for insurance of its deposit accounts. The
FDIC utilizes a risk-based premium system in which an institution pays premiums
for deposit insurance on its SAIF-insured deposits based on supervisory
evaluations and on the institution's capital category under the OTS's prompt
corrective action regulations. See "Prompt Corrective Action."
Although the FDIC insures commercial banks as well as thrifts, the insurance
funds for commercial banks and thrifts have been segregated into the Bank
Insurance Fund (the "BIF") and the SAIF. The FDIC is required to maintain the
reserve levels of both the BIF and the SAIF at 1.25% of insured deposits. If the
reserve level of an insurance fund falls below 1.25%, the FDIC is required by
law to impose a premium of at least 23 basis points on all institutions whose
accounts are insured by that fund until its ratio is restored above the 1.25%
minimum. The BIF's reserve ratio was 1.26% and the SAIF's reserve ratio was
1.38% as of June 30, 2002.
Beginning in 1997, commercial banks have been required to share in the payment
of interest due on Financing Corporation ("FICO") bonds used to provide
liquidity to the savings and loan industry in the 1980s. Annual FICO assessments
added to deposit insurance premiums equaled 1.79 basis points for SAIF and BIF
members for the first semi-annual period of 2002 and 1.71 basis points for SAIF
and BIF members for the second semi-annual period of 2002.
SAIF insurance may be terminated by the FDIC, after notice and a 30-day
corrective period, if the FDIC finds that a financial institution has engaged in
unsafe or unsound practices, is in an unsafe or unsound condition to continue
operations, or has violated any applicable law, regulation, order or condition
imposed by the FDIC. The 30-day period may be eliminated by the FDIC with the
approval of the OTS.
The House of Representatives has passed and the Senate is considering
legislation that would reform the deposit insurance system by, among other
things, (i) increasing FDIC insurance coverage from $100,000 to $130,000 per
account (with certain retirement accounts generally receiving increased
coverage) and indexing future coverage to accommodate inflation, (ii) merging
the BIF and the SAIF into a single new Deposit Insurance Fund, (iii) permitting
the Fund's required reserve ratio to float in a designated range, (iv)
eliminating the current prohibition against assessing risk-based premiums on
well-capitalized institutions with high supervisory ratings, thus permitting the
FDIC to assess ongoing premiums for all institutions based on their risk
profile, and allowing gradual increases in those premiums if the new Fund's
ratio falls below the lower end of the designated range, (v) providing, in the
case of the House bill, dividends to institutions if the ratio exceeds the upper
end of the range, and (vi) providing refunds or credits towards future
assessments based on an institution's earlier contributions to the BIF or the
SAIF. Because it remains unclear at this time whether, or in what form, any such
legislation ultimately may be enacted, the bank is unable to assess the
potential effects on the bank.
REGULATORY CAPITAL
The bank is subject to:
o a minimum tangible capital requirement;
o a minimum core (or leverage) capital requirement; and
o a minimum risk-based capital requirement.
Each of these requirements generally must be no less stringent than the capital
standards for national banks. At September 30, 2002, the bank's tangible capital
ratio was 5.63%, its core (or leverage) capital ratio was 5.63%, and its total
risk-based capital ratio was 10.86%, compared to the minimum requirements of
1.50%, 4.00% and 8.00%, respectively.
The tangible capital requirement adopted by the OTS requires the bank to
maintain "tangible capital" in an amount not less than 1.5% of tangible assets.
"Tangible capital" is defined as core capital less investments in certain
subsidiaries and any intangible assets (including supervisory goodwill), plus
qualifying servicing assets valued at the amount that can be included in core
capital.
Under the minimum leverage capital requirement, Chevy Chase must maintain a
ratio of "core capital" to tangible assets of not less than 4.0%. "Core capital"
generally includes common shareholders' equity, noncumulative perpetual
preferred stock and minority interests in consolidated subsidiaries, less
investments in certain subsidiaries and certain intangible assets.
Under OTS regulations, servicing assets can be included in core capital in an
amount up to 100% of core capital. Non-mortgage servicing assets are subject to
a sublimit of 25% of core capital. For these purposes, servicing assets are
valued at the lesser of 90% of fair market value or 100% of the current
unamortized book value. At September 30, 2002, the bank had qualifying servicing
assets with a carrying value of $60.3 million, which constituted 9.5% of core
capital at that date. The federal banking agencies have not exercised their
authority to permit inclusion in core capital of up to 100 percent of the fair
market value of readily marketable mortgage servicing rights.
The risk-based capital requirements imposed by the OTS vary the amount of
capital required for an asset based on the degree of credit risk associated with
that asset and include off-balance sheet items in the asset base used to compute
the bank's risk-based capital ratio.
There are currently four categories of risk-weightings:
o 0% for cash and similar assets;
o 20% for qualifying mortgage-backed securities;
o 50% for qualifying residential permanent real estate loans; and
o 100% for other assets, including consumer loans, commercial real estate loans,
loans more than 90 days past due, and real estate acquired in settlement of
loans.
The bank generally must maintain risk-based capital equal to 8.0% of
risk-weighted assets, with at least half of that amount in the form of core
capital.
The OTS amended its capital regulations, effective July 1, 2002, to permit a
broader range of residential mortgage loans to qualify for the 50% risk
weighting category. The final amendments also indicate that residential mortgage
loans with negative amortization features that are initially assigned to the 50%
risk-weighting may have to be reassigned to the 100% risk-weighting if, as a
result of negative amortization, the loan-to-value ratios are no longer
"commensurate" with the risk associated with the loans. The OTS intends to
conduct a more comprehensive assessment of negatively amortizing loans and may
issue supervisory guidance on their capital treatment.
Capital also must be maintained against assets sold with recourse despite the
fact that the assets are accounted for as having been sold. On November 29,
2001, the OTS and the other federal bank regulatory agencies revised their
risk-based capital regulations to address the regulatory capital treatment of
certain residual interests in asset securitizations. Residual interests include
interest-only strips receivable, spread accounts, cash collateral accounts,
over-collateralization of receivables, retained subordinated interests and other
similar forms of on-balance sheet assets that function as credit enhancements.
The rule became effective January 1, 2002 and applies to those transactions that
closed on or after that date. For those transactions entered into prior to the
effective date, the bank has chosen, pursuant to the rule, to delay the
application of the rule until December 31, 2002. For those transactions, the
bank currently maintains dollar-for-dollar capital against the securitized
assets in an amount equal to the amount of recourse retained by the bank, but
not greater than the otherwise applicable capital requirement on the underlying
loans. For transactions closed on or after January 1, 2002, the revisions:
o require that risk-based capital be held in an amount equal to the amount of
residual interest that is retained on balance sheet following a securitization,
net of any deferred tax liability (i.e., dollar-for-dollar), even if that amount
exceeds the otherwise applicable capital requirement on the underlying loans;
o require a deduction from Tier 1 capital equal to the amount of credit
enhancing interest-only strips receivable that exceeds 25 percent of Tier 1
capital; and
o apply a "ratings based approach" that sets capital requirements for positions
in securitizations according to their relative risk exposure.
At September 30, 2002, the bank had $67.0 million in residual interests that,
under the rule, will be subject to a dollar-for-dollar deduction from total
capital on December 31, 2002. Of this amount, $37.3 million was already subject
to a dollar-for-dollar deduction from total capital at September 30, 2002. The
remainder of these residual interests, to the extent still retained by the bank,
will be subject to the dollar-for-dollar deduction from total capital beginning
December 31, 2002. At September 30, 2002, the bank had credit enhancing
interest-only strips receivable of $32.9 million, which constituted 5.2% of Tier
1 capital at that date.
The bank may use supplementary capital to satisfy the risk-based capital
requirement to the extent of its core capital. Supplementary capital includes
cumulative perpetual preferred stock, qualifying non-perpetual preferred stock,
qualifying subordinated debt, non-withdrawable accounts and pledged deposits,
and allowances for loan and lease losses up to a maximum of 1.25% of
risk-weighted assets. At September 30, 2002, the bank had $71.1 million in
allowances for loan and lease losses, all of which was includable as
supplementary capital.
Subordinated debt may be included in supplementary capital with OTS approval
subject to a phase-out based on its remaining term to maturity. The phase-out
permits these instruments to be included in supplementary capital under one of
two options:
o at the beginning of each of the last five years prior to the maturity date of
the instrument, the bank must reduce the amount eligible to be included by 20%
of the original amount, or
o during the seven years immediately prior to an instrument's maturity, the bank
may include only the aggregate amount of maturing capital instruments that
mature in any one year that does not exceed 20% of its capital.
The bank has selected the second option for its subordinated debentures due 2005
and must continue to use that option for its subordinated debentures due 2008
and any future issuances as long as the prior issuance remains outstanding. At
September 30, 2002, the bank had $250.0 million in maturing subordinated capital
instruments, all of which was includable as supplementary capital. Of that
amount, $150.0 million matures in 2005 and $100.0 million matures in 2008. See
"Deposits and Other Sources of Funds - Borrowings."
On May 10, 2002, the OTS repealed the interest-rate risk component of its
risk-based capital regulation. The OTS is authorized to establish individual
minimum capital requirements for thrifts on a case-by-case basis, including
capital requirements based on an application of its interest rate risk model
used to identify those thrifts that are exposed to excessive interest rate risk.
The bank continues to monitor its interest-rate exposure in accordance with OTS
guidance. See "Asset and Liability Management."
The OTS also considers concentration of credit risk and risks arising from
non-traditional activities, as well as a thrift's ability to manage these risks,
in evaluating whether the thrift should be subject to increased capital
requirements.
All or a portion of the assets of each of the bank's subsidiaries are generally
consolidated with the assets of the bank for regulatory capital purposes unless
all of the bank's investments in, and extensions of credit to, those
subsidiaries are deducted from capital. The bank's investments in, and loans to,
subsidiaries engaged in activities not permissible for a national bank, are with
certain exceptions, deducted from capital under each of the three regulatory
capital requirements. The bank's real estate development subsidiaries are its
only subsidiaries engaged in activities not permissible for a national bank. At
September 30, 2002, the bank's investments in, and loans to, these
"non-includable subsidiaries" totaled approximately $1.6 million, of which $1.4
million constituted a deduction from tangible capital. The bank has $0.2 million
of valuation allowances maintained against its non-includable subsidiaries,
which, pursuant to OTS guidelines, are available as a credit against the
otherwise required deductions from capital.
OTS capital regulations also require a 100% deduction from total capital of all
equity investments that are not permissible for national banks. The bank's only
asset at September 30, 2002 that is treated as an equity investment for
regulatory capital purposes is a property classified as real estate held for
sale. At September 30, 2002, the book value of this property was $2.1 million,
which was required to be deducted from total capital.
OTS capital regulations provide a five-year holding period for real estate
acquired in settlement of loans ("REO" or "real estate held for sale") to
qualify for an exception from treatment as an equity investment. The five year
period may be extended by the OTS. If an REO property is considered an equity
investment, its then-current book value is deducted from total capital.
Accordingly, if the bank is unable to dispose of any REO property prior to the
end of its applicable five-year holding period and is unable to obtain an
extension of that five-year holding period from the OTS, the bank could be
required to deduct the then-current book value of such REO property from
risk-based capital. In December 2001, the bank received from the OTS additional
extensions through December 19, 2002, of the holding periods for certain of its
REO properties acquired through foreclosure in fiscal years 1990, 1991 and 1995.
The bank intends to request from the OTS an additional extension of the holding
periods for these assets. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Financial Condition - Capital."
Under guidance issued by the OTS and other federal bank regulatory agencies,
institutions with subprime lending portfolios that exceed 25% of Tier 1 capital
generally are expected to hold capital against those portfolios in an amount
that is 1 1/2 to 3 times the amount required for non-subprime assets of the same
type. However, examiners are given broad discretion over how to apply the
guidelines to a particular institution. Although the bank's subprime automobile
lending portfolio (held through a subsidiary) exceeded the 25% threshold at
September 30, 2002, the subsidiary stopped originating new loans effective
November 9, 2000 and the bank has not been directed to maintain additional
capital against its subprime portfolio since the guidance was issued in January
2001.
In January 2001, the Basle Committee on Banking Supervision published a revised
proposal to amend its 1988 risk-based capital accord, which forms the basis for
the risk-based capital requirements of the OTS and the other U.S. federal
financial institution regulators. Key components of the revised proposal
include:
o adding a fifth risk-weighting of 150 percent for loans to low-quality
companies;
o using rating agency assessments to determine risk-weightings for claims on
banks, commercial loans and securitization interests;
o liberalizing capital requirements for certain collateralized and guaranteed
loans;
o authorizing regulators to use the supervisory review process to determine
whether to impose increased capital requirements on individual institutions with
high levels of interest-rate risk or to require reduction of that risk;
o establishing a methodology for requiring that capital be maintained against
operational risk; and
o authorizing regulators to impose explicit capital requirements on managed or
securitized assets.
The Basle Committee continues to review comments received on, and the results of
several quantitative impact studies on the effects of, its January 2001 release,
as amended, and continues to refine its proposed amendments to the 1988 capital
accord as appropriate. Currently, the Basle Committee expects to finalize its
amendments to the 1988 capital accord in late 2003, and U.S. banking regulators
are expected to amend their capital rules by 2006. The bank is unable to predict
whether, or in what form, any final changes will be adopted by the Basle
Committee, or the extent to which any changes actually adopted will be reflected
in the capital requirements that apply to the bank.
The bank's ability to maintain capital compliance depends on a number of
factors, including, for example, changes in regulatory requirements, general
economic conditions and the condition of local markets. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Financial Condition - Capital." The OTS has the authority to require an
institution to maintain capital at levels above the minimum levels generally
required, but has not done so for the bank.
PROMPT CORRECTIVE ACTION. The OTS and the other federal banking agencies have
adopted regulations which apply to every FDIC-insured commercial bank and thrift
institution a system of mandatory and discretionary supervisory actions, which
generally become more severe as the capital levels of an individual institution
decline. The regulations establish five capital categories for purposes of
determining an institution's treatment under these prompt corrective action
provisions.
An institution is categorized as "well capitalized" under the regulations if (i)
it has a leverage 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%, and (ii)
is not subject to any written agreement, order, capital directive or prompt
corrective action directive issued by the OTS to meet and maintain a specific
capital level.
An institution is considered "adequately capitalized" if its leverage ratio is
at least 4.0% (3.0% if rated in the highest supervisory category), its tier 1
risk-based capital ratio is at least 4.0% and its total risk-based capital ratio
is at least 8.0%.
An institution with a leverage ratio below 4.0% (3.0% if rated in the highest
supervisory category), a tier 1 risk-based capital ratio below 4.0% or a total
risk-based capital ratio below 8.0% is considered "undercapitalized." An
institution with a leverage ratio or tier 1 risk-based ratio under 3.0% or a
total risk-based ratio under 6.0% is considered "significantly
undercapitalized." Finally, an institution is considered "critically
undercapitalized," and subject to provisions mandating appointment of a
conservator or receiver, if its ratio of "tangible equity" to total assets is
2.0% or less. "Tangible equity" generally includes core capital plus cumulative
perpetual preferred stock.
An institution's classification category could be downgraded if, after notice
and an opportunity for a hearing, the OTS determined that the institution is in
an unsafe or unsound condition or has received and has not corrected a less than
satisfactory examination rating for asset quality, management, earnings or
liquidity. The bank has not received notice from the OTS of any potential
downgrade.
At September 30, 2002, the bank's leverage ratio of 5.63%, its tier 1 risk-based
ratio of 7.08%, and its total risk-based capital ratio of 10.86% exceeded the
minimum ratios established for "well-capitalized" institutions.
QUALIFIED THRIFT LENDER TEST. The bank must meet a Qualified Thrift Lender
("QTL") test to avoid imposition of certain restrictions. The QTL test requires
the bank to maintain a "thrift investment percentage" equal to a minimum of 65%.
The numerator of the percentage is the bank's "qualified thrift investments" and
the denominator is the bank's "portfolio assets." "Portfolio assets" is defined
as total assets minus
o the bank's premises and equipment used to conduct the bank's business;
o liquid assets up to 20 percent of total assets; and
o intangible assets, including goodwill.
The QTL test must be met on a monthly average basis in nine out of every 12
months.
The bank's "qualified thrift investments" consist of residential housing loans
(including home equity loans and manufactured housing loans), mortgage-backed
securities, FHLB and Fannie Mae stock, small business loans, credit card loans
and educational loans. Portions of other assets are also includable, provided
that the total of these assets does not exceed 20% of portfolio assets. Assets
in this category include consumer loans (other than credit card and educational
loans); 50% of residential housing loans originated and sold within 90 days;
investments in real estate-oriented service corporations and 200% of mortgage
loans for residences, churches, schools, nursing homes and small businesses in
low- or moderate-income areas where credit demand exceeds supply. Intangible
assets, including goodwill, are specifically excluded from qualified thrift
investments.
The bank had 88.8% of its assets invested in qualified thrift investments at
September 30, 2002, and met the QTL test in each of the previous 12 months.
An institution that fails to meet the QTL test is subject to significant
penalties. Immediately after an institution ceases to meet the QTL test, it may
not:
o make any new investment or engage directly or indirectly in any other new
activity unless the investment or activity would be permissible for a national
bank;
o establish any new branch office at any location at which a national bank could
not establish a branch office;
o obtain new advances from the FHLB; or
o pay dividends beyond the amounts permissible if it were a national bank.
One year following an institution's failure to meet the test, the institution's
holding company parent must register and be subject to supervision as a bank
holding company. Three years after failure to meet the QTL test, an institution
may not retain any investments or engage in any activities that would be
impermissible for a national bank. Failure to meet the QTL test also could limit
the bank's ability to establish and maintain branches outside of its home state
of Virginia.
Because the bank is engaged in activities that are not currently permissible for
national banks, such as investing in subsidiaries that engage in real estate
development activities, failure to satisfy the QTL test would require the bank
to terminate these activities and divest itself of any prohibited assets held at
such time. Based on a review of the bank's current activities, management of the
bank believes that compliance with these restrictions would not have a
significant adverse effect on the bank. However, the B.F. Saul Real Estate
Investment Trust (the "Trust"), which owns 80% of the bank, is engaged in real
estate ownership and development activities currently prohibited for bank and
financial holding companies. As a result, failure by the bank to meet the QTL
test, in the absence of a significant restructuring of the Trust's operations,
would, in effect, require the Trust to reduce its ownership of the bank to a
level at which it no longer would be deemed to control the bank.
The bank has taken, and will continue to take, steps to meet the QTL test by
structuring its balance sheet to include the required percentage of qualified
thrift investments.
DIVIDENDS AND OTHER CAPITAL DISTRIBUTIONS. OTS regulations limit the ability of
the bank to make "capital distributions." "Capital distributions" include
payment of dividends, stock repurchases, cash-out mergers, repurchases of
subordinated debt and other distributions charged against the capital accounts
of an institution. The regulations do not apply to interest or principal
payments on debt, including interest or principal payments on the bank's
outstanding subordinated debentures.
The bank must notify the OTS before making any capital distribution. In
addition, the bank must apply to the OTS to make any capital distribution if the
bank does not qualify for expedited treatment under OTS regulations. If the bank
qualifies for expedited treatment, an application is required only if the total
amount of all of the bank's capital distributions for the year exceeds the sum
of the bank's net income for the year and its retained net income for the
previous two years.
In considering a notice or application, the OTS will not permit a capital
distribution if:
o the bank would be undercapitalized following the distribution;
o the capital distribution raises safety and soundness concerns; or
o the capital distribution violates any statute, regulation, agreement with the
OTS, or condition imposed by the OTS.
The OTS has approved the payment of dividends on the bank's outstanding 13%
Noncumulative Perpetual Preferred Stock, Series A (the "13% Preferred Stock"),
provided that:
o immediately after giving effect to the dividend payment, the bank's core and
risk-based regulatory capital ratios would not be less than 4.0% and 8.0%,
respectively;
o dividends are earned and payable in accordance with the OTS capital
distribution regulation; and
o the bank continues to make progress in the disposition and reduction of its
non-performing loans and real estate owned.
Dividends paid on the 10 3/8% Noncumulative Exchangeable Preferred Stock, Series
A, (the "REIT Preferred Stock") issued by Chevy Chase Preferred Capital
Corporation (the "REIT Subsidiary") are not considered "capital distributions"
provided the bank is classified as "well capitalized." However, if the bank were
not classified as "well capitalized," the entire amount of the REIT Subsidiary
preferred dividends would be treated as a capital distribution. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Financial Condition - Capital."
In addition, the OTS has conditioned the bank's recent payments of common stock
dividends on the bank's maintaining its well-capitalized status. Failure of the
bank to remain well capitalized therefore could have a material adverse effect
on the bank's ability to pay dividends on both its common and REIT Preferred
Stock.
In May 1988, in connection with the merger of a Virginia thrift into the bank,
the B.F. Saul Company (the "Saul Company") and the Trust entered into a capital
maintenance agreement in which they agreed not to cause the bank, without prior
written approval of the OTS, to pay dividends in any fiscal year in excess of
50% of the bank's net income for that fiscal year, provided that any dividends
permitted under such limitation could be deferred and paid in a subsequent year.
The bank is subject to other limitations on its ability to pay dividends. The
indenture pursuant to which $150 million principal amount of the bank's 9 1/4%
Subordinated Debentures due 2005 was issued in 1993 provides that the bank may
not pay dividends on its capital stock unless, after giving effect to the
dividend, no event of a continuing default shall have occurred and the bank is
in compliance with its regulatory capital requirements. In addition, the amount
of the proposed dividend may not exceed the sum of:
o $15 million;
o 66 2/3% of the bank's consolidated net income (as defined) accrued on a
cumulative basis commencing on October 1, 1993; and
o the aggregate net cash proceeds received by the bank after October 1, 1993
from the sale of qualified capital stock or certain debt securities, minus the
aggregate amount of any restricted payments made by the bank.
Notwithstanding these restrictions on dividends, provided no event of default
has occurred or is continuing under the 1993 Indenture, the 1993 Indenture does
not restrict the payment of dividends on the 13% Preferred Stock or any
payment-in-kind preferred stock issued in lieu of cash dividends on the 13%
Preferred Stock or the redemption of any such payment-in-kind preferred stock.
The indenture pursuant to which $100 million principal amount of the bank's 1996
Debentures was issued provides that the proposed dividend may not exceed the sum
of the restrictions discussed above for the 1993 Indenture and the aggregate
liquidation preference of the bank's 10?% Noncumulative Preferred Stock, Series
B (the "Series B Preferred Stock"), if issued in exchange for the outstanding
REIT Preferred Stock. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Financial Condition - Capital" and
"Security Ownership of Certain Beneficial Owners and Management."
The payment of any dividends on the bank's common stock and preferred stock will
be determined by the Board of Directors based on the bank's liquidity, asset
quality profile, capital adequacy and recent earnings history, as well as
economic conditions and other factors that the Board of Directors determines are
relevant, including applicable government regulations and policies. See
"Deposits and Other Sources of Funds - Borrowings."
LENDING LIMITS. The bank generally is prohibited from lending to one borrower
and its related entities amounts in excess of 15% of unimpaired capital and
unimpaired surplus. The bank may lend an additional 10% for loans fully secured
by readily marketable collateral. The bank's regulatory lending limit was
approximately $143.2 million at September 30, 2002, and no group relationships
exceeded this limit at that date.
SAFETY AND SOUNDNESS STANDARDS. The federal financial institution regulators
have developed standards to evaluate the operations of depository institutions,
as well as standards relating to asset quality, earnings and compensation. The
operational standards cover internal controls and audit systems, loan
documentation, credit underwriting, interest rate exposure, asset growth and
employee compensation. An institution that fails to meet a standard that is
imposed through regulation may be required to submit a plan for corrective
action within 30 days. If a savings association fails to submit or implement an
acceptable plan, the OTS must order it to correct the deficiency, and may:
o restrict its rate of asset growth;
o prohibit asset growth entirely;
o require the institution to increase its ratio of tangible equity to assets;
o restrict the interest rate paid on deposits to the prevailing rates of
interest on deposits of comparable amounts and maturities; or
o require the institution to take any other action the OTS determines will
better carry out the purpose of prompt corrective action.
Imposition of these sanctions is within the discretion of the OTS in most cases,
but is mandatory if the savings institution commenced operations or experienced
a change in control during the 24 months preceding the institution's failure to
meet these standards, or underwent extraordinary growth during the preceding 18
months.
The asset quality standards require that the bank establish and maintain a
system to identify problem assets and prevent deterioration of those assets. The
earnings standards require that the bank establish and maintain a system to
evaluate and monitor earnings and ensure that earnings are sufficient to
maintain adequate capital and reserves.
REGULATORY ASSESSMENTS. The OTS imposes five separate fees to fund its operations:
o semi-annual assessments for all savings institutions;
o examination fees for certain affiliates of savings institutions;
o application fees;
o securities filing fees; and
o publication fees.
Of these fees, the semi-annual assessments are the most significant, totaling
$1.7 million for the bank for the 12 month period ending December 31, 2002.
The OTS formula for charging examination and supervisory assessments imposes a
surcharge on institutions with a supervisory rating of 3, 4 or 5. Surcharges are
also imposed on "complex institutions," which the OTS defines as any institution
with over $1 billion of off-balance sheet assets consisting of loans serviced
for others, trust assets and recourse obligations or direct credit substitutes.
The bank is treated as a "complex institution" for these purposes.
OTHER REGULATIONS AND LEGISLATION. The bank must obtain prior approval of the
OTS before merging with another institution or before acquiring insured deposits
through certain transactions. Also, as a SAIF-insured institution, the bank is
subject to limitations on its ability to buy or sell deposits from or to, or to
combine with, a BIF-insured institution. Despite these restrictions,
SAIF-insured thrifts may be acquired by banks or by bank holding companies under
certain circumstances.
The federal agencies regulating financial institutions possess broad enforcement
authority over the institutions they regulate, including the authority to impose
civil money penalties of up to $1 million per day for violations of laws and
regulations.
Federally chartered thrifts like Chevy Chase generally are permitted to operate
branches anywhere in the United States, provided that they meet the QTL test and
their regulatory capital requirements and have at least a satisfactory rating
under the Community Reinvestment Act ("CRA").
Amounts realized by the FDIC from the liquidation or other resolution of any
insured depository institution must be distributed to pay claims (other than
secured claims to the extent of any such security) in the following order of
priority:
o administrative expenses of the receiver;
o any deposit liability of the institution;
o any other general or senior liability of the institution (which is not an
obligation described below);
o any obligation subordinated to depositors or general creditors which is not a
stockholder obligation; and
o any obligation to stockholders arising as a result of their status as
stockholders.
ENVIRONMENTAL REGULATION. The bank's business and properties are subject to
federal and state laws and regulations governing environmental matters,
including the regulation of hazardous substances and wastes. Under the federal
Comprehensive Environmental Response, Compensation and Liability Act of 1980, as
amended ("CERCLA"), and under some state laws, owners of properties and secured
lenders which take a deed-in-lieu of foreclosure, purchase a mortgaged property
at a foreclosure sale, or operate a mortgaged property may become liable in some
circumstances for the costs of cleaning up hazardous substances regardless of
whether they have contaminated the property. These costs could exceed the
original or unamortized principal balance of a loan or the value of the property
securing a loan. The bank is eligible in many instances for an exemption from
CERCLA liability as a secured creditor, provided the bank does not participate
in the management of a property and only acts to protect its security interest
in the property. Under this exemption, the Bank may foreclose on a mortgaged
property, purchase it at a foreclosure sale or accept a deed-in-lieu of
foreclosure, provided it seeks to sell the mortgaged property at the earliest
practicable commercially reasonable time on commercially reasonable terms. Other
federal and state environmental laws may impose additional liabilities in
certain circumstances, including certain state laws that impose environmental
liens that could be senior to the bank's prior recorded liens. These laws may
influence the bank's decision whether to foreclose on property that is found to
be contaminated. The bank's general policy is to obtain an environmental
assessment prior to foreclosing on commercial property.
Recent Developments. In response to the September 11 terrorist attacks, on
October 26, 2001, President Bush signed into law the Uniting and Strengthening
America by Providing Appropriate Tools Required to Intercept and Obstruct
Terrorism Act (the "USA Patriot Act"). Title III of the USA Patriot Act amends
the Bank Secrecy Act and contains provisions designed to detect and prevent the
use of the U.S. financial system for money laundering and terrorist financing
activities by, among other things, imposing new compliance obligations on
savings associations, trust companies and securities broker-dealers. Many of
these compliance obligations focus on transactions between U.S. financial
institutions and non-U.S. banks, entities and individuals, and therefore will
not have a significant impact on the bank's operations. However, the bank has
taken steps to enhance its anti-money laundering policies and procedures
following enactment of the USA Patriot Act and will continue to monitor
developments regarding implementation of the Act and make further adjustments to
those policies and procedures as appropriate.
On July 29, 2002, the Department of Housing and Urban Development proposed a
rule that would: (i) clarify the disclosure rules regarding yield spread
premiums paid to mortgage brokers and their cost to borrowers, (ii) amend the
format of the good faith estimate ("GFE") disclosure, and (iii) allow lenders to
provide guaranteed packages of settlement services and prescribe a form, as an
alternative to the traditional GFE disclosure, for lenders to use when
presenting guaranteed packages of settlement services to consumers. While the
rule confirms that yield spread premiums are a permissible form of mortgage
broker compensation and would permit the bank to provide guaranteed packages of
settlement services to its borrowers, the bank is uncertain whether or in what
form the proposed rule will ultimately be adopted and accordingly is not yet
able to ascertain the impact it may have on the bank. Comments on the proposed
rule were due by October 28, 2002.
FEDERAL RESERVE SYSTEM
The Federal Reserve Board requires the bank to maintain reserves against its
transaction accounts and certain non-personal deposit accounts. Because reserves
generally must be maintained in cash or non-interest-bearing accounts, the
effect of the reserve requirement is to decrease the bank's earnings.
Prior to November 27, 2001, the first $5.5 million of the bank's transaction
accounts were subject to a 0% reserve requirement. The next $37.3 million in net
transaction accounts were subject to a 3% reserve requirement and any net
transaction accounts over $42.8 million were subject to a 10% reserve
requirement. Effective November 27, 2001, the FRB increased the amount of
transactions accounts subject to a 0% reserve requirement from $5.5 million to
$5.7 million and decreased the "low reserve tranche" from $37.3 million to $35.6
million, which brings the net transaction amount that was subject to the 10%
reserve requirement to amounts over $41.3 million. The bank met its reserve
requirements for each period during the year ended September 30, 2002. Effective
November 26, 2002, the first $6.0 million of the bank's transaction accounts
will be subject to a 0% reserve requirement. The next $36.1 million in net
transaction accounts will be subject to a 3% reserve requirement and net
transaction accounts over $42.1 million will be subject to a 10% reserve
requirement.
The bank may borrow from the Federal Reserve's "discount window," but only after
exhausting all reasonable alternate sources of funds, including the FHLB. FDICIA
imposes additional limitations on the ability of the Federal Reserve to lend to
undercapitalized institutions through the discount window.
COMMUNITY REINVESTMENT ACT
Under the CRA and the OTS's regulations, the bank has a continuing and
affirmative obligation to help meet the credit needs of its local communities,
including low- and moderate-income neighborhoods and low- and moderate-income
individuals and families, consistent with the safe and sound operation of the
institution. The OTS is required to assess the institution's record in
satisfying the intent of the CRA in connection with its examination of the bank.
In addition, the OTS is required to take into account the bank's record of
meeting the credit needs of its community in determining whether to grant
approval for certain types of applications.
The bank is committed to fulfilling its CRA obligation by providing access to a
full range of credit-related products and services to all segments of its
community. Based on the last OTS examination covering the period from June 1997
through January 2000, the bank received a "satisfactory" CRA rating. The bank
anticipates that its next CRA examination will take place in the latter part of
2002 or early in 2003.
Under the CRA, the bank is tested in three areas:
o LENDING - how well the bank meets the credit needs of low- and
moderate-income borrowers and neighborhoods in its defined
assessment areas;
o SERVICE - the bank's ability to deliver reasonable and accessible
financial products and services, such as retail banking branches
and ATMs, and support community development services, such as
financial literacy education and homebuyer counseling; and
o INVESTMENT - the bank's ability to commit to innovative and
qualified CRA investments such as equity investments which support
and promote affordable housing and economic development in low-
and moderate-income neighborhoods in the bank's assessment areas.
Examples of qualified CRA investments are the bank's investment in the Mid
Atlantic Affordable Housing Fund I in January 2000 for $5 million and in the Mid
Atlantic Affordable Housing Fund II in March 2001 for $5 million. These
investments allowed the bank to provide equity financing to several multifamily
housing projects located in Maryland, Delaware, Northern Virginia and the
District of Columbia, which provide rental housing for low- and moderate-income
seniors and families. Because the bank's investments qualify for low-income
housing tax credits under federal tax laws, the bank will receive tax benefits
relating to these investments over the next 15 years.
During fiscal year 2002, the bank continued to increase its CRA investments by
purchasing CRA targeted mortgage backed securities, which had a book value of
$20.6 million at September 30, 2002. These securities are comprised of loans
made to low- and moderate-income borrowers and are secured by properties in low-
and moderate-income neighborhoods within the bank's assessment area. Further,
the bank in June 2002 made a qualified CRA investment in the form of a $225,000
loan to the Washington Area Community Investment Fund ("WACIF"), designated by
the Department of Treasury as a Community Development Investment Fund. This
investment allows WACIF to provide financing to non-profit organizations engaged
in building affordable housing in the Washington, DC area.
On July 19, 2001, the OTS and the other federal banking regulators issued a
joint advance notice of proposed rulemaking, seeking public comment on a broad
range of issues under the agencies' current CRA regulations in an effort to
assess how the regulations should be amended to better analyze a financial
institution's performance under the CRA. Comments on the notice of proposed
rulemaking were due October 17, 2001. The bank is unable to predict whether, and
in what form, any final changes will be adopted, or the impact those changes may
have on the bank.
OTHER ASPECTS OF FEDERAL LAW
The bank is also subject to federal statutory provisions covering matters such
as security procedures, currency transactions reporting, insider and affiliated
party transactions, management interlocks, truth-in-lending, electronic funds
transfers, funds availability, equal credit opportunity and privacy of consumer
information.
HOLDING COMPANY REGULATION
The Trust, the Saul Company, Chevy Chase Property Company, and Westminster
Investing Corporation (the "Holding Companies") are registered as "savings and
loan holding companies" because of their direct or indirect ownership interests
in the bank, and are subject to regulation, examination and supervision by the
OTS. The bank is prohibited from making or guaranteeing loans or advances to or
for the benefit of the Holding Companies or other affiliates engaged in
activities beyond those permissible for bank holding companies and from
investing in the securities of the Holding Companies or other affiliates.
Transactions between the bank and the Holding Companies must be on terms
substantially the same, or at least as favorable to the bank, as those that
would be available to non-affiliates.
On April 16, 2002, the OTS published a revised Regulatory Handbook for Holding
Companies. The revised handbook mostly reorganizes and expands upon aspects of
the earlier edition, but also suggests a more active role for the OTS in the
direct regulation of thrift holding companies such as the Holding Companies. The
revised handbook places a greater emphasis on reviewing the adequacy of the
Holding Companies' capital, their level of debt, and their ability to fund
outstanding debt obligations, and suggests that particular scrutiny will be
given to holding companies that, like the Holding Companies, are engaged in real
estate activities.
The Holding Companies must obtain OTS approval before acquiring any federally
insured savings institution or any savings and loan holding company. The status
of the Holding Companies as "unitary thrift holding companies" and the
activities in which the Holding Companies may engage have been grandfathered
under the Gramm-Leach-Bliley Act of 1999 (the "GLB Act"). As grandfathered
unitary thrift holding companies, the Holding Companies are virtually
unrestricted in the types of business activities in which they may engage
provided the bank continues to meet the QTL test. See Qualified Thrift Lender
Test. The GLB Act prohibits the sale of grandfathered unitary thrift holding
companies such as the Holding Companies (together with their thrift
subsidiaries) or their thrift subsidiaries alone to commercial companies.
Corporate reorganizations are expressly permitted.
If the Holding Companies were to acquire one or more federally insured
institutions and operate them as separate subsidiaries rather than merging them
into the bank, the Holding Companies would become "multiple" savings and loan
holding companies. As multiple savings and loan holding companies, the Holding
Companies would be subject to limitations on the types of business activities in
which they would be permitted to engage, unless the additional thrifts were
troubled institutions acquired pursuant to certain emergency acquisition
provisions and all subsidiary thrifts met the QTL test. The Holding Companies
may acquire and operate additional savings institution subsidiaries outside of
Maryland and Virginia only if the laws of the target institution's state
specifically permit such acquisitions or if the acquisitions are made pursuant
to emergency acquisition provisions.
The Trust and the Saul Company entered into an agreement with OTS's predecessor,
the Federal Savings and Loan Insurance Corporation, to maintain the bank's
regulatory capital at the required levels, and, if necessary, to infuse
additional capital to enable the bank to meet those requirements. Since the
execution of this agreement, the OTS has changed its policy and no longer
requires such agreements from companies acquiring thrift institutions. In
addition, the regulatory capital requirements applicable to the bank have
changed significantly as a result of FIRREA. The OTS has stated that capital
maintenance agreements entered into prior to the modification of OTS policy and
the enactment of FIRREA were not affected by those changes. The Trust and the
Saul Company have not sought to modify the existing agreement. To the extent the
bank is unable to meet regulatory capital requirements in the future, the OTS
could seek to enforce the obligations of the Trust and the Saul Company under
the agreement.
If the bank were to become "undercapitalized" under the prompt corrective action
regulations, it would be required to file a capital restoration plan with the
OTS setting forth, among other things, the steps the bank would take to become
"adequately capitalized." The OTS could not accept the plan unless the Holding
Companies guaranteed in writing the bank's compliance with that plan. The
aggregate liability of the Holding Companies under such a commitment would be
limited to the lesser of:
o an amount equal to 5.0% of the bank's total assets at the time the bank became
"undercapitalized," or
o the amount necessary to bring the bank into compliance with all applicable
capital standards as of the time the bank fails to comply with its capital plan.
If the Holding Companies refused to provide the guarantee, the bank would be
subject to the more restrictive supervisory actions applicable to "significantly
undercapitalized" institutions. See "Regulation - Prompt Corrective Action."
RECENT ACCOUNTING PRONOUNCEMENTS
The bank adopted Financial Accounting Standards Board ("FASB") Statement of
Financial Accounting Standard ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133") effective October 1, 2000. SFAS
133 was amended by SFAS No. 137, "Accounting for Derivative Instruments and
Hedging Activities - Deferral of Effective Date of Financial Accounting
Standards Board Statement No. 133" ("SFAS 137") and SFAS No. 138, "Accounting
for Certain Derivative Instruments and Certain Hedging Activities - an amendment
of FASB Statement No. 133" ("SFAS 138"). SFAS 133, as amended by SFAS 137 and
SFAS 138, establishes accounting and reporting standards for derivative
instruments and hedging activities. SFAS 133 requires an entity to recognize all
derivative instruments as either assets or liabilities in the statement of
financial condition and measure those instruments at fair value. Changes in the
fair value of those instruments are reported in earnings or other comprehensive
income depending on the use of the derivative, its hedge designation and whether
the hedge is effective in achieving offsetting changes in the fair value or cash
flows of the asset or liability hedged. On October 1, 2000, the bank recorded an
after tax loss of $476 thousand in Other Comprehensive Income representing its
transition adjustment from the adoption of these standards.
On July 1, 2002, the bank implemented FASB guidance regarding the application of
SFAS 133, which requires that interest rate locks ("IRL") on mortgage loans held
for sale be treated as derivatives. The IRLs are treated as free standing
derivatives with changes in fair value recorded in the income statement and
reported on the balance sheet. In connection with this change, the bank's
forward sale commitments were re-designated from cash flow hedges to either fair
value hedges or non-designated hedge relationships. The net income statement
impact of the change was $80 thousand, net of tax. The net impact on other
accumulated comprehensive income was $1.2 million.
SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities - a replacement of SFAS No. 125," ("SFAS 140")
was issued in September 2000. SFAS 140 provides consistent standards for
distinguishing transfers of financial assets that are sales from transfers that
are secured borrowings. Under SFAS 140, after a transfer of financial assets, an
entity recognizes the financial and servicing assets it controls and the
liabilities it has incurred, derecognizes financial assets when control has been
surrendered, and derecognizes liabilities when extinguished. SFAS 140 was
effective for transfers after March 31, 2001, except that the effective date for
the isolation standards was suspended for financial institutions until January
1, 2002, and was effective for disclosures about securitizations and collateral
and for recognition and reclassification of collateral for fiscal years ending
after December 15, 2000. The adoption of SFAS 140 did not have a material impact
on the bank's financial condition or results of operations.
SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142") was issued in
June 2001. SFAS 142 supersedes APB Opinion No. 17, "Intangible Assets." SFAS 142
establishes new guidance on accounting for goodwill and other assets acquired in
a business combination and reaffirms that acquired intangible assets should
initially be recognized at fair value and the costs of internally developed
intangible assets should be charged to expense as incurred. SFAS 142 also
requires that goodwill arising in a business combination should no longer be
amortized, but, instead, be subjected to impairment testing. An impairment loss
is recognized if fair value is less than the carrying amount. SFAS 142 is
effective for fiscal years beginning after December 15, 2001 and must be applied
as of the beginning of the fiscal year. At October 1, 2002, the fair value of
the goodwill recorded on the bank's balance sheet exceeded its carrying value.
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets"
("SFAS 144") was issued in August 2001. SFAS 144 supersedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of," and the accounting and reporting provisions of APB Opinion No.
30, "Reporting the Results of Operations - Reporting the Effects of Disposal of
a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions." SFAS 144 addresses financial accounting and reporting
for the impairment or disposal of long-lived assets and broadens the
presentation of discontinued operations to include more disposal transactions.
SFAS 144 is effective for fiscal years beginning after December 15, 2001. The
adoption of this statement will not have a material effect on the bank's
financial condition or results of operations.
MARKET AREA
The bank's principal deposit and lending markets are located in the Washington,
DC metropolitan area. Service industries and federal, state and local
governments employ a significant portion of the Washington, DC area labor force,
while a substantial number of the nation's 500 largest corporations have some
presence in the area. The Washington, DC area's seasonally unadjusted
unemployment rate is generally below the national rate and was 3.6% in August
2002, compared to the national rate of 5.6%.
Chevy Chase historically has relied on retail deposits originated in its branch
network as its primary funding source. See "Deposits and Other Sources of
Funds." Chevy Chase's principal market for deposits consists of Montgomery and
Prince George's Counties in Maryland and Fairfax County in Virginia.
Approximately 7.3% of the bank's deposits at September 30, 2002 were obtained
from depositors residing outside of Maryland, Northern Virginia and the District
of Columbia. Chevy Chase had the largest market share of deposits in Montgomery
County, and ranked third in market share of deposits in Prince George's County
at June 30, 2001, according to the most recently published industry statistics.
The per capita incomes of Montgomery and Fairfax Counties rank among the highest
of counties and equivalent jurisdictions nationally. These two counties are also
the Washington, DC area's largest suburban employment centers, with a
substantial portion of their labor force consisting of federal, state and local
government employees. Private employment is concentrated in services and retail
trade centers. The unemployment rate in Montgomery and Fairfax Counties in
August 2002 of 2.6% and 3.0%, respectively, were below the national rate of 5.6%
and individual state rates of 4.2% for both Maryland and Virginia for the same
month.
The bank historically has concentrated its lending activities in the Washington,
DC metropolitan area. In recent years, the bank has expanded its lending
activities outside the Washington, DC Metropolitan area. See "Lending
Activities."
INVESTMENT AND OTHER SECURITIES
The bank is required by OTS regulations to maintain sufficient liquidity to
ensure its safe and sound operations. See "Regulation - Liquidity Requirements."
To meet this requirement, the bank maintains a portfolio of cash, federal funds,
treasury securities and other readily marketable fixed-income securities.
Management's objective is to maintain liquidity at a level sufficient to assure
adequate funds to meet expected and unexpected balance sheet fluctuations.
The bank classifies its U.S. Government securities and mortgage-backed
securities as either "held-to-maturity," "available-for-sale" or "trading" at
the time such securities are acquired. All U.S. Government securities and
mortgage-backed securities were classified as held-to-maturity at September 30,
2002 and 2001.
As part of its mortgage banking activities, the bank exchanges loans held for
sale for mortgage-backed securities and then sells the mortgage-backed
securities, which are classified as trading securities, to third party investors
in the month of issuance. Gains and losses on sales of trading securities are
determined using the specific identification method. There were no
mortgage-backed securities classified as trading securities at September 30,
2002 and 2001.
At September 30, 2001, the bank held automobile receivables-backed securities,
which were classified as trading securities. These securities were created as
part of two automobile loan securitizations and represent subordinate classes of
certificates retained by the bank. The securities were redeemed during fiscal
year 2002.
At September 30, 2002 and 2001, the bank held shares in Concord EFS, Inc., a
publicly traded ATM service provider, with a carrying value of $3.9 million and
$5.5 million, respectively, which were classified as trading securities.
LENDING ACTIVITIES
LOAN AND LEASE PORTFOLIO COMPOSITION. At September 30, 2002, the bank's loan and
lease portfolio totaled $8.8 billion, which represented 78.3% of its total
assets. All references in this report to the bank's loan portfolio refer to
loans and leases, whether they are held for sale and/or securitization or for
investment, and exclude mortgage-backed securities. Loans collateralized by
single-family residences constituted 63.8% of the loan and lease portfolio and
49.9% of total assets at that date. The following table sets forth information
concerning the bank's loan and lease portfolio net of unfunded commitments for
the periods indicated.
LOAN AND LEASE PORTFOLIO
(Dollars in thousands)
September 30,
------------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
-------------------- ------------------- ------------------- -------------------- --------------------
% of % of % of % of % of
Balance Total Balance Total Balance Total Balance Total Balance Total
------------ ------- ----------- ------- ----------- ------- ------------ ------- ------------ -------
Single family residential (1) $4,545,519 51.5 % $4,519,269 52.9 % $4,870,474 58.6 % $3,944,932 60.9 % $1,760,266 63.2 %
Home equity (1) 1,090,325 12.3 646,390 7.6 427,399 5.1 398,745 6.2 202,319 7.2
Commercial real estate and
multifamily 20,578 0.2 30,703 0.4 39,230 0.5 57,051 0.9 74,164 2.7
Real estate construction and
ground (2) 260,199 2.9 267,303 3.1 296,705 3.6 228,464 3.5 108,379 3.9
Commercial (2) 803,168 9.1 769,443 9.0 596,384 7.2 394,142 6.1 174,076 6.2
Prime Automobile loans (1) 623,734 7.0 600,865 7.0 772,899 9.3 717,712 11.1 121,350 4.4
Automobile leases 1,130,425 12.8 1,124,106 13.2 568,091 6.8 109,724 1.7 22 -
Subprime automobile loans (1) 232,001 2.6 420,658 5.0 620,588 7.4 480,533 7.4 236,454 8.5
Home improvement and related
loans (1) 102,922 1.2 116,394 1.4 91,130 1.1 113,650 1.7 74,351 2.7
Overdraft lines of credit and
other consumer 37,300 0.4 36,356 0.4 31,608 0.4 31,645 0.5 33,484 1.2
------------ ------- ----------- ------- ----------- ------- ------------ ------- ------------ -------
8,846,171 100.0 % 8,531,487 100.0 % 8,314,508 100.0 % 6,476,598 100.0 % 2,784,865 100.0 %
------------ ======= ----------- ======= ----------- ======= ------------ ======= ------------ =======
Less:
Unearned premiums and
discounts (1,690) (2,445) (3,814) (5,589) (2,163)
Net deferred loan
origination costs (57,627) (40,554) (34,833) (16,133) (850)
Allowance for loan and
lease losses 71,109 63,018 54,018 58,139 60,157
------------ ----------- ---------- ------------ ------------
11,792 20,019 15,371 36,417 57,144
------------ ----------- ---------- ------------ ------------
Total loans and
leases receivable $8,834,379 $8,511,468 $8,299,137 $6,440,181 $2,727,721
============ =========== =========== ============ ============
- -----------------------------------------------------------------------------------------------------------------------------------
(1) Includes loans held for securitization and/or sale, if any.
(2) Net of undisbursed portion of loans.
The bank adjusts the composition of its loan and lease portfolio in response to
a variety of factors, including regulatory requirements and asset and liability
management objectives. See "Regulation - Regulatory Capital," "Qualified Thrift
Lender Test" and "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Financial Condition - Asset and Liability
Management."
CONTRACTUAL PRINCIPAL REPAYMENTS OF LOANS AND LEASES. The following table shows
the scheduled contractual principal repayments of the bank's loans and leases at
September 30, 2002. The entire balance of loans held for securitization and/or
sale is shown in the year ending September 30, 2003, because such loans are
expected to be sold in less than one year.
CONTRACTUAL PRINCIPAL REPAYMENTS
(In thousands)
- -----------------------------------------------------------------------------------------------------------------------------------
Principal
Balance Approximate Principal Repayments
Outstanding at Due in Years Ending September 30,
----------------------------------------------------------------------------------------------
September 30, 2018 and
2002(1) 2003 2004 2005 2006-2007 2008-2012 2013-2017 Thereafter
---------------- --------------- ------------ ------------ ----------- ------------ ------------ --------------
Single family
residential $ 3,624,711 $ 55,086 $ 62,847 $ 66,863 145,845 $ 447,573 $ 569,271 $ $ 2,277,226
Home equity 1,090,325 20,340 21,470 22,307 46,199 135,961 213,638 630,410
Commercial
real estate
and multifamily 20,578 249 431 2,314 2,319 15,265 - -
Real estate
construction
and ground 260,199 198,879 57,801 609 735 2,175 - -
Commercial 803,168 342,950 107,474 69,238 91,409 136,118 10,564 45,415
Prime automobile
loans 333,078 93,755 92,184 71,044 69,119 6,976 - -
Automobile leases 1,130,425 309,361 358,944 260,540 198,413 3,167 - -
Subprime automobile
loans 232,001 96,110 80,549 49,461 5,881 - - -
Home improvement
and related loans 101,156 4,890 5,013 5,110 10,559 27,822 27,196 20,566
Overdraft lines of
credit and
other consumer 37,300 7,269 6,654 6,794 15,344 1,239 - -
Loans held for
securitization
and/or sale 1,213,230 1,213,230 - - - - - -
---------------- --------------- ------------ ------------ ----------- ------------ ------------ --------------
Total loans
and leases
receivable(2) $ 8,846,171 $ 2,342,119 $ 793,367 $ 554,280 585,823 $ 776,296 $ 820,669 $ 2,973,617
================ =============== ============ ============ =========== ============ ============ ==============
Fixed-rate loans
and leases $ 3,729,051 $ 931,258 660,913 $ 451,115 427,874 $ 417,263 $ 342,456 $ 498,172
Adjustable-rate loans 3,903,890 197,631 132,454 103,165 157,949 359,033 478,213 2,475,445
Loans held for
securitization
and/or sale 1,213,230 1,213,230 - - - - - -
---------------- ------------- ------------ ------------ ----------- ------------ ------------ --------------
Total loans
and leases
receivable(2) $ 8,846,171 $ 2,342,119 $ 793,367 $ 554,280 585,823 $ 776,296 $ 820,669 $ 2,973,617
================ =============== ============ ============ =========== ============ ============ ==============
- ------------------------------------------------------------------------------------------------------------------------------------
(1) Of the total amount of loans and leases outstanding at September 30, 2002,
which were due after one year, an aggregate principal balance of approximately
$2.8 billion had fixed interest rates and an aggregate principal balance of
approximately $3.7 billion had adjustable interest rates.
(2) Before deduction of reserve for loan losses, unearned premiums and discounts
and deferred loan fees.
Actual payments may not reflect scheduled contractual principal repayments due
to the effect of loan refinancings, prepayments and enforcement of due-on-sale
clauses. Due-on-sale clauses give the bank the right to declare a "conventional
loan" -- one that is neither insured by the Federal Housing Administration nor
partially guaranteed by the Veterans' Administration -- immediately due and
payable in the event, among other things, that the borrower sells the property
securing the loan without the consent of the bank. Although the bank's
single-family residential loans historically have had stated maturities of
generally 30 years, such loans normally have remained outstanding for
substantially shorter periods because of these factors. At September 30, 2002,
excluding loans held for securitization and/or sale, aggregate principal
repayments of $1.1 billion against all loans are contractually due within the
next year. Of this amount, $936.7 million is due on fixed-rate loans and $198.8
million is due on adjustable-rate loans.
ORIGINATION, PURCHASE AND SALE OF REAL ESTATE LOANS. The bank has general
authority to make loans secured by real estate located throughout the United
States. The following table shows changes in the composition of the bank's real
estate loan portfolio and the net change in mortgage-backed securities.
ORIGINATION, PURCHASE AND SALE OF REAL ESTATE LOANS
(IN THOUSANDS)
For the Year Ended September 30,
--------------------------------------------------------------------------------
2002 2001 2000
-------------------- -------------------- --------------------
Real estate loan originations and purchases: (1)
Single family residential $ 5,036,548 $ 3,184,380 $ 1,666,639
Home equity 902,845 528,450 267,694
Commercial real estate and multifamily - - 4,602
Real estate construction and ground 259,858 259,130 259,537
-------------------- -------------------- --------------------
Total originations and purchases 6,199,251 3,971,960 2,198,472
-------------------- -------------------- --------------------
Principal repayments (2,512,415) (1,789,846) (502,156)
Sales (2,043,630) (674,652) (383,824)
Loans transferred to real estate acquired
in settlement of loans (4,174) (720) (5,616)
-------------------- -------------------- --------------------
(4,560,219) (2,465,218) (891,596)
-------------------- -------------------- --------------------
Transfers to mortgage-backed securities (2) (1,186,436) (1,676,885) (302,260)
-------------------- -------------------- --------------------
Increase (decrease) in real estate loans $ 452,596 $ (170,143) $ 1,004,616
==================== ==================== ====================
(1) Net of undisbursed portion of loans.
(2) Represents real estate loans which were pooled and exchanged for
mortgage-backed securities.
SINGLE-FAMILY RESIDENTIAL REAL ESTATE LENDING. The bank originates a variety of
loans secured by single-family residences. At September 30, 2002, $5.6 billion,
or 63.8%, of the bank's loan and lease portfolio consisted of loans secured by
first or second mortgages on such properties, as compared to $5.2 billion, or
60.5%, at September 30, 2001. Of these amounts, $12.9 million and $34.5 million
consisted of FHA-insured or VA-guaranteed loans at September 30, 2002 and 2001,
respectively. Approximately 34.8% of the principal balance of the bank's
single-family residential real estate loans at September 30, 2002 were secured
by properties located in Maryland, Virginia or the District of Columbia.
The bank originates VA, FHA and a wide variety of conventional residential
mortgage loans through its wholly owned mortgage banking subsidiary, B. F. Saul
Mortgage Company, and through Chevy Chase Mortgage, a division of the bank. The
bank currently offers fixed-rate loans with maturities of 10 to 30 years and
adjustable-rate residential mortgage loans, principally with maturities of 30
years.
The bank maintains a network of third party originators, including loan brokers
and financial institutions, in order to supplement its direct origination of
single-family residential mortgage loans. The bank determines the specific loan
products and rates under which the third party originates the loan, and subjects
the loan to the bank's underwriting criteria and review. During the year ended
September 30, 2002, approximately $3.2 billion of loans settled under this
program.
Interest rates on the majority of the bank's ARMs are adjusted based on either
changes in (a) yields on U.S. Treasury securities or (b) the London Interbank
Offered Rate ("LIBOR") of varying maturities. The interest rate adjustment
provisions of the bank's ARMs may contain limitations on the frequency and/or
maximum amount of interest rate adjustments. These limitations are determined by
a variety of factors, including mortgage loan competition in the bank's markets.
The bank has significantly expanded its origination of residential ARMs with
interest rates that adjust monthly, semi-annually and annually, some of which
provide a borrower with a below-market introductory rate and a variety of
monthly payment options. One of the payment options could result in interest
being added to the principal of the loan, or "negative amortization." During
fiscal years 2002 and 2001, the bank originated $3.0 billion and $0.9 billion,
respectively, of these ARMs, all of which contained terms that limit the amount
of negative amortization to no more than 10% of the original loan amount. At
September 30, 2002, loans with this negative amortization option totaled $2.4
billion, which includes approximately $5.0 million of negative amortization in
excess of the original principal balance. The bank is monitoring the risks
associated with these ARM products, and has established terms for loans it
originates (including caps on the amount of negative amortization) designed to
minimize credit risks without adversely affecting the bank's competitive
position. Increased emphasis of these ARM products is a key part of management's
efforts to focus on originating mortgage loans with interest rates that adjust
more frequently in order to reduce the bank's interest-rate risk in the event
market interest rates rise from their current historically low levels. At
September 30, 2002, 81.5% of the bank's residential mortgage loans were
comprised of ARMs and 62.3% of the bank's residential mortgage loans were
comprised of ARMs that have interest rates which adjust annually or more
frequently.
Loan sales provide the bank with liquidity and additional funds for lending,
enabling the bank to increase the volume of loans originated and thereby
increase loan interest and fee income as well as gains on sales of loans. In
fiscal year 2002, sales of mortgage loans originated or purchased for sale by
the bank totaled $2.0 billion compared to $674.7 million during fiscal year
2001. The marketability of loans, loan participations and mortgage-backed
securities depends on purchasers' investment limitations, general market and
competitive conditions, mortgage loan demand and other factors.
The bank's conforming fixed-rate, single-family loans are originated on terms
which conform to Federal Home Loan Mortgage Corporation, Federal National
Mortgage Association and Government National Mortgage Association guidelines in
order to facilitate the securitization and/or sale of those loans. In order to
manage its interest-rate exposure, the bank hedges its held for sale mortgage
loan pipeline by entering into whole loan and mortgage-backed security forward
sale commitments. Sales of residential mortgage loans are generally made without
recourse to the bank. At September 30, 2002, the bank had $930.6 million of
single-family residential loans held for securitization and/or sale to
investors.
From time to time, as part of its capital and liquidity management plans, the
bank may consider exchanging loans held in its portfolio for lower risk-weighted
mortgage-backed securities and retaining those securities in its portfolio
rather than selling them. The bank did not exchange any of its loans held in its
portfolio for mortgage-backed securities during fiscal year 2002. During fiscal
year 2001, the bank exchanged $837.7 million of single-family residential loans
held in its portfolio for mortgage-backed securities, which the bank retained
for its own portfolio.
When the bank sells a residential whole loan or loan participation and retains
servicing, or purchases mortgage servicing assets from third parties, it
collects and remits loan payments, makes certain insurance and tax payments on
behalf of borrowers and otherwise services the loans. The servicing fee,
generally ranging from 0.25% to 0.50% per year of the outstanding loan principal
amount, is recognized as income over the life of the loans. The bank also
typically derives income from temporary investment for its own account of loan
collections pending remittance to the participation or whole loan purchaser. At
September 30, 2002, the bank was servicing residential permanent loans totaling
$6.9 billion for other investors. See "Loan Servicing."
SALES OF MORTGAGE-BACKED SECURITIES. The bank originates and sells
mortgage-backed securities pursuant to its normal mortgage banking operations.
The securities are generally issued in the same month as they are sold. The
securities are formed from conforming mortgage loans originated for sale or from
conforming mortgage loans resulting from the borrower's election to convert from
an adjustable-rate loan to a fixed-rate loan. Mortgage-backed securities held
for sale in conjunction with mortgage banking activities are classified as
trading securities. During the years ended September 30, 2002 and 2001, the bank
originated and sold $1.2 billion and $848.6 million, respectively, of
mortgage-backed securities and recognized gains of $6.2 million and $14.5
million, respectively. As a result of the sale of trading securities in the
month such securities are formed, the Consolidated Statements of Cash Flows in
this report reflect significant proceeds from the sales of trading securities,
even though there are no balances of such securities at September 30, 2002.
HOME EQUITY LENDING. The bank makes home equity loans and credit line loans, the
majority of which are secured by a second mortgage on the borrower's home. Home
equity credit line loans provide revolving credit, bear interest at a variable
rate that adjusts monthly based on changes in the applicable interest rate index
and generally are subject to a maximum annual interest rate of between 18.0% and
24.0%. Generally, except for any amortization of principal that may occur as a
result of monthly payments, there are no required payments of principal until
maturity. Home equity loans have fixed rates of interest and amortize over their
term, which ranges from five to 20 years.
From time to time, the bank may purchase home equity loans and credit line loans
from other lenders as a way to supplement its direct origination of these loans.
During fiscal years 2002 and 2001, the bank made no such purchases.
Securitization and sale of home equity credit line receivables has been an
important element of the bank's strategies to enhance liquidity and to maintain
compliance with regulatory capital requirements. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Financial
Condition." The bank transferred $32.8 million and $46.2 million of home equity
credit line receivables in existing trusts to investors and recognized gains of
$1.3 million and $1.8 million during the years ended September 30, 2002 and
2001, respectively. The bank continues to service the underlying accounts.
COMMERCIAL REAL ESTATE AND REAL ESTATE CONSTRUCTION LENDING. Commercial real
estate, real estate construction and ground loans are originated directly by the
bank. Aggregate balances of residential and commercial construction, ground and
commercial real estate and multifamily loans decreased 5.8% to $280.8 million at
September 30, 2002, from $298.0 million at September 30, 2001. The bank provides
financing, generally at market rates, to certain purchasers of its real estate
owned. Additionally, the bank finances the construction of residential real
estate, principally single-family detached homes and townhouses, but generally
only when a home is under contract for sale by the builder to a consumer. Loan
concentrations among types of real estate are reviewed and approved by the
bank's Credit Risk Management Committee.
COMMERCIAL LENDING. The bank makes loans to business entities for a variety of
purposes, including working capital and acquisitions of real estate, machinery
and equipment or other assets. A wide variety of products are offered, including
revolving lines of credit for working capital or seasonal needs; term loans for
the financing of fixed assets; letters of credit; cash management services; and
other deposit and investment products. Concentrations among industries and
structure types, such as syndications, are reviewed and approved by the bank's
Credit Risk Management Committee.
Business development efforts of the bank's Business Banking Group have been
concentrated in the major industry groups in the metropolitan Washington, DC and
Baltimore areas, as well as a broad base of businesses and community service
organizations. Commercial loans increased $33.8 million (or 4.4%) during fiscal
year 2002 from $769.4 million at September 30, 2001 to $803.2 million at
September 30, 2002. In addition, management believes that the ability to offer a
broader variety of investment products and fiduciary services to institutional
customers through the bank's subsidiaries, ASB Capital Management, Inc. and
Chevy Chase Trust Company, will continue to enhance the operations of the
Business Banking Group.
At September 30, 2002, the bank held $219.9 million of participations in
commercial loans originated by other financial institutions. The $219.9 million
represents 27.4% of total commercial loans, a decrease from $282.2 million, or
36.7% of total commercial loans, at September 30, 2001.
Federal laws and regulations limit the bank's commercial loan portfolio to 20%
of assets, with at least 10% consisting of small business loans. At September
30, 2002 the bank complied with this limit.
OTHER CONSUMER LENDING ACTIVITIES. In addition to the types of loans described
above, Chevy Chase currently offers a variety of other consumer loans, including
automobile loans and leases, overdraft lines of credit and other unsecured loans
for traditional consumer purchases and needs. The bank does not offer its own
credit card loans, but has an agreement with another financial institution
pursuant to which that institution issues credit cards in the bank's name to the
bank's local customers. The bank's portfolios of automobile loans and automobile
leases, home improvement and related loans and other consumer loans totaled $2.0
billion, $102.9 million and $37.3 million, respectively, at September 30, 2002,
which accounted for a combined 24.0% of total loans at that date. During fiscal
year 2002, the bank purchased or originated $760.0 million of automobile loans
and leases.
The bank entered the automobile leasing business during fiscal year 1998. The
bank purchases vehicles, subject to lease contracts, from automobile dealers. At
each of September 30, 2002 and 2001, the bank's portfolio of automobile leases
totaled $1.1 billion. In addition to credit risk associated with a lessee's
possible default under the lease, the bank is exposed to the risk that the value
of the vehicle at maturity of the lease may be less than the future residual
value as estimated by the bank at the inception of the lease. To reduce that
risk, the bank (a) purchases insurance in the full amount of the estimated
residual value to protect the bank against possible future decreases in residual
values, and (b) does not use estimates of residual value that exceed published
industry estimates unless that excess is also insured. Although the bank insures
residual values, losses at lease maturity may not be fully covered by that
The bank stopped originating subprime automobile loans in November 2000.
However, the bank's subprime automobile lending portfolio, which totaled $232.0
million at September 30, 2002, continues to exceed 25% of its Tier 1 capital. As
a result, the bank remains potentially subject to the federal banking agencies'
supplemental guidance for subprime lending. See, "BUSINESS - Regulatory
Capital." The bank will continue its collection efforts on the remaining
portfolio.
Federal and state lawmakers and regulators are considering, and in some cases
have adopted, a variety of additional requirements relating to subprime and
perceived abusive or "predatory" lending practices. Those requirements range
from increased reporting and capital requirements to prohibition of specific
lending practices. In light of the bank's decision to stop originating subprime
automobile loans, management currently believes that any other enactments of new
regulatory requirements for these types of loans should not have a material
adverse effect on the bank's financial condition.
Federal laws and regulations limit the bank's secured and unsecured consumer
loans to 35% of its total assets. Home improvement, secured deposit account and
educational loans are not included in the 35% limit. At September 30, 2002, the
bank complied with this limit.
REAL ESTATE LOAN UNDERWRITING. In the loan approval process, Chevy Chase
assesses both the borrower's ability to repay the loan and the adequacy of the
proposed security. The Board of Directors has delegated credit approval
authority to the Executive Loan Committee and certain senior officers based on
credit authorizations approved by the Board of Directors. Generally, all
construction and commercial real estate loans are reviewed and approved by the
Executive Loan Committee. Any significant loan not conforming to the bank's
approved policies must be approved by the Executive Loan Committee or the Chief
Executive Officer. All credit exposures of $30 million or more are presented to
the Board of Directors for final approval.
The approval process for all types of real estate loans includes appraisals or
evaluations of the properties securing such loans and a review of the
applicant's financial statements and credit, payment and banking history,
financial statements of any guarantors, and tax returns of guarantors of
construction and commercial real estate loans.
In an effort to minimize the increased risk of loss associated with construction
and development loans, Chevy Chase considers the reputation of the borrower and
the contractor, reviews pre-construction sale and leasing information, and
requires an independent inspecting engineer or architect to review the progress
of multifamily and commercial real estate projects. In addition, the bank
generally requires personal guarantees of developers for all development loans
and, if a general contractor is used by the developer, may require the posting
of a performance bond.
The bank generally lends on its residential mortgage loans up to 95% of the
appraised value of owner-occupied single-family homes. In some circumstances,
the bank originates a first and second residential mortgage loan simultaneously,
provided that the aggregate loan amount does not exceed 95% of the appraised
value of the residential property. The bank generally also lends up to 90% of
the lesser of the acquisition cost or the appraised value of the completed
project to finance the construction of such homes. The loan-to-value ratio
generally applied by the bank to commercial real estate loans and multifamily
residential loans has been 80% of the appraised value of the completed project.
Currently, the bank offers home equity loans and credit line loans up to a 100%
maximum loan-to-value ratio.
LTV ratios are determined at the time a loan is originated. Consequently,
subsequent declines in the value of a loan's collateral could expose the bank to
losses. Loans with LTV ratios above 90 percent without mortgage insurance may
not exceed 100 percent of the bank's total risk-based capital.
OTS regulations require institutions to adopt internal real estate lending
policies, including LTV limitations conforming to specific guidelines
established by the OTS. The bank's current lending policies conform to these
regulations.
On all loans secured by real estate, other than home improvement and related
loans and certain home equity credit line loans, Chevy Chase requires title
insurance policies protecting the priority of the bank's liens. The bank
requires fire and casualty insurance for permanent loans including home equity
credit line loans and fire, casualty and builders' risk insurance for
construction loans. The borrower selects the insurance carrier, subject to Chevy
Chase's approval. Generally, for any residential loan in an amount exceeding 80%
of the appraised value of the security property, Chevy Chase currently requires
mortgage insurance from an independent mortgage insurance company. The majority
of the bank's mortgage insurance is currently placed with four carriers.
Substantially all fixed-rate mortgage loans originated by the bank contain a
due-on-sale clause which provides that the bank may declare a loan immediately
due and payable in the event, among other things, that the borrower sells the
property securing the loan without the consent of the bank. The bank's ARMs
generally are assumable, subject to certain conditions.
COMMERCIAL LOAN UNDERWRITING. All commercial loan applications are underwritten
and approved under authorities granted to specified committees and individuals
as outlined in the bank's credit policies. All credit exposures of $30 million
or more are presented to the Board of Directors for final approval. The scope
and depth of the underwriting for a particular request are generally dictated by
the size and complexity of the proposed transaction. All commercial loans
greater than $100,000 are assigned a risk rating at inception, based on a
risk-rating system established in the bank's credit policies.
Subsequent to origination, all commercial loans with balances greater than
$100,000 are reviewed at least annually. Changes in the credit quality of the
loans are noted and the risk ratings are modified as appropriate.
OTHER CONSUMER LOAN AND LEASE UNDERWRITING. Other consumer loans and leases,
which include automobile loans and leases, home improvement and related loans
and overdraft lines of credit, are originated or purchased by the bank after a
review in accordance with established underwriting procedures.
The underwriting procedures are designed to provide a basis for assessing the
borrower's ability and willingness to repay the loan or lease. In conducting
this assessment, the bank considers the borrower's ratio of debt to income,
various credit scoring models and evaluates the borrower's credit history
through a review of a written credit report compiled by a recognized consumer
credit reporting bureau. The borrower's equity in the collateral and the terms
of the loan or lease are also considered. The bank's guidelines are intended
only to provide a basis for lending decisions, and exceptions to the guidelines
may, within certain limits, be made based upon the credit judgment of the bank's
lending officer. The bank periodically conducts audits to ensure compliance with
its established underwriting policies and procedures.
The bank purchases residual value insurance on vehicles to reduce the
risk that the vehicle's value at maturity of the lease may be less than
the estimated future residual value at the inception of the lease. The bank
periodically conducts audits of its vehicle lease files to ensure compliance
with the requirements of the residual value insurance policies.
Prior to November 2000, the bank also originated subprime automobile loans
through one of its operating subsidiaries. The underwriting guidelines for this
subsidiary applied to a category of lending in which loans may be made to
applicants who have experienced certain adverse credit events and therefore
would not necessarily meet all of the bank's guidelines for its traditional loan
program, but who meet certain other creditworthiness tests. These loans may
experience higher rates of delinquencies, repossessions and losses, especially
under adverse economic conditions, compared with loans originated pursuant to
the bank's traditional lending program. In November 2000, the bank stopped the
origination of subprime automobile loans. The bank continues its collection
efforts on the remaining portfolio.
LOAN ORIGINATIONS, SECURITIZATIONS AND SALES - RETAINED INTERESTS AND SERVICING
ASSETS. In connection with its loan origination, securitization and sale
activities, the bank generally retains various interests in the sold loans,
including servicing assets and interest-only strips receivable. The bank also
purchases servicing assets related to loans originated by third parties. The
bank records these interests as assets on its financial statements. In some
cases, the bank determines the carrying value of the asset based on expected
future cash flows to be received by the bank from the underlying asset. Some of
these cash flows are payable to the bank before the claims of others, while
other cash flows are subordinated to the claims of others. The table below
summarizes the carrying value of these assets at September 30, 2002.
Not Subordinated Subordinated Total
------------------- ------------------- ------------------
(in thousands)
Servicing assets $ 60,430 $ - $ 60,430
Interest only strips receivable 56,456 32,850 89,306
Overcollateralization of loans - 15,865 15,865
Reserve accounts - 18,264 18,264
------------------- ------------------- ------------------
Total $ 116,886 $ 66,979 $ 183,865
=================== =================== ==================
LOAN SERVICING. The bank's investment in servicing assets is periodically
evaluated for impairment. The bank stratifies its servicing assets for purposes
of evaluating impairment by taking into consideration relevant risk
characteristics, including loan type and note rate. The bank evaluates its
servicing assets for impairment based on fair value. To measure fair value of
its servicing assets, the bank uses either third party market prices or
discounted cash flow analyses using market based assumptions for servicing fee
income, servicing costs, prepayment rates and discount rates.
If actual prepayment or default rates significantly exceed the estimates used to
calculate the carrying values of the servicing assets, the actual amount of
future cash flow could be less than the expected amount and the value of the
servicing assets, as well as the bank's earnings, could be negatively impacted.
No assurance can be given that underlying loans will not experience significant
increases in prepayment or default rates or that the bank may not have to write
down the value of its servicing assets. See Note C and Note 15 to the
Consolidated Financial Statements in this report.
The bank receives income through servicing of loans and fees in connection with
loan origination, loan modification, late payments, changes of property
ownership and miscellaneous services related to its loans. Servicing income,
earned on (a) single-family residential mortgage loans owned by third parties
and (b) the bank's securitization and servicing of home equity, automobile and
home loan receivables portfolios, is a source of substantial earnings for the
bank. Income from these activities varies with the volume and type of loans
originated and sold.
The following table sets forth certain information relating to the bank's
servicing income as of or for the years indicated.
As of or for the Year Ended September 30,
-------------------------------------------------------------
2002 2001 2000
----------------- ----------------- -----------------
(in thousands)
Residential................................. $ 6,918,984 $ 5,943,737 $ 5,229,971
Home equity................................. 86,279 171,438 249,785
Automobile.................................. 803,852 1,190,979 867,046
Home Improvement loans...................... 35,410 57,313 81,847
----------------- ----------------- -----------------
Total amount of loans
serviced for others (1).................. $ 7,844,525 $ 7,363,467 $ 6,428,649
================= ================= =================
Servicing and securitization
income .................................. $ 84,160 $ 52,169 $ 28,991
================= ================= =================
--------------------
(1) The carrying value of the bank's servicing assets and interest-only strips
receivable at September 30, 2002, 2001 and 2000 was $149.7 million, $125.4
million and $108.0 million, respectively.
The bank's level of servicing and securitization income varies based in
large part on the amount of the bank's securitization activities with respect to
these loan types. As the bank securitizes and sells assets, acquires servicing
assets either through purchase or origination, or sells mortgage loans and
retains the servicing rights on those loans, the level of servicing and
securitization income generally increases. During fiscal year 2002, the bank
securitized and sold $1.7 billion of loan receivables through both new and
existing securitization trusts compared to $853.7 million during fiscal year
2001.
INTEREST-ONLY STRIPS RECEIVABLE. Interest-only strips receivable are carried at
fair value. The bank estimates fair value by computing the present value of
estimated future cash flows to be generated by the underlying loans. The
carrying value is adjusted and the adjustment is recognized as an unrealized
gain or loss in the period the change occurs. Several estimates are used when
determining the present value, the most significant of which are the estimated
rate of repayment of the underlying loans, discount rate and estimated credit
losses.
If actual prepayment or default rates significantly exceed the estimates used to
calculate the values of the interest only strips receivable, the actual amount
of future cash flow could be less than the expected amount and the value of the
interest only strips receivable, as well as the bank's earnings, could be
negatively impacted. No assurance can be given that underlying loans will not
experience significant increases in prepayment or default rates or that the bank
may not have to write down the value of its interest only strips receivable. See
Summary Of Significant Accounting Policies and Note 22 in Notes to the
Consolidated Financial Statements in this report.
OVERCOLLATERALIZATION OF LOANS AND RESERVE ACCOUNTS. Overcollateralization of
loans and reserve accounts represent assets of the bank which have been pledged
to the securitization trusts and which are subordinated to the interest of the
investors in those trusts. The bank carries these assets at their estimated fair
value, which is equal to the net present value of the future cash flows expected
to be received in respect of these assets.
DELINQUENCIES, FORECLOSURES AND ALLOWANCES FOR LOSSES
DELINQUENCIES AND FORECLOSURES. When a borrower fails to make a required payment
on a mortgage loan, the loan is considered delinquent and, after expiration of
the applicable cure period, the borrower is charged a late fee. The bank follows
practices customary in the banking industry in attempting to cure delinquencies
and in pursuing remedies upon default. Generally, if the borrower does not cure
the delinquency within 90 days, the bank initiates foreclosure action. If the
loan is not reinstated, paid in full or refinanced, the security property is
sold. In some instances, the bank may be the purchaser. Thereafter, the acquired
property is treated as real estate acquired in settlement of loans until it is
sold. Deficiency judgments generally may be enforced against borrowers in
Maryland, Virginia and the District of Columbia, but may not be available or may
be subject to limitations in other jurisdictions in which loans are originated
by the bank.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Financial Condition - Asset Quality - Delinquent Loans" for a
discussion of the bank's delinquent loan portfolio at September 30, 2002.
ALLOWANCES FOR LOSSES. The allowance for loan and lease losses represents
management's estimate of credit losses inherent in the bank's loan and lease
portfolios as of the balance sheet date. The bank's methodology for assessing
the appropriate level of the allowance consists of several key elements, which
include the allocated allowance, specific allowances for identified loans and
the unallocated allowance. Management reviews the adequacy of the valuation
allowances on loans and leases using a variety of measures and tools including
historical loss performance, delinquent status, current economic conditions,
internal risk ratings and current underwriting policies and procedures.
The allocated allowance is assessed on both homogeneous and non-homogeneous loan
portfolios. The range is calculated by applying loss and delinquency factors to
the outstanding loan balances of these portfolios. Loss factors are based on
analysis of the historical performance of each loan category and an assessment
of portfolio trends and conditions, as well as specific risk factors impacting
the loan and lease portfolios. Each homogeneous portfolio, such as single-family
residential loans or automobile loans, is evaluated collectively.
Non-homogeneous type loans, such as business banking loans and real estate
banking loans, are analyzed and segregated by risk according to the bank's
internal risk rating system. These loans are reviewed by the bank's credit and
loan review groups on an individual loan basis to assign a risk rating. Industry
loss factors are applied based on the risk rating assigned to the loan. Industry
loss factors are used because of the bank's lack of history in these portfolios.
A specific allowance may be assigned to non-homogeneous type loans that have
been individually determined to be impaired. Any specific allowance considers
all available evidence including, as appropriate, the present value of payments
expected to be received or, for loans that are solely dependent on collateral
for repayment, the estimated fair value of the collateral.
The unallocated allowance is based upon management's evaluation and judgement of
various conditions that are not directly measured in the determination of the
allocated and specific allowances. The conditions evaluated in connection with
the unallocated allowance may include existing general economic and business
conditions affecting the key lending areas of the bank, credit quality trends,
collateral values, loan volumes and concentrations, seasoning of the loan
portfolio, specific industry conditions within portfolio segments, recent loss
experience in particular segments of the portfolio, regulatory examination
results and findings of the bank's internal credit evaluations.
The allowances for losses are based on estimates and ultimate losses may vary
from current estimates. As adjustments to the allowances become necessary,
provisions for losses are reported in operations in the periods they are
determined to be necessary.
REO is carried at the lower of cost or fair value, less selling costs. To date,
sales of REO, non-residential mortgage loans, commercial loans and loans
classified as investments in real estate have resulted in no material additional
aggregate loss to the bank above the amounts already reserved. However, these
results do not necessarily assure that the bank will not suffer losses in the
future beyond its level of allowances.
The bank's review of its various asset portfolios takes place within its Asset
Review and Asset Classification Committees, which meet on a quarterly basis. The
Asset Classification Committee reviews risk performance trends within the bank's
loan and REO portfolios and economic trends and conditions, which might impact
those portfolios. This Committee also reviews the status of individual
criticized and classified assets from $500,000 up to $5,000,000 and the
allowance for loan and lease losses. The Asset Review Committee, which meets in
conjunction with the Asset Classification Committee, reviews the status of
individual criticized and classified assets of $5,000,000 and greater.
The Federal Financial Institutions Examination Council ("FFIEC"), which is
composed of the OTS and the other federal banking agencies, has issued
guidelines regarding the appropriate levels of general valuation allowances that
should be maintained by insured institutions and guidance on the design and
implementation of loan loss allowance methodologies and supporting documentation
practices. The bank believes that its levels of general valuation allowances at
September 30, 2002 and its procedures comply with the guidelines.
The bank's assets are subject to review and classification by the OTS upon
examination. Based on such examinations, the bank could be required to establish
additional valuation allowances or incur additional charge-offs.
DEPOSITS AND OTHER SOURCES OF FUNDS
GENERAL. Deposits are the primary source of the bank's funds for use in lending
and for other general business purposes. In addition to deposits, Chevy Chase
receives funds from loan repayments and loan sales. Loan repayments are a
relatively stable source of funds, while deposit inflows and outflows are
influenced by general interest rates and money-market conditions. Borrowings may
be used to compensate for reductions in normal sources of funds, such as deposit
inflows at less than projected levels or deposit outflows, or to support the
bank's operating or investing activities, or planned growth. In recent years,
the bank has relied to a greater degree on borrowed funds, particularly FHLB
advances, to fund its planned asset growth. This source of funding is generally
more volatile and expensive than traditional core deposits.
DEPOSITS. Chevy Chase currently offers a variety of deposit accounts with a
range of interest rates and maturities designed to attract both long-term and
short-term deposits. Deposit programs include Super Money Fund, Super Statement
Savings, Super NOW, Insured Money Fund, Checking, Simple Statement Savings,
Young Savers, Certificate, and special programs for Individual Retirement and
Keogh self-employed retirement accounts.
Chevy Chase attracts deposits through its branch network and advertisements, and
offers depositors access to their accounts through 771 ATMs, including 208 ATMs
located in grocery stores. These ATMs significantly enhance the bank's position
as a leading provider of convenient ATM service in its primary market area. The
bank is a member of the "STAR"(R) ATM network which offers nationwide access,
and the "PLUS"(R) ATM network, which offers worldwide access. In addition, the
bank has a partnership agreement with a regional grocery store chain that
authorizes the bank to provide in-store banking centers at potentially all of
its Maryland, Virginia, Delaware and Washington, DC area stores. As of September
30, 2002, the bank has opened 53 in-store banking centers as part of this
agreement.
Chevy Chase accepts brokered deposits as a way to diversify the bank's funding
sources and provide additional funding for planned growth. The bank had $76.9
million of brokered deposits at September 30, 2002, a decrease of 91.8% from
$941.4 million at September 30, 2001. Under FDIC regulations, the bank can
accept brokered deposits as long as it meets the capital standards established
for well-capitalized institutions or, with FDIC approval, adequately capitalized
institutions, under the prompt corrective action regulations. Brokered deposits
typically have higher interest rates and are more volatile than traditional
retail deposits. Management believes that brokered deposits are a viable
alternative source of funds for the bank, and will continue to evaluate the use
of brokered deposits as a source of funds in the future.
The bank obtains deposits primarily from customers residing in Montgomery and
Prince George's Counties in Maryland and Northern Virginia. Approximately 36.7%
of the bank's deposits at September 30, 2002 were obtained from depositors
residing outside of Maryland, with approximately 22.5% from depositors residing
in Northern Virginia.
The following table shows the amounts of Chevy Chase's deposits by type of
account at the dates indicated.
DEPOSIT ANALYSIS
(DOLLARS IN THOUSANDS)
September 30,
-----------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------------- -------------------- ------------------- -------------------- -------------------
% of % of % of % of % of
Balance Total Balance Total Balance Total Balance Total Balance Total
------------------- ------------ ------- ----------- ------- ------------ ------- -------------------
Demand and NOW accounts $ 2,436,156 32.8 % $ 2,070,976 27.4 % $ 1,849,203 26.3 % $ 1,606,169 27.9 % $ 1,329,839 27.2 %
Money market deposit accounts 1,953,312 26.3 1,570,297 20.8 1,156,829 16.4 1,125,405 19.5 1,019,569 20.9
Statement savings accounts 893,093 12.0 780,655 10.3 779,344 11.1 888,212 15.4 913,467 18.7
Jumbo certificate accounts 522,499 7.0 620,453 8.2 636,750 9.0 486,245 8.4 358,913 7.3
Brokered certificate accounts 76,948 1.0 941,409 12.5 1,306,419 18.6 532,588 9.3 - -
Other certificate accounts 1,420,408 19.1 1,461,473 19.3 1,195,999 17.0 1,016,118 17.6 1,168,746 23.9
Other deposit accounts 135,169 1.8 117,207 1.5 113,245 1.6 108,749 1.9 97,696 2.0
----------- ------- ------------ ------- ----------- ------- ------------ ------- ----------- -------
Total deposits $ 7,437,585 100.0 % $ 7,562,470 100.0 % $ 7,037,789 100.0 % $ 5,763,486 100.0 % $ 4,888,230 100.0 %
=========== ======= ============ ======= =========== ======= ============ ======= =========== =======
AVERAGE COST OF DEPOSITS
Year Ended September 30,
---------------------------------------------------
2002 2001 2000
- -------------------------------------------------------------------------------------------
Demand and NOW accounts 0.31% 0.60% 0.88%
Money market accounts 1.74% 3.56% 3.55%
Statement savings and
other deposit accounts 0.96% 1.52% 1.86%
Certificate accounts 4.14% 5.99% 5.69%
Total deposit accounts 2.15% 3.79% 3.71%
====== ====== ======
The range of deposit account products offered by the bank through its extensive
branch and ATM network allows the bank to be competitive in obtaining funds from
its local retail deposit market. At the same time, however, as customers have
increasingly responded to changes in interest rates, the bank has experienced
some fluctuations in deposit flows. Chevy Chase's ability to attract and
maintain deposits and its cost of funds will continue to be significantly
affected by market conditions and its pricing strategy.
The following table sets forth Chevy Chase's deposit flows during the periods
indicated.
Year Ended September 30,
-------------------------------------------------------------
2002 2001 2000
----------------- ----------------- -----------------
(in thousands)
Deposits to accounts........................ $ 48,432,739 $ 43,408,719 $ 38,470,514
Withdrawals from
accounts................................. (48,701,536) (43,131,644) (37,418,474)
----------------- ----------------- -----------------
Net cash to (from)
accounts................................. (268,797) 277,075 1,052,040
Interest credited to
accounts................................. 143,912 247,606 222,263
----------------- ----------------- -----------------
Net increase (decrease) in deposit
balances................................. $ (124,885) $ 524,681 $ 1,274,303
================= ================= =================
Deposit growth may be moderated by the bank from time to time either to take
advantage of lower cost funding alternatives or in response to more modest
expectations for loan and other asset growth.
The following table sets forth, by weighted average interest rates, the types
and amounts of deposits as of September 30, 2002, which will mature during the
fiscal years indicated.
WEIGHTED AVERAGE INTEREST RATES OF DEPOSITS
As of September 30, 2002
(DOLLARS IN THOUSANDS)
Demand, NOW
and Money Market Statement Other Certificate
Deposit Accounts Savings Accounts Core Accounts Accounts Total
----------------------- ---------------------- -------------------- ----------------------- -----------------------
Maturing During Weighted Weighted Weighted Weighted Weighted
Year Ending Average Average Average Average Average
September 30, Amount Rate Amount Rate Amount Rate Amount Rate Amount Rate
- --------------- -------------- -------- ----------- -------- ----------- -------- -------------- -------- -------------- --------
2003 $ 4,389,468 0.77% $ 893,093 0.79% $135,169 0.50% $ 1,686,449 2.88% $ 7,104,179 1.27%
2004 - - - - - - 149,760 3.38 149,760 3.38
2005 - - - - - - 48,288 5.17 48,288 5.17
2006 - - - - - - 103,401 4.88 103,401 4.88
2007 - - - - - - 31,957 4.38 31,957 4.38
-------------- ----------- ----------- -------------- --------------
Total $ 4,389,468 0.77% $ 893,093 0.79% $135,169 0.50% $ 2,019,855 3.09% $ 7,437,585 1.40%
============== =========== =========== ============== ==============
The following table summarizes maturities of certificate accounts in amounts of
$100,000 or greater as of September 30, 2002.
Year Ending September 30, Amount Weighted Average Rate
------------------------- -------------- ---------------------
(Dollars in thousands)
2003................................. $ 515,251 2.55%
2004................................. 48,236 3.45%
2005................................. 6,610 5.75%
2006................................. 26,532 4.90%
2007................................. 6,487 4.40%
-------------- -----
Total............................. $ 603,116 2.78%
============== =====
The following table represents the amounts of deposits by various interest rate
categories as of September 30, 2002 maturing during the fiscal years indicated.
MATURITIES OF DEPOSITS BY INTEREST RATES
As of September 30, 2002
(IN THOUSANDS)
Accounts Maturing During Year Ending September 30,
-----------------------------------------------------------------------------------------------------------
Interest Rate 2003 2004 2005 2006 2007 Total
- -------------------- --------------- -------------- -------------- --------------- -------------- ----------------
Demand deposits (0%) $ 779,634 $ - $ - $ - $ - $ 779,634
0.01% to 1.99% 5,009,028 7,240 - 53 - 5,016,321
2.00% to 2.99% 787,363 40,594 1,593 17 - 829,567
3.00% to 3.99% 307,348 72,436 11,829 1,691 2,294 395,598
4.00% to 4.99% 39,257 22,016 3,870 91,565 29,241 185,949
5.00% to 5.99% 30,123 2,593 6,694 5,775 422 45,607
6.00% to 7.99% 151,426 4,881 24,302 4,300 - 184,909
--------------- -------------- -------------- --------------- -------------- ----------------
Total $ 7,104,179 $ 149,760 $ 48,288 $ 103,401 $ 31,957 $ 7,437,585
=============== ============== ============== =============== ============== ================
BORROWINGS. The FHLB system functions as a central reserve bank providing credit
for member institutions. As a member of the FHLB of Atlanta, Chevy Chase is
required to own capital stock in the FHLB of Atlanta and is authorized to apply
for advances on the security of that stock and certain of its mortgages and
other assets, principally securities which are obligations of, or guaranteed by,
the United States or its agencies, provided certain standards related to
creditworthiness have been met.
Under the credit policies of the FHLB of Atlanta, credit may be extended to
creditworthy institutions based upon their financial condition, and the adequacy
of collateral pledged to secure the extension of credit. Extensions of credit
may be obtained pursuant to several different credit programs, each of which has
its own rate and range of maturities. Advances from the FHLB of Atlanta must be
secured by certain types of collateral with a value, as determined by the FHLB
of Atlanta, at least equal to 100% of the borrower's outstanding advances. The
bank had outstanding FHLB advances of $1.7 billion at September 30, 2002.
From time to time the bank enters into repurchase agreements, which are treated
as financings. The bank sells securities, which are usually mortgage-backed
securities, to a dealer and agrees to buy back the same securities at a
specified time, which is generally within seven to 90 days. The bank pays a
stated interest rate for the use of the funds for the specified time period to
the dealer. The obligation to repurchase the securities sold is reflected as a
liability and the securities underlying the agreements are included in assets in
the Consolidated Balance Sheets in this report. These arrangements are, in
effect, borrowings by the bank secured by the securities sold. The bank had
outstanding repurchase agreements of $505.1 million at September 30, 2002.
The following table sets forth a summary of the repurchase agreements of the
bank as of the dates and for the years indicated.
September 30,
------------------------------------------------
2002 2001
---------------- -----------------
(Dollars in thousands)
Securities sold under repurchase Agreements:
Balance at year-end........................................... $ 505,140 $ 110,837
Average amount outstanding during
the year................................................... 405,844 397,842
Maximum amount outstanding at any
Month-end.................................................. 559,957 534,170
Weighted average interest rate during
the year................................................... 1.95% 5.74%
Weighted average interest rate
on year-end balances....................................... 1.82% 3.21%
On November 23, 1993, the bank sold $150 million principal amount of its 9 1/4%
Subordinated Debentures due 2005 (the "1993 Debentures"). Interest on the 1993
Debentures is payable semiannually on December 1 and June 1 of each year. The
OTS approved the inclusion of the principal amount of the 1993 Debentures in the
bank's supplementary capital for regulatory capital purposes. Since December 1,
1998, the 1993 Debentures have been redeemable, in whole or in part, at any time
at the option of the bank.
On December 3, 1996, the bank sold $100 million principal amount of its 9 1/4%
Subordinated Debentures due 2008 (the "1996 Debentures"). Interest on the 1996
Debentures is payable semiannually on December 1st and June 1st of each year.
The OTS approved the inclusion of the principal amount of the 1996 Debentures in
the bank's supplementary capital for regulatory capital purposes. On December 1,
2001, the 1996 Debentures became redeemable, in whole or in part, at any time at
the option of the bank.
Under the OTS capital regulations, redemption of the 1993 Debentures or the 1996
Debentures prior to their stated maturity requires prior approval of the OTS
unless the debentures are redeemed with the proceeds of, or replaced by, a like
amount of "a similar or higher quality" capital instrument.
SUBSIDIARIES
OTS regulations generally permit the bank to make investments in service
corporation subsidiaries in an amount not to exceed 3.0% of the bank's assets,
provided that any investment in excess of 2.0% of assets serves primarily
community, inner city or community development purposes. These regulations also
permit the bank to make "conforming loans" to those subsidiaries and joint
ventures in an amount not to exceed 50% of the bank's regulatory capital. At
September 30, 2002, 2.0% and 3.0% of the bank's assets was equal to $225.7
million and $338.6 million, respectively, and the bank had $35.9 million
invested in its service corporation subsidiaries, $5.0 million of which was in
the form of conforming loans.
The bank may establish operating subsidiaries to engage in any activities in
which the bank may engage directly. There are no regulatory limits on the amount
the bank can invest in operating subsidiaries. The bank is required to provide
30 days advance notice to the OTS and to the FDIC before establishing a new
subsidiary or conducting a new activity in an existing subsidiary. The bank
engages in a variety of other activities through its subsidiaries, including
those described below.
REAL ESTATE DEVELOPMENT ACTIVITIES. Manor Investment Company, a subsidiary of
the bank, was engaged in certain real estate development activities commenced
prior to the enactment of FIRREA and continues to manage the remaining property
it holds. As a result of the stringent capital requirements that FIRREA applies
to investments in subsidiaries, such as Manor, that engage in activities
impermissible for national banks, Manor has not entered, and does not intend to
enter, into any new real estate development arrangements. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Financial Condition - Asset Quality."
SECURITIES BROKERAGE SERVICES. Chevy Chase Securities, Inc., is a wholly owned
subsidiary of Chevy Chase Financial Services Corporation ("CCFS"), a wholly
owned direct subsidiary of Chevy Chase. Chevy Chase Securities is a licensed
broker-dealer, which sells securities on a retail basis to the general public,
including customers and depositors of the bank.
INSURANCE SERVICES. Chevy Chase Insurance Agency, Inc., ("CCIA") a wholly owned
subsidiary of CCFS, is a licensed insurance broker offering a variety of
"personal line" property and casualty and life insurance programs to the general
public, including customers and depositors of the bank. CCIA's primary programs
consist of homeowner and automobile insurance in the property and casualty
sector and mortgage and credit life and disability insurance in the life
insurance sector.
LENDING SUBSIDIARIES. Chevy Chase engages in significant mortgage lending
activities through B. F. Saul Mortgage Company. See "Lending Activities." CFC -
Consumer Finance Corporation engaged in subprime automobile lending. In November
2000, the bank stopped the origination of subprime automobile loans. The bank
continues its collection efforts on the existing portfolio.
REIT SUBSIDIARY. Chevy Chase Preferred Capital Corporation invests in real
estate loans, mortgage-backed securities and related assets and issued preferred
stock to outside investors, which is included as Tier 1 capital of the bank.
INVESTMENT, MANAGEMENT AND FIDUCIARY SERVICES. The bank offers investment,
management and fiduciary services through two wholly owned subsidiaries: Chevy
Chase Trust Company, a licensed fiduciary and registered investment adviser,
which serves primarily high net worth individuals, and ASB Capital Management,
Inc., a registered investment adviser, which serves primarily institutional
customers.
SPECIAL PURPOSE SUBSIDIARIES. At September 30, 2002, Chevy Chase Real Estate,
LLC, ("CCRE") a wholly owned subsidiary of Chevy Chase, held 100% of the common
stock of 24 subsidiaries, 11 of which are active, a majority of which were
formed for the sole purpose of acquiring title to various real estate projects
pursuant to foreclosure or deed-in-lieu of foreclosure. The bank's investment in
the subsidiaries was $27.4 million at September 30, 2002. CCRE is an operating
subsidiary and, therefore, the bank's investment in CCRE is not subject to the
3.0% service corporation investment limit discussed above.
EMPLOYEES
The bank and its subsidiaries had 3,295 full-time and 445 part-time employees at
September 30, 2002. The bank provides its employees with a comprehensive range
of employee benefit programs, including group health benefits, life insurance,
disability insurance, paid sick leave, certain free deposit services and certain
loan discounts. See "Executive Compensation" for a discussion of certain
compensation programs available to the bank's executive officers. None of the
bank's employees is represented by a collective bargaining agent. The bank
believes that its employee relations are good.
COMPETITION
Chevy Chase encounters strong competition both in attracting deposits and making
loans in its markets. The bank's most direct competition for deposits comes from
other thrifts, commercial banks and credit unions, as well as from money market
funds and corporate and government securities. In addition to offering
competitive interest rates, Chevy Chase offers a variety of services, convenient
ATM locations and convenient office locations and hours to attract deposits.
Competition for real estate and other loans comes principally from other
thrifts, banks, mortgage banking companies, insurance companies and other
institutional lenders. Chevy Chase competes for loans through interest rates,
loan fees and the variety and quality of services provided to borrowers and
brokers.
The bank's major competition comes from local depository institutions and, as a
result of deregulation of the financial services industry and changing market
demands over recent years, regional, national and international financial
institutions and other providers of financial services. The GLB Act amended
federal law to permit broader affiliations among commercial banks, securities
firms, insurance companies, and other financial services providers.
The bank competes with numerous depository institutions in its deposit-taking
activities in the Washington, DC metropolitan area. The bank also competes with
these institutions in the origination of single-family residential mortgage
loans and home equity credit line loans. According to the most recently
published industry statistics, at June 30, 2001, Chevy Chase had the largest
market share, with approximately 27% of deposits, in Montgomery County,
Maryland, and ranked third in market share, with approximately 15% of deposits,
in Prince George's County, Maryland. Based on publicly available information,
Chevy Chase estimates that, in the Washington, DC metropolitan area, it is one
of the leaders in market share of single-family residential mortgage and home
equity credit line loans.
FEDERAL TAXATION
Savings institutions, such as the bank, generally are taxed in the same manner
as other corporations. There are, however, several special rules that apply
principally to savings institutions and, in some cases, other financial
institutions. Certain significant aspects of the federal income taxation of the
bank are discussed below:
GENERAL. The bank and its subsidiaries are included in the consolidated federal
income tax return filed by the Trust on a fiscal year basis. Each member of an
affiliated group of corporations which files consolidated income tax returns is
liable for the group's federal income tax liability.
BAD DEBT RESERVE. For taxable years beginning before December 31, 1995, savings
institutions that satisfied certain requirements were permitted to establish
reserves for bad debts and to deduct each year reasonable additions to those
reserves in lieu of taking a deduction for bad debts actually sustained during
the taxable year. To qualify for this treatment, at least 60% of a savings
institution's assets had to be "qualifying assets," including cash, certain U.S.
and state government securities and loans secured by interests in residential
real property.
In establishing its reserves from calendar year 1988 through fiscal year 1996,
the bank calculated its bad debt deduction for tax purposes using the experience
method. The experience method was based on the institution's actual loan loss
experience over a prescribed period. As of September 30, 1996, accumulated
reserves were approximately $111.8 million.
In 1996, Congress repealed the thrift bad debt provisions of the Internal
Revenue Code effective for taxable years beginning after December 31, 1995. As a
result, the bank can deduct only those bad debts actually incurred during the
respective taxable years. The bad debt provisions of the 1996 legislation also
require thrifts to recapture and pay income tax on bad debt reserves accumulated
since 1987 over a six year period, beginning with a thrift's taxable year
starting after December 31, 1995 or, if the thrift meets a loan origination
test, beginning up to two years later. The bank's accumulated reserves since
1987, which are subject to recapture under this rule are $101.3 million. Of this
amount, $16.9 million was recaptured in each of 1999, 2000, 2001 and 2002, and
$33.8 million remains subject to recapture over the remainder of the six year
recapture period which ends September, 2004. The tax liability related to the
recapture of the bad debt reserves accumulated since 1987 has been reflected in
the bank's financial statements.
CONSOLIDATED TAX RETURNS; TAX SHARING PAYMENTS. Generally, the operations of the
Trust have generated significant net operating losses and the bank's taxable
income generally has been sufficient to fully utilize the losses of the Trust.
Under the terms of a tax sharing agreement dated June 28, 1990, as amended, the
bank is obligated to make payments to the Trust based on its taxable income, as
explained more fully below.
The tax sharing agreement generally provides that each member of the Trust's
affiliated group is required to pay the Trust an amount equal to 100% of the tax
liability that the member would have been required to pay to the IRS if the
member had filed on a separate return basis. These amounts generally must be
paid even if the affiliated group has no overall tax liability or the group's
tax liability is less than the sum of those amounts. Under the tax sharing
agreement, the Trust, in turn, is obligated to pay to the appropriate tax
authorities the overall tax liability, if any, of the group. In addition, to the
extent the net operating losses or tax credits of a particular member reduce the
overall tax liability of the group, the Trust is required to reimburse that
member on a dollar-for-dollar basis, thereby compensating the member for the
group's use of its net operating losses or tax credits. Under the tax sharing
agreement, the bank and its subsidiaries are treated as a single member of the
Trust's affiliated group.
The bank made tax sharing payments of $5.7 million in fiscal year 2002. At
September 30, 2002, the amount of tax sharing payments due to the Trust from the
bank was $2.2 million. It is expected that the bank will have taxable income in
future years and additional operating losses of the Trust will be utilized to
reduce the overall tax liability of the group which would otherwise arise from
such taxable income of the bank or from the taxable income of other members of
the Trust's affiliated group.
In general, if the bank has net operating losses or unused tax credits in any
taxable year, under the tax sharing agreement the Trust is obligated to
reimburse the bank in an amount generally equal to (1) the tax benefit to the
group of using those tax losses or unused tax credits in the group's
consolidated federal income tax return for such year, plus (2) to the extent
those losses or credits are not used by the group in that year, the amount of
the tax refunds which the bank would otherwise have been able to claim if it
were not included in the consolidated federal income tax return of the group,
but not in excess of the net amount paid by the bank to the Trust pursuant to
the tax sharing agreement. There is no assurance that the Trust would be able to
fulfill this obligation. If the Trust did not make the reimbursement, the OTS
could attempt to characterize the nonpayment as an extension of credit by the
bank to the Trust which, as described above under "Holding Company Regulation,"
is prohibited under current law. The tax sharing agreement itself does not
provide for any specific remedies upon a breach by any party of its obligations
under the agreement.
The bank, as a member of an affiliated group of corporations filing consolidated
income tax returns, is liable under the Internal Revenue Code for the group's
tax liability. Although the bank would be entitled to reimbursement under the
tax sharing agreement for income tax paid with respect to the income of other
members of the affiliated group, there can be no assurance that the Trust or
other members would be able to fulfill this obligation.
STATE TAXATION
Maryland law does not allow the filing of consolidated income tax returns, and
thus the Trust and its subsidiaries, which includes the bank and its
subsidiaries, that are subject to Maryland income tax are required to file
separately in Maryland. The Trust and its subsidiaries are also subject to
income taxes in other states, some of which allow or require combined or
consolidated filings.
SEGMENTS
For information about industry segments, see Notes 30 and 36 to the Consolidated
Financial Statements.
ITEM 2. PROPERTIES
Real Estate
A list of the investment properties of the Real Estate Trust is set forth
under"Item 1. Business -- Real Estate -- Real Estate Investments."
The Trust conducts its principal business from its executive offices at 7501
Wisconsin Avenue, Suite 1500, Bethesda, Maryland. The Saul Company leases all
office facilities on behalf of the Trust.
Banking
During fiscal year 2002, the bank completed the consolidation of various office
locations to its new corporate headquarters at 7501 Wisconsin Avenue, Bethesda,
Maryland. At September 30, 2002, the bank conducted its business from its home
office at 7926 Jones Branch Drive, McLean, Virginia and its executive offices at
7501 Wisconsin Avenue, Bethesda, Maryland; its operations centers at 6151 and
6200 Chevy Chase Drive, Laurel, Maryland, and 14601 Sweitzer Lane, Laurel,
Maryland; its office facilities at 1101 Pennsylvania Avenue, NW, Washington, DC;
and 197 full-service offices located in Maryland, Virginia, Delaware and the
District of Columbia. On that date, the bank owned the building and land for 35
of its branch offices and leased its remaining 162 branch offices. Chevy Chase
leases the office facilities at 7926 Jones Branch Drive, 6200 Chevy Chase Drive,
14601 Sweitzer Lane, 1101 Pennsylvania Avenue, NW and the land at 7501 Wisconsin
Avenue. Chevy Chase owns the building at 7501 Wisconsin Avenue. In addition, the
bank leases office space in which its subsidiaries are housed. The office
facility leases have various terms expiring from fiscal years 2003 to 2022 and
the ground leases have terms expiring from fiscal years 2029 to 2081. The bank
also owns the building and land at 5202 President's Court, Frederick, Maryland,
the site of its former credit card operations center, which is now leased to
third parties and 6151 Chevy Chase Drive, Laurel, Maryland. The bank also owns
the building and leases the land at 7700 Old Georgetown Road, Bethesda,
Maryland. The bank also leases the office facilities at 7735 Old Georgetown
Road, Bethesda, Maryland. Both of these office facilities were occupied by bank
personnel prior to the consolidation into the bank's new corporate headquarters.
The bank is in the process of leasing and subleasing these facilities to third
parties. See Note 24 to the Consolidated Financial Statements in this report for
lease expense and commitments.
The following table sets forth the location of the bank's 197 full-service
branch offices at September 30, 2002.
1 Catoctin Circle 8201 Greensboro Drive 1100 Wilson Boulevard
Leesburg, VA 20176 McLean, VA 22102 Arlington, VA 22209
1100 W. Broad Street 234 Maple Avenue East 4229 Merchant Plaza
Falls Church, VA 22046 Vienna, VA 22180 Woodbridge, VA 22192
3941 Pickett Road 8436 Old Keene Mill Road 14125 St. Germain Drive
Fairfax, VA 22031 Springfield, VA 22152 Centreville, VA 20121
1439 Chain Bridge Road 8120 Sudley Road 3532 Columbia Pike
McLean, VA 22101 Manassas, VA 20109 Arlington, VA 22204
6367 Seven Corners Center 13344-A Franklin Farms Road 11200 Main Street
Falls Church, VA 22044 Herndon, VA 20171 Fairfax, VA 22030
1100 S. Hayes Street 20970 Southbank Street 13043 Lee Jackson Memorial Highway
Arlington, VA 22202 Potomac Falls, VA 20165 Fairfax, VA 22033
2932 Chain Bridge Road 7030 Little River Turnpike 2079 Daniel Stuart Square
Oakton, VA 22124 Annandale, VA 22003 Woodbridge, VA 22191
1201 Elden Street 3095 Nutley Street 2901-11 South Glebe Road
Herndon, VA 20170 Fairfax, VA 22031 Arlington, VA 22206
5613 Stone Road 4700 Lee Highway 7501 Huntsman Boulevard
Centreville, VA 20120 Arlington, VA 22207 Springfield, VA 22153
44151 Ashburn Shopping Plaza 5851 Crossroads Center Way 1230 West Broad Street
Ashburn, VA 20147 Falls Church, VA 22041 Falls Church, VA 22047
3690-A King Street 6800 Richmond Highway 10346 Courthouse Road
Alexandria, VA 22302 Alexandria, VA 22306 Spotsylvania, VA 22553
6609 Springfield Mall 7935 L Tysons Corner Center 3480 South Jefferson Street
Springfield, VA 22150 McLean, VA 22102 Falls Church, VA 22041
500 South Washington Street 11874 Spectrum Center 1459 North Point Village
Alexandria, VA 22314 Reston, VA 20190 Reston, VA 20194
10100 Dumfries Road 5230-A Port Royal Road 61 Catoctin Circle, NE
Manassas, VA 20110 Springfield, VA 22151 Leesburg, VA 20175
5870 Kingstowne Boulevard 8628-A Richmond Highway 6426 Springfield Plaza
Alexandria, VA 22310 Alexandria, VA 22309 Springfield, VA 22150
3499 S. Jefferson Street 3046 Gatehouse Plaza 21800 Town Center Plaza, #255
Baileys Crossroads, VA 22041 Falls Church, VA 22042 Sterling, VA 20164
1621 B Crystal Square Arcade 46160 Potomac Run Plaza 5740 Union Mills Road
Arlington, VA 22202 Sterling, VA 20164 Clifton, VA 20124
21100 Dulles Town Circle 9863 Georgetown Pike 8110 Fletcher Avenue
Dulles, VA 20166 Great Falls, VA 22066 McLean, VA 22101
7575 Newlinton Hall Road 2251 John Milton Drive 3501 Plank Road
Gainesville, VA 20155 Herndon, VA 20171 Fredericksburg, VA 22407
12445 Hedges Run Drive 7137 Columbia Pike 6011 Burke Center Parkway
Lakeridge, VA 22192 Annandale, VA 22003 Burke, VA 22015
8025 Sudley Road 1228 Elden Street 4309 Dale Boulevard
Manassas, VA 22110 Herndon, VA 22070 Dale City, VA 22193
41 West Lee Highway 3131 Duke Street 697 North Washington Street
Warrenton, VA 22186 Alexandria, VA 22314 Alexandria, VA 22313
43330 Junction Plaza 8098 Rolling Road 45545 Dulles Eastern Plaza
Ashburn, VA 20147 Springfield, VA 22153 Sterling, VA 20163
43931 Farmwell Hunt Plaza 6949 Commerce Street 26001 Ridge Road
Ashburn, VA 20147 Springfield, VA 22150 Damascus, MD 20872
17831 Georgia Avenue 15407 Excelsior Drive 317 Kentlands Boulevard
Olney, MD 20832 Bowie, MD 20716 Gaithersburg, MD 20878
8315 Georgia Avenue 5552 Norbeck Road 215 N. Washington Street
Silver Spring, MD 20910 Rockville, MD 20853 Rockville, MD 20850
11261 New Hampshire Avenue 6200 Annapolis Road 573 Governor Ritchie Highway
Silver Spring, MD 20904 Landover Hills, MD 20784 Severna Park, MD 21146
101 Halpine Road 33 West Franklin Street 4745 Dorsey Hall Drive
Rockville, MD 20852 Hagerstown, MD 21740 Ellicott City, MD 21042
6107 Greenbelt Road 6400 Belcrest Road 1130 Smallwood Drive
Berwyn Heights, MD 20740 Hyattsville, MD 20782 Waldorf, MD 20603
4 Bureau Drive 8740 Arliss Street 1040 Largo Center Drive
Gaithersburg, MD 20878 Silver Spring, MD 20901 Largo, MD 20774
19610 Club House Road 2409 Wooton Parkway 6335 Marlboro Pike
Gaithersburg, MD 20886 Rockville, MD 20850 District Heights, MD 20747
812 Muddy Branch Road 8845 Branch Avenue 7530 Annapolis Road
Gaithersburg, MD 20878 Clinton, MD 20735 Lanham, MD 20784
10211 River Road 1181 University Boulevard 11241 Georgia Avenue
Potomac, MD 20854 Langley Park, MD 20783 Wheaton, MD 20902
14113 Baltimore Avenue 19801 Century Boulevard 13484 New Hampshire Avenue
Laurel, MD 20707 Germantown, MD 20874 Silver Spring, MD 20904
7290-A Cradlerock Way 1009 West Patrick Street 7101 Democracy Boulevard
Columbia, MD 21045 Frederick, MD 21701 Bethesda, MD 20817
8676 Georgia Avenue 7937 Ritchie Highway 4825 Cordell Avenue
Silver Spring, MD 20910 Glen Burnie, MD 21061 Bethesda, MD 20814
12228 Viers Mill Road 19781-83 Frederick Road 7515 Greenbelt Road
Silver Spring, MD 20906 Germantown, MD 20876 Greenbelt, MD 20770
115 University Boulevard West 16827 Crabbs Branch Way 15777 Columbia Pike
Silver Spring, MD 20901 Rockville, MD 20855 Burtonsville, MD 20866
9707 Old Georgetown Road 2321-E Forest Drive 509 N. Frederick Avenue
Bethesda, MD 20814 Annapolis, MD 21401 Gaithersburg, MD 20877
7941 Tuckerman Lane 15460 Annapolis Road 5823 Eastern Avenue
Potomac, MD 20854 Bowie, MD 20715 Chillum, MD 20782
Stamp Student Union 20000 Goshen Road 3355 Corridor Market Place
College Park, MD 20742 Gaithersburg, MD 20879 Laurel, MD 20724
5400 Corporate Drive 12097 Rockville Pike 10400 Old Georgetown Road
Frederick, MD 21703 Rockville, MD 20852 Bethesda, MD 20814
20944 Frederick Road 10159 New Hampshire Avenue 6020 Marshalee Drive
Germantown, MD 20876 Hillandale, MD 20903 Elkridge, MD 21075
3601 St. Barnabas Road 10800 Baltimore Avenue 135 East Baltimore Street
Silver Hill, MD 20746 Beltsville, MD 20705 Baltimore, MD 21202
18331 Leaman Farm Road 8171 Elliot Road 2801 University Boulevard West
Germantown, MD 20876 Talbot, MD 21601 Kensington, MD 20895
1734 York Road 7700 Old Georgetown Road 4624 Edmondson Avenue
Lutherville, MD 21093 Bethesda, MD 20814 Baltimore, MD 21229
11399 York Road 18104 Town Center Drive 6000 Greenbelt Road
Cockeysville, MD 21030 Olney, MD 20832 Greenbelt, MD 20704
751 South Salisbury Boulevard 6197 Oxon Hill Road 9730 Groffs Mill Drive
Salisbury, MD 21801 Oxon Hill, MD 20745 Owings Mills, MD 21117
5700 Southeast Crain Highway 10821 Connecticut Avenue 6340 York Road
Upper Marlboro, MD 20772 Kensington, MD 20895 Towson, MD 21212
5476 Wisconsin Avenue 18006 Mateny Road 4622 Wilkens Avenue
Chevy Chase, MD 20815 Germantown, MD 20874 Baltimore, MD 21229
8100 Loch Raven Boulevard 7406 Baltimore Avenue 11301 Rockville Pike
Towson, MD 21286 College Park, MD 20740 Kensington, MD 20895
842 Muddy Branch Road 980 E. Swan Creek Road 7501 Wisconsin Avenue
Gaithersburg, MD 20878 Fort Washington, MD 20744 Bethesda, MD 20814
229 Kentlands Boulevard 3828 International Drive 5370 Westbard Avenue
Gaithersburg, MD 20878 Silver Spring, MD 20906 Bethesda, MD 20816
12051 Rockville Pike 3400 Crain Highway 7340 Westlake Terrace
Rockville, MD 20852 Bowie, MD 20716 Bethesda, MD 20817
15791 Columbia Pike 2315 Randolph Road 1327 Lamberton Drive
Burtonsville, MD 20866 Silver Spring, MD 20906 Silver Spring, MD 20902
2215 Bel Pre Road 45101 First Colony Way 13490 New Hampshire Avenue
Wheaton, MD 20906 California, MD 20619 Silver Spring, MD 20904
8401 Connecticut Avenue 802 Pleasant Drive 2611 Brandermill Boulevard
Chevy Chase, MD 20815 Rockville, MD 20850 Gambrills, MD 21054
5424 Western Avenue 8000 York Road 4701 Sangamore Road
Chevy Chase, MD 20815 Towson, MD 21252 Bethesda, MD 20816
13641 Connecticut Avenue 7940 Crain Highway 9245 Baltimore National Pike
Wheaton, MD 20906 Glen Burnie, MD 21061 Ellicot City, MD 21042
1000 Hilltop Circle 1161 Maryland Route 3N 625 Hungerford Drive
Baltimore, MD 21250 Gambrills, MD 21054 Rockville, MD 20850
7566 Ridge Road 1100 17th Street, NW 4000 Wisconsin Avenue, NW
Hanover, MD 21706 Washington, DC 20036 Washington, DC 20016
4455 Connecticut Avenue, NW 1545 Wisconsin Avenue, NW 1717 Pennsylvania Avenue, NW
Washington, DC 20008 Washington, DC 20007 Washington, DC 20006
2831 Alabama Avenue, SE 4860 Massachusetts Avenue, NW 925 15th Street, NW
Washington, DC 20020 Washington, DC 20016 Washington, DC 20005
1800 M Street, NW 210 Michigan Avenue, NE 1299 Pennsylvania Avenue, NW
Washington, DC 20036 Washington, DC 20017 Washington, DC 20005
5714 Connecticut Avenue, NW 1850 K Street, NW 22 Lighthouse Plaza
Washington, DC 20015 Washington, DC 20006 Rehoboth Beach, DE 19971
4400 Massachusetts Avenue, NW 3519 Connecticut Avenue, NW
Washington, DC 20016 Washington, DC 20008
At September 30, 2002, the net book value of the bank's office facilities,
including leasehold improvements, was $318.0 million, net of accumulated
depreciation of $92.8 million. See Note 23 to the Consolidated Financial
Statements in this report.
As of October 2002, the bank had received OTS approval to open five additional
full-service branch offices. The branches, two in Virginia and three in
Maryland, are scheduled to open during fiscal year 2003.
The bank owns additional assets, including furniture and data processing
equipment. At September 30, 2002, these other assets had a book value of $151.1
million, net of accumulated depreciation of $141.6 million. The bank also has
operating leases, primarily for certain data processing equipment and software.
Those leases have month-to-month or year-to-year terms.
ITEM 3. LEGAL PROCEEDINGS
In the normal course of business, the Trust is involved in certain litigation,
including litigation arising out of the collection of loans, the enforcement or
defense of the priority of its security interests, the continued development and
marketing of certain of its real estate properties, disputes with tenants and
certain employment claims. In the opinion of management, litigation which is
currently pending will not have a material adverse impact on the financial
condition or future operations of the Trust.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended September 30, 2002.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
There currently is no established public trading market for Common Shares. At
November 15, 2002, there were nine corporate or individual holders of record of
Common Shares. All holders of Common Shares at such date were affiliated with
the Trust. The Trust did not pay any cash dividends on its Common Shares during
the past two fiscal years. See "Item 12. Security Ownership of Certain
Beneficial Owners and Management."
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data of the Trust herein have been derived from the
Consolidated Financial Statements of the Trust. The data should be read in
conjunction with "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the Consolidated Financial Statements
included elsewhere in this report.
SELECTED FINANCIAL DATA
====================================================================================================================================
Year Ended September 30
---------------------------------------------------------------------
(In thousands, except per share amounts and other data) 2002 2001 2000 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
(Restated) (Restated) (Restated) (Restated)
STATEMENT OF OPERATIONS DATA:
Real Estate:
Total income $ 128,172 $ 142,952 $ 132,858 $ 106,025 $ 98,592
Total operating expenses 156,777 162,098 145,484 121,676 118,636
Equity in earnings of unconsolidated entities 9,057 7,402 7,291 4,964 1,642
Gain (loss) on sales of property -- 11,077 994 -- (331)
---------------------------------------------------------------------
Real estate operating loss (19,548) (667) (4,341) (10,687) (18,733)
---------------------------------------------------------------------
Banking:
Interest income 628,110 786,897 736,888 518,520 437,404
Interest expense 273,186 422,744 394,400 245,507 238,410
---------------------------------------------------------------------
Net interest income 354,924 364,153 342,488 273,013 198,994
Provision for loan losses (56,015) (67,852) (49,930) (22,880) (150,829)
---------------------------------------------------------------------
Net interest income after provision for loan and lease losses 298,909 296,301 292,558 250,133 48,165
---------------------------------------------------------------------
Other income:
Deposit servicing fees 113,640 101,482 88,253 69,570 51,997
Servicing and securitization income 84,160 52,169 28,991 31,509 231,674
Credit card fees -- -- -- -- 53,881
Gain on sales of trading securities, net 8,264 3,104 1,533 7,243 982
Net unrealized holding gains (losses) on trading securities (2,062) 1,054 -- 1,192 (1,258)
Gain (loss) on real estate held for investment or sale, net 992 2,815 (1,523) 34,049 (16,539)
Gain on sales of loans, net 4,094 4,904 1,443 3,779 290,434
Gain on other investment -- 10,294 -- -- --
Other 39,019 33,092 27,706 22,854 29,089
---------------------------------------------------------------------
Total other income 248,107 208,914 146,403 170,196 640,260
---------------------------------------------------------------------
Operating expenses 440,291 408,067 366,270 326,609 505,016
---------------------------------------------------------------------
Banking operating income 106,725 97,148 72,691 93,720 183,409
---------------------------------------------------------------------
Total Company:
Operating income 87,177 96,481 68,350 83,033 164,676
Provision for income taxes 24,386 27,682 19,637 28,258 43,385
---------------------------------------------------------------------
Income before extraordinary item and minority interest 62,791 68,799 48,713 54,775 121,291
Extraordinary item:
Loss on early extinguishment of debt, net of taxes -- -- (166) -- (9,601)
---------------------------------------------------------------------
Income before minority interest 62,791 68,799 48,547 54,775 111,690
Minority interest held by affiliates (10,051) (8,842) (5,269) (7,333) (21,921)
Minority interest -- other (25,313) (25,313) (25,313) (25,313) (25,313)
---------------------------------------------------------------------
Total company net income $ 27,427 $ 34,644 $ 17,965 $ 22,129 $ 64,456
=====================================================================
Net income available to common shareholders $ 22,009 $ 29,226 $ 12,547 $ 16,711 $ 59,038
Net income per common share:
Income before extraordinary item and minority interest $ 11.88 $ 13.13 $ 8.96 $ 10.22 $ 24.00
Extraordinary item:
Loss on early extinguishment of debt, net of taxes -- -- (0.03) -- (1.99)
---------------------------------------------------------------------
Income before minority interest 11.88 13.13 8.93 10.22 22.01
Minority interest held by affiliates (2.08) (1.83) (1.09) (1.52) (4.54)
Minority interest -- other (5.24) (5.24) (5.24) (5.24) (5.24)
---------------------------------------------------------------------
Total company net income $ 4.56 $ 6.06 $ 2.60 $ 3.46 $ 12.23
=====================================================================
- ------------------------------------------------------------------------------------------------------------------------------------
Continued on following page.
SELECTED FINANCIAL DATA
(Continued)
====================================================================================================================================
Year Ended September 30
---------------------------------------------------------------------
(In thousands, except per share amounts and other data) 2002 2001 2000 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
(Restated) (Restated) (Restated) (Restated)
BALANCE SHEET DATA:
Assets:
Real estate assets $ 437,514 $ 442,104 $ 433,189 $ 366,756 $ 325,351
Income-producing properties, net 285,308 282,984 238,249 207,407 183,879
Land parcels 41,323 40,835 39,716 39,448 40,110
Banking assets 11,269,453 11,412,752 10,727,269 9,151,405 6,723,140
Total company assets 11,706,967 11,854,856 11,160,458 9,518,161 7,048,491
Liabilities:
Real estate liabilities 663,376 667,176 665,838 590,885 562,622
Mortgage notes payable 326,232 331,114 313,746 221,126 207,680
Notes payable - secured 201,750 202,500 200,000 216,000 200,000
Notes payable - unsecured 55,156 50,717 47,463 46,122 50,335
Banking liabilities 10,606,111 10,781,754 10,122,392 8,570,344 6,145,695
Minority interest held by affiliates 89,007 82,538 77,314 72,551 71,828
Minority interest - other 218,307 218,307 218,307 218,307 218,306
Total company liabilities 11,576,801 11,749,775 11,083,851 9,452,087 6,998,451
Shareholders' equity 130,166 105,081 76,607 66,074 50,040
- ------------------------------------------------------------------------------------------------------------------------------------
OTHER DATA:
Hotels:
Number of hotels 18 18 16 15 12
Number of guest rooms 3,578 3,578 3,196 3,103 2,772
Average occupancy 61% 66% 71% 68% 68%
Average room rate $86.82 $94.32 $89.16 $85.45 $81.01
Office properties:
Number of properties 13 11 10 7 7
Leasable area (square feet) 1,978,016 1,796,571 1,684,425 1,277,243 1,270,087
Leasing percentages 86% 92% 98% 92% 100%
Land parcels:
Number of parcels 10 10 9 10 10
Total acreage 389 385 399 417 434
- ------------------------------------------------------------------------------------------------------------------------------------
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The Trust has prepared its financial statements and other disclosures on a
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. The term "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."
On July 31, 2002, the Trust filed a Current Report on Form 8-K stating that, as
a result of its internal accounting review, the Bank had determined that its net
income had been inadvertently overstated in prior periods due to certain
accounting errors involving interest-only strips receivable related to the
Bank's automobile loan securitizations.
In addition, as part of the restatement process, the Trust determined that
shareholders' equity was understated and net income was overstated related to it
investments in Saul Holdings Limited Partnership ("Saul Holdings") and Saul
Centers, Inc ("Saul Centers"), respectively, and accordingly changed its
accounting treatment related to these investments.
As a result, the Trust has restated its financial results and financial position
for the fiscal years ended September 30, 2000 and 2001. The restated amounts
include primarily adjustments for securitizations and the investments in Saul
Holdings and Saul Centers, but also include certain other revisions. The
restatements reduced net income by approximately $4.4 million ($3.8 million
related to securitizations and $0.6 million related to the Saul Centers
investment and other adjustments), from $22.4 million to $18.0 million for
fiscal year 2000. The restatements reduced net income by approximately $9.0
million ($8.5 million related to securitizations and $0.5 million related
primarily to the Saul Centers investment), from $43.6 million to $34.6 million
for fiscal year 2001. Shareholders' Equity increased $68.0 million from $8.6
million to $76.6 million at September 30, 2000 and increased $59.9 million from
$45.2 million to $105.1 million at September 30, 2001, as a result of the Saul
Holdings investment adjustments offset by the adjustments described above.
The other revisions impacted certain previously reported asset and liability
accounts. Real Estate assets were reduced due to a decrease in the carrying
value of the investment in Saul Centers. Banking assets and liabilities
increased primarily as a result of the reclassification of certain assets that
were netted within Other liabilities. The liability related to the Deferred Gain
- - Real Estate was reclassified to Equity, net of tax. Other Real Estate
liabilities increased as a result of the tax effect of that adjustment.
CRITICAL ACCOUNTING POLICIES. The Trust's consolidated financial statements are
prepared in accordance with accounting principles generally accepted in the U.S.
("GAAP"), which requires the Trust to make certain estimates and assumptions
that affect its reported results (see Summary of Significant Accounting in Notes
to the Consolidated Financial Statements included herein). The Trust has
identified four policies that, due to estimates and assumptions inherent in
those policies, involve a relatively high degree of judgment and complexity.
Real Estate
REAL ESTATE PROPERTIES: Income producing properties are stated at the lower of
depreciated cost (except those which were acquired through foreclosure or
equivalent proceedings, the carrying amounts of which are based on the lower of
cost or fair value at the time of acquisition) or net realizable value.
Interest, real estate taxes and other carrying costs are capitalized on projects
under construction. Once construction is completed and the assets are placed in
service, rental income, direct operating expenses, and depreciation associated
with such properties are included in current operations. The Real Estate Trust
considers a project to be substantially complete and held available for
occupancy upon completion of tenant improvements, but no later than one year
from the cessation of major construction activity. Substantially completed
portions of a project are accounted for as separate projects. Expenditures for
repairs and maintenance are charged to operations as incurred.
Depreciation is calculated using the straight-line method over the assets
estimated useful life. Tenant improvements are amortized on a straight-line
basis over the lesser of their estimated useful lives or the term of the related
lease.
Long-lived assets to be held and used are reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. If the sum of the expected cashflows (undiscounted and
without interest charges) is less than the carrying amount of the asset, the
Trust recognizes an impairment loss. Measurement of an impairment loss for
long-lived assets that the Trust expects to hold and use is based on the fair
value of the asset. Long-lived assets to be disposed of are generally reported
at the lower of carrying amount or fair value less costs to sell.
INCOME RECOGNITION: The Real Estate Trust derives room and other revenues from
the operations of its hotel. Hotel revenue is recognized as earned. The Real
Estate Trust derives rental income under noncancelable long-term leases from
tenants at its commercial properties. Commercial property rental income is
recognized on a straight-line basis.
Banking
LOAN LOSS RESERVES: The bank maintains allowances for possible losses on its
loans, leases and real estate at levels it believes to be adequate to absorb
estimated losses inherent in the loan, lease and real estate portfolios at the
balance sheet date. Management reviews the adequacy of the allowance for losses
using a variety of measures and tools appropriate for the asset type, including
historical loss performance, delinquent status, current economic conditions,
internal risk ratings, current underwriting policies and practices and market
values for similar assets.
DERIVATIVE INSTRUMENTS: The bank uses a variety of derivative financial
instruments in order to mitigate its exposure to changes in market interest
rates. To mitigate the risk that the value of mortgage loans held for sale will
change as interest rates change, the bank generally enters into mortgage-backed
security forward sales contracts. To mitigate the risk that the value of the
bank's mortgage servicing rights will change as interest rates change, the bank
uses futures contracts and options on futures contracts related to U.S. Treasury
securities. In addition, the bank issues commitments to make fixed-rate mortgage
loans in which the customer "locks in" the interest rate before closing on the
loan. These interest rate locks are treated as derivative instruments in the
financial statements. All derivative instruments are recorded on the balance
sheet at their fair value, which generally represents the amount of money the
bank would receive or pay if the item were bought or sold in a current
transaction. Fair market values are based on market prices when they are
available. If market quotes are not available, fair values are based on market
or dealer prices of similar items or discounted cash flows using market
estimates of interest rates, prepayment speeds and other assumptions.
When determining the extent to which interest rate exposures should be hedged,
the bank makes certain estimates and judgments relating to, among other things,
whether an interest-rate lock will become a loan, the timing of the loan
closing, the timing of the subsequent sale of the loan, and the prepayment speed
of mortgage loans underlying the mortgage servicing rights. To the extent that
the actual results are different than the bank's assumptions, the hedging
strategy may not be effective in offsetting the changes in the values of the
hedged items, and the bank's earnings may be adversely impacted.
INTEREST-ONLY STRIPS RECEIVABLE: From time to time, the bank sells loans and
retains an interest-only strip receivable related to the sold loans. The
interest-only strips receivable are initially recorded by allocating the
previous carrying value of the assets involved in the transactions between the
assets sold and the interests retained, including the interest-only strip
receivable. Subsequently, the interest-only strips receivable are measured at
their fair values. Fair value of these interest-only strips receivable is based
on discounted expected future cash flows, which are determined using market
assumptions such as discount rates and prepayment speeds, and, in certain
circumstances, an estimate of credit losses based on the bank's historical
experience. If actual prepayment or default rates significantly exceed the
estimates, the actual amount of future cash flow could be less than the expected
amount and the value of the interest-only strips receivable, as well as the
bank's earnings, could be negatively impacted.
MORTGAGE SERVICING RIGHTS: From time to time, the bank sells mortgage loans and
retains the right to service those loans ("originated MSR"). The originated MSR
are initially recorded by allocating the previous carrying value of the loans
between the portion sold and the retained originated MSR. The bank also
purchases the right to service mortgage loans originated by third parties
("purchased MSR" and, together with originated MSR, "MSR"). Purchased MSR are
initially recorded at their acquisition cost. Subsequent to origination or
purchase, MSR are carried at the lower of their amortized cost or fair value.
Fair value of MSR is based on discounted expected future income, net of related
expenses, to be generated by servicing the underlying loans. When determining
fair value, the bank uses several assumptions, the most significant of which are
the estimated rate of repayment of the underlying loans and the discount rate.
If actual prepayment rates significantly exceed the estimates, the actual amount
of future cash flow could be less than the expected amount and the value of the
MSR, as well as the bank's earnings, could be negatively impacted.
The bank believes that the judgments, estimates and assumptions used in the
preparation of the Consolidated Financial Statements are appropriate given the
factual circumstances at the time. However, given the sensitivity of our
Consolidated Financial Statements to these items, the use of other judgments,
estimates and assumptions, as well as differences between actual results and the
estimates and assumptions, could result in material differences in our results
of operations and financial condition.
Financial Condition
Real Estate
The Real Estate Trust's investment portfolio at September 30, 2002 consisted
primarily of hotels, office projects, and land parcels. See "Item 1. Business --
Real Estate -- Real Estate Investments." During fiscal 2002, the Real Estate
Trust added two office/warehouse buildings located in sterling, Virginia, to its
portfolio. One building contains 81,000 square feet of gross leasable area, but
is unleased at the date of this report. The other contains 100,000 square feet
of gross leasable area, and is 100% leased.
Overall, the hotel portfolio experienced an average occupancy rate of 61% and an
average room rate of $86.82 during fiscal 2002, compared to an average occupancy
of 66% and an average room rate of $94.32 during the prior year. For the 16
hotels owned throughout both periods, the average occupancies were 60% and 66%,
and the average rates were $83.65 and $91.96. REVPAR (revenue per available
room) for the 16 hotels was $50.51 for fiscal 2002, a 17.3% decrease from REVPAR
for fiscal 2001 of $61.05.
The Real Estate Trust was directly affected by the terrorist attacks of
September 11 because of the concentration of eleven of its hotels in the
Washington, DC metropolitan area, one of the sites of the attacks. In addition,
five of these eleven hotels are within minutes of either Washington Reagan
National Airport or Dulles International Airport, and thus, were more directly
affected by the sharp decline in air travel. The two hotels located close to
Reagan National were especially affected by Reagan National's prolonged closure
and limited flight schedule. Additionally, the entire portfolio has been
impacted, during fiscal 2002, by the economic downturn in the general business
sectors in the Washington, DC metropolitan area.
Office space in the Real Estate Trust's office property portfolio was 86% leased
at September 30, 2002, compared to a leasing rate of 92% at September 30, 2001.
The decline in leasing rate is primarily due to the Trust placing into service
during December 2001,an 81,000 square foot building in Sterling, Virginia, that
remains unleased. In addition, the Trust is beginning to experience a downward
trend in its leasing rates and renewals of leases commensurate with the
weakening commercial office markets in Northern Virginia as well as in Atlanta,
Georgia. At September 30, 2002, the Real Estate Trust's office property
portfolio consisted of 13 properties and had a total gross leasable area of
1,978,000 square feet, of which 242,000 square feet (12.2%) and 179,000 square
feet (9.1%) are subject to leases expiring in fiscal 2003 and fiscal 2004.
Banking
GENERAL. The bank's assets declined to $11.3 billion during fiscal year 2002, a
decrease of $143.3 million from fiscal year 2001. The bank recorded operating
income of $106.7 million during fiscal year 2002, compared to operating income
of $97.1 million during fiscal year 2001. The increase in income for fiscal year
2002 was primarily attributable to a $32.0 million increase in servicing and
securitization income, a $12.2 million increase in deposit servicing fees and a
decrease of $11.8 million in the provision for loan and lease losses. Partially
offsetting the increased income was an increase in operating expenses of $32.2
million, a $10.3 million prior year gain on other investment and a $9.2 million
decrease in net interest income. The increase in operating expenses is largely
attributable to an increase in servicing assets amortization and other loan
expenses. See "Results of Operations."
Servicing and securitization income increased $32.0 million, or 61.3%, during
fiscal year 2002 primarily as a result of increased securitization activity.
During fiscal year 2002, the bank securitized and sold $1.6 billion of loan
receivables and recognized a gain of $56.9 million compared to securitization of
$804.9 million of loan receivables and a gain of $27.9 million in fiscal year
2001. See Notes 2 and 10 to the Consolidated Financial Statements in this
report. See "Liquidity." The bank recognized a net unrealized loss of $8.7
million and $0.1 million on its interest-only strips receivable during the
fiscal years 2002 and 2001, respectively.
Real estate owned, net of valuation allowances, decreased from $30.8 million at
September 30, 2001 to $23.4 million at September 30, 2002. This reduction was
primarily due to sales in the Communities and other properties and to provisions
for losses, partially offset by capitalized costs. See "Asset Quality - REO."
At September 30, 2002, the bank's tangible, core, tier 1 risk-based and total
risk-based regulatory capital ratios were 5.63%, 5.63%, 7.08% and 10.86%,
respectively. The bank's capital ratios exceeded regulatory requirements as well
as the standards established for well-capitalized institutions under OTS prompt
corrective action regulations. See "Capital."
During fiscal year 2002, the bank declared and paid, out of the retained
earnings of the bank, cash dividends on its Common Stock in the aggregate amount
of $2,000 per share.
The bank's assets are subject to review and classification by the OTS upon
examination. The OTS concluded its most recent examination of the bank in June
2002.
ASSET QUALITY. Non-Performing Assets. The bank's level of non-performing assets
decreased during fiscal year 2002. The following table sets forth information
concerning the bank's non-performing assets at the dates indicated. The figures
shown are after charge-offs and, in the case of real estate acquired in
settlement of loans, after all valuation allowances.
NON-PERFORMING ASSETS
(DOLLARS IN THOUSANDS)
September 30,
-------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------- ------------- ------------- ------------- -------------
Non-performing assets:
Non-accrual loans:
Residential $ 13,680 $ 7,314 $ 5,171 $ 4,756 $ 8,106
Real estate and construction and ground 653 - 70 - -
------------- ------------- ------------- ------------- -------------
Total non-accrual real estate loans 14,333 7,314 5,241 4,756 8,106
Commercial 2,329 - - 269 -
Subprime automobile 7,755 13,379 12,026 6,640 3,563
Other consumer 2,344 7,028 5,399 1,607 938
------------- ------------- ------------- ------------- -------------
Total non-accrual loans (1) 26,761 27,721 22,666 13,272 12,607
------------- ------------- ------------- ------------- -------------
Real estate acquired in settlement of loans 94,665 115,931 129,213 133,157 218,972
Allowance for losses on real estate acquired
in settlement of loans (71,293) (85,152) (80,752) (84,405) (153,564)
------------- ------------- ------------- ------------- -------------
Real estate acquired in settlement of loans, net 23,372 30,779 48,461 48,752 65,408
------------- ------------- ------------- ------------- -------------
Total non-performing assets $ 50,133 $ 58,500 $ 71,127 $ 62,024 $ 78,015
============= ============= ============= ============= =============
Troubled debt restructurings $ - $ - $ - $ 11,714 $ 11,800
============= ============= ============= ============= =============
Allowance for losses on loans and leases $ 71,109 $ 63,018 $ 54,018 $ 58,139 $ 60,157
Allowance for losses on real estate held for investment 202 202 202 202 202
Allowance for losses on real estate acquired in
settlement of loans 71,293 85,152 80,752 84,405 153,564
------------- ------------- ------------- ------------- -------------
Total allowances for losses $ 142,604 $ 148,372 $ 134,972 $ 142,746 $ 213,923
============= ============= ============= ============= =============
Interest income recorded
Non-accrual assets $ 279 $ 358 $ 4 $ 17 $ 38
============= ============= ============= ============= =============
Restructured loans $ - $ - $ 340 $ 229 $ 367
============= ============= ============= ============= =============
Interest income that would have been recorded
had the loans been current in
accordance with their original terms
Non-accrual assets $ 3,141 $ 3,321 $ 2,434 $ 1,769 $ 1,081
============= ============= ============= ============= =============
Restructured loans $ - $ - $ 1,323 $ 1,261 $ 1,244
============= ============= ============= ============= =============
- ---------------------------------------------------------------------------------------------------------------------------------
(1) Before deduction of allowances for losses.
NON-PERFORMING ASSETS (CONTINUED)
September 30,
----------------------------------------------------------------------
2002 2001 2000 1999 1998
------------- ----------- ------------- ------------- ------------
Ratios:
Non-performing assets to total assets 0.44% 0.51% 0.66% 0.68% 1.16%
Allowance for losses on real estate loans to non-accrual
real estate loans (1) 44.04% 70.86% 205.76% 361.35% 204.18%
Allowance for losses on other consumer loans and leases to
non-accrual other consumer loans and leases (1)(2) 435.35% 230.55% 208.49% 440.52% 758.08%
Allowance for losses on loans and leases to non-accrual loans
and leases (1) 265.72% 227.33% 238.32% 438.06% 477.17%
Allowance for losses on loans and leases to total loans and
leases receivable (3) 0.80% 0.73% 0.65% 0.89% 2.16%
- -----------------------------------------------------------------------------------------------------------------------------------------
(1) Before deduction of allowances for losses.
(2) Includes subprime automobile loans.
(3) Includes loans and leases receivable and loans held for securitization
and/or sale, before deduction of allowance for losses.
Non-performing assets include non-accrual loans, non-accrual real estate held
for investment, and REO, acquired either through foreclosure or deed-in-lieu of
foreclosure, or pursuant to in-substance foreclosure. Non-accrual loans consist
of loans contractually past due 90 days or more or with respect to which other
factors indicate that full payment of principal and interest is unlikely.
Non-performing assets totaled $50.1 million, after valuation allowances on REO
of $71.3 million, at September 30, 2002, compared to $58.5 million, after
valuation allowances on REO of $85.2 million, at September 30, 2001. The bank
also maintained valuation allowances of $71.1 million and $63.0 million on its
loan and lease portfolio at September 30, 2002 and 2001, respectively. The $8.4
million decrease in non-performing assets reflected a net decrease in REO of
$7.4 million and a net decrease in non-accrual loans of $1.0 million.
Non-accrual Loans. The bank's non-accrual loans totaled $26.7 million at
September 30, 2002, a decrease from $27.7 million at September 30, 2001. At
September 30, 2002, non-accrual loans consisted of $14.3 million of non-accrual
real estate loans and $12.4 million of non-accrual subprime automobile,
commercial and other consumer loans compared to non-accrual real estate loans of
$7.3 million and non-accrual subprime automobile and other consumer loans of
$20.4 million at September 30, 2001. The increase in non-accrual real estate
loans reflects the general economic downturn. The decrease in non-accrual
subprime automobile loans reflects the winding down of that portfolio.
REO. At September 30, 2002, the bank's REO totaled $23.4 million, after
valuation allowances on such assets of $71.3 million as set forth in the
following table:
Balance Balance
Number of Before After Percent
Properties Gross Charge-offs Valuation Valuation Valuation of
Balance Allowances Allowances Allowances Total
------------ ---------- ---------- -------------- -------------- -------------- ----------
(Dollars in thousands)
Communities 2 $ 95,741 $ 9,700 $ 86,041 $ 67,562 $ 18,479 79.1%
Residential ground 1 100 - 100 100 - -
Commercial ground 1 9,991 2,732 7,259 3,631 3,629 15.5%
Single-family
residential properties 6 1,449 184 1,265 - 1,265 5.4%
------------ ---------- ---------- -------------- ------------- -------------- ----------
Total REO 10 $ 107,281 $ 12,616 $ 94,665 $ 71,293 $ 23,372 100.0%
============ ========== ========== ============== ============= ============== ==========
During fiscal year 2002, REO decreased $7.4 million, primarily as a result of
sales in the communities and other properties and additional provisions for
losses, which was partially offset by additional capitalized costs.
The bank's objective with respect to its REO is to sell those properties as
expeditiously as possible and in a manner that will best preserve the value of
the bank's assets. The bank's ability to achieve this objective will depend on a
number of factors, some of which are beyond its control, such as the general
economic conditions in the Washington, DC metropolitan area.
The principal component of REO consists of the two communities, both of which
are under active development. At September 30, 2002, one of the active
communities had 220 remaining residential lots, of which 140 lots, or 63.6%,
were under contract and pending settlement. This community also had
approximately 167 remaining acres of land designated for commercial use, of
which approximately 47 acres, or 28.1%, were under contract and pending
settlement. The other active community has only one remaining commercial lot,
which was under contract and pending settlement at September 30, 2002. In
addition, at September 30, 2002, the bank was engaged in discussions with
potential purchasers regarding the sale of additional residential units and
retail land.
The bank continues to monitor closely its major non-performing and potential
problem assets in light of current and anticipated market conditions. The bank's
asset workout group focuses its efforts on resolving these problem assets as
expeditiously as possible.
Potential Problem Assets. Although not considered non-performing assets,
primarily because the loans are not 90 or more days past due and the borrowers
have not abandoned control of the properties, potential problem assets are
experiencing problems sufficient to cause management to have serious doubts as
to the ability of the borrowers to comply with present repayment terms. At
September 30, 2002 and 2001, potential problem assets totaled $22.4 million and
$3.7 million, respectively.
The bank's Watch List Committee meets quarterly and reviews all relationships in
Commercial Lending which are rated as vulnerable, criticized or classified with
commitments of $1.0 million and greater. This Committee reviews the current
status of each relationship, recent changes, performance against the corrective
action plan presented at the prior meeting, and the current action plan for the
relationship. On September 10, 2002, the Committee reviewed loans with
outstanding balances of $74.3 million at June 30, 2002.
Delinquent Loans. At September 30, 2002, delinquent loans totaled $77.3 million,
or 0.9% of loans, compared to $111.2 million, or 1.3% of loans, at September 30,
2001. The following table sets forth information regarding the bank's delinquent
loans at September 30, 2002.
Principal Balance
(Dollars in Thousands)
-------------------------------------------------------------------------
Real Subprime Other Total as a
Estate Automobile Commercial Consumer Percentage
Loans Loans Loans Total of Loans (1)
----------- ------------- -------------- ------------ ---------- -------------
Loans delinquent for:
30-59 days... $ 5,064 $ 34,323 $ 3,875 $ 12,699 $ 55,961 0.6%
60-89 days.... 5,758 11,451 468 3,632 21,309 0.3%
------------- ------------- -------------- ------------ ---------- -------------
Total........... $ 10,822 $ 45,774 $ 4,343 $ 16,331 $ 77,270 0.9%
============= ============= ============== ============ ========== =============
- --------------------------
(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 permanent residential mortgage loans and home equity loans. Total
delinquent real estate loans decreased to $10.8 million at September 30, 2002,
from $16.0 million at September 30, 2001.
Total delinquent subprime automobile loans decreased to $45.8 million at
September 30, 2002, from $72.7 million at September 30, 2001 primarily because
the bank's portfolio of these 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 12 loans
totaling $4.3 million at September 30, 2002. There were no delinquent commercial
loans at September 30, 2001. The increase in delinquencies reflects the
maturation in the bank's portfolio.
Other consumer loans delinquent 30-89 days decreased to $16.3 million at
September 30, 2002 from $22.5 million at September 30, 2001. The decrease in
other consumer loan delinquencies is due to a change in the bank's automobile
loan and lease charge-off policy which took effect in fiscal year 2002.
Troubled Debt Restructurings. A troubled debt restructuring occurs when the bank
agrees to modify significant terms of a loan in favor of a borrower experiencing
financial difficulties. The bank had no troubled debt restructurings at
September 30, 2002 and 2001.
Real Estate Held for Investment. At September 30, 2002 and 2001, real estate
held for investment consisted of one property with book value of $0.9 million,
net of 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 years indicated and may
include charge-offs taken against assets, which the bank disposed of during such
years.
ANALYSIS OF ALLOWANCE FOR AND CHARGE-OFFS OF LOANS AND LEASES
(Dollars in thousands)
Year Ended September 30,
---------------------------------------------------------------------------------
2002 2001 2000 1999 1998
-------------- -------------- -------------- -------------- --------------
Balance at beginning of year $ 63,018 $ 54,018 $ 58,139 $ 60,157 $ 105,679
-------------- -------------- -------------- -------------- --------------
Provision for loan and lease losses 56,015 67,852 49,930 22,880 150,829
-------------- -------------- -------------- -------------- --------------
Reduction due to sale of credit card portfolio - - - - (87,609)
-------------- -------------- -------------- -------------- --------------
Charge-offs:
Single family residential and home equity (1,132) (786) (807) (617) (1,629)
Commercial real estate and multifamily (27) - (7,120) - -
Credit card - - - - (108,289)
Subprime automobile (40,695) (49,749) (40,110) (21,169) (7,298)
Other consumer (20,225) (17,685) (10,847) (4,988) (5,436)
-------------- -------------- -------------- -------------- --------------
Total charge-offs (62,079) (68,220) (58,884) (26,774) (122,652)
-------------- -------------- -------------- -------------- --------------
Recoveries (1):
Single family residential and home equity 76 80 78 85 49
Commercial real estate and multifamily 18 - - - -
Credit card - - - - 12,732
Subprime automobile 11,311 7,104 3,074 744 297
Other consumer 2,750 2,184 1,681 1,047 832
-------------- -------------- -------------- -------------- --------------
Total recoveries 14,155 9,368 4,833 1,876 13,910
-------------- -------------- -------------- -------------- --------------
Charge-offs, net of recoveries (47,924) (58,852) (54,051) (24,898) (108,742)
-------------- -------------- -------------- -------------- --------------
Balance at end of year $ 71,109 $ 63,018 $ 54,018 $ 58,139 $ 60,157
============== ============== ============== ============== ==============
Provision for loan and lease losses to average
loans and leases (2) 0.66% 0.78% 0.66% 0.48% 5.42%
Net loan and lease charge-offs to average loans
and leases (2) 0.57% 0.68% 0.71% 0.52% 3.91%
Ending allowance for losses on loans and leases to
total loans and leases (2) (3) 0.80% 0.73% 0.65% 0.89% 2.16%
(1) Includes proceeds received from the sale of charged-off loans.
(2) Includes loans held for securitization and/or sale.
(3) Before deduction of allowance for losses.
COMPONENTS OF ALLOWANCE FOR LOSSES ON LOANS AND LEASES BY TYPE
(Dollars in thousands)
September 30,
----------------------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
---------------------- --------------------- --------------------- --------------------- ----------------------
Percent of Percent of Percent of Percent of Percent of
Loans to Loans to Loans to Loans to Loans to
Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans
--------- ------------ --------- ----------- --------- ----------- --------- ----------- ---------- -----------
Balance at end of
year allocated to:
Single family
residential $ 1,953 51.5 % $ 2,127 52.9 % $ 2,127 58.6 % $ 3,127 60.9 % $ 1,822 63.2 %
Home equity 817 12.3 1,007 7.6 1,007 5.1 1,007 6.2 676 7.2
Commercial real
estate and
multifamily 124 0.2 197 0.4 893 0.5 10,580 0.9 10,828 2.7
Real estate
construction and
ground 3,419 2.9 1,852 3.1 4,757 3.6 2,472 3.5 3,225 3.9
Commercial 16,934 9.1 9,135 9.0 6,904 7.2 4,623 6.1 3,623 6.2
Prime Automobile
loans 4,150 7.0 7,034 7.0 6,034 9.3 3,334 11.1 3,034 4.4
Automobile leases 5,030 12.8 6,000 13.2 1,500 6.8 - 1.7 - -
Subprime automobile 32,000 2.6 32,000 5.0 28,782 7.4 28,782 7.4 26,010 8.5
Home improvement
and related loans 1,151 1.2 1,523 1.4 1,523 1.1 3,523 1.7 3,403 2.7
Overdraft lines of
credit and
other consumer 1,635 0.4 491 0.4 491 0.4 691 0.5 1,674 1.2
Unallocated 3,896 - 1,652 - - - - - 5,862 -
---------- ---------- --------- --------- ----------
Total $ 71,109 $ 63,018 $ 54,018 $ 58,139 $ 60,157
========== ========== ========= ========= ==========
- ------------------------------------------------------------------------------------------------------------------------------------
ANALYSIS OF ALLOWANCE FOR AND CHARGE-OFFS OF
REAL ESTATE HELD FOR INVESTMENT OR SALE
(IN THOUSANDS)
Year Ended September 30,
--------------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------- ------------- -------------- ------------- --------------
Balance at beginning of year:
Real estate held for investment $ 202 $ 202 $ 202 $ 202 $ 198
Real estate held for sale 85,152 80,752 84,405 153,564 140,738
------------- ------------- -------------- ------------- --------------
Total 85,354 80,954 84,607 153,766 140,936
------------- ------------- -------------- ------------- --------------
Provision for real estate losses:
Real estate held for investment - - - - 4
Real estate held for sale 700 4,200 1,400 - 18,856
------------- ------------- -------------- ------------- --------------
Total 700 4,200 1,400 - 18,860
------------- ------------- -------------- ------------- --------------
Charge-offs, net of recoveries :
Real estate held for sale:
Residential ground (1,589) - (64) (1,703) -
Commercial ground - - (3,397) - (6,030)
Communities (12,970) 200 (1,592) (67,456) -
------------- ------------- -------------- ------------- --------------
Total (charge-offs) recoveries on real estate
held for investment or sale (14,559) 200 (5,053) (69,159) (6,030)
------------- ------------- -------------- ------------- --------------
Balance at end of year:
Real estate held for investment 202 202 202 202 202
Real estate held for sale 71,293 85,152 80,752 84,405 153,564
------------- ------------- -------------- ------------- --------------
Total $ 71,495 $ 85,354 $ 80,954 $ 84,607 $ 153,766
============= ============= ============== ============= ==============
COMPONENTS OF ALLOWANCE FOR LOSSES
ON REAL ESTATE HELD FOR INVESTMENT OR SALE
(IN THOUSANDS)
September 30,
--------------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------- ------------- -------------- ------------- --------------
Allowance for losses on real estate
held for investment $ 202 $ 202 $ 202 $ 202 $ 202
------------- ------------- -------------- ------------- --------------
Allowance for losses on real estate held for sale:
Residential ground 100 1,689 1,689 1,520 3,123
Commercial ground 3,631 3,631 3,631 5,800 5,800
Communities 67,562 79,832 75,432 77,085 144,641
------------- ------------- -------------- ------------- --------------
Total 71,293 85,152 80,752 84,405 153,564
------------- ------------- -------------- ------------- --------------
Total allowance for losses on real
estate held for investment or sale $ 71,495 $ 85,354 $ 80,954 $ 84,607 $ 153,766
============= ============= ============== ============= ==============
The bank maintains valuation allowances for estimated losses on loans and leases
and real estate. The bank's total valuation allowances for losses on loans and
leases and real estate held for investment or sale decreased to $142.6 million
at September 30, 2002, from $148.4 million at September 30, 2001. The $5.8
million decrease was primarily attributable to a reduction in valuation
allowances on the REO communities following the completion of one of the
communities. The allowance for losses on loans and leases increased to $71.1
million at September 30, 2002 from $63.0 million at September 30, 2001, despite
decreased delinquencies and charge-offs during the current year. Management
believes that the increase was appropriate due to uncertain economic conditions.
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, delinquent status, current economic conditions, internal risk
ratings and current underwriting policies and procedures. Using this analysis,
management determines a range of acceptable valuation allowances.
The allowance for losses on loans secured by real estate and real estate held
for investment or sale totaled $77.8 million at September 30, 2002, which
constituted 71.4% of total non-performing real estate assets before valuation
allowances. This amount represented a $12.7 million decrease from the September
30, 2001 level of $90.5 million, or 73.5% of total non-performing real estate
assets before valuation allowances at that date.
When real estate collateral securing an extension of credit is initially
recorded as REO, it is recorded at the lower of cost or fair value, less
estimated selling costs, on the basis of an appraisal. As circumstances change,
it may be necessary to provide additional valuation allowances based on new
information. The allowance for losses on real estate held for sale at September
30, 2002 is in addition to approximately $12.6 million of cumulative charge-offs
previously taken against assets remaining in the bank's portfolio at September
30, 2002.
The bank from time to time obtains updated appraisals on its real estate
acquired in settlement of loans, including the communities. As a result of the
updated appraisals, the bank could be required to increase its valuation
allowances. The bank may also increase its allowances for losses after
considering local market conditions, including the bank's efforts to sell
individual properties or portions of properties. In addition to ongoing sales of
lots, management periodically receives and reviews offers to purchase various
parcels of these communities. If information is deemed credible and can be
supported with market comparables, additional allowances for losses may be
provided.
Consistent with regulatory requirements, the bank performs ongoing real estate
evaluations for all REO as a basis for substantiating the carrying values in
accordance with accounting principles generally accepted in the United States.
As indicated, as of September 30, 2002, the bank's REO consisted primarily of
two residential communities under active development. As a part of its
development activities, the bank maintains and updates real estate project
evaluations in accordance with regulatory requirements which include analyses of
lot and acreage sales, status and budgets for development activities and
consideration of project market trends. These real estate evaluations are
reviewed periodically as part of management's review and evaluation of the
carrying values of REO. Following a review of the real estate assets and the
related carrying values, management reports its actions to the bank's Board of
Directors. The allowance for losses on other consumer loans and leases,
including automobile, home improvement, overdraft lines of credit and other
consumer loans, decreased to $44.0 million at September 30, 2002 from $47.0
million at September 30, 2001. Net charge-offs of subprime automobile loans for
fiscal year 2002 were $29.4 million, compared to $42.6 million for fiscal year
2001. The decrease was primarily attributable to the decline in the bank's
portfolio of these loans as a result of the bank's prior decision to discontinue
origination of these loans.
ASSET AND LIABILITY MANAGEMENT. A key element of banking is the monitoring and
management of liquidity risk and interest-rate risk. The process of planning and
controlling asset and liability mix, volume and maturity to stabilize the net
interest spread is referred to as asset and liability management. The objective
of asset and liability management is to maximize the net interest yield within
the constraints imposed by prudent lending and investing practices, liquidity
needs and capital planning.
The bank's assets and liabilities are inherently sensitive to changes in
interest rates. These movements can result in variations to the overall level of
income and market value of equity. Based on the characteristics of a specific
asset or liability (including maturity, repricing frequency and interest rate
caps) a change in interest rates can significantly affect the contribution to
net income and market value for the instrument. If, in the aggregate, the bank's
assets mature or reprice more quickly or to a greater extent than its
liabilities, the bank is termed "asset sensitive" and will tend to experience
increased income and market value during periods of rising interest rates and
declining income and market value during periods of falling interest rates.
Conversely, if the bank's liabilities mature or reprice more quickly or to a
greater extent than its assets, the bank is termed "liability sensitive" and
will tend to experience decreased income and market value during periods of
rising interest rates and increased income and market value during periods of
falling interest rates.
The bank pursues an asset-liability management strategy designed both to control
risk from changes in market interest rates and to maximize interest income in
its loan and lease portfolio. To achieve this strategy, the bank emphasizes the
origination and retention of a mix of both adjustable-rate and fixed-rate loan
products.
Throughout fiscal year 2002, the bank continued to originate and hold in its
portfolio adjustable rate loan products at a greater volume than those with
fixed interest rates. At September 30, 2002, adjustable-rate loans accounted for
54.6% of total loans and leases, compared to 51.3% at September 30, 2001. This
increase was primarily due to increased originations of adjustable-rate mortgage
products, which typically reprice monthly and are tied to the one month LIBOR,
and an increase in payoffs of fixed-rate mortgage loans due to refinancing
activity.
A traditional measure of interest-rate risk within the banking industry is the
interest sensitivity "gap," which is the sum of all interest-earning assets
minus all interest-bearing liabilities subject to repricing within the same
period. Gap analysis is a tool used by management to evaluate interest-rate risk
which results from the difference between repricing and maturity characteristics
of the bank's assets and those of the liabilities that fund them. By analyzing
these differences, management can attempt to estimate how changes in interest
rates may affect the bank's future net interest income.
The bank views control over interest rate sensitivity as a key element in its
financial planning process and monitors interest rate sensitivity through its
forecasting system. The bank manages interest rate exposure and will narrow or
widen its gap depending on its perception of interest rate movements and the
composition of its balance sheet. For the reasons discussed above, the bank
might take action to narrow its gap if it believes that market interest rates
will experience a significant prolonged increase, and might widen its gap if it
believes that market interest rates will decline or remain relatively stable.
A number of asset and liability management strategies are available to the bank
in structuring its balance sheet. These include selling or retaining certain
portions of the bank's current residential mortgage loan production; altering
the bank's pricing on certain deposit products to emphasize or de-emphasize
particular maturity categories; altering the type and maturity of securities
acquired for the bank's investment portfolio when replacing securities following
normal portfolio maturation and turnover; lengthening or shortening the maturity
or repricing terms for any current period asset securitizations; and altering
the maturity or interest rate reset profile of borrowed funds, if any, including
funds borrowed from the FHLB of Atlanta.
The following table presents the interest rate sensitivity of the bank's
interest-earning assets and interest-bearing liabilities at September 30, 2002,
which reflects management's estimate of mortgage loan prepayments and
amortization and provisions for adjustable interest rates. Adjustable and
floating rate loans are included in the period in which their interest rates are
next scheduled to adjust, and prepayment rates are assumed for the bank's loans
based on recent actual experience. Statement savings and passbook 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 September 30, 2002 Real estate loans:
Adjustable-rate $ 2,541,628 $ 291,831 $ 289,480 $ 135,785 $ 104,314 $ 3,363,038
Fixed-rate 75,747 69,757 223,748 156,047 387,963 913,262
Home equity credit lines and second
mortgages 714,343 2,548 9,214 7,806 34,657 768,568
Commercial 648,146 20,843 65,958 44,230 24,885 804,062
Consumer and other 429,568 349,077 834,048 171,506 49,324 1,833,523
Loans held for securitization and/or sale 1,223,035 - - - - 1,223,035
Mortgage-backed securities 157,558 145,364 216,298 161,962 347,451 1,028,633
Other investments 234,934 - 46,445 - - 281,379
------------- -------------- -------------- ------------- ------------- --------------
Total interest-earning assets 6,024,959 879,420 1,685,191 677,336 948,594 10,215,500
Total non-interest earning assets - - - - 1,053,953 1,053,953
------------- -------------- -------------- ------------- ------------- --------------
Total assets $ 6,024,959 $ 879,420 $ 1,685,191 $ 677,336 $ 2,002,547 $ 11,269,453
============= ============== ============== ============= ============= ==============
Deposits:
Fixed maturity deposits $ 981,600 $ 686,592 $ 206,613 $ 145,050 $ - $ 2,019,855
NOW, statement and passbook accounts 2,172,465 44,828 149,305 101,621 216,565 2,684,784
Money market deposit accounts 1,953,312 - - - - 1,953,312
Borrowings:
Capital notes - subordinated - - - 150,000 100,000 250,000
Other 760,517 198 1,481,361 25,488 94,884 2,362,448
------------- -------------- -------------- ------------- ------------- --------------
Total interest-bearing liabilities 5,867,894 731,618 1,837,279 422,159 411,449 9,270,399
Minority interest - - - - 144,000 144,000
Total non-interest bearing liabilities - - - - 1,319,540 1,319,540
Stockholders' equity - - - - 535,514 535,514
------------- -------------- -------------- ------------- ------------- --------------
Total liabilities and stockholders' equity $ 5,867,894 $ 731,618 $ 1,837,279 $ 422,159 $ 2,410,503 $ 11,269,453
============= ============== ============== ============= ============= ==============
Gap $ 157,065 $ 147,802 $ (152,088) $ 255,177 $ 537,145
Cumulative gap $ 157,065 $ 304,867 $ 152,779 $ 407,956 $ 945,101
Adjusted cumulative gap as a percentage
of total assets 1.4 % 2.7 % 1.4 % 3.6 % 8.4 %
The bank's one-year gap as a percentage of total assets was positive 2.7% at
September 30, 2002, compared to negative 13.3% at September 30, 2001. The
improvement in the bank's one-year gap results primarily from an increase during
fiscal year 2002 in origination and retention of adjustable-rate mortgages,
other consumer loans, and commercial loans with repricing terms of one year or
less. The increase in assets with repricing characteristics of one year or less
was partially offset by an increase in fixed rate and non-contractual deposits
with similar maturities. The bank continues to consider a variety of strategies
to manage its interest rate risk position.
In addition to gap measurements, the bank measures and manages interest-rate
risk with the extensive use of computer simulation. This simulation includes
calculations of Market Value of Portfolio Equity and Net Interest Margin as
promulgated by the OTS's Thrift Bulletin 13a. Under this bulletin, institutions
are required to establish limits on the sensitivity of their net interest income
and net portfolio value ("NPV") to parallel changes in interest rates. Those
changes in interest rates are defined as instantaneous and sustained movements
of interest rates in 100 basis point increments. In addition, the bank is
required to calculate its ratio of NPV to the present value of total assets
("NPV Ratio") for each interest rate shock scenario. The following table shows
the estimated impact of parallel shifts in interest rates at September 30, 2002,
calculated in a manner consistent with the requirements of TB 13a.
(Dollars in thousands)
- --------------------------------------------------------------------------------------------------------------------
Changes in Change in
(Basis Points) Net Interest Net Portfolio
Change in Income(1) Value(2) NPV
Interest Rates Ratio
-------------------------------- -----------------------------------
Percent Amount Percent Amount
- ------------------- ------------- --------------- -------------- ----------------- ---------------
+ 200 +13.3% $ 49,736 -6.6% $ (69,787) 8.53%
+ 100 +8.5% 31,927 -1.8% (18,988) 8.89%
- 100 -10.2% (37,958) -2.5% (26,022) 8.74%
- ---------------------------------------------------------------------------------------------------------------------------
(1) Represents the difference between net interest income for 12 months in a
stable interest rate environment and the various interest rate scenarios.
(2) Represents the difference between net portfolio value (NPV) of the bank's
equity in a stable interest rate environment and the NPV in the various
rate scenarios. The OTS defines NPV as the present value of expected net
cash flows from existing assets minus the present value of expected net
cash flows from existing liabilities plus the present value of expected net
cashflows from existing off-balance sheet contracts.
Computations of prospective effects of hypothetical interest rate changes are
based on many assumptions, including relative levels of market interest rates,
prepayments and deposit runoff and, therefore, should not be relied upon as
indicative of actual results. Certain limitations are inherent in these
computations. Although certain assets and liabilities may have similar
maturities or periods of repricing, they may react at different times and in
different degrees to changes in the market interest rates. The interest rates on
certain types of assets and liabilities may fluctuate in advance of changes in
market interest rates, while rates on other types of assets and liabilities may
lag behind changes in market interest rates. Certain assets, such as
adjustable-rate mortgage loans, may have features, which restrict interest rate
changes on a short-term basis and over the life of the asset. In the event of a
change in market interest rates, loan prepayments and early deposit withdrawal
levels could deviate significantly from those assumed in making the calculations
set forth above. Additionally, credit risk may increase if an interest rate
increase adversely affects the ability of borrowers to service their debt.
INFLATION. The impact of inflation on the bank is different from the impact on
an industrial company because substantially all of the assets and liabilities of
the bank are monetary in nature. The most direct impact of an extended period of
inflation would be to increase interest rates and to place upward pressure on
the operating expenses of the bank. However, the actual effect of inflation on
the net interest income of the bank would depend on the extent to which the bank
was able to maintain a spread between the average yield on interest-earning
assets and the average cost of interest-bearing liabilities, which would depend
to a significant extent on its asset-liability sensitivity. The effect of
inflation on the bank's results of operations for the past three fiscal years
has been minimal.
DEFERRED TAXES. At September 30, 2002, the bank recorded a net deferred tax
liability of $93.9 million, which generally represents the cumulative excess of
the bank's income tax expense for financial reporting purposes over its actual
income tax liability. See Note 34 to the Consolidated Financial Statements in
this report.
CAPITAL. At September 30, 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 September 30,
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 $ 535,514
Minority interest in REIT Subsidiary (1) 144,000
-----------
679,514
Adjustments for tangible and core capital:
Intangible assets (43,199)
Non-includable subsidiaries (2) (1,413)
Non-qualifying purchased/originated loan
servicing rights (2,594)
------------
Total tangible capital 632,308 5.63% $ 168,583 1.50% $ 463,725 4.13%
------------ ======== ============= ======== ============ ========
Total core capital (3) 632,308 5.63% $ 449,554 4.00% $ 182,754 1.63%
------------ ======== ============= ======== ============ ========
Tier 1 risk-based capital (3) 632,308 7.08% $ 357,083 4.00% $ 275,225 3.08%
------------ ======== ============= ======== ============ ========
Adjustments for total risk-based capital:
Subordinated capital debentures 250,000
Allowance for general loan and lease losses 71,109
------------
Total supplementary capital 321,109
------------
Total available capital 953,417
Equity investments (2) (2,065)
------------
Total risk-based capital (3) $ 951,352 10.86% $ 714,166 8.00% $ 237,186 2.86%
============ ======== ============= ======== ============ ========
(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) 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.
(3) 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%.
Under the OTS prompt corrective action regulations, an institution is
categorized as well capitalized if it has a leverage or core capital ratio of at
least 5.0%, a tier 1 risk-based capital ratio of at least 6.0%, a total
risk-based capital ratio of at least 10.0% and is not subject to any written
agreement, order, capital directive or prompt corrective action directive to
meet and maintain a specific capital level. At September 30, 2002, the bank's
leverage, tier 1 risk-based and total risk-based capital ratios were 5.63%,
7.08% and 10.86%, respectively, which exceeded the ratios established for
well-capitalized institutions. The OTS may reclassify an institution from one
category to the next lower category, for example from well capitalized to
adequately capitalized, if, after notice and an opportunity for a hearing, the
OTS determines that the institution is in an unsafe or unsound condition or has
received and has not corrected a less than satisfactory examination rating for
asset quality, management, earnings or liquidity. The bank has not received
notice from the OTS of any potential downgrade.
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. Accordingly, if the bank is unable to dispose of any REO property,
whether through bulk sales or otherwise, prior to the end of its applicable
five-year holding period and is unable to obtain an extension of the five-year
holding period from the OTS, the bank could be required to deduct the
then-current book value of such REO property from total risk-based capital. In
December 2001, the bank received from the OTS an extension of the holding
periods for certain of its REO properties through December 19, 2002. The
following table sets forth the bank's REO at September 30, 2002, after valuation
allowances of $71.3 million, by the fiscal year in which the property was
acquired through foreclosure.
Fiscal Year (In thousands)
----------- ----------------
1990 $ 2,065(1)
1991 16,414(2)
1995 3,628(2)
2002 1,265
----------------
Total REO $ 23,372
================
- -------------------------------------------------------------------------------
(1) Includes REO with a net book value of $2.1 million, which the bank treats as
equity investments for regulatory capital purposes.
(2) Includes REO, with an aggregate net book value of $20.0 million, for which
the bank received an extension of the holding periods through December 19, 2002.
The bank intends to apply for further extensions of the holding periods for
these properties. Failure to obtain further REO extensions could adversely
affect the bank's regulatory capital ratios. The bank's ability to maintain or
increase its capital levels in future periods also will be subject to general
economic conditions, particularly in the bank's local markets. Adverse general
economic conditions or a downturn in local real estate markets could require
further additions to the bank's allowances for losses and further charge-offs.
Any of those developments would adversely affect the bank's earnings and thus
its regulatory capital levels.
The bank has historically relied on preferred stock and subordinated debt as
significant components of its regulatory capital. Those instruments require
significant fixed payments to holders, which increase the bank's expenses and
make it more difficult for the bank to generate additional core capital through
retained earnings.
The OTS has amended its capital rules to increase the amount of capital the bank
will be required to maintain against certain of its residual interests. As of
September 30, 2002, the bank had $67.0 million in residual interests that,
although includable in total capital at that date, would be subject to a
dollar-for-dollar deduction from total capital beginning December 31, 2002 under
the amendments. Of this amount, $37.3 million was already subject to a
dollar-for-dollar deduction from total capital at September 30, 2002. See
"Regulatory Capital."
The following table shows actual and proforma regulatory capital ratios at
September 30, 2002 adjusted for the impact of the new rule regarding treatment
of residual interests for regulatory capital purposes:
Actual Proforma
---------------------- -----------------------
Core capital 5.63% 5.63%
Tier 1 risk-based capital 7.08% 6.97%
Total risk-based capital 10.86% 10.83%
Failure by the bank to remain well capitalized could have a material adverse
effect on certain aspects of the bank's operations, including its ability to pay
dividends. See "Dividends and Other Capital Distributions."
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 source 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.
See also the discussion of potential limitations on the payment of dividends by
the bank contained in "Item 1. Business - Banking - Dividends and Other Capital
Distributions."
During fiscal 2002, the bank made tax sharing payments totaling $5.7 million and
dividend payments totaling $16.0 million to the Real Estate Trust. At
September 30, 2002, the Trust is due $2.2 million in tax sharing payments from
the bank.
In recent years, the operations of the Real Estate Trust have generated net
operating losses while the bank has reported net income. The Trust's
consolidation of the bank's operations into the Trust's federal income tax
return has resulted in the use of the Real Estate Trust's net operating losses
to reduce the federal income taxes the bank would otherwise have owed. 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 (1) the tax benefit to the
group using such tax losses or unused tax credits in the group's consolidated
federal income tax returns or (2) 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 fiscal 2002, the Real Estate Trust purchased through dividend
reinvestment approximately 381,000 shares of common stock of Saul Centers, and
as of September 30, 2002, owns approximately 3,410,000 shares representing 22.8%
of such company's outstanding common stock. As of September 30, 2002, the market
value of these shares was approximately $79.2 million. Substantially all of
these shares have been pledged as collateral with the Real Estate Trust's
revolving credit lenders.
As the owner, directly and through two wholly-owned subsidiaries, of a limited
partnership interest in Saul Holdings Partnership, the Real Estate Trust shares
in cash distributions from operations and from capital transactions involving
the sale of properties. The partnership agreement of Saul Holdings Partnership
provides for quarterly cash distributions to the partners out of net cash flow.
See "Item 1. Business -- Real Estate -- Investment in Saul Holdings Limited
Partnership." In fiscal 2002, the Real Estate Trust received total cash
distributions of $6.5 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 two revolving credit
lenders.
In March 1998, the Trust issued $200.0 million aggregate principal amount of 9
3/4% Senior Secured Notes due 2008. These Notes are nonrecourse obligations of
the Trust and 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 Trust.
During 2002, the Real Estate Trust sold unsecured notes, with a maturity
ranging from one to ten years, primarily to provide funds to repay maturing
unsecured notes. During fiscal 2002, the Real Estate Trust sold notes amounting
to $12.5 million at a weighted average interest rate of 9.8%. 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 a two-year
term 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 for this line is September 29,
2003. 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, and at September 30,2002, the rate was 4.75%. At
September 30, 2002, the Real Estate Trust had outstanding borrowings under the
facility of $1.8 million and unrestricted availability of $48.2 million.
In fiscal 1996, the Real Estate Trust established an $8.0 million revolving
credit line with an unrelated bank. This facility was for a one-year term, after
which any outstanding loan amount would amortize over a two-year period. During
fiscal 1997, 1998 and 2000, the line of credit was increased to $10.0, $20.0,
and $25.0 million. In November 2002, this line was increased to $35.0 million.
The current maturity date for this line is November 15, 2004. 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 September 30, 2002, the Real Estate Trust had no outstanding
borrowings and unrestricted availability of $25.0 million.
The maturity schedule for the Real Estate Trust's outstanding debt at September
30, 2002 for fiscal years commencing October 1, 2002 is set forth in the
following table:
Debt Maturity Schedule
(In thousands)
--------------------------------------------------------------
Notes Notes
Fiscal Mortgage Payable -- Payable --
Year Notes Secured Unsecured Total
------------- --------- ----------- ----------- --------------
2003 $ 49,298 $ 1,750 $ 12,351 $ 63,399
2004 10,666 -- 11,762 22,428
2005 11,452 -- 10,033 21,485
2006 98,488 -- 5,806 104,294
2007 4,582 -- 4,221 8,803
Thereafter 151,746 200,000 10,983 362,729
--------- ----------- ----------- --------------
Total $326,232 $201,750 $ 55,156 $ 583,138
--------------------------------------------------------------
Of the $326.2 million of mortgage notes outstanding at September 30, 2002,
$303.3 million was nonrecourse to the Real Estate Trust.
In August 2001, the Real Estate Trust closed three permanent loans on its three
Florida hotel properties. The loans aggregated $16.1 million, with a 7.77%
interest rate and a 10-year term. In August 2002, the Real Estate Trust paid off
its construction loan on Dulles North Four with the proceeds of a $9.0 million
permanent loan. The interest rate is 7.56% and the term is 10 years.
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 known as Loudoun Tech Phase I. The
cost of development was budgeted at approximately $8.4 million with financing of
$7.4 million. This loan has a five-year term, a floating interest rate and an
option for one two-year renewal. Construction was completed in December 2000,
and the building was placed in service in December 2001. No leases have been
signed as yet.
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 Four. Development costs were $10.8 million
and were financed with the proceeds of a $9.5 million construction loan. The
building was placed in service in April 2002. The Real Estate Trust has signed a
lease with a tenant for the entire building. As noted above, the construction
loan was repaid in August 2002 with the proceeds of a permanent loan.
On November 15, 2000, the Real Estate Trust purchased a 19.1 acre land parcel in
Laurel, Maryland, which contains a 105,000 square foot office/warehouse building
known as Sweitzer Lane. The purchase price was $13.8 million and was financed
from the Real Estate Trust's revolving credit lines. The entire building was
leased to Chevy Chase under a long-term agreement. The Real Estate Trust
obtained permanent loan financing in July 2001 of $10.8 million.
On December 18, 2000, the Real Estate Trust sold its 124-unit San Simeon
apartment project in Dallas, Texas. The sales price was $3.1 million and the
Real Estate Trust recognized a gain of $2.2 million on the transaction. The
proceeds of the sales were used to acquire a 10.7 acre parcel of land in Loudoun
County, Virginia, for $2.8 million.
On June 13, 2001, the Real Estate Trust sold a 4.79 acre section of its Circle
75 land parcel located in Atlanta, Georgia, for $3.0 million. The Real Estate
Trust recognized a gain of $2.4 million on this transaction.
On August 8, 2001, the Real Estate Trust sold Metairie Tower, a 91,000 square
foot office building located in Metairie, Louisiana, for $7.2 million. The Real
Estate Trust recognized a gain of $5.2 million on this transaction.
On September 7, 2001, the Real Estate Trust sold 9.5 acres of its Commerce
Center land parcel located in Ft. Lauderdale, Florida, for approximately $2.0
million, and recognized a gain of $245,000 on the transaction.
During fiscal 2001, the Real Estate Trust also received net proceeds of $2.0
million and recognized a gain of $620,000 from the condemnation of portions of
two land parcels in Colorado and Michigan.
The Real Estate Trust believes that the capital improvement costs for its
income-producing properties will be in the range of $11.0 to $19.0 million per
year for the next several years.
Banking
LIQUIDITY. The bank is required to maintain sufficient liquidity to ensure its
safe and sound operation. A standard measure of liquidity in the savings
industry is the ratio of cash and short-term U.S. Government and other specified
securities to net withdrawable accounts and borrowings payable in one year or
less. See "BUSINESS - Regulation - Liquidity Requirements."
The bank's primary sources of funds historically have consisted of:
o principal and interest payments on loans and mortgage-backed securities;
o savings deposits;
o sales of loans and trading securities;
o securitizations and sales of loans; and
o borrowed funds, including funds borrowed from the FHLB of Atlanta.
The bank's holdings of readily marketable securities constitute another
important source of liquidity. As of September 30, 2002, the estimated remaining
borrowing capacity, after market value and other adjustments, against that
portion of those assets that may be pledged to the FHLB of Atlanta and various
securities dealers totaled $1.5 billion. Assets available to be pledged to the
Federal Reserve Bank of Richmond totaled $648.5 million. A portion of these
assets may also be available to be pledged to the FHLB of Atlanta.
In addition, the bank from time to time accesses the capital markets as an
additional means of funding its operations and managing its capital ratios and
asset growth. Specifically, the bank has securitized financial assets, including
home equity, home loan and automobile loan receivables, as well as single-family
residential loans, because the securitizations provide the bank with a source of
financing at competitive rates and assist the bank in maintaining compliance
with regulatory capital requirements. Additionally, the securitizations have
permitted the bank to limit the credit risk associated with these assets while
continuing to earn servicing fees and other income associated with the
securitized assets.
Since 1988, the bank has securitized approximately $16.1 billion of loan
receivables. At September 30, 2002, the bank continues to service $1.3 billion,
$43.4 million, $792.9 million and $40.9 million of securitized residential
mortgages, home equity, automobile and home loan receivables, respectively.
Chevy Chase derives fee-based income from servicing these securitized
portfolios. However, that fee-based income has been adversely affected in prior
periods by increases in prepayments, delinquencies and charge-offs related to
the receivables placed in these securitized pools.
The bank's securitization transactions transfer the risk of repayment on
securitized assets to a trust, which holds the receivables and issues the
asset-backed certificates, and ultimately the risk of repayment is transferred
to the holders of those certificates. The bank retains credit risk with respect
to the assets transferred to the trust only to the extent that it retains
recourse based on the performance of the assets or holds certificates issued by
the trust. In its securitizations, the bank typically retains a limited amount
of recourse through one or more means, most often through the establishment of
reserve accounts, overcollateralization of receivables or retention of
subordinated asset-backed certificates. Reserve accounts are funded by initial
deposits, if required, and by amounts generated by the securitized assets over
and above the amount required to pay interest, defaults and other charges and
fees on the investors' interests in the securitization transaction. Because
amounts on deposit in the reserve accounts are at risk depending upon
performance of the securitized receivables, those amounts represent recourse to
the bank. At September 30, 2002 and 2001, total recourse to the bank related to
securitization transactions was $40.1 million and $60.6 million, respectively.
Under the OTS low-level recourse rule in effect during fiscal year 2002, which
sets capital requirements for assets sold with recourse at the lower of the
applicable capital requirement or the amount of recourse retained for
securitization transactions entered into before January 1, 2002, the bank
maintains dollar-for-dollar capital against the securitized assets in the amount
of the recourse retained up to the otherwise applicable capital requirement. The
OTS has amended its capital rules to increase the amount of capital the bank is
required to maintain against certain of its residual interests for transactions
that close on or after January 1, 2002. See "Regulatory Capital."
The bank securitized and sold $1.6 billion and $804.9 million of loan
receivables during fiscal year 2002 and 2001, respectively. At September 30,
2002 and 2001, the bank had $1.2 billion and $528.1 million, respectively, of
loan receivables held for securitization and/or sale. The proceeds from the
securitization and sale of single-family residential, home equity, automobile
and home loan receivables will continue to be a significant source of liquidity
for the bank.
As part of its operating strategy, the bank continues to explore opportunities
to sell assets and to securitize and sell mortgage, home equity, automobile and
home loan receivables and automobile leases to meet liquidity and other balance
sheet objectives.
The bank is also obligated under a recourse provision related to the servicing
of certain of its residential mortgage loans. At each of September 30, 2002 and
2001, the recourse to the bank under this arrangement totaled $3.4 million.
The bank uses its liquidity primarily to meet its commitments to fund maturing
savings certificates and deposit withdrawals, fund existing and continuing loan
commitments, repay borrowings and meet operating expenses. During fiscal year
2002, the bank used the cash provided by operating, investing and financing
activities primarily to meet its commitments (i) to fund maturing savings
certificates and deposit withdrawals of $48.6 billion, (ii) fund existing and
continuing loan commitments, including real estate held for investment or sale,
of $3.4 billion, (iii) purchase investments and loans of $3.3 billion, (iv) meet
operating expenses, before depreciation and amortization, of $399.5 million and
(v) repayments, net of proceeds, from borrowings of $160.6 million. These
commitments were funded primarily through (i) proceeds from customer deposits
and sales of certificates of deposit of $48.4 billion, (ii) proceeds from sales
of loans, trading securities and real estate of $3.5 billion, and (iii)
principal and interest collected on investments, loans, and securities of $3.4
billion.
The bank's commitments to extend credit at September 30, 2002 are set forth in
the following table.
(In thousands)
-----------------
Commitments to originate loans.................... $ 950,513
-----------------
Loans in process (collateralized loans):
Home equity..................................... 714,191
Real estate construction and ground............. 198,226
Commercial...................................... 324,755
-----------------
Subtotal 1,237,172
-----------------
Loans in process (unsecured loans):
Overdraft lines................................. 124,868
Commercial...................................... 390,385
-----------------
Subtotal 515,253
-----------------
Total commitments to extend credit................ $ 2,702,938
=================
Based on historical experience, the bank expects to fund substantially less than
the total amount of its outstanding overdraft line and home equity credit line
commitments, which together accounted for 31.0% of commitments to extend credit
at September 30, 2002.
At September 30, 2002, repayments of borrowed money scheduled to occur during
the next 12 months were $760.7 million. Certificates of deposit maturing during
the next 12 months amounted to $1.7 billion, including $76.9 million of brokered
deposits. The bank expects that a significant portion of these maturing
certificates of deposit will remain with the bank. In the event that deposit
withdrawals are greater than anticipated, particularly among the more volatile
brokered deposits, the bank may have to increase deposit interest rates or rely
on alternative and potentially higher cost sources of funds in order to meet its
liquidity needs.
There were no material commitments for capital expenditures at September 30,
2002.
The bank's liquidity requirements in years subsequent to fiscal year 2002 will
continue to be affected both by the asset size of the bank, the growth of which
may be constrained by capital requirements, and the composition of the asset
portfolio. Management believes that the bank's primary sources of funds,
described above, will be sufficient to meet the bank's foreseeable 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
The Real Estate Trust's ability to generate revenues from property ownership and
development is significantly influenced by a number of factors, including
national and local economic conditions, the level of mortgage interest rates,
governmental actions, such as changes in real estate tax rates, and the type,
location, size and stage of development of the Real Estate Trust's properties.
Debt service payments and most of the operating expenses associated with
income-producing properties are not decreased by reductions in occupancy or
rental income. Therefore, the ability of the Real Estate Trust to produce net
income in any year from its income-producing properties is highly dependent on
the Real Estate Trust's ability to maintain or increase the properties' levels
of gross income. The relative illiquidity of real estate investments tends to
limit the ability of the Real Estate Trust to vary its portfolio promptly in
response to changes in economic, demographic, social, financial and investment
conditions. See "Financial Condition - Real Estate."
The bank's operating results historically have depended primarily on its "net
interest spread," which is the difference between the rates of interest earned
on its loans and securities investments and the rates of interest paid on its
deposits and borrowings. In recent periods, the bank has generated significant
income from loan servicing and securities activities and deposit fees. In
addition to interest paid on its interest-bearing liabilities, the bank's
principal expenses are operating expenses.
Fiscal 2002 Compared to Fiscal 2001
Real Estate
The Real Estate Trust recorded income before depreciation and amortization of
debt expense of $0.5 million and an operating loss of $19.5 million for fiscal
2002, compared to income before depreciation and amortization of debt expense of
$18.9 million and an operating loss of $0.7 million for fiscal 2001. The decline
was largely attributable to lower revenues from hotels and office and industrial
properties.
Income after direct operating expenses from hotels decreased $6,154,000, or
17.6%, in fiscal 2002 from the level achieved in fiscal 2001. This decrease was
the net result of $870,000 generated from two newly constructed properties,
reduced by a decrease in income after expenses of $7,024,000 at the 16 hotels
owned throughout both periods. The decrease in total revenue of $3,816,000 was
further impacted by an increase of $2,337,000 in direct operating expenses. Room
sales for fiscal 2002 decreased $4,539,000 or 6.2%, from fiscal 2001, while food
and beverage sales increased $1,126,000 or 8.0%, over the prior year. For the 16
hotels owned throughout both periods, the decrease in total revenue was
$5,553,000 or 6.7%, and the increase in direct operating expense was $1,472,000
or 2.8%.
Income after direct operating expenses from office and industrial properties
decreased $1,219,000, or 4.3%, in fiscal 2002 compared to such income in fiscal
2001. Gross income decreased $1,476,000, or 3.7%, in fiscal 2002, while expenses
decreased $257,000, or 2.2%. The decline was largely due to increased vacancies.
Other income, which includes interest income, income from other real estate
properties and miscellaneous receipts, declined by $1,033,000, or 46.2%, in
fiscal 2002 due to lower interest income and the sale in fiscal 2001 of the Real
Estate Trust's only apartment project.
Land parcels and other expense decreased $41,000, or 3.5%, in fiscal 2002
primarily due to the sale of the Real Estate Trust's apartment project in fiscal
2001.
Interest expense decreased $110,000, or 0.2%, in fiscal 2002, primarily because
of lower interest rates on outstanding borrowings. The average balance of
outstanding borrowings increased to $578.9 million for fiscal 2002 from $560.1
million for the prior year. The change in average borrowings occurred as a
result of mortgage loan refinancings and unsecured note sales. The average cost
of borrowings was 8.67% in fiscal 2002 and 8.96% in fiscal 2001.
Capitalized interest decreased $282,000 49.7% during fiscal 2002 due to the
lower level of development activity in the current year.
Amortization of debt expense decreased $32,000, or 3.3%, primarily due to fewer
new financings completed during fiscal 2002 compared to fiscal 2001.
Depreciation increased $547,000, or 2.9%, in fiscal 2002 as a result of new
income-producing properties, new tenant improvements and capital replacements.
Advisory, management and leasing fees paid to related parties increased
$690,000, or 5.9%, in fiscal 2002. The advisory fee in fiscal 2002 was $475,000
per month compared to $363,000 per month for fiscal 2001, which resulted in an
aggregate increase of $1,347,000, or 30.9%. Management and leasing fees were
lower by $657,000,or 8.9%, in fiscal 2002 as a result of lower gross income on
which fees are based.
General and administrative expense decreased $2,024,000, or 45.1%, in fiscal
2002 principally as a result of the high level of write-offs of abandoned
development costs in fiscal 2001.
Equity in earnings of unconsolidated entities reflected earnings of $9,057,000
in fiscal 2002 and earnings of $7,402,000 in fiscal 2001, an increase of
$1,655,000 or 22.4%. The improvement was due to increased period-to-period
earnings of Saul Centers.
There were no property sales during fiscal 2002. Gain on sale of property was
$11,077,000 in fiscal 2001 and consisted of a $2.2 million gain on the sale of
an apartment project in Texas, a gain of $5.2 million on the sale of an office
project in Louisiana, and an aggregate gain of $3.7 million on the sales of land
parcels in Florida, Georgia, and Maryland, and the condemnation of two land
parcels in Colorado and Michigan.
Banking
OVERVIEW. The bank recorded operating income of $106.7 million for the year
ended September 30, 2002, compared to operating income of $97.1 million for the
year ended September 30, 2001. The increase in income in fiscal year 2002 was
primarily due to an increase in servicing and securitization income of $32.0
million, a $12.2 million increase in deposit service fees and an $11.8 million
decrease in the provision for loan and lease losses. Partially offsetting the
increased income was a $32.2 million increase in operating expenses, a $9.2
million decrease in net interest income and a $10.3 million gain on other
investment in fiscal year 2001. The bank's net income in future periods will
continue to be affected by increased operating expenses associated with
expansion of the bank's branch network and other areas of business and reliance
on relatively higher cost sources of funding to support continued growth.
NET INTEREST INCOME. Net interest income, before the provision for loan and
lease losses, decreased $9.2 million (or 2.5%) in fiscal year 2002 over fiscal
year 2001. Interest income during fiscal year 2002 included $0.3 million of
recorded income on non-accrual assets and restructured loans. The bank would
have recorded additional interest income of $2.9 million in fiscal year 2002 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)
Year Ended September 30,
------------------------------------------------------------------------------------------------
September 30, 2002 2001 2000
------------------------------ ------------------------------ -------------------------------
2002 Average Yield/ Average Yield/ Average Yield/
Yield/Rate Balances Interest Rate Balances Interest Rate Balances Interest Rate
------------- ------------------------------ ------------------------------ -------------------------------
Assets:
Interest-earning
assets:
Loans and leases
receivable, net(1) 6.15 % $ 8,470,938 $541,008 6.39 % $ 8,651,710 $695,441 8.04 % $ 7,594,852 $635,475 8.37 %
Mortgage-backed
securities 6.17 1,233,159 74,358 6.03 1,143,471 71,685 6.27 1,187,094 74,614 6.29
Federal funds sold
and securities
purchased under
agreements to
resell - 48,022 857 1.78 42,745 2,257 5.28 141,814 8,105 5.72
Trading securities - 47,241 2,988 6.33 40,762 2,508 6.15 18,964 1,288 6.79
Investment
securities 2.61 46,206 1,527 3.30 45,693 2,746 6.01 45,386 2,643 5.82
Other interest-
earning assets 3.09 200,286 7,372 3.68 188,484 12,260 6.50 220,134 14,763 6.71
------------ --------- ------------ --------- ------------- ---------
Total 6.06 10,045,852 628,110 6.25 10,112,865 786,897 7.78 9,208,244 736,888 8.00
----------- --------- ------- --------- ------- --------- -------
Non-interest
earning assets:
Cash 257,790 314,419 294,425
Real estate held
for investment or
sale 27,693 44,356 49,685
Property and
equipment, net 454,282 408,573 328,268
Goodwill and other
intangible
assets, net 25,832 26,381 26,233
Other assets 288,983 255,242 243,215
------------ ------------ -------------
Total assets $11,100,432 $ 11,161,836 $ 10,150,070
============ ============ =============
Liabilities and
stockholders'
equity:
Interest-bearing
liabilities:
Deposit accounts:
Demand deposits 0.22 $ 1,537,403 4,792 0.31 $ 1,311,067 7,851 0.60 $ 1,212,789 10,644 0.88
Savings deposits 0.75 974,371 9,346 0.96 883,756 13,392 1.52 942,985 17,531 1.86
Time deposits 3.10 2,370,643 98,262 4.14 2,964,052 177,619 5.99 2,721,138 154,737 5.69
Money market
deposits 1.47 1,813,702 31,512 1.74 1,370,774 48,744 3.56 1,107,338 39,351 3.55
------------ --------- ------------ --------- ------------- ---------
Total deposits 1.40 6,696,119 143,912 2.15 6,529,649 247,606 3.79 5,984,250 222,263 3.71
Borrowings 4.80 2,688,025 129,274 4.81 3,076,350 175,138 5.69 2,843,834 172,137 6.05
------------ --------- ------------ --------- ------------- ---------
Total liabilities 2.28 9,384,144 273,186 2.91 9,605,999 422,744 4.40 8,828,084 394,400 4.47
----------- --------- --------- --------- --------- --------- --------
Non interest-
bearing items:
Non-interest
bearing deposits 845,455 690,883 523,882
Other liabilities 223,507 250,614 203,199
Minority interest 144,000 144,000 144,000
Stockholders'
equity 503,326 470,340 450,905
------------ ------------ -------------
Total liabilities
and stockholders'
equity $11,100,432 $ 11,161,836 $ 10,150,070
============ ============ =============
Net interest income $354,924 $364,153 $342,488
========= ========= =========
Net interest
spread (2) 3.34 % 3.38 % 3.53 %
======= ======= =======
Net yield on
interest-earning
assets (3) 3.53 % 3.60 % 3.72 %
======= ======= =======
Interest-earning
assets to interest-
bearing liabilities 107.05 % 105.28 % 104.31 %
======= ======= =======
(1) Includes loans held for securitization and/or sale. 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. Includes $13,489 and $6,321 of net amortized loan costs in interest
income for the years ended September 30, 2002 and 2001, respectively. Net
amortized loan fees for the year ended September 30, 2000 amounted to $3,847.
(2) Equals weighted average yield on total interest-earning assets less weighted
average rate on total interest-bearing liabilities.
(3) Equals 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
(IN THOUSANDS)
Year Ended September 30, 2002 Year Ended September 30, 2001
Compared to Compared to
Year Ended September 30, 2001 Year Ended September 30, 2000
Increase (Decrease) Increase (Decrease)
Due to Change in (1) Due to Change in (1)
-------------------------------------------- -----------------------------------------
Total Total
Volume Rate Change Volume Rate Change
------------ -------------- ------------- ------------ ----------- ------------
Interest income:
Loans and leases (2) $ (14,270) $ (140,163) $ (154,433) $ 85,786 $ (25,820) $ 59,966
Mortgage-backed securities 5,485 (2,812) 2,673 (2,696) (233) (2,929)
Federal funds sold and securities
purchased under agreements to resell 250 (1,650) (1,400) (5,268) (580) (5,848)
Trading securities 405 75 480 1,342 (122) 1,220
Investment securities 31 (1,250) (1,219) 18 85 103
Other interest-earning assets 724 (5,612) (4,888) (2,056) (447) (2,503)
------------ -------------- ------------- ------------ ----------- ------------
Total interest income (7,375) (151,412) (158,787) 77,126 (27,117) 50,009
------------ -------------- ------------- ------------ ----------- ------------
Interest expense:
Deposit accounts 6,147 (109,841) (103,694) 20,494 4,849 25,343
Borrowings (20,611) (25,253) (45,864) 13,588 (10,587) 3,001
------------ -------------- ------------- ------------ ----------- ------------
Total interest expense (14,464) (135,094) (149,558) 34,082 (5,738) 28,344
------------ -------------- ------------- ------------ ----------- ------------
Increase (decrease) in net interest income $ 7,089 $ (16,318) $ (9,229) $ 43,044 $ (21,379) $ 21,665
============ ============== ============= ============ =========== ============
- ------------------------------------------------------------------------------------------------------------------------------------
(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 fiscal year 2002 decreased $158.8 million (or 20.2%) from the
level in fiscal year 2001 as a result of lower average yields and to a lesser
extent, lower average balances of loans and leases receivable.
The bank's net interest spread decreased slightly to 3.34% in fiscal year 2002
from 3.38% in fiscal year 2001. A shift in the mix of consumer loans to lower
yielding prime automobile loans and leases from higher yielding subprime
automobile loans contributed to the decrease. An increase in the average
balances of mortgage-backed securities, home equity loans and commercial loans,
which was funded primarily with Federal Home Loan Bank advances and deposits
partially offset the decline. Average interest-earning assets as a percentage of
average interest bearing liabilities increased to 107.05% in fiscal year 2002
compared to 105.28% in fiscal year 2001.
Interest income on loans and leases, the largest category of interest-earning
assets, decreased by $154.4 million from fiscal year 2001 primarily because of
lower average yields and to a lesser extent, lower average balances. The average
yield on the loan portfolio in fiscal year 2002 decreased 165 basis points (from
8.04% to 6.39%) from the average yield in fiscal year 2001. The average yield on
single-family residential loans decreased to 5.60% during fiscal year 2002 from
6.97% during fiscal year 2001, which resulted in an $80.0 million (or 22.8%)
decrease in interest income from such loans. Also contributing to the decreased
average yield on the loan and lease portfolio were decreases in the various
indices on which interest rates on adjustable rate loans are based.
Lower average balances of the bank's single-family residential loans, which
decreased $193.7 million (or 3.9%), also contributed to the decrease in interest
income from those loans. Average balances of automobile loans and leases and
construction loans decreased $210.7 million and $39.9 million, respectively, and
contributed to a $50.8 million and $10.5 million decrease in interest income
from those loans, respectively.
Interest income on mortgage-backed securities increased $2.7 million (or 3.7%)
primarily because of higher average balances. Offsetting the $89.7 million
increase in average balances was a decrease in the average interest rates on
those securities from 6.27% to 6.02%.
Interest expense on deposits decreased $103.7 million (or 41.9%) during fiscal
year 2002 due to decreased average rates. The 164 basis point decrease in the
average rate on deposits (from 3.79% to 2.15%) resulted from declining market
interest rates, which allowed the bank to reduce the interest paid on deposits,
coupled with a shift in the deposit mix towards lower cost money market and NOW
deposits. During fiscal year 2002, the bank decreased its use of higher cost
brokered deposits as an alternative funding source.
Interest expense on borrowings decreased $45.9 million (or 26.2%) in fiscal year
2002 from fiscal year 2001. A $395.0 million (or 17.5%) decrease in average
balances on Federal Home Loan Bank advances and a 27 basis point decrease in the
average rate paid on such borrowings (from 5.43% to 5.16%) resulted in a
decrease of $26.5 million in interest expense. During fiscal year 2002, interest
expense on securities sold under repurchase agreements decreased $13.8 million,
contributing to the decrease in interest expense on borrowings, as a result of
lower average rates (from 5.48% to 1.96%). A slight increase of $7.5 million in
the average balance partially offset the decrease in interest expense on
securities sold under repurchase agreements. .
PROVISION FOR LOAN AND LEASE LOSSES. The bank's provision for loan and lease
losses decreased to $56.0 million in fiscal year 2002 from $67.9 million in
fiscal year 2001. The $11.8 million decrease primarily reflected decreased
charge-offs of subprime automobile loans because the bank's portfolio of these
loans continues to decline as a result of the bank's prior decision to
discontinue originations of these loans. See "Financial Condition - Asset
Quality - Allowances for Losses."
OTHER INCOME. Other income increased to $248.1 million in fiscal year 2002 from
$208.9 million in fiscal year 2001. The $39.2 million (or 18.8%) increase was
primarily attributable to increases in servicing and securitization income of
$32.0 million and deposit service fees of $12.2 million, which were partially
offset by a non-recurring gain on other investment of $10.3 million in fiscal
year 2001.
Servicing and securitization income during fiscal year 2002 increased $32.0
million (or 61.3%) from fiscal year 2001, primarily as a result of gains of
$56.9 million resulting from the securitization and sale of $1.6 billion of loan
receivables during fiscal year 2002 compared to gains of $27.9 million resulting
from the securitization and sale of $804.9 million of loan receivables during
fiscal year 2001.
Deposit servicing fees increased $12.2 million (or 12.0%) during the current
year primarily due to fees generated from the continued expansion of the bank's
branch and ATM networks.
Gain on other investment was $10.3 million in fiscal year 2001. The $10.3
million non-recurring gain was the result of the sale of the bank's interest in
Star Systems, Inc. to Concord EFS, Inc.
OPERATING EXPENSES. Operating expenses for fiscal year 2002 increased $32.2
million (or 7.9%) from fiscal year 2001. The increase in operating expenses is
largely attributable to an increase in servicing assets amortization and other
loan expenses. These expenses increased $16.3 million primarily due to write-
downs in the market value of the bank's mortgage servicing assets. Increased
loan prepayments during fiscal year 2002 resulting from lower mortgage interest
rates in turn resulted in increased amortization of mortgage servicing assets.
Salaries and employee benefits increased $5.6 million (or 2.8%) in fiscal year
2002. Also contributing to the increase in operating expenses was an increase in
property and equipment expense of $4.5 million primarily due to land lease
expense and property taxes associated with the bank's new headquarters.
Fiscal 2001 Compared to Fiscal 2000
Real Estate
The Real Estate Trust recorded income before depreciation and amortization of
debt expense of $18.9 million and operating income of $0.7 million for fiscal
2001, compared to income before depreciation and amortization of debt expense of
$10.6 million and an operating loss of $4.3 million for fiscal 2000. The
improvement was largely attributable to higher income after direct operating
expenses for hotels and office and industrial properties, increased equity in
the earnings of unconsolidated entities, and increased gains on sale of
property.
Income after direct operating expenses from hotels increased $791,000, or 2.2%,
in fiscal 2001 over the level achieved in fiscal 2000. This net increase
resulted from $4,731,000 generated from three newly constructed properties,
while the results from 15 hotels owned throughout both periods reflected a
decrease in income after operating expenses of $3,940,000. The increase in total
revenue of $4,933,000 exceeded the increase of $4,142,000 in direct operating
expenses. However, the percentage increase in direct operating expenses of 7.0%
exceeded the percentage increase in total revenue of 5.2%. Room sales for fiscal
2001 increased $5,460,000 or 7.4%, over fiscal 2000, while food and beverage
sales decreased $749,000 or 4.4%, over the prior year. For the 15 hotels owned
throughout both periods, the decrease in total revenue was $4,591,000 or 4.9%,
and the decrease in direct operating expense was $651,000 or 1.1%.
Income after direct operating expenses from office and industrial properties
increased $3,840,000, or 15.5%, in fiscal 2001 compared to such income in fiscal
2000. Gross income increased $6,058,000, or 17.6%, in fiscal 2001, while
expenses increased $2,218,000, or 23.0%. The improvement was largely due to the
addition of four new properties during the two-year period.
Other income, which includes interest income, income from other real estate
properties and miscellaneous receipts, declined by $897,000, or 28.6%, in fiscal
2001 due to lower interest income and the sale early in the year of the Real
Estate Trust's only apartment project.
Land parcels and other expense decreased $128,000, or 9.8%, in fiscal 2001
primarily due to the sale of the Real Estate Trust's apartment project.
Interest expense increased $3,726,000, or 8.0%, in fiscal 2001, primarily
because of the higher level of outstanding borrowings. The average balance of
outstanding borrowings increased to $560.1 million for fiscal 2001 from $513.9
million for the prior year. The change in average borrowings occurred as a
result of mortgage loan refinancings and unsecured note sales. The average cost
of borrowings was 8.96% in fiscal 2001 and 9.00% in fiscal 2000.
Capitalized interest decreased $606,000 or 51.5%, during fiscal 2001 due to the
lower level of development activity in the current year.
Amortization of debt expense increased $328,000, or 50.1%, primarily due to new
financings completed during the year.
Depreciation increased $4,291,000, or 30.0%, in fiscal 2001 as a result of the
additions of new income-producing properties, new tenant improvements and
capital replacements.
Advisory, management and leasing fees paid to related parties increased
$749,000, or 6.8%, in fiscal 2001. The advisory fee in fiscal 2001 was $363,000
per month compared to $349,000 per month for fiscal 2000, which resulted in an
aggregate increase of $168,000, or 4.0%. Management and leasing fees were higher
by $582,000, or 8.5%, in fiscal 2001 as a result of increased gross income on
which fees are based.
General and administrative expense increased $683,000, or 17.9%, in fiscal 2001
as a result of the high level of write-offs of abandoned development costs.
Equity in earnings of unconsolidated entities reflected earnings of $7,402,000
in fiscal 2001 and earnings of $7,291,000 in fiscal 2000, an increase of
$111,000 or 1.5%. The improvement was due to increased period-to-period earnings
of Saul Centers.
Gain on sale of property was $11,077,000 in fiscal 2001 and consisted of a $2.2
million gain on the sale of an apartment project in Texas, a gain of $5.2
million on the sale of an office project in Louisiana, and an aggregate gain of
$3.7 million on the sales of land parcels in Florida, Georgia, and Maryland, and
the condemnation of two land parcels in Colorado and Michigan. Gain on sale of
property was $994,000 in fiscal 2000 due to the condemnation of a small section
of a land parcel in Georgia.
Banking
OVERVIEW. The bank recorded operating income of $97.1 million for the year ended
September 30, 2001, compared to operating income of $72.7 million for the year
ended September 30, 2000. The increase in income in fiscal 2001 was primarily
due to an increase in interest income from loans and leases of $60.0 million.
Also contributing to increased income were a $23.2 million increase in servicing
and securitization income, a $10.3 million gain on other investment and $13.2
million increase in deposit service fees. Partially offsetting the increase in
income were a $41.8 million increase in operating expenses, a $28.3 million
increase in total interest expense and a $17.9 million increase in the provision
for loan and lease losses.
NET INTEREST INCOME. Net interest income, before the provision for loan and
lease losses, increased $21.7 million (or 6.3%) in fiscal year 2001 over fiscal
year 2000. Included in interest income during fiscal year 2001 was $0.5 million
recorded on non-accrual assets and restructured loans. The bank would have
recorded additional interest income of $3.2 million in fiscal year 2001 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."
Interest income in fiscal year 2001 increased $50.0 million (or 6.8%) from the
level in fiscal year 2000 as a result of higher average balances of loans and
leases receivable, which was slightly offset by lower average yields on loans
and leases receivable.
The bank's net interest spread decreased to 3.38% in fiscal year 2001 from 3.53%
in fiscal year 2000. The 15 basis point reduction in the net interest spread
primarily reflected a shift in the mix of consumer loans to lower yielding prime
automobile loans and leases from higher yielding subprime automobile loans.
Partially offsetting this decline was an increase in the average balances of
earning assets, which was funded primarily with Federal Home Loan Bank advances
and deposits. Average interest-earning assets as a percentage of average
interest bearing liabilities increased slightly to 105.28% in fiscal year 2001
compared to 104.31% in fiscal year 2000.
Interest income on loans and leases, the largest category of interest-earning
assets, increased by $60.0 million from fiscal year 2000 primarily because of
higher average balances. Higher average balances of the bank's single-family
residential loans, which increased $463.9 million (or 10.2%), resulted in a
$28.3 million (or 8.8%) increase in interest income from those loans. Average
balances of automobile loans and leases, commercial loans and home equity loans
increased $363.4 million, $186.2 million and $58.3 million, respectively, and
contributed to a $20.4 million, $10.3 million and $2.2 million increase in
interest income from those loans, respectively. Lower average yields on these
loans partially offset the effects of the higher average balances.
The average yield on the loan portfolio in fiscal year 2001 decreased 33 basis
points (from 8.37% to 8.04%) from the average yield in fiscal year 2000.
Contributing to the lower average yield was a decrease in the yield on
automobile loans which resulted from management's decision to shift from higher
yielding subprime loans which have higher risks of default to lower yielding
prime automobile loans and leases with relatively lower risk of default. Average
subprime automobile loans as a percentage of total automobile loans and leases
declined to 24.1% during fiscal year 2001 from 29.2% during fiscal year 2000,
reflecting the bank's decision in November 2000 to stop origination of subprime
automobile loans. Also contributing to the decreased average yield on the loan
and lease portfolio were decreases in the various indices on which interest
rates on adjustable rate loans are based.
Interest income on mortgage-backed securities decreased $2.9 million (or 3.9%)
primarily because of a $43.6 million decrease in average balances.
Interest expense on deposits increased $25.3 million (or 11.4%) during fiscal
year 2001 due to increased average rates and average balances. The eight basis
point increase in the average rate on deposits (from 3.71% to 3.79%) resulted
from a shift in the deposit mix towards higher cost certificates of deposits and
money market deposits. During fiscal year 2001, the bank decreased its use of
brokered deposits as an alternative funding source.
Interest expense on borrowings increased $3.0 million (or 1.7%) in fiscal year
2001 over fiscal year 2000. A $294.0 million (or 15.0%) increase in average
balances on Federal Home Loan Bank advances was partially offset by a decrease
in the average rate on such borrowings (from 5.68% to 5.43%) which resulted in
an increase of $11.1 million in interest expense. Partially offsetting the
increase in interest expense on borrowings was a decrease in the average balance
of $93.6 million and average yield (from 6.08% to 5.48%) in securities sold
under repurchase agreements.
PROVISION FOR LOAN AND LEASE LOSSES. The bank's provision for loan and lease
losses increased to $67.9 million in fiscal year 2001 from $49.9 million in
fiscal year 2000. The $17.9 million increase primarily reflected increased
charge-offs as a result of the maturation of the bank's loan and lease portfolio
following recent growth and a deterioration in general economic conditions. See
"Financial Condition - Asset Quality - Allowances for Losses."
OTHER INCOME. Other income increased to $208.9 million in fiscal year 2001 from
$146.4 million in fiscal year 2000. The $62.5 million (or 42.7%) increase was
primarily attributable to increased servicing and securitization income of $23.2
million, deposit service fees of $13.2 million and gain on other investment of
$10.3 million.
Servicing and securitization income during fiscal year 2001 increased $23.2
million (or 80.0%) from fiscal year 2000, primarily as a result of gains of
$27.9 million resulting from the securitization and sale of $804.9 million of
automobile loan receivables during year 2001.
Deposit servicing fees increased $13.2 million (or 15.0%) during the current
year primarily due to fees generated from the continued expansion of the bank's
branch and ATM networks.
Gain on other investment income was $10.3 million in fiscal year 2001. The $10.3
million gain was the result of a pre-tax gain of $10.3 million from the sale of
the bank's interest in Star Systems, Inc. to Concord EFS, Inc.
OPERATING EXPENSES. Operating expenses for fiscal year 2001 increased $41.8
million (or 11.4%) from fiscal year 2000. The increase in operating expenses is
largely attributable to an increase in servicing assets amortization and other
loan expenses. These expenses increased $29.4 million primarily due to a $12.9
million write down in the market value of the bank's mortgage servicing assets
as a result of increased prepayments during fiscal year 2001 resulting from
lower mortgage interest rates and increased amortization of purchased and
originated mortgage servicing rights acquired in the latter half of fiscal year
2000. In addition, fiscal year 2000 included a reduction in servicing assets
amortization and other loan expenses as a result of a $6.3 million recovery of
prior valuation adjustments recorded against the bank's mortgage servicing
assets. Salaries and employee benefits increased $4.1 million (or 2.1%) in
fiscal year 2001, which includes $3.0 million of expenses related to the closing
of the subprime origination network in the first quarter of fiscal year 2001.
Also contributing to the increase in operating expenses was an increase in
property and equipment expense of $5.5 million primarily due to increased rent
expense and related property taxes associated with the addition of new deposit
branches during fiscal year 2001.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information required by this Item is included in Item "7. Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Financial Condition - Banking - Asset and Liability Management."
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements of the Trust and its consolidated subsidiaries are
included in this report on the pages indicated and are incorporated herein by
reference:
(a) Report of Independent Auditors.
(b) Consolidated Balance Sheets - As of September 30, 2002 and 2001.
(c) Consolidated Statements of Operations - For the years ended September
30, 2002, 2001 and 2000.
(d) Consolidated Statements of Comprehensive Income and Changes in
Shareholders' Equity - For the years ended September 30,
2002, 2001 and 2000.
(e) Consolidated Statements of Cash Flows - For the years ended September
30, 2002, 2001 and 2000.
(f) Notes to Consolidated Financial Statements.
Summary financial information with respect to the bank is also included in Part
I, Item 1.
REPORT OF INDEPENDENT AUDITORS
TRUSTEES AND SHAREHOLDERS
B.F. SAUL REAL ESTATE INVESTMENT TRUST
We have audited the accompanying consolidated balance sheets of B.F. Saul Real
Estate Investment Trust ("the Trust") as of September 30, 2002 and 2001, and the
related consolidated statements of operations, comprehensive income and
shareholders' equity and cash flows for each of the three years in the period
ended September 30, 2002. Our audits also included the financial statement
schedules listed in the Index at Item 15(a). These consolidated financial
statements and schedules are the responsibility of the Trust's management. Our
responsibility is to express an opinion on these consolidated financial
statements and schedules based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of B.F.
Saul Real Estate Investment Trust as of September 30, 2002 and 2001, and the
consolidated results of its operations and its cash flows for each of the three
years in the period ended September 30, 2002 in conformity with accounting
principles generally accepted in the United States. Also, in our opinion, the
related financial statement schedules, when considered in relation to the basic
financial statements taken as a whole, present fairly in all material respects
the information set forth therein.
As explained in the Notes to the financial statements, effective October 1,
2000, the Trust changed its method of accounting for derivative instruments and
hedging activities.
Ernst & Young LLP
McLean, Virginia
November 15, 2002
CONSOLIDATED BALANCE SHEETS
B. F. SAUL REAL ESTATE INVESTMENT TRUST
===================================================================================================================
September 30
--------------------------
(In thousands) 2002 2001
- -------------------------------------------------------------------------------------------------------------------
ASSETS (Restated)
Real Estate
Income-producing properties
Hotel $ 255,566 $ 254,165
Office and industrial 176,920 157,653
Other 2,803 2,825
------------ ------------
435,289 414,643
Accumulated depreciation (149,981) (131,659)
------------ ------------
285,308 282,984
Land parcels 41,323 40,835
Construction in progress 2,697 15,681
Cash and cash equivalents 13,963 13,860
Note receivable and accrued interest -- related party 6,487 7,787
Other assets 87,736 80,957
------------ ------------
Total real estate assets 437,514 442,104
- -------------------------------------------------------------------------------------------------------------------
Banking
Cash and other deposits 318,484 354,683
Interest bearing deposits 122,252 84,385
Loans held for securitization and/or sale 1,223,035 528,083
Trading securities 3,933 7,296
Investment securities (market value $46,969 and $46,181, respectively) 46,445 45,794
Mortgage-backed securities (market value $1,057,852 and $1,489,835, respectively) 1,028,633 1,474,495
Loans and leases receivable (net of allowance for losses of $71,109 and $63,018,
respectively 7,611,344 7,983,385
Federal Home Loan Bank stock 88,648 113,030
Real estate held for investment or sale (net of allowance for losses of $71,495
and $85,354, respectively) 24,297 31,704
Property and equipment, net 472,417 457,995
Goodwill and other intangible assets, net 24,863 26,896
Interest only strips, net 89,306 62,978
Servicing assets, net 60,430 62,434
Other assets 155,366 179,594
------------ ------------
Total banking assets 11,269,453 11,412,752
- -------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $11,706,967 $11,854,856
- -------------------------------------------------------------------------------------------------------------------
LIABILITIES
Real Estate
Mortgage notes payable $ 326,232 $ 331,114
Notes payable - secured 201,750 202,500
Notes payable - unsecured 55,156 50,717
Accrued dividends payable - preferred shares of beneficial interest 12,721 19,303
Other liabilities and accrued expenses 67,517 63,542
------------ ------------
Total real estate liabilities 663,376 667,176
- -------------------------------------------------------------------------------------------------------------------
Banking
Deposit accounts 7,437,585 7,562,470
Borrowings 659,484 282,350
Federal Home Loan Bank advances 1,702,964 2,240,598
Custodial accounts 208,805 113,456
Amounts due to banks 61,873 58,167
Other liabilities 285,400 274,713
Capital notes -- subordinated 250,000 250,000
------------ ------------
Total banking liabilities 10,606,111 10,781,754
- -------------------------------------------------------------------------------------------------------------------
Commitments and contingencies
Minority interest held by affiliates 89,007 82,538
Minority interest -- other 218,307 218,307
- -------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 11,576,801 11,749,775
- -------------------------------------------------------------------------------------------------------------------
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 71,913 48,498
Accumulated other comprehensive income (loss) -- (1,670)
------------ ------------
172,014 146,929
Less cost of 1,814,688 common shares of beneficial interest in treasury (41,848) (41,848)
------------ ------------
TOTAL SHAREHOLDERS' EQUITY 130,166 105,081
- -------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $11,706,967 $11,854,856
- -------------------------------------------------------------------------------------------------------------------
The Notes to Consolidated Financial Statements are an integral part of these statements.
CONSOLIDATED STATEMENTS OF OPERATIONS
B. F. SAUL REAL ESTATE INVESTMENT TRUST
===================================================================================================================
For the Year Ended September 30
----------------------------------------
(In thousands, except per share amounts) 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------------
REAL ESTATE (Restated) (Restated)
Income
Hotels $ 88,043 $ 100,314 $ 95,381
Office and industrial (including $5,100, $3,983 and $2,672
of rental income from banking segment, respectively) 38,923 40,399 34,341
Other 1,206 2,239 3,136
------------- ------------ ------------
Total income 128,172 142,952 132,858
- -------------------------------------------------------------------------------------------------------------------
Expenses
Direct operating expenses:
Hotels 59,204 63,578 59,436
Office and industrial properties 11,593 11,852 9,635
Land parcels and other 1,140 1,181 1,309
Interest expense 50,111 50,221 46,495
Capitalized interest (287) (569) (1,175)
Amortization of debt expense 950 982 654
Depreciation 19,147 18,600 14,309
Advisory, management and leasing fees - related parties 12,452 11,762 11,013
General and administrative 2,467 4,491 3,808
------------- ------------ ------------
Total expenses 156,777 162,098 145,484
- -------------------------------------------------------------------------------------------------------------------
Equity in earnings of unconsolidated entities 9,057 7,402 7,291
Gain on sale of property -- 11,077 994
- -------------------------------------------------------------------------------------------------------------------
REAL ESTATE OPERATING LOSS $ (19,548) $ (667) $ (4,341)
- -------------------------------------------------------------------------------------------------------------------
BANKING
Interest income
Loans and leases $ 541,008 $ 695,441 $ 635,475
Mortgage-backed securities 74,358 71,685 74,614
Trading securities 2,988 2,508 1,288
Investment securities 1,527 2,746 2,643
Other 8,229 14,517 22,868
------------- ------------ ------------
Total interest income 628,110 786,897 736,888
- -------------------------------------------------------------------------------------------------------------------
Interest expense
Deposit accounts 143,912 247,606 222,263
Short-term borrowings 15,401 63,225 55,977
Long-term borrowings 113,873 111,913 116,160
------------- ------------ ------------
Total interest expense 273,186 422,744 394,400
------------- ------------ ------------
Net interest income 354,924 364,153 342,488
Provision for loan and lease losses (56,015) (67,852) (49,930)
- -------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan and lease losses 298,909 296,301 292,558
- -------------------------------------------------------------------------------------------------------------------
Other income
Deposit servicing fees 113,640 101,482 88,253
Servicing and securitization income 84,160 52,169 28,991
Gain on sales of trading securities, net 8,264 3,104 1,533
Net unrealized holding gains (losses) on trading securities (2,062) 1,054 --
Gain (loss) on real estate held for investment or sale, net 992 2,815 (1,523)
Gain on sales of loans, net 4,094 4,904 1,443
Gain on other investment -- 10,294 --
Other 39,019 33,092 27,706
------------- ------------ ------------
Total other income 248,107 208,914 146,403
- -------------------------------------------------------------------------------------------------------------------
Continued on following page.
CONSOLIDATED STATEMENTS OF OPERATIONS (CONTINUED)
B. F. SAUL REAL ESTATE INVESTMENT TRUST
===================================================================================================================
For the Year Ended September 30
----------------------------------------
(In thousands, except per share amounts) 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------------
BANKING (Continued) (Restated) (Restated)
Operating expenses
Salaries and employee benefits $ 203,004 $ 197,444 $ 193,378
Loan 60,117 43,819 14,441
Property and equipment (including $5,100, $3,983 and $2,672
of rental expense paid to real estate segment, respectively) 42,256 37,738 32,240
Marketing 7,497 11,353 11,424
Data processing 32,498 28,316 24,447
Depreciation and amortization 38,710 34,197 32,434
Deposit insurance premiums 1,339 1,413 2,291
Amortization of goodwill and other intangible assets 2,034 2,205 2,519
Other 52,836 51,582 53,096
------------- ------------ ------------
Total operating expenses 440,291 408,067 366,270
- -------------------------------------------------------------------------------------------------------------------
BANKING OPERATING INCOME $ 106,725 $ 97,148 $ 72,691
- -------------------------------------------------------------------------------------------------------------------
TOTAL COMPANY
Operating income $ 87,177 $ 96,481 $ 68,350
Income tax provision 24,386 27,682 19,637
------------- ------------ ------------
Income before extraordinary item and minority interest 62,791 68,799 48,713
Extraordinary item:
Loss on early extinguishment of debt, net of taxes -- -- (166)
------------- ------------ ------------
Income before minority interest 62,791 68,799 48,547
Minority interest held by affiliates (10,051) (8,842) (5,269)
Minority interest -- other (25,313) (25,313) (25,313)
- -------------------------------------------------------------------------------------------------------------------
TOTAL COMPANY NET INCOME $ 27,427 $ 34,644 $ 17,965
Dividends: Real Estate Trust's perferred shares of beneficial interest (5,418) (5,418) (5,418)
------------- ------------ ------------
NET INCOME AVAILABLE TO COMMON
SHAREHOLDERS $ 22,009 $ 29,226 $ 12,547
NET INCOME PER COMMON SHARE
Income before extraordinary item and minority interest $ 11.88 $ 13.13 $ 8.96
Income before minority interest 11.88 13.13 8.93
Minority interest held by affiliates (2.08) (1.83) (1.09)
Minority interest -- other (5.24) (5.24) (5.24)
- -------------------------------------------------------------------------------------------------------------------
NET INCOME PER COMMON SHARE $ 4.56 $ 6.06 $ 2.60
- -------------------------------------------------------------------------------------------------------------------
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
===================================================================================================================
For the Year Ended September 30
----------------------------------------
(Dollars in thousands) 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------------
(Restated) (Restated)
COMPREHENSIVE INCOME
Net income $ 27,427 $ 34,644 $ 17,965
Other comprehensive income:
Net unrealized holding gains (losses) 1,670 (1,670) (6)
- -------------------------------------------------------------------------------------------------------------------
TOTAL COMPREHENSIVE INCOME $ 29,097 $ 32,974 $ 17,959
- -------------------------------------------------------------------------------------------------------------------
CHANGES IN SHAREHOLDERS' EQUITY
PREFERRED SHARES OF BENEFICIAL INTEREST
Beginning and end of period (516,000 shares) $ 516 $ 516 $ 516
------------- ------------ ------------
COMMON SHARES OF BENEFICIAL INTEREST
Beginning and end of period (6,641,598 shares) 6,642 6,642 6,642
------------- ------------ ------------
PAID-IN SURPLUS
Beginning and end of period 92,943 92,943 92,943
------------- ------------ ------------
RETAINED EARNINGS
Beginning of period 48,498 18,354 7,815
Net income 27,427 34,644 17,965
Minority interest in capital contribution -- -- (2,697)
Adjustments - Saul Holdings investment 1,406 918 689
Dividends:
Real Estate Trust preferred shares of beneficial interest:
Distributions payable (5,418) (5,418) (5,418)
------------- ------------ ------------
End of period 71,913 48,498 18,354
------------- ------------ ------------
ACCUMULATED OTHER COMPREHENSIVE INCOME
Beginning of period (1,670) -- 6
Net unrealized holding gains (losses) 1,670 (1,670) (6)
------------- ------------ ------------
End of period -- (1,670) --
------------- ------------ ------------
TREASURY SHARES
Beginning and end of period (1,814,688 shares) (41,848) (41,848) (41,848)
- -------------------------------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY $ 130,166 $ 105,081 $ 76,607
- -------------------------------------------------------------------------------------------------------------------
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
============================================================================================================================
For the Year Ended September 30
-------------------------------------------
(In thousands) 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES (Restated) (Restated)
Real Estate
Net loss $ (12,777) $ (723) $ (3,109)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Depreciation 19,147 18,600 14,308
Gain on sale of property -- (11,077) (994)
Early extinguishment of debt, net of taxes -- -- 166
Increase in accounts receivable and accrued income (2,633) 327 (691)
Increase (decrease) in deferred taxes (6,880) (388) (10,450)
Increase (decrease) in accounts payable and accrued expenses 1,425 (5,711) 1,892
Amortization of debt expense 1,847 1,717 1,620
Equity in earnings of unconsolidated entities (9,057) (7,402) (7,291)
Dividends and tax sharing payments 21,667 16,200 19,400
Other (5,082) (4,572) (2,441)
------------- ------------- -------------
7,657 6,971 12,410
------------- ------------- -------------
Banking
Net income 40,204 35,367 21,074
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Amortization of premiums, discounts and net deferred loan fees 16,220 11,132 372
Depreciation and amortization 38,710 34,197 32,434
Loss on retirement of fixed assets 2,587 -- --
Provision for loan and lease losses 56,015 67,852 49,930
Capitalized interest on real estate under development -- (2,017) (3,786)
Proceeds from sales of trading securities 1,196,001 844,637 303,499
Net fundings of loans held for sale and/or securitization (2,552,061) (1,629,837) (708,955)
Proceeds from sales of loans held for sale and/or securitization 2,286,369 1,485,780 1,054,025
Gain on sales of loans (4,094) (4,904) (1,443)
(Gain) Loss on sale of real estate held for sale (1,040) (6,241) (9,257)
Provision for losses on real estate held for investment or sale 700 4,200 1,400
(Gain) Loss on trading securities, net (6,202) (14,452) (1,533)
(Increase) decrease in interest-only strips (26,328) (30,019) (25,333)
(Increase) decrease in servicing assets 1,996 12,602 (44,577)
Amortization of goodwill and other intangible assets 2,042 2,214 2,530
(Increase) decrease in other assets 20,854 34,388 18,766
Increase in custodial accounts 95,349 52,542 38,286
Increase (decrease) in other liabilities 14,393 46,204 126,405
Minority interest held by affiliates 10,051 8,842 5,269
Minority interest - other 9,750 9,750 9,750
------------- ------------- -------------
1,201,516 962,237 868,856
------------- ------------- -------------
Net cash provided by operating activities 1,209,173 969,208 881,266
- ----------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Real Estate
Capital expenditures - properties (8,758) (22,546) (54,915)
Property acquisitions -- (16,535) (19,518)
Property sales 9,650 10,074 1,897
Note receivable and accrued interest -- related party
Repayments 1,300 4,000 3,750
Equity investment in unconsolidated entities 3,508 2,935 (6,955)
Other (239) 3 (354)
------------- ------------- -------------
5,461 (22,069) (76,095)
------------- ------------- -------------
Banking
Net proceeds from maturities of investment securities 45,000 -- 44,000
Net proceeds from redemption of Federal Home Loan Bank stock 84,559 58,894 11,877
Net proceeds from sales of real estate 21,905 31,183 28,590
Net principal collected of loans and leases 1,905,232 154,920 (1,008,875)
Principal collected (disbursed) on mortgage-backed securities 464,622 410,739 267,273
Purchases of Federal Home Loan Bank stock (60,177) (74,248) (22,371)
Purchases of investment securities (45,717) (119) (45,231)
Purchases of mortgage-backed securities (21,450) -- --
Purchases of loans receivable (3,211,964) (1,970,548) (1,549,508)
Purchases of property and equipment (55,839) (122,045) (92,971)
Purchasae of Tucker Asset Management, net -- (4,177) --
Disbursements for real estate held for investment or sale (10,884) (8,723) (9,607)
------------- ------------- -------------
(884,713) (1,524,124) (2,376,823)
------------- ------------- -------------
Net cash used in investing activities (879,252) (1,546,193) (2,452,918)
- ----------------------------------------------------------------------------------------------------------------------------
Continued on following page.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
B. F. SAUL REAL ESTATE INVESTMENT TRUST
============================================================================================================================
For the Year Ended September 30
-------------------------------------------
(In thousands) 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES (Restated) (Restated)
Real Estate
Proceeds from mortgage financing $ 14,562 $ 50,978 $ 130,802
Principal curtailments and repayments of mortgages (18,261) (32,442) (37,035)
Proceeds from secured note financings 1,750 20,500 24,200
Repayments of secured note financings (2,500) (18,000) (40,200)
Proceeds from sales of unsecured notes 7,601 9,310 10,246
Repayments of unsecured notes (3,162) (6,056) (8,905)
Costs of obtaining financings (1,005) (1,461) (2,651)
Dividends paid - preferred shares of beneficial interest (12,000) (12,000) (12,500)
------------- ------------- -------------
(13,015) 10,829 63,957
------------- ------------- -------------
Banking
Proceeds from customer deposits and sales of certificates of deposit 48,432,739 43,408,719 38,470,514
Customer withdrawals of deposits and payments for maturing certificates
of deposit (48,557,624) (42,884,038) (37,196,211)
Net increase in securities sold under repurchase agreements 394,303 (258,791) (156,943)
Capital contribution from parent -- -- 22,303
Advances from the Federal Home Loan Bank 7,271,409 19,932,789 2,348,672
Repayments of advances from the Federal Home Loan Bank (7,809,043) (19,639,162) (2,144,889)
Net increase (decrease) in other borrowings (17,169) 1,099 66,214
Cash dividends paid on preferred stock (9,750) (9,750) (9,750)
Cash dividends paid on common stock (20,000) (16,000) (16,000)
------------- ------------- -------------
(315,135) 534,866 1,383,910
------------- ------------- -------------
Net cash provided by (used in) financing activities (328,150) 545,695 1,447,867
- ----------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 1,771 (31,290) (123,785)
Cash and cash equivalents at beginning of year 452,928 484,218 608,003
------------- ------------- -------------
Cash and cash equivalents at end of year $ 454,699 $ 452,928 $ 484,218
- ----------------------------------------------------------------------------------------------------------------------------
Components of cash and cash equivalents at end of period as presented in the
consolidated balance sheets:
Real Estate
Cash and cash equivalents $ 13,963 $ 13,860 $ 18,129
Banking
Cash and other deposits 318,484 354,683 395,648
Interest-bearing deposits 122,252 84,385 70,441
------------- ------------- -------------
Cash and cash equivalents at end of period $ 454,699 $ 452,928 $ 484,218
- ----------------------------------------------------------------------------------------------------------------------------
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest (net of amount capitalized) $ 320,582 $ 480,083 $ 449,449
Income taxes paid (refunded) 19,226 (23,889) (69,691)
Shares of Saul Centers, Inc. common stock 7,988 7,878 3,770
Transfer of Tysons Park Place to real estate segment from banking segment -- -- 37,000
Cash received during the year from:
Dividends on shares of Saul Centers, Inc. common stock 4,969 4,287 3,770
Distributions from Saul Holdings Limited Partnership 6,527 6,527 6,527
Supplemental disclosures of noncash activities:
Rollovers of notes payable - unsecured 4,880 4,022 5,335
Loans held for sale and/or securitization exchanged for 1,186,436 839,224 297,462
trading securities
Loans receivable transferred to loans held for sale and/or 1,604,771 1,016,861 744,823
securitization 900 -- 1,260
Loans made in connection with the sale of real estate
Loans receivable transferred to real estate acquired in 4,174 720 5,616
settlement of loans
Loans receivable exchanged for mortgage-backed -- 837,661 4,798
securities held-to-maturity
- ----------------------------------------------------------------------------------------------------------------------------
The Notes to Consolidated Financial Statements are an integral part of these statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
GENERAL
B.F. Saul Real Estate Investment Trust operates as a Maryland real estate
investment trust. The principal business activities of B.F. Saul Real Estate
Investment Trust and its consolidated subsidiaries (the "Trust") are the
ownership of 80% of the outstanding common stock of Chevy Chase Bank, F.S.B.,
whose assets accounted for 96% of the Trust's consolidated assets as of
September 30, 2002, and the ownership and development of income-producing
properties. The properties are located predominantly in the mid-Atlantic and
Southeastern regions of the United States and consist principally of hotels,
office projects, and undeveloped land parcels. Chevy Chase Bank, F.S.B. is a
federally chartered and federally insured stock savings bank and, as such, is
subject to comprehensive regulation, examination and supervision by the Office
of Thrift Supervision ("OTS") and by the Federal Deposit Insurance Corporation
("FDIC"). The bank is principally engaged in the business of attracting deposits
from the public and using such deposits, together with borrowings and other
funds, to make loans secured by real estate, primarily residential mortgage
loans, and various types of consumer loans and leases and commercial loans. The
bank's principal deposit market is the Washington, DC metropolitan area.
"Real Estate Trust" refers to B.F. Saul Real Estate Investment Trust and its
wholly owned subsidiaries. Chevy Chase Bank, F.S.B. and its subsidiaries are
referred to in the consolidated financial statements and notes thereto as the
"bank" or the "Corporations". The accounting and reporting practices of the
Trust conform to accounting principles generally accepted in the United States
and, as appropriate, predominant practices within the real estate and banking
industries.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Real Estate
Trust and its subsidiaries. Accordingly, the accompanying financial statements
reflect the assets, liabilities, operating results, and cash flows for two
business segments: Real Estate and Banking. Entities in which the Trust holds a
non-controlling interest (generally 50% or less) are accounted for on the equity
method. See Note 3. All significant intercompany transactions, except as
disclosed elsewhere in the financial statements, including intercompany office
rental agreements, 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.
Although the financial results of Trust subsidiaries are included in these
consolidated financial statements, each Trust subsidiary, including, but not
limited to, Arlington Hospitality Corp., Auburn Hills Hotel Corporation, Dulles
Hospitality Corp., Herndon Hotel Corporation, Pueblo Hotel Corp. and Sharonville
Hotel Corporation, is a separate legal entity whose assets are not available to
pay the claims of creditors of other entities included in these consolidated
financial statements.
USE OF ESTIMATES
The financial statements have been prepared in conformity with accounting
principles generally accepted in the United States. In preparing the financial
statements, management is required to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
liabilities as of the date of the balance sheet and revenues and expenses for
the reporting period. Actual results could differ from those estimates.
ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived assets and certain identifiable intangibles to be held and used are
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. If the sum of the
expected cash flows (undiscounted and without interest charges) is less than the
carrying amount of the asset, the Trust recognizes an impairment loss.
Measurement of an impairment loss for long-lived assets and identifiable
intangibles that the Trust expects to hold and use is based on the fair value of
the asset. Long-lived assets and certain identifiable intangibles to be disposed
of are generally reported at the lower of carrying amount or fair value less the
cost to sell.
INCOME TAXES
The Trust files a consolidated federal income tax return which includes
operations of all 80% or more owned subsidiaries. It voluntarily terminated its
qualification as a real estate investment trust under the Internal Revenue Code
during fiscal 1978.
The Trust uses an asset and liability approach in accounting for income taxes.
Deferred income taxes are recorded using currently enacted tax laws and rates.
To the extent that realization of deferred tax assets is more likely than not,
such assets are recognized.
NET INCOME PER COMMON SHARE
Net income per common share is determined by dividing net income, after
deducting preferred share dividend requirements, by the weighted average number
of common shares outstanding during the year. For fiscal years 2002, 2001 and
2000, the weighted average number of shares used in the calculation was
4,826,910. The Trust has no common share equivalents.
RECLASSIFICATIONS
Certain reclassifications have been made to the consolidated financial
statements for the years ended September 30, 2001 and 2000 to conform with the
presentation used for the year ended September 30, 2002.
B. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - REAL ESTATE TRUST
CASH EQUIVALENTS
The Real Estate Trust considers all highly liquid, temporary investments with an
original maturity of three months or less to be cash equivalents.
PROPERTIES
Income-producing properties are stated at the lower of depreciated cost (except
those which were acquired through foreclosure or equivalent proceedings, the
carrying amounts of which are based on the lower of cost or fair value at the
time of acquisition) or net realizable value.
Interest, real estate taxes and other carrying costs are capitalized on projects
under construction. Once construction is completed and the assets are placed in
service, rental income, direct operating expenses, and depreciation associated
with such properties are included in current operations. The Real Estate Trust
considers a project to be substantially complete and held available for
occupancy upon completion of tenant improvements, but no later than one year
from the cessation of major construction activity. Substantially completed
portions of a project are accounted for as separate projects. Expenditures for
repairs and maintenance are charged to operations as incurred.
Depreciation is calculated using the straight-line method and estimated useful
lives of 28 to 47 years for buildings and up to 20 years for certain other
improvements. Tenant improvements are amortized over the lesser of their
estimated useful lives or the lives of the related leases using the
straight-line method.
INCOME RECOGNITION
The Real Estate Trust derives room and other revenues from the operations of its
hotel properties. Hotel revenue is recognized as earned. The Real Estate Trust
derives rental income under noncancelable long-term leases from tenants at its
commercial properties. Commercial property rental income is recognized on a
straight-line basis.
INVESTMENT IN SAUL CENTERS, INC.
The Real Estate Trust accounts for its investments in
Saul Holdings Limited Partnership and Saul Centers, Inc. on the equity method
of accounting because the Trust does not have effective control of the
respective entities.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments.
Cash and Cash Equivalents
The carrying amount approximates fair value because of the short-term maturity
of these instruments.
Liabilities
The carrying amount of notes payable - secured approximates their fair value
since most of the debt has been financed in recent periods at prevailing market
interest rates. The fair value of mortgage notes payable is based on
management's estimate of current market rates for its debt. At September 30,
2002, and 2001, the fair value of mortgage notes payable was $333.7 and $328.3
million. The fair value of notes payable - unsecured is based on the rates
currently offered by the Real Estate Trust for similar notes. At September 30,
2002 and 2001, the fair value of notes payable - unsecured was $59.4 and $51.9
million.
ACCOUNTING STANDARDS ISSUED BUT NOT YET ADOPTED:
SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142") was issued in
June 2001. SFAS 142 supersedes APB Opinion No. 17, "Intangible Assets." SFAS 142
establishes new guidance on accounting and for goodwill and other assets
acquired in a business combination and reaffirms that acquired intangible assets
should initially be recognized at fair value and the costs of internally
developed intangible assets should be charged to expense as incurred. SFAS 142
also requires that goodwill arising in a business combination should no longer
be amortized, but, instead, be subjected to impairment testing by comparing the
carrying value to the fair value. SFAS 142 is effective for fiscal years
beginning after December 15, 2001 and must be applied as of the beginning as of
the beginning of the fiscal year. The adoption of SFAS 142 on October 1, 2002,
had no material effect on the Real Estate Trust.
SFAS No. 144, "Accounting for Impairment or Disposal of Long Lived Assets"
("SFAS 144") was issued in August 2001. SFAS 144 supersedes SFAS NO. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of," and the accounting and reporting provisions of APC Opinion No.
30, "Reporting the Results of Operations- Reporting the Effects of Disposal of A
Segment of A Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions." SFAS 144 addresses financial accounting and reporting
for the impairment or disposal of long-lived assets and broadens the
presentation of discontinued operations to include more disposal transactions.
SFAS 144 is effective for fiscal years beginning after December 15, 2001. The
adoption of this statement will not have a material effect on the Real Estate
Trust's financial condition or results of operations. In subsequent periods,
should real estate properties be sold, they will be treated as discontinued
operations.
SFAS No. 145, "Rescission of SFAS 4,44 and 64, Amendment of SFAS 13, and
Technical Corrections" was issued in April 2002. SFAS 145 requires companies to
no longer report gains and losses associated with the extinguishment of debt as
a component of extraordinary gains and losses, net of tax. These gains and
losses will now be required to be presented within the statement of operations
in appropriate segregated line items. This statement is effective for fiscal
years beginning after December 15, 2002. The adoption of this statement will not
have a material effect on the Real Estate Trust's financial condition or its
results of operations.
C. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - THE BANK
CASH AND CASH EQUIVALENTS:
For purposes of reporting cash flows, cash and cash equivalents include cash and
due from banks, interest-bearing deposits, federal funds sold and securities
purchased under agreements to resell.
Federal Reserve Board regulations require the bank to maintain reserves in the
form of cash or deposits in its account at the Federal Reserve Bank of Richmond.
The bank's average reserve requirements, before credit for vault cash, were
$44.1, $189.1 and $163.9 million during the years ended September 30, 2002, 2001
and 2000, respectively.
LOANS HELD FOR SECURITIZATION AND/OR SALE:
At September 30, 2002 and 2001, loans held for sale are composed of
single-family residential loans, automobile loans and home improvement and
related loans originated or purchased for sale in the secondary market and are
carried at the lower of aggregate cost or aggregate market value. Single-family
residential loans held for sale will either be sold or will be exchanged for
mortgage-backed securities and then sold.
Gains and losses on sales of whole loans held for sale are determined using the
specific identification method.
The bank periodically securitizes and sells certain pools of loan receivables in
the public and private markets. Securitizations are recorded as sales. Loans
held for securitization and sale are reported at the lower of aggregate cost or
aggregate market value for each asset type.
U.S. GOVERNMENT AND MORTGAGE-BACKED SECURITIES:
The bank classifies its U.S. Government and mortgage-backed securities as either
"held-to-maturity," "available-for-sale" or "trading" at the time such
securities are acquired. U.S. Government and mortgage-backed securities
classified as "held-to-maturity" are reported at amortized cost. U.S. Government
and mortgage-backed securities classified as "available-for-sale" are reported
at fair value, with unrealized gains and losses, net of the related tax effect,
reported as a separate component of stockholders' equity. U.S. Government and
mortgage-backed securities classified as "trading" are reported at fair value,
with unrealized gains and losses included in earnings. All U.S. Government
securities and mortgage-backed securities are classified as held-to-maturity at
September 30, 2002 and 2001. Premiums and discounts on U.S. Government
securities and mortgage-backed securities are amortized or accreted using the
level-yield method. Realized gains and losses are determined using the specific
identification method.
TRADING SECURITIES:
As part of its mortgage banking activities, the bank exchanges loans held for
sale for mortgage-backed securities and then sells the mortgage-backed
securities, which are classified as trading securities, to third party investors
in the month of issuance. Proceeds from sales of trading securities were
$1,192.6, $848.6 and $299.9 million during the years ended September 30, 2002,
2001 and 2000, respectively. The bank realized net gains of $6.2, $14.5 and $1.5
million on the sales of trading securities for the years ended September 30,
2002, 2001 and 2000, respectively. Gains and losses on sales of trading
securities are determined using the specific identification method. There were
no mortgage-backed securities classified as trading securities at September 30,
2002 and 2001.
At September 30, 2001, the bank held automobile receivables-backed securities
with a carrying amount of $1.2 million, which were classified as trading
securities. These securities were created in conjunction with two automobile
loan securitization transactions and represented subordinate classes of
certificates retained by the bank. The securities were redeemed during fiscal
year 2002.
At September 30, 2002 and 2001, the bank held stock in Concord EFS, Inc. with a
carrying amount of $3.9 and $6.1 million, respectively, which was also
classified as trading securities. The bank recognized net unrealized holding
losses of $2.1 million on this investment during the year ended September 30,
2002. The bank recognized net unrealized holding gains of $1.1 million and net
realized gains of $10.3 million on this investment during the year ended
September 30, 2001.
LOAN ORIGINATION AND COMMITMENT FEES:
Nonrefundable loan fees, such as origination and commitment fees, and
incremental loan origination costs relating to loans originated or purchased are
deferred. Net deferred fees (costs) related to loans held for investment are
amortized over the life of the loan using the level-yield method. Net fees
(costs) related to loans held for sale are deferred until such time as the loan
is sold, at which time the net deferred fees (costs) become a component of the
gain or loss on sale.
IMPAIRED LOANS:
A loan is considered impaired when, based on all current information and events,
it is probable that the bank will be unable to collect all amounts due according
to the contractual terms of the agreement, including all scheduled principal and
interest payments. Loans reviewed by the bank for impairment include real estate
and commercial loans and loans modified in a troubled debt restructuring. Large
groups of smaller-balance homogeneous loans that have not been modified in a
troubled debt restructuring are collectively evaluated for impairment, which for
the bank include residential mortgage loans and other consumer loans. Impaired
loans are measured based on the present value of expected future cash flows,
discounted at the loan's effective interest rate or, as a practical expedient,
impairment may be measured based on the loan's observable market price, or, if
the loan is collateral-dependent, the fair value of the collateral. When the
measure of the impaired loan is less than the recorded investment in the loan,
the impairment is recorded through a valuation allowance. Loans for which
foreclosure is probable continue to be classified as loans.
Each impaired real estate or commercial loan is evaluated individually to
determine the income recognition policy. Generally, payments received are
applied as a reduction of principal.
At September 30, 2002 and 2001, the bank did not have any impaired loans. The
average recorded investment in impaired commercial and real estate loans for the
year ended September 30, 2000 was $51,000. The bank did not recognize any
interest income on its impaired loans for the years ended September 30, 2002,
2001 and 2000.
ALLOWANCES FOR LOSSES:
The allowance for loan and lease losses represents management's estimate of
credit losses inherent in the bank's loan and lease portfolios as of the balance
sheet date. The bank's methodology for assessing the appropriate level of the
allowance consists of several key elements, which include the allocated
allowance, specific allowances for identified loans and the unallocated
allowance. Management reviews the adequacy of the valuation allowances on loans
and leases using a variety of measures and tools including historical loss
performance, delinquent status, current economic conditions, internal risk
ratings and current underwriting policies and procedures.
The allocated allowance is assessed on both homogeneous and non-homogeneous loan
portfolios. The range is calculated by applying loss and delinquency factors to
the outstanding loan balances of these portfolios. Loss factors are based on
analysis of the historical performance of each loan category and an assessment
of portfolio trends and conditions, as well as specific risk factors impacting
the loan and lease portfolios. Each homogeneous portfolio, such as single-family
residential loans or automobile loans, is evaluated collectively.
Non-homogeneous type loans, such as business banking loans and real estate
banking loans, are analyzed and segregated by risk according to the bank's
internal risk rating system. These loans are reviewed by the bank's credit and
loan review groups on an individual loan basis to assign a risk rating. Industry
loss factors are applied based on the risk rating assigned to the loan. Industry
loss factors are used because of the bank's lack of history in these portfolios.
A specific allowance may be assigned to non-homogeneous type loans that have
been individually determined to be impaired. Any specific allowance considers
all available evidence including, as appropriate, the present value of payments
expected to be received or, for loans that are solely dependent on collateral
for repayment, the estimated fair value of the collateral.
The unallocated allowance is based upon management's evaluation and judgment of
various conditions that are not directly measured in the determination of the
allocated and specific allowances. The conditions evaluated in connection with
the unallocated allowance may include existing general economic and business
conditions affecting the key lending areas of the bank, credit quality trends,
collateral values, loan volumes and concentrations, seasoning of the loan
portfolio, specific industry conditions within portfolio segments, recent loss
experience in particular segments of the portfolio, regulatory examination
results and findings of the bank's internal credit evaluations.
The allowances for losses are based on estimates and ultimate losses may vary
from current estimates. As adjustments to the allowances become necessary,
provisions for losses are reported in operations in the periods they are
determined to be necessary.
ACCRUED INTEREST RECEIVABLE ON LOANS:
Loans are reviewed on a monthly basis and are placed on non-accrual status when,
in the opinion of management, the full collection of principal or interest has
become unlikely. Uncollectible accrued interest receivable on non-accrual loans
is charged against current period interest income.
REAL ESTATE HELD FOR INVESTMENT OR SALE:
REAL ESTATE HELD FOR INVESTMENT:
At September 30, 2002 and 2001, real estate held for investment consists of
developed land owned by one of the bank's subsidiaries. Real estate held for
investment is carried at the lower of cost or net realizable value. See Note 14.
REAL ESTATE HELD FOR SALE:
Real estate held for sale consists of real estate acquired in settlement of
loans ("REO") and is carried at the lower of cost or fair value (less estimated
selling costs). Costs relating to the development and improvement of property,
including interest, are capitalized, whereas costs relating to the holding of
property are expensed. The bank did not capitalize interest during the year
ended September 30, 2002 because development was substantially complete.
Capitalized interest amounted to $2.0 and $3.8 million for the years ended
September 30, 2001 and 2000, respectively.
PROPERTY AND EQUIPMENT:
Property and equipment is stated at cost, net of accumulated depreciation and
amortization. Depreciation and amortization are computed using the straight-line
method, which allocates the cost of the applicable assets over their estimated
useful lives. Major improvements and alterations to office premises and
leaseholds are capitalized. Leasehold improvements are amortized over the
shorter of the terms of the respective leases (including renewal options that
are expected to be exercised) or 20 years. Maintenance and repairs are charged
to operating expenses as incurred. Capitalized interest amounted to $4.7 and
$2.1 million during the years ended September 30, 2001 and 2000, respectively,
and was primarily related to the bank's new headquarters building that was
placed in service on October 1, 2002.
GOODWILL AND OTHER INTANGIBLE ASSETS:
Goodwill is stated net of accumulated amortization and is being amortized using
the straight-line method over 15 years. At September 30, 2002 and 2001, goodwill
totaled $23.7 and $25.0 million, respectively. In February 2001, the bank
purchased an investment management firm and recorded $4.2 million of goodwill.
The acquisition was accounted for using the purchase method and the operating
results have been included in the bank's Consolidated Statements of Operations
since the date of acquisition.
The premium attributable to the value of home equity relationships related to
certain home equity loans purchased in fiscal 1999, amounting to $1.1 and $1.9
million at September 30, 2002 and 2001, respectively, is included in goodwill
and other intangible assets in the Consolidated Balance Sheets. The bank did not
purchase any home equity loans in fiscal 2002 and 2001. This premium is being
amortized over the estimated term of the underlying relationships.
Accumulated amortization of goodwill and other intangible assets was $53.6 and
$51.5 million at September 30, 2002 and 2001, respectively.
SERVICING ASSETS:
Servicing assets are recorded when purchased and in conjunction with loan sales
and securitization transactions. Servicing assets, which are stated net of
accumulated amortization, are amortized in proportion to the remaining net
servicing revenues estimated to be generated by the underlying loans.
The bank periodically evaluates its servicing assets for impairment based upon
fair value. For purposes of evaluating impairment, the bank stratifies its
servicing assets taking into consideration relevant risk characteristics
including loan type and note rate. The fair value of servicing assets is
estimated using projected cash flows, adjusted for the effects of anticipated
prepayments, using a market discount rate. To the extent the carrying value of
servicing assets exceeds the fair value of such assets, a valuation allowance is
recorded. See Note 15.
INTEREST-ONLY STRIPS RECEIVABLE:
Interest-only strips receivable capitalized in the years ended September 30,
2002 and 2001 amounted to $68.6 and $55.2 million, respectively, and were
related to the securitization and sale of loan receivables.
The bank accounts for its interest-only strips receivable as trading securities
and, accordingly, carries them at fair value. The bank estimates the fair value
of the interest-only strips receivable on a discounted cash flow basis using
market based discount and prepayment rates. The fair value adjustments for
interest-only strips receivable are included in servicing and securitization
income. The fair value adjustments amounted to a net loss of $7.2 and $11.5
million in fiscal years 2002 and 2001, respectively, and a net gain of $2.8
million in fiscal year 2000.
Interest income on interest-only strips receivable is recognized using the
effective yield method over the estimated lives of the underlying loans. The
bank uses certain assumptions to calculate the carrying values of the
interest-only strips receivable, mainly estimates of prepayment speeds, credit
losses and interest rates, which are beyond the control of the bank. To the
extent actual results differ from the assumptions, the carrying values are
adjusted accordingly. See Note 16.
DERIVATIVE FINANCIAL INSTRUMENTS:
The bank uses various strategies to minimize interest-rate risk with respect to
its mortgage banking activities. At September 30, 2002 and 2001 all derivatives
are recorded on the balance sheet at their fair market value. At September 30,
2000 derivatives were recorded at their amortized cost.
ADOPTION OF RECENTLY ISSUED ACCOUNTING STANDARDS:
The bank adopted Financial Accounting Standards Board ("FASB") Statement of
Financial Accounting Standard ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133") effective October 1, 2000. SFAS
133 was amended by SFAS No. 137, "Accounting for Derivative Instruments and
Hedging Activities - Deferral of Effective Date of Financial Accounting
Standards Board Statement No. 133" ("SFAS 137") and SFAS No. 138, "Accounting
for Certain Derivative Instruments and Certain Hedging Activities - an amendment
of FASB Statement No. 133" ("SFAS 138"). SFAS 133, as amended by SFAS 137 and
SFAS 138, establishes accounting and reporting standards for derivative
instruments and hedging activities. SFAS 133 requires an entity to recognize all
derivative instruments as either assets or liabilities in the statement of
financial condition and measure those instruments at fair value. Changes in the
fair value of those instruments are reported in earnings or other comprehensive
income depending on the use of the derivative, its hedge designation and whether
the hedge is effective in achieving offsetting changes in the fair value or cash
flows of the asset or liability hedged. On October 1, 2000, the bank recorded an
after tax loss of $476,000 in Other Comprehensive Income representing its
transition adjustment from the adoption of these standards.
On July 1, 2002, the bank implemented FASB implementation guidance regarding the
application of SFAS 133, which requires that interest rate locks ("IRL") on
mortgage loans originated for sale be treated as derivatives. The IRLs are
treated as free standing derivatives with changes in fair value recorded in the
income statement and reported on the balance sheet. In connection with this
change, the bank's forward sale commitments were re-designated from cash flow
hedges to fair value hedges or non-designated hedge relationships. The net
income statement impact of the change was $80,000, net of tax. The net impact on
Other Comprehensive Income was $1.2 million.
SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities" - a replacement of SFAS No. 125," ("SFAS 140")
was issued in September 2000. SFAS 140 provides consistent standards for
distinguishing transfers of financial assets that are sales from transfers that
are secured borrowings. Under SFAS 140, after a transfer of financial assets, an
entity recognizes the financial and servicing assets it controls and the
liabilities it has incurred, derecognizes financial assets when control has been
surrendered, and derecognizes liabilities when extinguished. SFAS 140 was
effective for transfers after March 31, 2001, except that the effective date for
the isolation standards was suspended for financial institutions until January
1, 2002, and was effective for disclosures about securitizations and collateral
and for recognition and reclassification of collateral for fiscal years ending
after December 15, 2000. The adoption of SFAS 140 did not have a material impact
on the bank's financial condition or results of operations.
ACCOUNTING STANDARDS ISSUED BUT NOT YET ADOPTED:
SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142") was issued in
June 2001. SFAS 142 supersedes APB Opinion No. 17, "Intangible Assets." SFAS 142
establishes new guidance on accounting for goodwill and other assets acquired in
a business combination and reaffirms that acquired intangible assets should
initially be recognized at fair value and the costs of internally developed
intangible assets should be charged to expense as incurred. SFAS 142 also
requires that goodwill arising in a business combination should no longer be
amortized, but, instead, be subjected to impairment testing. An impairment loss
is recognized if fair value is less than the carrying amount. SFAS 142 is
effective for fiscal years beginning after December 15, 2001 and must be applied
as of the beginning of the fiscal year. At October 1, 2002, the fair value of
the goodwill recorded on the bank's balance sheet exceeded its carrying value.
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-lived Assets"
("SFAS 144") was issued in August 2001. SFAS 144 supersedes SFAS No. 121,
"Accounting for the Impairment of Long-lived Assets and for Long-Lived Assets to
be Disposed of," and the accounting and reporting provisions of APB Opinion No.
30, "Reporting the Results of Operations - Reporting the Effects of Disposal of
a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions." SFAS 144 addresses financial accounting and reporting
for the impairment or disposal of long-lived assets and broadens the
presentation of discontinued operations to include more disposal transactions.
SFAS 144 is effective for fiscal years beginning after December 15, 2001. The
adoption of this statement will not have a material effect on the bank's
financial condition or results of operations.
1. RESTATEMENT OF PRIOR YEAR FINANCIAL STATEMENTS - THE TRUST
On July 31, 2002, the Trust filed a Current Report on Form 8-K stating that, as
a result of its internal accounting review, the Bank had determined that its net
income had been inadvertently overstated in prior periods due to certain
accounting errors involving interest-only strips receivable related to the
Bank's automobile loan securitizations.
In addition, as part of the restatement process, the Trust determined that
shareholders' equity was understated and net income was overstated related to it
investments in Saul Holdings Limited Partnership ("Saul Holdings") and Saul
Centers, Inc ("Saul Centers"), respectively, and accordingly changed its
accounting treatment related to these investments.
As a result, the Trust has restated its financial results and financial position
for the fiscal years ended September 30, 2000 and 2001. The restated amounts
include primarily adjustments for securitizations and the investments in Saul
Holdings and Saul Centers, but also include certain other revisions. The
restatements reduced previously reported net income by approximately $4.4
million ($3.8 million related to securitizations and $0.6 million related to the
Saul Centers investment and other adjustments), from $22.4 million to $18.0
million for fiscal year 2000. The restatements reduced previously reported net
income by approximately $9.0 million ($8.5 million related to securitizations
and $0.5 million related primarily to the Saul Centers investment), from $43.6
million to $34.6 million for fiscal year 2001. Shareholders' Equity increased
$68.0 million from $8.6 million previously reported to $76.6 million at
September 30, 2000 and increased $59.9 million from $45.2 million previously
reported to $105.1 million at September 30, 2001, as a result of the Saul
Holdings investment adjustments offset by the adjustments described above.
The other revisions impacted certain previously reported asset and liability
accounts. Real Estate assets were reduced due to a decrease in the carrying
value of the investment in Saul Centers. Banking assets and liabilities
increased primarily as a result of the reclassification of certain assets that
were netted within Other liabilities. The liability related to the Deferred Gain
- - Real Estate was reclassified to Equity, net of tax. Other Real Estate
liabilities increased as a result of the tax effect of that adjustment.
See Note 3.
The following is a summary of the effects of the restatement, which includes the
effect of certain reclassifications.
September 30, 2001
-----------------------------------------------
As Reported As Restated
------------------------ ----------------------
Assets
Real Estate
Real estate, cash and notes receivable $ 361,147 $ 361,147
Other assets 86,983 80,957
------------------------ ----------------------
Total real estate assets $ 448,130 $ 442,104
Banking
Cash $ 409,995 $ 439,068
Loans held for securitzation and/or sale 528,083 528,083
Mortgage-backed and other securities 1,526,979 1,527,585
Loans and leases receivable, net 8,018,495 7,983,385
Property and equipment, net 437,795 457,995
Interest-only strips receivable, net 47,146 62,978
Other 419,973 413,658
------------------------ ----------------------
Total banking assets $ 11,388,466 $ 11,412,752
------------------------ ----------------------
Total assets $ 11,836,596 $ 11,854,856
======================== ======================
Liabilities
Real Estate
Debt and accrued dividends payable $ 598,270 $ 598,270
Deferred gains-real estate 113,045 -
Other 36,874 68,906
------------------------ ----------------------
Total real estate liabilities $ 748,189 $ 667,176
------------------------ ----------------------
Banking
Deposit accounts $ 7,562,470 $ 7,562,470
Borrowings 2,522,948 2,522,948
Other 403,190 446,336
Capital notes- subordinated 250,000 250,000
------------------------ ----------------------
Total banking liabilities $ 10,738,608 $ 10,781,754
------------------------ ----------------------
Minority interest held by affiliates 86,310 82,538
Minority interest- other 218,307 218,307
------------------------ ----------------------
Total liabilities $ 11,791,414 $ 11,749,775
------------------------ ----------------------
Shareholders' equity $ 45,182 $ 105,081
------------------------ ----------------------
Total liabilities and shareholders' equity $ 11,836,596 $ 11,854,856
======================== ======================
Year ended September 30, 2001 Year ended September 30, 2000
----------------------------------------------- -------------------------------------
As Reported As Restated As Reported As Restated
------------------------ ---------------------- ------------------- -----------------
Real Estate
Income $ 142,952 $ 142,952 $ 132,858 $ 132,858
Expense 161,802 162,098 145,484 145,484
Equity earnings-unconsolidated subsidiary 8,314 7,402 7,711 7,291
Gain on sale of properties 11,077 11,077 994 994
------------------------ ---------------------- ------------------- -----------------
Real estate operating income (loss) $ 541 $ (667) $ (3,921) $ (4,341)
------------------------ ---------------------- ------------------- -----------------
Banking
Net interest income:
Interest income $ 786,855 $ 786,897 $ 736,659 $ 736,888
Interest expense 422,744 422,744 394,400 394,400
------------------------ ---------------------- ------------------- -----------------
Net interest income 364,111 364,153 342,259 342,488
Provision for loan and lease losses 67,852 67,852 49,930 49,930
------------------------ ---------------------- ------------------- -----------------
Net interest income after provision
for loan and lease losses 296,259 296,301 292,329 292,558
------------------------ ---------------------- ------------------- -----------------
Other income:
Servicing and securitization income 69,792 52,169 38,441 28,991
Deposit servicing fees 101,482 101,482 88,253 88,253
Gain on trading securities, net 3,954 3,104 1,490 1,533
Net unrealized holding gain on trading
securities 448 1,054 - -
Gain (loss) on real estate held for
investment or sale, net 2,815 2,815 (1,523) (1,523)
Gain on sales of loans, net 4,904 4,904 1,486 1,443
Gain on other investment 10,294 10,294 - -
Other 32,242 33,092 26,112 27,706
------------------------ ---------------------- ------------------- -----------------
Total other income 225,931 208,914 154,259 146,403
------------------------ ---------------------- ------------------- -----------------
OPERATING EXPENSES
Salaries and employee benefits 198,480 197,444 193,204 193,378
Marketing expenses 11,353 11,353 11,424 11,424
Other operating expenses 198,064 199,270 160,688 161,468
------------------------ ---------------------- ------------------- -----------------
Total operating expenses 407,897 408,067 365,316 366,270
------------------------ ---------------------- ------------------- -----------------
Banking operating income 114,293 97,148 81,272 72,691
------------------------ ---------------------- ------------------- -----------------
Total Trust
Operating income 114,834 96,481 77,351 68,350
Income tax provision 34,963 27,682 23,217 19,637
------------------------ ---------------------- ------------------- -----------------
Income before extraordinary items and 79,871 68,799 54,134 48,713
minority interest
Extraordinary item- early extinguishment - - (166) (166)
of debt
Minority interest- affiliates (10,899) (8,842) (6,298) (5,269)
Minority interest- other (25,313) (25,313) (25,313) (25,313)
------------------------ ---------------------- ------------------- -----------------
Total Trust Net Income $ 43,659 $ 34,644 $ 22,357 $ 17,965
Dividends: Real Estate Trust's perferred shares
of beneficial interest (5,418) (5,418) (5,418) (5,418)
------------------------ ---------------------- ------------------- -----------------
Net Income Available to Common Shareholders $ 38,241 $ 29,226 $ 16,939 $ 12,547
Comprehensive Income
Trust Net Income $ 43,659 $ 34,644 $ 22,357 $ 17,965
Other Comprehensive Income (Loss) (1,670) (1,670) (6) (6)
------------------------ ---------------------- ------------------- -----------------
Total Comprehensive Income $ 41,989 $ 32,974 $ 22,351 $ 17,959
======================== ====================== =================== =================
NET INCOME PER COMMON SHARE
Income before extraordinary items and
minority interest $ 15.42 $ 13.13 $ 10.09 $ 8.96
Income before minority interest 15.42 13.13 10.05 8.93
Minority interest held by affiliates (2.26) (1.83) (1.30) (1.09)
Minority interest -- other (5.24) (5.24) (5.24) (5.24)
------------------------ ---------------------- ------------------- -----------------
NET INCOME PER COMMON SHARE $ 7.92 $ 6.06 $ 3.51 $ 2.60
======================== ====================== =================== =================
2. LIQUIDITY AND CAPITAL RESOURCES - REAL ESTATE TRUST
The Real Estate Trust's cash flow from operating activities has 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 financing, 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.
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.
During fiscal 2002, 2001 and 2000, the bank made tax sharing payments totaling
$5.7, $3.4 and $6.6 million to the Real Estate Trust. During fiscal 2002, 2001
and 2000, the bank made dividend payments totaling $16.0, $12.8 and $12.8
million to the Real Estate Trust.
In recent years, the operations of the Trust have generated net operating losses
while the bank has reported net income. The Trust's consolidation of the bank's
operations into the Trust's federal income tax return has resulted in the use of
the Trust's net operating losses to reduce the federal income taxes the bank
would otherwise have owed. 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.
3. SAUL HOLDINGS LIMITED PARTNERSHIP - REAL ESTATE TRUST
In fiscal 1993, the Real Estate Trust entered into a series of transactions
undertaken in connection with an initial public offering of common stock of a
newly organized corporation, Saul Centers, Inc. The Real Estate Trust
transferred its 22 shopping centers and one of its office properties together
with the debt associated with such properties to a newly formed partnership,
Saul Holdings, in which as of September 30, 2002, the Real Estate Trust owns
(directly or through one of its wholly owned subsidiaries) a 20.8% interest,
other entities affiliated with the Real Estate Trust own a 4.9% interest, and
Saul Centers owns a 74.3% interest. Certain officers and trustees of the Trust
are also officers and/or directors of Saul Centers.
In connection with the transfer of its properties to Saul Holdings, the Real
Estate Trust was relieved of approximately $196 million in mortgage debt and
deferred interest. Pursuant to a reimbursement agreement among the partners of
Saul Holdings and its subsidiary limited partnerships (collectively, the
"Partnerships"), the Real Estate Trust and its subsidiaries that are partners in
the Partnerships have agreed to reimburse Saul Centers and the other partners in
the event the Partnerships fail to make payments with respect to certain
portions of the Partnerships' debt obligations and Saul Centers or any such
other partners personally make payments with respect to such debt obligations.
At September 30, 2002, the maximum potential obligations of the Real Estate
Trust and its subsidiaries under this agreement totaled approximately $115.5
million.
The fair market value of each of the properties contributed to the Partnerships
by the Real Estate Trust at the date of transfer (the FMV of each such property)
exceeded the tax basis of such property (with respect to each property, such
excess is referred to as the FMV-Tax Difference). In the event Saul Centers, as
general partner of the Partnerships, causes the Partnerships to dispose of one
or more of such properties, a disproportionately large share of the total gain
for federal income tax purposes would be allocated to the Real Estate Trust or
its subsidiaries. In general, if the gain recognized by the Partnerships on a
property disposition is less than or equal to the FMV-Tax Difference for such
property (as previously reduced by the amounts of special tax allocations of
depreciation deductions to the partners), a gain equal to the FMV-Tax Difference
(as adjusted) will be allocated to the Real Estate Trust. To the extent the gain
recognized by the Partnerships on the property disposition exceeds the FMV-Tax
Difference (as adjusted), such excess generally will be allocated among all the
partners in Saul Holdings based on their relative percentage interests. In
general, the amount of gain allocated to the Real Estate Trust in the event of
such a property disposition is likely to exceed, perhaps substantially, the
amount of cash, if any, distributable to the Real Estate Trust as a result of
the property disposition. In addition, future reductions in the level of the
Partnerships' debt, or any release of the guarantees of such debt by the Real
Estate Trust, could cause the Real Estate Trust to have taxable constructive
distributions without the receipt of any corresponding amounts of cash.
Currently, management does not intend to seek a release of or a reduction in the
guarantees or to convert its limited partner units in Saul Holdings into shares
of Saul Centers common stock.
At the date of transfer of the Real Estate Trust properties to Saul Holdings,
liabilities exceeded assets transferred by approximately $104.3 million on an
historical cost basis. The assets and liabilities were recorded by Saul Holdings
and Saul Centers at their historical cost rather than market value because of
affiliated ownership and common management and because the assets and
liabilities were the subject of the business combination between Saul Centers
and Saul Holdings, newly formed entities with no prior operations.
Immediately subsequent to the business combination and initial public offering
of common stock by Saul Centers, Saul Centers had total owners' equity of
approximately $16.4 million of which approximately $3.5 million related to the
Real Estate Trust's original 21.5% ownership interest. As described in Note 1,
the Trust financial statements were restated to recognize the change in its
investment in the properties of approximately $107.8 million in accordance with
Staff Accounting Bulletin No. 51, and has been recorded as a direct increase in
the Trust's shareholders' equity, net of tax. Previously, such amounts had been
recorded as a deferred gain. Changes in the Real Estate Trust's equity
investment balance resulting from capital transactions of the investee are
recognized directly in the Trust's shareholders' equity in the accompanying
financial statements.
The management of Saul Centers has adopted a strategy of maintaining a ratio of
total debt to total asset value, as estimated by management, of fifty percent or
less. The management of Saul Centers has concluded at September 30, 2002, that
the total debt of Saul Centers remains below fifty percent of total asset value.
As a result, the management of the Real Estate Trust has concluded that fundings
under the reimbursement agreement are remote.
As of September 30, 2002, the Real Estate Trust's investment in the consolidated
entities of Saul Centers, which is accounted for under the equity method,
consisted of the following.
(In thousands)
-------------------------------------------------------------------
Saul Holdings:
Investment in partnership units $11,371
Distributions in excess of allocated net income (15,724)
Saul Centers:
Investment in common shares 58,628
Distributions in excess of allocated net income (10,735)
-------------
Total $ 43,540
=============
The $43.5 million balance is included in "Other assets" in the financial
statements.
The Trust's investment in Saul Centers exceeded the underlying book value of the
investment by $55.0 million at September 30, 2002. This amount is being
amortized over the useful life of the underlying real estate assets.
As of September 30, 2002, the Real Estate Trust, through its partnership
interest in Saul Holdings of 20.8% and its ownership of common shares of Saul
Centers of 22.8% (market value of $79.2 million at September 30, 2002),
effectively owns 37.7% of the consolidated entities of Saul Centers.
Substantially all of these shares and/or units have been deposited as collateral
for the Trust's revolving lines of credit. See Note 5.
The unaudited Condensed Consolidated Balance Sheet as of September 30, 2002 and
2001, and the unaudited Condensed Consolidated Statements of Operations for the
years ended September 30, 2002, 2001 and 2000 of Saul Centers follow.
Saul Centers, Inc.
Condensed Consolidated Balance Sheets
(Unaudited)
September 30,
-----------------------------
(In thousands) 2002 2001
- ----------------------------------------------- -------------- --------------
Assets
Real estate investments $ 487,945 $ 426,520
Accumulated depreciation (146,875) (133,938)
Other assets 37,586 49,855
-------------- --------------
Total assets $ 378,656 $ 342,437
============== ==============
Liabilities and stockholders' deficit
Notes payable $ 377,269 $ 350,247
Other liabilities 19,022 19,118
-------------- --------------
Total liabilities 396,291 369,365
Total stockholders' deficit (17,635) (26,928)
-------------- --------------
Total liabilities and stockholders' deficit $ 378,656 $ 342,437
============== ==============
Saul Centers, Inc.
Condensed Consolidated Statements of Operations
(Unaudited) For the Twelve Months
Ended September 30
-----------------------------
(In thousands) 2002 2001 2000
- ----------------------------------------------- -------- --------- ---------
Revenue
Base rent $73,893 $68,823 $62,763
Other revenue 18,182 15,775 14,754
-------- --------- ---------
Total revenue 92,075 84,598 77,517
-------- --------- ---------
Expenses
Operating expenses 17,752 16,021 14,741
Interest expense 24,927 24,898 23,529
Amortization of deferred debt expense 655 543 434
Depreciation and amortization 17,468 15,259 12,817
General and administrative 5,226 4,074 3,871
-------- --------- ---------
Total expenses 66,028 60,795 55,392
-------- --------- ---------
Operating income 26,047 23,803 22,125
Non-operating item
Gain on sale of property 1,426 -- 553
-------- --------- ---------
Net income before minority interest 27,473 23,803 22,678
Minority interest (8,069) (8,069) (8,068)
-------- --------- ---------
Net income $19,404 $15,734 $14,610
======== ========= =========
4. INVESTMENT PROPERTIES - REAL ESTATE TRUST
The following table summarizes the cost basis of income-producing properties and
land parcels together with their related debt.
(Dollars in Buildings and Related
thousands) No. Land Improvements Total Debt
- - ---------------------- ------ --------- --------------- ---------- ----------
September 30, 2002:
Income-producing
properties
Hotels 18 $18,684 $236,882 $255,566 $166,650
Office and industrial 13 14,786 162,134 176,920 160,846
Other 4 2,803 -- 2,803 --
------ --------- --------------- ---------- ----------
35 $36,273 $399,016 $435,289 $327,496 (1)
====== ========= =============== ========== ==========
Land Parcels 10 $41,323 $ -- $ 41,323 $ --
====== ========= =============== ========== ==========
(1) Amount includes $326.2 million mortgage notes payable and $1.3 million capital leases.
September 30, 2001:
Income-producing
properties
Hotels 18 $18,684 $235,481 $254,165 $171,477
Office and industrial 11 11,503 146,150 157,653 152,866
Other 4 2,825 -- 2,825 --
------ --------- --------------- ---------- ----------
33 $33,012 $381,631 $414,643 $324,343 (2)
====== ========= =============== ========== ==========
Land Parcels 10 $40,835 $ -- $ 40,835 $ --
====== ========= =============== ========== ==========
(2) Amount includes $322.8 million mortgage notes payable and $1.5 million capital leases.
On December 18, 2000, the Real Estate Trust sold its 124-unit San Simeon
apartment project in Dallas, Texas. The sales price was $3.1 million and the
Real Estate Trust recognized a gain of $2.2 million on the transaction. The
proceeds of the sales were used to acquire a 10.7 acre parcel of land in Loudoun
County, Virginia, for $2.8 million.
On June 13, 2001, the Real Estate Trust sold a 4.79 acre section of its Circle
75 land parcel located in Atlanta, Georgia for $3.0 million. The Real Estate
Trust recognized a gain of $2.4 million on this transaction.
On August 8, 2001, the Real Estate Trust sold Metairie Tower, a 91,000 square
foot office building located in Metairie, Louisiana, for $7.2 million. The Real
Estate Trust recognized a gain of $5.2 million on this transaction.
On September 7, 2001, the Real Estate Trust sold 9.5 acres of its Commerce
Center land parcel located in Ft. Lauderdale, Florida, for approximately $2.0
million, and recognized a gain of $245,000 on the transaction.
During fiscal 2001, the Real Estate Trust also received net proceeds of $2.0
million and recognized a gain of $620,000 from the condemnation of portions of
two land parcels in Colorado and Michigan.
5. DEBT - REAL ESTATE TRUST
Mortgage notes payable are secured by various income-producing properties, land
parcels, and properties under construction. Almost all mortgage notes are
payable in monthly installments, have maturity dates ranging to 2021 and accrue
interest at annual rates from 4.9% to 10.0%. Certain mortgages contain a number
of restrictions, including cross default provisions.
Notes payable - unsecured includes notes which have been sold by the Real Estate
Trust directly to investors at varying interest rates with maturities of one to
ten years. These notes do not contain any provisions for conversion, sinking
fund or amortization, but are subject to a provision permitting the Real Estate
Trust to call them prior to maturity. The weighted average interest rates were
9.8% and 10.1% at September 30, 2002 and 2001. During fiscal 2002 and 2001, the
Real Estate Trust sold notes amounting to approximately $7.6 and $9.3 million.
In March 1998, the Real Estate Trust issued $200.0 million aggregate principal
amount of 9 3/4% Senior Secured Notes. These Notes are nonrecourse obligations
of the Real Estate Trust and 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.
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 for this line is September 29,
2003. 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 September 30, 2002, the Real Estate Trust had
borrowings under the facility of $1.8 million and unrestricted availability of
$48.2 million. At September 30, 2002 the interest rate under this facility was
4.75%.
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, 1998 and 2000, the line of
credit was increased to $10.0, $20.0 and $25.0 million. The current maturity
date for this line is November 15, 2004. Interest is computed by reference to a
floating rate index. At September 30, 2002, the Real Estate Trust had no
outstanding borrowings and unrestricted availability of $25.0 million. At
September 30, 2002 the interest rate under this facility was 4.75%.
The maturity schedule for the Real Estate Trust's outstanding debt at September
30, 2002 for the fiscal years commencing October 1, 2002 is set forth in the
following table.
Debt Maturity Schedule
(In thousands)
--------------------------------------------------------------
Notes Notes
Fiscal Mortgage Payable -- Payable --
Year Notes Secured Unsecured Total
------------- --------- ----------- ----------- --------------
2003 $ 49,298 $ 1,750 $ 12,351 $ 63,399
2004 10,666 -- 11,762 22,428
2005 11,452 -- 10,033 21,485
2006 98,488 -- 5,806 104,294
2007 4,582 -- 4,221 8,803
Thereafter 151,746 200,000 10,983 362,729
--------- ----------- ----------- --------------
Total $326,232 $201,750 $ 55,156 $ 583,138
--------------------------------------------------------------
Of the $326.2 million of mortgage notes outstanding at September 30, 2002,
$303.3 million was nonrecourse to the Real Estate Trust.
6. LONG-TERM LEASE OBLIGATIONS - REAL ESTATE TRUST
The Real Estate Trust has no minimum future rental commitments and no long term
leases.
7. INCOME FROM COMMERCIAL PROPERTIES - REAL ESTATE TRUST
Income from commercial properties includes minimum rent arising from
noncancelable commercial leases. Minimum rent for fiscal years 2002, 2001, and
2000 amounted to $34.9, $37.0 and $32.1 million. Future minimum rentals as of
September 30, 2002 under noncancelable leases are as follows:
Fiscal Year (In thousands)
------------------------------------------------------------
2003 $ 32,530
2004 28,614
2005 24,827
2006 20,200
2007 15,547
Thereafter 58,100
-----------
Total $179,818
------------------------------------------------------------
8. TRANSACTIONS WITH RELATED PARTIES - REAL ESTATE TRUST
TRANSACTIONS WITH B. F. SAUL COMPANY AND ITS SUBSIDIARIES
The Real Estate Trust is managed by B. F. Saul Advisory Company, L.L.C.,
formerly B. F. Saul Advisory Company, (the "Advisor"), a wholly-owned subsidiary
of B. F. Saul Company ("Saul Co."). All of the Real Estate Trust officers and
four Trustees of the Trust are also officers and/or directors of Saul Co. The
Advisor is paid a fixed monthly fee which is subject to annual review by the
Trustees. The monthly fee was $475,000 during fiscal 2002, $363,000 during
fiscal 2001, and $349,000 during fiscal 2000. The advisory contract has been
extended until September 30, 2003, and will continue thereafter unless canceled
by either party at the end of any contract year. Certain loan agreements
prohibit termination of this contract.
Saul Co. and B.F. Saul Property Company ("Saul Property Co."), formerly known as
Franklin Property Company, a wholly-owned subsidiary of Saul Co., provide
services to the Real Estate Trust through commercial property management and
leasing, hotel management, development and construction management, and
acquisitions, sales and financings of real property. Fees paid to Saul Co. and
Saul Property Co. amounted to $6.8, $7.4 and $6.8 million in fiscal 2002, 2001
and 2000.
The Real Estate Trust reimburses the Advisor and Saul Property Co. for costs and
expenses incurred on behalf of the Real Estate Trust, in-house legal expenses,
and for all travel expenses incurred in connection with the affairs of the Real
Estate Trust.
The Real Estate Trust currently pays the Advisor fees equal to 2% of the
principal amount of the unsecured notes as they are issued to offset its costs
of administering the program. These payments amounted to $183,000, $93,000 and
$102,000 in fiscal 2002, 2001 and 2000.
A subsidiary of Saul Co. is a general insurance agency which receives
commissions and countersignature fees in connection with the Real Estate Trust's
insurance program. Such commissions and fees amounted to approximately $196,000,
$171,000 and $200,000 in fiscal 2002, 2001 and 2000.
At October 1, 1999, the Real Estate Trust had an unsecured note receivable from
the Saul Co. with an outstanding balance of $13.8 million. During fiscal 2002,
2001 and 2000, curtails of $1.3, $4.0 and $3.8 million were paid by the Saul Co.
Interest on the loans is computed by reference to a floating rate index. At
September 30, 2002, the total due the Real Estate Trust was $6.5 million.
Interest accrued on these loans amounted to $0.3, $0.7 and $1.1 million during
fiscal 2002, 2001 and 2000.
REMUNERATION OF TRUSTEES AND OFFICERS
For fiscal years 2002, 2001, and 2000, the Real Estate Trust paid the Trustees
approximately $95,000, $94,000 and $94,000 for their services. No compensation
was paid to the officers of the Real Estate Trust for acting as such; however,
one Trustee was paid by the bank for his services as Chairman and Chief
Executive Officer of the bank, and four received payments for their services as
directors of the bank. Four of the Trustees and all of the officers of the Real
Estate Trust receive compensation from Saul Co. as directors and/or officers.
SAUL HOLDINGS LIMITED PARTNERSHIP AND SAUL CENTERS, INC.
The Real Estate Trust accounts for these investments under the equity method.
The Real Estate Trust's share of earnings for fiscal 2002, 2001 and 2000 was
$9.1, $7.4 and $7.3 million. See Note 3.
OTHER TRANSACTIONS
The Real Estate Trust leases space to the bank and Saul Property Co. at two of
its income-producing properties. Minimum rents and expense recoveries paid by
these affiliates amounted to approximately $5.1, $4.0 and $2.7 million in fiscal
2002, 2001 and 2000.
9. LOANS HELD FOR SECURITIZATION AND/OR SALE - THE BANK
Loans held for securitization and/or sale are composed of the following:
September 30,
------------------------------------------------
(In thousands) 2002 2001
---------------------- ----------------------
Single-family residential $ 930,613 $ 233,359
Automobile 290,656 282,000
Home improvement and
related loans 1,766 12,724
---------------------- ----------------------
Total $ 1,223,035 $ 528,083
====================== ======================
10. INVESTMENT SECURITIES - THE BANK
At September 30, 2002 and 2001, investment securities are composed of U.S.
Government securities and are classified as held-to-maturity. Gross unrealized
holding gains and losses on the bank's U.S. Government securities at September
30, 2002 and 2001 are as follows:
Gross Gross
Unrealized Unrealized Aggregate Fair
(In thousands) Amortized Cost Holding Gains Holding Losses Value
----------------- ----------------- ----------------- -----------------
September 30, 2002
- ------------------
U.S. Government securities:
Original maturity after
one year, but within five
years $ 46,445 $ 524 $ - $ 46,969
================= ================= ================= =================
September 30, 2001
- ------------------
U.S. Government securities:
Original maturity after
one year, but within five
years $ 45,794 $ 387 $ - $ 46,181
================= ================= ================= =================
There were no sales of investment securities during the years ended September
30, 2002, 2001 and 2000.
11. MORTGAGE-BACKED SECURITIES - THE BANK
At September 30, 2002 and 2001, all mortgage-backed securities are classified as
held-to-maturity. Gross unrealized holding gains and losses on the bank's
mortgage-backed securities at September 30, 2002 and 2001 are as follows:
Gross Unrealized Gross Unrealized
Holding Holding Losses Aggregate
Amortized Cost Gains Fair
(In thousands) Value
------------------ ------------------ ------------------ ------------------
September 30, 2002
FNMA $ 226,680 $ 5,837 $ (2) $ 232,515
FHLMC 658,965 20,028 (4) 678,989
Private label, AAA-rated 142,988 3,459 (99) 146,348
------------------ ------------------ ------------------ ------------------
Total $ 1,028,633 $ 29,324 $ (105) $ 1,057,852
================== ================== ================== ==================
September 30, 2001
FNMA $ 295,712 $ 2,295 $ (2,354) $ 295,653
FHLMC 909,429 12,536 (1,608) 920,357
Private label, AAA-rated 269,354 5,517 (1,046) 273,825
------------------ ------------------ ------------------ ------------------
Total $ 1,474,495 $ 20,348 $ (5,008) $ 1,489,835
================== ================== ================== ==================
Contractual maturities of the bank's mortgage-backed securities at September 30,
2002 are as follows:
(In thousands)
Due within one year $ 57,946
Due after one year, but within five years 265,586
Due after five years, but within ten years 318,342
Due after ten years 386,759
---------------
Total $ 1,028,633
===============
Accrued interest receivable on mortgage-backed securities totaled $5.4 and $8.3
million at September 30, 2002 and 2001, respectively, and is included in other
assets in the Consolidated Balance Sheets.
12. LOANS AND LEASES RECEIVABLE - THE BANK
Loans receivable is composed of the following:
September 30,
--------------------------------------
(In thousands) 2002 2001
---------------- ---------------
Single-family residential $ 3,624,711 $ 4,287,000
Home equity 1,090,325 646,390
Real estate construction and ground 458,425 472,489
Commercial real estate and multifamily 20,578 30,703
Commercial 1,518,308 1,376,582
Automobile 333,078 318,865
Subprime automobile 232,001 420,658
Automobile leasing 1,130,425 1,124,106
Home improvement and related loans 101,156 103,670
Overdraft lines of credit and
other consumer 37,300 36,356
---------------- ---------------
8,546,307 8,816,819
---------------- ---------------
Less:
Undisbursed portion of loans 913,366 812,325
Unearned discounts and net
deferred loan origination costs (49,512) (41,909)
Allowance for losses on loans and leases 71,109 63,018
---------------- ---------------
934,963 833,434
---------------- ---------------
Total $ 7,611,344 $ 7,983,385
================ ===============
The bank serviced loans owned by others amounting to $7,844.5 and $7,363.5
million at September 30, 2002 and 2001, respectively.
Accrued interest receivable on loans totaled $27.8 and $39.0 million at
September 30, 2002 and 2001, respectively, and is included in other assets in
the Consolidated Balance Sheets.
13. ALLOWANCE FOR LOSSES - THE BANK
Activity in the allowance for losses on loans and leases receivable is
summarized as follows:
September 30,
----------------------------------------------------------
(In thousands) 2002 2001 2000
----------------- ----------------- ----------------
Beginning Balance $ 63,018 $ 54,018 $ 58,139
Provision for losses 56,015 67,852 49,930
Charge-offs (62,079) (68,220) (58,883)
Recoveries 14,155 9,368 4,832
----------------- ----------------- ----------------
Ending Balance $ 71,109 $ 63,018 $ 54,018
================= ================= ================
14. REAL ESTATE HELD FOR INVESTMENT OR SALE - THE BANK
Real estate held for investment or sale is composed of the following:
September 30,
---------------------------------
(In thousands) 2002 2001
-------------- ---------------
Real estate held for investment (net of allowance for losses $ 925 $ 925
of $202 for both periods)
Real estate held for sale (net of allowance for losses of
$71,293 and $85,152, respectively) 23,372 30,779
-------------- ---------------
Total real estate held for investment or sale $ 24,297 $ 31,704
============== ===============
Gain (loss) on real estate held for investment or sale is composed of the
following:
Year Ended September 30,
-----------------------------------------------------
(In thousands) 2002 2001 2000
--------------- -------------- ---------------
Provision for losses $ (700) $ (4,200) $ (1,400)
Net gain (loss) from operating properties 652 774 (260)
Net gain on sales 1,040 6,241 137
--------------- -------------- ---------------
Total gain (loss) $ 992 $ 2,815 $ (1,523)
=============== ============== ===============
15. MORTGAGE SERVICING RIGHTS - THE BANK
Servicing assets are recorded when purchased and in conjunction with loan sales
and securitization transactions. Activity in servicing assets is summarized as
follows:
Year ended September 30,
----------------------------------------------------------------------
(In thousands) 2002 2001 2000
-------------------- -------------------- --------------------
Beginning Balance $ 85,676 $ 78,636 $ 40,202
Additions 51,752 23,578 49,378
Amortization (26,313) (16,538) (10,944)
-------------------- -------------------- --------------------
Ending Balance 111,115 85,676 78,636
Valuation Allowance (50,685) (23,242) (3,591)
-------------------- -------------------- --------------------
Carrying Value $ 60,430 $ 62,434 $ 75,045
==================== ==================== ====================
Accumulated amortization was $133.4 and $107.5 million at September 30, 2002 and
2001. The aggregate fair value of servicing assets at September 30, 2002 and
2001 was $60.3 and $62.3 million, respectively.
Activity in the valuation allowance for servicing assets is summarized as
follows:
Year Ended September 30,
-----------------------------------------------------------
(In thousands) 2002 2001 2000
--------------- --------------- ---------------
Balance at beginning of year $ 23,242 $ 3,591 $ 9,724
Additions charged / (reductions
credited) to loan expenses
27,443 19,651 (6,133)
--------------- --------------- ---------------
Balance at end of year $ 50,685 $ 23,242 $ 3,591
=============== =============== ===============
There were no sales of rights to service mortgage loans during fiscal years
2002, 2001 and 2000. Servicing fees are included in servicing and securitization
income in the Consolidated Statements of Operations.
At September 30, 2002 and 2001, key assumptions and the sensitivity of the
current value of originated mortgage servicing assets to an immediate 10 percent
and 20 percent adverse change in those assumptions are as follows:
September 30, 2002
----------------------------------------------------
(Dollars in thousands) Single-Family Home Equity/
Residential Home Improvement
----------------------- ------------------------
Carrying value $ 50,171 $ 686
Weighted average life (in years) 3.1 4.7
Prepayment speed assumption (annual rate) (1) 29.39% 54.51%
Impact on fair value at 10% adverse change $ (3,110) $ (43)
Impact on fair value at 20% adverse change $ (5,712) $ (84)
Residual cash flows discount rate (annual) 9.05% 9.29%
Impact on fair value at 10% adverse change $ (967) $ (9)
Impact on fair value at 20% adverse change $ (1,899) $ (16)
September 30, 2001
----------------------------------------------------
(Dollars in thousands) Single-Family Home Equity/
Residential Home Improvement
----------------------- ------------------------
Carrying value $ 39,337 $ 1,502
Weighted average life (in years) 4.9 6.1
Prepayment speed assumption (annual rate) (1) 20.07% 30.55%
Impact on fair value at 10% adverse change $ (2,584) $ (96)
Impact on fair value at 20% adverse change $ (4,908) $ (180)
Residual cash flows discount rate (annual) 9.62% 11.53%
Impact on fair value at 10% adverse change $ (718) $ (20)
Impact on fair value at 20% adverse change $ (1,413) $ (37)
- -------------------------------
(1) Represents Constant Prepayment Rate.
16. LOAN SECURITIZATION TRANSACTIONS - THE BANK
The bank periodically sells various receivables through asset-backed
securitizations, in which receivables are transferred to trusts, and
certificates are sold to investors. The following chart summarizes the bank's
securitization activities as of or for the fiscal years ended September 30,
2002, 2001 and 2000.
As of or for the year ended September 30,
-----------------------------------------------------------------
(In thousands) 2002 2001 2000
------------------- ------------------- -------------------
Single-Family Residential
Loans sold into new trusts $ 1,400,685 $ - $ -
Outstanding trust certificate balance 1,341,712 - -
Gains recognized 52,452 - -
Automobile
Loans sold into new trusts $ 236,085 $ 804,861 $ 688,074
Outstanding trust certificate balance 792,949 1,171,575 856,006
Gains (losses) recognized 3,098 15,950 (3,955)
Home Equity
Loans sold into existing trusts $ 32,802 $ 46,229 $ 64,408
Outstanding trust certificate balance 41,013 86,224 135,719
Gains recognized 1,275 1,811 2,281
Home Improvement
Loans sold into existing trusts $ 1,547 $ 2,634 $ 1,900
Outstanding trust certificate balance 35,927 57,575 82,061
Gains recognized - - 27
The bank continues to service, and receive servicing fees on, the outstanding
balance of securitized receivables. The bank also retains rights, which may be
subordinated, to future cash flows arising from the receivables after the
expenses of the securitization trust are paid. The bank generally estimates the
fair value of retained interests based on the estimated present value of
expected future cash flows from securitized and sold receivables, using
management's best estimates of the key assumptions - credit losses, prepayment
speeds and discount rates commensurate with the risks involved.
The following table summarizes certain cash flows received from securitization
trusts:
Year Ended
September 30,
----------------------------------------
(In thousands) 2002 2001
------------------- -------------------
Proceeds from new securitizations $ 1,619,419 $ 804,861
Servicing fees received 14,030 12,217
Other cash flows received on retained interests 50,704 36,477
Servicing and securitization income includes the initial gains on current
securitization and income from interest-only strips receivable recognized in
connection with current and prior period securitization and sale transactions.
At September 30, 2002 and 2001, key assumptions and the sensitivity of the
current fair value of the retained interests to an immediate 10 percent and 20
percent adverse change in those assumptions are as follows:
September 30, 2002
---------------------------------------------------------------------
(Dollars in thousands) Single-Family Automobile Home Equity/
Residential Home Improvement
------------------- ---------------- -------------------------
Carrying value (fair value) $ 61,515 $ 51,625 $ 9,205
Weighted average life (in years) 4.57 1.19 1.29
Prepayment speed assumption (annual rate) 19.64%(1) 1.50%(2) 55.06%(1)
Impact on fair value at 10% adverse change $ (3,407) $ (1,488) $ (185)
Impact on fair value at 20% adverse change $ (6,422) $ (3,054) $ (349)
Expected credit losses (annual rate) 0.02% 0.96% 1.22%
Impact on fair value at 10% adverse change $ (39) $ (867) $ (59)
Impact on fair value at 20% adverse change $ (79) $ (1,734) $ (117)
Residual cash flows discount rate (annual rate) 8.50% 8.00% 8.59%
Impact on fair value at 10% adverse change $ (1,643) $ (476) $ (11)
Impact on fair value at 20% adverse change $ (3,207) $ (945) $ (22)
September 30, 2001
-------------------------------------------------------------
(Dollars in thousands) Automobile Home Equity/
Home Improvement
---------------------------- ---------------------------
Carrying value (fair value) $ 84,863 $ 19,140
Weighted average life (in years) 1.60 2.05
Prepayment speed assumption (annual rate) 1.53%(2) 36.76%(1)
Impact on fair value at 10% adverse change $ (2,138) $ (1,029)
Impact on fair value at 20% adverse change $ (4,276) $ (1,408)
Expected credit losses (annual rate) 0.87% 1.62%
Impact on fair value at 10% adverse change $ (1,465) $ (789)
Impact on fair value at 20% adverse change $ (2,931) $ (1,142)
Residual cash flows discount rate (annual rate) 8.00% 9.21%
Impact on fair value at 10% adverse change $ (961) $ (512)
Impact on fair value at 20% adverse change $ (1,905) $ (588)
Key assumptions used in measuring retained interests at the date of
securitizations completed during fiscal year 2002 and 2001are as follows:
Single-Family Home Equity/
Residential Automobile Home Improvement
------------- ---------- ----------------
Year Ended September 30, 2002
Prepayment speed assumption (annual rate) 19.56% (1) 1.50% (2) -
Expected credit losses (annual rate) 0.02% 0.96% -
Residual cash flows discount rate (annual rate) 8.50% 8.00% -
Year Ended September 30, 2001
Prepayment speed assumption (annual rate) - 1.55% (1) -
Expected credit losses (annual rate) - 0.95% -
Residual cash flows discount rate (annual rate) - 8.00% -
(1) Represents Constant Prepayment Rate.
(2) Represents absolute prepayment model or ABS - an assumed rate of prepayment each month relative to the original number
of automobile loans in a pool.
These sensitivities are hypothetical and should be used with caution. Changes in
fair value based on variations in assumptions generally cannot be extrapolated
because the relationship of the change in assumption to the change in fair value
may not be linear. The effects shown in the above tables of a variation in a
particular assumption on the fair value of interest-only strips receivable is
calculated without changing any other assumption. In reality, changes in one
factor may result in changes in another factor, which might magnify or
counteract the sensitivities.
Principal balances, delinquent amounts and net credit losses for securitized
loans were as follows:
As of or for the year ended
September 30, 2002
-----------------------------------------------------------------------------
(In thousands) Total Principal Principal Amount of
Loans Past Due 90 Days
or More or
Amount of Loans Non-Performing Net Credit Losses
--------------------- ------------------------ ------------------------
Single-family Residential $ 1,342,568 $ 2,032 $ -
Automobile 803,852 6,858 22,684
Home equity, home improvement and
related loans 99,913 741 378
--------------------- ------------------------ ------------------------
Total $ 2,246,333 $ 9,631 $ 23,062
===================== ======================== ========================
As of or for the year ended
September 30, 2001
-------------------------------------------------------------------------------
(In thousands) Total Principal Principal Amount of
Loans Past Due 90 Days
or More or
Amount of Loans Non-Performing Net Credit Losses
--------------------- ------------------------ --------------------------
Automobile $ 1,190,979 $ 7,660 $ 14,254
Home equity, home improvement and
related loans 182,641 1,719 1,335
--------------------- ------------------------ --------------------------
Total $ 1,373,620 $ 9,379 $ 15,589
===================== ======================== ==========================
17. PROPERTY AND EQUIPMENT - THE BANK
Property and equipment is composed of the following:
Estimated
Useful September 30,
-----------------------------------------
(Dollars in thousands) Lives 2002 2001
---------------- ----------------- ----------------
Land - $ 55,990 $ 50,275
Projects in progress - 4,473 37,071
Buildings and improvements 10-65 years 299,964 275,156
Leasehold improvements 5-20 years 120,708 114,869
Furniture and equipment 5-10 years 228,764 199,434
Automobiles 3-5 years 3,531 3,162
----------------- ----------------
713,430 679,967
Less:
Accumulated depreciation and amortization 241,013 221,972
----------------- ----------------
Total $ 472,417 $ 457,995
================= ================
Depreciation and amortization expense amounted to $38.7, $34.2 and $32.4 million
for the years ended September 30, 2002, 2001 and 2000, respectively.
18. LEASES - THE BANK
The bank has noncancelable, long-term leases for office premises and retail
space which have a variety of terms expiring from fiscal year 2003 to fiscal
year 2022 and ground leases which have terms expiring from fiscal year 2029 to
fiscal year 2081. These leases are accounted for as operating leases. Some of
the leases are subject to rent adjustments in the future based upon changes in
the Consumer Price Index and some also contain renewal options. The following is
a schedule by years of future minimum lease payments required at September 30,
2002:
Year Ending (In thousands)
September 30,
- ------------------------
2003 $ 26,653
2004 26,017
2005 25,276
2006 24,621
2007 23,868
Thereafter 391,649
--------------------
Total $ 518,084
====================
Rent expense totaled $29.9, $26.9 and $23.2 million for the years ended
September 30, 2002, 2001 and 2000, respectively. For operating leases with fixed
escalation amounts, rent expense is recognized on a straight line basis over the
term of the lease.
19. DEPOSIT ACCOUNTS - THE BANK
An analysis of deposit accounts and the related weighted average effective
interest rates at year end are as follows:
September 30,
-----------------------------------------------------------------------
2002 2001
---------------------------------- ------------------------------------
(Dollars in thousands) Weighted Weighted Average
Average
Amount Rate Amount Rate
----------------- ---------------- ------------------ -----------------
Demand accounts $ 779,634 - $ 642,490 -
NOW accounts 1,656,522 0.32% 1,428,486 0.44%
Money market deposit accounts 1,953,312 1.47% 1,570,297 2.83%
Statement savings accounts 893,093 0.79% 780,655 1.26%
Other deposit accounts 135,169 0.50% 117,207 0.99%
Certificate accounts, less than $100 1,416,739 3.23% 2,361,174 5.20%
Certificate accounts, $100 or more 603,116 2.78% 662,161 4.57%
----------------- ------------------
Total $ 7,437,585 1.40% $ 7,562,470 2.84%
================= ==================
The bank's deposits are insured by the FDIC up to $100,000 for each insured
depositor.
Interest expense on deposit accounts is composed of the following:
Year Ended September 30,
-------------------------------------------------------
(In thousands) 2002 2001 2000
--------------- --------------- --------------
NOW accounts $ 4,752 $ 7,773 $ 10,585
Money market deposit accounts 31,512 48,744 39,351
Statement savings accounts 8,447 11,963 15,684
Certificate accounts 98,262 177,619 154,738
Other deposit accounts 939 1,507 1,905
--------------- --------------- --------------
Total $ 143,912 $ 247,606 $ 222,263
=============== =============== ==============
Outstanding certificate accounts at September 30, 2002 mature in the years
indicated as follows:
Year Ending (In thousands)
September 30,
- ------------------------
2003 $1,686,449
2004 149,760
2005 48,288
2006 103,401
2007 31,957
-------------------
Total $2,019,855
===================
At September 30, 2002, certificate accounts of $100,000 or more have contractual maturities as indicated below:
(In thousands)
Three months or less $ 281,192
Over three months through six months 62,812
Over six months through 12 months 88,827
Over 12 months 170,285
--------------
Total $ 603,116
==============
20. SECURITIES SOLD UNDER REPURCHASE AGREEMENTS AND OTHER
SHORT-TERM BORROWINGS - THE BANK
Short-term borrowings are summarized as follows:
September 30,
------------------------------------------------------------
(Dollars in thousands) 2002 2001 2000
----------------- ---------------- ----------------
Securities sold under repurchase agreements:
Balance at year end $ 505,140 $ 110,837 $ 369,628
Average amount outstanding during the year 405,844 397,842 490,333
Maximum amount outstanding at any month end 559,957 534,170 647,779
Amount maturing within 30 days 505,140 110,837 369,628
Weighted average interest rate during the year 1.95% 5.74% 6.27%
Weighted average interest rate on year end balances 1.82% 3.21% 6.74%
Other short-term borrowings:
Balance at year end $ 154,344 $ 171,513 $ 170,414
Average amount outstanding during the year 169,037 169,820 137,607
Maximum amount outstanding at any month end 179,069 181,942 170,414
Amount maturing within 30 days 154,344 171,513 170,414
Weighted average interest rate during the year 1.17% 4.39% 5.42%
Weighted average interest rate on year end balances 1.07% 2.18% 5.87%
The investment and mortgage-backed securities underlying the repurchase
agreements were delivered to the dealers who arranged the transactions. The
dealers may have loaned such securities to other parties in the normal course of
their operations and agreed to resell to the bank the identical securities upon
the maturities of the agreements.
At September 30, 2002, the bank had pledged mortgage-backed securities and U.S.
Government securities with a combined book value of $181.8 million to secure
certain other short-term borrowings. Also at September 30, 2002, the bank had
pledged, but did not borrow against, other loans with a total principal balance
of $813.8 million.
21. FEDERAL HOME LOAN BANK ADVANCES - THE BANK
At September 30, 2002, advances from the Federal Home Loan Bank of Atlanta
("FHLB") totaled $1,703.0 million. The advances bear interest at a weighted
average interest rate of 5.36%, which is fixed for the term of the advances, and
mature over varying periods as follows:
(In thousands)
Six months or less $ 101,033
More than six months through one year 198
More than one year through three years 1,481,361
More than three years through five years 25,488
More than five years 94,884
-------------------
Total $ 1,702,964
===================
Under a Specific Collateral Agreement with the FHLB, advances are secured by the
bank's FHLB stock, qualifying first mortgage loans with a total principal
balance of $2,253.8 million, and certain mortgage-backed securities with a book
value of $140.6 million. The FHLB requires that members maintain qualifying
collateral at least equal to 100% of the member's outstanding advances at all
times. The collateral held by the FHLB in excess of the September 30, 2002
advances is available to secure additional advances from the FHLB, subject to
its collateralization guidelines.
22. CAPITAL NOTES - SUBORDINATED - THE BANK
Capital notes, which are subordinated to the interest of deposit account holders
and other senior debt, are composed of the following:
Issue September 30, Interest
-------------------------------
(Dollars in thousands) Date 2002 2001 Rate
----------------------- ------------- ------------- --------------
Subordinated debentures due 2005 November 23, 1993 $150,000 $150,000 9 1/4%
Subordinated debentures due 2008 December 3, 1996 100,000 100,000 9 1/4%
------------- -------------
Total $250,000 $250,000
============= =============
The 9 1/4% Subordinated Debentures due 2005 (the "1993 Debentures") are subject
to redemption at any time at the option of the bank, in whole or in part, at the
following redemption prices plus accrued and unpaid interest:
If redeemed during the (In thousands)
12-month period beginning Redemption
December 1, Price
----------------------------- ---------------
2002.......................... $ 100.925
2003 and thereafter........... $ 100.000
The 9 1/4% Subordinated Debentures due 2008 (the "1996 Debentures") are subject
to redemption at any time at the option of the bank, in whole or in part, at the
following redemption prices plus accrued and unpaid interest:
If redeemed during the (In thousands)
12-month period beginning Redemption
December 1, Price
----------------------------- ---------------
2002.......................... $ 103.700
2003.......................... $ 102.775
2004.......................... $ 101.850
2005.......................... $ 100.925
2006 and thereafter........... $ 100.000
The indenture pursuant to which the 1993 Debentures were sold (the "Indenture")
provides that the bank may not pay dividends on its capital stock unless, after
giving effect to the dividend, no event of default shall have occurred and be
continuing and the bank is in compliance with its regulatory capital
requirements. In addition, the amount of the proposed dividend may not exceed
the sum of (i) $15.0 million, (ii) 66 2/3% of the bank's consolidated net income
(as defined in the Indenture) accrued on a cumulative basis commencing on
October 1, 1993 and (iii) the aggregate net cash proceeds received by the bank
after October 1, 1993 from the sale of qualified capital stock or certain debt
securities, minus the aggregate amount of any restricted payments made by the
bank. Notwithstanding the above restrictions on dividends, provided no event of
default has occurred or is continuing, the Indenture does not restrict the
payment of dividends on the 13% Preferred Stock (as defined below) or any
payment-in-kind preferred stock issued in lieu of cash dividends on the
Preferred Stock or the redemption of any such payment-in-kind preferred stock.
The indenture pursuant to which the 1996 Debentures were sold provides that the
proposed dividend may not exceed the sum of the restrictions discussed above for
the 1993 Indenture and the aggregate liquidation preference of the new series of
preferred stock of the bank, if issued in exchange for the outstanding REIT
Preferred Stock (as defined below). See Note 24.
The bank received OTS approval to include the principal amount of the 1996
Debentures and the 1993 Debentures in the bank's supplementary capital for
regulatory capital purposes.
Deferred debt issuance costs, net of accumulated amortization, amounted to $5.2
and $6.3 million at September 30, 2002 and 2001, respectively, and are included
in other assets in the Consolidated Balance Sheets.
23. REAL ESTATE INVESTMENT TRUST SUBSIDIARY - THE BANK
Minority interest represents the net cash proceeds received by a subsidiary of
the bank (the "REIT Subsidiary") from the sale of $150.0 million of its
Noncumulative Exchangeable Preferred Stock, Series A, par value $5.00 per share
(the "REIT Preferred Stock"). Cash dividends on the REIT Preferred Stock are
payable quarterly in arrears at an annual rate of 10?%. The liquidation value of
each share of REIT Preferred Stock is $50,000 plus accrued and unpaid dividends.
Except under certain limited circumstances, the holders of the REIT Preferred
Stock have no voting rights. The REIT Preferred Stock is automatically
exchangeable for a new series of Preferred Stock of the bank upon the occurrence
of certain events.
The REIT Preferred Stock is redeemable at the option of the REIT subsidiary at
any time on or after January 15, 2007, in whole or in part, at the following per
share redemption prices plus accrued and unpaid dividends:
If redeemed during the (In thousands)
12-month period beginning Redemption
January 15, Price
----------------------------- ---------------
2007.......................... $ 52.594
2008.......................... $ 52.075
2009.......................... $ 51.556
2010.......................... $ 51.038
2011.......................... $ 50.519
2012 and thereafter........... $ 50.000
The bank received OTS approval to include the proceeds from the sale of the REIT
Preferred Stock in the core capital of the bank for regulatory capital purposes
in an amount up to 25% of the bank's core capital. Dividends on the REIT
Preferred Stock are presented as minority interest in the Consolidated
Statements of Operations.
24. PREFERRED STOCK - THE BANK
Cash dividends on the bank's Noncumulative Perpetual Preferred Stock, Series A
(the "Preferred Stock") are payable quarterly in arrears at an annual rate of
13%. If the Board of Directors does not declare the full amount of the
noncumulative cash dividend accrued in respect of any quarterly dividend period,
in lieu thereof the Board of Directors will be required to declare (subject to
regulatory and other restrictions) a stock dividend in the form of a new series
of payment-in-kind preferred stock of the bank.
The OTS has approved the inclusion of the Preferred Stock as core capital and
has not objected to the payment of dividends on the Preferred Stock, provided
certain conditions are met. The holders of the Preferred Stock have no voting
rights, except in certain limited circumstances.
Holders of the Preferred Stock will be entitled to receive a liquidating
distribution in the amount of $25,000 per share, plus accrued and unpaid
dividends for the then-current dividend period in the event of any voluntary
liquidation of the bank, after payment of the deposit accounts and other
liabilities of the bank, and out of the assets available for distribution to
shareholders. The Preferred Stock ranks superior and prior to the issued and
outstanding common stock of the bank with respect to dividend and liquidation
rights.
The Preferred Stock is redeemable by the bank at its option at any time on and
after May 1, 2003, in whole or in part, at the following per share redemption
prices in cash, plus, in each case, an amount in cash equal to accrued and
unpaid dividends for the then-current dividend period:
If redeemed during the (In thousands)
12-month period beginning Redemption
May 1, Price
----------------------------- ---------------
2003.......................... $ 27.250
2004.......................... $ 27.025
2005.......................... $ 26.800
2006.......................... $ 26.575
2007.......................... $ 26.350
2008.......................... $ 26.125
2009.......................... $ 25.900
2010.......................... $ 25.675
2011.......................... $ 25.450
2012.......................... $ 25.225
2013 and thereafter........... $ 25.000
25. RETIREMENT PLANS - THE BANK
The bank participates in a defined contribution profit sharing retirement plan
(the "Plan") which covers those full-time employees who meet the requirements as
specified in the Plan. Prior to January 1, 2002, the Plan, which can be modified
or discontinued at any time, required participating employees to contribute 2.0%
of their compensation. Beginning January 1, 2002, only corporate contributions
are made to the Plan. Corporate contributions, at the discretionary amount of up
to six percent of the employee's cash compensation, subject to certain limits,
were $9.5, $8.2 and $7.4 million for the years ended September 30, 2002, 2001
and 2000, respectively. There are no past service costs associated with the Plan
and the bank has no liability under the Plan other than its current
contributions. The Plan owns 4.0% of the bank's common stock.
The bank provides a supplemental defined contribution profit sharing retirement
plan (the "SERP") which covers certain highly-compensated full-time employees
who meet the requirements as specified in the SERP. The SERP, which can be
modified or discontinued at any time, requires participating employees to
contribute 2.0% of their compensation in excess of a specified amount. Corporate
contributions, equal to three times the employee's contribution, were $861,000,
$689,000 and $561,000 for the years ended September 30, 2002, 2001 and 2000,
respectively. There are no past service costs associated with the SERP. The
bank's liability under the SERP, which includes contributions from employees and
is not funded, was $8.7 and $6.6 million at September 30, 2002 and 2001,
respectively.
26. REGULATORY MATTERS - THE BANK
The bank's regulatory capital requirements at September 30, 2002 and 2001 were a
1.5% tangible capital requirement, a 4.0% core capital requirement and an 8.0%
total risk-based capital requirement. Under the OTS "prompt corrective action"
regulations, the bank must maintain minimum leverage, tier 1 risk-based and
total risk- based capital ratios of 4.0%, 4.0% and 8.0%, respectively, to meet
the ratios established for "adequately capitalized" institutions. At September
30, 2002 and 2001, the bank was in compliance with its tangible, core and total
risk-based regulatory capital requirements and exceeded the capital standards
established for "well capitalized" institutions under the "prompt corrective
action" regulations. The information below is based upon the bank's
understanding of the applicable regulations and related interpretations.
SEPTEMBER 30, 2002
-------------------------------------------------------------------------------------
(Dollars in thousands) MINIMUM EXCESS
ACTUAL CAPITAL REQUIREMENT CAPITAL
----------- -- ---------- ----------- -- ---------- ----------- --- ----------
As a % As a % As a %
Amount of Assets Amount of Assets Amount of Assets
----------- ---------- ----------- ---------- ----------- ----------
Capital per financial statements $535,514
Minority interest in REIT
Subsidiary(1) 144,000
-----------
Adjusted capital 679,514
Adjustments for tangible and core capital:
Intangible assets (43,199)
Non-includable subsidiaries(2) (1,413)
Non-qualifying purchased/
originated loan servicing (2,594)
-----------
Total tangible capital 632,308 5.63% $ 168,583 1.50% $ 463,725 4.13%
----------- ========== =========== ========== =========== ==========
Total core capital(3) 632,308 5.63% $ 449,554 4.00% $ 182,754 1.63%
----------- ========== =========== ========== =========== ==========
Tier 1 risk-based capital(3) 632,308 7.08% $ 357,083 4.00% $ 275,225 3.08%
----------- ========== =========== ========== =========== ==========
Adjustments for total risk-based capital:
Subordinated capital debentures 250,000
Allowance for general loan and
lease losses 71,109
-----------
Total supplementary capital 321,109
-----------
Total available capital 953,417
Equity investments(2) (2,065)
-----------
Total risk-based capital(3) $ 951,352 10.86% $ 714,166 8.00% $ 237,186 2.86%
=========== ========== =========== ========== =========== ==========
(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) Reflects an aggregate offset of $202 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.
(3) 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%.
SEPTEMBER 30, 2001
-------------------------------------------------------------------------------------
(Dollars in thousands) MINIMUM EXCESS
ACTUAL CAPITAL REQUIREMENT CAPITAL
----------- -- ----------- ----------- -- ----------- ---------- -- ----------
As a % of As a % of As a %
Amount Assets Amount Assets Amount of Assets
----------- ----------- ----------- ----------- ---------- ----------
Capital per financial statements $ 506,564
Minority interest in REIT
Subsidiary(1) 144,000
Accumulated other comprehensive
loss(2) 2,088
-----------
Adjusted capital 652,652
Adjustments for tangible and core capital:
Intangible assets (48,828)
Non-includable subsidiaries(3) (1,414)
Non-qualifying
purchased/originated loan servicing (3,592)
-----------
Total tangible capital 598,818 5.26% $ 170,715 1.50% $ 428,103 3.76%
----------- =========== =========== =========== ========== ==========
Total core capital(4) 598,818 5.26% $ 455,240 4.00% $ 143,578 1.26%
----------- =========== =========== =========== ========== ==========
Tier 1 risk-based capital(4) 598,818 6.50% $ 368,381 4.00% $ 230,437 2.50%
----------- =========== =========== =========== ========== ==========
Adjustments for total risk-based capital:
Subordinated capital debentures 250,000
Allowance for general loan and
lease losses 63,018
-----------
Total supplementary capital 313,018
-----------
Total available capital 911,836
Equity investments(3) (2,365)
-----------
Total risk-based capital(4) $ 909,471 10.12% $ 736,761 8.00% $ 172,710 2.12%
=========== =========== =========== =========== ========== ==========
(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 loss is included in
regulatory capital.
(3) Reflects an aggregate offset of $202 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. Accordingly, if the bank is unable to dispose of any REO property
(through bulk sales or otherwise) prior to the end of its applicable five-year
holding period and is unable to obtain an extension of such five-year holding
period from the OTS, the bank could be required to deduct the then-current book
value of such REO property from total risk-based capital. In December 2001, the
bank received from the OTS an extension of the holding periods for certain of
its REO properties through December 19, 2002. The bank intends to apply for a
further extension of the holding period for these properties. The following
table sets forth the bank's REO at September 30, 2002, after valuation
allowances of $71.3 million, by the fiscal year in which the property was
acquired through foreclosure.
Fiscal Year (In thousands)
--------------------------
1990 $ 2,065(1)
1991 16,414(2)
1995 3,628(2)
2002 1,265
----------------
Total REO $ 23,372
================
- -------------------------------------------------------------------------------------------------------------------------------
(1) Includes REO with a net book value of $2,065, which the bank treats as an
equity investment for regulatory capital purposes.
(2) Includes REO with an aggregate net book value of $20,042, for which the bank
received an extension of the holding periods through December 19, 2002.
At September 30, 2002, the bank had $37.3 million in residual interests relating
to its securitization activities that, although includable in total capital at
that date, would be subject to a dollar-for-dollar deduction from total capital
beginning December 31, 2002.
27. TRANSACTIONS WITH RELATED PARTIES - THE BANK
LOANS RECEIVABLE:
From time to time, in the normal course of business, the bank may make loans to
executive officers and directors, their immediate family members or companies
with which they are affiliated. These loans are on substantially the same terms
as similar loans with unrelated parties. An analysis of activity with respect to
these loans for the year ended September 30, 2002 is as follows:
(In thousands)
Balance, September 30, 2001 $ 13,072
Additions 13,095
Reductions (7,031)
------------------
Balance, September 30, 2002 $ 19,136
==================
SERVICES:
B. F. Saul Company, which is a shareholder of the Trust, and its subsidiaries
provide certain services to the bank. These services include property
management, insurance brokerage and leasing. Fees for these services were $0.8,
$1.7 and $0.9 million for the years ended September 30, 2002, 2001 and 2000,
respectively.
For each of the years ended September 30, 2002, 2001 and 2000, a director of the
bank was paid $100,000 for consulting services rendered to the bank and $5,000
for service on the Boards of Directors for two of the bank's subsidiaries.
Another director of the bank was paid $100,000 for services as Chairman of the
bank's Audit Committee. A third director of the bank was paid total fees of
$100,000 for each of the years ended September 30, 2002 and 2001 for consulting
services rendered to two subsidiaries of the bank and $5,000 for services as
Chairman of the Boards of Directors of those subsidiaries. A fourth director of
the bank was paid $50,000 for consulting services rendered to the bank for each
of the years ended September 30, 2002, 2001 and 2000.
TAX SHARING AGREEMENT:
The bank and the other companies in the Trust's affiliated group are parties to
a tax sharing agreement dated June 28, 1990 (the "Tax Sharing Agreement"). The
Tax Sharing Agreement provides for payments to be made by members of the Trust's
affiliated group to the Trust based on their separate company tax liabilities.
The Tax Sharing Agreement also provides that, to the extent net operating losses
or tax credits of a particular member are used to reduce the overall tax
liability of the Trust's affiliated group, such member will be reimbursed by the
other members of the affiliated group that have taxable income in an amount
equal to such tax reduction. The bank paid $5.7, $3.4 and $6.6 million to the
Trust during fiscal 2002, 2001 and 2000, respectively, under the Tax Sharing
Agreement. At September 30, 2002 and 2001, the estimated net tax sharing payment
payable to the Trust by the bank was $2.2 and $4.9 million, respectively.
OTHER:
The bank sold an office building located in McLean, Virginia to its parent
company, the B.F. Saul Real Estate Investment Trust, in December 1999. Because
this transfer was between entities under common control, the $13.5 million of
proceeds in excess of the bank's carrying value, net of related income taxes of
$8.8 million, was accounted for as a capital contribution.
The bank paid $9.2, $6.9 and $5.2 million for office space leased from or
managed by companies affiliated with the bank or its directors during the years
ended September 30, 2002, 2001 and 2000, respectively.
The Trust, the B. F. Saul Company, Chevy Chase Lake Corporation and Van Ness
Square Corporation, affiliates of the bank, from time to time maintain
interest-bearing deposit accounts with the bank. Those accounts totaled $31.3
and $28.0 million at September 30, 2002 and 2001, respectively. The bank paid
interest on the accounts amounting to $504,000, $989,000 and $736,000 during
fiscal years ended 2002, 2001 and 2000, respectively.
28. FINANCIAL INSTRUMENTS - THE BANK
The bank, in the normal course of business, is a party to financial instruments
with off-balance-sheet risk and other derivative financial instruments to meet
the financing needs of its customers and to reduce its own exposure to
fluctuations in interest rates. These financial instruments include commitments
to extend credit at both fixed and variable rates, letters of credit,
interest-rate cap agreements and assets sold with limited recourse. All such
financial instruments are held or issued for purposes other than trading.
These instruments involve, to varying degrees, elements of credit and
interest-rate risk in excess of the amount recognized in the Consolidated
Balance Sheets.
The contractual or notional amount of these instruments reflect the extent of
involvement the bank has in particular classes of financial instruments. For
interest-rate cap agreements, assets sold with limited recourse and forward
purchase and sale commitments, the contract or notional amounts do not represent
exposure to credit loss in the event of nonperformance by the other party. The
bank uses the same credit policies in making commitments and conditional
obligations as it does for on-balance-sheet instruments.
COMMITMENTS TO EXTEND CREDIT:
The bank had approximately $2.7 billion of commitments to extend credit at
September 30, 2002. Commitments to extend credit are agreements to lend to a
customer as long as there is no violation of any condition established in the
agreement. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Because many of the
commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements. These
commitments are subject to the bank's normal underwriting and credit evaluation
policies and procedures.
STANDBY LETTERS OF CREDIT:
Standby letters of credit are conditional commitments issued by the bank to
guarantee the performance of a customer to a third party. At September 30, 2002,
the bank had issued standby letters of credit in the amount of $86.5 million to
guarantee the performance of and irrevocably assure payment by customers under
construction projects.
Of the total, $53.5 million will expire in fiscal 2003 and the remainder will
expire over time through fiscal 2012. The credit risk involved in issuing
standby letters of credit is essentially the same as that involved in extending
loan commitments to customers. The bank holds mortgage-backed securities with a
book value of $2.6 million that have been pledged as collateral for certain of
these letters of credit at September 30, 2002.
RECOURSE ARRANGEMENTS:
The bank is obligated under various recourse provisions (primarily related to
credit losses) related to the securitization and sale of receivables. As a
result of these recourse provisions, the bank maintained restricted cash
accounts and overcollateralization of receivables amounting to $18.3 and $15.9
million, respectively, at September 30, 2002, and $26.0 and $26.7 million,
respectively, at September 30, 2001, both of which are included in other assets
in the Consolidated Balance Sheets. In addition, the bank owned subordinated
automobile receivables-backed securities with carrying values of $1.2 million at
September 30, 2001, which were classified as trading securities in the
Consolidated Balance Sheets.
The bank is also obligated under various recourse provisions related to the swap
of single-family residential loans for mortgage-backed securities issued by the
bank. At September 30, 2002, recourse to the bank under these arrangements was
$5.9 million, consisting of restricted cash accounts amounting to $3.5 million
and overcollateralization of receivables of $2.4 million. At September 30, 2001,
recourse to the bank under these arrangements was $6.6 million, consisting of
restricted cash accounts amounting to $4.2 million and overcollateralization of
receivables of $2.4 million.
The bank is also obligated under a recourse provision related to the servicing
of certain of its residential mortgage loans. The recourse to the bank under
this arrangement was $3.4 million at both September 30, 2002 and 2001.
DERIVATIVE FINANCIAL INSTRUMENTS:
In accordance with SFAS 133, the bank assigns derivatives to one of these
categories at the purchase date: fair value hedge, cash flow hedge or
non-designated hedge. SFAS 133 requires that bank assess the expected and
ongoing effectiveness of any derivative assigned to a fair value hedge or cash
flow hedge relationship.
FAIR VALUE HEDGES -- For derivatives designated as fair value hedges, the
derivative instrument and related hedged item are mark to market through
earnings.
The bank owns mortgage servicing rights which are subject to fluctuations in
their fair value. The bank hedges the change in fair value in mortgage servicing
rights related to changes in the benchmark Treasury rate through treasury
futures and options. The bank evaluates the mortgage servicing portfolio daily
at the pool level and monthly at the loan level to insure a high degree of
correlation between the hedging instruments and the servicing assets being
hedged. Management expects that the cumulative change in the value of the
hedging instrument will be between 80% and 120% of the inverse cumulative change
in the fair value of the hedged mortgage servicing rights. The effectiveness of
hedging relationships is assessed on a cumulative basis every three months and
whenever financial statements or earnings are reported by the bank.
At September 30, 2002, the bank owned treasury futures contracts representing a
notional amount of $19.0 million and fair value of $813,000, call options on the
treasury futures contracts representing a notional amount of $35.0 million and
fair value of $1.1 million and put options on treasury futures contracts
representing a notional amount of $41.5 million and fair value of $118,000
related to its mortgage servicing rights fair value hedges. The cumulative gain
on these derivative instruments in fiscal year 2002 was $8.6 million and is
reflected as a reduction of servicing assets amortization and other loan
expenses in the Consolidated Statements of Operations.
At September 30, 2001, the bank owned treasury futures contracts representing a
notional amount of $65.0 million, and fair value of $1.5 million, call options
on the treasury futures contracts representing a notional amount of $43.0
million and fair value of $1.1 million and put options on treasury futures
contracts representing a notional amount of $47.0 million and fair value of
$117,000 related to its mortgage servicing rights fair value hedges. At
September 30, 2001 the gain on these hedges was $2.5 million and is included as
a reduction of servicing assets amortization and other loan expenses in the
Consolidated Statements of Operations.
At September 30, 2002, the bank had certain forward delivery contracts, which
were designated as fair value hedges of loans held for sale. The net unrealized
loss in value of these contracts was $5.0 million at
September 30, 2002. The net unrealized gain in the value of the related hedged
item was $5.6 million.
CASH FLOW HEDGES -- For derivatives designated as cash flow hedges, mark to
market adjustments are recorded as components of equity. At September 30, 2002
the bank did not have any derivatives designated as cash flow hedges.
At September 30, 2001, the bank had mortgage-backed security net forward
delivery contracts of $220.5 million designated as cash flow hedges. The net
unrealized loss in value of these contracts was $2.1 million, net of related
taxes, at September 30, 2001. Forward delivery contracts generally settle within
90 days. Gains and losses were deferred and recorded as a component of the gain
on sales of loans at the time the forward sale commitment matures and the
related loan was sold.
NON-DESIGNATED HEDGES -- Certain economic hedges are not designated as cash flow
hedges or as fair value hedges for accounting purposes. As a result, changes in
their fair value are recorded in income.
At September 30, 2002, the bank had $261.9 million in forward delivery
contracts. The net unrealized loss in the value of these contracts was $2.1
million at September 30, 2002. At September 30, 2002, the bank had IRLs with a
notional amount of $468.2 million. The net unrealized gain in the value of the
IRLs was $1.9 million.
CONCENTRATIONS OF CREDIT:
The bank's principal real estate lending market is the metropolitan Washington,
DC area. In addition, a significant portion of the bank's consumer loan
portfolio was generated by customers residing in the metropolitan Washington, DC
area. Service industries and federal, state and local governments employ a
significant portion of the Washington, DC area labor force. Adverse changes in
economic conditions could have a direct impact on the timing and amount of
payments by borrowers.
29. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS - THE BANK
The majority of the bank's assets and liabilities are financial instruments;
however, certain of these financial instruments lack an available trading
market. Significant estimates, assumptions and present value calculations were
therefore used for the purposes of the following disclosure, resulting in a
great degree of subjectivity inherent in the indicated fair value amounts.
Because fair value is estimated as of the balance sheet date, the amount which
would actually be realized or paid upon settlement or maturity could be
significantly different. Comparability of fair value amounts among financial
institutions may be difficult due to the wide range of permitted valuation
techniques and the numerous estimates and assumptions which must be made.
The estimated fair values of the bank's financial instruments at September 30,
2002 and 2001 are as follows:
September 30,
--------------------------------------------------------------------------
2002 2001
------------------------------------ -----------------------------------
(In thousands) Carrying Fair Carrying Amount Fair
Amount Value Value
----------------- --------------- ----------------- ---------------
Financial assets:
Cash, due from banks,
Interest-bearing deposits, federal
funds sold and securities purchased
under agreements to resell $ 440,736 $ 440,736 $ 439,068 $ 439,068
Loans held for securitization and sale 1,223,035 1,248,473 528,083 531,842
Trading securities 3,933 3,933 7,296 7,296
U.S. Government securities 46,445 46,969 45,794 46,181
Mortgage-backed securities 1,028,633 1,057,852 1,474,495 1,489,835
Loans and leases receivable, net 7,611,344 7,754,414 7,983,385 8,079,489
Other financial assets 314,038 314,038 327,271 327,271
Financial liabilities:
Deposit accounts with no stated maturities 5,417,730 5,417,730 4,539,135 4,539,135
Deposit accounts with stated maturities 2,019,855 1,939,942 3,023,335 2,920,234
Securities sold under repurchase agreements
and other short-term borrowings and Federal
Home Loan Bank advances 2,362,448 2,259,163 2,522,948 2,443,395
Capital notes-subordinated 244,795(1) 250,500 243,744(1) 250,000
Other financial liabilities 473,715 473,715 383,743 383,743
- ---------------------------------------------------------------------------------------------------------------------------
(1) Net of deferred debt issuance costs which are included in other assets in
the Consolidated Balance Sheets.
The following methods and assumptions were used to estimate the fair value
amounts at September 30, 2002 and 2001:
CASH, DUE FROM BANKS, INTEREST-BEARING DEPOSITS, FEDERAL FUNDS SOLD AND
SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL: Carrying amount approximates
fair value.
LOANS HELD FOR SALE: Fair value is determined using quoted prices for loans, or
securities backed by loans with similar characteristics, or outstanding
commitment prices from investors.
LOANS HELD FOR SECURITIZATION AND SALE: The fair value of loans held for
securitization and sale is determined using discounted cash flow analysis.
TRADING SECURITIES: Carrying value equals fair value, which is based on quoted
market prices.
U.S. GOVERNMENT SECURITIES: Fair value is based on quoted market prices.
MORTGAGE-BACKED SECURITIES: Fair value is based on quoted market prices, dealer
quotes or estimates using dealer quoted market prices for similar securities.
LOANS AND LEASES RECEIVABLE, NET: Fair value of certain homogeneous groups of
loans (e.g., single-family residential, automobile loans, home improvement loans
and fixed-rate commercial and multifamily loans) is estimated using discounted
cash flow analyses based on contractual repayment schedules and management's
estimate of future prepayment rates. The discount rates used in these analyses
are based on either the interest rates paid on U.S. Treasury securities of
comparable maturities adjusted for credit risk and non-interest operating costs,
or the interest rates currently offered by the bank for loans with similar terms
to borrowers of similar credit quality. For loans, which reprice frequently at
market rates (e.g., home equity, variable-rate commercial and multifamily, real
estate construction and ground loans), the carrying amount approximates fair
value. The fair value of the bank's loan portfolio as presented above does not
include the value of established credit line customer relationships, or the
value relating to estimated cash flows from future receivables and the
associated fees generated from existing customers.
OTHER FINANCIAL ASSETS: The carrying amount of Federal Home Loan Bank stock,
accrued interest receivable, interest-bearing deposits maintained pursuant to
various asset securitizations and other short-term receivables approximates fair
value. Interest-only strips receivable and derivative financial instruments are
carried at fair value.
DEPOSIT ACCOUNTS WITH NO STATED MATURITIES: Deposit liabilities payable on
demand, consisting of NOW accounts, money market deposits, statement savings and
other deposit accounts, are assumed to have an estimated fair value equal to
carrying value. The indicated fair value does not consider the value of the
bank's established deposit customer relationships.
DEPOSIT ACCOUNTS WITH STATED MATURITIES: Fair value of fixed-rate certificates
of deposit is estimated based on discounted cash flow analyses using the
remaining maturity of the underlying accounts and interest rates currently
offered on certificates of deposit with similar maturities.
SECURITIES SOLD UNDER REPURCHASE AGREEMENTS AND OTHER SHORT-TERM BORROWINGS AND
FEDERAL HOME LOAN BANK ADVANCES: For these borrowings, which either reprice
frequently to market interest rates or are short-term in duration, the carrying
amount approximates fair value. Fair value of the remaining amounts borrowed is
estimated based on discounted cash flow analyses using interest rates currently
charged by the lender for comparable borrowings with similar remaining
maturities.
CAPITAL NOTES-SUBORDINATED: Fair value of the 1993 Debentures and the 1996
Debentures is based on quoted market prices.
OTHER FINANCIAL LIABILITIES: The carrying amount of custodial accounts, amounts
due to banks, accrued interest payable, notes payable and other short-term
payables approximates fair value.
30. BUSINESS SEGMENTS - THE BANK
The bank has three operating segments: retail banking, commercial banking, and
nonbanking services. Retail banking consists of traditional banking services,
which include lending and deposit products offered to retail and small business
customers. Commercial banking also consists of traditional banking services, as
well as products and services tailored for larger corporate customers.
Nonbanking services include asset management and similar services offered by
subsidiaries of the bank.
Selected segment information is as follows:
(In thousands) Retail Banking Other(1) Total
------------------ ----------------- -----------------
Year ended September 30, 2002
Operating income $ 522,318 $ 46,314 $ 568,632
Operating expense 398,890 41,911 440,801
------------------ ----------------- -----------------
Core earnings 123,428 4,403 127,831
Non-core items (10,546) (10,560) (21,106)
------------------ ----------------- -----------------
Operating income (loss) $ 112,882 $ (6,157) $ 106,725
================== ================= =================
Average assets $ 9,967,914 $ 1,132,518 $ 11,100,432
================== ================= =================
Year ended September 30, 2001
Operating income $ 452,972 $ 39,400 $ 492,372
Operating expense 367,417 37,796 405,213
------------------ ----------------- -----------------
Core earnings 85,555 1,604 87,159
Non-core items 9,784 205 9,989
------------------ ----------------- -----------------
Operating income (loss) $ 95,339 $ 1,809 $ 97,148
================== ================= =================
Average assets $10,073,206 $ 1,088,630 $ 11,161,836
================== ================= =================
Year ended September 30, 2000
Operating income $ 415,278 $ 32,840 $ 448,118
Operating expense 328,548 34,931 363,479
------------------ ----------------- -----------------
Core earnings 86,730 (2,091) 84,639
Non-core items (8,955) (2,993) (11,948)
------------------ ----------------- -----------------
Operating income (loss) $ 77,775 $ (5,084) $ 72,691
================== ================= =================
Average assets $ 9,277,180 $ 872,890 $ 10,150,070
================== ================= =================
- ---------------------------------------------------------------------------------------------------------------------------
(1) Includes commercial banking and non-banking services.
The financial information for each segment is reported on the basis used
internally by the bank's management to evaluate performance. Pretax core
earnings excludes certain items such as gains and losses related to certain
securitization transactions, adjustments to loan loss reserves in excess of net
chargeoffs, amortization of goodwill, and certain other nonrecurring items.
Items excluded from pretax core earnings are shown as non-core items.
Measurement of the performance of these segments is based on the management
structure of the bank and is not necessarily comparable with financial
information from other entities. The information presented is not necessarily
indicative of the segment's results of operations if each of the segments were
independent entities.
31. LITIGATION - THE BANK
During the normal course of business, the bank is involved in certain
litigation, including litigation arising out of its lending activities, the
enforcement or defense of the priority of its security interests, the continued
development and marketing of certain of its real estate properties and certain
employment claims. Although the amounts claimed in some of these suits in which
the bank is a defendant may be material, the bank denies liability and, in the
opinion of management, litigation which is currently pending will not have a
material impact on the financial condition or future operations of the bank.
32. COMMITMENTS AND CONTINGENCIES - THE TRUST
The Trust is involved in a number of lawsuits arising from the normal course of
its business. On the basis of consultations with counsel, management does not
believe that any material loss will result from the resolution of these matters.
Pursuant to a reimbursement agreement among the partners of the Saul Holdings
Partnership and certain of their affiliates, the Real Estate Trust and two of
its subsidiaries have agreed to reimburse Saul Centers and the other partners
in the event the Saul Holdings Partnership fails to make payments with respect
to certain portions of its debt obligations and Saul Centers or any such other
partners personally make payments with respect to such debt obligations. As of
September 30, 2002, the maximum potential obligation of the Real Estate Trust
and its subsidiaries under the agreement was $115.5 million.
33. MINORITY INTEREST - THE TRUST
At September 30, 2002 and 2001, minority interest held by affiliates of $89.0
and $83.3 million represent the 20% minority interest in the bank's common
shares.
Minority interest -- other consists of the following:
September 30,
--------------------------------------
(In thousands) 2002 2001
- ---------------------------------------- ---------------- ---------------
Preferred Stock of Chevy Chase's
REIT subsidiary (See Note 23) $ 144,000 $ 144,000
Chevy Chase's Preferred Stock
(See Note 24) 74,307 74,307
---------------- ---------------
Total minority interest -- other $ 218,307 $ 218,307
================ ===============
The proceeds paid by the Real Estate Trust to the bank for Tysons Park Place
exceeded the bank's carrying value. The $2.7 million minority interest in
capital contribution shown on the Consolidated Statements of Comprehensive
Income and Changes in Shareholders' Equity for fiscal 2000 represents
the 20% minority interest in the excess of proceeds over the carrying value, net
of related income taxes.
34. INCOME TAXES - THE TRUST
The Trust voluntarily terminated its qualification as a real estate investment
trust under the Internal Revenue Code during fiscal 1978.
The provisions for income taxes for the years ended September 30, 2002, 2001 and
2000, consist of the following:
Year Ended September 30,
-----------------------------------------------------
(In thousands) 2002 2001 2000
- ----------------------------------------------------------------------- ---------------- ---------------- ----------------
Current provision (benefit):
Federal $ 100 $ 3,720 $ (35,110)
State 1,563 1,595 (1,519)
---------------- ---------------- ----------------
1,663 5,315 (36,629)
---------------- ---------------- ----------------
Deferred provision (benefit):
Federal 20,408 27,700 49,211
State 2,315 (5,333) 7,055
---------------- ---------------- ----------------
22,723 22,367 56,266
---------------- ---------------- ----------------
Total $ 24,386 $ 27,682 $ 19,637
================ ================ ================
Tax effect of other items:
Tax effect of other equity transactions 757 495 371
Tax effect of net unrealized holding gains (losses) reported in
stockholders' equity 1,365 (1,365) (12)
---------------- ---------------- ----------------
Total $ 2,122 $ (870) $ 359
================ ================ ================
The Trust's effective income tax rate varies from the statutory Federal income
tax rate as a result of the following factors:
Year Ended September 30,
-----------------------------------------------------
(In thousands) 2002 2001 2000
- ----------------------------------------------------------------------- ---------------- ---------------- ----------------
Computed tax at statutory Federal income tax rate $ 30,511 $ 33,769 $ 23,924
Increase (reduction) in taxes resulting from:
Minority interest (5,447) (5,447) (5,447)
Goodwill and other purchase accounting adjustments 70 70 124
Change in valuation allowance for deferred
tax asset allocated to income tax expense (923) (6,565) (1,979)
State income taxes 3,458 4,131 5,432
Tax credits (1,583) (206) --
Other (1,700) 1,930 (2,417)
---------------- ---------------- ----------------
$ 24,386 $ 27,682 $ 19,637
================ ================ ================
The components of the net deferred tax asset (liability) were as follows:
September 30,
----------------------------------
(In thousands) 2002 2001
- ------------------------------------------------------------------------------------------ ---------------- ----------------
Deferred tax assets:
Unrealized gains on loans and investments, net $ 37,651 $ 15,163
State net operating loss carry forwards 44,730 44,303
Provision for loan and lease losses 23,077 11,855
Deferred compensation 11,026 9,269
Other 15,390 12,874
---------------- ----------------
Gross deferred tax assets 131,874 93,464
---------------- ----------------
Deferred tax liabilities:
Lease financing (174,769) (110,871)
Saul Holdings (45,322) (45,406)
Property (16,634) (3,295)
Other (13,402) (28,223)
---------------- ----------------
Gross deferred tax liabilities (250,127) (187,795)
---------------- ----------------
Valuation allowance (9,640) (10,081)
---------------- ----------------
Net deferred tax liability $ (127,893) $ (104,412)
================ ================
The Trust establishes a valuation allowance against the gross deferred tax asset
to the extent the Trust cannot determine that it is more likely than not that
such assets will be realized through taxes available in carryback years, future
reversals of existing taxable temporary differences or projected future taxable
income. Such a valuation allowance has been established to reduce the gross
deferred asset for state net operating loss carryforwards to an amount that is
considered more likely than not to be realized. At the bank, valuation allowances
of $538,000 have been provided against net operating loss carryforwards of
certain subsidiaries that do not generate sufficient stand-alone state taxable
income. At the Trust, state net operating loss carryforwards in excess of state
deferred tax liabilities are fully reserved due to expected future state tax
losses.
Management believes the existing net deductible temporary differences will
reverse during periods in which the bank generates taxable income in excess of
Real Estate Trust taxable losses. Management believes that the positive
consolidated earnings will continue as a result of the bank's earnings.
TAX SHARING AGREEMENT
The Trust's affiliated group, including the bank, entered into a tax sharing
agreement dated June 28, 1990, as amended. This agreement provides that payments
be made by members of the affiliated group to the Trust based on their
respective allocable shares of the overall federal income tax liability of the
affiliated group for taxable years and partial taxable years beginning on or
after that date.
Allocable shares of the overall tax liability are prorated among the members
with taxable income calculated on a separate return basis. The agreement also
provides that, to the extent net operating losses or tax credits of a particular
member are used to reduce overall tax liability of the Trust's affiliated group,
such member will be reimbursed on a dollar-for-dollar basis by the other members
of the affiliated group that have taxable income in an amount equal to such tax
reduction. Under the tax sharing agreement, the bank paid $5.7, $3.4 and $6.6
million, to the Trust during fiscal 2002, 2001 and 2000.
In recent years, the operations of the Real Estate 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 Real Estate 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 tax 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.
35. SHAREHOLDERS' EQUITY - THE TRUST
In June 1990, the Trust acquired from affiliated companies an additional equity
interest in the bank, which raised the Trust's ownership share of the bank to
80%. In exchange for the interest acquired, the Trust issued 450,000 shares of a
new class of $10.50 cumulative preferred shares of beneficial interest with a
par value of $1 (the "preferred shares"). The transaction has been accounted for
at historical cost in a manner similar to the pooling of interests method
because the entities are considered to be under common control. In addition, the
Trust acquired two real estate properties from an affiliate in exchange for
66,000 preferred shares.
The Trust paid preferred dividends of $12.0, $12.0 and $12.5 million in fiscal
2002, 2001 and 2000. At September 30, 2002, 2001, and 2000, the amount of
dividends in arrears on the preferred shares was $12.7 million ($24.65 per
share), $19.3 million ($37.41 per share) and $25.9 million ($50.16 per share).
36. INDUSTRY SEGMENT INFORMATION - THE TRUST
Industry segment information with regard to the Real Estate Trust is presented
below. For information regarding the bank, please refer to the "Banking"
sections of the accompanying financial statements.
Year Ended September 30
-----------------------------------------------------
(In thousands) 2001 2001 2000
- ------------------------------------------------------------------------ ---------------- ---------------- ----------------
INCOME (Restated) (Restated)
Hotels $ 88,043 $ 100,314 $ 95,381
Office and industrial properties 38,923 40,399 34,341
Other 1,206 2,239 3,136
---------------- ---------------- ----------------
$ 128,172 $ 142,952 $ 132,858
================ ================ ================
OPERATING PROFIT (LOSS) (1)
Hotels $ 16,034 $ 24,896 $ 27,013
Office and industrial properties 21,011 21,805 19,380
Other 43 1,040 1,776
---------------- ---------------- ----------------
37,088 47,741 48,169
Equity earnings of unconsolidated entities 9,057 7,402 7,291
Gain on sales of property -- 11,077 994
Interest and debt expense (50,774) (50,634) (45,974)
Advisory fee, management and leasing fees - related parties (12,452) (11,762) (11,013)
General and administrative (2,467) (4,491) (3,808)
---------------- ---------------- ----------------
Operating loss $ (19,548) $ (667) $ (4,341)
================ ================ ================
IDENTIFIABLE ASSETS (AT YEAR END)
Hotels $ 179,322 $ 189,170 $ 151,615
Office and industrial properties 128,917 114,270 105,493
Other 129,275 138,664 176,081
---------------- ---------------- ----------------
$ 437,514 $ 442,104 $ 433,189
================ ================ ================
DEPRECIATION
Hotels $ 12,805 $ 11,840 $ 8,932
Office and industrial properties 6,319 6,742 5,326
Other 23 18 51
---------------- ---------------- ----------------
$ 19,147 $ 18,600 $ 14,309
================ ================ ================
CAPITAL EXPENDITURES AND PROPERTY ACQUISITIONS
Hotels $ 1,987 $ 12,406 $ 37,681
Office and industrial properties 6,284 23,180 32,947
Other 487 3,495 3,805
---------------- ---------------- ----------------
$ 8,758 $ 39,081 $ 74,433
================ ================ ================
(1) Operating profit (loss) includes income less direct operating expenses and depreciation.
37. CONDENSED FINANCIAL STATEMENTS - THE TRUST
These condensed financial statements reflect the Real Estate Trust and all its
consolidated subsidiaries except for the bank which has been reflected on the
equity method.
CONDENSED BALANCE SHEETS
September 30
------------------------------------
(In thousands) 2002 2001
- ------------------------------------------------------------ ------------------------------------
(Restated)
ASSETS
Income-producing properties $ 435,289 $ 414,643
Accumulated depreciation (149,981) (131,659)
------------------------------------
285,308 282,984
Land parcels 41,323 40,835
Construction in progress 2,697 15,681
Equity investment in bank 356,028 330,153
Cash and cash equivalents 13,963 13,860
Note receivable and accrued interest -- related party 6,487 7,787
Other assets 87,736 80,957
------------------------------------
TOTAL ASSETS $ 793,542 $ 772,257
====================================
LIABILITIES
Mortgage notes payable $ 326,232 $ 331,114
Notes payable - secured 201,750 202,500
Notes payable - unsecured 55,156 50,717
Accrued dividends payable - preferred shares of beneficial interest 12,721 19,303
Other liabilities and accrued expenses 67,517 63,542
------------------------------------
Total liabilities 663,376 667,176
------------------------------------
TOTAL SHAREHOLDERS' EQUITY 130,166 105,081
------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 793,542 $ 772,257
====================================
* See Consolidated Statements of Shareholders' Equity
CONDENSED STATEMENTS OF OPERATIONS
For the Year Ended September 30
-------------------------------------------------------
(In thousands) 2002 2001 2000
- ------------------------------------------------------------ ------------------ ------------------------------------
(Restated) (Restated)
Total income $ 128,172 $ 142,952 $ 132,858
Total expenses (156,777) (162,098) (145,484)
Equity in earnings of unconsolidated entities 9,057 7,402 7,291
Gain on sales of property -- 11,077 994
------------------ ------------------------------------
Real estate operating income (loss) (19,548) (667) (4,341)
Equity in earnings of bank 40,204 35,367 21,074
------------------ ------------------------------------
Total company operating income 20,656 34,700 16,733
Income tax provision (benefit) (6,771) 56 (1,398)
------------------ ------------------------------------
Income before extraordinary item 27,427 34,644 18,131
Extraordinary item: loss on early extinguishment of debt -- -- (166)
------------------ ------------------------------------
TOTAL COMPANY NET INCOME $ 27,427 $ 34,644 $ 17,965
================== ====================================
CONDENSED STATEMENTS OF CASH FLOWS
For the Year Ended September 30
-------------------------------------------------------
(In thousands) 2002 2001 2000
- ------------------------------------------------------------ ------------------ ------------------------------------
(Restated) (Restated)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 27,427 $ 34,644 $ 17,965
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Depreciation 19,147 18,600 14,308
Gain on sale of property -- (11,077) (994)
Early extinguishment of debt, net of taxes -- -- 166
Equity in earnings of bank (40,204) (35,367) (21,074)
Increase in accounts receivable and accrued income (2,633) 327 (691)
Increase in deferred taxes (6,880) (388) (1,630)
Increase (decrease) in accounts payable and accrued expenses 1,425 (5,711) 1,892
Amortization of debt expense 1,847 1,717 1,620
Equity in earnings of unconsolidated entities (9,057) (7,402) (7,291)
Dividends and tax sharing payments 21,667 16,200 19,400
Other (5,082) (4,572) (2,441)
------------------ ------------------------------------
Net cash provided by (used in) operating activities 7,657 6,971 21,230
------------------ ------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures - properties (8,758) (22,546) (54,915)
Property acquisitions -- (16,535) (19,518)
Property sales 9,650 10,074 1,897
Note receivable and accrued interest -- related party
Repayments 1,300 4,000 3,750
Equity investment in bank -- -- (22,302)
Equity investment in unconsolidated entities 3,508 2,935 6,527
Other (239) 3 (354)
------------------ ------------------------------------
Net cash used in investing activities 5,461 (22,069) (84,915)
------------------ ------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from mortgage financing 14,562 50,978 130,802
Principal curtailments and repayments of mortgages (18,261) (32,442) (37,035)
Proceeds from secured note financings 1,750 20,500 24,200
Repayments of secured note financings (2,500) (18,000) (40,200)
Proceeds from sales of unsecured notes 7,601 9,310 10,246
Repayments of unsecured notes (3,162) (6,056) (8,905)
Costs of obtaining financings (1,005) (1,461) (2,651)
Dividends paid - preferred shares of beneficial interest (12,000) (12,000) (12,500)
------------------ ------------------------------------
Net cash provided by financing activities (13,015) 10,829 63,957
------------------ ------------------------------------
Net increase (decrease) in cash and cash equivalents 103 (4,269) 272
Cash and cash equivalents at beginning of year 13,860 18,129 17,857
------------------ ------------------------------------
Cash and cash equivalents at end of year $ 13,963 $ 13,860 $ 18,129
================== ====================================
MANAGEMENT'S STATEMENT ON RESPONSIBILITY
The Consolidated Financial Statements and related financial information in this
report have been prepared by the Advisor in accordance with generally accepted
accounting principles appropriate in the circumstances, based on best estimates
and judgments, with consideration given to materiality.
The Trust maintains a system of internal accounting control supported by
documentation to provide reasonable assurance that the books and records reflect
authorized transactions of the Trust, and that the assets of the Trust are
safeguarded.
The Board of Trustees exercises its responsibility for the Trust's financial
statements through its Audit Committee, which is composed of two outside
Trustees who meet periodically with the Trust's independent accountants and
management. The committee considers the audit scope, discusses financial and
reporting subjects, and reviews management actions on these matters. The
independent accountants have full access to the Audit Committee.
The independent accountants are recommended by the Audit Committee and confirmed
by the Board of Trustees. They provide an objective assessment of the fairness
and accuracy of the financial statements, consider the adequacy of the system of
internal accounting controls, and perform such tests and other procedures as
they deem necessary to express an opinion on the fairness of the financial
statements. Management believes that the policies and procedures it has
established provide reasonable assurance that its operations are conducted in
conformity with law and a high standard of business conduct.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
A Current Report on Form 8-K was filed by the Trust on June 28, 2002, relating
to this item.
PART III
ITEM 10. TRUSTEES AND EXECUTIVE OFFICERS OF THE TRUST
The Declaration of Trust provides that there shall be no fewer than three nor
more than twelve trustees, as determined from time to time by the trustees in
office. The Board of Trustees has fixed its permanent membership at six trustees
divided into three classes with overlapping three-year terms. The term of each
class expires at the Annual Meeting of Shareholders, which is usually held on
the last Friday of January.
The following list sets forth the name, age, position with the Trust, present
principal occupation or employment and material occupations, positions, offices
or employments during the past five years of each trustee and executive officer
of the Trust. Unless otherwise indicated, each individual has held an office
with the Trust for at least the past five years.
Class One Trustees --Terms End at the 2003 Annual Meeting
Gilbert M. Grosvenor, age 71, has served as a Trustee since 1971. Mr. Grosvenor
also serves as Chairman of the Board of Trustees of the National Geographic
Society and as a Director of Chevy Chase, Saul Centers, Marriott International
Corp., and Ethyl Corporation.
B. Francis Saul II, age 70, has served as a Chairman and Chief Executive Officer
of the Trust since 1969 and as a Trustee since 1964. Mr. Saul also serves as
President and Chairman of the Board of Directors of Saul Company, the Advisor,
Chevy Chase Property Company, Westminster Investing Corporation, and Chevy Chase
Lake Corporation, as Chairman of the Board and Chief Executive Officer of Chevy
Chase and Saul Centers, and as a Trustee of the National Geographic Society, the
Brookings Institute, the Johns Hopkins Medicine Board and Washington College.
Mr. Saul is the father of B. Francis Saul III.
Class Two Trustees --Terms End at the 2004 Annual Meeting
George M. Rogers, Jr., age 69, has served as a Trustee since 1969. Mr. Rogers is
a Senior Counsel in the law firm of Shaw Pittman LLP, Washington, DC, which
serves as counsel to the Trust and Chevy Chase, Mr. Rogers serves as a Director
of Chevy Chase, Saul Company, Chevy Chase Property Company, Westminster
Investing Corporation, and Chevy Chase Lake Corporation.
B. Francis Saul III, age 40, has served as a Trustee and Vice President of the
Trust since 1997. Mr. Saul also serves as a Director and/Vice Chairman of Chevy
Chase and as a Director and/or Officer of Saul Company, the Advisor, Saul
Property Co., Chevy Chase Property Company, Westminster Investing Corporation,
and Saul Centers. He is also a Chairman of the Board of Children's Hospital, and
the Boys and Girls Club of Greater Washington. Mr. Saul is the son of B. Francis
Saul II.
Class Three Trustees --Terms End at the 2005 Annual Meeting
Garland J. Bloom, Jr., age 71, has served as a Trustee since 1964. He is
currently a real estate consultant. Mr. Bloom was formerly Executive Vice
President and Principal of GMB Associates, Inc. (a real estate finance and
management firm) from 1988 to 1990 and Vice Chairman and Chief Operating Officer
of Smithy-Braedon Company (a real estate finance and management firm) from 1985
to 1987.
John R. Whitmore, age 69, has served as a Trustee since 1984. He also has served
as Senior Advisor to The Bessemer Group, Incorporated (a financial management
and banking firm) and its Bessemer Trust Company subsidiaries since 1998. Mr.
Whitmore is a director of Chevy Chase, Chevy Chase Property Company, Saul
Company and Saul Centers. During the period 1975-1998, Mr. Whitmore was
President and Chief Executive Officer of Bessemer Group, Incorporated and its
Bessemer Trust Company subsidiaries and a director of Bessemer Securities
Corporation.
Executive Officers of the Trust Who Are Not Directors
Philip D. Caraci, age 64, serves as Senior Vice President and Secretary of the
Trust, Executive Vice President of Saul Company, Senior Vice President of the
Advisor, Chairman of the Board of Saul Property Co., and a Director and
President of Saul Centers.
Stephen R. Halpin, Jr., age 47, serves as Vice President and Chief Financial
Officer of the Trust, and Senior Vice President and Chief Financial Officer of
Saul Company. He also serves as Executive Vice President and Chief Financial
Officer of Chevy Chase.
Patrick T. Connors, age 40, has served as a Vice President of the Trust and
Senior Vice President of Saul Company since January 2000. For the previous four
years, he was an attorney with Shaw Pittman LLP, Washington, DC.
Ross E. Heasley, age 63, serves as Vice President of the Trust, Saul Company,
the Advisor, Saul Property Co. and Saul Centers.
Henry Ravenel, Jr., age 68, serves as Vice President of the Trust, Saul Company,
the Advisor and Saul Centers.
Bill D. Tzamaras, age 41, has served as Vice President and Treasurer of the
Trust, Saul Company, Saul Property Co. and the Advisor since August 2001, and as
Vice President of Saul Company since October 2000. For the period September 1996
to October 2000, Mr. Tzamaras was a principal with Reznick, Fedder and
Silverman, Certified Public Accountants, in Bethesda, Maryland.
Committees of the Board of Trustees
The Board of Trustees met four times during fiscal 2002. Each member of the
board attended at least 75% of the aggregate number of meetings of the board and
of the committees of the board on which he served.
The Board of Trustees has two standing committees: the Audit Committee and the
Executive Committee.
The Audit Committee is composed of Messrs. Bloom and Grosvenor. Its duties
include nominating the Trust's independent auditors, discussing with them the
scope of their examination of the Trust, reviewing with them the Trust's
financial statements and accompanying report, and reviewing their
recommendations regarding internal controls and related matters. This committee
met nine times during fiscal 2002.
The Executive Committee is composed of Messrs. Rogers, Saul II and Whitmore. It
is empowered to oversee day-to-day actions of the Advisor and Saul Property Co.
in connection with the operations of the Trust, including the acquisition,
administration, sale or disposition of investments. This committee did not meet
during fiscal 2002.
Trustees of the Trust are currently paid an annual retainer of $12,500 and a fee
of $600 for each board or committee meeting attended. Trustees from outside the
Washington, D.C. area are also reimbursed for out-of-pocket expenses in
connection with their attendance at meetings. Mr. Saul II is not paid for
attending Executive Committee meetings. For the fiscal year ended September 30,
2002, the Real Estate Trust paid total fees of $95,000 to the Trustees,
including $15,000 to Mr. Saul II.
ITEM 11. EXECUTIVE COMPENSATION
The Trust pays no compensation to its executive officers for their services in
such capacity. Mr. Saul II receives compensation from the bank for his services
as the bank's Chairman of the Board of Directors and Chief Executive Officer,
Mr. Halpin receives compensation from the bank for his services as Executive
Vice President and Chief Financial Officer, and since 2000, Mr. Saul III
receives compensation from the bank for his services as Vice Chairman of the
Board of Directors. No other executive officers of the Trust received any
compensation from the Trust or its subsidiaries with respect to any of the
fiscal years ended September 30, 2002, 2001 and 2000
The following table sets forth the cash compensation paid by the bank to Mr.
Saul II, Mr. Halpin and Mr. Saul III for or with respect to the fiscal years
ended September 30, 2002, 2001 and 2000 for all capacities in which they served
during such fiscal years.
SUMMARY COMPENSATION TABLE
Annual Compensation
Long-Term All
Compensation Other
Name and Principal Position Year Salary Bonus Payouts Compensation
- --------------------------- ---- ---------- ---------- --------- ------------
B. Francis Saul II, 2002 $1,590,004 $1,240,000 $440,496 $431,260(1)
Chairman and Chief 2001 1,562,320 1,550,000 440,496 384,731(2)
Executive Officer 2000 1,550,000 1,500,000 504,280 331,604(3)
Stephen R. Halpin, Jr., 2002 $ 485,004 $ 58,200 $ 88,099 $ 89,731(1)
Executive Vice President 2001 $ 478,092 $ 71,250 88,099 75,487(2)
and Chief Financial Officer 2000 458,666 67,500 100,856 62,341(3)
B. Francis Saul III 2002 $ 225,004 $ 23,000 $ - $ 15,865(1)
Vice Chairman 2001 207,694 30,000 - 14,262(2)
2000 56,154 - - 3,369(3)
- - ----------------------------------------------------------------------------------------------------
(1) The total amounts shown in the "All Other Compensation" column for fiscal
year 2002 consist of the following: (i) contributions made by the bank to the
bank's Supplemental Executive Retirement Plan on behalf of Mr. Saul II
($193,230), Mr. Halpin ($25,878) and Mr. Saul III ($15,120); (ii) the taxable
benefit of premiums paid by the bank for group term insurance on behalf of Mr.
Saul II ($14,466), Mr. Halpin ($1,698) and Mr. Saul III ($744); (iii)
contributions to the B. F. Saul Company Employees Profit Sharing Retirement Plan
(the Retirement Plan), a defined contribution plan, on behalf of Mr. Halpin
($12,000); and (iv) accrued earnings on awards previously made under the bank's
Deferred Compensation Plan on behalf of Mr. Saul II ($223,564), Mr. Halpin
($50,155) and Mr. Saul III ($4,160).
(2) The total amounts shown in the "All Other Compensation" column for fiscal
2001 consist of the following: (i) contributions made by the bank to the bank's
Supplemental Executive Retirement Plan on behalf of Mr. Saul II in the amount of
$213,168, Mr. Halpin in the amount of $28,046, and Mr. Saul III in the amount of
$14,262; (ii) the taxable benefit of premiums paid by the bank for group term
insurance on behalf of Mr. Saul II in the amount of $14,466 and Mr.Halpin in the
amount of $1,457; (iii) contributions to the Retirement Plan, a defined
contribution plan, on behalf of Mr. Halpin in the amount of $10,200; and (iv)
accrued earnings on awards previously made under the bank's Deferred
Compensation Plan on behalf of Mr. Saul II in the amount of $157,097 and Mr.
Halpin in the amount of $35,784.
(3) The total amounts shown in the "All Other Compensation" column for fiscal
2000 consist of the following: (i) contributions made by the bank to the bank's
Supplemental Executive Retirement Plan on behalf of Mr. Saul II in the amount of
$213,258, Mr. Halpin in the amount of $27,421 and Mr. Saul III in the amount of
$3,369; (ii) the taxable benefit of premiums paid by the bank for group term
insurance on behalf of Mr. Saul II in the amount of $19,197 and Mr. Halpin in
the amount of $1,527; (iii) contributions to the Retirement Plan, a defined
contribution plan, on behalf of Mr.Halpin in the amount of $10,200; and (iv)
accrued earnings on awards previously made under the bank's Deferred
Compensation Plan on behalf of Mr. Saul II in the amount of $99,149 and Mr.
Halpin in the amount of $23,193.
LONG-TERM INCENTIVE PLAN AWARDS. The following table sets forth certain
information concerning the principal contributions (the "Principal
Contributions") credited by the bank to the accounts (the "Accounts") of the
executive officers of the bank named above for fiscal year 2001 under the bank's
Deferred Compensation Plan (the "Plan").
LONG-TERM INCENTIVE PROGRAM - AWARDS IN LAST FISCAL YEAR
Performance or Estimated Future Payouts (1)
Other Period Under Non-Stock Price-Based Plans
---------------------------------------------------
Until Maturation
Name or Payout Threshold Target(2) Maximum
- ----
------------------- --------------- -------------- -------------
B. Francis Saul II (3) 2004 $ 700,000 $ 1,511,248 $ 4,334,216
Stephen R. Halpin, Jr. 2011 $ 150,000 $ 323,839 $ 928,760
- --------------------
(1) The estimated future payouts shown in the table are based on assumed
performance rates for the bank during each year in the ten-year
performance period. The actual payouts under the Plan may vary
substantially from the payouts shown in the table, depending upon the
bank's actual rate of return on average assets for each fiscal year in
the ten-year performance period ending September 30, 2011.
(2) The Plan does not establish any target performance levels. The payout
amounts shown in this column have been calculated assuming that the
bank's rate of return on average assets during each of the years in the
performance period are the same as the bank's rate of return during the
fiscal year ended September 30, 2002.
(3) The payout amounts shown for all participants are the estimated amounts
that would be payable to such participants if their employment
continued with the bank for the entire ten-year performance period of
the Plan. During fiscal year 2002, Mr. Saul attained the age of 70, at
which time he became fully vested in the account maintained for his
benefit under the Plan for awards granted prior to fiscal year 2001.
Under the Plan, if Mr. Saul were to retire, he could elect to have the
bank pay out the Net Contribution (as defined) in his account prior to
the year 2011.
Certain of the awards credited by the bank to the Account maintained for the
benefit of Mr. Saul under the Plan vested at the time Mr. Saul attained age 60
in 1992 and age 70 in 2002. Certain other awards credited by the bank to the
Account maintained for the benefit of Mr. Saul will vest upon the earlier of:
o five years after the date of the award,
o his attainment of the age of 72 in 2004,
o his death, or
o his total or permanent disability, or a change in control of the bank (as
defined in the Plan).
Accordingly, as of September 30, 2002, Mr. Saul was fully vested in the Account
maintained for his benefit under the Plan for awards granted prior to fiscal
year 2001. As of that date, the vested Account balance maintained for Mr. Saul's
benefit under the Plan was $5,489,185. As of September 30, 2002, the following
individuals have vested amounts that are payable within 120 days after September
30, 2002: Mr. Saul ($440,496); Mr. Halpin ($88,099).
The Plan provides that, as of the end of each fiscal year in the ten-year period
ending September 30, 2011 (or the executive officer's earlier termination of
employment with the bank), the bank will add to or deduct from each executive
officer's Account a contribution or deduction, as the case may be, which
represents the hypothetical interest (which may be positive or negative) earned
on the Principal Contribution, based on the bank's rate of return on average
assets (as computed under the Plan) for the fiscal year then ended. (The
Principal Contribution, plus or minus any interest credited or deducted, is
referred to as the "Net Contribution.")
Executive officers are entitled to receive the Net Contribution in their
respective Account only upon full or partial vesting. Plan participants become
fully vested in their Account under the Plan, provided that they remain
continuously employed by the bank during the vesting period, upon the earliest
to occur of any of the following:
o September 30, 2011;
o attainment of age 63;
o death;
o total and permanent disability; or
o a change in control of the bank (as defined in the Plan).
Plan participants become partially vested, to the extent of 50% of the Net
Contribution in the Account, upon the termination of their employment by the
bank without cause (as defined in the Plan) after September 30, 2006.
Payouts are made under the Plan within 120 days after September 30, 2011, or the
earlier termination of the executive officer's employment with the bank,
provided that vesting or partial vesting has occurred under the Plan.
OTHER COMPENSATION AGREEMENTS. Mr. Halpin has entered into an agreement with the
bank entitled "Agreement For Executive Level Officers Governing Confidentiality,
Nonsolicitation, Ownership of Certain Works and Termination Upon Change in
Control" under which the executive officer has agreed not to compete with,
solicit customers of or solicit the employees of the bank for stated periods
following any termination of employment with the bank. In addition, the bank
agrees to pay the executive a specified amount if the executive is terminated
without cause in the three-year period following a change of control of the
bank. The amount payable varies depending upon the executive's base compensation
and most recent bonus, the length of the executive's employment with the bank
and the per share price at which the triggering change of control has occurred.
Mr. Halpin also has entered into "Special Retirement Compensation Agreements"
under which the executive receives an amount up to three times his base
compensation if he retires from the bank after reaching age 65. The executive is
not entitled to any such compensation if, prior to reaching age 65, he
voluntarily terminates his employment or is terminated for cause.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT
The following table sets forth certain information, as of November 15, 2002,
concerning beneficial ownership of Common Shares and preferred shares of
beneficial interest, referred to in this report as the "Preferred Shares," by
(a) each person known by the Trust to be the beneficial owner of more than 5% of
the Common Shares and the Preferred Shares, (b) each member of the Board of
Trustees, (c) each executive officer of the Trust named in the Summary
Compensation Table under "Item 11. Executive Compensation" and (d) all trustees
and executive officers of the Trust as a group.
Aggregate Number of Percent
Name of Shares of
Beneficial Owner Beneficially Owned (1) Class (1)
- - ----------------------- ---------------------- ------------------
B. Francis Saul II Preferred:
516,000 (2) 100.00%
Common:
4,807,510 (3) 99.60%
Philip D. Caraci Common:
19,400 (4) 0.40%
All Trustees and Preferred:
executive officers 516,000 (2) 100.00%
as a group (10 persons) Common:
4,826,910 100.00%
- - -----------------------
(1) Beneficial owner and percent of class are calculated pursuant to rule 13d-3
under the Securities Exchange Act of 1934.
(2) Consists of Preferred Shares owned of record by Saul Company and other
companies of which Mr. Saul is an officer, director and/or more than 10%
shareholder, comprising 270,000 Preferred Shares owned by Saul Company, 90,000
Preferred Shares owned by Franklin Development Company, Inc., 90,000 Preferred
Shares owned by The Klingle Corporation, and 66,000 Preferred Shares owned by
Westminster Investing Corporation. The address of each person listed in this
footnote is 7501 Wisconsin Avenue, Bethesda, Maryland 20814. Pursuant to Rule
13d-3, the Preferred Shares described above are considered to be beneficially
owned by Mr. Saul because he has or may be deemed to have sole or shared voting
and/or investment power in respect thereof.
(3) Consists of Common Shares owned of record by Saul Company and other
companies of which Mr. Saul is an officer and director and/or more than 10%
shareholder, comprising 1,125,739 Common Shares owned by Westminster Investing
Corporation, 43,673 Common Shares owned by Derwood Investment Corporation, a
subsidiary of Westminster Investing Corporation, 34,400 Common Shares owned by
Somerset Investment Company, Inc., a subsidiary of Westminster Investing
Corporation, 2,751,662 Common Shares owned by Saul Company, 283,400 Common
Shares owned by Columbia Securities Company of Washington, D. C., 172,918 Common
Shares owned by Franklin Development Company, Inc., and 395,718 Common Shares
owned by The Klingle Corporation. The address of each person listed in this
footnote is 7501 Wisconsin Avenue, Bethesda Maryland 20814. Pursuant to Rule
13d-3, the Common Shares described above are considered to be beneficially owned
by Mr. Saul because he has or may be deemed to have sole or shared voting and/or
investment power in respect thereof.
(4) Mr. Caraci has entered into an agreement with the Trust under which he is
required to sell all Common Shares he then owns to the Trust when his employment
by Saul Company and any of its affiliates ceases for any reason, including
retirement, termination, death or disability. The price Mr. Caraci will receive
for his Common Shares will be the greater of $28.00 per Share or the price the
Trust determines at the time is the fair market value thereof.
The Preferred Shares were issued in June 1990 in connection with the transaction
in which the Trust increased its equity interest in the bank from 60% to 80%.
The dividend rate on the Preferred Shares is $10.50 per share per annum.
Dividends are cumulative and are payable annually or at such other times as the
Trustees may determine, as and when declared by the Trustees out of any assets
legally available therefor. The Preferred Shares have a liquidation preference
of $100 per share. Subject to limits in certain of the Trust's loan agreements,
the Preferred Shares are subject to redemption at the option of the Trust at a
redemption price equal to their liquidation preference. Except as otherwise
required by applicable law, the holders of Preferred Shares are entitled to vote
only in certain limited situations, such as the merger of the Trust or a sale of
all or substantially all of the assets of the Trust.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Management Personnel
All of the officers of the Trust and Messrs. Saul II, Saul III, Rogers and
Whitmore, each of whom is a trustee of the Trust, are also officers and/or
directors of Saul Company and/or its subsidiaries. In addition, Messrs. Saul II,
Saul III, Whitmore, Grosvenor, Caraci and Heasley are also officers and/or
directors of Saul Centers and/or its subsidiaries.
Transactions with Saul Company and its Subsidiaries. The Real Estate Trust is
managed by the Advisor, a wholly owned subsidiary of Saul Company. The Advisor
is paid a fixed monthly fee subject to annual review by the trustees. The
monthly fee was $475,000 for fiscal 2002. The advisory contract has been
extended until September 30, 2003, and will continue thereafter unless cancelled
by either party at the end of any contract year. The monthly fee for fiscal 2003
will be $458,000. Certain loan agreements prohibit termination of this contract.
Saul Company and Saul Property Co., a wholly owned subsidiary of Saul Company,
provide services to the Real Estate Trust in the areas of commercial property
management and leasing, hotel management, development and construction
management, and acquisitions, sales and financings of real property. Fees to the
two companies amounted $6.8 million in fiscal 2002.
The Real Estate Trust reimburses the Advisor and Saul Property Co. for costs and
expenses incurred in connection with the acquisition and development of real
property on behalf of the Real Estate Trust, in-house legal expenses, and all
travel expenses incurred in connection with the affairs of the Real Estate
Trust.
The Real Estate Trust pays the Advisor fees equal to 2% of the principal amount
of publicly offered unsecured notes as they are issued to offset the Advisor's
costs of administering the program. The Advisor received $183,000 in such fees
in fiscal 2002.
B. F. Saul Insurance Agency of Maryland, Inc., a subsidiary of Saul Company, is
a general insurance agency that receives commissions and counter-signature fees
in connection with the Real Estate Trust's insurance program. Such commissions
and fees amounted to approximately $196,000 in fiscal 2002.
At October 1, 1999, the Real Estate Trust had an unsecured note receivable from
Saul Company with an outstanding balance of $13.8 million. During fiscal 2001
and 2002, curtails of $4.0 and $1.3 million were paid. Interest on the loans is
computed by reference to floating rate index. At September 30, 2002, the total
due the Real Estate Trust was $6.5 million. Interest accrued on this note
amounted to $274,000 in fiscal 2002.
The Trust has retained the law firm of Shaw Pittman LLP, at which Mr. Rogers is
senior counsel, to perform legal services for the Trust in fiscal 2002 and 2003.
The Board of Trustees of the Trust, including the two independent trustees,
reviews the fees and compensation arrangements between the Real Estate Trust and
Saul Company and its related entities and affiliates and believes that such fees
and compensation arrangements are as favorable to the Real Estate Trust as would
be obtainable from unaffiliated sources.
Transactions with Saul Centers.
Shared Services. The Trust shares with Saul Centers certain ancillary functions
at cost, such as computer and payroll services, benefits administration, and
in-house legal services. In addition, the Trust shares insurance expense with
Saul Centers on a pro rata basis. The Trust believes that the amounts allocated
to it for such shared services represent a fair allocation between the Trust and
Saul Centers.
Exclusivity Agreement and Right of First Refusal. The Real Estate Trust has
entered into an Exclusivity Agreement with, and has granted a right of first
refusal to, Saul Centers and Saul Holdings Partnership. The purpose of these
agreements is to minimize potential conflicts of interest between the Real
Estate Trust, Saul Centers and Saul
Holdings Partnership. The exclusivity agreement and right of first refusal
generally require the Real Estate Trust to conduct its shopping center business
exclusively through Saul Centers and Saul Holdings Partnership and to grant
these entities a right of first refusal to purchase commercial properties and
development sites that become available to the Real Estate Trust in the District
of Columbia or adjacent suburban Maryland. Subject to the exclusivity agreement
and right of first refusal, the Real Estate Trust will continue to develop,
acquire, own and manage commercial properties and own land suitable for
development as, among other things, shopping centers and other commercial
properties.
Reimbursement Agreement. Pursuant to a reimbursement agreement among the
partners of the Saul Holdings Partnership and certain of their affiliates, the
Real Estate Trust and two of its subsidiaries have agreed to reimburse Saul
Centers and the other partners in the event the Saul Holdings Partnership fails
to make payments with respect to certain portions of its debt obligations and
Saul Centers or any such other partners personally make payments with respect to
such debt obligations. As of September 30, 2002, the maximum potential
obligation of the Real Estate Trust and its subsidiaries under the agreement was
$115.5 million. See Note 3 to the Consolidated Financial Statements in this
report. The Real Estate Trust believes that Saul Holdings Partnership will be
able to make all payments due with respect to its debt obligations.
Tax Conflicts. The fair market value of each of the properties contributed to
Saul Holdings Partnership and its subsidiaries by the Real Estate Trust and its
subsidiaries in connection with the formation of Saul Centers and Saul Holdings
Partnership in 1993 exceeded the tax basis of such properties. In the event Saul
Centers or its wholly owned subsidiary, Saul QRS, Inc., acting as general
partner, causes Saul Holdings Partnership to dispose of, or there is an
involuntary disposition of, one or more of such properties, a disproportionately
large share of the total gain for federal income tax purposes would be allocated
to the Real Estate Trust and its subsidiaries as a result of the property
disposition. See Note 3 to the Consolidated Financial Statements in this report.
Property Dispositions. In October 2000, the Real Estate Trust sold a newly
constructed 30,000 square foot office/flex building located on a 2.2 acre site
in the Avenel Business Park in Gaithersburg, Maryland to Saul Centers. The $4.2
million purchase price was paid in cash. The price for the property was
determined by an independent third party appraisal. Management believes that the
disposition of this property was on terms no less favorable than those that
could have been obtained in a comparable transaction with an unaffiliated third
party.
Remuneration of Trustees and Officers. For fiscal 2002, the Trust paid the
trustees $95,000 in fees for their services. See "Item 10. Trustees and
Executive Officers of the Trust." No compensation was paid to the officers of
the Trust for acting as such; however, Mr. Saul II was paid by the bank for his
services as the bank's Chairman and Chief Executive Officer, Mr. Halpin was paid
by the bank for his services as Executive Vice President and Chief Financial
Officer, and Mr. Saul III was paid by the bank for his services as the bank's
Vice Chairman. See "Item 11. Executive Compensation." Messrs. Grosvenor, Rogers,
Saul II and Saul III receive compensation for their services as directors of the
bank and Messrs. Rogers, Saul II , Saul III and Whitmore and all of the officers
of the Real Estate Trust receive compensation from Saul Company and/or its
affiliated corporations as directors or officers thereof.
Related Party Rents. The Real Estate Trust leases space to the bank and the Saul
Property Co. at two of its income-producing properties. Minimum rents and
expense recoveries paid under these leases amounted to approximately $5.2
million in fiscal 2002. The bank leases space in several of the shopping centers
owned by Saul Centers. The total rental payments made to Saul Centers by the
bank in fiscal 2002 was $1.4 million. On September 24, 2001 the bank entered
into an agreement to lease to Saul Company approximately 46,000 square feet of
office space at its new corporate headquarters at 7501 Wisconsin Avenue,
Bethesda, Maryland. Total payments under the lease for fiscal 2002 were $1.1
million. In addition, the bank has retained Saul Company as its leasing agent to
secure tenants for additional space that will be available in the bank's new
corporate headquarters. The Trust believes that these leases have comparable
terms to leases that would have been entered into with unaffiliated parties.
ITEM 14. CONTROLS AND PROCEDURES
The Trust maintains a set of disclosure controls and procedures designed to
ensure that information required to be disclosed in the Trust's filings under
the Securities Exchange Act of 1934 is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commission's rules and forms. The principal executive and financial officers of
the Trust have evaluated the Trust's disclosure controls and procedures within
90 days prior to the filing of this Annual Report on Form 10-K and have
determined that such disclosure controls and procedures are effective.
Subsequent to the above evaluation, there were no significant changes in
internal controls or other factors that could significantly affect these
controls, including any corrective actions with regard to significant
deficiencies and material weaknesses.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) The following documents are filed as part of this report:
1. Financial Statements
The following consolidated financial statements of the Trust are
incorporated by reference in Part II, Item 8.
(a) Report of Independent Auditors.
(b) Consolidated Balance Sheets - As of September 30, 2002 and
2001.
(c) Consolidated Statements of Operations - For the years
ended September 30, 2002, 2001 and 2000.
(d) Consolidated Statements of Comprehensive Income and
Changes in Shareholders' Equity - For the years
ended September 30, 2002, 2001 and 2000.
(e) Consolidated Statements of Cash Flows - For the years
ended September 30, 2002, 2001 and 2000.
(f) Notes to Consolidated Financial Statements.
2. Financial Statement Schedules and Supplementary Data
(a) Schedules of the Real Estate Trust:
Schedule I - Condensed Financial Information - For the years
ended September 30, 2002, 2001 and 2000.
Schedule III - Consolidated Schedule of Investment Properties
As of September 30, 2002.
(b) Reports on Form 8-K
A Current Report on Form 8-K, dated July 31, 2002, was filed by the
Trust reporting the inadvertent overstatement of prior period net
income due to certain accounting errors involving the valuation of
interest-only strips receivables related to the bank's automobile
loan securitizations.
(c) Exhibits
EXHIBITS DESCRIPTION
---------- ------------------------------------------------------------------
3. ORGANIZATIONAL DOCUMENTS
(a) Second Amended and Restated Declaration of Trust filed with the
Maryland State Department of Assessments and Taxation on May 23,
2002 as Exhibit 3(a) to Registration Statement 333-70753 is
hereby incorporated by reference.
(b) Second Amended and Restated By-Laws of the Trust dated as of
May 23, 2002 as Exhibit 3(b) to Registration Statement 333-70753
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.
21.* List of Subsidiaries of the Trust.
- ---------------------
* Filed herewith.
B.F. SAUL REAL ESTATE INVESTMENT TRUST
CONDENSED FINANCIAL INFORMATION SCHEDULE I
(a) Required condensed financial information on the Trust is disclosed in the
audited consolidated financial statements included herewith.
(b) Amounts of cash dividends paid to the Trust by consolidated subsidiaries
were as follows:
`
Year Ended September 30
----------------------------------------
2002 2001 2000
$16,000,000 $12,800,000 $12,800,000
Consolidated Schedule of Investment Properties - Real Estate Trust Schedule III
September 30, 2002
(Dollars in Thousands)
Costs
Capitalized Basis at Close of Period
------------------------------------------
Initial Subsequent Buildings
Basis to to and
Hotels Trust Acquisition Land Improvements Total
- ------------------------------------------------ --------------------------------------- -----------------------------
Courtyard -- Tysons Corner, McLean VA $31,077 $ (388) $ 843 $ 29,846 $30,689
Crown Plaza -- National Airport, Arlington VA 26,979 5,691 4,229 28,441 32,670
Hampton Inn -- Dulles Airport, Sterling VA -- 6,505 290 6,215 6,505
Hampton Inn -- Dulles Town Center, Sterling VA 11,379 37 795 10,621 11,416
Holiday Inn, Cincinnati OH 6,859 3,997 245 10,611 10,856
Holiday Inn -- Dulles Airport, Sterling VA 6,950 21,636 862 27,724 28,586
Holiday Inn, Gaithersburg MD 3,849 15,850 1,781 17,918 19,699
Holiday Inn -- National Airport, Arlington VA 10,187 7,679 1,183 16,683 17,866
Holiday Inn, Pueblo CO 3,458 2,869 542 5,785 6,327
Holiday Inn -- Rochester Airport, Rochester NY 3,340 10,007 605 12,742 13,347
Holiday Inn -- Tysons Corner, McLean VA 6,976 13,740 2,265 18,451 20,716
Holiday Inn Express, Herndon VA 5,259 409 1,178 4,490 5,668
Holiday Inn Select, Auburn Hills MI 10,450 2,278 1,031 11,697 12,728
SpringHill Suites, Boca Raton FL 10,942 393 1,220 10,115 11,335
TownePlace Suites, Boca Raton FL 7,527 13 869 6,671 7,540
TownePlace Suites -- Dulles Airport, Sterling VA 5,849 301 219 5,931 6,150
TownePlace Suites -- Ft. Lauderdale FL 7,059 (3) 420 6,636 7,056
TownePlace Suites, Gaithersburg MD 6,382 30 107 6,305 6,412
--------------------------------------- --------------- -------------
Subtotal - Hotels $ 164,522 $ 91,044 $ 18,684 $ 236,882 $ 255,566
--------------------------------------- --------------- -------------
Commercial
- ------------------------------------------------
900 Circle 75 Pkway, Atlanta GA $33,434 $ 3,031 $ 563 $ 35,902 $36,465
1000 Circle 75 Pkway, Atlanta GA 2,820 1,442 248 4,014 4,262
1100 Circle 75 Pkway, Atlanta GA 22,746 2,852 419 25,179 25,598
8201 Greensboro, Tysons Corner VA 28,890 3,077 1,633 30,334 31,967
Commerce Ctr-Ph II, Ft Lauderdale FL 4,266 545 782 4,029 4,811
Dulles North, Loudoun County VA 5,882 70 507 5,445 5,952
Dulles North Two, Loudoun County VA 7,729 454 404 7,779 8,183
Dulles North Four, Loudoun County VA 11,093 -- 2,208 8,885 11,093
Dulles North Five, Loudoun County VA 5,078 (77) 535 4,466 5,001
Dulles North Six, Loudoun County VA 2,667 8 257 2,418 2,675
Loudoun Tech Center I, Loudoun County VA 5,334 -- 1,075 4,259 5,334
Sweitzer Lane, Laurel MD 13,703 -- 3,701 10,002 13,703
Tysons Park Place, Tysons Corner VA 21,811 65 2,454 19,422 21,876
--------------------------------------- --------------- -------------
Subtotal - Commercial $ 163,453 $ 11,467 $ 14,786 $ 162,134 $ 176,920
--------------------------------------- --------------- -------------
Consolidated Schedule of Investment Properties - Real Estate Trust (Continued)
September 30, 2002
(Dollars in Thousands)
Costs
Capitalized Basis at Close of Period
------------------------------------------
Initial Subsequent Buildings
Basis to to and
Purchase-Leasebacks Trust Acquisition Land Improvements Total
- ------------------------------------------------ --------------------------------------- -----------------------------
Chateau di Jon, Metairie, LA $ 1,125 $ -- $1,125 $ -- $ 1,125
Country Club, Knoxville, TN 500 (22) 478 -- 478
Houston Mall, Warner Robbins, GA 650 -- 650 -- 650
Old National, Atlanta, GA 550 -- 550 -- 550
--------------------------------------- --------------- -------------
Subtotal - Purchase-Leasebacks $ 2,825 $ (22) $2,803 $ -- $ 2,803
--------------------------------------- --------------- -------------
Total Income-Producing Properties $ 332,800 $ 102,489 $ 36,273 $ 399,016 $ 435,289
--------------------------------------- --------------- -------------
Land Parcels
- ------------------------------------------------
Arvida Park of Commerce,
Boca Raton, FL $ 7,378 (1,873) $5,433 $ 72 $ 5,505
Cedar Green, Loudoun Co., VA 3,314 25 2,832 507 3,339
Church Road, Loudoun Co., VA 2,586 2,194 4,780 -- 4,780
Circle 75, Atlanta, GA 12,927 3,263 16,051 139 16,190
Flagship Centre, Rockville, MD 1,729 144 1,769 104 1,873
Holiday Inn - Auburn Hills, Auburn Hills MI 218 -- 218 -- 218
Holiday Inn - Rochester, Roch., NY 68 -- 68 -- 68
Overland Park, Overland Park, KA 3,771 726 4,497 -- 4,497
Prospect Indust. Pk, Ft. Laud., FL 2,203 (1,943) 260 -- 260
Sterling Blvd., Loudoun Co., VA 505 4,088 2,617 1,976 4,593
--------------------------------------- --------------- -------------
Subtotal $34,699 $ 6,624 $ 38,525 $ 2,798 $41,323
--------------------------------------- --------------- -------------
Total Investment Properties $ 367,499 $ 109,113 $ 74,798 $ 401,814 $ 476,612
======================================= =============== =============
Consolidated Schedule of Investment Properties - Real Estate Trust (Continued)
September 30, 2002
(Dollars in Thousands)
Buildings
and
Date Improvements
Accumulated Related Date of Acquired/ Depreciable
Hotels Depreciation Debt Construction Transferred Lives (Years)
- ------------------------------------------------ ---------------------------- --------------------------------- --------------------
Courtyard -- Tysons Corner, McLean VA $ 3,411 $24,865 2000 12/00 40
Crown Plaza -- National Airport, Arlington VA 5,784 16,746 1959 12/97 39
Hampton Inn -- Dulles Airport, Sterling VA 2,969 6,298 1987 4/87 31.5
Hampton Inn -- Dulles Town Center, Sterling VA 1,724 9,159 2000 11/00 40
Holiday Inn, Cincinnati OH 6,664 5,712 1975 2/76 40
Holiday Inn -- Dulles Airport, Sterling VA 17,202 12,974 1971 11/84 28
Holiday Inn, Gaithersburg MD 9,344 7,151 1972 6/75 45
Holiday Inn -- National Airport, Arlington VA 9,401 5,452 1973 11/83 30
Holiday Inn, Pueblo CO 3,530 4,324 1973 3/76 40
Holiday Inn -- Rochester Airport, Rochester NY 7,576 13,985 1975 3/76 40
Holiday Inn -- Tysons Corner, McLean VA 9,643 16,463 1971 6/75 47
Holiday Inn Express, Herndon VA 939 4,694 1987 10/96 40
Holiday Inn Select, Auburn Hills MI 3,353 11,750 1989 11/94 31.5
SpringHill Suites, Boca Raton FL 1,139 6,028 1999 9/99 40
TownePlace Suites, Boca Raton FL 704 5,481 1999 6/99 40
TownePlace Suites -- Dulles Airport, Sterling VA 872 6,284 1998 8/98 40
TownePlace Suites -- Ft. Lauderdale FL 682 4,496 1999 10/99 40
TownePlace Suites, Gaithersburg MD 702 4,788 1999 6/99 40
-------------- -------------
Subtotal - Hotels $ 85,639 $ 166,650
-------------- -------------
Commercial
- ------------------------------------------------
900 Circle 75 Pkway, Atlanta GA $ 18,009 $23,839 1985 12/85 35
1000 Circle 75 Pkway, Atlanta GA 2,512 4,798 1974 4/76 40
1100 Circle 75 Pkway, Atlanta GA 13,716 12,790 1982 9/82 40
8201 Greensboro, Tysons Corner VA 14,555 37,581 1985 4/86 35
Commerce Ctr-Ph II, Ft Lauderdale FL 1,943 3,643 1986 1/87 35
Dulles North, Loudoun County VA 2,130 4,824 1990 10/90 31.5
Dulles North Two, Loudoun County VA 1,237 8,319 1999 10/99 40
Dulles North Four, Loudoun County VA 372 8,967 2002 4/02 40
Dulles North Five, Loudoun County VA 450 6,540 2000 3/00 40
Dulles North Six, Loudoun County VA 162 4,855 2000 10/00 40
Loudoun Tech Center I, Loudoun County VA 89 3,994 2001 12/01 40
Sweitzer Lane, Laurel MD 479 10,648 1995 11/00 40
Tysons Park Place, Tysons Corner VA 8,660 30,048 1976 12/99 30
-------------- -------------
Subtotal - Commercial $ 64,314 $ 160,846
-------------- -------------
Consolidated Schedule of Investment Properties - Real Estate Trust (Continued)
September 30, 2002
(Dollars in Thousands)
Date
Accumulated Related Date of Acquired/
Purchase-Leasebacks Depreciation Debt Construction Transferred
- ------------------------------------------------ ---------------------------- ---------------------------------
Chateau di Jon, Metairie, LA $ -- $ -- 11/73
Country Club, Knoxville, TN -- -- 5/76
Houston Mall, Warner Robbins, GA -- -- 2/72
Old National, Atlanta, GA -- -- 8/71
-------------- -------------
Subtotal - Purchase-Leasebacks $ -- $ --
-------------- -------------
Total Income-Producing Properties $ 149,953 $ 327,496
-------------- -------------
Land Parcels
- ------------------------------------------------
Arvida Park of Commerce,
Boca Raton, FL $ -- $ -- 12/84 & 5/85
Cedar Green, Loudoun Co., VA -- -- 10/00
Church Road, Loudoun Co., VA -- -- 9/84 & 4/85
Circle 75, Atlanta, GA 28 -- 2/77 & 1/84
Flagship Centre, Rockville, MD -- -- 8/85
Holiday Inn - Auburn Hills, Auburn Hills MI -- -- 7/97
Holiday Inn - Rochester, Roch., NY -- -- 9/86
Overland Park, Overland Park, KA -- -- 1/77 & 2/85
Prospect Indust. Pk, Ft. Laud., FL -- -- 10/83 & 8/84
Sterling Blvd., Loudoun Co., VA -- -- 4/84, 2/00 & 3/00
-------------- -------------
Subtotal $ 28 $ --
-------------- -------------
Total Investment Properties $ 149,981 $ 327,496
============== =============
CONSOLIDATED SCHEDULE OF INVESTMENT PROPERTIES - REAL ESTATE TRUST
NOTES:
(1) See Summary of Significant Accounting Policies for basis of recording
investment properties and computing depreciation. Investment
properties are discussed in Note 3 to Consolidated Financial
Statements.
(2) A reconciliation of the basis of investment properties and
accumulated depreciation follows.
BASIS OF INVESTMENT PROPERTIES AND ACCUMULATED DEPRECIATION
(In thousands)
For The Year Ended September 30
------------------------------------------------------------
2002 2001 2000
------------------- -------------------- -------------------
Basis of investment properties
- ---------------------------------------------------------------
Balance at beginning of period $ 455,478 $ 402,149 $ 351,629
Additions (reductions) during the period:
Capital expenditures and property acquisitions from
nonaffiliates 6,033 25,536 17,404
Transfer from banking segment -- -- 21,787
Sales to nonaffiliates (22) (7,678) (904)
Transferred from construction in progress, net 15,710 44,246 13,909
Other (587) (8,775) (1,676)
------------------- -------------------- -------------------
Balance at end of period $ 476,612 $ 455,478 $ 402,149
=================== ==================== ===================
Accumulated depreciation
- ---------------------------------------------------------------
Balance at beginning of period $ 131,659 $ 124,184 $ 104,774
Additions (reductions) during the period:
Depreciation expense 19,147 18,600 14,309
Transfer from banking segment -- -- 6,833
Sales to nonaffiliates -- (2,309) --
Other (825) (8,816) (1,732)
------------------- -------------------- -------------------
Balance at end of period $ 149,981 $ 131,659 $ 124,184
=================== ==================== ===================
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Trust has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
B.F. Saul Real Estate Investment Trust
December 10, 2002 B. Francis Saul II
---------------------------------------------
B. Francis Saul II
Chairman of the Board
Pursuant to the requirements of the Securities Exchanges Act of 1934. This
report had been signed below by the following persons on behalf of the
registrant and in the capacities indicated on the dates shown.
Signature Title Date
--------- ----- ----
B. Francis Saul II
- -------------------------- Trustee, Chairman of the Board
B. Francis Saul II (Principal Executive Officer) December 10, 2002
Stephen R. Halpin, Jr. December 10, 2002
- -------------------------- Vice President and Chief
Stephen R. Halpin, Jr. Financial Officer (Principal
Financial Officer)
Bill D. Tzamaras December 10, 2002
- -------------------------- Vice President and Treasurer
Bill D. Tzamaras (Principal Accounting Officer)
Garland J. Bloom, Jr. December 10, 2002
- -------------------------- Trustee
Garland J. Bloom, Jr.
Gilbert M. Grosvenor December 10, 2002
- -------------------------- Trustee
Gilbert M. Grosvenor
George M. Rogers, Jr. December 10, 2002
- -------------------------- Trustee
George M. Rogers, Jr.
B. Francis Saul III December 10, 2002
- -------------------------- Trustee
B. Francis Saul III
John R. Whitmore December 10, 2002
- -------------------------- Trustee
John R. Whitmore
CERTIFICATION
I, B. Francis Saul II, certify that:
1. I have reviewed this annual report on Form 10-K of B.F. Saul Real
Estate Investment Trust (the "registrant");
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly
present in all material respects the financial condition, results
of operations and cash flows of the registrant as of, and for, the
periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible
for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)
for the registrant and we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
annual report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent functions):
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in
this annual report whether there were significant changes in
internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: December 10, 2002
B. Francis Saul II
- ------------------------------
B. Francis Saul II
Trustee, Chairman of the Board
CERTIFICATION
I, Stephen R. Halpin, Jr., certify that:
1. I have reviewed this annual report on Form 10-K of B.F. Saul Real
Estate Investment Trust (the "registrant");
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly
present in all material respects the financial condition, results
of operations and cash flows of the registrant as of, and for, the
periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible
for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)
for the registrant and we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
annual report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent functions):
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in
this annual report whether there were significant changes in
internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: December 10, 2002
Stephen R. Halpin, Jr.
- -----------------------------------
Stephen R. Halpin, Jr.
Vice President and Chief Financial Officer
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
The undersigned, B. Francis Saul II, the Trustee, Chairman of the Board
of B.F. Saul Real Estate Investment Trust (the "Trust"), has executed this
certification in connection with the filing with the Securities and Exchange
Commission of the Trust's Annual Report on Form 10-K for the period ending
September 30, 2002 (the "Report"). The undersigned hereby certifies that:
(1) the Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) the information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Trust.
Date: December 10, 2002 B. Francis Saul II
----------------------------
B. Francis Saul II
Trustee, Chairman of the Board
CERTIFICATION OF CHIEF FINANCIAL OFFICER
PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
The undersigned, Stephen R. Halpin, Jr., the Vice President and Chief
Financial Officer of B.F. Saul Real Estate Investment Trust (the "Trust"), has
executed this certification in connection with the filing with the Securities
and Exchange Commission of the Trust's Annual Report on Form 10-K for the period
ending September 30, 2002 (the "Report"). The undersigned hereby certifies that:
(1) the Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) the information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Trust.
Date: December 10, 2002 Stephen R. Halpin, Jr.
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Stephen R. Halpin, Jr.
Vice President and
Chief Financial Officer
